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 Page 2 2001-DE-1801 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. Page 4 2001-DE-1801 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 Page 8 2001-DE-1801 Appendix A Page 9 2001-DE-1801 Appendix A Page 10 2001-DE-1801 Appendix A Page 11 2001-DE-1801 Appendix A Page 12 2001-DE-1801 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 Page 14 2001-DE-1801
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)