Housing and Urban Development Secretary Shaun Donovan asked Congress for a bigger stick to wield with large lenders that originate Federal Housing Administration mortgages around the country.
Make that two bigger sticks.
In testimony before the House Financial Services Committee Wednesday, Donovan asked lawmakers to authorize the FHA "to hold lenders accountable nationally for their performance." Right now HUD can easily shut down an individual branch that produces loans with outsized defaults, but it must go through a bureaucratic process to revoke a lender's national FHA license.
Perhaps more radically, HUD also wants the ability to "hold all FHA lenders responsible for their fraud or misrepresentations by indemnifying the FHA fund," Donovan said. As it stands, the FHA can make the lender that originated a defective loan eat the loss. HUD is asking for the right go after the companies that buy FHA loans from correspondent lenders, securitize them through the Government National Mortgage Association, and service them.
That would be "a huge expansion," said Brian Fitzpatrick, the chief executive of Aklero Process Solutions Inc., a Radnor, Pa., company that has automated the pre- and post-closing analysis of loan documentation.
"You have to bet that now investors" — that is, the lenders that buy loans from correspondents — "are going to be doing the same level of scrutiny on FHA loans that they've been doing on Fannie and Freddie loans."
Speaking to reporters after the hearing, Donovan and FHA Commissioner David Stevens emphasized that the liability for originators' misdeeds would not extend to the investors in Ginnie Mae's mortgage-backed securities.
"The steps are between us and the lenders," Stevens said. "The Ginnie Mae holder has no impact at all as a result of the actions we would take."
Brian Koss, the managing partner at Mortgage Network Inc., a privately held lender in Danvers, Mass., said the industry should welcome the changes HUD is asking for, though they would make doing business more costly and more of a hassle.
"They're making sure that lenders are double-checking everything, so it's a check of a check of a check," Koss said. "What it means is that everyone is in fear right now, and they're very nervous, so they're adding more layers and controls which raise the cost and time to process loans."
Donovan's requests were consistent with other steps HUD has been taking to raise the bar for lenders that do business with the FHA.
On Monday the department proposed a rule that would raise the minimum net-worth requirement for FHA-approved lenders to $1 million within the first year and $2.5 million within three years, from the current $250,000.
In an interview Tuesday, Stevens called $2.5 million a "bare minimum" that might increase over time.
"The mortgage industry is coming out of an unprecedented period where unscrupulous players and institutions without capital could call themselves a mortgage lender," he said. "The 'skin in the game' concept can take on many forms, but capital is what really counts."
Donovan told lawmakers that HUD also plans to create a "lender scorecard" showcasing the performance of FHA lenders that will be posted prominently on its Web site.
"One of the things that HUD is doing on regular basis is monitoring lenders and scrutinizing them more closely where they have … [FHA insurance] claims and default performance that is well above the average, more than double than what we see as the average," he said.
Brian Chappelle, a partner at Potomac Partners, a Washington consulting firm, said the scorecard would shine a spotlight on poor-performing FHA lenders that currently can only be found through a search of the agency's Neighborhood Watch program.
To replenish the FHA's dwindling reserves, Donovan in his testimony also proposed raising the up-front insurance premium to 3% from the current 1.75%, and requiring that borrowers put down more cash than the current minimum 3.5% of the home price.
For the first time ever, Donovan said, the FHA plans to adopt a minimum FICO score for applicants. But this is a mostly symbolic gesture, since most lenders already require scores of at least 620.
An actuarial review released last month showed that the FHA's capital reserves had fallen below its 2% congressionally mandated level, to 0.53%.
Combined with reserves held in its financing account, the FHA holds $31 billion to cover losses over the next 30 years, or roughly 4.5% of total insurance-in-force in reserves, Donovan told lawmakers.
Though the FHA is taking steps to minimize losses to its capital reserves, Donovan said the review found that even with growing volumes, more than 71% of the agency's losses over the next five years will come from loans that are already on its books.
After leaving the hearing, Committee Chairman Barney Frank, D-Mass., said he would give HUD what it needs to go after lenders.
"We gave them previously the ability to debar people," Frank told reporters. "Republicans are very high on [Donovan] as well. I think virtually any tool he asks for, we will give him."
The hearing was dominated by Republican concerns about the FHA's solvency and fears that lending standards are mirroring the problems that plagued some subprime borrowers by extending credit to those who could not afford to repay their loans.
Rep. Scott Garrett, the top Republican on the capital markets subcommittee, said lawmakers are worried the FHA could become the next to require a bailout.
Speaking to Donovan, Garrett said: "Members of both sides of the aisle would agree with your last point about wanting to see the economy actually growing again and to your point that housing can, will and should play a significant part in trying to get the economy back on track. The caveat to that is if FHA's situation continues to decline, and we get a worst-case scenario and we get to a bailout situation, that would be a horrendous situation for us to be in."