oversight

Freddie Mac Could Further Reduce Reimbursement Errors by Reviewing More Servicer Claims

Published by the Federal Housing Finance Agency, Office of Inspector General on 2014-08-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

           Federal Housing Finance Agency
               Office of Inspector General




 Freddie Mac Could Further Reduce
 Reimbursement Errors by Reviewing
       More Servicer Claims




Evaluation Report  EVL-2014-011  August 27, 2014
                  Freddie Mac Could Further Reduce Reimbursement
                  Errors by Reviewing More Servicer Claims

                  Why OIG Did This Report
                  Freddie Mac (along with Fannie Mae) supports the secondary residential
                  mortgage market by purchasing mortgages originated by banks and other
                  financial institutions. When Freddie Mac purchases a mortgage loan, it
  At A            contracts with mortgage servicers, such as large banks or mortgage companies,
                  to handle routine loan activities, such as collecting and fowarding mortgage
 Glance           payments.
    ———
                  When borrowers become delinquent, a servicer may be required to maintain
August 27, 2014   the property, pay taxes and insurance, and liquidate the loan. After the loan is
                  liquidated, the servicer seeks reimbursement of its expenses from Freddie Mac.

                  Freddie Mac paid servicers $1.4 billion in 2013. In this report we discuss
                  the process by which Freddie Mac reimburses its servicers for delinquency
                  expenses, examine the controls it put in place to minimize erroneous payments,
                  and estimate the rate of improper payments made by Freddie Mac in 2013.

                  What OIG Found
                  Freddie Mac has a Multi-layered Process for Assessing the Validity of Servicer
                  Reimbursement Claims

                  Under its multi-layered review, Freddie Mac identified and denied
                  approximately $126 million in erroneous claims in 2013. The following
                  summarizes the process:

                        Freddie Mac’s reimbursement system automatically denies any servicer
                         claims for reimbursement that do not meet established cost ceilings;

                        Next, Freddie Mac personnel review certain higher-risk claims to
                         determine their reasonableness; and

                        Finally, before any reimbursements are made, Freddie Mac selects a
                         random, statistically significant sample of claims for a detailed “pre-
                         payment review.” Servicers are required to submit supporting
                         documentation for each expense set forth in the selected claims. If a
                         servicer does not submit documentation by the required date, then the
                         expense in question will be denied, and the servicer may not resubmit a
                         claim for reimbursement of it.
                  Freddie Mac May be Able to Further Reduce Erroneous Servicer
                  Reimbursement Expenses

                  Freddie Mac’s process appears to be generally effective in reducing erroneous
                  servicer reimbursement expenses. However, we estimate that in 2013 Freddie
                  Mac paid about $70 million to settle erroneous claims for reimbursement that
                  were not subjected to the pre-payment review. Accordingly, we believe that
                  Freddie Mac may achieve additional savings by enlarging the sample of claims
  At A            that is subjected to the prepayment review.
 Glance           We acknowledge that Freddie Mac would incur additional expenses, such
    ———           as personnel costs, if it expanded the size of the prepayment review sample
                  beyond the current percentage of claims reviewed. However, we estimate that
August 27, 2014   doubling the percentage of claims reviewed would result in additional savings
                  of nearly $7 million at a cost of only about $1 million in higher Enterprise
                  personnel expenses.

                  At some point, however, the costs associated with expanding the pre-payment
                  review sample would likely exceed the potential financial benefits.

                  What OIG Recommends
                  We recommend that FHFA require Freddie Mac to:

                     1. Determine, by means of a cost-benefit analysis, whether to increase the
                        size of the sample of reimbursement claims that it subjects to the pre-
                        payment review.

                     2. If warranted by the result of the cost-benefit analysis, increase the size
                        of the sample of reimbursement claims that it subjects to pre-payment
                        review.

                  FHFA agreed that by August 31, 2014, it would direct Freddie Mac to
                  complete a cost-benefit analysis and, if warranted, to increase the sample size
                  by October 31, 2014.
TABLE OF CONTENTS ................................................................

AT A GLANCE ...............................................................................................................................2

ABBREVIATIONS .........................................................................................................................6

PREFACE ........................................................................................................................................7

CONTEXT .......................................................................................................................................8
      The Servicers’ Role in Protecting Freddie Mac’s Financial Interests ......................................8
      Freddie Mac’s Servicer Reimbursement Operations ................................................................9
              Freddie Mac Employs a Three Tier Process to Determine Whether to Pay a
                  Claim .......................................................................................................................10
              Business Rules ................................................................................................................10
              Queues ............................................................................................................................11
              The Pre-Payment Review Process – an Additional Level of Scrutiny ...........................11
      Freddie Mac Enhanced its Reimbursement System in Response to Internal Audit
      Reports ....................................................................................................................................13
      FHFA’s Oversight of Freddie Mac’s Reimbursement System ...............................................14

FINDING .......................................................................................................................................15
      Freddie Mac May Be Able to Reduce Servicer Reimbursement Errors by Further
      Expanding its Prepayment Review Sample ............................................................................15
              Freddie Mac’s Estimated Net Overpayments Were Nearly $70 Million in 2013 ..........15
              Expanding the Prepayment Review Sample Could Increase Reimbursement
                  Savings ....................................................................................................................16

CONCLUSION ..............................................................................................................................18

RECOMMENDATIONS ...............................................................................................................19

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................20
      Objectives ...............................................................................................................................20
      Scope.......................................................................................................................................20
      Methodology ...........................................................................................................................20



                                            OIG  EVL-2014-011  August 27, 2014                                                                  4
             Methodology for Estimating Potential Overpayments in Population of Claims
                Not Reviewed by Freddie Mac ................................................................................21

APPENDIX A ................................................................................................................................23
      FHFA’s Comments on FHFA-OIG’s Findings and Recommendation ..................................23

APPENDIX B: ...............................................................................................................................25
      Summary of Questioned Costs ...............................................................................................25

ADDITIONAL INFORMATION AND COPIES .........................................................................26




                                           OIG  EVL-2014-011  August 27, 2014                                                             5
ABBREVIATIONS .......................................................................

Desk Reference        Freddie Mac Expense Reimbursement Desk Reference

Enterprises           Fannie Mae and Freddie Mac

Fannie Mae            Federal National Mortgage Association

FHFA or Agency        Federal Housing Finance Agency

Freddie Mac           Federal Home Loan Mortgage Corporation

HERA                  Housing and Economic Recovery Act of 2008

IPERA                 Improper Payments Elimination and Recovery Act of 2010

OIG                   Federal Housing Finance Agency Office of Inspector General

OMB                   Office of Management and Budget

REO                   Real Estate Owned

Guide                 Freddie Mac Single Family Seller/Servicer Guide




                          OIG  EVL-2014-011  August 27, 2014                      6
PREFACE ...................................................................................

Since the 2008 financial crisis, Fannie Mae and Freddie Mac (together, the Enterprises) have
paid their servicers billions of dollars to manage the properties that secure their mortgages.

The servicers carry out their management duties in accordance with the Enterprises’ servicer
guidelines and other applicable documents and agreements. From time to time servicers are
required to advance payments on behalf of borrowers who have become delinquent. For the
most part, such payments are made to cover property maintenance, insurance, taxes, and loan
liquidation costs. Thereafter, the Enterprises reimburse the servicers.

In September 2013, we issued a report on Fannie Mae’s servicer reimbursement operations.1
In it, we made three findings. First, errors made by the contractor that Fannie Mae hired to
process its servicers’ reimbursement claims caused Fannie Mae to overpay its servicers about
$89 million in 2012. Second, the method by which Fannie Mae oversaw its contractor was
not effective in minimizing such overpayments. And third, FHFA’s oversight of Fannie
Mae’s operations was minimal prior to 2013.

In this report we focus upon Freddie Mac’s reimbursement operations, i.e., how Freddie Mac
reimburses its servicers for delinquency expenses. We also estimate the rate of improper
payments made by Freddie Mac in 2013.2

This evaluation was led by Bruce G. McWilliams, Senior Investigative Evaluator, and
Omolola Anderson, Senior Statistician, with assistance from Desiree I-Ping Yang, Financial
Analyst, and overseen by Angela Choy, Director. We appreciate the cooperation of all those
who contributed to this effort, especially members of the Default Fees and Claims Department
at Freddie Mac.

The report has been distributed to Congress, the Office of Management and Budget, and
others, and will be posted on OIG’s website, www.fhfaoig.gov.




Richard Parker
Deputy Inspector General for Evaluations

1
 See Evaluation of Fannie Mae’s Servicer Reimbursement Operations for Delinquency Expenses (EVL-2013-
012) (September 18, 2013), http://www.fhfaoig.gov/Content/Files/EVL-2013-012.pdf.
2
  We define the term “improper payments” to refer to the combination of payments in excess of what is
required, i.e., an “overpayment,” and less than what is required, i.e., an “underpayment.”




                                  OIG  EVL-2014-011  August 27, 2014                                  7
CONTEXT ..................................................................................

The Servicers’ Role in Protecting Freddie Mac’s Financial Interests

Freddie Mac (along with Fannie Mae) supports the secondary residential mortgage market by
purchasing mortgages originated by banks and other financial institutions. The Enterprises
either hold the mortgages in their investment portfolios or pool them into mortgage-backed
securities (MBS), the performance of which the issuing Enterprise guarantees. In either case,
when Freddie Mac purchases a mortgage, it has a financial interest in maintaining the value of
the home that secures its mortgage.

Freddie Mac goes about maintaining the value of the mortgages that it owns or guarantees by
contracting with servicers to perform a variety of duties, including:

        Collecting mortgage payments and processing late payments;

        Forwarding payments from the homeowners to Freddie Mac;

        Maintaining escrow accounts to pay property taxes and insurance; and

        Handling default proceedings and foreclosures as necessary.

As long as a borrower is current on his or her loan, then the servicer merely collects mortgage
payments and forwards them to Freddie Mac.3 The servicer’s responsibility increases when
the borrower defaults on the loan. Then the servicer must assist the borrower in finding a
solution to the delinquency problem in a manner that protects Freddie Mac’s financial
interest. For example, the servicer may help the borrower obtain an appropriate foreclosure
alternative, such as a loan modification or a short sale.4

If, however, a borrower cannot repay the mortgage or obtain a foreclosure alternative, then the
servicer is required to liquidate the mortgage through foreclosure. After the loan is liquidated

3
 The servicer may also collect escrow funds for taxes, insurance, or homeowner association (HOA) dues and
make payments in furtherance of such expenses.
The servicer retains a small percentage of the payment as a servicing fee. See FHFA’s Supervision of Freddie
Mac’s Controls over Mortgage Servicing Contractors (AUD-2012-001) (March 07, 2012),
http://www.fhfaoig.gov/Content/Files/AUD%202012-001_0.pdf.
4
  Foreclosure alternatives include payment plans, forbearance agreements, loan modifications, short sales, or
deeds-in-lieu of foreclosure. When a mortgage loan is modified its terms are adjusted to create a more
affordable monthly payment for the borrower. Upon completion of the modification, the mortgage is brought
current. In a short sale the borrower is permitted to sell the property for an amount that is less than the balance
of the mortgage, and, thus, avoid foreclosure.




                                     OIG  EVL-2014-011  August 27, 2014                                             8
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                          FIGURE 1. ENTERPRISE MORTGAGE SERVICING PROCESS






Freddie Mac’s Servicer Reimbursement Operations

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                                   OIG x EVL2014011 x August 27, 2014                                      9
             FIGURE 2. SERVICER COMPOSITION OF FREDDIE MAC’S REIMBURSEMENTS IN 2013
                                                                              Percent of
                          Rank                   Servicer                       Total
                           1        JP Morgan Chase Bank                              21%
                           2        Wells Fargo Home Mortgage Inc                     21%
                           3        Bank of America                                   12%
                           4        Nationstar Mortgage, LLC                          11%
                           5        Citimortgage Inc                                   8%
                                    Top Five Servicers                                72%
                            6       Ocwen Loan Servicing, LLC                          6%
                            7       US Bank                                            3%
                            8       PNC BANK, NA                                       2%
                            9       Cenlar FSB                                         2%
                           10       Fifth Third Bank                                   2%
                                    Top Ten Servicers                                 87%
                                    Other 450 Servicers                               13%
                        Total                                                        100%
Source: Freddie Mac. Numbers may not add due to rounding.

      Freddie Mac Employs a Three Tier Process to Determine Whether to Pay a Claim

Freddie Mac’s Reimbursement System is comprised of three parts: business rules, queues, and
pre-payment review. These parts are defined and described below.

      Business Rules

Generally, Freddie Mac reimburses a servicer after ensuring that its claim falls within the
parameters specified in its Single Family Seller/Servicer Guide (Guide).7 These parameters,
known as business rules, set forth how much and how frequently Freddie Mac will pay for
certain items.8

Freddie Mac employs the business rules to approve, adjust, or deny claims based upon
established expense limits and the date upon which the expense was incurred. If a servicer
expects to incur an expense that will exceed the limits set by Freddie Mac, then it must submit
a request for pre-approval (RPA) prior to submitting the claim. If Freddie Mac approves the

7
  Freddie Mac does not require a servicer to submit supporting documentation at the time the servicer submits
its expense reimbursement claim. However, Freddie Mac may require a servicer to submit supporting
documents at another point in the reimbursement process. For example, documentation is required if a claim
is subjected to pre-payment review, which is discussed later in this report.
8
    The business rules are programmed into the reimbursement system’s software.




                                    OIG  EVL-2014-011  August 27, 2014                                        10
exception in the RPA, then it will be programmed into the reimbursement system as an
acceptable expense. Otherwise, the request for reimbursement will be automatically reduced
or denied if it exceeds the limits or is not reimbursable.

     Queues

The Reimbursement System targets higher risk claims for additional review by the Claims
Department. These claims are identified by the business rules and are routed to workflow
queues for further analysis. Although the claims are reviewed for reasonableness, the
claimants are generally not asked to provide documentary evidence of the expenses
underlying the claims.

     The Pre-Payment Review Process – an Additional Level of Scrutiny

After all adjustments from the business rules and queues have been applied, but before
reimbursement is paid, a random, statistically significant sample of the claims is selected for a
pre-payment review.9 The servicers that submitted the affected claims are required to submit
documentation supporting each line item within seven business days.10 If a servicer fails to
submit documentation by the required date, then the line item in question will be denied, and
the servicer may not resubmit a claim in connection with it.

According to Freddie Mac, supporting documentation includes, among other things, copies
of original bills or invoices for expenses such as legal fees and costs, property inspections,
property preservation costs, primary mortgage insurance premiums, and condominium/
HOA/Planned Unit Development.11

After receiving an automated confirmation that documentation has been received on a claim,
the pre-payment reviewer assigned to the claim must manually confirm that documentation
exists for each line item within the claim. After reviewing the documents, the reviewer
approves, denies, or adjusts the amount in each line item.

9
 The Claims Department refers to the review as a “pre-audit review.” Since this review occurs prior to
payment, for presentational purposes we refer to the process as the “pre-payment review.”
10
   A servicer that requests an extension may be provided with up to five additional business days to submit
required documentation.
11
  Less frequently submitted standard documentation includes: copies of loan histories for the twelve
months prior to the due date of the last paid installment up to the date upon which the history was requested,
and information concerning tax payments. In some cases in which taxes are paid as a lump sum, the claimant
must provide a breakdown from the taxing authority that specifies the tax amount, including late charges,
penalties, and interest paid, if any.
The Claims Department noted that some smaller servicers with lower claim volumes may not consistently
adhere to the documentation submission requirements and has proposed additional training as a remedy.




                                   OIG  EVL-2014-011  August 27, 2014                                          11
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      FIGURE 3. DISTRIBUTION OF CLAIM REIMBURSEMENT ADJUSTMENTS IN 2013 ($ MILLIONS)

                                             Pre-payment Review
                                                   ($6.9M)
                                                     5%

                                           Queues
                                           ($26M)
                                             21%
                                                                 Business
                                                                   Rules
                                                                  ($93M)
                                                                    74%




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                                    OIG x EVL2014011 x August 27, 2014                                         12
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     FIGURE 4. DISTRIBUTION OF SERVICER EXPENSE REIMBURSEMENT CLAIMS IN 2013 PRE-PAYMENT
                                             REVIEW 


                                                           Attorney
                                                         Fees & Legal
                                 Taxes                                               HAMP
                                                            Costs
                                  43%                                                < 0.5%
                                                             24%




                                                                              Lender-Placed &
                              Other                                          Property Insurance
                               1% Mortgage          Maintenance                     21%
                                    Insurance           7%
                                       4%


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Freddie Mac Enhanced its Reimbursement System in Response to Internal Audit
Reports

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                                    OIG x EVL2014011 x August 27, 2014                                         13
In 2012, Internal Audit observed similar flaws and noted weaknesses in both the system’s
design as well as the sampling methodology employed by Freddie Mac’s Claims Department.
Specifically, Internal Audit identified the risk of duplicate payments to servicers and
inadequate targeting of the sample for expenses known to present higher risks.

After the audits, the Claims Department made several adjustments to the pre-payment portion
of the Reimbursement System. Specifically it:

      No longer permits servicers to resubmit claims for line items that have once been
       denied.

      Twice increased the sample rate it employs in its pre-payment review. These
       increases were intended to mitigate the risk occasioned by Freddie Mac’s decision not
       to require its servicers to document all of the expenses underlying their claims for
       reimbursement.

      Doubled the sample size for two servicers that consistently used incorrect codes when
       seeking reimbursement for default-related legal services. The errors would have
       resulted in reimbursements in excess of Freddie Mac’s limits.

Freddie Mac officials told us that during the third quarter of 2014 the Claims Department will
begin targeting specific expense codes that are subject to greater risk.

FHFA’s Oversight of Freddie Mac’s Reimbursement System

On January 8, 2014, DER issued a report on Freddie Mac’s expense reimbursement process.
In it, DER found that the Enterprise’s procedures for processing expense claims were
adequate and that management was taking appropriate steps to address concerns regarding
duplicate claims. However, DER did not specifically address the adequacy of Freddie Mac’s
sampling rate, nor did it offer any standards by which an appropriate rate might be
established.




                             OIG  EVL-2014-011  August 27, 2014                                14
FINDING ...................................................................................

Freddie Mac May Be Able to Reduce Servicer Reimbursement Errors by Further
Expanding its Prepayment Review Sample

Freddie Mac’s Reimbursement System is multi-layered and designed to mitigate the risks
inherent in paying its servicers’ claims for reimbursement. Although Freddie Mac’s system
is generally effective in reducing erroneous reimbursements, we estimate that in 2013 Freddie
Mac made about $70 million in net overpayments to its servicers.17 Accordingly, we
conclude that Freddie Mac’s Reimbursement System could be strengthened. Specifically, we
believe that Freddie Mac may be able to achieve additional cost savings by further expanding
the sample that it employs in its pre-payment reviews.

     Freddie Mac’s Estimated Net Overpayments Were Nearly $70 Million in 2013

In 2013, the three layers of Freddie Mac’s Reimbursement System – business rules, queues,
and pre-payment reviews – reduced servicer reimbursement payments by $126 million. The
pre-payment reviews accounted for $6.9 million of these reductions. Figure 5, below, shows
how pre-payment review reductions were distributed among the eight expense categories we
identified.18




17
   This is the net overpayment as it was calculated, i.e., overpayments less underpayments. For a full
discussion of methodology we employed, see the Objective, Scope, and Methodology section at the end of this
report.
18
   The Claims Department tracks reimbursements using over 200 line item codes; OIG collapsed these codes
into seven categories that reflect the maintenance and management of the properties that secure Freddie Mac’s
mortgages during their default and the eventual liquidation. We added an eighth category to capture escrow
amounts still held by the servicer. These escrow amounts typically offset – and thus reduce – the total expense
claim made by the servicer.




                                   OIG  EVL-2014-011  August 27, 2014                                           15
       FIGURE 5. ADJUSTMENT RATES IN THE 2013 PRE-PAYMENT REVIEW BY EXPENSE CATEGORY
                                         ($ MILLIONS)

                                                                                                Net
                                                        Net Amount        Net Amount        Adjustment
                Reimbursement Category                  Requested†         Adjusted           Rate19
          Taxes                                               $60.45             –$2.56           –4.24%
          Attorney Fees & Legal Costs                         $34.51             –$1.71           –4.95%
          Lender-Placed & Property Insurance                  $29.73             –$2.18           –7.32%
          Maintenance                                         $10.05             –$0.53           –5.31%
          Mortgage Insurance                                   $5.75             –$0.20           –3.45%
          Other Expenses                                       $0.82              $0.04            5.21%
          HAMP                                                 $0.06             –$0.02          –42.15%
          Escrow & Other Income20                            –$14.07              $0.26           –1.84%
          Total                                              $127.31             –$6.90           –5.42%
           †
            This is the outstanding requested amount after business rules are automatically applied and
           the “queues” check is completed.

Source: OIG categorization and analysis of Freddie Mac data. Numbers may not add due to rounding.

We can extrapolate these pre-payment review results to the approximately $1.3 billion of
expense items that were not subjected to the prepayment review. Thus, we estimate that on a
net basis, Freddie Mac overpaid about $70 million (a 5.4% error rate) of the $1.3 billion in
claims for reimbursement that were not subjected to a pre-payment review.21

     Expanding the Prepayment Review Sample Could Increase Reimbursement Savings

As previously noted, two Freddie Mac internal audit reports – one issued in 2010 and another
in 2012 – identified weaknesses in the sampling methodology employed in the pre-payment
review process. Thereafter, Freddie Mac increased the size of its sample and targeted certain
servicers for heightened scrutiny. According to Freddie Mac officials, both the expanded



19
   A negative adjustment rate indicates that payments for the respective category were a reduction of the
amount requested; a positive rate indicates that the payment was an increase in the amount requested. Net
Adjustment Rate equals Net Amount Adjusted divided by Net Amount Requested. The rates were calculated
using actual figures. The figures presented in the table are rounded.
20
   The amount requested for Escrow & Other Income is a negative value because the category includes items
for which the servicer files a claim for money owed to Freddie Mac. Consequently, the amount claimed offsets
the expenses incurred by the servicer.
21
   Details are provided in Figure 6, which is located in the Objective, Scope, and Methodology section of this
report.




                                   OIG  EVL-2014-011  August 27, 2014                                          16
samples and adverse sampling strategy have served to strengthen the Enterprise’s capacity to
manage the risks associated with its reimbursement of its servicers.

It is clear, however, that these two changes will not serve to identify all of the errors in the
$1.3 billion of servicer claims for reimbursement that were not subjected to the pre-payment
review process. Further, given our estimate of net overpayments of $70 million in 2013, we
can reasonably presume that expanding the sample beyond the current rate would result in
further savings.22

We acknowledge that expanding the size of the pre-payment review sample would increase
Freddie Mac’s operational costs. For example, we estimate that by doubling the amount of
reimbursement claims Freddie Mac reviews could require it to double the size of its pre-
payment review staff at a cost of about $1 million.23 However, we estimate that this
increase in the sample size would likely reduce erroneous payments by somewhere between
$6.80 million and $7.01 million.24




22
  The existing sample size is large enough to produce results that may be extrapolated with an acceptable
degree of confidence and precision to the balance of the claims for reimbursement, i.e., those that were not
subjected to Pre-Payment Review.
23
   We obtained staffing, salary, and overhead figures for the Claims Department. However, we recommend
that Freddie Mac complete a cost/benefit analysis to determine financial benefits that may be achieved by
increasing the size of this staff. See “Recommendations” below.
24
   This is a statistical 95% confidence interval for an overpayment rate interval of 5.34% and 5.50%. This
estimate assumes that the additional sample, of the same proportion, will follow the same distribution as the
initial sample in the prepayment review. We recognize, however, that, at some point, increasing the sample
size further would produce fewer benefits, until the costs overcame them.




                                    OIG  EVL-2014-011  August 27, 2014                                        17
CONCLUSION ............................................................................

Freddie Mac’s Reimbursement System contains controls designed to mitigate the risks
inherent in reimbursing its servicers for managing defaulted loans. Although the system
results in significant cost savings due to the identification of erroneous claims, we estimate
that Freddie Mac overpaid servicers approximately $70 million in 2013. We believe that
Freddie Mac and its conservator, FHFA, are responsible for assessing potential opportunities
to reduce such erroneous reimbursements and thereby mitigate the Enterprise’s financial
losses.




                              OIG  EVL-2014-011  August 27, 2014                               18
RECOMMENDATIONS ...............................................................

Based upon our findings, we recommend that FHFA require Freddie Mac to:

   1. Determine, by means of a cost-benefit analysis, whether to increase the size of the
      sample of reimbursement claims that it subjects to the pre-payment review.

   2. If warranted by the result of the cost-benefit analysis, increase the size of the sample
      of reimbursement claims that it subjects to pre-payment review.




                             OIG  EVL-2014-011  August 27, 2014                                19
OBJECTIVE, SCOPE, AND METHODOLOGY .................................

Objectives

The objective of this report was to evaluate Freddie Mac’s servicer reimbursement operations
for delinquency expenses and FHFA’s oversight of those operations.

When possible, OIG attempts to identify questioned and unsupported costs as well as to
estimate any funds that can be put to better use.25 This includes any reduction in outlays that
results from our recommendations. The recommendations outlined above would help Freddie
Mac reduce overpayments to servicers.

Scope

Our study was based on Freddie Mac’s expense reimbursements to servicers in 2013 for loans
in default; we did not review reimbursements made to REO contractors for already-foreclosed
loans.

Methodology

To achieve our objectives, we interviewed various Freddie Mac personnel to gather
information about the servicer reimbursement operations. We also interviewed FHFA
personnel to assess the extent of its oversight. Additionally, we requested, received, and
reviewed numerous internal documents from Freddie Mac and FHFA.

This evaluation was conducted under the authority of the Inspector General Act in accordance
with the Quality Standards for Inspection and Evaluation (January 2012), which were
promulgated by the Council of the Inspectors General on Integrity and Efficiency. These
standards require OIG to plan and perform an evaluation that obtains sufficient evidence to
provide a reasonable basis to support the findings and recommendations made herein. We
believe that the findings and recommendation discussed in this report meet these standards.

FHFA and the Enterprises provided technical comments on a draft of this report, which were
incorporated as appropriate. In response to our recommendations, FHFA agreed that by
August 31, 2014, it would direct Freddie Mac to complete a cost-benefit analysis, and, if
warranted, to increase the sample size of claims subject to Freddie Mac’s pre-payment review
by October 31, 2014.


25
     Inspector General Act of 1978, 5 U.S.C. App. 3 § 5(a)(6).




                                     OIG  EVL-2014-011  August 27, 2014                         20
The performance period for this evaluation was August 2013 and June 2014.

     Methodology for Estimating Potential Overpayments in Population of Claims Not
     Reviewed by Freddie Mac

To estimate potential overpayments in the population of claims not reviewed by Freddie Mac,
we extrapolated the results of the 308,067 expense items ($127.3 million in reimbursements)
that underwent Freddie Mac’s pre-payment review in 2013. Specifically, we performed the
following three steps:

     1. Separate negative adjustments (reductions) from positive adjustments
        (increases): We received a list of Freddie Mac’s expense items that were adjusted
        through the pre-payment review process. We classified negative value adjustments as
        reductions and positive value adjustments as increases.

     2. Calculate the rates of reduction, increase, and overall adjustments: The rates for
        all adjustment types were calculated as a ratio of the sum of the adjustments relative to
        the total dollars in the pre-payment review. Figure 8 illustrates the details of these
        calculations.

       FIGURE 8. CALCULATING THE ADJUSTMENT RATES IN THE PRE-PAYMENT REVIEW SAMPLE26

                                     Sum of all reduction
                                                                             –$8.5 mil
                                       adjustments ($)
     Reduction Rate (%)      =                                    =                                         –6.7%
                                   Total expense dollars in
                                                                             $127.3mil
                                   pre-payment review ($)



                                       Sum of all increase
                                                                               $1.6 mil
                                        adjustments ($)
      Increase Rate (%)       =                                    =                                         1.3%
                                    Total expense dollars in
                                                                              $127.3 mil
                                    pre-payment review ($)




26
   In the report we also present adjustment rates at the expense category level. In those instances, adjustment
rates were calculated in the same manner within the respective expense category.




                                    OIG  EVL-2014-011  August 27, 2014                                            21
                                  Sum of all adjustments
                                                                               –$6.9 mil
                                            ($)
      Overall (Net)                                               =
                            =                                                                            –5.4%
   Adjustment Rate (%)            Total expense dollars in        -
                                                                             $127.3 mil
                                  pre-payment review ($)
Source: OIG analysis.

    3. Apply the adjustment rates to the population of claim items excluded from pre-
       payment review: To calculate the value of claims not reviewed, we subtracted the
       expenses reviewed in the pre-payment process from the total 2013 expense population,
       $1.4 billion. To this result, we multiplied the net adjustment rate (5.4%). The
       resulting amount is the projected net overpayments in the population of claim items
       for which Freddie Mac does not review documentation. Specifically, we estimated
       that $69.5 million of the $1.3 billion in expense claims not selected for pre-payment
       review were overpayments. See Figure 10.

 FIGURE 9. CALCULATING POTENTIAL OVERPAYMENTS IN REIMBURSEMENT CLAIMS THAT WERE NOT
                                  REVIEWED ($MILLIONS)

   Claim items not                               Claim items in
                            Total claim
   in Pre-Payment       =                   -    Pre-Payment      =   $1,414         -   $127.3         $1,287
                            population
      Review ($)                                     Review



                                                      Net
                            Claim items            Reduction
    Estimated Net
                            not in Pre-         X     Rate
    Overpayments        =                                         = $1,287       X       5.4%           $69.5
                             Payment              Observed in
         ($)                  Review              Pre-Payment
                                                     Review
Source: OIG analysis of Freddie Mac data.

Finally, based on the above analysis, we detail overpayments, underpayments, and net
underpayments and relative error rates in Figure 10, below.

        FIGURE 10. PROJECTED OVERPAYMENTS AND UNDERPAYMENTS FROM FREDDIE MAC’S
                             REIMBURSEMENTS, 2013 ($ MILLIONS)

                                                                                      Net Financial
                                                                                     Loss to Freddie
                                     Overpayments            Underpayments                 Mac
               Projection                    $86.2                   $16.7                      $69.5
               Error Rate                     6.7%                    1.3%                       5.4%
Source: OIG extrapolation of Freddie Mac data.



                                  OIG  EVL-2014-011  August 27, 2014                                           22
APPENDIX A .............................................................................

FHFA’s Comments on FHFA-OIG’s Findings and Recommendation




                           OIG x EVL2014011
                           OI
                           OIG   EVL2
                                 EV
                                 EVL 20014 011 x August
                                        1 01    Augu
                                                 August
                                                   gu
                                                    ust
                                                     s 2 7, 2
                                                         7,
                                                        27,  014
                                                             01
                                                            2014                       23
OIG x EVL2014011
OIG   EVLL20
      EV   2014
            01401
                0111 x August
                       Augu
                       Aug st 2
                         gu     7, 2
                              27,   014
                                    014
                                   2014   24
APPENDIX B..............................................................................

Summary of Questioned Costs

 Rec                  Description                    Amount27*                     Category
                                                                     Funds Put to Better Use because of
     1   Improve reimbursement operations                TBD
                                                                     reduction in outlays
The table above summarizes monetary results by recommendations. The table illustrates the anticipated
monetary results based on statistical projections of overpayments.




27
  This amount will be determined by results from FHFA cost-benefit analysis and subsequent increase, if
warranted, in pre-payment sample rate.




                                  OIG  EVL-2014-011  August 27, 2014                                    25
ADDITIONAL INFORMATION AND COPIES .................................


For additional copies of this report:

      Call: 202–730–0880

      Fax: 202–318–0239

      Visit: www.fhfaoig.gov



To report potential fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

      Call: 1–800–793–7724

      Fax: 202–318–0358

      Visit: www.fhfaoig.gov/ReportFraud

      Write:

                FHFA Office of Inspector General
                Attn: Office of Investigation – Hotline
                400 Seventh Street, S.W.
                Washington, DC 20024




                               OIG  EVL-2014-011  August 27, 2014                        26