oversight

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)

                                                                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.




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                            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.


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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.




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                             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




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            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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