oversight

Gold Financial Services, Inc., San Antonio, TX, Did Not Follow HUD/FHA Requirements in Underwriting Two Loans and Originated a Third in Violation of Its Own Internal Controls

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-FW-1002




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

            //signed//
FROM:       Gerald R. Kirkland
            Regional Inspector General for Audit, Fort Worth Region, 6AGA

SUBJECT: Gold Financial Services, Inc., San Antonio, TX, Did Not Follow HUD/FHA
         Requirements in Underwriting Two Loans and Originated a Third in Violation of
         Its Own Internal Controls


                                    HIGHLIGHTS

 What We Audited and Why

             We performed an audit of Gold Financial Services, Inc. (Gold Financial), a
             Federal Housing Administration (FHA) direct endorsement lender and a branch of
             AmericaHomeKey, Inc., in San Antonio, TX. We selected Gold Financial for
             audit because its default rate was almost 10 percent for the audit period while the
             average default rate in the San Antonio area was 2.2 percent. Our objective was
             to determine whether Gold Financial complied with U. S. Department of Housing
             and Urban Development (HUD) and FHA loan origination requirements for loans
             endorsed between January 1, 2008, and December 31, 2009.

 What We Found


             Gold Financial did not follow HUD/FHA underwriting requirements in two of
             seven loan originations reviewed. Gold Financial’s underwriter did not require
             two borrowers to explain recent poor credit. As a result, Gold Financial
             originated two ineligible loans that resulted in a loss to HUD of $71,259 and an
             increased risk to the FHA insurance fund of $86,885.
           Gold Financial originated a third loan that did not violate HUD/FHA underwriting
           requirements, but did violate its own internal controls concerning borrowers with
           poor credit. Specifically, the underwriter did not require the borrower to have
           three months reserves in accordance with Gold Financial’s closing instructions.

What We Recommend


           We recommend that the Deputy Assistant Secretary for Single Family Housing
           require Gold Financial to (1) indemnify HUD for one ineligible loan with an
           unpaid principal balance of $144,808, thereby putting an estimated $86,885 to
           better use, and (2) reimburse the FHA mortgage insurance fund $71,259 for losses
           incurred on one loan.

           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 provided our discussion draft report to Gold Financial on September 9, 2010,
           and held the exit conference on September 20, 2010. We requested a written
           response by September 24, 2010. Gold Financial generally disagreed with the
           finding and provided its response on September 23, 2010. The complete text of
           its response, along with our evaluation of that response, can be found in appendix
           B of this report.




                                            2
                            TABLE OF CONTENTS

Background and Objective                                                             4

Results of Audit
      Finding:   Gold Financial Did Not Comply With HUD/FHA Requirements in          5
                 Underwriting Two Loans and Originated a Third in Violation of Its
                 Own Internal Controls

Scope and Methodology                                                                8

Internal Controls                                                                    9

Appendixes
   A. Schedule of Questioned Costs and Funds To Be Put to Better Use                 11
   B. Auditee Comments and OIG’s Evaluation                                          12




                                             3
                          BACKGROUND AND OBJECTIVE

Gold Financial Services, Inc. (Gold Financial), is a branch of AmericaHomeKey, Inc.
(AmericaHomeKey), and is located at 2943 Mossrock in San Antonio, TX. AmericaHomeKey is
a nonsupervised direct endorsement lender, approved by the U. S. Department of Housing and
Urban Development (HUD) to originate Federal Housing Administration (FHA) approved
mortgage loans on April 25, 2001.

The direct endorsement program simplifies the process for obtaining FHA mortgage insurance
by allowing lenders to underwrite and close the mortgage loan without prior HUD review or
approval. Lenders are responsible for complying with all applicable HUD regulations and are
required to evaluate the borrower’s ability and willingness to repay the mortgage debt. Lenders
are protected against default by FHA’s Mutual Mortgage Insurance Fund, which is sustained by
borrower premiums. FHA’s mortgage insurance programs help low- and moderate-income
families become homeowners by lowering some of the costs of their mortgage loans. FHA
mortgage insurance also encourages lenders to approve mortgages for otherwise creditworthy
borrowers and projects that might not be able to meet conventional underwriting requirements by
protecting the lender against default.

From January 1, 2008, to December 31, 2009, Gold Financial underwrote 2,204 FHA loans with
a total origination value of $271,832,906. During the same period, 212 of the loans (nearly 10
percent) 1 with a total origination value of $24,360,725 defaulted, and 33 of the 212 loans (more
than 15 percent) with a total origination value of $3,487,200 defaulted without the borrowers
making any payments.

As Gold Financial’s parent company, AmericaHomeKey established the internal control system
that Gold Financial was to follow when originating, underwriting, and closing FHA loans. Since
our review indicated weaknesses in the internal control system, we will conduct an audit of
AmericaHomeKey.

Our objective was to determine whether Gold Financial followed HUD and FHA loan
origination requirements for loans endorsed between January 1, 2008, and December 31, 2009.




1
    In comparison, the average default rate for all FHA loans in San Antonio, TX, was 2.2 percent.

                                                        4
                                    RESULTS OF AUDIT

Finding: Gold Financial Did Not Comply With HUD/FHA
         Requirements in Underwriting Two Loans and Originated a
         Third in Violation of Its Own Internal Controls
Gold Financial did not comply with HUD/FHA requirements in underwriting two of seven loans
reviewed, and did not comply with its own internal controls in underwriting a third loan. This
noncompliance occurred because Gold Financial’s underwriter failed to exercise due diligence in
underwriting the loans. Gold Financial’s underwriter approved loans for two borrowers that did
not provide required explanations for recent poor credit in violation of HUD/FHA requirements.
As a result, Gold Financial placed the FHA insurance fund at increased risk for one loan with an
estimated future loss of more than $86,000 and lost more than $71,000 on the sale of one
property. Gold Financial also violated its internal controls when it underwrote a loan after its
underwriter determined the borrower did not have sufficient required reserves.


                 Gold Financial originated two FHA loans with original loan values totaling
                 $248,835 that violated FHA’s requirements because the borrowers had unexplained
                 recent derogatory credit. HUD paid claims totaling $107,125 on one of the two
                 loans (loan number 495-7786023) that violated FHA requirements, foreclosed, and
                 lost $71,259 on the property sale. HUD can expect estimated losses of $86,885 for a
                 second loan (loan number 495-7829555) that violated FHA requirements.

    Two Loans with
    Unexplained Recent
    Derogatory Credit

                 According to HUD regulations 2 and its own processing instructions, 3 Gold
                 Financial was supposed to obtain explanations for recent derogatory credit, such
                 as judgments, collections, and other credit problems. HUD requires that the
                 borrower’s explanation make sense and be consistent with other credit
                 information. Further, the underwriter must document compensating factors to
                 justify approval when the borrower’s credit history reflects continuous slow
                 payments, judgments, and delinquent accounts.

                 Despite the requirements, Gold Financial’s underwriter failed to exercise due
                 diligence by not obtaining explanations or providing adequate justification for
                 approving two loans despite poor credit. For example, the underwriter said he
                 missed an auto repossession during the credit review for one of the loans.

2
     HUD Handbook 4155.1, REV-5. Mortgage Credit Analysis for Mortgage Insurance, paragraph 2-13
3
     AmericaHomeKey, Inc., Processing Module, page 22, Credit Explanations

                                                     5
                   As a result, Gold Financial’s underwriter originated two ineligible FHA loans: loan
                   number 495-7786023 for $99,922 and loan number 495-7829555 for $148,913.
                   HUD foreclosed and paid claims totaling $107,125 for loan number 495-7786023
                   and lost $71,259 on the property sale.

                   As of July 31, 2010, HUD had paid claims totaling $164,052 for loan number 495-
                   7829555. HUD foreclosed on the loan and listed the property for sale. The FHA
                   insurance fund is estimated to lose $86,8854 for the loan unless Gold Financial
                   indemnifies HUD.


    One Borrower Did
    Not Have Sufficient
    Reserves

                   According to Gold Financial’s internal controls (closing instructions) for one loan
                   for a borrower with a poor credit history, the underwriter was supposed to verify
                   that the borrower would have 3 months of cash reserves after the loan closing.
                   However, the underwriter did not verify that the borrower for FHA loan number
                   495-7775673 had the required cash reserves. The borrower’s bank balance was
                   overdrawn before closing, and after a payroll deposit, the bank balance was less
                   than half of the required reserves.

                   HUD regulations require that a borrower with recent poor credit have strong
                   compensating factors 5. The borrower had compensating factors, but the
                   underwriter noted in the closing instructions that the borrower needed the cash
                   reserves after closing due to poor credit. Therefore, Gold Financial did not
                   violate HUD regulations in this case but violated its own internal controls by
                   originating the loan without complying with the closing instructions.

                   As a result, Gold Financial approved the loan for $162,450. As of July 31, 2010, the
                   unpaid loan balance was $158,352; however, HUD had foreclosed on the loan and
                   listed the property for sale. HUD paid claims totaling $177,598 for the property, and
                   the FHA insurance fund is estimated to lose $95,011 on the property sale.




4
      According to the actuarial review of the FHA Mutual Mortgage Insurance Fund for fiscal year 2009, FHA’s
      average loss experience is about 60 percent of the unpaid principal balance upon sale of a mortgaged property.
      The unpaid balance for FHA loan 495-7829555 was $144,808 on July 31, 2010 and 60 percent of the unpaid
      balance is $86,885.
5
      HUD Handbook 4155.1 Rev 5, Mortgage Credit Analysis for Mortgage Insurance on One- to Four-Unit
      Mortgage Loans, paragraph 2-3

                                                           6
Conclusion

             Gold Financial’s underwriter did not comply with HUD regulations and Gold
             Financial’s internal instructions in originating three of seven loans reviewed. As
             a result, Gold Financial placed the FHA insurance fund at risk for two loans with
             original mortgage amounts totaling $248,835 that violated HUD/FHA regulations.
             HUD had paid claims totaling $271,177 for the two properties as of July 31, 2010,
             and lost $71,259 on the sale of one property. The FHA insurance fund could lose
             an estimated $86,885 on the sale of the other property which has been listed for
             sale.

             Gold Financial also violated its own internal controls when it originated a third
             loan without ensuring that the loan complied with its closing instructions. As a
             result, Gold Financial originated a third loan in which HUD foreclosed and paid
             claims totaling $177,598 for the property. The FHA insurance fund is expected to
             lose an estimated $95,000 on the sale of this property.

Recommendations


             We recommend that the Deputy Assistant Secretary for Single Family Housing
             require Gold Financial to

             1A. Indemnify HUD for one insured loan (number 495-7829555), with unpaid
                 principal balance of $144,808, thereby putting an estimated $86,885 to
                 better use based on the FHA insurance fund average loss rate of 60 percent
                 of the unpaid principal balance.

             1B. Reimburse the FHA insurance fund $71,259 for losses incurred on loan
                 number 495-7786023.




                                             7
                             SCOPE AND METHODOLOGY

To accomplish our objective, we

•   Reviewed applicable HUD regulations, requirements, mortgagee letters, and HUD Quality
    Assurance Division reports;
•   Reviewed reports and information on HUD’s Neighborhood Watch 6 and Single Family Data
    Warehouse; 7
•   Reviewed Gold Financial’s and AmericaHomeKey’s files, ledgers, policies, procedures, and
    independent audit reports; and
•   Conducted interviews with applicable HUD staff, Gold Financial staff, AmericaHomeKey
    staff, and borrowers.

Using HUD’s Neighborhood Watch system, we determined which FHA lenders originated the
most defaulted loans in the San Antonio, TX area. We selected the lender with the most
defaulted loans that was not already under Office of Inspector General (OIG) review. We
obtained a download of defaulted loans with six or fewer payments originated by the lender and
endorsed from January 1, 2008, to December 31, 2009. We determined that Gold Financial, a
branch of AmericaHomeKey, originated 2,204 loans, 212 (nearly 10 percent) of which later
defaulted. We further determined that 33 (more than 15 percent) of the 212 loans defaulted
without the borrowers making any payments. We selected a random nonstatistical sample of
seven loans with original loan values totaling $880,352 and reviewed the loan documents to
determine whether a pattern of defaults existed. We used a nonstatistical random sample
because we were determining what types of errors might exist and did not intend to project the
test results on the population of loans. We included four random zero-payment loans and three
random loans with between one and six payments before default.

We did not evaluate the reliability of HUD’s Neighborhood Watch system because we used the
data for background purposes only.

We performed our fieldwork between January 25 and June 15, 2010, at Gold Financial’s office
and our office in San Antonio, TX.

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
objective. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.

6
    Neighborhood Watch refers to a Web-based software application that displays loan performance data for
    lenders and appraisers using FHA-insured single-family loan information. The system is designed to highlight
    exceptions so that potential problems are readily identifiable.
7
    Single Family Data Warehouse is a large and extensive collection of database tables organized and dedicated to
    support the analysis, verification, and publication of single-family housing data. It consists of database tables
    structured to provide HUD users easy and efficient access to single-family housing case-level data on properties
    and associated loans, insurance, claims, defaults, and demographics.

                                                         8
                              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
               objective:

               •   Policies and procedures intended to ensure that FHA insured loans are
                   properly originated, underwritten, and closed.
               •   Safeguarding FHA insured mortgages from high-risk exposure.
               •   Policies and procedures intended to ensure that the quality control program is
                   an effective tool in reducing underwriting errors and noncompliance.

               We assessed the relevant controls identified above.

               A deficiency in internal controls 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.




                                                9
Significant Deficiencies


             Based on our review, we believe that the following item is a significant
             deficiency:

             Gold Financial did not have effective controls in place to ensure that the
             underwriters complied with HUD regulations and the organization’s internal
             instructions in originating, underwriting, and closing FHA loans (finding).




                                             10
                                             APPENDIXES

Appendix A

                    SCHEDULE OF QUESTIONED COSTS
                   AND FUNDS TO BE PUT TO BETTER USE

                       Recommendation          Ineligible 1/            Funds to be put to
                       number                                           better use 2/
                       1A                                               $86,885
                       1B                      $71,259




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.

2/   Recommendations that funds be put to better use are estimates of amounts that could be used more efficiently if
     an 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 recommendation to require Gold Financial to indemnify HUD for the loan that was not
     originated in accordance with HUD/FHA requirements will reduce FHA’s risk of loss to the FHA insurance
     fund. The amount above reflects that, upon the sale of the mortgaged property, FHA’s average loss experience
     is about 60 percent of the unpaid principal balance, based upon statistics provided by HUD (see footnote 4).




                                                         11
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION

Ref to OIG Evaluation   Auditee Comments




                         12
13
Comment 1




            14
Comment 2




Comment 3




            15
16
17
18
19
20
21
Comment 4




Comment 5




            22
23
Comment 6




            24
25
                                 OIG Evaluation of Auditee Comments

Comment 1        The auditee generally disagreed with the findings. We considered the auditee’s
                 comments and revised the report as appropriate.

Comment 2        The auditee clarified the relationship between Gold Financial and
                 AmericaHomeKey – We revised the report as appropriate.

Comment 3        The auditee asserted that FHA loan 495-7775673 complied with HUD
                 requirements and did not violate Gold Financial’s internal controls. After
                 discussions with HUD’s Quality Assurance Division, we agree that the loan
                 origination may not have violated HUD regulations, and we reduced estimated
                 losses from $181,896 for two loans to $86,885 for a single loan. However, we
                 maintain that Gold Financial violated its internal controls when it originated the
                 loan. We revised the report as appropriate.

Comment 4        The auditee asserted that it complied with HUD guidelines in analyzing the
                 borrowers’ overall credit profiles when it underwrote FHA loan 495-7786023 and
                 FHA loan 495-7829555 and summarized its assertion at Comment 4 (see page 22
                 of the report, first full paragraph). We disagree with the assertion because the
                 underwriter clearly did not consider both borrowers’ recent poor credit when it
                 originated the loans. The borrower of loan 495-7786023 had two repossessions
                 with the last occurring 17 months before the loan closed. The borrower on loan
                 495-7829555 also had two repossessions with the last occurring 11 months before
                 the loan closed. FHA requires that when a borrower has major derogatory credit
                 within the last 2 years, the borrower must provide a sufficient written explanation
                 and strong compensating factors, neither of which were in the loan file 8. We did
                 not revise the report.

Comment 5        The auditee disputed including estimated losses in the report because they are
                 estimates and because it believes that it complied with HUD guidelines in
                 originating the loans. The estimated losses are based on the average loss severity
                 rate from the Actuarial Review of the FHA Mutual Mortgage Fund for Fiscal
                 Year 2009 provided by HUD. Estimated losses are based on actuarial data and
                 HUD will determine the appropriate actions to take regarding the findings during
                 the management decision process. As stated in Comment 3, we reduced estimated
                 losses for one loan and revised the report as appropriate.

Comment 6        The auditee disputed that the loans were any reflection on AmericaHomeKey’s
                 internal policies and procedures. We disagree because AmericaHomeKey’s
                 internal policies and procedures allowed the faulty loans to be underwritten. We
                 did not revise the report.


8
    HUD Handbook 4155.1, Rev 5, paragraph 2-3 states “…major indications of derogatory credit – including
    judgments, collections, and any other recent credit problems – require sufficient written explanation from the
    borrower.”

                                                        26