oversight

First Funding, Incorporated, a Non-Supervised Loan Correspondent Largo, Maryland

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-06-29.

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

        AUDIT REPORT




    FIRST FUNDING, INCORPORATED

A NON-SUPERVISED LOAN CORRESPONDENT

               LARGO, MD


              2004-PH-1009

              JUNE 29, 2004
       OFFICE OF AUDIT, MID-ATLANTIC
             PHILADELPHIA, PA
                                                                Issue Date
                                                                        June 29, 2004
                                                               Audit Case Number
                                                                        2004-PH-1009




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



FROM: Daniel G. Temme, Regional Inspector General for Audit, Mid-Atlantic, 3AGA

SUBJECT: First Funding, Incorporated, a Non-Supervised Loan Correspondent
         Largo, Maryland


We completed an audit of First Funding, Incorporated. We selected First Funding, Incorporated for
review because of their high default rates. The objectives of our audit were to determine whether
First Funding, Incorporated: 1) implemented its quality control plan according to HUD
regulations; and 2) complied with HUD regulations, procedures, and instructions in the
origination of FHA-insured loans selected for review.

In accordance with HUD Handbook 2000.06 REV-3, within 60 days please provide us, for each
recommendation without a management decision, a status report on: the corrective action taken; the
proposed corrective action and the date to be completed; or why action is considered unnecessary.
Additional status reports are required at 90 days and 110 days after report issuance for any
recommendation without a management decision. Also, please furnish us copies of any
correspondence or directives issued because of the audit.

We appreciate the courtesies and assistance extended by the management and staff of First Funding,
Incorporated and the HUD Philadelphia Homeownership Center.

Should you or your staff have any questions, please contact Ms. Christine Begola, Assistant
Regional Inspector General for Audit, at (410) 962-2520.
Management Memorandum




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2004-PH-1009              Page ii
Executive Summary
We completed an audit of First Funding, Incorporated (First Funding), an FHA-approved, non-
supervised loan correspondent whose office is located in Largo, Maryland. The objectives of our
audit were to determine whether First Funding developed and implemented its quality control
plan according to HUD regulations; and complied with HUD regulations, procedures, and
instructions in the origination of FHA-insured loans selected for review. This included
determining whether First Funding exercised due diligence in originating its loans.

First Funding had not adequately developed and implemented a quality control plan that meets HUD
regulations. Furthermore, First Funding’s office operations did not comply with HUD-FHA
approval requirements. In addition, First Funding did not exercise due diligence in their loan
origination process. The results of our audit are summarized below and detailed in the Findings
Section of this report.



 First Funding’s Quality            First Funding did not adequately develop and implement a
 Control Process Was Not            quality control plan that fully meets HUD requirements as
 Adequate                           outlined in HUD Handbook 4060.1 REV-1, Chapter 6.
                                    First Funding also did not conduct required quality control
                                    reviews. Specifically, First Funding did not meet its 10
                                    percent sample requirement for quality control reviews for
                                    three months, review loans defaulting within the first six
                                    months, or review 10 percent of the rejected loans.
                                    Consequently, First Funding’s quality control reports were
                                    incomplete and of marginal value in improving loan
                                    origination performance. Furthermore, the staff assigned to
                                    quality control was not knowledgeable of HUD
                                    requirements.

 Office Operations Did              First Funding did not administer its loan correspondent office
 Not Comply With HUD-               operations in conformity with HUD-FHA approval
 FHA Requirements                   requirements. Specifically, First Funding did not: exercise
                                    control and responsible management supervision over their
                                    employees; require exclusivity of their employees; and
                                    maintain office space that is apart from any other entity.
                                    Because of these compliance deficiencies, First Funding’s
                                    eligibility as a HUD-FHA approved mortgagee is
                                    questionable. The operational deficiencies stem from First
                                    Funding’s disregard and/or lack of knowledge of HUD-FHA
                                    approval requirements.

 First Funding Did Not              Our audit of loan origination activities disclosed that First
 Exercise Due Diligence In          Funding did not always originate FHA-insured loans in
 Originating Its Loans              accordance with HUD requirements. For example, First
                                    Funding did not exercise due diligence in the review of the

                                         Page iii                                    2004-PH-1009
Executive Summary


                    borrower’s liabilities and credit characteristics or verify a
                    borrowers source of funds. In addition, they charged the
                    borrower fees that were unjustified. Consequently, mortgage
                    loans of questionable eligibility were approved for FHA
                    insurance, and borrowers may have incurred unwarranted
                    costs. These deficiencies contributed to an increased risk to
                    the FHA insurance fund.
 Recommendations    We recommend that HUD take appropriate steps to ensure
                    First Funding takes immediate action to implement a quality
                    control plan that meets all HUD requirements. We also
                    recommend that HUD require First Funding to take
                    immediate action to correct its ongoing operational
                    deficiencies that do not comply with HUD-FHA loan
                    correspondent approval requirements. Further, HUD should
                    consider taking appropriate administrative action against First
                    Funding for its continual failure to comply with HUD
                    requirements.

 Auditee Comments   We provided our initial draft of this report to First Funding on
                    April 20, 2004.           We discussed the findings and
                    recommendations with First Funding at an exit conference on
                    May 6, 2004. First Funding provided written comments to
                    the draft on May 18, 2004. First Funding’s response consisted
                    of a five page letter and a copy of the Quality Control Plan.

                    Generally, First Funding concurred with our findings and
                    recommendations. However, they disagreed with our findings
                    concerning FHA Case Binder 249-4485090 and the use of
                    child support payments in calculating the debt to income
                    ratio. The complete text of the letter is included in Appendix
                    E. The Quality Control Plan is not included and is available
                    upon request.




2004-PH-1009            Page iv
Table of Contents
Management Memorandum                                                      i



Executive Summary                                                      iii



Introduction                                                            1



Findings

1. First Funding, Incorporated’s Quality Control Process               3
   Continues to Be Inadequate

2. First Funding, Incorporated’s Office Operations Did                 9
   Not Comply With HUD-FHA Approval Requirements

3. First Funding, Incorporated Did Not Exercise Due                    13
   Diligence Over Its Loan Origination Process


Management Controls                                                    21



Follow Up On Prior Audits                                              23



Appendices
A. Schedule of Questioned Costs and Funds Put to Better Use            25

B. First Funding, Incorporated (FFI) and Maryland Title                27
   and Escrow (MT&E) Office Space Diagram


                               Page v                         2004-PH-1009
Table of Contents


C. FHA-Insured Loans Selected for Review as of       29
   September 11, 2003

D. Status of FHA-Insured Loans Selected for Review   31
   as of January 30, 2004

E. Auditee Comments                                  33




2004-PH-1009                 Page vi
Introduction
HUD insures mortgages made by private lending institutions under Section 203 of the National
Housing Act. HUD designates these institutions as supervised mortgagees, non-supervised
mortgagees, loan correspondents, investing mortgagees, and government institutions. Depending
upon their designation, the institutions have the authority to originate, purchase, hold, service, or sell
FHA-insured mortgages. Specifically, a loan correspondent can only originate loans for an
approved sponsor.

First Funding, Incorporated was incorporated on August 13, 1997 under the laws of the state of
Maryland. First Funding received approval from HUD as a Title II non-supervised loan
correspondent on February 11, 1998. First Funding’s office is located at 1101 Mercantile Lane,
Suite 201, Largo, Maryland 20774.

As a non-supervised loan correspondent, First Funding’s principal activity is the origination of
mortgages for sale or transfer to an approved FHA sponsor under the HUD Single Family Direct
Endorsement Program. The sponsor is responsible to HUD for the actions of its loan correspondent
in originating insured mortgages. The sponsor underwrites the loans originated by the loan
correspondent and is required to supervise and perform quality control reviews of its loan
correspondents. The sponsor must be an approved mortgagee that is also authorized to participate in
the HUD Single Family Direct Endorsement Program.

From August 1, 2001 through July 31, 2003, First Funding originated 228 loans with a total
mortgage amount of $35,421,841. As of September 11, 2003, 15 of these loans (7 percent) have
gone into default status at least once. As of January 30, 2004, mortgagees initiated foreclosure
action on 10 of the 15 defaulting loans at least once during the life of the loan (see Appendix D).
HUD paid loss mitigation claims on three of the ten loans in foreclosure status with net losses to
HUD of $2,050, and paid a partial claim of $11,308 in loss mitigation costs on an additional loan in
which foreclosure had not been initiated.

HUD’s Quality Assurance Division performed a Title II monitoring review of First Funding in
February 2000 and July 2001. The results of the Quality Assurance Division’s reviews detailed in
the findings letters to First Funding and its sponsors are briefly discussed below.

The February 2000 findings letter, prepared by the Quality Assurance Division, disclosed that First
Funding failed to implement a quality control plan, failed to have office space that is separate and
apart from any other entity, and had deficiencies in their loan origination files such as false
documentation and inadequate sources of funds. The findings letter from the July 2001 review
disclosed that loan files originated by two particular loan officers contained falsified documentation
as well as instances of inadequacy of the source of funds. First Funding terminated the previously
mentioned loan officers’ employment subsequent to the Quality Assurance Division’s review.



 Audit Objectives                       The audit objectives were to determine whether First
                                        Funding complied with HUD regulations, procedures, and

                                             Page 1                                         2004-PH-1009
Introduction


                   instructions in the origination of FHA-insured loans
                   selected for review; and to determine whether First
                   Funding’s quality control plan was developed and
                   implemented according to HUD regulations.

 Audit Scope And   To accomplish the audit objectives, we:
 Methodology
                   •   Reviewed 100 percent of the FHA-insured loans (15 case
                       files) originated by First Funding that had gone into
                       default at least once as of September 11, 2003. The 15
                       loans reviewed were from the universe of 228 loans
                       originated by First Funding with beginning amortization
                       dates for the two-year period from August 1, 2001 to
                       July 31, 2003. The results of the detailed testing apply
                       only to the 15 FHA-insured loans selected and cannot be
                       projected to the universe of 228 FHA-insured loans.

                   •   Examined records and related documents of First
                       Funding.

                   •   Reviewed applicable HUD records relating to First
                       Funding’s non-supervised loan correspondent activities.

                   •   Conducted interviews with officials and employees of
                       First Funding and the HUD Quality Assurance Division.

                   In addition, we relied in part on data maintained by HUD in
                   the Single Family Data Warehouse and Neighborhood Watch.
                   We did not perform a detailed analysis of the reliability of
                   HUD’s Single Family Data Warehouse or Neighborhood
                   Watch data.

                   The audit generally covered the period of August 1, 2001
                   through July 31, 2003. This period was expanded to include
                   the most current data while performing our audit. Therefore,
                   where applicable, the audit period was expanded to include
                   current data through January 30, 2004. We conducted our
                   fieldwork from October 2003 through March 2004.

                   Our audit was conducted in accordance with Generally
                   Accepted Government Auditing Standards.




2004-PH-1009           Page 2
                                                                                         Finding 1


   First Funding, Incorporated’s Quality Control
        Process Continues to Be Inadequate
First Funding, Incorporated’s quality control process over its origination of insured mortgages was
deficient in a number of activities. Specifically, First Funding’s quality control plan did not
contain all of the specific elements as outlined in HUD Handbook 4060.1 REV-1, Chapter 6. In
implementing its plan First Funding did not meet its 10 percent sample requirement for quality
control reviews for three months, review loans defaulting within the first six months, or review
10 percent of rejected loans. Further, the quality control reports they prepared were incomplete
because they did not contain all of the required elements. The individual who performed the
quality control reviews was not knowledgeable of the requirements that should take place during
the quality control review. The deficiencies associated with First Funding’s quality control plan
and procedures stem from their lack of knowledge of HUD’s and their own quality control
requirements. Therefore, First Funding is unable to guarantee the accuracy, validity, and
completeness of its loan origination operations.



 First Funding’s Quality              As a condition of the HUD-FHA approval process, loan
 Control Plan Did Not                 correspondents must have and maintain a quality control plan
 Meet HUD Requirements                for the origination and servicing of insured mortgages. HUD
                                      Handbook 4060.1 REV-1, Chapter 6, provides the general
                                      requirements along with mortgagee type specific
                                      requirements for quality control plans. The primary objective
                                      of a quality control plan is to assure compliance with HUD-
                                      FHA requirements.

                                      During a review conducted by the Philadelphia
                                      Homeownership Center in 2000, First Funding was informed
                                      that their quality control plan did not contain all of the
                                      specific elements as outlined in HUD Handbook 4060.1
                                      REV-1, Chapter 6. HUD instructed First Funding to make
                                      sure it updated its plan to include all the required elements
                                      that pertain to loan correspondents.

                                      Although we found that First Funding completed some of the
                                      necessary changes, their quality control plan continues not to
                                      meet HUD requirements. Specifically, First Funding’s quality
                                      control plan did not include:

                                      •   Procedures to identify and review all loans that go into
                                          default within six months of closing.


                                          Page 3                                       2004-PH-1009
Finding 1


                           •   Written notification to        senior    management       if
                               deficiencies were noted.

                           •   Documentation of actions taken by management,
                               including identifying the cause of the deficiencies and
                               initiating prompt action to notify employees and correct
                               the deficiencies.

                           •   Expansion of the scope of quality control reviews if
                               fraudulent activity or patterns of deficiencies were
                               identified.

                           •   Procedures to keep its personnel informed of the
                               changes; and assure that employees are held
                               accountable for performance failures or errors.

                           •   Procedures to ensure that employees are knowledgeable
                               of and adhere to HUD-FHA requirements and the
                               mortgagee's policies and standards.

                           The lack of an adequate quality control plan prevented First
                           Funding from evaluating the accuracy, validity, and
                           completeness of its loan origination operations. Therefore,
                           First Funding did not identify and correct potential
                           deficiencies in the loan origination process.

 Ten Percent Sampling      HUD Handbook 4060.1 REV-1, paragraphs 6-1, General, and
 Requirement Was Not Met   6-3, General Quality Control Plan Requirements for Loan
                           Origination, state that quality control reviews are to be
                           performed within 90 days of the loan closing. The mortgagee
                           is required to review either: the lesser of 10 percent of all
                           loans closed on a monthly basis, or a random sample that
                           provides a 95 percent confidence level with 2 percent
                           precision.

                           We found First Funding did not follow their own
                           requirements for performing quality control reviews of 10
                           percent of monthly loans for August 2001, April 2002, and
                           November 2002. All other monthly loans were reviewed as
                           required. However, one of the loans that closed in August
                           2002 was not reviewed until September 2003, which is more
                           than a year after the loan closing date and therefore is outside
                           of the HUD required 90-day review period.




2004-PH-1009                   Page 4
                                                                              Finding 1


                          The failure to meet the sampling requirements in reviewing
                          the loans prevents First Funding from evaluating the
                          accuracy, validity, and completeness of its loan origination
                          operations.

 Required Reviews Were    Paragraphs 6-1, General, and 6-3, General Quality Control
 Not Completed On         Plan Requirements for Loan Origination, of HUD Handbook
 Defaulted And Rejected   4060.1 REV-1, also require the mortgagee to review all loans
 Loans                    which go into default within the first six months and review
                          10 percent of rejected loans. First Funding did not perform
                          quality control reviews on loans that went into default within
                          six or fewer payments as required, nor did they review
                          rejected loans. We identified via Neighborhood Watch that
                          from August 1, 2001 through July 31, 2003, 11 loans went
                          into default with less than six months of payments being
                          made. First Funding performed quality control reviews on
                          two borrowers a month after the closing date, not after the
                          loan went into default. The other nine loans did not have any
                          quality control reviews performed on them.

                          First Funding was unaware of the requirement to review all
                          loans defaulting within the first six months. They were also
                          unaware that 10 percent of rejected loans also needed to be
                          reviewed. The failure to complete the review of loans
                          defaulting within the first six months and rejected loans,
                          prevents First Funding from evaluating the accuracy, validity,
                          and completeness of its loan origination operations.

Quality Control Reviews   From August 2001 through July 2003, First Funding
Were Missing Pertinent    performed 27 quality control reviews. We found none of the
Information               27 reviews contained a written re-verification of the
                          borrower's employment or deposit institution, and a new
                          credit report was not obtained as required. Instead, First
                          Funding re-verified the borrower's information by telephone.
                          However, we found inconsistencies in the recorded contact
                          dates. For example, the date the quality control reviewer
                          contacted the borrower’s employer and deposit institution did
                          not match the date the quality control review was performed.
                          For some dates a significant amount of time elapsed between
                          the contact date and the date of the quality control review.

                          We also noted that 15 quality control reports were missing
                          pertinent information such as the FHA loan numbers and
                          closing dates. In three cases, the loan numbers were incorrect.
                          We obtained the missing information by reviewing


                              Page 5                                       2004-PH-1009
Finding 1


                            other documents such as the Home Mortgage Disclosure Act
                            forms, and a listing of loans originated by First Funding. We
                            also found 8 did not have a desk review of the property
                            appraisal done as required.

 Quality Control Reviewer   Per paragraph 6-1, General, of HUD Handbook 4060.1 REV-
 Was Not Adequately         1, the quality control plan is to provide for the independent
 Trained To Perform The     evaluation of the significant information gathered for use in
 Reviews                    the mortgage credit decision making and loan servicing
                            process for all loans originated or serviced. The quality
                            control reviews are to be performed by mortgagee
                            management/supervisory personnel who are knowledgeable
                            and have no direct loan processing, underwriting, or servicing
                            responsibilities.

                            At the time of our audit, the office manager of First Funding
                            was performing the quality control reviews. However, the
                            office manager was not adequately trained to carry out the
                            quality control activities. This individual was not aware of the
                            requirement that a written re-verification of the borrower's
                            employment and deposit institution must be obtained, and
                            that quality control reviews must be performed on loans that
                            go into default in less than six months after closing, as well as
                            loans that were rejected. The individual also explained that
                            she did not believe that First Funding was responsible for
                            obtaining a new credit report as part of the quality control
                            process.

                            In summary, as shown by the discussions above, First
                            Funding’s quality control process did not meet HUD’s
                            requirements or its own requirements for approved non-
                            supervised loan correspondents under the HUD Single
                            Family Direct Endorsement Program. The HUD Quality
                            Assurance Division identified similar deficiencies, as
                            discussed in the finding, in First Funding’s quality control
                            process during their Title II monitoring review of First
                            Funding in 2000.

                            Under HUD’s Single Family Direct Endorsement Program,
                            the mortgage loan is underwritten and closed without prior
                            HUD review or approval. Therefore, it is imperative that
                            First Funding implement its quality control policies and
                            procedures in accordance with HUD’s and its own
                            requirements. Without the establishment of a proper quality
                            control plan and procedures, First Funding is unable to


2004-PH-1009                     Page 6
                                                                    Finding 1


                   ensure the accuracy, validity, and completeness of its loan
                   origination operations.



Auditee Comments   First Funding agreed with our findings. After our audit,
                   First Funding reviewed HUD Handbook 4060.1 REV-1,
                   Chapter 6 to obtain a better understanding of their
                   responsibilities. Further, First Funding hired an outside
                   contractor to assist them in implementing a Quality Control
                   Plan and to provide quality control reviews on a monthly
                   basis.



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

                   1A.     Take appropriate monitoring measures to ensure that
                           First Funding, Incorporated makes changes to its
                           current quality control process, which includes
                           implementing requirements established by HUD in
                           their existing quality control plan and conducting
                           reviews according to HUD requirements.

                   1B.     Require First Funding, Incorporated’s senior
                           management to fully implement the quality control
                           plan. The controls should ensure First Funding
                           identify and correct deficiencies in the loan
                           origination process before it submits the loan
                           packages to the direct endorsement sponsor.

                   1C.     Consider taking administrative action(s) due to the
                           continual deficiencies and noncompliance found in
                           the quality control activities.




                         Page 7                                  2004-PH-1009
Finding 1




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2004-PH-1009    Page 8
                                                                                        Finding 2


First Funding, Incorporated’s Office Operations
  Did Not Comply With HUD-FHA Approval
                 Requirements
First Funding, Incorporated did not administer its non-supervised loan correspondent activities in
conformity with HUD-FHA approval requirements as discussed in HUD Handbook 4060.1
REV-1. Specifically, First Funding did not exercise control and responsible management
supervision over their employees or require exclusivity of their employees. Furthermore, they
failed to have office space that is separate and apart from any other entity. The deficiencies
associated with First Funding’s responsibilities stem from their lack of knowledge of HUD-FHA
mortgagee approval requirements. Therefore, First Funding’s eligibility as a HUD-FHA
approved mortgagee in the origination of FHA-insured loans is questionable.



 Senior Management Did               Paragraph 2-13, Control and Supervision of Staff, of HUD
 Not Adequately Control              Handbook 4060.1 REV-1, requires a mortgagee to exercise
 And Supervise Its                   control and responsible management supervision over their
 Employees                           employees. The requirement regarding control and
                                     supervision must include, at a minimum, regular and ongoing
                                     reviews of employee performance and of work performed.

                                     First Funding’s senior management did not exercise control
                                     and responsible management supervision over its
                                     employees and actively participate in the loan origination
                                     process performed by its loan officers and loan processors.
                                     Management stated the only review of a loan officer's work
                                     that takes place prior to submission to the sponsor is when
                                     the loan officer is "known to do sloppy work". In addition,
                                     senior management told us that they do quarterly verbal
                                     performance reviews of their employees but they do not
                                     document these reviews. Therefore, we were unable to
                                     support any evidence of ongoing reviews of employee
                                     performance.

 Employees Of The                    Paragraph 2-14, Conducting Mortgagee Business, of HUD
 Mortgagee Were Not                  Handbook 4060.1 REV-1, requires employees of the
 Employed Exclusively                mortgagee, excluding the receptionist, whether full or part
                                     time, to be employed exclusively by the mortgagee at all
                                     times, and conduct only the business affairs of the
                                     mortgagee during normal business hours. First Funding did
                                     not require exclusivity of its employees as required by


                                          Page 9                                     2004-PH-1009
Finding 2


                           HUD. A loan officer was allowed to originate FHA-
                           insured loans while employed by a real estate agency as a
                           realtor. In addition, this same loan officer was the realtor
                           on one of the loans that we reviewed, which went into
                           default within 6 months of closing. Furthermore, an
                           individual that formally worked as First Funding’s
                           bookkeeper and quality control reviewer was also the
                           settlement agent at Maryland Title and Escrow, the
                           settlement company which shares space with them. This
                           individual was the settlement agent on two of the loan files
                           we selected for review. The individual was still on the
                           payroll of First Funding when both of these loans went to
                           settlement.

 Mortgagee Shared Office   Paragraph 2-16, Office Facilities, of HUD Handbook
 Space With Another        4060.1 REV-1, requires that a mortgagee be located in a
 Entity                    space that is separate and apart from any other entity.
                           However, a mortgagee may share general reception-type
                           entrances or lobbies with another business. We found First
                           Funding shares office space with Maryland Title and
                           Escrow (MT&E) (Appendix B). Employees of First
                           Funding and MT&E worked in each other’s assigned area
                           and shared the area in which the office equipment was
                           located. Furthermore, while on site, we observed that on
                           numerous occasions, employees of First Funding would
                           answer the phone lines of MT&E and employees of MT&E
                           answered the phone lines of First Funding.



Auditee Comments           Overall First Funding agreed with our finding and
                           recommendations. First Funding acknowledged that they did
                           not know about the various HUD rules concerning the
                           documentation of staff supervision, exclusivity of employees,
                           and the use of the office space. Since our audit, First Funding
                           has attempted to implement new policies and procedures that
                           they hope will alleviate the issues noted.



OIG Evaluation of          We are encouraged by the fact that First Funding has started
Auditee Comments           to implement various policies and procedures that will
                           respond to the issues noted in this report. However, HUD
                           will need to determine if the proposed actions are acceptable
                           to correct the problems.


2004-PH-1009                   Page 10
                                                                       Finding 2

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

                  2A.      Require First Funding, Incorporated to take
                           immediate action to correct the operational
                           deficiencies not in compliance with HUD-FHA loan
                           correspondent approval requirements. This would
                           include the following:

                           •      Exercise control and responsible management
                                  supervision by senior management over its
                                  employees,

                           •      Require employees to be exclusive, and

                           •      Have office space that is separate and apart
                                  from another entity.

                  2B.      Review      First     Funding,   Incorporated’s
                           implementation of recommendation 2A and ensure
                           their operations comply with FHA approval
                           requirements.




                        Page 11                                     2004-PH-1009
Finding 2




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2004-PH-1009     Page 12
                                                                                                 Finding 3


 First Funding, Incorporated Did Not Exercise
Due Diligence Over Its Loan Origination Process
First Funding, Incorporated did not always originate FHA-insured loans in accordance with HUD
requirements. For the 15 FHA-insured loans we selected for review, First Funding did not maintain
complete loan origination files for any of the loans. We also found they did not exercise due
diligence in the review of the borrower’s liabilities and credit characteristics for two loans; charged
one borrower for fees which were unjustified, and did not verify a borrower’s source of funds. The
deficiencies associated with First Funding’s loan origination activities stem from: their lack of
knowledge of HUD requirements; failure to implement their quality control process; and senior
management’s lack of control and responsible supervision over First Funding’s employees. These
deficiencies contributed to an increased risk to the FHA insurance fund.



                                            We selected and reviewed a sample of 15 FHA-insured loans
                                            originated by First Funding1. Since First Funding is a loan
                                            correspondent and uses HUD-approved sponsor mortgagees
                                            to underwrite its FHA loans, we did not specifically focus on
                                            the adequacy of the loan underwriting. However, we did note
                                            a number of deficiencies related to the sponsor’s underwriting
                                            that directly related to First Funding’s role in the loan
                                            origination process. The deficiencies we identified in the
                                            FHA case binders and First Funding’s loan origination files
                                            are discussed below.

    Incomplete Loan Files                   HUD Handbook 4000.2 REV-2, requires the origination
                                            mortgagee to retain the entire case file pertaining to loan
                                            origination, either in hard copy or microfilm form, for at least
                                            two years from the date of insurance endorsement for
                                            auditing purposes. Upon request, mortgagees must make
                                            legible hard copies of the material available to HUD staff.

                                            First Funding did not maintain complete case files as
                                            required. For the 15 case files reviewed, copies of documents
                                            were missing signatures. In addition, two case files were
                                            missing bank statements, and one file did not include a gift
                                            letter.




1
    Loans with a beginning amortization date between August 1, 2001 and July 31, 2003

                                                 Page 13                                      2004-PH-1009
Finding 3


                          The absence of documentation in the case files prohibits First
                          Funding from ensuring it documented the loan origination
                          process properly. In addition, missing and/or incomplete
                          documentation may impede the performance of quality
                          control reviews.

                          FHA Case Binder 249-4485090

 Child Support Payments   Per HUD Handbook 4155.1 REV-4, CHG-1, child support
 Were Excluded In         payments must be included as a part of the debt ratios’
 Calculating Debt Ratio   calculations. Further, the HUD Handbook states the
                          mortgage payment and fixed payment to income ratios
                          should not exceed 29 and 41 percent respectively, unless
                          the mortgagee identifies compensating factors that could
                          justify exceeding these ratios. However, we found the
                          mortgagee did not include the child support payments
                          totaling $476 when it calculated the debt ratios. The
                          mortgagee calculated the mortgage payment to income
                          ratio at 31 percent and the fixed payment to income ratio at
                          43 percent; both exceeded HUD’s requirements. The
                          mortgagee identified as a compensating factor the fact that
                          the borrower was only going to increase rent payments by
                          $24. Per the loan file, the borrower was currently paying
                          rent of $1400 to his wife (with whom he lived) and the
                          estimated mortgage payment was going to be $1424.

                          According to HUD Handbook 4155.1 REV-4, CHG-1,
                          paragraphs 2-3A, the lender must determine the borrower’s
                          payment history of the housing obligations through
                          cancelled checks covering the most recent 12-month
                          period; thus the lender should have obtained cancelled rent
                          checks that were made payable to the borrower’s wife. We
                          did not find any evidence of the payments in the loan file.
                          Therefore, using the current rent payments of $1400 as a
                          compensating factor was not justifiable.

                          Consequently, we recalculated the debt ratios to include the
                          child support payments. Had the child support been
                          appropriately included, the ratios would have been 31
                          percent and 53 percent respectively. We did not identify
                          any other valid compensating factors to justify exceeding
                          the ratios.




2004-PH-1009                  Page 14
                                                                               Finding 3

Mortgagee Shopped For A    We also noted that for this case, First Funding submitted
Lender To Obtain Loan      the loan to various lenders until the loan was approved.
Approval                   The first lender noted that there were numerous conditions
                           of the loan that needed to be satisfied before they could
                           approve the loan. Specifically, the lender noted that First
                           Funding did not include the child support payments in the
                           calculation of the ratios. Documentation contained in the
                           First Funding’s loan origination file disclosed that once
                           they realized this, they withdrew the loan from the first
                           lender and submitted the loan to a second lender. The
                           President of First Funding explained that one reason they
                           withdrew the loan from the lender was because First
                           Funding did not agree with all of the conditions noted by
                           the lender.

                           The second lender approved the loan without including the
                           child support payments in the calculation of the ratios. The
                           President and a loan officer of First Funding explained that
                           this was not of great concern to them, because it is totally
                           upon the discretion of the lender whether or not to include the
                           payments. Also, representatives of First Funding explained
                           that the child support payments were going to end in less than
                           ten months of the closing of the loan. However, according to
                           HUD Handbook 4155.1 REV-4, CHG-1, paragraphs 2-11A,
                           child support payments lasting less than ten months must be
                           included in the calculation of debt to income ratios if the
                           amount of debt affects the borrower’s ability to make the
                           mortgage payment during the months immediately after loan
                           closing.

                           Based upon the facts presented above, First Funding
                           disregarded HUD loan origination requirements in order to
                           ensure that the loan was approved. Therefore we
                           recommend the sponsor indemnify HUD on the original
                           loan balance of $161,740.

                           FHA Case Binder 249-4328425

Borrower’s Payment         HUD Handbook 4155.1 REV-4, CHG-1, Previous Rental or
History Was Not Properly   Mortgage Payment History, states that the payment history of
Verified                   the borrower’s housing obligation is of significant
                           importance in evaluating credit. Thus, the lender must
                           determine the borrower’s payment history of their housing
                           obligations, prior to the issuance of the loan. Documentation
                           in First Funding’s loan file indicated the borrower owed


                               Page 15                                      2004-PH-1009
Finding 3


                         $1,800 in back rent payments. The borrower was to pay this
                         debt prior to loan settlement. However, we found no
                         documentation from First Funding’s files that showed the
                         borrower actually satisfied the debt prior to the mortgagee
                         issuing the loan.

                         FHA Case Binder 249-4110156

 Justification Was Not   The Tiered Pricing Rule as described in 24 CFR 202.12, and
 Provided For Overages   HUD Mortgagee Letters 94-16 and 94-43, allows the lender
                         to charge overages (discount fees) and retain them; however,
                         a lender’s customary lending practices may not provide for a
                         variation in “mortgage charge rates” (discount point,
                         origination fee, and other such fees) exceeding two
                         percentage points on its FHA-insured Single Family
                         mortgages within a geographical area. Any variation within
                         two percentage points must be based on actual variations in
                         fees or costs to the lender to make a loan. Whenever a lender
                         makes a variation in pricing within the two percent, the lender
                         must provide a justification. A record of the justification must
                         be maintained for a period of at least two years and must be
                         made available to the secretary upon demand.

                         First Funding charged the borrower an overage of $6,058 in
                         the form of a loan “discount”. We also found that the sponsor
                         paid First Funding $5,653.80 for a Yield Spread Premium.
                         According to the Real Estate Settlement Procedures Act, a
                         Yield Spread Premium is an indirect compensation from the
                         lender, which may reduce the up-front costs for a borrower,
                         but consequently increases the interest rate of the loan in
                         order to compensate the broker. When we questioned the
                         President of First Funding about being paid for both a
                         discount and a Yield Spread Premium, the President informed
                         us that the $6,058 was not an actual loan discount to reduce
                         the interest rate. The fee was actually charged to the
                         borrower because the President considered the loan “risky”,
                         and because there was no other place on the HUD-1 to note
                         these fees. The President also provided us with a copy of
                         their policy, which states that First Funding will charge two to
                         four points above their normal fees if the loan is determined
                         to be risky, so that it will cover their cost if a repurchase is
                         necessary due to an early default on the loan.




2004-PH-1009                 Page 16
                                                                             Finding 3


                        We did not perform an analysis to determine if the variation
                        in the “discount” exceeded two percentage points on First
                        Funding’s FHA-insured Single Family mortgages within the
                        geographical area. However, even if the variation was within
                        the required two percentage points, there was no justification
                        in the loan file that showed the variation charged was based
                        on actual variations in fees and costs incurred by First
                        Funding to originate the loan. The overage charged by First
                        Funding as a “discount” was not properly justified.
                        Therefore, we consider it to be a violation of HUD-FHA
                        regulations.

                        FHA Case Binder 249-4411035

Debt To Income Ratios   Per Handbook 4155.1 REV-4, CHG-1, the borrower’s
Exceeded HUD            mortgage payment to effective income ratio and total fixed
Requirements            payment to income ratio should not exceed 29 and 41 percent,
                        respectively, unless the mortgagee identifies compensating
                        factors that could justify exceeding these ratios. The effective
                        income ratio and total fixed payment to income ratios for the
                        above mentioned loan were calculated to be 29.59 and 47.16
                        percent respectively.

                        In calculating the monthly income, the co-borrower’s social
                        security payments were “grossed-up” by the Everbank
                        Wholesale Lending (Formerly First Alliance Bank)
                        underwriter. Handbook 4155.1 REV-4, CHG-1, Non-taxable
                        Income, states that if a source of regular income is not subject
                        to federal taxes, the amount of continuing tax savings
                        attributable to the non-taxable income source may be added
                        to the borrower’s gross income. The percentage of income
                        that may be added may not exceed the appropriate tax rate for
                        that income amount. We determined that the underwriter
                        used an incorrect percentage rate to gross-up the co-
                        borrower’s income. The co-borrower received social security
                        benefits for 2000 totaling $8,807. The tax rate for $8,807
                        ($733 per month) in 2000 was 15 percent, however, 25
                        percent was used to gross-up the income, thereby overstating
                        the co-borrower’s monthly income by $73. Using the correct
                        income tax rate, we determined the correct income and used
                        that amount to recalculate the ratios. When we recalculated
                        the mortgage to income ratio it was 29.93 percent (an
                        increase of .34 percent) and the fixed payment to income ratio
                        became 47.72 percent (an increase of .56 percent), which
                        exceeded HUD ratio limits.


                            Page 17                                       2004-PH-1009
Finding 3


                   Since the original ratios exceeded HUD requirements, the
                   underwriter     approved      compensating      factors.   The
                   compensating factors included the fact that the borrower had
                   an overall good credit rating and had the ability to save. The
                   underwriter also noted that the borrower would be receiving a
                   four percent raise two months after settlement. However, if
                   in fact the borrower’s four percent raise was included in the
                   calculation, the total fixed payment to income ratio would
                   still be 46.19 percent, which is 5.19 percent above HUD
                   requirements. Based upon our analysis, we do not believe
                   that either the compensating factors nor the grossed-up non-
                   taxable income justified the excessive ratios. HUD has
                   already paid a partial claim of $11,307.68 on this loan.
                   Furthermore, the borrower was in default as of January 30,
                   2004. Therefore, we recommend that the sponsor indemnify
                   HUD for the original insured loan balance of $210,003.

                   In summary, the above cases illustrate that HUD assumed
                   unnecessarily high risk when insuring the loans originated by
                   First Funding. The deficiencies associated with First
                   Funding’s loan origination activities stem from their lack of
                   knowledge of HUD requirements as demonstrated in the
                   origination of loans associated with the case illustrations
                   above. Further, as we discussed under the two previous
                   findings, First Funding’s failure to properly implement its
                   quality control process and exercise control and supervision
                   over its employees contributed to the problems we identified
                   in its loan origination process.

                   Since First Funding did not carry out its loan origination
                   activities in accordance with HUD requirements we
                   recommend the sponsor indemnify HUD on FHA Case
                   Numbers 249-4485090 and 249-4411035. We also
                   recommend that the eligibility of the “discount” charged on
                   FHA Case Number 249-4110156 be determined and
                   reimbursed if found unsupported. Additionally, HUD should
                   consider taking other administrative action(s) as deemed
                   appropriate for the deficiencies noted in the report.



Auditee Comments   First Funding agreed with our finding concerning the need
                   to properly document and maintain the loan files.
                   However, First Funding disagreed with our assessment of
                   FHA Case Binder 249-4485090. Specifically First


2004-PH-1009           Page 18
                                                                        Finding 3


                    Funding disagreed with our use of child support payments
                    in the debt to income ratio and the compensating factor of
                    rent and payments. First Funding believes that it was the
                    underwriter/sponsor’s responsibility to make an assessment
                    to include the child support payment in the debt to income
                    ratio and not First Funding’s. In addition, the
                    underwriter/sponsor accepted the compensating factor
                    once it was verified on the credit report.

                    First Funding also disagreed with our assessment that it did
                    not properly justify the overage charge. First Funding stated
                    that it charged the fee for the seven months of work that was
                    put in on this loan and believes it is justified.



OIG Evaluation of   In the case of the FHA Case Binder 249-448090, we
Auditee Comments    reviewed First Funding’s concern that the underwriter/
                    sponsor was aware of the child support payments not
                    included in the debt to income ratio and have adjusted our
                    recommendation to request indemnification from the sponsor
                    instead of First Funding. As for the overage charge, First
                    Funding was unable to provide proper support to show that it
                    based the variation charged on actual variations in fees and
                    costs incurred by First Funding to originate the loan. The
                    overage charged by First Funding as a “discount” was not
                    properly justified; therefore, we consider it to be a violation
                    of HUD-FHA regulations.



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

                    3A.      Determine whether First Funding, Incorporated’s
                             deficiencies in the loan origination process warrant
                             administrative action(s).

                    3B.      Request Indemnification from the sponsor on FHA
                             Case Number 249-4485090, whose original loan
                             balance was $161,740.

                    3C.      Determine the eligibility of the $6,058 overage
                             charged by First Funding on FHA Case Number 249-
                             4110156. If it is determined that these fees remain


                          Page 19                                    2004-PH-1009
Finding 3


                        unsupported, require First Funding to reimburse the
                        fees charged as follows:

                               i.     If the loan is current, make a refund to the
                                      borrowers,
                               ii.    If the loan is delinquent, apply a refund to
                                      the delinquency,
                               iii.   If a claim has been paid, pay a refund to
                                      HUD and sent to the HUD Single Family
                                      Claims Center.

               3D.      Request Indemnification from the sponsor on FHA
                        Case Number 249-4411035, whose original insured
                        loan balance was $210,003.




2004-PH-1009         Page 20
Management Controls
In planning and performing our audit, we considered the management controls of First Funding,
Incorporated to determine the audit procedures, not to provide assurance on their management
controls. Management controls include the plan of organization, methods, and procedures adopted
by management to ensure that its goals are met. Management controls include the processes for
planning, organizing, directing, and controlling program operations. They include the systems for
measuring, reporting, and monitoring program performance.



 Relevant Management                 We determined the following management controls were
 Controls                            relevant to our audit objectives:

                                     •   Loan Origination Process - Policies and procedures that
                                         management has in place to reasonably ensure that the
                                         loan origination process complies with the HUD-FHA
                                         program requirements.

                                     •   Quality Control Plan - Policies and procedures that
                                         management has in place to reasonably ensure
                                         implementation of HUD-FHA quality control
                                         requirements.

                                     The following audit procedures were used to evaluate the
                                     management controls:

                                     •   Review of established procedures formulated by First
                                         Funding in originating FHA-insured loans,

                                     •   Interviews with officials and employees of First Funding,

                                     •   Examination of records and related documents for FHA-
                                         insured loans originated between August 1, 2001 and July
                                         31, 2003,

                                     •   Review of records and files maintained by HUD’s
                                         Quality Assurance Division in connection with the
                                         oversight of First Funding, and

                                     •   Interviews with applicable officials and employees of
                                         HUD’s Quality Assurance Division relating to activities
                                         associated with First Funding.




                                         Page 21                                       204-PH-1009
Management Controls

 Significant Weaknesses   A significant weakness exists if management controls do not
                          give reasonable assurance that resource use is consistent with
                          laws, regulations, and policies; that resources are safeguarded
                          against waste, loss, and misuse; and that reliable data are
                          obtained and maintained, and fairly disclosed in reports.

                          Our review of First Funding’s management controls over its
                          loan origination and quality control procedures for the
                          origination of FHA-insured loans showed First Funding as
                          not complying with HUD requirements. Our audit disclosed
                          the following significant weaknesses with First Funding’s
                          Single Family loan program:

                          •   Quality control process,

                          •   Operating in accordance with HUD-FHA approval
                              requirements, and

                          •   The loan origination process.

                          The deficiencies are discussed in detail in the Findings in this
                          report.




2004-PH-1009                  Page 22
Follow Up On Prior Audits
This is the first audit of First Funding, Incorporated conducted by HUD’s Office of the Inspector
General. The mortgagee’s last independent audit report for the year ending September 30, 2002 did
not contain any findings.




                                         Page 23                                    2004-PH-1009
Follow Up On Prior Audits




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2004-PH-1009                 Page 24
                                                                                   Appendix A

Schedule of Questioned Costs
and Funds Put to Better Use
     Recommendation               Type of Questioned Cost                  Funds Put to
         Number              Ineligible 1/       Unsupported 2/            Better Use 3/
           3B                                                               $161,740
           3C                                          $6,058
           3D                                                                $210,003
        TOTALS                                         $6,058                $371,743



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

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

3/    Funds Put to Better Use are costs that will not be expended in the future if our
      recommendations are implemented.




                                        Page 25                                    2004-PH-1009
Appendix A




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2004-PH-1009     Page 26
                                                                                                                                   Appendix B

First Funding, Incorporated (FFI) and Maryland
Title and Escrow (MT&E) Office Space
Diagram
                                                      SHARED LOBBY AREA
                                                                                        FFI President




                                                                                                                   Door marked
                Door marked                                          Receptionist                                     “First
                 “Maryland                                              Desk                                        Funding”
                  Title and
                  Escrow”




                                                                                                                      Loan Officer
                 Closed Office
                    Space                                                                               Copy &
                                                                                                        Fax
                                                                                                        machine
                                                      Enclosed Wall Separating the Two
                                                                Corridors                                              QC
                                                                                                                     Reviewer


                 Closed Office
                    Space               Hall with   Door leading to FFI Suites
                                        Men’s &                                                                    Loan Processor
                                        Women’s
                                        Restrooms




                                                                                                                   Shared area with
                                                                                                                   Copier, employee
                                                                                                                   mailboxes for both
                   FFI Loan                                                                                        FFI & MT&E
                   Processor                                                                                       employees, shared
                                                                                                                   office supplies,
                                                                                                                   refrigerator, sink etc.


                                                                                         Door marked
                                                                                           MT& E

                                                                                                                   MT&E Settlement
                                                                                                                      Agent


                  Hallway




                                                                                         Door marked
                                                                                           MT&E


                                                                                                                  MT&E President
               Unlabeled door that leads to             FFI Secretary/              Conference Room
                   the hallway above                      Treasurer




2004-PH-1009                                         Page 27
Appendix B




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2004-PH-1009    Page 28
                                                                                   Appendix C

First Funding, Incorporated (FFI) and Maryland
Title and Escrow (MT&E) Office Space
Diagram
                                                        Payment
                                 Current                s Before
                                 Default      Defaul      First
        Case         Mortgage     as of          t       Default
       Number        Amount      9/11/03      Status    Reported       Sponsor Name
                                                                     American Mortgage
     249-4279983 $ 108,300           Y             68     11         Express Corp.
                                                                     American Mortgage
     249-4110156 $ 161,537           Y             12      0         Express Corp.
                                                                     Alliance Mortgage
     249-4256188 $ 51,507                          20      3         Company
     249-4430488 $ 165,597                         20      5         Chase Manhattan
     249-4485090 $ 161,740           Y             68      0         First Alliance Bank
                                                                     Cardinal Financial
     249-4498672 $ 174,224           Y             45      0         Company
     249-4411035 $ 210,003           Y             10      6         First Alliance Bank
     249-4414961 $ 165,901                         13      4         Chase Manhattan
                                                                     Cardinal Financial
     241-6094911 $ 127,839                         20      11        Company
                                                                     American Mortgage
     249-4328425 $ 101,310           Y             68      4         Express Corp.
                                                                     American Mortgage
     241-6329571 $ 147,682           Y             68      5         Express Corp.
                                                                     Aegis Mortgage
     249-4348725 $ 128,790           Y             42     10         Corporation
                                                                     International
     249-4419634 $ 137,910                         19      6         Mortgage Corporation
                                                                     International
     249-4388219 $ 125,012                         19      3         Mortgage Corporation
     249-4388697 $ 190,566                         19      9         First Alliance Bank
       TOTAL     $2,157,918

Default Status Codes Default Status Descriptions
         10                        Eligible for Partial Claim
         12                        Repayment
         13                        Paid in Full
         19                        Partial Reinstatement
         20                        Reinstated by Mortgagor
         42                        Delinquent 90 Days or More
         45                        Foreclosure Completed
         68                        First Legal Action to Foreclose

2004-PH-1009                             Page 29
Appendix C




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2004-PH-1009    Page 30
                                                                            Appendix D

Status of FHA-Insured Loans Selected for
Review as of January 30, 2004
                                            Current                   Loss
             Case         Mortgage         Default as   Default    Mitigation
            Number        Amount           of 1/30/04   Status     Claim Paid
          249-4279983   $ 108,300.00           Y          68
          249-4110156   $ 161,537.00           Y          12
          249-4256188   $ 51,507.00            N          20
          249-4430488   $ 165,597.00           N          20       $   625.00
          249-4485090   $ 161,740.00           Y          68
          249-4498672   $ 174,224.00           Y          43
          249-4411035   $ 210,003.00           Y          12       $11,307.68
          249-4414961   $ 165,901.00           N          13
          241-6094911   $ 127,839.00           N          20       $   750.00
          249-4328425   $ 101,310.00           Y          68
          241-6329571   $ 147,682.00           Y          68
          249-4348725   $ 128,790.00           N          19
          249-4419634   $ 137,910.00           N          19
          249-4388219   $ 125,012.00           N          19       $   675.00
          249-4388697   $ 190,566.00           N          19
            TOTAL       $2,157,918.00                              $13,357.68

       Default Status Codes      Default Status Descriptions
       12                        Repayment
       13                        Paid in Full
       19                        Partial Reinstatement
       20                        Reinstated by Mortgagor
       43                        Foreclosure Started
       68                        First Legal Action to Foreclose




2004-PH-1009                            Page 31
Appendix D




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2004-PH-1009    Page 32
                             Appendix E

Auditee Comments




                   Page 33   2004-PH-1009
Appendix E




2004-PH-1009   Page 34
          Appendix E




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          Appendix E




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