oversight

Mortgage Express's Quality Control Process Did Not Comply with HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-04-21.

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

                                                             Issue Date
                                                                      April 21, 2005
                                                             Audit Report Number
                                                                      2005-KC-1005




TO:        John C. Weicher, Assistant Secretary for Housing–Federal Housing
              Commissioner and Chairman, Mortgagee Review Board, H

           //signed//
FROM:      Ronald J. Hosking, Regional Inspector General for Audit, 7AGA

SUBJECT: Mortgage Express’s Quality Control Process Did Not Comply with
           HUD Requirements


                                    HIGHLIGHTS

 What We Audited and Why

             We audited Mortgage Express, Inc. (Mortgage Express), a Federal Housing
             Administration-approved loan correspondent located in La Vista, Nebraska,
             because its default rate has been significantly higher than the U.S. Department of
             Housing and Urban Development (HUD) Des Moines field office’s average over
             the past two years.

             Our audit objectives were to determine whether Mortgage Express properly
             developed and implemented a quality control plan and properly originated Federal
             Housing Administration mortgages.

 What We Found
             Mortgage Express’s quality control process did not comply with HUD
             requirements. Mortgage Express’s written quality control plan lacked many
             required elements. In addition, Mortgage Express did not conduct all required
             quality control reviews, nor did its management review completed quality control
             reports and take prompt corrective action when the reports identified deficiencies.

             Mortgage Express also did not follow HUD requirements when originating 18 of
             41 Federal Housing Administration mortgages reviewed. Because Mortgage
             Express’s Federal Housing Administration sponsors are ultimately responsible to


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           HUD for these deficiencies, we will address these deficiencies to the appropriate
           sponsors in separate reports.

What We Recommend
           We recommend that the Assistant Secretary for Housing–Federal Housing
           Commissioner and Chairman, Mortgagee Review Board, require Mortgage
           Express to implement controls to ensure that it follows HUD’s quality control
           requirements and verify that Mortgage Express has implemented proper controls.
           We also recommend that HUD take appropriate administrative action against
           Mortgage Express for continuing to operate without an adequate 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 a draft report to Mortgage Express on April 1, 2005, and received
           written comments on April 15, 2005, as requested. Mortgage Express generally
           agreed with our conclusions, and responded that it has updated its Quality Control
           Manual to conform to HUD requirements. Mortgage Express also plans to hire
           quality control staff and have its quality control function in compliance with HUD
           rules and regulations by the end of April 2005.

           The complete text of the auditee’s response can be found in appendix A of this
           report.




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                           TABLE OF CONTENTS

Background and Objectives                                                       4

Results of Audit
      Finding: Mortgage Express’s Quality Control Process Did Not Comply with   5
         HUD Requirements

Scope and Methodology                                                           8

Internal Controls                                                               9

Appendix
   A. Auditee Comments                                                          10




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                     BACKGROUND AND OBJECTIVES

Mortgage Express is a loan correspondent located in La Vista, Nebraska. A loan correspondent
is a lender that has as its principal activity the origination of Federal Housing Administration-
insured mortgages for sale or transfer to its sponsors.

Mortgage Express began operations in 1995 and became an approved loan correspondent for the
Federal Housing Administration in June 1998. Mortgage Express currently operates 18 branches
located in 11 states. Approximately 20 percent of Mortgage Express’s overall business involves
origination of Federal Housing Administration loans. Mortgage Express originated 804 Federal
Housing Administration-insured loans that closed from June 1, 2002, through May 31, 2004.

We selected Mortgage Express for review because its default rate has been significantly higher
than the U.S. Department of Housing and Urban Development (HUD) Des Moines field office’s
average over the past two years. At the beginning of our audit period, the percentage of Federal
Housing Administration loans originated by Mortgage Express that had defaulted within the first
two years was 140 percent of the national average, and its default rate had reached 150 percent of
the national average by the end of our audit period. When compared to regional averages,
Mortgage Express’s default rate at the end of our audit period was 390 percent of the Des
Moines field office’s average and 232 percent of the Omaha field office’s average.

Our audit objectives were to determine whether Mortgage Express properly developed and
implemented a quality control plan and complied with HUD regulations, procedures, and
instructions in the origination of Federal Housing Administration mortgages.




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                                RESULTS OF AUDIT

Finding: Mortgage Express’s Quality Control Process Did Not Comply
         with HUD Requirements
Mortgage Express had not established and implemented an adequate quality control process.
Mortgage Express’s written quality control plan did not include many required elements, and its
staff did not conduct all quality control reviews required by HUD. Further, Mortgage Express’s
management did not review the quality control reports of completed reviews and take prompt
corrective action on identified deficiencies. This occurred because Mortgage Express’s senior
management had not made quality control a priority. As a result, Mortgage Express is unable to
ensure the accuracy, validity, and completeness of its loan origination operations.


 Mortgage Express’s Process
 Did Not Meet HUD Standards

              Mortgage Express’s written quality control plan lacked many HUD-required
              elements specified in HUD Handbook 4060.1. HUD requires all Federal Housing
              Administration-approved lenders, including loan correspondents, to implement
              and continuously have in place a quality control plan for the origination of insured
              mortgages. The more significant deficiencies in Mortgage Express’s quality
              control plan included the absence of guidance on conducting onsite branch
              reviews at least once per year, reviewing all loans going into default within the
              first six months or first six payments due (i.e, early payment defaults), or
              completing quality control reviews within 90 days of loan closing.

              Further, Mortgage Express did not conduct all quality control reviews required
              during our audit period. It also did not perform the completed reviews in
              accordance with HUD regulations and did not take prompt corrective action when
              these reviews identified deficiencies. HUD Handbook 4060.1 requires lenders to
              conduct quality control reviews of loans within 90 days closing, and requires
              reviews either monthly or quarterly, depending on the number of loans closed
              each month. HUD also sets parameters on the sample size and selection of loans
              for review and requires lenders to review all early payment defaults.

              Mortgage Express provided quality control reports for June 2002 through
              December 2003. However, the reports did not demonstrate that Mortgage
              Express had conducted the reviews in accordance with HUD requirements. For
              example, the reports did not show that Mortgage Express had

                  o Conducted reviews of at least 10 percent of the Federal Housing
                    Administration loans closed during each review period.
                  o Conducted onsite reviews of branch offices.
                  o Reviewed all loans defaulting within six months of the closing date or
                    within the first six payments due. HUD’s systems showed that nine loans



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                    had defaults reported within the early default timeframe; however,
                    Mortgage Express had reviewed only two of these loans.

             Additionally, Mortgage Express’s senior management did not review the quality
             control reports; therefore, it could not ensure prompt action was taken to correct
             deficiencies noted in the reports.

             Mortgage Express could not provide reports for the remainder of our audit period,
             January through May 2004, because it has not performed quality control reviews
             since December 2003. Mortgage Express told us that in October 2003, it
             terminated the employee responsible for quality control reviews but did not hire a
             replacement until May 2004.

             Mortgage Express has been aware of its inadequate quality control program for
             more than two years, but it has not taken the necessary actions to ensure that its
             quality control program meets HUD requirements. HUD’s Quality Assurance
             Division reviewed Mortgage Express in 2002 and reported several problems with
             its quality control program. In response, Mortgage Express certified to HUD in
             August 2003 that it had updated its plan and that the updated plan met HUD
             requirements. However, as of December 2004, Mortgage Express had not
             updated its quality control plan and was still using its plan of July 1998–the same
             plan that HUD had previously determined did not comply with applicable
             requirements. Mortgage Express told us that it is updating its quality control plan
             to comply with HUD Handbook 4060.1.

Conclusion

             Mortgage Express did not establish and implement a quality control process that
             complied with HUD requirements. Its written plan lacked many significant
             elements necessary to conduct proper quality control reviews, and it did not
             ensure that it conducted quality control reviews in accordance with HUD
             regulations. Without a properly implemented quality control process, Mortgage
             Express cannot ensure that its loan origination operations comply with HUD
             requirements; that it is protecting itself and HUD from unacceptable risk; and that
             it is guarding against errors, ommissions, and fraud.

Recommendations

             We recommend that the Assistant Secretary for Housing–Federal Housing
             Commissioner and Chairman, Mortgagee Review Board,

             1A. Require Mortgage Express to establish and implement an adequate quality
                 control process.

             1B. Verify that Mortgage Express’s quality control process is fully implemented in
                 accordance with HUD regulations.



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1.C. Take appropriate administrative action against Mortgage Express for
     continuing to operate without an adequate quality control process.




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                         SCOPE AND METHODOLOGY

Mortgage Express originated 804 Federal Housing Administration-insured loans that closed from
June 1, 2002, through May 31, 2004. Of these 804 loans, we reviewed 41 loans that defaulted
within the first two years of the loan.

To achieve our objectives, we reviewed HUD’s rules, regulations, and guidance for proper
origination of Federal Housing Administration loans. We also reviewed previous HUD reviews
of Mortgage Express and the HUD case binders for the 41 defaulted loans. In addition, we
interviewed HUD staff to obtain background information on HUD requirements and Mortgage
Express.

We interviewed Mortgage Express’s management and staff to obtain information regarding its
policies, procedures, and management controls. We reviewed Mortgage Express’s written
policies and procedures to gain an understanding of how its processes are designed to function.
We also reviewed Mortgage Express’s case binders for the 41 defaulted loans and its quality
control plan and available quality control reports.

We relied upon computer-processed data contained in HUD’s Single Family Data Warehouse
system. We assessed the reliability of these data, including relevant general and application
controls, and found them to be adequate. We also performed sufficient tests of the data, and
based on the assessments and testing, we concluded that the data are sufficiently reliable to be
used in meeting our objectives.

We performed audit work from November 2004 through March 2005. The audit was conducted
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:

                  •   Controls over origination of Federal Housing Administration loans.

              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.


 Significant Weaknesses


              Based on our review, we believe the following item is a significant weakness:

                  •   Mortgage Express has not properly implemented a quality control plan and
                      process (see finding).




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Appendix A

             AUDITEE COMMENTS




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