Single-Family Housing:

Progress Made, but Opportunities Exist to Improve HUD's Oversight of FHA Lenders

GAO-05-13: Published: Nov 12, 2004. Publicly Released: Nov 12, 2004.

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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.

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.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In February 2005, HUD published a mortgage letter outlining changes in the ratings and codes used in connection with its technical review process for FHA single-family mortgages. The new ratings will be effective for mortgages reviewed and rated after January 1, 2005. Under the new system, underwriting will no longer be rated Good, Fair, or Poor. Instead, mortgages will be rated either Acceptable or Unacceptable in two categories: Mortgage Credit Underwriting and Valuation Underwriting. For mortgages rated Acceptable, the overall decision to approve the mortgage is considered sound and the level of risk acceptable, but there may be deficiencies noted that HUD expects the lender to address in future submissions for insurance endorsement. A rating of Unacceptable means that the mortgage exhibits such serious violations of FHA requirements and, therefore, poses such a level of risk to the Department that it should not have been approved. A mortgage rated as Unacceptable will require the lender to explain the decision to approve the mortgage and may result in a request to indemnify the Department against loss. According to HUD, it expects that this revised rating system will accurately reflect the risk level associated with recently insured mortgages while at the same time significantly reduce the number of unwarranted Poor ratings.

    Recommendation: To improve HUD's oversight of FHA mortgage lenders, the Secretary of HUD should direct the Assistant Secretary for Housing-Federal Housing Commissioner to 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.

    Agency Affected: Department of Housing and Urban Development

  2. Status: Closed - Implemented

    Comments: In April 2006, HUD published release notes outlining changes to FHA Connection and the Computerized Homes Underwriting Management System (CHUMS) that allow its homeownership centers to better establish a lender's review rate through the added Review Rules function. The Review Rules function, which is used by HUD's homeownership centers to set the review rate for direct endorsement lenders doing business within their geographic area, was added to the FHA Connection for authorized HUD personnel, effective April 17, 2006. Among other things, this function enables the homeownership centers to set the number of loans to be reviewed in the "Review 1 in X" field and the number of successive loans to be reviewed in the "Review Next X" field. Further, the number of loans that have already been reviewed also appears in the system. By adding the Review Rules function to this FHA information system, HUD has helped to ensure that the first 30 loans made by new direct endorsement lenders are reviewed as required.

    Recommendation: To improve HUD's oversight of FHA mortgage lenders, the Secretary of HUD should direct the Assistant Secretary for Housing-Federal Housing Commissioner to enhance FHA's information system to ensure that the first 30 loans made by new direct endorsement lenders are reviewed as required.

    Agency Affected: Department of Housing and Urban Development

  3. Status: Closed - Implemented

    Comments: In January 2005, HUD reported that it had modified its lender tracking system to distinguish between desk and on-site reviews.

    Recommendation: To improve HUD's oversight of FHA mortgage lenders, the Secretary of HUD should direct the Assistant Secretary for Housing-Federal Housing Commissioner to track lender reviews to distinguish between desk and on-site reviews.

    Agency Affected: Department of Housing and Urban Development

  4. Status: Closed - Implemented

    Comments: In May 2005, HUD issued updated instructions for the four homeownership centers to use when granting direct endorsement authority to lenders. These instructions state, among other things, that (1) lenders will be granted direct endorsement authority when they have successfully underwritten and processed 15 test cases within a twelve consecutive month period; and (2) that a lender is to be notified in writing that they cannot submit cases for at least 180 days if they have submitted 30 cases and have not met the standards.

    Recommendation: To improve HUD's oversight of FHA mortgage lenders, the Secretary of HUD should direct the Assistant Secretary for Housing-Federal Housing Commissioner to ensure that the homeownership centers are following the guidance for granting direct endorsement authority.

    Agency Affected: Department of Housing and Urban Development

  5. Status: Closed - Implemented

    Comments: On January 31, 2005, HUD issued standards for withdrawing and restoring direct endorsement authority. In addition to outlining circumstances under which direct endorsement authority may be withdrawn, the updated procedures described certain conditions under which withdrawal of direct endorsement authority would be mandatory. Specifically, any lender's branch office that has had 20 percent or more of its reviewed cases rated "unacceptable" under the new technical review rating system for at least two consecutive quarters will have its direct endorsement authority withdrawn.

    Recommendation: To improve HUD's oversight of FHA mortgage lenders, the Secretary of HUD should direct the Assistant Secretary for Housing-Federal Housing Commissioner to develop and implement guidance specifying the conditions under which a homeownership center must suspend a lender's direct endorsement authority.

    Agency Affected: Department of Housing and Urban Development

 

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