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. 33 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. 34
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)