Compliance & Regulation

Banks and thrifts are expected to look ahead in estimating the performance of their mortgage portfolios in determining the proper level of loan-loss reserves, according to a new policy statement by the federal banking agencies.Historical loss rates and recent credit trends are not sufficient in setting allowances for loan and lease losses, according to the interagency policy statement. "Management should also consider those qualitative or environmental factors that are likely to cause estimated credit losses associated with an institution's existing portfolio to differ from historical loss experience," the policy statement said. In documenting adjustments in historical loss experience, banks can cite relevant articles in newspapers and other publications, as well as notes from discussions with borrowers. "At this stage of the credit cycle, it is critical that reserves be maintained in a prudent and well-documented manner, and the policy statement will help us meet those objectives," Comptroller of the Currency John Dugan said.

The Office of Federal Housing Enterprise Oversight has directed Fannie Mae and Freddie Mac to comply with the federal banking regulators' nontraditional mortgage guidance when purchasing and securitizing interest-only and payment-option mortgages.The two housing government-sponsored enterprises are expected to take immediate action and develop policies that are consistent with the bank regulators' underwriting guidance on nontraditional mortgages and report back to OFHEO by Feb. 28. "Adoption of this guidance by the two housing GSEs should serve to enhance the overall level of underwriting standards, risk management practices and consumer protection throughout the mortgage market," OFHEO Director James Lockhart says in separate letters to the top executives of Fannie Mae and Freddie Mac. It is understood that the guidance also extends to the GSEs' purchases of private-label securitizations that contain IO and option adjustable-rate mortgages. A company spokesman said Freddie Mac is reviewing OFHEO's letter and had no further comment. Fannie said it supports prudent lending practices and will be talking to its customers to help understand the impact of the guidance. "We believe we will be able to respond fully to OFHEO by Feb. 28, 2007," a spokesman said.

The lending industry must embrace a licensing initiative by state banking and mortgage regulators to keep from crumbling under the weight of fraud and mismatched incentives, a proponent of the project said at SourceMedia's Mortgage Fraud Conference in Las Vegas.A national residential licensing system "has the potential to transform today's mortgage industry and imbue it with a level of professionalism and accountability that will make it easier for responsible mortgage companies to operate and harder for unethical companies to compete," said Tim Doyle, vice president of industry and agency relations at the Conference of State Bank Regulators. The CSBR, together with the American Association of Residential Mortgage Regulators, is building the system so the states can work together more effectively in supervising licensees as they move from one jurisdiction to another. But not everyone favors the system. One major opponent, the 27,000-member National Association of Mortgage Brokers, which speaks for the originators of some 60%-70% of all home loans, maintains that its members will be singled out unfairly by the system, which is due to begin operations in 12 months. All originators, not just brokers, should be covered by the system, the group contends. "It just doesn't make sense to include some and not others, because all consumers should benefit regardless of the distribution channel chosen," says NAMB president Harry Dinham, a Plano, Texas, broker. But Mr. Doyle said the initiative would "make a profound impact on addressing fraud."

Fannie Mae filed a $2 billion civil complaint Dec. 12 against its former outside auditor, KPMG LLP, accusing the firm of negligence and breach of contract.The congressionally chartered mortgage giant says because of KPMG's actions, it suffered more than $2 billion in damages and had to pay more than $1 billion (and counting) to restate its books. (Fannie Mae recently restated prior years' earnings downward by $6.3 billion.) Fannie's accounting scandal broke wide open in 2004 and resulted in the ouster of its former chairman and chief executive Franklin Raines and chief financial officer Timothy Howard. Investigators later found that the company violated a host of accounting rules involving hedging, amortization and other matters. The government-sponsored enterprise charges that KPMG's "repeated assurances" to its audit committee "have proven to be dramatically wrong," noting that it has been forced to restate financials to correct more than 30 accounting errors that the firm missed or "affirmatively approved." At deadline time, KPMG had not yet commented on the lawsuit.

The National Association of Home Builders says it can live with a GSE bill compromise that Treasury Department officials have developed with key House members, including the language regulating Fannie Mae and Freddie Mac's investment portfolios and product approvals."We are fine with the whole package," NAHB executive vice president and chief executive Jerry Howard told MortgageWire. NAHB is a close ally of Fannie and Freddie and Mr. Howard has warned repeatedly that the builders will oppose any legislation that "hamstrings" the two government-sponsored enterprises from fulfilling their mission and providing capital and liquidity for the housing market. He noted that approval process for new products will make sure Fannie and Freddie don't overstep their boundaries. "At the same time, we think it is a quick enough process to allow them to be nimble in the marketplace."

Training of employees is one of the keys to preventing mortgage fraud, and companies need to hold internal presentations to arm them with information, according to an expert on the topic who addressed the SourceMedia Mortgage Fraud Conference.Matt Holland, assistant vice president and residential mortgage fraud manager for Sovereign Bank, added that people need to attend such seminars and take information back to their companies to "share the knowledge." This, he said, helps to "contain a problem that is out of control." Lenders need to talk with their brokers and correspondents and tell them that policies to deter fraud are being implemented. This at least puts them on notice, or might even deter them from committing fraud, Mr. Holland said. It is also important, he said, to talk with other industry professionals and share the names of those committing fraud.

Lenders must band together to bar fake loans from coming in their doors, an admitted rookie to the mortgage business said at the SourceMedia Mortgage Fraud Conference in Las Vegas.Mark Nelson, who became senior vice president of risk management at JPMorgan Chase Bank less than a year ago, said lenders should follow the lead of the credit card and deposit industries by sharing data with each other. "If we put our collaborative brains together, we could put a big dent in what's happening to the industry," he said. While stressing that he's not a lawyer, Mr. Nelson said the perception among lenders that they cannot share data is wrong. Gramm-Leach-Bliley specifically allows data sharing as long as certain controls are put in place, he said, urging lenders to join industry coalitions aimed at fighting what by all accounts is a massive and growing billion-dollar-a-year problem. According to Jeffery Taylor, managing director of Digital Risk, Dallas, the number of mortgage fraud reports has jumped six-fold in the last five years, from 3,500 in 2000 to 27,000 in 2005. And that's just what's been reported, he emphasized, noting that much of what's taking place is slipping under lenders' radar screens. Mr. Taylor also pointed to another sobering statistic: That according to the FBI, roughly 80% of the losses attributed to fraud involve either collaboration or collusion by industry insiders. "If that's true," he commented, "it doesn't speak well for what we have in place to combat the problem."

The FBI says it feels the pain of every good mortgage business citizen who has ever turned suspicious activities into the agency for investigation and received no response, even months later."We share your frustration," G-man Bill Stern said at SourceMedia's Mortgage Fraud Conference in Las Vegas. "Agents who devote hundreds of hours investigating cases that aren't prosecuted are frustrated, too." Mr. Stern's mournful statement was in answer to a participant who wanted to know why he never heard back from the FBI after his company had spent hundreds of thousands of dollars to investigate possible corruption. A supervisory special agent who is the mortgage fraud point man in Washington that decides how the FBI's 56 field offices can best focus their limited resources, Mr. Stern didn't have a direct answer for the questioner, who asked what it takes to get the agency to investigate a possible crime. The man said that while his company lost $6.2 million, the state was able to gain six felony plea agreements with the perpetrators. Mr. Stern responded that the amount of the loss seemed sizable enough to warrant the FBI's interest. But he said he wasn't familiar with the case and couldn't provide a more specific answer, other than to note that "all cases can't be prosecuted."

The latest statistics from the Federal Bureau of Investigation confirm that mortgage fraud is on the upswing."We can't find a chart that doesn't show up in a big way," Special Agent Bill Stern said at SourceMedia's Mortgage Fraud Conference in Las Vegas. In even worse news, the FBI's mortgage fraud coordinator in Washington said the trend is moving away from rogue individuals who pull off the scams and toward members of organized crime. "Mortgage fraud is now a criminal enterprise that puts dollars in the hands of people who also are involved in such other crimes as drugs, murders, and gangs," he told the conference. As of early December, the number of suspicious activity reports concerning mortgage fraud is up 62%, from 21,994 to 35,617. Also up are the number of pending cases, the number of charges and convictions, and the amount of cases in which losses against financial institutions, the government and individuals exceed $1 million, "We are now prosecuting new cases at the rate of one a day," the G-man told the conference. As of the first week of December, he reported, 54% of the losses attributed to mortgage fraud were more than $1 million. Noting that the FBI must focus on these larger cases because it doesn't have the resources to pursue every suspect, Mr. Stern called on the mortgage business to work hand-in-hand with law enforcement officials at the state and federal levels "so we can leverage off your expertise."

Lew Ranieri -- the Wall Street sage who helped invent the MBS -- believes the Securities and Exchange Commission needs to play a central role in forcing issuers to increase disclosures on bonds collateralized by nontraditional residential loans.Mr. Ranieri told MortgageWire that "this isn't an indictment of the SEC," but added that "the transparencies are not what they should be." The interview followed a speech he made before a housing forum sponsored by the Office of Thrift Supervision. Mr. Ranieri also said the banks he is associated with have basically pulled out of the whole-loan market. (Mr. Ranieri said he has been a whole-loan investor for more than 20 years.) He said when his trading operation applied the new federal guidance on nontraditional mortgages to loans it was bidding on, it "kicked out 30% to 40%" of the product. Mr. Ranieri is concerned that end investors are not getting enough information on bonds backed by nontraditional mortgages, and that the new federal guidance is not applicable to this market because 80% of the product is sourced through loan brokers, winding up in bonds issued by companies not regulated by the banking agencies.