Billions of dollars of delinquent Federal Housing Administration-insured loans held on bank balance sheets are looking more and more like shadow nonperformers, and mortgage experts warn that banks are unlikely to be fully reimbursed for losses.
Though the largest banks said in their first-quarter results that they will eventually be reimbursed for all losses on FHA-insured loans, they will have to eat some of those losses if they violate servicing standards, the experts said.
Some lenders acknowledge privately they "think the line is blurred and they will be held accountable for any mistakes on FHA loans," said Brian Chappelle, a partner at Potomac Partners, a consulting firm in Washington, and a former HUD official. "Lenders are really at a loss as to when the insurance stops and their responsibility starts."
In the past two years, as delinquencies on FHA and Veterans Administration-insured loans have risen, banks have been aggressive in buying delinquent loans from the Government National Mortgage Association, or Ginnie Mae. Funding delinquent loans on their balance sheets is cheaper than making regular principal and interest payments to bond investors.
Most banks classify delinquent FHA loans as 90 days past due and still accruing interest, which some experts say is distorting bank earnings and overstating their profitability.
Rebel Cole, a finance and real estate professor at DePaul University in Chicago and a former Federal Reserve Board economist, said the majority of the loans should be listed as nonperforming because reimbursement by FHA is not a sure thing. He said banks should not be accruing interest on the loans and should charge them off after 180 days.
"There is no certainty of reimbursement on these loans, but it's showing up as paper profits," Cole said. "FHA isn't recognizing the losses, and the banks aren't recognizing the losses, and they're all complaining about the deadbeat borrowers that they are not kicking out of their houses."
Servicers can be penalized up to three times the amount of any FHA insurance claim if they have not offered loss-mitigation options to defaulted FHA borrowers. The average claim submitted to the Department of Housing and Urban Development last year was $167,782, so banks could potentially face up to $500,000 of penalties for each claim that would potentially be rejected for failing to provide loss mitigation.
"Lenders are reluctant to submit claims because they are worried that FHA will penalize them," Chappelle said.
Many servicers have delayed submitting claims to the FHA until they comply with consent orders issued earlier this month by the Office of the Comptroller of the Currency. The orders require an overhaul of servicing operations and a third-party review of the past two years of foreclosures.
Some industry experts say that when federal regulators assess penalties against the largest bank-servicers for failures identified in the consent orders, a significant portion of the damages will be paid to HUD for failures to perform appropriate loss mitigation on delinquent FHA-insured loans.
Some servicers are in negotiations with the FHA to ensure "they are not subject to some big liability issue," said a person familiar with the administration's thinking.
At yearend, Bank of America Corp. held $16.8 billion of loans insured by the FHA and the VA that were 90 days or more past due. Wells Fargo & Co. had $14.7 billion, Citigroup Inc. had $9.3 billion and JPMorgan Chase & Co. held $8.7 billion.
The vast majority of these delinquent loans either are still being worked out or are stuck somewhere in the foreclosure process. The FHA pays claims only when a loan has gone into foreclosure and the property has been conveyed back to it.
There is a potential benefit to the delays by lenders. The slower claims process may buy the FHA time to improve its financial condition and have more money to reimburse banks.
Qumber Hassan, a mortgage strategist at Credit Suisse, said the vast majority of delinquent FHA loans held on bank balance sheets will eventually default. The FHA has capital reserves of $33.3 billion to cover potential losses, and by raising premiums this year it is bolstering its reserves as well.
"They might be able to put some of these losses back to the banks," Hassan said. "So it looks like [the FHA] will steer through the crisis without needing more help from the government. [The FHA] may be able to get out of this mess without requiring a bailout."