GAO

United States General Accounting Office

Report to Congressional Requesters

April 2000 SINGLE-FAMILY

HOUSING

Stronger Oversight of

FHA Lenders Could

Reduce HUD’s

Insurance Risk

GAO/RCED-00-112

Page 1 GAO/RCED-00-112 Oversight of FHA Lenders

Contents

Letter 3

Appendixes Appendix I: Comments From the Department of Housing

and Urban Development 36

Appendix II: Objectives, Scope, and Methodology 42

Appendix III: GAO Contacts and Staff Acknowledgments 44

Tables Table 1: Results of the First Three Rounds of HUD’s Credit

Watch Program 25

Table 2: Summary of the Mortgagee Review Board’s Fiscal

Year 1999 Actions on 24 Cases as of November 1999 29

Figures Figure 1: Number of Single-Family Mortgage Loans Insured

by FHA, Fiscal Years 1997-99 6

Figure 2: Steps in the Approval Process for FHA-Insured

Mortgage Loans 7

Figure 3: Locations and Geographical Jurisdictions of HUD’s

Four Homeownership Centers 9

Figure 4: Frequency of Poor Ratings for Mortgage Credit

Analysis Given to 36 Approved Lenders in Their

Last 15 Preclosing Reviews 13

Figure 5: Number of Lender Reviews Performed, Fiscal

Years 1996-99 15

Figure 6: Percentage of Loans Receiving Technical Reviews by

Homeownership Center, Fiscal Year 1999 18

Figure 7: Percentage of Lenders, by Type, Whose Loan Origination

Authority Was Terminated Because of Excessive

Defaults and Insurance Claims on Loans Made For

the 24-Month Period Ending March 31, 1999 26

Abbreviations

CHUMS Computerized Homes Underwriting Management System

FHA Federal Housing Administration

GAO General Accounting Office

HUD Department of Housing and Urban Development
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United States General Accounting Office

Washington, D.C. 20548

Resources, Community, and

Economic Development Division

B-283389 Letr

April 28, 2000

The Honorable Rick A. Lazio

Chairman, Subcommittee on Housing

and Community Opportunity

Committee on Banking

and Financial Services

House of Representatives

The Honorable Susan M. Collins

Chairman, Permanent Subcommittee

on Investigations

Committee on Governmental Affairs

United States Senate

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. During fiscal year

1999 alone, FHA insured 1.3 million mortgages valued at about $124 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. Recent cases of

mortgage fraud across the country have raised concerns about HUD’s

oversight of these lenders. For example, in December 1999, HUD’s Office of

the Inspector General and the Department of Justice announced criminal

charges against 39 California mortgage lenders, real estate professionals,

and other persons accused of obtaining more than $110 million in

fraudulent FHA-insured loans.

As you requested, this report provides information on HUD’s oversight of

lenders participating in FHA’s mortgage insurance programs for singlefamily homes. While almost 10,000 lending institutions are approved to

participate in FHA’s single-family mortgage insurance programs, only about

2,900 of these 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. Specifically, this report

addresses the following questions: (1) How well does HUD ensure that

lenders granted direct endorsement authority by FHA are qualified to

receive such authority? (2) To what extent does HUD focus on high-risk

lenders in monitoring the lenders participating in FHA’s mortgage
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insurance programs? (3) To what extent is HUD holding lenders

accountable for poor performance? To address these questions, 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. Our

review focused on the adequacy of HUD’s policies and procedures for

overseeing lenders. We performed limited tests and analyses to determine

whether these policies and procedures were properly utilized to limit

HUD’s insurance risk.

Results in Brief HUD’s process for granting FHA-approved lenders direct endorsement

authority—the ability to underwrite loans and determine their eligibility for

FHA mortgage insurance without HUD’s prior review—provides limited

assurance that lenders receiving this authority are qualified. According to

HUD’s guidance, FHA-approved lenders seeking direct endorsement

authority must demonstrate “acceptable performance” in underwriting at

least 15 mortgage loans, which undergo evaluations, known as preclosing

reviews, by HUD’s homeownership centers. However, the guidance does

not define what would constitute overall acceptable performance on the 15

loans. In the absence of such a clear definition, HUD’s homeownership

centers’ recent performance in approving lenders for direct endorsement

authority was uneven. In the 6 months prior to our 1999 visits, the centers

granted direct endorsement authority to a total of 36 lenders. While many

of these lenders had demonstrated proficiency in underwriting mortgages,

many others made multiple and serious underwriting errors. Overall, 12 of

the 36 lenders had received 4 or more “poor” ratings from the centers for

their last 15 preclosing reviews.

Contrary to HUD’s guidance, the homeownership centers’ monitoring of

lenders does not adequately focus on the lenders and loans that pose the

greatest insurance risks to the Department. On-site evaluations of lenders’

operations—known as lender reviews—are one of HUD’s primary tools for

assessing the quality of lenders’ mortgage-lending practices. HUD’s

guidance states that 85 percent of the lender reviews should be targeted at

high-risk lenders. However, the homeownership centers have often not

reviewed the lenders that they consider to be the highest risk. For example,

although the Philadelphia center conducted reviews of 228 lenders during

fiscal year 1999, it reviewed only 39 of the 131 high-risk lenders (about 30

percent) that it designated as high priority for review that year. HUD

officials told us that the lack of experienced staff and limited travel funds
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impeded their ability to visit and review the riskiest lenders. Desk audits to

evaluate the underwriting quality of individual loans insured by FHA—

known as technical reviews—are another important tool for overseeing

lenders. Although the homeownership centers met the Department’s goal

to perform technical reviews of no less than 10 percent of all loans insured

in fiscal year 1999, they generally did not target these reviews at high-risk

lenders and loans as recommended by HUD’s guidance.

HUD has not taken sufficient steps to hold lenders accountable for poor

performance and program violations. 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

centers have made limited use of this ability. In fiscal year 1999 the

Philadelphia center suspended the direct endorsement authority of eight

lenders; however, the other three centers did not take this action against

any lenders. Furthermore, HUD’s technical review ratings for fiscal year

1999 showed frequent noncompliance by lenders with FHA’s requirements,

indicating that many other lenders may be candidates for this action. For

example, we identified 206 lenders that received “poor” ratings for their

mortgage credit decisions in more than 30 percent of the loans that HUD

reviewed in fiscal year 1999. Furthermore, on the basis of our analysis, if

HUD had reviewed all of the lenders’ fiscal year 1999 loans, the percentage

of poor ratings could have been expected to exceed 30 percent. Of these

lenders, 131 made 10 or more FHA-insured loans in fiscal year 1999. As of

October 1, 1999, HUD’s homeownership centers had not suspended the

direct endorsement authority of any of the 131 lenders we identified. In

May 1999, HUD’s headquarters implemented its Credit Watch program to

terminate the loan origination authority of lenders with excessive defaults

and insurance claims on FHA-insured mortgages. However, because the

program’s regulations pertain only to the lenders that originated the

troubled loans, HUD does not always hold accountable lenders that

underwrote and approved the loans. According to HUD, the program’s

regulations did not permit the Department to take enforcement actions

against these lenders.

This report makes recommendations designed to improve HUD’s processes

for (1) approving lenders to underwrite FHA-insured mortgages, (2)

targeting lenders and loans for quality control reviews, and (3) taking

enforcement actions against poorly performing lenders.
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Background Established by the National Housing Act, FHA insures lenders against

losses on mortgages for single-family homes. 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 1997 through 1999, the number of singlefamily mortgage loans that FHA insured grew from approximately 800,000

to nearly 1.3 million—a 63-percent increase. (See fig. 1.) For the 3 years

combined, FHA insured over 3 million mortgages with a total value of $292

billion.

Figure 1: Number of Single-Family Mortgage Loans Insured by FHA, Fiscal Years

1997-99

Source: HUD.

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. 2.) If the borrower defaults and the lender subsequently

forecloses on the loan, the lender can file an insurance claim with HUD for

0

200

400

600

800

1,000

1,200

1,400

1997 1998 1999

Fiscal year

Insured loans in thousands
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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 indicated that, as of September 30, 1999, the Fund exceeded the

legislative target for capital reserves.

Figure 2: Steps in the Approval Process for FHA-Insured Mortgage Loans

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.

HUD also 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 December 1999, about 9,950 lending institutions were approved to

participate in FHA’s mortgage insurance programs for single-family homes.

Homebuyer

• Reviews loan case file 

to ensure that all 

required paperwork is 

present and complete 

• Approves or rejects loan 

for FHA mortgage 

insurance on the basis 

of this review

HUD

homeownership center FHA-approved lender 

• Originates, underwrites,

and funds mortgage

loan

• Determines loan’s

eligibility for FHA

insurance

• Submits loan case file

to HUD

• Signs sales contract

on home

• Applies for mortgage

with FHA-approved

lender
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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.1 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. In 1996, as part

of an effort to streamline its lender approval process, HUD stopped

individually approving underwriters working for FHA lenders that were

granted direct endorsement authority. Prior to 1996, underwriters seeking

FHA’s approval had to submit applications to HUD, and HUD reviewed and

verified their experience and qualifications. HUD now relies on lenders to

certify that their underwriters meet FHA’s standards.

Some FHA-approved lenders with direct endorsement authority, known as

sponsoring lenders, enter agreements to underwrite and fund loans

originated by FHA lenders without direct endorsement authority, known as

loan correspondents. About 40 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. 3.) Under the 2020 plan, HUD’s single-family

housing staff was cut by more than 50 percent. The homeownership

centers are located in Atlanta, Georgia; Denver, Colorado; Philadelphia,

Pennsylvania; and Santa Ana, California, and report directly to HUD’s

Deputy Assistant Secretary for Single-Family Housing.

1

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.
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Figure 3: Locations and Geographical Jurisdictions of HUD’s Four Homeownership Centers

The centers are responsible for processing and approving mortgage

insurance as well as several critical aspects of HUD’s lender approval,

monitoring, and enforcement activities. These responsibilities include (1)

granting direct endorsement authority to qualified FHA-approved lenders;

(2) on-site evaluations of lenders’ operations, known as lender reviews, and

monitoring lenders’ performance through reviews of individual loans,

known as technical reviews, and (3) taking and initiating enforcement

actions against lenders that have not complied with FHA’s requirements.

Philadelphia

Atlanta

Denver

Santa Ana
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HUD’s headquarters also has important approval, monitoring, and

enforcement functions. For example, HUD’s headquarters approves and

annually recertifies lenders wishing 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,2 can impose administrative

sanctions against lenders, including withdrawing the lenders’ authority to

make FHA-insured loans.

Direct Endorsement

Approval Process

Provides Limited

Assurance That

Lenders Are Qualified

HUD’s process for granting FHA-approved lenders direct endorsement

authority—the ability to underwrite loans and determine their eligibility for

FHA mortgage insurance without HUD’s prior review—provides only

limited assurance that lenders receiving this authority are qualified. HUD’s

guidance does not adequately define the level of proficiency that lenders

must achieve in order to receive direct endorsement authority. As a result,

HUD’s homeownership centers have applied the guidance differently and

granted direct endorsement authority to lenders that demonstrated various

levels of proficiency. Many lenders were approved by the centers despite

making multiple underwriting errors. Lenders such as these may pose a

high insurance risk to the Department once they begin underwriting and

approving FHA-insured loans without HUD’s prior review.

2

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 the President of the Government National Mortgage Association.
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Standards for Granting

Direct Endorsement

Authority Are Not

Adequately Defined

HUD’s homeownership centers are responsible for granting direct

endorsement authority—the ability to underwrite loans and determine

their eligibility for FHA mortgage insurance without HUD’s prior review—

to lenders participating in FHA’s programs. According to HUD’s guidance,

FHA-approved lenders seeking direct endorsement authority must go

through a probationary period during which they are required to

demonstrate acceptable performance in underwriting at least 15 mortgage

loans. At HUD’s discretion, the probationary period may extend beyond 15

loans. The mortgages are submitted to and evaluated by HUD’s

homeownership centers against FHA’s underwriting requirements before

the lenders close the loans. Known as preclosing reviews, these evaluations

rate various aspects of the lender’s work, including the analysis of the

mortgage credit decision and the property appraisal, as “good,” “fair,” or

“poor.”3 A “good” rating indicates no underwriting deficiencies, a “fair”

rating indicates the presence of deficiencies that did not significantly affect

HUD’s insurance risk, and a “poor” rating indicates that underwriting errors

significantly increased HUD’s insurance risk. HUD’s guidance provides

specific criteria for the centers to use in determining these ratings.

While HUD’s guidance requires that lenders seeking direct endorsement

authority demonstrate acceptable performance on their preclosing

reviews, the guidance for what constitutes overall acceptable performance

is unclear. For example, the guidance does not state whether acceptable

performance requires that lenders receive all “good” scores or whether

combinations of “good” and “fair” scores are permitted. The guidance

makes no mention of whether a lender can receive any “poor” scores and

still qualify for direct endorsement authority. As a result of HUD’s vague

performance standards, the four homeownership centers have interpreted

what constitutes overall acceptable performance on the preclosing reviews

differently. Philadelphia center officials said they generally approved only

those lenders that had submitted at least 15 cases and had received only

“good” or “fair” ratings in their last five preclosing reviews. The Denver and

Atlanta centers interpreted the guidance as meaning that lenders had to

submit a total of 15 loans for which they received only “good” or “fair”

ratings in their preclosing reviews. Santa Ana center officials said they did

not have strict requirements regarding the number of loans that had to

receive “good” or “fair” ratings. While some officials at the centers believed

3

A preclosing review rates the quality of the loan-closing documents, the property appraisal,

the construction exhibits (for new or rehabilitated homes), and the mortgage credit

evaluation of the borrower.
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that the existing approval guidance gave them the flexibility they needed to

make approval decisions, others believed that more specific guidance was

necessary to ensure that the decisions were more consistent.

Recently Approved Lenders

Varied in Their Performance

in Preclosing Reviews

HUD’s four homeownership centers granted direct endorsement authority

to a total of 36 lenders during the 6 months prior to our 1999 visits to the

centers.4 Approximately 230 other lenders were in the process of seeking

but had not yet received direct endorsement authority at the time of our

visits. The 36 lenders submitted an average of 18 loans to the centers for

preclosing reviews.

We analyzed the 36 lenders’ ratings in preclosing reviews to illustrate the

different types of performance that the centers considered as acceptable.

Specifically, we reviewed the ratings that each lender received for

mortgage credit analysis—the evaluation of the borrower’s credit

worthiness—on the last 15 preclosing reviews before the lender received

direct endorsement authority. Our analysis showed significant variations in

what HUD’s homeownership centers considered as acceptable

performance, reflecting the vagueness and inconsistent application of

HUD’s approval standards. Overall, of the 36 lenders, 8 received no “poor”

ratings during their last 15 preclosing reviews, while 3 received 6 “poor”

ratings during their last 15 preclosing reviews. (See fig. 4.) The lenders’

errors included their failure to (1) verify the borrower’s employment and

income, (2) ensure that the borrower had sufficient income to support the

monthly mortgage payments, (3) explain delinquent accounts and

collections on the borrower’s credit reports, and (4) properly calculate the

borrower’s debts or liabilities. Twelve of the 36 lenders received “poor”

ratings in 4 or more of their last 15 preclosing reviews. In other words,

these 12 lenders made serious errors in underwriting over a quarter of the

mortgages they submitted to HUD to demonstrate their abilities to comply

with HUD’s requirements. While the centers felt that the lenders they

approved had shown the ability to underwrite FHA-insured loans properly,

we believe that lenders such as these 12 may pose a high insurance risk to

the Department once they begin underwriting and approving loans without

HUD’s prior review.

4

We visited the Philadelphia center in August 1999 and the Atlanta, Denver, and Santa Ana

centers in October 1999.
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Figure 4: Frequency of Poor Ratings for Mortgage Credit Analysis Given to 36 Approved Lenders in Their Last 15 Preclosing

Reviews

Note: Our analysis included all 36 lenders to whom the four homeownership centers had granted direct

endorsement authority in the 6 months prior to our visits to the centers. We visited the Philadelphia

center in August 1999 and the Denver, Santa Ana, and Atlanta centers in October 1999.

Source: GAO’s analysis of data from HUD’s homeownership centers.

Lenders

Percentage of cases rated poor

Philadelphia center

Denver center

Santa Ana center

Atlanta center

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

0

5

10

15

20

25

30

35

40

45
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Monitoring Process

Does Not Adequately

Focus on Riskiest

Lenders and Loans

HUD’s guidance stresses the importance of using risk analysis to allocate a

larger share of monitoring resources to program activities that pose the

highest risks to the Department. However, HUD’s homeownership centers

have not adequately focused their monitoring efforts on lenders and loans

that pose the greatest insurance risks. The centers use two monitoring

tools to ensure lenders’ compliance with FHA’s mortgage requirements: (1)

on-site evaluations of lenders’ operations, known as lender reviews, and (2)

desk audits of the underwriting quality of individual loans already insured

by FHA, known as technical reviews. In recent years, HUD substantially

increased the number of lender reviews that it performs. However, contrary

to HUD’s guidance, the centers have not always reviewed the lenders they

consider to be high risk. With respect to technical reviews, in fiscal year

1999, the centers met HUD’s goals regarding the percentage of loans

undergoing these reviews but, contrary to HUD’s guidance, selected most

of the loans at random instead of using a risk-based selection process. In

addition, while contractors perform most of the homeownership centers’

technical reviews, three of the four centers did not track the quality of the

contractors’ work against performance standards in the contracts.

Lender Reviews Increased

but Were Often Not of

Riskiest Lenders

In recent years, HUD has placed greater emphasis on performing on-site

evaluations of lenders’ operations. These 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 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. During fiscal years 1996 through 1999, HUD increased the

number of staff performing lender reviews from 23 to approximately 140.

Over this period, the number of lender reviews that HUD conducted also

increased. In fiscal year 1999, HUD’s homeownership centers conducted

932 lender reviews, exceeding the Department’s goal of 900 reviews.5 (See

fig. 5.)

5

HUD’s fiscal year 1999 goals required each of the four homeownership centers to conduct

225 lender reviews. All four centers exceeded this goal.
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Figure 5: Number of Lender Reviews Performed, Fiscal Years 1996-99

Source: GAO’s analysis of data from HUD.

HUD’s guidance states that lenders should be rated and prioritized for

review and that 85 percent of the reviews should be targeted at high-risk

lenders, while 15 percent should be selected randomly. Focusing on highrisk lenders increases the likelihood that HUD will uncover improper

lending practices, which the Department can then take steps to curtail.

However, we found that the homeownership centers did not always review

the lenders that they considered to pose the highest risks. The Philadelphia

center was the only one that had developed and could provide us with a list

of high-risk lenders that it considered to be a high priority for review in

fiscal year 1999.6 The list consisted of 131 lenders in the center’s

geographical jurisdiction. However, despite conducting reviews of 228

lenders during fiscal year 1999, the center reviewed just 39 of the 131

lenders on its priority list. Had the Philadelphia center complied with

6

The Denver center’s quality assurance division produces prioritized targeting lists for each

of the HUD field office locations within the center’s geographic jurisdiction. However, the

division did not save copies of the lists it used for targeting lenders in fiscal years 1998 or

1999. Therefore, we were unable to determine the extent to which the highest-priority

lenders had been reviewed.

0

100

200

300

400

500

600

700

800

900

1,000

1996

Lender reviews performed

1997 1998 1999

Fiscal year
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HUD’s guidance and targeted 85 percent of its reviews at high-risk lenders,

the center would have been able to review all of the lenders on its priority

list. We were unable to determine the extent to which the other three

centers reviewed the lenders they considered to be the highest risk because

they could not provide us with similar priority lists of high-risk lenders for

their fiscal year 1999 reviews. However, officials at these centers told us

that they often targeted for review those lenders that did not pose a high

insurance risk to HUD. For instance, the director of the Santa Ana center’s

quality assurance division estimated that half of the reviews that the center

performed in fiscal year 1999 were of lenders that had few or no early

defaults. Because early defaults are an indicator of poor lending practices

that may result in insurance losses, HUD considers them to be an important

factor in assessing lenders’ risk.

Homeownership center officials cited inexperienced staff and limited or

uncertain travel funds as reasons why high-risk lenders were not always

reviewed. According to center officials, most of the centers’ 140 staff who

conduct lender reviews assumed their current positions in fiscal years 1998

and 1999, largely from the pool of HUD field staff who remained

unassigned after HUD’s 1998 reorganization. The officials said that many of

these individuals had no background in lender monitoring or mortgage

credit issues. To address this problem, the officials said that they provided

both classroom and on-the-job training to the new staff. However, center

officials also told us that they generally did not allow staff with less than a

year of experience to review high-risk lenders because their inexperience

might lead them to overlook serious deficiencies. Furthermore, the centers’

quality assurance directors told us that they typically had little or no travel

funding during the first 2 to 3 months of the fiscal year. They said that

during these periods, center staff are forced to identify and review lenders

within commuting distances of the staffs’ homes or offices—without

primary regard to the lenders’ risk—in order to avoid incurring travel

expenses.

Furthermore, although HUD’s guidance states that lenders should be rated

and prioritized for review, the Department has not developed a systematic

process for doing so. HUD’s guidance lists several risk factors that should

be considered in targeting lenders for reviews, including default rates, the

late payment of mortgage insurance premiums to HUD, and the volume of

business. But the guidance indicates neither how these factors should be

weighted nor how lenders should be prioritized. As a result, the centers

have not targeted lenders for reviews in a consistent manner. We found that

neither the Santa Ana nor the Atlanta centers had standardized ways to
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assess lenders’ risk and prioritize them for review. In contrast, the

Philadelphia and Denver centers had implemented more systematic but

different approaches. For example, the Philadelphia center established, as

a high priority for review, those lenders that, during the previous 5 years,

had made over 500 FHA-insured mortgages and had high percentages of

loans that defaulted within 24 months relative to the national and

corresponding state averages. By comparison, the Denver center focused

on lenders that, during the previous 3 years, had the largest number of

loans that defaulted within 13 months.

Selection of Loans for

Technical Reviews Was Not

Based on Risk

Technical reviews—desk audits that evaluate the underwriting quality of

individual loans already insured by FHA—are another tool that HUD uses

to monitor the performance of lenders. Technical reviews that reveal

serious deficiencies may result, among other things, in HUD’s requiring the

lenders to compensate the Department for financial losses or HUD’s

suspending the lenders’ direct endorsement authority. While the

homeownership centers met the numerical goals for conducting technical

reviews during fiscal year 1999, the reviews, contrary to HUD’s guidance,

did not focus on loans that (1) exhibit high-risk characteristics or (2) were

made by lenders with known performance problems or newly approved

lenders. As a result, underwriting practices that significantly increase

HUD’s insurance risk may be going undetected.

All four of HUD’s homeownership centers met the Department’s goal to

perform technical reviews on no less than 10 percent of the FHA-insured

mortgage loans made during fiscal year 1999. The four centers combined

performed 151,575 technical reviews in fiscal year 1999, representing 11.7

percent of the loans that FHA insured that year. (See fig. 6.)
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Figure 6: Percentage of Loans Receiving Technical Reviews by Homeownership

Center, Fiscal Year 1999

Source: GAO’s analysis of data from HUD.

The homeownership centers, however, have not effectively implemented

HUD’s guidance, which recommends that high-risk loans should be

selected for technical reviews. The guidance cites as high-risk loans those

mortgage transactions involving multiunit dwellings; foreclosed HUDowned properties; and borrowers with unusually high expenses relative to

their income, among other factors. 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. Instead, the centers rely primarily on a random process

for selecting loans for technical reviews. According to center officials,

HUD’s Computerized Homes Underwriting Management System

(CHUMS)—a computer system that assists and supports HUD staff in

processing mortgage insurance for single-family homes—is programmed to

randomly select a certain percentage of each lender’s loans. However,

CHUMS currently cannot automatically identify and select for review those

loans that exhibit high-risk characteristics. Center officials told us that they

sometimes manually selected high-risk loans for review but that the large

0

2

4

6

8

10

12

14

Atlanta Denver Philadelphia Santa Ana Four

homeownership

centers

combined

Percentage of loans reviewed

Homeownership centers

HUD’s goal
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volume of loans they processed for FHA insurance, coupled with staffing

constraints, made it impractical to do this on a routine basis. According to

HUD officials, the Department is developing a “mortgage scorecard”

system, which, they believe, will enable HUD to readily identify high-risk

loans for technical reviews by assigning risk scores to all FHA-insured

mortgage loans on the basis of various characteristics of the loans. The

officials said that they hope to fully implement this system by the end of

fiscal year 2001.

CHUMS permits homeownership center staff to adjust the percentage of

each lender’s loans that are selected for technical reviews. HUD’s guidance

suggests that 5 to 10 percent of a lender’s loans should be selected for

technical reviews but that this percentage should be increased up to 100

percent if problems are noted with the lender’s performance (e.g., high

default rates, poor technical review ratings, or homebuyers’ complaints).

However, the centers have infrequently used their ability to adjust the

percentage of lenders’ loans selected for technical reviews to more closely

monitor lenders whose performance problems may increase HUD’s

insurance risk. HUD’s guidance states also that the centers should perform

technical reviews of 100 percent of the FHA-insured loans that are made by

lenders that are newly granted direct endorsement authority for 6 months

or through their first 50 loans. However, we found that the centers did not

consistently follow this guidance and lacked information systems to readily

identify and track the technical review ratings of new direct endorsement

lenders. For example, officials at the Philadelphia center told us they were

not aware of the guidance and selected only 10 percent of these lenders’

loans for technical reviews.

In contrast to HUD, both Fannie Mae and Freddie Mac—governmentsponsored enterprises that purchase home mortgages and issue mortgagebacked securities—perform quality control reviews on samples of loans

selected on the basis of risk as well as samples of loans selected at random.

Officials with both organizations told us they had databases and statistical

models to generate these samples automatically. The officials said they

used risk-based samples to focus their monitoring resources at high-risk

loans and lenders that made such loans.7 They said they used random

7

Some of the risk factors used by Fannie Mae and Freddie Mac to identify high-risk loans

may be applicable to FHA’s loan portfolio, while other factors may not. Fannie Mae and

Freddie Mac consider the specific factors they use to assess risk as confidential business

information.
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samples to determine the prevalence of underwriting deficiencies

throughout their entire loan portfolios.

Homeownership Centers’

Oversight of Technical

Review Contractors Was

Limited

The large majority of HUD’s technical reviews are performed by firms

under contract with the homeownership centers.8 Each contract contains

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 centers were not tracking the

contractors’ work against these standards. As a result, these centers lack

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.

Each technical review contract states that each month, HUD staff will

review the accuracy and completeness of the contractor’s work and

provide the contractors with performance feedback. The contracts for the

Atlanta, Philadelphia, and Santa Ana centers state that HUD may reject the

reviews if more than 10 percent of them contain significant errors or

omissions (e.g., incorrect ratings given or significant issues not identified)

and that an error rate of over 10 percent may be considered failure to

perform. The corresponding percentages in the Denver center’s contracts

are 20 percent.

We found that the Atlanta, Denver, and Philadelphia homeownership

centers did not track the percentage of the contractors’ work that

contained significant errors and omissions. Without this information, these

centers were not in a position to provide the contractors with adequate

performance feedback or, if necessary, to enforce the contracts’

performance clauses. The Santa Ana homeownership center’s evaluations

of one of its two technical review contractors revealed an error rate of over

20 percent for the 5-month period from April through August 1999—double

the center’s acceptable rate. However, the center did not hold the

contractor responsible for the high error rates, as provided for by the

contract. In October 1999, the center began to intensively monitor both of

8

Virtually all of the Atlanta, Santa Ana, and Denver centers’ technical reviews are performed

by contractors. In contrast, Philadelphia center officials said that their own staff performed

about one-third of the center’s reviews in fiscal year 1999. At the time of our review, the

Santa Ana and Denver centers each had two firms under contract, while the Atlanta and

Philadelphia centers each used a single contractor. The total annual value of the centers’

technical review contracts is about $2 million.
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its contractors in order to provide the contractors with detailed feedback

and to more aggressively enforce the contracts’ performance clauses. At

the time of our review, all four centers indicated that they were planning to

adopt a database system developed by the Denver center to, among other

things, capture and track the results of their evaluations of the technical

review contractors’ work.

Efforts to Hold Lenders

Accountable for Poor

Performance Have Not

Been Sufficient

To hold lenders accountable for program violations or poor performance,

HUD may (1) suspend their direct endorsement authority, (2) terminate

their loan origination authority through its Credit Watch program, or (3)

take enforcement action through its Mortgagee Review Board. However,

the homeownership centers have made only limited use of their ability to

suspend the direct endorsement authority. And while HUD’s Credit Watch

program is designed to hold lenders accountable for excessive loan

defaults and insurance claims on FHA-insured mortgages, the program

focuses on lenders who originated the troubled loans and has not held

accountable other FHA lenders who underwrote and approved the loans.

Furthermore, the Department’s authority to implement the program is also

facing a legal challenge, leaving the future of the program in doubt. Lastly,

HUD’s Mortgagee Review Board often takes over a year to impose

sanctions against lenders for program violations.

Homeownership Centers

Made Limited Use of 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. The centers suspended a total of eight

lenders in fiscal year 1999, but our analysis of HUD’s technical review

ratings for fiscal year 1999 showed frequent noncompliance by lenders with

FHA’s requirements, indicating that many additional lenders may be

candidates for this action. By not suspending poorly performing lenders,

HUD leaves itself vulnerable to lending practices that increase the

Department’s insurance risk.

HUD’s guidance allows the homeownership centers to suspend the direct

endorsement authority of lenders that fail to comply with FHA’s program

requirements but provides only general guidelines for determining which

lender’s direct endorsement authority should be suspended. For example,

the guidance states that the centers should consider suspending lenders

that exhibit “patterns” of noncompliance, but it does not define what would

constitute a pattern. Lenders whose direct endorsement authority is

suspended must submit their mortgage case files to the centers, which
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evaluate 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. Lenders that cannot

demonstrate satisfactory performance may have their direct endorsement

authority withdrawn by the centers.

Among the four homeownership centers, we found that the Philadelphia

center was the only one that had suspended the direct endorsement

authority of any lenders during fiscal year 1999. Specifically, the

Philadelphia center took this action against eight lenders in fiscal year

1999, citing underwriting violations identified by technical reviews or

lender reviews. While the Santa Ana center did not suspend any lender’s

direct endorsement authority, in October 1999, the center warned 27

lenders that it might do so if they did not submit plans to eliminate and

prevent the recurrence of underwriting deficiencies revealed in technical

reviews. The Denver and Atlanta centers did not suspend any lender’s

direct endorsement authority. Officials at these centers told us they had

concerns about the additional workload associated with suspending

lenders and lacked the information systems necessary to evaluate lenders’

performance. The centers have taken steps to address these problems, as

follows:

• In September 1999, the Atlanta center hired a contractor to evaluate the

underwriting decisions of lenders whose direct endorsement authority

may be suspended by the center in the future. Officials at the Atlanta

center said they lacked sufficient underwriting staff to do this function

themselves.

• Denver center officials said they were developing a database system to,

among other things, help all four centers better track and analyze the

results of technical reviews and identify poorly performing lenders for

enforcement actions. Although technical review ratings are entered into

CHUMS, this system is a limited monitoring tool because it does not

capture the reason for each rating—information that center officials

believe is necessary to justify enforcement actions against lenders.

We also found that the centers had not developed consistent criteria for

suspending lenders’ direct endorsement authority. For example, the

Philadelphia center suspended several lenders because, according to

center officials, the lenders received “fair” or “poor” ratings for

underwriting in over half of their technical reviews in fiscal years 1998 and

1999 and had above-average default rates on their FHA-insured mortgage
B-283389

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loans. In contrast, the Santa Ana center proposed suspending lenders solely

because the lenders’ underwriters received six or more “poor” ratings in

technical reviews conducted during July through September 1999,

regardless of the number of reviews the lenders received during the period.

Neither the Atlanta nor the Denver center had developed criteria for

suspending lenders’ direct endorsement authority.

Although HUD’s homeownership centers suspended the direct

endorsement authority of relatively few lenders in fiscal year 1999, our

analysis of HUD’s technical review ratings for fiscal year 1999 showed

frequent noncompliance by lenders with FHA’s requirements, indicating

that many lenders may be candidates for this action. Specifically, our

analysis showed that in fiscal year 1999, about 5,000 lenders received

technical review ratings for mortgage credit analysis for the FHA-insured

mortgages they originated and underwrote.9 Nearly 20 percent of the loans

subject to technical reviews received “poor” ratings for mortgage credit

analysis, meaning that the lenders made mistakes in evaluating the

borrowers’ credit worthiness that significantly increased HUD’s insurance

risk. We identified 206 lenders nationwide that, during fiscal year 1999,

received “poor” ratings for mortgage credit analysis on more than 30

percent of their reviewed loans and whose percentage of “poor” ratings, on

the basis of statistical analysis, could have been expected to exceed 30

percent, had HUD reviewed all of their fiscal year 1999 loans.10 Of these

lenders, 131 made 10 or more FHA-insured loans in fiscal year 1999. HUD’s

guidance does not define the extent of noncompliance with FHA’s

underwriting requirements that would warrant the suspension of a lender’s

direct endorsement authority. However, in our opinion, the extent of

noncompliance demonstrated by these 131 lenders indicates that they may

be candidates for this action. As of October 1, 1999, HUD’s homeownership

centers had not suspended any of these lenders’ direct endorsement

authority.

9

Lenders could have been counted more than once if they underwrote FHA-insured

mortgages in more than one HUD field office jurisdiction. The lenders made a total of

111,699 mortgage loans that received technical reviews from HUD.

10Our statistical analyses identified, at the 95-percent level of confidence, those lenders that

we would have expected to receive “poor” ratings on at least 30 percent of their loans, had

all of their fiscal year 1999 loans been subject to technical reviews.
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Lenders Underwriting Loans

Originated by Others

Escape Responsibility for

Excessive Default and

Claim Rates Under HUD’s

Credit Watch Program

HUD’s Credit Watch program is an enforcement tool that the Department

has used to terminate the loan origination authority of lenders with

excessive default and claim rates on FHA-insured loans. However, because

the program’s regulations pertain only to the lenders that originated the

troubled loans, HUD does not always hold accountable those lenders that

underwrote and approved the loans. For example, 18 of the 33 lenders

whose loan origination authority was terminated by HUD during the first

round of Credit Watch used other FHA lenders to underwrite all or virtually

all of the troubled loans that the 18 lenders originated. However, HUD did

not hold the lenders that underwrote these loans accountable. In addition,

a legal challenge to HUD’s authority to implement the program leaves the

program’s future in doubt.

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. HUD planned to terminate the loan origination authority of any

lender 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. Similarly, HUD planned to place on “Credit Watch”

status the lenders whose default and claim rates exceeded both the

national average and 200 percent of the corresponding HUD field office

average. While on Credit Watch status, the lender can continue to originate

FHA-insured loans, but its performance receives greater scrutiny from

HUD.

As of the end of January 2000, HUD had analyzed lenders’ default and claim

rates for the three 24-month periods ending on March 31, 1999, June 30,

1999, and September 30, 1999. HUD limited its analyses to lenders that had

a minimum of 25 defaults or claims during these periods. This program has

resulted in the Department’s actual or proposed termination of 50 lenders’

loan origination authority and the placement of 104 additional lenders on

Credit Watch status. (See table 1.)
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Table 1: Results of the First Three Rounds of HUD’s Credit Watch Program

a

Proposed as of February 1, 2000.

Source: HUD’s Office of Lender Activities and Program Compliance.

The regulations governing HUD’s Credit Watch program allow the

Department to hold accountable for excessive defaults or insurance claims

the lenders that originated the troubled loans. However, 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. HUD officials told us they recognized that

the underwriting lenders contributed to excessive defaults and insurance

claims but that the Credit Watch program’s regulations did not permit them

to take enforcement actions against these lenders. The officials said they

were considering regulatory changes to address this problem.

The results of the first round of the Credit Watch program illustrate the

program’s limitations as an enforcement tool. As shown in figure 7, of the

33 lenders that HUD terminated during the first round of the program, 17

were loan correspondents. Under HUD’s regulations, loan correspondents

sell or transfer loans that they originate to other FHA lenders, known as

sponsoring lenders, for underwriting and approval. Sponsoring lenders

underwrote the nearly 6,200 loans that the 17 loan correspondents

originated and FHA insured during the 24-month period of analysis, but

HUD did not impose sanctions against the sponsoring lenders through the

Credit Watch program. The remaining 16 lenders had the authority to

underwrite FHA-insured loans. However, 1 of these 16 lenders relied largely

on other lenders to underwrite the loans it originated. Specifically, HUD’s

data showed that other lenders underwrote 364 of the 365 loans that the

Credit Watch round

Number of lenders whose FHA loan

origination authority was terminated by HUD

Number of lenders that HUD placed on

Credit Watch status

1 33 56

2 5 25

3 12a 23

Total 50 104
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lender had originated and FHA insured during the 24-month period. The

data showed further that three lenders had underwritten 274 of these 364

loans and that the lenders’ default and claim rates for these loans were 6 to

13 times the national average and 3 to 6 times the corresponding HUD field

offices’ averages. Nevertheless, the three lenders were not subject to

enforcement actions under the Credit Watch program.

Figure 7: Percentage of Lenders, by Type, Whose Loan Origination Authority Was

Terminated Because of Excessive Defaults and Insurance Claims on Loans Made For

the 24-Month Period Ending March 31, 1999

Source: GAO’s analysis of data from HUD.

52%

48%

Loan correspondents (17)

Lenders authorized to underwrite

FHA-insured loans (16)
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In September 1999, one lender whose authority to originate FHA-insured

mortgage loans was terminated by HUD filed a lawsuit seeking to overturn

HUD’s actions. Among other issues, the lender contended that HUD had

exceeded its statutory authority when it issued its Credit Watch regulations

and that the manner in which HUD terminated the lender’s authority had

deprived the lender of due process. In October 1999, a federal district court

ruled that HUD’s Credit Watch regulations were invalid and set aside HUD’s

termination of the lender. The court stated that HUD’s statutory authority

requires that after determining that a lender has excessive defaults and

claims, HUD must provide the lender the opportunity to provide the

Department with a plan and timetable for correcting the defaults. The court

stated that HUD had sidestepped its statutory mandate by enacting

regulations that allowed the Department to terminate a lender’s authority

to originate loans whenever HUD deemed it appropriate because of the

lender’s default and claim rates. The court also concluded that even if HUD

had the authority to issue such regulations, the regulations denied the

lender its right to due process.11 In December 1999, the same court ruled

that its October 1999 decision did not affect the other lenders whose FHA’s

loan origination authority was terminated by HUD.

HUD has appealed this decision. An Assistant General Counsel in HUD’s

Litigation Division told us that, in HUD’s view, the National Housing Act

provides the Department with broad authority to issue regulations and

fashion programs for dealing with lenders with excessive default and claim

rates. According to this official, HUD also disagrees with the court’s

contention that HUD’s regulations denied the lender due process. He said

that the lenders whose authority HUD proposed to terminate were given 30

days written notice of HUD’s intention and were provided the opportunity

to explain the reasons for the high default and claim rates. HUD officials

told us that if the Department loses its appeal of the court decision, it will

seek legislation that authorizes HUD to continue the Credit Watch program.

Mortgagee Review Board’s

Process for Sanctioning

Lenders Is Time-Consuming

HUD’s Mortgagee Review Board (Board) can impose administrative actions

against FHA lenders that commit program violations. However, the Board

frequently takes over a year to impose sanctions against lenders and faces

challenges to improving its timeliness. As a result, some of these lenders

continue making FHA-insured loans for a year or more before they are held

accountable for the violations.

11Capitol Mortgage Bankers, Inc. v. Cuomo, 77 F. Supp. 2d 690 (D. Md. 1999).
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In fiscal year 1999, 68 cases were referred to the Board for 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 and involve lenders that make mortgages for single-family homes.

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 FHAapproved lenders, ranging from a letter of reprimand to withdrawal of a

lender’s FHA approval.

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. For example, we reviewed

the Board’s records for 24 of the 30 cases involving single-family housing

lenders that the Board acted on from October 1998 through April 1999.12 As

of November 1999, we found that in 18 of the 24 cases, the Board had either

reached settlement agreements with the lenders (5 cases) or was still

attempting to reach settlement agreements (13 cases). In the remaining six

cases, the Board had withdrawn the lenders’ FHA approval. (See table 2.)

Our analysis of the 24 cases further showed that the Board’s efforts to

review the cases and impose sanctions against lenders or to enter into

settlement agreements with them is frequently a time-consuming process.

As table 2 shows, for the 11 cases that the Board completed action on as of

November 1999, it took an average of 8.5 months from the notice of

violations to withdraw lenders’ FHA approval and an average of 11.2

months to reach settlement agreements. For one of the withdrawals and for

two of the settlement agreements, the Board took over a year to complete

these actions. For the 13 cases that the Board had not completed action on,

an average of 14.3 months had elapsed since the Board sent the lenders

notices of violation. The length of time required by the Board to complete

its actions in these 13 cases has allowed some of these lenders to continue

making FHA-insured loans for over a year without being held accountable

for their violations. For example, in April 1998, the Board sent a notice of

violation to one of these lenders because the lender committed several

12The records for the remaining six cases were being used by HUD staff and were not

available for our review (three cases) or our preliminary review indicated that the cases did

not involve single-family mortgage loans (three cases). As of November 1999, the official

minutes of the Board’s meetings during fiscal year 1999 were available only for the period

covering October 1998 through April 1999.
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violations, including using false information to originate loans. However,

the Board had not resolved the case as of November 1999—19 months

later—and during the 19-month period, the lender made over 300 FHAinsured mortgage loans.

Table 2: Summary of the Mortgagee Review Board’s Fiscal Year 1999 Actions on 24 Cases as of November 1999

Source: GAO’s analysis of data from HUD.

HUD does not have guidelines for the time it should take for the Board to

take enforcement actions against lenders. However, the Board recognizes

that its review process and its efforts to impose sanctions against or enter

into settlement agreements with lenders that commit program violations

can be time-consuming. The Board has taken some steps to speed up the

process. For example, the Board’s secretary told us that in December 1998,

the Board 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, the Board

recently hired another person to help the Board’s secretary review case

referrals and prepare the cases for the Board’s action. In addition, to speed

up the settlement agreement process, the Board plans 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. If a lender’s settlement offer

was acceptable to the Board, a settlement agreement could be prepared

and signed immediately. If a lender’s offer was not acceptable, the Board

could then make its own proposal for settling the case.

Type of Board action Number of cases

Average number of months elapsed since the

notices of violation

Board action completed

Lender’s FHA approval was withdrawn 6 8.5

Lender entered into a settlement agreement 5 11.2

Board action ongoing

Board and lender attempting to reach a

settlement agreement 13 14.3

Total 24
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Conclusions FHA insures tens of billions of dollars in mortgages for single-family homes

each year. While FHA’s Mutual Mortgage Insurance Fund is currently

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 important for HUD to hold

lenders accountable for the quality of these loans. However, HUD has not

taken adequate steps to maximize the effectiveness of its oversight

resources and minimize its insurance risk. Weaknesses in HUD’s approval,

monitoring, and enforcement efforts point to the need for improvements in

HUD’s oversight of FHA mortgage lenders.

HUD could significantly improve its process for approving lenders seeking

the authority to underwrite FHA-insured loans. Because the Department

lacks clear and specific standards for granting lenders direct endorsement

authority, its homeownership centers have implemented the existing

standards differently and approved lenders that demonstrated varying

levels of proficiency, including lenders that made multiple and serious

underwriting mistakes. Consequently, HUD has only limited assurance that

the lenders it is approving are qualified to underwrite loans and, therefore,

may be exposing the Department to unreasonable insurance risks.

Addressing this deficiency is especially important, given that since 1996,

HUD has no longer individually reviewed the qualifications of lenders’

underwriting staff.

Contrary to HUD’s guidance, the homeownership centers’ monitoring of

lenders does not adequately focus on the lenders and loans that pose the

greatest insurance risks to the Department. Focusing on high-risk cases

would increase HUD’s opportunities to uncover and curtail improper

lending practices. However, HUD’s homeownership centers often have not

conducted lender reviews of the lenders considered to pose the highest

risk, and HUD lacks a systematic process for identifying and prioritizing

such lenders for review. Furthermore, HUD’s centers have not consistently

targeted for technical reviews either high-risk loans or loans made by

problem lenders and newly approved lenders. In addition, HUD’s oversight

of contractors that perform technical reviews does not provide adequate

assurance that the contractors are doing a good job. Because of these

deficiencies, 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. Numerous lenders are not complying
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with FHA’s underwriting requirements, yet HUD’s homeownership centers

have suspended the direct endorsement authority of relatively few lenders.

Furthermore, HUD’s Credit Watch program is a strong enforcement tool

but a court decision has left the future of the program in doubt. In addition,

we believe that the program would be more effective if it held accountable

all the lenders involved in making problem loans rather than just those that

originated the loans. When poorly performing lenders are not held

responsible, they may continue to make loans that increase potential losses

to FHA’s insurance fund.

Recommendations To reduce the financial risks assumed by FHA and 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 do the following:

• Improve the process for granting lenders direct endorsement authority

by developing specific standards for overall acceptable performance in

preclosing reviews and ensuring that the homeownership centers

comply with these standards.

• More effectively monitor lenders’ performance by

• developing procedures to identify and prioritize high-risk lenders for

lender reviews and ensuring that the homeownership centers

consistently apply these procedures;

• developing procedures and enhancing FHA’s management

information systems to identify and select, for technical reviews,

loans and lenders within each homeownership center’s jurisdiction

that pose a high insurance risk to the Department;

• complying with guidance to perform technical reviews of all the FHAinsured loans that are made by lenders that are newly granted direct

endorsement authority; and

• tracking the performance of contractors conducting technical

reviews against performance standards in the contracts and taking

appropriate actions against contractors whose performance is not

acceptable.

• Strengthen its enforcement efforts by clarifying and implementing

guidelines for identifying lenders whose direct endorsement authority

should be suspended.

In addition, we recommend that once the legal basis of the Credit Watch

program is resolved, the Secretary of HUD direct the Assistant Secretary

for Housing-Federal Housing Commissioner, to revise the Credit Watch
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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.

Agency Comments We provided HUD with a draft of this report for review and comment. HUD

stated that while it did not always agree with the report’s characterization

of the Department’s practices and procedures for overseeing FHA lenders,

it generally agreed with the report’s recommendations.

In commenting on the draft report’s discussion of technical reviews of

loans, HUD took issue with our statement that its selection of loans for

review was not based on risk. HUD stated that it performs technical

reviews of all Section 203(k) rehabilitation loans, mortgages made to

nonprofit agencies, and other categories of mortgages that historically have

had higher default rates. Our report recognizes that the homeownership

centers have, on a limited basis, targeted some high-risk loans for technical

reviews. At the same time, the centers’ lack of information systems capable

of identifying high-risk loans makes it impractical for the centers to select

and review high-risk loans on a routine basis. Furthermore, the categories

of loans cited by HUD—Section 203(k) loans and mortgages made to

nonprofit agencies—account for a very small portion of FHA’s loan

portfolio.

HUD also disagreed with our finding that it was not monitoring the

performance of technical review contractors. Our draft report did not

present such a finding. Rather, we observed that three of the four

homeownership centers did not track the percentage of the contractors’

work that contained significant errors and omissions and, therefore, were

not in a position to provide the contractors with adequate performance

feedback or, if necessary, to enforce the contracts’ performance clauses.

HUD commented that our draft report’s discussion of lender reviews did

not adequately recognize that its targeting guidance requires

homeownership center staff to consider several factors, in addition to

lenders’ default and claim rates, in selecting lenders for review. Our report

recognizes that HUD’s guidance requires that various risk factors, such as

lenders’ loan volume and the late payment of mortgage insurance

premiums to HUD, be considered in targeting lenders for review. However,

our concern is that the guidance neither indicates how these factors should

weighted nor how lenders should be prioritized. As a result, the
B-283389

Page 33 GAO/RCED-00-112 Oversight of FHA Lenders

homeownership centers have not targeted lenders for reviews in a

consistent manner.

While agreeing with our recommendation to clarify and implement

guidelines for identifying lenders whose direct endorsement authority

should be suspended, HUD disagreed with the draft report’s finding that the

Department had made limited use of its ability to suspend the direct

endorsement authority of lenders. HUD stated that while the

homeownership centers had not actually suspended the authority of many

lenders, they had threatened suspension in several dozen cases every year

in an attempt to improve lenders’ performance. As our report notes, one

center suspended 8 lenders in fiscal year 1999 and another center

threatened to suspend 27 lenders in October 1999. At the other two centers,

we found only one instance in which the center threatened to suspend the

authority of a lender. Taken together, the actions of the four centers do not

appear to support HUD’s assertion that the centers have routinely used the

threat of suspension to improve lenders’ performance.

Finally, while HUD agreed with our recommendation to revise its Credit

Watch program to hold loan underwriters accountable for excessive default

and claim rates, HUD did not believe that it would be appropriate to stop

taking enforcement action against loan originators. We did not intend for

HUD to stop taking enforcement action against loan originators but rather

that the Credit Watch program hold both the lenders that originated the

troubled loans and the lenders that underwrote the loans accountable for

excessive default and claim rates because both share responsibility for the

quality of the loans.

The full text of HUD’s letter is presented in appendix I.

We conducted our work at HUD’s headquarters and its Atlanta, Denver,

Philadelphia, and Santa Ana homeownership centers. Our review focused

on the adequacy of HUD’s policies and procedures for overseeing lenders.

We reviewed regulations, handbook guidance, and other documents related

to HUD’s approval, monitoring, and enforcement activities for FHA lenders.

We interviewed officials from HUD’s Office of Insured Single-Family

Housing, Enforcement Center, Mortgagee Review Board, and the four

centers. We also interviewed representatives from Fannie Mae, Freddie

Mac, and a firm contracted by HUD to perform technical reviews. In

addition, we performed limited tests and analyses to determine whether

HUD’s policies and procedures were properly utilized to limit the
B-283389

Page 34 GAO/RCED-00-112 Oversight of FHA Lenders

Department’s insurance risk. We analyzed information on the performance

of all 36 lenders granted direct endorsement authority by the four

homeownership centers in the 6 months prior to our 1999 visits. We also

reviewed documentation from the centers pertaining to targeting of lenders

for on-site monitoring and technical reviews, the oversight of technical

review contractors, and enforcement actions against lenders. We analyzed

data from HUD’s Computerized Homes Underwriting Management System

to determine how frequently lenders received “poor” ratings for mortgage

credit analysis in technical reviews. We determined the number and types

of lenders sanctioned by HUD under its Credit Watch program as of the end

of January 2000. Finally, we reviewed the Mortgagee Review Board’s files

for information on its enforcement activities. We performed this review

from June 1999 through April 2000 in accordance with generally accepted

government auditing standards. Appendix II provides additional details on

our scope and methodology.

As arranged with your office, unless you publicly release its contents

earlier, we plan no further distribution of this report until 30 days after the

date of this letter. At that time, we will send copies to the Honorable Barney

Frank, Ranking Minority Member, Subcommittee on Housing and

Community Opportunity, House Committee on Banking and Financial

Services; the Honorable James A. Leach, Chairman, and the Honorable

John J. LaFalce, Ranking Minority Member, House Committee on Banking

and Financial Services; the Honorable Carl Levin, Ranking Minority

Member, Permanent Subcommittee on Investigations, Senate Committee

on Governmental Affairs; the Honorable Phil Gram, Chairman, and the

Honorable Paul S. Sarbanes, Ranking Minority Member, Senate Committee

on Banking, Housing, and Urban Affairs; and the Honorable Fred

Thompson, Chairman, and the Honorable Joseph Lieberman, Ranking

Minority Member, Senate Committee on Governmental Affairs. We will also

send copies of this report to the Honorable Andrew M. Cuomo, Secretary of

HUD; the Honorable William C. Apgar, HUD Assistant Secretary for

Housing-Federal Housing Commissioner; and the Honorable Jacob J. Lew,

Director, Office of Management and Budget. We will make copies available

to others upon request.
B-283389

Page 35 GAO/RCED-00-112 Oversight of FHA Lenders

Please call me on (202) 512-7631 if you or your staff have any questions

about this report. Major contributors to this report are listed in appendix

III.

Stanley J. Czerwinski

Associate Director, Housing and Community

Development Issues
Page 36 GAO/RCED-00-112 Oversight of FHA Lenders

Appendix I

Comments From the Department of Housing Apendxies

and Urban Development ApendxiI
Appendix I

Comments From the Department of Housing

and Urban Development

Page 37 GAO/RCED-00-112 Oversight of FHA Lenders
Appendix I

Comments From the Department of Housing

and Urban Development

Page 38 GAO/RCED-00-112 Oversight of FHA Lenders
Appendix I

Comments From the Department of Housing

and Urban Development

Page 39 GAO/RCED-00-112 Oversight of FHA Lenders
Appendix I

Comments From the Department of Housing

and Urban Development

Page 40 GAO/RCED-00-112 Oversight of FHA Lenders
Appendix I

Comments From the Department of Housing

and Urban Development

Page 41 GAO/RCED-00-112 Oversight of FHA Lenders
Page 42 GAO/RCED-00-112 Oversight of FHA Lenders

Appendix II

Objectives, Scope, and Methodology ApendxiI

Our objectives were to answer the following questions: (1) How well does

the Department of Housing and Urban Development (HUD) ensure that

lenders granted direct endorsement authority by the Federal Housing

Administration (FHA) are qualified to receive such authority? (2) To what

extent does HUD focus on high-risk lenders in monitoring the lenders

participating in FHA’s mortgage insurance programs? (3) To what extent is

HUD holding these lenders accountable for poor performance? Our review

focused on the adequacy of HUD’s policies and procedures for overseeing

lenders. We performed limited tests and analyses to determine whether

these policies and procedures were properly utilized to limit HUD’s

insurance risk.

To determine how HUD ensures that lenders granted directed endorsement

authority are qualified to receive such 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 FHAinsured mortgage loans without prior FHA review or approval. We

interviewed officials from HUD’s Office of Lender Activities and Program

Compliance and its four homeownership centers. We developed

information on the number of lenders granted direct endorsement

authority by each of the four homeownership centers during the 6 months

prior to our visit to each of the centers. We visited the Philadelphia center

in August 1999 and the Denver, Santa Ana, and Atlanta centers in October

1999. For each of the 36 lenders approved during this time period, we

reviewed documentation maintained by the centers to determine (1) the

ratings that the lender received on the mortgages it submitted to the center

to demonstrate its ability to comply with FHA’s requirements and (2)

whether the centers followed FHA’s procedures in granting lenders direct

endorsement program authority.

To determine the extent to which HUD is focusing its monitoring efforts on

high-risk lenders, we reviewed HUD’s guidance and procedures for

conducting technical reviews (i.e., review of individual loans performed

after approval of mortgage insurance to assess the quality of lenders’

underwriting practices) and lender reviews (i.e., on-site reviews of lenders’

operations by HUD staff). We determined the extent to which each of the

four homeownership centers met HUD’s fiscal year 1999 goals to (1)

conduct technical reviews of at least 10 percent of the single-family

mortgage loans insured by FHA during the fiscal year and (2) perform 225

lender reviews. We reviewed HUD’s use and oversight of contractors that

perform technical reviews and interviewed representatives from one
Appendix II

Objectives, Scope, and Methodology

Page 43 GAO/RCED-00-112 Oversight of FHA Lenders

contractor that was performing reviews for three of the four

homeownership centers. We interviewed officials at each of the centers on

a variety of issues dealing with technical reviews and lender reviews. The

issues discussed included the (1) centers’ criteria for targeting loans and

lenders for review, (2) procedures for monitoring the work of technical

review contractors, and (3) number and experience of the centers’ staff

who were performing lender reviews. We also interviewed representatives

from Fannie Mae and Freddie Mac regarding their efforts to monitor the

performance of lenders whose loans they purchase.

To determine the extent to which HUD is holding lenders accountable for

poor 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 poorly performing

lenders. Using data from HUD’s Computerized Homes Underwriting

Management System on the technical reviews conducted during fiscal year

1999, we determined the percentage of reviews that gave a “poor” rating for

mortgage credit analysis. Using these same data, we performed statistical

analyses to identify, at the 95-percent level of confidence, those lenders we

would have expected to have received “poor” ratings on more than 30

percent of their loans, had all of their fiscal year 1999 loans been subject to

technical reviews. We determined the number and types of lenders

sanctioned by HUD under its Credit Watch program as of the end of

January 2000. We reviewed the Board’s files for 24 of the 30 cases involving

single-family mortgage lenders that the Board acted on during October

1998 through April 1999 and determined the nature and status of the

Board’s actions as of November 1999.

Our reliability assessments of the specific data elements required for this

review indicated that the data were reliable enough for our analyses. To

assess reliability, we reviewed existing information about data quality and

controls supporting the data systems and discussed the data we analyzed

with agency officials to ensure that we interpreted them properly.

We performed this review from June 1999 through April 2000 in accordance

with generally accepted government auditing standards.
Page 44 GAO/RCED-00-112 Oversight of FHA Lenders

Appendix III

GAO Contacts and Staff Acknowledgments ApendxiI

GAO Contacts Stanley J. Czerwinski (202) 512-7631

Paul J. Schmidt (312) 220-7681

Acknowledgements In addition to those named above, Karen Bracey, Karin Lennon, John

McGrail, Stan Ritchick, Steve Westley, and Shana Whitehead made key

contributions to this report.

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