OIG Finds FHFA Deficient in Oversight of Fannie Mae Underwriting Guidelines and Variances

On Thursday the Federal Housing Finance
Agency (FHFA) Office of Inspector General (OIG) released the results of three
evaluations of FHFA’s oversight of the two government sponsored enterprises
(GSEs) Freddie Mac and Fannie Mae.  FHFA
is the successor conservator of the GSEs which were placed into government
conservatorship in August 2008.  The
other two evaluations, one of the oversight of the GSEs’ charitable giving and
the other of Fannie Mae’s participation in an industry convention, were reported earlier this morning.

This audit concerns the extent of FHFA’s
oversight of Fannie Mae’s single-family mortgage underwriting standards
.  Specifically, OIG reviewed FHFA’s written
policies for oversight of these standards and oversight of Fannie Mae’s
internal controls over its implementation of the standards.  OIG also plans to contract for additional
audit coverage related to the effectiveness of quality controls used by the
GSEs to determine compliance with underwriting standards.

The GSEs buy mortgages from lenders and
either keep them as investments, or package and sell them to other investors.  During the first 10 months of 2011, Fannie
Mae purchased nearly 2.1 million loans valued at $427 billion.  To be eligible for purchase, a mortgage must
satisfy the GSEs’ underwriting standards or have their approval to vary from
them.  Fannie Mae’s underwriting
standards, which it refers to as eligibility requirements, derive from a
combination of Congressional charter-based and traditional risk-based criteria.  Charter-based criteria would include original
principal balance limits and loan-to-value ratios while risk based criteria
focus on collateral, capacity, and creditworthiness.

Notwithstanding the housing boom and
subsequent housing collapse, Fannie Mae’s basic underwriting standards for
purchase-money loans secured by single-family, principal residences have not
changed materially since 2006.  However,
Fannie Mae has authorized a number of variances that have impacted those
underwriting standards
and the numbers of these have fluctuated substantially
over time.  In 2005 when standards were
loose, Fannie Mae authorized over 11,000 variances.  Between January 2005 and August 2007, Fannie
Mae began rescinding variances, which tightened underwriting standards.  Fannie Mae had over 600 variances as of
September 2011. These variances from underwriting standards effectively relax
those standards and this contributed to the credit losses and credit-related
expenses suffered by Fannie Mae in recent years.

As an alternative to qualifying mortgage
loans for Fannie Mae’s purchase by manually meeting its underwriting standards
(or authorized variances from them), most lenders rely on automated
underwriting software
.  Fannie Mae has
developed its own software, DU, which lenders use to evaluate whether
prospective mortgage loans are eligible for sale to the Enterprise.  In 2010, over 1,500 lenders used DU, and over
71% of the loans delivered to Fannie Mae were approved using the software.  Lenders may also develop their own
underwriting software, but Fannie Mae must approve and grant a variance for its

Fannie Mae’s single-family mortgage
business involves a nationwide network of approximately 2,500 approved mortgage
lenders and servicers
.  From January to
October 2011, Fannie Mae acquired over 2 million loans valued at over $427
billion.  To oversee this large venture, Fannie
Mae has established an oversight process that includes lender/servicer
assessment, quality assurance review and remediation for purchased loans, and
fraud detection.

  • Fannie Mae oversees
    its mortgage sellers and services with a team that reviews sellers’ documents
    and visits their offices.
  • Fannie Mae does
    not conduct compliance reviews on loans prior to purchase but its quality
    assurance group reviews samples of loans post-purchase to ensure they comply
    with the terms and conditions under which they were purchased.
  • A Mortgage Fraud
    Program (MFP) team reviews cases of suspected fraud, works to remediate it and
    recoup losses, and report fraud to appropriate authorities.

As conservator, FHFA assumed all of the
powers of the GSEs’ shareholders, directors, and officers.  In November 2008, FHFA delegated day-to-day
decision-making back to the GSEs’ officers and directors while identifying
particular activities that required its approval including those that involve
capital stock, dividends, increased risk limits, material changes in accounting
policy or reasonably foreseeable increases in operational risk and those that
will likely cause significant reputational risk.

In July 2009, FHFA further refined its
role with a regulation clarifying its delegation of day-to-day decision-making
authority.  The regulation requires FHFA
approval of all new GSE products and activities but states that “new products”
do not include any modification to underwriting criteria for those mortgages
purchased or guaranteed by the GSEs.

OIG found that FHFA does not have a
formal process for reviewing underwriting standards and variances
but it
informally reviews and comments on Fannie Mae’s proposed credit policy
changes.  However, FHFA’s review
mechanism was not designed to assess underwriting standards and variances and
does not assess them in a systematic manner.

FHFA also reviews, comments on, and
approves Fannie Mae’s Corporate Scorecard. OIG says that the scorecard is not a
substitute for a detailed consideration of underwriting standards and variances
and that Fannie Mae’s Corporate Scorecard for 2012 does not include explicit
goals for underwriting standards.

In contrast to FHFA’s decision not to
affirmatively review underwriting standards, the FHFA believes that feedback
and approval of the Corporate Scorecard is an appropriate conservatorship action.  However, underwriting standards and variances
control the mortgages that Fannie Mae acquires, not the scorecard’s goals, and
there are many factors that contribute to the better performance of recent
mortgage vintages.

OIG concluded that FHFA can strengthen
its oversight by creating formal processes for reviewing both  GSEs’ underwriting standards and variances
from them and enhance is guidance for planning and conducting its examinations
of the GSEs’ underwriting quality control.

To summarize, OIG’s audit determined the

  1. FHFA
    lacks policies and procedures controlling its process to review underwriting
    standards and variances.
  2. Guidance
    for targeted examinations of GSE compliance with underwriting standards can be

targeted examinations that included Fannie Mae’s quality control of compliance
with underwriting standards which began in 2011 is a positive step but
additional guidance is needed to ensure the success of underwriting
examinations going forward which should include criteria for independent
testing of quality control.

FHFA’s most recent quarterly risk assessment cited credit risk as a critical
concern due in part to the high volume of seriously delinquent loans.  This number seems to be declining and later
vintage loans are performing well but credit risk is noted to be increasing due
to Fannie Mae’s RefiPlus program with its high LTV ratios.  The new HARP program may exacerbate this
risk.  FHFA needs to address the increasing
credit risk through development of comprehensive examination guidance.

Mae also continues to authorize over 600 variances yet FHFA does not formally
review them and thus is not in a position to appreciate their nature and
scope.  Obtaining information about the
variances would help to educate FHFA about existing increased credit risk and
may improve examination guidance.

Following its audit, FHFA recommends

  • FHFA’s
    Division of Housing Mission and Goals formally establish a policy for its review
    process of underwriting standards and variances including escalation of
    unresolved issues reflecting potential lack of agreement.
  • The
    Division of Examination Program and Support enhance existing guidance for
    assessing adherence to underwriting standards and variances from them.

In OIG’s opinion, these recommendations
apply to FHFA’s responsibilities to Freddie Mac as well as to Fannie Mae.

FHFA responded to the OIG report,
agreeing with both recommendations and identifying proposed actions to address
them and OIG states it found the actions sufficient to resolve the
recommendations, subject to further review. 

…(read more)

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