U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT OFFICE OF INSPECTOR GENERAL April 18, 2013 MEMORANDUM NO: 2013-LA-1803 Memorandum TO: Charles S. Coulter Deputy Assistant Secretary for Single Family Housing, HU Dane M. Narode Associate General Counsel for Program Enforcement, CACC FROM: Tanya E. Schulze Regional Inspector General for Audit, Los Angeles Region, 9DGA SUBJECT: CTX Mortgage Company LLC, Dallas TX, 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 CTX Mortgage Company LLC. 1 We selected the lender based on the results of an auditability survey, which determined that CTX 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 CTX Mortgage failed to prevent the recording of prohibited restrictive covenants with 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 51358 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 842 2 loans underwritten by CTX 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 2012 and January 2013. 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 CTX 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 had gone into claim status and (2) loans that were still active. We selected a 100 percent review of the claim loans, 770 loans total, and elected to review a highly stratified attribute statistical sample of the 10,481 active loans. The stratified sample of the 72 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; • Interviewed some borrowers for loans on which HUD paid a claim; 2 770 claim loans and 72 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 • Conducted Internet research, identified and queried applicable county recorder 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 16-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, eight had disallowed covenants, which projects to 11.42 percent, or 1,196 loans. To account for the statistical margin of error, we subtracted the standard error (3.65) times a t-score of 1.67. As a result, we can be 95 percent confident that at least 555 of the 10,481 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 were 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 CTX Mortgage. We did not follow standards in these areas because our objective was to identify the extent to which CTX 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 CTX Mortgage was a nonsupervised direct endorsement lender 7 headquartered in Dallas, TX. It was approved to participate in HUD’s FHA mortgage insurance program in 1984 and voluntarily withdrew its FHA approval status in July 2010. CTX Mortgage, which was acquired by PulteGroup with the Centex merger, had transitioned all of CTX Mortgage’s loan origination production to Pulte Mortgage as of December 31, 2009. Its affiliate builder, Centex Homes, was the seller of the properties discussed in this review memorandum. 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 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 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 U.S. Government Accountability Office report on the FHA fund stated, “If 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), 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 CTX 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 CTX Mortgage did not follow HUD requirements regarding free assumability and liens when it underwrote loans that had executed and recorded agreements between sellers and the FHA borrower, containing prohibited restrictive covenants and potential liens in connection with FHA-insured properties. This noncompliance occurred because CTX Mortgage did not exercise 8 Annual Report to Congress, Fiscal Year 2012 Financial Status, FHA Mutual Mortgage Insurance Fund 9 U.S. 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 previously 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 due diligence and was unaware that the restrictive covenants recorded between the sellers and the borrowers violated HUD-FHA requirements. As a result, we found 683 FHA-insured loans (128 claim loans and 555 active loans) with a corresponding prohibited restrictive covenant with a potential lien recorded with the applicable county recording office, and CTX Mortgage placed the FHA fund at unnecessary risk for potential losses. Claim Loan Review Results We identified and reviewed all 770 claim loans underwritten by CTX 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 128 of the 770 claim loans with properties in Arizona, Florida, Georgia, South Carolina, and Utah. Of the 128 loans, 51 resulted in actual losses 13 to HUD totaling more than $5.2 million (see appendix C, table 1), and 77 resulted in claims paid totaling more than $7.9 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 72 of 10,481 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 8 of the 72 sampled active loans with properties in Arizona, Florida, and South Carolina. The eight loans were active with an unpaid principal balance of more than $1.5 million (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, 11.42 percent of the 72 weighted loan samples contained restrictive covenants, which are not allowed by HUD rules. Therefore, we can be 95 percent confident that at least 555 of the 10,481 active loans in our audit period had similar problems with unallowable restrictive covenants (see Methodology and Scope). 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 defined in 24 CFR 203.41(a)(3). 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 14 The CFR includes exceptions; however, the exceptions do not apply in this case. 6 occupancy period was limited by the seller, which violated HUD-FHA requirements 24 CFR 203.41(b) defined at 24 CFR 203.41(a)(3)(ii) and 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. Version 1 Version 2 7 The above examples illustrate the language contained in the restrictive covenants identified; specifically, that the property cannot be conveyed without limitations imposed by the seller until the occupancy period is over, which is contrary to the HUD-FHA free assumability requirements defined in 24 CFR 203.41(a)(3)(ii) and 203.41(a)(3)(iv). A distinction is that the restrictive covenants, while ineligible, do not necessarily prevent FHA from obtaining clear title in the event of foreclosure and conveyance. This distinction does not, however, alter the material fact that the loans should not have reached the point of foreclosure and conveyance as they were not eligible for FHA mortgage insurance. We also identified potential lien language, which stipulated monetary damages to the seller in the event of a breach in the agreement (see versions 1 and 2 above). A breach of the contract would include the borrower’s conveying or transferring the property during the specified occupancy period, which could result in a lien that is prohibited by 24 CFR 203.32. CTX Mortgage officials stated the prohibited restrictive covenants were allowed because they believed that the restrictive language, coupled with an owner occupancy requirement, were consistent with FHA requirements. Therefore, they allowed the use of sellers’ restrictive covenants on FHA properties. However, based on this information, we concluded that CTX 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. Materiality Consistent with prior HUD findings, we determined the existence of unallowable restrictive covenants to be a significant, material deficiency. In prior reviews, HUD identified unallowable restrictive covenants as a violation of Federal regulations and FHA requirements, considering the violations a material, serious deficiency, stating that loans with prohibited restrictive covenants were ineligible for FHA insurance. For the active loans reviewed, HUD determined that indemnification was appropriate if the lender could not provide adequate support indicating a termination of any restrictive language. Our recommendations are made in the same regard. The FHA loans identified in this memorandum were determined to be ineligible for FHA insurance; therefore, any loss or claim tied to the loans identified represents 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 loan should not have been FHA insured. In the same regard, the audit memorandum identifies a significant material deficiency that deemed the identified loans 8 ineligible for FHA insurance, thereby warranting recommendations for indemnification of the loans identified. According to the FHA Emergency Fiscal Solvency Act of 2013, 15 indemnification should be an appropriate remedy when HUD has suffered a loss tied to a loan that was not originated or underwritten appropriately. It states that if the HUD Secretary determines that the mortgagee knew, or should have known, of a serious or material violation of the requirements established by the Secretary, such that the mortgage loan should not have been approved and endorsed for insurance, and HUD pays an insurance claim with respect to the mortgage, the Secretary may require the mortgagee to indemnify HUD for the loss, irrespective of whether the violation caused the mortgage default. This pending legislation illustrates Congress’ specific intent to protect the FHA mortgage insurance fund and ensure its solvency by providing HUD with the appropriate tools and remedies. Impact and Risk for Losses We identified 683 loans (128 claim loans and 555 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 potential liens between the seller and borrowers, violated HUD-FHA requirements defined in 24 CFR 203.41(a)(3) 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, CTX Mortgage may have forced borrowers with decreasing financial capability to remain in their property longer than they would have otherwise. As a result, CTX 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 included language for remedies if the contract was breached. 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 136 loans identified, HUD would not otherwise see a loss on the uninsurable FHA loans, as they would not have been approved for FHA insurance and would not be the responsibility of the FHA fund. For the 51 claim loans identified as ineligible for FHA insurance, HUD suffered a loss it should not have otherwise suffered. Conclusion CTX Mortgage did not follow HUD requirements regarding free assumability and liens when it underwrote loans that had executed and recorded agreements between sellers and the FHA 15 Pending legislation, House Resolution 1145, sponsored by Congresswoman Maxine Waters and Congressman Michael E. Capuano on March 13, 2013. It was reintroduced under the 113th Congress after the 112th Congress referred it to the Committee on Banking, Housing, and Urban Affairs. 9 borrower, containing prohibited restrictive covenants and potential liens in connection with FHA-insured properties. We identified 683 loans (128 claim loans and 555 active loans) within our audit period that did not meet the requirements for FHA insurance, thereby rendering them ineligible for FHA insurance. CTX Mortgage’s failure to exercise due diligence allowed prohibited restrictive covenants with the potential for liens on the FHA-insured properties, which rendered the loans 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 136 (128 claim loans and 8 sampled active loans) loans reviewed where a prohibited restrictive covenant was found, 51 resulted in an actual loss to HUD of more than $5.2 million. Another 77 of these loans had claims paid totaling more than $7.9 million. The remaining eight loans found with prohibited restrictive covenants had a total unpaid mortgage balance of more than $1.5 million with an estimated loss to HUD of more than $892,000 (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 CTX 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 recommend that HUD’s Deputy Assistant Secretary for Single Family Housing require CTX Mortgage, after completion of recommendation 1A, to 1B. Reimburse the FHA fund for the $5,285,281 in actual losses resulting from the amount of claims and associated expenses paid on 51 loans that contained prohibited restrictive covenants and potential liens (see appendix C, table 1). 1C. Support the eligibility of $7,975,892 in claims paid or execute an indemnification agreement requiring any unsupported amounts to be repaid for claims paid on 77 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 eight 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 submitting claims on those loans identified. The eight active loans with prohibited restrictive covenants had a total unpaid mortgage balance of $1,564,969, which carries a potential loss of $892,032 16 that could be put to better use (see appendix C, table 3). 16 The potential loss was estimated based on HUD’s 57 percent loss severity rate, multiplied by the unpaid mortgage balance. The 57 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 December 2012. 10 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 $5,285,281 1C $7,975,892 1D $892,032 Total $5,285,281 $7,975,892 $892,032 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. 11 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 12 Comment 2 Comment 3 Comment 3 Comment 1 Comment 4 Comment 1 Comment 5 Comment 3 Comment 3 Comment 6 Comment 7 Comment 3 13 Comment 8 Comment 3 Comment 1 Comment 9 Comment 3 Comment 6 Comment 7 Comment 10 14 Comment 11 Comment 1 15 Comment 12 Comment 13 Comment 12 Comment 14 Comment 15 Comment 1 16 Comment 1 Comment 1 Comment 16 Comment 1 Comment 17 Comment 1 17 Comment 18 Comment 1 Comment 16 Comment 1 Comment 3 Comment 9 Comment 3 Comment 1 18 Comment 19 Comment 3 Comment 1 Comment 6 Comment 5 Comment 20 Comment 1 Comment 1 19 Comment 15 Comment 1 Comment 3 Comment 21 Comment 22 20 Comment 22 Comment 23 Comment 3 Comment 9 Comment 1 Comment 6 Comment 3 Comment 1 Comment 23 Comment 3 21 Comment 9 Comment 1 Comment 20 Comment 1 Comment 5 Comment 1 Comment 3 Comment 22 Comment 24 Comment 1 Comment 3 Comment 9 22 Comment 3 Comment 1 Comment 3 Comment 6 Comment 1 Comment 5 Comment 3 Comment 3 Comment 6 Comment 3 Comment 11 Comment 3 23 Comment 25 Comment 9 Comment 3 24 OIG Evaluation of Auditee Comments Comment 1 We disagree with CTX Mortgage’s assessment of the OIG review. Specifically, we disagree with CTX Mortgage’s interpretation of FHA requirements. These assessments include: • The prohibited restrictive covenants tracked FHA’s own underwriting requirements by discouraging “flippers” from fraudulently misrepresenting their occupancy intentions and did so in a manner entirely consistent with FHA guidelines; • The prohibited restrictive covenants were consistent with and did not violate FHA regulations; and • The restrictive covenant language contained in the agreements signed by the seller and borrower “tracks” the language in the “FHA Mortgage Form” 17 that would make it viewed as permissible or compliant with FHA regulations. To clarify, the audit memorandum findings do not take exception with the owner occupancy language as stated by CTX Mortgage. What CTX Mortgage does not address is that the prohibited restrictive covenants identified go beyond merely requiring owner occupancy, actually placing restrictions on the mortgage deed that violate HUD FHA regulations. A violation would not have occurred had the cited agreements merely required a one year occupancy. However, that was not the case. The audit memorandum discussed the agreement being between a third party to the mortgage, the seller, and the borrower as well as the agreement containing provisions for damages to the seller in the event of a breach, which violated 24 Code of Federal Regulation 203.41 and 203.32 respectively. By CTX Mortgage’s own admission, the seller “would agree not to enforce the Provision…” again illustrates the fact that the buyer must get the seller’s permission is a violation of 24 CFR 203.41(a)(3)(iv), the seller being considered a third party. Any reference in CTX Mortgage’s response to tracking or adhering to FHA guidelines is incorrect. The regulations under 24 CFR 203.41(a)(3), for free assumability of the property, emphasize the prohibition of a restriction where the conveyance of a property be subject to the consent of a third party, in this case the seller, and that such a document cannot be the basis of contractual liability of the borrower for breach of an agreement not to convey. The findings and related examples illustrate the agreements in question are between the seller and borrower and include provisions for damages to the seller if the borrower conveys 17 The “Supplement B” contained in CTX Mortgage’s response contained a poor copy of the “FHA Mortgage Form” and therefore was omitted from inclusion in appendix B of this audit memorandum. However, relevant excerpts were included below. 25 the property during the occupancy period, which clearly violate HUD FHA requirements. The violations make each identified loan ineligible for FHA mortgage insurance. A significant, material distinction exists; the “FHA Mortgage Form” cited by CTX Mortgage is the mortgage note between the lender and borrower, whereas the prohibited restrictive covenant discussed in the audit memorandum is between the seller, a third party to the mortgage, and the borrower. Additionally, the “FHA Mortgage Form” cited does not contain language that creates a basis of additional contractual liability of the borrower for breach of the agreement not to convey, see excerpt of Section 5 below. Start of “FHA Mortgage Form” – Between Borrower and Lender Section 5 of “FHA Mortgage Form” 26 We would like to clarify that the “FHA Mortgage Form” section 9, “Grounds for Acceleration of Debt” paragraph (a) are limited by regulations issued by the Secretary and paragraph (b) is subject to applicable law and with prior approval of the Secretary. In both these instances the “FHA Mortgage Form” discusses acceleration of debt at the approval of the Secretary rather than the creation of an additional liability to the seller that is found in the restrictive covenants recorded with applicable counties. Section 9(a) of “FHA Mortgage Form” Section 9(b) of “FHA Mortgage Form” Comment 2 To clarify, the audit memorandum does not, at any point, state that prohibited restrictive covenants were put in place for “pernicious reasons.” Rather, the memorandum reports on OIG’s findings, based on specific audit objectives, that violations did in fact occur. Comment 3 We strongly disagree with CTX Mortgage’s assertion that the OIG memorandum serves to threaten tens of millions of dollars in indemnity claims, solely because CTX provided mortgages to these homeowners. We also disagree with CTX Mortgage that the OIG’s recommendations to FHA for reimbursement and indemnification and a referral to HUD Office of Enforcement are completely without merit. The basis for recommending indemnification was in the OIG’s determination, consistent with HUD’s prior findings on similar violations where prohibited restrictive covenants were cited as a material, statute violation. Losses tied to loans that should not have received FHA mortgage insurance should appropriately be reimbursed to the FHA mortgage insurance fund or indemnified. The OIG recommendations are addressed to HUD for appropriate action, 27 fulfilling a public obligation to ensure HUD funds are safeguarded and spent appropriately. See also comment 1. The recorded prohibited restrictive covenants impacted the insurability of the reviewed loans. CTX Mortgage had a duty to ensure loans it approved for FHA insurance were in accordance with all HUD FHA rules and regulations. The FHA loans identified 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. CTX Mortgage’s assertion that neither the homebuyers nor the FHA insurance fund was harmed is incorrect. The prohibited restrictive covenants all carried the potential to harm FHA buyers. The scope of our audit was narrow and specific, 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 prohibited restrictive covenants, which violated Federal statute and were not eligible for FHA insurance; therefore, any loss or claim tied to the loans identified represents an unnecessary loss to HUD’s FHA insurance fund. As outlined in the audit memorandum, we specifically addressed the materiality of the findings. The OIG takes all potential and appropriate corrective actions into account when developing audit recommendations and those recommendations are addressed to HUD, not CTX Mortgage, for corrective action. For clarification, recommendation 1A recommends HUD’s Associate General Counsel for Program Enforcement to determine legal sufficiency for civil action. It is OIG’s responsibility to refer violations that may rise to the level that may warrant civil action to the HUD’s Office of Program Enforcement for its consideration. It is that office’s responsibility to evaluate the violations and determine what, if any, civil action is warranted. Treble damages are not stated anywhere in the recommendation or audit memorandum. Based on our conclusions, it was our duty and obligation to HUD and other stakeholders, including the American public, 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 fair, consistent, and appropriate given the materiality of the OIG finding. Therefore, the recommendations remain unchanged. 28 Comment 4 CTX Mortgage’s statement that the audit memorandum’s interpretation of FHA regulations is so inappropriately aggressive that FHA’s own documents would violate the OIG’s reading of its terms, is incorrect and without merit. We identified a specific situation, compared the restrictive language found to FHA regulations, and determined the recorded agreements violated HUD FHA regulations. HUD’s Office of Single Family Housing has made a similar determination in similar situations. See comments 1 and 16 for detailed explanations. Comment 5 CTX Mortgage is incorrect in assuming that restrictive covenant agreements were acceptable because FHA conducted post-endorsement reviews. Such assumptions are dangerous and should never be a substitute for reviewing and applying the actual HUD FHA regulations. These reviews were not necessarily all inclusive in scope and may not have included methodology to search public records for documents recorded in conjunction with the FHA-insured loans. Comment 6 To clarify, the audit memorandum does not state that CTX Mortgage “acted knowingly or with reckless disregard resulting in a false, fraudulent, or fictitious claim to FHA” as implied by CTX Mortgage’s response. See also comment 2. Comment 7 CTX Mortgage stated that no further actions are needed because the provision term in the prohibited agreements has expired for these loans. We acknowledge CTX Mortgage’s efforts to address the audit memorandum findings. Although, the findings cited restrictive covenants with an occupancy period of twelve or 24 months, there is a possibility that longer occupancy periods related to other loans exist. HUD will review the adequacy of CTX Mortgage’s analysis during the audit resolution process to determine if it was sufficient to satisfy the audit recommendations. We also acknowledge that CTX Mortgage no longer makes FHA loans and voluntarily withdrew its FHA loan status in 2010. As a result, we have removed recommendation 1E, which recommended that HUD ensure that the lender follow 24 CFR 203.32 and 203.41. Although the loans in question have an expired agreement, the presence of the restrictive covenant should have prevented them from reaching the point of receiving FHA mortgage insurance. Recommendations 1B, 1C, and 1D of the audit memorandum first seek reimbursement for the ineligible loans with an actual known loss, support or indemnification for those with claims but no known loss, and finally to nullify active loans with such restrictions or indemnify said loans. See also comment 3. Comment 8 To clarify we reviewed public records for 842 loans (770 claim loans and 72 statistically sampled active loans) and found that, of these, 136 (128 claim loans and 8 statistically sampled active loans) had unallowable restrictive covenants. The 8 statistically sampled active loans were projected to the universe of active loans (see Methodology and Scope section of the audit memorandum), resulting in an estimated 555 active loans with similar issues. Therefore, we reported that 29 there were 683 loans (128 claim loans and 555 active loans) with unallowable restrictive covenants. Comment 9 We disagree with CTX Mortgage that it is unreasonable to expect that it would treat these as a violation of FHA requirements because of the unclear nature of the regulations in question and FHA’s own documents. FHA regulations at 24 CFR 203.41 and 203.32 specifically prohibit restrictive covenants as identified in the audit memorandum. Additionally, HUD has previously determined that prohibited restrictive covenants were serious, material deficiencies that deemed FHA loans ineligible for mortgage insurance. Whether intentional or not, CTX Mortgage, as the underwriter, 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. We also disagree that the requirements were unclear and that the FHA documents were consistent with the agreements between the seller and borrower, see comment 1. Comment 10 CTX Mortgage’s conclusion that, because there is no evidence that the builder/seller actually exercised its rights under the agreement, therefore, no remediation is necessary is not material to the issues identified in the audit memorandum because violating 24 CFR 203.41 and 302.32 rendered the loans ineligible for FHA insurance. To that end, the recommendations specifically address the deficiencies identified, utilizing appropriate remedial options available to HUD and OIG. See also comment 3. Comment 11 OIG acknowledges CTX Mortgage’s explanation of intent and history. However, this does not lift the burden from CTX Mortgage to ensure all FHA loans approved for FHA mortgage insurance adhere to all HUD FHA regulations. See also comment 1. Comment 12 During the audit, the OIG auditors determined the restrictive covenants were in violation of HUD FHA regulations. The internal legal opinion cited by CTX Mortgage was used only as additional support that restrictive covenants are unallowable and violate FHA rules and regulations. The legal opinion was 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. Comment 13 We agree with CTX Mortgage; the audit memorandum has been revised to reflect the correct citation as 24 CFR 203.41(b). Comment 14 As discussed during the exit conference, the original discussion draft memorandum to CTX Mortgage excluded the citation of 24 CFR 203.41(a)(3)(ii), 30 agreeing that this would be incorporated into the final memorandum. As a result, the audit memorandum has been updated to include this citation. Comment 15 We disagree with CTX Mortgage’s statement that the cause included in the audit memorandum was quite a different assertion than that initially offered by the OIG in its draft finding outline. The cause included in the finding outline provided to CTX Mortgage stated, “This occurred because CTX Mortgage officials believed that the documents with the restrictive covenants, which contain an owner occupancy requirement, were consistent with FHA requirements and would in- turn help protect FHA from fraud.” However, we simplified the cause in the audit memorandum to state, in part that CTX Mortgage “was unaware that the restrictive covenants recorded between the sellers and the borrowers violated HUD-FHA requirements.” Additionally, CTX Mortgage commented in its response that our statement that CTX Mortgage was “unaware” that the restrictive covenants were a violation was a mischaracterization. A CTX Mortgage official clarified that in its opinion it was reasonable to believe that the provisions were permissible under 24 CFR 203.41 and it offered the loans for insurance in good faith. As a result, we have revised the audit memorandum “Restriction on Conveyance” section to incorporate more of the original language from the finding outline and the clarification provided by a CTX Mortgage official. CTX Mortgage was notified that the finding outline was a working document and the draft form was presented as a courtesy to enhance open communication and keep CTX Mortgage informed of the OIG’s progress and tentative conclusions in advance of the draft audit memorandum. The “Supplement A” contained in CTX Mortgage’s response contained a copy of a working document that was not intended for an external audience and therefore has been omitted from inclusion in appendix B of this audit memorandum. Comment 16 CTX Mortgage’s logic is flawed and does not appear to understand or make the distinction that the prohibited agreements in question are between the borrower and seller, a third party, and not between the borrower and lender. It is incorrect and inappropriate for CTX Mortgage to compare two clearly different agreements. See also comment 1. Comment 17 CTX Mortgage does not appropriately apply the HUD FHA regulations. The exceptions at 24 CFR 203.512, as discussed in its response, do not apply. Comment 18 CTX Mortgage presents hypothetical scenarios that are not relevant to the facts of OIG’s findings. The audit memorandum presented specific instances that violated HUD FHA regulations, as determined separately by HUD and OIG. See also comment 1. 31 Comment 19 We determined that CTX Mortgage’s conclusion that “the OIG fails to recognize that the liens imposed by the Provision are not in any way material to any claims offered on the loans by CTX or anyone else”, was irrelevant because the liens violated 24 CFR 203.32 rendering them ineligible for insurance. Therefore, the materiality to any claim offered on the loans is not relevant to the issue. Comment 20 The intention behind 24 CFR 203.41(b) is not in question. The audit scope focused solely on CTX Mortgage and its practices and was not an internal review of HUD and its regulations and policy decisions. The prohibited restrictive covenants identified violated HUD FHA regulations, thereby rendering them ineligible for FHA insurance. To that end, the intention behind the regulations do not change the fact that what occurred did not meet the stated requirements for insurance. See also comments 1 and 3. Comment 21 We agree with CTX Mortgage and acknowledge that the FHA Reform Act of 2010 was never finalized. However, this legislation has been updated and was reintroduced to the U.S. House of Representatives and is now known as the “FHA Emergency Fiscal Solvency Act of 2013.” This legislation clearly indicates the U.S. Congress’ specific intent to protect and ensure the fiscal solvency of the FHA mortgage insurance fund. The audit memorandum has been updated accordingly and reflects the new, updated pending legislation. As a result, there was no need to include CTX Mortgage’s “Supplement C” in appendix B of the audit memorandum. Comment 22 We disagree with CTX Mortgage’s claim that the OIG’s position is that any technical breach may serve as a basis for indemnification. The OIG reviews each situation independently and makes determinations on specific facts and merits. In this specific circumstance, the conditions for free assumability of the loan, as well as no additional liens outside the mortgage (with some exceptions noted in the CFR), were required to be met for the loan to be eligible for FHA mortgage insurance. We disagree that indemnification should only be utilized for traditional underwriting deficiencies (overstated income, understated liabilities, etc.). This interpretation opens a wide door for violations other than your typical underwriting deficiencies and sets a bad precedent to violating lenders. Therefore, in OIG’s assessment, indemnification is an appropriate remedy in these instances because it provides the remedy of alleviating any loss or potential loss on the loans from impacting the FHA mortgage insurance fund, as would be the case if the loans were not insured. Ultimately, the recommendations are directed to HUD for it to assess and enter in to a management agreement during the audit resolution process with OIG on the appropriate course of action. See also comment 3. Comment 23 We acknowledge CTX Mortgage’s admission that had it known the loans in question were in violation of HUD FHA regulations it would have taken corrective actions. Unfortunately, the violations have already occurred, and need to be remedied. See also comment 9. 32 Comment 24 We strongly disagree with CTX Mortgage’s interpretation that the audit memorandum stated, “CTX falsely certified that loans with recorded Provisions that it offered for insurance were in compliance with FHA regulations.” Rather the audit memorandum states, “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.” Comment 25 We strongly disagree with CTX Mortgage’s assertion that the audit memorandum demonstrates a failure to understand the purpose behind implementation of the prohibited agreements and the reasonableness of the position that the prohibited agreements did not violate FHA regulations. Also, CTX Mortgage’s response incorrectly attempts to explain HUD’s policy on implementing regulations and incorrectly interprets HUD FHA regulations. Additionally, CTX Mortgage inappropriately attempted to compare different agreements between the borrower and lender and the borrower and seller. As previously stated, the purpose behind the implementation of the restrictive covenants between the seller and borrower are irrelevant in light of the fact that ultimately the agreements violated 24 CFR 203.41 and 203.32, which rendered the loans ineligible for FHA insurance. See also comments 1, 3, 9, and 17. 33 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 18 023-2546269 $ 121,117 023-2548890 126,026 023-2600006 88,235 023-2606940 145,987 023-2607141 126,630 023-2616505 103,522 023-2626186 98,712 023-2633187 142,431 023-2636551 87,048 023-2638359 112,013 023-2639926 129,636 023-2640282 168,994 023-2645865 107,228 023-2657871 108,495 023-2658846 107,739 023-2658983 106,524 023-2662210 74,477 023-2664018 126,980 023-2667860 117,650 023-2670246 83,796 023-2672962 85,904 023-2678393 80,538 023-2687270 83,590 023-2692894 81,660 023-2702979 83,748 023-2711748 157,221 023-2734119 125,693 18 The actual loss to HUD was obtained from HUD’s Single Family Data Warehouse in January 2013. 34 FHA loan Recommendation 1B – number actual loss to HUD 18 023-2736575 102,241 023-2739956 132,773 023-2754188 121,564 023-2767963 134,039 023-2802986 90,700 023-2808756 136,593 023-2831845 128,621 023-2841372 115,348 023-2845923 87,206 023-2859236 94,425 023-2866742 77,698 023-2881710 123,397 023-2892517 103,099 023-2895863 27,878 023-2903499 36,378 023-2904965 79,155 023-2909848 139,167 023-2915583 111,594 023-2919011 133,594 105-4956949 65,322 461-4231022 71,920 521-6513170 50,964 521-6534720 77,055 521-6566978 62,956 Total $ 5,285,281 35 Table 2 - Claims paid, loss unknown Claim loan review results FHA loan Recommendation 1C – claims paid number but no actual loss known 19 023-2592234 $ 245,569 023-2608407 77,597 023-2610236 127,818 023-2621330 98,149 023-2623383 106,516 023-2623955 111,873 023-2624343 112,760 023-2625313 83,370 023-2633401 116,437 023-2636522 71,247 023-2637898 79,351 023-2645842 116,396 023-2650077 181,686 023-2655567 74,667 023-2674616 172,654 023-2683472 67,499 023-2687807 93,501 023-2687894 140,582 023-2700144 69,971 023-2703242 66,924 023-2705106 76,636 023-2711958 135,517 023-2740586 95,716 023-2744037 130,280 023-2745134 86,595 023-2775375 110,111 023-2778523 107,621 023-2780369 79,236 023-2780375 133,105 023-2780431 89,948 023-2780629 102,228 023-2785097 124,095 19 The claims paid values were obtained from HUD’s Neighborhood Watch system in January 2013. 36 FHA loan Recommendation 1C – claims paid number but no actual loss known 19 023-2799995 140,129 023-2808359 112,315 023-2841343 88,287 023-2853551 132,926 023-2888891 88,728 023-2893783 117,219 023-2897450 103,133 023-2909218 79,742 023-2909384 93,635 023-2909594 117,716 023-2912138 98,737 023-2915061 94,562 023-2916986 118,084 023-2919335 99,976 023-2921566 93,127 023-2962679 104,922 023-2967879 82,765 023-3018979 124,872 023-3030283 265,986 023-3205064 100,457 091-4329487 79,615 091-4334701 72,087 091-4353253 74,503 091-4365195 71,098 091-4374825 55,733 091-4401914 70,797 093-6334717 69,256 093-6399855 178,543 093-6419500 84,063 093-6469471 49,946 093-6483725 85,479 094-5336489 123,610 094-5358189 118,871 094-5358195 71,622 094-5392235 57,712 094-5448596 107,234 37 FHA loan Recommendation 1C – claims paid number but no actual loss known 19 094-5472782 145,958 094-5486781 96,653 094-5770285 70,178 094-5876266 63,051 094-5936786 72,410 095-0546694 144,893 461-4248454 49,851 521-6585490 185,704 521-6619326 34,052 Total $ 7,975,892 38 Table 3 - Potential loss to HUD Active loan sample results FHA loan Unpaid mortgage Recommendation 1D – number balance 20 potential loss on active loans16 023-2743561 $ 166,335 $ 94,811 023-2908757 117,703 67,091 023-3174732 235,507 134,239 091-4390312 266,653 151,992 094-5353674 225,299 128,420 094-5379222 137,122 78,160 094-5505483 169,091 96,382 461-4624996 247,259 140,938 Total $ 1,564,969 $ 892,032 21 20 The unpaid mortgage balance for each loan was obtained from HUD’s Single Family Data Warehouse in January 2013. 21 This value differs from the column total by a dollar because the actual figures, which included cents, were rounded. 39
CTX Mortgage Company LLC, Dallas TX, Allowed the Recording of Prohibited Restrictive Covenants
Published by the Department of Housing and Urban Development, Office of Inspector General on 2013-04-18.
Below is a raw (and likely hideous) rendition of the original report. (PDF)