MICHAEL SLACHTA, JR.
ASSISTANT INSPECTOR GENERAL FOR AUDITING
DEPARTMENT OF VETERANS AFFAIRS
THE UNITED STATES HOUSE OF REPRESENTATIVES
COMMITTEE ON VETERANS AFFAIRS
SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS
HEARING ON LOAN GUARANTY IN VETERANS AFFAIRS
March 16, 2000
Mr. Chairman and Members of the Subcommittee, today I will present to you the Office of Inspector General’s (OIG) views on the Department of Veterans Affairs (VA) Loan Guaranty Program. I will focus on Loan Guaranty Housing Credit Assistance Program Accounting, audits and investigations of Loan Guaranty Program Fraud, attributes of defaulted home loans, and the Loan Guaranty Service’s quality control system.
Housing Credit Assistance (HCA) Program Accounting
At the end of Fiscal Year (FY) 1999, the Housing Credit Assistance (HCA) program loan guaranty liability totaled $5.8 billion, and direct loans receivable and foreclosed properties awaiting sale totaled about $3.6 billion; program subsidy costs totaled $890 million for the year. The Department substantially completed corrective actions on conditions we reported on in prior years concerning serious weaknesses in direct loan portfolio, loan sales accounting, and Credit Reform subsidy model issues. Following the end of FY 1999, VA also began processing HCA program expenditures directly through VA's core financial system to resolve a Federal Financial Management Improvement Act noncompliance issue.
However, material internal control weaknesses remain that impede timely completion of financial statements and reduce the effectiveness of safeguards over HCA program resources. These six weaknesses are:
The Veterans Benefits Administration had a number of organization and system changes underway to address the internal control weaknesses. Management officials informed us that their goal is to complete all corrective actions by the end of FY 2000. Timely implementation is important. Accurate, reliable, and timely financial reports are essential to enable managers to carry out their fiduciary and stewardship responsibilities to VA beneficiaries and the public. Without them, the HCA financial statements will continue to be prepared untimely and are vulnerable to error. Additionally, program assets and resources may not be efficiently used or adequately safeguarded.
Audits and Investigations of Loan Guaranty Fraud
A goal of the Office of Inspector General is to ensure that all indications of serious criminal matters, impacting the loan guaranty program, are thoroughly investigated and referred to the Department of Justice or appropriate state agency for prosecution. The Office of Inspector General is conducting proactive and reactive reviews of defaulted and foreclosed VA loans to identify possible loan origination fraud and property management fraud.
Loan Origination Fraud
Loan Origination fraud occurs in VA’s home loan program. Loan origination fraud results when incorrect or falsified information is used to obtain or sell a guaranteed or insured mortgage. The Office of Inspector General’s proactive and reactive reviews of defaulted and foreclosed VA loans have focused on certain geographical areas with high default rates. As a follow-on to this review of high default areas, we audited the underwriting practices of six lenders (three in North Carolina and three in Georgia). We found potential fraud indicators in four of the six audits, in which lenders may have underreported the borrowers’ dependents (which requires more family income) and may not have disclosed some of the borrowers’ debts in the loan analysis. We also identified other practices that may or may not have been intentional but which contributed to the perception that the applicants were acceptable risks. The cases involving possible fraud are under investigation by our office. An example of a recent investigation is:
Property Management Fraud
Investigations into property fraud focused mostly on equity skimming. Equity skimming fraud involves profiting by assuming or purporting to assume existing loans, renting the homes to tenants, not making payments, and stealing the rental proceeds while the loan foreclosure is being processed. For example:
Attributes of Defaulted VA Home Loans
The Office of Inspector General reviewed the effect of the implementation of VA’s Housing Credit Assistance program policies on loan defaults. Our review found that:
Loan Guaranty Service’s Quality Control System
A recent review of Loan Guaranty Service’s quality control system concluded that several quality control conditions required management attention:
Loan Guaranty Service Management had not Periodically Updated Their Management Control Plan or Completed Internal Control Reviews
Loan Guaranty Service management had not updated their Management Control Plan, identifying high-risk areas in over 5 years nor had they completed required Internal Control Reviews of those areas in over 3 years. Internal Control Reviews are a primary method of identifying waste, fraud, and abuse.
Statistical Quality Control Reviews had not Identified Many Deficiencies
Loan Guaranty Services recently revised Statistical Quality Control program had not identified a significant number of deficiencies concerning compliance with Loan Guaranty Services policy and procedures.
Timely Reporting Would Improve the Lender Monitoring Unit Effectiveness
The Lender Monitoring Unit had not issued timely reports identifying loan underwriting deficiencies. We found that the Monitoring Unit actively reviewed lender underwriting and sent timely draft reports to Loan Guaranty Services management, but management had not issued timely final reports to the lenders. For Fiscal Year 1999, the Monitoring Unit had completed eight evaluations and draft reports, but as of August 1999, Loan Guaranty Services management had not issued any of the reports. The reports are important because they frequently result in improved underwriting and in lenders indemnifying VA for egregious underwriting resulting in foreclosure or VA having to pay the guarantee. Lenders indemnify VA for the guaranteed amount of the loan resulting from egregious underwriting, currently a maximum of $36,000.
Oversight of Direct Loan Servicing Needed Improvement
VA’s oversight of the contractor servicing VA’s direct loans had not ensured that loans were actively serviced. In June 1997, Loan Guaranty Service contracted for the servicing of its direct loan portfolio. As of September 30, 1999, the portfolio included about 29,000 direct loans with an unpaid principal balance valued at $1.8 billion. About 3,200 of these loans, with an unpaid principal balance valued at $209 million, were in serious default. VA defines seriously defaulted loans as those that are 5 or more months delinquent. The borrowers who are in serious default would need to pay $36 million to clear their outstanding delinquencies.
Our review of a sample of seriously defaulted direct loans revealed a number of contractor performance deficiencies.
The 3,200 seriously defaulted direct loans in the portfolio included about 1,700 with an unpaid principal balance valued at $110 million, where the borrower had filed for bankruptcy protection. Foreclosure action had not yet been initiated on the remaining 1,500 seriously defaulted loans, with an unpaid principal balance valued at $99 million. On the loans in our sample where the contractor had not made a timely foreclosure referral, the average delinquency was 11 months, with an average unpaid principal balance of $66,900. The average amount necessary to clear the delinquencies on these loans was $6,400. For the loans where the bankruptcy was not routinely monitored, the average delinquency was 47 months, with an average unpaid balance of $72,400. The average amount necessary to clear the delinquencies on these loans was $27,000.
In June 1997, at the time loan servicing was outsourced, Loan Guaranty Service had established a Portfolio Loan Oversight Unit (PLOU) to monitor the contractor’s performance. We found that the PLOU currently relies on the contractor’s self-generated reports to evaluate its performance. However, the contractor’s reports contained data that the PLOU can not validate. The PLOU also planned quarterly site visits to the contractor’s headquarters, but due to limited travel resources only two visits were made during FY 1999. We also found that Loan Guaranty Service did not monitor the servicing of potential foreclosure and bankruptcy cases to ensure appropriate and timely action was taken to prevent unnecessary loss of government funds.
As Loan Guaranty Service reorganizes and, in some instances outsources, its activities, it is essential that program integrity is maintained through close oversight of not only its own operations, but those of contractors and program participants as well.
This completes my statement Mr. Chairman. I would be pleased to answer any questions you and the committee may have.