The U.S. Department of Justice has filed a civil mortgage fraud lawsuit against Deutsche Bank AG and its subsidiary, MortgageIT Inc., for allegedly making “false certifications” to the U.S. Department of Housing and Urban Development (HUD) related to mortgage origination and certain practices by the subsidiary.

According to the Justice Department, the Federal Housing Administration (FHA) paid insurance claims on more than 3,100 mortgages, totaling $386 million for mortgages endorsed by MortgageIT. MortgageIT was shuttered years ago and no longer originates mortgages.

The Justice Department suit seeks damages and civil penalties under the False Claims Act for the alleged misstatements in connection with residential mortgage origination.

The government’s complaint, filed Tuesday in Manhattan federal court, says that between 1999 and 2009, MortgageIT was an approved direct endorsement lender, and endorsed more than 39,000 mortgages for FHA insurance, totaling more than $5 billion in underlying principal obligations.

“The mortgages were highly marketable for resale to investors because they were insured by the full faith and credit of the United States,” according to the government’s statement. The suit announcement was made by Preet Bharara, U.S. Attorney for the Southern District of New York; Tony West, Assistant Attorney General for the Justice Department’s Civil Division; Helen Kanovsky, General Counsel of HUD; and Michael P. Stephens, Acting Inspector General of HUD.

“As alleged, MortgageIT and Deutsche Bank ignored every type of red flag and breached every duty of due diligence before underwriting thousands of federally insured mortgages,” said U.S. Attorney Bharara. “While the homes the defendants issued loans for may have been built on solid ground, the defendants’ lending practices were built on quicksand.”

Deutsche Bank issued a statement about the suit: “Close to 90% of the activity covered by the US.Department of Justice (DOJ) allegations happened prior to Deutsche Bank’s acquisition of MortgageIT. When Deutsche Bank acquired MortgageIT in 2007, it was a Federal Housing Authority (FHA) lender that had been operating within the oversight of HUD for nearly a decade. We believe the claims against MortgageIT and Deutsche Bank are unreasonable and unfair, and we intend to defend against the action vigorously.”

As for the potential impact of the suit on commercial real estate, for now the residential mortgage originations are "mostly unrelated" to the commercial side, says Robert Bach, senior vice president and chief economist at brokerage Grubb & Ellis.

“Deutsche Bank in fact has been a major CMBS [commercial mortgage-backed securities] lender. CMBS lenders and buyers will continue to see opportunities on the commercial side even as this lawsuit against Deutsche Bank goes forward,” says Bach. In the commercial real estate industry, CMBS loans did not have the protections afforded to residential mortgages, he notes, while many residential loans were insured by Fannie Mae or Freddie Mac. “There was no such insurance on CMBS.”

The CMBS market will continue to re-emerge, “even if the Justice Department files more lawsuits against residential lenders for alleged abuses,” says Bach. “I don’t see these lawsuits as having a chilling effect on the commercial side.”

Mortgages “ineligible” for insurance

MortgageIT and Deutsche Bank, which acquired MortgageIT in January 2007, made substantial profits through the resale of the endorsed FHA-insured mortgages, according to the suit. “MortgageIT repeatedly made false certifications to HUD to obtain approval of mortgages that MortgageIT underwriters wrongfully endorsed for FHA insurance. These mortgages were not eligible for FHA insurance under HUD rules,” the officials said.

Despite the ineligibility, underwriters at MortgageIT endorsed the mortgages by falsely certifying that they had conducted the due diligence required by HUD, according to the suit. “By endorsing ineligible mortgages and falsely certifying compliance with HUD rules, MortgageIT wrongfully obtained approval of these ineligible mortgages for FHA insurance, thereby putting millions of FHA dollars at risk.”

“Many working families count on FHA’s mortgage insurance program to help them achieve the dream of home ownership,” said Assistant Attorney General West. “According to our complaint, these lenders put millions of dollars of taxpayer funds at risk and violated the integrity of this important program by making false certifications to HUD.”

Although the suit announcement did not cite commercial mortgage practices, what happens on the residential side of the commercial real estate industry at times can have serious implications for the commercial side. Credit issues that began with the subprime mortgage crisis on the residential side, for instance, eventually exacted a heavy toll on the commercial real estate side.

FHA mortgage insurance protects lenders against defaults on mortgages. FHA’s direct endorsement lender program grants participating lenders the authority to endorse mortgages that are qualified for FHA insurance.

Direct endorsement lenders act as fiduciaries of HUD in underwriting mortgages and endorsing them for FHA insurance. The integrity of the program requires these direct endorsement lenders to carefully review mortgages to ensure compliance with HUD rules and underwriting standards. These lenders are entrusted with safeguarding the public from taking on risks that exceed statutory and regulatory limits.

“We don’t tolerate fraud in FHA’s mortgage insurance business,” said HUD General Counsel Kanovsky. “Each and every lender has a responsibility to properly underwrite mortgages not only to protect FHA's insurance fund but those families who depend on the FHA mortgage insurance program to provide them safe and sustainable mortgage financing.”

The U.S. Attorney’s Civil Frauds Unit is pursuing the suit, with assistance from the Commercial Litigation Branch, Civil Division.

The lawsuit was brought in coordination with the federal Financial Fraud Enforcement Task Force. The interagency task force investigates and prosecutes financial crimes.