oversight

Pan American Financial Corporation Non-Supervised Direct Endorsement Lender Guaynabo, PR

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-01-27.

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

                                                             Issue Date
                                                               January 27, 2005
                                                             Audit Case Number
                                                                     2005-AT-1005




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




FROM:      Sonya D. Lucas
           Acting Regional Inspector General for Audit, 4AGA


SUBJECT: Pan American Financial Corporation
         Non-Supervised Direct Endorsement Lender
         Guaynabo, PR


                                  HIGHLIGHTS

 What We Audited and Why

            We audited Pan American Financial Corporation (Pan American) in Guaynabo,
            PR. Pan American is a non-supervised lender approved by the U.S. Department
            of Housing and Urban Development (HUD) to originate and approve Federal
            Housing Administration-insured single-family mortgages. We selected Pan
            American for review because of its high default rate.

            The audit objectives were to determine whether Pan American: (1) complied with
            HUD regulations, procedures, and instructions in the origination of Federal Housing
            Administration-insured single-family mortgages; and (2) implemented its quality
            control plan as required. We reviewed a sample of 25 Federal Housing
            Administration-insured loans to accomplish our objectives.




 Table of Contents
    What We Found


                 Pan American did not follow HUD requirements when originating and approving 17
                 Federal Housing Administration-insured loans totaling $2,782,706. In 10 loans, Pan
                 American did not exercise the care expected of a prudent lender in the analysis of the
                 borrower’s assets, earnings, and debts. Pan American also approved seven loans
                 that did not comply with HUD’s self-sufficiency requirement, and were over-insured
                 by $209,8891. The deficiencies occurred because Pan American did not establish
                 and implement adequate controls to ensure its employees followed HUD
                 requirements when processing and underwriting loans. These deficiencies
                 contributed to Pan American’s high default rate and increased HUD’s risk to the
                 Federal Housing Administration insurance fund.

                 Pan American did not fully implement its quality control plan as required. It has
                 not implemented procedures or controls to ensure all Federal Housing
                 Administration-insured loans that default within 6 months of closing undergo a
                 loan origination quality control review. We attribute this deficiency to Pan
                 American’s disregard of HUD requirements and instructions. As a result, HUD
                 has no assurance of the accuracy, validity, and completeness of Pan American’s
                 loan origination operations.

                 Pan American’s authority to endorse Federal Housing Administration-insured
                 loans is currently under Departmental suspension.

    What We Recommend


                 We recommend the Assistant Secretary for Housing-Federal Housing
                 Commissioner require Pan American to indemnify HUD against future losses on
                 nine loans totaling $1.39 million and pay down the mortgages of the seven
                 over-insured loans by $209,889. We further recommed HUD take appropriate
                 monitoring measures to ensure Pan American establishes and implements
                 appropriate controls so that its employees follow HUD requirements when
                 processing and underwriting loans, if HUD allows Pan American to continue as a
                 non-supervised direct endorsement lender. Finally, we recommend HUD require
                 Pan American to take the needed action to ensure the required quality control plan
                 reviews are conducted, if HUD allows Pan American to continue as a non-
                 supervised direct endorsement lender.




1
     HUD limits the maximum mortgage loan amount for three-and four-unit properties so that the monthly
     mortgage payment does not exceed the property’s monthly net rental income.


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Auditee’s Response


           We discussed our review results with Pan American and HUD officials during the
           audit. We provided a copy of the draft report to Pan American officials on
           December 7, 2004, for their comments and discussed the report with the officials at
           the exit conference on December 10, 2004. Pan American provided written
           comments on December 17, 2004.

           Pan American’s response did not state whether they agreed or disagreed with our
           audit recommendations. The response included a brief statement for each loan
           discussed in finding 1 and provided additional documents for our evaluation. Pan
           American did not provide comments for finding 2.

           The complete text of Pan American’s response, along with our evaluation of that
           response can be found in appendix B of this report.




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TABLE OF CONTENTS

Background and Objectives                                                           5

Results of Audit
      Finding 1: Pan American Did Not Follow HUD Requirements When                  6
      Originating Loans
      Finding 2: Pan American Did Not Fully Implement Its Quality Control Plan as   11
      Required

Scope and Methodology                                                               13

Internal Controls                                                                   14

Appendixes
   A. Schedule of Questioned Costs and Funds To Be Put to Better Use                16
   B. Auditee Comments and OIG’s Evaluation                                         17
   C. Summary of Loan Deficiencies                                                  35
   D. Active Loans Pan American Should Indemnify                                    36
   E. Narrative Loan Deficiencies                                                   37
   F. Criteria                                                                      52




                                            4
                         BACKGROUND AND OBJECTIVES


Pan American Financial Corporation (Pan American) was incorporated under the laws of the
Commonwealth of Puerto Rico on November 25, 1996. The U.S. Department of Housing and
Urban Development (HUD) approved Pan American as a Title II non-supervised direct
endorsement lender on June 13, 1997. Pan American originates Federal Housing
Administration, Department of Veteran Affairs, and conventional loans. Pan American’s main
office is located in Guaynabo, PR, with branch offices in Caguas, Manati, and Rio Grande.

Pan American originated 726 Federal Housing Administration-insured single-family loans, with
mortgages totaling $77.2 million, which had beginning amortization dates between
January 1, 2002, and December 31, 2003. According to HUD’s Neighborhood Watch system,
74 of the loans defaulted within the first 2 years of origination.

On July 12, 2004, HUD notified Pan American of its intent to suspend the HUD approval
agreement to originate Federal Housing Administration-insured single-family mortgages, citing
Pan American’s high default rate as the basis for the proposed termination. HUD suspended Pan
American’s approval as a Title II non-supervised direct endorsement lender on October 5, 2004.2
Pan American has the right to reapply at the end of the 6 month exclusion period for a new
origination approval agreement, provided that Pan American is still an approved lender, meeting
the general approval requirements under Title 24 of the Code of Federal Regulations, Part 202,
and the underlying causes for termination have been satisfactorily remedied.

The audit objectives were to determine whether Pan American: (1) complied with HUD
regulations, procedures, and instructions in the origination of Federal Housing Administration-
insured single-family mortgages; and (2) implemented its quality control plan as required.




2
    The suspension applies only to the main office.


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                                  RESULTS OF AUDIT

Finding 1: Pan American Did Not Follow HUD Requirements When
           Originating Loans
Pan American did not follow HUD requirements when originating and approving 17 Federal
Housing Administration-insured loans totaling $2,782,706. In 10 loans, Pan American did not
exercise the care expected of a prudent lender in the analysis of the borrower’s assets, earnings, and
debts. Pan American also approved seven loans that did not comply with HUD’s self-sufficiency
requirement, and were over-insured by $209,889. The deficiencies occurred because Pan American
did not establish and implement adequate controls to ensure its employees followed HUD
requirements when processing and underwriting loans. These deficiencies contributed to Pan
American’s high default rate and increased HUD’s risk to the Federal Housing Administration
insurance fund.



 Pan American Did Not Exercise
 Due Care

               Our examination of 10 loans approved by Pan American disclosed that Pan
               American did not exercise the care expected of a prudent lender in the analyses of
               the borrower’s assets, earnings, and debts. The review found that Pan American
               did not:

                   Document the stability of borrower income in accordance with HUD
                   requirements,
                   Ensure compliance with HUD borrower credit requirements,
                   Obtain information directly from the source allowing third parties to handle
                   key documents,
                   Document the source of borrower investment in accordance with HUD
                   requirements,
                   Provide valid or supported compensation factors when HUD’s debt to income
                   ratios of 29 and 41 percent were exceeded,
                   Ensure compliance with HUD maximum mortgage requirements, or
                   Clarify and/or adequately document important file discrepancies.

               We identified processing and underwriting deficiencies in all 10 loans as shown
               below.

                               Deficiencies               Number of Loans
                       Inadequate asset analysis             8 of 10
                       Inadequate earnings analysis          8 of 10
                       Inadequate debt analysis              5 of 10




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        The deficiencies noted above are not independent of one another as many of the
        loan files contained more than one deficiency. Appendix C provides a chart
        summarizing the loan processing deficiencies. Details of the deficiencies
        identified on each loan reviewed, including specific HUD requirements not met,
        are included in appendix E.

        Specific examples of Pan American’s poor processing and underwriting include:

           Case File Number 501-6581138. Pan American approved the loan without
           properly verifying the borrower’s earnings and assets. The review disclosed
           that Pan American used copies of tax returns to validate income information
           and qualify the borrower for the loan. We noted the tax returns were faxed,
           apparently from the seller’s real estate agent. The borrower stated that Pan
           American never asked for tax returns and could not explain where the
           documents came from. The tax returns used by Pan American were never
           filed with the Puerto Rico Treasury Department.

           The Settlement Statement reflected $7,300 in earnest money. According to
           information in the loan file, the source of the earnest money was the borrower’s
           savings, and it was deposited with the seller’s real estate agent. We noted the
           saving account statements and other documents related to the earnest money
           were faxed, apparently from the real estate agent. The borrower informed us the
           amount on the statements was not correct and the fund balance was overstated.
           The borrower also advised us that only $1,000 was provided as earnest money,
           not the $7,300 shown on the Settlement Statement. According to the borrower,
           all required documents were provided to the real estate agent, who forwarded
           them to Pan American. Contrary to requirements in HUD Handbook 4155.1,
           Revision 4, paragraph 3-1, Pan American allowed an interested third party to
           handle key documents. In addition, the date of closing was the only time the
           borrower had contact with Pan American officials.

           Case File Number 501-6549444. Pan American approved the loan without
           properly verifying the borrower’s income and assets. Tax returns were used
           to validate income information and qualify the borrower for the loan. The
           borrower informed us the tax returns were prepared by the seller’s real estate
           agent and could not explain where the agent obtained the information. The
           tax returns used by Pan American reflected earnings of $58,000, while the
           official tax return filed with the Puerto Rico Treasury Department showed
           $18,000.

           The Settlement Statement reflected $7,000 in earnest deposit. According to
           information in the loan file, the borrower provided the earnest money from his
           own savings, and it was deposited with the seller’s real estate agent. We
           noted that savings account statements and other documents related to the
           earnest money were faxed, apparently from the real estate agent. The
           borrower informed us the savings statements in the loan file did not reflect the
           correct amount of funds in the account and only $1,000 was provided as



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             earnest money. The borrower stated that all documents were provided to the
             real estate agent, who made them available to Pan American. Pan American
             allowed an interested third party to handle key documents in violation of HUD
             requirements contained in Handbook 4155.1, Revision 4, paragraph 3-1. In
             addition, the date of the loan closing was the only time the borrower had
             contact with Pan American officials.

             Case File Number 501-6713435. Pan American did not properly evaluate the
             borrower’s employment. The Request for Verification of Employment, dated
             September 27, 2002, stated the borrower commenced working at the Puerto
             Rico House of Representatives in October 2001. However, a certification,
             dated October 14, 2002, stated the borrower commenced working in February
             1998. There was no documentation in the loan file showing Pan American
             resolved this inconsistency. We contacted the employer and found the
             personnel office did not originate the October 2002 certification and the
             borrower had less than a year on the job at the time the Request for
             Verification of Employment was completed.

             Pan American miscalculated effective income by overstating earnings and
             understating the borrowers’ debt. The coborrower’s verification of
             employment reflected a monthly salary of $800. However, a copy of a wage
             statement included in the loan file showed a monthly salary of $754. Pan
             American used the higher amount to approve the loan, but there was no
             support clarifying the inconsistency. We contacted the employer and found
             the personnel office did not prepare the verification. The director of the
             school where the coborrower worked apparently completed the verification.
             According to the personnel office, the correct monthly salary was $754 as
             reflected in the earning statements. Pan American also excluded from the
             debt analysis monthly payments, totaling $205, the borrowers had with two
             creditors. This debt was included in the credit report, but there was no
             explanation or support for the understatement. Had Pan American used the
             correct amounts, it would have calculated the fixed obligations to effective
             income ratio at 54 percent, which exceeds HUD’s permissible rate of 41
             percent.

Pan American Did Not Comply
With Self-Sufficiency
Requirement

          Our examination of 15 loans approved for three- and four-unit properties showed
          Pan American did not take steps to ensure these were self-sufficient as required
          by HUD Handbook 4155.1, Revision 4, paragraph 1-8(C). We found seven loans
          with monthly mortgage payments exceeding the property’s monthly net rental
          income in violation of HUD requirements. Although Pan American officials
          stated they properly evaluated each loan to ensure compliance with HUD’s self-




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             sufficiency requirement, we did not find support in the loan files. As a result, the
             loans approved by Pan American were over-insured by $209,889 as shown below.

                                            Mortgage Amount
                    Case Number         Approved by    Determined          Overinsured
                                        Pan American    by OIG              Amount
                     501-6538799             $ 198,432  $ 140,077              $58,355
                     501-6649973               277,805    235,961               41,844
                     501-6806123               143,863    107,751               36,112
                     501-6820863               153,784    125,289               28,495
                     501-6604881               158,746    135,748               22,998
                     501-6618527               114,098     99,644               14,454
                     501-6817864               136,416    128,785                7,631
                        Total              $ 1,183,144  $ 973,255             $209,889

             We also reviewed the case files to determine whether borrowers had sufficient
             funds to close the loans, had Pan American enforced the self-sufficiency
             requirement. The Mortgage Credit Analysis Worksheets showed that borrowers
             did not have sufficient funds to cover the over-insured amounts as shown below.

                                                                   Borrower’s
                        Case             Overinsured          Funds       Possible
                       Number             Amount             Available    Shortage
                     501-6538799               $58,355           1,302      $ 57,053
                     501-6649973                41,844           5,140        36,704
                     501-6806123                36,112           5,113        30,999
                     501-6820863                28,495          26,315         2,180
                     501-6604881                22,998          19,269         3,729
                     501-6618527                14,454           3,004        11,450
                     501-6817864                 7,631           1,045         6,586


Conclusion


             Contrary to requirements contained in HUD Handbook 4155.1, “Mortgage Credit
             Analysis for Mortgage Insurance on One-to-Four Family Properties,” Pan
             American did not exercise sound judgment and due diligence in the processing
             and underwriting of loans to be insured by the Federal Housing Administration.
             In 10 loans, Pan American did not exercise the care expected of a prudent lender
             in the analysis of the borrower’s assets, earnings, and debts. Pan American failed
             to properly evaluate borrowers’ earnings and debts, allowed interested third
             parties to handle key documents, did not properly document the source of
             borrower investment, did not provide valid or supported compensation factors for
             excessive debt to income ratios, and did not clarify important file discrepancies.
             Pan American also approved seven loans that did not comply with HUD’s self-




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                  sufficiency requirement and, thus, were over-insured by $209,889. The
                  deficiencies occurred because Pan American did not establish and implement
                  adequate controls to ensure that its employees followed HUD requirements when
                  processing and underwriting loans. These deficiencies contributed to Pan
                  American’s high default rate and increased HUD’s risk to the Federal Housing
                  Administration insurance fund.

    Recommendations



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

                  1A. Require Pan American to indemnify HUD against future losses for the nine
                      actively insured loans totaling $1,391,208, for which Pan American did not
                      follow HUD loan origination requirements.3 Appendix D lists case numbers
                      for the loans included in this recommendation.

                  1B. Require Pan American to pay down the over-insured amount, totaling
                      $209,889, for the seven loans in which Pan American did not follow HUD’s
                      self-sufficiency requirement.

                  1C. Take appropriate monitoring measures to ensure Pan American establishes
                      and implements appropriate controls so that its employees follow HUD
                      requirements when processing and underwriting loans if HUD allows Pan
                      American to continue as a non-supervised direct endorsement lender.




3
       According to Neighborhood Watch, as of August 2004, 1 of the 10 loans has terminated FHA insurance
       without a claim (Case #501-6839882). Because this loan no longer represents a risk to the insurance fund, we
       have removed it from our recommendation.


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Finding 2: Pan American Did Not Fully Implement Its Quality
           Control Plan as Required

Contrary to HUD requirements, Pan American did not fully implement its quality control plan as
required. It has not implemented procedures or controls to ensure that all Federal Housing
Administration-insured loans that default within 6 months of closing undergo a loan origination
quality control review. We attribute this deficiency to Pan American’s disregard of HUD
requirements and instructions. As a result, HUD has no assurance of the accuracy, validity, and
completeness of Pan American’s loan origination operations.


 Early Default Loans Not
 Reviewed for Quality Control

              Although HUD Handbook 4060.1, “Mortgage Approval Handbook,” requires
              performing quality control reviews of all loans defaulting within 6 months of
              closing; our audit showed that Pan American did not perform all the required
              reviews. For example, of the eight early defaulted loans in our sample, Pan
              American only reviewed one loan. This loan was reviewed as part of the monthly
              review of loans, not as an early default case.

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

 Required Corrective Actions
 Were Not Taken

              In April 2002, HUD conducted a review, found that Pan American failed to
              maintain and implement a quality control plan in compliance with HUD
              requirements, and instructed management to revise and implement procedures to
              correct the deficiencies. HUD found Pan American did not review 28 loans that
              went into default within the first 6 months of closing. Pan American was
              instructed to conduct the reviews and provide a summary, along with copies of
              reports provided to senior management. As of the date of our review, Pan
              American did not take corrective actions, and the finding remains unresolved.




                                              11
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             Since HUD had previously instructed Pan American of its responsibilities to
             maintain and implement a quality control plan, management was knowledgeable
             of the requirements, yet Pan American management failed to fulfill its
             responsibilities. Pan American’s Quality Control Manager explained she did not
             know about the loans that defaulted within the first 6 months, since the loans are
             sold, and believed the responsibility of performing the reviews fell upon the entity
             that purchased the loans. A former Quality Control Manager also informed us she
             was not aware of the contents and/or requirements included in HUD Handbook
             4060.1. This was not an acceptable explanation for not performing an integral
             component of its Federal Housing Administration loan program responsibilities.


Conclusion


             Contrary to HUD requirements, Pan American has not implemented procedures or
             controls to ensure that all Federal Housing Administration-insured loans that
             default within 6 months of closing undergo a loan origination quality control
             review. We attribute this deficiency to Pan American’s disregard of HUD
             requirements and instructions. As a result, HUD has no assurance of the
             accuracy, validity, and completeness of Pan American’s loan origination
             operations.

Recommendation

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

             2A. Take appropriate monitoring measures to ensure Pan American conducts the
                 required quality control plan reviews and that corrective action is taken and
                 documented for all reported deficiencies if HUD allows Pan American to
                 continue as a non-supervised direct endorsement lender.




                                              12
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                        SCOPE AND METHODOLOGY


To achieve our audit objectives we reviewed

•      Applicable laws, regulations, and other HUD program requirements;
•      Procedures established by Pan American in originating Federal Housing Administration-
       insured loans;
•      Quality control plan of Pan American and its implementation; and,
•      Files and documents from HUD and Pan American.

We also reviewed 10 Federal Housing Administration-insured loans that had defaulted within the
first 2 years from origination. In addition, we reviewed 15 loans of three- and four-unit
properties to determine whether Pan American complied with HUD’s self-sufficiency
requirement.

In addition, we interviewed appropriate officials and staff from Pan American and HUD’s Atlanta
Single Family Homeownership Center. We also interviewed borrowers to verify the information in
the files.

We performed our review between February and October 2004. The audit covered the period
January 1, 2002, through December 31, 2003, but we extended the period as necessary to achieve
the audit objective.

We performed our review in accordance with generally accepted government auditing standards.




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                             INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:

   •   Effectiveness and efficiency of operations,
   •   Reliability of financial reporting, and
   •   Compliance with applicable laws and regulations.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.



 Relevant Internal Controls
              We determined the following internal controls were relevant to our audit objectives:

              •     Program Operations. Policies and procedures that management has in place
                    to reasonably ensure that the loan origination process complies with HUD
                    program requirements and that the objectives of the program are met.

              •     Validity and Reliability of Data. Policies and procedures that management
                    has implemented to reasonably ensure that valid and reliable data are
                    obtained, maintained, and used during the mortgage loan origination
                    process.

              •     Compliance with Regulations. Policies and procedures that management
                    has implemented to reasonably ensure that its loan origination process is
                    carried out in accordance with applicable regulations.

              We assessed the relevant controls identified above.

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




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  Table of Contents
Significant Weaknesses


           Based on our review, we believe the following items are significant weaknesses:

           •    Pan American did not follow HUD requirements when originating and
                approving 17 Federal Housing Administration-insured loans (see finding 1).

           •    Pan American has not implemented its quality control plan in accordance
                with HUD requirements (see finding 2).




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                                       APPENDIXES

Appendix A

                  SCHEDULE OF QUESTIONED COSTS
                 AND FUNDS TO BE PUT TO BETTER USE

                    Recommendation                             Funds To Be Put
                        Number               Ineligible 1/     to Better Use 2/
                            1A                                    $ 1,391,208
                            1B                $ 209,889


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
        polices or regulations.

2/      Funds to be put to better use are quantifiable savings that are anticipated to occur if an
        Office of Inspector General (OIG) recommendation is implemented, resulting in reduced
        expenditures at a later time for the activities in question. This includes costs not incurred,
        deobligation of funds, withdrawal of interest, reductions in outlays, avoidance of
        unnecessary expenditures, loans and guarantees not made, and other savings.




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Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         17
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Comment 1




                     18
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Comment 2




Comment 3




Comment 4




Comment 5




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.



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Comment 5




Comment 6




Comment 7




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.



                                              20
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Comment 8




Comment 9




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.




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Comment 10




Comment 11




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.




                                              22
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Comment 11




Comment 12




Comment 13




Comment 14




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.




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Comment 14




Comment 15




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.



                                              24
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Comment 15




Comment 16




Comment 17




Comment 18




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.




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Comment 18




Comment 19



Comment 20




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.




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Comment 21




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.



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                7.     501-6817864-[* Borrower 17]
                       Market Rent = 1,150-15%=977.50. See attached supporting documents.
                       PITI = 948.21
                       Ratio = .97%
Comment 21             (We did not use Rental Income for qualification. )




[*] Name of borrowers, family members, financial institutions, employees, and real estate agent
were redacted by OIG to preserve their privacy. In some instances, titles were inserted to
preserve the meaning of the text.




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                        OIG Evaluation of Auditee Comments



Comment 1
            Pan American’s response did not state whether they concur or not with our
            audit recommendations. The response included a brief statement for each loan
            discussed in finding 1, and provided additional documents for our evaluation.
            Pan American did not provide comments to finding 2.

            FHA Case Number 501-6839882-703
Comment 2
            Pan American did not verify assets in accordance with HUD requirements.
            The letter from the financial institution indicating the borrower could withdraw
            funds from the account is not sufficient to meet HUD requirements, or to
            ensure funds did not originate from an unallowable source. The appraisal
            report did not disclose that the subject property was sold less than 1 year
            before the appraisal date.

            FHA Case Number 501-6549444-703
Comment 3
            Pan American states it properly verified the borrower’s earnest money, and
            that using copies of key documents was proper. However, this is inconsistent
            with what we found in the files and with what the borrower told us. Pan
            American did not comment on our concern that all required documents were
            provided by the real estate agent (interested third party), which violates HUD
            requirements.

            The tax returns were not complete because Schedule A was missing. In
            addition, Pan American did not obtain a year-to-date profit and loss statement
Comment 4
            and balance sheet.

            Pan American did not comment on the issue that one of the comparables was
            superior to the subject property. We were able to identify properties sold
Comment 5
            within the vicinity of the subject property at prices below the appraised value
            of the subject property.

            Lenders must establish that the borrower has the ability to repay the mortgage
Comment 6
            debt and it must be supported by sufficient documentation. A field inspection
            is not sufficient to assess the financial strength, and properly determine if the
            business can be expected to generate sufficient income.




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Comment 7   FHA Case Number 501-6710133-703

            Pan American did not obtain sufficient documentation to ensure gift funds
            were not provided from an unacceptable source and were the donor’s personal
            funds. We found a relationship existed between the borrower and the seller.
            This was confirmed through an interview with the seller. Pan American
            acknowledges the borrower faxed letters that were used to support the credit
            history. Pan American did not comment on our concern that the borrower
            completed the Verification of Employment. In addition, Pan American did not
            explain the inconsistencies pertaining to the borrower’s employment date and
            monthly rent.

Comment 8   FHA Case Number 501-6581138-703

            Pan American states it properly verified the borrower’s earnest money.
            However, this is inconsistent with what was in the files and with what the
            borrower told us. Pan American did not verify assets in accordance with HUD
            requirements, and cannot ensure the funds were not from an unacceptable
            source. Pan American did not comment on the fact that an interested third
            party provided all required documents, which violates HUD requirements.
            Contrary to Pan American’s claim, the tax returns were not complete since
            Schedule A was missing. Pan American did not obtain a year-to-date profit
            and loss statement and balance sheet from the borrower.

            Lenders must establish that the borrower has the ability to repay the mortgage
            debt and must be supported by sufficient documentation. The field inspection
            is not sufficient to assess the financial strength and properly determine if the
            business can be expected to generate sufficient income.

            The borrower told us the electrical and other needed repairs were never
            completed although the inspection report reflected the repairs were done.
            Therefore, the property does not comply with HUD property standards.




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Comment 9    Pan American claims the estimated rental income of $1,700 used by the
             appraiser only considered the income of three units, and the correct rental
             income should be $2,300 for all four units. Contrary to Pan American’s claim,
             the appraiser’s estimate of $1,700 did consider all units within the property. In
             addition, Pan American did not provide any support showing how the $2,300
             was determined. Pan American did not ensure the loan complied with HUD’s
             self-sufficiency requirement.

             Pan American states the appraiser used comparable number 1 to determine the
             value of the subject property. However, Pan American did not comment on
             the fact that such comparable was superior to the subject property.

Comment 10   FHA Case Number 501-6665346-703

             Pan American claims that even considering the advances as an unsecured loan;
             the borrower would still qualify. Pan American did not adhere to HUD
             requirements by considering the advances.

             Pan American states that the borrower had $10,805 available for closing. This
             information is not consistent with the information we obtained. The $10,805
             included $5,303 in ineligible advances. In addition, the $11,848 in the savings
             account was not available since all the funds in the account were securing a
             loan the borrower had with the financial institution. Pan American did not
             properly determine whether assets could be included as cash reserves or cash
             to close.

             Pan American states that the property’s contracted monthly rental income was
             $2,160; therefore, it exceeded the monthly mortgage payment. This is not in
             accordance with HUD Handbook 4155.1, Revision 4. The handbook provides
             that lenders must use the appraiser’s estimate of fair market rent, in this case
             $1,975, and not the contracted rent as claimed by Pan American. The monthly
             mortgage payment exceeded the monthly net rental income, which violates
             HUD requirements.




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Comment 11   FHA Case Number 501-6620514-703

             Pan American claims the funds came from another account previously closed
             by the borrower. However, the documentation provided by Pan American
             did not support the alleged transfer of funds. Pan American did not properly
             verify or document the source of funds to close.

             Pan American states that it evaluated the borrower’s tax returns for credit
             analysis. The information obtained was not sufficient and HUD guidelines
             were not followed. Pan American did not obtain a year-to-date profit-and-
             loss statement and a balance sheet.

             Pan American did not comment on the borrower’s claim that he signed
             documents that were blank. The borrower informed us that he signed
             various applications that were blank and signatures on various documents
             were not his. The borrower told us he signed the documents on the closing
             date, despite the increase in price, because he already constructed a paved
             driveway, and had already moved out of the rental unit.

             The appraisal report contained inconsistencies related to the equipment
             reported as in place and considered to assess the property’s value. The
             borrower informed us that the appliances were not in the property. In
             relation to the property’s driveway, Pan American did not comment on the
             borrower’s claim that it was not paved and he made the improvements before
             the closing. The information provided by the borrower was consistent with a
             plot plan dated April 2002, that showed the property without a paved
             driveway.

             FHA Case Number 501-6758930-703

Comment 12   Pan American “grossed-up” the borrower’s earnings by 16 percent, and claims
             it was within the allowable range of 15 to 25 percent. This position is not in
             agreement with guidelines contained in Mortgagee Letter 97-26. Furthermore,
             Pan American did not provide documentation that could show how the
             “grossed-up” amount was determined.




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             Pan American did not comment on our concern that adequate explanation for
             recent indications of credit problems was not obtained. Responsibility for
             satisfying mortgage payments lies with the borrower. The contract between the
             lender and the borrower has precedence over any other agreement the borrower
             might have with a tenant. Therefore, the borrower was still responsible to satisfy
             the mortgage payments.

Comment 13   We acknowledge the borrower incorrectly certified he would occupy the
             property as his principal residence.

Comment 14   FHA Case Number 501-6526790-703

             Pan American did not verify earnings in accordance with HUD requirements.
             The most recent earning statements only covered a 15-day period instead of the
             required 30-day period. In addition, an interested third party handled key
             documents. Pan American did not obtain adequate explanation for recent
             indications of credit problems, and the compensating factor was not properly
             supported. In addition, the appraisal report should have reflected an adjustment
             because the property was located in a flood zone area.

             FHA Case Number 501-6684590-703

Comment 15   Pan American did not address our concern that a withdrawal document was not
             obtained to support the source of funds, as required by HUD. The earnings
             overstatement was uncovered through direct verification with the employer.
             This occurred because of a breakdown in the controls that allowed an interested
             third party to provide Pan American key documents containing
             misrepresentations. Pan American did not obtain an explanation for the debt that
             went into collections, and it did not use valid compensating factors.

             Although the property is located in a suburban area, comparables in the appraisal
Comment 16   report were not similar to the subject property. The comparables used by the
             appraiser were developments located in urban areas, located between 5 and 7 miles
             away from the subject.




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Comment 17   FHA Case Number 501-6713435-703

             The fact the property’s appraised value exceeded the selling price, does not
             diminish Pan American’s failure to follow HUD requirements. Although Pan
             American claims the repairs were made before the appraisal, it did not provide any
             documents to support this statement or the nature of the alleged repairs.


Comment 18   Pan American acknowledges it miscalculated effective income by overstating
             earnings.

             Pan American did not resolve the inconsistencies on the borrower’s date of
Comment 19   employment. Had Pan American verified this information, it would have found the
             borrower had less than a year on the job. Contrary to Pan American’s claim, the
             employer did not originate the October 2002 certification. The certification was
             faxed from the office of the real estate agent (interested third party).

             Pan American did not provide an acceptable compensating factor to approve the
Comment 20   loan. The compensating factor used did not support Pan American’s claim the
             applicant income was expected to increase.

             Pan American did not take steps to ensure the loans complied with HUD’s self-
             sufficiency requirements. Although Pan American claims the appraiser's
Comment 21   estimate of market rent does not consider the rental income of property's main
             unit, the documents provided did not show the basis for the claim. Our
             assessment followed guidelines contained in HUD Handbook 4155.1, Revision
             4. The appraiser’s estimate of fair market rent included all units within the
             subject’s property. Furthermore, the appraiser’s estimate is used to determine
             the property’s value using the income approach. For seven loans, the monthly
             mortgage payment exceeded the property’s monthly net rental income.




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Appendix C

                       SUMMARY OF LOAN DEFICIENCIES




                                                               Key Document                          Other
              Inadequate     Inadequate    Key Documents        Handled by  Inadequate             Deficiencies
  Case           Asset        Earnings          with             Interested    Debt      Excessive   and/or
 Number       Verification   Verification Misrepresentations    Third Party Verification  Ratios Inconsistencies
501-6665346        X              X                                                                     X
501-6581138        X             X                X                 X                                   X
501-6549444        X             X                X                 X                       X           X
501-6684590        X                              X                              X          X           X
501-6758930                      X                X                 X            X
501-6526790                      X                                  X            X                      X
501-6710133        X             X                                  X
501-6620514        X             X                X                 X            X          X           X
501-6713435        X             X                X                 X            X          X
501-6839882        X                                                                                    X
   Total           8              8               6                 7            5           4          7




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Appendix D

  ACTIVE LOANS PAN AMERICAN SHOULD INDEMNIFY



          Case          Loan      Settlement
         Number        Amount        Date               Status
       501-6665346     $233,157    06/28/02    In default
       501-6581138      191,983    03/14/02    In default
       501-6549444      185,908    02/12/02    In default
       501-6684590      181,565    09/04/02    Reinstated by mortgagor
       501-6758930      171,050    01/24/03    In default
       501-6526790      158,746    03/20/02    In default
       501-6710133       99,216    11/01/02    In default
       501-6620514       85,250    06/03/02    In default
       501-6713435       84,333    12/02/02    In default
          Total      $1,391,208




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Appendix E

                     NARRATIVE LOAN DEFICIENCIES



Case number:                 501-6549444
Mortgage amount:             $185,908
Section of Housing Act:      203B
Date of loan closing:        2/12/02
Current status:              In default as of 8/31/04 - first legal action
                             to commence foreclosure
Cause of default:            Excessive obligations

Summary:

Assets Analysis

The borrower’s earnest money was not properly verified. The savings account statements and
other documents used to support $7,000 in earnest money were faxed, apparently from the real
estate agent. The borrower informed us the amount in the statements was not correct and the
fund balance was overstated. The borrower also advised us that only $1,000 was provided as
earnest money, not the $7,000 shown on the Settlement Statement. The loan file did not contain
verification of deposit or originals of the two most recent bank statements. This is contrary to
requirements of HUD Handbook 4155.1, Revision 4, paragraph 3-1F. According to the
borrower, all required documents were provided to the real estate agent (interested third party),
who forwarded them to Pan American. In addition, the date of closing was the only time the
borrower had contact with Pan American officials.

Earnings Analysis

Pan American used tax returns to validate income information and qualify the borrower for the
loan. However, these did not include all corresponding schedules, as required by HUD
Handbook 4155.1, Revision 4, paragraph 2-9B. Also, the lender did not obtain a year-to-date
profit and loss statement and balance sheet. The borrower informed us the tax returns were
prepared by the seller’s real estate agent and could not explain where the agent obtained the
information. The 2001 tax returns used by Pan American reflected earnings of $58,000, while
the official tax return filed with the Puerto Rico Treasury Department showed $18,000.




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Other

The appraisal report contained items that could affect the value of the property. One of the
comparables included in the appraisal report was superior to the subject property. The appraisal
report included a statement indicating there were no comparables in the immediate vicinity of the
subject property. However, we were able to identify properties sold within the vicinity of the
subject property at prices below the appraised value of the subject property.

In addition, the property did not have a water heater in working condition in violation of property
standards contained in HUD Handbook 4000.2, Revision 2, paragraph 2-8F.




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Case number:                  501-6839882
Mortgage amount:              $208,354
Section of Housing Act:       203B
Date of loan closing:         4/17/03
Current status:               Terminated (paid in full) as of 8/31/04
Cause of default:             Excessive obligations

Summary:

Asset Analysis

Pan American did not obtain a verification of deposit or originals of the two most recent bank
statements, violating requirements of HUD Handbook 4155.1, Revision 4, paragraph 3-1F. The
documentation used to verify the assets by Pan American consisted of copies. As a result, Pan
American cannot ensure the funds were not from an unacceptable source and were the
borrower’s own funds. We consider that such assurance was imperative since the account was in
the name of the borrower’s sister-in-law.

Other

The appraisal report did not disclose the subject property was sold less than 1 year before the
appraisal date, violating Uniform Standards of Professional Appraisal Practice.

According to Neighborhood Watch, as of August 2004, this loan has terminated Federal Housing
Administration insurance without a claim. Because this loan no longer represents a risk to the
insurance fund, we have removed it from our recommendation.




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Case number:                 501-6713435
Mortgage amount:             $84,333
Section of Housing Act:      203B
Date of loan closing:        12/02/02
Current status:              In default as of 8/31/04 - first legal action
                             to commence foreclosure
Cause for default            Curtailment of borrower income

Summary

Assets Analysis

Pan American did not properly verify borrower’s cash investments. The Settlement Statement
reflected initial deposits totaling $1,550. This pertained to materials (sweat equity) allegedly
furnished by the borrower for repairs on the property and considered as the equivalent of a cash
investment by Pan American. The loan file included a letter from the seller, acknowledging the
borrower made $1,550 in improvements. Contrary to HUD Handbook 4155.1, Revision 4,
paragraph 2-10(O), Pan American did not obtain evidence of the nature of the repairs, the source
of the funds used to purchase the materials, and the market value of the materials. In addition,
the appraisal report did not list any repairs or improvements needed on the property.

Earnings Analysis

Pan American miscalculated effective income by overstating earnings. The coborrower’s
verification of employment reflected a monthly salary of $800. However, a copy of a wage
statement showed a monthly salary of $754. Pan American used the higher amount to approve
the loan, but there was no support clarifying the inconsistency. We contacted the employer and
found the personnel office did not prepare the verification. The director of the school where the
coborrower worked apparently completed the verification. According to the personnel office, the
correct monthly salary was $754 as reflected in the earning statements.

Pan American did not properly resolve conflicting information within the loan file in relation to
the borrower’s employment. The Request for Verification of Employment, dated September 27,
2002, stated the borrower commenced working at the Puerto Rico House of Representatives in
October 2001. However, a certification, dated October 14, 2002, stated the borrower
commenced working in February 1998. There was no documentation in the loan file showing
Pan American resolved this inconsistency. We contacted the employer and found the personnel
office did not originate the October 2002 certification. Had Pan American verified this
information, it would have found the borrower had less than a year on the job at the time the
Request for Verification of Employment was completed. Accordingly, Pan American did not
verify the borrower’s employment for the most recent 2 full years, as required by HUD
Handbook 4155.1, Revision 4, paragraph 2-6.




                                                40
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Debt Analysis

Pan American also excluded from the debt analysis monthly payments, totaling $205, the
borrowers had with two creditors. This debt was included in the credit report, but there was no
explanation or support for the understatement. Had Pan American used the correct amounts, it
would have calculated the fixed obligations to effective income ratio at 54 percent, which
exceeds HUD’s permissible rate of 41 percent, as prescribed in HUD Handbook 4155.1,
Revision 4, paragraph 2-12B.

Other

In addition, Pan American did not use or provide a significant compensating factor to approve
the loan, although the calculated fixed obligations to effective income ratio was 46 percent,
which exceeds HUD’s permissible rate of 41 percent. The compensating factor used by Pan
American indicated the borrower rejoined the work force and was currently working in public
relations. This was not an acceptable compensating factor, as prescribed in HUD Handbook
4155.1, Revision 4, paragraph 2-13.




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Case number:                    501-6710133
Mortgage amount:                $99,216
Section of Housing Act:         203B
Date of loan closing:           11/01/2002
Current status:                 In default as of 08/31/04 - first legal action
                                to commence foreclosure
Cause of default:               Other

Summary

Assets Analysis

Contrary to requirements of Mortgagee Letter 00-28, Pan American did not obtain sufficient
documentation to ensure $9,300 in gift funds were not provided from an unacceptable source and
were the donor’s own funds. We consider that such assurance was imperative since there was a
relationship among the borrower, seller, employer, and gift donor.4 Pan American did not obtain
bank statements that could show a history of the account and the existence of the donor’s funds.
Therefore, Pan American cannot assure the gift funds did not come from the seller or other
unacceptable source.

Other

Our review disclosed that key documents were handled by the borrower or were not obtained
directly from the source. For example, we found the borrower completed the Verification of
Employment in violation of HUD Handbook 4155.1, Revision 4, paragraph 3-2B. The
verification was faxed from an entity named V.V.O. Investment, but Pan American could not
explain what this entity was. In addition, letters from three vendors supporting the borrower’s
credit history were faxed from the same place, showing that documents were not obtained from
the source.5 Further, Pan American did not follow up or clarify other inconsistencies pertaining
to the borrower’s employment date and monthly rent. The borrower refused to be interviewed by
OIG.




4
    The seller was also the borrower’s employer, and the gift donor was the seller’s mother. In addition, the
     borrower is the daughter-in-law of the seller.
5
    In one of the vendor letters, the handwriting was similar to the borrower’s.


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Case number:                  501-6581138
Mortgage amount:              $191,983
Section of Housing Act:       203B
Date of loan closing:         3/14/02
Current status:               In default as of 8/31/04 - delinquent
Cause of default:             Curtailment of borrower income

Summary

Assets Analysis

The borrower’s earnest money was not properly verified. The Settlement Statement reflected
$7,300 in earnest money. The savings account statements and other documents used to support
the earnest money were faxed, apparently from the real estate agent. The borrower informed us
the amount in the statements was not correct and the fund balance was overstated. The borrower
also advised us that only $1,000 was provided as earnest money, not the $7,300 shown in the
Settlement Statement. The loan file did not contain a verification of deposit or originals of the
two most recent bank statements. This is contrary to requirements of HUD Handbook 4155.1,
Revision 4, paragraph 3-1F. According to the borrower, all required documents were provided
to the real estate agent (interested third party), who forwarded them to Pan American. In
addition, the date of closing was the only time the borrower had contact with Pan American
officials. Contrary to requirements contained within HUD Handbook 4155.1, Revision 4,
paragraph 3-1, Pan American allowed an interested third party to handle key documents.

Earnings Analysis

Pan American used copies of tax returns to validate income information and qualify the borrower
for the loan. However, these do not include all corresponding schedules as required by HUD
Handbook 4155.1, Revision 4, paragraph 2-9(B)(2). We also noted the tax returns were faxed,
apparently from the seller’s real estate agent. The borrower stated that Pan American never
asked for tax returns and could not explain from where the documents came. The tax returns
used by Pan American were never filed with the Puerto Rico Treasury Department.

Other

Pan American did not ensure the loan complied with HUD’s self-sufficiency requirement, as
included in HUD Handbook 4155.1, Revision 4, paragraph 1-8(C). As a result, the monthly
mortgage payment exceeded the property’s monthly net rental income. We estimated the loan
was overinsured by $13,018.

The appraisal report contained information that could adversely affect the value of the property.
One of the comparables included in the report was superior to the subject property. We also
found the property did not comply with property standards requirements contained in HUD
Handbook 4000.2, Revision 2, paragraph 2-8. The utilities (water and electricity) were not
independent for each unit.


                                                43
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Case number:              501-6665346
Mortgage amount:          $233,157
Section of Housing Act:   203B
Date of loan closing:     06/28/2002
Current status:           In default as of 08/31/04 - delinquent
Cause of default:         Curtailment of borrower income

Summary

Asset Analysis

Pan American did not properly determine whether assets could be included as cash reserves or
cash to close. Contrary to requirements contained in HUD Handbook 4155.1, Revision 4,
paragraph 2-10(I), Pan American allowed the use of $5,303 in salary advances to meet
investment requirements. A salary advance cannot be considered as assets to close since it
represents an unsecured loan.

In addition, Pan American improperly included $11,848 in a savings account as assets available
to the borrower, when all the funds in the account were securing a loan with the financial
institution. These restricted assets were included in the Mortgage Credit Analysis as assets
available in violation of HUD Handbook 4155.1, Revision 4, paragraph 2-10(D). We also
determined the borrower did not have a reserve of 3 months’ mortgage payments after closing,
required under HUD Handbook 4155.1, Revision 4, paragraph 1-8(C)(4).

Earnings Analysis

Pan American did not adequately verify retirement income. Pan American did not obtain
verification from the source or a tax return as required by HUD Handbook 4155.1, Revision 4,
paragraph 2-7.

Other

Pan American did not ensure the loan complied with HUD’s self-sufficiency requirement, as
included in HUD Handbook 4155.1, Revision 4, paragraph 1-8(C). As a result, the monthly
mortgage payment exceeded the property’s monthly net rental income. We estimated the loan
was overinsured by $21,547.




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Case number:                 501-6620514
Mortgage amount:             $85,250
Section of Housing Act:      203B
Date of loan closing:        06/03/02
Current status:              In default as of 08/31/04 - first legal action
                             to commence foreclosure
Cause of default             Other

Summary

Asset Analysis

Pan American did not properly verify or document the source of funds to close. The borrower
opened a bank account on April 18, 2002, with a balance of $1,734. The loan was settled on
June 3, 2002, with cash at closing of $1,734 from the borrower. HUD Handbook 4155.1,
Revision 4, paragraph 2-10(B), requires lenders to obtain an explanation and evidence of source
of funds on recently opened bank accounts. Pan American did not obtain such documentation.

Earnings Analysis

Pan American used tax returns to verify earnings and qualify the borrower for the loan.
However, the information obtained was not sufficient to determine the borrower’s financial
strength. For example, Pan American did not obtain a year-to-date profit-and-loss statement and
a balance sheet, as required by HUD Handbook 4155.1, Revision 4, paragraph 2-9(B).

Debt Analysis

Pan American did not properly determine debt to income ratios. The Mortgage Credit Analysis
Worksheet reflected the mortgage payment to income ratio at 27 percent and the fixed payment
to income ratio at 41 percent. We determined the correct mortgage payment to income ratio at
34 percent and the fixed payment to income ratio at 47 percent, both exceeding HUD’s
permissible rates. This occurred because Pan American did not consider in its analyses monthly
property taxes totaling $148.

Other

The appraisal report contained inconsistencies in relation to equipment included in the subject
property. Although the appraisal reflected the property was equipped with refrigerator,
range/oven, dishwasher, etc., the borrower informed us the property did not have a refrigerator,
screens, washer, and dryer. The borrower also informed us he constructed a paved driveway in
order for Pan American to approve the loan. The appraised value should have been adjusted
downward because the property lacked a paved driveway.




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Furthermore, the borrower informed us he signed between three and four loan applications that
were in blank and that the signatures on some of the documents were not his. The borrower
indicated he verbally agreed on a purchase price of $70,000 and did not realize the price had
increased to $86,000 until the closing date.




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Case number:                    501-6684590
Mortgage amount:                $181,565
Section of Housing Act:         203B
Date of loan closing:           09/04/2002
Current status:                 Reinstated by mortgagor as of 08/31/04
Cause of default:               Curtailment of borrower income

Summary

Asset Analysis

Contrary to requirements included in Mortgagee Letter 00-28, Pan American did not obtain
sufficient documentation to ensure $4,000 in gift funds were not provided from an unacceptable
source and were the donor’s own funds. Pan American did not obtain a withdrawal document to
support the source of the funds.

Earnings Analysis

Documents used by Pan American to determine the eligibility of the borrower contained gross
misstatements. The Verification of Employment, tax returns, and earnings statements all
overstated the borrower’s earnings. These documents reflected the borrower had annual earnings
of $54,463. However, we found the correct annual earnings were $29,473. Although the
employer confirmed he signed the Verification of Employment, he could not explain why or how
the earnings were overstated. We determined the fixed obligations to effective income to be 88
percent and the mortgage payment to effective income at 54 percent. Both ratios exceeded
HUD’s permissible rates. Had Pan American obtained the correct earnings information; it
should have determined the borrower did not qualify for the loan.

Debt Analysis

Pan American did not obtain an explanation for major derogatory information included in the
borrower’s credit report. The credit report reflected a $5,040 debt that went into collections.
Pan American did not obtain an explanation from the borrower for the adverse statement as
required by HUD Handbook 4155.1, Revision 4, paragraph 2-3.

Pan American did not properly document a valid compensating factor when the mortgage credit
ratios exceeded HUD’s guidelines. According to the Mortgage Credit Analysis Worksheet, the
total fixed payment to income ratio was 48 percent, exceeding HUD’s permissible rate of 41
percent. The compensating factors Pan American used were a) “First Time Homebuyer” and b)
“He Has Good Score 623/654.” These are not valid compensating factors to justify the mortgage
approval as contained in HUD Handbook 4155.1, Revision 4, paragraph 2-13.




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Other

We noted the properties used as comparables in the appraisal report were not similar to the
subject property. The subject property is in a suburban area while the comparables used by the
appraiser were housing developments in urban areas, located between 5 and 7 miles away from
the subject.




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Case number:                 501-6526790
Mortgage amount:             $158,746
Section of Housing Act:      203B
Date of loan closing:        3/20/02
Current status:              In default as of 9/28/04- first legal action
                             to commence foreclosure
Cause of default             Other

Summary

Earnings Analysis

Pan American failed to obtain an explanation for an 8-month gap in the borrower’s employment,
as required by HUD Handbook 4155.1, Revision 4, paragraph 2-6. In addition, the coborrower’s
verification of income did not comply with HUD Handbook 4155.1, Revision 4, paragraph
3-1(E). For example, earning statements obtained covered a 15-day period instead of the most
recent 30-day period. In addition, there was no indication within the loan file showing Pan
American verified by telephone all current employers. Also, we noted many documents were
photocopied but there was no certification the original documents were examined.

Debt Analysis

Pan American failed to obtain an adequate explanation for recent indications of credit problems,
as required by HUD Handbook 4155.1, Revision 4, paragraph 2-3. The coborrower’s credit
report reflected 18 instances in which car loan payments were past due. According to a letter
from the coborrower, the car was given to a family member with the condition that the family
member continues with the monthly payments of the loan. However, the family member was not
making the monthly payments, forcing the coborrower to reclaim the car and assume the loan.
This was not an acceptable explanation for not fulfilling the borrower’s responsibility and pay
obligations in a timely manner.

Pan American did not properly determine debt to income ratios. The Mortgage Credit Analysis
Worksheet reflected the mortgage payment to income ratio at 32 percent and the fixed payment
to income ratio at 42 percent. We determined the correct mortgage payment to income ratio at
34 percent and the fixed payment to income ratio at 44 percent. This occurred because Pan
American underestimated the monthly hazard insurance amount by $83. Since the property is
located in a flood zone area, the monthly hazard insurance premium was $206. In addition, one
of the compensating factors used by Pan American to justify approval of the loan was not
adequately supported. The compensating factor used stated the coborrower received monthly
child support totaling $240, which was not included in the effective income. However, the only
support was a letter from the child’s father acknowledging he makes the payments. This is not
sufficient evidence to support the alleged additional income.




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Other

Although the property was located in a flood zone area, the appraisal report did not reflect a
flood hazard adjustment. In addition, the appraisal report reflected an upward adjustment of
$5,000 in the “location” line item in all three comparables. This adjustment may be unwarranted
since comparables are located in areas with similar characteristics

We noted key documents related to the borrower’s income that were faxed to Pan American by a
real estate agent involved in the transaction. Among the documents faxed were earning
statements, Internal Revenue Service W-2 forms, rental income verification, letters evidencing
the status of certain debts, and copies of bank statements. HUD Handbook 4155.1, Revision 4,
paragraph 3-1, establishes that verification forms must pass directly between the lender and
provider without being handled by any third party.




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Case number:                      501-6758930
Mortgage amount:                  $171,050
Section of Housing Act:           234C
Date of loan closing:             1/24/03
Current status:                   In Default as of 9/28/04 - first legal
                                  action to commence foreclosure
Cause of default                  Illness of principal mortgagor

Summary

Earnings Analysis

Pan American did not properly document and support the adjustment made to the borrower’s
nontaxable income as required by HUD Handbook 4155.1, Revision 4, paragraph 2-7(P). Based
on loan file documents, the borrower received monthly Social Security income (nontaxable
within Puerto Rico) totaling $1,417. Pan American “grossed-up” the earnings by $227 without
documenting and supporting how this amount was determined. The Mortgage Credit Analysis
Worksheet included a statement incorrectly indicating $227 was 15 percent of the $1,417 in
Social Security earnings.6 We determined this amount was overstated by at least $14; the correct
amount was $213. We could not find any other information that could explain or show how the
“gross-up” of $227 was determined.

Debt Analysis

Pan American failed to obtain an adequate explanation for recent indications of credit problems,
as required by HUD Handbook 4155.1 Revision 4, paragraph 2-3. The borrower’s credit report
reflected six instances in which mortgage payments ($529) on another property were past due.
According to a letter from the borrower, the property was offered to a family member with the
condition that he takes over the responsibility of the mortgage payments. However, the family
member made no payments during this period. This was not an acceptable explanation for not
fulfilling the borrower’s responsibility and pay obligations in a timely manner.

Other

The borrower was not a bona fide occupant of the property as required by HUD Handbook
4155.1, Revision 4, paragraph 1-2. Although the borrower certified he would occupy the
property as his principal residence, he never moved in. According to the borrower, he never
intended to occupy the property, and Pan American officials were aware of his intentions. The
property was not purchased for purposes of primary residence use but, rather, to help his friend
(seller) refinance the property. The borrower also indicated the seller provided the earnest
money, and was the one making the monthly mortgage payments.

6
    According to Mortgagee Letter 97-26, lenders have the option of using either the published Internal Revenue
    Service tax tables for calculating the amount that may be “grossed-up” or using the minimum current tax rate of
    15 percent. The lender is responsible for justifying the amount used and ensuring the income is exempt from
    Federal taxation.


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Appendix F

                                          CRITERIA


Handbook 4000.2, Revision 2, paragraph 2-8, “General Acceptability Standards for Property”
provides a general outline of minimum property standards.

Section F describes utilities each property must include as follows:

     F. Services and Facilities. Utilities and other facilities should be independent for each unit
and must include

           a.   a continuing supply of safe, potable water,
           b.   sanitary facilities and a safe method of sewage disposal,
           c.   heating adequate for health and comfort,
           d.   domestic hot water, and
           e.   electricity for lighting and equipment.

HUD Handbook 4060.1, Revision 1, Change 1, “Mortgagee Approval Handbook,” Chapter 6,
“Quality Control Plan,” provides guidelines and requirements in relation to quality control
procedures to be implemented by all lenders.

Section 6-1 requires that all Federal Housing Administration-approved mortgagees, including loan
correspondents, must implement and continuously have in place a quality control plan for the
origination and/or servicing of insured mortgages as a condition of receiving and maintaining
Federal Housing Administration approval. Also, section 6-1 requires that quality control must be a
prescribed and routine function of each lender’s operations whether performed by a lender’s staff or
an outside source.

Section 6-3 contains the basic elements that are required in all quality control programs. Paragraph
6-3C requires that the lender properly train staff involved in quality control and provide them access
to current guidelines relating to the operations that they review. It is not necessary for lenders to
maintain these guidelines in hard copy format if they are accessible in an electronic format. Many
of the statutes, regulations, HUD Handbooks, and Mortgagee Letters that establish the requirements
for Federal Housing Administration programs may be accessed through HUD’s home page on the
World Wide Web.

Section 6-6 contains basic requirements for quality control of single-family production.
Paragraph 6-6D requires that “In addition to the loans selected for routine quality control reviews,
mortgagees must review all loans going into default within the first six payments. As defined here,
early payment defaults are loans that become 60 days past due.”




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Section 6-7 prescribes minimum elements for the production portion of a quality control program.
The lender must address the following elements, among others:

•   Determine whether the appraised value was established using reasonable comparables,
    reasonable adjustments, and in expectation of repairs required to meet minimum safety and
    soundness requirements. Determine whether a field review was performed if the value of the
    property increased 20 percent or more within 12 months of a previous sale (paragraph 6-7B).

•   Determine whether there are sufficient and documented compensating factors if the debt
    ratios exceed Federal Housing Administration limits (paragraph 6-7 J).

•   Determine whether the loan was submitted for insurance within 60 days of closing or included a
    payment history showing the loan was current when it was submitted for mortgage insurance
    (paragraph 6-7O).

•   Determine whether the seller acquired the property at the time of or soon before closing,
    indicating a possible property “flip” (paragraph 6-7P).

•   If possible, determine whether the mortgagor transferred the property at the time of closing or
    soon after closing, indicating the possible use of a “strawbuyer” in the transaction (paragraph 6-
    7Q).

HUD Handbook 4155.1, Revision 4, “Mortgage Credit Analysis for Mortgage Insurance on One-
to Four-Family Properties” provides updated instructions on qualifying borrowers for HUD-
insured mortgages. It describes the basic mortgage credit underwriting requirements for single-
family mortgage loans insured under the National Housing Act. It requires lenders to determine
the borrowers’ ability and willingness to repay the mortgage debt and, thus, limit the probability
of default or collection difficulties. Lenders are expected to exercise both sound judgment and
due diligence in the underwriting of loans to be insured by the Federal Housing Administration.

Paragraph 1-2 requires that “At least one borrower must occupy the property and sign the
security instrument and mortgage note for the property to be considered as owner-occupied.”

Paragraph 1-8C imposes self-sufficiency requirements on three- and four-unit properties as
follows:

“THREE- AND FOUR-UNIT PROPERTIES, regardless of occupancy status, must be self-
sufficient, i.e., the maximum mortgage is limited so that the ratio of the monthly mortgage
payment divided by the monthly net rental income does not exceed 100 percent. (The mortgage
calculations described below are in addition to those detailed in paragraphs 1-6 and 1-7.)

    1) The monthly payment is defined as principal, interest, taxes, and insurance, including
       mortgage insurance (PITI), as well as any homeowners’ association dues, computed at
       the note rate (no consideration for buydowns may be given).




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   2) Net rental income is the appraiser’s estimate of fair market rent from all units, including
      the unit chosen by the borrower for occupancy, less the FHA [Federal Housing
      Administration] office’s allowance for vacancies and maintenance (or 25 percent if the
      local FHA has not established a separate allowance).
   3) The above calculation is used only to determine the maximum loan amount. Borrowers
      must still qualify for the mortgage based on income, credit, cash to close, and the
      projected rents received from the remaining units. The projected rent may only be
      considered as gross income for qualifying purposes; it may not be used to offset the
      monthly mortgage payment.
   4) The borrower must have a reserve of three months’ mortgage payments (PITI) after
      closing on purchase transactions.”

Paragraph 2-3 provides that “While minor derogatory information occurring two or more years
in the past does not require explanation, major indications of derogatory credit, including
judgments and collections, and any other recent credit problems, require sufficient written
explanation from the borrower. The borrower’s explanation must make sense and be consistent
with other credit information in the file.”

Paragraph 2-6 establishes that “the lender must verify the borrower’s employment for the most
recent two full years. If a borrower indicates he or she was in school or in the military during
any of this time, the borrower must provide evidence supporting this, such as college transcripts
or discharge papers. The borrower must also explain any gaps in employment of a month or
more. Allowances for seasonal employment, such as is typical in the building trades, etc., may
be made.”

Paragraph 2-7E states: “Retirement and Social Security income. Such income requires
verification from the source (former employer, Social Security Administration) or through
federal tax returns. If any benefits expire within the first full three years, the income source may
only be considered as a compensating factor.”

Paragraph 2-7P states: “Non-taxable Income. If a particular source of regular income is not
subject to federal taxes (e.g., certain types of disability and public assistance payments, military
allowances, etc.), 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 and no additional
allowances for dependents are acceptable. The lender must document and support the
adjustments made (i.e., the amount the income is “grossed-up”) for any nontaxable income
source.”

Paragraph 2-9B prescribes documentation requirements for self-employed borrowers as follows:

   1) Signed and dated individual tax returns, plus all applicable schedules, for the most recent
      2 years;
   2) Signed copies of Federal business income tax returns for the last 2 years with all
      applicable schedules if the business is a corporation, an “S” corporation, or a partnership;
   3) A year-to-date profit-and-loss statement and balance sheet; and
   4) A business credit report on corporations and “S” corporations.



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Paragraph 2-10 establishes that “All funds for the borrower’s investment in the property must be
verified.”

Paragraph 2-10B states: “Savings and checking accounts. A verification of deposit (VOD) may
be used to verify these accounts, along with the most recent bank statement. If there is a large
increase in an account, or the account was opened recently, an explanation and evidence of
source of funds must be obtained by the lender.”

Paragraph 2-10D states: “Collateralized loans. Funds can be borrowed for the required
investment as long as satisfactory evidence is provided that they are fully secured by existing
marketable assets. Such assets may include stocks, bonds, automobiles, real estate (other than
the property being purchased), etc.”

In addition, certain types of loans secured against deposited funds, such as signature loans, the
cash value of life insurance policies, loans secured by 401(k)s, etc., in which repayment may be
obtained through extinguishing the asset, do not require consideration of a repayment for
qualifying purposes. However, in such circumstances, the asset securing the loan may not be
included as assets to close or otherwise considered as available to the borrower.

The borrowed funds must be provided by an independent third party. The seller, real estate agent
or broker, lender, etc., may not provide such funds. Unacceptable borrowed funds include
signature loans, cash advances on credit cards, and similar unsecured financing.

Paragraph 2-10I establishes that “A salary advance, however, cannot be considered as assets to
close since it represents an unsecured loan.”

Paragraph 2-10O establishes requirements for sweat equity in lieu of a cash investment on
property. Among these, “only the repairs or improvements listed on the appraisal or conditional
commitment are eligible for sweat equity. Any work completed or materials provided before the
appraisal is made are not eligible.” Also, “The borrower’s labor may be considered as the
equivalent of cash if the borrower can demonstrate his or her ability to complete the work in a
satisfactory manner. The lender must document the contributory value of the labor through
either the appraiser’s estimate or through a cost estimating service.”

Paragraph 2-12B states: “Total fixed payment to effective income. If the total mortgage payment
and all recurring charges does not exceed 41 percent of gross effective income, the relationship
of total obligations to income is considered acceptable. A ratio exceeding 41 percent may be
acceptable if significant compensating factors are presented.”

Paragraph 2-13 states: “COMPENSATING FACTORS that may be used in just approval of
mortgage loans with ratios exceeding our benchmark guidelines include those listed below.
Underwriters must state on the ‘remarks’ section of the HUD-92900-WS the compensating
factors used to support loan approval.




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A. The borrower has successfully demonstrated the ability to pay housing expenses equal to or
greater than the proposed monthly housing expense for the new mortgage. If the borrower over
the past 12-24 months has met his or her housing obligation as well as other debts, there should
be little reason to doubt the borrower’s ability to continue to do so despite having ratios in excess
of those prescribed.

B. The borrower makes a large downpayment toward the purchase of the property.

C. The borrower has demonstrated a conservative attitude toward the use of credit and an ability
   to accumulate savings.

D. Previous credit history shows that the borrower has the ability to devote a greater portion of
   income to housing expenses.

E. The borrower receives compensation or income not reflected in effective income, but directly
   affecting the ability to pay the mortgage, including food stamps and similar public benefits.

F. There is only a minimal increase in the borrower’s housing expense.

G. The borrower has substantial cash reserves after closing.

H. The borrower has substantial non-taxable income (if no adjustment made previously in the
   ratio computations).

I. The borrower has potential for increased earnings, as indicated by job training or education
   in the borrower’s profession.

J. The home is being purchased as a result of relocation of the primary wage-earner and the
   secondary wage-earner has an established history of employment, is expected to return to
   work, and there is reasonable prospects for securing employment in a similar occupation in
   the new area. The underwriter must address the availability of such possible employment.”

Paragraph 3-1 establishes that “Credit documents may be up to 120 days old at the time the loan
closes (180 days for proposed construction). Updated, written verifications must be obtained
when the age of the documents exceed these limits. Verification forms must pass directly
between lender and provider without being handled by any third party.”

Paragraph 3-1E requires the mortgagee to obtain a Verification of Employment and the most
recent pay stub. Paragraph 3-1E also provides that “As an alternative to obtaining a VOE
[verification of employment], the lender may choose to obtain from the borrower original pay
stub(s) covering the most recent thirty-day period, along with original copies of the previous two
years’ IRS [Internal Revenue Service] W-2 forms. The pay stub(s) must show the borrower’s
name, social security number, and year-to- date earnings. The “original” of the W-2 may be any
of the copies of the form not submitted with the borrower’s income tax returns. (These original




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documents may be photocopied and returned to the borrower.) The lender must also verify by
telephone all current employers. The loan file must include a certification from the lender that
original documents were examined and the name, title, and telephone number of the person with
whom employment was verified. The lender must also obtain a signed copy of form IRS 4506,
Request for Copy of Tax Form, form IRS 8821, or whatever document is appropriate for
obtaining tax returns directly from the Internal Revenue Service for all loans processed in this
manner. The lender may also use an electronic retrieval service for obtaining W- 2 and tax
return information.”

Paragraph 3-1F requires the lender to obtain a Verification of Deposit and most recent bank
statements, or “As an alternative to obtaining a verification of deposit, the lender may choose to
obtain from the borrower original bank statement(s) covering the most recent three month period.
Provided the bank statement shows the previous month’s balance, this requirement is met by
obtaining the two most recent consecutive statements.”

Paragraph 3-2B provides that “So as not to delay mortgage closings, verifications may also be
transmitted by facsimile machine. However, the lender’s file must contain the original
verification form that was mailed to and returned from the employer or creditor.”

Mortgagee Letter 00-28, “Gift Transfer Documentation”
If the donor purchased a cashier’s check, money order, official check, or any other type of bank
check as a means of transferring the gift funds, the donor must provide a withdrawal document
or canceled check for the amount of the gift, showing the funds came from the donor’s personal
account.




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