“’ ‘CJuiteci States General Accountinti Office Report to the Congress GAO , FINANCIAL AUDIT Government National Mortgage Association’s 1989 Financial Statements RI lllllllllll ll 142568 GAO/AFMD-9 l-8 united states GAO General Accounting Washington, D.C. 20548 Office Comptroller General of the United States El 14828 October 30,199O To the President of the Senateand the Speaker of the Houseof Representatives This report presents the results of our audit of the Government National Mortgage Association’s (GNMA) financial statements as of September30, 1989. Reports on GNMA’S internal control structure and on its compliance with laws and regulations are also provided. The Mortgage-BackedSecurities Program is GNMA'S primary activity whereby GNMA guaranteessecurities issued by private mortgage institu- tions that are backed by pools of home mortgages.Mortgagesin these pools are insured by the Federal Housing Administration @HA)or the Farmer’s Home Administration (FYIIHA), or guaranteed by the Depart- ment of Veterans Affairs (VA). For fiscal year 1989, GNMA operations resulted in income of $64 million, a decreasefrom fiscal year 1988 income of $206 million. The causeof this decreasewas the additional provision for estimated lossesdue to (1) increased use by VA of an option to limit its losses,(2) uninsured mortgages in the mortgage pools, (3) the failure of defaulted issuers to remit certain proceeds,and (4) unanticipated costs associatedwith increased levels of security issuer defaults. The 1989 audit also disclosedtwo material internal control weaknesses which increasethe risk of additional lossesto GNMA. First, GNMA did not always coordinate with FWAand VA on the monitoring of issuers of GNMA mortgage-backedsecurities. FXAand VA insure or guarantee most of the mortgages.Second,somesecurity issuers,primarily savings and loan institutions, have been allowed to continue in GNMA'S Mortgage-Backed Securities Program, even though they have violated GNMA requirements by including goodwill in their net worth calculations without specific approval. is a wholly-owned government corporation within the Department Background GNMA of Housing and Urban Development (HUD). GNMA administers the Mortgage-BackedSecurities Program which operates in the mortgage- financing market to provide secondary-market financing for most FWA, VA, and someFIIIHAhome loans. GNMA guaranteestimely payment of prin- cipal and interest on privately issued securities backed by pools of gov- ernment insured (FHA and FIIIHA)or guaranteed (VA) mortgages.For an Page 1 GAO/AFMD91-9 Government National Mortgage Assodatlon I El14828 annual fee of up to 6 basis points (0.06 percent) of the outstanding loan amount, GNMA will guarantee to provide scheduledpayments to security holders should the security issuers fail to do so. Security issuers are fully responsible for acquiring, originating, servicing, marketing, and administering the securities. Opinion on Financial We are required to conduct an audit of GNMA at least once every 3 years under the provisions of 31 USC. 9106. To fulfill our responsibility, we Statements contracted with the independent certified public accounting firm of Price Waterhouseto conduct a financial audit of GNMA for the year ended September30,1989. We determined the scopeof the audit work, monitored its progress at key points, reviewed the working papers of the certified public accountants, and performed other procedures as we deemednecessary.The 1989 audit was conducted in accordancewith generally acceptedgovernment auditing standards. Our prior financial audit of GNMA was conducted for the year ended September30,1986 (GAO/AFMD-87-66). GNMA contracted with Price Waterhousefor financial audits of its 1987 and 1988 financial statements. In our opinion, and consistent with the opinion of Price Waterhouse,the Government National Mortgage Association’s financial statements pre- sent fairly its financial position as of September30, 1989, and the results of its operations and its cash flows for the fiscal year then ended, in conformity with generally acceptedaccounting principles. Material Internal Price Waterhouse’sreport on internal control structure, with which we concur, disclosestwo reportable conditions that are material weaknesses Control Weaknesses and could result in additional lossesto GNMA. These weaknesseswere Exist consideredduring the audit and do not affect the opinion expressedon the fair presentation of GNMA'S financial statements, Lack of Coordination With GNMA did not coordinate with FHA and VA in all instancesin which it iden- FHA and VA tified a security issuer who was not in compliance with essential terms of the Mortgage-BackedSecurities Program, which allowed noncom- pliant issuers to remain in the program. Noncomplianceincludes instanceswhere the issuer did not meet capital requirements, filed inac- curate reports, failed to obtain an annual audit, or experiencedhigh Y delinquency rates. When issuers defaulted, FHAand VA bore the majority of losses,with GNMA absorbing the amounts not covered by insurance or guarantees. Page 2 GAO/AFMTJ-918 Government National Mortgage Amociation El14828 In its 1088 report on internal controls, Price Waterhouseidentified lack of coordination as a material weakness.HUD also reported it as a mate rial weaknessin its 1989 Federal Manager’sFinancial Integrity Act report. GNMA has targeted this problem for correction by December1990. As a first step, it has formed a task force of GNMA, F+HA, and VArepresen- tatives to facilitate better coordination and information sharing. Exceptions to GNMA GNMAdid not always take action when security issuers failed to meet Capital Requirements MIA’S capital requirements. GNMAallowed somesecurity issuers to con- tinue in the Mortgage-BackedSecurities Program even though they included goodwill in their net worth calculations without approval. Sincegoodwill represents ti intangible amount in excessof the assetsof a business,it doesnot add strength to an issuer’s capital base.Thus, GNMA guidelines prohibit issuers from including goodwill to meet the capital requirements of the Mortgage-BackedSecurities Program without GNMA'S written approval. In casesin which GNMA doesallow issuersto include goodwill to meet their capital requirements, there is increasedrisk that GNMA will experiencelossesthat capital requirements are intended to prevent. This issue was also identified as a material wealmessin the 1988 Price Waterhousereport on internal accounting controls. GNMA has targeted this problem for correction by December1990. GNMA is currently working with the Office of Thrift Supervision and the Resolution Trust Corporation on approachesfor dealing with GNMA security issuers who do not meet the new capital requirements of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. Price Waterhouse’sreport on compliance with laws and regulations, ComplianceWith with which we concur, disclosednothing to indicate that GNMA had not Laws and Regulations complied with applicable laws and regulations that could have a mate- rial effect on the financial statements. In fiscal year 1089, GNMA increasedits reserve for losseson the Reservefor Losses Mortgage-BackedSecurities Program to $629 million, from $606 million in fiscal year 1088. This loss reserve is established to cover probable w lossesthat will result in future cash payments arising from defaults by issuers of GNMA securities. Page 8 GAO/AFlMtHlJ3 Government National Mortgage Assocktion 1 El14828 Loss provisions are added to the reserve when defaults of security issuers becomeprobable. Thus, if GNMA believes more security issuers will default, it increasesits loss reserve. In most cases,GNMA places an issuer in default when the issuer fails to make timely principal and interest payments to security holders. If the mortgagesheld by the issuer to back the security are also in default, GNMA relies on FHA,or VA, as the insurer or guarantor to absorb the majority of any resulting losses.However, other costs and expensesassociatedwith a security issuer default, not covered by federal insurance or guarantee, are borne by GNAW Someof the reasonswhy the loss reserve has increased include the following: . VA’S use of its “no bid”’ option to limit its losseson defaulted mortgages to a specified percentage.When VA determines that it is more cost bene- ficial to pay only the guaranteed portion of the mortgage, lossesover and above the VA guarantee are paid by the GNMA security issuer, or by GNMA if the issuer is in default. There is a greater probability of lossesto GNMA in economically distressed areas,where declining property values may induce VA to use its no-bid option more extensively. As of Sep- tember 30,1080, GNMA estimated that it would incur $161 million in lossesdue to VA no bids, basedupon its overall exposure on VA loans. l Mortgage pools of defaulted security issuers contain uninsured mort- gages.Uninsured mortgages are included in the mortgage pools when issuers fail to remit insurance premiums, thus causing the mortgage insurance to lapse. Without insurance on the mortgagesbacking the GNMA securities, GNMA, rather than FHAor VA, becomesresponsible for lossesassociatedwith the mortgage default. As of September30,1080, GNMA estimated that it would incur $47 million in lossesfrom these unin- sured loans. l Defaulted issuers fail to remit proceedsfrom early mortgage payoffs or from claim settlements to security holders. Principal and interest pay- ments on mortgages backing GNMA securities are supposedto be passed through to security holders. When they are not, the mortgage principal balance is less than the security principal balance.If an issuer is later placed in default, then GNMA becomesresponsible for making up this shortfall when the security is liquidated. Lossesfor these shortfalls are included in a contingency pool for security issuer defaults. . Unanticipated costs causedby security issuer defaults. When security issuers default and GNMA becomesresponsible for servicing the security ‘In cases of default, VA has the option to pay the full amount of a defaulted mortgage to the mortgage holder and acquire the property or to pay only the guaranteed portion of the mortgage value and leave the property with the holder. The latter action is referred to as the VA “no bid” option. Page 4 GAO/APMD-91-8 Government National Mortgage Amwciatim ‘. I 8314838 portfolio, a number of unreimbursable costs are incurred. These costs are largely due to administrative and legal expensesand, recently, to missing escrow funds that GNMAmust make whole. GNMAand others have initiated investigations into these missing escrow funds and missing passthroughs of other proceedsto security holders. As of Sep- tember 30,1080, GNMAestimated that it would incur $278 million in lossesdue to these unanticipated costs. GNMA'S Mortgage-BackedSecurities reserve is established to cover esti- mated lossesresulting from the above situations, less the guarantee fees received. On a present value basis, GNMA has reserved $286 million for single-family mortgages and $61 million for multifamily mortgages as of September30,108O. These reserves,when added to the $203 million reserve established in prior years for mobile home losses,result in GNU'S total loss reserve of $620 million as of September30,108O. The Potential for Greater In recent years, GNMA has significantly increasedits Mortgage-Backed Losses Securities loss reserve becausea number of security issuers have been placed in default; While the majority of costs associatedwith issuer defaults result from defaulted mortgagesand are thus reimbursed by FFLA or VA, NM’S most significant exposure to lossesoccurs when the number of issuers defaulting on their GNMA obligations increases. First, VA’S increasing use of its no-bid option can causemore issuer defaults. Lossesnot covered by VA as a result of exercising its guarantee limitation must be borne by the security issuers,thus reducing their cap- ital. A reduced capital level, coupled with the need for more cash to make principal and interest payments to security holders, increasesthe probability that issuers will default on their security payments, thus increasing GNMA'S losses. Second,the number of defaults by single family issuers increasesGNMA'S risk. In June 1080, GNMA placed New York Guardian Mortgage Corpora- tion in default. Guardian is a major single-family issuer with $6.0 billion in GNMA mortgage-backedsecurities. Ten other single-family security issuers were placed in default in fiscal year 1080, up from five in fiscal year 1088. As of September30, 1080, GNMA had $10.3 billion in mortgage-backedsecurities outstanding that had been issued by defaulted single-family issuers. BecauseGNMA experiencesa loss when issuers fail to make timely principal and interest payments to security holders, the prospect of increased failures of security issuers directly increasesthe risk of loss to GNMA. Page 5 GAO/AF'MD-91-8 Qovemment NationalMortgage bsodatbn El14828 Finally, the number of defaults of multifamily issuers also increases GNMA'S risk. Structural and administrative flaws in the multifamily coinsuranceprogram have led to the default of GNMA'S two largest multi- family security issuers. In September 1088, GNMA placed in default DRG Funding, a major security issuer with $1.1 billion in GNMA securities backed by coinsured multifamily mortgages.It placed two additional multifamily issuers in default during fiscal year 1080. As of July 1000, GNMA had placed four more multifamily issuers in default, including its largest coinsurer, York Associates,Inc., with more than $2 billion in out- standing GNMA securities. These defaults prompted the Secretary of HUD, in January 1000, to cancel new issuer participation in the coinsurance program. As with single-family issuers,GNMA'S risk of loss directly increasesas multifamily security issuers fail to pay security holders, GNMA'S loss reserve is adequate at this time to cover the recent increase in issuer defaults. However, GNMA, like FHAand VA, is susceptible to greater lossesin the event economicconditions worsen, causing more issuers to default. We provided a draft of this report to responsibleAssociation officials Commentsof for comment. They concurred with the contents and indicated their com- CognizantOfficials mitment to correct the problems noted. During the course of its audit, Price Waterhousealso identified several matters which, although not material to the financial statements, are being communicated to GNMA separately. We are sending copiesof this report to the Director of the Office of Man- agementand Budget, the Secretary of the Treasury, the Secretary of Housing and Urban Development,the President of the Government National Mortgage Association, HUD'S Assistant Secretary for Adminis- tration, and the Chairman of the Oversight Board of the Resolution Trust Corporation. Charles A. Bowsher Comptroller General of the United States Page 6 GAO/AFMD-BlJ3 Government National Mortgage Association Page 7 GAO/AFMD4143 Government National Mortgage Association Letter Auditors’ Opinion 10 Auditors’ Report on 12 Internal Control Structure Auditors’ Report on 17 ComplianceWith Laws and Regulations Financial Statements 18 Balance Sheet 18 Statement of Revenuesand Expensesand Investment of 10 U.S. Government Statement of Cash Flows 20 Notes to the Financial Statements 22 Abbreviations FHA Federal Housing Administration Farmer’s Home Administration GNMA Government National Mortgage Association HUD Housing and Urban Development VA Department of Veterans Affairs Page 8 GAO/AFMD-91-8 Government National Mortgage Amodatlon Page B GAO/AFMb918 Govemment Natiod Mortgage A8sodation Auditors’ Opinion Olhce 01Governmenr Serwes Telemone2022960800 1801 KStreet N W WashIngton DC20006 To the Comptroller General of the United States and the Executive Vice President, Government National Mortgage Association: We have audited the accompanyingbalance sheets of the Government National Mortgage Association (GNMA) as of September 30, 1989 and 1988, and the related statements of revenues and expenses and investment of the U.S. Government, and of cash flows for the fiscal years then ended. These financial statements are the responsibility of GNMA’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance .. with generally accepted auditing standards and Government Au- issued by the Comptroller General of the United States. Those standirds require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit includes examining, on a test basis,. evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessingthe accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Government National Mortgage Association at September 30, 1989 and 1988, and the results of its operations and its cash flows for the fiscal years then ended in conformity with generally accepted accounting principles. GNMA has exposure to lossesbecauseof limitations to the guarantee provided by the Department of Veterans Affairs (VA), as discussed in Note E. VA, at its option, can limit its losses by not bidding on foreclosed property if the subsequent sale of the property will lead to lossesgreater than payment of the guaranteed portion of the mortgage. However, in the event an issuer of GNMA securities backed by VA-guaranteed loans goes into default, losses resulting from the limitations of the VA guarantee are borne by GNMA. Page 10 GAO/AF’hD91-9 Government National Mortgage Assodntion To the Comptroller General of the United States and the Executive Vice President, Government National Mortgage Association Page 2 As a result of VA’s policy, and because of other limitations to the default costs that GNMA can recover, loss reserves of $629.0 million in fiscal 1989 and $506.4 million in fiscal 1988 have been recorded in the financial statements. GNMA management believes that as of September 30, 1989,these reserves are sufficient to cover lossesfrom probable defaults of issuers of GNMA securities. February 28, 1990 Page 11 GAO/AFMD-918 Govemment National Mortgage Asaodation Auditors’ Fkport on Intwnd Control Structure Offlceof Government Serwces Telephone2022960600 1601 KStreet, N.W. Washington. DC20006 Price Waterhouse 4tB To the Comptroller General of the United States and the Executive Vice President, Government National Mortgage Association: We have audited the financial statements of the Government National Mortgage Association (GNMA) as of and for the year ended September 30, 1989, and have issued our report thereon dated February 28, 1990. We conducted our audit in. . accordance with generally accepted auditing standards and- issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. GNMA’s management is responsible for establishing and maintaining an internal control structure. In fulfilling this responsibility, estimates and judgments by management are required to assessthe expected benefits and related costs of internal control policies and procedures. The objectives of an internal control structure are to provide management with reasonable, but not absolute, assurance that (1) obligations and costs are incurred in compliance with applicable laws, (2) funds, property, and assets are safeguarded against waste, loss, and unauthorized use or misappropriation, and (3) assets, liabilities, revenues, and expenses applicable to operations are properly recorded and accounted for to permit the preparation of reliable financial reports and to maintain accountability over the entity’s assets. Because of inherent limitations in any internal control structure, errors or irregularities may nevertheless occur and not be detected. Also, projection of any evaluation of the structure to future periods is subject to the risk that procedures may become inadequate because of changes in conditions or that the effectiveness of the design and operation of policies and procedures may deteriorate. For purposes of this report, we have classified the significant policies and procedures relative to GNMA’s internal control structure in the following categories: Page 12 GAO/AFMD-9143 Government National Mortgage Association Report on Internal Controls Page 2 0 Treasury/Investments 0 Mortgage-Backed Securities Program 0 Subservicing of GNMA portfolios 0 Purchases/Disbursements For all categories listed above, we obtained i understanding of the design of relevant policies and procedures which comprise the control structure, determined whether they have been placed in operation, and assessedcontrol risk. We noted certain matters involving the internal control structure and its operation that we consider to be reportable conditions. Reportable conditions involve matters coming to our attention relating to significant deficiencies in the design or operation of the internal control structure that, in our judgment, could adversely affect the entity’s ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. A material weaknessis a reportable condition in which the design or operation of specific elements of the internal control structure do not reduce to a relatively low level the risk that errors or irregularities, in amounts that would be material in relation to the financial statements being audited, may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. Our study and evaluation disclosed the following conr$itionswhich we believe could result in material lossesto GNh$A and to the Department of Housing and Urban Development (HUD) as a whole. CO- ITS EFFQBT TO COORDINATE MONITPBIN~ VD U GNMA continues to experience significant losses in its Mortgage Backed Securities (MBS) program, primarily because of issuer defaults. The cost to HUD as a whole of defaults under this program is significant. In caseswhere an issuer is not in compliance with the significant terms of the MBS Guide, such as through failing the minimum net worth requirement, filing inaccurate reports, lack of audited financial statements, or through having high delinquency rates, GNMA should be able to take swift action to curb excessivelosses that will result from that issuer’s potential default. Page ia GAO/AFMD-91-8 Government National Mortgage Amoclation Audlmra’ Report on htmmal Cimwl8tmemre Report on Internal Controls Page 3 This issue was first raised in our internal control report for fiscal year 1988. HUD reported it as a material weaknessin its 1989 report issued pursuant to the Federal Managers’ Financial Integrity Act, and targeted December 1990for its correction. Since initially reported, GNMA has made progress in more quickly identifying problem issuers, and in withholding commitments from issuers who have violated MBS program requirements. However, there continue to be situations where disciplinary action could be better coordinated with the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). Coordination among GNMA, FHA and VA is important, because withholding the GNMA commitment after FHA insurance or VA guaranteesare endorsed might unduly expose FHA and VA to additional losses. Similarly, if FHA and VA continue to issue insurance and guarantees to issuers who have violated GNMA guidelines, then GNMA has increased exposure to loss. Therefore, disciplinary action must be a coordinated effort among all interested agencies. If GNMA identifies lender/issuers who have violated or are about to violate its program requirements, FHA and VA should be promptly informed so that they can determine if lenders should be disciplined before additional insurance or guarantees are allowed. We understand that task forces, which include .representativesfrom PI-IA, VA and GNMA, have been establishedto facilitate better coordination among these agencies. We encourage this cooperative effort and also recommend that GNMA continue its efforts to promptly inform FHA and VA when issuersfail to meet MRS guidelines, and then help coordinate sanctions and/or other disciplinary actions before new loans are insured or guaranteed by the subject issuers. In this regard, GNMA’s issuer monitoring systemprovides information about potential violations of MBS guidelines that should be shared with and analyzed by FHA and VA, after which GNMA should request action to prevent further endorsement by an issuer who is not in compliance. Similarly, FHA information with regard to excessivedefaults by individual issuers,and loans for which no premium has been received, should be. shared with GNMk Information exchanges such as those just mentioned should also be arranged with VA Where VA and PI-IA do not act on a timely basis to discipline potential problem issuersin their programs,then GNMA should suspendfurther commitment to those issuers under its regulatory authority. PRO-N JUSTIFlCAaON FOR ALLQWING SAVINGS AN&! ONS TO CO- -G GNMA m ION QF NET WOgTH OR CAPU&,, We continue to note instanceswhere certain Savingsand Loan institutions were allowed to continue as issuers of GNMA securities despite being in technical violation of GNMA’s net worth requirements. We understand that these Page 14 GAO/AFMD-Bl-(I Govemment National Mortgage Association . Audltom’ Reporton Internal Control Struchure Report on Internal Controls Page 4 0 institutions were allowed to continue because, after including goodwill in the net worth calculation, the institutions met GNMA requirements. However, GNMA guidelines specifically exclude goodwill from the net worth requirement. While we were informed that exceptions to the minimum net worth requirements were granted in these cases,there was no written evidence of this. As with the capital standards for Savings and Loan institutions, GNMA’s minimum net worth requirement is designed to protect GNMA from losses which occur when issuers default. In its simplest sense,capital or net worth is the total investment of a company in itself and can be measuredby subtracting the liabilities of a company from its assets. At times this measure of capital is insufficient becausecertain assetsdo not fulfill capital’s purpose of protecting against loss. For instance, goodwill, the amount paid in excessof the book value of an institution upon its purchase, does not provide any cover against losses. If issuers with capital or net worth that is insufficient to cover losses are allowed to continue in the MBS program, then GNMA may be exposing itself to additional loss. It is possible that some of the Savings and Loan institutions which have violated GNMA net worth requirements, but which have been allowed to continue in the MBS program, might also have violated the new capital standards of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). These institutions may be awaiting decisions by the Office of Thrift Supervision (OTS) that would allow them to continue operations, or resolution by the Resolution Trust Corporation (RTC). Where GNMA, to coordinate policy with the OTS and RTC, has been asked to waive net worth requirements, the reasons therefor should be properly documented in writing. In all cases involving a Savings and Loan Institution that is in technical violation of GNMA’s net worth requirements, the OTS and/or RTC should be contacted to determine the current status of the institution (i.e., whether the institution is in violation of the new capital rules and is in either conservatorship or receivership) and to determine how GNMA’s interests can best be protected. With respect to Savings and Loan institutions currently under resolution, GNMA has begun to coordinate its actions with those of the RTC. We believe similar coordination of effort is necessary for those Savings and Loan institutions (which are GNMA security issuers) that are still operating but are awaiting decisions by the OTS, FDIC or RTC. It is particularly important to identify those institutions that have failed FIRREA capital requirements but have not yet been passed to the RTC for resolution. In both cases, we recommend that (1) any decisions made to allow Savingsand Loan institutions to continue in the MBS program after they have violated GNMA net worth requirements, or FIRREA capital requirements, be coordinated with actions being taken or to be taken by the OTS, FDIC, or RTC, wherein GNMA’s interests are appropriately considered, and (2) that all decisions to grant Page 16 GAO/AF’MDBl-g Government National Mortgage AwmiaUon Report on Internal Controls Page 5 exceptions to the net worth requirements be accompanied by written explanations demonstrating that GNMA’s interests were adequately considered and protected when the exceptions were granted. Except for the conditions described above, our study and evaluation disclosed no other conditions which we considered to be material to the financial statements of GNMA taken as a whole. We considered the above conditions in determining the nature, timing, and extent of our audit tests. We concluded that they do not affect our opinion on the financial statements of GNMA for the year ended September 30, 1989. Our study and evaluation did, however, reveal areas with potential for improvement in internal controls. These areas and our recommendations for improvement are included in a separate letter to GNMA management. February 28, 1990 Page 10 GAO/AFMB9l-E Government National Mortgage Aamciatlon Auditors’ Repor&Compliance With Laws andl3egulatioru 5 Oflice 01Government Serwces Telephone202 296 OS00 1801 KStrest. N.W. Waahmgton, DC 20006 Price Mterhouse To the Comptroller General of the United States and the Executive Vice President, Government National Mortgage Association: We have audited the financial statements of’ the Government National Mortgage Association (GNMA) for the fiscal year ended September 30, 1989 and have issued our report thereon dated February 28, 1990. We conducted our audit in accordance II with generally accepted auditing standards and Govenunent issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. The management of GNMA is responsible for compliance with laws and regulations. As part of obtaining reasonable assurance about whether the financial statements are free of material misstatement, we performed tests of GNMA’s compliance with certain provisions of applicable laws and regulations. However, our objective was not to provide an opinion on overall compliance with such provisions. The results of our tests indicate that, with respect to the items tested, GNMA complied in all material respects with the provisions referred to in the preceding paragraph. With respect to items not tested, nothing came to our attention that caused us to believe that GNMA had not complied, in all material respects, with such provisions. This report is intended for the information of the Congress, the U.S. General Accounting Office, and the management of GNMA. This restriction is not intended to limit the distribution of this report, which is a matter of public record. Y February 28, 1990 Page I7 Balance Sheet September 30 1989 1988 (Dollars In Thousands) Ametr: Funds in U.S. Treasury . . . . . . . . . . . . . . . . . $ 600 8 700 U.S. Government securities - Note B.... 1,730,300 1,711,700 Mortgages held for sale, net - Note C.. 21,700 50,600 Properties held for sale, net - Note D. 41,300 29,700 Accrued interest and other receivables. 59,500 55,100 Advances against defaulted Mortgage- Backed Security pools................ 162,000 52,800 Claims against lIUD/P’RA and VA.......... 15,400 5,200 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 loo_ Total Asseta . . . . . . . . . . . . . . . . . . . ...*.... $2,030,900 $1,905,900 Liabilities and Investment of U.S. Government Liabilities: Reserve for loss on Mortgage-Backed Securities Program - Note E.......... $629,000 $506,400 Trust and deposit liabilities.......... 45,900 48,000 Accounts payable and accrued liabilities 9,500 6.300 Total Liabilities...................... 684,400 560,700 Commitmente and Contingencies - Note F Inveetment of U.S. Government 1,346,500 1,345,200 $2,030.900 $1.905,900 See notes to financial statements. Page 18 GAO/AFMDol-O Government National Mortgage Association lWaneW Statamenta Statomont of Revenuea and Expenrea and Investment of U.S. Qovernment For the year ended September 30 1989 -- 1988 (Dollars In Thousands) Revenuer : Interest income......................... s 159,300 $ 195,000 Mortgage-Backed Securities Program income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244.100 231,000 Gain (loss) on investment in mortgages.. 400 (34,400) Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000 9,400 Net Revenue8 410,800 401,000 Expenses : Provision for loss on Mortgage-Backed Securities Program - Note E.......... $ 289,700 $ 146,000 Interest expense....................... 0 12,200 Mortgage-Backed Securities Program expeneeR............................. 50,000 30,500 Administrative and other expenses...... 16,700 6,700 Total Bxpenrer......................... 356,400 195,400 Excesr of Revenue Over Expcnsce........ $ 54,400 $ 205,600 Investment of U.S. Government at Beginning of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,345,200 $1.602.600 Excess of revenue over expenses........ 54,400 205,600 Returned to U.S. Treasury (53,100) (463,000) Invertment of U.S. Government at End of Year . . . . . . . . . . . . . . . . . . . . . . . . . . $1,346.500 $1,345,200 See notes to financial statements. Page 19 GAO/AFMD-91-8 Government National Mortgage Aseoclation . Statement of Ca8h Flow8 Increase (Decreare) ln Ca0L For the year ended September 30 1989 1988 (Dollars In Thousands) Cash flowr from operating activities: Interest received ...................... $164,400 $181,200 Mortgage-Backed Securities Program fees 243,000 231,000 Advances against defaulted Mortgage- Backed Security pools ................ (249.500) (149,200) Mortgage-Backed Securities Program cxpenrer ............................. (62,700) (31,900) Other income received .................. 62,800 17,600 Administrative expenses ................ (49,800) (7,400) Net cash provided by operating activities 108,200 241,300 Cash flows from investing activities: Proceeds from sale of mortgages ........ $ 25,900 $209,200 Principal repayments on mortgages ...... 3,400 37,600 Purchase of mortgagee .................. (1,400) (29,200) Purchase of propertie held for sale ... (140,600) (125,400) Proceeds from sale of properties ....... 48,100 13,700 Recoveries from PHA and VA ............. 28,000 15.800 Purchase of U.S. Treasury Securitiee, net ...................... (18,600) (38,000) Net cash (used) provided by investing activities ............................. (55,200) 83,700 Cash flows from financing activities: Cash returned to U.S. Treasury ......... (53,100) (463.000) Cash inflows from trust activities ..... 0 126,700 Net cash used in financing activities (53,100) (336,300) Net decrease in cash ..................... (100) (11,300) Cash at beginning of year ................ 700 12,000 Cash at end of year ...................... L 600 L 700 See notes to financial statements. Y Page 20 GAO/AFMD91-8 Government National Mortgage Association ii Ptlwlddstetamaata Reconciliation of Net Excess of Rerenua Over lhpanaea --. to Net Cash Provided by Operating Activities For the year ended Ileoteober 30 1989 * 1988 ‘T$XiGa In ThoiiZiZF Net exceae of revenue over expenses..,...... 8 54,400 $205,600 hdjuatmente to reconcile net exceea of reveaua over axpenses to net cash provided by operating activities: Provirion for loraea on Plortgage- Backed 8ecuritier Program.,.r.......... 289,700 146,000 (Gain) lore on inveatmant in mortgages... (400) 34,400 (Increase) decrease in accrued interest and other recaivablaa.................. (14,600) 8,600 (Increase) in advances against defaulted Mortgage-Backed Security pools......... (109.200) (43,100) (Decrease) increase in trust and deposit liabilities ............................ (2,100) 11,100 Lncreaaa (dacreaae) in accounts payable and accrued liabilities................ 3,200 (600) Net income from trust activities......... 0 (13,500) Decreare in Mortgage-Backed Securities reserve relating to operating activities .,,..........,.....*......... (112,800) (107,200) Total l djurtments.................... 53,800 35,700 Net cash provided by oparating activitiaa.. Q108,200 9241,300 See notes to financial statements. Page 21 Notor to the Flnsnclrl Sbtementr UOTN A-02GMI2ATIOU MD SmpIIupp OF SICUIFICANT ACCOUNTING POLICIES The Government National Mortgage Association (GNMA) was created in 1968 through amendment of Title III of the National Housing Act as a Goventment corporation within the Department of Housing and Urban Davalopo@nt (HUD) to administer mortgage support programs which could not be carried out in the private market. The Mortgage-iJacked Securities (HBS) Program is GNMA’s primary ongoing activity. The purpose of the program is to increase liquidity in the secondary mortgage market and attract new sources of capital for residential loans. Through the program, GNMA guarantees the timely payment of principal and interest on securities backed by pools of mortgages issued by private mortgage institutions. The guaranty is backed by the full faith and credit of the United States Government. CNHA requires that the mortgages be insured by the Federal Housing Administration (IMA) or the Farmer’s Home Administration (FmHA) or guaranteed by the Department of Veterans Affairs (VA). For several yeara until 1988, GNMA was also responsible for managing and liquidating a portfolio of mortgages, loans and other obligations that were acquired under various programs over several years. In addition, GNMA acted as trustee for two Federal trusts. U.S. Government Securities: U.S. Government securities are recorded at cost, net of unamortized discount or premiums. Discounts and premiums are amortized over the life of the security. Federal Housing Admlniutration (lWA) debentures are recorded at cost and are either held until maturity or used to pay FHA Insurance premiums. GNMA’s intent is to hold the securities until maturity. Mortgages and Properties Held for Sale: Mortgages and properties held for sale are reported on the Balance Sheet net of the allowance for loss on recovery or resale. The allowance for loss is established to reduce the carrying value of mortgages and properties held for sale to their estimated net realizable value, i.e. the amount GNMA expects to realize in cash upon sale of the mortgages and property or upon collection on the mortgages. Advances Against Defaulted Mortgage-Backed Security Pools: Advances against defaulted mortgage-backed security pools represent payments made to fulfill GNMA’s guaranty of timely principal and interest payment to MBS holders. Claims Against IilJDfFHA and VA: Claims against HUD/FHA and VA represent amounts receivable for recovery under FHA’s insurance and VA’s guarantee on defaulted mortgagee backing GNMA securities. Page 22 GAO/AP’lW%B1-8 Government National Mortgage Association Recognition of Revenuer and Expenses: Fees received for GNMA’e gwrantg of mortgage-backed securities are recognized as earned on an accrual baris. Fees recslved for commitments to subsequently guarantee mortgage-backed securities and commitments to fund mortgage loans are recognized when received. Losses on assets acquired through liquidation and claims against RUD/FHA and VA are recognized when they occur. Resarve for Loss on MES Program: In the operation of its MBS Programs, GNMA periodically monitors the financial condition and the operating results and statistics of issuers. As a result of these procedures, resarves are established to the extent management believes issuer defaults are probable, and Federal insurance and guarantees are insufficient to recoup GNMA advances. Funds in U.S. Treasury: All of GNMA’s receipts and disbursements are processed by the U.S. Treasury which, in effect, maintains GNU’s bank accounts. For purposes of the Statement of Cash Flows, Funds in U.S. Treasury are considered cash. NOTE B-U.S. GOVRRNMENTSECURITIES The U.S. Government securities and F’HA debentures are nonmarketable securities. Interest rates are established by U.S. Treasury and range from 5.5% to 12.75% annually. U.S. Government securities and PHA debentures at September 30 were as follows (dollars in thousands): Maturity 1989 1988 Less than one year $808,800 $750,800 One to two years 445,700 444,000 Three to five years 345 ) 900 452,800 More than five- years 137,000 77,000 1.737.400 1,724,600 Less: unamortized discounts (7,lOGJ (12,900) Total U.S. Government eecuritles $1,730,300 $1,711,700 NOTE C-MGRTGAGES HELD FOR SALE GNMA acquires certsin mortgages in order to protect the interests of GNMA security holders. Mortgages held for sale were as follows (dollars in thousands): At September 30, 1989 1988 Unpaid principal balance $ 23,600 $ 62,300 Allowance for doubtful recoveries (1,900) (II ,700) Mortgages, net $ 21,700 $ 50,600 Page 23 GAO/AF’MDBl-II Government National Mortgage Association , Nom D--PRoPRRTIEs RRLD FOR W ONHA, from time to time, acquires residential properties by foreclosure in order to protect the interaets of GNMA security holders. Properties held for sale were ns follows (dollars in thousands): At September 30, 1989 1988 Cost of properties $ 69,800 $ 81,500 Allowance for doubtful recoveries (28,500) (51,800) Properties, net $ 41,300 $ 29,700 NOTE E-RESERVE FOR LCSSES ON MRS PRoGRMf GNMA management believes that its reserves of $629.0 million at September 30, 1989 and $506.4 million at September 30, 1988 are adequate to cover probable losses from defaults by issuers of Gk&W securities. The reserves at September 30 comprise the following (dollars in thousands): MRS Program 1989 1988 Single Family $285,200 $120,000 Multifamily 50,500 6,000 Mobile Home 293,300 380,400 Total $629,000 $506,400 Changes in the reserve for the year ended September 30, 1989 were as follows (dollars in thousands): Single Multi- Mobile Family Fari ly Homes Total Balance, beginning of year $120,000 $6,000 $380,400 $506,400 Realized losses on security liquidation (68,700) (11,300) (87,100) (167,100) Provision 233,900 55,800 -O- 289,700 Balance, end of year $285,200 $50,500 $293,300 $629,000 As a result of limitations to the VA guarantee, GRMA is exposed to additional losses from securities backed by VA-guaranteed single family mortgages. GNMA management has estimated that losses approximating $285.2 million will probably result from defaulted issuers. Accordingly, GRMA has established a single family MM reserve. In the past management believed its losses from defaults by single family mortgage-backed securities issuers would be minimal because mortgages backtng the securities were either fully insured by FRA or because the VA guarantee effectively covered virtually all default losses. However, in recent years VA began to use an optional settlement whereby VA does not bid on foreclosed property if the subsequent sale of the property will lead to losses greater than the guaranteed portion of the mortgages (i.e., “VA no ” bids”). Unlike FRA insurance, which generally covers 100% of the defaulted Page 24 GAO/AF%fD-91-9Government National Mortgege Aeaodation Financlal Stat43menta single family mortgage, the VA guarantee is limited to a specified percentage of the mortgage. VA’s use of this optional settlement policy exposes GNtlA to additional lOs8eS when issuers of eecuritiee backed by VA- guaranteed mortgages default, particularly in regional areas experiencing economic streaa. GNMA estimates that between 30% and 40% of its $350 billion of single family mortgage-backed securities involve mortgages guaranteed by VA. GNMA has placed several major issuers of GNMA multifamily mortgage-backed securities in default. The multifamily mortgages backing the securities were coineurad by FHA and the issuers. In the opinion of management, and pursuant to an agreement between GNMA and PHA, GNMA will be indemnified by PHA for substantially all losses resulting from the default of these issuers. However, a reserve of $50.5 million has been recorded to cover administrative and other costs. The mobile home MBS reserve is for remaining payments to be made on losses from defaulted iseuere of GNMA mobile home mortgage-backed uecurities. Substantially all of the estimated losses on mobile home mortgage-backed securities ware accrued in 1987 as a result of actual or probable issuer defaults that took place In or prior to that year. NOTE F--COl’MI’l’MENTS AND CONTINGENCIES GNMA is contingently liable for timely principal and interest payments to mortgage-backed securities holders under its guarantee. The securities are backed by pools of FHA-insured, FmHA-insured, and VA-guaranteed mortgage loans. The total amount of securities outstanding at September 30, 1989 was approximately $361 billion, however GNMA’s contingent liability is considerably less because of the PHA and PmHA insurance and VA guarantee. Under its MBS guarantee, GNMA advanced $511.7 million in fiscal year ended 1989 and $385.5 million in 1988 against defaulted mortgage-backed security pools to facilitate timely pass-through payments, of which $262.2 million and $236.3 million respectively, was recovered. GNMA paid $140.6 million in 19R9 and $125.4 million in 1988 to purchase foreclosed properties and $29.2 million in 1988 to purchase mortgages in order to buy out the securities that were backed by those properties and mortgages, for the protection of the security holders. Prior to incurring a contingent liability as guarantor of mortgage-backed securities, GNMA accepts commitment applications from securities issuers. The commitment ends when the mortgage-backed securities are issued or when the commitment period expires. Outstanding commitments, as of September 30, 1989 were $29 billion. GN?lA has certain claims and lawsuits pending against it. Where claims are expected to result In payments, appropriate provision has been included in the financial statements. In the opinion of management and counsel, the resolution of other claims’ and lawsuits will not materially affect the financial position or operation of GM. Page 25 GAO/AFMD-91-8 Government National Mortgage Association I Ihandal Btatamente lloRI OIRBLATBD PARTIBS GNUA is rubject to controls ertabliehcd by government corporation control laws (32 U.S.C. 9101 through 9109) and management controls by the Secretary of HUD and the Director of the Office of Management and Budget. Such control8 could affect GNMA’s financial position or operating results in a manner that differs from those that might have been obtained if GtDlA were autonomous. HUD providea GNMA, without charge , use of space and equipment. Mminietra- tive expenses are allocated to GNMA by HUD. All GNt4A operations are performed by BUD personnel. HUD is reimbursed by GNUA for payroll and payroll related costs and other administrative services. Allocationa of these comts to GNMA are primarily based on projected staff hours required to carry out GtD4A operations, as a percentage of total projected staff hours for HUD. Allocated payroll related costs for which GNMh reimburses HUD Include matching contributiona to the Civil Service Retirement System (CSRS) and the Federal Employees Retirement Syetem (PERS). FERS went into effect for all HUD employees on January 1, 1987 pursuant to Public Law 99-335. GINA does not report its portion of the CSRS or FERS actuarial present value of accumulated benefits or unfunded pension liability, since these amounts are reported in total by the Office of Personnel Management. Carh receipts, disbursements and investment activities are processed by the U.S. Treasury. Funds in the U.S. Treasury represent cash currently available to finance purchase commitments and pay current liabilities. GtG4A has an outstanding authority to borrow up to $1.5 billion from the U.S. Treasury to finance its operations in lieu of appropriations if necessary. (916019) Page 28 GAO/AFMD414#Government National Mortgage Aeeociatlon ~ -~-- -_-.---ll.l- . .-....- - -.--._~_ Ordt~ring Information ‘i’hc* first. five copies of each GAO report are free. Additional copies are $2 c*ach. Orders should be sent to the following address, accom- panied by a check or money order made out to the Superintendent of I)ocumr~nts, when necessary. Orders for 100 or more copies to be mailthd to a single address are discounted 25 percent.. 1J.S. (;entaral Accounting Office I’.(). Hox 6015 Gaithtvsburg, MI) 20877 Ordtv-s may also be placed by calling (202) 275-6241.
Financial Audit: Government National Mortgage Association's 1989 Financial Statements
Published by the Government Accountability Office on 1990-10-30.
Below is a raw (and likely hideous) rendition of the original report. (PDF)