By Brian Montgomery, former FHA Commissioner and Vice Chairman, The Collingwood Group and Karen Garner Wing, Special Advisor to The Collingwood Group and former HUD Quality Assurance Division Manager

According to recent news stories, the HUD Office of Inspector General has put several lenders on notice regarding the quality of documents submitted as part of the FHA claims process.  Another large FHA lender has also been accused of poor quality control involving their loan origination processes.  In all instances, it has been reported that HUD or the Department of Justice is using the False Claims Act to seek treble damages among other penalties. 

Not surprisingly, other FHA lenders are increasingly concerned about what appears to be a significant increase in the number and severity of enforcement actions taken by HUD related to FHA single family loans.  Are there in fact more actions today and are the actions taken more severe?  Are more enforcement tools being used?

In reading official notices published by FHA in the Federal Register and news accounts, it certainly appears to be the new reality that enforcement tools are being used more often than in years past. The reality is that HUD has had available a long list of enforcement tools for a number of years. 

First some background information on HUD's lender oversight and monitoring functions.   

There are several offices within HUD that have responsibility for lending monitoring and carrying out these actions.  The type of review completed by each office varies, but ultimately the enforcement tools are similar. The organizations include:

  • HUD's Office of Inspector General for Audit (OIGA)
  • The FHA Quality Assurance Division (QAD)
  • Each of FHA's four Homeownership Centers (HOCs).  
  • Other offices support this effort including the Departmental Enforcement Center (DEC) and HUD General Counsel.

The majority of compliance reviews are completed by QAD and the vast majority (90%) of those are settled between the lender/servicer and the QAD. The enforcement actions used by QAD can include repayment of unallowable fees or indemnification agreements. These settlement options have been used for more than two decades.

While both the OIG and QAD Offices have some degree of authority and do negotiate settlements for lender non-compliance, HUD's ultimate authority for administering enforcement of non-compliance is the Mortgagee Review Board (MRB). Of the total number of compliance reviews completed by QAD each year, only a 10%* are referred to the MRB.

The MRB does not conduct reviews or audits of lenders; rather it receives referrals from the Offices previously mentioned along with HUD's Departmental Enforcement Center. The sanctions that the MRB may impose include: reprimands, suspension of authority; civil money penalties and indemnification of loans or complete withdrawal of a lender's FHA approval.   Many times, MRB enforcement actions may be delayed at the request of the HUD OIG as part of an on-going criminal investigation.

All MRB actions are accompanied by a Press Release and official Notice in the Federal Register so in addition to the potential monetary loss, there is a significant reputational risk to contend with which is difficult to define but may be equally damaging.  Additionally, HUD may take an action against a lender for poor performance without even looking at a single loan file.  Punitive actions through FHA Credit Watch along with removal of a lender's Direct Endorsement authority can occur if a lenders default and claim ratio is more than two times the FHA rate for a given geographic area.

HUD may also refer lenders to the Department of Justice for consideration of sanctions under the  Program Fraud Civil Remedies Act (PFCRA). Under PFCRA, a false statement can bring a civil money penalty of $7,500 per violation.  PFCRA is not available for individual claims that exceed $150,000.  Under the False Claims Act, a penalty of up to $11,000 plus up to three times the amount of damages can be sought.).

But the tools do not stop with enforcement actions that are available against the lender as a corporation.  For years, HUD has been able to sanction individual participants including loan officers, appraisers, real estate agents or underwriters. HUD may take an action to suspend (Limited Denial of Participation) a participant's involvement in FHA loans or a debarment action which is a government-wide action for a period of two years to life.  Like lenders, these individuals may also be held accountable by the Department of Justice and PFCRA and Civil Money Penalties assessed personally.

The practice of conducting compliance reviews and OIG Audits of FHA lenders origination and servicing practices is nothing new.  This has existed for over 30 years. What has changed is the number of reviews completed and the Agency's use of all available enforcement tools where as in the past the most common enforcement action was a request for indemnification. 

In those cases there is an executed Indemnification Agreement between HUD and the lender (typically the originating lender) and the Agreement is in place for 5 years from the date of endorsement.  A simple calculation of how much this will cost is to compute the difference between the FHA claim amount (unpaid principal balance plus allowed expenses and fees) and the amount the REO property is sold for. 

While this has often been very costly to a lender, the real estate market of the past few years has significantly raised the potential loss.  This is due to the dramatic increase in FHA's loan limits that began in mid-2008 coupled with a very depressed REO market.  Add on the fact that FHA and OIG target early payment defaults for their compliance review and you have the potential for an indemnification agreement on one loan exceeding $100,000 and potentially several hundred thousand dollars in high cost areas.  Under this scenario, it doesn't take too many indemnification actions to bring down a mid-size FHA lender.

The increase in the number of enforcement actions can also be tied to the significant increase in FHA's market share - from 2% a few years ago to over 30% in the past year.  Because of the decrease in conventional credit, more homebuyers including higher income and higher FICO score borrowers are turning to FHA for their loan.  More loans have meant more program interest and a significant increase in the number of lenders approved to participate. 

Another reason for the increase in enforcement numbers is that HUD's OIG for Audit appears to have increased their activities in this area.  The recently published report on "Operation Watchdog" detailed the OIG's findings in reviewing the underwriting of 15 FHA Direct Endorsement lenders. The OIG's recommendations to the FHA program staff was to, "...pursue appropriate remedies under the Program Fraud Civil Remedies Act against each lender and/or its principals for incorrectly certifying to the integrity of the data or that due diligence was exercised during the underwriting..."  While the OIG is an extension of Congress and does not report to the HUD Secretary (as established by its enabling legislation), the recommendations made in the report clearly show an intention to maximize enforcement actions that are available to FHA.  And in most cases, the HUD OIG or Department of Justice does not need FHA's concurrence to pursue possible civil or criminal violations.

There are likely a number of reasons for HUD and the Department of Justice (DOJ) increasing the use of the enforcement tools in its arsenal.  The public outcry over the financial market meltdown and its ripple effect of high unemployment coupled with the perception that banks helped fuel the fire has left legislators, government officials and the public, demanding action to punish wrongdoers as well as put remedies in place to help ensure it does not happen again. 

While more actions are likely being taken, has HUD and FHA actually changed its philosophy on compliance?  The answer is no.  The premise behind FHA's Direct Endorsement program which came into being in the early 1980's is that FHA would establish guidelines for lenders to follow in originating and servicing FHA loans.  This was a huge change from the prior 50 years when FHA employees performed the loan appraisals and underwriting.  The industry felt it could do the job better and faster, resulting in an increase in business. The lenders own employees would have responsibility for complying with the guidelines.  In return for the privilege of controlling their own loan processing, lenders were required to monitor themselves through the implementation of a Quality Control (QC) Plan.  In this way, lenders did self monitoring and could correct their own problems before they grew.

What has changed with FHA's Direct Endorsement plan?  Probably a combination of several actions including lenders not implementing a Quality Control program, management not taking appropriate corrective actions when deficiencies were noted, lenders implementing credit overlays to try and fix problems - all against a backdrop of depressed housing prices and homeowners in trouble unable to sell their home.

Is the heightened level of enforcement warranted?  Most likely the answer is yes.  As previously noted, there are many new lenders to the FHA program coupled with a significant rise in the number of loans on the books.  As a base of comparison, in 2005, the entire FHA housing portfolio (know as insurance-in-force) was around 4 million homes.  Today, it is more than 7 million.   This is a level of growth unprecedented in FHA's 77 year history.

It could also be the case that many new participants were more interested in making loans than in monitoring their own performance. FHA made it clear that lenders participating in its loan programs were responsible for their own destiny.  Guidelines were published and data available to track performance.  Companies finding themselves on the receiving end of today's increase enforcement actions are likely companies that did not take the guidelines or the performance monitoring tools seriously.  

Given the significant financial risk to lenders if HUD or DOJ takes an enforcement action, should lenders continue to originate and service FHA loans?  Absolutely yes.  The fundamental programs remain sound and a benefit to the community and a financial benefit to lenders.  What can lenders do to protect themselves?  The answer is obvious: monitor, monitor, and monitor.

Use the tools FHA has provided to you in a proactive way to identify the areas of risk within your company.  When you see a problem, determine how wide-spread it is and then take immediate action to stop it.  FHA's Neighborhood Watch provides data to examine lender performance on a national, state, or local level.  It can help a lender identify if one particular branch office is responsible for its problems or is it a company-wide problem. Implementing an FHA compliant Quality Control Plan and taking appropriate corrective actions is vital to a lenders success and moreover protecting its brand.



*Percentage of cases referred to the MRB by the Quality Assurance Division found at www.hud.gov, MRB Frequently Asked Questions website.