Issue Date
July 25, 2008
Audit Report Number
2008-AT-1010
TO: Brian D. Montgomery, Assistant Secretary for Housing-Federal Housing
Commissioner (H)
FROM: James D. McKay, Regional Inspector General for Audit, 4AGA
SUBJECT: Meridian Lending, Inc., Monroe, Georgia, Did Not Follow HUD Requirements
in Originating Two Insured Loans
HIGHLIGHTS
What We Audited and Why
We audited Meridian Lending, Inc. (Meridian), a Federal Housing Administration
(FHA)-approved direct endorsement lender, to determine whether it followed the
U.S. Department of Housing and Urban Development’s (HUD) requirements for
(1) borrower eligibility and creditworthiness and property eligibility when
underwriting loans and (2) implementing a quality control program. We selected
this lender because of its high default rates.
What We Found
Meridian did not follow HUD requirements in originating two of the eight FHA-
insured loans reviewed. As a result, Meridian placed HUD’s insurance fund at
risk for as much as $271,750.
In addition, Meridian did not review its early defaulting loans in a timely manner
and did not review all early defaulting loans. This condition occurred because
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Meridian incorrectly pulled its early defaults report data from HUD’s
Neighborhood Watch system. It pulled only current defaults, instead of pulling
all defaults to ensure that it captured all of the early defaults when extracting the
data from the system. As a result, the lender adversely impacted the goals of
HUD’s quality control program, which is designed to protect the lender and HUD
from unacceptable risk.
What We Recommend
We recommend that the Assistant Secretary for Housing-Federal Housing
Commissioner require Meridian to indemnify HUD for the potential loss on the
loan with a significant deficiency and reimburse HUD for the claim loss on the
other loan. We also recommend that the Assistant Secretary for Housing ensure
that Meridian conducts its quality control reviews in a timely manner and reviews
all early defaulting loans as required by HUD 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 discussed our review results with Meridian and HUD officials during the
audit. We provided a copy of the draft report to Meridian on June 30, 2008, for
its comments and discussed the report with Meridian officials at the exit
conference on July 3, 2008. Meridian provided written comments on July 3,
2008. Meridian generally agreed with our findings. The complete text of the
auditee’s response, along with our evaluation of that response, can be found in
appendix B of this report.
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TABLE OF CONTENTS
Background and Objectives 4
Results of Audit
Finding 1: Meridian Did Not Follow HUD Requirements in 5
Originating Two Insured Loans
Finding 2: Meridian Did Not Fully Comply with HUD Quality 7
Control Requirements
Scope and Methodology 9
Internal Controls 10
Appendixes
A. Schedule of Questioned Costs and Funds to Be Put to Better Use 12
B. Auditee Comments and OIG’s Evaluation 13
3
BACKGROUND AND OBJECTIVES
Meridian Lending, Inc. (Meridian), is a nonsupervised direct endorsement lender operating from
its home office in Monroe, Georgia. The U.S. Department of Housing and Urban Development
(HUD) Federal Housing Administration (FHA) approved Meridian as a nonsupervised mortgage
company in 2002.
Meridian originated 273 loans with original mortgage amounts totaling more than $37 million.
Twenty-one of the loans defaulted within the first year of closing. Of the 21 loans, 17 defaulted
within the first six payments. The amount of the defaulted loans totaled more than $3.4 million.
According to data from HUD’s Neighborhood Watch system, more than half (seven) of the 17
early defaults were due to curtailment of income. The chart below shows the default reasons and
number of payments before default for the eight files reviewed.
Loan Reason for default Payments before first 90-day
number default reported
1 Excessive obligations 1
2 Excessive obligations 1
3 Marital difficulties 2
4 Curtailment of income 3
5 Illness of borrower’s family member 3
6 Curtailment of income 3
7 Excessive obligations 6
8 Unable to contact borrower n/a
The objectives of the audit were to determine whether the lender followed HUD requirements for
(1) borrower eligibility and creditworthiness and property eligibility when underwriting loans
and (2) implementing a quality control program.
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RESULTS OF AUDIT
Finding 1: Meridian Did Not Follow HUD Requirements in Originating
Two Insured Loans
Meridian did not follow HUD requirements in originating two of the eight FHA-insured loans
reviewed. As a result, it placed HUD’s insurance fund at risk for as much as $271,750. Our
review did not disclose additional deficiencies in Meridian’s underwriting process or errors in
the files reviewed.
One Loan Had Underwriting
Deficiencies
Meridian incorrectly used a boarder’s wages as a compensating factor for
approving a loan with a mortgage amount of $130,050. HUD requirements do not
allow a boarder’s wages to be used as a compensating factor; only a boarder’s
rental income, if adequately documented, can be used. HUD Handbook 4155.1,
REV-5, paragraph 2-7M, provides that a boarder’s rental income can be used as a
compensating factor only if there is adequate documentation provided to the
lender. Meridian should not have used the boarder’s wages; the only income that
could have been used was the boarder’s rental income. Meridian did not have
adequate documentation to include the boarder’s income as a compensating
factor. This loan defaulted within the first six payments due to excessive
obligations. Also, the loan did not undergo a quality control review as required
by HUD Handbook 4060.1, paragraph 7-6D. The loan amount was $130,050, and
HUD should seek an indemnification agreement from the lender.
A Second Deed Was Executed
the Day of Closing
Meridian originated a loan with a mortgage of $141,700, in which a second deed
was executed the day of closing. On the day of loan closing, the borrower’s spouse
took ownership interest in the FHA-insured property without Meridian’s consent or
consideration of the spouse’s creditworthiness during underwriting and without
signing the mortgage note security instruments executed at loan closing. HUD
Handbook 4155.1, REV-5, paragraph 2-2D, does not permit an individual to take an
ownership interest in the property at settlement without signing the mortgage note
and all security instruments. Persons taking ownership interest should be treated as
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coborrowers, and the lender should have considered the spouse’s income, assets,
liabilities, and credit history.
This condition occurred because the lender’s closing process did not include steps to
ensure that loans were closed as underwritten. Because the spouse took ownership
at closing, she should have been treated as a coborrower. The lender should have
considered her creditworthiness during the underwriting process. The loan defaulted
and was submitted for claim to HUD. HUD acquired the property, and it was resold.
HUD incurred a loss of $34,172 on the resale.
Recommendations
We recommend that the Assistant Secretary for Housing-Federal Housing
Commissioner require Meridian to
1A. Indemnify HUD $50,720 for the insured loan originated at $130,050,
which was contrary to HUD requirements.
1B. Reimburse HUD $34,172 for the actual loss HUD incurred on the claim
from the loan that HUD sold.
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Finding 2: Meridian Did Not Fully Comply with HUD Quality Control
Requirements.
Meridian did not review its early defaulting loans in a timely manner and did not review all early
defaulting loans. This condition occurred because Meridian incorrectly pulled its early defaults
report data from HUD’s Neighborhood Watch system. It pulled only current defaults, instead of
pulling all defaults to ensure that it captured all of the early defaults when extracting the data
from the system. As a result, the lender adversely impacted the goals of HUD’s quality control
program, which was designed to protect the lender and HUD from unacceptable risk.
All Early Defaults Were Not
Reviewed
Lenders closing 15 or fewer loans monthly are required to perform quality control
reviews on a quarterly basis, and the review must include all loans going into
default within the first six payments. However, Meridian only had one quality
control review of its early defaults from April 2007 through May 2008. The
review covered early defaults from June 2007 through February 2008 and
included 11 of the 17 early defaults. The quality control review did not disclose
significant deficiencies.
Meridian incorrectly pulled its early defaults report data from the Neighborhood
Watch data system. It pulled only current defaults, instead of pulling all defaults
to ensure that it captured all of the early defaults when extracting the data from
the system. In addition, it did not ensure that its early defaults were reviewed in a
timely manner.
Meridian adversely impacted the goals of HUD’s quality control program to
ensure compliance with HUD’s and the lender’s own origination or servicing
requirements throughout its operations, designed to protect the lender and HUD
from unacceptable risk. Quality control is intended to guard against errors,
omissions, and fraud. Untimely quality control reviews do not ensure swift and
appropriate corrective action.
During the audit, the lender took corrective action to identify all early default
loans and to review the early default loans that had not been reviewed.
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Recommendations
We recommend that the Assistant Secretary for Housing-Federal Housing
Commissioner
2A. Ensure that Meridian conducts its quality control reviews in a timely
manner and that it reviews all early defaulting loans as required by HUD
regulations.
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SCOPE AND METHODOLOGY
Meridian originated 273 FHA-insured loans with beginning amortization dates from March 1,
2006, through February 29, 2008. Twenty-one of the loans defaulted within the first year of
closing. Of the 21 loans, 17 defaulted within the first six payments. We reviewed eight of the
defaulted loans for loan origination deficiencies. We selected the eight loans based on their
reasons for default, front and back ratios, and the number of payments before default.
To accomplish the audit objectives, we
• Obtained an understanding of applicable laws and regulations that related to single-
family requirements,
• Reviewed Meridian’s independent public accountant annual financial audits,
• Reviewed Meridian’s loan case files,
• Reviewed Meridian’s quality control plan and quality control reviews,
• Reviewed Meridian’s management controls over originating FHA-insured loans,
• Interviewed Meridian’s staff to obtain information regarding its policies and procedures,
and
• Interviewed program staff of HUD’s Quality Assurance and Processing and Underwriting
Divisions.
We used data maintained by HUD in the Neighborhood Watch system for background
information and in selecting our sample of loans for review. We did not rely on the data to base
our conclusions. Therefore, we did not assess the reliability of the data.
We classified $50,720 as funds to be put to better use. This is 39 percent of the $130,050
original mortgage amount for the loan that did not meet HUD requirements. We used 39 percent
because HUD has determined that 39 percent is the average loss on indemnified loans.
Our audit generally covered the period March 1, 2006, through February 29, 2008. We
performed work at the Home Ownership Center in Atlanta, Georgia, and at Meridian’s home
office located in Monroe, Georgia. We performed the review from April to June 2008.
We performed our review in accordance with generally accepted government auditing standards.
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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
implemented to reasonably ensure that the loan origination process
complies with HUD program requirements.
• Quality control plan - Policies and procedures that management has
implemented 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.
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Significant Weaknesses
Based on our review, we believe that the following items are significant weaknesses:
• Meridian did not follow HUD requirements in originating two insured loans
(see finding 1).
• Meridian did not fully comply with HUD quality control requirements
(see finding 2).
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APPENDIXES
Appendix A
SCHEDULE OF QUESTIONED COSTS
AND FUNDS TO BE PUT TO BETTER USE
Recommendation Funds to be put to
number Ineligible 1/ better use 2/
1A $50,720
1B $34,172 ________
Total $34,172 $50,720
1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
that the auditor believes are not allowable by law; contract; or federal, state, or local
policies or regulations.
2/ Recommendations that funds 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 not incurred by implementing recommended improvements,
avoidance of unnecessary expenditures noted in preaward reviews, and any other savings
which are specifically identified. In this instance, implementation of our
recommendation to indemnify a loan not originated in accordance with HUD
requirements will reduce the risk of loss to the FHA insurance fund. The above amount
reflects HUD statistics, which show that FHA, on average, loses 39 percent of the claim
paid for each property.
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Appendix B
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
Comment 1
Comment 2
Comment 3
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OIG Evaluation of Auditee Comments
Comment 1 Meridian Lending stated that the boarder’s total income went into the household,
and they lived together for three years. However, Meridian did not properly use
the boarder’s rental income as a compensating factor for this loan. Meridian used
the boarder’s wages as additional income for a compensating factor. HUD
requirements state that only a boarder’s rental income, if adequately documented,
could be used as a compensating factor. Meridian did not follow HUD
requirements when using compensating factors in underwriting the loan.
Neighborhood Watch shows that as of July 7, 2008, the loan was still in default
and was three months delinquent.
Comment 2 Although all of the factors used to underwrite the loan were appropriate, a second
deed was executed on the day of closing, giving the borrower’s spouse ownership
interest without being a part of the underwriting process. It is the lender’s
responsibility to ensure that the loan closed according to the closing instructions.
Meridian Lending did not ensure that this loan closed according to the closing
instructions.
Comment 3 Meridian Lending acknowledged that it did not ensure that all early default loans
underwent a quality control review. During the audit, the lender took corrective
action to identify all early default loans and to review the early default loans that
had not been reviewed.
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Meridian Lending, Inc., Monroe, Georgia, Did Not Follow HUD Requirements in Originating Two Insured Loans
Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-07-25.
Below is a raw (and likely hideous) rendition of the original report. (PDF)