oversight

Nationwide Home Loans, Miami, FL, Did Not Follow HUD Requirements in Approving FHA Loans and Implementing Its Quality Control Program

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-10-25.

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

                                                                 Issue Date
                                                                       October 25, 2010
                                                                 Audit Report Number
                                                                        2011-AT-1001




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


           //signed//
FROM:      James D. McKay, Regional Inspector General for Audit, Atlanta Region, 4AGA

SUBJECT: Nationwide Home Loans, Miami, FL, Did Not Follow HUD Requirements in
          Approving FHA Loans and Implementing Its Quality Control Program

                                   HIGHLIGHTS

 What We Audited and Why

            We audited Nationwide Home Loans, Inc. (Nationwide), a Federal Housing
            Administration (FHA)-approved direct endorsement lender, located in Miami, FL.
            The audit objectives were to determine whether the lender followed U.S.
            Department of Housing and Urban Development (HUD) requirements when (1)
            originating and underwriting loans and (2) implementing its quality control
            program. We selected this lender because its high default rate of 23 percent was
            significantly higher than the Miami HUD area average default rate of 10 percent.

 What We Found

            Nationwide did not follow HUD requirements when it used various independent
            loan officers to originate its loans. Specifically, it used at least 16 independent
            loan officers to originate 41 loans underwritten in the Miami HUD area in 2009.
            These 16 loan officers were also employed by or owned businesses involved with
            mortgage lending or other related fields such as real estate sales and mortgage
            processing. This condition occurred because the lender disregarded HUD
            requirements when originating its loans. As a result, Nationwide approved loans
            that were not eligible for FHA insurance and increased the risk to the FHA
            insurance fund by more than $4 million.
           In addition, Nationwide did not follow HUD requirements when originating and
           underwriting loans for FHA insurance. It used inaccurate and unsupported
           information to qualify borrowers for five of six FHA loans reviewed. This
           condition occurred because the lender disregarded HUD requirements, did not
           exercise due care in originating and underwriting these loans for FHA insurance,
           and lacked controls to ensure compliance with HUD requirements. As a result,
           Nationwide approved loans that did not qualify for FHA insurance and
           unnecessarily placed the FHA insurance fund at risk for almost $1 million.

           Further, Nationwide did not implement a quality control program that complied
           with HUD requirements. It did not conduct quality control reviews in compliance
           with requirements, and its written quality control plan did not contain the required
           provisions. These conditions occurred because Nationwide disregarded HUD
           requirements. As a result, Nationwide increased the risk to the FHA insurance
           fund because it did not have assurance regarding the accuracy, validity, and
           completeness of its loan origination and underwriting operations.


What We Recommend

           We recommend that the Deputy Assistant Secretary for Single Family Housing
           require Nationwide to indemnify HUD for the 46 ineligible FHA loans with an
           estimated potential loss of $5 million. We also recommend that Nationwide be
           referred to the Mortgagee Review Board for consideration of imposing civil
           money penalties for the ineligible loans and taking appropriate administrative
           actions against the individuals and entities responsible. Finally, we recommend
           that Nationwide develop, implement, and enforce (1) written controls to ensure
           that loans are originated and underwritten in accordance with HUD requirements
           and (2) a quality control program that complies with HUD 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 the
           audit.


Auditee’s Response

           We discussed our review results with Nationwide and HUD officials during the
           audit. We provided a copy of the draft report to Nationwide on September 22,
           2010, for its comments and discussed the report with officials at the exit
           conference on October 7, 2010. Nationwide provided its comments on October 7,
           2010. It generally agreed with our findings.

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

                                            2
                             TABLE OF CONTENTS

Background and Objectives                                                        4

Results of Audit
        Finding 1: Nationwide Did Not Follow HUD Requirements When It Used       5
                   Independent Loan Officers To Originate Loans
        Finding 2: Nationwide Did Not Follow HUD Requirements When Originating   10
                   and Underwriting FHA Loans
        Finding 3: Nationwide Did Not Follow HUD Requirements When               14
                   Implementing Its Quality Control Program

Scope and Methodology                                                            20

Internal Controls                                                                23

Appendixes
   A.   Schedule of Funds To Be Put to Better Use                                25
   B.   Auditee Comments and OIG’s Evaluation                                    26
   C.   Schedule of Indemnification Amounts for the 41 Loans                     29
   D.   Loan Details for the Five Loans                                          31
   E.   Schedule of Indemnification Amounts for the Five Loans                   39




                                              3
                      BACKGROUND AND OBJECTIVES

Nationwide Home Loans, Inc. (Nationwide) is a Federal Housing Administration (FHA)-approved
non-supervised direct endorsement lender based in Miami, FL. Under the direct endorsement
program, the U.S. Department of Housing and Urban Development (HUD) authorizes approved
lenders to underwrite FHA loans without HUD’s prior review and approval. A non-supervised
lender is an institution which has as its principal activity the lending or investing of funds in real
estate mortgages. It may submit applications for mortgage insurance and may originate, underwrite,
purchase, hold, and service insured loans or sell mortgages. Nationwide became an FHA-approved
lender in August 2007 and currently does not have any active branch offices. The lender does not
sponsor any loan correspondents but acts as the principal for three authorized agents. The principal-
authorized agent relationship provides the lender the flexibility to collaborate with another FHA
lender to originate FHA loans.

HUD’s Neighborhood Watch system showed that from March 1, 2008, to February 28, 2010,
Nationwide originated 218 loans in HUD’s Miami office jurisdiction. As of February 28, 2010, 50
of the 218 loans (23 percent) with mortgage amounts totaling more than $10.8 million were in
default. Nationwide’s default rate significantly exceeded the Miami office jurisdiction’s default rate
of 10 percent. However, the lender has not originated any FHA loans since July 2009. In
November 2009, Nationwide came under new ownership. Currently, most of Nationwide’s
employees involved in originating and underwriting the loans from our audit period are no longer
employed at Nationwide.

On June 18, 2010, HUD notified Nationwide of its intent to terminate the lender’s origination
approval agreement because of its high default and claim rate. On July 30, 2010, an informal
hearing was held between Nationwide and HUD officials. On September 9, 2010, HUD terminated
Nationwide’s origination approval agreement for a period of six months.

Our audit objectives were to determine whether the lender followed HUD requirements when (1)
originating and underwriting loans and (2) implementing its quality control program.




                                                  4
                                  RESULTS OF AUDIT


Finding 1: Nationwide Did Not Follow HUD Requirements When It
Used Independent Loan Officers To Originate Loans
Nationwide did not follow HUD requirements when it used independent loan officers to
originate its loans. Specifically, it used at least 16 independent loan officers to originate 41 loans
underwritten in the Miami HUD area in 2009, contrary to HUD requirements. These 16 loan
officers were also employed by or owners of businesses involved with mortgage lending or other
related fields. This condition occurred because the lender disregarded HUD requirements when
originating its loans. As a result, Nationwide approved loans that were not eligible for FHA
insurance and increased the risk to the FHA insurance fund by more than $4 million.



               Nationwide did not follow HUD requirements when it used independent loan
               officers to originate 41 loans with mortgages totaling more than $7 million. It
               underwrote 126 loans in the Miami HUD area in 2009. We reviewed 123 of the
               lender’s loan files. Lenders must follow HUD Handbook 4060.1, REV-2, “FHA
               Title II Mortgagee Approval Handbook,” to operate as an FHA-approved lender.
               This handbook provides the general requirements to be approved for participation
               in FHA mortgage insurance programs and provides specific requirements related
               to the loan origination functions. Paragraph 2-13 of HUD Handbook 4060.1,
               REV-2, states that lenders are not permitted to outsource functions that materially
               affect underwriting decisions or increase the risk to FHA. Specifically, lenders
               are not allowed to outsource the management, underwriting, and loan origination
               functions. In addition, HUD Handbook 4060.1, REV-2, paragraph 2-9A defines
               an employee as those individuals under the direct supervision and control of an
               FHA approved lender. Below is a table that summarizes that the types of
               independent loan officers that originated the loans, number of loans and mortgage
               amounts involved, and associated violations.

   Loan                         Prohibited by HUD         Loans     Original       Unpaid     Indemnification
  Officers   Relationship    (HUD Handbook 4060.1,       Involved   Mortgage      Principal      Amount
                                       REV-2)                                     Balance
     12      Not FHA        Paragraph 2-9G (Employees      21       $3,775,035   $3,726,281     $2,235,768
             Approved       Are Not Allowed to Have
             Lenders        Outside Employment in
                            Mortgage Lending, Real
                            Estate, or Related Fields)




                                                  5
   4      FHA Loan         Paragraph 2-18                20    $3,357,086   $3,332,587    $1,999,552
          Correspondent    (Require Authorized Loan
                           Correspondent and Sponsor,
                           or Principal and Authorized
                           Agent Relationship)

  16      Employed By      Paragraph 2-13                41    $7,132,121   $7,058,867    $4,235,320
(Total)   or Owned         (Outsourcing of Loan
          Businesses       Origination Function)
          Involved in
          Mortgage         Paragraph 2-22
          Lending or       (Compensation for Services
          Related Fields   Not Permitted by HUD)

             The table includes an estimated loss of more than $4.2 million from the 41 loans
             based on 60 percent of the unpaid principal balance of $7 million. Sixty percent
             of the unpaid principal balance was the average loss incurred by HUD for fiscal
             year 2009 when the FHA property was resold for less than the unpaid principal
             balance as determined by HUD statistics.


Independent Loan Officers Were
Affiliated With Other Mortgage
Lending Entities or Related Fields


             Nationwide knowingly used at least 16 loan officers that were also employed by
             or owners of other mortgage lending, real estate, or other related fields to
             originate 41 loans for Nationwide in 2009. According to HUD Handbook 4060.1,
             REV-2, paragraph 2-9G, loan officers are allowed to have outside employment,
             but the outside employment may not be in mortgage lending, real estate, or a
             related field.

             Nationwide was aware that these independent loan officers were employed by or
             owners of other mortgage lending companies or related services. Various
             documents were found throughout the lender’s loan files which indicated that
             these individuals worked for other companies during the time they originated
             loans for Nationwide. The front cover of the lender’s loan file identified the
             names of the other lending companies and/or independent loan officers that
             originated the loans. Broker fee sheets were found in some of the lender loan files
             that itemized the independent loan officers’ compensation with the names of the
             broker company or loan officers for originating the loan. In addition, the loan
             applications listed the names of the independent loan officers that originated the
             loans as employees of Nationwide.

             The Florida Division of Corporations’ Web site disclosed that these independent
             loan officers were owners, presidents, vice presidents, directors, and managing
             members of the same businesses found on or within Nationwide’s loan files.
             Although documentation in the files identified that the independent loan officers
                                                   6
           performed loan origination functions, these loans were submitted to HUD as
           being originated by Nationwide. Therefore, Nationwide submitted false
           information to HUD for FHA insurance.

           For example, the lender’s loan file for FHA loan 095-1109120 contained several
           documents indicating that the loan officer worked for another mortgage company.
           The file contained a loan application with the independent loan officer’s signature
           as an employee of Nationwide, an employment verification processed by the
           independent loan officer’s own mortgage company, and the front cover of the file
           showed the name of the independent loan officer and her mortgage company. In
           addition, the settlement agent for this loan was the vice president of the
           independent loan officer’s company. From our search of the Florida Division of
           Corporations Web site, we found that the independent loan officer was the
           president of the mortgage company shown on the front cover of the lender’s loan
           file. As of August 31, 2010, this loan was in the foreclosure process.

           In addition, 12 of the 16 independent loan officers were not from FHA-approved
           lenders, so they may not have been familiar with FHA requirements and were not
           authorized to originate FHA loans. The 12 independent loan officers originated
           21 of the 41 loans. Four of the twenty one (19 percent) loans were delinquent as
           of August 31, 2010.


FHA-Approved Lenders Used
Did Not Have the Required
Established Relationship With
Nationwide

           Nationwide used FHA-approved lenders that did not have the required established
           relationship with Nationwide to originate loans. HUD Handbook 4060.1, REV-2,
           paragraph 2-18, states that lenders may not perform only a part of the loan
           origination process, such as taking the loan application, and routinely transfer the
           underwriting package to another lender except between a loan correspondent and
           its sponsor and a principal and its authorized agent.

           Four of the sixteen independent loan officers that originated 20 of the 41 loans for
           Nationwide were identified as owners of FHA-approved loan correspondent
           lender entities. Of the 20 loans originated by the other FHA lenders, only 4 were
           disclosed in the HUD Neighborhood Watch system as being originated by the
           other lenders. As FHA-approved lenders, the lenders should have been familiar
           with HUD requirements for participating in the FHA program. The FHA lenders
           used by Nationwide did not have approved loan correspondent and sponsor or
           principal and authorized agent relationships with Nationwide. Six of the twenty
           (30 percent) loans originated by the FHA approved loan correspondents were
           delinquent as of August 31, 2010 and only one was disclosed as being originated
           by the FHA loan correspondent.

                                            7
Nationwide Made Various
Payments to the Independent
Loan Officers

           Nationwide used various methods to pay the independent loan officers. In some
           instances, it paid the commission directly to the other mortgage lending company
           instead of to the independent loan officer. Many of these payments were not
           disclosed on the HUD-1 settlement statements. Nationwide also issued Internal
           Revenue Service (IRS) form W-2 to some of these independent loan officers.
           These payments were not allowed because the loan originations by the
           independent loan officers were not permitted by HUD, and all of the payments to
           them are considered prohibited payments. HUD Handbook 4060.1, paragraph 2-
           22, states that a lender may not pay any fee, kickback, compensation, or thing of
           value (including a fee representing all or part of the lender’s origination fee) to
           any person or entity in connection with a FHA-insured mortgage transaction
           except for services actually performed and permitted by HUD.

The Lender Disregarded HUD
Requirements

           Nationwide’s current owner stated that he was unaware of this practice when he
           acquired the business in November 2009. All of the loans were underwritten
           between January and July of 2009 when the business was under the management
           of the former owner. The former owner stated that independent loan officers were
           used to originate loans but they were all from FHA-approved lenders. Although 4
           of the independent loan officers were from FHA-approved lender entities, the
           remaining 12 were not. In addition, 16 of the 20 loans originated by the FHA-
           approved lenders were not disclosed to HUD as having been originated by these
           other FHA lenders and were reported as having been originated by Nationwide.

           As a result of Nationwide’s use of independent loan officers, Nationwide
           increased the risk to the FHA insurance fund. It did not have direct control and
           supervision of its independent loan officers to ensure that they followed HUD
           requirements when originating the loans. In addition, the use of the independent
           loan officers skewed and circumvented the monitoring and enforcement efforts of
           the lender’s own quality control reviews and by HUD. Allowing these
           independent loan officers to originate loans for more than one FHA lender at a
           time permits poorly performing and ineligible loans to be spread across multiple
           lenders, which makes it more difficult for HUD and the lender to identify the
           individuals or entities responsible for these loans. We estimate that HUD would
           suffer a loss of more than $4.2 million from the 41 loans based on 60 percent of
           the unpaid principal balance of $7 million. Sixty percent of the unpaid principal
           balance was the average loss incurred by HUD for fiscal year 2009 when the FHA



                                            8
             property was resold for less than the unpaid principal balance as determined by
             HUD statistics.

             As of August 31, 2010, 10 of the 41 loans (24 percent) were delinquent or in the
             foreclosure process, while the remaining 31 were current or reinstated.

             Appendix C lists the 41 loans originated by the independent loan officers.

Conclusion


             Nationwide used 16 independent loan officers to originate 41 ineligible loans with
             mortgages totaling $7 million. Nationwide was not allowed to contract out the
             origination functions, and the independent loan officers were not allowed to have
             outside employment in mortgage lending, real estate, or related fields. However,
             various documents throughout the lender’s loan files indicated that the loan
             officers worked for these businesses, including other FHA lenders, when they
             originated loans for Nationwide. As a result, Nationwide increased the risk to the
             FHA insurance fund by $4 million by (1) not having direct control and
             supervision of the independent loan officers to ensure that FHA requirements
             were followed when originating the loans; (2) misrepresenting the individuals and
             entities that originated and processed the loans to HUD on which HUD relied for
             its monitoring and enforcement efforts; and (3) misrepresenting the origins of the
             loans, which would circumvent the lender’s own quality control review when
             identifying root causes for deficiencies or fraud.

Recommendations


     We recommend that the Assistant Secretary for Housing-Federal Housing Commissioner

     1A. Require Nationwide to indemnify the 41 ineligible FHA-insured loans with an
         estimated loss of $4,235,320. The estimated loss was based on the loss severity rate
         of 60 percent as determined by HUD statistics for fiscal year 2009 and the total
         unpaid principal balance of $7,058,867 of the 41 loans as of August 2010.

     1B. Refer Nationwide to the Mortgagee Review Board to take appropriate
         administrative action against the lender including debarring the responsible
         individuals and imposing civil money penalties for the 41 ineligible loans and
         associated false statements.

     1C. Require Nationwide to develop, implement, and enforce written controls to ensure
         that the loans are originated by allowable loan officers or FHA-approved lenders
         that have established authorized relationships with the lender in accordance with
         HUD requirements.



                                              9
Finding 2: Nationwide Did Not Follow HUD Requirements When
           Originating and Underwriting Loans
Nationwide did not follow HUD requirements when originating and underwriting loans for FHA
insurance. It used inaccurate and unsupported information to qualify borrowers for five of six
FHA loans reviewed. This condition occurred because the lender disregarded HUD
requirements, did not exercise due care in originating and underwriting these loans for FHA
insurance, and lacked controls to ensure compliance with HUD requirements. As a result,
Nationwide approved loans that did not qualify for FHA insurance and placed the FHA insurance
fund at risk for almost $1 million.


 Loans Had Significant
 Underwriting Deficiencies

              Nationwide did not follow HUD requirements when originating and underwriting
              five of the six loans reviewed. The five loans had original mortgage amounts
              totaling more than $1.6 million. Lenders must follow HUD Handbook 4155.1,
              REV-5, “Mortgage Credit Analysis for Mortgage Insurance on One-to Four-Unit
              Mortgage Loans,” when underwriting FHA loans. This handbook describes the
              procedures for evaluating the borrower’s credit history, capacity to make
              payments, and available cash assets to close the mortgage. The lender is
              responsible for eliciting a complete picture of the borrower’s financial situation,
              source of funds for the transaction, and intended use of the property. The lender’s
              decision to approve the loan must be documented, supported, and verifiable.

              The table below shows the summary of deficiencies identified for the five loans.

                                 Inaccurate or                                       Minimum
                                 unsupported                             Maximum     required Property
                                  employment    Inadequate Unsupported allowable       cash    not owner
                                    & other    credit analysis source of mortgage   investment occupied
               FHA case number      income                       funds   exceeded     not met
                 095-1164560           X                                                           X
                 095-0927805           X
                 095-0679947           X              X            X                    X
                 095-1026242           X              X
                 095-1076080           X              X                     X
                    Total              5              3            1         1          1         1


              Examples of the underwriting deficiencies include the following:

              Inaccurate Employment Information
              Nationwide did not accurately verify or support borrowers’ employment
              information for five loans. HUD Handbook 4155.1, Chapter 2, Section 2, states
              that income may not be used in calculating the borrower’s qualifying ratios if it
              comes from any source that cannot be verified, is not stable, or will not continue.

                                               10
HUD Mortgagee Letter 2005-16 updated the qualifying front and back ratios to 31
and 43 percent, respectively.

For FHA loan 095-0927805, the lender used $9,087 as the borrower’s monthly
employment income to qualify the borrower for the $276,353 FHA-insured
mortgage. This amount included income from two different jobs. However, we
confirmed with the borrower and the first employer that the borrower’s monthly
employment income was $2,759. The borrower stated that she never held the
second job and did not provide employment information to the lender regarding
the second job. Our recalculation of the borrower’s qualifying front and back
ratios equaled 98 and 133 percent instead of 29.7 and 40.4 percent, respectively.
As a result, the borrower would not have qualified for the loan because the lender
submitted inaccurate employment information to HUD. In addition, the
borrower’s recalculated qualifying ratios overwhelmingly exceeded the FHA-
established qualifying ratios.

Inadequate Credit Analysis
Nationwide omitted borrowers’ liabilities from consideration in approving their
loans without written explanation for three loans. HUD Handbook 4155.1,
paragraph 2-11, states that in computing the qualifying ratios, the lender must
include the monthly housing expense and all other recurring charges extending 10
months or more. 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.

For FHA loan 095-1076080, the lender omitted $27,372 of the borrower’s debts
in computing the qualifying ratios. The lender only considered $16,496 of the
borrower’s debts while the documentation in the loan file showed debts totaling
$43,868. The $27,372 of debts omitted were student loans. There was no written
evidence that the student loans would have been deferred for more than 12
months. Our recalculation of the borrower’s qualifying front and back ratios
equaled 41 and 96 percent, respectively. As a result, the borrower would not have
qualified for the loan because the borrower’s recalculated qualifying ratios
significantly exceeded the FHA-established qualifying ratios.

Loan Amount Greater Than Maximum Allowable Mortgage
Nationwide did not properly calculate the maximum allowable mortgage and
approved a loan that exceeded the maximum allowable mortgage amount. HUD
Handbook 4155.1, paragraph 1-7, specifies that mortgages may only be insured
for up to a certain amount provided the borrower makes the required minimum
cash investment. HUD Mortgagee Letter 05-43 updated the maximum allowable
mortgage amount for refinanced loans. The letter stated that refinance loans in
which the borrower received cash back in excess of $500 would be allowed a
maximum allowable mortgage amount of 95 percent of the appraisal value.

                                11
          For FHA loan 095-1076080, the lender approved a mortgage of $330,000 for this
          cash-out refinance loan. The borrower received $3,190 to pay the 2008 property
          tax shown in the HUD-1 settlement statement. The appraisal report for the loan
          showed that the property was appraised at $345,000. Therefore, the maximum
          loan amount should have been $327,750 or 95 percent of the appraised value. As
          a result, the mortgage amount exceeded the maximum allowable mortgage by
          $2,250.

          Appendix D details the deficiencies for each of the five loans and Appendix E
          provides a schedule of indemnification amounts for those loans.

The Lender Lacked Controls
and Disregarded HUD
Requirements

          Nationwide disregarded HUD requirements, did not exercise due care in
          originating and underwriting these loans for FHA insurance, and lacked controls
          to ensure compliance with HUD requirements. As a direct endorsement lender,
          Nationwide was allowed to endorse mortgage loans for FHA insurance without a
          detailed technical underwriting review by HUD. In approving loans for FHA
          insurance, the underwriter certified that he (1) had personally reviewed the
          application documents, (2) ensured that prudent underwriting procedures were
          followed, and (3) was familiar with HUD requirements such as the procedures
          referenced in HUD Handbook 4155.1.

          We reviewed the loan files with the underwriter associated with the loans to
          determine why these loans were approved with deficiencies. The underwriter was
          aware of some of the FHA requirements, such as requiring documentation to
          justify omitting a borrower’s liabilities, but decided to disregard this requirement.
          For example, the underwriter omitted a portion of a borrower’s student loans
          without justification. The underwriter stated he knew deferred liabilities such as
          student loans required documentation showing a deferral of more than 12 months
          to be excluded from the qualifying ratios. The underwriter acknowledged that the
          file was not adequately documented to show the student loans were deferred for
          more than 12 months.

          In another instance, the underwriter did not exercise due care by not questioning
          the 2 years of amended tax returns, which substantially increased the borrower’s
          income from $25,000 to about $91,000, filed a few months before the loan
          application. Finally, Nationwide lacked controls to ensure compliance such as
          including the required documentation to support employment income or source of
          funds. In addition, Nationwide did not have written controls to ensure the
          underwriter’s decision complied with HUD underwriting requirements and that
          documentation sufficiently supported the underwriter’s decision before closing. It
          also had an insufficient post-quality control program (see finding 3).



                                           12
             We estimate that HUD would suffer a loss of $951,674 from the five loans based
             on 60 percent of the unpaid principal balance of nearly $1.6 million. Sixty
             percent of the unpaid principal balance was the average loss incurred by HUD for
             fiscal year 2009 when the FHA property was resold for less than the unpaid
             principal balance as determined by HUD statistics.


Conclusion


             Nationwide did not follow HUD requirements when originating and underwriting
             five of six FHA loans reviewed. The deficiencies occurred because the lender
             disregarded HUD requirements, did not exercise due care, and lacked adequate
             controls to ensure that the loans were originated and underwritten in accordance
             with HUD requirements. As a result, Nationwide approved and insured five loans
             that were not eligible for FHA insurance. The loans placed the FHA insurance
             fund at risk for almost $1 million in potential losses.

Recommendations

             We recommend that the Deputy Assistant Secretary for Single Family Housing

             2A. Require Nationwide to indemnify the five ineligible FHA loans with an
                 estimated loss of $951,674. The estimated loss was based on the loss
                 severity rate of 60 percent as determined by HUD statistics for fiscal year
                 2009 and the total unpaid principal balance of $1,586,123 of the five loans
                 as of August 2010.

             2B. Determine the amount of over-insured mortgage for FHA case 095-1076080
                 and require Nationwide to pay down the loan balance and provide evidence
                 of the principal reduction.

             2C. Refer Nationwide to the Mortgagee Review Board to take appropriate
                 administrative action against the lender, including debarring the responsible
                 individuals and imposing civil money penalties.

             2D. Require Nationwide to develop, implement, and enforce written controls to
                 ensure that loans are originated and underwritten in accordance with HUD
                 requirements.




                                             13
Finding 3: Nationwide Did Not Follow HUD Requirements When
Implementing Its Quality Control Program
Nationwide did not implement a quality control program that complied with HUD requirements.
Specifically, it did not conduct quality control reviews in compliance with requirements, and its
written quality control plan did not contain the required provisions. These conditions occurred
because Nationwide disregarded HUD requirements. As a result, Nationwide increased the risk
to the FHA insurance fund because it did not have assurance regarding the accuracy, validity,
and completeness of its loan origination and underwriting operations.


As a condition of receiving and maintaining FHA approval, Nationwide must implement and
continuously have in place a quality control program for the origination and/or servicing of
insured mortgages. HUD Handbook 4060.1, REV-2, paragraph 7-2, states that lenders must
design their quality control program to meet the basic goals of ensuring compliance with FHA’s
and the lender’s origination and servicing requirements; protecting FHA and the lender from
unacceptable risk; guarding against errors, omissions, and fraud; and ensuring swift and
appropriate corrective action. The lender’s quality control program contained deficiencies in its
quality control reviews and its written quality control plan.

Quality Control Reviews Did Not
Comply With HUD Requirements

               Nationwide did not have any quality control reviews performed before May 2009,
               although the former owner was aware that quality control reviews were required
               as part of being an FHA lender. As part of the current owner’s due diligence to
               determine the viability of purchasing Nationwide, an external contractor was
               hired in May 2009 to perform quality control reviews. The contractor performed
               quality control reviews on 14 FHA loans that Nationwide closed between March
               and July 2009. Nationwide did not underwrite any FHA loans after July 2009.
               We analyzed the quality control reviews performed and determined that
               Nationwide did not perform its quality control reviews according to HUD
               requirements. We found the following deficiencies:

               Loans Not Reviewed Within Time Limit
               HUD Handbook 4060.1, REV-2, paragraph 7-6A, states that loans must be
               reviewed within 90 days from the end of the month in which the loan closed.
               None of the 14 quality control reviews were performed within the 90 day limit.
               The elapsed days ranged from 96 to 264.

               Frequency of Reviews Not Performed
               HUD Handbook 4060.1, REV-2, paragraph 7-6B, states that for lenders closing
               more than 15 loans monthly, quality control reviews must be conducted at least
               monthly and must address one month’s activity. Lenders closing 15 or fewer
               loans monthly may perform quality control reviews on a quarterly basis. Based

                                               14
on the lender’s loan activity from April 2008 to July 2009, it should have
performed quarterly reviews for the months of April 2008 to September 2008.
However, no reviews were performed. From October 2008 to July 2009, the
lender should have performed at least ten monthly reviews. However, only five
reviews were conducted monthly for the months of March 2009 to July 2009. No
reviews were performed on loans that closed before March 2009. Therefore, the
lender did not perform quality control reviews in accordance with the frequency
basis required by HUD.

Ten Percent of the Originated Loans Not Reviewed
HUD Handbook 4060.1, REV-2, paragraph 7-6C, states that a lender that
originates and/or underwrites 3,500 or fewer FHA loans per year must review 10
percent of its FHA loans. The lender originated 298 FHA loans from April 2008
to March 2010, requiring quality control reviews of at least 30 loans. However,
only 14 quality control reviews were performed on the loans that closed between
March and July 2009. Therefore, the lender did not have quality control reviews
performed on 10 percent of the originated loans as required by HUD.

Early Payment Default Loans Not Reviewed
HUD Handbook 4060.1, REV-2, paragraph 7-6D, states that all early payment
default loans must be reviewed. Early payment default loans are loans that have
defaulted within the first six payments and become 60 days past due. During the
2-year period of April 2008 through March 2010, Nationwide had 33 early
payment default loans. None of the 33 early payment default loans were
reviewed.

Credit Reports Not Obtained
HUD Handbook 4060.1, REV-2, paragraph 7-6E(1), states that a new credit
report must be obtained for each borrower whose loan is included in a quality
control review unless the loan was a streamline refinance or was processed and
approved by an automated underwriting system. Two of the fourteen loans
reviewed were not approved by an automated underwriting system. Thus, for the
two loans, credit reports should have been obtained for the borrowers. However,
the credit reports for the borrowers were not obtained.

Document Reverifications Not Performed
HUD Handbook 4060.1, REV-2, paragraph 7-6E(2), states that documents
contained in the loan file, such as documents relating to borrower’s income, gifts,
or sources of funds, should be checked for sufficiency and subjected to written
reverification. We reviewed 5 of the 14 quality control reviews to determine
whether reverifications were performed on the documents in the loan files. For all
five loans, the borrower’s employment income, sources of funds, and/or gift funds
were not properly reverified.




                                15
For the reverification of employment on one loan, the external contractor only
reverified one of the borrower’s two jobs and did not reverify the borrower’s
other employment, reasoning that it was not used to qualify for the loan. We
reviewed the income documents for both employers and noted that both were used
to calculate the gross monthly income to qualify for the loan. The external
contractor did not send out the reverification of the borrower’s source of funds on
four loans, reasoning that the lender did not pay upfront or reimburse the cost to
have the financial institution verify the borrower’s sources of funds. Lastly, the
external contractor did not reverify the gift funds for two loans.

Field Appraisal Not Performed
HUD Handbook 4060.1, REV-2, paragraph 7-6E(3), states that lenders are
expected to perform field reviews on 10 percent of the loans selected per year
during the sampling process. Thus, since the lender performed quality control
reviews on 14 FHA loans during the year, at least 1 field appraisal should have
been performed. The external contractor confirmed that it did not have any field
appraisals conducted for its reviews.

Occupancy Verification Not Performed
HUD Handbook 4060.1, REV-2, paragraph 7-6E(4), states that in cases in which
the occupancy of the subject property is suspect, the lender must attempt to
determine whether the borrower is occupying the property. The external
contractor stated that the occupancy of a property may be suspect when the loan
application indicates that (1) the borrower will not be occupying the property as a
primary residence, (2) the borrower owns a property other than the FHA property,
or (3) the FHA property is relatively far from the borrower’s place of
employment. These indicators were present on 3 of the 14 loans. For two loans,
the loan application showed that the borrower owned another property and was
living in it before purchasing the FHA property. For another loan, the loan
application showed that the FHA property was located in a different county more
than 122 miles from the borrower’s place of employment. These indicators
should have resulted in attempts to determine whether the borrower was
occupying the property. However, our review showed that occupancy
verifications were not performed.

Conditions Needed for Loan Clearance and Closing Not Verified
HUD Handbook 4060.1, REV-2, paragraph 7-6G, states that each loan selected
for a quality control review must be reviewed to determine whether conditions
required for closing were met, the seller was the owner of record or was exempt,
the loan closed and funds were disbursed according to instructions, and the
closing and legal documents were accurate and complete. In our interview with
the external contractor, the contractor indicated that she did not know that she was
required to determine that the seller was the owner of record and to review the
funds to determine that they were disbursed in accordance with the underwriting
and closing instructions.



                                 16
           Corrective Actions Not Adequate To Address Deficiency
           HUD Handbook 4060.1, REV-2, paragraph 7-3I, states that review findings must
           be reported to the lender’s senior management within one month of completion of
           the initial report. Management must take prompt action to deal appropriately with
           any material findings such as discontinuance of borrower’s employment income
           before the loan closing and sufficient documentation to support employment
           income. Of the 14 quality control reviews, at least 3 findings were material and
           required a response by the lender’s management. Although the lender’s
           management responded to two of the three reviews, its response was not prompt
           and did not appropriately respond to the cited deficiencies. The reports were
           provided to the lender in the first week of October 2009, but the lender did not
           provide a response until the end of December 2009. The lender’s management
           did not respond to the other review. Thus, we assessed that the lender did not
           implement action to promptly and appropriately deal with material findings
           resulting from the quality control reviews.


The Written Plan Did Not
Contain Required Provisions

           Nationwide’s written quality control plan did not contain HUD-required
           provisions. HUD Handbook 4060.1, REV-2, paragraph 7-3G, requires that each
           loan selected for a quality control review be reviewed to determine whether (1)
           conditions required for closing were met, (2) the seller was the owner of record or
           was exempt, (3) the loan closed and funds were disbursed according to
           instructions, and (4) the closing and legal documents were accurate and complete.
           Nationwide’s written quality control plan did not contain the last three provisions.
           Nationwide’s management acknowledged that these provisions should have been
           included in its written plan and explained that it was an oversight.

The Lender Disregarded HUD
Requirements

           Nationwide disregarded HUD requirements to implement and continuously have
           in place a compliant quality control program. It increased the risk to the FHA
           insurance fund because it did not have assurance regarding the accuracy, validity,
           and completeness of its loan origination and underwriting operations.

           The current management officials acknowledged that they were responsible for
           the deficiencies with the quality control reviews and provided explanations for the
           deficiencies. Nationwide’s management stated that the priorities at the time were
           to determine the general quality of the loans, what procedures were in place and
           what procedures needed to be implemented, and, ultimately, whether to purchase
           the company. The current management recognized that the quality control
           reviews would not be performed in a timely manner, and the early payment

                                            17
             default loans were not reviewed because following HUD’s requirements was not
             the objective of the reviews.

             In addition, Nationwide did not evaluate the work of the external contractor to
             ensure that the contractor

                    Reverified the borrower’s credit when needed;
                    Reverified the borrower’s employment, sources of funds, and gift funds;
                    Reverified the borrower was occupying the property if occupancy of the
                    subject property was suspect.
                    Conducted a field appraisal of 10 percent of the loans selected for review;
                    Determined whether the seller was the owner of record;
                    Determined whether the loan closed and funds were disbursed according
                    to instructions; and

             Management stated that it was not aware that the external contractor did not
             perform these required services.

             Further, the lender did not evaluate the work of staff to ensure that corrective
             actions were sufficient to address the deficiencies cited in the quality control
             report. Management agreed that the responses for the two quality control reports
             did not sufficiently address the cited deficiencies. Management explained that the
             responses for the other quality control report was not prepared because by the
             time the lender received the reports, the underwriter no longer worked at
             Nationwide.

Conclusion


             Nationwide did not follow HUD requirements when implementing its quality
             control program. The lender disregarded HUD requirements to implement and
             have a continuous quality control program that complied with HUD requirements.
             As a result, Nationwide increased the risk to the FHA insurance fund because it
             did not have assurance regarding the accuracy, validity, and completeness of its
             loan origination and underwriting operations. In addition, the effectiveness of
             Nationwide’s quality control program to guard against errors, omission, and fraud
             was diminished.




                                             18
Recommendations


    We recommend that the Deputy Assistant Secretary for Single Family Housing

           3A. Require Nationwide to develop, implement, and enforce a quality control
               program that complies with HUD requirements. Specifically, the lender needs
               to establish a written plan with controls, ensure that quality control reviews
               meet HUD requirements, and enforce and maintain its quality control program
               on a continual basis.

           3B. Perform a review of Nationwide’s quality control program within 9 months
                to determine whether adequate controls have been established and quality
                control reviews are conducted in compliance with HUD requirements.




                                           19
                         SCOPE AND METHODOLOGY

Nationwide underwrote 218 loans within the jurisdiction of the Miami HUD office between the
amortization dates of March 1, 2008, and February 28, 2010. As of February 28, 2010, 50 loans
with mortgage amounts totaling $10.8 million were in default. We did not perform a 100 percent
selection or a representative selection using statistical or nonstatistical sampling. We selected 6
loans for review based on various risk factors including loans (1) with mortgage amounts of
$300,000 or greater, (2) that defaulted within 6 months of closing, and (3) that recently
defaulted. The original mortgages of the six loans totaled approximately $1.98 million, and the
unpaid principal balance totaled approximately $1.97 million. The results of our review apply
only to the loans reviewed and cannot be projected to the universe of loans. We accessed HUD’s
Neighborhood Watch system to obtain information about the lender and its loans.

To accomplish the audit objectives, we

           Reviewed applicable HUD handbooks and mortgagee letters;
           Reviewed Nationwide’s written policies and procedures for originating and
           underwriting loans;
           Reviewed FHA loan files and Nationwide’s loan files;
           Reviewed Nationwide’s written quality control plan;
           Analyzed the quality control review reports;
           Interviewed Nationwide’s former and current employees, external quality control
           contractors, and the lender’s current management; and
           Verified the accuracy of the information from the loan files with the borrowers and
           borrowers’ employers.

Based on our interviews with the former owner and employees and our review of the loan files,
we identified that the lender used independent loan officers to originate and/or process many of
its FHA loans. For the 126 FHA loans that closed in 2009 totaling more than $22.4 million, we
reviewed 123 of the lender’s loan files to determine whether the loan was originated by an
independent contract loan officer contrary to HUD requirements. Three of the loan files were
not reviewed because the lender could not locate these files. We also reviewed the lender’s
general ledgers, 2009 IRS forms W-2 and 1099 issued by the lender, personnel files, and
applicable HUD handbooks and mortgagee letters, as well as conducted searches on the HUD
Neighborhood Watch system and Florida’s Division of Corporations’ Web site.

We assessed the reliability of computer-processed data maintained on two systems – HUD’s
Neighborhood Watch system and the external contractor’s quality control system.

HUD’s system is designed to highlight exceptions so that potential problems are readily
identifiable. In particular, the system gives the ability to identify and analyze patterns, by
geographic area or originating lender, in loans which became 90 days delinquent during the first
2 years. We assessed the reliability of the computer-processed data by comparing the data with
the information we obtained from public records, our review of the loan file, and our verification


                                                20
with borrowers and employers. Specifically, we compared the following five data fields from
the HUD Neighborhood Watch system:

           Borrower’s name or the ownership of the property,
           Date of loan closing,
           Mortgage amount,
           Qualifying ratios, and
           Period the servicer reported the first legal action to commence foreclosure.

Our analyses showed that the qualifying ratios in the HUD system were not accurate and not
supported by the loan files and our review. Additionally, public records showed that two of the
foreclosure action dates posted on the HUD system were incorrect. The foreclosure action dates
recorded in the HUD system showed the action occurring two to three months after the action
dates found in the public records. Considering the overall results, we determined that the
computer-processed data in HUD’s Neighborhood Watch system related to qualifying ratios and
foreclosure actions were unreliable (see finding 2).

For the quality control system, we selected 5 of the 14 quality control reviews performed and
selected 4 computer-processed data fields to assess the data’s reliability – (1) date of loan
closing, (2) loan officer, (3) appraiser, and (4) date reverifications were sent. We compared the
data to the documents contained in the lender’s loan files such as the HUD-1 settlement
statement, loan application, and appraisal report. We also compared the data to the dates on the
employment, source of funds, and/or gift reverification packages contained in the quality control
folders and to the information obtained from our interview with the external contractor. The
information obtained from the external contractor and our review of the reverification packages
did not support that the reverifications were sent as indicated in the quality control system.
Therefore, we determined that the computer-processed data in the external contractor’s quality
control system related to reverification dates were not accurate and were unreliable (see finding
3).

During the course of the audit, we clarified HUD regulations and discussed potential issues with
the Atlanta Homeownership Center, Quality Assurance Division. We also discussed the findings
with Nationwide’s current management.

We classified more than $5 million as funds to be put to better use. This is 60 percent of the $8.6
million in unpaid principal balances for the 46 FHA-insured loans that did not meet HUD’s
requirements. We used 60 percent because it has been determined that upon sale of the
mortgaged properties, FHA’s average loss was about 60 percent of the unpaid principal balance
for fiscal year 2009.

Our review generally covered the period March 1, 2008, through February 28, 2010, and was
extended as necessary. We conducted our fieldwork from April to July 2010 at Nationwide’s
office in Miami, FL, and at various other locations in the Miami-Dade and Broward County
areas to conduct our interviews with the borrowers, employers, former owner and employees,
and external quality control contractor.


                                                21
We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objectives. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objectives.




                                               22
                              INTERNAL CONTROLS

Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to

         Effectiveness and efficiency of operations,
         Reliability of financial reporting, and
         Compliance with applicable laws and regulations.

Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals, and objectives. Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program operations as well as the
systems for measuring, reporting, and monitoring program performance.




 Relevant Internal Controls

               We determined that the following internal controls were relevant to our audit
               objectives:

                  Program operation – Policies and procedures that management has implemented
                  to reasonably ensure that a program meets its objectives.

                  Reliability of data – Policies and procedures that management has implemented
                  to reasonably ensure that valid and reliable data are obtained, maintained, and
                  fairly disclosed in reports.

                  Compliance with laws and regulations – Policies and procedures that
                  management has implemented to reasonably ensure that resource use is
                  consistent with laws and regulations.

               We assessed the relevant controls identified above.

               A deficiency in internal control exists when the design or operation of a control does
               not allow management or employees, in the normal course of performing their
               assigned functions, the reasonable opportunity to prevent, detect, or correct (1)
               impairments to effectiveness or efficiency of operations, (2) misstatements in
               financial or performance information, or (3) violations of laws and regulations on a
               timely basis.




                                                 23
Significant Deficiencies


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

                Nationwide did not follow HUD requirements when it used independent loan
                officers to originate loans (see finding 1).

                Nationwide did not follow HUD requirements when originating and
                underwriting FHA loans (see finding 2).

                Nationwide did not follow HUD requirements when implementing its quality
                control program (see finding 3).




                                              24
                                    APPENDIXES

Appendix A

     SCHEDULE OF FUNDS TO BE PUT TO BETTER USE


                        Recommendation             Funds to be put to
                               number                   better use 1/

                               1A                        $4,235,320
                               2A                          $951,674
                              Total                      $5,186,994

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

     Implementation of our recommendations to require Nationwide to indemnify HUD for
     the 46 materially deficient and ineligible loans will reduce the risk of loss to the FHA
     insurance fund. The amount above reflects HUD’s estimated loss of 60 percent of the
     unpaid principal balance of $8,644,990 from the loans as of August 31, 2010.




                                             25
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                          26
27
                         OIG Evaluation of Auditee Comments

Comment 1   Nationwide did not disagree with our findings or recommendations. The current
            owner stated that he acquired Nationwide in November 2009, and had no
            knowledge of the prior practices which are alleged to have occurred in connection
            with loans underwritten between January and July 2009. The current owner
            stated he had no affiliation with the prior owners and management of Nationwide.
            In addition, Nationwide stated it is dedicated to ensuring that the practices alleged
            in the draft report are not repeated by Nationwide in the future, and will continue
            to fully cooperate with our office and HUD regarding this matter.

            Nationwide’s agreement with the findings and recommendations indicates its
            willingness to make necessary improvements to ensure it follows HUD
            requirements when originating and underwriting loans, and implementing its
            quality control program.




                                             28
Appendix C

             SCHEDULE OF INDEMNIFICATION AMOUNTS
                       FOR THE 41 LOANS

                                                   Original    Unpaid
        Independent loan       FHA case no.        mortgage   mortgage   Indemnification
No.        officer (LO)                            amount     balance       amounta
1     LO 1 - (1) FHA lender   095-1047157*         $193,325   $191,214      $114,728
2                             095-1058709*         $228,021   $226,927      $136,156
3                             095-1078312*         $255,290   $251,364      $150,818
4                             095-1085785          $ 62,790   $ 61,684      $ 37,010
5                             095-1109120*         $209,859   $208,900      $125,340
6                             095-1134778          $165,938   $163,826      $ 98,296
7                             095-1139588          $ 95,635   $ 94,160      $ 56,496
8                             095-1191588*         $171,830   $170,219      $102,131
9                             095-1204810          $131,965   $145,027      $ 87,016
10                            095-1232098          $106,160   $104,480      $ 62,688
11                            095-1255995          $132,554   $130,766      $ 78,460
12                            095-1280403          $142,373   $140,416      $ 84,250
13                            095-1329603          $ 72,659   $ 71,644      $ 42,986
14    LO 2                    095-1008912*         $167,785   $165,594      $ 99,356
15                            095-1097305          $211,105   $209,613      $125,768
16    LO 3                    095-1156592*         $108,007   $107,019      $ 64,211
17                            095-1165848          $117,727   $115,780      $ 69,468
18    LO 4 - (2) FHA lender   095-0725361          $142,172   $140,317      $ 84,190
19                            095-1107323          $205,214   $204,463      $122,678
20    LO 5 - (3) FHA lender   095-1164416          $113,898   $111,970      $ 67,182
21                            095-1226982          $142,373   $139,959      $ 83,975
22                            095-1231448*         $166,920   $164,815      $ 98,889
23    LO 6                    095-1187400          $147,184   $144,572      $ 86,744
24                            095-1201032          $ 76,493   $ 75,041      $ 45,025
25                            095-1246515          $181,649   $178,972      $107,383
26                            095-1261853          $111,935   $110,221      $ 66,133
27                            095-1309457          $143,355   $141,443      $ 84,866
28    LO 7                    095-1119525*         $219,833   $216,970      $130,182
29                            095-1198353          $130,494   $128,238      $ 76,943
30                            095-1207838          $270,019   $266,069      $159,642




                                              29
                                                              Original             Unpaid
          Independent loan                                    mortgage            mortgage           Indemnification
No.          officer (LO)             FHA case no.            amount              balance               amounta
31      LO 8                         095-1323719              $166,920            $166,464              $ 99,879
32      LO 9 - (4) FHA lender        095-1085018              $267,073            $264,696              $158,818
33                                   095-1085053              $351,037            $345,740              $207,444
34      LO 10                        095-1076891              $ 98,188            $ 96,458              $ 57,875
35                                   095-1213602              $245,471            $241,586              $144,951
36      LO 11                        095-1264049              $ 98,384            $ 97,032              $ 58,219
37      LO 12                        095-1139536              $185,576            $183,924              $110,354
38      LO 13                        095-1177780              $ 99,415            $ 97,882              $ 58,729
39      LO 14                        095-1212484*1            $368,207            $364,072              $218,443
40      LO 15                        095-1147886              $202,991            $201,732              $121,039
41      LO 16                        095-1276292              $424,297            $417,598              $250,559

                                           Totals             $7,132,121          $7,058,867            $4,235,320
a
  We classified the $4,235,320 as funds to be put to better use. This is 60 percent of the $7,058,867 in unpaid
principal balances for the 41 loans as of August 31, 2010. The 60 percent is the estimated percentage of loss
to HUD for fiscal year 2009 when the FHA property was resold for less than the unpaid principal balance.




The FHA case numbers with an asterisk (*) indicate the loans that were delinquent or in the foreclosure process as
of August 31, 2010.


                                                        30
Appendix D

                                     LOAN DETAILS

                                                                                    Appendix D-1

FHA case #: 095-1164560                   Mortgaged amount: $402,930

Date of loan closing: 04/07/2009          Unpaid principal balance: $402,125

Loan purpose: Purchase - existing         Default status: First legal action to commence foreclosure


Employment Income Not Supported
The lender did not perform due diligence when verifying the borrower’s employment income.
HUD Handbook 4155.1, REV-5, chapter 2, section 2, states that income may not be used in
calculating the borrower’s qualifying ratios if it comes from any source that cannot be verified, is
not stable, or will not continue. Documents contained in the loan file such as the loan
application, verification of employment, and pay stubs indicated that the borrower held two jobs.
In addition, the loan file contained the borrower’s amended 2007 and 2008 tax returns, which
increased the borrower’s taxable income from $9,110 to $73,157 and from $25,560 to $91,061,
respectively. The 2007 and 2008 amended tax returns were dated January 14, 2009, and March
6, 2009, respectively. The borrower started the loan process in March 2009. The loan file
contained no explanation regarding the increase to the borrower’s income. The lender used the
documents to support a monthly income of $7,953. Using the same documents, we calculated a
monthly income of $7,477.

Our verifications with the two employers did not support the lender’s income amount. We were
only able to verify $1,614 from one of the borrower’s employers. For the borrower’s other
employment, the employer stated that he did not know the borrower’s income and did not have
documentation to confirm the borrower’s income. Yet, the individual was the vice president of
the company at the time and had confirmed his signature on the verification of employment and
the paychecks to the borrower. Due to the employer’s inability to verify the borrower’s income
and an appearance of a financial relationship between the employer and the borrower (discussed
below), we question the accuracy of the income information for this employer as reported in the
loan file submitted to HUD. Therefore, we also could not recalculate the qualifying (housing
payment-to-income and debt-to-income) ratios.

FHA Property Not Owner Occupied
HUD Handbook 4155.1, REV-5, paragraphs 1-1 and 1-2, state that FHA’s single-family
programs are limited to owner-occupied principal residences. A principal residence is a property
that will be occupied by the borrower for the majority of the calendar year. HUD will not insure
a mortgage if the transaction was designed to use FHA mortgage insurance as a vehicle for
obtaining investment properties, even if the property to be encumbered will be the only one
owned using FHA mortgage insurance. We conducted an onsite visit to the FHA property and

                                                31
found the property to be rented. The renters stated and provided support to show that they began
renting the property in August 2009 and paid rent to someone who claimed to be the property
manager. Coincidentally, the name of the property manager was the same as the individual who
employed the borrower but contended that he could not provide documentation to support the
borrower’s income.




                                               32
                                                                                                  Appendix D-2

FHA case #: 095-0927805                        Mortgaged amount: $276,353

Date of loan closing: 11/25/2008               Unpaid principal balance: $267,625

Loan purpose: Purchase - existing              Default status: Delinquent


Employment Income Not Accurate
The lender did not perform due diligence when verifying the borrower’s employment income.
HUD Handbook 4155.1, REV-5, Chapter 2, Section 2, states that income may not be used in
calculating the borrower’s qualifying ratios if it comes from any source that cannot be verified, is
not stable, or will not continue. The loan application indicated that the borrower had two places
of employment and that the second employment ended in January 2008. Yet, the loan file also
contained October and November 2008 pay stubs and a verification of employment dated
November 2008 from the second employer. The lender considered the total $9,087 monthly
income from both employers but did not explain the inconsistency among the documents. Using
the income from the two employers, the lender calculated housing payment-to-income and debt-
to-income ratios of 29.7 and 40.4 percent, respectively.

Our verification with the borrower did not support the $9,087 monthly income. For the second
employer, the borrower stated that she did not work for the employer and had not heard of it.
Specifically, the borrower stated that she did not know the person who signed the verification of
employment and did not provide and had not seen the pay stubs and IRS forms W-2 from the
second employer that were in the loan file. We verified the borrower’s employment information
with her first employer. Based on the records provided by the first employer, we calculated the
borrower’s monthly income at the time to be $2,759. Using the verified and supported income
amount, we calculated qualifying ratios of 97.7 and 133.0 percent.2 Given the excessively high
ratios, the borrower would not have qualified for an FHA mortgage loan.




2
 Mortgagee Letter 2005-16 listed the benchmark housing payment-to-income and debt-to-income ratios to be 31
and 43 percent, respectively.

                                                     33
                                                                                       Appendix D-3

FHA case #: 095-0679947                    Mortgaged amount: $280,596

Date of loan closing: 06/17/2008           Unpaid principal balance: $279,830

Loan purpose: Purchase - existing          Default status: First legal action to commence foreclosure


Employment Income Not Accurate
The lender did not perform due diligence when verifying the borrower’s employment income.
HUD Handbook 4155.1, REV-5, Chapter 2, Section 2, states that income may not be used in
calculating the borrower’s qualifying ratios if it comes from any source that cannot be verified, is
not stable, or will not continue. Documents contained in the loan file such as the borrower’s and
coborrower’s pay stubs, tax returns, and Social Security letters did not support the income
amount reported by the lender. The lender reported monthly income of $9,339, whereas our
review of the documentation supported a monthly income of $8,118.

Our verification with the borrower and the tax returns ordered from the IRS during our interview
supported a significantly lower amount. Our review of the tax returns and interview with the
borrower showed that the borrower’s monthly employment and Social Security income was
$4,361. The borrower stated that the information in the tax returns contained in the loan file was
not accurate and not provided by her.

Source of Funds Not Supported
The lender did not verify the borrower’s funds to close. HUD Handbook 4155.1, REV-5,
paragraphs 2-10 and 3-1F, state that all funds for the borrower’s investment in the property must
be verified and documented. A verification of deposit, along with the most recent bank
statement, is to be provided to verify savings and checking accounts. Although a verification of
deposit was in the loan file, it was not for the account provided in the loan application, and the
loan file did not contain bank statements of the borrower’s bank account to verify the $13,204
reported on the loan application. The borrower stated that the $13,204 listed in the loan account
as her bank balance was incorrect.

Inadequate Credit Analysis
The lender did not include all of the borrower’s liabilities or explain why it omitted the liabilities
from the qualifying ratio calculation. HUD Handbook 4155.1, REV-5, paragraph 3-1, states that
the application package must contain all documentation supporting the lender’s decision to
approve the mortgage loan. The borrower’s credit report listed total monthly recurring liabilities
of $1,275. However, the lender only considered $1,029 of the borrower’s liabilities in its
calculation without providing a reason why the other liabilities were not included. Since the
amount of liabilities was used in the calculation of the debt-to-income ratio and to support the
lender’s decision to approve the loan, documentation showing how the lender calculated the ratio
should be included in the loan file.




                                                 34
Using the verified and supported income amount (see issue above) and considering all of the
borrower’s liabilities listed on the credit report, we calculated qualifying ratios of 56.7 and 85.9
percent. Given the excessively high ratios, the borrower would not have qualified for the FHA
mortgage loan.

In addition, the lender did not obtain a written explanation from the borrowers to adequately
explain the reason(s) for 23 collection accounts. HUD Handbook 4155.1, REV-5, paragraph 2-3,
states that past credit performance serves as the most useful guide in determining a borrower’s
attitude toward credit obligations and predicting a borrower’s future actions. When delinquent
accounts are revealed, the lender must document its analysis as to whether the late payments
were based on a disregard for financial obligations, an inability to manage debt, or factors
beyond the control of the borrower. When major indications of derogatory credit including
judgments or collections exist, the lender must require sufficient written explanation from the
borrower, and the explanation must make sense and be consistent with the other credit
information in the file. The loan file contained a letter which explained that the borrowers were
disputing many accounts or had no knowledge of the accounts. However, the lender did not
ensure that the explanation addressed all 23 accounts. In addition, collections on 8 of the 23
accounts were started in 2008, the time the borrower began the loan process.

Minimum Required Cash Investment Not Met
The lender did not ensure that the borrower made the minimum cash investment to qualify for
the loan amount. HUD Handbook 4155.1, REV-5, paragraph 1-7, states that HUD will insure
the maximum loan amount provided that the borrower has made a cash investment of at least 3
percent of the contract sales price. Three percent of the contract sales price on the property is
$8,550. The HUD-1 settlement statement showed that the borrower invested only $6,818, for a
shortage of $1,732.




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                                                                                       Appendix D-4



FHA case #: 095-1026242                    Mortgaged amount: $305,962

Date of loan closing: 01/13/2009           Unpaid principal balance: $305,962

Loan purpose: Purchase - existing          Default status: First legal action to commence foreclosure


Employment Income Not Accurate
The lender did not perform due diligence when verifying the borrower’s employment income.
HUD Handbook 4155.1, REV-5, chapter 2, section 2, states that income may not be used in
calculating the borrower’s qualifying ratios if it comes from any source that cannot be verified, is
not stable, or will not continue. The loan application contained in the loan file listed the
borrower’s monthly income at $7,706. The amount was supported by the borrower’s 2006 and
2007 tax returns, which had reported annual incomes of $88,839 and $96,010, respectively.
However, our review of the lender’s loan file contained tax transcripts from the IRS that had
been pulled January 12, 2009, which indicated that the borrower had total income of $9,300 in
2006 and did not file a tax return in 2007. Another review of the 2006 and 2007 tax returns
contained in the loan file showed that written on the 2006 tax return was the phrase “does not
match” and written on the 2007 tax return was the phrase “did not file.” The loan file contained
no explanation for the discrepancy or follow-up on the issue.

The borrower was self-employed. We were not able to locate the borrower to verify the
information. We contacted a former officer of the company, but the individual certified that he
did not have documentation regarding the borrower’s employment. HUD Handbook 4155.1,
REV-5, paragraph 2-9C, states that the lender must establish the borrower’s earnings trend over
the previous 2 years. Since the borrower’s earnings could not be established for the past 2 years,
the lender should not have approved this loan. As a result, we could not determine the
borrower’s effective income and could not recalculate the borrower’s qualifying ratios.

Inadequate Credit Analysis
The lender did not include all of the borrower’s liabilities or explain why it omitted the liabilities
from the qualifying ratio calculation. HUD Handbook 4155.1, REV-5, paragraph 3-1, states that
the application package must contain all documentation supporting the lender’s decision to
approve the mortgage loan. According to the credit report, the borrower had a $29,576 car loan
that the lender did not include in its calculation of the borrower’s liabilities. The loan file
contained no documentation to explain why the lender omitted the liability from the debt-to-
income ratio calculation. Since the amount of liabilities is used to calculate the ratio and support
the lender’s decision to approve the loan, documentation showing how the lender calculated the
ratio should be included in the loan file.




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                                                                                       Appendix D-5

FHA case #: 095-1076080                    Mortgaged amount: $335,775

Date of loan closing: 01/22/2009           Unpaid principal balance: $330,581

Loan purpose: Refinance – cash out         Default status: Reinstated


Employment Income Not Supported
The lender did not perform due diligence when verifying the borrower’s employment income.
HUD Handbook 4155.1, REV-5, paragraph 3-1, states that the application package must contain
all documentation supporting the lender’s decision to approve the mortgage loan. When standard
documentation does not provide enough information to support this decision, the lender must
provide additional explanatory statements, consistent with other information in the application,
to clarify or supplement the documentation submitted by the borrower. Documents contained in
the loan file such as the borrower’s pay stubs did not support the income amount of $6,928
reported by the lender. In addition, our verification of the borrower’s employment income
supported a monthly income of $6,582.

Inadequate Credit Analysis
The lender did not include all of the borrower’s liabilities or explain why it omitted the liabilities
from the qualifying ratio calculation. The lender omitted $27,372 of the borrower’s debts in
computing the qualifying ratios. The lender only considered $16,496 of the borrower’s debts
while the documentation in the loan file showed debts totaling $43,868. The $27,372 of debts
omitted were student loans. HUD Handbook 4155.1, REV-5, paragraph 2-11C, states that if a
debt payment such as a student loan is scheduled to begin within 12 months of the mortgage loan
closing, the lender must include the anticipated monthly obligation in the underwriting analysis
unless the borrower provides written evidence that the debt will be deferred to a period outside
the timeframe. The loan file contained no written evidence that the student loans would be
deferred outside the timeframe and no written explanation from the lender regarding why the
other liabilities were not included to calculate the debt-to-income ratio. Further, HUD Handbook
4155.1, REV-5, paragraph 3-1, states that the application package must contain all
documentation supporting the lender’s decision to approve the mortgage loan. Thus,
documentation showing how the lender calculated the ratio should be included in the loan file.

Without the written explanations, we considered the total liabilities listed on the borrower’s
credit report to calculate a monthly recurring debt (not considering housing payments) of $3,656.
Using the correct income amount (see issue above) and considering all of the borrower’s
liabilities, we calculated qualifying ratios of 40.6 and 96.1 percent. Given the excessive ratios,
the borrower would not have qualified for a FHA mortgage loan.

In addition, the lender did not obtain a written explanation from the borrower to adequately
explain the reason(s) for the four delinquent accounts, five collection accounts, and one
judgment. HUD Handbook 4155.1, REV-5, paragraph 2-3, states that past credit performance
serves as the most useful guide in determining a borrower’s attitude toward credit obligations

                                                 37
and predicting a borrower’s future actions. When delinquent accounts are revealed, the lender
must document its analysis as to whether the late payments were based on a disregard for
financial obligations, an inability to manage debt, or factors beyond the control of the borrower.
When major indications of derogatory credit including judgments or collections exist, the lender
must require sufficient written explanation from the borrower, and the explanation must make
sense and be consistent with the other credit information in the file. The loan file contained no
written explanation. By not obtaining a reasonable explanation, the lender failed to properly
examine the borrower’s pattern of credit behavior.


Loan Amount Greater Than Maximum Allowable Mortgage
The lender did not properly calculate the mortgage amount. This was a “cash out” refinance.
The HUD-1 settlement statement showed that the borrower used the loan to pay off her 2008
property tax of $3,190. The HUD-1 also showed that the loan paid off the borrower’s prior
mortgage amount of $307,000. Mortgagee Letter 2005-43 states that FHA will insure a cash-out
refinance of up to 95 percent of the appraiser’s estimate of value. Applying the percentage to the
appraised value of $345,000, we calculated a maximum loan amount of $327,750. However, the
lender allowed the mortgage amount of the refinance to be set at $330,000. Therefore, the
mortgage amount exceeded the maximum loan amount by $2,250. The mortgage loan was
overinsured by $2,250.




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Appendix E

          SCHEDULE OF INDEMNIFICATION AMOUNTS
                   FOR THE FIVE LOANS


     FHA case              Unpaid principal            Indemnification         Status of loan as of
      number                   balance                    amount*               August 31, 2010
    095-1164560               $ 402,125                   $241,275             Foreclosure process
    095-0927805               $ 267,625                   $160,575                 Delinquent
    095-0679947               $ 279,830                   $167,898             Foreclosure process
    095-1026242               $ 305,962                   $183,577             Foreclosure process
    095-1076080               $ 330,581                   $198,349                 Reinstated

        Totals                 $1,586,123                  $951,674

  *We classified the $951,674 as funds to be put to better use. This is 60 percent of the $1,586,123
  in unpaid principal balances for the five loans. The 60 percent is the estimated percentage of loss
  to HUD for fiscal year 2009 when the FHA property was resold for less than the unpaid principal
  balance.




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