Issue Date August 12, 2005 Audit Report Number 2005-LA-1007 TO: Brian D. Montgomery, Assistant Secretary for Housing – Federal Housing Commissioner, H FROM: Joan S. Hobbs, Regional Inspector General for Audit, Pacific/Hawaii Region, 9DGA SUBJECT: KB Home Mortgage Company, Los Angeles, California, Improperly Submitted 13 Late Requests for Single Family Mortgage Insurance HIGHLIGHTS What We Audited and Why We audited KB Home Mortgage Company (KB), a nonsupervised lender approved to originate, underwrite, and submit insurance endorsement requests under the U.S. Department of Housing and Urban Development’s (HUD) Single Family Direct Endorsement program. We selected KB for audit because of its high late endorsement rate. Our primary objective was to determine whether KB complied with HUD’s regulations, procedures, and instructions in the late submission of insurance endorsement requests. Our secondary objective was to determine whether KB established and implemented a written quality control plan in accordance with HUD requirements. What We Found Our review of KB’s automated system and selected loan files disclosed that KB improperly submitted only 13 of 1,083 loans for late endorsement during the period August 11, 2002, through April 11, 2004. Additionally, by establishing a new process for loan submission in 2003, KB substantially reduced the number of loans submitted for late endorsement. Of the 13 loans totaling $1,774,049, two were conveyed to HUD and resulted in losses, three were terminated through streamline refinances, and eight remain active. Because the borrowers were behind on five of the 13 loans when they were endorsed and there were late payments on the other eight loans within six months prior to being submitted, KB increased HUD’s insurance risk. Data entered into KB’s automated system was often erroneous and may have contributed to the high incidence of late endorsed loans. KB’s current written quality control plan, adopted in 2003, meets HUD requirements. The implementation of the quality control plan will be evaluated as part of a separate concurrent audit of KB’s loan origination process. What We Recommend We recommend that HUD take administrative action up to and including the recovery of losses on $79,260 in paid claims and indemnification of loans with a total mortgage value of $537,578. These loans were not current when submitted for endorsement. We also recommend that HUD take appropriate administrative action against KB for violating the requirements in effect at the time when it submitted loans without proper six-month payment histories. In addition, we recommend HUD require KB to establish and implement written policies and procedures to ensure loans submitted to HUD for late endorsement meet late submission requirements and to reasonably ensure that valid and reliable data are obtained, maintained, and accurately disclosed in reports. 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 KB a draft report on June 20, 2005, and held an exit conference with KB officials on June 29, 2005. KB provided written comments on July 25, 2005, revised on July 26, 2005. The written comments only partially agreed with our report findings. After the receipt of the auditee’s comments we adjusted our recommendations to reflect HUD’s recent change in the late submission requirements. The complete text of the auditee’s response, along with our evaluation of that response, can be found in appendix B of this report. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: KB Improperly Submitted 13 Late Requests for Endorsement 5 Scope and Methodology 8 Internal Controls 10 Followup on Prior Audits 12 Appendixes A. Schedule of Questioned Costs and Funds to Be Put to Better Use 13 B. Auditee Comments and OIG’s Evaluation 14 C. Federal Requirements 22 D. Loans Submitted for Late Endorsement with Late Payments 23 3 BACKGROUND AND OBJECTIVES The National Housing Act, as amended, established the Federal Housing Administration, an organizational unit within the U.S. Department of Housing and Urban Development (HUD). The Federal Housing Administration provides approved mortgage lenders with insurance against losses on mortgage loans to qualifying homebuyers. The mortgage insurance program is authorized under Title II, section 203(b), of the National Housing Act and governed by regulations in Title 24, Code of Federal Regulations, Part 203. HUD Handbook 4165.1, REV 1, requires that loans submitted for insurance endorsement more than 60 days after closing meet certain late request standards. These standards include ensuring that the borrower has made, within the calendar month due, all loan payments up to the time of submission or at a minimum, made six consecutive monthly payments within the calendar month due. Appendix C provides details of HUD requirements for late endorsement requests. On April 15, 1965, HUD approved KB, a wholly owned subsidiary of the builder/developer KB Home, to originate Federal Housing Administration loans as a nonsupervised lender. KB also originates Department of Veterans Affairs loans and conventional loans, primarily for customers purchasing homes from its parent company. Currently, KB operates 11 branches in 9 states. KB has a corporate office located at 10990 Wilshire Boulevard, Los Angeles, California, and a processing and underwriting center in Las Vegas, Nevada. During a two-year period from August 11, 2002, through August 11, 2004, KB originated 10,250 Federal Housing Administration loans with total original mortgage amounts of more than $1.4 billion. The audit’s primary objective was to determine whether KB’s late requests for endorsement complied with HUD’s requirements. We also reviewed KB’s quality control plan to determine whether it met the requirements detailed in HUD Handbook 4060.1, REV 1. 4 RESULTS OF AUDIT Finding 1: KB Improperly Submitted 13 Late Requests for Endorsement From August 2002 through April 2004, KB improperly submitted 13 loans to HUD with mortgages totaling more than $1.7 million. These loans were submitted for insurance endorsement, even though borrowers had delinquent payments within six months prior to the loan submission date. This occurred because KB did not have adequate controls to ensure that its employees consistently enter and maintain accurate information in its data systems or always follow HUD’s requirements for late requests for insurance endorsement. Although these inappropriate submissions were only a small percentage of the total loans KB submitted for endorsement, they were still a risk to the Federal Housing Administration insurance fund. KB Improperly Submitted 13 Requests for Late Endorsement Our analysis of the mortgage payment histories provided by KB and endorsement data from HUD’s systems showed that KB improperly submitted only 13 out of 1,083 late requests for insurance endorsements tested (see appendix D in this report). KB initially agreed that the 13 loans had late payments and were improperly submitted. After endorsement, two loans, having original mortgage amounts totaling $298,467, were foreclosed and conveyed to HUD. After selling the properties, HUD incurred a loss of $104,706. HUD also suffered a loss of $4,157 from a partial claim on a loan that is currently active. The insurance fund remains at risk for 11 loans as follows: • The insurance was terminated without a claim on three of the loans with original mortgage amounts of $370,989 through streamline refinances. Because the loans were replaced with new Federal Housing Administration-insured loans and the streamline refinance process assumes the original loan was properly submitted, the improper submission and the risk to the insurance fund carries through to the new loan. The risk, based on the mortgage amounts for the new loans, is $375,916. • The remaining eight loans, with $1,104,593 in total original mortgage amounts, hold active Federal Housing Administration insurance and still pose a future risk to the insurance fund. 5 HUD Changed its Late Loan Submission Requirements On May 17, 2005, after the completion of our audit, HUD issued Mortgagee Letter 2005-23. This Mortgagee Letter changed HUD’s requirements for loans submitted late for endorsement and only requires lenders to certify that the most recent payment that came due was made within the month that the loan was submitted. The Mortgagee Letter eliminates the requirement that loans submitted late are not eligible for endorsement until six consecutive payments have been made prior to and/or within the calendar month due. Of the 13 loans reported above, five were not current at the time they were submitted to HUD for insurance endorsement and would not have met the new requirements. To Ensure Lasting Improvement, KB Needs to Establish Written Controls for Late Endorsements and Data Entry Integrity KB made a proactive effort to reduce the number of late submissions to HUD. The loans we tested were submitted during a period of 2 1/2 months in 2002, 12 months in 2003, and 3 months in 2004. The number of late endorsement requests KB submitted during that period dropped from an average of 69 per day in 2002 to less than one per day in 2004, showing significant improvement. KB officials explained that they recognized a problem in 2002 and instituted a new process in early 2003 to reduce the number of late submissions. Overall, between 2002 and 2003, the percentage of improper late submissions was small, less than two percent of the total loans submitted late. In addition, we did not identify any loans that were improperly submitted during the first three months of 2004. Officials said KB reviews the printed payment histories before submitting the late endorsement requests to HUD to ensure they meet payment standards. However, officials were unable to provide any written procedures, and the reviews are not documented. As a result, there is no assurance all loan submissions will consistently meet HUD requirements. We also tested KB’s data reliability and found inconsistencies, indicating KB lacked adequate controls to ensure that valid and reliable data are obtained, maintained, and accurately disclosed in reports. KB cannot consistently ensure compliance with HUD requirements for submission of loans without accurate records of closing, submission, and resubmission dates. Because of these 6 inconsistencies in the KB database, we had to modify our audit techniques to meet our objectives. Problems included • KB’s data included illogical submission dates. We tested 43 loans and found six cases in which KB’s data indicated the loans were submitted after HUD endorsed them and one case in which KB’s data indicated HUD endorsed the loan the same day KB shipped it. When the submission dates were not reasonable, we had to rely on the endorsement dates. • When HUD returned an endorsement request to KB because of deficiencies in the submission package, KB did not track resubmission dates in a date field. Resubmission dates were entered into a text field, along with other comments, or not at all. In addition, KB recorded the resubmission day and month but not the year. Therefore, we had to rely on HUD’s resubmission dates. Recommendations We recommend that HUD’s Assistant Secretary for Housing – Federal Housing Commissioner 1A. Take appropriate administrative action against KB up to and including recovery of losses on $79,260 in paid claims and indemnification of four loans, totaling $537,578, that were not current when submitted for endorsement. 1B. Take appropriate administrative action against KB for violating the requirements in effect at the time when it submitted eight loans without proper six-month payment histories. 1C. Require KB to establish and implement adequate written policies and procedures to ensure loans submitted to HUD for late endorsement meet late submission requirements and to reasonably ensure that valid and reliable data are obtained, maintained, and accurately disclosed in reports. 7 SCOPE AND METHODOLOGY We performed our audit work between January 4, 2005, and May 31, 2005, which included fieldwork at KB’s Las Vegas, Nevada, office. The audit covered the period from August 11, 2002, through April 11, 2004, and was modified as needed to meet our objectives. To accomplish our audit objectives, we reviewed (1) relevant statutory, regulatory, and HUD handbook requirements; (2) electronic loan records from KB and HUD; and Federal Housing Administration files from HUD’s Homeownership Centers; (3) KB’s internal controls relating to submission of late requests for endorsement; and (4) KB’s quality control plan. We also looked at the results of reviews of KB by HUD’s Quality Assurance Division, and we interviewed KB’s management, employees, and quality control contractor. We relied on computer-processed data provided by KB and data contained in HUD’s Single Family Data Warehouse. We modified audit techniques as necessary to accomplish audit objectives despite some problems with KB’s data integrity. We assessed the reliability of HUD’s data and determined the data were sufficiently reliable to be used in meeting our audit objectives. To determine the sample of loans for electronic review, we used HUD’s Single Family Data Warehouse to identify the 10,250 Federal Housing Administration loans originated by KB with closing dates between August 11, 2002, and August 11, 2004. The total original mortgage amount of these loans was more than $1.4 billion. The following table shows the adjustments made to the initial universe to arrive at the universe of 1,083 loans submitted for late endorsement, which we tested for late payments. 8 Description of loans Number of Original loans mortgage amount Originated by KB from August 11, 2002, 10,250 $1,440,902,501 through August 11, 2004 Submitted within 60 days after closing <8,055> <1,132,527,146> Subtotal 2,195 308,375,355 Due to a change in HUD requirements, we filtered out loans closed on or after April 11, 2004 <99> <14,139,110> Subtotal 2,096 294,236,245 Federal Housing Administration numbers found in HUD’s system but not in KB’s system <14> <2,083,724> New construction loans and loans submitted for endorsement before first payment due date <811> <111,780,279> Subject to late endorsement requirements 1,271 180,372,242 Transferred to an investor before first payment due date – no payment history in KB’s system <175> <24,778,884> Subtotal 1,096 155,593,358 Loans with final submission dates after April 11, 2004 <13> <1,842,001> Loans tested for late payments 1,083 $153,751,357 We found that some of the submission dates KB recorded were illogical. Most of the illogical dates were after the endorsement dates, which would indicate HUD endorsed the loans for insurance before KB submitted a request. In some cases, KB’s record of the submission date indicated HUD endorsed the loans on the same day KB shipped them. In those cases, we substituted the endorsement date for the illogical submission date. When HUD rejected a loan and sent it back to KB for correction of deficiencies, we used resubmission dates from HUD’s databases because KB did not maintain a date field for this information. We compensated for likely differences between actual submission and endorsement by only reviewing loans with at least 63 days between closing and submission, instead of 60. Finally, we reviewed Federal Housing Administration files for all loans in which electronic testing indicated the late submissions had unacceptable late payments. We provided KB an opportunity to provide additional documentation or information. We performed our review in accordance with generally accepted government auditing standards. 9 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, • Compliance with applicable laws and regulations, and • Safeguarding resources. 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 implemented to reasonably ensure that the delayed loan endorsement process complies with HUD’s requirements and meets the objectives of the direct endorsement program. • Validity and reliability of data - Policies and procedures that management has implemented to reasonably ensure that valid and reliable data are obtained, maintained, and fairly disclosed in reports. • Compliance with laws and regulations - Policies and procedures that management has implemented to reasonably ensure that resource use is consistent with laws and regulations. • Safeguarding resources - Policies and procedures that management has implemented to reasonably ensure that resources are safeguarded against waste, loss, and misuse. 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. 10 Significant Weaknesses Based on our review, we believe the following items are significant weaknesses: • Program operations - KB did not establish procedures and controls to ensure employees only submitted loans meeting HUD’s payment requirements for late insurance endorsement (see finding). • Validity and reliability of data - KB’s management did not establish policies and procedures that reasonably assured valid and reliable data were obtained and maintained (see finding). • Compliance with laws and regulations - KB did not always follow HUD’s regulations when it improperly submitted late requests for mortgage insurance when borrowers had not made timely mortgage payments (see finding). • Safeguarding resources - KB improperly submitted late requests for insurance endorsement for 13 loans with mortgages totaling more than $1.7 million. The improper submissions increased the risk to the Federal Housing Administration insurance fund (see finding). 11 FOLLOWUP ON PRIOR AUDITS This was the first audit of KB by HUD’s Office of Inspector General (OIG). Under a separate audit, we are also reviewing KB’s loan originations in one branch office during 2002. The last two independent auditors’ reports for KB covered the years ending November 30, 2002, and November 30, 2003. Neither report contained any findings. From July 2002 through June 2004, HUD’s Homeownership Centers performed multiple quality assurance reviews of KB branches in California, Texas, Nevada, Arizona, and Florida. Most of the findings were related to loan origination and underwriting deficiencies. 12 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Ineligible 1/ Unsupported 2/ Unreasonable or Funds to be put number unnecessary 3/ to better use 4/ 1A $79,260 $537,578 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 policies or regulations. 2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program or activity when we cannot determine eligibility at the time of audit. Unsupported costs require a decision by HUD program officials. This decision, in addition to obtaining supporting documentation, might involve a legal interpretation or clarification of departmental policies and procedures. 3/ Unreasonable/unnecessary costs are those costs not generally recognized as ordinary, prudent, relevant, and/or necessary within established practices. Unreasonable costs exceed the costs that would be incurred by a prudent person in conducting a competitive business. 4/ “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an 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. 13 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 14 15 Comment 1 Comment 1 16 Comment 1 Comment 2 Comment 3 17 Comment 4 Comment 5 Comment 6 Comment 7 18 19 20 OIG Evaluation of Auditee Comments Comment 1 We agree KB improved on its submission of late endorsements during the audit period, and that the improper late submissions were only a small portion of KB’s overall loan activity, as mentioned in the report. However, if KB had adequate controls in place, the move of its post-closing operations should not have impacted its submission of proper late endorsements. Comment 2 KB has not provided any expanded written procedures over late submissions. Comment 3 KB has also not provided us with explanations over submission date discrepancies. Comment 4 KB’s response appears to indicate it misunderstood a portion of the report. In the case of the four loans cited by KB, we are questioning late payments within the six months prior to submission, not after submission. This has been clarified in the report. Comment 5 In case 492-6418088, we reviewed the additional information submitted by KB and have accepted KB’s position that the payment was timely. As a result, this case was removed from the report, reducing the number of improper late submission from 14 to 13. Comment 6 In case 052-2382816, we agree that HUD’s current requirements would have excluded this loan from late endorsement requirements, and we have therefore removed it from our questioned costs. However, the criteria was not in effect at the time KB submitted the loan to HUD for endorsement, and HUD’s change in policy was not retroactive. As a result, it would have been considered an improper late submission under HUD Handbook 4165.1, REV 1. Comment 7 Although three loans did not default or have additional late payments within the six-month period after submission, this does not mean that the submissions were retroactively acceptable. HUD was still at an increased risk upon submission, and the loans would have violated HUD requirements over late submissions. 21 Appendix C Federal Requirements Title 24, CFR (Code of Federal Regulations), part 203.255(b), states, “For applications for insurance of mortgages originated under the direct endorsement program under this part, the mortgagee shall submit to the Secretary of Housing and Urban Development (HUD) within 60 days after the date of the loan or such additional time as permitted by the Secretary, properly completed documentation and certifications.” HUD Handbook 4165.1, REV-1, “Endorsement for Insurance for Home Mortgage Programs (Single Family),” dated November 30, 1995, chapter 3, section 3-1(A), states late requests for endorsement procedures apply if • The loan is closed after the firm commitment, • Direct endorsement underwriter’s approval expires, and/or • The mortgage is submitted to HUD for endorsement more than 60 days after closing. Section 3-1(B) states a loan request for endorsement from the lender must include (1) An explanation for the delay in submitting for endorsement and actions taken to prevent future delayed submissions. (2) A certification that the escrow account for taxes, hazard insurance, and mortgage insurance premiums is current and intact except for disbursements which may have been made from the escrow accounts to cover payments for which the accounts were specifically established. (3) A payment ledger that reflects the payments received, including the payment due for the month in which the case is submitted if the case is submitted after the 15th of the month. For example, if the case closed February 3 and the case is submitted April 16, the payment ledger must reflect receipt of the April payment, even though the payment is not considered delinquent until May 1. Payments under the mortgage must not be delinquent when submitted for endorsement. (a) The lender must submit a payment ledger for the entire period from the first payment due date to the date of submission for endorsement. Each payment must be made in the calendar month due. (b) If a payment is made outside the calendar month due, the lender cannot submit the case for endorsement until six consecutive payments have been made within the calendar month due. (4) A certification that the lender did not provide the funds to bring the loan current or to effect the appearance of an acceptable payment history. 22 Appendix D LOANS SUBMITTED FOR LATE ENDORSEMENT WITH LATE PAYMENTS Case no. Original Loan status New case no. New Original HUD’s mortgage – streamline mortgage mortgage loss on amount refinances amount amount – sale - active loans claims 361-2686984 $133,278 Claim $25,446 491-7506428 * $165,189 Claim $79,260 495-6301772 $94,953 Streamline 495-6502950 $95,395 refinance 493-7177876 $131,957 Streamline 493-7742111 $134,281 refinance 495-6268006 $144,079 Streamline 495-6590065 $146,240 refinance 495-6258327 * $111,193 Active $111,193 052-2382816 $192,918 Active $192,918 495-6328644 * $141,526 Active $141,526 091-3653998 * $127,687 Active $127,687 495-6319773 $135,096 Active $135,096 491-7631213 $104,717 Active/partial $104,717 $4,157 claim 091-3630090 $134,284 Active $134,284 492-6532719 * $157,172 Active $157,172 Totals $1,774,049 $375,916 $1,104,593 $108,863 * Loans that were not current when submitted. 23
KB Home Mortgage Company, Los Angeles, California, Improperly Submitted 13 Late Requests for Single Family Mortage Insurance
Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-08-12.
Below is a raw (and likely hideous) rendition of the original report. (PDF)