REQUIRED READING: It was bound to happen. It was always known that the rapid market growth of the Federal Housing Administration's (FHA) insured-loan portfolio in recent years had major implications for servicing, but how, exactly, that expanded footprint would translate on the back end was, for a long time, quite unclear.
Even if the agency's book of business maintained delinquency rates in line with modern-day expectations – and so far it has, thanks largely to interventional measures that have helped make recent-vintage books some of the highest quality in history – it would be impossible for the FHA to roughly double its historic market share of 10% to 15% and have it not play out in a meaningful way for servicers.
"The percentage of FHA loans in portfolio, with just a natural delinquency rate for FHA, will continue to put pressure, from a volume perspective, on servicers for years to come," says Scott Brinkley, vice president of outsourcing and technology solutions at CoreLogic.
Several recent developments, however, indicate the key threats in FHA servicing could relate to intensified auditing from the U.S. Department of Housing and Urban Development (HUD) and heightened scrutiny of insurance claims. Skepticism about the long-term solvency of the agency's insurance fund has led one analyst to suggest the FHA will clamp down on servicing claims, costing the biggest banks upwards of $13.5 billion in denials.
Some servicers have already felt the sting. A recent finding from HUD's Office of the Inspector General (OIG) recommended that HUD pursue reimbursement of nearly $5 million in pre-foreclosure sale claims filed by CitiMortgage. That recommendation arrives while servicers, some for the first time, are ramping up use of their FHA loss mitigation tools, pre-foreclosure deals included.
Meanwhile, there remains trepidation throughout all of mortgage banking regarding the U.S. Department of Justice's (DOJ) interest in the False Claims Act, the vehicle through which the DOJ has sued Deutsche Bank and its MortgageIT subsidiary. That suit alleges that MortgageIT made fraudulent claims to the FHA regarding loan production due diligence (e.g., failing to verify borrowers' financial information) and reviews that were supposed to occur for early-payment defaults. Under the False Claims Act, the federal government can seek civil penalties of up to $11,000 per claim, plus treble damages.
Legal experts say servicers are no less at risk for False Claims Act litigation than are lenders.
"Certainly the potential for False Claims Act liability lies with servicers just as it does with originators," says Adam Feinberg, an attorney with Washington, D.C.-based Miller & Chevalier. "An alleged false claim in the FHA context could arise because of fraud in the origination of a mortgage, but that doesn't have to be the case."
An esoteric domain made more complex
In an Oct. 3 investor note titled "FHA Claim Denials: The Next Shoe To Drop?" FBR Capital Markets analyst Paul Miller wrote, "Today, due to the state of the FHA's financial position and the possibility of further home-price declines, the agency is motivated to take a closer look at the life of a loan before paying out claims to conserve cash.
"While both lenders and servicers could face claim denials, we believe that the agency's hyper-technical servicing requirements make it more likely that servicers, and not originators, could be most at risk in the near term," the note said.
The FHA's most recent actuarial report, released late last year, revealed the agency's Mutual Mortgage Insurance Fund (MMIF) to be in bad shape, carrying a 0.5% capital ratio that is well below the congressionally mandated floor of 2%. That report forecast that the fund would be able to slowly rebuild, assuming, in part, that home values held steady, which they haven't, according to Miller. Although he does not believe the next actuarial report, due out in mid-November, will show the MMIF has fallen into the red, Miller says the fund "has a high probability of being negative next year." (EDITOR'S NOTE: This article was originally published in the December edition of Servicing Management, prior to the release last month of the MMI fund audit report.)
That leads him to believe that the FHA could step up its auditing and attempt to recoup money elsewhere – namely, by denying servicing claims.
"We've heard anecdotally that FHA can pretty much get whatever they want from banks, because nobody's doing anything right," Miller says.
He gives as an example the FHA requirement for servicers to make face-to-face contact with delinquent borrowers within narrowly prescribed time frames – something that Miller says few, if any, servicers are doing right now.
Pushback from HUD is "just a natural progression," adds Brinkley.
"I think when the insurance funds for investors reach a loss-severity threshold that they can't tolerate, just like a health insurance or auto insurance company, they're going to spend an enormous amount of money trying to get out of paying," he says.
In even the calmest of times, the processing of FHA servicing claims remains a highly esoteric domain. But under a deluge of foreclosure starts and stops and increased loss mitigation activity, it becomes all the more troublesome to navigate. Voluntary and externally imposed foreclosure moratoria decimate foreclosure timelines and, in turn, complicate the work for servicers' claims processing units.
FHA claim auditors chiefly target the accuracy of claims, zeroing in on the overpayment of accrued interest or other out-of-pocket advances that servicers may have requested in error (due to, for example, the failure to meet one of the FHA's processing timelines or disbursements that exceed allowables).
There are two primary components to filing an FHA insurance claim via HUD Form 27011. The first stage, Part A, notifies HUD that the property is coming and triggers the title transfer of the property. It is through this process that a servicer receives the unpaid principal balance and the accrued interest related to a foreclosed loan, Brinkley says.
The second part, Part B, is processed after the title work is approved by HUD and requests reimbursement to servicers for all out-of-pocket advances – both escrow advances and corporate advances (court and attorney costs, preservation and protection expenses) – incurred throughout the delinquency of a loan and the foreclosure process.
The timeline-sensitive Part A tracks all of the milestones a loan hits between the 60th day of delinquency and the completion of a foreclosure action. Servicers' claims processors must take painstaking care to ensure their calculations for accrued-interest reimbursement correctly reflect the activity on a given loan, applying timeline forbearance, when necessary (e.g., due to bankruptcy or other approved hold reason).
While the FHA acknowledges and allows for certain events that are beyond servicers' control and can delay processing time frames, such as a foreclosure moratorium or a sheriff's failure to timely evict an occupant, servicers must be able to provide documentation to support their claims.
"When you're starting and stopping [foreclosures] and you have a very specific time frame with which you've got to comply, you do need to self-curtail," says Jodi Gaines, CEO of Claims Recovery Financial Services LLC.
Much of the activity surrounding FHA claims, she adds, can be attributed to a policy change at the agency in recent years mandating that 100% of claims be reviewed – a drastic change from years past, when auditors were examining only a sample of claims. Gaines says it is crucial for servicers to automate as much of the process as possible to minimize the likelihood of reporting errors.
Servicers must also maintain staff that are familiar with the regulations and protocols associated with claims processing, Brinkley says. Without that competency, a shop faces significant downstream risk as it relates to HUD auditing.
"It's a pretty high-stakes game to make sure that the foreclosure's processed timely and the claims processor analyzes the timeline accordingly and requests only the appropriate amount of interest back from HUD," he says.
There is reason to believe servicers have already increased their self-curtailing efforts. A Sept. 6 rating action from Moody's Investors Service downgraded the ratings of 59 tranches issued by GSMPS Mortgage Loan Trust, whose collateral includes FHA-insured fixed- and adjustable-rate mortgages. The downgrade was the result of the rating agency's updated loss projection for the portfolio, which, in part, "accounts for higher potential pool losses due to self-curtailment of claims by servicers whereby they pass expenses as deemed reasonable to the trusts instead of submitting them to HUD," the announcement said.
Later in the same announcement, Moody's explained that HUD can impose "significant penalties" on servicers if it discovers, in subsequent servicer audits, claim process irregularities. "This can prompt servicers to push more expenses to the trust that they deem reasonably incurred than submit them to HUD and face significant penalty," the note said.
Speculation that the FHA has recently begun using a heavier hand with servicers, however, may be off base, according to Karen Garner-Wing, founding partner of GWN Consulting LLC.
Before joining the private sector, she spent more than two decades in various roles at the agency, including as branch chief in HUD's quality assurance division and as director of the FHA's lender approval and recertification division. She considers the FHA one of the industry's earliest adopters of progressive loss mitigation strategies, and she says the agency's enforcement tools have been in place for "many years."
"Those haven't changed," Garner-Wing says. "The bottom line is that if these servicers are both servicing and filing their claims to the rules, then there is nothing for [an auditor] to do." That said, it is only natural for servicers' increased use of certain FHA programs (i.e., the FHA Pre-Foreclosure Sale (PFS) program) to draw the interest of HUD entities such as the OIG, according to Garner-Wing.
"The Pre-Foreclosure Sale program has been at FHA for years, but let's face it: It wasn't used years ago," she says. "People weren't underwater, and the circumstances of the market were different."
Evidence of the HUD OIG's concern in this area can be found in a Sept. 30 audit report pertaining to a review of short sales that CitiMortgage executed in 2010. The office analyzed 68 of the company's nearly 1,900 FHA short sales from last year and found that Citi closed 63 of those deals without properly determining borrower eligibility for the program. The HUD OIG recommended that HUD require Citi to reimburse HUD for the 63 claims (totaling nearly $5 million) and require Citi to strengthen its internal controls around the PFS program.
In its formal response, Citi said it "respectfully disagrees" with the office's assertion that it violated the agency's servicing requirements. "The findings described in the HUD OIG report are based on the auditors' interpretation of the guidelines outlined for the PFS program, which are not aligned with [Citi's] interpretation of these guidelines," the servicer said.
Although the HUD OIG faulted Citi for alleged shortcomings in its loss mitigation assessments and not necessarily discrepancies in the claims-filing process itself, the action underscores the attention being paid to servicers.
False Claims Act fear
Not to be ignored in the discussion of FHA servicing risk is the pending False Claims Act lawsuit against MortgageIT, which HUD and the DOJ announced earlier this year. According to FBR's Miller, that case reaffirms that HUD and the FHA are paying close attention to procedural issues – an area where some servicers may find themselves particularly vulnerable.
The False Claims Act focuses on persons who knowingly submit false or fraudulent claims for payment to the federal government or to an entity funded by the U.S. The act provides liability for knowingly using a false record to get a claim paid and for knowingly concealing or avoiding an obligation to pay money to the government, according to Miller & Chevalier attorney Feinberg. That liability could apply to servicers if they know of problems in the origination of the loan but nonetheless submit a claim on the loan after it has gone into foreclosure.
An added danger for claimants, Feinberg says, is the False Claims Act's whistleblower provision. Because whistleblower claims are filed under seal and typically undergo lengthy investigations before being unsealed, there is usually a significant lag between the time a claim is filed and when it is made public.
‘If there's an insider at a servicer who sees some improprieties going on and they file a False Claims Act case, we might not find out about it for years,’ he says.
