Issue Date July 12, 2006 Audit Report Number 2006-AT-1013 TO: Larry Knightner, Director, Office of Public Housing Program Center, 4EPH FROM: James D. McKay Regional Inspector General for Audit, 4AGA SUBJECT: The Housing Authority of the City of North Charleston, South Carolina, Inappropriately Pledged Assets to Secure a Loan and Caused Delays in Its Oakleaf Homeownership Program HIGHLIGHTS What We Audited and Why We audited the Housing Authority of the City of North Charleston’s (Authority) implementation of the U.S. Department of Housing and Urban Development (HUD) Section 5(h) homeownership program and its use of Public Housing Capital Fund program funding (capital funding) to renovate and convert 68 public housing units to 64 homeownership housing units, known as Oakleaf Estates (Oakleaf). We conducted the audit in response to a request from HUD’s Columbia, South Carolina, Public Housing Program Center (HUD). What We Found The Authority inappropriately pledged public housing program funds covered by its annual contributions contract with HUD to secure a $400,000 commercial bank loan for real estate improvements at Oakleaf. In addition, the Authority’s noncompliance with program requirements and untimely planning caused delays in its Oakleaf homeownership program. The delays hampered the Authority’s Table of Contents ability to provide homeownership opportunities to low-income individuals and families in a timely manner. What We Recommend We recommend that the director of the Office of Public Housing Program Center ensure that the Authority obtains prior approval from HUD before entering into any future contract or agreement that obligates annual contributions contract funds to secure debt. We also recommend that the director require the Authority to provide a reasonable plan for completing the project and selling the units, and properly assess and document homebuyers progress and related time extensions. 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 We discussed the findings with the Authority and HUD officials during the audit. We provided a copy of the draft report to the Authority Officials on May 31, 2006, for their comments. We discussed the report with the Authority and HUD officials at the exit conference on June 27, 2006. The Authority provided its written comments to our draft report on June 15, 2006. The complete text of the Authority’s response, along with our evaluation of that response, can be found in Appendix B of this report. The Authority also provided exhibits with its response that are available for review upon request. Table of Contents 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: The Authority Inappropriately Pledged Its Annual Contributions 5 Contract Funds to Secure a Bank Loan Finding 2: The Authority’s Noncompliance with Requirements and Untimely 7 Planning Delayed the Oakleaf Homeownership Program Scope and Methodology 10 Internal Controls 11 Appendixes A. Schedule of Funds to Be Put to Better Use 12 B. Auditee Comments and OIG’s Evaluation 13 3 BACKGROUND AND OBJECTIVES The Housing Authority of the City of North Charleston (Authority) is a public body corporate and politic organized under the laws of the state of South Carolina by the city of North Charleston to provide housing for qualified low-income individuals. The city of North Charleston appoints a governing board for the Authority, and the board designates its own management. In March 2002, the Authority submitted a Section 5(h) homeownership program (plan) to HUD’s Special Application Center to convert 68 Oakleaf public housing units to homeownership housing units for low-income individuals and families. On June 6, 2002, the Special Application Center executed the implementing agreement (agreement) and incorporated the Authority’s plan. The Authority later reduced the number of homeownership units included in the project from 68 to 64 units. The plan stated that Public Housing Capital Fund program funds (capital funds) would be used to fund the project. From 2000 through 2005, the Authority received more than $7.1 million in capital funds, of which it appropriated and spent nearly $2.3 million for the Oakleaf project. At the time of our audit, the project was not complete. The 64-unit project contained 36 completed units, 21units that were under renovation, and 7 units that were awaiting renovation. However, due to project management concerns, HUD’s South Carolina field office refused to approve the Authority’s request for additional capital funds to complete the project. The plan allowed qualified homebuyers 18 to 24 months to clear up credit issues and qualify for loans to purchase the units they occupied under the Authority’s lease purchase agreement. Homebuyers signed a lease with option to purchase under the homeownership program when they moved into the renovated unit they planned to purchase. The Authority then worked with the homebuyers to help ensure that they would qualify to purchase their unit within the 18- to 24- month period. Our audit objectives were to determine whether the Authority administered its capital funding for Oakleaf in accordance with HUD’s program requirements for financial management and reasonableness and necessity of expenditures and whether the Oakleaf project was adequately progressing toward accomplishing its homeownership objective. Table of Contents 4 RESULTS OF AUDIT Finding 1: The Authority Inappropriately Pledged Its Annual Contributions Contract Funds to Secure a Bank Loan The Authority inappropriately pledged funds covered under its annual contributions contract with HUD (HUD contract) to secure a $400,000 bank loan. The executive director stated that this occurred because the Authority did not know the loan agreement included language that pledged HUD contract funds to secure the loan. The security clause placed HUD contract funds at risk of not being available when needed to meet the affordable housing needs of low-income individuals and families the funds were intended to assist. HUD Contract Funds Pledged as Collateral The Authority inappropriately pledged HUD contract funds to secure a $400,000 loan obtained to pay for improvements at Oakleaf. Section 7 of the HUD contract, dated January 14, 2003, states “...the HA [housing authority] shall not in any way encumber any such project, or portion thereof, without the prior approval of HUD. In addition, the HA shall not pledge as collateral for a loan the assets of any project covered under this ACC [annual contributions contract].” The executive director stated that the Authority did not know the loan agreement included language that pledged all funds on deposit to secure the loan. The Authority had more than $2.9 million in HUD contract funds on deposit with the bank when it made the loan. An Authority representative stated that the Authority obtained the $400,000 loan to pay Oakleaf renovation costs after HUD denied the Authority’s request for additional capital funding for the project. HUD denied the request because of concerns raised during its March 2004 management review regarding the Authority’s noncompliance with various requirements that included financial management and procurement issues. HUD questioned, among other things, the Authority’s lack of documentation to support the reasonableness of Oakleaf’s renovation costs. Conclusion At the time of our on-site review, the Authority had not drawn any funds against the loan. We informed the Authority that the loan agreement inappropriately obligated HUD contract funds. The Authority contacted the bank and amended the loan agreement to remove the security clause that obligated HUD contract Table of Contents 5 funds. We examined the amended loan agreement and verified that the terms and provisions that obligated HUD contract funds had been removed. Recommendations We recommend that the director of the Office of Public Housing Program Center, Columbia, South Carolina, ensure that the Authority 1A. Deobligates the $400,000 in HUD contract funds used to secure the bank loan. 1B. Obtains approval from HUD before entering into any future contracts or agreements that encumber or pledge HUD contract funds as collateral. Table of Contents 6 Finding 2: The Authority’s Noncompliance with Requirements and Untimely Planning Delayed the Oakleaf Homeownership Program The Authority’s noncompliance with various program requirements and incomplete planning for the homeowners association caused delays that might have been avoided or reduced. The delays hampered the Authority’s timely completion of Oakleaf for homeownership opportunities to low-income individuals and families. For instance, the 64-unit project has been underway for more than three years, but only 36 (56 percent) of the units have been completed; 21 units were under renovation, and renovation had not begun on seven units. Only four units had been sold, and eight units were vacant. Delays Due to Noncompliance with Program Requirements The Authority’s noncompliance with various requirements caused HUD to suspend the Oakleaf project in May 2004 and deny the Authority’s request for capital funds to complete the project. These actions resulted from HUD’s March 2004 management review of the Authority’s implementation of the project. At the time of our and HUD’s review, the Authority had spent the $2.3 million in capital funds that HUD approved for the project. The suspension and resulting project delay might have been avoided or reduced if the Authority had complied with requirements. HUD made recommendations to address financial management and procurement concerns noted during its review. However, HUD requested that we audit the project primarily due its concerns about whether the project costs were reasonable. We obtained the services of a HUD construction analyst, whose assessment indicated that the project’s overall costs were not excessive. We examined contracts and other supporting documents (e.g., invoices) for more than $852,000 spent on the Oakleaf project. The amounts were for contract services, materials, and/or supplies incurred for Oakleaf. Table of Contents 7 Unsupported Time Extensions Granted to Prospective Homebuyers The Authority did not document why it allowed four of six homebuyers included in our test to exceed the time allowed by its homeownership plan to purchase their units. The plan, section 907.7, “Method of Sale,” provides that the lease purchase phase will be available to all participants who can qualify for a mortgage within an 18-month period. The homebuyer may request one six-month extension. If at the end of the extension period, it is determined that the homebuyer is still not eligible for homeownership, the homebuyer will have a choice of becoming a renter at an alternative property or through the Section 8 program. The files for the four homebuyers did not adequately document the basis for the extensions granted by the Authority. The Authority also granted the extensions without providing evidence that the homebuyers had requested them. Months beyond Expected Unit Move-in Date of Months the 18 allowed in months to Number Date review elapsed the plan close 2797 Apr. 23, 2003 Feb. 2006 34 16 2 2790B Aug. 4, 2004 Feb. 2006 19 1 12 2722C Mar. 28, 2003 Feb. 2006 35 17 Immediate 2767 May 4, 2004 Feb. 2006 22 4 Immediate For instance, the homebuyer in unit 2797 had lived in the unit for more than 34 months but had not qualified to purchase the unit. The Authority’s October 2005 letter to the homebuyer noted that the homebuyer was no longer employed and had not taken steps to resolve credit issues noted in action plans, dated April 2003, September 2004, and May 2005. Yet, on January 17, 2006, the Authority amended the lease addendum contract through June 1, 2006. The file did not contain adequate documentation to support the Authority’s continued extension of the contracts. The files for the other three cases contained a similar lack of documentation for time extensions. Delay in Resolving Legal Matters The Authority did not resolve in a timely manner legal matters that delayed the sale of two completed housing units. An Authority representative told us that in July 2004, the two homebuyers were ready to purchase their units. The representative stated that the Authority could not finalize the sales because it had not completed the legal steps associated with incorporation of the homeowners association, association bylaws, and association covenants. As a result, one homebuyer did not purchase the unit until January 2006, and the other homebuyer developed credit problems and had not purchased the unit at the time of our review. On March 19, 2002, the Authority obtained an opinion from its legal council pursuant to the requirement at 24 CFR Table of Contents 8 [Code of Federal Regulations] 906.21(g). The legal opinion did not mention any problems associated with incorporation of the homeowners association. We requested but the Authority did not provide an adequate explanation for the delays associated with the homeowners association. Conclusion The delays postponed the availability of affordable homeownership opportunities to low-income individuals and families. Recommendations We recommend that the director of the Office of Public Housing Program Center, Columbia, South Carolina, require the Authority to 2A. Develop and submit to HUD a reasonable plan for completion of the renovation and sale of the remaining 60 Oakleaf units to qualified homebuyers. 2B. Assess and document the adequacy of all homebuyers’ progress toward qualifying to purchase their units. 2C. Offer and document alternative housing options to homebuyers who are ineligible to purchase their unit or who decline to purchase their unit and the homebuyers response to the offers. 2D. Ensure that each file contains proper documentation for all time extensions granted to homebuyers to qualify to purchase their unit. Table of Contents 9 SCOPE AND METHODOLOGY Our audit objectives were to determine whether the Authority administered its capital funding for Oakleaf in accordance with HUD’s program requirements for financial management and reasonableness and necessity of expenditures and whether the Oakleaf project was adequately progressing toward accomplishing its homeownership objective. To accomplish our objectives, we • Reviewed applicable laws, regulations, and other HUD program requirements. • Reviewed HUD’s files, including management reviews and related correspondence concerning the Authority’s homeownership program. • Reviewed the Authority’s records, including the homeownership plan, Section 5(h) implementation agreement, procurement plan, homeownership program files, financial records supporting project disbursements, and tenancy (e.g., contracts, check vouchers, invoices, tenant records). • Toured the Oakleaf project site and walked through several units. • Interviewed HUD and Authority program staff and Authority contract staff. • Requested, obtained, and considered a legal opinion from the HUD Office of Inspector General’s (OIG) Office of Legal Counsel on whether the one-for-one replacement requirement applied to Oakleaf’s reduction from 68 to 64 units. The requirement did not apply. • Examined contracts, invoices, and other supporting documents for $852,000 of the $2.3 million in project costs. We selected contracts and invoices for large individual amounts or for repetitive purchases that we considered material. We discontinued testing based on an independent assessment we requested and obtained from a cost analyst from HUD’s Columbia Multifamily Housing Division. The cost analyst estimate indicated the overall Oakleaf project costs were reasonable. • Examined homeowner files for 6 of the 24 completed occupied units to determine whether the homebuyers had made adequate progress toward qualifying to purchase their units. We conducted our fieldwork from October 2005 to February 2006 at the Authority’s office in North Charleston, South Carolina; HUD’s Office in Columbia, South Carolina; and our office in Jacksonville, Florida. Our audit period was from July 1, 2001, through November 30, 2005. We expanded our audit period as needed to accomplish our objectives. We performed our review in accordance with generally accepted government auditing standards. Table of Contents 10 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: • Controls over compliance with laws and regulations. • Controls over the implementation of the homeownership program. • Controls over the safeguarding of resources. We assessed the relevant controls identified above. A significant weakness exists if management 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 items are significant weaknesses: • The Authority needs to improve controls to prevent the inappropriate pledging of Authority assets to secure loans (Finding 1). • The Authority needs to improve controls to ensure proper implementation of its homeownership program (Finding 2). Table of Contents 11 APPENDIXES Appendix A SCHEDULE OF FUNDS TO BE PUT TO BETTER USE Funds to be put Recommendation to better use 1/ 1A $ 400,000 _______ Total $ 400,000 1/ “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an OIG recommendation is implemented, resulting in reduced expenditures at a later time 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. In this instance, if the Authority implements our recommendation, it will deobligate the Authority’s inappropriate obligation of HUD contract funds and make them available to accomplish their intended purpose. Table of Contents 12 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Table of Contents 13 Comment 1 Comment 1 Comment 2 Comment 2 Table of Contents 14 Comment 3 OIG Evaluation of Auditee Comments Comment 3 Comment 2 Comment 4 Comment 5 Comment 4 Comment 5 Table of Contents 15 Comment 4 Comment 6 Comment 7 Comment 4 Comment 8 Comment 8 Comment 8 Table of Contents 16 Comment 8 Comment 8 Table of Contents 17 Comment 1 Comment 9 Comment 4 Comment 3 Comment 5 Comment 5 Comment 4 Comment 8 Table of Contents 18 Evaluation of Auditee Comments Comment 1 Contrary to the Authority’s position, the written provisions of the loan agreement obligated the Authority’s annual contribution contract funds. The finding is valid and will not be removed from the report. We further discussed this issue with the executive director during the exit conference held on June 27, 2006, and he agreed with our observation. Comment 2 We recognize that the regulations do not specify a time-period for project completion. We revised recommendation 2A to focus on requiring the Authority to provide HUD a reasonable plan for completing the renovation and sale of all Oakleaf units. Comment 3 We recognize that the HUD’s Section 5(h) homeownership regulations do not permit an Authority to require original occupants of homeownership projects to move in order to make a dwelling available for sale to someone else. The regulations and the Authority’s homeownership plan do, however, permit and encourage Authority’s to offer alternative housing options to individuals who are ineligible for purchase or decline to purchase their unit. This was the point made in the finding. We found some evidence that the Authority provided this option to homebuyers but we found no documentation of the homebuyers response. Comment 4 We recognize that the homeownership plan does not specifically state how the Authority is to document time extensions granted to homebuyers. We also recognize that there are many justified reasons to grant such extensions. However, the Authority’s management is responsible for ensuring the files contain proper documentation for allowing homebuyers to remain in the program beyond the 18 months specified in the plan and the extension periods allowed by the plan. The absence of specific documentation methods in the homeownership plan does not excuse the Authority from its responsibility to ensure that the files contain proper information needed to track and assess homebuyers progress, or lack thereof toward homeownership. We further discussed this issue with the executive director during the exit conference held on June 27, 2006, and he agreed with our observation. Comment 5 The Authority’s written response was the first information we received that it had granted a one-time extension to all Oakleaf homebuyers. The files did not contain documentation of the extension. The executive director stated that the extension was not in writing. The Authority is responsible for ensuring that such decisions are properly documented. Comment 6 Contrary to the Authority’s position, the delays discussed in the finding postponed the availability of affordable housing opportunities to low-income individuals and families. Without the delays, the project would have been completed earlier and the units would have been available for sale earlier. Table of Contents 19 Comment 7 We revised recommendation 2D to remove reference to the homeownership plan. The revision focused on ensuring that the Authority includes proper documentation in its homeownership files. Comment 8 While we were on site conducting the audit we asked the Authority several times to explain why the legal issues associated with the homeowner’s organization were not resolved earlier. The Authority did not provide an adequate explanation. The detail provided in the Authority’s written comments to the finding is the first detailed explanation received for the delays. The Authority’s comments cite obstacles but they do not adequately explain and justify the delays that prevented their ability to immediately sell completed units to the first homebuyers who qualified to purchase their units. The issues mentioned in the Authority’s comments mostly included predictable issues that should have been anticipated and resolved prior to any units being completed and made available for sale. Comment 9 The Authority requested that we revise finding two but provided no support to justify the requested revision. We did not revise the finding. Table of Contents 20
The Housing Authority of the City of North Charleston, South Carolina, Inappropriately Pledged Assets to Secure a Loan and Caused Delays in Its Oakleaf Homeownership Program
Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-07-12.
Below is a raw (and likely hideous) rendition of the original report. (PDF)