oversight

HUD's Office of Healthcare Programs Generally Approved Section 232 FHA-Insured Loans in Accordance With HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-08-10.

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

          Office of Healthcare Programs
                 Washington, DC
    HUD’s Approval of Section 232 FHA-Insured Loans




Office of Audit, Region 3    Audit Report Number: 2018-PH-0001
Philadelphia, PA                                August 10, 2018
To:            Roger M. Lukoff, Deputy Assistant Secretary, Office of Healthcare Programs, HP
               //signed//
From:          David E. Kasperowicz, Regional Inspector General for Audit, Philadelphia
               Region, 3AGA
Subject:       HUD’s Office of Healthcare Programs Generally Approved Section 232
               FHA-Insured Loans 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 HUD’s approval of Section 232 Federal Housing
Administration (FHA)-insured loans.
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
215-430-6734.
                    Audit Report Number: 2018-PH-0001
                    Date: August 10, 2018

                    HUD’s Office of Healthcare Programs Generally Approved Section 232 FHA-
                    Insured Loans in Accordance With HUD Requirements




Highlights

What We Audited and Why
We audited the U.S. Department of Housing and Urban Development’s (HUD) approval of
Section 232 Federal Housing Administration (FHA)-insured loans based on our initiative to
focus HUD management’s attention on problem areas with the Section 232 program. Our audit
objective was to determine whether HUD approved Section 232 FHA-insured loans for projects
that qualified for mortgage insurance in accordance with HUD requirements.

What We Found
HUD generally approved Section 232 FHA-insured loans for projects that qualified for mortgage
insurance in accordance with HUD requirements. For the three loan files reviewed, valued at
nearly $50 million, HUD maintained documentation to show that it adequately reviewed (1) loan
applications for program eligibility; (2) financial operations of the operator; (3) the
creditworthiness of the borrower, operator, and operator parent; (4) professional liability
insurance; and (5) the project capital needs assessment. However, it did not adequately evaluate
the creditworthiness of the management agents as required. This condition occurred because
HUD’s underwriters did not follow procedures. As a result, if HUD does not implement controls
and procedures to ensure that it properly evaluates the creditworthiness of management agents, it
could approve loans for projects with management agents that significantly impact the financial
position of the project.

What We Recommend
We recommended that HUD develop and implement controls and procedures to ensure that its
underwriters properly evaluate the creditworthiness of management agents when underwriting
future loans. It took immediate corrective action during the audit to implement the
recommendation.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................5
         Finding: HUD Generally Approved Section 232 FHA-Insured Loans in Accordance
         With HUD Requirements ................................................................................................. 5

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

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

Appendix .................................................................................................................13
         A. Auditee Comments and OIG’s Evaluation ............................................................. 13




                                                               2
Background and Objective
In 1959, under Section 232 of the National Housing Act, Congress established the U.S.
Department of Housing and Urban Development’s (HUD) Section 232 program. The Section
232 program is a Federal Housing Administration (FHA) mortgage insurance program that
insures HUD-approved lenders against financial loss from mortgage defaults. HUD’s Office of
Residential Care Facilities (ORCF), within HUD’s Office of Healthcare Programs, administers
the program. Section 232 loans help finance nursing homes, assisted living facilities, and board
and care facilities. Proposed projects are evaluated based on whether the proposal is an
acceptable insurance risk for the FHA insurance fund. Section 232 loans may be used to finance
the purchase, refinance, new construction, or substantial rehabilitation of a project. The program
contains the following seven types of loans.

                Loan type                                          Loan description
    1. Section 232 new                     This is a loan in which all project and construction
       construction                        elements are installed as part of the construction contract
                                           and no work has been done before the issuance of the
                                           HUD firm commitment. 1
    2. Section 232 substantial             This is a loan for projects undergoing substantial repairs or
       rehabilitation                      improvements.
    3. Section 232-223(f) purchase         This is a loan for projects that do not meet the
       or refinance                        requirements for substantial rehabilitation but are eligible
                                           for refinance or purchase under this section. Existing
                                           FHA-insured loans may refinance under section 223(f).
    4. Section 232-223(a)(7)               This is a streamline refinanced loan for an existing FHA-
       refinance                           insured loan.
    5. Section 232-241(a)                  This is a loan for existing FHA-insured loans to complete
       supplemental loans                  additions, repairs, replacements, energy conservation
                                           measures, improvements, or combinations of these items.
                                           The purpose of these loans is to provide financing to keep
                                           the property competitive, extend its economic life, and
                                           provide for replacement of obsolescent equipment.
    6. Section 223(d) operating            This is a supplemental loan that provides owners of FHA-
       loss loan                           insured projects a vehicle for recouping their out-of-pocket
                                           expenditures to fund unforeseen operating deficits during
                                           the early years of the project’s operation.
    7. Section 232(i) fire safety          This is a loan for financing the purchase and installation of
       equipment loan                      fire safety equipment, primarily fire sprinkler systems.



1
     HUD’s agreement to provide mortgage insurance on loans under the provisions of section 232


                                                         3
Loan applications are completed by borrowers and reviewed and submitted by a HUD
preapproved lender. After the lender submits the application package to HUD, an ORCF
underwriter reviews the application, exhibits, and the lender’s conclusions. The ORCF
underwriter uses a punch list, 2 which contains the following nine areas, to review the application:
    1.   general underwriting and program eligibility;
    2.   financial operations and appraisal review;
    3.   creditworthiness of the borrower;
    4.   creditworthiness of the operator;
    5.   creditworthiness of the operator parent;
    6.   creditworthiness of the management agent;
    7.   professional liability insurance, State surveys, and risk management programs;
    8.   project capital needs assessment review (physical condition); and
    9.   preparation for loan committee and firm commitment.

After the ORCF underwriter reviews the documentation and the lender’s recommendation, the
underwriter presents the results of his or her review to a loan committee. The loan committee
reviews the application and the underwriter’s recommendations and either approves or rejects it.
If the loan committee approves the application, a firm commitment will be issued. If the loan
committee rejects the application, a rejection letter will be issued.

As of October 2017, HUD’s Section 232 portfolio included 4,086 active loans, valued at more
than $28.5 billion, with unpaid principal balances totaling more than $26.1 billion.

Our objective was to determine whether HUD approved Section 232 FHA-insured loans for
projects that qualified for mortgage insurance in accordance with HUD requirements.




2
    A punch list is an internal HUD document containing review steps ORCF underwriters are required to complete
    while underwriting loans.


                                                        4
Results of Audit

Finding: HUD Generally Approved Section 232 FHA-Insured
Loans in Accordance With HUD Requirements
For the three loan files reviewed, valued at nearly $50 million, HUD maintained documentation
to show that it adequately reviewed (1) loan applications for program eligibility; (2) financial
operations of the operator; (3) the creditworthiness of the borrower, operator, and operator
parent; (4) professional liability insurance; and (5) the project capital needs assessment.
However, it did not adequately evaluate the creditworthiness of the management agents as
required. This condition occurred because HUD’s underwriters did not follow procedures. As a
result, if HUD does not implement controls and procedures to ensure that it properly evaluates
the creditworthiness of management agents, it could approve loans for projects with management
agents that significantly impact the financial position of the project. After we notified HUD of
this issue, it took immediate corrective action to ensure that it adequately evaluates the
creditworthiness of management agents when underwriting future loans.

Loan Applications Met Program Eligibility
For the three files reviewed, HUD adequately reviewed the loan applications for program
eligibility. According to the section 232-223(f) punch list, a preapproved lender was required to
review the loan application before it was submitted to HUD for review. In addition, the
borrower was required to meet loan-to-value requirements based on whether it was classified as a
nonprofit or for-profit entity. Also, the punch list required underwriters to review previous
participation documents and identify any identities of interest with the lender. For the three files
reviewed, HUD maintained documentation, such as an approved lender listing; calculations of
each project’s loan-to-value percentage; copies of previous participation forms and related HUD
approvals; and copies of form HUD-90013, Consolidated Certification, identifying any identities
of interest. This documentation showed that an approved lender was used, HUD verified that all
three loans met the loan-to-value requirements, underwriters conducted previous participation
reviews for required entities, and HUD verified that no identities of interest existed with the
lender.

HUD Adequately Reviewed the Financial Operations for the Operator
According to the punch list, HUD was required to review the financial operations and appraisals
for the operator. The punch list also required ORCF underwriters to review third-party appraisal
reports and ORCF’s appraisal reviews to determine whether the value conclusions in the reports
agreed with the lender narrative. In addition, the punch list required underwriters to review the
operator’s financial statements to determine its financial position. For the three loans reviewed,
HUD adequately reviewed the financial operations of the operator, which included
documentation, such as third-party appraisal reports and ORCF’s appraisal review, the lender’s
review of the operator’s financial statements, and the underwriter’s verification that net operating
income was acceptable and generally in line with the operator’s historical net operating income.



                                                 5
    HUD Adequately Reviewed the Creditworthiness of the Borrower, Operator, and Operator
    Parent
    For the three loans reviewed, HUD adequately reviewed the creditworthiness of the borrower,
    operator, and operator parent. The three loans were submitted as part of a large portfolio 3 of 48
    loans with a combined mortgage amount totaling more than $433 million. According to HUD
    Handbook 4232.1, chapter 17, a portfolio corporate credit review is required for all midsize and
    large portfolios. 4 Portfolio corporate credit review procedures apply to owners and operators to
    assess the credit risk. HUD reviews all materials submitted in the portfolio corporate credit
    review and determines whether the portfolio is an acceptable risk to the general insurance fund
    based on operation and ownership experience, financial strength, quality indicators, and any
    pending legal issues including the jurisdictional regulatory environments. Once HUD completes
    the review, it issues a corporate credit review memorandum notifying the lender of approval or
    rejection for individual applications. For the three loans reviewed, HUD adequately assessed the
    borrower, operator, and operator parent’s financial strength, quality of care, and ownership
    experience during the corporate credit review. The corporate credit memorandum contained a
    detailed review of the financial position, history with HUD, and ownership experience and
    provided organizational charts and resumes to show that the entities had experience in the senior
    care industry.

    Loan Applications Met Professional Liability Insurance Requirements
    According to HUD Handbook 4232.1, appendix 14.1, professional liability insurance
    requirements apply to new applications on behalf of residential care facilities seeking mortgage
    insurance under section 232(f) for the purchase or refinance of an existing facility. In addition,
    the punch list required that a professional liability analyst perform a professional liability
    insurance review of large portfolios before issuing a firm commitment. For the three loans
    reviewed, HUD adequately reviewed the professional liability insurance and ensured that the
    loan applications met the professional liability insurance requirements. Because all three loans
    had common ownership and were part of a large portfolio, a 50-plus operator review of the
    professional liability insurance was completed. HUD maintained documentation, such as the
    operator’s financial statements; copies of approved waivers; State licensing surveys; and a
    memorandum containing the results of HUD’s review of the operator’s loss histories, claim
    history, and Center for Medicare and Medicaid Services ratings, to show that it reviewed the
    operator’s financial performance, loss histories, applicable waivers, claims history, and Center
    for Medicare and Medicaid Services ratings.

    Project Capital Needs Assessments Were Completed and Reviewed
    For the three loans reviewed, HUD adequately reviewed the project capital needs assessments,
    which were completed by a third party and submitted by the lender. The project capital needs
    assessments reported on the physical condition of the property and recommended repairs. HUD
    verified that the repairs suggested by the lender were in line with the needs assessor’s repair
    conclusions. Also, HUD verified that repairs were clearly described and the projects met


3
     The borrower was the same for these 48 loans.
4
     Midsize portfolio = up to 49 facilities and a total mortgage amount > $90 million and < $250 million. Large
     portfolio = 50 or more facilities and a total mortgage amount > $250 million.


                                                            6
accessibility requirements. For the three loans, the projects needed critical and noncritical
repairs. The costs of those repairs were being financed as part of the refinance transaction. In
addition, HUD ensured that the lender provided a replacement reserve funding schedule to show
the projects’ proposed initial and annual deposit and a positive reserve balance for the first 15
years. According to the punch list, the recommended minimum balance for the replacement
reserve account was $1,000 per unit. For the three projects reviewed, the replacement reserve
funding schedule showed that the projects had 109 units, 69 units, and 64 units with initial
deposits totaling $109,000, $69,000, and $64,000 and annual deposits totaling $128,075,
$103,500, and $81,280, respectively.

HUD Did Not Adequately Evaluate the Creditworthiness of Management Agents
According to the punch list, underwriters were required to evaluate the creditworthiness of the
management agent. Specifically, underwriters were required to review the lender narrative,
credit reports, and the Consolidated Certification and perform internet searches for potential
investigations or litigation. If any of the sources reported delinquent Federal debt, judgments,
lawsuits or legal actions, bankruptcies, tax liens, or Medicare-Medicaid fraud, the ORCF
underwriter was required to have the lender address any issues before HUD issued a firm
commitment. According to 24 CFR (Code of Federal Regulations) 200.230, a principal 5 may be
disapproved for participation if there are unresolved findings as a result of HUD or other
government audits or investigations. In addition, HUD Handbook 4232.1, chapter 6, states that a
principal may be rejected if there are judgments or actions against the principal that (1) could
significantly impact the financial position of the individual, firm, or corporation or (2) result in a
determination that the individual, firm, or corporation is an unacceptable credit risk.

For the three files reviewed, the borrower used the same management agent. We reviewed the
credit report for the management agent and found that there were no significant issues.
However, we performed an internet search on the management agent and found that it was a
defendant in a legal action 6 in which a complainant accused the management agent of Medicare
and Medicaid fraud. The complainant alleged that while working at a nursing home facility,
which was managed by the management agent company, the complainant witnessed staff
submitting false Medicare and Medicaid claims. The initial complaint was filed in June 2011;
however, the management agent company was not specifically named as a defendant until an
amended complaint was filed in June 2013. According to a news article, in February 2017, a
Florida Federal jury found that the management agent company, along with operators of 52
skilled nursing facilities, was liable for more than $115 million in damages stemming from the
false claims. Specifically, the jury ruled that the management agent should be held liable for
$109.8 million in damages for submitting 123 false Medicare claims. However, in January 2018,
a Federal court in Florida overturned the jury verdict. When the lender submitted the application
to HUD in January 2016, this case was ongoing, and the issue was not addressed by the lender or

5
    A principal is defined as a principal or private entity proposing to participate in a project as a borrower, operator,
    parent of the operator, management agent, general contractor, or the like. A principal may have an active role in
    a project and direct the activities and affairs of the borrower entity or be involved in decision making, or a
    principal may have a passive role in which the principal’s participation is limited to an ownership interest in the
    project.
6
    United States ex rel. Angela Ruckh v. Salus Rehabilitation, LLC, et al


                                                             7
HUD. The lender disclosed this specific legal action in the Consolidated Certification.
However, HUD did not review this document and did not address this issue before issuing the
firm commitment. This condition occurred because the underwriters did not follow procedures.
The underwriters’ supervisor stated that they relied heavily on the lender narrative and the lender
narratives for these three loans did not disclose the legal action. However, the Consolidated
Certification disclosed the legal action. Therefore, the underwriters should have been aware of
the legal action because the punch list required them to review the Consolidated Certification. If
HUD does not implement controls and procedures to ensure that it properly evaluates the
creditworthiness of management agents, it could approve loans for projects with management
agents that significantly impact the financial position of the project.

HUD Took Action To Correct the Issue
After we notified HUD of the issue, it took immediate corrective action to ensure that it
adequately evaluates the creditworthiness of management agents when underwriting future loans.
It updated the punch list by adding additional review steps, to include requesting that the Office
of General Counsel review the Consolidated Certification form and identify any material legal
issues. The updated punch list will also require the underwriter to perform additional internet
searches on the project, borrower, operator, management agent, and their principals and parent
organizations to identify any significant adverse information before the loan committee decides
whether to issue the firm commitment. On July 19, 2018, HUD implemented the updated punch
list by issuing a memorandum to its underwriters and managers to inform them that the updated
punch list was effective immediately.

Conclusion
HUD generally approved Section 232 FHA-insured loans for projects that qualified for mortgage
insurance in accordance with HUD requirements. However, for three loans reviewed, it did not
adequately evaluate the creditworthiness of management agents as required. Without controls
and procedures to ensure that it properly evaluates the creditworthiness of management agents,
HUD could approve loans for projects with management agents that significantly impact the
financial position of the project. During the audit, HUD took immediate corrective action to
ensure that it adequately evaluates the creditworthiness of management agents when
underwriting future loans.

Recommendations
We recommend that the Deputy Assistant Secretary for Healthcare Programs

       1A.     Develop and implement controls and procedures to ensure that HUD’s
               underwriters properly evaluate the creditworthiness of management agents when
               underwriting future loans.

               On July 19, 2018, HUD implemented the recommendation by updating its punch
               list and issuing a memorandum to its underwriters and managers to inform them
               that the updated punch list was effective immediately. Therefore, no further
               action is required by the Office of Healthcare Programs. At issuance of this audit
               report, we will enter a management decision into HUD’s Audit Resolution and


                                                 8
Corrective Action Tracking System, along with the updated punch list and
memorandum, to show that final action was completed.




                                9
Scope and Methodology
We conducted the audit from October 2017 through July 2018 at our office located in
Philadelphia, PA. The audit covered the period October 2015 through September 2017.

To accomplish our objective, we reviewed

   •   relevant background information, including portfolio data and prior HUD Office of
       Inspector General (OIG) audit reports.
   •   the National Housing Act of 1959.
   •   applicable HUD regulations; HUD Handbook 4232.1, REV-1; HUD Notice H 2016-15;
       and punch lists related to section 232-223(f) loans.
   •   HUD’s organizational chart and employee listing.

We interviewed staff from HUD’s Office of Healthcare Programs and Office of Residential Care
Facilities.

To achieve our audit objective, we relied in part on computer-processed data from HUD’s
Multifamily Data Mart, Multifamily Delinquency and Default Reporting system, and the Online
Property Integrated Information Suite. Although we did not perform a detailed assessment of the
reliability of the data, we did perform a minimal level of testing and found the data to be
adequate for our purposes at the time of review. The testing entailed comparing loan information
in HUD’s system to the electronic loan files provided by HUD.

As of October 2017, the Section 232 program portfolio included 4,086 active loans with original
loan amounts totaling more than $28.5 billion and unpaid principal balances totaling more than
$26.1 billion. The loans had final endorsement dates between May 1986 and October 2017. To
narrow our universe, we focused on loans with final endorsement dates during the period
October 1, 2015, through September 30, 2017. During that period, there were 569 loans with
original loan amounts totaling more than $5.9 billion and unpaid principal balances totaling more
than $5.8 billion. Based on an initial analysis of the data, we identified 28 loans that were
delinquent and refinanced. We sorted the 28 loans and selected 3 of the 4 loans with the highest
original loan amounts totaling nearly $50 million, with unpaid principal balances of more than
$48.8 million. HUD issued firm commitments for these three loans on July 29, 2016.
During our review of the sample loan files and additional analysis of the data, we determined
that the initial universe of 28 delinquent and refinanced loans was incorrect. Of the 569 loans
with final endorsement dates within our audit period, 543 were refinances and only 1 was
previously delinquent. Therefore, less than 1 percent of the loans endorsed during the audit
period was delinquent. Although our initial approach to review loans that were delinquent and
refinanced was flawed, the results of our review are valid because nearly all of the loans



                                                10
endorsed during the audit period had not been delinquent and we reviewed three of them to
determine whether HUD approved Section 232-FHA insured loans for projects that qualified for
mortgage insurance in accordance with applicable HUD requirements.
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 controls were relevant to our audit objective:

•   Program operations – Policies and procedures that management has implemented to
    reasonably ensure that a program meets its objectives.

•   Validity and reliability of data – Policies and procedures that management has implemented
    to reasonably ensure that valid and reliable data are obtained, maintained, and fairly
    disclosed in reports.

•   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 controls identified above.

A deficiency in internal control exists when the design or operation of a control does not allow
management or employees, in the normal course of performing their assigned functions, the
reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or
efficiency of operations, (2) misstatements in financial or performance information, or (3)
violations of laws and regulations on a timely basis.

We evaluated internal controls related to the audit objective in accordance with generally
accepted government auditing standards. Our evaluation of internal controls was not designed to
provide assurance regarding the effectiveness of the internal control structure as a whole.
Accordingly, we do not express an opinion on the effectiveness of HUD’s internal control.




                                                  12
Appendix

Appendix A


             Auditee Comments and OIG’s Evaluation


Ref to OIG
Evaluation
              Auditee Comments




Comment 1




Comment 1




                               13
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




                               14
                         OIG Evaluation of Auditee Comments


Comment 1   HUD stated that it concurred with the recommendation. It also stated that it made
            changes to the punch list and is extending the new procedure to include the
            borrower, operator and principal of the operator, and the management agent. It
            further stated that its ORCF underwriters would perform internet searches on all
            principals of the Consolidated Certification. HUD stated that if it identifies any
            questionable findings, it would request an explanation from the lender and may
            also request assistance from the Office of General Counsel to interpret the matter
            to determine the potential impact and risk to the long-term viability of the FHA-
            insured loan. HUD issued a memorandum to its underwriters and managers on
            July 19, 2018, implementing the updated punch list effective immediately. We
            reviewed the updated punch list and the memorandum and confirmed that HUD’s
            actions sufficiently addressed the intent of our recommendation. We will close
            this recommendation concurrent with the report issuance.




                                             15