Department of Housing and Urban Development, Office of Inspector General | Housing and Urban Development | Alethes, LLC, Lakeway, TX, Did Not Properly Underwrite a Selection of FHA Loans

Alethes, LLC, Lakeway, TX, Did Not Properly Underwrite a Selection of FHA Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-09-08.

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

September 8, 2010
Audit Report Number

2010-LA-1807

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

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

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

SUBJECT: Alethes, LLC, Lakeway, TX, Did Not Properly Underwrite a
Selection of FHA Loans

INTRODUCTION

We reviewed 20 Federal Housing Administration (FHA) loans Alethes, LLC (Alethes),
underwrote as a FHA direct endorser. Our review objective was to determine whether Alethes
underwrote the 20 loans in accordance with FHA requirements. This review was 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
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 U.S. Department of Housing and Urban Development (HUD)
Handbook 2000.06, REV-3. Please furnish us copies of any correspondence or directives issued
because of the review.

The complete text of the lender’s response, along with our evaluation of that response, can be
found in appendix C of this memorandum.
SCOPE AND METHODOLOGY

Alethes is one of 15 direct endorsers we selected from HUD’s publicly available Neighborhood
Watch1 system (system) for a review of underwriting quality. These direct endorsers 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 Alethes that defaulted within the first 30 months and (1)
that were not streamlined refinanced, (2) that were not electronically underwritten by Fannie
Mae or Freddie Mac, and (3) in which an association existed with an underwriter (usually an
individual) with a high number of claims.

BACKGROUND

Alethes was a nonsupervised direct endorsement lender based in Lakeway, TX. FHA approved
Alethes as a direct endorser in July 2001; however, Alethes’ direct endorsement approval was
withdrawn for 3 years by the Mortgagee Review Board in May 2010. FHA’s mortgage
insurance programs help low- and moderate-income families become homeowners by lowering
some of the costs of their mortgage loans. FHA mortgage insurance also encourages lenders to
approve mortgages for otherwise creditworthy borrowers that might not be able to meet
conventional underwriting requirements by protecting the lender against default. The direct
endorsement program simplifies the process for obtaining FHA mortgage insurance by allowing
lenders to underwrite and close the mortgage loan without prior HUD review or approval.
Lenders are responsible for complying with all applicable HUD regulations and are required to
evaluate the borrower’s ability and willingness to repay the mortgage debt. Lenders are
protected against default by FHA's Mutual Mortgage Insurance Fund, which is sustained by
borrower premiums.

The goal of Operation Watchdog is to determine why there is such a high rate of defaults and
claims. We selected 20 loans in claim status for each of the 15 lenders. The 15 lenders selected
for Operation Watchdog endorsed 183,278 loans valued at $31.3 billion during the period
January 2005 to December 2009. These same lenders also submitted 6,560 FHA insurance
claims with an estimated value of $794.3 million from November 2007 through December 2009.
During this period, Alethes endorsed 8,162 loans valued at more than $944 million and
submitted 801 claims worth $92.6 million.

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

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

1
Neighborhood Watch is a system that aids HUD/FHA staff in monitoring lenders and FHA 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 lenders performance.

2
consider the internal controls or information systems controls of the lenders reviewed, consider
the results of previous audits, or communicate with lender 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 audit results.

RESULTS OF REVIEW

Alethes did not properly underwrite 19 of the 20 loans reviewed because its underwriters did not
follow FHA’s requirements. As a result, the FHA insurance fund suffered actual losses of more
than $1 million, as shown by the following table.

Number of payments
FHA/loan number Closing date before first default Original mortgage amount Actual loss to HUD
491-8729593 1/9/2006 0 $109,061 $42,852
491-8747204 11/23/2005 9 $161,665 $88,177
491-8766328 4/21/2006 3 $96,425 $72,032
491-8817515 6/28/2006 1 $111,072 $51,782
491-8842946 8/4/2006 0 $79,170 $51,177
491-8846382 9/26/2006 0 $148,724 $70,908
491-8856548 8/23/2006 1 $135,178 $95,916
491-8875185 10/26/2006 2 $52,584 $39,424
491-8913905 1/23/2007 2 $95,057 $72,375
491-8927014 3/7/2007 12 $143,939 $59,749
491-8932218 3/19/2007 0 $126,500 $61,236
491-9013914 8/27/2007 1 $137,837 $35,618
491-9042939 10/5/2007 10 $125,874 $43,392
491-9052920 11/15/2007 8 $158,543 $26,748
491-9067953 1/11/2008 0 $185,095 $66,613
491-9081188 1/3/2008 2 $114,991 $50,464
492-7753781 1/24/2007 2 $141,479 $70,991
492-7916830 11/15/2007 1 $137,944 $26,570
492-7963491 3/12/2008 0 $107,315 $30,423
Totals $2,368,453 $1,056,447

The following table summarizes the material deficiencies that we identified in the 19 loans.

Number of
Area of noncompliance loans
Income 6
Liabilities 4
Excessive ratios 8
Assets 8
Gift funds 10
Credit history 18
Verification of rent 1

3
Appendix A shows a schedule of material deficiencies in each of the 19 loans. Appendix B
provides a detailed description of all loans with material underwriting deficiencies noted in this
report.

Income

Alethes improperly included unsupported income in calculations of borrowers’ ratios in six
loans. It did not properly document part-time income, child support income, overtime income,
Supplemental Security Income (SSI), and employment history. HUD requires that employment
be verified for 2 full years and income be analyzed to determine whether it is expected to
continue through at least 3 years (see appendix B for detailed requirements).

For example, for loan number 491-8856548, the borrower held a part-time job for only 17½
months. Since the job was not held, uninterrupted, for the past 2 years, the income could only be
used as a compensating factor. Alethes improperly included $1,320 in the borrower’s monthly
income.

For loan 491-9081188, the borrower’s three latest pay stubs included in the file showed no
overtime income earned but showed year-to-date overtime of $3,835. No overtime should have
been included in the borrower’s monthly income since there was no documented evidence that
the borrower would continue to earn overtime income.

Liabilities

Alethes did not properly assess the borrowers’ financial obligations for four loans. HUD
requires lenders to consider debts that would affect the borrowers’ ability to make mortgage
payments during the months immediately after loan closing, obligations of a nonpurchasing
spouse in a community property State, and projected student loan payments to begin within 12
months of the mortgage loan closing in its underwriting analysis (see appendix B for detailed
requirements).

For example, for loan number 491-9081188, the borrower’s credit report revealed an account
with an outstanding balance of $3,800 and eight remaining monthly payments of $475 that was
not included in the qualifying ratios. All recurring charges extending 10 months or more must be
included in computing the debt-to-income ratios, and debts lasting less than 10 months must be
included if the monthly amount affects the borrower’s ability to make mortgage payments
immediately after closing. We considered this payment to be significant because it was 21.3
percent of the borrower’s supported monthly income of $2,227 and would most likely have
affected the borrower’s ability to make the mortgage payment during the months immediately
after loan closing.

For loan number 491-8747204, the borrower’s spouse had a $13,323 debt on her credit report for
past-due child or family support payable to an attorney general’s office with a monthly payment
of $365. Since the property being purchased was in a community property State, this debt should
have been included in the calculation of the borrower’s debt-to-income ratios.

4
Excessive Debt Ratios

Alethes improperly approved eight loans in which the borrowers’ qualifying ratios exceeded
FHA’s guidelines without identifying strong compensating factors. Effective April 13, 2005, the
mortgage payment-to-income and total debt-to-income ratios were increased to 31 and 43
percent, respectively. If either or both ratios are exceeded on a manually underwritten mortgage,
the lender is required to describe the compensating factors used to justify the mortgage approval
(see appendix B for detailed requirements).

For example, for loan number 491-8747204, Alethes calculated the borrower’s debt-to-income
ratios at 34.303 and 43.345 percent but did not list compensating factors. After our review of the
FHA file and all documents provided by the lender in response to the subpoena issued as part of
Operation Watchdog3, we found no documentation to support any of the acceptable
compensating factors. Income earned by the nonpurchasing spouse could have been used as a
compensating factor if the income had been documented sufficiently.

For loan 492-7963491, Alethes approved the loan with excessive ratios and inadequate
compensating factors. As originally calculated, the mortgage payment-to-income and total debt-
to-income ratios were 39.85 percent. The lender inappropriately used an incorrect mortgage
payment amount when calculating the qualifying ratios. The mortgage credit analysis
worksheet4, dated February 29, 2008, used $989 as the mortgage payment including taxes and
insurance. However, the truth in lending statement, dated March 12, 2008, and first payment
letter indicated a mortgage payment including taxes and insurance of $1,132. The mortgage
payment-to-income and total debt-to-income ratios, as recalculated after considering the $1,132
mortgage payment, increased to 45.63 percent. Alethes’ underwriter listed four compensating
factors, but none were documented, acceptable compensating factors.

Assets

Alethes did not properly verify borrowers’ assets for eight loans. HUD requires lenders to verify
the source of earnest money deposits that are more than 2 percent of sales price or that appear
excessive based on the borrower’s history of accumulating savings. HUD also requires lenders
to obtain a verification of deposit or, alternatively, the borrower’s bank statements listing the
ending balance of a 3-month period and obtain a credible explanation for any large increase in an
account (see appendix B for detailed requirements).

For example, for loan number 492-7963491, the borrower’s earnest money deposit of $1,500 was
excessive based on his savings. The borrower’s bank statement showed that his ending balance
one day before the earnest money deposit was made was only $150. The bank statement also did
not show additional transactions supporting the earnest money deposit. The lender did not
otherwise verify the source of funds used for the earnest money deposit.

3
Each of the 15 lenders selected under Operation Watchdog was served an Inspector General subpoena for all files
and documents related to the loans reviewed.
4
The mortgage credit analysis worksheet is used by a lender to record calculations, comments, and other
information considered in determining whether a borrower has the funds to close and the capacity to repay a
mortgage.

5
For loan number 491-9013914, Alethes did not document the source of two large deposits to the
coborrower’s checking account totaling $2,335. All funds for the borrower’s investment in the
property must be verified and documented. A deposit of $885 on May 30, 2007, required an
explanation since it was $200 more than any other deposit listed on the statement. A deposit of
$1,450 on May 25, 2007, required explanation because it exceeded all of the other deposits on
the statement by more than $700. All of the other large deposits shown on the statements were
from the coborrower’s employer. The beginning and ending balances in the account between
April 27 and June 26, 2007, did not exceed $2,129. These two deposits were 41.6 and 68.1
percent of this amount, respectively. The lender must obtain a credible explanation of the source
funds if there is a large increase in an account.

Gift Funds

Alethes did not document the transfer of gift funds to the borrower for 10 loans. HUD requires
evidence that gift funds are transferred from the donor’s account to the borrower or to the
settlement company on behalf of the borrower and that these funds came from an acceptable
source (see appendix B for detailed requirements).

For example, for loan number 491-8846382, the gift letter indicated that the borrower received a
$5,000 gift from DPA Alliance Corporation. The transfer of these funds to the settlement
company on behalf of the borrower was not documented in the FHA file or the lender file.

For loan number 491-9042939, the gift letter indicated that the borrower received a gift of
$7,612 from Nehemiah Corporation of America. The transfer of the funds from the donor to the
settlement company on behalf of the borrower was not documented in the file.

Credit History

Alethes did not properly evaluate the borrowers’ credit histories for 18 loans. It did not
document its reason(s) for accepting a number of collections, charge-offs, and judgments,
especially those for housing and utilities (see appendix B for detailed requirements).

For example, for loan number 491-8932218, the borrowers had 62 collection accounts and 15
charge-offs. Of these 62 collections, 15 accounts were opened within the 24 months preceding
the loan closing. The borrower had two charged-off accounts for electric service and three
judgments filed by an apartment complex. The borrower explained the majority of these
delinquent debts, and Alethes’ underwriter listed five compensating factors, but only one was
acceptable and documented.

For loan number 491-9067953, the borrowers’ credit report listed 36 collection accounts.
Sixteen of these were opened within 24 months of loan closing. The borrowers’ credit report
also showed 10 charge-offs, with 1 of the 10 being opened within 24 months of loan closing.
Older collections and charge-offs for electric and phone service also appeared on the borrowers’
credit report. The borrowers explained the majority of these debts, but Alethes did not provide
strong, supported compensating factors, given the borrowers’ credit history.

6
Verification of Rent

For loan number 491-8766328, Alethes did not properly verify the borrowers’ rental history for
12 months, as required by HUD. The lender only verified the borrower’s and coborrower’s
previous rental history for 9 months, and several different addresses were used as the borrowers’
current residence on the forms in the loan file without explanation.

Incorrect Underwriter’s Certifications Submitted to HUD

We reviewed the certifications for the 19 loans with material underwriting deficiencies for
accuracy. Alethes’ direct endorsement underwriters incorrectly certified that due diligence was
used in underwriting the 19 loans. When underwriting a loan manually, HUD requires a direct
endorsement lender to certify that it used due diligence and reviewed all associated documents
during the underwriting of a loan.

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

RECOMMENDATIONS

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

1A. Determine legal sufficiency and if legally sufficient, pursue remedies under the Program
Fraud Civil Remedies Act against Alethes and/or its principals for incorrectly certifying
to the integrity of the data or that due diligence was exercised during the underwriting of
19 loans that resulted in losses to HUD totaling $1,056,447, which could result in
affirmative civil enforcement action of approximately $2,255,394.5

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

1B. Take appropriate administrative action against Alethes 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.

5
Double damages plus a $7,500 fine for each of the 19 infractions.

7
Schedule of Ineligible Cost 1/

Recommendation number Amount

1A $1,056,447

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

8
Appendix A

SUMMARY OF MATERIAL UNDERWRITING DEFICIENCIES

Incomplete verification of rent history
Significant credit-related deficiencies
Unsupported income or questionable

Excessive debt-to-income ratio

Insufficient gift documentation
Underreported liabilities
employment history

Unsupported assets

or no credit
FHA loan number

491-8729593 X X X
491-8747204 X X X X
491-8766328 X X X X X
491-8817515 X X X X
491-8842946 X
491-8846382 X X
491-8856548 X X X X X X
491-8875185 X X
491-8913905 X X
491-8927014 X X
491-8932218 X
491-9013914 X X
491-9042939 X X X X
491-9052920 X X
491-9067953 X X
491-9081188 X X X X X X
492-7753781 X
492-7916830 X
492-7963491 X X X X X

9
Appendix B

LOANS WITH MATERIAL UNDERWRITING DEFICIENCIES

Loan number: 491-8729593

Mortgage amount: $109,061

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: January 9, 2006

Status as of June 2, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $42,852

Summary

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

Income

Alethes overstated the borrower’s child support income by $328.90 per month. The borrower
received monthly child support payments of $150 for one child and $286.16 for another child.
The $150 per month child support payments were adequately documented and supported by a
court order, corresponding deposits to the borrower’s bank account, and payment records from
the Texas Attorney General for the preceding 12-month period. However, the $286.16 child
support payments were supported only by deposits of $143.08 from the Texas Attorney General
twice a month as shown on the borrower’s bank statements. A note in the FHA file on the
borrower’s bank statement indicated that the $143.08 child support payment twice a month
would not be counted. Nevertheless, both monthly payments were “grossed up” to $172.50 and
$328.90 per month, respectively, and included as other income in calculating the borrower’s
debt-to-income ratios. Recalculating the borrower’s ratios without considering $328.90 in child
support income results in ratios of 34.5 and 51 percent. Both of these ratios exceed HUD’s
acceptable ratios of 31 and 43 percent. However, the property purchased was a newly
constructed energy-efficient home (EEH). The benchmark qualifying ratios may both be
exceeded by up to 2 percentage points when the borrower is purchasing an EEH according to

10
HUD Handbook 4155.1, paragraph 2-19. Both of the recalculated ratios still exceeded 33
percent and 45 percent.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-7F, states that child support income may be
considered as effective if such payments are likely to be consistently received for the first 3 years
of the mortgage. The borrower must provide a copy of the final divorce decree, legal separation
agreement, or voluntary payment agreement, as well as evidence that payments have been
received during the last 12 months. Mortgagee Letter 2005-16 states that for manually
underwritten mortgages for which the direct endorsement underwriter must make the credit
decision, the qualifying ratios are raised to 31 and 43 percent. Mortgagee Letter 2005-16 also
states that properly documented child support can be grossed up under the same terms and
conditions as other nontaxable income sources. HUD Handbook 4155.1, REV-5, paragraph 2-
19, states that the benchmark qualifying ratios may both be exceeded by up to 2 percentage
points when the borrower is purchasing an EEH.

Excessive Debt Ratios

Alethes calculated the borrower’s debt-to-income ratios at 30.85 and 45.61 percent, respectively,
but still listed three compensating factors to justify approving the mortgage. The compensating
factors listed on the mortgage credit analysis worksheet were either not acceptable according to
HUD Handbook 4155.1, paragraph 2-13, or not supported by documentation included in the file.
The compensating factors listed were (1) potential pay increase, (2) first-time home buyer, (3)
new construction-EEH, and (4) minimum increase in house expense. The borrower’s potential
for pay increase was not supported by evidence of job training or education in the borrower’s
profession. First-time home buyer is not an acceptable compensating factor. New construction-
EEH is not an acceptable compensating factor listed in the handbook. However, since the
property purchased was a newly constructed EEH, the benchmark ratios could be exceeded up to
2 percent, resulting in maximum ratios of 33 and 45 percent according to HUD Handbook
4155.1, paragraph 2-19. The borrower’s housing expense increased by $211 per month or 28
percent. No compensating factors were supported by documentation in the file.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be
used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are
those listed in the handbook. Underwriters must record in the “remarks” section of the form
HUD-92900 (mortgage credit analysis worksheet) the compensating factor(s) used to support
loan approval. A compensating factor used to justify mortgage approval must be supported by
documentation.

11
Assets

Alethes did not document the source of the borrower’s earnest money deposit as required when
the deposit seems excessive based on the borrower’s history of accumulated savings. The
borrower’s earnest money deposit was a $500 money order. However, the borrower’s checking
account balance was less than $25 on the day the money order was purchased. Also, the earnest
money deposit was made before the borrower received an $800 gift from her cousin.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-10A, requires the lender to verify with
documentation the deposit amount and the source of funds if the amount of the earnest money
deposit exceeds 2 percent of the sales price or appears excessive based on the borrower’s history
of accumulating savings.

12
Loan number: 491-8747204

Mortgage amount: $161,665

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: November 23, 2005

Status as of June 2, 2010: Claim

Payments before first default reported: Nine

Loss to HUD: $88,177

Summary

We found material underwriting deficiencies relating to the borrower’s liabilities, debt-to-income
ratios, gift funds, and credit history.

Liabilities

Alethes improperly omitted the debt of a nonpurchasing spouse from liabilities used to calculate
the borrower’s qualifying debt-to-income ratios. The borrower’s spouse had a $13,323 debt on
her credit report for past-due child or family support payable to an attorney general’s office with
a monthly payment of $365. The borrower’s total recurring expenses of $763 ($398 plus $365)
should have been used in calculating the borrower’s debt-to-income ratios. Recalculation of the
borrower’s total fixed payment-to-income resulted in a ratio of 51.636 percent. Texas is a
community property State.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-2D, states that except for the obligations
specifically excluded by State law, the debts of the nonpurchasing spouse must be included in the
borrower’s qualifying ratios if the borrower resides in a community property State or the
property to be insured is located in a community property State. Although the nonpurchasing
spouse’s credit history is not to be considered a reason for credit denial, a credit report must be
obtained for the nonpurchasing spouse to determine the debt-to-income ratio.

Excessive Debt Ratios

Alethes calculated the borrower’s debt-to-income ratios at 34.303 and 43.345 percent but did not
list compensating factors. After our review of the FHA file and all documents provided by the
lender in response to the subpoena, we found no documentation to support any of the acceptable

13
compensating factors listed in HUD Handbook 4155.1, paragraph 2-13. Income earned by the
nonpurchasing spouse could have been used as a compensating factor if the income had been
documented sufficiently.

HUD/FHA Requirements

Mortgagee Letter 2005-16 states that for manually underwritten mortgages for which the direct
endorsement underwriter must make the credit decision, the qualifying ratios are raised to 31 and
43 percent. HUD Handbook 4155.1, REV-5, paragraph 2-13, states that a compensating factor
used to justify mortgage approval must be supported by documentation.

Gift Funds

Alethes did not document the transfer of gift funds to the borrower as required. The gift letter
indicated that the borrower received a $4,485 gift from The Genesis Foundation, Inc. The
transfer of these funds to the settlement company on behalf of the borrower was not documented
in the FHA file or the lender file.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-10C2, states that regardless of when the gift funds
are made available to the home buyer, the lender must be able to determine that the gift funds
ultimately were not provided from an unacceptable source and were indeed the donor’s own
funds. When the transfer occurs at closing, the lender remains responsible for obtaining
verification that the closing agent received funds from the donor for the amount of the purported
gift and that those funds came from an acceptable source.

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections and
charged-off accounts, especially those for housing and utilities. The borrower’s credit report
listed 12 accounts in collections. Three of the twelve collection accounts were opened less than
24 months before the loan closed. Two of the three accounts were medical debts; the third
account was for telephone service. The borrower explained that the telephone account was
prepaid and should never have appeared on his credit report. The borrower did not give an
explanation for the medical debts. Two of the older collection debts were for past apartments
rented by the borrower. The borrower explained that his debt to one apartment complex resulted
from fees for carpet and cleaning charged when he moved out. The debt was $1,621, and the
borrower explained that the apartment complex also kept his deposit. The borrower’s
explanation for his other debt owed on an apartment he rented was that he had to move in with
his parents to get on his feet and get a better job.

The borrower also had four charged-off accounts on his credit report. Two of the four charge-
offs were for electric service. The borrower explained that he called to disconnect service when
he moved out, but the service was not disconnected, and the utility charged the borrower for

14
service provided to the new resident. The borrower explained that he was not sure what the
second account was for. One of four charged-off accounts was an auto loan. The borrower
explained that he returned the car in lieu of repossession and did not expect to owe the remaining
balance of $12,654. The remaining charged-off debt was to a jeweler who the borrower
explained accelerated his loan, but the borrower could not pay in full and continued to make
monthly payments.

No compensating factors were documented to support Alethes’ decision to approve this loan
with the borrower’s credit history.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that the basic hierarchy of credit
evaluation is the manner of payments made on previous housing expenses, including utilities,
followed by the payment history of installment debts, and then revolving accounts. Generally,
an individual with no late housing or installment debt payments should be considered as having
an acceptable credit history, unless there is major derogatory credit on his or her revolving
accounts. 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 derogatory information occurring 2 or more years in the
past does not require explanation, major indications of derogatory credit–including judgments,
collections, and other recent credit problems–require sufficient written explanation from the
borrower. The lender must document its reason for approving a mortgage when the borrower has
collection accounts or judgments.

Paragraph 2-3 also states that 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.

15
Loan number: 491-8766328

Mortgage amount: $96,425

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: April 21, 2006

Status as of June 2, 2010: Claim

Payments before first default reported: Three

Loss to HUD: $72,032

Summary

We found material underwriting deficiencies relating to the borrowers’ income, debt-to-income
ratios, assets, credit history, and rental history.

Income

Alethes improperly used the coborrower’s $693.45 SSI income in calculating monthly income.
The SSI was documented by only the first page of a multiple page document from the Social
Security Administration (SSA) and refers to figures listed on later pages. The first page did not
indicate whether or for how long the income was to continue and was dated more than 120 days
before loan closing. Since there was no documentation verifying that the SSI income would
continue for a full 3 years, it should not have been used to calculate monthly income. No newer
documents from SSA were found in the FHA or lender file. Recalculation of the borrowers’
ratios without considering this income resulted in ratios of 39.007 and 56.373 percent.

HUD/FHA Requirements

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. Paragraph 2-7E
states that retirement and Social Security income require verification from the source (former
employer, SSA) or Federal tax returns. If any benefits expire within the first full 3 years, the
income source may be considered only as a compensating factor. Paragraph 3-1 states that all
documents may be up to 120 days old at the time the loan closes (180 days for new construction)
unless this or other applicable HUD instructions specify a different timeframe or the nature of
the document is such that its validity for underwriting purposes is not affected by being older
than the number of prescribed days (e.g., divorce decrees, tax returns). Updated, written
verifications must be obtained when the age of the documents exceeds these limits.

16
Excessive Debt Ratios

Alethes did not list acceptable compensating factors supported by documentation to justify
approving the loan with ratios that exceeded the benchmarks set by HUD as required by HUD
Handbook 4155.1, paragraph 2-13. The ratios reported by Alethes were 30.250 and 43.720
percent. The following compensating factors were listed: (1) potential growth, (2) first-time
home buyer, (3) good rental, and (4) raise in April 2006. Potential growth is assumed to mean
potential growth in income; however, there was no evidence of job training or education in the
file to support this compensating factor. First-time home buyer is not an acceptable
compensating factor listed in HUD Handbook 4155.1. Good rental is assumed to refer to a
minimal increase in housing expenses or a demonstrated ability to pay higher housing expenses.
Neither was documented in this file. Rather, the borrowers’ housing expense increased by $360
per month. There was no documentation from the borrower’s employer to indicate that the
borrower received a raise in April 2006, the month that the loan closed.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be
used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are
those listed in the handbook. Underwriters must record in the “remarks” section of the form
HUD-92900 the compensating factor(s) used to support loan approval. A compensating factor
used to justify mortgage approval must be supported by documentation.

Assets

Alethes improperly verified the borrowers’ assets. All funds for the borrower’s investment in the
property must be verified and documented. The file contained a bank statement for only 1
month. The file did not contain a verification of deposit or at least 2 months of bank statements
as required.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 3-1, states that a verification of deposit and most
recent bank statements are to be provided. As an alternative to obtaining a verification of
deposit, the lender may obtain from the borrower original bank statement(s) covering the most
recent 3-month period. Provided the bank statement shows the previous month’s balance, this
requirement is met by obtaining the two most recent, consecutive statements. Paragraph 2-10
states that all funds for the borrower’s investment in the property must be verified and
documented.

17
Credit

Alethes did not document its reason(s) for accepting the borrowers’ history of collections and
charged-off accounts, especially those for housing and utilities. The borrowers had 19 collection
accounts listed on their credit reports. Two of these collection accounts were opened by the
borrowers in the 24 months before the loan closed. The borrowers’ credit reports also listed two
charged-off accounts.

One of the borrowers’ collection accounts was for an apartment. Another collection account was
for telephone service. Both charged-off accounts were for electric service. The borrowers
explained that illness and caring for a grandchild were the reasons for their collections and
charge-offs.

Alethes did not list acceptable compensating factors supported by documentation to justify loan
approval, given the borrowers’ credit history, as required by HUD Handbook 4155.1, paragraph
2-13 (see Excessive Debt Ratios section above).

HUD/FHA Requirements

Verification of Rent

Alethes did not properly verify the borrowers’ rental history for 12 months as required. The
lender only verified the borrower’s and coborrower’s previous rental history for 9 months. A
verification of rent was missing for the remainder of the 12 months required. There were also
some discrepancies noted with the borrower’s and coborrower’s addresses listed on the forms in
the FHA case file. Several different addresses were used as the borrowers’ current residence.

18
HUD/FHA Requirements

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

19
Loan number: 491-8817515

Mortgage amount: $111,072

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: June 28, 2006

Status as of June 2, 2010: Claim

Payments before first default reported: One

Loss to HUD: $51,782

Summary

We found material underwriting deficiencies relating to the borrower’s liabilities, debt-to-income
ratios, gift funds, and credit history.

Liabilities

Alethes improperly omitted a liability of $1,232 with a corresponding monthly payment of $402.
This payment should have been included in the calculation of the borrower’s ratios because it
would have affected the borrower’s ability to make mortgage payments in the months
immediately after loan closing, even though the borrower vehemently explained her plan to have
the debt paid in full by the time her first mortgage payment was due. Including this payment in
the borrower’s total fixed payment-to-income ratio would have resulted in a ratio of 52.336
percent.

HUD/FHA Requirements

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 additional recurring charges extending 10 months or more,
including payments on installment accounts, child support or separate maintenance payments,
revolving accounts and 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; this is especially true if the borrower will have limited or
no cash assets after loan closing.

20
Excessive Debt Ratios

Alethes did not list sufficient, acceptable compensating factors supported by documentation to
justify approving the loan with ratios that exceeded the benchmarks set by HUD as required by
HUD Handbook 4155.1, paragraph 2-13. Alethes calculated the borrower’s ratios at 37.990
percent and listed two compensating factors: (1) paying debt as scheduled, allowing more
income toward housing, and (2) receives documented income-not used for qualifying. The first
compensating factor listed is not an acceptable compensating factor listed in HUD Handbook
4155.1. The second compensating factor listed is an acceptable compensating factor supported
by documentation in the file. However, we do not consider this single compensating factor
strong enough to overcome the borrower’s recalculated ratios.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be
used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are
those listed in the handbook. Underwriters must record in the “remarks” section of the form
HUD-92900 the compensating factor(s) used to support loan approval. A compensating factor
used to justify mortgage approval must be supported by documentation.

Gift Funds

Alethes did not document the transfer of gift funds to the borrower as required. The gift letter
indicated that the borrower received a $2,850 gift from The Genesis Foundation, Inc. The
transfer of these funds to the settlement company on behalf of the borrower was not documented
in the FHA file or the lender file.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrowers’ history of collections and
charged-off accounts, especially those for housing and utilities. The borrowers had 15 collection
accounts listed on their credit reports. Six of these accounts were placed for collection in the 24
months before the loan closed. The borrowers’ credit reports also listed two charged-off
accounts.

21
Two of the borrowers’ collection accounts were for apartments. One of the borrowers explained
that she broke her lease because her unit had been broken into and she was assured that she
would not be held responsible for what was owed for the remainder of the lease. Another
collection account was for telephone service. The borrower explained that this bill may have
been from the apartment that she left and may have been overlooked. One of the two charged-
off accounts was for electric service, but the borrower claimed that she had not had service from
the electric company that placed the account for collection.

Alethes did not list acceptable compensating factors supported by documentation to justify loan
approval, given the borrower’s credit history, as required by HUD Handbook 4155.1, paragraph
2-13 (see Excessive Debt Ratios section above).

HUD/FHA Requirements

22
Loan number: 491-8842946

Mortgage amount: $79,170

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: August 4, 2006

Status as of June 2, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $51,177

Summary

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

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections and
charged-off accounts, especially those for utilities. The borrower had nine collection accounts
listed on his credit report and a history of late payments. Of these nine collection accounts, four
accounts were opened within the 24 months preceding the loan closing. One of the four accounts
was for telephone service. The other three accounts were for medical debts and a debt to a
public library. The borrower did not provide an explanation for these four collection accounts.

Alethes did not provide strong, supported compensating factors, given the borrower’s credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. Alethes’ underwriter listed the
following compensating factors to justify mortgage approval: (1) first-time home buyer, (2)
year-to-date income is higher than the average used to qualify, (3) limited credit user, and (4)
potential for bonus income. First-time home buyer is not an acceptable compensating factor
listed in HUD Handbook 4155.1. Income higher than the average used to qualify is also not a
valid compensating factor and any potential for increased earnings must be supported by
documentation of job training or education. The borrower was not a limited credit user as
evidenced by the multiple collection accounts on his credit report. To be eligible for a bonus, the
borrower must not be absent from work or late for work and have no accidents, injuries, or
disciplinary actions during the year. The borrower received a bonus of only $134 in 2005.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that the basic hierarchy of credit
evaluation is the manner of payments made on previous housing expenses, including utilities,

23
followed by the payment history of installment debts, and then revolving accounts. Generally,
an individual with no late housing or installment debt payments should be considered as having
an acceptable credit history, unless there is major derogatory credit on his or her revolving
accounts. 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 derogatory information occurring 2 or more years in the
past does not require explanation, major indications of derogatory credit–including judgments,
collections, and other recent credit problems–require sufficient written explanation from the
borrower. The lender must document its reason for approving a mortgage when the borrower has
collection accounts or judgments.

Paragraph 2-3 also states 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.

24
Loan number: 491-8846382

Mortgage amount: $148,724

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: September 26, 2006

Status as of June 2, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $70,908

Summary

We found material underwriting deficiencies relating to the borrower’s gift funds and credit
history.

Gift Funds

Alethes did not document the transfer of gift funds to the borrower as required. The gift letter
indicated that the borrower received a $5,000 gift from DPA Alliance Corporation. The transfer
of these funds to the settlement company on behalf of the borrower was not documented in the
FHA file or the lender file.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections and
charged-off accounts, especially those for housing and utilities. The borrower had 32 collection
accounts and six charge-offs listed on her credit report. Of these 32 collections, 4 accounts were
opened within the 24 months preceding the loan closing. One of the four accounts was for a
condominium complex. One older collection was for gas service, and two charged-off accounts
were for electric service. The other three recent collections were for medical and other debts.

25
No explanations were found in the FHA file. The lender file included the borrower’s explanation
that she experienced an illness between 2000 and 2005. The borrower recovered at the end of
2005. The borrower’s pay was also cut between 2004 and 2005. The borrower explained that
her insurance should have paid medical bills listed on her credit report.

HUD/FHA Requirements

26
Loan number: 491-8856548

Mortgage amount: $135,178

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: August 23, 2006

Status as of June 2, 2010: Claim

Payments before first default reported: One

Loss to HUD: $95,916

Summary

We found material underwriting deficiencies relating to the borrower’s income, liabilities, debt-
to-income ratios, assets, gift funds, and credit history.

Income

Alethes improperly included the borrower’s $1,319.82 monthly part-time employment income in
the calculation of her debt-to-income ratios. The borrower had not been working the part-time
job uninterrupted for the past 2 years, and Alethes did not justify and document that she would
continue to work the part-time job. Since the part-time position had been held for only 17½
months, the income earned could only be used as a compensating factor. In addition to
improperly including the part-time income, Alethes overstated the borrower’s income from her
primary employment. The monthly income listed in the file was $2,866, but the documents in
the file did not support this figure. The supported monthly income was $2,509.75, listed on the
verification of employment and all pay stubs included in the file. Recalculation of the
borrower’s ratios using only $2,509.75 monthly income results in ratios of 55.044 and 56.439
percent, while HUD’s benchmark ratios are 31 and 43 percent.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-7B, states that part-time/second job income may be
used in qualifying if the lender documents that the borrower has worked the part-time job
uninterrupted for the past 2 years and will continue to do so. Income from a part-time position
that has been received for less than 2 years may be included as effective income, provided the
lender justifies and documents that the income’s continuance is likely. Income from part-time
positions not meeting these requirements may be considered as a compensating factor only.

27
Liabilities

Alethes improperly excluded the borrower’s obligation to repay student loans from the
calculation of debt-to-income ratios. The borrower had $35,554 total student loan debt. The file
contained documentation showing that the borrower was enrolled in graduate school for the
spring 2006 semester. The first payment on the borrower’s student loan would likely be due in
November 2006, only 3 months after loan closing, if the spring semester ended in May 2006.
The lender did not obtain evidence of a planned graduation date from the university the borrower
attended. Without evidence that the loans would be deferred until at least 12 months after loan
closing, the monthly payment should have been included in calculating the borrower’s ratios. A
5 percent monthly payment on the student loans of $1,777.70 was used to recalculate the
borrower’s total fixed payment-to-income ratio of 76.309 percent, compared to the ratio listed on
the mortgage credit analysis worksheet of 33.840 percent.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-11C, states that if a debt payment, such as a
student loan, is scheduled to begin within 12 months of the mortgage loan closing, the lender
must include the anticipated monthly obligation in the underwriting analysis, unless the borrower
provides written evidence that the debt will be deferred to a period outside this timeframe. HUD
Handbook 4155.1, REV-5, paragraph 2-11A, 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).

Excessive Debt Ratios

Alethes’ underwriter calculated the borrower’s qualifying ratios at 33 and 33.84 percent and
listed the following compensating factors: (1) greater income potential, (2) 3 percent salary
increase-September 2006, (3) receive annual bonus of $1,200 in November, (4) not heavy credit
user, (5) has received ownership counseling, (6) increase in hours on part-time job. Only two of
these factors were supported by documentation in the file. The verification of employment from
the borrower’s primary employer did indicate that the borrower was to receive a 3 percent rate
increase shortly after loan closing, and the borrower’s part-time job can be used as a
compensating factor. Greater income potential was not documented with evidence of job
training or education in the borrower’s profession. There was no evidence in the file
documenting a history of bonuses received by the borrower. The borrower did not have a
conservative attitude toward the use of credit since her credit report included 30 accounts with
some collections and charge-offs. Attendance of housing counseling is not an acceptable
compensating factor listed in HUD Handbook 4155.1, paragraph 2-13.

28
HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be
used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are
those listed in the handbook. Underwriters must record in the “remarks” section of the form
HUD-92900 the compensating factor(s) used to support loan approval. A compensating factor
used to justify mortgage approval must be supported by documentation.

Assets

Alethes did not obtain a credible explanation of the source of a $2,000 deposit to the borrower’s
savings account. Since this was a large increase in the borrower’s balance, Alethes was required
to verify the source of the funds.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-10B, states that 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.

Gift Funds

Alethes also did not document the transfer of gift funds to the borrower as required. The gift
letter indicated that the borrower received a $5,300 gift from DPA Alliance Corporation. The
transfer of these funds to the settlement company on behalf of the borrower was not documented
in the FHA file or the lender file.

HUD/FHA Requirements

Credit

29
from her separation from her husband; she thought that he had taken care of the accounts. The
borrower also had a judgment showing on her credit report filed by a housing authority. The
borrower paid the judgment approximately 1 month before loan closing.

Alethes did not provide strong, supported compensating factors, given the borrower’s credit
history, as required by HUD Handbook 4155.1, paragraph 2-13 (see Excessive Debt Ratios
section above).

HUD/FHA Requirements

30
Loan number: 491-8875185

Mortgage amount: $52,584

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: October 26, 2006

Status as of June 2, 2010: Claim

Payments before first default reported: Two

Loss to HUD: $39,424

Summary

We found material underwriting deficiencies relating to the borrowers’ gift funds and credit
history.

Gift Funds

Alethes did not document the transfer of gift funds to the borrowers as required. The gift letter
indicated that the borrowers received a $1,590 gift from Alta Crossing, Inc. The transfer of these
funds to the settlement company on behalf of the borrowers was not documented in the FHA file
or the lender file.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrowers’ history of collections and
charged-off accounts, especially those for utilities. The borrowers had 22 collection accounts
and one charge-off listed on their credit report. Of these 22 collections, 11 accounts were opened
within the 24 months preceding the loan closing. Nine of the eleven accounts were for medical
debts, and two were for cell phone debts. The borrowers’ charged-off account was for electric
service.

31
The borrowers explained that they had a family emergency that required them to move back to
Texas from Wisconsin and they made payment arrangements on the largest recent medical debt,
as well as one of the cell phone bills. The other cell phone bill was to be paid off at loan close.
There were no explanations given for the other older debts.

Alethes did not provide strong, supported compensating factors, given the borrowers’ credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. Alethes’ underwriter listed the
following compensating factors to justify mortgage approval: (1) borrower has excellent rental
history, (2) borrower receives overtime income not used in qualifying, and (3) coborrower’s
Social Security income was not grossed up. Two of the compensating factors are valid. The
borrower did earn overtime pay that was not used in calculating debt-to-income ratios, and the
coborrower’s SSI was not grossed up. However, good rental history is not an acceptable
compensating factor listed in HUD Handbook 4155.1. Nevertheless, documented overtime was
seldom more than 15 hours per pay period at a rate of $11 per hour ($165), coupled with the
benefits of not paying tax on SSI of less than $550 per month, in our opinion, does not overcome
the borrowers’ credit history.

HUD/FHA Requirements

32
Loan number: 491-8913905

Mortgage amount: $95,057

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: January 23, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: Two

Loss to HUD: $72,375

Summary

We found material underwriting deficiencies relating to the borrower’s gift funds and credit
history.

Gift Funds

Alethes did not document the transfer of gift funds to the borrower as required. The gift letter
indicated that the borrower received a $4,382.12 gift from Alta Crossing, Inc. The transfer of
these funds to the settlement company on behalf of the borrower was not documented in the FHA
file or the lender file.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections and
charged-off accounts, especially those for housing and utilities. The borrower had 25 collection
accounts, three charge-offs, and one repossession listed on her credit report. Of these 25
collections, 12 accounts were opened within the 24 months preceding the loan closing. Seven of
the twelve accounts were for medical debts. The borrower explained that she was out of work
and did not have medical insurance. One of the twelve accounts was for insurance. The

33
borrower explained that she paid the insurance company but it did not get her check. One of the
twelve accounts was for a cell phone debt. The borrower explained that the debt was for three
phones that she returned. One of the twelve accounts was for a debt to the U.S. Department of
Education. The borrower explained that she was not aware that her loan was no longer in
deferment. The borrower settled this debt before loan closing. One of the twelve accounts was
for residential telephone service. The borrower explained that she was not aware of the debt but
paid it before closing. The last 1 of the 12 accounts was for a debt owed to an apartment
complex. The borrower explained that the debt resulted from an apartment that she moved out of
but did not have a chance to clean before the locks were changed.

Two of the borrower’s charged-off accounts were for revolving debts, and the third was for a
utility account opened less than 24 months before the loan closed. The borrower explained that
she did not receive a bill for the balance on this account. The borrower’s car was also
repossessed within 24 months before loan closing. The borrower explained that her car was
repossessed because she was laid off and her new job paid less, so she was not able to keep up
with her obligations.

Alethes did not provide strong, supported compensating factors, given the borrower’s credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. Alethes’ underwriter listed the
following compensating factors to justify mortgage approval: (1) good rental history, (2)
reserves after closing, (3) borrower gets overtime not used in qualifying, and (4) child support
not grossed up for qualifying. Two of the compensating factors are valid. The borrower did earn
overtime pay that was not used in calculating debt-to-income ratios, and the child support
received by the borrower was not grossed up. However, good rental history is not an acceptable
compensating factor listed in HUD Handbook 4155.1. For cash reserves to be used as a
compensating factor, the borrower must have enough reserves to cover at least three mortgage
payments according to HUD Handbook 4155.1, paragraph 2-13G. The borrower’s bank
statement, dated December 1, 2006, showed a balance of $1,092.80, but the borrower was
required to have at least $1,709.73 to use cash reserves as a compensating factor. Nevertheless,
during the 5 months the borrower had been working for her latest employer, she earned only
$440.28 in overtime, an average of $88 per month, coupled with the benefits of not paying tax on
child support of $440 per month, in our opinion, does not overcome the borrowers’ credit
history.

HUD/FHA Requirements

34
past does not require explanation, major indications of derogatory credit–including judgments,
collections, and other recent credit problems–require sufficient written explanation from the
borrower. The lender must document its reason for approving a mortgage when the borrower has
collection accounts or judgments.

35
Loan number: 491-8927014

Mortgage amount: $143,939

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: March 7, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: 12

Loss to HUD: $59,749

Summary

We found material underwriting deficiencies relating to the borrowers’ gift funds and credit
history.

Gift Funds

Alethes did not document the transfer of gift funds to the borrowers as required. The gift letter
indicates that the borrowers received a $4,570 gift from Nehemiah Corporation of America. The
transfer of these funds to the settlement company on behalf of the borrowers was not
documented in the FHA file or the lender file.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrowers’ history of collections and
charged-off accounts, especially those for utilities. The borrowers had five collection accounts
and three charge-offs. Of these five collections, four accounts were opened within the 24 months
preceding the loan closing. These four collections were for a cell phone debt, two debts for
residential telephone service, and a debt to the U.S. Department of Education. The coborrower

36
explained that he canceled cellular service after erroneous charges for calls to Mexico were not
taken off his bill and refused to pay for the calls. The coborrower also explained that one of the
residential telephone debts resulted from service he had in college in 2002 when he was not
working and could not make the payments. The other residential telephone debt was for service
the coborrower established for his brother, who did not make the payments and the service was
canceled. The borrower explained that she did not complete a class and was charged for it,
resulting in the debt to the U.S. Department of Education. This debt was paid before loan
closing.

The borrowers’ three charged-off accounts were for electric service and a furniture purchase
credit account. The coborrower explained that he opened what he thought was a secured credit
card account but later found out that the credit was only good for the purchase of furniture, and
he was charged a monthly fee. The coborrower instructed his bank not to pay the monthly fee
from his bank account, and that resulted in the accumulation of the debt. The borrower
explained that she was charged a fee for not maintaining electric service for 1 year. The
borrower paid the fee when she found out about it. The coborrower did not explain his charged-
off account for electric service.

Alethes did not provide strong, supported compensating factors, given the borrowers’ credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. Alethes’ underwriter did not list
compensating factors. The underwriter only pointed out that the property being purchased was
new construction, allowing the debt-to-income ratios to exceed HUD’s benchmarks by 2 percent
because the property qualified as an EEH according to HUD Handbook 4155.1, paragraph 2-19.

HUD/FHA Requirements

37
Loan number: 491-8932218

Mortgage amount: $126,500

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: March 19, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $61,236

Summary

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

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections,
charged-offs and judgments, especially those for housing and utilities. The borrower had 62
collection accounts and 15 charge-offs. Of these 62 collections, 15 accounts were opened within
the 24 months preceding the loan closing. Of these 15 accounts, 14 were medical debts. The
borrower explained that she had medical insurance and these accounts should have been paid by
her insurance provider. One of the 15 collection accounts was for an installment loan. The
borrower explained that the account had been paid but did not explain why the debt became a
collection.

The borrower’s credit report listed 15 charged-off accounts. She had two charged-off accounts
for electric service. The borrower explained that she got one account in her name for her sister,
who did not pay; the borrower did not know that the account was on her credit report. She
claimed that the other account had been paid. The borrower also had three judgments filed
against her by an apartment complex. She explained that she rented an apartment for her sister,
who had just broken up with her husband. Her sister left the apartment in good standing. These
judgments were paid.

38
verification of employment with an average of $96.96. The other four compensating factors are
not acceptable or supported by documentation. Employment stability is not an acceptable
compensating factor listed in HUD Handbook 4155.1; employment stability is required for loan
approval. The borrower credit report listing 80 derogatory accounts did not support the claim
that she was a limited credit user. The borrower’s housing expense increased by $213.74 or 21.4
percent. The borrower had $375.01 in a retirement account. However, only 60 percent of the
balance in the account can be counted as cash reserves, and evidence of redemption is required
according to HUD Handbook 4155.1, paragraph 2-10K. This compensating factor can only be
used if cash reserves are enough to cover three mortgage payments according to HUD Handbook
4155.1, paragraph 2-13G. In this case, three mortgage payments would be $2,524.83, and there
was no evidence in the file that funds had been withdrawn for the retirement account.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-3, states the basic hierarchy of credit evaluation is
the manner of payments made on previous housing expenses, including utilities, followed by the
payment history of installment debts, and then revolving accounts. Generally, an individual with
no late housing or installment debt payments should be considered as having an acceptable credit
history, unless there is major derogatory credit on his or her revolving accounts. 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 derogatory information occurring 2 or more years in the past does not
require explanation, major indications of derogatory credit–including judgments, collections, and
other recent credit problems–require sufficient written explanation from the borrower. The
lender must document its reason for approving a mortgage when the borrower has collection
accounts or judgments.

39
Loan number: 491-9013914

Mortgage amount: $137,837

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: August 27, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: One

Loss to HUD: $35,618

Summary

We found material underwriting deficiencies relating to the borrowers’ assets and credit history.

Assets

Alethes did not document the source of two large deposits to the coborrower’s checking account
totaling $2,335.42. All funds for the borrower’s investment in the property must be verified and
documented. A deposit of $885.42 on May 30, 2007, required an explanation since it was $200
more than any other deposit listed on the statement. A deposit of $1,450 on May 25, 2007,
required explanation because it exceeded all of the other deposits on the statement by more than
$700. All of the other large deposits shown on the statements were from the coborrower’s
employer. The beginning and ending balances in the account between April 27 and June 26,
2007, did not exceed $2,129.36. These two deposits were 41.6 and 68.1 percent of this amount,
respectively.

HUD/FHA Requirements

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

Credit

Alethes did not document its reason(s) for accepting the borrowers’ history of collections and
charged-off accounts, especially those for utilities. The borrowers had 16 collection accounts
and 10 charge-offs. Of these 16 collections, six accounts were opened within the 24 months

40
preceding the loan closing. Of these six accounts, three were medical debts, two were revolving
credit accounts, and one was a cell phone debt. No explanation letters were included in the FHA
file but were found in the lender file. The borrowers’ explanation letter found in the lender file
did not explain these debts. The letter only explained late payments on a mortgage the
coborrower had with her ex-husband and the coborrower’s collection on an auto loan. Three of
the borrowers’ 10 charged-off accounts were for electric service. These accounts were also not
explained.

HUD/FHA Requirements

41
Loan number: 491-9042939

Mortgage amount: $125,874

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: October 5, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: 10

Loss to HUD: $43,392

Summary

We found material underwriting deficiencies relating to the borrowers’ income, assets, gift
funds, and credit history.

Income

Alethes did not obtain verifications of employment from one of the borrowers’ employers. This
loan closed on October 5, 2007. Both borrowers had been working for their current employer
since March 2007. Both of the borrowers also listed Applebees as an employer in 2007 on their
loan application. However, this employment was not verified. No verifications of employment
or pay stubs from Applebees dated in 2007 were in the loan file. Both of the borrowers
previously worked for Applebees in 2005, and this employment was documented with Internal
Revenue Service W-2 forms.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-6, states that we do 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.

Assets

Alethes did not verify the source of the borrowers’ $1,000 earnest money deposit. The
borrowers’ bank statements included in the file showed balances of $816.55 on September 19,
2007, $5.56 on July 10, and $835.33 on June 7. The borrowers’ bank statement covering their
August 19, $1,000 money order was not included in the file. No other source of accumulated
assets was documented in the file.

42
HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-10, states that all funds for the borrower’s
investment in the property must be verified and documented. If the amount of the 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.

Gift Funds

Alethes did not document the transfer of gift funds to the borrowers as required. The gift letter
indicated that the borrowers received a $7,612 gift from Nehemiah Corporation of America. The
transfer of these funds to the settlement company on behalf of the borrowers was not
documented in the FHA file or the lender file.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrowers’ history of collections,
especially for housing. The borrowers had 11 collection accounts on their credit report. Of these
11 collections, four accounts were opened within the 24 months preceding the loan closing. Of
these four accounts, two were medical debts and the other two resulted from debts to an
apartment complex. The borrowers explained that the medical debts were from when the
borrower was 16 and should have been paid by his parents’ insurance. The borrowers explained
that they moved out of the apartment complex because it was water damaged and bug infested
and they believed it was a health hazard, but the apartment management did not take care of the
problems after the borrowers’ many complaints.

Alethes did not provide strong, supported compensating factors, given the borrowers’ credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. Alethes’ underwriter listed only
that the property purchased was new construction on the mortgage credit analysis worksheet. No
acceptable, supported compensating factors were listed to justify mortgage approval.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that the basic hierarchy of credit
evaluation is the manner of payments made on previous housing expenses, including utilities,

43
followed by the payment history of installment debts, and then revolving accounts. Generally,
an individual with no late housing or installment debt payments should be considered as having
an acceptable credit history, unless there is major derogatory credit on his or her revolving
accounts. 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 derogatory information occurring 2 or more years in the
past does not require explanation, major indications of derogatory credit–including judgments,
collections, and other recent credit problems–require sufficient written explanation from the
borrower. The lender must document its reason for approving a mortgage when the borrower has
collection accounts or judgments.

44
Loan number: 491-9052920

Mortgage amount: $158,543

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: November 15, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: Eight

Loss to HUD: $26,748

Summary

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

Excessive Debt Ratios

Alethes’ underwriter calculated the borrower’s qualifying ratios at 35.095 and 44.203 percent.
The property purchased was new construction qualifying as an EEH and, therefore, the debt-to-
income ratios are allowed to exceed benchmark ratios by 2 percent (33 percent and 45 percent)
according to HUD Handbook 4155.1, paragraph 2-19. However, the underwriter did not list
compensating factors to justify mortgage approval with a mortgage payment-to-income ratio of
35.095 percent as required by HUD Handbook 4155.1, paragraph 2-13.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be
used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are
those listed in the handbook. Underwriters must record in the “remarks” section of the form
HUD-92900 the compensating factor(s) used to support loan approval. A compensating factor
used to justify mortgage approval must be supported by documentation.

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections and
charge-offs (including utilities) and a foreclosure. The borrower had six collection accounts, one
charge-off, and a foreclosure on his credit report. Of these six collections, one was for
residential telephone service. The charged-off account was for electric service. The foreclosure
was in July 2004, and the new FHA loan closed on November 15, 2007. However, a foreclosure

45
more than 3 years earlier does not disqualify a borrower. The borrower explained that his hours
were reduced and he fell behind on his bills and could not sell his house or his car. However,
Alethes’ underwriter did not list compensating factors to justify mortgage approval with the
borrower’s credit history as required by HUD Handbook 4155.1, paragraph 2-13.

HUD/FHA Requirements

46
Loan number: 491-9067953

Mortgage amount: $185,095

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: January 11, 2008

Status as of June 2, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $66,613

Summary

We found material underwriting deficiencies relating to the borrowers’ assets and credit history.

Assets

Alethes did not adequately verify the borrowers’ assets. A verification of deposit or bank
statements covering the most recent 3-month period were not obtained as required. The lender
only obtained the December 2007 bank statement. The borrower also provided the November
2007 bank statement; however, the account was opened on November 9, 2007, and the beginning
and ending balances were both zero.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 3-1F, states that verification of deposit and most
recent bank statements are to be provided. As an alternative to obtaining a verification of
deposit, the lender may obtain from the borrower original bank statement(s) covering the most
recent 3-month period.

Credit

Alethes did not adequately document its reason(s) for accepting the borrowers’ history of
collections and charge-offs, especially for utilities. The borrowers’ credit report listed 36
collection accounts. Of these 36 collections, 16 were opened within 24 months of loan closing.
Fourteen of the sixteen recent collections were for medical debts. The borrowers explained that
these medical debts resulted from major injuries to the coborrower and their son from a car
accident in June 2001. The loan officer analyzed the borrowers’ credit and reported in the file
that “these medical collections have been recycled over a number of years.” However, the debt
was still owed. The other two collections were for orthodontics and Internet service. The

47
borrowers explained that these recent debts resulted from an error by the orthodontics provider
and the previous car accident. One older collection was for phone service. The borrowers’
credit report also showed 10 charge-offs, with 1 of the 10 being opened within 24 months of loan
closing. This charged-off debt was for an installment loan. The borrowers did not explain this
charge-off. Three older charged-off accounts were also for phone service and electric service.

Alethes did not provide strong, supported compensating factors, given the borrowers’ credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. The underwriter listed two
compensating factors: (1) low ratios and (2) minimal housing increase. Having low ratios is not
an acceptable compensating factor listed in HUD Handbook 4155.1; low ratios are necessary for
loan approval. There was only a minimal increase in the borrowers’ monthly housing expense.
This is an acceptable, documented compensating factor, but in our opinion, it alone is not strong
enough to overcome the borrowers’ credit history.

HUD/FHA Requirements

48
Loan number: 492-9081188

Mortgage amount: $114,991

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: January 3, 2008

Status as of June 2, 2010: Claim

Payments before first default reported: Two

Loss to HUD: $50,464

Summary

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

Income

Alethes improperly included overtime in the borrower’s monthly income used to calculate debt-
to-income ratios. While the borrower’s pay stub for the period ending November 4, 2007,
indicated year-to-date overtime earnings of $3,835, no overtime had been earned by the borrower
during that pay period and the four previous weekly pay periods. There was no documentation
in the file to indicate that the overtime would continue.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-7A, 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. The lender must develop an average of bonus or overtime income for the past
2 years, and the employment verification must not state that such income is unlikely to continue.
Periods of less than 2 years may be acceptable provided the lender justifies and documents in
writing the reason for using the income for qualifying purposes.

Liabilities

Alethes improperly omitted a liability extending less than 10 months. The borrower’s credit
report revealed an account with an outstanding balance of $3,800 and related monthly payment
of $475 that was not included in qualifying ratios. This payment was to continue for another 8
months; however, the monthly payment of $475.00 is considered significant at 21.3 percent of

49
the borrower’s supported monthly income of $2,227.33 and most likely affected the borrower’s
ability to make the mortgage payment during the months immediately after loan closing.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-11A, states that 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.

Excessive Debt Ratios

Alethes’ underwriter calculated the borrower’s qualifying ratios at 39.73 and listed the following
compensating factors: (1) limited credit user and (2) reserves. Neither of these compensating
factors was supported by documentation included in the file. The borrower was not a limited
credit user. He had a total of 29 accounts listed on his credit report. The mortgage credit
analysis worksheet listed $2,095 cash reserves, enough to cover 2 months’ housing expenses of
$1,024.03. However, to use cash reserves as a compensating factor, the borrower must have at
least three times the amount of his monthly housing expenses according to HUD Handbook
4155.1, paragraph 2-13G.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be
used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are
those listed in the handbook. Underwriters must record in the “remarks” section of the form
HUD-92900 the compensating factor(s) used to support loan approval. A compensating factor
used to justify mortgage approval must be supported by documentation.

Assets

Alethes did not adequately verify the source of funds for the earnest money deposit. According
to the sales contract, the borrower provided earnest money of $500 on November 21, 2007, in the
form of a money order. However, a copy of the money order was not included in the file. The
bank statement provided indicated that the borrower opened his bank account on November 27,
2007. The borrower’s girl friend wrote in a letter that she allowed the borrower to have his pay
direct deposited to her bank account. However, no bank statements from the girl friend’s
account appeared in the file. No other documents in the file provided evidence of the borrower’s
accumulated savings before November 27, 2007.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-10A, states that if the amount of the earnest money
exceeds 2 percent of the sales price or appears excessive based on the borrower’s history of
accumulated savings, the lender must verify with documentation the deposit amount and the
source of funds.

50
Gift Funds

Alethes did not document the transfer of gift funds to the borrower as required. The gift letter
indicated that the borrower received a $5,715 gift from DPA Alliance Corporation. The transfer
of these funds to the settlement company on behalf of the borrower was not documented in the
FHA file or the lender file.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections and a
charge-off, especially for housing. The borrower had 29 accounts listed on his credit report. Of
these, 19 were collections, and one was a charge-off. Three of the borrower’s 19 collection
accounts were opened within 24 months of loan closing. These three accounts were for medical
debts. One older collection was for a debt owed to an apartment complex. None of the
borrower’s collection or charged-off accounts were explained in the file.

Alethes did not provide strong, supported compensating factors, given the borrower’s credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. (The compensating factors
listed by the underwriter are discussed in the Excessive Debt Ratios section for this loan.)

HUD/FHA Requirements

51
Paragraph 2-3 also states 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.

52
Loan number: 492-7753781

Mortgage amount: $141,479

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: January 24, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: Two

Loss to HUD: $70,991

Summary

We found material underwriting deficiencies relating to the borrowers’ credit history.

Credit

Alethes did not document its reason(s) for accepting the borrowers’ history of collections,
charge-offs, and a judgment, especially those for housing and utilities. The borrowers had 20
collections listed on their credit report, two of them occurring less than 24 months earlier. Both
were medical debts. One older collection account was to a utility company. The borrowers also
had 11 charged-off accounts on their credit report with one being less than 24 months earlier.
This debt was on an installment loan. In addition, the borrowers had a judgment on a debt owed
to an apartment complex. No explanation of these debts was found in the FHA file. The
borrowers’ explanation letter was found in the lender file. The borrowers’ explanation letter
stated that due to severe medical issues, the borrowers amassed great debt to the extent that they
had to move back into their parents’ house to get back on their feet. Although the borrowers
identified severe medical issues as the cause of their indebtedness, they did not identify a
resolution to their problems and stated that their medical obligations had increased since their
son had recently been diagnosed with additional severe medical issues.

HUD/FHA Requirements

53
an individual with no late housing or installment debt payments should be considered as having
an acceptable credit history, unless there is major derogatory credit on his or her revolving
accounts. 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 derogatory information occurring 2 or more years in the
past does not require explanation, major indications of derogatory credit–including judgments,
collections, and other recent credit problems–require sufficient written explanation from the
borrower. The lender must document its reason for approving a mortgage when the borrower has
collection accounts or judgments.

54
Loan number: 492-7916830

Mortgage amount: $137,944

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: November 15, 2007

Status as of June 2, 2010: Claim

Payments before first default reported: One

Loss to HUD: $26,570

Summary

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

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections,
charge-offs, and a judgment, especially those for utilities. The borrower had 21 collections listed
on her credit report, two of them occurring less than 24 months earlier. One of the recent
collections was on a debt for gas service, and the other was for residential telephone service.
The borrower explained that she was not aware of one debt and had paid the other debt late but
in full. The borrower also had three charge-offs, one of them being approximately 26 months
earlier. This charged-off account balance was $9,628. The borrower explained that the debt
resulted from voluntarily returning a car when she could no longer afford the payments. A
December 2005 judgment was also listed on the borrower’s credit report. The judgment was
paid approximately 3 months before the loan closed.

Alethes did not provide strong, supported compensating factors, given the borrower’s credit
history, as required by HUD Handbook 4155.1, paragraph 2-13. Alethes’ underwriter listed the
following compensating factors to justify mortgage approval: (1) borrower has potential for
increase in income, (2) borrower had credit established, (3) borrower has good ratios, (4) there is
only a minimal increase in the borrower’s proposed monthly housing, (5) minimal debt user, and
(6) new construction. The loan file contained evidence supporting only one of the listed
compensating factors-there was only a minimal increase in the borrower’s housing expense-
since the borrower’s housing expense increased from $1,200 to $1,384.66. The file contained
documentation to support an additional, acceptable compensating factor not listed: the borrower
has substantial nontaxable income. The borrower received child support ranging from $550 to
$620 per month that was not used in computing her ratios. However, the corresponding
compensating factor was correctly not listed on the mortgage credit analysis worksheet since the
borrower had been receiving child

55
support for 7 years before the loan and did not maintain a good credit history. There was no
evidence of the borrower’s continuing education or training in her profession in the file to
support her potential for increased income. The other compensating factors listed on the
worksheet are not acceptable, according to HUD Handbook 4155.1. Although, since the
property was new construction, the borrower’s debt-to-income ratios were allowed to exceed
HUD’s benchmarks by 2 percent according to HUD Handbook 4155.1, paragraph 2-19.
However, the single, acceptable compensating factor listed on the worksheet (there was only a
minimal increase in the borrower’s housing expense), in our opinion, is not strong enough to
overcome the pattern of disregard for her financial obligations shown in the borrower’s credit
history.

HUD/FHA Requirements

56
Loan number: 492-7963491

Mortgage amount: $107,315

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: March 12, 2008

Status as of June 2, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $30,423

Summary

We found material underwriting deficiencies relating to the borrower’s income, debt-to-income
ratios, assets, gift funds, and credit history.

Income

Alethes overstated the borrower’s effective income by including overstated overtime income.
Instead of using the overtime year-to-date earnings found in the most recent pay stub, the lender
should have taken an average of overtime income earned over the past 21 months. The lender
documented 21 months of overtime: $2,094 for 8 months of 2006, $6,379 for all of 2007, and
$429 for 1 month of 2008. Over 21 months, the average overtime was $424, $108 less than that
determined by the lender. Recalculation of the borrower’s ratios considering less overtime
income results in the 39.85 percent ratios rising to 41.65 percent.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-7A, 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. The lender must develop an average of bonus or overtime income for the past
2 years, and the employment verification must not state that such income is unlikely to continue.
Periods less than 2 years may be acceptable provided the lender justifies and documents in
writing the reason for using the income for qualifying purposes.

Excessive Debt Ratios

Alethes 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
39.85 percent. The lender inappropriately used an incorrect mortgage payment amount when

57
calculating the qualifying ratios. The mortgage credit analyses worksheet, dated February 29,
2008, used $988.80 as the mortgage payment including taxes and insurance. However, the truth
in lending statement, dated March 12, 2008, and first payment letter indicated a mortgage
payment including taxes and insurance of $1,132. The mortgage payment-to-income and total
debt-to-income ratios, as recalculated after considering the $1,132 mortgage payment, increased
to 45.63 percent.

Alethes included four compensating factors: (1) first-time home buyer, (2) outstanding
advancement and income potential, (3) good rental history, and (4) married for less than a year
and spouse will be seeking employment. First-time home buyer is not an acceptable
compensating factor listed in HUD Handbook 4155.1. The borrower’s potential for increased
income is not documented by job training or education in the borrower’s profession. Good rental
history is not an acceptable compensating factor, and the borrower was paying only $675 in
monthly rent compared to his $1,132 mortgage payment. Being newly married and having
possible future income of a spouse are not valid compensating factors listed in HUD Handbook
4155.1, paragraph 2-13.

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,
Chapter 2, Section 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 form HUD-
92900 the compensating factor(s) used to support loan approval. A compensating factor used to
justify mortgage approval must be supported by documentation

Assets

Alethes did not adequately verify the source of funds used as earnest money. The borrower’s
earnest money deposit of $1,500, made on January 15, 2008, was excessive based on the
borrower’s savings. The borrower’s bank account activity showed an ending balance of $150 on
January 14, 2008, but did not show transactions supporting the earnest money deposit. No other
documentation of accumulated assets was found in the file.

HUD/FHA Requirements

HUD Handbook 4155.1, REV-5, paragraph 2-10, states that all funds for the borrower’s
investment in the property must be verified and documented. If the amount of the earnest money

58
exceeds 2 percent of the sales price or appears excessive based on the borrower’s history of
accumulated savings, the lender must verify with documentation the deposit amount and the
source of funds.

Gift Funds

Alethes did not properly document gift funds received by the borrower. The gift letter indicated
that the borrower was to receive $5,715 at closing from DPA Alliance Corporation. However,
the lender did not provide evidence that the gift funds were transferred from the donor’s account
to the settlement company on behalf of the borrower.

HUD/FHA Requirements

Credit

Alethes did not document its reason(s) for accepting the borrower’s history of collections,
charge-offs, and a judgment, especially those for housing and utilities. The borrower had nine
collection accounts on his credit report. Of these nine collections, four accounts were opened
within the 24 months preceding the loan closing. Of these four accounts, two were medical
debts, one was for an auto loan, and one was for residential telephone service. The borrower did
not provide an explanation of these collections. The borrower’s credit report also showed five
charged-off accounts. One of the charged-off accounts was for electric service. The borrower
did not provide an explanation of these charge-offs. In addition, the borrower had a judgment on
his credit report for a debt owed to an apartment complex. This judgment was paid in the month
before loan closing. The borrower explained that he rented the apartment for his sister and her
children, but he was not aware of that his sister moved out of the apartment still owing 2 month’s
rent.

HUD/FHA Requirements

59
an acceptable credit history, unless there is major derogatory credit on his or her revolving
accounts. 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 derogatory information occurring 2 or more years in the
past does not require explanation, major indications of derogatory credit–including judgments,
collections, and other recent credit problems–require sufficient written explanation from the
borrower. The lender must document its reason for approving a mortgage when the borrower has
collection accounts or judgments.

60
APPENDIX C

LENDER COMMENTS AND OIG’s EVALUATION

Ref to OIG Evaluation Lender Comments

Comment 1

61
62
OIG’s Evaluation of Lender Comments

Comment 1 The lender reports that it is “shut down” and does not have the resources at this
time to provide specific comments, but the president believes that “every one of
the files was signed off on by a Denver HUD H.O.C insuring specialist before
FHA insured the loans.” However, there is no evidence of underwriting reviews
conducted by the Denver HOC in any of the 19 loan files with reported
underwriting deficiencies. The Denver HOC has confirmed that no pre-
endorsement underwriting reviews were conducted in these loans. According to
HUD Handbook 4165.1, REV-2, Endorsement for Insurance for Home Mortgage
Programs (Single Family), paragraph 2-15, Pre-Endorsement Review - General,
FHA will do a limited review of each document to ascertain compliance. No
further review is required or authorized unless FHA has reason to suspect fraud or
misrepresentation (including negligent misrepresentation), in any of the
documents submitted.

We will work with HUD and the lender during the audit resolution process to
address our conclusions on each of the loans and determine the appropriate action.