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Federal Housing Finance Agency v. HSBC North America Holdings Inc.

United States District Court, S.D. New York

July 25, 2014

HSBC NORTH AMERICA HOLDINGS INC., et al., Defendants, And other FHFA cases

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[Copyrighted Material Omitted]

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For Federal Housing Finance Agency, plaintiff: Philippe Z. Selendy, Manisha M. Sheth, Andrew R. Dunlap, David B. Schwartz, QUINN EMANUEL URQUHART & SULLIVAN, LLP, New York, NY; Marc E. Kasowitz, Christopher P. Johnson, Michael A. Hanin, Kanchana Wangkeo Leung, KASOWITZ, BENSON, TORRES & FRIEDMAN LLP, New York, NY.

For HSBC North America Holdings Inc., HSBC USA Inc., HSBC Markets (USA) Inc., HSBC Bank USA, N.A., HIS Asset Securitization Corp., HSBC Securities (USA) Inc., Neal Leonard, Gerard Mattia, Todd White, and Jon Voigtman, defendants: Mark G. Hanchet, John M. Conlon, Michael O. Ware, MAYER BROWN LLP, New York, NY.

For Goldman, Sachs & Co., GS Mortgage Securities Corp., Goldman Sachs Mortgage Co., The Goldman Sachs Group, Inc., Goldman Sachs Real Estate Funding Corp., Howard S. Altarescu, Kevin Gasvoda, Michelle Gill, David J. Rosenblum, Jonathan S. Sobel, Daniel L. Sparks, and Mark Weiss, defendants: Richard H. Klapper, Theodore Edelman, Michael T. Tomaino, Tracy Richelle High, SULLIVAN & CROMWELL LLP, New York, NY.

For Nomura Holding America Inc., Nomura Asset Aceptance Corp., Nomura Home Equity Loan, Inc., Nomura Credit & Capital, Inc., Nomura Securities International, Inc., David Findlay, John McCarthy, John P. Graham, Nathan Gorin, and N. Dante LaRocca, defendants: Bruce E. Clark, Katherine J. Stoller, SULLIVAN & CROMWELL LLP, New York, NY; Amanda F. Davidoff, Elizabeth Cassady, SULLIVAN & CROMWELL LLP, Washington, DC.

For RBS Securities Inc., defendant: Thomas C. Rice, David J. Woll, Andrew T. Frankel, Alan Turner, SIMPSON THACHER & BARTLETT LLP, New York, NY.

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DENISE COTE, United States District Judge.

Table of Contents


I. Fannie and Freddie

II. The Life of a Mortgage Loan

A. Underwriting

B. Sampling

C. Defendants' Representations to Purchasers

D. Repurchase Obligations

E. GSEs' Pre-Purchase Access to Security-Specific Information

1. GSEs Did Not Trade on Material Non-Public Information,

Including Loan Files

2. The GSEs' Access to Loan-Level Information

F. GSEs' Post-Purchase Analyses

1. Anti-Predatory Lending Reviews

2. Performance Monitoring

III. Originator Reviews

IV. Aggregator Reviews

A. Goldman Sachs


C. Nomura


V. The GSEs Were Aware of the Risk of Defective Loans

A. GSEs Had Extensive Experience With Subprime Loans Through Single

Family Purchases

B. Knowledge of the Risks of Low- and No-Documentation Loans 29

C. General Knowledge of the Subprime Marketplace

D. Risk that Originator Defects Might Reach Supporting Loan Groups

E. Risk of Inaccuracies in Defendants' Representations

1. The GSEs' Pre-Purchase Credit Risk Analyses

2. Appraisal Bias

VI. Single Family Discovery Rulings

VII. FHFA's Allegations and the Instant Motion


I. Relevant Standards

A. Summary Judgment Standard

B. Elements of Sections 11 and 12(a)(2) Claims

C. Actual Knowledge

II. FHFA's Burden

III. The GSEs Did Not Have Actual Knowledge of Falsity

A. The GSEs' General Knowledge

B. The GSEs Actually Believed Certain Representations Were Inaccurate

C. GSEs Believed Some Defective Loans Might Reach SLGs

1. Mortgage Loans May Reflect Origination Practices

2. Expectation " Inherent" in GSEs' Business Practices

3. Defendants' Use of Sampling

4. Repurchase Obligations

D. Limits on Discovery


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Plaintiff Federal Housing Finance Agency (" FHFA" ), as conservator for the Federal National Mortgage Association (" Fannie Mae" ) and the Federal Home Loan Mortgage Corporation (" Freddie Mac" ) (together, the Government-Sponsored Enterprises or " GSEs" ), brought these actions against financial institutions involved in the packaging, marketing, and sale of residential mortgage-backed securities (" RMBS" ) purchased by the GSEs between 2005 and 2007, alleging among other things that Defendants[1] made materially false statements in offering documents for the RMBS (the " Offering Documents" ). FHFA has moved for partial summary judgment on several grounds. At issue in this Opinion is FHFA's motion concerning the GSEs' knowledge of the falsity of these statements.

FHFA urges that no reasonable jury could find that the GSEs knew these statements were false; accordingly, FHFA requests partial summary judgment on Defendants' knowledge defense under 15 U.S.C. § 77k(a) (" Section 11" ) and the absence-of-knowledge element of FHFA's claims under 15 U.S.C. § 77l(a)(2) (" Section 12(a)(2)" ) and similar provisions of D.C.'s and Virginia's Blue Sky laws. See D.C. Code § 31-5606.05(a)(1)(B) (" D.C. Blue Sky law" ); Va. Code Ann. § 13.1-522(A)(ii) (" Virginia Blue Sky law," and together with the D.C. Blue Sky law, the " Blue Sky Laws" ). For the reasons set forth below, FHFA's motion is granted.


FHFA brought sixteen related actions in this district alleging misstatements in the Offering Documents for certain RMBS certificates purchased by the GSEs between 2005 and 2007 (the " Certificates" ). All but four actions have settled. The remaining actions concern 65 residential mortgage-backed securities issued or underwritten by Defendants (the " Securities" ), which the GSEs purchased for more than $19 billion.

RMBS are securities entitling the holder to income payments from pools of residential

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mortgage loans (" Supporting Loan Groups" or " SLGs" ) held by a trust. Each of the mortgage loans underlying the Securities at issue (the " Mortgage Loans" ) began as a loan application approved by a financial institution, known as the loan's originator (the " Originator" ).[2] Goldman Sachs, HSBC, and Nomura acted as " aggregators" here,[3] purchasing Alt-A and subprime[4] mortgage loans and then pooling them together, on the basis of credit or other characteristics. The loans selected for a given securitization were transferred to a trust created specifically for that private-label securitization (" PLS" ).

Within a given securitization, the loans were placed into one or more Supporting Loan Groups. For example, Goldman Sachs's INDX 2005-AR18 securitization, offered through a Prospectus Supplement of September 2, 2005, was comprised of twenty-three classes of Certificates and two Supporting Loan Groups with an aggregated stated principal balance of over $2.4 billion. Goldman Sachs represented that the original principal balances of the loans in one group " conform[ed] to Fannie Mae and Freddie Mac guidelines" that set maximum initial loan balances, and made no such guarantee about the loans in the second group.

The trust then issued certificates to Defendants, who in turn sold them to the GSEs, which entitled the holder to a stream of income from borrowers' payments on the loans in a particular Supporting Loan Group. Thus, a certificate's value depended on the ability of mortgagors to repay the loan principal and interest and the adequacy of the collateral in the event of default.

The certificates linked to each SLG were further subdivided into tranches of varying seniority. Holders of the most senior certificates for a given SLG were paid first, after which holders of the next-most-senior certificates received payment, and so on. Thus, should some borrowers in an SLG default on their loans, certificates in the junior-most tranche would absorb all or most of the shortfall before payments to more senior certificates were affected. Accordingly, the most senior certificates were subject to less risk than were more junior certificates. By apportioning risk in this way, Defendants were able to create AAA-rated securities from Alt-A and subprime loans. The GSEs purchased senior Certificates -- often only the most senior -- with the highest credit ratings.

The Defendants raise arguments about the GSEs' knowledge concerning many facets of the origination and securitization process. Below are the principal facts linked to Defendants' major arguments, as well as needed context for those facts. All reasonable inferences are drawn in favor of Defendants, as non-movants. Where Defendants offered a litany of similar examples, the Court has attempted to select the strongest or most illustrative. For reasons given in the Discussion section, the Court finds that many of these facts have little bearing on the question at issue here:

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whether the GSEs actually knew that the Defendants' specific representations in the Offering Documents at issue here were false.

I. Fannie and Freddie

Fannie Mae and Freddie Mac are government-sponsored enterprises created to ensure liquidity in the mortgage market. Fannie Mae was established in 1938, Freddie Mac in 1970. Their primary business is to purchase mortgage loans from originators that conform to the GSEs' standards (" conforming loans" ) and then either hold those loans on their own books or securitize them for offer to the public. This side of their business is known as the " Single Family" side. In 2000, the GSEs began to purchase quantities of Alt-A and subprime loans as well and securitizing some of those purchases. Office of Policy Development and Research, U.S. Department of Housing and Urban Development, Fannie Mae and Freddie Mac: Past, Present and Future (2009), in 11 Cityscape: J. Pol'y Dev. & Res. 231, 236-37 (2009).

Each GSE also conducts a second business. The GSEs purchase and hold private-label mortgage-backed securities (PLS), although this is a substantially smaller portion of their activities. It is the PLS that the GSEs purchased from the Defendants that prompt the claims in these lawsuits. The GSEs held approximately $100 billion in PLS in 2002, with roughly $35 billion in subprime and $3 billion in Alt-A PLS; at their peak, in 2005, the GSEs' PLS holdings had grown to approximately $350 billion, with roughly $145 billion in subprime and $40 billion in Alt-A PLS. Cong. Budget Office, Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market 10 (Dec. 2010); [5] Nat'l Comm'n on the Causes of the Fin. & Econ. Crisis in the U.S., The Financial Crisis Inquiry Report 124 fig. 7.3 (2011).[6]

II. The Life of a Mortgage Loan

The process that created a private-label security, whether followed faithfully or not, generally worked as follows.

A. Underwriting

A loan file that contained the documents assembled by an originator for a given Mortgage Loan was reviewed in a process called " underwriting" at one or more times before the Loan was placed in a securitization. In the first instance, the originator underwrote each Loan it approved, confirming that it met applicable underwriting guidelines, was valued reasonably and accurately, and was not fraudulent. Originators sometimes made case-by-case exceptions to their underwriting guidelines when a loan application failed to meet a certain guideline but appeared to nonetheless qualify for a mortgage program based on compensating factors.

Defendants, who functioned as " aggregators" of the Mortgage Loans, acquired loans from Originators in order to pool them into Supporting Loan Groups that would be tied to securities. Before purchasing these loans and issuing securities backed by them, the GSEs understood that Defendants -- or third-party vendors on Defendants' behalf -- conducted due diligence review of the loan pools to confirm that the loans met the relevant underwriting guidelines as well as to confirm other characteristics of the loans that were described

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in the prospectus supplements that accompanied each securitization, such as the loans' loan-to-value (" LTV" ) ratios[7] and combined loan-to-value (" CLTV" ) ratios[8] and the owner-occupancy rates for the properties underlying the loans. Based on these reviews, Defendants might refuse to purchase some loans.

B. Sampling

As the Defendants described their due diligence practices to one or both GSEs, when Defendants conducted due diligence review of a pool of loans, they often reunderwrote a sample of the loans. HSBC, for example, disclosed to PLS investors that it reunderwrote the loan file against not only the originator's underwriting guidelines but also HSBC's own eligibility standards. It employed a " 10% minimum adverse and random sample" for prime and Alt-A loans, and " 25% minimum adverse and random sample" (20% adverse and 5% random) for subprime loans. " An adverse sample . . . [wa]s selected based on the layered risks inherent in the loans (i.e., those posing the greatest default and loss [risk] in the pool)." This adverse sample was created by a " proprietary model, which w[ould] risk-rank the mortgage loans in the pool" based on a dozen indicia of credit risk. The selection of the sample depended as well on HSBC's evaluation of the " [o]verall risk level of the mortgage pool," " [p]rior transaction due diligence results," and the " [f]inancial standing of the seller."

A 2006 Freddie Mac review of Goldman Sachs reported that Goldman Sachs's " due diligence sampling model . . . relies primarily on adverse selection to ensure they see the loans with the highest probabilities of default." The review found that Goldman Sachs's " Alt A and Subprime sample levels depend on seller" ; the sample size was " [t]ypically 50%" but could be " 20-25% for more seasoned sellers." These samples were " typically 85-90% adversely selected."

Similarly, Fannie Mae reported in a 2006 review that RBS's " typical sample size" for non-prime loans was 25%, " predominantly adversely selected." For prime and Alt-A loans, " sampling size [wa]s determined by a statistical calculation intended to obtain a 95 percent confidence interval, a less than 10 percent error rate, and precision of five percent or greater." RBS " require[d] additional adverse selection for compliance [red flags], high loan balance, low FICO [credit] score, seasoning, or other abnormal loan characteristics." [9]

A Freddie Mac report on Nomura's diligence practices in March 2006 found that Nomura conducted property and compliance due diligence on 100% of loans. Nomura conducted credit due diligence on 100% of loans in pools with amounts less than $25 million, and on 20% of loans in pools with greater amounts.

C. Defendants' Representations to Purchasers

In the offering documents for each security, Defendants made representations to

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purchasers, like the GSEs, concerning the mortgage loans' adherence to applicable guidelines and the loans' characteristics. The offering documents included a Shelf Registration Statement filed with the Securities and Exchange Commission (" SEC" ), as well as the relevant Prospectus and Prospectus Supplements.[10]

For instance, with respect to Supporting Loan Group I in Goldman Sachs's Securitization FFML 2006-FF13,[11] an SLG that backed a senior Certificate purchased by Fannie Mae, Goldman Sachs represented that:

(1) " [t]he mortgage loans were originated or acquired generally in accordance with the underwriting guidelines described in th[e] prospectus supplement" ;
(2) 67% of the loans (or 68.94% of the pool by principal balance) had an LTV ratio of 80% or lower, and the same percentage had a CLTV ratio of 80% or lower;
(3) 100% of the underlying properties were owner occupied; and
(4) the Certificate would be " rated . . . in the one of the four highest [credit] rating categories." [12]

D. Repurchase Obligations

Many of the Offering Documents for the Securities at issue included a repurchase provision requiring Originators or Defendant sponsors to buy back a " defective" loan in certain circumstances. In many cases, the Originator or sponsor was obligated to repurchase a loan if it was originated as a result of fraud, negligence, or a misrepresentation or omission. For example, with respect to FFML 2006-FF13, First Franklin Financial Corp. (" First Franklin" ), as Originator, or Goldman Sachs, as sponsor, was " obligated to repurchase, or substitute for, [any] mortgage loan" should it happen that, " with respect to [that] mortgage loan[,] any of [First Franklin's or Goldman Sachs's] representations and warranties . . . are breached in any material respect as of the date made."

E. GSEs' Pre-Purchase Access to Security-Specific Information

1. GSEs Did Not Trade on Material Non-Public Information, Including Loan Files.

Given federal securities laws prohibiting insider trading, the GSEs understood that their PLS traders and any others involved in purchase decisions could not be privy to material nonpublic information about the Securities. In addition to purchasing PLS, the GSEs purchased mortgage loans directly through the Single Family side of their businesses. But, because of the securities laws, " there was a firewall between [each GSE's PLS business] and [its] single family" business. For example, Fannie Mae's Single Family Counterparty

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Risk Management Group (" SFCPRM" ) recognized that it " must exercise extreme caution when disseminating information relating to PLS Counterparties," since it was barred from " sharing non-public information with the Mortgage Portfolio Traders" at PLS. Likewise, Freddie Mac required that non-public information be scrubbed from data about a given PLS deal before PLS traders could review it. In particular, the GSEs understood that federal securities laws barred them from " pre-settlement access to the loan files."

2. The GSEs' Access to Loan-Level Information

The GSEs' PLS traders were often given access only to aggregated information concerning a securitization or supporting loan group as a whole. This information typically included the distributions of LTV and CLTV ratios, owner-occupancy rates, FICO credit scores, no- and low-documentation loans, mortgage type (e.g., fixed-rate or amortizing adjustable rate), and Alt-A and subprime loans.

There is no evidence that the GSEs were ever given pre-purchase access to the loan files for the Mortgage Loans. But, in at least one PLS deal in March 2006, HSBC sent Paul Norris (" Norris" ), who was responsible for Fannie Mae's PLS portfolio, loan-level information including each loan's originator, LTV ratio, and property street address.[13] In July and September 2007, Fannie Mae used a proprietary automated valuation model (" AVM" ), called the Retrospective Property Service (" RPS" ), to test the appraised property values in three prospective PLS deals, none of which is at issue in these actions. To run an RPS test, Fannie Mae needed to have, among other data, the street addresses for the mortgage properties. An AVM can offer insight into the risk of appraisal bias in a given loan.[14] David Gussman (" Gussman" ), a Fannie Mae Vice President in the Capital Markets Strategy division, testified that Fannie Mae " ran [RPS] sort of on an ad hoc basis on a couple of deals" in or around September 2007 and was " investigating" whether to use it " on all PLS deals going forward" but never did so " because we never got that data we're talking about" for enough deals. In a September 2007 email discussing the use of RPS in connection with another PLS deal, a Fannie Mae employee noted that " [f]or seasoned [i.e., older] deals I don't think we have address data."

The only evidence with respect to Freddie Mac indicates that loan-level information, including property street addresses, was not provided to PLS traders, although others at both GSEs had access to loan-level information to review the extent to which loans would meet affordable housing goals set for the GSEs by the U.S. Department of Housing and Urban Development and to request that loans that did not meet housing goals be removed from a prospective Supporting Loan Group.[15] There is no evidence that the GSEs ever used property street addresses to conduct a pre-purchase

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test of the Mortgage Loans at issue in these actions for appraisal bias.

F. GSEs' Post-Purchase Analyses

1. Anti-Predatory Lending Reviews

The GSEs made efforts to discourage predatory lending practices such as prepayment penalties and excessive fees and points, or lending without regard to a borrower's ability to repay the loan. But, " because of SEC related restrictions related to public securities, the [pre-purchase] loan level due diligence [for anti-predatory lending compliance] [wa]s managed by the seller of securities, not Fannie Mae Legal." These sellers were required to make representations and extend warranties about compliance with these anti-predatory policies. The GSEs had the right to " put back" any loans that violated the " reps and warranties." Consequently, Fannie Mae's Legal Department took steps after the purchase of a PLS certificate to confirm that the PLS sellers had complied with Fannie Mae's anti-predatory lending policy. The Legal Department undertook operational reviews of Originators after the settlement date of PLS purchases and required transaction-specific due diligence 90 days after the settlement date. These reviews were not shared with Fannie Mae's PLS traders.

As of May 2005, Fannie Mae's anti-predatory lending review was conducted as follows. Once Fannie Mae's Supporting Loan Group was finalized, and prior to settlement, Fannie Mae required that the issuer or underwriter have its due diligence provider " generate a Fannie Mae compliance exception report" (" Fannie Mae Exception Report" ). Loans identified as exceptions had to be cleared with the diligence provider or removed from the SLG prior to settlement. Ninety days after settlement, the Fannie Mae Exception Report was sent to Fannie Mae's Legal Department. The Legal Department would review the Report and require immediate repurchase of any loan exceptions that remained in the SLG.[16]

Defendants have submitted two such Fannie Mae Exception Reports. The first, issued in April 2006 concerning Goldman Sachs Securitization GSAMP 2006-FM1, noted that the " borrower does not have sufficient ability to pay" in 10 loans (1% of the sample reviewed), as well as several other compliance violations, including excessive finance charges or certain documents missing from the loan file. The second, issued in July 2005 concerning a securitization not at issue in these actions underwritten by RBS, did not find that any borrowers had insufficient ability to repay the loan.

2. Performance Monitoring

After purchasing RMBS, the GSEs monitored the performance of their Securities. They received monthly " remittance reports" that reflected delinquencies and early payment defaults (" EPDs" ) in the underlying Mortgage Loans. Freddie Mac created a " Weakest Deals Report" listing struggling securities and a " Mortgage ABS Portfolio Report" that tracked delinquency rates by loan type. Similarly, Fannie Mae created a monthly " Watch List" identifying poorly performing PLS deals. Several of the GSEs' former employees testified that EPDs may suggest

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misrepresentations in the underlying loan applications.

In the late summer and fall of 2006, the GSEs saw an increase in EPDs, including in the PLS they held. On August 25, 2006, a Fannie Mae weekly email sent by PLS trader Shayan Salahuddin (" Salahuddin" ) concerning news in the subprime market noted that H& R Block, the parent of Option One Mortgage (" Option One" ), took losses " due to an increase in early payment defaults on Option One originations." Salahuddin continued:

Investors should carefully consider how this affects their view of origination standards and quality control in the subprime sector, as Option One has long been considered on[e] of the better originators. However, from a purely economic perspective, this issue is more poignant to originators than to investors as originators are required to repurchase loans that default within the first couple of payment cycles.

Salahuddin testified that " in late 2006 . . . the increase in defaults in deals in general was . . . concerning." A December 15, 2006 email from Kin Chung (" Chung" ), Fannie Mae's Director of PLS Surveillance, noted, based on preliminary data, that " our 2006 vintage [of PLS] is showing much faster ramping in delinquencies than previous vintages" and that " the 2006Q2 [second-quarter 2006] vintage is performing significantly worse than the 2006Q1 vintage."

In November 2006, an internal Freddie Mac document titled " Summary of Freddie Non-Agency Portfolio and the Subprime Market" reported, with respect to the " 2006 Vintage" of loans, that " 2006 60 day delinquencies ('DQ') [i.e., loans where monthly payments are more than 60 days past due] are greater than all other vintages at comparable seasoning, including 2000 which was the worst vintage of this decade." In particular, the summary notes that the 60 day DQ rate was equivalent to 90 basis points (" bps" ) for the 2003 vintage, 160 bps for the 2005 vintage, and 240 bps for the 2006 vintage. It also reports that " more leveraged 2nd liens and high LTV loans have performed worse in 2006 relative to any other vintage," that there is a " significant incidence of foreclosure in the 2006 vintage at such an early stage," and that " there has been a noticeable decline in underwriting standards (higher CLTVs, lower FICOs)." The summary states that " [u]nderwriting is a major concern as originators are stretching for volume." With respect to EPDs in particular, the summary reported that " [e]arly payment defaults are up significantly, especially for loans with piggyback seconds [second mortgages]," with " Option One, Accredited and WAMU hav[ing] reported significantly higher levels of EPD."

Freddie Mac's December 2006 " MABS [Mortgage Asset Backed Securities] Industry Review" reported " a pervasive loosening of credit standards in originators' underwriting guidelines." It determined that " the combination of lower HPA [home price appreciation] and aggressive underwriting practices ha[d] begun to show up in delinquency and EPD figures." The review noted that Fitch projected that " 2006 vintage subprime mortgages will perform substantially worse in 2007, with cumulative lifetime losses ultimately reaching 7%, the worst collateral losses of any vintage to date," and that " [s]erious subprime delinquencies ha[d] increased almost 50% year-over-year."

These trends continued in 2007. For example, a June 8, 2007 Fannie Mae " PLS Credit Trend Report" for the month of May noted that " Fannie Mae 2006 investments continue to demonstrate the higher delinquency rate as well as cumulative

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losses than other vintages at the same age," that " Fannie Mae 2007 subprime investments are tracking the 2006 vintage in 60 days delinquency rate," and that " Fannie Mae 2007 Alt-A acquisitions perform worse than the 2006 vintage at the same age." The report also found that " Fannie Mae 2006 and 2005 investments have significantly higher Foreclosure rate and REO[17] percentage compared to other vintages at the same age. This is consistent with the looser underwriting standards during that period."

III. Originator Reviews

The GSEs' Single Family businesses investigated and approved originators before purchasing mortgage loans from them. The PLS operations at the GSEs relied on those reviews, or the results of those reviews, from the Single Family operations in making their trading decisions.

As of August 2006, Fannie Mae required PLS to confirm, among other things, that any originator of more than 10% of the underlying mortgage loans was on a list of Fannie Mae approved originators. Its SFCPRM was tasked with approving originators. SFCPRM reviews, some of which included on-site visits, primarily assessed " [c]ounterparty risk," which was " the risk of financial loss to Fannie Mae resulting from [the counterparty]'s failure to meet its contractual obligation[s]," including inability to meet repurchase obligations. SFCPRM also examined originators' underwriting protocols, appraisal practices, and fraud detection. In some instances SFCPRM, itself or through a third-party vendor, conducted loan-level reviews of a sample of the originators' loans.

Pre-approval from Freddie Mac's Alternative Market Operations Group (" AMO" ) was required for any originator that originated loans constituting more than 1% of the unpaid principal balance of Freddie's PLS portfolio. AMO was part of Freddie's Single Family business. AMO's counterparty reviews of originators examined, among other things, the originator's adherence to its underwriting guidelines and its appraisal protocols. AMO originator reviews typically included on-site visits and reunderwriting of fifty loan files. While PLS traders at Freddie Mac had access to AMO's originator reviews, it appears that Fannie Mae's traders were only given a list of approved originators.

SFCPRM conducted an on-site operational review of Originator First Franklin on May 24 and 25, 2006.[18] Defendants list First Franklin as the sole " major originator" in eight of the 65 Securities at issue and as one of several " major originators" in two of the Securities. Among the counterparty risks SFCPRM evaluated were the " [r]isk of poor underwriting performance and deterioration of credit quality in originations" and the " [r]isk of poor due diligence around property valuation and collateral support." SFCPRM's summary findings concerning First Franklin's origination practices were as follows:

First Franklin has acceptable operational practices and procedures to mitigate the risk associated with the origination of Subprime collateral. FF utilizes quality control and quality assurance findings to enhance their processes and procedures. Sales and branch office compensation is based heavily on loan

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performance and QC [quality control] findings, rather than simply on loan volume. This creates companywide awareness around quality, not quantity.
The appraisal review process utilizes CoreLogic's LoanSafe to mitigate the risk associated with fraudulent and inflated appraised values. The use of CoreLogic and other vendors is considered a best practice within the industry. FF's automated underwriting system, Easy Writer, is rules based and allows for loan scenarios to be placed in the best available loan program. FF's [sic] is very conscious of predatory lending and has hard stops built into their LOS [loan origination system] to prevent the origination of loans which violate state and federal predatory guidelines. FF also tracks all loan exceptions ...

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