oversight

FHA Delayed Sending Violation Notices to Lenders That Did Not Meet Recertification Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-08-06.

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

                                                                  Issue Date
                                                                               August 6, 2010
                                                                   
                                                                  Audit Report Number
                                                                               2010-KC-0002




TO:        Vicki Bott, Deputy Assistant Secretary for Single Family Housing, HU

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

SUBJECT: FHA Delayed Sending Violation Notices to Lenders That Did Not Meet
           Recertification Requirements


                                     HIGHLIGHTS

 What We Audited and Why

             In response to a congressional request, we audited the Federal Housing
             Administration (FHA) Title II single-family lender renewal process. The
             objective of the audit was to determine whether FHA ensured that lenders
             submitted recertification forms, annual fees, and audited financial statements in a
             timely manner.


 What We Found


             FHA did not ensure that lenders submitted recertification forms, annual fees,
             and/or audited financial statements in a timely manner. The Lender Approval and
             Recertification Division (Division) did not promptly issue notices of violation to
             lenders that did not submit required annual recertification documentation and/or
             fees when due.
What We Recommend


           We recommend that the Office of Lender Activities and Program Compliance
           require the Division to revise the recertification process to discontinue issuing
           notices of deficiency and issue notices of violation promptly for all lenders that do
           not submit or attempt to submit one or more of the required items by the due date.
           For each recommendation without a management decision, please respond and
           provide status reports in accordance with U.S. Department of Housing and Urban
           Development (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 the discussion draft to HUD on June 15, 2010, and requested a
           response by July 15, 2010. HUD provided a response on July 21, 2010. HUD
           formally disagreed with our finding. The complete text of the response, along
           with our evaluation of that response, can be found in appendix A of this report.




                                             2
                            TABLE OF CONTENTS


Background and Objective                                                          4


Results of Audit

Finding: The Division Delayed Sending Violation Notices to Lenders That Did Not   7
         Meet Recertification Requirements


Scope and Methodology                                                             11



Internal Controls                                                                 13


Appendixes
   A. Auditee Comments and OIG’s Evaluation                                       14




                                            3
                       BACKGROUND AND OBJECTIVE


The Federal Housing Administration’s (FHA) mortgage insurance programs help low- and
moderate-income families become homeowners by lowering some of the costs of their mortgage
loans. FHA mortgage insurance encourages lenders to make loans to otherwise creditworthy
borrowers who might not be able to meet conventional underwriting requirements by protecting
the lender against default.

Title II of the National Housing Act, Section 203(b) is FHA’s One- to Four-Family Mortgage
Insurance Program. It expands homeownership opportunities for first-time home buyers and
other borrowers who would not otherwise qualify for conventional mortgages on affordable
terms, as well as for those who live in underserved areas where mortgages may be harder to get.
These obligations are protected by FHA’s Mutual Mortgage Insurance Fund, which is sustained
entirely by borrower insurance premiums.

The number of lenders participating in the FHA program has recently increased. This increase
can be attributed to the turmoil in the financial industry and reduced availability of conventional
credit. The following chart shows the changes in the number of lenders participating in the FHA
program from 8,401 in 2006 to 12,232 in 2009. During 2009, these lenders originated more than
two million in loans worth more than $376 billion.



                                    Title II FHA lenders
      14,000

      12,000

      10,000

       8,000
                                                                                         2006
       6,000                                                                             2007

       4,000                                                                             2008
                                                                                         2009
       2,000

           0
               Nonsupervised  Nonsupervised    Supervised  Supervised loan    Total
                mortgagee          loan        mortgagee correspondent
                              correspondent




                                                   4
To maintain status as an FHA-approved lender, lenders must electronically submit a yearly
verification report and pay an annual fee for their main and registered branch offices. This
action must be completed within 30 days of the lender’s fiscal yearend date. Further, lenders are
required to electronically submit annual audited financial statements that meet the requirements
of the Secretary of Housing and Urban Development within 90 days of the lender’s fiscal
yearend date. The lender’s auditor must verify that the information submitted accurately reflects
the paper copy of the statements.

The Office of Lender Activities and Program Compliance oversees the Lender Approval and
Recertification Division (Division). The Division is responsible for reviewing recertification
items and referring noncompliant lenders to the Mortgagee Review Board (MRB) for possible
sanctions. The Division begins this legal process by preparing notices of violation on behalf of
the MRB. The HUD Reform Act of 1989 (12 USC § 1708) established the MRB, and the Code
of Federal Regulations (24 CFR Part 25) outlines its duties and procedures. FHA-approved
lenders who knowingly and materially violate FHA program statutes, regulations, and handbook
requirements are subject to administrative sanctions by the MRB.

Before 2008, the Division had authority to withdraw lenders for failure to comply with FHA’s
annual recertification requirements. The Division lost this authority due to a 2007 administrative
hearing ruling. The hearing involved a lender that was withdrawn from the FHA program by the
Division for not submitting its audited financial statements on time, although there were
extenuating circumstances. The U.S. Department of Housing and Urban Development (HUD)
lost this hearing because the lender was not given due process.

In fiscal year 2009, the Federal Housing Commissioner issued mortgagee letters that changed the
annual lender recertification process:

   Mortgagee Letter 2009-01 informed lenders that if they failed to complete the recertification
    requirements in an acceptable, timely manner, they would be brought before the MRB.
   Mortgagee Letter 2009-25 became effective September 1, 2009, and required FHA-approved
    lenders seeking renewal to complete the electronic annual certification in FHA Connection.
   Mortgagee Letter 2009-31 implemented the Helping Families Save Their Homes Act of
    2009, enacted on May 20, 2009. The letter included additional standards that an FHA
    program participant must meet and required notification of these standards after approval. It
    also expanded FHA’s ability to seek civil money penalties against any owners, officers, or
    directors of an FHA-approved lender for violations of program requirements. It further
    required that all supervised lenders submit an annual audited financial statement within 90
    days of their fiscal yearend.

On April 20, 2010, HUD published the final rule change for the lender approval and
recertification process. As of May 20, 2010, only mortgagees will be required to obtain FHA
approval and recertification. Loan correspondents will continue to be authorized to participate in
the origination of loans through association with an approved mortgagee, but these entities no
longer will be subject to the FHA lender approval process.




                                                5
Because of the rule change, FHA added 30 days to the fiscal yearend December 31, 2009, loan
correspondents’ audited financial statement due date. These loan correspondents must continue
to comply with existing requirements for the submission of their annual certifications and
renewal fees.

Our audit objective was to determine whether FHA ensured that lenders submitted recertification
forms, annual fees, and audited financial statements in a timely manner.




                                               6
                                RESULTS OF AUDIT


Finding: The Division Delayed Sending Violation Notices to Lenders
That Did Not Meet Recertification Requirements
The Division did not promptly issue notices of violation to lenders that did not submit required
annual recertification documentation and/or fees when due. This condition occurred because the
Division’s process for handling noncompliant lenders was not adequate. As a result, FHA
insured loans made by noncompliant lenders, putting the insurance fund at risk.




 The Division Delayed Sending
 Violation Notices to Lenders


              The Division delayed issuing notices of violation to lenders that did not submit
              required annual recertification documentation and/or fees when due. These
              notices inform lenders that the MRB is considering administrative sanctions for
              noncompliance with FHA’s annual recertification requirements. Instead of
              issuing the notices of violation as soon as the recertification submissions were
              overdue, the Division issued them 7 months after the recertification due date.

              The regulations at 24 CFR (Code of Federal Regulations) 202.3(b) state,
              “Recertification. On each anniversary of the approval of a lender or mortgagee,
              the Secretary [of HUD] will determine whether recertification, i.e., continued
              approval, is appropriate. The Secretary will review the yearly verification report
              required by §202.5(n)(2) and other pertinent documents, ascertain that all
              application and annual fees have been paid, and request any further information
              needed to decide upon recertification.”

              The regulations at 24 CFR 25.6 provide the MRB regulations for lender renewal
              compliance. The regulations state the failure of a mortgagee to submit its
              required annual audit report of its financial condition within 90 days of the close
              of its fiscal year, unless an extension is granted, creates grounds for administrative
              action. In addition, a failure to comply with any certification or condition of
              approval also creates grounds for administrative action. This includes the annual
              submission of the certification form and annual fees within 30 days of the end of
              the lender’s fiscal year. The late submission of the recertification, fee payments
              and/or annual audit report constitutes a false certification and is therefore subject
              to administrative action.




                                                7
           Lenders with fiscal years ending on December 31, 2008, were required to submit
           annual recertification forms and fees by January 31, 2009. Additionally,
           nonsupervised lenders were required to submit annual financial statements by
           March 31, 2009. However, more than 5,000 of the 8,000 lenders with a
           December 31, 2008, fiscal yearend date submitted one or more of the annual
           recertification documents and/or fees late or not at all. The following chart shows
           the percentage of recertification items that were on time, late, or not submitted.

                      Annual submission of recertification items
                      for lenders with a December 2008 yearend
            100%
             90%
             80%
             70%
             60%
                                                                                  Timely
             50%
             40%                                                                  Late
             30%                                                                  Still missing
             20%
             10%
              0%
                    Verification form     Fee payment       Audited financials


The Division’s Process Was Not
Adequate

           The Division’s process for managing lenders with overdue recertification
           submissions was not adequate to ensure compliance with the recertification
           requirements. In an attempt to reduce the number of lenders with late
           submissions, the Division sent a notice of deficiency to the 2,394 lenders that did
           not submit the required documents and/or fees 4 months after the recertification
           submission due date. The notice of deficiency informed lenders that they had 30
           days to cure the deficiency or they would be referred to the MRB for sanctions.
           The Division was not required to send the notices of deficiency and only 469 of
           the 2,394 lenders cured within 30 days of the notice.

           Three months after the notifications of deficiency were sent, the Division sent
           notices of violation to the remaining 1,102 lenders that failed to cure the
           deficiency. The notice of violation gives the lender 30 days to provide a response.
           Thirty nine of those lenders completed the submission requirements within 30
           days of receiving the notice, thereby curing the deficiency. The Division did not
           have any policies or procedures addressing when the notices should be issued.
           The process used by the Division is depicted in the chart below.



                                            8
Insured Loans Made by
Noncompliant Lenders Put the
Insurance Fund at Risk


                The Division’s delay in issuing notices of violation on behalf of the MRB allowed
                the noncompliant lenders to originate FHA loans for an additional 7 months.
                During this period, these noncompliant lenders originated 7,107 FHA-insured
                loans worth almost $1.4 billion.

                The noncompliant lenders had higher default and claim rates than the national
                average. We analyzed the default and claim rates for lenders that received a
                notice of violation for failure to submit one or more of the required items. As
                shown below, the noncompliant mortgagees had an average default rate that was
                almost twice as high as the national rate.


                                                  Average default and claim percentage
          National           Noncompliant
          average                       lenders




                                                          Mortgagees

                                                  Loan correspondents



                                                          Mortgagees

                                                  Loan correspondents

                                                                        0%       2%   4%   6%   8%




                                                                             9
          If the Division had issued the notices of violation in a timely manner, the
          noncompliant lenders would have been sanctioned sooner, limiting the exposure
          of the FHA fund to loans from these risky lenders.

Recommendation

          We recommend that the Office of Lender Activities and Program Compliance
          require the Division to

          1A.    Revise the recertification process to discontinue issuing notices of
                 deficiency and issue notices of violation promptly for all lenders that do
                 not submit or attempt to submit one or more of the required items by the
                 due date.




                                          10
                         SCOPE AND METHODOLOGY


We performed an audit of the FHA single-family annual lender approval process in response to a
congressional request. Among other items, the request wanted to know what challenges FHA
was facing in enforcing its own rules. On September 30, 2009, we issued Audit Report Number
2009-SE-0004, Controls over FHA’s Single-Family Lender Approval Process Need
Improvement. Based on the report findings, we decided to audit the lender annual recertification
process. Our audit covered 8,080 Title II lenders with December 2008 fiscal yearends that were
required to submit annual recertification items. We conducted our fieldwork from October 2009
through April 2010 at the Division in Washington, DC, and in our office.

To accomplish our objective, we

      Reviewed applicable laws and regulations,
      Interviewed appropriate Division and Office of General Council staff,
      Examined MRB meeting documents, and
      Analyzed lender data contained in Single Family Housing Enterprise Data Warehouse
       (SFHEDW), Neighborhood Watch, Institutional Master File (IMF), and Lender
       Assessment SubSystem (LASS).
We gained an understanding of the lender recertification process and procedures by interviewing
HUD staff and reviewing the laws and regulations affecting FHA lenders’ annual recertification.
We were informed of an administrative law judge ruling, HUDALJ 07-052-MR, that resulted in
the Division’s losing its authority to sanction FHA lenders, requiring all noncompliant lenders to
go before the MRB. We reviewed this case law, notices sent to lenders not complying with
annual renewal requirements, and MRB actions taken against these lenders.

We determined the December 2008 fiscal yearend lenders that did not submit the required items
timely by using data provided by the Division from LASS and IMF. The LASS data contained
lenders’ audited financial statement data including submission dates. The IMF data contained
verification form submission dates as well as fee payment dates and amounts. The lender fee
payment and financial statement submission dates were system generated, while the verification
form submission dates were entered by Division staff. We combined these data files using a
database application. We examined the data to determine whether FHA lenders submitted the
required annual recertification form, fee, and audited financial statements in a timely manner.
We prepared a graph using the combined data that showed the percentage of lenders that were
late for each of the three recertification items.

We assessed the reliability of the LASS and IMF data by performing electronic testing for errors
in accuracy and completeness. We removed discrepancies, such as inaccurate submission dates
and lenders not required to recertify, from the data before our analysis. We considered the
submission dates sufficiently reliable in determining the timeliness of lender submissions.




                                                11
We determined the amount of risk associated with December 2008 fiscal yearend lenders that
received a notice of violation. We obtained data from SFHEDW and Neighborhood Watch to
establish the activity level and performance of FHA lenders that did not meet deadlines. We
used 7 months of SFHEDW data to determine the total number and value of loans originated by
noncompliant lenders between March 31 and October 23, 2009. We used the 2 year default and
claim rate Neighborhood Watch data as of March 31, 2009, to determine default and claim rates
for noncompliant lenders. We created a graph to show noncompliant lenders and total lenders
default and claim rates in the report. We did not assess the reliability of the data as the data were
only used to demonstrate the potential impact of the finding.

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
objective. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                                 12
                              INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following controls are achieved:

      Program operations,
      Relevance and reliability of information,
      Compliance with applicable laws and regulations, and
      Safeguarding of assets and resources.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. They include the processes and procedures for planning,
organizing, directing, and controlling program operations as well as the systems for measuring,
reporting, and monitoring program performance.




 Relevant Internal Controls
              We determined that the following internal control was relevant to our audit
              objective:

                 Policies and procedures to prevent ineligible lenders from continuing to
                  participate in the FHA program.

              We assessed the relevant control identified above.

              A significant weakness exists if management controls do not provide reasonable
              assurance that the process for planning, organizing, directing, and controlling
              program operations will meet the organization’s objectives.


 Significant Weaknesses


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

                 HUD allowed lenders to continue conducting FHA business while in
                  noncompliance with recertification requirements.




                                               13
                        APPENDIXES

Appendix A
        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation      Auditee Comments




Comment 1




                            14
Ref to OIG Evaluation   Auditee Comments




Comment 2




Comment 3
Comment 1




                         15
Ref to OIG Evaluation                Auditee Comments




Comment 4




Comment 5




Comment 6




                        OIG Evaluation of Auditee Comments



                                       16
Comment 1: FHA is still delaying sending out violation notices to lenders that do not meet
           recertification requirements. The Division has not sent out notices of violation for
           December 2009 lenders that did not submit timely recertification items as of the
           date of this report. The Division sent out notices of deficiency for these lenders in
           June of 2010 even though these notices are not legally required for due process.

Comment 2: The regulations at 24 CFR § 25.2(b)(1) state the MRB can authorize the Division
           to take nondiscretionary action against lenders.

Comment 3: We agree that FHA has taken proactive measures to streamline the process.
           However it has not significantly affected the time to issue the notices of violation.

Comment 4: The Division already provides lenders with reminders 60, 30, and 15 days prior to
           the recertification due date. Thus lenders that do not submit the recertification
           items timely are clearly noncompliant with FHA annual recertification
           requirements, including the requirements in the lenders’ annual on-line
           certification.

Comment 5: Lenders are given 3 reminders prior to the recertification date deadlines. Lenders
           ignoring these reminders are already demonstrating an unwillingness to conform
           to the recertification requirements. Noncompliant lenders are subject to
           administrative action by the MRB in accordance with 24 CFR 25.6.
           Sending NODs to the noncompliant lenders is unnecessary, does not serve as an
           effective deterrent, and delays referral to the MRB.

Comment 6: FHA did not disagree with any factual data included in our report.




                                               17