In a civil fraud case alleging reckless mortgage lending and false claims against Deutsche Bank and MortgageIT, the U.S. government announced it had reached a $202 million settlement. The government’s lawsuit, filed May 3, 2011, sought damages and civil penalties under the False Claims Act for repeated false certifications to HUD in connection with the residential mortgage origination practices of MortgageIT, a wholly-owned subsidiary of Deutsche Bank AG since 2007.

The suit alleged approximately a decade of misconduct in connection with MortgageIT’s participation in the Federal Housing Administration’s (FHA) Direct Endorsement Lender Program (DEL program), which delegates authority to participating private lenders to endorse mortgages for FHA insurance. The suit accused the defendants of having submitted false certifications to HUD, including false certifications that MortgageIT was originating mortgages in compliance with HUD rules when in fact it was not. In the settlement, MortgageIT and Deutsche Bank admitted, acknowledged and accepted responsibility for certain conduct alleged in the complaint, including that, contrary to the representations in MortgageIT’s annual certifications, MortgageIT did not conform to all applicable HUD-FHA regulations.

MortgageIT also admitted that it submitted certifications to HUD stating that certain loans were eligible for FHA mortgage insurance when in fact they were not; that FHA insured certain loans endorsed by MortgageIT that were not eligible for FHA mortgage insurance; and that HUD consequently incurred losses when some of those MortgageIT loans defaulted. The defendants also agreed to pay $202.3 million to the United States to resolve the government’s claims for damages and penalties under the False Claims Act. The settlement was approved by U.S. District Judge Lewis Kaplan.

“MortgageIT and Deutsche Bank treated FHA insurance as free government money to backstop lending practices that did not follow the rules,” said Manhattan U.S. Attorney Preet Bharara. “Participation in the Direct Endorsement Lender program comes with requirements that are not mere technicalities to be circumvented through subterfuge as these defendants did repeatedly over the course of a decade. Their failure to meet these requirements caused substantial losses to the government – losses that could have and should have been avoided. In addition to their admissions of responsibility, Deutsche Bank and MortgageIT have agreed to pay damages in an amount that will significantly compensate HUD for the losses it incurred as a result of the defendants’ actions.”

“This is an important settlement for the United States, both in terms of obtaining substantial reimbursement for the FHA insurance fund for wrongfully incurred claims, and in obtaining the defendants’ acceptance of their role in the losses they caused to the taxpayers,” added Acting Assistant Attorney General Stuart Delery.

The following allegations are based on the complaint filed in Manhattan federal court by the government in this case:

Between 1999 and 2009, MortgageIT was a participant in the DEL program, a federal program administered by the FHA. As a Direct Endorsement Lender, MortgageIT had the authority to originate, underwrite and endorse mortgages for FHA insurance. If a Direct Endorsement Lender approves a mortgage loan for FHA insurance and the loan later defaults, the holder of the loan may submit an insurance claim to HUD for the costs associated with the defaulted loan, which HUD must then pay. Under the DEL program, neither the FHA nor HUD reviews a loan before it is endorsed for FHA insurance. Direct Endorsement Lenders are therefore required to follow program rules designed to ensure that they are properly underwriting and endorsing mortgages for FHA insurance and maintaining a quality control program that can prevent and correct any deficiencies in their underwriting. These requirements include maintaining a quality control program, pursuant to which the lender must fully review all loans that go into default within the first six payments, known as “early payment defaults.” Early payment defaults may be signs of problems in the underwriting process, and by reviewing early payment defaults, Direct Endorsement Lenders are able to monitor those problems, correct them, and report them to HUD. MortgageIT failed to comply with these basic requirements.

As the complaint further alleged, MortgageIT was also required to execute certifications for every mortgage loan that it endorsed for FHA insurance. Since 1999, MortgageIT endorsed more than 39,000 mortgages for FHA insurance, and FHA paid insurance claims on more than 3,200 mortgages, totaling more than $368 million, for mortgages endorsed for FHA insurance by MortgageIT, including more than $58 million resulting from loans that defaulted after Deutsche Bank AG acquired MortgageIT in 2007. As alleged in the complaint, a portion of those losses was caused by the false statements that the defendants made to HUD to obtain FHA insurance on individual loans. Although MortgageIT had certified that each of these loans was eligible for FHA insurance, it repeatedly submitted certifications that were knowingly or recklessly false. MortgageIT failed to perform basic due diligence and repeatedly endorsed mortgage loans that were not eligible for FHA insurance.

The complaint also alleged that MortgageIT separately certified to HUD, on an annual basis, that it was in compliance with the rules governing its eligibility in the DEL program, including that it conduct a full review of all early payment defaults, as early payment defaults are indicators of mortgage fraud. Contrary to its certifications to HUD, MortgageIT failed to implement a compliant quality control program and failed to review all early payment defaults as required. In addition, the complaint alleges that, after Deutsche Bank acquired MortgageIT in January 2007, Deutsche Bank managed the quality control functions of the Direct Endorsement Lender business, and had its employees sign and submit MortgageIT’s Direct Endorsement Lender annual certifications to HUD. Furthermore, by the end of 2007, MortgageIT was not reviewing any early payment defaults on closed FHA-insured loans. Between 1999 and 2009, the FHA paid more than $92 million in FHA insurance claims for loans that defaulted within the first six payments.