Fannie Mae, to date, has always seemed more aggressive than Freddie Mac in pressing major lenders to repurchase problem loans. Fannie has continually ratcheted up its requests for servicers to buy back loans, while Freddie has reduced its requests over the past four consecutive quarters.
Late last month, the Office of Inspector General at the Federal Housing Finance Agency issued a report that sheds some light on this disparity.
The OIG report focuses solely on Freddie's policy for screening defaulted loans for possible underwriting defects that could trigger a loan buyback request or a demand for reimbursement to cover losses. The report does not cover Fannie's policies, but is highly critical of Freddie's approach.
The OIG auditors rely heavily on the findings of an unidentified FHFA senior examiner. The examiner recognized that Freddie's loan repurchase review policy is too restrictive and the GSE could lose “billions of dollars” unless it is corrected.
Freddie generally reviews loans that go into default during the first two years for underwriting defects, and only if there are indications of inflated appraisals or fraud.
In mid-2010, the FHFA senior examiner observed that alt-A and interest-only mortgages generally default during years three through five, mainly due to later resets that raise the interest rate and increase monthly payments.
Yet most of Freddie's high-risk loans were not being reviewed for potential repurchase claims because they did not default during the first two years.
As of June 30, Freddie had $104 billion of alt-A loans and $82 billion in interest-only payment mortgages in its single-family credit guarantee portfolio. Nearly 12% of the alt-A loans and 18% of IO loans are 90 days or more past due.
The examiner estimated that 100,000 foreclosed alt-A and IO loans in the 2006 vintage were excluded from repurchase reviews because of Freddie's policy, thus “eliminating any chance to put ineligible loans back to the lenders.”
FHFA examiners met with Freddie managers in June 2010, urging them to conduct their own analysis on loans defaulting after two years. But Freddie declined, while the GSE regulator decided not to press the issue, according to the inspector general's report.
The OIG reported that Freddie senior managers were skeptical that repurchase claims would “increase appreciably” or cover the additional expense of conducting more expansive reviews.
Freddie executives also resisted making any changes—claiming a more aggressive approach to repurchase claims could “adversely affect Freddie's business relationships with Bank of America and other large sellers,” the OIG report says.
In early December 2010, Freddie reached a tentative agreement with B of A to settle all existing repurchase claims on Countrywide loans and future claims (with limited exceptions) for $1.35 billion.
The bank also reached a $1.52 billion settlement with Fannie Mae involving past and present repurchase claims—but not future claims on Countrywide loans. (B of A acquired Countrywide in 2008.)
Freddie executives told the board of directors that $1.35 billion was at the high end of the range of expected repurchase recoveries. And the settlement will improve Freddie's ongoing relationship with B of A.
Overriding the objections of the senior examiner, FHFA acting director Edward DeMarco approved Freddie's settlement. However, later on, DeMarco placed a temporary halt on future settlements by Freddie.
The FHFA insists the suspension is related to “continuing questions involving loan quality reviews by Freddie Mac” and it is not related to the Bank of America settlement.
“FHFA has not changed its view that the (B of A) settlement reached in December was appropriate and reasonable,” FHFA senior associate director Jeffrey Shohn says in a written response to the OIG report.
The OIG contends that FHFA senior managers should have required the GSE to start testing and reviewing loans that defaulted after two years—several months before the B of A settlement.
It would have placed the FHFA in a “better position to evaluate Freddie Mac's repurchase claim settlement with Bank of America,” the OIG report says.
Earlier this year, Freddie managers finally initiated a test of 1,000 interest-only loans that were previously excluded from repurchase reviews.
In August, Freddie reported the preliminary results to the FHFA. It shows that “at least 15% of the sample—a higher percentage than anticipated by Freddie Mac management in connection with the Bank of America settlement—contains apparent representation and default defects” that could prompt a repurchase claim, according to the OIG report.
The GSE is expected to complete a final report on the tests by the end of the year.
Rep. Brad Miller, D-N.C., called the OIG report “very damning” and said top Freddie Mac officials should lose their jobs. “The most infuriating finding is that Freddie Mac knowingly settled too cheaply to remain on good terms with Bank of America and others in the financial industry,” Miller said.
