oversight

Citywide Home Loans in Salt Lake City, UT, Did Not Comply with Federal Housing Administration Loan Origination and Quality Control Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-05-04.

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

                                                                 Issue Date
                                                                          May 4, 2005
                                                                 Audit Report Number
                                                                              2005-DE-1003




TO:         Frank L. Davis, General Deputy Assistant Secretary for Housing, H

            //signed//
FROM:       Ronald J. Hosking, Regional Inspector General for Audit, 8AGA


SUBJECT: Citywide Home Loans in Salt Lake City, UT, Did Not Comply with Federal
            Housing Administration Loan Origination and Quality Control Requirements


                                   HIGHLIGHTS

 What We Audited and Why

             We audited Citywide Home Loans (Citywide) in Salt Lake City, UT. We
             determined an audit was warranted based on loan origination and quality control
             deficiencies identified in a prior audit.

             Our audit objectives were to determine whether Citywide complied with U.S.
             Department of Housing and Urban Development (HUD) regulations, procedures,
             and instructions in the origination of insured loans selected for review and to
             determine whether Citywide’s quality control plan, as implemented, met HUD’s
             requirements.

 What We Found

             Citywide did not comply with HUD regulations, procedures, and instructions in
             the origination of 20 of the 23 loans selected for review. Citywide used
             independent loan officers to originate insured loans. HUD prohibits this practice
             because it represents an increased risk to the insurance fund.

             Citywide’s quality control reviews were not performed in a timely manner, and
             corrective actions taken for deficiencies identified were not documented.

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           Citywide used a contractor to implement its quality control plan. However, the
           contractor completed only 42 percent of the required quality control reviews of
           the loan files within the 90 days timeframe requirements.

What We Recommend


           We recommend that the Assistant Secretary for Housing-Federal Housing
           Commissioner take appropriate action as recommended in the two findings of this
           audit report. This action should include requiring Citywide to bring its policies
           and procedures for the origination of insured loans into full compliance with HUD
           regulations and to fully implement its quality control process.

           For each recommendation without a management decision, please respond and
           provide status reports in accordance with HUD Handbook 2000.06, REV-3.
           Please furnish us copies of any correspondence or directives issued because of the
           audit.

Auditee’s Response


           We provided the discussion draft of the audit report to Citywide on March 25,
           2005, and requested its comments by April 18, 2005. Citywide provided its
           written response on April 14, 2005. Citywide generally disagreed with finding 1
           and generally agreed with finding 2. The complete text of Citywide’s response,
           along with our evaluation of that response, can be found in appendix A of this
           report. Along with its comments, Citywide provided an updated quality control
           plan. However, we did not include the updated quality control plan in the report.




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                            TABLE OF CONTENTS

Background and Objectives                                                        4

Results of Audit

      Finding 1: Citywide Allowed Independent Contractors To Originate Federal   5
                 Housing Administration-Insured Loans

      Finding 2: Citywide’s Quality Control Process Is Deficient                 7

Scope and Methodology                                                            9

Internal Controls                                                                10

Appendixes

      A. Auditee Comments and OIG’s Evaluation                                   11




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                      BACKGROUND AND OBJECTIVES

In December 1998, Citywide Home Loans (Citywide) was incorporated in Utah as a for-profit
corporation. Citywide originates Federal Housing Administration, Veterans Affairs, and
conventional mortgage loans. Citywide received approval from the U.S. Department of Housing
and Urban Development (HUD) as a Title II nonsupervised loan correspondent on April 20,
2000. We reviewed Citywide’s loan origination and quality control activities at its main office
located at 4001 South 700 East, Suite 250, Salt Lake City, UT 84107.

Citywide originated 1,156 Federal Housing Administration-insured loans, with a beginning
amortization date between April 1, 2001, and August 31, 2004, for properties located in Utah.
The total mortgage amount for these loans was $146,036,270. As of August 31, 2004, insurance
claims had been paid on 38 loans, 82 loans had defaulted, and 26 loans were still in default. As
of December 30, 2004, HUD had paid insurance claims on 11 of the 23 loans that we reviewed,
with losses on the sale of six of the 11 loans totaling $287,115.

Between January 2003 and September 2004, Citywide had 67 independent contract loan officers
originating insured loans.

The objectives of our review were to determine whether Citywide complied with HUD’s
regulations, procedures, and instructions in the origination of insured loans selected for review
and to determine whether Citywide’s quality control plan, as implemented, met HUD’s
requirements.




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                                    RESULTS OF AUDIT

Finding 1: Citywide Allowed Independent Contractors To Originate
            Federal Housing Administration-Insured Loans
Citywide allowed independent contractors, self-employed individuals as defined by Internal
Revenue Service Form 1099, to originate Federal Housing Administration-insured loans. HUD
prohibits using contract loan officers because it represents an increased risk to the insurance
fund. Citywide told us it was acting upon verbal comments made by HUD staff that its loan
origination procedures were in compliance with HUD requirements. However, these procedures
did not fully comply with HUD's written requirements.


    Use of Independent Contract
    Loan Officers


                For 20 of 23 loans reviewed, Citywide permitted independent contract loan
                officers, who did not receive on-going supervision, to originate HUD-insured
                single family mortgage loans.1 Citywide entered into written agreements with the
                independent loan officers that defined their business relationship as a contracted
                service, rather than an employer-employee relationship. Citywide compensated
                the loan officer contractors for each insured loan closed by paying commissions.
                The commissions were based on the size of the loans, less administrative and
                processing fees and a charge for office space. The agreements also contained
                provisions indemnifying Citywide from any risk associated with the loan officers’
                contracted responsibilities.

                Citywide management informed the OIG that they were acting upon verbal
                confirmation received from HUD program staff that its operations complied with
                HUD requirements. Citywide management also stated that they were following
                what they believed to be the industry norms within the state of Utah for the
                origination of government insured loans.

                However, HUD Handbook 4060.1, REV-12, and Mortgagee Letter 95-36
                prohibits lenders from using these business relationships to originate
                insured loans. HUD requires that lenders originate insured loans only with
                their own employees and supervise their loan production.

                Citywide has since revised its business relationship with its loan officers by
                eliminating the indemnification provision in the contracts and references to


1
 Mortgagee Letter 95-36.
2
 Handbook 4060.1, REV-1 was subsequently revised during our audit period. The revision is Handbook 4060.1,
REV-1, CHG-1.

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             “independent contractor.” However, we believe these steps are insufficient for
             full compliance with HUD requirements.

             Over the course our audit, we have seen evidence of Citywide's attempts to come
             into compliance with HUD's requirements. As mentioned above, Citywide has re-
             written their contract to eliminate the indemnification provision. The majority of
             Citywide's loan officers now work in Citywide's office, which allows Citywide to
             provide the loan officers with increased supervision. We believe that Citywide is
             continuing to work towards full compliance with HUD requirements.

Conclusion
             Citywide did not fully comply with HUD's written requirements. According to
             Citywide’s owner, he believed that the company operated in compliance with
             HUD requirements. Citywide's owner believed he was in compliance because
             HUD staff provided him with verbal clarification that the practice of using
             Internal Revenue Service Form 1099 was OK. However, the verbal clarification
             did not support HUD's written requirements. It is Citywide’s responsibility to
             obtain written approval from HUD program staff for any deviations from HUD’s
             written requirements. Citywide’s owner also stated that paying the contract loan
             officers as self-employed entities, instead of company employees, was simply a
             business decision that increased their commission income.

             HUD prohibits using contract loan officers because it represents an increased risk
             to the insurance fund. We believe that Citywide did not exercise the required
             level of supervision over these loan officers and their loan origination activities.

Recommendations

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

             1A   Ensure Citywide has changed its policies and procedures for the origination
                  of Federal Housing Administration-insured loans to fully comply with all
                  HUD directives and regulations.




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Finding 2: Citywide’s Quality Control Process Is Deficient
Citywide’s quality control plan does not contain all of the elements required by HUD. The
quality control reviews were not performed in a timely manner, and corrective actions taken for
the noted deficiencies were not documented. Further, Citywide did not report withdrawn and
denied loans in accordance with the Home Mortgage Disclosure Act. The deficiencies
associated with Citywide’s quality control process are due to Citywide not fully complying with
HUD's and its own requirements. Because its quality control processes are deficient, Citywide is
unable to ensure the accuracy, validity, and completeness of its loan origination operations.


 Plan Does Not Contain All
 Required Elements
              Our review disclosed that Citywide’s quality control plan does not contain all of
              HUD’s required elements. For example, the plan does not require the assurance
              of loans being processed by employees or authorized agents of Citywide, nor does
              the plan require the analysis of all loans that default within the first 6 months.
              Citywide was not aware that this was a requirement. Further, the plan has not
              been updated to incorporate changes as a result of the revised chapter 6 of HUD
              Handbook 4060.1-REV-1, CHG-1. Citywide explained that it did implement the
              changes, but it had not updated the plan to reflect those changes.

 Reviews Performed Late


              Citywide did not adequately monitor the performance of its quality control
              contractor. Citywide used a third party contractor to perform its quality control
              reviews. However, the reviews were not performed in a timely manner.
              Additionally, the corrective actions taken for deficiencies were not documented.
              We found that 58 percent of the quality control reviews of loans selected for
              review were performed more than 90 days after the loans were closed. According
              to Citywide management, Citywide submitted reports to its third party contractor
              for selection of loans for review on time. However, the third party contractor was
              late in performing the quality control reviews. Citywide was unaware that the
              reviews were being performed late until it was identified by the OIG.

              Following our onsite review in September 2004, Citywide sent a letter to its third
              party contractor requesting that the quality control reviews be performed within
              the 90-day requirement.

 Reporting Requirements Not
 Met

              Citywide did not meet HUD’s requirements for reporting withdrawn or denied
              applications based on credit decisions in accordance with the Home Mortgage
              Disclosure Act. Citywide did not comply with the Home Mortgage Disclosure

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                  Act for the years 2001 and 2002 because at the time it did not realize that it was a
                  requirement. For 2003, Citywide mistakenly sent the Home Mortgage Disclosure
                  Act report to the Federal Reserve Board instead of HUD.


    Incomplete Case Files

                  Citywide was not maintaining the entire case file as required. Citywide was able
                  to provide us with a loan file for 17 of the 23 loans we reviewed. Six of the 23
                  loan files selected for review could not be located by Citywide, and 3 of those 6
                  files were within the required 2-year retention period.3 We reviewed the 17 loan
                  files for completeness. In all seventeen cases, copies of documents used during
                  the loan origination process were missing, incomplete, and/or unsigned. Citywide
                  explained that it did try to obtain all of the required documents; however, it was
                  difficult to obtain the documents from the sponsors, and/or title companies.


                  The absence of documentation in the case files prevented Citywide from ensuring
                  that the loan origination process was properly documented. In addition, missing
                  and/or incomplete documentation may impede the performance of quality control
                  reviews.


    Conclusion


                  We concluded that the deficiencies associated with Citywide’s quality control
                  process are due to Citywide not fully complying with HUD’s and its own
                  requirements.4 Without proper establishment of a quality control process,
                  Citywide is unable to ensure the accuracy, validity, and completeness of its loan
                  origination operations. Potential deficiencies may not be identified and corrected
                  in a timely manner, resulting in an increased risk to HUD’s insurance fund.

    Recommendations

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

                  2A. Require Citywide to fully establish and implement its quality control process
                      in accordance with HUD’s requirements.

                  2B. Review Citywide’s implementation of 2A and ensure Citywide’s quality
                      control process is fully implemented in conformity with HUD’s
                      requirements.

3
    HUD Handbook 4000.2, REV-2, 5-10.
4
    HUD Handbook 4060.1, REV-1, 2-13, and Handbook 4060.1, REV-1, CHG-1

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                         SCOPE AND METHODOLOGY

Our audit generally covered the period of April 1, 2001, through August 31, 2004. When
applicable, we expanded the audit period to include current data. We conducted our preliminary
survey fieldwork in June 2003 and our subsequent audit fieldwork was conducted from
September 2004 thru February 2005.

Our audit approach was to identify and evaluate the internal controls in place over the key areas
of Citywide’s Federal Housing Administration-insured loan origination activities. Our review
methodology entailed the review of 23 insured loans from the universe of 1,156 such loans
originated by Citywide with a beginning amortization date between April 1, 2001, and August
31, 2004, for properties located in Utah.

We selected a number of insured loans based on certain characteristics identified that pertained
to the audit. We chose not to use 100 percent selection as the sheer number of auditable
transactions precludes examining each unit in the universe. The results of our testing apply only
to the 23 loans reviewed and cannot be projected to the universe of 1,156 loans.

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

To accomplish the audit objectives, we

•      Interviewed HUD’s management and staff to obtain background information on
       Citywide.
•      Reviewed applicable Federal and HUD regulations and other applicable reference
       materials related to single-family requirements.
•      Reviewed the Federal Housing Administration case binders and Citywide’s scanned loan
       case files.
•      Obtained information from current and past employers for the borrower(s) and/or
       coborrower(s) identified in the case files mentioned in the previous bullet.
•      Interviewed Citywide officials, staff, and independent loan officers to obtain information
       regarding its policies and procedures.
•      Reviewed Citywide’s quality control plan and available quality control reviews.
•      Reviewed the independent auditor’s reports for fiscal years 2001, 2002, and 2003.
•      Reviewed the general ledger entries for the checking account for the period January 2003
       through August 2004.

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




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                              INTERNAL CONTROLS

Internal controls are 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:

              •        Loan Origination Process – Policies and procedures established by
                       management to ensure Federal Housing Administration-insured loans are
                       originated in accordance with HUD requirements and

              •        Quality Control Process – Policies and procedures established by
                       management to ensure the quality control plan has been implemented and
                       related reviews are performed in accordance with HUD requirements.

              We assessed the relevant controls identified above.

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

 Significant Weaknesses


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

                   •    Citywide does not have an adequate loan origination process to ensure
                       compliance with HUD requirements (finding 1), and

                   •   Citywide does not have an adequate quality control process to ensure
                       compliance with HUD requirements (finding 2).




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                        APPENDIX

Appendix A

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation     Auditee Comments




Comment 1


Comment 2




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12
                         OIG Evaluation of Auditee Comments

Comment 1   Citywide states that it has both spoken to and received emails from the HUD
            program staff. However, Citywide was not able to provide written verification of
            the guidance provided by HUD regarding the use of the Internal Revenue Service
            Form 1099.

Comment 2   Citywide states that the auditors reviewed and agreed that Citywide is taking all
            the risk for its Loan Officers. We agree that the new contract no longer contains
            the indemnification clause. However, the scope of our audit included loans that
            were originated by loan officers who were under a contract that held them
            responsible for indemnification.




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