Contractor Want Ad Starkly Lays Out FHA's Shortcomings

Calling its own techniques "outdated," the Federal Housing Administration is looking for outside help to prevent defaults in its $760 billion single-family mortgage portfolio.

In a 118-page request for proposals issued last month and obtained by American Banker, the agency said its loan-level reviews "lack the detail necessary to swiftly and efficiently identify loans that have the potential to result in delinquency, default and/or foreclosure."

To protect its mortgage insurance fund, the FHA plans to hire a third-party contractor to find and fix deficiencies in its systems, and improve the agency's detection of fraud and monitoring of the risk at counterparties, not least of all lenders.

The agency, which insures 20% to 25% of the home loans written today, wants more defaulted loans audited before it pays out lenders' claims on them. Currently, most of the FHA's audits are done right after the loan closes.

"They've admitted that they need help," said Ed Pinto, a consultant and former chief credit officer of Fannie Mae. "It comes down to how do they figure out what the lenders are doing, if they are originating and servicing properly and how they audit all of that. They are looking at the need to evaluate counterparty risk and claims as they come in."

For years, FHA commissioners have complained to Congress of the need for additional funds to improve the agency's technology. But the impetus to change has only come in the past year as FHA originations — and defaults — have surged.

"FHA is very much behind in their processes, and especially their technology to scale their programs," said Lisa Schreiber, the chief strategy officer at NetMore America, a lender in Walla Walla, Wash.

For the first two years that NetMore offered FHA loans, the lender had to send the agency paper files even though the company had gone paperless, Schreiber said.

"They must manage risk — the audits must increase and the quality issues addressed more — and they must utilize current technologies in order to create scale."

An FHA spokeswoman declined to comment on the $32 million, multiyear contract it has put out for bid.

Sylvia Alayon, a vice president and director of operations at the Consumer Mortgage Audit Center in Fort Lauderdale, Fla., a nonprofit that conducts loan audits for borrowers, called the invitation for proposals "very progressive and forward thinking" for an agency with "a reputation for being very bureaucratic and not a fan of the private sector."

"It's definitely a sign of the times we are in," Alayon said.

The request for proposals said that even though the agency collects vast amounts of data on the loans it insures, "FHA does not make extensive use of business intelligence tools to manage and aggregate data."

"Very few users have the capacity to efficiently manipulate data," the document said.

The FHA said it also needs assistance "in identifying what data it should be receiving" from its lenders, and ensuring that data "is reliable and an accurate reflection of the current environment."

The outside contractor would also review appraisal reports, mortgage credit analysis, underwriting decisions and closing documents.

Brian Chappelle, a partner at Potomac Partners, a Washington consulting firm, said an outside contractor "will ratchet up the sophistication of the tools that FHA has."

"They are using technology from 25 years ago," said Chappelle, a former FHA official.

"Part of this process is they're going to put a fraud tool on the front end to make sure there isn't occupancy or investor fraud," Chappelle said, "and then they're going to use other automated tools to identify early-payment defaults" — loans that go bad within a few months of being originated.

Pinto, who has been a prominent critic of the FHA in recent years, called the proposed contract "soup to nuts."

"There's been a general admission that their systems are woefully behind the times, and their volume is eight times what it was three years ago," he said.

With increased loan volume and market share have come higher defaults and losses.

According to the Mortgage Bankers Association, 13.15% of FHA loans were 90 days overdue or in foreclosure at the end of the first quarter, up from 8.67% in the third quarter.

In November, a long-awaited audit of the FHA showed that in the year that ended Sept. 30, the FHA's capital reserve ratio had fallen to 0.53%, well below the congressionally mandated minimum of 2%.

Nevertheless, lenders and industry experts credit FHA Commissioner David Stevens for taking steps to improve the agency's technology and internal controls.

Under Stevens, the FHA has tightened underwriting guidelines, such as by requiring higher down payments from borrowers with low credit scores. In October, the FHA hired longtime Freddie Mac executive Bob Ryan as chief risk officer, a new position.

Stevens also has asked Congress to give the agency more power to make lenders indemnify it for loans that were improperly originated or where fraud or misrepresentations occurred.

In January, Stevens testified at a House Financial Services subcommittee hearing that the FHA currently has the authority to demand indemnification from just 29% of its lenders for losses on loans that involved underwriting errors or fraud.

One piece of self-criticism in the request for proposals may itself be outdated.

The document said "servicer information is only received on defaulted loans, rather than its entire portfolio of insured loans." But Chappelle said this was not the case. Whoever wrote that passage must have "used old documents from the previous crowd" who ran the FHA during the Bush administration, Chappelle said. "They always had enough data," he said. "It just takes people who can analyze the data."