That's the conclusion of a report issued Tuesday morning by the inspector general of the Federal Housing Finance Agency, Fannie Mae's conservator. The government-sponsored enterprise reasonably believed that transferring troubled loans from the beleaguered Bank of America to a "high-touch" servicer would prevent additional losses and save borrowers' homes—but it had to negotiate a high price in order for Bank of America to promptly release them.
If Fannie had demanded a lower price, Bank of America would have had 90 days to line up a better offer.
"B of A may well have recognized that the prospect of a three-month delay in the transaction…provided it some leverage," the report states. It found that the bank's handling of loans was considered "below average," but not so bad as to allow Fannie Mae to seize the servicing immediately and without payment. Fannie ultimately coughed up an extra $70 million to speed the transfers along, the report says.
Beyond explaining the terms of the Bank of America deal, the OIG's review shed light on a largely unacknowledged Fannie Mae program to shift loans from struggling banks to smaller specialty mortgage companies. The OIG found that the effort—initially not disclosed to the FHFA—has significant promise, but has been on ice over FHFA concerns that it rewarded underperforming servicers. In an addendum to the report, the FHFA agreed the program had value.
Over the course of at least 13 deals, Fannie has paid $1.5 billion to purchase or finance the purchase of 700,000 loans. Once acquired, the loans were sent to delinquency-oriented servicers, such as Nationstar Mortgage and Green Tree Servicing. The FHFA has previously blocked attempts to learn the details of these contracts, such as a public records request filed by American Banker.
The deals came about after Fannie analysts realized that 70% of the GSE's mortgage losses stemmed from loan portfolios with a total principal balance of $300 billion to $400 billion. Because major banks were neither equipped nor compensated to provide extensive borrower outreach and foreclosure alternatives, the GSE concluded that "specialty servicers could potentially help avoid substantial anticipated credit losses," the report says.
Given the size of the expected losses—Fannie expected to take a $10.9 billion credit hit on the 384,000-loan B of A portfolio alone—the anticipated benefits outweighed the costs of freeing them, the OIG concluded.
The report raises questions about the quality and extent of communication between Fannie personnel and the FHFA, which has overseen both GSEs since their 2008 financial collapse. Fannie did not initially inform the agency of its plan to transfer high-risk loans to a new servicer, and only mentioned it "during the internal approval process" of a $512 million payment to Bank of America.
Not everyone at the FHFA initially liked the deal, with some staff arguing that servicing buyouts created a moral hazard.
"FHFA stated that such transactions not only failed to encourage improved servicer performance, but actually encouraged and even rewarded poor performance," the OIG report says.
The regulator forced Fannie to take the deal back to B of A, which eventually agreed to a $70 million "clawback" clause if the portfolio didn't improve under new management.
Overall, the OIG's analysis concluded that, while negotiating a price with an underperforming servicer was vexing, it was worth it for the possible savings.
Yet the B of A deal was the last that Fannie has been allowed to undertake. According to the OIG report, the FHFA halted the servicing repurchases and redistributions after finding Fannie's actions paid a premium to underperforming servicers.
"According to FHFA, in instances where Fannie Mae had opportunities to [transfer loans without paying a premium], this option was not exercised," the OIG report says.
Without directly saying the FHFA should permit Fannie to resume the sales, the OIG report concludes that the Bank of American transaction "was part of a larger, essentially sound initiative," and that Fannie was right to pay a premium to avoid delays and costly feuds with servicers. Nonetheless, the report suggests that Fannie could do a better job valuing servicing rights, and that the FHFA should have been told of the program much earlier.