Issue Date July 26, 2006 Audit Report Number 2006-LA-1018 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: First Magnus Financial Corporation Did Not Comply with HUD Guidelines When Underwriting Six Federal Housing Administration-Insured Loans HIGHLIGHTS What We Audited and Why We completed an audit of loan origination and business practices at the First Magnus corporate office, in Tucson, Arizona. The objective of the audit was to determine whether First Magnus originated and processed Federal Housing Administration-insured loans in accordance with applicable HUD rules and regulations. What We Found First Magnus did not comply with U.S. Department of Housing and Urban Development (HUD) requirements when underwriting six Federal Housing Administration-insured loans as the sponsoring lender. What We Recommend We recommend the Assistant Secretary for Housing-Federal Housing Commissioner take appropriate administrative action regarding First Magnus. This action, at a minimum, should include indemnifying HUD $95,151 for estimated losses incurred for the three loans processed and originated outside HUD rules and regulations. 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 audit. Auditee’s Response We provided the draft report to First Magnus on June 20, 2006, and held an exit conference on July 11, 2006. First Magnus generally disagreed with our report. The complete text of the auditee’s response, along with our evaluation of that response, can be found in appendix B of this report. Due to the volume of the exhibits to the auditee’s response, the exhibits will be made available upon request. 2 TABLE OF CONTENTS Background and Objective 4 Results of Audit Finding 1: First Magnus did not follow HUD requirements when underwriting 5 six Federal Housing Administration-insured loans Scope and Methodology 10 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 13 C. Schedule of Deficiencies 23 D. Civil Money Penalties 24 3 BACKGROUND AND OBJECTIVE Background First Magnus Financial Corporation (First Magnus) is a wholesale lender that was incorporated and approved by the U.S. Department of Housing and Urban Development (HUD) as a non- supervised lender in 1996. Its corporate office is located in Tucson, Arizona. As of April 24, 2006, First Magnus had 333 active branch offices and sponsors 2,031 Federal Housing Administration-approved loan correspondents. As a wholesale lender, First Magnus underwrites and funds loans received by its loan correspondents and other brokers. First Magnus operates First Magnus Lender Services, which provides the following services to its customers: full-service credit reporting, flood determination, appraisals, full-service insurance and title/escrow. In addition, First Magnus operates Charter Funding (Charter), the retail-lending arm of the mortgage company. Charter’s corporate office is located in Tucson, Arizona. Charter has affiliates in Arizona that provide the following services to its customers: appraisals, insurance, credit reporting and title/escrow. First Magnus’ Tucson corporate office originated 503 Federal Housing Administration-insured loans totaling more than $56 million, between January 1, 2003, and December 31, 2005. The chart below shows the current status of those loans. Description Number Percentage Amount HUD loans originated 480 95.0 $54,245,204.00 Defaults reported 22 4.37 $2,430,682.00 Loans to claim 1 0.02 $90,081.00 We reviewed 8 of the 503 loans originated during this period. Objective Our objective was to determine whether First Magnus originated and processed Federal Housing Administration-insured loans in accordance with applicable HUD rules and regulations. 4 RESULTS OF AUDIT Finding 1: First Magnus did not follow HUD requirements when underwriting six Federal Housing Administration-insured loans First Magnus did not comply with HUD rules, regulations, procedures and instructions in the processing and origination of six Federal Housing Administration-insured single family loans. The lender disregarded HUD requirements when it originated and processed the six Federal Housing Administration-insured loans sampled during our review. As a result, HUD has been exposed to unnecessary insurance risks because the lender approved borrowers for Federal Housing Administration-insured loans totaling $640,517 for which the borrowers may not be able to make the monthly mortgage payments. This amount represents the total insured amount for the six of eight loans reviewed that had deficiencies. False lease and third-party document handling First Magnus did not verify the borrower’s loan documentation and approved a loan based on false documents for Federal Housing Administration insured-loan #023-2090700. The First Magnus loan file had a rental agreement that indicated the borrower owned a previously occupied mobile home and would collect a rental amount of $550 per month. The claimed rental income generated from the rental property was disclosed on the borrower’s loan application as supplemental income to support the borrower's ability to make monthly mortgage payments on the subject property. The lender used his information, along with other factors and information, to approve the borrower for the $90,538 loan. However, we did not find a copy of the lease agreement in the Federal Housing Administration loan file submitted to HUD. During an onsite visit, the borrower said he never owned the property and said he was a renter. The borrower stated that the property was a trailer home, but was unsure whether it still existed. He also stated he did not know why the application would show rental earnings for the property. Based on the discussion, it appears the lease agreement found in First Magnus' loan file was a false document. In addition, a real estate firm handled and faxed documents to First Magnus for loan approval and received a $2,760 commission. Those documents included W-2s, pay stubs, and a 1040A Federal Income Tax form. 5 HUD Handbook 4155.1 REV-5, Paragraph 3-1, states, no document used in the processing or underwriting of a loan may be handled or transmitted by or through an interested third party to the transaction. These documents should not have been accepted and this loan should not have been submitted for endorsement until documents that had not passed through interested third parties had been obtained and re-verified. In addition, Mortgagee Letter 2001-01 holds lenders responsible for verifying the authenticity of those documents faxed to it through telephone verifications. There was no evidence First Magnus complied with these requirements. A prior HUD Quality Assurance Division review report dated February 2004 cited First Magnus for the same practice of allowing third parties to handle borrower documents used to approve Federal Housing Administration-insured loans. Incorrect branch identification number used to originate and process loans Five of the eight Federal Housing Administration-insured loans reviewed were originated and processed using incorrect HUD approved branch identification numbers (see appendix C). In addition, one of the loans (#022-1767707) was originated and processed by an unapproved branch by using the corporate office’s identification number (7979400002). According to Neighborhood Watch, HUD's single-family database system, the branch was not HUD approved to originate and process Federal Housing Administration-insured loans until January 2004. However, Federal Housing Administration-insured loan #022-1767707 was originated and processed in November 2003 by the unapproved branch. As part of processing the loan, loan processors entered both the lender identification number and borrower information obtained from the loan officer into the lender’s own Point computer system. The information and lender identification number is downloaded from the Point system into an automated underwriting system for use in approval of the respective loan. First Magnus' failure to use the correct lender identification number to originate and process Federal Housing Administration-insured loans compromises HUD's ability to track the performance of HUD-approved branch offices through systems such as Neighborhood Watch. Further, unapproved or problem branches may use HUD- approved branch office’s lender identification numbers to process Federal Housing Administration-insured loans. HUD handbook 4060.1 REV-1 states lender identification numbers are assigned to each branch and lender for exclusive use in originating and processing Federal Housing Administration-insured loans and monitoring purposes. 6 During our audit, First Magnus acknowledged this problem and reportedly corrected this issue. A prior HUD Quality Assurance Division review report dated February 2004 cited First Magnus for the same practice of using the incorrect lender identification numbers to originate and process Federal Housing Administration- insured loans. In response to the Quality Assurance Division report, in April 2004 First Magnus indicated it would correct the problem. However, a second Quality Assurance Division report was issued in October 2005 and First Magnus continued to disregard HUD’s requirement regarding exclusive use of lender identification numbers. In its January 2006 response to the Quality Assurance Division finding, First Magnus stated that it concurs with the finding and its Compliance Department has sent emails to each branch providing them with correct identification numbers. However, we have no information confirming the problem has actually been corrected. Lack of documentation for source of gift funds Federal Housing Administration-insured loan (#022-1719928) had insufficient documentation to determine whether the $13,300 in gift funds was provided from the donor to the borrower. The file did not include a withdrawal document (e.g. bank statements, transaction slips) or cancelled check as is required by Mortgagee Letter 00-28 and as a result, the underwriting/approval did not comply with HUD requirements. HUD Mortgagee Letter 2000-28 requires adequate documentation to support the donor’s ability to provide gift funds to the borrower. A prior HUD Quality Assurance Division report, dated February 2004, cited First Magnus for failing to obtain adequate documentation to support gift funds provided to the borrower. Spouse’s debt not included in loan approval One streamlined refinanced Federal Housing Administration-insured loan (#022- 1759781) was tied to a prior Federal Housing Administration-insured loan (#022- 1658467) that did not include the debts of the borrower's spouse. Both loans were processed and originated by First Magnus. The spouse's debt was not submitted to the lender’s Automated Underwriting System in order to approve the original purchase loan. 7 HUD Handbook 4155.1 REV-4 Paragraph 2-2D states "...the debts of the non- purchasing spouse must be considered in the qualifying ratios if the borrower resides in a community property state." Both the borrower and the non-purchasing spouse reside in the state of Arizona, which is a community property state. The non-purchasing spouse's debt should have been considered in determining the debt-to-income ratios, as well as whether the purchased loan should have been approved. If the lender had included the non-purchasing spouse's debt of $1,532 instead of $1,212 determined by the automated underwriting system, the borrower's debt-to-income ratio would have increased from 36/53 to 36/66. The $320 difference ($1,532 minus $1,212) in excluded debt resulted in a 24.5 percent increase in the ratio. This increase in the borrower’s debt-to-income ratio may have adversely affected the borrower's ability to pay the monthly mortgage to the Federal Housing Administration- insured loan. Further, the borrower would not have been able to obtain a refinanced Federal Housing Administration-insured loan if the original purchase loan had not been approved. Conclusion First Magnus disregarded HUD requirements by using false documentation, incorrect branch indentification numbers, third party handling of documents, lack of documentation for gift sources and excluding spouse’s debts to originate and process six of the eight loans in our sample (see appendix C). HUD Quality Assurance Division reports issued in February 2004 and October 2005 cited similar deficiencies against the lender. Yet, there was no information to confirm whether the lender actually corrected the deficiencies. These deficiencies caused unnecessary risk to the Federal Housing Administration’s insurance fund totaling $640,517. In addition, the deficiencies increased the risk of borrower’s defaulting or foreclosing on the Federal Housing Administration-insured loans. Recommendations We recommend the assistant secretary for Housing-Federal Housing Commissioner require First Magnus to 1A. Indemnify HUD $25,408 for estimated loss on Federal Housing Administration-insured loan #023-2090700 which was approved based on a false lease and documents handled by a real estate firm (see appendix C). 8 1B. Indemnify HUD $41,232 for estimated loss on Federal Housing Administration-insured loan #022-1767707, which was originated and processed by an unapproved branch (see appendix C). 1C. Indemnify HUD $28,511 for estimated loss on Federal Housing Administration-insured loan #022-1759781 (see appendix C). This Federal Housing Administration-insured refinance loan was tied to the original Federal Housing Administration-insured purchase loan #022-1658467, which was approved without taking into consideration the spouse's debt. 1D. Ensure and provide evidence that all branch offices, including loan processors and loan officers, now use the correct lender identification number when originating and processing loans. 1E. Pay civil money penalties for the four loans identified in this report that were originated and processed using the incorrect branch lender identification number. This is also a repeated finding from previous HUD Quality Assurance Division reviews (see appendix D). 9 SCOPE AND METHODOLOGY We performed audit work from October 2005 through May 2006. The audit period covered January 2003 through December 2005. To accomplish our objective, we • Reviewed eight Federal Housing Administration-insured loans that were originated by First Magnus during the period of January 2003 through December 2005; • Interviewed First Magnus employees, independent contract loan officers and processors and sponsor underwriters; • Interviewed borrowers, title company employees, neighbors and borrowers’ employers; • Reviewed First Magnus financial records, employee personnel files and employee benefits documents; and, • Reviewed public records and databases. We obtained information from HUD’s Neighborhood Watch system that showed there were 23 defaults reported during the audit period. Of those 23, there was one loan in claim status, two loans that were paid off and two loans indemnified by HUD. We selected eight loans for review. During the review, we identified information indicating Real Estate Settlement Procedures Act violations by First Magnus involving the payment of quality incentives, also known as volume- based incentives, to brokers for originating and processing federally related mortgage loans. The results will be addressed later in a separate report. 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, • Compliance with applicable laws and regulations and • Safeguarding of assets. 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: • Reliability of loan documents used to approve the Federal Housing Administration-insured loans. • Processing and origination of Federal Housing Administration-insured loans in compliance with HUD rules and regulations. • Safeguarding Federal Housing Administration-insured loans from high risk exposure. 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: • First Magnus disregarded applicable HUD rules and regulations when it processed and originated Federal Housing Administration-insured loans. 11 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Funds To Be Put Number to Better Use 1/ 1A $25,408 1B $41,232 1C $28,511 1/ “Funds to be put to better use” are estimates of amounts that could be used more efficiently if an Office of Inspector General (OIG) recommendation is implemented. This includes reductions in outlays, deobligation of funds, withdrawal of interest subsidy costs, costs not incurred by implementing recommended improvements, avoidance of unnecessary expenditures noted in preaward reviews, and any other savings which are specifically identified. Implementation of our recommendation to indemnify loans that were not originated in accordance with Federal Housing Administration requirements will reduce Federal Housing Administration’s risk of loss to the insurance fund. The amount above reflects that, upon sale of the mortgaged property, Federal Housing Administration’s average loss experience is about 29 percent of the claim amount, based upon statistics provided by HUD. 12 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 13 Comment 1 Comment 2 Names have been redacted for privacy 14 Comment 3 Comment 4 Comment 5 15 16 17 Comment 6 Comment 7 18 Comment 8 19 OIG Evaluation of Auditee Comments Comment 1 Contrary to HUD requirements, an interested third party (Realtor) handled and faxed documents. We interviewed and confirmed with the borrower that he did not own the mobile home and instead was a renter. We have no indicators that the borrower created the false lease and believe it was created by an interested third party. Regarding the lender's claim that the supplemental credit report showed a secured credit line of $7,707 for an asset it contends was for a mobile home, the credit report did not state that it was for a mobile home or any other type of residence. It could have been for an automobile, a secured credit card, etc., but the lender did not practice due diligence to follow up and determine the ownership of the claimed asset. The underwriter stated she did not notice that many of the documents were faxed and that without the lease income the debt-to-income ratios would have been too high to qualify the borrower for the mortgage. Comment 2 OIG is conducting a follow-up of the alleged comments and have interviewed both lender staff and OIG staff. We take such allegations of derogatory and offensive remarks very seriously. Once the review is completed, we will take whatever actions are deemed appropriate. Comment 3 During a follow-up discussion, the underwriter stated she did not notice the questioned documents were faxed by a real estate company when the loan was underwritten. HUD Handbook 4000.4 REV-1 CHG-2 (July 13, 1994), Paragraph 2-4 provides a list of responsibilities the underwriter must take. Among them, the underwriter must have an awareness of the warning signs that may indicate irregularities, and an ability to detect fraud, as well as the responsibility that the underwriting decisions are performed with due diligence in a prudent manner. This responsibility includes ensuring a third party (e.g. real estate) is not involved in the handling of borrower documents. In addition to the referenced HUD Handbook 4155.1 REV-5, Paragraph 3-1 criteria in the report, the handbook states that lenders may not accept or use documents relating to the credit, employment or income of borrowers that are handled by or transmitted from or through interested third parties (e.g., real estate agents, builders, sellers) or by using their "equipment" (e.g., fax machines, E- mail). The use of the realtor's fax machine to transmit borrower's document to the lender constitutes a violation of the HUD handbook. For this loan, after interviewing the borrower we determined that the lender received and used a false lease to improperly qualify the borrower for the loan (see comment 1 above for additional comments on this loan). 20 Comment 4 First Magnus provided us with documentation showing the branch (Long Mortgage) was approved on January 20, 2004. We revised the report to reflect the actual date HUD approved the branch. However, the facts remain that the branch office was not approved at the time loan number 022-1767707 was originated and processed in November 2003. Comment 5 The issue of incorrect branch identification numbers being used to originate and process loans was in the Draft Report because it had been previously addressed during HUD's Quality Assurance Division site visits in November 2003, December 2003 and July 2005 but the practice had continued. On 7/12/06, subsequent to our exit conference to confirm statements made to us in various interviews, First Magnus provided us documentation and evidence to show it implemented corrective actions in August/September 2005 and February 2006 to ensure branches used the correct branch identification number to originate and process FHA mortgage loans. We reviewed the documentation and evidence presented at the exit conference and concluded it to be sufficient to resolve this part of the finding and the related recommendation. Recommendation 1D will be considered closed upon report issuance. Comment 6 First Magnus contends the documents in the loan file for gift funds provided to the borrower were sufficient. The facts in the report are correct and we disagree with First Magnus' statement that the report is incorrect. Mortgage Letter 2000- 28 requires that if the donor purchased a cashier's check as a means of transferring the gift funds, then the donor must provide a withdrawal document (e.g. bank statements, withdrawal slip) or canceled check for the amount of the gift showing the funds came from the donor's personal bank account. Neither the First Magnus file nor the HUD loan file have the required documentation to show the gift funds came from the donor's personal bank account. In addition, First Magnus misquoted Mortgagee Letter 2000-28 in the report. Mortgage Letter 2000-28 states the lender must, not may (as mentioned by First Magnus), be able to determine that the gift funds were not ultimately provided from an unacceptable source and were indeed the donor's own funds. There was no evidence First Magnus obtained the necessary documentation to determine whether the gift funds were from an unacceptable source and were actually the donor's own funds. Comment 7 Even though First Magnus agreed the underwriter who approved the purchase loan in 2002 did not include the husband's debt, it contends the refinance loan was correctly underwritten and approved and should not be indemnified. The lender's response fails to mention that this was a streamline refinance and as such HUD allows these to be underwritten without mortgage credit underwriting and no 21 credit report with the presumption that the original HUD-insured loan met HUD's requirements. The borrower's ability to obtain a stream-lined refinance loan was predicated on First Magnus' approval of the original purchase loan in 2002. According to HUD's Neighborhood Watch System, as of June 6, 2006, the loan was in default and the last payment received was for January 2006. Comment 8 First Magnus incorrectly assumed the amount in civil penalties was $151,660 for the five loans identified in the report (Schedule D) as having been processed using the incorrect branch ID. HUD can impose civil money penalties up to the maximum amount of $6,500 per loan. However, HUD's assessment of civil money penalties to the lender is on a case-by-case basis and it is up to HUD to determine the assessment amounts. 22 Appendix C SCHEDULE OF DEFICIENCIES Loan case Closing date Loan Unpaid 29 percent Loan status 1 2 3 4 5 number amount balance** estimate loss* 022-1751765 August 25, 2003 $90,081.00 $89,116.00 $25,844.00 Claim x 022-1759781 September 29, 2003 $101,398.00 $98,313.00 $28,511.00 Active but x x Delinquent 023-2090070 May 7, 2004 $90,538.00 $87,613.00 $25,408.00 Active x x x 022-1795425 April 28, 2004 $107,998.00 $0.00 $0.00 Terminated*** x 022-1767707 November 7, 2003 $137,837.00 $142,181.00 $41,232.00 Active x 022-1719928 May 23, 2003 $112,665.00 $108,387.00 $31,432.00 Active x TOTAL 1 5 1 1 1 History: 1 - False documentation 2 - Branch office used the incorrect lender ID 3 - 3rd party handling of documents 4 - Insufficient documentation for source of gift funds 5 - Spouse's debts not included in loan approval * - Unpaid balance multiplied by 29 percent of claim amount, based upon statistics provided by HUD ** - The unpaid mortgage loan balances reflect data obtained from NeighborhoodWatch on June 6, 2006 *** - Non-conveyance foreclosure – third party sale 23 Appendix D CIVIL MONEY PENALTIES FHA Case # Loan Amount Unpaid Balance 29 percent estimated loss* 1 022-1751765 $90,081.00 $89,116.00 $25,844.00 2 022-1767707 $137,837.00 $142,181.00 $41,232.00 3 022-1759781 $101,398.00 $98,313.00 $28,511.00 4 023-2090070 $90,538.00 $87,613.00 $25,408.00 24
First Magnus Financial Corporation Did Not Comply with HUD Guidelines When Underwriting Six Federal Housing Administration-Insured Loans
Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-07-26.
Below is a raw (and likely hideous) rendition of the original report. (PDF)