oversight

Assurity Financial Services, LLC, Englewood, CO, Did Not Properly Underwrite a Selection of FHA Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-08-05.

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
                                                                                                 Region IX
                                                                         611 West Sixth Street, Suite 1160
                                                                                 Los Angeles, CA 90017
                                                                                    Voice (213) 894-8016
                                                                                      Fax (213) 894-8115


                                                                  Issue Date

                                                                           August 5, 2010
                                                                  Audit Report Number

                                                                           2010-LA-1804


MEMORANDUM FOR: Vicki B. Bott, Deputy Assistant Secretary, Single Family, HU

                          Dane M. Narode, Associate General Counsel for Program
                          Enforcement, CE



FROM:                     Tanya E. Schulze, Regional Inspector General for Audit, 9DGA

SUBJECT:                  Assurity Financial Services, LLC, Englewood, CO, Did Not Properly
                          Underwrite a Selection of FHA Loans


                                      INTRODUCTION

We performed a review of 20 Federal Housing Administration (FHA) loans underwritten by
Assurity Financial Services, LLC (Assurity). Our review objective was to determine whether
Assurity underwrote the 20 loans in accordance with Federal Housing Administration (FHA)
requirements. This review is part of Operation Watchdog, an Office of Inspector General (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 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 Assurity’s two owners/senior managers
and asked them to provide written comments on our discussion draft memorandum. Their
attorney provided written comments on their behalf on July 1, 2010, in which they disagreed
with the report. The complete text of the response, along with our evaluation of that response,
can be found in appendix C of this memorandum
                                     SCOPE AND METHODOLOGY

Assurity 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 claim status.
We selected loans for Assurity that defaulted within the first 30 months and were (1) not
streamline refinanced, (2) not electronically underwritten by Fannie Mae or Freddie Mac, and (3)
associated with an underwriter (usually an individual) with a high number of claims.

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
consider the internal controls or information systems controls of Assurity, consider the results of
previous audits, or communicate with Assurity’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.

                                               BACKGROUND

Assurity was an FHA-approved non-supervised mortgage lender headquartered in Englewood,
CO between May 2005 and March 2010. Assurity was approved to originate FHA loans as a
non-supervised loan correspondent on March 21, 2002, and was approved to underwrite FHA
loans under HUD’s direct endorsement program on May 20, 2005. However, Assurity ceased
lending operations on February 26, 2010, and did not renew its FHA approval as of March 31,
2010. As a non-supervised mortgage lender, Assurity was allowed to underwrite and close FHA
loans without HUD’s prior review or approval with the obligation to follow HUD regulations
and requirements.

FHA, created by Congress in 1934, is the largest mortgage insurer in the world aimed at helping
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 required to evaluate the borrower’s ability
and willingness to repay the mortgage debt. Lenders are protected against default by FHA’s

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
mutual mortgage insurance fund, which is sustained by borrower premiums. The mortgage
insurance fund pays claims to lenders in the event of a homeowner default.

The goal of Operation Watchdog is to determine why there is such a high rate of defaults and
claims. The 15 lenders selected for our review endorsed 183,278 loans valued at $31.3 billion
during the period January 2005 to December 2009. These same lenders submitted 6,560 FHA
insurance claims with an estimated value of $794.3 million from November 2007 through
December 2009. During this time, Assurity endorsed 6,831 loans valued at more than $1.21
billion and submitted 183 FHA insurance claims with an estimated value of more than $32.7
million.

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

                                         RESULTS OF REVIEW

Assurity did not follow HUD requirements when underwriting 8 of the 20 FHA-insured loans.
The loans reviewed contained significant underwriting deficiencies that impacted the insurability
of the loans. This noncompliance occurred because the lender failed to exercise due diligence in
underwriting these loans. As a result, FHA’s insurance fund suffered actual losses totaling
$968,954 for six loans and estimated potential losses of $212,043 for two loans, as shown in the
following table.

                                                   Number of
                                                                         Original
           FHA loan                                 payments
                              Closing date                               mortgage       Loss to HUD
            number                                 before first
                                                                         amount
                                                     default
         023-2343260            04/14/06               18            $   219,037        $      153,517
         023-2397348            10/16/06               20                236,495               170,120
         043-7406274            05/31/07                2                187,267               138,524
         052-4159366            09/28/07                0                167,475               147,831
         052-4311569            04/11/08                1                103,377               60,8293
         094-5402355            04/09/08                1                255,526              151,2143
         095-0485724            10/31/07               11                212,135               165,306
         095-0539086            12/28/07                3                310,000               193,656
                                 Totals                              $ 1,691,312        $ 1,180,9974




3
  We estimated the loss to HUD for these loans because the foreclosed-upon properties have not been resold by
HUD. The estimated loss was calculated based on 60 percent of the unpaid principal balance (according to
Neighborhood Watch). The 60 percent severity rate was the average loss published in the FHA Annual
Management Report for Fiscal Year 2009.
4
  $1,180,997 = $968,954 for six loans with actual HUD loss + $212,043 for two loans with estimated HUD loss.

                                                        3
Significant Underwriting Deficiencies

The loan file review of 20 FHA-insured loans identified eight with significant underwriting
deficiencies that included improper calculation of income, inadequate documentation of income,
inadequate determination of liabilities, and inadequate compensating factors when the debt-to-
income ratios exceeded HUD’s minimum requirements. Assurity did not underwrite the eight
loans as required by HUD Handbook 4155.1, REV-5, which states, ―the lender must establish
that the borrower has the ability and willingness to repay the mortgage debt. This decision must
be predicated on sound underwriting principles consistent with the guidelines, rules, and
regulations described throughout this Handbook and must be supported by sufficient
documentation.‖ The eight loans, which totaled more than $1.655 million in unpaid mortgage
balances, were approved based on many factors that included reported monthly income,
recurring debt obligations, assets, and/or compensating factors. However, Assurity closed many
of the loans based on inadequate determination and evaluation of these factors. See appendix A
for a schedule of material deficiencies and appendix B for a detailed narrative of each of the
eight loans. The following table summarizes the material deficiencies that we identified in the
eight loans.

                                                        Number of
                             Area of noncompliance
                                                          loans
                               Income                        4
                               Liabilities                   2
                               Excessive ratios              8
                               Credit                        2

Income

Assurity did not properly verify borrowers’ income or determine income stability for four loans.
For example, for loan number 052-4311569, Assurity did not adequately support the borrower’s
income through standard or alternative documentation standards and should have questioned the
borrower’s income stability and likelihood of continued employment. Without adequate
verification and income support, the lender should not have used the borrower’s stated income
for qualifying purposes.

For loan number 121-2399761, the underwriter did not calculate the borrower’s bonus income
correctly. The lender determined that there was $519 in bonus income per month by taking a 2-
year average of bonus income as listed in the verification for 2005 and 2006. However, the
verification detailed bonus income information for 2007 until the middle of December, almost a
complete year. Although the lender used 2 years to average bonus income as required, the lender
should have used 2007 and 2006 instead of 2006 and 2005, reflecting more current earnings. We
determined a bonus income of $397 per month, a difference of $122 per month.




                                                  4
Liabilities

Assurity did not properly assess the borrowers’ financial obligations for two loans. For example,
for loan 094-5402355, Assurity failed to adequately consider rental property to be included as
income or as a recurring liability. The gross rental amount should have been reduced by 25
percent (to account for vacancies and maintenance), then subtracted by the mortgage amount on
the existing property. If the outcome is positive, it can be considered effective income. If it is
negative, it is considered a recurring liability. We determined a recurring liability of $211.75
(gross income of $1,375 reduced by 25 percent is $1031.25. We then subtracted the mortgage
amount of $1,243 to arrive at $211.75).

For loan 095-0539086, a recurring liability in the amount of $1,565 was inappropriately
excluded. Although the recurring debt had less than 10 months of payments, it could impact the
borrower’s ability to pay the FHA mortgage in the first few months. Since the borrower had zero
cash assets or reserves, the lender should have included the debt.

Excessive Ratios and Compensating Factors

Assurity improperly approved eight loans without adequate compensating factors or failed to
correctly calculate qualifying ratios. For example, Assurity approved loan number 052-4159366
when the borrower’s mortgage payment-to-income and debt-to-income ratios exceeded FHA’s
requirements of 31 and 43 percent, respectively. The mortgage payment-to-income ratio and
total debt-to-income ratio were 37.70 and 51.38 percent, respectively. Assurity provided five
compensating factors; however, all but one were determined to be inadequate. The single ratio
was not enough to overcome excessive qualifying ratios.

Credit

Assurity did not properly analyze the borrower’s credit for two loans. For example, for loan
number 023-2343260, Assurity failed to obtain letters of explanation for delinquent accounts
identified in the credit report. Included in the delinquent accounts was an automobile loan
charge-off in the amount of $9,139. The underwriter did not conduct due diligence in analyzing
the borrower’s ability to manage debt and failed to adequately address and explain delinquent
accounts.

Lack of Due Diligence

Because Assurity did not follow HUD regulations and requirements when underwriting and
closing FHA loans, it inappropriately approved eight loans that had significant underwriting
deficiencies. The lender did not exercise both sound judgment and due diligence when it
submitted these loans for FHA insurance. As a result, the FHA insurance fund was at increased
risk for losses on three loans with significant underwriting deficiencies totaling $212,043 in
unpaid principal mortgage balances. The FHA insurance fund has already realized losses of
$968,954 on six inappropriately approved FHA loans. The losses resulted when the properties
that secured these six loans were sold and the insurance claims and other expenses incurred by
HUD exceeded the sales proceeds.

                                                5
                                             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 Assurity and/or its principals for
                incorrectly certifying to the integrity of the data or that due diligence was exercised
                during the underwriting of eight loans that resulted in losses to HUD totaling
                $1,180,997, which could result in affirmative civil enforcement action of
                approximately $2,421,9925.

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

       1B.      Take appropriate administrative action against Assurity 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.


                                           Schedule of Ineligible Cost 1/

                                        Recommendation
                                            number                     Amount
                                                 1A                  $1,180,997
                                                Total                $1,180,997

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.




5
    Double damages plus a $7,500 fine for each of the eight incorrect certifications.

                                                             6
                                 APPENDIXES

Appendix A

SUMMARY OF MATERIAL UNDERWRITING DEFICIENCIES


                                     Underwriting deficiencies
         FHA loan
          number                                 Qualifying
                           Income   Liabilities                  Credit
                                                    ratios
        023-2343260          x                         x           x
        023-2397348                                    x
        043-7406274          x                         x
        052-4159366                                    x
        052-4311569          x                         x
        094-5402355                     x              x
        095-0485724          x                         x
        095-0539086                     x              x           x
          Significant
                             4          2              8           2
       deficiency totals




                                       7
Appendix B

 LOANS WITH MATERIAL UNDERWRITING DEFICIENCIES

Loan number: 023-2343260

Mortgage amount: $219,037

Section of Housing Act: 203(b)

Loan purpose: Refinance

Date of loan closing: April 14, 2006

Status as of April 30, 2010: Claim

Payments before first default reported: 18

Loss to HUD: $153,517

Summary

We found material underwriting deficiencies relating to the borrower’s income, credit history,
excessive ratios, and compensating factors.

Income

Assurity used excessive overtime as part of effective income. The lender based the borrower’s
overtime calculation on an average overtime pay of $766 per month, which was based on 3
years’ performance ($7,556 in 2004, $12,713 in 2005, and $407 through 3 months in 2006.)
However, the borrower’s overtime pay significantly decreased in 2006, indicating a decline in
the earnings trend. The lender did not provide sound rationalization for included overtime
income before the decline. Based on this decline, the lender should have used an average of
current overtime earnings, or $136 ($406 divided by 3 months), to reflect the borrower’s current
earning potential.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-7(A), states that both overtime and bonus income
may be used to qualify if the borrower has received such income for the past 2 years and it is
likely to continue. An earnings trend also must be established and documented for overtime and
bonus income. If either type shows a continual decline, the lender must provide a sound
rationalization in writing for including the income for borrower qualifying.



                                                8
Credit

Assurity did not properly analyze the borrower’s credit history. Four accounts were listed under
collection accounts, including a charge-off of $9,139 in March 2005. The lender failed to obtain
the borrower’s written explanation for the derogatory credit and failed to provide written
explanations for the 11 inquiries shown on the credit report in the last 90 days. Additionally, the
lender did not provide analysis or documentation explaining the recent home equity loan in the
amount of $63,931 taken out in March 2006. Given the lack of information regarding the recent
home equity loan, the derogatory credit, and the lack of written explanations for the 11 inquiries
shown on the credit report in the last 90 days, it appears that the lender did not perform a
satisfactory mortgage credit analysis for this borrower.

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
borrower’s future actions. If the credit history, despite adequate income to support obligations,
reflects continuous slow payments, judgments, and delinquent accounts, strong compensating
factors will be necessary to approve the loan. When delinquent accounts are revealed, the lender
must document its analysis as to 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 judgments, 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.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-3(C), states that FHA does not require that
collection accounts be paid off as a condition of mortgage approval. Collections and judgments
indicate a borrower’s regard for credit obligations and must be considered in the analysis of
creditworthiness, with the lender documenting its reasons for approving a mortgage when a
borrower has collection accounts or judgments.

Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. As
originally calculated, the mortgage payment-to-income and total debt-to-income ratios were
35.71 and 43.39 percent. However, as recalculated after considering the excessive overtime, the
mortgage payment-to-income and total debt-to-income ratios were 42.14 and 51.20 percent. The
ratios were excessive under each scenario and required strong compensating factors.

Assurity included four compensating factors: 10 percent equity in property (not a valid
compensating factor), reducing mortgage payment, steadily increasing income, and clean credit
history in the past 12 months. The mortgage payment was not being reduced, as it only appeared
as a reduction based on a home equity loan taken out by the borrower 1 month before closing.
The verification of employment indicated a decline in the earnings rate. Lastly, although the
borrower had made timely payments on revolving accounts during the past 12 months, the credit

                                                 9
history did not indicate a conservative attitude toward credit (as illustrated by collection and
charge-off accounts).

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt-to-income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.
Underwriters must record in the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.

HUD Handbook 4155.1, REV-5, paragraph 2-13(G), states that ―assets‖ such as equity in other
properties and the proceeds from a cash-out refinance are not to be considered as cash reserves.




                                                 10
Loan number: 023-2397348

Mortgage amount: $236,495

Section of Housing Act: 203(b)

Loan purpose: Refinance

Date of loan closing: October 16, 2006

Status as of April 30, 2010: Claim

Payments before first default reported: 20

Loss to HUD: $170,120

Summary

We found material underwriting deficiencies relating to the borrowers’ qualifying ratios and
compensating factors.

Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. The
borrowers’ mortgage payment-to-income ratio and total debt-to-income ratio of 48.17 percent
exceeded HUD’s allowable ratios of 31 and 43 percent. The lender did not provide adequate
compensating factors, as required, to overcome excessive ratios.

The lender provided the following compensating factors on the HUD Form 929006: high credit
scores and no credit late payments with exception of disputed medical collection accounts (part
of a valid compensating factor), no history of mortgage late payments (not a valid compensating
factor), job stability (not a valid compensating factor), and 10 percent home equity (not a valid
compensating factor). Only one of the compensating factors are acceptable according to HUD
Handbook 4155.1, REV-5, paragraph 2-13. However, the borrowers did not demonstrate an
ability to accumulate savings, which is required along with a conservative attitude toward the use
of credit. The loan file did not contain supporting documents to indicate accumulated savings
or assets. Although 28 derogatory public records or collections were filed, the borrower had
exhibited a conservative attitude towards credit evidenced by zero balances on revolving
accounts and no derogatory accounts aside from the medical collections. Housing expenses had
significantly increased by 22 percent. The borrowers’ original housing expenses were $1,471
but had increased by $323 to $1,717. The borrowers had not successfully demonstrated the
ability to pay increased housing expenses equal to or greater than the proposed monthly housing
expenses for the new mortgage over the past 12-24 months. Lastly, the borrowers did not have a
documented potential for increased earnings, as indicated by job training or education in the


6
    The Mortgage Credit Analysis Worksheet is used to determine borrower eligibility and credit worthiness.

                                                          11
borrowers’ profession. The borrowers’ income remained the same, while their housing expenses
had significantly increased.

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt-to-income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.
Underwriters must record in the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.

HUD Handbook 4155.1, REV-5, paragraph 2-13(C), states the borrower has demonstrated an
ability to accumulate savings and a conservative attitude toward the use of credit.

HUD Handbook 4155.1, REV-5, paragraph 2-13(I), states that the borrower has a potential for
increased earnings, as indicated by job training or education in the borrower's profession.

HUD Handbook 4155.1, REV-5, paragraph 2-13(G), states that ―assets‖ such as equity in other
properties and the proceeds from a cash-out refinance are not to be considered as cash reserves.




                                                12
Loan number: 043-7406274

Mortgage amount: $187,267

Section of Housing Act: 203(b)

Loan purpose: Refinance

Date of loan closing: May 31, 2007

Status as of April 30, 2010: Claim

Payments before first default reported: Two

Loss to HUD: $138,524

Summary

We found material underwriting deficiencies relating to the borrower’s income, excessive ratios,
and compensating factors.

Income

Assurity inappropriately used unverified self-employment income as effective income. Although
a 2006 tax return and transcripts for 2005 were included in the loan file, the lender did not
include a profit and loss statement and a balance sheet for the current year to date (the loan
closed on May 25, 2007). Without information on the profit and loss for the first 5 months of the
current year the lender should have been unable to determine whether the business could be
expected to continue to generate sufficient income for the borrower’s mortgage needs.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-9(B)(3), requires the lender to obtain a year-to-date
profit and loss statement and balance sheet.

HUD Handbook 4155.1, REV-5, paragraph 2-9(C), states that the lender must analyze carefully
the business’s financial strength, the source of its income, and the general economic outlook for
similar businesses in the area to determine whether the business can be expected to continue to
generate sufficient income for the borrower’s needs.

Additionally, the lender adjusted the borrower’s annual income for depreciation, meals, home
office expenses, and other without providing an analysis or explanation for inclusion or
subtraction. Without a reasonable explanation or analysis, the lender should only have added
back depreciation. Therefore, income should have been $36,677 ($35,181 plus $3,188
depreciation) in 2005 and $43,039 ($39,851 plus $3,188 depreciation) in 2006. As an average,



                                                13
the monthly income used for qualifying should have been $3,322 ($36,677 plus $43,039 divided
by 24 months), a difference of $576 from the $3,898 used by the lender.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-9(C)(1), states that the amount shown on the
Internal Revenue Service (IRS) Form 1040 as ―adjusted gross income‖ must be increased or
decreased, based on the lenders’ analysis of the individual tax returns. The sole proprietorship
income calculated on schedule C is business income. Depreciation or depletion may be added
back to adjusted gross income.

Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. As
originally calculated, the mortgage payment-to-income and total debt-to-income ratios were both
38.77 percent. However, as recalculated after considering the recalculated self-employment
income, the mortgage payment-to-income and total debt-to-income ratios were both 45.48
percent. Originally, only the mortgage payment-to-income ratio was excessive. After
recalculation, both ratios were excessive. Both scenarios required compensating factors.

Assurity included five compensating factors: lowering the interest rate from 6.5 to 6 percent
fixed (not a valid compensating factor), $171 in monthly savings (not a compensating factor
since the debt consolidation included liens, judgments, and collections), 639 Fair Isaac
Corporation (FICO) score (not a valid compensating factor), paying off all derogatory credit (not
a valid compensating factor), and 23-month clean mortgage history (valid compensating factor).
Given the borrower’s derogatory credit history, the single compensating factor of clean mortgage
history was not sufficient.

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt-to-income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.
Underwriters must record in the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.




                                                14
Loan number: 052-4159366

Mortgage amount: $167,475

Section of Housing Act: 203(b)

Loan purpose: Refinance

Date of loan closing: September 28, 2007

Status as of April 30, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $147,831

Summary

We found material underwriting deficiencies relating to the borrower’s excessive ratios and
compensating factors.

Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. The
borrower’s mortgage payment-to-income ratio was 37.70 percent, and the total fixed payment-to-
income ratio was 51.38 percent. Both ratios exceeded the required maximums of 31 and 43
percent. The lender did not document sufficient compensating factors to justify ratios that are
significantly above the limits.

Assurity included five compensating factors: length of time employed (not a valid compensating
factor), no mortgage late payments (valid compensating factor), $472 per month savings (not a
valid compensating factor), increasing income with potential earnings of $7,100 per month (not a
valid compensating due to lack of supporting documentation showing potential for increased
earnings), and spouse earns income not included as effective income (not supported, as
combined tax returns indicate losses for 2005 and 2006 due to the spouse’s business).

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt-to-income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.



                                                15
Underwriters must record in the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.

HUD Handbook 4155.1, REV-5, paragraph 2-13(I), states that the borrower has a potential for
increased earnings, as indicated by job training or education in the borrower's profession.




                                             16
Loan number: 052-4311569

Mortgage amount: $103,377

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: April 11, 2008

Status as of April 30, 2010: Claim

Payments before first default reported: One

Loss to HUD: $60,829 (estimated)

Summary

We found material underwriting deficiencies relating to the borrower’s income, excessive ratios,
and compensating factors.

Income

Assurity did not properly verify the borrower’s income or determine income stability. The
lender failed to adequately support the borrower’s income through standard or alternative
documentation standards, and it should not have been used as effective income without
additional support. Since the lender failed to obtain a written verification of employment, it was
obligated to obtain a telephone verification, pay stubs covering the most recent 30-day period,
and IRS Forms W-2 from the previous 2 years. However, the lender failed to adequately satisfy
alternative documentation requirements. The lender did not obtain a telephone verification of
employment and only obtained a single pay stub covering a 14-day period and IRS Forms W-2
covering years 2005, 2006, and 2007.

Without adequate income support, the lender should have questioned the stability of the
borrower’s income. The absence of a verification of employment (written or telephone) makes it
difficult to determine the likelihood of continued employment. The borrower’s previous job
history exhibited income and job instability. According to the uniform residential loan
application and the IRS Forms W-2, the borrower had held employment at 11 different
employers since 2005. In 2007, the borrower held employment at four different employers.
According to the IRS Forms W-2, income was limited until the current employment.
Additionally, employment was not always in the same line of work.




                                                17
HUD/FHA Requirements

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 a source that cannot be verified, is not stable, or will not continue.

HUD Handbook 4155.1, REV-5, paragraph 3-1(E), states that a verification of employment and
the borrower’s most recent pay stub are to be provided. As an alternative to obtaining a
verification of employment, the lender may obtain the borrower’s original pay stub(s) covering
the most recent 30-day period, along with original IRS Forms W-2 from the previous 2 years.
The lender must also verify by telephone all current employers. The loan file must include a
certification from the lender that original documents were examined and the name, title, and
telephone number of the person with whom employment was verified.

Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. The
borrower’s mortgage payment-to-income ratio was 47.29 percent, and the total fixed payment-to-
income ratio was 49.55 percent. Both ratios exceeded the required maximums of 31 and 43
percent. The lender did not document sufficient compensating factors to justify ratios that are
significantly above the limits. Based on this information alone, the loan should not have been
approved. However, the lender also inappropriately included income that was not adequately
supported (see Income section above).

Assurity did not include compensating factors. The borrower exceeded both qualifying ratios as
originally calculated. We could not recalculate the ratios based on the unsupported income since
the income should not have been used for qualifying calculations. To overcome the exceeded
ratios, significant compensating factors should have been listed and documented. Based on the
loan file, we determined the presence of only two compensating factors (conservative attitude
toward credit and minimal increase in housing expense), which was determined not adequate to
overcome excessive ratios, the lack of employment verification, and the borrower’s unstable
previous employment history

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt-to-income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.
Underwriters must record in the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.

                                                18
Loan number: 094-5402355

Mortgage amount: $255,526

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: April 9, 2008

Status as of April 30, 2010: Claim

Payments before first default reported: One

Loss to HUD: $151,214 (estimated)

Summary

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

Liabilities

Assurity did not correctly calculate the borrower’s recurring liabilities. The lender included a
recurring liability credit account with a monthly payment of $6 dollars. However, the credit
report showed the credit account with an outstanding balance of $105 and a monthly payment of
$20, indicating fewer than 10 months of payments remaining. Additionally, the lender failed to
adequately consider rental property to be included as income or as a recurring liability. The
gross rental amount should have been reduced by 25 percent (to account for vacancies and
maintenance), then subtracted by the mortgage amount on the existing property. If the outcome
is positive, it can be considered effective income. If it is negative, it is considered a recurring
liability. A recurring liability of $211.75 should have been determined (gross income—$1,375
reduced by 25 percent is $1,031.25. We then subtracted the mortgage amount of $1,243 to arrive
at $211.75).

HUD/FHA Requirements

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

HUD Handbook 4155.1, REV-5, paragraph 2-7(M)(2), states that the gross rental amount must
be reduced for vacancies and maintenance by 25 percent (or the percentage developed by the



                                                 19
jurisdictional Homeownership Center) before subtracting principal, interest, taxes, and insurance
and any homeowners’ association dues, etc., and applying the remainder to income (or recurring
debts, if negative).

Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. As
originally calculated, the mortgage payment-to-income ratio was 41 percent and total debt-to-
income ratio was 42 percent. However, as recalculated after considering the inappropriately
excluded rental income liability, the total debt-to-income ratio increased to 44.77 percent. Both
scenarios presented excessive qualifying ratios.

Assurity included one compensating factor, the borrower’s ability to manage debt (valid
compensating factor). However, the single compensating factor is not enough to justify
mortgage approval. The borrower’s mortgage on the new property more than doubled his
previous mortgage, increasing from $1,280 to $2,530, further diminishing his ability to save, and
the borrower’s credit report indicated more than one previous mortgage loan with derogatory
information.

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt–to-income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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 2-5, states that there is a danger of ―layering
flexibilities‖ in assessing mortgage insurance risk and simply establishing that a loan transaction
meets minimal standards does not necessarily constitute prudent underwriting. The lender is
responsible for adequately analyzing the probability that the borrower will be able to repay the
mortgage obligation in accordance with the terms of the loan.

HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.
Underwriters must record in the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.

HUD Handbook 4155.1, REV-5, paragraph 2-13(C), states the borrower has demonstrated an
ability to accumulate savings and a conservative attitude toward the use of credit.

HUD Handbook 4155.1, REV-5, paragraph 2-13(I), states that the borrower has a potential for
increased earnings, as indicated by job training or education in the borrower's profession.




                                                20
Loan number: 095-0485724

Mortgage amount: $212,135

Section of Housing Act: 203(b)

Loan purpose: Refinance

Date of loan closing: October 31, 2007

Status as of April 30, 2010: Claim

Payments before first default reported: 11

Loss to HUD: $165,306

Summary

We found material underwriting deficiencies relating to the borrower’s income, excessive ratios,
and compensating factors.

Income

Assurity did not adequately verify the borrower’s employment and did not assess its stability.
The lender failed to explain inconsistencies in the loan file regarding the borrower’s current
employment. The lender used a verbal verification of employment for 2007 wages, which
extended to August 6, 2007, just 2.5 months before closing, instead of obtaining pay stubs from
the borrower.

The borrower had four employers over the past 4 years according to the uniform residential loan
application. Although they were in the same field of work, the reasons for ending employment
indicated that employment may not have continued in the future. The verification of
employment for the current employer did not comment on the probability of continued
employment. A second verification for a different employer stated that the reason for leaving
was ―dissatisfied with work arrangements.‖

Due to the borrower’s inconsistent employment history, current earnings evidenced by the pay
stubs and not previous earnings should have been used for qualification. As stated by Assurity,
average earnings were used to calculate income, which includes earnings from previous
employment. The lender should have used the $18 hourly rate of the current employer as listed
in the four paystubs in the loan file. Although the VOE for the current employer states an
average of 30.25 hours per week, we used a conservative work week of 40 hours to reflect hours
illustrated in the paystubs. We determined monthly earnings of $3,120 ($18/hour x 40 hours x
52 weeks divided by 12 months), a difference of $519 from the $3,639 used on the MCAW.




                                               21
HUD/FHA Requirements

HUD Handbook 4155.1,REV-5, paragraph 3-1(E), states that a verification of employment and
the borrower’s most recent pay stub are to be provided.

HUD Handbook 4155.1, REV-5, paragraph 2-2, states 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 a source that cannot be verified, is not stable, or will not continue.

HUD Handbook 4155.1, REV-5, paragraph 2-7, states that the income of each borrower to be
obligated for the mortgage debt must be analyzed to determine whether it can reasonably be
expected to continue through at least the first 3 years of the mortgage loan.

Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. As
originally calculated, the mortgage payment-to-income and total debt-to-income ratios were
48.54 percent. Both ratios exceeded the acceptable maximums of 31 and 43 percent,
respectively. As recalculated using the overstated income discussed above, the mortgage
payment-to-income and total debt-to-income ratios are 56.61 percent. However, the qualifying
ratios cannot be relied on since the lender did not adequately verify the borrower’s employment
and determine its stability or likelihood to continue.

Assurity included six compensating factors: 751 credit score (not a valid compensating factor),
paying off all debt (not a valid compensating factor), savings of $438 per month (not a valid
compensating factor), limited credit use (not a valid compensating factor as borrower
consolidated debt paying off with refinance proceeds), clean mortgage history (valid
compensating factor), and using conservative income (not a valid compensating factor—
insufficient document support).

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt-to- income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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 2-5 states that there is a danger of ―layering
flexibilities‖ in assessing mortgage insurance risk and simply establishing that a loan transaction
meets minimal standards does not necessarily constitute prudent underwriting. The lender is
responsible for adequately analyzing the probability that the borrower will be able to repay the
mortgage obligation in accordance with the terms of the loan.

HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.

                                                22
Underwriters must record in the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.




                                            23
Loan number: 095-0539086

Mortgage amount: $310,000

Section of Housing Act: 203(b)

Loan purpose: Refinance

Date of loan closing: December 28, 2007

Status as of April 30, 2010: Claim

Payments before first default reported: Three

Loss to HUD: $193,656

Summary

We found material underwriting deficiencies relating to the borrower’s liabilities, excessive
ratios, compensating factors, and credit.

Liabilities

Assurity inappropriately excluded recurring liabilities from the borrower’s mortgage credit
analysis. The credit report identified a recurring liability in the amount of $1,565 with a monthly
payment of $458. Although it appeared the liability had fewer than 10 months of payments
remaining, lenders are required to include these liabilities 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 has limited or no cash assets after loan closing. The uniform
residential loan application indicated that the borrower had zero cash assets and reserves. The
$10,000 resulting from the cash-out refinance is not considered cash reserves. Therefore, the
lender should have included the recurring liability of $1,565 at $458 per month.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-11(A), states that debts lasting fewer 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.

HUD Handbook 4155.1, REV-5, paragraph 2-11(A)(1), states that if the account shown on the
credit report has an outstanding balance, monthly payments for qualifying purposes must be
calculated at the greater of 5 percent of the balance or $10 (unless the account shows a specific
minimum monthly payment).HUD Handbook 4155.1, REV-5, paragraph 2-13(F), states that
―assets‖ such as equity in other properties and the proceeds from a cash-out refinance are not to
be considered as cash reserves.

                                                24
Excessive Ratios and Compensating Factors

Assurity approved the FHA loan with excessive ratios and inadequate compensating factors. As
originally calculated, the mortgage payment-to-income ratio was 34.89 percent, and total debt-to-
income ratio was 43.99 percent. However, as recalculated after considering the inappropriately
excluded recurring liability, the total debt-to-income ratio increased to 50.47 percent. Both
scenarios presented excessive qualifying ratios, exceeding acceptable maximums of 31 and 43
percent. Significant compensating factors should have been listed by the lender.

Assurity included four compensating factors: clean mortgage history (valid compensating factor;
however, the borrower’s derogatory credit history made this compensating factor less impactful),
savings of $289 per month (not adequately supported), lower mortgage payment (valid
compensating factor; however, the borrower had no cash assets and the decrease was minimal—
$192 ($2,803 - $2,611)), and low loan-to-value ratio (not a valid compensating factor).

HUD/FHA Requirements

Mortgagee Letter 2005-16 increased the mortgage payment-to-income and debt-to-income ratios
from 29 and 41 percent to 31 and 43 percent, respectively. It stated that 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 2-5, states that there is a danger of ―layering
flexibilities‖ in assessing mortgage insurance risk and simply establishing that a loan transaction
meets minimal standards does not necessarily constitute prudent underwriting. The lender is
responsible for adequately analyzing the probability that the borrower will be able to repay the
mortgage obligation in accordance with the terms of the loan.

HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating factors that may be used to
justify approval of mortgage loans with ratios exceeding FHA benchmark guidelines.
Underwriters must record n the ―remarks‖ section of the HUD Form 92900 the compensating
factor(s) used to support loan approval. A compensating factor used to justify mortgage
approval must be supported by documentation.

Credit

Assurity did not obtain from the borrower a letter explaining two open collection accounts. The
credit report indicated two open collection accounts: $189 and $138. The lender did not
document its analysis on loan approval despite a number of derogatory accounts.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that when delinquent accounts are
revealed, the lender must document its analysis as to 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. While minor

                                                25
derogatory information occurring 2 or more years in the past does not require explanation, major
indications of derogatory credit–including judgments, 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.




                                               26
APPENDIX C

         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 1




                          27
Comment 2




Comment 3




Comment 4




            28
Comment 5




Comment 6




Comment 7




            29
Comment 8




Comment 9




Comment 10




             30
Comment 11




             Names redacted for privacy reasons.




                                          31
Comments
1, 2, and 3




              32
Comments
2, 4, and 10




               33
Comments
2 and 3




Comment 12




Comment 5



Comment 13




             34
Comment 14




             35
36
Comments
4, 6, and 9




Comment 7




Comment 38




              37
Comment 15




Comment 8




             38
Comment 16




             39
Comment 10




Comment 11




             40
Comment 17




             41
Comment 5




Comments
5, 6, and 9




              42
Comments
4, 7, and 10




               43
44
45
Comment 18




Comment 19




             46
Comment 20




Comment 21




             47
48
Comment 22




             49
Comment 23




             50
Comment 24




Comment 25




             51
Comment 26




             52
Comment 27




             53
Comment 28




             54
Comment 28




             55
56
Comment 29




Comment 30




Comment 30




             57
Comment 30




             58
59
Comment 31




Comment 31




Comment 31




             60
Comment 32




Comment 32




             61
62
Comment 33




             63
64
65
Comment 34




             66
Comment 35




Comment 36




             67
Comment 37




             68
                         OIG’s Evaluation of Lender Comments

Comment 1   Assurity disagrees with our recommendations. The fact remains that
            underwriting lapses did occur that should have affected the insurability of eight
            loans. 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. Title 31, United States
            Code, section 3801, ―Program Fraud Civil Remedies Act of 1986,‖ provides
            federal agencies, which are the victims of false, fictitious, and fraudulent claims
            and statements, with an administrative remedy to recompense such agencies for
            losses resulting from such claims and statements; to permit administrative
            proceedings to be brought against persons who make, present, or submit such
            claims and statements; and to deter the making, presenting, and submitting of
            such claims and statements in the future.

Comment 2   Assurity asserts the principals had no way of knowing the eight loans (reduced
            from 13, see comments 18-37) contained deficiencies. The memorandum does
            not make any assertion that the principals had knowledge or should have had
            knowledge of underwriting deficiencies. The review specifically focuses and
            identifies eight loans with significant underwriting deficiencies. The
            recommendations were created as corrective action for a lack of due diligence
            when underwriting the specified loans.

Comment 3   Assurity states the OIG would set a precedent in this case by transferring
            liability for credit decisions from the company to its principals and
            shareholders, with significant negative results. We recommend that HUD
            determine the legal sufficiency for pursuing remedies under the Program Fraud
            Civil Remedies Act against Assurity and/or its principals for incorrect
            certifications, and take appropriate administrative action.

Comment 4   Assurity questions the basis for OIG’s conclusions. The review identified 8 out
            of 20 loans with significant underwriting deficiencies and was appropriately
            reported as such. As stated in the report, the review work was completed
            according to generally accepted government auditing standards (GAGAS), see
            also comment 7. The scope was limited to identify underwriting deficiencies at
            lenders with high rates of default, based on a review of the loan files. Our
            targeted efforts and analysis were appropriate and fulfilled our review
            objectives. The limited scope does not take away from our conclusion that
            deficiencies should have been identified and/or explained by the underwriter
            and should have precluded FHA loan approval.

Comment 5   Assurity questions the materiality of OIG’s findings, based on its overall loan
            portfolio. As stated in its response, Assurity’s older portfolio did underperform.
            Our review focused on the time period between November 1, 2007 and October
            31, 2009 due to risk factors indicating a higher rate of default and claim. The
            findings in the memorandum are limited to the eight loans identified with

                                           69
             significant underwriting deficiencies. Assurity’s attempt to minimize the
             review results based on materiality does not take away from the fact that
             significant underwriting deficiencies were identified due to a lack of due
             diligence. The findings in the memorandum focuses on the 20 loans reviewed,
             regardless of the percentage those loans represent of Assurity’s total loan
             production. The recommendations are focused squarely on eight loans and are
             intended to provide corrective actions in regards to those loans only.

Comment 6    Assurity questions the review methodology. We disagree, as the loan sample
             was not intended to be statistical or random. Our sample was the result of
             targeted analysis to specifically identify loans that are high risk and had gone
             into claim status. Our review does not project results to Assurity’s universe of
             FHA loans, and limits conclusions to the eight FHA loans identified as having
             significant underwriting deficiencies. Nowhere in the memorandum are the
             findings referred to as systemic.

Comment 7    Assurity questions OIG’s assertion that GAGAS was followed with the specific
             exceptions disclosed. As required by Government Auditing Standards, chapter
             1.12(b) and 1.13, the report clearly states the applicable requirement(s) not
             followed, the reasons for not following the requirement(s), and how not
             following the requirements affected, or could have affected, the audit. The
             scope and methodology section of the report addresses all required aspects.

Comment 8    Assurity takes issue with the press release and conference call announcing
             OIG’s initiative. The HUD press release on January 12, 2010 does not make
             any accusations or presumptions of fraud. Specifically, Inspector General
             Donohue stated, ―The goal of this initiative is to determine why there is such a
             high rate of defaults and claims with these companies and whether there is
             wrongdoing involved.‖ The main objective was to identify high risk loans that
             had failed and determine the reason for failure. Government Auditing
             Standards, chapter 7.30 states that in planning the audit, auditors should assess
             risks of fraud occurring that is significant within the context of the audit
             objectives. The detection and investigation of fraud is and always will be an
             objective of OIG audits and reviews.

Comment 9    Assurity questions the loan sample used. The review focused on a recent two
             year period between November 1, 2007 and October 31, 2009. All lenders were
             compared using the same period and selection criteria. The 20 Assurity loans
             selected, whether from an older portfolio, represents a period with a high rate of
             default and claim. Regardless of when the loans were underwritten, they should
             have been properly underwritten in accordance with HUD requirements.

Comment 10   Assurity states previous reviews and audits have not found material
             deficiencies. This OIG review is independent of all other reviews. Our
             objective was to review failed FHA loans and identify the root causes for



                                            70
             failure. The subject review identified loans with significant underwriting
             deficiencies.

Comment 11   Assurity disagrees with the FHA termination date. The report has been
             amended to show Assurity ceased lending operations on February 26, 2010 and
             therefore, did not renew its FHA approval as of March 30, 2010.

Comment 12   Assurity asserts internal controls were adequate and questions the basis of
             OIG’s findings. As stated in the scope and methodology section of the
             memorandum, internal controls were not reviewed due to the limited scope and
             specific review of the underwriting of 20 targeted loans. See also comments 4
             and 6.

Comment 13   The discussion of HUD’s ability to collect up-front mortgage insurance
             premiums has no bearing on our findings and is not material to the issues
             identified.

Comment 14   Assurity requests HUD/FHA not pursue remedies or enforcement actions
             against the company and/or its principals for the multiple reasons in its
             response. We considered the information provided in Assurity’s response and
             have reduced the number of loans with significant deficiencies from 13 to eight.
             However, the eight loans still present significant underwriting deficiencies that
             were caused by a lack of due diligence. See also comments 1 and 2.

Comment 15   Assurity questions the method of audit notification and attributes the publicity at
             the outset of our review with causing irreparable harm that lead to the
             company’s failure. Our review was part of a national initiative targeted at
             identifying lenders with high rates of default and claim and FHA loans carrying
             high risk underwriting decisions. The press release and conference call on
             January 12, 2010 did not make accusations or presumptions of fraud; rather,
             facts were presented indicating an increasing risk to the FHA insurance fund
             based on high rates of claim and default. See also comment 8.

Comment 16   Assurity presented historical data on how it received its approval to originate
             FHA loans. We obtained the March 31, 2002 authorized date from HUD’s
             publicly available Neighborhood Watch system, which did not disclose the
             detailed information stated by Assurity. After further research, we revised the
             Background section to clarify that Assurity was approved as a nonsupervised
             mortgage lender and could begin underwriting FHA loans under HUD’s direct
             endorsement program on May 20, 2005. Although the information provided
             does serve as background data, it is not material to the underwriting deficiencies
             and lack of due diligence illustrated in the audit memorandum. The 20 Assurity
             loans we reviewed were endorsed by the FHA between 2006 and 2008. See
             also comment 10.




                                            71
Comment 17   Assurity comments that a material fact germane to any discussion of the
             background of the FHA today is the recent decline in the FHA’s capital reserve
             level. The decline was caused by the high rate of claims among FHA loans. As
             mentioned in comment 8, the goal of the OIG’s initiative is to determine why
             there is such a high rate of defaults and claims.

Comment 18   For loan number 095-0539086, we disagree with Assurity’s analysis on
             liabilities. According to the URLA, the monthly mortgage payment was
             reduced from $2,803 to $2,611, a reduction of only $192, not the $746 reduction
             stated by Assurity.

             While we agree the borrower’s debt was paid off prior to closing, it does not
             indicate the borrower’s ability to manage debt. To the contrary, the debts paid
             off included two collection accounts and one derogatory account. Additionally,
             the lender failed to obtain explanation letters for the three derogatory accounts.

             While only two payments remained of $458, it was significant enough to
             include because of the high dollar amount to be paid, the borrower’s past
             derogatory credit, the slight reduction in the mortgage payment, and the lack of
             cash reserves. The $10,000 referenced by Assurity is from the refinance
             transaction and cannot be considered as cash reserves (HUD Handbook 4155.1
             REV-5, chapter 2, paragraph 2-13(F)). Nothing in the loan file indicates the
             borrower’s ability to handle a higher debt level.

Comment 19   For loan number 095-0539086, we disagree with Assurity’s analysis on
             excessive ratios and compensating factors. While Assurity claims the original
             mortgage amount listed does not include taxes and insurance, documentation
             proving otherwise was not provided. Current housing expenses are listed as
             $2,803 on the URLA and FHA Connection application. Based on the
             documentation reviewed, our analysis stands.

             As stated by Assurity, employment stability is not a valid compensating factor.
             We found only one compensating factor, which was not significant enough to
             overcome excessive qualifying ratios of 34.89 and 50.47 percent.

Comment 20   For loan number 095-0539086, we agree with Assurity’s analysis on credit. We
             agree that the two collection accounts were paid off at closing, as evidenced by
             the settlement statement. The report has been updated accordingly. However,
             the loan file did not contain the required letters of explanation for the two
             collection accounts.

Comment 21   For loan number 023-2343260, we disagree with Assurity’s analysis on income.
             Assurity should have considered the large decrease in overtime over the first
             quarter of 2006. Such a large decline from a quarterly average of $3,178 in
             2005 to only $407 in the first quarter of 2006 is significant enough to warrant
             consideration. It is not reasonable to include overtime of the past two years if

                                            72
             there is such a large decline in the current and most important period. As noted
             by Assurity, a letter of explanation should have been obtained detailing the
             decrease in overtime earnings for the first quarter of 2006. Regardless of the
             financial position of the employer, a large decline in overtime earnings is
             significant and warrants consideration and documentation of analysis by the
             lender.

Comment 22   For loan number 023-2343260, we disagree with Assurity’s analysis on credit.
             Combined, the derogatory credit, lack of explanation and analysis for collection
             accounts and inquires, and the recent second mortgage of $60,000 without
             adequate explanation indicates the lender did not complete a thorough and
             complete mortgage credit analysis.

             To focus only on the three accounts that were paid as agreed is misleading and
             takes away the significance of analyzing credit where derogatory credit is
             involved. Although three of the collection accounts occurred more than two
             years prior to closing, the lender still failed to obtain an explanation for each
             collection account. However, the most significant account is the $9,139 auto
             loan charge-off, which occurred within a year of loan closing. FHA mortgage
             credit analysis is independent of the analysis other lenders on separate
             transactions may have performed in the past. Our analysis indicates a disregard
             for credit, evidenced by multiple collection accounts and a current high
             outstanding balance of $31,343 for three accounts. Having multiple derogatory
             accounts requires strong compensating factors and analysis from the lender,
             both which were absent.

             As stated by Assurity, a letter of explanation for inquiries was not obtained.
             Regardless of the make-up of the inquiries, the lender is responsible for
             obtaining a letter of explanation for recent inquiries.

Comment 23   For loan number 023-2343260, we disagree with Assurity’s analysis on
             excessive ratios and compensating factors. Neither the loan file or the Assurity
             response contain any documentation showing the $60,000 second mortgage
             obtained within a month of closing was used to pay off any outstanding debt.
             HUD Handbook 4155.1 Rev. 5, Chapter 2, Section 2-3 states, ―The lender must
             ascertain the purpose of any recent debts…‖ The credit report ordered March
             20, 2006 does not show the second mortgage listed in the URLA with a balance
             of $63,931 (the number of monthly payments remaining is not shown on the
             URLA).

             According to the URLA, the borrower’s mortgage payment actually went from
             $976 to $1,474, an increase of $498. Neither the loan file or the Assurity
             response contain documentation showing the second mortgage obtained within a
             month of closing was used to pay off any outstanding debt. Therefore, the
             revolving debt of $317 was appropriately included in the calculation of
             qualifying ratios.

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             The equity of 10 percent in the subject property from the refinance is not a valid
             compensating factor. The loan is a refinance transaction and, therefore does not
             include a downpayment. The compensating factor cited by Assurity only
             applies to a purchase transaction, HUD Handbook 4155.1, REV-5, paragraph 2-
             13(B). Although the potential for increased wages is a valid compensating
             factor, the loan file did not indicate this is the situation. The VOE shows a
             decrease in overtime earnings and the borrower’s last pay increase, within a
             month of closing, to be only $0.40 per hour. There is nothing in the loan file
             that would have indicated the potential for increased earnings to lend itself as a
             compensating factor.

Comment 24   For loan number 052-4311569, we disagree with Assurity’s analysis on income.
             We do not disagree with the way the lender has described how the underwriter
             documented the borrower’s income. However, it continues to fall short of
             meeting required documentation standards for employment verification. The
             significance of employment verification is to verify the employer, earnings,
             stability, and likelihood of continuance. None of the documents provided verify
             stability or likelihood of continuance. Of the five documents provided by
             Assurity, only one (IRS W-2s for years 2005, 2006, and 2007) satisfies
             alternative documentation standards. However, no W-2 was provided for the
             current employer. The paystub did not cover a 30 day period. The bank
             statements are not a valid source of employment verification. The Rapid
             Reporting statement is no different than an IRS W-2 and is not a valid source of
             employment verification. The IRS tax transcripts, again, are no different than
             an IRS W-2.

Comment 25   For loan number 052-4311569, we disagree with Assurity’s analysis on
             excessive ratios and compensating factors. The MCAW does not list any
             compensating factors, as required. The borrower’s conservative attitude toward
             credit was identified in the report as a compensating factor. However, it was
             determined to be insufficient to overcome the excessive qualifying ratios,
             especially considering the borrower’s volatile previous employment history.

             We agree there was a minimal increase in the housing expense. The report has
             been revised to show it is a valid compensating factor. However, this does not
             change our decision. The lender failed to identify compensating factors on the
             MCAW. Even with two compensating factors, the loan should still not have
             received FHA loan approval due to the borrower’s unstable previous
             employment and the significant lack of employment verification as discussed
             above.

Comment 26   For loan number 095-0485724, we disagree with Assurity’s analysis on income.
             We agree with Assurity in that paystubs as stated were in fact provided in the
             loan file and the report has been updated accordingly. However, the loan file
             still exhibits inconsistencies that should have been cleared by the lender. The
             VOE for the current employer does not state the probability of continued

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             employment. Between June 20, 2005 and loan closing, the borrower held four
             different jobs, indicating job instability. An adequate explanation was not
             provided. There were W-2s for previous employer AFC for 2005 and 2006,
             however, the VOE indicates the borrower worked for AFC from December 1,
             2006 through August 6, 2007.

             Further analysis indicates the lender failed to properly calculate the borrower’s
             income. Due to the borrower’s inconsistent employment history, current
             earnings evidenced by the pay stubs and not previous earnings should have been
             used for qualification. As stated by Assurity, average earnings were used to
             calculate income, which includes earnings from previous employment. The
             lender should have used the $18 hourly rate of the current employer as listed in
             the four paystubs in the loan file. Although the VOE for the current employer
             states an average of 30.25 hours per week, we used a conservative work week of
             40 hours to reflect hours illustrated in the paystubs. We determined monthly
             earnings of $3,120 ($18/hour x 40 hours x 52 weeks divided by 12 months), a
             difference of $519 from the $3,639 used on the MCAW.

Comment 27   For loan number 095-0485724, we disagree with Assurity’s analysis on
             excessive ratios and compensating factors. Using the appropriately OIG
             recalculated income above, the mortgage payment-to-income and total fixed
             payment-to-income ratios are 56.61 percent, significantly excessive. As stated
             in the memorandum, only one compensating factor exists, the borrower’s clean
             mortgage history, which is clearly not sufficient to overcome significantly
             excessive qualifying ratios.

Comment 28   For loan number 052-3849541, we agree with Assurity’s analysis on liabilities.
             We agree with Assurity’s analysis regarding the $834 liability. The loan has
             been removed from the memorandum, dropping the total loans identified with
             significant underwriting deficiencies to eight. Removal of the $155 monthly
             payment from the total fixed-to-income ratio results in a ratio of 43 percent,
             within acceptable limits. However, exclusion of the student loan is still
             inappropriate given the lack of documentation and continues to represent an
             underwriting deficiency.

Comment 29   For loan number 093-6106930, we agree with Assurity’s analysis on income.
             We agree with Assurity’s assessment citing the online verification as an
             adequate VOE. HUD Handbook 4155.1 REV-5, Chapter 3, Section 3-1 states
             the VOE may be faxed documents or printed pages from the Internet if they
             clearly identify their sources (e.g., contain the names of the borrower’s
             employer). Therefore, this segment of the finding has been removed from the
             memorandum.

Comment 30   For loan number 093-6106930, we agree with Assurity’s analysis on liabilities.
             We accept Assurity’s assessment of the updated credit report. The recurring
             liability was appropriately excluded from qualifying ratio calculations. The

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             result is a total fixed payment-to-income ratio of 43.71 percent, not materially
             excessive. Therefore, the loan has been removed from the memorandum report
             and associated appendix. However, the loan still presents underwriting
             deficiencies of failing to explain the payment of debt and failing to obtain letters
             of explanation for derogatory credit accounts.

Comment 31   For loan number 052-4174471, after additional analysis, we determined the
             excessive mortgage payment-to-income ratio of 35.89 percent is not material
             because the total fixed payment-to-income ratio of 39.09 is four percent below
             the acceptable limit. Therefore, the loan has been removed from the report and
             associated appendix, dropping the total loans identified with significant
             underwriting deficiencies to eight. However, the loan still presents
             underwriting deficiencies in the areas of a lack of compensating factors for the
             excessive mortgage payment-to-income ratio, unexplained collection accounts
             and inadequately documented gift funds.

Comment 32   For loan number 052-4197834, we disagree with Assurity’s conclusion that gift
             funds were adequately documented in the file. However, after further analysis,
             we determined the mortgage payment-to-income ratio and total fixed payment-
             to-income ratio of 28.27 were well within acceptable limits of 31 and 43
             percent, respectively. Therefore, the loan has been removed from the
             memorandum report and associated appendix. However, the loan still presents
             underwriting deficiencies in the areas of unexplained collection accounts with a
             significant balance of $6,034 and inadequately documented gift funds.

Comment 33   For loan number 023-2397348, we disagree with Assurity’s analysis on
             excessive ratios and compensating factors. Although the $125 and $35
             collections appear repetitious, Assurity failed to obtain or provide
             documentation showing the numerous collection accounts were duplicates.

             After further analysis, the borrower’s conservative attitude towards credit could
             be a valid compensating factor. The appendix has been updated accordingly.
             However, it is still not considered a compensating factor because the HUD
             Handbook 4155.1, REV-5, paragraph 2-13(C) requirement states ―the borrower
             has demonstrated an ability to accumulate savings and a conservative attitude
             toward the use of credit.‖ Both factors must be present. The report states the
             borrowers did not demonstrate the ability to accumulate savings because of the
             lack of supporting asset documentation, agreed to by Assurity in its response.
             Therefore, this is not a valid compensating factor.

             We disagree with Assurity’s assessment of the borrower’s housing expenses.
             The URLA shows the then current housing expense as $1,471 and the new
             housing expense as $1,717. The credit explanation letter provided by the
             borrower also stated that it was their understanding the housing expenses were
             increasing $223, from $1,471 to $1,717. Assurity did not provide additional
             documentation to indicate otherwise.

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             We disagree with Assurity’s assessment of the borrower’s potential future
             earnings. Although training opportunities could be present at the borrower’s
             employer, the loan file does not contain documentation indicating enrollment or
             future enrollment. While the VOE does indicate a previous increase of three
             percent and a projected unknown increase in July 2007, this appears to be an
             annual wage increase and not reflective of a significant pay increase. Based on
             the documentation in the loan file, there is no evidence of the borrower’s
             potential for increased earnings through job training or education. We disagree
             that 10 percent equity is an appropriate compensating factor. The loan is a
             refinance transaction and, therefore does not include a downpayment. The
             compensating factor cited by Assurity only applies to a purchase transaction,
             HUD Handbook 4155.1, REV-5, paragraph 2-13(B).

Comment 34   For loan number 052-4152809, we agree with Assurity’s analysis on income,
             citing the online verification as an acceptable VOE, acceptable paystubs and W-
             2s. HUD Handbook 4155.1 REV-5, Chapter 3, Section 3-1 states the VOE may
             be faxed documents or printed pages from the Internet if they clearly identify
             their sources (e.g., contain the names of the borrower’s employer). The
             qualifying ratios of 28.37 and 39.05 percent are within acceptable limits.
             Therefore, the loan has been removed from the memorandum report and
             associated appendix.

Comment 35   For loan number 094-5402355, Assurity has agreed with our position and stated
             the rental income was calculated incorrectly. Therefore, no changes were made
             to the memorandum or associated appendix.

Comment 36   For loan number 094-5402355, we disagree with Assurity’s assessment of
             excessive ratios and compensating factors. The borrower’disposable income
             can only be considered a compensating factor if it is documented the borrower
             has the ability to accumulate savings and/or significant cash reserves as a result
             of the disposable income (HUD Handbook 4155.1 REV-1, chapter 2, paragraph
             2-13(C) and 2-13(G)). The loan file did not contain documentation illustrating
             either compensating factor.

Comment 37   For loan number 052-4159366, we disagree with Assurity’s assessment of
             excessive ratios and compensating factors. While we agree the 2005 and 2006
             tax returns indicate increased year-over-year earnings, we conclude this is not a
             valid compensating factor. The loan file does not include any documentation to
             show the potential for increased earnings indicated by job training or education
             in the borrower’s profession, as required by HUD Handbook 4155.1, REV-5,
             paragraph 2-13(I).

             Assurity discussed the borrower’s mortgage payment remaining at the same
             level with the refinance. We acknowledged in the report that no late mortgage
             payments satisfied the compensating factor requirement of successfully
             demonstrating the ability to pay housing expenses equal to or greater than the

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             proposed monthly housing expense for the new mortgage. However, this
             compensating factor is not sufficient to overcome significantly excessive
             qualifying ratios of 37.70 and 51.38 percent.

             We disagree with Assurity’s assessment on the reduction of debt as a
             compensating factor. According to the HUD-1 and the credit report, the

             borrower only paid off $9,745 in debts, reducing the recurring liabilities by
             $408. However, $21,195 was still outstanding with a recurring liability of $659.
             The $659 was appropriately included in the calculation of the total fixed
             payment-to-debt ratio. The payoff of debts and total reduction of liabilities is
             not a valid compensating factor as this was incorporated into the calculation of
             the total fixed payment-to-income ratio which resulted in a significantly
             excessive percentage of 51.38 percent.

Comment 38   Assurity questions the basis of not adhering to all GAGAS requirements. We
             disagree as our review objective was the basis for the limited scope and the
             appropriate decision to target our review efforts on a review of underwriting and
             specific loan files. Our review was focused on underwriting and the associated
             risks to the FHA insurance program. It was not necessary to adhere to all
             aspects of GAGAS to accomplish our objective and maintain a complete and
             accurate reporting product. See also comment 7.




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