oversight

Gershman Investment Corporation, Non-Supervised Direct Endorsement Lender, Clayton, MO

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-07-28.

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

                     AUDIT REPORT




               GERSHMAN INVESTMENT CORPORATION
           NON-SUPERVISED DIRECT ENDORSEMENT LENDER
                          CLAYTON, MO

                          2004-KC-1004

                           July 28, 2004



                      REGION 7 OFFICE OF AUDIT
                          KANSAS CITY, KS




Table of Contents
                                                                           Issue Date
                                                                                   July 28, 2004
                                                                          Audit Case Number
                                                                                   2004-KC-1004




         TO: John C. Weicher, Assistant Secretary for Housing-Federal Housing Commissioner,
               and Chairman, Mortgagee Review Board, H

               /signed/
         FROM: Ronald J. Hosking, Regional Inspector General for Audit, 7AGA

         SUBJECT: Gershman Investment Corporation, Clayton, MO

         We have completed an audit of Gershman Investment Corporation, a non-supervised direct
         endorsement lender approved to originate Federal Housing Administration insured loans. We
         selected Gershman for audit because they are one of the larger mortgagees in the St. Louis area and
         had a slightly above average default rate. Our audit objectives were to determine if Gershman
         complied with HUD regulations, procedures, and instructions in the origination of the FHA-insured
         single-family mortgages and to determine whether Gershman’s late requests for endorsement
         complied with HUD’s requirements.

         We found that Gershman improperly originated 27 loans, with original mortgage amounts totaling
         $2,476,749. While Gershman’s procedures for submitting late requests for endorsement were effective
         overall, Gershman did improperly submit five loans for late endorsement, with mortgage amounts
         totaling $525,402. In addition, Gershman was deficient in its quality control review activities. This
         report contains three findings with recommendations requiring action by your office.

         In accordance with HUD Handbook 2000.06 Revision-3, within 60 days please provide us, for each
         recommendation without management decisions, 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 me at (913) 551-5870.




Table of Contents
                        THIS PAGE LEFT
                            BLANK
                        INTENTIONALLY




         2004-KC-1004     Page ii


Table of Contents
         Executive Summary
         We have completed an audit of Gershman Investment Corporation (Gershman), a non-supervised
         direct endorsement lender approved to originate Federal Housing Administration insured loans. We
         selected Gershman for audit because they are one of the larger mortgagees in the St. Louis area and
         have a slightly above average default rate on Federal Housing Administration loans. Our audit
         objectives were to determine if Gershman complied with HUD regulations, procedures, and
         instructions in the origination of the FHA-insured single-family mortgages and to determine
         whether Gershman’s late requests for endorsement complied with HUD’s requirements.



                                               Gershman did not adhere to HUD requirements and prudent
          Gershman Did Not Follow
                                               lending practices when originating 27 of the 43 loans we
          HUD Requirements when
                            When               examined for compliance. The 27 loan files contained
          Processing
          Originating Loans                    unsupported income, unsupported assets, underreported
                                               liabilities, questionable and/or derogatory credit histories,
                                               inadequate qualifying ratios, and other inconsistent and/or
                                               questionable documentation.       The deficiencies occurred
                                               because Gershman did not have an adequate control
                                               environment to ensure that its employees followed HUD
                                               requirements when processing and underwriting loans. These
                                               27 loans totaling $2,476,749, represent an increased risk to the
                                               Federal Housing Administration insurance fund.

                                               Overall, Gershman’s procedures for submitting late requests for
          Gershman’s Late                      endorsement were effective.        However, Gershman did
          Endorsement Request                  improperly submit five loans for insurance endorsement when
          Procedures Were                      the borrowers had delinquent payments prior to loan
          Generally Effective                  submission. These five improperly submitted loans, with
                                               mortgages totaling $525,402, represent an increased risk to the
                                               Federal Housing Administration insurance fund.

                                               Gershman was deficient in its quality control review activities.
          Gershman Was Deficient               Gershman did not conduct reviews within 90 days of loan
          In Its Quality Control               closing and did not review the required number of loans closed.
          Review Activities                    Without fully implementing adequate quality control policies
                                               and procedures, Gershman is unable to ensure the accuracy,
                                               validity, and completeness of its loan origination operations.

                                               We provided results of our loan file reviews and late
          Coordination Regarding               endorsement testing to Gershman during the audit, and
          Audit Results                        received and evaluated its verbal responses. We also held an
                                               exit conference with Gershman on June 3, 2004. Gershman
                                               provided written comments to our findings on July 8, 2004.
                                               We incorporated excerpts of the comments into our report as

                                                   Page iii                                      2004-KC-1004


Table of Contents
         Executive Summary

                             appropriate. Appendices C and E contain Gershman’s
                             response to our draft report. While the 35 attachments
                             referenced in Gershman’s response are not included in this
                             report, they are available upon request. We provided a
                             complete copy of Gershman’s response to the Action Official
                             addressed in this report.

                             We recommend that the Assistant Secretary for Housing-
           Recommendations   Federal Housing Commissioner, and Chairman, Mortgagee
                             Review Board, take appropriate administrative action against
                             Gershman Investment Corporation based on the information
                             contained in the findings. This action should, at a minimum,
                             include requiring indemnification for the 28 actively insured
                             loans and reimbursement for claims and related losses already
                             incurred on the three loans that have gone into claim status.
                             Additionally, HUD should ensure that Gershman’s quality
                             control policies and procedures are fully implemented in
                             accordance with current HUD requirements.




         2004-KC-1004            Page iv


Table of Contents
Table of Contents
Management Memorandum                                                       i



Executive Summary                                                        iii



Introduction                                                              1



Findings

1.    Gershman Did Not Follow HUD Requirements When
      Originating Loans                                                 3
2.    Gershman’s Late Endorsement Request Procedures
      Were Generally Effective                                          9
3.    Gershman Was Deficient In Its Quality Control
      Review Activities                                                13



Management Controls                                                     19



Follow Up On Prior Audits                                               21



Appendices
     A.   Schedule of Questioned Costs and Funds Put to Better Use      23
     B.   Loan Processing Deficiencies Chart                            25
     C.   Loan Processing Deficiencies Narrative Case Summaries         27
     D.   Chart of Loans Examined                                       81
     E.   Auditee Comments                                              83




                                 Page v                        2004-KC-1004
         Table of Contents



         Abbreviations:
         FHA            Federal Housing Administration
         HUD            Department of Housing and Urban Development
         OIG            Office of Inspector General




         2004-KC-1004                          Page vi


Table of Contents
         Introduction
         HUD’s Single Family Direct Endorsement Program insures mortgage loans under Section 203 of the
         National Housing Act (12 U.S.C. 1709). This program allows mortgagees to originate loans without
         prior HUD review or approval. Gershman Investment Corporation, located at 7 North Bemiston,
         Clayton, Missouri, received HUD approval to participate in the Direct Endorsement Program on
         August 5, 1983. Between August 1, 2001 and July 31, 2003, Gershman originated 1,210 loans
         totaling $130,962,140 under FHA programs.



                                             Our audit objectives were to determine if Gershman complied
          Audit Objectives and               with HUD regulations, procedures, and instructions in the
          Scope                              origination of the FHA-insured single-family mortgages and
                                             to determine whether Gershman’s late requests for
                                             endorsement complied with HUD’s requirements.

                                             Our audit generally covered the period of August 1, 2001
                                             through July 31, 2003. We conducted field work from
                                             December 2003 through April 2004.

                                             Our audit approach was to evaluate Gershman’s loan
          Audit Methodology                  origination and submission processes.

                                             To accomplish the audit objectives, we reviewed HUD’s
                                             rules, regulations, and guidance for proper origination and
                                             submission of FHA loans.             We interviewed HUD
                                             management and staff to obtain background information on
                                             FHA requirements and Gershman. We also reviewed
                                             previous HUD reviews and OIG audits of Gershman to
                                             understand deficiencies previously reported by HUD.

                                             We interviewed Gershman’s management and staff to
                                             determine its process for originating FHA-insured loans and
                                             submitting them for endorsement.         Additionally, we
                                             reviewed Gershman’s policies and procedures to gain an
                                             understanding of how its processes are designed to
                                             function. We also reviewed Gershman’s quality control
                                             plan and quality control review reports covering twenty-
                                             three months.

                                             During our audit, we examined documents in the HUD and
                                             Gershman loan files for 43 loans originated under HUD’s
                                             203(b) or 234(c) programs to determine whether the files
                                             contained adequate documentation to support approval of
                                             the loans. With the exception of those loans included in

                                                  Page 1                                    2004-KC-1004


Table of Contents
         Introduction

                        Finding 2 and those whose insurance had been terminated
                        without a claim by the time of selection, we reviewed all
                        loans that had gone into default within the first two years.
                        Additionally, we reviewed payment histories for all 336
                        loans submitted for endorsement more than 61 days after
                        closing to determine whether the late requests met HUD’s
                        requirements for timely borrower payments before
                        submission for FHA-insurance endorsement.

                        To conduct our audit, we relied upon computer-processed
                        data contained in HUD’s Single Family Data Warehouse.
                        We assessed the reliability of this data including relevant
                        general and application controls and found them to be
                        adequate. We also conducted sufficient tests of the data.
                        Based on these tests and assessments, we conclude the data
                        are sufficiently reliable to be used in meeting our
                        objectives.

                        Specifically, we relied upon default status information in
                        HUD’s systems when selecting loans for detailed review.
                        Additionally, we relied upon closing and endorsement dates
                        when conducting our review of late endorsements. We used
                        the mortgage amount and claims status from HUD’s system
                        for information purposes.

                        We conducted the audit in accordance with generally
                        accepted government auditing standards.




         2004-KC-1004       Page 2


Table of Contents
                                                                                                       Finding 1


           Gershman Did Not Follow HUD Requirements
                    When Originating Loans
         Gershman Investment Corporation did not adhere to HUD requirements and prudent lending practices
         when originating 27 of the 43 loans we examined for compliance. The 27 loan files contained
         unsupported income, unsupported assets, underreported liabilities, questionable and/or derogatory
         credit histories, inadequate qualifying ratios, and other inconsistent and/or questionable documentation.
         The deficiencies occurred because Gershman did not have an adequate control environment to ensure
         that its employees followed HUD requirements when processing and underwriting loans. These 27
         loans totaling $2,476,749, represent an increased risk to the Federal Housing Administration insurance
         fund.



                                                 HUD Handbook 4155.1, Revision 4, Change 1, requires
           HUD Requirements                      mortgagees to determine the borrowers’ ability and
                                                 willingness to repay the mortgage debt, and thus, limit the
                                                 probability of default or collection difficulties. Mortgagees
                                                 should evaluate the stability and adequacy of income, funds
                                                 to close, credit history, qualifying ratios, and compensating
                                                 factors. Lenders must ensure that application package
                                                 contains sufficient documentation to support their decision
                                                 to approve the mortgage loan.

                                                 HUD Handbook 4000.4, Revision-1, Change-2, requires
                                                 mortgagees to employ underwriters who will make
                                                 underwriting decisions with due diligence in a prudent
                                                 manner. Underwriters are to coordinate all phases of the
                                                 underwriting process, personally reviewing the application
                                                 documents of each loan. They should have an ability to
                                                 detect fraud and be aware of warning signs that may indicate
                                                 irregularities.

                                                 HUD also permits mortgagees to use approved automated
                                                 underwriting systems, including Fannie Mae's Desktop
                                                 Underwriter. Desktop Underwriter requires all data entered,
                                                 downloaded, or imported to be true, accurate, and complete.
                                                 Additionally, when Desktop Underwriter approves a loan, it
                                                 requires lenders to comply with all messages and conditions
                                                 listed on the Findings Report and to review the credit report,
                                                 confirming that the data evaluated was accurate.

                                                 Our examination of 43 loans originated by Gershman from
           Loans Did Not Comply                  August 1, 2001 through July 31, 2003 disclosed significant
           with HUD Requirements
                                                      Page 3                                        2004-KC-1004


Table of Contents
         Finding 1

                               origination deficiencies in 27 of the 43 cases. The
                               following table summarizes the individual categories of loan
                               deficiencies.

                                                                           # OF      % OF
                                 TYPE OF NON-COMPLIANCE
                                                                          LOANS      LOANS
                                 Inconsistent/Unsupported Income           16         37%
                                 Inconsistent/Unsupported Assets           14         33%
                                 Inconsistent/Underreported Liabilities     6         14%
                                 Questionable/Derogatory Credit History     7         16%
                                 Inadequate Qualifying Ratios               4          9%
                                 Inconsistent/Questionable Information      3          7%

                               The deficiencies noted in this table are not independent of
                               one another as many of the loan files contained more than
                               one deficiency. Appendix B provides a chart summarizing
                               the files with loan processing deficiencies. Additionally,
                               Appendix C details the deficiencies identified on each loan
                               reviewed, including the specific HUD requirements not met
                               when processing the loans.

                               According to Neighborhood Watch, as of March 31, 2004,
                               one of the 27 loans has terminated FHA insurance without a
                               claim. Because this loan no longer represents a risk to the
                               insurance fund, we have removed the loan from our
                               recommendations. The original mortgage amount of the
                               remaining 26 loans is $2,427,141.

                               HUD has paid claims on three of the 26 loans, with original
                               mortgage amounts totaling $187,043. HUD has sold two of
                               the three properties, incurring losses of $40,217. While
                               claims of $71,010 have been paid on the third loan, the
                               amount of the loss will not be known until the property is
                               sold. 10 of the 23 loans actively insured are currently in
                               default; four are in some stage of the foreclosure process, and
                               the borrowers on five of the loans have filed for bankruptcy.
                               The remaining 13 loans are no longer in default.

                               Gershman did not have an adequate control environment to
          Inadequate Control   ensure that its employees followed requirements when
          Environment          underwriting loans.

                               A direct endorsement underwriter manually underwrote 11
                               of the deficient loans. When processing these loans,
                               Gershman did not sufficiently adhere to HUD requirements

         2004-KC-1004                 Page 4


Table of Contents
                                                                                     Finding 1

                                 and prudent lending practices. For example, in FHA Case
                                 #292-4058693, Gershman failed to document adequate
                                 compensating factors when the 54.96% debt ratio exceeded
                                 the regulatory maximum of 41%.

                                 Gershman used Desktop Underwriter to underwrite 16 of the
                                 deficient loans. In many of these cases, Gershman did not
                                 comply with all messages and conditions listed on the
                                 Findings Report. In some cases, Gershman failed to ensure
                                 that all data entered into the system was true, accurate, and
                                 complete.     For example, in FHA Case 133-0103574,
                                 Gershman did not include a real estate loan with $978
                                 monthly payments when entering liabilities into Desktop
                                 Underwriter.

                                 Gershman’s loan processors are responsible for submitting
                                 information to Desktop Underwriter and clearing all
                                 messages and conditions listed on the Findings Report.
                                 During the audit period, loans were reviewed by
                                 underwriters only when Desktop Underwriter rejected a
                                 loan. Gershman reports that it now requires underwriters to
                                 review all loans underwritten by Desktop Underwriter.

                                 Gershman’s deficient quality control activities may have also
                                 contributed to the loan origination deficiencies. As discussed
                                 in Finding 3 of this report, this failure has led to Gershman’s
                                 inability to ensure the accuracy, validity, and completeness of
                                 its loan origination operations.

                                 Because HUD’s Single Family Direct Endorsement Program
          Impact of Inadequate   allows mortgagees to underwrite and close loans without
          Underwriting           prior HUD review or approval, it is imperative that approved
                                 lenders follow HUD requirements and prudent lending
                                 practices when originating loans to be insured by HUD.
                                 Inadequate underwriting results in HUD insuring mortgages
                                 that do not meet the minimum requirements. Improperly
                                 originated loans increase the risk of loss to the HUD
                                 mortgage insurance fund. For example, all 27 loans cited
                                 with origination deficiencies had been in default within two
                                 years of closing.

                                 The deficiencies cited relate to loans closed between August
                                 1, 2001 and July 31, 2003. Prior to this two-year period,
                                 Gershman’s percentage of total defaults within two years of
                                 loan origination was average for the area. However, during
                                 the two-year audit period, this percentage was consistently

                                       Page 5                                     2004-KC-1004


Table of Contents
         Finding 1

                             above average, at times more than fifty percent higher than
                             the St. Louis HUD Office average. However, since the audit
                             period, Gershman’s percentage has declined and is now
                             below the area average.


         Auditee Comments    While Gershman did not provide an overall response to our
                             draft finding, the cover letter to their response package
                             indicates that they have always been committed fully to strict
                             compliance with HUD-FHA requirements and are committed
                             to demonstrating this through their loan origination activities.
                             Additionally, Gershman notes that many of the alleged
                             findings are not supported or represent a misrepresentation of
                             the facts. Appendix E contains the complete text of
                             Gershman’s response package cover letter

                             Gershman’s comments to our draft report included responses
                             to each of the 64 deficiencies cited for the 31 loans included
                             in the draft finding. These responses were transcribed and
                             inserted into Appendix C. While the 35 attachments
                             referenced in Gershman’s response are not included in this
                             report, they are available upon request.


         OIG Evaluation of   Gershman provided additional documentation sufficient to
         Auditee Comments    clear 14 of the 64 individual deficiencies included in the
                             draft finding. This removed 4 loans from the finding as
                             many loans had multiple deficiences. We adjusted the
                             body of this finding as well as Appendices B and C to
                             reflect the updated deficiency counts.       Additionally,
                             Appendix C contains OIG’s evaluation of Gershman’s
                             comments regarding each of the 64 deficiencies cited in the
                             draft finding.


         Recommendations     We recommend that the Assistant Secretary for Housing-
                             Federal Housing Commissioner, Chairman, Mortgagee
                             Review Board:

                             1A.   Require Gershman to indemnify HUD/FHA for the 23
                                   actively insured loans, totaling $2,240,098, in which
                                   Gershman did not follow HUD/FHA loan origination
                                   requirements. Appendix B lists FHA case numbers for
                                   the loans included in this recommendation.



         2004-KC-1004              Page 6


Table of Contents
                                                                       Finding 1

                    1B.   Require Gershman to reimburse HUD/FHA $4,675 for
                          losses already incurred on loans in which Gershman
                          did not follow HUD/FHA loan origination
                          requirements. Appendix B lists FHA case numbers for
                          the loans included in this recommendation.

                    1C.   Require Gershman to reimburse HUD/FHA for the
                          $40,217 in related losses incurred on properties sold
                          for two loans in which Gershman did not follow
                          HUD/FHA loan origination requirements. Appendix
                          B lists FHA case numbers for the loans included in this
                          recommendation.

                    1D.   Require Gershman to reimburse HUD/FHA for the
                          $71,010 in claims paid for the property not yet sold on
                          a loan in which Gershman did not follow HUD/FHA
                          loan origination requirements. Appendix B lists FHA
                          case number for the loan included in this
                          recommendation.

                    1E.   Ensure that Gershman has implemented an effective
                          control environment that prevents Gershman from
                          submitting loans for FHA insurance endorsement that
                          do not meet HUD/FHA requirements.




                          Page 7                                   2004-KC-1004


Table of Contents
         Finding 1




                        THIS PAGE LEFT
                            BLANK
                        INTENTIONALLY




         2004-KC-1004       Page 8


Table of Contents
                                                                                                Finding 2


                    Gershman’s Late Endorsement Request
                     Procedures Were Generally Effective
         Overall, Gershman’s procedures for submitting late requests for endorsement were effective.
         However, Gershman did improperly submit five loans for insurance endorsement when the borrowers
         had delinquent payments prior to loan submission. These five improperly submitted loans, with
         mortgages totaling $525,402, represent an increased risk to the Federal Housing Administration
         insurance fund.




         HUD Requirements                    HUD Handbook 4165.1, Revision-1, requires that loans
                                             submitted for insurance endorsement more than 60 days after
                                             closing meet certain late request standards. These standards
                                             are designed to ensure the degree of risk to HUD at the time
                                             of endorsement is no greater than the degree of risk existing
                                             at the time of closing.

                                             Specifically, HUD requires late requests to include a payment
                                             ledger reflecting all payments received, including the
                                             payment due for the current month, if the case is submitted
                                             after the 15th of the month. The mortgage payments must not
                                             be delinquent when the loan is submitted for endorsement,
                                             and each payment must be made in the calendar month due.
                                             If a payment is made outside the calendar month due, the
                                             lender cannot submit the case for endorsement until six
                                             consecutive payments have been made within the proper
                                             calendar month due.

                                             Using HUD’s Neighborhood Watch and Single Family Data
         Loan Universe to Test               Warehouse systems, we identified 1,210 loans originated by
                                             Gershman between August 1, 2001 and July 31, 2003.

                                             We limited our universe to only those loans received by
                                             HUD more than 61 days after the loan closed or with blank
                                             endorsement dates in HUD systems. We eliminated loans
                                             received or submitted to HUD within 60 days of closing
                                             and those submitted before the first due date. We also
                                             eliminated new construction loans, which are not subject to
                                             late endorsement procedures, and loans subsequently paid-
                                             in-full, as they no longer represent a risk to the FHA
                                             insurance fund. We tested the remaining 336 loans for
                                             improper late requests for endorsement. Appendix D


                                                  Page 9                                     2004-KC-1004


Table of Contents
         Finding 2

                                includes a diagram illustrating both the scope and findings
                                of our testing.

                                In performing our tests to determine whether Gershman
         Testing Methodology    complied with HUD’s endorsement requirements, we
                                compared HUD and Gershman loan data. We also examined
                                payment histories to identify the presence of payments made
                                outside of the month due and delinquent payments prior to
                                submission.

                                Overall, Gershman did not have a significant problem with
         Improperly Submitted   late requests for endorsement as their procedures for
         Loans                  submitting late requests for endorsement were generally
                                effective. Our analysis of the payment histories and
                                endorsement data for the 336 loans tested revealed only five
                                improper late requests. These five loans, totaling $525,402 in
                                original mortgage amounts, were submitted for endorsement
                                even though the borrowers had delinquent payments prior to
                                submission. The following table lists the original mortgage
                                amounts and the late payment dates for each of the five loans
                                improperly submitted.

                                                           ORIGINAL         LATE
                                     FHA LOAN NUMBER
                                                        MORTGAGE AMOUNT PAYMENT DATE
                                       292-4083810           $150,220           2/1/02
                                       292-4200558           $91,563            9/1/02
                                       292-4263088           $82,113            4/1/03
                                       292-4294692           $83,653            5/1/03
                                       292-4329421           $117,853           6/1/03
                                                             $525,402

                                According to Neighborhood Watch, as of March 31, 2004,
                                two of the five loans, with original mortgage amounts of
                                $241,783, are in some stage of the foreclosure process. HUD
                                cannot identify the loss on these loans until the claims are
                                completed and the properties are sold. In addition, HUD has
                                paid $500 loss mitigation costs on one of the loans that is in
                                foreclosure. Because each of the five actively insured loans
                                had delinquent payments prior to submission to HUD, the
                                degree of risk to the FHA insurance fund at the time of
                                endorsement was greater than the degree of risk existing at
                                the time of closing.




         2004-KC-1004                 Page 10


Table of Contents
                                                                                 Finding 2


         Auditee Comments    A summary of Gershman’s comments on our draft finding
                             follows. Appendix E contains the complete text of the
                             comments.

                             In its response, Gershman noted that they have implemented
                             a new procedure to assure that loans are submitted to HUD
                             for endorsement with the correct documentation.
                             Specifically, all loans submitted for endorsement after 60
                             days of closing, or that are re-submitted for endorsement
                             and require copies of pay histories, are now required to be
                             reviewed by the insuring department supervisor. The
                             supervisor initials the loan file after confirming that the pay
                             history is correct and the submission is in compliance with
                             HUD guidelines. As a result of this change, Gershman
                             believes that its late requests for endorsement will be fully
                             consistent with HUD guidelines.

                             Gershman’s review of the five loan files disclosed that in
                             three cases, the monthly payments were made timely but
                             one of the payments was subsequently returned for
                             insufficient funds. They note that, in each of the three
                             cases, the borrowers replaced the insufficient funds check
                             the month following the payment due date.

                             Gershman’s review also disclosed that HUD had returned
                             four of the five loan files prior to the payment date cited.
                             According to Gershman, two files were returned for
                             additional documentation while one file was returned for
                             mortgage insurance payment. Gershman claims that one
                             file (FHA Case #292-4329421) was incorrectly returned
                             because of a zip code discrepancy on the insured property.


         OIG Evaluation of   We commend Gershman for taking steps to improve its
         Auditee Comments    submission process. If fully implemented, the new procedure
                             should help prevent future occurrences of improper late
                             submissions.

                             Gershman noted that four of the five loan files had been
                             returned by HUD. Specifically, Gershman explains that
                             one file (FHA Case #292-4329421) was incorrectly
                             returned by HUD because of a zip code discrepancy.
                             However, because Gershman did not provide a copy of the
                             Notice of Return sent by HUD, we were unable to verify
                             the reason for late submission and included this loan in our

                                   Page 11                                    2004-KC-1004


Table of Contents
         Finding 2

                           finding. We did not review the Notices of Return for the
                           remaining three loans; however, the reasons cited by
                           Gershman would subject the loan to late endorsement
                           procedures.

                           While Gershman’s comments may put the individual cases in
                           context, we believe that all five loans were improper
                           submissions and should be indemnified. Regardless of the
                           individual circumstances, each of the five loans cited had
                           payments made outside the calendar month due prior to the
                           late submission. This is a clear violation of HUD guidelines.
                           Gershman should not have submitted the five cases for
                           endorsement until six consecutive payments had been made
                           within the proper calendar month due.


         Recommendations   We recommend that the Assistant Secretary for Housing-
                           Federal Housing Commissioner, Chairman, Mortgagee
                           Review Board:

                           2A.    Require Gershman to indemnify HUD/FHA for the
                                  five loans improperly submitted for endorsement
                                  with mortgage amounts totaling $525,402.

                           2B.    Require Gershman to reimburse HUD/FHA $500
                                  for losses already incurred on the loans improperly
                                  submitted for endorsement.




         2004-KC-1004            Page 12


Table of Contents
                                                                                                   Finding 3


           Gershman Was Deficient In Its Quality Control
                      Review Activities
         Gershman was deficient in its quality control review activities. Gershman did not conduct reviews
         within 90 days of loan closing and did not review the required number of loans closed. Without fully
         implementing adequate quality control policies and procedures, Gershman is unable to ensure the
         accuracy, validity, and completeness of its loan origination operations.




         HUD Requirements                      HUD Handbook 4060.1, Revision-1, Chapter 6 requires
                                               mortgagees to have and maintain a written Quality Control
                                               Plan which provides for internal or external audits, or other
                                               independent reviews, of the mortgagee’s origination of
                                               insured mortgages.

         Scope and Methodology                 We queried HUD’s Single Family Data Warehouse for all
                                               loan origination activity between August 1, 2001 and July
                                               31, 2003 and for default activity on those originated. We
                                               reviewed Gershman’s external quality control review
                                               reports as well as internal management review and early
                                               payment default reports. However, because the quality
                                               control review reports and subsequent management review
                                               reports were only available through June 2003, we were
                                               unable to conduct full testing of July 2003.

                                               In performing our tests to determine whether Gershman
                                               complied with HUD’s quality control requirements, we
                                               compared HUD requirements and data with Gershman’s
                                               quality control plan and related review reports. When
                                               examining the number of loans originated each month, we
                                               rounded the number of loan reviews required before
                                               comparing with Gershman data.

                                               Gershman was deficient in its quality control review
         Months
         DeficientReviewed
                    Quality Control            activities. Gershman did not conduct the required reviews
         Activities                            within 90 days of loan closing and did not review the
                                               required number of loans closed.

                                               HUD requires quality control reviews be performed within
         Closed Loan Review                    90 days of loan closing. Gershman’s quality control policy
         Timeliness Requirement                does not contain a similar statement.



                                                   Page 13                                     2004-KC-1004


Table of Contents
         Finding 3

                                On average, the contracted quality control firms received
                                loans selected for review 161 days after closing and issued
                                reports 228 days after closing. The following table details
                                the timeliness of reviews performed both before and after the
                                contractor changes made by Gershman.

                                                                   AVERAGE #     AVERAGE #
                                  QUALITY                            DAYS          DAYS
                                                   MONTHS          BETWEEN       BETWEEN
                                  CONTROL                            LOAN          LOAN
                                                  REVIEWED
                                CONTRACTOR                        CLOSING AND   CLOSING AND
                                                                    RECEIPT       REPORT
                                   Firm A        8/01 - 10/01           134         176
                                   Firm B        11/01 - 4/03           168         247
                                   Firm A         5/03 - 6/03           171         193

                                While Gershman did not meet HUD’s timeliness
                                requirements for any of the 23 months reviewed, they report
                                that reviews are now consistently performed within 90 days
                                of closing.

                                HUD requires mortgagees to review the lesser of ten
         Closed Loan Review     percent of all loans closed on a monthly basis, or a random
         Sampling Requirement   sample that provides a 95 percent confidence level with
                                two percent precision. Gershman’s quality control policy
                                requires review of at least ten percent of loans closed.

                                While Gershman reviewed ten percent of the loans closed
                                between August 2001 and June 2003, they did not meet the
                                ten percent sample requirement for five of the 23 months
                                reviewed.

                                                NUMBER          NUMBER OF       NUMBER OF
                                 MONTH                           REVIEWS
                                                OF LOANS                         REVIEWS
                                REVIEWED                        REQUIRED
                                                 CLOSED                         PERFORMED
                                                                 (rounded)
                                   9/01           56                6               5
                                   3/02           42                4               3
                                   4/02           45                5               1
                                   5/02           36                4               3
                                   7/02           39                4               3

                                Gershman did consistently meet HUD’s sampling
                                requirements for the last 11 months of the review period.
                                They report that the deficiency has been corrected.


         2004-KC-1004                 Page 14


Table of Contents
                                                                                    Finding 3

                                 HUD requires mortgagees to analyze all loans that go into
         Early Default Reviews   default within the first six months.             Accordingly,
                                 Gershman’s quality control policy requires review of all
                                 loans which go into default within the first six payments.

                                 Gershman analyzed all 19 loans that defaulted during the
                                 first six payments. Gershman reports that both internal
                                 quality control personnel and an independent underwriter
                                 analyze early default loans for trends and deficiencies.
                                 Although Gershman’s early default analysis met HUD’s
                                 requirement, it did not result in identifying specific
                                 deficiencies with individual loans. Our examination of 14
                                 of the 19 loans reviewed by Gershman staff disclosed
                                 significant origination deficiencies in eight cases. These
                                 eight loans are included in Finding 1.

                                 Since the audit period, in November 2003, HUD updated
                                 its quality control handbook. It now requires a more
                                 comprehensive documentation review and verification
                                 process be performed on early payment defaults.
                                 Gershman should update their quality control policies and
                                 procedures to comply with the updated handbook.

                                 The deficiencies associated with Gershman’s quality control
          Inability to Adhere    activities stem from Gershman’s inability to adhere to HUD
          to Requirements        requirements and their own established requirements while
                                 outsourcing quality control activities.

                                 In 1999, Gershman began utilizing an outside quality control
                                 firm to perform reviews of loans originated. Gershman
                                 reports that once they identified that reviews were not being
                                 performed in a timely manner and that the contractor was
                                 often selecting loans on a quarterly basis, they took several
                                 actions to remedy the situation, including switching
                                 contractors twice. Additionally, Gershman reports that in
                                 June 2004, they will begin performing all quality control
                                 procedures internally in an attempt to further strengthen
                                 controls.

                                 Gershman’s written quality control policy may have also
                                 contributed to the deficient quality control activities.
                                 While the policy requires ten percent of all loans closed be
                                 selected for review, it does not specify that loans are to be
                                 selected on a monthly basis as required by HUD.
                                 Additionally, Gershman’s quality control policy does not


                                       Page 15                                   2004-KC-1004


Table of Contents
         Finding 3

                            include a statement requiring reviews be performed within
                            90 days of the closing of the loan as required by HUD.

                            Under HUD’s Single Family Direct Endorsement Program,
                            the mortgage loan is underwritten and closed without prior
                            HUD review or approval. Therefore, it is imperative that
                            approved lenders implement quality control policies and
                            procedures in accordance with HUD’s and its own
                            requirements. Without fully implementing adequate quality
                            control policies and procedures, Gershman is unable to ensure
                            the accuracy, validity, and completeness of its loan origination
                            operations.

         Auditee Comments   A summary of Gershman’s comments on our draft finding
                            follows. Appendix E contains the complete text of the
                            comments.

                            While Gershman recognizes that there were some
                            shortcomings regarding the timeliness and sample size of its
                            closed loan reviews during the audit period, they believe the
                            concerns primarily resulted from the failure of their former
                            quality control firm to conform fully with HUD requirements.
                            Further, Gershman believes that the shortcomings cited in our
                            draft finding are not representative of their overall quality
                            control review activities and notes that their quality control
                            activities have not been an issue in prior OIG audits or HUD
                            reviews

                            Specifically, Gershman noted the following regarding the
                            timeliness and sample size of its closed loan reviews covering
                            our audit period.
                            • 11 of the 21 closed loan reviews performed by Firm A in
                                2001 were completed timely.
                            • During the time Gershman contracted Firm B, they were
                                instructed not to send the monthly listing of closed loans
                                until the prior month review was complete. Additionally,
                                Firm B selected loans on a quarterly basis for the first half
                                of 2002 and did not select an adequate number of loans
                                for the July 2002 review.

                            Gershman notes that it has been able to substantially reduce
                            its early default ratio as a result of its internal early default
                            reviews. Gershman explains that its previously above
                            average early default ratio was due to the selling of its
                            servicing portfolio and increased refinance activity.

         2004-KC-1004             Page 16


Table of Contents
                                                                                 Finding 3

                             According to Gershman, its constant review of early default
                             loans led to changes in its underwriting procedures and has
                             contributed to its early default ratio decreasing to 63% of the
                             HUD St. Louis Office average.

                             Gershman declares that it has an effective Quality Control
                             program in place and is in compliance with the HUD
                             requirements. Gershman notes that it has taken the necessary
                             steps to assure that reviews are completed timely and
                             indicates that sampling for closed loan reviews is in full
                             compliance.

                             In their written comments, Gershman also states that the July
                             2003 closed loan review was completed by Firm A December
                             11, 2003 and was available for OIG review.


         OIG Evaluation of   We commend Gershman for its current early default ratio,
         Auditee Comments    which is below the HUD St. Louis Office average. By
                             updating and fully implementing its quality control plan,
                             Gershman can better ensure the accuracy, validity, and
                             completeness of its loan origination operations.

                             As noted both in this finding and in the introduction of this
                             report, our audit covered the period of August 1, 2001
                             through July 31, 2003. This finding is a snapshot of
                             Gershman’s quality control activities and is not intended to
                             report on Gershman’s activities prior to or subsequent to the
                             audit period. Further, we disagree with Gershman’s assertion
                             that its quality control activities have not been an issue in
                             prior audits or reviews. While we did not examine all prior
                             HUD reviews, the 1987 OIG audit found that Gershman’s
                             quality control plan needed to be improved and followed.

                             Gershman notes that it was properly relying upon the
                             contracted quality control firms. However, HUD Handbook
                             4060.1, Revision-1, Chapter 6 states that mortgagees are
                             responsible for ensuring that the quality control requirements
                             are met when utilizing outside firms. It is ultimately
                             Gershman’s responsibility to comply.

                             Our analysis indicates that only one of the 21 loans selected
                             for review in 2001 by Firm A was received within 90 days of
                             loan closing. Based on report dates, none were completed
                             within 90 days of closing.


                                   Page 17                                    2004-KC-1004


Table of Contents
         Finding 3

                           Last, we question Gershman’s comment that the July 2003
                           report was available for our examination. The audit
                           notification letter requested all documents for the audit
                           period, including quality control reports. Gershman initially
                           provided reviews covering 21 months of the audit period and
                           subsequently provided two monthly reviews completed by
                           Firm A on December 11, 2003. However, they did not
                           supply the July 2003 review. Regardless, the July 2003
                           review was not completed within 90 days of closing.


         Recommendations   We recommend that the Assistant Secretary for Housing-
                           Federal Housing Commissioner, Chairman, Mortgagee
                           Review Board:

                           3A.    Require Gershman to update its quality control
                                  policies and procedures in accordance with HUD
                                  requirements.

                           3B.    Ensure Gershman’s quality control process is fully
                                  implemented   in    accordance      with    HUD
                                  requirements.




         2004-KC-1004            Page 18


Table of Contents
         Management 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 the following management controls were
          Relevant Management
                                              relevant to our audit objectives:
          Controls
                                                  •   Controls over the loan origination process.

                                                  •   Controls over the loan submission process.

                                                  •   Controls over the quality control process.

                                              The following procedures were used to examine the
          Assessment Procedures               management controls:

                                                  •   Review of established loan origination and quality
                                                      control procedures formulated by Gershman.

                                                  •   Examination of records and documents for FHA-
                                                      insured loans originated during a two-year period.

                                                  •   Interviews with applicable officials and employees of
                                                      HUD’s Quality Assurance Division.

                                                  •   Interviews with Gershman officials and employees.

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

                                              Based on our review, we believe significant weaknesses exist
                                              in the following areas:

                                                  •   Loan origination process (see Finding 1).

                                                  •   Quality control process (see Finding 3).




                                                  Page 19                                        2004-KC-1004


Table of Contents
         Management Controls




                               THIS PAGE LEFT
                                   BLANK
                               INTENTIONALLY




         2004-KC-1004           Page 20


Table of Contents
         Follow Up On Prior Audits
         This is the third HUD Office of Inspector General Audit of Gershman Investment Corporation.

         The first OIG audit report pertaining to the origination, settlement, administration, and servicing of
         mortgage loans insured with HUD was issued June 15, 1984. All findings have been cleared.

         The second OIG audit report pertaining to loan origination and quality control was issued March
         25, 1987. All findings have been cleared.




                                                    Page 21                                      2004-KC-1004


Table of Contents
         Follow Up On Prior Audits




                                     THIS PAGE LEFT
                                         BLANK
                                     INTENTIONALLY




         2004-KC-1004                 Page 22


Table of Contents
                                                                                               Appendix A


                          Schedule of Questioned Costs and
                              Funds Put to Better Use
                                             Type of Questioned Cost                    Funds Put to
               Recommendation
                                       ___Ineligible        __Unsupported              ___Better Use
              _____Number_____
                                         (1/)___                (2/)__                     (3/)___
                     1A                                                                  $2,240,098
                     1B                    $4,675
                     1C                   $40,217
                     1D                                           $71,010
                     2A                                                                   $525,402
                     2B                    $500


         1/       Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
                  that the auditor believes are not allowable by law, contract or Federal, State or local
                  policies or regulations.

         2/       Unsupported costs are costs charged to a HUD-financed or HUD-insured program or
                  activity and eligibility cannot be determined at the time of audit. The costs are not
                  supported by adequate documentation or there is a need for a legal or administrative
                  determination on the eligibility of the costs. Unsupported costs require a future decision
                  by HUD program officials. This decision, in addition to obtaining supporting
                  documentation, might involve a legal interpretation or clarification of Departmental
                  policies and procedures.

         3/       Funds Put to Better Use are costs that will not be expended in the future if our
                  recommendations are implemented. For this review, the funds put to better use consist of
                  loans and guarantees not made because of indemnification.




                                                    Page 23                                    2004-KC-1004


Table of Contents
         Appendix A




                        THIS PAGE LEFT
                            BLANK
                        INTENTIONALLY




         2004-KC-1004    Page 24


Table of Contents
                                                                                                                  Appendix B


                         Loan Processing Deficiencies Chart
                                                                                                       Other
                       Inconsistent   Inconsistent    Inconsistent   Questionable
           FHA                                                                        Inadequate    Inconsistent
                          and/or         and/or          and/or         and/or                                      Finding 1
           Case                                                                       Qualifying       and/or
                       Unsupported    Unsupported    Underreported    Derogatory                                 Recommendation
          Number                                                                        Ratios      Questionable
                         Income          Assets        Liabilities   Credit History
                                                                                                   Documentation
         292-4051541                       X                               X                                          1C
         292-4054430                       X                               X              X                           1A
         292-3998744        X                             X                                                           N/A
         292-4064761                       X              X                                                           1A
         292-4058693                                                       X              X             X             1A
         292-4057783                                                       X                                          1A
         292-4067535        X                                                                                         1A
         292-4076810        X                                              X                                         1A, 1B
         292-4076992        X              X                                                                          1C
         292-4082499        X              X              X                                                           1A
         292-4079136        X                                                                                        1A, 1B
         292-4105387        X              X                                                                         1A, 1B
         292-4095609        X                                                                                        1A, 1B
         292-4108675                       X                                                                          1A
         292-4119353        X              X                                                                         1A, 1B
         292-4126430        X              X                                                                          1A
         292-4123196                                                       X                            X            1A, 1B
         292-4153878                       X              X                X                                         1A, 1B
         292-4159228        X                                                                                         1A
         292-4129226        X                                                                           X             1A
         292-4169219        X              X                                                                         1A, 1B
         292-4171792                       X                                                                          1A
         133-0103574                                      X                                                           1A
         292-4194032                                                                      X                          1A, 1B
         133-0104240        X              X                                                                          1D
         292-4218860        X                             X                                                           1A
         133-0104569        X              X                                              X                           1A
            Total          16             14               6               7              4             3




                                                               Page 25                                            2004-KC-1004


Table of Contents
         Appendix B




                        THIS PAGE LEFT
                            BLANK
                        INTENTIONALLY




         2004-KC-1004      Page 26


Table of Contents
                                                                                             Appendix C


                            Narrative Case Presentations
         Gershman’s response to the deficiencies cited in Finding 1 of the draft report was transcribed
         and inserted into this appendix. Appendix E contains the cover letter of Gershman’s response to
         our draft report and its comments on Findings 2 and 3. While the 35 attachments referenced in
         Gershman’s response are not included in this report, they are available upon request.


         FHA CASE NUMBER: 292-4051541                           DATE OF LOAN CLOSING: 8/3/2001
         LOAN PURPOSE: Purchase                                 INSURED AMOUNT: $29,968
         UNDERWRITER TYPE: Manual                               HOUSING/DEBT RATIOS: 21.80/21.80
         STATUS AS OF 3/31/2004: Property conveyed to Insurer. HUD incurred a loss of $17,722 on the sale
         of the subject property. First default reported after three payments.

         Inconsistent/Unsupported Assets
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-10 requires lenders to
         ensure that the borrower has sufficient funds available to close the loan. Paragraph 2-10B
         requires the lender to obtain an explanation and source of funds when savings and checking
         account verification reveals a large increase in the account balance.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $897 and the borrower needed $2,166 to close. According to the settlement
         statement, the borrower only needed $143 to close after taking out gift funds, earnest money,
         seller paid expenses, and borrower prepaid expenses. According to the underwriting worksheet
         and application, the borrower’s assets include a checking account with a $559 balance. Bank
         statements covering 4/13/01-6/8/01 indicate two unidentified deposits on 5/16/01 ($200) and
         6/7/01 ($250). These deposits warrant an explanation and evidence of source of funds as they
         caused a large increase in the account balance, given the otherwise small balance. Without the
         deposits, the borrower would not have had sufficient funds available to close the loan.
         AUDITEE COMMENTS: According to the [settlement statement], the borrower needed $142.73 to
         close this loan. We did not deem it necessary to question the 2 deposits on the borrower’s bank
         statement as there was not a large increase in the account balance and did not exceed 2% of the
         sales price. To the contrary, the 6/8/01 bank statement had confirmed a balance as of 5/11/01 of
         $674.91 and an ending balance of $559.58. This balance was sufficient for the cash needed to
         close. We respectfully submit that we complied fully with HUD guidelines and there is no basis
         for this finding.
         OIG EVALUATION OF AUDITEE COMMENTS: HUD regulation does not specify that only deposits
         in excess of 2% of the sales price be considered large deposits. As documented above, the
         unexplained deposits represent a large increase in respect to the account balance. The loan was
         approved using a bank statement balance of $559.58. Without the two deposits, the borrower’s
         account balance would have been $109.58 and there would not have been sufficient funds
         available to close the loan.

         Questionable/Derogatory Credit History
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-3 requires lenders to
         develop a credit history from utility payment records, rental payments, automobile insurance

                                                  Page 27                                   2004-KC-1004


Table of Contents
         Appendix C

         payments, or other means of direct access from the credit provider for borrowers who do not use
         traditional credit. Also, neither the lack of credit history nor the borrower’s decision not to use
         credit may be used as a basis for rejection. According to Paragraph 2-3A, the payment history of
         the borrower’s housing obligations is of significant importance in evaluating credit. Lenders
         must determine the borrower’s payment history of the housing obligations for the most recent
         12-month period.
         OIG FINDING: The credit report did not list a credit score; the only item listed on the credit
         report is a paid collection ($55) from 1997/1998. Gershman did verify seven months worth of
         payment records for one utility and the borrower’s rent. The verification of rent does verify
         $200 monthly payments. However, it was completed by the landlord the same day as the
         processor and does not list a phone number, fax number, or address for the landlord, possibly
         indicating that Gershman did not directly verify the rent. The file also contained a gas service
         bill for one month, which shows a balance brought forward. It is unclear if the borrower made
         late payments for gas service or for any of the unverified utilities (i.e.
         telephone/water/sewer/trash/ insurance). Gershman did not adequately develop the borrower’s
         credit history.
         AUDITEE COMMENTS: We respectfully submit that this borrower did not have a credit score. We
         properly developed the borrower’s credit history using his landlord verification and one utility
         account. The most weight was put on the rent of $200 per month given that his new monthly
         mortgage payment was $274. With regards to the landlord verification being completed the
         same day, Gershman permits its employees to hand carry verification in order to expedite the
         processing.
         OIG EVALUATION OF AUDITEE COMMENTS: While Gershman did verify seven months of rental
         history and electricity payments, they failed to satisfy HUD requirements. Gershman did not
         verify twelve months of housing payments and failed to explain the balance brought forward on
         the gas service bill.


         FHA CASE NUMBER: 292-4054430                    DATE OF LOAN CLOSING: 8/3/2001
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $120,582
         UNDERWRITER TYPE: Manual                        HOUSING/DEBT RATIOS: 25.12/43.73
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default after nine payments.

         Inconsistent/Unsupported Assets
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-10 requires lender to
         ensure that the borrower has sufficient funds available to close the loan. Paragraph 2-10K states
         that if the borrower claims assets through the sale of stocks and bonds, actual receipt of funds
         must be verified. Paragraph 2-10A allows for savings and checking account verification by
         obtaining a verification of deposit and the most recent bank statement. Paragraph 3-1F permits
         alternative verification consisting of the two most recent consecutive bank statements showing
         the previous month’s balance. Provided documents are not more than 120 old when the loan
         closes, there is no need to update.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $3,960 and the borrower needed $15,172 to close. According to the settlement
         statement, the borrower only needed $13,553 to close after taking out earnest money, seller paid

         2004-KC-1004                                Page 28


Table of Contents
                                                                                             Appendix C

         expenses, and borrower prepaid expenses. The HUD case binder included documentation of a
         savings account, checking account, savings bonds, gift, and equities account. A 7/28/01
         document reveals that the savings account balance was $4,369 after depositing all savings bonds.
         An 8/2/01 document reveals that the checking account balance was $9,000 after depositing the
         fully documented gift. While a bank statement shows a $2,172 equities account balance, the
         statement is outdated and there is no proof that the borrower ever received the funds. Based on
         the $4,369 savings account balance and $9,000 checking account balance listed on the most
         recent documents located in the file, the borrower had only $13,369 available. Had the correct
         amount been entered on the underwriting worksheet, the borrower’s reserves would have been
         negative and there would not have been sufficient funds to close the loan.
         AUDITEE COMMENTS: The borrower had assets of $13,369 that we verified and he needed
         $13,553 to close. This was a difference of $184. The borrower received a paycheck on the day
         of closing that would have more than covered this difference. Further, the cash investment for
         this loan was substantially more than the statutory investment requirement of $3,960. The
         underwriter made a judgment call to accept the documentation received for the assets for these
         reasons. We respectfully submit that we properly underwrote and approved this borrower.
         OIG EVALUATION OF AUDITEE COMMENTS: While closing occurred on a Friday, a day on which
         the borrower would normally receive a paycheck, Gershman still failed to properly verify and
         document that the borrower had sufficient funds to close.

         Questionable/Derogatory Credit History
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-3 describes the criteria
         for analyzing the borrowers credit, stating that HUD does not arbitrarily require that collection
         accounts be paid off as a condition for loan approval, but does require that court-ordered
         judgments be paid-off before the mortgage loan is eligible for insurance endorsement (An
         exception may be made if the borrower has been making regular and timely payments on the
         judgment and the creditor is willing to subordinate that judgment to the insured mortgage).
         OIG FINDING: A court order indicates that the borrower owed $2984 in retroactive child support
         due 3/30/99; additionally, a 7/30/01 credit report indicates a collection from the Division of
         Child Services with a $442 balance and 4/99 opening date. While it appears that the borrower
         might be paying the collection off slowly in conjunction with his $373 monthly child support
         payments (the amount deducted is approximately $466 monthly), there is no documentation
         showing that the $442 has been paid off or that the Division of Child Services agreed to
         subordinate the judgment.
         AUDITEE COMMENTS: It was noted that a 7/30/01 credit report indicated a collection from the
         Division of Child Services with a $442 balance, and an April 1999 opening date. Although it is
         true that court-ordered judgments be paid off before the mortgage loan is eligible for insurance
         endorsement, it was noted that an exception may be made if the borrower has been making
         regular and timely payments on the judgment, and the creditor is willing to subordinate the
         judgment to the insured mortgage. In the referenced matter, the borrower was making a regular
         and timely payment in excess of his existing monthly child support payment that would have
         satisfied the outstanding $442 balance within a 5-month period. Further, it was not necessary to
         obtain a verification that the Division of Child Services had agreed to subordinate their
         judgment, as their interest by operation of law was subordinate to the insured mortgage on the
         property that was secured by the Deed of Trust. We respectfully submit that the auditors finding
         is not supported.

                                                    Page 29                                  2004-KC-1004


Table of Contents
         Appendix C

         OIG EVALUATION OF AUDITEE COMMENTS: While the borrower’s pay stubs do show a deduction
         for approximately $466 per month, the deduction is to “Acct R,” which could be a retirement
         account based on IRA account documents located in the file. The file does not contain sufficient
         evidence that the borrower has been making regular and timely payments on the collection.

         Inadequate Qualifying Ratios
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-12 requires lenders to
         compute the debt ratio, which should not exceed 41% unless significant compensating factors are
         listed in the remarks section of the underwriting worksheet. According to Paragraph 2-13, if the
         borrower has successfully demonstrated the ability to pay housing expenses equal to or greater
         than the proposed monthly housing expense for the new mortgage, it may be presented as a
         compensating factor.
         OIG FINDING: The underwriting worksheet shows a debt ratio of 43.73% and lists the following
         compensating factors: "score 572; long term empl.; 17 mo. rental history on time; 1st time
         homebuyer." While rental history is an acceptable compensating factor, the 7/30/01 verification
         of rent indicates that the borrower’s rent is currently due/unpaid and shows the rent amount as
         only $775 monthly, an amount not equal to or greater than the new monthly housing expense of
         $954.67. Gershman staff noted in an 4/2/2004 meeting that two additional compensating factors
         could have been listed on the underwriting worksheet: this was not a maximum financing loan
         and the borrowers put $14,000 down.
         AUDITEE COMMENTS: The loan had a [debt] ratio of 43.73%. This loan was for new
         construction and the [debt] ratio guideline was 43%. Importantly, additional compensating
         factors were that the borrower made a large down payment to purchase the property and the child
         support debt used in the ratio was overstated because of the repayment of past due balance as
         noted above. The higher payment we counted in the ratios was reduced by $73.00 per month
         within 5 months of closing. We respectfully submit that this loan was underwritten consistent
         with HUD guidelines.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that this was
         a new construction energy efficient home. HUD Handbook 4155.1, Revision-4, Change-1,
         Paragraph 2-19 allows borrowers to exceed the qualifying ratios by up to two percent (31/43%)
         when purchasing or refinancing an energy-efficient home. Regardless, the loan exceeded the
         qualifying ratio guidelines, and Gershman failed to present adequate compensating factors on the
         underwriting worksheet to support the approval of this loan.


         FHA CASE NUMBER: 292-3998744                      DATE OF LOAN CLOSING: 8/7/2001
         LOAN PURPOSE: Purchase                            INSURED AMOUNT: $49,608
         UNDERWRITER TYPE: Automated                       HOUSING/DEBT RATIOS: 26.00/28.00
         STATUS AS OF 3/31/2004: Terminated (paid in full). First default reported after 12 payments.

         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report requires employment income be supported
         by the most recent year-to-date pay stub documenting one full month’s earnings and a verbal
         confirmation of employment.



         2004-KC-1004                                Page 30


Table of Contents
                                                                                              Appendix C

         OIG FINDING: The Desktop Underwriter Findings Report shows monthly base employment
         income of $1,733. While the verification of employment indicates a $400/week salary based on
         40 hrs/week and $10/hour, both the year-to-date verification of employment income and four
         weeks of paystubs indicate average monthly income of only $1,315. Gershman based the $1,733
         base income on the $400/week salary listed on a verification of employment, even though only
         $1,315 base income was verified through year-to-date income, paystubs, and W-2’s.
         AUDITEE COMMENTS: We used the borrower’s base monthly income of $1,733 as properly
         verified on the employment verification. See Exhibit 2. Further, although the pay stubs and W-
         2’s showed $1,315, the borrower had a part time job with average monthly income of $671 that
         we did not use in qualifying. The borrower also had other income from dividends and capital
         gains as reflected on his 1999 and 2000 tax returns not used to qualify. Had we used the lower
         income of $1,315 per month noted by the auditor, the qualifying ratios would have been
         36%/38% and we would have manually approved the loan as it met fully HUD guidelines for
         approval.
         OIG EVALUATION OF AUDITEE COMMENTS: Condition #8 of the Desktop Underwriter Findings
         Report required income be supported by the most recent year-to-date pay stub documenting one
         full month’s earnings. As previously noted, the pay stubs provided did not support the income
         used to qualify. Additionally, information regarding secondary income referenced was not
         submitted to Desktop Underwriter, as the file did not contain adequate documentation to support
         the income. Last, the interest and dividends referenced are from an Edward Jones account,
         which was not adequately verified. The tax returns included do not evidence the account
         balance, the availability of the funds, or the likelihood of continued dividend income and capital
         gains. Furthermore, Gershman notes that had they only counted $1,315 monthly income, they
         would have manually underwritten this loan. However, and significantly, Gershman did not
         manually underwrite this loan; instead Gershman submitted the loan to Desktop Underwriter and
         failed to satisfy the condition listed on the Findings Report.

         Inconsistent/Unsupported Assets
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $1,500 and the borrower needed $3,583 to close. According to the settlement
         statement, the borrower only needed $1,228 to close after taking out gift funds and borrower
         prepaid expenses. According to the Desktop Underwriter Findings Report, the borrower’s assets
         consisted of savings and checking accounts with respective balances of $676 and $6,286.
         However statements located in the Gershman case file show three unidentified deposits totaling
         $7,612 between 4/30/01 and 5/21/01, each in excess of two percent of the sales price. Without
         these deposits, there would not have been sufficient funds available to close the loan.
         AUDITEE COMMENTS: It was the underwriter’s judgment as permitted under the [Direct
         Endorsement] program, to accept the documentation regarding the verification of source of
         funds. The original loan application listed an account with Edward Jones at a value of $6,500.
         There is proper verification that the borrower had these funds because there were dividends and
         capital gains shown on his 1999 and 2000 tax returns. The bank statements also showed auto
         debit from his account to Edward Jones. The Desktop Underwriter Findings Report only
         required the most recent bank statement. There was no condition for verification of large
         deposits. We respectfully submit that this finding is not supported and that we properly verified
         the borrower’s assets to close.

                                                    Page 31                                   2004-KC-1004


Table of Contents
         Appendix C

         OIG EVALUATION OF AUDITEE COMMENTS: Although the large deposits were not adequately
         verified, we concur with Gershman’s assertion that the Desktop Underwriter Findings Report did
         not contain a condition for verification of large deposits. We have removed this deficiency from
         Finding 1 and adjusted Appendix B.

         Inconsistent/Underreported Liabilities
         CRITERIA: According to HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-11C, if a
         debt payment, such as a student loan, is scheduled to begin within twelve months of the
         mortgage loan closing, the lender must include the anticipated monthly obligation in the
         underwriting analysis unless the borrower can provide evidence that the debt may be deferred to
         a period outside this timeframe.
         OIG FINDING: According to the borrower’s credit report, a $16,768 student loan was in
         deferment status as of May 2001. However, Gershman did not verify the likelihood of continued
         deferment status. According to www.ed.gov, borrowers have a six-month grace period once they
         are no longer in deferment status. Using the graduated repayment plan and the current interest
         rate (which would probably project lower payment amounts than the borrower’s rate), the
         borrower would owe $83 per month if in repayment status.
         AUDITEE COMMENTS: The loan was underwritten using Desktop Underwriter. The credit report
         showed the student loan not in repayment. See Exhibit 3. The Desktop Underwriter Findings
         Report did not require any conditions regarding this student loan. Further, had we counted the
         $83 per month as a debt the ratios would have been 36%/44% using the lower income noted by
         the auditor. Significantly, the compensating factors to approve this loan would have been cash
         reserves in excess of 12 months mortgage payments and income not used to qualify as noted
         above. Based on these compensating factors, we would have manually approved this loan as it
         met fully HUD guidelines for approval. We respectfully submit that this finding is not
         supported.
         OIG EVALUATION OF AUDITEE COMMENTS: According to Section VI of the Desktop Underwriter
         Government Underwriting Service User’s Guide for FHA Loans, if the borrower has a liability
         that is exempt from qualifying based on FHA guidelines, the debt may be omitted provided the
         loan file contains documentation to support the omission based on FHA guidelines. Gershman
         failed to include the documentation required by HUD/FHA guidelines. Furthermore, Gershman
         notes that had the debt been included, they would have manually underwritten this loan and
         documented compensating factors. However, and significantly, Gershman did not manually
         underwrite this loan; instead Gershman submitted the loan to Desktop Underwriter and failed to
         follow the automated system’s guidelines.


         FHA CASE NUMBER: 292-4064761                   DATE OF LOAN CLOSING: 8/23/2001
         LOAN PURPOSE: Purchase                         INSURED AMOUNT: $71,379
         UNDERWRITER TYPE: Automated                    HOUSING/DEBT RATIOS: 15.58/45.09
         STATUS AS OF 3/31/2004: Reinstated by Mortgagor. First default Reported after 11 payments.

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Findings Report required depository assets be verified
         using the most recent monthly or quarterly bank statement.

         2004-KC-1004                               Page 32


Table of Contents
                                                                                                  Appendix C

         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $2,175 and the borrower needed $2,176 to close. According to the settlement
         statement, the borrower only needed $1,452 to close after taking out earnest money, seller paid
         expenses, and borrower prepaid expenses. The Desktop Underwriter Findings Report includes a
         checking account with a $390 balance and lists $390 cash reserves. A checking account
         printout, which does not have the depository name on it, shows a 7/5/01 ending balance of $358.
         While an 8/14/01 verification of deposit lists a $390 average account balance, it also lists a $0
         current balance. It is unclear whether Desktop Underwriter would have approved the loan
         without the $390 checking account, as there would not have been cash reserves and the debt ratio
         was already above the 41% benchmark .
         AUDITEE COMMENTS: The Borrower’s needed $1,451 to close this transaction as needed on the
         [settlement statement]. There was documentation in the file evidencing that their uncle gave
         them a gift for $2,175. See Exhibit 4. The gift funds were given to the title company at closing.
         Since the amount needed was only $1,451, the difference of $724 was given to the borrowers.
         Our underwriter analyzed the bank verifications and it was evident that the average balance of
         $390 was reasonable for cash reserves. The underwriter determined that the amount of gift in
         excess of the funds needed to close was more than the $390 used for cash reserves. Therefore,
         this supported the Underwriter Findings.
         OIG EVALUATION OF AUDITEE COMMENTS: According to the settlement statement, the borrower
         needed $1,451.88 to close. While Gershman is correct that the borrower received a $2,175 gift,
         which covered closing costs, they were still required to accurately submit the checking account
         balance. Gershman agrees that the average balance was submitted rather than the current
         available balance.

         Inconsistent/Underreported Liabilities
         CRITERIA: According to HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-11A, the
         borrower's liabilities include all installment loans, revolving charge accounts, real estate loans,
         alimony, child support, and all other continuing obligations. Paragraph 2-11A states that
         monthly payments on revolving accounts must be calculated at the greater of five percent of the
         balance or $10.
         OIG FINDING: While the 8/20/01 credit report lists an account with a $60 balance and $10
         monthly payments, an 8/3/01 borrower letter located in the Gershman case binder reveals a
         recent $1,300 increase in the account balance. This balance increase was not disclosed on the
         Desktop Underwriter Findings Report and would have increased the debt ratio from 45.09% to
         46.65%. It is unclear whether Desktop Underwriter would have approved the loan as the debt
         ratio was already above the benchmark 41% and the additional debt may have caused the loan to
         exceed DU’s internal risk threshold.
         AUDITEE COMMENTS: Our credit report was run after the 8/3/01 letter from the borrower. The
         credit report showed Dillard’s verified in July, and there was no indication of such a charge. The
         borrower’s letter indicated that the Dillard’s balance would be higher due to the purchase of
         airline tickets for $1,300. The letter also stated that this would be paid off using their tax refund.
         The letter further stated that the borrower had received an in-school deferment and was not
         paying his student loans since he was back in school full time. The student loan payments were
         counted as debts with monthly payments of $246. Consistent with HUD guidelines that provide
         the underwriter with discretion, the underwriter made the judgment call that a Dillard’s payment
         of $10 counted in the ratios and the student loan payment of $246, there was no reason to count

                                                      Page 33                                    2004-KC-1004


Table of Contents
         Appendix C

         any additional payment for the airline tickets. The student loan deferral payments and the tax
         refund offset this and did not require any additional documentation. The Underwriter Findings
         would not have changed.
         OIG EVALUATION OF AUDITEE COMMENTS: Because the 8/3/01 borrower letter indicated that the
         $1,300 Dillard’s charge was recent, Gershman should have expected that the July verification
         would not include the charge. Additionally, HUD Handbook 4155.1, Revision-4, Change-1,
         Paragraph 2-11C required Gershman to include the student loan payment unless they obtained
         evidence from the borrower that the payments would not begin within twelve months of the
         mortgage loan closing. As previously noted, the $1,300 balance increase would have increased
         the debt ratio to at least 46.65% and should have been included in the submission to Desktop
         Underwriter.


         FHA CASE NUMBER: 292-4058693                     DATE OF LOAN CLOSING: 8/30/2001
         LOAN PURPOSE: Purchase                           INSURED AMOUNT: $89,195
         UNDERWRITER TYPE: Manual                         HOUSING/DEBT RATIOS: 8.58/54.96
         STATUS AS OF 3/31/2004: Delinquent. First default reported after 20 payments.

         Questionable/Derogatory Credit History
         CRITERIA: According to HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-5, if a
         borrower is presently delinquent on any Federal debt (e.g., Federal student loan), the borrower is
         not eligible until the delinquent account is brought current, paid or otherwise satisfied, or a
         satisfactory repayment plan is made between the borrower and the Federal agency owed and is
         verified in writing. Additionally, according to Paragraph 2-3A, the payment history of the
         borrower’s housing obligations is of significant importance in evaluating credit. Lenders must
         determine the borrower’s payment history of the housing obligations for the most recent 12-
         month period.
         OIG FINDING: While all borrower debts shown on the credit report and application are
         consistently documented, there are not sufficient explanations for the 1999, 2000, or 2001 late
         payments or for the amount past due shown on the 7/8/01 student loan billing statement (note
         that four of these delinquencies were during the borrower's current employment). Also, the
         borrower’s rental history is questionable. The borrower application indicates that the borrower
         has rented 1044 Provence Drive for 2.5 years ($430/month). While the 3/21/01 verification of
         rent indicates that the borrower rented from 10/8/98-7/31/01 for $430/month, the ending rent
         date is four months after the date on the verification of rent.
         AUDITEE COMMENTS: The underwriter used the credit letters dated 3/20/01 and 7/13/01 for
         sufficient explanation of the 1999 thru 2001 late payments. These letters explained that gaps in
         the borrower’s employment caused the late payments. The gaps in employment were evidenced
         by the various employment verifications in the loan file. The auditor also stated that four of the
         delinquencies occurred while the borrower was employed. But, clearly the lingering effects of
         previous gaps in employment were relevant to the delinquencies.
         While there was no explanation for the past due amount shown on the 7/8/01 student loan billing
         statement, it is clearly reflected that payments were being made and accepted monthly. This was
         further supported by the credit report. The underwriter accepted the credit letter regarding
         employment history as sufficient explanation for the late payments on the student loans. In

         2004-KC-1004                               Page 34


Table of Contents
                                                                                                  Appendix C

         addition, the credit report stated that the student loan accounts had been transferred. It has been
         our experience that when accounts are transferred, there are frequently errors and/or issues with
         the payment posting.
         The original loan application was taken 3/14/01. The rent verification dated 3/21/01 showed the
         borrower had rented since 10/8/98, which was 2.5 years. See Exhibit 5. The verification was
         completed showing the full term of the lease that ended 7/31/01. The auditor stated this is an
         issue, but rent verifications are often completed in this manner. In addition to the rent
         verification being dated 3/21/01, it was faxed to our office on the same date. The verification
         indicated that the rent was current and had been paid as agreed. The underwriter determined to
         weight the rental history more heavily than the credit card payments.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         lingering effects of previous gaps in employment were relevant to the later delinquencies.
         However, while Gershman’s comments adequately address the late payments on the borrower’s
         student loan, they do not address the amount shown as past due. Additionally, while Gershman’s
         asserts that the 3/21/01 rent verification is sufficient, it dated more than 120 days prior to closing
         and is not sufficient according to HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 3-1.

         Inadequate Qualifying Ratios
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-12 requires lenders to
         compute the debt ratio, which should not exceed 41% unless significant compensating factors are
         listed in the remarks section of the underwriting worksheet. Paragraph 2-13 notes that when the
         borrower receives compensation or income not reflected in effective income, but directly
         affecting the ability to pay the mortgage, it can be used as a compensating factor. However,
         according to Paragraph 2-7D, individuals whose commission income shows a decrease from one
         year to the next require significant compensating factors to allow for loan approval.
         Additionally, unless adequate documentation to exclude the debt is obtained, Paragraph 2-11B
         requires contingent liabilities such as mortgage debts be included in qualifying ratios.
         OIG FINDING:        According to the underwriting worksheet, the debt ratio is 54.96%
         (4834.37/8795). Compensating factors listed include “income from only 1 co-signor used; gross
         from 1099 $7409 per mo 24 mo avg.; $825 mtg. pd by daughter = 37% ratio." The co-signor
         income not used to qualify is commission and bonus income from real estate sales; however, the
         monthly commission income had declined over $2,500 in the past year. Additionally, the only
         documentation found to support the claim that the co-signor’s $825 monthly mortgage payment
         is paid by their daughter are four months worth of cancelled checks averaging only $420/month,
         which would have only decreased the debt ratio to 50.19%.
         AUDITEE COMMENTS: The auditor indicated that the income of the co-signor not used to qualify
         had declined by $2,500 in the past year. This income not used to qualify was from real estate
         sales commissions and was not a significant decline. Importantly this income was used only as a
         compensating factor. The amount of her income using a 24-month average was $7,409 per
         month. Had we used this income, the [debt] ratio would have been well within the HUD
         guidelines and no compensating factors would have been required.
         The other factor was that the co-signors had a mortgage obligation with their daughter where the
         daughter was paying either all or part of the payment. There was evidence in the file that she
         was making payments to them for this debt. We were unable to verify consistent payment from
         the daughter and therefore, we counted the entire debt and used this as a compensating factor.


                                                      Page 35                                    2004-KC-1004


Table of Contents
         Appendix C

         Not counting this mortgage debt would have made the [debt] ratio within HUD guidelines. We
         respectfully submit that this finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman stated that the co-signor’s commission
         income had declined by $2,500 in the past year when in fact it had declined $2,500 monthly to
         $5,755. Because HUD regulation requires significant compensating factors when commission
         income is included that shows a decrease from one year to the next, the commission income
         would not qualify as a significant compensating factor itself. As noted by Gershman, there was
         not sufficient evidence to show that the co-signor’s daughter was paying one of the mortgage
         debts. The documentation provided by Gershman to show that the daughter pays the debt does
         not support a significant decrease in the debt ratio.

         Inconsistent/Questionable Documentation
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-2A says that neither a
         co-borrower nor a cosigner may be a party that has an interest in the transaction, such as the real
         estate agent. Exceptions may be granted if the seller and co-borrower/cosigner is a family
         member of the occupant owner. Furthermore, Paragraph 1-7b states that inducements to
         purchase result in a dollar-for-dollar reduction to the sales price before applying the appropriate
         Loan-to-Value ratio.
         OIG FINDING: According to documentation located in the Gershman file, there are two co-
         signors on this loan. While Gershman claims that the non-occupying co-signers were the
         borrowers’ parents, there was no documentation in the file to support a family relationship.
         However, documentation in the file indicates that the borrower may have rented from the co-
         signors in the past. Additionally, the sales contract lists one of the co-signers as a selling agent
         acting on behalf of the buyer/borrower, and the settlement statement shows a $2,386.80
         commission to the agent’s firm that could be construed as an inducement to purchase or cosign.
         AUDITEE COMMENTS: We respectfully submit that the auditor’s finding is incorrect. The loan
         file contained evidence that the co-signors were the borrower’s mother and stepfather. There
         was [pre-approval] mortgage application completed by the Gershman loan officer stating that the
         [borrower] is the [co-signor’s] son. See Exhibit 6.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the pre-
         approval document notes that the borrower is the co-signor’s son. However, this document is
         not dated or signed and is not evidence that the co-signor, who had an interest in the transaction,
         was a family member of the owner occupant.


         FHA CASE NUMBER: 292-4057783                     DATE OF LOAN CLOSING: 8/31/2001
         LOAN PURPOSE: Purchase                           INSURED AMOUNT: $143,396
         UNDERWRITER TYPE: Manual                         HOUSING/DEBT RATIOS: 18.98/20.73
         STATUS AS OF 3/31/2004: Delinquent. First default reported after five payments. Borrower declared
         bankruptcy on 7/12/2002.

         Inconsistent/Unsupported Assets
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $4,347 and the borrower needed $7,238 to close. According to the settlement

         2004-KC-1004                                Page 36


Table of Contents
                                                                                                  Appendix C

         statement, the borrower only needed $5,273 to close after taking out earnest money and borrower
         prepaid expenses. According to the application and underwriting worksheet, the borrowers’
         available assets consisted of a checking account ($9), savings account ($25), and proceeds from
         the sale of their prior residence ($15,998). However, the bank statement used to support the
         savings account balance was outdated, and the 8/8/01 printout used to support the checking
         account balance shows a $150 transfer from the savings account. Additionally, the settlement
         statement included to support the proceeds from the sale of the borrower’s prior residence was
         not signed by the purchaser and was dated three months prior to closing. There is no
         documentation that the proceeds were still available when the loan was underwritten and closed.
         AUDITEE COMMENTS: HUD guidelines state that a fully executed [settlement statement] must be
         provided as evidence of the cash sales proceeds accruing to the borrower. Our file contained a
         fully executed seller’s [settlement statement]. The guidelines also state that documents may be
         up to 120 days old at the time the loan closes. The [settlement statement] in our file was dated
         6/1/01 and this loan closed on 8/31/01. There was no reason for us to question that the proceeds
         were still available at the time of closing. We respectfully submit that this finding is not
         supported.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that they
         were not required to question the proceeds as the settlement statement was dated within 120 days
         of closing. While the checking and savings accounts were not eligible to be counted as available
         assets for qualifying purposes due to the $150 transfer, the amount ($34) is negligible. We have
         removed this deficiency from Finding 1 and adjusted Appendix B.

         Questionable/Derogatory Credit History
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-3 describes the criteria for
         analyzing the borrowers credit, stating that if the credit history, despite adequate income to support
         obligations, reflects continuous slow payments, judgments, and delinquent accounts, strong
         offsetting factors will be necessary to approve the loan…A period of financial difficulty in the past
         does not necessarily make the risk unacceptable if a good record has been maintained since.
         Furthermore, Paragraph 2-3A notes, the payment history of the borrower's housing obligations is of
         significant importance in evaluating credit and requires lenders to determine the borrower's payment
         history of the housing obligations for the most recent 12-month period.
         OIG FINDING: According to the 5/10/01 credit report, the borrower and co-borrower average
         credit scores are 507 and 553 respectively. The borrowers filed Chapter 13 Bankruptcy in 1995,
         and were discharged in February 2001. Since the bankruptcy, the borrowers’ have had late
         payments as recent as February 2001, charge offs as recent as October 2000, account settlements,
         and collections. Also, the credit report shows that the borrowers' current mortgage was $1,556
         past due. No offsetting factors were presented on the underwriting worksheet.
         AUDITEE COMMENTS: The underwriter reviewed the borrower’s credit and the credit explanation
         letter and made the underwriting decision to approve the loan. The Chapter 13 Bankruptcy was
         filed in December 1995. The borrowers explained that this was due to two business ventures
         that failed. The late payments after the bankruptcy were explained and some of the accounts
         were disputed by the borrowers. Further, the credit report showed accounts paid as agreed and
         the borrowers had re-established credit.
         The borrower had been employed on his job for 16 years. The qualifying ratios were strong at
         19% and 21%. The borrowers had worked diligently to pay off past credit accounts as evidenced
         by the repayment of the Chapter 13 Bankruptcy (as opposed to Chapter 7). At the time of

                                                      Page 37                                    2004-KC-1004


Table of Contents
         Appendix C

         application, the borrowers had minimal amount of outstanding credit. The borrowers were
         previous homeowners and had cash reserves of $9,837 after closing, therefore, the underwriter
         made the judgment call to approve this loan. HUD guidelines authorize the underwriter to judge
         the overall merits of the loan and determine what compensating factors apply in approving a
         loan.
         According to the credit report dated 5/10/01, there were two payments due on the Countrywide
         Mortgage. The credit report showed there were no late payments since 1997 and the underwriter
         assumed that the borrower did not make payments while the house was under contract for sale.
         The sales contract for this sale was dated 3/28/01 and the [settlement statement] verified that this
         loan was paid off 6/1/01, which was 3 months prior to closing. We respectfully submit that the
         auditors finding is without basis.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         previous mortgage was paid off approximately three months prior to closing. However, we
         disagree with Gershman’s assertion that the borrower had adequately re-established credit.
         Since filing bankruptcy in 1995, the borrowers have opened seven lines of credit. Five of these
         accounts have prior adverse ratings; additionally, one of the five was closed by the credit
         grantor, one was closed by the borrowers, two were settled, and one resulted in a charge off
         which the borrower claims was paid in full. The remaining two accounts, opened in 11/00 and
         4/01, are in good standing. Since filing for bankruptcy, the borrowers have had a $1,145 charge
         off on an old account, which they dispute, and three collections totaling less than $200. The only
         other account listed on the credit report with activity since the bankruptcy is an overdraft
         protection account. Based on this analysis, we do not believe that Gershman demonstrated that
         the borrower adequately re-established credit.


         FHA CASE NUMBER: 292-4067535                    DATE OF LOAN CLOSING: 9/13/2001
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $60,181
         UNDERWRITER TYPE: Automated                     HOUSING/DEBT RATIOS: 20.26/32.23
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after two payments.

         Inconsistent/Unsupported Income
         CRITERIA: According to the Desktop Underwriter Findings Report, employment income must be
         supported by recent pay stubs documenting one full month's earnings and a written, verbal, or
         electronic verification of employment acceptable to FHA. Also, unless the current employer
         confirms two-year employment, the lender must obtain either W-2(s), verifications of
         employment, direct IRS income verification, or electronic verification for the most recent two
         years.
         OIG FINDING: While the monthly income used to qualify can be derived from verifications of
         employment, the total decreases by nearly $500 when computed from year-to-date borrower and
         co-borrower earnings. Because the borrowers’ current employers did not confirm a two-year
         history, Gershman was required to obtain W-2’s or verification(s) of employment for current and
         previous employers covering the last two years. However, they did not obtain documents
         covering the full two years and did not explain why several notes in the Gershman case file listed
         additional unverified employers for the borrowers. Additionally, they did not explain a three-
         month gap in borrower employment or the additional paystubs located in the Gershman case file

         2004-KC-1004                                Page 38


Table of Contents
                                                                                             Appendix C

         that indicate the borrower possibly changed jobs just a month before closing. Gershman did not
         satisfy all conditions listed on the Desktop Underwriter Findings Report and did not adequately
         verify the stability of employment.
         AUDITEE COMMENTS: We respectfully submit that in reference to the verification of
         employment, the original loan application dated 8/13/01 showed the borrower’s employment
         history back to 5/99, which is more than the required two-year period. There were tax returns in
         the file obtained from the borrower and directly from the IRS to show income for this borrower
         for 1999 and 2000. The tax form for 2000 was discarded inadvertently. The borrows originally
         applied for a First Time Homebuyer loan through Missouri Housing and Development
         Commission that required the most recent three years of tax returns. Importantly, this would
         have included the 2000 tax return. The loan did not close using this First Time Homebuyer
         program. The tax return may have been discarded inadvertently.
         According to the original loan application, there was not a gap in employment nor did the
         borrower change jobs before closing. The additional pay stubs in the file were from a part-time
         job that was also listed on the original loan application. There were two pay stubs in the file
         from [Employer B] showing the borrower worked 24 hours a week at $22.61 per hour. This
         income was not used to qualify. We respectfully submit that the borrower’s income was
         properly determined.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertions that an
         8/13/01 application showed the borrower’s employment history back to 5/99. However, the file
         did not contain the required documents covering the two-year period.
         We concur with Gershman’s assertion that the additional borrower pay stubs were from a job
         listed on the original loan application. While a month worth of 24 hour week, $22.61 per hour
         pay stubs would more than cover the $500 overstatement in earnings shown above, the
         application shows only $260 monthly income from this position. Additionally, we note that
         because Gershman did not properly verify this income, it could not be used for qualifying
         purposes.

         Inconsistent/Unsupported Assets
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $1,860 and the borrower needed $5,480 to close. According to the settlement
         statement, the borrower did not need any funds to close after taking out secondary financing,
         earnest money, and borrower prepaid expenses. According to the 9/12/01 Desktop Underwriter
         Findings Report, the borrower’s assets and reserves consisted of three bank accounts, totaling
         $1,797. The bank statements for these accounts reveal that one of the accounts started with a
         negative balance while the other two started with a zero balance. Bank statements covering
         5/16/01-6/26/01 and 5/16/01-7/24/01 reveal six unidentified deposits, including two deposits for
         $2,681 and $1,000. Without the two unexplained deposits, the borrower would have had
         negative account balances and no reserves.
         AUDITEE COMMENTS: We respectfully submit that the borrower’s assets were supported. In a
         letter dated 5/14/01, the co-borrower received a notice from the IRS about her 2000 tax return
         being amended, and changing her tax refund to 3,881. On 5/16/01, the co-borrower deposited a
         total of $3,681 in two separate accounts. $2,681 was deposited into a new checking account.
         And $1,000 was deposited into a new savings account. Also, the loan application stated that the


                                                   Page 39                                  2004-KC-1004


Table of Contents
         Appendix C

         co-borrower received child support that was not used to qualify. This would account for the
         other unidentified deposits into their bank account.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         $3,881 tax refund is evidence of funds for the two deposits totaling $3,681. We removed this
         deficiency from Finding 1 and adjusted Appendix B.


         FHA CASE NUMBER: 292-4076810                    DATE OF LOAN CLOSING: 9/19/2001
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $84,333
         UNDERWRITER TYPE: Manual                        HOUSING/DEBT RATIOS: 10.92/17.92
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after 19 payments.

         Inconsistent/Unsupported Income
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Chapter 2 requires that the lender
         establish the borrower's capacity to repay the mortgage debt. Income from a source that cannot
         be verified, is not stable, or will not continue should not be used when calculating the borrower's
         qualifying ratios. Paragraph 2-7A requires lenders to develop a two-year average of bonus or
         overtime income, and indicates that if the earnings trend indicates a continual decline, the lender
         must provide a sound rationalization for including the income of the borrower qualifying.
         OIG FINDING: According to the underwriting worksheet and application, the borrower’s
         monthly overtime income is $687. However, while the verification of employment indicates that
         overtime is likely to continue, it also indicates an average of only 40 hours per week and average
         monthly overtime income of $1,067 in 1999, $648 in 2000, and only $158 for 2001. The two-
         year average monthly overtime income is only approximately $560 and there is no explanation in
         the file for the continual decline.
         AUDITEE COMMENTS: The underwriter made a decision consistent with the discretion permitted
         under the [Direct Endorsement] program to use the overtime of $687 per month. This was based
         on the fact that the difference in overtime from 1999 to 2000 was only $530. This was not a
         significant difference to concern the underwriter. The year to date overtime was used in the
         average even though the monthly average was less than the last 2 years. The underwriter was
         not able to determine when the borrower worked the overtime hours during the year and the last
         2 full years were the best indication of the overtime worked. In addition to this, the [debt] ratio
         would have only increased to 20% if no overtime was used for the borrower’s qualifying income.
         We respectfully submit that the borrower’s income was properly determined.
         OIG EVALUATION OF AUDITEE COMMENTS: According to the 8/28/01 verification of
         employment, while the difference in total income between 1999 and 2000 was only $537, the
         difference in overtime income between the two years was $5,032. An October 1999 raise in base
         pay made up for the decreased overtime in 2000. Regardless of the qualifying ratios, Gershman
         failed to properly verify the overtime income according to HUD guidelines as required by
         Desktop Underwriter.

         Questionable/Derogatory Credit History
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-3 describes the criteria
         for analyzing the borrowers credit, stating that past credit performance serves as the most useful
         guide in determining the attitude toward credit obligations that will govern the borrower’s future

         2004-KC-1004                                Page 40


Table of Contents
                                                                                                Appendix C

         actions...if the credit history, despite adequate income to support obligations, reflects continuous
         slow payments, judgments, and delinquent accounts, strong offsetting factors will be necessary
         to approve the loan. Furthermore, while minor derogatory information occurring two or more
         years in the past does not require explanation, major indications of derogatory credit, including
         judgments and collections, and any other recent credit problems, require sufficient written
         explanation from the borrower. The borrower’s explanation must make sense and be consistent
         with other credit information in the file.
         OIG FINDING: While the borrowers filed Chapter 13 bankruptcy in 1998, they have completed
         their payout period and were discharged in March 2001. Their reasons for filing bankruptcy
         include loss of employment, unexpected legal costs and co-signing problems with a child,
         maintenance on a prior residence, and problems with a car they could not afford. They also
         noted that they now make more money than they ever have. However, the credit report shows
         that since filing for bankruptcy, the borrowers have only opened five accounts. While one of the
         accounts was in good standing, three have gone into collection, and the fifth has reported 30, 60,
         and 90-day late payments as recent as April 2001. While a borrower note indicates that the last
         account has been settled, the credit report indicates that its balance is still more than $850 over
         the credit limit.
         AUDITEE COMMENTS: The underwriter reviewed the five accounts noted above and made an
         underwriting judgment call to approve this loan based on other positive factors. The borrower
         filed Chapter 13 Bankruptcy in 1999, which they successfully completed and was discharged in
         3/01. The credit letter adequately explained the reasons for the bankruptcy. The underwriter
         considered the fact that the borrower filed a Chapter 13 bankruptcy and had repaid over $21,000
         of debt to be a strong positive factor. Two of the accounts noted above by the auditor were for
         telephone service and were minimal amounts. A third account was for a credit card and
         sufficient explanation was provided by the borrower.
         In addition, the underwriter considered the rent and auto loan, which were paid as agreed as
         evidence that the borrower had re-established credit. The borrower’s rent verification indicated
         that the rent had been paid as agreed for 5 years with the current rent payment of $645. The new
         mortgage payment was $741. This was less than a 15% increase in housing expense. HUD
         guidelines permit the underwriter to judge the overall merits of the loan application and to
         determine what compensating factors apply. We respectfully submit that we made the
         appropriate underwriting decision regarding this loan.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         borrower had completed Chapter 13 Bankruptcy (paying approximately $140 weekly) and was
         properly making rental payments over the past 5 years. The borrowers have since opened an
         auto loan account. This increase in monthly debt combined with the increased monthly housing
         expense raise the borrower’s monthly payments by $538, an amount approximately equal to
         what the borrower had been paying on the Chapter 13 Bankruptcy. Additionally, while it is true
         that two of the three recent collections are small amounts and that the borrower provided an
         explanation for the credit card account, these instances are still significant as they represent the
         borrower’s credit activities since filing for bankruptcy. Gershman failed to present adequate
         compensating factors to support the approval of this loan.


         FHA CASE NUMBER: 292-4076992                       DATE OF LOAN CLOSING: 9/22/2001

                                                     Page 41                                   2004-KC-1004


Table of Contents
         Appendix C

         LOAN PURPOSE: Non-Streamline Refinance                 INSURED AMOUNT: $91,603
         UNDERWRITER TYPE: Automated                            HOUSING/DEBT RATIOS: 28.80/55.62
         STATUS AS OF 3/31/2004: Property conveyed to Insurer. HUD incurred a loss of $22,495 on the sale
         of the subject property. First default reported after six payments.

         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report requires all overtime and bonus income be
         verified and documented according to current FHA standards. HUD Handbook 4155.1,
         Revision-4, Change-1, Paragraph 2-7A requires lenders to develop a two year average of bonus
         or overtime income, and indicates that if the earnings trend indicates a continual decline, the
         lender must provide a sound rationalization for including the income of the borrower qualifying.
         OIG FINDING: According to the Desktop Underwriter Findings Report, the borrower’s $2,778
         gross monthly income included $438 overtime/bonus income. This amount was computed using
         a 20.4-month average with figures from the verification of employment; however, a 24-month
         average from the verification of employment indicates only $408 monthly overtime/bonus
         income. Further, a note in the file indicates a 19-month total monthly income average of $2,647
         including overtime. Gershman failed to document overtime income according to current FHA
         standards as required by Desktop Underwriter. Additionally, because the debt ratio already
         exceeded 41%, it is unclear if Desktop Underwriter would have approved the loan had the
         correct amount been entered.
         AUDITEE COMMENTS: We underwrote the loan as follows; we used the monthly base income as
         stated on the employment verification that was $2,340. See Exhibit 7. We also used other
         earnings consisting of overtime and bonus averaged over a 20.4 month period. The employment
         verification dated 9/12/01 had year-to-date overtime and bonus of $3,637 and overtime and
         bonus for 2000 was $5,292. This total of $8,929 averaged over 20.4 months equates to $438 per
         month which when added to the base pay totaled the monthly income used of
         $2,778. The employment verification stated that the year-to-date earnings are through 8/31/01.
         Therefore, we could have used a 20-month average of the overtime and bonus for $448 per
         month. However, we used a conservative approach and chose to use the lower amount
         calculated above.
         We compared our calculation above to the OIG auditor’s calculation to determine why there is a
         variance. We broke the auditor’s calculation into two parts, overtime and bonus. The OIG
         auditor calculated the overtime by taking overtime of $1,397 for 1999, $3,642 for 2000, and
         $1904 for year-to-date, for a total of $6,943, divided over 26 months equaled $267 per month.
         Our underwriter made the decision to use a period less than 24 months since the borrower started
         in June 1999 and we had no way of knowing when she started working overtime hours. The
         overtime used by our underwriter was a mere $5 more per month than that amount used by the
         OIG auditor.
         The primary difference in our income calculation as compared to the OIG auditor’s was bonus
         income. The Auditor calculated the bonus income using a 24-month average of the 2000 bonus
         income, and the year-to-date bonus as reflected on the employment verification for an average of
         $141. We respectfully submit that this is not accurate, because the employment verification,
         while dated 9/12/01, contained information that was valid through 8/31/01, and therefore, the
         auditor should have used a 20-month average which would have been $169. Our underwriter
         used the $165 per month, which is less than the average based on the verification. We were
         justified in using a less than 24-month average, because the file contained 2 pay stubs where the

         2004-KC-1004                               Page 42


Table of Contents
                                                                                              Appendix C

         borrower’s bonus income had increased from one month to the next. See Exhibit 8. The OIG
         Auditor’s use of a 24-month average assumes that the borrower had received all bonus income as
         of 8/31/01. There is no basis for this assumption. We respectfully submit that this finding is not
         supported and the borrower’s income was properly calculated.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman incorrectly stated the method used to
         arrive at the $408 OIG calculation for overtime/bonus income. The verification of employment
         shows total bonus/overtime of $3,639 in 2001 (year-to-date for eight months), $5,292 in 2000
         (for twelve months), and $1,397 in 1999 (for 6.5 months). Because we only needed to count the
         last four months of 1999 to arrive at the 24-month average, we only counted $860. Thus, the
         total overtime/bonus income earned in the 24-month period was $9,791, an average of $408 per
         month.
         Gershman did not take a conservative approach. To support this assertion, we call attention to
         the note located in the Gershman file, which indicates a 19-month total monthly income of
         $2,647. This is lower than the $2,778 used by Gershman when submitting the loan to Desktop
         Underwriter.
         This is significant because the 54.08 debt ratio submitted to Desktop Underwriter (based on
         $1,502 total expense payments) was already lower than the 55.62 debt ratio listed on the
         underwriting worksheet (based on $1,545 monthly expense payments). This ratio already
         exceeded 41% and Desktop Underwriter may not have approved the loan had either the
         increased monthly payments ($1,545) or decreased overtime/bonus income ($408) been used.
         With both of these factors taken into consideration, the ratio jumps to 56.22%. Gershman
         violated HUD regulation by using a shorter average in order to increase the overtime/bonus
         income, thus decreasing the debt ratio.

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Findings Report requires depository assets be verified by
         either a verification of deposit, the most recent statement showing the previous month’s balance,
         or the most recent two months statements. Also, cash reserves must be verified.
         OIG FINDING: According to the settlement statement, the borrower did not need funds to close
         and instead received $8,569 at closing. According to the Desktop Underwriter Findings Report,
         the borrower’s assets included a retirement account ($4,187) and a checking account ($768).
         While a 6/30/01 retirement account statement supports the balance used, the statement was
         incomplete as only three of the five pages were included in the case binders. While a 6/15/01-
         7/20/01 statement supports the checking account balance, it shows over $4,000 in unidentified
         deposits. Gershman failed to adequately verify assets used to qualify and cash reserves. In a
         4/27/04 meeting, Gershman noted that this was a refinance and that the assets were not needed
         for the investment. However, because the assets were included on the Desktop Underwriter
         Findings Report as cash reserves, they were required to be adequately verified.
         AUDITEE COMMENTS: The auditor noted that the retirement bank account statement only
         contained 3 of 5 pages. However, and significantly, the 3 pages of the retirement account
         statement contained all the specific information that was required for underwriting purposes.
         Regarding the bank statement, the auditor indicated that the checking account bank statement
         showed over $4,000 in unidentified deposits. This account was a joint bank account belonging
         to the borrower and her husband, who was not on the loan. The deposits were obviously for his
         payroll deposits on a weekly basis. In addition, the [Desktop Underwriter Findings Report] did
         not contain any condition requiring us to verify large deposits. Significantly, our file also

                                                    Page 43                                   2004-KC-1004


Table of Contents
         Appendix C

         contained a prior months’ bank statement that showed a balance of $1,978 with similar deposits
         for the month. See Exhibit 9. Therefore, we adequately verified assets used to qualify and cash
         reserves. Gershman respectfully submits that this finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman’s claim that the incomplete retirement
         account statement contained all necessary information cannot be substantiated, as it is unclear if
         the additional pages would disclose important information such as loans. Additionally, while
         five of the thirteen unidentified deposits shown on the 7/20/01 checking account statement may
         be weekly payroll deposits, there is no documentation to support these or any the remaining
         deposits. Gershman failed to adequately verify the reserves submitted to Desktop Underwriter.


         FHA CASE NUMBER: 292-4081385                    DATE OF LOAN CLOSING: 10/10/2001
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $73,841
         UNDERWRITER TYPE: Manual                        HOUSING/DEBT RATIOS: 17.42/36.96
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after 21 payments.

         Questionable/Derogatory Credit History
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: The credit report lists the borrower and co-borrower credit scores as 572 and 539
         respectively. It also reveals a judgment, several collections/charge-offs, and late payments as
         recent as 6/01, including an 8/00 90-day late payment on a federal education debt. Although a
         6/28/01 borrower note offers explanations for the slow payments and claims that they are now in
         credit counseling, it also mentions that the borrower was laid off for parts of 1999 and 2001,
         calling into question the stability of income. According to the underwriting worksheet, the
         borrowers housing expense is "increasing less than 10%," and the borrowers have "paid as
         agreed for 4+ years" on their current housing; while a 6/29/01 verification of rent supports the
         claim that no late payments have occurred, the borrowers were not consistently meeting other
         obligations during that time period. Additionally, an undated note from the co-borrower
         indicates that the borrowers have moved to a new address not verified.
         AUDITEE COMMENTS: The decision to approve this loan was a judgment call by the underwriter
         as permitted under HUD [Direct Endorsement] program requirements. It was determined that
         the borrowers provided sufficient explanations for their past credit deficiencies. The primary
         reasons for the credit deficiencies involved three separate medical situations involving surgeries
         for the co-borrower and an accident with her son and not a disregard for her financial
         obligations.
         The borrower’s employment was analyzed and the underwriter used the base income from the
         employment verification. Also, according to the employment verification, the borrower received
         overtime and other income that offset his earnings for time not worked. See Exhibit 10. The
         2000 gross earnings and year to date average fully support the income used.
         According to the borrowers’ explanations, he was laid off and the co-borrower was out of work
         but they continued to meet their housing obligation. The landlord verification of the borrowers
         rent properly verified that the borrowers had paid $725 a month rent and had been tenants since
         1996. See Exhibit 11. Given the fact that the borrower’s mortgage payment was only increasing
         $7.00 per month, the underwriter did not require any additional information regarding their



         2004-KC-1004                               Page 44


Table of Contents
                                                                                               Appendix C

         residency. We respectfully submit that we made an appropriate underwriting decision consistent
         with HUD guidelines regarding this loan.
         OIG EVALUATION OF AUDITEE COMMENTS: We agree with Gershman’s assertion that the credit
         deficiencies appear to have been due to extenuating circumstances rather than a disregard for
         financial obligations. Due to the explanations provided, we removed this deficiency from
         Finding 1 and adjusted Appendix B.


         FHA CASE NUMBER: 292-4082499                      DATE OF LOAN CLOSING: 10/18/2001
         LOAN PURPOSE: Purchase                            INSURED AMOUNT: $129,065
         UNDERWRITER TYPE: Automated                       HOUSING/DEBT RATIOS: 21.14/39.47
         STATUS AS OF 3/31/2004: Partial reinstatement. First default reported after 14 payments.

         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report requires all overtime income be verified
         and documented according to current standard FHA documentation guidelines. HUD Handbook
         4155.1, Revision-4, Change-1, Paragraph 2-7A indicates that if the bonus and overtime earnings
         trend indicates a continual decline, the lender must provide a sound rationalization for including
         the income of the borrower qualifying.
         OIG FINDING: According to the application, the borrower has been with his current employer since
         June 2001 and was previously self-employed; while documents confirm the borrower’s current
         employment and self-employment in 1999 and 2000, there is no documentation covering the first
         half of 2001. According to the Desktop Underwriter Findings Report, the co-borrower’s gross
         monthly income included $185 overtime pay; however, the verification of employment indicates a
         continual decline in overtime income from January 1999 to September 2001.
         AUDITEE COMMENTS: We were aware of the gap in employment but made the decision to accept
         the documentation provided. Since the borrower’s earnings from self-employment for 1999 and
         2000 averaged $363 per month, it was evident that he needed to find a job with more stable
         income. The underwriter made the assumption that the borrower was winding down his business
         during the first 5 months of 2001. Thus, an explanation would not have affected our
         underwriting decision.
         We included monthly overtime income of $185 a month for the co-borrower’s income. The
         auditor noted that the verification of employment indicated a continual decline in overtime
         income from January 1999 to September 2001. However, and significantly, the co-borrower’s
         bonus income increased and the overall difference was minimal.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the gap
         in borrower employment could be adequately explained by his transition from self-employment
         to his current employment. However, Gershman’s explanation for including the co-borrower
         overtime income is not sufficient. The monthly overtime income had decreased from $217 in
         1999 to $192 in 2000 and $176 in 2001. HUD requires mortgagees to provide a sound
         rationalization for including overtime income, such as this, that is continually declining.
         Additionally, the increase in monthly bonus income from 1999 to 2000 was $12, and there was
         no bonus income listed for 2001 as of September 9th.




                                                     Page 45                                   2004-KC-1004


Table of Contents
         Appendix C

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Findings Report required verification of the $24,415 assets
         claimed and verification of all cash, which should not include funds received as a gift.
         Additionally, Desktop Underwriter noted that the retirement account could only be listed at 60%
         of its value and required explanation/documentation for recent large deposits in excess of two
         percent of the property’s sales price.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $3,903 and the borrower needed $5,626 to close. According to the settlement
         statement, the borrower only needed $3,138 to close after taking out earnest money and borrower
         prepaid expenses. According to the Desktop Underwriter Findings Report, the borrowers’ assets
         included a retirement account valued at $18,864 , a checking account ($3,875), and a savings
         account ($1,676). Account statements and documents indicate that 60% of the retirement
         account balance is less than $9,000 when loans are taken into consideration. Bank statements
         and an Internet printout reveal that the bank accounts were overstated by $1,500 due to an
         8/20/01 transfer between accounts and show unidentified deposits totaling over $8,800. While a
         borrower note explained that one $3,000 deposit was the return of money owed by her parents,
         there was no documentation to support her claim. Gershman failed to adequately verify the
         $24,415 assets claimed on the Desktop Underwriter Findings Report. With the correct
         retirement account balance and the $1,500 transfer and $8,800 unidentified deposits taken out,
         the borrower would have less than $4,200 available and $1,100 in reserves, and it is unclear if
         Desktop Underwriter would have approved the loan.
         AUDITEE COMMENTS: The auditor noted that 60% of the retirement account statement dated
         9/30/01 would have been less than $9,000 when loans against the retirement account were taken
         into consideration. The auditor refers to a 9/30/01 statement but the only statement in the file is
         a 6/30/01 statement. One of the loans against the retirement account was for $8,352 taken out in
         September of 2001. The proceeds were deposited into the checking account and the file
         contained evidence of this deposit and showed an account balance of $8,049 as of 10/16/01. See
         Exhibit 12. The assets available from the retirement account after taking out the loans using
         60% would have been $8,934.
         Of the $8,800 of unidentified deposits, only the one deposit for $3,000 exceeded 2% of the sales
         price. The file contained an explanation letter from the co-borrower that this was money owed
         to her from her parents. Although this was less than the $24,415 stated in the Underwriter
         Findings, the loan still would have received an approve/eligible.
         The auditor indicates that it is unclear whether Desktop Underwriter would have approved this
         loan with the assets noted above. We strongly disagree with this because the qualifying ratios
         were within HUD guidelines, the borrower’s credit scores were above 650 and they had
         sufficient assets to close. We would have approved this loan manually as it met HUD
         guidelines.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that there was
         no 9/30/01 statement and that the qualifying balance of the retirement account was $8,934; we
         deleted the reference to a 9/30/01 statement. Additionally, we concur with Gershman’s assertion
         that using the 10/16/01 checking account document eliminates the $1,500 overstatement. While
         we concur with Gershman’s assertion that only one deposit required explanation, we do not
         believe that the explanation provided is satisfactory. After removing the $3,000 deposit from the
         10/16/01 checking account balance and adjusting the retirement account balance to $8,934, the
         available assets are $15,659 ($8,049 checking - $3,000 deposit + $1,676 savings + $8,934

         2004-KC-1004                                Page 46


Table of Contents
                                                                                              Appendix C

         retirement). While it appears the borrower have had sufficient funds to close, the reserves would
         be $8,756 less than claimed in Desktop Underwriter. Because Desktop Underwriter is an
         automated system with risk thresholds dependent on a variety of factors, it is unclear whether the
         loan would have been approved had the correct amount of available assets been submitted.

         Inconsistent/Underreported Liabilities
         CRITERIA: The Desktop Underwriter Findings Report requires loans be resubmitted to the
         system when a debt or obligation with monthly liability greater than $100 is revealed during the
         loan process.
         OIG FINDING: An additional application located only in the Gershman file lists an additional
         debt of $17,000 with $175 monthly payments. When included in the qualifying ratios, the debt
         ratio increases to 42.5%.
         AUDITEE COMMENTS: This loan did not appear on the credit report and was not included in the
         Underwriter Findings. It is not clear if this debt was outstanding at the time of underwriting.
         However, if we had included this debt in the fixed monthly payments, the [debt] ratio would
         have been 42.5%. Importantly, this loan was for the purchase of a new construction home and
         43% was the HUD guideline for this ratio. We believe Desktop Underwriter would have
         approved this loan. In addition, we would have manually underwritten and approved it as it
         complied with applicable HUD requirements.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that this was
         a new construction energy efficient home. HUD Handbook 4155.1, Revision-4, Change-1,
         Paragraph 2-19 allows borrowers to exceed the qualifying ratios by up to two percent (31/43%)
         when purchasing or refinancing an energy-efficient home. However, Gershman did not follow
         the Desktop Underwriter requirements. Because Desktop Underwriter is an automated system
         with risk thresholds dependent on a variety of factors, it is unclear whether the loan would have
         been approved had the additional debt been submitted.


         FHA CASE NUMBER: 292-4079136                    DATE OF LOAN CLOSING: 10/26/2001
         LOAN PURPOSE: Non-Streamline Refinance          INSURED AMOUNT: $126,875
         UNDERWRITER TYPE: Automated                     HOUSING/DEBT RATIOS: 37.46/49.76
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after 12 payments.

         Inconsistent/Unsupported Income
         CRITERIA: According to the Desktop Underwriter Finding Report, employment income must be
         supported by the most recent year-to-date pay stub documenting one full month's earnings and
         written, verbal, or electronic verification acceptable to FHA. Additionally, overtime income
         must be verified and documented according to FHA guidelines. HUD Handbook 4155.1,
         Revision-4, Change-1, Paragraph 2-7A requires lenders to develop a two year average of bonus
         or overtime income, and indicates that if the earnings trend indicates a continual decline, the
         lender must provide a sound rationalization for including the income of the borrower qualifying.
         OIG FINDING: According to the Desktop Underwriter Findings Report, the borrower’s $2868
         gross monthly income includes $355 overtime income. While the verification of employment
         indicates that overtime/bonus income is likely to continue, a 20.2-month average indicates
         monthly overtime/bonus income of only $190. Additionally, a 24-month average of all types of

                                                    Page 47                                   2004-KC-1004


Table of Contents
         Appendix C

         income indicates gross monthly income of only $2,761. Because the qualifying ratios already
         exceeded the 29%/41% benchmarks, it is unclear if Desktop Underwriter would have approved
         the loan had the correct amount been entered.
         AUDITEE COMMENTS: Gershman properly underwrote this loan as follows; we took the hourly
         rate from the pay stub of $14.50, and used 40 hours per week, which equates to a monthly base
         pay of $2,513 or $30,160 annually. See Exhibit 13. We also gave the borrower credit for
         overtime in the amount of $355.00 per month. We calculated overtime by taking the total
         income earned from the employment verification for 2000 and subtracted the base pay of
         $30,160.
         Importantly, this income was less than the 20.2 month average and the year-to-date 8.2 average
         shown on the employment verification. In addition, the hourly rate of $14.50 we used was lower
         than the amount verified on the employment verification of $15 per hour. We believe that our
         underwriting was conservative because the employment verification indicated that the borrower
         was working an average of 45 hours per week at a base hourly pay rate of $15.00. It does not
         appear that the auditors took these facts into consideration.
         HUD Guidelines allow for a less than 24-month average of overtime income. In this case our
         underwriter determined that this was warranted as the borrower started employment in June
         1999. The verification did not state her gross earnings for that year nor a breakdown between
         base pay and overtime. It was the underwriter’s judgment call as permitted by HUD guidelines
         that the average of 20.2 months overtime and bonus was proper in this case. Gershman
         respectfully submits that the auditor’s finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         employment verification shows a $15 hourly pay rate and a 45-hour average workweek.
         However, we disagree with Gershman’s assertions that they properly underwrote this loan.
         While the verification does not show the 1999 income, a W-2 provided does; we used this W-2
         along with the verification to arrive at the 24-month gross monthly income average of $2,761.
         Even if we took a less conservative approach, the documentation provided does not show that the
         borrower has received overtime income of $355 per month. Based on the verification, the
         average overtime income was $135 per month in 2000 and $256 per month for the first 8.2
         months of 2001. While this does indicate that overtime is increasing, it does not adequately
         support the $355 overtime figure used.


         FHA CASE NUMBER: 292-4105387                    DATE OF LOAN CLOSING: 11/8/2001
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $163,922
         UNDERWRITER TYPE: Automated                     HOUSING/DEBT RATIOS: 27.00/38.00
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after 11 payments.

         Inconsistent/Unsupported Income
         CRITERIA: According to the Desktop Underwriter Finding Report, employment income must be
         supported by the most recent year-to-date pay stub documenting one full month's earnings and
         written, verbal, or electronic verification acceptable to FHA.
         OIG FINDING: According to the Desktop Underwriter Findings Report, the borrower’s base
         monthly income is $3,138. While a verbal verification of employment for the borrower does not
         indicate the borrower’s base pay, paystubs located in the HUD case binder indicate a $3,045

         2004-KC-1004                               Page 48


Table of Contents
                                                                                              Appendix C

         year-to-date average monthly base pay; more recent paystubs located in the Gershman case
         binder show that the borrower only worked 55 hours in a three week time period and indicate a
         $2,911 year-to-date average monthly base pay. Additionally, the borrower’s 2000 W-2 shows
         average monthly gross income of only $2,617. Gershman failed to verify the $3,138 borrower
         base monthly income.
         AUDITEE COMMENTS: The borrower was a union carpenter whose hours worked fluctuated. The
         underwriter used a 20.67 average gross earning because the 2001 year to date monthly average
         gross earnings were higher than 2000. The auditor notes that the 2001 year to date base pay was
         $2,911. Had this amount been used, the qualifying ratios were 28%/39%. Further, we took a
         32.67 month average including 1999 W-2 gross earnings and the borrower’s average monthly
         income was $2820. The qualifying ratios were 29%/40%. In both of these analyses, the
         borrowers qualified and the loan would have been approved. We respectfully submit that this
         finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: While Gershman’s assertions regarding the debt
         ratio at various income amounts may be true, they failed to adequately support the income used
         to qualify when submitting the loan to Desktop Underwriter for endorsement. Desktop
         Underwriter requires all data entered, downloaded, or imported to be true, accurate, and
         complete.

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Findings Report requires depository assets be verified by a
         verification of deposit, the most recent statement showing the previous month’s balance, or the
         most recent two months statements. Also, if the amount of earnest money appears excessive
         based on the borrower’s history of accumulating savings, the lender must verify the deposit
         amount and the source of funds according to current FHA guidelines. Desktop Underwriter also
         requires that the lender verify all cash reserves after closing submitted to the system. HUD
         Handbook 4155.1, Revision-4, Change-1, Paragraph 2-10A says that satisfactory documentation
         of an excessive earnest deposit includes a copy of the cancelled check or a certification from the
         deposit holder acknowledging receipt of funds and separate evidence of the source of funds.
         Evidence of source of funds includes a verification of deposit or bank statement showing that the
         average balance at the time the deposit was made was sufficient to have included the earnest
         money deposit.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $5,157 and the borrower needed $12,432 to close. According to the settlement
         statement, the borrower only needed $3,398 to close after taking out $8,059 earnest money
         (4.7% of the sales price) and borrower prepaid expenses. According to the Desktop Underwriter
         Findings Report, the borrowers’ assets consisted of a savings account ($3,804), a checking
         account ($837), and net equity from the sale of a previous residence ($6,033). However, bank
         statements reveal a $950 overstatement of assets due to several account transfers and
         documentation in the Gershman case binder indicates that the borrowers’ savings account
         balance may have been as low as $2,603 on 11/7/01. These balance reductions mean there
         would not have been sufficient funds to close the loan. Also, it is not clear if the net proceeds
         from the sale of the borrowers’ prior residence were already included in the accounts as the sale
         occurred several months prior to the bank statement dates. Additionally, while faxed copies of
         checks and a letter from the buyer indicate that the $8,059 earnest money deposit has been
         received, the check copies are not cancelled copies and there is no evidence of source of funds.

                                                    Page 49                                   2004-KC-1004


Table of Contents
         Appendix C

         While the $6,033 net proceeds may have been applied to the earnest money deposit, $2,026 of
         the deposit would remain unverified. It is unclear if Desktop Underwriter would have approved
         the loan had the correct amounts been entered.
         AUDITEE COMMENTS: The borrowers had $4,903 in their bank account at Commerce Bank
         shortly before closing. See Exhibit 14. This included $2,603 in savings account and a $2300
         gift from a parent that the auditors did not take into consideration. Since this verification is
         dated the day before closing, there was not overstatement of assets.
         The borrowers paid the earnest money of $8,059 at two different times. The first amount was
         paid on April 18, 2001. The second check for $7,058.65 was written on May 16, 2001 but was
         not deposited until June 6, 2001. This is consistent with the borrowers receiving the proceeds
         from the sale of their previous home on June 5, 2001 of $6,033. In addition to this, we had the
         borrower’s August and September bank statements for Commerce Bank showing balances of
         $2,833 and $3,804 in their personal investment savings account. This clearly evidenced that
         they had a history of accumulating savings to meet the asset requirement to pay $1,000 and
         $1,025 in earnest money over a 7-week period. This was in compliance with condition #23 of
         the Underwriter Findings. We respectfully submit that the borrowers assets were properly
         verified.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         November 7, 2001 checking account balance was $4,903 after depositing the $2,300 gift.
         Additionally, we agree that there was no overstatement of the bank accounts because the $4,903
         checking account balance adequately covers the amount of the overstatement. Based on the
         amount verified, there were sufficient assets to cover the $3,398 due at closing.
         However, Condition #23 of the Desktop Underwriter Findings Report states “If the amount of
         earnest money deposit exceeds 2 percent of the sales price or appears excessive based on the
         borrower’s history of accumulating savings, the lender must verify the deposit amount and the
         source of funds.” The earnest money deposit was 4.7% of the sales price. Gershman failed to
         adequately verify the source of funds for $2,026 of the deposit.


         FHA CASE NUMBER: 292-4095609                      DATE OF LOAN CLOSING: 11/9/2001
         LOAN PURPOSE: Purchase                            INSURED AMOUNT: $81,200
         UNDERWRITER TYPE: Manual                          HOUSING/DEBT RATIOS: 20.30/34.28
         STATUS AS OF 3/31/2004: Partial reinstatement. First default reported after 14 payments.

         Inconsistent/Unsupported Income
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Chapter 2 requires that the lender
         establish the borrower's capacity to repay the mortgage debt. Paragraph 2-8 requires borrowers
         employed by businesses owned by family members to provide additional income documentation,
         including evidence that he or she is not an owner of the business. This may be done with copies
         of the borrower’s signed personal tax returns or a signed copy of the corporate tax return
         showing ownership percentages.
         OIG FINDING: According to the underwriting worksheet, the borrower monthly base income is
         $2,600. While a verification of employment and paystubs support the $,2600 borrower base
         monthly income, it was completed by the borrower’s brother. Additionally, had the borrower
         earned $600/week for the last eight months of 2000 as claimed on the verification of

         2004-KC-1004                               Page 50


Table of Contents
                                                                                              Appendix C

         employment, his 2000 income would have been approximately $5,000 higher than that shown on
         the W-2. While the file contained no evidence that the borrower was not an owner of a family
         business, Gershman confirmed with the brother (president of the company) in April 2004 that the
         borrower was not an owner of the business.
         AUDITEE COMMENTS: The underwriter used the base monthly income of $2,600 per month to
         qualify the borrower. This was supported by an employment verification and pay stubs. The
         employment verification stated past years earnings of $26,000. While the W-2 showed a lower
         amount, the borrower received a raise of $200 per week sometime in April of 2000. The
         underwriter did not question the variance because the borrower was making a cash down
         payment of $27,000. Importantly, if the lower income figure based on the 2000 W-2 of $1,933
         per month was used, the ratios would have been 24/41. This loan would be approved under
         HUD guidelines. (We are in the process of obtaining a signed statement from James Owens that
         will confirm that Jeremy Owens had no ownership in a family owned business. If necessary, we
         will provide this to the auditors when received).
         OIG EVALUATION OF AUDITEE COMMENTS: While Gershman’s assertions may all be correct,
         they still failed to obtain evidence, prior to closing, that the borrower was not an owner of a
         family business.

         Questionable/Derogatory Credit History
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to a fax from the borrowers, they submitted a pay history showing the
         past year of payments on their prior home. However, the pay history shows the borrower’s
         father as the account holder and monthly payments of approximately $200, some of which were
         late. While the father had recently passed away and a letter of distribution shows the borrowers
         received the property, the late payments are not explained.
         AUDITEE COMMENTS: The underwriter made the judgment call as permitted under HUD
         guidelines that the borrowers had adequately explained the late payments on the mortgage they
         were paying for the property they inherited from their father. Specifically, the co-borrower
         explained that she became ill in July of 2000 due to a pregnancy and problems continued until
         the baby was born in 2001. The application dated 8/1/01 confirmed that the borrowers had a
         three month old dependent. We respectfully submit that this finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         borrowers adequately explained the late payments on the mortgage. We have removed this
         deficiency from Finding 1 and adjusted Appendix B.


         FHA CASE NUMBER: 292-4108675                    DATE OF LOAN CLOSING: 11/26/2001
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $88,798
         UNDERWRITER TYPE: Automated                     HOUSING/DEBT RATIOS: 22.00/40.00
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after nine payments.

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Findings Report requires depository assets be verified by
         either a verification of deposit, the most recent statement showing the previous month’s balance,
         or the most recent two months statements. Additionally explanation and documentation must be

                                                    Page 51                                   2004-KC-1004


Table of Contents
         Appendix C

         obtained for recent large deposits (other than gifts) in excess of two percent of the property’s
         sales price.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $2,697 and the borrower needed $4,216 to close. According to the settlement
         statement, the borrower only needed $867 to close after taking out gift funds, earnest money, seller
         paid expenses, and borrower prepaid expenses. According to the Desktop Underwriter Findings
         Report, the borrower’s assets consisted of $666 in two bank accounts and $2,136 Certificate of
         Deposit (CD). While the CD is verified by a 10/7/01 slip showing interest paid, the document
         indicates that the borrower made the deposit, which is greater than two percent of the sales price,
         approximately four months prior to closing. Also, Gershman should have verified whether the funds
         from the CD were accessible. There is no indication that the funds were available for withdrawal
         prior to the maturity date, and the CD appears to be securing a debt (a check from the borrower is for
         a “CD loan"). Gershman failed to satisfy the requirements for asset verification established by
         Desktop Underwriter prior to closing. Without using funds from the CD, there would not have been
         sufficient assets to close the loan.
         AUDITEE COMMENTS: With regards to the deposit made for the Certificate of Deposit, the loan
         file contained a copy of the borrower’s 2000 tax returns that clearly shows a refund of $3,367 for
         taxes paid. See Exhibit 15. This return was prepared on 2/2/01. We accepted this as evidence
         that the borrower used these funds for the [Certificate of Deposit].
         The Desktop Underwriter Findings Report included a loan with St. John’s Bank with a balance
         due of $778 and a monthly payment of $159. This payment amount matches the amount on the
         check marked “CD loan” and was properly counted by us in the qualifying ratios. At the time of
         closing, the borrower owed only one more payment on this loan. The borrower’s first payment
         on the HUD insured mortgage was January 1, 2002. With the CD maturing on January 7, 2002,
         just a few days later, we allowed this CD to be used for reserves and therefore, properly
         documented this account. We respectfully submit that the borrower’s assets were properly
         supported and the loan was underwritten consistent with HUD guidelines.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman agrees that there was still a loan on the
         CD as of the date of closing. Gershman failed to establish that the borrower could withdraw
         additional CD funds prior to the maturity date. Without using funds from the CD, there would
         not have been sufficient funds to close the loan.


         FHA CASE NUMBER: 292-4119353                      DATE OF LOAN CLOSING: 12/10/2001
         LOAN PURPOSE: Purchase                            INSURED AMOUNT: $147,793
         UNDERWRITER TYPE: Manual                          HOUSING/DEBT RATIOS: 19.26/37.67
         STATUS AS OF 3/31/2004: Partial reinstatement. First default reported after five payments.

         Inconsistent/Unsupported Income
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Chapter 2 requires that the lender
         establish the borrower's capacity to repay the mortgage debt. Income from a source that cannot
         be verified, is not stable, or will not continue should not be used when calculating the borrower's
         qualifying ratios. Additionally, Paragraph 2-7A requires lenders to develop a two-year average
         of bonus or overtime income used to qualify.



         2004-KC-1004                                 Page 52


Table of Contents
                                                                                               Appendix C

         OIG FINDING: The underwriting worksheet lists borrower and co-borrower base monthly income
         as $3,520 and $3,062 respectively. While the borrower verification of employment projects
         $3,111 base monthly income and indicates that overtime is likely to continue, it does not list the
         amount of overtime income earned in 2000 or 2001; Gershman obtained the $3,520 income
         amount from a borrower paystub, which included overtime. The borrower’s overtime income
         was used to qualify but was not adequately verified or computed. While a verification of
         employment and W-2’s support the $3,062 co-borrower monthly income, a paystub indicates
         average monthly income of only $2,361. In a 4/16/04 meeting, Gershman noted that co-
         borrower’s year-to-date income was probably lower because of maternity leave (the application
         indicates she has a 1-year old child).
         AUDITEE COMMENTS: The year to date average of the borrower’s income was used in qualifying.
         Although the [verification of employment] did not provide an itemization as to the overtime
         income, the verification reflects clearly that overtime income would continue. The pay stub
         dated 12/3/01 reflects that the borrower had earned an average monthly income of $3527. In
         addition, this calculation of monthly income included the first 6 months of the year at the lower
         wage prior to his raise on 7/1/01. Regardless, using the Borrower’s base pay of $3111 per
         month, the qualifying ratios would have been within HUD guidelines at 20.5/40.15.
         We did not question the year to date earnings for the co-borrower because the application stated
         that they have a one year old child. With this being the case, co-borrower was on maternity
         leave for some portion of 2001. We respectfully submit that we made an appropriate decision
         consistent with HUD guidelines regarding this loan.
         OIG EVALUATION OF AUDITEE COMMENTS: While we agree with Gershman’s assertion that the
         loans qualifying ratios would still be within HUD guidelines if the borrower’s overtime income
         were taken out, Gershman still failed to verify the overtime income that was used to qualify. We
         concur with Gershman’s assertion that they adequately documented the co-borrower’s income
         based on her circumstances. Consistent with HUD guidelines, Gershman’s documentation
         showed that the borrower had been employed in her current job for at least six months and that
         the borrower had a two-year work history prior to the her absence from the work force.

         Inconsistent/Unsupported Assets
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-10 requires all funds for
         the borrower's investment in the property be verified and describes the criteria for verifying gift
         funds. Paragraph 2-10C says that lenders must document the transfer of gift funds from the
         donor to the borrower (Donor: a withdrawal slip or cancelled check; Borrower: a deposit slip or
         bank statement showing the deposit); the lender must verify that funds not deposited prior to
         closing are received from the donor by the closing agent. Additionally, the file must contain a
         gift letter specifying the dollar amount, signed by the donor and borrower, stating no repayment
         is required, and showing the donor's name, address, telephone number, and relationship to the
         borrower.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $4,469 and the borrower needed $5,888 to close. According to the settlement
         statement, the borrower only needed $3,040 to close after taking out earnest money and borrower
         prepaid expenses. An undated application located in the Gershman file notes the down payment
         source as “checking/savings and gift,” and a 12/8/01 letter in the HUD case binder indicates that
         the borrowers received a $1,000 cash gift for the purchase of their home. However, the letter
         does not state the donor’s address or relationship to the borrower, there is no proof of transfer,

                                                     Page 53                                   2004-KC-1004


Table of Contents
         Appendix C

         and the underwriting worksheet and settlement statement located in the HUD case binder do not
         mention the gift.
         AUDITEE COMMENTS: Upon review of the file prior to closing, the underwriter determined that
         the $1,000 gift was not needed for closing. Therefore, the donor and gift information was not
         obtained. We used computer printouts from St. John’s Bank dated 12/8/01 for assets to close.
         See Exhibit 16. There were two accounts totaling $3,053 which was more than the $3,040
         needed to close. One of the statements showed a last deposit of $1,611 which was not more than
         2% of the sales price and in line with deposits made in previous months. The borrower’s
         monthly income supported the ability to make a deposit of this amount. In addition, we also had
         evidence of an investment account with Paine Webber with an account balance of $3,017. See
         Exhibit 17. We respectfully submit that the borrower’s assets were properly verified.
         OIG EVALUATION OF AUDITEE COMMENTS: HUD regulation does not specify that only deposits
         in excess of 2% of the sales price be considered large deposits. However, our finding addresses
         the gift funds not properly documented. While we concur with Gershman’s claim that the two
         accounts totaling $3,053 would have covered the $3,040 needed to close, it is not clear if the
         $1,000 gift funds were deposited prior to the 12/8/01 borrower bank verifications. Had the
         account balance been $1,000 less, there would not have been sufficient assets to close the loan.

         Questionable/Derogatory Credit History
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to the underwriting worksheet, the borrowers have monthly payments
         for debts and obligations totaling $1,212. According to the 12/6/01 credit report, there have been
         several recent late payments on one account; while the file contains satisfactory explanations for
         the late payments and shows that the account was brought current, the documentation also shows
         that the balance is over the credit limit. Additionally, there are no explanations for three
         collections listed on the credit report. The underwriting worksheet shows four offsetting factors,
         "Good rent history verified 2 yrs; (cb) long term, stable employment; reserves in 401k; good
         ratios." However, the prior monthly rent was less than 40% of the proposed monthly mortgage
         payment, the co-borrower’s year-to-date income projects a decline (which could indicate
         instability and a need to adjust the ratios), and there is a loan against most of the co-borrower's
         401k.
         AUDITEE COMMENTS: The one account with recent late payments was satisfactorily explained.
         According to the Providian statement, the account holder gave them flexibility for paying this
         account. The three unexplained collections were with NCO and were all medical related. Since
         the amounts were all small around $100 each, we did not require further explanation. The
         compensating factors listed clearly show that the borrower’s credit within the last 2 years had
         been good. All of the derogatory credit except for the Providian account had occurred more than
         three years ago. This loan met HUD guidelines for approval.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman agreed that the borrowers had some
         degree of a derogatory credit history, including recent late payments for which they obtained
         borrower explanations. It is our understanding that Gershman included the four compensating
         factors listed to offset this derogatory credit history. Our analysis of Gershman’s comments for
         “Inconsistent/Unsupported Income” determined that the co-borrower’s employment income and
         history was fully documented. Based on this compensating factor, we have removed this
         deficiency from Finding 1 and adjusted Appendix B.


         2004-KC-1004                                Page 54


Table of Contents
                                                                                                 Appendix C



         FHA CASE NUMBER: 292-4126430                DATE OF LOAN CLOSING: 12/18/2001
         LOAN PURPOSE: Purchase                      INSURED AMOUNT: $73,212
         UNDERWRITER TYPE: Automated                 HOUSING/DEBT RATIOS: 26.37/47.96
         STATUS AS OF 3/31/2004: Foreclosure Completed. First default reported after nine payments.
         Borrower declared bankruptcy on 10/30/2003.

         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report requires employment income be supported by
         the most recent year-to-date pay stub documenting one full month's earnings and a written, verbal, or
         electronic verification acceptable to FHA.
         OIG FINDING: The Desktop Underwriter Findings Report shows base monthly income of $2,527.
         Although the pay stubs in the file support the monthly income used, they do not appear to follow the
         criteria that "the most recent year-to-date pay stub documenting one full month's earnings" must be
         verified because they are not chronological and there should have been more recent pay stubs
         available at the time of application. A 12/17/01 bank statement printout shows smaller direct payroll
         deposits, averaging nearly $800 less net income per month than the pay stubs provided; this
         indicates that the borrower's income had substantially decreased as the date of underwriting/closing
         approached. Furthermore, on the last pay stub provided (dated 10/5/01), the year-to-date gross
         earnings is $20,699.80 while the 12/1/01 verification of employment shows an approximate year-to-
         date gross earnings of $32,900; this indicates that the borrower received increased income of
         approximately $6,000 per month between October and November 2001. Gershman failed to explain
         the conflicting documentation showing both increases and decreases to borrower income in the
         months prior to underwriting/closing.
         AUDITEE COMMENTS: The original loan application was taken on 10/26/01 and we had the
         borrower’s pay stub dated 10/5/01. We used a verification of employment along with this pay
         stub to document the borrower’s income. See Exhibit 18. We did not use alternate
         documentation, therefore the most recent year to date pay stub documenting one full month’s
         earnings was not needed. However, we did have the verification of the 10/19/01 payroll deposit
         as evidenced from the October bank statement. See Exhibit 19. We determined the borrower’s
         income by taking the year to date income from the 10/5/01 pay stub of $20,699 over an 8.19
         month average. This equaled $2,527. We did not use the higher year to date income on the
         employment verification dated 12/1/01 and as a result we had no reason to question the payroll
         deposits on the December bank statement. Further, we had no reason to question the amount of
         net payroll deposits when we had a standard verification of employment and we had no
         knowledge of the borrower’s elected payroll deductions. We respectfully submit that this
         finding is not supported and that the borrower’s income was properly determined and
         documented.
         OIG EVALUATION OF AUDITEE COMMENTS: As noted in the Auditee comments under
         “Inconsistent/Unsupported Assets,” this loan was underwritten and approved by Desktop
         Underwriter. Condition #13 on the Desktop Underwriter Findings Report states “[the
         borrower’s] income must be supported by: 1) the most recent year-to-date pay stub documenting
         one full month’s earnings and any one of the following to verify current employment: a) written
         verification of employment, 2) verbal verification of employment…or 3) electronic verification
         of employment.” Gershman was required to obtain the most recent year to date pay stub

                                                      Page 55                                   2004-KC-1004


Table of Contents
         Appendix C

         documenting one full month’s earnings. Additionally, HUD Handbook 4000.4, Revision-1,
         Change-2, Paragraph 2-5 requires mortgagees to obtain and verify information with at least the same
         care that would be exercised if originating a mortgage when the mortgagee would be entirely
         dependent on the property as security to protect its investment.

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Findings Report required the depository assets be verified
         with a verification of deposit, the most recent statement showing the previous month’s balance,
         or the most recent two months statements. Additionally, lenders must obtain explanations for
         recent large deposits in excess of two percent of the sales price and verify all cash reserves after
         closing.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $2,250 and the borrower needed $4,013 to close. According to the settlement
         statement, the borrower only needed $334 to close after taking out gift funds, earnest money, and
         borrower prepaid expenses. The final Desktop Underwriter Findings Report lists the borrower’s
         checking account balance as $1,287 while the underwriting worksheet shows the assets as $742
         and $545 already paid ($1,287 total). While a 12/14/01 Internet printout confirms the $742
         balance, it also indicates two unidentified deposits on 9/12/01 ($500) and 12/10/01 ($300).
         These two deposits warrant an explanation as almost all other deposits to this account have been
         from the borrower's employer, and the latter deposit substantially increased the bank balance just
         before closing. While neither deposit was greater than two percent of the sales price, without
         them, the borrower would not have been able to demonstrate sufficient assets to close and would
         not have the $202 in reserves claimed on the Desktop Underwriter Findings Report. It is unclear
         whether Desktop Underwriter would have approved the loan had the correct amounts been
         entered as the debt ratio was already above the 41% benchmark.
         AUDITEE COMMENTS: This loan was underwritten and approved by Desktop Underwriter.
         Condition #20 on the Desktop Underwriter Findings Report states “ If applicable, obtain an
         explanation and documentation for recent large deposits (other than gift) in excess of 2 percent
         of sales price. After reviewing the borrower’s bank statements, there were not deposits made
         greater than 2% of the sales price. Further, and importantly, HUD guidelines do not require that
         we verify the source of any deposit made by the borrower that is less than 2% of the sales price,
         as was the case with this loan. The borrower had a credit score of 702. He demonstrated
         responsibility for managing his money and had a history of fulfilling his obligations. The
         borrower lived with his family prior to closing. It was reasonable that this money had been
         saved during this time. We respectfully submit that there was not reason to question any bank
         deposits and the auditor’s finding is not valid.
         OIG EVALUATION OF AUDITEE COMMENTS: HUD regulation does not specify that only deposits
         in excess of 2% of the sales price be considered large deposits. However, this loan is subject to
         Desktop Underwriter requirements. Condition #18 requires depository assets “be verified by one
         of the following: 1) verification of deposit, 2) most recent bank statement showing previous
         month’s balance, or 3) most recent two months bank statements.” Additionally, Condition #21
         on the Desktop Underwriter Findings Report states “You must verify all cash reserves after
         closing submitted to Desktop Underwriter.” The $1,287 checking account balance entered into
         Desktop Underwriter by Gershman was not properly verified as the bank statement listed a $742
         ending balance. Additionally, without the two deposits cited, the borrower would not have had
         the amount of reserves claimed in Desktop Underwriter.

         2004-KC-1004                                Page 56


Table of Contents
                                                                                                 Appendix C




         FHA CASE NUMBER: 292-4123196                    DATE OF LOAN CLOSING: 2/4/2002
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $52,937
         UNDERWRITER TYPE: Manual                        HOUSING/DEBT RATIOS: 11.40/41.96
         STATUS AS OF 3/31/2004: Delinquent. First default reported after 18 payments. Borrower declared
         bankruptcy on 1/9/2004.

         Questionable/Derogatory Credit History
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-3 states that past credit
         performance serves as the most useful guide in determining the attitude toward credit obligations
         that will govern the borrower’s future actions. Major indications of derogatory credit, including
         judgments and collections, and any other recent credit problems, require sufficient written
         explanation from the borrower. According to Paragraph 2-3E, a chapter 7 bankruptcy will not
         disqualify a borrower if at least two years have passed since it was discharged and the borrower has
         re-established good credit (or has chosen not to incur new credit obligations), and has demonstrated
         an ability to manage financial affairs. A chapter 13 bankruptcy will not disqualify a borrower if one
         year of the payout period has elapsed with satisfactory performance and the court grants the
         borrower approval. Additionally, Paragraph 2-3A states that the payment history of the borrower’s
         housing obligations is of significant importance in evaluating credit and requires lenders to
         determine the borrower’s payment history of the housing obligations for the most recent 12-month
         period.
         OIG FINDING: According to her credit report, the borrower filed for Chapter 7 bankruptcy in
         1997 and Chapter 13 bankruptcy in 1999. While the file contains sufficient documentation
         showing the borrower has been making regular Chapter 13 bankruptcy payments and that the
         courts agreed to subordinate financing, the borrower’s credit report indicates a current collection
         on an account opened since the bankruptcy. According to the application, the borrower has
         rented two different apartments/houses in the past two years. The verification of rent covering
         March 1999 to November 2001 shows one three-day late payment. Additionally, the verification
         of rent covering November 2001-January 2002 indicates that the money order for the December
         2001 payment is currently lost in the mail; a photocopy of the money order lists both the
         borrower and her previous landlord as tenants. According to the borrower's driver license, her
         full name includes her previous landlord’s last name. No explanation of these inconsistencies
         was found in the file.
         AUDITEE COMMENTS: This loan was approved by Desktop Underwriter but was ineligible for a
         bankruptcy discharged of less than 2 years. The Desktop Underwriter Findings stated that this
         case was ineligible due to a review of the credit report indicated the presence of a bankruptcy
         within the most recent 2 years. A Direct Endorsement Underwriter must review the credit report
         and verify that the bankruptcy is within HUD guidelines. The underwriter reviewed the
         bankruptcy and determined it was a Chapter 13 and the borrower had made payments as
         scheduled. The Chapter 13 Bankruptcy was filed in 1999 and there was more than a 12-month
         payout under the bankruptcy. In addition, the underwriter verified that the Bankruptcy Court
         gave permission for the borrower to purchase the home while in bankruptcy. This was all the
         Direct Endorsement Underwriter was required to do according to the Desktop Underwriter
         Findings.     The auditor’s other comments regarding verification of rent and landlord

                                                      Page 57                                   2004-KC-1004


Table of Contents
         Appendix C

         discrepancies were not required to be addressed. Therefore, we respectfully submit that this
         finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertions that they
         were not required to verify rental history and that they adequately addressed the reasons the loan
         was tagged ineligible by Desktop Underwriter. However, the documents located in the file,
         including the rental verifications obtained, contain several inconsistencies regarding the
         borrower’s identity and history. According to HUD Handbook 4000.4, Revision-1, Change-2,
         Paragraph 2-4C5, the underwriter should be aware of the warning signs that may indicate
         irregularities. Gershman failed to resolve the inconsistencies cited.

         Inconsistent/Questionable Documentation
         CRITERIA: According to HUD Handbook 4000.4, Revision-1, Change-2, Paragraph 2-4C5, the
         underwriter should be aware of the warning signs that may indicate irregularities and perform
         underwriting decisions with due diligence in a prudent manner.
         OIG FINDING: According to the underwriting worksheet, there was a borrower and a cosigner.
         A note from the borrower indicates that the cosigner is her uncle, allowing the mortgage to be
         excluded from the 75% Loan-to-Value ratio rule. However, the settlement statement does not
         list the cosigner, and Form HUD-54111 Request for Insurance Endorsement does not list the
         cosigner even though it includes the cosigner income. In a 4/2/04 meeting, Gershman indicated
         that title companies sometimes have issues with cosigners signing the settlement statement, as
         they are not part of the contract. However, they did not explain why the cosigner was not listed
         on the Request for Endorsement.
         AUDITEE COMMENTS: Although the [settlement statement] was not signed by the co-signor, and
         he was not listed on the Request for Endorsement, the co-signor did in fact sign the Note, termite
         inspection, Important Notice to Homebuyer and other relevant documents. Importantly, neither
         the collateral security nor the co-signors obligation on the loan were impaired as a result of his
         failure to sign the [settlement statement] or be listed on the Request for Endorsement.
         OIG EVALUATION OF AUDITEE COMMENTS: Because Gershman failed to list the co-signor on the
         Request for Endorsement, the co-signor’s name and social security number are not listed in
         HUD’s Single Family Data Warehouse. This information is crucial as it to ensures that the both
         HUD and the loan servicer hold the co-signor accountable for his obligation on the loan.


         FHA CASE NUMBER: 292-4153878                    DATE OF LOAN CLOSING: 3/8/2002
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $129,073
         UNDERWRITER TYPE: Manual                        HOUSING/DEBT RATIOS: 21.82/49.00
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after four payments.

         Inconsistent/Unsupported Income
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: On the application, the borrower says he has been with his current employer for
         22 years; however, an electronic verification of employment lists 1/23/96 as the service date.
         Furthermore, bank statements do not show direct payroll deposits during the five-week period of
         1/25/02-3/5/02, even though the borrower’s pay was direct deposited prior to 1/25/02. A note
         from the borrower indicates that while his employer had filed Chapter 11 bankruptcy and

         2004-KC-1004                               Page 58


Table of Contents
                                                                                             Appendix C

         withheld payroll, it was now stable. In a 4/2/04 meeting, Gershman indicated that while they do
         not compare paystubs with bank statements, they would not have seen the ceasing of direct
         deposits as a problem because the borrower could have chosen to begin receiving paper checks.
         AUDITEE COMMENTS: The underwriter did not question the difference in the dates of
         employment from the application and the electronic verification because the electronic
         verification showed significantly more than the 2-year employment history required by HUD.
         Further, we respectfully submit that the auditor’s comment regarding payroll deposits for the
         five-week period from 1/25/02 to 3/5/02 is incorrect. These bank statements are for 2 different
         accounts. The statement for his checking account ran for one-week period of 2/26 to 3/5. See
         Exhibit 20. According to previous deposits that showed his payroll to be on a bi-weekly basis,
         there would not have been a deposit for payroll that week. The savings account statement ran
         from 1/25/02 to 3/1/02. See Exhibit 21. The borrower had never had his paycheck direct
         deposited into his savings account.
         The pay stub in the file for this borrower is dated 1/11/02 with year to date earnings of
         $2,365.38. His verification of employment was done on 2/28/02 with a year to date total income
         of $10,211.52. See Exhibit 22. With a salary of $61,500, his monthly income would be $5,125.
         As of 2/28/02 his monthly income averaged $5,105.76. This clearly indicates that there are no
         inconsistencies with his earnings and not receiving paychecks. We respectfully submit that this
         finding is not valid.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that there
         were no inconsistencies with the borrower’s earnings. We have removed this deficiency from
         Finding 1 and adjusted Appendix B.

         Inconsistent/Unsupported Assets
         CRITERIA: According to Mortgagee Letter 98-29, the minimum cash investment is three percent
         of the sales price. HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-10, requires all
         funds for the borrower's investment in the property be verified. Paragraph 3-1F allows checking
         and savings accounts to be verified by obtaining the two most recent consecutive bank
         statements (provided the bank statement shows the previous month's balance). By most recent,
         HUD means at the time the initial application is made. Provided the document itself is not more
         than 120 days old when the loan closes, there is no need to update. However, Paragraph 2-10B
         requires an explanation and evidence of source of funds when there is a large balance increase in
         checking or savings accounts. Additionally, Paragraph 2-10C requires verification of gifts with
         a gift letter specifying the dollar amount, signed by the donor and borrower, stating no
         repayment is required, and showing the donor's name, address, telephone number, and
         relationship to the borrower. Lenders must also document the transfer of gift funds from the
         donor to the borrower (Donor: a copy of the donor's withdrawal slip or cancelled check;
         Borrower: a copy of the deposit slip or bank statement showing the deposit); when funds are not
         deposited prior to closing, the lender must verify that the closing agent received funds from the
         donor for the amount of the gift.
         OIG Findings: According to the underwriting worksheet, the statutory minimum required
         investment was $3,960 and the borrower needed $5,502 to close. According to the settlement
         statement, the borrower only needed $4,654 to close after taking out earnest money, seller paid
         expenses, and borrower prepaid expenses. According to the underwriting worksheet, the
         borrower’s assets included a savings account ($300), a checking account ($594), and a gift
         ($4,000). The only statement obtained to support the savings account was dated more than 120

                                                    Page 59                                  2004-KC-1004


Table of Contents
         Appendix C

         prior to closing. While bank statements ending on 1/11/02 support the checking account
         balance, an additional Internet printout located in the Gershman file indicates a 3/5/02 balance of
         $2,695. Additionally, the documents reveal seventeen insufficient funds charges and almost
         $3,000 in unidentified deposits. The gift letter indicates that the gift is to the borrower’s wife
         and lists the donor’s relationship to the borrower as “mother.” While a 3/8/02 $3,500 check to
         the borrower’s wife and 3/8/02 withdrawal slip for $500 confirm the $4,000 amount, they do not
         adequately document the transfer of funds from the donor to the borrower. The borrower’s wife
         was a non-purchasing spouse, and there is no proof that either the borrower or closing agent
         received the gift funds from the donor. If any of these assets were taken out of the funds
         available, the borrower would not have met the 3% requirement and there would not have been
         sufficient funds available to close.
         AUDITEE COMMENTS: The borrower received a gift at closing from his wife’s parents. We are
         submitting a copy of the cancelled check and a bank statement savings withdrawal to adequately
         document the transfer of funds for the gift. See Exhibit 23. The Internet printouts that the
         auditor is referring to were for 2 separate accounts. One is for a checking account showing a
         balance of $2,694 and savings account showing a balance of $322 for a total of $3,016. See
         Exhibits 20 and 21. These statements reflect deposits in excess of $4,000. Outside of his tax
         return refund of $3,158, there were 3 deposits. The first was on 2/11/02 for $441.58. The
         second was on 2/11/02 for $314.60, and the third on 2/25/02 for $261.03, for a total 1,017.21.
         See Exhibit 21. These deposits were all made into his savings account. Considering this
         borrower’s yearly salary of $61,500, and the fact that he was living with relatives, this amount of
         money is not out of line, or even considered to be large deposits (less than 2% of sales price)
         under HUD requirements. We respectfully submit that the borrowers assets are fully supported.
         OIG EVALUATION OF AUDITEE COMMENTS: On a closer review, Gershman’s file contains
         documentation for two savings accounts and one checking account. However, only one savings
         account was eligible for qualifying purposes as the second is only supported by an outdated
         statement. We agree with Gershman’s assertion that the combined balance of the eligible
         checking and savings accounts as of 3/5/02 was $3,016.
         The additional gift documentation submitted by Gershman included a photocopied $3,500 check
         numbered 5304 while the photocopied check located in the HUD case binder is numbered 5400.
         Regardless of this discrepancy, Gershman failed to show that the borrower or closing agent
         received the gift funds from the donor as both check versions are made out to the borrower’s
         non-purchasing spouse.
         Because Gershman failed to document the transfer of gift funds to either the borrower or the
         closing agent, these funds were not properly verified. After removing the gift funds and
         adjusting the bank accounts to the $3,016 combined balance, the borrower would not have had
         sufficient funds to close the loan.

         Inconsistent/Underreported Liabilities
         CRITERIA: According to HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-11A, the
         borrower's liabilities include all installment loans, revolving charge accounts, real estate loans,
         alimony, child support, and all other continuing obligations. In computing the debt ratio, the
         lender must include the monthly housing expense, and all other additional recurring charges.
         Paragraph 2-12 instructs lenders to compute two ratios: the housing ratio and the debt ratio; these
         ratios should not exceed 29/41% respectively unless significant compensating factors are
         presented.

         2004-KC-1004                                Page 60


Table of Contents
                                                                                              Appendix C

         OIG FINDING: One debt listed on the credit report shows a balance of $2,765 and no payment
         amount. While a borrower explanation indicates that the account is only open until the insurance
         settlement from an accident is complete, there is no proof that the account was settled. This
         account is listed on the application with $138 payments, but is not included on the underwriting
         worksheet. Had the $138 monthly payment been included, the 42.75% debt ratio would have
         exceeded the 41% threshold.
         AUDITEE COMMENTS: Consistent with HUD guidelines that provide the underwriter with
         discretion, the underwriter made the judgment call not to count the payment for $138.
         According to the borrower’s explanation letter, his wife was in a near fatal car accident totaling
         the car. They were waiting for an insurance settlement to pay the balance due of $2,765.
         Therefore, we respectfully submit that the underwriter was justified in not counting the payment
         since the account would be settled.
         OIG EVALUATION OF AUDITEE COMMENTS:                 As noted in Gershman’s comments for
         “Questionable/Derogatory Credit History,” they claim that this debt will be covered by gap
         insurance. However, Gershman failed to provide evidence that the gap insurance coverage even
         existed. Gershman failed to properly support the exclusion of the $138 monthly payment.

         Questionable/Derogatory Credit History
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-3 describes the criteria
         for analyzing the borrowers credit, stating that if the credit history, despite adequate income to
         support obligations, reflects continuous slow payments, judgments, and delinquent accounts,
         strong offsetting factors will be necessary to approve the loan. Further, Paragraph 2-3A states
         that the payment history of the borrower's housing obligations is of significant importance in
         evaluating credit and requires lenders to determine the borrower's payment history of the housing
         obligations for the most recent 12-month period.
         OIG FINDING: On the 2/1/02 credit report, there are twenty-two 30-day late payments, nine 60-
         day late payments, and five 90-day late payments, the most recent of which was just a few
         months prior to closing. The borrower’s explanations for the late/missed payments include his
         fiancé’s car accident and subsequent surgery, priority of wedding bills, being misled by a car
         dealership finance department, overlooking accounts while catching up on car payments, and not
         knowing an account was late or still active because it belonged to his ex-wife. While 10 months
         of rental history are verified, three of the payments were 1-5 days late. Furthermore, while the
         application lists only two addresses covering the last two years, the credit report shows a third
         address reported during the two-year period prior to closing.
         AUDITEE COMMENTS: There were three different late pay accounts in 2001. All of the others
         were prior to 1998. According to the borrowers, one of these accounts would be closed once the
         gap insurance was settled. This auto loan account was opened in September 2000 with a balance
         of $21,000. The account was last verified on 12/01, with a balance of $2,765. It has been our
         experience that it is typical for gap insurance not to pay until the refund of the unexpired
         warranty is also paid. The gap insurance will pay the remainder and it is common for creditors
         to tell borrowers not to make the payments and their credit will not be impacted during that
         period.
         The other two accounts with late payments in 2001 were revolving accounts. All installment debt
         and rent were paid on time. The auditor noted that three of the rent payments were 1-5 days late.
         It is common that apartment leases give the tenant a 5-day grace period.


                                                    Page 61                                   2004-KC-1004


Table of Contents
         Appendix C

         The underwriter did not question the third address noted by the auditor. The file contained rent
         verifications from 1/1/00 to 10/31/01 and the borrower lived with family from 11/1/01 until the
         time of application. It is possible that the third address could have been for his father who has
         the same name.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertions that the
         documentation obtained adequately established the borrower’s residence for the two year period
         prior to closing and that the three late rental payments were minor issues not requiring
         explanation. While we agree with Gershman that only three accounts had late payments in 2001,
         we disagree with their assertion that all other late payments were prior to 1998. Four accounts,
         including two of the three accounts with late payments in 2001, had late payments in 1999 or
         2000. Additionally, Gershman failed to verify the existence of the gap insurance said to cover
         the auto loan account.


         FHA CASE NUMBER: 292-4159228                     DATE OF LOAN CLOSING: 3/14/2002
         LOAN PURPOSE: Purchase                           INSURED AMOUNT: $100,365
         UNDERWRITER TYPE: Automated                      HOUSING/DEBT RATIOS: 20.00/49.00
         STATUS AS OF 3/31/2004: First legal action to foreclose. First default reported after 13 payments.
         Borrower declared bankruptcy on 10/29/2003.

         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report required the lender to obtain signed
         borrower individual tax returns, including schedules, for the most recent two years to support
         self-employment income used to underwrite the case. HUD Handbook 4155.1, Revision-4,
         Change-1, Paragraph 2-7A requires lenders to develop a two year average of bonus or overtime
         income used to qualify.
         OIG FINDING: The Desktop Underwriter Findings Report shows base monthly income for the
         borrower and co-borrower of $1,819 and $2,574 respectively. While several W-2’s, a 1099, and
         tax returns support the borrower’s $1,819 monthly self-employment income, the tax returns were
         not signed. While the co-borrower’s verbal verification of employment does verify a 7/17/00
         beginning date of employment, it does not address income. W-2’s and employer printouts
         indicate $2,422 co-borrower gross monthly income, including overtime, when averaged over
         18.35 months. Gershman used a 13-month average of gross income for the co-borrower and
         included overtime income not properly documented.
         AUDITEE COMMENTS: Our loan file contained copies of what was sent to the investor. The
         signed tax returns were sent to the investor who purchased the loan. We did not make a copy of
         the signature page. The 2000 tax returns were prepared by H and R Block as indicated at the
         bottom of the signature page of the return.
         As stated on the application, the co-borrower was a surgical technician. In this job, she was
         working less than 40 hours per week. It consisted of different hours worked and earnings paid
         such as days, evenings, weekends, and call pay based on need. These various hours worked is
         very typical in the medical profession. The underwriter used an average of 13 months and gave
         the co-borrower credit for the hours she worked during this time because it was more reflective
         of the average number of hours worked per week. The 2001 year to date report from her
         employer showed a very low number of hours and was not representative of the number of hours

         2004-KC-1004                               Page 62


Table of Contents
                                                                                               Appendix C

         worked at the time of application. We respectfully submit that the auditors finding in this regard
         is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman’s asserts that the tax returns signed prior
         to closing were sent to the investor and has since obtained a signed copy for their records.
         However, Gershman’s claim that the 2001 year to date report from the co-borrower’s employer,
         which showed a very low number of hours, was not representative of the number of hours
         worked at the time of application further supports our finding that Gershman failed to properly
         verify the co-borrower income used to qualify. HUD requirements state that income that is not
         stable or will not continue may not be used in calculating the borrower's qualifying ratios.

         Inconsistent/Unsupported Assets
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $3,058 and the borrower needed $3,059 to close. According to the settlement
         statement, the borrower only needed $1,795 to close after taking out earnest money, seller paid
         expenses, and borrower prepaid expenses. The Desktop Underwriter Findings Report list $7313
         assets available. However, an Internet printout covering 1/23/02-3/12/02 shows $9,650 in
         unidentified deposits to the borrower’s checking account during the forty-day period, three of
         which are each approximately two percent of the sales price. Because the co-borrower’s income
         is directly deposited, the only way to account for all of the unidentified deposits is with the
         borrower’s income. While a note from the co-borrower indicates that two of the three
         questioned deposits were borrower payroll deposits, no supporting documentation was provided.
         Additionally, 2001 borrower self-employment receipts listed on a tax return only project
         approximately $7,588 receipts in a forty-day time period. Also, it is unclear whether Desktop
         Underwriter would have approved with lower reserves considering the debt ratio was already
         above the 41% benchmark.
         AUDITEE COMMENTS: The only deposit that exceeded the 2% sales price was for $2,200. The
         borrowers’ explanation for this was a gift from their father. This amount was subtracted from
         the total assets available because we were unable to properly document the transfer of the gift
         funds. We did have an explanation for the other deposits but did not require more
         documentation because the deposits did not exceed 2% of the sales price. The auditor stated that
         there was $9,650 in unidentified deposits. However, and significantly, the auditor failed to take
         the $2,200 gift from her father into consideration. With the gift subtracted from the deposits, the
         borrower’s self-employed receipts were sufficient assets for the source of funds. We respectfully
         submit that the borrowers assets were fully supported and documented.
         OIG EVALUATION OF AUDITEE COMMENTS: We agree with Gershman’s assertion that the
         removal of the $2,200 deposit reduced the total of unidentified deposits to $7,450, an amount
         reasonably explained by the borrower’s self-employment status. We have removed this
         deficiency from Finding 1 and adjusted Appendix B.


         FHA CASE NUMBER: 292-4129226                      DATE OF LOAN CLOSING: 3/26/2002
         LOAN PURPOSE: Purchase                            INSURED AMOUNT: $50,115
         UNDERWRITER TYPE: Automated                       HOUSING/DEBT RATIOS: 17.27/39.54
         STATUS AS OF 3/31/2004: Foreclosure started. First default reported after 16 payments.

                                                     Page 63                                   2004-KC-1004


Table of Contents
         Appendix C



         Inconsistent/Unsupported Income
         CRITERIA: According to the Desktop Underwriter Findings Report, all overtime and bonus
         income must be verified and documented according to current FHA documentation guidelines.
         HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-7 requires lenders to develop a two
         year average of bonus or overtime income, and indicates that if the earnings trend indicates a
         continual decline, the lender must provide a sound rationalization for including the income of the
         borrower qualifying.
         OIG FINDING: According to the Desktop Underwriter Findings Report, the borrower’s $2,539
         total monthly income consists of $1,734 base pay, $260 overtime pay, and $545 social security
         pay. A verification of employment confirms a three-year employment history, base pay of
         400/week, and average hours of 48/week. However, the verification of employment also
         indicates average monthly base/overtime income of $1,173/$357 in 2000, $1,472/$260 in 2001,
         and $1,651/$79 in 2002; none of the totals are even within $250 of the $1,994 total base and
         overtime income claimed. Additionally, recent paystubs project only $1,796 gross monthly
         income and indicate that the borrower averaged only 40.8 hours/week over six-weeks. While the
         borrower’s recent promotion to management explains the large increase in base pay, there is no
         explanation for the continual decline in overtime income shown on the verification(s) of
         employment, W-2’s, and paystubs.
         AUDITEE COMMENTS: The [employment verification] confirmed the borrower’s base pay of
         $1,734 and a 12-month average of the 2001 overtime earning of $260 to qualify. See Exhibit 24.
         The year to date overtime was for only a six week period (at most) and we did not put much
         weight on this since the [verification] confirmed that the borrower’s average hours worked per
         week was 48 and the probability of employment was good. As such, we actually used a more
         conservative approach in calculating the overtime income of $260 by utilizing the 2001 average
         as the overtime income based on the [verification] would have amounted to $520 of monthly
         overtime income. Further, if the overtime income was calculated by utilizing the verified 110
         week period (1/1/00-2/11/02), the monthly overtime income would have amounted to $296. In
         addition, there was additional Social Security income that was not used in calculating the
         applicable income. With the $1.00 per hour raise the borrower received 8/24/01, the total
         earnings over the past 2 years supported our income calculation. We respectfully submit that
         this finding is not valid.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman failed to adequately verify income used
         to qualify. As previously stated, the file does not contain an explanation for the continual
         decline in overtime income shown on the verification(s) of employment, W-2’s, and pay stubs.

         Inconsistent/Questionable Documentation
         CRITERIA:      HUD Handbook 4000.4, Revision-1, Change-2, Paragraph 2-4C2 requires
         underwriters to review appraisal reports and compliance inspections performed by fee and staff
         personnel to ensure reasonable conclusions, sound reports, and compliance with HUD
         requirements. HUD Handbook 4150.1, Revision-1, Paragraph 6-10B states requires each
         appraisal report to contain at least one conventional comparable, if available, and says that the
         data should include comparable sales in competing neighborhoods and should not necessarily be
         limited to the subject neighborhood or subdivision or block.
         OIG FINDING: Although the appraisal report notes that the appraiser used the best comparable
         properties available, all three comparable properties were FHA financed.

         2004-KC-1004                               Page 64


Table of Contents
                                                                                              Appendix C

         AUDITEE COMMENTS: The appraiser addressed this fully in his report. Significantly, he did not
         use any conventional properties because they were not comparable. He stated clearly in his
         report that other sales would have resulted in larger and or less desirable adjustments. This
         property is located in an area that predominately has FHA financing for the source of mortgage
         money. The HUD guidelines state that conventional are to be used if available. Importantly,
         they were not available for this appraisal as stated by the appraiser. See Exhibit 25. We
         respectfully submit that this finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: The appraisal does mention the word conventional
         when noting that other sales would have resulted in larger and or less desirable adjustments and
         does not state that conventional properties were not available.


         FHA CASE NUMBER: 133-0103108                      DATE OF LOAN CLOSING: 4/3/2002
         LOAN PURPOSE: Purchase                            INSURED AMOUNT: $83,686
         UNDERWRITER TYPE: Automated                       HOUSING/DEBT RATIOS: 15.76/24.70
         STATUS AS OF 3/31/2004: Foreclosure started. First default reported after 19 payments.

         Inconsistent/Unsupported Assets
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $2,550 and the borrower needed $3,824 to close. According to the settlement
         statement, the borrower only needed $2,472 to close after taking out earnest money and borrower
         prepaid expenses. According to the Desktop Underwriter Findings Report, the borrower’s assets
         consisted of a checking account with a $4,805 balance. While one page of a 3/7/02 bank-
         stamped printout supports the balance used, the other pages were not provided. While a 2/27/02
         bank statement reveals a $3,250 unexplained deposit on 2/15/02, documentation shows that the
         borrower owned several savings bonds with a total value in excess of the unexplained deposit.
         Also, it is not clear whether there were any large deposits between 2/27/02 and 3/7/02. In a
         4/27/04 meeting, Gershman indicated that Desktop Underwriter does not require documentation
         when exchanged securities are sold.
         AUDITEE COMMENTS: Gershman’s loan file has copies of the borrowers’ bank account
         statements and bank generated computer printouts for a period of 12/17/01-3/4/02. There was
         one deposit that was more than 2% of the sales price as conditioned on the Desktop Underwriter
         Findings. This deposit on 2/15/02 was for $3,249.60 and the source of funds is verified by the
         documentation of the borrower’s ownership of U.S. Savings Bonds valued at $6,229.08. See
         Exhibit 26. There was a computer generated Savings Bonds calculator statement from the U.S.
         Treasury website showing the value of the Savings Bonds owned by the borrower. This
         statement was generated from the internet and was consistent with the copies of the savings
         bonds provided. It showed the value of the bonds as of 1/27/02 and confirmed the value of the
         bond cashed in for $3,249.60. See Exhibit 27. This statement was signed by the borrower’s
         mother to use as verification of the value of the bonds. Consistent with HUD guidelines,
         Gershman accepted this as documentation and explanation for the large deposit. The bank-
         stamped printout was a total of 4 pages and shows the activity of the account from 1/29/02-
         3/4/02. See exhibit 28. There were no unexplained deposits reflected on this printout. The



                                                    Page 65                                  2004-KC-1004


Table of Contents
         Appendix C

         borrower’s assets were properly documented. Gershman respectfully submits that the auditor’s
         finding is not valid.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         borrower’s assets were properly documented. We have removed this deficiency from Finding 1
         and adjusted Appendix B.


         FHA CASE NUMBER: 292-4169219                     DATE OF LOAN CLOSING: 4/19/2002
         LOAN PURPOSE: Purchase                           INSURED AMOUNT: $69,903
         UNDERWRITER TYPE: Automated                      HOUSING/DEBT RATIOS: 20.02/37.95
         STATUS AS OF 3/31/2004: Delinquent. First default reported after five payments.

         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report requires employment income be supported
         by the most recent year-to-date pay stub documenting one full month's earnings and a written,
         verbal, or electronic verification acceptable to FHA. Desktop Underwriter allows income from a
         second job (part-time) to be used in qualifying if the borrower has worked the part-time job
         uninterrupted for the past two years and will continue to do so; if the income has been received
         for less than two years, it may be included provided the lender determines that the income’s
         continuance is likely. Furthermore, if the current employer does not confirm a two-year
         employment history, Desktop Underwriter requires lenders to obtain W-2(s), verification(s) of
         employment, IRS income verification, or electronic verification for the most recent two years.
         OIG FINDING: The Desktop Underwriter Findings Report lists the borrower’s monthly base pay
         as $1,994 and other monthly earnings of $1,115. The $1,994 monthly base pay from Employer
         A was based on year-to-date gross income for 2.5 months and includes overtime without
         establishing a two-year pattern; the borrower’s year-to-date base monthly income was only
         $1,636. The $1,115 other monthly earnings was based on the first pay stub from a job with
         Employer B that the borrower started approximately one month before closing; however, the
         verification of employment for this job stated that the likelihood of continuation was only 50/50.
         Additionally, while the underwriting worksheet notes, "using averages for two current jobs this
         average equals $3109/mo; 2001 average for all jobs worked = $5499/month," there were several
         inconsistencies in the verifications of the third source of monthly income and W-2’s located in
         the case binders show only $1,959 average gross monthly income for the previous two years.
         Gershman did not adequately support the employment income used to underwrite this loan.
         AUDITEE COMMENTS: Excluding any overtime income, based upon the [employment
         verification] for [Employer A] and [Employer B] the borrower’s monthly base income was
         verified to be $1525 and $1776, respectively, for a total monthly base income of $3301. The
         $1115 computed for [Employer B], as inputted into Desktop Underwriter, was for less than the
         full pay period. After factoring her fixed expenses of $1161 her [debt] ratio equaled 35% which
         was acceptable pursuant to HUD guidelines.
         The employment verification from [Employer B] indicated that there was a 50/50 chance on
         probability of continued employment, but it was also stated that the borrower seemed reliable
         and that she would probably receive a pay increase in 90 days. The underwriter determined that
         this income was acceptable because of the borrower’s experience in the nursing field. We
         respectfully submit that the borrower’s income was properly submitted.

         2004-KC-1004                               Page 66


Table of Contents
                                                                                             Appendix C

         OIG EVALUATION OF AUDITEE COMMENTS: While we concur that Gershman adequately verified
         the income from Employer B, they did not properly verify the overtime income from Employer
         A. Desktop Underwriter requires all data entered, downloaded, or imported to be true, accurate,
         and complete. Gershman did not enter any overtime income into the system and instead entered
         all income from Employer A as base income. This is significant as Desktop Underwriter
         provides different messages for the various types of income and typically requires all overtime
         income be verified and documented according to current FHA standards (see FHA Case Number
         292-3998744, 292-4076992, etc). HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-
         7A requires lenders to develop a two year average of bonus or overtime income. Periods of less
         than two years may be acceptable provided the underwriter adequately justifies and documents
         his or her reason for using the income for qualifying purposes. This loan did not contain the
         necessary documentation to support the income used to qualify. After removing the $469
         overtime income ($1,994 total - $1,525 base), the remaining income totals $2,640 ($1,525 +
         $1,115). This amount corresponds to a 44% debt ratio, which exceeds the 41% threshold defined
         in HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-12.

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Finding Report requires that the lender verify the gift and
         document the transfer of gift funds in accordance with HUD ML 00-28. Mortgagee Letter 00-28
         says that when the transfer of gift funds occurs at closing, the lender remains responsible for
         obtaining verification the closing agent received funds from the donor for the amount of the
         purported gift. Additionally the Findings Report requires lenders to verify cash reserves, which
         are not to include funds received as a gift.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $2,130 and the borrower needed $2,648 to close. According to the final
         settlement statement, the borrower needed $1,305 to close after taking out earnest money, seller
         paid expenses, and borrower prepaid expenses. According to the Desktop Underwriter Findings
         Report, the borrower’s assets consisted of a $50 bank account and a $3,000 gift not yet
         deposited. However, the underwriting worksheet, settlement statement, and gift documents
         indicate that the gift amount was only $2,500.
         AUDITEE COMMENTS: There was no impact in Desktop Underwriter regarding the borrower’s
         reserves. Gift funds excess not included. At the time of closing, the actual amount of the gift
         was for $2,500. This would not have affected the Desktop Underwriter Findings Report because
         gift funds are not included as reserves. The cash reserves would have remained $50 and it would
         not have changed the underwriting decision. We respectfully submit that this finding is not
         valid.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that Desktop
         Underwriter does not include excess gift funds in cash reserves. However, Gershman agrees that
         the information submitted to Desktop Underwriter was incorrect. Desktop Underwriter requires
         all data entered, downloaded, or imported to be true, accurate, and complete.


         FHA CASE NUMBER: 292-4171792                     DATE OF LOAN CLOSING: 5/24/2002
         LOAN PURPOSE: Purchase                           INSURED AMOUNT: $124,019
         UNDERWRITER TYPE: Automated                      HOUSING/DEBT RATIOS: 32.77/47.93

                                                   Page 67                                  2004-KC-1004


Table of Contents
         Appendix C

         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after eight payments.

         Inconsistent/Unsupported Income
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: The Desktop Underwriter Findings Report lists co-borrower monthly base
         income of $1,993. While the year-to-date section on a recent paystub indicates average gross
         monthly income of $2,169, the current base pay projects a base monthly income of only $1,645.
         Additionally, W-2’s and tax returns call into question the stability of the co-borrower’s
         employment and income. In 2000, the co-borrower averaged $352 gross monthly income and
         had three employers and an unsuccessful attempt at self-employment. In 2001, she averaged
         $1,394 gross monthly income and was employed by only two employers during the year,
         including her current employer. Gershman failed to establish the stability of the co-borrower’s
         employment and income.
         AUDITEE COMMENTS: The co-borrower’s pay stub dated 5/08/2002 shows straight time hours at
         66 and PTO (paid time off) hours of 13.75 for a total of 79.75 hours. See Exhibit 29. The pay
         stub specifically reflects a benefit for PTO and thus should be properly counted when analyzing
         the co-borrower’s income. The year to date earnings supported that the co-borrower was
         working at least 40 hours per week. It appears that the auditor did not take the PTO hours into
         consideration when projecting her base pay above.
         There was no reason to question the stability of employment. The co-borrower had, in fact,
         worked consistently for the past 2 years. She attempted to work as a self-employed hairstylist
         and although she was not successful, she found subsequent employment within 1 month when
         she went to work for [Employer A]. This was supported by a W-2 and she remained in the
         service industry for over 2 years. Gershman underwrote this loan according to HUD guidelines.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s income calculations
         and explanations regarding the stability of income. We have removed this deficiency from
         Finding 1 and adjusted Appendix B.

         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Findings Report required net equity from pending sales be
         verified with a fully executed settlement statement.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $3,750 and the borrower needed $7,289 to close. According to the settlement
         statement, the borrower only needed $5,870 to close after taking out earnest money and borrower
         prepaid expenses. According to the Desktop Underwriter Findings Report, the borrowers’ assets
         consisted of $16,022 proceeds from the sale of their prior residence and a $351 bank account.
         However, the final settlement statement for the sale shows only $13,961 cash to the borrower at
         settlement. Had the correct amount of assets been entered, the borrower would have had
         different reserves than claimed on Desktop Underwriter, and it is not clear if Desktop
         Underwriter would have approved the loan. In a 4/16/04 meeting, Gershman noted that because
         the borrowers ended up having more reserves than claimed on the Desktop Underwriter Findings
         Report, they did not resubmit the loan.
         AUDITEE COMMENTS: It is Gershman’s policy and practice to carefully review all loans before
         loan closing to determine that the minimum cash investment has been made, the amount of cash
         needed to close is sufficient, and the cash reserve requirement from the Desktop Underwriter
         Findings Report has been met. The Underwriter Findings showed cash to close of $9,001. The

         2004-KC-1004                               Page 68


Table of Contents
                                                                                                 Appendix C

         [settlement statement] showed the actual cash required to close of $5,869 and cash paid outside
         of closing for homeowner’s insurance of $524 for a total of $6,393. So, the actual amount to
         close was less than the amount used in Desktop Underwriter.
         The Underwriter Findings reported net equity from sale of their home of $16,022. The actual
         proceeds from sale of their home was $13,961 which when added to their $351 cash gave them
         assets to close of $14,321. After deducting the actual cash requirement of $6,393, this left cash
         reserves of $7,928. This is more than the cash reserves stated on the Underwriter Findings of
         $7,372. Therefore, there was no reason to resubmit this loan through Desktop Underwriter. We
         respectfully submit that this finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman’s $6,393 actual cash requirement
         calculation did not include $343 for expenses paid outside closing or $500 for the borrower’s
         cash deposit. According to Section VI of the Desktop Underwriter Government Underwriting
         Service User’s Guide for FHA Loans, the loan file must contain evidence that deposits have
         cleared the borrower’s account. With the corrected requirement of $7,236, the cash reserves
         would be $7,085, less than the amount used in Desktop Underwriter. Regardless, the asset
         information submitted to Desktop Underwriter by Gershman was incorrect.


         FHA CASE NUMBER: 133-0103574                       DATE OF LOAN CLOSING: 6/14/2002
         LOAN PURPOSE: Purchase                             INSURED AMOUNT: $96,485
         UNDERWRITER TYPE: Automated                        HOUSING/DEBT RATIOS: 17.16/55.92
         STATUS AS OF 3/31/2004: First legal action to foreclosure. First default reported after 13 payments.

         Inconsistent/Underreported Liabilities
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-11A requires lenders to
         include all recurring charges, including real estate loans, when computing qualifying ratios.
         Paragraph 2-12 instructs that lenders to compute two ratios: the housing ratio and the debt ratio;
         these ratios should not exceed 29/41% respectively unless significant compensating factors are
         presented. Desktop Underwriter requires resubmission if any liabilities over $100 per month had
         been omitted.
         OIG FINDING: The underwriting worksheet shows gross monthly income of $4,739, total fixed
         payments of $2,650, and ratios of 17.16% and 55.92%. The Desktop Underwriter Findings Report
         shows an additional $750 monthly income (rental income), total fixed payments of $2,108, and
         ratios of 14.82% and 38.41%. Gershman failed to explain the $542 total fixed payments difference
         between the two documents. While a lease agreement and sales contract confirm a $750/month 2-
         year lease agreement and a 6/7/04 closing date, the credit report shows a $97,509 current mortgage
         on the property with a monthly payment $228 more than the monthly rental income. Gershman
         underreported monthly liabilities by $978 by failing to include the mortgage payment in the Desktop
         Underwriter underwriting analysis. When the mortgage is included, debt ratio jumps to over 56%.
         AUDITEE COMMENTS: After a careful review of this file and performing a manual underwrite, we
         determined that the housing ratio and the [debt] ratio were within the applicable HUD
         guidelines. The base monthly income of $4739 was actually understated and has been
         recalculated to be $4822. The debt stated on the underwriting worksheet and in Desktop
         Underwriter were both inaccurate as they overstated the recurring expenses. After review, the
         recurring expenses were $1495. This was computed by utilizing $728 of debt reflected on the

                                                      Page 69                                    2004-KC-1004


Table of Contents
         Appendix C

         credit report, $350 child support and $416 for the negative net rental income. The negative net
         rental income was computed by taking 75% of the lease payment ($750 x .75 = $562) and
         deducting that amount from the mortgage payment ($978). Therefore, the housing ratio was
         17% and the [debt] ratio was 47.7%. After considering the applicable compensating factors the
         approval of this loan was fully warranted. The applicable compensating factors were the
         following: 1) The borrowers had successfully demonstrated the ability to pay housing expenses
         greater than the proposed monthly housing expense for the new mortgage over the past 12-24
         months. The credit report shows no late payments for the past 12 months and the borrowers had
         this loan for 2 years, 2) The borrower has substantial documented 11 months of cash reserves
         available after closing, 3) The borrower had a long-term employment history (21 years) with the
         government. We respectfully submit that we made an appropriate underwriting decision
         consistent with HUD guidelines regarding this loan.
         OIG EVALUATION OF AUDITEE COMMENTS: Desktop Underwriter requires all data entered,
         downloaded, or imported to be true, accurate, and complete. Gershman agrees that the
         information entered into Desktop Underwriter was inaccurate and incomplete. Additionally,
         Gershman agrees that the qualifying ratios were calculated incorrectly and inconsistently.
         Gershman did not manually underwrite this loan. Regardless, the underwriting worksheet did
         not document significant compensating factors as required by HUD to exceed qualifying ratios
         on a manually underwritten loan. Additionally, while we did not verify the base monthly income
         or all recurring expenses now claimed by Gershman, we observed that the reduction in monthly
         child support from $475 to $350 is not sufficiently documented and that Gershman’s $416
         negative net rental income calculation failed to include $48 homeowner’s insurance ($575
         annual premium / 12 months = $48) and should have been $464.


         FHA CASE NUMBER: 132-1565888                       DATE OF LOAN CLOSING: 6/14/2002
         LOAN PURPOSE: Purchase                             INSURED AMOUNT: $54,150
         UNDERWRITER TYPE: Automated                        HOUSING/DEBT RATIOS: 14.62/32.83
         STATUS AS OF 3/31/2004: First legal action to foreclose. First default reported after nine payments.

         Inconsistent/Unsupported Assets
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $1,650 and the borrower needed $3,063 to close. According to the settlement
         statement, the borrower only needed $2,540 to close after taking out earnest money and borrower
         prepaid expenses. According to the 6/12/02 Desktop Underwriter Findings Report, the
         borrower’s assets included a checking account ($3341) and two savings accounts ($31). While a
         6/11/02 verification of deposit confirms the three balances, the lender portion shows that they
         were only trying to verify a $358 checking account balance. Additionally, a 5/13/02 Desktop
         Underwriter Findings Report lists the checking account balance as $358, lists a $3,000 gift not
         yet deposited, and has a handwritten note on it saying "will take Gift off. All will be in SAV.
         No Gift." In a 4/16/04 meeting, Gershman noted that the 5/13/02 Desktop Underwriter Findings
         Report was created the day the application was taken; because they later realized that there was
         no gift, they did not list a gift on the 6/12/02 Desktop Underwriter Findings Report. Gershman



         2004-KC-1004                                 Page 70


Table of Contents
                                                                                               Appendix C

         failed to adequately verify cash reserves and explain/document the large checking account
         balance increase.
         AUDITEE COMMENTS: On the original loan application, the borrower stated that he had $4,500 in
         his bank accounts. There is no mention of a gift on the application. The loan processor made an
         input error when loading the assets into our processing system, and subsequently downloaded
         into desktop underwriter. Our processing system prepares the deposit verification with the
         information loaded by the processor. Therefore, the deposit verification was sent out with an
         understated amount in the checking account. The verification of deposit received back from the
         bank on 6/11/02 indicated the borrower had $3,341 in his checking account. See Exhibit 30.
         The average balance for the previous two months was $4,480, therefore, there was no increase in
         the balance, and the amount of cash reserve was properly documented and actually understated.
         When the desktop underwriter findings were reviewed and compared to the initial application,
         the processor corrected the assets on the application to match the assets verified. The initial and
         final application signed by the borrower states that the source of funds for closing was from
         savings and checking accounts. Our loan file was properly documented. Gershman respectfully
         submits that the audit finding is incorrect.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur that the loan file was properly
         documented, as the average checking account balance for the previous two months was $4,480
         and the source of funds was listed as savings and checking accounts on the applications. We
         have removed this deficiency from Finding 1 and adjusted Appendix B.




         FHA CASE NUMBER: 292-4194032                 DATE OF LOAN CLOSING: 6/21/2002
         LOAN PURPOSE: Purchase                       INSURED AMOUNT: $78,764
         UNDERWRITER TYPE: Manual                     HOUSING/DEBT RATIOS: 22.68/41.22
         STATUS AS OF 3/31/2004: Repayment. Borrower declared bankruptcy on 7/11/2003.


         Inadequate Qualifying Ratios
         CRITERIA: According to the Desktop Underwriter Findings Report, this case was referred
         because the risk exceeds the risk threshold for automated approval for an FHA loan. An FHA
         registered direct endorsement underwriter must analyze the loan and determine if the borrower
         meets FHA standard capacity and credit policy guidelines. Desktop Underwriter required
         documentation to support the omission of several debts and required a direct endorsement
         underwriter to determine that any short term debt, including those omitted by Desktop
         Underwriter, would not negatively affect the borrower’s ability to make mortgage payments
         during the early months of the loan following loan settlement. The Desktop Underwriter
         Findings Report indicates that the direct endorsement approval form requires a direct
         endorsement underwriter signature and says that only a direct endorsement lender could submit
         the loan for endorsement. HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-12
         instructs that lenders must compute two ratios: the housing ratio and the debt ratio; these ratios
         should not exceed 29/41% respectively unless significant compensating factors are presented.
         OIG FINDING: While the direct endorsement approval form has a direct endorsement
         underwriter signature, the underwriting worksheet does not. The underwriting worksheet also

                                                     Page 71                                   2004-KC-1004


Table of Contents
         Appendix C

         shows Desktop Underwriter as the underwriter and lists the debt ratio as 41.22% without
         including compensating factors. There is no documentation to support the omission of a debt
         with Toyota ($14,749/$375); with this debt included, the debt ratio is 54.44%. Additionally,
         there is no documentation proving that an FHA registered direct endorsement underwriter
         determined whether short-term debt would negatively affect the borrower’s ability to make the
         early mortgage payments. In a 4/27/04 meeting, Gershman noted that this loan would have been
         approved if manually underwritten.
         AUDITEE COMMENTS: This file was reviewed and underwritten by a Direct Endorsement
         underwriter. The [underwriting worksheet] and direct endorsement approval were incorrectly
         completed showing Desktop Underwriter. The approval form was also signed by a Direct
         Endorsement underwriter, certifying the loan was rated refer and was manually underwritten.
         See Exhibit 31.
         It has always been our policy when manually underwriting FHA loans to round ratios down
         which in this case would have been 41% and thus we would not have listed the compensating
         factors. However, several compensating factors did exist. Specifically, the borrower earned
         commission income not used to qualify, bonus income was not used to qualify, and additional
         child support income was not used to qualify. Using any one of these would have lowered the
         qualifying ratio under 41%.
         After carefully reviewing the file, we have determined the Toyota debt was properly omitted
         because the applicant had sold this vehicle. The credit report dated 4/25/02 showed the last date
         verified as May 2000 and the account was closed. The credit report also showed an auto loan
         that was taken out in March of 2001. She acquired a new vehicle at that time and as a single
         person did not have a need for 2 cars. The borrower confirmed that she sold the Toyota car in
         2000 and the debt was paid off. (Borrower will provide confirmation in writing if necessary).
         We respectfully submit that the auditor’s finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: The underwriter signed direct endorsement approval
         serves as documentation to support that the underwriter determined whether short-term debt
         would negatively affect the borrower’s ability to make the early mortgage payments. However,
         Gershman failed to include documentation to support the omission of the debt with Toyota when
         underwriting the loan as required by the Desktop Underwriter Findings Report. It should also be
         noted that while the credit report indicates the account is closed to further purchases, it shows a
         balance due.




         FHA CASE NUMBER: 133-0104240                           DATE OF LOAN CLOSING: 8/23/2002
         LOAN PURPOSE: Purchase                                 INSURED AMOUNT: $65,472
         UNDERWRITER TYPE: Automated                            HOUSING/DEBT RATIOS: 20.51/47.37
         STATUS AS OF 3/31/2004: Case no longer active. While HUD paid a claim of $71,010, the amount
         of the loss is not known at this time. First default reported after one payment.


         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report requires all employment income be
         supported by paystubs documenting one full month of income and a written, verbal, or electronic

         2004-KC-1004                                Page 72


Table of Contents
                                                                                                 Appendix C

         verification of employment acceptable to FHA. HUD Handbook 4155.1, Revision-4, Change-1,
         Paragraph 2-6 requires lenders to examine the borrower’s past employment record, qualifications
         for the position, previous training and education, and the employer’s confirmation of continued
         employment. Additionally, Paragraph 2-7Q indicates that projected or hypothetical income is
         acceptable for qualifying purposes only when verified with the employer.
         OIG FINDING: The Desktop Underwriter Findings Report lists the borrower’s monthly income as
         $2,279. A 7/31/02 paystub indicates gross monthly income average of only $1,843. While an
         8/12/02 letter from the employer indicates that the borrower will get a 6% raise on 2/28/03, a second
         8/12/02 letter located only in the Gershman file indicates that because the borrower recently
         completed Certified Physician Assistant training “in the top 5% of her class, on the September of
         2002 paycheck will show her new salary of $27,360.00 annually that is rewarded for all students
         who score this high." While there were no explanations for the conflicting letters, the $2,279
         monthly income used to underwrite this loan corresponds to the letter located only in the Gershman
         file. Gershman failed to adequately verify the borrower’s employment and income.
         AUDITEE COMMENTS: This loan was underwritten using Desktop Underwriter. The loan
         processor accepted a letter from an Assistant Professor at [University A] stating that the
         borrower’s income would be $27,360 a year because of placement in her class in the top 5%.
         The file also contained a letter from the same person dated the same day that the processor felt
         contained incorrect information and asked for a new letter.
         OIG EVALUATION OF AUDITEE COMMENTS: Desktop Underwriter requires all data entered,
         downloaded, or imported to be true, accurate, and complete. This file did not contain adequate
         documentation that Gershman attempted to resolve the discrepancies noted. Gershman
         submitted to HUD the employment verification that its processor felt contained incorrect
         information.


         Inconsistent/Unsupported Assets
         CRITERIA: The Desktop Underwriter Finding Report requires depository assets be verified by
         either a verification of deposit, the most recent statement showing the previous month’s balance,
         or the most recent two months statements.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $1,995 and the borrower needed $3,113 to close. According to the settlement
         statement, the borrower only needed $1,178 to close after taking out earnest money, seller paid
         expenses, and borrower prepaid expenses. The Desktop Underwriter Findings Report includes a
         checking account with a $2,630 balance as an available asset. While the 7/31/02 checking
         account statement shows previous and new balances of $2,705 and $2,630 respectively, the 2
         (representing $2,000) on these balances is crooked and is not present on any of the transaction
         date balances. Direct verification with the credit union indicated 7/1/02 and 7/31/02 balances of
         $705 and $630 respectively, confirming that the bank statement submitted in the HUD case
         binder was altered, causing assets to be overstated by $2,000.
         AUDITEE COMMENTS: This loan was approved by Desktop Underwriter. The documentation for
         the asset verification submitted by the borrower was accepted. The processor checked the
         verification for the beginning and ending balances and used the ending balance for the bank
         account balance. The balance totals were not checked and the statement was not questioned. If
         the bank statement was altered, it was without our knowledge.


                                                      Page 73                                   2004-KC-1004


Table of Contents
         Appendix C

         OIG EVALUATION OF AUDITEE COMMENTS: Desktop Underwriter requires all data entered,
         downloaded, or imported to be true, accurate, and complete. This file did not contain adequate
         documentation that Gershman attempted to resolve the discrepancy noted.




         FHA CASE NUMBER: 292-4218860                    DATE OF LOAN CLOSING: 8/29/2002
         LOAN PURPOSE: Purchase                          INSURED AMOUNT: $63,462
         UNDERWRITER TYPE: Automated                     HOUSING/DEBT RATIOS: 28.39/31.79
         STATUS AS OF 3/31/2004: Reinstated by mortgagor. First default reported after 12 payments.


         Inconsistent/Unsupported Income
         CRITERIA: The Desktop Underwriter Findings Report requires explanation for gaps in
         employment of two months or longer. Additionally, employment income be supported by the
         most recent year-to-date pay stub documenting one full month's earnings and a written, verbal or
         electronic verification of employment acceptable to FHA.
         OIG FINDING: The application indicates that the borrower has been with his current employer
         since 5/1/01 and was employed with his previous employer from 6/00-2/01. While W-2’s
         indicate two additional employers during the past two years, the three-month gap in employment
         is not explained.
         AUDITEE COMMENTS: According to the loan application, the borrower was 19 years old when he
         applied for the loan in August of 2002 and his driver’s license confirmed his age. He would
         have graduated high school in May of 2001. Jobs previous to May of 2001 would have been part
         time jobs while he was in high school. Therefore, we respectfully submit that there was no gap
         in employment requiring an explanation.
         OIG EVALUATION OF AUDITEE COMMENTS: While the borrower may have been a student prior
         to May 2001, Gershman did not obtain verification of prior student status for the borrower.


         Inconsistent/Underreported Liabilities
         CRITERIA: According to HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-11A, the
         borrower's liabilities include all installment loans, revolving charge accounts, real estate loans,
         alimony, child support, and all other continuing obligations.
         OIG FINDING: The Desktop Underwriter Findings Report lists borrower debts including a
         $4,550 student loan with $15 monthly payments. However, neither the credit report nor the loan
         statements show a monthly payment amount, and the loan statement shows a different balance.
         According to the direct loans home page (www.ed.gov/DirectLoan), the minimum monthly
         payment for the standard or extended repayment plan is $50. Gershman failed to document how
         it arrived at the monthly payment amount used in the underwriting analysis.
         AUDITEE COMMENTS: The student loan statement in our loan file showed no payment due date.
         This was confirmed by the credit report. We did not obtain information about the length of
         deferment so we counted a student loan payment $15 per month as a payment estimated from the

         2004-KC-1004                                Page 74


Table of Contents
                                                                                            Appendix C

         statement in our file. Importantly, if we had counted a payment of $50, the [debt ratio] would
         have been 33.6%. This loan would have been approved by Desktop Underwriter.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         correct monthly payment would not increase the ratios substantially. Regardless, Gershman did
         not submit accurate and complete data as required by Desktop Underwriter.




         FHA CASE NUMBER: 133-0104569                     DATE OF LOAN CLOSING: 10/1/2002
         LOAN PURPOSE: Purchase                           INSURED AMOUNT: $95,044
         UNDERWRITER TYPE: Manual                         HOUSING/DEBT RATIOS: 24.54/42.53
         STATUS AS OF 3/31/2004: Delinquent. First default reported after 0 payments.


         Inconsistent/Unsupported Income
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Chapter 2 requires that the lender
         establish the borrower's capacity to repay the mortgage debt. Specifically, Paragraph 2-7
         requires lenders to develop a two-year average of bonus or overtime income.
         OIG FINDING: According to the underwriting worksheet, the borrower’s monthly base income is
         $3,624. W-2’s indicate average monthly income of only $3,064 in 2000 and $3,073 in 2001.
         While paystubs show only $3,035 base monthly income, a handwritten note on one paystub
         indicates, "Base = 3,035 mo; ytd = 4,559 mo avg.; ytd+2001 = 3,624 mo." The base monthly
         income computed by Gershman included overtime income when it was not adequately verified.
         AUDITEE COMMENTS: We underwrote the loan using alternative documentation for income
         verification as permitted by HUD guidelines. According to HUD guidelines, we were required
         to obtain pay stubs covering the most recent 30-day period, along with IRS W-2 forms from the
         previous 2 years. We properly obtained pay stubs for 7/19/02 and 8/02/02 and W-2’s from 2000
         and 2001. The pay stubs provided by the employer covered the most recent 30-day period.
         Since this was the method of income verification required by HUD for alternative
         documentation, we did not have a breakdown detail of the overtime worked for 2000 and 2001.
         Thus, we took a 19.06 month average of the borrower’s earnings to determine her monthly
         income. We respectfully submit that we made the proper income determination consistent with
         HUD guidelines.
         OIG EVALUATION OF AUDITEE COMMENTS: While the loan file did contain alternative
         documentation, Gershman was still required to follow HUD requirements for including overtime
         income for qualifying purposes. HUD Handbook 4155.1, Revision-4, Change-1, Chapter 2
         states that overtime income may be used to qualify if the borrower has received such income for
         approximately the past two years and there are reasonable prospects of its continuance. Periods
         of less than two years may be acceptable provided the underwriter adequately justifies and
         documents his or her reason for using the income for qualifying purposes. Based on the
         borrower’s W-2’s and base income amount, it appears that overtime has been received for less
         than eight months. Gershman failed to adequately justify and document its reason for including
         the overtime income for qualifying purposes.




                                                   Page 75                                 2004-KC-1004


Table of Contents
         Appendix C

         Inconsistent/Unsupported Assets
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-10 requires all funds for
         the borrower's investment in the property be verified. Paragraph 2-10B requires an explanation
         and evidence of source of funds be obtained when there is a large increase in a checking or
         savings account balance.
         OIG FINDING: According to the underwriting worksheet, the statutory minimum required
         investment was $2,940 and the borrower needed $4,492 to close. According to the settlement
         statement, the borrower only needed $1,367 to close after taking out earnest money, seller paid
         expenses, and borrower prepaid expenses. According to the underwriting worksheet, the
         borrower’s assets included three bank accounts with balances of $2,647, $150, and $2,748.
         While bank statements and printouts located in the HUD and/or Gershman case files support the
         account balances, they also reveal five unidentified deposits totaling $7,812. According to a
         note located in the HUD Case Binder, the borrower took $3,500 out of a joint account and
         $4,000 out of a personal account after her divorce, and has since re-deposited some of the money
         for closing costs. While there is a $4,000 withdrawal from one of the borrower’s accounts, there
         is no documentation to support the remaining $3,812 in unexplained deposits. Documentation is
         necessary as the borrower always deposited the full amount of her payroll . In a 4/2/02 meeting,
         Gershman noted that they only confirm large deposits when they are needed for the investment.
         AUDITEE COMMENTS: The auditor indicated there were $3,812 of unexplained deposits. This
         consisted of four deposits of $838, $363, $500, and $510 along with $1600 that was part of a
         $5600 deposit. We respectfully submit that none of these deposits are in excess of 2 percent of
         the sales price and therefore, would not have been considered large deposits requiring an
         explanation under HUD guidelines. Despite the fact that we were not required to obtain such
         documentation, the borrower did provide a letter of explanation that accounted for $7,500. The
         $4000 deposit noted by the auditor was included in the $7,500 but the remaining $3,500 would
         account for most of the $3,812 deposited. See Exhibit 32. We respectfully submit that this
         finding is not supported.
         OIG EVALUATION OF AUDITEE COMMENTS: HUD regulation does not specify that only deposits
         in excess of 2% of the sales price be considered large deposits. As documented above, the
         unexplained deposits represent a large increase in the borrower’s account balances. While
         Gershman did obtain an explanation from the borrower, they failed to obtain evidence of the
         source of funds. Gershman should have obtained evidence such as prior bank statements as the
         borrower originally withdrew the $7,500 from personal accounts.


         Inadequate Qualifying Ratios
         CRITERIA: HUD Handbook 4155.1, Revision-4, Change-1, Paragraph 2-12 requires lenders to
         compute two ratios: the housing ratio and the debt ratio; these ratios should not exceed 29/41%
         respectively unless significant compensating factors are listed in the remarks section of the
         underwriting worksheet.
         OIG FINDING: Even though the underwriting worksheet showed a 42.53% debt ratio, it did not
         list any compensating factors. In a 4/2/04 meeting, Gershman indicated that although they failed
         to list compensating factors on the underwriting worksheet, there were several including that the
         borrower has been with current employer for seven years, the borrower was a previous owner,
         the borrower put 5% down, and this loan is not a maximum financing loan.


         2004-KC-1004                               Page 76


Table of Contents
                                                                                                Appendix C

         AUDITEE COMMENTS: While the compensating factors noted by the auditor were not specifically
         included on the [underwriting worksheet], the compensating factors did exist and justify the
         approval of this loan. HUD guidelines clearly anticipate and permit ratios to be exceeded where
         significant compensating factors exist. Based on the amount the borrower actually paid at the
         closing of $1,367, there were 5 months cash reserves after closing. Also, the borrower had a
         previous mortgage payment of $1,248 that was paid as agreed. The proposed housing payment
         was $889. She demonstrated the ability to make timely mortgage payments and had the
         responsibility of owning a home. We respectfully submit that we made the proper underwriting
         decision in accordance with HUD guidelines.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman agrees that the required listing of
         compensating factors was not present on the underwriting worksheet. After reviewing the
         factors Gershman now states that they used, we found that they were unsupported. Because the
         borrower’s previous home was acquired jointly and sold when she divorced, the borrower did
         not successfully demonstrate the ability to pay housing expenses equal to or greater than the
         proposed monthly housing expense over 12-24 months as required by HUD. Additionally, it is
         unclear how Gershman arrived at five months reserves, as the borrower’s $4,178 reserves
         ($5,545 assets -$1,367 paid at closing) only cover 2.7 months of the monthly fixed payment
         listed on the underwriting worksheet.


         Inconsistent/Questionable Documentation
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: There are multiple variations of the borrower’s name found on various
         overlapping dates in the HUD and Gershman case files. Also, although the deed of trust only
         lists the borrower, it does not indicate her marital status. While a 10/1/02 application indicates
         that the title will be held as a marital waiver, a 7/26/02 application indicates that the borrower’s
         husband/ex-husband will hold title and shows a crossed out co-borrower. Additionally, a note
         located in the Gershman file says "Separation or divorce decree; marital waiver?," and the
         settlement statement from the sale of the borrower’s previous residence lists both the borrower
         and her husband/ex-husband as sellers.
         AUDITEE COMMENTS: In regards to the “variations” of the borrower’s name, our file properly
         contained a name affidavit certifying that these names were the same person. See Exhibit 33.
         According to the application taken on July 26, 2002, the borrower indicated she would be
         divorced. Her ex-husband was listed in case the divorce was not finalized and he had to provide
         a marital waiver. There was also another name on the initial application and that individual
         application and that individual decided not to buy the property with the borrower. Therefore, he
         was properly removed from the loan application. We respectfully submit that the auditors
         finding is without basis.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman assertion that the name
         affidavit and explanations provided address the inconsistencies noted. We have removed this
         deficiency from Finding 1 and adjusted Appendix B.




         FHA CASE NUMBER: 292-4281408                       DATE OF LOAN CLOSING: 12/19/2002

                                                     Page 77                                   2004-KC-1004


Table of Contents
         Appendix C

         LOAN PURPOSE: Non-Streamline Refinance            INSURED AMOUNT: $59,529
         UNDERWRITER TYPE: Automated                       HOUSING/DEBT RATIOS: 18.88/29.44
         STATUS AS OF 3/31/2004: Foreclosure started. First default reported after 10 payments.


         Inconsistent/Unsupported Income
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: Tax returns used to support borrower self-employment income were not signed
         by the borrower.
         AUDITEE COMMENTS: Gershman’s loan file contains copies of all the documents that were sent
         to the investor. Accordingly, the signed tax returns were sent by Gershman to the investor who
         purchased the loan. We cannot determine with certainty the reason that we did not make a copy
         of the signature page. However, and importantly, we have been able to have the borrower re-
         sign the tax returns for our file. See Exhibit 34. Gershman respectfully submits that there was
         not material effect on the insurability of this loan and that the missing copy of the signature page
         of the tax returns in our file did not disqualify the borrower from obtaining a HUD-FHA insured
         mortgage.
         OIG EVALUATION OF AUDITEE COMMENTS: Gershman asserts that the tax returns signed prior to
         closing were sent to the investor and has since obtained a signed copy for their records. We
         concur that the missing copy of the tax returns in Gershman’s file did not disqualify the
         borrower. We have removed this deficiency from Finding 1 and adjusted Appendix B.


         Inconsistent/Questionable Documentation
         CRITERIA: Not Applicable. Deficiency has been removed from Finding 1.
         OIG FINDING: The appraisal value in May 2001 was $45,500. According to the December 2002
         appraisal included with this cash-out refinance, the property is valued at $69,000; this indicates
         that the property value increased by over 50% in approximately nineteen months. In a 4/27/04
         meeting, Gershman noted that they did not have a problem with the appraisal as values tend to
         increase over time and the property could have been undervalued in 2001.
         AUDITEE COMMENTS: As stated in the application, the borrower purchased this property in May
         2001 for $45,500. The appraisal of December 2002 states a value of $69,000. In the
         supplemental addendum to the appraisal, the appraiser states, “This area has seen a steady
         increase in value in the last 24 months. Children of ‘baby boomers’ are of house buying age, and
         this area has affordable housing stock. As a result, there has been a steady influx of younger
         home buyers which is forcing prices upwards. The average days on the market in the subject’s
         general area is 35 days, which is below the metro area of 53 days. Also impacting value are
         active listings/pending sales as they typically set the high end of the value range.” See Exhibit
         35. For these reasons, Gershman believes that the value was accurate and justified by the
         appraiser. Further a Gershman Direct Endorsement Underwriter reviewed the appraisal in
         accordance with HUD guidelines and determined the value to be accurate and reasonable. The
         appraised value is supported by comparable sales and there are no large or inconsistent
         adjustments. Gershman notes also that the auditors did not state an opinion as to a valuation
         different than set forth in the appraisal report, or indicate that any of the comparable sales are
         inaccurately reported and not a fair measure of the subject property. Our underwriter performed
         the necessary analysis to assure the value was reasonable. As further support that the value was

         2004-KC-1004                                Page 78


Table of Contents
                                                                                           Appendix C

         reasonable, the property was sold in June 2004 for $99,000. Accordingly, Gershman respectfully
         submits that this finding is not supported and should be dismissed.
         OIG EVALUATION OF AUDITEE COMMENTS: We concur with Gershman’s assertion that the
         underwriter performed the necessary analysis to assure the value was reasonable. We have
         removed this deficiency from Finding 1 and adjusted Appendix B.




                                                  Page 79                                 2004-KC-1004


Table of Contents
         Appendix C




                      THIS PAGE LEFT
                          BLANK
                      INTENTIONALLY




                          Page 80      2004-KC-1004


Table of Contents
                                               Appendix D


         Chart of Loans Examined for Late Endorsement
                    Scope and Methodology




                             Page 81           2004-KC-1004


Table of Contents
         Appendix D




                        THIS PAGE LEFT
                            BLANK
                        INTENTIONALLY




         2004-KC-1004       Page 82


Table of Contents
                                                                                         Appendix E


                                      Auditee Comments
         This appendix contains the cover letter of Gershman’s response to our draft report and their
         comments on Findings 2 and 3. Gershman’s response to the deficiencies cited in Finding 1 was
         transcribed and inserted into Appendix C. While the 35 attachments referenced in Gershman’s
         response are not included in this report, they are available upon request.




                                                Page 83                                  2004-KC-1004

Table of Contents
         Appendix E




         2004-KC-1004   Page 84

Table of Contents
                              Appendix E




                    Page 85   2004-KC-1004

Table of Contents
         Appendix E




         2004-KC-1004   Page 86

Table of Contents
                              Appendix E




                    Page 87   2004-KC-1004

Table of Contents
         Appendix E




         2004-KC-1004   Page 88

Table of Contents
                              Appendix E




                    Page 89   2004-KC-1004

Table of Contents
         Appendix E




         2004-KC-1004   Page 90

Table of Contents