oversight

Cambridge Home Capital, LLC Non-Supervised Mortgagee, Great Neck, NY

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-07-19.

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                 AUDIT REPORT




          CAMBRIDGE HOME CAPITAL, LLC
           NON-SUPERVISED MORTGAGEE
             GREAT NECK, NEW YORK

                        2004-NY-1003

                        July 19, 2004



                       OFFICE OF AUDIT
                     NEW YORK/NEW JERSEY




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                                                             Issue Date
                                                                     July 19, 2004
                                                             Audit Case Number
                                                                     2004-NY-1003




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


FROM: Alexander C. Malloy, Regional Inspector General for Audit, 2AGA


SUBJECT:      Cambridge Home Capital, LLC
              Non-Supervised Mortgagee
              Great Neck, New York

We completed an audit of Cambridge Home Capital, LLC (Cambridge), a non-supervised
mortgagee. The objectives of the audit were to determine whether Cambridge: (1) approved
insured loans in accordance with the requirements of the U.S. Department of Housing and Urban
Development/Federal Housing Administration (HUD/FHA), which require adherence to prudent
lending practices; and, (2) developed and implemented a Quality Control Plan that meets
HUD/FHA requirements. The review covered the period between September 1, 2001 and August
31, 2003.

Our review concluded that Cambridge did not always adhere to prudent lending practices during
the approval process of 11 of the 18 loans that we examined during our audit. In addition, we
found that Cambridge did not document variations in its mortgage charge rate and that its
Quality Control Plan has not been fully implemented.

In accordance with HUD Handbook 2000.06 REV-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 recommendations 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 Garry Clugston, Assistant Regional
Inspector General for Audit, on (716) 551-5755, extension 5901.



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2004-NY-1003              Page ii
Executive Summary
We completed an audit of Cambridge Home Capital, LLC (Cambridge) in Great Neck, New
York, a non-supervised mortgagee. The objectives of the audit were to determine whether
Cambridge: (1) approved insured loans in accordance with the requirements of the U.S.
Department of Housing and Urban Development/Federal Housing Administration (HUD/FHA),
which require adherence to prudent lending practices; and, (2) developed and implemented a
Quality Control Plan that meets HUD/FHA requirements. The audit covered the period between
September 1, 2001 and August 31, 2003 and involved a review of 18 HUD/FHA insured loans
that totaled $4,190,050. A summary of the results of our review is provided below.




Eleven loans with                 We concluded that Cambridge did not always adhere to
                                  prudent lending practices in approving 11 of the 18
underwriting deficiencies
                                  HUD/FHA insured loans we reviewed. In particular, we
                                  noted that 11 of the 18 loans had at least one significant
                                  underwriting deficiency. Some of the underwriting
                                  deficiencies identified are as follows:

Underwriting processing                •   Debt/Income Ratios Exceeded HUD/FHA
deficiencies                               Standards
                                       •   Inadequate Property Valuation
                                       •   Inadequate Asset Verification
                                       •   Inadequate Income Verification
                                       •   Insufficient Gift Information
                                       •   Inadequate Debt Verification
                                       •   Minimum Investment Not Provided
                                       •   Bankruptcy Discharge less than 2 Years

                                  We believe that the underwriting deficiencies occurred
                                  because Cambridge did not ensure that the loans were
                                  approved in accordance with HUD/FHA requirements and
                                  did not ensure that its Quality Control Plan was being fully
                                  implemented. As a result, mortgages were approved for
                                  unqualified borrowers causing HUD/FHA to assume an
                                  unnecessary insurance risk.

Variations in mortgage            Also, our review disclosed that Cambridge did not
charge rates were not             document variations in its mortgage charge rate. HUD’s
documented                        Tiered Pricing Rule limits the variation in the mortgage
                                  charge rate to FHA single-family borrowers when the
                                  borrowers ‘lock in’ the interest rate on or around the same
                                  day, using the same mortgage type (e.g., 30 year fixed), and
                                  the properties financed are located in the same geographical
                                  area. The rule prohibits any variation of more than two-
                                  percentage points in mortgage charge rates (discount
                                  points, loan origination, interest rate and other fees,
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Executive Summary


                         combined). The rule also requires that, for variations in the
                         mortgage charge rates up to two percentage points, the
                         lender base the charges on actual costs incurred in the
                         origination of each respective FHA loan, provide a
                         justification for the variance in the loan file, and retain the
                         record for two years.

                         Cambridge did not document, nor provide adequate
                         justification for variations in its mortgage charge rates. As a
                         consequence, we believe Cambridge’s lending practices
                         may unfairly impose greater borrowing costs on some FHA
                         borrowers. Moreover, we could not determine whether the
                         borrowers received anything of value for discount points
                         that were charged. We attribute this to Cambridge’s failure
                         to properly monitor to ensure compliance with HUD
                         requirements on mortgage charge rates, overages, and
                         tiered pricing.

 Weaknesses in Quality   In addition, Cambridge has not implemented procedures or
 Control Plan            established controls to ensure that all loans defaulting
                         within six months of closing undergo a quality control
 Implementation
                         review. This occurred because Cambridge did not ensure
                         that its Quality Control Plan was being fully implemented.
                         Consequently, Cambridge is not fully utilizing its Quality
                         Control Plan, which is designed to enhance and maintain
                         accuracy, validity, and completeness in its loan origination
                         process.

                         Regarding the first finding, we recommend that Cambridge
  Recommendations        reimburse HUD/FHA for losses on four of the loans that have
                         gone to claim/partial claims and indemnify HUD/FHA
                         against future losses on 10 of the 11 loans identified in
                         Appendix A of this report. Also, Cambridge should provide
                         your office with a corrective action plan containing
                         assurances that all guidelines pertaining to underwriting
                         HUD/FHA insured loans will be followed by its underwriting
                         staff. Regarding the second and third findings, we made
                         specific recommendations for corrective action.

                         Although our audit disclosed significant deficiencies
                         relating to loan underwriting, quality control, and mortgage
                         charge rates, we noted Cambridge has restructured its
                         operations to address some of these deficiencies. For
                         instance, Cambridge has replaced some of its underwriters
                         and no longer contracts with most of the appraisers utilized
                         during the audit period. Cambridge acknowledged that the



2004-NY-1003                 Page iv
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                                                         Executive Summary


                  operational changes were initiated because they became
                  aware of certain weaknesses associated with past practices.
                  Cambridge has been proactive in an effort to affect positive
                  change within its operating and control environments.
                  Notwithstanding, Cambridge needs to address the
                  deficiencies sited in this report to prevent HUD from
                  assuming an unnecessary insurance risk on HUD/FHA
                  insured mortgages.

                  The results of our audit were discussed with Cambridge
Exit conference   personnel throughout the course of the on-site audit work.
                  We forwarded a copy of the draft report for review and
                  comment to Cambridge on May 11, 2004 and held an exit
                  conference on June 16, 2004 at Cambridge’s Offices. We
                  received Cambridge’s narrative response and supporting
                  documentation at the exit conference. Cambridge requested
                  that the narrative response and supporting documentation
                  be included in whole in the report. We included excerpts of
                  the comments with the findings, and provided the complete
                  text in Appendix D of this report; we did not attach the
                  supporting documentation because it was too voluminous.




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2004-NY-1003        Page vi
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Table of Contents
Management Memorandum                                                      i



Executive Summary                                                        iii



Introduction                                                              1



Findings

1.     Inadequate Loan Underwriting Practices Resulted in Approval
       of HUD/FHA Insured Loans for Unqualified Borrowers                 3

2.     Cambridge Did Not Document Variations in its Mortgage
       Charge Rate                                                        7

3.     Cambridge Has Not Fully Implemented Its Quality Control
       Plan                                                             15



Management Controls                                                     19



Follow Up On Prior Audits                                               21


Appendices
     A Summary of Loan Origination Deficiencies                         23


     B-01 to B-11 Narrative Case Presentations                          25

     C Schedule of Questioned Costs and Funds Put to Better Use         43

     D Auditee Comments                                                 45

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Table of Contents




Abbreviations

FHA            Federal Housing Administration
HOC            Home Ownership Center
HUD            U.S. Department of Housing and Urban Development
OIG            Office of Inspector General




2004-NY-1003                          Page viii
Introduction
Cambridge Home Capital, LLC (Cambridge) is a non-supervised mortgagee located at 80
Cuttermill Road, Great Neck, New York. Cambridge became an authorized Direct Endorsement
mortgagee on November 12, 1999 and currently underwrites HUD/FHA insured loans and
conventional loans. During our audit period from September 1, 2001 to August 31, 2003
Cambridge originated, under its Direct Endorsement Program, 436 HUD/FHA insured loans
amounting to $108,721,834 in the New York Field Office area. At March 31, 2004, the
mortgages for 41 of the 436 loans were in default status.



                                 The objectives of the audit were to determine whether
  Audit Objectives               Cambridge: (1) adhered to prudent lending practices and
                                 approved insured loans in accordance with U.S.
                                 Department of Housing and Urban Development/Federal
                                 Housing Administration (HUD/FHA) rules and regulations;
                                 and, (2) developed and implemented a Quality Control Plan
                                 that meets HUD/FHA requirements.

                                 The purpose of our review was to confirm the accuracy of the
  Audit Scope and                material information used as a basis for underwriting and
  Methodology                    closing loans. We obtained background information by:

                                 •   Reviewing relevant HUD regulations, requirements,
                                     and Mortgagee Letters.

                                 •   Examining reports and information maintained on
                                     HUD’s Neighborhood Watch Early Warning System
                                     and Single Family Data Warehouse.

                                 •   Interviewing members of HUD’s Quality Assurance
                                     Division.

                                 To accomplish our audit objectives, we selected a sample
                                 of 18 loans from HUD’s Neighborhood Watch System with
                                 beginning amortization dates between September 1, 2001
                                 and August 31, 2003. In selecting our sample we focused
                                 on identifying loans currently in default, which had very
                                 few or no payments made prior to a first reported default.
                                 As a result, the sample of 18 loans consisted of loans where
                                 borrowers made less than seven payments prior to the first
                                 reported default. The 18 loans in our sample were
                                 HUD/FHA insured loans that totaled $4,190,050. The
                                 results of our detailed testing only apply to the 18 loans
                                 selected and cannot be projected over the universe of the
                                 436 loans.

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Introduction



                 In 14 of the 18 loans in our sample there was a prior sale
                 within one year of the closing date. Many of these
                 properties involved rehabilitation and had a significant
                 increase in the sales price of the property. As a result, we
                 selected eight of the properties to have the appraisals
                 reviewed by the OIG appraiser. The purpose of the reviews
                 was to determine if the estimated value ascribed in the
                 appraisal report was adequately supported; and if not,
                 should Cambridge have known that the appraisal was
                 deficient and returned it to the appraiser for corrections and
                 explanations.

                 In addition, we used Audit Command Language (ACL)
                 software to analyze data provided by Cambridge on all 436
                 loans relating to discount points and mortgage charge rates.

                 Our file review and audit procedures included: (a) analyses
                 of borrowers’ income, assets, and liabilities; (b)
                 verifications of selected data on the settlement statements;
                 (c) desk reviews of selected appraisals; (d) analyses of
                 discount points and mortgage charge rates; and, (e)
                 inquiries with borrowers, HUD Officials, and Cambridge
                 staff.

                 We performed the audit fieldwork between November 2003
  Audit Period   and May 2004. Our audit pertained to loans originated
                 between September 1, 2001 and August 31, 2003. As
                 necessary, we reviewed loan activity prior and subsequent
                 to our audit period. Our audit work was performed at
                 Cambridge’s office in Great Neck, New York. The audit
                 was conducted in accordance with Generally Accepted
                 Governmental Auditing Standards.




2004-NY-1003         Page 2
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                                                                                     Finding 1


      Inadequate Loan Underwriting Practices
     Resulted in Approval of HUD/FHA Insured
         Loans for Unqualified Borrowers
Our review disclosed that Cambridge did not adhere to prudent lending practices when
approving 11 of the 18 loans that we examined during our audit. We noted that underwriting
deficiencies occurred because Cambridge personnel did not assure that the loans were processed
in accordance with all applicable HUD/FHA requirements and did not ensure that its Quality
Control Plan was being fully implemented. As a result, mortgages were approved for unqualified
borrowers causing HUD/FHA to assume an unnecessary insurance risk.

Section 2-1 of HUD Handbook 4000.4 REV-1, Single Family Direct Endorsement Program
requires mortgagees to conduct its business operations in accordance with accepted sound
mortgage lending practices. Also, HUD Handbook 4000.4 REV-l, Chapter 2, Section 2-5,
provides that the mortgagee must obtain and verify information with at least the same care that
would be exercised in originating the loan in which the mortgagee would be entirely dependent
on the property as security to protect its investment.

In our opinion, Cambridge did not always adhere to the above requirements, as discussed below,
when it underwrote 11 of the 18 loans we reviewed.



                                    Our examination of 18 loans approved by Cambridge
 Examined 18 loans                  between September 1, 2001 and August 31, 2003, disclosed
                                    that Cambridge either did not follow all applicable HUD
                                    requirements or did not exercise the care expected of a
                                    prudent lender in approving 11 of those loans.
                                    Consequently, we found significant underwriting
                                    deficiencies in those 11 cases, as shown below:


                                                  Deficiencies              Number of Loans
                                   Ratios Exceeded HUD/FHA Standards           8 of 11 loans
                                   Inadequate Property Valuation               8 of 11 loans
                                   Inadequate Asset Verification               2 of 11 loans
                                   Inadequate Income Verification              1 of 11 loans
                                   Insufficient Gift Information               1 of 11 loans
                                   Inadequate Debt Verification                1 of 11 loans
                                   Minimum Investment Not Provided             1 of 11 loans
                                   Bankruptcy Discharge < 2 Years              1 of 11 loans
                                    For example, our review of FHA case number 374-
                                    3830526 disclosed that debt-to-income ratios exceeded

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Finding 1

               HUD/FHA standards. The borrower's mortgage payment
               expense to effective income ratio was 38.85 percent and the
               total fixed payment to effective income ratio was 46.80
               percent. HUD Handbook 4155.1 REV-4, Paragraph 2-12
               states that these ratios cannot exceed 29 percent and 41
               percent respectively without listing compensating factors.
               The compensating factors provided on the Mortgage Credit
               Analysis Worksheet did not provide adequate justification
               for approving the loan with ratios exceeding the HUD/FHA
               standards.

               For FHA Case number 374-3999860, our review of the
               appraisal disclosed several items that should have alerted
               Cambridge to problems with the appraisal report. For
               example, the appraiser did not comment as to the dollar
               amount of the renovations included in the value estimate,
               nor did the appraiser comment on the quality of the
               renovation work. The appraiser did not disclose the source
               or verify any cost of the renovation work. The appraisal
               report indicates a price range of $145,000 to $290,000 with
               the predominant price being $225,000. The appraiser's
               value estimate of $262,000 is considerably higher than the
               predominant price and no explanation is provided. Also, the
               appraiser indicates that this property has a separate unit in
               the basement consisting of a kitchen, bath, bedroom, and a
               den/living room. This is not acceptable for FHA mortgage
               insurance. Basement living units do not meet FHA's
               acceptability criteria. As a result, the appraisal did not
               adequately support the ascribed value estimate. The above
               items are indicators of problems with the appraisal and, as
               such, should have caused Cambridge to question the
               reliability of the appraisal report before accepting it.

               At March 31, 2004, the mortgages of nine of the eleven
               loans were in default, one of the loans was current, and one
               had gone to claim. At the completion of our audit
               fieldwork, HUD had paid $146,530, representing partial
               claims on three loans and a full claim on one loan. This
               amount represents a loss to the government and is
               considered a disallowed cost. Thus, the amount should be
               reimbursed to HUD. The ten HUD/FHA insured loans that
               have not gone to full claim had delinquent mortgages
               amounting to $2,258,900. We are requesting
               indemnification for those loans (See Appendix C).

               Appendix A to this report provides a summary of the loan
               underwriting deficiencies noted during our review, while


2004-NY-1003       Page 4                                           TOC
                                                                     Finding 1

                   Appendixes B-01 through B-11 provide an individual
                   description of the underwriting deficiencies for each of the
                   11 loans. The deficiencies occurred because Cambridge
                   representatives did not adhere to HUD/FHA requirements,
                   comply with prudent lending practices and did not ensure
                   that its Quality Control Plan was being fully implemented.
                   In our opinion, the deficiencies resulted in the approval of
                   mortgages for unqualified borrowers, which have caused
                   HUD/FHA to assume an unnecessary risk.


Auditee Comments   Cambridge’s comments are included with the individual
                   narrative case presentations in Appendices B-01 to B-11.


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

                   1A.     Reimburse HUD for the actual loss of $96,265 on
                           case number 374-3772590 and for the partial claim
                           payments of $50,265 on case numbers 374-
                           3956133, 374-3778152, and 374-3913246, which
                           amount to a total of $146,530 (See Appendix C).

                   1B.     Indemnify HUD/FHA against future losses on ten
                           of the loans in question (374-3726304, 374-
                           3776804, 374-3935308, 374-3833863, 374-
                           3830526, 374-3999860, 374-4048106, 374-
                           3956133, 374-3778152, and 374-3913246). The
                           mortgage amounts associated with these loans total
                           $2,258,900, which will be considered funds put to
                           better use when indemnified (See Appendix C).

                   1C.     Provide your office with a corrective action plan to
                           assure that all HUD/FHA guidelines regarding the
                           underwriting of HUD/FHA insured loans are
                           followed by its underwriting staff.




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2004-NY-1003    Page 6          TOC
                                                                                        Finding 2


 Cambridge Did Not Document Variations in its
           Mortgage Charge Rate
HUD’s Tiered Pricing Rule limits the variation in the mortgage charge rate to FHA single-family
borrowers when the borrowers ‘lock in’ the interest rate on or around the same day, using the
same mortgage type (e.g., 30 year fixed), and the properties financed are located in the same
geographical area. The rule prohibits any variation of more than two-percentage points in
mortgage charge rates (discount points, loan origination, interest rate and other fees, combined).
The rule also requires that, for variations in the mortgage charge rates up to two percentage
points, the lender base the charges on actual costs incurred in the origination of each respective
FHA loan, provide a justification for the variance in the loan file, and retain the record for two
years.

Cambridge did not document, nor provide adequate justification for variations in its mortgage
charge rates. As a consequence, we believe Cambridge’s lending practices may have unfairly
imposed greater borrowing costs on some FHA borrowers. Moreover, we could not determine
whether the borrowers received anything of value for discount points that were charged. We
attribute this to Cambridge’s failure to properly monitor to ensure compliance with HUD
requirements on mortgage charge rates, overages, and tiered pricing.



                                     Tiered Pricing Rule 24 CFR 202.12 provides that the
 Criteria                            customary lending practices of a mortgagee for its single
                                     family insured mortgages shall not provide for a variation
                                     in mortgage charge rates that exceeds two percentage
                                     points for a designated day or other time period. Any
                                     variations in the mortgage charge rate up to two percentage
                                     points under the mortgagee's customary lending practices
                                     must be based on actual variations in fees or costs to the
                                     mortgagee to make the mortgage loan, which shall be
                                     determined after accounting for the value of servicing
                                     rights generated by making the loan and other income to
                                     the mortgagee related to the loan. Fees or costs must be
                                     fully documented for each specific loan.

                                     Variation in mortgage charge rates for a mortgage type is
                                     determined by comparing all mortgage charge rates offered
                                     by the mortgagee within an area for the mortgage type for a
                                     designated day or other time period, including mortgage
                                     charge rates for all actual mortgage applications.
                                     Mortgagee Letter 94-16 provides that any variation within
                                     two percentage points must be based on actual variations in
                                     fees or costs to the lender to make a loan. Mortgagees are
                                     required to maintain records on pricing information that
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Finding 2


                                       would allow for reasonable inspection by HUD for a period
                                       of at least two years.

                                       Our review disclosed variations in Cambridge’s mortgage
   No justification for                charge rates on the 18 loans in our sample. For example,
   charge rate variations              loan numbers: 374-3795401, 374-3795657, 374-3999860,
                                       374-3935308, and 374-4099301 had a variation in the
                                       mortgage charge rate from other loans with the same
                                       interest lock-in date. While the variations were within two
                                       percentage points, Cambridge could not provide adequate
                                       documentation to support the variation as required by
                                       Mortgagee Letter 94-16.

                                       Cambridge was unable to provide rate sheets for the loans in
   Cambridge did not                   our sample. Cambridge officials told us that because their
   maintain rate sheets                procedures did not allow the loan officers to price the loan,
                                       Cambridge did not maintain rate sheets. The prices were
                                       determined by the scenario desk based on the information
                                       Cambridge had from potential investors for the loan.

  Borrowers may not have               Without rate sheets, we could not determine whether
  received anything of                 borrowers received anything for the discount points charged.
  value                                Cambridge’s records indicated in many cases that there is no
                                       relationship between the interest rate charged and the
                                       discount points charged. For example, we examined loans
                                       that had the same lock date where borrowers were charged
                                       the same discount points but two different interest rates.
                                       Also, there were cases in which two borrowers were charged
                                       the same interest rate and one borrower was charged discount
                                       points while the other was not charged points. These
                                       examples are as follows:

                                   Origi-                                 Service
 Case                              nation Discount Note    Loan    Loan Release Loan           Loan
 Number      Lock Date Closed Date   Fee       Fee Rate Amount     Price Premium Purpose       Type
 374-3970112 8/9/2002    8/13/2002      1        1    8 $236,250   104.5      2.2 Purchase     Fixed
 374-4004560 8/9/2002    8/12/2002      1        1  7.5 $273,200 103.375      2.2 Purchase     Fixed

 374-3731992 11/27/2001   11/27/2001     1            0   8 $310,550 103.375    2.2 Purchase   Fixed
 374-3802026 11/27/2001   11/28/2001     1            2   8 $188,000 103.375    2.2 Purchase   Fixed

                                       Because of the variations in Cambridge’s charge rates on the
 Scope                                 18 loans in our sample, we performed an analysis on a
                                       broader range of loans. We examined the 436 FHA insured
                                       loans originated by Cambridge in the New York Field Office
                                       area with beginning amortization dates in our audit period.



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                                                                                                 Finding 2


                                           We performed a separate analysis on 386 fixed rate loans,
                                           and 50 adjustable rate mortgages.

                                           Our analysis disclosed instances over the two-year period
  Cambridge has not                        in which there was a variation in the origination fee,
  performed adequate                       discount points, and interest rates for loans with a lock date
  monitoring of its                        on the same day or within a few days span. Based on these
  variations in charge rates               results, we believe that Cambridge did not perform adequate
                                           monitoring of the variations in origination fee, discount
                                           points, and interest rates. Examples of the variations in the
                                           origination fee, discount points, and interest rates are as
                                           follows:

                                        Origi-                                 Service
Case                                    nation Discount Note    Loan    Loan Release Loan            Loan
Number        Lock Date Closed Date       Fee       Fee Rate Amount     Price Premium Purpose        Type
374-3734159   10/9/2001 10/10/2001           1        1    7 $310,550 100.75       1.5 Purchase      Fixed
374-3749521   10/9/2001   10/9/2001          1        2    8 $299,150 102.875      1.5 Purchase      Fixed
374-3777017   10/9/2001   10/9/2001          1        2 8.25 $201,800     103      1.5 Purchase      Fixed

374-3673139   11/30/2001   11/30/2001       1        1 8.25 $231,350 102.875        1.5   Purchase   Fixed
374-3749284   11/30/2001    12/6/2001       1        2     8 $302,700 103.625       2.2   Purchase   Fixed
374-3806381   11/30/2001   12/12/2001       1        2   7.5 $301,250 102.375       2.2   Purchase   Fixed
374-3820659   11/30/2001   11/30/2001       1      2.5     7 $223,700 102.375       2.2   Purchase   Fixed
374-3844213   11/30/2001   11/30/2001       1        0 7.875 $235,250     105         2   Purchase   Fixed
374-3850622   11/30/2001    12/5/2001       1        2 7.75 $314,050    106.5         2   Purchase   Fixed
374-3852810   11/30/2001   12/12/2001       1        2     8 $196,400 103.625       2.2   Purchase   Fixed

374-4121763     4/4/2003     4/8/2003       1        2     7 $215,500   102.75        2 Purchase     Fixed
374-4149437     4/8/2003     4/9/2003       0        0     7 $383,950   102.75        2 Purchase     Fixed

374-3805311 2/19/2002       2/20/2002       1        5      8 $152,250 104.625      2.2 Refinance Fixed
374-3831278 2/21/2002       2/22/2002       1        2    7.5 $198,400 102.581      1.5 Refinance Fixed

374-3827381 1/2/2002         1/2/2002       1        3     6 $217,850 102.588         1 Purchase     ARM
374-3875370 1/3/2002         1/4/2002       1     0.75     6 $219,050 102.494         1 Purchase     ARM
374-3862144 1/10/2002       1/11/2002       1        3     7 $241,200     102         1 Purchase     ARM

                                           The variations in the origination fee, discount points, and
                                           interest rates may have resulted in overages to Cambridge.
                                           Mortgagee Letter 94-43 provides that overages occur when
                                           loan officers or someone at the lender are allowed to charge
                                           a higher interest rate, origination fee, or discount points for
                                           a loan than the lender's market rate for FHA-insured loans
                                           during the same period of time. Lenders should be careful
                                           that overages are not applied in a manner that would violate
                                           FHA's Tiered Pricing Rule. Paragraph 6-8A(2) of HUD
                                           Handbook 4060.1 REV-1 CHG-1, provides that a


                                                Page 9                                        2004-NY-1003   TOC
Finding 2


                    mortgagee’s Quality Control Plan verify that the mortgagee
                    is in compliance with HUD’s requirements concerning
                    tiered pricing, overages, and premium pricing. Since
                    Cambridge did not maintain adequate justification for its
                    variations in the origination fee, discount points, and
                    interest rates, it could not properly monitor to ensure
                    compliance with HUD requirements on overages or tiered
                    pricing.

                    In summary, Cambridge did not provide adequate
   Summary          justifications for variations in mortgage charge rate within the
                    two percentage points. Also, Cambridge did not monitor
                    compliance with HUD requirements on overages or tiered
                    pricing. Furthermore, we question whether borrowers
                    received something of value for the discount points that they
                    were charged. Thus, we are questioning the eligibility of the
                    $1,599,865 in total loan discount fees charged to the
                    borrowers during our audit period based on a lack of
                    pricing documentation justifying the fees. In this regard,
                    we consider the $1,599,865 unsupported costs pending
                    further review by HUD (See Appendix C).



 Auditee Comments   Cambridge stated that it’s mortgage interest rates and
                    discount points structure is set by its president and no loan
                    officers are or ever have been permitted to seek a rate or
                    discount points in excess of that determined by the
                    president and prohibited by HUD requirements. That being
                    the case, Cambridge submits that there are no overages as
                    HUD defines that term, much less those resulting from
                    discriminatory practices.

                    Cambridge provided that only its principals know the basis
                    for rate determination. They alone are aware of general
                    overhead, commissions, pricing in the secondary market
                    and other relevant factors. It is the company’s president
                    who makes this determination. In setting rates on FHA-
                    insured mortgage loans for home purchasers, those rates
                    presume the payment of two discount points. The reason
                    for this presumption is inherent in the structure of these
                    transactions and a direct result of HUD’s willingness to
                    permit homebuyers to obtain from sellers a concession of
                    up to 6%. Most importantly, neither in the case of loans
                    facilitating purchases nor in the case of refinancing does
                    Cambridge consider the size of the loan nor does it consider
                    race, color, religion, sex, national origin or any other


2004-NY-1003            Page 10                                             TOC
                                                   Finding 2


prohibited basis in determining either rate or discount
points to be charged.

Cambridge submits that accommodations are made for
instances when there is no concession, the concession is
limited in dollar amount, or the buyer may have no other
available funds from which to pay discount points. While
causing variations in interest rates and discount points
charged among borrowers, these business accommodations
are fully compatible with HUD’s objective to encourage
home ownership, evidence Cambridge’s sound business
judgment and cannot reasonably be seen as a violation of
the Tiered Pricing Rule or other HUD prohibition. While
the foregoing accounts for most variations, other business
considerations     explain    the    balance.     Business
considerations, applied on an occasional basis, do not
violate the Tiered Pricing Rule and are permissible as
amplified by HUD’s responses to public comments.

Cambridge submits that the auditor’s concern that
borrowers may have not received anything of value for
discount points charged, is unwarranted. As previously
indicated, in the case of home purchasers, those borrowers
obtained favorable rates on the basis of the payment of
discount points which rates would not have been available
had those points not been agreed upon.

The record of all pertinent transactions appears in the
individual loan files maintained by Cambridge at its
offices. Cambridge respectfully submits that had the
auditors more carefully reviewed those files, they would
have noted ratio limitations causing loan rate reductions
and further noted that Cambridge’s variations in discount
points charged was occasioned by individual borrower’s
insufficiency of funds to meet those charges.

HUD-1’s for loans closed at Cambridge during the audit
period properly classified discount points. In the event that
any Cambridge employee stated otherwise, that employee
was misinformed. At no time was risk assessment reflected
in Cambridge’s pricing. Since the president determined that
pricing, only he could have explained fully the manner in
which he set Cambridge’s rates.




    Page 11                                     2004-NY-1003    TOC
Finding 2


 OIG Evaluation of   The point in our finding is that Cambridge did not provide
                     adequate justification for variations within two percentage
 Auditee Comments    points in mortgage charge rates. Because adequate
                     justification was not provided for the variations, we could
                     not determine if Cambridge complied with the HUD
                     requirements on tiered pricing as stated in Mortgagee letter
                     94-16. To date, Cambridge has not been able to provide
                     documentation that its variations in mortgage charge rates
                     are based on actual variations in fees or costs to the lender
                     to make the loan.

                     Also, Cambridge did not provide documentary evidence
                     supporting the fact that borrowers received something of
                     value for the discount points charged. In fact, Cambridge’s
                     comments support that its lending practices may unfairly
                     impose greater borrowing costs on some FHA borrowers.
                     Some borrowers are charged more simply because they
                     have the ability to pay the presumed two percentage
                     discount points set in Cambridge’s price. Our concern is
                     with those cases where two or more borrowers obtain the
                     same interest rate and there was a variation in the discount
                     points, or cases where a borrower obtains a higher interest
                     and had to pay more discount points than the borrower with
                     a lower interest rate.

                     We removed the statements made by the Cambridge
                     official on the charging of discount points from the finding
                     based on Cambridge’s statement that the official must have
                     been misinformed, and that the statements do not reflect
                     Cambridge’s policies and procedures.



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

                     2A.        Determine the eligibility of the $1,599,865 in loan
                                discount fees charged to the borrowers that lacked
                                adequate pricing documentation justifying the
                                fees.

                     2B.        Require Cambridge to adequately document that
                                all variations in mortgage charge rates within two
                                percentage points are based on actual variations in
                                fees or costs to Cambridge to make the mortgage
                                loan.

2004-NY-1003               Page 12                                          TOC
                                                Finding 2



2C.        Require Cambridge to implement Quality Control
           procedures to ensure compliance with HUD
           requirements on overages and tiered pricing.




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Finding 2




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2004-NY-1003   Page 14
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                                                                                        Finding 3



     Cambridge Has Not Fully Implemented Its
              Quality Control Plan
Our review disclosed that Cambridge did not always comply with its Quality Control Plan and
HUD requirements pertaining reviews of defaulted loans. Specifically, Cambridge has not
implemented procedures or established controls to ensure that all FHA/HUD insured loans that
defaulted within six months of closing undergo a Loan Origination Quality Review as required
by HUD requirements. This occurred because Cambridge did not ensure that its Quality Control
Plan is being fully implemented. Consequently, Cambridge is not fully utilizing its Quality
Control Plan, which is designed to enhance and maintain accuracy, validity, and completeness in
its loan origination process.



                                    Cambridge developed and maintains a Quality Control Plan
Quality Control Plan
                                    for the origination of insured mortgages. However, our
established but not fully
                                    review showed that Cambridge did not always comply with
implemented
                                    certain provisions of its Quality Control Plan. In particular,
                                    procedures have not been implemented, or controls
                                    established, to ensure that all insured loans that default
                                    within six months of closing are subjected to a loan
                                    origination Quality Control Review.

                                    Paragraph 6-1C of HUD Handbook 4060.1 REV-1,
Criteria                            requires that a mortgagee’s Quality Control Plan must
                                    provide for sampling of loans to be reviewed. Mortgagees
                                    that choose to use the random sample method must review
                                    all loans that went into default within six months of
                                    closing, in addition to the number selected for random
                                    sample.

                                    In addition, Section 4.1.1 of Cambridge’s Quality Control
Cambridge has
                                    Plan mandates that for closed loans, 100% of the loans with
established internal
                                    defaults of 90 days within one year of origination are
quality control
                                    subject to a quality control review.
procedures
                                    Also, Cambridge’s operating policies and procedures
                                    manual contains the quality control policies and procedures
                                    of the third party provider that Cambridge uses for quality
                                    control services. The policy provides that early payment
                                    defaults are loans that have gone into default within the
                                    first six months of closing. It is important to have a
                                    complete review of these loans to identify problem areas in
                                    origination, through the analysis of loans and the loan

                                        Page 15                                   2004-NY-1003


                                                                                       TOC
Finding 3


                          process. One hundred percent of early payment loans
                          should be selected for quality control review.

                          Despite clearly defined HUD regulations and internally
Early default loans not   established policies that require performing quality control
reviewed for quality      reviews of loans defaulting within six months of closing,
control                   our audit showed that Cambridge has not implemented
                          controls or procedures to ensure that early default loans
                          have been adequately reviewed for quality control. In fact,
                          none of the 18 loans selected for our audit testing were
                          reviewed for quality control by Cambridge even though 17
                          of the 18 loans in our sample were in default within six
                          months of closing.

                          Some of the deficiencies the quality control requirements
                          are designed to prevent and correct were evident in the loan
                          files we reviewed. In Finding 1, we discussed significant
                          deficiencies in Cambridge's origination and underwriting
                          processes, including: ratios exceeded HUD/FHA standards,
                          inadequate     property     valuation,    inadequate    asset
                          verification, and other deficiencies. Therefore, until
                          Cambridge fully implements the quality control plan, there
                          is inadequate assurance that Cambridge is originating and
                          underwriting loans in accordance with HUD/FHA
                          requirements, or that deficiencies are being corrected.

                          Quality control reviews of early default loans are
                          particularly important since such reviews would provide
                          valuable information to management regarding the causes
                          of defaults, and may disclose underwriting deficiencies
                          associated with the loan. Such reviews may also disclose
                          indicators of fraudulent activities or other significant
                          discrepancies that mortgagees are required to report to
                          HUD.



 Auditee Comments         Cambridge acknowledged its failure to adhere to its Quality
                          Control Plan to extent indicated by the audit team.




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


2004-NY-1003                  Page 16
                                                                               TOC
                                                    Finding 3



3A.        Implement controls and procedures to ensure that
           all loans that default within six months of closing
           are properly reviewed in accordance with its
           Quality Control Plan.




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Finding 3




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2004-NY-1003   Page 18          TOC
Management Controls
In planning and performing our audit, we considered the management controls of Cambridge to
determine our auditing procedures, not to provide assurance on the controls. Management
controls include the plan of organization, methods and procedures adopted by management to
ensure that its goals are met. Management controls include the processes for planning,
organizing, directing, and controlling program operations. Management controls 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
                                   •   Program Operations – Policies and procedures that
                                       management has implemented to reasonably ensure that a
                                       program meets its objectives.

                                   •   Compliance with Laws and Regulations – Policies and
                                       procedures that management has implemented to
                                       reasonably ensure that resource use is consistent with
                                       laws and regulations.

                                   •   Safeguarding Resources – Policies and procedures that
                                       management has implemented to reasonably ensure that
                                       resources are safeguarded against waste, loss, and misuse.

                                   •   Validity and Reliability of Data – Policies and procedures
                                       that management has implemented to reasonably ensure
                                       that valid and reliable data are obtained, maintained, and
                                       fairly disclosed in reports.

                                   We assessed all the relevant controls identified above.

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

                                   Based on our review, we believe that significant weaknesses
  Significant weaknesses           exist in the following management controls. These
                                   weaknesses are described in the findings section of this
                                   report and summarized below.

                               •   Cambridge did not assure that certain loans were processed
                                   in accordance with all applicable HUD/FHA requirements,

                                       Page 19                                   2004-NY-1003

                                                                                     TOC
Management Controls


                          Finding 1 (Program Operations), (Compliance with Laws
                          and Regulations).

                      •   Cambridge did not document variations in its mortgage
                          charge rates, Finding 2 (Compliance with Laws and
                          Regulations).

                      •   Cambridge did not fully implement its Quality Control Plan
                          to ensure that all HUD/FHA insured loans that defaulted
                          within six months of closing undergo a Loan Origination
                          Quality Review, as required by HUD requirements, Finding
                          3 (Program Operations), (Compliance with Laws and
                          Regulations).




2004-NY-1003                  Page 20                                        TOC
Follow up on Prior Audits
There are no prior OIG audit reports regarding Cambridge Home Capital, LLC.




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Follow Up On Prior Audits




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2004-NY-1003                 Page 22
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                                                                                                                                     Appendix A

Summary of Loan Origination Deficiencies



                                                 Cambridge Home Capital, LLC
                                                        Great Neck, NY
                                             Summary of Loan Origination Deficiencies
                                      Ratio(s)                                                                                  Bankruptcy
                                 Loan Exceeded Inadequate Inadequate     Insufficient Inadequate    Inadequate     Minimum      Discharged
HUD/FHA        Mortgage    Settlement HUD/FHA Property    Asset          Gift         Income        Debt           Investment Less than      Appendix
Case Number     Amount           Date Standards Valuation Verification   Information Verification   Verification   Not Provided Two Years    Reference


374-3830526    $172,250      11/9/01     X          X                                                                   X                       B-01


374-3956133    $245,150      5/22/02     X                      X                                                                   X           B-02


374-3999860    $257,050      5/23/02     X          X                                                                                           B-03


374-3913246    $132,900       3/4/02     X          X                         X                                                                 B-04


374-3935308    $231,350      6/27/02     X                      X                                                                               B-05


374-3772590    $319,450      8/15/01     X          X                                      X                                                    B-06


374-4048106    $293,350      8/20/02     X                                                                X                                     B-07


374-3776804    $284,500      8/27/01     X          X                                                                                           B-08


374-3778152    $221,500       9/6/01                X                                                                                           B-09


374-3726304    $225,450      8/10/01                X                                                                                           B-10


374-3833863    $195,400      4/16/02                X                                                                                           B-11
Totals        $2,578,350                 8          8            2            1            1              1             1            1




                                                   Page 23                                                                        2004-NY-1003

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Appendix A




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2004-NY-1003    Page 24
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                                                                                    Appendix B-01
                                                                                      Page 1 of 2
Narrative Case Presentations

FHA Case Number:            374-3830526

Loan Amount:                $172,250

Settlement Date:            11/9/01

Status:                     Default - Foreclosure Started

Payments Before First
Default Reported:           5

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 38.85 percent, and the
total fixed payment to effective income ratio was 46.80 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing compensating factors. The compensating factors provided on the Mortgage Credit
Analysis Worksheet did not provide adequate justification for approving the loan with ratios
exceeding the HUD/FHA standards.

B.     Borrower Did Not Provide the Minimum Required Investment

The earnest money deposit of $3,000, the $700 paid at closing, the $400 appraisal fee, and the
$100 credit report fee totals $4,200 for the borrower’s investment. The $4,200 is $1,050 less
than the minimum required investment of $5,250. The files did not contain evidence indicating
that the borrower paid the loan origination fee outside of closing in the amount of $1,697.50. The
National Housing Act requires minimum cash investments to be 3 percent of the Secretary’s
estimate of the cost of acquisition. FHA has determined that the minimum cash investment be
based on sales price without considering closing costs (Mortgagee Letter 98-29, October 22,
1998).

The minimum down payment requirement of 3 percent was not met by the borrower at closing
according to the Post Endorsement Technical Review Underwriting Report prepared by Horizon
Consulting Incorporated. The report claims that the borrower was short of the minimum down
payment requirement by $1,550.00, and as such, the loan was overinsured.

C.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisal disclosed several items that should have alerted Cambridge to problems
with the appraisal report. For example, the appraiser did not comment as to the dollar amount of the
renovations included in the value estimate. Nor did the appraiser comment on the quality of the
renovation work. As a result, the appraisal did not adequately support the ascribed value estimate.

                                          Page 25                                   2004-NY-1003

                                                                                            TOC
Appendix B-01
Page 2 of 2

Section 3-3G of HUD Handbook 4000.4, Single Family Direct Endorsement Program requires the
mortgagee's underwriter to review the appraisal to determine whether or not the appraiser's
conclusions are acceptable. The above items are indicators of problems with the appraisal and, as
such, should have caused Cambridge to question the reliability of the appraisal report before
accepting it.

Cambridge’s Comments

Cambridge is willing to indemnify HUD with respect to this loan.




2004-NY-1003                             Page 26                                          TOC
                                                                                    Appendix B-02
                                                                                      Page 1 of 2
Narrative Case Presentation

FHA Case Number:          374-3956133

Loan Amount:              $245,150

Settlement Date:          05/22/02

Status:                   Default - Foreclosure Started, Partial Claim paid $14,623.66

Payments Before First
Default Reported:     1

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 38.02 percent, and the
total fixed payment to effective income ratio was 46.28 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing significant compensating factors. The compensating factors provided on the
Mortgage Credit Analysis Worksheet did not provide adequate justification for approving the
loan with ratios exceeding the HUD/FHA standards.

B.     Loan Closed 18 Months after Bankruptcy Discharged

HUD Handbook 4155.1 REV-4, Paragraph 2-3E, states that an elapsed period of less than two
years from the date the bankruptcy was discharged may be acceptable if the borrower can show
that the bankruptcy was caused by extenuating circumstances beyond his or her control and has
since exhibited an ability to manage financial affairs. It also provides that the borrower's current
situation should be such that the events leading to the bankruptcy are not likely to reoccur. The
borrower's bankruptcy was discharged November 7, 2000 and the loan closed May 5, 2002. The
files did not contain evidence that the bankruptcy was caused by extenuating circumstances or
that the borrower has since exhibited an ability to manage financial affairs in a manner that
would prevent another bankruptcy from occurring.

C.     Inadequate Verification of Assets Available

Cambridge indicated on the Mortgage Credit Analysis Worksheet that assets available were
$1,513.00. According to the borrower's bank statement, the borrower only had $682.18 available
at the time the Mortgage Credit Analysis Worksheet was prepared. Our review of the borrower’s
bank statement indicated a large deposit of $1,005.01 was made on May 22, 2002. HUD
Handbook 4155.1 REV-4, Paragraph 2-10B states that if there is a large increase in the
borrower's bank account, an explanation and evidence of source of funds must be obtained by the
lender. There was no indication in the file indicating that Cambridge determined the validity of
this deposit. Also, the loan application and Cambridge's comments indicate that $500 of the

                                          Page 27                                   2004-NY-1003


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Appendix B-02
Page 2 of 2

$1,513 assets available on the Mortgage Credit Analysis Worksheet is from cash saved at home.
HUD Handbook 4155.1 REV-4, Paragraph 2-10M provides that borrowers who have saved cash
at home and are able to adequately demonstrate the ability to do so are permitted to have this
money included as an acceptable source of funds to close the mortgage. To include such funds in
assessing the homeowner's cash assets for closing, the borrower must provide satisfactory
evidence of the ability to accumulate such savings. Also, the asset verification process requires
the borrower to explain how such funds were accumulated and the amount of time taken to do so.
The lender must determine the reasonableness of the accumulation of the funds based on the
borrower's income stream, the time period the funds were saved, spending habits, and a history
of using financial institutions. Based on the documentation in the file, the borrowers did not
provide satisfactory evidence of an ability to accumulate such savings.

Cambridge’s Comments

There was a presence of at least five compensating factors, fully
documented in Cambridge loan files, which collectively were
considered in making this loan.

Cambridge   stated  that   the borrower  met  the  two-pronged
requirement in the regulations regarding the extent that the
bankruptcy was caused by extenuating circumstances and she
exhibited a documented ability to manage her financial affairs
after the bankruptcy filing.

The borrower regularly deposited into her checking account her
bi-weekly paycheck and withdrew from that account such sums that
were necessary for her to meet her day-to-day living expenses.
The characterization by the auditors of the borrower’s “ large
deposit ” is unjustified. HUD guidelines provide that the lender
must determine the reasonableness of an accumulation of funds
based upon the borrower’s income stream taking into account
borrower’s spending habits and history, which Cambridge properly
considered in this case.

OIG’s Evaluation of Cambridge’s Comments

The compensating factors provided in the Mortgage Credit Analysis Worksheet were not
adequate justification for the approval of the loan. Those additional factors provided by
Cambridge do not depict the underwriters stated merits of the loan including which
compensating factors apply.

We disagree that the stolen car was an extenuating circumstance. The police report indicated that
the car was stolen on December 22, 1995 and the bankruptcy was not filed until July 27, 2000.

The underwriter did not provide evidence or an explanation of the large deposit or the cash saved
at home at the time of loan approval.




2004-NY-1003                             Page 28                                          TOC
                                                                                   Appendix B-03
                                                                                     Page 1 of 2
Narrative Case Presentation

FHA Case Number:            374-3999860

Loan Amount:                $257,050

Settlement Date:            05/23/02

Status:                     Default - Foreclosure Started

Payments Before First
Default Reported:           6

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 34.58 percent, and the
total fixed payment to effective income ratio was 43.41 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing compensating factors. The compensating factors provided on the Mortgage Credit
Analysis Worksheet did not provide adequate justification for approving the loan with ratios
exceeding the HUD/FHA standards.

B.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisal disclosed several items that should have alerted Cambridge to
problems with the appraisal report. For example, the appraiser did not comment as to the dollar
amount of the renovations included in the value estimate; nor did the appraiser comment on the
quality of the renovation work. The appraiser did not disclose the source or verify any cost of the
renovation work. The appraisal report indicates a price range of $145,000 to $290,000 with the
predominant price being $225,000. The appraiser's value estimate of $262,000 is considerably
higher than the predominant price and no explanation is provided. Also, the appraiser indicates
that this property has a separate unit in the basement consisting of a kitchen, bath, bedroom, and
a den/living room. This is not acceptable for FHA mortgage insurance. Basement living units do
not meet FHA's acceptability criteria. As a result, the appraisal did not adequately support the
ascribed value estimate. Section 3-3G of HUD Handbook 4000.4, Single Family Direct
Endorsement Program, requires the mortgagee's underwriter to review the appraisal to determine
whether the appraiser's conclusions are acceptable. The above items are indicators of problems
with the appraisal and, as such, should have caused Cambridge to question the reliability of the
appraisal report before accepting it.

Cambridge’s Comments

The existence of five compensating factors justifies Cambridge’s
approval of the borrower and conforms fully to HUD/FHA
guidelines.

                                          Page 29                                   2004-NY-1003

                                                                                         TOC
Appendix B-03
Page 2 of 2


The Audit Report notes that the appraiser did not disclose the source or verify any cost of
renovation work. HUD/FHA requirements impose no obligation on the appraiser to include such
information in his report and thus these comments are unwarranted. The auditors further contend
that Cambridge should have been alerted to the discrepancy between the predominant prices of a
single-family home in the neighborhood and the price of the subject premises. The subject
premises was a fully renovated two-family residence and accordingly, any comparison to the
price of a single-family residence, predominant or otherwise, is inappropriate. The auditors
finally criticize the appraisal for including a finished basement
as habitable space. A review of the file and in particular, the
appraisal, indicates that it was not included.

OIG’s Evaluation of Cambridge’s Comments

The compensating factors provided in the Mortgage Credit Analysis Worksheet were not
adequate justification for the approval of the loan. Those additional factors provided by
Cambridge do not depict the underwriters stated merits of the loan including which
compensating factors apply.

There is a lack of information relating to the source of the cost associated with the repairs. Also,
it is unknown whether the value estimate included any portion of the repairs and improvements.
Thus, the appraisal did not adequately support the ascribed value estimate. The predominant
price relates to the neighborhood characteristics and not whether the subject property is one or
more units. Moreover, our concern wasn’t whether the basement unit was included in the price,
but to point out that the basement unit does not meet FHA acceptability criteria and is not
acceptable for FHA insurance. These items are indicators of problems with the appraisal and, as
such, should have caused Cambridge to question the reliability of the appraisal report before
accepting it.




2004-NY-1003                              Page 30                                            TOC
                                                                                   Appendix B-04
                                                                                     Page 1 of 2
Narrative Case Presentation

FHA Case Number:           374-3913246

Loan Amount:               $132,900

Settlement Date:           03/4/02

Status:                    Default - Foreclosure Started, Partial Claim paid $15,387.93

Payments Before First
Default Reported:          3

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 33.84 percent, and the
total fixed payment to effective income ratio was 44.53 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing compensating factors. The compensating factors provided on the Mortgage Credit
Analysis Worksheet did not provide adequate justification for approving the loan with ratios
exceeding the HUD/FHA standards.

B.     Gift Funds Not Verifiable

According to Mortgagee Letter 00-28, "When FHA reviews the performance of a lender on loans
where gift funds were provided for the downpayment, it must be able to trace the gift funds from
the donor to the homebuyer." The case file did not contain evidence showing that the donor
account was verified, or a copy of the gift check, etc. for the $29,270 gift provided the borrower,
which was used in part for the $4,050 down payment. The documentation in the case file only
supported that $29,270 was deposited into newly opened bank accounts that were in the names of
both the borrower and the donor. It is questionable whether the donor actually gifted any funds
to the borrower since the donor retained access and control over the use of the funds, and since
the funds remained in an account on which the donor was named.

C.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisal disclosed several items that should have alerted Cambridge to
problems with the appraisal report. For example, the appraiser lists repairs and improvements
that were made on the property and the cost associated with the repairs; however, the appraiser
did not disclose the source of the information. Also, the appraiser did not indicate if the value
estimate included any portion of the repair and improvement costs. As a result, the appraisal did
not adequately support the ascribed value estimate. Section 3-3G of HUD Handbook 4000.4,
Single Family Direct Endorsement Program, requires the mortgagee's underwriter to review the
appraisal to determine whether the appraiser's conclusions are acceptable. The above items are

                                          Page 31                                   2004-NY-1003

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Appendix B-04
Page 2 of 2

indicators of problems with the appraisal and, as such, should have caused Cambridge to
question the reliability of the appraisal report before accepting it.

Cambridge’s Comments

The existence of four compensating factors justifies Cambridge’s approval of
the borrower and conforms fully to HUD/FHA guidelines.

The contention that loan file did not contain evidence of a gift and that the gift was the source of
the down payment is not supported by the documentation contained in the loan file. The source
of the funds is documented in the loan file as having been derived by the donor as an award
under Worker’s Compensation Law. Initially, the funds were deposited into a joint account in the
name of both the borrower and her sister, the donor. At all times the borrower had full use of the
funds on deposit as verified in writing by the donor. Subsequently, the funds were transferred to
an account solely in the borrower’s name and from that account the contract deposit was made.

The Audit Report notes that the appraiser did not disclose the source or verify any cost of
renovation work. HUD/FHA requirements impose no obligation on the appraiser to include such
information in his report and thus these comments are unwarranted.

OIG’s Evaluation of Cambridge’s Comments

Review of the Mortgage Credit Analysis Worksheet does not indicate adequate compensating
factors for the debt-to-income ratios exceeding HUD/FHA standards.

Cambridge has not provided any evidence that the gift funds were deposited into an account
solely in the borrower name as stated in the comments.

HUD Handbook 4150.1 REV-1, Chapter 5-1 provides that an analysis of the physical
improvements results in conclusions as to the desirability, utility and appropriateness of the
physical improvements as factors in the determination of mortgage risk and the ultimate estimate
of value. In the appraisal, there is a lack of information relating to the source of the cost
associated with the repairs. Also, it is unknown whether the value estimate included any portion
of the repairs and improvements. Thus, the appraisal did not adequately support the ascribed
value estimate.




2004-NY-1003                              Page 32                                            TOC
                                                                                Appendix B-05
                                                                                  Page 1 of 1
Narrative Case Presentation

FHA Case Number:            374-3935308

Loan Amount:                $231,350

Settlement Date:            06/27/02

Status:                     Current - Foreclosure Started

Payments Before First
Default Reported:           3

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 36.55 percent, and the
total fixed payment to effective income ratio was 41.85 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing compensating factors. The compensating factors provided on the Mortgage Credit
Analysis Worksheet did not provide adequate justification for approving the loan with ratios
exceeding the HUD/FHA standards.

B.     Inadequate Verification of Assets Available for Funds to Close

Cambridge indicated on the Mortgage Credit Analysis Worksheet, dated May 5, 2002, that the
borrower had paid $12,187, and that the assets available were $11,247. We could only verify that
$7,560 had been paid into the transaction at May 5, 2002. We found discrepancies in the
supporting documents for the source of the funds deposited into the borrower’s checking
account. Our review showed that from May 3, 2002 to June 27, 2002 the borrower deposited
$19,800 into a checking account with $15,900 of this amount coming from a private savings plan
known as a Su Su (meaning to collect and then hand out). However, our review of the supporting
documentation indicated that there were only two payments from the Su Su plans totaling
$10,600 and that $6,800 was transferred into the checking account from an unidentified savings
account.

Also, Cambridge did not question the reasonableness of whether the borrower had the ability to
accumulate these amounts along with paying off debt based on the borrower’s income and
savings history. We reviewed bank statements from January 15, 2002 through June 27, 2002 and
found that the borrower’s income and savings would not have been sufficient to close the loan
and to pay off the debts identified as being paid during this period.

Cambridge’s Comments

Cambridge is willing to indemnify with respect to this loan.

                                          Page 33                                2004-NY-1003

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Appendix B-06
Page 1 of 2
Narrative Case Presentation

FHA Case Number:              374-3772590

Loan Amount:                  $319,450

Settlement Date:              08/15/01

Status:                       Claim, Preforeclosure Sale, Amount Claimed $96,265.42

Payments Before First
Default Reported:             2

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 29.61 percent, and the
total fixed payment to effective income ratio was 44.75 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing significant compensating factors. The underwriter identified four items on the
Mortgage Credit Analysis Worksheet as compensating factors for approval of the loan. The
compensating factors included job stability, conservative use of credit, previous homeowner with
excellent payment history, and three months reserves,which based on the loan circumstances,
were not adequate. Cambridge is required to document the stability of the borrowers' income.
For properties with three or more units the borrower needs to have three months of reserves to
qualify. In regards to the borrowers being a previous homeowner with excellent payment history,
this would be an adequate compensating factor if the borrowers had shown the ability to pay
housing expenses that were equal or greater than the proposed monthly expense. For this case,
the borrowers’ housing expense increased by 16 percent. Lastly, the compensating factor of
conservative use of credit, in and of itself, is not adequate. Also, the credit reports on the
borrower indicate less than a conservative use of credit. There are several newly opened
accounts, accounts with high balances, and an instance of a delinquent account. The
compensating factors provided on the Mortgage Credit Analysis Worksheet did not provide
adequate justification for approving the loan with ratios exceeding the standards.

B.        Inadequate Rental Income Documentation

Cambridge did not gather adequate documentation to determine the effects of rental income on
the total fixed payment to income ratio. Specifically, Cambridge did not properly factor in a
second rental property in calculating the total fixed payment to income ratio. Our analysis
indicated that the second rental property would have resulted in an obligation of $842.87 that
needed to be factored into the fixed payment to income ratio. Factoring this amount would
increase the ratio from 44.75 percent to 54.18 percent. Basically, our concern was that
Cambridge did not obtain the necessary documentation to accurately calculate the effects of
rental income.

2004-NY-1003                             Page 34
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                                                                                    Appendix B-06
                                                                                      Page 2 of 2


C.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisals disclosed several items that should have alerted Cambridge to
problems with the appraisal report. For example, the appraiser did not offer any comments
regarding the property meeting the FHA criteria for a three-unit structure. The appraiser listed
repairs and improvements that were made to the property and the costs associated with the
repairs, however the appraiser did not disclose any other source of information. Also, the
appraiser did not indicate if the value estimate included any portion of the repair and
improvement costs. The repair list shows that a new roof was installed. However, a roof
certification by a roofing contractor was not in the file. In the section of the appraisal report on
neighborhood data, it indicates the single-family house price range to be $165,000 to $225,000
with the predominant price being $180,000. The appraiser's value estimate of $325,000 is
significantly higher than the predominant price and no explanation is provided. As a result, the
appraisal did not adequately support the ascribed value estimate. Section 3-3G of HUD
Handbook 4000.4, Single Family Direct Endorsement Program, requires the mortgagee's
underwriter to review the appraisal to determine whether the appraiser's conclusions are
acceptable. The above items are indicators of problems with the appraisal, and, as such, should
have caused Cambridge to question the reliability of the appraisal report before accepting it.

Cambridge’s Comments

Cambridge acknowledges that it’s underwriting of this loan fell short of HUD/FHA
requirements. Cambridge requests that it be provided with further information concerning
HUD’s claimed loss expenses with respect to this loan.




                                          Page 35                                     2004-NY-1003
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Appendix B-07
Page 1 of 1
Narrative Case Presentation

FHA Case Number:            374-4048106

Loan Amount:                $293,350

Settlement Date:            08/20/02

Status:                     Default - Foreclosure Started

Payments Before First
Default Reported:           6

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 35.96 percent, and the
total fixed payment to effective income ratio was 41.77 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing compensating factors. The compensating factors provided on the Mortgage Credit
Analysis Worksheet did not provide adequate justification for approving the loan with ratios
exceeding the HUD/FHA standards.

B.     Inadequate Debt Verification

An account named "Visa Secured - S51" indicated bi-weekly payroll deductions of $50.00 that
were deposited in the account and then paid out of the account the day after the deposits were
made. This liability wasn’t included on the Mortgage Credit Analysis Worksheet and was not
addressed by the underwriter. Adding $108 per month to the borrower’s liabilities would have
increased the total fixed payment to effective income ratio from 41.77 percent to 43.47 percent.

Cambridge’s Comments

In this case, there was minimal recurring debt and to criticize Cambridge with the benefit of
hindsight is simply unfair. The auditors criticized Cambridge for not taking into account periodic
payments made by the borrower in connection with a secured credit card, which they viewed as
an additional debt which caused them to calculate that the borrower’s debt/income ratio slightly
exceeded the 41% guideline, to wit: 43.47%. Cambridge submits that the auditor’s criticism in
this regard is not supported.

OIG’s Evaluation of Cambridge’s Comments

The compensating factors provided in the Mortgage Credit Analysis Worksheet were
questionable as valid justification for the approval of the loan. Those additional factors provided
by Cambridge do not depict the underwriters stated merits of the loan including which
compensating factors apply.
2004-NY-1003                              Page 36
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                                                                                  Appendix B-08
                                                                                    Page 1 of 2
Narrative Case Presentation

FHA Case Number:            374-3776804

Loan Amount:                $284,500

Settlement Date:            08/27/01

Status:                     Default - Foreclosure Started

Payments Before First
Default Reported:           0

Pertinent Details

A.     Debt-to-Income Ratios Exceeded HUD/FHA Standards

The borrower's mortgage payment expense to effective income ratio was 30.9 percent, and the
total fixed payment to effective income ratio was 45.23 percent. HUD Handbook 4155.1 REV-4,
Paragraph 2-12 states that these ratios cannot exceed 29 percent and 41 percent respectively
without listing compensating factors. The compensating factors provided on the Mortgage Credit
Analysis Worksheet did not provide adequate justification for approving the loan with ratios
exceeding the HUD/FHA standards.

B.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisal disclosed several items that should have alerted Cambridge to
problems with the appraisal report. For example, the appraisal report identifies the property as
being a 2-unit structure. However, the appraiser does not offer any comments regarding the
property meeting the FHA criteria for a two-unit structure. Also, there are discrepancies in the
appraisal involving the repair list. The repair list shows that a new roof was installed, however,
the roof condition certification states that the roof has a 4-5 year remaining life. This does not
correspond with the life expectancy of a new roof. The appraisal report states that the heating
system is a "new FHA" (forced hot air), but the repair list shows a "new boiler". The forced hot
air system would not require a new boiler. In the section of the appraisal report on neighborhood
data, it indicates the single-family house price range to be $150,000 to $275,000 with the
predominant price being $190,000. The appraiser's value estimate of $290,000 is considerably
higher than the predominant price and no explanation is provided. As a result, the appraisal did
not adequately support the ascribed value estimate. Section 3-3G of HUD Handbook 4000.4,
Single Family Direct Endorsement Program, requires the mortgagee's underwriter to review the
appraisal to determine whether or not the appraiser's conclusions are acceptable. The above items
are indicators of problems with the appraisal and, as such, should have caused Cambridge
question the reliability of the appraisal report before accepting it.




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Appendix B-08
Page 2 of 2

Cambridge’s Comments

Again, while acknowledging the existence of compensating factors, the auditors unjustifiably
criticize Cambridge’s underwriting in approving a loan with ratios exceeding HUD/FHA
guidelines. Cambridge verified the borrower’s employment. The verification revealed a steady
increase in earnings (a compensating factor). The verification further indicated that the borrower
had been employed for approximately seven years and that his probability of continued
employment was good (a second compensating factor).

It is acknowledged that the appraisal report makes reference to a “boiler”, whereas the proper
reference should have been to a burner. This inconsistency, in Cambridge’s opinion, did not in
any way affect the value estimate of the premises, since the price of either piece of equipment is
similar. Similarly, the fact that there appears to be a discrepancy between the appraisal report’s
notation of a new roof and the contents of the roof certification indicating a four to five year
remaining life, does not impact significantly upon the value of the premises. Finally, the auditors
again unfairly criticize the appraisal report citing the predominant price of a single-family
residence in the neighborhood. The subject premise is a renovated two-family house, and
accordingly, reference to the predominant price of a one-family house in the neighborhood is
inappropriate.

OIG’s Evaluation of Cambridge’s Comments

The compensating factors provided in the Mortgage Credit Analysis Worksheet were not
adequate justification for the approval of the loan. Those additional factors provided by
Cambridge do not depict the underwriters stated merits of the loan including which
compensating factors apply.

There is no evidence in the file that the underwriter questioned the inconsistencies acknowledged
by Cambridge. Also, the predominant price relates to the neighborhood characteristics and not
whether the subject property is one or more units. These items are indicators of problems with
the appraisal and, as such, should have caused Cambridge to question the reliability of the
appraisal report before accepting it.




2004-NY-1003                              Page 38                                           TOC
                                                                                  Appendix B-09
                                                                                    Page 1 of 1
Narrative Case Presentation

FHA Case Number:            374-3778152

Loan Amount:                $221,500

Settlement Date:            09/6/01

Status:                     Default - Foreclosure Started, Partial Claim Paid $20,254.40

Payments Before First
Default Reported:           3

Pertinent Details

A.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisal disclosed several items that should have alerted Cambridge to
problems with the appraisal report. For example, one of the rear bedrooms should not be counted
as a bedroom since one has to pass through the bedroom of the rear exit door to access other
habitable space. The code for existing property states that the bedroom means of access shall not
be through another bedroom or other habitable space. As a result, the appraisal did not
adequately support the ascribed value estimate. Section 3-3G of HUD Handbook 4000.4, Single
Family Direct Endorsement Program, requires the mortgagee's underwriter to review the
appraisal to determine whether the appraiser's conclusions are acceptable. The above items are
indicators of problems with the appraisal and, as such, should have caused Cambridge to
question the reliability of the appraisal report before accepting it.

Cambridge’s Comments

While the sketch in the appraiser’s report erroneously makes it appear that one of the bedrooms
did not have a separate entrance, a subsequent visit by the appraiser confirmed that it is the
sketch and not the appraisal report that was in fact inaccurate. Each bedroom at the residence has
a separate entrance notwithstanding that the appraiser’s sketch did not properly depict this
condition. Had the sketch been accurate, the appraisal report would have noted functional
obsolescence; however, no such notation appears therein.

OIG’s Evaluation of Cambridge’s Comments

Our contention is that Cambridge should have questioned the reliability of the appraisal report
before accepting it. The appraiser’s records and interview with the homeowner on May 20,
2004, were not available to the underwriter at the time of approval.




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Appendix B-10
Page 1 of 1
Narrative Case Presentation

FHA Case Number:             374-3726304

Loan Amount:                 $225,450

Settlement Date:             08/10/01

Status:                      Default - Foreclosure Started

Payments Before First
Default Reported:            0

Pertinent Details

A.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisal disclosed several items that should have alerted Cambridge to
problems with the appraisal report. For example, the appraiser does not indicate when the
renovations on the property took place or who the owner was at the time of the renovations. The
appraiser did not comment as to the dollar amount of the renovations included in the value
estimate, nor did the appraiser comment on the quality of the renovation work. Although the
appraiser indicates that the appraisal is subject to completion of a list of repairs, inspections, and
other conditions, the list was not attached to the appraisal. As a result, the appraisal did not
adequately support the ascribed value estimate. Section 3-3G of HUD Handbook 4000.4, Single
Family Direct Endorsement Program, requires the mortgagee's underwriter to review the
appraisal to determine whether or not the appraiser's conclusions are acceptable. The above items
are indicators of problems with the appraisal and, as such, should have caused Cambridge to
question the reliability of the appraisal report before accepting it.

Cambridge’s Comments

The appraiser first visited these premises on July 12, 2001. At that time the subject premises was
“in the process of being completely renovated.” Though not required, values of individual items
are set forth, the total estimate of all work to be performed in the amount of $32,000.
Subsequently, the appraiser revisited the premises on August 08, 2001 as indicated by the
Compliance Inspection Report. The report indicates that all work had been completed and fully
details the extent of the renovation.

OIG’s Evaluation of Cambridge’s Comments

The $32,000 in work identified had already been completed. There is a lack of information
relating to the source of the cost associated with the additional repairs. Also, it is unknown
whether the value estimate included any portion of the repairs and improvements. Thus, the
appraisal did not adequately support the ascribed value estimate.



2004-NY-1003                               Page 40
                                                                                              TOC
                                                                                    Appendix B-11
                                                                                      Page 1 of 1
Narrative Case Presentation

FHA Case Number: 374-3833863

Loan Amount:                $195,400

Settlement Date:            04/16/02

Status:                     Default - Foreclosure Started

Payments Before First
Default Reported:           4

Pertinent Details

A.     Appraisal Report was Not Adequately Reviewed

Our review of the appraisal disclosed several items that should have alerted Cambridge to
problems with the appraisal report. For example, Cambridge should have obtained an
explanation from the appraiser as to why the sales price per square foot exceeded the top end of
the adjusted sales price. Also, the appraiser did not comment as to the dollar amount of the
renovations included in the value estimate, nor did the appraiser comment on the quality of the
renovation work. As a result, the appraisal did not adequately support the ascribed value
estimate. Section 3-3G of HUD Handbook 4000.4, Single Family Direct Endorsement Program,
requires the mortgagee's underwriter to review the appraisal to determine whether or not the
appraiser's conclusions are acceptable. The above items are indicators of problems with the
appraisal and, as such, should have caused Cambridge to question the reliability of the appraisal
report before accepting it.

Cambridge’s Comments

A careful review of the appraisal report contained in this loan file does not support the auditor’s
criticism that the sales price per square foot for the subject premises “exceeded the top end of the
adjusted sales price.” The auditor’s report alleges that the dollar amount of renovations was not
included in the value estimate. As previously stated, there is no HUD/FHA requirement for the
inclusion of such information in the appraisal report.

OIG’s Evaluation of Cambridge’s Comments

Cambridge should have obtained an explanation why the sale price per square foot exceeded the
top end of the adjusted sales price. Furthermore, there is a lack of information relating to the
source of the cost associated with the repairs. Also, it is unknown whether the value estimate
included any portion of the repairs and improvements. Thus, the appraisal did not adequately
support the ascribed value estimate.




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2004-NY-1003    Page 42          TOC
                                                                                 Appendix C
Schedule of Questioned Costs and Funds Put to Better Use

                           Type of Questioned Costs
     Finding          Ineligible          Unsupported           Funds Put to
     Number           Costs 1/                   Costs 2/       Better Use 3/

      1             $146,530                      ---0---       $2,258,900

      2                 ---0---             $1,599,865             ---0---

      3                 ---0---                   ---0---          ---0---

      Total         $146,530                $1,599,865         $2,258,900

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 whose eligibility cannot be clearly determined during the
      audit since such costs were not supported by adequate documentation. A legal opinion or
      administrative determination may be needed on these costs.

3/    Funds put to better use are costs that will not be expended in the future if our
      recommendations are implemented, for example, costs not incurred, de-obligation of
      funds, withdrawal of interest, reductions in outlays, avoidance of unnecessary
      expenditures, loans and guarantees not made, and other savings.




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2004-NY-1003   Page 44
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                                                                               Appendix D
Auditee Comments




  June 15, 2004


  Mr. Alexander C. Malloy
  Regional Inspector General
  For Audit, 2AGA
  Office of Audit
  New York/New Jersey



  RE: Response to Audit Report of Cambridge Home Capital, LLC issued by the Regional
      Inspector General, dated June, 2004.


  Dear Mr. Malloy:

  Enclosed, please find Cambridge Home Capital LLC's response to the Audit Report issued by
  the Office of Inspector General, Department of Housing and Urban Development, referenced
  above. Cambridge Home Capital, LLC, takes issue with the findings and recommendations
  contained in the Audit Report and has responded to each finding contained therein.

  Should you have any questions concerning anything contained in Cambridge's response, please
  do not hesitate to contact us or our counsel at your convenience.




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                                         Page 45                                   2004-NY-1003
Appendix D

                                         FINDING 1
                               LOAN ORIGINATION DEFICIENCIES

        As set forth in the Audit Report, the auditors concluded that Cambridge did not always adhere to
prudent lending practices in approving eleven of the eighteen HUD/FHA insured loans reviewed. While
various alleged underwriting deficiencies are identified, the two most often cited criticisms were (1) ratios
exceeded HUD/FHA Standards (8 of 11 loans) and (2) Inadequate Property Valuation (8 of 11 loans).

        On the basis of the foregoing, the auditors recommend that Cambridge be required to (1) reimburse
HUD for actual losses; (2) indemnify HUD/FHA against future losses on ten of the loans in question; and (3)
provide a corrective action plan.

                                      CAMBRIDGE'S RESPONSE

         Prior to offering a case-by-case response to the Auditors' findings, a brief overview is
warranted. In each of the 18 cases reviewed, the loans were in default. It is respectfully submitted
that this created a skewed audit sample and HUD's alleged findings are not indicative of Cambridge's
overall performance. Cambridge respectfully submits further that the auditors appear to have (1)
failed to consider and/or give weight to relevant information contained in the loan files; (2)
overlooked or misstated and misapplied applicable HUD guidelines; and (3) otherwise focused on
shortcomings insufficient to warrant the audit report recommendations. Cambridge's foregoing
contention can be best demonstrated by analyzing the often stated criticisms regarding ratios
allegedly exceeding FHA/HUD standards and claims of inadequate property valuations.

                                           HUD/FHA RATIOS

         HUD Handbook 4155.1 Rev-4, Chg 1, Mortgage Credit Analysis for Mortgage Insurance on One-
to-four Family Properties (which contains the HUD guidelines applicable during the timeframe that
Cambridge originated the loans subject to the audit) discusses debt-to-income ratios and the compensating
factors that may be used to exceed those ratios. As stated therein, ratios can be exceeded when significant
compensating factors exist. Rather than establishing arbitrary percentages that may not be exceeded, the
underwriter is authorized and encouraged by HUD to judge the overall merits of the loan and permitted to
determine what compensating factors apply and, most importantly, the extent to which ratios may be
exceeded.

         Handbook 4155.1 Rev-4, Chg 1 sets forth a variety of compensating factors which may be used in
justifying approval of mortgage loans with ratios exceeding HUD benchmark guidelines, the lender is
advised that it is HUD's intention to allow ratios to be exceeded where significant compensating factors
exist. HUD further advises the lender that it relies on the underwriter to judge the overall merits of the
loan application and to determine what compensating factors apply and to the extent to which ratios may
be exceeded. Among the enumerated compensating factors set forth in Handbook 4155.1, Rev-4, Chg 1,
Chapter 2, Section 5 paragraph 2-13 are:
     • The borrower has demonstrated an ability to accumulate savings and a conservative attitude
         toward the use of credit;
     • Previous credit history shows that the borrower has the ability to devote a greater portion
         of income to housing expenses;
     • There is only a minimal increase in the borrower's housing expense;
     • The borrower has substantial cash reserves after closing; The borrower has potential for
         increased earnings, as indicated by job training or education in the borrower's profession.




2004-NY-1003                                  Page 46                                            TOC
                                                                                            Appendix D

        While Handbook 4155.1 Rev-4 Chg 1 establishes a guideline ratio of 29% of the total mortgage
payment to gross income and a 41% ratio of total mortgage payment together with all recurring charges
to gross income, that section does not quantify the extent to which those ratios may be exceeded given
the presence of one or more of the compensating factors. The lender is left broad discretion to
determine the extent to which ratios may be exceeded. This policy is fully consistent with HUD's Direct
Endorsement Underwriting Procedures and objective of promoting home ownership opportunities to
qualified low and moderate income borrowers.

         Generally, each of the loans for which ratio deficiencies were cited had significant
compensating factors fully documented in the loan files which supported Cambridge's favorable
underwriting decision. In some instances, the auditors overlooked relevant existing compensating
factors, fully documented in the files, and at other times failed to give such factors appropriate weight.
Cambridge respectfully submits that it made appropriate underwriting decisions consistent with HUD
guidelines regarding each of these loans.

                              INADEQUATE PROPERTY VALUATIONS

         It is critical to the underwriting process that the lender obtain an accurate and complete
appraisal to ensure that it properly meets the minimum requirement and eligibility standards for an
FHA-insured mortgage. Cambridge has at all times complied fully with this requirement. Cambridge
utilizes only appraisers who are approved by FHA and carefully reviews all appraisals in accordance
with HUD-FHA guidelines.

        The auditors' criticism of appraisal reports contained in the loan files reviewed falls into two
categories: (1) the valuation of the subject premises was higher than the predominant price of single-family
homes in the neighborhood; and (2) the appraiser either failed to note the cost of enumerated renovations or
where cost estimates appear, the source of those estimates. Cambridge respectfully submits that the alleged
findings are not supported or represent a misunderstanding of the facts.

         The Uniform Residential Appraisal Report (URAP) form used by FHA approved appraisers contains
various information concerning the subject premises. Included in that report is various data, including but not
limited to the price range and predominant price of singlefamily housing in the neighborhood.

        An analysis of the eight loans criticized for alleged appraisal deficiencies reveals that the
auditors frequently misinterpreted the significance of the neighborhood information contained at the top
of the report. The auditors repeatedly state that Cambridge should have been "alerted" to the
discrepancy between the predominant price noted for a single family home in the neighborhood and the
estimate value set forth by the appraiser after appropriate consideration of comparable sales. In this
regard, Cambridge respectfully submits that the auditors were clearly wrong.

        In the first instance, there is no provision in the appraisal report for noting the predominant
price in the neighborhood of multifamily housing. That a multi-family house has a substantially higher
value than the predominant price of single-family housing in the neighborhood is plainly not
appropriate for purposes of comparison. Many of the loans criticized by the audit team were for multi-
family housing and accordingly, the "discrepancy" noted by the auditors is not supported.

        Further, and importantly, in the case of the valuation of one-family homes, the predominant
price of single-family housing in the neighborhood does not impose a limit on the valuation of the
subject premises where appropriate comparable sales are noted, justifying the appraiser's conclusion.
HUD imposes no restriction on the lender limiting its lending to the price of the predominant home in
the neighborhood. For the most part, the "discrepancy" between the predominant price stated and the
estimate value of the subject premises reflects the fact that the subject premises had been fully


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                                               Page 47                                          2004-NY-1003
Appendix D

renovated. A full and fair reading of the relevant appraisal reports notes the improvements made to
each premises and fully explains why Cambridge neither should have been nor was "alerted".

        With respect to the auditors' allegations that property valuations were inadequate on the basis that
appraisers either failed to note the cost of renovations or the source of such estimates where cost estimates
were included, those allegations are not supported.

        Cambridge is not aware of any HUD/FHA requirement that the appraisal reports must contain
an estimate of the cost of renovations, much less the source of such cost estimates. Absent such a
mandate, it is simply unfair for the auditors to criticize otherwise comprehensive appraisals that have
been performed in accordance with HUD/FHA guidelines. To the extent that the appraiser considered
the renovated condition of the premises in forming an opinion as to value, each of the relevant
appraisals appropriately itemize those renovations. In so doing, the appraisers fully complied with all
applicable HUD/FHA requirements.

        While other criticisms of minor alleged shortcomings are cited by the auditors and addressed by
Cambridge in the individual case responses stated below, in not one instance do the auditors (1) state an
opinion as to valuation different than that set forth in the appraisal report; (2) indicate that any of the
comparable sales are inaccurately reported or that such sales are not a fair measure of the subject
properties' valuation; or (3) offer an appraisal at variance with the appraisals contained in Cambridge's
files.

        For the reasons set forth above, to the extent indicated below, Cambridge respectfully
submits that the audit findings regarding appraisals be dismissed.
        (1)    FHA CASE NO.: 374-3830526
               LOANAMOUNT. $172,250.00
               SETTLEMENT DATE: 11/9/01

        Cambridge is willing to indemnify HUD with respect to this loan.
        (2)    FHA CASE NO.: 374-3956133
               LOANAMOUNT. $245,150.00
               SETTLEMENT DATE: 05/22/02

                                               OIG Finding

        The auditors in their Narrative Case Presentation set forth the following three alleged violations
by Cambridge in originating this loan; (a) Debt-to-Income Ratios Exceeded HUD/FHA standards and
the compensating factors did not provide adequate justification for exceeding the standards; (b) Loan
Closed 18 Months after Bankruptcy Discharge; (c) Inadequate Verification of Assets Available in that a
large deposit of $1,005.01 was made on May 22, 2002 and the borrower accumulated $500 cash, saved
at home without demonstrating the ability to have accumulated such funds.

                                         Cambridge's Response

        As referenced above, one of the enumerated compensating factors listed in Handbook 4155.1
Rev-4, Chg 1 is that the borrower has documented substantial cash reserves (equal to at least three
months) after closing. In this case, the borrower had accumulated $14,000 in her pension plan which
funds were not required for closing. While the assets accumulated by the borrower were not liquid,
pension funds are readily convertible to cash, provided the requisite taxes are deducted. Such funds,
therefore, met fully the requirements of one of the compensating factors as defined in Handbook 4155.1
Rev-4, Chg 1. Assuming a reduction of 25% of this non-liquid asset, to account for requisite taxes if




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                                                                                              Appendix D

withdrawn, the borrower demonstrated cash reserves of approximately $10,500 which exceeded the
three-month requirement.

         The borrower, at the time of application, was a tenured employee of the New York City Department
of Corrections having been on the job for a period in excess of eight years (such job stability was considered
a second compensating factor though not specifically enumerated). Cambridge took into account prior union
pay raises (a third compensating factor although not specifically enumerated), the borrower's proven ability to
accumulate savings (a fourth compensating factor specifically enumerated) in exceeding the back ratio. The
front ratio's variation was permitted after determining that there was only minimal recurring debt. An
additional compensating factor considered by Cambridge's underwriter was the borrower's favorable long-
term rental history (a fifth compensating factor specifically enumerated)

         The foregoing clearly demonstrates the presence of at least five compensating factors, fully
documented in Cambridge loan files, which collectively were considered in making this loan. While the
auditors acknowledge the existence of these factors, they nonetheless criticize Cambridge's underwriting
stating that such compensating factors did not provide adequate justification for approving the loan with
ratios exceeding guidelines. Cambridge respectfully submits that this criticism is without basis when the fully
documented compensating factors are given due consideration and appropriate weight as contemplated by
HUD/FHA guidelines.

        Handbook 4155.1 Rev-4, Chg 1, Chapter 2, Section 1, paragraph 2-3E states in pertinent part that a
Chapter 7 bankruptcy does not disqualify a borrower from obtaining an FHA insured mortgage if at least two
years have elapsed since the date of the discharge of the bankruptcy. That paragraph further provides that an
elapsed period of less than two years, but not less than twelve months, may be acceptable if the borrower can
show that the bankruptcy was caused by extenuating circumstances beyond her control and has since
exhibited a documented ability to manage her financial affairs in a responsible manner.

         In this case, the borrower met the two-pronged requirement to the extent that the bankruptcy was
caused by extenuating circumstances and she exhibited a documented ability to manage her financial affairs
after the bankruptcy filing.

         The borrower had purchased a 1994 Ford 4-door sedan in order to travel to and from her job with the
Department of Corrections of the City of New York. That vehicle was purchased in March 1997. Prior to the
borrower having an opportunity to place the registration sticker on her vehicle, it was stolen. While the
borrower had obtained liability insurance, she did not obtain sufficient insurance to cover the loss incurred as
a result of the theft of her vehicle. The borrower at the time of the application was a single parent with three
children and required the automobile to facilitate her travel to and from her job. As a result, she was left with
insufficient funds to satisfy the loan which was incurred to acquire the vehicle and had to use her available
disposable income to pay for alternate transportation to and from her job. This was the sole motivating factor
in her decision to file for bankruptcy. The borrower reestablished new credit after the bankruptcy and all
obligations thereafter were paid as and when due.

         As demonstrated above, the bankruptcy was clearly caused by extenuating circumstances beyond the
borrower's control. This event was a criminal act perpetrated by a third party unrelated to the borrower's
actions and not in any way attributable to reckless acts of spending or otherwise, and accordingly, the event
was not likely to recur. The credit report indicates eight accounts, post bankruptcy, with not a single late
payment, which demonstrated to Cambridge that the borrower managed her financial affairs in a
responsible manner. Cambridge properly found the borrower acceptable and the auditors' criticism is
thus not supported.

        The auditors' final criticism of this loan was that the borrower had made a "large unexplained
deposit" shortly before the closing. Again, Cambridge respectfully submits that the auditors' comments


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Appendix D

are not supported. As of May 22, 2002, the borrower had accumulated the sum of $1,012.69 in her
bank. The auditors noted that a deposit of $1,005.01 was made on May 22, 2002. The borrower
regularly deposited into her checking account her bi-weekly paycheck and withdrew from that account
such sums that were necessary for her to meet her day-to-day living expenses. The characterization by
the auditors of the borrower's "large deposit" is unjustified. HUD guidelines provide that the lender
must determine the reasonableness of an accumulation of funds based upon the borrower's income
stream taking into account borrower's spending habits and history, which Cambridge properly
considered in this case.

         With respect to the auditor's comment related to the failure to document the borrower's
accumulation of $500, it is clear that the auditors did not review the bank statements contained in the
loan file and failed to properly note the contents of those statements. The borrower's bank statements
indicate a regular pattern of cash withdrawals. Taken together with the zero balances on her charge
cards, it should have been evident to the auditors as it was to Cambridge that this borrower regularly
accumulated cash at home to pay her bills and to meet expenses.

        For the reasons set forth above, Cambridge believes that it properly underwrote and approved
this borrower since Cambridge complied with applicable guidelines established by HUD. Annexed
hereto and made a part hereof and marked as Schedule "J-2" are copies of the borrowers credit report;
automobile registration and report of lost or stolen vehicle; retail certificate of sale and bank
statements.

      (3)      FHA CASE NO. 374-3999860
               LOANAMOUNT. $257,050
               SETTLEMENT DATE: 05/23/02

                                            OIG Finding

        The auditors in their Narrative Case Presentation set forth the following three (3) alleged
violations by Cambridge in originating this loan; (a) Debt-to-Income Ratios Exceeded HUD/FHA
standards and the compensating factors did not provide adequate justification for exceeding the
standards; (b) Appraisal Report was Not Adequately Reviewed in that the appraiser failed to comment
as to the dollar amount of the renovations, included value estimate; the appraiser's value estimate of
$262,000 is considerably higher than the predominant price of single-family homes; and the basement
living units did not meet FHA acceptability criteria.

                                      Cambridge's Response

         In this case, the borrower had very little recurring debt based upon the credit report (a
specifically enumerated compensating factor) which permits greater latitude in qualifying the borrower
as provided in Handbook 4155.1 Rev-4, Chg 1. The only open account was Sears in the amount of $308
which accounted for a minimal monthly payment of $12. The borrower was employed as a field
technician employed by Verizon and the borrower received a substantial pay raise in 2001. In
accordance with Handbook 4155.1 Rev-4, Chg 1, the borrower had the potential for increased earnings
by job training in the borrower's occupation (a second specifically enumerated compensating factor).
The union contract historically provided for periodic raises and it was anticipated that the employment
and increased compensation would continue (a third compensating factor). Additionally, overtime
income was anticipated (a fourth compensating factor). The borrower's credit history demonstrated a
history of timely repayment of loans and consistent timely payment of rent (a fifth compensating
factor). The existence of the above-referenced compensating factors, justify Cambridge's approval of
the borrower and conform fully to HUD/FHA guidelines.




2004-NY-1003                                Page 50                                        TOC
                                                                                           Appendix D

        The auditors were critical of the appraisal contained in Cambridge's files and cited four claimed
deficiencies. The Audit Report notes that the appraiser did not disclose the source or verify any cost of
renovation work. Again, HUD/FHA requirements impose no obligation on the appraiser to include such
information in his report and thus these comments are unwarranted. Looked at fairly, the appraisal is
comprehensive, including the itemization of the remodeling of the subject property with specific
reference to new windows, flooring, drywall, paint, kitchen fixtures, cabinets and appliances, ceramic
bathroom fixtures and updated electric and plumbing service.

        The auditors further contend that Cambridge should have been alerted to the discrepancy
between the predominant price of a single-family home in the neighborhood and the price of the subject
premises. In the first instance, the subject premises was a fully-renovated two-family residence and
accordingly, any comparison to the price of a single family residence, predominant or otherwise, is
inappropriate. Additionally, as previously noted, the fact that a fully-renovated home may be
substantially more valuable than the predominant price of such homes in a neighborhood in which
many homes have yet to be fully renovated is unremarkable. Accordingly, the best measure of value is
the comparable sales noted in the report which cannot and should not be discredited by reference to the
predominant price of single family homes.

        The auditors finally criticize the appraisal for including a finished basement as habitable space.
A review of the file and in particular, the appraisal, indicates that it was not included. In support of this
contention, as shown by the first page of the appraisal which identifies a square footage of gross living
area of 1412. The aggregate of levels 1, 2 and 3 does not include the sum of 527 square feet, which is
the basement area. Looking at the relevant information of the subject premises in the sales
comparison analysis located on page two, the sales price is indicated as $261,100. A price per square
foot of gross living area of $184.92 is stated, which is calculated by dividing the sales price by 1412
which, as previously noted, does not include the basement area. Annexed hereto and made part
hereof and marked Schedule "J-3" are copies of the borrower's credit report, appraisal report and
rental verification form.

       (4)     FHA CASE. NO. 374-3913246
               LOAN AMOUNT. $132,900
               SETTLEMENT DATE: 3/04/02

                                               OIG Finding

        The auditors in their Narrative Case Presentation set forth the following three alleged
violations by Cambridge in originating this loan; (a) Debt-to-Income Ratios Exceeded HUD/FHA
standards and the compensating factors did not provide adequate justification for exceeding the
standards; (b) Gift Funds Not Verifiable in that it is indicated that the case file did not contain
evidence that a gift existed and that the gift was the source of the down payment; (c) Appraisal
Report Was Not Adequately Reviewed in that the appraiser failed to disclose the source of the
information associated with the renovations and the cost and failed to support the value estimate.

                                         Cambridge's Response

          Again, reference is made to Handbook 4155.1 Rev-4, Chg 1 which describes the
compensating factors that may be used to exceed the qualifying ratios. A review of Cambridge's file
indicates that the borrower showed liquid cash reserves of $4,739.28 after closing which exceeded
the three-month requirement (a specifically enumerated compensating factor). Additionally, the
borrower anticipated experiencing only a minimal housing expense increase from $1,200 to $1,328 (a
second compensating factor).



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Appendix D

        Further, the file demonstrates very little recurring debt (a third compensating factor) and the
borrower demonstrated employment stability by retaining the same job for 27 years (a fourth
compensating factor). Accordingly, Cambridge's decision to make this loan in spite of small variations
in both the back and front ratios fully complied with HUD's guidelines and was in all respects proper.

         The auditors' second criticism was that the loan file did not contain evidence of a gift and that
the gift was the source of the down payment. This contention is not supported by the documentation
contained in the loan file. The source of the funds is documented in the loan file as having been derived
by the donor as an award under Worker's Compensation Law. Initially, the funds were deposited into a
joint account in the name of both the borrower and her sister, the donor. At all times the borrower had
full use of the funds on deposit as verified in writing by the donor. Subsequently, the funds were
transferred to an account solely in the borrower's name and from that account the contract deposit was
made. Finally, documenting this gift is a pre-funding Gift Letter confirmation form and Gift Affidavit
appearing in Cambridge's files.

        The auditors' final criticism of this loan is based on the appraiser's alleged failure to disclose
the source of information associated with the renovations and the cost of such renovations. The
appraisal contained all necessary information including comparable sales. Once again, the appraisal
was performed by an FHA-approved appraiser and the contract price fell squarely within the range of
recent comparable sales. The auditors' criticism regarding the appraisers' failure to disclose the source
of information associated with renovations and the cost of such renovations, has been fully dealt with in
prior sections of this response and, accordingly, need not be reiterated here.

        Annexed hereto and made a part hereof and marked as Schedule "J-4" are copies of the
borrower's credit report, Mortgage Credit Analysis Worksheet (MCAW), Gift Affidavit signed by
borrower's sister, pre-funding gift letter confirmation, copy of Workers' Compensation Board Notice of
Approval, copy of letter from donor indicating borrower has full use of funds in account and copies of
probative bank statements.


       (5)      FHA CASE NO. 374-3935308
                LOANAMOUNT. $231,350
                SETTLEMENT DATE: 06/27/02


        Cambridge is willing to indemnify with respect to this loan.

       (6)      FHA CASE NO. 374-3772590
                LOANAMOUNT. $319,450
                SETTLEMENT DATE: 08/15/01


        While not in agreement with all of the auditors' criticisms, Cambridge acknowledges that its
underwriting of this loan fell short of HUD/FHA requirements. The underwriter who reviewed this file
is no longer employed by Cambridge. Cambridge respectfully requests that it be provided with further
information concerning HUD's claimed loss expenses with respect to this loan.

       (7)      FHA CASE NO. 374-4048106
                LOANAMOUNT. $293,350
                SETTLEMENT DATE: 08/20/02

                                              OIG Finding



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                                                                                         Appendix D

       The auditors in their Narrative Case Presentation set forth the following three alleged violations
by Cambridge in originating this loan; (a) Debt-to-Income Ratios Exceeded HUD/FHA standards and the
compensating factors purportedly did not provide adequate justification for approving the loan; and (b)
Inadequate Debt Verification concerning an account entitled "Visa Secured-S51."

                                         Cambridge's Response

        Reference is once again made to Handbook 4155.1 Rev-4, Chg 1 which permits the lender to
consider compensating factors in approving mortgage loans with ratios exceeding FHA's benchmark
guidelines.

        In this case, the borrower's only debt was $1,300 which required modest monthly payments in the
amount of $35. The auditors criticized Cambridge for not taking into account periodic payments made by
the borrower in connection with a secured credit card, which they viewed as an additional debt which
caused them to calculate that the borrower's debt/income ratio slightly exceeded the 41% guideline, to
wit: 43.47%. Cambridge respectfully submits that the auditor's criticism in this regard is not supported.

        Even if the secured credit card is to be considered a recurring debt, the inclusion of the $50
deduction caused the ratio to be exceeded by less than 2-1/2%. As stated in Handbook 4155.1 Rev-4, Chg
1, the underwriter has broad discretion in approving borrowers who exceed the guidelines. In this case,
there was minimal recurring debt and to criticize Cambridge with the benefit of hindsight is simply unfair.
The adjustment to the ratios is clearly permitted.

         Unlike an unsecured credit card debt, the cardholder in this case could not exceed charges on the
IR card in excess of the security previously deposited. Accordingly, in the event that the borrower was
unable to make the periodic payments as required, the credit card company would have merely offset any
balance due and owing against the security. For that reason, Cambridge believes that a secured transaction
of this type is clearly distinguishable from that where no security has been placed with the credit card
company and, accordingly, should not be treated as a conventional debt.


         Annexed hereto and made part hereof and marked as Schedule "J-7" is a copy of the borrower's
credit report.

       (8)      FHA CASE NO. 374-3776804
                LOANAMOUNT. $284,500
                SETTLEMENT DATE: 08/27/01

                                              OIG Finding

         The auditors in their Narrative Case Presentation set forth the following three alleged violations
by Cambridge in originating this loan; (a) Debt-to-Income Ratios Exceeded HUD/FHA standards without
listing compensating factors and further state that the MCAW did not provide adequate justification for
approving the loan with ratios exceeding the HUD/FHA standards; (b) Appraisal Report was Not
Adequately Reviewed in that the report does not offer comment regarding the property meeting the FHA
criteria for a two-unit structure; the repair list shows a new roof was installed, however, the roof
certification states that the roof has only a four to five year remaining life; that the appraiser's value
estimate is considerably higher than the predominant price of a single-family house; the repair list shows
a "new boiler" when the heating system (forced hot air) does not require one and that the value appraisal
is considerably higher than the single-family house price range contained in the report.



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Appendix D

                                         Cambridge's Response

         Again, while acknowledging the existence of compensating factors, the auditors unjustifiably
criticize Cambridge's underwriting in approving a loan with ratios exceeding HUD/FHA guidelines.

        Prior to making this loan, Cambridge verified the borrower's employment as a field service
technician with Keyspan, one of the area's largest utility companies. The verification revealed a steady
increase in earnings (a compensating factor), from the year 1999, 2000 through 2001. The verification
further indicated that the borrower had been employed for approximately seven years and that his
probability of continued employment was good (a second compensating factor). When taking into account
potential overtime and ordinary pay increases, Cambridge determined that the borrower met the criteria
contained in Handbook 4155.1 Rev-4, Chg 1 in approving this loan. Further, based upon the contents of
the verification of employment, the borrower enjoyed an approximate eight percent increase in income
over the most recent three-year period. These compensating factors clearly provided adequate justification
for the modest ratio variations noted in the audit report.

         With respect to the appraisal report, prior to making this loan, Cambridge obtained a Certificate
of Occupancy report which indicated that the premises was a two-family dwelling. The Certificate of
Occupancy further indicated that the premises contained a gas heating system. It is acknowledged that the
appraisal report makes reference to a "boiler", whereas the proper reference should have been to a burner.
This inconsistency, in Cambridge's opinion, did not in any way affect the value estimate of the premises,
since the price of either piece of equipment is similar. Similarly, the fact that there appears to be a
discrepancy between the appraisal report's notation of a new roof and the contents of the roof
certification indicating a four to five year remaining life, does not impact significantly upon the value
of the premises.

        Finally, the auditors again unfairly criticize the appraisal report citing the predominant price of
a single family residence in the neighborhood. The subject premises are a renovated two-family house,
and accordingly, reference to the predominant price of a one-family house in the neighborhood is
inappropriate.

       As contained on the comment addendum, the improvements were specifically enumerated.
These improvements were completed and, accordingly, the appraiser determined the value of the
premises by giving due consideration to the premises' renovated condition.

         Based upon all of the foregoing, Cambridge respectfully submits that it made an appropriate
underwriting judgment approval based upon all supportive documentation in its possession, which
justified the approval of this loan. Annexed hereto and made part hereof and marked as Schedule "J-8"
are copies of the following documents: appraisal report, Certificate of Occupancy report, and
Employment Verification.

       (9)      FHA CASE NO. 374-3778152
                LOANAMOUNT. $221,500
                SETTLEMENT DATE: 09/06/01

                                              OIG Finding

        The auditors in their Narrative Case Presentation allege that Cambridge should have been
"alerted" to problems with the appraisal report. However, only one such item is specifically noted in
connection with this comment. That item relates to the fact that one of the rear bedrooms of the premises
should not have been counted as a bedroom since allegedly one had to pass through an adjacent bedroom




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                                                                                           Appendix D

in order to gain access to it. The basis for the auditor's comment is a sketch which was attached to the
appraiser's report.

                                         Cambridge's Response

         While that sketch in the appraiser's report erroneously makes it appear that one of the bedrooms did
not have a separate entrance, a subsequent visit by the appraiser confirmed that it is the sketch and not the
appraisal report which was in fact inaccurate. Each bedroom at the residence has a separate entrance
notwithstanding that the appraiser's sketch did not properly depict this condition. Had the sketch been
accurate, the appraisal report would have noted functional obsolescence; however, no such notation appears
therein.

        The fact that the sketch was made in error, does not diminish the estimated value of the subject
premises nor properly cause the quality of the overall report to be in question.

        Annexed hereto and made part hereof and marked as Schedule "J-9" is a copy of the Appraisal
Report with addendum.

       (10)     FHA CASE NO. 374-3726304
                LOANAMOUNT. $225,450
                SETTLEMENT DATE: 08/10/01

                                               OIG Finding

        The auditors in their Narrative Case Presentation allege that Cambridge should have been
"alerted" to problems with the appraisal report noting that the appraiser did not indicate that
renovations on the property had been made nor the identity of the owner who renovated the premises.
The auditors further criticized the appraiser for not commenting on the dollar amount of the
renovations or the quality of the work performed.

                                         Cambridge's Response

         Given the circumstances of this case, Cambridge respectfully submits that the auditor's
comments are not supported. The appraiser first visited these premises on July 12, 2001. The
appraisal report of even date indicates that at that time the subject premises was "in the process of
being completely renovated." The addendum to the appraisal report indicates the nature of work that
was ongoing, including new kitchen, walls, flooring, painting and some windows. Though not required,
values of individual items are set forth, the total estimate of all work to be performed in the amount of
$32,000. The auditor's comment that the owner of the premises at the time of renovation was not noted
is indicative of the fact that the auditors failed to adequately read the report and to consider its contents.
The report on its face indicates the identity of the owner at the time of renovation as The Chicago Corp.

        Subsequently, the appraiser revisited the premises on August 08, 2001 as indicated by the
Compliance Inspection Report. That report indicates that all work had been completed and fully details
the extent of the renovation, including all new bathrooms and kitchens, all new drywall throughout the
dwelling, including basement, new boiler and water heater, new stairs, exterior foundation repair and
painting, siding repairs, new interior and exterior doors and garage painted. Appended to the
Compliance Inspection Report are photographs of the renovated premises further confirming their
condition subsequent to the renovation. Clearly, the renovation had been performed in an appropriate
manner and the initial appraisal of the premises indicated, even prior to the completion of the
renovations, that the condition of the premises was "good."



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                                               Page 55                                         2004-NY-1003
Appendix D

         By reason of the foregoing, nothing in the appraisal report should have "alerted" Cambridge to
any problems. It is clear that the appraisals were conducted in a most careful manner, including but not
limited to, a compliance inspection. Further, the auditors, while commenting on this appraisal, do not
state that the valuation set forth did not fairly and accurately reflect the condition of the premises at or
about the time of sale. Annexed hereto and made part hereof and marked as Schedule "J-10" are copies
of the Appraisal Report and Compliance Inspection Report.

       (11)     FHA CASE NO. 374-3833863
                LOANAMOUNT. $195,400
                SETTLEMENT DATE: 04/16/02

                                               OIG Finding

        The auditors in their Narrative Case Presentation allege that the appraisal report disclosed
several items that should have "alerted" Cambridge to problems with the appraisal report. In particular,
they note that the sales price per square foot for the subject premises "exceeded the top end of the
adjusted sales price." Also, the auditor noted that the appraiser did not comment as to the dollar amount
of renovations included in the value estimated, nor allegedly comment on the quality of the renovation
work.

                                          Cambridge's Response

         A careful review of the appraisal report contained in this loan file does not support the auditor's
criticism. While it is true that the subject premises' price per square foot is somewhat higher than three of
the Comparable sales noted, it is almost identical to the per square foot calculation in Comparable #3 set
forth in the appraisal report. It is noteworthy that with respect to Comparable #3, that it is the only
Comparable which like the subject premises, includes a full finished basement. Further, the condition of
both the subject premises and Comparable #3 are each noted as "average/good" whereas the other
comparables note as their conditions merely "average". Based on the presence of a finished basement and
the condition of the subject premises as noted in the appraisal report, it was both fair and appropriate to
consider the subject premises more closely in line with the per square foot cost asserted with Comparable
#3 than with the other Comparables noted.

         While the auditor's report alleges that the dollar amount of renovations was not included in the
value estimate. As previously stated, there is no HUD/FHA requirement for the inclusion of such
information in the appraisal report. The addendum to the appraisal specifically notes that the property
had been completely renovated. In particular, the presence of an all-new kitchen and bathroom were
noted as were new walls and ceilings and the fact that all rooms had been painted. New carpeting was
installed in all rooms except the kitchen and bathroom and the basement had been newly finished.

        Accordingly, while the appraiser did not comment on the dollar amount of the renovations,
clearly he considered the renovated condition of the premises in reaching a valuation determination and
referred to the subject as renovated and in "good condition" in that section of the addendum entitled
"Condition of Improvements."

        Taking into account the foregoing, Cambridge respectfully submits that there is no justification
for the auditor's comment that Cambridge should have been "alerted" to problems with the appraisal
report. Annexed hereto and made part hereof and marked as Schedule "J-11" is a copy of the Appraisal
Report.




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                                                                                         Appendix D

                                                Summary

        Cambridge respectfully submits that the Audit Report should be amended to delete the
findings except to the extent indicated above.

         In each instance where Cambridge has disputed the auditor's findings, there is more than ample
justification in each of the relevant files to support Cambridge's underwriting and approval of those
loans.

        Criticisms based on (1) alleged failures to obtain sufficient documentation warranting approval
of loans where benchmark ratios were exceeded or (2) alleged undue weight ascribed to existing
compensating factors are not supported. Cambridge respectfully submits that these criticisms indicate
the auditors' failure to carefully scrutinize the contents of loan files and reluctance to give appropriate
weight to fully documented existing compensating factors in accordance with HUD-FHA guidelines.

        Similar criticisms regarding alleged inadequacy of appraisals are not supported. Those
comments reflect the auditors' (1) improper efforts to impose requirements, i.e. costs and sources of
renovations, not required by HUD/FHA and (2) inappropriate use of predominant neighborhood pricing
of one family housing as contradicting recent comparable sales noted in otherwise comprehensive
appraisals performed in accordance with HUD-FHA requirements.

                                              Conclusion

        Cambridge appreciates the opportunity to respond to the draft audit findings. Cambridge
further respectfully submits that on the basis of this response, the Audit Report and its
recommendations should be revised and, except to the extent noted, be amended.




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                                             Page 57                                        2004-NY-1003
Appendix D

                          FINDING 2 ORIGINALLY ENTITLED
                 "CAMBRIDGE VIOLATED HUD's TIERED PRICING RULE"
                AND SUBSEQUENTLY AMENDED TO "CAMBRIDGE DID NOT
               DOCUMENT VARIATIONS IN ITS MORTGAGE CHARGE RATES"

        Cambridge respectfully submits that it has always been committed to strict compliance with
HUD requirements, including HUD's Tiered Pricing Rule and requirements regarding overages.
Cambridge at all times adheres to all fair lending requirements and mandates the equal treatment of
all prospective borrowers without regard to race, sex, sexual orientation, color, national origin,
religion, age, marital status, disability or any other prohibited basis. Cambridge makes no exception
to the principle that every prospective applicant for mortgage credit receives fair and equal treatment.

     A. Background

        HUD's Tiered Pricing Rule provides in pertinent part that "a lender's customary lending
practices may not provide for a variation in `mortgage charge rates' (discount points, origination fees
and other such fees) exceeding two percentage points on its FHA-insured single-family mortgages
within a geographic area. "The rule further provides that "any variation within two points must be
based on actual variations in fees or costs to the lender to make a loan" and that "variations may take
into account the value of servicing rights generated by making the loan and other related income to
the lender." (Mortgagee Letter 94-16)

        The prohibition against tiered pricing implements section 203(t) of the National Housing Act.
The purpose of the rule is to eliminate a mortgagee's discriminating pricing of FHA-insured
mortgages. The section is concerned with lending practices that unfairly impose costs and charges
that are higher for smaller loans than for larger loans. (Mortgagee Letter 94-16, Section I
"Introduction")

        As amplified by HUD's responses to public comments made a portion of Mortgagee Letter 94-16:

        (i)      The rule sought to minimize a mortgagee's recordkeeping burden and does not require a
                 separate and distinct recordkeeping system;
        (ii)     The rule permits a mortgagee to have a lending policy that permits occasional deviations
                 from the standard terms that it is generally offering to customers in its lending area, even
                 if beyond a two percentage point variation, provided thosedeviations are not applied in a
                 discriminating fashion and are available to purchasers on lower as well as higher-priced
                 homes on an individual basis.

        Overages are the subject of Mortgagee Letter 94-43. As defined therein "overages occur when
loan officers are allowed to charge a higher interest rate, origination fee, or discount points for a loan than
the lender's market rate for FHA-insured loans during the same period of time. As further set forth
"although not inherently discriminatory, in some instances the practice of charging overages may result in
discrimination on a prohibited basis in violation of the Fair Housing Act (FHAct) or the Equal Credit
Opportunity Act (ECOA). Under both FHA and ECOA, prohibited bases include race, color, religion, sex
and national origin.

     B. Initial Audit Report Finding

        The Audit Report initially stated that "Cambridge did not always comply with HUD's Tiered
Pricing Rule in determining the mortgage charge rates for its FHA borrowers." The report indicated that
"Cambridge originated FHA insured mortgages with the same interest lock date that have variations in
mortgage charge rates exceeding two percentage points." Further, the auditors stated that "Cambridge did




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not document nor provide adequate justification for variations in its mortgage charge rates for loans
originated within two percentage points."

        In support of these findings, the report identified ten instances over a two-year period out of 436
FHA loans in which it was claimed that variations in Cambridge's mortgage charge rates exceeded two
percentage points. Those instances were set forth in charts appearing at pages 8, 9 and 10 of the report.

    C. Redrafted Audit Report Findings

         On May 26, 2004, Cambridge received an amendment to the initial audit report consisting of a
new Finding 2. No longer entitled "Cambridge Violated HUD's Tiered Pricing Rule," the new Finding 2
is entitled: "Cambridge did not Document Variations in its Mortgage Charge Rate." This redraft is of
considerable import.     Apparently, the auditors upon due consideration have themselves determined that
their audit did not disclose adequate support for their original claim that Cambridge had violated the
Tiered Pricing Rule. Instead, the auditors most recently have decided that the most they can conclude
from their audit is that Cambridge failed to properly document variations and that the auditors are
therefore left to speculate as to the reason for variations in mortgage charge rates. As set forth in the
redrafted Finding 2, the auditors now speculate that the variations may have been the result of lending
practices that did not comply with HUD requirements on overages or tiered pricing.

        As shall be demonstrated in this response, justification for variations in the mortgage charge rates
appear in each of the relevant loan files and such variations are not the result of discriminatory lending
practices either those prohibited by the Tiered Pricing Rule or barred as discriminatory overages as stated
in Mortgagee Letter 94-43.

    D. Preliminary Statement

         As shall be demonstrated in latter portions of this response, variations in mortgage rates and
discount points charged to Cambridge customers are unrelated to either the size of the loan sought or
reflective of any overages discriminatory or otherwise.

        Cambridge's mortgage interest rates and discount points structure is set by its president, Seth
Kramer, and no loan officers are or ever have been permitted to seek a rate or discount points in excess
of that determined by Mr. Kramer and prohibited by HUD requirements. That being the case,
Cambridge respectfully submits that there are no overages as that term is defined by HUD, much less
those resulting from discriminatory practices.

    E. The Method of Determining Mortgage Charge Rates
       Employed by the Auditors is Flawed

         In support of the auditor's original conclusion, that Cambridge had violated HUD's Tiered
Pricing Rule, they calculated mortgage charge rates by merely adding the original fee to the discount
fee and note rate. This methodology is best visualized by reference to the charges originally appearing
at page 8, 9 and 10 of the initial report. In each of those instances, a calculation appears entitled
"Mortgage Charge Rate" and the numeral below that heading is the sum of those numerals appearing
under the headings "Origination Fee", "Discount Fee", and "Note Rate".
         Apparently, after review of the initial report, the auditors themselves concluded that they were
not comfortable with this method of calculation. Accordingly, while the revised report continues to
refer to "variations in mortgage charge rates", the charts now contained within that section no longer
reflect a mortgage chart rate or how such rate was determined on a case-by-case basis.




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        In the auditor's initial report, the discount fee and note rate were given equal weight thereby
causing apparent variations where none existed or otherwise overstating such variations. If, and only if,
a 1 % discount fee would entitle a borrower to a corresponding 1 % reduction in the note rate, would
the auditor's analysis be appropriate and accurate. As shall be more fully described below, Cambridge
respectfully submits that such an assumption was completely unwarranted; contrary to industry-wide
standards; incompatible with Cambridge's practices and accordingly, wholly unsustainable.

         By way of example, one need only consider case numbers 374-3673139 and 3743749284
appearing in the initial report. Both of these loans were locked on the same date. Each borrower paid a
1% origination fee. The difference in these loans is that one borrower paid a 1% discount fee obtaining
a note rate of 8.25 while the other paid an additional 1 % discount fee (a total of 2%) thereby obtaining
an 8% note rate. Clearly, these borrowers were treated fairly and equally in that the additional discount
fee paid by the borrower in case number 374-3749284 was reflected in a corresponding reduction in
note rate. By merely adding the note rate paid by these borrowers to the discount and origination fees
charged, the auditors arrived at different mortgage charge rates of 10.25 and 11. This difference was
illusory.

         For purposes of further illustration of the flawed methodology initially utilized by the auditors
in calculating the mortgage charge rate, consider the following hypothetical. Assume a mortgagee
prevailing rate of 8%. Further assume that borrower A chooses to accept that rate and does not take
advantage of the opportunity to buy down the rate by the payment of discount points. On the other
hand, borrower B prefers a lower rate and thus pays four points to buy the rate down a full 1% to 7%.
The auditor's method of calculation, assuming each borrower pays a 1 % origination fee would lead to
the following calculation in the mortgage charge rate paid by the two hypothetical borrowers:

        Borrower A: Origination fee 1 + discount fee 0 + note rate 8 =
        Mortgage charge rate of 9

        Borrower B: Origination fee 1 + discount fee 4 + note rate 7 =
        Mortgage charge rate of 12

        The apparent difference in the mortgage charge rates of the two hypothetical borrowers would
thus be calculated at 3, well in excess of the limitations imposed to the Tiered Pricing Rule. Utilizing
the auditor's flawed methodology, to equalize the mortgage charge rates of borrower A and borrower B,
borrower B's note rate would have had to have been reduced to 4%!

         This result again merely reflects the auditor's inappropriate calculation of the mortgage charge
rate rather than indicating a real difference in the treatment of our two hypothetical borrowers. This
example further illustrates that in accepting discount points without reducing the note rate on a one-for-
one basis (which, of course, no lender can prudently do), a lender may be viewed as having violated the
Tiered Pricing Rule where no such violation has occurred.

       Cambridge respectfully submits that an appropriate analysis would require the auditors to
consider the impact of each discount point on the note rate rather than merely adding the two.
Assuming that each discount point paid entitles a borrower to a .25% reduction in the note rate, the
mortgage charge rate for case numbers 374-3673139 and 374-3749284 would be identical.

        Further, Cambridge respectfully submits that nowhere within the rule is there authority for the
methodology employed by the auditors in this case. While the rule requires the auditors to consider
origination fees, discount fees and loan rates, it neither requires nor authorizes auditors to merely
derive the arithmetic sum of the three, giving equal weight to discount points and note rate as if they
bore a 1 to 1 relationship.




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       Importantly, an analysis of the loans set forth at pages 8, 9 and 10 of the initial audit report
considering the discount fees paid as impacting of the note rate as previously described, rather than
merely calculating the arithmetic sum, yields mortgage charge rates none of which vary in excess of 2%.

     F. Cambridge's Standard Practice and Procedure in
        Setting Interest Rates on FHA Insured Mortgage Loans

         HUD permits a lender to set interest rates on a periodic basis without limitation. Such rates
reflect a lender's business judgment as to the rate which it requires at any point in time to originate a
mortgage loan. Various factors typically influence a lender in considering and setting rates. At
Cambridge, such factors include, but are not limited to, the average basic cost of origination by
allocation of general overhead among the mortgages originated; commissions; prices available in the
secondary market; servicing release premiums and rates set by competitors in the marketplace.

         Establishing an appropriate "par" rate is critical to the success or failure of a mortgage lender.
If the rate is too low on a worst-case basis, the enterprise will fail. It is equally critical to avoid setting
the rate so high as to adversely affect market share.

        The information which forms the basis for rate determination at Cambridge is known only to its
principals. They and they alone are aware of general overhead, commissions, pricing in the secondary
market and other relevant factors. It is the company's president who makes this determination.

        In setting rates on FHA-insured mortgage loans for home purchasers, those rates presume the
payment of two discount points. The reason for this presumption is inherent in the structure of these
transactions and a direct result of HUD's willingness to permit home buyers to obtain from sellers a
concession of up to 6%.

         Cambridge's typical borrowers have negotiated a full seller's concession of up to 6% reflected
in the contract between the parties. In so doing, the borrower has, in advance, determined it
advantageous to obtain the best rate obtainable by the payment of discount points. Were it otherwise,
the seller's concession would be of limited value, if not wholly valueless to the borrower. This is true
because any portion of a seller's concession not utilized for allowable closing costs is retained by the
seller and results in a windfall to him or her.

         By way of further clarification allowable costs without inclusion of discount points would
rarely, if ever, exceed 3% to 4% of the purchase price. To the extent that the borrower negotiates a
concession of up to 6%, it is clear from the outset that they expect to pay discount points, the purpose
of which is to obtain a favorable rate, resulting in a lower monthly payment.

         To fully utilize the maximum available seller's concession, thereby giving full benefit to the
borrower, customarily permits the inclusion of two discount points within allowable costs. Cambridge
accordingly sets its prevailing rate assuming the payment of two discount points, such rate being lower
than it would have been had the points not been charged, thus benefiting the borrower.

        Interest rates and discount fees are treated somewhat differently for refinance transactions since
there are no seller's concessions and, accordingly, the borrower's intention to pay points cannot be
inferred. Additionally, this market is especially competitive and rate sensitive.

         The rate and discount point structure in these transactions is thus negotiated on a case-by-case
basis. In some instances, borrowers prefer a higher rate without requiring the payment of discount fees.
In other cases, the prime objective is the lowest rate, in which event discount fees are warranted and


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acceptable. It is thus difficult and unavailing to compare rates and points in these cases, particularly
since rates often vary merely on the basis of whether or not the borrower seeks a "cash out" from the
refinance.

         Most importantly, neither in the case of loans facilitating purchases nor in the case of
refinancing does Cambridge consider the size of the loan nor does it consider race, color, religion, sex,
national origin or any other prohibited basis in determining either rate or discount points to be charged.
While the auditors, noting variations in rates and discount points charged, stated a concern that
Cambridge's lending practices may violate the Tiered Pricing Rule or evidence prohibited overages,
there is no justification for these concerns that is supported by any information contained in the loan
files which were carefully reviewed by the auditors for a period of seven months.

     G. Variations

       Cambridge's ability to obtain its prevailing rate is impacted by (1) availability of funds from
which to pay discount points; and (2) ratio requirements limiting loan rates to be charged, to qualified
borrowers.

        As previously stated, a 6% seller's concession typically permit the payment of two discount
points. However, in some instances there is no concession negotiated by the buyer or the concession is
limited in dollar amount. In such cases, the buyer may have no other available funds from which to pay
discount points. Cambridge then seeks to increase the loan rate; however, in most cases the ratio
requirements imposed by HUD prevent Cambridge from doing so. Accordingly, Cambridge then has
two choices: (1) not make the loan; or (2) reduce the loan rate without the payment of discount points.
Cambridge's policy is and has always been, whenever feasible and when circumstances dictate, to select
option (2). That is, when debt/income ratios require a reduction in note rate below its prevailing rate,
Cambridge first seeks additional discount points to compensate for such reduction and, if the
borrower does not have sufficient funds with which to purchase such discount points, Cambridge
closes the loan nonetheless rather than refusing to do so. In no event is Cambridge's policy impacted
by the size of the loan or any other discriminatory consideration.

        Conversely, there are numerous instances where, often at the closing, it appears that the total
of all allowable costs (which cannot be readily calculated until shortly before or at the closing)
including the two discount points to be charged exceed the 6% allowable seller's concession. It is not
the exception but the rule that in most instances the borrower has insufficient funds to pay the closing
costs in excess of the concession. Cambridge again facilitates closings and accommodates its
borrowers by waiving that portion of the discount fees to which it is entitled required to permit the
transaction to close.

         Cambridge respectfully submits that these accommodations, while causing variations in
interest rates and discount points charged among borrowers are fully compatible with HUD's objective
to encourage home ownership, evidence Cambridge's sound business judgment and cannot reasonably
be seen as a violation of the Tiered Pricing Rule or other HUD prohibition.

       While the foregoing accounts for most variations, other business considerations explain the
balance. In one instance, case number 374-4245311, the low note rate (4.5%) and absence of a
discount fee was due to the fact that the borrower was a close personal friend of the company's
president.

      In some instances, borrowers obtained favorable rates and discount point structures to enable
Cambridge to compete with other lenders actively soliciting the borrower (i.e., 374-
3806092).Similarly, a discount point was waived to accommodate a borrower who was a client of a



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business acquaintance (374-3822332). These types of considerations, applied on an occasional basis,
do not violate the Tiered Pricing Rule and are permissible as amplified by HUD's responses to public
comments.

        The foregoing further constitutes a response to the auditors' concern that their audit identified
loans having the same lock date where borrowers were charged the same discount points but two
different interest rates. From this, it appears that the auditors incorrectly deduced that there was no
relationship between interest rate and discount points charged and caused them to observe that they
could not determine whether borrowers received anything for discount points charged.

        Due to ratio limitations and cash availability, rates and discount points were adjusted (reduced)
to accommodate the needs of individual borrowers so that loans which would otherwise have been
rejected were closed. Cambridge at all times sought to obtain its prevailing rate including two discount
points in the case of home purchases; however, when prevented from doing so, sound business
judgment prevailed. This policy fully explains why on a given day two borrowers may have paid equal
discount points and obtained different loan rates. In all probability, the lower loan rate was dictated by
ratio limitations which ordinarily would have warranted an additional discount fee which was not
available and therefore waived by Cambridge for the benefit of the borrower.

        Cambridge respectfully submits that the auditor's concern that borrowers may have not received
anything of value for discount points charged, is unwarranted. As previously indicated, in the case of
home purchasers, those borrowers obtained favorable rates on the basis of the payment of discount
points which rates would not have been available had those points not been agreed upon.

        Cambridge is engaged in a highly competitive business. If it had indeed charged discount
points, not reflected in its note rates, it would not have been able to effectively compete with other
FHA lenders. At all times Cambridge has sought to enhance its market share and effectively compete
with other FHA lenders by establishing and implementing competitive pricing policies. As part and
parcel of this policy, discount points are charged to permit reduced note rates and any suggestion to the
contrary is simply erroneous.

     H. Cambridge's Recordkeeping Responsibility

         As articulated in both the original draft audit report and as appears in the more recent revision,
including in its heading, the auditors were troubled by Cambridge's alleged failure to document
variations in mortgage charge rates. On this point, Cambridge respectfully submits that the auditors are
clearly in error. HUD imposes no requirement on lenders to maintain or publish rate sheets. While rate
sheets may be useful to lenders who regularly engage in a wholesale operation, they are of no practical
value to Cambridge. Moreover, as appears in the comments to the Tiered Pricing Rule, HUD seeks to
minimize a mortgagor's recordkeeping practices and does not require a separate and distinct
recordkeeping system.

         The record of all pertinent transactions appears in the individual loan files maintained by
Cambridge at its offices. Cambridge respectfully submits that had the auditors more carefully reviewed
those files, they would have noted ratio limitations causing loan rate reductions and further noted that
Cambridge's variations in discount points charged was occasioned by individual borrower's
insufficiency of funds to meet those charges. The fact that the auditors did not recognize these practical
constraints on Cambridge's charges does not support their claim that they were not documented, but
rather merely supports the conclusion that the auditors did not fully appreciate the importance of the
documents which were maintained and appear in each relevant loan file.

     I. Statement Attributable to Cambridge Employees


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Appendix D


        Both of the audit reports allege that "a Cambridge official acknowledged that they most likely
misclassified it (discount points) on HUD-1 for loans during the examination period." The report
further states that "according to a Cambridge official" in most cases a borrower did not receive a
lower interest rate for discount points and that the unnamed official considered the loan discount on
the HUD-1 to be "risk based pricing." It is inconceivable that any Cambridge senior management
employee familiar with Cambridge's policies and practices would have made such remarks. These
comments, if accurately reported, do not accurately reflect Cambridge's lending policies, and must
have been taken out of context. Unfortunately, the auditors failed to speak to Cambridge's president,
Seth Kramer, notwithstanding that they were present in Cambridge's offices for several months. Had
they done so, they would have been informed that (1) Mr. Kramer sets daily rates and policy on
discount points; and (2) that such policy is as described above, benefiting borrowers for the discount
points paid.

         HUD-1's for loans closed at Cambridge during the audit period properly classified discount
points. In the event that any Cambridge employee stated otherwise, that employee was misinformed.

       At no time was risk assessment reflected in Cambridge's pricing. Since that pricing was
determined by Mr. Kramer, only he could have explained fully the manner in which he set
Cambridge's rates and had anyone inquired, would have readily dispelled the auditors of any notion
that Cambridge engaged in risk-based pricing.

        As a final observation, perhaps the audit team misinterpreted remarks made by the unnamed
Cambridge official who in good faith believed he or she was accurately characterizing the manner in
which rates were set. Mr. Kramer has often stated that in setting mortgage rates for FHA borrowers, one
of the many considerations he as Cambridge's president evaluates is the mortgagee risk inherent generally
in such transactions, for example, the potential obligation to repurchase certain loans in the event of an
early payment default or fraud perpetrated by the borrower. This is merely a reflection of the cost of
doing business as are other costs in maintaining and staffing of loan officers. Seen in this light, risk
assessment is but one factor reflected in par rates set but has no relevance in determining rates among
borrowers. This is not risk-based pricing as prohibited by HUD.

                                               Summary

        In the opinion of Cambridge, the entire contents of Findings 2 of the Audit Report should be
deleted for the following reasons:
            •    The auditors found no evidence of discriminatory lending targeting borrowers of lesser
                 amounts for excessive charges in violation of the Tiered Pricing Rule;
            •    The auditors found no evidence of either overages or discriminatory overages in violation
                 of the prohibitions set forth in Mortgagee Letter 94-43;
            •    The auditor's method in determining mortgage charge rates was fatally flawed and thus
                 they could not conclude that any instances variations exceeded 2%;
            •    The auditors failed to note information in loan files justifying variations mistakenly
                 believing that such justification required separate documentation;
            •    The auditors failed to interview Cambridge's president to obtain information on policies
                 and procedures in place respecting the manner in which daily par rates were established
                 and how rates were impacted by discount fees charged.

                                              Conclusion

        On the basis of the foregoing, Cambridge respectfully submits that Finding 2 of the Audit Report
should be deleted in its entirety.



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                                                                                      Appendix D

                                     FINDING 3
                       CAMBRIDGE HAS NOT FULLY IMPLEMENTED
                             ITS QUALITY CONTROL PLAN

        As set forth in the Audit Report the auditors found that Cambridge did not always comply with
its Quality Control Plan (QCP) and HUD requirements pertaining to reviews of defaulted loans.
Specifically, the auditors cited Cambridge's failure to ensure that all FHA/HUD insured loans that
defaulted within six (6) months of closing undergo a Loan Origination Quality Review.

        The auditor's claim this deficiency was "evident" in the loan files reviewed and imply that
deficiencies cited in Findings 1 & 2 of the audit report might have been avoided had Cambridge
fully implemented its QCP.

                                    CAMBRIDGE'S RESPONSE

        Cambridge acknowledges its failure to adhere to its QCP to the extent indicated by the
audit team. Cambridge did not, as required by its QCP, review 100% of all loans defaulted within
six (6) months of closing. The principals of the company accept full responsibility for this
omission.

        Having been advised of this oversight, Cambridge has reacted immediately and appropriately
to ensure full compliance with its QCP. The Company's Executive Vice President and its Quality
Control Manager have been directed to regularly monitor HUD's Neighborhood Watch Early Warning
System (at least on a monthly basis), so that early defaults may be identified.

        The files for each such loan shall be promptly and carefully reviewed by management to
determine, where possible, the cause of such defaults and to enable identification of any underwriting
deficiencies. Any fraudulent borrower activity will be duly noted and reported to HUD.

      On the basis of the foregoing, HUD should be assured that going forward Cambridge will fully
implement and adhere to its QCP.

        Notwithstanding the foregoing, the auditor's implication that alleged deficiencies cited in
Findings 1 & 2 were related to Cambridge's acknowledged failure to subject all early defaulted loans to
Quality Control Review is rejected. As to Finding 1, in all but three (3) instances, Cambridge has
refuted the claim of loan origination deficiencies. Similarly, Cambridge has demonstrated that Finding
2 is unsustainable and, with all due respect, the auditor's contentions inconsistent with pertinent
documents contained in the loan files reviewed.

        To the extent that Cambridge's underwriting of the reviewed loans was appropriate and in
full compliance of HUD/FHA requirements, strict adherence to its QCP would not have affected its
determination to make these loans nor have caused alteration of its underwriting procedures.




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