oversight

University Village Took Distributions Without Being in a Surplus-Cash Position or Having Prior HUD Approval

Published by the Department of Housing and Urban Development, Office of Inspector General on 2016-09-28.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

    University Village, LLC, Orem, UT
                Section 223(f) Multifamily Program




Office of Audit, Region 8          Audit Report Number: 2016-DE-1004
Denver, CO                                         September 28, 2016
To:            Tom Azumbrado, Regional Director, West Multifamily Region, 9AHMLAP


               //signed//
From:          Ronald J. Hosking, Regional Inspector General for Audit, 8AGA
Subject:       University Village Took Distributions Without Being in a Surplus-Cash Position
               or Having Prior HUD Approval


Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of University Village, LLC, Orem, Utah multifamily
section 223(f) program.
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
913-551-5870.
                    Audit Report Number: 2016-DE-1004
                    Date: September 28, 2016

                    University Village Took Distributions Without Being in a Surplus-Cash
                    Position or Having Prior HUD Approval




Highlights

What We Audited and Why
We audited University Village Apartments in Orem, UT because the U.S. Department of
Housing and Urban Development (HUD) had found ineligible withdrawals and substandard
physical conditions at the property. Our objective was to determine whether University Village
complied with its HUD multifamily Federal Housing Administration regulatory agreement when
taking distributions.

What We Found
University Village took unauthorized distributions without being in a surplus-cash position or
having prior HUD approval. It took nine unauthorized distributions from April 2014 to March
2016 totaling more than $305,000.

What We Recommend
We recommend that the Director of HUD’s Denver Office of Multifamily Housing Programs
require University Village to (1) repay the project $305,351 for the unauthorized distributions
and (2) develop and implement policies for owner distributions to ensure that it complies with its
regulatory agreement.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................4
         Finding: University Village Took Unauthorized Distributions ................................... 4

Scope and Methodology ...........................................................................................7

Internal Controls ......................................................................................................8

Appendixes ................................................................................................................9
              A. Schedule of Questioned Costs ............................................................................... 9

              B. Auditee Comments and OIG’s Evaluation ........................................................ 10




                                                              2
Background and Objective
University Village Apartments is an 83-unit, three-story family apartment project located at 1270
South Sandhill Road in Orem, UT, and owned by University Village, LLC. The company has two
managing members who have an equal share in the ownership of the property. The managing
members also own Stonecrest Group, LLC, which manages the property and the managing
member’s other non-Federal Housing Administration (FHA)-insured properties. FHA insurance
fund insures lenders against mortgage default loss and facilitates the purchase or refinancing of
existing multifamily housing. The program allows for long- term mortgages (up to 35 years) that
can be financed with Government National Mortgage Association (GNMA) Mortgage-Backed
Securities. This eligibility for purchase in the secondary mortgage market improves the availability
of loan funds and permits more favorable interest rates.
The owners originally purchased the subject property in August
2005 for $4.5 million. In May 2012, the company received an
FHA section 223(f) cash-out refinance loan in the amount of
$4.52 million. During the loan closing, the managing members
executed a regulatory agreement with the U.S. Department of
Housing and Urban Development (HUD) in which they agreed
to be bound by the terms and conditions of the regulatory
agreement for a mortgage loan insured by FHA. These terms
include certain restrictions on taking owner distributions from
project funds.




One of the regulatory agreement restrictions states the project can only take distributions at certain
times of the year, and only after a HUD-designed computation shows that there is ‘extra’ cash that
can be taken as distributions, and only up to that calculated amount.

Our audit objective was to determine whether University Village complied with its HUD
multifamily FHA regulatory agreement when taking distributions.


                                                   3
Results of Audit

Finding : University Village Took Unauthorized Distributions
University Village took distributions without being in a surplus-cash position or having prior
HUD approval. This condition occurred because University Village lacked controls over the
distribution of surplus cash and did not fully understand the rules for taking surplus cash. As a
result, more than $305,000 was unavailable to help maintain the property, which recently failed a
HUD physical inspection.

University Village Took Unauthorized Distributions
University Village took distributions without being in a surplus-cash position or having prior
HUD approval. According to University Village’s regulatory agreement with HUD,

   1. Any distributions of funds require prior written approval from HUD.
   2. HUD allows distributions of project funds only after the end of a semiannual or annual
      fiscal period and only in an accounting period immediately following the computation of
      surplus cash.

On October 26, 2015, HUD’s Departmental Enforcement Center notified University Village that
it had taken $41,898 in unauthorized distributions. On November 5, 2015, University Village
paid HUD back its project funds for the unauthorized distributions identified. However, we
identified nine additional unauthorized distributions to the owners or to a non-project bank
account totaling more than $305,000. The regulatory agreement requires that University Village
take distributions only from surplus cash and deposit all funds into an account in the project’s
name. University Village deposited the unauthorized distributions in the Stonecrest Group
money market account instead of the dedicated University Village project account.

Table 1 outlines the dates and amounts of the distributions:

Table 1

              Date                 Amount                         Description

          4/10/2014                 $8,380               Distribution - for owner note
          5/12/2014                  8,380               Distribution - for owner note
          12/17/2014                10,000                 Distribution - Stonecrest
          4/13/2015                 30,000                Transfer to Money Market
          5/26/2015                 37,195               Distribution - for owner note
          7/15/2015                 24,396                        Distribution
          7/15/2015                 42,000                        Distribution



                                                 4
           12/10/2015               45,000                  Transfer to Money Market
            3/16/2016               100,000                 Transfer to Money Market
             Total                  305,351

For the distributions listed above, University Village did not complete the required surplus-cash
computation or obtain prior HUD approval before taking the distributions. HUD’s Real Estate
Assessment Center (REAC) reviews the annual computation of surplus cash and may require
additional information or corrections before approving distributions. Table 2 shows the REAC
reviewed annual surplus-cash computation from 2012 to 2015 for University Village.

Table 2

              Computation year                                Surplus cash (deficiency)

                      2012                                             $(56,121)
                      2013                                              (39,605)
                      2014                                              (38,459)
                      2015                                               73,860



From 2012 to 2014, University Village was in a negative-cash surplus position; therefore, it
could not take distributions. At the end of 2015, University Village was in a surplus-cash
position, which normally would allow it to make a distribution in 2016. However, it could not
take distributions until it repaid all of its unauthorized distributions from previous years.

University Village Lacked Controls Over the Distribution of Surplus Cash
University Village lacked controls over the distribution of its surplus cash. Specifically, it lacked
controls to ensure that it completed the required surplus-cash computations before making owner
distributions and made owner distributions only when in a surplus-cash position. The project
accountant stated that University Village was generally aware of the distribution requirements in
the regulatory agreement but did not fully understand the rules for taking surplus cash.

Project Funds Were Unavailable for Required Repairs
More than $305,000 was unavailable to help maintain the property, which recently failed a HUD
physical inspection. On June 19, 2014, REAC assessed an inspection score of “68c*.” Any
score below 79 requires an annual inspection. The “c” in the score represents at least one life-
threatening health and safety deficiency, while the “*” denotes at least one inoperable smoke
detector. HUD performed another inspection of the property on August 6, 2015, and assessed an
inspection score of “42c*.” All inspections with a score of 59 and below are subject to referral
to HUD’s Departmental Enforcement Center (DEC). The DEC manages the day-to-day recovery
and enforcement strategies for selected high-risk properties. They work directly with owner to
achieve compliance with property physical assessement requirements. University Village could
have used the $305,000 in unauthorized distributions to address maintainance difficiencies
identified by HUD.


                                                  5
Finally, if the owners continue to not comply with the surplus cash distribution requirements
outlined in the regulatory agreement, then they are subject to criminal penalities, civil liability,
and adminstrative sanctions.
Recommendations
We recommend that the Director of HUD’s Denver Office of Multifamily Housing Programs
require University Village to
       1A.     Repay the project $305,351 for the unauthorized distributions from non-project
               funds.
       1B.     Develop and implement policies for owner distributions to ensure compliance
               with its regulatory agreement.




                                                   6
Scope and Methodology
Our audit work covered University Village, LLC’s records from 2012 to 2016. We performed
our work between May and June 2016 at the management office located at 1800 North State
Street, Provo, UT.

To accomplish our objective, we

      Reviewed background information and applicable laws and regulations.
      Reviewed various reports and documents to determine the financial and physical unit
       conditions of the project. The reports and documents included information contained in
       HUD’s Real Estate Management System and documents maintained by the multifamily
       project manager assigned to monitor the project.
      Performed a walk-through inspection of the exterior of the project and reviewed HUD
       inspection reports to determine the project’s overall physical condition.
      Reviewed the reserves for replacement account.
      Reviewed the FHA section 223(f) cash-out refinance loan documentation.
      Reviewed all bank statements associated with the project from 2012 to 2016.
      Reviewed the 2012, 2013, and 2014 audited financial statements.
      Interviewed the managing member and chief financial officer of University Village, LLC.
      Interviewed HUD staff responsible for the program.

Using University Village, LLC’s bank records from May 2012 to March 2016, we identified a
total of 94 financial transfers to and from the project account totaling $1.87 million. We
determined that the greatest risk for unauthorized distribution by the auditee would be in those
financial transactions that were greater than or equal to $1,500. We reviewed the 63 financial
transfers meeting those criteria. The 63 transactions totaled $1.73 million, or 96 percent of all
transfers. We did not use statistical sampling due to the small number of transactions; therefore,
the results apply only to the 63 financial transfers reviewed.
We did not rely on computer-generated data as audit evidence or to support our audit
conclusions. We based all of our conclusions on source documentation reviewed during the
audit. We also used source documentation obtained from HUD and the auditee for background
information purposes.
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 objective.



                                                 7
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:

   Controls over compliance with Regulatory Agreement that have been implemented to
    reasonably ensure that purchasing activities, record keeping, payments to vendors, and
    income-reporting activities comply with applicable laws and regulations.

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.
Significant Deficiency
Based on our review, we believe that the following item is a significant deficiency:
   University Village did not have controls to ensure that distributions complied with applicable
    laws and regulations.




                                                  8
Appendixes

Appendix A


                             Schedule of Questioned Costs
                            Recommendation
                                              Ineligible 1/A
                                number
                                    1A            $305,353
                                  Totals           305,353


1/   Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
     that the auditor believes are not allowable by law; contract; or Federal, State, or local
     policies or regulations.




                                             9
Appendix B
             Auditee Comments and OIG’s Evaluation



Ref to OIG    Auditee Comments
Evaluation




Comment 1


Comment 2
Comment 3
Comment 4


Comment 5




Comment 6




                               10
                          OIG Evaluation of Auditee Comments


Comment 1   The regulatory agreement states that the project can take distributions only from
            surplus cash. Making payments on an owner’s note is a distribution and therefore
            not authorized because the project was not in a surplus cash position until 2015.
Comment 2   The regulatory agreement requires the project to deposit its funds into a
            University Village account. Although the project provided a list of bank accounts
            during the underwriting process, it did not have approval to deposit project funds
            into a non-project account. Transferring or depositing funds into the Stonecrest
            Group account from the project is considered a distribution.
Comment 3   During our review, we found that the $10,000 was a distribution taken from the
            project account. University Village can work with HUD to show this went to
            authorized project expenses.
Comment 4   As stated in the finding, the project cannot take distributions until it has repaid all
            of its unauthorized distributions from previous years. While the project might not
            have realized it had outstanding unauthorized distributions, it is the project’s
            responsibility to ensure compliance with its regulatory agreement. If HUD later
            determines the project made unauthorized distributions prior to the surplus cash
            distribution, the owners must repay the prior unauthorized distributions and then
            recalculate its surplus cash position.
Comment 5   University Village can work with HUD to clear the physical inspection
            discrepancies.
Comment 6   It is our stance that if the project had not taken the unauthorized distributions it
            could have used those funds to better maintain the project.




                                               11