“The banks say they are certain of repayment but that’s simply not true,” says Rebel Cole, a finance and real estate professor at DePaul University in Chicago and a former Federal Reserve Board economist.

Buried in Fine Print: $57B of FHA Loans Big Banks May Have to Eat

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Most banks define delinquent FHA loans as those 90 days or more past due but still accruing interest. B of A has $21.4 billion of delinquent FHA loans on its books, while Wells has $19 billion, Citi has $4.2 billion and JPMorgan Chase has $3.3 billion. The banks also have on their books more than $8.6 billion of "nonaccrual" delinquent loans on which the FHA is no longer covering interest. Almost $7 billion of those loans are held by JPMorgan Chase.

DePaul's Cole says that the numbers are misleading, however.

Bank of America, for example, lists only a fraction of its $23 billion in defaulted FHA loans as nonaccrual. But in a footnote to its second quarter filing with the Securities and Exchange Commission, B of A says the FHA, as the insurer, has stopped paying interest on $17 billion of the defaulted loans. Cole insists those also should be listed as nonaccrual.

Some observers suggest that the loans could sit on the four banks' balance sheets until they settle existing disputes with the FHA over their underwriting. B of A and Citibank have already negotiated settlements over False Claims Act violations with the FHA or are in the midst of doing so.

The settlements are to resolve claims involving an unknown amount of previously filed FHA claims that could date back a decade or more. After the legal claims involving these mortgages are cleared up, the banks will be able to file new claims for loans still on their balance sheets.

"At some point there is going to be a settlement and it will include the loans held on their balance sheets, and at that point they will be able to file claims," said one attorney who represents a bank currently in settlement talks.

In all, 10 FHA lenders are currently in negotiations with HUD and the Justice Department, David A. Montoya, HUD's Inspector General, told legislators last month. The FHA's servicing review teams have found widespread violations of servicing practices, and the expectation is that the FHA will be reimbursed for claims it has already paid, Montoya said.

"Given the sheer volume of loans involved and high error rates identified in underwriting, settlements and favorable court actions may result in significant recoveries by the government from each of the 10 lenders," Montoya told a House subcommittee on Sept. 10.

Any recoveries, of course, would help the FHA bolster its own finances. Though the FHA says it has already set aside reserves to cover losses, the agency remains undercapitalized and had to tap the Treasury Department for a bailout last month.

"There's no question that HUD is stepping up its enforcement efforts and that's a euphemism for collection efforts," says Schulman, the K&L Gates attorney.

The FHA has more than $32 billion in reserves, but it faces an estimated $70 billion in future payouts on loans originated just from 2007 through 2009, according to the 2012t from the Government Accountability Office. In all, the FHA has roughly 686,000 seriously delinquent loans, representing $106 billion in total principal balances for all lenders. These distressed assets continue to be a major drag on the housing market, distorting the supply of homes for sale because so many remain stuck in the foreclosure process.

Last year, the U.S. Attorney for the Southern District of New York, the Justice Department, HUD's general counsel and HUD's Office of Inspector General settled civil fraud cases with three large banks: Deutsche Bank's Mortgage IT unit for $202.3 million, CitiMortgage for $158.3 million and Flagstar Bank for $132.8 million. Each of those settlements involved the lender's admission that they submitted what are called "false annual certifications" to HUD. A spokesman for Citi says because of its past settlement, it has continued to file new claims and expects the FHA to pay for all losses.

In addition, B of A agreed last year to pay roughly $1 billion to resolve allegations of misconduct for loans originated by Countrywide Financial, which it bought in 2008. That settlement helped FHA patch a $688 million budget shortfall.

B of A in particular has dramatically whittled down its backlog of delinquent FHA loans. From the fourth quarter of 2012 to the second quarter of this year, B of A sold off $8 billion in mortgage servicing rights, essentially unloading soured FHA loans to nonbank servicers Nationstar Mortgage (NSM) and Ocwen Financial (OCN). Those servicers now have the authority to file claims with the FHA once loans go through foreclosure.

Of the four lenders, Wells appears to be the most resistant to a settlement.

The bank is locked in a bitter legal dispute with Preet Bharara, the U.S. Attorney for the Southern District of New York, and HUD over allegations of widespread FHA underwriting violations going back a decade.

Wells has claimed it received a broad release from False Claims liability as part of the $25 billion national mortgage settlement, but regulators have disputed that claim in court.

Wells "believes it acted in good faith and in compliance with FHA and HUD rules," a spokesman said in an email. "We look forward to presenting facts to vigorously defend against this action."

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Comments (3)
Right now the industry is all about defense against an unyielding, overzealous, Monday morning second guessing regulatory environment.
I would also like to clarify your comment below regarding FHA targeted clients:

The FHA insures home loans issued by banks and other mortgage lenders to low-income and first-time home buyers

Back in the early 80's this was true but for over 20 years there is no income limit or restrictions to only first time buyers. This has provided more buyers the opportunity to own a home and improved FHA's balance sheet.
The talk now of going back to the old way of limiting income and restricting to first time buyers will severely weaken FHA by saddling FHA with only the highest risk loans.
Posted by markwhite | Tuesday, October 08 2013 at 2:25PM ET
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Posted by markwhite | Tuesday, October 08 2013 at 2:26PM ET
It is clear that that most of the sources in this article haven't spent a single moment in an actual foreclosure courtroom. I challenge anyone that wants to opine about the state of this industry or the reactions of the stakeholders and government handmaidens to come on down and spend a few hours just observing the chaos, the lies, the fraud and the catastrophe that continues to play out in actual courtrooms. One particularly irksome point is the common refrain, "the unreasonably long time it takes to complete a foreclosure"...well folks, if you spent time in courtrooms or communities you'd understand that it's your side of church that's causing most of the delays...again, the lies, the fraud, the chaos.
Posted by weidnerlaw | Tuesday, October 08 2013 at 9:53PM ET
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