oversight

James B. Nutter Did Not Meet HUD's or Its Own Quality Control Requirements Regarding the Number of Loans to Review

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-09-03.

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

                                                            Issue Date
                                                                     September 3, 2008
                                                            Audit Report Number
                                                                         2008-KC-1005




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


           //signed//
FROM:      Ronald J. Hosking, Regional Inspector General for Audit, 7AGA

SUBJECT: James B. Nutter Did Not Meet HUD’s or Its Own Quality Control Requirements
           Regarding the Number of Loans to Review


                                   HIGHLIGHTS

 What We Audited and Why

             We reviewed James B. Nutter and Company’s (J.B. Nutter) quality control
             program. Our objective was to determine whether J.B. Nutter followed U.S.
             Department of Housing and Urban Development (HUD) quality control
             requirements for home equity conversion mortgages insured by the Federal
             Housing Administration (FHA).

             We audited J.B. Nutter because it is a large volume lender of FHA-insured home
             equity conversion mortgages. From January 2004 through March 2008, J.B.
             Nutter originated or sponsored 11,453 home equity conversion mortgages valued
             at more than $2.27 million.

 What We Found
             For six months in 2007 and 2008, J.B. Nutter did not meet HUD’s or its own
             quality control requirements regarding the number of loans to review. We also
             identified minor exceptions with the lender’s documentation of payment of hazard




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           insurance and property taxes, and communicated the minor exceptions to HUD in
           a separate management letter.

What We Recommend


           We recommend that the Assistant Secretary for Housing – Federal Housing
           Commissioner ensure that J.B. Nutter follows HUD requirements regarding the
           minimum number of endorsed loans to be reviewed for quality control purposes.

           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

           J.B. Nutter generally agreed with our audit conclusions. We provided the draft
           report to J.B. Nutter on August 13, 2008, and requested a response by August 27,
           2008. It provided written comments on August 22, 2008.

           The complete text of the auditee’s response, along with our evaluation of that
           response, can be found in appendix A of this report.




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                           TABLE OF CONTENTS

Background and Objectives                                                  4

Results of Audit
      Finding: J.B. Nutter Did Not Meet HUD’s or Its Own Quality Control   5
                 Requirements Regarding the Number of Loans to Review

Scope and Methodology                                                      8

Internal Controls                                                          9

Other Matters                                                              10

Appendixes
   A. Auditee Comments and OIG’s Evaluation                                11




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                     BACKGROUND AND OBJECTIVES

James B. Nutter and Company (J.B. Nutter) is a nonsupervised lender based in Kansas City,
Missouri. J.B. Nutter was incorporated in 1955 and became an approved lender for the Federal
Housing Administration (FHA) in 1957.

The Housing and Community Development Act of 1987 established a federal mortgage
insurance program to insure home equity conversion mortgage loans. A home equity conversion
mortgage, also known as a reverse mortgage, is a special type of home loan that lets borrowers
62 years of age or older convert a portion of the equity in their home into cash. Unlike a
traditional home equity loan or second mortgage, the loans do not have to be repaid until the
borrowers no longer use the home as their principal residence. FHA insures home equity
conversion mortgages to protect lenders against a loss if amounts withdrawn exceed the equity
when the property is sold.

From January 2004 through March 2008, J.B. Nutter originated or sponsored 19,675 FHA loans,
of which 11,453 were home equity conversion mortgages. Loan correspondents originated and
J.B. Nutter sponsored most of these mortgages. J.B. Nutter currently sponsors more than 600
loan correspondents nationwide. It was also the first lender in the nation to close an FHA reverse
mortgage.

Our objective was to determine whether the J.B. Nutter followed HUD quality control
requirements for home equity conversion mortgages.




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                                RESULTS OF AUDIT

Finding:      J.B. Nutter Did Not Meet HUD’s or Its Own Quality Control
              Requirements Regarding the Number of Loans to Review
For six months in 2007 and 2008, J.B. Nutter did not meet HUD’s or its own quality control
requirements when it provided fewer FHA loans for review to its contractors than required. This
occurred because J.B. Nutter’s quality control manager was not satisfied with the initial
contractor’s performance. While J.B. Nutter sought out another contractor with home equity
conversion mortgage experience, it chose to provide a limited number of loans for quality control
review and to avoid paying review costs for poor service. As a result, J.B. Nutter could not
ensure the accuracy, validity, and completeness of its loan originations.


 The Quality Control Process
 Did Not Meet HUD or J.B.
 Nutter Standards

              J.B. Nutter did not provide the required number of loans to its quality control
              contractors for review. HUD Handbook 4060.1, REV-2, states that a lender who
              originates and/or underwrites 3,500 or fewer FHA loans per year must review 10
              percent of the FHA loans it originates. A lender who originates more than 3,500
              FHA loans per year may review 10 percent of its loans or a statistical random
              sampling that provides a 95 percent confidence level with 2 percent precision.

              J.B. Nutter chose the 10 percent option and selected the samples to provide to its
              quality control contractors. However, it did not provide its contractors with the
              required number of total FHA or home equity conversion mortgages for review.

              Our audit concentrated on home equity conversion mortgages, and, therefore, the
              following chart illustrates the percentage of home equity conversion mortgages
              that J.B. Nutter’s contractors evaluated during the six months that we reviewed.
              For the five months reviewed under the initial contractor (four months in 2007
              and January 2008), J.B. Nutter provided only 1 to 2 percent of the loans required
              for review. For the month reviewed under the new contractor (February 2008),
              J.B. Nutter provided a larger sample of about 8 percent but still did not provide
              the required 10 percent of loans for review.




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                        Number of FHA                                  Percentage     Percentage
                        loans endorsed* Number                         of HECMs       of HECMs
                        (excluding         of HECM** Number of         reviewed vs.   reviewed vs.
                        streamline         loans        HECM loans HECMs              all FHA loans
    Endorsed month refinances)             endorsed     reviewed       endorsed       endorsed
    February 2008             1,437           1,420          113           7.96%           7.86%
    January 2008              1,560           1,552           25           1.61%           1.60%
    December 2007              823             808            16           1.98%           1.94%
    June 2007                  525             504            8            1.59%           1.52%
    May 2007                   606             597            10           1.68%           1.65%
    April 2007                 617             601            7            1.16%           1.13%
     * Number of loans based on data in HUD’s Single Family Date Warehouse system
     ** Home equity conversion mortgage (HECM)

            As the chart shows, home equity conversion mortgages made up the vast majority
            of J.B. Nutter’s FHA portfolio. Therefore, even if the initial contractor had
            reviewed all of the other types of FHA loans, it would not have met the 10 percent
            requirement. For the February 2008 review, the contractor reviewed three FHA
            loans in addition to the home equity conversion mortgages, attaining 8.1 percent
            of FHA loans. While J.B. Nutter significantly improved its number of reviewed
            loans, it was not sufficient to reach the 10 percent requirement.

Managers Were Aware of
Requirements but Chose to
Limit the Number of Loans
Provided for Review

            J.B. Nutter’s quality control manager was aware of HUD’s and J.B. Nutter’s loan
            review requirements. However, due to the poor performance of the initial
            contractor, the manager decided to limit the number of loans provided for quality
            control reviews. This allowed J.B. Nutter to avoid paying review costs for poor
            service until the contractor improved its services or J.B. Nutter was able to hire a
            contractor with more experience in reviewing home equity conversion mortgages.


The Lender Could Not Ensure
that FHA Loans Submitted for
Insurance Were Acceptable

            Without an adequate quality control program, J.B. Nutter could not ensure that it

                •   Complied with HUD requirements when originating loans;
                •   Protected itself and HUD from unacceptable risk; and
                •   Guarded against errors, omissions, and fraud.



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          As a result, HUD lacked assurance that J.B. Nutter identified and corrected
          potential deficiencies in its loan origination process before submitting loans for
          FHA insurance.

Recommendation

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

          1A. Ensure that J.B. Nutter follows HUD requirements regarding the minimum
              number of endorsed loans to be reviewed for quality control purposes.




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                         SCOPE AND METHODOLOGY

To accomplish our objectives, we reviewed J.B. Nutter’s quality control plan and quality control
reports. We interviewed J.B. Nutter management and HUD staff. We also reviewed HUD’s and
J.B. Nutter’s underwriting policies and procedures and J.B. Nutter’s loan servicing procedures
and documentation.

Our audit period was January 1, 2004, through March 31, 2008. During that time, JB Nutter
originated or sponsored 19,675 FHA-insured loans. Of those loans, 11,453 were home equity
conversion mortgages valued at more than $2.27 million. We reviewed the HUD and J.B. Nutter
loan files for 15 home equity conversion mortgages. Four of the loans had been FHA insured for
more than one year. We reviewed the servicing documentation for these four loans, including
servicing notes and proof of payment documentation for hazard insurance and property taxes.

We relied on computer-processed data contained in HUD’s Single Family Data Warehouse
system solely to select a sample of loans for review. Based on previous experience, assessments,
and testing of the data, we concluded that the data were sufficiently reliable to the extent used for
sample selection.

We performed audit work from May through July 2008 at J.B. Nutter’s main office at 4153
Broadway, Kansas City, Missouri. We conducted our 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 objective. We believe that the evidence obtained provides a
reasonable basis for our findings and conclusions based on our audit objective.




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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:

              •       Controls to ensure that J.B. Nutter had implemented its quality control
                      plan and adequately monitored its quality control contractor for
                      compliance.

              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 Weakness

              Based on our review, we believe the following item is a significant weakness:

              •       J.B. Nutter did not have adequate controls to ensure that it fully
                      implemented its quality control plan and met HUD requirements.




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                                  OTHER MATTERS

During the audit, we became aware of an issue that HUD needs to be aware of regarding lender
documentation of proof of payment for property hazard insurance and taxes when the borrower
elects to pay these expenses personally. HUD allows home equity conversion mortgage borrowers
to pay these required homeowner expenses personally or through escrow accounts with their lender.
When borrowers elect to pay the expenses personally, HUD requires lenders to obtain proof of
payment on an annual basis to show that the property is actively insured with hazard insurance and
that property taxes have been paid.

We determined that J.B. Nutter frequently relied on insurance declaration pages from insurance
companies as proof of payment in lieu of receipts or similar documentation proving that the
borrower had paid the premiums and was actively insured. According to several insurance
companies, an insurance declaration page generally serves to describe the offered coverages and
associated costs, not to provide assurance that premiums are paid and the insurance is current.
Similarly, J.B. Nutter relied on staff data entries/notations to its computerized servicing system
indicating that borrowers had paid their property taxes. Its staff frequently used government
Web sites to confirm property tax payments; however, the staff notations were not supported by
receipts or similar documentation proving that the borrower had paid his or her property taxes.

For J.B. Nutter, this was not a reportable issue that required HUD to take action. However, we
recommend that HUD include this area of concern in its future monitoring of FHA-approved
lenders.




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                        APPENDIXES

Appendix A

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation      Auditee Comments




Comment 1




                            11
Ref to OIG Evaluation   Auditee Comments




Comment 2




Comment 3




                         12
Ref to OIG Evaluation   Auditee Comments




                         13
Ref to OIG Evaluation   Auditee Comments




Comment 2




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                       OIG Evaluation of Auditee Comments

Comment 1   We commend J.B. Nutter for taking steps to improve its quality control program
            to ensure that it receives a useful and acceptable quality control service and
            meets HUD’s requirements on FHA loans. Ongoing compliance with HUD’s
            quality control requirements should help ensure that J.B. Nutter submits FHA
            loans for insurance that meet HUD’s standards.

Comment 2   The draft report provided to J.B. Nutter for a response addressed J.B.Nutter’s
            compliance with HUD’s 10 percent quality control requirement based on the
            number of FHA loans closed in each of six months reviewed. Due to
            subsequent comments that we received from HUD, we changed the final report
            to reflect J.B. Nutter’s performance based solely on endorsed loans. This
            change did not affect the overall finding that J.B. Nutter did not comply with
            HUD’s quality control requirements regarding the number of loans reviewed.

            In addition, J.B. Nutter’s response to the draft report addressed its more recent
            performance using the number of loans closed, based on information in HUD’s
            data systems that we provided to J.B. Nutter. Due to HUD’s comments on the
            draft report, we recomputed J.B. Nutter’s more recent performance on the
            number of loans reviewed, using the number of endorsed loans. The new data
            showed that J.B. Nutter has generally improved its compliance with HUD’s 10
            percent quality control requirement in recent months, as demonstrated in the
            following chart.

                                                                    Percentage
                                                                     of HECMs
                                     Number of       Number of     reviewed vs.
                                      HECMs           HECMs           HECMs
                Endorsed month       endorsed        reviewed        endorsed
                February 2008          1,420            113            7.96%
                March 2008             1,355            118            8.71%
                April 2008             1,369            151           11.00%
                May 2008                992             134           13.50%
                June 2008              1,541            143            9.28%
                July 2008              1,485            162           10.91%


Comment 3   We understand that J.B. Nutter limited the number of reviewed loans as part of
            its efforts to mitigate the poor service that it was receiving from the initial
            contractor. Our comments regarding the cost savings were intended to explain
            that J.B. Nutter recognized that it was receiving poor service and not getting
            what it paid for in quality control reviews. Therefore, limiting the number of
            loans reviewed (and paid for) during the period in question was a business
            decision that J.B. Nutter management made to keep the company from paying
            for poor service, not as a means to save costs in general.




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