Loan repurchase requests from Fannie Mae and Freddie Mac are finally tapering off. Unfortunately for lenders, a crackdown by the Federal Housing Administration is filling the void.
In recent months the government agency has been denying claims and threatening lawsuits in unprecedented volume, lenders and their lawyers said. Though the underwriting failures and flaws it has flagged stem mostly from the bubble years, mortgage lenders are becoming skittish about making new FHA-backed loans.
The agency increasingly is forcing lenders to bear the risk on new loans with technical defects such as having a borrower's previous address listed incorrectly in a loan file. Some lenders were alarmed that FHA payments of foreclosure-related claims fell 15% last quarter.
"HUD is acting like any insurance agency, if a loan goes bad and there is some deficiency, they are not going to pay the claim," said Darlin McRoyal, an FHA consultant and senior compliance advisor at ComplianceEase, a Burlingame, Calif., compliance and auditing firm.
FHA officials have blamed the decline on delays in the foreclosure process, and said their inventory of loans in foreclosure is at a historic high of nearly 176,000 loans.
The Department of Housing and Urban Development, which oversees FHA, has stronger weapons to punish lenders than the government-sponsored enterprises, which can force them to repurchase bad loans and can also issue fines.
HUD can bring criminal charges against executives responsible for overseeing compliance with FHA rules. If a lender falsely certifies that loans have satisfied FHA's requirements, it can be penalized for up to three times the amount of any FHA insurance claim.
"If you're running a bank and you realize there is more liability, it changes the whole risk calculation," said Jeffrey Naimon, a partner at the law firm BuckleySandler LLP in Washington who represents banks.
Several major lenders are currently in settlement discussions with HUD for violations cited in audits dating back several years, lawyers who represent lenders in these discussions said. Some are concerned that settlement agreements with HUD may not be binding with other agencies such as the Justice Department.
Lenders raised concerns about the increased liability on FHA loans after the Justice Department filed a civil fraud suit this month against Deutsche Bank AG and its home lending unit, MortgageIT, for failing to conduct quality-control reviews of FHA-insured loans. FHA paid insurance claims on 14,000 defaulted loans from Deutsche between 1999 to 2009 totaling $386 million. The suit claims Deutsche acted with "reckless disregard" and seeks treble damages under the False Claims Act, or $1.2 billion.
Last week, U.S. Bancorp agreed to pay $1.2 million to settle allegations with HUD that it did not comply with FHA requirements on 27 loans originated in 2003 and 2004 than resulted in losses of $465,000.
Matthew Pineda, president of Castle & Cooke Mortgage LLC in Salt Lake City, said that two years ago it took FHA about 10 days to pay a claim. Now, lenders routinely have to jump through more hoops, including going through a due diligence committee and a quality control committee.
"The reason you take the risk (on an FHA loan) is because of the insurance, but now you can't depend on that insurance," Pineda said. "They're offsetting losses by making the lender eat it, so lenders have more liability than they ever did before because they're losing out on their ability to make claims."
The largest lenders hold billions of dollars of delinquent FHA loans on their balance sheets for which they have not yet filed claims.
Some industry experts said banks are conducting internal audits of these loans to ensure borrowers were offered loss mitigation by servicers, another HUD requirement, and that they have proper documentation before filing a claim.
HUD typically does not review loan files before closing and instead relies on the certification from lenders that the loan is in compliance with rules and requirements.
In the first quarter, Bank of America Corp. held $19.8 billion of loans insured by the FHA and the Veterans Administration that were 90 days or more past due. Wells Fargo & Co. had $14.4 billion, JPMorgan Chase & Co. held $9.8 billion and Citigroup Inc. had $5.4 billion.
Because the False Claims Act has a statute of limitation of 10 years, lenders are worried that they will be forced into major settlements with HUD particularly on loans originated in 2005 and 2006, when FHA volume first started to spike. Lenders recognize they have a big FHA liability problem, McRoyal said, because when many of the largest subprime lenders went out of business in 2007, their underwriters switched to FHA and continued the lax practices that were part of the cause of the mortgage meltdown.
"Quality control and due diligence did not get much attention because people were too busy funding loans and it was all stated-income," McRoyal said, referring to the "no doc, low doc," alternative-A loans that were common during the boom years. "Now you need to audit everything."
Mary Kladde, president and chief executive at Titan Lending Corp., a Denver back-office fulfillment provider, said a quality control review costs roughly $125 per loan and a fraud audit about $12 per loan but many lenders still do not conduct routine loan reviews.
"If we look at what's happened in the last four years and lenders have the ability to review loans and ensure they are quality loans, why wouldn't they do it?" she said. "The losses are so much higher when everything goes bad."
Because FHA's volume has increased dramatically in the past few years (the agency now insures 30% of all originations), lenders are not getting paid quickly after filing a claim, McRoyal said.
"HUD wants lenders to do their own due diligence, to find errors themselves, and to report the errors and put risk controls in place so it doesn't happen," she said. She cited files that contained words such as "sloppy files, sloppy lender," or "you knew or you should have known [that there was a problem with the underwriting]."
Many lenders tried to protect themselves against default risk by adding overlays such as requiring minimum FICO scores of 620 or 640 on FHA loans. But a consumer advocacy group filed a redlining complaint with HUD earlier this year claiming lenders were refusing to accept FHA applications from qualified borrowers.
David Berenbaum, chief program officer at the National Community Reinvestment Coalition, which is discussions with roughly 20 lenders about the overlays, said there is more concern about requests for "indemnification of the existing portfolio," where FHA wants lenders to cover the loss on a default.
"A big part of the issue is that lenders were not following FHA requirements and that's when they're being asked to indemnify loans," he said.