Recent indications from the Department of Housing and Urban Development (HUD), HUD’s Office of Inspector General (OIG), and quarterly SEC filings by lenders of FHA mortgages, strongly suggest that HUD’s aggressive enforcement actions against FHA lenders over the past few years are likely to continue in the New Year. Lenders should remain vigilant of new FHA enforcement actions and be aware of the common underwriting and origination practices and FHA program requirements targeted by HUD in prior investigations.
In its annual report to Congress last month on the financial state of the Mutual Mortgage Insurance Fund (the Fund), HUD cited its increased enforcement activity against FHA-approved lenders as a key policy change by the administration that contributed to returning the Fund to a positive balance for the first time in two years. The report states that HUD will continue its focus on enforcement actions and ask Congress for “[a]uthority to better monitor and enforce lender compliance” with FHA program guidelines.
Earlier this quarter, the HUD-OIG issued a press release highlighting its joint efforts with the Department of Justice (DOJ) to pursue civil investigations to secure “significantly sized settlements” against the largest FHA lenders for failure to follow FHA loan origination and underwriting guidelines. The OIG’s statement also noted that the settlements were part of “a continuing effort” to pursue problems in the underwriting practices of FHA lenders.
In addition, a number of third quarter filings by FHA lenders indicate that several of HUD’s enforcement actions remain ongoing and unresolved, and that lenders remain wary of future enforcement actions. Even smaller lenders of FHA loans are cautious of HUD enforcement actions. A recent public filing concerning a merger of two small FHA lenders identified as a risk factor for the banks’ FHA lending that “[HUD-OIG] has become active in enforcing FHA regulations with respect to individual loans and has partnered with the [DOJ] in filing lawsuits against lenders for systemic violations” under the False Claims Act, and other federal laws.
These public statements demonstrate that HUD’s increased enforcement activity against FHA lenders, including increased indemnification requests, revocation of lender approval, and most prominently, civil enforcement actions under the False Claims Act, FIRREA, and other federal and state laws, will likely continue next year.
Reviewing recent enforcement actions and consent orders against FHA lenders reveals that there are several common underwriting and origination practices and core FHA program requirements consistently targeted by HUD. While these actions mostly focused on loans originated from between 2004 and 2012, lenders should nonetheless be aware of these target areas in anticipation of potential new enforcement actions.
First, in nearly every settlement and ongoing action against FHA lenders, HUD has alleged that the lender systematically originated loans that violated HUD’s underwriting guidelines. Specifically, HUD alleged that lenders had unacceptably high defect rates; failed to exercise due diligence in the underwriting process; failed to properly document borrower income; improperly calculated borrower income; and failed to properly validate loans through the AUS computerized underwriting system. In its action against one prominent lender, HUD alleged that during certain months, 50% of the FHA loans the lender originated failed to comply with FHA guidelines because the loans exceeded DTI ratios without compensating factors, and loan data entered into AUS was not properly validated, among other defects. Likewise, HUD alleged that another mortgage lender manipulated borrower data entered into the AUS system to generate an Approve/Accept rating, and failed to manually downgrade loans to “Refer” pursuant to the guidelines for TOTAL Scorecard. And against another bank lender, HUD contended that underwriters failed to obtain complete employment histories for borrowers, miscalculated the maximum mortgage amounts available to borrowers, and gave borrowers excessive cash back at closing.
Second, HUD targeted improper training and compensation of underwriters. HUD alleged that lenders failed to properly train underwriters; permitted non-DE certified underwriters to underwrite loans; and allowed underwriters to receive commissions in violation of FHA program requirements. Against one bank lender, HUD contended that non-DE certified underwriters were permitted to review and clear underwriting conditions, and that underwriters were given bonuses based on quotas and volume instead of quality, which resulted in higher defect rates for the top producing underwriters. HUD also alleged that lenders inadequately trained FHA underwriters, evidenced by underwriters receiving more training on loan products that were far less complicated than FHA loans.
Third, HUD frequently targeted lenders’ Quality Control programs. HUD alleged that lenders failed to conduct monthly reviews as required by FHA; QC staff cleared loans as acceptable that otherwise were underwritten with significant defects; and that management failed to remediate problems identified in QC reviews. In an action against one lender over loans made by a company it acquired, HUD asserted that, despite conducting QC reviews, the QC results were never reviewed, were not reported to management, and no changes were implemented based on the QC findings. Similarly, HUD alleged that some lenders had inadequate QC staff, and that the true volume of defects were underreported due to unclear and inconsistent application of the definitions of “material” and “significant” underwriting errors. HUD also targeted banks where management was allegedly aware that in given months up to 50% of its FHA loans failed to comply with FHA guidelines, but took no remediation action.
Fourth, HUD asserted that lenders violated FHA’s requirement to self-report loans that failed to meet guideline requirements. For example, in one case, a lender purportedly identified thousands of loans that required self-reporting, but systematically failed to report any of those loans to HUD. In another, the bank allegedly pressured managers not to self-report loans that violated FHA guidelines.
Finally, HUD targeted FHA lenders for other practices and violations of FHA program requirements, including failing to respond to post-endorsement technical reviews; failing to identify fraudulent loans; and using appraisals that violated FHA guidelines or contained inflated and unsupported values.
With HUD projecting the balance in the FHA Fund to significantly improve in the coming year and thereafter, there is little doubt that enforcement actions will remain one tool HUD uses to improve the Fund balance. It is likely that these new enforcement actions will concentrate on medium and small volume producers of FHA loans given that HUD’s enforcement actions over the past two years focused mostly on the largest volume originators. Regardless of size, however, all FHA lenders should review their current and past underwriting and origination practices for compliance with FHA guidelines and program requirements in light of the common areas targeted by HUD, and be aware that the New Year will likely bring new enforcement actions.