Federal Housing Administration: Improving Disposition and Oversight Practices May Increase Returns on Foreclosed Property Sales
Released: 2013-07-22T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: With mortgage foreclosures at historic levels in recent years, FHA is faced with disposing of a high volume of REO properties. The enterprises, other federal agencies, and private sector mortgage servicers also dispose of REO properties from their foreclosures. To assess the relative effectiveness of FHA’s REO dispositions, GAO examined (1) FHA’s disposition goals, strategies, practices, and effectiveness in disposing of properties compared with those of the enterprises and private servicers; and (2) FHA’s oversight of the contractors that maintained and marketed its REO properties. GAO analyzed REO disposition data from FHA and the enterprises, including modeling to control for property differences across the entities. GAO also collected requirements, policies, and interviews on each entity’s oversight of its REO dispositions.

section_title: What GAO Found
paragraphs: The Federal Housing Administration's (FHA) performance in selling its foreclosed properties--known as real estate-owned (REO) properties--lagged the performance of both of the government-sponsored enterprises (enterprises), Fannie Mae and Freddie Mac. FHA disposed of more than 400,000 properties from January 2007 through June 2012. Its combined 2007-2012 returns, measured by the net execution rate (net sales proceeds divided by independently assessed property values) were about 4 to 6 percentage points below the enterprises' returns. After controlling for certain differences in their properties' characteristics (e.g., value, location, and local market conditions), differences in combined returns between FHA and the enterprises persisted at an estimated 2 to 5 percentage points.

Further, while the enterprises took an average of around 200 days after foreclosure to dispose of REO properties, FHA took about 340 days--more than 60 percent longer . A similar pattern persisted even after controlling for certain property differences. FHA also took longer than the Department of Veterans Affairs (VA). For FHA, unlike the others, a significant part of the time between the foreclosure sale and REO sale is taken by loan servicers who must complete certain activities before conveying title to FHA. In the first half of 2012, FHA's disposition returns and timelines generally improved relative to the enterprises'. All three entities use similar strategies to dispose of their REO properties, but FHA does not use some practices that the enterprises and private mortgage servicers use that may have the potential to improve its sales performance. For example, FHA does not repair its properties to increase their marketability, something both enterprises do. And unlike the enterprises, FHA does not incorporate information from multiple sources in setting list prices or consistently take into account market conditions when reducing prices. Instead, it relies on one appraisal in setting initial prices and often reduces them by set amounts. GAO found that if FHA's execution rate and disposition time frame had equaled those of the enterprises in 2011, it could have increased its proceeds by as much as $400 million and decreased its holding costs--which can include items such as taxes, homeowners' association fees, and maintenance costs--by up to $600 million for the year.

In addition, FHA’s oversight of the contractors that it uses to maintain and dispose of REO properties has weaknesses, and it does not use some of the oversight tools other entities use that might prove effective. First, government internal control standards require complete, updated policies and procedures to guide program oversight. But FHA has not updated its REO disposition handbook since 1994, even though the agency implemented a different program and contractor structure in 2010. In the absence of a central source of updated guidance, GAO and FHA internal auditors found inconsistencies in both contractor activities and staff oversight across FHA’s four regional homeownership centers. Second, FHA has not implemented a uniform system for evaluating contractor performance. For instance, FHA has yet to implement a proposed version of the type of scorecard that the enterprises use to assess differences in contractor performance. Also, its planned incentive structure for contractors has been found not to comply with federal contracting rules. These two shortcomings have prevented FHA from assigning work according to contractors’ performance—a key quality control in its new REO program structure. Further, FHA aims to inspect 2 to 6 percent of its REO properties annually, although other entities with REO properties report inspecting between 25 and 35 percent monthly, or between 7 and 40 percent annually. Finally, FHA has not taken steps to ensure that the listing brokers marketing its REO properties are located close enough to the properties to have adequate knowledge of local markets. Without implementing more effective activities to evaluate contractor performance and ensure compliance with program requirements, FHA’s REO properties may continue to remain on the market longer and sell for lower prices than properties held by the enterprises.

section_title: What GAO Recommends
paragraphs: GAO makes 10 recommendations intended to increase FHA’s returns on the disposition of REO properties, including considering repairs that increase net proceeds, requiring the use of additional information for setting initial and subsequent listing prices; and improving its oversight of its contractors, including updating and maintaining comprehensive guidance, implementing a performance inspections, and ensuring that listing brokers are appropriately located. FHA reviewed a draft of this report and agreed with GAO’s recommendations.

section_title: Letter
paragraphs: The Federal Housing Administration (FHA) within the Department of  Housing and Urban Development (HUD) strives to assist low- and  moderate-income borrowers obtain home loans by providing guarantees  to private lenders. In 2012, FHA insured about 1.2 million single-family  mortgages, providing about $227 billion in mortgage insurance. With the  high rate of mortgage loan defaults since 2006, FHA has had to take  possession of a large number of foreclosed properties. FHA’s inventory  of these real estate-owned (REO) properties grew from over 25,000 in  2007 to a peak of more than 65,000 by the end of 2011, an increase of  about 160 percent. Other government agencies that operate housing  finance programs, including the Department of Veterans Affairs (VA) Loan  Guaranty Service and the Department of Agriculture’s Rural Housing  Service (RHS), as well as the two government-sponsored enterprises (the  enterprises), Fannie Mae and Freddie Mac, also have experienced  increasing numbers of REO properties. All of these entities seek to sell or  otherwise dispose of their REO properties in order to recover some  portion of the loss on the original failed loans.

REO properties must be maintained, repaired if necessary, evaluated to  determine an appropriate selling price, and marketed for sale. Conducting  these activities effectively can ensure that FHA maximizes returns and  minimizes maintenance and other holding costs. You requested that we  examine various aspects of FHA’s REO activities. This report examines  (1) how FHA’s disposition goals, strategies, and practices and  effectiveness in disposing of properties compares with those of other  entities; and (2) how FHA oversees the contractors that maintain and  market its REO properties.

To identify the goals and strategies for REO programs at FHA and other  entities, we reviewed program regulations, requirements, and policies. To  assess the effectiveness of FHA’s REO property dispositions, we  analyzed disposition data from FHA and the other federally related  entities, including all REO properties disposed of from January 2007  through June 2012. We did not include RHS in our analysis of REO  property disposition performance because it only obtains and manages  REO properties through its direct loan program and it had a comparatively  small number of such dispositions. During the period of our analysis  RHS’s direct loan property dispositions were less than 1 percent of FHA’s  dispositions. RHS also did not have property-level data available for many  of the data elements that we included in our analyses. Similarly, we were  not able to obtain some information on VA’s REO dispositions because it  was in the process of transitioning to a new REO property management  contractor. We created regression models to assess the extent of  differences between FHA’s performance and that of the two enterprises  after accounting for some differences in the characteristics of the  properties they acquired. We also used these models to identify factors  that could explain differences in performance. We determined that the  REO disposition data were sufficiently reliable for the purposes of our  analysis. To determine how FHA and the other entities oversaw the  contractors that managed and disposed of their REO properties, we  reviewed program regulations, requirements, and policies and interviewed  staff from these entities as well as from some private sector mortgage  servicers that also acquired and disposed of REO properties. We  conducted this performance audit from February 2012 to June 2013 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. For more information on the  methodologies used in this report, see appendix I.
subsections: section_title: Background
paragraphs: Established by the National Housing Act of 1934, FHA’s single-family  mortgage insurance program helps home buyers obtain home mortgages  by providing insurance on single-family mortgage loans. The mortgage  insurance allows FHA-approved private lenders to provide qualified  borrowers with mortgages on properties with one to four housing units  and generally compensates lenders for nearly all of the losses incurred on  such loans. FHA insures mortgages on properties that meet its criteria,  providing guarantees for initial purchases, construction and rehabilitation,  and refinancing. To support the program, FHA imposes up-front and  annual mortgage insurance premiums on home buyers. The agency has  played a particularly large role among minority, low-income, and first-time  home buyers. In 2012, about 78 percent of FHA-insured home purchase  loans went to first-time home buyers, about 32 percent of whom were  minorities.
subsections: section_title: Other Mortgage Market Participants
paragraphs: A number of other federal and private sector entities participate in the  mortgage market. Along with FHA, the VA Loan Guaranty Service and  RHS administer federal government programs that insure or guarantee  single-family mortgages made by private lenders. In addition to these  government agencies, private companies insure lenders against losses  on home mortgages, and private lenders make loans without mortgage  insurance. The enterprises also participate in the U.S. housing market by  purchasing mortgages from lenders.

VA’s Loan Guaranty program is an entitlement program that provides  eligible veterans, active duty military personnel, and certain other  individuals with housing benefits. The VA guaranty program allows  mortgage lenders to extend loans to eligible borrowers on favorable  terms—for example, with no down payment—and provides lenders with  financial protections against the losses associated with such mortgages.  To help support the program, borrowers are required to pay a funding fee  that equals a certain percentage of the loan amount, although service- connected disabled veterans are exempt from paying this fee. The  program may also receive congressional appropriations if needed.

RHS operates guaranteed and direct loan programs to help rural  Americans with very low incomes, low incomes, and in some cases  moderate incomes purchase single-family homes. The purpose is to  provide financing with no or low down payments at favorable rates and  terms. The loans are generally for the purchase, construction,  rehabilitation, or relocation of a dwelling and related structures. RHS- guaranteed loans are made through approved local lenders, with RHS  providing the lenders substantial financial protections against associated  losses. The loans are available to qualifying borrowers who meet  applicable household income limits and seek to buy properties in eligible  rural areas. Under its direct loan program, RHS extends loans to qualified  borrowers—who must have low incomes and be without adequate  housing—for the purchase of properties that are modest in size, design,  and cost.

Congress established the enterprises as for-profit, shareholder-owned  corporations. They share a primary mission to stabilize and assist the  U.S. secondary mortgage market and facilitate the flow of mortgage  credit. To accomplish this goal, the enterprises purchase conventional  mortgages that meet their underwriting standards, obtaining their funds  through borrowing or by issuing mortgage-backed securities, which are  securities backed by pools of mortgages. The enterprises hold some of  the purchased mortgages in their portfolios, but they package most of  them for sale to investors in the secondary mortgage market. In exchange  for a fee, the enterprises guarantee these investors the timely payment of  principal and interest. Both enterprises are also required to purchase  mortgages that serve low- and moderate-income families. On September  6, 2008, the Federal Housing Finance Agency placed the enterprises into  conservatorship out of concern that the enterprises’ deteriorating financial  condition threatened the stability of financial markets.

Institutions that originate home mortgages generally do not hold such  loans as assets on their balance sheets but instead sell them to other  financial institutions for the purpose of securitizing the mortgage. These  securities pay interest and principal to their investors, which include  financial institutions and pension funds, among others. In the past,  institutions originating mortgage loans took care of all the activities  associated with servicing them—including accepting payments, initiating  collection actions for delinquent payments, and foreclosing if necessary.  With the advent of securitization, entities known as mortgage servicers— which can be large mortgage finance companies or commercial banks— typically undertake such activities on behalf of the current owners of the  loans.

section_title: Foreclosure Process
paragraphs: If a borrower defaults on a mortgage loan secured by the property, the  mortgage note holder is generally entitled to pursue foreclosure to obtain  title to the property. The foreclosure process is governed by state laws  and differs across states, but foreclosed properties are typically sold at  auction, as shown in figure 1. Once the borrower is in default, the  mortgage servicer—often in conjunction with the borrower and entities  with an interest, such as mortgage guarantors and insurers—must decide  whether to pursue a home retention workout or other foreclosure  alternative or to initiate foreclosure. The mortgage owner or servicer  generally initiates foreclosure once the loan becomes 90 days or more  delinquent unless the borrower can resolve the loan’s delinquency by  paying the outstanding amount or some other resolution occurs, such as  a borrower repayment plan or loan modification. If the foreclosure process  is completed and no third party purchases the home at the foreclosure  sale, the home usually becomes the property of the loan holder or  servicer as part of an REO inventory.

However, certain states provide the previous owners of foreclosed  properties with a right of redemption that allows them to pay amounts  owed to the lender and reclaim ownership. During redemption periods,  the previous borrower or current occupant is allowed to remain in the  residence and the REO property owner or servicer generally is not  permitted to pursue activities such as evicting property residents or  securing properties. Some states may have a confirmation process to  complete the foreclosure process and transfer title that may also delay  possession and marketing of an REO property. Typically, the redemption  or confirmation period begins after the foreclosure sale and lasts from  around 1 to 6 months or more. However, if properties become vacant,  some state laws may permit the shortening of redemption periods and  allow the REO property owners or servicers to take control of foreclosed  properties.

The acquisition of REO properties differed across the entities that we  reviewed. When a servicer forecloses on an FHA-insured property that is  not sold to a third party, the foreclosure is held in the lender’s or servicer’s  name, and the lender or servicer is responsible for the property until it is  conveyed to FHA. FHA requires servicers to oversee properties during  redemption periods, to evict residents if properties not in redemption  periods are occupied, and to perform critical maintenance on properties.  The servicer files a claim with FHA, and FHA conducts its inspections  before accepting the title. The length of time between the foreclosure sale  and entry of a property into FHA’s REO inventory depends in part on  state foreclosure laws as well as the actions of the loan’s servicer.  According to FHA rules, a servicer needs marketable title before it can  convey a property to FHA, and the title is generally considered to be  marketable only after the borrower has left the home or been evicted, any  redemption period has expired, and other required actions have taken  place. After conveyance to FHA, the property is assigned to FHA’s  contractors, which begin the process of preparing the REO property for  sale.

Other federally related entities that acquire REO properties take custody  of and are responsible for them closer to the time of the foreclosure sale.  For example, the enterprises require servicers to convey properties to  them within 24 hours of foreclosure sales, while VA requires servicers to  provide notice of their intent to convey properties within 15 days of  foreclosure sales, although servicers have 60 days (or longer in certain  jurisdictions) to provide evidence of acceptable title to conveyed  properties. RHS’s REO process varies, depending on whether the  property has had a guaranteed or direct loan. With direct loans, RHS  takes possession of the property after the foreclosure sale and manages  the entire REO process. With guaranteed loans, the lender receives title  to the property and maintains, markets, and disposes of the property, and  RHS oversees the process. Because RHS acquires and disposes only of  REO properties related to its direct loans, we generally considered only  these types of properties when discussing RHS’s REO disposition.

section_title: REO Disposition Process
paragraphs: Disposing of REO properties can involve various activities, although the  disposition process is generally similar across entities. While a property is  held as part of an entity’s REO inventory, the entity is responsible for  maintenance, including cleaning, lawn care, snow removal, and security.  If a property has a tenant or is otherwise occupied, eviction proceedings  may need to occur before it is offered for sale. After any redemption  periods expire and evictions take place, properties are usually assessed  to determine their market value. The market value is used to determine  the selling, or listing, price. A listing real estate broker is usually chosen to  market the property publicly, generally through a multiple listing service  system—a database set up by a group of real estate brokers to provide  information about properties for sale. If a property does not attract interest  at its initial listing price, the price can be reduced. Once a purchase offer  is accepted, the sale closing process occurs, and ownership is transferred  to the new owner.

section_title: REO Program Structures and Use of Contractors
paragraphs: Since 1999, FHA has been outsourcing to private sector contractors the  maintenance and disposition of its REO properties. Entities that dispose  of REO properties typically use various types of contractors, including  those that manage the marketing or maintenance activities for a large  number of properties. These larger contractors often use subcontractors  to provide specific services related to the marketing or maintenance of  properties, such as listing the property for sale or cutting the lawn. In June  2010, FHA launched the third generation of its Management and  Marketing (M&M) contractor program, known as M&M III. Under prior  arrangements, FHA’s M&M contractors were responsible for both the  maintenance and marketing of FHA’s REO properties. However, under  M&M III these functions are performed by separate contractors, including  maintenance contractors that are responsible for preserving properties  and marketing contractors that are responsible for selling the homes.  Under the M&M III structure, FHA also uses contractors called Mortgagee  Compliance Managers that protect FHA’s interests in foreclosed  properties that lenders have not yet conveyed to FHA. The M&M III  structure was also meant to include an additional contractor to serve as  an oversight monitor to assist FHA in overseeing its REO program’s  performance, including the other M&M III contractors.

FHA conducts its mortgage loan insurance programs and its REO  disposition program through four regional operating locations called  homeownership centers, or HOCs. The homeownership centers are  located in

Atlanta, Georgia;

Denver, Colorado;

Philadelphia, Pennsylvania; and

Santa Ana, California.

Each of these homeownership centers oversees FHA operations in the  states within their region (see fig. 2). Under M&M III, FHA contracts with  entities to provide the necessary maintenance or marketing services in  multiple areas that cover several states. Within each of these contract  areas, multiple entities generally will receive either maintenance or  marketing contracts as a way of fostering competition among the  contractors to improve their responsiveness, reduce risk, and increase  net returns to FHA. FHA staff—known as government technical  representatives—in each of these locations oversee the maintenance and  marketing contractors, including monitoring and evaluating their  performance and providing technical guidance and assistance.

Other entities also use contractors to manage and dispose of REO  properties, but to varying degrees. For example, officials from one of the  enterprises said that it used three nationwide contractors for property  maintenance, with each operating in different states. According to these  officials, contractors inspect the properties, but field-based quality control  employees also do property inspections. For disposition, this enterprise  has its own internal management group that markets and sells REO  properties using its own network of listing brokers. The enterprise’s  officials said that to help adjust capacity based on REO inventories, the  enterprise had also contracted with external asset management  companies that did not use its broker network. The officials noted that the  enterprise recently ended its use of these contractors, as its REO  inventories had declined.

The other enterprise has used contractors to manage and dispose of its  REO properties since 2008. According to officials, this enterprise initially  used one sales management contractor but added two more in March  2011. These officials explained that each of the three contractors  operated in every geographic area, allowing the enterprise to more easily  change the contractor managing a property if necessary. The enterprise’s  officials also said that it managed the network of service providers—such  as listing brokers, property maintenance companies, and repair  contractors—that its sales management contractors used to ensure a  consistent process and minimize potentially adverse relationships among  contractors. Officials said that the enterprise primarily maintained  relationships with local service providers rather than nationwide providers  because markets differed at the local level. The enterprise’s oversight  structure includes several different groups, including oversight monitors  that review specific areas of contractor performance, individual business  teams that also review performance across all contractors, and vendor  oversight teams that serve as liaisons between the business units and  contractors.

VA and RHS use different approaches. VA staff told us that the agency  used a single contractor to manage the maintenance and disposition of its  entire REO inventory. This contractor uses numerous subcontractors to  maintain and market properties and manage the subcontractors.  According to its staff, VA wanted one company to manage everything so  that it could have a single point of interaction and accountability. RHS  uses both contractors and its own staff to dispose of REO properties,  according to agency officials. For its direct loans, RHS staff manage the  disposition of any foreclosed properties for which it takes possession in  about half of the states, while a central RHS office oversees contractors  that manage and dispose of properties in the remaining states. Officials  said that for several years RHS had been transitioning from using its own  staff to using contractors to dispose of properties. For its guaranteed  loans, RHS does not use contractors but relies on lenders that take  possession of the REO properties with some RHS oversight. If a lender  completes foreclosure or a deed-in-lieu of foreclosure on a loan that RHS  guarantees, the lender receives title to the property and maintains,  markets, and disposes of the property.

section_title: The Housing Crisis Increased the Volume of REO Properties
paragraphs: As a result of the large number of loan defaults arising during the housing  crisis, FHA and the other entities have generally experienced significant  growth in their REO property disposition activities. As shown in the figure  below, each of the entities disposed of an increasing number of REO  properties during that time. RHS was not included in the figure because it  had no more than 218 direct loan REO property dispositions in any  quarter during the time period.

section_title: Changes to Its Disposition Practices Could Help FHA Improve Results
paragraphs: Our review of FHA and other federally related housing entities found that  they pursued similar goals and strategies for disposing of REO properties,  including seeking to sell most properties to owner-occupants—individuals  planning to occupy the homes as primary residences. But data for REO  dispositions from January 2007 through June 2012 showed that FHA’s  returns from selling its REO properties generally trailed the returns  earned by the enterprises. This difference declined when differences in  property characteristics, such as location and value, were considered. In  addition, we found that FHA, on average, took significantly longer to sell  its properties than the enterprises and VA—more than 130 and 70  additional days, respectively. We also evaluated how the method used to  sell properties and the type of purchaser affected FHA’s performance.  The large majority of FHA’s dispositions were retail sales to owner- occupants or investors, and our analysis of FHA’s performance indicated  that the agency achieved higher returns on sales to owner-occupants  than on sales to investors and other buyers. However, FHA had a smaller  share of owner-occupant sales than the enterprises. We also found that,  in making these sales, FHA did not follow several practices that other  entities used in disposing of REO properties that could potentially  increase the agency’s returns, including repairing properties to increase  their market value, using multiple inputs to set list prices, and using  market-based information to make subsequent list price reductions.
subsections: section_title: FHA and Other Federally Related Entities Have Similar Goals and Strategies for Disposing of REO Properties
paragraphs: FHA’s goals for disposing of its REO properties were similar to those of  the other entities we reviewed. According to staff from FHA, VA, and the  enterprises, each entity aims to maximize the financial return of REO  dispositions while minimizing each property’s time in inventory.  Specifically, FHA’s regulatory goals for its REO program are to dispose of  properties in a manner that expands home ownership opportunities,  strengthens neighborhoods and communities, and ensures a maximum  return to the mortgage insurance fund. Currently, the performance of  FHA’s REO program is assessed against three formal goals:  reducing the average number of days from acquisition to listing REO  properties for sale by 2 percent from the prior fiscal year’s average,  reducing the average number of days in inventory by 2 percent from  the prior fiscal year’s average, and  conducting at least 12 REO workshops/meetings to promote  acquisition and reuse of foreclosed properties in Neighborhood  Stabilization Program areas.

While not having a formal goal addressing the expected return on its REO  sales, FHA staff told us that they attempted to improve the solvency of  FHA’s insurance fund by targeting a gross execution rate—that is, a  property’s sale price as a share of its assessed value, or list price—of 100  percent although they said they use a specific target of at least 80 percent  when evaluating homeownership center performance. VA staff said that it  advises the contractors that market its REO properties that their  execution rate target is 80 percent—based on a property’s net sales  proceeds rather than gross sales price—but offers additional  compensation incentives for a rate of 88 percent or better. One of the  enterprises has a procedural manual for REO sales that notes that its  goal is to sell properties for “as close to 100 percent of the list price as  possible.”

FHA and the other entities we reviewed pursued similar strategies to  achieve their goals. Staff from these entities explained that they  attempted to sell their REO properties primarily via retail sales to either  owner-occupants or to investors, who would likely renovate them for  resale or rentals. Retail REO sales usually are conducted by private real  estate brokers that market the properties the same way they market other  properties—for example, listing them in a multiple listing service. Officials  from these entities explained that they pursued retail sales because such  sales produced higher net returns than other methods of selling the  properties, such as selling multiple properties at once—bulk sales—or  selling individual or multiple properties at auctions. Officials of some of  these entities said that they generally pursued these alternative  disposition strategies only after retail sales had proven unsuccessful and  that often such sales involved low-value properties or properties with  problems that made sales through retail methods difficult.

Officials from FHA and other federally related housing entities said that  they preferred retail sales not only because of their higher returns, but  also because such sales generated more purchases by owner-occupants.  Further, some of the officials and representatives of some nonprofit  organizations said that owner-occupant sales were better for stabilizing  communities and protecting home values. Owner-occupants are assumed  to have more incentive to maintain their properties than investor owners  that may be absent or focused primarily on maximizing rental income.  They also said that owner-occupant sales generally yielded a higher  financial return than sales to investors. FHA staff noted that selling to  owner-occupants helped to achieve one of HUD’s overall agency goals— to expand home ownership opportunities—and said that FHA required  sales records for REO properties to reflect the type of buyer. To further  promote sales to owner-occupants, FHA and some of the other entities  often use methods such as exclusive access periods. For example, FHA  accepts offers on properties that qualify for FHA insurance only from  owner-occupants for the first 30 days of the listing.

In some cases, FHA also disposes of REO properties at a discount  through certain programs intended to further its agency’s mission goal of  creating strong, sustainable, inclusive communities and quality affordable  homes. These discount sale programs represented only a small fraction  of FHA’s total REO dispositions from January 2007 through June 2012.  They include the Asset Control Area program, discount sales to nonprofit  organizations and government entities, the Good Neighbor Next Door  program, and the $1 Home Sale program.

Asset Control Area. Properties located in areas that HUD has  designated for revitalization based on the area’s household incomes,  home ownership rates, and level of FHA-insured mortgage  foreclosure activity can be offered to sale to municipal government  entities or approved nonprofits through this program. These  properties are offered at discounts of at least 50 percent of the  appraised value of the property for properties valued at over $25,000.

Properties valued at less than that amount may be sold for as little as  $100.

Discount sales to nonprofit organizations and government entities.

Qualified nonprofit organizations and government entities may also  purchase FHA properties at a discount. Discounts range from 10 to 30  percent, depending on the property’s FHA insurability status, location,  and other factors. For example, one initiative provides grantees  participating in the Neighborhood Stabilization Program exclusive  access to newly conveyed REO properties that are located in their  designated areas for 2 days after the grantee is notified that an  appraisal has been obtained.

Good Neighbor Next Door. Under this program, properties in  revitalization areas can also be offered to police officers, teachers, fire  fighters, and emergency medical technicians at 50 percent off of the  list price. $1 Home Sale. Sales of “aged inventory” (properties listed for sale for  more than 6 months) can also be made for $1 plus closing costs to  local governments to support local housing and community  development initiatives.

section_title: FHA’s Returns on REO Sales Slightly Lagged Those of the Enterprises and Dispositions Took Substantially Longer to Complete
paragraphs: FHA’s returns from selling its REO properties generally have trailed the  returns of the two enterprises but its performance has improved recently.  FHA also took longer to dispose of properties than the enterprises but  showed recent improvement in this area. Each of these entities achieved  better results when conducting retail sales of individual properties than  when using other disposition methods and when selling properties to  owner-occupants rather than to investors and other buyers. All of the  entities, including private REO servicers, that we interviewed assessed  their performance in disposing of REO properties using a variety of  metrics. For example, execution rates gauge success in maximizing a  property’s sale prices. They can be calculated by comparing either a  property’s gross sales price or net sales proceeds with some measure of  the property’s value, such as an assessed value from an independent  appraiser or the price at which the property was listed for sale.  Properties that sell for larger percentages of the assessed value or listed  price generate higher returns for the seller. We analyzed data from REO  properties disposed of from January 2007 through June 2012 to  determine FHA’s and the enterprises’ net execution rates based on  independently assessed value, which represents the entities’ net sales  proceeds as a percentage of those values. Our analysis showed that  the aggregate net execution rate for FHA was 4 and 6 percentage points  lower depending on the enterprise (see fig. 4).

To account for the possibility that the performance differences were  attributable to differences in the property characteristics of each of these  entities’ REO inventories, we developed a regression model to control for  the effects on the net execution rates of certain property characteristics— such as location, value, and local real estate market conditions—that  were beyond the entities’ control. Based on this analysis, we estimate that  FHA’s aggregate independently assessed value net execution rate still  trailed that of the enterprises by 2 and 5 percentage points.

Similarly, FHA’s aggregate net execution rate based on initial list prices  for the entire period was worse than enterprise 2’s and enterprise 1’s by 3  and 6 percentage points, respectively, as shown in figure 5. After  controlling for the effects of certain property characteristics—as we did for  the independently assessed value net execution rate—we estimate that  FHA’s net execution rate based on initial list prices was less than that of  enterprise 2 and enterprise 1 by 2 and 4 percentage points, respectively.

When comparing aggregate execution rate performance based on gross  sales prices rather than net sales proceeds, the difference between FHA  and the enterprises widened slightly for both independently assessed  values and initial list prices. Both FHA’s net and gross execution rates  improved relative to the enterprises during the first half of 2012 and for  the list price ratio, FHA’s performance was equal to that of the  enterprises.

Although the difference in aggregate net sales returns between FHA and  the enterprises over the entire period was 6 percent or less, a small  improvement in performance can yield substantial amounts of additional  revenue because FHA disposes of tens of thousands of properties each  year. For example, if FHA had achieved a similar net execution rate  based on independently assessed value as enterprise 2, it would have  received over $400 million in additional revenue for 2011 alone. And if  FHA’s aggregate net execution rate for 2011 had been 1 percentage point  higher, FHA would have received over $90 million in additional revenue.

FHA took significantly longer to sell its properties than the enterprises and  VA, but the differences decreased in the first half of 2012. For each  entity, we analyzed the time in days that elapsed between the date of the  foreclosure sale of the property to the closing date of the REO sale.  Based on this analysis, FHA took on average about 340 days from the  foreclosure sale to sell its REO properties based on dispositions from  January 2008 through June 2012, compared with just over 200 days for  the enterprises and about 270 for VA (fig. 6). This difference between  FHA and the enterprises in average REO timelines persisted after  controlling for the average effects of certain property characteristics such  as location, value, and local real estate market conditions.

Longer disposition times can create additional costs for items such as  taxes, insurance, home owners’ association fees, maintenance costs, and  other expenses (holding costs) and leave properties exposed to an  increased risk of vandalism and other property damage. We found that if  FHA’s average number of days from foreclosure sale to REO disposition  had equaled those of the enterprises, it could have avoided around $600  million in extra holding costs for 2011 alone. Furthermore, the negative  impact of vacant properties on neighborhoods and property values has  been identified in prior GAO reports and other sources, underscoring the  importance of minimizing the amount of time required to dispose of  properties after the foreclosure sale.

The differences in the length of time FHA took to dispose of REO  properties relative to the other entities was largely attributable to  differences in one specific period—the time from the foreclosure sale until  the date of the initial REO valuation. FHA and the other organizations  obtain the initial value assessment once a property is ready to be listed  for sale and marketed to potential buyers. The assessment is typically  made after the expiration of any redemption period after the foreclosure  sale and any necessary eviction action, as well as cleaning, maintenance,  and repair of the property. FHA’s average for this period was 184 days,  while the enterprises’ averages were 69 (enterprise 1) and 66 days  (enterprise 2). As discussed previously, FHA acquires its REO  properties from mortgage servicers at a later date after the foreclosure  sale than the enterprises and other entities. Having multiple entities  complete its postforeclosure sale activities, such as eviction, could be one  reason that FHA’s average time from foreclosure to initial valuation was  longer than the times for the other entities. As we stated in our 2002  report on FHA’s process for selling REO properties, the enterprises, VA,  and RHS have one entity that is responsible for the custody,  maintenance, and sale of foreclosed properties, but FHA divides these  responsibilities among its mortgage servicers and REO contractors, all of  which operate largely independently of one another. This divided  approach to property custody could delay the initiation of critical steps  necessary to sell REO properties quickly. As a result, in 2002 we  recommended that HUD establish unified property custody as a priority  for FHA and that it determine and implement the optimal method for  establishing unified property custody. In their response at the time of the  report, HUD said that it agreed that a unified custody approach may  streamline processes and oversight, reduce holding time, and increase  net return. HUD also said that the agency intended to continue research  to determine the feasibility of unified custody within the framework of  existing statutory requirements and explore statutory changes that would  increase efficiencies in the property disposition program. However, HUD  subsequently determined that it would not be advisable for the agency to  establish unified property custody as an objective for the agency and it  did not implement our recommendation. The analysis in this report once  again highlights the need for FHA to consider whether the potential  benefits from unified property custody, such as shorter REO disposition  timelines and lower holding costs, outweigh any costs and challenges  associated with acquiring REO properties from servicers closer to the  foreclosure sale date.

Once the initial value assessment was completed, it took FHA an average  of 168 days to sell a property, which was more comparable to the  enterprises’ average timelines of 142 and 132 days. And in the first half of  2012, FHA had a shorter average time from initial valuation to completed  REO sale than the enterprises, as shown in figure 7.

Some of this difference may be due to the time taken to list a property for  sale. From January 2008 through June 2012, FHA took an average of 32  days to list a property for sale after receiving the value assessment,  compared to 13 days for enterprise 1 and 24 days for enterprise 2. In the  first half of 2012, however, FHA’s average had fallen to 18 days.  Similarly, FHA took slightly longer to sell its properties once they were  listed—an average of 136 days compared to 119 for enterprise 1 and 118  for enterprise 2. But in the first half of 2012, FHA’s average time from  listing to sale was shorter than the enterprises’. FHA officials indicated  that its lagging performance prior to 2012 may have been due, at least in  part, to limitations in their ability to adjust the level of homeownership  center staff resources in response to increases in inventory that occurred  in the years prior to 2012. FHA’s recent performance relative to the  enterprises may also reflect continued progress in implementing its new  M&M III contractor program structure that began in the middle of 2010.

We tested certain factors that were to some degree under FHA’s and the  enterprises’ control to explore whether these factors helped to explain the  differences in REO disposition performances. We included these factors  (time from foreclosure sale to REO disposition, ratio of initial list price to  initial valuation amount, disposition method, and buyer type) in additional  regression models to determine whether their inclusion significantly  changed the results. These models indicated that the length of time from  the foreclosure sale to the REO sale was associated with FHA’s lower net  execution rate relative to the enterprises. Specifically, when our  regression models included the time from the foreclosure sale to the REO  sale, FHA’s relative performance deficit in terms of the independently  assessed value net execution rate was eliminated completely. Such a  result indicates that the longer time FHA requires to acquire and sell  properties could be an important factor in explaining differences in  execution rate performance. However, an actual causal relationship is  difficult to isolate and prove, as additional factors—such as deteriorated  property conditions or variations in market conditions within ZIP code  areas—that were not incorporated into our regressions could also explain  both the performance difference and the difference in the average total  disposition time between FHA and the enterprises.

Aligning with their stated preferences for retail sales, the predominant  share of FHA’s and the enterprises’ REO property dispositions were  through retail sales of individual properties to owner-occupants or  investors (fig. 8). From January 2007 through June 2012, retail sales  were about 97 percent of FHA’s dispositions, about 99 percent of  enterprise 1’s, and 91 percent of enterprise 2’s. Enterprise 2 had the  highest share of bulk and auction sales over the time period, representing  almost 7 and 2 percent of its total dispositions, respectively. Less than 4  percent of FHA’s dispositions from January 2007 through June 2012, on  average, were for programs related to its housing mission goals (e.g.,  discounts and donations). Dispositions through the enterprises’ programs  that market properties to nonprofits and public entities (e.g., discounts  and donations) accounted for less than 0.5 percent of total dispositions  from January 2007 through June 2012.

Retail sales also generated higher returns than other disposition methods.  For example, FHA’s independently assessed value and initial list price  execution rates (net sales proceeds as a share of property values or list  prices) were both 30 percent higher for its retail sales than for its mission  program dispositions for sales from January 2007 through June 2012.  The enterprises, particularly enterprise 2, also generally had higher  execution rates for retail sales than other disposition methods over the  same period. Specifically, enterprise 2’s independently assessed value  execution rate for retail sales was 52 percent higher than for its auction  sales, 95 percent higher than for its bulk sales, and 62 percent higher  than for its nonprofit and public entity sales. For enterprise 1, retail sales  were 36 percent, 40 percent, and 1 percent higher, respectively, than  sales using these methods.

We also examined FHA’s performance in selling REO properties to  different types of buyers. Our analysis of data for all dispositions from  January 2007 through June 2012 showed that FHA achieved higher  returns on sales to owner-occupants than on sales to investors and other  buyers, although it had a smaller share of these types of dispositions than  the enterprises. FHA’s independently assessed value and initial list price  net execution rates both were 25 percent higher for sales to owner- occupants than for sales to nonowner-occupant investors. The  enterprises experienced smaller return premiums—ranging from 10 to 19  percent—from owner-occupant sales as measured by these sales return  measures.

FHA’s and the enterprises’ overall returns on owner-occupant sales were  generally comparable. Specifically, FHA’s net execution rate based on  independently assessed value was the same as enterprise 1’s and four  percentage points less than enterprise 2’s. Based on initial list price,  FHA’s net execution rate was 2 percentage points less than enterprise 1’s  and the same as enterprise 2’s. Yet FHA sold a smaller share of its  properties to owner-occupant buyers than the enterprises. Specifically,  about 58 percent of FHA’s sales from January 2007 through June 2012  were to owner-occupant buyers, compared to 63 and 68 percent for the  enterprises. FHA’s share of owner-occupant sales increased to about 64  percent in the first half of 2012. Figure 9 shows FHA’s and the  enterprises’ percentage of REO property sales to owner-occupants,  based on our analysis of data from sales of REO properties from January  2007 through June 2012.

Properties that FHA sold to owner-occupants also had higher average  sales prices and were sold more quickly than properties that were sold to  other buyers. For example, the average price of FHA’s sales to owner- occupants from January 2007 through June 2012 was more than  $77,000, compared to less than $50,000 for sales to nonowner- occupants. Likewise, it took FHA an average of 42 fewer days to dispose  of properties sold to owner-occupants during the same time period than  were needed to complete sales to investors and other buyers, as  measured from the foreclosure sale date. The average sale prices of the  enterprises’ owner-occupant sales were around twice the average  amount of their sales to investors and other buyers, but the timelines  were similar for both types of sales.

Results from our regression models also indicated that the type of buyer  was associated with FHA’s lower independently assessed value net  execution rate—which gauges success in maximizing a property’s sale  price. When we controlled for differences in the share of sales to owner- occupants in our regression models, FHA’s performance deficit relative to  the enterprises for independently assessed value net execution rate was  reduced. However, this association does not necessarily mean that this  factor caused the performance difference. For example, additional  factors—such as deteriorated property conditions or the existence of  certain amenities that might attract owner-occupants—that were not  controlled for in our regressions could also explain the differences in  performance and share of owner-occupant sales between FHA and the  enterprises.

Based on our analysis of all dispositions from January 2007 through June  2012, the enterprises repaired more properties than FHA and  experienced higher returns than on properties that they did not repair.  Our review of data for all REO dispositions during this period showed that  the enterprises spent at least $1,000 on repairs for 29 percent (enterprise  1) and 23 percent (enterprise 2) of the properties they sold. FHA,  however, spent at least that amount on only about 5 percent of its  properties. Based on our analysis, we found that properties repaired by  the enterprises netted higher independently assessed value net execution  rates, after accounting for repair costs, and also achieved higher list price  net execution rates. Specifically, the enterprises’ net execution rates  based on independently assessed value—including the cost of repairs— were 3 to 4 percentage points higher over the entire period for properties  with at least $1,000 in repair costs than for properties with repair costs  less than that amount. The difference for the net execution rate based  on list price over the entire period was 3 percentage points for each of the  enterprises. However, the enterprises’ properties with at least $1,000 in  repair costs sold an average of 33 to 47 days more slowly than properties  with lower repair costs, as measured from the initial valuation date. These  differences may reflect the time required to complete repairs or a greater  willingness to market the property for a longer period.

Our analysis also showed that FHA netted higher returns on sales of REO  properties that were in better condition—that is, that met minimum  property standards to qualify for FHA insurance. To be eligible for an  FHA-insured loan, a property must be in a condition and location free of  known hazards and adverse conditions that could affect occupants’ health  and safety or the structural soundness of any improvements or that could  impair the use and enjoyment of the property. For example, FHA requires  properties to have adequate heating, hot water, and electricity. Based on  our analysis of data for all REO dispositions from January 2007 through  June 2012, FHA received higher sales returns for properties that were  eligible for FHA insurance (eligible) than it did for properties that were  deemed ineligible because their condition did not meet these standards  (ineligible). FHA’s independently assessed value net execution rate was  12 percentage points higher for eligible properties than for ineligible  properties for all dispositions during this period. Furthermore, eligible  properties sold faster than ineligible properties, which took an average of  88 additional days—26 percent longer—from the foreclosure sale date to  sell.

FHA staff told us that while they generally did not repair REO properties  to increase the sale value, some properties are repaired to address health  and safety concerns and to preserve the property’s condition. FHA  officials also noted that while the agency might conduct these types of  repairs when necessary, FHA does not repair properties specifically to  meet its minimum property standards. FHA officials explained that FHA  had a long-standing policy of not repairing properties. They said that the  agency does not conduct repairs because of concerns about having to  oversee contractors that perform the work and HUD’s inability to obtain  volume discounts on replacement appliances or other home fixtures  because of the agency’s preference for using small contractors. They also  said that having to comply with HUD procurement guidelines and the  Davis-Bacon Act made it more difficult for FHA to engage in construction  projects to repair properties and increase sale returns. However,  officials noted that in 2011 FHA had begun a small pilot program in its  Atlanta homeownership center to assess the impact of repairs on  properties’ marketability. This program selected favorable properties— that is, relatively high-quality properties in a few counties in the Atlanta  metropolitan area—to repair and officials indicated that results had  generally been positive. The pilot involved about 50 completed sales and  around 80 additional properties as of September 2012, according to FHA  officials. However, the officials also said that FHA had not analyzed the  sale prices of the repaired properties to determine whether it was  achieving higher returns than it could achieve without conducting repairs.  Additionally, one FHA official expressed concern that the existing policy  not to repair properties prevented FHA from capturing the additional  returns that can come from selling repaired properties for higher prices.  Instead, the official said that selling properties without making repairs  intended to increase the sale value allowed investors to purchase them,  make the repairs, and capture the additional returns.

Similarly, VA and RHS staff said that their agencies generally did very few  repairs to REO properties and that most generally were sold without  repairs intended to increase the sale value, largely because repairs did  not generally result in higher returns. In some cases, VA has conducted  minor (cosmetic) repairs in order to improve returns, according to VA  staff. However, staff noted that in general the costs associated with  making these repairs have not been fully recovered by the eventual sale  proceeds. They further noted that some cosmetic repairs—such as fixing  windows, painting, or installing new carpeting—may increase sale  returns, but major repairs often reduced returns, at least in part because  of the additional costs of repairs and holding the property longer. The VA  officials told us that a few years ago they conducted a small case study of  repair work done for six properties and found no positive result from doing  the repairs. RHS officials also said that RHS did not make repairs for the  majority of its direct loan REO properties unless repairs were needed for  safety. For properties in its guaranteed loan program, RHS generally has  not had lenders complete cosmetic repairs but may consider repairs to  increase returns on a case-by-case basis. RHS officials also said that  lenders completed repairs on guaranteed properties for safety reasons  and to preserve and protect the property.

In contrast to FHA, VA, and RHS direct loan properties, the enterprises  and the three private mortgage servicers we contacted did make case-by- case determinations on conducting cosmetic repairs to improve returns,  increase the likelihood of an owner-occupant purchase, or meet  neighborhood standards. Officials from these entities said that they did  repairs on between about 20 to 40 percent of their REO properties,  although staff from one of the private mortgage servicers indicated that  they had been repairing up to 80 percent of their properties due to the  lengthy foreclosure process. One of the enterprise’s officials told us that it  had been repairing more REO properties as a way to improve the impact  on neighborhoods as well as to earn the highest possible return. For  example, the officials said that about 80 percent of repaired properties  were sold to owner-occupants compared to about 50 percent of  unrepaired properties. They also explained that repair decisions were  based on numerous factors, including neighborhood conditions, potential  buyers, and the costs of the repairs. As the length of time that an unsold  property remains on the market increases, the enterprise may reassess  the repair decision to see if performing repairs could add value and  facilitate a sale. Officials also said that the enterprise repaired properties  based on expected returns, regardless of value. The other enterprise also  makes decisions on whether and to what extent to do repairs on a  property-by-property basis, primarily to increase returns, according to  staff. This enterprise’s staff said that they viewed repairing properties as a  way to maximize the properties’ value and increase the chances of selling  them to owner-occupants. They said that the enterprise also tried to  ensure that properties conformed to neighborhood standards and were  competitive with other properties for sale in the area. In some areas  where the potential for vandalism was high, they said that the enterprise  would be less likely to make repairs early in the REO process but would  complete them just prior to closing.

Among the goals that FHA staff described for the agency’s REO  disposition program were maximizing net returns to the mortgage  insurance fund and increasing home ownership, but FHA may be failing  to take advantage of the opportunity for increased financial returns by not  repairing more properties. FHA’s policy to limit repairs only to those  related to health and safety concerns may in part explain why it sells  fewer properties to owner-occupants than is the case for the enterprises.  Repairing properties only to address health and safety concerns would  not necessarily result in a property that meets standards for FHA  eligibility, and as a result FHA may be selling fewer properties to owner- occupants, many of whom may be interested in FHA loans. As we have  shown, FHA’s sales of eligible properties yield higher returns than those  that are not in an eligible condition. If FHA repaired ineligible REO  properties to make them eligible, the agency might be able to realize  higher sales returns, avoid the holding costs related to the longer  disposition time frames for ineligible properties, and further its mission of  increasing home ownership.

section_title: FHA Uses a Single Assessment of Market Value in Setting List Prices, but Other Entities Use Multiple Sources
paragraphs: FHA uses only one input to set list prices—an appraisal, or professional  appraiser’s estimate of the property’s fair market value based on market  research and analysis as of a specific date. Other entities use additional,  generally accepted methods for establishing a listing price for their  properties, including obtaining an estimate from a real estate broker— known as a broker’s price opinion (BPO). BPOs are estimates of the  market value of a particular property prepared by a real estate broker,  agent, or sales person. In addition, market values for properties can also  be estimated using automated valuation models (AVMs), computerized  programs that estimate property values using proprietary and public data,  such as tax records and information kept by county recorders and  multiple listing services, and other real estate records.

FHA’s marketing contractors set REO property list prices at the appraisal  value, although their marketing contractors also have access to BPOs.  FHA’s regulations require the use of an independent appraiser when  setting a price for an REO property, and FHA staff told us that properties  typically are listed at the appraised value. Based on our review of  property dispositions from January 2007 through June 2012, the list  prices of more than 98 percent of FHA’s properties equaled the appraised  market value. However, FHA field staff told us that the agency’s  marketing contractors often also ordered BPOs to evaluate and review list  prices and were required to obtain BPOs when requested by FHA. These  additional valuations are not used to change the list price; however, FHA  staff said that the listing brokers used BPOs to evaluate and support list  price reductions when properties did not sell. Staff from one of FHA’s four  homeownership centers noted that its marketing contractors often have  properties’ listing brokers complete a BPO during the listing process to  assess the accuracy of the appraisal value used in setting the list price.

These staff said that if the BPO value differed greatly from the appraisal  value, the marketing contractor might discuss the valuation with the  appraiser and request that the value be reconsidered. Although they said  that they could only recall one or two instances of appraisers changing  their valuations after these discussions, the staff at this office considered  comparing the appraisal value to a BPO value to be an effective practice  on a case-by-case basis. A review of the plans of selected marketing  contractors showed that contractors were to obtain BPOs during the  listing process and also when considering subsequent list price  reductions. For example, some contractors’ marketing plans called for an  initial BPO when the property was listed for sale and every 30 days  thereafter as a way to evaluate the appraised value and appraiser  performance and to analyze market data. The contracts between FHA  and its marketing contractors also state that the contractor must obtain an  independent BPO when directed by FHA staff.

In contrast, the enterprises, VA, RHS, and the three private mortgage  servicers we interviewed all use at least two methods—either an  appraisal and BPO or two BPOs—to estimate the market value of their  REO properties as part of determining a list price. The enterprises also  use an AVM to provide an additional value estimate and incorporate  additional information and analysis beyond the supplemental valuation  information into their list price decisions. For example, the enterprises  produce list price guidance based on factors such as location, market  conditions, comparable sales, REO sales trends, and input from listing  agents. Following this guidance, the enterprises may set a list price above  or below the estimated market value based on whether the property is  located in a depreciating or appreciating market. For property dispositions  from January 2007 through June 2012, one enterprise set the initial list  price for less than 1 percent of its properties at the independent BPO  value, and 28 percent were within 5 percent of the BPO value. The other  enterprise set initial list prices at the appraised market values for fewer  than 10 percent of the REO properties that it disposed of during this  period, and 28 percent of initial list prices were within 5 percent of the  appraised value.

Using multiple information sources could improve the accuracy of FHA’s  market value estimates and list prices. Officials from other federal  housing agencies and the enterprises said that multiple inputs increased  accuracy by providing a range of independently valued assessments.  Providers of appraisals and BPOs use different approaches to valuing  properties and combining the two methods produces the best results,  according to officials from some entities. For example, appraisals are to  be conducted by trained and certified independent professionals with no  interest in the outcome of the sales, but these appraisals focus on past  sales and listings and may not reflect current price trends. BPOs,  although conducted by brokers who may have an interest in the outcome,  may reflect more knowledge of the properties and local markets. In  addition, appraisers may have difficulty finding comparable property sales  in some rural areas, and officials said that appraisals are more costly to  obtain than BPOs. If estimates from different sources vary, entities  reconcile them to produce a market value estimate that reflects a broader  and more diverse base of information and analysis than an estimate from  a single source. Our analysis of the enterprises’ reconciled value  estimates—which incorporate all of their market value inputs such as  appraisals, BPOs, and AVMs—indicated that the reconciled values  generally were lower than independent value assessments reflecting a  single source such as an appraisal or BPO and accordingly reflected final  sale prices somewhat more accurately. For all dispositions from January  2007 through June 2012, the enterprises’ reconciled value estimates  were closer to gross sale prices than their independent value  assessments were by 1 and 7 percentage points overall.

The use of multiple valuation methods could help FHA more accurately  estimate the market values of its REO properties, increasing the  likelihood of selling properties more quickly and at prices that best reflect  current market conditions. FHA officials indicated that BPOs and AVMs  could reduce costs and increase the accuracy of FHA’s market value  assessments by better reflecting recent market trends. A senior official  from FHA’s single family housing program also said that using AVMs  could improve FHA’s ability to identify the most appropriate marketing and  disposition strategies for certain properties by providing more accurate  and timely market value estimates. In early 2013, FHA’s Santa Ana  homeownership center began a pilot program to evaluate the use of  AVMs in validating appraised market values, according to agency  officials. The officials explained that the pilot program uses a model that  incorporates results from multiple AVMs to assess the independent  appraisals. They said that the model has helped to identify opportunities  for FHA to increase list prices based on market analysis. The officials also  said that they were considering other options to establish accurate list  prices and reduce risks from appraised market values that were  unnecessarily low relative to market conditions. They stated that FHA was  working with HUD’s Office of General Counsel (OGC) to determine if the  regulatory requirement that list prices be based on an appraisal allowed  them to be based on multiple sources that include an appraisal rather  than solely on the appraised market value.

section_title: FHA’s Use of Nonmarket- Based Price Reductions Differs from Other Entities’ Practices and May Contribute to Lower Returns
paragraphs: FHA generally did not take into account market conditions when reducing  the list prices for REO properties that do not sell. FHA’s marketing  contractors determine when and by how much the list prices should be  reduced. FHA’s marketing contractors create plans for each of the  geographic contract areas in which they operate that describe how they  intend to market and sell FHA properties and submit these plans to FHA’s  homeownership centers for approval. The marketing plans include a  schedule identifying time frames and percentage thresholds for reducing  list prices. For example, a schedule might indicate that for properties that  have been listed for sale for between 30 to 60 days, the list price should  be set at 90 percent of appraised value. These schedules vary by  marketing contractor and FHA homeownership center. For example, the  schedules’ quantitative thresholds for the amount and timing of price  reductions can differ, although most plans use one of two standard  amounts. Some schedules describe a reduction of “up to” a certain  percentage of the appraised value or current list price, while others  specify that properties will be listed for an amount “no less than” a  percentage of the appraised value or current list price. Our analysis of  each of the 23 marketing plans used by FHA’s marketing contractors  showed that all but one used a schedule for price reductions.

However, FHA lacks a clear and consistent policy for how price  reductions should be conducted, allowing each of its homeownership  centers to approve marketing contractors’ plans for reducing list prices.  FHA headquarters and homeownership center officials whom we  interviewed differed on the extent to which price reductions required  review and approval by FHA staff. Officials from FHA’s headquarters said  that marketing contractors had to provide supporting documentation to  justify why a price reduction was necessary and receive prior approval  from homeownership center staff for all proposed reductions, even if they  were following a schedule. However, officials we spoke with at each of  the centers said that their marketing contractors typically did not need and  did not obtain prior review and approval from FHA staff as long as they  followed the approved price reduction schedules in their marketing plans.  They added that marketing contractors only needed to provide  documentation to FHA homeownership center staff and receive  homeownership center approval for price reductions that exceed  marketing plan thresholds. Further, staff from homeownership centers  described to us different practices that they followed when considering  price reductions in excess of marketing plan schedules. For example, the  Atlanta and Denver offices allowed exceptions to the schedule for  individual properties, but the Santa Ana office does not allow any price  reductions in excess of the schedule, according to staff.

Analysis of FHA’s REO property dispositions indicated that marketing  contractors generally followed the price reduction schedules  systematically when reducing properties’ list prices. To assess the extent  to which list price reductions on FHA’s properties followed these  schedules, we analyzed list price data from FHA’s REO property  dispositions from June 2011 through June 2012 and compared the price  changes to the schedules in contractors’ marketing plans. Based on this  analysis, we found that almost half of the properties that FHA sold over  the period had at least one price reduction. Of these, about 75 percent of  the initial reductions were for a scheduled amount. Most price reduction  schedules based this amount on one of two specific percentages.

Only one of FHA’s four homeownership centers—Denver—preferred its  marketing contractors to base list price reductions on evaluations of  market conditions rather than on a schedule. Denver center officials said  that they encouraged marketing contractors to base price reduction  decisions on evaluations of individual property-level market data. The  Denver center also requires its marketing contractors to provide  supporting documentation for all price reductions on REO properties, and  its staff review the documentation for a small sample of these reductions,  according to officials. Furthermore, one contractor’s price reduction  schedule for the Denver center included a threshold range for price  reductions rather than a specific percentage. One marketing contractor in  the region did not have a price reduction schedule in its marketing plan  and instead analyzed market conditions, the appraisal, and other  information to determine a new list price.

None of the marketing contractors in the other centers used a range for  price reductions or had marketing plans that did not include a price  reduction schedule. Officials from one homeownership center indicated  that automated reductions were easier, quicker, and required fewer  resources. Those from another center noted that following such  reductions helped to find the right price in a structured fashion. In  contrast, officials from the Denver center identified several disadvantages  to using systematic price reductions and said that they attempted to have  the schedules removed from contractors’ marketing plans at the  beginning of the M&M III program. However, they explained that officials  at FHA headquarters at that time strongly resisted the change. Although  differences in disposition performance cannot be attributed solely to  pricing practices, the Denver homeownership center performed better  both in terms of sales returns and speed of sales than either the  Philadelphia or Atlanta centers even when we controlled for regional  differences, as we discuss later in the report. And compared to the  enterprises’ performance in the states where each center operates, the  Denver center’s performance compared more favorably with the  enterprises’ performance than did that of the other centers, which lagged  the enterprises.

While homeownership centers generally reduced REO properties’ list  prices with similar frequency, some differences existed in the degree to  which contractors’ price reductions followed marketing plan schedules.  Based on our analysis of data on all property dispositions from June 2011  through June 2012, each of the homeownership centers reduced prices  for close to the overall average of 47 percent. However, the Denver  center reduced prices by scheduled amounts less frequently than the  other centers, consistent with its preference that contractors base price  reduction decisions on evaluations of market conditions. For example,  almost 90 percent of the Santa Ana center’s initial price reductions were  for a scheduled amount, compared with 58 percent for the Denver center.  The Atlanta and Philadelphia centers had figures of 81 percent and 76  percent, respectively.

Other federally related housing entities with REO inventories generally  based their decisions to reduce prices on evaluations of property-level  information and market conditions. According to officials from the  enterprises and VA documents that we reviewed, these entities used  individual assessments of market conditions rather than predetermined  schedules when considering the timing and amount of list price revisions.  These entities also defined thresholds to identify when reductions  required additional levels of approval. RHS follows a schedule for its  direct loan program, but agency officials acknowledged limitations with  this approach including a lack of flexibility. Market participants that we  interviewed, including real estate brokers, an industry consultant, and a  nonprofit organization, identified disadvantages with systematic price  reductions, such as the potential for interested buyers to adjust the timing  and amount of their bids in anticipation of a discounted price. The limited  use of price reduction schedules may provide certain advantages by  establishing clear benchmarks for determining when to evaluate a  property’s market situation and which reduction amounts should require  review and approval by FHA staff. However, reducing list prices based  solely on a schedule may lower prices at times and by amounts that are  not optimal, potentially lowering FHA’s net return. For example, a property  whose list price is reduced excessively or hastily may sell at a price that is  unnecessarily low based on market conditions, leading to lower returns  for FHA. Also, mispriced properties may take longer to sell thereby  increasing FHA’s holding costs. In contrast, a strategy of basing price  reductions more comprehensively on evaluations of property-level  information and market conditions would likely be more flexible and could  provide more accurate prices. Further, because many marketing  contractors already obtain BPOs and other assessments of market  conditions and are sometimes required to do so, such an approach would  likely not involve significant costs for FHA.

section_title: FHA Could Further Improve Its Monitoring and Evaluation of REO Contractors
paragraphs: FHA does not have a current and complete set of policies and procedures  for its current REO disposition program as required by internal control  standards. Federal internal control standards require agency  management to conduct monitoring of program quality and performance  through the establishment and review of performance measures and  indicators. Under the new contract structure that FHA introduced in 2010,  the agency intended that its staff conduct specific activities to assess  whether its contractors were meeting minimum requirements under the  contracts, but these reviews have not been occurring. Further, while FHA  is in the process of implementing procedures to better ensure that FHA  homeownership centers perform consistent oversight activities, it has not  implemented a critical component of the plan—a scorecard to evaluate  contractor performance against standard metrics that would allow it to  compare the quality of its contractors’ activities. Our review also showed  that FHA was not conducting as many or as frequent in-person property  inspections as other entities that dispose of REO properties and that it  was not taking steps to determine that listing brokers were located  sufficiently close enough to the properties they were selling to ensure  local market knowledge. Finally, although assigning work to contractors in  part on the basis of their performance was intended to have been a key  quality assurance mechanism under the new contract structure, FHA has  encountered various obstacles to implementing this condition.
subsections: section_title: FHA’s Lack of Current Policies and Procedures for REO Disposition May Create Inefficiencies
paragraphs: FHA does not have a current and complete set of policies and procedures  for its current REO disposition program, as required by internal control  standards. These standards require formally documented policies and  procedures that are clear and readily available. Such materials can be  used to provide guidance to staff in the performance of their day-to-day help ensure that activities are performed consistently across an help ensure that the agency complies with federal laws and  agency,  communicate management’s directives, and  regulations.

These control standards require that policies and procedures be reviewed  regularly and updated when necessary. In keeping with these  requirements, the enterprises have well-documented policies and  procedures for their REO disposition programs. One of the enterprises  has consolidated its guidance and expectations for its staff and  contractors in a single, comprehensive guide that it updates as needed.

The other enterprise does so using multiple documents that are  accessible from a single location.

However, while FHA has an REO Disposition Handbook that outlines  policies, procedures, and key controls for REO activities, the agency has  not updated the handbook since 1994. FHA describes the Disposition  Handbook’s objectives as providing comprehensive guidance that reflects  program requirements and that stresses the importance of internal  controls, incorporates fiscal procedures, and provides clear statements of  policy for field office staff. However, the handbook does not reflect the  current structure, processes, or requirements that FHA uses to dispose of  properties. Nevertheless, FHA’s contracts reference it as a source of  applicable guidance. FHA headquarters staff told us that the disposition  handbook was outdated and did not reflect the current REO program  structure, including the use of the multiple types of contractors and their  responsibilities. But staff from one FHA homeownership center told us  that they continued to use the handbook for policy guidance in certain  areas, such as broker registration, contract extensions, rental  agreements, and the closing agent monitoring checklist.

Instead of updating its Disposition Handbook, FHA relies on mortgagee  letters, housing notices, and contracts to document its current policies  and procedures. FHA headquarters staff told us that they had not taken  steps to update the program handbook and that they used these letters  and notices to provide new and revised guidance to their staff and  contractors. FHA officials also indicated that the terms of its contracts with  service providers served to document the REO process and performance  expectations. However, as mentioned earlier, these contracts refer to the  outdated Disposition Handbook as a source of reliable guidance. Also,  using multiple contracts rather than a single consolidated document as a  source of policies and expectations for staff and contractors creates the  potential for inconsistencies. In addition, FHA has a decentralized REO  disposition process managed through four homeownership centers,  underscoring the need for a single source of guidance on policies and  procedures for headquarters and field staff. FHA’s contractors may have  multiple contracts overseen by different centers, and in a February 2013  report, HUD’s Office of the Inspector General (OIG) found that one of  FHA’s REO contractors faced different procedural requirements across  the various HUD operating regions in which it was active. According to  HUD OIG staff, they had also found a lack of consistent expectations for  contractors across homeownership centers. For example, some centers  were requiring maintenance contractors to pay any homeownership  association fees and other unpaid bills before sale closings, but other  centers expected marketing contractors to make these payments. In  some cases, FHA faced delayed sales closings for failing to pay these  fees on a timely basis.

Lack of consistent and updated guidance on policy and procedures may  also make oversight of contractors less efficient and may increase the  REO program’s operating costs. FHA staff in two homeownership centers  told us that they spent significant amounts of time responding to policy  inquiries from contractors and seeking answers to questions about policy  within the agency. Staff from one of these homeownership centers  indicated that more guidance on policy matters would be beneficial and  said that they needed additional support for procedures. The lack of a  single, up-to-date form of guidance for the REO program leaves FHA  without important internal controls, has resulted in extra costs in time and  resources for FHA staff, and has created a burden for some contractors  who face differing requirements across regions.

Further, the lack of consistent guidance may be a factor in the execution  rate performance of the four homeownership centers. For instance, some  centers may be using practices that increase contractor performance that  other centers have not tried. As discussed previously, our analysis of  FHA’s property dispositions revealed differences in performance levels  across its homeownership centers. For instance, aggregate sales returns  based on independently assessed value and list price execution rates for  all properties disposed from January 2007 through June 2012 were 13  and 12 percentage points higher for the Santa Ana and Denver centers  than for the Philadelphia center and 7 percentage points higher than for  the Atlanta center. Each year within the overall period showed similar  patterns with the Santa Ana and Denver centers typically having higher  execution rates than the Atlanta and Philadelphia centers. Even after  controlling for the average effects of certain property characteristics, such  as value and changes in local housing prices, Santa Ana and Denver had  higher execution rates than Atlanta and Philadelphia.

Because regional housing market differences could affect performance of  the homeownership centers even after controlling for certain property  characteristics, we compared the performance of the homeownership  centers with the performance of the enterprises in the states where each  center operates. For all dispositions from January 2007 through June  2012, the Denver center’s aggregate independently assessed value net  execution rate was comparable to that of the enterprises in the states  where it was responsible for REO property dispositions. The Santa Ana  and Atlanta centers lagged the enterprises by 2 to 6 percentage points for  dispositions in their respective states, while the Philadelphia center  lagged the enterprises by 8 and 11 percentage points (fig. 10). After  controlling for the average effects of certain property characteristics, such  as value, ZIP code, and changes in local housing prices, differences in  the homeownership centers’ performance relative to the enterprises  generally persisted. However, Santa Ana’s performance decreased while  Philadelphia’s increased such that their performance differences relative  to the enterprises were similar. Denver’s performance declined slightly  but remained comparable to that of the enterprises and the Atlanta  center’s performance improved but still lagged that of the enterprises.

The average number of days to complete an REO disposition from the  date that FHA acquired properties also varied, from 164 for the Denver  center to 212 for the Philadelphia center for all dispositions from January  2008 through June 2012. Other time frames—such as from the initial list  date to the completed sale—also illustrated performance differences  among the homeownership centers, as did the results for individual years.  Even after controlling for the average effects of certain property  characteristics, such as value and changes in local real estate prices,  these differences persisted. Because regional housing market differences  also could affect the time required to dispose of properties, we compared  the homeownership centers’ time frame performance with that of the  enterprises in the states where the centers operate. For all dispositions  from January 2008 through June 2012, the Denver center’s average  number of days from a property’s initial valuation to the completed REO  sale was generally equivalent to that of the enterprises. The Santa Ana,  Atlanta, and Philadelphia centers, in order, took longer to sell properties  than did the enterprises in the states in which they operate (fig. 11). After  we controlled for the average effects of certain property characteristics,  such as value, ZIP code, and changes in local housing prices, the  average number of days from initial valuation to completed sale for each  of the homeownership centers generally exceeded that of the enterprises  to an even greater extent. The Denver center exceeded the enterprises  by the least number of days, while Philadelphia exceeded the enterprises  by the most.

Returns on sales of FHA’s REO properties also varied across marketing  contractors, as did the time that the contractors required to complete  dispositions. From 2010—when FHA implemented its new contract  structure—to 2012, the difference between the contractors with the best  and worst execution rates based on independently assessed value was  between 12 percent and 19 percent each year. Of the seven marketing  contractors, one had the best execution rate in each of the last 2 years  and another had the worst rate for each of those years. Likewise, the  difference between the contractors with the best and worst time frame for  the number of days from acquisition to completed sale ranged from 11  percent to 40 percent each year. Again, one contractor—not the same  one that had the best execution rate—had the best time frame in each of  the last 2 years and another—the same one that had the worst execution  rate in each of the last two years—had the worst time frame for each of  the last 2 years.

These differences raise questions about the guidance that FHA provides  to its homeownership centers and contractors tasked with managing and  selling REO properties. For instance, FHA has not identified optimal  practices and included them in a single consolidated handbook, although  some centers could be using practices that could benefit others.  According to an FHA headquarters official, staff in each homeownership  center analyze their office’s performance against the overall agency goals  of reducing the time that REO properties are in inventory and the time it  takes to list properties for sale, steps that should decrease the costs  associated with dispositions. According to this official, each center  analyzes this data monthly and takes corrective action as deemed  necessary, and recently the performance across homeownership centers  on these timeline measures have been similar. The official also noted that  homeownership center staff complete standard contractor monitoring  activities monthly to identify and address potential problems with  disposition performance. Although having each homeownership center  evaluate its own performance is an important internal control step, it does  not replace an independent performance assessment across all of FHA’s  centers, nor does it address the causes of any differences in performance  across centers. FHA has yet to conduct any analysis to identify  differences in execution rate performance across homeownership centers  and the factors that may account for such differences, although doing so  could help to improve performance at all centers and reduce costs across  the REO program.

section_title: FHA Has Yet to Implement a Uniform System for Evaluating Contractor Performance
paragraphs: Under the new contract structure—known as M&M III—created in 2010,  FHA expected that its staff and an oversight contractor would conduct a  number of specific activities to monitor its REO maintenance and  marketing contractors’ performance, including (1) assessing whether its  contractors are meeting minimum contractual requirements, and (2) using  standard metrics in a scorecard to evaluate the level of contractors’  performance. Federal internal control standards require agency  management to monitor program quality and performance through the  establishment and review of performance measures and indicators. Also,  HUD contracting standards and guidelines require the periodic evaluation  of a contractor’s performance to help ensure that services conform to the  contract’s quality and quantity requirements.

Under the new M&M III program structure FHA homeownership center  staff were expected to evaluate maintenance and marketing contractors  monthly to determine whether they were meeting minimum contract  standards. Staff were expected to perform this analysis using a tool—the  performance requirements summary—that assessed the contractors  against several minimum standards. However, staff at FHA’s four  homeownership centers have not been performing the systematic reviews  envisioned in HUD guidelines and the M&M III program structure to  determine whether contractors are meeting minimum performance  requirements. FHA staff in the four centers told us that they had not been  using the planned assessment tool as intended and instead had just been  reviewing the quality of contractors’ performance more informally and  subjectively. FHA homeownership center staff explained that they did not  complete formal performance requirements summary reports to be  shared with contractors because FHA did not have a standard reporting  mechanism. Instead, they informally assess contractors by examining  performance trends, reports on properties exceeding suggested time  frames for disposition, property inspections, and public feedback. FHA  homeownership center staff indicated that the tool was not available  because the methodology for producing it was to have been developed by  the oversight monitor contractor, but the initial firm chosen for this role did  not produce results that FHA deemed usable and FHA did not renew its  contract when it expired in 2011. FHA headquarters officials also said that  the original contractor oversight plans were not implemented because this  contract was not renewed. By not completing these assessments, FHA  has not systematically or uniformly determined whether contractors have  been performing as intended. Without a comprehensive system to  evaluate whether contractors are meeting minimum performance  standards, FHA risks not being able to ensure the most efficient and  effective disposition of its properties.

Additionally, FHA has failed to implement another critical component of its  M&M III program structure—a uniform tool known as a performance  scorecard—that was to have been used to compare the level of  contractor performance with that of other contractors. FHA intended to  use contractor performance scorecards to determine which contractors  would continue to receive new assignments of REO properties, and how  many they would receive. However, FHA officials said that they never  implemented use of a contractor performance scorecard because of the  terminated relationship with its oversight monitor contractor that was  responsible both for developing the scorecard and for the actual  monitoring. While the performance requirements summary was a tool to  identify minimum contractor performance, the scorecard would allow FHA  to evaluate the level of contractor performance using standard metrics  and to better compare the relative quality of a contractor’s activities  against that of other contractors. For example, other entities use a  scorecard to rank contractors on their overall performance as well as on  certain component metrics that together comprise their overall score.  Component metrics used by these entities include measures such as the  average time to complete certain tasks or services or the results of  oversight inspections.

More recently, FHA has taken some steps to increase the consistency of  its monitoring activities. A 2012 report by HUD’s OIG found that staff in  FHA’s four homeownership centers had developed their own contractor  oversight procedures that had led to inconsistent oversight of REO  contractors. During the course of the OIG audit, FHA headquarters staff  developed standardized plans—one for monitoring maintenance  contractors and one for monitoring marketing contractors—that the  homeownership centers were to begin using in June 2012. Each of these  two standardized monitoring plans includes various contract monitoring  tasks, such as measuring performance in key areas and reviewing  disposition status reports for properties that exceed certain REO  processing time frames (e.g., that have been in the REO inventory for  more than a year). As part of these plans, FHA included a contractor  performance scorecard that its staff had developed. However, FHA  officials said that the scorecard was not implemented due in part to  difficulties renewing FHA’s contract with the provider of its REO data  management system. To assist in its development of a standard method  of evaluating contractor performance, including scorecards, FHA officials  said that a new contractor was hired in September 2012. FHA officials  said that the scorecards would likely require the approval of each of the  maintenance and marketing contractors, as it was not included in their  original contracts as a basis for performance evaluation.

In contrast, the enterprises and private sector mortgage servicers that we  interviewed had been using scorecards to evaluate and compare  contractor performance and as a basis for assigning work to contractors.  These scorecards generally tracked a variety of metrics related to quality  and time frames, such as the number of days that a property was listed  for sale, different measures of sales returns, and completion of  maintenance and repair work. For example, one of the enterprises uses  performance results from monthly scorecards and quarterly report cards  to ascertain whether its contractors are meeting its standards for  performance. Its officials and those from two private mortgage servicers  we spoke with said that they also used scorecard results to make  decisions about reducing or ending their use of poorly performing  contractors. Officials from some of these entities said that they also used  scorecards to compare the performance of individual contractors to the  performance of all contractors in a similar geographic area. These  officials also said that the contractors knew how the scorecards were  being used to assess their performance and that their business  relationship with the company and the volume of work they received  depend on the assessments.

In the absence of a scorecard, FHA homeownership center staff indicated  that they were taking steps to evaluate contractors individually and to  provide feedback on their performance. But homeownership centers were  using different processes that were inconsistent, fragmented, and  informal. For example, staff at two centers said that they relied on  individual measures of performance such as case reviews and summary  reports of properties’ progression through different stages of the  disposition process. Staff from one of these centers explained that while  they had a sense of whether a contractor was doing a good job or not,  they did not have the ability to formally compare performance across  contractors. Staff from one center told us that some staff members had  created a scorecard-like tool to evaluate the performance of contractors  for which they had oversight responsibilities, but had been told by HUD  contracting officials that they could not share the results with the  contractors until FHA introduced a standard scorecard nationwide.  However, staff from a different office said that they had shared certain  individual contractor performance information with their contractors.

Without a functioning, standardized scorecard, FHA does not have a  uniform tool for evaluating the overall level of its contractors’ performance  and cannot effectively make distinctions about relative performance  differences across contractors or tell contractors how their performance  compares to their peers. This shortcoming also limits FHA’s ability to  identify and address underperforming contractors and creates the risk  that FHA cannot ensure the most efficient and effective disposition of its  properties.

section_title: FHA’s Contractor Oversight Lacked Key Activities Used by Other Entities
paragraphs: Our review also showed that FHA was not conducting certain contractor  oversight activities performed by some other entities that dispose of REO  properties. Specifically, FHA was not conducting as many or as frequent  in-person property inspections as other entities and was not taking steps  to ensure that listing brokers were close enough to the REO properties  they were chosen to market to know local market conditions and  efficiently access the properties. One of the ways that FHA’s oversight  activities varied from other federally related housing entities and private  mortgage servicers was the extent to which it conducts in-person property  inspections. HUD’s Contract Monitoring Guide states that inspections are  the best way to determine the quality of a contractor’s performance. FHA  and other entities typically have their contractors visit properties regularly  to inspect the properties’ condition and to perform routine maintenance  such as lawn cutting. However, they also have their own staff or third- party contractors that visit properties for oversight purposes, including  ensuring that contractors are performing their required duties and  maintaining properties to expected standards. According to staff from one  of FHA’s homeownership centers, performing in-person property  inspections is critical because they allow FHA staff to review contractor  performance, identify problems needing resolution, and conduct quality  assurance checks, especially in the absence of a uniform scorecard.  FHA’s standard monitoring plans include property site visits to help  ensure that maintenance contractors are conducting their own routine  inspections and maintaining the condition of assigned properties in  accordance with their contractual requirements. They also are meant to  help ensure that marketing contractors are following required standards  and procedures when conducting sales activities. FHA’s plans call for in- person inspection of 2 percent of properties three times per year.  However, FHA homeownership center staff had varying interpretations of  FHA headquarters’ expectations for the amount and timing of property  inspections. For example, staff in some centers told us that they aimed to  inspect 2 percent of properties annually, while staff in another center said  they targeted 6 percent of properties annually. The timing of the  inspections also varied across the homeownership centers from a certain  percentage each month to a certain percentage in three of the four  quarters of the fiscal year.

According to FHA officials, a lack of adequate travel funds and staff  capacity has created challenges for homeownership centers in  conducting in-person property inspections. Staff at some centers said that  a lack of available funds could delay some inspections until the end of the  fiscal year, when funds might become available. Others noted that in the  past they had inspected more properties within proximity to the  homeownership center when travel funds were not available. However,  waiting to conduct inspections until the end of the fiscal year and  restricting them to a limited geographic area limits their effectiveness, as  the inspections may not target properties in certain locations or  contractors equally. Further, contractors may become aware that they are  unlikely to have properties inspected early in the year or in certain  locations.

To supplement the in-person inspections, FHA attempts to use other  means of monitoring whether its contractors are complying with its  expectations, but the effectiveness of these efforts is also uncertain. For  example, FHA homeownership center staff may conduct reviews of the  evidence, such as photographs of the property, that contractors submit to  document that they have performed routine inspections and other  activities. However, in 2012 HUD OIG audits found that contractors could  upload pictures that do not accurately depict a property’s condition or  incomplete reports that limited the effectiveness of these reviews. To  supplement its own staffs’ monitoring efforts, FHA’s contractors that are  responsible for marketing REO properties also complete some  inspections as part of their quality control plans. Additionally, property  listing agents employed by the marketing contractors inspect the work of  maintenance contractors for all properties that are listed and sold.  However, the effectiveness of these reviews may be limited because FHA  staff told us that the property listing agents have often been reluctant to  submit negative reports on maintenance contractors’ performance  because of fear of damaging working relationships with these other  contractors.

The number of in-person inspections that FHA completes may not be  sufficiently effective to ensure that FHA’s contractors are conducting their  activities in compliance with contractual requirements. In multiple reports  issued between March 2012 and February 2013, HUD’s OIG found that  contractors responsible for maintaining and marketing FHA’s REO  properties were often not performing the required work at all or were not  performing to the expected level of quality. For example, a September  2012 HUD OIG report examined a Las Vegas, Nevada, FHA contractor  and found that it did not secure or properly maintain 40 percent of the 96  properties that the OIG examined. Another report from September 2012  reviewed 125 properties nationwide and determined that FHA’s  contractors did not properly maintain 75 of them, as evidenced by  unmaintained yards, unclean conditions, lack of security, and water  leaks. The review also found that for 100 of the 125 properties, FHA’s  maintenance contractors did not conduct routine inspections in a timely  manner. Furthermore, this OIG audit revealed that FHA’s maintenance  contractors nationwide were paid for inspections for which they had not  completed the required documentation and may not have conducted. One  of FHA’s homeownership centers developed a report to identify these  missing routine inspections and, in coordination with HUD’s procurement  office, requested reimbursement of fees paid to five of its contractors  totaling more than $1.3 million for more than 10,000 inspections from  June 2011 through February 2012.

In contrast to the amount of in-person inspections done by FHA, other  federally related housing entities and private mortgage servicers we  spoke with indicated that they conducted in-person inspections of much  larger percentages of their REO properties and conducted them more  frequently. For example, staff from one of the enterprises told us that it  performed in-person oversight inspections of 25 to 30 percent of its REO  properties monthly using an independent inspection firm. The other  enterprise said that it completed in-person inspections of around 35  percent of properties monthly, using both an independent inspection firm  and its own staff. VA officials noted that it conducted in-person  inspections on at least 10 to 20 percent of its REO properties annually  and in fiscal year 2012 the agency inspected over 40 percent. In addition,  staff from one of the private mortgage servicers we interviewed told us  that its own field agents inspected about 40 percent of its properties,  while two other private mortgage servicers said that they inspected about  7 and 10 to 12 percent of their properties on a monthly basis throughout  the year.

Federal internal control standards require that agency management  conduct effective monitoring to assess program quality and performance  over time and work to address any identified deficiencies. Other entities,  whether federally related or private, found that frequent in-person  property inspections were an effective way to better ensure that  contractors were performing required activities and to assess the quality  of their work. As a result of not conducting in-person inspections of a  greater share of its REO properties and not inspecting them more  frequently, FHA may not discover potential maintenance and disposition  problems, potentially resulting in poorly maintained properties that sell for  lower prices.

In addition, FHA does not have the procedures that the enterprises have  to ensure that properties are assigned to listing brokers located close  enough to the properties to have sufficient knowledge of the local market.  Using listing brokers that are close to and familiar with properties and the  surrounding communities improves the chances that the properties will be  shown as often as possible and will be well maintained. FHA’s contracts  require its marketing contractors to use local real estate professionals  whose primary place of business is within reasonable proximity of the  listed property. However, FHA does not have either a definition of  “reasonable proximity” or formal guidelines or procedures for determining  whether properties are assigned to local listing brokers, according to  officials. FHA headquarters officials said that they had an informal goal of  using brokers located within 20 miles of a listed property, but noted that  consistently defining what constitutes reasonable proximity could be  difficult. For example, distances that would be considered reasonable in  an urban area might not be realistic in a rural location. FHA  homeownership center staff said that headquarters had not yet  implemented clear criteria or controls for the marketing contractors that  assigned properties to brokers.

In the absence of clear criteria from FHA headquarters, homeownership  centers often made their own determinations on using brokers within  reasonable proximity to properties. For instance, FHA staff at one center  told us that after discovering as part of unrelated inspections that listing  brokers for some of its properties were not local, the center and its  marketing contractors had decided that “local” generally meant within 50  miles, with exceptions for sparsely populated areas. Centers also varied  in their reviews of listing brokers’ proximity to their listed properties. One  center noted that such reviews were part of annual inspections of  marketing contractors. However, officials at another center said that they  did not believe the proximity of listing brokers was a major concern and  did not monitor it closely and instead placed more emphasis on overall  performance. Officials from one listing broker that has sold properties for  two of FHA’s marketing contractors said that there had been many  instances of listed properties being more than 50 miles from the listing  broker’s office. They also noted that many of these more-distant listing  brokers were not members of the listing service that includes properties  for those local markets, which resulted in a lack of proper exposure for  FHA’s properties. Without clear guidance from FHA on the use and  oversight of listing brokers, homeownership centers may continue to  make their own determinations on what constitutes “reasonable proximity”  to listed properties and may not be able to ensure that properties are  being effectively marketed by knowledgeable agents.

In contrast, the enterprises have established guidelines for the selection  of local listing brokers and conduct monitoring to ensure brokers’  proximity to the listed properties. For example, one of the enterprise’s  REO sales guidelines states that properties should be no further than 25  miles from the listing broker, although this threshold is used more often  for rural areas, according to officials. In urban areas the goal is to assign  a broker as close as 5 miles to the property. The officials also told us that  the enterprise used reports to monitor the distances between listing  brokers and their assigned properties and addressed situations involving  longer distances on a case-by-case basis. Officials from the other  enterprise emphasized the importance of using listing brokers located  close to listed properties because of local brokers’ market knowledge.  This enterprise has a goal for broker proximity of about 15 to 20 miles,  according to these officials, but the distances can vary in rural areas. The  officials also told us that the enterprise had an Internet-based REO  management system that assigned properties to listing brokers by  geographic area. The enterprise’s staff define the geographic areas within  which its listing brokers can receive property assignments when it adds  them as approved service providers and conduct reviews of listing  brokers’ office locations.

section_title: FHA Has Not Assigned Work to Contractors Based on Evaluations of Their Performance
paragraphs: As part of the new M&M III program structure it introduced in 2010, FHA  intended to implement a key quality control—assigning contractors work  according to the quality of their performance—but has encountered  obstacles to implementing this mechanism. The Federal Acquisition  Regulation (FAR) stipulates a strong preference for using multiple  contractors for the types of contracts that FHA has used to manage and  dispose of REO properties. With respect to the types of contracts that  FHA has used to manage and dispose of REO properties, the FAR  provides that the agency must provide each contractor with a fair  opportunity to be considered for the work. FHA designed its M&M III  contract structure to include 10 geographic areas with multiple  maintenance and marketing contractors operating within most areas.  During the first year of the M&M III contracts, FHA assigned equal  percentages of REO properties to each contractor in a contract area to  satisfy the minimum guarantee under the contract. After the first year,  FHA intended to use performance evaluations to help determine the  shares of its REO properties within a contract area that it would assign to  each of the multiple contractors operating in that area, with the high- performing contractors receiving the largest allocations of properties.

FHA planned to divide property assignments within the overall contract on  a percentage allocation basis, so that all individual contractors in an area  would receive a minimum share of the work as long as the contractors  met minimum performance requirements.

However, FHA has been unable to implement this system as intended for  two reasons. First, until it implements the planned scorecards or other  uniform evaluation method, FHA has no way to systematically generate  the information needed to assign work based on performance. Second,  after implementing the new M&M III program structure, FHA encountered  challenges in ensuring that its performance-based allocation contract  structure complied with the FAR. In late 2011, HUD’s OGC advised FHA  that the process of allocating a minimum share of property assignments  to each of its contractors was not compliant with the FAR rules requiring  that each contractor have a fair opportunity to compete and win all the  work for which it is competing. FHA officials said that the performance- based competitions that OGC determined would be compliant with federal  acquisition rules, with contractors winning either all or none of the work  assignments, would jeopardize the financial viability of some contractors.  These officials explained that contractors have high overhead costs and  could go out of business if they did not receive at least some property  assignments for more than a few weeks.

As the result of these obstacles to implementing performance-based  allocations as planned, FHA has continued to assign properties to  marketing contractors based on equal allocations in a contract area. It  also assigns work to maintenance contractors solely on the basis of the  cost. FHA staff told us that they could not identify an acceptable  alternative to assigning work among multiple contractors that was also  compliant with federal acquisition rules. Instead, FHA plans to award new  contracts that give all property assignments in a contract area to a single  contractor for at least a year. FHA staff said that if the contractor  performed poorly or was unable to provide the necessary services, the  property assignments could be shifted to a contractor in a neighboring  area by redefining the contract area. However, the practical difficulties  and challenges involved in redefining contract areas and reassigning all  properties among contractors could make implementing this option  difficult. Further, it is not clear that FHA has fully explored other options  that are compliant with federal acquisition rules.

In terms of performance incentives, FHA officials said that its discretion in  determining whether to renew annual contracts was the most important.  However, this particular incentive may be less powerful than the frequent  reallocation of work envisioned under the M&M III contract structure.  According to officials, FHA has never failed to renew an annual contract  for the 50-plus maintenance and marketing contracts that have been part  of the current contract structure since 2010. FHA staff told us that under  the maintenance and marketing contracts’ terms, they could reassign  properties to another contractor or suspend property assignments to a  poorly performing contractor, but these options have rarely been used.  According to agency officials, since 2010 FHA has suspended a  contractor’s assignments only once for a period of 1 month and has not  yet reassigned properties from one contractor to another on the basis of  poor performance. FHA officials said that they had not defined standard  criteria for the number of instances of deficient performance that would be  required before these actions were taken. Rather, FHA staff perform a  risk assessment, and the contractor is given an opportunity to address  any deficiencies.

FHA has tried to create other incentives for superior performance. It pays  marketing contractors a percentage of a property’s sale price at the time  of sale based on the disposition price and time frame. These payments  are higher for properties with sale prices above a set percentage of the  initial listing price and within a certain time frame. Over the second half of  2012, almost one-third of FHA’s sales met the thresholds for the higher  fee amount, according to FHA data. However, FHA procurement officials  told us that the bonus fee structure was not a normal contract incentive  and that FHA also was considering including more typical performance  incentives and disincentives in contracts. They explained that the only  specific disincentive or performance penalty in the current contracts is  FHA’s ability to assess late fees if contractors delay sale closings.  Without performance-based work assignments, however, FHA’s ability to  motivate contractor performance is limited because it has few other  incentives and disincentives and uses them infrequently. As a result, FHA  cannot ensure that its maintenance and marketing contractors are  performing at the highest possible levels.

In contrast, the enterprises and private market servicers we interviewed  use performance-based work assignments to align contractor incentives  and promote high performance. None of these entities are required to  follow federal acquisition regulations. Officials from one of the enterprises  explained that if one of its contractors consistently performed better than  others based on scorecard assessments, the high-performing contractor  would receive more work assignments, with the amount dependent on  capacity considerations. This system applies to its national marketing  contactors, listing brokers, maintenance contractors, and other service  providers. The other enterprise also considers performance when  assigning properties to contractors such as listing brokers, according to  its officials. Officials from two private mortgage servicers we interviewed  told us that they assigned additional work to contractors with better  performance on their scorecard indicators and that poor contractor  performance could lead to fewer work assignments or termination.

section_title: Conclusions
paragraphs: The housing crisis has increased the number of REO properties in FHA’s  inventory. The agency’s ability to effectively dispose of these properties in  ways that maximize sales proceeds and minimize holding time could help  increase the government’s financial returns. We found that FHA’s  disposition performance and the time required to complete sales of REO  properties lagged the performance of the government-sponsored  enterprises. Our analysis of FHA’s REO activities revealed that the  agency was not employing some of the disposition practices that the  enterprises and other housing entities used. These practices could be a  factor in other entities’ ability to dispose of REO properties for higher  returns and with less holding time and include: using multiple means of assessing property values to better assure  that REO properties are fairly valued and thus more likely to sell faster  and at the highest price, making improvements to properties with characteristics that are more  likely to result in a higher sales price if repaired, and basing price reductions for properties that do not sell at the original list  price on market conditions rather than on a predetermined schedule.

If FHA could perform as well as the enterprises in disposing of REO  property, it could potentially generate hundreds of millions of dollars in  additional sales proceeds and reduce maintenance and other holding  costs from its future REO activities.

Federal internal control standards call for agencies to have  comprehensive policies and means to help ensure that program  objectives are being met and that expected activities are being  completed. However, FHA has not taken the actions necessary to ensure  that its controls and oversight activities are effective in several areas.  Specifically,

FHA lacks comprehensive guidance for its REO program and a  process for updating this guidance as policies and procedures  change. Having such guidance could better ensure consistent  practices across homeownership center staff and uniform oversight of  the numerous contractors that carry out maintenance and marketing  activities. Further, having a robust revision process would allow FHA  to incorporate best practices that it identifies by analyzing differences  in performance across homeownership centers, something it currently  does not do.

FHA has fully implemented neither mechanisms for evaluating  contractors’ activities against minimum expected standards nor a  scorecard that would allow staff to compare contractor performance to  identify high- and low-performing contractors. Addressing this issue is  critical to better ensuring contractors are performing as expected and  meeting program goals.

Given the FHA Inspector General’s findings that REO properties were  not always being well-maintained as required by the service providers’  contracts, the number of in-person inspections currently being  undertaken by FHA does not appear to be effective.

FHA lacks controls to help ensure that the brokers marketing its  properties meet FHA contractual requirements that brokers be in  reasonable proximity to their properties. As a result, FHA risks having  brokers that do not have the expected level of local market knowledge  and cannot conduct effective marketing activities because they are  too far away.

FHA contracts generally lack incentives and disincentives that would  encourage performing high-quality work consistent with other entities’  practices. Implementing a more frequent performance-based  assessment and assigning work on the basis of performance could  improve returns on REO properties and reduce property holding  times.

Collectively addressing these issues could improve FHA’s oversight of its  contractors by, for example, ensuring that their properties are inspected  regularly and that they face consequences for not meeting program  requirements.

section_title: Recommendations for Executive Action
paragraphs: To increase the potential for higher financial returns from FHA’s  disposition of REO properties, the Secretary, HUD, should direct the  Commissioner, FHA, to identify and implement changes in current  practices or requirements that could improve REO disposition outcomes,  including  requiring the use of multiple estimates of market value when  determining initial list prices,  considering whether conducting repairs could increase the amount of  net proceeds from specific property sales, and ensuring that the timing and amount of price reductions for its listed  properties are made on the basis of an evaluation of market  conditions rather than on standardized schedules.

To improve its oversight of the REO disposition program, the Secretary,  HUD, should direct the Commissioner, FHA, to update its REO program disposition handbook, or equivalent  document, to include a current and consolidated set of policies and  procedures for managing and disposing of FHA’s REO properties; establish a process for analyzing differences in disposition  performance and practices across homeownership centers that can  be used to periodically update this handbook or equivalent  documentation to reflect current policy and procedures;  implement a mechanism for systematically reviewing contractors’  compliance with minimum performance requirements through the use  of standard metrics; ensure the completion and implementation of the scorecard currently  being developed, including ensuring that performance metrics  included in the scorecard are consistent with those used to review  contractors’ compliance with minimum performance requirements; determine more effective ways, including increased use of in-person  inspections, to better ensure that contractors comply with expected  requirements;  implement controls to ensure that listing brokers are located within  close enough proximity to their listed properties to effectively market  REO properties; and  take steps to develop a legally acceptable means of assigning work to  REO contractors that uses more frequent assessments of past  performance.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to HUD, FHFA, Fannie Mae, Freddie  Mac, VA, and RHS for their review and comment. HUD provided written  comments, which are reprinted in appendix II. Fannie Mae, Freddie Mac,  and VA provided technical comments on the draft report, which we  incorporated as appropriate. In a letter from the Assistant Secretary for  Housing – Federal Housing Commissioner, HUD agreed with our  recommendations. HUD also identified actions that it has taken or  planned to take in response to our recommendations. For example, HUD  wrote that FHA plans to update its REO disposition handbook. In addition,  in response to our recommendation that FHA establish a process for  analyzing differences in disposition performance and practices across  homeownership centers that can be used to periodically update the  handbook, HUD pointed to the monitoring plan that FHA has implemented  for its contractors that will analyze disposition performance and practices  across homeownership centers. HUD also wrote that any identified best  practices will be noted, discussed, and communicated to homeownership  centers and contractors. It will be important for FHA to also periodically  update the handbook to reflect these changes in practices, as we  recommended. HUD acknowledged that budgetary constraints affect  implementation of contractor performance scorecards—critical elements  in three of our recommendations—and limit its ability to make increased  use of in-person property inspections that we suggested could be used to  better ensure that contractors comply with expected requirements. While  recognizing that FHA’s scope for action may be limited by available  budgetary resources, we emphasize the importance of considering not  just the costs to undertake these steps but also the potential savings and  improved disposition outcomes that would be realized from enhanced  contractor oversight.

In response to our recommendation to develop a legally acceptable  means of assigning work to REO contractors that uses more frequent  assessments of past performance, HUD said that FHA has taken steps in  its new REO contracts to provide incentives to high-performing  contractors and disincentives to lower-performing contractors by  transitioning inventory among them based on performance and price.  When implementing such a contract structure, we encourage FHA to  consider inventory transitions on a frequent basis, such as quarterly, to  align with the frequency of the scorecard performance assessments.

In technical comments, the Director of Regulatory Affairs of Fannie Mae  noted that the REO execution rate performance information that our  report presents was inconsistent with publicly disclosed loss severity  rates published by FHA.  Although loss severity rates—which measure  loss on a defaulted loan as a percentage of the unpaid principal  balance—can be presented when discussing REO performance, we did  not include such analysis in our report because this measure reflects  factors beyond the control of the REO programs of these entities. For  example, loss severity rates can be affected by the original loan-to-value  ratio, loan amortization schedule, origination date, changes in market  values, or the existence of mortgage insurance. We therefore do not use  loss severity rates to assess REO performance. Fannie Mae also noted  that the performance execution information that uses independent  valuations may not be comparable across entities because not all REO  sellers use the same valuation methodology. Our report notes that the  entities use different methods for obtaining an independent valuation— including an independent appraisal for FHA and one of the enterprises  and an independent BPO for the other enterprise—and that any  systematic differences between the appraisals and BPOs could affect the  performance results. We also calculated execution rate results using list  prices and these calculations showed similar results.

As agreed with your offices, 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 interested congressional  committees, HUD, FHFA, Fannie Mae, Freddie Mac, VA, and RHS. In  addition, the report will be available at no charge on the GAO website at  http://www.gao.gov.

If you or your offices have any questions about this report, 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 report. GAO staff who made key contributions to this report  are listed in appendix III.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to examine (1) real estate-owned (REO) property  disposition practices used by the Housing and Urban Development  Department’s (HUD) Federal Housing Administration (FHA) and other  federally related housing entities and how FHA’s effectiveness compares  to that of these entities, and (2) how FHA oversees its REO disposition  program.

To examine the disposition practices, we reviewed REO program  regulations, requirements, and policies to determine the goals and  strategies for these activities of FHA and other federally related housing  entities, including the Department of Veterans Affairs (VA), the  Department of Agriculture’s Rural Housing Service (RHS), and two  housing government-sponsored enterprises (the enterprises)—Fannie  Mae and Freddie Mac. We interviewed HUD and FHA staff in the  agency’s Washington, D.C., headquarters and staff in the four regional  homeownership centers that oversee REO activities in their areas. We  also interviewed staff from other federally related housing entities about  the goals and strategies of their REO activities. We also discussed REO  goals and strategies with staff from three large private-sector mortgage  servicers that also acquire and dispose of REO properties. We selected  these servicers because they were among the largest servicers of home  mortgages. To obtain additional information on REO activities, we also  interviewed staff from the National Association of Realtors, two local  realtors identified as knowledgeable about REO properties by that  association, and community groups or government housing entities in  various cities with large REO concentrations. We also interviewed the  National Community Stabilization Trust, which administers a database of  REO properties for purchase by community groups, and an appraisal  group responsible for promoting appraisal standards.

To assess the effectiveness of FHA’s REO dispositions, we obtained and  analyzed REO disposition data from FHA and the other federally related  housing entities, including all REO properties disposed of from January 1,  2007, through June 30, 2012, as well as properties in inventory at the end  of the period. Specifically, we obtained data from the data management  systems of FHA, the enterprises, VA, and RHS. We did not include RHS  in our analysis of REO property disposition performance because it only  obtains and manages REO properties through its direct loan program and  these are very small in number compared to the other entities. For  example, in the period of analysis, RHS’s direct loan property dispositions  represented less than 1 percent of FHA’s REO dispositions. RHS also did  not have property-level data available for many of the data elements that  we included in our analyses. Table 1 shows the number of dispositions for  each entity that occurred during this time period based on the data that  we received and analyzed. For RHS, we used data on its direct loan  properties because it only acquires and disposes of REO properties  related to its direct loans and does not do so for properties from its  guaranteed loan program.

We assessed the reliability of these data by reviewing agency data  documentation, interviewing officials, and testing for missing values,  outliers, and obvious errors. VA and RHS did not have property-level data  available that were necessary for some of the calculations in this report.  In particular, VA and RHS did not have data available on initial REO  valuation dates, type of sales method, and type of buyer. Additionally, VA  did not have data on initial REO appraisal amounts and RHS did not have  data on net sales proceeds. We excluded VA and RHS from calculations  that used these data elements and noted these instances as applicable.  We addressed missing data by excluding those properties with missing  data elements from analyses that relied on those elements as necessary.  Finally, in analyses using the net sales proceeds data element, we  excluded properties with net sales proceeds of $0, as this is an unlikely  value for that element and could indicate missing data. We excluded  additional properties from our regression models, as described below. In  no instance did we exclude more than 13 percent of all properties. After  making the necessary qualifications, corrections, and related  assumptions, we believe that the data were reliable for our purposes as  described in this appendix.

To determine the performance in maximizing the sales price of REO  dispositions by the entities, FHA homeownership centers, and FHA asset  managers, we calculated various execution rates. These rates included  the ratio of REO dispositions’ gross sales prices (for gross execution  rates) or net sales proceeds (for net execution rates) to one of several  estimated property valuations. The measures of property values that we  used included (1) the sum of an independent assessment of a property’s  value—an independent appraisal or BPO conducted by a third party if the  entity did not use appraisals—plus any repair costs for that property, and  (2) the initial list price for the REO property. We calculated aggregate  execution rates for each organization by dividing the sum of their property  dispositions’ net sales proceeds by the sum of the properties’  independently assessed values or initial list prices. We used aggregate  execution rates because, by showing the net return on the total estimated  value of properties in an entity’s portfolio, the aggregate rates better  reflect the entity’s overall performance than an average of the execution  rates of individual properties. The aggregate rate calculates execution  rate performance on a value-weighted basis, with higher value properties  having a greater impact on the aggregate rate than low-value properties.  An average of individual properties’ execution rates gives equal weight to  properties of different values despite their unequal effects on total net  returns.

To assess the timeliness of the entities’ REO property dispositions, we  calculated the average number of days from the foreclosure sale to the  day on which they sold or otherwise disposed of the property, as well as  the number of days they took to move properties between various points  within the REO process.

To account for the possibility that differences in performance results  between FHA and the enterprises might be due to differences in the  characteristics of the properties that each entity acquired and disposed of  in their REO programs, we used the data on the REO property  dispositions from January 1, 2007, through June 30, 2012, to create  various regression models. The general regression specification for these  models was:  y is the performance measure being assessed, such as net execution  as a percent of independently assessed value or time from  foreclosure to REO sale closing; organization is an indicator variable for the entity holding the property;

X is a series of control variables related to the property and  represents the relationship between variable j and the outcome  variable, independent of the other variables in the model;  zip is an indicator variable for the property’s ZIP code;  valuation indicates the range of the property’s independently  assessed value; α, β, and γ are the parameters of interest; and e represents an error term.

We interacted the ZIP code and valuation category variables to allow the  average effect of the valuation category on the performance measure to  vary between ZIP codes. The parameters of interest were the coefficients  for each organization.

We used the following additional property characteristics as control  variables in the regressions: number of bedrooms (as a categorical variable), number of units for the property (as a categorical variable), year the property was built (as a categorical variable),  the change in the FHFA House Price Index for the property’s ZIP code  from the month of the initial valuation to the month one quarter after  the initial valuation, and  the change in the FHFA House Price Index for the property’s ZIP code  from the month of the initial valuation to one month after the initial  valuation month.

In addition, for regressions with an execution rate as the outcome  variable, we included the month and year of REO acquisition as a  categorical control variable. For regressions with the number of days from  the foreclosure sale to the REO disposition as the outcome variable, we  included the number of weeks from the scheduled date of the last  completed payment to the date of the foreclosure sale as a categorical  control variable.

For the regression models with an execution rate as the outcome  variable, we weighted every property by the amount of the property’s  independently assessed value. This was done so that the percentage  point differences resulting from the regressions would be similar to overall  aggregate differences for models where only the entity dummies were  included. Weighting by property value also reduced the effect of  heteroskedasticity that was likely present over the range of valuations.

To reduce the effect of outliers on the regression estimates, we excluded  certain property records that had irregular values for a few data elements.  For the regression models with an execution rate based on either the  independently assessed value or reconciled value as the outcome  variable, we excluded properties with independently assessed value net  execution rates greater than 300 percent or less than negative 300  percent. Such large or small execution rates suggest a highly inaccurate  valuation or otherwise irregular data such as a very low property value or  sales price. For models with execution rate based on initial REO list price  as the outcome variable, we excluded properties with the highest and  lowest 1 percent of values for the ratio of initial REO list price to  independently assessed value for all properties. In total, we excluded  fewer than 12 percent of all properties in our data for each of the net  execution models.

Due to these exclusions, the population of properties used in the net  execution regression models was smaller than the full population that was  used when calculating the aggregate results. As a result, to estimate the  percentage point difference in net execution rates between FHA and the  enterprises for the full population, we multiplied the percentage point  differences from the aggregate execution rates by the ratio of the  percentage point differences resulting from the full regression model to  the percentage point differences resulting from a regression model with  only entity variables.

For the models where the time from the foreclosure sale to the completed  REO property disposition was the performance measure, we excluded  properties that had a negative value for the number of days from the  foreclosure sale to the completed REO property disposition. In total, we  excluded less than 13 percent of all properties for the time frame models.

We took various steps to test these regression models for robustness.

We used various thresholds for the exclusion of property records from  the net execution models. For example, we tested results when the  models excluded properties with independently assessed values  above and below certain amounts rather than properties with  execution rates above and below certain amounts.

We used various specifications for certain property and market  characteristics. For example, we tested models where the categorical  variable for independently assessed value was not interacted with ZIP  code, where it was specified as a log, and where it was specified as a  polynomial. We also tested models where the change in the FHFA  House Price Index in each ZIP code was specified as the change in  the index in the year prior to the disposition date and in the month  prior to that date.

We included additional property characteristics as a control variable in  the models or excluded some of the property characteristics. For  example, we tested models where a property’s occupancy status at  REO acquisition was included as a control variable. This variable  ultimately was not included in our final models because a significant  percentage of FHA’s property dispositions were missing data for this  variable.

These models showed qualitatively similar results for the reduction in the  performance difference between FHA and the enterprises relative to  regressions with only entity variables. However, the final model for net  execution rates had one of the largest reductions in the performance  difference between FHA and the enterprises. This appeared to be due to  the interaction of properties’ independently assessed values and ZIP  codes.

To identify factors that could help explain differences in FHA’s REO  performance relative to that of the enterprises, we also created models  that included various factors (time from foreclosure sale to REO  disposition, ratio of initial list price to initial valuation amount, disposition  method, and buyer type) at least partially under the entities’ control and  examined how their inclusion affected estimates of the performance  difference between the entities as measured by net execution rates.

To compare the performance of FHA homeownership centers and  contractors, we computed execution rates and average time frames for  the properties they managed. When examining time frames, we focused  on the time frame from a property’s initial valuation to completion of the  disposition because initial valuation was the date available from both FHA  and the enterprises that most closely reflected when FHA’s  homeownership centers begin managing and overseeing the disposition  of REO properties. In addition, when comparing homeownership center  performance, we developed regression models to account for the  possibility that differences in performance results between the  homeownership centers might be due to differences in the characteristics  of the properties that each center disposed of in their REO programs. To  further control for regional differences that our nationwide regression  models may not have been able to capture, we compared the  performance of the homeownership centers to the performance of the  enterprises in the states where each center operates. For this analysis,  we also conducted separate regressions for each homeownership center  region to account for differences in the characteristics of properties  between homeownership centers and the enterprises in those states. For  the regression models used to compare the performance of the  homeownership centers, we controlled for the same property and housing  market characteristics that we included in our regression models  comparing FHA’s overall performance to that of the enterprises.  However, we did not include ZIP code in the models directly comparing  homeownership center performance because the homeownership centers  operate in regions with mutually exclusive ZIP codes.

To examine the price reduction strategies used by FHA, we also obtained  additional data on all listing prices for properties that FHA disposed of  from June 30, 2011, through June 30, 2012. To determine if price  reductions occurred at a scheduled amount, we compared the price  reductions reflected by these data to the price reduction schedules, if any,  listed in FHA contractors’ marketing plans. One contractor did not have a  price reduction schedule in its marketing plan so we considered price  reductions for properties managed by this contractor to be according to  schedule if they occurred at one of the two standard reduction  percentages that appeared in most other contractors’ marketing plans. In  addition, some marketing plans for one contractor specified a range for  the price reduction amount. In these cases, we considered a price change  to be for a scheduled amount if the price was reduced by one of the two  standard reduction percentages that appeared in most contractors’  marketing plans. Finally, for marketing plans that specified that price  changes could be up to a certain amount, we considered a price change  to be for a scheduled amount only if the price change was for the  maximum amount, since the goal of this analysis was determine how  often price changes were for particular, predictable, amounts.

To determine how the entities oversee their REO programs, including the  contractors they use to perform various REO-related activities, we  interviewed staff from FHA and the housing entities. We also reviewed  program regulations, requirements, and policies related to oversight. We  also discussed REO oversight activities with the staff from the three  private sector mortgage servicers.

section_title: Appendix II: Comments from the Department of Housing and Urban Development

section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Cody Goebel, Assistant  Director; Kevin Averyt; Stephen Brown; Emily Chalmers; William R.  Chatlos; Robin Ghertner; DuEwa Kamara; John Karikari; Jon Menaster;  Alise Nacson; Jessica Sandler; Jena Sinkfield; Jack Wang; William T.  Woods; and Ethan Wozniak made key contributions to this report.


Question-summary annotations: questions: question: How did FHA's performance in selling REO fare?
answer: The Federal Housing Administration's (FHA) performance in selling its foreclosed properties--known as real estate-owned (REO) properties--lagged the performance of both of the government-sponsored enterprises (enterprises), Fannie Mae and Freddie Mac.
child_questions: question: How specifically was FHA's performance less successful than government-sponsored enterprises?
answer: Its combined 2007-2012 returns, measured by the net execution rate (net sales proceeds divided by independently assessed property values) were about 4 to 6 percentage points below the enterprises' returns.

question: After controlling for differences, how specifically was FHA's performance less successful than government-sponsored enterprises?
answer: After controlling for certain differences in their properties' characteristics (e.g., value, location, and local market conditions), differences in combined returns between FHA and the enterprises persisted at an estimated 2 to 5 percentage points.

questions: question: How did the time of foreclosure between enterprises and FHA differ?
answer: Further, while the enterprises took an average of around 200 days after foreclosure to dispose of REO properties, FHA took about 340 days--more than 60 percent longer . A similar pattern persisted even after controlling for certain property differences.
child_questions: question: Why might FHA have taken more time to foreclose?
answer: For FHA, unlike the others, a significant part of the time between the foreclosure sale and REO sale is taken by loan servicers who must complete certain activities before conveying title to FHA.

question: What does FHA not use that may have resulted in decreased performance?
answer: For example, FHA does not repair its properties to increase their marketability, something both enterprises do. And unlike the enterprises, FHA does not incorporate information from multiple sources in setting list prices or consistently take into account market conditions when reducing prices.
child_questions: question: What does FHA do instead of these actions?
answer: Instead, it relies on one appraisal in setting initial prices and often reduces them by set amounts.

question: What did GAO find if FHA's execution rate and disposition time frame had equaled those of the enterprises?
answer: GAO found that if FHA's execution rate and disposition time frame had equaled those of the enterprises in 2011, it could have increased its proceeds by as much as $400 million and decreased its holding costs--which can include items such as taxes, homeowners' association fees, and maintenance costs--by up to $600 million for the year.

questions: question: What is the problem with FHA's oversight of contractors?
answer: In addition, FHA’s oversight of the contractors that it uses to maintain and dispose of REO properties has weaknesses, and it does not use some of the oversight tools other entities use that might prove effective.

question: Why does FHA need to update its REO disposition handbook?
answer: First, government internal control standards require complete, updated policies and procedures to guide program oversight. But FHA has not updated its REO disposition handbook since 1994, even though the agency implemented a different program and contractor structure in 2010.
child_questions: question: What is the result of not having an updated handbook?
answer: In the absence of a central source of updated guidance, GAO and FHA internal auditors found inconsistencies in both contractor activities and staff oversight across FHA’s four regional homeownership centers.

question: What has prevented FHA from assigning work according to contractors' performance?
answer: For instance, FHA has yet to implement a proposed version of the type of scorecard that the enterprises use to assess differences in contractor performance. Also, its planned incentive structure for contractors has been found not to comply with federal contracting rules. These two shortcomings have prevented FHA from assigning work according to contractors’ performance—a key quality control in its new REO program structure.

question: What steps has FHA not taken regarding listing brokers?
answer: Finally, FHA has not taken steps to ensure that the listing brokers marketing its REO properties are located close enough to the properties to have adequate knowledge of local markets.

questions: question: Why is FHA faced with disposing high volume of REO properties?
answer: With mortgage foreclosures at historic levels in recent years, FHA is faced with disposing of a high volume of REO properties.

question: What did GAO examine to assess relative effectiveness of FHA's REO dispositions?
answer: To assess the relative effectiveness of FHA’s REO dispositions, GAO examined (1) FHA’s disposition goals, strategies, practices, and effectiveness in disposing of properties compared with those of the enterprises and private servicers; and (2) FHA’s oversight of the contractors that maintained and marketed its REO properties.
child_questions: question: What did GAO analyze to get this information?
answer: GAO analyzed REO disposition data from FHA and the enterprises, including modeling to control for property differences across the entities.

question: What other information did GAO collect?
answer: GAO also collected requirements, policies, and interviews on each entity’s oversight of its REO dispositions.