Issue Date
July 17, 2006
Audit Report Number
2006-LA-1014
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 Failed to Ensure Underwriting Certifications for Federal
Housing Administration Loans Were Accurate
HIGHLIGHTS
What We Audited and Why
We performed an audit of KB Home Mortgage Company (KB) after a prior HUD
Office of Inspector General (OIG) audit found indications that KB underwriters
inaccurately certified that they underwrote certain Federal Housing
Administration loans. The objective of the audit was to follow up on this
potential violation and determine the extent to which it occurred.
What We Found
KB failed to ensure underwriter certifications for Federal Housing Administration
loans were accurate. In an estimated 206 of 543 HUD loans targeted for review,
KB’s underwriters certified that they personally underwrote the loans when they
did not. As a result, HUD has no assurance that these loans were properly
underwritten to ensure they were eligible for Federal Housing Administration
mortgage insurance; therefore, HUD was exposed to unnecessary insurance risk
for these loans.
What We Recommend
We recommend that HUD’s assistant secretary for housing require KB, for any
current or future FHA loan operations for which KB may exercise management
control, to ensure that underwriter certifications for HUD-insured loans are only
executed by direct endorsement underwriters after personally reviewing the
appraisal, credit application, and all associated documents and using due diligence
in underwriting the mortgage.
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
report.
Auditee’s Response
We provided KB a draft report on June 8, 2006. We offered to hold an exit
conference to discuss the finding in detail, yet KB declined this offer. KB
provided written comments on June 26, 2006. The complete text of KB’s
response, along with our evaluation of that response, can be found in appendix A
of this report.
2
TABLE OF CONTENTS
Background and Objectives 4
Results of Audit
Finding 1: KB Failed to Ensure Underwriter Certifications for Federal Housing 5
Administration Loans Were Accurate
Scope and Methodology 8
Internal Controls 9
Followup on Prior Audits 10
Appendixes
A. Auditee Comments and OIG’s Evaluation 11
3
BACKGROUND AND OBJECTIVES
The U.S. Department of Housing and Urban Development’s (HUD) Federal Housing
Administration provides mortgage insurance on home loans made by its approved lenders.1
This insurance provides lenders with protection against losses if the homeowner defaults on
the loan.
KB Home Mortgage Company (KB) originated Federal Housing Administration, U.S.
Department of Veterans Affairs, and conventional loans primarily for customers purchasing
newly constructed homes from its parent company, KB Home. Until recently, KB operated
11 branch offices in nine states and regional operations centers (for processing and
underwriting) in Las Vegas, Nevada, and San Antonio, Texas. KB’s corporate office was
located at 10990 Wilshire Boulevard, Los Angeles, California. KB has been a HUD-
approved lender since April 15, 1965, and was authorized to originate loans under HUD’s
direct endorsement program.
KB was a wholly owned subsidiary of the builder/developer KB Home. However, the assets
of KB have been sold to Countrywide Home Loans, and a new joint venture company named
Countrywide KB Home Loans was formed by KB Home and Countrywide Home Loans to
make residential loans to KB Home (builder) customers.
Our audit objective was to determine whether KB underwriters inaccurately certified that
they underwrote certain Federal Housing Administration loans. This audit was performed
after a prior HUD Office of Inspector General (OIG) audit (audit report number 2005-LA-
1011) found potential problems in this area.
1
The Federal Housing Administration mortgage insurance program is authorized under Title II, Section 203(b), of
the National Housing Act and is governed by regulations in 24 CFR [Code of Federal Regulations], Part 203.
4
RESULTS OF AUDIT
Finding 1: KB Failed to Ensure Underwriter Certifications for Federal
Housing Administration Loans Were Accurate
KB failed to ensure underwriter certifications for Federal Housing Administration loans were
accurate. Based upon statistical sample testing, we found that in an estimated 206 of 543 HUD
loans targeted for review, KB’s underwriters certified that they personally underwrote the loans
when they did not. As a result, HUD has no assurance that these loans were properly
underwritten to ensure they were eligible for Federal Housing Administration mortgage
insurance; therefore, HUD was exposed to unnecessary insurance risk for these loans. This
problem occurred because KB failed to implement adequate policies and procedures to ensure
HUD’s underwriting requirements were followed.
HUD Relies upon Lenders to
Underwrite HUD-Insured Loans
Lenders approved to originate HUD-insured loans, known as direct endorsement
lenders, underwrite and close individual mortgage loans without any detailed
technical underwriting review performed by HUD. Therefore, HUD relies upon
the lenders and their underwriters to determine the homebuyers’ credit and
capacity to repay the mortgage and to ensure the loans meet HUD’s insurance
program requirements. The lenders’ underwriters must sign a certification (HUD
form 92900A) that they personally reviewed the loan documents and used due
diligence in underwriting the mortgage. The underwriting review by approved
lenders is a critical component of HUD’s home loan insurance program and is
needed to limit HUD’s risk of losses due to foreclosures or collection difficulties
on the loans it insures. Additionally, HUD collects data to monitor the
performance of the direct endorsement underwriters, and, therefore, it is important
that HUD has correct data indicating which underwriter performed the
underwriting analysis and made the decision on the loans it insures.
206 of 543 Loans Were
Inaccurately Certified by KB
Underwriters
Based upon statistical sample testing, we determined an estimated 206 HUD-
insured loans originated by KB contained inaccurate underwriter certifications.
The statistical sample testing included a review of 104 HUD loans selected from a
targeted group of 543 loans originated by KB during the period September 1,
5
2002, through August 31, 2003. These 543 loans were selected for review
because HUD’s automated records listed a different underwriter than KB’s
automated records indicating the information submitted to HUD may not be
accurate. For each of the sample loans, we reviewed the underwriter’s
certification form (HUD form 92900A), KB’s underwriter conditions sheet, and
the mortgage credit analysis worksheet and interviewed the underwriters who
signed the underwriter certification forms.2
In 35 of the 104 loans reviewed (projected to 206 of the 543 loans targeted for
review), KB’s underwriters signed the underwriter certification form but stated
they did not fully underwrite the loans as required. In these cases, the
underwriters stated they only performed a limited or cursory review that included
clearing remaining underwriting conditions (if any) and signing off of the loan
without a complete review of the loan file as required. Accordingly, KB failed to
ensure that the underwriter certifications for these Federal Housing
Administration loans were accurate.
KB Failed to Implement
Adequate Policies and Procedures
Most of the underwriters interviewed stated it was company practice for
underwriters to sign off on loans for other underwriters, who had left the company
or who were out of the office temporarily, without performing a thorough
underwriting review. Some of the underwriters interviewed stated they were
asked by KB management to not reunderwrite the loans but, rather, only to clear
any remaining conditions before signing the underwriter certifications. Some of
the underwriters interviewed stated they were routinely given underwriter
certification forms and asked to sign them without seeing the loan file.
Inaccurate Certifications
Increased HUD’s Insurance Risk
Because KB’s underwriters signed underwriting certification forms without
personally underwriting the loans, HUD has no assurance that these loans were
properly reviewed to ensure they were eligible for Federal Housing
Administration mortgage insurance. Therefore, HUD was exposed to
unnecessary insurance risk for these loans. Also, since the affected loan files did
not correctly indicate which underwriter performed the underwriting analysis and
made the decision, HUD’s ability to monitor the performance of these
underwriters was limited.
2
The statistical sample testing is explained further in the “Scope and Methodology” section of this audit report.
6
Conclusion
KB failed to ensure underwriter certifications for Federal Housing Administration
loans were accurate for an estimated 206 of 543 HUD loans targeted for review.
This was caused by KB’s failure to follow HUD’s underwriting requirements and
resulted in additional insurance risk to HUD for the affected loans. It also limited
HUD’s ability to monitor underwriters’ performance.
Recommendations
We recommend that the assistant secretary for housing - federal housing
commissioner
1A. For any current or future FHA loan operations for which KB may exercise
management control, require KB to ensure that underwriter certifications for
HUD-insured loans are only executed by direct endorsement underwriters after
personally reviewing the appraisal, credit application, and all associated
documents and using due diligence in underwriting the mortgage.
7
SCOPE AND METHODOLOGY
Our audit testing related to underwriter certifications (finding 1) generally covered the period
from September 1, 2002, through August 31, 2003. During this period, KB originated 5,970
Federal Housing Administration loans for amounts totaling approximately $853 million.
The objective of the audit was to determine whether KB underwriters accurately certified that
they underwrote certain Federal Housing Administration loans. To accomplish our audit
objective, we
• Selected and reviewed a statistical sample of HUD loans underwritten by KB to
determine whether underwriter certifications were accurate.
• Interviewed former KB underwriters and managers.
• Reviewed data obtained during a recent HUD OIG audit related to KB loan
originations.
We also performed audit steps to determine whether KB allowed ineligible loan settlement fees.
This was another potential problem area identified during the prior HUD OIG audit of KB loan
origination procedures (audit report number 2005-LA-1011). This area will be separately
addressed at a later date.
The following statistical sampling procedures were used to obtain the projected number of
inaccurate underwriter certifications (finding 1). We identified 543 Federal Housing
Administration loans with underwriter approval dates on and between September 1, 2002, and
August 31, 2003, for which HUD’s automated records indicated a different underwriter than
KB’s automated records. The period reviewed was determined based upon testing conducted
during a prior HUD OIG audit of KB, which identified potential problems with the underwriter
certifications. We separated the 543 loans into two groups according to the reported underwriter
approval date (416 sample loans approved before April 16, 2003, and 127 approved on or after
this date). We pulled a statistical sample that included 104 of the 543 loans (59 sample loans
approved before April 16, 2003, and 45 approved on or after this date), obtained related
documents from KB’s loan files, and interviewed all but one of the underwriters associated with
these loans. One underwriter associated with 9 of the 104 (8.7 percent) sample cases selected
refused our request for an interview. Rather than selecting replacement sample cases for these
nine loans, we counted these untested sample items as valid and correct underwriter certifications
when projecting the sample results. The confidence level for the sample was 90 percent, and the
overall sampling error was 7.8 percent. The sample testing results for each stratified group (59
sample loans approved before April 16, 2003, and 45 approved on or after this date) were
projected separately and then combined.
We performed our fieldwork from September 2005 through April 2006. We performed our audit
in accordance with generally accepted government auditing standards.
8
INTERNAL CONTROLS
Internal controls are an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:
• Effectiveness and efficiency of operations,
• Reliability of financial reporting, 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
No testing of controls was performed during this followup audit since KB no
longer originates any loans and the purpose of this followup review was to
develop the nationwide monetary impact and possible penalties for past
management control weaknesses. Although we did not perform any tests of
controls, we did find KB’s parent company, KB Home Mortgage operations, to
some extent, are continuing as they have been assumed by another entity and
remain partially under the same ownership. Accordingly, we are reporting the
significant control weakness noted below.
Significant Weaknesses
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.
Based on our review, we believe the following item is a significant weakness:
• KB’s controls were not adequate to ensure underwriter certifications for
Federal Housing Administration loans were accurate (see finding 1).
9
FOLLOWUP ON PRIOR AUDITS
Prior Report Title and Number
We issued audit report number 2005-LA-1011 on September 26, 2005. The report contained one
finding that KB did not originate 19 loans in compliance with HUD requirements and prudent
lending practices. This prior audit, related to KB’s loan origination process, also found indications
that 1) KB allowed ineligible loan settlement fees, and 2) KB underwriters inaccurately certified
that they underwrote certain Federal Housing Administration loans. The current audit was
performed to follow up on these potential problems.
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APPENDIXES
Appendix A
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
11
12
13
Comment 1
Comment 2
14
Comment 3
15
Comment 4
16
17
OIG Evaluation of Auditee Comments
Comment 1 KB’s response states they were unable to conduct their own review of the loan
files referenced in the report or interview the associated underwriters. KB was
provided a copy of the draft report and HUD OIG offered to hold an exit
conference to discuss the findings in detail, yet KB declined this offer. Also, KB
was provided a list of the 104 sample loans, accessed the loan file records and
provided OIG the FHA loan file documents needed for OIG’s audit procedures.
Therefore, KB had copies of all of the documents reviewed and had knowledge of
which KB underwriters were involved in the testing. KB could have contacted
any or all of these 15 underwriters to discuss the sample loans. KB’s decision not
to perform its own testing on the sample loans, however, does not affect the
validity of the results described in the audit report.
For clarification, HUD OIG interviewed 14 of the 15 underwriters associated with
the 104 sample loans and found 10 of these underwriters signed certifications
without fully underwriting the loans.
Comment 2 KB’s Response questions the use of statistical sampling procedures and notes that
a 90% confidence level is “hardly a firm confidence level”. HUD OIG disagrees
with this opinion and finds the use of a 90% confidence level is a generally
accepted method for extrapolating statistical sample results and was fully
appropriate for the audit objectives in this case. The statistical procedures are
disclosed in the scope and methodology section of the audit report. It should be
noted that HUD OIG pursued a statistical sampling methodology only after KB
refused OIG’s request to provide loan file documents for all of the 543 loans
selected for review claiming it would be too burdensome to retrieve these
documents. Furthermore, while arguing that providing records for all 543 loans
would be too burdensome, KB agreed that the sample of 104 loans would be
sufficient to draw conclusions. In an email message dated October 7, 2005 from a
KB representative to HUD OIG, KB stated the following:
Comment 3 KB’s response notes that its official company policy was to comply with HUD
requirements for signing underwriter certifications. As presented in the audit
report finding, the practices at KB did not always adhere to such a policy. The
audit report notes that most of the underwriters interviewed stated it was company
18
practice for underwriters to sign off on loans for other underwriters, who had left
the company or who were out of the office temporarily, without performing a
thorough underwriting review.
Comment 4 KB’s response states KB can not implement the report recommendation since its
current role is that of an investor and not as an active participant in the day-to-day
operations of its new joint venture mortgage company. This new joint venture
arrangement is noted in the audit report. We revised the report recommendation
based upon KB’s comments. The purpose of the recommendation is to place KB
on notice of the violations and ensure any current and/or future FHA loan
activities of KB do not result in recurrence of the problems noted in the report.
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KB Home Mortgage Failed to Ensure Underwriting Certifications for Federal Housing Administration Loans Were Accurate
Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-07-17.
Below is a raw (and likely hideous) rendition of the original report. (PDF)