oversight

The Lender Generally Underwrote the Second and Delaware Project Loan in Accordance With HUD Rules and Regulations

Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-09-27.

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

                   Berkeley Point Capital
                      Bethesda, MD
        Multifamily Accelerated Processing Program
       Second and Delaware Project (Kansas City, MO)




Office of Audit, Region 7      Audit Report Number: 2018-KC-1003
Kansas City, KS                                September 27, 2018
To:            Mary V. Walsh, Director, Office of Multifamily Housing Programs,
               Southwest Region, 6AHMLA


               //signed//
From:          Ronald J. Hosking, Regional Inspector General for Audit, 7AGA
Subject:       The Lender Generally Underwrote the Second and Delaware Project Loan in
               Accordance With HUD Rules and Regulations




Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of the underwriting for the Second and Delaware
multifamily project.
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 website. 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: 2018-KC-1003
                    Date: September 27, 2018

                    The Lender Generally Underwrote the Second and Delaware Project Loan in
                    Accordance With HUD Rules and Regulations




Highlights

What We Audited and Why
We audited the lender, Berkeley Point Capital, and the underwriting for the Second and
Delaware project loan. We initiated the review of the loan underwriting based on a previous
review of the Second and Delaware project, which focused on the construction and development
of the project. The almost $46 million project is Federal Housing Administration (FHA) insured
and sitting substantially incomplete near downtown Kansas City, MO, with no additional work
being performed. The lender has disbursed approximately $21 million for the development and
construction of the project so far. Our audit objective was to determine whether the loan for the
Second and Delaware project was underwritten in accordance with U.S. Department of Housing
and Urban Development (HUD) rules and regulations.

What We Found
The lender generally underwrote the loan in accordance with HUD rules and regulations, except
it did not ensure that the general contractor met FHA’s experience requirements. The contractor
did not meet the large loan requirement of mortgagee letter 2014-18. This deficiency occurred
because a previous lender that completed the underwriting did not consider the contractor’s lack
of experience to be material. As a result, this could contribute to the loan going into default if
the project is not completed.

The underwriting on this loan was completed by a different lender, which sold its FHA
construction loan portfolio to Berkeley Point Capital. As of the issue date of this report, HUD
was working with a new lender to issue a new loan to fund the completion of the project. This
new loan would pay off the original loan held by Berkeley Point Capital. With the issuance of
the new loan, Berkeley Point Capital would no longer be involved with the Second and Delaware
project.

What We Recommend
We recommend that the Southwest Regional Director of Multifamily Housing require that the
current or future lender ensure that the project uses a contractor that is proven to be qualified and
capable of completing the project.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................5
         Finding: The Lender Generally Underwrote the Loan in Accordance With HUD
         Rules and Regulations, Except It Did Not Ensure That the General Contractor
         Met FHA’s Experience Requirements ............................................................................ 5

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

Internal Controls ......................................................................................................9

Appendixes ..............................................................................................................10
         A. Auditee Comments and OIG’s Evaluation ............................................................. 10

         B. Criteria ....................................................................................................................... 13




                                                                     2
Background and Objective
The Second and Delaware marketing website described the project as a 276-unit, luxury, loft,
apartment community that combines sustainability, simple sophistication, and long-lasting
construction, bringing a new level of urban living to Kansas City, MO. Using rigorous “passive
house” energy-efficiency standards, the building would consume 90 percent less energy than
standard buildings, making the project one of the most efficient buildings on the planet.

The general contractor permanently stopped work on the project in June 2017, and the project
sits incomplete today.

In January 2016, the U.S. Department of Housing and Urban Development (HUD) insured the
Second and Delaware’s mortgage for more than $49 million under section 221(d)(4) of the
National Housing Act. Section 221(d)(4) insures mortgage loans to facilitate the new
construction or substantial rehabilitation of multifamily rental or cooperative housing for
moderate-income families, the elderly, and the handicapped. Section 221(d)(4) insures lenders
against loss on mortgage default and assists private industry in the construction or rehabilitation
of rental and cooperative housing by making capital more readily available. Borrowers may use
insured mortgages to finance the construction or rehabilitation of detached, semidetached, row,
walkup, or elevator-type rental or cooperative housing containing five or more units. Eligible
borrowers include public, profit-motivated sponsors; limited distribution, nonprofit cooperatives;
builder-seller, investor-sponsors; and general borrowers.

Section 221(d)(4) is eligible for multifamily accelerated processing. The sponsor works with the
multifamily accelerated processing-approved lender, which submits required exhibits for the
preapplication stage. HUD reviews the lender’s exhibits and will either invite the lender to apply
for a firm commitment for mortgage insurance or decline to consider the application further. If
HUD determines that the exhibits are acceptable, the lender then submits the firm commitment
application, including a full underwriting package, to the local Office of Multifamily Housing
Programs hub or program center for review. HUD reviews the application to determine whether
the proposed loan is an acceptable risk. Consideration includes market need, zoning,
architectural merits, capabilities of the borrower, availability of community resources, etc. If the
proposed project meets program requirements, the local Multifamily hub or program center
issues a commitment to the lender for mortgage insurance.

Oppenheimer Multifamily Housing and Healthcare Finance completed the underwriting and loan
execution in January 2016. On July 21, 2016, Berkeley Point Capital, our auditee, entered into a
mortgage servicing rights purchase and sale agreement with Oppenheimer Multifamily Housing
and Healthcare Finance to assume the section 221(d)(4) loan for the Second and Delaware
project.

Berkeley Point Capital was a top five Federal National Mortgage Association and Federal Home
Loan Mortgage Corporation lender in 2017, with a 30-year history and a servicing portfolio of


                                                 3
$58 billion. Berkeley Point Capital and its affiliates offer a full complement of government-
sponsored enterprise, FHA, Life Company, and Conduit products paired with extensive
multifamily, affordable, student, and senior housing, along with healthcare expertise. This
includes more than 3,300 loans in 49 States and represents more than 500,000 multifamily units
and 68.3 million in square footage.

The lender had disbursed approximately $21 million for the development and construction of the
project at the time of the work stoppage.

Our objective was to determine whether the loan for the Second and Delaware project was
underwritten in accordance with HUD rules and regulations.




                                               4
Results of Audit

Finding: The Lender Generally Underwrote the Loan in
Accordance With HUD Rules and Regulations, Except It Did Not
Ensure That the General Contractor Met FHA’s Experience
Requirements
The lender generally underwrote the loan in accordance with HUD rules and regulations, except
it did not ensure that the general contractor met FHA’s experience requirements. This deficiency
occurred because a previous lender did not consider the contractor’s lack of experience to be
material. As a result, this could contribute to the loan going into default if the project is not
completed.

The Lender Generally Underwrote the Loan in Accordance With HUD Rules and
Regulations
Our review of the underwriting file included the firm commitment application, calculation of the
debt service coverage ratio, appraisals, market studies, the developer’s prior experience and
financial status, the general contractor’s prior experience and financial status, the architectural
and cost analysis report, credit reports, and court records. Berkeley Point Capital purchased the
loan for the Second and Delaware project after Oppenheimer Multifamily Housing and
Healthcare Finance completed the underwriting process. The lender generally underwrote the
loan in accordance with HUD rules and regulations, except it did not ensure that the general
contractor met FHA’s experience requirements.

The General Contractor Did Not Meet FHA’s Experience Requirements
During the firm commitment stage of the underwriting process, the general contractor submitted
a resume that included the general contractor’s previous experience. The Multifamily
Accelerated Processing Guide, paragraph 8.3(J), requires the lender to review the contractor’s
previous experience. It requires the resume to show the level of experience needed to
successfully complete the development of the project. Additionally, mortgagee letter 2014-18
states that contractors without substantial prior experience in multifamily, construction lease-up,
and property operations and which have not previously successfully owned or developed other
large multifamily projects would not qualify for a large loan under any of the insurance
programs. The mortgagee letter defines a large loan as $25 million or more. Further, it states
that related experience in single-family development or in development of commercial properties
is not an acceptable substitute for the required prior multifamily experience. Since HUD insured
the Second and Delaware’s mortgage for more than $49 million, which met the requirements of a
large loan, the general contractor should have met the experience requirements to be qualified.

At the time the contractor submitted a statement of contractor qualifications, they had contracts
for two ongoing projects that met the large loan threshold. However, because they were not yet
completed, the lender could not be certain that the contractor could successfully develop a large


                                                 5
loan project. The contractor’s firm commitment resume included two previous HUD projects in
which it filled the role of general contractor. The two contracts were signed individually for
more than $19.3 and $16.6 million. The two projects were wood frame walk-up buildings,
where the Second and Delaware project was a mid-rise concrete structure. Furthermore, these
two other HUD contracts the contractor completed allocated 7.9% and 8.2% of their contracts for
concrete work, respectively, but the Second and Delaware project allocated 29.6% of its contract
for concrete. The two previously completed HUD contracts were not similar in size and scope to
the Second and Delaware project.

The Lender Did Not Consider the Contractor’s Lack of Experience To Be Material
During our review, we learned that the previous lender valued a contractor’s locality over its
previous experience. The lender stated that HUD had expressed some concern over using an out-
of-area contractor because of problems it had encountered on previous projects that used out-of-
State contractors. Additionally, the lender stated that it believed subcontractors would help fill
any voids in the general contractor’s lack of experience.

A New Loan Could Be Issued
The contractor’s lack of experience could be a contributing factor if the project is not completed
and the loan ultimately goes into default. The underwriting on this loan was completed by a
different lender, which sold its FHA construction loan portfolio to Berkeley Point Capital. As of
the issue date of this report, HUD was working with a new lender to issue a new loan to fund the
completion of the project. This new loan would pay off the original loan held by Berkeley Point
Capital. With the issuance of the new loan, Berkeley Point Capital would no longer be involved
with the Second and Delaware project.

Recommendations
We recommend that the Southwest Regional Director of Multifamily Housing

       1A.     Require that the current or future lender ensure that the project uses a contractor
               that is proven to be qualified and capable of completing the project.




                                                 6
Scope and Methodology
We performed our audit work from January through May 2018 at our office in Kansas City, KS,
except for one visit to the Berkeley Point Capital offices in Bethesda, MD, from January 30
through February 1. The audit period covered the period January 1, 2014, through January 31,
2016.

To accomplish our objective, we reviewed the underwriting file, which included

      the firm commitment application,
      the calculation of the debt service coverage ratio,
      appraisals,
      market studies,
      the developer’s prior experience and financial status,
      the general contractor’s prior experience and financial status,
      the architectural and cost analysis report,
      credit reports, and
      court records.

Additionally, we

      reviewed a HUD handbook, the Code of Federal Regulations, mortgagee letters, and the
       2011 Multifamily Accelerated Processing Guide;
      interviewed HUD and Berkeley Point Capital staff;
      reviewed the loan file at Berkeley Point Capital;
      reviewed the general contractor’s and architect of records’ contracts;
      reviewed the purchase escrow and assignment agreement; and
      reviewed the regulatory agreement.

Oppenheimer Multifamily Housing and Healthcare Finance completed the multifamily
accelerated processing underwriting for the Second and Delaware loan. We were unable to
review its internal controls or interview its underwriting staff because it discontinued its FHA
lending operations in 2016. We did not evaluate Berkeley Point Capital’s internal controls
because it did not underwrite the loan.

We conducted the review based on information contained in the Berkeley Point Capital project
file, placing no reliance on systems Berkeley Point Capital used or maintained. The records we
obtained from Berkeley Point Capital and reviewed for audit evidence were not computer
generated or based. Therefore, we did not conduct an assessment of data reliability.

Except for the limitations on our review of internal controls, as described above, we conducted
the audit in accordance with generally accepted government auditing standards. Those standards


                                                 7
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.




                                                 8
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 the underwriting process.

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.

Oppenheimer Multifamily Housing and Healthcare Finance completed the underwriting before
our auditee, Berkeley Point Capital, purchased the loan. We did not evaluate Berkeley Point
Capital’s internal controls because it did not underwrite the loan. Accordingly, we do not
express an opinion on the effectiveness of Berkeley Point Capital’s internal controls.




                                                 9
Appendixes

Appendix A
             Auditee Comments and OIG’s Evaluation



Ref to OIG
              Auditee Comments
Evaluation




Comment 1




                               10
             Auditee Comments
Ref to OIG
Evaluation




Comment 2




                            11
                         OIG Evaluation of Auditee Comments


Comment 1   We agree that 24 CFR part 203 is only applicable to Single Family loans. We
            removed language in the report that says Berkeley Point assumed responsibility
            for the underwriting when it purchased Oppenheimer Multifamily Housing and
            Healthcare Finance’s construction loan portfolio. This report makes no
            determination of liability for any potential damages.

Comment 2   We made the suggested changes in the report.




                                            12
Appendix B
                                          Criteria

Multifamily Accelerated Processing Guide, Chapter 8.3

Section J – Analyzing the Borrower’s and Contractor’s Previous Experience

      Subsection 1

      The Lender’s underwriter must evaluate the resume of the principal(s). The principal
      must have positive experience and qualifications in developing, owning or building
      similar multifamily properties.

Mortgagee Letter 2014-18, Section III

Part D – Other Underwriting Requirements for Large Loans

      The following underwriting and mortgage credit requirements apply to all Large Loans at
      or above $25M under any of the rental housing insurance programs.

      Subsection iii

      Large Loan borrowers must have substantial prior experience developing, construction
      and owning multifamily projects that are similar in size and scope to what is proposed.
      Borrowers or contractors without substantial prior experience in multifamily,
      construction lease up and property operations, and who have not previously successfully
      owned or developed other large multifamily projects, will not qualify for a Large Loan
      under any of the insurance programs. Related experience in single family development
      or in development of commercial properties is not acceptable substitute for the required
      prior multifamily experience and may not be a basis for a waiver of the experience
      requirement.




                                              13