oversight

Allied Home Mortgage Capital Corporation, Houston, Texas, Did Not Fully Follow HUD's Branch Office Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-02-10.

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

                                                                  Issue Date
                                                                           February 10, 2009
                                                                  Audit Report Number
                                                                               2009-FW-1005




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

            Henry S. Czauski, Acting Director, Departmental Enforcement Center, CV


FROM:      Gerald R. Kirkland
           Regional Inspector General for Audit, Fort Worth Region, 6AGA

SUBJECT: Allied Home Mortgage Capital Corporation, Houston, Texas, Did Not Fully
         Follow HUD’s Branch Office Requirements


                                     HIGHLIGHTS

 What We Audited and Why

             We reviewed Allied Home Mortgage Capital Corporation (Allied), a nonsupervised
             loan correspondent. The objective of the review was to determine the validity of a
             hotline complaint that Allied operated its branches in violation of U. S. Department
             of Housing and Urban Development (HUD) requirements. Specifically, the
             complaint alleged that Allied required its branch managers to enter into certain
             contractual relationships, pay branch operating expenses, and provide
             indemnification for losses and damages, all of which were prohibited branch
             arrangements.


 What We Found

             The complaint was partially valid as Allied did not fully follow HUD’s branch office
             requirements. Allied required branch mangers to personally enter into certain
             contractual agreements, such as office space leases, equipment contracts, and utility
             arrangements, at all five branches reviewed. Also, Allied did not consistently pay
           rental, utility, and telephone expenses at all five branches. Further in one instance,
           Allied requested that a former employee use personal funds to cover branch
           operating losses. The allegation that Allied required its employees to indemnify it
           for loan losses was not valid. In addition, although not alleged in the complaint,
           testing disclosed that Allied hired an ineligible employee to originate Federal
           Housing Administration insured single family mortgages.

What We Recommend


           We recommend HUD’s Assistant Secretary for Single Family Housing

                     Require Allied to immediately discontinue its current practices related to
                     leases/agreements for all branch offices; adopt new practices and controls
                     that require it to directly enter into leases and/or agreements; and implement
                     the necessary policies, systems, and controls to ensure that it pays all
                     required branch operating costs.
                     Require the Quality Assurance Division to confirm that all Allied branch
                     offices have appropriate agreements and take appropriate actions if
                     compliance does not occur.
                     Request the Mortgagee Review Board pursue civil money penalties and/or
                     administrative sanctions as appropriate against Allied Home Mortgage
                     Capital Corporation for the violations cited in this report.

           Further, we recommend that the Acting Director of the Departmental Enforcement
           Center pursue civil money penalties or take administrative action, as appropriate,
           against the responsible parties for the violations cited in this report.

           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 a draft to Allied and requested a response by January 15, 2009. Allied
           provided written comments on January 15, 2009. Allied generally agreed with our
           report but provided additional comments to explain why the conditions occurred.
           The complete text of Allied’s response, along with our evaluation of that response,
           can be found in appendix A of this report.

           At HUD’s request, we made minor changes to the report terminology. We also
           further clarified the recommendations to better ensure that appropriate corrective
           actions are taken.




                                                2
                            TABLE OF CONTENTS

Background and Objective                                                        4

Results of Audit
      Finding 1: Allied Did Not Fully Follow HUD’s Branch Office Requirements   5

Scope and Methodology                                                           11

Internal Controls                                                               13

Appendixes

   A. Auditee Comments and OIG’s Evaluation                                     14




                                            3
                        BACKGROUND AND OBJECTIVE

Allied Home Mortgage Capital Corporation (Allied) was approved on September 26, 1991, as a
nonsupervised loan correspondent for single family loans insured by the Federal Housing
Administration (FHA). Allied’s corporate headquarters is located at 6110 Pinemont in Houston,
Texas. According to its website, Allied is the largest U. S. privately held mortgage
banker/mortgage broker with hundreds of branch offices throughout the U. S. and the Virgin
Islands. According to HUD’s Neighborhood Watch system, as of June 9, 2008, Allied had 467
active branches.

The U. S. Department of Housing and Urban Development’s (HUD) Office of Inspector General
(OIG) received a hotline complaint, alleging that Allied did not follow HUD rules and requirements
when operating its branch offices. Specifically, the complaint alleged that Allied required its
branch managers to enter into certain contractual relationships, pay branch operating expenses, and
provide indemnification for losses and damages, all of which violated HUD requirements.

The objective of the review was to determine the validity of a hotline complaint that Allied operated
its branches in violation of HUD requirements.




                                                   4
                                     RESULTS OF AUDIT

Finding 1 Allied Did Not Fully Follow HUD’s Branch Office
          Requirements
Allied did not completely follow HUD’s rules, regulations, procedures, and instructions when
operating and managing its branch offices. Specifically, for all five branches reviewed, Allied did
not ensure that contractual agreements were in its name. It also did not consistently pay rental,
utility, and telephone expenses at all five branches. These conditions occurred because Allied did
not have a system in place to ensure that it paid all operating expenses and it apparently attempted
to maintain a separation between itself and its branches. Further, Allied requested that a former
employee use personal funds to cover branch operating losses when the branch’s operating account
had a negative balance. In addition, it hired an ineligible employee because its president overrode
its internal controls. As a result, Allied did not maintain the close supervisory control and oversight
of its branches required by HUD and exposed HUD to possible unnecessary insurance risk.


    Allied Did Not Ensure Branch
    Contractual Agreements Were
    in Its Name


                None of the office space lease agreements for the five branches reviewed were in
                Allied’s name. Instead, the branch managers personally entered into and signed the
                lease agreements. Four of the five branch managers had signed month-to-month
                subleases with Allied to show that Allied was paying the operating expenses.
                However, ultimate responsibility for the lease payments continued to rest with the
                branch manager if Allied canceled the sublease. The lease for the fifth branch was in
                the branch manager’s name with the designation “d.b.a. Allied Home Mortgage.”
                When Allied closed two of the five branches, one manager became liable for
                approximately one month on the lease, and the other manager became responsible
                for the remaining 33 months on that branch’s lease.

                In two cases, the branch managers submitted equipment leases in Allied’s name:
                one for 36 months and one for 66 months. However, Allied instructed the vendors to
                remove its name from the equipment leases and required that the leases be put in the
                branch managers’ names. One branch also had a utility bill in the branch manager’s
                name.

                According to HUD’s requirements, Allied was prohibited from requiring that
                contractual relationships with vendors be in the name of the employee.1 According
                to Allied’s audited financial statements, it entered into month-to-month operating
                leases to minimize its future lease commitments. By not directly entering into
1
     HUD Mortgagee Approval Handbook 4060.1, REV-2, paragraph 2-14, and Mortgagee Letter ML 00-15.


                                                     5
                 leases, Allied apparently attempted to maintain a separation between itself and its
                 branch offices which was inconsistent with the close supervisory control and
                 oversight of its branches required by HUD.2


    Allied Did Not Consistently Pay
    Rental Expenses


                 Allied did not consistently pay the monthly rental amounts at all five branches
                 reviewed during the 27 months tested. The following table shows the number of
                 months Allied did not pay rent and the outstanding rent due or credit balance as of
                 March 31, 2008.

                                                          Number of
                                  Branch                months rent was             Amount of rent
                                  number                   not paid                under/(over)paid
                                   2315                       15                           $148,090
                                   1785                        7                               2,626
                                   0835                        2*                            (2,587)
                                   0173                        3                               2,081
                                   1886                        1**                             1,500
                                   Total                                                   $151,710
                         *For an additional 5 out of 27 months reviewed, Allied did not pay rent, but the branch had a credit
                          balance due. Also, in addition to the monthly rental payment, the lease agreement required $6,270 for
                          the lease year, but it was silent as to how or when it was to be paid.
                       ** Although Allied closed the branch on January 17, 2008, it did not pay rent that was due on
                          January 1, 2008.

                 Allied had a system in place named Auto-Pay that would automatically pay the
                 branches’ monthly rental expenses. Allied staff members said that this system
                 allowed them to verify that all monthly rental payments were made. However,
                 Allied did not consistently use the system for all branches during the period
                 reviewed. As shown in the table, Allied’s system did not work. Allied could not
                 explain why this condition occurred. HUD’s policies required Allied to pay all of
                 the operating expenses of its branches.3 In addition, Allied’s written policies stated
                 that Allied should have always paid all branch core expenses including rent.




2
      HUD Mortgagee Approval Handbook 4060.1, REV-2, paragraphs 2-9 A and D.
3
      HUD Mortgagee Approval Handbook 4060.1, REV-2, Paragraph 2-8.


                                                            6
    Allied Did Not Consistently Pay
    Utility and Telephone Expenses

                In addition to rental expenses, Allied did not pay the required operating costs of
                utility and telephone expenses for all five branches for the 27 months reviewed.4

                Utilities

                Allied’s records showed that it did not pay any utility expenses at three of the five
                branches during the 27 months reviewed. At another branch, Allied occasionally
                paid utility expenses. Allied consistently paid utility expenses at the fifth branch
                until the month it closed the branch. The following table shows the number of
                months Allied did not make utility payments.

                                   Branch               Number of months
                                   number               payments not made
                                    1785                       27
                                    0835                       19
                                    2315                       27
                                    0173                       27
                                    1886                        1

                Telephone Expenses

                Allied’s records showed that it also did not consistently pay telephone expenses at
                all five branches. The following table shows the number of months in which Allied
                did not pay telephone expenses, according to its records, and the range of the
                payment amounts for the months in which Allied paid telephone expenses as the
                payment amounts fluctuated.

                                               Number of                Range of payment amounts
                         Branch              months payments
                         number                 not made                        Low           High
                          1785                     27
                          0835                     10                              $ .72        $1,027
                          2315                      9                                275         7,941
                          0173                      6                                173         2,188
                          1886                      2*                               309           554
                 * One of the two nonpayment months was the month Allied closed the branch.




4
     HUD Mortgagee Approval Handbook 4060.1, REV-2, Paragraph 2-8.


                                                           7
                Allied’s written policies required it to pay all core operating expenses each month,
                which included both telephone and utility expenses Allied did not consistently pay
                these expenses because it did not have a system for determining whether core
                expenses such as utility and telephone expenses were paid each month. In addition,
                it did not maintain records showing the amounts due each month or whether the
                branch managers submitted utility or telephone bills for payment. Instead, Allied
                allowed its branch managers to decide which operating expenses to submit for
                payment or reimbursement, rather than requiring that they be turned in monthly for
                payment.

                By not ensuring that it paid all core expenses such as office space rent, telephone and
                utility expenses, Allied did not maintain the close supervisory control and oversight
                over its branches as required by HUD and exposed HUD to possible unnecessary
                insurance risk.

    Allied Requested that One
    Former Branch Manager Pay
    for Branch Operating Losses

                Allied requested a former branch manager use his personal funds to cover
                operational expenses when one branch had an extremely high operating account
                deficit. In emails between the former branch manager and the president of Allied,
                the president told the branch manager that he needed to “bring money to the table.”
                In another email, the former branch manager told the president of Allied that he was
                in the process of getting funding from an additional source to cover losses at another
                branch. The branch manager did not provide proof that he ever made a payment to
                Allied to cover the operating losses. However, HUD’s rules prohibit requiring an
                employee to use personal funds to cover operating expenses if funds are not
                available from an operating account.5

    Complaint Concerning
    Indemnifications was Invalid


                The complaint allegation that Allied required its branch managers to indemnify it for
                losses and damages was invalid. According to HUD’s policies, HUD may require
                FHA approved lenders to enter into indemnification agreements on FHA insured
                loans when HUD determines that the loans expose HUD to an unacceptable level of
                risk. An indemnification agreement states that the lender will repay HUD for any
                losses it incurs on loans covered by the agreement. Allied did not require branches
                to repay it for losses incurred for loans under an indemnification agreement. Allied
                did require branches to repay it for premiums earned on defaulted loans, which is an
                allowed operating expense according to HUD’s requirements.

5
     HUD Mortgagee Approval Handbook 4060.1, REV-2, paragraph 2-14, and Mortgagee Letter ML 00-15.



                                                     8
    Allied Hired an Ineligible
    Employee to Initiate FHA
    Loans

                 Allied hired an employee who lived in a different state, more than 300 miles from
                 the HUD approved branch, to initiate loans declined by the employee’s husband,
                 who worked at another mortgage company. HUD’s policies prohibit taking on an
                 existing, separate mortgage company or broker and allowing it to originate insured
                 mortgages under the approved lender’s HUD mortgagee number. In addition, this
                 practice is a violation of HUD’s rules prohibiting third-party originations of FHA-
                 insured loans.6 The employee also indicated that she would be working for another
                 real estate or mortgage company while working for Allied. However, HUD’s rules
                 prohibit staff from having outside employment in mortgage lending, real estate, or a
                 related field.7

                 Allied’s staff determined that the employee was ineligible and attempted to stop her
                 from being hired. However, Allied’s president overrode internal controls, and she
                 was hired. The employee is no longer employed at Allied and did not originate any
                 FHA loans. However, top management’s willingness to override controls and the
                 advice of staff exposed HUD to increased risk that another ineligible employee could
                 also be hired. In addition, this incident supports the contention that Allied did not
                 exercise adequate control and supervision over its branches as required.8

    Conclusion


                 Allied did not have effective systems and controls in place to ensure that it fully
                 complied with HUD’s rules, regulations, procedures, and instructions when it
                 operated its branches. Allied took steps indicating that it attempted to maintain a
                 separation between itself and its branch offices. This action was inconsistent with
                 the close supervisory control and oversight of its branch employees required by
                 HUD and exposed HUD to increased risk to the FHA insurance fund.




6
     Mortgagee Letter 00-15 and HUD Mortgagee Approval Handbook 4060.1, REV-2, paragraph 2-19.
7
     HUD Mortgagee Approval Handbook 4060.1, REV-2, paragraph 2-9G.
8
     HUD Mortgagee Approval Handbook 4060.1, REV-2, paragraphs 2-9 A and D.



                                                      9
Recommendations



         We recommend that HUD’s Assistant Secretary for Single Family Housing

         1A.      Require Allied to immediately discontinue its current practices related to
                  office space, utility, and equipment leases/agreements for all branch offices,
                  and adopt new practices and controls that require Allied to directly enter into
                  those leases and/or agreements.

         1B.      Require Allied to implement the necessary policies, systems, and controls to
                  ensure that it pays all branch operating costs, including rental, utility, and
                  telephone expenses.

         1C.      Require HUD’s Quality Assurance Division to confirm that all Allied branch
                  offices have appropriate agreements. For those branches that do not comply,
                  take appropriate action to ensure compliance including but not limited to
                  prohibiting the branch office from originating FHA insured loans, and/or
                  referring Allied to the Mortgagee Review Board.

         1D.      Request the Mortgagee Review Board pursue civil money penalties and/or
                  administrative sanctions as appropriate against Allied Home Mortgage
                  Capital Corporation for the violations cited in this report.

         We also recommend that the Acting Director of HUD’s Departmental Enforcement
         Center

         1E.      Pursue civil money penalties and administrative sanctions, as appropriate,
                  against the responsible parties for the violations cited in this report.




                                             10
                              SCOPE AND METHODOLOGY

Our objective was to determine the validity of a hotline complaint that Allied operated its branches
in violation of HUD requirements. To accomplish our objectives, we

        Reviewed background information and HUD criteria that control branching arrangements.
        Reviewed the hotline complaint and documentation supplied.
        Reviewed various reports, databases, and documents to determine existing conditions at
        Allied. The documents included Allied’s Branch Training Manual and HUD’s Quality
        Assurance Division’s most recent review of Allied.
        Reviewed Allied's fiscal year 2006 and 2007 audited financial statements for information
        related to Allied's branching operations and for indications of questionable activities.
        Selected a nonrepresentative sample9 of 5 of 548 (467 active and 81 terminated) Allied
        branch offices for review including branch 0173 in Kingwood, Texas; branch 0835 in
        Fairview Park, Ohio; branch 1785 in Houston, Texas; branch 1873 in Grove, Oklahoma; and
        branch 2315 in Kansas City, Missouri. We selected a nonrepresentative sample instead of a
        representative sample to review specific items of interest (branches) which were alleged to
        have specific violations of HUD’s branching requirements. We selected three branches
        which were listed in the documentation supporting the hotline complaint. We also selected
        two branches at random which were not listed in the complaint and which were located in
        the Houston area.
        For each branch selected, obtained and reviewed data in Allied’s files, including office
        space leases and other contractual agreements; performed limited testing of expenses; and
        reviewed employee files to test employment agreements and pay status.
        Made site visits to two Allied branches.
        Interviewed former branch managers, Allied officials, and staff from HUD’s Quality
        Assurance Division and Program Enforcement Division.
        Performed certain tests on the computer-processed financial data obtained from Allied. We
        determined the data to be sufficiently reliable to meet our objectives.

We also used data maintained by HUD in the Neighborhood Watch system 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.

Our review covered the period January 1, 2006, through March 31, 2008. We performed our audit
from June through November 2008. We conducted the review at the corporate headquarters of
Allied located in Houston, Texas; two of Allied’s area branch offices located in Houston and
Kingwood, Texas; and the HUD office located in Houston, Texas. The scope of our review was
generally limited to issues raised in the complaint regarding prohibited branch arrangements.



9
    A nonrepresentative sample selection is appropriate when enough is known about the population to identify a
    relatively small number of items of interest.



                                                         11
We performed our review in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the review to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our objective. We
believe that the evidence obtained provides a reasonable basis for our findings and conclusions
based upon our objective.




                                               12
                                INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides reasonable
assurance that the following objectives are 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. They include the processes and procedures for planning, organizing,
directing, and controlling program operations as well as the systems for measuring, reporting, and
monitoring program performance.



 Relevant Internal Controls


               We determined that the following internal controls were relevant to our audit
               objectives:

                  Policies and procedures that management has implemented to reasonably ensure
                  that its operations meet HUD’s requirements in an effective and efficient
                  manner.

               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 that the following items are significant weaknesses:

                  Allied did not ensure that branch contractual agreements were in its name.
                  Allied did not consistently pay the required core operating costs of rental, utility,
                  and telephone expenses for the five branch offices reviewed.
                  Allied’s president overrode its internal controls to hire an ineligible employee.




                                                  13
Appendix A

          AUDITEE COMMENTS AND OIG’S EVALUATION

Ref to OIG Evaluation   Auditee Comments




Comment 1




                                    14
Comment 2




Comment 1




Comment 2




Comment 3




            15
Comment 3




Comment 4




Comment 5




Comment 6




            16
17
                           OIG Evaluation of Auditee Comments

Comment 1   Allied agreed with the facts disclosed in the report but offered additional comments
            to explain the conditions reported. Allied also said that neither the government nor
            any private party incurred any loss as a result of its practices. We disagree that no
            private parties incurred a loss resulting from Allied’s practices. When Allied
            terminated three of the five branches reviewed, the branch manager became
            personally responsible for expenses.

Comment 2   Allied’s response did not address the fact that the branches’ rental leases were not in
            its name. HUD’s policies require branch contractual agreements to be in the name
            of the HUD/FHA approved mortgagee, not in the name of the branch manager.

            Allied further stated that its policy required equipment lease agreements to be
            approved at the corporate office only. We disagree. Allied’s written policies that we
            obtained, dated from 2005 through March 2008, do not state this. Instead they
            required signed equipment subleases in Allied’s name.

Comment 3   Allied said staff turnover and new computer software were the reasons for rental
            expenses not being paid. HUD policy required it to pay all operating expenses of its
            branches, including rent. Since Allied did not have effective systems and controls in
            place, these expenses were not paid.

            Allied also considered the missing rental payments from four of the branches
            reviewed to be a de minimus amount. We disagree. The 13 missed payments
            actually totaled $17,307, not $3,620 as stated by Allied. Further, all five branches
            reviewed had at least one month where Allied did not make a rental payment.

Comment 4   In addition to its previous comments, Allied said that some utility payments were
            included in lease payments. Our review did disclose that three of the five branches
            had leases that contained references to utility costs. However, one lease included
            only partial utilities and Allied did make a few utility payments for this branch, but
            did not pay those utilities every month. For another, the lease included statements
            that indicated utility costs were covered but also stated that the landlord could adjust
            for excess utilities and bill the lessee for costs in excess of calculated annual costs
            which indicated utility payments may have occurred and not been paid. For the third
            lease, our testing included only one month where utility costs were included in the
            lease which indicated that utility costs should have been paid by Allied for the other
            months. In addition, telephone expenses are not normally included in lease
            payments and we did not observe that telephone expenses were included in any of
            the lease agreements reviewed.

Comment 5   Allied stated that the deviation from HUD policies is apparent, rather than actual.
            We disagree. Allied’s emails provided enough discussion to determine that the
            branch manager was asked to provide personal funding to cover branch operating
            losses which is prohibited by HUD’s rules.



                                               18
Comment 6   Allied stated that the emails do not fully disclose the complete discussions and
            circumstances surrounding the hiring of the ineligible employee. We agree that the
            emails do not reflect oral discussions, but they do show warnings by staff to Allied’s
            president that this employee should not have been hired which were disregarded.




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