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We audited Somerset Investors Corporation (Somerset), dba Somerset Mortgage Bankers, a Federal Housing Administration (FHA)-approved direct endorsement lender located in Melville, NY. The audit objectives were to determine whether Somerset (1) originated FHA-insured refinanced loans in accordance with the requirements of the U.S. Department of Housing and Urban Development (HUD)/FHA and (2) conducted quality control reviews that complied with HUD/FHA requirements.

Somerset did not always originate refinanced loans in accordance with HUD/FHA requirements. Specifically, 8 of 11 loans we reviewed exhibited underwriting deficiencies significant enough to warrant indemnification as did six loans subject to Somerset’s quality control review that we reviewed. Consequently, 14 mortgage loans with an outstanding principal balance of over $4.6 million were approved, which presented an unnecessary risk to the FHA insurance fund.

Somerset’s written quality control plan complied with HUD/FHA requirements; however, the quality control reviews conducted did not comply with HUD’s and its own quality control requirements regarding sample size and reporting Consequently, assurance was lessened that Somerset’s quality control process would identify and address underwriting problems in a timely manner and thus protect Somerset and FHA from unacceptable risk.

We recommend that HUD require Somerset to (1) indemnify HUD for potential estimated losses of nearly $2.8 million for 14 loans with significant underwriting deficiencies, (2) strengthen controls over its underwriting procedures to provide assurance that HUD/FHA requirements are met, and (3) implement procedures to ensure that quality control reviews comply with HUD/FHA requirements.