Issue Date
March 22, 2011
Audit Report Number
2011-PH-1009
TO: Dane M. Narode, Associate General Counsel for Program Enforcement, CACC
Craig T. Clemmensen, Director, Departmental Enforcement Center, CACB
//signed//
FROM: John P. Buck, Regional Inspector General for Audit, Philadelphia Region,
3AGA
SUBJECT: Deutsche Bank Berkshire Mortgage, Inc., Bethesda, MD, Acquired a $45.6
Million Loan That Was Not Properly Underwritten in Accordance With HUD’s
Multifamily Accelerated Processing Program
HIGHLIGHTS
What We Audited and Why
We audited the underwriting of a $45.6 million mortgage loan that was acquired
by Deutsche Bank Berkshire Mortgage, Inc. (the Lender)1 to rehabilitate Wingate
Towers and Garden Apartments. The audit was performed based on a request
from the U.S. Department of Housing and Urban Development’s (HUD) Office of
Multifamily Development. The Federal Housing Administration (FHA)-insured
loan went into default in October 2009 and in May 2010, HUD paid a $44.3
million insurance claim to the Lender. HUD subsequently sold the property in a
note sale in September 2010 for $14.5 million resulting in a loss of $29.8 million.
1
On October 21, 2004, the Lender acquired and became responsible for the loan origination activities, personnel,
books and records related to this loan from Berkshire Mortgage Finance Limited Partnership (the Underwriter). The
personnel the Lender acquired from the Underwriter continued to oversee the Wingate Towers and Garden
Apartments project from the commencement of the construction phase through final endorsement of the loan. On
February 7, 2005, the Underwriter changed its name to Berkshire Mortgage Finance Limited Partnership Liquidation
(BMFLP Liquidation).
The audit objective addressed in this report was to determine whether the $45.6
million FHA-insured loan acquired by the Lender was underwritten in accordance
with HUD requirements.
What We Found
The Lender acquired a $45.6 million FHA-insured loan that was not underwritten
in accordance with HUD requirements. The Underwriter failed to properly
assess, as required, the financial wherewithal of the owner and general contractor,
or the construction capabilities of the general contractor. The Underwriter also
significantly understated the amount of repairs needed to bring the property up to
marketable condition. Based on the Underwriter’s recommendation, HUD
approved the project and the general contractor. The project failed, resulting in a
loss of $29.8 million to the taxpayer.
What We Recommend
We recommend that HUD’s Associate General Counsel for Program Enforcement
perform a legal review of applicable documents to determine the responsible party
that is liable for incorrectly certifying to the integrity of the data or that due
diligence was exercised by the underwriting of the loan that resulted in a loss to
HUD totaling $29.8 million which could result in affirmative civil enforcement
action of more than $118 million,2 and to pursue remedies under the False Claims
Act against the responsible party if it is determined legally sufficient to do so.
Additionally, we recommend that the Director, Departmental Enforcement
Center, take appropriate administrative action against the responsible party for the
material underwriting deficiencies cited in this report.
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 provided a draft report to the Lender on January 14, 2011. We discussed the
audit results with the Lender during the audit and at an exit conference on
January, 28, 2011. The Lender provided written comments to our draft report on
2
We estimated the potential affirmative civil enforcement action of approximately $118 million by determining the
amount of the claim paid times 3 minus the amount of the note sale ($44,274,712 times 3 minus $14,499,999 =
$118,324,137).
2
February 8, 2011. 3 It disagreed with the report. The complete text of the
Lender’s response, along with our evaluation of that response, can be found in
appendix B of this report.
3
BMFLP Liquidation was not asked to provide written comments to the draft audit report. Although it technically
is an existing entity, BMFLP Liquidation has no employees and is not actively engaged in business.
3
TABLE OF CONTENTS
Background and Objective 5
Results of Audit
Finding: The Lender Acquired a $45.6 Million FHA-Insured Loan That Did Not 7
Meet HUD’s Underwriting Requirements
Scope and Methodology 13
Internal Controls 14
Appendixes
A. Schedule of Questioned Costs 15
B. Auditee Comments and OIG’s Evaluation 16
4
BACKGROUND AND OBJECTIVE
Section 221(d) (4) of the National Housing Act authorizes loans insured by the Federal Housing
Administration (FHA) for the substantial rehabilitation of multifamily rental or cooperative housing
for moderate-income families, the elderly, and the handicapped. Under the U.S. Department of
Housing and Urban Development’s (HUD) Multifamily Accelerated Processing program (MAP),
approved lenders prepare, process, and submit loan applications for multifamily mortgage
insurance. In accordance with MAP guidelines, the sponsor works with a MAP-approved lender,
which submits required exhibits for the pre-application stage. After HUD reviews the exhibits, it
either invites the lender to apply for a firm commitment for mortgage insurance or declines to
further consider the application. For acceptable exhibits, the lender submits the firm commitment
application, including a full underwriting package, to HUD for review to determine whether the
loan is an acceptable risk. Considerations include market need, zoning, architectural merits,
capabilities of the borrower, etc. If HUD determines that the project meets program requirements, it
issues a firm commitment to the lender for mortgage insurance.
In August 2002, HUD’s Baltimore, MD, Multifamily Program Center (center) received a Section
221(d) (4) substantial rehabilitation mortgage loan application from Berkshire Mortgage Finance
Limited Partnership (the Underwriter), a MAP-approved lender, on behalf of Wingate
Development, LLC, the owner of Wingate Towers and Garden Apartments. The Wingate Towers
and Garden Apartments property is a 717-unit apartment complex built in the mid-1960s on a 21.6
acre site located in southwest Washington, DC. The original appraiser was not approved by HUD.
However, the owner obtained another appraiser and resubmitted the application in December
2002. The center issued an initial endorsement for a $45.6 million mortgage loan on August 22,
2003. The property was also financed with low-income housing tax credits and tax-exempt
mortgage revenue bonds financing. The substantial rehabilitation was to be completed in
approximately 21 months. The substantial rehabilitation was not completed until 2008.
On October 21, 2004, German American Capital Corporation (GACC) purchased the mortgage
banking, brokerage, lending, and servicing business of the Underwriter. After the asset purchase by
GACC, the Underwriter’s business was continued by a GACC affiliate named Deutsche Bank
Berkshire Mortgage, Inc. (the Lender), which took over the Underwriter’s offices, files, and
employees. On February 7, 2005, the Underwriter changed its name to Berkshire Mortgage Finance
Limited Partnership Liquidation (BMFLP Liquidation). BMFLP Liquidation exists for the sole
purpose of providing security against losses to GACC. Although it technically is an existing entity,
BMFLP Liquidation has no employees and is not actively engaged in business. Since the GACC
acquisition, BMFLP Liquidation has not maintained audited financial statements.
On October 1, 2009, 73 months after acquiring the loan and making 7 mortgage payments, the
owner defaulted on the loan. Based upon the final settlement statement, the note was assigned to
HUD, and HUD recorded the assignment on February 9, 2010. HUD paid $44.3 million to the
Lender for the Wingate Towers and Garden Apartments’ insurance settlement and sold the
mortgage note for $14.5 million, a loss of $29.8 million.
5
HUD’s Office of Multifamily Development Lender Qualification and Monitoring Division
completed a review on Wingate Towers and Garden Apartments in October 2008. The purpose of
reviewing the potentially troubled project was to determine whether the Lender complied with
program requirements. The Division’s February 27, 2009, report concluded that the Lender
primarily caused the default by not performing an adequate underwriting analysis. The report stated
that the Lender failed to properly scrutinize the experience and credit worthiness of the owner and
general contractor, and failed to ensure the scope of work was adequate. The report also stated that
the Lender permitted the use of unauthorized valuation techniques which inflated the mortgage
amount. The division’s determination was that the misrepresentation by the Lender’s underwriter
was the primary reason for the default and assignment of the loan.
The audit objective addressed in this report was to determine whether the $45.6 million FHA-
insured loan acquired by the Lender was underwritten in accordance with HUD requirements.
6
RESULTS OF AUDIT
Finding: The Lender Acquired a $45.6 Million FHA-Insured Loan That
Did Not Meet HUD’s Underwriting Requirements
The Lender acquired a loan in which the Underwriter did not perform a complete financial
analysis of the owner or general contractors as required and did not accurately evaluate the
experience and qualifications of the sponsor and general contractor. The Underwriter also failed
to ensure that the scope of work included all needed repairs to bring the property to a marketable
condition. The Underwriter did not practice the required due diligence during its analyses.
Based on the Underwriter’s recommendation, HUD insured a mortgage loan that was not feasible
nor completed within the established timeframe. The project failed and resulted in a loss to
HUD of $29.8 million.
The Underwriter Did Not
Perform a Complete Financial
Analysis of the Owner or the
General Contractors
A key component of the underwriting process is to assess the mortgagor’s ability
to manage the development, construction, completion, and successful lease-up of
the property. The Underwriter did not perform a complete financial analysis of
the owner or the general contractor of the project. Specifically, the Underwriter
did not (1) perform a full credit investigation of the sponsor and the principals of
the project and (2) obtain complete financial statements from the general
contractors to accurately determine its working capital position.
The Underwriter did not perform a full credit investigation of the sponsor and the
principals of the project. The Underwriter failed to obtain a credit report for the
sponsor of the property 4 because the business entity had been formed 10 months
prior to the insurance application. Thus, the business entity had no business
concerns. The Underwriter also stated that five of the principals’ business entities
were newly formed thus commercial credit reports could not be obtained. Since the
sponsor and affiliated principals’ companies were newly formed and had no
operating history, the Underwriter was required to obtain individual credit reports of
those parties.
The Underwriter also did not verify the trade references for the sponsor and the
principals. The Underwriter’s file did not include complete records verifying that
bank and trade references were performed and the Underwriter did not ensure that
4
MAP Guidebook, chapter 8, section 8.3.E.3
7
all principals completed the necessary forms to disclose account numbers, present
balances, and terms of the accounts. The MAP Guidebook required that bank and
trade references be verified to confirm financial stability. 5
The Underwriter did not obtain complete financial statements and supporting
schedules of the principals and its general contractors. 6 The unaudited financial
statements of the principals did not include the supporting schedules for accounts
receivable, notes receivable, pledged assets, accounts payable and notes payable as
required. The Underwriter also failed to obtain various financial statements
including balance sheets, income and expense statements, and statements showing
the business’ financial position, fund balances, notes and other relevant financial
statements. According to the incomplete financial statements that were obtained,
two of the principals had suffered net losses between $34,450 and $138,718 over a
2-year period. The MAP Guidebook required the Underwriter to obtain and review
the supporting financial statements and schedules for the past 3 years.7
The Underwriter did not accurately determine the general contractors’ joint venture8
working capital position. Working capital is the excess of current assets over current
liabilities. The MAP Guidebook required the Underwriter to make a working capital
determination. In order to determine working capital, the Underwriter was required
to obtain financial statements showing the contractors’ current assets and liabilities
as of the same cut-off date. Although the contractors submitted balance sheets, the
cut-off dates for the financial statements were different. One set of financial
statements was dated March 3, 2003, and the other was dated April 30, 2003. The
Underwriter should have required both parties to submit balance sheets with the
same cutoff dates to be able to determine a more accurate working capital position.
The MAP Guidebook required the Underwriter to perform a comparative analysis
of the information obtained from the credit reports and financial statements. This
process would have allowed the Underwriter to obtain a complete financial
picture of all parties involved in the Wingate Towers and Garden Apartments
loan. Without obtaining the appropriate credit reports and complete financial
statements, the Underwriter did not make an accurate determination as to whether
the borrowers or the general contractors had the financial wherewithal to develop,
build and complete the project. The Underwriter certified that the loan was an
acceptable risk to the HUD multifamily insurance program when it had not
practiced due diligence in evaluating the credit of the borrowers.
5
MAP Guidebook, chapter 8, section 8.3.H
6
MAP Guidebook, chapter 8, section 8.4
7
MAP Guidebook, chapter 8, section 8.4.B.2.a
8
The MAP Guidebook, chapter 8, section 8.4.C.12.d, permits a joint venture if a general contractor does not have an
acceptable working capital position. The joint venture may be established with a financially stronger general
contractor provided these firms’ combined working capital equals at least 5 percent of all construction contract
amounts. However, prior to initial endorsement the joint venture terminated, leaving a less experienced contractor
to perform the rehabilitation.
8
The Underwriter Did Not
Accurately Evaluate the
Sponsor’s and General
Contractor’s Experience
The Underwriter did not accurately evaluate the sponsor’s and general
contractor’s experience as required. The MAP Guidebook required that the
Underwriter ensure that the owner and general contractor have sufficient
experience in developing, owning or building similar multifamily properties.9
The Underwriter was required to carefully evaluate whether the owner’s or
general contractor’s past experience included work performed on similar projects,
the length of time served on each project, and past roles in the multifamily
business. The resume provided for the sponsor indicated limited management
experience with multifamily-insured projects and no ownership experience. The
sponsor’s previous experience instead dealt with real estate lending and real estate
development. The resume did not reflect experience with the day-to-day
management of any multimillion dollar multifamily projects. As a result, the
managing general partner of the ownership entity could not resolve construction
issues that occurred during the rehabilitation, nor could they contribute
financially. In October 2007, the sponsor and the other general partner agreed
that they would withdraw from the ownership and terminate any future
involvement.
The resume provided by the general contractor did not provide complete
information indicating that they had sufficient experience with rehabilitating a
multifamily-insured project. The general contractor’s resume failed to show the
size of the projects completed and the role of the general contractor related to
each project. Based upon the project experience list provided by the general
contractor, the general contractor had worked on 101 projects. However, of the
101 projects, only 1 project had substantial rehabilitation costs of more than $26
million. The general contractor was ultimately removed in May 2005 due to
significant issues related to the work performed and was replaced by the bonding
company.
The MAP Guidebook required the Underwriter to evaluate the resumes of the
principals. Specifically, the Underwriter was to evaluate the sponsor’s and
general contractor’s experience in developing, owning or building similar
multifamily properties. The Underwriter was also to evaluate the type and size of
previous projects and the past roles in the multifamily business. The Underwriter
incorrectly asserted that both parties had adequate experience. Ultimately, due to
lack of funds, poor management, and poor workmanship during the rehabilitation
of the project, both the sponsor and the general contractor were removed from the
project before the project was completed. A project that was to be completed
within 2 years was completed within 5 years. Although the Underwriter had not
9
MAP Guidebook, chapter 8, section 8.3.J
9
adequately evaluated the owner’s and general contractor’s resumes, it
recommended the loan for insurance. Unfortunately, HUD relied on the
Underwriter’s recommendation and the loan was insured.
The Underwriter Failed To
Ensure That the Scope of Work
Included All Needed Repairs
For a substantial rehabilitation project, the scope of work must provide for the
replacement of all doors, windows, roofs, cabinets, and mechanical/conveyance
systems. A detailed work writeup must describe in narrative form the required
rehabilitation. Although a scope of work was prepared, the Underwriter
incorrectly determined the scope of work that would bring the property up to a
marketable condition.
A third party cost review estimated that the project would incur construction costs
of more than $26 million. However, the Underwriter failed to ensure that the
estimated costs included costs for asbestos removal and other needed repairs. The
architect’s survey report identified asbestos-containing materials throughout the
property and provided recommendations for asbestos removal. The Underwriter
ensured HUD that the asbestos would be removed in accordance with all local and
Federal regulations. However, the general contractor was not aware of the
additional costs associated with the removal. Thus, during the rehabilitation of
the project, the general contractor filed a demand for arbitration claiming that the
asbestos removal was outside of the scope of work. The additional cost of the
asbestos removal was $680,000.
The project also experienced numerous changes to the original scope of work.
Specifically, the general contractor submitted 99 change orders throughout the
project. The change orders included requests for extensions to complete the project,
and for replacing additional drywall, flooring and doors. Overall, the change orders
included the following increased costs:
Original cost Change order Percent
Work item estimate amount Total cost increase
Asbestos not
removal $0 $680,000 $680,000 applicable
Drywall $467,272 $360,500 $ 827,772 77
Floors $305,244 $302,318 $607,562 99
Doors $1,028,282 $260,518 $1,288,800 25
At completion of the project in 2008, the Wingate Towers and Garden Apartments
loan construction costs totaled more than $70 million, an increase of $44 million
from the original $26 million. Although the project had rehabilitation costs totaling
more than $70 million, the property never reached its projected 95 percent
10
occupancy level, revenues estimated during underwriting were not realized, and
ultimately the project failed. HUD paid a $44.3 million claim on the property.
The Underwriter’s Certification
Was Incorrect
The Underwriter incorrectly certified that due diligence was used in the underwriting
of the Wingate Towers and Garden Apartments loan. Specifically, the Underwriter
certified that the MAP application for FHA-insured multifamily loans was prepared
and reviewed in accordance with HUD requirements although it had not properly
analyzed the credit history of the sponsor and principals, accurately evaluated the
sponsor’s and general contractor’s experience, and incorrectly determined the scope
of work to bring the property up to marketable condition as required by the MAP
Guidebook.
Conclusion
HUD placed confidence in the Underwriter’s integrity and competence but it
failed to follow and implement the MAP Guidebook and other relevant guidance
during the underwriting of the loan. The Underwriter did not properly analyze the
credit history of the sponsor and principals, accurately evaluate the sponsor’s and
general contractor’s experience, and incorrectly determined the scope of work to
bring the property up to marketable condition as required by the MAP Guidebook.
As a result, HUD approved a loan with significant financial and business risk.
The owner defaulted on the loan resulting in a loss to HUD of $29.8 million.
Recommendations
We recommend that HUD’s Associate General Counsel for Program Enforcement
1A. Perform a legal review of applicable documents to determine the responsible
party that is liable for incorrectly certifying to the integrity of the data or
that due diligence was exercised by the underwriting of the loan that
resulted in a loss to HUD totaling $29.8 million.
1B. If legally sufficient, pursue remedies under the False Claims Act against the
responsible party if they are found liable for incorrectly certifying to the
integrity of the data or that due diligence was exercised by the underwriting
of the loan that resulted in a loss to HUD totaling $29,774,713 which could
result in affirmative civil enforcement action of more than $118 million.
11
We further recommend that the Director of HUD’s Departmental Enforcement
Center
1C. Pursue administrative actions, as appropriate, against the responsible party
for the material underwriting deficiencies cited in this report.
12
SCOPE AND METHODOLOGY
We conducted the audit from June to December 2010 at the Lender’s offices located at 4550
Montgomery Avenue, Bethesda, MD, HUD’s Office of Multifamily Development in
Washington, DC, and our offices located in Richmond, VA. The audit covered the period
December 2002 through December 2009.
To accomplish our objective, we reviewed
Relevant background information including HUD’s monitoring reports and project
reviews;
HUD’s MAP Guidebook and other requirements;
The Lender’s audited financial statements; and
The underwriting loan file for Wingate Towers and Garden Apartments which included
the pre- and firm application, property appraisal report, construction contract,
certifications, and other financial information used during the underwriting process.
We conducted interviews with the Lender’s acquired staff, including the originating underwriter,
construction specialist and officials from HUD’s Office of Multifamily Development. We
selected and reviewed the Underwriter’s loan file for the Wingate Towers and Garden
Apartments FHA-insured multifamily loan.
We determined the loss to the FHA fund to be $29.8 million (the amount of the claim paid
$44,274,712 minus the amount of the note sale $14,499,999 = $29,774,713).
We estimated the potential affirmative civil enforcement action of approximately $118 million
by determining the amount of the claim paid times 3 minus the amount of the note sale
($44,274,712 times 3 minus $14,499,999 = $118,324,137).
We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.
13
INTERNAL CONTROLS
Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to
Effectiveness and efficiency of operations,
Reliability of financial reporting, and
Compliance with applicable laws and regulations.
Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals and objectives. Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program operations as well as the
systems for measuring, reporting, and monitoring program performance.
Relevant Internal Controls
We determined that the following internal controls were relevant to our audit
objective:
Policies, procedures and other management controls implemented to ensure
that the Lender administered the Wingate Towers and Garden Apartments
loan in accordance with HUD’s MAP requirements.
We assessed the relevant controls identified above.
A deficiency in internal control exists when the design or operation of a control does
not allow management or employees, in the normal course of performing their
assigned functions, the reasonable opportunity to prevent, detect, or correct (1)
impairments to effectiveness or efficiency of operations, (2) misstatements in
financial or performance information, or (3) violations of laws and regulations on a
timely basis.
We evaluated internal controls related to the audit objective in accordance with
generally accepted government auditing standards. Our evaluation of internal
controls was not designed to provide assurance regarding the effectiveness of the
internal control structure as a whole. Accordingly, we do not express an opinion on
the effectiveness of the Lender’s internal control.
14
APPENDIXES
Appendix A
SCHEDULE OF QUESTIONED COSTS
Recommendation Unreasonable or
number unnecessary 1/
1B $29,774,713
1/ Unreasonable or unnecessary costs are those costs not generally recognized as ordinary,
prudent, relevant, and/or necessary within established practices. Unreasonable costs
exceed the costs that would be incurred by a prudent person in conducting a competitive
business. We determined the unreasonable costs to be the loss to the FHA fund of
$29,774,713 (the amount of the claim paid $44,274,712 minus the amount of the note
sale $14,499,999).
15
Appendix B
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
16
Comment 1
Comment 2
Comment 2
Comment 2
Comment 2
17
Comment 3
Comment 4
Comment 5
Comment 5
18
Comment 5
Comment 2
19
Comment 1
Comment 2
Comment 2
Comment 2
Comment 1
Comment 1
Comment 2
20
Comment 2
Comment 2
Comment 2
21
Comment 2
Comment 4
Comment 5
22
Comment 5
Comment 5
Comment 5
Comment 5
Comment 3
23
Comment 3
Comment 5
Comment 6
24
Comment 6
Comment 7
Comment 8
25
Comment 9
26
Comment 5
Comment 10
Comment 5
Comment 10
27
Comment 5
Comment 11
Comment 12
Comment 5
Comment 10
28
Comment 5
Comment 10
Comment 13
Comment 14
29
Comment 14
30
OIG Evaluation of Auditee Comments
Comment 1 The Lender’s overall underwriting history was not the subject of this audit.
Comment 2 The audit was performed at the offices of the Lender that acquired the loan
origination files and personnel who underwrote and serviced the $45.6 million
FHA-insured loan that was the subject of this audit. HUD paid the Lender $44.3
million in an FHA insurance settlement and sold the mortgage note for $14.5
million, a loss of $29.8 million to the taxpayer.
On October 21, 2004, GACC purchased the mortgage banking, brokerage,
lending, and servicing business of the Underwriter. After the asset purchase by
GACC, the Underwriter’s business was continued by a GACC affiliate named
Deutsche Bank Berkshire Mortgage, Inc. (the Lender), which took over the
Underwriter’s offices, files, and employees. On February 7, 2005, the
Underwriter changed its name to Berkshire Mortgage Finance Limited
Partnership Liquidation (BMFLP Liquidation). An attorney representing BMFLP
Liquidation informed us that the company exists for the sole purpose of providing
security against losses to GACC. Although it technically is an existing entity,
BMFLP Liquidation has no employees and is not actively engaged in business.
Since the GACC acquisition, BMFLP Liquidation has not maintained audited
financial statements.
During the audit, we conducted interviews with the responsible staff who
continued to work for the Lender, including the originating underwriter and
construction specialist. We also reviewed the complete loan file for the Wingate
Towers and Garden Apartments loan. We have made changes to the report to
address the Lender’s concerns that the underwriting problems occurred prior to its
acquisition of the loan. After the audit exit conference, the Lender provided
documents which it asserted relieved it of any legal liability for the poor
underwriting of the company it acquired. Therefore, we have added a
recommendation for HUD to perform a legal review of these documents to
determine the legal liability of the responsible party involved in these
transactions. We have also revised the other two recommendations to include any
parties who are ultimately determined to be legally responsible for incorrectly
certifying that due diligence was exercised in the underwriting of this loan.
Comment 3 We are not aware of the existence of such a report. Also, HUD’s Office of
Multifamily Development again informed us it was not aware of the existence of
such a report.
Comment 4 HUD’s approval of the Wingate Towers and Garden Apartments loan application
was based on the Underwriter’s certification that the loan was feasible and would
not be a risk to the FHA fund.
31
Comment 5 We conducted the audit in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform the audit to
obtain sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objective. We believe that the
evidence obtained provides a reasonable basis for our findings and conclusions
based on our audit objective. The audit evidence clearly showed that the
Underwriter failed to properly assess, as required, the financial wherewithal of the
owner and general contractor, or the construction capabilities of the general
contractor. The Underwriter also significantly understated the amount of repairs
needed to bring the property up to marketable condition. Based on the
Underwriter’s recommendation, HUD approved the project and the general
contractor. The project failed, resulting in a loss of $29.8 million to the taxpayer.
HUD’s Office of Multifamily Development also reviewed the underwriting of this
loan and similarly reported in February 2009 that serious underwriting
deficiencies resulted in the loan default. Specifically it reported that the Lender
failed to
properly scrutinize the experience and creditworthiness of the owner and
general contractor, directly contributing to the project’s failure, and
ensure the scope of work was sufficient to bring the property up to
marketable condition.
Comment 6 Since the sponsor and affiliated principals’ companies were newly formed and
had no operating history, the Underwriter was required to obtain individual credit
reports of responsible parties. The Lender acknowledges that the Underwriter did
not obtain individual credit reports. The Lender provides other unverified
information here but does not explain how it negates a failure to comply with the
applicable HUD underwriting requirements designed to ensure that the loan was
feasible and would not be a risk to the FHA fund.
Comment 7 The MAP Guidebook required that all sponsors, principals and general
contractors complete HUD Form 92013 to document that the credit references
included bank, trade, and other credit information. The Underwriter did not
ensure that the forms were completely filled out as required and did not verify the
information required on the forms. For example, one of general contractors listed
six trade references and only one trade reference was verified. The Underwriter
also did not ensure that a verification of deposit be present for each bank
reference listed. The Lender provides other unverified information here but does
not explain how it negates a failure to comply with the applicable HUD
underwriting requirements designed to ensure that the loan was feasible and
would not be a risk to the FHA fund.
Comment 8 The MAP Guidebook required that the sponsor, mortgagor and general
contractors provide financial statements and supporting schedules for the last 3
years of existence. One of the project’s general contractors was not required to
32
adhere to HUD’s requirement. The Lender acknowledges that the Underwriter
did not require that both general contractors submit the supporting schedules as
required. The Lender provides other unverified information here but does not
explain how it negates a failure to comply with the applicable HUD underwriting
requirements designed to ensure that the loan was feasible and would not be a risk
to the FHA fund.
Comment 9 The financial documentation dates for the joint venture financial statements used
in the working capital calculation were 58 days apart. The working capital
analysis is used to determine the difference between the general contractor’s
assets and liabilities. The Underwriter could not have accurately determined
whether there was adequate working capital for the Wingate Towers project since
the financial documentation did not have the same cutoff dates.
Comment 10 Although the Lender asserts that there was adequate leverage of financial
commitment and experience of the principals and sponsors to complete the
project, the project ultimately failed. The sponsor did not have adequate
experience to provide day-to-day site control of the property. As discussed in the
audit report, both the sponsor and the general contractors had limited experience
with multimillion dollar projects. The MAP Guidebook required that the financial
capacity and experience be considered by the Lender to determine if the sponsor
and general contractor had the capacity to develop, build, and complete the
project. The MAP Guidebook also required that the Underwriter pay close
attention to the type and sizes of projects, length of time served in capacity, and
past roles in multifamily businesses of the sponsor. The sponsor’s resume did not
demonstrate the level of experience needed to successfully complete the
development of the project.
Comment 11 The general contractor’s resume did not provide complete information indicating
sufficient experience and did not provide the size of the projects completed.
Although the Lender asserts that one of the general contractors recently assisted
with a project in the District of Columbia, the project that has been mentioned had
total rehabilitation costs of $4 million. The Wingate Towers and Garden
Apartments project originally cost approximately $46 million due to substantial
rehabilitation. The general contractor did not have enough experience to
rehabilitate the project, thus a joint venture was formed. However, per records
reviewed, the joint venture disbanded 2 days before initial endorsement. Thus,
the less experienced general contractor was to complete the project. The general
contractor could not complete the project and was ultimately removed from it.
Comment 12 The audit report has been revised based on information provided at the exit
conference and now does not include the results of the past multifamily project
experience of one of the Wingate Towers and Garden Apartments’ loan’s co-
general partner.
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Comment 13 Although the Lender asserts that the property failed due to crime and other area
improvements that did not take place, our review of the underwriting of the loan
showed severe deficiencies with the credit investigation, experiences of its owners
and inadequate scope of work. We cannot confirm the Lender’s assertion that the
property failed because other financial commitments did not materialize.
Comment 14 The change orders included requests for extensions to complete the project and
the replacement of drywall, flooring and doors. Only a small amount of change
orders were associated with tenant damages.
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Deutsche Bank Berkshire Mortgage, Inc., Bethesda, MD, Acquired a $45.6 Million Loan That Was Not Properly Underwritten in Accordance With HUD's Multifamily Accelerated Processing Program
Published by the Department of Housing and Urban Development, Office of Inspector General on 2011-03-22.
Below is a raw (and likely hideous) rendition of the original report. (PDF)