oversight

Eustis Mortgage Did Not Always Operate Its FHA Program In Accordance With HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2013-03-21.

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

OFFICE OF AUDIT
REGION 6
FORT WORTH, TX




                  Eustis Mortgage Corporation
                        New Orleans, LA

       HUD Federal Housing Administration Direct
                Endorsement Lender




2013-FW-1002                                    MARCH 21, 2013
                                                        Issue Date: March 21, 2013

                                                        Audit Report Number: 2013-FW-1002




TO:            Charles S. Coulter
               Deputy Assistant Secretary for Single Family Housing, HU

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


SUBJECT:       Eustis Mortgage Corporation, New Orleans, LA, Did Not Always Comply With
               HUD-FHA Underwriting and Quality Control Program Requirements


    Attached is the U.S. Department of Housing and Urban Development (HUD), Office of
Inspector General’s (OIG) final results of our review of Eustis Mortgage Corporation’s loan
origination, underwriting, and quality control program policies and procedures.

    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
817-978-9309.
                                            Date of Issuance March 21, 2013
                                            Eustis Mortgage Corporation, New Orleans, LA, Did Not
                                            Always Comply With HUD-FHA Underwriting and
                                            Quality Control Program Requirements



Highlights
Audit Report 2013-FW-1002


 What We Audited and Why                     What We Found

We audited Eustis Mortgage                  Eustis Mortgage did not underwrite 4 of 18 defaulted
Corporation, a Federal Housing              FHA-insured loans in accordance with HUD
Administration (FHA) direct                 requirements. These conditions occurred because
endorsement lender located in New           Eustis Mortgage’s staff was not always aware of the
Orleans, LA. We selected Eustis             applicable HUD underwriting requirements. As a
Mortgage as a result of our regional risk   result, these loans exposed HUD to unnecessary
analysis and the U.S. Department of         insurance risks totaling more than $270,000.
Housing and Urban Development
(HUD), Office of Inspector General’s        Further, Eustis Mortgage’s quality control program did
(OIG) annual audit plan goal to review      not fully comply with HUD requirements. These
single-family programs and lenders.         conditions occurred because Eustis Mortgage did not
Our objective was to determine whether      (1) have adequate basic controls over its quality
Eustis Mortgage (1) complied with           control program and (2) fully understand all of HUD’s
HUD regulations, procedures, and            requirements. As a result, it increased the risk to the
instructions when originating and           FHA insurance fund because it could not always
underwriting its FHA-insured single-        ensure compliance with FHA’s and its own origination
family mortgages and (2) had                requirements; guard against errors, omissions, and
implemented a quality control program       fraud; and ensure swift and appropriate corrective
that met HUD requirements.                  action.

 What We Recommend

We recommend that the Deputy
Assistant Secretary for Single Family
Housing require Eustis Mortgage to (1)
indemnify four loans with unpaid
principal balances of $490,274, thereby
putting an estimated $279,456 to better
use; (2) implement a quality control
plan that complies with HUD
requirements; and (3) provide training
to its staff and contractors concerning
HUD underwriting and quality control
requirements.
                            TABLE OF CONTENTS

Background and Objective                                                  3

Results of Audit
      Finding 1: Eustis Mortgage Did Not Always Underwrite Its
                 FHA-Insured Loans in Accordance With HUD Requirements    4
      Finding 2: Eustis Mortgage’s Quality Control Program Did Not
                 Fully Meet HUD’s Requirements                            7

Scope and Methodology                                                    12

Internal Controls                                                        14

Appendixes
A.    Schedule of Funds To Be Put to Better Use                          16
B.    Auditee Comments and OIG’s Evaluation                              17
C.    Summary Data For Questioned Loans                                  27
D.    Case Narratives                                                    28




                                            2
                         BACKGROUND AND OBJECTIVE

Eustis Mortgage Corporation is headquartered at 1100 Poydras Street, New Orleans, LA. It has
seven active branches located in Deridder, LA, Baton Rouge, LA, Gulf Shores, AL, Metairie,
LA, Gulfport, MS, Mandeville, LA, and Bossier City, LA. Eustis Mortgage has been a Federal
Housing Administration (FHA) approved lender since 1964. It is a nonsupervised lender and
was approved by the U.S. Department of Housing and Urban Development (HUD) as an
unconditional direct endorsement lender on February 6, 1989. After originating loans, Eustis
Mortgage sells the loans and thus does not service the loans.

HUD’s direct endorsement program simplified the process for obtaining FHA mortgage
insurance by allowing lenders to underwrite and close mortgage loans without prior HUD review
or approval. All FHA lenders must follow all applicable statutes, regulations, and HUD’s
written instructions, including program handbooks and mortgagee letters. Specifically, lenders
must follow HUD Handbook 4155.1, “Mortgage Credit Analysis for Mortgage Insurance on
One-to-Four-Unit Mortgage Loans,” when underwriting FHA loans. The lender is responsible
for eliciting a complete picture of the borrower’s financial situation, source of funds for the
transaction, and intended use of the property. Its decision to approve the loan must be
documented, supported, and verifiable. Lenders are protected against loan default 1 by FHA’s
Mutual Mortgage Insurance Fund, which is sustained by borrower premiums. The lenders bear
less risk because FHA pays a claim to the lender in the event that a borrower defaults on a loan.

FHA-approved lenders are also required to implement and continuously have in place a quality
control plan for the origination of insured mortgages as a condition of receiving and maintaining
FHA approval.

According to HUD’s Neighborhood Watch system, 2 Eustis Mortgage originated 762 FHA loans
between July 1, 2010, and June 30, 2012, totaling more than $116 million. Of the 762 loan
originations, as of June 30, 2012, 18 loans had defaulted totaling more than $2.5 million.

Our objective was to determine whether Eustis Mortgage (1) complied with HUD regulations,
procedures, and instructions when originating and underwriting its FHA-insured single-family
mortgages and (2) had implemented a quality control program that met HUD requirements.




1
    HUD defines a default as the inability to make timely mortgage payments or otherwise comply with mortgage
    terms. A loan is considered in default when no payment has been made 30 days after the due date. Once a loan
    is in default, the lender may exercise legal rights defined in the contract to begin foreclosure proceedings.
2
    Neighborhood Watch is Web-based software that displays loan performance data for FHA-insured single-family
    loans. The system is designed to highlight exceptions so that potential problems are readily identifiable.



                                                       3
                                   RESULTS OF AUDIT


Finding 1: Eustis Mortgage Did Not Always Underwrite Its FHA-
Insured Loans in Accordance With HUD Requirements
Eustis Mortgage did not always underwrite its FHA-insured loans in accordance with HUD
requirements. This condition occurred because Eustis Mortgage’s staff was not always aware of
the applicable HUD underwriting requirements. As a result, these loans exposed HUD to
unnecessary insurance risks totaling more than $270,000. 3



    Eustis Mortgage Did Not Follow
    HUD-FHA Underwriting
    Requirements

                Our review of 18 defaulted loans determined that 4 (22 percent) contained
                material deficiencies because the loans were not manually underwritten as
                required 4 when the borrower’s credit report contained disputed collection
                accounts. The following table summarizes the loan deficiencies.

                                  Loan deficiencies summary
                           Loan number        Disputed credit accounts
                           221-4549952                   X
                           221-4642722                   X
                           221-4603968                   X
                           221-4528193                   X

                Because the borrowers for the four loans had disputed accounts on their credit
                reports, HUD required Eustis Mortgage to manually underwrite the loans.
                Instead, it processed these loans using an automated underwriting system. We
                performed additional analysis of the four loans to determine whether they met the
                manual underwriting requirements. Each loan had multiple manual underwriting
                deficiencies as follows:

                    x   The files for two loans did not include all required traditional or
                        alternative asset documentation. 5


3
     See appendix C.
4
     FHA’s Technology Open to Approved Lenders (TOTAL) Mortgage Scorecard User Guide, effective December
     2004, Chapter 2, System Overides and Manual Downgrades, Credit Issues, Disputed Accounts
5
     HUD Handbook 4155.1, paragraph 1.B.2.c



                                                    4
                      x   For three loans, the files did not include a written explanation from the
                          borrower for inquiries shown on the credit report in the last 90 days. 6
                      x   The files for four loans did not include a written explanation from the
                          borrower for collection accounts occurring within the past 2 years. 7 The
                          files also did not contain documentation showing Eustis Mortgage’s
                          analysis of the collection accounts in dispute. 8
                      x   The files for three loans did not contain documentation of a 12-month
                          rental or mortgage payment history. 9
                      x   The files for three loans showed that the borrowers’ ratios exceeded the
                          qualifying ratios, but Eustis Mortgage did not document the compensating
                          factors for qualifying ratios as required. 10 As an example, one borrower’s
                          front and back ratios exceeded the qualifying ratios by more than 8 and 12
                          percentage points, respectively.

                  Since Eustis Mortgage did not properly underwrite these four loans, they were not
                  eligible for FHA insurance.

                  See appendix D for the case file narratives.

     Eustis Mortgage Did Not
     Understand the Requirements


                  Eustis Mortgage did not always understand the requirements. According to Eustis
                  Mortgage, it was not aware that HUD required it to review the disputed collection
                  accounts until April 2011, after it had underwritten the loans, because it believed
                  that HUD issued confusing guidance. Eustis Mortgage staff explained that
                  HUD’s requirements concerning the disputed accounts caused a lot of confusion
                  with mortgage lenders nationwide. According to the staff, after HUD first issued
                  the disputed accounts guidance in 2010, it later had to issue a mortgagee letter to
                  clarify how the disputed accounts were to be viewed. The staff was unable to
                  obtain clarification from HUD. Staff stated that it made the underwriting error
                  due to the confusion regarding the requirements. Once HUD issued definitive
                  guidance, Eustis Mortgage changed its policies to review the disputed collection
                  accounts when applicable. However, it should have followed the HUD
                  requirements in effect at the time the loans were underwritten and referred the
                  loans to a direct endorsement underwriter for manual review. 11


6
      HUD Handbook 4155.1, paragraph 4.C.2.c
7
      HUD Handbook 4155.1, paragraph 4.C.2.d-e
8
      HUD Handbook 4155.1, paragraph 4.C.1.c
9
      HUD Handbook 4155.1, paragraph 4.C.2.b
10
      HUD Handbook 4155.1, paragraphs 4.F.3.b and 4.F.2.b-c
11
      TOTAL Mortgage Scorecard User Guide, effective December 2004, Chapter 2, System Overides and Manual
      Downgrades, Credit Issues, Disputed Accounts



                                                      5
     Conclusion

                   Because Eustis Mortgage was not always aware of HUD’s requirements, it did not
                   manually underwrite four loans when required. As a result, these four ineligible
                   loans exposed HUD to unnecessary insurance risks totaling more than $270,000.


     Recommendations

                   We recommend that the Deputy Assistant Secretary for Single Family Housing
                   require Eustis Mortgage to

                   1A. Indemnify HUD for four insured loans with unpaid principal balances of
                       $490,274, thereby putting an estimated $279,456 to better use based on the
                       FHA insurance fund average loss rate of 57 percent of the unpaid principal
                       balances. 12

                   1B. Provide periodic training to ensure that origination and underwriting staff
                       members are aware of current HUD underwriting requirements outlined in
                       HUD Handbook 4155.1 and the TOTAL Mortgage Scorecard User Guide.




12
      Based on FHA’s first quarter 2013 fiscal year-to-date loss severity rate of 57 percent, supported by the Single
      Family Acquired Asset Management System’s case management profit and loss by acquisition as of December
      2012



                                                           6
Finding 2: Eustis Mortgage’s Quality Control Program Did Not Fully
Meet HUD’s Requirements
Eustis Mortgage’s quality control program did not fully comply with HUD requirements.
Specifically, Eustis Mortgage did not (1) document branch site visit compliance reviews, (2)
document quality control review sample sizes and selections, (3) always maintain documentation
to support that it reported review findings to its senior management within required timeframes,
(4) notify HUD’s Quality Assurance Division when quality control review findings had serious
violations, or (5) review loans that went into default within the first six payments. These
conditions occurred because Eustis Mortgage did not (1) have adequate basic controls over its
quality control program or (2) fully understand all HUD requirements. As a result, it increased
the risk to the FHA insurance fund and could not provide reasonable assurance that it (1)
originated loans properly; (2) guarded against errors, omissions, and fraud; and (3) ensured swift
and appropriate corrective action.



     Eustis Mortgage Did Not Have
     Documentation Supporting
     That It Performed Site Visits


                 Eustis Mortgage did not have documentation to support that it performed site
                 reviews of its branch offices that originated FHA-insured loans. HUD required
                 Eustis Mortgage to perform annual site visits to all of its branches to ensure that
                 lending practices conformed to all applicable requirements. 13 However, Eustis
                 Mortgage did not have documentation to support that it performed the required
                 reviews from July 1, 2010, through June 30, 2012. Eustis Mortgage had since
                 implemented a branch visit log to document when it performed site visits.
                 However, this log addressed only performance and did not cover a review or
                 verification that each branch met items required by HUD Handbook 4060.1.
                 Some of the requirements that were not met included verifying (1) proper branch
                 registration with FHA; (2) a professional and business-like environment; (3)
                 branch staff had access to the most current and relevant statutes, regulations,
                 HUD issuances, and handbooks; and (4) assurance that the branch office did not
                 employ or contract with persons under debarment or suspension.




13
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-3(G)



                                                     7
     Eustis Mortgage Did Not Follow
     Quality Control Requirements


                  Eustis Mortgage did not always ensure that its quality control reviews followed
                  HUD requirements. Since March of 1996, Eustis Mortgage had employed a
                  quality control contractor, Advanced Financial Technology, Inc. (ADFITECH), to
                  perform its quality control function. In addition, it used an independent contractor
                  to work with ADFITECH to address the results of quality control findings and
                  take the appropriate actions. ADFITECH performed the quality control reviews
                  monthly as required. However, our review of 23 quality control reports, covering
                  July 2010 through May 2012, determined that

                      x For all reports, Eustis Mortgage did not document how it determined the
                      sample sizes and selections for the reviews as required 14 before providing the
                      sample selections to ADFITECH. The reports listed only the loans selected
                      for review and the loan type.

                      x For four reports, Eustis Mortgage did not have documentation to support
                      that review findings were reported to its senior management within 1 month of
                      completion of the initial quality control report as required. 15 There was no
                      indication on the reports, via a signature, initial, or date, evidencing that
                      management reviewed the documents.

                      x For three reports, Eustis Mortgage did not have documentation to support
                      that it took corrective actions on findings cited in the quality control reviews
                      as required. 16 For instance, in the April 2011 report, two of three sampled
                      loans did not include evidence that an issue concerning the review of a limited
                      denial of participation list had been resolved.

     HUD Was Not Notified of
     Serious Findings

                  Eustis Mortgage did not always ensure that it reported serious findings to HUD.
                  As an additional reporting requirement, HUD required that findings of fraud or
                  other serious violations be immediately referred, in writing, to the appropriate
                  Quality Assurance Division Director. In lieu of submitting a paper report, HUD
                  required Eustis Mortgage to use the lender reporting feature in the Neighborhood
                  Watch Early Warning System. 17 However, for 8 of the 23 quality control reports
                  reviewed, we identified 13 serious findings that Eustis Mortgage did not refer to

14
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-6(C)
15
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-3(I)
16
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-3(I)
17
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-3(J)



                                                     8
                  HUD. According to Eustis Mortgage, it believed that as long as it resolved the
                  items in-house, there was no need to contact HUD regarding the matter, indicating
                  that it did not understand the requirement.

     Eustis Mortgage Did Not
     Perform Required Reviews of
     Some Defaulted Loans

                  Eustis Mortgage did not review early payment defaults 18 as required by its
                  policies and procedures 19 and by HUD. 20 Eustis Mortgage was required to review
                  all loans going into default within the first six payments, in addition to loans
                  selected for routine quality control reviews. However, it could not provide
                  documentation showing that it met this requirement. According to Eustis
                  Mortgage, its record keeping was lacking in this area, but it planned to begin
                  maintaining copies of the required quality control defaulted loan reviews. As of
                  January 2013, Eustis Mortgage had begun implementing quality control reviews
                  of the defaulted loans.

     Eustis Mortgage’s Quality
     Control Program Was Not
     Adequate

                  Eustis Mortgage’s quality control program was not adequate. HUD required
                  Eustis Mortgage to continuously have a quality control plan for the origination of
                  insured mortgages as a condition of receiving and maintaining FHA approval. 21
                  HUD allowed Eustis Mortgage to obtain contractors to perform the quality control
                  function but placed responsibility on Eustis Mortgage for ensuring that the
                  contractors met HUD’s requirements. In addition, any contractor arrangement
                  required a written agreement, which stated the roles and responsibilities of each
                  party and accessibility for review by HUD staff. 22 However, we noted the
                  following deficiencies:

                  Eustis Mortgage’s quality control plan did not include sufficient detail – Neither
                  Eustis Mortgage’s March 2012 nor its March 1996 quality control plan included
                  all required elements needed to ensure compliance with HUD’s quality control
                  requirements. Specifically, neither plan




18
      Early payment defaults are loans that become 60 days past due within the first six payments.
19
      Eustis Mortgage Corporation FHA Loan Origination Quality Control Policy, updated March 20, 2012
20
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-6(D)
21
      HUD Handbook 4060.1, REV-2 (FHA Title II Mortgagee Approval Handbook), paragraph 7-1
22
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-3(B)



                                                       9
                  (1) Addressed the timeliness and frequency of monthly reviews of delinquent loan
                      servicing, claims, and foreclosures and the sample size of such reviews. 23 In
                      addition, it did not clearly detail quality control requirements once Eustis
                      Mortgage sold or transferred a loan for servicing.

                  (2) Clearly stated, “review findings must be reported to the mortgagee’s senior
                      management within one month of completion of the initial report,” as required
                      by HUD’s guidance.

                  Eustis Mortgage’s contracts had deficiencies – Eustis Mortgage did not have a
                  required written agreement with the independent contractor that performed its
                  quality control follow-up from March through October 2012. It executed an
                  agreement, effective November 1, 2012. The contract did not stipulate
                  compliance with HUD’s quality control requirements or explain the ramifications
                  for not doing so and did not address monitoring and oversight. In addition, Eustis
                  Mortgage’s contract with ADFITECH was not dated and did not address
                  monitoring and oversight.

                  Eustis Mortgage did not provide required training to contractors – Eustis
                  Mortgage could not provide documentation showing that it provided required
                  training to either of its quality control contractors. 24 While it provided
                  documentation showing that ADFITECH had its own internal training, Eustis
                  Mortgage did not provide evidence that it provided ADFITECH with training or
                  access to current guideance . Eustis Mortgage did not provide training to the
                  independent contractor that performed its quality control follow-up. To address
                  this deficiency, in November 2012, Eustis Mortgage provided the quality control
                  follow-up contractors with computer access to FHA guideance.

     Conclusion

                  Because Eustis Mortgage did not have adequate basic controls over its quality
                  control program and fully understand all HUD requirements, it did not (1)
                  document branch site visit compliance reviews, (2) document quality control
                  review sample sizes and selections, (3) always maintain documentation to support
                  that it reported review findings to its senior management within required
                  timeframes, (4) notify HUD of review findings with serious violations, and (5)
                  review loans that went into default within the first six payments. Therefore,
                  Eustis Mortgage increased the risk to the FHA insurance fund and could not
                  provide reasonable assurance that (1) it protected HUD from unacceptable risk;
                  (2) the likelihood of errors, omissions, and fraud was lessened; and (3) its loan
                  origination and underwriting operations ensured accuracy, validity, and
                  completeness.

23
      HUD Handbook 4060.1, REV-2 (FHA Title II Mortgagee Approval Handbook), paragraph 7-10
24
      HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook), paragraph 7-3(C)



                                                    10
Recommendations

          We recommend that the Deputy Assistant Secretary for Single Family Housing
          require Eustis Mortgage to

          2A. Implement a quality control plan that complies with HUD requirements
              outlined in HUD’s Handbook 4060.1, REV-2, to include ensuring that the
              plan is adequate to correct deficiencies identified in this report.

          2B. Provide training to ensure that its quality control staff and contractors are
              aware of HUD’s quality control program requirements.

          2C. Update its contract with its quality control contractors to ensure that the
              contracts contain all HUD requirements, including follow-up, management
              review, HUD notification requirements, and lender contract monitoring.




                                           11
                             SCOPE AND METHODOLOGY

We conducted the audit at Eustis Mortgage’s headquarters office in New Orleans, LA, and the
HUD Office of Inspector General’s (OIG) field offices in New Orleans and Baton Rouge, LA.
We performed our audit between August 2012 and January 2013.

To accomplish our objective, we

     x   Reviewed applicable HUD-FHA regulations, requirements, and mortgagee letters;
     x   Reviewed reports and information on HUD’s Neighborhood Watch system;
     x   Reviewed Eustis Mortgage’s policies and procedures, quality control plan, contracts,
         reports, and independent audit reports;
     x   Reviewed a 100 percent sample of 18 defaulted loans with original mortgage amounts
         totaling more than $2.5 million;
     x   Reviewed a nonstatistical sample of 9 property appraisals associated with 8 25 of the
         defaulted loans;
     x   Conducted onsite visits to the properties of the 17 defaulted loans 26 and interviewed 6
         borrowers; and
     x   Conducted interviews with applicable HUD and Eustis Mortgage staff.

During the audit period, Eustis Mortgage originated 762 loans totaling more than $116 million.
For the 18 defaulted loans, we reviewed the loan files to determine whether the loan originations
and underwriting procedures were performed in accordance with HUD laws and regulations. 27
For our appraisal review, a HUD OIG appraiser performed a desk review of a nonstatistical
sample of nine appraisals associated with eight of the defaulted loans to determine whether the
appraisals complied with HUD requirements. 28 We selected the appraisals based on visual
observations of the properties; and data mining which identified one appraiser that prepared
appraisals associated with at least 5 of the 18 defaulted loans. Through reviews of the file data,
we determined that the data were generally reliable. The HUD OIG appraiser questioned all nine
of the appraisals; however, due to the subjectivity involved in the appraisal process, we did not
report the potential deficiencies.

For our quality control program review, we assessed Eustis Mortgage’s quality control plan and
23 quality control reports issued within our audit scope to determine whether these complied
with HUD’s requirements. 29

Our audit scope generally covered July 1, 2010, through June 30, 2012. We expanded the scope
as needed to accomplish our audit objectives. We conducted the audit in accordance with
25
     One loan had two appraisals because the property was sold 94 days before the new loan’s sales contract.
26
     We did not observe the property of one loan due to its travel distance.
27
     HUD Handbook 4155.1, Mortgage Credit Analysis for Mortgage Insurance-on One to Four Unit Mortgage
     Loans, effective May 2009, updated March 24, 2011
28
     HUD Handbook 4150.2, CHG-01, Valuation Analysis of Single Family One to Four Unit Dwellings
29
     HUD Handbook 4060.1, REV-2 ( FHA Title II Mortgagee Approval Handbook)



                                                       12
generally accepted government auditing standards. Those standards require that we plan and
perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that the evidence obtained
provides a reasonable basis for our findings and conclusions based on our audit objectives.




                                                13
                              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

   x   Effectiveness and efficiency of operations,
   x   Reliability of financial reporting; and
   x   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:

                  x   Controls intended to ensure that FHA-insured single-family loans were
                      originated and underwritten in compliance with HUD requirements.
                  x   Controls intended to ensure that the quality control program complied with
                      HUD requirements and was effective in reducing underwriting errors and
                      noncompliance.

               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.




                                                 14
Significant Deficiencies

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

                x   Eustis Mortgage did not have adequate controls to ensure that its FHA-
                    insured loans were originated and underwritten in accordance with HUD
                    requirements (finding 1).
                x   Eustis Mortgage did not have adequate controls to ensure that its quality
                    control program was implemented in accordance with HUD requirements
                    and was effective in reducing underwriting errors (finding 2).




                                              15
                                    APPENDIXES

Appendix A

     SCHEDULE OF FUNDS TO BE PUT TO BETTER USE

                                                         Funds to be
                 Recommendation
                                                         put to better
                     number
                                                            use 1/
                         1A                                   $279,456


                      TOTAL                                  $279,456


1/   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. In this
     instance, implementation of recommendation 1A will reduce FHA’s risk of loss to the
     insurance fund for the four loans by $279,456 based on FHA’s first quarter 2013 fiscal
     year-to-date loss severity rate of 57 percent, supported by the Single Family Acquired
     Asset Management System’s case management profit and loss by acquisition as of
     December 2012.




                                             16
       Appendix B

            AUDITEE COMMENTS AND OIG’S EVALUATION




Comment 1




                             17
Comments 3,
4, 5, and 6


Comment 2




Comment 2




Comment 2




              18
Comment 2




Comment 2




            19
Comment 3




            20
Comment 4




            21
Comment 5




            22
Comment 6




            23
                                OIG Evaluation of Auditee Comments

Comment 1        Eustis Mortgage generally agreed with the findings and explained that it intended
                 to use the results of the report to improve performance in operations and that it
                 has already put procedures in place to help in that effort. We appreciate Eustis
                 Mortgage’s proactive approach in improving its operational performance based on
                 the findings identified in this report.

Comment 2        Eustis Mortgage agreed and has taken initiative to address the deficiencies
                 identified in finding 2 regarding its quality control program. We appreciate Eustis
                 Mortgage's efforts in correcting these deficiencies. Eustis Mortgage provided
                 additional documentation to support its corrective actions; however, due to its size
                 we did not include this documentation in the final report. Eustis Mortgage should
                 provide the final supporting documentation to HUD's staff, which will assist
                 Eustis Mortgage with resolving the recommendations.

Comment 3        Eustis Mortgage stated that it did not understand the requirement that if the credit
                 report reflected a disputed account that it required a manual downgrade review by
                 a direct endorsement underwriter. It also stated that it is company policy that all
                 FHA loans be reviewed by a direct endorsement underwriter and this loan would
                 have been approved as a refer, with front and back ratios of 31.94 and 36.40
                 percent, respectively; and loan to value of 70 percent. However, there was no
                 documentation in the file supporting the underwriter’s analysis or determination
                 that the underwriter would have approved this loan with the listed ratios, one of
                 which exceeded the FHA limits by 0.94 percent. 30 The file documentation
                 showed that, based on the disputed accounts, the loan should have been manually
                 underwritten and because it was not, the file did not contain supporting
                 documentation that was required for a manual review to support a loan approval.
                 Thus, we stand by our original conclusion.

Comment 4        Eustis Mortgage stated that it did not understand the requirement that if the credit
                 report reflected a disputed account that it required a manual downgrade review by
                 a direct endorsement underwriter. It also stated that it is company policy that all
                 FHA loans are reviewed by a direct endorsement underwriter and this loan was
                 reviewed by the underwriter but since the loan was rated an “accept” with high
                 ratios, no further action was taken. We disagree as the file being rated as an
                 “accept” was irrelevant since the loan required a manual downgrade based on the
                 disputed accounts on the borrower’s credit report. In addition, the front and back
                 ratios exceeded the FHA qualifying ratios by more than 8 and 12 percentage
                 points, respectively. Further, this borrower defaulted after the first monthly
                 payment and is in foreclosure stage. Because the loan was not manually
                 downgraded, the file did not contain supporting documentation that was required


30
     FHA’s Mortgage Payment to Income (Front End Ratio) is not to exceed 31 percent and the Total Fixed Payment
     to Income (Back End Ratio) is not to exceed was 43 percent - HUD Handbook 4155.1, paragraph 4.F.2.b-c.



                                                      24
            for a manual review to support a loan approval. Thus, we stand by our original
            conclusion.

            Regarding the miscalculated income, we reviewed Eustis Mortgage’s response
            and agree with the explanation. Thus, we removed the verbiage from the report.

Comment 5   Eustis Mortgage stated that it did not understand the requirement that if the credit
            report reflected a disputed account that it required a manual downgrade review by
            a direct endorsement underwriter. It further stated that it is company policy that
            all FHA loans are reviewed by a direct endorsement underwriter and this loan was
            reviewed by the underwriter and would have been approved with front and back
            end ratios of 37.66 and 37.66 percent, respectively; and loan to value of 75
            percent. We disagree as there was no documentation in the file supporting the
            underwriter’s analysis or determination that the underwriter would have approved
            this loan with the listed ratios’, as the front ratio exceeded the FHA limits by 7.66
            percentage points. Eustis Mortgage further stated compensating factors that
            would offset the mortgage payment factor of 37.66 percent were, the borrower (1)
            was in law enforcement and on the job for 20 years; (2) did not obtain maximum
            loan to value, and (3) was debt free with $15,000 in cash reserves. However,
            there was no documentation in the file listing these compensating factors or any
            analysis of these factors prior to loan approval.

            In addition, due to the disputed accounts in the borrower’s credit report, the loan
            review required a manual downgrade. Because the loan was not manually
            downgraded, the file did not contain supporting documentation that was required
            for a manual review to support a loan approval, including the compensating
            factors that the lender now lists in response to this report. Finally, this loan is
            currently in default and commencing to foreclosure. Thus, we stand by our
            original conclusion.

            Regarding the payment during the month of refinance, we reviewed Eustis
            Mortgage’s response and additional documentation. We agree with the
            explanation and therefore removed the verbiage from the report.

Comment 6   Eustis Mortgage stated that it did not understand the requirement that if the credit
            report reflected a disputed account that it required a manual downgrade review by
            a direct endorsement underwriter. It further stated that it is company policy that
            all FHA loans be reviewed by a direct endorsement underwriter and this loan
            would have been approved as a refer with front and back end ratios of 20.57 and
            37.48 percent, respectively. There was no documentation in the file supporting
            the underwriter’s analysis or determination that the underwriter would have
            approved this loan with the listed ratios. The file documentation showed that,
            based on the disputed accounts, the loan should have been manually underwritten
            and because it was not, the file did not contain supporting documentation that was
            required for a manual review to support a loan approval.




                                             25
                  Regarding the automated underwriting system report before closing not being in
                  the file, HUD regulations require that the loan package contain all documentation
                  that supports Eustis Mortgage’s decision to approve the mortgage loan. 31 As
                  stated above, the loan should have been manually underwritten. However, when
                  relying on the automated underwriting system for the underwriting of a loan,
                  Eustis Mortgage should have an automated underwriting system report that shows
                  approval before the loan closing, not after, to comply with HUD requirements.

                  As related to the required elements missing from the gift letter, this loan file
                  included two forms of a gift letter, one in a standardized gift letter form and the
                  other in the loan application. Eustis Mortgage's additional documentation and
                  explanation did not address the deficiency that the standardized gift letter form
                  was missing the donor’s address and telephone number, and the gift letter in the
                  loan application was also missing the telephone number, all required elements that
                  should have been included. Thus, we stand by our original conclusions.




31
     HUD Handbook 4155.1, paragraph 1.B.1.g



                                                  26
Appendix C

                 SUMMARY DATA FOR QUESTIONED LOANS

           Loan                 Mortgage            Unpaid principal balance                  Computed benefit
          Number                Amount              as of December 31, 2012                  of indemnification 32
        221-4549952              $ 99,300                           $ 95,630                            $ 54,509
        221-4642722               131,577                            127,933                               72,922
        221-4603968               181,800                            175,538                              100,057
        221-4528193                 94,724                            91,173                               51,968
        Totals                   $507,401                           $490,274                            $279,456




32
     Based on FHA’s first quarter 2013 fiscal year-to-date loss severity rate of 57 percent, supported by the Single Family
     Acquired Asset Management System’s case management profit and loss by acquisition as of December 2012




                                                               27
Appendix D

                                    CASE NARRATIVES


                           Case Narrative – Loan Number 221-4549952

Mortgage amount: $99,300
Date of loan closing: September 1, 2010
Status as of December 31, 2012: Reinstated after loss mitigation intervention
Payments before first default: 12
Total claim paid: Loss mitigation partial claim totaling $7,181
HUD loss: N/A

Underwriting Deficiencies:
x Credit report contained disputed items.

Summary:

Borrower’s Credit Report Contained Disputed Items
The borrower had a collection account that was in dispute. According to the Total Scorecard
Userguide that was in effect at the time of the origination and underwriting, “If the credit report
reveals that the borrower is disputing any credit accounts or public records, the mortgage
application must be referred to a direct endorsement underwriter for review.” 33 Therefore, the
file should have been manually underwritten. We performed additional analysis to determine
whether this loan met manual underwriting requirements. Since the loan was not manually
underwritten, Eustis Mortgage did not meet the following requirements, resulting in material
deficiencies:

Eustis Mortgage did not

x    Obtain a written explanation from the borrower for major indications of derogatory credit
     (collections) within the past 2 years. The loan file did not contain documentation showing
     Eustis Mortgage’s analysis of the basis for the derogatory debt (collections that were in
     dispute).
x    Obtain a written explanation regarding inquiries shown on the credit report in the last 90
     days.
x    Document compensating factors in the file justifying the excessive front-end qualifying ratio
     of 31.94 percent, which exceeded the FHA limit of 31 percent.
x    Obtain the 12-month rental or mortgage payment history.

33
     TOTAL Mortgage Scorecard User Guide, effective December 2004, Chapter 2, System Overrides and Manual
     Downgrades, Credit Issues, Disputed Accounts




                                                    28
                           Case Narrative – Loan Number 221-4642722

Mortgage amount: $131,577
Date of loan closing: March 2, 2011
Status as of December 31,, 2012: Foreclosure deed recorded
Payments before first default: One
Total claim paid: $0
HUD loss: N/A

Underwriting Deficiencies:
x Credit report contained disputed items.

Summary:

Borrower’s Credit Report Contained Disputed Items
The borrower had a collection account that was in dispute. According to the Total Scorecard
Userguide that was in effect at the time of the origination and underwriting, “If the credit report
reveals that the borrower is disputing any credit accounts or public records, the mortgage
application must be referred to a direct endorsement underwriter for review.” 34 Therefore, the
file should have been manually underwritten. We performed additional analysis to determine
whether this loan met manual underwriting requirements. Since the loan was not manually
underwritten Eustis Mortgage did not meet the following requirements, resulting in material
deficiencies:

Eustis Mortgage did not

x    Meet the traditional or alternative asset documentation requirements because there was no
     verification of deposit located in the file for both the borrower and coborrower. There were
     also no bank statements covering 3 consecutive months.
x    Obtain a written explanation from the borrower for major indications of derogatory credit
     (collections) within the past 2 years. The loan file did not contain documentation showing
     Eustis Mortgage’s analysis of the basis for the derogatory debt (collections that were in
     dispute).
x    Document compensating factors justifying the excessive front- and back-end qualifying
     ratios, which were 39.21 and 55.51 percent, respectively. These percentages exceeded the
     FHA front- and back-end limits of 31 and 43 percent, respectively.
x    Obtain the 12-month rental or mortgage payment history.




34
     TOTAL Mortgage Scorecard User Guide, effective December 2004, Chapter 2, System Overrides and Manual
     Downgrades, Credit Issues, Disputed Accounts




                                                    29
                           Case Narrative – Loan Number 221-4608968

Mortgage amount: $181,800
Date of loan closing: November 30, 2010
Status as of December 31, 2012: First legal action to commence foreclosure
Payments before first default: 14
Total claim paid: $0
HUD loss: N/A

Underwriting Deficiencies:
x Credit report contained disputed items.

Summary:

Borrower’s Credit Report Contained Disputed Items
The borrower had a collection account that was in dispute. According to the Total Scorecard
Userguide that was in effect at the time of the origination and underwriting, “If the credit report
reveals that the borrower is disputing any credit accounts or public records, the mortgage
application must be referred to a direct endorsement underwriter for review.” 35 Therefore, the
file should have been manually underwritten. We performed additional analysis to determine
whether this loan met manual underwriting requirements. Since the loan was not manually
underwritten, Eustis Mortgage did not meet the following requirements, resulting in material
deficiencies:

Eustis Mortgage did not

x    Obtain a written explanation from the borrower for inquiries shown on the credit report in the
     last 90 days.
x    Obtain a written explanation from the borrower for major indications of derogatory credit
     (collections) within the past 2 years. The loan file did not contain documentation showing
     Eustis Mortgage’s analysis of the basis for the derogatory debt (collections that were in
     dispute).
x    Document compensating factors in the file justifying the excessive front-end qualifying ratio,
     which was 38.7 percent. This percentage exceeded the FHA limit of 31 percent.




35
     TOTAL Mortgage Scorecard User Guide, effective December 2004, Chapter 2, System Overrides and Manual
     Downgrades, Credit Issues, Disputed Accounts




                                                    30
                          Case Narrative – Loan Number 221-4528193

Mortgage amount: $94,724
Date of loan closing: July 30, 2010
Status as of December 31, 2012: Type II special forbearance-trial payment plan
Payments before first default: 13
Total claim paid: $0
HUD loss: N/A

Underwriting Deficiencies:
x Credit report contained disputed items.
x Automated underwriting system report before closing was not provided.
x Gift letter did not include all required elements.

Summary:

Borrower’s Credit Report Contained Disputed Items
The borrower had a collection account that was in dispute. According to the Total Scorecard
Userguide that was in effect at the time of the origination and underwriting, “If the credit report
reveals that the borrower is disputing any credit accounts or public records, the mortgage
application must be referred to a direct endorsement underwriter for review.” 36 Therefore, the
file should have been manually underwritten. We performed additional analysis to determine
whether this loan met manual underwriting requirements. Since the loan was not manually
underwritten, Eustis Mortgage did not meet the following requirements, resulting in material
deficiencies:

Eustis Mortgage did not

x    Meet the traditional or alternative asset documentation requirement because there was no
     verification of deposit and the loan file contained a bank statement covering only 1 month,
     instead of the required 3 months. 37
x    Obtain a written explanation from the borrower for inquiries shown on the credit report in the
     last 90 days.
x    Obtain a written explanation from the borrower for major indications of derogatory credit
     (collections) within the past 2 years. The loan file did not contain documentation showing
     Eustis Mortgage’s analysis of the basis for the derogatory debt (collections that were in
     dispute).
x    Obtain a 12-month rental or mortgage payment history.


36
   TOTAL Mortgage Scorecard User Guide, effective December 2004, Chapter 2, System Overrides and Manual
   Downgrades, Credit Issues, Disputed Accounts
37
   HUD Handbook 4155.1, paragraph 1.B.2.c




                                                   31
Automated Underwriting System Report Before Closing Was Not Provided
Eustis Mortgage was unable to provide the automated underwriting system findings that
qualified the borrower at closing. Specifically, the automated underwriting system was run
August 4, 2010, but the closing date was July 30, 2010.

Gift Letter Did Not Include All Required Elements
The gift letter in the file and identified on the final uniform residential loan application did not
include the donor’s address and telephone number as required.




                                                  32