oversight

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)

                                                              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