Auditors See Rising Defaults in Rural Loans
Seeking to buoy a strained rural economy in the midst of the recession, Congress ordered up a huge increase in federal mortgage guarantees for small-town home buyers as part of the 2009 economic stimulus package.
The response from lenders was immediate. The value of federally backed rural home loans soared to $16.2 billion in fiscal 2009, up from just $3.7 billion two years earlier. Last year, the guarantees reached nearly $16.8 billion.
Now, a newly released audit has found that the rural loan program, administered by the United States Department of Agriculture, was plagued by lax government oversight and many of the same sloppy banking practices that fed the broader mortgage debacle.
Although the auditors looked at only a tiny sample of the 133,053 loan guarantees made in 2009, they estimated that tens of thousands might have been done improperly and warned that a wave of defaults might be looming.
Analysts said the problems echoed those exposed earlier in the mortgage crisis, with banks seemingly eager to collect fees for loans in which they retained little or no risk.
“In a couple years, when these loans are going bad, everybody’s going to say, ‘Oh me, oh my, how did this happen?’ ” said Christopher Whalen, managing director of Institutional Risk Analytics, a bank rating and consulting firm. “There’s no surprises here.”
While U.S.D.A. officials acknowledged that there had been some problems, they said the program had achieved the goals of the stimulus.
“We’re very confident that the overall objective of the recovery act was met,” said Tammye H. Treviño, the administrator of the Rural Housing Service, which runs the program. “At a time when new-home construction and home sales in rural America were struggling, we continued to make loans.”
The audit estimated that more than 10 percent of the loans made possible through the program might have been to borrowers who were not eligible because they did not meet the minimum financial requirements and might not have had the means to pay them back. In many instances, lenders improperly calculated income figures for borrowers. The audit, released last week by the office of the U.S.D.A. inspector general, Phyllis K. Fong, also found that U.S.D.A. officials failed to detect the errors.
The report did not say whether any lenders appeared to have intentionally skirted the rules.
The audit looked at 100 randomly selected loans. That is a very small statistical sample, but the auditors deemed their findings, which they said were preliminary, significant enough to require immediate attention.
The results looked very familiar to Tommy Duncan, executive vice president of Quality Mortgage Services, a Tennessee company that reviews hundreds of mortgages each year for banks that participate in the guarantee program. “Rural housing needs help in closing the gaps in underwriting,” Mr. Duncan said.
The auditors reported that 18 of the loans they examined were made to borrowers whose income or work history was either clearly insufficient to qualify or questionable enough that it could put their ability to repay at risk. Eight of those borrowers had already fallen behind in payments, the auditors said, including one that had defaulted on an $80,000 mortgage.
The loan guarantees are intended for low- and moderate-income borrowers, but they must still show that they have sufficient income to repay the loans.
In a written response to the audit, the U.S.D.A. acknowledged the need for improvements, although in the majority of cases, it said, the auditors were incorrect in concluding that borrowers should not have qualified for loans. The agency said it had previously made changes to address similar problems.
In an interview, Ms. Treviño said that lenders in the program, which included both large national banks and small institutions in rural communities, had not meant to break the rules. “I don’t believe there is any intent by anyone to defraud the government and give a loan to someone who is ineligible,” she said. “A lender by nature is going to be conservative when he’s doing income calculations.”
The huge increase in loan guarantees occurred almost overnight, as the agency rushed to approve loans on the hurry-up timetable of the stimulus program, whose broader goal was to give a rapid boost to the economy. The rural program focused on communities with populations under 20,000 that were outside metropolitan areas. The loans required no down payment.
But the growth strained the capacity of the Rural Housing Service to monitor the loans. “I think it’s fair to say that staff has been stretched in the last year or so with the increase in production,” Ms. Treviño said.
The foreclosure rate for the U.S.D.A.’s portfolio of guaranteed mortgages rose to 2.25 percent in the fiscal year that ended Sept. 30. The year before, the rate was 1.72 percent, and in 2007, it was 1.38 percent.
The agency was quick to point out that its foreclosure rate was lower than the rate for loans insured by the Federal Housing Administration, a similar but much larger program that covers all areas of the country, not just small towns or rural communities. The F.H.A.’s foreclosure rate in 2009 was 3.32 percent, up from 2.32 percent a year earlier. The F.H.A. has not yet released final data for last year; in the third quarter the rate was 3.22 percent.
Until recently, the rural housing guarantee program was financed through fees charged to lenders and with tax money. Last year, Congress passed a law intended to make the agency self-supporting. It allowed the agency to increase the fees it charged so that it could operate without using taxpayer money. An increase in defaults could force it to increase fees further, however.
The audit identified numerous additional problems with the program.
The auditors said that as many as one in six borrowers who received guaranteed loans should have been ineligible because their income was too high to qualify for the subsidy. Those borrowers may have prevented needier applicants from receiving guarantees.
In three cases, the audit found that buyers used guaranteed loans to buy homes with above-ground swimming pools, even though Congress prohibited stimulus money from being spent on pools. A U.S.D.A. spokesman said that those three loans had already been shifted to guarantees not linked to stimulus money.
The loan guarantee program was financed with $133 million in stimulus money, which was meant for administrative costs and reserves against potential defaults related to 81,000 loans.
The problems at the Rural Housing Service mirror those in other government housing programs. The portfolio of the F.H.A., which encourages banks to make low-cost loans to working-class families by insuring the lenders against loss, increased sharply in the early years of the bust. The agency served, in essence, as the lender of last resort as private mortgages became more difficult to get.
F.H.A. default rates are now falling, but the absolute numbers are rising as the loan portfolio continues to expand to nearly seven million. More than half a million F.H.A. loans are in default — a number that analysts think will swell if the real estate market turns down again or if the job market does not recover.