Deutsche MortgageIT Case Costs $202M

In an effort to settle a civil fraud lawsuit with the U.S. government, Deutsche Bank AG (DB - Snapshot Report) has consented to paying $202.3 million. The lawsuit is related to the fraudulent practices on part of MortgageIT, a subsidiary of Deutsche Bank, in managing mortgages.

The Allegations

MortgageIT, which was acquired by Deutsche in 2007, has been accused of issuing false certifications to the Department of Housing and Urban Development (HUD). The company has been alleged of lying about the quality of certain loans, which were in fact ineligible, but were made to qualify for the Federal Housing Administration (FHA) mortgage insurance.

MortgageIT failed to follow all the required government regulations. Consequently, the government had to incur substantial payments when the loans defaulted. Deutsche Bank and MortgageIT admitted to their misconduct and acknowledged that applicable HUD-FHA regulations were not followed.

Notably, between 1999 and 2009, MortgageIT was a participant in the Direct Endorsement Lender Program, which was administered by the Federal Housing Administration (FHA). Being a Direct Endorsement Lender, MortgageIT was authorized to originate, underwrite, and endorse mortgages for FHA insurance.

Now, if a loan has been approved by a Direct Endorsement Lender for FHA insurance, and if it defaults subsequently, an insurance claim can be submitted to HUD by the loan holder for the defaulted loan related costs, and HUD must pay that. Also, neither the FHA nor HUD reviews a loan before it is endorsed for FHA insurance in case of the Direct Endorsement Lender Program.

For this, the Direct Endorsement Lender needs to follow a set of guidelines to make sure that it is underwriting properly and endorsing mortgages for FHA insurance. The Lender therefore needs to maintain a quality control program.

Moreover, MortgageIT certified to HUD that it was in compliance with the regulations for its eligibility to the Direct Endorsement Lender Program, and this included a conduction of full review of all early payment defaults, since early payment defaults signal mortgage fraud.

However, Deutsche Bank’s MortgageIT has been accused of not implementing a compliant’s quality control program and it failed to review all early payment defaults as required. Moreover, by the end of 2007, MortgageIT stopped reviewing any early payment default. As a matter of fact, FHA paid over $92 million in FHA insurance claims for loans that defaulted within the first six payments between 1999 and 2009.

The Deutsche Bank’s MortgageIT settlement was approved by United States District Judge and $202.3 million will be paid to settle government’s claims for damages and penalties under the False Claims Act.

In Conclusion

For Deutsche Bank, the settlement can be considered as a relief as it removes the litigation overhang. It will extract a part of its earned money but the company has already made reserves. But above all, the litigation blemishes the company’s image to some extent.

However, the settlement is vital as it reimburses the FHA insurance fund for improper claims incurred and furthermore, for the acknowledgement on part of the company for the misdoings for which taxpayers’ hard earned money were lost.

In fact, such fraudulent practices in the mortgage business have been blamed for causing the 2008 financial crisis. Besides Deutsche Bank’s MortgageIT, similar allegations have been made against Citigroup Inc. (C - Analyst Report) earlier and the company agreed to pay millions for settling such claims.

Currently, the shares of Deutsche BankAg retain the Zacks #3 Rank, which translates into a short-term Hold rating. Also, considering the fundamentals, we maintain our long-term Neutral recommendation on the stock.