By: Krista Cooley
On Wednesday, HUD issued Mortgagee Letter 2013-10 to implement the Lender Insurance (“LI”) regulation it finalized in January of 2012. As announced in the final regulation, FHA mortgagees participating in the LI program will be required, as a condition of approval for LI authority, to indemnify HUD for self-endorsed loans that HUD deems ineligible for FHA insurance. Mortgagee Letter 2013-10 provides additional guidance on the Department’s policy changes regarding indemnification, which are effective for all loans insured by LI mortgagees on or after April 9, 2013. The Mortgagee Letter and a revised Lender Insurance Guide released Wednesday provide additional guidance regarding LI changes, including LI eligibility criteria and HUD’s processes to monitor, terminate, and reinstate LI authority.
Since announcing in November of 2012 that an independent actuarial review of the FHA Mutual Mortgage Insurance (MMI) Fund found that the Fund’s capital reserve ratio has fallen to -1.44%, which represents a negative economic value of $16.3 billion, HUD has aggressively sought to mitigate the risk of the Fund’s insolvency. The powerful indemnification authority set forth in the final regulation and this Mortgagee Letter represent the latest step in HUD’s significant efforts to improve FHA’s safety and soundness and to transfer the risks associated with FHA-insured loans from the Department, and thus the American taxpayer, to FHA-approved mortgagees, particularly those participating in the LI program.
Indemnification Policy Clarifications
The Mortgagee Letter reiterates HUD’s authority to demand indemnification for serious and material violations of FHA origination requirements and instances of fraud or misrepresentations about which the lender knew or should have known. For serious and material violations that caused the loan not to be eligible for FHA insurance, the lender will be required to indemnify HUD for any loss on the loan if it goes into default within five years of mortgage insurance endorsement. For fraud or misrepresentation, the lender will be required to indemnify HUD for any loss for the life of the loan.
While the final regulation was silent as to the procedures HUD would follow in demanding indemnification from LI mortgagees, Mortgagee Letter 2013-10 provides details regarding this process. The Mortgagee Letter clarifies that HUD will provide lenders with an opportunity to refute an indemnification determination before making a final demand for indemnification. Specifically, when HUD uncovers fraud, misrepresentation, or serious and material violations of FHA origination requirements through post-endorsement technical reviews, appraisal reviews, on-site mortgagee monitoring reviews, audits conducted by HUD’s Office of Inspector General, or other means, HUD will notify the LI mortgagee that a preliminary assessment based on file documentation indicates that the loan contains material findings such that HUD is exposed to an unacceptable level of risk.
HUD will provide the LI mortgagee an opportunity to present additional documentation to address the review findings. If the LI mortgagee does not respond, or if HUD determines, after reviewing the LI mortgagee’s response, that the deficiencies have not been resolved, HUD will send a notice of indemnification to the LI mortgagee, which will demand that the LI mortgagee indemnify HUD against any possible financial loss stemming from that loan pursuant to the final regulation. Demands for indemnification may be made by the Director of the Quality Assurance Division in HUD’s Homeownership Centers, by the Office of Lender Activities and Program Compliance, or by the Mortgagee Review Board.
In addition to fraud and misrepresentation, Mortgagee Letter 2013-10 includes a non-exhaustive list of actions that may be considered serious and material violations of FHA requirements if the LI mortgagee knew or should have known of the violation. These violations include, but are not limited to:
• Failing to ensure that the borrower meets applicable eligibility requirements in accordance with HUD requirements;
• Failing to verify the creditworthiness, income, and/or employment of a borrower in accordance with HUD requirements;
• Failing to verify the assets used by the borrower for down payment and/or closing costs, or to meet applicable reserve requirements, in accordance with HUD requirements;
• Failing to ensure that the amount of the mortgage insured is consistent with the loan type, property value and other applicable HUD requirements;
• Failing to ensure that the loan was current and met any applicable payment history requirements at the time of insurance endorsement in accordance with HUD requirements;
• Failing to address property deficiencies identified in the appraisal affecting the health and safety of the occupants or the structural integrity of the property in accordance with HUD requirements; and
• Failing to ensure that the appraisal of the property satisfies HUD appraisal requirements and other applicable HUD requirements.
Mortgagee Letter 2013-10 also clarifies that the mortgagee that insured the loan will be responsible for indemnifying HUD, regardless of how the loan was originated, including loans in which a Third Party Originator was an FHA-approved lender. In cases involving a principal and an authorized agent where the principal insures the loan, HUD may seek indemnification from the authorized agent for any serious and material violations of HUD requirements or for fraud or misrepresentation. In instances where an outstanding indemnification exists at the time of claim for insurance benefits, HUD will pay insurance benefits to the holder of the mortgage, as long as the holder is not the same entity that was named in the indemnification agreement.
According to the Mortgagee Letter, indemnified loans are eligible for streamline refinance. If HUD pays a claim on a non-credit qualifying streamline refinance loan, HUD will continue to hold the mortgagee that indemnified the original loan responsible for any loss suffered by HUD. For credit qualifying streamline refinance transactions, the indemnification on the previous loan will be terminated. In both instances, the LI mortgagee insuring the streamline refinance will be responsible for any loss suffered by HUD in connection with serious and material violations of HUD requirements or fraud or misrepresentation in connection with the refinanced loan.
Additional Policy Changes
Mortgagee Letter 2013-10 includes additional guidance regarding LI eligibility criteria for new LI lenders and LI lenders created by a merger, acquisition or reorganization. Importantly, Mortgagee Letter 2013-10 and the revised LI Guide include procedures for applying for LI approval, which is an electronic process for new LI applicants and a manual process for LI lenders created by merger, acquisition, or reorganization.
The Mortgagee Letter also provides details regarding LI termination and reinstatement procedures. As detailed in the final regulation, LI authority may be terminated when, among other things, a lender fails to maintain a two-year claim and default rate equal to 150% or less of the two-year claim and default rate for the states in which the mortgagee has underwritten loans. Beginning in July of 2013, HUD will monitor LI performance and compliance with LI requirements of mortgagees whose compare ratios exceed 150% on a quarterly basis and may terminate LI authority for mortgagees who fail to meet LI requirements. Like HUD’s Credit Watch program, HUD’s Headquarters will monitor LI mortgagee compare ratios based on quarterly data as of March 31, June 30, September 30, and December 31. Mortgagee Letter 2013-10 and the revised LI Guide also list the circumstances under which the Department can suspend a lender’s LI authority, which include, among others, failing to submit case binders in a timely manner or failing to adequately conduct pre-endorsement reviews.
HUD warns existing LI lenders that changes to the compare ratios used to monitor LI mortgagees, from a national rate to a rate based on the states in which the lender does business, as well as a move from annual reviews to quarterly reviews, could affect LI eligibility of current LI lenders. Because of these changes, existing LI lenders should use the next few months to ensure they are monitoring their LI performance under the new standards. The LI Guide provides detailed instructions on how to monitor LI performance via HUD’s Neighborhood Watch System.
A lender whose LI authority has been terminated may not reapply for at least six months from the date of termination, and the reinstatement request must be in writing. At the time of application for reinstatement, the lender must have unconditional Direct Endorsement approval and a two-year claim and default rate that does not exceed 150% of the aggregate claim and default rate for the states in which it underwrote loans. Among other items, the reinstatement application must include a corrective action plan identifying the changes in internal policies and procedures that address the termination issues and evidence that the plan has been implemented.
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According to the revised LI Guide, over 700 mortgagees are currently participating in the LI program and, in any given month, approximately 80% of all forward loans are being endorsed under the LI program. Based on the predominance of the LI program among FHA-insured loans, the policy changes announced this week will have a significant impact on FHA-approved lenders, who will soon find themselves the target of HUD’s audits and monitoring reviews, which may lead to increased demand for indemnifications. With these policy changes, lenders are likely to be more conservative in their underwriting decisions, which could result in fewer FHA originations and reduced financing opportunities to more Americans.
To read our Client Alert on the final regulation regarding Lender Insurance issued in January of 2012, click here.