Nearly half of SunTrust's (STI) $1 billion settlement with federal agencies will help bolster the Federal Housing Administration's mortgage insurance fund.
Though the FHA was not expected to tap Treasury for additional funding this year, the SunTrust settlement puts the agency on much better financial footing.
It would not be the first time, and it may not be the last, that the FHA has used settlement dollars to improve or claw its way back to profitability. In 2012, Bank of America (BAC) paid nearly $1 billion, including $750 million in cash to compensate the FHA for past losses. That settlement essentially kept the FHA's mortgage insurance fund from going into the red.
"It almost seems like FHA is trying to make a case to lower insurance fees by 'taxing' lenders through litigation," says Anthony Sanders, a professor of real estate finance at George Mason University.
SunTrust is expected to pay as much as $418 million to the FHA to resolve its potential liability under the federal False Claims Act.
"The settlement provides FHA with more flexibility and a bit of a cushion in terms of the politics around the mortgage insurance fund," says Jeff Davis, a managing director at Mercer Capital's financial institutions group. When the B of A pact was announced in 2012, FHA Commissioner Carol Galante emphasized that such settlements were "not a gift," but rather were a way for banks to resolve allegations of fraudulent and wrongful conduct.
The FHA's mortgage insurance fund is expected to have a surplus at the end of September, according to the White House's fiscal 2015 budget, which took into account the boost to reserves from FHA's increase in premiums. Higher home prices also helped.
The fund supports the FHA's residential and reverse mortgage insurance programs. The White House budget projects the FHA's mortgage insurance fund will have $7.8 million in reserve at the end of fiscal 2014 (which ends in September), even though the FHA's 2013 actuarial review forecasted a negative value of over $1 billion.
Last year, the FHA tapped the Treasury for $1.7 billion, the first time in its history that it needed an infusion of federal funding.
It is unclear exactly how much FHA will get. SunTrust will pay $10 million to the federal government to cover losses it caused the FHA, the Department of Veterans Affairs and the Rural Housing Service, the Justice Department stated. An FHA spokesman could not say whether that would come out of the agency's $418 million portion of the deal. (There is another $500 million in consumer relief and $50 million in additional cash penalties.)
FHA's share of mortgage originations has fallen dramatically in the past year to roughly 15%, and is now below 2002 levels. Galante has stressed that the agency will not roll back its 1.35% annual mortgage insurance premium or its 1.75% upfront premium. Though such a change would make loans more affordable, the FHA had to raise premiums to strengthen its insurance fund, which must maintain a 2% surplus.
SunTrust had previously disclosed it expected a settlement in February, and has already set aside reserves for it.
The Justice Department did not mince words in detailing SunTrust's conduct in underwriting FHA loans.
“SunTrust's irresponsible FHA lending practices caused grievous harm to homeowners and the housing market, as well as wasting hundreds of millions of dollars in taxpayer funds,” Stuart F. Delery, an assistant attorney general for the Justice Department’s civil division, said in a press release Tuesday.
The $172.4-billion-asset Atlanta bank knew that as many half of the FHA loans it originated did not adhere to agency guidelines, the Justice Department said.
SunTrust admitted that from 2006 to early 2012, it originated home loans that did not meet FHA's guidelines, and failed to have a quality control program of any consequence. The bank also failed to self-report to HUD that it had uncovered defective loans.
The Justice Department said that SunTrust's management described its own quality control program as "severely flawed" and "ineffective." Further, the volume of problem loans was "excessive," and the errors rates were "elevated" and at an "unacceptable level."
SunTrust admitted that numerous audits and other documents disseminated to its management from 2009 to 2012 had described significant flaws and inadequacies in its origination, underwriting and quality control processes.
William H. Rogers Jr., SunTrust's chairman and chief executive, said in a press release that he was "pleased to have resolved these legacy mortgage matters."
He did not directly address the allegations by the Justice Department that management contributed to so many failures.
The bank said it has made "significant improvements to its mortgage underwriting processes and internal controls," including increased training.