oversight

Homestead Funding Corp., Allentown, Pennsylvania, Issued and Submitted for Endorsement Loans with an Increased Risk of Defaults and Claims

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-12-02.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                                                       Issue Date
                                                                             December 2, 2005
                                                                       Audit Report Number
                                                                             2006-PH-1004




TO:                Brian D. Montgomery, Assistant Secretary for Housing – Federal Housing
                    Commissioner, H

FROM:


SUBJECT:            Homestead Funding Corp., Allentown, Pennsylvania, Issued and Submitted for
                     Endorsement Loans with an Increased Risk of Defaults and Claims



                                         HIGHLIGHTS

    What We Audited and Why

                   We audited the Allentown, Pennsylvania, branch of Homestead Funding Corp.
                   (Homestead), a nonsupervised direct endorsement lender approved to originate
                   Federal Housing Administration single-family mortgage loans, because its default
                   rate was above the state’s default rate and it was recommended by the U.S.
                   Department of Housing and Urban Development’s (HUD) Quality Assurance
                   Division. Our audit objective was to determine whether Homestead complied with
                   HUD’s regulations, procedures, and instructions in the origination of Federal
                   Housing Administration loans.

    What We Found

                   Homestead’s Allentown branch office did not originate all Federal Housing
                   Administration loans in accordance with HUD’s loan origination requirements.
                   Of the 11 loans we selected for review, 1 the branch office did not fully comply

1
    Originally valued at $895,638
           with Federal Housing Administration requirements for 4 of the loans valued at
           $270,701. Homestead did not exercise due diligence in the review of assets and
           accepted faxed documents from realtors. These deficiencies were caused by a
           lack of due professional care and contributed to an increased risk to the Federal
           Housing Administration insurance fund. In addition, required quality control
           reviews were not done in a timely manner. This occurred because Homestead did
           not have adequate internal controls in place to ensure the reviews were completed
           timely. As a result, Homestead did not identify or correct problems with the
           accuracy, validity, and completeness of its loan origination in a timely manner.

What We Recommend

           We recommend that the assistant secretary for housing – federal housing
           commissioner request from Homestead an indemnification of $95,107 on two
           loans which it issued contrary to HUD’s loan origination procedures, and
           $175,594 on two loans that went into default causing HUD to pay a claim.
           Further, we recommend that Homestead develop internal procedures to more
           closely monitor its underwriting procedures. In addition, we recommend that
           Homestead strengthen its internal controls to ensure that required quality control
           reviews are completed within HUD’s required timeframe.

           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 Homestead on October 28, 2005, and requested a
           response by November 28, 2005. Homestead provided written comments on
           November 21, 2005. Homestead Funding Corp. generally agreed with our
           findings. After considering Homestead’s comments on a case that has been paid
           in full, we decided to remove the case from the report.

           The complete text of Homestead’s response, along with our evaluation of that
           response, can be found in appendix B of this report.




                                            2
                            TABLE OF CONTENTS


Background and Objectives                                                        4

Results of Audit
      Finding 1: Homestead’s Allentown Branch Office Did Not Fully Comply with   5
      HUD Requirements When Originating Loans

      Finding 2: Homestead Did Not Complete Quality Control Reviews Timely       8

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 Case File Discrepancies                                        15
   D. Narrative Case Presentations                                               16




                                            3
                      BACKGROUND AND OBJECTIVES


The U.S. Department of Housing and Urban Development’s (HUD) strategic plan states that part
of its mission is to increase homeownership, support community development, and increase
access to affordable housing free from discrimination.

The National Housing Act, as amended, established the Federal Housing Administration, an
organizational unit within HUD. The Federal Housing Administration provides insurance for
lenders against loss on single-family home mortgages.

Beginning in 1983, HUD implemented the direct endorsement program, which authorized
approved lenders to underwrite loans without HUD’s prior review and approval. HUD can place
them on credit watch status or terminate their approval if their rate of defaults and claims
exceeds the normal rate for the area. Many sanctions are available for taking actions against
lenders or others who abuse the program.

The Allentown branch of Homestead Funding Corp. (Homestead) is one of its nine active branches
with direct endorsement approval. Homestead, whose main office is located in Albany, New York,
issued 5,584 Federal Housing Administration loans worth $606,797,431 between May 1, 2003, and
April 30, 2005, of which 381 were issued by the Allentown branch at a value of $36,698,478. Of the
381 loans issued, 17 loans worth $1,580,317 went into default within the first two years. Of these,
we reviewed 11 loans worth $895,638 that were in default status with 12 payments or fewer after
closing.

The specific objectives of our review were to determine whether Homestead originated Federal
Housing Administration-insured loans in accordance with prudent lending practices and HUD
requirements and whether the lender implemented a quality control plan that meets HUD’s
requirements. We reviewed case files from both the Homeownership Center and the lender and
reviewed Homestead’s oversight of its branches.




                                                4
                                RESULTS OF AUDIT


Finding 1: Homestead’s Allentown Branch Office Did Not Fully
Comply with HUD Requirements When Originating Loans
Homestead did not always originate Federal Housing Administration-insured loans in accordance
with HUD requirements. For 4 of the 11 loans we reviewed, originally valued at $895,638,
Homestead did not exercise due diligence in the review of assets and accepted faxed documents
from realtors. The deficiencies stem from the lack of due professional care at the branch office.
These deficiencies contributed to an increased risk to the Federal Housing Administration
insurance fund. Therefore, Homestead should indemnify $95,107 for two defaulted loans and
$175,594 for claims paid on two loans.




 Homestead Did Not Properly
 Verify the Borrower’s Funds to
 Close

              HUD requirements state that if the amount of the earnest money deposit exceeds 2
              percent of the sales price or appears excessive based on the borrower’s history of
              accumulating savings, the lender must verify with documentation the deposit
              amount and the source of funds.

              HUD requires the lender to verify savings and checking accounts. A verification
              of deposit, along with the most recent bank statement, may be used to accomplish
              this. If there is a large increase in an account or the account was opened recently,
              the lender must obtain a credible explanation of the source of those funds. In
              addition, as an alternative to obtaining a verification of deposit, the lender may
              obtain from the borrower original bank statements covering the most recent three-
              month period. Provided the bank statement shows the previous month’s balance,
              this requirement is met by obtaining the two most recent, consecutive statements.

              For four of the cases reviewed, Homestead did not adequately verify the borrower’s
              funds to close. For case number 441-7352967, the earnest money could not be
              verified because of an unsupported gift and escrow deposit. In case number 441-
              7433339, the bank statement provided for the savings account was not in the
              borrower’s name, and there was no documentation showing that the borrower was
              added to the account. If the earnest money and savings account had not been used
              for cases 441-7352967 and 441-7433339, respectively, the borrowers would not
              have had the funds to close. Further, case number 441-7189755 had an unexplained




                                               5
           large deposit, and case number 441-7302787 did not have consecutive bank
           statements.

Homestead Accepted Faxes
from Third-Party Participants


           HUD requirements state that a lender 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.

           For case numbers 441-7352967 and 441-7302787 Homestead accepted faxes from
           interested third-party participants. Both cases had multiple documents that were
           faxed from the realtor. Those documents included rent receipts, gift letters, bank
           statements, employment earnings statements, and a child support court order.


Miscellaneous Items


           Although these issues do not require an indemnification, in three of the case files we
           reviewed, Homestead did not follow the loan origination requirements of HUD. The
           issues include

               •   Allowing the use of overtime when it could not be determined whether it
                   would continue,

               •   Allowing the use of commission when it could not be determined whether it
                   would continue, and

               •   Accepting an amount that was “to be saved” as an asset on the loan
                   application.

           The above cases illustrate that HUD assumed unnecessarily high risk when
           insuring the loans originated by Homestead. The deficiencies associated with
           Homestead’s loan origination activities stem from the lack of due care in applying
           HUD loan requirements. Therefore, Homestead should indemnify $95,107 for
           two defaulted loans and $175,594 for claims paid on two loans. See appendix C
           for the Schedule of Case File Discrepancies and appendix D for the Narrative
           Case Presentations, which contain the specific HUD regulations cited.




                                             6
Recommendations



          We recommend that the assistant secretary for housing – federal housing
          commissioner

          1A.     Request Homestead indemnify $95,107 on two defaulted loans and
                  $175,594 for claims paid on two loans, in which Homestead’s loan
                  origination procedures did not comply with HUD requirements.

          1B.     Require Homestead to develop internal procedures to more closely
                  monitor its underwriting procedures.




                                           7
Finding 2: Homestead Did Not Complete Quality Control Reviews
Timely
Homestead did not complete its quality control reviews within 90 days as required by HUD
regulations. This problem occurred because Homestead did not have adequate internal controls
in place to ensure the reviews were completed timely. As a result, Homestead did not identify or
correct problems with the accuracy, validity, and completeness of its loan origination in a timely
manner.




 Quality Control Reviews Were
 Not Completed within the 90-
 Day Requirement


               HUD Handbook 4060.1 states that loans must be reviewed within 90 days of the
               closing of the loan. Homestead’s quality control plan states one of its policies is
               to ensure sufficient controls to measure results and discrepancies within two or
               three months of loan closing.

               Homestead usually did not complete its quality control reviews within 90 days.
               We reviewed Homestead’s 249 quality control review reports from May 2003
               through March 2005 and found that only one review was performed within the
               90-day requirement. The remaining 248 loans were reviewed from 103 to 660
               days after loan closing.

               Homestead’s compliance officer stated that Homestead is known for its streamline
               loans and that this causes an influx of work. Homestead adjusted its plan to
               consider this; however, due to the lack of adequate staff, it is still not reviewing
               the loans within the timeframe required by HUD regulations. Homestead
               employs one quality control analyst to perform the reviews and has another
               employee who helps when time permits. The compliance officer stated that she
               needs additional staff to do the quality control reviews in a timely manner.

               As a result of the untimely reviews, problems are not identified as early as
               possible after the loan closing. Early detection of common problems may prevent
               future unacceptable loans from being approved.




                                                 8
Recommendations


          We recommend that the assistant secretary for housing – federal housing
          commissioner

          2A.     Require Homestead to strengthen its internal controls to ensure that the
                  quality control reviews are completed within HUD’s required timeframe.




                                           9
                        SCOPE AND METHODOLOGY


To accomplish our objectives, we

   •   Reviewed Federal Housing Administration-insured loans (11 cases) originated by
       Homestead’s Allentown branch between May 1, 2003, and April 30, 2005, that had gone
       into default at least once. The 11 loans were part of a universe of 381 loans originated by
       the Allentown branch during that time. The results of the detailed testing apply to the 11
       loans reviewed only and cannot be projected to the universe of Federal Housing
       Administration-insured loans.

   •   Examined records and related documents of Homestead.

   •   Reviewed applicable HUD handbooks and mortgagee letters.

   •   Conducted interviews with officials and employees of Homestead and the HUD Quality
       Assurance Division.

In addition, we relied, in part, on data maintained by HUD in the Single Family Data Warehouse
and Neighborhood Watch systems. We did not perform a detailed analysis of the reliability of
these programs.

The audit generally covered the period from May 1, 2003, to April 30, 2005. When applicable,
the audit period was expanded to include current data through July 31, 2005. We conducted our
fieldwork from June through September 2005.

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, 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


              We determined the following internal controls were relevant to our audit objectives:

                  •   Loan origination process – Policies and procedures that management has in
                      place to reasonably ensure that the loan origination process complies with
                      HUD program requirements.

                  •   Quality control plan – Policies and procedures that management has in place
                      to reasonably ensure implementation of HUD quality control requirements.

              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:

                  •   Homestead did not operate in accordance with HUD requirements as they
                      relate to loan issuance and quality control.

              The deficiencies are discussed in detail in the Results of Audit section of this
              report.



                                               11
APPENDIXES


Appendix A

               SCHEDULE OF QUESTIONED COSTS
              AND FUNDS TO BE PUT TO BETTER USE

                  Recommendation            Unsupported      Funds to be put
                         number                 costs 1/      to better use 2/
                                  1A           $175,594              $95,107

1/   Unsupported costs are those whose eligibility or reasonableness cannot be clearly
     determined during the audit since they were not supported by adequate documentation or
     due to other circumstances. Under federal cost principles, a cost must be adequately
     supported to be eligible.

2/   “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an
     Office of Inspector General (OIG) recommendation is implemented, resulting in reduced
     expenditures at a later time for the activities in question. This includes costs not incurred,
     deobligation of funds, withdrawal of interest, reductions in outlays, avoidance of
     unnecessary expenditures, loans and guarantees not made, and other savings.




                                              12
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                         13
                        OIG Evaluation of Auditee Comments


Comment 1   After checking the HUD database, Neighborhood Watch, we discovered that case
            441-7401683 was indeed “Paid in Full.” We have removed this case from the
            report.




                                          14
Appendix C

         SCHEDULE OF CASE FILE DISCREPANCIES

                              Unpaid                                      Acceptance
                   Mortgage                                 Unsupported
     Case number              principal        Claim paid                   of third-
                    amount                                    assets
                              balance                                     party faxes

     441-7433339    $39,992   $39,621                           X

     441-7352967    $55,957   $55,486                           X             X

     441-7302787    $66,970                     $70,514         X             X

     441-7189755    $96,239                    $105,080         X

      TOTALS       $259,158   $95,107          $175,594         4             2




                                          15
Appendix D

                     NARRATIVE CASE PRESENTATIONS

Case number: 441-7433339

Mortgage amount: $39,992

Date of loan closing: February 6, 2004

Status: Foreclosure started

Payments before first default reported: Two

Unpaid principal balance: $39,621

Summary:

       Homestead did not properly verify the borrower’s funds to close.

Pertinent Details:

       Funds to Close Were Not Properly Verified or Supported

       A verification of deposit, along with the most recent bank statement, may be used to
       verify savings and checking accounts. If there is a large increase, the lender must verify
       the source of funds (HUD Handbook 4155.1, paragraph 2-10B). All funds for the
       borrower’s investment in the property were not properly verified. The savings account
       provided was not in the buyer’s name, and there was no documentation showing that the
       buyer was added to the account. If the savings account had not been used, the buyer
       would not have had the funds to close.




                                               16
Case number: 441-7352967

Mortgage amount: $55,957

Date of loan closing: October 23, 2003

Status: Reinstated by mortgagor who retains ownership

Payments before first default reported: Four

Unpaid principal balance: $55,486

Summary:

       Homestead (1) did not properly verify the borrower’s funds to close and (2) accepted
       faxed documents from interested third-party participants.

Pertinent Details:

       Funds to Close Were Not Properly Verified or Supported

       HUD Handbook 4155.1, paragraph 2-10A, states that if the amount of the earnest money
       deposit exceeds 2 percent of the sales price or appears excessive based on the borrower’s
       history of accumulating savings, the lender must verify with documentation the deposit
       amount and the source of funds. Homestead did not properly verify the borrower’s funds
       to close. The earnest money deposit, which exceeded 2 percent of the sales price,
       included a gift, cash, and a returned security check for renting the property previously.
       Homestead did not verify that the gift money was given from the donor’s account. In
       addition, Homestead could not verify whether the cash for the earnest money deposit was
       given by the borrower and deposited into an escrow account.

       Homestead Inappropriately Accepted Faxed Documents from Interested Third-Party
       Participants

       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 (e.g., real estate
       agents, builders, sellers) or by using its equipment (HUD Handbook 4155.1, paragraph 3-
       1). Homestead accepted faxed documents from a realtor. These documents included the
       borrower’s rent receipts, gift letter, and bank statements.




                                               17
Case number: 441-7302787

Mortgage amount: $66,970

Date of loan closing: August 1, 2003

Status: Property conveyed to insurer

Payments before first default reported: Eight

Claim paid: $70,514

Summary:

       Homestead (1) did not properly verify the borrower’s funds to close and (2) accepted
       faxed documents from interested third-party participants.

Pertinent Details:

       Funds to Close Were Not Properly Verified or Supported

       A verification of deposit, along with the most recent bank statement, may be used to
       verify savings and checking accounts (HUD Handbook 4155.1, paragraph 2-10 B). As an
       alternative to obtaining a verification of deposit, the lender may obtain from the borrower
       original bank statements covering the most recent three-month period. Provided the bank
       statement shows the previous month’s balance, this requirement is met by obtaining the
       two most recent, consecutive statements (HUD Handbook 4155.1, paragraph 3-1 F). All
       funds for the borrower’s investment in the property were not properly verified. A
       verification of deposit was not obtained; in addition, the two most recent consecutive
       bank statements were not obtained. There were two bank statements in the file; however,
       they were not consecutive. There was a two-month gap between the statements.

       Homestead Inappropriately Accepted Faxed Documents from Interested Third-Party
       Participants

       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 (e.g., real estate
       agents, builders, sellers) or by using its equipment (HUD Handbook 4155.1, paragraph 3-
       1). Homestead accepted faxed documents from a realtor. These documents included the
       gift letters, bank statements, court order for child support, and employment earnings
       statements.




                                                18
Case number: 441-7189755

Mortgage amount: $96,239

Date of loan closing: May 1, 2003

Status: Property conveyed to insurer

Payments before first default reported: 10

Claim paid: $105,080

Summary:

       Homestead did not properly verify the borrower’s funds to close.

Pertinent Details:

       Funds to Close Were Not Properly Verified

       A verification of deposit, along with the most recent bank statement, may be used to
       verify savings and checking accounts. If there is a large increase, the lender must verify
       the source of funds (HUD Handbook 4155.1, paragraph 2-10 B). A majority of the funds
       for the borrower’s investment in the property was not properly verified. A large deposit
       into the savings account was not explained.




                                               19