Insights

The Federal Housing Administration (FHA) recently adopted a final rule aimed at strengthening FHA by enhancing its risk management functions through increased oversight of FHA-approved lenders. This FHA update summarizes key components of the final rule.

The final rule, effective May 20, 2010, was published in the Federal Register on April 20, 2010 (75 FR 20718), and a correction to the rule was published on May 4, 2010 (75 FR 23582). The final rule amends FHA regulations pertaining to the approval of mortgage lenders (24 CFR Part 202). Specifically, the final rule:

Net Worth Requirements.

Since 1993, FHA has required approved lenders to have a net worth of at least $250,000. The final rule dramatically increases net worth requirements over a three-year period. For lenders and mortgagees participating in FHA single family programs, the final rule imposes the following net worth requirements:

Phased-in Net Worth Requirements for 2010 and 2011

• New lender applicants. Effective on May 20, 2010, an applicant for FHA approval must have a net worth of not less than $1 million, of which no less than 20% must be liquid assets.
  
• Approved lenders and mortgagees. For an approved lender or mortgagee with FHA approval as of May 20, 2010, the new net worth requirements are effective on May 20, 2011. An approved lender or mortgagee that is not a small business must have a net worth of not less than $1 million, of which no less than 20% must be liquid assets. An approved lender or mortgagee that is a small business (i.e., the approved lender or mortgagee meets the Small Business Administration size standards for its industry classification) must have a net worth of not less than $500,000, of which no less than 20% must be liquid assets.
  
• Net Worth Requirements for 2013 and Subsequent Years. Effective on May 20, 2013, irrespective of size, an applicant for FHA approval and an approved lender or mortgagee must have a net worth of not less than $1 million, plus additional net worth of 1% of the total volume in excess of $25 million of FHA single family insured mortgages originated, underwritten, purchased, or serviced during the prior fiscal year, up to a maximum required net worth of $2.5 million. No less than 20% of the required net worth must be liquid assets.

FHA Approval Process.

The final rule limits the FHA approval process to mortgagees. Loan correspondents will no longer be approved by FHA, although loan correspondents will continue to have the opportunity to participate in FHA programs as third-party originators (TPOs) through sponsorship by FHA-approved mortgagees. A loan correspondent may also apply to FHA to obtain approval as a mortgagee.

A loan correspondent with FHA approval as of May 20, 2010, will maintain its FHA approval through December 31, 2010, and may continue to originate FHA-insured loans through the end of the calendar year without sponsorship. HUD has indicated it will further consider the prohibition on a TPO closing a loan in its own name. Unless HUD changes this prohibition, currently FHA-approved loan correspondents (that subsequently will become TPOs) will be prohibited from closing FHA-insured loans in their own names commencing January 1, 2011.

HUD believes that the elimination of FHA approval of loan correspondents is prudent for FHA and efficient for both FHA and mortgage lenders. It is HUD’s position that the mortgagee, by underwriting, servicing, or owning a loan, is the most critical lending party to a mortgage transaction. The mortgagee determines whether a borrower qualifies for the mortgage for which the borrower applied, and this determination includes an assessment of the risk of lending money to the borrower. As such, HUD believes it is appropriate that FHA’s approval process and oversight be focused on the mortgagee.

In eliminating FHA’s approval of loan correspondents, FHA-approved mortgagees assume full responsibility to ensure that a sponsored TPO adheres to FHA’s loan origination and processing requirements. In the supplementary information accompanying the final rule, HUD notes that FHA-approved mortgagees have always had significant responsibility and liability for actions of sponsored loan correspondents. HUD believes that the additional responsibility required of sponsoring FHA-approved mortgagees under the final rule is minimal. Because mortgagees are already responsible for ensuring that FHA requirements are met for mortgage loans originated by loan correspondents, HUD believes it is appropriate for mortgagees to continue doing so for TPOs.

Criteria Under HFSH Act.

The final rule incorporates criteria specified in section 203 of the HFSH Act. HUD previously announced these criteria in a mortgagee letter entitled “Strengthening Counterparty Risk Management,” issued September 18, 2009. Although the current rulemaking was not necessary to implement the statutory requirements, HUD chose to update FHA’s regulations to incorporate these criteria. Among other things, section 203 of the HFSH Act:

• Precludes any lending entity not approved or authorized by FHA from participating in FHA programs;
• Establishes additional ineligibility criteria for FHA-approved lenders and mortgagees;
• Requires FHA-approved lenders and mortgagees to use their HUD-registered business names in all advertisements and promotional materials related to FHA programs; and
• Requires FHA-approved lenders and mortgagees to notify FHA if individual employees are subject to any sanction or other administrative action.

The final rule reflects FHA’s on-going efforts to manage risk and to restore FHA’s reserves to mandated levels. FHA remains a key player in the recovery of the housing market, and we’ll continue to report on FHA’s activities in future issues of Basis Points.

Sharon Bangert is a partner in the Washington, D.C., office of Hudson Cook, LLP. Basis Points readers can reach Sharon at 202-327-9703 or by email at sjbangert@hudco.com.