A largely overlooked change at the Department of Housing and Urban Development could increase competition in mortgage lending by encouraging more banks to offer Federal Housing Administration loans.
Late last year HUD ended a policy requiring small banks to complete an internal control and compliance audit to offer FHA loans. The move will benefit banks with less than $500 million of assets, says Ron Haynie, vice president of mortgage finance policy at the Independent Community Bankers of America.
Eliminating the cost of an audit should prompt more of those banks to revisit FHA lending. Many smaller banks stopped originating FHA mortgages when the eligibility requirements become cost-prohibitive, industry experts say.
"A compliance audit is expensive," Haynie says. "If you are only doing a few FHA loans a year, then there is not a lot of revenue that offsets this."
In 2009 HUD changed its eligibility requirements for financial institutions to participate in FHA lending. The agency required all approved mortgage lenders, including supervised banks, to submit a full outside financial audit and a compliance audit as part of recertification. The compliance audit reviewed whether a financial institution had proper controls in place to monitor loan quality.
In 2011 the FHA waived its financial audit requirement and instead allowed smaller bankers to submit unaudited call reports that were already required by federal regulators.
The change did little to ease the burden on smaller banks, says Wes Ware, practice group manager of risk and compliance at CCG Catalyst Consulting Group. Most external auditors will not sign off on a compliance audit unless there is a complete financial review, so "it didn't do a lot of good to eliminate that one part," he says.
HUD's shift reflected a realization that smaller banks were already reporting much of the information it needed to other regulators, a spokesman says. The agency decided that it would also accept the same type of data that banks were filing with other agencies when determining eligibility.
Anywhere from 250 to 300 banks may have quit making FHA loans because of the audits, Haynie says. Financial and compliance audits add about $15,000 to $25,000 in annual costs for a bank, he says.
For instance, Union Bank in Beulah, N.D., started the paperwork to qualify, but chose to steer clear of FHA loans after the $84 million-asset bank's accounting firm outlined the costs of a financial review and compliance audit, Haynie says.
Another North Dakota bank — Peoples State Bank of Velva — decided to let its eligibility expire. Haynie says the $86 million-asset bank was upset when its customers ended up going to another bank that continued to offer FHA loans.
Calls to Union Bank and Peoples State were not returned.
Community banks prize customer relationships, so sending "customers to a larger aggregator was difficult," Haynie says.
The FHA's changes should make smaller banks more competitive, particularly in rural markets and areas with a higher concentration of lower-income residents, industry experts say. The ability to make FHA loans could also help those banks book more loans, Haynie says.
Removing a barrier to entry will not ensure that all eligible banks will participate. United Bank of Michigan in Grand Rapids doesn't offer FHA loans because it has been unable to build enough scale to offset the costs, says Art Johnson, the $449 million-asset bank's chairman and chief executive. He says United has found other ways to serve customers.
Still, Johnson says he is encouraged that the government was responsive to feedback from the banking industry about the burden of the requirements. "
"As a community banker, I like having lots of options, even if some of them aren't ideal for us," Johnson says. "If there are 5,000 community banks, then there are 5,000 different business models. Having more programs that help us take care of customers is good for the community bank model."
So far, the change has come in the form of a waiver; it will not become permanent until the FHA completes a rulemaking process, Haynie says.
And the change certainly doesn't increase the odds that the government will relax any other rules. "HUD has its own issues and problems in the mortgage industry, and I don't see them relaxing a lot of other standards," Ware says.