A $150,000 wake-up call.

The adverse financial results that can occur in a mortgage banking operation as a result of violations of HUD's requirements can have a major impact on the company's bottom line. In a time of maximizing profits, many CEOs don't focus on the quality of their products, looking instead to the volume of production as an indicator that all is well. Unfortunately, such an approach can have serious financial consequences down the road as HUD strengthens its enforcement efforts.

HUD's 2020 Management Reform Plan, now in its second year, made the enforcement of HUD requirements a top departmental priority. An enforcement center was established to ensure compliance with HUD's requirements and to take action against those companies, individuals and other program participants that violate these requirements. One area of responsibility assigned to the enforcement center is that of providing staff support to HUD's Mortgagee Review Board (MRB).

In addition to creating the enforcement center, HUD increased the number of its mortgagee monitors from 25 to more than 125 and placed them in the four homeownership centers (HOCs) under newly created quality control divisions. These monitors are HUD employees who actually visit the lender's place of business and conduct an in-depth review of the lender's origination and servicing of FHA-insured mortgages.

Also, in addition to substantially increasing the number of monitors, the monitoring review goal for FY99 was increased to 900 reviews, up from the less than 200 reviews that were performed the previous year. As part of the FY99 goal, 120 of the reviews will focus on the servicing practices of mortgagees, with special emphasis on the efforts of the servicer to provide loss mitigation to borrowers in default.

Most of HUD's monitoring reviews result in somewhat routine findings that can be resolved by correspondence and/or meetings between the company and the quality assurance division in the HOC. Historically, however, between 10 and 15 percent of the reviews result in MRB actions. The MRB is a board within HUD consisting of most of the department's assistant secretaries; it is chaired by the assistant secretary for housing-federal housing commissioner. This year, it is reasonable to expect that the chief operating officers of 60 to 90 FHA-approved lenders will get a letter from the FHA commissioner advising them of major problems that surfaced in the review of their activities. If you receive such a letter, it marks the beginning of an experience likely to be remembered for a long time.

Terms like "suspension," "civil money penalties," "withdrawal of approval" and "indemnification" suddenly are a part of your vocabulary, and they can result in substantial financial loss to your company. Let me explain. If a mortgagee indemnifies HUD on one single-family mortgage, the potential loss to the company is about $30,000 should that loan go to claim. Five loans, and the potential is in the range of $150,000; 10 loans would be $300,000. Clearly, it can get expensive very quickly. Civil money penalties are authorized by statute up to $5,500 per violation. The MRB has a number of possible sanctions that it can mix and match as it deems appropriate.

The initial reaction of many executives is that "it can't happen to my company." Let me assure you that if you believe this because "you run a tight operation," I would suggest you do a little homework before you come to this conclusion. A mortgagee monitor who shows up on your doorstep is there to look for problems. In addition to selecting some cases at random, the monitor will be armed with a list of high-risk cases, such as those that have defaulted in the first year, have gone to claim within a year or two after origination or carry other higher-risk characteristics such as loans involving gift letters or loans where credit ratios were exceeded, based on compensating factors.

The monitor will spend the next several days reviewing the origination files on each of the loans. Reverifications will be sent out, and the monitor will interview borrowers, real estate agents, nonprofits, employers, banks and so on, to reconstruct the origination process on each individual case to ascertain if any violations occurred. For example, if the borrower was told by the loan originator to ignore a debt, sign a blank application or fake a gift letter, it's going to surface. Since HUD holds lenders responsible for the acts of its employees - including loan originators - in situations where the borrower would not have otherwise qualified, your company may end up indemnifying HUD on the loan. It's as simple as that: one loan originator cutting a few corners to increase his commission. If the loan originator does it on several loans over a month or two, the ultimate expense to the company can be staggering. This same approach of scrutinizing high-risk defaulted loans holds true with HUD's servicing reviews.

Now is the time to focus on the quality of your origination and servicing operations. Your company's quality control plan (QCP) should be reviewed to ensure it meets HUD's requirements. Many of the problems inherent in originating and servicing loans may be found and corrected by following an effective QCP. Company policies on honesty and integrity should be properly understood by all employees. Adequate training is a must! The Mortgage Bankers Association of America (MBA) has excellent educational programs that can prepare your employees. If your office has major shortcomings, outside experts should be brought in to help. Finally, you must commit yourself to constant vigilance if you wish to avoid major problems with HUD. I can assure you that it is a small price to pay to avoid a HUD Mortgagee Review Board experience.

John J. Coonts is associate director of HUD's Enforcement Center in Washington, D.C., with oversight responsibility for cases being presented to the Mortgagee Review Board and suspension and debarment actions within the center. Previously, Coonts was director of HUD's Office of Insured Single Family Housing.