oversight

1st Preference Mortgage Corporation, York, PA, and Greenbelt, MD, Did Not Originate All Federal Housing Administration Loans in Accordance with HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-03-23.

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

                                                               Issue Date
                                                                      March 23, 2006
                                                               Audit Report Number
                                                                      2006-PH-1008




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



FROM:


SUBJECT:   1st Preference Mortgage Corporation, York, PA, and Greenbelt, MD, Did Not
            Originate All Federal Housing Administration Loans in Accordance with
            HUD Requirements


                                 HIGHLIGHTS

 What We Audited and Why

           We audited the York, Pennsylvania, and Greenbelt, Maryland, branch offices of
           1st Preference Mortgage Corporation (1st Preference), a nonsupervised mortgage
           company approved to originate Federal Housing Administration single-family
           mortgage loans. We selected these branch offices because their average default
           rates were above the states’ average default rates. Our audit objective was to
           determine whether 1st Preference acted in a prudent manner and complied with the
           U.S. Department of Housing and Urban Development’s (HUD) regulations,
           procedures, and instructions in the origination of Federal Housing Administration
           loans.

 What We Found

           1st Preference’s York, Pennsylvania, and Greenbelt, Maryland, branch offices did
           not originate 38 percent of the Federal Housing Administration loans selected for
                    review in accordance with HUD’s loan origination requirements. Of the 16 loans
                    we selected to review, 1 the branch offices did not fully comply with Federal
                    Housing Administration requirements for six loans valued at $561,506. 1st
                    Preference did not exercise due diligence in the review of assets and gifts
                    obtained during the loan closing process. These deficiencies were caused by a
                    lack of due professional care at the branch offices and contributed to an increased
                    risk to the Federal Housing Administration insurance fund. In addition, 1st
                    Preference did not complete timely quality control reviews or site reviews of its
                    branch offices or document the review of loans that went into early default.
                    These deficiencies occurred because 1st Preference did not have adequate internal
                    controls in place to ensure the reviews were completed in a timely manner or that
                    the reviews of the branch offices and defaulted loans were documented. As a
                    result, 1st Preference 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 1st Preference to develop internal procedures to more
                    closely monitor its origination and underwriting procedures. In addition, we
                    recommend that 1st Preference strengthen its internal control procedures to ensure
                    reviews are completed in a timely manner and reviews of the branch offices and
                    defaulted loans are documented.

                    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 a draft report to 1st Preference on February 17, 2006. We discussed
                    the report with 1st Preference at the exit conference on March 6, 2006. 1st
                    Preference provided written comments to our draft findings on March 15, 2006.
                    The complete text of 1st Preference’s response, along with our evaluation of that
                    response, can be found in appendix A of this report.




1
    Originally valued at $1,858,620.


                                                     2
                            TABLE OF CONTENTS


Background and Objectives                                                           4

Results of Audit
      Finding 1: 1st Preference’s York and Greenbelt Branch Offices Did Not Fully   6
      Comply with HUD’s Loan Origination Requirements

      Finding 2: 1st Preference’s Quality Control Plan and Its Implementation Did   9
      Not Comply with HUD Requirements

Scope and Methodology                                                               12

Internal Controls                                                                   13

Appendixes
   A. Auditee Comments and OIG’s Evaluation                                         14
   B. Schedule of 16 Federal Housing Administration-Insured Loans Selected for      20
      Review
   C. Schedule of Case File Discrepancies                                           21




                                              3
                            BACKGROUND AND OBJECTIVES


The National Housing Act, as amended, established the Federal Housing Administration, an
organizational unit within the U.S. Department of Housing and Urban Development (HUD). The
Federal Housing Administration provides insurance to private lending institutions under Section
203 of the National Housing Act. HUD designates these institutions as supervised lenders,
nonsupervised lenders, loan correspondents, investing lenders, and government institutions.
Depending upon its designation, the institution has the authority to originate, purchase, hold,
service, or sell Federal Housing Administration-insured mortgages. A nonsupervised lender is a
financial institution, the principal activity of which is lending or investing funds in real estate
mortgages.

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 the lenders 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.

1st Preference Mortgage Corporation (1st Preference) was incorporated to perform all aspects of
mortgage lending on September 4, 1990, under the laws of the state of Maryland. On August 8,
1991, HUD authorized 1st Preference as a nonsupervised mortgage company. 1st Preference’s
main office is located at 9423 Bel Air Road, Nottingham, Maryland.

The York and Greenbelt branches of 1st Preference are two of its seven active branch offices.
Between July 1, 2003, and June 30, 2005, 1st Preference originated 771 Federal Housing
Administration-insured mortgages totaling $94,786,292. 1st Preference’s overall compare ratio 2
for the company was 79 percent and its default rate was below the national average. The York
and Greenbelt branch offices originated 321 loans totaling $39,133,272. Of these, we reviewed
16 loans, originally valued at $1,858,620, that were in default status with 12 payments or fewer.

                                     Branch                            Default       Default loan
                                   originations       Loan value        loans           value
                       York            138            $12,358,113         9           $ 789,309
              Branch




                       Greenbelt       183            $26,775,159          7          $1,069,311
                       Total           321            $39,133,272         16          $1,858,620

HUD’s Quality Assurance Division’s March 2004 review of 1st Preference’s loan origination
procedures cited several loan origination deficiencies. 1st Preference did not adequately
document the source and/or adequacy of funds used for gift funds, down payments, and closing
costs.



2
 According to Neighborhood Watch, this ratio reveals the discrepancy between the subject’s default and claim
percentage to which it is being compared.


                                                        4
The objectives of our review were to determine whether 1st Preference 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 met HUD’s
requirements.




                                             5
                                    RESULTS OF AUDIT


Finding 1: 1st Preference’s York and Greenbelt Branch Offices Did Not
Fully Comply with HUD’s Loan Origination Requirements

1st Preference did not always originate Federal Housing Administration-insured loans in
compliance with HUD requirements. For 6 of the 16 loans we reviewed, originally valued at
$561,506, 1st Preference did not exercise due diligence in the review of assets and gifts obtained
during the loan closing process (see appendix C). The deficiencies occurred due to a lack of due
professional care at the branch offices. Consequently, 1st Preference increased the risk to the
Federal Housing Administration insurance fund. Therefore, 1st Preference should develop and
implement control procedures to more closely monitor its origination and underwriting
procedures.




    1st Preference Did Not
    Adequately Verify Borrowers’
    Assets



                 Unsupported Source of Earnest Money Deposit

                 HUD requirements 3 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 the funds. For case 441-7306314, 1st Preference did not
                 adequately document the source of an earnest money deposit. The earnest money
                 deposit in this case exceeded 5 percent of the contract sales price and appeared
                 excessive based upon the borrowers’ savings history. Instead of obtaining a bank
                 statement or canceled check to support the source of funds, 1st Preference
                 obtained a letter from the seller acknowledging the receipt of the earnest money.
                 However, a letter from the seller acknowledging receipt does not support that the
                 deposit was from the borrowers’ own funds. As of August 1, 2005, legal action
                 has commenced to start the foreclosure process. We would request
                 indemnification for this loan with an unpaid loan balance of $98,421 since we



3
    HUD Handbook 4155.1, REV-5, paragraph 2-10.



                                                  6
                have no assurance the earnest money was from the borrowers’ own funds.
                However, this loan was paid off on March 10, 2006.

                Inaccurate Use of Child Support as Effective Income

                1st Preference did not adequately support the use of child support income in one
                case, resulting in an overstatement in the borrower’s financial ability to meet her
                new housing obligations. HUD requirements 4 state that child support may be
                included as effective income if the payments are likely to continue for the next
                three years and there is evidence that payments have been received during the last
                12 months. For case 241-7417716, 1st Preference’s loan files did not demonstrate
                the child support had been received for three of the previous 12 months as
                required. Since this is only a technical deficiency, it does not warrant
                indemnification. The loan was in default, but the borrower is making repayments
                to bring the loan current.

                Sources of Gift Funds Not Identified

                HUD requirements 5 state that the lender must document the transfer of gift funds
                from the donor to the borrower to ensure that the gift funds are provided from
                acceptable sources. In three of the cases reviewed, 1st Preference did not
                adequately identify the sources of gift funds as required by HUD. For cases 441-
                7433424, 442-2465417, and 241-7220158, 1st Preference did not obtain the wire
                transfer receipts or copies of the gift checks to document the transfer of the funds.
                Without identifying the sources of the gifts, there was no assurance the funds
                were provided from acceptable sources. Since these are only technical
                deficiencies and we were able to determine that the organizations providing the
                funds were legitimate, we are not requesting that these loans be indemnified.

                Secondary Financing Terms Not Clearly Identified

                HUD requirements 6 state that if a borrower is obtaining secondary financing, each
                transaction must be documented, and the loan instruments must be included in the
                endorsement binder. In two cases, 1st Preference did not obtain the required loan
                instruments for the secondary financing the borrowers received.

                    •   In case 441-7433424, an incomplete draft copy of the loan instrument was
                        provided in the file. It lacked the borrower’s name, signature, and loan
                        amount. The actual loan amount the borrower received differed
                        considerably from the amount originally stated in the gift letter.

                    •   In case 241-7523242, the loan instrument was not provided. Therefore,
                        the secondary loan amount and contingencies were not clearly identified.

4
  HUD Handbook 4155.1, REV-5, paragraph 2-7(F).
5
  HUD Handbook 4155.1, REV-5, paragraph 2-10.
6
  HUD Handbook 4155.1, REV-5, paragraph 1-13.


                                                  7
                  Had the secondary financing not been received, the borrower would not
                  have had sufficient funds to close.

          We were able to obtain copies of the loan instruments, so we are not requesting
          indemnification on these loans. However, it is 1st Preference’s responsibility to
          obtain these documents to ensure the funds were provided from acceptable
          sources and that the terms were allowable under HUD regulations.

Recommendations



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

          1A.     Require 1st Preference to develop and implement internal control
                  procedures to more closely monitor its origination and underwriting
                  process (specifically in the areas of earnest money deposits, child support,
                  gift funds, and secondary financing).




                                            8
Finding 2: 1st Preference’s Quality Control Plan and Its Implementation
Did Not Comply with HUD Requirements


1st Preference’s quality control reviews and plan did not fully comply with HUD regulations. 1st
Preference did not complete its quality control reviews within 90 days, complete site reviews of
its branch offices, or document its review of loans that went into early default. These
deficiencies occurred because 1st Preference did not have adequate internal controls in place to
ensure the reviews were completed in a timely manner or that the reviews of the branch offices
and defaulted loans were documented. As a result, 1st Preference 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 7 states that loans must be reviewed within 90 days of the
                    closing of the loan. To ensure that the 90-day goal is met, 1st Preference
                    contracted out the review process to Qualimae. 8 Each month, Qualimae selected
                    10 percent of all of the loans issued to determine that the files were complete and
                    all necessary verifications were completed. Once Qualimae completed its review,
                    it provided a status report to 1st Preference, denoting any discrepancies found in
                    the file.

                    We reviewed the quality control reviews for 11 loans that closed from April 2004
                    through March 2005 and found that only five of the reviews were performed
                    within the 90-day requirement. The remaining six loans were reviewed from 91
                    to 162 calendar days after the loan closed.

                    Part of the reason the reviews were not completed within the 90-day requirement
                    was that 1st Preference did not submit the copies of the loan files to Qualimae in a
                    timely manner. In addition, 1st Preference did not ensure that Qualimae
                    completed the reviews. For example, in September 2005, we requested copies of
                    the Qualimae reports for loans that closed in January 2005. 1st Preference did not
                    realize it had never received the reports from Qualimae. As a result of these
                    untimely reviews, 1st Preference was unable to identify loan origination

7
    Paragraph 6-6(A).
8
    Qualimae was hired by 1st Preference to conduct its post closing reviews.


                                                            9
                   deficiencies in a timely manner and take prompt corrective actions when
                   necessary.

     Required Reviews of Branch
     Offices Were Not Documented
     in Plan



                   HUD Handbook 4060.1 9 states that a lender’s quality control plan should include
                   plans to complete site reviews of traditional and nontraditional branch offices
                   engaged in origination or servicing of Federal Housing Administration-insured
                   loans. However, 1st Preference’s quality control plan did not require site reviews.
                   Thus, there was limited assurance that 1st Preference’s branch offices were in
                   compliance with HUD’s requirements and that its staff was knowledgeable of
                   HUD’s loan origination and underwriting requirements.

     Review of Defaulted Loans Was
     Not Documented



                   HUD Handbook 4060.1 10 states that all loans going into default within the first
                   six payments must be reviewed. 1st Preference’s quality control plan did not
                   require its independent agent to review early default loans as required by HUD.
                   Instead, 1st Preference officials reviewed the early default loans themselves, but
                   did not formally document their review. Review of early default loans assists in
                   detecting loan origination deficiencies in a timely manner. Since 1st Preference’s
                   quality control process did not formally document early default reviews, we have
                   limited assurance that HUD was protected from unacceptable risk; guarded
                   against errors, omissions, and fraud; and assured that swift and appropriate
                   corrective action would be taken when necessary in the origination of Federal
                   Housing Administration-insured loans.


     Recommendations


                   We recommend that the assistant secretary for housing – federal housing
                   commissioner require 1st Preference to

                   2A.    Develop and implement procedures to ensure its quality control reviews
                          are performed/completed within HUD’s required timeframe.


9
    Paragraph 6-3(G).
10
     Paragraph 6-6(D).


                                                    10
2B.   Revise its quality control plan to comply with HUD requirements, thus
      ensuring site reviews and early default loan reviews are completed and
      documented.




                              11
                        SCOPE AND METHODOLOGY


To accomplish our objectives, we

   •   Reviewed 100 percent of the Federal Housing Administration-insured loans (16 cases)
       originated by 1st Preference’s branch offices in York, Pennsylvania, and Greenbelt,
       Maryland, between July 1, 2003, and June 30, 2005, that had gone into default at least
       once.

   •   Examined records and related documents of 1st Preference.

   •   Reviewed applicable HUD handbooks, mortgagee letters, and other relevant HUD
       publications.

   •   Conducted interviews with officials and employees of 1st Preference and the HUD
       Quality Assurance Division.

In addition, we relied in part on data maintained by HUD in its Neighborhood Watch system.
We did not perform a detailed analysis of the reliability of this data.

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

We performed our review in accordance with generally accepted government auditing standards.




                                              12
                             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’s 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:

              •   1st Preference did not operate in accordance with HUD requirements as they
                  relate to loan origination and quality control.

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


                                               13
                        APPENDIXES


Appendix A

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation      Auditee Comments




Comment 1




Comment 2



Comment 3




                            14
Comment 4




Comment 5




Comment 6




Comment 7




            15
16
17
                         OIG Evaluation of Auditee Comments


Comment 1   We have verified loan 441-7306314 was paid off on March 10, 2006, through a
            sale of the property by the borrower. The report has been revised to reflect this
            change.

Comment 2   For loan 241-7417716, we disagree with 1st Preference’s assessment to include
            child support as part of the borrower’s effective income. Based upon the
            payments documented, we do not believe 1st Preference obtained sufficient
            documentation to demonstrate both the consistency of and a willingness to pay
            child support payments. HUD Handbook 4155.1, REV-5, paragraph 2-7(F) states
            that there must be evidence that payments have been received during the last
            twelve months prior to receiving the loan. Periods of less than twelve months
            may be acceptable, provided the payer’s ability and willingness to make timely
            payments is adequately documented by the lender. The file contained
            documentation to support the borrower received child support payments for 9 of
            the previous 12 months. However, the loan entered early default due to a
            curtailment in the borrower’s income. This curtailment of the borrower’s income
            may be related to the borrower not receiving regular child support payments. The
            letter provided by the borrower explaining the missing three months worth of
            child support payments due to a reconciliation period was not adequate to
            conclude the nine months worth of child support received established consistency
            and a willingness to pay. As a result, the child support payments should not have
            been included as effective income.

Comment 3   We are pleased that 1st Preference has started to take corrective action by updating
            its closing instructions to include obtaining a copy of the wire transfers of gift
            funds from the Title Companies. Though we have not audited this action, we
            hope this action will bring 1st Preference into full compliance with HUD’s gift
            fund documentation requirements found in HUD Handbook 4155.1, REV-5,
            paragraph 2-10(C).

Comment 4   We agree that the funds the borrower received in loan 441-7433424 were labeled
            a grant from Dauphin County on the HUD-1 Settlement Statement. However,
            based upon documentation reviewed in the loan file, the borrower received a
            second or subordinated mortgage for $3,266. Though no interest is attached to
            this fund, the program stipulates the entire amount of the mortgage received will
            be repaid upon the sooner of (1) the sale of the property, (2) the transfer of legal
            or equitable title, or (3) the repayment of all borrowed principal. Thus, the
            borrower’s receipt of the funds creates a secondary financing agreement. For loan
            241-7523242, the borrower received $4,750 from the Housing Venture Fund. The
            reservation request form for this funding clearly stated the funds were secured.
            Also, program information specified the repayment contingencies for the funds.
            The borrower is required to live in the property for a minimum of five years, with
            20% of the amount provided reduced each year. If the property is sold within this



                                             18
            five-year period, a lien is created against the property. Since secondary financing
            is created, completed loan instruments are required in this case as well. HUD
            Handbook 4155.1, REV-5, paragraph 1-13 states that any financing, other than a
            Federal Housing Administration-insured first mortgage, that creates a lien against
            the property is considered secondary financing and not a gift, and copies of the
            loan instrument are to be included in the loan files.

Comment 5   We are encouraged that 1st Preference is taking steps to ensure that its quality
            control reviews are performed within HUD’s 90-day requirement, and that it is
            going to begin documenting management reviews of Qualimae reports, as well as
            any defaulted loans. We hope these steps taken by 1st Preference will bring them
            in full compliance with HUD’s quality control guidelines found in HUD
            Handbook 4060.1, REV-1 paragraphs 6-6(A) and 6-6(D).

Comment 6   Based on the results of our review, there was no documentation to support that 1st
            Preference completed site reviews in compliance with requirements stated in
            HUD Handbook 4060.1, REV-1, paragraph 6-3(G). Specifically, some of HUD’s
            requirements include confirming the following: (1) ensuring the offices are
            properly registered with HUD with its current address, (2) operations are
            conducted in a professional, businesslike environment, and (3) the offices are
            sufficiently staffed with trained personnel. Also, 1st Preference’s quality control
            plan did not require site reviews. Though 1st Preference’s President may visit his
            branch offices regularly, there is no documentation to support his visits entailed
            the review of the required elements specified in paragraph 6-3(G).

Comment 7   In 1st Preference’s conclusion, its President stated, “you are all auditors, and it is
            your job to find faults.” On the contrary, our main objective in this audit was to
            determine whether the lender acted in a prudent manner and complied with
            established requirements when originating Federal Housing Administration-
            insured loans.




                                              19
Appendix B

              SCHEDULE OF 16 FEDERAL HOUSING
         ADMINISTRATION-INSURED LOANS SELECTED FOR
                          REVIEW


The following shows the 16 loans selected for review:

                                      Default Information
                                                   Status
                                      Currently code as
                        Mortgage         in        of Dec.
     Case number        amount         default    30, 2005 Current servicing sponsor
     081-0777169        $148,393         Y            12      Wells Fargo Bank
     241-6990028        $100,434         Y            68      Wells Fargo Bank
     241-7417716        $173,615         Y            12      Wells Fargo Bank
     249-4796890        $155,295         NR           20     Chase Home Finance
     241-7220158        $ 70,350         Y            12      SunTrust Mortgage
     249-4807515        $267,452         N            13      Washington Mutual
     249-4853742        $153,772         N            13      Washington Mutual
     441-7433611        $ 63,945         N            20      Wells Fargo Bank
     442-2489051        $ 83,331         Y            68      Wells Fargo Bank
     442-2465417        $ 40,904         N            19     Chase Home Finance
     241-7523242        $118,958         N            20    National City Mortgage
     441-7551464        $112,106         N            20    National City Mortgage
     441-7306314        $ 93,227         Y            68       GMAC Mortgage
     441-7217278        $137,786         N            20       GMAC Mortgage
     441-7433424        $ 64,452         Y            12    Washington Mutual Bank
     441-7427169        $ 74,600         N            20          M&T Bank


                                          Default status
                    Codes                 Descriptions
                     12      Repayment
                     13      Paid in full
                     19      Partial reinstatement
                             Reinstated by borrower who retains
                      20     ownership
                      68     First legal action to commence foreclosure
                      NR     Not reported in Neighborhood Watch




                                              20
Appendix C

             SCHEDULE OF CASE FILE DISCREPANCIES




                         Original         Unpaid     Incomplete
                 Case    mortgage        principal      asset
                number   amount           balance      support
              441-
              7433424    $ 64,452        $ 63,349        X
              442-
              2465417    $ 40,904        $ 39,189        X
              441-
              7306314    $ 93,227        $ 98,421        X
              241-
              7523242    $118,958        $131,255        X
              241-
              7220158    $ 70,350        $ 68,019        X
              241-
              7417716    $173,615        $170,828        X
               TOTAL     $561,506        $571,061




                                    21