FHA Loan Difficulties; Monitoring Counterparties, Affiliate Fees; Selling Loans Servicing Retained?

A new study by PayScale finds “Gen Y” aged 35 years and younger are having a hard time out there. About 16% who have a job are living at home still due to financial hardship & 12% have moved home at least 1x in the past. And this group is expected to keep the housing industry going forward? Here you go. Of course, this is misleading. Put another way, 84% are out on their own, and 88% have not moved back home in the last year.

I received this note on counterparty from Willie Newman, the president of Cole Taylor Mortgage. “Rob, as recent commenters on this site have noted, OCC guidance issued October 30 requires bank management to ‘…identify, measure, monitor, and control the risks associated with third-party relationships…’  Non-bank originators also should pay close attention to the counterparty risk created by vendor relationships. There’s much more scrutiny from our regulators – and we’ve seen this directly – regarding vendor management. That’s one reason Cole Taylor Mortgage this year reduced the number of MI providers we use to three, and centralized the process of selecting mortgage insurance providers. We don’t think MI is something that should be decentralized. It doesn’t make sense for people who get paid based on production to be making risk decisions for us. For us, selection of an MI provider (in CTM’s case, Essent, Genworth, and MGIC) is a risk-oriented process and not simply a pricing, marketing or relationship strategy. We try to understand and stay ahead of where the regulatory process is going. With the combination of the risk involved and the downstream potential exposure to the counterparty, I think regulators would be pleased to know that we’re actively managing those relationships and controlling the processes related to vendor management.”

Last Saturday this commentary had a letter from a reader saying, "There were panel members who were commenting on the CFPB Affiliate Business rules that go into effect in January and their calculation of the fees generated by those affiliates and the impact on point & fees calculation of QM.  Some indicated the fee was only that portion the lender retained. Recently I attended the MBA Residential Loan Production Committee meeting here in DC and CFPB Associate Director David M. Silberman specifically addressed that question, bluntly stating that THE ENTIRE fee charged by the affiliate (title or appraisal affiliate) is to be included in the 3% points & fees calculation of QM. I thought you might wish to provide this to your readers since there seems to be interpretation otherwise, which is not consistent with the CFPB's."

But Jean O., a compliance manager from California, writes, “In your commentary you state that the entire fee charged by an affiliate is included in Points and Fees for QM Loans – as quoted by David M. Silberman, Associate Director of CFPB. Last week I talked to an attorney with the CFPB in response to an email I sent regarding Affiliate Fees because we do have Affiliate Companies where this determination will be important. The attorney, Andy A., specifically told me that the only part of the charges from an Affiliate is the portion retained by the Affiliate.  For example, an Insurance Agency is an Affiliate and the charge on the HUD is to that insurance Agency for $1000.00 for the Homeowner’s Policy.  The Agency passes through $900.00 to the Insurance Company, e.g. AETNA, and retains $100.00 as their brokerage fee.  Only the portion retained i.e. $100, is included in Points and Fees. Similarly, if the Affiliate is a Title Company, the Escrow and Notary Fees and any other fees charged by the Title Company for Services performed and retained by the company are included in Points and Fees.  But…..when it comes to the Title Insurance Fees, again only that portion retained by the Title Company is included in the Points and Fees, not the portion passed through to the Insuring Company for the cost of the Title Insurance. When we are getting mixed messages from people at the same agency, this is very confusing to us who are in the process of writing Policies and Procedures for our mortgage company.”

“Rob, why don’t the aggregators like Wells or Chase buy loans servicing retained, and let the lender service them?” That’s an easy one: control, liability, and customer retention. A mortgage servicer collects payments from the borrower on behalf of the investor, handles customer service, pays real estate taxes & insurance on escrowed loans (and pays 2% on escrow balances in states like California), negotiates loan modifications on behalf of the investor, etc. If something goes wrong with the loan, will the investor (such as an insurance company, pension fund, money manager in Korea, whoever) want the loan serviced by Chrisman Mortgage, with $500 million in servicing, or Wells Fargo, with $ trillion? A certain number of companies, while desirous of retaining servicing, and given their servicing department insufficient resources, leaving them ill-equipped to handle future problems or even the current onslaught of regulations.

Recently Stu Gersh wrote, “I had to comment on your paragraph discussing an opinion about how an LO loves their job, but hates the system. I just turned down a gentleman looking to purchase a new home with a price of over $1 million and a down payment of over $600,000. His middle credit score was almost 770. His crime? He’s retired and his multi-million dollar stock portfolio did not produce enough income to “qualify” and I could not annuitize the assets because they were not in retirement accounts. So guess what? He’s going to use the additional $1.5 million dollars he received from the sale of his previous home and PAY CASH for the new home. My company loses the loan. I lose the commission and the trust of the RE agent that sent him my way. As I see it, the lending parameters have swing so far that the pendulum is off its pivot point.”

There are a lot of questions about the FHA program, so let’s take a look at some recent questions and events regarding the program – especially why any lender should take a good, hard look at the program before originating FHA loans. An all-encompassing treatise would take up hundreds of pages, so I just wanted to hit the highlights given some of the questions that seem to come up.

First, banks are sitting on an enormous volume of delinquent FHA loans. According to a recent American Banker article, Bank of America, Citigroup, JPMorgan Chase and Wells Fargo have $57 billion in seriously delinquent, FHA-insured, loans against which no FHA claims have been made.  Moreover, the top ten largest FHA lenders are holding more than 550,000 seriously delinquent FHA loans.

With FHA insurance, FHA guarantees a recovery of the losses to a lender on a defaulted mortgage; however, in recent years, the industry has seen more and more insurance claims contested. Not only do lenders risk FHA claim audits, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) and the False Claims Act allow the government to seek significant monetary damages against  lenders where the government can establish that defaulted loans were not originated to FHA standards. Therefore companies are doing more research on defaulted loans before filing any claims that will raise flags with the agency and regulators.

But what damages are available to the government under FIRREA and the False Claims Act? For FIRREA, the DOJ has begun using the civil money penalty provision of FIRREA to investigate and prosecute persons suspected of financial fraud. Recently, the DOJ has invoked FIRREA, often in conjunction with the False Claims Act to seek multimillion- or multibillion-dollar penalties against some of the largest financial institutions in the US. Earlier this year, for example, the DOJ filed its largest-ever lawsuit under FIRREA against the world's largest credit rating agency, Standard & Poor's ("S&P"), seeking more than $5 billion in civil money penalties based on allegations that S&P engaged in a scheme to defraud investors who purchased residential mortgage backed securities and collateralized debt obligations. FIRREA provides the DOJ with a number of key advantages in conducting investigations and bringing civil penalty suits against persons suspected of financial fraud, including a broad scope, investigative powers (like subpoenas), a ten year statute of limitations, and Civil Money penalties up to $1.1 million per violation – who wants that risk?

Under the False Claims Act (which states that any person presenting a claim, record or statement related to an obligation to pay, or conceals or decreases an obligation to pay the government is liable for damages), it applies to FHA lenders and servicers seeking a government guarantee on mortgage loans. FHA Direct Endorsement (DE) lenders undergo an annual and loan level certification, under which they are liable for the False Claims Act if they fail to meet the standards laid out in the certification. Servicers filing inappropriate claims for property management costs could also be liable under the False Claims Act.

The damages include a civil penalty of at least $5,500 in addition to treble damages, or three times the amount of damages the government sustains as a result of the claim. The threat of treble damages under the False Claims Act may explain why some of the largest lenders may choose to absorb the losses on FHA loans instead of submitting claims. And those who keep track of such things know that the Dodd-Frank Act expanded the False Claims Act so whistleblowers can receive 10 to 30 percent of damages recovered in excess of $1 million.

The type of violations pursued also appears to vary widely.  For example, one lender’s False Claims suit was based on underwriting deficiencies, another on inadequate reporting, and another on loans the lender did not even originate but instead acquired during the purchase of the originating lender.

And it is not the officers at Mayberry RFD who are enforcing this. The Collingwood Group writes, “The government is pursuing a new collaborative approach for the various groups to share relevant information and then delegate enforcement accordingly.  Therefore, FHA lenders and servicers are subject to the scrutiny of not one or two regulators, but instead half a dozen oversight parties, including FHA, HUD OIG and its new Joint Civil Fraud Division, the DOJ, President Obama’s Financial Fraud Enforcement Task Force and its Mortgage Backed Securities (MBS) Working Group, and even the State Attorneys General - and their own conscious – and these investigations can begin after a claim is filed.”

It is said that the FHA does not only use Compare Ratios in flagging lenders, but also volume. All FIRREA and False Claims enforcement actions to date have involved mortgage originators.  Even in the case where a FHA lender sells the mortgage servicing rights to a new servicer, the originator is still liable. Therefore, whether the lender is the servicer and files a FHA claim or a separate servicer files a claim that is found to violate the False Claims Act, the lender is responsible for the damages. But servicers are not off the radar screen: they can also liable for False Claims Act and FIRREA violations. In circumstances where the original lender is the servicer of the loan, of course, then that lender is liable. Servicers would be liable under the False Claims Act is if inappropriate or excessive claims were charged to HUD for allowable property preservation, protection, foreclosure and legal costs associated with conveyance claims.  And yes, lenders who purchased other lenders are liable for the loans originated by the acquired entity.

In the world of “it is not enough to monitor yourself, but you also must monitor everyone of substance with whom you do business,” FHA lenders are reviewing vendor relationships and bifurcating post-closing quality control (QC) and standards. Since the originator is held liable for most damages, FHA lenders should ensure that outsourced service providers clearly understand the nuances of FHA QC.  Lenders should actively manage third party vendors to ensure close attention is paid to FHA standards and timelines in order to mitigate risk.