Joint Report on Federally Owned or Overseen Real Estate Owned Properties

Published by the Federal Housing Finance Agency, Office of Inspector General on 2013-06-03.

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

This report was initially published on May 30, 2013, and contained a
mathematical error in adding the GSE and HUD inventories; the correct
total is 1,708,033. The underlying data are accurate and have not changed;
the error was an adding mistake only. The total inventory number was
corrected on pages 3 and 11.

In addition, a discrepancy with how “shadow inventory” is indicated
was adjusted on page 10. And, an example used to demonstrate a trend
between seriously delinquent mortgages and REO inventories was
removed from page 12 after it was brought to our attention that the
example was incorrect. The adjusted report was reposted on June 3, 2013.
 Joint Report on Federally Owned or Overseen
         Real Estate Owned Properties
                               May 2013
U.S. Department of Housing and Urban Development Office of Inspector General
         Federal Housing Finance Agency Office of Inspector General
                                                   Table of Contents

Executive Summary................................................................................................................... 3

Background on REO................................................................................................................... 4
           Default and Foreclosure................................................................................................ 4
           Managing REO Inventory............................................................................................... 4
           HUD’s REO Contractor Structure................................................................................... 7
           The GSEs’ REO Contractor Structure............................................................................ 9
           The “Shadow Inventory”.............................................................................................. 10

HUD & GSE Actions and Initiatives.........................................................................................12
           FHA Note Sales Program and Distressed Asset Stabilization Program....................12
           FHFA and Fannie Mae REO Pilot Program..................................................................13

OIG Efforts on REO................................................................................................................... 14
           HUD-OIG........................................................................................................................ 14
           FHFA-OIG....................................................................................................................... 17

Conclusion................................................................................................................................ 21

Appendix A—Participating Offices of Inspectors General......................................................22
           U.S. Department of Housing and Urban Development..............................................22
           Federal Housing Finance Agency................................................................................23

Appendix B—Acronyms and Abbreviations..............................................................................25

Appendix C—Glossary...............................................................................................................26

Appendix D—Contact Information...........................................................................................29

                                    Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
                         Executive Summary
The Offices of Inspector General for the U.S. Department of Housing and
Urban Development and the Federal Housing Finance Agency (HUD-OIG
and FHFA-OIG) have produced this report on “real estate owned” (REO)
properties. REO are residential properties that have been foreclosed upon and
transferred into an REO inventory for management and ultimately disposition.
This report addresses REO properties held by or on behalf of either HUD or
the Government-Sponsored Enterprises (GSEs or enterprises) for which FHFA
serves as conservator—the Federal National Mortgage Association (Fannie
Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

HUD and the GSEs have created infrastructures to manage and sell REO
properties. Though those infrastructures differ somewhat from one another,
they all rely heavily on contractors to perform tasks central to effective
REO management: (1) securing properties to avoid theft, vandalism, and
unauthorized use; (2) maintaining and repairing properties as needed;
(3) pricing properties appropriately through broker price opinions or
appraisals and satisfactory promotional efforts; and (4) selling properties
to homeowners or investors within a reasonable period.

As of September 30, 2012, HUD held 37,445 REO properties while the GSEs
held 158,138. In addition, the “shadow inventory”—residential loans at least
90 days delinquent—totaled 1,708,033 properties, roughly 8.7 times the size of
the HUD and GSE REO inventories combined. Even a fraction of the shadow
inventory falling into foreclosure could considerably swell HUD and GSE
inventories of REO properties.

This report reviews recent initiatives by HUD and the GSEs to shrink their
respective REO inventories, as well as steps taken by HUD-OIG and FHFA-
OIG to assess and address their respective agencies’ REO activities.

               Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
                                  Background on REO

Default and Foreclosure
     Most residential real estate purchases in the United States are financed through
     loans provided by banks or other lenders, which typically require a secured
     interest or mortgage on the property in exchange for financing the purchase.
     Among other promises, a borrower agrees to repay the mortgage over time in
     accordance with its terms. A borrower’s failure to do so is called default.

     Once a borrower defaults, the creditor holding the mortgage—the originating
     lender, a subsequent institution that purchased the mortgage, or some other
     entity such as a mortgage insurer—may foreclose on the property in an effort
     to recoup the amount due under the mortgage. Foreclosure is a legal process
     by which the creditor might mitigate its losses by acquiring and selling the
     property. Once foreclosure is completed, the property enters into the creditor’s
     REO inventory until it can be sold.

     The current housing crisis has seen a significant increase in the incidence of
     mortgage defaults and foreclosures. Foreclosed and vacant properties can have
     profoundly negative consequences in the neighborhoods and communities
     in which they are located, including but not limited to reduced property
     values. According to the U.S. Government Accountability Office, vacant,
     foreclosed properties can reduce prices of nearby homes by $8,600 to $17,000
     per property.1 In addition, vacant residential properties may attract crime,
     cause blight, and threaten public safety. Public policy and financial market
     observers have attributed delinquency and foreclosure increases to a wide
     range of causes and have offered varying policy prescriptions for what remains
     a continuing problem.

Managing REO Inventory
     A creditor typically takes possession of a foreclosed property to preserve its
     value until it can be sold. Such efforts are referred to as “REO management.”
     Creditors may take the following steps to manage REO inventories

          1.	 Hire qualified REO contractors—law firms, property
              maintenance companies, real estate brokers, and others—to
              secure, maintain, market, and sell REO properties.

     1	 Government Accountability Office, Vacant Properties: Growing Number Increases Communities Costs and
     Challenges, GAO-12-34 (November 4, 2011).

                        Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
    2.	 Provide contractor training.

    3.	 Establish standard policies and procedures for key REO
        maintenance activities, such as the number of times per month
        lawns must be cut.

    4.	 Establish budgets and reimbursement schedules for routine
        property maintenance activities. In some cases, repairs may
        enhance a property’s value and thereby maximize returns.
        Without an effective way of making such determinations,
        a creditor could reimburse contractors for repairs that are
        unnecessary and increase property management costs.
        However, a creditor must also be mindful that foreclosed
        properties located in economically distressed areas may be
        particularly difficult to sell. In some cases, demolishing rather
        than rehabbing the property may be more cost effective.

    5.	 Require multiple bids or reviews for proposed repairs that
        exceed pre-established dollar thresholds.

    6.	 Conduct onsite inspections of selected properties to ensure
        that they are secured, maintained, and repaired according to
        established standards.

    7.	 Require multiple broker price opinions or appraisals to
        establish each foreclosed property’s fair market value.

    8.	 Audit bills submitted by contractors to ensure their
        appropriateness and screen for potential fraud.

    9.	 Conduct account reviews and performance management audits
        and monitor contractors using established metrics, including
        contractual obligations.

    10.	 Withhold payments to contractors for services rendered until
         such services have been completed satisfactorily and suspend
         or terminate unsatisfactory contractors.

Large national REO inventories present significant challenges to
accomplishing these tasks. HUD, FHFA, and the GSEs are particularly
sensitive to such risks, given the size of their respective REO inventories.

               Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
As of September 30, 2012, HUD’s nationwide REO inventory totaled 37,445
properties, while the GSEs’ totaled 158,138 (Figures 1 and 2).2

     Figure 1: HUD REO Properties by State, as of September 30, 2012

2	 HUD, Month End Acquisition Property Report (September 30, 2012); FHFA, Foreclosure Prevention Report
for Third Quarter 2012. Accessed April 10, 2013, at http://www.fhfa.gov/webfiles/24858/3q12FPR_final.pdf.

                   Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
         Figure 2: GSE REO Properties by State, as of September 30, 2012

     HUD and the GSEs generally rely on extensive networks of contractors and
     subcontractors to maintain and sell their properties. These networks require
     significant oversight to ensure that they perform effectively and that they
     mitigate both REO-related expenses and foreclosure’s negative effects.

HUD’s REO Contractor Structure
     The Federal Housing Administration (FHA), which is part of HUD, insures
     both single-family and multifamily mortgage loans made by approved lenders.
     If a buyer defaults on an FHA-insured loan, the lender acquires the title to
     the property by foreclosure, a deed in lieu of foreclosure, or other acquisition
     method. The lender then files a claim for insurance benefits and conveys the
     property to the Secretary of HUD.

     Since 1999, HUD has outsourced the disposition of its REO inventory to
     private contractors under its Management and Marketing (M&M) program.
     In June 2010, HUD awarded contracts under the third generation of M&M.
     M&M III consists of the following major processes: (1) preconveyance
     activity, (2) conveyance activity, (3) postconveyance activity, (4) property
     management activity, (5) marketing activity, (6) accounting and reconciliation,
     and (7) oversight monitoring. REO disposition efforts are administered

                    Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
through HUD Homeownership Centers located in Atlanta, Georgia; Denver,
Colorado; Philadelphia, Pennsylvania; and Santa Ana, California. Each center
is responsible for a designated geographic area. The disposition structure’s key
elements include:

    •	 Mortgage compliance manager (MCM): MCMs perform a variety
       of pre- and postconveyance services to ensure that HUD’s interests
       are protected. These services include reviewing property inspections
       to ensure that the property is in conveyance condition, resolving
       conveyance exceptions, providing guidance to lenders related to pre-
       and postconveyance responsibilities, and leveraging HUD’s software
       and information systems to execute and complete the tasks within this

    •	 Field service manager (FSM): FSM companies provide property
       maintenance and preservation services such as inspecting, securing,
       maintaining, and repairing the property.

    •	 Asset manager (AM): AMs handle REO property marketing and sales.

    •	 Oversight monitor: Oversight monitors focus on overall portfolio
       analysis and oversight of the disposition process.

The Single Family Insurance System (SFIS) is HUD’s primary system for
recording insurance and claim payments for all FHA-insured single-family
loans. SFIS utilizes P260, a web-based system of record for all REO case
management transactions. P260 assigns each HUD-owned property to FSMs
and AMs and tracks the disposition activity from conveyance to sale. AMs and
FSMs are required to scan and upload documents relating to properties, such
as inspection reports and photographs. The system also tracks preconveyance
activities. It integrates data from SFIS, FHA Connection, and the Single
Family Accounting Monitoring System (SAMS). FHA Connection is a web-
based system by which lenders report the status of insured loans. Also, FHA
Connection allows HUD to post information of interest to lenders. SAMS is
HUD’s automated system for managing, processing, and monitoring acquired
and custodial single-family properties. It is HUD’s primary system of record
for tracking financial information and accounting data for properties acquired
by HUD.

P260 automatically assigns an FSM to the property. The assigned FSM
completes required inspections and cleanout services. An AM, also assigned
automatically, completes the required inspection and orders an appraisal.

               Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
     The AM receives the appraisal and conducts an inspection before listing. If
     the property needs to be reconveyed to the lender for whatever reason, the
     property may be held off the market. The AM conducts a direct sale if the
     property is eligible for special programs. If it is not, the AM establishes the
     property’s value and validates that the property is ready to list. The general list
     period is 180 days. If the property is not sold within this timeframe, the AM
     offers the property to local governments. If there is an acceptable offer, the AM
     accepts it and ratifies the contract. The closing agent orders a title search. If the
     property is sold with FHA insurance and meets certain requirements, testing
     of lead-based paint or wood-destroying organisms may be ordered. Finally,
     the AM closes the property through a closing agent and reconciles the sales

The GSEs’ REO Contractor Structure
     The GSEs also manage their REO inventories using a series of contractors
     (Figure 3).

                           Figure 3: GSEs’ REO Oversight Structure


                                        Asset Management Firm

     Secure                    Maintenance                   Valuation
     Property                   & Repair                    & Marketing

    Real estate                  Property                     Appraisers                   Real estate
    brokers                      maintenance                                               brokers
                                                              Broker price
    Eviction                                                  opinion firms                Closing/title
    attorneys                    Repair                                                    companies
                                                              Real estate
                                 contractors                                               and attorneys
    Property                                                  brokers
    maintenance                  Real estate
    companies                    brokers

     3	 HUD, Management & Marketing III Overview: Video Participant Guide (2010). Accessed April 5, 2013, at

                        Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
         •	 Asset management firms: These firms direct certain REO
            contractors in the performance of day-to-day property management

         •	 Real estate brokers: Instead of or in addition to hiring asset
            management firms, the GSEs may contract brokers to manage portions
            of their REO inventory. Their contractual duties could include
            identifying and mitigating hazardous conditions at the properties,
            developing and implementing marketing plans, listing properties, and
            evaluating offers.

         •	 Attorneys: The GSEs contract attorneys in the states in which their
            properties are located to accomplish a variety of legal tasks, such
            as managing evictions. Designated attorneys and national title
            companies are employed to ensure that the GSEs obtain title to
            foreclosed properties and manage the closing process upon resale.

         •	 Property maintenance companies and repair contractors: These
            contractors secure and maintain properties by removing interior
            and exterior debris, cleaning houses, cutting lawns, inspecting and
            repairing plumbing, and winterizing structures, among other things.
            They also make repairs, such as fixing leaking roofs, repairing or
            replacing appliances, and installing major systems, such as heating
            and air conditioning units.

         •	 Appraisers and broker price opinion firms: These contractors
            help the GSEs determine the value and listing prices of foreclosed
            properties by reviewing comparable sales and conducting appraisal

The “Shadow Inventory”
     While the burden of managing their respective REO inventories successfully
     is significant enough, Fannie Mae, Freddie Mac, and HUD must also pay
     close attention to “shadow inventory.” This inventory consists of properties
     with mortgages that are over 90-days delinquent, but which have not yet
     completed the foreclosure process and therefore have not yet hit the active real
     estate market. As of September 30, 2012, shadow inventory properties vastly
     outnumbered properties already in the REO inventories (Figure 4).

                    Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
                   Figure 4: Single-Family REO Inventories and Mortgages over
                         90 Days Delinquent, as of September 30, 2012

                                                                                        Ratio of Shadow to
       Creditor                 Shadow Inventory               REO Inventory              REO Inventory
 Fannie Mae                          598,490                     107,225                      5.6 to 1
 Freddie Mac                         368,159                      50,913                      7.2 to 1
 Enterprises Total*                  966,649                     158,138                      6.1 to 1
 HUD                                 741,384**                    37,445***                 19.8 to 1
 Overall Total                     1,708,033                     195,583                      8.7 to 1

*	   GSE figures are derived from FHFA’s Foreclosure Prevention Report for Third Quarter 2012. Accessed
     February 27, 2013, at http://www.fhfa.gov/webfiles/24858/3q12FPR_final.pdf.
**	 HUD’s Single Family Data Warehouse as of September 30, 2012. This is a collection of database tables
    structured to provide HUD users easy and efficient access to single-family housing case-level data on
    properties and associated loans, insurance, claims, defaults and demographics.
***	 HUD’s Month End Acquisition Property Report from Single Family Asset Management System as of
     September 30, 2012.

         FHA-approved lenders must report the status of all delinquent loans to HUD
         each month until final resolution. In the event of foreclosure, which results in
         FHA-insured properties entering HUD’s REO inventory, the final resolution
         is the insurance claim paid after the foreclosure auction is completed and the
         marketable title is transferred to HUD. FHA’s Quarterly Report to Congress
         on the Financial Status of the Mutual Mortgage Insurance Fund provides
         information on serious delinquency trends and numbers of REO dispositions
         and associated loss rates.4 The average loss rate on REO properties for the
         quarter ending September 30, 2012, was 62.1 percent.5 Of the 741,384 active 90-
         day delinquent loans as of September 30, 2012, 219,699 were in foreclosure.6

         The serious delinquency rate (more than 90 days delinquent) held steady at
         9.4 percent in the third quarter. This level is about 1.4 percent higher than this
         time a year ago. Three factors appear to be driving this result. The first is the
         persistence of loans in serious delinquency as lenders attempt to craft workout

         4	 HUD, Quarterly Report to Congress: FHA Single-Family Mutual Mortgage Insurance Fund Programs,
         FY 2012 Q3. Accessed April 10, 2013, at http://portal.hud.gov/hudportal/documents/huddoc?id=fhartc_

         5	 The loss rate was used in a HUD-OIG report published on February 5, 2013, and can be accessed
         at http://www.hudoig.gov/Audit_Reports/Final%20Audit%20Memorandum_Standard%20Pacific%20

         6	   Calculation by HUD-OIG from data in HUD’s Single Family Data Warehouse.

                             Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
     plans. The second is the duration of loans in foreclosure processing.7 The third
     is that the historically large books of business for fiscal years 2009 and 2010 are
     at the age at which their serious delinquency rates are increasing toward their
     lifecycle peaks.

     FHFA-OIG has not independently estimated the extent to which the level of
     seriously delinquent mortgages could increase the GSEs’ REO inventories over
     time. However, the GSEs’ data suggest that the numbers could be significant
     given the extent to which many borrowers are behind on their mortgage
     payments. Fannie Mae has stated that due to elevated numbers of delinquent
     borrowers, among other challenges in the housing sector, it does not expect its
     REO inventory to return to pre-financial crisis levels for years.8

                       HUD & GSE Actions and Initiatives
     HUD and the GSEs have taken steps to shrink their REO inventories.

FHA Note Sales Program and Distressed Asset Stabilization Program
     The FHA Office of Asset Sales was established December 1, 2001, by the
     HUD Deputy Assistant Secretary for Finance and Budget to coordinate the
     disposition of FHA-held single-family and multifamily mortgage notes. The
     FHA note sales program began as a pilot in 2010 and has resulted in the
     sale of nearly 2,400 single-family loans as of April 2013. Under the program,
     FHA-insured notes are sold competitively at a market-determined price
     generally below the outstanding principal balance. Once the note is purchased,
     foreclosure is delayed for at least 6 months as the borrower gets direct help
     from his or her servicer to find an affordable foreclosure alternative. The
     investor purchases the loan at a discount and then takes additional steps to

     7	 Such duration can be affected by multiple factors, including state laws governing homebuyers’ rights
     of redemption. In general, redemption laws permit homeowners to “redeem” foreclosed properties by
     paying off the outstanding debt within a specified time after foreclosure. These laws may have the effect
     of tying up the property after foreclosure and rendering it more difficult to sell. This, in turn, results in
     additional carrying costs for the GSEs as well as lost income on the mortgage.

     8	 Fannie Mae, 2011 10-K Report, at 16. Accessed February 27, 2013, at http://phx.corporate-ir.net/

                         Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
     help the borrower avoid default, whether by modifying the loan terms or
     helping the borrower through a short sale, to maximize the return on the sale.9

     A servicer can place a loan into the loan pool if the following criteria are met:

           •	 Borrower is at least 6 months delinquent on his or her mortgage,

           •	 Servicer has exhausted all steps in the FHA loss mitigation process,

           •	 Servicer has initiated foreclosure proceedings, and

           •	 Borrower is not in bankruptcy.

     In September 2012, FHA enhanced its single-family note program to include
     pools of expanded size and use criteria with the goal of yielding better
     outcomes for troubled borrowers, neighborhoods, and taxpayers. This
     revamped program is referred to as the Distressed Asset Stabilization Program.
     HUD recognizes that thousands of FHA borrowers who are delinquent on
     their loans and have exhausted the loss mitigation interventions available
     through FHA. By strategically selling notes to new servicers rather than
     carrying out foreclosure, FHA can reduce costs while helping to stabilize
     communities. Beginning with the September 2012 sale, FHA will increase
     the number of loans available for purchase from about 1,800 a year up to
     5,000 a quarter and add a new neighborhood stabilization pool to encourage
     investment in communities hardest hit by the foreclosure crisis.10 The offerings
     from the Distressed Asset Stabilization Program first occurred in September
     2012 with the latest offering conducted in March 2013. As of April 2013, the
     program has resulted in the sale of nearly 26,000 mortgages. Another offering
     is planned for June 2013 with an anticipated sale of 15,000 to 20,000 loans.

FHFA and Fannie Mae REO Pilot Program
     In August 2011, FHFA, HUD, and the Department of the Treasury issued a
     Request for Information, soliciting public comment on new and advantageous
     ways to sell single-family REO properties held in their inventories. In February
     2012, FHFA directed Fannie Mae to launch an REO Pilot Program, as a result
     of public feedback, in which bids were solicited from qualified investors to
     purchase and then rent for a specified number of years about 2,500 of Fannie
     Mae’s foreclosed single-family properties. These properties were located in

     9	 HUD, HUD to Expand Sale of Troubled Mortgages through Program Designed to Help Borrowers Avoid
     Costly, Lengthy Foreclosures, HUD No. 12-096 (June 8, 2012). Accessed April 5, 2013, at http://portal.hud.

     10	 Id.

                         Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
    geographically concentrated areas across the United States. Investors were
    qualified to bid after an extensive review process that evaluated their financial
    strength, asset management experience, property management expertise, and
    experience in the geographic area.

    FHFA has targeted metropolitan areas hit hardest by foreclosures: Atlanta,
    Chicago, Las Vegas, Los Angeles, Phoenix, and parts of Florida. In September
    2012, FHFA announced that Pacifica Companies, LLC was the first winning
    bidder in the REO Pilot Program, in which the investor purchased 699
    properties in Florida. Subsequently, the Cogsville Group, LLC purchased 94
    Fannie Mae REO properties in Chicago in October 2012. FHFA also announced
    in November 2012 that Colony Capital, LLC purchased 970 properties in
    California, Arizona, and Nevada.11

                                  OIG Efforts on REO

    In its continuing efforts to improve the integrity of the single-family insurance
    program, HUD-OIG has proactively sought to identify high-risk areas within
    FHA’s REO program for audit opportunities. Specifically, in 2011 HUD-OIG
    conducted an auditability survey of HUD’s REO program and identified
    audit opportunities in the areas of oversight, field service management, and
    asset management. HUD-OIG subsequently completed four audits: (1) HUD’s
    oversight of its REO M&M III program;12 (2) Innotion Enterprises (an FSM
    contractor)’s performance;13 (3) the reasonableness of certain Innotion pass-
    through costs;14 and (4) Ofori and Associates, PC (an Asset Manager)’s
    compliance with case processing requirements and timeframes.15 Below is a
    summary of the audit objectives and results from those four issued reports.

    1. Audit of HUD’s Oversight of Its REO Management and Marketing Program III
    HUD-OIG audited HUD’s oversight of its REO M&M III program. This audit
    work focused on HUD’s oversight of the Asset Managers (AMs) and Field

    11	 Properties in Atlanta were not awarded and will be evaluated for disposition through Fannie Mae’s
    retail REO sales operation or through future transactions.

    12	 http://www.hudoig.gov/Audit_Reports/2012-LA-0003.pdf, issued September 18, 2012.

    13	 http://www.hudoig.gov/Audit_Reports/2012-LA-1010.pdf, issued September 12, 2012.

    14	 http://www.hudoig.gov/Audit_Reports/2013-LA-0801.pdf, issued October 3, 2012.

    15	 http://www.hudoig.gov/Audit_Reports/2013-BO-1001.pdf, issued February 19, 2013.

                       Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
Service Managers (FSMs), as well as enforcement of contract requirements,
including listing prices, bid thresholds, valuation, maintenance, inspections,
and payments. The objective was to determine whether HUD’s policies and
procedures provided for efficient and effective oversight of AMs and FSMs
under M&M III program.

The audit identified that HUD did not have adequate procedures in place
to ensure consistent and adequate enforcement of AM and FSM contracts.
Specifically, (1) list prices were not always reduced according to the marketing
plans, (2) bids were approved that did not meet HUD’s flexible threshold,
(3) bids were rejected that met the marketing plan thresholds, (4) bids that
met applicable thresholds were not always counteroffered or forwarded to the
government technical representative for approval, and (5) properties were not
assigned to field service managers based on performance even when HUD
identified performance issues.

In addition, HUD did not always pay FSMs in accordance with their
contracts, resulting in an estimated net underpayment of $553,784 to FSMs.
This condition occurred because HUD did not develop national standard
procedures and did not implement a performance scorecard to assign
properties to FSMs based on performance. As a result, HUD’s REO properties
may not have always been competitively valued, holding time may not have
always been minimized, sales may not have always achieved the highest net
return, and properties may have been assigned to contractors that did not
perform at a satisfactory performance level.

2. Audit of Innotion Enterprises, Inc.
HUD-OIG audited one of HUD’s REO M&M III FSMs. This audit work
focused on how well Innotion Enterprises, Inc. met the six primary objectives
of its FSM contract. Specifically, HUD identified six primary objectives for
the FSM contract, which are to ensure that (1) FHA-insured properties are
maintained in a manner that preserves communities, (2) HUD has real-time
access to all property-related information, (3) properties are secured and safe
from hazardous conditions, (4) property values are preserved, (5) properties
are maintained in a manner that reflects a high standard of care, and (6) there
is a high level of customer satisfaction with HUD’s property disposition
program. The overall audit objective was to determine whether Innotion
performed property preservation and protection services according to contract

                Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
The audit identified that Innotion did not always perform property protection
and preservation services according to contract requirements. Specifically,
38 of 96 (39.6 percent) properties selected materially failed to meet contract
requirements because homes were not secured or properly maintained. As
a result of Innotion not always following HUD’s and its own policies and
procedures, compounded by its inadequate quality control, HUD did not
have assurance that Innotion maintained REO homes at the high standard
of care required in the performance of work statement. HUD paid Innotion
$11,210 for monthly services for 38 homes that did not reflect a high standard
of care. If Innotion does not implement adequate controls and procedures to
address property protection and preservation deficiencies, HUD will spend
approximately $1 million for inadequate services over the next year.

3. Audit of Innotion Enterprises, Inc. Pass-through Costs
In conjunction with the external audit of Innotion, HUD-OIG reviewed the
termite inspection pass-through costs that it submitted to HUD for payment
as part of its REO M&M III program FSM contract. The objective was to
determine whether Innotion’s Las Vegas, Nevada, branch met administrative
requirements concerning pass-through cost reasonableness.

HUD-OIG determined that HUD paid for unnecessary administrative costs of
Innotion’s subcontractor under HUD’s FSM contract. This condition occurred
because of the unclear definitions of actual and administrative costs in HUD’s
contract with Innotion. Although the contract stated that Innotion could
pay only the amount billed and not add its own administrative costs, it did
not specifically disallow the payment of administrative costs incurred by a
subcontractor, such as One Stop, that subcontracted Innotion’s work to other
termite inspection contractors. As a result, 30 percent of the termite inspection
costs paid by HUD in the sample were for administrative costs of Innotion’s
subcontractor. If HUD does not revise its FSM field contracts, it may continue
to pay for unnecessary administrative costs for termite inspections and other
pass-through costs submitted by its FSM contractors.

4. Audit of Ofori and Associates, PC
HUD-OIG audited one of HUD’s REO M&M III AMs. This audit work
focused on determining whether or not Ofori complied with case processing
requirements and timeframes to obtain the highest net return for HUD’s REO
inventory and minimize holding time.

               Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
     The audit identified that Ofori did not always comply with case processing
     requirements and timeframes for the disposition of REO properties assigned to
     them. Specifically, it did not always perform all case processing requirements
     in a timely manner to minimize holding time and costs to HUD. They did not
     adequately document information in case files and in the HUD P260 computer
     system.16 This condition occurred because Ofori officials did not always
     follow contract and marketing plan requirements; they did not have adequate
     controls in place to ensure that case processing requirements were completed
     and documented; and they did not always adequately address procedures,
     processes, and timeframes they would follow. As a result, HUD did not have
     assurance it always received the highest net return on its REO inventory and
     that holding time was minimized.

     Ofori officials have begun addressing the deficiencies identified during our
     audit, including a checklist for Ofori’s marketing specialists to use to improve
     the review of appraisals and for hard to sell properties; had updated their
     inspection and closing procedures; and were revising their marketing plans.
     Ofori officials also began notifying HUD of amounts paid at closing that
     were not previously reported to HUD, however, Ofori needs to ensure that
     the added controls address the deficiencies identified in the report, including
     conflicts of interest, and are followed.

     Given the risks associated with the GSEs’ REO management, FHFA-OIG is
     implementing a proactive audit and evaluation strategy under which it will
     assess FHFA’s related oversight and conservatorship efforts. It is intended to
     determine whether FHFA and the GSEs manage REO to maximize financial
     recoveries and minimize the negative effects of foreclosures on affected
     communities. In this regard, FHFA-OIG will analyze the potential effectiveness
     of these REO management activities, and determine whether proper risk
     management controls are in place to prevent fraud and abuse.

     FHFA-OIG’s REO strategy consists of the following:

     1. Audit of FHFA’s Oversight of the Enterprises’ REO Management Programs
     Since 2008, FHFA has consistently listed the GSEs’ large REO inventories as
     contributing to “critical concern” ratings in their quarterly risk assessments.
     However, in spite of FHFA’s identification of REO as a prominent and

     16	 P260 is an internet based system that serves as a primary system of record for all REO case
     management transactions.

                         Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
ascending risk, FHFA did not conduct targeted examinations or similar
focused reviews of REO until 2011. FHFA-OIG subsequently audited FHFA’s
oversight of the GSEs’ REO management programs.17 This audit focused
on FHFA’s supervision of the GSEs’ management and marketing of REO

FHFA-OIG found that FHFA’s targeted examinations, which were completed
in 2012, were positive supervisory steps that the agency can supplement in the
future by closely assessing other REO risk areas that need focused supervision
(i.e., areas in addition to contractor management and the management of
unmarketable homes and canceled foreclosures). For example, the GSEs’
sizable shadow inventory may stress their systems for cost-effectively
managing, marketing, and disposing of REO. FHFA-OIG also found that
FHFA will benefit from using a more comprehensive REO risk assessment and
from using this assessment to enhance its planning of supervisory activities.
According to FHFA’s Supervision Handbook, risk assessment is the process of
developing a comprehensive, risk-focused view of a GSE in order to formulate
and articulate a current understanding of its emerging and existing risk
characteristics, to be used as a blueprint for planning supervisory activities.18
However, until early in 2011, FHFA’s supervisory planning did not focus on
the significant and increasing risks associated with the GSEs’ REO. FHFA-OIG
recommended that FHFA implement a more comprehensive performance risk
assessment of REO and link the results to supervisory plans that address those
risks through specific supervisory activities.

2. Assessments of FHFA’s Oversight of the Enterprises’ REO Management
In pending and planned FHFA-OIG activities, FHFA-OIG intends to cover the
key steps in the REO management process, including matters such as securing
the property, maintenance and repair, valuation and marketing, and sale.
FHFA-OIG is considering several evaluations of FHFA’s oversight of the GSEs’
planning, monitoring, and management of REO, with a focus on their ability
to handle future workloads and mitigate adverse effects on homeowners and
communities. The specific objectives of these REO activities are or will be to
assess FHFA’s oversight of the GSEs’:

17	 FHFA-OIG, FHFA’s Supervisory Risk Assessment for Single-Family Real Estate Owned, AUD-2012-005
(July 19, 2012).

18	 FHFA, FHFA Division of Enterprise Regulation Supervision Handbook 2.1 (June 16, 2009), at 40. Accessed
February 27, 2013, at http://www.fhfa.gov/webfiles/2921/DERHandbook21.pdf.

                    Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
    •	 Management systems, risk controls, and capacity to deal with any
       surge of foreclosures in their REO inventories due to seriously
       delinquent mortgages; and

    •	 Efforts to mitigate the effects of concentrations of REO inventories and
       abandoned or vacant foreclosed properties in economically distressed
       areas of the country.

3. Assessments of Any Expanded REO Program
FHFA-OIG also plans to assess FHFA’s and Fannie Mae’s REO Pilot Program
should FHFA decide to implement the sale-rental commitment model on a
wider scale. The areas that FHFA-OIG may cover include:

    •	 Whether the program is achieving key expected outcomes and the
       quality of the data and analytics FHFA and Fannie Mae use to make
       such determinations. For example, the evaluation could cover FHFA’s
       and Fannie Mae’s basis for determining whether, in certain cases,
       it is more cost-effective to proceed with the bulk sale with rental
       commitment model than it is to make sales through the traditional
       retail channel.

    •	 The quality of the controls that are established to ensure that investors
       have sufficient expertise and financial resources to meet their rental
       commitments, as well as Fannie Mae’s and FHFA’s efforts to ensure
       compliance with these controls.

    •	 The quality of the processes by which Fannie Mae monitors investor
       compliance with their rental commitments and the restrictions on the
       number of properties that may be sold annually, as well as FHFA’s
       oversight of the GSEs’ processes; FHFA’s and Fannie Mae’s program
       enforcement efforts to ensure compliance with program requirements;
       and, where necessary, their efforts to penalize or sanction investors for

    •	 FHFA’s general oversight of Fannie Mae’s efforts to implement the
       program, as well as its technical expertise and the sufficiency of the
       resources allocated to these efforts.

              Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
4. Assessment of FHFA’s Oversight of Enterprise Controls over Single-Family
Property Inspections for REO
FHFA-OIG also plans to assess FHFA’s oversight of single-family property
inspections at the GSEs, which view property inspections as essential to the
successful management of their REO inventories. Property inspections are
required at various points in the mortgage servicing process, including upon
delinquency, in foreclosure, and while managing and disposing of REO. These
inspections should determine the overall condition of the property, security
of the house, occupancy status, maintenance and capital repair requirements,
neighborhood conformity, and other related information. Inspectors must be
qualified to perform the inspections.

With this audit and evaluation strategy, FHFA-OIG believes that it will be well
positioned to:

    •	 Determine whether FHFA is ensuring that the GSEs are effectively
       mitigating REO risks and costs and the negative impacts of
       foreclosures on communities and

    •	 Evaluate the effectiveness of the controls associated with selling in
       bulk foreclosed properties with rental commitments.

Further, FHFA-OIG will be in a position to make recommendations, as
necessary, to strengthen FHFA’s REO-related oversight and conservatorship

               Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
This report is the latest effort from the Federal Housing Inspectors General,
a joint initiative consisting of Offices of Inspector General (OIGs) for Federal
agencies that play central roles in supporting housing in the United States: the
U.S. Departments of Agriculture, Housing and Urban Development (HUD),
Veterans Affairs, and the Federal Housing Finance Agency (FHFA). These
OIGs are working to protect the U.S. taxpayer by eliminating fraud, waste, and
abuse in federal housing programs.

REO management and disposition are challenging tasks, likely to become
more so as shadow inventory is foreclosed upon and becomes REO properties.
HUD-OIG and FHFA-OIG have undertaken significant work to ensure that
their respective agencies address REO-related issues effectively and efficiently.
Substantial attention must continue to be paid to the manner in which HUD,
FHFA, and the GSEs handle such issues.

               Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
                               Appendix A
               Participating Offices of Inspectors General

U.S. Department of Housing and Urban Development
     HUD has its origins in the National Housing Act of 1934, which created the
     Federal Housing Administration (FHA). Since 1934, the FHA has helped more
     than 41 million families to become and remain homeowners.19 The Office of
     Housing within HUD oversees the FHA, the largest mortgage insurer in the
     world, as well as regulates housing industry business. HUD’s Single Family
     programs include mortgage insurance on loans to purchase new or existing
     homes, condominiums, manufactured housing, houses needing rehabilitation,
     and for reverse equity mortgages to elderly homeowners.20 HUD was
     established in 1965 through the Housing and Urban Development Act and
     continues to administer federal programs that provide assistance for housing
     and community development. HUD-OIG was established by the Inspector
     General Act of 1978. Over the years, HUD-OIG has forged an alliance with
     HUD personnel in recommending ways to improve departmental operations
     and in prosecuting program abuses. HUD-OIG strives to make a difference in
     HUD’s performance and accountability.

     HUD-OIG is committed to the statutory mission of detecting and preventing
     fraud, waste, and abuse and promoting the effectiveness and efficiency of
     government operations. While organizationally located within the Department,
     HUD-OIG operates independently with separate budgetary authority. It seeks

          •	 Promote efficiency and effectiveness in programs and operations,

          •	 Detect and deter fraud and abuse,

          •	 Investigate allegations of misconduct by HUD employees, and

          •	 Review and make recommendations regarding existing and proposed
             legislation and regulations affecting HUD.

     HUD-OIG’s audits, inspections and evaluations, and investigations continue to
     complement the Department’s strategic initiatives, and its employees continue

     19	 http://www.huduser.org/portal/publications/hsgfin/fha_singlefamily2012.html, accessed April 8,

     20	 http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/hsgabout, accessed April 8,

                        Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
     to work with the Department to improve HUD’s effectiveness. As a result,
     HUD-OIG has developed and implemented better and more effective audit

     During the public reporting period from April 1 through September 30,
     2012, HUD-OIG’s audit work identified more than $827 million in funds that
     could be put to better use and more than $1.2 billion in questioned costs, and
     accumulated nearly $34 million in collections. HUD-OIG reported more than
     $538 million in recoveries and receivables, 354 indictments and informations,
     285 convictions, pleas, and pretrial diversions, and 280 arrests.21

Federal Housing Finance Agency
     FHFA was established by the Housing and Economic Recovery Act of
     2008 (HERA) in the midst of the worst economic crisis in decades. HERA
     created FHFA by consolidating into one agency HUD’s Office of Federal
     Housing Enterprise Oversight, the Federal Housing Finance Board, and
     the GSE mission office within HUD. FHFA’s mission is to provide effective
     supervision, regulation, and oversight of Fannie Mae, Freddie Mac, and the 12
     Federal Home Loan Banks. FHFA is charged with promoting their safety and
     soundness, supporting housing finance and affordable housing, and fostering
     a stable and liquid mortgage market. In September 2008, FHFA became the
     conservator of Fannie Mae and Freddie Mac. At that time, both GSEs began to
     receive federal support and, to date, have received a combined total of $187.5
     billion from the Treasury. As conservator, FHFA has the authority to ensure
     that they are preserving and conserving their assets.

     HERA also established FHFA-OIG. FHFA-OIG began operating in October
     2010, following Senate confirmation of its first Inspector General. FHFA-
     OIG works to promote the economy, efficiency, and effectiveness of FHFA’s
     programs; prevent and detect fraud, waste, and abuse; and seek sanctions
     and prosecutions against those who are responsible for such fraud, waste,
     and abuse. FHFA-OIG also provides independent and objective reporting
     to the FHFA Director, Congress, and the American people through audits,
     evaluations, and investigations. Among the effects of FHFA-OIG’s reporting
     efforts is Freddie Mac’s likely recovery of approximately $1 billion in added
     income in 2012 and up to $3.4 billion in later years, due to Freddie Mac
     broadening the scope of loans reviewed for potential repurchase claims after
     FHFA-OIG determined that its prior loan review scope was too narrow.

     21	 An information is a charging document in which the defendant foregoes his or her constitutional
     right to have the facts of the case presented to a grand jury. Usually, an information is accompanied by
     a plea agreement.

                         Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
FHFA-OIG has had several key accomplishments since it began. From its start,
with limited staff and resources, FHFA-OIG commenced operations and has
issued 32 reports through September 30, 2012. For additional information on
any of FHFA-OIG’s published reports, visit www.fhfaoig.gov/Reports. FHFA-
OIG has also initiated and participated in criminal, civil, and administrative
investigations. Notably, FHFA-OIG made significant contributions to the
investigation, prosecution, and conviction of seven individuals connected
to Taylor, Bean & Whitaker Mortgage Corporation and Colonial Bank, who
defrauded Freddie Mac and other victims out of $2.9 billion, making it among
the largest mortgage frauds in U.S. history. Further, FHFA-OIG has made over
80 recommendations to date in order to improve the transparency, efficiency,
and effectiveness of FHFA’s operations and aid in the prevention and detection
of fraud, waste, and abuse.

              Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
                          Appendix B
                   Acronyms and Abbreviations
Enterprises	      Fannie Mae and Freddie Mac

Fannie Mae 	      Federal National Mortgage Association

FHA 	             Federal Housing Administration

FHFA 	            Federal Housing Finance Agency

FHFA-OIG 	        Federal Housing Finance Agency Office of Inspector General

Freddie Mac 	     Federal Home Loan Mortgage Corporation

GAAP 	            Generally Accepted Accounting Principles

GSE 	             Government-Sponsored Enterprise

HERA 	            Housing and Economic Recovery Act of 2008

HUD 	             U.S. Department of Housing and Urban Development

HUD-OIG	          U.S. Department of Housing and Urban Development Office
                  of Inspector General

M&M	              Management and Marketing

MCM	              Mortgage Compliance Manager

REO 	             Real Estate Owned

SAMS	             Single Family Accounting Monitoring System

SFIS	             Single Family Insurance System

                Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
                                                 Appendix C
         A request or demand for payment on a guaranteed loan by the loan holder due
         to default by the borrower. The guarantor will generally issue the payment to
         the loan servicer, who will be responsible for forwarding the funds to the loan
         holder in accordance with its servicing agreement.

         A specific sum of money due by agreement or otherwise.22 Obligations can
         be incurred by households (consumer debt) or corporations (corporate debt).
         Corporate debt may also refer to securities issued by a corporation, each an
         individual obligation owed by the corporation to the investor.

Deed in lieu
      A voluntary transfer of property from the borrower to the loan holder for a
      release of all obligations under the mortgage.

       Failure to comply with an obligation’s terms.

         In the context of residential mortgage finance, the difference between the fair
         market value of the borrower’s home and the outstanding balance on the
         mortgage (and any other debt secured by it, such as home equity loans).

Federal Home Loan Mortgage Corporation (Freddie Mac)
      A federally chartered corporation that purchases residential mortgages,
      securitizes them, and sells them to investors; this provides lenders with funds
      that can be used to make loans to homebuyers.

Federal Housing Administration (FHA)
      Part of HUD, provides mortgage insurance on loans made by approved
      lenders throughout the United States and insures residential mortgages against
      payment losses. It is the largest insurer of mortgages in the world, having
      insured more than 34 million properties since its inception in 1934.

Federal National Mortgage Association (Fannie Mae)
      A federally chartered corporation that purchases residential mortgages and

         22	 Garner, Bryan A., ed., Black’s Law Dictionary, 7th ed., p. 300 (2000).

                              Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
       converts them into securities for sale to investors. By purchasing mortgages,
       Fannie Mae supplies funds to lenders so they may make loans to homebuyers.

       A legal procedure in which a mortgaged property is sold in a legal process to
       pay the outstanding debt in case of default.23 Foreclosure laws vary according
       to each state’s statutes on the topic. Generally, foreclosures are either judicial
       (i.e., conducted primarily through court proceedings) or nonjudicial (i.e.,
       conducted largely outside of the state’s judicial system).

Government-Sponsored Enterprises (GSEs)
      Business organizations chartered and sponsored by the federal government,
      such as Fannie Mae and Freddie Mac.

      An agreement to repay a loan or ensure performance. It may be limited in time
      and amount.24 With respect to mortgage-backed securities, a guarantee takes
      the form of assurance of timely principal and interest payments to security

       Indemnification one obtains against loss from a specific hazard or peril.26
       Mortgage insurance is one such example. A federal agency may insure private
       lenders against the risk that a particular borrower will default on his or her
       mortgage. By offering to insure the borrower’s mortgage, the federal agency
       reduces the risks those private lenders might incur and thereby encourages
       those lenders to extend credit to borrowers who might not otherwise qualify
       for mortgages in the private market.

Loan Modification
      A loan modification alters the original loan’s terms to make it comparatively
      easier for the borrower to pay back what is owed. A loan modification may
      extend the period in which the borrower must repay the amounts due,
      reduce those amounts, or take some other step to make the obligation less
      burdensome on the borrower.

       23	 Mortgage Bankers Association, Mortgage Banking Terms, 10th ed., p. 67 (2004).

       24	 Esty, Benjamin C., Glossary of Project Finance Terms and Acronyms (2004). Accessed August 30, 2011, at

       25	 HUD, Glossary. Accessed August 30, 2011, at http://portal.hud.gov/hudportal/HUD?src=/program_

       26	 Institute of Financial Education, Glossary of Financial Services Terminology, p. 40 (1990).

                            Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
Loss Mitigation
      Steps taken by the mortgage lenders to avoid the need to foreclose on
      properties subject to a mortgage upon which the borrower is at risk of going
      into default. Such steps may benefit both the lender and the borrower.
      Examples of loss mitigation activities include but are not limited to loan
      modifications and short sales.

Real Estate Owned (REO)
       A class of real property owned by the lender. The term REO is derived from
       the Generally Accepted Accounting Principles (GAAP) category, “Other Real
       Estate Owned.” Under GAAP, REO properties are booked as nonperforming
       assets due to the lender’s lack of recourse against the borrower. The lender
       may acquire the property through a forcible repossession or foreclosure or by
       the borrower’s voluntary award, such as a deed in lieu of foreclosure.27

       Certain activities undertaken in connection with loans. Servicing a mortgage
       loan means taking those steps that are necessary to maintain the loan from
       when it is made until when the last payment is received, at which point the
       mortgage instrument is canceled. Servicing steps are varied and may include
       billing the borrower, collecting mortgage payments, and escrowing real estate
       tax and fire and casualty insurance payments.28

Short Sale
       The sale of a mortgaged property in which the lender permits the property to
       be sold for less than the full amount owed on the loan. However, a lender’s
       permitting a short sale does not necessarily entail acceptance of this lesser
       amount as full payment on the loan or otherwise waiving the remaining

      Term used to describe situations in which the homeowner’s equity is below
      zero (i.e., the home is worth less than the balance of the loan(s) it secures).

       27	 Washington State Department of Financial Institutions, Managing Your Credit Union’s OREO Property:
       Guidance and Best Practices (2010). Accessed August 31, 2011, at www.dfi.wa.gov/cu/pdf/oreo-best-

       28	 Institute of Financial Education, Glossary of Financial Services Terminology, p. 46 (1990).

                            Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013
                 Appendix D
             Contact Information

U.S. Department of Housing and Urban Development
Office of Inspector General
451 7th Street, SW
Washington, DC 20410
Main Phone: 1-202-708-0430
Hotline Phone: 1-800-347-3735

Federal Housing Finance Agency
Office of Inspector General
400 7th Street, SW
Washington, DC 20024
Main Phone: 1-202-730-0880
Hotline Phone: 1-800-793-7724

   Joint Report on Federally Owned or Overseen Real Estate Owned Properties • May 2013