The Federal Housing Finance Agency's (FHFA) Office of Inspector General (OIG) has issued a report on the progress FHFA has made in correcting substantial deficiencies OIG identified in a settlement agreement with Bank of America (BOA) in 2011.  The settlement involved repurchase claims made by Freddie Mac against BOA seeking reimbursement for loans purchased from the bank which later defaulted.  FHFA oversaw negotiations leading to the settlement.

The number of repurchase requests issued divided by the number of loans reviewed is the repurchase rate.  As of September 2010 Freddie Mac had requested repurchase of 59,513 of the 250,833 loans it had reviewed between 2005 and July 31, 2010, a rate of 24 percent.  However, as of that time it had received reimbursement for only 35,569, 14 percent, of the loans it had reviewed.  By the end of 2010 the company's outstanding repurchase claims against all loan sellers totaled $3.8 billion.

On January 3, 2011 FHFA announced that Freddie Mac and Fannie Mae had agreed to settle various claims against BOA and the bank had agreed to pay Freddie Mac $1.35 billion to settle current and future loan repurchase claims on 787,000 loans.  There was considerable public criticism of the settlement agreement at the time it was announced in January 2011 and OIG undertook an evaluation of FHFA's oversight, issuing a report on September 27, 2011.

OIG found that an FHFA examiner had raised concerns about Freddie Mac's loan review process months before the BOA settlement but FHFA did not act on or test the ramifications of these concerns.  Freddie Mac's practice was to review loans that became non-performing within two years of origination or with payment problems within that time frame. This meant Freddie Mac had systematically excluded from the review process many loans it had purchased or guaranteed between 2005 and 2007.  These were boom years for originations and produced vintages defaulting at high levels.  The method of review could potentially cost Freddie Mac billions of dollars of losses that could otherwise have been avoided.

The FHFA had examiner noted that the two-year time frame was flawed because of the substantially higher incidence of default after that time due to the expiration of low interest teaser-rate loan features and falling home prices that prevented refinancing. 

Freddie Mac senior management was also engaged in a process of "overrides" in which they elected not to request repurchase of meaningful numbers of loans, admittedly because, among other reasons, they wanted to maintain good business relations with loan sellers.

Based on the review, OIG made two general recommendations to FHFA; it should improve Freddie Mac's loan review process and act to improve FHFA's management process.

Among specific points raised regarding the first recommendation was the FHFA should withhold approval of Freddie Mac's repurchase settlements until it could be confident that concerns about the review process have been resolved; senior management should oversee the GSE's "out of sample" loan testing and consider independently validating the testing and should issue internal guidance regarding its handling of future repurchase settlements should they arise. The repost also recommended an evaluation of whether Fannie Mae and Freddie Mac should adopt consistent review practices for repurchase claims.

There were two specific recommendation to improve FHFA management in this area; direct supervisors must properly and timely address and act upon significant concerns brought to their attention and senior managers  must address and act on significant concerns when they become aware that the normal reporting and supervisory process is not working properly.

After the initial report Freddie Mac senior management devised a new strategy to review a substantial number of "legacy loans" in default and thereafter presented the strategy to FHFA and proposed to employ it until it was no longer cost effective to do so.  Freddie Mac implemented the new strategy in March 2012 and in June informed sellers and servicers that they would begin to see further increases in the number of non-performing loans sampled by Freddie Mac.

OIG estimates that an additional $2.2 billion to $3.4 billion in repurchase requests will be initiated for the legacy loans originated during the housing boom.  For loans selected for review in 2012 alone Freddie Mac will save somewhere in the range of $0.8 billion to $1.2 billion by making additional repurchase requests. This analysis is premised on, among other things, the review of an additional 350,000 legacy loans.

FHFA also adopted the OIG recommendation that Fannie Mae and Freddie Mac adopt consistent review practices.  In its directive of January 19, 2012 the two GSEs were told to align their seller/servicer contracts in this and seven other areas.