oversight

HUD Did Not Ensure That Lenders Verified That FHA-Insured Properties in Flint, MI, Had Safe Water

Published by the Department of Housing and Urban Development, Office of Inspector General on 2016-07-29.

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

       Office of Single Family Housing,
               Washington, DC
          Oversight of FHA-Insured Loans in Flint, MI




Office of Audit, Region 3        Audit Report Number: 2016-PH-0003
Philadelphia, PA                                       July 29, 2016
To:            Robert E. Mulderig, Acting Deputy Assistant Secretary for Single Family
               Housing, HU
               //signed//
From:          David E. Kasperowicz, Regional Inspector General for Audit, Philadelphia
               Region, 3AGA
Subject:       HUD Did Not Ensure That Lenders Verified That FHA-Insured Properties in
               Flint, MI, Had Safe Water



Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of HUD’s oversight of Federal Housing
Administration (FHA)-insured loans in Flint, MI.

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
215-430-6734.
                    Audit Report Number: 2016-PH-0003
                    Date: July 29, 2016

                    HUD Did Not Ensure That Lenders Verified That FHA-Insured Properties in
                    Flint, MI, Had Safe Water




Highlights

What We Audited and Why
We audited the U.S. Department of Housing and Urban Development’s (HUD) oversight of
Federal Housing Administration (FHA)-insured loans in Flint, MI. We conducted the audit
based on recent news reports that identified high levels of lead contamination and because HUD
had insured loans on properties in Flint that closed after the City of Flint began using the Flint
River as its water source in April 2014, including 144 loans with unpaid balances totaling $11.2
million that were endorsed after the health department first declared a public health emergency
on October 1, 2015. Our audit objective was to determine whether HUD ensured that properties in
Flint, MI, that were approved for FHA mortgage insurance had a continuing and sufficient supply of
safe and potable water.

What We Found
HUD did not ensure that lenders verified that properties in Flint, MI, that were approved for
FHA mortgage insurance had a continuing and sufficient supply of safe and potable water.
Specifically, 11 of the 17 files reviewed did not contain evidence of water testing to show that
the water was safe, and subsequent testing performed by the State of Michigan showed that at
least 4 of the 11 properties had lead and copper levels above the Environmental Protection
Agency’s action levels. This condition occurred because HUD’s existing controls were not
designed to specifically detect whether the loan files contained evidence of water testing. The
issues identified represent an ongoing safety concern. Further, HUD and homeowners also face
an increased risk of loss if property values decrease due to the water safety issues, and
homeowners may not have sufficient resources needed to attain and maintain safe water.

What We Recommend
We recommend that HUD direct the applicable lenders to provide evidence showing that the
properties had a safe and potable water source at the time the loans closed and were endorsed, or,
if the lenders cannot provide this evidence, direct them to perform water testing and any
necessary remediation to ensure that the properties currently have a safe and potable water
source, or indemnify HUD against any future loss, thereby putting up to $10.8 million to better
use. We also recommend that HUD take appropriate administrative action against the parties
involved for any cases where they did not take appropriate steps to ensure that properties in Flint,
MI, had a safe and potable water source, and improve its controls to ensure that it does not insure
additional loans in Flint for properties that do not have a safe and potable water source.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................5
         Finding: HUD Did Not Ensure That Lenders Verified That FHA-Insured
         Properties in Flint Had Safe Water................................................................................. 5

Scope and Methodology .........................................................................................10

Internal Controls ....................................................................................................12

Appendixes ..............................................................................................................13
         A. Schedule of Funds To Be Put to Better Use ............................................................ 13

         B. Auditee Comments and OIG’s Evaluation ............................................................. 14




                                                             2
Background and Objective
The Federal Housing Administration (FHA) provides mortgage insurance on loans made by
FHA-approved lenders throughout the United States and its territories. It is the largest insurer of
mortgages in the world, insuring more than 34 million properties since its inception in 1934. The
FHA became part of the U.S. Department of Housing and Urban Development (HUD) in 1965.
HUD’s single-family housing programs include mortgage insurance on loans to purchase or
refinance new or existing homes. Because HUD insures the loan, lenders are able to offer
borrowers low downpayments and low closing costs.

To be eligible for an FHA-insured loan, borrowers must meet certain credit qualifications.
Additionally, the properties must meet minimum property requirements. HUD Handbook
4000.1, section II, paragraph A.3.a.ii(F) 1 establishes standards and provides guidance on
minimum property requirements, including that properties have a sufficient supply of safe and
potable water. 2 Further, regulations at 24 CFR (Code of Federal Regulations) 200.926d(f) state
that properties must contain a safe water supply and 24 CFR 203.52 discuss requirements for
loans on properties where public water systems do not meet basic requirements.

The Safe Drinking Water Act requires the Environmental Protection Agency (EPA) to determine
levels of contaminants in drinking water at which no adverse health effects are likely to occur.
The EPA has set the maximum contaminant level goal for lead in drinking water at zero because
lead is a toxic metal that can be harmful to human health even at low exposure levels. It has set
the maximum contaminant level goal for copper at 1,300 ppb (parts per billion). The EPA also
sets enforceable standards known as action levels for lead and copper, which are the highest
levels of the contaminants allowed in drinking water. Regulations at 40 CFR 141.80(c) 3 state
that the action levels are exceeded if the concentration of lead or copper in more than 10 percent
of tap water samples collected is greater than 15 ppb of lead 4 or 1,300 ppb of copper. According
to the EPA, exposure to lead in drinking water may cause cardiovascular issues, increased blood
pressure, decreased kidney function, and reproductive problems in adults. Infants and children
are at risk of behavior and learning problems, lower IQ’s, hyperactivity, slowed growth, hearing
problems, and anemia. Further, both the EPA and the Centers for Disease Control and
Prevention agree that there is no known safe level of lead in a child’s blood. Exposure to copper
in drinking water may cause gastrointestinal distress as well as liver or kidney damage.

Recent news reports have identified water quality issues across the country, including high levels
of lead in Flint, MI. The contamination in Flint is believed to be a result of the City of Flint’s
switching its water supply to the Flint River on April 25, 2014, which it did as a cost-saving

1
    HUD Handbook 4000.1 was implemented on September 14, 2015. This handbook superseded Appendix K of
    HUD Handbook 4910.1, which contained the same guidance.
2
    Potable water is water that is suitable for drinking.
3
    The EPA publishes the action levels in 40 CFR 141.80(c).
4
    While the EPA acknowledges that lead is harmful at low exposure levels and sets the maximum contaminant
    goal at zero, it also sets an action level that is enforceable.


                                                       3
measure. While residents began to complain about the water quality by June 2014 and reported
health issues such as rashes, hair loss, and slowed growth in children, officials from the City and
the Michigan Department of Environmental Quality stated that the water was in compliance with
Federal and State standards as recently as September 2015. However, on October 1, 2015, the
Genesee County Health Department declared a public health emergency and issued a “do not
drink” advisory. Since then, several additional emergency declarations have been made,
including declarations by the City on December 14, 2015, the Genesee County Commission on
January 4, 2016, the State of Michigan on January 5, 2016, and President Obama on January 16,
2016.

As of March 25, 2016, the State had tested 16,955 water samples from residential properties. Of
the 16,955 samples, 1,305 samples had tested above the EPA action level for lead, and 78
samples had tested above the EPA action level for copper. The table below shows the lead
testing results from the State.

                                                  Number of                 Percentage of
                         Lead ppb
                                               samples collected          samples collected
                               0                       8,465                     49.93
                             1-15                      7,185                     42.37
                            16-50                       829                       4.89
                           51-149                       292                       1.72
                           > = 150                      184                       1.09
                           Totals                     16,955                       100

As of March 31, 2016, HUD had more than 13,362 actively insured loans in Genesee County,
including 4,701 loans for properties located in Flint. 5 Since April 25, 2014, when the City
switched its water source to the Flint River, HUD had endorsed 616 6 loans for properties in Flint
with unpaid balances totaling $45.8 million. Of the 616 loans, 144 were endorsed after the
health department first declared a public health emergency on October 1, 2015. The unpaid
balances for these 144 loans total more than $11.2 million. In February 2016, HUD issued a
question and answer document that recognized the water contamination crisis in Flint and
reminded lenders and other stakeholders involved with FHA transactions of the requirements for
properties to be eligible for insurance. The guidance stated that if a property was located in an
area serviced by an unacceptable water system with unacceptable levels of contaminants,
including lead, a water test must be completed.

Our audit objective was to determine whether HUD ensured that properties in Flint, MI, that
were approved for FHA mortgage insurance had a continuing and sufficient supply of safe and
potable water.


5
    This includes loans that were closed before April 2014, when Flint switched its water supply to the Flint River.
6
    HUD had endorsed 616 loans as of March 10, 2016. Note that this did not include streamline refinances because
    they do not require an appraisal.


                                                          4
Results of Audit

Finding: HUD Did Not Ensure That Lenders Verified That FHA-
Insured Properties in Flint Had Safe Water
HUD did not ensure that lenders verified that properties in Flint, MI, that were approved for
FHA mortgage insurance had a continuing and sufficient supply of safe and potable water.
Specifically, 11 of the 17 files reviewed did not contain evidence of water testing to show that
the water was safe, and subsequent testing performed by the State showed that at least 4 of the 11
properties had lead and copper levels above the EPA action levels. This condition occurred
because HUD’s existing controls were not designed to specifically detect whether the loan files
contained evidence of water testing. Further, while HUD took steps to remind lenders and
appraisers of the requirements after the President signed the emergency declaration in January
2016, it did not always document its efforts and did not proactively reach out to individual
lenders. The issues identified represent an ongoing safety concern for homeowners and
household members. HUD and homeowners also face an increased risk of loss if property values
decrease due to the water safety issues, and homeowners may not have sufficient resources
needed to attain and maintain safe water. If HUD directs the lenders for the 11 loans reviewed
and the additional 127 loans not selected for review to provide evidence showing that the
properties had a safe and potable water source at the time the loan closed, or, if the lenders
cannot provide this evidence, directs them to perform water testing and any necessary
remediation to ensure that the properties currently have a safe and potable water source, or
indemnify HUD against any future loss, it could put up to $10.8 million to better use.

Loan Files Did Not Always Contain Evidence of Water Testing
Loan files did not contain evidence to show that the properties had safe and potable water.
Regulations at 24 CFR 200.926d(f) and HUD Handbook 4000.1, section II, paragraph
A.3.a.ii(F) 7 state that properties are required to have a continuing and sufficient supply of safe
and potable water. We reviewed 17 loan files related to properties located in Flint 8 to determine
whether the files contained evidence that the water was safe. Of the 17 loan files reviewed, only
6 contained evidence of water testing and showed that the water was not contaminated. The files
for the remaining 11 loans did not contain evidence of water testing. As a result, HUD did not
have assurance that the properties for the 11 loans, with unpaid balances totaling $786,398, had a
continuing and sufficient supply of safe and potable water.




7
    HUD Handbook 4000.1 was implemented on September 14, 2015. This handbook superseded Appendix K of
    HUD Handbook 4910.1, which contained the same guidance.
8
    Fifteen of the 17 loans closed after the health department first declared a public health emergency on October 1,
    2015, and all 17 loans were endorsed after October 1, 2015. The closing date is the date the property sale or
    refinance was final, and the endorsement date is the effective date of the FHA mortgage insurance.


                                                           5
Water Testing Performed by the State Showed That HUD Insured at Least Four Properties
With High Levels of Lead and Copper
HUD insured at least four properties that had lead and copper levels above the EPA action level.
Regulations at 40 CFR 141.80(c) state that the action level is exceeded if tap water samples
contain more than 15 ppb of lead or 1,300 ppb of copper. The properties for 4 of the 11 loans
discussed above were subsequently tested by the State 9 and had lead and copper levels exceeding
the EPA action levels. The lead levels for the 2 most egregious cases were 254 ppb and 746 ppb,
the latter of which is almost 50 times higher than the EPA action level. The table below shows
the results of the water testing conducted by the State.


                                                    Results of water          Date of water
          Case            Closing date /                                                              Unpaid
                                                     testing by the           testing by the
         number         endorsement date                                                              balance
                                                          State                    State
                             6/19/2015 /            Lead – 28 ppb
     262-2192537                                                                1/26/2016             $26,187
                               1/4/2016           Copper – 5,430 ppb
                             8/20/2015 /
     262-2223129                                      Lead – 22 ppb             3/15/2016              58,433
                               2/2/2016
                            10/16/2015 /           Lead – 746 ppb
     262-2234269                                                                 2/2/2016              52,617
                              11/2/2015           Copper – 1,520 ppb
                            12/22/2015 /
     262-2246398                                    Lead – 254 ppb 10           2/17/2016              78,334
                              1/28/2016
                                               Total                                                 $215,571

While the State’s testing was performed after the loans closed and were endorsed, the lenders
may have detected the water contamination issues if they had tested the water. The loans for
these four properties had unpaid balances totaling $215,571.

HUD Did Not Have Adequate Controls in Place To Ensure That Lenders Followed
Applicable Requirements
The conditions described above occurred because HUD did not have adequate controls in place
to ensure that lenders followed all applicable requirements when approving loans for properties
located in Flint. While HUD had several controls in place, such as its post endorsement
technical review and regular monitoring review processes, these controls were not designed to
specifically address the issue of required water testing of properties in areas serviced by a public
water system with known issues. For example,
     •    The regular endorsement process was not designed to specifically detect whether the loan
          files contained evidence of water testing. Loans that are insured through the Lender


9
     In each of the four cases, the water testing performed by the State took place after the loan had closed and was
     endorsed for FHA mortgage insurance.
10
     The property has since tested below 15 ppb for lead, although we do not know whether remediation was
     performed on the property to address the initial test results.


                                                            6
          Insurance Program 11 are not reviewed by HUD before endorsement. While loans that are
          not insured through the program are reviewed by a HUD contractor before endorsement
          to check for the presence of certain documents, the contractor does not check for
          evidence of water testing.
     •    HUD’s post endorsement technical review process was not designed to specifically detect
          whether the loan files contained evidence of water testing. Rather, the review forms were
          designed to identify whether the appraisal had noted any problems with the individual
          water supply system or indications of unsafe, unsanitary, or unsound living conditions.
          Further, the process used to select loans for review 12 did not require HUD to review any
          loans for properties located in Flint that closed after October 1, 2015.
     •    HUD’s regular monitoring process was not designed to specifically detect whether the
          loan files contained evidence of water testing. The Quality Assurance Division’s Desk
          Guide did not include steps to verify that lenders followed requirements to ensure that
          properties had a safe and potable water source. Further, while the Single Family Loan
          Review Basis for Ratings guide contained a finding code for properties that did not meet
          minimum property requirements or standards, there were no examples regarding water
          contamination issues. Finally, while HUD had performed two reviews after October 1,
          2015, for lenders that had approved loans for properties located in Flint since the first
          emergency declaration, its findings did not discuss water contamination issues.

HUD Began To Take Steps To Remind Lenders and Appraisers of the Requirements
After the President signed an emergency declaration on January 16, 2016, HUD took several
steps to remind lenders and appraisers of the applicable requirements. For example, in February
2016, HUD issued a question and answer document about the contamination in Flint to recognize
the presidential declaration of emergency. The document reminded lenders and other
stakeholders of the requirements for properties to be eligible for FHA mortgage insurance and of
the need for water testing for properties located in areas serviced by public water systems with
unacceptable levels of contaminants. Before the development of this document and related
summary sheet, HUD did not have specific guidance for its FHA Resource Center to use when
answering inquiries about public water contamination issues. 13 While HUD stated that it also
discussed the contamination in Flint during its regular appraiser and underwriter training held in
Detroit, MI, in March 2016, the course materials did not address this topic 14 and it did not
provide documentation detailing the discussions. Further, HUD did not proactively reach out to

11
     The Lender Insurance Program allows high-performing lenders to self-insure certain FHA loans without a pre-
     endorsement review by a HUD contractor.
12
     The process used to select loans for post endorsement technical reviews considered several factors, such as the
     type of loan and whether the borrower had failed to make payments. It also included a random selection
     component and allowed HUD to manually select certain loans for review, including loans on which it had
     received a lender, borrower, or public complaint. As of March 2016, no loans on properties located in Flint that
     closed after October 1, 2015, had been selected for review.
13
     The FHA Resource Center received several dozen inquiries from lenders regarding the water contamination
     issues in Flint.
14
     The appraiser presentation only discussed the need for inspections of well and septic systems, and the
     underwriter presentation only contained references to the conditional commitment direct endorsement statement
     of appraised value.


                                                           7
lenders when the Genesee County Health Department first declared a public health emergency
on October 1, 2015.

Conclusion
HUD did not ensure that lenders verified that properties in Flint, MI, that were approved for
FHA mortgage insurance had a continuing and sufficient supply of safe and potable water. This
condition occurred because HUD’s existing controls were not designed to specifically detect
whether the loan files contained evidence of water testing. Further, while HUD took steps to
remind lenders and appraisers of the requirements after the President signed the emergency
declaration, it did not always document its efforts and did not proactively reach out to individual
lenders. The issues identified represent an ongoing safety concern for homeowners and
household members. HUD and homeowners may also face an increased risk of loss if property
values decrease due to the water safety issues, and homeowners may not have sufficient
resources needed to attain and maintain safe water. If HUD works with the applicable lenders to
ensure that the subject properties for these 11 loans have a safe and potable water source or the
lenders perform any necessary remediation or indemnify HUD against future loss, up to
$786,398 could be put to better use.

Further, because 11 of the 17 loan files reviewed did not contain evidence of water testing and at
least 4 of the related properties subsequently tested by the State showed high lead and copper
levels, we believe that additional loan files may not contain evidence of water testing and the
related properties may have high levels of lead and copper. Specifically, since October 1, 2015,
HUD had insured 99 additional loans that closed after October 1, 2015, and 28 loans that closed
before October 1, 2015. If HUD works with the applicable lenders to ensure that the subject
properties for these additional 127 loans 15 have a safe and potable water source or the lenders
perform any necessary remediation or indemnify HUD against future loss, up to $10 million
could be put to better use.

Recommendations
We recommend that the Acting Deputy Assistant Secretary for Single Family Housing

          1A.      Direct the applicable lenders to provide evidence that the properties for the four
                   FHA-insured loans reviewed, which had lead and copper levels above the EPA
                   action level, had a safe and potable water source at the time the loans closed and
                   were endorsed, or, if the lenders cannot provide this evidence, direct them to
                   perform water testing and any necessary remediation to ensure that the properties
                   have a safe and potable water source, or indemnify HUD against any future loss,
                   thereby putting up to $215,571 to better use.



15
     These 127 loans are part of the 144 loans that were endorsed after the health department first declared a public
     health emergency on October 1, 2015. As discussed in the Scope and Methodology section of this report, we
     reviewed 17 of the 144 loans. Based on the results of our review, we believe that the files for the additional 127
     loans not reviewed may not contain evidence of water testing and the related properties may have high levels of
     lead and copper.


                                                            8
1B.   Direct the applicable lenders to provide evidence that the properties for the seven
      additional FHA-insured loans reviewed, for which the files did not contain
      evidence of water testing, had a safe and potable water source at the time the
      loans closed and were endorsed, or, if the lenders cannot provide this evidence,
      direct them to perform water testing and any necessary remediation to ensure that
      the properties have a safe and potable water source, or indemnify HUD against
      any future loss, thereby putting up to $570,827 to better use.

1C.   Direct the applicable lenders to provide evidence that the properties for the 99
      FHA-insured loans, which closed after October 1, 2015, but were not included in
      our sample, had a safe and potable water source at the time the loans closed and
      were endorsed, or, if the lenders cannot provide this evidence, direct them to
      perform water testing and any necessary remediation to ensure that the properties
      have a safe and potable water source, or indemnify HUD against any future loss,
      thereby putting up to $7,514,800 to better use.

1D.   Direct the applicable lenders to provide evidence that the properties for the 28
      FHA-insured loans, which closed before October 1, 2015, and were endorsed after
      October 1, 2015, but were not included in our sample, had a safe and potable
      water source at the time the loans closed and were endorsed, or, if the lenders
      cannot provide this evidence, direct them to perform water testing and any
      necessary remediation to ensure that the properties have a safe and potable water
      source, or indemnify HUD against any future loss, thereby putting up to
      $2,512,464 to better use.

1E.   Take appropriate administrative action against the lenders and appraisers for any
      cases (identified through recommendations 1A through 1D) where it finds that
      they did not take appropriate steps to ensure that properties had a safe and potable
      water source.

1F.   Improve its controls to ensure that it does not insure additional loans in Flint for
      properties that do not have a safe and potable water source. These controls could
      include updating its endorsement or monitoring processes until the water
      contamination issue has been resolved in Flint.




                                        9
Scope and Methodology
We conducted the audit from March through May 2016 at our offices located in Philadelphia and
Pittsburgh, PA. The audit covered the period April 2014 through March 2016.

To achieve our audit objective, we reviewed
     •    Relevant background information;
     •    Applicable regulations, HUD handbooks, mortgagee letters, and other guidance;
     •    The Flint water crisis timeline of events and residential water testing data located on the
          State’s Web site; 16 and
     •    Complete loan files provided by the lenders.

We interviewed HUD staff from the Office of Single Family Housing and the Philadelphia
Homeownership Center.

We relied in part on computer-processed data in HUD’s Single Family Data Warehouse.
Although we did not perform a detailed assessment of the reliability of the data, we performed a
minimal level of testing and found the data to be adequate for our purposes. The testing included
matching information obtained from the Single Family Data Warehouse to the complete loan
files provided by the lenders.

To select a sample of loans for review, we obtained and analyzed data contained in HUD’s
Single Family Data Warehouse, along with residential water testing data from the State’s Web
site to determine whether HUD had insured loans on properties that had tested above the EPA’s
action level for lead or copper and to select a sample of loan files for review. The data from
HUD’s Single Family Data Warehouse was current as of March 10, 2016, and the State’s water
testing data was current as of March 25, 2016. We identified 616 FHA-insured loans that closed
on or after April 25, 2014, with unpaid balances totaling $45.8 million. Of the 616 loans,
     •    We identified 114 loans that closed after October 1, 2015, with unpaid balances totaling
          more than $8.6 million. Of these 114 loans, the properties for 13 loans had testing results
          on the State’s Web site as of March 25, 2016. Of the 13 properties, 2 had lead levels
          exceeding the EPA action level, and 1 had copper levels exceeding the EPA action level.
          The lenders that underwrote these 2 loans had a total of 15 loans in our universe of 114
          loans. We selected all 15 of these loans for review because the high lead levels gave us
          reason to believe that the lenders had not ensured that the properties had a safe and
          potable water source, despite the loans closing after the public was informed by the
          government that the water was not safe.

16
     The State established http://www.michigan.gov/flintwater as a central location for information related to the
     Flint water crisis.


                                                            10
   •   We identified 30 loans that closed before October 1, 2015, but were endorsed after
       October 1, 2015, with unpaid balances totaling $2.6 million. Of these 30 loans, the
       properties for 4 loans had testing results on the State’s Web site, 2 of which had lead
       levels exceeding the EPA action level. We selected the two loan files for review to
       determine whether HUD had ensured that loans closed on or before but endorsed after
       October 1, 2015, met requirements for a safe and potable water source before
       endorsement.

In total, our sample included 17 loans, with unpaid balances totaling $11.2 million, from 4
different lenders. Although this approach did not allow us to make a projection to the entire
population of FHA-insured properties in Flint since April 25, 2014, with unpaid balances totaling
$45.8 million, it was sufficient to achieve our objective. For each of the 17 loans in our sample,
we obtained and reviewed complete loan files to identify information related to the water source,
water quality, testing performed on the water, and remediation related to water quality issues.

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.




                                                11
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 control was relevant to our audit objective:
•   Compliance with applicable laws and regulations – Policies and procedures that management
    has implemented to reasonably ensure that the use of resources is consistent with laws and
    regulations.
We assessed the relevant control 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:
•   HUD lacked adequate controls to ensure that lenders complied with all applicable
    requirements when approving loans for properties located in Flint, and that FHA-insured
    properties in Flint had a continuing and sufficient supply of safe and potable water.




                                                  12
Appendixes

Appendix A


                       Schedule of Funds To Be Put to Better Use
                         Recommendation Funds to be put
                             number          to better use 1/
                                1A              $215,571
                                  1B                 570,827
                                  1C                7,514,800
                                  1D                2,512,464
                                 Total             $10,813,662

1/   Recommendations that funds be put to better use are estimates of amounts that could be
     used more efficiently if an Office of Inspector General (OIG) recommendation is
     implemented. These amounts include reductions in outlays, deobligation of funds,
     withdrawal of interest, costs not incurred by implementing recommended improvements,
     avoidance of unnecessary expenditures noted in preaward reviews, and any other savings
     that are specifically identified. In this instance, implementation of our recommendations
     to direct the applicable lenders to provide evidence that the properties had a safe and
     potable water source at the time the loans closed and were endorsed, or, if the lenders
     cannot provide this evidence, direct them to perform water testing and any necessary
     remediation to ensure that the properties have a safe and potable water source, or
     indemnify HUD would reduce the risk of loss to the FHA insurance fund because HUD
     would be relieved of potential future claim liabilities for any properties shown not to have
     a safe and potable water source.




                                              13
Appendix B
             Auditee Comments and OIG’s Evaluation



Ref to OIG    Auditee Comments
Evaluation




Comment 1



Comment 2


Comment 3




                               14
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation


Comment 3




Comment 4




                               15
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




Comment 5



Comment 6




Comment 7




Comment 8




                               16
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation


Comment 8




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                         OIG Evaluation of Auditee Comments

Comment 1   HUD stated that FHA guidelines evidence the program’s commitment to ensuring
            that residences that are candidates for mortgage insurance have a safe and potable
            water supply and cited regulations at 24 CFR 200.926d. While it is important that
            HUD has these regulations, we found that HUD did not have adequate controls in
            place to ensure that lenders verified that properties in Flint, MI, that were
            approved for FHA mortgage insurance after the first emergency declaration was
            made on October 1, 2015, had a continuing and sufficient supply of safe and
            potable water.

Comment 2   HUD indicated that it generally agrees with OIG’s recommendations and has been
            working to ensure that its lenders and appraisers in the Flint, MI, area meet their
            obligations under applicable regulations. As part of the audit resolution process,
            HUD will need to detail the actions it plans to take to address each
            recommendation.

Comment 3   HUD indicated that its February 8, 2016, issuance and the work it has initiated in
            response to our audit supplement its continued efforts in response to the Flint
            water crisis. These efforts include extending the Strong Cities, Strong
            Communities engagement in Flint through 2016, reserving funds for the Flint
            Housing Commission to assist public housing and Housing Choice Voucher
            program residents, providing technical assistance to the City on how best to
            leverage existing HUD resources to respond to this crisis, and coordinating the
            economic recovery work of the Federal interagency working group. We
            acknowledge that HUD has taken several positive steps toward addressing the
            Flint water crisis. For example, according to a May 2016 fact sheet released by
            the White House about Federal support for the Flint water crisis response and
            recovery, HUD has worked with the Flint Housing Commission to ensure
            installation and future upkeep of water filters in every unit of public housing.
            However, we found that since the first public health emergency declaration was
            made on October 1, 2015, HUD’s efforts were not adequate to ensure that
            properties in Flint, MI, that were approved for FHA mortgage insurance had a
            continuing and sufficient supply of safe and potable water.

Comment 4   HUD contended that loans endorsed for FHA insurance during the period
            October 1, 2015, through January 16, 2016, – and the information provided in
            those loan files by appraisers and lenders regarding the water supply for the
            subject housing unit – should be considered individually, relative to the changing
            landscape of circumstances and information provided by State and local
            authorities about the condition of publicly sourced water in Flint. HUD further
            stated that despite the Genesee County Board of Commissioners’ public health
            emergency declaration on October 1, 2015, local officials continued to make
            public announcements that they would ensure that Flint residents would have
            access to safe and potable water. We disagree with HUD regarding how it plans



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            to consider loans that were endorsed during the period October 1, 2015, through
            January 16, 2016, on a case-by-case basis. While the presidential declaration of
            emergency did not take place until January 16, 2016, the timing of this declaration
            did not change the responsibility of lenders to ensure that properties in Flint, MI,
            had a continuing and sufficient supply of safe and potable water. The Genesee
            County Health Department declared a public health emergency and issued a “do
            not drink” advisory on October 1, 2015. Between October 1, 2015, and
            January 16, 2016, the public health emergency and “do not drink” advisory were
            still in effect. Therefore, lenders should have verified that properties in Flint, MI,
            had a continuing and sufficient supply of safe and potable water through water
            testing before loans were approved for FHA mortgage insurance. Further, we
            note that additional emergency declarations were made during the period in
            question, including declarations by the City on December 14, 2015, the Genesee
            County Commission on January 4, 2016, and the State of Michigan on January 5,
            2016.

Comment 5   HUD indicated that it issued its “FHA Information of Water Contamination Crisis
            in Flint, Michigan” document on February 8, 2016, following the presidential
            declaration. HUD stated that this document reminded lenders and other
            stakeholders involved with FHA transactions of the requirements for properties to
            be eligible for insurance and said that given the water crisis in Flint, lenders may
            require evidence that properties meet water safety requirements, such as testing or
            remediation. We found that while the document did state that lenders may require
            evidence, this statement was in response to a general question about what
            evidence is required. In response to a question asking whether there were policies
            requiring water testing on properties in Flint, MI, the document stated that a water
            test is required for properties located in areas serviced by public water systems
            with unacceptable levels of contaminants.

Comment 6   HUD indicated that it is in the process of reviewing loan files for 50 properties
            located in Flint, MI, for which the appraisals were completed on or after
            February 8, 2016. HUD further stated that while its research is not complete, it
            has not identified any loan files in which the water supply was documented to be
            unsafe. It believed that as a result of its efforts, water testing is now occurring.
            However, as HUD indicated during a June 28, 2016, meeting, several of the 50
            loan files that it was reviewing did not contain evidence of water testing, similar
            to the 11 loan files discussed in the finding that did not contain evidence of water
            testing to show that the water was safe. Without evidence of water testing, HUD
            cannot ensure that lenders verified that properties in Flint, MI, that were approved
            for FHA mortgage insurance had a continuing and sufficient supply of safe and
            potable water. Further, while reviewing loans for which the appraisals were
            completed on or after February 8, 2016, is a positive step toward addressing our
            recommendations, HUD needs to review the loan files for all loans that were
            endorsed after October 1, 2015.




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Comment 7   HUD indicated that concurrent with its duty to enforce the standards for minimum
            property requirements is FHA’s commitment to carry out the Secretary’s goal of
            promoting access to credit in all communities and noted that this is particularly
            important in communities like Flint that are underserved by the mortgage lending
            community. HUD stated that it is critical that FHA not eliminate opportunities for
            access to credit for families who most need it for home purchase. Although
            HUD’s commitment to carry out the Secretary’s goal of promoting access to
            credit in all communities is important, the ongoing safety concern for
            homeowners and household members should be a priority. As discussed in the
            finding, we found that HUD insured at least four properties in Flint, MI, that had
            lead and copper levels above the EPA action level. According to the EPA,
            exposure to lead in drinking water may cause cardiovascular issues, increased
            blood pressure, decreased kidney function, and reproductive problems in adults.
            Infants and children are at risk of behavior and learning problems, lower IQ’s,
            hyperactivity, slowed growth, hearing problems, and anemia. Further, both the
            EPA and the Centers for Disease Control and Prevention agree that there is no
            known safe level of lead in a child’s blood. Exposure to copper in drinking water
            may cause gastrointestinal distress as well as liver or kidney damage.

Comment 8   HUD indicated that it is essential that FHA’s policy for underwriting mortgage
            loans be consistent across the entire Nation – including but not limited to the
            requirement for a safe and potable water supply. It noted that when a mortgage is
            submitted for endorsement, FHA requires a property appraisal and an underwriter
            certification, stating that the underwriter personally reviewed the appraisal report
            and credit application and that the proposed mortgage complies with FHA
            underwriting requirements, including FHA’s requirement for a safe and potable
            water supply. HUD further stated that appraisers must be geographically
            competent, which means that the appraiser is familiar with the local area and
            understands the local market. Relative to water quality, HUD indicated that the
            requirement for local competency puts the burden on each appraiser to know
            whether water testing is necessary. Based on the results of our audit, we do not
            believe that lenders and underwriters met their responsibility to ensure that
            properties in Flint, MI, had a safe and potable water supply and that appraisers
            had a consistent understanding of when water testing was necessary. For
            example, we found evidence of water testing for five loans for which the
            appraisals were completed after the Genesee County Health Department declared
            a public health emergency and issued a “do not drink” advisory on October 1,
            2015, and for one loan for which the appraisal was completed before October 1,
            2015. In contrast, we identified 11 loans for which the files did not contain
            evidence of water testing, including 7 loans for which the appraisals were
            completed after various declarations. In one case, the appraisal was completed on
            January 13, 2016, and the loan file did not contain evidence of water testing. This
            appraisal was completed after the October 1, 2015, declaration discussed above
            and after additional emergency declarations were made by the City on




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December 14, 2015, the Genesee County Commission on January 4, 2016, and the
State of Michigan on January 5, 2016. HUD should take appropriate
administrative action against the lenders and appraisers for any cases in which it
finds that they did not take appropriate steps to ensure that properties in Flint, MI,
had a safe and potable water source and improve its controls to ensure that it does
not insure additional loans in Flint for properties that do not have a safe and
potable water source.




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