oversight

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)

                                                                    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




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                     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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                                                   4
                                 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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