A watchdog report says that the Federal Housing Finance Agency jumped the gun when it required Fannie Mae and Freddie Mac to implement a new representation and warranty framework — exposing both companies to unnecessary risk.
The pair of secondary lenders implemented the new representation and warranty framework in September 2012 as part of a broader series of strategic initiatives known as “seller-servicer contract harmonization.”
While sellers had previously been liable for repurchases for the life of the loan, the changes enabled relief from such liability if the loan meant specific acceptable payment history criteria at various points during the life of the loan.
But a report issued by the FHFA Office of Inspector General said that agency mandated implementation of the new framework before Fannie and Freddie were ready.
Significant operational risks were unresolved at the time of implementation, according to the report, FHFA’s Representation and Warranty Framework Audit.
The OIG said that neither government-sponsored enterprise had implemented the processes, procedures and systems needed to operate within the new framework before it went live.
In Freddie’s case, an August 2012 risk analysis identified two systems that would need to be created and multiple systems that would need enhancement in order to support the framework. But the McLean, Va.-based company determined that the two systems would not be fully functional for two years.
Over at Washington, D.C.-based Fannie, implementation of numerous necessary systems still hadn’t been completed as of July and isn’t expected to be done until late next year.
“As a result, there is an inherent risk for potential errors and the enterprises may experience credit losses that otherwise may have been mitigated through use of contractual remedies such as repurchases,” the report stated.
In addition, the OIG said that FHFA mandated a 36-month sunset period for representation and warranty relief but failed to validate the secondary lenders’ analyses or perform sufficient additional analysis to determine whether financial risks were appropriately balanced between the GSEs and sellers.
The OIG was critical of the 36-month period because an internal analysis by Freddie found repurchase defects were far less likely on loans with an as-agreed 48-month payment history than a clean 36-month history.
“Thus, losses to the enterprise could be less with a longer sunset period,” the OIG stated. “Therefore, FHFA cannot support that the sunset period selected does not unduly benefit sellers at the Enterprises’ expense.”
FHFA should assess with the current operational capabilities of Fannie and Freddie minimize the financial risk from the new framework, according to the OIG.
In addition, an FHFA assessment should determine whether financial risks of the new framework, including the sunset period, are balanced between the GSEs and sellers — though FHFA disagreed with this recommendation.
