oversight

Suburban Mortgage Associates, Inc., Bethesda, MD, Cost HUD $14 Million an Additional $26.2 Million at Risk

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-09-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                AUDIT REPORT




Suburban Mortgage Associates, Inc., Bethesda, MD, Cost HUD
  $14 Million and Placed an Additional $26.2 Million at Risk


                      2005-BO-1008

                    September 30, 2005


                OFFICE OF AUDIT, REGION 1
                       BOSTON, MA
                                                                              Issue Date:
                                                                                       September 30, 2005
                                                                              Audit Report Number:
                                                                                        2005-BO-1008




TO:            Brian Montgomery, Assistant Secretary for Housing – Federal Housing
                  Commissioner, H
               Margarita Maisonette, Director of Departmental Enforcement Center, CV



FROM:          for John A. Dvorak, Regional Inspector General for Audit, 1AGA

SUBJECT: Suburban Mortgage Associates, Incorporated, Bethesda, Maryland, as an
         Approved Lender, Cost HUD $14 Million and Placed an Additional $26.2
         Million at Risk.

                                           HIGHLIGHTS

    What We Audited and Why

                 We audited specific U.S. Department of Housing and Urban Development (HUD)
                 insured mortgages originated and serviced by Suburban Mortgage Associates,
                 Incorporated (Suburban Mortgage), of Bethesda, Maryland. During a review of
                 nursing homes that defaulted on their HUD-insured mortgages, we found that
                 three1 defaulted nursing homes and one2 financially troubled nursing home
                 received HUD-insured mortgages from the same lender, Suburban Mortgage. Our
                 audit objective was to assess the performance of Suburban Mortgage in carrying
                 out its origination and servicing functions through a review of Suburban
                 Mortgage’s HUD-insured loans.




1
  Suburban provided these three loans to Coventry Health Center, Edmund Place Health Center, and Hillside Health
Center.
2
  Suburban provided this loan to Mount Saint Francis Health Center.
    What We Found
                  We found significant irregularities in how Suburban Mortgage originated and
                  serviced six HUD-insured loans to affiliated3 entities by failing to perform its
                  fiduciary responsibilities. We identified four HUD-insured loans that Suburban
                  Mortgage originated to identity-of-interest entities. Suburban Mortgage also
                  originated a HUD-insured loan to a property that its executive vice president
                  formerly owned. Additionally, Suburban Mortgage originated a HUD-insured
                  loan to a property whose owners had other business ventures with its executive
                  vice president. Appendix C delineates the relationships between these entities.
                  As of January 24, 2005, three affiliated entities4 had defaulted on their loans.
                  Suburban Mortgage requested assignment of the three defaulted loans to HUD.
                  HUD paid Suburban Mortgage’s claim for two of the defaults. These two defaults
                  caused HUD a combined net loss of $14 million. The third defaulted loan has an
                  unpaid principal balance of $12.6 million. As of April 29, 2005, HUD notified
                  Suburban Mortgage the claim for insurance was denied for this loan. The risk of
                  loss on this defaulted loan and two other identity-of-interest loans could cause
                  HUD to lose an additional $26.2 million. We also found that Suburban
                  Mortgage’s servicing failures contributed to unnecessary interest and penalties of
                  $229,673 from the late payment of real estate taxes.

    What We Recommend

                  We recommend that HUD: (1) require reimbursement of $229,673 for the
                  unnecessary charges allowed by Suburban Mortgage, and (2) terminate the $26.2
                  million in HUD-insured loans to the remaining three identity-of-interest
                  properties. In addition, we recommend that HUD take appropriate administrative
                  sanctions against Suburban Mortgage and its principals for its failure to perform
                  its mortgage-related fiduciary duties.

                  For each recommendation without a management decision, please respond and
                  provide status reports in accordance with HUD Handbook 2000.06, REV-3.
                  Please furnish us copies of any correspondence or directives issued because of the
                  audit.

    Auditee’s Response

                  The auditee’s narrative response, along with our evaluation of that response, can
                  be found in appendix D of this report. The auditee also provided exhibits to
                  support its position, but these exhibits were too voluminous to include in our
                  report. We received these exhibits on June 7, 2005 and June 30, 2005.

3
  Throughout this report we use the term affiliated to refer to the identity-of-interest relationships or business
ventures the executive vice president had with the six HUD-insured properties discussed in this report.
4
  These three entities are Edmund Place Health Center, Coventry Health Center, and Hillside Health Center.

                                                            2
                              TABLE OF CONTENTS

Background and Objectives                                                                5

Results of Audit
        Finding 1: Suburban Mortgage’s Failure to Perform Its Fiduciary                  7
        Responsibilities Caused Defaults and Unnecessarily Increased the Risk to HUD-
        Insured Loans
                                                                                        18
Scope and Methodology

Internal Controls                                                                       19

Appendixes
   A.   Schedule of Questioned Costs and Funds to Be Put to Better Use                  21
   B.   Definitions                                                                     22
   C.   Affiliated Entities                                                             25
   D.   Auditee Comments and OIG’s Evaluation                                           29




                                              3
                      BACKGROUND AND OBJECTIVES

The U.S. Department of Housing and Urban Development (HUD), through its subsidiary, the
Federal Housing Administration, allows approved lenders to provide loans eligible for HUD-
insured mortgages to private entities. This mortgage insurance provides lenders with protection
against losses related to loan defaults. These loans must meet specific criteria outlined in the
National Housing Act. Loans insured under Section 232 of the National Housing Act fund the
construction and rehabilitation of residential health care facilities. Loans insured under Section
221(d)(4) of the National Housing Act fund new construction or substantial rehabilitation of
multifamily rental or cooperative housing.

HUD’s regulatory guidelines for these programs are contained within Title 24 of the Code of
Federal Regulations. Each entity receiving a HUD-insured multifamily loan enters into a
regulatory agreement with HUD. The regulatory agreement identifies many terms and
conditions with which property owners must comply. HUD also provides guidance on lender
responsibilities in the form of HUD directives and handbooks and through references contained
in the United States Code and the Code of Federal Regulations. HUD guidance establishes
requirements for approved lenders and entities receiving HUD-insured mortgages and prohibits
certain business practices. Appendix B discusses specific guidance.

Suburban Mortgage Associates, Incorporated (Suburban Mortgage), is a HUD-approved lender
with offices located at 4630 Montgomery Avenue, Bethesda, MD. In 1978, the president and the
executive vice president created Suburban Mortgage and divided the ownership of the
corporation between themselves and a second corporation with each entity receiving a third of
the company. During our audit period, Suburban Mortgage had three members on its board of
directors: (1) the president and chief executive officer, (2) the executive vice president, and
(3) the partner of a law firm that provides legal counsel for Suburban Mortgage. Suburban
Mortgage advised that its executive vice president terminated his role as a board member in
November 2003, but was unable to provide his letter or resignation. Instead, Suburban Mortgage
provided a copy of the minutes of the board of directors’ meeting dated November 13, 2003
signed by the president of Suburban Mortgage. The replacement for the executive vice president
is the attorney who has represented the executive vice president as a registered agent for serveral
affiliated properties and companies. As of August 2003, Suburban Mortgage had used HUD
insurance for 57 loans totaling $314.3 million. Of this total, entities receiving 12 loans
defaulted, causing HUD to pay Suburban Mortgage more than $64 million, representing the
outstanding amount of these loans at the time of default.




                                                 4
The executive vice president of Suburban Mortgage had multiple roles in its operation while also
having multiple roles at entities receiving HUD-insured loans through Suburban Mortgage.
During the audit period, the executive vice president also served as

       One of three board members for Suburban Mortgage,
       A consultant to Suburban Mortgage who is paid to originate loans,
       An ownership partner of four separate entities that received HUD-insured loans from
       Suburban Mortgage,
       The owner of a separate management company managing the individual properties that
       received the HUD-insured loans from Suburban Mortgage,
       The president or general partner of three service companies. These service companies
       have been paid by the properties that received their HUD-insured loans from Suburban
       Mortgage.

The executive vice president’s four children also own and operate service companies and a
management agent doing business with Suburban Mortgage and/or entities that received HUD-
insured loans from Suburban Mortgage. Appendix C discusses these identity-of-interest
relationships.

Our objective was to assess the performance of Suburban Mortgage in originating and servicing
selected HUD-insured loans. During our audit, we also made special note of the involvement of
affiliated entities receiving these loans and the extent to which affiliated companies and entities
were transacting business with each other.




                                                 5
                                       RESULTS OF AUDIT

Finding 1: Suburban Mortgage’s Failure to Perform Its Fiduciary
Responsibilities Caused Defaults and Unnecessarily Increased the Risk
to HUD-Insured Loans
Suburban Mortgage failed to perform its fiduciary responsibilities for HUD-insured loans
totaling $62.8 million. Suburban Mortgage

      •    Allowed its executive vice president to ratify HUD-insured loans for properties in which
           he had an ownership interest.
      •    Paid the executive vice president for loan originations on HUD-insured loans for
           properties in which he had an ownership interest.
      •    Provided misleading and confusing information to HUD regarding identity-of-interest
           relationships involving the executive vice president of Suburban Mortgage and two
           mortgagors.
      •    Did not report to HUD cash distributions to owners of identity-of-interest properties with
           HUD-insured loans that it knew or should have known about.
      •    Failed to notify HUD of an identity-of-interest mortgagor’s failure to pay the mortgage
           principal, required reserve for replacements deposits, and real estate taxes.

These conditions occurred because the management of Suburban Mortgage ignored prudent
business practices and failed to follow proper management controls. As a result of these
conditions, Suburban Mortgage

      (1) Cannot assure HUD of its compliance with applicable federal regulations,
      (2) Caused HUD a $14 million loss due to two5 defaulted loans that Suburban Mortgage
          originated for affiliated entities,
      (3) Increased HUD’s risk of loss on three remaining identity-of-interest, HUD-insured loans
          totaling $26.2 million, and
      (4) Permitted an affiliated entity to incur $229,673 in unnecessary penalties.




5
    The two loans are Coventry Health Center and Edmund Place Health Center.

                                                        6
Suburban Mortgage provided $62.8 million in HUD-insured loans to affiliated entities as shown
below.

                Property                    Location       Loan Amount      Date
   Coventry Health Center              Coventry, RI         $15,308,700   May 1994
   Hillcrest Village                   Providence, RI         5,752,800   June 1992
   Hillside Health Center              Providence, RI        12,979,300 August 1998
   Mount St. Francis Health Center     Woonsocket, RI         8,616,900   July 1995
   Edmund Place Health Center          East Providence, RI    9,147,900   June 1995
   Riverview Nursing Home              Coventry, RI          11,068,700 November 1996
                          Total                             $62,874,300

 Executive Vice President
 Ratifies Loans to Affiliated
 Entities


                     The executive vice president of Suburban Mortgage ratified two loans,
                     insured by HUD, in which he had direct ownership interests: Coventry
                     Health Center, and Hillcrest Village. The executive vice president also
                     ratified one loan to Edmund Place Health Center that was managed by one
                     of his children’s companies. HUD regulations state that approved lenders
                     (such as Suburban Mortgage) and any officer, partner, director, principal,
                     or employee shall not be engaged in business practices that do not
                     conform to generally accepted practices of prudent lenders or that
                     demonstrate irresponsibility. Allowing the executive vice president to
                     ratify these loans does not conform to prudent lending practices.


 Executive Vice President Paid
 to Originate Loans to Entities
 that the Executive Vice
 President May Have Owned

                     HUD regulations prohibit payments by lenders such as Suburban
                     Mortgage to persons associated with or receiving compensation from the
                     owner. The executive vice president has ownership interest in four
                     properties to which Suburban Mortgage provided HUD-insured loans.
                     Financial records for two of these properties showed that the executive
                     vice president received consideration from each property in his role as
                     general partner of the ownership entity. Regulations state a mortgagee
                     may not pay anything of value in connection with any insured mortgage
                     transaction to any person or entity if such person has received any other
                     consideration from the mortgagor for services related to the transaction.
                     In this case, Suburban Mortgage paid commissions to the executive vice


                                              7
                            president, who received a partnership interest from the mortgagor as part
                            of the loan transactions.

                            Suburban Mortgage confirmed the executive vice president performed
                            work as a loan originator for the company. From 2001 to 2003, Suburban
                            Mortgage paid its executive vice president, as a consultant, approximately
                            $65,000 per year for loan origination services. Suburban Mortgage could
                            not provide documents and records to specifically identify which loans the
                            executive vice president originated.

    Misleading Assertions by
    Suburban Mortgage Regarding
    Loan Recipients


                            Suburban Mortgage used traditional application procedures to process the
                            six loans to affiliated entities. For these loans processed using traditional
                            application procedures, Suburban Mortgage originated and serviced the
                            loan while HUD underwrote the loan and approved it for insurance. For
                            two6 loans, Suburban Mortgage certified that the loan to the identity-of-
                            interest entity was not an identity-of-interest or was an arms-length
                            transaction7. While an identity-of-interest relationship between the
                            mortgagee and the owner is allowed per HUD regulations, it must be fully
                            disclosed. We found the other loan was not an arms-length transaction.
                            Appendix C delineates these misleading assertions.




6
    These two loans were for Hillside Health Center and Mount Saint Francis Health Center.
7
    See appendix B for definition of arms-length transaction.

                                                          8
    Suburban Did Not Report
    Owner Distributions to HUD


                         Suburban Mortgage did not report to HUD cash distributions made to the
                         owners of two identity-of-interest properties that Suburban knew or should
                         have known about. Coventry Health Center and Mount Saint Francis
                         Health Center paid out more than $1.1 million to its general partner in
                         loans and unearned fees while the properties were financially distressed.
                         The general partner of each of these two entities is also the executive vice
                         president of Suburban Mortgage. The audited financial statements
                         received by Suburban Mortgage showed partners’ fees to Coventry Health
                         Center and Mount Saint Francis.

                                                Coventry Health Center
                                  Payments in Fiscal Year Ended December 31, 1998
                          Executive Service Fee                     60,833
                                  Loan                              15,000
                                  Total                            $75,883

                                         Mount Saint Francis Health Center
                          Payments in Fiscal Year               Partners’ fees.
                                  2000                              201,600
                                  2001                              228,847
                                  2002                              301,003
                                  2003                              322,100
                                  Total                           $1,053,550

                         These projects were financially troubled and carried significant account
                         payables8. As the mortgagee, Suburban Mortgage should have reviewed
                         annual financial statements9 to ensure that project funds were properly
                         utilized for the stability of the project. Stability of the project benefits
                         both HUD and the mortgagee. A mortgagee’s quality control program
                         must ensure that findings discovered by employees during the normal
                         course of business are reported to HUD within 60 days of the initial
                         discovery10. Our review of Suburban Mortgage’s records noted that
                         Suburban Mortgage personnel did not detect the cash distributions or
                         question the necessity or the appropriateness of the payments. If Suburban
                         Mortgage had sufficiently reviewed the independent public accountant


8
  At December 31, 1999, Coventry Health Center had accounts payable of $2,872,234. At December 31, 2002,
Mount Saint Francis Health Center had accounts payable of $1,673,000.
9
  This requirement may be found in chapter 2 of the HUD Handbook 4350.4 Insured Multifamily Mortgagee
Servicing and Field Office Remote.
10
   This requirement may be found in chapter 6 of the HUD Handbook 4060.1 Mortgage Approval Handbook.

                                                     9
                           reports for these properties, the distributions could have been identified
                           and reported to HUD. HUD then could have taken corrective action.

                           Additionally, mortgagees are required to report instances of fraud11 or
                           other abuses. Findings of fraud or other serious violations must be
                           referred, in writing, to the director of the Quality Assurance Division. We
                           found that, as general partner of Coventry Health Center and Mount Saint
                           Francis Health Center, the executive vice president of Suburban Mortgage
                           received distributions far in excess of surplus cash, which violates the
                           regulatory agreement as well as federal regulations. As a general partner
                           of the projects, the executive vice president signed the regulatory
                           agreement and was aware, or should have been aware, of the regulatory
                           requirements of the properties. Consequently, a principal of Suburban
                           Mortgage had knowledge of a violation of federal regulations and was
                           under an obligation to report it to HUD. We will address the specifics of
                           violations found at Coventry Health Center and Mount Saint Francis
                           Health Center in future reports related specifically to those properties.

                           Suburban Mortgage’s executive vice president has a disincentive to
                           provide HUD with accurate and complete information for HUD to take
                           appropriate corrective action. Suburban Mortgage’s executive vice
                           president benefited from these cash disbursements. In addition to the
                           payments noted above, the executive vice president or his companies
                           received:

                               •   Payment as a consultant from Suburban Mortgage to originate
                                   loans,
                               •   Partnership fees from the properties to which Suburban Mortgage
                                   provided HUD insured loans, and
                               •   Executive compensation from the properties to which Suburban
                                   Mortgage provided HUD insured loans.

                           Also, the executive vice president, his companies, and/or one or more of
                           his children received payments from the properties they owned or were
                           affiliated with and to which Suburban Mortgage provided HUD-insured
                           loans. As owner of Suburban Mortgage, the executive vice president also
                           benefited from the profits generated by the $19 million in mortgage
                           interest that Suburban received from these affiliated loans. Suburban
                           Mortgage funds its loans through a series of warehouse lender lines of
                           credit. During our audit period, the president and the executive vice
                           president each personally guaranteed these warehouse lines of credit.
                           Renewable annually, this line of credit began at $1.5 million in 1996 and
                           rose to $3 million by 2003. Suburban Mortgage needs these lines of credit
                           to have money available to loan. Therefore, given the personal guarantees

11
     This requirement may be found in chapter 6 of the HUD Handbook 4060.1 Mortgage Approval Handbook.

                                                      10
                  of the president and executive vice president, each had the ability to
                  significantly influence the operations of Suburban Mortgage.

Failure to Notify HUD of
Delinquent Mortgage and
Reserves Payments
                  Suburban Mortgage’s loan records for Hillside Health Center showed that
                  this identity-of-interest company did not pay the mortgage principal or
                  submit deposits for the reserve for replacement account from August 1999
                  until March 2003. Initially, Suburban Mortgage claimed that HUD
                  allowed Hillside Health Center to defer the mortgage principal payments
                  and the reserve deposits in 1999. Later, Suburban Mortgage’s
                  management acknowledged that no request was made of HUD for the
                  deferral of these payments. As of February 2003, the delinquent principal
                  payments totaled $229,722, and the delinquent deposits to the reserve for
                  replacement account totaled $597,883. Hillside Health Center informed
                  Suburban Mortgage in August 1999 that it was unable to pay the mortgage
                  principal or the deposits for the reserve for replacement account and
                  requested that these payments be deferred until the final endorsement.
                  The final endorsement never took place, and the Hillside Health Center
                  went into receivership in March 2004. Suburban Mortgage requested
                  assignment of the Hillside Health Center’s $12 million mortgage to HUD
                  in June 2004. HUD denied the claim in April 2005. Suburban Mortgage’s
                  failures to obtain HUD approval or otherwise appropriately advise HUD
                  of the deficiency precluded HUD from taking appropriate corrective
                  action and possibly preventing the assignment.


Suburban Did Not Assure
Payment of Real Estate Taxes
                  In September 1999, Hillside Health Center notified Suburban Mortgage
                  that it would pay all real estate taxes. While Suburban Mortgage received
                  notices of unpaid real estate taxes for Hillside Health Center from the City
                  of Providence for tax years 1999, 2000, and 2001, Suburban Mortgage did
                  not take action to ensure that Hillside Health Center paid the taxes when
                  due. After receiving the overdue notices for each year, Hillside Health
                  Center established payment plans to pay the overdue taxes.




                                           11
                           Due to the lack of timely payments, the city added $229,673 in additional
                           interest charges as shown in the following table.

                             Tax year        Taxes assessed         Taxes paid           Interest charged
                              1999              $207,308              $239,768                     $32,460
                              2000              $293,296              $333,048                      39,752
                              2001              $313,194              $340,998                      27,804
                              2002              $330,384              $460,041                     129,657
                                                   Total                                           229,673

                           Upon inquiry, Suburban Mortgage advised that it did not consider these
                           taxes overdue because of Hillside Health Center’s payment plans.
                           Suburban Mortgage believed there was no need to notify HUD of these
                           developments.

     Prudent Lending Practices


                           To identify whether the mortgages to affiliated entities represented prudent
                           mortgage lending practices, we contacted members of the mortgage banking
                           industry to obtain their comments as to the propriety and appropriateness of
                           these relationships. Without identifying the names or locations of any
                           persons, entities, or businesses involved, we asked the representative for
                           their comments on the relationship noted in our review. The representative
                           commented that

                                     The situations described did not represent proper arms-length
                                     transactions and this issue should be examined further.

                                     Significant risks existed in relation to the mortgage loans
                                     identified. This was due to the lack of proper arms-length
                                     relationships, as noted.

                                     Although the situations described were not explicitly prohibited by
                                     HUD’s regulation and guidelines12, these situations were unusual
                                     and were not common or customary within the industry.

                                     The general standards applicable to the situations described were
                                     prudence and appropriateness on the part of the lender in
                                     performing its mortgage lending business practices.



12
  Although HUD regulations do not prohibit identity-of-interest relationships, HUD regulations at 24 CFR 202.5(j)
do require that neither the lender or mortgagee, nor any officer, partner, director, principal or employee of the lender
or mortgagee shall be engaged in business practices that do not conform to generally accepted practices of prudent
mortgagees or that demonstrate irresponsibility.

                                                          12
                                  The requests for loans (and the underlying loan insurance from
                                  HUD) should have been refused at the time they were made. HUD
                                  should terminate the insurance for these loans.

                         We also contacted the State of Maryland – the Office of the Commissioner
                         of Financial Regulation regarding the identity-of-interest scenarios. Again,
                         our purpose was to obtain independent comments from a state regulatory
                         authority that oversees mortgage companies in Maryland. As in the case of
                         the mortgage banking representative, we did not identify the names of any
                         persons, entities, or businesses involved; however, we did indicate that we
                         were inquiring about a mortgage company within the State of Maryland. In
                         response to our request, the office advised

                                  None of the transactions were arms-length in nature.

                                  Subsequent transactions between the lender, owner, and affiliated
                                  companies were unusual and were not customary in the mortgage
                                  banking industry.

                                  The fact that the executive vice president of Suburban Mortgage is
                                  also involved in ownership of various entities that provided
                                  services to the nursing homes is a cause for concern.

                                  Had HUD been in possession of all the facts surrounding the
                                  executive vice president’s involvement in the nursing homes and
                                  service providers, HUD’s decision on these loans might have been
                                  different.

                         From the statements made by the mortgage banking representative and state
                         regulatory official, we concluded that the transactions between Suburban
                         Mortgage, as the lender, and the owners were not arms-length in nature. In
                         addition, the relationships among the various entities identified are not
                         customary within the mortgage banking industry and do not represent
                         prudent and appropriate practices.

     Suburban Mortgages’ Failures
     Lost HUD Millions

                         Three of the six mortgages that Suburban Mortgage provided to properties
                         owned by or affiliated to its executive vice president defaulted on their
                         HUD-insured loans. Suburban Mortgage requested assignment of the
                         three loans to HUD. HUD paid Suburban for two loans and denied the
                         claim13 on the third, which effectively terminates the insurance. After

13
  Suburban Mortgage has filed a suit against HUD regarding HUD’s decision to deny the $12 million insurance
claim for Hillside Health Center. The outcome of this suit is unknown.

                                                      13
                          paying two of the claims, HUD took over the mortgage note and allowed
                          the sale of the property. HUD incurred a combined net loss of
                          $14,003,674 on the sale of these two mortgage notes.

                                                         Original              Unpaid
                          Name                                                                      Loss on sale
                                                         mortgage              principal
                          Coventry Health
                                                             $15,308,700          $15,120,597 $6,292,52014
                          Center
                          Edmund Place Health
                                                               $9,147,900           $8,935,730        $7,711,154
                          Center
                                               Total         $24,456,600          $24,056,327       $14,003,674

                          Suburban Mortgage failed to act in a proper fiduciary capacity and thereby
                          protect HUD from unacceptable risk of loan default. HUD should pursue
                          Suburban Mortgage for the recovery of these losses.

                          HUD is at risk of incurring additional losses from defaults on the four
                          loans to affiliated entities . HUD could lose the outstanding balance of
                          $26.2 million that Suburban Mortgage loaned to the identity-of-interest
                          properties of Hillside Health Center, Hillcrest Village, and Mount Saint
                          Francis Health Center. HUD could also lose the outstanding balance of
                          $11.1 million that Suburban Mortgage loaned to the affiliated property of
                          Riverview Nursing Home. To alleviate the increased risk on the
                          remaining four loans, HUD should terminate the loan insurance on the
                          identity-of-interest loans. HUD should also withdraw Suburban
                          Mortgage’s approval to participate in its mortgage insurance programs to
                          preclude any recurrence of the conditions cited in this report.

     Referral to the Mortgagee
     Review Board

                          HUD notified Suburban Mortgage of the following violations in a letter,
                          dated January 30, 2003:

                                   Suburban Mortgage accepted interest-only payments from the
                                   mortgagor of Hillside Health Center beginning in August 1999 and
                                   failed to inform HUD until January 2003 that the mortgage
                                   principal payments were delinquent; and

                                   The mortgagor did not make the required deposits to the reserve
                                   for replacement account beginning in August 1999, and the lender
                                   failed to notify HUD that these deposits were delinquent.

14
  In a separate report, dealing exclusively with Coventry Health Center, the Office of Inspector General (OIG) will
recommend that HUD pursue recovery of the loss of $6,292,520 from the former owners of Coventry Health Center.
The executive vice president of Suburban Mortgage was the part of the ownership entity.

                                                        14
             In addition, the local HUD office referred Suburban Mortgage on
             February 10, 2003, to HUD’s Mortgagee Review Board, requesting the
             imposition of sanctions against Suburban Mortgage as the lender for the
             Hillside Health Center property. The Mortgagee Review Board oversees
             the performance of lenders participating in Federal Housing
             Administration insurance programs.

             On February 20, 2003, Suburban Mortgage notified HUD that Hillside
             Health Center had entered into payment plan agreements with the City of
             Providence for the 2000, 2001, and 2002 real estate taxes; but the
             agreements did not address the taxes for 1999. In response, HUD sent a
             supplemental violation notice, on February 27, 2003, to Suburban
             Mortgage that included the failure to (1) collect real estate tax escrows for
             the property commencing in 1999 and (2) report these tax delinquencies to
             HUD in a timely manner.

Conclusion



             Suburban Mortgage did not adequately perform as an approved lender in
             HUD’s multifamily mortgage insurance program by failing to carry out all
             of its fiduciary responsibilities. Suburban Mortgage, along with affiliated
             entities, provided misleading, confusing, and conflicting information to
             HUD for affiliated properties in which the executive vice president of
             Suburban Mortgage had an interest. As a result, HUD lacked a complete
             and thorough understanding of the identity-of-interest interrelationships
             between the affiliated parties and entities involved with the properties.
             Without proper information regarding identity-of-interest relationships and
             timely notification of default, HUD was prevented from taking corrective
             remedial actions. Suburban Mortgage’s failures caused $14 million in
             losses to HUD and put another $26.2 million of HUD funds at
             unnecessarily increased risk. HUD should take administrative sanctions
             against Suburban Mortgage and its principals for its failure to perform its
             mortgage-related fiduciary duties.




                                      15
     Recommendations

                         We recommend that HUD’s assistant secretary for housing-federal
                         housing commissioner

                         1A.     Require Suburban Mortgage and the owners of the Hillside Health
                                 Center to reimburse $229,673 for the interest charges incurred
                                 from the late payment of the real estate taxes15.

                         1B.     Terminate the insurance for the three remaining loans to identity-
                                 of-interest affiliated properties—Hillside Health Center, Hillcrest
                                 Village, and Mount Saint Francis Health Center—estimated to be
                                 $26.2 million16.

                         We also recommend that HUD’s assistant secretary for housing-federal
                         housing commissioner, in conjunction with the director of HUD’s
                         Departmental Enforcement Center,

                         1C.     Take appropriate administrative sanctions against Suburban
                                 Mortgage and its principals for its failure to perform its mortgage-
                                 affiliated fiduciary duties.




15
   Suburban Mortgage has filed a suit against HUD regarding HUD’s decision to deny the insurance claim for
Hillside Health Center. The outcome of this suit is unknown. If HUD prevails, HUD will not seek repayment and
Recommendation 1A will be closed.
16
   The claim and lawsuit for Hillside Health Center affects Recommendation 1B also. If HUD prevails,
Recommendation 1B will be decreased by the $12 million associated with the Hillside Health Center claim.

                                                     16
                         SCOPE AND METHODOLOGY

The scope of our review included selected HUD-insured loans provided by Suburban Mortgage
for various HUD-insured properties in New England. At the time these loans were initiated,
Suburban Mortgage processed loans using traditional application procedures, with HUD
performing the underwriting function for the loans. Later, Suburban Mortgage began using
multifamily accelerated processing, whereby it performed all of the loan functions including
underwriting.

To accomplish our audit objectives, we performed onsite work from October 2003 to April 2004.
During the audit, we reviewed federal requirements including Title 24 of the Code of Federal
Regulations), HUD’s handbooks and directives, and records of Suburban Mortgage, including
the minutes of its board of directors’ meetings. We also searched state records of Rhode Island
and Maryland to obtain background information on Suburban Mortgage and affiliated entities.
We interviewed HUD multifamily housing personnel and the management and staff of Suburban
Mortgage to obtain information on its internal controls, applicable to the origination and
servicing functions performed for selected loans, and performed general risk assessments of
these loan functions.

We identified a population of 57 HUD-insured loans valued at $314 million processed by
Suburban Mortgage. Of the 57 loans, we selected six loans for review. Four of these loans had
identifiable identity-of-interest relationships between the mortgagors and the executive vice
president of Suburban Mortgage and two loans were affiliated through business ventures with the
executive vice president of Suburban Mortgage. For the six loans, we reviewed loan origination
and servicing functions at HUD’s Providence field office and at Suburban Mortgage and
examined affiliated records to determine whether these procedures complied with HUD’s
regulations.

We also obtained information from the City of Providence, Rhode Island, regarding the real
estate taxes for Hillside Health Center. We determined the timing of these tax payments and the
amount of interest and penalties paid by Hillside Health Center’s owners. We contacted
mortgage banking industry representatives and a State of Maryland banking regulatory official to
obtain relevant information regarding the identity-of-interest/conflict-of-interest issues involving
Suburban Mortgage and affiliated parties/entities noted during our review.

The audit covered the period from January 1, 2001 through December 31, 2003. When
appropriate, the audit was extended to include other periods. We performed our review in
accordance with generally accepted government auditing standards.




                                                17
                               INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:

       Effectiveness and efficiency of operations,
       Reliability of financial reporting, and
       Compliance with applicable laws and regulations.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.



 Relevant Internal Controls


We determined the following internal controls were relevant to our audit objectives:

       Suburban Mortgage’s controls over loan origination.
       Suburban Mortgage’s controls over loan servicing.

We assessed the relevant controls identified above.

A significant weakness exists if internal controls do not provide reasonable assurance that the
process for planning, organizing, directing, and controlling program operations will meet the
organization’s objectives.

 Significant Weaknesses


Based on our review, we believe the following are significant weaknesses (see finding 1):

       Suburban Mortgage did not have controls to prevent one of its board members from
       ratifying HUD-insured loans for properties in which this board member had an ownership
       interest.

       Suburban Mortgage did not have controls to ensure its board member was not paid for
       loan origination work on HUD-insured loans where the member received a partnership
       interest.




                                                 18
Suburban Mortgage did not have controls to ensure information provided to HUD
regarding identity-of-interest relationships involving Suburban Mortgage and mortgagors
was complete and accurate.

Suburban Mortgage did not have procedures in place to ensure HUD-insured properties’
annual financial statements are adequately reviewed and irregularities are reported to
HUD.

Suburban Mortgage did not have controls in place to ensure HUD was notified of a
mortgagors’ failure to pay mortgage principal, reserve for replacements deposits, or real
estate taxes.




                                        19
                                           APPENDIXES

Appendix A

                   SCHEDULE OF QUESTIONED COSTS
                  AND FUNDS TO BE PUT TO BETTER USE

          Recommendation                    Ineligible 1/               Funds to be put to better
              Number                                                             use 2/
                 1A                          $229,67317
                 1B                                                           $26,256,580 18
                Totals                       $229,673                          $26,256,580


1/      Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
        that the auditor believes are not allowable by law; contract; or federal, state, or local
        polices or regulations.

2/      “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an
        Office of Inspector General (OIG) recommendation is implemented, resulting in reduced
        expenditures later for the activities in question. This includes costs not incurred,
        deobligation of funds, withdrawal of interest, reductions in outlays, avoidance of
        unnecessary expenditures, loans and guarantees not made, and other savings.




17
   Suburban Mortgage has filed a suit against HUD regarding HUD’s decision to deny the insurance claim for
Hillside Health Center. The outcome of this suit is unknown. If HUD prevails, HUD will not seek repayment and
Recommendation 1A will be closed.
18
   The claim and lawsuit for Hillside Health Center affects Recommendation 1B also. If HUD prevails,
Recommendation 1B will be decreased by the $12 million associated with the Hillside Health Center claim.

                                                     20
Appendix B
                                        DEFINITIONS


Arms-length transactions - Arms-length transactions are business dealings in which each
involved party acts independently of each other involved party. In arms-length transactions,
neither party is subject to the other’s influence or control. For affiliated entities and identity-of-
interest entities to be considered arms-length, the entities must behave in their dealings or
arrangements as if there were two unrelated parties. In addition, HUD guidance stipulates that
approved lenders (and any officer, partner, director, principal, or employee thereof) shall not be
engaged in business practices that do not conform to generally accepted practices of prudent
lenders or that demonstrate irresponsibility. Prudent lending practices dictate that transactions be
arms-length in nature.

Conflict of interest – 24 CFR 202.5(l), A mortgagee may not pay anything of value, directly or
indirectly, in connection with any insured mortgage transaction or transactions to any person or
entity if such person or entity has received any other consideration from the mortgagor, seller,
builder, or any other person for services related to such transactions or related to the purchase or
sale of the mortgaged property, except that consideration approved by the secretary of HUD may be
paid for services actually performed. The mortgagee shall not pay a referral fee to any person or
organization.

Fiduciary responsibilities - HUD Handbook 4350.4, “Insured Multifamily Mortgagee Servicing
and Field Office Remote,” discusses the principles of fiduciary responsibilities . An entity acts in a
“fiduciary capacity” when the business being transacted or the money/property being managed is
not for the benefit of the entity but for the benefit of another person/entity. The relationship
between the two parties involves great confidence, trust, and a high degree of good faith. In a
fiduciary relationship, neither party may (1) exert influence or pressure upon the other, (2) take
selfish advantage of this trust, or (3) deal with the subject matter of the trust in such a way as to
benefit (the entity) or prejudice the other (entity) except in the exercise of the utmost good faith and
with the full knowledge and consent of that other (entity). Business shrewdness, hard bargaining,
and astuteness to take advantage of the forgetfulness or negligence of another are totally prohibited
between parties (entities) standing in a fiduciary relationship to one another.




                                                   21
Identity-of-interest - In relation to HUD programs, an identity-of-interest relationship is defined
as existing between two parties (entities) when, for the first entity, either

    (a) The owner entity or a general partner of the owner entity or
    (b) Any officer or director of the owner entity or
    (c) Any person who directly or indirectly controls 10 percent or more of the voting rights or
        owns 10 percent or more of the owner entity

is also one of the following of the second entity:

    (a) An owner, general partner, officer, or director or
    (b) A person who directly or indirectly controls 10 percent or more of the voting rights or
        owns 10 percent or more of the owner entity.

In this definition, a “person” refers to any individual, partnership, corporation, or other business
entity. Any ownership, control, or interest held or possessed by a person’s spouse, child,
grandchild, sibling, or other relation by blood or marriage is attributed to that person for this
determination.

Absolute independence in decision-making and in business practices is rarely an attainable goal;
however, conflicts can often be resolved or remedied by actions such as

                •   Adequate disclosure of conflicts,
                •   Removal of persons with identified conflicts from decision-making and from
                    roles of authority, and
                •   Divestiture of ownership and affiliated interests.

Mortgagee approval - HUD Directive 4060.1, “Mortgagee Approval Handbook,” requires lenders
to design programs that meet the goals of (1) assuring compliance with HUD’s requirements;
(2) protecting the lender and HUD from unacceptable risk; (3) guarding against errors, omissions,
and fraud; and (4) assuring swift and appropriate corrective action.

Mortgage payments and defaults - 24 CFR [Code of Federal Regulations] 200.84, “Mortgagor
Payment Requirements,” requires that mortgage agreements provide for the owner to pay to the
lender equal monthly payments to amortize all taxes (among other items). The mortgage shall
further provide that such payments be held by the lender for paying the taxes before the taxes
become delinquent. HUD defines a “mortgage default” as the failure of the owner to make any
payment due under the mortgage or the failure to perform any other covenant under the
provisions of the mortgage [24 CFR 207.255]. HUD also requires that if the mortgage default
(as defined) is not cured within the 30-day grace period, the lender must notify HUD within 30
days of such default [24 CFR 207.256]. Further, HUD requires the lender to certify that it will
follow HUD’s terms, conditions, and requirements associated with the HUD-insured loan [24
CFR 200.51].

Oversight of mortgagors - HUD’s regulations governing Federal Housing Administration
insurance programs provide for oversight of owners by means of a regulatory agreement. The

                                                   22
regulatory agreement requires that owners be prohibited from paying out any property funds
except for reasonable operating expenses and necessary property repairs. The regulatory
agreement also states that property owners shall not transfer any personal property of the
property without prior HUD approval.

Owners’ advances - HUD Handbook 4370.2, “Financial Operations and Accounting Procedures
for Insured Multifamily Properties,” states that owner advances made for reasonable and
necessary operating expenses may be repaid from surplus cash at the end of the annual or
semiannual period. These regulations also prohibit repayments of owner advances when a
property is in a non-surplus-cash position.

Payments by mortgagees - In 24 CFR [Code of Federal Regulations] 202.5, “Approval of
Lending Institutions and Mortgagees,” HUD prohibits certain business practices on the part of its
approved lenders. These regulations specifically prohibit payments by the lender to persons
associated with and receiving compensation from the owner(s).

Review by mortgagees - HUD Handbook 4350.4, “Insured Multifamily Mortgagee Servicing
and Field Office Remote,” provides that lenders should always review monthly or annual
revenue and expense statements from the owner and compare them with previous statements.
Analysis of these statements may identify conditions leading to delinquencies that could be
prevented. For delinquent mortgage loans, the lender needs to determine the causes of the
delinquency, including improper financial operations, such as payments to owners, loans to
owners or other properties, or excessive costs, particularly when identity-of-interest vendors are
involved.

Surplus cash - Surplus cash, as defined in the regulatory agreement, is the cash remaining after
the payment of (1) all sums due or currently required to be paid under the terms of any HUD-
insured loan, (2) all amounts required to be paid into the reserve for replacements, and (3) all
obligations of the project other than the HUD-insured loans (unless deferment of this obligation
has been approved by the secretary of housing and urban development) and the segregation of
special funds required to be maintained by the project and tenant security deposits.




                                                23
Appendix C
                                     Affiliated Entities

As noted in our finding, the executive vice president had affiliated interests in six properties that
received loans from Suburban Mortgage. Suburban Mortgage provided four HUD insured loans
to identity-of-interest properties, as shown in the following chart.

           The Executive Vice President and Identity-of-interest HUD Insured Properties
                                    Executive Vice President
                                      Suburban Mortgage


   Coventry Health             Hillside               Hillcrest Village      Mount Saint Francis
    Care Center              Health Center              Apartments             Health Center
   General Partner          General Partner           General Partner         General Partner


Coventry Health Center - The executive vice president of Suburban Mortgage was a general
partner in Coventry Health Center Associates, a limited partnership that owned the property. On
February 19, 2001, the State of Rhode Island placed Coventry Health Center in receivership.

Hillside Health Center - The executive vice president of Suburban Mortgage was a limited
partner in Hillside Health Center Associates, a limited partnership that owned Hillside Health
Center. The general partner of this partnership was Consultants, Incorporated, a real estate
consulting firm in which the executive vice president has an affiliation. According to the limited
partnership documents for Hillside Health Center Associates, the executive vice president’s
percentage interest in the partnership profits and losses was 99 percent. The State of Rhode
Island placed Hillside Health Center into receivership in March 2004. Suburban requested
assignment of Hillside Health Center’s mortgage. This claim was denied by HUD in April 2005.
A lawsuit has been filed by Suburban to force HUD to pay the claim. For this loan, Suburban
Mortgage added a rider to the mortgagee’s certificate that stated that: (1) the executive vice
president has an interest in the mortgagor (Hillside Health Center) as revealed it the agreement
and certificate of limited partnership; (2) additionally, the executive vice president has an
interest in the mortgagee (Suburban Mortgage); and (3) however, this transaction is an arms
length transaction and neither the mortgagor nor the mortgagee has a controlling interest in the
other.

Hillcrest Village - The executive vice president of Suburban Mortgage was a general partner in
Hillcrest Village Associates, a limited partnership that owned Hillcrest Village. Hillcrest
Village’s management agent, Management Realty Services, was a consulting firm in which one
of the executive vice president’s children and two business associates of the executive vice
president were principals. Hillcrest Village also received rental subsidies from HUD.

Mount Saint Francis Health Center - The executive vice president of Suburban Mortgage was a
general partner in Mount Saint Francis Associates, a limited partnership that owned Mount Saint

                                                 24
Francis Health Center. The limited partner of Mount Saint Francis Health Center was another
limited partnership whose general partner was also the president of Riverview Nursing Home,
Incorporated (the limited partnership that owned Riverview Nursing Home).

Suburban Mortgage provided two HUD insured loans to affiliated properties, as shown in the
following chart.

     The Executive Vice President and other business ventures with HUD Insured Properties
                                Executive Vice President
                                  Suburban Mortgage




                      Edmund Place             Riverview Nursing Home
                       Health Center           (afilliated through Mount
                      (former owner)          Saint Francis Health Center


Edmund Place Health Care Center - The executive vice president of Suburban Mortgage did not
participate in the ownership of Edmund Place at the time of HUD insurance and default.
According to records obtained from the State of Rhode Island, the executive vice president was
part of the partnership from 1981 to 1989. The loan received initial endorsement from HUD in
December 1993. The executive vice president’s identity-of-interest management agent, Sterling
Health Care Management, managed the property for the owners who defaulted.

Riverview Nursing Home - The executive vice president of Suburban Mortgage did not
participate in the ownership at Riverview Nursing Home. The president of Riverview Nursing
Home, Incorporated (the limited partnership that owned Riverview Nursing Home), was also a
general partner of the limited partnership that owned Mount Saint Francis Health Center.

 Other Affiliated Companies


During our audit of Suburban Mortgage, we identified numerous companies that the executive
vice president of Suburban Mortgage and/or one or more of his children had an ownership
interest. These companies, listed below, were doing business with one or more of the affiliated
properties to which Suburban Mortgage provided HUD-insured loans.

Consultants, Incorporated - This company provided real estate management consulting services
to the following affiliated properties: Coventry Health Center, Edmund Place Health Center,
Hillside Health Center, and Riverview Nursing Home. We were unable to determine actual
ownership. However, in March 2003, Consultants, Incorporated, reported to the State of Rhode
Island that two of the executive vice president’s children were principals in Consultants,
Incorporated. A July 2003 Dun & Bradstreet report identified Consultants, Incorporated, as a
subsidiary of a consulting firm named for the executive vice president. This report also
identified the executive vice president of Suburban Mortgage as the president of Consultants,
Incorporated. The Dun & Bradstreet information on Consultants, Incorporated, conflicts with
the information provided to HUD. The affiliated owners for three of the four properties, to
                                               25
which Consultants, Incorporated, provided services, defaulted on their HUD-insured loans. The
State of Rhode Island placed two of these properties into receivership. Consultants Inc. was also
the general partner of the ownership entity of Hillside Health Center.

Management Realty Services - This company managed Hillcrest Village. Management Realty
Services is a consulting firm in which two of the executive vice president’s children and one of
the business associates of the executive vice president are principals.

My Place, Incorporated - This company provided human resource/employee benefit services to
at least two affiliated properties: Coventry Health Center and Mount Saint Francis Health
Center. One of the executive vice president’s children is a principal in My Place, Incorporated.

Simon & Windsor Interiors, Incorporated - This company provides interior decorating services to
at least two affiliated properties: Coventry Health Center and Mount Saint Francis Health
Center. Two of the executive vice president’s children are principals in Simon & Windsor
Interiors, Incorporated.

Sterling Health Care Management - This firm is a health care management company that
performed as the management agent for Coventry Health Center, Edmund Place Health Center,
and Mount Saint Francis Health Center. At various points in time, the executive vice president
and/or three of his children were identified as principals for Sterling Health Care Management.

 Affiliated Entities Provided
 Misleading Information
 to HUD
The executive vice president and affiliated entities provided misleading, confusing, and
conflicting information to HUD, including the following:

               For the Mount Saint Francis loan, the executive vice president signed a
               declaration that stated, “I hereby certify that there is no identity-of-interest to any
               of the parties involved in this proposal, i.e., contractor, architect, mortgagee.”
               The executive vice president signed this declaration as the general partner of the
               partnership owner. This statement conflicted directly with the fact that the
               executive vice president also co-owned Suburban Mortgage.

               In May 1995, Suburban Mortgage sent a letter to HUD certifying that Suburban
               Mortgage had no interest in the owner of Mount Saint Francis Health Center, and
               the owner of Mount Saint Francis Health Center had no interest in Suburban
               Mortgage. While technically correct, these statements were misleading since the
               executive vice president is the co-owner of Suburban Mortgage and the general
               partner of the partnership owning Mount Saint Francis Health Center and that
               relationship was not disclosed.

               Documents related to the application of the loan insurance for the Mount Saint
               Francis Health Center showed several instances in which both the executive vice

                                                 26
president and the president of Suburban Mortgage signed the same documents but
represented different entities. In these instances, the president signed on behalf of
Suburban Mortgage while the executive vice president signed as the general
partner for the partnership that owned Mount Saint Francis Healh Center.
Without knowing the relationship of these two individuals and their joint
ownership of Suburban Mortgage, outside observers could not identify that these
transactions occurred between affiliated parties.

For the Hillside Health Center loan, the July 1998 mortgagee certificate contained
a rider stating that the executive vice president has an interest in Hillside Health
Center and an interest in Suburban Mortgage. The rider further stated that this
transaction is an arms-length transaction and neither Suburban Mortgage nor
Hillside Health Center has a controlling interest in the other. This statement is
misleading since it does not identify that the executive vice president owns 50
percent of Suburban Mortgage and personally guarantees the $3 million
warehouse line of credit that keeps Suburban in business. Interests between
affiliated entities need not be controlling to demonstrate significant influence. As
a main investor in the mortgagor entity, the executive vice president’s relationship
with Suburban Mortgage was material and significant. Based on the servicing of
the loan, as shown in this report, the lender did not treat this transaction as arms-
length in nature.




                                 27
 Appendix D

            AUDITEE COMMENTS AND OIG’S EVALUATION


 Ref to OIG Evaluation      Auditee Comments




Comment 1




Comment 2




                             28
Comment 3




Comment 4

Comment 5




Comment 6




            29
Comment 7




Comment 8




            30
Comment 9




            31
Comment 10




Comment 11




             32
Comment 12




Comment 13




             33
Comment 14




Comment 15




             34
Comment 16

Comment 17




Comment 18




             35
Comment 19




Comment 20




             36
Comment 21




             37
Comment 22




Comment 23




             38
Comment 24




             39
40
Comment 25




             41
Comment 26




             42
Comment 27




             43
Comment 28




             44
Comment 29




             45
Comment 30




             46
47
48
49
                       OIG Evaluation of Auditee Comments


Comment 1   Although the mortgage banker finds these situations were not specifically
            prohibited, the auditee’s conclusion that that these situations provide no basis
            for questioning Suburban Mortgage is false. In 24 CFR 202.5 (j), Ineligibility,
            the regulations advise that neither the lender or mortgagee, nor any officer,
            partner, director, principal or employee of the lender or mortgagee shall be
            engaged in business practices that do not conform to generally accepted
            practices of prudent mortgagees or that demonstrate irresponsibility.
            Therefore, Suburban Mortgage is required to comply with generally accepted
            practices of prudent mortgagees. By originating loans that were not arms-
            length transactions and creating conflicts of interest, Suburban Mortgage has
            violated this regulation. No changes were made to the report.

Comment 2   The report does not state that Suburban Mortgage should have pursued action
            outside of reporting the incident to HUD. We made wording changes and
            added HUD requirements to clarify the mortgagee’s responsibilities.

Comment 3   The report does not state that identity-of-interest equates to improper cash
            distributions. We have adjusted the report for clarity.

            The requirements cited within this report trace to a federal regulation or HUD
Comment 4   handbook. No changes were made to the report.

            As noted in footnote 12 on page 13, we do not take exception to the identity-
Comment 5   of-interest relationships in the lending process where appropriately disclosed.
            OIG is aware of multifamily accelerated processing requirements and
            traditional application processing requirements and it is unclear as to what part
            of the report the auditee is referring. No changes were made to the report.

            As stated in 24 CFR 202.5, mortgagees are required to act prudently. Our
Comment 6   definition of arms length transactions is derived from Code of Ethics of the
            National Association of Mortgage Originators, Canon of Ethics for the
            Mortgage Bankers Associations, and the internet publication of
            Dictionary.Law.Com. We did not make changes to the report to include these
            references.

            OIG began its review of Suburban Mortgage in August 2003 before Suburban
Comment 7   Mortgage’s assignment of Hillside Health Center. Our report is not an attempt
            to justify HUD’s actions. No changes were made to the report.




                                           50
Comment 8    Our original calculation of the number of defaults included mortgages that had
             been prepaid. We have adjusted the reported number of defaults.

Comment 9    During the audit period of January 1, 2001, to December 31, 2003, the
             executive vice president held the roles described in the bullets on page 6. We
             have adjusted the report to show that the second management agent and two of
             the service companies were owned by partnerships or corporations owned, in
             part, by one or more of executive vice president’s children.

             The executive vice president owned Edmund Place from 1981 to 1989.
Comment 10   Sterling Health Care Management managed Edmund Place for its subsequent
             owners at the time of default. Sterling Health Care Management is owned by
             children of the executive vice president. We have adjusted the report to reflect
             this relationship.

             Riverview Towers is affiliated with Mount Saint Francis Health Center--not an
Comment 11   identity-of-interest entity with Suburban Mortgage. Riverview Towers is
             affiliated with the executive vice president of Suburban Mortgage because the
             general partner of Riverview Towers is a limited partner of the partnership that
             owns Mount Saint Francis Health Center. The executive vice president is the
             general partner of the limited partnership that owns Mount Saint Francis
             Health Center. We made wording changes to clarify.

             We have adjusted the report to reflect that Hillcrest Village is not in
Comment 12
             receivership.

             HUD approves the loan for Federal Housing Administration insurance, but the
Comment 13   mortgagee must first agree to take the loan. The mortgagee also shares in the
             risk for each loan and the assumption of this risk requires approval by the
             mortgagee’s board of directors. To allow a board member to ratify a loan
             where he has an identity-of-interest shows these loans were not proper arm’s-
             length transactions. From the auditee’s comments, it appears that Suburban
             Mortgage did not evaluate the loans for its own risk, which shows a total lack
             of responsibility in the lending process.

             The executive vice president owned Edmund Place from 1981 to 1989, which
Comment 14   is prior to the 1993 loan from Suburban Mortgage to the new owners of
             Edmund Place. We have adjusted the report to reflect this relationship.

             We have edited the report to clarify how the staed regulation specifically
Comment 15   applies to the situation noted.




                                             51
Comment 16    See Comment 10.

              The violation in the report is that the executive vice president cannot be paid
Comment 17    on both sides of the transaction. Our report does not state only employees can
              originate loans. We adjusted our report to further clarify.

              The executive vice president signed two separate documents. On
Comment 18    September 28, 1994, the executive vice president signed one document stating
              that each principal sponsor had no relationship with the present mortgagee.
              On September 28, 1994, the executive vice president signed another document
              certifying that there was no identity-of-interest to any of the parties identified
              in the proposal. Where the first certification addresses the request for the
              relationship with the present mortgagee, it does not explain why the second
              certification was submitted. No changes were made to the report

              While technically correct, the full relationship was not disclosed to HUD and
Comment 19
              was therefore misleading. No changes were made to the report.

              The certification that Hillside Health Center was an arms-length transaction
 Comment 20   was an incorrect certification. When one person has a significant interest in
              both parties to a transaction and the parties act differently in this transaction
              than they do in transactions with unrelated parties, the transaction cannot be
              considered arm’s length. No changes were made to the report.

Comment 21    See Comment 2.

              Management fees were not mentioned in our report. Partners’ fees and
Comment 22
              executive service fees were received by the owner, who was also the executive
              vice president, but these fees were not necessary operating expenses and the
              mortgagee should have sufficient knowledge of real estate to know this.
              Therefore, the use of project funds for unearned fees should have been
              reported to HUD. We have edited the report for clarification.

              Current distributions from companies owned by the executive vice president
 Comment 23   would be lost by reporting his improper distributions or failure to make
              mortgage payments. This creates a disincentive for the executive vice
              president (who was the one with the knowledge) that would not be present
              under normal circumstances. He would have also been susceptible to
              administrative sanctions. No changes were made to the report.

Comment 24    The report states that the executive vice president benefits from the profits
              generated on $19 million in interest. The report did not state that Suburban
              Mortgage made a profit of $19 million. No changes were made to the report.




                                          52
Comment 25   General industry practice requires all estimated tax and insurance payments
             due up until the amortization of the escrow (end of construction) be covered by
             loan proceeds. This gives the mortgage company control over ensuring
             payments are made. Therefore, when the amortization period was postponed
             and the loan proceeds were no longer covering the payments, the source of
             those payments were no longer known or controlled by Suburban Mortgage.
             Mortgage companies maintain control of tax and insurance payments to protect
             their risk from tax liens and damage to the premises not covered by insurance.
             Since HUD insured the loan, the risk of loss was almost completely carried by
             HUD and it was the mortgagee’s responsibility to protect HUD’s interest. By
             not creating an escrow when the construction period was complete, HUD’s
             investment was at risk. No changes were made to the report.

Comment 26   See Comment 1.

             We clarified the report to reflect that certain loans were not identity-of-interest
Comment 27   loans and adjusted the recommendations.

Comment 28   As discussed in this report, Suburban Mortgage has misrepresented its
             relationships with these properties. Based on its inappropriate actions, the
             remaining identity-of-interest loans put HUD at an unacceptable risk.
Comment 29
             The identity-of-interest relationships addressed in our report are between
             Suburban Mortgage and the identity-of-interest properties. These relationships
             were not clearly disclosed to HUD. No change to the report is needed.
Comment 30
             Suburban Mortgage has sued HUD over HUD’s decision to not pay the claim
             at Hillside Health Center. At the time of report issuance, the outcome of this
             litigation is unknown. We have adjusted the report to acknowledge the
             litigation.




                                             53