A surge in demand for FHA-backed loans is likely to overtax the oversight resources of the Federal Housing Administration, making the program more vulnerable to fraud schemes, HUD’s inspector general told lawmakers this week.
The growth in demand — FHA backed $71.7 billion in single-family mortgages in the first three months of the year, up 245 percent from a year ago — comes as delinquencies and foreclosures hit new highs, threatening to deplete the FHA’s insurance fund below statutory minimums for the first time since 1934.
The FHA insurance program has always been self-sustaining, relying on premiums paid to the fund to cover losses due to fluctuating defaults and foreclosures.
If the fund falls below levels mandated by Congress, that would require an increase in premiums or an injection in taxpayer dollars to make up the shortfall, said Kenneth Donohue, inspector general of the Department of Housing and Urban Development.
FHA-backed loans accounted for about one in five purchase loans during the last three months of 2008, Donohue said, up from 6 percent the previous year. When refinancings are added to the equation, FHA’s market share was 63 percent, he said.
The FHA’s current exposure from single-family mortgage loans totals more than $560 billion, representing 4.8 million FHA-insured mortgages, Donohue said in testimony before the House Financial Services Subcommittee on Oversight and Investigations.
The FHA’s single-family insurance fund, which covers losses on the mortgages it insures, shrank nearly 40 percent in a one-year period, from $21 billion to $12.9 billion as of September.
Congress has mandated that the insurance fund be maintained at a ratio equaling 2 percent of the mortgages insured by FHA. That ratio has slipped from an estimated 6.4 percent at the end of September 2007 to 3 percent one year later.
Depending on the economic assumptions used to make projections, Donohue said the ratio could dip below 2 percent in coming years, which would require raising premiums or a congressional appropriation to restore the insurance fund to the required levels. Although the insurance fund is thought to be above the statutory minimum now, re-estimations will be performed over the summer, he said.
About 7 percent of FHA loans are currently in default — marked by more than 90 days nonpayment status, foreclosure or bankruptcy — and the Mortgage Bankers Association reports 13 percent are 30 days or more overdue.
While the ailing economy and declining home prices have sent delinquency and default rates soaring in many markets, Donohue said HUD’s Office of the Inspector General is also concerned about FHA’s ability to monitor lenders and detect fraud.
The number of FHA-approved lenders grew by 525 percent in two years, growing from 692 at the end of September 2006 to 3,300 two years later. From October to March, the FHA approved another 1,600 lenders, Donohue said, and 12,000 mortgagees and loan correspondents currently hold FHA lending authority.
"The integrity and reliability of this crop of program loan originators is, in our view, unproven, and in light of the aggressive recent history of this industry, may pose a risk to the program," Donohue said.
HUD is currently investigating several FHA lenders who were active in the subprime market during the boom. Other lenders have been allowed to reacquire their FHA approval despite "past abuses," Donohue said.
He noted that a former owner and manager of an Arizona lender, First Magnus Financial Corp., last year obtained approval to originate and process FHA loans as StoneWater Mortgage, after First Magnus filed for bankruptcy and was accused in a HUD audit of paying kickbacks to mortgage brokers, builders and real estate brokerages to win business (see story). …CONTINUED
In a recent review of FHA’s Mortgagee Review Board requested by Sen. Charles Grassley, R-Iowa, HUD’s Office of the Inspector General found the board’s sanctions affected only a small number of lenders, and that sanctions and fines were "frequently mitigated." The board rarely cited lenders with violations that would warrant withdrawal of their FHA lending authority, Donohue said.
Donohue also listed numerous recent cases of outright mortgage fraud involving FHA-insured mortgages. They included a case in Philadelphia where an appraiser and two settlement agents were sentenced to prison in connection with a scheme that cost HUD $4.46 million when 183 mortgages defaulted.
FHA’s loan limits have been increased to as much as $729,750 in high-cost housing markets, and the larger loans may "be much more attractive" to mortgage fraud rings because of the potential to "extract greater payouts" in fraudulent loan schemes, he said.
The FHA’s risk management tools include computerized monitoring of loan default and claim rates, post-endorsement underwriting and appraisal reviews, and on-site lender monitoring, Donohue said.
But FHA will face a challenge in keeping up with the increasing volume of loans generated by lenders. Currently, FHA relies on a random, manual process by contractors who select for approximately 2 percent of lender endorsements for review, down from 5 percent before the recent increase in demand for loans.
A number of audits have noted significant lender underwriting deficiencies, inadequate quality controls, and other "operational irregularities," Donohue said.
To some extent, Donohue said, the FHA "has had to work with the hand it was dealt" in terms of funding and "industry-led initiatives to diminish its authority."
"The FHA cannot keep pace with an industry that is increasingly technology-driven, and it cannot use its revenues to invest in any new technology," Donohue said. "Many of its deficiencies could be mitigated with additional resources dedicated to systems and staffing enhancement. Our audit and investigative work point to critical front-end and back-end process issues that, if strengthened, could enable the FHA to overcome some of its present vulnerabilities."
Donohue said FHA needs to do a better job tracking the actions of individuals, rather than focusing primarily on the companies they work for. The FHA’s systems don’t currently capture information on "key individuals" involved in home transactions, such as the originating loan officer.
"We would like to see that that person’s name and corresponding identifying information (i.e., license, etc.) are put in FHA’s data fields," Donohue said. "If the system could also capture information on other key players such as the real estate agent for the seller and buyer, and other parties to the transaction, that too would be helpful for purposes of increasing integrity in the processes in our investigative and audit functions."
A recently enacted bill, S 896, increases the authority of regulators to take actions against individuals, and not just their employers, Donohue noted.
The bill extends civil monetary penalties to owners, officers, or directors and not just the "mortgagee or lender," and allows FHA to deny eligibility to officers, partners, directors, principals, managers, supervisors, loan processors, loan underwriters, or loan originators who may have been suspended, indicted, convicted or had unresolved findings contained in an OIG audit or investigation.
HUD’s Office of the Inspector General is also recommending that an FHA Appraiser Fee Panel, similar to one dismantled by lawmakers in 1994, be reinstated to relieve pressures on appraisers to "hit the numbers."
The new Home Valuation Code of Conduct instituted by Fannie Mae and Freddie Mac is an improvement, Donohue said, but "contains vulnerabilities" that could allow lenders to manipulate appraisal management companies who don’t return numbers desired by "unscrupulous lenders."
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