U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT OFFICE OF INSPECTOR GENERAL February 5, 2013 MEMORANDUM NO: 2013-LA-1801 Memorandum TO: Charles S. Coulter Deputy Assistant Secretary for Single Family Housing, HU Dane Narode Associate General Counsel for Program Enforcement, CACC FROM: Tanya E. Schulze Regional Inspector General for Audit, Los Angeles Region, 9DGA SUBJECT: Standard Pacific Mortgage, Inc., Irvine, CA, Allowed the Recording of Prohibited Restrictive Covenants INTRODUCTION The U.S. Department of Housing and Urban Development (HUD), Office of Inspector General (OIG), conducted a limited review of loans underwritten by Standard Pacific Mortgage, Inc. 1 We selected the lender based on the results of an auditability survey, which determined that Standard Pacific Mortgage allowed prohibited restrictive covenants to be filed against Federal Housing Administration (FHA)-insured properties. The objective of our review was to determine the extent to which Standard Pacific Mortgage failed to prevent the recording of prohibited restrictive covenants or potential liens in connection with FHA-insured loans closed between January 1, 2008, and December 31, 2011. HUD Handbook 2000.06, REV-4, provides 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 review. 1 FHA identification number 11775 Office of Audit (Region 9) 611 West Sixth Street, Suite 1160, Los Angeles, CA 90017 Phone (213) 894-8016, Fax (213) 894-8115 Visit the Office of Inspector General Web site at www.hudoig.gov. 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. METHODOLOGY AND SCOPE We reviewed 153 2 loans underwritten by Standard Pacific Mortgage with closing dates between January 1, 2008, and December 31, 2011. We conducted the audit work from the HUD OIG Phoenix, AZ, Office of Audit between June and November 2012. To accomplish our objective, we • Reviewed prior HUD OIG audit reports with findings that included lenders allowing prohibited restrictive covenants; 3 • Reviewed relevant FHA requirements set forth in 24 CFR (Code of Federal Regulations) Part 203 and HUD Handbooks 4000.2 and 4155.2; • Reviewed a HUD OIG legal opinion pertaining to restrictive covenants; • Reviewed a HUD management decision discussing prohibited restrictive covenants; • Reviewed prior reviews conducted by the HUD Quality Assurance Division; • Discussed the prohibited restrictive covenants with Standard Pacific Mortgage officials; and • Obtained and reviewed FHA loan data downloaded from HUD’s Single Family Data Warehouse 4 and Neighborhood Watch systems. 5 We analyzed the Single Family Data Warehouse data as of May 31, 2012, and separated the data into two categories: (1) loans that went into claim status and (2) loans that were still active. We selected a 100 percent review of the claim loans, 84 loans total, and elected to review a highly stratified attribute statistical sample of the 2,691 active loans. The stratified sample of the 69 loan samples was randomly selected and weighted by means of a computer program in SAS® using a seed value of 7. To meet the audit objective, we also • Requested and received copies of the lender’s FHA lender files for the loans selected for review; 2 84 claim loans and 69 statistically selected active loans 3 Audit report numbers 2009-LA-1018, 2010-LA-1009, and 2011-LA-1017 4 HUD’s Single Family Data Warehouse is a collection of database tables structured to provide HUD users easy and efficient access to single-family housing case-level data on properties and associated loans, insurance, claims, defaults, and demographics. 5 Neighborhood Watch is a Web-based software application that displays loan performance data for lenders and appraisers by loan types and geographic areas, using FHA-insured single-family loan information. 2 • Interviewed some borrowers for loans where HUD paid a claim; • Conducted Internet research, identified and queried applicable county recorders’ offices, and searched Accurint 6 to obtain and review recorded documents related to the sampled FHA-insured mortgages; and • Compiled and summarized the loan data with corresponding prohibited restrictive covenants. For the audit sample, the percentage and number of loans with unallowable restrictive covenants were computed based on the weighted sampling results and extended to the population using the “surveyfreq” procedure provided by SAS®. We used a nine-strata sample design to control for potential bias that might arise from varying rates of price escalation and varying resale demand based on population density. Of the selected samples, 5 had disallowed covenants, which projects to 7.33 percent, or 197.3 loans. To account for the statistical margin of error, we subtracted the standard error (80.55) times a t-score of 1.67. As a result, we can be 95 percent confident that at least 62.8 of the 2,691 loans had similar problems with unallowable restrictive covenants. We relied in part on and used HUD computer-processed data to select the claim and active loans reviewed for prohibited restrictive covenants. Although we did not perform a detailed assessment of the reliability of data, we performed a minimal level of testing and determined that the data was sufficiently reliable for our purposes. We conducted our work in accordance with generally accepted government auditing standards, except that we did not consider the internal controls or information systems controls of Standard Pacific Mortgage. We did not follow standards in these areas because our objective was to identify the extent to which Standard Pacific Mortgage allowed prohibited restrictive covenants and how that affected the FHA single-family insurance program risk. To meet our objective, it was not necessary to fully comply with the standards, nor did our approach negatively affect our review results. BACKGROUND Standard Pacific Mortgage is a nonsupervised direct endorsement lender 7 headquartered in Irvine, CA. It was approved to participate in HUD’s FHA mortgage insurance program in December 2004. Its affiliate builder, Standard Pacific Homes, was the seller of the properties discussed in this review memorandum. 6 Accurint LE Plus accesses databases built from public records, commercial data sets, and data provided by various government agencies. 7 A nonsupervised lender is a HUD-FHA-approved lending institution that has as its principal activity the lending or investment of funds in real estate mortgages and is not a supervised lender, a loan correspondent, a governmental institution, a government-sponsored enterprise, or a public or State housing agency and has not applied for approval for the limited purpose of being an investment lender. 3 FHA, created by Congress in 1934, is the largest mortgage insurer in the world aimed at helping low- and moderate-income families become homeowners by lowering some of the costs of their mortgage loans. It is also the only government agency that operates entirely from its self- generated income, from mortgage insurance paid by homeowners, and costs the taxpayers nothing. FHA mortgage insurance encourages lenders to approve mortgages for otherwise creditworthy borrowers that might not be able to meet conventional underwriting requirements by protecting the lender against default. However, according to HUD-FHA requirements, the lender has the responsibility at loan closing to ensure that any conditions of title to the property are acceptable to FHA and that the mortgaged property will be free and clear of all liens other than the mortgage. Lenders are responsible for complying with all applicable HUD regulations and in turn are protected against default by FHA’s Mutual Mortgage Insurance Fund, which is sustained by borrower premiums. In the event of homeowner default, the FHA fund pays claims to participating lenders. To this end, lenders have a responsibility to ensure that the FHA fund is protected by approving only those loans that meet all eligibility requirements. The FHA fund capital reserve ratio has a congressional mandate of 2 percent. However, based on the 2012 annual report to Congress on the FHA fund, 8 its capital reserve ratio had fallen below zero to a negative 1.44 percent. A Government Accountability Office report on the FHA fund stated, “[i]f the [capital] reserve account were to be depleted, FHA would need to draw on permanent and indefinite budget authority to cover additional increases in estimated credit subsidy costs.” 9 Therefore, the FHA fund would no longer run on only self-generated income. We reviewed a legal opinion 10 from OIG’s Office of Legal Counsel regarding the seller’s restriction on conveyance of FHA properties. Counsel opined that the recorded agreements between the seller and borrowers would constitute a violation of HUD statutes, regulations, or handbook requirements. In its opinion, the Office of Legal Counsel specifically stated that 24 CFR 203.41(b)(iv), pertaining to consent by a third party, appears to violate HUD’s regulations. In this case, the seller is considered a third party. Additionally, we obtained a HUD management decision on the recommendations of a prior OIG audit 11 not related to Standard Pacific Mortgage. In the decision, HUD agreed that the execution of prohibited restrictive covenants is a violation of Federal regulations and FHA requirements and considered the violation a serious deficiency, stating that loans with prohibited restrictive covenants are ineligible for FHA insurance. RESULTS OF REVIEW Standard Pacific Mortgage did not follow HUD requirements regarding free assumability and liens when it underwrote loans that had executed and recorded agreements between Standard 8 Annual Report to Congress, Fiscal Year 2012 Financial Status, FHA Mutual Mortgage Insurance Fund 9 Government Accountability Office testimony, GAO-12-578T, Mortgage Financing, FHA and Ginnie Mae Face Risk-Management Challenges, issued March 29, 2012 10 The legal opinion was obtained during the review of a separate lender (2011-LA-1017) for a similar restriction contained in the FHA purchase agreement. 11 Audit report 2011-LA-1017 4 Pacific Homes and the FHA borrower, containing prohibited restrictive covenants and liens in connection with FHA-insured properties. This noncompliance occurred because Standard Pacific Mortgage did not exercise due diligence and was unaware that the restrictive covenants recorded between Standard Pacific Homes and the borrowers violated HUD-FHA requirements. As a result, we found 90 FHA-insured loans (28 claim loans and 62 active loans) with a corresponding prohibited restrictive covenant and lien recorded with the applicable county recording office, and Standard Pacific Mortgage placed the FHA fund at unnecessary risk for potential losses. Claim Loan Review Results We identified and reviewed all 84 claim loans underwritten by Standard Pacific Mortgage, 12 limited to loans closed between January 1, 2008, and December 31, 2011. In our review of the applicable county recorders’ documents, we identified unallowable restrictive covenants corresponding to 28 of the 84 claim loans with properties in Arizona and Florida. Of the 28 loans, 15 resulted in actual losses 13 to HUD totaling $1.53 million (see appendix C, table 1), and 13 resulted in claims paid totaling $1.39 million, but the properties had not been sold by HUD (see appendix C, table 2). Active Loan Sample Results Additionally, we completed a random attribute statistical sample and selected 69 of 2,691 active loans within our audit period. In our review of the applicable county recorders’ documents of the sampled active FHA loans, we identified an unallowable restrictive covenant corresponding to 5 of the 69 sampled active loans with properties in Arizona and Florida. The five loans were active with an unpaid principal balance of $878,000 (see appendix C, table 3). Based on a highly stratified sample, designed to minimize error and accommodate varying rates of price escalation and varying demand based on population density, 7.33 percent of the 69 weighted loan samples contained restrictive covenants, which are not allowed by HUD rules. Therefore, we can be 95 percent confident that at least 62 of the 2,691 active loans in our audit period had similar problems with unallowable restrictive covenants (see Scope and Methodology). Restriction on Conveyance For each FHA loan, the lender certifies on the Direct Endorsement Approval for HUD/FHA- Insured Mortgage, form HUD-92900-A, that the mortgage was eligible for HUD mortgage insurance under the direct endorsement program (see lender certification excerpts below). 12 Based on HUD’s Single Family Data Warehouse as of May 31, 2012 13 The actual loss is the calculated amount of loss resulting from the sale of a HUD property. The loss is calculated based on the sales price - [acquisition cost + capital income/expense (rent, repair costs, taxes, sales expenses, and other expenses)]. 5 The FHA insurance requirements, set forth in 24 CFR 203.41(b), state that to be eligible for insurance, the property must not be subject to legal restrictions on conveyance. Further, 24 CFR 203.41(a)(3) defines legal restrictions on conveyance as “any provision in any legal instrument, law or regulation applicable to the mortgagor or the mortgaged property, including but not limited to a lease, deed, sales contract, declaration of covenants, declaration of condominium, option, right of first refusal, will, or trust agreement, that attempts to cause a conveyance (including a lease) made by the mortgagor to: (i) Be void or voidable by a third party; (ii) Be the basis of contractual liability of the mortgagor for breach of an agreement not to convey, including rights of first refusal, pre-emptive rights or options related to mortgagor efforts to convey; (iii) Terminate or subject to termination all or a part of the interest held by the mortgagor in the mortgaged property if a conveyance is attempted; (iv) Be subject to the consent of a third party; (v) Be subject to limits on the amount of sales proceeds retainable by the seller; or (vi) Be grounds for acceleration of the insured mortgage or increase in the interest rate.” Additionally, 24 CFR 203.32 states that a “mortgagor must establish that, after the mortgage offered for insurance has been recorded, the mortgaged property will be free and clear of all liens other than such mortgage, and that there will not be outstanding any other unpaid obligations contracted in connection with the mortgage transaction or the purchase of the mortgaged property, except obligations that are secured by property or collateral owned by the mortgagor independently of the mortgaged property.” 14 Finally and of most significance, HUD Handbooks 4000.2, paragraph 5-1(B), and 4155.2, paragraph 6.A.1.h, both state that it is the lender’s responsibility at loan closing to ensure that any conditions of title to the property are acceptable to FHA. In essence, it is the duty of the lender to ensure that FHA loans approved for mortgage insurance are eligible and acceptable according to FHA rules and regulations. The restrictive covenants identified placed a prohibited restriction on the conveyance by a third party of the FHA properties, conflicting with the lender’s certification that the loans met HUD-FHA insurance requirements set forth in 24 CFR 203.41 (a)(3). 14 The CFR includes exceptions; however, the exceptions do not apply in this case. 6 HUD Handbook 4155.1, paragraph 4.B.2.b, states, “FHA security instruments require a borrower to establish bona fide occupancy in a home as the borrower’s principal residence within 60 days of signing the security instrument, with continued occupancy for at least one year.” However; these security instruments would be between the lender and borrower, not a third party like the seller. Extra emphasis must be placed on the fact that the conveyance of the property, during the occupancy period, was at the consent of the seller, which violated HUD-FHA requirements at 24 CFR 203.41(a)(3)(iv). The following are excerpts from two versions of the recorded restrictive covenants found between the seller, a third party to the FHA loans, and borrowers. The above examples illustrate the language contained in the restrictive covenants identified; specifically, that the property cannot be transferred from the buyer to another until the occupancy period is over “without the prior written consent of [Standard Pacific Homes], which consent may be given or withheld in [Standard Pacific Home’s] sole and absolute discretion,” which is contrary to the HUD-FHA free assumability requirements set forth in 24 CFR 203.41(a)(3)(iv). We also identified lien language, which stipulated monetary damages to the seller in the event of a breach in the agreement (see excerpt below). A breach of the contract would include a borrower selling, leasing, or otherwise transferring the property during the occupancy period. In some instances, the restrictive covenant specifically stated that the buyer granted a lien to the seller, Standard Pacific Homes, which is contrary to 24 CFR 203.32. 7 The following are excerpts from three versions of the recorded restrictive covenants specifying liquid damages for conveying the property within the specific restriction period. Standard Pacific Mortgage officials stated that they were unaware that the restrictive covenants recorded between Standard Pacific Homes and the borrowers violated HUD-FHA requirements. In one discussion, Standard Pacific Mortgage officials informed us that they had reviewed the 8 restrictions on occupancy and believed these were consistent with and not in conflict with HUD- FHA requirements. Therefore, they allowed the use of Standard Pacific Homes’ restrictive covenants on FHA properties. However, in some instances, the purchase contracts contained in the lender’s FHA files contained language stating that the covenant did not apply to buyers that purchased the property using FHA financing (see excerpt below). Based on this information, we concluded that Standard Pacific Mortgage did not exercise due diligence, demonstrated by its failure to ensure that language in the recorded property agreements was appropriate and followed HUD rules and regulations. Standard Pacific Mortgage officials stated that the document was commonly used with other mortgage financing instruments and was mistakenly executed and recorded on the FHA loans. Impact and Risk for Losses We identified 90 loans (28 claim loans and 62 active loans) within our audit period that had unallowable restrictive covenants on the FHA-insured properties. The third-party agreements, which contained the prohibited restrictive covenants preventing free assumability of the property and liens between the seller and borrowers, violated HUD-FHA requirements set forth in 24 CFR 203.41 (a)(3)(iv) and 203.32, respectively, thereby materially impacting the insurability of the questioned loans, making the loans ineligible for FHA insurance. Additionally, the borrowers in the restrictive covenant agreements were restricted in their ability to rent, lease, sell, or otherwise convey the FHA properties. By allowing the restrictive conveyance agreements on FHA properties that at minimum appeared to hinder free assumability, Standard Pacific Mortgage may have forced borrowers with decreasing financial capability to remain in their property longer than they would have otherwise. As a result, Standard Pacific Mortgage’s failure to exercise due diligence placed the FHA fund at unnecessary risk for potential losses by approving ineligible properties for FHA insurance and restricting borrowers’ ability to rent, lease, sell, or otherwise convey the FHA properties and stipulating unallowable liens for liquid damages for a breach of the agreement. Of most significance, insuring properties that are not eligible for mortgage insurance increases the risk to an FHA fund that is already facing dangerously low levels of funding. For the 90 loans identified, HUD would not otherwise see a loss on the uninsurable FHA loans, as they would not 9 have been approved for FHA insurance and would not be the responsibility of the FHA fund. For the 15 claim loans identified as ineligible for FHA insurance, HUD suffered a loss it should not have otherwise suffered. Conclusion Standard Pacific Mortgage did not follow HUD requirements regarding free assumability and liens when it underwrote loans that had executed and recorded agreements between Standard Pacific Homes and the FHA borrower, containing prohibited restrictive covenants and liens in connection with FHA-insured properties. We identified 90 loans (28 claim loans and 62 active loans) within our audit period that did not meet the requirements for FHA insurance, thereby rendering them ineligible for FHA insurance. Standard Pacific Mortgage’s failure to exercise due diligence allowed prohibited restrictive covenants with liens on the FHA-insured properties, which rendered them uninsurable. These uninsurable loans placed the FHA fund at unnecessary risk for potential losses because HUD would not otherwise see a loss on loans not insured by the FHA fund. Of the 33 (28 claim loans and 5 sampled active loans) loans reviewed with prohibited restrictive covenants, 15 resulted in an actual loss to HUD of more than $1.53 million. Another 13 of these loans had claims paid totaling more than $1.39 million. The remaining five loans found with prohibited restrictive covenants had a total unpaid mortgage balance of more than $878,000 with an estimated loss to HUD of more than $544,000 (see appendix C). RECOMMENDATIONS We recommend that HUD’s Associate General Counsel for Program Enforcement: 1A. Determine legal sufficiency and if legally sufficient, pursue civil remedies (31 U.S.C. (United States Code) Sections 3801-3812, 3729, or both), civil money penalties (24 CFR 30.35), or other administrative action against Standard Pacific Mortgage, its principals, or both for incorrectly certifying to the integrity of the data or that due diligence was exercised during the origination of FHA-insured mortgages. We also recommend that HUD’s Deputy Assistant Secretary for Single Family Housing require Standard Pacific Mortgage to pursue recommendations 1B through 1E after completion of recommendation 1A: 1B. Reimburse the FHA fund for the $1,535,189 in actual losses resulting from the amount of claims and associated expenses paid on 15 loans that contained prohibited restrictive covenants and liens (see appendix C, table 1). 1C. Support the eligibility of $1,390,235 in claims paid or execute an indemnification agreement requiring any unsupported amounts to be repaid for claims paid on 13 loans for which HUD has paid claims but has not sold the properties (see appendix C, table 2). 1D. Analyze all FHA loans originated, including the five active loans identified in this memorandum, or underwritten beginning January 1, 2008, and nullify all active restrictive covenants or execute indemnification agreements that prohibit it from 10 submitting claims on those loans identified. The five active loans with prohibited restrictive covenants had a total unpaid mortgage balance of $878,979, which carries a potential loss of $544,967 15 that could be put to better use (see appendix C, table 3). 1E. Follow 24 CFR 203.32 and 203.41 by excluding restrictive language and prohibited liens for all new FHA-insured loan originations and ensure that policies and procedures reflect FHA requirements. Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Funds to be put Ineligible 1/ Unsupported 2/ number to better use 3/ 1B $1,535,189 1C $1,390,235 1D $544,967 Total $1,535,189 $1,390,235 $544,967 1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor believes are not allowable by law; contract; or Federal, State, or local policies or regulations. 2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program or activity when we cannot determine eligibility at the time of the audit. Unsupported costs require a decision by HUD program officials. This decision, in addition to obtaining supporting documentation, might involve a legal interpretation or clarification of departmental policies and procedures. 3/ 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. If HUD implements our recommendations to indemnify loans not originated in accordance with HUD-FHA requirements, it will reduce FHA’s risk of loss to the fund. See appendix C for a breakdown, by FHA loan number, of the funds to be put to better use. 15 The potential loss was estimated based on HUD’s 62 percent loss severity rate, multiplied by the unpaid mortgage balance. The 62 percent loss rate was the average loss on FHA-insured foreclosed-upon properties based on HUD’s Single Family Acquired Asset Management System’s “case management profit and loss by acquisition” as of September 2012. 11 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Comment 2 Comment 3 Comment 4 12 Comment 5 Comment 6 Comment 7 Comment 8 Comment 9 13 Comment 9 Comment 10 14 Comment 10 Comment 11 15 Comment 3 Comment 4 Comment 5 Comment 12 Comment 13 16 Comment 13 Comment 5 Comment 12 Comment 14 Comment 6 17 Comment 5 Comment 6 Comment 8 Comment 14 Comment 15 Comment 7 Comment 8 Comment 14 Comment 7 Comment 15 18 Comment 7 Comment 15 Comment 7 Comment 15 Comment 5 Comment 7 Comment 15 19 Comment 7 Comment 8 Comment 7 Comment 8 Comment 13 Comment 14 Comment 8 20 Comment 3 Comment 9 Comment 4 Comment 6 Comment 7 Comment 5 Comment 8 Comment 16 21 22 23 24 25 26 27 28 29 30 31 OIG Evaluation of Auditee Comments Comment 1 We disagree with Standard Pacific Mortgage’s request under footnote one. The two documents cited were used only to support that restrictive covenants have been reviewed by multiple parties and all have agreed they are unallowable and violate FHA rules and regulations. The legal opinion and management decision were obtained and reviewed after we conducted our own analysis and came to our own conclusion that HUD requirements were violated by the execution and recording of the restrictive covenants. Additionally, the documents were used to promote consistency between the recommendations contained within this audit memorandum and HUD actions taken against a lender in a similar situation. Comment 2 We disagree with the assertion that the audit memorandum erroneously lumps together multiple Standard Pacific Homes contract documents that contain different terms. The scope of our audit included a review of each type of contract document. We categorized the contracts as containing unallowable restrictive covenants based on the documents violating HUD’s free assumability requirements set forth in 24 CFR 203.41(a)(3) and lien provisions under 24 CFR 203.32. Additionally, we provided, in the body of the audit memorandum, excerpts of each set of verbiage violating these requirements. We determined it would be repetitive and unnecessary to include a copy of each of the 33 questioned documents when an excerpt of each version would suffice. Comment 3 Standard Pacific Mortgage takes exception, claiming the contract documents reviewed are not impermissible restrictive covenants. We disagree, as stated in the audit memorandum, the documents executed and recorded with the county recorders’ offices contained unallowable restrictive covenants – that at a minimum appear to – prevent free assumability of the FHA property and contain unallowable liens. Comment 4 We disagree that the OIG did not consider whether Standard Pacific Mortgage knew or reasonably could have been expected to know that the documents containing the restrictive covenants were being recorded. As evidenced by the audit memorandum, included in the Scope and Methodology section of the audit memorandum, we reviewed the lender responsibilities as well as its relationship with the seller. The following is an excerpt from the audit memorandum. Standard Pacific Mortgage officials stated that they were unaware that the restrictive covenants recorded between Standard Pacific Homes and the borrowers violated HUD-FHA requirements. In one discussion, Standard Pacific Mortgage officials informed us that they had reviewed the restrictions on occupancy and believed these were consistent with and not in conflict with HUD-FHA requirements. Therefore, they allowed the use of Standard Pacific Homes’ restrictive covenants on FHA properties. However, in some instances, the purchase contracts contained in the 32 lender’s FHA files contained language stating that the covenant did not apply to buyers that purchased the property using FHA financing... Based on this information, we concluded that Standard Pacific Mortgage did not exercise due diligence, demonstrated by its failure to ensure that language in the recorded property agreements was appropriate and followed HUD rules and regulations. Comment 5 We disagree with Standard Pacific Mortgage’s statement that indemnification is not its responsibility and would still be unwarranted even if HUD determined that unallowable restrictive covenants were recorded and it should have known about them. The FHA loans identified in this audit memorandum were determined to be ineligible for FHA insurance; therefore, any loss or claim tied to the loan presents an unnecessary loss to HUD’s FHA insurance fund. As with any underwriting review, deficiencies identified, such as overstated income and understated liabilities, do not have to be the reason an FHA loan went into default or claim for HUD to seek indemnification. Rather, the deficiencies are used as evidence that the FHA loan should not have been FHA-insured. In the same regard, the audit memorandum identifies a significant material deficiency that deemed the identified loans ineligible for FHA insurance; thereby warranting recommendations for indemnification of the loans identified. Based on our conclusions, it was our duty and obligation to HUD and other stakeholders to recommend HUD take necessary, appropriate action. In HUD’s prior actions, it also deemed the deficiency significant enough to warrant indemnification. We believe the recommendations contained in the audit memorandum are appropriate given the materiality of the OIG finding. As stated above, the recorded prohibited restrictive covenants impacted the insurability of the reviewed loans. Standard Pacific Mortgage had a duty to ensure loans it approved for FHA insurance were in accordance with all HUD rules and regulations. In addition, the FHA Reform Act of 2010 states, if the Secretary determines that a mortgage executed by a mortgagee approved by the Secretary under the direct endorsement program or insured by a mortgagee pursuant to the delegation of authority under section 256 was not originated or underwritten in accordance with the requirements established by the Secretary, and the Secretary pays an insurance claim with respect to the mortgage within a reasonable period specified by the Secretary, the Secretary may require the mortgagee to indemnify the Secretary for the loss. Comment 6 We disagree that the seller’s efforts to ensure that homebuyers were not using FHA financing to obtain loans for investment properties was consistent with HUD policy. The FHA requirements do emphasize a one year occupancy period. However, we would like to emphasize that under 24 CFR 203.41(a)(3), for free assumability of the property, that there is a prohibition of a restriction where the conveyance of a property be subject to the consent of a third party, in this case the 33 seller. An example of such language is contained within the audit memorandum and additional excerpts from a recorded agreement are provided below to show more language contained within some of the agreements. 34 * Names redacted for privacy reasons. Comment 7 Standard Pacific Mortgage’s assertion that there is no evidence that any homebuyer was harmed is not relevant. The scope of our audit was to identify the presence of unallowable restrictive covenants and to determine if those restrictions violated HUD rules and regulations. To that end, we concluded that there were unallowable restrictive covenants, which are identified in this audit 35 memorandum, which violated Federal statute and were not eligible for FHA insurance. Therefore, any loss or claim tied to the loan presents an unnecessary loss to HUD’s FHA insurance fund. See also comment 5. Comment 8 We acknowledge and appreciate Standard Pacific Mortgage’s steps taken to comply with applicable rules and regulations as a result of this review. Documentation evidencing corrective actions should be provided to HUD during audit resolution. HUD will review the adequacy and implementation of Standard Pacific Mortgage’s corrective actions during the audit resolution process to determine if they were sufficient. Comment 9 Standard Pacific Mortgage stated that the unallowable restrictive covenants were not intended to be recorded with FHA financing, however, it affirmed that they were indeed recorded. Whether intended or not, the unallowable restrictive covenants were recorded with FHA financed mortgage loans, violating HUD’s rules and regulations as stated in the audit memorandum. As the lender, Standard Pacific Mortgage carries the burden to ensure all loans that receive FHA mortgage insurance are eligible and meet all HUD rules and regulations. For clarification, the audit memorandum finding is based on the executed and recorded documents at the applicable county recorders’ offices that are publicly available. The Non-FHA/VA Buyer Declaration and Rep & Warranty Version documents referred to by Standard Pacific Mortgage are not the same documents and do not contain the same language as the restrictive covenant documents recorded at the county recorders’ offices. Of most significance, the documents referred to by Standard Pacific Mortgage in attachment A, Non-FHA/VA Buyer Declaration, of its response contained one version of the purchase agreement (Schedule A to Purchase Contract or Declaration of Covenant Restricting Resale, Marketing or Rental of Property) that included the unallowable restrictive covenants, which were executed and recorded with the applicable county recorders’ offices. Standard Pacific Mortgage preceded this document in its response with an Addendum to Purchase Contract Occupancy/Investment Disclosure, which contained the language excluding FHA/VA financed properties. However, the Addendum to Purchase Contract Occupancy/Investment Disclosure was not an executed and recorded document with the county recorders’ offices. Therefore, there appeared to be no executed and recorded agreement with the county recorders’ offices that excludes the FHA financed properties from the agreed restrictive covenants. Comment 10 We acknowledge Standard Pacific Mortgage’s claim that the Schedule A was not legally enforceable because it lacks consideration. Any records or information related to this claim should be provided to HUD during the audit resolution. To clarify, the existence of the publicly executed and recorded documents containing the restrictive covenants is in question and not the legality of said documents. See also comments 3 and 9. 36 Comment 11 Standard Pacific Mortgage provides information stating that controls were in place to prevent the recording of prohibited restrictive covenants on FHA loans. However, the recording of such restrictions were still allowed to occur. Based on Standard Pacific Mortgage’s response, it appears that a breakdown in communication and internal control allowed the recording of prohibited restrictive covenants. Whether intentional or not, Standard Pacific Mortgage, as the lender, is responsible for ensuring the loan and its title instruments meet all HUD rules and regulations. As stated in the audit memorandum, HUD Handbooks 4000.2, paragraph 5-1(B), and 4155.2, paragraph 6.A.1.h, both state that it is the lender’s responsibility at loan closing to ensure that any conditions of title to the property are acceptable to FHA. In essence, it is the duty of the lender to ensure that FHA loans approved for mortgage insurance are eligible and acceptable according to FHA rules and regulations. See also comment 4. Comment 12 We disagree with Standard Pacific Mortgage’s assertions that we may not extrapolate additional violations by referencing these loans. If an unallowable restrictive covenant was found on a statistically selected random sample items (active loan review) these loans are projectable to the universe of the loans (see Scope and Methodology section of the audit memorandum). As stated in the New York Law Journal’s article The Use of Statistical Sampling as Evidence, by George Bundy Smith and Thomas J. Hall, Statistical sampling is a scientific methodology by which one draws conclusions about a large population of data by measuring and analyzing a smaller, representative sample of the population. When the sample is randomly selected and of sufficient size so as to achieve statistical significance, statisticians may confidently make inferences about the larger population by reviewing the sample. As such, statistical sampling can provide an efficient way to estimate accurately larger populations of data, and has been utilized across many spectrums outside of the courtroom, including election polling, television ratings, unemployment surveys and analyses of public health issues. To clarify, the audit memorandum recommendations do not include a request for indemnification of any active loans projected to have similar unallowable restrictive covenants. Rather, recommendation 1D of the audit memorandum, limited the indemnification of active loans to the five sampled and reviewed loans where an unallowable restrictive covenant was found, but the recommendation also allows the lender to nullify active loans with active restrictive covenants instead of executing loan indemnifications. Comment 13 Standard Pacific Mortgage included in its response Attachment B Rep & Warranty Version. We do not take exception to the language in these agreements that the borrower occupy or intend to occupy the FHA financed property; however, we take issue with the language contained within the agreements that 37 specify that if the property is conveyed within the occupancy period that a breach of contract would occur resulting in damages owed to the seller. As stated in the audit memorandum, the prevention of free assumability of the FHA property and liens are violations of HUD's requirements. The documents identified in the audit memorandum were obtained through public record inquiries are unallowable restrictive covenants. See also comment 9. Comment 14 We acknowledge Standard Pacific Mortgage’s recognition that the two Tampa FHA loan numbers 093-6736524 and 093-6695022 had restrictive covenants. However, we disagree with Standard Pacific Mortgage that the unallowable restrictions do not warrant indemnification. Although the two loans in question have an expired restriction and no loan default, respectively, the presence of the restrictive covenant should have prevented them from reaching the point of receiving FHA mortgage insurance. Recommendation 1D of the audit memorandum first seeks to ensure that any active unallowable restrictive covenants on the five active loans be terminated. Indemnification on the five loans that are active is recommended only where the active unallowable restriction is not terminated. See also comment 5. Comment 15 We disagree with Standard Pacific Mortgage’s statement that the audit memorandum implies borrowers were harmed. The audit memorandum states that the appearance of unallowable restrictive covenant may have impacted borrowers in their decision making or ability to convey their property. See also comment 7. Comment 16 We acknowledge Standard Pacific Mortgage’s efforts to adhere to HUD’s rules and regulations and appreciate the consideration given to the audit findings. However, the finding and recommendations remain unchanged as the response and supporting documentation do not fully address the deficiencies cited. With regard to recommendation 1B and 1C, the FHA loans identified were determined to be ineligible for FHA mortgage insurance. With regard to recommendations 1D and 1E, Standard Pacific Mortgage should provide documentation evidencing corrective actions taken to HUD during audit resolution. HUD will review the adequacy and implementation of Standard Pacific Mortgage’s corrective actions to determine adequacy. See also comments 5 and 8. 38 Appendix C SUMMARY OF FHA LOANS REVIEWED Table 1 - Actual loss to HUD Claim loan review results FHA loan Recommendation 1B – number actual loss to HUD 16 023-2623614 $ 98,995 023-2694003 80,954 023-2709846 118,012 023-2737614 108,438 023-2739962 110,065 023-2745583 101,603 023-2769226 90,198 023-2809302 129,163 023-2884798 53,346 023-2890770 98,206 023-2931245 135,021 023-2931750 111,243 023-2963543 109,864 023-2991777 82,323 023-3170701 107,758 Total $ 1,535,189 16 The actual loss to HUD was obtained from HUD’s Single Family Data Warehouse in November 2012. 39 Table 2 - Claims paid, loss unknown Claim loan review results FHA loan Recommendation 1C – claims paid number but no actual loss known 17 023-2618236 $ 114,106 023-2618252 106,310 023-2618269 153,972 023-2624416 95,448 023-2685546 101,314 023-2719049 103,229 023-2736116 143,263 023-2741806 119,762 023-2751458 84,152 023-2768640 124,402 023-2858180 89,638 023-2890373 108,565 093-6736524 46,074 Total $ 1,390,235 17 The claims paid values were obtained from HUD’s Neighborhood Watch system in November 2012. 40 Table 3 - Potential loss to HUD Active loan sample results FHA loan Unpaid mortgage Recommendation 1D – number balance 18 potential loss on active loans15 023-2771367 $ 246,428 $ 152,785 093-6695022 251,938 156,201 093-6888630 148,667 92,174 093-7049064 112,221 69,577 093-7345094 119,725 74,230 Total $ 878,979 $ 544,967 18 The unpaid mortgage balance for each loan was obtained from HUD’s Single Family Data Warehouse in November 2012. 41
Standard Pacific Mortgage, Inc., Irvine, CA, Allowed the Recording of Prohibited Restrictive Covenants
Published by the Department of Housing and Urban Development, Office of Inspector General on 2013-02-05.
Below is a raw (and likely hideous) rendition of the original report. (PDF)