A U.S. attorney is taking a novel approach to suing Deutsche Bank for the alleged "reckless" Federal Housing Administration (FHA) lending practices of its MortgageIT subsidiary with the case sending a chill through other government lenders who fear they, too, may be on the government’s hit list.
In unveiling the lawsuit in New York, U.S. attorney Preet Bharara said MortgageIT and Deutsche Bank "repeatedly lied" to the Department of Housing and Urban Development (HUD) about its quality control procedures for reviewing newly originated FHA-insured loans.
The FHA generally cites some origination defect before refusing to pay claims or seek indemnification for future losses. But in this case, the U.S. attorney is stating that Deutsche Bank is responsible for all defaults because of MortgageIT's "failure" to implement a quality control program.
"In order to qualify for this privileged status as a direct endorsement lender, financial institutions must meet quality control standards, commit to due diligence, and certify the quality of each and every mortgage they endorse," Bharara said at a recent press conference, unveiling the suit.
He went on to allege that Deutsche Bank made false annual certifications to HUD that MortgageIT was in compliance with FHA requirements, including quality control.
As a result, the U.S. attorney is pursuing treble damages on defaulted loans as well as punitive and compensatory damages that could total up to $1 billion.
"There should be penalties for not doing proper quality control," one industry advisor told National Mortgage News. "But should those penalties, such as treble damages, be applied to every loan that goes bad?"
In early May, the U.S. attorney sent subpoenas to some top 20 FHA lenders seeking information about their quality control programs, according to sources familiar with the matter. Some are concerned the subpoenas could prompt lenders to tighten already tight lending standards.
It’s understood the subpoenas are aimed at lenders with higher-than-normal default rates.
But MortgageIT was definitely an outlier. The Deutsche unit originated 39,000 FHA-insured loans between 1999 and 2009 totaling more than $5 billion. Roughly 14,000—or 36%—have defaulted.
In its lawsuit against Deutsche, the government noted that the FHA has already paid $386 million of MortgageIT's claims, but added that “hundreds of millions of dollars of additional FHA insurance claims” may lie ahead.
The German bank acquired MortgageIT in January 2007, at the height of the mortgage boom. The lawsuit said the investment banking firm operated MortgageIT as part of its residential mortgage business. Deutsche quietly liquidated the lender in 2009.
"Close to 90% of the activity covered by the allegations happened prior to Deutsche Bank’s acquisition of Mortgage IT," Deutsche Bank said in response to the lawsuit. "We believe the claims against MortgageIT and Deutsche Bank are unreasonable and unfair, and we intend to defend against the action vigorously.”
Mortgage banking attorney Larry Platt said it is rare for the government to go after the parent of a subsidiary. "I don't know what legal authority would give the government the right to hold the parent responsible for the acts of its FHA-approved lender," Platt said.
The K&L Gates partner also noted that the reliance on annual statements of compliance and regular quality control to "justify these kind of damages is unusual."
The lawsuit against Deutsche Bank has "high PR content, but low legal foundation," Platt said.