Issue Date July 5, 2005 Audit Report Number 2005-SE-1006 TO: Brian D. Montgomery, Assistant Secretary for Housing - Federal Housing Commissioner, H FROM: Joan S. Hobbs, Regional Inspector General for Audit, Region X, 0AGA SUBJECT: Washington Mutual Bank, Seattle, WA, Washington Mutual Bank Submitted 609 Late Endorsement Loans with Unacceptable Payment Histories HIGHLIGHTS What We Audited and Why We audited late endorsement payment histories at Washington Mutual Bank (Washington Mutual), Seattle, Washington. We selected Washington Mutual because of its high number of late single-family loan submissions for Federal Housing Administration insurance during calendar years 2002 and 2003. Our objective was to determine whether Washington Mutual’s late requests for endorsement complied with the U.S. Department of Housing and Urban Development’s (HUD) payment history requirements. What We Found From March 2002 to October 2004, Washington Mutual improperly submitted 609 loans to HUD, totaling more than $69 million, for insurance endorsement when the borrowers had delinquent payments within six months before the submission date. This occurred because Washington Mutual did not have adequate controls to ensure that its employees followed HUD’s requirements regarding late requests for insurance endorsement. However, in response to Federal Housing Administration Quality Assurance Division findings, Washington Mutual began planning and implementing improvements to its organization, procedures, and controls in July 2003 and achieved a reduction in late endorsement submissions during 2004. What We Recommend We recommend that HUD take appropriate administrative action up to and including recovery of losses on $1,091,214 in paid claims and indemnification of loans with a total mortgage value of $18,695,819. These loans were not current when submitted for endorsement (see appendix A). We also recommend that HUD take appropriate administrative action against Washington Mutual for violating the requirements in effect at the time when it submitted loans without proper six-month payment histories. Auditee’s Response We provided Washington Mutual a draft report on May 12, 2005, and held an exit conference with Washington Mutual officials on May 26, 2005. Washington Mutual provided written comments on June 10, 2005. The written comments generally agreed with our report findings, but disagreed as to their significance. Washington Mutual disagreed with the extent of recommended indemnifications citing recent changes in HUD’s late submission requirements and the materiality of the internal control weakness for late endorsements. Upon evaluating the written comments, we adjusted our recommendations to reflect HUD’s recent change in the late submission requirements. The complete text of the auditee’s response, along with our evaluation of that response, can be found in appendix B of this report. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: Washington Mutual Submitted 609 Late Endorsement Loans with 5 Unacceptable Payment Histories Scope and Methodology 9 Internal Controls 11 Appendixes A. Schedule of Questioned Costs and Funds to Be Put to Better Use 12 B. Auditee Comments and OIG’s Evaluation 14 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 insurance to private lenders 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 24 Code of Federal Regulations 203. Through the direct endorsement process, the lender underwrites and closes the mortgage loan without prior HUD review or approval. The purpose of late request for endorsement procedures is to ensure that the degree of risk to HUD is no greater than existed at the time of closing, before the mortgage may be endorsed. A request for insurance endorsement is considered late and triggers additional documentation whenever the binder is received by the appropriate HUD home ownership center more than 60 days after mortgage loan settlement or funds disbursement, whichever is later. The Federal Housing Administration believes that this is sufficient time for the mortgage lender to assemble the binder, obtain any final documents or signatures, and ship the binder to the appropriate center for endorsement. Washington Mutual Bank (Washington Mutual) has an administrative office in Seattle, Washington and is a supervised direct endorsement lender approved to originate Federal Housing Administration-insured single-family loans. In a series of acquisitions beginning in 2001, Washington Mutual acquired two federal savings banks that had mortgage lending operations: Bank United and The Dime Savings Bank of New York, FSB, which owned North American Mortgage Company. Washington Mutual also acquired three other mortgage companies: PNC Mortgage Corporation of America, Fleet Mortgage Corporation, and HomeSide Lending, Incorporated. From 2000 to 2003, Washington Mutual’s total home lending and refinancing for conventional and insured mortgages increased from $51.5 billion to $384.2 billion; it decreased to $212.4 billion in 2004. During the period from March 2002 to October 2004, Washington Mutual submitted 64,905 Federal Housing Administration loans worth $7.4 billion with closing dates from January 2002 through June 2004 to HUD for insurance. Our objective was to determine whether Washington Mutual’s late requests for endorsement complied with HUD’s payment history requirements. The audit steps were designed to detect endorsed loans for which the borrowers made late payments before the lender submitted the loan to HUD for insurance endorsement. Washington Mutual provided significant resources and valuable assistance in support of this audit. 4 RESULTS OF AUDIT Finding 1: Washington Mutual Submitted 609 Late Endorsement Loans with Unacceptable Payment Histories From March 2002 to October 2004, Washington Mutual improperly submitted 609 loans, totaling more than $69 million, as late requests for insurance endorsement to HUD when the borrowers had mortgage payment delinquencies within six months before the submission date. This occurred because Washington Mutual did not have adequate controls to ensure its employees followed HUD’s requirements regarding late requests for insurance endorsement. Consequently, the inappropriately submitted loans increased the risk to the Federal Housing Administration insurance fund. HUD Requirements For our audit period, HUD Handbook 4165.1, REV 1, required that loans submitted for insurance endorsement more than 60 days after closing meet certain late request standards. The standards included ensuring that the borrower has made, within the calendar month due, all loan payments up to the time of submission or at a minimum, made six consecutive monthly payments within the calendar month due. They also required that the current month’s payment be received when submitting loans after the 15th of the month. These rules were further clarified by HUD Mortgagee Letter 2004-14. Improperly Submitted Loans After obtaining and reconciling the electronic records from HUD and Washington Mutual, we tested for the presence of unacceptable payment histories on loans submitted as late requests for insurance endorsement. Our automated analysis of the payment histories provided by Washington Mutual and endorsement data from HUD’s systems showed that for the 37,648 loans with late endorsement requests tested, Washington Mutual submitted 1,011 loans with questionable payment histories. Washington Mutual reviewed the 1,011 payment histories and provided reasonable explanations for 402 transactions. Washington Mutual agreed that the remaining 609 loans were submitted as late endorsement requests even though the borrowers had unacceptable payment histories before submission. 5 Late endorsement loans with unacceptable payment histories present a higher risk to the Federal Housing Administration insurance fund in comparison to other loans. Of the 609 loans submitted with unacceptable payment histories, 126 (20.69 percent) have defaulted since insurance endorsement, compared to approximately 4 percent for all Washington Mutual loans. Number Number of of defaults claims as of as of Number March Default March Claims of loans 2005 rate 2005 rate All loans during audit period 2,825,498 201,473 7.13% 29,056 1.03% Originated or sponsored by Washington Mutual from Jan. 1, 2002, through June 30, 2004 64,905 2770 4.27% 373 0.57% Late endorsement loans tested 37,648 1494 3.97% 205 0.54% Late endorsement loans with unacceptable payment histories 609 126 20.69% 17 2.79% As of May 2005, 50 of the 609 loans have been paid in full and no longer represent a risk to the Federal Housing Administration insurance fund. Of the remaining 559 loans, 18 have proceeded to claims, and 541 are still insured and pose a risk to the Federal Housing Administration insurance fund. HUD Changed its Late Loan Submission Requirements On May 17, 2005, after the completion of our audit, HUD issued Mortgagee Letter 2005-23. This Mortgagee Letter changed HUD’s requirements for loans submitted late for endorsement and only requires lenders to certify that the most recent payment that came due was made within the month that the loan was submitted. The Mortgagee Letter eliminates the requirement that loans submitted late are not eligible for endorsement until six consecutive payments have been made prior to and/or within the calendar month due. According to the Mortgagee Letter, “FHA believes its risk at insurance endorsement is based by the status of the mortgage at the time of endorsement and is, therefore, eliminating this requirement in the late endorsement request.” 6 Of the 559 loans reported above, 179 were not current at the time they were submitted to HUD for insurance endorsement and would not have met the new requirements. We provided HUD officials and Washington Mutual with spreadsheets identifying the loans improperly submitted to HUD as late requests for endorsement. We have not included the detailed spreadsheets in this report but can provide them upon request. Controls Needed Improvement Washington Mutual submitted loans with unacceptable payment histories because it did not have a control environment sufficient to ensure that its employees followed HUD’s submission requirements for late endorsements and was not adequately prepared to handle a rapid increase in its single-family lending business. A July 2003 Washington Mutual internal audit report acknowledged weaknesses and recommended improvements to controls over government lending and insurance. As a result, Washington Mutual began reorganizing and developing new controls over its mortgage lending activities. Washington Mutual currently operates two national post closing operations centers in Florence, South Carolina, and Jacksonville, Florida. Since the reorganizations, these centers perform servicing functions as well as certain post closing activities more commonly associated with originating, including obtaining Federal Housing Administration insurance endorsements. Current controls contain new processes to track the status of loans from closing to insurance endorsement. Washington Mutual added to its operating instructions quality control steps that test Federal Housing Administration requirements within the process centers and also centrally by its servicing risk oversight organization. These steps include specific attention to the payment history issue; however, they do not address the requirement that the current month’s payment be received when submitting after the 15th of the month. Washington Mutual agreed to incorporate this additional requirement into its operating instructions and quality control checklists used to check for six months of acceptable payment history. Washington Mutual also acknowledged that it was not prepared to handle the sudden increase in mortgage volume that occurred in 2002. The increase in mortgage volume was due to decreasing interest rates, resulting in an increase in refinance activity. The problem was intensified by the growth of Washington Mutual’s mortgage business from numerous acquisitions of other mortgage lenders. 7 During our audit timeframe of January 2002 to June 2004, Washington Mutual submitted late requests for endorsement for 71 percent of its Federal Housing Administration-insured loans. By the end of 2004, Washington Mutual had reduced the percentage of late requests to fewer than 10 percent for new Federal Housing Administration-insured loans. Recommendations We recommend that the Assistant Secretary for Housing - Federal Housing Commissioner 1A. Take appropriate administrative action against Washington Mutual up to and including recovery of losses on $1,091,214 in paid claims and indemnification of 179 loans, totaling $ 18,695,819, that were not current when submitted for endorsement (see appendix A). 1B. Take appropriate administrative action against Washington Mutual for violating the requirements in effect at the time when it submitted 380 loans without proper six month payment histories. 8 SCOPE AND METHODOLOGY Our review covered the period from January 1, 2002, through June 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) lender and HUD electronic loan records for 64,905 Federal Housing Administration loans, including 93 Federal Housing Administration loan files; and (3) the lender’s internal controls relating to loan origination. In addition, we interviewed the lender’s post closing operations and corporate staff as well as HUD personnel. We relied on computer-processed data provided by Washington Mutual and data contained in HUD’s Single Family Data Warehouse. We conducted tests to ensure that the data were sufficiently reliable to be used in meeting our objectives. To determine our sample of loans for electronic review, we selected all loans submitted by Washington Mutual for Federal Housing Administration insurance that were submitted 66 or more days after closing. By means of HUD’s Single Family Data Warehouse system, we identified 64,905 loans submitted by Washington Mutual having a closing date from January 2002 through June 2004. The following table shows the adjustments made to the initial 64,905 loans: Original Number mortgage of loans amounts Originated or sponsored by Washington Mutual from Jan. 2002 through June 2004 64,905 $7,416,603,694 Submitted less than 66 days after closing 18,709 2,115,694,881 Paid in full 7,866 1,016,975,776 New construction loans, late endorsement requirements not applicable 652 85,769,909 Loans with no electronic payment histories available 30 2,815,501 Late endorsement loans tested 37,648 $4,195,347,627 Late endorsement loans with unacceptable payment histories 609 69,270,511 To test the remaining 37,648 loans for proper submission, we derived a submission date from the dates in HUD’s systems. We considered the submission date to be the date HUD received the 9 loan for insurance endorsement. However, if HUD rejected the loan and returned it to Washington Mutual for correction of deficiencies, we used the date Washington Mutual resubmitted the loan to HUD for review. If HUD’s data did not contain the date Washington Mutual resubmitted the loan for endorsement, we used the endorsement date as the submission date. Our tests also required the use of the loan closing dates to identify those loans submitted to HUD 66 days or more after the loan closed. We compared the closing dates provided by Washington Mutual to those in HUD’s Single Family Data Warehouse and found that some loans had a variance of a few days. We selected 30 files with a variance and determined that while the Single Family Data Warehouse uses the settlement date, Washington Mutual used the later of settlement or funding date, which complies with the latest HUD guidance defined in HUD Handbook 4000.2, REV 3, section 5-1, and clarified in Mortgagee Letter 2004-14. We reviewed the Federal Housing Administration loan files for those loans close to the 66-day cutoff to ensure the variance did not impact our report. We performed our audit work from November 8, 2004, through April 5, 2005. We conducted fieldwork at Washington Mutual’s corporate offices in Seattle, Washington. We performed our review in accordance with generally accepted government auditing standards. 10 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 Based on our review, we believe the following item is a significant weakness: • Washington Mutual did not have adequate controls to prevent or detect payment history inadequacies in its Federal Housing Administration insurance applications. During our audit, we observed corrective actions that greatly reduced the number of late endorsement requests during 2004 (finding 1). 11 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Ineligible 1/ Unsupported Unreasonable or Funds to be put number 2/ unnecessary 3/ to better use 4/ 1A $183,602 $907,612 $18,695,819 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. The amount shown includes loss mitigation incentive payments and net claims. A net claim is the total claim paid by HUD including loss mitigation incentives, less any proceeds from HUD’s sale of the insured property. 2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program or activity when we cannot determine eligibility at the time of audit. Unsupported costs require a decision by HUD program officials. This decision, in addition to obtaining supporting documentation, might involve a legal interpretation or clarification of departmental policies and procedures. The amount shown is for gross claims. A gross claim is the amount of the claim paid by HUD before any recovery from the sale of the property by HUD. At the time of the audit, HUD had not yet sold the properties. 3/ Unreasonable/unnecessary costs are those costs not generally recognized as ordinary, prudent, relevant, and/or necessary within established practices. Unreasonable costs exceed the costs that would be incurred by a prudent person in conducting a competitive business. 4/ “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an Office of Inspector General (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. For this review, these funds consist of loans and guarantees not made because of indemnification. 12 Breakdown of the Questioned Costs for 179 Loans (Recommendation 1A) 13 loans with claims that were not current when endorsed Ineligible Funds to be put to Loss better use mitigation Unsupported (loan amount on currently Case number Net claims incentives (gross claim) insured loans) 052-2472537 $179,279 052-2850637 16,497 091-3840740 128,319 093-5703781 107,536 105-1292493 95,298 161-1980143 122,719 221-3501664 144,041 321-2189164 $71,593 352-4572657 0 381-6405040 33,056 422-2514641 67,544 492-6221004 27,919 581-2395831 86,004 Total claims $172,193 $907,612 166 active loans including loans with loss mitigation payments that were not current when submitted Ineligible Funds to be put to Loss better use mitigation Unsupported (loan amount on Case number Net claims incentives (gross claim) currently insured loans) 011-4894943 $750 $80,900 092-9214003 750 70,443 137-1575710 625 76,835 137-2068450 625 132,915 161-1959939 625 67,446 352-4630533 750 163,706 422-2596045 750 52,577 491-8263572 5,159 107,778 581-2396531 625 94,141 581-2492156 750 93,354 156 others - active * 17,755,724 Total 166 active 11,409 18,695,819 * No claims or loss mitigation paid on these loans 13 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 14 Ref to OIG Evaluation Auditee Comments Comment 1 Comment 2 Comment 3 15 Ref to OIG Evaluation Auditee Comments 16 Ref to OIG Evaluation Auditee Comments Comment 3 17 Ref to OIG Evaluation Auditee Comments Comment 2 18 Ref to OIG Evaluation Auditee Comments Comment 4 Comment 5 Comment 6 19 Ref to OIG Evaluation Auditee Comments Comment 6 Comment 4 20 Ref to OIG Evaluation Auditee Comments Comment 3 21 Ref to OIG Evaluation Auditee Comments 22 Ref to OIG Evaluation Auditee Comments 23 OIG Evaluation of Auditee Comments Comment 1 HUD’s change in policy is not retroactive and was subsequent to when the 609 loans were improperly submitted for insurance endorsement. As discussed in Finding 1, we removed loans that were current at the time of submission from our questioned costs. We maintain that these loans present a higher risk to the Federal Housing Administration insurance fund, as demonstrated in Comment 5 below, and request appropriate administrative sanctions in Recommendation 1B. Comment 2 The table in Finding 1 shows that, for our audit period, all of the Washington Mutual late endorsement loans defaulted at approximately the same rate as all of its Federal Housing Administration-insured loans. However, Washington Mutual’s late endorsement loans with unacceptable payment histories in the prior six months defaulted and proceeded into claims at a rate five times higher. Comment 3 Our evaluation of internal controls is limited to late endorsement payment histories and cannot be extrapolated to other HUD requirements or the system of internal controls, taken as a whole. Our report discloses internal control weaknesses during our audit period that could be routinely detected through automated procedures. Using computer-based analytical tools, we were able to identify all loans submitted late with improper payment histories. Similarly, Washington Mutual could have incorporated computer algorithms into its loan payment history systems that would detect all loans without adequate payment histories. We acknowledge that Washington Mutual has taken the necessary steps to strengthen its controls over the late submission of loans for insurance and state so in both Finding 1 and in the Internal Controls section of this report. Comment 4 We identified 50 loans that were paid in full and excluded from questioned costs in Appendix A. After reviewing Washington Mutual’s support, we determined that their list of 124 paid in full loans includes refinanced loans that still have active insurance. We provided Washington Mutual the opportunity to correct the figures in their response, but they declined. Washington Mutual replied that they believe the status of the original loan does not carry forward when it is refinanced since the original loan is legally extinguished. Because Washington Mutual declined to include refinanced loans, the remaining figures in their response are understated. HUD Handbook 4000.4 REV-1, CHG-2 Section 5-8 discusses indemnification agreements. It states in part, “These agreements essentially guarantee that the Department will not suffer a loss on the loans. The mortgagee agrees to abstain from filing a claim or to reimburse the Department if a subsequent holder files a 24 claim. The term of the agreement varies with the severity of the violation, typically they are effective for five years from the date of endorsement.” Examples of standard indemnification agreements include a paragraph explaining that the indemnification extends to streamline refinanced loans even if refinanced by another lender. A streamline refinance relies on the original loan’s underwriting and insurance. Therefore, Washington Mutual is still responsible for the original underwriting and insurance endorsement submission of these active, refinanced loans. Comment 5 We identified 559 loans that are active according to HUD systems. Of these loans, 380 were current at the time of endorsement submission and would comply with the new HUD endorsement rules. However, these loans recorded significantly higher rates of default and claims than other loans, producing 50 defaults and 4 claims, or 13.16 percent and 1.05 percent respectively. Number Number of of defaults claims as of as of Number March Default March Claims of loans 2005 rate 2005 rate Late endorsement loans tested 37,648 1494 3.97% 205 0.54% Loans that were current when submitted to HUD 380 50 13.16% 4 1.05% Current loans that later established 6 months of payment history 288 17 5.90% 1 0.35% Current loans that did not establish 6 months of payment history 92 33 35.87% 3 3.26% Comment 6 We identified 179 loans that were not current at the time of endorsement submission and would not comply with current endorsement rules. These loans recorded 9 times as many defaults and 13 times as many claims compared to other loans tested. As shown below, even the loans that established a 6 month payment history defaulted 6 times more often and had 12 times the claim rate than the other loans tested. Therefore, we do not agree that these loans should not be indemnified because there is no basis to assume there is less risk for these loans. 25 Number Number of of defaults claims as of as of Number March Default March Claims of loans 2005 rate 2005 rate Late endorsement loans tested 37,648 1494 3.97% 205 0.54% Non-current loans that later established 6 months of payment history 92 21 22.83% 6 6.52% Non-current loans that did not establish 6 months of payment history 87 43 49.43% 7 8.05% Total non-current loans 179 64 35.75% 13 7.26% 26
Washington Mutual Bank, Seattle, WA, Washington Mutual Bank Submitted 609 Late Endorsement Loans with Unacceptable Payment Histories
Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-07-05.
Below is a raw (and likely hideous) rendition of the original report. (PDF)