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Inspector: Better Guidance Needed from FHFA on Multifamily Loan Exams

The ""Office of the Inspector General"":http://www.fhfaoig.gov/ for the ""Federal Housing Finance Agency"":http://www.fhfa.gov/ (FHFA-OIG) says in a new report that the agency needs to provide better guidance for investigators examining the GSEs' multifamily loan portfolios.

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In the ""report"":http://origin.www.fhfaoig.gov/Content/Files/AUD-2013-004.pdf, OIG notes rental demand has increased dramatically since the housing crisis, with an estimated 4.9 million new renters hitting the market since 2006. However, private sector financing has been somewhat dry, giving ""Fannie Mae"":http://www.fanniemae.com/portal/index.html and ""Freddie Mac"":http://www.freddiemac.com/ a dominant presence in the multifamily secondary market. As of December 2011, the two Enterprises collectively held about 33.8 percent ($285 billion) of outstanding multifamily mortgage debt.

Given the size of their investment and their dominant role in the secondary market, OIG says it is ""imperative"" for FHFA--as conservator of the GSEs--to supervise Fannie Mae and Freddie Mac's multifamily businesses and ensure underwriting standards are being upheld.

While FHFA has been active in conducting targeted examinations of the Enterprises' portfolios, the inspector general says the practices used by examiners need improvement.

For example, FHFA's Fannie Mae examiners pulled a random pool of 60 loans in the GSE's portfolio and reviewed only 30 ""due to resource constraints."" While OIG acknowledges the sample used ""may have been adequately representative,"" the examiners failed to retain documentation that would allow the inspector's office to fully assess the sampling methodology.

On the other hand, the Freddie Mac examiners reviewed a more limited sample of 17 loans and specifically excluded 829 multifamily loans valued at approximately $11.5 billion because those loans may contain additional ""nuances"" like credit enhancements.

Further, while the Freddie Mac sample had an average multifamily loan size of $13 million, only one sampled loan actually exceeded that amount. As a result, OIG says the sample may not have given FHFA reasonable assurance of asset quality.

""Not only are larger loans inherently more risky--one $90 million loan in default may be worse than nine $5 million loans in default--but Freddie Mac's underwriting requirements become more restrictive as loan values and risks rise,"" OIG comments in the report. ""Because the largest loan FHFA examined was $18 million, whereas the overall population included loans up to $205 million, these more restrictive underwriting standards were effectively outside of the examination's review.""

OIG attributes the difference in sampling techniques used by the two investigative teams to the absence of FHFA policies of procedures on how to collect samples for review. In contrast, many of FHFA's industry peers (and its Federal Home Loan Bank examiners) have adopted sampling guidance that requires representative or proportional methods to select adequate samples from loan populations.

These examinations are particularly critical to supervising risk given indications that the Enterprises are expanding their multifamily books of business and have relaxed some of their underwriting standards in the past. These standards have a direct, material impact on the level of risk associated with their multifamily loans. Thorough FHFA oversight is key to balancing these risks with the potential returns in order to ensure that the taxpayers' interests are protected,"" OIG concludes.

FHFA issued a response to the report, agreeing that ""there is an opportunity to enhance [FHFA's] supervisory approach by providing additional guidance to examiners in the area of sample selection, specifically for the review of multifamily loans."" The agency said it is in the process of developing such guidance.

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