First Source Bank,
South Bend, IN
HUD’s Loss Mitigation Program for FHA-Insured
Loans
Office of Audit, Region 5 Audit Report Number: 2015-CH-1006
Chicago, IL September 11, 2015
To Kathleen Zadareky, Deputy Assistant Secretary for Single Family Housing, HU
//signed//
From: Kelly Anderson, Regional Inspector General for Audit, Chicago Region, 5AGA
Subject: First Source Bank, South Bend, IN, Did Not Always Properly Implement Its Loss
Mitigation and Quality Control Programs in Accordance With HUD
Requirements
Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of First Source Bank’s implementation of its Loss
Mitigation program for Federal Housing Administration-insured loans.
HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on
recommended corrective actions. For each recommendation without a management decision,
please respond and provide status reports in accordance with the HUD Handbook. Please furnish
us copies of any correspondence or directives issued because of the audit.
The Inspector General Act, Title 5 United States Code, section 8M, requires that OIG post its
publicly available reports on the OIG Web site. Accordingly, this report will be posted at
http://www.hudoig.gov.
If you have any questions or comments about this report, please do not hesitate to call me at
312-353-7832.
Audit Report Number: 2015-CH-1006
Date: September 11, 2015
First Source Bank, South Bend, IN, Did Not Always Properly Implement Its
Loss Mitigation and Quality Control Programs in Accordance With HUD
Requirements
Highlights
What We Audited and Why
We audited First Source Bank, a Federal Housing Administration (FHA) supervised lender
located in South Bend, IN. We selected First Source based on our analysis of risk factors of
single-family loan servicers in Region 5’s jurisdiction.1 Our audit objectives were to determine
whether First Source (1) consistently and appropriately applied loss mitigation options for
eligible borrowers, (2) accurately reported the default and 90-day delinquency status of FHA-
insured loans, and (3) performed servicing quality control reviews that met the U.S. Department
of Housing and Urban Development’s (HUD) requirements.
What We Found
First Source did not always (1) implement its Loss Mitigation program in accordance with
HUD’s requirements and (2) accurately report borrowers’ loan default information or loss
mitigation activities in FHA Connection. These servicing deficiencies resulted in (1) HUD
incurring losses of more than $105,000 and (2) an increased risk to the FHA Mutual Mortgage
Insurance Fund of more than $258,000. In addition, HUD did not always have complete and
accurate information to properly assess the performance of FHA-insured loans and effectively
monitor First Source’s loss mitigation efforts.
First Source did not always (1) review a sample of 10 percent of its nonperforming2 FHA-insured
loans monthly and (2) maintain complete quality control records. As a result, HUD and First
Source lacked assurance that potential servicing deficiencies were identified and mitigated in a
timely manner, thus potentially resulting in an increased risk to FHA’s Mutual Mortgage
Insurance Fund.
What We Recommend
We recommend that the Deputy Assistant Secretary for Single Family Housing require First
Source to (1) reimburse HUD $32,885 for the one loan that did not receive active and proper loss
mitigation or were improperly denied loss mitigation, (2) support or reimburse HUD $139,487
for the loans that lacked evidence that appropriate loss mitigation was applied, (3) indemnify
HUD $191,074 for the active loans that did not receive proper loss mitigation, and (4) implement
adequate procedures and controls to address the issues cited in this audit report.
1
The region contains six States: Illinois, Indiana, Michigan, Minnesota, Ohio, and Wisconsin.
2
Delinquent or defaulted loans, claims, and foreclosures
Table of Contents
Background and Objectives ....................................................................................3
Results of Audit ........................................................................................................4
Finding 1: First Source Did Not Always Actively and Properly Implement Its Loss
Mitigation Program in Accordance With HUD’s Requirements ................................. 4
Finding 2: First Source Did Not Always Comply With HUD’s and Its Own Quality
Control Requirements ...................................................................................................... 8
Scope and Methodology .........................................................................................10
Internal Controls ....................................................................................................12
Appendixes ..............................................................................................................14
A. Schedule of Questioned Costs .................................................................................. 14
B. Auditee Comments and OIG’s Evaluation ............................................................. 15
C. Criteria ....................................................................................................................... 24
D. Schedule of Loss Mitigation Deficiencies ................................................................ 26
E. Estimated Losses to HUD From Loss Mitigation Deficiencies ............................. 27
F. Schedule of Reporting Deficiencies ......................................................................... 28
G. Schedule of Other Servicing Deficiencies ............................................................... 29
H. Case Narratives ......................................................................................................... 30
2
Background and Objectives
First Source Bank, a supervised lender,3 received approval as a Federal Housing Administration
(FHA) lender on December 11, 1934. On February 28, 1991, First Source became an
unconditional FHA direct endorsement lender, which also originates and services U.S.
Department of Veterans Affairs and conventional loans.
FHA provides mortgage insurance on loans made by FHA-approved lenders. This insurance
provides lenders with protection against losses as the result of homeowners’ defaulting on their
mortgage loans. The lenders bear less risk because FHA will pay a claim to the lender in the
event of a borrower’s loan default. Loans must meet certain requirements established by FHA to
qualify for insurance.
The U.S. Department of Housing and Urban Development (HUD) established the Loss
Mitigation program in 1996 to ensure that distressed FHA-insured borrowers would have
opportunities to keep their homes and reduce losses to FHA’s insurance fund. Loan servicers
must offer loss mitigation options to borrowers in distress based on the borrower’s financial
circumstances and the status of the loan. The program consists of reinstatement options to
promote retention of borrowers’ homes and disposition options, which assist borrowers in
disposing of their homes.
The reinstatement options are special forbearance, partial claim, loan modification, and the
Home Affordable Modification Program (HAMP). A special forbearance is a written repayment
agreement between a loan servicer and borrower, containing a plan to reinstate a delinquent loan.
A partial claim consists of an interest-free loan to the borrower in the amount needed to reinstate
the mortgage, thereby becoming a subordinate mortgage payable to HUD. The FHA-HAMP loss
mitigation option, which became effective August 15, 2009, combines the loan modification and
partial claim loss mitigation options.
The disposition options are preforeclosure sale and deed in lieu of foreclosure. The
preforeclosure sale option allows the defaulted borrower to sell his or her home and use the sales
proceeds to satisfy the mortgage debt even if the proceeds are less than the amount owed. A
deed in lieu of foreclosure allows a borrower to turn over his or her home to HUD in exchange
for a release from all mortgage obligations.
Our objectives were to determine whether First Source (1) consistently and appropriately applied
loss mitigation options for eligible borrowers, (2) accurately reported the default and 90-day
delinquency status of FHA-insured loans, and (3) performed servicing quality control reviews
that met HUD’s requirements.
3
A supervised lender is an FHA-approved financial institution that is a member of the Federal Reserve System or an
institution with accounts insured by the Federal Deposit Insurance Corporation or the National Credit Union
Administration.
3
Results of Audit
Finding 1: First Source Did Not Always Actively and Properly
Implement Its Loss Mitigation Program in Accordance With HUD’s
Requirements
First Source did not always (1) consistently and appropriately implement its loss mitigation
program in accordance with HUD’s requirements and (2) accurately report borrowers’ loan
default information or loss mitigation activities in FHA Connection.4 These weaknesses
occurred because First Source lacked adequate procedures and controls to ensure that it complied
with HUD requirements. These servicing deficiencies resulted in (1) HUD incurring losses of
more than $105,000 and (2) an increased risk to the FHA Mutual Mortgage Insurance Fund of
more than $258,000. In addition, HUD did not always have complete and accurate information
to properly assess the performance of FHA-insured loans and effectively monitor First Source’s
loss mitigation efforts.
First Source Did Not Consistently and Appropriately Implement Its Loss Mitigation
Program
First Source did not consistently and appropriately implement its loss mitigation program in
accordance with HUD requirements. For 12 of the 40 loans (30 percent) reviewed, First Source
did not properly
Evaluate or analyze the borrower’s financial situation to arrive at the correct loss
mitigation eligibility decision for 2 loans,
Select or correctly implement the appropriate loss mitigation option for 7 loans,5
Maintain documentation to support its loss mitigation decision for 2 loans, and
File the incentive claim for 1 loan in a timely manner.
The tables in appendices D and E of this report shows the loans with significant loss mitigation
deficiencies cited above and the actual or estimated loss amounts associated with the
deficiencies. Appendix C contains the related criteria.
First Source Did Not Always Properly Enter Borrowers’ Loan Default and Loss Mitigation
Information Into FHA Connection
First Source did not always consistently and accurately enter borrowers’ loan default information
or loss mitigation activities into FHA Connection. Of the 40 loans reviewed, First Source did not
enter (1) complete default information for 2 loans and (2) accurate loss mitigation activities for
13 loans. For example, First Source reported a borrower’s loss mitigation status in FHA
Connection as a type II special forbearance trial payment plan when according to its servicing
4
FHA Connection is an Internet-based system that allows FHA-approved lenders to have real-time access to several
of FHA’s systems over HUD’s Internet system for the purpose of originating and servicing FHA loans.
5
Three of the seven loans were only cited in the recommendations, see footnote 8.
4
records, the borrower was participating in the FHA-HAMP loan modification loss mitigation
option (see appendix F).
Other Servicing Deficiencies
Contrary to HUD regulations, for 16 of the 40 loans (40 percent), First Source was unable to
support that it (1) performed a limited denial of participation or General Services Administration
search on the borrowers and (2) performed a title search. The table below shows the servicing
deficiencies for the 16 loans (see appendix G).6
Servicing deficiencies Count
Lack of limited denial of participation or General Services
Administration search 16
Lack of title search 1
Total 17
First Source Lacked Adequate Procedures and Controls
The weaknesses described above occurred because First Source lacked adequate procedures and
controls to ensure that it complied with HUD requirements. Specifically, First Source used a
workout checklist to analyze borrowers’ loans for loss mitigation; however, it did not
consistently update its review checklist to account for changes in HUD’s servicing regulations.
For example, the checklist indicated that 31 percent of a borrower’s gross monthly income was
the starting point for loss mitigation in accordance with Mortgagee Letter 2009-23. However,
this mortgagee letter was updated7 to emphasize that rather than starting the review based on a
borrower’s gross monthly income, lenders should assess the borrower’s overall income,
employment status, and surplus income.
In addition, First Source experienced staff turnover in significant default servicing positions.
According to its assistant vice president of mortgage loan servicing, First Source went through a
transition period from August through December 2013 in which it transferred responsibilities and
functions from its former loss mitigation specialist to a newly hired specialist. During that
timeframe, the vice president of mortgage loan servicing had to devote more time to directly
performing loss mitigation and training new loss mitigation staff rather than overseeing and
reviewing borrowers’ payment plans and monitoring the loss mitigation process.
According to First Source, regarding the inaccurate information reported in HUD’s FHA
Connection, in July 2012, when it changed from using an in-house servicing and reporting
system to a commercial servicing system, the transition resulted in data errors. For example,
when First Source’s loss mitigation specialist would enter a loan’s default information into the
new system, the system would automatically change the loan’s oldest unpaid installment date to
July 2012. According to First Source, it had reached out to HUD to correct the reporting
6
One of the sixteen loans contained more than one deficiency
7
Mortgagee Letter 2012-22
5
deficiencies. However, as of June 2015, First Source had not provided documentation to show
that it had reported data inaccuracies to HUD and that the errors had been corrected.
Conclusion
First Source lacked adequate procedures and controls to ensure that it (1) actively and properly
implemented its loss mitigation program in accordance with HUD requirements and (2)
accurately reported borrowers’ loan default information or loss mitigation activities in FHA
Connection. These servicing deficiencies resulted in (1) HUD incurring losses and paying partial
and loss mitigation incentive claims of more than $105,000 on four loans and (2) an increased
risk to the FHA Mutual Mortgage Insurance Fund of more than $258,000 on five loans.8 In
addition, HUD did not always have complete and accurate information to properly assess the
performance of FHA-insured loans and effectively monitor First Source’s loss mitigation efforts.
Recommendations
We recommend that HUD’s Deputy Assistant Secretary for Single Family require First Source to
1A. Reimburse HUD $32,885 for loss incurred on one loan that did not receive active
and proper loss mitigation or were improperly denied loss mitigation.
1B. Support or reimburse HUD $71,827 for the loss incurred or incentive claim paid
on two loans (FHA case numbers 151-8081634 and 151-9161593) that lacked
support of appropriate loss mitigation decisions.
1C. Indemnify HUD $191,074 for two loans that were still active and did not receive
proper loss mitigation (FHA case numbers 151-6263199 and 151-9226347) and
one loan (FHA case number 156-0374114) in which the borrower’s revised
payment was incorrect (50 percent loss severity rate applied to the unpaid balance
of $382,147)9
1D. Support or indemnify HUD $67,660 for the two active loans (FHA case
numbers151-9161593 and 263-4317828) that lacked evidence that loss mitigation
was properly implemented (50 percent loss severity rate applied to the unpaid
principal balance of $135,318).
1E. Reimburse HUD $500 for the inappropriate loss mitigation incentive claim paid
on a loan in which the claim was not filed in a timely manner.
8
Of the 12 loans with significant loss mitigation deficiencies, we did not question the amount of the partial claim for
4 loans. On February 14, 2014, HUD issued a letter clarifying that if the lender elected to use an FHA-HAMP loan
modification and partial claim and the partial claim was used to reduce a borrower’s mortgage payment below the
target principal, interest, taxes, and insurance payment, FHA would not request a refund for the unnecessary partial
claim amount if the borrower’s trial payment plan was approved before May 1, 2014. For one loan, the loss
mitigation incentive claim was questioned in recommendation 1B and the unpaid principal balance was questioned
in recommendation 1D.
9
See appendix E
6
1F. Strengthen its controls over its loss mitigation process. Such controls should
include but not be limited to (1) improving its process for implementing loss
mitigation and reviewing loss mitigation decisions to confirm that they are correct
and comply with HUD’s requirements, (2) providing additional training to all
staff members who have contact with borrowers who are eligible to participate in
loss mitigation, and (3) ensuring the accuracy of the information maintained in its
loan servicing system.
7
Finding 2: First Source Did Not Always Comply With HUD’s and
Its Own Quality Control Requirements
First Source did not always adequately implement its quality control program in accordance with
HUD requirements and its own quality control plan. Specifically, it did not always (1) review a
sample of 10 percent of its nonperforming FHA-insured loans monthly and (2) maintain
complete quality control records. This noncompliance occurred because First Source lacked
adequate procedures and controls to ensure that it complied with HUD’s quality control
requirements and its own quality control plan. As a result, HUD and First Source lacked
assurance that potential servicing deficiencies were identified and mitigated in a timely manner,
thus potentially resulting in an increased risk to FHA’s Mutual Mortgage Insurance Fund.
First Source’s Sample Size for Its Servicing Reviews Was Not Always Sufficient
First Source did not always review a sample of 10 percent of its nonperforming FHA-insured
loans monthly. HUD requires that lenders servicing less than 3,500 loans in their total FHA loan
portfolio review 10 percent of the FHA loans for each area of servicing.10 The areas to be
reviewed for servicing include delinquent loans, loss mitigation efforts, foreclosure processing,
claims, and claims without conveyance of title.
Further, First Source’s monthly delinquent loan population did not always include all relevant
loans. According to First Source’s policy, it would not include a loan in its delinquent servicing
population if the loan had been reviewed within the previous 18 months. However, its policy did
not take into account (1) loans that had multiple delinquency episodes or (2) relevant delinquent
servicing benchmarks that could occur after the loan had been reviewed. For example, First
Source reviewed one loan when the borrowers had been 2 months delinquent in their mortgage
payments; however, relevant delinquent servicing benchmarks, such as loss mitigation actions
and foreclosure activities, had not occurred at the time this loan was selected for review. In
accordance with First Source’s policy, this loan would not have been reviewed again for at least
18 months.
In addition, First Source did not always review separate samples of loans (1) for properties that
were in foreclosure or (2) submitted for claim. Instead, it combined the loans for these servicing
areas and selected a sample of 10 percent for review. We identified loans that had been reviewed
as part of First Source’s foreclosure review that had been excluded from its claim review. As a
result of these loans having been excluded, they had not been reviewed for several significant
events, such as the (1) timely submission of each property’s deed to HUD, (2) vacancy
inspections, and (3) conveyance of the properties to HUD within 30 days after the acquisition of
their titles, since these events would have occurred after the associated properties had been
foreclosed upon.
First Source Did Not Maintain Complete Quality Control Records
First Source did not always maintain quality control review records as required by its quality
control plan. As part of its quality control program documentation, it was required to maintain
records of its reviews for up to 3 years. However, First Source was unable to provide
10
HUD Handbook 4060.1, REV-2, paragraphs 7-10(B) and (C)
8
documentation of its monthly review of foreclosures, claims, and delinquent loans for December
2012. However as a result of our audit, First Source located its audit documentation to support
its review of delinquent loans for December of 2012. Further in July 2015, First Source
performed a retroactive review of the loans that were in foreclosure or resulted in claims in
December 2012.
First Source Lacked Adequate Procedures and Controls
First Source lacked adequate procedures and controls to ensure that it (1) reviewed a sample of
10 percent of its nonperforming FHA-insured loans monthly and (2) maintained documentation
of its quality control servicing reviews in accordance with HUD requirements and its own quality
control plan. According to First Source’s compliance manager and assistant vice president for
quality assurance, the quality control manager and staff were told to exclude loans that had been
reviewed in the last 18 months to reduce the chance of loans being reviewed several times, thus
keeping a loan that had not been reviewed from being selected. Further, First Source was not
able to explain why the records had not been maintained for up to 3 years as required by its plan.
As a result of our audit, to ensure that it reviewed a sample of 10 percent of its nonperforming
loans as required by HUD, First Source modified its quality control plan to include loans that had
been previous reviewed in the last 18 months.
Conclusion
First Source lacked adequate procedures and controls to ensure that it adequately implemented
its quality control program in accordance with HUD’s requirements and its own quality control
plan. As a result, HUD and First Source lacked assurance that potential servicing deficiencies
were identified and mitigated in a timely manner, potentially resulting in an increased risk to
FHA’s Mutual Mortgage Insurance Fund.
Recommendations
We recommend that HUD’s Deputy Assistant Secretary for Single Family Housing require First
Source to
2A. Implement adequate procedures and controls to ensure that it (1) complies with
HUD requirements for reviewing nonperforming loans and (2) maintains
complete records to support its loss mitigation activities.
9
Scope and Methodology
We performed our audit work from December 2014 through June 2015 at First Source’s office in
South Bend, IN, and our offices located in Chicago, IL, Columbus, OH, and Detroit, MI. The
audit covered the period December 1, 2012, through November 1, 2014, and was adjusted as
necessary.
To accomplish our objectives, we reviewed applicable HUD handbooks, regulations, mortgagee
letters, and other reports and policies related to HUD’s Loss Mitigation program. Further, we
reviewed First Source’s servicing policies and procedures, quality control plan, and quality
control documentation. We also reviewed First Source’s electronic and hardcopy loan servicing
files. We interviewed First Source’s employees and HUD’s National Servicing Center staff.
Loss Mitigation Review
Using data maintained in HUD’s Single Family Data Warehouse system11 as of January 26,
2015, we identified 2,323 loans that were serviced by First Source during the audit period,
December 1, 2012, through November 1, 2014. From the universe of loans identified, we
randomly selected 15 loans for review during the survey, 5 loans each from the following three
categories: loans that went into claim, loans for which HUD paid loss mitigation incentive
claims, and active loans that were in default 90 days or more during the audit period.
During the audit phase, we reviewed a sample of 25 loans,12 which represented 100 percent of
FHA-insured loans in First Source’s portfolio that fell into one of the following categories: (1)
loans that went into claim (claim status) during our audit period for which HUD paid loss
mitigation claims (8 loans), (2) loans for which HUD paid a loss mitigation claim and the
servicer denied loss mitigation or the loss mitigation efforts failed during the audit period (13
loans), and (3) loans that went into claim with no reported loss mitigation cost to HUD for which
the servicer denied loss mitigation or the loss mitigation efforts had failed (4 loans).
For the 40 loans reviewed, we determined whether First Source documented its attempts to
contact each borrower in default before the 90-day deadline of the borrower’s financial review
for home retention options (for example, special forbearance, loan modification, and partial
claim) in accordance with HUD requirements. We reviewed the collection notes, copies of
notification letters sent to borrowers, and other documentation in the servicing files to determine
whether First Source repeatedly attempted to contact the borrowers, as applicable, regarding loss
mitigation or to request missing documentation. Further, we determined whether First Source (1)
properly evaluated borrowers’ financial information to determine the appropriate loss mitigation
option that could be offered to the borrowers and took the appropriate loss mitigation actions that
11
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.
12
We excluded three loans reviewed during the survey phase; therefore, a total of 25 (28 - 3) loans were reviewed
during the audit phase.
10
were reasonably expected to generate the smallest financial loss to the FHA insurance fund and
(2) generally made appropriate attempts to intervene before it initiated the first legal action and,
as appropriate, initiated the foreclosure process in a timely manner in accordance with applicable
HUD requirements. We also reviewed the delinquent loan reporting to ensure that information
in HUD systems was recorded accurately. The significant deficiencies identified are included in
this report.
The conclusion in this audit report is limited to the 40 loans reviewed. We did not include First
Source’s compliance with HUD’s loss mitigation requirements for its entire portfolio of serviced
and sponsored FHA-insured loans.
Quality Control Review
For our review of First Source’s quality control program, we obtained First Source’s quality
control review reports that were completed during our audit period, December 1, 2012, to
November 1, 2014. We performed analyses to determine whether First Source complied with
HUD regulations for the servicing quality control reviews of the following: (1) areas to be
reviewed, (2) frequency, and (3) sample size.
We relied on information maintained in HUD’s Neighborhood Watch and Single Family Data
Warehouse systems13 for informational and sampling purposes only. We also relied on data
maintained in First Source’s servicing system, such as electronic loan files. Although we did not
perform a detailed assessment of the reliability of the data, we performed a minimal level of
testing and found the data to be adequately reliable for our purposes. The testing consisted of
comparing data in the electronic files to information from HUD’s systems. The audit results
were based on our review of electronic and supporting hardcopy documentation maintained by
First Source.
We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective(s). We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objectives.
13
Neighborhood Watch refers to a Web-based software application that displays loan performance data for single-
family lenders and appraisers using FHA-insured single-family loan information. The system is designed to
highlight exceptions so that potential problems are readily identifiable.
11
Internal Controls
Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to
Effectiveness and efficiency of operations,
Reliability of financial reporting, and
Compliance with applicable laws and regulations.
Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals, and objectives. Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program operations as well as the
systems for measuring, reporting, and monitoring program performance.
Relevant Internal Controls
We determined that the following internal controls were relevant to our audit objectives:
Effectiveness and efficiency of operations – Policies and procedures that management has
implemented to reasonably ensure that a program meets its objectives.
Reliability of financial reporting – Policies and procedures that management has
implemented to reasonably ensure that valid and reliable data are obtained, maintained, and
fairly disclosed in reports.
Compliance with applicable laws and regulations – Policies and procedures that management
has implemented to reasonably ensure that resource use is consistent with laws and
regulations.
We assessed the relevant controls identified above.
A deficiency in internal control exists when the design or operation of a control does not allow
management or employees, in the normal course of performing their assigned functions, the
reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or
efficiency of operations, (2) misstatements in financial or performance information, or (3)
violations of laws and regulations on a timely basis.
Significant Deficiencies
Based on our review, we believe that the following items are significant deficiencies:
First Source lacked adequate procedures and controls to ensure that it consistently and
appropriately implemented its loss mitigation program in accordance with HUD’s
12
requirements and accurately reported borrowers’ loan default information or loss mitigation
activities in FHA Connection (see finding 1).
First Source lacked adequate procedures and controls to ensure that it adequately
implemented its quality control plan for servicing delinquent FHA-insured loans in
accordance with HUD requirements or its own quality control plan (see finding 2).
13
Appendixes
Appendix A
Schedule of Questioned Costs
Funds To Be
Recommendation Unsupported Put To Better
number Ineligible 1/ 2/ Use
1A $32,885
1B $71,827
1C $191,074
1D 67,660
1E 500
Totals $ 33,385 $ 139,487 $191,074
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 Office of Inspector General (OIG) recommendation is
implemented. These amounts include reductions in outlays, deobligation of funds,
withdrawal of interest, costs not incurred by implementing recommended improvements,
avoidance of unnecessary expenditures noted in preaward reviews, and any other savings
that are specifically identified. In this instance, the funds to be put to better use represent
savings by the FHA insurance fund realized by not having to pay future claims on loans that
default.
14
Appendix B
Auditee Comments and OIG’s Evaluation
Ref to OIG Auditee Comments
Evaluation
Comment 1
15
Auditee Comments
Ref to OIG
Evaluation
Comment 2
Comment 3
Comment 4
Comment 5
Comment 6
Comment 7
16
Auditee Comments
Ref to OIG
Evaluation
Comment 8
Comment 9
Comment 10
Comment 11
17
Ref to OIG Auditee Comments
Evaluation
Comment 12
Comment 13
Comment 14
Comment 15
Comment 16
18
Ref to OIG Auditee Comments
Evaluation
Comment 17
Comment 18
Comment 19
19
OIG Evaluation of Auditee Comments
Comment 1 First Source contends that four loans were erroneously included in the exceptions
identified in the report, and no case narratives were provided to support the
inclusion of these loans. First Source further maintains that these statements were
mitigated during the audit. Our communication during the audit as well as after
the exit conference included narratives that explained each of the four mentioned
loans were included in the report because First Source filed an unnecessary partial
claim when an FHA-HAMP modification was the appropriate decision option. In
response, First Source provided a clarification letter from HUD that stated “it has
come to FHA’s attention that the policy guidance included in Mortgagee Letter
2012-22 and Mortgagee Letter 2013-32 has been misinterpreted by some
lenders…if the lender elected to use FHA-HAMP loan modification and partial
claim, and the partial claim was used to reduce a mortgagor’s mortgage payment
below the targeted payment, FHA will not request a refund for the extraneous
partial claim amount, provided that the mortgagor’s trial payment plan was
approved before May 1, 2014.” As the partial claims represented unnecessary and
unwarranted charges to the FHA insurance fund we included them in the report,
but did not seek indemnification or reimbursement. These four loans will remain
in the report.
Comment 2 First Source contends that it was aware of reporting errors and had contacted
HUD for correction. The audit team reviewed the correspondence provided by
First Source and was unable to locate any communication with HUD or the
national servicing center regarding First Source’s request for assistance or
guidance to correct the problem. First Source provided documentation that was
consistent with its explanation that mortgage servicing errors occurred during a
system change-over; however, no documentation was provided to show that it was
aware of reporting errors or communication with HUD that advised that these
errors could not or should not be corrected.
Comment 3 First Source contends that the “How to Avoid Foreclosure Pamphlet” was
provided to the borrowers. First Source provided documentation that the required
letters had been sent; therefore, we modified the report as appropriate.
Comment 4 First Source contends that one of the files contained notes and a servicing history.
We disagee. During the audit, First Source provided an initial payment history;
however, it did not provide explanations for gaps in reporting of servicing. The
audit team reviewed additional documentation and was able to determine that the
gaps were from when the mortgage was current, which did not necessitate
detailed servicing notes. Since this loan was current, we removed this exception
from the report.
Comment 5 We reviewed the provided exhibits and removed this exception from the report.
20
Comment 6 First Source contends it was using the waterfall checklist instituted by Mortgagee
Letter 2012-22. We agree that the two files contained documentation to show that
First Source used Mortgagee Letter 2012-22. However, FHA case number 151-
9161593 the issue cited in the report did not involve the use of the waterfall,
instead it involved the lack of support for the borrower’s income. For FHA case
number 263-4240417 we removed the inclusion of this loan based on additional
documentation (see comment #17). The report did not question whether First
Source used the waterfall; instead the report stated that First Source did not
consistently update its review sheet to reflect changes made to HUD’s servicing
requirements.
Comment 7 First Source contends that the report used an incorrect title for one of its staff. We
agree, and changed the last paragraph to state that according to First Source’s
assistant vice-president of mortgage loan servicing.
Comment 8 Although First Source agreed with this finding, it contends that it had always used
a 10 percent sample size. As detailed in the report, it did not always use a 10
percent sample size that included all relevant loans as required by HUD.
Comment 9 First Source acknowledged that a portion of one its auditing workpapers were
missing. First Source should work with HUD in addressing the recommendation
in the audit report.
Comment 10 First Source contends that the borrowers had entered into bankruptcy and under
HUD regulations could not be contacted. We agree. The requirements that were
in-place when the loan was serviced did not permit First Source to perform loss
mitigation on borrowers in chapter 7 bankruptcy that had not reaffirmed their
mortgages. One month after the borrower was denied loss mitigation, servicing
criteria was changed to allow borrowers that had not reaffirmed their mortgage
eligible for loss mitigation. Therefore, we removed this exception from the
report.
Comment 11 First Source contends that because the borrower had one payment in his
possession to immediately apply towards the arrearage which would have reduced
the balance, it could be brought current in 6 months with 85 percent of the
borrower’s surplus income. Therefore, he qualified for a formal forbearance. We
disagree. The documented payment plan in the borrower’s file listed this amount
as a regular mortgage payment and First Source’s response defined the amount as
a payment. As these amounts represent actual mortgage payments; instead of
surplus income, they should not be applied to the total arrearages. Therefore, this
exception will remain in the report.
Comment 12 We agree and removed the exception regarding loss mitigation from the report.
However, this loan still contained reporting deficiencies; therefore, it was still
included in the report.
Comment 13 We agree and removed the exception from the report.
21
Comment 14 First Source provided documentation to show that it was instructed by HUD
during a servicing review in January 2013 that total income should include food
stamps along with earned income to determine loss mitigation eligibility. They
also provided a letter from the borrower’s employer that supported her income as
$10 per hour. These two factors qualified the borrower for the FHA-HAMP
option that was selected. We agree that under the FHA-HAMP program, food
stamps can be considered as income. The borrower’s servicing file contained a
financial statement that listed $647 as food stamps. However, the file did not
contain documentation to show that the borrower received $647 per month in food
stamps and that this source and amount of income was likely to reasonably
continue for at least the next 12 months as required by mortgage letter 2013-32.
Additionally, the letter identified that the borrower was employed part time
earning $10 per hour, but it did not indicate the expected number of hours, as part
time hours could vary. Therefore, without documentation of (1) the amount and
continuity of the borrower’s food stamp income and (2) the number of hours that
the borrower worked per week, we were unable to determine if First Source made
the appropriate loss mitigation eligibility decision. Therefore, the exception
regarding the potentially inappropriate loss mitigation decision will remain in the
report.
Comment 15 First Source agrees that the loss mitigation specialist failed to consider the
borrower’s self-employment income when analyzing the case; however, the
borrower was not living in the property and was not eligible for FHA-HAMP.
However the “Supplemental Documentation—Frequently Asked Questions Home
Affordable Modification Program” guide states that if the borrower had been
occupying the property as his or her principal residence immediately before his or
her displacement, intends to occupy the property as his or her principal residence
upon his or her return and the current occupant was not a tenant, the mortgage
loan was eligible for consideration under HAMP. Furthermore First Source’s
notes indicate the borrower had wanted to save his home. He had the quit claim
deed, and was advised to submit his packet for a possible workout. Based on the
supplemental guidance and the borrower’s income, the borrower qualified for a
FHA-HAMP loan modification. The purpose of the residency requirement was to
keep borrowers from receiving loss mitigation for a rental property or an
abandoned property. Therefore, this exception will remain in the report.
Comment 16 First Source states that loss mitigation was not required because the borrower
informed First Source that she could not afford the home, and wanted to keep the
other home that was awarded through the divorce. First Source’s servicing notes
did not show that the borrower was moving to the other home and that she did not
believe she could afford the current home. Furthermore, the borrower lived in the
property nearly 6 months after the foreclosure sale. The notes indicate that First
Source told the borrower that it would not stop the foreclosure sale. Therefore,
this exception will remain in the report.
Comment 17 We agree and removed this exception from the report.
22
Comment 18 First Source acknowledged that its documentation could have been more complete;
however, its collection notes showed that the borrower was uncooperative. We
acknowledge that First Source collection notes showed that the borrower was initially
uncooperative. However, as detailed in the report First Source inappropriately denied
the borrower’s participation in the deed in lieu loss mitigation option because an
income tax lien was placed on the property, although there were sufficient
incentive funds available to pay off the lien. Mortgagee Letter 2002-13 states that
funds may be used to pay off junior liens to clear the title.
Comment 19 We agree and removed this exception from the report.
23
Appendix C
Criteria
Finding 1
HUD Handbook 4330.1, REV-5, section 7-12, states that lenders must ensure that servicing files
fully document that all servicing requirements have been followed and steps have been taken to
save a mortgage before to deciding to foreclose. All actions taken with respect to collection,
forbearance, or other actions alternative to foreclosure must be fully documented.
Mortgagee Letter 2000-05 states that loss mitigation is not optional and servicers are required to
document their evaluation of each delinquent loan no later than the 90th day of delinquency to
determine which loss mitigation option was appropriate as this is the only way to ensure that a
default was addressed in a timely manner and cured before the loan falls further into
delinquency. Further, it requires servicers to use loss mitigation whenever feasible to avoid
foreclosure and retain a complete audit trail confirming compliance with all loss mitigation
requirements.
Mortgagee Letter 2008-43 states that if the lender’s evaluation indicates that the borrower was
not eligible for preforeclosure sale or another loss mitigation option, the lender must immediately
advise the borrower of this decision in writing, explaining the reason for denial and giving the
borrower at least 7 calendar days to respond. In the servicing or claim review file, the lender
must maintain all evidence (such as supporting documentation, including all communication
logs) of compliance with HUD’s Loss Mitigation program requirements. Additionally, all
properties sold under the preforeclosure sale program must have a clear, marketable title. Before
executing form HUD-90045 (approval to participate), the lender must obtain a title search or
preliminary report verifying that the title was not impaired with unresolvable title problems or
with junior liens that cannot be discharged as permitted by HUD.
Mortgagee Letter 2009-23 states that under FHA-HAMP, the lender may receive an incentive fee
of up to $1,250. This total includes $500 for the partial claim. It also states that for partial claim
filing, lenders must file a claim for insurance benefits for the partial claim within the 60-day
timeframe stated in Mortgagee Letter 2003-19 to receive incentive fees for the FHA-HAMP loss
mitigation action.
The Mortgagee Letter 2009-23 attachment providing guidelines for FHA-HAMP states that no
credit alert interactive voice response system review is required but HUD’s limited denial of
participation and General Services Administration exclusion lists are required checks for all
borrowers.
24
Mortgagee Letter 2009-39 states that no later than the January 2010 reporting cycle, all lenders
must report borrowers approved to begin the FHA-HAMP trial payment plan as Single Family
Default Monitoring System status code 39.
Mortgagee Letter 2009-39, Appendix 1 – Delinquency or Default Status Codes, provides that an
account in foreclosure requires further reporting. This reporting includes the first legal action to
commence foreclosure (code 68), which indicates that the first public legal action required to
initiate foreclosure has been completed.
Mortgagee Letter 2012-22 streamlined FHA’s loss mitigation home retention option priority
order by replacing its current four-tier incentive structure with a three-tier structure, consisting of
special forbearances, loan modifications, and FHA-HAMP. It also updated the incentive order
by adding initial assistance options, consisting of informal and formal forbearances, which are
the only options available to delinquent borrowers without verifiable losses of income or
increases in living expenses. Informal forbearance plans are oral agreements relating to a period
of 3 months or less, and formal forbearance plans are written agreements relating to a period of
greater than 3 months but less than 6 months. If the lender has concluded that 85 percent of the
borrower’s surplus income is sufficient to bring the mortgage current within 6 months, the only
available loss mitigation option is a formal forbearance plan that provides for repayment within 6
months. If 85 percent of surplus income will not cure the arrearage, a stand-alone modification
or FHA-HAMP needs to be considered. It also states that for the borrower to be eligible for
FHA-HAMP, he or she should not have surplus income that is greater than $300. A surplus
income is required only for a formal forbearance or stand-alone modification.
Mortgagee Letter 2013-32 states that to qualify for FHA-HAMP, a defaulted borrower must not
have received a stand-alone modification or FHA-HAMP in the previous 24 months.
Finding 2
HUD Handbook 4060.1, REV- 2, paragraph 7-3(K), states that quality control review reports and
followup must be maintained by the lender for up to 2 years and made available to HUD.
HUD Handbook 4060.1, REV-2, paragraph 7-10(B), states that due to the importance of these
aspects of servicing, lenders must perform monthly reviews of delinquent loan servicing, claims,
and foreclosures.
HUD Handbook 4060.1, REV-2, paragraph 7-10(C), states that lenders servicing fewer than
3,500 loans in their FHA portfolio must review 10 percent of the FHA loans for each area of
servicing in paragraph 7-10(A) in accordance with the review period described in paragraph 7-
10(B).
First Source’s quality control plan requires audit (quality control) records to be maintained for 3
years.
25
Appendix D
Schedule of Loss Mitigation Deficiencies
Loss mitigation deficiencies
Failure to Failure to
Inappropriate maintain file a loss
or incorrectly documentation mitigation
Incorrect implemented to support loss claim in a
FHA eligibility loss mitigation mitigation timely
case number decision option action manner
151-6263199 X
151-6319689 X
151-7757005 X
151-7832112 X
151-7967923 X
151-8081634 X
151-9021088 X
151-9161593 X
151-9226347 X
156-0374114 X
156-0882200 X
263-4317828 X
Totals 2 7 2 1
26
Appendix E
Estimated Losses to HUD From Loss Mitigation Deficiencies
Actual and estimated losses
Unpaid Partial
FHA principal Loss claim Recommendation Recommendation Recommendation Recommendation Recommendation
case number balance Incurred paid 1A 1B 1C14 1D15 1E
1 151-6263199 $63,132 $31,566
2 151-6319689* 54,501 $12,225
3 151-7757005* 47,780 5,827
4 151-7832112* 97,764 7,956
5 151-7967923* 46,958 3,410
6 151-8081634 $71,077 $71,077
7 151-9021088 92,289 500 $500
8 151-9161593 89,119 750 750 $44,560
9 151-9226347 254,959 127,480
10 156-0374114 64,056 8,15416 32,028
11 156-0882200 32,885 32,885
12 263-4317828 46,199 23,100
Totals $856,757 $103,962 $38,822 $32,885 $71,827 $191,074 $67,660 $500
Note: FHA case numbers with an asterisk (*) were excluded based on our comments in footnote number 8.
14
Unpaid principal balance *50 percent
15
Unpaid principal balance *50 percent
16
This loan was eligible for a partial claim; however, the borrower’s payment after the loan modification was too
high.
27
Appendix F
Schedule of Reporting Deficiencies
Reporting deficiencies
Lacked Inaccurate loss
complete mitigation
delinquent or activity
FHA default reported to
case number information HUD
132-2247156 X
151-6319689 X
151-6950561 X
151-7469703 X
151-7627104 X
151-7741034 X
151-7832112 X
151-8171735 X
151-9021088 X
156-0512627 X
156-0528157 X
263-4240417 X
263-4551015 X X
263-4814803 X
Totals 2 13
28
Appendix G
Schedule of Other Servicing Deficiencies
Other servicing deficiencies
No limited
denial of
participation
or General
Services
FHA Administration Lack of
case number search title search
132-2247156 X
151-6319689 X
151-6704382 X
151-6950561 X
151-7627104 X
151-7741034 X
151-7832112 X
151-7967923 X
151-9021088 X
151-9161593 X
151-9272081 X
151-9349122 X
156-0528157 X
156-0592444 X
263-4240417 X
263-4551015 X X
Totals 16 1
29
Appendix H
Case Narratives
FHA case number: 151-6263199
Loan amount: $82,264
Unpaid principal balance: $63,132
Months delinquent: 9
Status as of 7/2//2015: First legal action to commence foreclosure
Servicing deficiency: An inappropriate loss mitigation option was selected.
First Source approved the borrower for a loss mitigation option for which he did not qualify.
Contrary to HUD’s requirements,17 it incorrectly determined that the borrower qualified for a
formal forbearance. HUD requires that for a formal forbearance, 85 percent of the borrower’s
surplus income needs to be enough to cure arrears or bring the loan current within 6 months.
However, 85 percent of the borrower’s surplus income was enough to bring the loan current
within 7 months, not 6 months. Because the plan did not meet the requirements for a formal
forbearance, the servicer should have continued down the priority order list and considered other
loss mitigation options, including loan modification or partial claim.
17
Mortgagee Letter 2012-22
30
FHA case number: 151-8081634
Loan amount: $89,103
Unpaid principal balance: $0
Months delinquent: 24
Status as of 4/30/2015: Property conveyed to HUD
Servicing deficiency: Supporting documentation for its loss mitigation evaluation was not
maintained.
First Source did not maintain documentation supporting that a formal financial analysis was
completed for the borrower’s eligibility for loss mitigation as part of its complete claim review
file. According to HUD Handbook 4330.1, REV-5, paragraph 1-4(E), First Source was required
to retain the servicing file for a minimum of the life of the mortgage plus 3 years. Although First
Source indicated that a formal financial analysis had been completed, it was unable to locate the
financial documents as part of its claim review file. Therefore, we were unable to determine the
borrower’s financial condition and whether the loss mitigation options were properly considered
and made available to the borrower.
31
FHA case number: 151-9021088
Loan amount: $100,671
Unpaid principal balance: $92,289
Months delinquent: 0
Status as of 4/30/2015: Reinstated after loss mitigation intervention
Servicing deficiency: The loss mitigation claim was not filed in a timely manner.
First Source did not file in a timely manner to receive a loss mitigation partial claim incentive
payment of $500. The borrower was eligible for FHA-HAMP, which included a loan
modification and a partial claim. However, HUD requires that lenders file a claim for insurance
benefits for the partial claim within the 60-day timeframe stated in Mortgagee Letter 2003-19 to
receive incentive fees for the FHA-HAMP loss mitigation action. Further, HUD requirements
refer to the 60-day timeframe as “within 60 days of the date the subordinate lien to HUD is
executed.” The loss mitigation claim information in HUD’s Neighborhood Watch system
indicated that the date received for the partial claim was December 6, 2013, which was more
than 60 days from the date on which the subordinate lien was executed, August 28, 2013.
32
FHA case number: 151-9161593
Loan amount: $99,816
Unpaid principal balance: $89,119
Months delinquent: 8
Status as of 6/4/2015: First legal action to commence foreclosure
Servicing deficiency: An inappropriate loss mitigation option was selected.
First Source selected a loss mitigation option for which the borrower did not qualify. First
Source used the borrower’s food stamps as income to qualify her for a FHA-HAMP. However,
it did not obtain documentation from the borrower or funding agency to verify the amount and
expected continuance in order to use food stamps as income. Additionally, the borrower’s part-
time income was supported by a letter from her employer which identified her hourly wage but
did not state the expected number of hours. When we used supported income, which excluded
the food stamp income, due to lack of support of continuance, the borrower did not qualify for
FHA-HAMP and should have been considered for a preforeclosure sale or deed in lieu loss
mitigation option.
Mortgagee Letter 2000-05 states that to be considered for any of the loss mitigation options, the
borrower must provide detailed financial information to the lender. Regardless of the option
under consideration, the lender must analyze the borrower’s current and future ability to meet the
monthly mortgage obligation by estimating the borrower’s assets and surplus income.
33
FHA case number: 151-9226347
Loan amount: $275,793
Unpaid principal balance: $254,959
Months delinquent: 17
Status as of 4/30/2015: Property conveyed to HUD
Servicing deficiency: An improper eligibility decision was made.
First Source did not properly review the borrower’s financials and, thus, made an incorrect
eligibility decision for loss mitigation. During the servicing period, the borrower separated from
his wife, who was living in the subject property while he was living in an apartment. Initially,
the borrower had attempted to complete a short sale, but several offers did not materialize.
When the divorce decree was finalized and the borrower’s wife moved out of the house, he
decided that he wanted to save the property. First Source mistakenly concluded after analyzing
the borrower’s financials that he could not afford to stay in the house. However, based on our
analysis, the borrower had adequate income and was eligible for FHA-HAMP with a loan
modification and partial claim.
Although, the payment that was determined using the partial claim was above the target
payment, it was still within 40 percent of the borrower’s income. First Source calculated the
borrower’s income as $4,000 per month. However, when we calculated the borrower’s income,
using his pay stubs and self-employment income, we determined that his income was $5,700. As
a result of our calculation, the borrower’s front-end ratio would be lower than the front-end ratio
that was calculated using First Source’s income amount.
34
FHA case number: 156-0374114
Loan amount: $69,279
Unpaid principal balance: $64,056
Months delinquent: 0
Status as of 4/2/2015: Reinstated by borrower without loss mitigation claim
Servicing deficiency: An incorrectly implemented loss mitigation option.
First Source incorrectly calculated the borrower’s target monthly payment for an FHA-HAMP
modification. Mortgagee Letter 2012-22, attachment A, shows a series of calculations and
comparisons to determine the target monthly payment amount for an FHA-HAMP modification.
Specifically, First Source used the borrower’s incorrect gross income and a higher market
interest rate of 4.75 percent instead of 4.50 percent for its calculation of the target monthly
payment. This error resulted in a target monthly payment of $591 instead of $511. As a result,
the trial payment and the permanent payment was $80 (16 percent) higher than it should have
been for the remaining life of the loan.
35
FHA case number: 156-0882200
Loan amount: $214,423
Unpaid principal balance: $0
Months delinquent: 21
Status as of 4/30/2015: Property conveyed to HUD
Servicing deficiency: An improper eligibility decision was made.
The servicing files did not support that First Source made the proper eligibility decision for loss
mitigation. After analyzing the borrower’s income and expenses, First Source incorrectly
concluded that the borrower did not qualify for a loan modification because she had deficit
income. HUD provides guidance stating that an owner-occupant borrower with surplus income
of less than 15 percent or $300 may be approved for a standard or stand-alone (rate and term)
modification under FHA-HAMP guidelines.18 It would depend on successful completion of a
trial payment plan and whether there were other burdens (for example, a non-FHA lien that the
holder is unwilling to subordinate) that prohibited a modification. Using the priority order list,
our analysis indicated that the borrower qualified for FHA-HAMP, consisting of a loan
modification with a partial claim payment option. This option would have resulted in a partial
claim of $56,624, which would have lowered the borrower’s payments from $1,500 to $1,235
per month and allowed for a front-end ratio of 25 percent.
18
Frequently Asked Questions for Mortgagee Letters 2012-22 and 2013-32
36
FHA case number: 263-4317828
Loan amount: $50,145
Unpaid principal balance: $46,199
Months delinquent: 22
Status as of 1/29/2015: Foreclosure sale held
Servicing deficiency: Supporting documentation for its loss mitigation decision was not
maintained.
In November 2013, the servicer reported that the borrower had been approved to participate in its
preforeclosure sale program, which was about 3 months after the borrower was supposedly
approved for a special forbearance (August 10 through November 8, 2013). Additionally,
according to the servicer’s activity notes, on January 14, 2014, First Source started the
procedures for the deed in lieu loss mitigation option; however, the borrower’s servicing file did
not contain documentation detailing the result of the preforeclosure sale loss mitigation option.
On February 6, 2014, First Source denied the borrower’s participation in the deed in lieu loss
mitigation option because an income tax lien was placed on the property, although there were
sufficient incentive funds available to pay off the lien. Mortgagee Letter 2002-13 states that
funds may be used to pay off junior liens to clear the title. First Source stated that the loan was
denied because there were liens other than the income tax lien on the property. However, it was
unable to provide documentation to support these liens.
37
First Source Bank, South Bend, IN, Did Not Always Properly Implement Its Loss Mitigation and Quality Control Programs in Accordance With HUD Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2015-09-11.
Below is a raw (and likely hideous) rendition of the original report. (PDF)