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. 10 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. 19
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)