The Financial Times reports that California (with the largest US property market) said “no thanks” to an offer of roughly $15 billion in lower monthly mortgage payments and reduced loan balances for its residents in talks to settle allegations of mortgage-related misdeeds by leading US banks. “Bank of America had guaranteed California borrowers would receive $8bn in mortgage aid, while Wells Fargo and JPMorgan Chase committed at least $5bn to the state’s distressed homeowners, according to people familiar with the matter, who declined to give exact figures.” Using my HP 12C, California would have received more than half of about $25 billion of aid that would be available to borrowers in a nationwide deal under discussion to settle allegations that banks illegally seized homes using faulty documentation. “The proposals offered were inadequate for California because they did not contain the aspects vital for our state: transparency, real relief for distressed homeowners and strong enforcement mechanisms to guarantee accountability,” said Shum Preston, a spokesman for the state attorney-general. Back to the drawing board.

Turning to FHA news, I received this thoughtful note on FHA compare ratios. "I wanted to share a thought on FHA's compare ratios and their "hard coding" of 150% as the max to be eligible for LI (lender insurance). The problem with this approach is quickly evident using a bit of math. A compare ratio is a peer based metric.  In other words, everyone's compare is based off of the entire group's average 90 day delinquent figures. When a hard cap is placed at 150 - with death penalty type consequences if that cap is exceeded, the results are very predictable. Any company that is moving toward 150 will quickly clamp down hard on their FHA lending. They will put FICO score minimums, DTI maximums, etc., in place. They will tell their underwriters to be very, very careful.  They will move away from areas of the country that are experiencing economic challenges. And, in doing so, those companies will see their 90 day defaults drop. And that will drop the average that calculates everyone's compare ratio, so when the average goes down, any company whose 90 day delinquents didn't go down by an equal amount, will see their compare ratio go up. Those companies will then tighten - which will mean the average will again drop - which means that any company whose 90 day delinquents remained static - will have their compare ratio rise. And so on. Just watch – my guess is that after a few years FHA lending will become extraordinarily tight.  Taken to its logical conclusion, if average 90 defaults fall below 1.0%, any firm that has 1.51% (an extraordinarily clean book) would have a 151% compare ratio and would be terminated by FHA. A compare ratio is a useful tool - but to wrap draconian penalties around it is a terrible mistake. Those who the FHA program is meant to help, the borrower who isn't, by definition, ‘perfect’, is going to be the big loser."

Lenders have indeed been abuzz about last Friday’s FHA announcement of the latest in a series of steps to protect and strengthen the FHA’s Mutual Mortgage Insurance Fund, while enabling the agency to continue to fulfill its mission to provide access to homeownership for qualified borrowers. “These new regulations strengthen the process by which FHA requires certain lenders to indemnify the U.S. Department of Housing and Urban Development (HUD) for insurance claims paid on mortgages that are found not to meet the agency's guidelines. In addition, the final rule requires all lenders with the authority to insure mortgages on HUD’s behalf (‘Lender Insurance’ mortgagee) to meet stricter performance standards to gain and maintain their approval status.  More than 80 percent of all FHA forward mortgage loans are insured by Lender Insurance lenders.” To read this press release in its entirety, please visit: http://portal.hud.gov/hudportal/HUD?src/press/press_releases_media_advisories/2012/HUDNo.12-010.

One industry operations person summed things up. “The new edict covers three issues. The first is regarding indemnifications. The primary change is that all direct endorsement lenders with lender insurance authority will be subject to indemnification procedures and will not be able to negotiate the settlement as is the current practice. The mortgagee shall indemnify HUD for an FHA insurance claim paid within 5 years of mortgage insurance endorsement, if the mortgagee knew or should have known of a serious and material violation of FHA origination requirements, such that the mortgage loan should not have been approved and endorsed by the mortgagee and irrespective of whether the violation caused the mortgage default.

The second is regarding Lender Insurance Authority. In order to retain their Lender Insurance authority, mortgagees must maintain the acceptable claim and default rate required of them when they were initially delegated such authority. A mortgagee has an acceptable claim and default rate if its rate of claims and defaults is at or below 150% of the average rate for insured mortgages in the state(s) in which the mortgagee operates. HUD will monitor a mortgagee’s eligibility to participate in the Lender Insurance program on an ongoing basis. And the third addresses the Lender Insurance Rule in the Case of Corporate restructuring. The proposed rule would facilitate the compliance of new lending institutions resulting from a merger, acquisition, or reorganization with the statutory requirements for Lender Insurance approval.”

FHA mortgagees participating in the Lender Insurance (“LI”) program will be required to indemnify HUD for self-endorsed loans that HUD deems ineligible for FHA insurance based on final regulations. Since January 1, 2006, FHA mortgagees, with approval from HUD, have been permitted to endorse loans themselves, without first having to send the loans to HUD. The final regulation marks the first time HUD will make significant changes to the LI program, one of which automatically increases LI lenders’ liability for the loans they close and self-endorse. These changes finalize LI regulations proposed by HUD in October 2010 and will take effect on February 24, 2012. Under the final regulation, LI lenders will be required to indemnify HUD for an FHA insurance claim paid within five years of mortgage endorsement if the lender knew or should have known of a serious and material violation of FHA origination requirements that would have rendered the mortgage ineligible for FHA insurance, regardless of whether the violation caused the default. An LI lender also will be required to indemnify HUD for an insurance claim if the lender knew or should have known that fraud or misrepresentation was involved in connection with the origination of the loan. While FHA-approved mortgagees may be used to receiving periodic indemnification requests from HUD as part of an enforcement action, until now, HUD has not had the authority to require lenders to indemnify the Department. Effective February 24, 2012, each time LI lenders self-endorse FHA loans, they are agreeing to automatically indemnify HUD for any losses on loans identified as containing serious and material violations or fraud. HUD notes in the preamble to the final regulation that it will use existing practices, such as post-endorsement technical reviews, quality assurance monitoring reviews, lender self-reports, OIG audits, and other HUD investigations to identify loans for which HUD will demand indemnification. HUD assures lenders that these processes will afford ample opportunities to submit additional information to HUD.

While LI lenders may have the opportunity to defend themselves against indemnification demands, it is likely, with this new financial recovery regulation, that HUD will focus its audits on LI loans, rather than loans from non-LI lenders. And, that inevitably means that participation in the LI program will be costly for FHA mortgagees. HUD also will begin to monitor a lender’s eligibility to participate in the LI program on an “ongoing basis,” rather than annually as it does now. HUD will change its formula for calculating a lender’s default/claim rate by measuring whether the LI lender’s default/claim rate is below 150% of the average rates for the states in which it does business, as opposed to 150% of the national average. Finally, new mortgagees resulting from merger, acquisition, or restructuring will now be eligible for the LI program under certain circumstances, despite having less than a two-year performance history. Should a lender be terminated, the regulation provides a process, similar to that used for the Credit Watch program, to seek reinstatement. Lenders may find themselves re-evaluating the costs and benefits of participating in the LI program. And, should lenders determine that these costs are too high, HUD may find itself manually reviewing every FHA loan prior to endorsement, wiping out the benefits of the LI program for both HUD and FHA mortgagees.

And is any company prepared for an FHA audit? Especially since going forward companies will be dealing with a changed threshold for indemnification requests to a standard that the lender, “knew or should have known” of a serious violation or fraud?  “The Collingwood Group invites you to listen in on a conference call with FHA and Mortgagee Review Board (MRB) experts to address steps that lenders and servicers can take to be proactive, manage risk and avoid FHA enforcement sanctions.” Several authorities will converse on the purpose, function and procedures of the Mortgagee Review Board, FHA sanctions and will provide insight into navigating FHA compliance reviews and HUD Inspector General Audits. It is free, and being held on Thursday, February 9^th from 2-3 EST. To register:

http://www.directeventreg.com/registration/event/46706588.

(Editor’s opinion note: The FHA can say all it wants about its capital ratios being fine. Most analysts don’t believe it. And, HUD, just like any organization in this situation, is going to do what it can to lower risk, increase return, and continue to try to stick to its charter. None of this should be a surprise to anyone.)

Looking very briefly at the markets, there is not much going on. Rates are stable, and with some of the transition going on, most of the focus is, and should be, on the structural changes in the mortgage industry (like those above) rather than rates which may not do much for a long time. (There, I said it.) That said, things were quiet overnight and heading into the weekend, and the 10-yr seems content around 1.95% and MBS prices are a shade better.

(Parental Discretion Advised.)
As a kid, I was always told by my parents to brush my teeth. Maybe if I'd seen this 1 minute video, I would have had even more motivation: http://www.youtube.com/watch?vHEYT32Huv2c&featureyoutu.be