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ATTACHMENT A
1. Since at least January 2006, Franklin American Mortgage Co. (“Franklin
American”) has been a Direct Endorsement lender approved by the Federal Housing
Administration (“FHA”) and U.S. Department of Housing and Urban Development
(“HUD”). As a Direct Endorsement Lender, Franklin American is authorized by HUD to
originate and underwrite mortgage loans on HUD’s behalf, including determining a
borrower’s creditworthiness and whether the proposed loan met all applicable HUD
requirements. Franklin American obtained Lender Insurance status in June 2006. As a
Direct Endorsement lender with Lender Insurance status, Franklin American is
authorized to endorse mortgage loans for HUD insurance without any pre-endorsement
review of the mortgage application by HUD. Prior to obtaining Lender Insurance status,
HUD performed a limited review of loans Franklin American submitted for FHA
insurance pursuant to the requirements of 24 C.F.R. § 203.255(c).
2. HUD required Direct Endorsement lenders, such as Franklin American, to
follow applicable HUD regulations and underwriting requirements in originating and
underwriting mortgage loans for FHA insurance, including those requirements set out in
HUD’s Handbooks and Mortgagee Letters.
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3. HUD required Direct Endorsement lenders, such as Franklin American, to
submit certain proposed FHA originations through a HUD-approved Automated
Underwriting System (“AUS”) in conjunction with a tool known as Technology Open to
Approved Lenders (“TOTAL”). According to the FHA’s TOTAL Mortgage Scorecard
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The requirements referenced in paragraphs two through eleven of this document reflect standard HUD-
FHA program requirements for Direct Endorsement lenders as provided in HUD’s Handbooks and
Mortgagee Letters.
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User Guide, TOTAL evaluated the overall creditworthiness of the applicants based on a
number of credit variables. After a proposed loan was submitted, TOTAL would either:
(1) approve the mortgage subject to certain eligibility criteria or other conditions,
including conditions that the lender validate the information that formed the basis for
TOTAL’s determination; or (2) refer the mortgage application for manual underwriting
by the lender in accordance with HUD requirements. Franklin American understood that
TOTAL’s determination was based on the integrity of the data supplied by the lender.
HUD has promulgated requirements for calculating data used by TOTAL.
4. HUD required Direct Endorsement lenders, such as Franklin American, to
implement and maintain a quality control program in accordance with HUD Handbook
requirements for FHA loans in order to maintain Direct Endorsement lender status. HUD
required the FHA quality control function to be independent of FHA mortgage
origination and underwriting functions. HUD required Direct Endorsement lenders, such
as Franklin American, to review a sample of loans based on the number of FHA loans
originated and/or underwritten per year. HUD Handbook 4060.1 REV-2, § 7-6.C. Direct
Endorsement lenders, such as Franklin American, were also required to review each FHA
mortgage loan that became 60 days delinquent within the first six payments, which HUD
defined as “early payment defaults” or EPDs. Id. HUD required Direct Endorsement
lenders, such as Franklin American, in performing these quality control reviews, to
review the mortgage loan file, re-verify certain information, review the soundness of
underwriting judgments, document the review and any findings in a quality control
report, and report the findings to senior management within one month.
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5. HUD required Direct Endorsement lenders, such as Franklin American, to
self-report to HUD all findings related to FHA mortgage loans that constituted “material
violations of FHA or mortgagee requirements and represent an unacceptable level of
risk” and all findings of “fraud or other serious violations.” HUD Handbook 4060.1
REV-2, §§ 7-3.J & 7-4.D. Direct Endorsement lenders, such as Franklin American, were
also required to take “prompt action to deal appropriately with any material findings.” Id.
§ 7-3.I.
6. In order to obtain Direct Endorsement status, HUD required Direct
Endorsement lenders, such as Franklin American, to certify as follows:
I certify that, upon the submission of this application, and with its
submission of each loan for insurance or request for insurance
benefits, [Franklin American] has and will comply with the
requirements of the Secretary of Housing and Urban Development,
which include, but are not limited to, the National Housing Act (12
U.S.C. § 1702 et seq.) and HUD’s regulations, FHA handbooks,
mortgagee letters, and Title I letters and policies with regard to
using and maintaining its FHA lender approval.
7. Additionally, HUD required a Direct Endorsement lender, such as
Franklin American, to submit an Annual Certification stating:
I know, or am in a position to know, whether the operations of
[Franklin American] conform to HUD-FHA regulations,
handbooks, and policies. I certify that to the best of my
knowledge, [Franklin American] conforms to all HUD-FHA
regulations necessary to maintain its HUD-FHA approval, and that
[Franklin American] is fully responsible for all actions of its
employees including those of its HUD-FHA approved branch
offices.
Alternatively, HUD required a Direct Endorsement lender, such as Franklin American, to
submit a statement to HUD that it was unable to so certify and to explain why it could not
execute the certification.
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8. To qualify as a Direct Endorsement underwriter an underwriter must
satisfy several requirements. The Direct Endorsement underwriter “must have a
minimum of three years full-time recent experience (or equivalent experience) reviewing
both credit applications and property appraisals.” HUD Handbook 4000.4, REV-1,
CHG-2, ch. 2-4.A.3; see also HUD Handbook 4155.2 ch. 2.A.4.a. The underwriter must
also be a “reliable and responsible professional skilled in mortgage evaluation” and “must
be able to demonstrate his or her knowledge and experience regarding the principles of
mortgage underwriting.” HUD Handbook 4000.4, REV-1, CHG-2, ch. 2-4.A.1; see also
HUD Handbook 4155.2 ch. 2.A.4.a.
9. HUD considers the Direct Endorsement underwriter to be “the focal point
of the Direct Endorsement program.” HUD Handbook 4000.4, REV-1, CHG-2, ch. 2-
4.C. The Direct Endorsement underwriter must assume the following responsibilities:
(1) compliance with HUD instructions, the coordination of all phases of underwriting,
and the quality of decisions made under the program; (2) the review of appraisal reports,
compliance inspections and credit analyses performed by fee and staff personnel to
ensure reasonable conclusions, sound reports and compliance with HUD requirements;
(3) the decisions relating to the acceptability of the appraisal, the inspections, the buyer’s
capacity to repay the mortgage, and the overall acceptability of the mortgage loan for
HUD insurance; (4) the monitoring and evaluation of the performance of fee and staff
personnel used for the Direct Endorsement program; and (5) awareness of the warning
signs that may indicate irregularities, and an ability to detect fraud, as well as the
responsibility that underwriting decisions are performed with due diligence in a prudent
manner.
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10. With respect to each mortgage loan submitted or endorsed by Franklin
American for FHA insurance, either a Franklin American mortgagee representative or a
Franklin American Direct Endorsement underwriter was required to certify that the
mortgage “is eligible for HUD mortgage insurance under the Direct Endorsement
program.” For each loan that was approved using AUS, a Franklin American mortgagee
representative was required to certify to the “integrity of the data supplied by [Franklin
American] used to determine the quality of the loan [and] that a Direct Endorsement
Underwriter reviewed the appraisal.” For each FHA loan that Franklin American
approved using manual underwriting, a Franklin American Direct Endorsement
underwriter was required to certify that he or she “personally reviewed the appraisal
report (if applicable), credit application, and all associated documents and ha[s] used due
diligence in underwriting the[e] mortgage.”
11. For every mortgage loan approved by Franklin American, whether through
manual underwriting or the use of an AUS, a Franklin American Direct Endorsement
underwriter was required to certify that:
I, the undersigned, as authorized representative of Franklin
American at this time of closing of this mortgage loan, certify that
I have personally reviewed the mortgage loan documents, closing
statements, application for insurance endorsement, and all
accompanying documents. I hereby make all certifications
required for this mortgage as set forth in HUD Handbook 4000.4.
12 When a borrower defaults on an FHA-insured loan underwritten and
endorsed by a Direct Endorsement lender, such as Franklin American, the lender, or if the
mortgage or servicing rights were transferred after closing, the mortgage holder or
servicer, has the option of submitting a claim to HUD to compensate the lender for any
loss sustained as a result of the default. As such, once a mortgage loan is endorsed for
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FHA insurance, HUD insures the risk of the borrower defaulting on that mortgage, which
is realized if an insurance claim is submitted.
13. The Department of Justice has investigated Franklin American with regard
to its origination, underwriting, quality control, and endorsement practices, as well as its
submissions of certifications, related to certain FHA-insured single-family residential
mortgage loans originated between January 1, 2006, and December 31, 2012, and for
which claims for FHA insurance benefits were submitted by July 10, 2015 (the “Released
Loans”). The following statements apply to the Released Loans only.
14. Between January 1, 2006, and December 31, 2012, Franklin American
certified for FHA mortgage insurance pursuant to the Direct Endorsement Program
certain Released Loans that did not meet certain HUD requirements and therefore were
not eligible for FHA mortgage insurance under the Direct Endorsement Program.
15. Since 2006, Franklin American underwrote and endorsed FHA-insured
loans primarily through two business channels: retail and wholesale. In the retail
channel, Franklin American employees worked directly with prospective borrowers to
prepare mortgage applications and gather the relevant supporting materials. The
employees then transmitted the materials to Franklin American’s underwriting
department to be underwritten. If the application was approved, Franklin American
would then fund the loan and endorse it for FHA insurance. In the wholesale channel,
mortgage brokers who were not employed by Franklin American worked with borrowers
to prepare mortgage applications and relevant materials. Those brokers then transmitted
those materials to Franklin American for underwriting, funding, and endorsement for
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FHA insurance if the application was approved.
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Franklin American considered loans
originated through the wholesale channel to present greater risk than those originated
through the retail channel.
16. From 2006 through 2010, Franklin American’s FHA loan production grew
substantially. Most of this growth occurred through the origination of loans in the
wholesale channel. After 2010, Franklin American’s FHA loan production decreased and
leveled off.
17. Franklin American employed Direct Endorsement underwriters who
would receive and review a loan application and the supporting documentation submitted
by a broker or account executive. The Direct Endorsement underwriter could then
approve the loan, approve the loan with conditions, suspend the loan, or reject the loan.
The documents initially received by Franklin’s Direct Endorsement underwriters
frequently did not suffice to approve a loan. In those cases, the Direct Endorsement
underwriter could approve the loan with conditions, meaning that additional
documentation was required before the loan could be fully assessed and endorsed. The
conditions set by the Direct Endorsement underwriter could involve issues directly
affecting the creditworthiness of the borrower (i.e., the borrower’s ability to repay the
loan) and the eligibility of the loan for FHA insurance. Such conditions required
documentation related to income, employment, assets, liabilities, credit, and collateral.
18. Between 2006 and 2010, Franklin American established a position called a
junior underwriter or junior government underwriter. Junior underwriters were not
required to be Direct Endorsement underwriters. When the Direct Endorsement
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Franklin American also had a “correspondent” channel. In that channel, it purchased FHA-insured loans
that had been originated, underwritten, and endorsed by other lenders. Franklin American generally did not
underwrite or endorse the FHA-insured loans it purchased through the correspondent channel.
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underwriter reviewed and conditionally approved a loan for FHA insurance, the junior
underwriters were tasked with reviewing certain conditions. This included obtaining and
reviewing documentation to determine if the condition had been satisfied. Among other
things, some junior underwriters at times cleared conditions related to income,
employment, assets, liabilities, credit, and collateral.
19. Franklin American also set goals that its Direct Endorsement underwriters
review a certain number of loan applications each day (generally four to five loans during
most of the relevant period, but sometimes more during periods of particularly high
demand). These goals would be communicated to Franklin American’s Direct
Endorsement underwriters by Franklin American management. For example, during one
period of particularly high demand when Franklin American was experiencing a backlog
of loan applications, an assistant vice president and government underwriting manager
wrote to several underwriters that “[t]he requirement for new loans used to be 5-6 per day
when you still had your [resubmissions] and appraisals to review. Those shifted to
another team and your daily requirement became a minimum of 9 per day. Some of you
are constantly hitting this number each and everyday and the company is paying you a
bonus for your achievements. EVERYONE needs to be hitting this number each and
everyday not just a day here or a day there and we need to be consistent. Some of you
come in early, stay late, take things home, etc to get the job done….some of you work the
regular hours with minimal extra….and this will not work.”
20. In some instances, internal communications also reflect that sales and
production managers discussed terminating the employment of underwriters if they
consistently did not review the number of loans set by management. For example, a vice
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president of wholesale production noted in a May 18, 2007, email to an executive vice
president and senior vice president: “Were [sic] is the accountability? I have put 4 [sales]
people on Produce or Perish this month. We need to replace those underwriters who
can’t get with the program and produce. No more excuses.” An executive vice president
wrote to a government underwriting manager in a January 15, 2009, email discussing a
daily goal that underwriters review eight loan files that “[t]he people that are doing the
bare minimum will need to be made aware that their services are about to be terminated.
We cannot accept the minimal performance any longer. I will give them one week or
they will be looking for another job.”
21. Franklin American also sought to incentivize the processing of loan
applications by offering bonus programs to underwriters based in part on the number of
loan files reviewed. For example, Direct Endorsement underwriters were eligible for a
bonus in 2009 if they reviewed an average of 5 loans a day and met other requirements,
including as to quality. In 2010, Direct Endorsement underwriters were eligible for
bonuses for each loan over 100 that they reviewed in a particular month. The top tier of
the bonus plan contemplated the possibility that Direct Endorsement underwriters could
underwrite from 201 to 225 loans per month. In announcing an updated bonus plan in
2011, Franklin American noted that “[a]s with prior Bonus Plans, the primary component
to achieve bonus will be meeting production goals which tie into goals of the division and
company.”
22. In 2006, a third party was performing quality control reviews of closed
loans underwritten by Franklin American. Franklin American later changed its outside
vendor before bringing the quality control review of closed loans in house. Although the
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quality control reviews varied over time, those reviews generally assigned a rating to
particular deficiencies and the quality of a loan as a whole. For example, many of
Franklin American’s quality control reviews that it performed in-house would categorize
a deficiency as critical, major, moderate, or minor. Franklin American defined a
deficiency as “critical” if it “affects the decision, collectability, insurability, and salability
of the loan,” and “major” if it “affects the decision, quality, and insurability of the loan
and could affect the salability.” Based on the quality and quantity of the deficiencies,
Franklin American would then rate the loan as good, acceptable, fair, or poor.
23. After the loans were reviewed, Franklin American or a third party would
then prepare “management reports” that were submitted to the vice president of quality
control or a quality control manager as well as to managers of Franklin American’s three
business channels. The management reports were also occasionally provided to higher-
level management, such as executive vice presidents.
24. The management reports prepared by Franklin American or a third party
identified substantial numbers of loans with serious deficiencies. For example, a third
party audited 89 of Franklin American’s closed loan files from its retail and wholesale
business channels that were originated in March 2006. Those audits revealed over 40
deficiencies in the loan files that were labeled “serious.” The quality control report from
December 2008 indicated that year-to-date between 15 percent and 28 percent of the
loans underwritten by Franklin American in its wholesale and retail business channels
were rated poor. The report states that a significant number of loans underwritten by
Franklin American had serious deficiencies. The December 2009 quality control report
indicated that year-to-date 13 to 19 percent of the loans Franklin American underwrote in
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its wholesale and retail business channels were rated poor. By 2010, those averages had
increased to between 22 and 30 percent.
25. From 2006 until around 2010, Franklin American inconsistently
conducted EPD reviews. Those reviews that were conducted identified a significant
number of loans that were rated poor and that contained “serious” underwriting
deficiencies.
26. The quality control reports also show certain deficiencies related to junior
underwriters. For example, Franklin American underwrote a property that closed in May
2009. The post-close quality control review of that property noted several “major”
deficiencies related to inadequate documentation of gift funds and a failure to address
overdrafts on bank statements, large deposits, and debts. When the Direct Endorsement
underwriter was questioned about these deficiencies, she responded that they were all
errors by the junior underwriter. Similarly, Franklin American’s quality control review
of a loan originated in May 2010 identified a “critical” deficiency related to income not
being entered into the AUS in the proper category. The Direct Endorsement underwriter
responded to the finding by noting that the junior underwriter made the mistake and
stating that this finding made “a good case for [the] reasoning behind [the] junior
[underwriter] position going away.”
27. A letter from HUD to Franklin American’s president dated March 17,
2006, provided that “[w]e would like to note that the Neighborhood Watch Early
Warning System allows mortgagees to report serious deficiencies, patterns of non-
compliance, or suspected fraud, to HUD in a uniform, automated fashion. Mortgagees
shall use the ‘Reporting’ feature of the Neighborhood Watch Early Warning System
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menu in lieu of submitting a written report to the Quality Assurance Division. As stated
in Mortgagee Letter 05-26, use of the Neighborhood Watch Reporting tool became
mandatory in November 2005 . . . .” In addition, Franklin American’s quality control
plans consistently recognized its duty to make such self-reports.
28. Franklin American did not make any self reports until 2009. Franklin
American’s assistant vice president of government credit policy noted in February 2008
that “since 2005 we’ve been required to self-report in Neighborhood Watch, any fraud or
serious deficiencies that we discover on FHA loans. . . . [O]ur reporting history is blank.”
Franklin American reported 4 loans in 2009, 50 loans in 2010, 26 loans in 2011, 21 loans
in 2012, and 21 loans in 2013.
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Very few of these self-reported loans were reported for
containing serious underwriting deficiencies.
29. As a result of Franklin American’s conduct and omissions, HUD insured
hundreds of loans approved by Franklin American that were not eligible for FHA
mortgage insurance under the Direct Endorsement Program, and that HUD would not
otherwise have insured. HUD subsequently incurred substantial losses when it paid
insurance claims on those Released Loans.
30. The statements herein apply only to certain mortgages which are the
subject of the release in this Agreement. This document is not an admission as to any
conduct related to any mortgage not released in this Agreement, nor is it an admission of
any legal liability. Franklin American reserves the right to contest the use or application
of this document in any future litigation.
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Thirty-nine of the self-reported loans in 2010 and eighteen of the self-reported loans in 2011 were related
to fraud at a single broker.
