Single-Family Housing
Progress Made, but Opportunities Exist to Improve HUD's Oversight of FHA Lenders Gao ID: GAO-05-13 November 12, 2004Every year, the Department of Housing and Urban Development (HUD), through its Federal Housing Administration (FHA), insures billions of dollars in home mortgage loans made by private lenders. Oversight of lenders has historically been a challenge for HUD. In January 2003, GAO reported that, due in part to poor lender oversight, HUD's single-family mortgage insurance programs remained a high-risk area. This report examines (1) how well HUD follows its guidance when granting lenders direct endorsement authority (the ability to underwrite loans and determine their eligibility for FHA mortgage insurance without HUD's prior review), (2) the extent to which HUD uses a risk-based approach when monitoring FHA lenders, and (3) the extent to which HUD holds accountable lenders that it identifies as not complying with its performance requirements.
HUD has not consistently followed its guidance for granting direct endorsement authority. The guidance requires that, to receive the authority, lenders must, within a 1-year period, submit for HUD's approval at least 15 mortgage loans that HUD assesses "good" or "fair" using its assessment criteria, including the last 5 consecutive loans. However, we found that HUD deviated from this guidance when granting authority to some of the 49 lenders that were approved between October 1, 2002, and April 30, 2004. For example, HUD granted authority to 7 lenders who did not submit the minimum 15 loans rated "good" or "fair." HUD has been using a risk-based approach to monitoring lenders, employing, among other things, aggregate loan performance data to target lenders for review. However, certain factors limit the usefulness of its monitoring tools. First, the rating system HUD uses when performing technical reviews--desk audits to evaluate the underwriting quality of loans insured by FHA--does not currently reflect the different levels of risk that detected underwriting errors pose to the insurance fund. HUD is in the process of revising the system to improve its usefulness. Second, while GAO found that, in fiscal year 2003 and the first half of fiscal year 2004, HUD generally reviewed those lenders that met its targeting criteria, its reports on lender reviews do not distinguish between those conducted on-site (at lenders' offices) and off-site ("desk" reviews). HUD's guidance allows desk reviews, but on-site reviews are preferred because, among other things, they allow for direct observation and the ability to easily review more loans. HUD's reports do not identify the number of off-site reviews, but a manual search of records showed that 70 of the 910 lender reviews conducted in fiscal year 2003 were off-site reviews. HUD's efforts to hold poor performing lenders accountable have not been comprehensive. HUD has made limited use of its ability to suspend the direct endorsement authority of noncompliant lenders, suspending 7 (of about 2,900 lenders with direct endorsement authority) in fiscal year 2003 and the first half of fiscal year 2004. Further, HUD's Mortgagee Review Board can take over a year to take action, during which time noncompliant lenders may continue to make FHA-insured loans.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-05-13, Single-Family Housing: Progress Made, but Opportunities Exist to Improve HUD's Oversight of FHA Lenders
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Report to Congressional Addressees:
November 2004:
SINGLE-FAMILY HOUSING:
Progress Made, but Opportunities Exist to Improve HUD's Oversight of
FHA Lenders:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-13]:
GAO Highlights:
Highlights of GAO-05-13, a report to congressional addressees:
Why GAO Did This Study:
Every year, the Department of Housing and Urban Development (HUD),
through its Federal Housing Administration (FHA), insures billions of
dollars in home mortgage loans made by private lenders. Oversight of
lenders has historically been a challenge for HUD. In January 2003, GAO
reported that, due in part to poor lender oversight, HUD‘s single-
family mortgage insurance programs remained a high-risk area. This
report examines (1) how well HUD follows its guidance when granting
lenders direct endorsement authority (the ability to underwrite loans
and determine their eligibility for FHA mortgage insurance without
HUD‘s prior review), (2) the extent to which HUD uses a risk-based
approach when monitoring FHA lenders, and (3) the extent to which HUD
holds accountable lenders that it identifies as not complying with its
performance requirements.
What GAO Found:
HUD has not consistently followed its guidance for granting direct
endorsement authority. The guidance requires that, to receive the
authority, lenders must, within a 1-year period, submit for HUD‘s
approval at least 15 mortgage loans that HUD assesses ’good“ or ’fair“
using its assessment criteria, including the last 5 consecutive loans.
However, we found that HUD deviated from this guidance when granting
authority to some of the 49 lenders that were approved between October
1, 2002, and April 30, 2004. For example, HUD granted authority to 7
lenders who did not submit the minimum 15 loans rated ’good“ or ’fair.“
HUD has been using a risk-based approach to monitoring lenders,
employing, among other things, aggregate loan performance data to
target lenders for review. However, certain factors limit the
usefulness of its monitoring tools. First, the rating system HUD uses
when performing technical reviews”desk audits to evaluate the
underwriting quality of loans insured by FHA”does not currently reflect
the different levels of risk that detected underwriting errors pose to
the insurance fund. HUD is in the process of revising the system to
improve its usefulness. Second, while GAO found that, in fiscal year
2003 and the first half of fiscal year 2004, HUD generally reviewed
those lenders that met its targeting criteria, its reports on lender
reviews do not distinguish between those conducted on-site (at lenders‘
offices) and off-site (’desk“ reviews). HUD‘s guidance allows desk
reviews, but on-site reviews are preferred because, among other things,
they allow for direct observation and the ability to easily review more
loans. HUD‘s reports do not identify the number of off-site reviews,
but a manual search of records showed that 70 of the 910 lender reviews
conducted in fiscal year 2003 were off-site reviews.
HUD‘s efforts to hold poor performing lenders accountable have not been
comprehensive. HUD has made limited use of its ability to suspend the
direct endorsement authority of noncompliant lenders, suspending 7 (of
about 2,900 lenders with direct endorsement authority) in fiscal year
2003 and the first half of fiscal year 2004. Further, HUD‘s Mortgagee
Review Board can take over a year to take action, during which time
noncompliant lenders may continue to make FHA-insured loans.
What GAO Recommends:
This report includes five recommendations designed to improve HUD‘s
processes for approving and monitoring FHA mortgage lenders and for
sanctioning them for unacceptable performance. In responding to a draft
of this report, HUD agreed with the recommendations but commented that
the report does not fully recognize the accomplishments resulting from
its changes to lender oversight.
www.gao.gov/cgi-bin/getrpt?GAO-05-13.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact David G. Wood at (202)
512-8678 or woodd@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Homeownership Centers Have Not Consistently Followed HUD's Guidance for
Granting Direct Endorsement Authority:
HUD's Monitoring Is Risk-Based, but Certain Factors Limit the
Usefulness of Its Monitoring Tools:
Efforts to Hold Lenders Accountable for Poor Performance Have Not Been
Comprehensive:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Comments from the Department of Housing and Urban
Development:
Appendix III: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Figures:
Figure 1: FHA Mortgage Application Process:
Figure 2: Geographical Jurisdictions of HUD's Four Homeownership
Centers and Lender Branches in Each Jurisdiction:
Figure 3: Preclosing Review Loan Rating Categories and Scoring System:
Figure 4: Steps to Be Taken Each Quarter to Target Lenders for Lender
Reviews:
Figure 5: Extent to Which Lenders Reviewed by Homeownership Centers
Were Targeted Lenders, Fiscal Year 2003 and First Two Quarters of
Fiscal Year 2004:
Figure 6: Extent to Which Lenders Targeted by Homeownership Centers
Were Reviewed, Fiscal Year 2003 and First Two Quarters of Fiscal Year
2004:
Figure 7: Percentage of Loans Receiving Technical Reviews, Fiscal Year
2003 and First Two Quarters of Fiscal Year 2004:
Figure 8: Percentage of Technical Review Contractors' Work Reviewed by
Homeownership Centers in Fiscal Year 2003:
Figure 9: Technical Review Contractors' Fiscal Year 2003 Performance:
Figure 10: Percentage of "Poor" Ratings Assigned during Technical
Reviews Performed in Fiscal Year 2003 and First Two Quarters of Fiscal
Year 2004, by Category:
Figure 11: Deficiencies Most Commonly Cited during Technical Reviews
Performed in Fiscal Year 2003 and First Two Quarters of Fiscal Year
2004:
Figure 12: Results of the First 19 Rounds of HUD's Credit Watch
Program:
Figure 13: Status of the Mortgagee Review Board's Actions on 32 Cases
as of June 2004:
Abbreviations:
CHUMS: Computerized Homes Underwriting Management System:
FHA: Federal Housing Administration:
HECM: Home Equity Conversion Mortgage:
HUD: Department of Housing and Urban Development:
Letter November 12, 2004:
The Honorable Paul S. Sarbanes:
Ranking Minority Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Michael G. Oxley:
Chairman:
The Honorable Barney Frank:
Ranking Minority Member:
Committee on Financial Services:
House of Representatives:
Every year, the Department of Housing and Urban Development (HUD),
through its Federal Housing Administration (FHA), insures billions of
dollars in home mortgage loans made by private lenders.[Footnote 1]
During fiscal year 2003 alone, FHA insured over 1.3 million mortgages
valued at about $160 billion. While FHA insures lenders against nearly
all losses resulting from foreclosed loans, it relies on the lenders to
underwrite the loans and determine their eligibility for FHA mortgage
insurance.[Footnote 2] Oversight of FHA lenders has historically been a
challenge for HUD. In April 2000, we reported on weaknesses in HUD's
lender approval, monitoring, and enforcement efforts.[Footnote 3] We
also reported in January 2003 that, due in part to poor lender
oversight, HUD's single-family mortgage insurance programs remained a
high-risk area for HUD.[Footnote 4] Furthermore, HUD's Office of
Inspector General noted in its most recent semiannual report to
Congress that FHA's single-family mortgage insurance programs continue
to be a major management challenge for the department.[Footnote 5]
While over 10,000 lending institutions are approved to participate in
FHA's single-family mortgage insurance programs, only about 2,900 of
these institutions have direct endorsement authority, meaning that they
can underwrite loans and determine their eligibility for FHA mortgage
insurance without HUD's prior review. Lenders with this authority
underwrite virtually all FHA-insured mortgages for single-family homes.
This report examines (1) how well HUD follows its guidance when
granting lenders direct endorsement authority, (2) the extent to which
HUD uses a risk-based approach when monitoring the lenders
participating in FHA's mortgage insurance programs, and (3) the extent
to which HUD is holding lenders that it identifies as not complying
with its requirements accountable for their performance. We conducted
this review on the initiative of the Comptroller General.
To address our objectives, we reviewed the activities of HUD's
headquarters and its four homeownership centers in Atlanta, Georgia;
Denver, Colorado; Philadelphia, Pennsylvania; and Santa Ana,
California, which administer HUD's single-family housing activities in
all 50 states, the District of Columbia, and Puerto Rico. At each
homeownership center, we reviewed the documentation maintained on
lenders to which HUD had recently granted direct endorsement authority.
We also obtained and analyzed data on the lenders that HUD had targeted
for reviews and on the loans HUD had selected for technical reviews in
fiscal year 2003 and the first two quarters of fiscal year 2004.
Finally, we reviewed case files acted on by the Mortgagee Review Board-
-an enforcement body chaired by HUD's Assistant Secretary for Housing-
Federal Housing Commissioner. We assessed the reliability of the HUD
data we used by discussing the data with knowledgeable agency
officials, reviewing information about the systems, and performing
electronic testing to detect obvious errors in completeness and
reasonableness. We determined that the data were sufficiently reliable
for the purposes of this report.
We performed our work from December 2003 to September 2004 in
accordance with generally accepted government auditing standards.
Appendix I provides additional details on our scope and methodology.
Results in Brief:
HUD's homeownership centers are not consistently following the
department's guidance for granting direct endorsement authority. FHA-
approved lenders must demonstrate "acceptable performance" in
underwriting at least 15 mortgage loans before receiving direct
endorsement authority. HUD's four homeownership centers perform
evaluations, known as preclosing reviews, of these loans in order to
assess lenders' performance. According to HUD's guidance, acceptable
performance is defined as submitting a minimum of 15 loans that are
rated "good" or "fair" within a 1-year probationary period, with the
last 5 consecutive cases rated "good" or "fair." We found, however,
that the homeownership centers have not consistently followed this
guidance, based on our analysis of the preclosing reviews performed for
all 49 lenders that entered the probationary period on or after October
1, 2002, and were granted direct endorsement authority by April 30,
2004. For example, 7 of the 49 lenders were granted direct endorsement
authority, although they did not submit the minimum 15 loans rated
"good" or "fair."
HUD uses a risk-based approach to monitoring lenders, employing
aggregate loan performance data, complaints of irregularities or
fraudulent practices, the results of technical reviews of individual
loans, and/or other factors to target lenders for review. However,
certain factors limit the usefulness of its monitoring tools.
* HUD's technical reviews do not distinguish between different levels
of risk. Technical reviews are desk audits to evaluate the underwriting
quality of individual loans insured by FHA. In February 2004, HUD
implemented an algorithm that allows it to select loans for technical
reviews based on certain risk factors, such as loans made to first-time
homebuyers and adjustable rate mortgages. However, the ratings that are
assigned during technical reviews do not currently reflect the
different levels of risk that underwriting errors pose to the insurance
fund. According to our analysis of technical reviews conducted in
fiscal year 2003 and the first two quarters of fiscal year 2004, 70
percent of the loans rated on mortgage credit analysis received "poor"
ratings, meaning that the lenders made mistakes in evaluating the
borrowers' creditworthiness. Under the current rating system, there is
no way to distinguish a "poor" that represents a deficiency posing a
risk to the insurance fund from a "poor" that represents a compliance
or documentation issue (such as an undated or unsigned form). The
homeownership centers are in the process of revising the rating system
to make it more risk-based. Despite their numbers--over 130,000 in
fiscal year 2003 and the first two quarters of fiscal year 2004--
technical reviews serve a limited purpose and do not help HUD identify
loans that have a high probability of default or loans susceptible to
fraud.
* HUD's reports on lender reviews do not distinguish between on-site
and desk reviews. One of HUD's primary tools for evaluating the quality
of lenders' mortgage-lending practices is lender reviews, which are
generally on-site evaluations of lenders' operations. Since May 2000,
the homeownership centers have been selecting lenders for lender
reviews based on their default and claim rates on FHA-insured
mortgages. We found that, in fiscal year 2003 and the first half of
fiscal year 2004, HUD generally reviewed those lenders that met its
targeting criteria. However, HUD's reports on lender reviews do not
identify the number of reviews that were performed as desk reviews
(off-site reviews). Although HUD's guidance allows staff to complete
desk reviews of lenders' operations, the guidance and homeownership
center officials acknowledge that on-site reviews at the lender's main
office or branch are the preferred method of monitoring lenders'
operations. Because HUD's reports do not routinely track the number of
desk reviews, HUD officials conducted a manual search of their records
and determined that 70 of the 910 lender reviews conducted in fiscal
year 2003 were off-site reviews.
HUD's efforts to hold poorly performing lenders accountable for their
performance have not been comprehensive. HUD has recently proposed
changes to improve the effectiveness of its Credit Watch program--an
enforcement tool used to terminate the loan origination authority of
lenders with excessive default and claim rates on FHA-insured loans.
Specifically, it has proposed holding the lenders that underwrote the
loans, in addition to the lenders that originated the loans,
accountable for excessive defaults or insurance claims. Although HUD's
guidance allows the homeownership centers to suspend the direct
endorsement authority of lenders that fail to comply with FHA's
underwriting requirements, the homeownership centers have made limited
use of this ability. In fiscal year 2003 and the first two quarters of
fiscal year 2004, the Philadelphia homeownership center suspended the
direct endorsement authority of seven lenders; however, the other three
homeownership centers did not take this action against any lenders.
Additionally, the Mortgagee Review Board's (Board) process for
sanctioning lenders is time consuming. The Board, which can impose
administrative sanctions against lenders, has taken over a year to
complete its actions, during which time the lender can continue to make
dozens of loans.
This report contains recommendations designed to improve HUD's
processes for approving and monitoring FHA mortgage lenders and
sanctioning them for unacceptable performance. We provided HUD with a
draft of this report for review and comment. HUD agreed with our
recommendations but disagreed with some of our findings and stated that
the report does not fully recognize the accomplishments resulting from
changes it has made to lender oversight. We did not change our findings
because HUD provided no new evidence, and we believe that the report
appropriately recognizes the progress HUD has made.
Background:
Established by the National Housing Act, FHA insures lenders against
losses on mortgages for single-family homes.[Footnote 6] Lenders
usually require mortgage insurance when a homebuyer has a down payment
of less than 20 percent of the value of the home. FHA mortgage
insurance allows a homebuyer to make a modest down payment and obtain a
mortgage for the balance of the purchase price. FHA plays a
particularly large role in certain market segments, including low-
income borrowers and first-time homebuyers. During fiscal years 2001 to
2003, the number of single-family mortgage loans that FHA insured
annually averaged about 1.2 million. For the 3 years combined, FHA
insured about 3.7 million mortgages with a total value of about $425
billion.
A homebuyer seeking a FHA-insured mortgage must submit a mortgage
application to a FHA-approved lender. Once the lender approves the
loan, it sends the loan documents to HUD for approval of FHA mortgage
insurance. (See fig. 1.) If the borrower defaults and the lender
subsequently forecloses on the loan, the lender can file an insurance
claim with HUD for the unpaid balance of the loan. FHA insures most of
its mortgages for single-family housing under its Mutual Mortgage
Insurance Fund (Fund). To cover lenders' losses, FHA collects insurance
premiums that borrowers pay to lenders and deposits the premiums in the
Fund. The Fund has historically been self-sufficient. An actuarial
study by Deloitte & Touche LLP for fiscal year 2003 indicated that the
Fund exceeded the legislative target for capital reserves.[Footnote 7]
Figure 1: FHA Mortgage Application Process:
[See PDF for image]
[End of figure]
Lenders must obtain approval from HUD to participate in FHA's mortgage
programs. In addition to an application form and fee, lenders are
required to submit supporting documentation, including the resumes of
senior corporate officers; certified financial statements; and
photographs and floor plans of the lender's main office. HUD uses this
information to determine whether the applicants meet FHA's requirements
for lending experience; financial worth; and adequacy of facilities,
among other things. All applicants also must have a written quality
control plan that meets FHA's requirements. Additionally, HUD
determines whether any of the lenders' principal officers are
ineligible to participate in FHA's programs because of outstanding
federal debts; because of recent bankruptcies or derogatory credit; or
because they have been suspended, debarred, or otherwise excluded from
the department's programs and activities. Lenders must be annually
recertified by HUD to maintain their FHA-approved status.
As of August 2004, over 10,000 lending institutions were approved to
participate in FHA's mortgage insurance programs for single-family
homes. Most FHA-approved lenders are authorized to originate FHA-
insured loans, meaning that they can accept mortgage applications,
obtain employment verifications and credit histories on applicants,
order appraisals, and perform other tasks that precede the loan
underwriting process. Approximately 2,900 of the FHA-approved lending
institutions also have direct endorsement authority, meaning that they
can underwrite loans and determine their eligibility for FHA mortgage
insurance without HUD's prior review.[Footnote 8] Underwriting refers
to a risk analysis that uses information collected during the
origination process to decide whether to approve a loan. Virtually all
FHA-insured mortgages for single-family homes are underwritten by
lenders with direct endorsement authority.
Some FHA-approved lenders with direct endorsement authority, known as
sponsoring lenders, enter into agreements to underwrite and fund loans
originated by other FHA lenders who do not have direct endorsement
authority, known as loan correspondents. About 71 percent of FHA's
approved lenders are loan correspondents, meaning that they originate
FHA-insured mortgages and sell or transfer the loan paperwork to
sponsoring lenders for underwriting and approval. According to HUD's
regulations, sponsoring lenders are responsible for the loan
origination activities of their loan correspondents.
HUD's 2020 Management Reform Plan, which was announced in 1997,
consolidated the single-family mortgage housing activities of HUD's 81
field offices into four homeownership centers, each of which is
responsible for a multistate area. (See fig. 2.) The homeownership
centers are located in Atlanta, Georgia; Denver, Colorado;
Philadelphia, Pennsylvania; and Santa Ana, California; and report
directly to the Deputy Assistant Secretary for Single Family Housing in
HUD's Washington, D.C., headquarters.
Figure 2: Geographical Jurisdictions of HUD's Four Homeownership
Centers and Lender Branches in Each Jurisdiction:
[See PDF for image]
[End of figure]
The homeownership centers are responsible for processing and approving
mortgage insurance, as well as implementing several critical aspects of
HUD's lender approval, monitoring, and enforcement activities. These
responsibilities include (1) evaluating, through a process known as
preclosing reviews, loans submitted by FHA-approved lenders seeking
direct endorsement authority and granting direct endorsement authority
to qualified lenders; (2) evaluating lenders' operations, through a
process known as lender reviews, and monitoring lenders' performance
through reviews of individual loans, known as technical reviews; and
(3) taking enforcement actions against lenders that have not complied
with FHA's requirements. HUD's headquarters also has important
approval, monitoring, and enforcement functions. For example, HUD's
headquarters is responsible for annually recertifying lenders that wish
to participate in FHA's mortgage programs. HUD's Credit Watch program,
an initiative to identify and impose sanctions against lenders with
unacceptably high rates of defaults and insurance claims on FHA-insured
mortgages, is managed by HUD's Office of Lender Activities and Program
Compliance. HUD's Mortgagee Review Board, an enforcement body chaired
by HUD's Assistant Secretary for Housing-Federal Housing Commissioner,
can impose administrative sanctions against lenders, including
withdrawing the lenders' authority to make FHA-insured loans.[Footnote
9]
In April 2000, we reported on HUD's lender approval, monitoring, and
enforcement efforts. Among other things, we noted that HUD's guidance
for granting direct endorsement authority was not clear, which led the
homeownership centers to interpret it differently. We also reported
that HUD's monitoring did not focus on the lenders and loans that posed
the greatest insurance risks to the department. In addition, we
observed that the homeownership centers were making only limited use of
their ability to suspend lenders' direct endorsement authority and that
HUD's Credit Watch program pertained only to the lenders that
originated troubled loans.
Homeownership Centers Have Not Consistently Followed HUD's Guidance for
Granting Direct Endorsement Authority:
HUD's homeownership centers, which are responsible for granting direct
endorsement authority to lenders participating in FHA's programs, have
not consistently followed HUD's guidance for granting this authority.
According to departmental guidance, FHA-approved lenders seeking direct
endorsement authority must go through a probationary period and are
required to demonstrate "acceptable performance" in underwriting at
least 15 mortgage loans. During this probationary period, the lenders
send to the homeownership centers mortgage loans that have not yet been
"closed"--that is, the borrower has not yet taken on the loan
obligation. The homeownership centers then evaluate the loans against
FHA's underwriting requirements.[Footnote 10] During these
evaluations, known as preclosing reviews, the homeownership centers
rate the quality of the construction exhibits (for new or rehabilitated
homes), the valuation of the mortgaged property, and the mortgage
credit evaluation of the borrower as "good," "fair," or
"poor."[Footnote 11] (See fig. 3.) According to HUD guidance, a "good"
rating indicates no underwriting deficiencies, a "fair" rating
indicates the presence of deficiencies that would not affect the
insurance eligibility determination, and a "poor" rating indicates
underwriting errors that would significantly increase HUD's insurance
risk. HUD's guidance provides specific criteria for the homeownership
centers to use in determining these ratings.
Figure 3: Preclosing Review Loan Rating Categories and Scoring System:
[See PDF for image]
Note: "N/A" means not applicable. The three loan examples are provided
for illustration only. The overall rating is equal to the lowest rating
assigned to an individual rated category. For example, if one category
is rated "poor," the overall rating for that loan is a "poor."
[End of figure]
In our April 2000 report, we noted that HUD's guidance for granting
direct endorsement authority was unclear because it did not define what
would constitute overall acceptable performance. As a result, we found
that the homeownership centers had implemented the existing guidance
differently and had approved lenders that demonstrated varying levels
of proficiency, including lenders that had made multiple and serious
underwriting mistakes. In response to our report, HUD issued its
current guidance for granting FHA-approved lenders direct endorsement
authority in September 2002. The guidance states that, in order to
qualify for direct endorsement authority, a lender must submit a
minimum of 15 mortgage loans that receive ratings of "good" or "fair"
within a year, with the last 5 consecutive loans rated "good" or
"fair." These 15 mortgages may include loans for home purchase
transactions (including 203(k) loans) and full credit-qualifying
refinances.[Footnote 12] Only 5 of the 15 required mortgages may be
from a combination of automated underwriting, streamline refinances,
and fully underwritten loans denied by other lenders.[Footnote 13] In
addition, a lender cannot submit more than 30 mortgage loans for HUD's
review during this probationary period. The guidance states that, if
the lender has submitted 30 loans and has not met the standards to be
granted direct endorsement authority, the lender must be notified that
it cannot submit mortgage loans for at least 6 months.
Although HUD has issued specific guidance, the homeownership centers
have not consistently followed it. To determine how well each
homeownership center followed HUD's guidance, we analyzed preclosing
review ratings given to the loans submitted by all 49 lenders that
entered the probationary period on or after October 1, 2002, (after the
guidance was implemented) and were granted direct endorsement authority
by April 30, 2004.[Footnote 14] (Approximately 290 other lenders were
in the process of seeking, but had not yet received, direct endorsement
authority as of April 30, 2004.) The 49 lenders submitted an average of
24 loans to the homeownership centers for preclosing reviews.
Our analysis showed that the homeownership centers granted some of the
49 lenders direct endorsement authority in violation of HUD's criteria.
Specifically, we found the following:
* Seven of the lenders did not submit at least 15 mortgage loans that
were rated "good" or "fair."
* Two lenders were granted direct endorsement authority although the
last 5 consecutive loans they submitted were not rated "good" or
"fair."[Footnote 15]
* One lender exceeded the allowed 1-year probationary period, and eight
lenders submitted more than the 30 loans allowed before being granted
direct endorsement authority. The number of mortgage loans submitted by
these lenders ranged from 31 to 73.
Our analysis of the loans submitted by the 49 lenders was based on
information contained in a log maintained for each lender seeking
direct endorsement authority. According to homeownership center
officials, they use this log to determine if a lender has met HUD's
standards. When commenting on the results of our analysis, HUD
officials stated that some of the information in the logs we reviewed
was incorrect. For example, they noted that some of the loans were
incorrectly entered as automated underwriting cases. Because the
information in the log is what the homeownership center officials use
to determine if the standards have been met, we did not change our
findings based on the new information provided by HUD. HUD officials
also noted that they had sometimes used management discretion when
applying the standards. For example, for one case in which we
determined that the last five consecutive cases were not rated "good"
or "fair," the homeownership center staff determined that, despite the
one loan rated "poor" out of the last five, the lender had submitted a
sufficient number of loans rated "good" or "fair" to be approved.
HUD's Monitoring Is Risk-Based, but Certain Factors Limit the
Usefulness of Its Monitoring Tools:
Although HUD has adopted a risk-based approach to monitoring lenders,
certain factors limit the usefulness of the tools it employs. The
homeownership centers rely on two primary monitoring tools to ensure
lenders' compliance with FHA's mortgage requirements: (1) lender
reviews, which are generally on-site evaluations of lenders'
operations, performed by HUD staff and (2) technical reviews, which are
desk audits of the underwriting quality of individual loans already
insured by FHA, performed mainly by contractors. Since May 2000, the
homeownership centers have generally been targeting for review those
lenders they consider to be high risk, but HUD's reports do not
distinguish between on-site and desk reviews. HUD has started selecting
loans for technical reviews based on characteristics associated with
risk and done a better job of tracking the performance of the
contractors that perform most of HUD's technical reviews. However, its
technical review rating system does not currently reflect the different
levels of risk that underwriting errors pose to the insurance fund.
Although HUD Is Following Its Guidance in Targeting High-Risk Lenders,
Its Reports Do Not Identify Desk Reviews:
Since May 2000, the homeownership centers have targeted lenders for
review based on indicators of risk, and our analysis shows that they
have generally reviewed the lenders that they have identified as high-
risk lenders. Although on-site reviews are the preferred method of
monitoring, HUD's reports do not identify the number of desk reviews
performed.
Most Lenders Reviewed Were Targeted Based on Risk:
Lender reviews typically involve an in-depth analysis of a sample of
loans and assessments of lenders' internal control systems for making
loans. If a lender review finds serious deficiencies with specific
loans or the lender's internal controls, HUD may take actions that
reduce the department's insurance risk, such as requiring the lender to
compensate HUD for financial losses that HUD has incurred or may incur
on certain loans. Staff assigned to each homeownership center's quality
assurance division are responsible for scheduling and performing these
reviews. In fiscal year 2003, HUD's homeownership centers conducted 910
lender reviews, exceeding the department's goal of 900 reviews.
In April 2000, we reported that, contrary to HUD's guidance, the
homeownership centers were not always reviewing the lenders that they
considered to pose the highest risks and concluded that HUD lacked a
systematic process for identifying and prioritizing such lenders for
review. In response, HUD issued a May 2000 memo calling for the
homeownership centers to target lenders for lender reviews based on
indicators of risk. Because early defaults and claims--loans reported
as 90 days or more delinquent and loans terminated by claim within the
first 24 months of origination--are an indicator of poor lending
practices that may ultimately result in insurance losses, HUD considers
them to be the primary risk factors in targeting lenders for review.
Thus, each quarter the homeownership centers use data from HUD's
Neighborhood Watch Early Warning System (Neighborhood Watch)--an
information system that displays loan performance data by loan types
and geographic areas--to identify the lenders that pose the highest
risk to the insurance fund in terms of defaults and claims.[Footnote
16] In addition, the guidance lists other factors to be considered when
targeting lenders, including the length of time since their last
review, complaints or reports of irregularities or fraudulent activity
in a lender's practices, and the results of HUD's technical reviews of
individual lenders' loans. (See fig. 4.) According to HUD, the target
reports developed each quarter to identify the lenders to be reviewed
are "fluid;" for example, changes may result if there is a large number
of complaints about a particular lender.
Figure 4: Steps to Be Taken Each Quarter to Target Lenders for Lender
Reviews:
[See PDF for image]
Note: Other factors that the homeownership centers are to consider
during the targeting process include high-risk programs such as the
203(k) program and sudden increases in business volume.
[End of figure]
We found that HUD's homeownership centers are generally following this
guidance when targeting lenders for reviews. All four homeownership
centers provided us with lists of the lenders they targeted for review
in fiscal year 2003 and the first two quarters of fiscal year 2004 and
the lenders they reviewed during the same time period. Overall, our
analysis of these lists showed that about 80 percent of the lenders
reviewed by the four homeownership centers during these six quarters
were lenders on their target lists. As shown in figure 5, the
percentage of lenders reviewed by each homeownership center that were
on their target lists ranged from 68 percent in Denver to 89 percent in
Atlanta.
Figure 5: Extent to Which Lenders Reviewed by Homeownership Centers
Were Targeted Lenders, Fiscal Year 2003 and First Two Quarters of
Fiscal Year 2004:
[See PDF for image]
[End of figure]
Furthermore, about 69 percent of the lenders that were targeted by the
homeownership centers had been reviewed by the end of the six quarters.
As shown in figure 6, the percentage of lenders that were targeted and
reviewed ranged from 57 percent for Santa Ana to 82 percent for
Philadelphia. According to HUD, reviews not completed during the
quarter are carried over to the subsequent quarter and nearly all are
completed.
Figure 6: Extent to Which Lenders Targeted by Homeownership Centers
Were Reviewed, Fiscal Year 2003 and First Two Quarters of Fiscal Year
2004:
[See PDF for image]
[End of figure]
HUD is seeking to improve its risk-based monitoring of lenders.
According to HUD officials, the department has hired a contractor to
help it analyze all collected FHA loan data to determine if more of it
can be used to target lenders for review. According to the statement of
work, the contractor is to design, among other things, a risk-based
model using HUD data that will identify lenders that pose a risk to the
FHA insurance fund.[Footnote 17] In developing this model, the
contractor is to (1) analyze risk-based models used by Fannie Mae,
Freddie Mac, and private mortgage insurers to determine how these
entities evaluate the risk related to single-family loans; (2) analyze
the data available in HUD's data systems that can be used to develop
risk-based model(s); and (3) recommend additional data not already
available in HUD's systems that should be used in the development of a
risk-based model.[Footnote 18]
Reports Did Not Distinguish Between On-Site and Desk Reviews:
According to HUD's guidance on conducting lender reviews, a desk review
may be acceptable for a focused review--a review of a specific
operational area, specific loan type, or specific issue--and necessary
when travel funds are constrained. Even so, both HUD and homeownership
center officials acknowledge that on-site reviews are the preferred
method of monitoring lenders' operations. General HUD guidance on
monitoring states that on-site monitoring reviews are essential for
high-risk programs. In addition, its guidance on conducting lender
reviews lists certain factors that should be considered, including
determining if the lender's office facilities meet HUD's requirements.
For example, when conducting an on-site review a reviewer should, among
other things, observe whether the public can properly identify the
lender. Homeownership center officials also note that on-site reviews
are preferable because they can request additional loans to review on
short notice and they sometimes get leads from employees who want to
disclose problems. On-site reviews also give HUD an opportunity to
provide technical assistance to the lenders.
All four homeownership centers are performing some off-site lender
reviews (i.e., desk reviews); however, their reports do not identify
the number of desk reviews performed. At our request, homeownership
center officials conducted a manual search of their records and
determined that 70 of the 910 lender reviews performed in fiscal year
2003 (about 8 percent) were desk reviews. Although all four
homeownership centers performed at least some desk reviews, HUD's
Office of Lender Activities and Program Compliance, the headquarters
office that oversees lender reviews, described all of the reviews that
the homeownership centers performed in fiscal year 2003 as on-site
reviews in its annual report.
HUD Now Selects Loans for Technical Reviews Based on Risk and Better
Oversees Contractors, but Its Reviews Serve a Limited Purpose:
In response to recommendations in our April 2000 report, HUD has
started selecting loans for technical reviews based on loan risk
characteristics and improved its oversight of the contractors that
perform technical reviews. However, technical reviews serve a limited
purpose because the system used to rate lender performance on
individual loans does not identify the underwriting errors that pose
the greatest risk, and the reviews do not help HUD identify (1) loans
that have a high probability of default or claim or (2) loans
susceptible to fraud.
Selection Is Generally Based on Loan Risk Characteristics:
Technical reviews are desk audits that evaluate the underwriting
quality of individual loans already insured by FHA. They are similar to
preclosing reviews in that HUD evaluates the quality of the
construction exhibits (for new or rehabilitated homes), the valuation
of the mortgaged property, the mortgage credit evaluation of the
borrower, and the loan-closing documents and assigns a "good," "fair,"
or "poor" rating in each applicable category. Reviews revealing serious
deficiencies may result in, among other things, HUD's requiring the
lenders to compensate the department for financial losses or HUD's
suspending the lenders' direct endorsement authority. In total, the
four homeownership centers performed 133,446 technical reviews in
fiscal year 2003 and the first two quarters of fiscal year 2004,
representing 7 percent of the loans that FHA insured during that time
period (see fig. 7).
Figure 7: Percentage of Loans Receiving Technical Reviews, Fiscal Year
2003 and First Two Quarters of Fiscal Year 2004:
[See PDF for image]
[End of figure]
Prior to February 2004, HUD used the Computerized Homes Underwriting
Management System (CHUMS)--a computer system that assists and supports
HUD staff in processing mortgage insurance for single-family homes--to
randomly select a certain percentage of each lender's loans for
technical reviews. However, as we noted in our April 2000 report, HUD's
guidance recommends that the loans selected for technical reviews
should be those that pose a high risk of loss to the insurance fund. In
February 2004, HUD implemented a CHUMS algorithm that provides a risk-
based statistical process for selecting loans for review at time of
approval. The algorithm selects loans for review based on certain
characteristics--such as loans made to first-time homebuyers, loans
with adjustable rate mortgages, and loans for multiple housing units.
According to HUD officials, loans that exhibit these high-risk
characteristics are, all other things being equal, more likely to be
subject to default and/or contain underwriting errors than loans that
do not.
Homeownership center staff also have the ability to adjust, in CHUMS,
the percentage of a lender's loans selected for technical reviews to
more closely monitor certain lenders. For example, HUD's guidance
states that the homeownership centers should perform technical reviews
of 100 percent of at least the first 30 FHA-insured loans made by newly
approved direct endorsement lenders. However, our analysis of loans
made by the 49 lenders that entered the probationary period on or after
October 1, 2002, and were granted direct endorsement authority by April
30, 2004, shows that the homeownership centers have not followed this
guidance. As of June 2004, only 16 of these lenders had used their
direct endorsement authority to make loans. Contrary to HUD guidance,
the homeownership centers had reviewed only about 7 percent of these
lenders' early loans. According to homeownership center officials, they
do not always select the first 30 loans to review because some of the
lender's early loans may have been made by a new branch office of which
they are unaware.[Footnote 19] Also, CHUMS does not automatically
maintain the 100 percent designation used to flag a new lender's early
loans for review. As part of an effort to control the volume of
technical reviews, CHUMS revises some of the review percentages each
quarter. As a result, the 100 percent designation for newly authorized
lenders is sometimes changed to less than 100 percent, causing the
homeownership centers to miss some of these lenders' loans.
Tracking of Technical Review Contractors' Performance Has Improved in
Recent Years:
The large majority of HUD's technical reviews are performed by firms
under contract with the homeownership centers, and HUD has done a
better job of tracking these contractors' performance in recent
years.[Footnote 20] In our April 2000 report, we noted that the
technical review contracts in place at the time contained specific
performance standards expressed as the maximum acceptable percentage of
reviews that could contain significant errors or omissions. However, we
found that three of the four homeownership centers were not tracking
the contractors' work against these standards. As a result, these
homeownership centers lacked the information necessary to evaluate the
quality of the contractors' work or to determine whether actions should
be taken against the contractors for poor performance.
The four homeownership centers are currently evaluating the quality of
their contractors' work. Each homeownership center's technical review
contract states that the contractor must deliver 90 percent of the
completed reviews without any errors. An error is defined as any
instance in which HUD has to change a "poor" rating to a "good" or
"fair" rating or when it has to change a "fair" or "good" rating to a
"poor" rating. To determine if the contractor is meeting this standard,
the contracts require HUD to randomly select and evaluate a minimum of
5 percent of the contractor's completed reviews. If the contractor's
error rate exceeds 10 percent for the review period, HUD's payment will
be reduced by 1 percent for each error percentage point above 10
percent. As shown in figure 8, the homeownership centers reviewed at
least 5 percent of their contractors' work in fiscal year 2003.
Figure 8: Percentage of Technical Review Contractors' Work Reviewed by
Homeownership Centers in Fiscal Year 2003:
[See PDF for image]
[End of figure]
The homeownership centers have used the results of their quality
assurance reviews to track their contractors' performance. For each
month in fiscal year 2003, the four homeownership centers calculated
their contractors' error rate (a total of 60 calculated error rates
because Santa Ana uses two contractors). As a result, they were able to
track whether their contractors exceeded the allowed error rate of 10
percent. As shown in figure 9, three of the four centers identified
that their contractors had exceeded the allowed error rate.
Figure 9: Technical Review Contractors' Fiscal Year 2003 Performance:
[See PDF for image]
[End of figure]
Despite better tracking, the homeownership centers were not always able
to hold their contractors accountable for unacceptable performance.
Only the Santa Ana center could provide us with support that it
assessed contractors a penalty when appropriate in fiscal year 2003.
According to an Atlanta center official, they did not assess a
disincentive to the contractor in fiscal year 2003 when its error rate
exceeded 10 percent because they did not complete their quality
assurance reviews within 30 days. The official also stated that they
had solved the timing problem as of October 2003 and that all reviews
are currently completed within the 30-day requirement in order to
properly assess disincentives. Similarly, a Denver center official
stated that the center did not assess any disincentives because system
problems made it difficult to calculate the error rates correctly. The
center has since corrected the problem, according to the same official.
The Philadelphia center's contractor did not exceed the allowed error
rate in fiscal year 2003.
Technical Reviews Serve Limited Purpose:
Homeownership center staff have questioned the usefulness of technical
reviews because the rating system does not identify the underwriting
errors that pose the greatest risk to the insurance fund. According to
homeownership center officials, the current rating system results in
too many "poor" ratings being assigned. To determine the percentage of
"poor" ratings assigned, we requested data from all four homeownership
centers for fiscal year 2003 and the first two quarters of fiscal year
2004. As shown in figure 10, the percentage of "poor" ratings was over
50 percent for at least one category at three of the four homeownership
centers. At each homeownership center, the highest percentage of "poor"
ratings was in mortgage credit. Overall, 70 percent of the loans that
were rated in the mortgage credit category received "poor" ratings.
Figure 10: Percentage of "Poor" Ratings Assigned during Technical
Reviews Performed in Fiscal Year 2003 and First Two Quarters of Fiscal
Year 2004, by Category:
[See PDF for image]
Note: Not all loans are evaluated in all four categories. For example,
only loans for new or rehabilitated homes receive an architecture and
engineering rating.
[End of figure]
Although HUD guidance states that a "poor" rating indicates
underwriting errors that significantly increased HUD's insurance risk,
homeownership center officials said that the current system does not
distinguish between a "poor" rating that represents a compliance or
documentation issue and a "poor" rating that represents a risk to the
insurance fund. Our analysis of the most common deficiencies cited
during technical reviews performed in fiscal year 2003 and the first
two quarters of fiscal year 2004 shows that the majority of them are
compliance issues. As shown in figure 11, the most common deficiencies
cited often involve problems with paperwork. According to homeownership
center officials, only 3 of the 10 deficiencies that we identified as
the most common represent a risk to the FHA insurance fund.
Figure 11: Deficiencies Most Commonly Cited during Technical Reviews
Performed in Fiscal Year 2003 and First Two Quarters of Fiscal Year
2004:
[See PDF for image]
Note: These were the most commonly cited deficiencies that must result
in a "poor" rating. For some deficiencies, the reviewer has the
discretion to decide, based on the severity of the deficiency, whether
the rating should be "fair" or "poor."
[A] The Credit Alert Interactive Voice Response System is a federal
government database of delinquent federal debtors maintained to
prescreen direct loan applicants for creditworthiness. HUD maintains a
list of parties who have been issued a limited denial of participation-
-an action that excludes a party from further participation in a HUD
program area. The General Services Administration maintains a list of
parties excluded from receiving (1) federal contracts or certain
subcontracts and (2) certain types of federal financial and
nonfinancial assistance and benefits.
[B] The "For Your Protection: Get a Home Inspection" form stresses the
importance of obtaining a home inspection prior to purchase.
[C] The purpose of the homebuyer summary form is to provide timely
information to the buyer for repairs to be completed or property
conditions that have to be satisfied prior to FHA insurance
endorsement.
[D] The HUD-1 form, also called the Settlement Statement, records the
money flows that take place when the ownership of a home is transferred
from a seller to a buyer.
[End of figure]
HUD's financial statement auditors have also questioned the usefulness
of technical reviews. In the audit of FHA's financial statements for
fiscal years 2002 and 2003, the independent auditors noted that
technical reviews, as currently designed, assisted the homeownership
centers in reporting documentation and processing errors back to the
lenders but did not help them identify loans that have a high
probability of default or claim as a result of poor lender underwriting
practices.[Footnote 21] When the auditors analyzed data on the 2,000
lenders with the highest volume of originations, they found no strong
correlation between the percentage of technical review "poor" ratings
received by a lender and the lender's early default and claims rates.
As a result, the auditors recommended that HUD consider redesigning the
technical review process as an early warning control that better
predicts loan performance so that it could be used not only as a lender
monitoring tool but also as an effective tool to assist FHA in
identifying lenders that originate loans that have a high probability
of going to default or claim.
HUD officials acknowledged that technical reviews were not designed to
help HUD identify loans that have a high probability of default or
claim or loans susceptible to fraud; instead, they were designed to
evaluate the quality of the lender's underwriting. The department has
taken several steps to make technical reviews more meaningful,
according to HUD officials. First, HUD has converted the Underwriting
Reports System--the system used to track the results of technical
reviews--to a web-based system, which will allow it to perform more
analysis of the technical review ratings. Second, HUD plans to revise
the deficiency codes used to assign technical review ratings.
Currently, there are over 250 codes for mortgage credit and valuation
issues. The homeownership centers have proposed reducing that number
substantially and replacing the "poor" rating with a "risk issues"
rating--reserved for those deficiencies that affect the eligibility of
the loan--and the "fair" rating with a "compliance issues" rating,
given for those errors that do not affect eligibility.
Efforts to Hold Lenders Accountable for Poor Performance Have Not Been
Comprehensive:
To hold lenders accountable for poor performance, HUD may (1) terminate
their loan origination authority through its Credit Watch program, (2)
suspend their direct endorsement authority, or (3) take enforcement
action through its Mortgagee Review Board. HUD has terminated the loan
origination authority of 262 lender branch offices and has recently
proposed changes to make its Credit Watch program more effective as a
means of sanctioning lenders responsible for high rates of defaults and
insurance claims. However, the homeownership centers have rarely used
their ability to suspend direct endorsement authority. Further, HUD's
Mortgagee Review Board sometimes takes a year or more to take action
against lenders for program violations, during which time the lender
can continue to make dozens of loans.
HUD Has Proposed Credit Watch Changes to Improve Program's
Effectiveness:
HUD has recently proposed changes to improve the effectiveness of its
Credit Watch program. In May 1999, HUD announced that it would begin to
use its Credit Watch program to sanction lenders with excessively high
loan default and claim rates. Initially, HUD planned on a quarterly
basis to (1) terminate the loan origination authority of any lender
branch office whose default and claim rates on mortgages insured by FHA
during the preceding 24 months exceeded both the national average and
300 percent of the average rate for the HUD field office serving the
lender's geographic location (field office rate) and (2) place on
Credit Watch status the branch offices whose default and claim rates
exceeded 200 percent of the average field office rate. While on Credit
Watch status, the branch could continue to originate FHA-insured loans,
but HUD would review the insured loans that the branch originated
during a 6-month period from the date the Credit Watch status became
effective for excessive default rates. In October 2001, HUD announced
that it was eliminating the placement of lenders on Credit Watch status
because advanced warning of excessive default and claim rates was no
longer necessary since the department had provided lenders with access
to their performance via Neighborhood Watch. Also, in September 2002,
HUD stated that it would be gradually reducing the 300 percent
termination threshold set for the HUD field office rate to the 200
percent allowed in HUD's regulations.
As of July 2004, HUD had conducted 19 rounds under its Credit Watch
initiative, with the last round being based on analysis of the 24-month
period ending December 31, 2003.[Footnote 22] This program has resulted
in the department's termination of 262 branch offices' loan origination
authority.[Footnote 23] As shown in figure 12, the number of branch
offices that were terminated as a result of each round has varied.
Figure 12: Results of the First 19 Rounds of HUD's Credit Watch
Program:
[See PDF for image]
[End of figure]
Currently, the regulations governing HUD's Credit Watch program only
allow the department to hold the lenders that originated the troubled
loans accountable for excessive defaults or insurance claims. The
regulations do not address HUD's authority to also hold accountable
those lenders that have underwritten the loans. When originating
mortgage loans, lenders perform such functions as accepting mortgage
applications and obtaining employment verifications and credit reports
on the borrowers. When underwriting mortgage loans, lenders use this
information to determine whether borrowers are able to make their
mortgage payments and whether the loans should be approved. As shown in
figure 12, 44 percent of the lenders terminated during the first 19
rounds of Credit Watch were loan correspondents--lenders that sell or
transfer loans that they originate to other FHA lenders, known as
sponsoring lenders, for underwriting and approval.
In response to a recommendation in our April 2000 report, HUD has
published a proposed rule making several amendments to the Credit Watch
program, including holding underwriting lenders accountable for
excessive default and claim rates.[Footnote 24] The proposed rule,
issued in April 2003, includes several changes designed to strengthen
HUD's capacity to safeguard the FHA mortgage insurance fund.
Specifically, it proposes, among other things, applying the default and
claim threshold to both originating and underwriting lenders and
prohibiting a lender from opening a new branch office in the same
lending area as an existing branch that has received a notice of
proposed termination. The proposed rule was open for comments through
June 2, 2003, and HUD submitted an interim rule to the Office of
Management and Budget in July 2004.
Homeownership Centers Rarely Used Their Ability to Suspend Lenders'
Direct Endorsement Authority:
HUD's homeownership centers have made limited use of their ability to
suspend the direct endorsement authority of lenders that fail to comply
with FHA's program requirements. Lenders whose direct endorsement
authority is suspended but who wish to continue underwriting mortgages
insured by FHA must submit each proposed mortgage case file to a
homeownership center, which evaluates the lenders' underwriting
decisions before deciding whether to insure the loans. The lenders must
follow this procedure until HUD's evaluations of the case files
indicate that the lenders have demonstrated satisfactory performance in
underwriting loans.
HUD's guidance allows the homeownership centers to suspend direct
endorsement authority but does not prescribe the circumstances under
which the homeownership centers must do so. HUD's handbook on the
direct endorsement program provides general guidelines. For example,
the guidance states that the homeownership centers should consider
suspending lenders that exhibit "patterns" of noncompliance, but it
does not define what would constitute a pattern. After our April 2000
report recommended that HUD clarify and implement guidelines for
identifying lenders whose direct endorsement authority should be
suspended, the department issued supplemental guidance in a November
2000 memo. The memo describes certain conditions under which the
homeownership centers may suspend direct endorsement
authority.[Footnote 25]
Among the four homeownership centers, we found that the Philadelphia
homeownership center was the only one that suspended the direct
endorsement authority of any lenders during fiscal year 2003 and the
first two quarters of fiscal year 2004. Specifically:
* The Philadelphia homeownership center took this action against seven
lenders during this time frame, citing underwriting violations
identified during technical reviews and high default rates.[Footnote
26]
* Although the Denver homeownership center did not suspend any lender's
direct endorsement authority during the same time period, it had warned
seven lenders that it might do so if they did not address underwriting
deficiencies revealed in technical reviews.
* Rather than suspending a lender's direct endorsement authority,
Atlanta homeownership center officials told us they will work with
problem lenders to develop performance improvement plans. Such plans
generally involve raising the percentage of a lender's loans that are
selected for technical reviews, meeting with the lender to discuss its
performance, and requiring the lender's staff to take training.
* Similarly, Santa Ana homeownership center officials said that they
tend to increase the percentage of a lender's loans that are selected
for technical reviews instead of suspending direct endorsement
authority.
HUD officials provided several reasons why they do not make more use of
their ability to suspend direct endorsement authority. Officials at all
four homeownership centers told us that suspending lenders would create
an additional workload for them. Atlanta and Santa Ana officials also
noted that suspending a lender's direct endorsement authority would
threaten the lender's business. In addition, Denver officials observed
that large lenders, when faced with suspension at one branch, would
just send all their FHA loans to another branch. Finally, Santa Ana
officials stated that, as long as the percentage of "poor" ratings
assigned during technical reviews was so high, they did not want to
rely on them as grounds for suspending direct endorsement authority.
Headquarters officials noted that they want the homeownership centers
to conduct lender reviews after problems are identified during
technical reviews rather than immediately suspend lenders' direct
endorsement authority.
Although HUD's homeownership centers suspended the direct endorsement
authority of relatively few lenders in fiscal year 2003 and the first
two quarters of fiscal year 2004, our analysis of HUD's technical
review ratings for the same time period showed frequent noncompliance
by lenders with FHA's requirements. About 7,800 lender branch offices
received technical review ratings for mortgage credit analysis for the
FHA-insured mortgages they underwrote.[Footnote 27] Of these branch
offices, we identified 1,203 that had at least 10 loans reviewed and
received a "poor" rating for mortgage credit analysis--meaning that the
lenders made mistakes in evaluating the borrowers' creditworthiness--on
75 percent or more of their reviewed loans. Even though the current
rating system does not identify the underwriting errors that pose the
greatest risks, this level of noncompliance indicates that more lenders
may be candidates for enforcement action.
Mortgagee Review Board's Process for Sanctioning Lenders Is Time-
Consuming:
HUD's Mortgagee Review Board (Board) can impose administrative
sanctions against FHA lenders that commit program violations, such as
withdrawal of a lender's FHA approval. HUD does not have guidelines for
the time it should take for the Board to take enforcement actions
against lenders. We found the process can take over a year from the
time the lender is notified of its violations to Board action.
The majority of the cases referred to the Board are the result of
lending violations revealed in lender reviews performed by HUD's
homeownership centers. Once the Board reviews and accepts a referral,
it sends the lender a notice of violation that provides the lender 30
days to respond in writing to the Board. After reviewing the lender's
response, the Board decides what actions to take. The Board may impose
a number of sanctions against FHA-approved lenders, ranging from a
letter of reprimand--a letter informing the lender of the existence or
occurrence of a violation of HUD's requirement and directing the lender
to bring and maintain its activities into conformity with all HUD
requirements--to withdrawal of a lender's FHA approval. During the
period of withdrawal (generally 3 to 5 years), HUD will not insure any
mortgage originated by the withdrawn lender. Except for a letter of
reprimand, the lender has a right to a hearing before the Board's
sanction becomes final.
The majority of the Board's actions result in settlement agreements,
which require lenders to indemnify improperly originated loans; pay
fines; and/or take actions to prevent future lending violations. In
June 2004, we reviewed the Board's records for the 32 cases involving
single-family housing lenders that the Board had acted on in the
previous 12 months.[Footnote 28] We found that in 22 of the 32 cases,
the Board had either reached a settlement agreement with the lender (20
cases) or was still attempting to reach a settlement agreement (2
cases).[Footnote 29] In 8 of the cases, the Board had withdrawn the
lenders' FHA approval. In the remaining 2 cases, the Board had either
assessed a civil money penalty (1 case) or was still pursuing a civil
money penalty (1 case).
Our analysis of the 32 cases further showed that the Board's effort to
review the cases and impose sanctions against lenders or to enter into
settlement agreements with them is frequently a time-consuming process.
As figure 13 shows, it took an average of 6.7 months from the notice of
violation to withdraw lenders' FHA approval and an average of 11.1
months to reach settlement agreements. For the one case where the Board
assessed a civil money penalty, it took 27.6 months from the notice of
violation to complete the action. The process is even lengthier when
considering the time elapsed between the referral and the final Board
action. It took an average of 10.3 months from the referral to withdraw
lenders' FHA approval and an average of 17.7 months to reach settlement
agreements. It took 34.8 months from the referral to assess one lender
a civil money penalty.
Figure 13: Status of the Mortgagee Review Board's Actions on 32 Cases
as of June 2004:
[See PDF for image]
[End of figure]
The length of time required by the Board to complete its actions
allowed nine of the lenders to continue making FHA-insured loans for
over a year without being held accountable for their violations. For
example, in April 2003, the Board sent a notice of violation to one of
these lenders because the lender had committed several violations,
including allowing non-FHA approved entities to originate loans,
failing to properly verify borrower information, and charging excessive
and/or unallowable fees. By the time the Board withdrew the lender's
FHA approval in April 2004, the lender had made 584 additional FHA-
insured mortgage loans.
The length of time required for the Board to withdraw lenders' FHA
approval has improved somewhat since our April 2000 report. We found
then that, for the six cases completed during our time frame for that
report, it took an average of 8.5 months from the notice of violation
to withdraw lenders' FHA approval (as opposed to 6.7 months for the
completed cases we reviewed in June 2004).[Footnote 30] The length of
time required for settlement agreements is about the same. We reported
in April 2000 that it took an average of 11.2 months to reach the five
completed settlement agreements, which is similar to the 11.1 months
for the completed cases we reviewed in June 2004. At that time, Board
officials told us that they had taken some steps to speed up the
process. For example, the Board's secretary told us that in December
1998 the Board had adopted a policy of meeting every 2 months to
consider case referrals. This official told us that prior to adopting
this policy, the Board did not have an established meeting schedule and
met only whenever a sufficient number of cases had accumulated for
review. Also, to speed up the settlement agreement process, the Board
planned in future violation letters to ask the lenders whether they
would be willing to settle their cases and, if so, under what terms and
conditions.
HUD officials recognize that the Mortgagee Review Board process can be
time-consuming and have taken some steps to speed it up. They noted
that progress on certain cases can be slowed when HUD's Office of
Inspector General requests that the Board place a hold on the
processing of cases against lenders until the Inspector General has
completed its investigations. During fiscal years 2003 and 2004, the
Inspector General asked for a hold on 14 cases. In accordance with its
plans, the Board has started asking lenders prior to Board meetings
whether they would be willing to settle their cases. If a lender's
settlement offer is acceptable to the Board, a settlement agreement can
be prepared and signed immediately. If a lender's offer is not
acceptable, the Board can then make its own proposal for settling the
case. Also, the Board has hired new staff and plans to implement an
internal quality control process by the end of calendar year 2004.
Conclusions:
FHA insures tens of billions of dollars in mortgages for single-family
homes each year. While FHA's Mutual Mortgage Insurance Fund is
financially healthy, poor lending practices could adversely affect the
Fund's financial position. Because lenders underwrite virtually all
FHA-insured mortgages without HUD's prior review, it is essential that
HUD allow only qualified lenders to participate in its single-family
programs, adequately monitor lenders and loans to assess the risks they
pose, and hold lenders accountable for the quality of the loans they
make.
Contrary to HUD's guidance, the homeownership centers have granted
direct endorsement authority to some lenders that did not demonstrate
performance that is acceptable under HUD's criteria. Ensuring that the
lenders that are being granted direct endorsement authority demonstrate
acceptable performance would better assure HUD that these lenders are
qualified to underwrite loans without HUD's prior review. By not
following HUD's guidance, the homeownership centers may be exposing the
department to unreasonable insurance risks.
The homeownership centers generally use a risk-based approach to
monitoring, which helps them to focus on the lenders and loans posing a
high insurance risk to the department. However, HUD's oversight of
lenders could be improved. First, while the homeownership centers are
targeting high-risk lenders for examination, they do not always conduct
these reviews on-site at the lenders' offices, even though HUD's
guidance states that on-site reviews are the preferred method of
monitoring. Tracking the lender review process to distinguish between
desk and on-site reviews would help HUD ensure that the majority of
high-risk lender reviews continue to be conducted on-site. Second,
contrary to HUD's guidance, the homeownership centers have not
consistently targeted for technical reviews loans made by newly
approved lenders. This lack of consistency is due in part to weaknesses
in the information system (CHUMS) HUD uses to select loans for
technical reviews. Third, the ratings that are assigned during
technical reviews do not currently reflect the different levels of risk
that underwriting errors pose to the insurance fund. The homeownership
centers have proposed revisions to the rating system, which, if
implemented, may better ensure the usefulness of technical reviews in
identifying the lenders that pose the greatest insurance risk to the
department. Because of these conditions, HUD's lender reviews and
technical reviews are not as effective as they could be in mitigating
financial losses to the department.
HUD has not taken sufficient steps to hold lenders accountable for poor
performance and program violations. HUD's reviews show that numerous
lenders did not comply with FHA's underwriting requirements, yet HUD's
homeownership centers have suspended the direct endorsement authority
of relatively few lenders. Even though the technical review rating
system as currently implemented does not properly reflect the risk that
different underwriting errors pose to the insurance fund, the extent of
lender noncompliance revealed by the reviews indicates that more
lenders may be candidates for enforcement action. By failing to suspend
poorly performing lenders, HUD leaves itself vulnerable to lending
practices that increase the department's insurance risk.
Recommendations for Executive Action:
To improve HUD's oversight of FHA mortgage lenders, we recommend that
the Secretary of HUD direct the Assistant Secretary for Housing-Federal
Housing Commissioner to take the following five actions:
* Ensure that the homeownership centers are following the guidance for
granting direct endorsement authority.
* Track lender reviews to distinguish between desk and on-site reviews.
* Enhance FHA's information system to ensure that the first 30 loans
made by new direct endorsement lenders are reviewed as required.
* Expeditiously complete efforts to revise the technical review rating
system so that the ratings better reflect the risks that different
underwriting errors pose to the FHA insurance fund.
* Develop and implement guidance specifying the conditions under which
a homeownership center must suspend a lender's direct endorsement
authority.
Agency Comments and Our Evaluation:
We provided a draft of this report to HUD for its review and comment.
In a letter from the Assistant Secretary for Housing-Federal Housing
Commissioner (see app. II), HUD agreed with our five recommendations.
Specifically, HUD:
* agreed that it would update its guidance for granting direct
endorsement authority and ensure that the homeownership centers
consistently apply the requirements for granting direct endorsement
authority;
* stated that its lender tracking system had been modified to
distinguish between desk and on-site reviews;
* noted that it was aware of the limitations of its information system
to accurately identify and count the first 30 loans made by new direct
endorsement lenders, and was pursuing system enhancements to ensure
that loans made by new direct endorsement lenders are reviewed as
required;
* stated that it was in the final phase of implementing a new technical
review rating system, to be completed by January 2005; and:
* stated that it was currently developing consistent standards for
returning lenders to preclosing status (i.e., suspending lenders'
direct endorsement authority) and that implementation would occur by
January 2005.
HUD also highlighted its program accomplishments, commenting that,
while the report acknowledges that FHA has implemented policy and
procedural changes since our last review, it does not fully recognize
the substantial achievements and accomplishments that resulted from
these changes. The department described improvements in lender
monitoring, lender approval and recertification, and lender training,
among other things. While we agree that HUD has made improvements, a
number of the accomplishments cited were outside the scope of our
review. Our draft report recognized a number of specific improvements
that were relevant to our objectives. For example, we noted that HUD
had revised its guidance for granting direct endorsement authority and
started targeting lenders and loans for review based on risk.
HUD also disagreed with some of our findings. First, HUD stated that
our discussion of the percentages of lenders targeted and reviewed
(figs. 5 and 6) did not acknowledge that target reports developed each
quarter to identify the lenders to be reviewed are fluid and decisions
regarding which lenders to review are subject to outside influences.
For example, staff may be directed to complete other reviews based on
information from sources other than Neighborhood Watch. HUD also noted
that the reviews not completed during the quarter are carried over to
the subsequent quarter and nearly all are completed. We included
figures 5 and 6 in our draft report as empirical evidence supporting
our statement that the homeownership centers generally were reviewing
the lenders on their targeting list. Further, our draft report--in the
text preceding figure 4--acknowledged that the centers used other
information to develop their targeting lists, specifically citing
examples such as the existence of complaints about lenders.
Nevertheless, we added to this text based on HUD's comments.
Second, regarding the Mortgagee Review Board, HUD noted that the Board
carries out a highly regulated administrative process that may lead to
serious sanctions and penalties for lenders; therefore, the department
is obligated to afford maximum due process to these lenders. HUD also
stated that our conclusion that the length of time it takes for the
Board to act on a case allows a lender to continue with inappropriate
practices is misleading because (1) HUD staff communicate the findings
of lender reviews to lenders during mandatory exit conferences and (2)
the Board has the ability to suspend a lender or move a case quickly
through the process when significant problems are found. We do not
agree that the statement is misleading. Our report stated that the
length of time required by the Board to complete its actions allowed
nine lenders to continue making FHA-insured loans for over a year
without being held accountable for their violations. While HUD may
notify a lender of violations found during a lender review, such
notification does not guarantee that the lender will choose to correct
or improve its practices. Finally, although the Board has the ability
to suspend lenders, it did not choose to suspend the nine lenders we
highlighted in our report.
HUD agreed with our statement that HUD's preferred method for
monitoring is to conduct on-site reviews of lenders. It also noted that
the difference between a desk review and an on-site review is minimal,
but went on to say that its tracking system had been modified to
distinguish between desk and on-site reviews. Finally, HUD stated that
it anticipates publication of the Credit Watch regulation discussed in
the report by the second quarter of fiscal year 2005.
We are sending copies of this report to the Secretary of Housing and
Urban Development and to other interested congressional committees. We
also will make copies available to others upon request. In addition,
the report will be available at no charge on the GAO Web site at
[Hyperlink, http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact me at (202) 512-8678 or woodd@gao.gov or Paul Schmidt at (312)
220-7681 or schmidtpj@gao.gov. Staff contacts and other key
contributors are listed in appendix III.
Sincerely,
David G. Wood:
Director, Financial Markets and Community Investment:
[End of section]
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
Our objectives were to examine (1) how well the Department of Housing
and Urban Development (HUD) follows its guidance when granting lenders
direct endorsement authority, (2) the extent to which HUD uses a risk-
based approach when monitoring the lenders participating in the Federal
Housing Administration's (FHA) mortgage insurance programs, and (3) the
extent to which HUD is holding lenders that it identifies as not
complying with its requirements accountable for their performance.
To determine how well HUD follows its guidance when granting lenders
direct endorsement authority, we reviewed HUD's regulations,
procedures, and other guidance relating to its process for approving
lenders and granting lenders direct endorsement authority. Lenders with
direct endorsement authority can underwrite and close FHA-insured
mortgage loans without prior FHA review or approval. We interviewed
officials from HUD's Office of Lender Activities and Program
Compliance, Office of Single Family Program Development, and its four
homeownership centers. We requested from each homeownership center the
number of lenders that entered the probationary period on or after
October 1, 2002, and were granted direct endorsement authority by April
30, 2004. We chose October 1, 2002, as the start date because HUD
revised its guidance for granting lenders direct endorsement authority
in September 2002. We used April 30, 2004, as our ending date because
we visited the four homeownership centers in May and June 2004. For
each of the 49 lenders that were approved during this time period, we
reviewed documentation maintained by the centers and entered the
ratings that the lender received on the mortgages it submitted to the
center into a data collection instrument.[Footnote 31] All of the data
collected was independently verified. We then analyzed the data to
determine whether the centers followed FHA's procedures for granting
lenders direct endorsement authority.
To determine the extent to which HUD is using a risk-based approach
when monitoring lenders, we reviewed HUD's guidance and procedures for
conducting lender reviews (i.e., reviews of lenders' operations by HUD
staff) and technical reviews (i.e., reviews of individual loans
performed after approval of mortgage insurance to assess the quality of
lenders' underwriting practices). We reviewed HUD's use and oversight
of contractors that perform technical reviews. We interviewed officials
at each of the centers on a variety of issues dealing with lender
reviews and technical reviews. The issues discussed included the (1)
centers' criteria for targeting loans and lenders for review, (2)
number of off-site lender reviews, (3) the number and type of "poor"
ratings assigned during technical reviews, and (4) procedures for
monitoring the work of technical review contractors. We also
interviewed Fannie Mae and Freddie Mac to discuss their efforts to
monitor the lenders that participate in their programs.
In addition to these steps, we obtained and analyzed lists of the
lenders that the homeownership centers targeted for lender reviews in
fiscal year 2003 and the first two quarters of fiscal 2004 and the
lenders they reviewed during the same time period. (We analyzed six
quarters of data to ensure that the most recent data was considered.)
We compared the lenders reviewed with those that were targeted to
assess the extent to which HUD was performing lender reviews on lenders
that it considered to pose a high risk to the insurance fund. We also
analyzed the data to determine the percentage of targeted lenders that
were reviewed.
To determine the extent to which the homeownership centers were
reviewing the first 30 loans made by new direct endorsement lenders, we
analyzed data from HUD's Single Family Data Warehouse on the loans
endorsed by the 49 direct endorsement lenders that entered the
probationary period on or after October 1, 2002, and were granted
direct endorsement authority by April 30, 2004. Only 16 of the 49
lenders had endorsed loans as of June 19, 2004.
To determine the percentage of "poor" ratings each lender received
during technical reviews, we analyzed data from HUD's Underwriting
Reports System for fiscal year 2003 and the first two quarters of
fiscal 2004. When we requested the data from each homeownership center,
the Philadelphia and Santa Ana centers provided just the technical
reviews where the review date was within our six-quarter time frame. In
contrast, the Atlanta and Denver centers provided databases that
included reviews outside our scope (including reviews where the review
date was blank). To be consistent with the data that the other two
centers provided, we limited our analysis of the data provided by
Atlanta and Denver to just those technical reviews where the review
date was within our six-quarter time frame. We used this data to
determine the percentage of "poor" ratings assigned during technical
reviews and the most common deficiencies cited during technical
reviews.
To determine the extent to which HUD is holding lenders that it
identifies as not complying with its requirements accountable for their
performance, we reviewed HUD's regulations and policy guidance to
determine the enforcement options available to HUD. We interviewed
officials from HUD's Office of Lender Activities and Program
Compliance, Enforcement Center, and Mortgagee Review Board. At each of
the four homeownership centers, we discussed with cognizant officials
each center's efforts to take enforcement actions against lenders that
have violated program requirements. We determined the number and types
of lenders sanctioned by HUD under its Credit Watch program as of the
end of July 2004. In June 2004, we reviewed the Board's files for the
32 cases involving single-family mortgage lenders that the Board had
acted on in the previous 12 months and determined the nature and status
of the Board's actions. In addition, we analyzed data to determine the
length of time it took the Board to take action against these lenders.
To assess the reliability of the various HUD data we used, we discussed
the data with knowledgeable agency officials, reviewed information
about the systems, and performed electronic testing to detect obvious
errors in completeness and reasonableness. We determined that these
data were sufficiently reliable for the purposes of this report.
We performed our work from December 2003 to September 2004 in
accordance with generally accepted government auditing standards.
[End of section]
Appendix II: Comments from the Department of Housing and Urban
Development:
U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT:
WASHINGTON, DC 20410-8000:
ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER:
OCT 27 2004:
Mr. David Wood, Director:
Financial Markets and Community Investment:
U.S. Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Mr. Wood:
Thank you for permitting the Federal Housing Administration (FHA) the
opportunity to address the Draft Report, "Single Family Housing:
Progress Made, but Opportunities Exist to Improve HUD's Oversight of
FHA Lenders." While the report acknowledges that FHA has implemented
policy and procedural changes since the last GAO audit, performed in
2000, it does not fully recognize the substantial achievements and
accomplishments that resulted from these changes. FHA believes it is
not only appropriate, but also necessary for the report to clearly
present and highlight these significant achievements. FHA's response to
the GAO report is organized into three sections: 1) Program
Accomplishments; 2) Response to GAO Findings/Factual Errors; and 3)
Response to Recommendations for Executive Action.
Section 1: Program Accomplishments:
Since publication of the April 2000 GAO report, "Single Family Housing:
Stronger Oversight of FHA Lenders Could Reduce HUD's Insurance Risk,"
FHA has made significant and dramatic improvements. These
accomplishments and activities are listed below:
A) Lender Monitoring:
* Since GAO's last audit, FHA has conducted over 900 monitoring reviews
per year, and has targeted these reviews more precisely on the lenders
that pose the greatest risk to FHA. Although the number of lender
monitoring reviews conducted has remained fairly stable, the actions
and sanctions resulting from the reviews have increased. In several
important categories, the number of sanctions or the dollar amount have
more than doubled; referrals to HUD's Office of Inspector General (OIG)
have more than quintupled.
The following table represents actions/sanctions taken with respect to
lenders, comparing approximately the three years prior to GAO's last
audit with the three years since the audit.
LENDER ACTIONS/SANCTIONS
[See PDF for image]
The dollar amount is based on the historical average loss of $30,000;
The dollar amount is based on the more recent average loss of $23,300:
[End of table]
* For FY 2004, the actions and sanctions resulting from risk-based
lender monitoring reviews remain at the same high level. For example,
the Mortgagee Review Board took action against 32 lenders, withdrew the
FHA approval of 8 of them, and assessed $2.33 million in civil money
penalties. Nearly 2,600 indemnification agreements were executed, for a
potential savings to the FHA Insurance Funds of more than $60 million.
In addition, over 250 referrals were made to the OIG for further
investigation.
* FHA has lowered the Credit Watch threshold from 300% of the local
field office early default rate, to 200%. FHA started this process in
FY 2003, gradually lowering the Credit Watch threshold each quarter,
and fully implemented the 200% standard beginning with the first
quarter of FY 2004. The effect of the new threshold is shown by the
increased number of lenders targeted for termination in recent
quarters, as documented in Figure 12 of the GAO draft report. Since
Credit Watch started in May 1999, FHA has terminated 261 lender
branches, placed 219 branches on warning status, and currently has
another 14 branches under review.
* FHA has enhanced the Neighborhood Watch Early Warning system to make
available additional lender and loan data and offer the flexibility to
sort and array this information in a variety of optional standard
reports. HUD uses Neighborhood Watch to perform risk-based targeting of
lenders for on-site lender reviews, but the tool has also proven to be
a valuable asset to HUD's OIG. The lending industry uses the system as
a self-policing tool to monitor the performance of its branches and
overall operations as well as for monitoring current and potential
business partners. It is available to the public and used by consumer
advocacy groups to monitor lenders' performance within their
communities.
* FHA has implemented a "Comprehensive Review" approach for its largest
lenders. Instead of reviewing the largest lenders at only the branch
level, these in-depth reviews are designed to evaluate a lender's
entire operation, focusing on institutional loan volume, the activities
of the lender's retail sponsors, underwriting, servicing policies and
procedures, and any high-risk areas of its business.
B) Lender Approval and Recertification:
FHA's new lender recertification procedures also enhance FHA's ability
to mitigate risk. The Lender Assessment Sub-System (LASS), implemented
in September 2002, uses early warning indicators to identify FHA-
approved lenders that fail to meet FHA financial requirements or that
are experiencing financial stress. By flagging financially unstable
lenders, LASS enables FHA to quickly deny recertification to lenders
that pose a risk to FHA. Under the previous manual recertification
procedures, FHA required on average 90 to 180 days to determine which
lenders required removal, produce and send a notification of deficiency
letter, and terminate the lender. Now, FHA knows within one hour of the
lender's recertification due date whether the lender is deficient and
can immediately issue a 30-day deficiency notice, followed by a
termination notice if the problems are not corrected within 30 days.
LASS also provides FHA a more comprehensive financial analysis and
assessment of a lender's risk to FHA. FHA removes on average 1500
lenders per year, and the improved efficiency has allowed FHA to devote
staff to other lender oversight activities.
* FHA has implemented the "pay.gov" system to allow lenders to pay their
annual recertification fee electronically via the FHA Connection.
* FHA has completed implementation of LASS for submission and analysis
of over 5,500 annual recertification audits. FHA has dedicated 5 full-
time, licensed, professional auditors to review all audits identified
as deficient.
FHA has enhanced the LASS system to allow additional electronic
processing of termination appeals and targeting of lenders for on-site
reviews based on key financial indicators, such as: net profitability,
measured by net income to total assets; available liquid capital,
measured by current assets minus current liabilities; capacity to meet
ongoing fixed expenses, measured by current assets to current
liabilities; and overall debt, measured by total liabilities to total
assets. These indicators for individual lenders will be compared to
industry benchmarks as well as lender peer groups.
* FHA has reorganized the Lender Approval and Recertification Division
into two branches to improve management of the approval and
recertification functions.
C) Mortgagee Review Board:
The Mortgagee Review Board function was transferred back to the Office
of Lender Activities and Program Compliance (OLA) from the Office of
General Counsel, Departmental Enforcement Center, in late November
2003. In less than a year, OLA has taken a number of actions to improve
the coordination between the participants involved, while streamlining
the process. Personnel changes in the Board staff have resulted in a
better mix of skills and experiences. The position of Secretary to the
Board has also been merit staffed.
D) Regulations:
Since GAO's previous report, FHA has published five final rules to
strengthen lender accountability and improve lender compliance with FHA
requirements. Summaries of the final rules are provided below:
* Final Rule FR-4592-F-02 (Effective August 9, 2002), Single Family
Mortgage Insurance, Section 203(k) Consultant Placement and Removal
Procedures enacted 24 CFR §200 & §203, establishing placement and
removal procedures for HUD's list of qualified consultants under the
Section 203(k) Rehabilitation Loan Insurance Program. A 203(k) lender
may select a qualified independent consultant, who is an expert in the
field of home inspection, cost estimating, and construction, to perform
various tasks required for the rehabilitation of the property. The
establishment of these placement and removal procedures better protects
203(k) borrowers and lenders as well as safeguards the FHA insurance
fund.
* Final Rule FR-4615-F-02 (Effective June 2, 2003), Prohibition of
Property Flipping in HUD's Single Family Mortgage Insurance Programs
enacted 24 CFR §203.37 and amended § 203.255, to prohibit property
"flipping," the practice whereby a property recently acquired is resold
for a considerable profit with an artificially inflated value, often
abetted by a lender's collusion with the appraiser. Specifically, the
final rule prohibits FHA insured financing of properties purchased and
resold within a 90 day period and requires additional information on
properties resold in 90 to 180 days that increase in value by 100%. The
new requirements are designed to protect FHA homebuyers from becoming
victims of predatory flipping activity.
* Final Rule FR-4620-F-02 (Effective June 16, 2003), Appraiser
Qualifications for Placement on FHA Single Family Appraiser Roster,
amended 24 CFR §200.202 & §200.24, strengthening the licensing and
certification requirements for placement on the FHA Appraiser Roster.
Appraisers on the FHA Appraiser Roster must have credentials that are
based on the minimum licensing/certification standards issued by the
Appraiser Qualifications Board of the Appraisal Foundation. The final
rule also provides that an appraiser whose license or certification in
any state has been revoked, suspended, or surrendered as a result of a
state disciplinary action will be automatically suspended from the
Roster until HUD receives evidence that the state imposed sanction has
been lifted.
* Final Rule FR-4720-F-02 (Effective April 9, 2004), FHA Inspector
Roster enacted 24 CFR §200.170, 200.171, and 200.172, establishing the
FHA Inspector Roster eligibility requirements and procedures for
placement of inspectors on the Roster, recertification of Roster
inspectors, and removal of inspectors from the Roster. In addition, the
Rule announces implementation of a national inspector examination and
identifies when a mortgagee must use an inspector listed on the Roster.
The examination will test the applicant's knowledge and understanding
of FHA requirements and residential building standards. An FHA Roster
Inspector is required for new construction, either when there is no
local inspection authority or if the lender, for whatever reason,
elects not to have inspections performed by the local jurisdiction. For
existing construction, FHA requires an inspection when repairs are of a
structural nature and a licensed engineer or other person specifically
licensed to conduct an inspection is not available.
* Final Rule FR-4722-F-02 (Effective August 19,2004) FHA Single Family
Mortgage Insurance; Lender Accountability f„ or Appraisals amended 24
CFR § 25 & 203, reaffirming that lenders are accountable for the
quality of appraisals on properties securing FHA-insured mortgages.
Specifically, lenders that submit appraisals to HUD that do not meet
FHA requirements may be subject to the imposition of sanctions by the
HUD Mortgagee Review Board. The codification of theses policies
provides HUD additional enforcement authority, reminds lenders of their
responsibilities with respect to appraisals, and ensures that
homebuyers receive an accurate statement of the appraised value of
their homes.
E) Training:
National Lender Training: FHA conducted National Lender Training that
covers a variety of topics, including: FHA lender approval,
underwriting, closing, TOTAL Scorecard, appraisal requirements,
quality assurance, and servicing requirements. Training sessions were
conducted in 4 locations during FY 2004 (Orlando, FL; Philadelphia, PA;
Denver, CO and Atlanta, GA), and a session will be held in Santa Ana,
CA in November 2004. The training offers lenders and appraisers
comprehensive information on FHA's policies, procedures, and
requirements. The purpose of the training is to improve lender
compliance, and thereby to reduce risk to FHA. To date, more than 1,000
lenders and appraisers have participated in the national training. All
participants were provided comprehensive training manuals that can be
used for future reference.
Local Training: The FHA Homeownership Centers (HOCs) conduct more than
200 local training sessions each fiscal year. The topics include, but
are not limited to, underwriting, the TOTAL Scorecard, FHA appraisal
requirements, loss mitigation, and FHA Connection. The local training
supplements the national training, offering more detailed information
on FHA's requirements. Approximately 50 to 100 participants are served
in each training session.
F) TOTAL Mortgage Scorecard Deployment:
FHA's mortgage scoring algorithm was deployed in January 2004. TOTAL
became mandatory for new scored loans made after May 1, 2004 and for
all scored loans made after August 1, 2004. The data captured by the
scorecard, especially the credit bureau scores, allow FHA to better
understand and evaluate the overall credit risk of mortgages entering
its portfolio. This data also allows FHA to examine individual lender
portfolios, to analyze differences between product offerings (for
example, whether there are discernible differences in the credit
quality of borrowers seeking adjustable rate mortgages compared to
those seeking fixed-rate mortgages), to identify high-risk mortgages,
and to better estimate default/claim assumptions.
G) Updated Mortgage Credit Underwriting Handbook:
FHA published a revised mortgage credit handbook (HUD-4155.1, "Mortgage
Credit Analysis for Mortgage Insurance, One to Four Family Properties")
at the beginning of FY 2004. The handbook, last revised in 1995,
incorporated all major credit policy revisions made since then, which
were outlined in 50 mortgagee letters published between September 1995
and September 2003. The handbook also clarified those policy areas that
may have been open to interpretations by lenders that did not conform
to FHA's original intention.
H) Updated Mortgagee Letters to Eliminate Fraud and Reduce Program
Risks:
FHA has implemented initiatives that enhance FHA's ability to mitigate
risks to the FHA Insurance Funds by identifying negligent and/or
fraudulent activity associated with underwriting FHA mortgage loans.
* FHA issued Mortgagee Letter 2004-13, announcing that FHA lenders must
enter credit bureau scores for mortgages underwritten without benefit
of automated technology. This requirement allows FHA to examine the
credit quality of these mortgages with the same level of precision as
those mortgages scored by TOTAL. Going forward, virtually all mortgages
made to individuals will have credit scores available in FHA's CHUMS
system, which will enable FHA able to examine the quality of these
loans and be better able to predict default/claim trends, just as the
agency does with mortgages scored through FHA's TOTAL mortgage
scorecard.
FHA issued Mortgagee Letter 2004-17 on Social Security Number
verification. This initiative reduces the likelihood that a borrower on
a FHA mortgage is using a false social security number or otherwise
committing identity theft and fraud in connection with obtaining an
FHA-insured mortgage.
* FHA issued Mortgagee Letter 2004-28, prohibiting several risky credit
policy practices. The Mortgagee Letter requires that for new
construction transactions, the lender underwrite the mortgage using a
realistic estimate of property taxes once the taxing authority has
reassessed the improvements on a property. Previously, some lenders
ignored the eventual increase in the monthly taxes, with disastrous
results when the homeowner was unable to absorb the large mortgage
payment increase. Now, the lender must be satisfied that the homeowner
has the income to support the increased payment. In addition, due to
the unacceptable performance of mortgages underwritten with buy-down
accounts, this Mortgagee Letter prohibits the lender from using the
buy-down rate to qualify the borrower for a mortgage. Together, these
two changes will result in a reduced incidence of early defaults
stemming from the shock of increased payments.
Section 2: Response to GAO Findings/Factual Errors:
FHA is concerned that the draft report contains several significant
factual errors. A list of these errors, along with the appropriate
correction, is provided below:
On pages 16 -17 of the draft report, GAO's discussion of Figures 5 and
6 does not acknowledge that target reports developed each quarter to
identify the lenders to be reviewed are fluid and decisions regarding
which lenders to review are subject to outside influences. All four
HOCs target lenders quarterly for review. The Quality Assurance
Division (QAD) attempts to complete all of the lender reviews on the
schedule. At times, staff may be directed to complete other reviews
based on information from sources other than Neighborhood Watch, which
is the underlying targeting tool. For example, changes may result if
there are a large number of complaints about a particular lender. Also,
during a review, monitors sometimes discover a further problem with the
lender and the review may take longer than expected. In other
instances, OIG Investigation and Audit staff have contacted FHA and
requested that the agency not review a lender listed on the quarterly
schedule. In several cases, the lender targeted went out of business,
was acquired, or merged. Normally, the reviews not completed during the
quarter are carried over to the subsequent quarter and nearly all are
completed.
On page 18 of the draft report, GAO states that HUD's preferred method
for monitoring is to conduct on-site reviews of lenders. This is true,
and over 92 percent of the lender reviews completed in FY 2003 were on-
site reviews. A desk review may be appropriate for a focused review
that emphasizes a specific file review method; also it may be necessary
when travel funds are constrained. Desk reviews are an acceptable
method of review and, as implemented, the use of desk reviews has been
consistent with outstanding FHA policy guidance.
The difference between a desk review and an on-site review is minimal;
the primary difference concerns checking the facilities and signage.
The most important aspect of a lender review (whether on-site or desk)
involves sifting through files to evaluate compliance with FHA
requirements, contacting borrowers and other parties to the
transaction, and verifying data. In fact, desk reviews are as likely as
on-site reviews to result in significant outcomes, such as Mortgagee
Review Board cases, debarments, and fraud referrals to the OIG.
While HUD staff has taken the initiative to use on-site reviews to
provide technical assistance to lenders, this is simply an added
benefit - it is, however, not the purpose of a monitoring review. HUD
offers many other opportunities and avenues for lenders to receive
guidance on HUD policies and procedures, including training and Direct
Endorsement updates offered by the HOCs, electronic notifications of
program policy changes, and most recently, the National Lender Training
offered throughout the country.
On pages 27 - 28 of the draft report, GAO states that HUD has proposed
Credit Watch changes to improve the program's effectiveness. In fact,
HUD anticipates publication of the Credit Watch regulation by the
second quarter of FY2005. Single Family data systems are being modified
to permit prompt implementation of the rule.
On page 32 of the draft report, it was correctly noted that the process
for Board actions is time-consuming. We appreciate that GAO
acknowledges that average processing times have improved. The
Department will continue to seek ways to streamline the Board's
activities and improve its efficiency, to the extent possible.
However, we believe that it is also important to note that the
Mortgagee Review Board carries out a highly-regulated administrative
process that which may lead to serious sanctions and penalties for
lenders. These sanctions and penalties have the potential to cause
severe financial impact on lenders. Therefore, the Department is
obligated to afford maximum due process to these lenders. Each case is
unique, and there is a high level of review and follow up for the
Department to ensure the accuracy and completeness of the documentation
supporting the charges made against a lender. Careful deliberations by
the Department are essential to ensure that proper actions are taken
against the participants involved, and that Board decisions can
withstand subsequent legal challenges. Lenders, who may or may not be
represented by legal counsel, have the opportunity to challenge the
Board's proposed actions through written and oral arguments.
Negotiations on any number of issues can, at times, be protracted. In
all but the most serious cases the Board strives to reach settlements
that are of the most benefit to the government. GAO's reference (page
34) to a lender who originated 584 additional loans before the Board
took action is an example of protracted negotiations and legal
maneuvering. By taking the extra time to develop its case, HUD obtained
a significant settlement from the lender, in which the lender not only
paid for its previous violations of HUD policy, but also agreed to
change its practices. Absent this extensive case development, HUD would
have had to drop the case due to a lack of legal sufficiency.
On page 34, the conclusion that the length of time it takes for the
Board to act on a case allows a lender to continue with inappropriate
practices is misleading for two reasons. First, as part of its lender
monitoring process, the HOC QAD conducts a mandatory exit conference
with each lender at the conclusion of the on-site or desk review. This
conference is held with the President, CEO, or designee for main
offices, and the Branch Manager or designee for branch offices. At the
conference, the HUD monitor discusses with the lender problems and
deficiencies with loan files and in the lender's operations. The HUD
monitor communicates to the lender the severity behind each finding
(specific program violation), as well as minor findings, which may have
already been resolved by the lender or closed out at the exit
conference. Many lenders take actions to correct or improve practices
to comply with HUD's specific program requirements before, or shortly
after the exit conference. Second, when the monitors discover
significant problems that pose a financial risk to FHA or FHA
borrowers, the Board has the ability to suspend a lender or move a case
quickly through the process to protect the financial interests of the
FHA funds and/or the public.
Section 3: Response to Recommendations for Executive Action:
GAO Recommendation: Ensure that Homeownership Centers are following the
guidance for granting Direct Endorsement authority.
FHA Response: FHA will update its guidance and ensure that all HOCs
consistently apply the requirements for granting direct endorsement
authority.
GAO Recommendation: Track lender reviews to distinguish between desk-
and on-site reviews:
FHA Response: The lender tracking system has been modified to
distinguish between desk and on-site reviews. HUD's reporting has not
distinguished between the two because there is little difference
between the results of an on-site and a desk review. The source of
valid findings has little relevance in the type of action taken by HUD.
GAO Recommendation: Enhance FHA's information system to ensure that the
first 30 loans made by new Direct Endorsement lenders are reviewed as
required.
FHA Response: FHA is aware of the limitations of its information system
to accurately identify and count the first 30 loans made by new Direct
Endorsement lenders. FHA is pursuing system enhancements to ensure that
loans made by new DE lenders are reviewed as required.
GAO Recommendation: Expeditiously complete efforts to revise the
technical review rating system so that ratings better reflect the risk
that different underwriting errors pose to the FHA insurance fund.
FHA Response: As FHA has previously informed GAO, for the past 12
months the agency has been actively engaged in efforts to revise the
technical review rating system. FHA is in the final phase of
implementation, which is to be completed by January 2005. These efforts
have been complex in nature as well as time-consuming since the scope
of work encompasses not only changes to operating procedures but also
to information systems.
GAO Recommendation: Standards for Re-Entering Lenders into Pre-Closing
Status:
FHA Response: FHA is currently developing consistent standards for
returning lenders to pre-closing status. Implementation will occur by
January 2005.
Sincerely,
Signed by:
John C. Weicher:
Assistant Secretary for Housing-Federal Housing Commissioner:
[End of section]
Appendix III: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
David Wood (202) 512-8678:
Paul Schmidt (312) 220-7681:
Staff Acknowledgments:
In addition to those individuals named above, Eric Diamant, Mark Egger,
Harold Fulk, Nadine Garrick, Curtis Groves, John McGrail, Marc Molino,
Josephine Perez, David Pittman, Terry Richardson, Paige Smith, and
Raymond Wessmiller made key contributions to this report.
(250171):
FOOTNOTES
[1] FHA is a part of HUD, and the Assistant Secretary for Housing is
also the Federal Housing Commissioner.
[2] Underwriting refers to a risk analysis that uses information
collected during the origination process to decide whether to approve a
loan.
[3] GAO, Single-Family Housing: Stronger Oversight of FHA Lenders Could
Reduce HUD's Insurance Risk, GAO/RCED-00-112 (Washington, D.C.: Apr.
28, 2000).
[4] GAO, High-Risk Series: An Update, GAO-03-119 (Washington, D.C.:
Jan. 1, 2003).
[5] U.S. Department of Housing and Urban Development, Office of
Inspector General, Semiannual Report to Congress, October 1, 2003
through March 31, 2004 (Washington, D.C.).
[6] Single-family loans insured by FHA may be used to finance the
purchase of new or existing one-to-four-family properties. 12 U.S.C.
1709(b).
[7] Capital reserves are the amount of capital reserved to cover
estimated future losses resulting from the payment of claims on
defaulted mortgages and administrative costs.
[8] To be eligible to receive direct endorsement authority and to
underwrite FHA-insured loans, a lender, in addition to meeting other
HUD requirements, must be one of the following: (1) a member of the
Federal Reserve System or an institution whose accounts are insured by
the Federal Deposit Insurance Corporation or the National Credit Union
Administration; (2) a financial institution whose principal activity is
lending or the investing of funds in real estate mortgages; or (3) a
federal, state, or municipal government agency.
[9] The other members of the Board are HUD's General Counsel, Chief
Financial Officer, Assistant Secretary for Administration, Assistant
Secretary for Fair Housing and Equal Opportunity, and Director of the
Enforcement Center; and the President of the Government National
Mortgage Association.
[10] At the Atlanta, Denver, and Philadelphia homeownership centers,
staff perform these evaluations. In contrast, a contractor performs
these evaluations for the Santa Ana homeownership center.
[11] During a preclosing review, the Denver homeownership center also
sometimes evaluates the quality of the loan-closing documents.
[12] Under the 203(k) Home Rehabilitation Mortgage Insurance program, a
borrower can get one mortgage loan to finance both the acquisition and
rehabilitation of the property. A refinance transaction involves
repaying an existing real estate debt from the proceeds of a new
mortgage that has the same borrower and the same property.
[13] When automated underwriting is used, a computer-based tool
simplifies the processing of loan applications by analyzing, among
other things, how a borrower managed credit obligations in the past and
whether the borrower has the ability to repay the mortgage loan. It
then provides a recommendation to the lender to approve the loan or
refer it for manual underwriting. A streamline refinance is a type of
refinance transaction that requires less paperwork. For example,
streamline refinances can be made without an appraisal, and HUD does
not require a credit report.
[14] One additional lender with direct endorsement authority applied
for and was granted the authority to underwrite Home Equity Conversion
Mortgages (HECM)--mortgages that can be used by senior homeowners to
convert equity into income--during this time period. HUD's guidance
states that, after receiving direct endorsement approval, lenders may
apply for approval to underwrite specialized loans such as HECM and
203(k) loans by submitting a minimum of five consecutive cases of that
type rated "good" or "fair." According to our analysis, the lender
submitted a minimum of five consecutive HECM cases rated "good" or
"fair."
[15] In three additional cases, the lender continued submitting loans
after it had satisfied HUD's requirements of having a total of 15 loans
rated "good" or "fair," with the last 5 of the 15 loans rated "good" or
"fair." One of the extra loans submitted was rated "poor," which meant
that the last five consecutive cases submitted by the lender were not
rated "good" or "fair."
[16] The loan information in Neighborhood Watch is displayed for a 2-
year origination period and is updated monthly.
[17] The risk-based model that is to be developed by the contractor
must be adaptable and compatible with HUD's Neighborhood Watch System.
The lender information that may be used in developing the model
includes, among other things, the percentage of originations with late
up-front mortgage insurance premiums, the percentage of signed
indemnification agreements (which require the lender to compensate HUD
for financial losses that HUD has incurred or may incur on certain
loans), and high default and claim rates.
[18] Both Fannie Mae and Freddie Mac are federally-chartered
corporations that purchase residential mortgages and convert them into
securities for sale to investors; by purchasing mortgages, they supply
funds that lenders may loan to potential homebuyers.
[19] Direct endorsement authority is granted to a lender's home office
and applies to all of the lender's branch offices.
[20] Virtually all of the Atlanta, Philadelphia, and Santa Ana
homeownership centers' technical reviews are performed by contractors.
In contrast, Denver homeownership center staff performed 44 percent of
the homeownership center's reviews in fiscal year 2003. At the time of
our study, the Santa Ana homeownership center had two firms under
contract, while the Atlanta, Denver, and Philadelphia homeownership
centers each used a single contractor.
[21] To complete the FHA audit, HUD's Inspector General contracted with
the independent certified public accounting firm of KPMG LLP. U.S.
Department of Housing and Urban Development, Office of Inspector
General, Audit of the Federal Housing Administration's Financial
Statements for Fiscal Years 2003 and 2002, 2004-FO-0001 (Washington,
D.C.: Nov. 25, 2003).
[22] Every quarter, HUD conducts a round of Credit Watch by reviewing
the rate of defaults and claims on loans insured by FHA within the
preceding 24-month period.
[23] A terminated lender branch may request to have its authority to
originate FHA loans reinstated no earlier than 6 months after the
effective date of the termination.
[24] In our April 2000 report, we recommended that HUD revise the
Credit Watch program's regulations to cover lenders that underwrite
FHA-insured loans with excessive default and claim rates, as well as
those lenders that originate such loans.
[25] These conditions include when a lender has maintained a "poor"
percentage in excess of 20 percent for more than 90 days after being
placed on 100 percent review status or when a lender has a claim and
default rate that exceeds both the national rate and 250 percent of the
field office rate (the rate for the HUD field office serving the
lender's geographic location).
[26] The Philadelphia homeownership center first identifies lenders
that (1) have a default rate that exceeds 150 percent of the field
office rate and (2) have received technical review "poor" ratings over
20 percent (when more than 20 loans have been reviewed) and begins to
review 100 percent of their loans. For lenders that do not improve
after two quarters, the homeownership center suspends their direct
endorsement authority.
[27] Lenders could have been counted more than once if they underwrote
FHA-insured mortgages in more than one homeownership center
jurisdiction.
[28] The 32 cases were acted on in Board meetings held in June 2003,
August 2003, October 2003, December 2003, February 2004, and April
2004.
[29] In one case that resulted in a settlement agreement, the Board
also issued the lender a letter of reprimand.
[30] We reviewed 24 cases involving single-family housing lenders that
the Board acted on from October 1998 through April 1999. As of November
1999, the Board had completed action on 11 of the cases, while action
was still pending on 13 cases.
[31] One additional lender, which already had direct endorsement
authority, was granted the authority to underwrite Home Equity
Conversion Mortgages (HECM)--mortgages that can be used by senior
homeowners to convert equity into income.
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