FHFA-OIG Looks at GSE Counterparty Risk, Servicing Contracts

by devteam September 18th, 2012 | Share

The Federal Housing Finance Agency’s Officernof Inspector General (FHFA-OIG) has completed two evaluations related tornservicing of Fannie Mae and Freddie Mac’s (the GSEs) owned and guaranteedrnportfolios.  Reports were issued onrnTuesday from an evaluation related to Fannie Mae’s High Touch Servicing Programrnand a separate evaluation of FHFA’s oversight of the GSE’s management ofrnhigh-risk sellers and servicers.  </p

The first evaluation looked at a programrninitiated by Fannie Mae to handle high risk loans.  FHFA-OIG evaluated a single transactionrnbetween Freddie Mac and Bank of America under its High Touch ServicingrnProgram.  While it found little to faultrnabout that transaction it did suggest a few specific changes in FHFA and FanniernMae management and supervision. </p

The High Touch Servicing Program</butilizes specialty servicers who work with at-risk borrowers to help reduce therndefaults on mortgages owned or guaranteed by Fannie Mae.  In order to transfer mortgage servicingrnrights (MSR) to those servicers Fannie May must first terminate the currentrnservicing contract.  In the summer ofrn2011 Fannie Mae proposed to purchase the mortgage servicing rights tornapproximately 384,000 mortgage loans from Bank of America (BOA) for $512rnmillion, a transaction that attracted the attention of the media and ofrnCongress which asked OIG to review it.</p

OIG found that the transaction with BOArnwas part of a larger and essentially sound initiative.  That transaction was the largest for the HighrnTouch Program to that point and the amount paid was consistent with otherrntransactions under the program.   Anrninternal audit by Fannie Mae, however, raised questions about the controlsrnsurrounding the servicing program as well as the likelihood it would achievernthe projected savings.  Similarly FHFA-OIGrnfound that Fannie Mae had relied on a single consultant to price mostrntransactions under the program and that the terms of the standard  Fannie Mae servicing contract appeared tornconstrain transfers at no or reduced cost for reasons related to the portfolio’srnperformance.  It also determined thatrnFHFA’s oversight of the program needed improvement.</p

FHFA-OIG recommends that FHFA ensurernthat Fannie Mae does not have to pay a premium to transfer inadequatelyrnperforming portfolios.  This might bernachieved through the reduction or elimination of the 90 day period during whichrnservicers are able to seek potential buyers for a portfolio, contractrnprovisions allowing purchase of MSR at a pre-established rate based onrnperformance criteria or by Fannie Mae’s retention of the right to approve thernsale of MSR to ensure transfer to an appropriate servicer.</p

The report makes several otherrnrecommendations:</p<ul class="unIndentedList"<liFHFArnshould henceforth require that Fannie Mae and Freddie Mac (the GSEs) getrnapproval from FHFA for any unusual or high cost new initiatives. </li<liFHFArnshould ensure that Fannie may apply more rigor and scrutiny to pricingrnsignificant MSR transactions. </li<liFHFArnshould review the assumptions underlying High Touch and, as the programrndevelops reevaluate the performance criteria.rn</li</ul

The second evaluation arose out of the bankruptcyrnof a Freddie Mac servicer in 2009.  ThernGSEs monitor counterparties (e.g., sellers and servicers) that they haverndesignated as high-risk and as of the third quarter of 2011 had over 300rnservicers on watch lists and had stopped doing business with 40 of them.   When the bankruptcy occurred, Freddie Macrnhad to file a $1.8 billion claim against the servicer’s estate, part of anrnestimated $6.1 billion the GSEs have lost from failures of four counterpartiesrnsince 2008.  The GSEs estimate they haverna remaining risk exposure of approximately $7.2 billion from counterpartyrnportfolios totaling $955 billion.</p

The FHFA-OIG evaluation found that FHFArnhad asked for contingency plans from the GSEs for managing credit and counterpartyrnrisk but had not published written policy guidance for these plans, insteadrnfield testing draft examinations procedures, hoping that the GSEs wouldrnvoluntarily conform their procedures to the Agency’s examinationrninstructions.  Consequently, the GSEsrnhave not developed plans.  </p

Fannie Mae initially said its “ActionrnPlans” for high risk seller/servicers were contingency plans but FHFA-OIG notedrnthat, while they listed remedial actions for specific deficiencies, they do notrnlay out advance comprehensive plans for reducing the GSEs’ risk exposure.  In response to a second request for plans,rnFannie Mae told FHFA that it had informally discussed such planning withoutrndeveloping an actual plan.</p

In response to FHFA-OIG’s request forrnplans, Freddie Mac provided various documents for screening counterparties,rnmonitoring them, and remediating specific risks.  While these actions may help mitigate FreddiernMac’s counterparty risk, the GSEs’ tools and actions do not constitute anrnoverall contingency plan because they do not lay out a comprehensive plan ofrnaction in the case of deteriorating financial condition or failure of arncounterparty.</p

In early 2012 the examiners-in-charge ofrnboth GSEs agreed with FHFA-OIG’s conclusion that the GSE’s do not have adequaterncontingency plans to manage the risk of a failed seller/servicer.  FHFA-OIG recommended that FHFA issuernstandards for the GSEs to develop comprehensive contingency plans that at arnminimum should include quantitative assessment, event management, monitoring,rnand testing elements and that it finalize its February 2012 draft examinationrnmanual to include elements related to contingency planning.

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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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