A watchdog agency lambasted the regulator of Fannie Mae and Freddie Mac for failing to assess the risks of a plan to reduce loan buybacks for banks and mortgage lenders.
The Federal Housing Finance Agency adopted the plan last year even though Fannie and Freddie did not have the technology in place to make it work, the agency's inspector general said.
The FHFA's so-called "representation and warranty" framework was supposed to reduce taxpayer losses and improve the quality of loans backed by the government-sponsored enterprises. The plan also was designed to give banks and mortgage lenders relief from costly repurchases, thus encouraging them to make more loans to borrowers with lower credit scores.
The framework was a significant change from the past when Fannie and Freddie only reviewed a sampling of loans they acquired, or examined loans only after, not before, a borrower defaulted.
But the inspector general's report found that FHFA, Fannie and Freddie did not adequately consider the operational risks of not having the necessary computer systems, tools and processes in place. As a result, banks and mortgage lenders may have received too much relief from buybacks, the report said. Taxpayers now are at even greater risk for losses that cannot be recouped down the road, the inspector general warned.
"There is potentially [the] unmitigated risk of errors in the new loan review framework and the [GSEs] may experience credit losses that otherwise could have been avoided," the inspector general said in the report to be released Wednesday. "Without adequate systems and processes, achieving a positive economic outcome for the [GSEs] through implementation of the new framework is uncertain."
The 37-page report describes the FHFA's plan to implement the new framework in January 2013 even though various loan tracking systems had not been built yet. Freddie, for example, did not have "the necessary systems in place" to assess either the eligibility of loans or to validate appraisal data by the plan's start date, the report found.
"Despite FHFA's awareness that Freddie Mac would not have the systems and tools in place it deemed necessary to help identify non-compliant loans and reduce credit losses, FHFA continued with its January 1, 2013, implementation for the new framework," the report stated.
The report, signed by Russell A. Rau, the deputy inspector general for audits, said that the FHFA, Fannie and Freddie had relaxed a number of requirements without any analysis.
Loans delivered to Fannie and Freddie after July 1 of this year relieve lenders of certain repurchase obligations as long as the borrower makes 36 months of consecutive, on-time payments. Lenders that refinanced borrowers using the government's Home Affordable Refinance Program got relief from repurchasing bad loans after just a year of consecutive, on-time payments.
The report criticizes the FHFA for adopting these "sunset periods," ranging from one year to three years, before the GSEs made changes to their systems and processes.
Lenders "stand to benefit from the lack of preparation as loans start to pass the sunset dates without thorough screening of their quality," the report stated.
Moreover, the timetable was so tight that Fannie and Freddie could not possibly flag all defective loans, the report said.
The GSEs "needed to shift the primary focus of their quality control efforts from nonperforming loans where underwriting defects may be more obvious, to the larger population of performing loans within the sunset period," the report stated. "FHFA has performed limited work to ensure that necessary controls are in place and operating effectively prior to the applicable sunset periods."
Despite the concerns raised, the FHFA does not intend to conduct reviews and has no exams scheduled on the quality control process or rep and warranty framework.
The report strikes a particularly admonishing tone about the FHFA's decision-making process. The FHFA asked Fannie and Freddie to recommend a specific sunset period for lenders to get relief from buybacks. Fannie recommended a 36-month sunset period, while Freddie suggested 48 months; the FHFA did not perform a sufficient analysis before going with Fannie's number.
"FHFA did not perform any procedures to validate the underlying mortgage data, test the results furnished by the [GSEs], or direct the [GSEs] to re-work their analysis using the same criteria, such as consistent sampling methodologies and vintages of the mortgages selected for review," the report stated. "FHFA also did not develop an understanding of any measures taken by the [GSEs] to validate this data."
Since defaults by borrowers tend to rise after three years, the report said the FHFA appears be foregoing potential recoveries.
The GSEs now bear the risk that they "no longer have the repurchase remedy available to them if underwriting quality problems exist," the report found.
The FHFA disagreed with one of the inspector general's two recommendations. The agency will continue to examine and review the GSEs' loan purchase operations. But it does not plan on analyzing the financial risks of the new framework, including the sunset periods.
Sandra Thompson, an FHFA deputy director, wrote in a letter to Rau this month that "revisiting those decisions" may have an adverse market effect and may not align with "FHFA's objective of increased lending to consumers."