oversight

Sterling National Mortgage Company, Inc., Great Neck, NY, Did Not Properly Underwrite a Selection of FHA Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-09-30.

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
                                                                     26 Federal Plaza, Room 3430
                                                                        New York, NY 10278 0068


                                                         MEMORANDUM NO: 2010-NY-1809

September 30, 2010

MEMORANDUM FOR:               Vicki Bott, Deputy Assistant Secretary for Single Family
                                     Housing, 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: Sterling National Mortgage Company, Inc., Great Neck, NY, Did Not Properly
         Underwrite a Selection of FHA Loans


                                      INTRODUCTION

We conducted a review of Federal Housing Administration (FHA) loans underwritten by Sterling
National Mortgage Company, Inc. (Sterling), an FHA direct endorsement lender. The review
was conducted as part of the Office of Inspector General’s (OIG) 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 Sterling underwrote 20 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.

The draft memorandum report was provided to Sterling officials on September 10, 2010 and
Sterling officials provided a written response on September 24, 2010. Sterling officials generally
disagreed with our findings and recommendations. The complete text of Sterling officials’
response, along with our evaluation of that response, can be found in appendix C of this
memorandum, except for the exhibits, which were too voluminous to be included within the
report. Adjustments were made to the report in some areas based on the additional
documentation and comments provided in Sterling’s written response.
                                     METHODOLOGY AND SCOPE

Sterling is 1 of 15 direct endorsement lenders we selected from HUD’s publicly available
Neighborhood Watch1 system (system) for a review of underwriting quality. These direct
endorsement lenders all had a compare ratio2 in excess of 200 percent of the national average as
listed in the system for loans endorsed between November 1, 2007, and October 31, 2009. We
selected loans from Sterling that had gone into claim status and defaulted within the first 30
months. These loans were (1) not streamline refinanced, (2) not electronically underwritten by
Fannie Mae or Freddie Mac, and (3) associated with an underwriting lender identified as having
a high number of loans going to claim. The sample of loans consisted of 1 purchase and 19
refinances. 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 Sterling, consider the results of previous
audits, or communicate with Sterling’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 defaults 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

Sterling is a HUD-approved Title II non-supervised3 lender located in Great Neck, NY. Sterling
became a direct endorsement lender on February 3, 1997. Under the direct endorsement
program, lenders are allowed to underwrite FHA-insured single-family mortgages without prior
review, but FHA 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 loss in case of default by FHA’s Mutual Mortgage Insurance Fund,
which is sustained by borrower premiums. Sterling was approved to participate in the Lender’s
Insurance (LI) program on September 6, 2007. 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 review4 being conducted by FHA. Under the LI program, the approved lender

1
  Neighborhood Watch is a Web-based data processing, automated query, reporting, and analysis system designed to
  highlight exceptions in lending practices for high-risk lenders so that potential problems are readily identifiable.
2
  HUD defines “compare ratio” as a value that reveals the largest discrepancies between the direct endorser’s default
  and claim percentage and the default and claim percentage to which it is being compared. FHA policy establishes
  a compare ratio of more than 200 percent as a warning sign of a lender’s performance.
3
  A non-supervised lender is a HUD/FHA-approved lending institution that has as its principal activity the lending or
  investment of funds in real estate mortgages and may be approved to originate, sell, purchase, hold, and/or service
  HUD/FHA-insured mortgages, depending upon its wishes and qualifications.
4
  A pre-endorsement review of the FHA case binder is conducted by HUD’s Homeownership Center staff 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.
                                                          2
performs its own pre-endorsement review and provides mortgage loan-level data to FHA via
FHA Connection.5 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. Sterling was removed from the LI program on September 23, 2009. HUD’s
Quality Assurance Division conducted its last review of Sterling on March 23, 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, Sterling endorsed 3,554
loans valued at more than $758 million and submitted 31 claims worth more than $5.1 million.

The objective was to determine whether Sterling underwrote the 20 selected loans in accordance
with HUD/FHA requirements and if not, whether the underwriting reflected systemic problems.

                                             RESULTS OF REVIEW

Sterling officials did not underwrite 6 of the 20 loans reviewed in accordance with HUD/FHA
regulations. As a result, the FHA insurance fund suffered actual losses of more than $429,703
on 5 loans and faces a potential loss of $79,120 on 1 loan for total losses of more than $508,823
as shown in the table below.

                                 Number                                                            Potential
                                                                                                                   Total
                                     of                                                             loss to
                                                                        Original                                actual and
     FHA /loan      Closing     payments     Acquisition    Unpaid                   Actual loss     HUD
                                                                        mortgage                                 potential
      number         date         before        cost        balance                   to HUD6      (60% of
                                                                        amount                                    loss to
                                   first                                                            unpaid
                                                                                                                   HUD
                                 default                                                           balance)

    022-1885701    08/31/2007       10           150,306     139,506       142,100      111,279                    111,279
    105-3453987    02/26/2008        3           147,794     141,420       142,871       61,050                     61,050
    361-3078756    05/09/2007        2           174,476     163,526       165,648       49,280                     49,280
    381-8219106    12/06/2007        9           141,057     131,866       134,445                    79,120        79,120
    412-5666814    12/04/2007        0           233,217     195,152       198,940       90,212                     90,212
    412-5681688    12/27/2007        1           146,215     122,704       125,098      117,882                    117,882
                                                                          $909,102     $429,703      $79,120      $508,823




5
    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.
6
    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.
                                                             3
The following table summarizes the material underwriting deficiencies that we identified in the 6
loans.

         Area in which underwriting deficiencies were found                       Number of loans7
      Income                                                                            3
      Liabilities                                                                          1
      Assets                                                                               1
      Borrower investment in property not verified                                         1
      Skipped mortgage payments                                                            3


Appendix A of this report shows a summary schedule of material deficiencies in each of the 6
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.

Unsupported Income or Questionable Employment History

Sterling officials incorrectly calculated the borrowers’ income or did not verify employment
stability for three loans. For loan number 412-5666814, Sterling officials incorrectly calculated
borrower gross monthly income because Social Security income for the co-borrower was
incorrectly calculated. Specifically, Sterling officials calculated the co-borrower’s monthly
Social Security income as $2,312; however, documentation only verified $1,360 in monthly
Social Security income. Although we were unable to determine whether the borrowers were
required to file a Federal income tax return, we “grossed up” the Social Security income by 25
percent, which results in monthly co-borrower Social Security income of only $1,700 and not the
$2,312 used to qualify. Using the $1,700 of co-borrower Social Security income increases the
front ratio from 33.98 to 38.74 percent and the back ratio from 48.08 to 54.81 percent, requiring
significant compensating factors to justify mortgage approval. The mortgage credit analysis
worksheet listed compensating factors of “good mortgage payment history, reducing monthly
mortgage payment, and consolidation of debts.” “Good mortgage payment history” is not an
acceptable compensating factor as defined by HUD Handbook 4155.1 REV-5, paragraph 2-13
because the borrowers paid their November 1, 2007, mortgage payment 30 days past due.
Although the borrowers received $9,821.48 in cash from this cash-out refinanced mortgage, they
defaulted on this mortgage with zero payments made. Furthermore; the remaining two factors
listed on the mortgage credit analysis worksheet are not acceptable compensating factors.

Underreported Liabilities

Sterling officials underreported liabilities for one loan. For loan number 105-3453987, Sterling
officials did not include the monthly payments related to two student loans, totaling $13,860

7
    The deficiencies noted are not independent of one another, as one loan may have contained more than one
    deficiency.
                                                          4
($8,193 and $5,667), in the calculation of the borrowers’ debt-to-income ratios, and did not
analyze and document whether the loans shown as deferred on the credit report were scheduled
for repayment after the mortgage loan had been closed for a period of at least 12 months.
Without documentation that these two debts would be deferred to a period outside of 12 months
of the loan closing, there is no assurance that the borrowers’ ratios were calculated correctly.
Further, given that the back ratio was 44.29 percent and exceeded HUD’s benchmark of 43
percent, including these debts in the underwriting analysis may have significantly affected the
borrowers’ ability to make their mortgage payments.

Unsupported Assets

Sterling officials did not adequately verify borrower assets for one loan. For loan number 022-
1885701, Sterling officials did not verify or document that the borrowers had adequate assets to
close on this refinance. The mortgage credit analysis worksheet showed that the borrowers
needed $904 to close, and the HUD-1 settlement statement, dated August 31, 2007, showed that
the borrowers were required to pay $1,694 at closing. Sterling’s file only documented
borrowers’ assets totaling $902 as shown on a bank account inquiry, dated August 31, 2007.
Therefore, the borrowers needed an additional $792 in cash to close on this refinance, and
Sterling officials did not verify that the borrowers had sufficient funds to close.

Borrower Investment in Property Not Verified

Sterling officials did not ensure that the borrowers met the statutory investment requirement for
one loan. For loan number 105-3453987, the mortgage credit analysis worksheet showed that
the sales price for this purchase was $144,000 and the statutory investment requirement was
$4,320. The HUD-1 settlement statement showed that the borrowers made a $500 earnest money
deposit and paid $2,592 at closing, resulting in a total cash investment of only $3,092. The
HUD-1 settlement statement did not list any closing costs that were paid outside of closing by
the borrowers. Therefore, the borrowers’ statutory investment requirement was short by $1,228,
and Sterling officials did not verify that the borrowers’ investment in the property was made.

Skipped Mortgage Payments

Contrary to requirements, Sterling officials allowed skipped mortgage payments on 3 refinanced
loans. Each month’s mortgage payment generally covers the previous month’s interest and
principal amounts due; therefore, when a conventional mortgage is refinanced into an FHA
mortgage it is important that all prior payments due are not rolled into the FHA mortgage. For
loan number 381-8219106, Sterling’s file included a mortgage payoff statement, dated
November 21, 2007, which was valid through December 12, 2007, and listed an unpaid principal
balance of $97,555.27. The HUD-1 settlement statement showed that this no-cash-out refinance
loan closed on December 6, 2007, with a disbursement date of December 11, 2007, and a
mortgage payoff amount of $99,852.96, which included interest, late charges and other fees from
November 1 through December 12, 2007. Since the files did not show that an adjustment was
made to reduce the interest applicable to November 2007, we concluded that the borrowers did
not make the December 1, 2007, mortgage payment. Therefore, Sterling officials allowed the
borrowers on a no-cash-out refinance that was not current at the time of refinance, to skip the
November 2007 conventional mortgage payment and roll it over into the new FHA mortgage
                                                 5
loan. Additionally, the borrowers did not make the December 1, 2007, payment due on their
second mortgage, and it was also rolled into the new FHA mortgage loan.

Incorrect Underwriter’s Certifications Submitted to HUD

We reviewed the certification for the 6 loans with material underwriting deficiencies for
accuracy. Sterling’s direct endorsement underwriters incorrectly certified that due diligence was
used in underwriting these 6 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.

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 provide Federal agencies, which are the
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 who knowingly violates any of the 14 violations listed,
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 Sterling and/or its
           principals for incorrectly certifying to the integrity of the data or that due diligence was
           exercised during the underwriting of 6 loans that resulted in actual losses of $429,703 on
           5 properties and a potential loss of $79,120 on 1 property for a total loss of $508,823,
           which could result in affirmative civil enforcement action of approximately $1,062,646.8

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

1B.        Take appropriate administrative action against Sterling 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.



8
    Double damages for actual loss amounts related to 5 loans and potential loss related to 1 loan ($508,823 x 2 =
    $1,017,646) plus $45,000, which is a $7,500 fine for each of the 6 loans with material underwriting deficiencies,
    equals $1,062,646.
                                                            6
                        SCHEDULE OF INELIGIBLE COSTS


                      Recommendation                          Ineligible 1/
                             number
                                     1A                          $508,823

                                 Totals                          $508,823

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 5
   properties ($429,703) and the potential loss related to 1 property ($79,120).




                                                  7
Appendix A

SUMMARY OF MATERIAL UNDERWRITING DEFICIENCIES




                                Unsupported Income or Questionable




                                                                                                                      Borrower Investment in Property not




                                                                                                                                                            Skipped Mortgage Payments
                                                                     Underreported Liabilities
                                       Employment History




                                                                                                 Unsupported Assets




                                                                                                                                   Verified
      FHA Number




       022-1885701                                                                               X                                                          X

      105-3453987*                                                      X                                                       X

       361-3078756                         X

      381-8219106*                                                                                                                                          X

      412-5666814*                       X

      412-5681688*                         X                                                                                                                X

         TOTALS                            3                            1                          1                             1                             3

   * 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 that the loans
     without the asterisk were originated before Sterling was approved to participate in the LI program on
     September 6, 2007.




                                                                                   8
Appendix B

 LOANS WITH MATERIAL UNDERWRITING DEFICIENCIES


Loan number: 022-1885701

Mortgage amount: $142,100

Section of Housing Act: 204 (b)

Loan purpose: No-cash-out refinance

Date of loan closing: 08/31/2007

Status as of June 30, 2010: Claim

Payments before first default reported: 10

Loss to HUD: $111,279

Summary:

We found material underwriting deficiencies relating to a skipped mortgage payments and assets.

Skipped Mortgage Payments

Contrary to the requirements, Sterling officials did not ensure that the mortgage being refinanced
was current and allowed the borrowers to skip their last two conventional mortgage payments
and roll them over into the new FHA mortgage. Each month’s mortgage payment generally
covers the previous month’s interest and principal amounts due; therefore, when a conventional
mortgage is refinanced into an FHA mortgage it is important that all prior payments due are not
rolled into the FHA mortgage. Sterling’s file included a mortgage payoff statement, dated
August 29, 2007, which was valid through September 18, 2007, and listed an unpaid principal
balance as of July 1, 2007, of $103,999.53. Added to this amount were interest of $1,750.93
from July 1 to September 18, 2007 and various fees of $194.11 for a total payoff of $105,944.57.
The HUD-1 settlement statement showed that this loan closed on August 31, 2007, with a
disbursement date of September 6, 2007, and a mortgage payoff of $105,798.67, which included
interest, late, and other fees from July 1 to September 18, 2007. The difference of $145.90
between the mortgage payoff statement and the HUD-1 settlement statement represents a
reduction of 5 days of interest at $29.18 per day. Nevertheless, if the borrower had made the
July and August mortgage payments, the principal and interest amounts covering July and
August 2007 would have been removed, but they were included in the payoff amount.
Therefore, the borrowers did not make the July 1 and August 1, 2007, mortgage payments, and
Sterling officials allowed a no-cash-out refinance on a mortgage that was not current at the time
                                                   9
of refinance and allowed skipped conventional mortgage payments to be rolled into the new
FHA loan.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 1-10, provides that lenders are not permitted to allow
borrowers to “skip” payments and the borrower is either to make the payment when it is due or
bring the monthly mortgage payment check to settlement because FHA does not permit the
inclusion of mortgage payments “skipped” by the homeowner in the new mortgage amount. For
example, a borrower whose mortgage payment is due June 1 and who expects to close the
refinance before the end of June is not permitted to roll the June mortgage payment into the new
FHA loan amount.

Mortgagee Letter 2005-43, dated October 31, 2005, states that for no-cash-out (rate and term)
refinances, the mortgage being refinanced must be current for the month due.

Unsupported Assets

Sterling officials did not verify or document that the borrowers had adequate funds to close on
this refinance. The mortgage credit analysis worksheet showed that the borrowers needed
$904.07 to close, and the HUD-1 settlement statement, dated August 31, 2007, showed that the
borrowers were required to pay $1,694 at closing. Sterling’s file only documented borrowers’
assets totaling $902 as shown on a bank account inquiry, dated August 31, 2007. Therefore, the
borrowers needed an additional $791.58 in cash to close on this refinance; however, Sterling
officials did not document or verify that the borrowers had sufficient funds to close.

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.




                                               10
Loan number: 105-3453987

Mortgage amount: $142,871

Section of Housing Act: 203 (b)

Loan purpose: Purchase

Date of loan closing: 02/26/2008

Status as of June 30, 2010: Claim

Payments before first default reported: Three

Loss to HUD: $61,050

Summary:

We found material underwriting deficiencies relating to the borrower’s investment in the
property and underreported liabilities.

Borrower Investment in Property Not Verified

Sterling officials did not ensure that the borrowers met the statutory investment requirement.
The mortgage credit analysis worksheet showed that the sale price for this purchase was
$144,000 and the statutory investment requirement was $4,320. The HUD-1 settlement
statement showed that the borrowers made a $500 earnest money deposit and paid $2,592.45 at
closing, resulting in a total cash investment of only $3,092.45. The HUD-1 settlement statement
did not list any closing costs that were paid outside of closing by the borrowers. Therefore, the
borrowers’ statutory investment requirement was short by $1,227.55, and Sterling officials did
not verify that the borrower investment in the property was made.

HUD/FHA Requirements:

Mortgagee Letter 98-29, dated October 22, 1998, states, “The National Housing Act requires the
minimum cash investment to be 3 percent of the [HUD] Secretary's estimate of the cost of
acquisition. FHA has determined that the minimum cash investment be based on sales price
without considering closing costs to further Congressional objectives of simplifying the FHA
maximum mortgage amount calculation without significantly increasing FHA’s risk.” Closing
costs will not be included in calculating the 3 percent cash requirement but may be included in
satisfying the 3 percent requirement. Mortgagee Letter 2003-01, dated January 14, 2003, made
permanent the down-payment simplification procedures described in Mortgagee Letter 98-29.

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.

                                                11
Underreported Liabilities

Sterling officials did not include the monthly payments related to two student loans, totaling
$13,860 ($8,193 and $5,667), in the calculation of the borrowers’ debt-to-income ratios and did
not analyze and document whether the loans shown as deferred on the credit report were
scheduled for repayment after the mortgage loan had been closed for a period of at least 12
months. Without documentation that these two debts would be deferred to a period outside of 12
months of the loan closing, there is no assurance that the borrowers’ ratios were calculated
correctly. Further, given that the back ratio was 44.29 percent and exceeded HUD’s benchmark
of 43 percent, including these debts in the underwriting analysis may have significantly affected
the borrowers’ ability to make their mortgage payments.

HUD/FHA Requirements:

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

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.




                                                12
Loan number: 361-3078756

Mortgage amount: $165,648

Section of Housing Act: 203 (b)

Loan purpose: Cash-out refinance

Date of loan closing: 05/09/2007

Status as of June 30, 2010: Claim

Payments before first default reported: Two

Loss to HUD: $49,280

Summary:

We found material underwriting deficiencies relating to incorrect calculation of income, resulting
in excessive ratios.

Incorrect Calculation of Income, Resulting in Excessive Ratios

Sterling officials incorrectly calculated the borrowers’ overall effective monthly income by
including $4,083 in commission income related to the borrower without properly documenting
that it had been received for the past two years and was likely to continue. Additionally, the co-
borrower’s gross monthly income of $3,950 reported on the verification of employment was
included in the calculation even though it was not supported by the pay stub. The borrower’s
verification of employment, dated April 16, 2007, showed that the borrower earned commission
income of $4,225 for 2007 for employment that began on February 5, 2007. Although
verifications of employment from the borrower’s two previous employers showed commission
income, this income cannot be used to qualify because it would not continue through the first 3
years of the mortgage loan. Further, Sterling officials used the co-borrower’s income of $3,950
from a verification of employment, dated April 12, 1007; however, a copy of the co-borrower’s
pay stub, dated April 6, 2007, for the period March 26 to April 1, 2007, showed a weekly salary
of $1,046.25 and year-to-date earnings of $10,449.30. Using the year-to-date earnings, we
calculated the co-borrower’s monthly income to be $3,483.10 and not $3,950.

While Sterling officials calculated the borrowers’ overall effective monthly income as $11,533,
which consisted of the borrower’s base pay of $3,500, the borrower’s commission income of
$4,083, and the co-borrower’s base pay of $3,950, only gross monthly income of $6,983.10 was
documented and verified. As a result of our income recalculation, the borrowers’ qualifying
ratios increased; specifically, the front ratio increased from 11.44 to 18.89 percent and the back
ratio increased from 47.87 to 79.05 percent. Sterling officials documented the following
compensating factors on the addendum to the mortgage credit analysis worksheet: “manual
underwrite, own home 14 years, lowering rate/payments, average commission over 2 years, letter
from borrower explains he is not currently paying alimony per divorce decree was only 12
                                                   13
months, employer pays Chrysler included in ratio, and excellent reserves.” Although “cash
reserves” is a valid compensating factor, it is not considered significant enough to justify
approving a mortgage with a back ratio of 79.05 percent, especially since the borrowers
defaulted with only two mortgage payments made. The other compensating factors listed were
not valid or not supported by adequate documentation.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-7D, states that commissions earned for less than 1
year are not considered effective income, commission income must be averaged over the
previous 2 years, and the borrower must provide copies of signed tax returns for the last 2 years,
along with the most recent pay stub. Paragraph 2-7 also 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.

Chapter 2 of HUD Handbook 4155.1, REV-5, provides that the anticipated amount of income
and the likelihood of its continuance must be established to determine a borrower’s capacity to
repay mortgage debt and income may not be used in calculating the borrower’s income ratios if it
comes from a source that cannot be verified, is not stable, or will not continue.

Mortgagee Letter 2005-16, dated April 13, 2005, states that for manually underwritten
mortgages, the qualifying ratios are raised to 31 and 43 percent and if either or both ratios are
exceeded on a manually underwritten mortgage, the lender must describe the compensating
factors used to justify mortgage approval.

HUD Handbook 4155.1, REV-5, paragraph 2-13, provides that compensating factors may be
used to justify approval of mortgage loans with ratios that exceed HUD benchmark guidelines;
however, underwriters must note in the “remarks” section of the mortgage credit analysis
worksheet any compensating factor used and provide supporting documentation.

HUD Handbook 4155.1, REV-5, paragraph 1-11 B, cautions that cash-out refinances for debt
consolidation represent a considerable risk, especially if the borrower has not had an attendant
increase in income, and such transactions must be carefully evaluated.




                                                 14
Loan number: 381-8219106

Mortgage amount: $134,445

Section of Housing Act: 203 (b)

Loan purpose: No-cash-out refinance

Date of loan closing: 12/06/2007

Status as of June 30, 2010: Claim

Payments before first default reported: Nine

Potential Loss to HUD: $79,120

Summary:

We found a material underwriting deficiency relating to a skipped mortgage payment.

Skipped Mortgage Payment

Contrary to the requirements, Sterling officials did not ensure that the mortgage being refinanced
was current and allowed the borrowers to skip their last conventional mortgage payment and roll
it over into the new FHA mortgage. Each month’s mortgage payment generally covers the
previous month’s interest and principal amounts due; therefore, when a conventional mortgage is
refinanced into an FHA mortgage, it is important that all prior payments due are not rolled into
the FHA mortgage. Sterling’s file included a mortgage payoff statement, dated November 21,
2007, which was valid through December 12, 2007, and listed an unpaid principal balance of
$97,555.27. The HUD-1 settlement statement showed that this no-cash-out refinance loan closed
on December 6, 2007, with a disbursement date of December 11, 2007, and a mortgage payoff
amount of $99,852.96, which included interest, late charges and other fees from November 1
through December 12, 2007. Since the files did not show that an adjustment was made to reduce
the interest applicable to November 2007, we concluded that the borrowers did not make the
December 1, 2007, mortgage payment. Therefore, Sterling officials allowed the borrowers on a
no-cash-out refinance that was not current at the time of refinance, to skip the November 2007
conventional mortgage payment and roll it over into the new FHA mortgage loan. Additionally,
the borrowers did not make the December 1, 2007, payment due on their second mortgage, and it
was also rolled into the new FHA mortgage loan.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 1-10, provides that lenders are not permitted to allow
borrowers to “skip” payments and the borrower is either to make the payment when it is due or
bring the monthly mortgage payment check to settlement because FHA does not permit the
inclusion of mortgage payments “skipped” by the homeowner in the new mortgage amount. For
example, a borrower whose mortgage payment is due June 1 and who expects to close the
                                             15
refinance before the end of June is not permitted to roll the June mortgage payment into the new
FHA loan amount.

Mortgagee Letter 2005-43, dated October 31, 2005, states that for no-cash-out (rate and term)
refinances, the mortgage being refinanced must be current for the month due.




                                               16
Loan number: 412-5666814

Mortgage amount: $198,940

Section of Housing Act: 203 (b)

Loan purpose: Cash-out refinance

Date of loan closing: 12/04/2007

Status as of June 30, 2010: Claim

Payments before first default reported: Zero

Loss to HUD: $90,212

Summary:

We found material underwriting deficiencies relating to incorrect calculation of income, resulting
in excessive ratios, and income stability not established.

Incorrect Calculation of Income, Resulting in Excessive Ratios

Sterling officials incorrectly calculated the borrower’s gross monthly income because Social
Security income for the co-borrower was incorrectly calculated. Specifically, Sterling officials
calculated the co-borrower’s monthly Social Security income as $2,312; however,
documentation only verified $1,360 in monthly Social Security income. Although we were
unable to determine whether the borrowers were required to file a Federal income tax return, we
“grossed up” the Social Security income by 25 percent, which results in monthly co-borrower
Social Security income of only $1,700 and not the $2,312 used to qualify. Using the $1,700 of
co-borrower Social Security income increases the front ratio from 33.98 to 38.74 percent and the
back ratio from 48.08 to 54.81 percent, requiring significant compensating factors to justify
mortgage approval. The mortgage credit analysis worksheet listed compensating factors of
“good mortgage payment history, reducing monthly mortgage payment, and consolidation of
debts.” “Good mortgage payment history” is not an acceptable compensating factor as defined
by HUD Handbook 4155.1 REV-5, paragraph 2-13 because the borrowers paid their November
1, 2007, mortgage payment 30 days past due. Although the borrowers received $9,821.48 in
cash from this cash-out refinanced mortgage, they defaulted on this mortgage with zero
payments made. Furthermore; the remaining two factors listed on the mortgage credit analysis
worksheet are not acceptable compensating factors.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-7E, states that retirement and Social Security
income require verification from the source (former employer, Social Security Administration)
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.
                                                 17
HUD Handbook 4155.1, REV-5, paragraph 2-7Q, states that if a particular source of regular
income is not subject to Federal taxes (e.g., certain types of disability and public assistance
payments, military allowances), the amount of continuing tax savings attributable to the
nontaxable income source may be added to the borrower’s gross income. The percentage of
income that may be added may not exceed the appropriate tax rate for that income amount, and
no additional allowances for dependents are acceptable. The lender must document and support
the adjustments (the amount the income is grossed up) made for any nontaxable income source.
Child support income cannot be grossed up. The lender should use the tax rate used to calculate
last year's income tax for the borrower. If the borrower is not required to file a Federal income
tax return, the tax rate to use is 25 percent.

Mortgagee Letter 2005-16, dated April 13, 2005, states that for manually underwritten
mortgages, the qualifying ratios are raised to 31 and 43 percent and if either or both ratios are
exceeded on a manually underwritten mortgage, the lender must describe the compensating
factors used to justify mortgage approval

HUD Handbook 4155.1, REV-5, paragraph 2-13, provides that compensating factors may be
used to justify approval of mortgage loans with ratios that exceed HUD benchmark guidelines;
however, underwriters must note in the “remarks” section of the mortgage credit analysis
worksheet any compensating factor used and provide supporting documentation.

Income Stability Not Established

Sterling officials did not verify the borrower’s employment for the most recent 2 full years;
therefore, income stability was not established. The verification of employment from the
borrower’s current employer showed that the borrower was employed from September 19, 2007,
to the date of the closing, December 4, 2007, which was a period of 2½ months. The verification
of employment from the borrower’s prior employer showed that the borrower was employed
from December 17, 2006, to September 23, 2007, which is 9 months. Therefore, Sterling
officials verified borrower employment for 11.5 months, and there was an unexplained gap in
borrower employment of 12.5 months.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-6, states that the lender must verify the borrower’s
employment for the most recent 2 full years and the borrower must explain any gaps in
employment spanning 1 month or more.




                                                 18
Loan number: 412-5681688

Mortgage amount: $125,098

Section of Housing Act: 203 (b)

Loan purpose: No-cash-out refinance

Date of loan closing: 12/27/2007

Status as of June 30, 2010: Claim

Payments before first default reported: One

Loss to HUD: $117,882

Summary:

We found material underwriting deficiencies relating to incorrect calculation of income, resulting
in excessive ratios, and a skipped mortgage payment.

Incorrect Calculation of Income, Resulting in Excessive Ratios

Sterling officials incorrectly calculated borrower gross monthly income. Specifically, Sterling
officials calculated the borrower’s monthly base pay as $2,004 using the annual salary of
$24,044 as shown on the verification of employment from the borrower’s current employer.
However, the borrower’s pay stub from her current employer only showed year-to-date earnings
through November 2, 2007, of $19,247.58, which is an average of $1,924.76 per month.
Additionally, Internal Revenue Service forms W-2 for 2005 and 2006 from the same employer
showed total earnings of $11,082.07 and $15,364.36, respectively. Using the $1,924.76 for
income increases the front ratio from 49.51 to 51.41 percent and the back ratio from 50.43 to
52.38 percent, requiring significant compensating factors. The mortgage credit analysis
worksheet listed compensating factors of “using income for one child only, manual underwritten,
income from paystubs/voe, loan to value of 88 percent, and rate and term refinance.” There was
no documentation in the file to support that the child support income for the borrower’s other
two children would continue for the first 3 years of the mortgage; however, the children were
ages 19 and 20 at the time of loan closing. None of the remaining compensating factors is valid
for approving a mortgage with a front ratio of 51.41 percent and a back ratio of 52.38 percent,
considering that the borrower defaulted with only one mortgage payment made.

HUD/FHA Requirements:

Chapter 2 of HUD Handbook 4155.1, REV-5, provides that the anticipated amount of income
and the likelihood of its continuance must be established to determine a borrower’s capacity to
repay mortgage debt and income may not be used in calculating the borrower’s income ratios if it
comes from a source that cannot be verified, is not stable, or will not continue.

                                               19
Mortgagee Letter 2005-16, dated April 13, 2005, states that for manually underwritten
mortgages, the qualifying ratios are raised to 31 and 43 percent and if either or both ratios are
exceeded on a manually underwritten mortgage, the lender must describe the compensating
factors used to justify mortgage approval

HUD Handbook 4155.1, REV-5, paragraph 2-13, provides that compensating factors may be
used to justify approval of mortgage loans with ratios that exceed HUD benchmark guidelines;
however, underwriters must note in the “remarks” section of the mortgage credit analysis
worksheet any compensating factor used and provide supporting documentation.

Skipped Mortgage Payment

Contrary to the requirements, Sterling officials did not ensure that the mortgage being refinanced
was current and allowed the borrower to skip the last conventional mortgage payment and roll it
over into the new FHA mortgage. Each month’s mortgage payment generally covers the
previous month’s interest and principal amounts due; therefore, when a conventional mortgage is
refinanced into an FHA mortgage it is important that all prior payments due are not rolled into
the FHA mortgage. Sterling’s file included a mortgage payoff statement, dated November 29,
2007, which was valid through December 26, 2007, and showed that the December 1, 2007,
mortgage payment was due. The payoff statement also listed an unpaid principal balance of
$115,632.23. The HUD-1 settlement statement showed that this no-cash-out refinance loan
closed on December 27, 2007, with a disbursement date of January 2, 2008, and a mortgage
payoff of $118,046.92, which included interest, late charges and other fees from November 8 to
December 26, 2007. If the borrower had made the December 1, 2007, mortgage payment, the
interest figure would have been reduced, but it was included in the payoff amount. Therefore,
the borrower did not make the December 1, 2007, mortgage payment, and Sterling officials
allowed the borrower on a no-cash-out refinance that was not current at the time of refinance, to
skip the December 2007 conventional mortgage payment and roll it over into the new FHA
mortgage loan.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 1-10E, provides that lenders are not permitted to
allow borrowers to “skip” payments and the borrower is either to make the payment when it is
due or bring the monthly mortgage payment check to settlement because FHA does not permit
the inclusion of mortgage payments “skipped” by the homeowner in the new mortgage amount.
For example, a borrower whose mortgage payment is due June 1 and who expects to close the
refinance before the end of June is not permitted to roll the June mortgage payment into the new
FHA loan amount.

Mortgagee Letter 2005-43, dated October 23, 2005, states that for no-cash-out (rate and term)
refinances, the mortgage being refinanced must be current for the month due.




                                                 20
APPENDIX C

         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




                          21
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 1




                          22
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 2




                          23
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 3




                          24
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 3




                          25
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 4




                          26
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 5




                          27
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 5




Comment 5




                          28
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 5




Comment 6




                          29
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 7




Comment 7




                          30
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 8




                          31
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 8




                          32
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 9




                          33
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 10




Comment 11




                          34
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 11




                          35
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 12




                          36
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 12




                          37
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 13




                          38
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 13




Comment 13




Comment 14




                          39
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 14




Comment 14




                          40
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 15




Comment 16




Comment 16




Comment 16




                          41
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 17




                          42
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 17




Comment 17




                          43
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 17




                          44
         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




Comment 17




                          45
                   OIG’s Evaluation of Lender Comments


Comment 1   In their response, Sterling officials stated that increasingly restrictive underwriting
            criteria has been implemented due to the rising trend in its compare ratio, which
            has resulted in a compare ratio of 174 percent as of August 31, 2010. Since our
            review did not consider the internal controls of Sterling, we did not evaluate
            Sterling’s new underwriting criteria; however, we note that Neighborhood Watch
            shows that Sterling’s compare ratio is no longer more than 200 percent as of
            August 31, 2010.

Comment 2   Sterling officials have taken issue with the press release announcing OIG’s
            Operation Watchdog initiative; however, the January 12, 2010 HUD press release
            does 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 the 15 companies and whether there may have been wrongdoing involved.
            The detection and investigation of fraud is the responsibility of the Office of
            Inspector General in each of its audits and reviews. As such, the reviews are
            proactive in trying to identify systemic problems that HUD needs to address.

Comment 3   For FHA loan number 137-3791174, Sterling officials agree that the underwriter
            in this case should have qualify the borrower with a lower amount of monthly
            income than what was used; however, Sterling officials disagree that
            compensating factors were not presented and documented. In their response,
            Sterling officials stated that the mortgage credit analysis worksheet noted no
            payment shock, which meant that the borrowers experienced a minimal increase
            of $54 in their mortgage payment. Since Paragraph 2-13 F of HUD Handbook
            4155.1 REV-5 lists a minimal increase in housing expenses as a valid
            compensating factor, we have revised the deficiency to state that borrower income
            was incorrectly calculated; however, a valid compensating factor was presented
            and documented, therefore, the deficiency and the loan was removed from the
            report.

Comment 4   For FHA loan number 241-7994157, Sterling officials provided additional
            documentation supporting the use of overtime income to qualify; therefore, we
            have removed this deficiency and loan from the report.

Comment 5   For FHA loan number 361-3078756, Sterling officials state that they documented
            that the borrower received commission income since 2003; therefore, it should
            have been included. We disagree because although the borrower had earned
            commission income in the past, he had only been employed with his current
            employer for more than two months at the time the verification of employment
            was signed and Paragraph 2-7 D of HUD Handbook 4155.1 REV-5 states that
            commissions earned for less than one year are not considered effective income.
            Regarding the co-borrower’s income, Sterling officials state that there are no FHA
            guidelines requiring the use of year to date earnings to calculate qualifying
            income. Although this is correct, the verification of employment for the co-
                                             46
            borrower was faxed from the borrower’s employer; therefore, it is questionable
            and should not have been used. By using the year to date earnings from the co-
            borrower’s paystub, we obtain a more accurate calculation of income earned by
            the co-borrower. Therefore, this loan and deficiency will remain in the report.

Comment 6   For FHA loan number 381-8219106, based on Sterling comments and a second
            review of Mortgagee letter 2005-43, the material deficiency related to incorrect
            calculation of income, resulting in excessive ratio has been removed from the
            report.

Comment 7   For FHA loan number 412-5666814, Sterling officials acknowledge that the
            borrower’s income was incorrectly calculated; however, officials maintain that the
            file documented significant compensating factors. We disagree because the
            compensating factors presented of good mortgage payment history, loan to value
            of 80.82 percent, and decrease in borrower’s mortgage payment were not valid.
            Good mortgage payment history and decrease in mortgage payment are not valid
            because the borrowers paid their November 1, 2007 mortgage payment thirty days
            past due. Although HUD may consider a loan to value of 80.82 percent a valid
            compensating factor, it is not significant enough to justify approving a mortgage
            with a back ratio of 54.81 percent. In addition, Sterling officials stated that the
            borrower defaulted due to illness of the primary mortgagor; however, this is not a
            valid argument to justify not making any payments after receiving over $9,821 at
            closing and defaulting on this mortgage with zero payments made. Therefore, this
            deficiency and the loan will remain in the report.

Comment 8   For FHA loan number 412-5681688, Sterling officials state that there are no FHA
            guidelines requiring the use of year-to-date earnings to calculate qualifying
            income and the file documented significant compensating factors. Although this
            is correct, the income shown on the verification of employment form and used to
            qualify was not supported by the borrower’s pay stub; therefore, it should not
            have been used. By using the year to date earnings from the borrower’s paystub,
            we obtain a more accurate calculation of income earned by the borrower.
            Regarding the documentation of significant compensating factors, Sterling
            officials contend that the child support income for the borrower’s other two
            children, which was not used to qualify is a significant compensating factor
            regardless of whether such income was expected to continue for the first three
            years of the mortgage. We disagree because the borrower defaulted on this
            mortgage with only one payment made and the reason for default was curtailment
            of borrower income. Therefore, this loan and deficiency will remain in the report.

Comment 9   For FHA loan number 105-3453987, Sterling officials agreed that monthly
            payments for the two student loans should have been included in the borrowers’
            back ratio; however, officials stated that the file documented compensating
            factors of good prior mortgage and significant cash reserves of over $3,200. We
            disagree because the borrowers’ credit report show that the borrowers paid their
            July 2007 mortgage payment 30 days past due and paid their August 2007
            mortgage payment 60 days past due. Additionally, the borrowers’ bank
                                              47
               statements only showed cash of $5,238.65 and the borrowers needed $2,592.45 to
               close, which results in cash reserves of only $2,646.20. This is only 2.5 months
               of cash reserves and not the three months required to be a valid compensating
               factor. Therefore, this loan and deficiency will remain in the report.

Comment 10 For FHA loan number 241-7994157, Sterling officials agreed that 12 months of
           on-time payments should have been documented to support excluding the
           contingent liability of $395; and officials state that the credit report shows that 22
           months of payments have been made without any history of delinquency. Based
           on our review of the credit report and evaluation of Sterling official comments,
           we agree that 22 months of on time payments were made. As a result, we have
           removed the deficiency and the loan from the report.

Comment 11 For FHA loan number 263-4019928, based on Sterling’s response and the fact
           that the borrowers received cash back at closing of $1,679.62, which was
           sufficient to pay off the $300 credit card balance, we have removed the deficiency
           and the loan from the report.

Comment 12 For FHA loan number 043-7417616, Sterling officials agreed that the borrower’s
           back ratio exceeded HUD’s benchmark. In their response, Sterling officials stated
           that the mortgage credit analysis worksheet noted no payment shock, which meant
           that the borrowers experienced a minimal increase of $117 in their mortgage
           payment. Since Paragraph 2-13 F of HUD Handbook 4155.1 REV-5 lists a
           minimal increase in housing expense as a valid compensating factor, and based on
           Sterling officials comments, we have removed the excessive ratio deficiency and
           this loan from the report.

Comment 13 For FHA loan number 011-5725717, Sterling officials provided all eight pages of
           the borrower’s credit report and a letter of explanation for derogatory accounts;
           therefore, we have removed the deficiency and the loan from the report.

Comment 14 For FHA loan number 105-3453987, Sterling officials provided documentation
           showing that the borrowers’ paid a total of $766 outside of closing for closing
           costs and was $461.55 short of the three percent minimum investment. Sterling
           officials stated that they would be willing to buy down the principal balance of
           this loan by $461.55 to remedy the over-insured amount. Since this loan has
           already gone to claim and HUD experienced a loss of $61,050, buying down the
           principal will not provide a remedy. As a result, the deficiency and the loan
           remain in the report.

Comment 15 For FHA loan number 263-4019928, Sterling officials provided documentation
           showing that the borrowers paid their last mortgage payments; therefore, the
           skipped mortgage payment deficiency and the loan have been removed from the
           report.



                                               48
Comment 16 Sterling officials stated that since nine9 loans with skipped mortgage payments
           were cash-out refinances, the borrowers would have paid their last mortgage
           payments through a reduction in their cash payout. We believe that the Sterling
           official’s explanation is reasonable in that if the borrower would have brought the
           last mortgage payment to closing, they would have received a higher payout in
           their cash out refinances. Therefore, we have removed the deficiency related to
           skipped mortgage payments for FHA loan numbers 011-5725717, 043-7417616,
           105-3753842, 137-3791174, 241-7994157, 361-3078756, 371-3791979, and 412-
           5666814, and we have removed FHA loan numbers, 011-5725717, 043-7417616,
           105-3753842, 241-7994157, and 371-3791979 from the report.

                    Note however, Sterling officials incorrectly stated that loan number 022-1885701
                    was a cash-out refinance, but it was a no-cash-out refinance. Furthermore,
                    Sterling officials did not address the skipped mortgage payments for this loan and
                    the other two no cash-out refinances (381-8219106, and 412-5681688); therefore,
                    these deficiencies and loans will remain in the report.

Comment 17 Sterling officials believe that the recommendations for remedies under Program
           Fraud Civil Remedies Act, Civil Money Penalties, and/or administrative action
           are not appropriate and should be removed from the report. However, we did not
           change the recommendations because violations of FHA rules are subject to civil
           and administrative action. Nevertheless, the report does recommend that HUD
           make determinations of the legal sufficiency of the deficiencies cited and pursue
           remedies under the Program Fraud Civil Remedies Act, Civil Money Penalties,
           and/or administrative actions, if necessary.




9
    Sterling officials mentioned nine cash-out refinance loans instead of eight because they inadvertently included
    FHA loan number 022-1885701, a no-cash-out refinance loan, in the discussion. While there are nine cash-out
    refinance loans, FHA loan number 263-4019928, a cash-out refinance loan, was discussed separately in comment
    15 above.
                                                          49