oversight

First National Bank, Gillette, Wyoming, Did Not Follow HUD Requirements in Originating and Underwriting Insured Loans and Did Not Have a Quality Control Plan

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-09-24.

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

                                                                   Issue Date
                                                                            September 24, 2008
                                                                   Audit Report Number
                                                                                2008-DE-1004




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

            //signed//
FROM:       Ronald J. Hosking, Regional Inspector General for Audit, 8AGA

SUBJECT: First National Bank, Gillette, Wyoming, Did Not Follow HUD Requirements in
            Originating and Underwriting Insured Loans and Did Not Have a Quality
            Control Plan


                                    HIGHLIGHTS

 What We Audited and Why

             We audited First National Bank of Gillette (First National Bank), a Federal
             Housing Administration (FHA)-approved direct endorsement lender, to determine
             whether it properly processed insured loans and to determine whether its quality
             control plan met the U.S. Department of Housing and Urban Development’s
             (HUD) requirements. We audited First National Bank because of its high default
             rate and the Office of Inspector General’s strategic goal to reduce fraud in single-
             family insurance programs.

 What We Found
             First National Bank did not follow HUD regulations when originating and
             underwriting 18 FHA loans. The originating and underwriting deficiencies occurred
             because First National Bank management did not properly train its originators and
             underwriters and it did not develop effective procedures for monitoring their actions
             to ensure compliance with HUD directives.

             In addition, First National Bank did not have a written quality control plan, and its
             third-party contractor, who performed the quality control reviews, did not perform
             all reviews in accordance with HUD requirements. These deficiencies were due



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           to management’s not placing a high priority on the quality control process and not
           adequately training new staff.

What We Recommend


           We recommend that the Assistant Secretary for Housing – Federal Housing
           Commissioner take appropriate action against First National Bank for not
           following HUD requirements. At a minimum, HUD should require First National
           Bank to bring its procedures for the origination and underwriting of insured loans
           into full compliance with HUD regulations and to develop and implement a
           written quality control plan.

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

Auditee’s Response


           We provided the draft report to First National Bank on September 9, 2008 and
           requested written comments to the report by September 24, 2008. First National
           Bank concurred with the report and declined to provide formal written comments.




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                           TABLE OF CONTENTS

Background and Objectives                                                       4

Results of Audit
      Finding 1: First National Bank Did Not Follow HUD Regulations When        5
                 Originating and Underwriting 18 FHA Loans
      Finding 2: First National Bank Did Not Have an Adequate Quality Control   7
                 Program

Scope and Methodology                                                           9

Internal Controls                                                               10

Appendixes
   A. Narrative Case Summary                                                    11
   B. Schedule of Minor Deficiencies                                            12




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                     BACKGROUND AND OBJECTIVES

First National Bank of Gillette (First National Bank) is located in Gillette, Wyoming. The U.S.
Department of Housing and Urban Development’s (HUD) Federal Housing Administration
(FHA) approved First National Bank as a supervised mortgage company on June 3, 1965.

First National Bank originated 298 FHA-insured loans, with beginning amortization dates from
May 1, 2006, through April 30, 2008, with a total original mortgage amount of more than $50.1
million. Twenty of these loans (6.71 percent) defaulted within the first two years of closing.
The original mortgage amount of the defaulted loans totaled more than $3.2 million.

The objectives of the audit were to determine whether First National Bank acted in a prudent
manner and complied with HUD regulations, procedures, and instructions in the origination
and/or underwriting of the FHA-insured loans selected for review and to determine whether First
National Bank’s quality control plan, as implemented, met HUD requirements.




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                                 RESULTS OF AUDIT

Finding 1: First National Bank Did Not Follow HUD Regulations When
            Originating and Underwriting 18 FHA Loans
First National Bank violated HUD requirements in originating and underwriting 18 FHA-insured
loans. One of the loans contained deficiencies that affected the credit quality (insurability) of the
loan. The originating and underwriting deficiencies occurred because First National Bank
management did not properly train its originators and underwriters and it did not develop
effective procedures for monitoring their actions to ensure compliance with HUD directives. As
a result, HUD insured improperly underwritten loans, and there was an increased risk to the FHA
insurance fund.


 First National Bank Violated
 HUD Underwriting
 Requirements


               First National Bank violated HUD requirements in originating and underwriting 18
               FHA-insured loans. One loan contained significant underwriting deficiencies
               because First National Bank used unacceptable income sources. Specifically, an
               underwriter used income from part-time employment received for less than two
               years, and the justification provided by the lender did not substantiate that the
               income was likely to continue.

               First National Bank also underwrote 17 loans that contained minor underwriting
               deficiencies. While these deficiencies did not affect the overall insurability of the
               loans, they indicated a lack of commitment to quality underwriting. The lender
               needs to ensure that it follows all facets of HUD requirements when originating
               FHA loans. We provided details of these deficiencies to First National Bank during
               our review. Appendix C summarizes the deficiencies in each of the 17 loans.
 Originators and Underwriters
 Lacked Training and
 Supervision


               The underwriting deficiencies occurred because First National Bank management
               did not properly train its originators and underwriters and it did not develop
               effective procedures for monitoring their actions to ensure compliance with HUD
               directives. Additionally, there was a high turnover in staff, which meant that
               inexperienced staff originated the FHA-insured loans.




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There Was an Undue Risk to
HUD’s Insurance Fund


             First National Bank placed HUD’s insurance fund at risk by not following HUD
             originating and underwriting requirements. The one loan with significant
             deficiencies was sold by the loan servicer after our audit work was completed, and
             there was no resulting loss to HUD. We verified with HUD that the loan’s status
             was terminated and no claims or fees would be requested from HUD.


Conclusion

             One of the loans we reviewed contained deficiencies that affected the credit
             quality (insurability) of the loan. However, the loan servicer sold this loan after
             our audit work was completed. There was no loss to HUD. Seventeen of the
             loans contained deficiencies that did not affect the credit quality (insurability) of
             the loans. First National Bank needs to better train and supervise its staff so that
             these types of deficiencies do not continue.

Recommendations

             We recommend that the Assistant Secretary for Housing – Federal Housing
             Commissioner

                    1A.     Require First National Bank to develop and implement procedures
                            for monitoring its origination and underwriting processes.

                    1B.     Require First National Bank to train its staff who originate and
                            underwrite FHA-insured loans.




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Finding 2: First National Bank Did Not Have an Adequate Quality
            Control Program
First National Bank did not have a written quality control plan, nor did it comply with other
HUD requirements concerning its quality control program. These deficiencies are due to
management not placing a high priority on the quality control process and not adequately
training new staff. Without a quality control plan, management cannot effectively monitor the
origination and underwriting of FHA loans to ensure compliance with HUD requirements.




 First National Bank Did Not
 Have an Adequate Quality
 Control Program

              First National Bank did not have a written quality control plan. Management
              officials stated that they believed they had a quality control plan at one time but were
              unable to locate it. They explained that First National Bank is in the process of
              developing and implementing a new quality control plan.

              First National Bank used a third-party contractor to perform its quality control
              reviews, but it did not always get loans for review to the contractor in a timely
              manner. Consequently, the contractor could not complete the quality control
              reviews within 90 days of closing as required by HUD.

              In addition, First National Bank did not always take action regarding the quality
              control review report findings. Management stated that it reviewed the quality
              control review report findings during the biweekly staff meetings. However, it only
              reviewed 5 of the 23 quality control review reports covering our audit period.
              Further, when management conducted staff meetings to discuss the quality control
              review reports, it did not document planned or actual corrective action.

              First National Bank did not ensure that the contractor followed HUD requirements.
              The contractor did not review the FHA-insured loans with early defaults and did not
              perform field reviews of appraisals on 10 percent of the loans reviewed during the
              quality control process.

              To help resolve these deficiencies, First National Bank contacted its third-party
              contractor. Additionally, it contacted its investors to ask that they inform it of early
              defaults so that it can perform quality control reviews on the early defaulted loans.




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First National Bank Did Not
Place a High Priority on the
Quality Control Process


                First National Bank’s management considered its main priority to be the day-to-day
                operations of the bank and did not place a high enough priority on the quality control
                process. Additionally, when staff responsible for the quality control process left,
                management did not ensure that the new staff were adequately trained in the quality
                control process.

   Monitoring of Origination and
   Underwriting Was Ineffective


                Without an adequate quality control program, First National Bank’s management
                could not effectively monitor the origination and underwriting of FHA loans to
                ensure compliance with HUD requirements.

   Conclusion


                First National Bank had not developed and implemented a written quality control
                plan in accordance with HUD requirements. Without proper establishment of a
                quality control process, First National Bank was unable to ensure the accuracy,
                validity, and completeness of its loan origination operations. Therefore, potential
                deficinecies might not be identified and corrected in a timely manner, resulting in
                an increased risk to the insurance fund.

   Recommendations


                We recommend that the Assistant Secretary for Housing – Federal Housing
                Commissioner

                       2A.     Require First National Bank to develop and implement a written
                               quality control plan in accordance with HUD requirements.

                       2B.     Require First National Bank to train its staff regarding the quality
                               control program requirements.

                       2C.     Review First National Bank’s written quality control plan and its
                               implementation to ensure that it meets HUD requirements.




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                               SCOPE AND METHODOLOGY

First National Bank originated 298 FHA-insured loans with beginning amortization dates from May
1, 2006, through April 30, 2008. Twenty of these loans defaulted within the first two years of
closing. We excluded a terminated loan because it was no longer active. We reviewed the
remaining 19 defaulted loans that had active status.

To accomplish the audit objectives, we

•   Reviewed regulations and reference materials related to single-family requirements.
•   Reviewed the FHA case binders for compliance with regulations.
•   Reviewed First National Bank’s loan case files.
•   Interviewed First National Bank’s real estate loan staff to obtain information regarding its
     policies and procedures.

We used data maintained by HUD in the Single Family Data Warehouse and Neighborhood Watch
systems for background information and in selecting our sample of loans. We did not rely on the
data to base our conclusions. Therefore, we did not assess the reliability of the data.

We performed the review work from June to July 2008.

We conducted our review 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.




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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:

              •       Management’s controls to ensure that it originates and underwrites FHA-
                      insured loans in accordance with HUD requirements.

              •       Management’s policies and procedures to ensure that it implements a quality
                      control plan and performs related reviews in accordance with HUD
                      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 items are significant weaknesses:

              •       First National Bank did not have adequate procedures to ensure that it
                      followed HUD requirements in the origination and underwriting of FHA-
                      insured loans (finding 1).

              •       First National Bank did not have a quality control plan for effectively
                      monitoring the origination and underwriting of FHA-insured loans (finding
                      2).




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                                    APPENDIXES

Appendix A

                        NARRATIVE CASE SUMMARY

  HUD case number:                 5911010949
  Loan amount:                     $123,892
  Closing date:                    August 28, 2007
  Status at time of review:        First 90-day default reported after one payment
  Current status:                  Terminated

  Unallowable Use of Part-Time Income in Borrower Qualification
  First National Bank underwrote and approved the mortgage using part-time income for a job
  the borrower had held for less than one month. The borrower had not worked in the same
  line of work for the previous eight months. The justification and documentation provided by
  First National Bank were not adequate to establish the stability and effectiveness of the part-
  time income. Therefore, HUD insured the loan based on First National Bank’s inaccurate
  representation that the borrower met HUD qualifying guidelines.

  As of August 5, 2008, this loan was nine months delinquent. The servicer sold this loan on
  August 15, 2008, after our audit work was completed. There was no loss to HUD associated
  with the sale of this property, and the servicer did not submit fees to HUD for
  reimbursement.

  HUD Requirements
  HUD Handbook 4155.1, REV-5, CHG-1, chapter 2, section 2, paragraph 2-7.B
  The lender must establish that it reasonably expects the income of the borrower to continue.
  The lender may use part-time income in qualifying if it documents that the borrower has
  held the part-time job, uninterrupted, for the past two years and will continue to do so.
  Income received for less than two years from a part-time position may be included as
  effective income, provided the lender justifies and documents that the income’s continuance
  is likely.




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Appendix B

             SCHEDULE OF MINOR DEFICIENCIES




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