Sixth in a series

More than two years after the mortgage crisis began, doing business with government agencies has probably never been so critical for home lenders — or expensive.

Federal Housing Administration loans, for example, are pretty much the only product lenders can offer borrowers who have little money for a down payment. But on Friday the Department of Housing and Urban Development announced several steps to protect the FHA's vulnerable financial condition, and the most important ones involved shifting risk to lenders.

Similarly, Fannie Mae and Freddie Mac have become even more aggressive about making lenders buy back faulty loans in the year since they were taken over by the government.

For any of the three F's, "if there's any reason they can push a loan back, they will," said Brian Koss, the managing partner at Mortgage Network Inc., a privately held lender in Danvers, Mass. "You have to cover yourself."

On Friday HUD proposed to put lenders on the hook for faulty loans originated by mortgage brokers.

"We expect those with the capital to fund these loans for the brokers to be held accountable," Dave Stevens, the FHA commissioner, said in an interview Friday.

As part of that change, brokers would no longer be required to get FHA's approval to arrange loans — the so-called "mini-Eagle" designation. It would be up to the lenders with "full Eagle" status to monitor them.

"The biggest misnomer is to think that FHA has the ability to do oversight of individual brokers," Stevens said. "It's not something we have the resources to do."

The proposed change, which is open for public comment, could expand FHA's reach beyond its current 7,000 brokers. It will "allow the major lenders to expand their broker population," Stevens said.

Brian Chappelle, a partner at Potomac Partners, a Washington consulting firm, said community banks that may originate just 10 loans a month will also have access to FHA that they didn't have before. "It will expand the reach of FHA to a broader segment of the market," Chappelle said, while "putting the risk on the companies with the deep pockets."

HUD also said Friday that it will propose a rule hiking the minimum net worth requirement for FHA lenders to $1 million. This would ensure lenders have the financial wherewithal to indemnify the FHA against losses.

FHA's current net worth minimum of $250,000 has been in place since 1993; the proposed increase would bring the FHA in line with the standard of its sister agency, the Government National Mortgage Association. (FHA and Ginnie Mae are both part of HUD).

The department said it may also propose raising the net worth requirement "further in future years to a level comparable to those required by GSEs and other market institutions." (Fannie, a government-sponsored enterprise, requires lenders to have at least $1.65 million in net worth.)

Koss said FHA appeared to be "playing catch up" with the GSEs. "They have plugged a lot of holes that people were taking advantage of because FHA was not quick to market," Koss said, adding that the changes may add costs and reduce volume "for those lenders who shouldn't be in the business anyway."

Effective Jan. 1, HUD is tightening requirements in the streamlined refinancing program for homeowners who already have FHA mortgages. Lenders said the changes will end the pervasive practice of "churning" FHA loans.

For example, a borrower will be required to have made at least six payments on the FHA loan that is being refinanced.

"There are plenty of lenders who would routinely call their customers every 90 days to refinance, which just puts the borrower into more debt but pads their commissions," said Rodney Anderson, the executive director and managing partner of Rodney Anderson Lending Services, a unit of the Dallas lender Everett Financial.

FHA will also have a "net tangible benefit" test for streamlined refis — the transaction must either reduce the total mortgage payment; reduce the term of the loan; or switch the borrower from an adjustable to a fixed rate.

Paola Kielblock, a national product specialist at Fairway Independent Mortgage Corp., in Madison, Wis., said that as a result, lenders will no longer be able to refinance as many customers as possible on just a quarter-point dip in interest rates.

"It's a huge deal especially because FHA business has increased so substantially in the last year."

According to National Mortgage News, today FHA accounts for 25% of all residential mortgages written — a stark contrast to three years ago when the agency had a mere 3% market share. But as FHA's prominence has risen, so have its delinquencies and losses. HUD said Friday that a forthcoming annual audit forecasts that the FHA's capital reserve ratio will fall below the Congressional requirement of 2%.

"We're not the new subprime by any stretch," FHA commissioner Stevens said. But after the collapse of the subprime market in August 2007, FHA was "adversely selected" for a time as the last resort for low-quality loans, he said.

And although FHA has been getting more creditworthy borrowers since then, "just like the rest of the industry, we're not immune to the impacts of what's happening with home prices," Stevens said.

The sheer volume of loans with poor underwriting characteristics has overwhelmed the agencies. Fannie, for example, used to review loans that defaulted within a few months of closing but now has been so swamped that it sorts through loans that have gone into foreclosure, said Maria Brewster, the director of the GSE's centralized repurchase team.

In its quarterly financial filing with the Securities and Exchange Commission last month, Freddie said repurchases of mortgages by lenders from Freddie because of breaches of representations and warranties more than doubled from the year prior to $1.7 billion in the first half.

Fannie did not disclose the amount of such repurchases from it, but said in its quarterly filing that they "continued to increase significantly in the first six months of 2009" as the company reviewed increasing numbers of bad loans. Fannie said it expects repurchase requests to remain high into 2010.

"In the last year, [Fannie and Freddie] have dramatically increased aggressiveness on repurchase requests," Chappelle said. "That is definitely the No. 1 operational issue."

Otherwise, doing business with Fannie and Freddie today is much like it was before they were placed into conservatorship, several market participants said.

David Motley, the president of the $1 billion-asset Colonial Savings in Fort Worth, said the only change he had seen is that Fannie "doesn't take us to lunch as much any more."

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