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)