oversight

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)

                                                            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