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Lawsuits May Cut Mortgage Access

NEW YORK ( TheStreet) -- Getting a home loan is only going to be tougher, as banks tighten standards for Federal Housing Administration (FHA) loans amid rising legal claims.

Analysts at FBR Capital have long been worried that the FHA's poor fiscal health will lead it to deny insurance claims and file lawsuits over servicing and origination of FHA loans.

The FHA insures banks against defaults on loans and has seen its share of the mortgage origination market rise from 3% in 2005 to 24% in 2011 in the wake of the sub-prime crisis. But the high default rate during the crisis has drained its resources.

The latest budget plan found that the FHA might need as much as $688 million from the U.S. Treasury to bridge a shortfall in its reserves. That problem was quickly resolved by the recent $26-billion mortgage settlement between the nation's largest servicers and the 49 states.

Under the settlement, the five banks would have to inject $1 billion into the agency's capital reserves to settle claims related to servicing.

Still, not all legal concerns have been put to rest. Analyst Paul Miller notes that the settlement only covers servicing violations and not origination violations. He cites the example of Flagstar Bancorp (FBC - Get Report) which recently entered into a settlement with the Justice Department for $133 million related to fraudulent FHA lending practices.

Bank of America (BAC - Get Report) also entered into a $1 billion settlement with the Justice Department over allegations that the bank's Countrywide Unit knowingly made loans insured by the FHA to unqualified home buyers.

Recent fines also include Citi Mortgage, a subsidiary of Citigroup (C - Get Report) agreed to pay $158 million to settle a civil complaint by the Manhattan attorney's office, accusing the company of routinely certifying that loans qualified for FHA when they did not.

According to FBR, the fines imposed on banks could be quite severe, in some cases trebling damages for violations of FHA's "highly complicated and technical" rules.

The recent Flagstar settlement might just be a one-off, but the analysts believe that the "damage to lender confidence" has already been done. "We believe that this settlement could result in lenders reexamining their risk with respect to FHA lending and tightening standards for the FHA product. Our major concern is that the tightening credit policies could lead to fewer borrowers being able to qualify for an FHA mortgage," the analysts wrote in a note Monday.
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