oversight

KB Mortgage Company Did Not Follow HUD Requirements When Originating Insured Loans, Phoenix, Arizonia

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-09-26.

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

                                                             Issue Date
                                                                  September 26, 2005
                                                             Audit Report Number
                                                                    2005-LA-1011




TO:       Brian D. Montgomery, Assistant Secretary for Housing – Federal Housing
          Commissioner, H



FROM:     Joan S. Hobbs, Regional Inspector General for Audit, Region IX, 9DGA

SUBJECT: KB Home Mortgage Company Did Not Follow HUD Requirements When
           Originating Insured Loans


                                 HIGHLIGHTS

 What We Audited and Why

           We audited KB Home Mortgage Company (KB) insured loan originations in the
           Phoenix, Arizona, metropolitan area because the KB default and claim rate under
           the Department of Housing and Urban Development’s (HUD) Phoenix office
           jurisdiction was almost triple the average for that office. Our primary audit
           objective was to determine whether KB originated HUD-insured loans in
           accordance with prudent lending practices and HUD requirements.

 What We Found


           KB did not originate the 19 loans in our sample in compliance with HUD
           requirements or prudent lending practices. All 19 loans involved origination
           deficiencies that should have precluded their approval. The deficiencies included
           false employment data, overstated income, understated liabilities, unacceptable
           credit histories, improper treatment of downpayment gifts and/or interest rate
           buydowns resulting in overinsured mortgages, inaccurate or excessive qualifying
           ratios without compensating factors, and borrower overcharges for unsupported or
           unallowable fees. We attribute the problems to inadequate internal controls over
           the loan origination process and, according to former KB underwriting staff, KB’s
           emphasis on production over prudent lending practices. As a result, KB placed
           HUD’s single family insurance fund at risk for 19 unacceptable loans with
           original mortgages totaling $2,509,576, and borrowers were overcharged $9,400.
           HUD remains at risk and/or has incurred losses totaling $1,218,681 related to 15
           of the 19 loans.

What We Recommend


           We recommend that HUD take appropriate administrative action against KB
           under Mortgagee Review Board and/or other authority. At a minimum, this
           should include seeking appropriate monetary sanctions for 15 of the loans totaling
           $1,218,681 and requiring KB to reimburse the borrowers or HUD for $9,400 in
           unearned, unallowable, or excessive fees.

           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 with the discussion draft report on July 15, 2005, and held an
           exit conference with KB on July 25, 2005. KB provided preliminary summary
           comments pertaining to the discussion draft on July 29, 2005. These summary
           comments, and the information exchanged during the exit conference, were
           incorporated where appropriate in the final draft report delivered to KB on
           August 2, 2005. KB’s formal written response to the final draft report was
           received on August 17, 2005. KB disagreed with most of the report.

           The complete text of KB’s formal response, along with our evaluation of that
           response, can be found in appendix B of this report. We have also expanded and
           updated the body of the report, as well as some of the case summaries, to address
           KB’s preliminary and formal responses.




                                            2
                             TABLE OF CONTENTS

Background and Objectives                                                4

Results of Audit
        Finding 1: KB Did Not Originate Loans in Compliance with HUD     5
                   Requirements and Prudent Lending Practices

Scope and Methodology                                                    18

Internal Controls                                                        20

Followup on Prior Audits                                                 21

Appendixes
   A.   Schedule of Questioned Costs and Funds to Be Put to Better Use   22
   B.   Auditee Comments and OIG’s Evaluation                            23
   C.   Schedule of Loan Deficiencies                                    84
   D.   Narrative Case Summaries                                         85




                                              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 is governed by
regulations in 24 Code of Federal Regulations, Part 203. Most loans are insured under HUD’s
Direct Endorsement Program1, which authorizes lenders to underwrite and close loans without
prior HUD review or approval.

KB Home Mortgage Company (KB) is a wholly owned subsidiary of the builder/developer KB
Home. KB originates Federal Housing Administration, Department of Veterans Affairs, and
conventional loans primarily for customers purchasing newly constructed homes from its parent
company. Until recently, KB operated 11 branch offices in nine states. KB has a corporate office
located at 10990 Wilshire Boulevard, Los Angeles, California, and Regional Operations Centers
(for processing and underwriting) in Las Vegas, Nevada, and San Antonio, Texas. KB has been a
HUD-approved lender since April 15, 1965, with approved branch office operations in Arizona
since 1993, and is authorized to originate loans under HUD’s Direct Endorsement Program. At the
July 25, 2005 exit conference KB officials advised us of a pending sale of all KB assets and the
transfer of all KB Home loan origination business to Countrywide Financial Corporation.

Our primary audit objective was to determine whether KB originated HUD-insured loans in
accordance with prudent lending practices and HUD requirements.




1
    24 CFR 203.5

                                                4
                                RESULTS OF AUDIT

Finding 1:        KB Did Not Originate Loans in Compliance with HUD
                  Requirements and Prudent Lending Practices

KB did not originate the 19 loans in our sample in compliance with HUD requirements or
prudent lending practices. All 19 loans involved origination deficiencies that subjected HUD to
unacceptable insurance risk totaling $2,509,576. HUD has incurred losses or remains at risk for
losses on 15 of the loans totaling $1,218,681. The improper loan originations also resulted in
inappropriate charges to borrowers on all 19 loans totaling $9,400. We attribute the problems to
an inadequate internal control environment and, according to former KB underwriting staff,
KB’s emphasis on production over prudent lending practices.



 HUD Requirements


              Regulations at 24 Code of Federal Regulations, Section 202.5(j)(4) require HUD-
              approved lenders, officers, directors, and employees to conform with generally
              accepted prudent and responsible lending practices. Section 202.5(h) provides
              that lenders shall implement written quality control plans that assure compliance
              with HUD regulations and other issuances regarding loan origination. The
              specific requirements for HUD-insured loan originations are principally described
              in HUD Handbooks 4000.2, 4000.4 and 4155.1, the HUD Homeownership Center
              Reference Guide, and various Mortgagee Letters.

 KB Did Not Have Adequate
 Control Over Loan
 Originations

              KB deviated from HUD requirements and prudent lending practices in originating
              all 19 loans in our sample. Although KB provided us with current and
              predecessor quality control plans that meet HUD requirements, the controls
              intended in the plans were not applied or implemented in the origination of these
              loans. Rather, in originating these 19 loans, KB apparently acceded to the
              interests of the parent builder/seller (KB Home) or their own bottom line. KB
              Home is in the business of building and selling homes, and the sales cannot be
              consummated unless its prospective buyers are approved for home mortgage
              loans. Similarly, KB does not earn origination or other fees on loans that are not
              approved, and KB Home is the source of virtually all KB loans. Three former KB
              underwriters told us that if the builder wanted a loan approved, it would be
              approved.

                                               5
                 In our opinion, KB unduly emphasized approval of these loans over quality
                 control and prudent lending practices to meet its corporate production objectives.
                 KB procedures inhibited proper underwriting of all 19 loans in our sample, and in
                 four cases (023-1063809, 023-1107968, 023-1135453, and 023-1357024), KB or
                 KB Home employees may have been aware of or involved in the falsification of
                 employment documentation.


    KB Procedures Precluded
    Proper Underwriting

                 KB’s procedures precluded proper underwriting of all 19 loans we reviewed.
                 Three former underwriters claimed KB policy discouraged the disapproval of any
                 loans and that underwriters were instructed to “condition” rather than disapprove
                 loans. If the underwriters suggested that loans be denied, they would be referred
                 to a KB supervisor who would normally approve them. When loans were
                 conditionally approved, both the conditional and final underwriter approvals were
                 based on incomplete borrower qualification documentation. These underwriter
                 assertions are supported by documentary evidence in KB and HUD case files for
                 all 19 loans.

                 The underwriter conditionally approved all 19 loans we reviewed, with provisions
                 that additional documentation be obtained and/or conditions be met. Conditions
                 imposed by the underwriter were detailed on internal KB condition sheets. In two
                 cases (023-1013299 and 023-1104448), the conditional approvals were based on
                 qualification packages that only included the preliminary loan applications and
                 credit reports. For the other 17 cases, the underwriter said some additional
                 qualification documentation would have been reviewed at the time of conditional
                 approvals, but the qualification packages were not complete for any of these
                 loans, as evidenced by the condition sheets.

                 In addition, for all 19 cases, loan processors and loan counselors (not the
                 underwriter) signed off on the condition sheets, indicating the underwriter
                 conditions were satisfied. Although KB claims loan processors and loan
                 counselors did not receive traditional loan commissions, both job classifications
                 did receive case specific “incentive payments” based on their individual overall
                 retention or capture rates.2 These incentive payments constitute improper
                 commission payments under the spirit and intent of the Mortgagee Approval
                 Handbook3, which prohibits commissioned employees from performing any
                 underwriting activities.




2
    Percentage of loan applications approved.
3
    HUD Handbook 4060.1 REV-1, paragraph 2-17.

                                                  6
                   When loan processing was complete, the underwriter was only provided with the
                   Mortgage Credit Analysis Worksheets (form HUD-92900-PUR) and Direct
                   Endorsement Approvals (form HUD-92900-A) for signature. The underwriter
                   was not provided with the complete borrower qualification package or the
                   condition sheet for any of the loans to verify that the underwriting conditions had
                   been satisfied. Therefore, in all 19 cases, KB procedures resulted in the
                   underwriter falsely certifying to having personally reviewed all documents
                   associated with the credit application.

                   In one of our sample cases (023-1063809), the form HUD-92900-A certification
                   was signed by a KB underwriter other than the one who underwrote the loan, and
                   was signed before it was completely filled out. Another underwriter, who was
                   still employed by KB during our audit, admitted to signing six other underwriter
                   certifications for loans4 she did not underwrite. She said she had been requested
                   to sign the false underwriter certifications by her KB supervisor.

                   Inappropriate KB origination procedures and emphasis on production over
                   prudent lending practices precluded proper underwriting of all 19 loans we
                   reviewed. Prudent impartial origination, underwriting, and internal control
                   procedures should have identified or prevented most of the problems we found
                   including (among others) false employment data, overstated income, understated
                   liabilities, negative credit histories, improper treatment of downpayment gifts or
                   interest buydowns resulting in overinsured mortgages, inaccurate or excessive
                   qualifying ratios without compensating factors, and borrower overcharges for
                   unsupported or unallowable fees. None of the 19 loans in our sample should have
                   been approved by KB for HUD insurance.

    False Employment Data
    (4 of 19 Cases)

                   HUD Handbook 4000.4, REV-1, CHG-2, paragraph 5-3, classifies the
                   misrepresentation of the borrower’s financial capacity by the lender as the highest
                   level of deficiency. HUD Handbook 4000.2, REV-2, paragraph 1-21, requires
                   lenders to immediately report the detection of any violations of law or regulation,
                   false statements, or program abuses to HUD.

                   We determined that 4 of 19 cases in our sample contained false employment
                   documents. The false documentation included pay stubs, Internal Revenue
                   Service W-2 forms, and verifications of employment. We confirmed the false
                   employment data by interviewing the borrowers and/or the employers and through
                   wage reports from the state of Arizona Department of Economic Security.

                   In one case (023-1063809), the loan file contained a false telephone verification
                   of employment. The document indicated the loan processor contacted the
4
    Six loans not included in our sample.

                                                    7
employer by phone on March 22, 2002, and verified that the coborrower was an
active employee as of that date. However, the employer told us that the
coborrower separated from the company on March 8, 2002. Therefore, at the time
of KB’s telephone verification, the loan processor should have been told the
coborrower’s employment was terminated. However, the telephone verification
form incorrectly stated that the coborrower was still continuously employed as of
March 22, 2002.

In the second case (023-1357024), false employment documents found in the loan
file included a pay stub, a W-2 form, and a verification of employment. HUD
Handbook 4000.2, REV-2, paragraph 3-6, prohibits the handling of verification
forms by loan applicants and real estate agents. Nonetheless, KB did not question
the authenticity of these documents although they were faxed from the real estate
agent, whom we later found to be the primary borrower’s mother. When we
showed these documents to the employer, he stated that although the borrower
was employed at the business, the employer did not issue the pay stub and W-2
form in the loan file. The employer explained that both the borrower and the
realtor were also his relatives. Therefore, when the borrower hand carried the
blank verification form to him, the employer signed it blank because he assumed
the borrower would fill in the correct wage information. The employer stated he
later became aware of the false verification of employment during a KB
reverification process and immediately reported it to KB personnel. However,
KB failed to report the detection of this violation to HUD as required.

The third case (023-1107968), includes another false telephone employment
verification form. The telephone verification indicated that Air One Transport
reported the borrower to be currently employed as of March 28, 2002, and
explained a discrepancy in the name of the business (Air One Transport versus
Express Parcel Services). We interviewed representatives of both Air One
Transport and Express Parcel Services and determined that the borrower was not
employed by Air One Transport on March 28, 2002, that the business name
explanation was untrue, and that the person reportedly contacted by the KB
processor to verify the borrower’s stated employment with Express Parcel
Services did not work for that firm. In this case and two other cases (023-
0876050 and 023-110448), KB also did not obtain sufficient documentation, as
required by HUD Handbook 4155.1, REV-4, paragraph 3-1E, to support borrower
or coborrower income. For one borrower, concurrent/part-time income was not
verified, and for the other two, pay stubs were not obtained covering 30 days of
current employment.

In the fourth false employment case (023-1135453), the loan file contained two
false pay stubs, a false W-2 form, and a false online verification of employment.
The borrower told us her last date of employment was January 24, 2002, and her




                                 8
                   final pay stub was dated March 1, 2002. The borrower stated she expressed her
                   concern to the loan counselor that she might not be able to afford the mortgage
                   because she was laid off. However, the loan counselor reassured her that she
                   would still qualify based on the income documentation she had previously
                   provided. When we showed the income documents to the borrower, she
                   confirmed the two pay stubs, dated March 15 and 29, 2002, and one of the two
                   W-2 forms in the loan file were never issued to her and that she never submitted
                   these items to KB. These pay stubs, showing the same amounts for the year-to-
                   date earnings and deductions, together with an unexplained switch from
                   commissioned to salaried earnings, were clear indications that these documents
                   were fabricated. In addition, the online verification KB ostensibly obtained on
                   March 12, 2002,5 indicated the borrower was an active employee as of April 23,
                   2002.6 The discrepancy between the online verification date and employment
                   status date suggested the verification was altered. Finally, wage reports from the
                   Department of Economic Security, and our reverification with the same online
                   employment verification service, confirmed the two pay stubs, W-2 form, and
                   original online verification of employment were all false documents.

                              Figure 1: False Employment Example, Case 023-1135453
                    The pay stub, dated March 1, 2002, is the only authentic document submitted by
                      the borrower. The second and third pay stubs show an unrealistic increase in
                     earnings and depict a salaried rather than commisioned employee. The second
                    and third pay stubs are virtually identical, although the third should have shown
                                             increased year-to-date earnings.




               P a y stu b d a te d                  F a lse P a y stu b                   F a lse P a y stu b
                    3 /0 1 /0 2                      d a te d 3 /1 5 /0 2                  d a te d 3 /2 9 /0 2




5
    Form shows Internet web address and online access date as March 12, 2002.
6
    The “active as of” date is later than the date the online verification was supposedly obtained.

                                                            9
Overstated Income
(14 of 19 Cases)

            HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-7, states for most cases,
            borrower income will be limited to salaries and wages. However, several other
            types of income may be treated as effective income. To include other types of
            income as effective income, the lender must obtain additional documentation to
            support its determination that these other sources of income can be expected to
            continue for the first three years of the mortgage loan. For example, for overtime/
            bonus income or part-time income to be included as effective income, an earnings
            trend needs to be established. To do so, the lender must document the income for
            the past two years and determine the income can reasonably be expected to
            continue.

            KB overstated the borrower income for 14 of the 19 cases. While the false
            employment data contributed to the overstated income in four of the cases already
            discussed, most of the 14 cases contained overstated income because KB
            inappropriately included overtime/bonus income, part-time income, child support,
            or a combination thereof in its calculation. In seven of the cases, KB included
            overtime/bonus or part-time income in the calculations without verifying such
            income for the previous two years and/or justifying the likelihood of continuance.

Understated Liabilities
(4 of 19 Cases)

            HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-11, requires lenders to
            consider all recurring obligations, contingent liabilities, and projected obligations
            that meet HUD’s specific guidelines when evaluating a loan application. In
            computing debt-to-income ratios, the lender must include all borrower liabilities
            extending 10 months or more. Debts lasting less than 10 months must be counted
            if the amount of the debt affects the borrower’s ability to pay immediately after
            loan closing.

            KB did not consider all outstanding liabilities when approving 4 of the 19 loans
            we reviewed. KB failed to include education loans, revolving credit accounts,
            and credit cards. For example, in case 023-1043232, the borrower’s recurring
            liabilities of $711 were understated by $194 because KB failed to include an open
            credit card account, and in case 023-1135453, the borrower’s recurring liabilities
            of $519 were understated by $697 because KB failed to include three education
            loans and two credit cards.




                                             10
Unacceptable Credit Histories
(15 of 19 Cases)


            HUD Handbook 4155.1, REV-4, paragraph 2-3, says the most useful guide in
            determining the attitude toward credit obligations is past credit performance. The
            handbook requires lenders to provide strong offsetting factors to approve loans in
            which the credit histories reflect continuous slow payments, judgments, and
            delinquent accounts, despite adequate income to support the obligations.
            Accordingly, sufficiency of income is not considered a valid compensating factor
            for a negative credit history.

            In 15 of 19 cases, the borrower credit histories demonstrated significant disregard
            toward credit obligations. Credit reports for these borrowers included adverse
            information such as bankruptcy, poor credit ratings, and numerous charge-off or
            collection accounts. In most instances, KB obtained “explanation letters” from
            the borrowers but did not provide offsetting or compensating factors.

Overinsured Mortgages and
Improper Treatment of
Downpayment Gifts or
Buydowns (9 of 19 Cases)



            We determined that 9 of the 19 cases involved overinsured mortgage loans. In
            eight of the cases, the overinsured mortgages resulted (in part) from improper
            treatment of downpayment “gift” funds that were derived from the borrowers but
            routed through the seller (KB Home) and nonprofit gift providers. In these cases,
            the sources of the gifts were actually the borrowers, who were required to agree to
            increased sales prices to accommodate the gifts. Sales prices were increased by
            the amount of the gifts plus the nonprofit agency administrative fees.

            HUD Handbook 4155.1, REV-4, paragraph 2-10, states that no repayment of a
            gift may be expected or implied. Since the gifts were funded via increased sales
            prices, the borrowers were repaying the gifts over the life of the loans. Therefore,
            they were not eligible gifts, and the loans were overinsured by the amount of the
            gifts plus the administrative fees.

            Furthermore, although HUD does not approve or disapprove individual nonprofit
            agency downpayment gift programs, Mortgagee Letter 96-18 clarifies HUD’s
            position as to the unacceptability of programs involving quid pro quo
            arrangements. Unacceptable arrangements are described as those whereby the
            assistance is only available if the buyer obtains financing with a particular lender
            or buys a particular builder’s property. KB Home’s requirement that the buyer

                                             11
            execute an amendment/addendum increasing the price of an existing sales
            contract, to accommodate the nonprofit gift, clearly constitutes an inappropriate
            quid pro quo arrangement.

            In three of the nine cases, the sales prices were also increased to accommodate
            interest rate buydowns. In these cases, the mortgage was also overinsured
            because the borrowers financed the interest rate buydowns through increased sales
            prices.

                         Figure 2: Sales Price Increase, Case 023-1211310
                   The sales price was increased $1,341 for the gift ($841) plus the
                   nonprofit administrative fee ($500).




                                                         The sales price was increased
                                                        $1,341 for the gift plus the non-
                                                         profit administrative charge
                                                                 ($841 + $500).

            The borrower
        received $841 in gift
          funds. The seller
        reimbursed the non-
          profit for $1,341.


Inaccurate/Excessive Qualifying
Ratios without Compensating
Factors (15 of 19 Cases)


            HUD Handbook 4155.1, REV-4, paragraphs 2-12 and 2-13, specified that the
            ratio of mortgage payment to effective income (front ratio) generally may not
            exceed 29 percent, and the ratio of total fixed payments to effective income (back
            ratio) may not exceed 41 percent, unless significant compensating factors are
                                              12
       presented. The handbook allows greater latitude in considering compensating
       factors for the front ratio than the back ratio.

       In 10 of the 19 cases in our sample, the borrower(s)’ debt-to-income ratios
       calculated by KB exceeded the handbook guidelines, yet KB approved the loans
       and submitted them for insurance endorsement without presenting compensating
       factors. For 5 of the 10 cases, compensating factors were added to the Mortgage
       Credit Analysis Worksheets in the KB loan files before the files were provided for
       our review. These (potential) compensating factors were not included on the
       Mortgage Credit Analysis Worksheets in the HUD case binders, so they do not
       appear to have been considered in approving the loans.

       Moreover, after adjusting for overstated income and understated liabilities as
       discussed above, borrower debt-to-income ratios exceeded HUD guidelines for 15
       of the 19 loans in our sample. Compensating factors were not presented by KB
       for any of the 15 loans at the time they were approved. The following table
       depicts these excessive qualifying ratios.

                                 Figure 3: Qualifying Ratios

                                       K B C a lcu lated                     O IG C a lcu lated
                                 M ortgage         T otal F ix ed      M ortgage         T otal F ix ed
     H U D C a se N o.         P aym en t-to-     P aym en t-to-     P aym en t-to-      P aym en t-to-
                              Inco m e R atio    Inco m e R atio    Inco m e R atio     In com e R atio
   H U D R eq u irem en t         29 .00 %           4 1.00 %           2 9.00 %            4 1.00 %
1       0 23 -0 87 60 50           3 5.1 9             4 1.6 2            39 .3 6             46 .5 5
 2      0 23 -1 01 32 99           3 1.8 6             4 5.9 7            36 .1 9             52 .2 2
 3      0 23 -1 04 32 32           2 5.9 9             4 6.5 6            35 .7 7             71 .8 9
 4      0 23 -1 05 26 83           3 4.9 9             4 9.4 6            38 .9 9             55 .1 2
 5      0 23 -1 06 38 09           2 7.4 3             3 8.4 9            40 .8 1             57 .2 7
 6      0 23 -1 10 44 48           3 4.7 5             4 4.9 2            61 .4 8             79 .4 6
 7      0 23 -1 10 79 68           2 3.1 5             4 7.5 3            23 .9 5             49 .1 8
 8      0 23 -1 11 34 41           2 4.7 0             3 2.3 3            32 .7 5             49 .4 5
 9      0 23 -1 13 54 53           2 0.6 3             3 0.1 7            28 .8 9             60 .1 9
10      0 23 -1 14 52 05           3 0.2 9             4 5.0 0            30 .2 9             44 .7 0
11      0 23 -1 18 54 14           3 1.4 5             4 4.4 7            31 .4 5             44 .4 7
12      0 23 -1 21 13 10           3 4.7 2             4 5.9 9            40 .1 2             53 .1 5
13      0 23 -1 23 48 10           3 9.3 0             4 0.3 8            39 .3 0             40 .3 8
14      0 23 -1 25 44 60           2 9.8 7             2 9.8 7            53 .3 0             76 .0 6
15      0 23 -1 35 70 24           2 4.6 0             4 0.9 4            47 .2 7             79 .1 4

 C ases W ith E x cessiv e
                                     8                  9                 13                  14
   In d iv id u a l R atios
 C ases W ith E x cessiv e
                                              10                                    15
 F ro n t o r B ack R atios




                                             13
Unsupported or Unallowable
Fees (19 of 19 Cases)


           HUD Handbook 4000.2, REV-2, provides guidance as to what customary and
           reasonable closing costs and fees can be collected by the lender from the
           borrower. Chapter 2-15 of the HUD Homeownership Center Reference Guide
           provides a more detailed description of closing costs and fees. Whenever “actual
           costs” are permitted, it is expected that they will not exceed reasonable and
           customary costs for the area.

           An unallowable fee is one that has been identified by the local HUD office as not
           being a necessary/normal part of the loan origination process. An unearned fee is
           a closing cost for which there is no actual service or thing of value attached to it.
           An excessive fee is a closing cost charged to the borrower beyond the amount
           allowed by HUD.

           On all 19 of the loans in our sample, we determined that KB failed to ensure that
           the borrower was not charged excessive, unallowable, or unearned fees. The
           improper fees were not accompanied by supporting documentation or justification
           for any of the 19 loans. As a result, KB allowed a total of $9,400 in excessive,
           unallowable, or unearned fees (ranging from $240 to $1,757 per case) to be
           charged to the borrowers. The following schedule illustrates the improper charges
           for each loan:

                             Figure 4: Unallowable/Unearned/ Excessive Fees




                                            14
           Although 17 of the 19 loans included a $250 charge to the borrower for a contract
           or transaction coordination fee paid to HomeSafe, Inc., in one case (023-
           1185414), KB has already reimbursed the borrower for the unearned/unallowable
           HomeSafe fee in response to a post-endorsement review by the Santa Ana
           Homeownership Center Quality Assurance Division.

Prohibited Involvement by
Interested Third Party
(19 of 19 Cases)


           HUD Handbook 4000.2, REV-2, paragraph 3-6, and HUD Handbook 4155.1,
           REV-4, CHG-1, paragraph 3-1, prohibit the handling of verification items by an
           interested third party. Documents relating to income/employment verification and
           verification of deposit must not pass through the hands of the applicant or an
           interested third party. Also, HUD Handbook 4060.1, REV-1, paragraph 2-17,
           prohibits commissioned employees from performing any underwriting activities.

           KB allowed KB Home (builder/seller) sales representatives to collect pay stubs,
           W-2 forms, and bank statements from the borrowers. Loan processors and loan
           counselors, who were paid incentives based on their retention or capture rates,
           also certified to underwriter conditions in all 19 cases, as evidenced by the
           internal KB condition sheets. As discussed earlier, KB procedures effectively
           transferred the ultimate underwriting eligibility determinations from the
           underwriters to commissioned loan processors and loan counselors. In one case
           (023-1135453), the loan counselor knew of and may have created false
           employment documentation.

Inappropriate Use of Buydown
Rate (5 of 19 Cases)


           HUD Handbook 4155.1,REV-4, paragraph 2-14, provides underwriting
           requirements that must be met in order for a HUD loan to qualify at the buydown
           rate. A buydown not meeting all the handbook criteria may only be considered as
           a compensating factor. In addition, the lender must establish that the eventual
           increase in mortgage payments will not adversely affect the borrower and chance
           of default.

           For 5 of the 19 loans, KB qualified the borrowers using the buydown rate but
           failed to show that the scheduled mortgage payment increase would not adversely
           affect the borrowers or the chance of default. On all five loans, one or both
           (front/back) qualifying ratios exceeded the HUD maximums.



                                           15
Debt Paid by Interested Third-
Party (4 of 19 Cases)


            According to Mortgagee Letter 2002-02, it is not acceptable underwriting to use
            debt-to-income qualifying ratios which are reduced through payments made by
            property sellers or nonprofit agencies. HUD deems such payment of consumer
            debt by third parties to be an inducement to purchase, which should result in a
            dollar-for-dollar reduction in the sales price.

            On 4 of the 19 loans, KB allowed third parties to pay off the borrowers’ consumer
            debts. For all four loans, the borrowers provided little or no money at closing.
            The source(s) of funds to close the loans were primarily nonprofit gifts, secondary
            financing loans, and seller loan proceeds. Since the consumer debts were all paid
            at closing, it is clear that they were paid using either the seller’s funds or the
            nonprofit gift/loan funds.


Downpayment Unverified or
Provided by Interested Third-
Party (4 of 19 Cases)


            HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-10, requires the lender to
            verify all funds for the borrower’s investment in the property. The funds may
            come from the borrowers’ savings or checking account, but if there is a large
            increase in an account, the lender must obtain an explanation and evidence of the
            source of funds. Interested third parties are not allowed to provide funds toward
            the borrower’s minimum required investment.

            For 4 of the 19 sample loans, the downpayment was unverified or was provided
            by an interested third party. In three of the cases, KB failed to obtain an
            explanation and evidence for the source of funds, although large and unusual
            deposits are shown on the bank statements. In one of the cases, the borrower told
            us he borrowed funds from the real estate agent because he did not have sufficient
            funds to close.




                                            16
    Recommendations

                 We recommend that HUD’s Assistant Secretary for Housing-Federal Housing
                 Commissioner

                 1A. Initiate settlement negotiations with KB, requesting reimbursement and/or
                     indemnification for HUD’s actual and potential losses on 15 of the 19 loans,
                     detailed in appendix A, totaling $1,218,681.7

                 1B. Require KB to reimburse the borrowers or HUD $9,400 for unearned and
                     unallowable fees.




7
  Since overinsured case number 023-1052683 is still active, indemnification should include requiring KB to pay
the servicing lender $20,346 toward any arrearages and to principal.

                                                       17
                             SCOPE AND METHODOLOGY

KB was selected for review due to high default and claim rates, both nationally and under the
Phoenix, Arizona, HUD field office jurisdiction. At the time of the selection, KB had the highest
default and claim rate nationally of the largest 28 lenders (253 percent of average). It also had
the highest default and claim comparison ratio (282 percent) of the 22 largest lenders originating
loans under the Phoenix office jurisdiction.

Using HUD’s Neighborhood Watch early warning system, we made a nonrepresentative
selection of 19 loans from a listing of 129 early default8 loans originated under the Tempe,
Arizona, branch office identification number. Loans originated under the KB Phoenix branch
office identification number were not selected, because that branch had recently been reviewed
by HUD’s Quality Assurance Division. However, KB performed all loan processing and
underwriting for all Arizona loans from its Las Vegas, Nevada, Regional Operations Center, so
the branch office identification numbers associated with any Arizona loans are immaterial.

To accomplish our objective, we

    ‰   Reviewed relevant HUD rules, regulations, and guidance.

    ‰   Reviewed KB and HUD case files for the 19 sample loans and First American Title
        escrow files for 18 of the sample loans.9

    ‰   Obtained Arizona Department of Economic Security wage reports on the borrowers for
        all 19 loans.

    ‰   Interviewed 10 borrowers.

    ‰   Interviewed 33 current and former employers.

    ‰   Obtained six employment verifications from an online verification service.

    ‰   Interviewed the former KB employee who underwrote all 19 of the loans and interviewed
        three other former KB underwriters.10

We relied upon computer-processed data contained in HUD’s Neighborhood Watch system and
Single Family Data Warehouse system. The reliability of data in the Single Family Data
Warehouse system has been assessed by an independent contractor and the HUD Office of
Inspector General (OIG) and has been found to be adequate. The assessment included relevant
general and application controls. Since the data in the Neighborhood Watch system are derived

8
   Loans that went into default within three years of closing.
9
   First American Title could not locate its escrow file for one of the loans.
10
    KB would not allow us to interview any current employees without a manager present.

                                                       18
from the Single Family Data Warehouse system, the data in both systems were considered
sufficiently reliable to be used in meeting our objectives. During the audit, we did not note any
discrepancies between information in the 19 loan files and the data in these two automated HUD
systems.

All of the loans included in our sample were Arizona early default loans closed in 2002, so the
problems identified in these loans should not necessarily be construed as extending to KB’s more
recent or national production. However, since some issues identified during this loan origination
audit do have possible systemic implications, we plan to conduct a followup review and provide
updated conclusions in a later report. It should be noted that as of April 30, 2005, KB’s national
and Phoenix office default and claim comparison ratios had improved to 146 percent and 164
percent respectively. While these ratios are still high, they represent significant improvements.

The audit fieldwork was performed between December 15, 2004, and April 20, 2005. The audit
was conducted in accordance with generally accepted government auditing standards.




                                               19
                             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,
   •   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 assessed the following internal controls that we determined were relevant to our
              audit objectives:

                  •   Policies, procedures, and controls that management has in place to
                      reasonably ensure that the loan origination process complies with HUD’s
                      requirements and prudent lending practices.

              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 issue is a significant weakness:

              •       KB did not have adequate internal controls to reasonably ensure that loan
                      originations complied with HUD requirements and prudent lending practices
                      (see finding).




                                               20
                       FOLLOWUP ON PRIOR AUDITS


This audit was coordinated with a concurrent HUD-OIG audit of KB late endorsements. The results
of the late endorsement audit are included in Audit Report Number 2005-LA-1007. These two
concurrent audits were the first HUD-OIG audits of KB.

We obtained and reviewed three independent auditors’ reports on KB that encompassed four
fiscal years ending November 30, 2000, 2001, 2002, and 2003. None of these reports contained
any findings.

From July 2002 through June 2004, HUD’s Quality Assurance Division performed multiple
reviews of KB branches in California, Texas, Nevada, Arizona, and Florida. On June 16, 2005,
KB signed a $3.2 million settlement agreement with HUD relating to one of these reviews
conducted in May of 2004. The settlement was to resolve HUD’s January 26, 2005, notice of
violation to KB for loan origination improprieties involving 373 (primarily Texas) loan
originations.




                                              21
                                    APPENDIXES

Appendix A

               SCHEDULE OF QUESTIONED COSTS
              AND FUNDS TO BE PUT TO BETTER USE

      Recommendation            Ineligible 1/         Unsupported 2/        Funds to be put to
          number                                                            better use 3/
       1A (tabulation            $145,625                $291,974                 $781,082
          below)
       1B (tabulation              $9,400
         page 14)

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
     polices or regulations.

2/   Unsupported costs are those costs charged to a HUD-financed or HUD-insured program
     or activity when an eligibility determination cannot be made at the time of the audit. A
     legal opinion or administrative determination may be needed on these costs.

3/   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.




                                                22
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         23
Comment 1




            24
25
Comment 2




            26
Comment 3




            27
Comment 4




Comment 5




Comment 6




                            28
            Names have been redacted for privacy
29
30
31
Comment 7




            32
Comment 8




            33
Comment 9




            34
Comment 10




Comment 11




             35
Comment 12




             36
Comment 13




             37
Comment 14




             38
Comment 15




             39
40
Comment 16




             41
Comment 17




             42
43
Comment 18




             44
Comment 19




             45
Comment 20




Comment 21




             46
Comment 22




             47
Comment 23




             48
49
Comment 24




             50
Comment 25




             51
Comment 26




             52
Comment 27




             53
54
55
Comment 28




             56
57
Comment 29




             58
59
60
Comment 30




             61
Comment 31




Comment 32




             62
Comment 33




Comment 34




             63
64
Comment 35




             65
66
Comment 36




             67
Comment 37




             68
Comment 38




             69
Comment 39




             70
Comment 40




             71
72
73
                         OIG Evaluation of Auditee Comments

Comment 1   In our opinion, many of the problems identified in the 19 loans we reviewed
            occurred because KB procedures during 2002, at the very least permitted, and
            (based on the evidence) prescribed that underwriters certify loans that they had
            not adequately determined met HUD requirements. This was a systemic issue
            resulting from undue actual or perceived corporate pressure to approve loans. It
            cannot reasonably be attributed to one “rogue” underwriter. KB’s poor national
            default/claim loan performance and the company wide remedial actions KB
            implemented (as repeatedly mentioned in KB’s comments) are clear evidence and
            acknowledgement that problem loans were not isolated to one office or to one
            underwriter. We do recognize that KB has taken positive actions in an attempt to
            address deficiencies in the loan origination process. Where appropriate, we have
            made revisions to this final report to address the overall and specific concerns
            expressed in KB’s response.

Comment 2   We interviewed four former KB underwriters including one underwriter who was
            terminated in 2005, after HUD formally notified her of her Limited Denial of
            Participation. We do not normally conduct interviews with only former
            employees, however, at the entrance conference KB’s attorney told us we could
            only speak with current employees if their supervisor was present. We felt that
            under those circumstances, employees would not provide candid responses.

Comment 3   KB makes electronic images of loan files, so their ability to locate files should not
            have been greatly encumbered by the transfer of business to Countrywide Home
            Loans.

Comment 4   KB contends they addressed the problem of poor Phoenix area loans by closing
            the Tempe branch office on December 30, 2002. They do not mention that they
            had just obtained approval for a new branch office serving the same metropolitan
            Phoenix area on December 18, 2002, or that all Arizona loan underwriting was
            handled out of their Las Vegas Regional Operations Center. In fact, little if any
            business was ever likely conducted in the Tempe branch since preliminary
            applications, as well as bank statements, pay stubs and W-2 forms were routinely
            collected at the builder sales offices. In addition, many of the loan counselors and
            loan processors involved in the 19 loans we reviewed appear to have been
            physically located in the Las Vegas Regional Operations Center, not in Tempe.
            Although we asked KB for home addresses and work locations for their then
            current and former employees, we were only provided with employee listings
            showing their geographic and/or programmatic areas of responsibility.

Comment 5   KB’s portrayal of their supposed proactive termination of this underwriter is
            inaccurate. HUD affirmed her Limited Denial of Participation on March 29,
            2005, and KB terminated her employment effective on April 25, 2005. Her KB
            separation notice states that she was terminated because of the HUD sanctions,
            not due to “poor performance.”

                                             74
Comment 6     Resolution of the issues cited in the two prior HUD Quality Assurance Division
              reviews of Tucson (July 2002) and Phoenix (March 2004) branch office
              originations were case specific remedies, not procedural changes or improvements
              relating to the operation of either branch. Resolution for the Tucson branch
              review included indemnification agreements for 7 of 19 loans. The Phoenix
              branch review was resolved with indemnification agreements on 6 of 15 loans

Comment 7     We interviewed four former KB underwriters.

Comment 8     We interviewed three former underwriters that said KB strongly discouraged the
              disapproval of any loans; that they were told to condition rather than disapprove
              loans; and that if the builder wanted a loan approved, it would be approved. The
              fourth former KB employee we interviewed only worked as an underwriter for
              three months during 2003 and never underwrote any HUD loans. This
              underwriter could neither confirm nor deny the statements made by the other three
              underwriters.

Comment 9     Subsequent to the exit conference, KB provided us with an extensive listing of
              cases they claim pertained to loan applications that were denied by 21 different
              underwriters or by an automated underwriting system. We requested that KB
              provide us with the actual case files for 30 cases we selected from KB’s listing so
              that we could confirm they did in fact represent legitimate underwriter denials.
              KB provided us with 7 of the 30 case files we requested and 15 additional case
              files that they selected. The former underwriters told us that the vast majority of
              these cases would have been pre-screening denials, not underwriter decisions to
              deny applications. That is, loan counselors requested that underwriters deny the
              applications in KB’s automated loan origination system because the loan
              counselors had determined during pre-screening that it would be a waste of time
              trying to get the applicants qualified. Loan counselors did not have user access or
              authority to deny loans in KB’s computer system, so underwriters were asked to
              deny the applications to free up the related properties for sale to other prospective
              buyers. Although several of the 22 case files KB provided do include some
              evidence of underwriter evaluation of the cases, most of the cases, including many
              of those selected by KB, show no evidence of underwriter evaluation but do
              include notes indicating the loan counselors or KB managers instructed the
              underwriters to deny the loans.

Comment 10 During the audit, we requested copies of all KB loan origination policy and
           procedure statements. KB provided us with only those policy and procedure
           statements they deemed pertinent to our review. They did not provide any policy
           or procedure statement describing the preparation or use of their internal
           underwriter condition sheet.

Comment 11 Here KB acknowledges that the underwriter would not have seen critical credit,
           employment, and source of funds documents for the loans we reviewed, although

                                               75
              they attribute this fact to the underwriter’s noncompliance with KB’s
              (undocumented) policy relative to the use of asterisks on the underwriter
              condition sheet. Nevertheless, they state repeatedly in responses to individual
              cases that the underwriter “…had no reason to question…”; “…exercised
              reasonable discretion…”; “…properly examined…”; “…made a reasonable
              judgment…”; or “…analyzed the totality of the circumstances…” in approving
              the loans. The acknowledgement by KB that the underwriter did not see the
              complete qualification packages subsequent to conditional approval invalidates all
              arguments as to proper “underwriter” determinations.

Comment 12 The problem with KB underwriters signing the HUD-92900-A certifications and
           Mortgage Credit Analysis Worksheets for loans which they did not underwrite
           does not appear to be limited to just six loans. We have identified 549 cases
           where the KB loan origination database shows the loan as underwritten by a
           different underwriter than is shown in the HUD Single Family Data Warehouse
           system. We plan on addressing this issue during our followup review.

Comment 13 As stated in Comment 10 above, KB did not provide us with any policy or
           procedure statement relating to the underwriter condition sheets or the
           implications of an asterisk next to any underwriter conditions. KB does
           acknowledge that loan processors and loan counselors signed off on underwriter
           conditions relating to credit, employment, and funds documents which should
           have been verified by the underwriter. They again concede that these critical
           qualification documents would not have been provided to the underwriter for
           review absent the asterisk. Therefore, their attributing these occurrences to a
           single underwriter’s violation of KB’s thus far unsubstantiated “policy” regarding
           the underwriter condition sheets is unjustified.

Comment 14 Per the examples KB provided of their incentive compensation programs, loan
           counselors could receive payments of a flat $200 per loan for all loans closed
           during a given month. Loan counselors could also receive an additional payment
           of up to $200 per loan based on their individual overall retention rate. A retention
           rate of 80 percent or more would qualify for the full $200 per loan payment.
           Similarly, the loan processors incentive compensation program specifies that
           processors were eligible for incentive payments of up to $10 per loan based on
           their individual overall retention rate. The KB incentive compensation programs
           for loan counselors and processors provided for other additional compensation
           based on community or division customer satisfaction scores. However, the
           initial $200 per closed loan payments to loan counselors, and the retention based
           payments to both loan counselors and processors constitute unallowable
           commission payments by any definition.

Comment 15 KB employees who would have been involved in or at least aware of the false
           employment documents would have primarily been loan counselors and loan
           processors. Terminating the underwriter and closing the Tempe branch did not
           address or resolve the problem (see Comment 4).

                                              76
Comment 16 Case No. 023-1063809 – Employment Documentation The underwriter had no
           reason to question the information set forth in the telephone verification of
           employment for the coborrower only because, as indicated by the initials on the
           underwriter condition sheet, the underwriter never saw the telephone verification.
           If the underwriter had seen the telephone verification, there would have been
           reason to question its authenticity. The loan file contained several pay stubs from
           The Picture People ranging from October 2001 through March 22, 2002. The pay
           stubs show the coborrower had been working between 53 to 88 hours each pay
           period between October 2001 and January 2002. Pay stubs for February and
           March 2002 indicate the coborrower worked significantly fewer hours. The final
           pay stub, dated March 22, 2002, covering a two-week period from March 2, 2002
           to March 16, 2002 shows the coborrower only worked 10 hours and cashed-out
           her vacation time. The pay stubs depict the final days of the coborrower’s
           employment in clear contrast with the subsequent false telephone verification.

Comment 17 Case No. 023-1107968 – Employment Documentation As in the previous case,
           the underwriter condition sheet indicates that the underwriter would not have seen
           the false telephone verification. If the underwriter had reviewed the telephone
           verification as required by HUD and KB’s stated policy, there would have been
           several reasons to question its authenticity. There were also other very apparent
           discrepancies in the loan application and employment documents for the
           coborrower. Notably, the W-2s in the loan file contradict the telephone
           verification statement that Air One Transport bought Express Parcel. KB also
           improperly used a pay stub from Air One Transport to supplement the pay stub
           from Express Parcel to meet the 30-day pay stub requirement. Lastly, the
           Universal Residential Loan Application only showed employment from Express
           Parcel and not Air One Transport.

Comment 18 Case No. 023-1043232 – Income Calculation There are no documents in the file
           to support KB’s contention that the borrower was salaried versus an hourly
           employee. In fact, the single bi-weekly pay stub KB used to project monthly
           earnings shows overtime earnings, which is atypical of salaried employees. This
           same pay stub dated March 15, 2002, shows identical amounts earned for the pay
           period as well as for the year-to-date. There was no explanation in the loan file
           for this anomaly. It was not reasonable to calculate the borrowers income as a
           salaried employee based entirely on the one questionable pay stub. Regarding
           child support, HUD Handbook 4155.1 REV-4 Paragraph 2-7 F requires evidence
           of actual receipt of the child support payment for the previous twelve months.
           This is in addition to a copy of the divorce decree. The banks statements show
           recurring deposits in irregular amounts over a period of only seven months and do
           not constitute acceptable evidence according to the handbook. The divorce decree
           provided for the child support payments to be processed through the court, so
           deposits of any payments from the court should have been in consistent recurring
           amounts. The loan file does not include copies of cancelled checks or other
           acceptable evidence of the purported child support payments, and the bank

                                              77
              statements (which do not constitute acceptable evidence) cover only seven
              months.

Comment 19 Case No. 023-1186721 – Income Calculation By KB’s own admission, the non-
           purchasing spouse’s income was erroneously included on the Mortgage Credit
           Analysis Worksheet. This resulted in a significant understatement of the
           qualifying ratios that were used in the underwriting decision and illustrates a
           pattern of serious underwriting deficiencies related to this case.

Comment 20 Case No. 023-1043232 – Liabilities Calculation The credit report shows two
           separate American Express accounts of approximately the same amounts ($3,937
           at $196 per month and $3,892 at $194 per month). We excluded the first account
           from our calculation of borrower liabilities since it was the responsibility of the
           ex-husband per the divorce decree. The second account was the responsibility of
           the borrower, and KB should not have excluded that account from the calculation
           of borrower liabilities.

Comment 21 Case No. 023-1113441 – Liabilities Calculation HUD Handbook 4155.1 REV-4,
           Paragraph 2-11.C, requires that student loans be included in borrower monthly
           obligation calculations unless the borrower can provide evidence that the debt
           may be deferred beyond twelve months of closing. The most recent credit report
           shows nine student loans outstanding and totaling nearly $24,000. The two Fst
           Nat-Lub accounts are included in the nine open accounts under a new creditor
           (Panhandle). KB did not obtain evidence that any of the student loans were
           deferred beyond twelve months of closing as required. Neither is there any
           evidence in the loan file suggesting the borrower was still enrolled in school. The
           credit report shows four of the student loan accounts as having been active within
           the previous year with adverse ratings.

Comment 22 Case No. 023-1254460 – Liabilities Calculation The borrower’s $4,329 debt
           should not have been excluded from the qualifying ratio calculation. KB
           inappropriately assumed that the borrower would have paid four $355 payments
           on the $4,329 loan between April 15 and August 30, 2002. HUD Handbook
           4000.2 REV-2, Paragraph 3-6 stipulates that credit documents must be no more
           than 90 days old at the time of underwriting. KB relied on a credit report that was
           137 days old. In order to exclude the debt, a new credit report should have been
           obtained to substantiate that there were less than ten months of payments
           remaining on this account.

Comment 23 Case No. 023-0687906 – Credit History According to HUD Handbook 4155.1
           REV-4 Paragraph 2-4, alternative or nontraditional credit accounts may be used to
           supplement a traditional credit report having an insufficient number of trade items
           reported, but may not be used to offset derogatory references in the traditional
           credit report. Also, prior collection accounts must be given due consideration in
           evaluating the borrower’s credit worthiness regardless whether they are paid off
           prior to closing or not. The credit reports demonstrate that the coborrower

                                              78
              allowed several accounts to remain in collection during the two years prior to the
              loan application, all while continuously employed and earning income KB
              considered viable for use in the mortgage loan qualification. Finally, neither of
              the two letters purportedly from the borrower and coborrower explaining prior
              credit problems and numerous recent credit inquiries are signed or dated.
              Unsigned attestation or certification documents are not valid for any real estate
              transaction. The underwriter conditionally approved the loan subject to
              satisfactory letters explaining the prior delinquent credit and recent inquiries. The
              loan counselor’s initials on the underwriter condition sheet relative to these
              conditions demonstrate that the underwriter never saw the explanation letters.

Comment 24 Case No. 023-1028162 – Credit History The most recent credit report only
           showed two derogatory accounts. However, these were two of only three total
           credit accounts, and one of the derogatory accounts was a collection account still
           owing. The only other account shown on the credit report was a child support
           obligation reported by the Arizona Department of Economic Security.
           Documentation of alternative credit included: statements from Cox Cable (for
           both basic and expanded service); a four month old statement from Arizona
           Public Service indicating the borrower had past due payments in three of the
           preceding seven months; an undated statement from Southwest Gas reporting four
           late payments in twelve months of service; and an auto insurance coverage
           certificate. Other than the cable company obligation, the only credit documented
           for this borrower was bad credit. The underwriter did not analyze the totality of
           the circumstances and reasonably determine that the borrower presented a
           reasonable credit risk as claimed by KB. The underwriter condition sheet shows
           that the loan counselor signed off on all but 3 of 36 conditions imposed for loan
           approval. The underwriter never saw any of the documentation she deemed
           necessary to resolve the unacceptable credit history.

Comment 25 Case No. 023-1186721 – Credit History HUD Handbook 4155.1 REV-4, CHG-1,
           Paragraph 2-3E provides that Chapter 7 liquidation will not disqualify the
           borrower if at least two years have passed since the bankruptcy was discharged
           and the borrower has reestablished good credit and demonstrated an ability to
           manage financial affairs. However, the borrower had not reestablished good
           credit. In fact, the borrower had derogatory debts on her credit report that were
           incurred after the bankruptcy, some of which were not paid until loan closing.
           The debts included an almost $8,000 charge off (remained outstanding after loan
           closing), a civil judgment for an unpaid debt, and other collection/charge off
           accounts. The underwriter did not analyze the totality of the circumstances and
           reasonably determine that the borrower had accepted responsibility for her credit
           obligations and presented an acceptable risk. As evidenced by the underwriter
           condition sheet, the loan counselor signed off on all but 2 of 20 conditions
           imposed for loan approval. The underwriter never saw any of the documentation
           she deemed necessary to resolve the unacceptable credit history.




                                               79
Comment 26 Case No. 023-1211310 – Credit History HUD Handbook 4155.1 REV-4, CHG-1,
           Paragraph 2-3 states that while minor derogatory information occurring two or
           more years in the past does not require explanation, major indications of
           derogatory credit, including judgments and collections, and any other recent credit
           problems, require sufficient written explanation from the borrower. Although the
           original debts for many of the derogatory credit accounts were incurred more than
           two years prior to the credit report date, at least three of these accounts had
           missed or late payments within one year of the credit report. One of the collection
           accounts remained outstanding for over two years, and seven charge off or
           collection accounts were not paid prior to or at closing. KB points to the stability
           and longevity of the borrower’s employment as offsetting the past poor credit
           performance. In reality, the disregard of credit obligations during periods of
           stable employment is a more serious impediment to credit qualification than poor
           credit performance during periods of unemployment. The loan file does not
           include any explanation for the unacceptable credit history. Contrary to KB’s
           assertion, the underwriter did not analyze the totality of the borrower’s credit
           history, did not examine all the information in the loan file, and did not determine
           that the past derogatory credit did not affect the borrower’s current attitude toward
           credit obligations. The underwriter did not verify even one of the 37 conditions
           she imposed for loan approval per the condition sheet.

Comment 27 Case No. 023-1322842 – Credit History The underwriter did not review the
           “totality” of the borrower credit history. This is evidenced by the fact that
           someone other than the underwriter signed off on several credit related condition
           sheet items. Actually, the totality of the credit qualification documents for this
           loan clearly depicts an unacceptable credit risk. Although the collection and
           charge off accounts are excluded from the total debt qualifying ratio calculation,
           the handbook does require that they be considered in the overall credit
           qualification decision. In this case, over $10,000 in chargeoff and collection
           accounts were not paid off prior to closing and several had been referred to
           collection agencies or attorneys. Although some of the accounts with derogatory
           histories were opened twelve or more months prior to loan application, two
           collection accounts and one of the delinquent accounts were opened within four
           months preceding the original loan application. Finally, the stability of both
           borrowers’ employment is not a compensating factor for their poor credit. A
           pattern of credit abuse and disregard for financial obligations during periods of
           stable employment is actually an even greater impediment to proper credit
           qualification than credit problems attributable to periods of unemployment.

Comment 28 Mortgagee Letter 96-18 provides that it is inappropriate to approve “quid pro quo
           arrangements whereby assistance is only available if the buyer obtains financing
           with a particular lender or buys a particular builder’s property.” The mortgagee
           letter also states “the source of funds for the gift to the borrower must be totally
           unrelated to the loan transaction.” The nonprofit gift program utilized by KB
           Home (builder/seller) for the loans we reviewed was clearly in violation of the

                                              80
              mortgagee letter as well as HUD Handbook 4155.1, which states that no
              repayment of a gift may be expected or implied. The purchase agreement
              addendums wherein buyers were required to agree to increased sales prices in
              order to receive the gift funds were definitely tied to the purchase of the specific
              KB Home properties to which the purchase agreements applied. The example of
              a purchase agreement addendum (shown in Figure 2 of the report and referenced
              as Exhibit O-2 b in KB’s response) also specifies that the gift was conditioned
              upon the buyers obtaining financing through KB Home Mortgage Company. By
              requiring buyers to agree to an increased sales price to accommodate the gift
              amount plus the nonprofit administrative fee, KB Home as seller was obtaining
              repayment of the gift funds from the buyer. Any other seller “incentive”
              contributions to these transactions were irrelevant to the inappropriate treatment
              of the gift funds.

Comment 29 Normally, interest rate buydown funds are provided by the seller, and any such
           seller contributions in excess of the allowable six percent maximum must result in
           dollar-for-dollar reductions in the sales price as well as proportionate reductions
           in the maximum insurable mortgage. In the three cases cited in the report, the
           actual sources of the buydowns funds were the homebuyers since they were
           required to agree to increases in sales prices to accommodate the buydowns.
           HUD does allow buyers to pay traditional discount points to reduce the (30 year)
           mortgage interest rate, but those buyer contributions cannot be financed through
           the insured mortgage. Similarly, buyer contributions toward short-term (1 to 3
           year) interest reductions (buydowns) would not be eligible for financing through
           the insured mortgage. KB is correct that current HUD requirements do not
           specifically address the scenario of sellers recovering buydown funds through
           increased sales prices. However, KB’s logic that the practice is acceptable since
           it is not specifically precluded is both flawed and less than prudent.

Comment 30 As discussed in Comment 11, KB has acknowledged that the underwriter would
           not have seen all critical credit qualification documents for any of the loans we
           reviewed. The absence of any compensating factors on Mortgage Credit Analysis
           worksheets in the official HUD case files where KB’s own calculations of
           qualifying ratios exceeded HUD benchmarks was not just a negligent omission by
           the underwriter. The underwriter did not and could not have considered the
           potential compensating factors that KB now retrospectively wishes to raise.

Comment 31 For each case included in our review, we showed the underwriter the Mortgage
           Credit Analysis Worksheets as included in both the HUD and KB case files. The
           underwriter said the handwriting on every one of the KB case file worksheets
           specifying compensating factors was not hers.

Comment 32 See Comments 30 and 31.

Comment 33 Case No. 023-1043232 – Excessive Ratios without Compensating Factors This
           case involved several loan origination deficiencies apart from the excessive ratios

                                               81
              without specification of any compensating factors. Although there is evidence in
              the case file of the borrower enrolling in college level courses, this was not
              considered by the underwriter and would be a questionable application of
              compensating factors anyway. The borrower was paying for the college courses
              by incurring additional student loan debt and was not projected to graduate until
              September 2005, or over three and one half years after the March 2002 loan
              application. See Comments 30 and 31.

Comment 34 Case No. 023-1186721 – Excessive Ratios without Compensating Factors We
           removed this case from Figure 3 and eliminated the excessive ratio deficiency
           from Appendix C as well as from the Narrative Case Summary since the total debt
           ratio only minimally exceeded the HUD benchmark.

Comment 35 KB incorrectly interprets the HUD Handbook restrictions on third party handling
           of credit and verification documents as only applying to the credit report and the
           actual employment and deposit verification forms. KB also incorrectly assumes
           that we took exception to the borrowers’ handling of pay stubs, bank statements,
           and W-2 forms. Our position is that HUD’s concern relates to the unnecessary
           handling of any income, asset or credit qualification documents by the seller
           agents, realtors, or commissioned lender staff. Case No. 023-1357024 included a
           false pay stub and a false W-2 form that were faxed from the real estate agent’s
           office. Case No. 023-1135453 included two false pay stubs and a false W-2 form.
           Based on our interview with the borrower, the KB commissioned loan counselor
           may have been involved in creating these documents. Critical income, asset, and
           credit qualification documents were routinely collected and transmitted by KB
           Home (seller) sales representatives for most if not all of the cases we reviewed.

Comment 36 Case No. 023-1052683 – Buydown Rates Handbook 4155.1 REV-4, CHG-1,
           Paragraph 2-14 requires the lender to show the eventual increase in mortgage
           payments will not adversely affect the borrower and likely lead to default.
           Otherwise, the buydown interest rate may only be used as a compensating factor.
           The handbook requires that the underwriter specifically state which of four
           criteria the borrower meets, and for the criteria involving potential for increased
           income, the handbook requires documentation of job training or education in the
           borrower’s profession or a history of the borrower’s career advancement along
           with increases in earnings. Neither the primary borrower’s recent overtime
           earnings nor the co-borrower’s newly found employment meet the handbook
           criteria. Furthermore, the underwriter did not specify that the borrowers met any
           of the four handbook criteria, and based on the underwriter condition sheet, does
           not appear to have reviewed any employment documentation for either borrower.
           We disagree with KB’s retrospective evaluation of the borrowers’ potential for
           increased earnings.

Comment 37 Case No. 023-1254460 – Buydown Rates As in the previous case, the
           underwriter did not specify that the borrower met the handbook criteria relative to



                                              82
              potential increased income, and we disagree with KB’s retrospective evaluation
              thereof. Although the borrower kept one Denny’s job throughout the loan
              origination, he replaced the second Denny’s job (making $8 per hour) with a job
              at Abuelo’s Mexican Restaurant, still making only $8 per hour. Clearly the
              borrower did not exhibit a potential for increased earnings. None of the credit,
              asset, or employment conditions imposed by the underwriter were signed off
              (verified) by the underwriter.

Comment 38 Case No. 023-1107968 – Payment of Debts KB is correct that Mortgagee Letter
           02-02 does specifically preclude third party payment of the homebuyer’s
           consumer debt in order to meet debt to income ratio requirements. However, the
           mortgagee letter also addresses third party payment of consumer debt apart from
           the qualifying ratio calculation. The mortgagee letter makes it clear that HUD
           considers the payment of consumer debt by third parties to be an inducement to
           purchase that must result in a dollar-for-dollar reduction to the sales price, as well
           as a commensurate reduction in the maximum insurable mortgage calculation.
           There were no reductions in the sales price or maximum insurable mortgage
           calculation for this loan associated with the third party payment of consumer debt.

Comment 39 Case No. 023-0687906 – Downpayment Verification The bank records KB refers
           to are not bank statements. They only provide account activity information but do
           not show account balances. Therefore, they do not demonstrate that the borrower
           had sufficient funds in the account to make the $2,421 payment into escrow.
           Neither do they cover the required three month time period. The one actual bank
           statement in the file dated February 25, 2002, shows a beginning balance in the
           savings account of $25 and a single deposit of $3,537. The source of this large
           and unusual deposit was not verified as required. Whereas the underwriter
           condition sheet specified the need to obtain satisfactory proof of the borrower’s
           downpayment, closing costs and payoffs, these documents were not obtained, and
           no KB employee signed off on this condition.

Comment 40 Case No. 023-1028162 – Downpayment Verification The borrowers’ statement
           relative to the source of funds is inadequate evidence that the downpayment was
           not derived from unallowable sources. The bank statements did not support a
           pattern of savings and the borrowers did not claim to have saved the cash at home.
           Also, HUD Handbook 4155.1 REV-4, Paragraph 2-10 cautions that borrowers
           with bank accounts are less likely to save money at home than individuals with no
           history of bank accounts. The unusual $2,500 bank deposit represented more than
           half of the amount required to close and was deposited only one month prior to
           closing. It definitely required verification as per the HUD handbook, and was
           also one of the conditions imposed by the underwriter but signed off by the
           commissioned loan counselor.




                                               83
Appendix C

             SCHEDULE OF LOAN DEFICIENCIES




                          84
Appendix D

                      NARRATIVE CASE SUMMARIES

HUD case number:      023-0687906
Loan amount:          $117,394
Settlement date:      August 29, 2002
Status:               Borrowers retain ownership; not currently in default
Indemnification:      $117,394

KB underwrote and approved the mortgage based on unacceptable credit history. It failed to
verify the borrowers’ downpayment came from a legitimate source. Therefore, HUD insured the
loan based on KB’s inaccurate representation that the borrowers met HUD qualifying guidelines.
Additionally, KB overcharged the borrowers $320. KB also allowed interested third parties to
handle vital loan documents.

A. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3, 2-4. Both borrowers’ credit
      histories were unacceptable. KB failed to obtain alternative credit accounts from the
      borrower to supplement her limited credit history. The only credit account on her credit
      report was a collection account. At the same time, the coborrower’s credit report shows
      13 accounts, of which eight (62 percent) were collections or charge-offs.

B. Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB allowed commissioned loan counselors and loan processors to sign off on
      underwriter conditions and allowed KB Homes sales representatives to complete loan
      processing functions. Sales representatives obtained pay documents, bank statements,
      and signatures on the Uniform Residential Loan Application.

C. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $20 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), and a $250 HomeSafe
      “coordinator fee” (unearned/unallowable).

D. Unverified source of downpayment
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-10. The borrowers ostensibly
      paid $2,421 into escrow as part of their cash investment. However, KB did not verify the
      borrowers had sufficient funds to close. To establish that the borrowers had sufficient
      funds, KB was required to obtain two bank statements, but KB only obtained one bank
      statement.




                                              85
Narrative Case Summary                                        Appendix D-01


Recommendations
   ‰ Indemnify HUD for mortgage amount of $117,394.
   ‰ Refund $320 in overcharges to the borrowers or to HUD.




                                           86
Narrative Case Summary                                                            Appendix D-02


HUD case number:      023-0876050
Loan amount:          $124,690
Settlement date:      January 9, 2002
Status:               Resold by HUD at net loss
Loss on resale:       $12,471

KB underwrote and approved the mortgage based on overstated income, insufficient employment
documentation, inappropriate use of the buydown rate, no compensating factors, and the
borrower’s unacceptable credit history. Therefore, HUD insured the loan based on KB’s
inaccurate representation that the borrower met HUD qualifying guidelines. Additionally, KB
overcharged the borrower $512, overinsured the HUD mortgage by $3,636, and allowed
interested third parties to handle vital loan documents.

A. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      failed to include compensating factors on the Mortgage Credit Analysis Worksheet
      submitted to HUD for excessive front and back ratios of 35.19 percent and 41.62 percent.
      We recalculated the qualifying ratios using the correct gross monthly income and
      recurring liabilities discussed below. The recalculated mortgage payment-to-income ratio
      of 39.36 percent exceeds the HUD requirement by 10.36 percent. The total fixed
      payment-to-income ratio of 46.55 percent exceeds the HUD requirement by 5.55 percent.
      KB did not provide compensating factors on the Mortgage Credit Analysis Worksheet
      submitted to HUD.

B. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrower’s credit history was unsatisfactory. The credit report indicated the borrower
      had three charge-off accounts still owing ($1,694 total outstanding), five collection
      accounts still owing, and eight federal student loans with twenty-eight 90-day late
      payments, one outstanding civil judgment, and two accounts with a combined twenty-two
      30-day lates, five 60-day lates, and six 90-day lates. Although three of the five collection
      accounts and the civil judgment were paid, KB did not obtain bank statements to show
      the payoffs came from the borrower’s funds. The borrower’s credit history indicates a
      history of abuse and debt mismanagement. Although the borrower did submit an all-
      encompassing explanation letter, KB did not obtain additional documentation to mitigate
      the borrower’s poor credit history.

C. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The borrower’s monthly income of
      $2,876 on the Mortgage Credit Analysis Worksheet is overstated by $304. KB calculated
      the borrower’s income year-to-date earnings up to May 31, 2001, including overtime and
      a bonus. However, KB did not fulfill the overtime/bonus requirements. KB did not
      obtain documentation or verification from the employer stating overtime was likely to
      continue. The KB loan file does not provide evidence to show that KB performed an
      earnings trend. The documents in the loan file indicate a negative earnings trend.



                                               87
Narrative Case Summary                                                          Appendix D-02



D. Inappropriate use of buydown rate
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-14. KB qualified the borrower
      using the buydown interest rate but failed to show that the scheduled mortgage payment
      increase would not adversely affect the borrower and likely lead to default. To use the
      buydown interest rate to qualify, the underwriter must document the borrower’s ability to
      handle the scheduled mortgage payment increase.

E. Insufficient employment documentation
       HUD Handbook 4155.1, REV-4, paragraph 3-1E. KB did not obtain a 30-day period
       of pay stubs to show the borrower’s current earnings. The loan file only contained one
       biweekly pay stub, covering a 15-day period. The 30-day period is required because KB
       only executed a telephone employment verification.

F. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and allowed KB Home sales representatives to handle vital loan documents.

G. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower $21 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), a $60 payoff fee (unallowable),
      a $56 working capital fee (unallowable), a $75 statement fee (unallowable), and a $250
      HomeSafe “coordinator fee” (unearned/unallowable).

H. Overinsured mortgage
      HUD Handbook 4155.1 REV-4, Paragraph 1-6, 1-7. KB overinsured the HUD
      mortgage by $3,636. KB increased the sales price from $117,990 to $121,677, a
      difference of $3,687, to accommodate a 2:1 buydown received by the borrower and paid
      by the seller. By increasing the sales price, KB allowed the seller to be reimbursed for
      the buydown by financing the buydown through the borrower.

Recommendations
   ‰ Reimburse HUD for loss of $12,471.
   ‰ Refund $512 in overcharges to the borrower or to HUD.




                                              88
Narrative Case Summary                                                            Appendix D-03


HUD case number:      023-1013299
Loan amount:          $143,806
Settlement date:      January 31, 2002
Status:               Resold by HUD at net loss
Loss on resale:       $18,721

KB underwrote and approved the mortgage based on overstated income, no compensating
factors, an unacceptable credit history, and insufficient loan documentation. Therefore, HUD
insured the loan based on KB’s inaccurate representation that the borrower met HUD qualifying
guidelines. Additionally, KB overcharged the borrowers $560, allowed the payment of
consumer debts by an interested third party, and allowed interested third parties to handle vital
loan documents.

A. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      did not provide compensating factors on the Mortgage Credit Analysis Worksheet
      submitted to HUD to overcome a mortgage payment-to-income ratio of 31.86 percent and
      a total fixed payment-to-income ratio of 45.97 percent. We recalculated the qualifying
      ratios using the correct gross monthly income discussed below. The recalculated
      mortgage payment-to-income ratio of 36.19 percent exceeds the HUD requirement by
      7.19 percent. The total fixed payment-to-income ratio of 52.22 percent exceeds the HUD
      requirement by 11.22 percent.

B. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrower’s credit history was unsatisfactory. The credit report indicated the borrower
      had six collection accounts (one still outstanding and inappropriately paid at closing), one
      open charge-off account, two paid charge-off accounts, two accounts with a combined
      two 30-day late payments, three 60-day late payments, and one 90-day late payment. KB
      did not obtain additional documentation to mitigate the borrower’s poor credit history.

C. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The primary borrower’s monthly
      income of $3,052 on the Mortgage Credit Analysis Worksheet is overstated by $550. The
      pay stubs, dated January 25, 2002, and January 11, 2002, show overtime of one and
      eleven hours, respectively. In contrast, the 2001 pay stubs, dated June 29, 2001, and
      June 15, 2001, show overtime hours of 96 and 77, respectively. The pay stubs indicate a
      negative earnings trend. KB did not obtain documentation or verification from the
      employer stating overtime was likely to continue. The KB loan file does not provide
      evidence to show that KB performed an earnings trend analysis.

D. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and also allowed KB Homes sales representatives to complete loan-processing



                                               89
Narrative Case Summary                                                         Appendix D-03


       functions. Sales representatives obtained earnings documents, bank statements, and
       signatures on the Uniform Residential Loan Application.

E. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower $25 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), a second bond and additional
      check fee $100 (unallowable), a $60 working capital fee (unallowable), a $75 statement
      fee (unallowable), and a $250 HomeSafe “coordinator fee” (unearned/unallowable).

F. Inducement to purchase
      Mortgagee Letter 2002-02. KB allowed a third party to pay off the borrower’s
      consumer debts. The HUD-1 Settlement Statement lists five accounts paid at closing:
      four Master Financial Group accounts for $963 and a Fingerhut account for $244.
      Outside of a nonprofit bond loan for $8,700, the borrower deposited only $137.41 into
      escrow. Since the debts were paid out of the settlement escrow account, and the
      borrower did not deposit enough to cover the consumer debts paid off, the debts were
      paid using portions of the seller’s sales proceeds or using the nonprofit bond loan.

G. Loan approved without supporting documentation
      HUD Handbook 4155.1, REV-4, paragraph 3-1. An internal underwriting conditions
      sheet states, “file approved on stated income only, borrowers to provide income
      documentation to support monthly earnings of $4,160.” The underwriter stated that the
      condition meant she underwrote the loan based only on the credit report and loan
      application. The underwriter did not have the pay stubs, verifications of employment,
      W-2 forms, bank statements, etc., when approving the loan.

Recommendations
   ‰ Reimburse HUD for loss of $18,721.
   ‰ Refund $560 in overcharges to the borrower or to HUD.




                                              90
Narrative Case Summary                                                             Appendix D-04


HUD case number:      023-1028162
Loan amount:          $92,689
Settlement date:      January 31, 2002
Status:               Currently in default (as of April 1, 2005)
Indemnification:      $92,689

KB underwrote and approved the mortgage for borrowers with unacceptable credit history. KB
failed to verify the borrowers’ downpayment came from a legitimate source. This resulted in HUD
insuring the loan for borrowers who did not meet HUD qualifying guidelines. Additionally, KB
overcharged the borrowers $314 and allowed interested third parties to handle vital loan documents.

A. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3, 2-4. The borrowers’ credit
      history was unacceptable. KB used alternative credit sources to supplement the
      borrowers’ limited credit history. However, alternative credit accounts used were
      unacceptable because they too showed a pattern of late payments and past dues.

B. Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB allowed commissioned loan processors and loan counselors to sign off on
      underwriter conditions and also allowed KB Homes sales representatives to complete
      loan-processing functions. Sales representatives obtained pay documents and signatures
      on the Uniform Residential Loan Application.

C. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $14 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), and a $250 HomeSafe
      “coordinator fee” (unearned/unallowable).

D. Unverified source of downpayment
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-10. KB did not verify the
      source of the borrowers’ $4,700 cash investment paid into escrow. The bank statement
      shows an unusual deposit of $2,500 into the borrowers’ bank account before the cash
      investment was made. Although KB did obtain a letter of explanation from the
      borrowers, describing their ability to save, KB did not verify the source of this deposit.

Recommendations
   ‰ Indemnify HUD for mortgage amount of $92,689.
   ‰ Refund $314 in overcharges to the borrowers or to HUD.




                                                91
Narrative Case Summary                                                           Appendix D-05



HUD case number:      023-1043232
Loan amount:          $116,520
Settlement date:      April 5, 2002
Status:               Foreclosed and resold by HUD at net loss
Loss on sale:         $29,112

KB submitted the loan for endorsement without compensating factors to justify approval of the
loan with a ratio exceeding HUD requirements. KB underwrote and approved the mortgage
based on overstated income, understated liabilities, and an inappropriate buydown interest rate.
It failed to verify the borrower’s downpayment came from a legitimate source. Therefore, HUD
insured the loan based on KB’s inaccurate representation that the borrower met HUD qualifying
guidelines. Additionally, KB overcharged the borrowers $552 and allowed interested third
parties to handle vital loan documents.

A. No compensating factors
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      did not provide compensating factors in the Mortgage Credit Analysis Worksheet
      submitted to HUD to support the approval for a loan with a total fixed payment-to-
      income ratio of 46.56 percent. This underwriter-calculated ratio exceeded HUD
      requirements by 5.56 percent.

B. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-12, 13. We recalculated the
      qualifying ratios using the correct gross monthly income and recurring liabilities
      discussed below. The recalculated mortgage payment-to-income ratio of 35.77 percent
      exceeds the HUD requirement by 6.77 percent, and the total fixed payment-to-income
      ratio of 71.81 percent exceeds the HUD requirement by 30.81 percent.

C. Overstated income
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-7. The borrowers’ monthly
      income of $3,199 on the Mortgage Credit Analysis Worksheet is overstated by $688. KB
      and HUD loan files do not have sufficient evidence to justify the receipt of child support
      income. Moreover, KB included overtime earned in the base income calculation without
      following HUD requirements. The correct gross monthly income should be $2,511.

D. Understated liabilities
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-11. The borrowers’ recurring
      liabilities of $711 on the Mortgage Credit Analysis Worksheet are understated by $194.
      KB failed to include one account: American Express for $3,892 at $194 per month.

E. Inappropriate use of buydown interest rate to qualify
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-14. KB qualified the borrower
      using the buydown interest rate but failed to show that the scheduled mortgage payment
      increase would not adversely affect the borrower and likely lead to default. To use the



                                               92
Narrative Case Summary                                                           Appendix D-05



       buydown interest rate to qualify, the underwriter must document the borrower’s ability to
       handle the scheduled mortgage payment increase.

F. Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB allowed commissioned loan processors and loan counselors to sign off on
      underwriter conditions and allowed KB Homes sales representatives to complete loan-
      processing functions. Sales representatives obtained bank statements and signatures on
      the Uniform Residential Loan Application.

G. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $20 in excess hazard
      insurance (unallowable), $53 in excess homeowners association dues (unallowable), a
      $50 signing fee (unallowable), a $30 payoff fee (unallowable), $74 in working capital
      (unallowable), a $75 transfer fee (unallowable), and a $250 HomeSafe “coordinator fee”
      (unearned/ unallowable).

H. Unverified source of downpayment
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-10. KB did not verify the
      source of the borrowers’ $2,963 cash investment paid into escrow. The bank statement
      shows two unusual deposits of $1,626 and $1,560 into the borrowers’ bank account a few
      days before the cash investment was made. KB did not verify the source of these
      deposits.

Recommendations
   ‰ Reimburse HUD $29,112 for the loss on sale.
   ‰ Refund $552 in overcharges to the borrowers or to HUD.




                                              93
Narrative Case Summary                                                            Appendix D-06


HUD case number:      023-1052683
Loan amount:          $147,520
Settlement date:      March 19, 2002
Status:               Borrowers retain ownership; not currently in default; partial claims
Indemnification:      $156,354 ($147,520 + $8,834 partial claims)

KB submitted the loan for endorsement without compensating factors to justify approval of the loan
with a ratio exceeding HUD requirements. KB underwrote and approved the mortgage based on
overstated income and an inappropriate buydown interest rate. Therefore, HUD insured the loan
based on KB’s inaccurate representation that the borrowers met HUD qualifying guidelines.
Additionally, KB overcharged the borrowers $321, allowed payoff of consumer debts by an
interested third party, overinsured the HUD mortgage by $20,346, and allowed interested third
parties to handle vital loan documents.

A. No compensating factors
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      did not provide compensating factors in the Mortgage Credit Analysis Worksheet
      submitted to HUD to support the approval for a loan with a mortgage payment-to-income
      ratio of 34.99 percent and a total fixed payment-to-income ratio of 49.46 percent. These
      underwriter-calculated ratios exceeded HUD requirements by 5.99 percent and 8.46
      percent, respectively.

B. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-12, 13. We recalculated the
      qualifying ratios using the correct gross monthly income discussed below. The
      recalculated mortgage payment-to-income ratio of 38.99 percent exceeds HUD
      requirement by 9.99 percent, and the total fixed payment-to-income ratio of 55.12 percent
      exceeds the HUD requirement by 14.12 percent.

C. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3, 2-4. The borrowers’ credit
      history was unacceptable. Four of seven accounts (57 percent) on the credit report were
      collection accounts.

D. Overstated income
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-7. The borrowers’ monthly
      income of $2,799 on the Mortgage Credit Analysis Worksheet is overstated by $287.
      The correct gross monthly income should be $2,512.

E. Inappropriate use of buydown interest rate to qualify
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-14. KB qualified the borrowers
      using the buydown interest rate but failed to show that the scheduled mortgage payment
      increase would not adversely affect the borrowers and likely lead to default. To use the
      buydown interest rate to qualify, the underwriter must document the borrowers’ ability to
      handle the scheduled mortgage payment increase.



                                                94
Narrative Case Summary                                                         Appendix D-06


       Third-party loan processing
       HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
       3-1. KB allowed commissioned loan processors and loan counselors to sign off on
       underwriter conditions and also allowed KB Homes sales representatives to complete
       loan-processing functions. Sales representatives obtained pay documents, bank
       statements, and signatures on the Uniform Residential Loan Application.

F. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $21 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), and a $250 HomeSafe
      “coordinator fee” (unearned/unallowable).

G. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 1-6, 1-7; Mortgagee Letter 96-
      18. KB overinsured the HUD mortgage by $20,346. KB increased the sales price from
      $126,690 to $142,324, a difference of $15,634, to cover the nonprofit gift, seller-paid
      loan discount, and seller-paid buydown. By increasing the sales price, KB converted the
      nonprofit gift and seller-paid incentives into a loan that became part of the mortgage.
      Also, KB did not decrease the sales price as consideration for the payoff of consumer
      debts by a third party.

H. Inducements to purchase
      Mortgagee Letter 2002-02. KB allowed a third party to pay off the borrowers’
      consumer debts. The HUD-1 Settlement Statement lists two accounts paid at closing: 1st
      Investors for $4,549 and RMA for $457. Outside of an $11,277 nonprofit gift, the
      borrowers brought a total of only $500 to closing. Since the debts were paid out of the
      settlement escrow account and the borrowers did not deposit enough to cover the
      consumer debts paid off, the debts were paid using portions of the seller’s sale proceeds
      or using the nonprofit gift funds.

Recommendations
   ‰ Pay $20,346 to the servicing lender to reduce loan amount.
   ‰ Indemnify HUD for $136,008 for the reduced mortgage amount ($127,174) and partial
     claims paid ($8,834).
   ‰ Refund $321 in overcharges to the borrowers or to HUD.




                                              95
Narrative Case Summary                                                             Appendix D-07


HUD case number:      023-1063809
Loan amount:          $140,641
Settlement date:      April 30, 2002
Status:               Foreclosed and resold by HUD at net loss
Loss on sale:         $18,891

KB underwrote and approved the mortgage using a falsified employment verification document and
overstated income. Further, the KB underwriter made false certifications to HUD stating the
mortgage was underwritten with due diligence. Therefore, HUD insured the loan based on KB’s
inaccurate representation that the borrowers met HUD qualifying guidelines. Additionally, KB
overcharged the borrowers $529 and allowed interested third parties to handle vital loan documents.

A. False certifications
       HUD Handbook 4000.4, REV-1, CHG-2, paragraph 3-16; Mortgagee Letter 95-31.
       KB’s underwriter falsely certified that the loan was underwritten through having
       personally reviewed the pertinent loan documents. However, the underwriter, whose
       signature appears on the direct endorsement approval (HUD-92900-A) that was
       submitted to HUD, did not underwrite the mortgage. This mortgage was underwritten,
       approved, and insured without the underwriter’s due diligence.

B. Falsified verification of employment
       HUD Handbook 4000.4, REV-1, CHG-2, paragraph 5-3. KB used a falsified
       verification of employment form to qualify the borrowers for the mortgage. The
       coborrower separated from her employer on March 8, 2002. However, KB’s telephone
       verification of employment, dated March 22, 2002, falsely stated the coborrower was still
       employed as of the date of the verification.

C. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-12, 13; Mortgagee Letter 97-
      26. We recalculated the qualifying ratios using the correct gross monthly income
      discussed below. The recalculated mortgage payment-to-income ratio of 40.81 percent
      exceeds HUD requirement by 11.81 percent, and the total fixed payment-to-income ratio
      of 57.27 percent exceeds the HUD requirement by 16.27 percent.

D. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3, 2-4. The borrowers’ credit
      history was unacceptable. The borrowers did not establish good credit after their
      bankruptcy was discharged in 1994. Three of four accounts (75 percent) opened since
      then went into collection.

E. Overstated income
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-7. The borrowers’ monthly
      income of $4,567 on the Mortgage Credit Analysis Worksheet is overstated by $1,499.
      Since the coborrower’s employment was false, the correct gross monthly income should
      only include the borrower’s verified income of $3,068.



                                                96
Narrative Case Summary                                                    Appendix D-07


      Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB allowed commissioned loan processors and loan counselors to sign off on
      underwriter conditions and also allowed KB Homes sales representatives to complete
      loan-processing functions. Sales representatives obtained pay documents, bank
      statements, and signatures on the Uniform Residential Loan Application.

F. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $24 in excess hazard
      insurance (unallowable), $20 in excess homeowners association dues (unallowable), a
      $100 signing fee and bond loan fee (unallowable), a $60 working capital fee
      (unallowable), a $75 statement fee (unallowable), and a $250 HomeSafe “coordinator
      fee” (unearned/ unallowable).

Recommendations
   ‰ Reimburse HUD $18,891 for the loss on sale.
   ‰ Refund $529 in overcharges to the borrowers or to HUD.




                                           97
Narrative Case Summary                                                          Appendix D-08


HUD case number:      023-1104448
Loan amount:          $121,570
Settlement date:      March 29, 2002
Status:               Current, reinstated by borrower
Indemnification:      $122,320 ($121,570 + $750 expenses)

KB underwrote and approved the mortgage based on overstated income, insufficient employment
documentation, an unacceptable credit history, excessive qualifying ratios with no compensating
factors, and insufficient loan documentation. Therefore, HUD insured the loan based on KB’s
inaccurate representation that the borrower met HUD qualifying guidelines. Additionally, KB
overcharged the borrower $517, allowed the payment of consumer debts by an interested third
party, and allowed interested third parties to handle vital loan documents.

A. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      did not provide compensating factors in the Mortgage Credit Analysis Worksheet
      submitted to HUD to overcome a mortgage payment-to-income ratio of 34.75 percent and
      a total fixed payment-to-income ratio of 44.92 percent. We recalculated the qualifying
      ratios using the correct gross monthly income discussed below. The recalculated
      mortgage payment-to-income ratio of 61.48 percent exceeds the HUD requirement by
      32.48 percent. The total fixed payment-to-income ratio of 79.46 percent exceeds the
      HUD requirement by 38.46 percent.

B. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrowers’ credit history was unsatisfactory. The credit report indicated the primary
      borrower had five open accounts with three of the accounts as unpaid collections (60
      percent). Two of the collections were inappropriately paid at closing (see below), and
      one account remained outstanding. The coborrower did not have a credit history.

C. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The borrower’s monthly income of
      $2,990 on the Mortgage Credit Analysis Worksheet is overstated by $1,300. KB added
      $1,300 of concurrent/part-time employment of less than two years without justifying its
      likelihood of continuance. The KB and HUD loan files do not contain documents to
      conclude that the income’s continuance is likely.

D. Insufficient employment documentation
       HUD Handbook 4155.1, REV-4, paragraph 3-1E. KB did not obtain a 2001 W-2 form
       or complete a verification of employment for the primary borrower’s concurrent/part-
       time employment. Without the required documentation, KB would not have been in a
       position to determine the income stability or likelihood of income continuance.




                                              98
Narrative Case Summary                                                        Appendix D-08


       Third-party loan processing
       HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
       allowed commissioned loan processors and loan counselors to sign off on underwriter
       conditions and also allowed KB Homes sales representatives to complete loan-processing
       functions. Sales representatives obtained earnings documents, bank statements, and
       signatures on the Uniform Residential Loan Application.

E. Unearned/unallowable fees
     HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
     Reference Guide; 24 CFR 3500.14. KB charged the borrower $38 in excess hazard
     insurance (unallowable), a $50 signing fee (unallowable), a $20 check processing fee
     (unallowable), a $75 statement fee (unallowable), $84 in working capital to Central and
     Dobbins homeownership association (unallowable), and a $250 HomeSafe “coordinator
     fee” (unearned/unallowable).

F. Loan approved without supporting documents
      HUD Handbook 4155.1, REV-4, paragraph 3-1. An internal underwriting conditions
      sheet states, “file approved on stated income only, borrowers to provide income
      documentation to support monthly earnings of $3,290.” The underwriter stated that the
      condition meant she underwrote the loan based only on the credit report and loan
      application. The underwriter did not have the pay stubs, verifications of employment,
      W-2 forms, bank statements, etc., when approving the loan.

Recommendations
   ‰ Indemnify HUD for the $121,570 loan amount plus $750 partial payment totaling
     $122,320.
   ‰ Refund $517 in overcharges to the borrower or to HUD.




                                             99
Narrative Case Summary                                                           Appendix D-09


HUD case number:      023-1107968
Loan amount:          $115,568
Settlement date:      March 29, 2002
Status:               Property resold by HUD at net profit
Indemnification:      None

KB underwrote and approved the mortgage based on false employment data, overstated income,
insufficient employment documentation, an unacceptable credit history, and no compensating
factors. Therefore, HUD insured the loan based on KB’s inaccurate representation that the
borrower met HUD qualifying guidelines. Additionally, KB overcharged the borrower $387,
allowed the payment of consumer debts by an interested third-party, and allowed interested third
parties to handle vital loan documents.

A. False employment data and insufficient employment documentation
       HUD Handbook 4000.2, REV-2, paragraph 1-21; 4000.4, REV-1, paragraph 5-3;
       4155.1, REV-4, paragraph 3-1E; Mortgagee Letter 97-26. KB used a false telephone
       employment verification for the coborrower’s employment. The telephone verification
       was executed on March 20, 2002, by a loan processor, even though the coborrower
       stopped working on November 15, 2001. Also, KB did not obtain a 30-day period of pay
       stubs to show the coborrower’s current earnings. The loan file only contained one 15-day
       pay stub. The 30-day period is required because KB executed a telephone employment
       verification.

B. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      failed to include compensating factors on the Mortgage Credit Analysis Worksheet
      submitted to HUD for an excessive total fixed payment-to-income ratio of 47.53 percent.
      We recalculated the qualifying ratios using the correct gross monthly income and
      recurring liabilities discussed below. The recalculated mortgage payment-to-income ratio
      of 23.95 percent does not exceed the HUD requirement, but the total fixed payment-to-
      income ratio of 49.18 percent exceeds the HUD requirement by 8.18 percent.

C. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrowers’ credit history was unsatisfactory. The credit report indicated the borrowers
      had four collection accounts (one outstanding, one paid, and two paid at closing), two
      open charge-off accounts ($1,953 outstanding), two accounts with combined sixteen 30-
      day lates, one 60-day late, and two accounts with adverse ratings. KB did not obtain
      additional documentation to mitigate the borrowers’ poor credit history.

D. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The borrower’s monthly income of
      $4,462 on the Mortgage Credit Analysis Worksheet is overstated by $150. KB calculated
      the coborrower’s gross monthly income of $2,100 from earnings at a previous employer.




                                              100
Narrative Case Summary                                                         Appendix D-09


       KB should have used the current employer when calculating the coborrower’s gross
       monthly income.

E. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and also allowed KB Homes sales representatives to complete loan-processing
      functions. Sales representatives obtained pay documents, bank statements, and signatures
      on the Uniform Residential Loan Application.

F. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower $17 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), a $50 bond escrow fee
      (unallowable), a $20 payoff fee (unallowable), and a $250 HomeSafe “coordinator fee”
      (unearned/ unallowable).

G. Inducement to purchase
      Mortgagee Letter 2002-02. KB allowed a third party to pay off the borrower’s
      consumer debts. The HUD-1 Settlement Statement lists two accounts paid at closing:
      Kenneth Eisen & Atuc. for $173 and NCO Financial System for $64. Outside of a
      nonprofit bond loan for $7,000, the borrowers did not bring any money to closing. Since
      the debts were paid out of the settlement escrow account and the borrower did not deposit
      enough to cover the consumer debts paid off, the debts were paid using the seller’s funds
      or using the nonprofit bond loan.

Recommendations
   ‰ Refund $387 in overcharges to the borrower or to HUD.




                                             101
Narrative Case Summary                                                          Appendix D-10



HUD case number:      023-1113441
Loan amount:          $137,564
Settlement date:      July 15, 2002
Status:               Foreclosed
Indemnification:      $137,564

KB underwrote and approved the mortgage based on overstated income and understated
liabilities. Therefore, HUD insured the loan based on KB’s inaccurate representation that the
borrowers met HUD qualifying guidelines. Additionally, KB overcharged the borrowers $515
and overinsured the HUD mortgage by $7,785. KB also allowed interested third parties to
handle vital loan documents.

A. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1 REV-4, CHG-1, Paragraph 2-12, 13; Mortgagee Letter 97-
      26. We recalculated the qualifying ratios using the correct gross monthly income and
      recurring liabilities discussed above. The recalculated mortgage payment-to-income ratio
      of 32.75 percent exceeds HUD requirement by 3.75 percent, and the total fixed payment-
      to-income ratio of 49.45 percent exceeds the HUD requirement by 8.45 percent.

B. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrowers’ credit histories were unacceptable. For the primary borrower, 16 of 17
      accounts (94 percent) were collection or charged off accounts. Nine of the
      collection/charged off accounts remained unpaid after settlement ($8,119 total
      outstanding charge-offs). For the coborrower, three of five accounts (60 percent) were
      collection or charged off accounts. All three of these accounts remained unpaid after
      settlement.

C. Overstated income
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-7. The borrowers’ monthly
      income of $4,622 on the Mortgage Credit Analysis Worksheet is overstated by $1,138.
      KB and HUD loan files do not have sufficient evidence to justify the receipt of child
      support income. Moreover, KB included overtime earned in the base income calculation
      without following HUD requirements. The correct gross monthly income should be
      $3,484.

D. Understated liabilities
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-11. The borrowers’ recurring
      liabilities of $353 on the Mortgage Credit Analysis Worksheet are understated by $229.
      KB included two accounts: Mercury Finance for $11,184 at $333 per month and Capital
      One Bank for $210 at $20 per month. KBHM failed to include two accounts, Fst Nat-
      Lub for $2,750 at $138 per month and Fst Nat-Lub for $1,826 at $91 per month.




                                              102
Narrative Case Summary                                                          Appendix D-10



E. Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB allowed commissioned loan processors and loan counselors to sign off on
      underwriter conditions and also allowed KB Homes sales representatives to complete
      loan-processing functions. Sales representatives obtained pay documents, bank
      statements, and signatures on the Uniform Residential Loan Application.

F. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $20 in excess hazard
      insurance (unallowable), $24 in excess homeowners association dues (unallowable), a
      $50 signing fee (unallowable), a $96 working capital fee (unallowable), a $75 transfer fee
      (unallowable), and a $250 HomeSafe “coordinator fee” (unearned/unallowable).

G. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 1-6, 1-7; Mortgagee Letter 96-
      18. KB overinsured the HUD mortgage by $7,785. KB increased the sales price from
      $128,990 to $136,886, a difference of $7,896, to cover the nonprofit gift. By increasing
      the sales price, KB converted a nonprofit gift into a loan that became part of the
      mortgage.

Recommendations
   ‰ Indemnify HUD for mortgage amount of $137,564.
   ‰ Refund $515 in overcharges to the borrowers or to HUD.




                                              103
Narrative Case Summary                                                           Appendix D-11



HUD case number:      023-1135453
Loan amount:          $138,003
Settlement date:      April 19, 2002
Status:               Paid in full on March 1, 2005, property sold by borrower
Indemnification:      None

KB underwrote and approved the mortgage based on false employment data, overstated income,
understated liabilities, and unacceptable credit history. Therefore, HUD insured the loan based
on KB’s inaccurate representation that the borrower met HUD qualifying guidelines.
Additionally, KB overcharged the borrower $380, overinsured the HUD mortgage by $8,883,
and allowed interested third parties to handle loan documents.

A. False employment data
       HUD Handbook 4000.2, REV-2, paragraph 1-21; 4000.4, REV-1, paragraph 2-5;
       Mortgagee Letter 97-26. KB knowingly approved the HUD loan using false
       employment data. The borrower stated her last date of employment was January 24,
       2002, as evidenced by her last pay stub, dated March 1, 2002, with earnings of $4,468.
       The state of Arizona Department of Economic Security verified the wages earned in 2002
       as $4,305. The loan file contained two false pay stubs, dated March 15, 2002, and
       March 29, 2002. The borrower confirmed she did not receive pay stubs past March 1,
       2002. The loan file also contains a false W-2 form and false online verification of
       employment. The borrower confirmed she only received one W-2 form in 2001. The KB
       and HUD loan files include a second (false) 2001 W-2 form for $25,501. The online
       verification completed on March 12, 2002, falsely states the borrower was an active
       employee as of April 23, 2002. However, we completed a verification using the same
       online service and received a termination date of January 24, 2002. The borrower said
       she notified the KB loan counselor that she had lost her job, and that the loan counselor
       assured her she would still qualify based on that employment.

B. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. We
      recalculated the qualifying ratios using the correct gross monthly income and recurring
      liabilities discussed below. The recalculated mortgage payment-to-income ratio of 28.89
      percent does not exceed the HUD requirement, but the total fixed payment-to-income
      ratio of 60.19 percent exceeds the HUD requirement by 19.19 percent.

C. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrower’s credit history was unsatisfactory. The credit report indicated the borrower
      had two unpaid collection accounts (both paid at closing), an auto loan with six payments
      30 days late, two student loans with a combined two payments 60 days late, and one
      credit card with a 60-day late payment. The credit report also detailed five civil
      judgments between June 1996 and January 2002 (all satisfied).




                                              104
Narrative Case Summary                                                        Appendix D-11


D. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. Although the income was based on
      false employment data, we analyzed the income calculations to show that KB did not
      prudently calculate the borrower’s income. The borrower’s income of $5,440 on the
      Mortgage Credit Analysis Worksheet is overstated by $1,556. KB did not take into
      account the borrower’s historical earnings.

E. Understated liabilities
      HUD Handbook 4155.1, REV-4, paragraph 2-11. The borrower’s recurring liabilities
      of $519 on the Mortgage Credit Analysis Worksheet are understated by $697. KB failed
      to include three education loans and two credit cards: Educaid-TMS for $11,466 at $573
      per month, U.S Department of Education for $2,223 at $25 per month, AES Military
      Supply for $981 at $50 per month, Capital One for $856 at $26 per month, and Capital
      One for $453 at $23 per month.

F. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions, and also allowed KB Homes sales representatives to complete loan-
      processing functions. Sales representatives obtained earnings documents, bank
      statements, and signatures on the Uniform Residential Loan Application

G. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower a $50 signing fee
      (unallowable), a $20 additional check fee (unallowable), $60 in working capital to
      Mountain Ranch homeowners association (unallowable), and a $250 HomeSafe
      “coordination fee” (unearned/ unallowable).

Recommendations
   ‰ Refund $380 in overcharges to the borrower or to HUD.




                                            105
Narrative Case Summary                                                         Appendix D-12



HUD case number:     023-1145205
Loan amount:         $142,729
Settlement date:     August 29, 2002
Status:              Foreclosed and resold by HUD at net loss
Loss on sale:        $21,462

KB submitted the loan for endorsement without compensating factors to justify approval of the
loan with ratios exceeding HUD requirements. Therefore, HUD insured the loan based on KB’s
inaccurate representation that the borrowers met HUD qualifying guidelines. Additionally, KB
overcharged the borrowers $468 and overinsured the HUD mortgage by $1,673. KB also
allowed interested third parties to handle vital loan documents.

A. No compensating factors
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB did
      not provide compensating factors in the Mortgage Credit Analysis Worksheet submitted to
      HUD to support the approval for a loan with a mortgage payment-to-income ratio of 30.29
      percent and a total fixed payment-to-income ratio of 45.00 percent. These underwriter-
      calculated ratios exceeded HUD requirements by 1.29 percent and 4.00 percent,
      respectively.

B. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-12, 13. We recalculated the
      qualifying ratios using the correct recurring liabilities of $581. The recalculated
      mortgage payment-to-income ratio of 30.29 percent exceeds HUD requirement by 1.29
      percent, and the total fixed payment-to-income ratio of 44.70 percent exceeds the HUD
      requirement by 3.70 percent.

C. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3, 2-4. The borrowers’ credit
      history was unacceptable. Seven of sixteen accounts (44 percent) reported as
      collection/charge-off accounts. Two of the seven collection/charge-off accounts
      remained unpaid after settlement in the amount of $7,821.

D. Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB allowed commissioned loan processors and loan counselors to sign off on
      underwriter conditions and allowed KB Homes sales representatives to complete loan-
      processing functions. Sales representatives obtained pay documents, bank statements,
      and signatures on the Uniform Residential Loan Application.

E. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $39 in excess hazard
      insurance (unallowable), a $50 bond loan fee (unallowable), a $50 signing fee
      (unallowable), a $10 payoff account fee (unallowable), $44 in working capital



                                             106
Narrative Case Summary                                                          Appendix D-12



       (unallowable), a $25 transfer fee (unallowable), and a $250 HomeSafe “coordinator fee”
       (unearned/unallowable).

F. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 1-6, 1-7; Mortgagee Letter 96-
      18. KB overinsured the HUD mortgage by $1,673. KB increased the sales price from
      $142,790 to $144,490, a difference of $1,700, to cover the nonprofit gift. By increasing
      the sales price, KB converted a nonprofit gift into a loan that became part of the
      mortgage.

Recommendations
   ‰ Reimburse HUD $21,462 for the loss on sale.
   ‰ Refund $468 in overcharges to the borrowers or to HUD.




                                              107
Narrative Case Summary                                                         Appendix D-13


HUD case number:     023-1185414
Loan amount:         $150,602
Settlement date:     June 25, 2002
Status:              Foreclosed and resold by HUD at net profit
Indemnification:     None

KB submitted the loan for endorsement without compensating factors to justify approval of the
loan with ratios exceeding HUD requirements. KB failed to verify the borrower’s downpayment
came from a legitimate source. KB charged the borrower $1,757 for unearned/ unallowable fees.
Additionally, KB allowed interested third parties to handle vital loan documents.

A. No compensating factors
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      did not provide compensating factors in the Mortgage Credit Analysis Worksheet
      submitted to HUD to support the approval for a loan with a mortgage payment-to-income
      ratio of 31.45 percent and a total fixed payment-to-income ratio of 44.47 percent. These
      underwriter-calculated ratios exceeded HUD requirements by 2.45 percent and 3.47
      percent, respectively. KB added compensating factors to the Mortgage Credit Analysis
      Worksheet and resubmitted it to the HUD’s Santa Ana Homeownership Center in
      response to a post-endorsement technical review.

B. Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB allowed commissioned loan processors and loan counselors to sign off on
      underwriter conditions and also allowed KB Homes sales representatives to complete
      loan-processing functions. Sales representatives obtained pay documents, bank
      statements, and signatures on the Uniform Residential Loan Application.

C. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $20 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), $56 in working capital
      (unallowable), a $75 statement fee (unallowable), a $50 bond loan fee (unallowable), a
      $250 HomeSafe “coordinator fee” (unearned/unallowable), and a $1,506 loan discount
      (unearned/unallowable). After the Santa Ana Homeownership Center’s post-
      endorsement technical review, which identified the HomeSafe “coordinator fee” as an
      unallowable fee, KB reimbursed the borrower by applying a reduction to the loan
      principal.

D. Downpayment provided by interested third party
     HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-10. The borrower supposedly
     paid $4,981 into escrow as part of the cash investment. KB only verified that a portion of
     these funds came from the borrower’s payroll check. According to the borrower, he
     borrowed funds from the real estate agent the week before closing because he did not
     have sufficient funds to close. This was evident on the bank statement, which shows a



                                             108
Narrative Case Summary                                                         Appendix D-13


      $900 deposit three days before closing. Without this deposit, the borrower would not
      have had sufficient funds to close.

Recommendations
   ‰ Refund $1,757 in overcharges to the borrower or to HUD.




                                            109
Narrative Case Summary                                                          Appendix D-14



HUD case number:      023-1186721
Loan amount:          $129,614
Settlement date:      August 19, 2002
Status:               Foreclosed and resold by HUD
Loss on resale:       $32,146

KB underwrote and approved the mortgage based on overstated income and an unacceptable
credit history. Therefore, HUD insured the loan based on KB’s inaccurate representation that the
borrower met HUD qualifying guidelines. Additionally, KB overcharged the borrower $350,
allowed the payment of consumer debts by an interested third party, overinsured the HUD
mortgage by $11,209, and allowed interested third parties to handle vital loan documents.

A. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrower’s credit history was unsatisfactory. The credit report indicated that the
      borrower filed for Chapter 7 bankruptcy on April 3, 1998, and that the bankruptcy was
      discharged on July 22, 1998. After the bankruptcy discharge, the borrower had one
      payment past 30 days late, two charge-offs totaling $8,275, two collection accounts
      totaling $334, and one civil judgment for $424. KB did not obtain additional
      documentation to mitigate the borrower’s continued poor credit history.

B. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The borrower’s monthly income of
      $7,620 on the Mortgage Credit Analysis Worksheet is overstated by $3,810. KB added
      $3,810 in unsubstantiated income to the borrower’s verified income of $3,810 to arrive at
      a grand total of $7,620. However, the KB and HUD loan files do not support additional
      borrowers or concurrent employment to justify a $3,810 increase in gross monthly
      income.

C. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and also allowed KB Home sales representatives to handle vital loan
      documents.

D. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower $20 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), a $30 pay-off fee
      (unallowable), and a $250 HomeSafe “coordinator fee” (unearned/unallowable).

E. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, paragraph 1-6, 1-7; Mortgagee Letter 96-18. KB
      overinsured the HUD mortgage by $11,209. KB increased the sales price from $111,590
      to $120,772, a difference of $9,182, to cover the nonprofit gift. By increasing the sales

                                              110
Narrative Case Summary                                                           Appendix D-14


       price, KB converted a nonprofit gift into a loan that became part of the mortgage. Also,
       KB did not decrease the sales price as consideration for the payoff of consumer debts by
       a third party.

F. Inducements to purchase
      Mortgagee Letter 2002-2. KB allowed the payment of consumer debts by a third party.
      The HUD-1 Settlement Statement lists three accounts paid at closing: civil judgment for
      $1,866, Surety Acceptance for $202, and Allied Interstate for $132. Outside of a $8,682
      nonprofit gift, the borrower only brought a total of $350 to closing. Therefore, the debts
      were paid using seller sale proceeds or the nonprofit gift funds.

Recommendations
   ‰ Reimburse HUD for loss of $32,146.
   ‰ Refund $350 in overcharges to the borrower or to HUD.




                                              111
Narrative Case Summary                                                          Appendix D-15



HUD case number:      023-1211310
Loan amount:          $150,573
Settlement date:      July 26, 2002
Status:               Foreclosed
Indemnification:      $156,347 ($154,378 (claim) + $1,969 (expenses))

KB underwrote and approved the mortgage based on overstated income, an unacceptable credit
history, a false social security number, and no compensating factors. Therefore, HUD insured
the loan based on KB’s inaccurate representation that the borrower met HUD qualifying
guidelines. Additionally, KB overcharged the borrower $583, overinsured the HUD mortgage
by $1,322, and allowed interested third parties to handle vital loan documents.

A. False social security number
       HUD Handbook 4155.1, REV-4, paragraph 3-2C; 4000.2, REV-2, paragraph 1-20;
       24 CFR 202.5(j)(4). KB approved the HUD mortgage with knowledge that the
       coborrower was using a false social security number. During the loan process, the
       coborrower had been in the United States for less than one year. KB performed an online
       employment verification using the coborrower’s reported social security number. The
       online verification revealed that the social security number was attached to another
       person other than the coborrower. KB inappropriately continued with the loan approval
       without obtaining an explanation or resolution of the serious discrepancy.

B. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. KB
      failed to include compensating factors on the Mortgage Credit Analysis Worksheet
      submitted to HUD for excessive front and back ratios of 34.72 percent and 45.99 percent.
      We recalculated the qualifying ratios using the correct gross monthly income discussed
      below. The recalculated mortgage payment-to-income ratio of 40.12 percent exceeds the
      HUD requirement by 11.12 percent. The total fixed payment-to-income ratio of 53.15
      percent exceeds the HUD requirement by 12.15 percent.

C. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrowers’ credit history was unsatisfactory. The credit reports for the primary borrower
      and his nonpurchasing spouse showed numerous charge-offs and adverse ratings. The
      borrower had four charge-offs ($1,654 outstanding), six collections (four outstanding),
      and two accounts with two 30-day late payments. The borrower had a paid collection
      that was a government fine from Maricopa County.

D. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The borrower’s income of $3,832 on
      the Mortgage Credit Analysis Worksheet is overstated by $516. Since the primary
      borrower, who was an auto detailer, was paid on a per-car rather than hourly basis, KB
      should have taken an average of the borrower’s prior two years’ earnings. For the



                                              112
Narrative Case Summary                                                           Appendix D-15


       coborrower, KB used an 80-hour biweekly work schedule; however, the loan file only
       substantiates a 60 to 70hour work schedule.

E. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and also allowed KB Homes sales representatives to complete loan-processing
      functions. Sales representatives obtained pay documents, bank statements, and signatures
      on the Uniform Residential Loan Application.

F. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; 24 CFR 3500.14; chapter 2-15,
      HUD Homeownership Reference Guide. KB charged the borrower $21 in excess
      hazard insurance (unallowable), a $50 additional escrow fee (unallowable), a $50
      courtesy signing fee (unallowable), $24 in excess homeownership association dues
      (unallowable), a $75 transfer fee (unallowable), $113 in working capital to Dynamite
      homeownership association (unallowable), and a $250 HomeSafe transaction
      coordination fee (unearned/unallowable).

G. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, paragraph 1-6, 1-7; Mortgagee Letter 96-18. KB
      overinsured the HUD mortgage by $1,322. KB increased the sales price from $150,990
      to $152,331, a difference of $1,341, to cover the nonprofit gift. By increasing the sales
      price, KB converted a nonprofit gift into a loan that became part of the mortgage.

Recommendations
   ‰ Reimburse HUD for any losses incurred when the property is resold. The amount of the
     claim and expenses to date are $156,347.
   ‰ Refund $583 in overcharges to the borrower or to HUD.




                                              113
Narrative Case Summary                                                            Appendix D-16


HUD case number:      023-1234810
Loan amount:          $131,442
Settlement date:      August 9, 2002
Status:               Paid in full on March 1, 2005, property sold by borrowers
Indemnification:      None

KB inappropriately qualified the borrowers at the buydown rate and did not provide
compensating factors to overcome a high mortgage payment-to-income ratio. Additionally, KB
overcharged the borrower $504, overinsured the HUD mortgage by $8,645, and allowed
interested third parties to handle vital loan documents

A. Excessive qualifying ratios without compensating factors
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee letter 97-26. KB
      did not provide compensating factors to overcome a mortgage payment-to-income ratio
      of 39.30 percent. The ratio exceeded HUD requirements by 10.30 percent.

B. Inappropriate use of buydown rate
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-14. KB qualified the borrower
      using the buydown interest rate but failed to show that the scheduled mortgage payment
      increase would not adversely affect the borrower and likely lead to default. To use the
      buydown interest rate to qualify, the underwriter must document the borrower’s ability to
      handle the scheduled mortgage payment increase.

C. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and also allowed KB Homes sales representatives to complete loan-processing
      functions. Sales representatives obtained pay documents, bank statements, and signatures
      on the Uniform Residential Loan Application.

D. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower $42 in excess hazard
      insurance (unallowable), $24 in excess homeownership association fees, a $50 courtesy
      signing fee (unallowable), $63 in working capital (unallowable), a $75 statement fee
      (unallowable), and a $250 HomeSafe “coordinator fee” (unearned/unallowable).

E. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, paragraph 1-6, 1-7; Mortgagee Letter 96-18. KB
      overinsured the HUD mortgage by $8,883. KB increased the sales price from $111,590
      to $120,772, a difference of $9,182, to cover the nonprofit gift. By increasing the sales
      price, KB converted a nonprofit gift into a loan that became part of the mortgage.

Recommendations
   ‰ Refund $504 in overcharges to the borrower or to HUD.




                                              114
Narrative Case Summary                                                         Appendix D-17



HUD case number:     023-1254460
Loan amount:         $124,863
Settlement date:     August 30, 2002
Status:              Claim paid
Indemnification:     $135,627

KB underwrote and approved the mortgage based on overstated income, unacceptable concurrent
employment, inappropriate use of the buydown rate, and understated liabilities. Therefore, HUD
insured the loan based on KB’s inaccurate representation that the borrower met HUD qualifying
guidelines. Additionally, KB overcharged the borrower $343, overinsured the HUD mortgage
by $14,298, and allowed interested third parties to handle vital loan documents.

A. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, paragraph 2-12, 13; Mortgagee Letter 97-26. We
      recalculated the qualifying ratios using the correct gross monthly income and recurring
      liabilities discussed below. The recalculated mortgage payment-to-income ratio of 53.30
      percent exceeds the HUD requirement by 24.30 percent. The total fixed payment-to-
      income ratio of 76.06 percent exceeds the HUD requirement by 35.06 percent.

B. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The borrower’s monthly income of
      $2,784 on the Mortgage Credit Analysis Worksheet is overstated by $1,224. KB
      calculated the borrower’s primary income by using year-to-date earnings through April
      17, 2002. However, the year-to-date earnings included overtime and did not reflect
      future and past performance. KB should have used the written verification of
      employment stating $9 per hour for 40 hours per week.

C. Unacceptable concurrent employment
      HUD Handbook 4155.1, REV-4, paragraph 2-7B. KB used $817 from concurrent
      employment. However, the earnings KB included were derived from previous
      employment and not the actual concurrent employment. Even if calculated correctly, the
      concurrent employment should have only been included as a compensating factor
      because of the small timeframe on the job (three months) and the lack of documentation
      to support the likelihood of employment continuance.

D. Understated liabilities
      HUD Handbook 4155.1, REV-4, paragraph 2-11. The borrower’s recurring liabilities
      of $0 on the Mortgage Credit Analysis Worksheet are understated by $355. KB failed to
      include an auto loan with a balance of $4,329 and a monthly payment of $355. More
      than 10 months remained on the payment schedule.

E. Inappropriate use of buydown rate
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-14. KB qualified the borrower
      using the buydown interest rate but failed to show that the scheduled mortgage payment
      increase would not adversely affect the borrower and likely lead to default. To use the

                                             115
Narrative Case Summary                                                           Appendix D-17

       buydown interest rate to qualify, the underwriter must document the borrower’s ability to
       handle the scheduled mortgage payment increase

F. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and also allowed KB Home sales representatives to handle vital loan
      documents.

G. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower $18 in excess hazard
      insurance (unallowable), $75 in working capital to a homeowners association
      (unallowable), and a $250 HomeSafe “coordinator fee” (unearned/unallowable).

H. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, paragraph 1-6, 1-7; Mortgagee Letter 96-18. KB
      overinsured the HUD mortgage by $14,298. KB increased the sales price from $106,390
      to $120,890, a difference of $14,500, to cover the nonprofit gift ($4,800), the incentive
      toward closing costs ($2,709), and the incentive toward the buydown/discount ($4,091).
      By increasing the sales price, KB converted incentives/gift funds into borrower financed
      items.

Recommendations
   ‰ Reimburse HUD for any losses that may be incurred when the property is sold. The
     amount of claims paid to date is $135,627.
   ‰ Refund $343 in overcharges to the borrower or to HUD.




                                              116
Narrative Case Summary                                                          Appendix D-18


HUD case number:      023-1322842
Loan amount:          $150,128
Settlement date:      October 28, 2002
Status:               Currently in default, partial claim paid
Indemnification:      $154,761 ($150,128 + $4,633 partial claim)

KB underwrote and approved the mortgage based on overstated income and an unacceptable
credit history. Therefore, HUD insured the loan based on KB’s inaccurate representation that the
borrower met HUD qualifying guidelines. Additionally, KB overcharged the borrower $249 and
allowed interested third parties to handle vital loan documents.

A. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, paragraph 2-3, 2-5; 24 CFR 203.5(c). The
      borrowers’ credit history was unsatisfactory. The credit report indicated the borrowers
      had nine paid collection accounts, two collection accounts outstanding (paid during loan
      process), three open charge-off accounts ($9,317 outstanding), one outstanding collection
      account, three accounts with combined six 30-day lates, two 60-day lates, and one 90-day
      late. The borrowers also had a judgment, from a previous tenant, satisfied only two
      months before loan settlement. KB did not obtain additional documentation to mitigate
      the borrowers’ poor credit history.

B. Overstated income
      HUD Handbook 4155.1, REV-4, paragraph 2-7. The borrower’s monthly income of
      $4,888 on the Mortgage Credit Analysis Worksheet is overstated by $173. KB did not
      calculate the primary borrower and coborrower’s overtime/bonus income, according to
      HUD requirements. For the primary borrower, KB calculated the income based on
      current overtime/bonus earnings and did not consider the historical overtime/bonus
      earnings trend. For the coborrower, KB did not adequately document that overtime had
      been received the past two years and, therefore, was not able to determine an earnings
      trend.

C. Third-party loan processing
      HUD Handbook 4155.1, REV-4, paragraph 3-1; 4000.2, REV-2, paragraph 3-6. KB
      allowed commissioned loan processors and loan counselors to sign off on underwriter
      conditions and also allowed KB Homes sales representatives to complete loan-processing
      functions. Sales representatives obtained pay documents, bank statements, and signatures
      on the Uniform Residential Loan Application.

D. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrower $18 in excess hazard
      insurance (unallowable), a $50 bond loan fee (unallowable), a $50 courtesy signing fee
      (unallowable), $56 in working capital to Dynamite homeowners association
      (unallowable), and a $75 statement fee (unallowable).



                                              117
Narrative Case Summary                                       Appendix D-18


Recommendations
   ‰ Indemnify HUD for $154,761.
   ‰ Refund $249 in overcharges to the borrower or to HUD.




                                          118
Narrative Case Summary                                                          Appendix D-19


HUD case number:      023-1357024
Loan amount:          $133,661
Settlement date:      October 28, 2002
Status:               Foreclosed and resold by HUD at net loss
Loss on sale:         $12,822

KB underwrote and approved the mortgage using falsified employment and income documents.
The use of falsified documents occurred because interested third parties were allowed to handle
verification forms and pay documents. Therefore, HUD insured the loan based on KB’s inaccurate
representation that the borrowers met HUD qualifying guidelines. Additionally, KB overcharged
the borrowers $240 and overinsured the HUD mortgage by $7,564.

A. Falsified employment
       HUD Handbook 4000.2, REV-2, paragraph 1-21; 4000.4, REV-1, CHG-2,
       paragraph 5-3. KB used falsified employment documents to qualify the borrowers for
       the mortgage. The false documents include a verification of employment, a W-2 form,
       and a pay stub. The employer confirmed the W-2 form and pay stub to be false. The
       manager who signed the false verification of employment admitted to signing the form
       blank. He confirmed income information on the verification of employment was grossly
       overstated. He became aware of the false verification of employment and reported it to
       KB personnel when KB contacted him to re-verify the borrower’s employment.
       However, KB did not report to HUD that it detected false documents in the loan file.

B. Inaccurate/excessive debt-to-income ratios
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-12, 13; Mortgagee Letter 97-
      26. We recalculated the qualifying ratios using the correct gross monthly discussed
      below. The recalculated mortgage payment-to-income ratio of 47.27 percent exceeds
      HUD requirement by 18.27 percent, and the total fixed payment-to-income ratio of 79.14
      percent exceeds the HUD requirement by 38.14 percent.

C. Unacceptable credit history
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3, 2-4. The primary borrower’s
      credit history was unacceptable. Six of six accounts were reported as collection accounts.
      Two of these six collection accounts remained unpaid after settlement.

D. Overstated income
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-7. The borrowers’ monthly
      income of $4,333 on the Mortgage Credit Analysis Worksheet is overstated by $2,080.
      Since the borrower’s employment was false, the correct gross monthly income should
      only include the coborrower’s verified income of $2,253.

E. Third-party loan processing
      HUD Handbook 4000.2, REV-2, paragraph 3-6; 4155.1, REV-4, CHG-1, paragraph
      3-1. KB permitted interested third parties to handle verification forms and loan
      documents. KB allowed the borrower to hand-carry a blank verification of employment

                                              119
Narrative Case Summary                                                           Appendix D-19

       to the employer. KB also allowed the completed verification of employment, W-2 forms,
       and pay stubs to be submitted via the real estate agent. These turned out to be fabricated
       documents to overstate income. The commissioned loan processor and loan counselor
       signed off on underwriter conditions and KB allowed KB Homes sales representatives to
       complete loan-processing functions. Sales representatives obtained pay documents, bank
       statements, and signatures on the Uniform Residential Loan Application.

F. Unearned/unallowable fees
      HUD Handbook 4000.2, REV-2, paragraph 5-3; chapter 2-15, HUD Homeownership
      Reference Guide; 24 CFR 3500.14. KB charged the borrowers $19 in excess hazard
      insurance (unallowable), a $50 signing fee (unallowable), a $96 working capital fee
      (unallowable), and a $75 statement fee (unallowable).

G. Overinsured mortgage
      HUD Handbook 4155.1, REV-4, CHG-1, paragraph 1-6, 1-7; Mortgagee Letter 96-
      18. KB overinsured the HUD mortgage by $7,564. KB increased the sales price from
      $122,990 to $130,662, a difference of $7,672, to cover the nonprofit gift. By increasing
      the sales price, KB converted a nonprofit gift into a loan that became part of the
      mortgage.

Recommendations
   ‰ Reimburse HUD $12,822 for the loss on sale.
   ‰ Refund $240 in overcharges to the borrowers or to HUD.




                                              120