oversight

Clarion Mortgage Capital, Inc., Centennial, Colorado

Published by the Department of Housing and Urban Development, Office of Inspector General on 2001-06-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                    U.S. Department of Housing and Urban Development
                                 Office of Inspector General, Rocky Mountain
                                            633 17th Street, North Tower, 14th Floor
                                                   Denver, CO 80202-3607
                                                         (303) 672-5452
                                                      Fax (303) 672-5006

OFFICE OF INSPECTOR GENERAL FOR AUDIT
                                                                                       Audit Memorandum
                                                                                       No. 2001-DE-1801

June 1, 2001

MEMORANDUM FOR: Ronald C. Bailey, Director, Denver Homeownership Center, 8AHH


FROM: Robert Gwin, District Inspector General for Audit, 8AGA

SUBJECT: Clarion Mortgage Capital, Inc., Centennial, Colorado

                                          INTRODUCTION

We completed a review of Clarion Mortgage Capital, Inc. (Clarion), Centennial, Colorado. The
objectives of the review were to determine if Clarion:

   •   Was fulfilling loan correspondent requirements relating to the functions of its loan
       officers; and,

   •   Had management controls pertaining to its loan officer functions concerning FHA
       mortgage insurance loan origination, and that such controls ensured that FHA loan
       origination files were properly established and processed.

We reviewed Clarion’s loan officer processing and accounting procedures for FHA insured loans
originated between January 1, 1997 and October 31, 2000. We accomplished the objectives by
evaluating Clarion’s: management controls over its loan officer functions; accounting procedures
for the loan origination income and expenses; and procedures for the development of FHA loan
origination files. We reviewed records relating to FHA loan originations, which were
maintained by Clarion, and interviewed Clarion personnel as well as independent Clarion
contract loan officers. In addition, we reviewed applicable HUD records and files and
interviewed pertinent HUD staff within the Denver Homeownership Center.

We conducted the onsite work during November and December 2000. Additional information
was subsequently obtained from HUD. The results of the site work were discussed with Clarion
officials during our site review. The draft audit memorandum was presented to Clarion officials
for their review and comment during an exit conference on April 30, 2001. Their written
response is included as Appendix A. We conducted our review in accordance with Generally
Accepted Government Auditing Standards.

                                           BACKGROUND

Clarion Mortgage Capital, Inc. was incorporated under the laws of the State of Colorado on
September 10, 1996 and commenced operations on September 11, 1996. The primary business
activity of the company is loan origination and brokerage. Clarion was approved by HUD as a
Loan Correspondent on November 21, 1996. Clarion, as a Loan Correspondent, was authorized
to complete the origination functions for FHA loans. Clarion negotiated agreements with HUD-
approved Sponsors to underwrite the loans.

Clarion’s main office is located at 9034 East Easter Place, Suite 204, Centennial, Colorado.
Clarion also has obtained HUD approval for four branch offices, as of June 2000, in the
following locations: Tustin, California; La Grange, California, Grapevine, Texas, and San
Antonio, Texas. In addition, Clarion has contracted with independent loan officers to perform
the loan origination functions.

HUD insured loan statistics shows a total of 3,155 FHA loans originated by Clarion during the
audit period of January 31, 1997 through October 31, 2000. HUD’s latest default statistics, for
Clarion for the two-year period ending January 31, 2001, identified 44 loans defaulting within
the first two years, out of a total of 2,330 loans originated by Clarion. Clarion’s default rate of
1.89 is lower than the rest of the country that has a default rate of 3.79.

                                       RESULTS OF REVIEW

We reviewed Clarion’s management controls over the loan officer origination functions and the
accounting procedures for the origination of FHA mortgages. Clarion had adequate management
controls over these functions.

Finding: Improper Loan Originating Functions by Independent Contract Parties.

Our review of Clarion’s management controls over its loan origination functions and the
accounting procedures for the origination of FHA mortgages showed Clarion not to be in
compliance with HUD requirements in two areas:

    •   Clarion used independent contracted loan officers to originate FHA loans, in Clarion's
        name, instead of using regular company employees; and,

    •   Three of the four designated HUD-approved branch offices were only offices of
        independent contract loan officers.

Clarion has been using independent contract loan officers to perform all loan origination
functions for Clarion including those functions that are required by HUD regulations to be
performed by only Clarion employees. Based upon an October 1997 meeting with HUD
representatives, Clarion made several operating changes to comply with the guidance provided
by HUD. The HUD representatives, involved in the meeting, stated that the contract loan

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officers would be considered employees if Clarion executed a memorandum of understanding,
with each loan officer, requiring that he or she work exclusively for Clarion. Clarion executed a
memorandum of understanding with each contract loan officer requiring exclusivity to Clarion.
Therefore, Clarion considered the loan officers to be employees and their loan origination
activities to be in harmony with HUD requirements.

HUD needs to provide clarifying instructions to Clarion detailing the requirements for processing
loan origination packages by contract loan officers who are under independent contracts with
Clarion and by Clarion employees. This would also include guidance on the establishment and
use of branch office for processing loan originations.

    HUD Requirements The Federal Register, dated March 1, 1999, Part IV, addressed Title 24
    of the Code of Federal Regulations, Part 3500. The Federal Register included the Real Estate
    Settlement Procedures Act Statement of Policy 1999-1, which stated that HUD identified 14
    services or functions normally performed in the origination of a loan. Mortgagee Letter 95-
    36 stated that customary loan officer functions may not be contracted out. The Mortgagee
    Letter listed loan origination functions which may be contracted out. However, it stated that
    such functions must be contracted out to a commercial provider of the types of services being
    requested, and may not be contracted out to third party loan originators, real estate brokers
    and other similar entities.

    HUD Mortgagee Letter 95-36 states that a branch office could be located in either
    commercial or non-commercial space; however, there must be at least one employee working
    exclusively for the mortgagee. Mortgagee Letter 00-15 requires a HUD/FHA approved
    mortgagee to pay all of its operating expenses including the compensation of all employees
    of branch offices, office rent, and other similar expenses incurred in operating a mortgage
    lending business.

    HUD Handbook 4060.1, para. 2-13, Control and Supervision of Employees, states that
    Mortgagees are required to exercise control and responsible management supervision over
    their employees. The requirement regarding control and supervision must include, at a
    minimum, regular and ongoing reviews of employee performance and of work performed.

    Clarion’s Operations At the time of our review, Clarion was using independent contract loan
    officers to carry out the required loan origination functions. The contract, which independent
    loan officers signed, stated that Clarion assumed no responsibility over them for the
    direction, supervision and control of their loan origination activities.

    The procedures in place at the time of our review provided that the contract loan officers
    would perform all functions relating to the origination of an insured mortgage. The contract
    loan officer signed the loan closing documents on behalf of Clarion. The loan origination
    package would then be forwarded to a Sponsoring Mortgagee, who was a HUD-approved
    Direct Endorsement Mortgagee. The Direct Endorsement Mortgagee would review the loan
    package for completeness and conformity with HUD requirements and then process the loan
    for FHA mortgage insurance.




                                                 Page 3                                  2001-DE-1801
The contract loan officer attended the closing for a loan and then met with Clarion to receive
his or her loan origination commission. The contract loan officer provided the closing
disbursements check, received from the title company at closing, and the loan origination
documents package to Clarion accounting personnel. The accounting personnel reviewed the
document package for completeness. If no problems were identified, the commission was
calculated and disbursed to the contract loan officer.

As part of a quality control procedure, Clarion did contract with a separate entity to perform
a review of 10 percent of all completed loan origination packages for compliance with HUD
requirements.

Clarion obtained HUD approval to operate four branch offices. Two were for offices in
California and two in Texas. At the time of our review, only one of the branch offices was
functioning as a branch office within HUD guidelines. This office, located in Tustin,
California, had regular employees of Clarion and the office overhead and rent was paid
directly by Clarion. The other three branch offices were actually offices or residences of loan
officers under contract with Clarion. None of the office operating costs was being paid by
Clarion.

HUD Requirements Not Met Clarion’s procedures of using independent contract loan
officers to perform all loan origination functions is at variance with HUD requirements.
Certain loan functions are to be performed by only employees of the mortgagee and not by
third party contractors. HUD required the mortgagee to have control and supervision of the
employees and to monitor their loan origination activities.

The independent contractors, while working exclusively for Clarion, perform all loan
origination activities for Clarion including those required to be performed by Clarion’s own
employees. The contractors operate from their residences or commercial space. Each of the
contractors pays their own operating or overhead expenses that are funded from the loan
origination commissions from Clarion. None of the contractors’ expenses are paid directly
by Clarion. The loan officer contract stated that Clarion assumed no responsibility over the
loan officer for the direction, supervision and control of the loan origination activities.

Clarion Considers Their Operations Satisfactory to HUD Clarion officials considered their
operation to be in conformity with HUD requirements. While the loan officers are under
separate contracts with Clarion, Clarion considers the contract loan officers to be Clarion
employees. Clarion pays its contract loan officers a fee that is based upon 85 percent of the
loan origination revenue for each closed loan package the contractor processes. The fee,
while higher than what other mortgagees would pay, is made to cover the operating and
overhead expenses of the contract loan officers.

In addition, Clarion monitors and evaluates the loan origination activities of the contract loan
officers through its independent evaluation of each closed loan package. Clarion uses an
independent company to perform a review of 10 percent of all loan origination packages
closed for Clarion by its contract loan officers. The review determines whether the closed
loans met HUD requirements.



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    In like manner, Clarion performs a review of each closed loan when the contract loan officer
    submits a request for their particular loan commission. Before Clarion pays the loan
    commission, Clarion through the use of a checklist ensures that the required forms were
    completed by the loan officer.

    Clarion considered their use of contract loan officers to be acceptable by HUD.
    Representatives of HUD's Denver Homeownership Center, Quality Assurance Division, met
    with Clarion officials on October 6, 1997. The understanding between the HUD
    representatives and Clarion was that a contract loan officer would be considered an employee
    of Clarion if a memorandum of understanding, requiring exclusivity by the loan officer, was
    signed. Clarion added a memorandum of understanding to each loan officer contract. The
    memorandum of understanding stated that: the contract loan officer would abide by all HUD
    regulations; the loan officer would direct all originated loans through Clarion while working
    with Clarion; and, the contract would be terminated if the loan officer originated loans as an
    employee of a company other than Clarion.

    In an October 15, 1997 letter to Clarion, HUD requested that copies of the signed
    memorandum of understanding be provided to HUD within 15 days. The letter further stated
    that once the signed copies were received, HUD would consider the issue resolved. Clarion
    submitted copies of the signed agreements to HUD at the end of October 1997. The
    understanding between Clarion and the HUD representatives does not coincide with HUD’s
    official position on employee requirements.

    HUD Clarification Is Needed While we recognize that Clarion officials have been acting in
    good faith, their business structure is not in full compliance with HUD requirements. HUD
    needs to provide clarifying instructions to Clarion on HUD requirements for processing loan
    origination packages by contract loan officers and by Clarion employees. This will need to
    include a determination as to whether loan officers under independent contracts with Clarion
    are actually employees of Clarion and thereby are permitted to perform those loan origination
    activities which are to be performed by only Clarion employees. Guidance will also need to
    be included on the establishment and use of branch offices for processing loan originations.

Clarion’s Response

Clarion officials provided their written response on May 11, 2001. The entire response is
included in Appendix A. The response states, in part, “Clarion believes it is in full compliance
with FHA program requirements, having gone so far as to obtain prior HUD approval for the key
components of its loan origination procedures.” Therefore, they disagree with the report
conclusion that Clarion’s loan origination arrangements are improper or not in compliance with
HUD requirements and with recommendation 1A. They explain that HUD agreed that their loan
officers are “employees” as this term is used in the FHA program requirements; that Clarion
assumes full responsibility for the quality of all their loans; and, that they have supervisory and
management controls over their loan officers.

The response further states, “Clarion asserts that it has complied with the letter and spirit of
Mortgagee Letter 95-36, in all respects.” Clarion pays a high commission, which they consider
to be indirect payment of overhead costs. However, Clarion is willing to change their procedures


                                                 Page 5                                  2001-DE-1801
and directly pay the overhead for all branch offices, which they will do to address concerns
expressed in the draft audit memorandum.

Clarion suggests that there is no need to refer this matter to HUD’s Denver Homeownership
Center, as it previously has provided the clarification to Clarion that such a referral would be
seeking, and Clarion requests that this matter be closed without further proceedings.

OIG’s Evaluation of Clarion’s Response

Clarion’s position focuses entirely on the fact that Clarion considers its contract loan officers to
be “employees” of Clarion and is in harmony with HUD requirements. Clarion maintains that it
has more than required supervisory and management controls over its contract loan officers.
Clarion’s supervision and management controls as detailed in their response deals with the
selection and initial oversight of contract loan officers and in the post loan closing reviews of the
contract loan officer loan origination activities. While HUD regulations require direct
supervision of employees, Clarion does not provide any supervision of the loan officers in their
loan origination activities prior to loan closing. This is supported by Clarion’s loan officer
contracts which state Clarion assumes no responsibility over the loan officer for the direction,
supervision and control of the loan origination activities.

We recognize in the audit memorandum that Clarion obtained guidance from a HUD
representative and has basis for considering their operations to be in compliance with the HUD
requirements. However, during the audit work, various parties expressed different
interpretations of the applicable HUD requirements. Therefore, HUD needs to make a
determination of the actual meaning of the applicable requirements and provide this information
and any related guidance to Clarion. This needs to include a determination as to whether
independent contract loan officers are considered to be actual employees of Clarion.

Recommendations

We recommend that the Denver Homeownership Center:

1A. Provide clarifying instructions to Clarion for complying with HUD regulations concerning
    loan origination requirements and what functions are to be performed by Clarion
    employees and contract loan officers. This will need to include a determination as to
    whether independent contract loan officers are considered to be actual employees of
    Clarion. In addition guidance and instructions will need to be provided to Clarion for the
    proper establishment and use of a branch office.

1B. Review Clarion’s implementation of recommendation 1A and ensure that Clarion’s loan
    origination procedures and operations are in conformity with HUD’s requirements.

These recommendations will be controlled under the Departmental Automated Audit
Management System. Within 60 days please furnish to this office, for each recommendation in
this report, a status report on: (1) the corrective action taken; (2) the proposed corrective action
and the date to be completed; or (3) why action is considered not necessary. Also, please furnish
us copies of any correspondence or directives issued because of the audit.


                                                   Page 6                                    2001-DE-1801
We appreciate the courtesies and assistance extended by the personnel of Clarion Mortgage
Capital, Inc. and the Denver Homeownership Center. Should you have any questions, please
contact Ernest Kite, Assistant District Inspector General for Audit, at (303) 672-5452.




                                              Page 7                               2001-DE-1801
                                Appendix A

Auditee’s Comments




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           Appendix A




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            Appendix A




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            Appendix A




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            Appendix A




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                                                                                  Appendix B

Distribution
Clarion Mortgage Capital, Inc.
Secretary’s Representative, 8AS (2)
Director, Denver Homeownership Center, 8AHH (2)
Deputy Assistant Secretary for Single Family Housing, HU, Room 9282
Special Assistant for Single Family Housing, HU, Room 9278
Deputy Secretary, SD, Room 10100
Chief of Staff, S, Room 10000
Assistant Secretary for Administration, A, Room 10100
Deputy Chief of Staff, S, Room 10226
Deputy Chief of Staff for Operations, S, Room 10226
Deputy Chief of Staff for Programs and Policy, S, Room 10226
Assistant Secretary for Congressional and Intergovernmental Relations, J, Room 10120
Senior Advisor to the Secretary, Office of Public Affairs, S, Room 10132
Deputy Assistant Secretary for Public Affairs, W, Room 10222
Counselor to the Secretary, S, Room 10234
General Counsel, C, Room 10214
Deputy General Counsel, CB, Room 10220
Office of Policy Development and Research, R, Room 8100
Assistant Deputy Secretary for Field Policy and Management, SDF, Room 7106
Director, Office of Department Operations and Coordination, I, Room 2124
Chief Procurement Officer, N, Room 5184
Chief Information Officer, Q, Room 3152
Chief Financial Officer, F, Room 2202
Deputy Chief Financial Officer for Operations, FF, Room 10166
Director, Office of Budget, FO, Room 3270
Director, Enforcement Center, V, 200 Portals Building
Director, Real Estate Assessment Center, X, 1280 Maryland Ave., SW, Suite 800
Departmental Audit Liaison Officer, FM, Room 2206
Headquarters Audit Liaison Officer, Public and Indian Housing, PF, Room P8202
Field Audit Liaison Officer, 6AF, (2)
Director of Scheduling and Advance, AL, Room 10158
Assistant Deputy Secretary for Field Policy and Management, SDF, Room 7108 (2)
Special Assistant to the Deputy Secretary for Program Management, SD, Room 10100
Acquisitions Librarian, Library, AS, Room 8141
Inspector General, G, Room 8256
The Honorable Fred Thompson, Chairman, Committee on Governmental Affairs, 340 Dirksen
        Senate Office Building, United States Senate, Washington, DC 20510
The Honorable Joseph Lieberman, Ranking Member, Committee on Governmental Affairs, 706
        Hart Senate Office Building, United States Senate, Washington, DC 20510
Honorable Dan Burton, Chairman, Committee on Governmental Reform, 2185 Rayburn Bldg.,
        House of Representatives, Washington, DC 20515
Henry A. Waxman, Ranking Member, Committee on Governmental Reform, 2204 Rayburn
        Bldg., House of Representatives, Washington, DC 20515

                                          Page 13                             2001-DE-1801
                                                                                Appendix B


Ms. Cindy Fogleman, Subcommittee on Oversight and Investigations, Room 212, O’Neil House
        Office Building, Washington, DC 20515
Director, Housing and Community Development Issue Area, United States General Accounting
        Office, 441 G Street, NW, Room 2474, Washington, DC 20548 (Attention: Judy
        England-Joseph )
Deputy Staff Director, Counsel, Subcommittee on Criminal Justice, Drug Policy and Urban
Resources, B373 Rayburn House Office Building, Washington, DC 20515
Steve Redburn, Chief, Housing Branch, Office of Management and Budget, 725 17th Street, NW,
        Room 9226, New Executive Office Building, Washington, DC 20503
Andy Cochran, House Committee on Financial Services, 2129 Rayburn H. O. B., Washington,
        DC 20515




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