Mortgage Mess 'Next Shoe to Drop' is FHA: Analyst

NEW YORK ( TheStreet) -- The largest mortgage lenders and servicers could be hit with another government agency bombshell, according to Paul Miller of FBR Capital Markets.

In the wake of the Federal Housing Finance Agency's mortgage putback lawsuits against Bank of America ( BAC), Citigroup ( C), JPMorgan Chase ( JPM) and a dozen other lenders, the nation's largest banks could be facing a wave of losses on insurance claim denials by the Federal Housing Administration, or FHA.

According to Miller, who cited "conversations with industry and Washington contacts," there is "a growing concern over the risk that FHA loans pose to originators and servicers," since the agency "only a $4.7 billion capital buffer against a $1 trillion portfolio, which translates into a reserves to insured loan ratio, or capital ratio, of 0.50%, well below the 2% mandated minimum."

This means the FHA could be forced to tap into its credit line with the Treasury in order to continue paying out on lenders' and servicers' claims.

Since "the FHA needs to avoid tapping into its credit line to prevent comparisons to Fannie Mae and Freddie Mac," according to Miller, the agency has increased its mortgage insurance premiums and increased borrowers' down payment requirements. If those measures fail to shore-up the FHA's finances, the analyst said "the agency could turn to widespread claim denials in order to reduce losses to its insurance fund."

Miller said that the FHA's focus in its efforts to deny more claims "will likely be on missteps made in the hyper technical servicing process," although "the possibility remains that the agency could be looking for any mistakes made throughout the loan's life, therefore exposing the lenders to losses as well."

While providing detailed loss estimates for the largest mortgage lenders and servicers, the analyst said that "until there is more widespread evidence of FHA claim denials, we believe that the risk is more of a headline risk than a capital concern."

Based on a 1.3% loss rate, which Miller said was "the current average loss rate for GSE Fannie and Freddie originations," and using the "compare ratio," which is "a measure of a company's default rate as compared to the local market rate," Miller estimated that mortgage loan servicers could be facing $13.53 billion in losses from FHA claims denials, while mortgage lenders could be facing $11.52 billion in losses.
  • For Wells Fargo (WFC), Millers estimates "implied losses" of $3.55 billion as a servicer and another $3.29 billion in losses as a lender.
  • Bank of America could be facing losses of $2.33 billion in losses as a servicer and $2.12 billion in losses as a lender.
  • For JPMorgan Chase, FHA claims denials could lead to losses of $1.39 billion as a servicer and 1.42 billion as a lender.
  • Citigroup's losses as a servicer from FHA claims denials could total $1.66 billion, while its losses could total $810 million.
  • U.S. Bancorp (USB) could lose $760 million as a servicer and $700 million as a lender.
  • Flagstar Bancorp (FBC) faces "implied losses" of $300 million as a servicer and $390 million as a lender from FHA claims denials.
  • For PNC Financial Services (PNC), Miller estimates that losses from FHA claims denials as a loan servicer could total $240 million, while the company's losses as a lender could total $210 million.

Wells Fargo and JPMorgan declined to comment on Miller's loss estimates. A Bank of America spokesman said "we do not comment on speculation."

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.