Federal Housing Administration: Opportunities Exist to Improve Defaulted Single-Family Loan Sales

HUD insures single-family mortgage loans and is authorized to sell defaulted loans under the National Housing Act. In fiscal years 2010–2016, FHA auctioned off approximately 111,000 loans to private purchasers under DASP. DASP helped reduce a backlog of federally insured defaulted loans stemming from the 2007–2011 financial crisis and was intended to protect the MMI Fund by paying insurance claims before the costly foreclosure process.

GAO was asked to evaluate DASP. This report examines, among other things, certain DASP procedures, including verifying loan eligibility criteria, and documentation; FHA's evaluation of the identified outcomes of sold loans and how these compare with similar, unsold loans; and the potential effects that changes to DASP might have on the MMI Fund. GAO reviewed FHA policies, contracts, and reports, and interviewed FHA officials, selected servicers and purchasers based on sales participation, and other stakeholders. GAO also conducted a statistical analysis comparing outcome data for sold loans and similar loans that remained FHA-insured and analyzed the effect of loan pool characteristics on bidder participation.

The Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) uses multiple entities to check loan eligibility for the Distressed Asset Stabilization Program (DASP)—in which FHA accepts assignment of eligible, defaulted single-family loans from servicers in exchange for claim payments and sells the loans in competitive auctions. After servicers submit loans for sale, FHA and its contractors concurrently check loan data for completeness, validity, and eligibility. FHA relies on servicers to check eligibility a few weeks before and again after the bid date. The status of delinquent loans can be fluid, and a change in eligibility status close to this date may not be detected. GAO's analysis of fiscal year 2016 default data indicates about 2.67 percent of loans that FHA sold were ineligible based on length of delinquency or loss mitigation status. Without checking loan eligibility closer to bidding, FHA risks selling ineligible loans, and borrowers could lose access to benefits.

FHA does not evaluate outcomes for sold loans against similar unsold loans. GAO found that, in aggregate, sold defaulted loans were more likely to experience foreclosure than comparable unsold defaulted loans (see figure). However, GAO's analysis identified varying outcomes by purchasers and sales. For example, some purchasers' loans had higher probabilities of avoiding foreclosure, with borrowers making regular payments again by 24 months after the transfer of loans. Also, loans sold in 2016 sales were less likely to experience foreclosure compared to unsold loans. HUD policy states that the agency's evaluations isolate program effects from other influences. Evaluating outcomes for sold loans against similar unsold loans could help FHA determine whether DASP is meeting its objective of maximizing recoveries to the Mutual Mortgage Insurance Fund (MMI Fund) and understand the extent to which DASP helps borrowers.

Changing some of FHA's auction processes may help the MMI Fund. FHA could increase participation and MMI Fund recoveries in its auctions by communicating upcoming sales earlier. One purchaser said that additional notice would allow it time to plan for the capital needed to bid. Also, FHA set reserve prices (minimum acceptable price) based on the amount it expected to recover after loans completed foreclosure—yet GAO estimates that some of these loans will avoid foreclosure (see figure). As a result, FHA risks recovering less for the MMI Fund in loan sales than if the loans had not been sold.

GAO is making nine recommendations to FHA, including establishing specific time frames to check loan eligibility, evaluating loan outcome data, and changing auction processes to help protect the MMI Fund. FHA generally agreed with seven recommendations, and neither agreed nor disagreed with two. GAO maintains that all the recommendations are valid.

The Department of Housing and Urban Development’s (HUD) Federal  Housing Administration (FHA) helps to broaden homeownership by  insuring single-family mortgage loans with less strict underwriting  standards and lower down payments compared with conventional loans.  The mortgage insurance allows FHA-approved private lenders to provide  qualified borrowers with mortgages and generally compensates them for  nearly all of the losses incurred on such loans. The Mutual Mortgage  Insurance Fund (MMI Fund), which covers almost all FHA single-family  mortgages, is statutorily required to maintain at least a 2 percent capital  ratio, defined as the economic value of the fund divided by the amortized  insurance-in-force.

The housing crisis of 2007–2011 resulted in historic rates of mortgage  defaults and foreclosures. Since the beginning of the crisis, the federal  government has directly or indirectly supported more than two-thirds of  the value of new mortgage originations in the single-family housing  market. For example, many of these defaulted mortgages were insured  by FHA or securitized by the government-sponsored enterprises (the  enterprises) Fannie Mae and Freddie Mac. FHA sold pools of defaulted  loans in auctions through the Distressed Asset Stabilization Program  (DASP). DASP is a program in which FHA accepts assignment of  eligible, defaulted single-family mortgage loans in exchange for claim  payments to servicers—which cover the unpaid mortgage balance and  associated costs—and terminates FHA insurance. FHA then sells the  loans in competitive auctions to qualified purchasers. DASP has helped to  reduce FHA’s backlog of defaulted loans and was intended to help  maximize recoveries to the MMI Fund by avoiding the costly foreclosure  process. According to a HUD Office of Inspector General (OIG) report,  from 2010 through 2016 FHA used DASP to sell approximately 111,000  defaulted mortgage loans with an unpaid principal balance of about $19  billion. Insurance claims for sales from 2013 through 2016 accounted for  about 20 percent of FHA claims to lenders over the period.

You asked us to review DASP. This report examines (1) the changes  FHA has made to the program over time; (2) certain DASP procedures,  including those associated with loan eligibility, and documentation; (3)  FHA’s evaluation of the identified outcomes for loans that have been sold  through DASP and how these compare with similar, unsold loans; and (4)  the potential effects that changes to DASP might have on the MMI Fund.

To address all of the objectives, we reviewed relevant laws, FHA policies,  contracts, and agency reports. We interviewed officials of FHA and its  contractors, the Federal Housing Finance Agency (FHFA), and the  enterprises, as well as representatives of companies that service or  purchase mortgages and other industry stakeholders. To address the first  objective, we examined Participating Servicer Agreements (servicer  agreements) and Conveyance, Assignment, and Assumption Agreements  (purchaser agreements) from 2010 through 2016—the last year in which  a DASP sale was held; HUD’s OIG Reports on DASP; and press releases  on HUD’s website regarding changes to the program. We also  interviewed FHA staff and asked them to provide us with a list of changes  to the program from 2010 through 2016.

To address the second objective, we reviewed agreements between FHA  and mortgage servicers and statements of work for FHA’s contractors to  identify procedures in place to monitor loan eligibility. We analyzed the  default status data for loans sold in 2016 at the submission and bid dates  to determine whether loans had eligible status for sale. To assess the  reliability of the default status data, we performed electronic checks for  consistency and validity. We found the data to be sufficiently reliable for  determining default status and length of delinquency. Additionally, we interviewed FHA and contractor officials to discuss their procedures for  monitoring loan eligibility.

To address the third objective, we used multiple FHA data sources to  match loans sold through DASP to similar, unsold loans and compare  outcomes across the groups. Specifically, we identified a comparison  group of unsold loans that closely resembled sold loans on characteristics  that could affect the likelihood of foreclosure. To compare outcomes, we  identified common categories of possible outcomes for sold and unsold  loans. Using postsale reports from purchasers for sold loans and default  status reports from servicers for unsold loans, we tracked the outcomes  at monthly intervals. To assess the reliability of loan and outcome status  data, we performed various electronic tests on the logic of the data. We  excluded a small percentage of loans with invalid data and found the  remaining data to be sufficiently reliable for matching sold loans to unsold  loans and comparing outcomes. We also evaluated the loan modifications  offered by individual purchasers from the 2013–2016 DASP sales. We  obtained pre- and postmodification payment data from FHA and  calculated the change in borrowers’ monthly mortgage payments. To  assess the reliability of the modification data, we checked for missing and  invalid data entries across different modification fields. We found the data  to be sufficiently reliable for the purpose of assessing the modifications.

To address the fourth objective, we identified key characteristics that may  make loan pools attractive to certain purchasers from interviews with  industry stakeholders. We built regression models to determine the extent  to which loan pool characteristics were associated with bidder  participation for FHA loan sales and the enterprises’ defaulted loan sales.  We obtained data from FHA and the enterprises on bids and the timing of  sales. We generated FHA pool characteristics from loan level data in the  Aggregate Loan Database (submitted loan database) and supplemented  them with FHA default status data. For the enterprises, we used pool  characteristics from a published FHFA report. This report provided a  range of characteristics to compare to those of FHA’s pools. To assess  the reliability of the FHA data, we performed reasonableness checks,  which resulted in the removal of 4 percent of FHA’s pools. We determined  that data for the remaining pools were sufficiently reliable for the  purposes of examining association with bidder participation. To calculate  pool reserve prices, we obtained FHA quarterly loss severity data by  disposition method for 2013–2016. Using our results from the outcomes  comparison analysis, we calculated pool-level reserve prices and  compared them to the winning pool-level bids.

To assess the effect that changing FHA’s auction design could have on  the MMI Fund, we reviewed economics literature on auction structures  and auction descriptions in business and commercial literature. We  developed a detailed description of FHA’s current auction structure and  participants and assessed the benefits and drawbacks of various auction  design details. We interviewed DASP stakeholders about potential  changes to FHA auctions. We interviewed purchasers on their potential  interest in these changes and examined FHA sale data following an  instance of a single purchaser winning all the pools in a sale. In addition,  we compared FHA’s DASP auction structure against key characteristics  of successful auctions that we identified in economics and business  literature. Appendix I provides additional details about our objectives,  scope, and methodology, and appendix V provides more information on  our matching and outcomes analysis.

We conducted this performance audit from January 2017 to July 2019 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

History of the Distressed Asset Stabilization Program

The National Housing Act authorized HUD’s Office of Housing to accept  assignment of and sell defaulted single-family mortgage loans.  Additionally, Office of Management and Budget (OMB) Circular No. A-11  (2016) states that under the Debt Collection Improvement Act of 1996,  credit agencies with over $100 million in loan assets are expected to sell  defaulted loan assets that are more than 1 year delinquent, with some  exceptions. The OMB Circular further states that the agency may not be  required to sell loan assets if a serious conflict exists between selling  loans and policy goals. In 2017, FHA insured over $1 trillion in single- family mortgage loans, including more than 200,000 loans in default.

Consistent with the National Housing Act and OMB Circular, FHA uses  DASP to reduce its backlog of defaulted loans by selling loans that are  severely delinquent. As of 2016, loans must be at least 8 months  delinquent to be eligible for sale through DASP. In addition, servicers  must evaluate borrowers for all FHA loss mitigation options in order for  loans to be eligible for sale through DASP.

FHA has called its single-family forward loan sales program by different  names over the years, but it became known as DASP beginning with  FHA’s third loan sale in 2012. We use DASP throughout this report to  refer to FHA loan sales, regardless of the timing or the program name.  Between 2010 and 2016, FHA held a total of 16 sales, with between one  and four sales annually. As seen in figure 1, the number of loans sold  varied significantly among the sales.

Figure 2 shows the extent to which FHA has sold defaulted loans in each  state in 2013-2016. The map also indicates states with longer expected  foreclosure timelines. The foreclosure process is governed by state laws  and differs across states. FHA establishes expected timelines for  completing foreclosure and acquiring title to the property in each state. As  discussed later, the foreclosure process involves a number of costs,  which may be higher in states with longer expected foreclosure timelines.  Additional information on the loans sold through DASP can be found in  appendix II.

Loan Delinquency, Loss Mitigation, and Costs to the Mutual Mortgage Insurance Fund Associated with Different Loan Disposition Methods

A loan becomes delinquent after the borrower misses a single payment  and goes into default after it is at least 31 days—two full payments—past  due, including when a borrower may miss payments sporadically over  time without repaying the missed amount. Loan servicers—which can  be large mortgage finance companies or commercial banks—are  responsible for accepting payments from borrowers and managing  mortgages. FHA requires the servicers to provide monthly reports on  each loan with one or more missed payments through its Single Family  Default Monitoring System (default monitoring system). Before initiating  foreclosure actions, FHA requires servicers to contact the borrower,  collect information on the borrower’s finances, and evaluate the borrower  using the following ordered steps, referred to as the waterfall of loss  mitigation priorities:  informal forbearance through an oral agreement allowing for reduced  or suspended payments for a period of 3 months or less;  formal forbearance with written repayment plans, which combine a  suspension or reduction in monthly mortgage payments with a  repayment period;  special forbearance of up to 12 months for borrowers who are  unemployed;

FHA-Home Affordable Modification Program (HAMP), which works to  get a borrower to return to making regular payments (reperforming);  FHA-HAMP offers qualified borrowers a loan modification that results  in an affordable monthly payment amount that does not exceed 40  percent of the borrower’s gross monthly income by reamortizing the  debt for a new 30-year term at a fixed interest rate at or below the  market rate and, under certain circumstances, deferring the payment  of principal through the use of a partial claim; and non-retention disposition methods, including a preforeclosure sale  (also known as a short sale) in which the borrower sells a property  and the mortgage is satisfied for less than the amount that is owed, or  deed-in-lieu of foreclosure in which the borrower voluntarily transfers  a property to FHA to release all mortgage obligations; FHA may also  provide move-out incentive payments to borrowers for short sales and  deeds-in-lieu of foreclosure.

To qualify for most of these actions, borrowers must be in default. A  servicer must evaluate a borrower for the loss mitigation options monthly,  but a borrower may not qualify for any option. However, a borrower’s  circumstances are fluid and eligibility can change. For example,  borrowers who previously did not qualify for any loss mitigation options  could be eligible to be evaluated for loss mitigation options again after  starting a new job. FHA provides servicers with incentive payments of  varying size for taking certain loss mitigation actions.

FHA generally requires servicers to either use a loss mitigation option for  which a borrower qualifies or initiate foreclosure within 6 months of the  default date, but a loan also may become eligible for disposition through a  DASP sale when loss mitigation has been exhausted and it meets other  eligibility criteria. FHA provides servicers with a list of loan eligibility  criteria in the servicer agreement for each sale. Servicers use the criteria  to identify which loans are eligible for a DASP sale. For example,  eligibility criteria include that a loan must be FHA-insured, have no more  than four dwelling units, and have an unpaid principal balance (amount  owed) greater than $20,000. Other criteria relate to length of delinquency,  loan-to-value (LTV) ratio, and the condition of the property. Loans that  qualify for loss mitigation or have a foreclosure date scheduled or  completed during the sale period are not eligible for DASP. Information  on changes to loan eligibility criteria throughout the history of the program  can be found later in this report.

Each of the disposition methods FHA uses when loss mitigation on  defaulted loans is exhausted has different costs to FHA’s MMI Fund (see  table 1). For the nonretention disposition methods of short sale, deed-in- lieu of foreclosure, third-party sale, or foreclosure—which we refer to as  “out of home” methods—FHA pays a claim to the servicer in the amount  of the unpaid mortgage balance and other expenses. In addition, for a  deed-in-lieu of foreclosure or foreclosure—in which the property enters  HUD’s inventory of real estate owned (REO) property—FHA also incurs  costs associated with maintaining, repairing, and selling the property.  This generally results in a greater loss to the MMI Fund. In the case of a  DASP sale, FHA avoids interest and servicing costs during the  foreclosure period as well as REO-related expenses, but incurs the cost  of the difference between the unpaid balance and expenses and the  amount FHA receives for the loan it sells.

Process of the Distressed Asset Stabilization Program

The loan sale process has three distinct phases: presale, due diligence  and bid, and postsale (see figs. 3, 4, and 5, respectively). FHA  contractors (the transaction specialist, the compliance analytics  contractor, and the program financial advisor) facilitate and perform  various tasks throughout these phases. The summary below reflects the  process according to 2016 sales documents (the most recent DASP sales  documents available), other supplemental information, and interviews  with FHA officials and contractors.

Figure 3 shows the presale phase. During this phase, FHA or its  contractor notifies interested servicers and communicates loan eligibility  criteria to servicers through the servicer agreement. Servicers that plan  to participate in the sale identify a list of eligible loans, certify the accuracy  and eligibility of the loans, and provide the list to FHA for review through  the Claim Submission Report. The servicer uploads information on the  loans submitted to FHA. FHA creates the submitted loan database, which  includes each accepted loan’s current unpaid balance, payment history,  and an estimate of the underlying property value. According to FHA  staff, FHA reviews the eligible loans submitted by servicers and, with the  advice of its transaction specialist contractor, groups them into pools  based on geography and other factors. FHA sells loans in national pools  or Neighborhood Stabilization Outcome (NSO) pools, for which  purchasers must meet specific neighborhood stabilization outcomes for  50 percent or more of the properties in the pool.

Next, an FHA contractor notifies prospective purchasers about the  upcoming sale via email, and notices are posted in the Federal Register,  industry publications, and newspapers. Purchasers can include private  equity firms, hedge funds, rental housing companies, and nonprofit  organizations. Prospective purchasers must submit to FHA a  Confidentiality Agreement and a Qualification Statement. FHA reviews  the documentation to determine whether the purchaser qualifies to  participate in the sale.

Figure 4 depicts the due diligence and bid phase of a DASP sale. During  this phase, prospective purchasers receive access to the data room—a  shared data website—to review materials including the loan information  provided by servicers (due diligence materials); bid instructions; and sale  agreement that describes representations, warranties, and postsale  requirements, among other things. The servicer, FHA staff, and FHA  contractors continue to verify the eligibility of the loans. Prospective  purchasers place bids on each loan in a pool and deposit a percentage of  their total bid amount. FHA evaluates the bids and selects the highest  bidder for each pool based on the total of the loan-level bids. FHA then  notifies that bidder and provides an executed purchaser agreement that  describes postsale servicing and reporting requirements. Purchasers  must agree to follow the terms of the purchaser agreement including  avoiding finalizing foreclosures for 6 or 12 months (depending on whether  the sale occurred prior to July 2015), evaluating borrowers for loan  modification, and reporting outcomes to FHA.

Figure 5 depicts the postsale phase. During the postsale phase, FHA  provides the list of sold loans to the servicer and winning purchaser,  which together determine servicing transfer dates. After bid day, servicers  verify that loans continue to meet eligibility criteria for the sale and begin  submitting insurance claims to FHA. Purchasers pay FHA for the loans  that are sold, and servicers transfer loan information and complete  mortgage files to the purchasers. When servicers submit claims to FHA  for sold loans, they must report the reason any loans are not transferred.  For example, a loan might not be transferred due to ongoing loss  mitigation activity or another reason, such as no longer meeting  delinquency eligibility criteria, and would remain with the servicer and  FHA insured. Following the final transfer of loan documentation, servicing  is transferred from the servicer to the purchaser. The servicer notifies the  borrowers of the transfer of servicing and termination of their FHA  mortgage insurance. Following the transfer, the purchaser sends the  borrowers a similar notice of transfer and any required disclosures.

Following the final settlement date, the purchaser submits the first of 16  quarterly reports on the status of the sale portfolio using the format  provided in FHA’s Post-Sale Reporting tool. If a purchaser demonstrates  a pattern of failing to report, FHA may disqualify the purchaser from future  sales. During the first 12 months of the reporting period, purchasers must  evaluate borrowers for a HAMP modification or a substantially similar  modification. Additionally, the purchaser must avoid foreclosure for 12  months unless the home is vacant or there are extenuating  circumstances.

The purchaser agreement allows the purchaser 10 months starting with  the servicing transfer date to notify HUD of any alleged breach of FHA’s  representations and warranties on purchased loans. For example, a  breach could be that a loan does not meet eligibility requirements, is not  covered by a valid hazard insurance policy, or has an outstanding  mechanic’s lien. After notifying the original servicer and reviewing any  response, FHA determines whether there is a breach and the appropriate  remedy. The breach remedy can include a cure of the breach (such as by  the servicer paying an outstanding lien), reduction in claim payment, or  repurchase by the servicer. The servicer has 60 days to comply with the  remedy. If a breach results in the repurchase of the loan by the original  servicer, the purchaser will transfer servicing back to the original servicer.

Program Requirements and Processes for DASP Have Changed over Time

FHA made changes to DASP by adding borrower protections and made  efforts to increase the participation of nonprofit organizations. FHA also  changed loan eligibility criteria and bidding processes to increase  recoveries to the MMI Fund. Other changes included automating and  streamlining processes.

Some Changes Responded to Concerns about Borrower Protections and Nonprofit Participation

FHA has added to DASP protections for borrowers and requirements to  help stabilize neighborhoods in response to concerns raised by various  stakeholders. For example, borrower protections included extending the  moratorium on foreclosures from 6 months to 12 months and requiring the  purchaser to offer a HAMP or substantially similar modification to qualified  borrowers beginning with its July 2015 loan sale. In September 2016,  FHA also added payment shock protection, which limited increases in a  borrower’s interest rate to 1 percent per year following a 5-year reduced  rate period. In an effort to stabilize neighborhoods, FHA added a  requirement in 2016 prohibiting purchasers from walking away from  vacant properties. In a hearing before the House Committee on  Financial Services in July 2016, the HUD Secretary stated that the  changes that FHA made to the program in 2015 and 2016 were designed  with input from a broad range of stakeholders and were assessed for how  well the changes would fulfill the agency’s goal of strengthening  neighborhoods.

In 2015, FHA made several outreach efforts to expand the participation of  nonprofit organizations in DASP. These efforts included offering nonprofit  organizations a “first look” at vacant REO properties, allowing purchasers  to resell to nonprofit organizations, and conducting a webinar to educate  and encourage the participation of nonprofit organizations. These efforts  came about following a September 2014 report from the Center for  American Progress and suggestions from other stakeholders that FHA  make it easier for nonprofit organizations to participate in DASP. In  2016, FHA set a target that 10 percent of bids come from nonprofit  organizations and local governments, including offering loans in targeted  distressed areas. In 2015 and 2016, FHA offered nine pool sales directed  at nonprofit organizations only. Some members of Congress expressed  concern over FHA’s efforts to encourage participation of nonprofit  organizations, stating that FHA would likely get lower bids than it would  normally receive from private companies.

Changes to Loan Eligibility Criteria and Bidding Were Intended to Increase Recoveries

According to FHA officials, FHA changed its loan eligibility criteria for  inclusion in DASP sales in order to decrease losses to the MMI Fund and  to give servicers more time to work with borrowers on loss mitigation.  FHA lists the eligibility criteria to qualify loans for FHA’s loan sale program  in each servicer agreement. Our analysis of the servicer agreements from  2010 through 2016 showed that some criteria remained the same during  the period, such as the requirement that servicers must have evaluated  borrowers for all loss mitigation actions in accordance with FHA  regulations or that loans in certain types of bankruptcy were ineligible.  Other criteria changed during that period, including the following  examples:

Delinquency requirements for eligible loans changed from six full  payments past due to eight full payments past due beginning with the  first DASP sale in 2016; and

FHA changed its eligible LTV ratio. Between the 2010 sale and the  second DASP sale in 2012, FHA set a minimum LTV ratio for loan  sales at 85 percent or higher—meaning that to qualify for sale, the  ratio of the amount owed on the loan to the estimated value of the  property was required to be 85 percent or higher. Beginning with the  first DASP sale in 2015, FHA set minimum eligible LTV ratios by  state—70 percent in New York and New Jersey and 85 or 100 percent  for other states, with about half the states in each percentage  category.

FHA officials said that they analyzed loan-level bid amounts and found  that they had greater recoveries relative to REO disposition on loans with  shorter delinquencies and higher LTV ratios. According to the officials,  this was because these loans had a higher probability of modification by  purchasers. Further, they said that the changes in eligibility criteria related  to delinquency and LTV ratio were intended to decrease losses to the  MMI Fund.

In addition, FHA lowered limits on loan-level bid pricing to minimize the  potential negative effects of ineligible loans being removed from sales  after bidding. Purchasers could use loan-level bid pricing to strategically  take advantage of the expected removal of ineligible loans after bidding.  Because a purchaser pays only for the loans that are actually transferred  and some loans are removed from sales due to ineligibility, such as due  to changes in loss mitigation or foreclosure status, FHA receives less in  actual returns on the sale than the winning—highest—bid. For selected  loan pools in the second sale in 2013 and the first sale in 2014, FHA  analyzed the bid amounts of loans that became ineligible after purchasers  had bid. Before the 2015 sale, FHA lowered its maximum purchasers’  loan-level bid amount from 200 to 175 percent of the unpaid balance of a  loan.

Other Changes Included Automating and Streamlining Processes

FHA contractors deployed tools in 2015 and 2016 to automate previously  manually intensive processes of collecting data and emails from about 30  different purchasers and tracking the status of sold loans. FHA,  contractors, and purchasers we interviewed said that these processes  improved data quality, efficiency, and communication among parties.

A postsale reporting tool and data repository enables the contractor to  send mass emails and target email reminders of upcoming due dates,  including report deadlines, to purchasers that have not submitted  required documents. In addition, the tool validates data by checking  for logic and data type.

A loan sale system conducts automated checks of data in the  submitted loan database for completeness and accurate file layout.  The system also checks whether all required documents are included  on the shared data website that purchasers use to perform due  diligence and determine bid amounts. The system automatically  generates a report of errors that is sent to servicers.

A web-based breach tracking tool that streamlines and centralizes  tracking of loans that breach—that is, were transferred to purchasers  but did not meet eligibility standards. The tool allows the purchasers  to submit breach requests, notifies servicers automatically about  pending breaches, and allows auction stakeholders to review  breaches and update the status of the loan.

FHA Lacks Specific Time Frames for Its Loan Eligibility Checks, Criteria for Holding Sales, and Documentation of Key Procedures and Performance Measures

Multiple Entities Check Loan Eligibility, but the Timing of FHA’s Checks May Allow Ineligible Loans to Be Sold

Servicers identify eligible loans for inclusion in a DASP sale, certify  eligibility, and update loan information and remove ineligible loans prior to  bid day. FHA staff and contractors described the various checks they  conduct to generally verify a loan’s continued eligibility by reviewing the  loan’s default status in FHA’s default monitoring system and in some  cases other servicer data before a sale. Specifically, both FHA staff and  the compliance analytics contractor conduct eligibility tests by checking  each submitted loan’s default status. The transaction specialist contractor  told us it conducts automated checks of the loan submission and related  data that servicers submit to check for data completeness and valid  formatting. Additionally, this contractor also checks that the loans match  eligibility criteria and that all required documents were submitted. Starting  in 2015, FHA officials told us that FHA and its three primary contractors  began to verify that all loans submitted for sale had an eligible default  status as part of their quality-control process. FHA officials said that any  updates or changes servicers make to the status of submitted loans  require the program financial advisor contractor to repeat its quality- control procedures.

In addition, servicers are expected to ensure that loans meet eligibility  criteria until the loan is sold and servicing responsibilities are transferred  to the purchaser. The servicer agreement states that an eligible mortgage  loan meets all eligibility criteria as of the date it is submitted for sale and  continues to meet all such requirements as of the claim date. FHA  officials said that servicers check eligibility at the loan submission date,  approximately 3 weeks prior to the bid day when they update loan  information, and at the claim date. Servicers should remove ineligible  loans from the sale. In 2014, FHA required servicers to self-certify the  accuracy of the default status of loans. FHA officials told us that it also  has absolute discretion to exclude one or more loans from the sale.

According to FHA officials, FHA has two different provisions in place to  correct when a loan should not have been sold. One provision, as  described earlier, allows the purchaser to initiate the breach process and  the servicer either corrects the reason for the breach or FHA repurchases  the loan. Another provision is the “claw-back” provision. Under this  provision, FHA or the former servicer can require the purchaser to return  the loan to FHA in exchange for the amount the purchaser paid for the  loan.

However, we found examples of potentially ineligible loans that were  submitted for sale and were sold in DASP auctions. Of the 12,210 loans  sold in 2016, a small percentage of loans (about 2.65 percent) did not  meet eligibility criteria based on their default status on the date loans  were submitted. The error rate was similar at the bid date for the 12,210  loans sold in 2016. In particular, about 2.67 percent of these loans did not  meet eligibility criteria based on their default status on the bid date.  These loans were ineligible for varied reasons, including because they did  not meet FHA’s length of delinquency requirement, were involved in  certain types of bankruptcy, or were undergoing loss mitigation and  therefore should have remained under FHA insurance protection.

Ineligible loans may have been sold because the status of loans changed  after the servicer and FHA completed their eligibility checks. FHA’s staff  and contractors conduct multiple eligibility checks concurrently during the  presale and due diligence and bid phases—about 12 to 14 weeks before bid day according to FHA officials. These early checks conducted by  FHA’s staff and contractors do not necessarily occur in a specific order or  according to specific timelines. FHA officials told us that FHA relies on the  servicers to perform eligibility checks a few weeks before bid day and  again after the sale when the servicer submits the claim. However, the  status of delinquent loans can be very fluid. According to our analysis of  FHA data, 23 percent of loans from 2010 to 2016 were removed between  the bid date and the claim date. FHA officials told us that servicers  remove loans after FHA’s reviews to maintain compliance with  representations and warranties under the servicer agreement. FHA  officials also explained that loan removal was due to changes in loans’  eligibility status, such as entering into loss mitigation or the scheduling of  a foreclosure sale.

We reviewed a nongeneralizable sample of 10 loans that appeared to be  ineligible and interviewed FHA officials about these loans. We found that  some changes in the eligibility of loans could be missed due to the length  of time between eligibility checks and data updates. The status of loans  can change multiple times during a sale process. FHA requires servicers  to self-report the status of defaulted loans on a monthly basis to the  default monitoring system, usually within the first 5 days of the month, but  servicers may report changes throughout the month if a loan’s status  changes. However, FHA officials told us that the system updates once a  month. FHA’s eligibility checks may have occurred before the updates  were posted to the default monitoring system. FHA officials told us that  FHA relies on the controls in place and contractual agreements with the  servicers that require them to ensure that loans are eligible when  submitted to FHA for sale and when they file a claim with FHA. As a  result, FHA may not be aware of a change in loan eligibility that was  reported in the default monitoring system after its eligibility checks were  completed.

Federal internal control standards require that management design  control activities to achieve objectives and respond to risks. Control  activities can be either preventive or detective. A preventive control  activity prevents an entity from failing to achieve an objective or address a  risk. Although FHA has implemented a number of controls to prevent  ineligible loans from being sold, these controls may miss loans that  change status after the eligibility check because FHA staff and  contractors do not have a designated time in the process to conduct the  eligibility check. Without spacing the timing of the various checks  throughout the process, including some checks that occur closer to the  bid date, FHA staff and contractors do not have the most reliable and  updated data from which to make decisions regarding loan eligibility, and  FHA could be selling some ineligible loans. If FHA sells a loan that is  ineligible to be sold because of ongoing loss mitigation, it pays a claim for  a loan that may become reperforming and never require a claim.  Likewise, borrowers could lose access to benefits such as reevaluation  for the suite of FHA loss mitigation options.

FHA Has Not Documented All of Its Policies

FHA has begun to centralize its existing written guidance, but policies for  when program changes should be evaluated are not documented in this  guidance. A July 2017 report from the HUD OIG found that HUD did not  develop formal guidance or procedures for its single-family note sales  program and recommended that the agency develop and implement  formal procedures and guidance for DASP. FHA responded to the OIG  that the operations of the DASP sales were documented in a series of  procedures used internally by staff and externally by stakeholders.

In May 2018, FHA officials told us that in response to the OIG’s  recommendation, they were consolidating their current written procedures  and guidance into one Asset Sales Handbook to centralize the  information for internal and external stakeholders. (See app. III for a  description of these documents.) FHA officials told us the key documents  governing a DASP sale include the servicer agreement, purchaser  agreement, detailed instructions for bid day, and specific requirements for  qualified servicers.

However, we found that if FHA were to compile these existing documents  into an Asset Sales Handbook, it would still be missing some important  program policies. As of February 2019, FHA officials confirmed that they  had no written policies documenting when program changes should be  evaluated. When FHA described its process for evaluating program  changes, officials stated that the informal practice was to consider  changes when planning for a new sale. However, as stated earlier, FHA  made a number of changes in 2015 and 2016 but has not held a DASP  sale since 2016. FHA officials said the date of the next DASP sale is  unknown. FHA also experienced another period when no sales were  conducted between 2005 and 2009.

Federal internal control standards require that management implement  control activities through policies. This includes documenting in policies  the internal control responsibilities of the organization and periodically  reviewing policies, procedures, and related control activities for continued  relevance and effectiveness in achieving the entity’s objectives. For  example, the standards state that if there is a significant change in an  entity’s process, management reviews the process in a timely manner  after the change to determine that the control activities are designed and  implemented appropriately. However, FHA officials told us that they had  not evaluated whether the most recent program changes were effective or  should be revised because they were not planning a new sale yet. With  several years between sales, written policies for regular consideration  and review of program changes can help to ensure that FHA is reviewing  the effectiveness of previous changes and controls and considering  potential new changes in a timely manner.

FHA Has Not Provided Clear Objectives or Measurable Performance Targets for DASP

FHA has a DASP program objective of maximizing recoveries to the MMI  Fund and has some specific targets to assess whether it is meeting this  objective. On a quarterly basis, FHA measures how recovery for asset  sales compares to foreclosure with REO dispositions and other  disposition types, such as short sales and claims without conveyance of  title. FHA officials explained that they maximize recovery by holding open  and competitive auctions for nonperforming single-family loans, with the  highest bidder as the winner. In addition, the Office of Risk develops a  reserve price—an estimate of the expected REO recovery value of each  loan in a sale and a benchmark for comparison with the bids received—to  minimize the risk that FHA will not get the best recovery for the loan. In  the past, when FHA received a bid below the reserve price, it opted to not  sell the pool. As a result, the reserve price serves as a critical target in the  agency’s determination of whether to sell.

In contrast, FHA has not developed specific targets for meeting what  appear to be additional DASP objectives, based on a variety of program  documents and recent program changes. In 2016, for example, the HUD  Secretary testified before Congress that DASP has a dual goal— ”support recoveries to the  Fund while preserving  homeownership and help stabilize neighborhoods.” Similarly, in  HUD’s 2016 Post-Sale Report to the FHA Commissioner, HUD explained  that it designed DASP “to maximize recoveries to the , and  when possible, help keep borrowers—otherwise headed to foreclosure— in the home.” HUD’s recent changes to DASP likewise appear to  recognize program objectives in addition to maximizing recoveries to the  MMI Fund. When HUD extended the prohibition against foreclosure from  6 months to 12 months in 2015, for instance, a HUD press release stated  that such changes “not only strengthen the program but help to ensure it  continues to serve its intended purposes of supporting the MMI Fund and  offering borrowers a second chance at avoiding foreclosure.” And when  HUD changed DASP in 2016 to prohibit purchasers from abandoning low- value properties in high-foreclosure neighborhoods, it declared that this  was done to help stabilize neighborhoods.

Despite these repeated department statements that DASP has a “two- fold” goal and multiple “intended purposes,” FHA officials told us that  preserving homeownership and stabilizing neighborhoods are “ancillary  benefits”—positive consequences that flow from DASP’s objective of  maximizing recoveries for the MMI Fund—but not objectives  themselves. Because FHA does not consider homeownership  preservation and neighborhood stabilization to be program objectives, the  agency has not developed targets to meet them. FHA officials explained  that they measure and monitor the extent to which purchasers meet  requirements for NSO pools, for instance, by collecting loan outcome data  from purchasers for 4 years. These purchasers must have no less than  50 percent of the loans in each NSO pool achieve outcomes such as  keeping borrowers in their homes and properties occupied through  rentals. However, FHA does not have a similar target for national pools,  which represent about 80 percent of the sold loans. FHA requires  purchasers of national pools to report on borrower outcomes quarterly for  4 years, but does not measure the extent to which these outcomes meet  a specific target and are achieving program objectives.

Prior GAO work identified key attributes of successful performance  measures and indicated that performance measures should be clear,  have measurable numerical targets, and demonstrate results. In  addition, according to federal internal control standards, management  should define objectives clearly to enable the identification of risks and  define risk tolerances. This includes, for example, defining objectives in  specific and measurable terms to allow for the assessment of  performance toward achieving objectives. Although FHA officials told us  that DASP has one objective with resulting “ancillary benefits,” it also  cited these same benefits as additional program goals and purposes in  the recent past. Without clarifying the program’s objectives in light of  relevant laws, regulations, and agency statements and setting  measurable targets to achieve these objectives, particularly for national  pools, FHA cannot ensure that DASP is achieving optimal results.

The Timing of DASP Sales Is Not Informed by Performance Data

FHA has not used performance data to establish criteria for the timing of  DASP sales. FHA officials said they have not set criteria for when to hold  sales, such as the size of the portfolio of defaulted loans or other  considerations. In contrast, Fannie Mae estimates the number of defaulted loans needed to be sold to achieve its goals and assesses  market conditions to produce a detailed schedule of sales for the year.  Our analysis of FHA’s default monitoring system data shows that several  years after the housing crisis, FHA continues to insure a backlog of  defaulted loans with six or more missed payments (see fig. 6). FHA  officials stated that, in July 2018, FHA had about 300,000 defaulted loans,  which is similar to the number of loans as in years when the DASP  program was active. Most servicers we talked to told us that they  preferred selling defaulted loans through DASP rather than taking them  through the REO disposition process due to the servicing responsibility  and costs associated with foreclosure. However, FHA officials told us that  they did not know when the next sale would be.

The GPRA Modernization Act of 2010 established an expectation that  agencies use evidence and performance data in decision making.

Specifically, the act changed agency performance management roles,  planning and review processes, and reporting to ensure that agencies  use evidence and performance data in decision making. Our prior work  has stated that although the act’s requirements apply at the agency-wide  level, they can also serve as leading practices at other organizational  levels, such as component agencies, offices, programs, and projects.

Because specific criteria for when to hold sales are not in place, FHA’s  timing of and decisions to hold DASP sales were inconsistent. FHA held  16 DASP sales between 2010 and 2016. These sales occurred at  varying frequencies. For example, FHA held between one and four sales  per year, and the number of months between sales ranged from 2 to 10  months. Officials stated that DASP should be used to address a large  buildup of defaulted loans and because of its lower loss severity  compared with REO dispositions. Officials also told us they have not  developed criteria because FHA operates DASP as a pilot program and  continues to make changes after each sale. However, without analyzing  the performance data of the portfolio of defaulted loans to identify criteria  for the timing of DASP sales—even as a pilot program—FHA cannot  make fully informed decisions about when to hold sales and may not be  optimizing its use of the program in achieving its objectives.

FHA Does Not Evaluate Loan Outcomes, and Sold Loans Experienced Foreclosure at a Higher Rate Than Unsold Loans in Some Cases

FHA does not evaluate loan outcomes for loans sold through DASP and  does not monitor the modifications offered by individual purchasers. Our  analysis of FHA outcome data found that in aggregate, sold loans were  less likely to avoid foreclosure than similar, unsold loans. However, our  analysis also found that for some sales and some purchasers, sold loans  were more likely to avoid foreclosure compared to unsold loans. A  number of factors may contribute to differences in outcomes between  sold and unsold loans by sale and purchaser, including increased  postsale servicing and reporting requirements and the types of  modifications offered by individual purchasers.

FHA Does Not Compare Outcomes for Sold Defaulted Loans to Similar, Unsold Loans

FHA does not use the data it collects to evaluate outcomes for loans sold  through DASP compared to outcomes for similar, unsold loans. We  reviewed a contractor report and FHA’s periodic reports on DASP  outcomes and found that they lacked critical outcome information.  Specifically, in 2017, a contractor analyzed home equity preserved as a  result of the foreclosures avoided through DASP, and then estimated the  effect of avoided foreclosures on surrounding areas. However, the  contractor did not estimate the effect of foreclosure avoidance relative to  unsold loans. Borrowers with unsold loans may also avoid foreclosure, for  example, if their circumstances change and they become eligible for  foreclosure mitigation options again. FHA’s periodic reports on outcomes  also do not compare outcomes between sold and unsold loans.

FHA officials told us they had not conducted such a comparison because  they expect all loans eligible for sale to be foreclosed. A foreclosed  mortgage with an REO property disposition results in the greatest losses  to the MMI Fund. However, our analysis of FHA data does not support  these claims. When we compared loans sold through DASP to unsold  loans with similar characteristics, we found that some unsold loans  achieved an outcome other than foreclosure—21 to about 34 percent at  various times within a 4-year period.

FHA officials also told us that they evaluate loan outcomes by tracking the  extent to which purchasers are meeting NSO requirements. However,  because about 80 percent of loans were not sold through NSO pools,  FHA’s evaluation covers only about 20 percent of DASP loans. In  addition, FHA’s NSO requirements are targeted toward achieving specific  outcomes for a property or community—such as donating the property to  a land bank—rather than an individual loan or borrower. Our analysis  indicates that sold loans had higher foreclosure rates than unsold loans  regardless of whether they were sold through national or NSO pools. estimated current loan-to-value ratio, and

The matched comparison attempted to  minimize differences between sold and  unsold loans across these factors in order to  isolate the effect on outcomes of being sold  out of FHA’s insurance program.

We have previously found that evaluations often involve creating a  comparison group. Furthermore, HUD policy states that its evaluations  use methods that isolate to the greatest extent possible the effects of the  program from other influences. FHA could use loans not sold through  DASP to estimate what outcomes would have been observed in the  absence of the program and the associated losses to the MMI Fund. A  process to evaluate outcomes for sold loans relative to similar, unsold  loans could help FHA determine whether DASP is meeting its financial  objective of maximizing recoveries to the MMI Fund and understand the  extent to which DASP is helping struggling homeowners.

FHA Does Not Monitor the Modifications Offered by Individual Purchasers or Collect All Data Needed to Evaluate Their Sustainability

In its reports on DASP outcomes, FHA periodically reports at an  aggregate level the change in monthly payments resulting from the  modifications offered by purchasers. However, FHA does not track or  report the change in payments by individual purchasers. A 2016 white  paper prepared by the Department of the Treasury in conjunction with  HUD and FHFA defined loss mitigation sustainability as offering solutions  that work the first time. It further stated that modifications that provide  meaningful payment reduction will decrease the chance of a homeowner  redefaulting. Additionally, we reported in 2012 that the change in a  borrower’s monthly mortgage payment is among the factors that can  significantly influence the success of a modification. Since 2015, FHA  has required purchasers to offer eligible borrowers HAMP-like  modifications or substantially similar modifications designed to lower  borrowers’ monthly payments to an affordable and sustainable amount.

However, FHA does not monitor the extent to which individual purchasers  complied with the requirement to offer payment-lowering modifications to  eligible borrowers. We found that while the majority of the modifications  offered to borrowers whose loans were sold in 2015 or later decreased  monthly payments by more than 20 percent, about 8 percent of  modifications increased or did not result in a change in payment. Not all  borrowers are eligible for a payment-lowering modification, and,  according to FHA officials, some modifications could increase monthly  payments for borrowers with a large number of missed payments. As  discussed later, our analysis found that outcomes can vary greatly by  purchaser, and purchasers may not offer comparable modification  options. See appendix IV for information on the types of modifications  purchasers have used.

Furthermore, FHA may not have the data it needs to evaluate whether  payment-lowering modifications offered by purchasers remain  sustainable. In the second 2016 sale, FHA began requiring that modified  interest rates be fixed for at least 5 years and thereafter that they not  increase by more than 1 percent per year. FHA also began requiring  purchasers to report data related to interest rates for modified loans,  including the modified interest rate and the number of years it would  remain fixed. However, based on our review of reported modification  information, none of the purchasers from this sale reported these data.  Additionally, about 22 percent of the modifications offered to borrowers  whose loans were sold in the 2015 sale or later included a deferment.  Under deferment, borrowers are allowed to temporarily stop making  payments toward some or all of their principal balance, interest, or other  indebtedness, and deferment may result in a balloon payment at a later  date. Other than type of deferment, FHA does not require purchasers to  report details of the deferment or the effect on payments following the  deferral period. As a result, we could not determine the long-term effect  on monthly payments for many modifications offered by purchasers.  Some advocacy group representatives we spoke with expressed  concerns about purchasers offering unsustainable modifications. For  example, one advocacy group representative told us that some  purchasers may offer modifications that initially lower monthly payments  but later adjust to levels that are higher than what they were prior to  modification.

FHA requires purchasers to report some information that would allow it to  determine the types of modifications offered by individual purchasers as  well as the sustainability of these modifications. As mentioned previously,  FHA officials said they expect all loans eligible for sale to be foreclosed  and consider any nonforeclosure outcome achieved by purchasers to be  an improvement. This expectation may deter FHA from evaluating the  modifications offered by individual purchasers or the sustainability of  modifications. Federal internal control standards state that management should use quality information to achieve its objectives, which includes  identifying information requirements needed to achieve the objectives,  evaluating the data it receives from internal and external sources to  ensure they are sufficiently reliable for use in making informed decisions,  and using the data for effective monitoring. Without monitoring individual  purchasers’ modifications or collecting key data elements, FHA cannot  determine whether purchasers are meeting the postsale requirements or  the extent to which eligible homeowners obtain sustainable modifications.

Sold Loans Were More Likely to Experience Foreclosure Than Unsold Loans in the Aggregate, but Not for Later Sales and Some Purchasers

Our analysis showed that sold loans were more likely to experience  foreclosure than similar, unsold loans overall within a 48-month period  after servicing transfer (see fig. 7). In the aggregate, the probability of  experiencing foreclosure was greater overall for sold loans compared to  unsold loans. For example, the probability of foreclosure 24 months after  the servicing transfer date was 43 percent for sold loans and about 36  percent for unsold loans, a statistically significant difference.  Additionally, we analyzed the probability that a borrower reperformed,  received a temporary action such as forbearance or a trial modification, or  received a short sale or deed-in-lieu of foreclosure—foreclosure  avoidance outcomes. In the aggregate, the probability that sold loans  avoided foreclosure ranged from about 15 to 24 percent at various times  within a 3-year period beginning 12 months after the servicing transfer  date. Foreclosure avoidance rates for unsold loans were higher, ranging  from 21 to about 34 percent during this period.

We found that sold loans were less likely to result in owners staying in  their homes compared to unsold loans due to out-of-home actions (see  fig. 8). The probability of reperforming was greater overall for unsold  loans compared to sold loans. Additionally, unsold loans were more likely  to receive an in-home temporary action. In contrast, sold loans were  more likely to result in a short sale or a deed-in-lieu of foreclosure,  through which borrowers avoid foreclosure but lose the title to their  homes. See appendix VI for a comparison of reperforming, short sale or  deed-in-lieu of foreclosure, and temporary action outcomes between sold  loans and unsold loans.

Although we found that sold loans were more likely to experience  foreclosure in aggregate, for later sales, after about 12 months, rates of  avoiding foreclosure were similar or greater for sold loans compared to  unsold loans, and for some purchasers rates of foreclosure were similar  or smaller for sold loans compared to unsold loans. For the second  2013 sale through the 2015 sale, we found that sold loans were less likely  to avoid foreclosure compared to unsold loans (see fig. 9). In the 2016  sales, however, after about 12 months the sold loans were more likely to  avoid foreclosure compared to similar unsold loans. Further, after an  additional 12 months—24 months after the servicing transfer date—loans  sold in the first sale in 2016 avoided foreclosure at a rate that was 5  percentage points greater than unsold loans. Loans sold in the second  sale in 2016 were also consistently less likely to foreclose compared to  unsold loans. We discuss potential explanations for these differences  among sales in the section that follows.

We also found differences in the rates of foreclosure and some outcomes  that avoid foreclosure achieved by different purchasers (see fig. 10). For  example, the probability of a loan reperforming 24 months after the  servicing transfer date ranged from about 0.2 to about 25 percent for  selected DASP purchasers. While most of these purchasers fell below the  reperforming estimate of 18 percent for similar, unsold loans, one  purchaser exceeded this rate. Foreclosure and short sale or deed-in-lieu  of foreclosure probabilities 24 months after the servicing transfer date  also differed among these purchasers, ranging from 31 to about 90  percent and from 8 to about 30 percent, respectively. These rates  generally exceeded the foreclosure and short sale or deed-in-lieu of  foreclosure estimates for similar, unsold loans (34 and about 9 percent,  respectively).

Purchasers told us that the outcome they pursue for a loan depends in  part on the borrower’s preference. According to purchasers, for borrowers  who want to keep their homes, the best option is to try to modify the loan  and achieve reperformance status. Purchasers also said that for  borrowers who do not want a modification or for whom a modification is  not possible, they may pursue a short sale or deed-in-lieu of foreclosure,  which have a less negative effect on borrowers’ credit than a foreclosure.  Representatives of a consumer advocacy group and a research  organization told us that foreclosure has the most negative effect on the  borrower’s credit. A Fair Isaac Corporation (FICO) study found that, in  some cases, foreclosure had a more negative effect on comparable  borrowers’ credit profiles than a short sale or deed-in-lieu of foreclosure.

FHA officials, purchasers, and servicers said that purchasers have more  flexibility and are in a better position than FHA servicers to provide more  generous mitigation options. A senior FHA official emphasized that  purchasers have more financial flexibility because they generally buy the  defaulted loans at a discount from FHA (that is, less than the unpaid  principal balance). According to different DASP stakeholders, purchasers  can  forgive a portion of the principal, offer a deferment that is greater than 30 percent of unpaid principal extend the term of a loan beyond 30 years,  reduce the interest rate below the current market rate, offer more than one modification in a 2-year period, and offer more generous terms for deeds-in-lieu of foreclosure and short  sales.

In contrast, FHA is restricted in the loss mitigation options it can offer.  FHA officials told us that it does not offer debt forgiveness, but may defer  a limited amount of principal through a partial claim. FHA officials also  said they generally set loan term ranges to meet requirements for  securitization in the secondary mortgage market, including a fixed interest  rate and a 30-year term. In addition, FHA’s loss mitigation alternatives to  foreclosure, such as short sales and deeds-in-lieu of foreclosure, are  restricted or approved by FHA based on their chance of success and the  associated financial effect on the MMI Fund.

However, representatives of some advocacy groups told us that  borrowers generally benefit from their loans remaining insured and unsold  because FHA’s loss mitigation process is more transparent. They said  that information on the loss mitigation process under FHA is publicly  available, while it can be difficult to access information about some  purchasers’ loss mitigation processes. Also, starting in 2012, FHA policies  attempted to provide a more consistent loss mitigation process for  borrowers across all FHA servicers. In contrast, purchasers can have  varying processes for offering loss mitigation options.

Various Factors May Contribute to Differences in Outcomes by DASP Sale and Purchaser

A number of factors may contribute to differences in outcomes between  sold and unsold loans by DASP sale and purchaser, such as increased  postsale servicing and reporting requirements, variations in purchaser  participation across sales, and differences in the modifications offered by  purchasers.

FHA Has Expanded Postsale Requirements and Use of NSO Pools

Changes in postsale servicing requirements may account for higher  reperforming rates for sold loans in the 2016 sales. As discussed  previously, FHA introduced additional servicing requirements in 2015  aimed at offering additional protections to borrowers whose loans were  sold through DASP. For example, FHA began requiring purchasers to  evaluate borrowers for HAMP or substantially similar modifications aimed  at lowering borrowers’ monthly payments and offer these modifications to  eligible borrowers.

Further, the share of loans sold through NSO pools relative to national  pools has increased, which may also account for higher reperforming  rates for sold loans in the 2016 sales. As noted previously, NSO and  nonprofit pools have additional postsale outcome requirements. We  compared outcomes for loans sold in NSO pools to outcomes for loans  sold in national pools and found that loans sold in NSO pools were more  likely to reperform, possibly due to higher occupancy rates in NSO pools  compared with national pools. As shown in figure 11, the share of loans  sold through NSO and nonprofit pools relative to loans sold through  national pools increased between 2013 and 2016, from about 12 percent  of the total loans in our scope for the 2013 sales to about 45 percent of  loans in the 2016 sales.

In addition, FHA introduced a reporting requirement in 2015 that  purchasers continue reporting the outcome status of loans even after  selling them to new buyers, as opposed to reporting the loans as resold  with no further outcome updates. Purchasers may have returned these  loans to performing status before selling them because performing loans  are more profitable, but the performing status would not have been  reported before 2015. The use of resales as a status was substantially  lower in the second sale in 2016 compared to the first sale in 2013—0.04  percent of reported statuses compared to 29 percent of reported  statuses. This change could be reflected in the higher reperforming  outcomes we observed for sold loans in 2016.

Purchasers Varied across Individual Sales and May Not Have Offered Comparable Modifications

Our analysis indicated that individual purchasers did not consistently buy  loans across sales and the share of loans bought by individual  purchasers varied. For example, about 42 percent of the purchasers in  our scope bought loans in one sale, while about 27 percent of purchasers  bought loans in three or more sales. The share of loans bought by  individual purchasers has also varied by sale (fig. 12). For example, one  purchaser bought about 4 percent of the loans sold in the second sale in  2013 but about 82 percent of the loans sold in the first sale in 2016. This  purchaser had higher reperforming and lower foreclosure outcomes  compared to other purchasers.

In addition, purchasers may not consistently offer modification options.  Approximately 18 percent of the sold loans in our scope received one or  more modifications. However, individual purchasers offered modifications  at varying rates, from no modifications to 46 percent of the loans they  purchased. Our analysis also indicates that the type of modifications offered may differ by purchaser. For example, we found that about 88  percent of the modifications that had decreased monthly payments by 30  percent or more were offered by two of the 25 purchasers that reported  modifying loans. In addition, the share of modifications offered by  individual purchasers that resulted in no payment change or an increase  in payment varied. For example, eight purchasers reported either no  change or an increase in payment in 51 to 75 percent of the modifications  they offered. In contrast, three other purchasers reported either no  change in payment or an increase in payment in less than 10 percent of  their modifications.

Purchasers’ investment goals and expertise could affect borrower  outcomes. DASP purchasers include investment firms, rental housing  companies, and nonprofit organizations with varying investment goals.  In interviews, purchasers cited various goals for purchased loans. For  example, an executive of a nonprofit organization said its primary goal  was to help borrowers avoid foreclosure, while representatives of an  investment firm told us that their goal was to maximize the return for each  purchased loan. A representative of one advocacy group told us that  purchasers’ different areas of expertise could make different foreclosure  and foreclosure avoidance options more or less profitable for them. For  example, purchasers with an extensive background in loan servicing may  be able to offer modifications at a lower cost, while rental companies may  consider DASP as a source for inventory for properties to rent if loss  mitigation fails.

Additionally, purchasers can have varying levels of success in contacting  borrowers to discuss modifications or disposition options for the loans  they purchased. Most purchasers noted that it was often difficult to make  contact with borrowers because houses were vacant or borrowers  avoided contact. For example, one purchaser said it was unable to reach  about 25 percent of borrowers for the loans it purchased. Another  purchaser said it was unable to reach about half of the borrowers.  Furthermore, while several purchasers said they primarily contacted  borrowers via the notice of servicing transfer and by phone, one  purchaser also said that a more successful outreach method involved in- person visits to borrowers’ homes, but that such visits may not always be  feasible due to resource constraints.

FHA’s Current Practices May Not Optimize Savings to the MMI Fund, and the Effect of Some Changes Is Unclear

FHA May Be Recovering Less for the MMI Fund Than It Could Due to Its Scheduling and Reserve Pricing Practices

FHA announces bid dates in the Federal Register and industry  publications but does not communicate long-range notice of upcoming  sales. FHA held multiple sales in 2011, 2012, 2013, 2014, and 2016, but  the sales were not held at set intervals or at set dates throughout the  years. FHA has not held any DASP sales since September 2016, and  officials stated that they do not know when FHA will hold another sale.

Our interviews indicate that communicating long-range notice of sales  could help keep participation robust and increase bid amounts. One  purchaser told us that it was eager for FHA to restart DASP sales.  However, purchasers would like to receive additional notice of sales. One  purchaser told us that additional notice of FHA sales would allow it the  time to plan or raise additional capital needed to participate in a DASP  sale. Another purchaser said that, without knowledge of when another  sale will occur, it will invest elsewhere. Losing bidders to other entities’  sales could affect bid amounts in DASP sales. According to economic  literature, increasing the number of bidders in an auction generally should  increase bid amounts—a financial objective for the program.

Federal internal control standards state that management should  externally communicate the necessary quality information so that external  parties can help the entity achieve its objectives and address related  risks. For example, although Fannie Mae does not publish an annual  schedule, market participants know when to expect Fannie Mae sales  because it has held them multiple times a year. In contrast, FHA does not  hold regular sales or signal to the market when it will hold its next sale  through its outreach because DASP remains a pilot program. FHA  officials said they change program parameters with each sale, so it is  difficult to schedule sales in advance. We previously noted that, even  implementing DASP as a pilot program, FHA could use performance data  to establish criteria for the timing of sales and to help optimize the use of  the program to achieve its objectives. Similarly, by communicating long- range notice of upcoming sales to market participants, FHA could  encourage bidder participation and potentially help meet its objective of  maximizing recoveries to the MMI Fund. As discussed in appendix VII,  characteristics of successful auctions include attracting sufficient interest  in the auction and in designing the auction to meet its objectives. Without  communicating long-range notice, FHA may be recovering less than it  could for the MMI Fund.

FHA sets reserve prices—a minimum amount that it is willing to accept as  the winning bid—to help ensure that the MMI Fund is minimally affected  by the sale. FHA generates a reserve price for each loan and adds those  prices together to generate a pool reserve price. If FHA does not receive  a bid on a pool that is at or above its reserve price, FHA may choose not  to sell the pool. Any amount of the bid above the reserve price  represents additional potential proceeds to the MMI Fund.

FHA officials stated that they expect that all DASP loans would be  foreclosed and the properties placed in its REO inventory had they not  been sold. FHA officials stated that they establish each loan’s reserve  price considering the percentage of the unpaid balance FHA expects to  recover through foreclosure and REO disposition. A recent HUD OIG  report found that for loans sold in 2015 and 2016, FHA experienced a 3  percent lower loss rate compared with similar loans that were foreclosed  and the associated property placed into FHA’s REO inventory. Loss  estimates have varied over time and by location of the property  associated with the loan, but generally an REO disposition results in the  greatest loss to the MMI Fund. For example, FHA’s Office of Risk  estimated that from fiscal year 2013 through the first quarter of 2017, FHA  lost 61 percent (recovering about 39 percent) of the unpaid balance on  REO dispositions compared to about 46 percent (recovering 54 percent)  of the unpaid balance on other nonloan sale dispositions.

FHA officials stated that unsold defaulted loans would likely result in  foreclosure and being placed in the REO inventory. However, our  analysis of outcomes showed that comparable unsold loans resulted in a  range of outcomes, not just foreclosure and REO disposition. Specifically,  our analysis of outcomes in sales between 2013 and 2016 showed that  about 66 percent of unsold loans with characteristics similar to sold loans  resulted in foreclosure or remained unresolved. The remaining 34  percent of these unsold loans resulted in a range of nonforeclosure  outcomes (including returning the loan to performing status), all of which  could produce smaller losses to the MMI Fund compared with REO  disposition. Further, our analysis found that about 14 percent of the loans  returned to performing status or were terminated as paid in full, thereby  generating very little to no loss to the MMI Fund.

FHA may be setting its reserve prices too low in some cases. FHA sets a  loan’s reserve price considering the percentage of the unpaid balance it  expects to recover through an REO disposition to guarantee the minimum  recovery proceeds to the MMI Fund. However, when the expected losses  to the MMI Fund for some loans are smaller—such as in the case of a  different disposition method or a terminated loan—the reserve price  would need to be higher to guarantee the minimum recovery proceeds to  the MMI Fund. If FHA could recover more of the unpaid loan balance  through a non-REO disposition method, setting the reserve price at the  expected recovery of the unpaid balance from an REO disposition would  be too low. See figure 13 for an illustrative example of how reserve prices  could be affected based on different expectations of loan dispositions.

The extent to which the MMI Fund could be negatively affected depends  on how reserve prices compare to the actual winning bids. In figure 13,  if FHA set the reserve price of pool A at $3,900,000, FHA would sell the  pool to the highest bidder that bid at least $3,900,000. If the highest bid  was less than $3,900,000, FHA may not sell the pool. If the highest bid for  the pool was at least $3,900,000 but less than $5,054,000, the MMI Fund  would be negatively affected because FHA could have recovered more by  not selling the pool. If the highest bid was at least $5,054,000, the MMI  Fund may not be negatively affected by the sale. Using a simplified  method to calculate reserve prices that does not consider differences in  local housing markets, we estimate that 31 percent of the loan pools FHA  sold in its 2013–2016 sales had winning bids greater than FHA reserve  prices but less than our calculated reserve prices. For about 14 percent  of the pools, our calculated reserve price was 10 percent or more below  the winning bid, and for 7 percent of the pools, our calculated reserve  price was 25 percent or more below the winning bid.

Federal internal control standards state that management should use  quality information to achieve the entity’s objectives. This includes  designing a process that uses the entity’s objectives and related risks to  identify the information requirements needed to achieve the objectives  and address the risks. However, FHA is not considering information on  the range of potential outcomes for loans in setting its reserve pricing  because it expects all sold loans to result in foreclosure and REO  disposition. Without considering other disposition methods in its reserve  pricing, FHA risks recovering less for the MMI Fund in loan sales than if  the loans had not been sold and risks not meeting its objective.

FHA Does Not Analyze Key Information before Setting Eligibility Criteria

FHA’s eligibility criteria specify the characteristics of the loans that can be  selected for a loan sale, but FHA does not analyze its portfolio to identify  loan characteristics for which DASP would be the lowest-cost disposition  method or consider market information before setting the criteria. FHA  has analyzed bid amounts from previous sales and made changes to  eligibility criteria related to length of delinquency and LTV ratio, in part,  intended to increase MMI Fund recoveries. For example, using analysis  of its 2014 sales, FHA determined the LTV ratios that produced the  highest loan-level recoveries relative to REO dispositions and changed  the loan eligibility criteria for the minimum LTV ratios by state for its 2015  sale. According to FHA, this change was intended to make more loans  eligible for disposition through DASP sales in certain states that had long  foreclosure processes.

However, FHA does not analyze its portfolio of defaulted loans to identify  characteristics of loans that, if sold, would minimize the loss to the MMI  Fund relative to all other disposition methods to inform eligibility criteria  for sales. FHA may have missed an opportunity to evaluate when loan  sales would be the most effective disposition method to maximize  recoveries to the MMI Fund—a financial objective of the program. FHA  contracted with CoreLogic in 2016 to develop a tool to determine the  lowest-cost disposition for defaulted loans in FHA’s portfolio but did not  include loan sales as a potential disposition method. The tool is intended  to generate estimates of property values and holding costs and determine  the lowest cost disposition method for a given loan at a given time. Used  broadly, this information could help FHA identify loan criteria for which  DASP sales would be the most effective disposition method and set loan  eligibility criteria for DASP loans. However, FHA excluded DASP  because, according to the contractor, the data on DASP had been too  inconsistent to be reliably included in the CoreLogic tool. Therefore, FHA  cannot use the tool to identify loan characteristics for which DASP could  be the lowest-cost disposition method or to inform its decisions in setting  loan eligibility criteria.

Further, FHA determines eligibility criteria before considering current  market information. FHA’s transaction specialist gathers market  information before the sale, but FHA does not consider it before setting  eligibility criteria and soliciting eligible loans from servicers. The  transaction specialist analyzes the market and develops a sales strategy  report using the loans submitted by the servicers. The report contains  information on available capital for key purchasers, the number and type  of loans purchasers are interested in buying, other entities’ upcoming  sales, and potential pooling strategies for the loans submitted. FHA uses  the information to develop pools intended to maximize the sale proceeds,  but not to identify characteristics of loans meeting purchasers’  preferences and inform decisions in setting eligibility criteria.

FHA’s current approach risks setting criteria that may not maximize  recovery to the MMI Fund because it may be selling loans that could  result in a smaller loss to the MMI Fund than if they had remained under  FHA insurance. FHA generally analyzes how to maximize sales proceeds  after setting loan eligibility criteria and reviewing the servicers’ submitted  loans because servicers select the loans, voluntarily participate, and may  not submit all eligible loans. Further, setting loan eligibility criteria that  increase servicers’ cost to identify loans may reduce servicer  participation. In addition, FHA does not use current market information  because, according to officials, they use data from past sales to  determine market preferences and their primary concern is the effect on  the MMI Fund. However, FHA has not held a sale since 2016, so market  preferences may have changed. Additionally, purchaser participation may  decline if loans do not match their preferences. Generally, fewer bidders  indicate less interest in the pools and could result in decreased prices,  which would reduce returns to the MMI Fund.

By implementing DASP, HUD intended to maximize recoveries to the  MMI Fund. Without analyzing its loan portfolio to identify when loan sales  would be the most cost-effective disposition method and considering  market information before setting loan eligibility criteria, FHA cannot  appropriately calibrate its loan eligibility criteria to maximize recovery to  the MMI Fund.

The Effects on the MMI Fund of Changes to Auction Structure and Pooling Strategies Are Unclear

Based on our analysis of comparable mortgage industry auctions, FHA’s  auction structure mirrors the industry standards of pooled, highest bidder,  sealed bid auctions. Other auction structures we examined, such as  single loan sales and adding a winner-take-all option, would involve  tradeoffs. For example, an analysis by DebtX, a loan sale advisor,  showed that FHA would have earned higher proceeds in a prior DASP  sale if it had awarded based on single-loan bids rather than the pool-level  bids. However, our interviews with FHA officials and purchasers  revealed uncertainty in how proceeds from single-loan bids would  compare to bids for pooled loans. For example, FHA officials said they  benefit from economies of scale when offering larger pools and that  administrative costs associated with servicing transfers would be higher if  FHA sold loans individually. Furthermore, purchasers may decline to bid  on individual loans. Purchasers we interviewed expressed interest in sets  of loans rather than individual loans, in part to manage risk. When  asked about smaller pools, FHA officials stated that they have used small  pools to attract nonprofit bidders, but we found that these pools had a low  number of bidders and many were not traded.

The effect on the MMI Fund of adding a winner-take-all option to FHA’s  auction structure is uncertain. Such a structure could result in increased  bid amounts. In a winner-take-all option, each bidder would choose to  either participate at the sale level or pool level in the winner-take-all  option. In either case, the bidder would place loan-level bids that would  be rolled up to the pool or sale level. If a winner-take-all bid exceeds the  aggregate of the highest pool-level bid for each pool, all pools are  awarded to the winner-take-all bidder. By definition, if a winner-take-all  bidder won the auction, the resulting bid would increase FHA’s overall  sale proceeds.

However, a winner-take-all structure could discourage bidder  participation, which could lead to reduced bid amounts. Smaller entities  and larger nonwinning bidders may be less likely to participate in future  sales because of the costs associated with participating. According to  auction theory, the higher the cost of performing due diligence and  qualifying for and participating in the auction, the more bidder  participation will be discouraged. Although the extent of purchasers’ due  diligence checks differed, all the purchasers we interviewed told us that  they expend funds to purchase property valuations on at least a sample  of loans to check whether the valuations listed in the servicer data were  reasonable. Some purchasers also expend funds to examine servicing  records or perform legal searches related to the loans. Additionally,  bidders are required to submit deposits with their bids that FHA will return  if the bidder is not awarded the pool or pools. One purchaser told us it  was reluctant to spend the money on due diligence if it did not have a  reasonable chance at winning the pool or pools. According to economic  literature, having fewer bidders in an auction generally results in  decreased prices and an increased opportunity for bidders to form  strategic partnerships that would decrease competition.

See appendix VII for more information on auction structures.

It is unclear whether changes to FHA’s pooling strategy—that is, its  approach for selecting loans to include in its loan sale pools—would result  in more bidders or higher bid amounts. We compared the pooling  practices and pool-level data of FHA with those of Freddie Mac and  Fannie Mae (the enterprises) to determine whether pooling strategy  affected the number of bids. The enterprises started selling defaulted  loans in 2015—much later than FHA—and have continued to do so, with  Freddie Mac and Fannie Mae both holding sales in October 2018. FHA  held three DASP sales in fiscal years 2015 and 2016 that overlapped with  the time frame of the enterprises’ sales. FHA and enterprise pools had  different financial characteristics—loans in FHA pools were less  delinquent, the properties were more likely to be occupied, and the loans  had lower underlying property values compared to loans in enterprise  pools (see fig. 14). Nonetheless, FHA received similar numbers of bids  and bid amounts relative to the estimated property values as the  enterprises. Generally, the number of bidders for FHA and the enterprises  was between three and six, and bid amounts were typically between 58  and 71 percent of the underlying estimated property value. Many of the  purchasers of FHA’s DASP loan pools also purchased the enterprises’  pools of defaulted loans.

It is unclear whether adjusting the pooling strategy to focus on specific  loan characteristics would increase the number of bidders for FHA.  Enterprise officials told us that they pool by geography, occupancy, and  LTV ratio and also try to create loan pools such that all loans have the  same servicer. Unlike the enterprises, FHA does not pool loans by similar  characteristics, and pools frequently have loans from more than one  servicer. FHA officials told us they primarily use geography and pool size  to pool loans. However, FHA officials also told us they try to include  loans to make the pools attractive to different types of purchasers. Loans  may be valued differently by bidders with unique strengths—such as  strong default servicing infrastructures or experience rehabilitating  properties—that would make the loans more profitable to them compared  to other bidders. FHA officials stated that they encourage higher, outlier  bids by structuring pools to attract different types of bidders.

We found differences in the extent to which loan-pool characteristics were  associated with bidder participation for FHA’s and the enterprises’  defaulted loan sales. Our multiple variable regression analyses of how  loan-pool characteristics predict the number of bidders showed the  following:

Pools with a higher percentage of occupied properties were  associated with an increase in the number of bidders in FHA pools but  a decrease in the number of bidders in enterprise pools.

Average LTV ratio was not associated with the number of bidders for  FHA or the enterprises.

National pools were associated with more bidders for FHA. This  result may be due to fewer FHA postsale requirements for national  pools.

For FHA pools, more servicers was associated with fewer bidders,  possibly due to higher transaction costs. Although 86 percent of  FHA pools had fewer than five servicers, the number of servicers for  FHA pools ranged from one to 21. In contrast, all enterprise pools  were single-servicer pools, except for four out of 101 pools (about 4  percent) that each had two servicers.

See appendix I for a detailed description of these analyses.

Setting aside pools for nonprofit organizations has not significantly  expanded bidder participation in FHA loan sales. FHA performs market  outreach to educate potential purchasers about the DASP process, but  barriers to entry exist in terms of qualifications and the underlying capital  required. In its 2015 sale, FHA began offering nonprofit-only pools. In  2016, FHA established a goal of selling 10 percent of assets to nonprofits  and local governments. In 2015–2016, FHA offered nine pools exclusively  to nonprofits, of which five (about 56 percent) received bids at or above  FHA’s reserve price and were traded. Each pool received between one  and three bids. Despite heavy marketing, all traded pools were awarded  to two organizations, including one first-time purchaser. In comparison,  from 2010–2016, FHA offered 191 national and NSO pools, and 185  (about 97 percent) received bids at or above FHA’s reserve price and  were traded. Several stakeholders told us that most nonprofit  organizations do not have the capacity to service delinquent loans, but  they may be able to participate in the program in a different capacity. For  example, two purchasers partnered with nonprofit organizations to  perform outreach to borrowers.

Since 2002, FHA has used loan sales intermittently to reduce its backlog  of defaulted mortgages and preserve the financial health of the MMI  Fund. In addition, some homeowners have received additional  opportunities to modify their loans and retain their homes through the  program. Yet, our review found several areas where FHA can improve its  management of DASP through more formalized procedures and  analyses, as follows.

Improving controls. By evaluating eligibility at various points throughout  the 3-month period prior to the sales, including after the servicer update,  FHA could better prevent the sale of ineligible loans. Additionally, as FHA  finalizes its comprehensive procedures, it can better ensure that it is  considering the effects of previous changes on the program by including  procedures for reviewing and documenting program changes in a timely  manner.

Using performance data. FHA has not developed key performance  measures for DASP. Without measurable targets related to clear program  objectives, FHA is not well-positioned to assess the effectiveness of  DASP—which is still considered a pilot program—in achieving its  objectives. Furthermore, by using performance data to determine the  optimal timing of DASP sales, FHA could help the program achieve  higher recoveries.

Evaluating outcomes. FHA has not conducted an analysis that  compares the extent to which sold loans help avoid foreclosure, as  compared to similar, unsold loans. Such an analysis would help assess  DASP’s effectiveness in meeting a program objective.

Monitoring and evaluating purchasers’ modifications. FHA does not  monitor purchasers of defaulted loans to ensure they are complying with  FHA’s requirement to offer payment-lowering modifications to eligible  borrowers. Additionally, FHA may not collect the data it needs to evaluate  whether modifications offered by purchasers remain sustainable. With  better monitoring, FHA could determine whether individual purchasers are  meeting these requirements.

Maximizing benefits of loan sales. FHA has opportunities to make  changes in how loan sales are held and structured that could enhance  bidder participation and better meet the DASP objective of maximizing  recoveries to the MMI Fund—which are two characteristics of successful  auctions. Providing better advance notice to prospective bidders, setting  reserve prices based on realistic expectations, and setting loan eligibility  requirements that encourage more bidding could improve the results of  DASP sales and thereby reduce losses to the MMI Fund.

We are making the following nine recommendations to FHA:  The Commissioner of FHA should ensure that its eligibility checks are  conducted throughout the DASP sale process, such as by establishing a  schedule to check for eligibility at certain milestones. (Recommendation  1)

In formalizing procedures for DASP, the Commissioner of FHA should  document processes for timely consideration and review of program  changes. (Recommendation 2)

The Commissioner of FHA should clearly define DASP objectives and  develop measurable targets for all program objectives. (Recommendation  3)

The Commissioner of FHA should use performance data to develop  criteria for when to hold DASP sales. (Recommendation 4)

The Commissioner of FHA should evaluate loan outcomes under DASP  compared to outcomes for similar, unsold loans. (Recommendation 5)

The Commissioner of FHA should monitor individual purchasers’  compliance with FHA’s modification requirements and ensure the  purchasers submit the data needed to evaluate the sustainability of  modifications. (Recommendation 6)

The Commissioner of FHA should communicate long-range notice to  prospective bidders of upcoming DASP sales. (Recommendation 7)

The Commissioner of FHA should develop a methodology to assess the  range of possible outcomes for loans when setting DASP reserve prices.  (Recommendation 8)

The Commissioner of FHA should analyze FHA’s loan portfolio and  market information before setting loan eligibility criteria.  (Recommendation 9)

We provided a draft of this report for review and comment to HUD and  FHFA. HUD provided written comments, which have been reproduced in  appendix VIII, that communicate FHA’s response to the report. Both HUD  and FHFA provided technical comments, which we have incorporated, as  appropriate.

In its written response, FHA’s management generally agreed that  opportunities exist for improvement to single-family loans through more  formalized procedures and analyses, as the defaulted loan disposition  option transitions to a permanent disposition alternative. FHA generally  agreed with seven recommendations and did not explicitly agree or  disagree with two recommendations.

FHA neither agreed nor disagreed with our recommendation that FHA  should ensure that its eligibility checks are conducted throughout the  DASP sale process, such as by establishing a schedule to check for  eligibility at certain milestones. FHA stated that it works with the servicers  and relies on them to determine eligibility throughout the DASP sale  process. FHA also stated that its management agrees to include a  schedule of eligibility checks in its procedures. We acknowledge that  servicers check loan eligibility throughout the process, as stated in the  report. However, we maintain that FHA and its contractors should also  space their own checks throughout the process, specifically scheduling  some closer to the bid date, and not rely exclusively on the servicers for  this function at the end of the sale process.

FHA neither agreed nor disagreed with our recommendation that FHA  should clearly define DASP objectives and develop measurable targets  for all program objectives. FHA management stated that it believes it  already has clear objectives and performance management in place for  its DASP objective to maximize recoveries to the MMI Fund and that it  measures whether it is meeting this objective. We acknowledge that  FHA’s objective to maximize recoveries to the MMI Fund is clear and that  it has a measureable target. However, as stated in the report, agency  documents and program changes reflect additional program objectives  related to preserving homeownership, helping to stabilize neighborhoods,  and offering borrowers a second chance at avoiding foreclosure that do  not have measurable targets. We maintain that FHA should clarify its  program’s objectives in agency documents, whether that be one objective  or several, and ensure that each objective has a measurable target.

FHA also took issue with aspects of our comparison of sold and unsold  loans in its written response and technical comments.

In its written response, FHA noted that the unsold loans in our  analysis are invalid for comparison to sold loans because these  unsold loans had not been deemed by servicers as having completed  all applicable loss mitigation activities prior to being included in the  analysis the way sold loans had. We attempted to minimize  differences between the sold and unsold loans by matching loans  across several variables that could affect the likelihood of foreclosure  or foreclosure avoidance. We found a high rate of similarity between  the two groups and indirectly controlled for any differences in the  extent of loss mitigation by including length of delinquency as one of  the matching variables. According to the FHA servicing handbook,  servicers are generally required to either use a loss mitigation option  for which a borrower qualifies or initiate foreclosure within 6 months of  the default date.

In its technical comments, FHA also noted that our matching of  comparison loans omitted important variables. In particular, FHA  noted that the analysis did not hold constant several factors related to  the risk of foreclosure, including default risk as measured by FICO  scores, debt-to-income ratios, home price appreciation, and loan  amount and term. However, we indirectly controlled for loan term and  home prices by matching loans by origination years and indirectly  controlled for loan amount and home prices by matching on  categories of LTV ratios. We did not control for debt-to-income ratios  or FICO scores, but FHA’s data systems did not contain them for  unsold loans and FHA does not include them as criteria for DASP  eligibility. Further, these variables may not be substantially different  between the sold and unsold loans because the loans in both groups  are severely delinquent. We revised the report to clarify that we  estimated the LTV ratio at the time of the DASP sale. We calculated  the LTV ratio using the outstanding loan amount and estimating  current property values by adjusting the original sale values for  regional changes in home prices over time.

In addition, FHA stated in technical comments that our comparison  group is invalid because 100 percent of loans in DASP sales would  end in foreclosure if they were not included in a sale. FHA stated that  the only loans eligible for sale are those for which the only alternative  remaining to the borrower is foreclosure. However, we disagree that  all sold loans would have ended in foreclosure had they not been  sold. As discussed in the report, unsold loans with characteristics  similar to sold loans experience a range of outcomes, including up to  34 percent experiencing outcomes other than foreclosure following  sales. In addition, the status of delinquent loans can be very fluid  throughout the sale process, even after purchasers place bids on  them, and borrowers who previously did not qualify for a loss  mitigation option could become eligible to be evaluated again (and  their loan could become ineligible for sale) if their circumstances  change. For example, our analysis of FHA data found that from 2010  through 2016 about 23 percent of loans were removed from sales  between the bid and claims dates due to, among other things, loans  entering into loss mitigation. Furthermore, we found that for five  individual loan pools, more than half of the loans were removed from  the sales between the bid and claims dates. These results argue  against the validity of FHA’s presumption that all loans selected for  sales would have ended in foreclosure.

Although our matching process does not capture all potential foreclosure  risk characteristics and our results should be interpreted accordingly, our  analysis supports our assumption that the pools of sold and unsold loans  are generally comparable and describes relationships between DASP  participation and loan outcomes. We maintain that our approach is  reasonable using the available data and forms a sound basis for the  findings and recommendations in the report. As FHA considers actions in  response to our recommendations about evaluating loan outcomes and  assessing its methodology for setting reserve prices, we encourage it to  further enhance the robustness of these analytical methods. .  As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the appropriate  congressional committees, the Secretary of HUD, the Director of FHFA,  and other interested parties. In addition, this report will be available at no  charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-8678 or garciadiazd@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. Key contributors to this report are listed in  appendix IX.

Appendix I: Objectives, Scope, and Methodology

The objectives of our report were to examine (1) the changes the Federal  Housing Administration (FHA) has made to the Distressed Asset  Stabilization Program (DASP) over time; (2) certain DASP procedures,  including those associated with loan eligibility, and documentation; (3)  FHA’s evaluation of the identified outcomes for loans that have been sold  through DASP and how these compare with similar, unsold loans; and (4)  the potential effects that changes to DASP might have on the Mutual  Mortgage Insurance Fund (MMI Fund).

Databases Used in Analyses throughout the Report

To conduct the data analyses discussed in the sections below, we used  the FHA data sets listed in table 2. (We discuss the use and reliability of  these data sets in the sections that follow this table.)

To address all the objectives, we reviewed relevant laws, agency  documents, and agreements. We reviewed the National Housing Act,  Department of Housing and Urban Development (HUD) program  evaluation policy and sale notices in the Federal Register, and Office of  Management and Budget (OMB) Circular A-11. We reviewed HUD’s  contractual agreements with servicers and purchasers for each DASP  sale from 2010 to 2016, which are called, respectively, Participating  Servicer Agreements (servicer agreements) and Conveyance,  Assignment, and Assumption Agreements (purchaser agreements). We  also reviewed other agency documents, including HUD’s Fiscal Year  2017 Annual Performance Report, FHA’s DASP sale results, FHA’s  Actuarial Reports, HUD’s Reports to the Commissioner on Post Sale  Reporting, and the Federal Housing Finance Agency’s (FHFA) Enterprise  Non-performing Loan Sales Reports. We also reviewed prior GAO work  on related topics.

We interviewed officials from multiple offices within HUD, including the  Offices of Asset Sales, Single Family Asset Management, Risk  Management and Assessment, Finance and Budget, and the National  Servicing Center. We also interviewed HUD’s three primary contractors  for DASP at the time of our review—transaction specialist: Verdi  Consulting; compliance analytics: SP Group; and program financial  adviser: NOVAD Management Consulting. We interviewed officials from  FHFA and the government-sponsored enterprises (enterprises)—Freddie  Mac and Fannie Mae—as they also auction defaulted loans. We  interviewed and reviewed reports from selected consumer advocacy  organizations and industry stakeholders that included five servicers,  seven purchasers, and two loan-sale advisory firms. In interviews, we  generally discussed with participants the following topics: changes to  DASP over time; what works well and what could be improved in DASP;  foreclosure avoidance options that purchasers offer; the effectiveness of  FHA’s 2015 and 2016 DASP reforms; communication to borrowers whose  loans are selected for a DASP sale; and the auction process and effect of  alternative auction structures on the MMI Fund.

To select servicers and purchasers to interview, we analyzed the bid day  pool-level data and postsale data, respectively. We selected and  interviewed five servicers from a universe of 56 servicers based on high  and low participation in terms of number of sales, loans sold, and the  unpaid balance of the loans and type of institution (bank and nonbank).  We selected and interviewed seven purchasers from a universe of 29  purchasers based on participation, postsale foreclosure rate, and type of  institution (for-profit and nonprofit). The views and practices of the  servicers and purchasers we selected may not represent those of the  servicers or purchasers not selected.

Identifying and Mapping Loans Sold through DASP

To identify a complete list of the loans sold through DASP (sold loans), as  described in the background section of the report and used in analyses  throughout, we obtained and analyzed postsale reporting data. Per the  purchaser agreements, purchasers are required to report the outcome  status of sold loans on a quarterly basis for 4 years following the transfer  of loan servicing responsibilities. The quarterly postsale reports did not  always include data for every purchased loan. We therefore compared  the number of loans included in each quarterly postsale report for each  pool and used the quarterly reports with the highest loan count to develop  a complete list of the loans sold through DASP.

To develop the map showing the concentration of sold loans by state, we  used data from the Single Family Default Monitoring System (default  monitoring system) to calculate the ratio of loans sold through DASP to  FHA-insured, defaulted loans with six or more missed payments in July of  each year. We then categorized states into five ratio categories based on  the distribution of ratios across states. We limited our review of  participants and characteristics to the loans included in our comparison  analysis of outcomes to provide descriptive context for this analysis.

To assess the reliability of the data sources above, we interviewed FHA  officials about how the data were collected, processed, and accessed.  We also identified the sold loans that were not reported in the default  monitoring system at the time servicers submitted the loans to FHA for sale. We found that less than 0.1 percent of the sold loans in our scope  were not reported as delinquent by servicers and determined that, due to  their small percentage, excluding these loans would not bias our results.  Based on our interviews and review of unreported loans, we concluded  that servicers generally reported sold loans in the default monitoring  system, and we found the data to be sufficiently reliable for the purpose of  identifying and describing sold loans.

Examining DASP’s Current Process and How It Changed over Time

To describe the DASP process and changes to the program over time, we  reviewed FHA documentation, legislation, and other reports. To describe  how DASP currently works, we analyzed the 2016 servicer and purchaser  agreements and interviewed FHA officials and servicers. To describe how  the program changed over time and the type of changes that FHA made,  we reviewed HUD’s authorizing legislation to accept assignment and sell  loans, program requirements under OMB Circular No. A-11, and HUD  press releases that announced the program’s initiation and changes. To  identify changes in servicer agreements and purchaser agreements since  2010, we performed a content analysis identifying differences from sale- to-sale (one servicer agreement and one purchaser agreement for each  sale between 2010 and 2016). One analyst performed the review, and a  second analyst verified the selected content. To gather additional  background information on the program and the changes over time, we  reviewed reports issued by the HUD Office of Inspector General (OIG)  and consumer advocacy and other research organizations such as the  National Consumer Law Center, Center for American Progress, and  Urban Institute. To corroborate our information on the program and  changes, we asked FHA to provide us a list of changes to the program  between 2010 and 2016, and we interviewed FHA officials in HUD  headquarters and at the National Servicing Center. We further  corroborated our understanding of DASP through interviews with the  servicers and purchasers.

Evaluation of Certain DASP Procedures and Documentation

To identify FHA’s procedures for monitoring loan eligibility, we examined  procedures identified in the servicer agreements and contracts and  statements of work for entities assisting in oversight of DASP sales. We  assessed the extent to which these procedures existed and were working  effectively by reviewing status codes from FHA’s default monitoring  system and examining relevant findings from HUD OIG audit reports. We  found limited information in agency documentation on steps conducted to  verify loan eligibility and had to rely on discussions with FHA staff and  contractors on monitoring processes. We also interviewed servicers on  their process for selecting loans and certifying loan eligibility for DASP.  We further corroborated this information by providing a combined list of  steps to FHA officials to verify accuracy.

To assess whether FHA’s procedures for assessing loan eligibility were  working, we determined the extent to which FHA’s sold loans appeared to  be ineligible in its 2016 sales. To identify the ineligible loans, we  compared the eligibility criteria listed in the 2016 servicer agreements to  the data in the default monitoring system. We obtained the default  information for sold loans for the period 2 months prior to the bid date— the period when servicers generally submit loans for sale—and at the bid  date. We limited our analysis to loans sold in 2016 because FHA’s loan  eligibility criteria changed from sale to sale and 2016 was the most recent  year a sale occurred. We selected a nongeneralizable sample of 10 loans  with ineligible default codes in the default monitoring system as of the bid  date. To determine why FHA sold loans that appeared to be ineligible, we  provided list of sold loans with ineligible codes to FHA staff for them to  research and provide their explanations.

We followed up in interviews with officials from FHA’s Office of Asset  Sales to further clarify their responses. We also interviewed FHA officials  regarding data reliability and to ensure that our understanding of the  default codes and their corresponding eligibility or ineligibility for sale was  accurate. We also performed electronic checks for consistency and  validity and found the data to be sufficiently reliable for the purpose of  determining default status, length of delinquency, and the extent to which  loans that FHA sold in 2016 appeared to be ineligible.

To assess whether DASP purchasers offered borrowers payment- lowering modifications, we evaluated the loan modifications offered by  individual purchasers by comparing borrowers’ monthly mortgage  payments prior to being modified to their monthly payments after being  modified. We obtained postmodification payment data from the postsale  reports and premodification payment data from the submitted loan  database. Using the most recent postsale record for each modified loan,  we calculated the change in payment resulting from the modifications  offered by DASP purchasers. To confirm that we used the appropriate  data sources and variables for our analysis, we contacted FHA’s Program  Financial Advisor, who collects postsale reporting data and reports some  information on modifications. Our analysis included all loans sold in DASP  sales that occurred between 2013 and 2016, with some exceptions, in  line with the scope of our comparison analysis of outcomes. We selected  this scope because it represented the period for which FHA was generally  able to provide consistent postsale quarterly reports.

In addition, to assess the sustainability of the modifications offered by  DASP purchasers, we used data on modification type from the postsale  reports to calculate the number of modifications that included a  deferment. We identified loan modification characteristics from prior GAO  work. We also reviewed the purchaser agreements and postsale reports  to examine the information available on modified interest rates. Our  analysis was limited to modifications that were reported using the more  expansive list of characteristic codes introduced in 2016, which  accounted for about 95 percent of the modifications in our scope.

To assess the reliability of the modification data, we checked for missing  or invalid data entries across different modification fields, including  modification date, modification type, and monthly payment before and  after a modification. We found that purchasers generally reported  consistent information on modifications for loans sold in DASP sales that  occurred between 2013 and 2016 and determined the data to be  sufficiently reliable for the purpose of calculating payment change and  assessing the sustainability of modifications.

Comparison Analysis of Outcomes for Sold Loans and Unsold Loans

We used multiple FHA data sources to match sold loans to similar unsold  loans and compare outcomes across the groups. We used data from  FHA’s default monitoring system and integrated database to obtain  information on loan-level characteristics for both sold and unsold loans,  such as length of delinquency. However, FHA data did not contain loans’  current property value or current loan-to-value (LTV) ratio. To calculate  the current property value, we generated property values for sold and  unsold loans based on data in the integrated database, including property  value at origination, date of origination, and location information. We then  aged the property values to the matching month and year using FHFA’s  House Price Index data, which considers geography. We calculated the  LTV ratio for sold and unsold loans by dividing the current unpaid  principal balance obtained from the default monitoring system by the  calculated current property value. To identify the loans sold through  DASP and to determine their outcomes, we used postsale reporting data  reported by DASP purchasers. To determine monthly outcome statuses  for unsold loans, we used FHA’s default monitoring system and integrated  database.

Our analysis generally included loans sold in DASP sales that occurred  between 2013 and 2016, but we excluded some sales and pools for  various reasons. We excluded loans sold in the DASP sales that occurred  from 2010 through 2012 because FHA could not provide semiannual or  quarterly postsale reports for these loans. We excluded loans sold in  Neighborhood Stabilization Outcome (NSO) pools in the first sale in 2013  because FHA had not yet implemented reporting requirements for more  detailed information on loan status for NSO pools. We excluded Direct  Sales, through which FHA directly transfers loans to government entities,  as well as Aged Delinquent Portfolio Loan Sales, because these sales do  not follow normal DASP procedures. Lastly, we excluded loans in pools  that were offered for sale but not traded and loans that dropped out  before transfer and were never sold. FHA was generally able to provide  quarterly reports for the remaining sales and pools within the required  reporting time frame.

We took a number of steps to prepare and ensure the reliability of the  data used to match sold loans to similar, unsold loans and compare  outcomes. We generated seven datasets corresponding to the seven  DASP sales in our scope. Each dataset was made up of the records in  the default monitoring system 2 months prior to the bid date for the  corresponding DASP sale—the time servicers submit eligible loans for sale to FHA, according to FHA officials. We eliminated duplicate case  numbers as well as erroneous submissions, and we added sale and pool  variables to identify sold loans based on the master list of sold loans. We  also excluded unsold loans that were ineligible for sale at the time of  matching. Specifically, we reviewed FHA’s servicer agreements and  developed criteria for excluding unsold loans from matching based on  sale eligibility requirements outlined in these agreements. We interviewed  FHA officials to ensure that our understanding of the default status codes  and their corresponding ineligibility for sale was accurate. We then used  this information to identify and exclude ineligible loans.

We performed a variety of electronic checks to test the completeness,  consistency, and logic of outcome statuses for sold and unsold loans as  reported by servicers. We excluded or corrected, where possible, a small  percentage of sold and unsold loans (2 percent excluded and about 11  percent corrected) that had invalid or illogical reported statuses. We also  excluded loans with invalid case numbers, loans erroneously reported as  sold by purchasers, and other problem records. These exclusions  accounted for less than 1 percent of the sold loans in our scope.

We found that three pools were missing more than half of the expected  number of postsale reports. Because these pools accounted for less than  2 percent of the sold loans in our scope, we decided to keep these pools  in our analysis as they provided additional data points for estimating  outcome probabilities, and including them would not significantly bias our  results.

Finally, when assessing data reliability, we consulted relevant  documentation on the default monitoring system, integrated database,  and postsale reporting systems and the specific fields used from these  systems. We also interviewed officials knowledgeable about how data  from these systems were collected, maintained, and accessed. Based on  these steps, we determined that the data were sufficiently reliable for the  purpose of matching sold loans to similar, unsold loans and comparing  outcomes.

We used statistical matching methods to identify a comparison group of  unsold loans that closely resembled sold loans on loan characteristics that could affect the likelihood of foreclosure. Unsold loans were matched  to sold loans for each sale, resulting in seven groups of unsold loans  corresponding to loans sold in the seven DASP sales that occurred in  2013–2016. We matched unsold to sold loans 2 months prior to the bid  date across the following characteristics:

Length of delinquency. Number of missed payments at matching.

Occupancy status. Whether property was occupied or vacant at  matching.

Location. Location of the property, based on latitude and longitude.

Servicer. FHA-approved, mortgage servicer.

Loan-to-Value (LTV) ratio category. Value of the property relative to  the outstanding unpaid balance on the loan at matching.

Loan origination. Year of the loan’s origination.

We excluded modification status from the matching criteria. While there is  some indication that loans that have been modified once are more likely  to redefault in the future, this is largely dependent on the quality of the  modification. However, modification quality could not be determined  based on the FHA data we received.

Our analysis did not seek to conduct a definitive evaluation of the causal  effects on outcomes of being sold through DASP. Instead we sought to  improve on simple comparisons of outcomes between sold and unsold  loans by constructing a comparison group of unsold loans that were  similar to sold loans on loan-level characteristics known to affect the  likelihood of foreclosure. For example, matching sold and unsold loans by  location minimized variation in neighborhood characteristics and local  housing markets that could be associated with a higher or lower likelihood  of foreclosure. We selected these factors based on our previous work on  foreclosure mitigation and on consultations with subject-matter experts  within GAO. See appendix V for more information on our statistical  matching analysis.

To compare outcomes for sold and unsold loans, we identified outcomes  using postsale reporting data dictionaries in FHA’s purchaser agreements  as well as FHA’s status codes used in its default monitoring system and  integrated database data dictionaries. We grouped the outcomes into six  outcome categories. To assign sold loans to a category, we used FHA’s  postsale reporting data, and to assign unsold loans to a category, we  used FHA’s default monitoring system and integrated database data. The  outcome categories were as follows:

Foreclosure. Loans terminated with foreclosure.

Reperforming. Loans restored to performing status either under the  original mortgage terms or through a permanent modification. In this  outcome, the borrower retains ownership of the home.

Temporary Action. Loans with temporary action that allow the  borrower to retain ownership of the home—for example, an  agreement for paying the loan balance or restoring it to performing  status has been reached but has not met FHA’s time requirement to  meet FHA’s definition of performing. This category may also include  other interventions that have the intent of keeping the borrower in the  home, such as forbearance.

Short sale/deed-in-lieu of foreclosure. Loans that avoid foreclosure  through short sales and deeds-in-lieu of foreclosure. In this outcome  the borrower loses ownership of the home.

Unresolved. Loans remaining in default status and whose outcomes  were unresolved.

Other. Loans whose outcomes do not fit into these other categories.

A number of sold loans were reported by purchasers as resold, with no  further outcome updates, and we decided to categorize these separately.  Purchasers had the option of reporting on loans as resold until 2015,  when FHA introduced a reporting requirement that purchasers continue  reporting the outcome status of loans even after selling them to new  buyers. For the loans in our scope, the percentage of postsale reports  that included a status of resold ranged from 7 to 35 percent for the 2013  and 2014 sales, before dropping to less than 1 percent beginning with the  2015 sale. Purchasers may have returned resold loans to performing  status before selling them because performing loans are more profitable,  and, by categorizing these loans separately, we may have undercounted  performing loans for the earlier DASP sales. While we considered  classifying loans reported as resold as performing, our review of status  sequences for loans with at least one resold status showed that  purchasers reported a range of nonperforming outcomes before and after  the resold status, indicating that not all resold loans were performing. We  therefore determined that categorizing resold loans separately would  result in more reliable estimates for sold loans.

Using data from the default monitoring system to classify outcomes for  the matched, unsold loans in our analysis required us to make some  assumptions that may have resulted in overcounting performing, unsold  loans. Because the default monitoring system only contains data on  delinquent loans and does not include status information on performing  loans, our classification of performing, unsold loans was based on  whether or not a servicer reported the loan in the default monitoring  system in a given month. As a result, we assumed that unreported loans  were performing. However, a missing report could also be the result of a  reporting omission by the servicer, rather than an indication of a  performing status. To mitigate the risk of overcounting performing, unsold  loans, we used a variable indicating the length of a loan’s current default  episode to help us distinguish between performing loans and servicer  omissions. Specifically, we counted unsold loans as performing only if the  default episode length in the most recent default monitoring system report  was less than the reported episode length in the default monitoring  system report preceding the period of no reporting. We assumed that a  lower default episode length in the most recent default monitoring system  report meant that the borrower was making payments during the period of  no reporting. Otherwise, we classified periods of no reporting as  missing.

We compared monthly outcomes for sold loans and unsold loans after  servicing transferred to the purchaser. We set the origin of the  observation period to the latest servicing transfer date in each pool of sold  loans and their associated matched unsold loans. Because the latest  servicing transfer date varied across these groups, the number of  observations and the associated dates varied across pools and sales. We  measured outcomes for up to a maximum of 48 months, from January  2013 through December 2017, the most recent full quarter of postsale  reporting data available at the time of our review. The follow-up periods  ranged from the full, 4-year reporting period required by FHA for loans  sold in the 2013 sales to 1 year for loans sold in the second sale in 2016.  See appendix V for more information on our statistical analysis of  outcomes for sold loans and unsold loans.

Potential Effects of Changes to DASP on the MMI Fund

Association of Pool-Level Characteristics with Bidder Participation

To examine the extent to which loan-pool characteristics were associated  with bidder participation for FHA loan sales and the enterprises’  nonperforming loan sales, we built regression models. We identified from  interviews key characteristics (independent variables) that may make loan  pools attractive to certain bidders, such as having a single servicer or low  vacancy. We obtained bid-day data from FHA and the enterprises that  included the number of bidders (dependent variable) and the winning bid  amounts, as well as the timing of the sale. We generated FHA pool  characteristics from the loan level data in FHA’s submitted loan database  and supplemented  it with FHA default status data (see table 2 above for  further information about FHA’s data sets). For the enterprises, we  obtained pool characteristics from a published FHFA report. This report  provided a range of characteristics to compare to those of FHA’s pools.

See table 3 for our regression estimates of the relationship between pool  characteristics and the number of bidders in FHA’s DASP sales and the  enterprises’ sales. The associated p-values are presented in  parentheses, and *, **, and *** denote significance at 10 percent, 5  percent, and 1 percent or better, respectively. In the report body we use  the 95 percent confidence level as indicating significance of the  regression estimates.

To assess the reliability of the FHA data, we performed reasonableness  checks that resulted in the removal of FHA’s 2010 sale due to a large  number of invalid case numbers and two additional pools from later sales,  we also removed pools based on missing or invalid date—in total 4  percent of FHA’s pools. We did not independently verify the data in the  FHFA reports, but we interviewed the FHFA staff that generated the  report about the reliability of the data. Some limitations stem from the  differences between FHA’s and the enterprises’ pools and the underlying  loans as well as the data available on the pools. For example, we use  data from FHA sales from 2011–2016 and from sales in 2015–2017 for  the enterprises. We use the time variables to control for housing market  differences as well as the defaulted loan sale market. Additionally, we  included FHA’s nontraded pools but not the enterprises’ nontraded pools  because the FHFA reports did not present data on these pools. We  showed the differences and similarities across the entities in figure 14 in  the report. We determined that data for the remaining pools were  sufficiently reliable for examining the association of pool characteristics  with bidder participation and for comparison between the enterprises’ and  FHA’s sales.

To calculate pool reserve prices, we obtained FHA data on quarterly loss  severity by disposition method for 2013–2016. Using our results from the  outcomes comparison analysis, we calculated pool-level reserve prices  and compared them to winning pool-level bids.

To assess the effect that changing FHA’s auction design could have on  the MMI Fund and to identify elements of a successful auction structure,  we reviewed economic literature on auction structures and auction  descriptions in business and commercial literature. To compare the DASP  auction structure with the enterprises as well as mortgage auctions in the  private market, we analyzed agency and enterprise documents and  interviewed market participants. We developed a detailed description of  FHA’s and the enterprises’ current auction structures, including  information about the nature of the loan pools being auctioned; about  sellers, purchasers, and other auction stakeholders; and about the  benefits and drawbacks of the auction design.

In interviews, we received suggestions about aspects of FHA auctions  that, if changed, may increase bidder participation. To examine these  aspects, we interviewed purchasers on their potential interest in these  changes and examined FHA sale data following an instance of a single  purchaser winning all the pools in a sale. To assess the DASP auction  structure, we compared it to selected characteristics of successful  auctions and determined the extent to which the characteristics were  used by FHA.

We conducted this performance audit from January 2017 to July 2019 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Appendix II: DASP Servicers, Purchasers, and Characteristics of Sold Loans

This appendix includes descriptive information about the Federal Housing  Administration’s (FHA) Distressed Asset Stabilization Program (DASP)  servicers, purchasers, and sold loans. The information presented is  generally based on loans sold in DASP sales that occurred between 2013  and 2016.

Thirty-two servicers participated in DASP sales between fiscal years 2013  and 2016, with the largest participating servicer offering 48 percent (more  than 44,000) of the loans sold. As seen in figure 15, the number of  servicers increased from nine in the first sale in 2013 to 22 in the second  sale in 2016. During this same period, 26 purchasers participated in the  DASP sales, with the largest participating purchaser buying 27 percent  (about 25,000) of the loans sold.

The share of loans offered by individual servicers also varied over time  and by sale. One or two servicers offered the majority of sold loans in  earlier sales, but more servicers offered a greater share of the loans sold  in later sales (see fig. 16). For example, one servicer offered 89 percent  of the loans sold in the first sale in 2013, about 51 percent of the loans  sold in the second sale in 2014, and about 8 percent of the loans sold in  the second sale in 2016. During this time, new servicers began offering  loans for sale, and servicers that had offered a smaller share of the loans  sold in earlier sales began offering a larger share of loans for sale.

Characteristics of Loans Sold through DASP

Occupancy status. The majority of properties sold through DASP were  occupied by the borrower, with a smaller portion having been vacated  (see fig. 17). DASP purchasers told us that their ability to contact and  engage borrowers is one determinant in whether they are able to offer  loss mitigation options to avoid foreclosure. One purchaser noted that in  cases where it is unable to contact the borrower, which may indicate that  the property is vacant, it tries to foreclose as quickly as possible.

Delinquency. The majority of loans sold through DASP had missed 12 or  more payments (see fig. 18). As discussed earlier, a loan becomes  delinquent after a borrower misses a single payment, and goes into  default after it is two payments past due. Generally, servicers must utilize  a loss-mitigation option or initiate foreclosure within 6 months of default.  As we previously reported, serious delinquency is among the factors  associated with an increased likelihood of foreclosure.

Loan-to-Value (LTV) ratio. About 18 percent of sold loans had an LTV  ratio of 110 or greater (see fig. 19). The LTV ratio represents the unpaid  principal balance of a loan as a percentage of the current property value.  As we previously reported, negative equity or a high LTV ratio is among  the factors associated with an increased likelihood of foreclosure.

Origination. As figure 20 shows, sold loans were more likely to have  originated at the peak of the housing crisis in 2008 and 2009. FHA  officials told us that they used DASP to reduce the significant backlog of  defaulted loans they were faced with following the housing crisis.

Appendix III: Federal Housing Administration Documents Guiding the Distressed Asset Stabilization Program

In this appendix, we describe the documents the Federal Housing  Administration (FHA) uses to guide the Distressed Asset Stabilization  Program. The documents listed in table 4 represent the current written  procedures and guidance that FHA planned, as of May 2018, to  incorporate into a single document—the Asset Sales Handbook—to  centralize the information for internal and external stakeholders.

Appendix IV: Reported Postsale Modification Actions

We examined the different types of actions purchasers have used to  modify loans they purchased through the Distressed Asset Stabilization  Program (DASP) and the expected effect of each type of action on  borrowers’ payments. Table 5 summarizes our findings on postsale  modification actions. Our analysis was limited to modifications reported  using reporting codes introduced in the purchaser agreement for the first  sale in 2016, and included loans sold between fiscal years 2013 and  2016. We found that the Federal Housing Administration (FHA) may not  have the data it needs to determine whether payment-lowering  modifications offered by purchasers were sustainable—for example, a  modification in which a low payment was later adjusted to higher than  what it was prior to modification. Therefore, we could not determine the  long-term effect on payment for many modifications offered by  purchasers, as noted by “unclear” in the last column of table 5.

Appendix V: Additional Information on Matching and Outcomes Analysis

This appendix provides additional methodological details on our analysis  to compare outcomes between loans sold through the Distressed Asset  Stabilization Program (DASP) and a comparison group of similar unsold  loans. The analysis consisted of two parts: (1) applying statistical  methods for constructing matched comparison groups and (2) estimating  a statistical model of loan outcomes using the matched sample of loans.

Additional Information on Matching Analysis

We matched one unsold loan to each sold loan, using exact and  Mahalanobis distance matching methods. We matched exactly on  occupancy status, state, and loan servicer, and we matched the  distributions of loan delinquency period, loan-to-value ratio (divided into  five categories), geographic coordinate, and origination year. Unsold  loans could be matched multiple times in order to maximize the degree of  similarity between the sold and unsold loans, given constrained sample  sizes of potential comparison loans. (That is, we used one-to-one  matching with replacement.) Matching occurred separately for each loan  sale in order to measure the matching variables 2 months before each  sale occurred. We assessed the quality of candidate matched samples by  consulting univariate empirical-QQ plots, descriptive statistics, and  multivariate Kolmogorov-Smirnov tests of equal distributions for each of  the matching variables, as implemented in the “Matching” package for the  statistical software, R, version 3.5.1.

We attempted to match exactly within the smallest geographical area that  sample sizes allowed. Location is important for the outcomes of Federal  Housing Administration (FHA) loans and is potentially correlated with  many unobserved variables, such as local housing market conditions.  After experimenting with multiple geographic areas, such as the census  tract and county, we chose a strategy of matching exactly on state and  matching in distribution on latitude, longitude, and product. This ensured  that the comparison loans were in the same states as the sold loans,  which held constant differences in foreclosure processes and other  political and legal differences. Although the matched loans were  potentially in different counties or municipalities than the sold loans,  generally they were still close to each other, as measured by the  geographic coordinates.

We obtained a similar matched sample of comparison loans for each loan  sale, as summarized in table 6 and figures 21 and 22. Although we  conducted the matching separately for each sale (exactly matched), we  combined the sales and their matched comparison loans for the purpose  of summarizing their similarity across the matching variables.

Additional Information on Outcome Analysis

We used statistical modeling methods designed for longitudinal time-to- event or “duration” data to compare outcomes for sold and matched  unsold loans. Conventional duration methods, such as “competing risks”  models, would estimate the probability that a loan experienced one or  more terminal outcomes by a certain follow-up time. These methods  assume that event times are observed exactly, and that no outcome can  occur more than once. These assumptions were not realistic for our  analysis. Loans could transition among several nonterminal outcomes  over time, such as reperforming or temporary action, before experiencing  a terminal outcome, such as foreclosure. Our data sources measured the  status of unsold loans monthly and sold loans quarterly. However, events  could occur on any date, in continuous time, so the status of each loan  was unknown between pairs of reporting times (or interval-censored).

We used Multi-State Markov models to account for these features of the  data. Our models assumed a directed graphical structure for how loans  could transition among events between observed follow-up times, as  described in figure 23. We developed our model of possible transitions  based on FHA’s typical process for managing unsold delinquent loans  and DASP program rules for managing sold delinquent loans. To simplify  the model, we did not allow paths for transitions that were infrequently  observed, illogical, or inconsistent with prior knowledge about loan  management. These unusual transitions in the data may reflect  misclassified outcomes or transitions through unobserved outcomes  between observation times. Table 7 gives the sample counts of the  transitions in the matched sample of loan-month observations.

The graphical version of our model implied a matrix of modeled  transitions among outcomes, with transition probabilities set to 0 for paths  between outcomes not shown in the graph. Specifically, we defined the  loan outcomes at time t, Y, as a stochastic process, taking values  according to an underlying model of transition probabilities from time 0 to  t:  where r and s denoted two outcomes from the set of outcomes above in  table 7, such as unresolved and reperforming. Consistent with existing  literature, we assumed that the outcome process was a time- homogenous Markov chain. This assumption made the model  mathematically tractable, but required the transition probability at any  follow-up time to be independent of prior outcomes and constant over the  observation period. (We estimated versions of the model that relaxed this  assumption, as described below.) Under this assumption, we modeled the  transition hazard rate from outcome r to s as:  where x and βrs were vectors of covariates and transition-specific  parameters (excluding an intercept) and qrs was an unspecified  proportional baseline hazard. All covariates were time-invariant  characteristics of the loans measured at baseline, 2 months prior to the  loan’s bid date, used to create the matched sample. We estimated βrs  using maximum likelihood estimation methods, as implemented by the  “msm” package in R 3.5.1.

The body of this report provides estimated transition probabilities for  various groups of loans, including loans that were sold or unsold. We  estimated the probability of a loan’s transitioning from unresolved at t = 0  to some other outcome at t using the estimated parameters and the  matrix exponential P(t) = exp(tQ), where P and Q are the matrices of  transition probabilities and hazards, respectively, for all outcomes r and  s. We used Monte Carlo simulation from the fitted multivariate normal  distribution of the parameters to estimate 95 percent confidence intervals  for the transition probabilities, using 1,000 draws. In appendix VI, we  provide more detailed estimates of these transition probabilities and their  confidence intervals for key findings discussed in the body of this report.

Our models estimated the difference in transition probabilities between  sold and unsold loans in the matched sample by including an indicator for sold status in x. We estimated transition probabilities for certain  subpopulations of loans, like specific purchasers or loan sales, by  estimating separate models for each subpopulation. This approach  allowed the models to be fully stratified and reduced computational  burdens associated with estimating many parameters using a sample of 1  million or more observed transitions, as a fully interactive specification  between sold status and the subpopulation variables would have  required. However, this approach prevented us from estimating the partial  interactions between sold loan status and the subpopulation variables.

We conducted several validation and robustness checks of the analyses  reported in the body of this report. These included the following:

Predictive fit. We did not design our models to predict future  outcomes but rather to make inferences about the difference in  transition probabilities between sold and matched unsold loans.  However, to identify substantial problems with model fit, we compared  the observed prevalence of each outcome to the estimated  prevalence expected under our models. Figure 24 shows the  predictive fit for models with a covariate in x for sold status and a  piecewise-constant indicator for the period after month 12. The  estimated and observed prevalence are generally close for most  outcomes before month 40. After that month, the model  underestimates the prevalence of foreclosure and overestimates the  prevalence of unresolved. This lack of fit late in the observation period  may reflect the substantial effect of sales cohort, which we modeled  through separate models stratified by sale rather than as a covariate.  In any case, the model fit was acceptable, given our nonpredictive use  of the model and the limitations of using observed outcome  prevalence rates to validate predictions of a process with interval  censoring.

Time-inhomogenous models. We relaxed our assumption that the  transition intensities were constant throughout the observation period  by including indicators in x for whether the observation fell before or  after 12 months. FHA changed DASP rules before the 2015 sales to  extend the moratorium on foreclosures from 6 months to 12 months.  Outcome transition estimates from a model including these time  indicators plus a sold indicator appear in table 8, along with our base  estimates from a time-homogenous model with only the sold indicator.  Although Akaike Information Criterion values showed that the  piecewise model improved the fit, the estimated transition probabilities  generally supported the same substantive conclusions. The piecewise  model estimated that sold loans were somewhat more likely to  transition to a short sale or deed-in-lieu outcome, and somewhat less  likely to transition to reperforming, but the direction of the association  was the same as in the time-homogenous model. We used the time- homogenous model to provide results in the body of this report and in  appendix VI, due to the considerable computing time required to  estimate models with piecewise-constant covariates.

Appendix VI: Data for Selected Outcome Figures and Additional Outcome Estimates

In this appendix, we provide data for selected borrower outcome figures  presented in this report. We also provide additional outcome figures and  data, as well as outcome data for sold loans and unsold loans by some  loan-level characteristics. These figures and data are based on the  statistical matching and modeling analysis of loans sold through the  Distressed Asset Stabilization Program (DASP) and similar, unsold loans  described in appendix I and appendix V of this report.

Tables 9–12 present data for selected outcome figures shown in the  report. Table 9 presents estimates of foreclosure and foreclosure  avoidance outcome rates for sold loans and similar, unsold loans, based  on statistical models (fig. 7). Table 10 presents these estimates for out-of- home and in-home outcomes (fig. 8). Figure 9 in the body of this report  shows the foreclosure and foreclosure avoidance outcomes by DASP  sale, and tables 11 and 12 present these estimates for all outcomes by  DASP sale, 12 and 24 months following the servicing transfer date,  respectively.

As discussed in appendix I, to compare foreclosure and foreclosure  avoidance outcomes for sold and unsold loans, we assigned loans to one  of six outcome categories. Figure 25 and table 13 present the outcome  figures and associated data for sold and unsold loans across all six  categories.

Figures 26–29 compare specific outcomes for sold and unsold loans  across different loan characteristics. We selected characteristics and  outcomes that showed clear patterns or differences between sold and  unsold loans. Our analysis showed that the loan-to-value (LTV) ratio was  less strongly associated with reperforming rates for sold loans compared  to similar, unsold loans (see fig. 26). For example, while the probability of  reperforming varied across different LTV ratio categories for unsold loans,  the probability varied less for sold loans.

Our analysis of outcomes by different delinquency categories showed that  length of delinquency was less strongly associated with reperforming  rates for sold loans compared to similar, unsold loans (see fig. 27). For  example, while the probability of reperforming 12 months after the  servicing transfer date ranged from 8 to 29 percent across different  delinquency lengths for unsold loans, this range was smaller for sold  loans—about 9 to about 16 percent.

Our analysis of outcomes by year of loan origination showed that length  of delinquency was less strongly associated with reperforming rates for  sold loans compared to similar, unsold loans (see fig. 28). For example,  the year of loan origination did not affect the probability of reperforming  for sold loans. However, for unsold loans the probability of reperforming  was lowest for loans originating in 2007–2008 at the beginning of the  housing crisis.

Our analysis of outcomes by occupancy showed that, for occupied  properties, sold loans were more likely to experience foreclosure  compared with similar, unsold loans (see fig. 29). However, for vacant  properties, sold loans experience foreclosure at equal or smaller rates  compared to similar, unsold loans.

Appendix VII: Additional Auction Structure Information and Evaluation

The Federal Housing Administration (FHA) uses a pooled, highest-bidder,  sealed-bid auction structure to sell its single-family defaulted residential  mortgages through the Distressed Asset Stabilization Program (DASP).  This auction structure is consistent with industry standards and private  market practices for selling these mortgages and includes many  characteristics of a successful auction. We identified characteristics of  successful auctions by reviewing economics literature on auction  structures and auction descriptions in business and commercial literature,  and we obtained information about the nature of the loans being  auctioned, about sellers, purchasers and other auction stakeholders, and  about the benefits and drawbacks to each of various details of the auction  design. Table 14 shows some auction characteristics and an evaluation of  FHA’s DASP design.

Appendix VIII: Comments from the Department of Housing and Urban Development

Appendix IX: GAO Contact and Staff Acknowledgments

In addition to the contact named above, Jill Naamane (Assistant Director),  Rhonda Rose (Analyst in Charge), Abigail Brown, Stephen Brown, Karen  Jarzynka-Hernandez, John Karikari, May Lee, Ned Malone, Paulina  Maqueda-Escamilla, John McGrail, Samuel Portnow, Tovah Rom, Jena  Sinkfield, Anne Stevens, Jeff Tessin, Jim Vitarello, Sarah Wilson, and  Elisa Yoshiara made key contributions to this report. Also contributing to  this report were DuEwa Kumara and Jason Rodriguez.

The Federal Housing Administration helps increase homeownership by insuring mortgage loans that have less strict standards and lower down payments than conventional loans. The housing crisis of 2007-2011 led to historic rates of mortgage defaults, many of which were insured by FHA.

FHA can sell these loans in order to limit its losses from defaults. We found that the defaulted loans FHA sold were more likely to go into foreclosure than the defaulted loans FHA kept. In addition, about 3% of the loans FHA sold were not actually eligible for sale.

We made 9 recommendations, including that FHA establish a schedule for its eligibility checks.