Issue Date
November 10, 2010
Audit Report Number
2011-PH-1004
TO: Vicki Bott, Deputy Assistant Secretary for Single Family Housing, HU
//signed//
FROM: John P. Buck, Regional Inspector General for Audit, Philadelphia Region,
3AGA
SUBJECT: NFM, Inc., Linthicum, MD, Did Not Fully Implement Its Quality Control Plan
in Accordance With HUD Requirements
HIGHLIGHTS
What We Audited and Why
We audited NFM, Inc. (NFM), a nonsupervised1 lender approved to originate
Federal Housing Administration (FHA) single-family mortgage loans. We
selected NFM based on significant risk indicators, which included a high
percentage of loans with front- and/or and back-end ratios in excess of U.S.
Department of Housing and Urban Development (HUD) requirements and loans
defaulting within six or fewer payments. Our objective was to determine whether
NFM complied with HUD requirements in the origination and quality control
review of FHA loans.
What We Found
NFM generally complied with HUD requirements in the origination of FHA
loans. We reviewed cash assets used to meet the minimum required investment,
employment and income records, liabilities, and credit characteristics for a sample
of six loans and found no significant discrepancies. However, we found that
1
A nonsupervised lender is an FHA-approved lending institution that has as its principal activity the lending or
investing of funds in real estate mortgages.
NFM did not implement certain aspects of its quality control plan in accordance
with HUD requirements. It did not perform routine quality control reviews within
the timeframe required by HUD. It also did not review all loans that defaulted
within the first six payments in a reasonably timely manner. These conditions
occurred because NFM did not emphasize HUD requirements and did not fully
implement its quality control plan. Consequently, the effectiveness of the plan,
which was designed to ensure accuracy, validity, and completeness in its loan
underwriting process, was lessened.
What We Recommend
We recommend that HUD’s Deputy Assistant Secretary for Single Family
Housing direct NFM to fully implement its quality control functions as required
and follow up in 9 months to ensure the lender’s compliance.
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 a draft report to NFM on October 19, 2010. We discussed the audit
results with NFM during the audit and during an exit conference on October 26,
2010. NFM provided written comments to our draft report on November 2, 2010.
It agreed with our report. The complete text of the auditee’s response can be
found in appendix A of this report.
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TABLE OF CONTENTS
Background and Objective 4
Results of Audit
Finding: NFM Did Not Fully Implement Its Quality Control Plan in Accordance 5
With HUD Requirements
Scope and Methodology 7
Internal Controls 8
Appendixes
A. Auditee Comments 10
3
BACKGROUND AND OBJECTIVE
The U.S. Department of Housing and Urban Development’s (HUD) strategic plan states that part
of its mission is to increase home ownership, support community development, and increase
access to affordable housing free from discrimination.
The National Housing Act, as amended, established the Federal Housing Administration (FHA),
an organizational unit within HUD. FHA provides insurance for lenders against loss on single-
family home mortgages.
In 1983, HUD implemented the direct endorsement program, which authorized approved lenders
to underwrite loans without HUD’s prior review and approval. There are three types of approved
direct endorsement lenders—supervised, nonsupervised, and governmental institutions. A
supervised lender is an FHA-approved financial institution that is a member of the Federal
Reserve System or an institution with accounts insured by the Federal Deposit Insurance
Corporation or the National Credit Union Administration. A nonsupervised lender is an FHA-
approved lending institution that has as its principal activity the lending or investing of funds in
real estate mortgages. A governmental institution includes a Federal, State, or municipal
government agency; a Federal Reserve Bank; a Federal Home Loan Bank; the Federal Home
Loan Mortgage Corporation; and the Federal National Mortgage Association. HUD requires
lenders to use its Neighborhood Watch system to monitor and evaluate their performance and has
many sanctions available for taking actions against lenders or others that abuse the direct
endorsement program.
NFM, Inc. (NFM), is a nonsupervised direct endorsement lender for FHA loans. Its main office
is located in Linthicum, MD. NFM originated 332 loans between April 2008 and March 2010
that defaulted within the first 2 years. Of the 332 loans valued at about $71 million, we
identified 22 valued at approximately $5 million that were underwritten by NFM. Prior to
August 2008, NFM was a loan correspondent. Therefore, it did not underwrite all the defaulted
loans identified. We reviewed 6 of the 22 loans valued at more than $1.2 million.
On August 20, 2008, HUD approved NFM’s request for unconditional direct endorsement.
Accordingly, NFM was permitted to underwrite and close mortgage loans without prior HUD
review. Participation in the direct endorsement program is a privilege accorded only to lenders
who continue to demonstrate the ability to originate mortgage loans in accordance with HUD’s
underwriting policy.
Our objective was to determine whether NFM complied with HUD requirements in the
origination and quality control review of FHA loans.
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RESULTS OF AUDIT
Finding: NFM Did Not Fully Implement Its Quality Control Plan in
Accordance With HUD Requirements
NFM did not follow HUD requirements related to the timeliness of routine quality control
reviews. It also did not review all loans that defaulted within the first six payments (early
payment defaults) in a reasonably timely manner. These conditions occurred because NFM did
not emphasize HUD requirements and did not fully implement its quality control plan.
Consequently, the effectiveness of the plan, which was designed to ensure accuracy, validity, and
completeness in its loan underwriting process, was lessened.
Reviews Not Within the
Required Timeframe
HUD Handbook 4060.1, paragraph 7-6A, states that lenders must review loans
routinely selected for quality control reviews within 90 days from the end of the
month in which the loan closed. This requirement is intended to ensure that
problems left undetected before closing are identified as early after closing as
possible. In accordance with HUD’s requirement, NFM’s quality control plan
states that quality control reviews must be performed within 90 days from the end
of the month in which the loan closed. NFM did not always perform quality
control reviews within the timeframe required by HUD. We randomly selected
10 of 319 FHA loans, which NFM indicated that it had reviewed, to determine
whether the quality control reviews were conducted in a timely manner. We
determined that all 10 of the FHA loans were not reviewed in a timely manner.
The loans were reviewed between 96 and 208 days from the end of the month in
which they closed. NFM acknowledged that it did not perform quality control
reviews in a timely manner. It stated that quality control reviews were late during
part of the audit period because the contractor responsible for performing the
reviews was going through bankruptcy proceedings. It also stated that the
timeliness requirement would be enforced going forward.
Early Payment Default Loans
Not Reviewed in a Reasonably
Timely Manner
HUD Handbook 4060.1, paragraph 7-6D, requires lenders to review all loans going
into default within the first six payments. HUD defines early payment defaults as
loans that become 60 days past due within the first 6 payments. NFM’s quality
5
control plan states that all loans going into default within the first 6 months must be
reviewed. HUD does not indicate a timeframe within which these loans must be
reviewed; however, it states that one of the basic overriding goals of quality control
is to ensure swift and appropriate corrective action. Therefore, prudence would
dictate that these loans be reviewed shortly after being identified as early payment
defaults.
NFM did not review all early payment defaults as required by HUD and its own
quality control plan. It did not conduct quality control reviews of 54 of 56 early
payment defaults that occurred during the audit period. NFM acknowledged that it
did not review early payment defaults as required and stated that the requirement
would be enforced going forward.
During the audit, NFM took action and reviewed the 54 loans. Although NFM
reviewed the loans, the reviews were not performed in a reasonably timely manner.
The 54 loans were reviewed a minimum of 7 months after default. Therefore, while
NFM reviewed the loans it had not previously reviewed, its review process did not
fully meet the intent of the quality control process as defined by HUD.
Conclusion
NFM did not perform routine quality control reviews within the required
timeframe and did not review its early payment defaults in a reasonably timely
manner. These conditions occurred because NFM did not emphasize HUD
requirements and did not fully implement its quality control plan. As a result, the
effectiveness of the plan, which was designed to ensure accuracy, validity, and
completeness in its loan underwriting process, was lessened.
Recommendations
We recommend that HUD’s Deputy Assistant Secretary for Single Family Housing
direct NFM to
1A. Implement its quality control functions as required and follow up with the
lender in 9 months to ensure its compliance.
6
SCOPE AND METHODOLOGY
We performed our audit work between July and August 2010 at NFM’s main office located at 505
Progress Drive, Linthicum, MD. Our review period was from April 2008 through March 2010.
We queried HUD’s Neighborhood Watch system for information on lenders’ default rates. HUD’s
Neighborhood Watch system is a Web-based software application that displays loan performance
data for lenders and appraisers by loan types and geographic areas, using FHA-insured single-
family loan information. The loan information is displayed for a 2-year origination period and is
updated on a monthly basis. HUD requires lenders to use the Neighborhood Watch system to
monitor and evaluate their performance.
Based on the Neighborhood Watch query results, we identified and selected NFM for review based
on significant risk indicators, which included a high percentage of loans with front- and/or back-
end ratios in excess of HUD requirements and loans defaulting within six or fewer payments.
NFM had 190 loans with front- and/or back-end ratios in excess of HUD requirements. It also
had 132 loans which defaulted within 6 or fewer payments.
NFM originated 332 loans between April 2008 and March 2010 that defaulted within the first 2
years. After eliminating terminated and streamline refinanced loans, 259 defaulted loans remained.
The 259 loans, valued at more than $54.2 million, defaulted after 12 payments or fewer. We
selected the top six loans with the highest back-end ratios and underwritten by NFM, valued at
approximately $1.3 million, for review.
To determine whether NFM complied with HUD requirements in its origination and quality control
of FHA loans, we performed the following:
Reviewed applicable HUD handbooks and mortgagee letters,
Reviewed case files for the six sample loans,
Examined records and related documents of NFM, and
Conducted interviews with officials of NFM and discussed issues with HUD employees.
In addition, we relied in part on data maintained by HUD in its Neighborhood Watch system.
Although we did not perform a detailed assessment of the reliability of the data, we performed a
minimal level of testing and found the data to be adequately reliable for our purposes.
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 objective.
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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:
Loan origination process – Policies and procedures that management has in
place to reasonably ensure that the loan origination process complies with HUD
program requirements.
Quality control plan – Policies and procedures that management has in place to
reasonably ensure implementation of HUD quality control requirements.
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.
Significant Deficiency
Based on our review, we believe that the following item is a significant deficiency:
8
NFM did not implement its quality control plan to ensure full compliance with
HUD’s quality control requirements.
9
Appendix A
AUDITEE COMMENTS
10
11
12
13
NFM, Inc., Linthicum, MD, Did Not Fully Implement Its Quality Control Plan in Accordance With HUD Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-11-10.
Below is a raw (and likely hideous) rendition of the original report. (PDF)