oversight

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)

                                                                              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


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              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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