New Challenges. FHA Compliance and Enforcement & Multi-State Examination Process

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1 New Challenges Clinton Rockwell Melissa Klimkiewicz Kathryn Ryan June 24, 2010 California Mortgage Bankers Association FHA Compliance and Enforcement & Multi-State Examination Process

2 FHA Compliance and Enforcement 2

3 Current Environment 3 years ago FHA accounted for 2-3% of market Currently FHA accounts for almost 30% of market FHA loans experiencing poor performance Required secondary reserves fell below 2% limit Congress/Administration placing extreme pressure on HUD to improve FHA program Intense media scrutiny 3

4 HUD/FHA Plans Improve quality of new FHA loans Strengthen capacity of FHA lenders Increase FHA capital Increase enforcement 4

5 New Net Worth Requirements May 20, 2010 All new applicants must possess $1 million net worth May 20, 2011 Lenders approved as of May 20, 2010 must possess $1 million net worth, unless small business exception applies Small business lender approved as of May 20, 2010 must possess $500,000 net worth May 20, 2013 Single-family lenders must possess a net worth of $1 million plus 1% of total volume in excess of $25 million Multifamily lenders must possess a net worth of $1 million If perform servicing must possess an additional 1% of total volume in excess of $25 million If do not perform servicing must possess an additional 0.5% of total volume in excess of $25 million 5

6 End of Loan Correspondent Approval May 20, 2010 No longer accepting loan correspondent applications Third party originators May originate if sponsored by a DE mortgagee May not underwrite or close loans in their own name January 1, 2011 Currently approved LCs no longer have FHA approval Only approved mortgagees will have access to FHA Connection and be permitted to order case numbers Generally, sponsoring mortgagees will be responsible for TPOs compliance with FHA requirements 6

7 End of Loan Correspondent Approval (Cont d) Loan performance Neighborhood Watch will have date on all loans originated via a sponsored TPO relationship so that sponsoring mortgagees may evaluate TPO trends and performance Aggregate comparative data will be available Employment requirements FHA s employment requirements for approved mortgagees and lenders are outlined in Chapter 2 of Handbook , Rev. 2. Mortgagees must ensure that TPOs adhere to all applicable federal, state and local requirements governing their FHA loan origination and processing activities. 7

8 Principal-Authorized Agent Changes Implementation of the new rules waived until January 1, 2011 (ML ) Both parties must possess unconditional DE approval Principal must originate and the Authorized Agent must underwrite Loans may close in either party's name, and either party may submit the loan for insurance Parties roles must be documented in FHA Connection 8

9 Areas Approved for Business Retail and direct lending originations Existing AAFB rules apply Must be licensed to perform originations in each state where performing originations Sponsored TPO loans May underwrite in any state where permitted by the state to underwrite, and where the TPO is permitted to originate May order case numbers for any state where approved to underwrite. 9

10 HUD/FHA Plans Improve quality of new FHA loans Strengthen capacity of FHA lenders Increase FHA capital Increase enforcement 10

11 Increased Enforcement Withdrawals of lender approval lenders Since July 1, 2009 more than 350 lenders Marked Increased in: Quality Assurance Division ( QAD ) audits Credit Watch terminations Mortgagee Review Board ( MRB ) actions Office of Inspector General ( OIG ) inquiries Enforcement actions against 6 times as many lenders since FY 2009 than from FY combined 11

12 Mortgagee Review Board Actions MORTGAGEE REVIEW BOARD HISTORICAL ACTIONS BY FISCAL YEAR Total Number of Cases Fact Based Cases Recertification Cases Actions Taken Withdrawal Of Approval Suspension (From Secretary Stevens March 11, 2010 testimony to House FinServ Committee) 12

13 QAD Audits HOC level HOCs emboldened by calls to improve program Disconnects between HOC and HQ policies May result in indemnification through voluntary settlement and/or referral to MRB 13

14 Indemnifications 2 scenarios Abstain from filing an insurance claim on the loan Reimburse FHA if a subsequent holder of the loan files an insurance claim and FHA suffers a financial loss disposing of the property Incontestability clause provides limited protection Current authority Request voluntary indemnification Require indemnification from LI participants not used Proposed authority FHA Reform Act of extends authority to require indemnification to all DE lenders New regulations implement LI indemnification authority 14

15 Credit Watch Termination Actions Historically, applied to a particular branch office within a HUD office jurisdiction Now, applies to all loans that a mortgagee underwrites in a HUD office jurisdiction, irrespective of the particular branch involved FHA Reform Act of 2010 would apply Credit Watch on a nationwide basis Terminations announced on HUD website and in Federal Register 15

16 MRB Actions Withdraw/suspend approvals Civil money penalties Indemnifications through voluntary settlement Findings fraud and/or technical fouls Underwriting errors Failure to implement adequate quality control Marketing/advertising Announced via press releases and Federal Register 16

17 OIG Inquiries Broad authority to serve subpoenas -- extends to third parties outside HUD s regulatory jurisdiction Subpoenaed 15 mortgage companies with significant claim rates (January 12) Goal determine reason for high claim rates and whether any wrongdoing was involved IG Donohue: We aren t making any accusations at this time, we have no evidence of wrongdoing Named companies publicly Devastating for warehouse lender, investor, and consumer relationships 17

18 This is only the beginning HUD seeking to strengthen: Suspension / termination authority Indemnification authority False Claims based litigation not a hypothetical threat Elimination of FHA approval of loan correspondents Approved mortgagees will be responsible for approving and ensuring compliance of Third Party Originators ( TPOs ) 18

19 Common Concerns Lender s own compliance Compliance of TPOs that lender sponsors How to respond to HUD inquiries 19

20 Best Defense is a Strong Offense Rules are complex, constantly changing, and often a matter of subjective interpretation Additionally, HUD will now rely on sponsoring lenders to police loan correspondents Deviation from FHA rules can be extremely costly Financial impact Legal risk Reputational harm 20

21 Ordinary Course Audits Better understanding of, and ability to manage, risks (e.g., internal risk and third party risk) Ability to test internal controls before HUD tests them Options to consider Loan file review Loan originator and underwriter review Quality Control Plan drafting and revision New and existing mortgage broker (TPO) compliance assessment Comprehensive reporting to management, protected by attorney-client privilege Employee and/or third-party compliance training Recommend independent, expert FHA underwriters Know HUD s interpretation of the rules Can detect issues that internal underwriting/qc staff missed If engaged through law firm, attorney-client privilege protection 21

22 Strategies When Forced to Be on Defense If HUD institutes an inquiry, investigation or litigation, lenders must: Efficiently and accurately determine validity of claims Utilize findings to formulate an effective defense strategy Determine how to interface with HUD personnel Explain the situation to wholesale lenders, investors, borrowers, and employees 22

23 Determine Validity of Claims Common claims Credit Watch high compare ratio in area(s) QAD/MRB/OIG Underwriting does not meet HUD requirements QC program not sufficiently stringent Employees / third-parties engaged in fraud or misrepresentation Failure to report certain business changes Net branching Etc. Prompt response required typically 1 month or less Internal underwriting/qc staff may be reluctant or unable to identify all issues 23

24 Develop Response Strategy Arguments to consider (alone or in combination): HUD s data is inaccurate Mitigating factors E.g., large employer in area went out of business; underserved areas Application of rules is subjective Policies/practices have improved since the time of the loans at issue Must be able to prove HUD will check! Mea culpa -- offer $$ Civil money penalties and/or indemnifications Means of presenting arguments (alone or in combination): Formal written response Informal s/calls to HUD officials In-person meetings with HUD officials 24

25 Develop Response Strategy Special Considerations Credit Watch Termination decision based predominantly on statistics Formal appeal process can be largely perfunctory MRB Not permitted to present case directly to MRB Board meets in private MRB receives recommendations from staff any oral arguments must be made via meeting with staff members If MRB terminates lender s approval, there is no stay pending appeal OIG Separate from (and sometimes at odds with) HUD staff Very reluctant to enter discussions with lenders Success may depend on ability to obtain relief outside formal processes 25

26 Interface with HUD Personnel Well-crafted formal written responses Telephone calls and in-person meetings with appropriate, high-level HUD officials Difficult to obtain especially given current scrutiny Often only obtainable through back channels Must determine: Who should contact HUD What they should say When they should say it 26

27 Respond to Wholesale Lenders, Investors, Borrowers, and Employees HUD inquiries/actions can have immediate, devastating impact E.g., January HUD OIG subpoenas Response can include: Direct communications with individual wholesale lenders, investors, borrowers, and/or employees Public statements and media releases Must determine: Who should respond What they should say When they should say it 27

28 Experienced Team Is Critical Attorneys Independent FHA underwriters Government relations consultants Public relations professionals 28

29 Multi-State Examination Process 29

30 Background CSBS/AARMR initiative to bring uniformity, modernization, and effectiveness to state mortgage examinations Pool of state examiners conduct joint and concurrent exams of Multi-State Mortgage Entities ( MMEs ) under the direct supervision of a single Examiner-in-Charge ( EIC ) States may participate on-site or off-site Single report of examination with state-specific sections 30

31 Overview of Examination Process Scheduling of Exams On-site Exam, if necessary Establishing Examination Teams Formal Exit Conference and Final Written Report MME Examination Plan MME Response to Report Entry Letter and Information Request Supervisory Actions 31

32 Automated System Balance between compliance review and safety and soundness review (e.g., portfolio risk, liquidity, management controls, fraud investigations) Expect a more comprehensive pre-exam request for info Automated compliance review system allows for computational and transactional review of 100% of the loan portfolio Ability to pre-screen entire portfolio Expect follow up requests for info for potentially problematic files Automated compliance is a technological challenge Need to store data in format that allows easy electronic extraction All lenders are expected to provide loan portfolio data uploads to state regulators by

33 Self-Monitoring Regulators encourage self-monitoring as part of modernization Expectation is that licensees will identify problems and begin proactive correction for the majority of problems without need for regulatory intervention 33

34 Safety & Soundness Focus Regulators looking at prudential concerns: Competency of firm management Risk management procedures Adequacy of policies and procedures Capital adequacy and liquidity Portfolio risk Adequacy of training 34

35 Multi-State Settlements Expect public, large scale settlements following multi-state exams June 25, 2009 Non-Traditional Mortgage Guidance $9 million to 14 states March 24, 2010 HMDA Data $1.25 million to 35 states 35

36 SAFE Act - Mortgage Call Reports 36

37 SAFE Act - Mortgage Call Reports NMLS proposal designed to fulfill SAFE Act requirements and create uniform financial and activity reporting across state lines Two parts Financial condition report on the company Mortgage Loan Activity Report for each state in which company is licensed or registered Proposal dramatically expands company reporting requirements NMLS solicited comments in March and deadline was May 14; only 88 comments received 37

38 SAFE Act - Mortgage Call Reports (Cont d) Requirement on company, not individual licensees, to submit quarterly reports Narrow reporting requirements e.g., 12 subcategories Failure to submit within 45 days of end of quarter will result in deficiency placed on license/registration that could prevent renewal Does not displace other state reporting requirements 38

39 Questions and Follow-up? Clinton Rockwell Melissa Klimkiewicz Kathryn Ryan