oversight

The Office of Housing Had Not Fully Developed Formal Risk Based Procedures for Postendorsement Underwriting Reviews of Multifamily and Healthcare Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2013-05-13.

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

 OFFICE OF AUDIT
 REGION 4
 ATLANTA, GA




           U.S. Department of Housing and Urban
                       Development

     Insured Multifamily and Healthcare Programs
                   Washington, DC




2013-AT-0001                                 MAY 13, 2013
                                                        Issue Date: May 13, 2013

                                                        Audit Report Number: 2013-AT-0001


TO:            Carol Galante, FHA Commissioner-Assistant Secretary, Office of Housing, H



FROM:          Nikita N. Irons, Regional Inspector General for Audit, Atlanta Region, 4AGA

SUBJECT:       The Office of Housing Had Not Fully Developed Formal Risk Based Procedures
               for Postendorsement Underwriting Reviews of Multifamily and Healthcare Loans

    Attached are the U.S. Department of Housing and Urban Development (HUD), Office of
Inspector General (OIG), final results of our review of the Office of Housing’s multifamily and
healthcare insured mortgage programs.

    HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on
recommended corrective actions. For each recommendation without a management decision,
please respond and provide status reports in accordance with the HUD Handbook. Please furnish
us copies of any correspondence or directives issued because of the audit.

    The Inspector General Act, Title 5 United States Code, section 8L, requires that OIG post its
publicly available reports on the OIG Web site. Accordingly, this report will be posted at
http://www.hudoig.gov.

   If you have any questions or comments about this report, please do not hesitate to call me at
404-331-3369.
                                            Date of Issuance: May 13, 2013
                                            The Office of Housing Had Not Fully Developed
                                            Formal Risk-Based Procedures for
                                            Postendorsement Underwriting Reviews of
                                            Multifamily and Healthcare Loans



Highlights
Audit Report 2013-AT-0001


 What We Audited and Why                    What We Found

We audited certain portions of the U.S.    For the audit period ending December 2011, the
Department of Housing and Urban            Office of Housing had not fully developed
Development’s (HUD) multifamily            formal risk-based procedures and controls for
housing and healthcare insured             postendorsement underwriting reviews of insured
mortgage programs as part of our fiscal    loans for multifamily and healthcare (Section
year 2012 annual audit plan. The           232) projects. These conditions occurred
objective of the review was to             because senior management had not fully
determine the adequacy of the Office of    implemented departmental guidance for
Housing’s procedures and controls for      management controls. The audit identified the
selecting, conducting, and following up    need for improvement in several areas, including
on postendorsement underwriting            but not limited to instances in which required
reviews of insured multifamily and         postendorsement underwriting reviews were not
healthcare loans and use of the reviews    conducted, no postendorsement review
to identify and correct adverse            requirements for some project types, and more
underwriting conditions detected by        complete procedures for follow-up on review
them. We did not review any other          results. The failure to conduct the reviews in all
aspects of their risk-based programs       cases where they were required or needed
beyond postendorsement underwriting        represented missed opportunities to identify
reviews.                                   adverse underwriting patterns and correct them
                                           in a timely manner in an effort to help reduce
 What We Recommend                         losses to the insurance fund.


We recommend that the Assistant
Secretary for Housing-FHA [Federal
Housing Administration] Commissioner
develop and implement more complete
written procedures and controls for
conducting and following up on
postendorsement underwriting reviews
of HUD’s insured multifamily and
healthcare loans processed by the Office
of Multifamily Housing Programs and
the Office of Healthcare Programs.
                           TABLE OF CONTENTS

Background and Objective                                                          3

Results of Audit
      Finding: The Office of Housing Had Not Fully Developed Formal Risk-Based    5
               Controls and Procedures for Postendorsement Underwriting
               Reviews of Multifamily and Healthcare Loans

Scope and Methodology                                                            11

Internal Controls                                                                12

Appendix                                                                         13




                                          2
                         BACKGROUND AND OBJECTIVE

    Since 1937, the U.S. Department of Housing and Urban Development’s (HUD) Federal
    Housing Administration (FHA) multifamily mortgage insurance has been a major source of
    financing for affordable housing. Between January 1, 2007, and December 31, 2011, FHA
    insured more than $47.4 billion in mortgage loans to facilitate the construction, substantial
    rehabilitation, purchase, and refinancing of multifamily housing projects and healthcare
    facilities. FHA mortgage insurance protects lenders against financial losses stemming from
    defaults. HUD’s Office of Housing is responsible for establishing requirements for the
    administration of HUD’s multifamily mortgage insurance program primarily through its
    Office of Multifamily Housing Programs and the Office of Healthcare Programs.

    Starting in 2009, Housing initiated and later completed major changes to enhance its
    underwriting processes for multifamily and healthcare insured loans. The changes included
    but were not limited to revisions to its underwriting procedures, implementation of
    Multifamily hub and national loan review committees, the establishment of the Office of
    Healthcare Programs in April 2009, and the transfer of the Section 232 program from
    multifamily to healthcare. The changes were designed and implemented to improve the
    quality of underwriting for multifamily and healthcare loans. Specifically

        •   Multifamily is responsible for the overall management, development, direction, and
            administration of HUD’s multifamily housing programs. It provides direction and
            oversight for FHA mortgage insurance loan origination using multifamily accelerated
            processing (MAP) and traditional application processing (TAP). HUD designed MAP
            to establish national standards for approved lenders to follow when preparing, processing,
            and submitting loan applications for FHA multifamily mortgage insurance. The MAP
            program is intended to provide a consistent, expedited mortgage insurance application
            process at each HUD Multifamily hub or program center. The Multifamily Lender
            Qualification and Monitoring Division (LQMD) is responsible for monitoring MAP
            lenders and providing general oversight of lender performance. Housing had not
            established formalized requirements to monitor TAP loans underwritten and approved
            by HUD staff.

        •   Healthcare is responsible for the administration, processing, and approval of loans for
            healthcare projects. The office administers FHA’s healthcare programs that provide
            mortgage insurance on loans that finance the construction, renovation, acquisition, or
            refinancing of healthcare facilities, such as residential care facilities and hospitals.
            The office processes Section 232 loans using LEAN 1 processing, developed in 2008
            for Section 232 applications. All Section 232 loans are processed and approved by
            healthcare’s headquarters office staff.



1
 LEAN refers to the procedures implemented by HUD which standardized the process used by lenders to assemble
Section 232 loan application packages and for use by HUD staff to underwrite the applications.


                                                      3
The objective of the audit was to review the adequacy of procedures and controls used by the
Office of Housing for selecting, conducting, and following up on postendorsement
underwriting reviews of multifamily and healthcare insured loans and use of the reviews to
identify and correct adverse underwriting conditions detected by them.




                                           4
                               RESULTS OF AUDIT

Finding: The Office of Housing Had Not Fully Developed Formal Risk-
Based Controls and Procedures for Postendorsement Underwriting
Reviews of Multifamily and Healthcare Loans
The Office of Housing could improve the postendorsement review process by more fully
developing formal risk-based procedures and controls for conducting, following up on, and
assessing the results of postendorsement underwriting reviews of insured loans for multifamily
and healthcare (Section 232) projects and better adherence to procedures that were in place. We
identified the need to develop and formalize more complete written procedures for conducting
(1) postendorsement underwriting reviews by Multifamily, (2) trend assessments by Multifamily,
and (3) postendorsement underwriting reviews and trend assessments by Healthcare. These
conditions occurred because senior management within Housing had not fully implemented
required management controls. The failure to conduct the reviews in all cases where they were
required or needed represented missed opportunities to identify adverse underwriting patterns
and correct them in a timely manner in an effort to help reduce losses to the insurance fund.


 More Complete Procedures and
 Controls Needed for
 Conducting Postendorsement
 Underwriting Reviews

              Housing had not fully developed formal risk-based monitoring procedures and
              controls to ensure that Multifamily and Healthcare conducted and properly
              followed up on postendorsement underwriting reviews. HUD Handbook 1840.1,
              Departmental Management Control Program, paragraph 1-3(D)(4), provides that
              the Assistant Secretary for Housing is responsible for implementing management
              control requirements for the Office of Housing. Office of Management and
              Budget Circular A-123, Section IV, requires managers to continuously monitor
              and assess the effectiveness of management controls for their programs.

              Multifamily and Healthcare did not conduct all postendorsement reviews that
              were required, did not require reviews for some project types, or did not conduct
              the required number of reviews. The additional information obtained from the
              reviews could have helped Housing identify inadequate underwriting patterns and
              the ability to initiate timely action to correct them. This condition occurred
              because senior managers in Housing had not fully established formalized the
              required complete risk-based procedures and controls.




                                              5
    Better Compliance Needed for
    Postendorsement Underwriting
    Reviews and Better Procedures
    for Trend Assessments by
    Multifamily

                 Housing had not fully established formal adequate risk-based controls and
                 procedures for postendorsement underwriting reviews of loans processed and
                 approved by Multifamily using traditional application processing (TAP), and
                 multifamily application processing (MAP). Handbook 1840.1, Paragraph 7-3,
                 requires that all monitoring is to be based on the application of risk management
                 concepts. As a result, Housing did not have readily available trend information
                 needed from the reviews to assess and correct any adverse underwriting patterns
                 that the reviews may have identified to help protect the insurance fund from
                 losses.

                 Traditional Application Processing - Housing had not fully established formal
                 risk-based procedures and controls to select, conduct, follow up, and access
                 postendorsement underwriting reviews of TAP loans that were underwritten and
                 approved by HUD staff. This condition was significant considering that during
                 our audit period, January 2007 through December 2011, HUD’s system showed
                 that Multifamily had 19 early assigned TAP loans, but Multifamily reviewed only
                 1 2 of the loans in 2010, leaving 18 loans with mortgages totaling more than $140
                 million that were not reviewed. Multifamily had established requirements to
                 review all early assigned and a sample of other MAP loans, but it had not
                 established similar requirements for TAP loans.

                 Section 1-4 of The Multifamily Lender Qualification and Monitoring Division’s
                 (LQMD) internal desk guide provides that LQMD may conduct reviews of TAP
                 loans underwritten by HUD staff. However, this statement was not a requirement
                 to conduct the reviews. Multifamily officials stated that they did not believe that
                 it was necessary or a good use of resources to establish procedures to conduct
                 postendorsement reviews of TAP loans because TAP loans represented only about
                 2 or 3 percent of their production volume. Multifamily officials further stated that
                 about a third of the TAP loans identified in HUD’s system were erroneously
                 coded and should have been recorded as MAP loans. Multifamily officials stated
                 that this data integrity issue was caused by misclassifications when the staff
                 entered the information into HUD’s system. As a result of this condition, we
                 could not readily identify how many TAP loans were in Multifamily’s inventory.
                 However, as long as TAP loans are a part of Multifamily processing then they are
                 subject to HUD’s risk-based monitoring requirements.



2
 We identified this review, although a Multifamily official stated that Multifamily did not perform postendorsement
underwriting reviews of TAP loans.

                                                         6
                    Multifamily officials stated that although TAP loans were not reviewed by
                    LQMD, they were included in the pool of pipeline loans (loans still in the
                    underwriting process) reviewed by the Office of Risk Management. They stated
                    that Risk Management randomly selected five loans per month for
                    postcommitment quality control reviews through a memorandum of
                    understanding with Multifamily, which was executed in February 2012. 3 The
                    memorandum provided that the reviews were to evaluate the quality of
                    multifamily underwriting to ensure that underwriters complied with the MAP
                    guide but the MAP guide is not applicable to TAP loans. In addition, the
                    memorandum did not specifically provide for the selection and review of TAP
                    loans.

                    Multifamily Accelerated Processing - Housing had not fully established formal
                    risk-based postendorsement underwriting review procedures for Multifamily, and
                    it needed to improve written procedures and controls to ensure that Multifamily
                    followed requirements that were in place for conducting postendorsement
                    underwriting reviews of early assigned MAP loans. Section 4-4 of LQMD’s
                    internal desk guide requires postendorsement underwriting reviews of all early
                    assigned loans (assigned within 4 years of endorsement) and selective review of
                    other MAP loans based on various loan and project characteristics, including but
                    not limited to mortgage amount, default or election to assign within 4 years of
                    final endorsement, size of the project, and geographic location. Specifically,
                    Multifamily had not

                    •      Conducted postendorsement underwriting reviews of all early assigned
                           MAP loans since 2009. Multifamily conducted reviews of only 12 of the 34
                           MAP loans that were early assigned during the period covered by the
                           review, January 1, 2007, through December 31, 2011. This left 22 loans
                           with mortgages totaling more than $268 million that were not reviewed,
                           although Multifamily was required to review all early assigned loans
                           (Section 4-4 of LQMD internal desk guide). The Director of LQMD stated
                           that no other reviews were conducted in 2010 and 2011 because LQMD was
                           in the process of reevaluating and revising its monitoring processes and
                           procedures. The Director stated that in 2012 LQMD had resumed
                           performing postendorsement underwriting reviews of early assigned loans
                           as part of its lender reviews and that reviews of several of the other early
                           assigned loans questioned as not reviewed were underway or would be
                           scheduled.

                    •      Fully established and implemented formal risk-based procedures for
                           determining the number of reviews to conduct, selecting risk-based samples,
                           and following up on MAP loans that were not early assignments. Handbook
                           1840.1, Paragraph 7-3 requires (a) identification of the monitoring objective
                           to determine what is to be monitored, (b), timely risk-based monitoring, (c)
                           selection of programs/program participants for monitoring, and (d)
3
    This was after we started our audit.

                                                      7
    documenting the process and recording the rationale for choosing
    participants. Although procedures were lacking, LQMD reviewed 44 loans
    that were not early assignments and 1 early assigned TAP loan. We
    observed that Housing’s Office of Evaluation produced and distributed
    comprehensive and thorough trend reports that could be used to assist in the
    risk-based assessments required for selecting loans for postendorsement
    review. For instance, the reports showed beneficial information such as
    endorsements, claims, defaults, and delinquencies by HUD office and
    section of the Housing Act.

•   Fully established and implemented timeframes for conducting
    postendorsement underwriting reviews of early assigned and other loans.
    When we brought this matter to the attention of Multifamily officials, they
    revised LQMD’s internal desk guide to specify that all early claim MAP
    loans would be reviewed within 1 year of claim, but they did not specify a
    timeframe for conducting reviews of loans that were not early claim. The
    guide provided only that LQMD would review a sample of other loans to the
    extent that it had the capacity to do so with no reference to a timeframe and
    the number of loans to be reviewed.

•   Fully developed procedures to assess and document trends identified by the
    postendorsement underwriting reviews and follow up to address corrective
    action when needed. Handbook 1840.1, Paragraph 7-3, requires identifying
    whether follow-up corrective actions are necessary. Multifamily officials
    acknowledged the lack of written procedures related to these two issues.
    They stated that the collection and analysis of LQMD’s underwriting
    review results were documented in HUD’s SharePoint and the results were
    discussed in the minutes of monthly staff meetings and that they provide
    MAP training to address underwriting deficiencies and program violations.
    Multifamily officials believed that the assessing and tracking approaches
    they had in place were adequate and did not believe that written procedures
    were required. We believe that written procedures are needed to ensure that
    the data is compiled and assessed in a consistent manner and to help
    enhance the results for use by Housing to identify risk areas that should be
    considered when establishing monitoring objective as required by Handbook
    1840.1, paragraph 7.5D.

    For instance, in 2009, LQMD prepared a comprehensive report with
    background information on defaults and claims by HUD field offices; lender
    default and claim activity; and a summary of risk factors, trends, and
    recommended actions associated with its planning, conducting, and
    assessment of 23 postendorsement reviews conducted in 2008. The report
    was an effective example of the type of periodic assessments of
    postendorsement underwriting review results that, as discussed above, is
    required to help in establishing risk based monitoring objectives. We
    assessed the results of 22 postendorsement reviews and the results

                               8
                          confirmed the trends cited in HUD’s assessment. We found no evidence of
                          a similar assessment since 2009.

    No Postendorsement
    Underwriting Reviews and
    Trend Assessments by
    Healthcare

                    Housing had not fully established formal risk-based postendorsement
                    underwriting review procedures and controls for Section 232 loans processed and
                    approved by Healthcare. Handbook 1840.1, Paragraph 7-3, requires that all
                    monitoring is to be based on the application of risk management concepts. In
                    addition, neither Housing nor Healthcare had conducted or arranged for others to
                    conduct postendorsement underwriting reviews of Section 232 loans since
                    Healthcare received responsibility for the program from Multifamily in March 2009.
                    The reviews were needed to ensure that lenders and HUD staff complied with FHA
                    underwriting requirements and help reduce the risk of losses to the insurance funds
                    due to poor quality underwriting.

                    The absence of reviews was significant, considering that from January 2010 through
                    December 2011, Healthcare endorsed more than 730 Section 232 loans with
                    mortgages that totaled more than $6 billion. 4 Specifically, Housing had not
                    established and implemented risk-based procedures and controls to be followed
                    by Healthcare staff to

                    •     Determine the number of postendorsement underwriting reviews to conduct;
                    •     Select risk-based samples of loans for postendorsement review;
                    •     Conduct and document the reviews;
                    •     Follow up and resolve review findings; and
                    •     Assess, develop, and follow up on trends resulting from reviews.

                    A Healthcare representative stated that Healthcare had not conducted or asked
                    LQMD to conduct postendorsement underwriting reviews because it did not feel
                    that the reviews were necessary, considering the extensive underwriting controls
                    that Healthcare had put in place. This comment was not consistent with
                    Handbook 1840.1, Paragraph 7-3, which requires (a) identification of the
                    monitoring objective to determine what is to be monitored, (b), timely risk-based
                    monitoring, (c) selection of programs/program participants for monitoring, (d)
                    identification of whether follow-up corrective actions are necessary, and (e)
                    documenting the process and recording the rationale for choosing participants.
                    Further, trend data prepared by Housing’s Office of Evaluation showed increasing
                    delinquencies for Section 232 loans, which highlights the need to consider such
                    projects for postendorsement underwriting reviews. Specifically, the March 2012

4
    We found no evidence that any of the endorsed loans had gone to early assignment.

                                                          9
                   report showed 20 delinquencies and claims in the fourth quarter of 2009 and 36 in
                   March 2012, representing an 80 percent increase. 5

                   We do not question Healthcare’s claim of a thorough underwriting process but we
                   do questions Housing’s under-developed written procedures to subject
                   Healthcare’s underwriting process to the required risk based monitoring
                   requirements in Handbook 1840,1, paragraph 7-3.

    Conclusion

                   Housing needs to fully develop formal risk-based procedures and controls for
                   Multifamily and Healthcare to conduct, follow up on, and assess the results of
                   postendorsement underwriting reviews. These conditions occurred because senior
                   management within Housing had not fully developed and implemented required
                   management controls. The conditions are significant, considering that during the
                   5-year audit period, Housing endorsed 86 loans with mortgages totaling more than
                   $1.3 billion that were either delinquent, in default, or assigned. The average
                   mortgage for a troubled loan amounted to more than $16 million, coupled with a
                   HUD recovery of only 48 percent of mortgage amounts on note sale loans. 6 Thus,
                   a single troubled loan had the potential of exposing HUD’s insurance fund to
                   millions of dollars in losses. This condition underscores the importance of having
                   fully developed procedures and controls for conducting postendorsement
                   underwriting reviews. The failure to conduct the reviews in all cases where they
                   were required or needed represented missed opportunities to identify adverse
                   underwriting patterns and correct them in a timely manner in an effort to help
                   reduce losses to the insurance fund.

    Recommendations

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

                   1A.       Develop and implement more complete and formalized written procedures
                             and controls for risk-based postendorsement underwriting, complete with
                             objectives and procedures for Multifamily and Healthcare for selecting
                             samples, conducting and documenting reviews, resolving review findings,
                             assessing the reviews for adverse underwriting trends, and following up on
                             trends identified by the reviews.


5
  We recognize that some of the delinquencies and claims may relate to loans processed and approved by Multifamily before
Healthcare took over the Section 232 program in 2009. However, the monitoring requirements previously cited for Handbook
1840.1 is applicable to Housing without regard to whether the loans were processed and approved by Multifamily or Healthcare.
In this case, Healthcare is now responsible for the monitoring.
6
  We obtained the recovery percentage from Housing’s Office of Asset Sales based on multifamily and healthcare loan note sales
from September 2007 to December 2011.

                                                             10
                        SCOPE AND METHODOLOGY

We performed the review from January to October 2012 at HUD headquarters in Washington,
DC, and Office of Inspector General (OIG) offices in Jacksonville, FL, and Atlanta, GA. The
audit survey covered the period January 1, 2007, through December 31, 2011. We adjusted the
period when necessary.

To accomplish our audit objective, we

   •   Reviewed reports issued by the Government Accountability Office (GAO) from 2002 to
       2011 to identify issues and recommendations that were relevant to our survey objectives
       and determine whether HUD had initiated appropriate actions to address the concerns
       raised by GAO.

   •   Reviewed recent OIG reports related to our survey objective.

   •   Interviewed Multifamily and Healthcare headquarters officials and reviewed the policies
       and procedures they used to process and underwrite multifamily loans and conduct and
       follow up on postendorsement underwriting reviews.

   •   Reviewed reports issued by the Office of Evaluation on delinquency and claim rate
       activity and trends.

   •   Reviewed HUD’s information system data on insured multifamily and healthcare loans
       for patterns and trends such as defaults, delinquencies, assignments, high default and
       claim lenders, and high default and claim hubs and field offices. We did not test the
       reliability of the system from which the data was obtained because we only used it for
       background and informational purposes.

   •   Selected and reviewed all 22 reports involving defaulted loans from among 57 LQMD
       postendorsement review reports issued between 2007 and 2011 for underwriting
       deficiency patterns and trends.

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 finding and
conclusion based on our audit objective.




                                               11
                              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:

               •      Compliance with laws and regulations to ensure that the Office of Housing
                      developed and implemented comprehensive procedures and controls for
                      postendorsement underwriting reviews of HUD have insured multifamily
                      and healthcare loans.

               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:

               •      The Office of Housing had not fully developed formal comprehensive risk-
                      based controls and procedures for postendorsement underwriting reviews
                      of multifamily and healthcare loans (finding 1).



                                                 12
                                         APPENDIX

The Assistant Secretary for Housing-Federal Housing Commissioner informed us by email that
she agreed with the draft report as revised to address concerns raised by her and her staff at the
exit conference and that she had no written comments for use to include in the final report.




                                                13