oversight

FHA Paid Claims for Approximately 4,457 Preforeclosure Sales That Did Not Meet Minimum Net Sales Proceeds Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2013-09-05.

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

OFFICE OF AUDIT
REGION 9
LOS ANGELES, CA




                  Office of Single Family Housing
                          Washington, DC

               FHA Preforeclosure Sales Program




2013-LA-0002                                    SEPTEMBER 5, 2013
                                                        Issue Date: September 5, 2013

                                                        Audit Report Number: 2013-LA-0002




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

               Monica A. Clarke
               Deputy Assistant Secretary for Finance and Budget (Acting), HW




FROM:          Tanya E. Schulze
               Regional Inspector General for Audit, Los Angeles Region, 9DGA


SUBJECT:       FHA Paid Claims for Approximately 4,457 Preforeclosure Sales That Did Not
               Meet Minimum Net Sales Proceeds 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 HUD’s oversight of Federal Housing
Administration (FHA) Preforeclosure Sales Program claims.

    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
213-894-8016.
                                         September 5, 2013
                                         FHA Paid Claims for Approximately 4,457
                                         Preforeclosure Sales That Did Not Meet Minimum Net
                                         Sales Proceeds Requirements



Highlights
Audit Report 2013-LA-0002


 What We Audited and Why                   What We Found

We audited the Federal Housing           Of 95 statistically selected claims paid from September
Administration (FHA) Preforeclosure      1, 2011, through November 30, 2012, 47 did not meet
Sales Program claim process. We          the minimum net sales proceeds criteria or were
initiated the nationwide audit in        approved based upon variances without a documented
accordance with our goal to contribute   justification. HUD paid ineligible preforeclosure sale
to improving the integrity of FHA        claims because it did not design adequate controls to
single-family insurance programs.        ensure that lenders complied with the minimum net
                                         sales proceeds requirements. HUD’s controls were
Our audit objective was to determine     inadequate to (1) correctly determine the required
whether the U.S. Department of           minimum proceeds amount, (2) ensure that variance
Housing and Urban Development            approvals were consistent with the program’s
(HUD) paid ineligible preforeclosure     objectives, (3) ensure the quality of appraisals used to
sale claims that did not meet the net    establish minimum net sales proceeds amounts, and (4)
sales proceeds requirements.             ensure the reliability of lender-provided claim data.

 What We Recommend                        By projecting our sample results, we estimate that
                                          HUD paid more than $404 million in claims for 4,457
                                          preforeclosure claims that did not meet the program
We recommend that the Deputy              requirements. Sales proceeds were deficient in these
Assistant Secretaries for Single Family cases by an estimated amount of $8.62 million. The
Housing and Finance and Budget            ultimate cost to the FHA insurance fund associated
develop and implement controls to         with the $404 million in ineligible claims is not known
ensure that preforeclosure claims         because loss amounts (if any) for each loan would have
comply with the program’s net sales       varied depending on how the loan default was
proceeds requirements, including          otherwise resolved if the program rules were followed.
procedures to (1) implement controls to At a minimum, claim losses would have been reduced
ensure that lenders comply with the       by the $8.62 million in deficient proceeds if HUD
preforeclosure program minimum sales required the appropriate proceeds amount based upon
proceeds requirements, (2) evaluate the documented competitive marketing periods.
reliability of lender-provided claim
data, (3) immediately discontinue the
practice of approving variance requests
without a valid documented
justification, and (4) implement controls
to evaluate the quality of preforeclosure
sale claim property valuations.
                             TABLE OF CONTENTS

Background and Objective                                                              3

Results of Audit

      Finding:     FHA Paid More Than $404 Million in Ineligible Claims for
                   Approximately 4,457 Preforeclosure Sale Claims That Did Not Meet
                   Minimum Net Sales Proceeds Requirements                            4

Scope and Methodology                                                                 11

Internal Controls                                                                     14

Appendixes
A.    Schedule of Funds To Be Put to Better Use                                       16
B.    Auditee Comments and OIG’s Evaluation                                           17
C.    Schedule of Deficiencies                                                        23
D.    Criteria                                                                        26




                                             2
                       BACKGROUND AND OBJECTIVE

The U.S. Department of Housing and Urban Development’s (HUD) Federal Housing
Administration (FHA) provides mortgage insurance on home loans made by its approved
lenders. This insurance is paid for by borrowers and provides lenders with protection against
losses if the homeowner defaults on the loan. Lenders may submit an insurance claim to HUD
for losses incurred if a property is foreclosed upon; however, the lender must first attempt to
work with the homeowner and consider options available as part of HUD’s loss mitigation
program, which can assist the borrower in bringing the loan current or allow the borrower to
dispose of the home without foreclosure. HUD’s single-family Preforeclosure Sales Program is
one option under HUD’s loss mitigation program.

The Preforeclosure Sales Program allows an FHA borrower in default (resulting from an adverse
and unavoidable financial situation) to sell his or her home at fair market value and use the sales
proceeds to satisfy the mortgage debt, even if the proceeds are less than the amount owed. This
program is appropriate for borrowers whose financial situation requires that they sell their home
but who are unable to do so without FHA relief because the gross recovery on the sale of the
property is less than the amount owed on the mortgage. After the property is sold, lenders
submit an FHA insurance claim and are compensated for the difference between the sales
proceeds and the amount owed on the mortgage (including accrued interest and reimbursable
costs). Lenders are required to ensure that the borrower and property meet the program
requirements specified in HUD Mortgagee Letter 2008-43, 1 Preforeclosure Sales Program –
Utilizing the Preforeclosure Sale Loss Mitigation Option to Assist Families Facing Foreclosure,
issued December 24, 2008. These criteria require lenders to ensure that a minimum proceeds
amount is obtained from the property sale based on the length of time a property was
competitively marketed for sale. The intent of this requirement was to limit HUD’s losses and
reduce the possibility of program abuse.

From September 1, 2011, through November 30, 2012, FHA paid 45,378 preforeclosure sale
claims totaling more than $4 billion. HUD’s Claims Branch administers the preforeclosure claim
process, and its Post Insurance Division conducts quality control reviews for a sample of claims
paid. HUD’s National Servicing Center administers a variance process that allows lenders to
request an exception to the program’s requirements.

Our audit objective was to determine whether HUD paid ineligible preforeclosure sale claims
that did not meet the net sales proceeds requirements.




1
    See appendix D.


                                                 3
                                        RESULTS OF AUDIT


Finding:            FHA Paid More Than $404 Million in Ineligible Claims for
                    Approximately 4,457 Preforeclosure Sale Claims That Did
                    Not Meet Minimum Net Sales Proceeds Requirements
HUD paid claims for approximately 4,457 ineligible preforeclosure sale claims totaling an
estimated $404 million2 that did not meet the program requirements or were approved based
upon variances without a documented justification. HUD paid ineligible preforeclosure sale
claims because its controls were not properly designed to (1) correctly determine required
minimum sales proceeds amounts, (2) ensure that variance approvals were consistent with the
program objectives, (3) ensure the quality of appraisals used to establish the minimum sales
proceeds amounts, and (4) ensure the reliability of lender-provided claim data. As a result, the
FHA insurance fund incurred and remained at risk for unnecessary losses.



    HUD Did Not Correctly
    Determine Required Minimum
    Sales Proceeds Amounts

                    FHA paid preforeclosure sale claims that did not meet the sales proceeds criteria
                    and were, therefore, not eligible in accordance with the program requirements.
                    We reviewed a statistical sample of 95 preforeclosure sale claims paid from
                    September 1, 2011, through November 30, 2012, to determine whether the claims
                    met HUD’s minimum sales proceeds requirements. Of the 95 files reviewed, 35,
                    or 37 percent, did not meet the program’s net proceeds criteria based upon the
                    actual competitive marketing period under the program and were, therefore, not
                    eligible.

                    Calculation of Net Sales Proceeds
                    HUD’s automated claim processing system and postclaim quality control review
                    process did not correctly calculate or verify required minimum preforeclosure
                    sales proceeds amounts. HUD Mortgagee Letter 2008-43 stated that the
                    minimum required proceeds amount for preforeclosure sales was based on the
                    length of time a property was competitively marketed for sale. For the first 30
                    days of marketing under the program, lenders were permitted to approve only
                    offers that would result in sales proceeds totaling at least 88 percent of a
                    property’s appraised value. For the next 30 days of competitive marketing,
                    required proceeds were 86 percent of the appraised value, and thereafter, required
                    proceeds were 84 percent of the appraised value. HUD implemented these

2
    See Scope and Methodology for details of our projections.


                                                          4
                 requirements, in part, as a result of a prior Office of Inspector General (OIG) audit
                 (audit report number 2005-LA-0001), which found that investors had abused the
                 preforeclosure program and obtained properties below fair market value. By
                 limiting property sale amounts based upon how long properties were actively
                 marketed, for example, through an active listing with a real estate agent, these
                 rules could limit HUD’s program losses by reducing the risk of program abuse
                 and increasing the likelihood that preforeclosure property sales would occur at or
                 near fair market value as intended.

                 Incorrect Net Sales Proceeds
                 HUD’s claim payment system and postclaim review process did not include
                 controls to properly enforce the minimum sales proceeds requirements. HUD did
                 not accurately determine how long properties were competitively marketed for
                 sale and, accordingly, which of the minimum sales proceeds percentage
                 requirements was applicable. Without consideration for the actual competitive
                 marketing period, HUD calculated the minimum required proceeds based upon
                 the number of days elapsed from the borrower’s acceptance into the
                 preforeclosure program to the property sale closing date. This calculation was not
                 consistent with the mortgagee letter requirements or the intent of these
                 requirements because it often overestimated the actual marketing period under the
                 program. The following diagram represents, in general terms, the difference
                 between the actual competitive marketing period under the program and the
                 calculation used by HUD.




                 For example, for 1 3 of the 95 sample claims reviewed, the borrower executed a
                 sales contract before entering the program and therefore, marketed the property
                 for zero days under the program; however, HUD incorrectly calculated the
                 marketing period as 170 days because the closing did not occur until months later.
                 Based on the actual marketing period under the program (less than 30 days),
                 required sale proceeds should have been 88 percent of the appraisal value, yet
                 HUD paid the claim with proceeds totaling only 84 percent.

                 HUD used incorrect dates to calculate the sales proceeds requirements because it
                 did not properly design controls to enforce the program requirements. HUD’s

3
    Loan 095-5849645


                                                   5
           automated claim processing system did not collect information necessary to
           determine how long properties were marketed. For example, the automated claim
           system did not track when properties were listed for sale, when sales contracts
           were signed, or when borrowers otherwise ceased accepting competitive offers.
           Additionally, HUD’s postclaim review process did not include an evaluation of
           claim file information, such as listing broker documentation, to determine the
           actual competitive marketing period.

           An official from HUD’s National Servicing Center stated that lenders were
           advised of HUD’s sales proceeds calculation methodology, which relied on
           borrower approval and sale closing dates. Because this calculation did not
           consider the actual competitive marketing period, the program’s sales proceeds
           requirement could easily be circumvented by scheduling closing dates to
           accommodate HUD’s enforcement policy.

HUD’s Controls Over
Preforeclosure Claim Variances
Were Not Adequate

           FHA paid preforeclosure sale claims based on variances that were not adequately
           documented. Our review of 95 statistically selected preforeclosure sale claims
           paid from September 1, 2011, through November 30, 2012, found that 12, or 12.6
           percent, of these property sales were approved based upon an unjustified variance.
           Five of these twelve claims involved an exception to the program’s partial claim
           requirements.

           Variance Process
           HUD administers a variance process that allows lenders to request an exception to
           the preforeclosure program requirements based upon a valid justification.
           Variance requests can include minor items such as appraisal expiration date
           extensions or more significant exceptions that result in substantially higher claim
           amounts than permitted under the program requirements. Variances are submitted
           electronically and documented through HUD’s Extension and Variance
           Automated Requests System (EVARS) and employees at HUD’s National
           Servicing Center are responsible for reviewing these requests. EVARS includes a
           field for documenting HUD’s approval or denial of variance requests and a field
           for documenting comments made by the HUD reviewer regarding the review
           decision. Based upon variance data provided by HUD’s National Servicing
           Center, HUD approved 1 or more variance requests for 27,455 (60.5 percent) of
           the 45,378 of the preforeclosure claims paid during our audit period from
           September 1, 2011, through November 30, 2012.

           Inadequate Variance Controls
           HUD did not have adequate controls to ensure that variance approvals were
           consistent with the program objectives. HUD’s variance request form required
           lenders to provide a written justification documenting the reason an exception to


                                            6
                 the program requirements was appropriate. However, HUD did not always
                 require a specific justification when approving variance requests for insufficient
                 net sales proceeds, particularly those involving partial claim notes due to HUD.
                 Mortgagee Letter 2008-43 required that the outstanding balance on a partial claim
                 note (unpaid subordinate mortgage) be deducted when calculating the required
                 minimum net sales proceeds. However, as a practice, HUD approved lender
                 variance requests to exclude partial claim amounts from the net proceeds
                 calculation without requiring a specific justification 4 documenting the basis for
                 excluding the partial claim. For net sales proceeds variances without a
                 documented justification, including those involving partial claims, EVARS also
                 did not document the basis for HUD’s approval decision or demonstrate that the
                 approval was consistent with the program objectives.

                 For example, HUD approved sales proceeds variance requests based on the
                 justifications below, which stated only “approval to pay partial claim in the
                 amount of $10,073.15” and “please review to accept $137,598 min net proceeds.”
                 These variance requests indicated that the program requirements were not met yet
                 did not explain why an exception should be made. In these cases, the variance
                 form did not document the basis for HUD’s variance approval decision or
                 demonstrate that the approval was consistent with the program objectives.

                                                            Example 1




                                                            Example 2




                 This condition occurred because HUD did not design adequate controls such as
                 written procedures or criteria that could be systematically applied to ensure that
                 variance approvals were consistent with the program objectives and adequately
                 documented to support variance review decisions. Without these controls, HUD
                 did not have sufficient information available for management or audit review to
                 determine whether the granted variances were appropriate. Additionally, HUD
                 did not have adequate assurance that the variance process appropriately limited
                 program losses and restricted opportunities for program fraud or abuse.




4
 HUD’s National Servicing Center stated that variances involving partial claims were approved for loans that would
otherwise meet the minimum proceeds requirements but for the partial claim amount.


                                                        7
    Estimated Ineligible and
    Excessive Claims Totaled at
    Least $404 Million

                 By projecting our sample results, including 35 claims that did not meet the
                 minimum sales proceeds criteria and 12 that were approved based upon
                 unjustified variances, to the universe of 11,063 claims, 5 we estimated that FHA
                 paid at least $404 million in claims for 4,457 preforeclosure sale claims with
                 insufficient sales proceeds during our audit period. Net sales proceeds were
                 deficient in these cases by an estimated amount of $8.62 million.6

    HUD’s Controls Over
    Preforeclosure Property
    Valuations Were Not Adequate

                 HUD did not have adequate controls in place over preforeclosure sale claim
                 appraisals used to determine required minimum preforeclosure sales proceeds
                 amounts. Mortgagee Letter 2008-43 required that lenders obtain an appraisal to
                 ensure that preforeclosure program properties were sold at or near fair market
                 value. It also stated that HUD performs appraisal monitoring reviews, subject to
                 the imposition of sanctions for appraisal deficiencies that do not meet HUD’s
                 requirements.

                 HUD did not implement controls to enforce the program’s appraisal requirements
                 and ensure the quality of appraisals used to establish the minimum proceeds
                 amounts. After a HUD OIG audit issued in 2005 (audit report number 2005-LA-
                 0001) found that HUD lacked controls over preforeclosure program appraisals,
                 HUD implemented an appraisal review process that was administered by a
                 contractor. However, in approximately 2007, HUD discontinued the appraisal
                 review contract and did not implement a similar control. Because HUD did not
                 have controls for evaluating the quality and reliability of appraisals, it did not
                 have appropriate assurance that preforeclosure program property valuations were
                 appropriate. Accordingly, HUD’s risk of losses associated with improper
                 valuations increased.

                 Because the scope of our audit did not include a complete review of property
                 appraisals and data were not available to estimate appraisal deficiencies, our audit
                 results do not include an estimate of the potential impact of this control
                 deficiency. We recommend that HUD evaluate the risk associated with
                 unchecked appraisals and implement appropriate controls sufficient to ensure that
                 preforeclosure program property valuations are appropriate. HUD officials stated

5
  See Scope and Methodology for details of our projections.
6
  OIG typically reports estimated cost savings for a one year period. The $8.62 million in deficient proceeds
identified is based on the audit sample, which covered a 15 month period, was proportionally adjusted to $6.9
million, reflecting the estimated savings for a 12 month period. See appendix A.


                                                         8
             that they had preliminary plans to develop a new method for estimating
             preforeclosure property values that, if designed and implemented effectively,
             could address this deficiency.

HUD’s Controls Over Claim
Submission Data Reliability
Needs Improvement

             HUD’s automated claim processing system did not include controls to verify the
             reasonableness of lender claim form entries pertinent to the minimum required
             sales proceeds calculation. For example, HUD did not have system edits to
             identify an appraisal value entry error of $20,000 instead of $200,000. As a
             result, it did not have appropriate assurance that claim amounts were properly
             determined based upon accurate information. We reviewed a targeted,
             nonrepresentative sample of 25 preforeclosure claims paid during the audit period
             from September 1, 2011, through November 30, 2012, to determine whether dates
             or amounts related to HUD’s minimum sales proceeds calculation were correctly
             reported. The samples selected for review exhibited unusual claim form dates or
             amounts. Of the 25 sample claims, 17 were paid despite reported values that
             appeared unreasonable. The errors identified through the audit testing resulted
             primarily in apparent claim underpayments; however, the identified control
             deficiency may have resulted in excessive or ineligible claims that were not
             identified by our limited testing. The results demonstrate that HUD’s claim
             payment system did not include basic application controls to validate the
             reasonableness of claim form values pertinent to the minimum sales proceeds
             calculation, a key factor in determining claim eligibility and amounts.

Conclusion

             FHA paid approximately 4,457 ineligible preforeclosure sale claims totaling an
             estimated $404 million that did not meet the program requirements or were
             approved based upon variances without a documented justification. This
             condition occurred because HUD did not design program controls to ensure
             compliance with program requirements. HUD needs to strengthen its controls to
             ensure that the program objectives are met and that it pays only eligible
             preforeclosure sale claims that met the sales proceeds requirements.




                                              9
    Recommendations

                 We recommend that the HUD Deputy Assistant Secretaries for Single Family
                 Housing and Finance and Budget 7

                 1A.      Design and implement controls to ensure that lenders comply with the
                          preforeclosure program minimum sales proceeds requirements to put
                          $6,898,518 8 to better use. These controls should include procedures to
                          correctly determine the competitive marketing period in accordance with
                          Mortgagee Letter 2008-43 and ensure that variance requests are evaluated
                          and approved only with a valid documented justification.

                 1B.      Evaluate the risk associated with HUD’s claim system controls over data
                          reasonableness and consider additional measures to address this risk.
                          HUD should consider implementing an application system control to
                          identify unreasonable claim form entries pertinent to the minimum sales
                          proceeds calculation.

                 We also recommend that the HUD Deputy Assistant Secretary for Single Family
                 Housing

                 1C.      Immediately discontinue the practice of approving variance requests
                          without a valid documented justification.

                 1D.      Design and implement controls to evaluate the quality of preforeclosure
                          sale claim property valuations and detect or prevent possible program
                          abuse involving undervaluation.




7
  The recommendations do not specifically follow the order in which the deficiencies appear in the audit report to
better address the recommendations to the appropriate action officials.
8
  The $8.62 million in deficient proceeds identified is based on the audit sample, which covered a 15 month period,
was proportionally adjusted to $6.9 million, reflecting the estimated savings for a 12 month period. See appendix A.


                                                        10
                            SCOPE AND METHODOLOGY

We performed our audit work between November 2012 and July 2013. We conducted audit
fieldwork at the Phoenix Office of Audit. The audit generally covered HUD’s procedures in
place for preforeclosure claims paid from September 1, 2011, through November 30, 2012. To
accomplish our audit objective, we

    •   Interviewed HUD officials from HUD’s Office of Single Family Housing, Claims
        Branch, Post Insurance Division, and National Servicing Center.

    •   Reviewed Preforeclosure Sales Program records maintained by HUD.

    •   Obtained and reviewed preforeclosure sale claim data from HUD’s Single Family Data
        Warehouse.

    •   Evaluated HUD’s controls over Preforeclosure Sales Program requirements to determine
        whether ineligible or excessive claims may have been paid.

    •   Reviewed a targeted, nonrepresentative sample of 25 preforeclosure claims paid during
        the audit period from September 1, 2011, through November 30, 2012, to determine
        whether dates or amounts related to the HUD’s net sales proceeds calculation were
        correctly reported.

    •   Selected and reviewed a statistical sample of 95 preforeclosure claims paid from
        September 1, 2011, through November 30, 2012, to determine whether the claims met
        HUD’s minimum sales proceeds requirements.

From September 1, 2011, through November 30, 2012, HUD paid 45,378 preforeclosure sale
claims totaling more than $4.0 billion.9 The nine lenders with the highest volume of
preforeclosure sales submitted more than 87 percent of these claims. When designing the audit
statistical sample, we limited the sample universe to these top nine lenders. We included only
claims that had a reported net sales proceeds amount that was less than 88 percent of the reported
appraisal value and claims reporting that more than 30 days elapsed between the borrowers’
program participation approval date and closing date. The audit universe for the statistical
sample included 11,063 claims totaling more than $1 billion. We relied in part on data
maintained by HUD in its Single Family Data Warehouse database to identify preforeclosure
claims paid during our audit period and the associated claim amounts. Although we did not
perform a detailed assessment of the reliability of the data, we determined that the computer-
processed data were sufficiently reliable for our purposes. The HUD system data for the
sampled items were validated by reviewing documents supplied by the sampled lenders.


9
 We did not select claims before September 1, 2011, for our sample universe because a recent HUD OIG audit,
audit report number 2012-KC-0004, included statistical sample testing to evaluate preforeclosure sale claim
borrower eligibility for this period.


                                                      11
A stratified systematic sample of 95 claims was identified for auditing among 14 strata of the
audit universe. Additionally, to control for the possibility that preforeclosure sale claims were
adversely affected differently across real estate markets, each claim was assigned a real estate
market change indicator, and within each of the 14 strata, a sort was performed on this indicator.
The sample design was stratified as shown in the table below.

                                           Strata design

                         Preforeclosure   Sampling     Probability of
               Strata                                                   Sampling weight
                             claims         size         selection

              Group 1a        281            2           0.007117           140.50
              Group 1b        303            3           0.009901           101.00
              Group 2a        881            8           0.009081           110.13
              Group 2b        876            7           0.007991           125.14
              Group 2c        879            7           0.007964           125.57
              Group 2d        875            7           0.008000           125.00
              Group 2e        882            8           0.009070           110.25
              Group 3a        515            4           0.007767           128.75
              Group 3b        524            4           0.007634           131.00
              Group 4a       1,006           9           0.008946           111.78
              Group 4b       1,015           9           0.008867           112.78
              Group 4c       1,009           9           0.008920           112.11
              Group 4d       1,007           9           0.008937           111.89
              Group 4e       1,010           9           0.008911           112.22

                Total       11,063           95            N/A               N/A


We reviewed the statistical sample of preforeclosure sale case files to evaluate whether the
claims met the preforeclosure program net sales proceeds criteria. Marketing periods for the
preforeclosure program were determined based on documentation provided by the associated
lenders. The marketing period start date was determined as the first day the property was listed
for sale after the borrower was approved for participation in the preforeclosure program. The
competitive marketing period end date was determined based upon the date the ultimate buyer
and seller executed a sale contract, unless the sale contract specified that competitive offers
could be accepted after the contract date or there was evidence provided indicating that
competitive marketing continued after the contract date. It is possible that some form of
marketing could have occurred after the sale contract date in some cases, however, for the noted
exceptions, there was no evidence such as additional offers or real estate broker documentation
to support that this occurred. We calculated the net sales proceeds deficiency amounts by
subtracting the actual net proceeds from the appropriate percentage (84,86 or 88 percent) of the
appraised value, based upon the actual marketing period duration. There were four spares used,
and they were taken from their respective strata. Hence, no sampling weights had to be
recalculated. The preforeclosure claims that did not meet the program requirements were
documented by the amount of claim that was overpaid based on the program requirement that


                                                  12
was not met, either by the amount of deficient proceeds based on the correct marketing time or
by the amount of deficient proceeds based on inadequate variance approvals by HUD.

Our sample was designed using stratification to ensure that the minor differences observed in the
marketing timeframe and unjustified variances were detectable and projectable. Since our
method of stratification tended to capture the changes unique to local market value, our sample
design also had a meaningful ability to control for the variability inherent in the claim amount
paid by FHA. Hence, our sample design gave us an acceptably precise projection of the total
claims amount attributable to loans with these defects. Additional testing was conducted on this
premise, and it was found that this sample design conformed to the stated confidence intervals
and did not carry the unnecessary risk of a spurious error.

       Universe projection:    $15,714,919.91 – 1.664 ⨉ $4,262,179.31 = $8,623,148.32
       Claims affected:         5,404.49 – 1.664 ⨉ 569.27= 4,457.3
       Total claim projection: $503,316,952.40 – 1.664 ⨉ $59,575,724.32 = $404,189,863.10

The projection amounts were computed based on the sampling results and extended to the
population. Based on this computation, we found that 47 of 95 statistically selected claims paid
did not meet the minimum net sales proceeds criteria (35) or were approved based upon
variances without a documented justification (12). This amounts to an average of $1,420 per
claim paid. Deducting for statistical variance to accommodate the uncertainties inherent to
statistical sampling, we can say, with a one-sided confidence interval of 95 percent, that the
average amount per claim was $779. Extrapolating this to the 11,063 preforeclosure claims in
the audit universe, we can say at least $8.62 million in funds was paid on claims that did not
meet program requirements, and it could be more. Additionally, this defect was found across
many preforeclosure claims, and we can also say, with a one-sided confidence interval of 95
percent, that at least 4,457 claims in our universe were affected valued at $404 million, and it
could be more. The $8.62 million in deficient proceeds identified is based on the audit sample,
which covered a 15 month period, was proportionally adjusted to $6.9 million, reflecting the
estimated savings for a 12 month period (see appendix A).

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




                                               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

   •   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:

                  •   Controls over minimum net sales proceeds requirements.
                  •   Controls over variance evaluations and approvals.
                  •   Controls over property valuations.
                  •   Controls over data reliability and reasonableness.

               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 Deficiencies

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

                  •   HUD did not have adequate controls to ensure that preforeclosure claims met
                      the program’s minimum sales proceeds requirements (finding).
                  •   HUD did not have adequate controls to ensure that preforeclosure sale claim
                      variances were adequately evaluated and approved (finding).



                                                 14
•   HUD did not have adequate controls to ensure the quality of preforeclosure
    sale claim property valuations and detect or prevent possible program abuse
    involving undervaluation (finding).
•   HUD did not have adequate controls to ensure data reliability and
    reasonableness (finding).




                             15
                                    APPENDIXES

Appendix A

     SCHEDULE OF FUNDS TO BE PUT TO BETTER USE

               Recommendation                              Funds to be put to
                   number                                    better use 1/
                     1A                                       $6,898,518

                                                               $6,898,518


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.

     Funds to be put to better use for recommendation 1A represent the amount of deficient
     net sales proceeds found based upon the statistical sample results. In this instance, if
     HUD implements our recommendations, it will ensure that preforeclosure sale claims are
     paid only for eligible sales that meet the sales proceeds requirements, and it will prevent
     payment of future ineligible claims. Our estimate reflects only the initial year of this
     benefit. The $8,623,148 amount of deficient proceeds identified based on the audit
     sample, which covered a 15 month period, was proportionally adjusted to reflect the
     estimated savings for a 12 month period.

            Monthly deficient proceeds: $8,623,148 ÷ 15 months = $574,876.53
            12 month estimate:          $574,876.53 × 12 months = $6,898,518.40

     Also, although we determined that the claim amounts paid were ineligible because the
     claims did not meet the program requirements, to be conservative, we estimated the
     future savings based only on the portion of the ineligible claim associated with the
     amount of deficient sales proceeds. For example, if an $80,000 ineligible claim paid had
     net sales proceeds that were deficient by $250, our estimate projects a savings based only
     on $250. The estimated amount does not include potential offsetting costs incurred by
     HUD to implement our recommendations to strengthen controls.




                                             16
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




                         17
Comment 3




Comment 4



Comment 5




Comment 6




            18
Comment 6




            19
                         OIG Evaluation of Auditee Comments

Comment 1   HUD stated it will reevaluate its minimum net sales proceeds criteria and utilize
            its Quality Assurance Division to review a sample of preforeclosure claims to
            ensure the minimum net sales proceeds requirements were met.

            HUD’s intention to implement additional controls over preforeclosure claims is
            consistent with OIG audit report recommendation 1A. However, we note that any
            planned corrective actions should be sufficient to ensure that lenders correctly
            determine preforeclosure competitive marketing periods in accordance with
            Mortgagee Letter 2008-43. As noted in the audit report, HUD’s automated claim
            processing system (Single Family Claim’s system) and post-claim quality control
            review process did not correctly calculate or verify required minimum
            preforeclosure sales proceeds amounts. Additionally, HUD advised lenders of its
            net sales proceeds calculation methodology that did not consider the actual
            competitive marketing period. HUD should design controls to directly address
            these deficiencies.

Comment 2   With respect to approval of variance requests, HUD appeared to disagree with the
            audit report and stated it evaluates and approves variance requests to meet its
            existing criteria delineated in instructions provided to the OIG.

            As stated in the audit report, we found HUD did not design adequate controls
            such as written procedures or criteria that could be systematically applied to
            ensure that variance approvals were consistent with the program objectives and
            adequately documented to support variance review decisions. During the audit,
            the Director of Servicing and Loss Mitigation at HUD’s National Servicing
            Center, who also reviewed variance requests, indicated he was not immediately
            familiar with any review criteria or guidance other than Mortgagee 2008-43
            which does not include criteria or review procedures for the variance process. He
            later provided a one page document that listed six factors that could cause a sale
            to result in low net sales proceeds. For example, the document listed “States with
            large property taxes” and “payment of a partial claim”. The document did not
            establish appropriate standards, thresholds or documentation requirements for the
            variance review process. Furthermore, we note that our review of 95 statistically
            selected preforeclosure sale claims found that 12, or 12.6 percent, of these
            property sales were approved based upon variances without a documented
            justification.




                                            20
Comment 3   HUD did not disagree with the audit report recommendation 1B and stated it will
            evaluate the risk associated with HUD’s claim system controls over data
            reasonableness and consider additional measures to address the risk. This
            response indicates agreement with OIG audit report recommendation 1B and
            therefore we concur with this response.

Comment 4   HUD stated it only approves variance requests that meet criteria delineated in
            instructions that were provided to OIG, yet will “expand its instructions” based on
            the OIG audit recommendation.

            We agree that additional procedures are needed to provide adequate controls over
            the variance process. However, as explained above in comment 2 and the audit
            report, HUD did not design adequate controls such as written procedures or
            criteria that could be systematically applied to ensure that variance approvals
            were consistent with the program objectives and adequately documented to
            support variance review decisions. During the audit, the Director Servicing and
            Loss Mitigation at HUD’s National Servicing Center was not immediately
            familiar with any additional review process guidance and the referenced
            document later provided did not include criteria or documentation requirements
            for the variance review process.

Comment 5   HUD noted that partial claim amounts have increased due to recent loss
            mitigation program changes and that this has led to more variance requests within
            the preforeclosure program. HUD also noted that limiting or reducing variance
            approvals has a negative impact on the Mutual Mortgage Insurance Fund.

            As explained in the OIG audit report finding, HUDs decision to routinely provide
            variances excluding partial claims amounts from the preforeclosure program net
            sales proceeds calculation was not consistent with the program requirements
            specified in Mortgagee Letter 2008-43 which require that such amounts be
            deducted. Regarding HUD’s assertion that limiting variance approvals results in
            increased losses, we note that, in our opinion, removing certain restrictions for
            partial claim amounts could encourage abuse of the partial claim program and
            provides additional incentives for borrowers to take advantage of the claim
            process rather than seek alternatives that could be far less costly to HUD. While
            preforeclosure claim losses may be slightly lower overall relative to conveyance
            claims due to various factors, such as limiting participation to properties that have
            not been abandoned etc…, this does not necessarily mean that reducing existing
            preforeclosure program restrictions will result in lower total losses.

Comment 6   HUD stated that FHA recently implemented controls over preforeclosure property
            valuations that require lenders to obtain a broker price opinion or automated
            valuation estimate and obtain HUD approval if these secondary valuations
            indicate a value outside certain thresholds. HUD also stated its Quality Assurance
            Division will review a sample of preforeclosure sale transactions and utilize




                                             21
automated valuation models and broker price opinions to help validate the
accuracy of appraisals.

We agree that additional controls over preforeclosure claim valuations are
necessary. We note that any planned corrective actions should be sufficient to
provide adequate assurance that preforeclosure valuations are being performed
and documented in accordance with the program requirements and to detect and
prevent possible program abuse involving undervaluation. For example, the
appraisal reviewers should have adequate proficiency to determine compliance
with the preforeclosure program appraisal requirements specified in HUD
Handbook 4150.2 (Valuation Analysis for Single Family One-to Four-Unit
Dwellings). These reviews should be performed on an adequate number of
preforeclosure claims and provide a sufficient basis to hold mortgagees
accountable for the quality of appraisals. Additionally, the appraisal review
results should be adequately documented and reviewed by management to
evaluate overall appraisal compliance for the program.




                                22
 Appendix C

                       SCHEDULE OF DEFICIENCIES


                                             Ineligible claims
          Ineligible claims
Sample                                           based on            Excessive
         based on program       Excessive                                             Total claim
 item                                          inadequate              claim
             marketing        claim amount                                             amount
number                                           variance             amount
              duration
                                                approvals
  1              X            $   1,360.00                       $            -   $      81,893.85
  2                                      -                                    -          83,363.54
  3              X                1,147.92                                    -          77,290.39
  4                                      -          X                  3,115.51         162,764.70
  5              X                8,520.00                                    -          43,816.06
  6                                      -                                    -         116,713.49
  7                                      -                                    -          83,358.19
  8              X                  987.70                                    -          61,662.73
  9                                      -          X                  3,739.72         125,222.44
  10             X                  226.40                                    -          17,834.83
  11             X                  389.28                                    -         139,367.36
  12                                     -                                    -         108,315.66
  13                                     -                                    -         134,518.92
  14                                     -                                    -          94,373.91
  15                                     -                                    -         261,097.56
  16                                     -                                    -         128,582.41
  17                                     -                                    -          73,870.08
  18                                     -                                    -         154,011.00
  19                                     -                                    -          80,755.87
  20                                     -          X                  4,950.72          82,648.80
  21                                     -                                    -         114,101.12
  22                                     -                                    -          61,750.37
  23                                     -                                    -         208,945.39
  24                                     -                                    -         144,130.88
  25                                     -                                    -          69,140.16
  26                                     -          X                  2,517.28         102,241.20
  27                                     -                                    -         130,537.46
  28                                     -                                    -          22,900.12
  29                                     -                                    -          69,920.00
  30                                     -          X                  1,707.85         102,360.96
  31                                     -                                    -          25,459.77



                                             23
                                             Ineligible claims
          Ineligible claims
Sample                                           based on        Excessive
         based on program       Excessive                                     Total claim
 item                                          inadequate          claim
             marketing        claim amount                                     amount
number                                           variance         amount
              duration
                                                approvals
  32             X                   714.4                                -     200,660.97
  33             X                  274.65                                -      54,024.41
  34             X                  790.20                                -      82,032.30
  35             X                1,841.53                                -     155,955.32
  36                                     -                                -     105,410.40
  37             X                1,103.40                                -      54,264.17
  38             X                1,918.73                                -     141,564.03
  39                                     -                                -     205,316.35
  40             X                  498.31                                -     148,732.67
  41                                     -                                -     103,658.60
  42             X                1,367.00                                -      95,704.40
  43                                     -                                -     108,545.67
  44             X                  281.38                                -     116,784.40
  45                                     -                                -     121,703.69
  46                                     -          X              1,394.20      79,382.34
  47                                     -                                -     132,512.64
  48                                     -                                -      45,623.52
  49             X                1,120.00                                -      97,555.29
  50                                     -                                -      53,498.02
  51                                     -                                -      52,285.76
  52             X                  886.92                                -      81,014.86
  53                                     -                                -     131,821.28
  54             X                  856.69                                -     128,088.61
  55             X                  685.63                                -      53,663.03
  56             X                  434.80                                -      72,152.29
  57             X                  631.97                                -     103,145.23
  58                                     -                                -     121,417.40
  59                                     -          X              5,761.21     149,670.38
  60             X                  401.62                                -      95,382.47
  61                                     -          X             10,169.32      46,481.99
  62             X                  580.83                                -      85,564.70
  63             X                2,600.00                                -      55,757.08
  64                                     -          X              6,997.75     116,511.66
  65                                     -                                -      84,571.12
  66                                     -                                -      30,509.27
  67             X                3,287.15                                -      89,054.91



                                             24
                                              Ineligible claims
          Ineligible claims
Sample                                            based on            Excessive
         based on program       Excessive                                           Total claim
 item                                           inadequate              claim
             marketing        claim amount                                           amount
number                                            variance             amount
              duration
                                                 approvals
  68                                      -          X               3,963.30           52,031.77
  69                                      -                                 -          217,240.99
  70                                      -                                 -           23,499.95
  71                                      -                                 -          129,590.59
  72                                      -                                 -           61,339.42
  73                                      -                                 -          207,286.86
  74             X                 1,810.95                                 -           47,162.76
  75             X                 1,643.15                                 -           48,100.62
  76             X                 3,192.21                                 -          125,878.02
  77                                      -          X               4,975.18          163,550.76
  78                                      -                                 -           48,220.37
  79                                      -          X              30,800.00           95,364.61
  80                                      -                                 -           71,377.81
  81                                      -                                 -           25,195.24
  82             X                 1,700.00                                 -          108,833.84
  83                                      -                                 -           90,002.80
  84                                      -                                 -           44,604.57
  85                                      -                                 -           55,126.74
  86             X                   250.15                                 -          161,930.73
  87             X                 2,607.88                                 -           72,272.13
  88             X                    45.18                                 -           33,050.34
  89             X                 1,349.90                                 -           30,557.38
  90             X                 2,853.18                                 -          124,184.04
  91             X                 2,440.00                                 -           30,280.66
  92                                      -                                 -          131,082.36
  93                                      -                                 -           27,119.83
  94                                      -                                 -           28,980.40
  95                          $           -                       $         - $        126,841.86
Totals          35            $   50,799.11          12           $    80,092.04   $ 9,143,677.90




                                              25
Appendix D

                                        CRITERIA

Mortgagee Letter 2008-43: Preforeclosure Sale Program – Utilizing the PFS Loss
                          Mitigation Option to Assist Families Facing Foreclosure

Preforeclosure Sale Introduction

The Pre-Foreclosure Sale (PFS) option allows mortgagors in default (resulting from an adverse
and unavoidable financial situation) to sell their home at FMV [fair market value] and use the
sales proceeds to satisfy the mortgage debt even if the proceeds are less than the amount owed.
This option is appropriate for mortgagors whose financial situation requires that they sell their
home, but they are unable to do so without FHA relief because the gross recovery on the sale of
their property (i.e., sales price minus sales expenses) is less than the amount owed on the
mortgage. HUD’s home retention alternatives such as Special Forbearance, Mortgage
Modification, or Partial Claim must first be considered and determined unlikely to succeed due
to the mortgagor’s financial situation. Mortgagees must maintain supporting documentation to
demonstrate that a comprehensive review of the mortgagor’s financial records was completed,
and that the mortgagor did not have sufficient income to sustain the mortgage. Under no
circumstances shall the PFS option be made available to mortgagors who have abandoned their
mortgage obligation despite their continued ability to pay.

To participate in the program, mortgagors must be willing to make a commitment to actively
market their property for a period of 3 months, during which time the mortgagee delays
foreclosure action. Mortgagors who successfully sell to a third party within the required time
may receive a cash consideration of up to $1,000. Mortgagees also receive a $1,000 incentive
for successfully avoiding the foreclosure and complying with all the requirements of this ML
[mortgagee letter]. If the property does not sell, mortgagors are encouraged to use the deed-in-
lieu of foreclosure (DIL) option, providing the title on the property is marketable. By following
procedures and time frames included in this ML, a mortgagee may submit a FHA insurance
claim and be compensated for the difference between the sales proceeds and the amount owed on
the mortgage (including accrued interest and reimbursable costs).

A PFS sale must be an outright sale of the property. If a foreclosure occurs after the mortgagor
unsuccessfully participated in the PFS process in good faith, neither the mortgagee nor HUD will
pursue the mortgagor for a deficiency judgment.

E. Property Value

Properties offered for sale through the PFS Program are to be listed at no less than the “As Is”
value as determined by an appraisal completed in accordance with the requirements of HUD
Handbook 4150.2 (Valuation Analysis for Single Family One-to Four-Unit Dwellings). To this
end, mortgagees must:



                                                26
   •   Obtain a standard electronically-formatted appraisal from an appraiser on FHA’s
       Appraiser Roster. The selected appraiser must not share any business interest with the
       mortgagor or the mortgagor’s agent. Appraisals obtained by the buyer, seller, real estate
       agent, or other interested parties may not be used to establish the FMV of the property for
       the PFS Program. It also important to note that:

           1. The appraisal must contain an “as-is” FMV for the subject property;
           2. The appraisal will be valid for six months; and
           3. Distress sales may not be used by the appraiser to establish comparable values
              unless they represent the only comparables within reasonable proximity of the
              subject property.

       •   Provide a copy of the appraisal to the homeowner, sales agent, or HUD, upon request.

       •   Mortgagees are reminded that in accordance with HUD regulations at 24 CFR [Code
           of Federal Regulations] Part § 203.365 (c) they are responsible for the accuracy of all
           documentation used in the PFS decision, including accurate and complete appraisal
           information.

In an effort to ensure that the most current FMV is used for the PFS, a mortgagee may obtain a
new FHA appraisal, even if the property was appraised by an FHA Roster Appraiser within the
preceding 6 months. To be reimbursed through HUD’s claim filing process, the cost of the
appraisal must be reasonable and customary for the market area where the appraisal is
performed. The appraisal must be retained in the claim/servicing file, even if the PFS is not
approved or completed.

H. Approval to Participate

After determining that a mortgagor and property meet the participation requirements herein, the
mortgagee must notify the mortgagor using Form HUD-90045 (Approval to Participate). The
form shall include the date by which the mortgagor’s sales contract must be executed.

J. Contract Approval

The mortgagee must determine if the property was marketed at the gross offering price (close to
FMV) and the minimum net sales proceeds’ requirements (described herein) have been met. The
mortgagee will be liable for any insurance claim overpayment on a PFS transaction that closes
with net sales proceeds less than the percentages indicated below.

   •   Net Sales proceeds – Regardless of the property’s sale price, a mortgagee may not
       approve a PFS contract if the net sales proceeds fall below the minimum allowable
       thresholds stated herein. HUD has established guidelines for varying minimum net sales
       proceeds based on the length of time a property has been competitively marketed for sale.

           1. For the first 30 days of marketing, mortgagees may only approve offers that will
              result in minimum net sales proceeds of 88% of the “as-is” appraised FMV.


                                               27
       2. During the next 30 days of marketing, mortgagees may only approve offers that
          will result in minimum net sales proceeds of 86% of the “as-is” appraised FMV.

       3. For the duration of the PFS marketing period, mortgagees may only approve
          offers that will result in minimum net sales proceeds of 84% of the “as-is”
          appraised FMV.

       4. Mortgagees have the discretion to deny or delay sales where an offer may meet or
          exceed the 84%, if it is presumed that continued marketing would likely produce a
          higher sale amount. However, the mortgagee is still limited to 4 to 6 months after
          the date of the mortgagor’s approval to participate in the PFS Program.

•   Allowable Settlement Costs – The term “Net Sales proceeds” is defined as the sales price
    minus closing/settlement costs (i.e., reasonable and customary costs per jurisdiction that
    are deducted at settlement). Allowable settlement costs include:

       1. Sales commission consistent with the prevailing rate but, not to exceed 6%;

       2. Real estate taxes prorated to the date of closing;

       3. Local/state transfer tax stamps and other closing costs customarily paid by the
          seller including the seller’s costs for a title search and owner’s title insurance;

       4. Consideration payable to seller of $750 or $1,000 (i.e., if such consideration is not
          used to discharge junior liens);

       5. Up to $2,500 to be used for the discharge of junior liens if closing occurs within
          90 days. Within 90 days, the first $1,000 represents the mortgagor’s
          consideration and the additional $1,500 represents FHA’s consideration for a total
          of $2,500. If settlement occurs after 90 days, the first $750 represents the
          mortgagor’s consideration and the additional $1,500 represents FHA’s
          consideration for a total of $2,250;

       6. Outstanding partial claim amount. This entire amount must be paid when
          calculating the net sales proceeds. The seller, buyer, or other interested party may
          contribute the difference if the net sales proceeds’ amount falls below the
          allowable threshold; and

       7. Up to 1% of the buyer’s first mortgage amount if the sale includes FHA
          financing.




                                             28