Single-Family Housing: Stronger Oversight of FHA Lenders Could Reduce HUD's Insurance Risk

In November 2000, HUD's Office of Single-Family Program Development issued standards for granting lenders direct endorsement authority and monitoring lender performance. The standards state that, in order to receive direct endorsement authority, a lender must submit 15 consecutive loan cases that are rated "good" or "fair" by HUD's homeownership centers. The standards also require that the centers (1) maintain a file, for every lender that requests direct endorsement authority, containing all correspondence and including copies of all underwriting reports prepared by the centers on loan cases submitted by the lenders; and (2) enter the results of all reviews into FHA's automated Underwriting Report System.

During the last quarter of fiscal year 2000, HUD implemented new procedures for targeting lenders for quarterly on-site reviews. To identify the potential list of lenders for review, the procedures first require that each homeownership center develops a list of the 200 lenders with the highest loan default and claim rates in the center. The procedures then require that each center add the following to this list: the names of 203(k) lenders targeted by the center based on loan defaults; Title I lenders targeted by each center based on loan volume, fraudulent activities, borrower complaints, or referrals by HUD's Inspector general or others; "random" lenders identified by HUD headquarters at the beginning of each fiscal year; and any lenders showing a 100 percent increase in loan originations over a 12-month period. The centers must use the resulting lists to target lenders for on-site reviews. The centers are required to document their targeting decisions, and the lists of targeted lenders must be approved by the center directors. The centers are also required to provide HUD headquarters with a monthly status report detailing the progress of their targeted reviews.

On September 30, 2001, HUD contracted with Deloitte and Touche to develop an algorithm that will enable FHA to select loans for review on the basis of risk factors. The algorithm should be completed by June 30, 2002. Funding for programming the algorithm into HUD's Computerized Home Underwriting System will be proposed for the fiscal year 2003 budget. In February 2004, HUD implemented the algorithm in its Computerized Homes Underwriting Management Systems that provides a risk-based statistical process to automatically select cases for technical review. The algorithm makes selections based on loan characteristics and risk data related to endorsement activity. Factors in the algorithm include calculated risk, risk thresholds, and review percentages. Some of the weighted loan characteristics used in the risk factor calculation include the back-end ratio and loan to value ratio.

In November 2000, HUD's Office of Single Family Program Development issued standards for granting lenders direct endorsement authority and monitoring lender performance that instructs the homeownership centers to conduct, upon granting a lender direct endorsement authority, post-endorsement technical reviews of the lender's files at the 100 percent level for the first 6 months or 50 cases, whichever comes first.

HUD made its governmental technical monitors responsible for tracking the performance of technical review contractors against performance standards in the contracts. In addition, HUD approved a revised Statement of Work (SOW) for its technical review contracts that spells out quality control procedures for both the contractor and for HUD. The procedures require that at a minimum, the contractor review 10 percent of all cases it completes each month. The reviews are to be done by an underwriter not involved in the original review of the cases. The contractor must provide HUD with a monthly list of all cases reviewed and, for each review, a statement by the reviewer as to whether he or she agrees or disagrees with the rating given by the original reviewer. The procedures also require that HUD randomly select and conduct in-depth quality assurance reviews of at least five percent of all the cases completed by the contractor each month. Finally, the procedures establish acceptable levels of performance that the contractor must meet each month, and specify the monetary damages that HUD will assess against the contractor if it fails to achieve this level of performance. According to HUD, as of June 2001, the Philadelphia and Santa Ana homeownership centers have already awarded new technical review contracts that contain the revised SOW, and the Atlanta and Denver centers will pursue contracts with the revised SOW as soon as their existing contracts expire.

In November 2000, HUD's Office of Single Family Program Development issued standards for granting lenders direct endorsement and monitoring lender performance. The standards stipulate that HUD's homeownership centers may suspend a lender's direct endorsement authority based on a written request or referral from a center's Quality Assurance Division. The standards also state that the centers may suspend the direct endorsement authority of any lender (1) that is identified with continued evidence of fraud, (2) that has a "poor" performance percentage that is in excess of 20 percent for more than 90 days after being placed on 100 percent review status, or (3) that has a claim and default rate that exceeds both the national rate and 250 percent of the field office rate.

On December 17, 2004, HUD published an interim rule that revised FHA's Credit Watch Termination Initiative. As of January 18, 2005, HUD will review, on an ongoing basis, the number of defaults and claims on mortgages originated, underwritten, or both, by each mortgagee in the geographic area served by a HUD field office. Under the interim rule, HUD may notify a mortgagee that its direct endorsement approval will terminate 60 days after notice is given, if the mortgagee had a rate of defaults and claims on insured mortgages underwritten in an area which exceeded 200 percent of the normal rate and exceeded the national default and claim rate for insured mortgages. If a mortgagee's direct endorsement approval is terminated, it may not underwrite single-family insured mortgages for the area(s) identified in the termination notice.