oversight

Treehouse Mortgage, LLC, Non-Supervised Loan Correspondent Denver, Colorado

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-03-11.

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

                                                              Issue Date
                                                                      March 11, 2004
                                                             Audit Case Number
                                                                           2004-DE-1002




TO: John C. Weicher, Assistant Secretary for Housing-Federal Housing Commissioner, H




FROM: Robert C. Gwin, Regional Inspector General for Audit, 8AGA

SUBJECT: Treehouse Mortgage, LLC, Non-Supervised Loan Correspondent
         Denver, Colorado

                                    INTRODUCTION

We have completed an audit of Treehouse Mortgage, LLC, a HUD approved Non-
Supervised Loan Correspondent, in Denver, Colorado. We selected Treehouse for review
because of their high default and claim rates. The objectives of our review were to
determine whether: (1) the mortgagee complied with HUD regulations, procedures, and
instructions in the origination of FHA-insured loans; and (2) the mortgagee’s quality control
plan, as implemented, met HUD requirements.

During our audit, we performed tests for compliance with HUD’s requirements for the
origination of FHA-insured loans. We reviewed a sample of 20 FHA-insured loans that
had defaulted within the first twenty-four months of origination. We reviewed
Treehouse’s quality control plan to determine if it complied with HUD requirements. We
conducted the audit in accordance with Generally Accepted Government Auditing
Standards.

In accordance with HUD Handbook 2000.06 REV-3, within 60 days please provide us, for
each recommendation without a management decision, 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 unnecessary. Additional status reports are required at 90 days and 120
days after report issuance for any recommendation without a management decision. Also,
please furnish us copies of any correspondence or directives issued because of the audit.

Should you or your staff have any questions, please contact R. Ernest Kite, Assistant
Regional Inspector General for Audit, at (303) 672-5452.
                                     SUMMARY
Our review identified two findings. Contrary to FHA requirements, Treehouse used
contract loan officers that were not HUD-approved to originate FHA insured loans.
Treehouse also did not have a formal written quality control plan and was deficient in its
overall quality control activities.

Treehouse contracted with several independent loan officers to originate FHA insured
loans. Treehouse paid the contract loan officers a commission on each FHA loan.
Because these loan officers worked as independent contractors, Treehouse management
were not able to oversee their performance with the same level of control as their own
employees. HUD considers proper oversight and control of the loan origination process
as key to reducing FHA mortgage insurance risks.

During our fieldwork, Treehouse implemented changes over the use of contract loan
officers. Two of the three remaining contract loan officers were converted to full time
employees. The third contract loan officer will no longer originate FHA insured loans.
These changes have brought Treehouse into compliance with HUD requirements.

Treehouse did not comply with HUD quality control requirements for over two years.
Treehouse’s quality control plan was informal and inadequate. In addition, Treehouse
did not perform required quality control reviews on all defaulted loans or meet HUD’s
minimum sampling requirements. Treehouse also did not submit any written reports to
senior management that identified deficiencies noted in the files reviewed or the
responsible employees. Treehouse’s non-compliance with HUD requirements prevented
management from taking corrective actions on deficiencies noted or ensuring the
completeness, accuracy, and validity of their loan origination files.

Prior to our on-site review, Treehouse management hired an independent consultant to
develop a new comprehensive quality control plan that would be in full compliance with
HUD requirements. Using this new quality control plan, Treehouse management
reviewed all FHA insured loans currently in default and ten percent of all FHA insured
loans originated. If Treehouse continues to follow this new quality control plan, as
written, it should provide adequate assurance to management that their origination
operations comply with HUD directives.

                                  BACKGROUND
HUD approved Treehouse as a Title II non-supervised loan correspondent on May 4,
2000 and granted them the authority to originate HUD-FHA insured loans. From
September 2000 through August 2003, Treehouse endorsed 356 FHA insured loans with
a total mortgage amount of $58,267,190. Of these 356 FHA insured loans, HUD has paid
claims on eight of the loans for a total of $1,075,382.46.

We selected Treehouse Mortgage for review due to its high default and high claim rates.
Treehouse’s default and claims rate is significantly higher (146%) than the average for all


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lenders in the state of Colorado. At September 2003, Treehouse had a default claim rate
of 3.80% while other lenders in Colorado had an average default rate of 2.60%. At
August 31, 2003, HUD’s records show that thirteen insured loans had defaulted within
the first two years. As of October 2003, six of these FHA insured loans were in default
and four of these loans had been submitted to HUD for insurance claim.

The primary objectives of our review were to determine if their loan origination
procedures and activities comply with HUD requirements; and establish whether their
Quality Control Plan, as implemented, meets HUD requirements.

We completed a review of Treehouse’s operations using loans originated between
September 1, 2000 and August 31, 2003. Our on-site review was conducted during the
months of November and December 2003 and January 2004. Treehouse’s loan
origination operations were reviewed and policies and procedures were measured against
those stated by members of management and Treehouse employees.

                                               Finding 1

                               Use of Contract Loan Officers

Treehouse Mortgage was using contract loan officers to perform customary loan officer
functions that can only be performed by full time employees of the mortgagee. Federal
regulations and HUD directives specifically state that there are certain loan officer
functions that may not be contracted out to third party loan originators, real estate
brokers, and other similar entities. The mortgagee cannot exercise the same level of
control and supervision over contract loan officers that it can over its full time
employees. Therefore, the mortgagee lacks the same level of assurance that the loan
origination functions accomplished by contract loan officers are completely in
accordance with federal regulations and HUD directives.

Federal Register (March 1, 1999) Part IV Real Estate Settlement Procedures Act
(RESPA) Statement of Policy 1999-1 identifies 14 services or functions normally
performed in the origination of a loan by the loan correspondent. Mortgagee Letter 95-36
states that mortgagees may not contract out the customary loan officer functions, as
mortgagees are held responsible for the quality of loans and compliance with HUD
requirements1. In addition, such services and functions as these may not be contracted
out to third party loan originators, real estate brokers, and other similar entities. In other
words, customary loan officer functions are to be performed by employees of the
mortgagee.


1
  Functions not to be contracted (1) analyzing the prospective borrower's income and debt and
prequalifying the prospective borrower (2) educating the prospective borrower in the home buying and
financing process; (3) advising the borrower about the different types of loan products; (4) providing
disclosure forms to the borrower; (5) assisting the borrower with credit problems; (6) maintaining regular
contact with the borrower, and other related parties to the loan application, and (7) gather any additional
information as needed.


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HUD Handbook 4060.1, REV-1, requires mortgagees to exercise control and responsible
management and 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. This handbook further requires a mortgagee to
maintain adequate office space in a location conducive to performing mortgage-lending
business. A mortgagee’s employees may not use their signatory authority to bind the
mortgagee in a home, car, or similar space that is not a part of the mortgagee’s office. In
addition, a mortgagee is required to pay all of its operating expenses incurred in operating
a mortgage lending business. This includes the compensation of employees of its main
and branch offices.

Treehouse Mortgage used both loan officer employees and contract loan officers to
accomplish the required loan origination functions for FHA-insured loans. Treehouse
Mortgage, relying on advice from their law firm, entered into a Loan Officer Service
Agreements with several of their loan officers.

The Loan Officer Service Agreement contained an “Exclusivity Clause” stating that the
contract loan officers would not originate loans for any other mortgage company, other
than Treehouse. The agreement contained several paragraphs in direct violation of HUD
directives. One provision stated the loan officer would indemnify and hold harmless the
mortgagee from all damages, costs, and expenses, including attorney fees, incurred by the
mortgagee, resulting from any violation of the provisions of agreement. Several other
paragraphs stated that the loan officer is not a Treehouse employee.

Treehouse allowed the contract loan officers to perform all loan origination functions,
including those that employees of the mortgage company are required to perform. The
contract loan officers operated from their own residences and paid their own operating
and overhead expenses.

Treehouse misunderstood and misapplied HUD’s requirements concerning the use of
non-employees to originate FHA insured loans. Treehouse’s contracted law firm
represented another mortgagee in the Santa Ana Homeownership Center’s region who
was using a similar loan officer service agreement. This mortgagee submitted the
agreement to the Santa Ana Homeownership Center for their approval, was granted
approval for its use, and was told that it met HUD requirements. Consequently,
Treehouse modified this same agreement to meet Colorado law and used this agreement
with several loan officers originating FHA insured loans.

Because contract loan officers work independently and are not under the direct
supervision of the mortgagee, Treehouse cannot effectively ensure the accuracy, validity,
and completeness of its loan origination operations. Treehouse’s operations are small
and because of this, management is directly involved in the supervision and control of its
loan officers who are full time employees. This cannot be said about contract loan
officers’ performance because they operate out of remote locations removed from
Treehouse’s offices. In addition, potential deficiencies in the loan origination packages
could go undetected, thus leaving the FHA insurance fund at risk. HUD requires



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mortgagees to perform ongoing reviews of employees’ performance. With Treehouse’s
use of independent contractor loan officers, working from their homes, and Treehouse’s
lack of an effective quality control program, the FHA insurance fund is even more
vulnerable to risk.

Treehouse Mortgage has already stopped the practice of using contract loan officers to
originating FHA-insured loans. At the time of our review, there were only three loan
officers that were still functioning as contract loan officers. Two of these three contract
loan officers are now full time loan officer employees under the direct control and
supervision of management. The third loan officer can no longer originate FHA-insured
loans.

                                AUDITEE COMMENTS

Treehouse, in their written comments, which are included in their entirety in Appendix A,
basically concurred with our finding and recommendations. Management has already
initiated corrective action to address the problem. All loan officers are now IRS Form
W-2 employees.

Treehouse, in their written comments, included a note to HUD stated that they believe
that large mortgagees in Colorado are still operating using contract loan officers, which
makes it impossible for smaller mortgagees to compete with the larger mortgagees.


                  OIG EVALUATION OF AUDITEE COMMENTS

The positive steps taken by Treehouse Mortgage, LLC to discontinue the practice of using
contract loan officers to originate FHA insured loans will help to alleviate the condition
addressed in our finding.

                                RECOMMENDATIONS

We recommend the Assistant Secretary for Housing-Federal Housing Commissioner:

1A Obtain written assurances from Treehouse Mortgage that only loan officers who are
full time employees of Treehouse will originate FHA insured loans.

1B Conduct sufficient reviews of Treehouse Mortgage’s loan origination activities to
ensure FHA insured loans are accomplished by only full time loan officer employees.




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                                                Finding 2

                Non-Compliance with Quality Control Requirements

Treehouse Mortgage, LLC, did not comply with HUD’s quality control requirements.
Treehouse did not have a formal written quality control plan until October 2003, twenty-
six months after receiving HUD-FHA approval. Treehouse failed to review loans
defaulting within the first six months and did not review ten percent of rejected loans. In
addition, Treehouse did not meet its quality control review sampling requirement of
selecting at least ten percent of all FHA-insured loans originated monthly for review.
Furthermore, Treehouse did not accomplish quarterly written reports to its senior
management for review. Consequently, Treehouse had reduced management controls
over its loan origination operations. Furthermore, any identifiable loan origination
deficiency could go uncorrected. Accordingly, Treehouse was unable to properly ensure
the accuracy, validity, and completeness of their loan origination operations.

Under HUD Regulations2, Treehouse is to implement a written quality control plan that
assures compliance with the regulations and other HUD issuances regarding mortgage
loan origination. HUD Handbook 4060.1 REV-1 details the requirements for
Treehouse’s quality control plan over the origination of FHA insured mortgage loans.
Loan correspondents are required to have a quality control plan in place that is sufficient
in scope to enable them to evaluate the accuracy, validity, and completeness of their loan
origination operations. Quality control reviews are to be performed within 90 days of
loan closing and are to include a specified sampling percentage of originated loans.

Additionally, Treehouse is to analyze all loans that go into default within the first six
months and ten percent of total loans rejected. Furthermore, the quality control plan is to
include procedures for expanding the scope of the review where a pattern of deficiencies
or fraudulent activity exists.

Treehouse did not have a formal written quality control plan until October 2003, twenty-
six months after its inception. During this period, Treehouse Mortgage applied an
informal quality control plan that was used only to complete cursory reviews of loan
origination packages. Treehouse did not review loans that defaulted within the first six
months nor did they review ten percent of rejected loans. The lack of a quality control
plan prevented Treehouse from fully evaluating the quality of their loan originations.
Furthermore, loan processing deficiencies, such as errors and omissions or unacceptable
patterns or trends, would not have been readily identifiable or go undetected.

Treehouse is a small business that uses micro-management practices and management is
thoroughly involved throughout the loan origination process. Management believed that
these practices would be sufficient to ensure the overall quality of the loan origination
packages.


2
    Section 202.5 of Title 24 of the Code of Federal Regulations


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Treehouse also relied on reviews conducted by their sponsors as a primary quality control
check. The sponsors send reports to Treehouse indicating issues that required attention
and Treehouse management would then correct the problems within the file. With the
small number of loans originated at Treehouse, management felt this method would
address their deficiencies.

Before the Denver OIG review, Treehouse hired an independent consultant to assist with
the development of a quality control plan. Management developed a plan that they
believe to be in full compliance with HUD requirements. We reviewed the new plan and
found it to be comprehensive and in conformity with HUD requirements. If implemented
correctly, the plan will provide adequate management control to the loan origination
operations at Treehouse Mortgage.

However, after the new quality control plan was completed in October 2003, Treehouse
management reviewed all defaulted loans and a ten percent sample of all loans originated
for the past two years. The sampling of the reviewed loans did not meet HUD
regulations and the time requirements were not satisfied. The quality control manager
simply picked random files from storage boxes to complete ten percent of the total loans
originated and then reviewed a minimum of one file for each loan officer that had not yet
had a file reviewed. The quality control officer did not use a random selection process
for selecting the loans to review.

After we discussed the quality control plan with Treehouse management, they have
decided to change the manner that they complete their quality control reviews in order to
comply with HUD regulations. The quality control manager will use a random number
generator to obtain the cases that will be reviewed so sampling requirements will be
fulfilled. Also, reviews will be completed quarterly due to the small number of loans
originated each month. This will ensure that the quality control reviews will meet the
time requirements.

We completed case binder reviews on twenty defaulted loans at Treehouse and compared
any deficiencies to those identified by Treehouse management using their new quality
control plan. Our review showed that Treehouse’s quality control reviews were adequate
and appeared to detect all discrepancies that were contained within the files.

                               AUDITEE COMMENTS

Treehouse, in their written comments, basically concurred with our finding and
recommendations. Management has already initiated corrective action to address the
problem. Treehouse has developed a Quality Control Plan and will conduct quarterly
reviews.




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                   OIG EVALUATION OF AUDITEE COMMENTS

The positive steps taken by Treehouse Mortgage, LLC to develop and implement a Quality
Control Plan and to conduct quarterly reviews, will help to alleviate the condition addressed
in our finding.

                                RECOMMENDATIONS

We recommend the Assistant Secretary for Housing-Federal Housing Commissioner:

2A Obtain written assurances from Treehouse Mortgage that their quality control plan
has been fully implemented, and

2B Evaluate the implementation of Treehouse’s quality control plan during HUD’s next
Quality Control review and evaluate its compliance with HUD requirements.

                             MANAGEMENT CONTROLS

In planning and performing our survey, we considered the management controls relevant to
HUD’s FHA loan origination program to determine our survey procedures, not to provide
assurance on the controls. Management controls include the plan of organization, methods
and procedures adopted by management to ensure that its goals are met. Management
controls include the processes for planning, organizing, directing, and controlling program
operations. They include the systems for measuring, reporting, and monitoring program
performance.

We determined that the following management controls were relevant to our audit
objectives:

   •   Loan Origination Process; and
   •   Quality Control Plan

We used the following audit procedures to evaluate the management controls:

   •   Review of established procedures formulated by Treehouse in originating FHA-
       insured loans,
   •   Interviews with officials and employees of Treehouse and other related parties
       and entities,
   •   Examination of Treehouse Mortgage’s records and related documents for FHA-
       insured loans originated between August 1, 2000 and September 31, 2003, and
   •   Review of records and files maintained by HUD’s Quality Assurance Division in
       connection with the oversight of the HUD-FHA approved Loan Correspondent
       Treehouse.




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It is a significant weakness if management controls do not provide reasonable assurance
that the process for planning, organizing, directing, and controlling program operations
will meet an organization’s objectives.

Our review of Treehouse Mortgage, LLC’s management controls over its loan origination
procedures for the origination of FHA-insured loans showed Treehouse as not complying
with HUD requirements. Based on our audit, we believe weaknesses exist in the
following two areas:

   •   Loan Origination Process (Finding 1); and
   •   Quality Control Process (Finding 2)


                         FOLLOW-UP ON PRIOR AUDITS

This is the first review of Treehouse Mortgage, LLC by the Denver Office of Inspector
General for Audit.




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                   Appendix A


AUDITEE COMMENTS




       10
11
                                                                    Appendix B

                     DISTRIBUTION OUTSIDE OF HUD

The Honorable Susan M. Collins, Chairman, Committee on Government Affairs
The Honorable Joseph Lieberman, Ranking Member, Committee on Government Affairs
The Honorable Thomas M Davis, III, Chairman, Committee on Government Reform
The Honorable Henry A. Waxman, Ranking Member, Committee on Government
Reform
Elizabeth Meyer, Senior Advisor, Subcommittee on Criminal Justice
Clinton C. Jones, Senior Counsel, Committee on Financial Services
Kay Gibbs, Committee on Financial Services
Mark Calabria, Committee on Banking, Housing, and Urban Affairs
W. Brent Hall, U.S. General Accounting Office (HallW@GAO.GOV)
Steve Redburn, Chief Housing Branch, Office of Management and Budget
Linda Halliday, Department of Veterans Affairs, Office of Inspector General




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