Banks Face New Multibillion-Dollar Mortgage Slam: Analyst

NEW YORK ( TheStreet) -- FBR Capital Markets analyst Paul Miller believes that the largest U.S. mortgage loan servicers could be facing billions in losses from Federal Housing Administration (FHA) claims audits.

In its annual report to Congress on Tuesday, the FHA said that its insurance fund declined even further from last year and its capital ratio "measures reserves in excess of those needed to cover projected losses over the next 30 years."

The agency's economic worth has declined to $2.6 billion as of Sept. 30, from $4.7 billion a year earlier.

The FHA insures over $1 trillion in single family mortgage loans, with borrowers paying a monthly premium for the coverage. The agency said that its Mutual Mortgage Insurance Fund, or MMI, had increased to $33.7 billion as of Sept. 30, from $33.3 billion a year earlier, but that its capital reserve ratio was just .024%, falling from 0.50% a year earlier, and far below the 2.00% minimum required by Congress.

The FHA says thr agency projects that its capital ratio will reach the required 2.00% during Fiscal 2014.

FBR Capital Markets analyst Paul Miller said in a report on Wednesday that since the FHA believes that "unless housing prices stabilize, the insurance fund has a 50% chance of running at a deficit," banks fear that "the FHA's worsening financial condition could prompt the agency to audit claims."

When an FHA-insured loan goes bad, the lender files a claim with the agency, which the FHA typically pays-out quickly. Miller said that "due to the state of the FHA's financial position and the possibility of further home price declines, the agency is motivated to take a closer look at claims it has paid out to recoup losses," and that "the agency's hyper-technical servicing requirements make it more likely that servicers, and not originators, could be most at risk in the near term.

Miller said that Bank of America ( BAC), Wells Fargo ( WFC) and JPMorgan Chase ( JPM) faced "the highest level of losses given their high volume of FHA originations and robust servicing portfolios," with potential claims denials to loan servicers costing $13.5 billion, and another $11.5 billion in costs to the industry if the FHA also targets lenders.
  • For Wells Fargo, Miller estimates potential losses of $3.55 billion as a servicer and another $3.29 billion in losses as a lender.
  • Bank of America could face $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 (C) 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), the analyst 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.

Considering the brewing outcry in Washington over the Fannie Mae, Freddie Mac and their regulator, the Federal Housing Finance Agency, Miller believes that "the FHA needs to avoid tapping into its credit line to prevent comparisons to the GSEs," and should its various improvements to risk management and strengthened loan underwriting requirements prove inadequate, "the industry fears the possibility that the agency could turn to widespread claim audits in order to recoup losses."

Reluctance by the threatened banks to lend through FHFA makes it "no surprise that borrowers are finding it harder to obtain loans," emphasizing the tightrope walk that the FHA and the Obama Administration is waling.

While losses from loans insured by the FHFA through the first quarter of 2009 were continuing to "place a significant strain" on the agency's resources and were expected "to reach $26 billion within a few more years," the agency said that loans insured during its fiscal 2010 and 2011 were "expected to be very profitable, providing significant net revenues to offset losses on earlier books."

In a nod to President Obama, the FHA said that the Obama Administration's "sweeping reforms" had "improved loan quality, strengthened lender enforcement, and helped to protect future loan performance." The agency said that "loans insured to-date under the Obama Administration are providing $18 billion in economic value for the MMI Fund," and forecasted that its Fiscal 2012 loan book would "add an additional $9 billion in economic value" to the MMI.

Among the Obama Administration's reforms to FHA have been improvements to risk management, increased enforcement of FHA rules, strengthening of net worth requirements for FHA lenders, increased mortgage insurance premiums and "specifically, a minimum down payment of 10 percent" required for "borrowers with credit scores below 580," while "applicants with credit scores below 500 are no longer eligible for FHA insurance."

The agency's traditional down payment requirement for most borrowers was just 3%.

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

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.

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.

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