Luther Towers II, Wilmington, DE
HUD-Insured Section 202 Multifamily Rental Housing
for Seniors and Persons With Disabilities
Office of Audit, Region 3 Audit Report Number: 2018-PH-1006
Philadelphia, PA September 21, 2018
To: Dean J. Santa, Director, Northeast Region Asset Management Division, 2AH
//signed//
From: David E. Kasperowicz, Regional Inspector General for Audit, Philadelphia
Region, 3AGA
Subject: The Owner of Luther Towers II, Wilmington, DE, Did Not Manage Its HUD-
Insured Project in Accordance With Its Regulatory Agreement and 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 the HUD-insured Luther Towers II 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
215-430-6734.
Audit Report Number: 2018-PH-1006
Date: September 21, 2018
The Owner of Luther Towers II, Wilmington, DE, Did Not Manage Its HUD-
Insured Project in Accordance With Its Regulatory Agreement and HUD
Requirements
Highlights
What We Audited and Why
We audited Luther Towers II because it was a high-risk multifamily project that received low
inspection and financial assessment scores on our multifamily risk assessment for projects within
our region and we had never audited it. Our audit objective was to determine whether the owner
managed the project in accordance with its regulatory agreement and U.S. Department of
Housing and Urban Development (HUD) requirements.
What We Found
The owner of Luther Towers II did not manage the project in accordance with its regulatory
agreement and HUD requirements. Specifically, the owner (1) could not show that it always
used project funds for costs that were reasonable and necessary for the operation of the project
because it commingled HUD funds totaling more than $1.7 million with its own funds and those
of its other activities, (2) pledged up to $100,000 in project funds as security for its line of credit,
(3) used project funds totaling more than $407,000 to pay its line of credit liability, (4) managed
the project without a HUD-approved management certification and management entity profile,
and (5) did not ensure that all tenant security deposit funds were deposited into the project’s
security deposit bank account. These conditions occurred because the owner (1) lacked an
understanding of the terms of the regulatory agreement and HUD requirements, (2) had poor
record-keeping practices, and (3) did not have controls to ensure that the project was managed in
accordance with the regulatory agreement and HUD requirements. As a result, disbursements
totaling more than $2.1 million were unsupported, and up to $100,000 in project funds could be
put to better use.
What We Recommend
We recommend that HUD require the owner to (1) provide documentation to show that
disbursements totaling more than $2.1 million were reasonable and necessary expenses for the
operation of the project or repay the project from non-project funds for any amount it cannot
support, (2) segregate project bank accounts from the owner’s bank accounts, (3) remove project
bank accounts as security for its line of credit, (4) submit a management certification and other
required documentation to HUD for review and approval, and (5) develop and implement
policies and procedures to ensure that the project funds are used in accordance with its regulatory
agreement and HUD requirements.
Table of Contents
Background and Objective......................................................................................3
Results of Audit ........................................................................................................4
Finding: The Owner of Luther Towers II Did Not Manage the Project in
Accordance With Its Regulatory Agreement and HUD Requirements ....................... 4
Scope and Methodology .........................................................................................10
Internal Controls ....................................................................................................11
Appendixes ..............................................................................................................12
A. Schedule of Questioned Costs and Funds To Be Put to Better Use ...................... 12
B. Auditee Comments and OIG’s Evaluation ............................................................. 13
C. Unsupported Disbursements From Project Funds to the Owner’s Other
Accounts ..................................................................................................................... 16
2
Background and Objective
Luther Towers II receives U.S. Department of Housing and Urban Development (HUD) project-
based Section 8 assistance for 136 housing units available to seniors and persons with
disabilities. The project is located at 1420 North Franklin Street, Wilmington, DE. The project
is owned by Lutheran Senior Services, Inc., incorporated in Delaware on March 31, 1967.
Thirty-one of the subsidized apartments are operated as assisted living units. The owner, a
nonprofit corporation, also operates a restaurant in the project’s building; an assisted living
program; and another apartment building for the elderly, Luther Towers I, which does not
receive HUD housing assistance payments.
The owner had two mortgages insured by the Federal Housing Administration (FHA) under
Section 202 1 of the Housing Act of 1959, one for the project and another for Luther Towers I.
The owner signed a mortgage on the project with HUD for $5 million in 1977. On May 22,
2018, the owner refinanced both loans under Section 207, according to Section 223(f) of the
National Housing Act 2 for more than $8.9 million, as one mortgage with two buildings.
Additionally, the owner received a $2.7 million HUD grant in 2003 to convert 31 apartments into
assisted living facility units.
HUD regulates the project through a regulatory agreement with the owner. The project received
nearly $4 million in housing assistance from HUD over the last 4 years, as shown in the
following table.
Total project-based voucher
Fiscal year
funding received
2014 $ 908,707
2015 956,250
2016 1,016,278
2017 1,078,225
Total 3,959,460
Our audit objective was to determine whether the owner managed the project in accordance with
its regulatory agreement and HUD requirements.
1
Until the creation of the Section 811 program in 1990, the Section 202 program provided funding to nonprofit
organizations that developed and operated housing for seniors with very low incomes and people with
disabilities.
2
Section 207-223(f) insures mortgage loans to facilitate the purchase or refinancing of existing multifamily rental
housing. These projects may have been financed originally with conventional or FHA-insured mortgages.
3
Results of Audit
Finding: The Owner of Luther Towers II Did Not Manage the
Project in Accordance With Its Regulatory Agreement and HUD
Requirements
The owner of Luther Towers II did not manage its multifamily project in accordance with its
regulatory agreement and HUD requirements. Specifically, the owner (1) could not show that it
always used project funds for costs that were reasonable and necessary for the operation of the
project because it commingled HUD funds totaling more than $1.7 million with its own funds
and those of its other activities, (2) pledged up to $100,000 in project funds as security for its line
of credit liability, (3) used project funds totaling more than $407,000 to pay its line of credit
liability, (4) managed the project without a HUD-approved management certification and
management entity profile, and (5) did not ensure that all tenant security deposit funds were
deposited into the project’s security deposit bank account. These conditions occurred because
the owner (1) lacked an understanding of the terms of the regulatory agreement and HUD
requirements, (2) had poor record-keeping practices, and (3) did not have controls to ensure that
the project was managed in accordance with the regulatory agreement and HUD requirements.
As a result, the project incurred more than $2.1 million in unsupported costs from improper
transfers of project funds to the owner’s bank accounts and payments on the owner’s line of
credit. The project also exposed project funds to risk from creditor claims of up to $100,000.
Additionally, HUD was prevented from properly performing its oversight of the project because
the owner did not have an approved management certification and other required forms. Finally,
the owner put tenant funds at risk because it did not deposit all security deposits into the
project’s security deposit account.
The Owner Could Not Show That Bank Transfers of Project Funds Totaling More Than
$1.7 Million Were for Reasonable and Necessary Expenses
The owner may have disbursed project funds totaling more than $1.7 million during our audit
period for costs benefiting the owner’s other activities. According to the owner’s business
manager, most expenses, including payroll, for all of the owner’s entities were paid from a
“shared” accounts payable bank account. The business manager and the prior business manager
transferred lump sum estimates of the project’s share of costs from the bank account in which
HUD deposits housing assistance payments to the owner’s “shared” accounts payable bank
account. Because the transfers were estimates, there was no documentation to show that the
amounts transferred were for eligible project costs. The chart in appendix C shows the transfers
totaling more than $1.7 million from the bank account in which HUD funds were deposited to
the owner’s other bank accounts.
The owner’s bank accounts were all in the name of the owner, Lutheran Senior Services, Inc.
The descriptions of the bank accounts in the chart below were provided by the owner. They
were not listed in the account titles on the bank statements.
4
Bank account descriptions
1 Luther Towers II (HUD project) revenue
2 Luther Towers II reserve for replacement
3 Luther Towers II security deposits
4 Luther Towers I revenue
Luther Towers I reserves and security
5
deposit accounts
6 General fund
7 Payables
8 Payroll investment (retirement)
The information in the accounting system was not reliable because it was inaccurate due to poor
record keeping. The business manager stated that the accounting system did not record
transactions in separate general ledger accounts for each of the owner’s activities and the cash
accounts were commingled. Therefore, adjustments and reconciliations to correct the accounts
had to be done after each year end. Although the last fiscal year ended December 31, 2017, the
adjustments had not been made. For example, we found a disbursement for $10,450 on the HUD
revenue account bank statement dated December 21, 2017, which was recorded in the accounting
system as a disbursement from the Luther Towers I bank account. Further, the business manager
stated it was to pay an invoice for food, which was an expense of the owner’s restaurant.
The regulatory agreement required the owner to establish a revenue account with a Federal
Deposit Insurance Corporation-insured bank. Rents and any income arising from the operation
of the project must be deposited into this account, and expenditures must be made from this
account. The regulatory agreement also required project income and other funds to remain
segregated from any other funds, and income and funds of the project must be spent only for the
project. Finally, the regulatory agreement required all receipts to be deposited in the name of the
project into the bank and be withdrawn only for expenses of the project, in accordance with the
operating budget approved by HUD. Project funds should be used only to make mortgage
payments, make required deposits to the reserves for replacement account, and pay reasonable
expenses necessary for the operation and maintenance of the project. Further, HUD Handbook
4370.2, REV-1, section 2-6, requires that only reasonable and necessary expenses be charged to
the project and states that all disbursements from a project’s regular operating account must be
supported by approved invoices, bills, or other supporting documentation.
These deficiencies occurred because the owner’s executive director and staff lacked knowledge
regarding the terms of the regulatory agreement and HUD requirements, had poor record-
keeping practices, and a lack of controls to ensure that it complied with its regulatory agreement
and applicable HUD requirements. During the audit, the executive director and business
manager stated that they purchased additional accounting software to segregate the project’s
revenues and expenses. As a result, we could not determine what portion of the transfers to the
owner’s accounts reflected eligible project costs that were reasonable and necessary for the
5
operation and maintenance of the project. Therefore, disbursements totaling more than $1.7
million were unsupported.
The Owner Used the Project’s Bank Accounts as Collateral, in Violation of the Regulatory
Agreement, and Made Unsupported Loan Payments
Contrary to the terms of the regulatory agreement, the executive director stated that he opened a
$100,000 line of credit for the owner in 2010. During the audit period, the business managers
transferred more than $407,000 from the project’s HUD revenue bank account to pay down the
liabilities on the line of credit. HUD Handbook 4370.2, REV-1, section 2-6, requires that only
reasonable and necessary expenses be charged to the project, and the regulatory agreement
requires all receipts to be withdrawn only for expenses of the project in accordance with a budget
approved by HUD. The chart below shows the transfers from the project’s HUD revenue bank
account to the owner’s line of credit.
Year Amount transferred
2016 $208,880
2017 198,135
Total 407,015
Additionally, because bank accounts with the project’s funds on deposit were included with all
of the owner’s bank accounts as security for the line of credit, up to $100,000 may be at risk of
loss if the owner defaults on its liability. The loan agreement stated that the owner’s money on
deposit at the bank would secure the loan. Because the project’s revenue, reserve for
replacement, and security deposit bank accounts were in the owner’s name, project funds were at
risk. Further, this was a violation of the regulatory agreement, which states that the borrower
assigns all of its rights to the income of the mortgaged property to HUD. It also states that the
borrower must not, without HUD’s permission, encumber any personal property, including rents,
and must not pay out any funds except as provided in the regulatory and building loan
agreements.
HUD officials stated that they did not approve the line of credit, and the executive director
confirmed that he did not get HUD’s approval. The executive director stated that the transfers
were made to ensure that funds were available for payroll liabilities and to manage cash flow
deficiencies. From 2016 to 2017, the executive director’s salary increased $37,000, which he
stated was funded by the line of credit. He also stated the salary increase was approved by the
board of directors, but we did not find a record of it in the corporate minutes. HUD officials
stated that such a large a salary increase would need to be submitted as part of a new budget for
the project. The owner did not submit a new budget for the project. Instead, it received an
automatic annual operating cost adjustment factor of approximately 1 or 2 percent.
These conditions occurred because the owner did not have policies and procedures to ensure that
it complied with its regulatory agreement and HUD requirements. As a result, disbursements
6
totaling more than $407,000 were unsupported because the costs may not have been reasonable
and necessary for the operation and maintenance of the project. By removing the project’s
accounts as security for the owner’s line of credit, the project will put up to $100,000 in project
funds to better use because the funds will no longer be at risk from claims from the owner’s
creditors.
The Owner Operated the Project Without an Approved Management Certification
For our audit period, the owner did not submit the required management entity approval
documents, including disclosing its identity-of-interest relationships to HUD. The project is
managed by the executive director and his staff, who are employees of the owner. The executive
director had been in this position since 2009. He had a familial relationship with the human
resources director who was his wife. HUD stated that it did not have a management certification
or entity profile for the project.
HUD Management Agent Handbook 4381.5, REV-2, section 2.2, required the owner to submit
the management certification and other information to HUD for review. HUD officials stated
that the owner needed to submit the correct owner’s management certification 3 and a
management entity profile. This condition occurred because the project lacked controls to ensure
that it complied with its regulatory agreement and applicable HUD requirements. The owner’s
executive director stated that he would work with HUD to file the correct management
certification and any other forms and documents HUD required. Because the owner did not
submit the required forms, HUD was not aware of the identity-of-interest relationships and
related financial transactions, preventing it from properly conducting its oversight
responsibilities.
The Owner Did Not Ensure That All Tenant Security Deposit Funds Were Deposited Into
the Security Deposit Bank Account
The owner did not follow HUD requirements to deposit all tenant security deposits into a
separate security deposit account. According to the bank statement, the security deposit account
balance as of December 31, 2017, was $39,168, after adjustment for a deposit in transit. The
project’s security deposit by tenant summary spreadsheet total was $39,512, resulting in a
deficiency of $344. The manager stated that the spreadsheet balance was correct, and she
deposited $344 to the project’s security deposit account after we asked her about the
discrepancy. The human resources director stated that sometimes a security deposit might be
deposited into the revenue account, along with rent or other payments. HUD Handbook 4370.2,
REV-1 chapter 2 section 2-9, required that the security deposit bank account balance be
confirmed with the amount shown on the books. This condition occurred because the owner
lacked policies and procedures to ensure that it reconciled the bank balance to the amount of
tenant deposits shown on the books, as required. Tenant funds could be at risk of loss because
the security deposit bank account had insufficient funds to account for all tenant deposits paid.
During the audit, the manager deposited $344 to the account to correct the deficiency. The
3
Project owner’s or management agent’s certification for multifamily housing projects for identity-of-interest or
independent management agents (HUD form 9839)
7
executive director stated that going forward the staff would perform regular account
reconciliations to ensure that tenant funds were deposited into the correct bank account.
Conclusion
The owner did not manage its multifamily project in accordance with its regulatory agreement
and HUD requirements. The owner could not show that it used more than $2.1 million 4 in
project funds for costs that were reasonable and necessary for the operation of the project;
improperly pledged up to $100,000 in project funds as security for its line of credit liability;
managed the project without a HUD-approved management certification and management entity
profile; and did not deposit all tenant security deposit funds into the project’s security deposit
bank account. These conditions occurred because the owner lacked an understanding of the
terms of the regulatory agreement and HUD requirements, had poor record-keeping practices,
and did not have controls to ensure that the project was managed in accordance with the
regulatory agreement and HUD requirements. As a result, disbursements of project funds
totaling more than $2.1 million were unsupported; project funds of up to $100,000 were at risk
from creditor claims; HUD was prevented from properly performing its oversight of the project;
and tenant funds for security deposits were at risk. By removing the project’s accounts as
security for the owner’s line of credit, the project will put up to $100,000 in project funds to
better use because the funds will no longer be at risk from claims from the owner’s creditors.
Recommendations
We recommend that the Director of HUD’s Northeast Region Asset Management Division direct
the owner to
1A. Provide documentation to show that disbursements totaling $2,136,849 and any
bank transfers to the owner’s non-project accounts that occurred outside of our
audit period were reasonable and necessary expenses for the operation of the
project or repay the project from non-project funds for any amount that it cannot
support.
1B. Provide documentation to show that project funds are segregated in the project’s
name, in accordance with the regulatory agreement and HUD requirements.
1C. Take immediate action to remove project bank accounts as security for the
owner’s line of credit and, thereby put up to $100,000 to better use.
1D. Submit a project owner’s or management agent’s certification, management entity
profile, current budget and other required documentation to HUD for review and
approval.
1E. Develop and implement controls to ensure that the project complies with the
regulatory agreement and applicable HUD requirements, including but not limited
to policies and procedures for maintaining project funds in separate bank accounts
4
See Appendix C
8
in the project’s name, using project funds only for necessary expenses of the
project, and reconciling bank accounts to the project’s computerized accounting
records.
We recommend that the Director of HUD’s Northeast Region Asset Management Division
1F. Provide training and technical assistance to the owner’s executive director and
staff to ensure compliance with the terms of its regulatory agreement and
applicable HUD requirements.
9
Scope and Methodology
We conducted the audit from November 2017 through August 2018 at the offices of Luther
Towers II located at 1420 North Franklin Street, Wilmington, DE, and at our office located in
Philadelphia, PA. The audit covered the period January 1, 2016, through December 31, 2017.
To accomplish our objective, we reviewed
• HUD’s files for the project, including the mortgage and regulatory agreement.
• HUD’s program requirements at 24 CFR (Code of Federal Regulations) Parts 983 and 5;
HUD Handbooks 4350.3, 4350.5, 4370.2, and 4381.5; housing assistance payment
agreements; and other guidance.
• the owner’s audited 2016 financial statements.
• the owner’s computerized financial records.
• the owner’s bank statements into which the project-based Section 8 assistance funds were
deposited.
• return of the owner’s Organization Exempt From Income Tax forms (Internal Revenue
Service Form 990) for the fiscal year ending December 31, 2015.
We also
• observed the physical condition of the project.
• interviewed employees of the owner and HUD staff.
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.
10
Internal Controls
Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to
• effectiveness and efficiency of operations,
• reliability of financial reporting, and
• compliance with applicable laws and regulations.
Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals, and objectives. Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program operations as well as the
systems for measuring, reporting, and monitoring program performance.
Relevant Internal Controls
We determined that the following internal controls were relevant to our audit objectives:
• 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 resource use 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.
Significant Deficiencies
Based on our review, we believe that the following items are significant deficiencies:
• The owner lacked an understanding of the terms of the regulatory agreement and HUD
requirements.
• The owner lacked controls to ensure that the project was managed in accordance with its
regulatory agreement and HUD requirements.
11
Appendixes
Appendix A
Schedule of Questioned Costs and Funds To Be Put to Better Use
Recommendation Funds to be put
Unsupported 1/ to better use 2/
number
1A $2,136,849
1C $100,000
1/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program
or activity when we cannot determine eligibility at the time of the audit. Unsupported
costs require a decision by HUD program officials. This decision, in addition to
obtaining supporting documentation, might involve a legal interpretation or clarification
of departmental policies and procedures.
2/ 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, if the owner implements our
recommendations, the project will protect project assets from creditor claims.
12
Appendix B
Auditee Comments and OIG’s Evaluation
Ref to OIG Auditee Comments
Evaluation
Comment 1
Comment 2
13
Auditee Comments and OIG’s Evaluation
Ref to OIG Auditee Comments
Evaluation
Comment 2
Comment 2
Comment 3
Comment 4
14
OIG Evaluation of Auditee Comments
Comment 1 The owner stated that it will show HUD that the bank transfers to its non-project
accounts totaling more than $2.1 million were for costs that were reasonable and
necessary for the operation of the project. As part of the audit resolution process,
HUD will review the documentation provided by the owner, determine whether it
satisfies the recommendation, and provide its determination and the
documentation to OIG for review and concurrence.
Comment 2 The owner agreed with the recommendation. As part of the audit resolution
process, HUD and OIG will agree on the necessary documentation to be provided
by the owner to show that its corrective actions satisfied the recommendations.
Comment 3 The owner stated that while it does not concede that it failed to perform tasks, it is
prepared to work with HUD to implement and strengthen necessary controls to
ensure future compliance with the regulatory agreement and applicable HUD
requirements. As stated in the audit report, the owner lacked controls to ensure
that the project was managed in accordance with the regulatory agreement and
HUD requirements such as to maintain project funds in separate bank accounts in
the project’s name, use project funds only for necessary project expenses and
reconcile bank accounts to the project’s computerized accounting records. The
owner stated that it will take corrective actions that address the intent of the
recommendations. As part of the audit resolution process, HUD and OIG will
agree on the necessary documentation to be provided by the owner to show that
its corrective actions satisfied the recommendation.
Comment 4 The owner stated that it will accept training from HUD. We acknowledge the
owner’s positive attitude toward the audit report and the recommendations.
15
Appendix C
Unsupported Disbursements From Project Funds to the Owner’s Other Accounts
Transfers to the Transfers to the Transfers to Transfers
Transfers to Total
owner’s shared owner’s payroll the owner’s to the
the owner’s transfers to
Year accounts investment Luther owner’s
general fund other
payable bank (retirement) Towers I credit
bank account accounts
account bank account bank accounts card
2016 $805,500 $450 $46,610 $4,500 $857,060
2017 838,118 $16,956 17,700 872,774
Totals 1,643,618 16,956 18,150 46,610 4,500 1,729,834
Total
Transfers to pay the
transfers to Total of all
Year owner’s line of
other transfers
credit
accounts
2016 $857,060 $208,880 $1,065,940
2017 872,774 198,135 1,070,909
Totals 1,729,834 407,015 2,136,849
16
The Owner of Luther Towers II, Wilmington, DE, Did Not Manage Its HUD-Insured Project in Accordance With Its Regulatory Agreement and HUD Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-09-21.
Below is a raw (and likely hideous) rendition of the original report. (PDF)