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
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)