AUDIT REPORT SCHELLER-HESS YODER AND ASSOCIATES NON-SUPERVISED LOAN CORRESPONDENT PORTLAND, OREGON 2004-SE-1002 JANUARY 9, 2004 OFFICE OF AUDIT, REGION X SEATTLE, WASHINGTON Issue Date January 9, 2004 Audit Case Number 2004-SE-1002 TO: John C. Weicher, Assistant Secretary for Housing-Federal Housing Commissioner, H FROM: Frank E. Baca, Regional Inspector General for Audit, 0AGA SUBJECT: Scheller Hess-Yoder and Associates Non-Supervised Loan Correspondent Portland, Oregon We completed an audit of Scheller Hess-Yoder and Associates (SHYA), doing business as Advanced Mortgage Resources in Portland, Oregon. We selected SHYA for review because of their high default and claim rates. Our report contains two findings with recommendations requiring action by your office. In accordance with HUD Handbook 2000.06 REV-3, within 60 days please provide us, for each recommendation without a management decision, a status report on: (1) the corrective action taken; (2) the proposed corrective action and the date to be completed; or (3) why action is considered unnecessary. Additional status reports are required at 90 days and 120 days after report issuance for any recommendations 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 Scheller Hess- Yoder & Associates. Should you or your staff have any questions, please contact me at (206) 220-5360. Management Memorandum THIS PAGE LEFT BLANK INTENTIONALLY 2004-SE-1002 Page ii Executive Summary We completed an audit of Scheller Hess-Yoder and Associates (SHYA), doing business as Advanced Mortgage Resources (AMR) in Portland, Oregon. SHYA is a non-supervised loan correspondent approved by HUD to originate FHA-insured loans under HUD’s Single Family Direct Endorsement Program. The audit objectives were to determine if (1) SHYA acted in a prudent manner and complied with HUD regulations, procedures, and instructions in the origination of Federal Housing Administration (FHA) loans, and (2) SHYA's Quality Control Plan, as implemented, meets HUD requirements. The review covered the period from October 1, 1999 to July 31, 2003. A summary of our review results is provided below. We found that SHYA disregarded HUD/FHA requirements Independent Branches And and entered into agreements with outside contractors to act as Leased Employees independent branches or leased employees to originate FHA- insured loans (Finding 1). The agreements between SHYA and these contractors are in violation of HUD/FHA requirements because (1) HUD/FHA prohibits lenders from contracting for customary loan officer functions; (2) the written agreements specify that the loan officers are not employees of SHYA; and (3) the written agreements include provisions that the outside contractors indemnify SHYA for any actions on the contractors’ part that were a violation of any applicable statute or regulation. Further, SHYA did not adequately supervise the contractors’ employees as required by HUD/FHA. Loan applications completed by the non-SHYA employees contained misleading certifications to HUD that full time SHYA employees processed the applications. HUD/FHA considers the practice of mortgagees using unauthorized branches and non-employees for the origination of insured loans a significant risk to the FHA insurance fund. We also found that SHYA disregarded HUD's quality control Quality Control requirements and its own HUD-approved Quality Control Plan Requirements and allowed the person responsible for conducting SHYA’s quality control reviews to also process and originate FHA- insured loans (Finding 2). SHYA’s quality control reviewer received loan officer commissions on three of the four FHA loans that she originated. Such a conflict of interest on the part Page iii 2004-SE-1002 Executive Summary of a quality control reviewer is a violation of HUD requirements with respect to the need for an independent quality control review, and limits assurance to HUD that an independent quality control review is performed on SHYA’s loans. We are recommending that (1) SHYA reimburse HUD/FHA Recommendations for claims paid on one loan originated by an unapproved branch and three loans originated under “employee lease” agreements, (2) SHYA indemnify HUD/FHA against current and future losses on four loans originated under its unapproved branch office agreements and 47 loans originated under “employee lease” agreements, (3) HUD/FHA consider seeking civil monetary penalties against Scheller Hess-Yoder and Associates, its unapproved branch offices, and its “leased employees” for submitting false certifications on the loan applications, and (4) SHYA indemnify HUD/FHA against future losses on one of the four loans originated by its quality control reviewer. We are further recommending that HUD/FHA determine whether Scheller Hess-Yoder and Associates’ deficiencies in its loan origination activities warrant its removal from participation in HUD’s Single Family Mortgage Insurance Programs. If HUD determines that Scheller Hess-Yoder and Associates can maintain their approval as a non-supervised loan correspondent, then it should take appropriate monitoring measures to ensure that SHYA (1) discontinues the practice of submitting loans that are originated by “leased employees” or unauthorized branches, and (2) fully implements its Quality Control Plan. We issued a discussion draft report on September 25, 2003, and discussed the audit results with SHYA’s President at an exit conference on October 31, 2003. SHYA provided written comments to the draft report on December 4, 2003, disagreeing with finding one and generally agreeing with finding two. The findings section of this report summarizes and evaluates SHYA’s comments. A copy of SHYA’s response is included in Appendix B. 2004-SE-1002 Page iv Table of Contents Management Memorandum i Executive Summary iii Introduction 1 Findings 1. Scheller Hess-Yoder and Associates Allowed Unapproved Branches and Non-Employees to Originate Insured Loans 5 2. SHYA is Not in Full Compliance With HUD/FHA Quality Control Requirements 19 Management Controls 23 Appendices A. Schedule of Questioned Costs and Funds Put to Better Use 25 B. Auditee Comments 27 C. Loans Originated Under Independent Contractor/Branch Agreements 37 D. Loans Originated Under Employee Lease Agreements 39 E. Distribution Outside of HUD 43 Page v 2004-SE-1002 Table of Contents Abbreviations AMR Advanced Mortgage Resources FHA Federal Housing Administration HUD U.S. Department of Housing and Urban Development ML Mortgagee Letter NW Neighborhood Watch OIG Office of Inspector General QAD Quality Assurance Division QCP Quality Control Plan SHYA Scheller Hess-Yoder and Associates URLA Uniform Residential Loan Application 2004-SE-1002 Page vi Introduction Background Scheller Hess-Yoder and Associates (SHYA) doing business as Advanced Mortgage Resources (AMR), was incorporated under the laws of the state of Oregon on July 15, 1992. SHYA received approval from HUD as a Title II non-supervised loan correspondent on May 12, 1999. SHYA’s office is located at 6400 SW Canyon Court, Suite 200, Portland, Oregon 97221. As a non-supervised loan correspondent, SHYA originates mortgages for sale to FHA-approved sponsor lenders under the HUD/FHA Single Family Direct Endorsement Program. In July 2002, HUD’s Quality Assurance Division (QAD) performed a monitoring review of SHYA. The results of the review were summarized in the August 14, 2002 findings letter to SHYA. QAD’s findings centered on SHYA’s lack of an adequate Quality Control Plan (QCP). The following is an excerpt from the findings letter: “AMR does not have a QCP that is in conformity with HUD requirements. HUD- approved loan correspondents are required to adopt, maintain and implement such a plan. While HUD does not prescribe specific elements, guidelines are available in HUD Handbook 4060.1 REV-1, Chapter 6. The pertinent elements are outlined in the QCP ‘checklist’ that was provided to you during the on-site review. For example, AMR’s QCP does not contain procedures for written reverification of employment, deposits, gift letter, or other sources of income. The QCP did not contain any procedures for review of 203(k) Rehabilitation Mortgage loans as required by Handbook 4240.4 REV-2, paragraph 1-20 or HUD Mortgagee Letter. Also, AMR did not submit early-payment default loans for quality control review. HUD Handbook 4060.1, paragraph 6-1(d)(3), requires that mortgagees analyze all HUD/FHA insured loans that go into default within the first six months. Mortgagees can access a list of defaulted loans originated under their mortgagee identification number through Neighborhood Watch Early Warning System. Please refer to Mortgagee Letter 00-20 for further instructions. Because of the seriousness of this violation, you are requested to forward to this office a copy of your revised quality control plan. Further, please provide evidence of your quality control reviews of early-payment defaults and the assurance that you will conduct these reviews in the future.” By October 1, 2002 SHYA submitted a revised Quality Control Plan that was acceptable to HUD/FHA and the QAD finding was closed. Page 1 2004-SE-1002 Introduction According to HUD’s Neighborhood Watch website, for the past two years SHYA had consistently higher default rates for loans defaulting within 12 months from beginning amortization dates than the overall average rate for the state of Oregon as follows: Default Rate by Selected Calendar Quarters 6/30/01 – 6/30/03 Quarter Ending 06/30/03 12/31/02 06/30/02 12/31/01 6/30/01 Scheller Hess-Yoder 4.32% 7.77% 7.05% 4.67% 3.70% Entire State of Oregon 2.20% 2.47% 2.36% 2.43% 2.33% Relative Comparison 196% 315% 299% 192% 159% During our audit period of October 1, 1999 to July 31, 2003, SHYA originated 431 FHA-insured single family loans amounting to $58,950,904. As of July 31, 2003, 43 of these loans have gone into default status at least once. SHYA’s 10 percent default rate for this period was over three times the default rate for all FHA single-family loans originated in the state of Oregon during the same period. To date, foreclosure action has been initiated on 25 of the 43 defaulting loans. Fourteen of the 25 loans in foreclosure status have gone into claims status, with net losses to HUD of $415,250, for an average net loss of $29,661 per loan. Net losses on the remaining 11 loans in foreclosure status had yet to be determined at the time of our audit. The audit objectives were to determine if SHYA acted in a Audit Objectives, Scope, prudent manner and complied with HUD regulations, And Methodology procedures, and instructions in the origination of Federal Housing Administration (FHA) loans, and to determine whether SHYA's Quality Control Plan, as implemented, meets HUD requirements. To accomplish our audit objectives, we: • Reviewed the FHA case files for a sample of 32 of the 33 FHA-insured loans originated by SHYA that had gone into default at least once as of January 9, 2003, at the beginning of our audit work. The FHA case file for one of the 33 defaulting loans was not available for review. The 32 loans reviewed were from the universe of 330 originated by SHYA with beginning amortization dates for the three-year period from October 1, 1999 to November 1, 2002. The 2004-SE-1002 Page 2 Introduction results of the detailed testing apply only to the 32 loans selected and cannot be projected to the entire universe of 330 loans. • Examined records at SHYA including loan origination files, loan origination logs, loan pipeline reports, payroll records, and personnel files. • Conducted interviews with SHYA officials and employees. • Interviewed available borrowers as needed. Initially, our audit covered the period October 1, 1999 to November 1, 2002. This period was expanded to include the most current data while performing our review. Thus, we expanded the audit period to include loans originated by SHYA that were endorsed as of July 31, 2003. We performed the audit in accordance with Generally Accepted Government Auditing Standards. Page 3 2004-SE-1002 THIS PAGE LEFT BLANK INTENTIONALLY 2004-SE-1002 Page 4 Finding 1 Scheller Hess-Yoder and Associates Allowed Unapproved Branches and Non-Employees to Originate Insured Loans Contrary to HUD/FHA requirements, Scheller Hess-Yoder and Associates (SHYA), doing business as Advanced Mortgage Resources (AMR), acted as a conduit for loans originated by unapproved branches and independent loan officers who were not SHYA employees. SHYA disregarded HUD/FHA requirements and entered into agreements with outside contractors to act as independent branches or leased employees to originate FHA-insured loans. The agreements between SHYA and these contractors are in violation of HUD/FHA requirements because (1) HUD/FHA prohibits lenders from contracting for customary loan officer functions; (2) the written agreements specify that the loan officers are not employees of SHYA; and (3) the written agreements include provisions that the outside contractors indemnify SHYA for any actions on the contractors’ part that were a violation of any applicable statute or regulation. Further, SHYA did not adequately supervise the contractors’ employees as required by HUD/FHA. Additionally loan applications completed by the non- SHYA employees contained certifications to HUD that full time SHYA employees processed the applications. HUD/FHA considers the practice of mortgagees using unauthorized branches and non-employees for the origination of insured loans a significant risk to the FHA insurance fund. HUD Handbook Requirements for Loan Correspondents HUD/FHA Prohibits Unauthorized Branch According to HUD Handbook 4060.1 REV-1: Offices and Requires Close Supervision of Mortgagee • Lenders (including loan correspondents) must be approved Employees by HUD to originate, purchase, hold or sell HUD/FHA insured mortgages (Paragraph 1-2). • Lenders must submit applications to HUD for each branch office submitting loans for insurance (Paragraph 1-2 A). • Lenders are required to pay a $300 application fee and a $200 annual recertification fee for each branch office (Paragraph 2-3). • Each branch office of a loan correspondent must have a net worth of $25,000 (Paragraph 2-4 D). Page 5 2004-SE-1002 Finding 1 • A lender is fully responsible for the actions of its branch office (Paragraph 2-16). • A lender must pay all of its own operating expenses. This includes the compensation of all employees of its main and branch offices. Compensation may be on the basis of a salary, salary plus commission, and commission only. Other operating expenses that must be paid by the mortgagee include, but are not limited to, equipment, furniture, office rent, overhead, and other similar expenses incurred in operating a mortgage lending business (Paragraph 2-17). • Lenders must exercise control and responsible management supervision over their employees. The requirement regarding control and supervision must include, at a minimum, regular and ongoing reviews of employee performance and work performed (Paragraph 2-13). • All employees of the mortgagee except receptionists, whether full time or part time, must be employed exclusively by the mortgagee at all times, and conduct only the business affairs of the mortgagee during normal business hours (Paragraph 2-14). Mortgagee Letter Requirements Mortgagee Letter 95-36 (ML 95-36) prohibits lenders from contracting out for customary loan officer functions. Mortgagee Letter 00-15 (ML 00-15) makes it clear that HUD/FHA considers the practice of mortgagees using unauthorized branches and non-employees for the origination of insured loans a significant risk to the FHA insurance fund. Accordingly, ML 00-15 provides further guidance and clarification regarding the Department's requirements for FHA- approved mortgagee branch offices and employee agreements, stating, in part: “The Department has learned that some HUD/FHA approved mortgagees are engaged in the practice of taking on an existing, separate mortgage company or broker as a branch and allowing that separate entity to originate insured mortgages under the 2004-SE-1002 Page 6 Finding 1 approved mortgagee's HUD Mortgagee Number. Some mortgagees refer to this arrangement as a ‘net branch.’ This, however, constitutes a prohibited net branch arrangement…” and “As part of on-site mortgagee monitoring reviews, the Department has obtained ‘employment’ agreements executed by HUD/FHA approved mortgagees and their ‘net branches.’ A number of the provisions in these agreements violate Departmental branch requirements. For example, there are provisions that: • require all contractual relationships with vendors such as leases, telephones, utilities, and advertising to be in the name of the ‘employee’ (branch) and not in the name of the HUD/FHA approved mortgagee. • require the ‘employee’ (branch) to indemnify the HUD/FHA approved mortgagee if it incurs damages from any apparent, express, or implied agency representation by or through the ‘employee's’ (branch's) actions. • require the ‘employee’ (branch) to issue a personal check to cover operating expenses if funds are not available from an operating account. These provisions violate Paragraphs 1-2, 2-13, 2-17, and 3-2B of the Mortgagee Approval Handbook 4060.1 Rev-1. Taken as a whole, such provisions seem designed to maintain a clear separation between the HUD/FHA approved mortgagees and their so-called ‘branches,’ which is inconsistent with the close supervisory control over all employees mandated by the handbook. The Department believes that the origination of insured mortgages by lenders that have not received HUD/FHA approval increases the risk to the FHA insurance funds and to the public. Accordingly, mortgagees found to be in violation may be subject to the full range of HUD sanctions.” (emphasis added) Contrary to HUD/FHA regulations and without obtaining SHYA Submitted Loans HUD’s approval, SHYA allowed two independent entities to Originated by Entities That originate FHA-insured loans using SHYA’s approved Were Not HUD Approved mortgagee name and FHA lender identification number. SHYA Page 7 2004-SE-1002 Finding 1 entered into an “Independent Contractor Agreement Associate Loan Officer” with a mortgage broker doing business as The Mortgage Source. According to the agreement, the broker would represent SHYA for all real estate loans generated. SHYA also entered into an “Independent Contractor Agreement Branch Office” with an independent contractor doing business as P&L Financial Services Inc. Under this agreement, P&L Financial Services would operate and manage a branch office of SHYA. These agreements effectively create branch offices of SHYA; however, SHYA did not submit required branch office notifications to HUD for the two branches. Consequently, HUD could not effectively monitor the performance of the SHYA branches because it is not aware of who is actually responsible for originating the branches’ loans. These agreements are also in direct violation of HUD/FHA requirements because neither the broker nor the contractor are exclusive employees of SHYA. Both agreements specifically state that the broker/contractor is not a partner, agent, or employee of SHYA. The contracts further state that the broker/contractor is not eligible to participate in any of SHYA’s employee benefit programs, and is not covered by any SHYA insurance program, including workers’ compensation. The contracts also make the broker/contractor responsible for all expenses, insurance, and taxes. Both contracts include indemnification agreements to protect SHYA from any liability associated with the actions of the broker/contractor. Mortgagee Letter 00-15 expressly prohibits these indemnification agreements. Such indemnification agreements put the FHA insurance fund at risk because they are structured to transfer any liability associated with improper loan origination practices from the HUD-approved lender to a non- approved entity that HUD has no knowledge of. The agreement with The Mortgage Source states “Independent Contractor agrees to indemnify and hold Company harmless for any loss, damage, fees, or costs incurred by reason of Independent Contractor’s misrepresentation, fraud, or violation of any statute or regulation, violation of any rules, regulations or policies of Company, or violation of any other applicable statute or regulation.” 2004-SE-1002 Page 8 Finding 1 The contract with P&L Financial Services contains similar language, stating “Commissioned Contractor agrees to indemnify and hold Company harmless for any loss, damage, fees, or costs incurred by reason of Commissioned Contractor’s misrepresentation, fraud, or violation of any statute or regulation, violation of any rules, regulations or policies of Company, violation of any other applicable statute or regulation, or actions of Commissioned Contractor that result in claims made against Company.” Both contracts required the contractors to pay a loan processing fee to SHYA with each loan package submitted for processing. The processing fees to SHYA were $300 per loan for the Mortgage Source and $395 per loan for P&L Financial. The contracts also allowed SHYA to earn a portion of the fees (loan origination fee, yield spread premiums, and service release premiums) generated by loans originated by the contractors. According to its agreement, The Mortgage Source receives 80 percent of the fees from its closed loans with the remaining 20 percent going to SHYA. According to its contract, P&L Financial receives 60 to 80 percent of fees from its closed loans, with the remaining 20 to 40 percent going to SHYA. Under its agreement, The Mortgage Source originated four FHA-insured loans totaling $448,704. One of the four loans went into foreclosure and claim status, leading to the payment of an insurance claim by HUD. P&L Financial Services originated eight FHA-insured loans totaling $895,896 under its branch agreement. Four of these eight loans were refinanced with new FHA-insured mortgages originated by P&L Financial under its “Employee Lease Agreement.” Although both agreements establish branch office arrangements between the two contractors and SHYA, HUD was never notified of the existence of the branches, and all loans originated by them were under SHYA’s lender number. This arrangement allowed the branches to operate without providing HUD assurance that the branches had adequate financial reserves and oversight, thereby putting the FHA fund at risk. SHYA ignored HUD requirements that lender employees be SHYA Submitted Loans employed exclusively by the lender, and entered into Originated by Loan Officers agreements with loan officers that were not SHYA employees That Were Not SHYA Employees Page 9 2004-SE-1002 Finding 1 to produce loans. In August 2000, SHYA replaced its branch office agreement with P&L Financial Services with a “Employee Lease Agreement.” Under the terms of this agreement, P&L Financial Services “leased” its owner and employees to SHYA to originate single family loans. SHYA entered into similar contracts in which the owners of two other companies, LS Financial Corp. and Diverse Lending Inc., were “leased” to SHYA to originate loans. According to the agreements, SHYA is the customer and each of the three companies is a provider. All three contracts make it clear that the provider is not an employee of SHYA stating: “…nothing in this agreement shall be construed to make Provider a partner, agent, or employee of Customer. Provider agrees to be responsible for paying any and all required Federal, State or Local taxes or insurance incurred by it’s employees actions.” The contracts with LS Financial Corp. and Diverse Lending Inc. also specify that the provider is responsible for any and all employee benefits. Compensation for the contractors is in the form of commissions based upon a split of loan origination and other fees between the contractor (“leased employee”) and SHYA that are generated at loan closing. According to its contract, P&L Financial earns from 70 to 80 percent of fees earned on closed loans with the remainder going to SHYA. The contracts for both LS Financial Corp. and Diverse Lending allowed the contractors to earn 70 percent of the loan fees generated, with the remainder also going to SHYA. As with the above branch agreements, all three employee lease contracts contain language to protect SHYA against any consequences of detrimental actions on the parts of the provider’s employees stating: “Provider agrees to indemnify and hold Customer harmless for any loss, damage, fees or costs incurred by reason of Providers employee’s misrepresentation, fraud, or violation of any statute or regulation, violation of any rules, regulations or policies of Customer, violation of any other applicable statute or regulation, or actions of Provider that result in claims made against the Customer.” All three contracts contain language that SHYA would provide direct supervision of the provider’s employees in the course of 2004-SE-1002 Page 10 Finding 1 day-to-day operations. However, we found inadequate supervision of the leased employees as SHYA did not perform ongoing reviews of the leased employees’ performance. Further, although SHYA’s president told us that the loans generated by the leased employees receive the same quality control review as the loans produced by SHYA’s own employees, prior to the October 2002 closeout of findings of a review conducted by HUD’s Quality Assurance Division, SHYA did not have an adequate quality control plan in place. Thus all loans originated by the leased employees up to then did not receive an adequate quality control review. Under these agreements, the owner of LS Financial Corp. originated five FHA loans totaling $616,042 and the owner of Diverse Lending Inc. originated six FHA loans totaling $770,900. HUD/FHA paid a claim on one of the loans originated by LS Financial. Two of the six loans originated by Diverse Lending have gone into default at least one time, and one of these went into foreclosure and claim status, leading to the payment of an insurance claim by HUD. Under its employee lease agreement, the owner of P&L Financial Services originated 60 loans totaling $7,707,872, one of which was actually originated by the owner’s assistant even though the P&L Financial Services owner signed the mortgage documents as the originating loan officer and as an employee of SHYA. Eight of these 60 loans were refinanced with new FHA-insured loans originated by P&L Financial. Nine of the 60 loans originated by P&L Financial have defaulted at least once, with four of the nine loans going into foreclosure status and one going into claim status. Lenders are required to submit a completed Uniform Loan Files Contained Residential Loan Application (URLA), signed and dated by all Improper Certifications borrowers and the lender, and the Addendum to the URLA (form HUD- 92900-A) containing signed Lender’s Certifications for each insured loan. Section II B of the Lender’s Certification states “The information contained in the Uniform Residential Loan Application and this Addendum was obtained directly from the borrower by a full-time employee of the undersigned lender or its duly authorized agent and is true to the best of the lender’s knowledge and belief.” (emphasis added) Page 11 2004-SE-1002 Finding 1 During the review of the 32 FHA case files of defaulting SHYA loans, we found five loans that the contractors, who by contract are neither full-time employees or agents of SHYA, certified that they were SHYA employees on the URLA and/or the HUD-92900-A as follows: Loan Number 569-0512568 – the owner of Diverse Lending signed both the URLA and HUD-92900-A as an employee of SHYA. Loan Number 569-0495611 – the owner of The Mortgage Source signed both the URLA and HUD- 92900-A as an employee of SHYA. Loan Number 431-3486696 – the owner of P&L Financial signed both the URLA and HUD-92900-A as an employee of SHYA. Loan Number 431-3502928 – the owner of P&L Financial signed the URLA as an employee of SHYA and a SHYA employee signed the HUD-92900-A. Loan Number 431-3570514 – the owner of P&L Financial signed the URLA as an employee of SHYA and a SHYA employee signed the HUD-92900-A. We also found the following three loans originated by P&L Financial in which a regular SHYA employee “signed for” the owner of P&L Financial on the URLA and a SHYA employee signed the HUD-92900-A: Loan Number 431-3516559 Loan Number 431-3544957 Loan Number 561-7356616 1. At the exit conference, OIG audit staff “effectively ignored” Auditee Comments information provided by SHYA in their initial response. Also, the “Final Audit Report…completely ignores every single piece 2004-SE-1002 Page 12 Finding 1 of information, documentation, and explanation…” SHYA had provided in their October 24, 2003 written comments, at the exit conference, and in an October 31, 2003 letter. 2. It instructed the Mortgage Source to cease all FHA loan originations in a letter sent July 14, 2001 that was inadvertently dated July 14, 2000. The last loan originated by The Mortgage Source was endorsed on October 9, 2001. However, SHYA agrees to indemnify HUD against four loans originated by The Mortgage Source. 3. The branch office agreement between SHYA and Phillip Jack (P & L Financial Services, Inc.) never came to fruition. A branch office was never created or opened and the agreement never enforced by either party. Instead, Mr. Jack worked out of SHYA’s main office. As such, HUD should re-consider its recommendation that SHYA indemnify HUD against future losses on four loans. 4. Regardless of the language of the Employee Lease agreements, which were drafted with tax consequences in mind, every person that worked under these agreements was in fact an employee of SHYA under Oregon law. These loans were processed in the same manner as any other SHYA loan, and the originators were supervised the same as any other SHYA employee. In addition, HUD itself has allowed the use of Independent Contractor agreements. Further, SHYA had previously received acknowledgement from a HUD Single Family official that the Employee Lease Agreement was acceptable for use under FHA. Evidencing this was a fax sent to the HUD official on July 30, 2002, which was mistakenly dated July 30, 2000. Shortly after the fax was sent, the Compliance Officer telephoned the SHYA owner and informed him that the agreement was acceptable for use under FHA. However, in accordance with representations made by HUD- OIG staff, SHYA has complied with HUD’s technical requirement. 5. In its January 5, 2004 response to our email notifying SHYA of a modification to the finding recommendations, SHYA claimed that OIG had no intention whatsoever of taking into consideration anything that SHYA had to contribute, say, or provide in support of its position relating to the audit. Page 13 2004-SE-1002 Finding 1 OIG Evaluation of 1. HUD-OIG staff fully considered all information provided by Auditee Comments SHYA. In its response, SHYA mistakenly refers to the formal Draft Audit Report as the Final Audit Report, even though the transmittal letter and every page of the Draft Audit Report clearly identified it as a draft report. Although we issued a Discussion Draft Audit Report on September 25, 2003, the transmittal letter sent with the Discussion Draft explained that it was to be used for discussion at the exit conference, and that subsequent to the exit conference we would issue a formal draft report for SHYA’s written comments. In addition, at the exit conference OIG staff fully discussed with SHYA representatives all issues they wanted to go over regarding their response to the Discussion Draft Audit Report. 2. SHYA agreed to indemnify The Mortgage Source loans identified in the audit finding. 3. SHYA’s comments are not consistent with what P&L Financial Services (Mr. Phillip Jack) told HUD-OIG audit staff. Mr. Jack indicated that the Independent Contractor Agreement (and subsequently the Employee Lease Agreement) were the only agreements with SHYA that he worked under. 4. SHYA’s citations of Oregon law do not appear to conflict with HUD requirements regarding the use of branch offices or non-employees by lenders. The issues raised by the finding are matters of substance, not merely semantics or form. For example, the provision in these individuals’ agreements that shifts liability to the employees or net branches could have material financial implications for HUD. Also, the SHYA contractors indicated to us that they had little if any supervision by SHYA. HUD did not allow a lender to have a similar type of employee agreement such as used by SHYA, as alluded to in SHYA’s response. In the case mentioned by SHYA, HUD had required a lender to revise its employee agreement to meet HUD requirements, most notably to revise the provision that tried to shift liability for indemnification to the employee. 2004-SE-1002 Page 14 Finding 1 The HUD official that SHYA claims approved the Employee Lease Agreement emphatically told us that she never gave SHYA permission to use these Agreements, nor has she ever received a fax from SHYA regarding the matter. The copies of fax documentation that SHYA provided are incomplete, and in our opinion do not provide support or convincing evidence for their contention that HUD approved the agreements. 5. As noted above, the HUD-OIG staff fully considered all information provided by SHYA in response to our draft findings. Recommendations We recommend that the Assistant Secretary for Housing- Federal Housing Commissioner, Chairman, Mortgagee Review Board: 1A. Require Scheller Hess-Yoder and Associates to indemnify HUD/FHA against future losses and reimburse HUD/FHA for the $78,781 claim paid on Loan # 569- 0495611 that was originated under the branch office agreement with The Mortgage Source. 1B. Require Scheller Hess-Yoder and Associates to indemnify HUD/FHA against current and future losses on the two currently insured loans with no claims paid, that were originated by The Mortgage Source and the two currently insured loans originated by P&L Financial under their branch office agreements. These loans are identified in Appendix C of this report. 1C. Require Scheller Hess-Yoder and Associates to indemnify HUD/FHA against future losses and reimburse HUD/FHA for: (1) the $63,623 claim paid on Loan # 431-3570514 originated by P&L Financial; (2) the $105,451 claim paid Loan # 569-0514841 originated by LS Financial and (3) the $18,755 claim paid on Loan # 569-0512568 originated by Diverse Lending. All three loans were originated under leased employee agreements. Page 15 2004-SE-1002 Finding 1 1D. Require Scheller Hess-Yoder and Associates to indemnify HUD/FHA against current and future losses on the two currently insured loans with no claims paid that were originated by of LS Financial Corp., the four currently insured FHA loans with no claims paid that were originated by Diverse Lending Inc., and the 41 currently insured loans with no claims paid that were originated by P&L Financial under their leased employee agreements. These loans are identified in Appendix D of this report. 1E. For each loan, identified in Appendix A that was originated by the unapproved branches and leased employees, consider seeking civil monetary penalties against Scheller Hess-Yoder and Associates for submitting false certifications on the loan applications. 1F. Consider seeking civil monetary penalties against the owner of: • Diverse Lending for false certifications on the loan application forms for FHA loan number 569-0512568; • The Mortgage Source for false certifications on the loan application forms for FHA loan number 569-0495611; • P&L Financial for false certifications on the loan application forms for FHA loan numbers 431-3486696, 431-3502928, 431-3570514, 431-3516559, 431-3544957, and 561-7356616. 1G. Determine whether Scheller Hess-Yoder and Associates’ deficiencies in its loan origination activities warrant its removal from participation in HUD’s Single Family Mortgage Insurance Programs. Consider taking appropriate administrative sanctions. 1H. If HUD determines that Scheller Hess-Yoder and Associates can maintain their approval as a non-supervised loan correspondent, take appropriate monitoring measures to ensure that Scheller Hess-Yoder and Associates discontinues the practice of submitting loans that are originated by “leased employees” or unauthorized branches. 2004-SE-1002 Page 16 Finding 1 THIS PAGE LEFT BLANK INTENTIONALLY Page 17 2004-SE-1002 Finding 2 SHYA is Not in Full Compliance With HUD/FHA Quality Control Requirements Scheller, Hess Yoder & Associates did not fully implement its Quality Control Plan (QCP), which they revised as a result of a previous review by HUD’s Quality Assurance Division (QAD). Specifically, in July 2002 a review by the QAD found that SHYA’s QCP was inadequate, and required the lender to submit a revised QCP that meets HUD/FHA guidelines. By October 1, 2002 SHYA submitted a revised QCP that was acceptable to HUD and the finding by QAD was closed. However, we found that SHYA disregarded HUD's quality control requirements and its own QCP by allowing the person responsible for conducting SHYA’s quality control reviews to also process and originate FHA-insured loans. In addition, the quality control reviewer received loan officer commissions on three of the four FHA loans that she originated. Such a conflict of interest on the part of a quality control reviewer is a violation of HUD requirements with respect to the need for an independent quality control review, and limits assurance to HUD that an independent quality control review is performed on SHYA’s loans. To ensure that loans are originated and approved in accordance The Quality Control with HUD/FHA rules and regulations, HUD requires lenders to Reviewer Cannot Process perform regular quality control reviews. These reviews must FHA-Insured Loans provide for independent evaluation of the significant information gathered for use in the mortgage credit decision making and loan servicing process for all loans originated or serviced by the mortgagee. HUD Handbook 4060.1 Chapter 6 Quality Control Plan Paragraph 6-1 states: “Mortgagees must establish a written Quality Control Plan which utilizes a program of internal or external audit or provides for an independent review by the mortgagee's management/supervisory personnel who are knowledgeable and have no direct loan processing, underwriting or servicing responsibilities.” This requirement for an independent review is reflected in SHYA’s Quality Control Plan. According to the job description for the quality control reviewer from Section III, Paragraph C of the QCP, “The reviewer's job does not involve processing FHA loans. He or she reports directly to the Page 19 2004-SE-1002 Finding 2 President of the company. The quality control reviewer's job does not include personnel matters.” SHYA’s Pipeline report shows that the same person who is SHYA’s Quality Control responsible for performing its quality control reviews originated Reviewer Originated FHA- the following four FHA-insured loans: Insured Loans FHA Case Number1 Loan Endorsement Amount Date 431-3668869 $171,800 12/04/01 431-3563723 $177,393 05/17/01 569-0538696 $132,914 05/03/02 569-0559116 $136,867 02/11/03 Our review of the loan documents found that the quality control reviewer signed the initial loan applications as the interviewer for all four of the above loans, and the lender’s certification for loan number 431-3563723. The quality control reviewer told us that she performed all of the duties as the loan officer for these loans. The reviewer also disclosed that she received a commission fee for originating and processing three of the four loans. No commission was paid to her on one loan because the borrower was also a SHYA loan officer. In addition to originating the four loans, the quality control reviewer also performs another loan processing duty: she and SHYA’s loan processing manager are responsible for inputting loan and borrower information into the lender’s automated underwriting system. In our opinion, HUD does not have adequate assurance that SHYA is processing loans in conformance with FHA requirements because the quality control reviewer’s loan origination and processing duties compromises her independence when performing quality control reviews. 1 Loan Numbers 431-3668869, 431-3563723, and 569-0538696 have been terminated and are no longer insured by the FHA 2004-SE-1002 Page 20 Finding 2 SHYA stated that it now understands that HUD’s prohibition Auditee Comments against having the same person review and process FHA loans includes the originating of FHA-insured loans. As such, SHYA has taken action to ensure the Quality Control person is not involved in any aspect of originating and processing FHA loans. SHYA further agreed to indemnify HUD against any future losses attributable to the loan originated by the individual that performed Quality Control reviews. OIG Evaluation of SHYA’s response is substantially responsive to the finding. Auditee Comments We recommend that the Assistant Secretary for Housing- Recommendations Federal Housing Commissioner, Chairman, Mortgagee Review Board: 2A. Require Scheller Hess-Yoder and Associates to indemnify HUD/FHA against future losses on FHA loan number 569-0559116. 2B. Take appropriate monitoring measures to ensure that Scheller Hess-Yoder and Associates fully implements its Quality Control Plan. Page 21 2004-SE-1002 Finding 2 THIS PAGE LEFT BLANK INTENTIONALLY 2004-SE-1002 Page 22 Management Controls In planning and performing our audit, we considered the management controls of SHYA to determine our audit procedures, not to provide assurance on their management controls. Management controls are the plan of an organization, methods and procedures adopted by management to ensure that its goals are met. Management controls include processes for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance. We determined that the following management controls were Relevant Management relevant to our audit objectives: Controls • Program Operations. Policies and procedures that management has in place to reasonably ensure that the loan origination process is in compliance with the HUD/FHA program requirements, and that the objectives of the programs are being met. • Quality Control Plan. Policies and procedures that management has in place to reasonably ensure implementation of HUD/FHA quality control requirements. A significant weakness exists if management controls do not Significant Weaknesses 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, maintained, and fairly disclosed in reports. Based on our review, we believe that SHYA’s management controls have significant weaknesses and regarding HUD requirements in the following areas: • SHYA violated HUD/FHA requirements regarding FHA’s loan origination process by submitting loans originated by unapproved branches and non-employees (Finding 1). • SHYA violated HUD/FHA’s quality control process requirements because its quality control reviewer also processed insured loans (Finding 2). Page 23 2004-SE-1002 Management Controls We also found that SHYA does not ensure that policies and standards relating to loan origination are known by SHYA employees. Our interviews with SHYA employees in general indicate that they are not always aware of nor do they possess copies of documents such as written job descriptions, written loan origination policies and procedures, or the SHYA quality control plan. 2004-SE-1002 Page 24 Appendix A Schedule of Questioned Costs and Funds Put to Better Use Recommendation Type of Questioned Cost Funds Put Number Ineligible 1/ Unsupported 2/ To Better Use 3/ 1A. $ 78,781 1B. $ 512,850 1C. $82,387 $105,451 1D. $6,339,706 2A. $ 136,867 Totals $82,378 $184,232 $6,989,423 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 policy or regulations. The amount shown is for two net claims. A net claim is the total claim paid by HUD less any proceeds from HUD’s sale of the insured property. 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. The amount shown is for two gross claims. A gross claim is the amount of the claim paid by HUD prior to any recovery from the sale of the property by HUD. At the time of the audit, the properties were not yet sold by HUD. 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. The table on the following page shows a breakdown of the above schedule by the description of each individual category of questioned cost. Page 25 2004-SE-1002 Appendix A Recommen- Un- Funds Put dation Ineligible supported To Better Number Description of Cost 1/ 2/ Use 3/ Gross Claim Paid on Loan # 569-0495611 1A. Originated by The Mortgage Source $ 78,781 Total Loan Amount of 2 Currently Insured FHA Loans 1B. Originated by The Mortgage Source $ 282,864 Total Loan Amount of 2 Currently Insured FHA Loans Originated by P&L Financial as 1B. Branch Office $ 229,986 Net Loss on Claim Paid on Loan # 431- 1C. 3570514 Originated by P&L Financial $63,623 Gross Claim Paid on Loan # 569-0514841 1C. Originated by LS Financial $105,451 Net Claim Paid on Loan # 569-0512568 1C. Originated by Diverse Lending $18,755 Total Loan Amount of 41 Currently Insured FHA Loans Originated by P&L Financial as 1D. Leased Employee $5,581,416 Total Loan Amount of 4 Currently Insured FHA Loans 1D. Originated by Diverse Lending $ 499,492 Total Loan Amount of 2 Currently Insured FHA Loans 1D. Originated by LS Financial $ 258,798 Loan Amount of Currently Insured FHA Loan #569-0559116 Originated by SHYA 2A. Quality Control Reviewer $ 136,867 2004-SE-1002 Page 26 Finding 2 Totals $82,378 $184,232 $6,989,423 Page 27 2004-SE-1002 Appendix B Auditee Comments The auditee comments, dated December 4, 2003 and January 5, 2004 are attached to this appendix. The attachments to the December 4, 2003 comments are voluminous and impractical to include in this appendix. A hard copy file of the auditee comments and all the attachments are kept at the HUD-OIG Office in Seattle and are available upon request. Page 29 2004-SE-1002 Appendix B 2004-SE-1002 Page 30 Appendix B Page 31 2004-SE-1002 Appendix B 2004-SE-1002 Page 32 Appendix B Page 33 2004-SE-1002 Appendix B 2004-SE-1002 Page 34 Appendix B Page 35 2004-SE-1002 Appendix B 2004-SE-1002 Page 36 Appendix B Page 37 2004-SE-1002 Appendix B THIS PAGE LEFT BLANK INTENTIONALLY 2004-SE-1002 Page 38 Appendix C Loans Originated Under Independent Contractor/Branch Agreements P&L Financial – September 10, 1998 Branch Office Agreement Currently Insured Loans (Recommendation 1B.) Refinanced FHA Case Closing Endorsement Case Number Mortgage Loan Status Number Date Date (if applicable) Amount * 12/11/03 431-3576415 then to 431-3445026 05/25/00 07/24/00 431-3724006 $107,207 current 569-0523111 then to 569-0476375 07/31/00 09/08/00 569-0566458 $122,779 current TOTAL P & L: 2 Loans $229,986 The Mortgage Source - May 21, 1996 Branch Office Agreement Currently Insured Loans (Recommendation 1B.) Refinanced FHA Case Closing Endorsement Case Number Mortgage Loan Status Number Date Date (if applicable) Amount * 12/11/03 569-0507420 then to 569-0470547 04/28/00 08/07/00 569-0568370 $173,343 current 569-0504938 06/25/01 07/16/01 569-0565814 $109,521 current TOTAL The Mortgage Source: 2 Loans $282,864 *Original loan amount or loan amount for the loans refinanced by SHYA. Page 39 2004-SE-1002 Appendix C THIS PAGE LEFT BLANK INTENTIONALLY 2004-SE-1002 Page 40 Appendix D Loans Originated Under Employee Lease Agreements P&L Financial – August 4, 2000 Employee Lease Agreement Current, Defaulting & Foreclosed Insured Loans (Recommendation 1D.) Refinanced FHA Case Closing Endorsement Case Number Mortgage Loan Status Number Date Date (if applicable) Amount * 12/11/03 431-3463115 08/07/00 09/14/00 431-3662646 $ 82,566 current 431-3471163 08/23/00 10/03/00 431-3731427 $131,425 current 431-3474521 08/23/00 01/16/01 431-3674908 $144,591 current 431-3486696 10/11/00 11/07/00 $135,230 in default 431-3614638 then to 431-3881503 then to 431-3489482 11/08/00 01/03/01 431-3982601 $120,472 current foreclosure 431-3502928 12/08/00 01/04/01 $173,343 commenced prior default, 431-3516559 01/30/01 02/21/01 $100,916 now current 431-3516650 02/28/01 03/28/01 431-3789541 $78,828 current 431-3528216 03/13/01 04/23/01 431-3900537 $166,374 current 431-3531868 03/01/01 08/24/01 $168,617 current prior default, 431-3544957 03/30/01 03/30/01 $142,980 now current 431-3550707 04/18/01 05/17/01 $161,994 current 431-3596796 07/03/01 11/09/01 $149,651 current 431-3622771 08/15/01 01/28/02 $146,697 current prior default, 431-3628404 09/26/01 11/29/01 $132,034 now current *Original loan amount or loan amount for the loans refinanced by SHYA. Page 41 2004-SE-1002 Appendix D Refinanced FHA Case Closing Endorsement Case Number Mortgage Loan Status Number Date Date (if applicable) Amount * 12/11/03 431-3656831 11/15/01 12/07/01 $177,219 current 431-3665906 11/28/01 12/27/01 $157,278 current 431-3686804 12/26/01 02/07/02 $139,806 current 431-3699498 02/05/02 02/20/02 $121,842 current 431-3724297 03/21/02 04/05/02 $100,992 current 431-3735412 06/28/02 08/20/02 $173,093 current 431-3760583 06/26/02 08/16/02 $130,826 current 431-3765408 06/28/02 07/31/02 $142,759 current 431-3771767 07/01/02 07/24/02 $151,620 current 431-3773876 10/17/02 11/21/02 $157,528 current 431-3785317 08/30/02 11/30/02 $151,738 current 431-3826956 11/27/02 02/06/03 $135,351 current 431-3841273 11/22/02 01/13/03 $ 91,083 current 431-3862714 01/29/03 04/18/03 $155,099 current 431-3863834 04/30/03 05/29/03 $138,868 current 431-3866479 03/19/03 06/04/03 $108,300 current 431-3879408 02/28/03 07/01/03 $ 94,906 current 431-3891099 03/18/03 04/01/03 $181,437 current 431-3912958 05/29/03 07/08/03 $156,545 current 431-3922932 05/07/03 06/19/03 $135,091 current 431-3931406 05/28/03 07/01/03 $137,458 current 561-7149449 10/31/00 11/15/00 561-7356616 $129,462 foreclosed 569-0515506 09/28/01 12/26/01 $108,709 current 569-0531970 02/27/02 05/10/02 $144,338 current 569-0545979 07/31/02 10/08/02 $109,026 current foreclosure 569-0553171 12/04/02 02/05/03 $115,324 commenced TOTAL P&L: 41 Loans $5,581,416 *Original loan amount or loan amount for the loans refinanced by SHYA. 2004-SE-1002 Page 42 Appendix D Diverse Lending – April 23, 2001 Employee Lease Agreement Current & Defaulting Insured Loans (Recommendation 1D.) Refinanced FHA Case Closing Endorsement Case Number Mortgage Loan Status Number Date Date (if applicable) Amount * 12/11/03 431-3569988 04/27/01 06/14/01 $ 91,665 current 431-3688000 12/17/01 02/07/02 $129,369 current 561-7405571 12/03/01 01/11/02 $151,452 default 569-0514914 09/17/01 03/11/02 $127,006 current TOTAL Diverse Lending: 4 Loans $499,492 LS Financial – March 1, 2001 Employee Lease Agreement Current Insured Loans (Recommendation 1D.) Refinanced FHA Case Closing Endorsement Case Number Mortgage Loan Status Number Date Date (if applicable) Amount * 12/11/03 431-3555024 04/09/01 05/29/01 $136,852 current 431-3681270 11/30/01 12/21/01 $121,946 current TOTAL LS Financial: 2 Loans $258,798 *Original loan amount or loan amount for the loans refinanced by SHYA. Page 43 2004-SE-1002 Appendix D THIS PAGE LEFT BLANK INTENTIONALLY 2004-SE-1002 Page 44 Appendix E Distribution Outside of HUD The Honorable Susan M. Collins, Chairman, Committee on Government Affairs The Honorable Joseph Lieberman, Ranking Member, Committee on Government Affairs The Honorable Thomas M Davis, III, Chairman, Committee on Government Reform The Honorable Henry A. Waxman, Ranking Member, Committee on Government Reform Elizabeth Meyer, Senior Advisor, Subcommittee on Criminal Justice Andy Cochran, House Committee on Financial Services Clinton C. Jones, Senior Counsel, Committee on Financial Services Kay Gibbs, Committee on Financial Services Mark Calabria, Committee on Banking, Housing, and Urban Affairs W. Brent Hall, U.S. General Accounting Office Steve Redburn, Chief Housing Branch, Office of Management and Budget Linda Halliday, Department of Veterans Affairs, Office of Inspector General Page 45 2004-SE-1002
Scheller Hess-Yoder and Associates Non-Supervised Loan Correspondent Portland, Oregon
Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-01-09.
Below is a raw (and likely hideous) rendition of the original report. (PDF)