oversight

National Bank of Kansas City, Overland Park, KS, Did Not Follow HUD's Underwriting and Quality Control Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-06-04.

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

                                                                Issue Date
                                                                         June 4, 2010
                                                                 
                                                                Audit Report Number
                                                                             2010-KC-1005




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

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


SUBJECT: National Bank of Kansas City, Overland Park, KS, Did Not Follow HUD’s
           Underwriting and Quality Control Requirements


                                   HIGHLIGHTS

 What We Audited and Why

             We audited National Bank of Kansas City (National Bank) because its 2-year
             default ratio for sponsored loans was more than three times (339 percent) the
             sponsored average for the 2 years ending September 30, 2009. We reviewed 16
             Federal Housing Administration (FHA) loans underwritten by National Bank and
             National Bank’s quality control program.

             Our audit objectives were to determine whether National Bank followed FHA
             requirements for (1) borrower eligibility and creditworthiness and property
             eligibility when underwriting loans and (2) implementing a quality control
             program.

 What We Found


             National Bank did not follow the U.S. Department of Housing and Urban
             Development’s (HUD) requirements regarding income, liability, and asset
             determination in 4 of the 16 defaulted loans reviewed. These loans had material



                                             1
           underwriting deficiencies that affected the insurability of the loans. National
           Bank also did not comply with HUD’s quality control requirements. Specifically,
           its plan lacked elements required by HUD, and it did not ensure that its quality
           control reviews met HUD requirements.

What We Recommend


           We recommend that the Deputy Assistant Secretary for Single Family Housing –
           Federal Housing Commissioner require National Bank to indemnify HUD for two
           actively insured loans with unpaid principal balances totaling more than $385,600
           and future losses on two loans with unpaid principal balances totaling more than
           $280,800. Also, we recommend that HUD verify that National Bank provides its
           underwriters with additional training on its new procedures and properly performs
           its quality control function.


           For each recommendation without a management decision, please respond and
           provide status reports in accordance with HUD Handbook 2000.06, REV-3.
           Please furnish us copies of any correspondence or directives issued because of the
           audit.

Auditee’s Response


           We provided the draft report to National Bank on May 6, 2010 and requested a
           response by May 21, 2010. It provided written comments on May 20, 2010.

           The complete text of the auditee’s response, along with our evaluation of that
           response, can be found in appendix B of this report.




                                            2
                             TABLE OF CONTENTS

Background and Objectives                                                         4

Results of Audit
        Finding 1: National Bank Did Not Follow HUD’s Underwriting Requirements   5
        for Four FHA Loans
        Finding 2: National Bank Did Not Comply With HUD’s Quality Control        8
        Requirements

Scope and Methodology                                                             10

Internal Controls                                                                 11



Appendixes
   A.   Schedule of Questioned Costs and Funds To Be Put to Better Use            12
   B.   Auditee Comments and OIG’s Evaluation                                     13
   C.   Criteria                                                                  16
   D.   Schedule of Significant Underwriting Deficiencies                         20
   E.   Case Studies for Four Questioned Loans                                    21
   F.   Quality Control Plan Missing Elements                                     25




                                             3
                     BACKGROUND AND OBJECTIVES

National Bank of Kansas City (National Bank) is a supervised direct endorsement lender based in
Overland Park, KS. There are two types of approved direct endorsement mortgagees-supervised
and nonsupervised. A supervised mortgagee is an FHA-approved financial institution that is a
member of the Federal Reserve System or an institution whose accounts are insured by the Federal
Deposit Insurance Corporation or the National Credit Union Administration. A nonsupervised
lender is an FHA-approved lending institution that has as its principal activity the lending or
investment of funds in real estate mortgages. National Bank received approval from the Federal
Housing Administration (FHA) on February 18, 1992. It previously had branch offices in
Springfield, MO; Topeka, KS; and Tempe, AZ. However, these branches ceased operations in
September 2008 since National Bank wanted to centralize their loan operations in one location.

From October 1, 2007, through September 30, 2009, National Bank originated 320 sponsored loans
and 1,372 retail loans. For National Bank’s sponsored loans, outside brokers often gathered the
borrower’s loan information and provided it to National Bank for loan underwriting. These loans
were later sold to National Bank’s investment partners. For the retail loans, all loan origination
processes are handled exclusively by National Bank employees. The compare ratio for National
Bank’s sponsored loans that defaulted within the first 2 years was 337 percent. However, the
compare ratio for National Bank’s retail loans that defaulted within the first 2 years was only 51
percent. The compare ratio is a comparison of the lender’s default rates with other lenders in a
geographic area as defined by the U. S. Department of Housing and Urban Development (HUD).

National Bank had two separate divisions originating its sponsored and retail loans. During
2007, National Bank opened a wholesale (sponsored) business lending unit, New Vision
Residential Lending. However, it decided to terminate the business activities of New Vision
Residential Lending in February 2008. The mortgage division responsible for originating retail
loans is still in business.

Our audit objectives were to determine whether National Bank followed FHA requirements for
(1) borrower eligibility and creditworthiness and property eligibility when underwriting loans
and (2) implementing a quality control program.




                                                4
                                 RESULTS OF AUDIT

Finding 1: National Bank Did Not Follow HUD’s Underwriting
Requirements for Four FHA Loans
National Bank did not follow HUD’s underwriting requirements while underwriting four FHA
loans. This condition occurred because National Bank did not have adequate procedures and
policies in place. As a result, the lender placed the insurance fund at unnecessary risk for more
than $671,550 in mortgages.



 Underwriting Did Not Meet
 HUD Standards

               National Bank did not follow HUD’s underwriting requirements for 4 of the 16
               loans reviewed. We found five material deficiencies in the four loans. The
               following table summarizes the material deficiencies identified.

                                 Material deficiency       Number of loans
                                      Income                    3
                                     Liabilities                1
                                       Assets                   1

               Appendix C, criterion 16-23, contains the criteria applicable to the material
               deficiencies. Appendix D contains a schedule of the material deficiencies, mortgage
               amounts, and the unpaid principal balances identified in each of the four loans.
               Appendix E contains detailed narratives for each of the loans.

               Income
               National Bank did not properly evaluate the income amount for three of the four
               loans. Lenders may not use income in evaluating the borrower’s loan that it cannot
               verify, is not stable, or will not continue.

               For example, in FHA case number 441-8260266, National Bank overstated the
               borrower’s total monthly income by $1,103. First, the lender estimated the
               borrower’s base monthly income as $2,047. However, the borrower’s base monthly
               income was $1,560 in 2008, $2,698 in 2007, and $3,036 in 2006. The borrower’s
               average monthly base income decreased approximately $1,138 from 2007 to 2008
               and $338 from 2006 to 2007. The lender did not establish a stable income trend
               supporting the borrower’s rate of pay at the time of the loan closing. Also, there was
               nothing in the loan file to indicate whether the borrower’s position was seasonal.
               The borrower’s base monthly employment income should only have been calculated
               as $1,560, $487 less than that used by the lender.


                                                 5
           Also, the lender determined that the borrower should include $616 in unemployment
           compensation as monthly income. It based this amount on the borrower’s having
           received unemployment compensation in 2007 and 2006. However, there was
           nothing in the loan file to indicate that the borrower received this type of
           compensation in 2008 and no documentation to show reasonable assurance of its
           continuance. Since the $616 in unemployment compensation should have not been
           included as income and the borrower’s base monthly income should have been $487
           less, the borrower’s monthly income was overstated by $1,103.

           Liabilities
           National Bank understated the borrower’s liabilities for one loan. In this case, the
           lender did not include a recurring monthly payment of $398. HUD requires
           lenders to consider all recurring obligations, contingent liabilities, and projected
           obligations that meet HUD’s specific stipulations when evaluating a loan
           application.

           Assets
           National Bank did not properly verify the assets used to close one loan. The
           HUD-1 settlement statement showed that the borrower paid $7,631in closing
           costs. The verification of deposit showed a savings account balance of $17,511.
           However, the savings account statement listed large deposits of $1,000, $11,077,
           and $1,600 with no explanations for the source of those funds.

           HUD 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.


Adequate Underwriting
Procedures Were Not in Place

           National Bank did not have adequate procedures in place. Although it used an
           FHA loan approval checklist and income calculations worksheet, it did not
           provide adequate guidance concerning income trend analysis and asset
           verification to its underwriters.

           During our review, National Bank showed us that it recently took several actions
           to improve its asset verification process. First, it added a step in its loan approval
           checklist to remind underwriters to verify large deposits. Second, it now requires
           its underwriters to document the source of any deposit over $1,000.

           All of the loans that we questioned due to material deficiencies closed before the
           above actions took place. Although these actions were noteworthy, additional




                                             6
           training on these new procedures would improve National Bank’s underwriting
           process.


Loans Placed the FHA
Insurance Fund at Unnecessary
Risk of Loss

           National Bank placed the FHA insurance fund at an increased risk of loss on four
           loans with original mortgage amounts totaling more than $671,550. Two loans
           were in claims, and two were still active.


Recommendations


           We recommend that the Deputy Assistant Secretary for Single Family Housing
           require National Bank to

           1A. Indemnify HUD for two actively insured retail loans with unpaid principal
               balances of $385,693. The projected loss is $231,416 based on the FHA
               insurance fund average loss rate of 60 percent for fiscal year 2009.

           1B. Indemnify HUD for future losses on two sponsored loans with unpaid
               principal balances totaling $280,839 for which HUD had not sold the
               property. The projected loss is $168,503 based on the FHA insurance fund
               average loss rate of 60 percent for fiscal year 2009.

           1C. Adequately train its underwriters on its new procedures.




                                           7
Finding 2: National Bank Did Not Comply With HUD’s Quality
Control Requirements
National Bank did not comply with HUD’s quality control requirements. This noncompliance
occurred because National Bank did not properly interpret HUD’s quality control requirements.
As a result, the FHA insurance fund was placed at an increased risk of loss.



 Quality Control Plan Was
 Incomplete and Quality Control
 Reviews Were Not Adequate

              National Bank did not comply with HUD’s quality control requirements.
              Specifically, its plan lacked elements required by HUD, and it did not ensure that its
              quality control reviews met HUD requirements.

              National Bank’s quality control plan lacked 14 required elements. For example, the
              plan did not address the requirement that quality control reviews be completed
              within 90 days of closing; verify the identity of the loan applicant; include
              documented onsite reviews of branch offices; or identify patterns of early defaults
              by location, program, loan characteristic, loan correspondent, or sponsor. Appendix
              F contains the details of the 14 missing elements.

              In addition, National Bank did not ensure that its quality control reviews met HUD
              requirements. Specifically, it did not

                     Ensure that the quality control reviews included all early defaults.
                     Properly document onsite quality control reviews of branch offices.
                     Conduct onsite quality control reviews of the Topeka, KS, and Springfield,
                      MO, branch offices in 2007.
                     Semiannually check its employees against the limited denial of
                      participation/General Services Administration list.

              Appendix C, criterion 1-15, contains HUD’s specific quality control criteria.

 National Bank Did Not
 Properly Interpret HUD’s
 Quality Control Requirements

              National Bank did not properly interpret HUD’s quality control requirements. For
              example, it stated that it knew about the requirement to conduct the early payment
              default reviews and branch reviews but it did not know it had to document them.

              As a result of our review, National Bank revised its quality control plan and added
              the 14 missing elements. In addition, it developed new procedures to ensure that


                                                8
           employees are checked semiannually against the limited denial of
           participation/General Services Administration list.


There Was an Increased Risk to
the FHA Insurance Fund


           Without a properly implemented quality control program, the FHA insurance fund
           is placed at an increased risk of loss. Specifically, the lender is unable to ensure
           the accuracy, validity, and completeness of its loan origination operations. In
           addition, it may not identify potential deficiencies and make needed corrections in
           a timely manner.


Recommendation


           We recommend that the Deputy Assistant Secretary for Single Family Housing

           2A. Perform a review of National Bank’s quality control function in 6 months to
               ensure that it complies with HUD’s requirements.




                                            9
                         SCOPE AND METHODOLOGY

We performed our audit work from November 2009 through March 2010 at National Bank’s
office at 10700 Nall Avenue, Overland Park, KS. Our audit period was October 1, 2007, through
September 30, 2009.

To accomplish our objectives, we reviewed HUD’s and National Bank’s underwriting policies
and procedures. We interviewed National Bank’s management and staff. Also, we reviewed
HUD and National Bank loan files. In addition, we reviewed National Bank’s quality control
plan and quality control reviews.

National Bank had 111 defaults with a beginning amortization date between October 1, 2007,
and September 30, 2009. Of these, 74 were sponsored loans, and 37 were retail loans. Of the 74
sponsored loans, 1 had been terminated and no longer had FHA insurance. Of the 73 remaining
sponsored loans, 7 had gone to claims, and 66 were still active. At the beginning of our review,
we reviewed all seven sponsored loans in claims status with mortgage amounts totaling
$972,735. Next, we selected a sample of nine retail loans. We selected the only two loans in
claims status as of November 10, 2009. Next, we selected the only seven active loans that had
five or fewer payments made before the first 90-day default and were in default as of November
10, 2009. The total mortgage amount of the nine retail loans was nearly $1.5 million.

When identifying underwriting deficiencies, we assessed whether the deficiencies were material
and should have caused the lender to disapprove the loan. We considered deficiencies that
affected the approval and insurability of the loans as significant and recommended that HUD
take appropriate action on these loans.

We relied on computer-processed data contained in HUD’s Single Family Data Warehouse and
Neighborhood Watch systems. During the audit, we assessed the reliability of the data and
found the data to be adequate. Therefore, we concluded that the data were sufficiently reliable to
be used in meeting our objectives.

We assigned a value to the potential savings to HUD if it implements our recommendations to
require National Bank to indemnify loans with material deficiencies. For those loans for which
HUD had not yet incurred a loss, we applied FHA’s loss experience of 60 percent for fiscal year
2009 as provided by HUD. The amount reflects that, upon sale of the mortgaged property,
FHA’s average loss experience is about 60 percent of the unpaid principal balance based upon
statistics provided by HUD.

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




                                               10
                              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 controls were relevant to our audit
              objectives:

                     Controls to ensure that FHA loans meet HUD underwriting requirements.
                     Controls to ensure that the lender implements a quality control program that
                      complies with HUD requirements.

              We assessed the relevant controls identified above.

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

 Significant Weaknesses


              Based on our review, we believe that the following items are significant weaknesses:

                     National Bank did not have adequate controls in place to ensure that FHA
                      loans met HUD underwriting requirements (see finding 1).
                     National Bank did not have adequate controls in place to ensure that its
                      quality control program met HUD requirements (see finding 2).




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                                 APPENDIXES

Appendix A

             SCHEDULE OF QUESTIONED COSTS
            AND FUNDS TO BE PUT TO BETTER USE
              Recommendation                           Funds to be put
              number                                   to better use 1/
                      1A                                  $231,416
                      1B                                  $168,503

    Recommendations that funds be put to better use are estimates of amounts that could be
    used more efficiently if an Office of Inspector General (OIG) recommendation is
    implemented. These amounts include reductions in outlays, deobligation of funds,
    withdrawal of interest, costs not incurred by implementing recommended improvements,
    avoidance of unnecessary expenditures noted in preaward reviews, and any other savings
    that are specifically identified.

    Implementation of our recommendations to require National Bank to indemnify HUD for
    materially deficient loans will reduce the risk of loss to the FHA insurance fund. The
    amount above reflects that, upon sale of the mortgaged property, FHA’s average loss
    experience is about 60 percent of the unpaid principal balance based upon statistics
    provided by HUD. [$385,693 X .60=$231,416 and $280,839 X .60=$168,503]




                                          12
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                         13
Ref to OIG Evaluation                      Auditee Comments



                                             Auditee Comments

              Comment 1 Appendix E - case #251-3405672 – Issue unverified assets.
             Although it is our normal practice to document large deposits it appears that in
Comment 2    this case an exception was made due to the VOD showing a 2 month average
             balance of $17,004 with a current balance of $17,511. The large deposit of
             $11,077 was made 41 days prior to the date of the VOD. The account is not a
             new account and the required cash was $8,896 well below the average balance.

             Comment 2 Appendix E – case #292-4824038 – Issue overstatement of income.
             Issue understated liability
             Using a more conservative approach in calculating the income supports
             sufficient income for this loan when compensating factors are considered.
Comment 3    2006 W-2 shows total income of $42,298/12 = $3,533.17 per month.
             2007 W-2 shows total income of $44,586/12 = $3,715.50 per month.
             2008 pay stub thru 3/1/08 has year-to-date income of $7,884/2 = $3,942 a month.
             Last 24 months equals (2 x 3658 + 12 x 3715.50 + 10 x 3533.17 = $87,801.70/24
             = $3,658.40 per month.
             Housing ratio is 34.25% (1252.97 / 3658.40)
             Debt ratio is 45.13% (1650.97 / 3658.40)
             Compensating factor for debt ratio exceeding 45% is verified assets exceeding
             $6,000, which is more than the required 2 months amount.

             Comment 3 Appendix E – case #291-3603287 – Issue calculation of co-
             borrower’s income.
             Agree that co-borrower’s income was miscalculated. Compensating factors for
             ratios higher than 31/43 are:
             • Good rental history with no lates
Comment 4    • Borrower has stable employment.
             • Co-borrower has been back to work for 5 months after maternity leave.
             • Co-borrower was off work due to a high risk pregnancy from 1/07 to 8/07 per
             LOE.
             • All revolving debt paid off.




                                              14
                         OIG Evaluation of Auditee Comments

Comment 1   We commend National Bank for updating their underwriting procedures and
            taking quick action in correcting their quality control deficiencies.

Comment 2   National Bank did not adequately verify and document the $11,077 deposit so it is
            unknown whether these funds were from the borrower’s savings or a gift. HUD
            Handbook 4155.1, REV-5, paragraph 2-10 states that if there was a large increase
            in an account, the lender must obtain a credible explanation on the source of those
            funds.

Comment 3   National Bank agreed the payment-to-income ratio and total debt-to-income ratios
            exceeded HUD’s maximum ratios of 31 and 43 percent, respectively. The
            mortgage credit analysis worksheet did not list assets as a compensating factor.
            HUD Handbook 4155.1, REV-5, paragraph 2-13, states that underwriters must
            state the compensating factors used to support the loan approval in the remarks
            section of the underwriting worksheet. Also, those assets were needed to help
            close on the loan so the borrower actually did not have two months in reserves.

Comment 4   National Bank agreed the coborrower’s income was miscalculated. Also, the
            mortgage credit analysis worksheet did not list any compensating factors. HUD
            Handbook 4155.1, REV-5, paragraph 2-13, states that underwriters must state the
            compensating factors used to support the loan approval in the remarks section of
            the underwriting worksheet.




                                            15
Appendix C
                                         CRITERIA

Criterion 1
HUD Handbook 4060.1, REV-2, paragraph 7-3, states that there are several basic elements that
are required in all quality control programs that apply to both origination and servicing.
Paragraph 7-3F states that all aspects of the mortgage operation, including but not limited to all
branch offices or sites, FHA-approved loan correspondents, authorized agents, loan officers or
originators, processors, underwriters, appraisers, closing personnel, and all FHA loan programs,
must be subject to the lender’s quality control reviews.

Criterion 2
HUD Handbook 4060.1, REV-2, paragraph 7-6A, states that loans must be reviewed within 90
days from the end of the month in which the loan closed. This requirement is intended to ensure
that problems left undetected before closing are identified as early after closing as possible.

Criterion 3
HUD Handbook 4060.1, REV-2, paragraph 7-3G, states that lender offices, including traditional,
nontraditional branch, and direct lending offices engaged in origination or servicing of FHA-
insured loans, must be reviewed to determine that they are in compliance with HUD’s
requirements. Paragraph 7-3G(1) states that the review must include but not necessarily be
limited to confirmation of the following items:

      Location is properly registered with HUD and the address is current.
      Operations are conducted in a professional, business like environment; if located in a
       commercial space, the office is properly and clearly identified for any walk-in customers,
       has adequate office space and equipment, is in a location conducive to mortgage lending,
       and is separated from any other entity by walls or partitions.
      Servicing office provides toll-free lines or accepts collect calls from borrowers.
      Personnel at the office are trained and have access to relevant regulatory guidance.
      Procedures are revised to reflect changes in HUD requirements, and personnel are
       informed of the changes in HUD requirements.
      Personnel at the office are all employees of the lender.
      Office does not employ or have contract with anyone who is currently under debarment,
       suspension, or limited denial of participation.

Criterion 4
HUD Handbook 4060.1, REV-2, paragraph 7-3J, states that findings of fraud or other serious
violations must be immediately referred in writing (along with any available supporting
documentation) to the Director of the Quality Assurance Division in the HUD homeownership
center having jurisdiction. If HUD staff is suspected of involvement, OIG should be notified.




                                                16
Criterion 5
HUD Handbook 4060.1, REV-2, paragraph 7-3L, states that the lender should determine that no
one is employed for HUD origination, processing, underwriting, or servicing who is debarred,
suspended, subject to a limited denial of participation, or otherwise restricted from participation
in HUD/FHA programs. Lenders must check the employee list at least semiannually.

Criterion 6
HUD Handbook 4060.1, REV-2, paragraph 7-3G(2), states that the criteria used by the lender to
determine the frequency of onsite reviews must be in writing and available for review by HUD at
the corporate office and any branch office that is not being reviewed annually.

Criterion 7
HUD Handbook 4060.1, REV-2, paragraph 7-5A, states that lenders should monitor the
application process and must verify the identity of the loan applicant.

Criterion 8
HUD Handbook 4060.1, REV-2, paragraph 7-5C, states that lenders must identify patterns of
early defaults by location, program, loan characteristic, loan correspondent, or sponsor. In
addition, paragraph 7-6D states that in addition to loans selected for routine quality control
reviews, lenders must review all loans going into default within the first six payments. Early
payment defaults are loans that become 60 days past due.

Criterion 9
HUD Handbook 4060.1, REV-2, paragraph 7-6G, states that each loan selected for a quality
control review must be reviewed to determine whether the seller was the owner of record or was
exempt from the owner of record requirement in accordance with HUD regulations.

Criterion 10
HUD Handbook 4060.1, REV-2, paragraph 7-7C, states that the lender should determine whether
loan documents requiring signature (other than blanket verification releases) were signed by the
borrower or the lender employees only after completion and all corrections were initialed by the
borrowers or lender employees.

Criterion 11
HUD Handbook 4060.1, REV-2, paragraph 7-7F, states that the lender should determine whether
more than one credit report was ordered and whether all credit reports were submitted with the
loan package to HUD/FHA or the direct endorsement underwriter.

Criterion 12
HUD Handbook 4060.1, REV-2, paragraph 7-7G, states that the lender should determine
whether outstanding judgments shown on the report were shown on the mortgage credit analysis
worksheet and acceptably explained in accompanying documentation.

Criterion 13
HUD Handbook 4060.1, REV-2, paragraph 7-7H, states that the lender should determine
whether the loan file contains pertinent documentation of the borrower’s source of funds for the



                                                17
required investment, the acceptability of that source, and that any obligation to repay the funds is
included on the uniform residential loan application.

Criterion 14
HUD Handbook 4060.1, REV-2, paragraph 7-7J, states that the lender should determine whether
there are sufficient and documented compensating factors if the debt ratios exceed FHA limits.

Criterion 15
HUD Handbook 4060.1, REV-2, paragraph 7-7P, states that the lender should determine whether
the seller acquired the property at the time of closing or soon after closing, indicating the
possible use of a straw buyer in the transaction.

Criterion 16
HUD Handbook 4155.1, REV-5, paragraph 2-6, states that the anticipated amount of income and
the likelihood of its continuance must be established to determine a borrower’s capacity to repay
mortgage debt. Income may not be used in calculating the borrower’s income ratios if it comes
from any source that cannot be verified, is not stable, or will not continue. This section describes
acceptable types of income, procedures for calculating effective income, and requirements for
establishing income stability. HUD 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. To analyze and document the
probability of continued employment, lenders must examine the borrower’s past employment
record, qualifications for the position, previous training and education, and the employer’s
confirmation of continued employment.

Criterion 17
HUD Handbook 4155.1, REV-5, paragraph 2-11A, states that the borrower’s liabilities include
all installment loans, revolving charge accounts, real estate loans, alimony, child support, and
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, alimony, etc. Debts lasting less than 10 months must be counted if the
amount of the debt affects the borrower’s ability to make the mortgage payment during the
months immediately after loan closing, especially if the borrower will have limited or no cash
assets after loan closing.

Criterion 18
Mortgagee Letter 2005-16 states that for manually underwritten mortgages in which the direct
endorsement underwriter makes the credit decision, the qualifying ratios are raised to 31 percent
and 43 percent. This change will allow a larger number of deserving families to purchase their
first home while not increasing their 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.

Criterion 19
HUD Handbook 4155.1, REV-5, paragraph 2-13, lists various compensating factors that may be
used in justifying approval of loans with excessive qualifying ratios. Underwriters must state the


                                                18
compensating factors used to support loan approval in the remarks section of the underwriting
worksheet.

Criterion 20
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. In addition, paragraph 2-10A states
that if the amount of earnest money deposit exceeds 2 percent of the sales price or appears
excessive based on the borrower’s history of accumulating savings, the lender must verify with
documentation the deposit amount and the source of funds. Paragraph 2-10B adds that a
verification of deposit, along with the most recent bank statement, may be used to verify savings
and checking accounts. If there was 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.

Criterion 21
Direct Underwriting Findings states that if the amount of the earnest money deposit or other
large deposits exceed 2 percent of the sales prices or appears excessive based on the borrower’s
history of accumulating savings, the lender must verify the deposit amount and source of funds
according to FHA guidelines. The lender must also determine that any recent debts were not
incurred for any part of the cash investment on the property being purchased.

Criterion 22
HUD Handbook 4155.1, REV-5, paragraph 2-7L, states that income received from government
assistance programs is acceptable, subject to documentation from the paying agency, provided
the income is expected to continue at least 3 years. If the income is not expected to be received
for at least 3 years, such income may be considered a compensating factor. (Unemployment
income must be documented for 2 years. Reasonable assurance of its continuance is also
required. The requirement may apply to individuals employed on a seasonal basis, such as farm
workers, resort employees, etc.)

Criterion 23
Direct Underwriting Findings states that employment received under a welfare program,
unemployment income, workmen’s compensation, payments for foster children, etc., are
acceptable subject to documentation from the paying agency provided the income is expected to
continue at least 3 years. If not expected to last at least 3 years, such income may be considered
a compensating factor. Unemployment income requires a 2-year documentation of receipt and
reasonable assurance of its continuance.




                                                19
        Appendix D

                                    SCHEDULE OF SIGNIFICANT
                                   UNDERWRITING DEFICIENCIES




                                                                                                                                     material deficiencies
                                                                                                                                      Total number of
                                                                                                                       Liabilities
                                                                                                     Income

                                                                                                              Assets
                                                                                      Potential
                                                                                       loss on
                                                                        Unpaid          active/
     FHA case           Loan type        Insurance      Mortgage       principal        claims
      number                               status        amount        balance          loans*

   251-3405672            Retail           Active       $219,800       $218,308      $130,985                 X                               1

   441-8260266            Retail           Active       $169,505       $167,385      $100,431       X                                         1

     Subtotals                                          $389,305       $385,693      $231,416
                                          Claims-
   292-4824038         Sponsored          not sold      $134,883       $134,473       $80,684       X                  X                      2
                                          Claims-
   291-3603287         Sponsored          not sold      $147,364       $146,366      $87,819        X                                         1
    Subtotals                                           $282,247       $280,839      $168,503
                                         2-active
                        2-retail         2-claims
       Totals         2-sponsored        not sold       $671,552       $666,532      $399,919

* Estimated future losses are based on HUD’s average loss rate of 60 percent of the unpaid principal balance for claims paid from the
    FHA insurance fund for fiscal year 2009.




                                                                 20
Appendix E

          CASE STUDIES FOR FOUR QUESTIONED LOANS

Case number: 251-3405672                      Insured amount: $219,800

Section of Housing Act: 203(b)                Status upon selection: Defaulted on the 1st
                                                  payment

Date of loan closing: March 20, 2008          Underwriter type: Automated


Assets
The lender did not verify the assets used to close the loan. The HUD-1 settlement statement
showed that the borrower paid closing costs of $7,630.54. The verification of deposit, dated
March 4, 2008, showed a savings account balance of $17,511. The demand deposit (savings
account) statement showed a balance of $20,102.46 as of February 11, 2008, and the earliest
balance listed was $5,567.39 as of January 14, 2008. The demand deposit statement showed
several large deposits with no explanations. On January 4, 2008, it listed a deposit of $1,000.
On January 22, 2008, it listed a deposit of $11,077.29. On February 4, 2008, it listed a deposit of
$1,600.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10B (criterion 20)
Direct Underwriter Findings (criterion 21)


Case number: 441-8260266                      Insured amount: $169,505

Section of Housing Act: 203(b)                Status upon selection: Defaulted on the 6th
                                                  payment

Date of loan closing: June 28, 2008           Underwriter type: Automated


Income
National Bank overstated the borrower’s income by $1,103. Also, it did not establish a stable
income trend supporting the borrower’s rate of pay at the time of the loan closing. The lender
estimated the borrower's base employment income as $2,047. According to the borrower’s
verification of employment, the borrower began his present job on July 10, 2006, which equated
to 6.32 months. According to the borrower’s 2006 Internal Revenue Service Form W-2 (W-2),
he earned $19,188 in 6.32 months. The 2007 W-2 indicated that the borrower earned $32,372.
As of June 1, 2008, the borrower had earned $7,799.42 in year-to-date income.




                                                21
The borrower’s average monthly income decreased approximately $1,138 from 2007 to 2008
($2,698-$1,560) and $338 ($3,036-$2,698) from 2006 to 2007. There was nothing in the loan
file to indicate whether the borrower’s position was seasonal and/or any gaps in employment
spanning 1 month or more. As a result, the borrower’s income should have been calculated as
$1,560. The difference between our calculation and the lender’s calculation of base employment
income was $487 ($2,047-$1,560). The lender correctly calculated the co-borrower's monthly
income as $2,183.

Also, the lender determined that the borrower had monthly unemployment income of $616 based
on the borrower’s unemployment compensation amounts received in 2007 and 2006 ($5,784 +
$8,991/24 months). However, there was nothing in the loan file to indicate whether the borrower
received unemployment compensation in 2008 and no documentation to show reasonable
assurance of its continuance. As a result, the $616 in unemployment compensation should not
have been included in the borrower’s total monthly income. Overall, the lender overstated the
borrower’s income by $1,103 ($487 +$616). This amount would have decreased the overall
monthly income to $3,743 ($1,560 + $2,183). The $1,103 decrease in income would have
increased the income ratios from 28.76 and 51.35 percent to 37.22 and 66.48 percent,
respectively.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-6 (criterion 16)
HUD Handbook 4155.1, REV-5, paragraph 2-7 L (criterion 22)
Direct Underwriter Findings (criterion 23)


Case number: 292-4824038                     Insured amount: $134,883

Section of Housing Act: 203(b)               Status upon selection: Defaulted on the 5th
                                                 payment

Date of loan closing: March 10, 2008         Underwriter type: Manual


Income
The lender overstated the borrower’s monthly income by $338 per month. We reviewed the
borrower’s verification of employment, recent pay stubs, and other income documentation and
determined that the borrower’s year-to-date income (pay period ending March 1, 2008) was
$7,885. The borrower’s three most recent pay stubs were for pay periods ending February 10,
February 23, and March 1, 2008. There was no paycheck for the pay period ending February 17,
2008, and based on year-to-date amounts, it appears that the borrower did not have a paycheck
for this pay period. The borrower’s income significantly varied from one paycheck to another
($754, $732, and $1,040 regular pay per paycheck for periods indicated above), and yet the
underwriter used only the 2 most recent months of income to calculate monthly income as
opposed to using the past 2 years (24 months). We also noted that the underwriter provided no
explanation for using 2 months of income as opposed to a 24-month period, yet the borrower had
provided W-2s for the past 3 years. Although there was sufficient documentation in the file



                                              22
showing that the borrower had been a truck driver for the past 2.5 years and the borrower’s
income increased from $40,872.40 in 2006 to $44,586.03 in 2007, the pay stubs and verification
of employment did not show the number of hours worked or the basis of compensation.
Therefore, the underwriter’s calculation of the borrower’s monthly income at $3,943.50 based on
2 months of income was incorrect, and the amount used to qualify was not adequately supported.
We calculated the borrower’s monthly income as $3605.46.


HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-6 (criterion 16)

Liabilities
The lender understated the borrower’s monthly liabilities by $398. We initially reviewed the
borrower’s uniform residential loan application, mortgage credit analysis worksheet, and credit
report for any differences. We noticed that the borrower reported a recurring monthly obligation
of $398 on the uniform residential loan application, which the loan underwriter did not include in
tabulating the loan qualifying ratios. According to the uniform residential loan application, the
recurring monthly obligation had an outstanding unpaid balance of $10,431. We reviewed the
borrower’s credit report for information evidencing the existence of this obligation but found no
information indicating its existence. There was no explanation in the loan file to determine
whether this liability was entered in error or even existed.

We recalculated the ratios using the recomputed income of $3,605.46 and underreported
liabilities of $398. The borrower’s revised mortgage payment-to-income ratio was 34.75
percent, and the total debt-to-income ratio was 45.79 percent. These ratios are above HUD’s
maximum ratios of 31 and 43 percent, respectively.


HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-11A (criterion 17)(
Mortgagee Letter 2005-16 (criterion 18)


Case number: 291-3603287                      Insured amount: $147,364

Section of Housing Act: 203(b)                Status upon selection: Defaulted on the 6th
                                                  payment

Date of loan closing: January 11, 2008        Underwriter type: Manual


Income
The lender did not accurately calculate the coborrower’s income as it initially calculated the
income as $833.11. The coborrower’s work history was sporadic for the 3 years preceding the
FHA loan closing. The coborrower had six jobs in 2005, four in 2006, and one indicated in
2007. We decided to use the 2006 W-2 income and the 2007 income to meet the FHA 2-year
requirement. If we add the coborrower’s 2006 income ($6,990.10) and the 2007 income


                                               23
($3,124.19) as of November 11, 2007 (10.77 months=10 months and 23 days/30 days), we
calculate a total income of $10,114.29. If we divide this total income by 22.77 months
($10,114.29/22.77), the monthly income would average $444.19. When we added the
borrower’s income $2,495.53 ($2,166.63 + $328.90) with the coborrower’s income ($444.19),
the revised total income was $2,939.72.

We recalculated the ratios using the recomputed income of $2,939.72. The borrower’s revised
mortgage payment-to-income ratio was 40.56 percent, and the revised total debt-to-income ratio
was 51.75 percent. These ratios are well above HUD’s maximum ratios of 31 and 43 percent,
respectively. We also noted that the mortgage credit analysis worksheet did not list
compensating factors.


HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-6 (criterion 16)
HUD Handbook 4155.1, REV-5, paragraph 2-13 (criterion 19) )Mortgagee Letter 2005-16
(criterion 18)




                                              24
Appendix F

                           QUALITY CONTROL PLAN
                             MISSING ELEMENTS

National Bank’s quality control plan did not contain the following 14 required elements per
HUD Handbook 4060.1, REV-2. The plan did not require the lender to

           o Address the requirement that quality control reviews should be performed within
             90 days of closing.

           o Review certain items at the branch offices, including whether the office provided
             toll-free lines or accepted collect calls from borrowers and whether personnel
             were employees of the lender or contract employees performing functions that
             FHA allows to be outsourced.

           o Immediately refer findings of fraud or other serious violations in writing (along
             with available documentation) to HUD or to refer HUD staff suspected of
             involvement to OIG.

           o Determine that no one is employed for HUD origination, processing,
             underwriting, or servicing who is debarred, suspended, subject to a limited denial
             of participation, or otherwise restricted from participation in the HUD/FHA
             programs. Lenders must check the employee list at least semiannually.

           o Determine that the frequency of onsite reviews must be in writing and available
             for review by HUD at the corporate office or any branch office that is not
             reviewed annually.

           o Verify the identity of the loan applicant.

           o Identify patterns of early defaults by location, program, loan characteristic, loan
             correspondent, or sponsor.

           o Verify that the seller was the owner of record or was exempt from the owner of
             record requirements.

           o Determine whether loan documents, requiring signature, were signed by the
             borrower or employees of the lender only after completion and that all corrections
             were initialed by the borrower and/or employees of the lender, as appropriate.

           o Determine whether the seller acquired the property at the time of closing or
             shortly before the closing, indicating a possible property flip. .



                                               25
o Determine whether more than one credit report was ordered and ensure that all
  credit reports are submitted.

o Determine whether outstanding judgments shown on the credit report were shown
  on the mortgage credit analysis worksheet and explained in accompanying
  documentation.

o Determine whether the loan file contains pertinent documentation of the
  borrower’s source of funds for the required investment, the acceptability of that
  source, and that any obligation to repay the funds is included on the form HUD
  92900.

o Determine whether there are sufficient and documented compensating factors if
  the debt ratios exceed FHA limits.




                                    26