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)


                 ‘CJuiteci States General Accountinti   Office
                 Report to the Congress
GAO                                                                       ,

                 FINANCIAL AUDIT
                 Government National
                 Mortgage Association’s
                 1989 Financial


GAO/AFMD-9 l-8
GAO          General Accounting
             Washington, D.C. 20548

             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

                   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

                            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

                            Page 2                    GAO/AFMTJ-918 Government National Mortgage Amociation

                       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


    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


                            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
                            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

                     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
Auditors’ Opinion                                                                                 10

Auditors’ Report on                                                                               12
Internal Control
Auditors’ Report on                                                                               17
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


                       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

                             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
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

                      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

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.

                    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

      Y   February 28, 1990

                               Page I7
Balance Sheet

                                                                                                    September   30
                                                                                        1989                      1988
                                                                                        (Dollars       In Thousands)

                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


                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.


                                                   Page 20                                   GAO/AFMD91-8 Government National Mortgage Association

                 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
     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

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.


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


GNMA acquires      certsin    mortgages in order to protect  the interests     of GNMA
security    holders.       Mortgages held for sale were as follows    (dollars   in

      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


 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.


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

                                      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

           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.