Big changes proposed for FHA; FHA - approved lenders and brokers participating in the program would face major changes if a proposed rule is adopted largely as proposed. A major hike in net - worth requirements is part of the proposal.
HUD announced the proposed regulations on Nov. 30, 2009, and gave the industry only 30 days to comment on the proposals. The Department received 275 comment letters from interested parties, suggesting that the proposed changes struck a nerve with FHA program participants and industry players. HUD must now consider those comments before issuing any final changes to its regulations.
HUD's focus on strengthening the FHA loan program and decreasing risks to the FHA Insurance Fund should be applauded. That said, in its zeal to improve the FHA program, HUD overlooked several practical components of the mortgage industry and did not address the significant implications of the proposals on FHA participants.
These changes would profoundly alter the way FHA-approved lenders deliver FHA-insured loans to the public--which may, in turn, adversely affect consumers. As we await HUD's final guidance on these proposals, this article provides a summary of the proposed regulation and highlights a few of the significant implications for FHA participants if the changes, as proposed, come to fruition.
Proposed regulatory changes
HUD's main goals in the proposed regulation are to eliminate the FHA approval requirement for loan correspondents and increase the net-worth requirements for FHA-approved lenders.
Elimination of loan correspondent approval
Currently, a mortgage originator can obtain approval to participate in the FHA program as either a "mortgagee" (lender) or a loan correspondent. A mortgagee is authorized to originate, underwrite, purchase, hold, service and sell FHA-insured loans. A loan correspondent is authorized to originate FHA-insured loans, and may close loans in its name and submit the loans for FHA insurance endorsement; however, the loan correspondent generally is not permitted to underwrite, purchase, hold or service FHA-insured loans.
A loan correspondent must obtain approval from HUD after demonstrating that it meets certain criteria--including, among others, maintaining a minimum net worth of $63,000 and having in place a quality-control plan. Loan correspondents are "sponsored" by lenders, who are responsible to HUD for supervising the actions of their loan correspondents; however, HUD holds a loan correspondent responsible for violations of HUD guidelines it commits, unless the sponsor knew or should have known of the loan correspondent's infractions.
The proposed regulation would remove the loan correspondent approval requirements from HUD's regulations. Instead, HUD would rely on FHA-approved lenders to ensure that the loan correspondents from which they obtain FHA-insured loan applications meet certain "applicable requirements."
An approved lender would continue to sponsor loan correspondents; however, in doing so, the lender would assume:
* responsibility for any loan correspondent that works with the lender in connection with an FHA-insured loan; and
* liability for the FHA-insured loans underwritten and closed in the name of the FHA-approved lender.
With regard to responsibility for loan correspondents, HUD would require FHA-approved lenders to ensure that "loan correspondents meet [HUD's] standards assuring their integrity and financial soundness." Specifically, FHA-approved lenders that accept loan applications from a non-FHA-approved entity would have to determine that the entity is not subject to the administrative sanctions that make an entity ineligible for participation in the origination of FHA-insured loans.
These ineligibility criteria were expanded by the Helping Families Save Their Homes Act and include, among other things, being: 1) suspended, debarred or otherwise restricted from participating in federal programs; 2) subject to governmental audits; or 3) in violation of the Secure and Fair Enforcement Mortgage Licensing Act of 2008 (SAFE Act).
The FHA-approved lender would also be liable for all aspects of the FHA-insured mortgages it originates, including those obtained from non-FHA-approved entities. FHA-approved lenders would be required to ensure compliance by all parties to the FHA transaction with all of HUD's requirements regarding loan origination, processing, underwriting and servicing.
HUD would hold the FHA-approved lender accountable for all violations of FHA requirements, including those infractions committed by the unapproved loan correspondents. Essentially, the proposed changes would hold a sponsor liable for the acts, errors and omissions of its non-approved loan correspondent, regardless of whether the sponsor had knowledge of the loan correspondent's violation of FHA requirements.
If the proposed regulations are adopted, entities that are currently approved as FHA loan correspondents would not be permitted to renew their status or convert their approval to mortgagee, and only FHA-approved lenders would be allowed to request FHA case numbers. In addition, the proposed amendments would require that all FHA-insured loans be underwritten by and closed in the name of the FHA-approved lender.
In each case in which a loan application is taken by a non-approved entity, the FHA-approved lender would be required to enter the non-approved entity's legal name and Tax Identification Number into HUD's FHA loan origination record system. While FHA would continue to maintain some basic information about loan correspondents, HUD would not have direct contact with non-approved loan originators and, it appears, would not track these entities through its Approval and Recertification Division, Quality Assurance Division, Neighborhood Watch System or Credit Watch Program. Rather, HUD would hold FHA-approved lenders solely responsible for the loan originators with which they associate.
Increased net-worth requirements
The proposed regulation also would increase the net-worth requirement for FHA-approved lenders from $250,000 to $2.5 million over a three-year period. Notably:
* Within one year of the effective date of any final regulation resulting from this rulemaking process, HUD would require supervised, non-supervised and investing lenders to have a minimum net worth of $1 million, of which at least 20 percent must be liquid assets consisting of cash or its equivalent.
* Within three years of the effective date, HUD would require supervised, non-supervised, and investing lenders to have a minimum net worth of $2.5 million, at least 20 percent of which must be held in liquid assets.
The proposed amendments would, for the first time, require investing mortgagees to comply with these increased net-worth requirements. As noted, the proposed regulatory changes were announced in connection with HUD's efforts to tighten its requirements and protect the solvency of the FHA Insurance Fund. The proposed net-worth increases provide a clear example of HUD's attempt to ensure that its lender partners are sufficiently capitalized to cover any liability for violations of FHA requirements that HUD may identify through its enforcement processes.
Implications for FHA participants
The proposed changes to HUD requirements regarding loan correspondent approval and increased net worth raise several considerations and questions. This is the case for both FHA-approved lenders that wish to continue originating, underwriting and closing FHA-insured loans, as well as those content with becoming or remaining non-FHA-approved loan correspondents or mortgage brokers.
The proposed loan correspondent-approval changes would result in increased oversight responsibilities for FHA-approved lenders and raise important questions regarding HUD's geographic lending area restrictions. The increased net-worth requirements, and the corresponding restrictions on non-approved entities' ability to process or close FHA loans, would put FHA participants--particularly small lenders--in the difficult position of choosing between the costs associated with raising significant capital or relinquishing FHA approval.
These proposed changes carry important implications that merit examination in more detail.
Loan correspondent approval changes
Increased need for oversight by FHA-approved lenders The most obvious implication of the proposed regulatory changes regarding the elimination of loan correspondent approval would be FHA-approved lenders' increased responsibility and liability for their loan correspondents. If HUD finalizes the proposed regulations as written, the Department will relinquish its jurisdiction over loan correspondents and hold FHA-approved lenders liable for all FHA loans. FHA-approved lenders that continue to accept FHA loan applications from non-FHA-approved entities will be responsible for monitoring the quality and performance of loans received from these non-approved entities.
With regard to quality-assurance audits, FHA-approved lenders will be liable to FHA for any issues identified in a loan file, including those violations committed by the non-FHA-approved entity in originating the loan. For instance, if a loan correspondent allows an employment verification to be hand-carried by the borrower, the FHA-approved lender that accepts this application package, rather than the loan correspondent, will be liable for any penalties HUD imposes for such an infraction.
FHA-approved lenders will be required to obtain FHA case numbers for all FHA-insured loans. Thus, for Credit Watch purposes, all FHA-insured loans, whether originated by a loan correspondent or the sponsoring lender, will be included in the lender's default/ claim rate. For these reasons, FHA-approved lenders that sponsor hundreds, or even thousands, of mortgage brokers may want to rethink taking on full responsibility and liability for the FHA-insured loans originated through these relationships.
Questions regarding geographic lending areas
HUD has not addressed how the proposed changes to loan correspondent-approval requirements will affect its geographic restrictions on loan origination and underwriting. Currently, each office of an FHA-approved lender or loan correspondent is authorized to operate only in those states designated by HUD as the entity's Areas Approved For Business (AAFB). The geographic restrictions apply to the taking of the loan application and underwriting of the loan.
HUD guidelines currently permit FHA-approved lenders with Direct Endorsement underwriting authority to sponsor loan correspondents operating in any jurisdiction and rely on the loan correspondent's AAFB to underwrite in all geographic areas in which the loan correspondent is authorized to take loan applications.
If the proposed regulations are adopted, HUD would no longer approve loan correspondents or dictate their AAFB. Thus, it is unclear whether FHA-approved lenders would be limited to their own AAFB for taking FHA loan applications and conducting underwriting activities, or whether the FHA-approved lenders would be able to accept FHA loan applications from non-FHA-approved entities for loans secured by properties located outside of the FHA-approved lender's own AAFB.
If FHA-approved lenders are limited to their own AAFB and can no longer rely on their loan correspondents' AAFB, it could severely restrict the areas in which many current Direct Endorsement lenders can do FHA business. This limitation would particularly disadvantage small FHA-approved lenders that do not have the financial resources or geographic reach to expand their own AAFB by opening branch offices in additional states.
Increased net-worth requirements
As if the changes associated with eliminating loan correspondent approval were not enough to digest, participants in the FHA program must also contend with the proposed higher net-worth requirements.
For currently approved loan correspondents and FHA-approved lenders with current net worth below $1 million, or even $2.5 million, the proposed increases to net-worth requirements would pose a significant decision. As the supplementary information points out, these entities must either: 1) increase their net worth to become, or maintain their status as, FHA-approved lenders; or 2) relinquish their status as FHA-approved lenders and participate in the FHA program by partnering with another FHA-approved lender as a loan correspondent or mortgage broker.
Given the three-year period the proposal provides to meet the $2.5 million net-worth requirement and the "other avenues of participation in FHA programs available to those mortgages not able to meet the new net-worth requirements," HUD concludes that the increase will not restrict any currently FHA-approved lender from participating in FHA programs. However, both of these options are wrought with consequences that HUD does not consider.
Raising sufficient capital to meet increased requirements
Those entities wishing to continue underwriting and closing FHA loans must raise the capital to meet the increased net-worth requirements, which, for example, would exclude receivables from affiliates. For those entities holding only the current $250,000 minimum net worth, this change would constitute a tenfold increase in capital.
Most businesses will find this increase to be substantial. However, the supplementary information states that, as HUD has not increased FHA net-worth requirements since 1993 and as the proposed increases are consistent with recent increases in net-worth requirements by the government-sponsored enterprises (GSEs), the proposed regulation is not "economically significant."
This conclusion rests on the assumption that increases in net worth would be met largely by changing the title of existing assets from the individual holdings of a lender's owners to those of the institutions. The supplementary information, however, provides no support for this conclusion and does not discuss the economic or legal considerations that an FHA-approved entity's ownership would make in determining whether such an asset transfer was in the entity's best interests.
Asset transfers and other efforts to raise sufficient capital could take substantial time and effort, and these entities must first analyze the business and tax consequences of such actions.
Considerations for entities not able to raise sufficient capital
For those loan correspondents and FHA-approved lenders unable or unwilling to meet the increased net-worth requirements, these entities must relinquish their FHA approval as mortgages and become non-approved loan correspondents. The supplementary information states that this business change would result in the non-FHA-approved loan correspondent no longer being able to underwrite or process FHA-insured loans.
In addition, the proposed amendments to HUD's regulations would require that all FHA-insured loans be closed in the name of the FHA-approved lender, rather than in the name of either the non-FHA approved lender or the loan correspondent. Although not addressed by HUD in the proposed regulation or its supplementary information, the inability of a non-FHA-approved loan correspondent or lender to process or close FHA-insured loans in its own name would create significant issues regarding state licensing requirements, operational systems changes and revenue streams.
Some of these issues include the following:
Non-approved entities will face increased administrative burdens I and costs associated with state licensing issues. For FHA-approved lenders and loan correspondents that currently close loans in their own name, the relinquishment of this ability ' would require these entities to broker their FHA loan applications to those entities that maintain their FHA-approved status as mortgages. This change effectively would put an end to the purchase of FHA-insured loans on a table-funded basis for those loan correspondents that do not seek to obtain mortgage approval and result in the unapproved loan correspondents becoming mortgage brokers under applicable state law.
The conversion from a lender that closes loans in the entity's name to a mortgage broker could trigger significant state licensing issues for these entities. Reviewing current licenses and state licensing provisions, implementing new and burdensome disclosures, and taking the steps necessary to convert these licenses could take months and impose significant administrative burdens and costs on lenders that choose not to maintain or obtain approval as a mortgagee.
Faced with these burdens, loan correspondents and FHA-approved lenders that cannot meet the net-worth requirements may elect not to continue participating in the origination of FHA-insured mortgage loans. This could result in less, rather than more, loan correspondent participation in the FHA program.
* Non-approved originators will be required to make significant and costly changes to operational systems. Moreover, conversion of a non-approved lender's FHA loan portfolio from a lending operation to a mortgage brokerage operation would require conversion of the entity's loan origination systems (LOSes), which also will require significant time and costs. It would take months for these entities to make changes to their operational systems to comply with the proposed regulatory changes regarding processing and closing and to ensure compatibility with their sponsors' origination systems.
HUD, however, does not include these costs in its economic analysis of the proposed regulatory amendments. We also note that these operational systems changes would be in addition to the systems changes that lenders and mortgage brokers are already being required to make to conform to the new disclosures under the Real Estate Settlement Procedures Act (RESPA) that became effective on Jan. 1, 2010. Those changes would be in addition to the software implementation necessary to adhere to new state compliance requirements mandated by the SAFE Act.
Again, the additional financial and regulatory burdens may well force a significant number of currently FHA-approved loan correspondents and small lenders to exit the FHA loan market. Such a development would decrease the number of entities providing affordable mortgage credit to eligible borrowers and increase the costs associated with obtaining an FHA-insured loan from the approved entities that remain.
* Non-approved originators will encounter considerable changes to revenue streams. Finally, the transfer to a mortgage broker operation for those small lenders and loan correspondents that currently close FHA-insured loans in their own name will also create considerable changes to these entities' revenue streams.
As lenders, these entities currently are not required to disclose back-end compensation; however, the non-FHA-approved entity acting as a mortgage broker would be required to disclose such compensation separately, which would shift profits and may result in lower income streams. HUD notes that non-FHA-approved entities would still be entitled to income streams derived from servicing-release premiums; however, as the proposed regulation would not permit these entities to close loans in their own name, servicing-release premiums would not be available to non-FHA-approved entities.
It is also unclear how a non-approved loan originator would be able to satisfy HUD's requirements for mortgage broker compensation under RESPA in FHA-insured transactions if such non-approved entities are not permitted to perform the loan processing or closing functions required by HUD. Finally, if the proposed changes to FHA take effect along with the Federal Reserve Board's proposed amendments to the regulations implementing the Truth in Lending Act (TILA), which would prohibit payments to mortgage brokers and a lender's loan officers based on a loan's interest rate or other terms, non-FHA-approved entities would be prohibited from earning yield-spread premiums or other compensation based on interest rate or loan terms.
The bottom line
In reading the supplementary information to the proposed regulation, one comes away with the impression that the proposed changes will not create any significant business or economic issues for currently approved FHA participants. In fact, this information suggests the proposed rule will benefit loan correspondents by allowing them to continue to participate in the FHA loan origination process without having to undergo the lender approval process.
Despite HUD's cavalier attitude, the proposed changes to loan correspondent approval and the increased net-worth requirements would dramatically impact both FHA-approved lenders and loan correspondents. If HUD finalizes these proposals, all FHA participants will have to consider these significant implications as they weigh the costs and benefits of whether to continue to participate in the FHA program and, if so, in what capacity.
As of this writing, the comment period has closed, and HUD is reviewing the comments made by FHA program participants and other interested parties. The industry now must wait for HUD's final regulations to resolve these issues. It is hoped that HUD's final guidance will address the significant regulatory and economic impacts the changes will have on FHA participants and provide the mortgage industry sufficient time to implement the changes before they become effective. Buckle your seatbelts.
Phillip L. Schulman is a partner and Krista Cooley is an associate in the Mortgage Banking and Consumer Financial Products Group of K&L Gates LLP in Washington, D.C. They can be reached at firstname.lastname@example.org and email@example.com.
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|Title Annotation:||Regulation; Federal Housing Administration; Department of Housing and Urban Development|
|Comment:||Big changes proposed for FHA; FHA - approved lenders and brokers participating in the program would face major changes if a proposed rule is adopted largely as proposed. A major hike in net - worth requirements is part of the proposal.(Regulation)(Federal Housing Administration)(Department of Housing and Urban Development)|
|Author:||Schulman, Phillip L.; Cooley, Krista|
|Date:||Feb 1, 2010|
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