OIG Recommends Expanded Review Policy for GSE Settlements

By: Jann Swanson • Fri, Aug 23 2013, 4:42 PM

In January 2013 the Federal Housing Finance Agency, conservator of Fannie Mae approved a settlement between Fannie Mae and Bank of America in the amount of $11.6 billion. The settlement resolved Fannie Mae's claims that Countrywide Mortgage, purchased by Bank of America in 2008, had breached its representations and warranties in selling it billions of dollars in residential mortgage loans between 2000 and 2008

There were three parts to the agreement. The first was to settle representation and warranty claims for defective loans and resulted in $10.26 billion in cash proceeds to Fannie Mae, $3.55 billion of which was a "make whole" payment, and $6.71 billion repurchased loans. The second part was a payment of $1.30 billion in compensatory fees for Bank of America's failure to meet foreclosure timelines. The third part, with no dollar value attached, allowed Bank of American to transfer approximately 1.1 million in servicing rights (MSR) for Fannie Mae owned or guaranteed loans to large "high touch servicers" with the capability of better handling distressed loans.

In September 2011 the Office of Inspector General (OIG) of FHFA recommended that FHFA issue internal guidance regarding the handling of any future repurchase settlements and on June 27, 2012, the Agency issued the FHFA Settlement Policy and the FHFA Settlement Procedural Guide. The policy applied to settlements of Fannie Mae and Freddie Mac (the GSEs) claims against counterparties related to mortgage repurchases, mortgage insurance, or private-label mortgage back securities (PLMBS). It calls for FHFA to direct and approve settlements that satisfy the goals of the conservatorship and exceed $50 million and provides the option for FHFA to review smaller transactions. It defines the respective roles of FHFA officials and GSE management and boards and was designed to ensure that relevant parties within FHFA had the opportunity to provide their views to the conservator on a proposed settlement.

At the suggestion of FHFA, the agency, Fannie Mae, Bank of America met in September 2011 to discuss the possibility of a comprehensive settlement relating to these legacy Bank of America loans. As the parties continued to meet, however, there were substantial differences of opinion about the value of the loans in question and the possibility of litigation was raised. By February 2012, Fannie Mae ceased purchasing Bank of America mortgages, except those tied to the Home Affordable Refinance Program (HARP). The two sides spent many hours discussing their valuation models.

Eventually, the parties agreed to divide the representation and warranty settlement into the two part reps and warranties settlement referenced above with "make whole" compensation for Fannie Mae's losses and a separate agreement to repurchase approximately 30,000 loans at the unpaid principal balance plus delinquent interest. This change helped break the stalemate and the two sides reached agreement more than a year after the first meeting. FHFA approved the settlement, and Fannie Mae and the bank completed the transactions in January 2013.

The January 2013 settlement with Bank of America provided the first opportunity for OIG to review FHFA's implementation of its new settlement policy and OIG has now released a report on that review and, as the second and third parts of the settlement fell outside of the FHFA policy, contrasting FHFA's oversight under the policy with its oversight of matters that fell outside of that policy.

The representation and warranty settlement was well above the $50 million threshold and therefore the Settlement Policy applied. It did not, however, apply to the resolution of compensatory fees or to the mortgage servicing transfer, regardless of how large they were, because those agreements did not involve mortgage repurchases, mortgage insurance, or PLMBS.

OIG analyzed the Settlement Policy and divided its provisions into more than 50 elements and then reviewed whether FHFA and Fannie Mae applied each of the 50 elements to the resolution of the representation and warranty dispute. Some of the main elements were:

Settlement Value and Commercial Reasonableness. Analysis by Fannie Mae and calculations of an independent consultant led Fannie Mae and FHFA to conclude that the value of the reps and warranty settlement exceeded the value absent a settlement and that the settlement was commercially reasonable.

Independent Third-Party Review. For settlements valued in excess of $500 million a knowledgeable third-party must review and attest that the proposed settlement is a commercially reasonable resolution. Fannie Mae obtained such a review and the consultant attested that the settlement was commercially reasonable in light of Fannie Mae's claims.

A settlement must also satisfy "one or more goals of conservatorship" and the policy lists reasons that meet that standard including that the settlement will reduce costs of pursuing claims though lengthier and more costly processes; speed the timeline for restoring stability to company operations, or bring certainty to and restore confidence in marketplace norms and practices. FHFA stated in announcing the settlement that it was "a major step forward in resolving issues from the past and providing greater certainty in the marketplace, which remain critical FHFA goals as conservator."

A settlement must also be "properly documented." OIG's review of the transaction records showed that the documents required by the Settlement Policy were included in the records.

The settlement must also be properly coordinated within FHFA and its legal, policy, and supervision staff who can analyze and assess the claims at issue. Supervision staff must also ensure that the Office of Conservatorship Operations (OCO) are aware of issues arising from its examinations that may be relative to the proposed settlement. Legal officials were involved from the beginning. The Office of Housing and Regulatory Policy (OHRP), while not involved in the reps and warranty settlement was involved in the transfer of mortgage servicing rights. Further FHFA staff were present at several meetings at which the settlement was discussed.

Under the Settlement Policy, OCO must-to the extent practicable and appropriate-ensure reasonable consistency with other GSE settlements with specific counterparties across similar types of claims. FHFA stated while comparisons are difficult across transactions Fannie Mae did present FHFA with information regarding other settlements from recent years.

OIG concluded that FHFA adhered to its own established policy in reviewing the representation and warranty settlement between Fannie Mae and Bank of America. But, given that they were not included in the policy, the resolution of compensatory fees and the transfer of servicing rights did not benefit from such an established process.

Fannie Mae had demanded compensatory fees from Bank of America for deficiencies in foreclosure management, specifically for the bank's failure to meet deadlines. The Bank had disregarding the demands and almost all compensatory fees assessed from 2010 through September 2012 remained outstanding until the date of the settlement - approximately $664 million.

Fannie Mae was able to bring Bank of America to the negotiating table because of the banks interest in completing a significant MSR transfer to specialty services and needed Fannie Mae's approval. It therefore agreed to negotiate resolution of the compensatory fee claims.

OIG found that the process FHFA used to review the compensatory fee resolution was not on par with the process it had established for representation and warranty settlements. One deficiency was that FHFA had failed to consider a comparable and contemporaneous situation at Freddie Mac. Fannie Mae's approval of the MSR sale was not formally a part of the settlement agreements but occurred simultaneously and FHFA recognized that the negotiation of the compensatory fee exposure was directly linked to the MSR transfer and was structured to provide greater leverage in the negotiation and resultant recovery of funds owed to Fannie Mae.

Both OIG and FHFA have long expressed concern about GSE servicing transfers and in September 2012 OIG recommended that FHFA more closely monitor transfers to high touch servicers. FHFA said it intended to ensure that Fannie Mae was adequately managing the risk related to these transfers and would continue to follow up through the 2013 examination cycle. Based on OIG's and its own studies FHFA was aware of the complexity and risk of large MSR transfers to specialty servicers and aware of the significance of its own review of these transfers.

Although FHFA has revised and refined its delegations of authority to the GSEs it continues to consider servicing transfer to be within the GSEs regular business activities and corporate discretion. However, along with being actively involved in most aspects of the Fannie Mae/Bank of America settlement FHFA's OHRP and its Division of Enterprise Regulation reviewed and OHRP ultimately approved the MSR transfer.

Nonetheless, OIG concluded the review of the MSR transfer did not reflect the depth of analysis that likely would have been accorded had FHFA followed a process comparable to that used in its newly established process for reviewing mortgage repurchase, mortgage insurance, and PLMBS settlements.

As to the larger settlement, OIG found that FHFA had followed its settlement review policy and procedures it had established with regard to mortgage repurchase, mortgage insurance, and PLMBS claims.

OIG concluded that there are several opportunities for improvement that FHFA might consider. The most important would be to develop procedures for settlement of compensatory fee claims and significant MSR transactions. It might also consider engaging staff earlier in the approval process and improving documentation showing that applicable requirements were satisfied.