Mortgage Financing: FHA and Ginnie Mae Face Risk-Management Challenges
Published: 2012-03-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In recent years, two components of HUD—FHA and Ginnie Mae—have played a major role in the single-family mortgage market. FHA insures lenders against losses from mortgage defaults. Ginnie Mae guarantees the timely payment of principal and interest for securities backed by federally insured or guaranteed mortgages. Due partly to the contraction of other mortgage market segments, FHA's and Ginnie Mae's business volumes have risen sharply. This growth highlights the need for these entities to properly manage financial risks while meeting the housing needs of borrowers.
This testimony discusses (1) changes in the financial condition of FHA's insurance fund, the budgetary implications of these changes, and how FHA evaluates the fund's financial condition; (2) steps FHA has taken to assess and manage risks; and (3) steps Ginnie Mae has taken to manage risks and estimate costs and revenues.
This testimony draws from GAO reports on FHA's oversight capacity (GAO-12-15), the financial condition of FHA's insurance fund (GAO-10-827R), and Ginnie Mae's risk management (GAO-12-49). GAO also reviewed updated information on the fund's condition as of September 30, 2011.
section_title: What GAO Found
paragraphs: For the third consecutive year, the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) reported that the capital ratio for the Mutual Mortgage Insurance Fund—the ratio of the fund's economic value to insurance obligations—has not met the 2 percent statutory minimum. FHA cites declines in the fund's economic value due to higher-than-expected defaults, claims, and losses. At the same time, the other component of the ratio, insurance obligations, grew rapidly. The fund's condition also worsened from a budgetary perspective, with balances in the fund's capital reserve account reaching new lows. If the account were depleted, FHA would require more funds to help cover costs on insurance issued to date. FHA has indicated that it will narrowly avoid this scenario in fiscal year 2012. FHA enhanced methods for assessing the fund's financial condition but has not fully addressed GAO's 2010 recommendation for improving the reliability of its estimates. It relies on a single economic forecast, which does not fully account for variability in future house prices and interest rates. The approach GAO recommended would simulate numerous economic paths for house prices and interest rates would improve the reliability of its capital ratio estimates.
FHA has taken or plans steps to better assess and manage risk. It created a risk office in 2010 and hired a consultant to recommend best practices. FHA plans to establish committees to evaluate risks at enterprise-wide and programmatic levels. It began a quality control initiative for single-family housing, in which program and field offices assess and report on risks, and enhanced lender and appraiser reviews. While FHA's consultant recommended integrating risk assessments, the quality control and risk office activities currently remain separate efforts. Also, since 2009, the Office of Single Family Housing has not updated assessments annually in accordance with HUD guidance. Without integrated and updated risk assessments that identify emerging risks, FHA lacks assurance it has identified all its risks. GAO recommended integrating quality control and risk office activities and updating assessments annually.
GAO and others have identified limited staff, substantial reliance on contractors, and the need for modernized information systems as risks that the Government National Mortgage Association (Ginnie Mae) may face. Ginnie Mae has several planned initiatives to enhance its risk-management processes related to gaps in resources, contracts, and issuers, but these plans have not been fully implemented. It will be important for Ginnie Mae to complete these initiatives as soon as practicable to enhance its operations. Also, in developing inputs and procedures for the model used to forecast costs and revenues, the agency did not consider certain practices identified in guidance for preparing cost estimates of federal credit programs. Ginnie Mae has not developed estimates based on the best available data, performed sensitivity analyses to determine which assumptions have the greatest impact on the model, or documented why it used management assumptions rather than available data. By not fully implementing certain practices, which GAO believes represent sound internal controls for models, Ginnie Mae's model may not use critical data that could affect the agency's ability to provide well-informed budgetary cost estimates and financial statements. GAO recommended that Ginnie Mae adopt these practices.
section_title: What GAO Recommends
paragraphs: GAO previously recommended that FHA and Ginnie Mae take additional steps to improve their risk management. FHA and Ginnie Mae agreed with these recommendations and said they had efforts under way to implement them.

section_title: Letter
paragraphs: I am pleased to be here today to discuss our work on the Department of  Housing and Urban Development’s (HUD) Federal Housing  Administration (FHA) and Government National Mortgage Association  (Ginnie Mae). As you know, FHA insures private lenders against borrower  defaults on mortgages that meet FHA criteria. FHA has helped millions of  families purchase homes through its single-family mortgage insurance  programs and insures almost all of its single-family mortgages under the  Mutual Mortgage Insurance Fund (Fund). Ginnie Mae is a wholly owned  government corporation in HUD that guarantees the timely payment of  principal and interest on securities backed by pools of federally insured or  guaranteed mortgages, including FHA-insured mortgages. Ginnie Mae’s  guarantee of mortgage-backed securities (MBS) helps link capital  markets to the nation’s housing markets.
FHA and Ginnie Mae have come to play a prominent role in mortgage  financing in the wake of the 2007-2009 financial crisis, the housing  downturn, and the contraction of the conventional mortgage market.  However, FHA reported in November 2011 that, for the third consecutive  year, the Fund was not meeting the statutory 2 percent capital reserve  requirement, as measured by the Fund’s estimated capital ratio—that is,  the Fund’s economic value divided by the insurance-in-force (outstanding  insurance obligations). Although the Fund historically has produced  budgetary receipts for the federal government, a weakening in the  performance of FHA-insured loans has heightened the possibility that  FHA could require additional funds to help cover its costs on insurance  issued to date. Although Ginnie Mae has accumulated a capital reserve,  the dramatic growth in outstanding Ginnie Mae-guaranteed MBS and the  default of a major Ginnie Mae issuer in 2009 also have focused attention  on the potential risks Ginnie Mae faces.
My statement today is based on three prior GAO reports: a September  2010 report on FHA’s financial condition, and two reports from November  2011—one on FHA’s risk assessment and human capital management  and one on Ginnie Mae’s risk management and cost modeling.  Specifically, I will discuss (1) how estimates of the Fund’s capital ratio  changed in recent years and the budgetary implications of changes in the  Fund’s financial condition, (2) how FHA and its actuarial review contractor  evaluate the financial condition of the Fund, (3) steps FHA has taken to  manage and assess risks, and (4) steps Ginnie Mae has taken to manage  risks and estimate costs and revenues.
To do this work, we analyzed actuarial reviews of the Fund and federal  budget documents, and interviewed FHA officials, staff from FHA’s  actuarial review contractor, and housing market researchers. We also  analyzed data on FHA’s business volume, market share, workload, and  staff and contractor resources. We reviewed documentation on the  proposed structure and functions of FHA’s Office of Risk Management  and Regulatory Affairs and the Office of Single Family Housing’s internal  quality control initiative. Further, we reviewed changes to FHA guidance  that address risks associated with lenders and appraisers and  documentation related to workforce and succession planning. For this  testimony, we also reviewed updated information on the Fund’s condition  as of September 30, 2011. Our study of Ginnie Mae assessed operational  risks and financial exposure. We reported on Ginnie Mae volume and  market share, reviewed guidance and Ginnie Mae’s credit subsidy  calculations and estimation model, and interviewed agency officials and  others. Our prior reports each include a detailed description of our scope  and methodology.
The work on which this statement was based was performed from  September 2009 to November 2011 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.
subsections: section_title: Background
paragraphs: Under the Federal Credit Reform Act of 1990 (FCRA), FHA and other  federal agencies must estimate the net lifetime costs—known as credit  subsidy costs—of their loan insurance or guarantee programs and include  the costs to the government in their annual budgets. Credit subsidy costs  represent the net present value of expected lifetime cash flows, excluding  administrative costs. When estimated cash inflows exceed expected  cash outflows, a program is said to have a negative credit subsidy rate  and generates offsetting receipts that reduce the federal budget deficit.  When the opposite is true, the program is said to have a positive credit  subsidy rate—and therefore requires appropriations. Generally, agencies  must produce annual updates of their subsidy estimates—reestimates— on the basis of information about actual performance and estimated  changes in future loan performance. FCRA recognized the difficulty of  making credit subsidy estimates that mirrored actual loan performance  and provides permanent and indefinite budget authority for reestimates  that reflect increased program costs. Upward reestimates increase the  federal budget deficit unless accompanied by reductions in other  government spending or an increase in receipts.
The Omnibus Budget Reconciliation Act of 1990 required the HUD  Secretary to take steps to ensure that the Fund attained a capital ratio of  at least 2 percent by November 2000 and maintained at least a 2 percent  ratio at all times thereafter. actuarial review of the economic net worth and soundness of the Fund.  The annual actuarial review is now a requirement in the Housing and  Economic Recovery Act of 2008, which also requires that the HUD  Secretary annually report to Congress on the results of the review.
Pub. L. No. 101-508. risk, which arises as borrowers become unable to make payments on  insured mortgages. Agencies also face counterparty risk. That is, an  agency may suffer losses due to weaknesses or uncertainties in the work  of its counterparties, which include lenders and appraisers for FHA and  issuers for Ginnie Mae. And all agencies face operational risks, the risk of  loss resulting from inadequate or failed internal processes, deficiencies in  staff numbers, training, and skills, or external events.
section_title: The Fund’s Financial Condition Has Continued to Worsen, Increasing the Possibility That FHA Will Require Additional Funds
paragraphs: The Fund’s capital ratio dropped sharply in 2008 and fell below the  statutory minimum in 2009, when economic and market developments  created conditions that simultaneously reduced the Fund’s economic  value (the numerator of the ratio) and increased the insurance-in-force  (the denominator of the ratio). According to annual actuarial reviews of  the Fund, the capital ratio fell from about 7 percent in 2006 to 3 percent in  2008 and 0.5 percent in 2009 (see fig. 1). For 2010 and 2011, the ratios  were 0.5 and 0.24 percent, respectively.
In its November 2011 report to Congress, HUD cited several reasons for  the declines from 2010 to 2011. These included the following:
Home prices were expected to continue falling. Forecasts for the 2010  actuarial study predicted house price declines of about 2.8 percent  before bottoming out in the middle of 2011. Forecasts for the 2011  actuarial study predicted declines of 5.6 percent for FHA’s single- family portfolio in 2011. Higher-than-expected declines in house  values contributed to both higher defaults and claims and higher loss- on-claim than anticipated in 2010.
More loans, particularly from the housing bubble years of 2006-2008  were in serious delinquency, and a significant percentage had been  there for more than 1 year. Claims become the most likely outcome  for extended delinquency loans, many of which are in foreclosure.
For the first time, the actuarial calculations built in a factor recognizing  the elevated redefault potential from the increased number of active  loans with a previous serious delinquency (3 months or more).
The independent actuaries also made a decision to treat foreclosure  actions likely affected by so called robosigning problems as expected  claims in 2012.
In reviewing the components of the capital ratio, the combination of a  relatively stable economic value (numerator of the ratio) and a declining  insurance-in-force (denominator) over much of the decade increased the  capital ratio. However, since 2008, the economic value has fallen as the  insurance-in-force has risen, dramatically lowering the capital ratio   (see fig. 2).
At the same time, the Fund’s condition has worsened from a budgetary  perspective. Historically, FHA has estimated that its loan insurance  program was a negative subsidy program (that is, estimated cash inflows  exceeded expected cash outflows). On the basis of these estimates, FHA  accumulated substantial balances in a budgetary account known as the  capital reserve account, which holds reserves in excess of those needed  for estimated credit subsidy costs and helps cover unanticipated  increases in those costs such as higher-than-expected claims. Reserves  needed to cover estimated subsidy costs are held in the Fund’s financing  account.
However, in recent years, the capital reserve account has covered large  upward reestimates of FHA’s credit subsidy costs through transfers to the  financing account. As a result, balances in the capital reserve account fell  dramatically—from $22 billion at the end of 2007 to an estimated $4.4  billion by the end of 2010 (see fig. 3). depleted, FHA would need to draw on permanent and indefinite budget  authority to cover additional increases in estimated credit subsidy costs.  FHA’s latest annual report to Congress raises the possibility that, if house  prices were to decline in 2012, the expected future losses on the current,  outstanding portfolio could exceed current capital resources. These would  be offset by the expected net receipts from the new 2012 cohort of loans.  But, according to HUD, if house prices were to decline in 2012 by an  amount rivaling that of 2011, these new loans would not be expected to  generate sufficient net receipts to offset any potential decline in value of  the current outstanding portfolio, potentially necessitating assistance from  the Department of the Treasury (Treasury). Under one stress scenario in  which house prices decline by 13.7 percent in 2011, rather than the 5.6  percent assumed in the baseline scenario, and house prices decline  another 1.3 percent in 2012, HUD estimates that it may require $13 billion  in assistance from Treasury to ensure the financing account has sufficient  loss reserves.
By the end of 2011, the balance in the capital reserve account rose slightly to $4.7 billion.
section_title: FHA’s Current Methodology for Assessing the Fund’s Condition Does Not Fully Account for Future Economic Volatility
paragraphs: As we reported in September 2010, FHA and its actuarial review  contractor enhanced their methods for assessing the Fund’s financial  condition but still were addressing other methodological issues that could  affect the reliability of estimates of the capital ratio. Annual actuarial  reviews of the Fund use statistical models to estimate the probability that  loans will prepay or result in insurance claims on the basis of certain loan  and borrower characteristics (such as loan-to-value ratios and borrower  credit scores) and key economic variables (such as house prices and  interest rates). FHA and its contractor have enhanced these models in  recent years, by incorporating additional variables related to loan  performance and developed an additional model to predict loss rates on  insurance claims. Also, consistent with recommendations we made in a  prior report, in 2003, the actuarial reviews began to analyze the impact of  more pessimistic economic scenarios—for example, nationwide declines  in home prices—than they did previously.
However, the current methodology is significantly limited by its reliance on  a single economic forecast to produce the estimate of the capital ratio that  is used to determine if the Fund is meeting the 2 percent capital reserve  requirement. This approach does not fully account for the variability in  future house prices and interest rates that the Fund may face. As a result,  baseline estimates of the capital ratio may tend to underestimate  insurance claims and mortgage prepayments and therefore may  overestimate the Fund’s economic value. In a November 2003 report, the  Congressional Budget Office concluded that FHA could project the Fund’s  cash flows more accurately by using an approach (stochastic simulation)  that involves running simulations of hundreds of different economic paths  to produce a distribution of capital ratio estimates.
Given the uncertainty that always surrounds estimates of future economic  activity, the report we issued in 2010 recommended that HUD require the  actuarial review contractor to use stochastic simulation of future economic  conditions, including house prices and interest rates, to estimate the  Fund’s capital ratio and include the results of this analysis in FHA’s  annual report to Congress on the financial status of the Fund. However,  the most recent annual report does not include an estimate of the Fund’s  capital ratio using this technique. In response to our 2010 report, FHA  officials told us that they were planning to require the actuarial review  contractor to use a stochastic simulation model for future actuarial  reviews. But, these officials said that the model would be used to examine  the implications of extreme economic scenarios on the Fund, and  decisions about using the model to estimate the Fund’s capital ratio had  not been made.
section_title: FHA Has Taken Steps to Address Risks, but Has Yet to Implement a Comprehensive Risk-Assessment Strategy
paragraphs: FHA faces risks resulting from its operations. FHA’s loan volume grew  significantly from 2006 to 2010. In 2006, FHA insured almost half a million  loans, totaling $70 billion in mortgage insurance. By 2010, it had more  than tripled to 1.7 million loans insured or about $319 billion in mortgage  insurance. During the same time period, FHA’s single-family staff  increased 8 percent, from 932 employees in 2006 to 1,011 employees in  2010, while increases in key workload areas often surpassed 100 percent  as follows:
Staff in the homeownership centers’ Processing and Underwriting  Division grew at a slower rate (22 percent) than key workload items,  particularly volume-driven loan reviews (which increased by more  than 100 percent).
Increases in contractor staff and workload related to management of  foreclosed or real estate-owned properties were substantial, but  noncontractor staff levels increased at more modest levels.
Loss mitigation actions more than doubled from 2006 to 2010, while  loss mitigation staff levels remained relatively constant.
subsections: section_title: Although FHA Worked to Address Credit and Operational Risk, It Has Not Yet Put a Comprehensive Strategy in Place
paragraphs: Although FHA has taken steps to assess credit and operational risks  facing its single-family insurance programs, its current risk-assessment  strategy is not comprehensive because it is not integrated across the  agency and lacks annual assessments and mechanisms to anticipate  changing conditions. To address credit risk and help improve the financial  condition of the Fund (which is supported by borrower premiums), FHA  raised premiums and made or proposed policy or underwriting changes.  For example, in April 2011, FHA increased its annual insurance premiums  from 0.85 percent to 1.10 percent for borrowers with 30-year loans with  initial loan-to-value ratios of 95 percent or less and from 0.90 percent to  1.15 percent for borrowers with 30-year loans with initial loan-to-value  ratios greater than 95 percent. Additionally, FHA increased down- payment requirements for borrowers with lower credit scores. FHA also  has proposed reducing allowable seller contributions at closing, thereby  helping to ensure that buyers put more of their own funds into the home  purchase. Further, FHA has been revising its mortgage scorecard  algorithm to recognize the effect of various risk elements not currently  discerned by the scorecard and determine what cases warrant manual  underwriting. According to FHA, these revisions are in the early stages,  and no completion date has been set.
To address operational risks and improve its risk-assessment strategy, in  2010, FHA established the Office of Risk Management and Regulatory  Affairs and created the position of Deputy Assistant Secretary for Risk  Management and Regulatory Affairs, which reports directly to the  Assistant Secretary for Housing-FHA Commissioner. To provide  assistance to the Office of Risk Management (one of the offices within the  Office of Risk Management and Regulatory Affairs) in developing a risk- management strategy and organizational structure and establishing risk- management policies and processes, FHA hired a consultant to produce  a comprehensive report and recommend best practices for its operation.According to FHA officials, FHA plans to adopt the consultant’s  recommendation to establish an enterprise risk committee to address  overall risk to the organization and a second tier of committees to address  program and operational risks. In addition, in 2009 the Office of Single  Family Housing implemented an internal quality control initiative at  headquarters and the four homeownership centers. For the areas  identified as high-risk, headquarters and the homeownership center  divisions developed plans to document control objectives and established  a monitoring strategy in which each homeownership center submits  quarterly reports to headquarters on the effectiveness of the controls,  including the status of any mitigation efforts.
However, FHA’s risk-assessment strategy raises several issues. First,  FHA’s current risk-assessment strategy is not comprehensive because it  is not integrated throughout the organization. While the consultant  recommended that FHA integrate risk assessment and reporting  throughout the organization, currently the Office of Single Family  Housing’s quality control activities and the Office of Risk Management’s  activities remain separate efforts. FHA officials noted that until the Office  of Risk Management sets up a governance process, the integration  suggested by the consultant would not be possible. In the meantime, FHA  officials stated that every effort was being made to help ensure that the  Office of Risk Management’s activities complemented program office  activities. Second, contrary to HUD guidance, the Office Single Family  Housing has not conducted an annual, systematic review of risks to its  program and administrative functions since 2009. According to an official  in this office, although management intended to conduct an annual  assessment, the dates slipped because of changes in senior leadership in  the Office Single Family Housing, and few staff were available to perform  assessments (because of attrition and increased workload). Finally, the  Office of Single Family Housing’s current risk-assessment efforts do not  include procedures for anticipating potential risks presented by changing  conditions. The consultant’s report proposes a reporting process and  templates for identifying emerging risks and provides specific examples.
Office of Risk Management officials told us that, once they are  operational, the risk committees eventually would determine the exact  design and content of these reports and templates.
Moreover, implementation and integration of the new risk-assessment  strategy and its planned tools has been slow because of delays in  defining the Office of Risk Management’s authority, difficulty filling new  staff positions in the Office of Risk Management, and changes in FHA  leadership.
All these factors limit FHA’s effectiveness in identifying, planning for, and  addressing risk. More specifically, without an integrated risk-assessment  strategy, certain risks may not be fully addressed at the operational level  in a way that minimizes risk to the insurance programs; without annual  reassessments of its risks, the Office of Single Family Housing lacks  assurance that its quality control efforts address all its risks; and without  ongoing mechanisms in place to anticipate and address new or emerging  risks, FHA lacks a systematic approach to help the agency identify,  analyze, and formulate timely plans to respond most effectively to  changed conditions and risks. Therefore, we recommended that FHA (1)  integrate the internal quality control initiative of the Office of Single Family  Housing into the operational risk processes of the Office of Risk  Management, (2) conduct an annual risk assessment, and (3) establish  ongoing mechanisms—such as use of the report templates from the 2010  consultant’s report—to anticipate and address risks that might be caused  by changing conditions. FHA agreed with the recommendations and, as  of January 2012, indicated that it either was working toward achieving the  recommendations or had plans to do so in the very near future. For  example, FHA said it would leverage or integrate existing risk  management efforts as soon as the Office of Risk Management’s final  governance structure and risk management strategies were in place. The  agency also stated that the Office of Risk Management would conduct an  annual risk assessment as a component of its overall risk management  strategy. It stressed that ongoing mechanisms to anticipate and address  risks related to changing conditions would be part of the office’s strategy.
section_title: FHA Has Taken Steps to Address Counterparty Risks but Continues to Face Human Capital Challenges
paragraphs: With growth in loan volume, the number of lenders and appraisers (or  counterparties) participating in FHA’s single-family programs also has  grown. The total number of FHA-approved lenders increased 24 percent,  from 10,370 in 2006 to 12,844 in 2010. The number of FHA-approved  appraisers increased approximately 67 percent from 33,553 in 2006 to  56,192 in 2010.
FHA has made recent changes to address risks posed by its lenders and  appraisers. For example, on May 20, 2010, FHA stopped approving new  loan correspondents. And as of January 1, 2011, existing loan  correspondents could no longer participate in FHA programs. Former loan  correspondents now can participate only as third-party originators through  sponsorship by FHA-approved lenders. As a result, as of September  2011, the number of FHA-approved lenders had declined to about 3,700.  Furthermore, the agency has increased the net worth requirement for  approved lenders. On May 20, 2011, FHA increased the requirement for  existing lenders to $1 million, except for lenders classified as small under  the Small Business Administration’s size standards (their requirement  increased to $500,000). As of May 20, 2013, FHA will require a net worth  of $1 million for all lenders, plus 1 percent of the total loan volume in  excess of $25 million, to a maximum required net worth of $2.5 million.  To help ensure that lenders and appraisers follow its policies and  procedures, FHA also has enhanced the criteria used to select loans for  reviews. Specifically, since May 3, 2010, the agency has considered high- risk loan or borrower characteristics, such as certain types of refinanced  loans and loans to borrowers with low credit scores. Additionally, FHA  increased the number of risk factors used to target lenders for review.  FHA also has revised its approach for overseeing appraisers.
FHA has addressed staffing and training needs and succession planning  to some extent, but it lacks plans that strategically address future  workforce needs, including replacing retiring staff. Although workforce  planning practices used by leading organizations include defining critical  skills and skill gaps, FHA’s current approach does not have mechanisms  for doing so. FHA previously had a multiyear workforce plan that identified  the critical competencies; analyzed skills and competencies, including  gaps; and proposed comprehensive strategies to address these gaps, but  it has not created another such plan. Instead, FHA has relied on occasional Resource Estimation and Allocation Process studies and  annual managerial assessments of staffing and training needs.
FHA also currently does not have a succession plan, although a plan for  2006–2009 identified mission-critical positions, analyzed existing staff  competencies, assessed the number of retirement-eligible employees,  and determined the probability of near-term retirements.  Succession  planning is particularly important because, as of July 2011, almost 50  percent of the Office of Single Family Housing staff at headquarters were  eligible to retire in the next 3 years. The percentage of staff eligible to  retire at the homeownership centers was even higher—63 percent.
While FHA has taken some steps to address succession planning, these  steps have been limited. FHA implemented two initiatives focused on  succession planning. The first, begun in 2010, was intended to help  ensure that, at any given time, at least two additional supervisors,  managers, or executives could perform the work of each supervisor,  manager, or executive. However, this does not apply to staff positions  beyond management. The second initiative also began in 2010. Its goal is  to train and develop staff. Neither initiative assesses the number of  retirement-eligible employees in critical positions as required by HUD  guidance. According to FHA officials, as resources have dwindled, they  have considered all their positions to be critical.
Department of Housing and Urban Development, Succession Management Plan, Fiscal  Year 2006-2009, (Washington, D.C.: September 2006). recommended that FHA develop workforce and succession plans for the  Office of Single Family Housing. FHA agreed, stating that it would  develop a formal workforce plan and had efforts under way to develop a  succession plan. For example, FHA indicated that it would conduct a  comprehensive workforce analysis by the end of January 2012 to  determine mission-critical positions, analyze skill gaps, and assess  retirement eligibilities and probabilities.
section_title: Ginnie Mae’s Risk Management and Cost Modeling Require Continuing Attention
paragraphs: Ginnie Mae has undertaken efforts to improve risk management, but as  many of these efforts remain in planning or under development, they  merit continued commitment and follow through from senior management.  Ginnie Mae faces operational risk related to limited staffing and reliance  on contractors in the context of increased market share and volume.  And, while Ginnie Mae’s revenues exceeded its costs, and it has  accumulated a capital reserve of about $14.6 billion, its modeling of  estimated cost and revenues could be improved by incorporating certain  practices, such as using the best available data, that we believe represent  sound internal controls for models.
subsections: section_title: Ginnie Mae Has Undertaken Efforts to Improve Risk Management, but Many Remain to Be Implemented
paragraphs: Ginnie Mae has taken steps to better manage operational and  counterparty risks and has several initiatives planned or under way. GAO  and others have identified limited staff, substantial reliance on  contractors, and the need for modernized information systems as risks  that Ginnie Mae may face. Ginnie Mae’s counterparty risk would stem  from the failure of issuers of Ginnie Mae-guaranteed MBS to provide  investors with monthly principal and interest payments.
Although Ginnie Mae’s market share and volume of MBS has increased  in recent years, its (noncontractor) staff levels have been relatively  constant during this time. In recent years, its actual staff levels have been  below its authorized staff levels. Ginnie Mae’s internal control reviews for  2009 and 2010 identified a control deficiency due to employee vacancies,  including multiple vacancies in certain positions relevant to internal  controls. The 2011 internal control review had no findings related to  employee vacancies. As part of a broad effort to address and mitigate its  operational risks related to staffing levels, Ginnie Mae has incorporated  some principles consistent with our internal control and management  tool. Consistent with this guidance, Ginnie Mae has identified skill gaps  in staff resources, developed a plan to hire additional staff, and made  changes to its organizational structure. The President’s budget for 2012  requested $30 million for administrative expenses at Ginnie Mae, which  included supporting 137 full-time equivalent positions (FTE). Ginnie Mae  officials told us that, if this request was not approved, the agency would  be forced to use its limited resources across its many risk-management  efforts and would leave it with little capacity to conduct preventative or  forward-looking analyses. The enacted 2012 budget provides $19.5  million for these administrative expenses and up to an additional $3  million, depending on the volume of Ginnie Mae’s guarantees.
Between 2005 and 2010, as Ginnie Mae’s volume and issuer activity  increased, and staff levels remained largely the same, the agency  increasingly relied on contractors. Contract obligations in 2010 were more  than 14 times the contract obligations in 2005. According to Ginnie Mae  officials, they have contracted out many functions because the agency  has flexibility to use agency revenues to procure contractors. That is,  statutorily Ginnie Mae has flexibility to spend funds for contracting  expenses because these expenses can be funded from agency revenues  without annual appropriations. Ginnie Mae depends on contractors to  provide a variety of services, including those related to guaranteeing  MBS, such as collecting data from issuers and processing monthly  principal and interest payments to investors. In addition, Ginnie Mae  relies on several contractors to take over the servicing responsibilities on  pooled loans when issuers default. Ginnie Mae has used its own staff as  well as third-party assessments of contracts, to oversee its contractors  but plans to provide additional staff resources to supplement the third- party assessments. However, officials said that implementation of this  plan has been put on hold due to changes in the Ginnie Mae budget.  Additionally, Ginnie Mae has conducted risk assessments of its contracts  and potential operational risks, and it plans to review the proposed  recommendations and determine how to implement them.
Ginnie Mae has been working on an ongoing initiative to improve its  information technology systems. According to officials, Ginnie Mae has  been working on the first phase of its business process improvement  initiative for the last few years based on a plan developed in conjunction  with the Office of Management and Budget. The main goal of the initiative  is to modernize the agency’s technology by consolidating processes and  eliminating redundant systems. Some of the weaknesses included  outdated data systems, a reliance on paper-based processes, and a lack  of integrated data systems. According to Ginnie Mae, the first phase of  the initiative resulted in the creation of nine new information technology  system initiatives such as a system that allows Ginnie Mae to receive  enhanced reporting and provide status information to issuers. Ginnie Mae  has been drafting a strategy document for its ongoing initiative to look for  additional improvement opportunities in its information technology  systems.
To manage its counterparty risk, Ginnie Mae has processes in place to  oversee MBS issuers that include approval, monitoring, and enforcement  and has revised its approval and monitoring procedures. For example, in  2010, Ginnie Mae increased the minimum net worth requirement for  issuers of Ginnie Mae-guaranteed MBS to $2.5 million. But, planned  initiatives to enhance its risk-management processes for issuers,  including its tracking and reporting systems, have not been fully  implemented. These initiatives include a plan to develop a database for  tracking the resolution and timing of findings from reviews of issuers. It  will be important for Ginnie Mae to complete its initiatives related to  operational and counterparty risk as soon as practicable. Our November  2011 report includes an appendix that contains a listing of Ginnie Mae’s  planned and proposed initiatives and their expected completion dates.
section_title: Ginnie Mae Has Not Yet Implemented Certain Practices for Modeling Costs and Revenues
paragraphs: In developing inputs and procedures for the model used to forecast costs  and revenues, Ginnie Mae did not consider certain practices identified in  Federal Accounting Standards Advisory Board (FASAB) guidance for  preparing cost estimates of federal credit programs. Ginnie Mae has not  developed estimates based on the best available data, performed  sensitivity analyses to determine which assumptions have the greatest  impact on the model, or documented why it used management  assumptions rather than available data. By not fully implementing  practices in FASAB guidance that we believe represent sound internal  controls for models, Ginnie Mae’s model may not be using critical data  that could affect the agency’s ability to provide well-informed budgetary  cost estimates and financial statements. This may limit Ginnie Mae’s  ability to accurately report to Congress the extent to which its programs  represent a financial exposure to the government.
We recommended in our November 2011 report on Ginnie Mae that the  HUD Secretary direct Ginnie Mae to take steps to ensure its model more  closely follows certain practices identified in FASAB guidance for  estimating subsidy costs of credit programs. More specifically, Ginnie  Mae should (1) assess and document that it is using the best available  data in its model and most appropriate modeling approach; (2) conduct  and document sensitivity analyses to determine which cash flow  assumptions have the greatest impact on the model; (3) document how  management assumptions are determined, such as those for issuer  defaults and mortgage buyout rates; and (4) assess the extent to which  management assumptions, such as those for issuer defaults and  mortgage buyout rates, can be replaced with quantitative estimates.  Ginnie Mae has indicated that it plans to implement all of our  recommendations but has not provided a specific timeline. In addition,  Ginnie Mae agreed with our observation about the importance of  completing ongoing and planned initiatives for enhancing its risk- management processes, as soon as practicable, to improve operations.
Mr. Chairman, Ranking Member Olver, and Members of the  Subcommittee, this concludes my prepared statement. I would be happy  to respond to any questions that you may have at this time.
section_title: GAO Contact and Staff Acknowledgments
paragraphs: For further information about this testimony, please contact me at 202- 512-8678 or sciremj@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this statement. Individuals making key contributions to this testimony  include Paige Smith, Assistant Director; Andrew Pauline, Assistant  Director; Steve Westley, Assistant Director; Dan Alspaugh; Nadine  Garrick Raidbard; John McGrail; Marc Molino; José R. Peña; Beth Reed  Fritts; Paul Revesz; and Barbara Roesmann.
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