OFFICE OF AUDIT REGION 4 ATLANTA, GA Prudential Huntoon Paige Associates, LTD Arlington, VA Multifamily Accelerated Processing Program 2014-AT-1015 SEPTEMBER 30, 2014 Issue Date: September 30, 2014 Audit Report Number: 2014-AT-1015 TO: Benjamin Metcalf, Deputy Assistant Secretary for Multifamily Housing, T Dane Narode, Associate General Counsel for Program Enforcement, CACC Craig T. Clemmensen, Director, Departmental Enforcement Center, CACB //signed// FROM: Nikita N. Irons, Regional Inspector General for Audit, Atlanta Region, 4AGA SUBJECT: Prudential Huntoon Paige Associates, LTD Did Not Underwrite and Process a $49 Million Loan in Accordance With HUD Requirements. Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector General’s (OIG) final results of our review of Prudential Huntoon Paige Associates’(Prudential) underwriting of a 221(d)(4) project, Preserve at Alafia (Alafia). HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on recommended corrective actions. For each recommendation without a management decision, please respond and provide status reports in accordance with the HUD Handbook. Please furnish us copies of any correspondence or directives issued because of the audit. The Inspector General Act, Title 5 United States Code, section 8M, requires that OIG post its publicly available reports on the OIG Web site. Accordingly, this report will be posted at http://www.hudoig.gov. If you have any questions or comments about this report, please do not hesitate to call me at 404-331-3369. September 30, 2014 Prudential Huntoon Paige Associates Did Not Underwrite and Process a $49 Million Loan in Accordance With HUD Requirements Highlights Audit Report 2014-AT-1015 What We Audited and Why What We Found We audited Prudential’s underwriting of Prudential did not underwrite and process the loan for a $49 million mortgage loan to develop the Preserve at Alafia in accordance with HUD’s the Preserve at Alafia, a multifamily guidelines and regulations. Specifically, Prudential did project located in Riverview, FL. We not properly analyze the appraisal and market study, initiated the review based on the early accurately estimate the project income and rental rates, default, assignment, and significant completely disclose all debts related to the property, amount of the project. Our objective adequately analyze the eligibility of the participants, was to determine whether Prudential and properly document prepaid costs. This condition underwrote and processed the loan for was caused by Prudential’s failure to practice prudent the Preserve of Alafia according to the underwriting and its failure to conduct a sufficient U.S. Department of Housing and Urban review of related documents and third party reports Development’s (HUD) requirements. that HUD relied on. As a result, Prudential exposed the Federal Housing Administration insurance fund to unnecessary risk and a loss of more than $20 million. What We Recommend We recommend that the Multifamily Hub refer Prudential to the Mortagee Review Board to take appropriate action against its noncompliance, the Office of General Counsel take appropriate enforcement actions against the responsible parties and pursue civil remedies under the False Claims Act, if legally sufficient, and the Departmental Enforcement Center pursue administrative actions, if warranted. TABLE OF CONTENTS Background and Objectives 3 Results of Audit Finding: Prudential Did Not Underwrite and Process a $49 Million Loan In Accordance With HUD Requirements 5 Scope and Methodology 15 Internal Controls 17 Appendixes A. Schedule of Questioned Costs 18 B. Auditee Comments and OIG’s Evaluation 19 C. Additional Land Sales 51 D. Average Rent Per Square Foot 52 E. Recalculated Rents 53 2 BACKGROUND AND OBJECTIVES Prudential Huntoon Paige Associates, LTD is one of the nation’s leading originators of FHA multifamily and healthcare loans with regional offices located throughout the United States. Prudential is a MAP approved lender that underwrote and processed a 221(d)(4) new construction of the Preserve at Alafia which consists of 351 units located in Riverview, FL. Section 221(d)(4) of the National Housing Act authorizes loans to be insured by the Federal Housing Administration (FHA) for the construction, substantial rehabilitation, and purchase or refinancing of multifamily projects. By insuring mortgages, HUD encourages private lenders (mortgagees) to enter the housing market to provide financing which otherwise might not be available to owners (mortgagors). Under the U.S. Department of Housing and Urban Development’s (HUD) Multifamily Accelerated Processing program (MAP), approved lenders prepare, process, review, and submit loan applications for multifamily mortgage insurance. In accordance with MAP guidelines, the sponsor works with the 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 the application. For acceptable exhibits, the lender submits the firm commitment application, including a full underwriting package, to HUD to determine whether the loan is an acceptable risk. Considerations include market need, zoning, architectural merits, capabilities of the borrowers, and so forth. If HUD determines that the project meets program requirements, it issues a firm commitment to the lender for mortgage insurance. In accordance with MAP guidelines and federal regulations, Prudential is responsible for reviewing all documents submitted to HUD for insurance. The pre-application for Alafia was submitted in August 2008, and the firm submission was submitted in April 2009, with approval granted in July 2009. This project was initially endorsed in December 2009 for more than $48 million and finally endorsed in March 2012, for more than $49 million, after receiving a $1.2 million mortgage increase. No principal payments were made for the loan that defaulted in May 2012, and assigned to HUD in December 2012. A claim was paid in March 2013, and the loan was included in a July 2013 note sale for $29 million, which resulted in more than a $20 million loss to HUD. HUD’s Office of Multifamily Housing Programs is responsible for the overall management, development, direction and administration of HUD's Multifamily Housing Programs. The Office of Multifamily Housing Development provides direction and oversight for FHA mortgage insurance loan origination including the implementation of the MAP program. The Lender Qualifications and Monitoring Division, which is a part of HUD’s Office of Multifamily, required Prudential to obtain a project default review of the Preserve at Alafia Apartments from a third party source. Its purpose was to determine what caused the default and whether the MAP lender complied with program requirements. Prudential hired a third party contractor that reviewed the loan documents and submitted its report on February 11, 2014, regarding Prudential’s non-compliance with the MAP Guide and HUD guidance, and 3 management of the default and election to assign processes. Our audit was initiated prior to the issuance of this report and was separate from this review. Our audit objectives were to determine whether Prudential underwrote and processed the loan for the Preserve of Alafia according to HUD’s requirements. 4 RESULTS OF AUDIT Finding: Prudential Did Not Underwrite and Process a $49 Million Loan in Accordance With HUD Requirements. Prudential did not underwrite and process the loan for the Preserve at Alafia in accordance with HUD’s guidelines and regulations. Specifically, Prudential did not properly analyze the appraisal and market study, accurately estimate the project income and rental rates, completely disclose all debts related to the property, adequately analyze the eligibility of the participants, and properly determine eligibility and document prepaid costs. This was caused by Prudential’s failure to practice prudent underwriting and to conduct a sufficient review of related documents and third party reports that HUD relied on. As a result, Prudential exposed the FHA insurance fund to unnecessary risk and a loss of more than $20 million. Prudential Did Not Perform an Adequate Review of the Appraisal Prudential was responsible for hiring third party appraisers, reviewing appraisals, ensuring that the appraiser was prudent and the appraisal included supported and verifiable information. 1 The land value determined by the appraisal of $10.5 million was used to calculate the mortgage amount that was insured by FHA. Prudential signed certifications stating that all of the in-house, third party forms, reports, and reviews were reviewed by Prudential in accordance to HUD guidelines. In addition, Prudential’s appraiser certified that the appraisal conformed with Uniform Standards of Professional Appraisal Practice. During our discussions, Prudential underwriting staff stated that the appraiser acted prudently and had extensive experience in appraising multifamily developments. Based on our review of various related documents, such as site plans, architectural reports, and correspondence and market data, we identified deficiencies with the appraisal and information that appeared to mislead the reader. The deficiencies included inappropriate comparable sales allowing land value to be overstated, unsupported adjustments, and inaccurate site information relevant to the appraisal. Inappropriate Comparable Sales We conducted a review of the appraisal and determined that an outlier 2 was used in the calculation of land value. The outlier consisted of a significantly higher 1 MAP Guide, Revised 2002, Section 11-1, 7-2, 2-10A, 15-1-A, Uniform Standards of Professional Appraisal Practice, Edition 2008-2009 Standard Rule 3, 3-1, 3-4 2 An outlier is something that lies outside of a reasonable range of values and varies significantly with data provided. 5 land sale on Main Street in Tampa, FL, with significantly different characteristics that skewed the land value (see Table 1). This particular land sale was inappropriately used because it was not comparable to the Preserve at Alafia in location and size, violating requirements. 3 We obtained market data for the comparable land sale which identified that the property was located in the Westshore Business District in Tampa, FL, the largest business district in Florida. The Preserve at Alafia; however, is located more than 20 miles south in Riverview, FL, next to the Alafia River, in a residential area under development, that also contained wetlands, and is significantly different from the Tampa Westshore Business District market. Taking a conservative approach and solely excluding the outlier, as discussed above, the estimated amount was $6.4 million or more than $4 million less than the $10.5 million appraised value (see Table1). Table 1 – Comparable land sales Comparables included in the appraisal Properties A B (Used by lender for value estimate) Size Prudential’s Recalculated adjusted I (acres) appraiser adjusted price/square foot price/square foot n Subject Property: Riverview, FL 26.62 Sale 1: Phillips- Riverview, FL 49.00 $ 2.67 $ 2.67 c Excluded-not o 2: Main Street - Tampa, FL Sale 5.70 $ 33.36 comparable n 3: Foxworth- Riverview, FL Sale 25.20 $ 8.29 $ 8.29 Sale d 4: 78th Street- Tampa, FL 16.14 $ 5.92 $ 5.92 Sale u 5: Oaks at Stone- Tampa, FL 4.66 $ 7.23 $ 7.23 Sale c 6: Courtney Trace- Brandon, FL 15.11 $ 7.20 $ 7.20 Sale 7: Rocky Creek-Tampa, FL 10.20 $ 2.78 $ 2.78 t Sale 8: Lake Kathy- Brandon, FL 22.91 $ 5.06 $ 5.06 i Average price per square foot $ 9.06 $ 5.593 n Adjusted average price per square foot $ 9.05 g Property square foot. 1,159,567 1,159,567 Land value (price/square foot times a square feet.) project $ 10,494,081.35 $ 6,485,292.58 In conducting additional reviews of the appraisal, we reviewed all land sales and adjustments and identified four of the eight sales used by Prudential’s appraiser, were out of the market area and were not comparable to the Preserve at Alafia. Land sales are required to be comparable in location and size according to HUD Handbook 4465.1. 4 We contacted local realtors and appraisers who provided additional sales in the Brandon, FL 5, and Riverview, FL, areas, which supported a range in value from $2.75 to $7.64 per square 3 HUD Handbook 4465.1, Section 2-1 4 HUD Handbook 4465.1, Section 2-1 5 Brandon, FL, was a submarket of Riverview, FL. Alafia is located in Riverview, FL. 6 foot. These land sales were available in public records for Prudential’s appraiser at the time of the original appraisal. We also determined that Prudential’s appraiser disregarded various indicators of the market downturn, and projected land value on the upper end of the scale. Based on this additional information, we recalculated the land value at an even lower amount of $6.1 million and not the $10.5 million calculated by Prudential’s appraiser. Prior to final approval, HUD questioned Prudential’s final submission. HUD’s correspondence to Prudential, dated June 3, 2009, stated that the $10.5 million land value was not supported, the price per unit should have been used instead of price per square foot to calculate land value, and requested justification for adjustments used in the appraisal. Prudential provided HUD a response including an additional appraisal which supported a $10.5 million value using price per unit. The appraiser obtained an average price per unit of $21,723, but used $30,000 per buildable unit, stating that the unit value was closer to the upper end of the price range but did not provide support. We do not agree that the new appraisal was representative of the current market. In addition, Prudential’s appraiser justified the appraisal and addressed HUD’s concerns by stating that more recent land sales could not be obtained, that the land values closer to the Tampa area did not experience a significant decrease, and that the waterfront location insulated it from fluctuations in the market. However, during the review of Prudential’s appraisal, we obtained two additional land sales that were available in public records and more comparable to the subject site (see Appendix C). Prudential allowed both appraisers to use the upper end of the scale to calculate land value and did not require the first appraiser to use land sales that were comparable to the Preserve at Alafia and were questioned by HUD, which resulted in an overstated land value. Inappropriate Adjustments The appraiser made adjustments based on the river location; however, the market reactions for multifamily properties may not have supported such an adjustment. Because the site plan included only 1 of the 11 apartment buildings with a direct river view, based on added premiums for river view units, the income for Alafia would have only increased by $28,800 per year. It is doubtful a prudent investor would pay considerably more for a water front site versus a non-water front site due to a return on investment of only $28,800 per year. Without additional sales and analysis, there was no support for a significant increase in site value based on the river influence. Also, Prudential’s appraiser failed to make appropriate adjustments based on the market reactions or other acceptable methods to adjust for notable differences, which was a violation of the Uniform Standards of Professional 7 Appraisal Practice. 6 The appraisal did not disclose that the Preserve at Alafia did not have adequate entrance and exit access, utilities were not provided to the site and that the site contained wetlands and potential species that were required to be removed by the County. The appraisal also stated the site would have road frontage, which was not consistent to site plans, as discussed below. By excluding these relevant characteristics of the subject site that would have required additional adjustments, the appraiser violated the Uniform Standards of Professional Appraisal Practice Standard Rule 1-2 7. This data was readily available to Prudential’s appraiser via public records, site plans, and other documentation. Inaccurate site information Prudential’s appraiser failed to properly identify the location of the vacant land site which is a violation of Uniform Standards of Professional Appraisal Practice 8 and did not correctly describe it as required by MAP Guide. 9 The appraisal included an aerial photograph of the acreage being appraised which indicated that Preserve at Alafia would have frontage along Gibsonton Road and the Alafia River (see Photo 1), which was not consistent with the site plans (see Photo 2). According to the site plans and our April 2014 site visit, Alafia did not have frontage along Gibsonton Road. This space was reserved for the commercial development. The appraiser should have had data to sufficiently identify the site, as required by Uniform Standards of Professional Appraisal Practice. 10 Photo 1- Aerial shot included in Photo 2 - Aerial shot based on site Prudential’s appraisal. plans and actual construction. 6 Uniform Standards of Professional Appraisal Practice, Edition 2008-2009 Standard Rule 1-2(e) and (i) and HUD Handbook 4465.1 Section 2-3 7 Uniform Standards of Professional Appraisal Practice, Edition 2008-2009 Standard Rule 1-2e 8 Uniform Standards of Professional Appraisal Practice, Edition 2008-2009 Standard Rule 1-2(e) and (i), and 2-2(iii) 9 MAP Guide, Revised 2002, Section 7-4 10 USPAP, Edition 2008-2009, Standard Rule 1-2e, comment line 518 8 HUD instructed Prudential to obtain a default review from a third party source to determine what caused the default. The report documented that Prudential’s underwriter failed to comment in the underwriting narrative that the appraisal noted that the current market rents may not allow for a cost feasible development at the time, which was critical to the mortgagor’s ability to sustain the project and a violation of MAP Guide. 11 In addition, the report documented that the land was overstated and that inappropriate comparable land sales were used by the appraiser. The reviewer used the price per unit methodology to determine financial feasibility and recalculated the land value at $6.6 million. The reviewer also stated that the significantly higher land sale was an outlier 12 based on multiple characteristics and should not have been included. Prudential Did Not Perform an Adequate Review of the Market Prudential did not ensure that the market study analysis included updated information to reflect the economic conditions and did not use the data available to make an adequate analysis of the overall demand and feasibility for the Preserve at Alafia, as required by HUD Handbook 4465.1. 13 The study included outdated statistics, such as unemployment rates, census data, and trend analysis for employment, and building permits, that were dated from January 2000 to May 2007, about 15 months prior to the effective date of the July 2008 report. The market study disregarded available data indicating market decline, such as unemployment rates, as listed by the U.S. Bureau of Labor Statistics that showed that unemployment rates were consistently rising and nearly doubling by June 2008, which was one month prior to the effective date of the report. In addition, the market study included comparable properties in which the average rent per square foot ranged from $1.09 to $1.14, but the market study proposed an average of $1.49 for Preserve at Alafia (see Appendix D). The comparable properties had larger floor plans and significantly lower rents in comparison to Alafia, and the market study showed no indication that the market could achieve similar rents to those proposed for the Preserve at Alafia. However, the market study stated the projects unique amenities and location justified the rents. Furthermore, the market study did not identify properties with occupancy levels above 90 percent with rents similar to Preserve at Alafia (see Table 2). The market included renters with the capacity to pay rents significantly lower than the rents for Alafia. Without an analysis of the market Alafia was targeting, the study was not useful and appeared to be misleading. 11 MAP Guide, Revised 2002, Section 7-1a 12 An outlier is something that lies outside of a reasonable range of numbers (values) and varies significantly with the other data provided. 13 HUD Handbook 4465.1 Section 1-8 9 Table 2 - Occupancy rates Hillsborough County Submarket: Brandon Quarter 1 Quarter 1 Quarter 1 Quarter 1 Lender 2008 2008 2008 2008 Market study revised occupancy average occupancy average proposed rents rents for rates rental rates rental for Alafia Alafia percentage rates percentage rates (average) (July 2009) All units 93.89 $ 870 94.37 $ 874 $ 1,484 $ 1,364 1 Bed/1 Bath 94.74 $ 724 96.27 $ 747 $ 1,263 $ 1,145 2 Bed/2 Bath 93.83 $ 942 95.02 $ 909 $ 1,492 $ 1,353 3 Bed/2 Bath 90.97 $ 1,124 89.53 $ 1,055 $ 1,698 $ 1,595 Prudential’s risk officer conducted an analysis of the market prior to underwriting, and indicated that the subject market area was listed as “red” which indicated market concerns. This would indicate that Prudential was aware of the state of the market and should have mitigated the risks accordingly. Prudential’s default report stated that the market study failed to include developments in the planning phase that were stalled due to a poor economic and credit environment, as required by MAP Guide. 14 The market study justified the Preserve at Alafia’s development by stating its unique location, off the Alafia River, and the superior amenities. However, the default report stated that the market’s willingness to pay rent premiums based on amenity packages and the location of property was not recession proof. The market study failed to adequately describe specific housing market conditions and characteristics of projects under construction, as required. 15 Prudential Overstated Project Revenue Prudential overstated the project revenue estimated for Preserve at Alafia because it failed to use available up-to-date market data and relied on optimistic indicators which was a violation of requirements. 16 The market study showed that the pricing strategy would offer a superior product, at a slightly higher than gross rent price. Prudential used this methodology and overstated the rents for Alafia, thus overstating the revenue that the property could achieve, which affected the project’s ability to meet its obligations. Prudential priced the units at the top of the market based on optimistic indicators, such as being a mixed use development and having a riverfront location. The mixed use factor was unsupported because it was not certain that the commercial development would be completed. Also, Prudential did not obtain market 14 MAP Guide, Revised 2002, Section 7-5 15 MAP Guide, Revised 2002, Section 7-5 16 MAP Guide, Revised 2002, Section 7-6 10 support to show a demand for riverfront properties in this area or the market’s willingness to pay higher rents in the subject area. Therefore, Prudential should have estimated rents according to the general market demand, as required 17. We recalculated the rents based on the comparable rental property with the highest rent per square foot, which ranged from $1.08 to $1.20, which was similar to rates actually being achieved (see Appendix E). We recalculated the rental income to $4.4 million per year compared to the proposed $5.3 million listed on the loan application dated July 2009, which was nearly $1 million less. During our appraisal review, we determined that the rent premiums of $570,960 per year were overstated. Specifically, the rent premiums, or additional revenue charged, for the river view and floor location were not consistent with site plans and market data. The site plans identified that only 1 building would have river views yet the appraiser calculated additional revenue from river views for multiple buildings. The market did not support the additional revenue for floor location with the exception of the top floor yet the appraiser calculated additional revenue for floors in addition to the top floor. We recalculated the premiums which ranged from $235,000 to $250,000, which is less than half of what was initially projected. During discussions with the current property management, we were able to verify that only one side of one building was charged a premium for river view and only top floor units were charged premiums. We identified significant concessions during the Preserve at Alafia’s lease up phase, including a $338 discount for a 2 bedroom unit, which reduced the rental income to $959 per month. Significant concessions reduced income that affected Alafia’s ability to pay its liabilities, such as the mortgage payments. As of April 2014, the project was receiving significantly lower rents than proposed by Prudential (see Table 3). Table 3 - Proposed rents compared to current rents Rents proposed by Prudential July 2009 Current rents as of April 2014 18 1 bed/1 bath 708 sq. ft. $1,100 757 sq. ft. $855-$905 1 bed/ 1 bath 731 sq. ft. $1,190 784 sq. ft. $885-$995 2 bed/ 2 bath 917 sq. ft. $1,350 980 sq. ft. $955-$1,065 2 bed/ 2 bath 935 sq. ft. $1,275 997 sq. ft. $980-$1,030 2 bed/ 2 bath 1,066 sq. ft. $1,435 1,134 sq. ft. $1,155-$1,265 3 bed/ 2 bath 1,198 sq. ft. $1,595 1,282 sq. ft. $1,409 17 MAP Guide, Revised 2002, Section 7-6b 18 The difference in size was due to Prudential’s use of net rentable square foot. 11 Prudential Failed to Disclose All Debts Related to the Project Prudential did not disclose more than $300,000 in liens against the subject property at the time the firm application was submitted to HUD, as required. 19 HUD staff conducted a lien search and identified the liens approximately 1 month prior to loan closing. On November 3, 2009, HUD corresponded with Prudential regarding the liens that were filed between May 2008 and March 2009, prior to the April 2009 firm commitment, and the liens filed afterwards between May and August 2009. On November 10, 2009, Prudential provided HUD additional information stating that they obtained a clear title and that funds were escrowed for payment of the liens. The credit reports provided by Prudential during the firm application did not include any debt associated with the property. In addition, we identified that the broker had additional roles in relation to the subject property. The broker also acted as a trustee for a $1 million loan to the mortgagors. The firm application submitted by Prudential did not include the additional $1 million debt on the land. In a November 5, 2009 letter, Prudential stated that the $1 million debt was erroneously left off the application but was included in the pre application underwriting narrative. However, the narrative did not disclose that the additional debt was associated with the broker. An invoice, later obtained, revealed that the broker acted as trustee for the $1 million predevelopment loan provided to the mortgagors. Prudential allowed the broker to have multiple roles which was a violation of the MAP Guide. 20 Prudential Failed To Adequately Analyze the Eligibility of the Participants Prudential failed to adequately assess the eligibility of the mortgagor and general contractor, as required. 21 According to the underwriting narrative included with the pre-application submission, the mortgagors and general contractor lacked prior HUD experience with multifamily insured projects. Two of the three mortgagor principals had unrelated experience that dealt with dentistry and corporate finance. Prudential should have mitigated the risk associated with key principals not having prior HUD experience. Based on the loan documents, Prudential did not analyze the financial capacity of the borrowers and mortgagors because the loan was fully funded and would be repaid through project revenue. Prudential should have practiced due diligence and conducted a review of the mortgagors’ financial capacity. If project revenue 19 MAP Guide, Revised 2002, Section 8-1, 12-1-4G, 8-14 20 MAP Guide, Revised 2002, Section 2-3J 21 MAP Guide, Revised 2002, Section 8-3J, 8-3A-4, 8-4A1-2, 8-3F, 8-16, 3-2K 12 was not achieved, which would affect the ability to make mortgage payments, the mortgagors would have been required to input additional capital in order to sustain the project during periods of limited cash flow. Therefore, Prudential should have assessed the financial capacity of the mortgagors. The additional risks involved, such as liens against property, size and amount of project, and lack of previous HUD experience should have also led Prudential to conduct such an assessment. Prudential Did Not Determine Eligibility and Obtain Adequate Support for Prepaid Costs Related to the Project Prudential allowed ineligible and unsupported prepaid costs to be included in the mortgage amount and disbursed to the mortgagors. The mortgagor intended to develop the property into a mixed use development, including commercial, retail, and apartments. However, only the costs related to the apartments should have been included as eligible prepaid costs. We identified several invoices that included unrelated cost to the development of the Preserve at Alafia that were incurred 2 to 3 years prior to initial endorsement. The unrelated charges included commercial development for a full service hotel, travel expenses for lodging and airfare to conventions, meals, and security devices for the owners’ businesses not located at the subject site. We also determined that some of the invoices lacked proper support to show a direct relation to the residential project. As a result, Prudential allowed costs unrelated to the development of the project to be included, which was a violation of National Housing Act. 22 Conclusion Prudential certified that the MAP application for the FHA-insured multifamily loan for Preserve at Alafia was prepared and reviewed in accordance with HUD requirements although it had not properly analyzed the appraisal and market analysis, provided unsupported revenue projections, did not properly analyze the experience and financial capacity of the principals, and did not accurately evaluate prepaid cost and debts associated with the property as required. The MAP approved Lender provided justifications that HUD relied on and failed to exercise prudent underwriting practices during the collapsing economy, and certified that the project was an acceptable risk. HUD placed confidence in Prudential’s integrity and competence, but Prudential failed to follow and implement the MAP Guide and other relevant guidance during the underwriting of and submission to HUD. As a result, HUD approved a 22 National Housing Act (12 U.S.C. 17151(d)(4)) Section 221 13 loan with significant financial and business risk. The owner defaulted on the loan resulting in a loss to HUD of more than $20 million. Recommendations We recommend that the Director of HUD’s Jacksonville Multifamily Hub: 1A. Refer Prudential Huntoon Paige Associates, LTD to the Mortgagee Review Board for appropriate action for violations that caused a more than $20 million loss to HUD’s FHA insurance fund. We also recommend that HUD’s Associate General Counsel for Program Enforcement: 1B. Take appropriate enforcement actions against the responsible parties and pursue civil remedies under the False Claims Act, if legally sufficient, against responsible parties 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 $20,157,329. 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. 14 SCOPE AND METHODOLOGY We conducted the audit from January to August 2014 at Prudential’s offices located in Atlanta, GA, HUD’s Office of Multifamily Development in Jacksonville, FL, and our offices located in Atlanta, GA. The audit covered the period from August 2008 through March 2012, and was adjusted as necessary. The review was conducted based on information contained in the Lenders project files with no reliance being placed on systems used and maintained by the Lender. The records to be obtained from the Lender and reviewed for audit evidence are not computer generated or based, therefore we did not conduct an assessment of data reliability. To accomplish our objective, we reviewed • Organizational charts effective from August 1, 2008 to December 31,2012; • HUD’s MAP Guidebook and other requirements; • Prudential’s policies and procedures that govern the MAP program related to preparing, processing, and submitting the subject application; • List of current and past employees, including job function, date of hire, and date of termination, if applicable, who were directly or indirectly involved with the processing or approval of the loan; • Prudential’s and HUD’s project files related to the Preserve at Alafia, including, but not limited to, correspondence files, emails, third party reports, processing and underwriting files, pre-application submissions, firm applications, servicing files, construction, and default activity; and • General contractor files related to the Preserve at Alafia, including, but not limited to construction plans, contracts, correspondence, and draw requests. We also conducted a site visit of the Preserve at Alafia in April of 2014. We conducted interviews with Prudential’s staff as well as HUD’s staff to better understand the loan details. We conducted a review of the appraisal used in underwriting that identified several deficiencies identified with Prudential’s appraisal which was used to support the findings included in this report. We reviewed 47 percent, or $510,781, of the $1,075,656 in invoices related to prepaid costs submitted by the mortgagors to Prudential. The sample was selected after conducting a risk assessment of the total invoices and by selecting invoices based on the amount and type of services. The mortgagors provided the invoices to support costs prior to initial endorsement that 15 were project related. The primary focus of the review of the invoices was to determine whether the costs were related to the project and included support that the costs were incurred and paid. We determined the loss to the FHA fund to be more than $20 million (the amount of the claim paid $49,667,329 minus the amount of the note sale $29,510,000 = $20,157,329). 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(s). We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. 16 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 objectives: • Policies, procedures and other management controls implemented to ensure that Prudential administered the Preserve at Alafia 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 whole. Accordingly, we do not express an opinion on the effectiveness of Prudential’s internal control. 17 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation Unreasonable or number unnecessary 1/ 1B $20,157,329 1/ Unreasonable or unnecessary costs are those costs not generally recognized as ordinary, prudent, relevant, 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 cost to be the loss to the FHA fund of $20,157,329. We determined the loss to the FHA fund to be more than $20 million (the amount of the claim paid $49,667,329 minus the amount of the note sale $29,510,000 = $20,157,329). 18 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Comment 2 19 Comment 3 Comment 1 Comment 4 Comment 1 20 Comment 5 Comment 6 Comment 7 21 Comment 8 Comment 9 22 Comment 9 Comment 9 23 Comment 9 Comment 10 24 Comment 10 Comment 11 Comment 11 Comment 12 25 Comment 13 Comment 12 Comment 14 Comment 13 26 Comment 15 Comment 8 27 Comment 10 Comment 16 28 Comment 16 Comment 16 Comment 17 29 Comment 17 30 Comment 17 Comment 18 Comment 18 31 Comment 19 32 Comment 19 33 Comment 19 Comment 19 Comment 19 34 Comment 20 Comment 21 35 Comment 22 Comment 23 Comment 24 36 Comment 24 Comment 25 37 Comment 26 38 Comment 1 39 OIG Evaluation of Auditee Comments Comments 1 Prudential’s comments state that the conclusion and recommendation in the draft report are deeply flawed in several respects and that they are all premised on the OIG improperly substituting its own post hoc judgments for the requirements of the MAP Guide and the on-the-ground, real-time judgments of HUD, PHP, and the qualified professionals retained to provide third-party reports and analyses. Prudential also states that the OIG’s draft report also fails to acknowledge HUD’s significant role in the underwriting and approval of the Loan, including the fact that it was approved by HUD. However, Prudential’s response failed to address their roles and responsibility in the underwriting process prior to HUD’s subsequent approval of documents. Based on the MAP Guide, HUD placed confidence, thus relied, on the documents provided by Prudential. In addition, HUD has a process for lender’s to obtain MAP approval and requires the lender to make certifications related to the review and acceptability of the risk for the project, which HUD also relied on. We reviewed the documents Prudential submitted to HUD for final approval and concluded that Prudential incorrectly certified that the loan was prepared and reviewed according to guidelines and HUD relied on the incorrect certifications. Prudential provided several exhibits in its response which will be provided to HUD to review as part of the management decision process. Comment 2 Prudential’s comments state that OIG took 18 months to conduct its review; however, our review initially began on February 27, 2013, and then was suspended on April 11, 2013. We restarted the audit in January 2014 and completed it in September 2014, which was approximately 9 months. In addition, Prudential stated the proposed findings in the draft report raised very different issues than the draft findings initially provided to Prudential in July 2014 and that they were provided limited time to submit their response. However, the draft findings provided in July 2014 were the same issues included in the draft report with more detail. After providing Prudential the draft findings, we informed them that they would be given an opportunity to respond in writing to the findings and their written response would be included in the final draft of the report. Prudential was continuously updated throughout the audit process regarding any changes and additions via email or phone conversations. The draft report was submitted to Prudential via email and FedEx on September 12, 2014 and we received their comments on September 24, 2014. Comment 3 Prudential’s comments state that the principal flaw in the draft report was that the OIG, with the benefit of hindsight, improperly substituted its judgment for the judgments that Prudential and HUD professionals made during the underwriting process on the basis of reports of independent, HUD-approved appraisers and analysts. 40 We reviewed the documents used at the time of underwriting, such as the market study, appraisal, proposed rents, market conditions, and prepaid cost submissions and determined that Prudential did not underwrite the loan for Alafia in accordance with guidelines as stated throughout our report. We only evaluated data available at the time of underwriting to reach the same conclusions. Additional data, such as the default report obtained by Prudential further substantiated our conclusions. Comment 4 Prudential’s comments state that the appraisers and analysts were approved by HUD at the commencement of underwriting and that each third-party appraiser identified in this report has significant multi-family experience. We acknowledge that HUD approved the appraiser and analysts; however, according to the MAP Guide Section 7-2, Prudential was responsible for third party contractors and according to Section 11-1 was responsible for reviewing third party reports to ensure the application and related documents met HUD guidelines. Comment 5 Prudential’s comments state that unforeseen circumstances caused the Project to fail is not evidence of any underwriting errors. However, Prudential was aware that the economy was experiencing market decline throughout the country during the underwriting of this project and due to the uncertainty of continuing market declines, should have taken precaution and practiced prudent underwriting during Alafia’s submission. Prudential was also aware that the submarket for Alafia was achieving significantly lower rents at the time of underwriting. Yet, they allowed Alafia to be priced at the top of the market stating that the location and amenities would insulate them from any changes in market. These additional risks should have been mitigated by Prudential. Prudential also states that for ground-up construction projects like Alafia, circumstances can change during the development and construction process that cause delays or increase costs. However, delays and additional cost may occur with any project which is why Prudential should have assessed the mortgagor’s capacity as required by the MAP Guide. However, Prudential did not assess the mortgagor’s financial capacity to sustain and add capital to the project if delays or additional cost were incurred. Comment 6 Prudential’s comments state among other things, the Project offered an outdoor pool with sundeck, Jacuzzi, BBQ area, car wash area, yoga pavilion, pet bathing and grooming station, volleyball court, walking trails, fishing pier overlooking the Alafia River, clubhouse, fitness center, media center, cyber café, spa facility and Wi-Fi hotspots. However, the comparable properties included in the market study and appraisal used during underwriting also included similar amenities to Alafia. Specifically, Tranquility Lake Apartments offered volleyball courts, gas fire pit, children park, car care center (wash/detail), two dog parks, fully gated community, elevator access in select buildings, full size washer/dryer in units, microwaves, garden 41 tubs, walk in closets, garages and carports, private patio/balcony, lake views, WIFI in clubhouse, fitness center, business center, game room, grilling areas and pool. This property is also located in Riverview, FL, next to a major interstate. Other comparable properties included in the market study and appraisal, located in Alafia’s submarket, Brandon, FL, included similar properties that were located with direct access to the interstate and within walking distance to restaurants, hotels, and shopping that at the time of underwriting was already constructed. These comparables had larger bedroom sizes and lower rents compared to Alafia. In addition, after a review of the site and construction plans dated September 2008 with final approval of May 2009, it was determined that the construction plans and site plans did not include plans for a car wash area, pet and grooming station, volleyball court, cyber café, spa facility other than a hot tub, or Wi-Fi hotspots located throughout the property as stated by Prudential and the appraisal. The current and past managers also confirmed that the only Wi-Fi on the property was around the clubhouse and pool area which is typical for all other apartment complexes in the area. The appraiser also made misleading and unsupported adjustments in the projected income based on unsupported facts between the comparable rentals and the subject property. The appraiser also projected rental premiums for water views, corner units and floors that were not supported by the site and construction plans. Comment 7 Prudential’s comments state that in 2010, as weak economic conditions persisted, HUD recognized the need to make significant changes in the “core underwriting standards” applicable to loans insured under HUD’s multifamily mortgage insurance programs and, on July 6, 2010, HUD issued Mortgagee Letter 2010-21 (commonly referred to as the “Risk Mitigation Notice”). Prudential fails to recognize that the market began to show indications of decline during the underwriting process in 2009 and failed to mitigate the risks involved with the uncertainties related to market changes. The MAP Guide applicable at the time of underwriting addressed the Lenders and the market analyst requirements and responsibilities which were violated as stated within our report. Prudential implies that HUD did not believe the situation was dire enough in 2009 to change the underwriting standards, however this conclusion should not be drawn considering the legal ramifications and cost associated with implementing changes in regulations on projects in process. Comment 8 Prudential contends that the Project was also significantly delayed because a dispute arose well after initial closing between the borrower and the local governmental authority over the construction of an emergency access road and the payment of certain impact fees and that this significantly delayed the availability of units in the market for over seven months, impacting the rent-up velocity of the Project. Prudential states that the unanticipated seven-month delay also caused operating losses far in excess of those projected in the underwriting because the 42 sizing of the initial operating deficit was based on staged occupancy as units became available. The cost of constructing the emergency access road and the additional impact fees further depleted the working capital reserve and consumed funds that could have otherwise been available to fund operating losses. However, new constructions may be subject to unanticipated delays and additional cost which is why a financial capacity assessment is important. However, Prudential does not address that they did not assess the financial capacity of the mortgagors during underwriting. Therefore, Prudential was unable to identify the need for additional funds from the mortgagors in the event that a delay occurred. In addition, Prudential submitted a mortgage increase package to HUD for approval of a $1.2 million mortgage increase because of the additional costs that included more than $500,000 for cost related to impact fees and roadwork. HUD stated this mortgage increase was due to the increase in cost to develop and complete the project. Comment 9 Prudential’s comments state that the OIG concluded that Prudential failed to conduct an adequate review of the appraisal, without even discussing Prudential’s review of the appraisal at all in its draft report. However, the appraisal was not prepared in accordance with HUD regulations. Specifically, the appraisal included misleading and unsupported information that HUD relied on. These issues were also addressed in the default report conducted by a third party reviewer hired by Prudential. In addition, the appraisal contained significant flaws not addressed by Prudential. Prudential only stated that the appraisers had significant experience appraising properties underwritten for FHA-insured loans and did not address their responsibility over the third party contractors hired. Comment 10 Prudential’s comments state that the appraisal satisfied its obligations of the MAP Guide and that the draft report failed to acknowledge the requirements set forth in Section 7.4 of the MAP Guide or to demonstrate how Prudential allegedly failed to satisfy those requirements. The reference for MAP 7-4 is footnote 9 of this report. The appraisal failed to adequately describe the site or include accurate photos of the site, as required by the MAP Guide. The aerial photo included land parcels for 39.96 acres with road frontage along Gibsonton Road, which were not the parcels for the apartments and only included 26.62 acres. The legal description and plat of the 26.62 acres clearly indicates that the phase two site consisting of 26.62 acres had no means of ingress and egress. This was also shown on a survey completed by Cumbey and Fair, Inc. dated October 31, 2008. Adequate access to the 26.62 acres was not obtained until April 8, 2009, when an easement for a private street located off of Gibsonton Road was conveyed to Alafia Apartments Complex, LLC. The surveys and site plans for the apartments, including the survey provided by Prudential with this response, never included these parcels. Prudential states “Prudential and HUD knew that it did not include all of the land” which we 43 determined to be inconsistent with the photo in the appraisal that includes all of the land which is also misleading. Prudential’s comments also state that, in conducting a post-default review of the Project, it was found that the appraisal generally satisfied the reporting requirements of the USPAP standards; however, the default report addressed some of the same issues we identified. Comment 11 Prudential’s comments state that the OIG seeks to substitute its own judgment, developed 5 years after the fact, with full knowledge of how the Project actually performed, for the 2009 opinion of the appraiser and that the OIG then concludes that the appraisal and Prudential’s review of the appraisal were insufficient because the OIG disagrees with the appraiser’s judgments. Prudential further states that the OIG alleges that the appraisal overvalued the land by considering inappropriate comparables, including improper adjustments, and relying on inaccurate site information. Prudential also states that the OIG objects to the inclusion of one of the comparable properties identified by the appraiser, and argues that the inclusion of this comparable improperly inflates the value of the Alafia land by some $4 million. We reviewed the appraisal used at the time of underwriting, which was the data available during underwriting and not 5 years later. We identified a significant outlier that allowed the land value to be overstated by more than $4 million. This outlier was included in the appraisal and was an outlier at the time of the appraisal. Comment 12 Prudential’s comments state that the concerns regarding the land value expressed in the draft report are the same concerns that were raised by HUD during the processing and underwriting of the loan. Prudential further states that those questions were answered to HUD’s satisfaction, yet the OIG seeks to reopen the same questions and substitute its judgment (with the benefit of hindsight) for that of two HUD-approved appraisers, Prudential and HUD. We reviewed the responses provided to HUD by both Prudential and the appraiser including the additional appraisal submitted after HUD questioned the same issues we questioned. These responses, which HUD relied on, were unsupported and misleading. Comment 13 Prudential’s comments state that the OIG cites two additional, comparable sales and asserts that “Prudential’s appraiser disregarded various indicators of the market downturn and projected land value on the upper end of the scale,” leading the OIG to “recalculate” the land value to $6.1 million and that this “recalculation” is inappropriate for several reasons. Prudential states first, Prudential, HUD, and the two HUD-approved appraisers all considered the market downturn when valuing the land at $10.5 million, a price $4.4 million less 44 than the purchase price paid for the land in an arms-length transaction that occurred less than one year earlier. However, the last arm’s length transaction occurred between 2005 and 2006 with Alafia River Property Group, LLLP, which was more than 3 years earlier at a time when the real estate market was at its peak. The purchase price in 2005 and January 2006 had little if any relevance to the site value in March 2009. Alafia River Property Group, LLLP actually conveyed the 26.62 acres plus an additional .34 acre to Alafia Apartments Complex, LLC on May 22, 2008, with a public disclosed consideration of $8,273,469 which is less than the $10,500,000. We also researched each comparable sale used by the appraiser and contacted realtors and other appraisers in the area for additional sales, as well as information related to the multifamily market prior to the effective date of the appraisal. Our review included comparable sales used by the appraiser, as well as additional sales in determining if the appraised value was supported by market reaction and whether or not the “AS IS” site value was credible based on facts and market conditions as of the effective date of the appraisal. Prudential also states that it was entirely reasonable for the appraisers to value the land at the “upper end of the scale” in light of its unique location, which included not only the views, but exceptionally good access to Interstate 75, the major highway in the area. However, the comparable properties included in the appraisal and market study, such as Tranquility Lake, The Addison, and Courtney Trace Apartments, had the same access to Interstate 75. These comparables had larger bedroom sizes and lower rents in comparison to Alafia. Also, based on facts related to the site, market conditions, comparable sales and other information obtained during the review of the “AS IS” site value of $10,500,000 as of March 4, 2009, were not supported. Comment 14 Prudential’s comments state that the OIG failed to cite USPAP Standard 3, which applies to the reviewer. Therefore, we included the reference for the Uniform Standards of Professional Appraisal Practice (USPAP) Standard 3 in footnote 1. This criterion was used in our review despite being omitted from the footnote; therefore, the conclusions drawn did not change. Comment 15 Prudential’s comments state that the OIG also asserts that the appraiser’s adjustments based on the Project’s river location were inappropriate because they did not accurately reflect the market, again without disclosing the methodology it used in reaching this conclusion. However, we determined that the appraiser’s adjustments were not appropriate based on market conditions at the time of underwriting, and support was not included in the appraisal for these adjustments as disclosed in our report. 45 Comment 16 Prudential’s comments state that the OIG’s assertions that the Project did not have adequate entrance and exit access, utilities were not provided to the site and that the site contained wetlands and potential species that were required to be removed by the County, are inaccurate. However, as stated in the report, the site did not have adequate entrance and exit access. The Master Water and Sewer Plan developed by Cumbey and Fair, Inc. dated August 2008 clearly indicates that utilities are located along Gibsonton Drive and that utilities were proposed to be run from Gibsonton Drive to the 26.62 acre site. The legal description and plat of the 26.62 acres clearly indicates that the Phase Two site consisting of 26.62 acres and had no means of ingress and egress. This was also shown on a survey completed by Cumbey and Fair, Inc. dated October 31, 2008. In addition, the lack of road frontage along a major road such as Gibsonton Road would have affected the land value. The comparable land sales used by the appraiser included such road frontage. Prudential also states in its comments that the wetlands did not in any way interfere with the development of the site, nor were there any material costs associated with removal of the species; in fact the existence of wetlands and the presence of animals is consistent with, and part of the attractiveness of, a heavily- wooded riverfront location. However, the removal of species from the property was required by the County, which also incurred additional cost. Prudential further states that the Lender Quality and Monitoring Division Default report obtained by Prudential noted that the underwriting narrative did not address the statement in the appraisal that current market rents may not allow for a cost feasible development at the time and that such statement in the appraisal was not, as the OIG asserts, critical to the mortgagor ability to sustain the project and a violation of the MAP Guide. Contrary to Prudential’s comments, the statement in the default report conducted by the third party reviewer hired by Prudential is critical and indicates that the project may not receive the projected revenue, thus making the entire project not feasible, especially, if the mortgagor’s does not have additional capital to put towards the project in the event the project revenue is not sufficient to make the mortgage payments. Comment 17 Prudential’s comments state that its market analysis was more than adequate. However, the market study was not adequate and supported as stated in our report. We identified various instances where the market study did not follow guidelines, such as failing to describe the characteristics of the market at the time of underwriting and the indicators of the market decline as well as not including statements regarding stalled projects due to the market conditions at the time. Prudential also states that the OIG fails to acknowledge that the market analysis was conducted by a qualified market analyst using data from the same area as the Project. However, Prudential failed to recognize that they certified that all documents submitted to HUD was adequate and reviewed according to 46 guidelines, which HUD relied on when making its certification. Prudential failed to address their responsibility for the third party market analyst. The market analyst also made a certification that the study was completed according to guidelines which was not correct. Comment 18 Prudential’s comments state that the OIG incorrectly asserts that the Market Study was supported by outdated information and that the OIG fails to note that the Market Study discusses both market trends and projections. However, we acknowledge that the market study included trend analysis of projected future outcomes; but, the market study failed to use statistics available to show current market decline, such as unemployment rates and building permits. Prudential states that despite OIG’s seeming contention to the contrary, the MAP Guide did not require that the market analysis be updated in 2009 in conjunction with the firm commitment application. However, we cited various requirements from the MAP Guide which states the study must adequately describe the market area and market conditions. The market study failed to assess and make projections and trends to include the uncertainty of continuing market decline. The default report conducted by the third party reviewer hired by Prudential also addressed the market conditions stating that Alafia’s location and amenities was not recession proof. In addition, the appraisal dated March 2009 did not include statistics to show the greater decline in the market. By February 2009, the unemployment rates more than doubled in the subject area and the market decline was more evident at the time of this appraisal but did not include data to give a clear picture of the present state of the economy. Comment 19 Prudential’s comments state that there was nothing incorrect about the process that Prudential followed to develop its estimates and that their underwriting of potential Project revenue was consistent with the MAP Guide and was appropriately based on both the rents approved by HUD in the invitation Letter and the Novogradac appraisal. We do not agree with Prudential’s comment. Despite the declining market, Prudential and the market analyst rationalize that the project would sustain throughout these market conditions at higher rents. However, Prudential and the third party contractors failed to include in its assessment the declining market conditions and still priced this project at the top of the market. Prudential also failed to address its responsibility for the third party contractors used during the underwriting process. It further failed to price the project at conservative levels. This was also confirmed during the lease up phase when significant concessions were provided and rents were decreased. Prudential comments state that using its own (unstated) assumptions, apparently developed from data it obtained in 2014 (five years after the actual underwriting), the OIG seems to have performed its own underwriting, and determined in the draft report that the correct estimate of Project income should have been $4.4 47 million per year and the rent premiums should only have been $235,000 to $250,000 per year. Prudential further states that the draft report does not provide the basis for the OIG’s calculations and assumed that such calculations are based on the current rents as of April 2014 reported in Table 3 of the draft report. However, we did not use data from 2014 to recalculate the rents including rent premiums. Instead we used the same files, reports, and data; such as site plans, appraisals, market study that was used and available at the time of underwriting. In addition, our report documents how the project rents were recalculated. We also included an additional table, Appendix E, to the report to further address Prudential’s comment. Comment 20 Prudential’s comments state that all debt related to the Project was fully disclosed to HUD before it issued the firm commitment. However, we determined that Prudential did not disclose all debts related to the project. The default occurred because the mortgage payments were not made due to lack of adequate project revenue. The liens, as discussed in comment 21, also identified additional debt owed by the mortgagors that would require additional funds for payoff in order for the loan to proceed to initial endorsement. Any additional funds owed by the mortgagors, including those used to pay off liens and additional loans could have been used to support the project. The mortgagors were unable to put additional capital into the project during the periods of inadequate revenue and Prudential failed to assess the mortgagor’s financial capacity during the underwriting process despite the declining market and additional debt owed by the mortgagors. Comment 21 Prudential’s comments state well after the submission of the mortgage insurance application, Prudential became aware of the existence of several liens that had been filed against the Project. Prudential also state these liens were not reflected in the title evidence, credit reports or public records searches received or conducted by Prudential prior to submission of the mortgage insurance application and did not any have information about the liens that it could have disclosed to HUD. However HUD identified the same liens during a public records search and therefore Prudential should have been aware of the liens prior to submission of its mortgage insurance application and the initial endorsement. Comment 22 Prudential’s comments state that they did not agree with our assertion that the broker had additional roles in relation to the subject property. Yet following this statement, Prudential states that it is true that the principal of the broker did act as trustee with respect to the pre-development loan. According to this comment made by Prudential, they agreed that the broker had an additional role. Prudential further states that the OIG made an erroneous assumption that the broker received some benefit from the $1 million loan. However, we did not state that the broker received some benefit from this loan as stated by Prudential, only 48 that the broker acted as the trustee, which allowed additional roles for the broker. According to the MAP Guide, these additional roles are not allowed. Comment 23 Prudential’s comments state that the OIG concluded, erroneously, that an affiliate company owned by the broker also obtained a fee for providing builder’s risk insurance for the Project at closing. Based on additional documents provided by Prudential, we deleted the statement regarding the builders risk insurance from the report. Comment 24 Prudential’s comments state that the OIG incorrectly indicates that it failed to adequately assess the eligibility of the mortgagor and general contractor. However, Prudential failed to recognize that they did not assess the mortgagor’s financial capacity, as required by MAP Guide Section 8-3A4. In addition the MAP Guide, Section 8-4 addresses the purpose of the financial capacity assessment including details of the review. In addition, the MAP Guide requires that all principals in the proposed transaction must submit detailed information regarding previous participation in governmental housing transactions in order to be approved by HUD for participation in any program of mortgage insurance. The underwriting narrative included with the pre-application did not document prior HUD experience. Also, we contacted one of the mortgagors who stated that not understanding or knowing the HUD guidelines made this process more difficult, which was something that should have been mitigated by Prudential. Comment 25 Prudential’s comments state that working closely with HUD, it properly determined the eligibility of, and obtained adequate support for, prepaid costs related to the Project. Prudential also states that any incorrect payments were small in amount and would have had no bearing on the mortgage default. However, Prudential did not obtain adequate support and inappropriately determined the eligibility of prepaid cost. The line item for organizational cost included more than $1 million in prepaid cost. The unrelated and unsupported prepaid costs diverted funds away from the project and allowed costs to be inappropriately reimbursed by mortgage proceeds. Based on the National Housing Act all cost must be related to the development of the project. Some invoices clearly stated that the services were for the commercial and hotel development, while others do not include adequate information to show a direct relation to the project, yet Prudential did not to address these costs. Comment 26 Prudential’s comments state that the OIG considered the wrong invoices. We compared Prudential’s spreadsheet provided with its response to the spreadsheet we used for our assessment of questioned costs. We identified that only 7 of the 70 invoices included within our sample were subsequently removed by Prudential. The seven invoices did not include costs charged to the project and represented a small amount. We selected a sample of invoices from the two binders Prudential submitted to HUD that included Prudential’s cost allocation of 49 prepaid costs. In addition, these cost were included in the initial draw request as supported by the initial draw submission line item for organization fees. Prudential also states that HUD determined the percentage allocation and that OIG inappropriately made a determination of how cost should be allocated. However, we contacted the vendors listed on the invoices to determine how the costs associated with the entire project should be allocated, which we presented to Prudential when the costs were questioned. HUD did not determine the cost allocation of 73 percent; this was determined by Prudential and submitted to HUD for approval. HUD relied on Prudential’s allocation and justifications which was unsupported. Prudential further states that the OIG ignores that HUD approved the prepaid expenses and the related draw request. However, HUD informed us that Prudential provided two different submissions. HUD rejected some invoices within the first submission and Prudential provided a second submission that HUD also disallowed cost. It was stated that Prudential should have included only approved invoices and HUD directly informed them that only invoices directly related to the project and those referencing the apartments on the invoice would be approved. 50 Appendix C ADDITIONAL LAND SALES Sale price/ Distance from Date of square. Sale subject Location sale foot price/unit Use of land property 4409 Tuscany Glen Court, Brandon , FL 3/11/2008 $ 7.64 $ 20,131 Multifamily 6 miles 11106 Lakewood Point Drive, Seffner, FL 7/3/2008 $ 2.74 $ 13,794 Multifamily 10 miles 51 Appendix D AVERAGE RENT PER SQUARE FOOT Average Average rent Year square Average per square Properties built foot rent foot THE PRESERVE AT ALAFIA 2009 984 $ 1,446.00 $ 1.49 THE ENCLAVE @ TRANQUILITY LAKE 2008 975 $ 1,092.00 $ 1.13 THE ADDISON 2007 1,176 $ 1,338.00 $ 1.14 COURTNEY TRACE 2006 1,019 $ 1,106.00 $ 1.09 ESTATES AT TUSCANY RIDGE (Currently Camden Visconti) 2006 1,204 $ 1,309.00 $ 1.09 52 Appendix E Recalculated Rents Square Rent foot of per Alafia square Adjusted units foot rents Number of units Rental revenue 757 $ 1.15 $ 870.55 56 $ 48,750.80 784 $ 1.20 $ 940.80 96 $ 90,316.80 952 $ 1.08 $1,028.16 103 $ 105,900.48 997 $ 1.10 $1,096.70 16 $ 17,547.20 1134 $ 1.10 $1,247.40 72 $ 89,812.80 1282 $ 1.10 $1,410.20 8 $ 11,281.60 Monthly projected rental revenue $ 363,609.68 Recalculated annual rental revenue $ 4,363,316.16 Prudential’s estimate per July 2009 application $ (5,338,140.00) Difference between recalculation and Prudential estimates (excluding other revenue) $ 974,823.84 53
Prudential Huntoon Paige Associates, LTD Did Not Underwrite and Process a $49 Million Loan in Accordance With HUD Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2014-09-30.
Below is a raw (and likely hideous) rendition of the original report. (PDF)