oversight

Birmingham Bancorp Mortgage Corporation, West Bloomfield, MI, Did Not Properly Underwrite a Selection of FHA Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-07-21.

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

                                             U.S. Department of Housing and Urban Development
                                             Office of Inspector General for Audit, Region V
                                             Ralph H. Metcalfe Federal Building
                                             77 West Jackson Boulevard, Suite 2646
                                             Chicago, Illinois 60604-3507

                                             Phone (312) 353-7832 Fax (312) 353-8866
                                             Internet http://www.hud.gov/offices/oig/




                                                                                MEMORANDUM NO:
                                                                                     2010-CH-1807

July 21, 2010

MEMORANDUM FOR: Vicki Bott, Deputy Assistant Secretary for Single Family, HU
                Dane M. Narode, Associate General Counsel for Program
                  Enforcement, CACC


FROM: Heath Wolfe, Regional Inspector General for Audit, 5AGA

SUBJECT: Birmingham Bancorp Mortgage Corporation, West Bloomfield, MI, Did Not
          Properly Underwrite a Selection of FHA Loans

                                      INTRODUCTION

We reviewed 20 Federal Housing Administration (FHA) loans that Birmingham Bancorp
Mortgage Corporation (Birmingham) underwrote as an FHA direct endorsement lender. Our
review objective was to determine whether Birmingham underwrote the 20 loans in accordance
with FHA requirements. This review is part of “Operation Watchdog,” an OIG initiative to
review the underwriting of 15 direct endorsement lenders at the suggestion of the FHA
Commissioner. The FHA Commissioner expressed concern regarding the increasing claim rates
against the FHA insurance fund for failed loans.

For each recommendation without a management decision, please respond and provide status
reports in accordance with the U.S. Department of Housing and Urban Development’s (HUD)
Handbook 2000.06, REV-3. Please furnish us copies of any correspondence or directives issued
because of the review.

We provided our discussion draft memorandum report to Birmingham’s management during the
review. We asked Birmingham to provide written comments on our discussion draft
memorandum report by June 7, 2010. Birmingham’s president provided written comments to the
discussion draft report, dated June 8, 2010. The president disagreed with our finding and
recommendations. The complete text of the lender’s comments, along with our evaluation of
that response, can be found in appendix C of this report, except for 61 exhibits of 170 pages of
documentation that was not necessary to understand the lender’s comments. We provided
HUD’s Deputy Assistant Secretary for Single Family Housing and Associate General Counsel

                                               1
for Program Enforcement with a complete copy of Birmingham’s written comments plus the 170
pages of documentation.

                                     METHODOLOGY AND SCOPE

Birmingham is 1 of 15 direct endorsement lenders we selected from the U.S. Department of
Housing and Urban Development’s (HUD) publicly available Neighborhood Watch1 system
(system) for a review of underwriting quality. These direct endorsement lenders all had a
compare ratio2 in excess of 200 percent of the national average as listed in the system for loans
endorsed between November 1, 2007, and October 31, 2009. We selected loans that had gone
into a claims status. We selected loans for Birmingham that defaulted within the first 30 months
and were (1) not streamline refinanced, and (2) for manually underwritten loans, associated with
underwriters (usually individuals) with a high number of claims.

                                               BACKGROUND

Birmingham is a nonsupervised direct endorsement lender based in West Bloomfield, MI. FHA
approved Birmingham as a direct endorser in July 1988. FHA’s mortgage insurance programs
help low- and moderate-income families become homeowners by lowering some of the costs of
their mortgage loans. FHA mortgage insurance also encourages lenders to approve mortgages
for otherwise creditworthy borrowers that might not be able to meet conventional underwriting
requirements by protecting the lender against default. The direct endorsement program
simplifies the process for obtaining FHA mortgage insurance by allowing lenders to underwrite
and close the mortgage loan without prior HUD review or approval. Lenders are responsible for
complying with all applicable HUD regulations and are required to evaluate the borrower’s
ability and willingness to repay the mortgage debt. Lenders are protected against default by
FHA’s mutual mortgage insurance fund, which is sustained by borrower premiums.

The goal of Operation Watchdog is to determine why there is such a high rate of defaults and
claims. We selected up to 20 loans in claim status from the 15 lenders. The 15 lenders selected
for Operation Watchdog endorsed 183,278 loans valued at $31.3 billion during the period
January 2005 to December 2009. These same lenders also submitted 6,560 FHA insurance
claims with an estimated value of $794.3 million from November 2007 through December 2009.
During this period, Birmingham endorsed 6,314 loans valued at more than $837 million and
submitted 502 claims worth more than $50 million.

Our objective was to determine whether the 20 selected loans were properly underwritten and if
not, whether the underwriting reflected systemic problems.

We performed our work from January through April 2010. We conducted our work in
accordance with generally accepted government auditing standards, except that we did not

1
  Neighborhood Watch is a system that aids HUD/FHA staff in monitoring lenders and its programs. This system
allows staff to oversee lender origination activities for FHA-insured loans, and tracks mortgage defaults and claims.
2
  HUD defines “compare ratio” as a value that reveals the largest discrepancies between the direct endorser’s default
and claim percentage and the default and claim percentage to which it is being compared. FHA policy establishes a
compare ratio of more than 200 percent as a warning sign of a lender’s performance.

                                                         2
consider the internal controls or information systems controls of Birmingham, consider the
results of previous audits, or communicate with Birmingham’s management in advance. We did
not follow standards in these areas because our objective was to aid HUD in identifying FHA
single-family insurance program risks and patterns of underwriting problems or potential
wrongdoing in poor-performing lenders that led to a high rate of defaults and claims against the
FHA insurance fund. To meet our objective it was not necessary to fully comply with the
standards, nor did our approach negatively affect our review results.

                                    RESULTS OF REVIEW

Birmingham did not properly underwrite 9 of the 20 loans reviewed because its underwriters did
not follow FHA’s requirements. As a result, FHA’s insurance fund suffered actual losses of
$643,340 as shown by the following table.

                                           Number of          Original
           FHA loan                     payments before       mortgage       Actual loss to
            number       Closing date     first default        amount             HUD
          105-3017718      5/29/07              1           $89,248          $57,256
          151-8410864     10/24/07               1           82,209            54,461
          201-3487218     11/03/05              9            41,800            44,773
          261-9009876      3/31/06               4           96,019           114,361
          261-9071686      5/25/06              19           59,073            63,185
          262-1681931      9/14/07               7           56,000            57,931
          263-3870605      3/30/06              3            90,578            86,252
          263-3922022     10/27/06             N/A           74,825            79,696
          263-3938261     11/20/06              0           101,408            85,425
                              Totals                       $691,160         $643,340

The following table summarizes the material deficiencies that we identified in the nine loans.

                                                          Number of
                                 Area of noncompliance      loans
                               Income                         4
                               Liabilities                    1
                               Excessive ratios               2
                               Assets                         2
                               Gift funds                     1
                               Credit report                  4
                               Verification of rent           4

Appendix A shows a schedule of material deficiencies in each of the nine loans. Appendix B
provides a detailed description of all loans with material underwriting deficiencies noted in this
report.

Income

Birmingham did not properly calculate borrower’s income or determine income stability for four
loans. HUD does not allow income to be used in calculating a borrower’s income ratios if it
cannot be verified, is not stable, or will not continue. Birmingham is required to analyze whether


                                                 3
income is reasonably expected to continue through at least the first 3 years of the mortgage loan
(see appendix B for detailed requirements).

For example, for loan number 105-3017718, Birmingham overstated the borrowers’ monthly
income by $701. Birmingham calculated the borrowers’ monthly income as $3,008 ($1,560 for
the borrower and $1,448 for the coborrower). We calculated the borrowers’ monthly income as
$2,307 ($869 for the borrower and $1,438 for the coborrower). To calculate the borrower’s
average monthly income, Birmingham used the current rate of pay of $9 per hour or $1,560 per
month. The borrower had not earned this income on a consistent basis for the last 12 months
although he had worked for the same employer for more than 1 year. The borrower’s stability of
income was questionable. His 2006 average monthly income of $626 was significantly less than
his average monthly income of $1,484 for the first 3 months of 2007. Birmingham should have
verified with the borrower’s employer whether his income was subject to seasonal influences and
determine why his monthly income more than doubled from 2006 to 2007. We contacted the
borrower’s employer, who verified that the employment was seasonal. We recalculated the
borrower’s monthly income for the 12 months before his loan closing to be $869. We also found
that the coborrower’s monthly income was overstated by $10 due to a calculation error by
Birmingham.

For loan number 151-8410864, Birmingham’s underwriter overstated the borrower’s gross
monthly income by $829. The underwriter did not use the full wage and employment
information available in the loan file and only used partial information to calculate the average
monthly income of $2,731. The partial information was more beneficial to the borrower. Using
the full available wage and employment information, we recalculated the borrower’s average
monthly income as $1,902. The underwriter used the year-to-date earnings of $9,559 reported
on the September 29, 2007, pay stub from the borrower’s recent employer, divided by 3.5
months. At this time, the borrower had received wages for more than 5 months. We recalculated
the borrower’s gross monthly income as $1,902 ($9,987 divided by 5.25), using the latest pay
stub for the period ending October 6, 2007, available in the loan file.

Liabilities

Birmingham did not properly assess the borrowers’ financial obligations for one loan. HUD
requires lenders to consider debts if the amount of the debts affects the borrower’s ability to
make the mortgage payment during the months immediately after loan closing (see appendix B
for detailed requirements).

For example, for loan number 105-3017718, the borrower’s child support wage garnishment of
$40 per week was not reported on the loan application or the mortgage credit analysis
worksheet3. The weekly child support payments computed to a monthly payment of $173 ($40
per week times 52 weeks divided by 12 months). This exclusion from the total monthly
obligations caused the fixed payment-to-income ratio to be understated on the worksheet. When
the fixed payment-to-income ratio was recalculated to include all of the borrower’s monthly
obligations, the ratio exceeded the qualifying percentage. Therefore, the exclusion of child


3
    The mortgage credit analysis worksheet is used to analyze and document mortgage approval.

                                                         4
support from monthly obligations was material, and Birmingham should not have approved the
loan.

Excessive Ratios

Birmingham improperly approved two loans when the borrowers’ ratios exceeded FHA’s
requirement. Effective April 13, 2005, the fixed payment-to-income and debt-to-income ratios
were increased from 29 and 41 percent to 31 and 43 percent, respectively. If either or both ratios
are exceeded on a manually underwritten mortgage, the lender is required to describe the
compensating factors used to justify the mortgage approval (see appendix B for detailed
requirements).

For loan number 105-3017718, the combination of overreported income and unreported
liabilities caused the debt-to-income ratios to be understated on the mortgage credit analysis
worksheet. The monthly mortgage payment-to-income ratio increased from 24.5 to 31.955
percent, and the total monthly fixed payment-to-income ratio increased from 33.31 to 50.963
percent, exceeding HUD’s qualifying ratios of 31 and 43 percent, respectively. The worksheet
did not include compensating factors.

For loan number 263-3870605, the borrower’s mortgage payment-to-income ratio exceeded
HUD’s allowable ratio of 31 percent. The ratio reported on the mortgage credit analysis
worksheet was 33.515 percent. Birmingham’s underwriter justified the excessive ratio by using
the borrower’s ability to pay housing expenses greater than the proposed monthly housing
expenses. However, Birmingham did not obtain independent verifications, such as cancelled
checks or receipts, of the borrower’s rental payments. Further, both verifications of rent were
faxed from the borrower’s employer.

Assets

Birmingham did not properly document the source of the borrowers’ funds to close for two
loans. HUD requires the lender to verify and document the borrower’s investment in the
property (see appendix B for detailed requirements).

For loan number 262-1681931, although the loan file included the borrower’s bank statement,
the loan file did not include an explanation for the large deposits. Birmingham’s underwriter
was unable to provide documentation or an explanation for the large deposits.

For loan number 263-3870605, the loan file included bank account activity reports from
February 24 to March 13, 2006. The reports did not show the name of the institution or the
borrower’s name. The reports showed a large deposit of $6,171, dated February 24, 2006. The
loan file included a copy of a cashier’s check, dated February 23, 2006, written to the borrower
and his wife for $6,171. The loan file also included a hand-written note stating that the reason
for the large deposit was a tax refund. However, Birmingham did not explain why the borrower
provided a copy of a cashier’s check from HSBC as support for his tax refund and not a copy of
either the tax return or a copy of his tax refund check.



                                                5
Gift Funds

Birmingham did not properly document gift funds received by borrower for one loan. HUD
requires that the lender be able to determine that gift funds ultimately were not provided by an
unacceptable source (see appendix B for detailed requirements).

For loan number 261-9071686, Birmingham’s underwriter did not verify that the gift funds came
from an acceptable source. Both of the loan applications (initial and final) showed that the
borrower’s source of the downpayment and/or closing costs was her checking/savings account.
A statement signed by the borrower 2 days before the closing indicated that her cousin gave her a
gift to ensure that she would be able to buy the home. The loan file included a copy of a gift
letter and a $2,500 gift check. We contacted the borrower, who stated that the gift donor was not
her cousin, but rather the seller of the property. The borrower also said that the loan officer told
her to purchase a $2,000 cashier’s check to bring to the closing.

Credit Report

Birmingham did not properly evaluate the borrowers’ credit history for four loans. HUD
requires the lender to consider collection accounts in analyzing a borrower’s creditworthiness.
The lender must explain all collections in writing (see appendix B for detailed requirements).

For example, for loan number 261-9009876, Birmingham did not obtain independent verification
from the borrower’s creditors to support loan approval. The borrower’s credit report, dated
March 3, 2006, showed that the borrower had several collection accounts including collections-
related debts with Comcast and Southwestern Bell Communications (SBC). The loan files
contained documents showing that the Comcast collection was satisfied by the return of the
equipment and the SBC collection was paid off. However, both of the documents were dated
March 20, 2006, and they were faxed to the mortgage company from the seller, an interested
party, on the same date.

Verification of Rent

Birmingham did not properly verify borrowers’ rental histories for four loans. HUD notes that
the payment history of the borrower’s housing obligations holds significant importance in
evaluating credit. The lender must determine the borrower’s housing payment history through
acceptable means, including verification of rent directly from the landlord or through cancelled
checks covering the most recent 12-month period (see appendix B for detailed requirements).

For example, for loan number 201-3487218, Birmingham did not obtain additional
documentation from the borrower to prove that a rental agreement existed and residency at the
property had been established for at least 6 months. Otherwise, the loan amount would have
been limited to 85 percent of the lower of the sales price or appraised value of the subject
property (85 percent loan to value). Since the borrower did not have any assets, the loan would
have been ineligible.




                                                 6
For loan number 261-9009876, Birmingham approved the loan without resolving inconsistencies
with the borrower’s rental history. There were no canceled checks or a lease agreement to
support the borrower’s rental history.

For loan number 263-3870605, Birmingham used verification of rent to establish credit history.
However, Birmingham’s underwriter did not obtain independent verification of the borrower’s
monthly housing expenses. Since both verifications were signed by the same individual for
properties located in California and Mississippi, Birmingham should have documented an
explanation of why the same individual signed both verifications and why both were faxed from
the borrower’s employer.

Incorrect Underwriter’s Certifications Submitted to HUD

We reviewed the certifications for the nine loans with material underwriting deficiencies for
accuracy. Birmingham’s direct endorsement underwriters incorrectly certified that due diligence
was used in underwriting the nine loans. When underwriting a loan manually, HUD requires a
direct endorsement lender to certify that it used due diligence and reviewed all associated
documents during the underwriting of a loan.

The Program Fraud Civil Remedies Act of 1986 (231 U.S.C. (United States Code) 3801)
provides Federal agencies, which are the victims of false, fictitious, and fraudulent claims and
statements, with an administrative remedy (1) to recompense such agencies for losses resulting
from such claims and statements; (2) to permit administrative proceedings to be brought against
persons who make, present, or submit such claims and statements; and (3) to deter the making,
presenting, and submitting of such claims and statements in the future.

                                             RECOMMENDATIONS

We recommend that HUD’s Associate General Counsel for Program Enforcement

1A.        Determine legal sufficiency and if legally sufficient, pursue remedies under the Program
           Fraud Civil Remedies Act against Birmingham and/or its principals for incorrectly
           certifying to the integrity of the data or that due diligence was exercised during the
           underwriting of 9 loans that resulted in losses to HUD totaling $643,340, which could
           result in affirmative civil enforcement action of approximately $1,354,1804.

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

1B.        Take appropriate administrative action against Birmingham and/or its principals for the
           material underwriting deficiencies cited in this report once the affirmative civil
           enforcement action cited in recommendation 1A is completed.




4
    Double damages plus a $7,500 fine for each of the nine incorrect certifications.

                                                            7
                              Schedule of Ineligible Cost 1/

                            Recommendation
                                number               Amount
                                   1A                $643,340


1/   Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
     that the auditor believes are not allowable by law; contract; or Federal, State, or local
     policies or regulations. The amount shown represents the actual loss HUD incurred when
     it sold the affected properties.




                                             8
                                                                                                                                                                                                                                   Appendix A




    263-3938261
                  263-3922022
                                263-3870605
                                              262-1681931
                                                            261-9071686
                                                                          261-9009876
                                                                                        201-3487218
                                                                                                      151-8410864
                                                                                                                    105-3017718
                                                                                                                                   FHA loan number
                                                                                                                                  Unsupported income or questionable
                                                                                                                                         employment history




                  X
                                                                                        X
                                                                                                      X
                                                                                                                    X
                                                                                                                                                     Underreported liabilities




                                                                                                                    X
                                                                                                                                              Excessive debt-to-income ratios



                                                                                                                    X




                                X




9
                                                                                                                                                       Unsupported assets




                                X
                                              X
                                                                                                                                                 Insufficient gift documentation
                                                            X


                                                                                                                                  Significant credit-related deficiencies
                  X                                                                                                                            or no credit
                                X
                                                                          X
                                                                                                                    X




                                                                                                                                  Incomplete verification of rent history
    X
                                X
                                                                          X
                                                                                        X
                                                                                                                                                                                   SUMMARY OF MATERIAL UNDERWRITING DEFICIENCIES
Appendix B

 LOANS WITH MATERIAL UNDERWRITING DEFICIENCIES


Loan number: 105-3017718

Mortgage amount: $89,248

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: May 29, 2007

Status: Claim

Payments before first default reported: One

Loss to HUD: $57,256

Summary:

We found material underwriting deficiencies relating to the borrowers’ credit, liabilities, income
and employment, and/or debt-to-income ratios.

Credit:

Birmingham did not adequately review the coborrower’s credit history before approving the
loan. The coborrower had poor credit including several unpaid collections and recent credit
inquiries. The recent collections were major indications of derogatory credit, and the recent
credit inquiries required written explanations from the coborrower. The coborrower wrote a
letter, which stated that she was unaware of the collection accounts, she would work with the
creditors, and the multiple credit inquiries were her attempt to “build” credit quickly.
Birmingham did not document an analysis of the credit history to determine whether the late
payments were based on a disregard for financial obligations, an inability to manage debt, or
factors beyond the control of the coborrower.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that neither the lack of credit history nor
the borrower’s decision not to use credit may be used as a basis for rejecting the loan application.
We also recognize that some prospective borrowers may not have an established credit history.
For those borrowers and for those who do not use traditional credit, the lender must develop a
credit history from utility payment records, rental payments, automobile insurance payments, or

                                                10
other means of direct access from the credit provider. The lender must document that the
providers of nontraditional credit do, in fact, exist and verify the credit information. Documents
confirming the existence of a nontraditional credit provider may include a public record from
State, county, or city records or other means providing a similar level of objective confirmation.
To verify the credit information, lenders must use a published address or telephone number for
that creditor.

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that when analyzing a borrower’s credit
history, the lender should examine the overall pattern of credit behavior rather than isolated
occurrences of unsatisfactory or slow payments. When delinquent accounts are revealed, the
lender must document its analysis regarding whether the late payments were based on a disregard
for financial obligations, an inability to manage debt, or factors beyond the control of the
borrower, including delayed mail delivery or disputes with creditors.

Major indications of derogatory credit–including all judgments, all collections, and any other
recent credit problems–require sufficient written explanation from the borrower. The borrower’s
explanation must make sense and be consistent with other credit information in the file.

Liabilities:

The borrower’s child support wage garnishment of $40 per week was not reported on the loan
application or the mortgage credit analysis worksheet. The weekly child support payment
computes to a monthly child support payment of $173 ($40 per week times 52 weeks divided by
12 months). This exclusion from the total monthly obligations caused the fixed payment-to-
income ratio to be understated on the worksheet. When the fixed payment-to-income ratio was
recalculated to include all of the borrower’s monthly obligations, the ratio exceeded the
qualifying ratio. Therefore, the exclusion of child support from monthly obligations was
material, and Birmingham should not have approved the loan.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-11A, states that recurring obligations must be
considered in qualifying borrowers. The borrower’s recurring obligations include all installment
loans, revolving charge accounts, real estate loans, alimony, child support, and all other
continuing obligations. In computing the debt-to-income ratios, the lender must include the
monthly housing expense and all other recurring charges extending 10 months or more, including
payments on installment accounts, child support or separate maintenance payments, revolving
accounts, etc.

Income:

The borrowers’ monthly income was overstated by $701 per month. Birmingham calculated
monthly income as $3,008 ($1,560 for the borrower and $1,448 for the coborrower). We
calculated the borrowers’ monthly income as $2,307 ($869 for the borrower and $1,438 for the
coborrower).



                                                11
Birmingham used the current rate of pay of $9 per hour to calculate the borrower’s monthly
income as $1,560. The borrower had not earned this income for the last 12 months although he
had worked for the same employer for more than 1 year. The borrower’s stability of his income
was questionable. Although he had worked a little more than 1 year for his current employer,
Birmingham did not document a stable rate of pay for the borrower.

His 2006 average monthly income of $626 was significantly less than his average monthly
income of $1,484 for the first 3 months of 2007. Birmingham did not determine the reason for
this wage increase. It needed to verify with the borrower’s employer whether his income was
subject to seasonal influences or determine why the average monthly income more than doubled
from 2006 to 2007. We contacted the borrower’s employer, who verified that the employment
was seasonal.

Since there was no verification documenting the reason for the borrower’s increased earnings
from 2006 to the first 3 months of 2007, we recalculated the borrower’s income for the most
recent 12-month period as $869. As a result, Birmingham overstated the borrower’s income by
$691 ($1,560 minus $869). We also determined that the coborrower’s income was overstated on
the mortgage credit analysis worksheet by $10 due to a calculation error.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-6, states that FHA does not impose a minimum
length of time a borrower must have held a position of employment to be eligible. However, the
lender must verify the borrower’s employment for the most recent 2 full years. The borrower
also must explain any gaps in employment spanning 1 month or more. Allowances for seasonal
employment, such as is typical in the building trades, may be made if documented by the lender.

Excessive Debt-to-Income Ratios:

The combination of overreported income and unreported liabilities caused the debt-to-income
ratios to be understated on the mortgage credit analysis worksheet. The monthly mortgage
payment-to-income ratio increased from 24.5 to 31.955 percent, and the total monthly fixed
payment-to-income ratio increased from 33.31 to 50.963 percent, exceeding HUD’s qualifying
ratios of 31 and 43 percent, respectively. The worksheet did not include compensating factors.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraphs 2-12, and Mortgagee Letter 2005-16 state that for
manually underwritten mortgages for which the direct endorsement underwriter must make the
credit decision, the qualifying ratios were raised to 31and 43 percent, respectively. This change
will allow a larger number of deserving families to purchase their first home while not increasing
the risk of default. As always, if either or both ratios are exceeded on a manually underwritten
mortgage, the lender must describe the compensating factors used to justify mortgage approval.




                                               12
Loan number: 151-8410864

Mortgage amount: $82,209

Section of Housing Act: 234 (c)

Loan purpose: Purchase

Date of loan closing: October 24, 2007

Status: Claim

Payments before first default reported: One

Loss to HUD: $54,461

Summary:

We found a material underwriting deficiency relating to the borrower’s income.

Income:

Birmingham’s underwriter overstated the borrower’s gross monthly income by $829 by using
partial employment information which was more beneficial to the borrower rather than using the
complete employment information in the loan file. The underwriter calculated the average
monthly income of $2,731 by using the partial employment information available in the loan file.
Using the complete employment information, we calculated the borrower’s average monthly
income as $1,902.

The underwriter calculated the monthly income as $2,731 by using the year-to-date earnings of
$9,559 reported on the September 29, 2007, pay stub divided by 3.5 months. This pay stub was
not the latest pay stub available, and as of September 29, 2007, the borrower had worked 5
months at this job, not 3.5 months. Further, the pay stub reported 40.80 hours worked, and
Federal taxes were not withheld.

We calculated the borrower’s gross monthly income as $1,902. We used the latest pay stub
available for the period ending October 6, 2007, which reported the year-to-date earnings of
$9,987 divided by 5.25 months, the number of months the borrower had been employed. The
borrower started employment on May 1, 2007. This pay stub showed that the borrower worked
28.90 hours and Federal taxes were withheld. The borrower was previously unemployed for 9
months prior to starting this employment. The borrower explained the employment gap which
was included in the loan file. Prior to the employment gap, the borrower was employed for more
than 4 years.

Using the average monthly income of $1,902 increased the qualifying ratios above the allowable
ratios of 31and 43 percent. The mortgage payment-to-income ratio increased to 43 percent from

                                              13
29.953 percent ($818 mortgage payment divided by $1,902). The total fixed payment-to-income
ratio also increased to 61.25 percent from 42.659 percent ($1,165 total fixed payment divided by
$1,902).

In a condition to close, Birmingham required the loan correspondent to provide a full verification
of employment from the borrower’s current employer with an explanation as to why the pay
stubs did not show Federal withholdings. Also, the correspondent was to confirm that the
borrower was an Internal Revenue Service (IRS) Form W-2 employee. A letter of explanation
was required to account for the inconsistency in withholding Federal taxes. One month of
consecutive pay stubs showing 40 hours worked per week and Federal taxes being deducted from
the pay stubs were also required. Further, the condition stated that if the documents were not
provided, the loan approval would be “null and void.”

The loan file did not include documentation of 1 full month of consecutive pay stubs showing a
40-hour work week or an explanation for the Federal taxes not having been withheld as required
by the underwriter’s condition.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 3-1, states that the application package must contain
all documentation supporting the lender’s decision to approve the mortgage loan.

Mortgagee Letter 2005-16, dated April 13, 2005, increased the payment-to-income and debt-to-
income ratios from 29 and 41 percent to 31 and 43 percent, respectively. If either or both ratios
are exceeded on a manually underwritten mortgage, the lender is required to describe the
compensating factors used to justify the mortgage approval.




                                                14
Loan number: 201-3487218

Mortgage amount: $41,800

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: November 3, 2005

Status: Claim

Payments before first default reported: Nine

Loss to HUD: $44,773

Summary:

We found material underwriting deficiencies relating to the borrower’s income and verification
of rent.

Income:

Birmingham approved the loan based on income which was not stable and was computed using
questionable pay stubs. The borrower applied for the loan in June 2005 when he was working as
a restaurant manager earning approximately $1,247 per month. Two months before loan closing,
the borrower, according to file documents, switched his employment from that of restaurant
manager to sand blaster in an auto body work shop, a totally different industry. The borrower’s
employment change increased his monthly earnings by $919, a 73.66 percent increase.
Birmingham accepted four pay stubs from the borrower’s new employment and used these pay
stubs to compute the borrower’s income. The borrower’s pay stubs showed that no Federal
income tax was withheld and the amounts withheld for both the Federal Insurance Contributions
Act (FICA) and Medicare were not accurate. The FICA tax for employees is 6.2 percent of
earned wages, and the Medicare tax for employees is 1.45 percent of earned wages. The pay
stubs showed that the FICA withholding was 7.885 percent and the Medicare withholding was
2.175 percent. Birmingham’s underwriter should have questioned the pay stubs and followed up
with additional verification, such as contacting the employer, qualifications for the job and
training, etc.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-6, states that FHA does not impose a minimum
length of time a borrower must have held a position of employment to be eligible. To analyze
and document the probability of continued employment, lenders must examine the borrower’s
past employment record, qualifications for the position, and previous training and education and
the employer’s confirmation of continued employment. A borrower who changes jobs

                                               15
frequently within the same line of work but continues to advance in income or benefits should be
considered favorably. In this analysis, income stability takes precedence over job stability.

Rental Verification:

The loan files did not document proper verification of rent. The borrower was residing in the
property he purchased. The seller, who was the landlord, provided the verification of rent to
Birmingham and the credit reporting agency. However, there was no other documentation. As
the seller was an identity of interest in the real estate transaction, Birmingham needed to obtain
additional documentation from the borrower to prove that a rental agreement existed and
residency at the property had been established for at least 6 months. Otherwise, the loan amount
would have been limited to 85 percent of the lower of the sales price or appraised value of the
subject property (85 percent loan to value). Since the borrower did not have any assets, the loan
would have been ineligible.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that when reviewing the borrower’s credit
and credit report, the lender must pay particular attention to previous rental payment history.
The payment history of the borrower’s housing obligations holds significant importance in
evaluating credit. The lender must determine the borrower’s payment history of housing
obligations through either the credit report, verification of rent directly from the landlord (with
no identity of interest with the borrower), or canceled checks covering the most recent 12-month
period.

HUD Handbook 4155.1, REV-5, paragraph 1-8A, states that identity-of-interest transactions on
principal residences are restricted to a maximum loan-to-value ratio of 85 percent. Identity of
interest is defined as a sales transaction between parties with family relationships or business
relationships. However, maximum financing above the 85 percent loan-to-value ratio is
permissible if a current tenant purchases the property that he has rented for at least 6 months
immediately predating the sales contract. To meet this exclusion, a lease or other written
evidence must be submitted to verify occupancy.

HUD Handbook 4155.1, REV-5, chapter 3, states the lender is responsible for asking sufficient
questions to elicit a complete picture of the borrower’s financial situation.




                                                16
Loan number: 261-9009876

Mortgage amount: $96,019

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: March 31, 2006

Status: Claim

Payments before first default reported: Four

Loss to HUD: $114,361

Summary:

We found material underwriting deficiencies relating to the borrower’s credit history and
verification of rent.

Credit:

Birmingham did not obtain independent verification from the borrower’s creditors to support
loan approval. The borrower’s credit report, dated March 3, 2006, showed that the borrower had
several collection accounts including collections-related debts with Comcast and Southwestern
Bell Communications (SBC). The loan files contained documents showing that the Comcast
collection was satisfied by the return of the equipment and the SBC collection was paid off.
However, both of the documents were dated March 20, 2006, and they were faxed to the
mortgage company from the seller, an interested party, on the same date.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 3-1, states that the lender may not accept or use
documents relating to the credit, employment, or income of borrowers that are handled by or
transmitted from or through interested third parties (e.g., real estate agents, builders, sellers) or
by using their equipment.

Verification of Rent:

Birmingham approved the loan without resolving inconsistencies with the borrower’s rent
history. There were inconsistencies in the borrower’s rental history in Birmingham’s file. A
verification of rent was completed by a managing partner for the landlord, who was also the
seller of the subject property (an identity-of-interest transaction). According to this verification
of rent, the borrower had rented at the property since January 1, 2005 (more than 1 year), which
contradicted the duration of .4 years listed on the uniform residential loan application signed by

                                                  17
the borrower on March 31, 2006. There were no canceled checks or a lease agreement to support
the borrower’s rental history.

The borrower’s credit report, dated March 3, 2006, showed an address discrepancy alert
indicating there was a substantial difference between the address used for the credit inquiry and
the addresses on file. The subject property location was not one of the addresses listed for the
borrower on the credit report. Further, Birmingham had not submitted documentation to support
whether the borrower lived at the property. The borrower’s driver’s license in Birmingham’s file
showed an address that was different from that of the subject property.

Another verification of rent or mortgage form, dated November 15, 2005, was completed for the
borrower for another address, and it showed that the borrower rented at that address from June 7,
2004, through November 15, 2005. However, this rental period overlapped the timeframe listed
on the previously mentioned verification of rent completed by the seller.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3A, states that the lender must determine the
borrower’s payment history of housing obligations through either the credit report, verification
of rent directly from the landlord (with no identity of interest with the borrower), or canceled
checks covering the most recent 12-month period.

HUD Handbook 4155.1, REV-5, paragraph 1-8A, states that the maximum financing above the
85 percent loan-to-value ratio is permissible when a current tenant purchases the property that he
or she has rented for at least 6 months immediately predating the sales contract (a lease or other
written evidence must be submitted to verify occupancy).

HUD Handbook 4155.1, REV-5, chapter 3, states that the lender is responsible for asking
sufficient questions to elicit a complete picture of the borrower’s financial situation, source of
funds for the transaction, and the intended use of the property. All information must be verified
and documented. Further, paragraph 3-1 of the handbook states that the application package
must contain all documentation supporting the lender’s decision to approve the mortgage loan.
When standard documentation does not provide enough information to support this decision, the
lender must provide additional explanatory statements, consistent with other information in the
application, to clarify or to supplement the documentation submitted by the borrower.




                                                18
Loan number: 261-9071686

Mortgage amount: $59,073

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: May 25, 2006

Status: Claim

Payments before first default reported: 19

Loss to HUD: $63,185

Summary:

We found a material underwriting deficiency relating to the borrower’s gift funds.

Gift Funds:

Birmingham’s underwriter did not verify that the gift funds came from an acceptable source.
Both loan applications (initial and final) showed that the borrower’s source of the downpayment
and/or closing costs was her checking/savings account. The loan file contained a statement from
the borrower that she could not use her savings/checking account because it had not been open
for at least 60 days. This statement was signed 2 days before closing. The statement further
stated that her cousin gave her a gift to ensure that she would be able to buy the home. The loan
file included a copy of the gift letter and a $2,500 gift check.

We contacted the borrower, who stated that the gift donor was not her cousin, but the seller of
the property. The borrower said that the loan officer told her to purchase a $2,000 cashier’s
check to bring to the closing.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-10 C(2), states that regardless of when the gift
funds are made available to the home buyer, the lender must be able to determine that the gift
funds ultimately were not provided from an unacceptable source and were indeed the donor’s
own funds. When the transfer occurs at closing, the lender remains responsible for obtaining
verification that the closing agent received funds from the donor for the amount of the purported
gift and that those funds came from an acceptable source.




                                                19
Loan number: 262-1681931

Mortgage amount: $56,000

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: September 14, 2007

Status: Claim

Payments before first default reported: Seven

Loss to HUD: $57,931

Summary:

We found a material underwriting deficiency relating to the borrower’s assets.

Assets:

Birmingham did not obtain an explanation of the source of funds for the borrower’s
downpayment and/or closing costs. The loan application reported that the source of the
borrower’s downpayment and/or closing costs was his own funds. The loan file included the
borrower’s bank statement for the period June 1 to June 30, 2007, which showed the beginning
balance on of $49.49 on June 1 and the ending balance of $7,155 on June 30. The statements
showed that three large deposits were made during the month of June ($4,337, $4,237, and
$3,700, respectively). The deposit of $3,700 was withdrawn on the same day. Birmingham’s
loan file did not document an explanation for the large deposits.

Birmingham’s underwriter was unable to provide an explanation because Birmingham’s loan file
was not available. She stated that there may have been additional documents to explain the large
deposits in the loan file, which were not included in the FHA case file. We obtained the loan file
from the loan servicer, Nationwide Advantage Mortgage Company, but it contained no
explanation for the large deposits.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-10, states that all funds for the borrower’s
investment in the property must be verified and documented. Paragraph 2-10B states that a
verification of deposit, along with the most recent bank statement, may be used to verify savings
and checking accounts. If there is a large increase in an account or the account was opened
recently, the lender must obtain a credible explanation of the source of those funds.




                                                20
Loan number: 263-3870605

Mortgage amount: $90,578

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: March 30, 2006

Status: Claim

Payments before first default reported: Three

Loss to HUD: $86,252

Summary:

We found material underwriting deficiencies relating to the borrower’s assets, liabilities, and
ratios.

Assets:

Birmingham’s underwriter did not obtain an explanation for the source of funds for the
borrower’s downpayment/closing costs. The loan application showed that the source of funds
was cash on hand. The loan file included bank account activity reports from February 24 to
March 13, 2006. The reports did not show the name of the institution or the borrower’s name.
The reports showed a large deposit of $6,171 on February 24, 2006. The loan file included a
copy of a cashier’s check, dated February 23, 2006, from HSBC that was written to the borrower
and his wife for $6,171. The loan file also included a hand-written note stating that the reason
for the large deposit was a tax refund. However, Birmingham did not provide an explanation of
why the borrower provided a copy of a cashier’s check from HSBC as support for his tax refund
and not a copy of either the tax return or a copy of his tax refund check.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-10B, states that a verification of deposit, along
with the most recent bank statement, may be used to verify savings and checking accounts. If
there is a large increase in an account or the account was opened recently, the lender must obtain
a credible explanation of the source of those funds. Paragraph 3 states that the lender is
responsible for asking sufficient questions to elicit a complete picture of the borrower’s financial
situation, the source of funds for the transaction, and the intended use of the property. All
information must be verified and documented.




                                                 21
Credit:

Birmingham’s underwriter did not obtain independent verification from the borrower’s creditors
to support loan approval. Since the credit report did not list any open accounts, the underwriter
developed a credit history by documenting two instances of alternative credit. However, in both
instances, letters were faxed by the borrower from his employer. One letter stated that the
borrower purchased a 1991 Chrysler New Yorker from a private seller for $1,300 and was
making $100 monthly payments. The letter was signed by the borrower and seller of the vehicle.
No other evidence was included in the file to show that the borrower purchased the vehicle. The
second letter stated that the borrower purchased a computer and mattress and box spring from
Aarons, his employer, and made monthly payments of $62.85 for the computer and $40.80 for
the mattress and box spring. The letter was signed by the store’s general manager. The file did
not document receipts to show the purchases.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that neither the lack of credit history nor
the borrower’s decision not to use credit may be used as a basis for rejecting the loan application.
FHA also recognizes that some prospective borrowers may not have an established credit history.
For those borrowers and for those who do not use traditional credit, the lender must develop a
credit history from utility payment records, rental payments, automobile insurance payments, or
other means of direct access from the credit provider. The lender must document that the
providers of nontraditional credit do, in fact, exist and verify the credit information. Documents
confirming the existence of a nontraditional credit provider may include a public record from
State, county, or city records or other means providing a similar level of objective confirmation.
To verify the credit information, lenders must use a published address or telephone number for
that creditor.

Verification of Rent:

Birmingham used two verifications of rent to establish credit history. However, Birmingham’s
underwriter did not obtain independent verification of the borrower’s monthly housing expenses.
The loan file included two verifications of rent, one dated January 30, 2006, from the borrower’s
landlord before he purchased the subject property. The verification reported the borrower’s
residency in Lake Isabella, CA, between March 2, 2005, and January 30, 2006, with a monthly
rent of $1,000. The second verification was also dated January 30, 2006, and was from the same
landlord. It listed the rental property as being in Bay St. Louis, MS, with a rent of $850 from
May 1, 2000, to February 24, 2005. As both verifications were signed by the same individual for
properties located in California and Mississippi, Birmingham should have documented an
explanation of why the same individual signed both verifications and why both were faxed from
the borrower’s employer.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3A, states that the payment history of the
borrower’s housing obligations holds significant importance in evaluating credit. The lender

                                                22
must determine the borrower’s payment history of housing obligations through either the credit
report, verification of rent directly from the landlord (with no identity of interest with the
borrower), or verification of mortgage directly from the mortgage servicer or through canceled
checks covering the most recent 12-month period.

Excessive Ratio:

The borrower’s mortgage payment-to-income ratio exceeded HUD’s allowable ratio of 31
percent. The ratio reported on the mortgage credit analysis worksheet was 33.515 percent.
Birmingham’s underwriter justified the excessive ratio by using the borrower’s ability to pay
housing expenses greater than the proposed monthly housing expenses.

The verification of rent reported the borrower’s rent payment as $1,000 for the past 11 months.
The proposed mortgage payment was $781, resulting in a monthly cost savings of $219.
Another verification of rent reported the borrower’s rent payment as $850 for the previous 12
months. However, Birmingham did not obtain independent verifications, such as cancelled
checks or receipts, of the borrower’s rental payments. Further, both verifications of rent were
faxed from the borrower’s employer.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-12, states that ratios are used to determine whether
the borrower can reasonably be expected to meet the expenses involved in homeownership and
otherwise provide for the family. If the mortgage payment expense-to-effective income ratio
exceeds 29 percent, it may be acceptable only if significant compensating factors, as discussed in
paragraph 2-13, are documented and are recorded on the mortgage credit analysis worksheet.

Mortgagee Letter 2005-16, dated April 13, 2005, increased the payment-to-income and debt-to-
income ratios from 29 and 41 percent to 31 and 43 percent, respectively. If either or both ratios
are exceeded on a manually underwritten mortgage, the lender is required to describe the
compensating factors used to justify the mortgage approval.

HUD Handbook 4155.1, REV-5, paragraph 2-13, states that FHA underwriters must record in
the remarks section of HUD Forms 92900-WS/HUD 92900-PUR the compensating factor(s)
used to support loan approval. Any compensating factor used to justify mortgage approval must
be supported by documentation. Paragraph 2-13A states that the borrower has successfully
demonstrated the ability to pay housing expenses equal to or greater than the proposed monthly
housing expense for the new mortgage over the past 12-24 months.




                                                23
Loan number: 263-3922022

Mortgage amount: $74,825

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: October 27, 2006

Status: Claim

Payments before first default reported: Not available

Loss to HUD: $79,696

Summary:

We found material underwriting deficiencies relating to the borrower’s rental income and credit
history.

Income:

Birmingham’s underwriter did not verify that the borrower owned the property scheduled to be
used for rental income. The net rental income of $216 was used to calculate the borrower’s gross
income. However, there was insufficient documentation in the loan files to support that the
borrower owned the property.

The loan application, dated October 27, 2006, showed that the borrower owned a mobile
property valued at $15,000 and that he was living at the property at the time of the loan
application and closing. However, the 2005 Spring Arbor Township property assessment
document indicated that the taxpayer for the mobile property was someone other than the
borrower.

A quit claim deed5 transfer occurred on August 31, 2006, 2 months before closing, for all of the
rights, title, interest, and claim to the parcel of land and improvements and appurtenances in
Jackson County for the mobile property from the grantor to the borrower (grantee). However,
this did not guarantee that the grantor had ownership rights to the property or that the property
was free of debt.

Birmingham’s underwriter should not have used net rental income. Using the borrower’s
average monthly employment income would increase the mortgage payment-to-income ratio


5
 A Quitclaim deed is a type of deed that releases the grantor’s ownership interest in a property to the grantee.
However, the grantor does not make any guarantee that: (1) the property is free of debt, (2) no one else claims to
own the property, or (3) he or she has any ownership interest in the property.

                                                         24
from 33.779 to 37.517 percent ($732.24 divided by $1,951.73). The total fixed payment-to-
income ratio would increase from 38.671 to 42.948 percent ($838.24 divided by $1,951.73).

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-7M, states that rent received for properties owned
by the borrower is acceptable if the lender can document that the rental income is stable.
Examples of stability may include a current lease, an agreement to lease, or rental history over
the previous 24 months that is free of unexplained gaps greater than 3 months. A Schedule E of
IRS Form 1040 and current leases are required to verify all rental income. If a property was
acquired since the last income tax filing and is not shown on Schedule E, a current signed lease
or other rental agreement must be provided.

HUD Handbook 4155.1, REV-5, chapter 3, states that the lender is responsible for asking
sufficient questions to elicit a complete picture of the borrower’s financial situation, the source
of funds for the transaction, and the intended use of the property. All information must be
verified and documented.

Credit:

Birmingham should not have approved this loan because the borrower had not demonstrated the
ability to pay housing expenses equal to or greater than the proposed monthly housing expense
for the new mortgage over the past 12 to 24 months or the borrower’s ability to accumulate
savings.

The borrower’s total monthly mortgage payment was $732. Before the loan closing, the
borrower was not known to have a rental or mortgage payment history except monthly payments
of $84. The borrower’s highest balance in his credit union account was $172. Further,
Birmingham’s underwriter did not show that the change in the housing expenses would not be
minimal. The change in the housing expenses was an increase of 773 percent, from $84 to $732.

To establish alternative credit, the borrower’s payment to a rental company was used. The
verification of loan, dated August 24, 2006, revealed that the borrower had one rent-to-own
account with a current balance of $1,149 and an installment payment of $34. The borrower had
seven late payments on this account. The borrower also had 18 late payments on another rent-to-
own account, which had a zero balance.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-1, states that the purpose of underwriting is to
determine a borrower’s ability and willingness to repay the mortgage debt, thus limiting the
probability of default and collection difficulties and to examine the property offered as security
for the loan to determine whether it is sufficient collateral.

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that past credit performance serves as the
most useful guide in determining a borrower’s attitude toward credit obligations and predicting a

                                                 25
borrower’s future actions. If the credit history, despite adequate income to support obligations,
reflects continuous slow payments and delinquent accounts, strong compensating factors will be
necessary to approve the loan. The lender must document its analysis regarding whether the late
payments were based on disregard for financial obligations or otherwise. Further, paragraph 2-
3C states that collections and judgments must be considered in the analysis of creditworthiness
with the lender documenting its reasons for approving a mortgage when the borrower has
collection accounts and judgments. The borrower must explain in writing all collections and
judgments.




                                               26
Loan number: 263-3938261

Mortgage amount: $101,408

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: November 20, 2006

Status: Claim

Payments before first default reported: Zero

Loss to HUD: $85,425

Summary:

We found a material underwriting deficiency relating to the borrower’s verification of rent.

Verification of Rent:

The borrower and coborrower were living in the property they were purchasing. However,
Birmingham’s underwriter did not address inconsistencies reported on the loan applications and
the verification of rent pertaining to their rental history found in Birmingham’s file. The final
loan application, dated November 20, 2006, signed by the borrower and coborrower reported that
they had been renting the subject property for 3 years. The application did not report their
monthly rent. Birmingham’s file included two separate initial loan applications, both dated
September 27, 2006. The borrower’s signed application reported that she had rented the subject
property for 3 years and her monthly rent was $600. The coborrower’s application only reported
that she had lived at the same property; however, it did not report how long she had lived there or
her housing expenses.

Birmingham’s file included a verification of rent from the landlord/owner, dated September 28,
2006. The verification showed the borrower had resided at the subject property since November
1, 2005, less than 1 year from the date of the loan application, and reported $930 as monthly rent.

The file did not include documentation resolving the differences between the loan applications
and the verification of rent regarding how long the borrower and coborrower had lived at the
subject property and their monthly rent. Further, Birmingham did not obtain a letter of
explanation from the borrower and coborrower addressing these inconsistencies. However, the
loan officer provided a certification on behalf of the borrower, stating that the borrower was
unable to provide canceled checks for the rental payments because the majority of the payments
were paid in cash.




                                                27
HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3A, states that the payment history of the
borrower’s housing obligations holds significant importance in evaluating credit. The lender
must determine the borrower’s payment history of housing obligations through either the credit
report, verification of rent directly from the landlord (with no identity of interest with the
borrower), or verification of mortgage directly from the mortgage servicer or through canceled
checks covering the most recent 12-month period.

HUD Handbook 4155.1, REV-5, paragraph 3, describes the documentation requirements for
each loan submitted for mortgage insurance and the specific requirements lenders must observe
in processing and underwriting FHA-insured mortgages. The lender is responsible for asking
sufficient questions to elicit a complete picture of the borrower’s financial situation. All
information must be verified and documented. Paragraph 3-1 states that the application package
must contain all documentation supporting the lender’s decision to approve the mortgage loan.
Paragraph 3-1L states that explanatory statements or additional documentation necessary to
make a sound underwriting decision are to be included in the case binder.




                                              28
APPENDIX C

         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




                          29
Ref to OIG Evaluation   Lender Comments




                         30
Ref to OIG Evaluation   Lender Comments




Comment 1




Comment 2




                         31
Ref to OIG Evaluation   Lender Comments




Comment 3




                         32
Ref to OIG Evaluation   Lender Comments




Comment 4




Comment 5


Comment 6



Comment 7




Comment 8




                         33
Ref to OIG Evaluation   Lender Comments




Comment 9




Comment 10




                         34
Ref to OIG Evaluation   Lender Comments




Comment 11




                         35
Ref to OIG Evaluation   Lender Comments




Comment 12




Comment 13




Comment 14




                         36
Ref to OIG Evaluation   Lender Comments




Comment 15



Comment 16




Comment 17




                         37
Ref to OIG Evaluation   Lender Comments




Comment 18




Comment 19




                         38
Ref to OIG Evaluation   Lender Comments




Comment 20




                         39
Ref to OIG Evaluation   Lender Comments




                         40
Ref to OIG Evaluation   Lender Comments




                         41
Ref to OIG Evaluation   Lender Comment




                         42
Ref to OIG Evaluation   Lender Comments




                         43
Ref to OIG Evaluation   Lender Comments




                         44
Ref to OIG Evaluation   Lender Comments




Comment 21




                         45
Ref to OIG Evaluation   Lender Comments




                         46
Ref to OIG Evaluation   Lender Comments




Comment 22




                         47
Ref to OIG Evaluation   Lender Comments




                         48
Ref to OIG Evaluation   Lender Comments




Comment 23




                         49
Ref to OIG Evaluation   Lender Comments




Comment 24




                         50
Ref to OIG Evaluation   Lender Comments




Comment 25




                         51
Ref to OIG Evaluation   Lender Comments




                         52
Ref to OIG Evaluation   Lender Comments




Comment 26




                         53
Ref to OIG Evaluation   Lender Comments




Comment 27




                         54
Ref to OIG Evaluation   Lender Comments




Comment 28




                         55
Ref to OIG Evaluation   Lender Comments




                         56
Ref to OIG Evaluation   Lender Comments




Comment 29




                         57
Ref to OIG Evaluation   Lender Comments




                         58
Ref to OIG Evaluation   Lender Comments




Comment 30




                         59
                         OIG’s Evaluation of Lender Comments

Comment 1   For loan number 105-3017718, Birmingham stated that it calculated the
            borrower’s income by using $9 per hour, the rate shown on his most recent pay
            stub, times 40 hours per week. Further, Birmingham asserted that the borrower’s
            work was not seasonal but the business fluctuated with the economy. As stated in
            our review, we disagreed with Birmingham’s calculations because the borrower’s
            income was not stable and he did not always work 40 hours each week.
            Therefore, we calculated the borrower’s average monthly income based on his
            income for the most recent 12-month period. The borrower’s employer told us
            that the borrower’s income was subject to seasonal influences. In other words,
            the income was not the same every week, and it varied based on business
            conditions. As the stability of income was questionable and it was not the same
            every week, Birmingham’s underwriter should have taken the average monthly
            income for the most recent 12-month period. Birmingham stated that the income
            was low in 2006 because the borrower missed work due to an injury. However,
            the borrower’s loan file did not indicate that this was the case.

Comment 2   For loan number 151-8410864, Birmingham asserted that we used the wrong date
            from which to calculate income and stated that the borrower’s hire date was May
            1, 2007, but the start date was June 12, 2007. Birmingham based its calculation
            on the assumption that the borrower earned $9,558 over a 3.5-month period.
            According to the borrower’s loan file, the employment start date was May 1,
            2007, and we used this date to calculate the average monthly income. We based
            our calculations on the assumption that $9,558 was earned over a 5-month period.
            After we received Birmingham’s comments, we contacted the borrower’s
            employer, who told us that the borrower started employment on May 1, 2007, as a
            part-time employee and his status changed to full-time employment on June 12,
            2007.

Comment 3   For loan number 093-6128495, Birmingham stated that the verification of rent
            showed that the lease was in both the borrower’s and coborrower’s names and
            they paid as required by the lease. We disagree. During our review, we found
            that the verification of rent did not show that the lease was in both the borrower’s
            and coborrower’s names. The coborrower’s name was listed on the verification
            of rent by Birmingham as part of the information to be verified. Further, the
            canceled checks for the rent supported that the payments were made by the
            borrower only. There was no lease agreement in the loan file supporting that the
            coborrower was part of the rental property.

            Birmingham provided documentation from the closing agent, a copy of the
            cashier’s (teller) check for $3,129. The check was payable to the Department of
            Revenue, State of Colorado. We accepted the documentation verifying that the
            liabilities were satisfied and revised the memorandum report.




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Comment 4   For loan number 105-3017718, Birmingham agreed that the underwriter did not
            include the child support payments but asserted that the ratios were still
            acceptable based on Birmingham’s income calculations. We disagree and did not
            accept Birmingham’s calculation of income. The combination of our income
            calculations and unreported liability increased the total monthly fixed payment-to-
            income ratio from 33.31 to 50.963 percent, exceeding HUD’s qualifying ratio.

Comment 5   For loan number 105-3017718, Birmingham asserted that the ratios were
            acceptable based on its calculations. As explained in our response to comment 4,
            the ratios were not acceptable.

Comment 6   For loan number 263-3870605, Birmingham asserted that its underwriter wrote
            “housing decreasing” on the mortgage credit analysis worksheet as a
            compensating factor. Birmingham explained that according to the verification of
            rent, the borrower’s housing expense was going down by $220. We disagree with
            the compensating factor because the verification of rent was questionable. As
            explained in our individual loan review, the loan file contained two verifications
            of rent. One reported the borrower’s rental payment as $1,000 for the past 11
            months, and another reported the rental payment as $850 for the previous 12
            months. Both verifications were signed on the same date and by the same
            individual, but one was for a property in California and the other for a property in
            Mississippi. They were also faxed from the borrower’s employer. Birmingham
            did not obtain independent verifications, such as cancelled checks or receipts of
            the rental payments.

Comment 7   For loan number 263-3922022, Birmingham stated that the slightly higher ratio
            was compensated by stable employment and overtime not used in the borrower’s
            income. In our individual loan review, we stated that Birmingham should not
            have used the unsubstantiated rental income of $216 from the mobile home to
            calculate the borrower’s gross income. Using the borrower’s average monthly
            income, without the rental income, would increase the borrower’s mortgage
            payment-to-income ratio from 33.779 to 37.517 percent. HUD’s acceptable ratio
            is 31 percent.

Comment 8   For loan number 262-1681931, Birmingham stated that it was only required to
            verify the current balance because the loan was approved through the automated
            system. We disagree. According to the FHA Total Mortgage Scorecard User
            Guide, the entire loan package must meet all FHA requirements except for those
            specifically excluded. FHA requires adherence to all eligibility rules and the
            documentation requirements as described in HUD Handbook 4155, REV-5. In
            our review, we stated that Birmingham did not obtain an explanation of the source
            of three recent large deposits of $4,337, $4,237, and $3,700 into the borrower’s
            account. These funds were the source of borrower’s downpayment.

Comment 9   For loan number 263-3870605, Birmingham asserted that the source of funds was
            cash on hand because the application signed by the borrower on March 16, 2006,

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              showed that the source of funds for closing was cash on hand and a tax refund.
              Birmingham also claimed that a check from HSBC for $6,171 was provided to the
              underwriter by the third-party loan correspondent and would have been explained
              to the underwriter as a tax advance loan. Birmingham did not explain why the
              borrower did not provide a copy of either the tax return or his tax refund check to
              verify a tax refund of $6,171.

Comment 10 For loan number 093-6128495, based on the evidence provided by Birmingham
           that the gift funds were sent directly to the closing agent, we excluded it as a
           material deficiency and revised our memorandum report.

Comment 11 For loan number 261-9071686, Birmingham stated that this loan was originated
           by a third-party broker and the documentation provided to it seemed perfectly
           legitimate. Birmingham provided a copy of the gift check and a gift letter. The
           borrower identified that the gift donor was her cousin. These documents were in
           the loan file, and we reviewed them. Birmingham did not provide any new
           documentation. As explained in our review, Birmingham’s underwriter did not
           verify that the gift funds came from an acceptable source. Both loan applications
           (initial and final) showed that the borrower’s source of the downpayment and/or
           closing costs was her checking/savings account. The borrower told us that the gift
           donor was not her cousin but the seller of the property.

Comment 12 For loan number 093-6128495, Birmingham asserted that the verification of rent
           showed that the lease was in both the borrower’s and coborrower’s names and
           paid as required by the lease. The verification of rent did not show that the lease
           was in both the borrower’s and coborrower’s names. The coborrower’s name was
           listed on the verification of rent by Birmingham as part of the information to be
           verified. Further, the canceled checks for the rental payments supported that the
           payments were made by the borrower only. There was no lease agreement in the
           file supporting that the coborrower was part of the rental property.

Comment 13 For loan number 105-3017718, Birmingham provided additional documentation
           from county records, pictures of the rental property, and a statement from the
           landlord verifying that the rental properties existed and the verifications of rent
           were proper. We accepted Birmingham’s documentation and removed the
           deficiency regarding the borrower’s credit history. However, Birmingham did not
           provide an explanation regarding the coborrower’s poor credit including several
           unpaid collections and recent credit inquiries.

Comment 14 For loan number 263-3922022, Birmingham asserted that our statement that 2
           rent-to-own loans were late 7 and 18 times, respectively, was misleading because
           they were not 30-day late payments but were only late from the due date. We
           cited what the creditor reported on the verification document.

Comment 15 For loan number 201-3487218, Birmingham stated that it had independent
           verification of rent from the landlord and the credit bureau. This information was

                                              62
              in the loan file, and we reviewed it. However, Birmingham did not address the
              material deficiency noted in our review. We stated that the seller was an identity
              of interest in the real estate transaction because the seller was also the landlord.
              Therefore, Birmingham should have obtained additional documentation from the
              borrower to prove that a rental agreement existed and residency at the property
              had been established for at least 6 months. A residency of 6 months is required
              for identity-of-interest transactions for financing above the 85 percent loan-to-
              value ratio.

Comment 16 For loan number 261-9009876, we disagree with Birmingham’s explanation that
           the rental and address history was properly documented by the borrower’s
           affidavit and verification of rent. As cited in our review, these documents did not
           resolve the inconsistencies in the borrower’s rental history. Birmingham did not
           provide any additional documentation. Birmingham indicated that it was unable
           to obtain canceled checks or a lease agreement to support the borrower’s rental
           history.

Comment 17 See comment 13.

Comment 18 Birmingham disagreed with our statement that there was a lack of due diligence
           on the part of its underwriters. The results of our review outlined in this report
           show that Birmingham’s underwriters did not use due diligence to underwrite the
           nine loans.

Comment 19 Birmingham believes that our recommendations for remedies under the Program
           Fraud Civil Remedies Act and administrative action are not appropriate. We did
           not change our recommendations because the recommendations are appropriate
           based on the issues cited in the memorandum. Violations of FHA rules are
           subject to civil and administrative action. The appropriateness of the civil money
           penalties will be determined by HUD.

Comment 20 Birmingham stated that according to the prior audits and reviews performed by
           OIG and HUD, all loans were underwritten according to FHA’s guidelines. In
           our review, we did not evaluate the prior audits or reviews.

Comment 21 Based upon the documentation provided by Birmingham, we removed this loan as
           a materially deficient loan from this memorandum report.

Comment 22 See comments 4 and 13.

Comment 23 See comment 2.

Comment 24 See comment 15.

Comment 25 For loan number 261-9009876, Birmingham provided documentation from the
           closing agent verifying that all conditions cited in our review were met and the

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              funds were sent directly to the agent. As a result, we removed this as material
              deficiency.See comment 16.

Comment 26 See comment 11.

Comment 27 See comment 8.

Comment 28 See comments 6 and 9.

Comment 29 See comments 7 and 14.

Comment 30 For loan number 263-3938261, Birmingham stated that the landlord was also the
           seller of the property and the borrower paid rent in cash. Birmingham further
           stated that rather than reject a borrower for paying cash, Birmingham’s policy was
           to put no weight on the verification of rent, and it did not consider the verification
           of rent to be a material document for the underwriting decision. Birmingham
           should have put weight on the verification of rent because the payment of the
           borrower’s housing obligations holds significant importance in evaluating credit.
           Birmingham’s response did not address the inconsistencies cited in our review.
           The borrower’s application reported that the rent was $600 per month, and the
           verification of rent showed a rent of $930 per month. In addition, the loan officer
           provided a certification on behalf of the borrower, stating that the borrower was
           unable to provide canceled checks for the rental payments because a majority of
           the payments were made in cash. Birmingham should have explained why this
           certification did not come from the borrower. Neighborhood Watch showed that
           the borrower did not make any mortgage payments before foreclosure.




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