oversight

Countrywide Bank, Milford and Madison, Connecticut, Did Not Comply with Certain HUD Requirements in Administering Its Federal Housing Administration Insured Loan Programs

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-07-24.

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

                                                                           Issue Date
                                                                                        July 24, 2008
                                                                           Audit Report Number
                                                                                    2008-BO-1007




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




FROM:          for John Dvorak, Regional Inspector General for Audit, Boston Region, 1AGA


SUBJECT: Countrywide Bank, Milford and Madison, Connecticut, Did Not Comply with
           Certain HUD Requirements in Administering Its Federal Housing
           Administration Insured Loan Programs


                                         HIGHLIGHTS

    What We Audited and Why


                We audited the Milford, Connecticut, branch office of Countrywide Bank, FSB
                (Countrywide1), which is a supervised national bank approved by the U.S.
                Department of Housing and Urban Development (HUD) to originate, underwrite,
                and service Federal Housing Administration (FHA) single-family insured loans.
                We selected the Milford, Connecticut, branch office largely based on a lender risk
                analysis, which showed that the loans it originated had a higher default percentage
                than the Connecticut state average. We expanded the audit to cover the Madison,
                Connecticut, branch office, which used the same FHA identification number.

                Our objectives were to determine whether the lender acted in a prudent manner
                and complied with HUD regulations, procedures, and instructions in the
                origination of the FHA-insured single-family mortgages selected for review; and
                whether its quality control plan as implemented met HUD requirements.

1
  “Countrywide Bank, FSB” (Federal Savings Bank) and “Countrywide” used interchangeably throughout this
report.
What We Found

           Countrywide did not fully comply with HUD regulations, procedures, and
           instructions in the origination of FHA-insured single-family mortgages.
           However, the lender’s quality control plan and implementation was adequate.

           Specifically, Countrywide allowed some borrowers utilizing secondary financing
           from an agency acting as an instrumentality of government to incorrectly receive
           cash back at closing in excess of their total cash deposit totaling $5,767. This
           occurred because Countrywide did not follow proper HUD underwriting
           guidelines, which resulted in the loans being overinsured and a minimal increased
           risk to the FHA insurance fund. Countrywide also did not properly notify HUD
           upon the sale and/or transfer of FHA-insured loans. This condition occurred
           because Countrywide was not fully aware of the HUD requirements regarding
           mortgage record changes.

What We Recommend


           We recommend that HUD’s Assistant Secretary for Housing–Federal Housing
           Commissioner require Countrywide to (1) pay down the principal by $5,767 for
           the five overinsured loans and implement controls to prevent cash back when
           secondary financing is used; and (2) update their mortgage records in HUD's
           system to reflect the appropriate mortgage holder and implement procedures to
           ensure the timely submission of mortgage record changes for future loans
           assigned or sold.

           For each recommendation in the body of the report without a management
           decision, please respond and provide status reports in accordance with HUD
           Handbook 2000.06, REV-3. Please also furnish us copies of any correspondence
           or directives issued because of the audit.

Auditee’s Response


           We provided Countrywide officials draft finding details throughout the course of
           the audit. We also provided Countrywide officials with a draft audit report on
           June 27, 2008, and requested a response by July 22, 2008. We discussed the draft
           report at an exit conference on July 17, 2008, and received their written comments
           on July 18, 2008. Countrywide agreed with the facts, conclusions, and
           recommendations in this report. Countrywide’s written response can be found in
           appendix B of this report.




                                           2
                           TABLE OF CONTENTS

Background and Objectives                                                     4

Results of Audit

   Countrywide Did Not Comply With Certain HUD Requirements Concerning the
   Origination and Servicing of FHA-Insured Loans                             6

Scope and Methodology                                                         8

Internal Controls                                                            10

Appendixes

   A. Schedule of Questioned Costs                                           12
   B. Auditee Comments                                                       13
   C. Schedule of Loans With Excess Cash Back to Borrowers                   14




                                          3
                         BACKGROUND AND OBJECTIVES

The National Housing Act, as amended, established the Federal Housing Administration (FHA),
an organizational unit within the U.S. Department of Housing and Urban Development (HUD).
FHA2 provides insurance to private lenders against losses on mortgages financing homes. The
basic single-family mortgage insurance program is authorized under Title II, Section 203(b) of
the National Housing Act and is governed by regulations in 24 CFR [Code of Federal
Regulations] Part 203. The single-family programs are generally limited to dwellings with one-
to four-family units. HUD Handbooks and Mortgagee Letters provide detailed processing
instructions, and advise the mortgage industry of major changes to FHA programs and
procedures.

There are two types of HUD-approved lenders3—supervised and nonsupervised. A non-
supervised lender is a financial entity that has as its principal activity the lending or investing of
funds in real estate mortgages, but it is not a member of the Federal Reserve System or an
institution whose accounts are insured. A supervised lender is a financial institution, which is a
member of the Federal Reserve System or an institution whose accounts the Federal Deposit
Insurance Corporation or the National Credit Union Administration insures. Prior to 2008, the
audited branches (Milford and Madison, Connecticut) were part of Countrywide Home Loans,
Inc., which was a non-supervised mortgage company. In January 2008, Countrywide integrated
its mortgage loan production divisions and certain other mortgage banking operations into
Countrywide Bank, FSB, which is a supervised national bank. Countrywide is a nationwide
lender and its corporate office is in Calabasas, California. Countrywide is responsible for the
loan quality and performance of all its branches4.

Based on HUD’s data, the Milford and Madison, Connecticut, branch offices originated
approximately 661 FHA loans from January 1, 2005, through March 31, 2008. The total original
mortgage amount for all loans originated during this period was more than $124 million.

As of March 31, 2008, the FHA loan default rate for loans that were originated by the Milford
and Madison, Connecticut, branch offices and went into default within the first two years of
origination was 4.18 percent. The rate for all other lenders that originated loans in Connecticut
for the last two years was 3.83. The Milford and Madison, Connecticut, branch offices have
consistently had a higher default rate during the early loan repayment period the last several
quarters as compared to other lenders that originated loans in Connecticut (see table on the
following page).




2
  The acronyms HUD and FHA are often used interchangeably.
3
  For ease of reading, we have chosen to use “lender” in lieu of “mortgagee” throughout this report. However,
lender is to be interpreted as an FHA-approved mortgagee as described in the regulations, program handbooks, etc.
4
  HUD Handbook 4060.1 REV-2, “FHA Title II Mortgagee Approval Handbook,” Chapter 2, Section 2-11.


                                                        4
 Comparison of early payment loan default percentages, Milford and Madison, Connecticut, Branch Offices,
 Countrywide Bank, and Connecticut Lenders
                                          Loan defaults (%)
                        Milford and Madison, CT,
                             Branch Offices,               Connecticut
 Quarter end date          Countrywide Bank                  Lenders             Compare ratio (%)*
 3/31/2008                        4.18                        3.83                       109
 12/31/2007                       4.83                        3.93                       123
 9/30/2007                        4.23                        3.62                       117
 6/30/2007                        4.38                        3.49                       126
 3/31/2007                        4.99                        3.59                       139
 12/31/2006                       4.57                        3.51                       130
 * A compare ratio is the percentage of originations that went into default or were claim terminated divided by
 the percentage of originations that went into default or were claim terminated for the selected geographic area.
 Compare ratio is the value that reveals the largest discrepancies between the subject’s default and claim
 percentage and the default and claim percentage to which it is being compared.



The audit objectives were to determine whether the lender acted in a prudent manner and
complied with HUD regulations, procedures, and instructions in the origination of the FHA-
insured single-family mortgages selected for review and whether its quality control plan as
implemented met HUD requirements. We also assessed other general aspects of Countrywide’s
operations as they related to continued lender approval.




                                                        5
                                   RESULTS OF AUDIT

Countrywide Did Not Comply With Certain HUD Requirements
Concerning the Origination and Servicing of FHA-Insured Loans
Countrywide did not comply with certain HUD requirements concerning the origination and
processing of FHA-insured loans. Specifically, Countrywide allowed five borrowers to
incorrectly receive cash back at closing in excess of their total cash deposit. This occurred
because Countrywide did not follow proper HUD underwriting guidelines governing the use of
secondary financing from an agency acting as an instrumentality of government. This failure to
follow prudent lending practices was not an indication of a pattern of noncompliance, but the
five loans were overinsured by $5,767, representing a minimal increased risk to the FHA
insurance fund. Countrywide also did not properly notify HUD upon the sale and/or transfer of
FHA-insured loans. This condition occurred because Countrywide was not fully aware of the
HUD requirements regarding mortgage record changes.



    Borrowers Incorrectly Received
    Cash Back

                Our review of 46 FHA-insured loan origination files identified five instances
                where the HUD-1 Settlement Statements indicated that the borrowers received
                cash back at closing in excess of their earnest money deposit or other upfront
                costs paid outside of closing. The borrowers received downpayment assistance
                from the Connecticut Housing Finance Authority (CHFA), which is considered an
                instrumentality of government. Federal, state, and local government agencies, as
                well as, nonprofit agencies considered instrumentalities of government, may
                provide secondary financing for the borrower’s entire cash investment in the
                FHA-insured property so long as it does not result in cash back to the borrower.5
                The total cash incorrectly received back by the five borrowers totaled $5,767 (see
                appendix C).

                Although Countrywide did not follow proper HUD underwriting guidelines, there
                was no indication of a pattern of noncompliance. Nonetheless, the five loans
                were overinsured by $5,767, representing a minimal increased risk to the FHA
                insurance fund and Countrywide will need to be more vigilant in its underwriting.




5
 HUD Handbook 4155.1 REV-5, “Mortgage Credit Analysis for Mortgage Insurance on One-to-Four Family
Properties,” Chapter 1, Section 5.


                                                   6
    Significant Number of
    Mortgage Records Not Updated


                 In November 2003, recognizing the new technology under which the mortgage
                 industry and HUD operates the single-family insurance programs, HUD eliminated
                 the paper mortgage insurance certificate in favor of electronic records maintained by
                 HUD for the purpose of verification of both the ownership and of the insured status
                 of a mortgage. As a result, HUD made several procedural changes that affected the
                 originating lender, the holding lender, and the servicing lender.6

                 HUD determined that it was imperative that the data contained in HUD’s Single
                 Family Insurance System regarding a lender’s FHA-insured portfolio be accurate.7
                 Of key concern is the submission of mortgage record changes and mortgage
                 insurance terminations that update HUD’s insurance system. Lenders must notify
                 HUD of a sale of an FHA-insured loan within 15 calendar days.8 HUD identified
                 that the most common problem was that lenders often did not update the holder of
                 record for each loan as required. As of December 1, 2005, only the existing holder
                 of record is able to provide HUD with mortgage record changes to update a new
                 holder of record, if 90 days have passed after endorsement.9 In addition, HUD will
                 not pay any claim for insurance benefits for which the information on the claim
                 and HUD’s FHA insurance system do not agree.

                 As of May 29, 2008, Countrywide was listed as the holding lender for 797 active
                 loans of which 751 (94 percent) were over 90 days past endorsement (see table
                 below).
                                                Countrywide Listed as Holding Lender
                                                       (as of May 29, 2008)
                                        Days Since        Number of             Percent of
                                      Endorsement        FHA Loans             Total Loans
                                    0 – 30                             1                   0.13%
                                    31 – 60                           26                   3.26%
                                    61 – 90                           19                   2.38%
                                    91 – 120                          16                   2.01%
                                    121 – 365                       165                  20.70%
                                    366 – 730                       194                  24.34%
                                    731 - 1,096                     184                  23.09%
                                    >1,096                          192                  24.09%
                                    Totals                          797                100.00%

                 However, Countrywide assigned a high percentage of FHA-insured loans to
                 CHFA at closing. We did not specifically identify which loans Countrywide
                 assigned to CHFA but estimate that Countrywide assigned over 600 loans during
                 our audit period. Therefore, CHFA should be reflected as the holding lender for

6
  Mortgagee Letter 2003-17.
7
  Mortgagee Letters 2003-17, 2004-34, 2005-11, and 2005-42.
8
  Title 24 of the Code of Federal Regulations, Part 203.431, "Sale of insured mortgage to approved mortgagee.”
9
  Mortgagee Letter 2005-42.


                                                        7
             these loans. Countrywide officials acknowledged that they had not been notifying
             HUD or updating mortgage record upon the sale and/or transfer of FHA-insured
             loans because they were not aware of the requirements, which are explained in a
             series of related mortgagee letters.

Conclusion

             Countrywide’s oversight of its underwriting overall appeared adequate and errors
             noted during our file reviews only have a minimal impact on HUD’s single-family
             mortgage insurance program. However, five borrowers incorrectly received cash
             back at closing, resulting in loans overinsured by $5,767 and a minimal increased
             risk to the FHA insurance fund. This occurred because Countrywide did not
             follow proper HUD underwriting guidelines. In addition, Countrywide did not
             properly notify HUD upon the sale and/or transfer of FHA-insured loans. This
             condition occurred because Countrywide was not fully aware of the HUD
             requirements regarding mortgage record changes. Inaccurate or untimely
             reporting of mortgage record changes directly affects the payment of claims for
             insurance benefits. As such, HUD will not pay any claim for insurance benefits
             for which the information on the claim and HUD’s FHA insurance system do not
             agree. Therefore, it is incumbent upon the lender to ensure that HUD’s records
             accurately reflect both the correct holder and servicer of record.

Recommendations

             We recommend that HUD’s Assistant Secretary for Housing–Federal Housing
             Commissioner require Countrywide to

             1A. Pay down the principal by $5,767 for the five overinsured loans. If HUD has
                 subsequently paid a claim on any of these loans, Countrywide should remit
                 this payment to HUD.

             1B. Implement controls to ensure that when instrumentalities of government
                 provide downpayment assistance or secondary financing for the borrower’s
                 cash investment in a FHA-insured property that it does not result in cash
                 back to the borrower.

             1C. Update their mortgage records in HUD's system to reflect the appropriate
                 mortgage holder.

             1D. Implement procedures to ensure the timely submission of mortgage record
                 changes for future loans assigned or sold.




                                             8
                        SCOPE AND METHODOLOGY

Our audit primarily covered the period of January 1, 2005, through December 31, 2007, and
included loans originated and sponsored by the Milford, CT, and Madison, CT branches of
Countrywide Bank, FSB. We extended the audit period as necessary through March 31, 2008.
We conducted our audit work from February 2008 through June 2008. We primarily carried out
our audit work at the Milford, CT, branch office of Countrywide Bank, FSB, and the local HUD
Hartford (Connecticut) field office. We focused the audit on the lender’s loan origination,
underwriting, servicing, and quality control operations.

To achieve our objectives, we identified, obtained, and reviewed relevant rules, regulations, and
guidance pertaining to the origination of single-family mortgages, including the Code of Federal
Regulations, HUD handbooks, Mortgagee Letters, and the United States Code. We also obtained
and analyzed critical documents from the loan origination files maintained by Countrywide and
HUD. We interviewed appropriate lender and HUD officials. In addition, we obtained an
understanding of controls significant to the audit objectives and considered whether the lender
designed and placed specific control procedures in operation.

We relied on information from HUD’s data systems. We reviewed existing information about
the data and performed sufficient tests to determine whether the data was reliable. Based on our
assessments, we determined that the data was sufficiently reliable for our purposes.

We selected 46 FHA-insured loans that defaulted within the first three years of origination for
detailed loan origination analysis. The 46 loans represented 100% of the loans that defaulted out
of the 661 loans originated during our audit period of January 1, 2005 through March 31, 2008.
The results of our detailed testing only relate to the loans reviewed. This sampling method
allowed us to focus on loans that had a greater inherent risk to the FHA insurance fund and/or of
noncompliance or abuse.

We also communicated minor issues disclosed during the audit with the auditee and sent a
separate letter to HUD program officials.

We conducted this performance audit in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions
based on our audit objectives. We believe that the evidence obtained provides a reasonable basis
for our findings and conclusions based on our audit objectives.




                                                9
                              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:
              •       Controls over program operations - Policies and procedures that
                      management has implemented to reasonably ensure that the HUD single-
                      family insurance program meets its objectives and that unintended actions do
                      not result.
              •       Controls over the validity and reliability of data - Policies and procedures
                      that management has implemented to reasonably ensure that valid and
                      reliable data (including computer-processed data) are obtained, maintained,
                      and fairly disclosed in reports and HUD computer systems.
              •       Controls over compliance with laws and regulations - Policies and
                      procedures that management has implemented to reasonably ensure that the
                      single-family program implementation is consistent with laws, regulations,
                      and provisions of contracts or grant agreements.

              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.




                                                 10
Significant Weaknesses

           Based on our review, we believe the following items are significant weaknesses:
           •      Controls over compliance with laws and regulations – Countrywide allowed
                  cash back to borrowers with secondary financing from an agency acting as
                  an instrumentality of government.
           •      Controls over the validity and reliability of data – Countrywide did not
                  update its mortgage records in a timely manner.




                                            11
                                   APPENDIXES

Appendix A

                SCHEDULE OF QUESTIONED COSTS

                           Recommendation            Ineligible 1/
                                  number
                                         1A               $5,767


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
     polices or regulations.




                                            12
Appendix B

             AUDITEE COMMENTS




                    13
Appendix C

                  SCHEDULE OF LOANS WITH EXCESS
                     CASH BACK TO BORROWERS


                                                 Earnest Deposit       Excess (Cash Paid to Borrower
                                    Cash Paid    and/or Other Costs    at Closing Less Earnest
                                    to Borrower Paid Outside of        Deposit and Other Costs Paid
#   Lender's Loan #   FHA #         at Closing   Closing               Outside of Closing)
1   100366494         061-2862414      $4,557.34           $2,200.00                        $2,357.34
2   102018386         061-2869934      $2,642.50           $2,000.00                           $642.50
3   123630311         061-2919271      $2,830.92           $2,600.00                           $230.92
4   155413159         061-3008096      $2,168.67             $634.00                        $1,534.67
5   138556782         061-3014821      $1,601.76             $600.00                        $1,001.76
                                       TOTAL EXCESS CASH BACK:                              $5,767.19




                                               14