No good reason for banks to offer more government-backed mortgages

For the past five years, commercial banks have been migrating away from the market for loans guaranteed by the Federal Housing Administration and the Department of Veterans Affairs — and there’s little evidence this trend is going to reverse itself anytime soon.

This is primarily because of the punitive fines imposed by the Department of Justice for errors in underwriting these loans, an ongoing problem for the industry.

The most visible departure was JPMorgan Chase, which paid $614 million in 2014 for allegedly submitting false claims for FHA-insured and VA-guaranteed mortgages. Shortly after that, JPMorgan ended its participation in the FHA market, a move that was followed by a number of other commercial banks.

Since 2014, the number of significant bank participants in the FHA/VA market has dwindled down to two — Wells Fargo and Flagstar — with the majority of the market now comprised of non-bank lenders. The liquidity in the FHA market, both for loans and servicing, has suffered accordingly. Indeed, during 2017, the economics of originating and servicing FHA loans deteriorated along with the broader market.

Both banks and independent mortgage banks, also known as IMBs, in the market for originating and servicing residential mortgages face a rapidly changing business landscape in 2018. The increase in direct costs in all areas of the mortgage market, combined with unfavorable conditions in the secondary loan market, compel a number of lenders and servicers to reassess their business strategies and exit the market. More than half of the top ten non-bank servicers are for sale, in bankruptcy or on the verge of failure.

While achieving profitability in the mortgage market overall is difficult, the FHA/VA market presents some unique challenges for depositories and IMBs alike.

On the positive side, the FHA pays lenders a healthy profit margin for originating loans for sale into Ginnie Mae securities. The FHA also allows servicers to charge as much as 44 basis points per loan, roughly twice the fee charged for conforming loans in the Fannie Mae/Freddie Mac market. But the cost of servicing performing FHA/VA loans is higher, largely due to the FHA’s byzantine rules. In fact, the cost of servicing generally has roughly tripled since 2012, making profitability uncertain, unless the servicer does virtually everything right.

A number of industry observers have been predicting for some time that banks will return to the FHA market — but so far little has changed to make this a reality.

The key issue that remains to be dealt with is the DOJ’s use of the False Claims Act against all mortgage lenders. Because prudential regulators have essentially told depositories to avoid headline risks involving mortgage lending, the prospect of a legal claim by the DOJ makes the FHA/VA market problematic for most commercial banks.

“The FHA plays a significant role in providing credit for first-time, low- to moderate-income and minority homebuyers,” JPM CEO Jamie Dimon wrote to his shareholders last year. “However, aggressive use of the False Claims Act (a Civil War act passed to protect the government from intentional fraud) and overly complex regulations have made FHA lending risky and cost prohibitive for many banks.”

Even assuming that the DOJ issue can be resolved, something that Housing and Urban Development Secretary Ben Carson has promised on a number of occasions, the bigger issue for commercial banks is the lack of profitability — both in the FHA/VA markets and also for mortgage loans generally. This is more than a little ironic since a number of market participants believe that it is not possible for IMBs to profitably service performing loans in the Ginnie Mae securities market.

Thus, while many IMBs are in dire financial straits, and the FHA badly wants to attract depositories back into the market, it is unlikely that banks will be returning to the FHA/VA loan market anytime soon.