Issue Date August 3, 2010 Audit Report Number 2010-BO-1007 TO: Vicki Bott, Deputy Assistant Secretary for Single Family Housing, HU FROM: John Dvorak, Regional Inspector General for Audit, Boston Region, 1AGA SUBJECT: New England Regional Mortgage Corporation, Salem, NH, Generally Complied With HUD Requirements for Loan Origination but Did Not Properly Underwrite One Loan HIGHLIGHTS What We Audited and Why We audited New England Regional Mortgage Corporation (Corporation), a Federal Housing Administration (FHA) lender approved to underwrite and close mortgage loans without prior FHA review or approval. We selected the Corporation because its early payment default rate for insured single-family loans originated between January 1, 2008, and December 31, 2009, was significantly higher than the default rate in the local area in which it does business. Our audit objectives were to determine whether (1) the Corporation acted in a prudent manner and complied with U.S. Department of Housing and Urban Development (HUD) regulations, procedures, and instructions for the origination, underwriting, and closing of the FHA-insured single-family loans selected for a detailed review and (2) its quality control plan, as implemented, fulfilled HUD’s requirements. What We Found The Corporation generally complied with HUD requirements in the origination of FHA-insured single-family loans. In addition, the Corporation’s quality control plan, as implemented, fulfilled HUD’s requirements. However, one loan had significant underwriting deficiencies that negatively affected the insurability of the loan. The underwriting deficiencies included improperly documented borrower income, an omitted liability, undervalued debt-to-income ratios, and failure to notify HUD of an employee loan transaction. These deficiencies occurred because the lender did not act in a prudent manner when it approved this loan. The loan was not eligible for FHA mortgage insurance and placed the FHA insurance fund at risk for a potential loss of more than $221,000. The Corporation was also incorrectly listed as the holding lender for 43 active loans and the servicing lender for 8 active loans. These errors occurred because the Corporation was not aware of HUD requirements regarding mortgage record changes after it sold loans to investing lenders. Inaccurate or untimely reporting of mortgage record changes directly affects the payment of claims for insurance benefits. HUD will not pay a claim for insurance benefits for which the information on the claim and HUD’s FHA insurance system do not agree. What We Recommend We recommend that HUD’s Deputy Assistant Secretary for Single Family Housing require the Corporation to indemnify HUD for a loss that may be incurred related to the loan that did not meet FHA insurance requirements. The projected loss to HUD of $221,590 is based on an actuarial review of FHA’s insurance fund prepared for HUD; a loss rate of 60 percent of the unpaid principal balance of the loan (see appendix C). We also recommend that the Corporation update its remaining 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 sold to investing lenders. 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 Corporation officials draft finding details throughout the course of the audit. We also provided the officials with a draft audit report on June 29, 2010, and requested a response by July 14, 2010. We discussed the draft report at an exit conference on July 7, 2010, and received the Corporation’s written comments on July 14, 2010. The Corporation generally disagreed with finding 1 and agreed with finding 2. The complete text of the auditee’s response, along with our evaluation of that response, can be found in appendix B of this report. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: The Corporation Did Not Underwrite One Loan in Accordance With 6 HUD Requirements Finding 2: Mortgage Records Were Not Accurate in HUD Systems 11 Scope and Methodology 13 Internal Controls 15 Appendixes A. Schedule of Funds To Be Put to Better Use 17 B. Auditee Comments and OIG’s Evaluation 18 C. Loan Details 42 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). FHA provides insurance to protect 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. We identified New England Regional Mortgage Corporation (Corporation) as a lender for review based on a risk assessment of mortgage lenders in the New England region. We identified the Corporation as having a higher than average FHA-insured mortgage default rate when compared to other FHA lenders. The lender originated and underwrote 526 loans during our review period with a total original mortgage amount of more than $126 million. The lender originated at least one FHA loan in eight different States during this period, with primary originations occurring in New Hampshire, Rhode Island, Massachusetts, and Connecticut. Forty of the loans (or 7.6 percent) defaulted within the first 2 years of origination, and three of the default loans (or 7.5 percent) were claim terminated. When comparing loans underwritten by the lender to the rest of the lenders in each State, the lender had a total early payment default percentage that was much higher than average (compare ratio1), especially for those loans originated in New Hampshire and Rhode Island (see table below). % of State State Total # of def def total State # of def State Compare Total defaults % def by 2 yr by 2 yr State defaults % def by 2 yr % of def by 2 State ratio orig. by 2 yr by 2 yr to claim to claim total orig. by 2 yr by 2 yr to claim yr to claim New Hampshire 403% 122 20 16.39 2 10.00 11,823 481 4.07 30 6.24 Rhode Island 172% 80 7 8.75 1 14.29 10,552 538 5.10 28 5.20 Massachusetts 106% 253 12 4.74 0 0.00 46,024 2,051 4.46 39 1.90 Connecticut 33% 52 1 1.92 0 0.00 35,641 2,065 5.79 45 2.18 Maine 0% 3 0 0.00 0 -- 9,603 503 5.24 7 1.39 Florida 0% 3 0 0.00 0 -- 146,205 15,188 10.39 187 1.23 Vermont 0% 11 0 0.00 0 -- 2,778 122 4.39 0 0.00 Maryland 0% 2 0 0.00 0 -- 93,141 6,956 7.47 138 1.98 Totals 526 40 7.6 3 7.5 *Source: HUD’s Neighborhood Watch/Early Warning System 1 The percentage of originations that are seriously delinquent or were claim terminated divided by the percent of originations that are seriously delinquent or were claim terminated for the selected geographic area. Compare ratio is the value that reveals the largest discrepancies between the subjects’ seriously delinquent and claim percentage and the seriously delinquent and claim percentage to which it is being compared. 4 In addition, the lender had a high compare ratio for several fiscal quarters (see table below). Corp. United United States Corp. total Corp. States United total United States Quarter Corp. total Corp. seriously % seriously United total States seriously % seriously end Compare total seriously total delinquent delinquent States seriously total delinquent delinquent dates ratio orig. delinquent claims and claims and claims total orig. delinquent claims and claims and claims 03/31/2010 141% 509 30 2 32 6.29 3,399,995 142,832 8,978 151,810 4.47 12/31/2009 139% 526 34 3 37 7.03 3,212,363 154,190 7,959 162,149 5.05 09/30/2009 152% 494 34 3 37 7.49 2,878,599 134,910 7,219 142,129 4.94 06/30/2009 167% 449 32 2 34 7.57 2,483,073 105,969 6,144 112,113 4.52 03/31/2009 207% 381 35 0 35 9.19 2,105,924 88,002 5,244 93,246 4.43 12/31/2008 201% 311 27 0 27 8.68 1,788,355 72,809 4,210 77,019 4.31 09/30/2008 193% 257 18 0 18 7.00 1,477,687 50,088 3,508 53,596 3.63 06/30/2008 129% 223 10 0 10 4.48 1,179,175 37,667 3,332 40,999 3.48 03/31/2008 109% 170 7 0 7 4.12 977,809 33,712 3,344 37,056 3.79 12/31/2007 132% 130 7 0 7 5.38 864,323 32,495 2,878 35,373 4.09 09/30/2007 131% 85 4 0 4 4.71 817,871 26,823 2,652 29,475 3.60 06/30/2007 173% 54 3 0 3 5.56 817,555 23,591 2,775 26,366 3.22 03/31/2007 77% 45 1 0 1 2.22 837,100 21,134 2,944 24,078 2.88 *Source: HUD’s Neighborhood Watch/Early Warning System The Corporation is a nonsupervised2 mortgage company. HUD authorized the lender to originate FHA loans in February 1992. The home office for the lender is located in Salem, NH, and it currently has three active branch offices in Connecticut, Massachusetts, and Rhode Island, all of which have opened within the last 3 years. The audit objectives were to determine whether (1) the Corporation acted in a prudent manner and complied with HUD regulations, procedures, and instructions for the origination, underwriting, and closing of the FHA-insured single-family loans selected for a detailed review and (2) its quality control plan, as implemented, fulfilled HUD’s requirements. 2 This designation applies to non-depository financial entities that have as their principal activity the lending or investment of funds in real estate mortgages. 5 RESULTS OF AUDIT Finding 1: The Corporation Did Not Underwrite One Loan in Accordance With HUD Requirements The Corporation did not underwrite one loan in accordance with HUD requirements. Specifically, our review of the loan exhibited underwriting deficiencies significant enough to warrant indemnification. The deficiencies included inadequate disclosure to HUD of a loan involving an employee, inadequate support for job/income stability of the borrower, inadequate credit history of the borrower and incorrect calculation of debt-to-income ratios. These deficiencies occurred because the lender did not act in a prudent manner when it approved the loan and may have been due to the financial interest in the transaction of both the president of the Corporation and the president’s spouse, a loan officer. Although the Corporation did not follow proper HUD underwriting guidelines for this loan, there was no indication of a pattern of noncompliance. However, the loan placed the FHA insurance fund at risk for loss of $221,590. Two Loans Had Significant Underwriting Deficiencies The Corporation did not underwrite one loan in accordance with HUD requirements. Specifically, the loan reviewed had significant underwriting deficiencies that warrant indemnification. FHA Case No. 341-0867550 We found significant underwriting deficiencies for this loan,3 including inadequate disclosure to HUD of a loan involving an employee, inadequate support for job/income stability of the borrower, inadequate credit history of the borrower and incorrect calculation of debt-to-income ratios. Inadequate Disclosure to HUD of a Loan Involving an Employee This loan involved an employee of the Corporation. The employee was the seller and had a financial interest in the transaction. The seller, a Corporation loan officer, was also married to the president of the Corporation and owned the property jointly with the president until the closing date of this loan. On the closing date, the president transferred ownership to the spouse, who then transferred ownership to the 3 This was the original case number for the purchase mortgage. The borrower had two later streamline refinances. The FHA case number on the last streamline refinance was 341-895000. 6 buyer.4 The Corporation did not adequately disclose to HUD that the loan involved an employee. The case was not clearly identified in the remarks section of the Mortgage Credit Worksheet and beneath Box F, "Employment," on the front of the case binder, as required.5 In addition, the employee was involved in the processing of the application. Supporting documentation for the loan application was sent to the attention of the loan officer, indicating that the employee was also involved in the origination process, which HUD regulations prohibit.6 Additionally, the president and spouse were the loan officers on two later FHA streamline refinance transactions. Finally, the underwriter certified on Form HUD-92900A, HUD/VA [U.S. Department of Veterans Affairs] Addendum to Uniform Residential Loan Application, that the lender, owners, officers, employees, or directors did not have a financial interest in or a relationship, by affiliation or ownership, with the seller involved in this transaction, which was not true. Inadequate Support for Job/Income Stability The Corporation accepted inadequate support for the job/income stability of the borrower.7 The Corporation did not adequately evalauate the documentation provided by the borrower and employer when it approved this loan. Specifically, income documentation did not adequately support that the borrower was an employee of, rather than a subcontractor for, the company that provided the verification of employment. The file contained a letter from the employer dated May 5, 2006, which indicated the borrower’s previous work history as a 1099 employee and current and future employment history with the employer. The underwriter requested and obtained a completed VOE form dated May 18, 2006 from the employer, which did not agree with information included in the letter previously provided by the employer. The verification of employment form and a letter provided by this company included discrepancies regarding income, overtime hours and dates of employment. Additionally, the prior-year earnings shown on the verification of employment form did not agree with the Internal Revenue Service (IRS) Form 1099 provided to the borrower. According to the letter, the borrower accepted a position as a foreman with the company as of May 1, 2006, the same month of the closing. The Corporation obtained one uncashed paycheck, dated May 26, 2006, to support current income. The deductions information on the pay stub were handwritten, did not include year-to-date information, and had inaccurate Medicare and Social Security deductions. The VOE form showed year-to-date 4 The president was not shown as the seller on the sales contract, although the president had ownership in the property until the closing date of this loan. 5 HUD Handbook 4000.4, REV-1, CHG-2, paragraph 1-14 6 HUD Handbook 4000.4, REV-1, CHG-2, paragraph 1-14. 7 HUD Handbook 4155.1, REV-5, paragraphs 2-6 and 2-7. 7 income of $22,000, which according to the Corporation, was year-to-date income up until the borrower’s promotion. The Corporation stated the uncashed paycheck was probably the borrower’s first pay check. The underwriter notated on the letter from the employer that the employer verbally verfiifed that the letter was a true and accurate statement. The borrower was paid as a subcontractor, not an employee. As a subcontractor, the borrower would have been liable for federal income and self-employment taxes on earnings that would have reduced net income, and the borrower would have been required to provide tax returns to the Corporation. A verification of employment obtained by the Corporation during a later FHA refinance transaction also showed that the borrower was in fact a subcontractor during this period. Additionally, the Corporation did not obtain adequate income documentation for the previous 2-year period. The borrower was self-employed and the Corporation did not obtain the borrower’s tax returns for the previous two years and did not obtain IRS Forms 1099 for two companies, as required.8 Instead, the underwriter accepted a letter and a payment printout for one company and an invoice from another company stating the amounts paid to the borrower for one tax year. Inadequate Credit History The Corporation did not adequately establish the borrower’s credit history or rental history.9 The credit report showed that the borrower had a limited credit history; therefore, the Corporation should have documented a nontraditional credit history for the borrower to include documenting timely payments for monthly bills such as rent, utilities, and insurance premiums. According to the borrower’s written statement, the borrower paid cash for bills but did not support that bills were paid on time. The Corporation obtained a Rent-A-Center printout showing that the borrower made cash payments; however, this payment history was more than 15 months before the loan transaction. In addition, the Corporation could not have verified an adequate rental payment history for the borrower, since the borrower’s spouse received housing rental assistance from the State housing finance agency for the unit they occupied. The borrower’s spouse was not a coborrower on the loan. Debt-to-Income Ratios Incorrectly Calculated The Corporation incorrectly calculated the housing payment-to-income ratio and the total monthly payments-to-income ratio at 36.25 and 40.54 percent, respectively, because it erroneoulsy excluded a cosigned loan for the borrower’s spouse, and used an incorrect overtime rate and overtime hours. The Corporation should have included this contingent liability in the calculation because since it was a new loan, there was an insufficient payment history by the spouse. In 8 HUD Handbook 4155.1, REV-5, paragraph 2-9.B. 9 HUD Handbook 4155.1, REV-5, paragraph 2-3 and 2-4. 8 addition, the bank did not provide a statement indicating that the borrower would not be liable should the spouse default on the loan. The Corporation also incorrectly used a higher overtime rate than the borrower was paid and used anticipated overtime hours instead of overtime hours for the previous two years.10 If the total mortgage payment11 does not exceed 31 percent of the gross effective income, the relationship of the mortgage payment to income is considered acceptable. A ratio exceeding 31 percent may be acceptable only if significant compensating factors are documented and are recorded on the mortgage credit analysis worksheet. In addition, if the total of the mortgage payment and all recurring charges does not exceed 43 percent of the gross effective income, the relationship of total obligations to income is considered acceptable. A ratio exceeding 43 percent may be acceptable only if significant compensating factors are documented and are recorded on the mortgage credit analysis worksheet.12 The correct ratios should have been 45.78 and 57.02 percent, respectively, and the minimal compensating factors listed were not supported. The Corporation Did Not Act in a Prudent Manner The Corporation did not act in a prudent manner when it approved the loan. It should have been more prudent when evaluating the documentation provided by the borrowers and employers and should have required additional supporting documentation to verify the borrower’s employment status. In addition, the Corporation’s president and underwriter agreed that they did not follow HUD requirements for loans involving an employee. The president and underwriter stated that they were not aware of the additional requirements when the employee was a seller in an FHA loan transaction. Conclusion The Corporation did not underwrite one loan reviewed in accordance with HUD requirements. This deficiency occurred because the lender did not act in a prudent manner when it underwrote the loan. In addition, the underwriting deficiencies may have been due to the financial interest of both the president of the Corporation and the president’s spouse, a loan officer, in the transaction. The two loans unnecessarily placed the FHA insurance fund at risk for more than $221,000 in potential losses should the property be foreclosed upon and resold for less than the unpaid principal balance. 10 HUD Handbook 4155.1, REV-5, paragraph 2-7.A. 11 Total housing payment includes principal and interest; escrow deposits for real estate taxes, hazard insurance, the mortgage insurance premium, homeowners' association dues, ground rent, special assessments, and payments for any acceptable secondary financing 12 HUD Handbook 4155.1, REV-5, paragraph 2-12.A. and 2-12.B and Mortgagee Letter 2005-16, Revised Qualifying Ratios and Treatment of Child Support. 9 Recommendations We recommend that HUD’s Deputy Assistant Secretary for Single Family Housing require the Corporation to 1A. Indemnify HUD for losses that have been or may be incurred related to FHA case number 341-0895000 (the original purchase FHA case number was 341-0867550). The projected loss to HUD of $221,590 is based on an actuarial review of FHA’s insurance fund prepared for HUD; a loss rate of 60 percent of the unpaid principal balance. 10 Finding 2: Mortgage Records Were Not Accurate in HUD Systems The Corporation was incorrectly listed as the holding lender for 43 active loans and the servicing lender for 8 active loans. This condition occurred because the Corporation was not aware of HUD requirements regarding mortgage record changes and considered it solely a responsibility of the new servicers of the loans to update the mortgage records after it sold the loans to investing lenders. Inaccurate or untimely reporting of mortgage record changes directly affects the payment of claims for insurance benefits. HUD will not pay a claim for insurance benefits for which the information on the claim and HUD’s FHA insurance system do not agree. Mortgage Records for the Corporation Were Not Accurate As of March 31, 2010, the Corporation was still listed as the holding lender for 43 active loans and the servicing lender for 8 active loans, most of which were more than 90 days past endorsement. The Corporation sells all loans that it originates, including the servicing rights, at closing to investing lenders. Originating lenders initially process the loan application. Holding lenders hold title to the mortgage note. Servicing lenders maintain the servicing rights to the loan as they relate to FHA-insured mortgages, including the collection of loan payments, servicing delinquent accounts, foreclosure processing, mortgage insurance premium billing, escrow administration, and general maintenance of records. In November 2003, recognizing the new technology under which the mortgage industry and HUD operate 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 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.13 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.14 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.15 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 13 Mortgagee Letter 2003-17. 14 Mortgagee Letters 2003-17, 2004-34, 2005-11, and 2005-42. 15 24 CFR 203.431, Sale of insured mortgage to approved mortgagee. 11 changes to update a new holder of record if 90 days have passed after endorsement.16 The Corporation Took Immediate Corrective Action Corporation officials acknowledged that they had not notified HUD or updated mortgage records upon the sale of FHA-insured loans because they were not aware of the requirements. However, they took immediate action on this finding. They stated that they had updated all mortgage records. HUD will have to verify the updated mortgage records after the next refresh of data in HUD’s single- family systems. Conclusion Corporation officials did not properly notify HUD upon the sale and/or transfer of FHA-insured loans. This condition occurred because the officials were not 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. HUD will not pay a 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 Deputy Assistant Secretary for Single Family Housing require the Corporation to 2A. Update its remaining mortgage records in HUD’s system to reflect the appropriate mortgage holder. 2B. Implement procedures to ensure the timely submission of mortgage record changes for future loans sold to investing lenders. 16 Mortgagee Letter 2005-42. 12 SCOPE AND METHODOLOGY We identified the Corporation as a lender for review based on a risk assessment of mortgage lenders in the New England region. We researched lenders using HUD’s Single Family Neighborhood Watch system (SFNW) and Single Family Housing Enterprise Data Warehouse system (SFHEDW). SFNW is a web-based comprehensive data processing, automated querying, reporting and analysis system designed to highlight exceptions to lending practices to high-risk lenders and mortgages, so that potential problems that may arise are readily identifiable. SFHEDW is data warehouse that is the key source of single-family data. SFHEDW allows queries and provides reporting tools to support oversight activities, market, and economic assessment, public and stakeholder communication, planning and performance evaluation, policies and guidelines promulgation, monitoring and enforcement. Our audit period was January 1, 2008, through December 31, 2009. We identified lenders that Were active direct endorsement lenders, Had a home or branch office in Region 1, Had originated at least 100 loans in the past 2 years, Had a higher percentage of loans that defaulted within the first 2 years after endorsement compared to the rest of the area selected for comparison, and Had not been reviewed by HUD OIG or HUD’s Quality Assurance Division in the past 5 years. To accomplish the survey objectives, we Identified, obtained, and reviewed relevant regulations pertaining to the origination of single-family mortgages, including the Code of Federal Regulations, HUD handbooks, mortgagee letters, and the United States Code. Obtained and reviewed pertinent performance information relating to the lender. Obtained and reviewed copies of policies and procedures that the lender uses for its loan origination processes. Reviewed HUD postendorsement technical review data. Reviewed HUD case binders. Reviewed the lender’s loan files to determine whether additional information was available that would support loan approval for FHA insurance that was not available in the HUD case binder. Reviewed the lender’s file for information (e.g., missing liabilities, missing credit history, borrower lost his/her job before closing and the lender was aware) that was not considered during the loan origination process, which would have precluded approval of the loan for FHA insurance. Performed reverifications of borrower asset and income information to confirm dates, amounts, and other information reported. Interviewed the borrower(s) and/or employer(s) to determine their roles in the transaction. Interviewed lender staff involved in the origination of loans for which we identified 13 deficiencies/irregularities. Performed tests to verify that the lender had implemented an adequate quality control plan and initiated immediate corrective action when discrepancies were found. Assessed other general aspects of the lender’s operations to ensure their continued lender approval status. We identified and conducted a detailed review of 19 FHA-insured loans originated by the Corporation. We selected the loans based on several risk factors from the 40 loans that went into early payment within the first 2 years of origination during our audit period: Loans that were claim terminated, Purchase loan transactions, Loans that went to claim with six or fewer payments before the first default being reported, Loans with excessive debt ratios, and Loans with gift letter amounts. The 19 loans represent the best loans for selection out of the 40 loans that were early payment defaults based on the analysis of available loan-level data and online records searches. This methodology allowed us to focus on loans that had a greater inherent risk to the FHA insurance fund and/or of noncompliance or abuse. We relied on information from systems used by HUD (including SFNW and SFHEDW) to target loans for review and verified that the information submitted to HUD was consistent with the information in the lender’s own files. We also used LexisNexis Investigative Portal to verify borrower and property information. LexisNexis is a web-based search tool that provides access to billions of public records, news, businesses, legal records, and other types of information, which helps locate individuals, businesses, and assets. Other evidence supported the information obtained; therefore, we determined that the data were sufficiently reliable for our purposes. The corroborating evidence independently supports our conclusions. We conducted the 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. 14 INTERNAL CONTROLS Internal control is a process adopted by those charged with governance and management designed to provide reasonable assurance about the achievement of the organization’s mission, goals, and objectives with regard to: Effectiveness and efficiency of operations, Reliability of financial reporting, and Compliance with applicable laws and regulations. Internal controls comprise the plans, policies, methods, and procedures used to meet the organization’s mission, goals, and objectives. Internal controls 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: Loan origination process - Policies and procedures established by management to ensure that FHA-insured loans are originated in accordance with HUD requirements. Quality control process - Policies and procedures established by management to ensure that the quality control plan has been implemented and related reviews are performed in accordance with HUD requirements. We assessed the relevant controls identified above. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, the reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or efficiency of operations, (2) misstatements in financial or performance information, or (3) violations of laws and regulations on a timely basis. 15 Significant Deficiency Based on our review, we believe that the following items are significant deficiencies: The Corporation did not follow HUD requirements when originating and underwriting an FHA loan (see finding 1). The Corporation did not ensure that its mortgage records were accurate in HUD systems (see finding 2). Separate Communication of Minor Deficiencies Minor internal control and compliance issues were reported to the auditee in a separate memorandum, dated July 7, 2010. 16 APPENDIXES Appendix A SCHEDULE OF FUNDS TO BE PUT TO BETTER USE Recommendation Funds to be put number to better use 1/ 1A $221,590 1/ Recommendations that funds be put to better use are estimates of amounts that could be used more efficiently if an OIG recommendation is implemented. These amounts include reductions in outlays, deobligation of funds, withdrawal of interest, costs not incurred by implementing recommended improvements, avoidance of unnecessary expenditures noted in preaward reviews, and any other savings that are specifically identified. Implementation of our recommendation to require the Corporation to indemnify HUD for the loan will reduce the risk of loss to the FHA insurance fund. The amount above reflects HUD’s estimated loss of 60 percent of the unpaid principal balance of the loan (see appendix C). 17 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 18 Comment 2 Comment 3 19 Comment 4 Comment 5 Comment 6 20 Comment 7 21 22 Comment 7 23 24 Comment 8 Comment 9 25 Comment 10 Comment 11 26 Comment 12 27 Comment 13 Comment 14 Comment 15 Comment 16 28 Comment 17 Comment 18 29 Comment 19 Comment 20 30 Comment 21 31 Comment 22 Comment 23 32 Comment 24 33 34 35 OIG Evaluation of Auditee Comments Comment 1 We were aware of the HUD postendorsement technical review. However, our review found additional underwriting deficiencies that warrant indemnification. We also disagree that the lender could have financed the borrower through other conventional loan programs. The fact is that the seller provided the down payment assistance to the borrower through a nonprofit organization in order for the borrower to meet the FHA minimum down payment requirements. In addition, based on the underwriting deficiencies found and the president of the Corporation’s conflict of interest (See comment 9), we believe that had conventional financing been an option, it would have been the proper choice for the lender. Comment 2 Our review focused on the borrower’s past credit worthiness and ability to pay at the time of the loan; not the borrower’s after-the-fact recent medical circumstances you indicate contributed to the loan default. Comment 3 Based on additional document received and discussions held with the Corporation, FHA case number 341-0896983 was removed from the report and as was the recommendation that the Corporation indemnify HUD for any future losses regarding this loan. Comment 4 We disagree. We answered the second objective relating to the Corporation’s quality control program in the “What We Found” section. However, in response to the auditee’s concerns we added, “In addition, the Corporation’s quality control plan, as implemented, fulfilled HUD’s requirements.” Comment 5 Our results only relate to the loans reviewed and to our audit review period. As of June 30, 2010, the Corporation has a higher serious delinquency rate as compared to the average of all other lenders, per the latest Neighborhood Watch report. See also Comment 6. The remaining loan with significant underwriting deficiencies in this report was a purchase loan transaction, which required a full manual underwriting analysis. Comment 6 The Corporation continues to have a higher default percentage when compared to other lenders, as shown in the background section of this report. Comment 7 We considered all evidence regarding the loans in question. After the additional documentation received and discussions held, we have removed all but the one loan from this report. The audit results as shown support a recommendation for indemnification of the loan. Additionally, we only selected 19 loans for review with the highest risk and the results only relate to the one loan. The method of selection of the loans reviewed did not result in a representational sample of the thousands of loans originated by the Corporation. 36 Comment 8 OIG disagrees that the Corporation acted in a prudent manner when approving FHA Loan #341-0867550. However, the discussion on inadequate documentation for funds to close was removed based on additional documentation provided at the exit conference, which had not been included in the loan file. The remaining significant underwriting deficiencies support the recommendation for indemnification for this loan, FHA Loan #341-0867550. OIG considered the Corporation’s written response and further explanation provided at the exit conference for FHA Loan #341-0896983 and removed this loan from finding 1 of this report. Comment 9 The underwriter stated during the exit conference that there was a conflict of interest, as the president of the Corporation had a financial interest in the property, and that is why they transferred the president’s ownership in the property to the president’s spouse. By doing this, the Corporation attempted to circumvent the regulation. The underwriter was also aware that the employee/spouse was the seller in this transaction, and certified that the seller was not an owner or employee of the company, which was not true. The Corporation agreed it did not follow the requirements required in HUD Handbook 4000.4. Although OIG agrees that the regulation was not in HUD Handbook 4155.1, Rev-5, the Corporation is required to follow all required guidance and regulations, and not knowing the regulations is not an acceptable argument. For loans where the owner, employees, officers, etc, are also sellers, HUD’s post endorsement reviews would be more stringent given the nature of the loan. In this case, not only did the Corporation not disclose this was an employee loan, there were other deficiencies identified during our review. Because we were aware this was an employee loan, we reviewed this loan in more detail. The underwriter was put in a situation of approving or denying a loan in which the underwriter’s employer and employer’s spouse were the seller’s of the property. Remaining completely objective in this conflict of interest situation would be difficult for anyone. Comment 10 The file contained many faxed documents from the borrower and third parties that were to the attention of the employee/seller. The initial credit report was also pulled under the seller’s name. The Corporation’s statement that the loan officer on this loan signed on using the employee’s/seller’s account information to pull the credit report is not a plausible explanation. Comment 11 The Corporation’s comment about the borrower’s perfect payment history is incorrect. The borrower went in and out of delinquency several times after the loan refinance transactions. The loan was only eligible for an FHA refinance after the borrower had cured the loan just before the refinance. HUD will need to 37 determine whether the involvement of the president and employee/spouse in the streamline refinances was allowable, given the history of the first loan. Comment 12 The Corporation did not adequately document what was clarified and discussed with the employer. The underwriter only notated on the employer’s letter that the employer verified this was a true and accurate statement; and it is factually correct that there was no year-to-date information on the uncashed paycheck dated May 26, 2006. However, the Corporation believes this was the borrower’s first paycheck, but it is unclear from the letter when the actual start date was for the new position. The letter states the borrower accepted the position of foreman on May 1, 2006. The VOE form includes all of 2006 income for the year-to-date. Comment 13 The Corporation stated it did not qualify the borrower based on the prior work history, although it obtained the documentation, but qualified the borrower based on the new job income. However, the new job income obtained did not adequately support that the borrower was an employee rather than a subcontractor. Verbal verification with this employer was not adequate to support that the borrower was an employee, and no longer just a subcontractor. We followed up with the borrower and confirmed the borrower was paid as a subcontractor, not an employee. The underwriter accepted an uncashed check with hand written deductions on the copy that did not have the correct Medicare and Social Security deductions to support the borrower’s current income as an employee for the company. We were unable to verify information with the employer during the audit, as the employer would not return our numerous phone calls. Comment 14 The VOE form dated May 18, 2006 showed $55,800 as the prior year earnings, which is a discrepancy of over $15,400 from the 1099 issued in 2005. The Corporation advised us that they talked to the employer and was told that there may have been another 1099 issued; yet the Corporation did not obtain a copy of the 1099 or explain the discrepancy in the file. The Corporation stated in its response that OIG had factual inaccuracies in regards to the VOE, employment dates, and YTD info. OIG stands by the statements in our report and that they are factual, and believes the OIG and the Corporation have different interpretations of the information and level of reliance on the supporting documentation provided. See Comment 12 above regarding year-to-date information. Our report states that the letter showed the borrower was hired on May 1, 2006. OIG reworded it to show the borrower accepted the position as of May 1, 2006 The VOE form dated May 18, 2006, showed that the borrower was hired on January 2005 but the letter stated the borrower worked at the company over 2.5 years as a 1099 employee. OIG agrees with the Corporation that future verbal 38 VOEs showed that the computer system did not go back far enough for the earliest start date. Comment 15 See comment12 above regarding year-to-date. Considering this was a loan in which the president of the Corporation and spouse/employee owned the property, the inconsistencies in documentation should have been relevant to the underwriter when considering whether the information provided by the borrower and employer were accurate, and could be relied on for qualifying the borrower for the loan. The underwriter must use due diligence when reviewing supporting documentation provided, especially when there are so many inconsistencies. Comment 16 The letter stated the employer anticipated the borrower working 50-60 hours per week. The VOE form, which the Corporation contends was for prior work history, showed 40-50 hours. The Corporation stated that it used the conservative 15 hours of overtime, however, the Corporation should have used average overtime hours for the past two years; not the anticipated hours as shown in the letter. Overtime hours shown on the uncashed check would only be one week’s worth of documented overtime in support of 15 hours of overtime for the borrower in this new position as a W-2 employee. The Corporation should have used the conservative 5 hours of overtime shown on the VOE form, or not included overtime hours at all. To be conservative in our calculations, we gave the borrower the 5 hours overtime. Further, there was no documentation in the file to support that the borrower cashed this check, as the Corporation stated. Comment 17 The Corporation should have used due diligence when reviewing the documentation provided and required additional support to show the borrower was no longer a subcontractor, but an employee. Although it obtained a letter, VOE form, and an uncashed check, there were enough discrepancies that the underwriter should have required additional documentation form this employer showing the borrower was an employee. The Corporation’s argument that the verbal VOE supports that the borrower was an employee is not adequate support. The notation on the letter that the letter was a true and accurate statement does not indicate anything regarding the discrepancies with the VOE form or uncashed check. The letter had no fax information on it and was not creased, indicating it was hand delivered. Per the borrower, the employer was present when the borrower completed the loan application, and the employer may have provided the letter at that time. Comment 18 The Corporation contends that the verbal verification from the streamline refinance has no bearing on this loan; however, it supports our statement that the borrower was never a W-2 employee, but was a subcontractor for the employer. Comment 19 Given that the documentation showed the borrower accepted the position of foreman for the company as of May 1, 2006, the same month of the closing, the Corporation should have obtained the tax returns. The file did not contain all of the 1099’s for the companies that the borrower stated worked as a subcontractor, 39 but instead were on an invoice and provided in a letter with a payment history. Additionally, for another loan that we reviewed, the tax returns were required when the borrower went from a subcontractor to an employee the month before the closing; but the Corporation was not consistent for this borrower. Comment 20 The borrower had an inadequate credit history. As such, the Corporation was required to document a nontraditional credit history, which would include residential rental payments, utility payments, insurance payments, etc. What the Corporation documented in the file was that the borrower paid cash to a furniture rental company, for which the last payment was almost 15 months prior to the closing of the loan. The credit report showed a credit card opened less than a year before which only had a $500 available credit limit. The credit report also showed new credit for two car loans, one of which the borrower was a cosigner. The Corporation documented that the spouse paid for the car loan exclusively, as evidenced by the bank statements that were in the spouse's name alone showing the payments. The credit report for the borrower showed no late rental payments for a 24-month period. The borrower lived at the property owned by the president and employee/spouse that he was buying. The Corporation’s response stated that the borrower made payments for rent at the Corporation’s address. At the exit meeting, it was stated that the borrower made cash payments to the underwriter and the underwriter maintained a spreadsheet to track the payments. However, we noted that the original credit report pulled in April 2006 for the borrower did not include information on the rental history. There was a credit report showing it was revised in May 2006, showing 24 months of rental history, which appears to have been added by the landlord, who was also the president of the Corporation and the employee/spouse. Based on the lease date, there would have only been 21 months of rental payment history at the time that the report was revised. The underwriter stated the credit report was used to support the credit history. OIG finds the credit history to be questionable since the information appears to have been added by the president or spouse after the initial report was pulled and there would have only been 21 months worth of history, not 24 months. The underwriter and president stated during the exit conference that the underwriter collected rental payments in cash from the borrower and recorded them in a spreadsheet, and the cash was put in a safe, not in a bank account. However, based on our review of the spouse’s bank statements provided at the time of the loan, the difference between the housing assistance payment and rent amount came out of the spouse’s bank account in the form of a check. The spouse was not on the loan and the borrower was not on the bank account. Therefore, the rental history could not have been verified for the borrower. Further, the actual rent to the president and spouse by the tenants was not the full amount as on stated the credit report, since the state housing finance agency paid a subsidy on this unit. There was no indication in the file that the underwriter supported the rental history/credit history with a spreadsheet of rental and 40 furniture payments maintained at the Corporation’s office, nor was this mentioned until the Corporation received our finding outlines and draft report. Therefore, it should not have been used to support the underwriting decision. Comment 21 OIG disagrees that the liability should have been excluded as there were only eight months of documented payments by the borrower's spouse. The Corporation and OIG have different interpretations of the regulations regarding the payments made within the previous 12 months. OIG used 85% of the rental income, used the correct overtime rate and used the overtime hours based on the historical average of 5 hours of overtime shown on the VOE form, and included the liability for the cosigned loan in its calculation, which results in a significantly higher debt to income ratio than the underwriter calculated. Based on our calculation, the ratios were not acceptable. See also comment 16 above regarding determination of overtime hours. Comment 22 The documented compensating factors on the MCAW were minimal debt (can use more income towards housing) and potential for increased earnings (recently promoted). In the auditee’s response, the Corporation stated there were additional compensating factors in the file; however, these were not documented on the MCAW. The Corporation's response stated that a compensating factor was a large down payment and low loan to value. However, the president and spouse/employee provided the $28,500 in downpayment assistance through a nonprofit that gifted the funds to the borrower, resulting in a lower loan to value ratio. Further, the response stated that the spouse's income would be a factor also; however, the Corporation should also have considered the spouse’s liabilities, which were unknown since the spouse was not on the loan. Finally, the response states that “the housing assistance was likely to continue with the buyer as the landlord.” We question how the assistance could continue, since the buyer resided in the unit that received housing assistance, in violation of HUD’s rules.17 Comment 23 The Corporation provided additional documentation after we presented the findings, in order to support the notation on the bank transaction screen stating the deposit was a security deposit. Based on the additional documentation, we removed this section from the finding of the report. However, we note that the original notation in the file was not adequate, but we accepted the additional support. Comment 24 OIG removed this loan from the finding of the report. We removed this loan based on the consideration of additional information/explanation provided by the auditee at the exit conference and in its written response. We did not base our decision on factual inaccuracies, as the Corporation contends. 17 24 CFR 982.352(a)(6) A unit occupied by its owner or by a person with any interest in the unit may not be assisted in the Section 8 tenant-based program. 41 Appendix C LOAN DETAILS Original Unpaid FHA mortgage principal Default status as of Estimated potential case number amount balance April 30, 2010 loss to HUD18 341-089500019 $377,195 $369,317 Special forbearance $221,590 18 The amount above reflects HUD’s estimated loss of 60 percent of the unpaid principal balance of the loans. 19 The original case number was 341-0867550. The borrower had two later streamline refinances. The FHA case number on the last streamline refinance was 341-895000. 42
New England Regional Mortgage Corporation, Salem, NH, Generally Complied With HUD Requirements for Loan Origination but Did Not Properly Underwrite One Loan
Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-08-03.
Below is a raw (and likely hideous) rendition of the original report. (PDF)