oversight

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)

                                                              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