Issue Date May 24, 2005 Audit Report Number 2005-FW-1009 TO: Frank L. Davis General Deputy Assistant Secretary for Housing, H FROM: Frank E. Baca Regional Inspector General for Audit, 6AGA SUBJECT: Allied's Quality Control Process Did Not Comply with HUD Requirements HIGHLIGHTS What We Audited and Why As part of the U.S. Department of Housing and Urban Development/Office of Inspector General’s (HUD/OIG) strategic plan, we audited Allied Home Mortgage Capital Corporation (Allied), a nonsupervised loan correspondent. We chose Allied for audit because of its high loan default rate. Our audit objectives were to determine whether Allied: (1) implemented a quality control plan according to HUD requirements and (2) complied with HUD regulations, procedures, and instructions in the origination of Federal Housing Administration insured single family mortgages. What We Found Allied had a quality control plan that complied with HUD requirements. However, it did not fully implement the plan. Allied did not always review early payment defaults, perform reviews of its offices, or complete its monthly quality control reviews in a timely manner. In addition, Allied’s monthly quality reviews were vague and failed to adequately address corrective actions. This occurred because Allied did not dedicate the resources necessary to operate an effective quality control program. As a result, Allied was unable to ensure the accuracy, validity, and completeness of its loan origination process. Allied did not follow HUD requirements when originating 20 Federal Housing Administration mortgages reviewed. Because Allied’s Federal Housing Administration sponsors are ultimately responsible to HUD for these deficiencies, we will address them to the appropriate sponsors in separate reports. What We Recommend We recommend that HUD’s general deputy assistant secretary for housing: • Ensure that Allied fully implements its quality control program. • Take appropriate administrative actions to include civil money penalties. 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 Allied disagreed with the report but acknowledged some deficiencies in its quality control procedures. The complete text of the auditee’s response, along with our evaluation of that response, can be found in Appendix A of this report. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding Allied Did Not Fully Implement Its Quality Control Plan 5 Scope and Methodology 9 Internal Controls 10 Appendixes A. Auditee Comments and OIG’s Evaluation 11 3 BACKGROUND AND OBJECTIVES Section 203(b)(1) of the National Housing Act, as amended, authorizes the U.S. Department of Housing and Urban Development (HUD) to provide mortgage insurance for single family homes. HUD must formally approve a lender that originates, purchases, holds, or sells Federal Housing Administration-insured loans. Lenders must follow the statutory and regulatory requirements of the National Housing Act and HUD’s instructions, guidelines, and regulations when originating insured loans. Lenders that do not follow these requirements are subject to administrative actions. On September 26,1991, HUD approved Allied Home Mortgage Capital Corporation (Allied) as a nonsupervised loan correspondent lender to originate Federal Housing Administration loans. As a condition for its approval, HUD required Allied to establish and maintain a quality control plan for the origination of insured loans. The quality control plan must be a prescribed function of Allied’s operations and assure that it maintains compliance with HUD’s requirements and its own policies and procedures. As a loan correspondent, Allied must send the Federal Housing Administration loans it originates to a HUD-approved direct endorsement sponsor for underwriting approval before loan closing and submission to HUD for insurance endorsement. The loan origination process includes taking initial loan applications, initiating the appraisal assignment, obtaining the credit report, and procuring verifications of deposit and employment. Based on the information gathered by the loan correspondent, the sponsor lender underwrites the loan and decides whether the borrower represents an acceptable credit risk for HUD. We selected Allied for audit because of its high loan default rate within the state of Texas. From July 1, 2002, to June 30, 2004, Allied originated 4,779 loans and experienced a default rate of 6.51 percent for loans defaulting in the first two years. The default rate for the state of Texas was only 4.31 percent. We limited our file reviews to the Hurst branch because it had the greatest number of early defaults of all of Allied’s HUD-approved branches in Texas. Allied voluntarily terminated the Hurst branch on March 23, 2004.1 Our audit objectives were to determine whether Allied: (1) implemented a quality control plan according to HUD requirements and (2) complied with HUD regulations, procedures, and instructions in the origination of the Federal Housing Administration insured single family mortgages. 1 Although we selected the Hurst branch for review, none of the loans in our sample was actually originated by the Hurst branch. Instead, seven different satellite offices using the Hurst branch’s identification number originated the loans. Six of these satellite offices are still originating Federal Housing Administration loans for Allied using the branch identification numbers of other HUD-approved branches. 4 RESULTS OF AUDIT Finding: Allied Did Not Fully Implement Its Quality Control Plan Allied had a quality control plan that complied with HUD requirements. However, it did not fully implement the plan. Allied did not always review early payment defaults, perform reviews of its offices, or complete its monthly quality control reviews in a timely manner. In addition, Allied’s monthly quality reviews were vague and failed to adequately address corrective actions. This occurred because Allied did not dedicate the resources necessary to operate an effective quality control program. As a result, Allied was unable to ensure the accuracy, validity, and completeness of its loan origination process. This contributed to an increased risk of loss to HUD’s insurance fund. Allied Is Behind in Performing Early Payment Default Reviews Allied is at least a year behind in performing early payment default reviews. Allied said it was not aware it had to perform early payment default reviews until a HUD monitoring review in January 2003. However, we noted its quality control plan, dated September 2000, included provisions to review early payment defaults. HUD did not issued its written monitoring findings until June 29, 2004. Afterwards, Allied began performing early payment default reviews starting with the oldest loans still shown in default. In October 2004, Allied issued its first report. Allied officials acknowledge they are at least a year behind in performing early payment default reviews. HUD Handbook 4060.1, REV-1, CHG-1, “Mortgagee Approval Handbook,” requires lenders to review all loans going into default within the first six payments. Allied Office Reviews Were Not Conducted in a Timely Manner Allied did not review all of its branch offices in 2004. Allied had 607 branches but only performed quality control reviews of 331 branches. HUD Handbook 4060.1, REV-1, CHG-1, requires lenders to conduct audits of their branch offices annually or provide written criteria supporting less frequent reviews. Allied’s quality control plan states the operations department will conduct regular onsite audits of new branches within 90 days of opening and perform yearly audits of existing branches as part of its ongoing commitment to quality control. On January 21, 2005, we requested that Allied provide the most recent reviews for the branch offices in our sample. As can be seen from the table below, the 5 reviews were not performed until after our request and were more than six months late. Branch office Date of most Prior review Months late recent review Hurst 01/25/2005 06/24/2003 7 669 Airport Freeway Dallas Closed 04/25/2001 N/A 3140 Coit Road Richardson 01/24/2005 06/25/2003 7 1202 Richardson Drive Arlington 01/25/2005 06/27/2003 7 1006 N. Bowen Road Arlington 01/25/2005 06/26/2003 7 3100 W. Arkansas Dallas 01/24/2005 06/25/2003 7 14001 Goldmark Drive Brownwood 01/26/2005 05/07/2003 9 807 B Center Street Allen 01/24/2005 06/25/2003 7 303 S. Jupiter Road Allied explained that it has experienced a lot of staff turnover within the operations department responsible for the reviews. The operations manager and several employees resigned in April, May, and June 2004. In September and October 2004, Allied only had two employees on staff. As of March 14, 2005, Allied had five employees in the operations department including the operations manager. Allied considers the department fully staffed. We question whether a staff of four is sufficient to review 607 branches annually. Allied’s Monthly Monitoring Reviews Were Not Always Completed in a Timely Manner Allied did not review loans within 90 days of closing. HUD requires lenders to review 10 percent of their loans within 90 days after the loan is closed. In March 2005, we requested that Allied provide support for its monitoring reviews for loans closed in September 2004. We requested copies of Allied’s reverifications of credit, employment, deposits, and appraisals for the 53 loans in its sample. We found Allied did not begin reverifications for half of the loans until more than 150 days after the loans closed. Further, Allied did not verify employment for 15 of the loans and did not provide evidence that it conducted desk reviews of the property appraisals. 6 Allied’s Monthly Monitoring Review Reports Were Vague Allied used vague language in its reports to describe the reverification of employment and deposits and field reviews of appraisals. The reports did not identify the reverifications Allied requested, the reverifications received, or any outstanding reverifications. They only stated, “Re-verifications of Employment, Previous Employment and Deposits are being completed on 100 percent of the audit sample for the current reporting period. There have been no discrepancies noted between the original documentation and the re-verifications that were received.” For the field reviews of appraisals, the reports stated review appraisals were ordered and completed for 10 percent of the audit sample. However, the report did not detail which appraisals were requested or provide the results of each new appraisal. The lack of specificity limits the usefulness of the reports and calls into question the quality of the reviews. Allied’s Monthly Monitoring Review Reports Did Not Identify Effective Corrective Actions Allied’s monthly quality control reports did not adequately address corrective actions. While all of the 2004 reports identified deficiencies, Allied proposed general corrective actions that did not address the specific deficiencies identified. For example, the August report rated two loan files as serious due to a missing credit report and appraisal. Although the report noted that Allied instructed the branch managers to provide missing documentation, it did not state why the deficiencies occurred. Further, Allied limited the report recommendations to a discussion of regional training sessions and improvements in the quality control review process. HUD Handbook 4060.1, REV-1, CHG-1, requires quality control reports to identify planned corrective actions, the timetable for their completion, and any planned follow-up actions. Allied needs to improve its quality control reviews by developing and reporting corrective actions aimed at preventing the specific deficiencies identified. Prior HUD Review Questioned Allied’s Quality Control Procedures HUD questioned Allied’s implementation of its quality control plan during a January 2003 review of its Albertville, Alabama branch. In its June 2004 monitoring letter, HUD requested that Allied submit documentation supporting its quality control review efforts for the prior six months for all branches using the 7 Albertville, Alabama branch identification number. In reviewing the documentation submitted by Allied, HUD concluded that Allied’s early payment default loan summary was “very general” and failed to include specifics such as the results or reverifications performed. HUD also found that Allied had not performed early payment default reviews for all loans defaulting in six or fewer payments. In addition, HUD questioned the effectiveness of management’s corrective actions as Allied had not reduced or eliminated problems such as missing documentation, unallowable fees, or overcharges for credit reports over the six-month period. Since Allied has yet to fully implement its quality control plan, we recommend HUD take appropriate administrative actions to reduce the risk to HUD’s insurance fund. Recommendations We recommend that the general deputy assistant secretary for housing: 1A. Ensure Allied brings its quality control process into full compliance with Federal Housing Administration rules. 1B. Take appropriate administrative actions to include civil money penalties. 8 SCOPE AND METHODOLOGY We conducted the audit at Allied’s main office in Houston, Texas. We conducted our audit from August 2004 through March 2005. To accomplish our objectives, we: • Reviewed applicable HUD handbooks and mortgagee letters. • Interviewed HUD staff, Allied management, and loan borrowers. • Reviewed Allied’s quality control plan and quality control reviews. • Performed site visits to 17 homes in our sample. • Mailed postal tracers to borrowers. • Performed Lexis/Nexis searches on borrowers. • Reviewed 20 Federal Housing Administration-insured loans. We reviewed 20 of the Federal Housing Administration-insured loans originated under the Hurst branch identification number between July 2002 and June 2004. The nonrepresentative selection of 20 loans was from a universe of 4,779 loans originated by Allied within the state of Texas. All of the borrowers in our sample defaulted on their loans after making two payments or fewer. The results of our detailed testing apply only to the 20 loans selected and cannot be projected to the universe of 4,779 loans. 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 HUD’s Single Family Data Warehouse or Neighborhood Watch data. The audit covered the period from July 2002 through June 2004. The period was adjusted as necessary. We performed our audit in accordance with generally accepted government auditing standards. 9 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 operation; • 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 Control We determined the following internal control was relevant to our audit objectives: • Controls over origination of Federal Housing Administration loans. We assessed the relevant control 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. Significant Weakness Based on our audit, we believe the following item is a significant weakness: • Allied did not fully implement its quality control plan consistent with HUD requirements. 10 APPENDIXES Appendix A AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 11 Comment 2 12 Comment 3 13 Comment 4 Comment 5 14 Comment 6 15 Comment 7 Comment 8 Comment 9 16 Comment 10 17 18 Comment 11 19 Comment 12 20 Comment 13 21 OIG Evaluation of Auditee Comments Comment 1 The scope of our review was July 2002 through June 2004. However, we extended our review of Allied’s quality control program through December 2004 due to the problems we found. Comment 2 We revised the draft to indicate that Allied issued its first report on early payment default reviews in October 2004. Comment 3 Allied officials do not believe it is fair for the OIG to state that Allied did not perform timely early payment default reviews since HUD does not provide a specific time frame for completing the reviews. We disagree. In order for the reviews to be useful to management, they must be completed in a timely manner. At the time of our review, Allied officials acknowledged being at least a year behind in performing early payment default reviews. Comment 4 We limited our review to loans identified by Neighborhood Watch as early payment defaults. Comment 5 Allied provides a number of explanations as to why it would have difficulty identifying early payment defaults beyond those identified by Neighborhood Watch. However, Allied does not offer an explanation as to why it did not timely review the early payment defaults identified by Neighborhood Watch. Allied’s quality control plan requires early payment default reviews and limits the reviews to loans that go 90 days without payment. Comment 6 Allied’s quality control plan requires on-site reviews of all new branches within 90 days of branch opening. Accordingly, only those branches opened in the last quarter of 2004 would be exempt from on-site monitoring. Comment 7 We did not consider Allied’s remote branch reviews because Allied was unable to provide written criteria supporting its decision not to review the branches on-site. HUD requires lenders to conduct annual, on-site branch reviews or establish written criteria for less frequent monitoring. Comment 8 We did not base our report conclusions solely upon the content of the loan summary reports. We requested Allied provide copies of the reverifications it performed for its September 2004 monthly monitoring review. We based our findings upon an analysis of the documentation provided by Allied. Comment 9 We revised the report to state that Allied did not verify employment for 15 of the loans. Comment 10 Allied was unable to produce copies of desk reviews of appraisals for loans included in its September 2004 monthly monitoring review. 22 Comment 11 Allied believes its monthly review reports identified effective corrective actions. We disagree. As noted in the report, Allied provided general corrective actions that did not address the specific deficiencies identified. Comment 12 We revised the report to exclude information HUD reported in their June 2004 monitoring letter. Comment 13 We believe our report accurately identifies a number of deficiencies in Allied’s quality control procedures. We commend Allied on its efforts to improve its quality control process and hope it will continue to make the improvements necessary to come into full compliance with HUD requirements. We also appreciate the professionalism and courtesy extended to audit staff. 23
Allied's Quality Control Process Did Not Comply with HUD Requirements, Houston, TX
Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-05-24.
Below is a raw (and likely hideous) rendition of the original report. (PDF)