oversight

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)

                                                                 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