Return of banks to government loan market still doubtfulJanuary 13, 2020
At the end of October last year, the Department of Housing and Urban Development and the Department of Justice set forth a memorandum of understanding to further the effective and efficient enforcement of the False Claims Act, with respect to participants in all Federal Housing Administration single-family mortgage insurance programs.
The objective of the MOU was to reduce uncertainty among mortgage lenders, banks and nonbanks alike, with respect to when the DOJ would bring FCA actions arise from alleged fraud with respect to government guaranteed loans.
“As part of a broad initiative to ensure that the severity of certain violations is matched with the appropriate remedy, HUD has worked to provide clarity and certainty to program participants concerning FHA’s requirements,” noted the joint HUD/DOJ statement. Specifically, HUD has considered how the False Claims Act fits within the spectrum of remedies that may be utilized to address violations of program requirements.
The mortgage industry received this news very positively, particularly since FCA actions by the Department of Justice has been blamed for the exodus of commercial banks from the FHA/USDA/VA loan market. A recent report by the Financial Stability Oversight Council notes that nonbanks now account for over three quarters of all Ginnie Mae issuance and service the vast majority of government loans.
In fact, small nonbanks originate the vast majority of all mortgage loans made in the United States, but then sell the loans into the secondary market. Banks then count these purchases as “originations.” For some reason the agencies represented in the FSOC don’t seem to understand this little nuance.
Despite the hard work by HUD Secretary Ben Carson and FHA Commissioner Brian Montgomery in crafting the MOU, banks are unlikely to return to the government loan market. The two largest banks that remain as significant Ginnie Mae issuers — Wells Fargo and Flagstar Bank — are among the few banks that have the operational skills to actually service government loans. Indeed, one of the inaner aspects of the FSOC report on the “systemic risks” presented by nonbank mortgage companies is that it fails to state that most commercial banks simply cannot operate profitably in the government loan market.
First and foremost, the challenges banks face when originating government loans and issuing Ginnie Mae securities makes this one of the worst performing asset classes that a bank can hold on its balance sheet. Between the relatively low mortgage coupons, the small size of government loans, and the still very real perils of facing consumers in any transaction makes the risk-adjusted return on capital of government loans negative. While larger banks may be able to justify holding such assets based upon scale, specifically in the case of Wells Fargo, smaller, privately owned banks simply have no reason to take this risk.
Second is the question of servicing. In order for a bank or nonbank to service loans in…