oversight

National City Mortgage Company, Federal Way Branch Nonsupervised Single-Family Mortgagee - Loan Origination

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-12-16.

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

                                                                Issue Date
                                                                December 16, 2004
                                                                Audit Report Number
                                                                2005-SE-1002




TO:        John C. Weicher, Assistant Secretary for Housing-Federal Housing
              Commissioner, H




FROM:      Frank E. Baca, Regional Inspector General for Audit, Northwest Region, 0AGA


SUBJECT: National City Mortgage Company, Federal Way Branch
         Federal Way, WA
         Nonsupervised Single-Family Mortgagee - Loan Origination


                                   HIGHLIGHTS

 What We Audited and Why

             We audited National City Mortgage Company’s Federal Way Branch Office
             because there had not been any reviews by the U.S. Department of Housing and
             Urban Development’s (HUD) Quality Assurance Division or Office of Inspector
             General (OIG), and the branch office had 25 defaults within the previous 2-year
             period.

             Our objectives were to determine whether the Federal Way Branch acted in a
             prudent manner and complied with HUD regulations, procedures, and instructions
             in the origination of the Federal Housing Administration-insured single-family
             mortgages selected for review, and whether the mortgagee’s quality control plan,
             as implemented, met HUD requirements.

 What We Found
           We found that the lender generally acted in a prudent manner and complied with
           HUD regulations, procedures, and instructions in the origination of the Federal
           Housing Administration-insured single-family mortgages selected for review.
           However, 2 of the 31 loans had a significant underwriting error.

           We also found that the lender did not perform quality control reviews for loans
           that defaulted within the first 6 months from closing. This matter is not addressed
           in this report, but will be explored in a nationwide audit of National City Mortgage
           Company to be conducted later this year.


What We Recommend


           We recommend that the lender indemnify Loan 561-7688322 in the amount of
           $235,660 and repay $5,506 to the Federal Housing Administration insurance fund
           for the loss on the sale of property for Loan 561-7561965.


Auditee’s Response


           The auditee concurred with the finding and recommendations and has taken
           corrective action. The complete text of the auditee’s response, along with our
           evaluation of that response, can be found in appendix B of this report.




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                            TABLE OF CONTENTS

Background and Objectives                                                4

Results of Audit

      Finding 1: National City Mortgage Did Not Always Comply with HUD   5
                 Underwriting Requirements

Scope and Methodology                                                    9

Internal Controls                                                        10

Appendixes
   A. Schedule of Questioned Costs and Funds To Be Put to Better Use     11
   B. Auditee Comments and OIG’s Evaluation                              12




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                     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 insurance to private mortgagees against loss on
mortgages financing homes. The basic home mortgage insurance program is authorized under
Title II, Section 203(b), of the National Housing Act and governed by regulations in Title 24,
Code of Federal Regulations, Section 203.

National City Mortgage Company’s Federal Way Branch is a traditional branch office located in
Federal Way, WA. The branch office was authorized by HUD to originate Federal Housing
Administration single-family loans on September 25, 2000.

National City Mortgage Company’s corporate office is located in Miamisburg, OH. It is a
nonsupervised lender approved under the Direct Endorsement Program to underwrite and close
mortgage loans without prior approval from HUD. National City Mortgage has been an
approved Federal Housing Administration lender since May 27, 1955, and is a wholly owned
subsidiary of National City Corporation, a business unit of National Consumer Finance. The
company has about 8,000 employees and operates 330 lending offices in 37 States. It is the
country’s ninth largest mortgage loan originator, with loan originations in excess of $105 billion
in 2003.

The audit objectives were to determine whether 1) the mortgagee acted in a prudent manner and
complied with HUD regulations, procedures, and instructions in the origination of the Federal
Housing Administration-insured single-family mortgages selected for review and 2) the
mortgagee’s quality control plan, as implemented, met HUD requirements.




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                                RESULTS OF AUDIT

Finding 1: National City Mortgage Did Not Always Comply with
           HUD Underwriting Requirements
For 2 of the 31 loans reviewed, we found the lender’s underwriters did not comply with HUD
Handbook instructions for qualifying borrowers for HUD-insured mortgages. This occurred
because the underwriter (1) did not obtain current income information and (2) mistook an
amended petition for divorce as the final decree and excluded the spouse’s liabilities from the
loan ratio calculations. Because of these underwriter errors, the lender approved two loans for
unqualified borrowers, resulting in a claim of $5,506 and in a $235,660 unnecessary risk of loss
to the HUD-Federal Housing Administration insurance fund.




 Two of the 31 Loans Reviewed Had a
 Significant Underwriting Error


               Underwriter Did Not Obtain Current Income Information - Loan 561-7688322

               Section 2, Effective Income, of HUD Handbook 4155.1, REV-4, CHG-1, issued
               September 28, 1995, requires the underwriter to ensure that the anticipated
               amount of income and likelihood of its continuance must be established to
               determine the borrower’s capacity to repay the mortgage debt.

               Part 2-7 D, Commission Income, of the Handbook also requires significant
               compensating factors for loan approval for individuals whose commission income
               shows a decrease from one year to the next. Additionally, part 2-9 C, Analyzing
               Income, states: “Annual earnings that are stable or increasing are acceptable.
               Conversely, a borrower whose business shows a significant decline in income
               over the period analyzed may not be acceptable even if current income and debt
               ratios meet our guidelines.”

               The borrower’s commission income went from $95,178 in 2000 to $81,632 in
               2001, a decrease of 14.2 percent. Even though the loan did not close until January
               21, 2003, the loan file had no documentation of the borrower’s 2002 income. We
               obtained a copy of the borrower’s 1099 tax form for 2002, which showed an
               income of $51,568. This was a 36.8-percent decline in the borrower’s income
               from 2001 to 2002 and a 45.8-percent overall decline in the borrower’s income
               from 2000 to 2002.

               The loan underwriter stated that she followed the instructions provided by the
               Loan Prospector System and only reviewed the two most recent borrower income
               tax returns that were available at that time, 2001 and 2000. The underwriter

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acknowledged that there had been a decline in the borrower’s income from 2000
to 2001 but felt that the decrease was not significant. The underwriter also stated
that no additional steps had been taken to determine the borrower’s 2002 income.

We recalculated the borrower’s debt to income ratios based on the 2002 income
of $51,568. The results showed a mortgage payment expense to effective income
ratio of 46 percent and a total fixed payment to effective income ratio of 50
percent. These ratios exceeded HUD guidelines. HUD Handbook 4155.1, REV-
4, CHG-1, chapter 2-12, Debt to Income Ratios, paragraph A, Mortgage Payment
Expense to Effective Income, states: “If the total mortgage payment does not
exceed 29 percent of gross effective income, the relationship of the mortgage
payment to income is considered acceptable. A ratio exceeding 29 percent may
be acceptable if significant compensating factors are presented.” The Handbook
also states under paragraph B, Total Fixed Payment to Effective Income: “If the
total mortgage payment and all recurring charges does not exceed 41 percent of
gross effective income, the relationship of total obligations to income is
considered acceptable. A ratio exceeding 41 percent may be acceptable if
significant compensating factors are presented.”

The underwriter did not comply with HUD Handbook requirements when
underwriting this loan. The underwriter noted the decline in the borrower’s
commission income from 2000 to 2001 but took no action to determine the
borrower’s 2002 income. A review of the 2002 income would have shown that
the borrower’s income was continuing to decline, and a recalculation of the
borrower’s debt to income ratios based on the current 2002 income level would
have shown that the borrower did not qualify for a Federal Housing
Administration loan.

Spouse’s Liablities Not Included in Loan Ratio Calculations - Loan 561-7561965

We reviewed the HUD loan file and found that the underwriter did not include the
nonpurchasing spouse’s liabilities in the debt to income ratio calculations.

HUD Handbook 4155.1, REV-4, CHG-1, section 2-2 D, states: “Except for those
obligations specifically excluded by state law, the debts of the non-purchasing
spouse must be considered in the qualifying ratios if the borrower resides in a
community property state or the property to be insured is located in a community
property state.”

The loan was originated in Washington, a community property State.

The HUD loan file showed that the borrower and the nonpurchasing spouse had
signed a petition for dissolution of marriage on July 4, 2002. They had also filed
an amended petition for dissolution of marriage on July 16, 2002. These petitions
listed the property, debts, and liabilities that would be the responsibility of the
petitioner (borrower) and respondent (nonparticipating spouse). However, there
was no final divorce decree in either the HUD or the lender loan file. The
regional underwriting manager stated that a final decree was necessary to exclude

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             the nonparticipating spouse’s debts from the debt to income ratio calculations.
             The loan underwriter said that she was aware that a final divorce decree was
             necessary to exclude the nonpurchasing spouse’s debt from the debt to income
             ratio calculations and that she must have mistaken the amended petition for
             dissolution of marriage for a final divorce decree.

             We contacted the Superior Court County Clerk’s Office where the petition was
             filed. The County Clerk said that the petition for dissolution of marriage had been
             dismissed and that the couple had reconciled. The borrower and nonpurchasing
             spouse were legally married when the loan closed on July 23, 2002.

             As previously mentioned, HUD Handbook 4155.1, REV-4, CHG-1, chapter 2-12,
             states that a mortgage payment to income ratio and a total fixed payment to
             income ratio exceeding 29 percent and 41 percent, respectively, may be
             acceptable if significant compensating factors are presented.

             We combined the borrower’s and nonpurchasing spouse’s debt and recalculated
             the debt to income ratios. The recalculation resulted in a mortgage payment to
             income ratio of 93.7 percent and a total fixed payment to income ratio of 127.7
             percent. However, the underwriter did not provide any compensating factors that
             showed that the ratios were acceptable. If the underwriter had included the
             nonpurchasing spouse’s debt in the debt to income ratio calculations, the borrower
             would not have qualified for the loan.

             This loan went into foreclosure, was conveyed to HUD who sold the property.
             This resulted in a loss on the sale of property of $5,506.


Conclusion


             The lender’s underwriters did not comply with HUD underwriting requirements
             for 2 of the 31 loans reviewed. These underwriting errors were significant.
             National City Mortgage Company should indemnify HUD $235,660 for Loan
             561-7688322 and repay the Federal Housing Administration insurance fund
             $5,506 for the loss for Loan 561-7561965.




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Recommendations



          We recommend that the Assistant Secretary for Housing-Federal Housing
          Commissioner require National City Mortgage to

          1A. Indemnify HUD $235,660 for loan 561-7688322.

          1B. Repay the Federal Housing Administration insurance fund $5,506 for the
              loss to HUD on Loan 561-7561965.

          National City Mortgage Company has entered into an agreement with HUD to
          indemnify loan 561-7688322. They have also repaid $5,506 to HUD for the loss
          to the Federal Housing Administration insurance fund for loan 561-7561965. The
          recommendations are therefore closed. No further action is required.




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                         SCOPE AND METHODOLOGY

Our review covered the period from May 1, 2002, through April 30, 2004, and was modified as
needed to achieve our objectives.

To accomplish our objectives we reviewed (1) relevant statutory, regulatory, and HUD
Handbook requirements; (2) 31 HUD loan files and 19 lender loan files; and (3) the lender’s
internal controls relating to loan origination. In addition, we interviewed lender branch and
corporate staff, as well as HUD personnel.

To determine our sample of loans for review we

   •   Downloaded from HUD’s Neighborhood Watch system a list of all defaulted loans for
       the period May 1, 2002, through April 30, 2004, originated by the Federal Way Branch of
       National City Mortgage Company.
   •   Selected all new loans that had not been paid in full.
   •   Selected refinanced loans not paid in full for which National City Mortgage Company
       was the original lender and the closing date of the original loan was May 1, 2001, or later
       (no more then 3 years from the ending date of our review period).
   •   Included in the sample the original loan and any refinanced loans relating to the original
       loan.

The sample selection method resulted in 31 loans for 21 borrowers, originated by the Federal
Way Branch of National City Mortgage Company.

We performed our review in accordance with generally accepted government auditing standards.




                                                9
                             INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:

   •   Effectiveness and efficiency of operations,
   •   Reliability of financial reporting, and
   •   Compliance with applicable laws and regulations.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.



 Relevant Internal Controls
              We determined the following internal controls were relevant to our audit objectives:

              •       Loan Origination Process - Policies and procedures that management has in
                      place to reasonably ensure that the loan origination process complies with
                      HUD program requirements.

              •       Quality Control Plan - Policies and procedures that management has in place
                      to reasonably ensure implementation of HUD quality control requirements
                      pertaining to loan origination.

              We assessed the relevant controls identified above.

              A significant weakness exists if management controls do not provide reasonable
              assurance that the process for planning, organizing, directing, and controlling
              program operations will meet the organization’s objectives.


 Significant Weaknesses


              Our review found that the lender had not performed required reviews of loans
              defaulting within the first 6 months from closing. However, we did not expand the
              scope of the assignment and perform additional audit work to determine the extent
              and significance of the lender’s noncompliance with HUD requirements. The Office
              of Inspector General (OIG) will address this issue later in a nationwide audit of
              National City Mortgage Company.




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                                       APPENDIXES

Appendix A

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

 Recommendation        Ineligible 1/     Funds To Be Put
     Number                              to Better Use 2/
      1A                                     $235,660
      1B                 $5,506


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/   “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.




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Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




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14
                          OIG Evaluation of Auditee Comments

National City Mortgage Company concurred with the audit finding and recommendations.




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