Department of Housing and Urban Development, Office of Inspector General | Housing and Urban Development | 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

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.”