Large lenders are pushing the Federal Housing Administration to revamp its loan defect taxonomy to provide more certainty about potential errors and mistakes that could lead to enforcement actions.
The Department of Housing and Urban Development issued the taxonomy last summer in an effort to help FHA lenders identify underwriting issues and reduce mistakes. But some said the proposal did not go far enough or provide enough clarity.
"We are trying to get to a place where you don't have minor errors creating treble damages risk under false claims," said Pete Mills, a senior vice president at the Mortgage Bankers Association.
MBA members were initially wary when the FHA began the development of a loan defect taxonomy in 2014. They were concerned it might give the Justice Department more ammunition to pursue FHA lenders for not adhering to lender standards.
But the group quickly came to support the project, recognizing its value in helping lenders avoid lawsuits from Justice for relatively minor underwriting mistakes.
"MBA supported the concept of developing a rational system that classifies defects according to their severity and proscribe remedies that are proportional to the nature of the defects," said Mills.
But the MBA and others were disappointed with the taxonomy released last June. For one, HUD made it clear that the taxonomy is not intended to shield lenders from enforcement actions by regulators.
The MBA argues that means enforcement actions will continue play an outsized role in the FHA market. It wants the defect taxonomy, for example, to spell out what is a big enough mistake to be considered "material" by regulators under the False Claims Act.
"DOJ enforcement actions continue to overshadow HUD's certification process. MBA urges HUD to complete and operationalize its Defect Taxonomy," Mills says in the April 14 comment letter.
The Financial Services Roundtable's Housing Policy Council is also looking for more clarity regarding the taxonomy.
"The Housing Policy Council believes that FHA lenders need more certainty on FHA underwriting and indemnification requirements," said John Dalton, president of the FSR's Housing Policy Council.
"Above all this includes distinguishing minor errors from errors that materially impact the insurability of FHA loans. We think a lot of hard work has gone into developing the defect taxonomy, which will hopefully provide this clarification. We hope that it will be implemented by HUD in a manner that provides lenders the clarity and certainty they need to be active FHA lenders," Dalton said in a statement.
Meanwhile, HUD has been considering different approaches for small FHA lenders that rarely are flagged for loan defects or forced to indemnify FHA for loan losses.
As mentioned in a July 2013 Federal Register notice, FHA might use statistical sampling to "extrapolate" a lender's defect rate.
For a lender that made 2,000 loans last year, FHA might sample 50 loans and find a 10% error rate. If HUD charged a $1,000 penalty per loan on 10% or 200 of the loans, the lender would be fined $200,000 to compensate FHA for the risk posed by the lender's origination processes.
This approach has raised objections from small lenders who contend they should only be liable for actual loan losses.
"We support FHA's efforts to provide more clarity about lending standards," said Scott Olson, executive directive of the Community Home Lenders Association. "However, we are strongly opposed to the assessment of fines or penalties based on extrapolation of sampling files."
A HUD spokesman responded that: "We are not moving forward at this time with the concept of statistical sampling. That said, we routinely conduct statistical sampling as part of our normal quality control program but the results are not used to extrapolate across a lender's or the FHA portfolio as a whole."
FHA is currently in the technology development stage of the taxonomy, according to a HUD spokesman. As part of the taxonomy framework, FHA wants to monitor trends in loan defects to "determine if policies can be enhanced to help lenders better comply with FHA standards," according to a June 18 FHA press release. And FHA needs an IT system to monitor those trends.
Meanwhile, the Justice Department has continued to bring scores of False Claims actions against FHA lenders over the past few years, which has forced many to tighten their lending standards and others to stop originating FHA-insured single-family loans.
On April 15, the Justice Department announced a settlement with Mount Laurel, N.J.-based Freedom Mortgage, which agreed to pay $113 million to settle government allegations that it failed to comply with FHA requirements in originating and servicing FHA-insured loans. On April 8, Wells Fargo agreed to a $1.2 billion settlement with the Justice Department.
The Justice Department and HUD's Office of Inspector General also have ongoing investigations of FHA lenders that could result in False Claims settlements from five to 10 lenders over the next six to 12 months.
Some observers expect these enforcement actions will be settled by the end of this year. But one knowledgeable source, who spoke on condition of anonymity, said that the Justice Department just subpoenaed a FHA lender within the past month to start a new False Claims Act investigation.
"Despite DOJ's affirmation that 'the False Claims Act requires more than mere negligence or a simple mistake to hold a person liable,' the industry finds little comfort in this premise due to the lack of a defined metric to classify varying levels of loan defects," the MBA says in a comment letter on HUD's lender certifications.
"HUD needs to take the necessary steps to circumscribe the Department of Justice's ability to use subjective judgments to what constitutes a material false claim under the False Claims Act," the MBA says in the April 14 comment letter.
But HUD could face scrutiny on Capitol Hill if they expand the taxonomy further.
"No matter what HUD does they are going to get blow back from Capitol Hill," said Edward Mills, a financial policy analyst at FBR Capital Markets.
"If they try to expand mortgage credit availability, the more Republicans are going to have concerns that it's going to add too much risk that the federal government is insuring. If they extend too much legal certainty to the lenders, that is going to get pushed back from congressional Democrats who say it is a give-away to the mortgage industry."
He said the issue of what constitutes a "false claim" will have to be resolved by the court.
"Ultimately a lot of this is going to be decided in the courts as to what is and what is not a false claim as part of a certification," said Edward Mills.
