In what is being billed by some as an effort to bring the banks back to FHA, HUD Secretary Ben Carson and Assistant Secretary Brian Montgomery yesterday rolled out the new proposed loan level certification as well as the implementation of the “taxonomy.”
These are two of the things that lenders have said need to be fixed before they return to the program.
In the press briefing by HUD it was clear that this is in part an effort to bring back institutions that had backed away from the program with HUD stating, “Since the housing crisis, the number of traditional banks participating in FHA’s single-family mortgage insurance programs has declined, resulting in a growing share of non-bank lenders originating FHA-insured mortgages.”
So What Is the Certification?
The new proposed certification is published in the federal register and can be seen here. What is key are changes limiting the attestation of the employee signing the certification to limit them from unknown information or information that they could not have known. The intent is to hold lenders accountable to clear and obvious errors or fraud, but to limit the legal risk for immaterial foot faults.
In the current certification, HUD inserted a final catch-all statement in the certification which states, “(h)The Mortgagee has exercised due diligence in processing this mortgage and in reviewing the file documents listed at HUD Handbook 4000.1, II.A.7.b. and the documents contain no defect that should have changed the processing or documentation and the mortgage should not have been approved in accordance with FHA requirements …” In conversations with members of the inspectors general office I recall them saying that “any defect” makes the loan uninsurable and should not have been approved.
To many lenders, and their legal advisors, this language essentially negates any other language in the certification by forcing the employee to assert that the loan being insured meets all applicable HUD regulations handbooks, guidebooks, MLs, etc, a broad swath of almost impossible things to be fully certain of and certainly eliminates exceptions for even immaterial human error. In effect, it retained all of the contingent liability in the minds of lenders.
And What Is The Taxonomy?
Simply put, this identifies the wide variety of defects made when originating an FHA loan from simple non-material mistakes all the way to intentional fraud or misrepresentations. It then categorizes them into four tiers with the first two consisting of severe loan level errors that must be addressed and the last two not necessarily requiring a response. The value of Taxonomy is that, if done well, it would limit the circumstances under which enforcement actions such as False Claims could be used. It holds lenders accountable for material errors and intentional fraud, but applies less onerous remedies to immaterial mistakes. You can see the full taxonomy proposal here.
Why did lenders leave the FHA?
In the midst of the Great Recession, with FHA facing mounting losses to their MMI fund, concerns about fraud and lender accountability was high. Because the volume of defaults was so high, the DOJ pursued lenders whose defaults were the result of a violation of the certifications made when insuring the mortgages in the first place. By sampling a small number of mortgages made, they extrapolated the error/defect rates across the entire portfolio resulting in significant estimates of violations by lenders in the program. But rather than applying loan level remedies or penalty’s, the DOJ used the False Claims act, otherwise known as the Lincoln Law, to address the issue. The basis of False Claims (FCA) is that once the mortgage insurance claim was submitted and paid by FHA on a loan that had an error (had a defect) when made, that lender made a false claim to the government for insurance as the loan should have been deemed uninsurable. I wrote a piece on this in Housing Wire in 2017 highlighting concerns about overreach by DOJ using this methodology in the first place.
The penalties were massive. Because FCA comes with treble damages, each incident did not result in the actual cost to remedy the situation, or even the net loss. Instead, it amounted to three times (treble) the loan amount per loan made. Multiplied across some of the nation’s largest bank portfolios we began to read of multi-billion dollar settlements between banks and the DOJ. And, in the case of resistance, the DOJ sued the lender. Today the one remaining known lawsuit is between DOJ and Quicken Loans, which is either headed to trial or may get settled this summer.
So why is this so important?
Because of what many of the nations largest financial institutions deemed as simply unacceptable risk by participating in the FHA program, they massively reduced their originations of FHA loans. And while many independent mortgage bankers have taken up the slack in the FHA program, the distortion in lending that has skewed volumes from banks to non-banks raises concerns about everything from broad access to credit for consumers across all institutions as well as counterparty risk at both FHA and GNMA.
As Ben Eisen of the Wall Street Journal made clear, FHA lost the banks and now wants them back. Just a look at the massive shift to non-banks in this chart by Urban, published in the WSJ:
So what’s changed with this proposal?
The proposed revision to the loan level certification modifies the “gotcha” language at the end the certification and inserts “to the best of my knowledge” in some key places. It retains a revised version of the final statement that appears to be egregious which states: “I, the undersigned authorized representative of the mortgagee, certify that I have personally reviewed the mortgage documents, and the application for insurance endorsement, and that the mortgage complies with the requirements and certifications set forth in SF Handbook 4000.1 Section II.A.7 Post-Closing and Endorsement and all conditions of approval have been satisfied.” Clearly this is far less onerous than the previous language. A copy of the actual proposed certification can be found here.
HUD’s proposed implementation of the “taxonomy” also limits the possibility of FCA to only defects that are most egregious.
So Will This Work?
It’s too soon to tell whether these changes will be enough to bring the banks back. For some, they say it does not go far enough. After years of excessive fines and long-term efforts to provide acceptable language to HUD, the reality is that achieving the goal of getting all the industry change requests in their certification was not likely. So we will have some who say it still falls short, while others will not let perfect be the enemy of the good.
Whatever changes in volumes we may or may not see, this completes a commitment that Secretary Carson made and Commissioner Montgomery helped move the ball forward. It’s a move in the right direction say most industry leaders, even if not perfect. As one key trade association employee said it, “we really couldn’t have hoped for a better starting point.”
David H. Stevens, CMB, is Contributing Editor at Mortgage Media. He has held various positions in real estate finance, including serving as SVP of Single Family at Freddie Mac, EVP at Wells Fargo Home Mortgage, President and COO of the Long and Foster Realty Companies, Assistant Secretary of Housing and FHA Commissioner, CEO of the Mortgage Bankers Association.