U. S. Department of Housing and Urban Development
Office of Inspector General
26 Federal Plaza, Room 3430
New York, NY 10278-0068
MEMORANDUM NO: 2010-NY-1807
September 27, 2010
MEMORANDUM FOR: Vicki Bott, Deputy Assistant Secretary for Single Family, HU
Dane M. Narode, Associate General Counsel for Program
Enforcement, CACC
FROM: Edgar Moore, Regional Inspector General for Audit, New York/New Jersey, 2AGA
SUBJECT: First Tennessee Bank, N.A., Memphis, TN, Did Not Properly Underwrite a
Selection of FHA Loans
INTRODUCTION
We conducted a review of Federal Housing Administration (FHA) loans underwritten by First
Tennessee Bank, N.A. (First Tennessee), an FHA direct endorsement lender. This review was
conducted as part of our Operation Watchdog 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.
The objective of the review was to determine whether First Tennessee underwrote 181 loans in
accordance with U.S. Department of Housing and Urban Development (HUD)/FHA
requirements.
For each recommendation without a management decision, please respond and provide status
reports in accordance with HUD Handbook 2000.06, REV-3. Please furnish us copies of any
correspondence or directives issued because of this review.
We sent the draft memorandum report to First Tennessee officials on August 20, 2010 and their
written comments were received on September 3, 2010. First Tennessee officials generally
disagreed with our findings and recommendations and maintained that in all cases, First
Tennessee complied with HUD/FHA underwriting requirements and made loans to qualified
borrowers.
1
We selected 20 loans for review; however, we later learned that 2 loans had fully executed indemnification
agreements. Therefore, we did not review those 2 loans; thus, we only reviewed 18 loans.
The complete text of First Tennessee officials’ response, along with our evaluation of that
response, can be found in appendix C of this memorandum. However, the exhibits, which
accompanied the response, have not been included in the report due to their volume. In addition,
as a result of First Tennessee officials’ written response and accompanying exhibits, several
sections of the report have been adjusted.
METHODOLOGY AND SCOPE
First Tennessee is 1 of 15 direct endorsement lenders we selected from HUD’s publicly available
Neighborhood Watch2 system (system) for a review of underwriting quality. These direct
endorsement lenders all had a compare ratio3 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 20 loans underwritten by First Tennessee officials that had gone into claim status within
30 months of the loans’ endorsement. The sample of 204 loans for detailed review was based on
a prioritization matrix that would ensure, to the maximum extent possible, the selected loans
were: (1) not streamlined refinanced; (2) not electronically underwritten by Fannie Mae or
Freddie Mac; and (3) associated with an underwriter lender identified as having a high number of
loans going to claim. We later learned that 2 loans had fully executed indemnification
agreements; therefore, we only tested 185 loans. To accomplish our objectives, we reviewed
applicable HUD handbooks, mortgagee letters, and reports from HUD’s Quality Assurance
Division.
We performed our work from March through July 2010. We conducted our work in accordance
with generally accepted government auditing standards, except that we did not consider the
internal controls or information systems controls of First Tennessee, consider the results of
previous audits, or communicate with First Tennessee’s management in advance. We did not
follow standards in these areas because our goal was to aid HUD in identifying material
underwriting deficiencies and/or potential wrongdoing on the part of poorly performing lenders
that contributed to a high rate of default and claims against the FHA insurance fund. To meet
our objectives, it was not necessary to fully comply with standards, nor did our approach
negatively affect our review results.
BACKGROUND
2
Neighborhood Watch is a Web-based data processing, automated query, reporting, and analysis system designed to
highlight exceptions to lending practices regarding high-risk mortgages so that potential problems are readily
identifiable.
3
HUD defines “compare ratio” as a value that reveals the largest discrepancies between the direct endorser’s default
and claim percentage and the default and claim percentage to which it is being compared. FHA policy establishes a
compare ratio of more than 200 percent as a warning sign of a lender’s performance.
4
In this case, the sample of 20 loans consisted of 18 purchases, of which 1 was electronically underwritten by Fannie
Mae, and 2 streamlined refinances. The 20 loans were originated by First Horizon Home Loans, a division of First
Tennessee Bank, N.A.
5
The18 loans consisted of 16 purchases, of which 1 was electronically underwritten by Fannie Mae, and 2 streamline
refinances.
2
First Tennessee is a HUD-approved Title II supervised lender located in Memphis, TN. A
supervised lender is a HUD/FHA-approved financial institution that is a member of the Federal
Reserve System or an institution, the accounts of which are insured by the Federal Deposit
Insurance Corporation or the National Credit Union Administration, which is not required to
have mortgage lending as its principal source of revenue. In addition, a supervised lender may
be approved to originate, sell, purchase, hold, and/or service HUD/FHA-insured mortgages,
depending on its wishes and qualifications. FHA approved First Tennessee as a supervised
lender on March 12, 1980. First Tennessee was approved to participate in the Lender’s
Insurance (LI) program, effective August 24, 2006. The LI program enables high-performing
lenders, pursuant to section 256 of the National Housing Act, to endorse FHA mortgage loans
without a pre-endorsement review6 being conducted by FHA. Under the LI program, the
approved lender performs its own pre-endorsement review and enters mortgage loan-level data to
FHA via FHA Connection.7 FHA Connection will perform an automated verification process to
check the data for accuracy and completeness, and the lender then will be able to endorse the
mortgage loan automatically. First Tennessee was removed from the LI program on December
1, 2009.
The goal of Operation Watchdog is to determine why the selected lenders had such a high rate of
defaults and claims as compared to the national average. We selected 20 loans in claim status
from 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, First Tennessee endorsed
58,350 loans valued at more than $9 billion and submitted 2,691 claims worth more than $340.3
million.
The objective of this review was to determine whether First Tennessee underwrote the 18
selected loans in accordance with HUD/FHA requirements and if not, whether the underwriting
reflected systemic problems.
RESULTS OF REVIEW
First Tennessee officials did not underwrite five of the 18 loans reviewed in accordance with
HUD/FHA regulations. As a result, the FHA insurance fund suffered actual losses of $435,574
on the five loans as shown in the table below.
6
A preendorsement review is conducted by HUD’s Homeownership Center staff on the FHA case binder to ensure
that FHA documentation requirements have been met, forms and certifications are properly executed, and FHA
Connection and Automated Underwriting System data have integrity.
7
FHA Connection is an interactive system available through the Internet that gives approved FHA lenders real-time
access to FHA systems for the purpose of conducting official FHA business in an electronic fashion.
3
Number of Original
Acquisition Unpaid Actual loss
Closing payments mortgage
FHA/loan number cost balance to HUD8
Date before first default amount
151-8161023 08/23/06 5 137,446 124,652 128,898 66,300
241-7877788 07/25/07 6 333,513 286,943 293,680 141,906
291-3491113 12/11/06 5 47,215 153,469 156,543 47,215@
332-4542658 03/11/08 0 230,771 210,591 214,368 121,347
441-7773869 03/31/06 10 101,862 84,544 87,310 58,806
$850,807 $860,199 $880,799 $435,574
@ This amount was obtained from HUD’s Single Family Insurance System (SFIS) and not HUD’s Single Family Acquired Asset
Management System (SAMS) and represents HUD’s acquisition costs for a preforeclosure sale. SFIS is used to maintain the
insurance-in-force database, which contains accurate and detailed case information on FHA-insured single-family properties.
The table below summarizes the material deficiencies that we identified in the five loans.
Area of noncompliance Number of loans9
Excessive ratios 1
Gift funds 4
Borrower’s investment 5
Appendix A of this report shows a summary schedule of material deficiencies in each of the five
loans, and appendix B provides a detailed description of all loans with material underwriting
deficiencies noted in this report.
Specific examples of these underwriting deficiencies follow.
Excessive Ratio(s) Without Adequate Compensating Factors
First Tennessee officials approved one loan that had a debt-to-income ratio (back ratio) that
exceeded HUD’s benchmark of 43 percent, as set forth in Mortgagee Letter 2005-16, without
valid compensating factors. For loan number 291-3491113, First Tennessee officials approved
the loan, which had a back ratio of 47.16 percent, and recorded the following compensating
factors on the mortgage credit analysis worksheet: “Credit: VOR (verification of rent) – 60
months on CR (credit report), 2 trades on CR Rpt + 12 mos.” However, these are not valid
compensating factors as defined by HUD Handbook 4155.1, REV-5, paragraph 2-13. In this
case, although the credit report showed that the borrower successfully demonstrated the ability to
pay housing expenses over the past 60 months, the proposed monthly mortgage payment of
$1,246.09 was more than 300 percent greater than the monthly rental payment of $375.
Therefore, First Tennessee officials did not provide adequate support for the compensating
factors used to justify the loan approval.
8
The loss amount was obtained from HUD’s Single Family Acquired Asset Management System (SAMS). SAMS
tracks properties from acquisition to final sales closing and maintains all accounting data associated with the case
records.
9
The deficiencies noted are not independent of one another, as one loan may have contained more than one
deficiency.
4
Inadequate Gift Fund Documentation
First Tennessee officials did not properly document the transfer of gift funds for four loans. For
example, for loan number 151-8161023, First Tennessee officials did not adequately verify the
transfer of a $3,921 gift; therefore, the borrower’s investment in the property was not verified.
The mortgage credit analysis worksheet showed that the borrower’s minimum cash investment
requirement was $3,921, and First Tennessee’s file contained a gift letter, dated August 22, 2006,
from a nonprofit corporation for a $3,921 gift to the borrower to assist with the property
purchase. The gift approval letter stated that $3,921 in gift funds would be wired from the
nonprofit to the closing attorney. However, neither the FHA case binder nor First Tennessee’s
file contained documentation verifying that the closing agent received the gift funds. The HUD-
1 settlement statement showed that the loan closed on August 23, 2006; however, there was no
documentation to verify that these gift funds were provided to the closing agent. Without
documentation verifying that the closing agent received the funds from the nonprofit, First
Tennessee officials did not verify and document that the gift funds ultimately did not come from
an unacceptable source. Consequently, the borrower’s investment in the property was not
properly verified and documented.
Borrower Investment in Property Not Verified and/or Documented
First Tennessee officials did not verify the borrower’s investment in the property for five loans.
This deficiency involved not adequately verifying and documenting the transfer of gift funds as
previously mentioned, and not ensuring that the borrowers met the minimum cash investment
requirement. In one example related to loan number 441-7773869, First Tennessee officials did
not ensure that the borrower met the 3 percent minimum cash investment requirement of $2,640.
First Tennessee’s file contained a sales contract, which reported that the borrower made a $1,000
earnest money deposit; a copy of a check, dated February 20, 2006, in the amount of $1,000
made payable to the selling broker for the earnest money deposit; and a copy of the borrower’s
bank statement for the period January 12 through February 12, 2006, which reported $2,107 in
personal funds. Furthermore, the HUD-1 settlement statement reflected that the borrower’s total
cash investment in the property was $2,485, which consisted of a $1,000 earnest money deposit,
$1,091 paid at closing, and $394 paid outside of closing. Since the minimum cash investment
requirement was $2,640, the borrower invested $155 less than was required.
Incorrect Underwriter’s Certifications Submitted to HUD
We reviewed the certification for the five loans with material underwriting deficiencies for
accuracy. First Tennessee’s direct endorsement underwriters incorrectly certified that due
diligence was used in underwriting these five 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 the loan.
Applicable Statutes
The Program Fraud Civil Remedies Act of 1986 (31 U.S.C. (United States Code) 3801-3812)
and (24 CFR (Code of Federal Regulations) Part 28) provides Federal agencies, which are the
5
victims of false, fictitious, and fraudulent claims and statements, with an administrative remedy
to (1) recompense such agencies for losses resulting from such claims and statements; (2) permit
administrative proceedings to be brought against persons who make, present, or submit such
claims and statements; and (3) deter the making, presenting, and submitting of such claims and
statements in the future, up to $7,500 for each violation and double the amount of paid claims
(recovery limited to claims of $150,000 or less).
Regulations at 24 CFR 30.35 provide that the Mortgagee Review Board may initiate a civil
money penalty action against any lender that knowingly violates any of the listed 14 different
violations, up to $7,500 for each violation but not to exceed $1.375 million.
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 and/or civil money penalties against First Tennessee and/or its
principals for incorrectly certifying to the integrity of the data or that due diligence was
exercised during the underwriting of five loans that resulted in actual losses of $435,574,
which could result in affirmative civil enforcement action of approximately $908,648.10
We also recommend that HUD’s Deputy Assistant Secretary for Single Family
1B. Take appropriate administrative action against First Tennessee and/or its principals for
the material underwriting deficiencies cited in this report once the affirmative civil
enforcement action cited in recommendation 1A is completed.
SCHEDULE OF INELIGIBLE COSTS
Recommendation number Ineligible 1/
1A $435,574
Totals $435,574
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.
10
Double damages for actual loss amounts related to five loans ($435,574 x 2 = $871,178) plus $37,500, which is a
$7,500 fine for each of the 5 loans with material underwriting deficiencies.
6
Appendix A
SUMMARY OF MATERIAL UNDERWRITING DEFICIENCIES
Excessive ratio(s) without adequate
Borrower investment in property
not verified and/or documented
Inadequate gift documentation
compensating factors
FHA loan number
151-8161023* X X
241-7877788* X X
291-3491113* X X X
332-4542658* X X
441-7773869 X
TOTALS 1 4 5
*Loan was originated under the LI program. Therefore, the lender self-insures the FHA loan and only submits those
case binders (paper or electronic) when requested for review by HUD. (Note the loan without the asterisk was
originated before First Tennessee was approved to participate in the LI program on August 24, 2006)
7
Appendix B
LOANS WITH MATERIAL UNDERWRITING DEFICIENCIES
Loan number: 151-8161023
Mortgage amount: $128,898
Section of Housing Act: 203(b)
Loan purpose: Purchase
Date of loan closing: August 23, 2006
Status as of June 30, 2010: Claim
Payments before first default reported: Five
Loss to HUD: $66,300
Summary:
We found a material underwriting deficiency relating to the borrower’s gift funds and investment
in the property.
Inadequate Verification of Transfer of Gift Funds
Borrower Investment in Property Not Verified
First Tennessee officials did not adequately verify the transfer of a $3,921 gift; therefore, the
borrower’s investment in the property was not verified. The mortgage credit analysis worksheet
showed that the borrower’s minimum cash investment requirement was $3,921, and First
Tennessee’s file contained a gift letter, dated August 22, 2006, from a nonprofit corporation for a
$3,921 gift to the borrower to assist with the property purchase. The gift approval letter stated
that $3,921 in gift funds would be wired from the nonprofit to the closing attorney. However,
neither the FHA case binder nor First Tennessee’s file contained documentation verifying that
the closing agent received the gift funds. The HUD-1 settlement statement showed that the loan
closed on August 23, 2006; however, there was no documentation to verify that these gift funds
were provided to the closing agent. Without documentation verifying that the closing agent
received the funds from the nonprofit, First Tennessee officials did not verify and document that
the gift funds ultimately did not come from an unacceptable source. Consequently, the
borrower’s investment in the property was not properly verified and documented.
8
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 and 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.
Mortgagee Letter 2004-28 provides that the lender must obtain and keep the documentation of
the wire transfer of downpayment funds from charities in its mortgage loan application binder.
9
Loan number: 241-7877788
Mortgage amount: $293,680
Section of Housing Act: 203(b)
Loan purpose: Purchase
Date of loan closing: July 25, 2007
Status as of June 30, 2010: Claim
Payments before first default reported: Six
Loss to HUD: $141,906
Summary:
We found a material underwriting deficiency relating to the borrower’s gift funds and investment
in the property.
Inadequate Verification of Transfer of Gift Funds
Borrower Investment in Property Not Verified
First Tennessee officials did not adequately verify the transfer of a $10,000 gift; therefore, the
borrower’s investment in the property was not verified. The mortgage credit analysis worksheet
showed that the borrower’s minimum cash investment requirement was $8,800, and First
Tennessee’s file contained a gift letter, dated June 27, 2007, from a nonprofit charitable
organization for a $10,000 gift to the borrower to assist with the property purchase. The gift
approval letter stated that $10,000 in gift funds would be wired from the nonprofit to the
settlement company at closing. The HUD-1 settlement statement showed that the loan closed on
July 25, 2007; however, there was no documentation to verify that these gift funds were provided
to the closing agent. Without documentation verifying that the closing agent received the funds
from the nonprofit, First Tennessee officials did not verify and document that the gift funds
ultimately did not come from an unacceptable source. Consequently, the borrower’s investment
in the property was not properly verified and documented.
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 and 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.
10
Mortgagee Letter 2004-28 provides that the lender must obtain and keep the documentation of
the wire transfer of downpayment funds from charities in its mortgage loan application binder.
11
Loan number: 291-3491113
Mortgage amount: $156,543
Section of Housing Act: 203(b)
Loan purpose: Purchase
Date of loan closing: December 11, 2006
Status as of June 30, 2010: Claim
Payments before first default reported: Five
Loss to HUD: $47,215
Summary:
We found material underwriting deficiencies relating to the borrower’s debt ratios, gift funds,
and investment in the property.
Excessive Debt-to-Income Ratio Without Valid Compensating Factors
First Tennessee officials did not document valid compensating factors to justify the approval of a
loan with a back ratio of 47.16 percent, which exceeded HUD’s benchmark of 43 percent. First
Tennessee officials recorded the following compensating factors on the mortgage credit analysis
worksheet: “Credit: VOR (verification of rent) – 60 months on CR (credit report), 2 trades on
CR Rpt + 12 mos.” However, these are not valid compensating factors as defined by HUD
Handbook 4155.1, REV-5, paragraph 2-13. In this case, although the credit report showed that
the borrower successfully demonstrated the ability to pay housing expenses over the past 60
months, the proposed monthly mortgage payment of $1,246.09 was more than 300 percent
greater than the monthly rental payment of $375. Therefore, First Tennessee officials did not
provide adequate support for the compensating factors used to justify the loan approval.
HUD/FHA Requirements:
Mortgagee Letter 2005-16 states that the qualifying ratios are 31 and 43 percent. If either or both
ratios are exceeded, the lender must describe the compensating factors used to justify the
mortgage approval.
HUD Handbook 4155.1, REV-5, paragraph 2-13, requires ratios exceeding HUD’s benchmark
guidelines to be accompanied by significant compensating factors documented on the mortgage
credit analysis worksheet, which justify the approval of the mortgage loan, and supporting
documentation must be provided.
12
Inadequate Verification of Gift Funds
Borrower Investment in the Property Not Verified
First Tennessee officials did not adequately document the source of an $8,000 gift.
Consequently, the borrower’s investment in the property was not properly verified and
documented. First Tennessee’s file documented a copy of the December 8, 2006, gift letter from
the borrower’s mother and an official check made payable to the title company, but did not
document a copy of the donor’s withdrawal slip or cancelled check as required. Therefore, First
Tennessee officials did not obtain evidence to ensure that the gift funds came from the donor’s
personal account and ultimately did not come from an unacceptable source. Moreover, the
$8,000 gift check allegedly issued to the title company was not reflected on the HUD-1
settlement statement. Since the borrower had verifiable assets of only $1,895, these gift funds
were needed to ensure that the borrower had sufficient funds to meet the minimum cash
investment requirement of $4,770 and the funds to close of $7,820. As a result, First Tennessee
officials did not properly verify and document the gift and the borrower’s investment in the
property.
HUD/FHA Requirements:
HUD Handbook 4155.1, REV-5, paragraph 2-10C, requires that the transfer of gift funds from
the donor to the borrower, by way of an official check, be documented by obtaining a copy of the
donor’s withdrawal slip or cancelled check for the amount of the gift, showing that the funds
came from the donor’s personal account. If the donor borrowed the gift funds and cannot
provide bank documentation, the donor must provide evidence that those funds were borrowed
from an acceptable source.
13
Loan number: 332-4542658
Mortgage amount: $214,368
Section of Housing Act: 203(b)
Loan purpose: Purchase
Date of loan closing: March 11, 2008
Status as of June 30, 2010: Claim
Payments before first default reported: Zero
Loss to HUD: $121,347
Summary:
We found a material underwriting deficiency relating to the borrower’s gift funds and investment
in the property.
Inadequate Verification of Transfer of Gift Funds
Borrower Investment in Property Not Verified
First Tennessee officials did not adequately verify and document the transfer of an $8,800 gift;
consequently, the borrower’s investment in the property was not substantiated. The purchase
agreement reported that the seller would contribute 3 percent of the purchase price or the
minimum cash investment requirement of $8,800 to the downpayment assistance program. In
addition, First Tennessee’s file contained a gift letter from a nonprofit organization, which stated
that it would wire $8,800 in gift funds to the closing office to assist the borrower with the
property purchase. The gift letter was signed and dated by the borrower on February 1, 2008.
The file also contained wiring instructions for the gift and a “wire in request,” dated February 22,
2008, faxed from the settlement company on March 6, 2008. Nevertheless, First Tennessee
officials did not document the execution of the wire transfer at closing on March 11, 2008. Since
First Tennessee officials did not verify and document that the wire transfer was received by the
closing office from the nonprofit, there was no evidence that the gift funds ultimately did not
come from an unacceptable source and that the borrower met the minimum cash investment
requirement of $8,800.
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 and 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
14
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.
Mortgagee Letter 2004-28 provides that the lender must obtain and keep the documentation of
the wire transfer of downpayment funds from charities in its mortgage loan application binder.
15
Loan number: 441-7773869
Mortgage amount: $87,310
Section of Housing Act: 203(b)
Loan purpose: Purchase
Date of loan closing: March 31, 2006
Status as of June 30, 2010: Claim
Payments before first default reported: 10
Loss to HUD: $58,806
Summary:
We found a material underwriting deficiency relating to the borrower’s investment in the
property.
Borrower’s Minimum Investment in Property Not Met
First Tennessee officials did not ensure that the borrower met the 3 percent minimum cash
investment requirement of $2,640. First Tennessee’s file contained a sales contract, which
reported that the borrower made a $1,000 earnest money deposit; a copy of a check, dated
February 20, 2006, in the amount of $1,000 made payable to the selling broker for the earnest
money deposit; and a copy of the borrower’s bank statement for the period January 12 through
February 12, 2006, which reported $2,107 in personal funds. Furthermore, the HUD-1
settlement statement reflected that the borrower’s total cash investment in the property was
$2,485, which consisted of a $1,000 earnest money deposit, $1,091 paid at closing, and $394
paid outside of closing. Since the minimum cash investment requirement was $2,640, the
borrower invested $155 less than was required.
HUD/FHA Requirements:
HUD Handbook 4155.1, REV-5, paragraph 1-7, states that the borrower must make a 3 percent
minimum cash investment in the property and borrower-paid closing costs may be used to meet
the cash investment requirements.
16
Appendix C
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
17
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
18
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 1
19
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 2
20
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 3
Comment 4
21
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 4
22
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 4
Comment 5
23
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 5
24
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 5
Comment 6
25
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 6
26
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 6
Comment 7
27
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 7
28
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 7
Comment 8
29
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 8
Comment 9
30
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 9
31
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 9
32
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 10
33
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 11
34
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 12
35
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 13
36
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 14
37
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 14
Comment 15
Comment 16
38
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 17
39
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 17
40
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 18
Comment 19
41
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 19
42
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 20
43
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 20
44
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 21
45
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 21
46
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 21
47
LENDER COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Lender Comments
Comment 21
48
OIG’s Evaluation of Lender Comments
Comment 1 First Tennessee officials questioned the methodology used to select the 18 loan
files reviewed. However, we want to point out that the loan sample was not
intended to be statistical or random. The sample was the result of a targeted
analysis to specifically identify loans that had gone into claim status. Further, we
did not project the results of the review to First Tennessee’s universe of FHA
loans. Consequently, the conclusions made only pertain to the five loans that
remain in the report, which were identified as having material underwriting
deficiencies.
Comment 2 First Tennessee officials took issue with the press release announcing OIG’s
Operation Watchdog initiative. However, the January 12, 2010, HUD press
release did not make any accusations or presumptions of fraud. The goal of the
initiative was to determine why there was such a high rate of defaults and claims
with respect to the 15 companies and whether wrongdoing may have been
involved. Since the detection and investigation of fraud is the responsibility of
the Office of Inspector General, the reviews were proactive attempts to identify
systemic underwriting problems that HUD should address.
Comment 3 First Tennessee officials stated that three of the ten loans cited in the report were
not insured under the Lender’s Insurance program (FHA Case Numbers: 121-
2299638, 321-2422822, and 441-7773869) and based on the actual case binders
submitted, HUD approved these loans for FHA insurance without identifying any
underwriting concerns. HUD approved these loans based on a pre-endorsement
review, which merely ensured that all necessary forms were present and executed,
and that the case binder was acceptable. HUD’s pre-endorsement review did not
involve an underwriting analysis of the loan. Nevertheless, FHA Case Numbers:
121-2299638 and 321-2422822 have been removed from the report as a result of
First Tennessee officials’ written response and the accompanying documentation,
which supported the removal of the reported deficiencies.
Comment 4 For FHA Case Number 291-3491113, First Tennessee officials stated that
although the loan file did not contain each and every borrower paystub for 30
consecutive days, the paystub included in the loan file did cover the most recent
30-day period as required since it reflected the borrower’s year-to-date earnings
over a 10-month period. Further, First Tennessee officials stated that the
borrower’s nontaxable social security benefits were grossed-up 15 percent based
on the borrower’s 2005 tax rate as defined by the federal IRS tax table.
Regardless of the 10 months of earnings reflected on the paystub, the fact remains
that the loan file only contained one paystub covering a two-week period. HUD
Handbook 4155.1, REV-5, paragraph 3-1 E requires lenders to obtain the
borrower’s original paystubs covering the most recent 30-day period along with
original IRS W-2 Forms from the previous two years when as an alternative, the
lender obtains a verbal rather than a written verification of employment, which
49
was the case with this loan. Additionally, the loan file did not contain
documentation to support the borrower’s 2005 tax rate as required by HUD
Handbook 4155.1, REV-5, paragraph 2-7Q. However, with the exception of one
paystub, the loan file did contain the alternative documentation required to verify
the borrower's two-year employment history and income stability. Further, we
were able to confirm First Tennessee officials' argument that the borrower's bank
statements reflected biweekly payroll deposits. In addition, since HUD allows
lenders to “gross-up” nontaxable income and we were able to verify the
percentage used by First Tennessee officials, we accepted the gross-up amount.
Therefore, based on the additional information provided and verified, we have
removed the related unsupported income deficiency from the report.
Comment 5 With respect to FHA Case Number 321-2422822, while the tax returns for 2003 and
2004 evidenced the borrower’s income for the past two years, they did not evidence
the borrower’s receipt of overtime income. Further, the verbal verification of
employment reported that the borrower was hired by the current employer on
February 27, 2004. Therefore, the borrower’s pay stub, referenced in First
Tennessee officials’ response, which includes overtime income through November
6, 2005, is only relevant to the discussion of overtime income earned by the
borrower after February 27, 2004 through November 6, 2005 or 20.33 months.
Furthermore, First Tennessee officials maintained that even using the lower income
calculation and higher qualifying ratios suggested in the report, the borrower still
would have qualified for FHA financing because of the presence of a significant
compensating factor. Namely, the borrower had $4,509 in cash reserves, which
would cover six months of mortgage payments. Moreover, First Tennessee officials
acknowledged that the loan file lacked additional paystubs and W-2 forms as
required by HUD Handbook 4155.1, REV-5, paragraph 3-1E. Nevertheless, given
First Tennessee official’s justification concerning the borrower’s ample cash
reserves, we have removed the deficiency and the loan from the report.
Comment 6 For FHA Case Number 332-4507321, First Tennessee officials agreed that
although the loan file did not contain each and every borrower paystub for 30
consecutive days, the paystub included in the loan file did cover the most recent
30-day period as required. In fact, the paystubs covered eight weeks of wages,
which were consistent over all eight weeks. In addition, First Tennessee officials
referenced a closed loan review, which re-verified the borrower’s employment
and income. However, evidence of this review was not provided.
The borrower was paid on a weekly basis. Thus, the four non-consecutive
paystubs covered four, not eight weeks of wages and the loan file did not
document the coborrower’s original paystubs covering the most recent 30-day
period as required by HUD Handbook 4155.1, REV-5, paragraph 3-1 E. First
Tennessee officials also stated that the coborrower’s nontaxable social security
benefits were grossed-up 25 percent based on the borrower’s 2006 tax rate as
defined by the federal IRS tax table. Nevertheless, the loan file did not contain
documentation to support the borrower’s 2006 tax rate as required by HUD
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Handbook 4155.1, REV-5, paragraph 2-7Q. Since HUD allows lenders to “gross-
up” nontaxable income, we have removed the unsupported income deficiency
from the report because it was the only issue remaining after First Tennessee
officials provided documentation to support the removal of the deficiencies
related to the inadequate verification of the transfer of gift funds and the
borrower’s investment in the property. Further, the unsupported income
deficiency by itself is not material to warrant punitive actions against the lender.
Comment 7 For FHA Case Number 521-6392924, First Tennessee officials acknowledged that
it had been unable to locate every verification item used to underwrite the loan,
but maintained that the loan file still contained substantial evidence of the
borrowers’ two-year employment history and income stability. Further, First
Tennessee officials stated that a recent quality control review performed by an
independent third-party firm successfully re-verified the borrowers’ employment
and income; however, this review was not provided.
First Tennessee officials agreed that the 2005 IRS W-2 forms were not
documented in the loan file and the length of employment reported on the loan
application differed from the verbal verification of employment. Officials
attributed the difference to the loan processor’s handwritten error on the
verification. However, although the loan application reported that the borrower
and coborrower had been employed for one year and one year and four months,
respectively; the credit report showed that the borrower and coborrower had been
employed by their current employers for approximately nine months. Yet, no
explanation was provided for this discrepancy. Moreover, only one of the
coborrower’s two current employers listed on the loan application was reflected
on the credit report and none of the borrowers’ former employers listed on the
loan application was reflected on the credit report.
With respect to the coborrower’s paystubs, First Tennessee officials
acknowledged that they were not consecutive, but contended that they covered a
10-week period, which was more than required. However, the three
nonconsecutive paystub did not cover 10 weeks, but rather six nonconsecutive
weeks. Thus, the loan file did not contain the coborrower’s original paystubs
covering the most recent 30-day period as required by HUD Handbook 4155.1,
REV-5, paragraph 3-1 E. Nevertheless, despite First Tennessee officials’ inability
to document the borrowers’ two-year employment histories, we removed the
deficiency from the report because it was the only one remaining after First
Tennessee officials provided documentation to support the removal of the
deficiencies related to unsupported assets, and the inadequate verification of the
transfer of gift funds and the borrower’s investment in the property. Further, the
income stability deficiency by itself is not material to warrant punitive actions
against the lender.
Comment 8 Regarding FHA Case Number 291-3491113, First Tennessee officials asserted that
the significant compensating factor concerning the borrower’s $4,682.27 in cash
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reserves, which was 3.75 times the mortgage payment of $1,246.09, justified the
approval of the mortgage loan with a debt-to-income ratio exceeding HUD’s
benchmark guidelines. Nevertheless, since the borrower had verifiable assets of
only $1,895, the funds included as cash reserves would have come from the $8,000
gift from the borrower’s mother. HUD Handbook 4155.1, REV-5, paragraph 2-
13G, expressly prohibits funds from gifts from any source to be included as cash
reserves.
In addition, while we agree that the borrower’s payment history on housing
obligations holds significant importance and is at the top of the hierarchy of credit
evaluation, the borrower’s ability to make a $375 rental payment for five years is
inconsequential given that the proposed mortgage was more than three times that
amount at $1,246.09. Further, by itself, a conservative attitude towards the use of credit
is not a valid compensating factor unless it is accompanied by the borrower’s
demonstrated ability to accumulate savings, which was not documented in this case.
Therefore, the deficiency will remain in the report.
Comment 9 With respect to FHA Case Number 291-3491113, contrary to First Tennessee
officials’ contention, not only are lenders required to obtain a written explanation
from the borrower for major indications of derogatory credit, which include
judgments, collections, and other recent credit problems, but HUD Handbook
4155.1, REV-5, paragraph 2-3B, requires the lenders to obtain from the borrower a
written explanation for all inquires shown on the credit report in the last 90 days.
In addition, First Tennessee officials maintained that the Circuit Court reported not
just that the borrower’s attorney had filed for a satisfaction of judgment on March
25, 2005, due to a pending garnishment, but that a release of garnishment was filed
and sent to the sheriff on March 29, 2005. Nevertheless, the credit reported, dated
October 13, 2006, did not reflect that the judgment had been satisfied and released.
Further, First Tennessee official’s handwritten notation on the credit report indicated
that the judgment would be paid at closing. The loan file contained a copy of a
check in satisfaction of the judgment, which was issued by the title company on the
date of closing, December 11, 2006. However, the file also contained a letter, dated
December 20, 2006, from the loan originator requesting that the check be reissued to
the borrower because “he had evidence that judgment had already been satisfied and
released. Therefore, while the loan file suggested that the judgment had been paid,
no conclusive evidence was documented. Nevertheless, since we confirm through
an online research database that the judgment had been satisfied, we have
removed the related credit deficiency from the report.
Comment 10 With respect to FHA Case Number 121-2299638, since the borrower’s credit union
account was not opened recently and the $12,375 deposit occurred five months
before the loan closed, we removed the deficiency related to unsupported assets and
the loan from the report.
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Comment 11 Regarding FHA Case Number 321-2422822, given First Tennessee officials’
response that the bank statement itself referenced the source of funds and there was
no further requirement to substantiate the source of such deposits with additional
documentation, we removed the deficiency related to unsupported assets and the
loan from the report.
Comment 12 Regarding FHA Case Number 332-4542658, First Tennessee officials contended
that the earnest money deposit did not exceed 2 percent of the sales price and was
not excessive based on the borrower’s financial situation or deposit history. As a
result, they were not required to verify with documentation the deposit amount and
the source of the funds. We removed the deficiency related to unsupported assets
from the report because we confirmed First Tennessee officials’ reference to the
other deposits in similar amounts reflected on the bank statements over the three-
month period documented.
Comment 13 With respect to FHA Case Number 521-6392924, First Tennessee officials
acknowledged that the various fax headers on the verification of deposit created
some confusion regarding the provision of the document and that the underwriter
should have included clarification regarding the source of the document.
Nevertheless, First Tennessee officials maintained that none of the fax headers
indicated that the verification passed through the hands of an interested third party.
In addition, there was no suggestion that the verification had been altered or that the
borrower did not have the funds reflected therein. Further, First Tennessee officials
stated that a recent quality control review performed by an independent third-
party firm successfully re-verified the borrowers’ assets. Since First Tennessee
officials provided the re-verification of deposit, which was faxed from the
depository on February 9, 2010, we removed the deficiency related to unsupported
assets and the loan from the report.
Comment 14 Regarding FHA Case Number 521-6392924, First Tennessee officials agreed that
the date of the wire transfer was not noted in the details of the wire transfer
documentation faxed by the settlement agent on May 31, 2007. As a result, First
Tennessee officials recently obtained and have provided an email from the
settlement agent confirming that the wire transfer was received on May 24, 2007,
which was before the loan closed on May 31, 2010. Therefore, the deficiency
regarding the inadequate verification of the transfer of gift funds has been removed
from the report.
Comment 15 Regarding FHA Case Number 241-7877788, First Tennessee officials were unable
to obtained evidence from the settlement agent that the gift funds were received
from the nonprofit at or before closing. Therefore, the deficiency regarding the
inadequate verification of the transfer of gift funds will remain in the report.
Comment 16 Without proper documentation of the wire transfer from the nonprofit to the
settlement agent, there was no conclusive evidence that the gift funds did not
ultimately come from an unacceptable source. While First Tennessee officials
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provided a copy of an “Incoming Wire/Direct Deposit Confirmation” for FHA Case
Number 151-8161023, the confirmation was neither signed nor dated by a settlement
agent official evidencing the receipt of the gift funds from the nonprofit at or before
closing. Regarding FHA Case Number 332-4507321, First Tennessee officials
provided wire transfer documentation evidencing that the settlement agent received
the gift funds from the nonprofit. As a result, the deficiency has been removed from
the report. With respect to FHA Case Number 332-4542658, First Tennessee
officials obtained a “Posted Receipt” for the wire transfer from the nonprofit;
however, the receipt was not signed by a settlement agent official. Consequently,
the deficiencies will remain in the report for FHA Case Numbers 151-8161023 and
332-4542658.
Comment 17 Regarding FHA Case Number 291-3491113, First Tennessee officials were unable
to locate a copy of the gift donor’s bank statement to document the funds used to
purchase the official check. Nevertheless, First Tennessee officials contended that
the donor indicated in the gift letter that she would obtain the gift funds from her
bank account and the official check was issued by her financial institution.
However, without a copy of the donor’s bank statement, there was no assurance that
the donor did not ultimately obtained the funds used to purchase the official check
from an unacceptable source. In addition, First Tennessee officials provided another
copy of the gift check it received from the settlement agent as confirmation of its
receipt of the gift fund. While we acknowledged that the settlement agent did obtain
sufficient funds needed to close the loan, First Tennessee officials did not provide
conclusive evidence that the gift funds came from the donor’s personal account as
required HUD Handbook 4155.1. REV-5, paragraph 2-10C. Accordingly, the
deficiency will remain in the report.
Comment 18 At the time the loans in question were originated, the 3 percent minimum cash
investment was a fundamental requirement of the FHA loan program. While FHA
allowed an outright gift of the 3 percent cash investment, the lender was responsible
for obtaining verification that the settlement agent received funds from the donor for
the amount of the purported gift and those funds came from an acceptable source.
Regardless of the source of funds to close the loans, the lender was ultimately
responsible for verifying and documenting the borrowers’ investment in the property
and that the funds were from acceptable sources.
First Tennessee officials state that rather than cite new allegations regarding the
source of the borrowers’ funds to close, the report merely repeats the assertions
made in the sections regarding gift fund documentation and the borrower assets.
Although the examples cited in this allegation are the same, the allegation is neither
repetitive nor inflammatory because without verifying and documenting the transfer
of gift funds or the source of assets, First Tennessee officials did not properly
substantiate the borrower’s investment in the property. Since one deficiency was
dependent on the other, this section is a summary of the deficiency related to the
borrowers’ investment. Further, in appendix B of the report, this allegation was not
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presented as a separate deficiency, but in conjunction with the gift fund
documentation and/or the borrower assets deficiencies.
Comment 19 Regarding FHA Case Number 241-7821658, First Tennessee officials provided a
copy of the Cashier’s Check for $4,555 that the borrower brought to closing. Thus,
we removed the deficiency related to minimum cash investment and the loan from
the report.
Comment 20 Regarding FHA Case Number 441-7773869, we removed all references in the
report, which suggested that sufficient documentary evidence did not exist to ensure
that the borrower invested $2,485 in the property. Nevertheless, the fact remains
and First Tennessee officials acknowledged that the borrower invested $155 less
than the 3 percent minimum cash investment requirement of $2,640, which resulted
in the loan’s over-insurance. Therefore, the deficiency will remain in the report and
during the audit resolution process, HUD will make the decision regarding whether
to allow the lender to buy down the loan.
Comment 21 First Tennessee officials believe that the recommendations for remedies under the
Program Fraud Civil Remedies Act, civil money penalties, and/or administrative
action are unwarranted in connection with these 10 loans and should be omitted
from the report. However, we did not revise our recommendations because
violations of FHA requirements subject lenders to civil and administrative actions.
Therefore, the report recommends that HUD as the action official, determine
whether the deficiencies cited for the now five loans that remain in the report are
legally sufficient to warrant the pursuit of remedies under the Program Fraud Civil
Remedies Act, civil money penalties, and/or administrative action.
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First Tennessee Bank, N.A., Memphis, TN, Did Not Properly Underwrite a Selection of FHA Loans
Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-09-27.
Below is a raw (and likely hideous) rendition of the original report. (PDF)