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)