oversight

Oakmont North Apartments I, II, and III Multifamily Mortgagor Operations Norfolk, Virginia

Published by the Department of Housing and Urban Development, Office of Inspector General on 1996-07-31.

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

                                                                    Issue Date

                                                                         July 31, 1996
                                                                    Audit Case Number

                                                                         96-PH-212-1019




TO:            Charlie Famuliner, Director, Multifamily Division,
               Virginia State Office, 3FHM


FROM:          Edward F. Momorella, District Inspector General for
               Audit, Mid-Atlantic, 3AGA

SUBJECT:       Oakmont North Apartments I, II, and III
               Multifamily Mortgagor Operations
               Norfolk, Virginia


We audited the operations of Oakmont North Apartments I, II, and III (projects), to determine
whether the owner and identity-of-interest management agent (agent) operated the projects
according to the terms and conditions of the Regulatory Agreement and applicable HUD
requirements.

The report identifies that the owner used projects revenue to reduce advances when the mortgages
were in default, and incurred ineligible and unsupported expenses. As a result the projects which
are in financial distress lost the use of needed revenue.

Within 60 days, please give us, for each recommendation made in the report, a status report on:
(1) the corrective action taken; (2) the proposed corrective action and the date to be completed;
or (3) why action is considered unnecessary. Also, please furnish us copies of any
correspondence or directives issued because of the audit.

If you have any questions, please contact Irving I. Guss, Assistant District Inspector General for
Audit, at (215) 656-3401.
Management Memorandum




96-PH-212-1019          Page ii
Executive Summary
We audited the operations of the projects to determine whether the owner operated the projects
according to the terms and conditions of the Regulatory Agreement, and applicable HUD
requirements.



                                    The owner reduced the projects overdrafts during mortgage
 Projects funds improperly
                                    default contrary to HUD requirements. The overdrafts
 applied to reduce
                                    represented the owner's debt payable to the bank. The
 overdrafts
                                    owner stopped making mortgage payments and projects
                                    revenue of $298,281 was improperly applied against the
                                    outstanding overdrafts.

                                    The owner paid ineligible and unsupported expenses which
 Projects paid
                                    totaled $56,249 and $2,390, respectively, contrary to HUD
 questionable costs
                                    requirements. The owner and agent did not manage these
                                    cash disbursements properly. As a result the projects which
                                    are in financial distress lost the use of needed revenue.

                                    We recommend the owner reimburse HUD the final
                                    overdraft amounts, repay the projects the ineligible costs
                                    and justify the unsupported costs.

                                    We discussed the draft findings with owner/agent
                                    representatives during the audit and at an exit conference
                                    held on July 23, 1996. The draft findings were provided to
                                    the owner and responses received were considered in our
                                    report. The owner responses are included as Appendix B.




                                            Page iii                               96-PH-212-1019
Executive Summary




96-PH-212-1019      Page iv
Table of Contents

Management Memorandum                                                  i


Executive Summary                                                     iii


Introduction                                                           1


Findings

    1      The Owner Improperly Reduced Bank
           Overdrafts During Mortgage Default                          3

    2      The Owner Paid Ineligible and Unsupported
           Expenses                                                    7


Internal Controls                                                    13


Follow Up On Prior Audits                                            15


Appendices
    A Schedule of Ineligible and
        Unsupported Costs                                            17


    B      Auditee Comments                                          19


    C      Distribution                                              27


Abbreviations
    HUD      Department of Housing and Urban Development


                                    Page v                 96-PH-212-1019
Table of Contents



         OIG        Office of Inspector General




96-PH-212-1019                                Page vi
Introduction
Oakmont Associates, Phase I, II, and III, a Virginia Limited Partnership, owner, was organized
on March 1, 1982 to acquire and operate Oakmont North Apartments I, II, and III. The general
partner of Oakmont Associates is Great Atlantic Management Company, Inc., an identity-of-
interest management agent owned solely by Edwin A. Joseph, a limited partner in Oakmont
Associates.

The projects consist of 456 units located in Norfolk, Virginia. The mortgages were endorsed for
insurance under Section 221(d)(3) of the National Housing Act. The owner executed five-year
Housing Assistance Payment contracts beginning November 1, 1992 for 55, 30, and 50 units for
Oakmont North I, II, and III, respectively.

The owner defaulted on the mortgages in October 1995. The mortgages were assigned to HUD
in March 1996. The owner agreed to a deed in lieu of foreclosure transaction in June 1996.
HUD took over management of the projects in June 1996.

Primary tenant records are maintained at the projects office. Financial records are maintained at
the agent's office at 2 Eaton Street, Suite 1100, Hampton, Virginia.



                                     The primary objective of the audit was to determine
 Audit Objectives
                                     whether the owner/agent managed the projects in
                                     accordance with HUD regulations and requirements.
                                     Specific objectives were to determine whether the
                                     owner/agent: (1) established adequate internal controls to
                                     safeguard the projects assets, assure reliable accounting
                                     data and operating efficiencies, (2) complied with the terms
                                     and conditions of management certifications and regulatory
                                     agreements, and (3) assured HUD housing assistance
                                     payments and claims are correct.

                                     We reviewed HUD, agent and projects files and interviewed
 Audit Scope
                                     pertinent HUD and agent staff.

                                     Our audit was performed between January 1996 and June
 Audit Period
                                     1996, and covered the activities from January 1995 through
                                     December 1995. The audit period was expanded when
                                     appropriate.

                                     We conducted the audit in accordance with generally
                                     accepted government auditing standards.




                                              Page 1                                 96-PH-212-1019
Introduction




96-PH-212-1019   Page 2
                                                                                    Finding 1




       The Owner Improperly Reduced Bank
        Overdrafts During Mortgage Default

The owner reduced the projects overdrafts during mortgage default contrary to HUD
requirements. The overdrafts represented the owner's debt payable to the bank. The owner
stopped making mortgage payments, and projects revenue of $298,281 was improperly applied
against the outstanding overdrafts.



                                  HUD Handbook 4370.2 REV-1, dated 5/92, paragraph 2-11
                                  A, prohibits the repayment of advances when the project is
                                  in a non-surplus cash position.

                                  In 1992, the projects operations did not generate sufficient
 Bank overdrafts owner
                                  revenues to cover the projects expenses. The owner and
 responsibility
                                  management company independently, on June 29, 1992,
                                  executed an indemnity agreement with the bank which
                                  permitted overdrafts to the projects accounts. Section 2 of
                                  the agreement states the owner "...hereby agrees to
                                  reimburse the Bank immediately upon demand by the Bank
                                  and without further action by it, for the full amount of any
                                  and all overdrafts resulting from time to time in the Deposit
                                  Accounts as the same shall occur..." The bank allowed the
                                  projects overdrafts to grow and did not demand payment.

                                  In October 1995, HUD informed the owner that the
 Overdrafts reduced when
                                  overdrafts were owner advances and repayment could only
 mortgage payments
                                  be made when the projects were in a surplus cash position.
 stopped
                                  The owner disagreed with HUD and discontinued making
                                  mortgage payments thereby allowing the overdrafts to be
                                  reduced.

                                  The projects monthly accounting reports indicated that the
                                  last mortgage payments were made in September 1995 and
                                  the overdrafts decreased as follows:




                                           Page 3                                  96-PH-212-1019
Finding 1




                    Overdrafts       Overdrafts       Overdrafts
                  After Sept 1995        At         Reduced During
       Project   Mortgage Payment   Apr 30, 1996    Mortgage Default




                                         The owner agreed to a deed in lieu of foreclosure and HUD
                                         started managing the projects on June 3, 1996. We
                                         requested, and the owner refused to provide us with updated
                                         overdraft amounts when HUD took the projects. The owner
                                         stated that HUD agreed not to pursue the reduction of the
                                         overdrafts as a condition for the deed in lieu of foreclosure
                                         transaction. The HUD Virginia State Office Chief Counsel
                                         stated that HUD did not agree to release owner liability for
                                         repaying owner advances during mortgage default on the
                                         deed in lieu documents. In the absence of projects surplus
                                         cash, reduction of the overdrafts was the owner's
                                         responsibility not the projects'.



Auditee Comments                         The owner's attorney stated this finding was not supported
                                         by law and did not violate the HUD Handbook provisions
                                         because the amount owed to the bank was a trade debt and
                                         not an owner advance. The overdraft funds were used to
                                         timely pay trade debts thereby providing the tenants with
                                         safe, clean and affordable housing.

                                         The attorney stated that the overdrafts were projects debt
                                         owed to the bank. The owners merely used their credit
                                         worthiness to convince the bank to allow the projects
                                         overdrafts.

                                         The attorney pointed out that the projects owed $164,772 in
                                         management fees to the identity-of-interest management
                                         agent as of December 31, 1995. Further, if the owners do
                                         pay any portion of the overdraft, these funds should be used
                                         to pay the management company's unpaid fees.

                                         The attorney stated that during the deed in lieu discussions,
                                         HUD told the owner that HUD would not pursue the
                                         overdraft issue.


96-PH-212-1019                                     Page 4
                                                                      Finding 1




OIG Evaluation of   The debt owed to the bank was not a project trade debt. We
Auditee Comments    classified the overdrafts similar to the owner obtaining bank
                    financing to advance funds to pay projects operating
                    expenses. The owner/agent executed the indemnity
                    agreement with the bank not the project entity. The bank
                    permitted the overdrafts and repayment was the owner's
                    responsibility.

                    The owner did not maintain units in decent, safe and
                    sanitary condition as documented in the latest HUD
                    inspection that failed 90 percent of the units inspected.

                    The owner benefitted from these overdrafts by delaying the
                    mortgages default and protecting the owner's investment in
                    the projects. In addition, the agent requested a ruling from
                    HUD in January 1995 concerning interest payments to an
                    owner who advances funds to a distressed property. In the
                    request, the agent classified funds from the owner line of
                    credit to keep the operating account current as an owner
                    advance. The bank allowed the overdrafts to continue
                    based on the owner's credit. HUD's decision stated that
                    operating advances and interest, if HUD approved, are to be
                    repaid from surplus cash. Based on the decision the agent
                    decided not to classify overdrafts as owner advances.

                    The projects' monthly accounting reports for December
                    1995 and May 1996 signed by the agent indicated that the
                    projects did not owe any management fees. The total
                    payables at the end of December 1995 totaled $78,539.
                    Therefore, how the attorney established $164,772 owed the
                    agent for management fees is not known.

                    The attorney did not provide any written documentation
                    that HUD agreed not to pursue the overdrafts.



Recommendation      We recommend the owner:

                    1A.    Provide HUD the final overdraft amounts at June 3,
                           1996. Recalculate and pay HUD the amount of
                           overdrafts (owner advances) reduced during




                             Page 5                                  96-PH-212-1019
Finding 1



                 mortgage default through June 3, 1996 totaling at
                 least $298,281.




96-PH-212-1019    Page 6
                                                                                      Finding 2




   The Owner Paid Ineligible and Unsupported
                   Expenses
The owner paid ineligible and unsupported expenses which totaled $56,249 and $2,390,
respectively, contrary to HUD requirements. The owner and agent did not manage these cash
disbursements properly. As a result the projects which are in financial distress lost the use of
needed revenue.



                                    The Regulatory Agreement paragraph 6b. states that the
                                    owner cannot pay out any funds for costs except for
                                    reasonable and necessary repairs. Paragraph 9b. states that
                                    payment for services, supplies or materials cannot exceed
                                    the amount ordinarily paid for such services, supplies, or
                                    materials in the area where the services are rendered or the
                                    supplies or materials furnished.

                                    The Management Certification in paragraphs 3a. and 4a.
                                    provides that the agent will (1) comply with the project's
                                    Regulatory Agreement, and (2) assure that all project
                                    expenses are reasonable in amount and necessary to the
                                    operation of the projects.

                                    A.      Ineligible costs

                                    The owner paid $56,249 for: (1) servicing costs for tax-
                                    exempt bonds, (2) bond refunder transaction costs from
                                    project funds and (3) duplicate costs.

                                    1.      Servicing costs of tax-exempt bonds
 Projects improperly paid
 owner's servicing and
                                         The owner paid servicing costs for tax-exempt bonds
 transaction costs
                                         secured by payments on the HUD insured mortgages of
                                         the projects. The agent disbursed $50,605 from 1991 to
                                         1995 for these costs from projects funds. According to
                                         the agent, records prior to 1991 were destroyed, and
                                         provided no comment why the costs were paid from
                                         projects funds. The Virginia State Office Chief Counsel
                                         advised us that these costs were not allowable project




                                              Page 7                                96-PH-212-1019
Finding 2



                      operating expenses and implied that these costs were
                      owners' costs.

                 2.      Bond refunder transaction costs

                 The owner improperly paid $5,414 for bond refunder
                 transaction costs from projects funds.

                 In a letter dated May 20, 1994, HUD provided the owner's
                 attorney the terms and conditions of payment of bond
                 refunder transaction costs. These transaction costs were to
                 be funded by owner contributions and tax-exempt and
                 taxable bonds issued by the bond refunder.

                 The owner incurred transaction costs of $190,000 at
                 settlement plus $5,414 paid from projects funds for costs of
                 a letter of credit posted by the owner related to the bond
                 refunder. The $190,000 was funded by tax-exempt and
                 taxable bonds issued by the bond refunder. The bond
                 refunder settlement statement did not include the $5,414
                 and was not funded by the bonds. The $5,414 was an
                 owner cost not a project cost and ineligible. HUD did not
                 approve bond refunder costs to be paid from projects funds.

                 3.      Duplicate costs

                 The owner paid $230 for duplicate bathroom floor work.
                 The owner paid for the same bathroom floor work for a unit
                 on two invoices dated 8/31/94 and 9/8/94. The owner paid
                 both invoices on the same check. We were advised that the
                 agent will seek reimbursement from the contractors.

                 Painting costs of $420 previously presented were resolved
                 based on the owner's response to the draft finding.

                 B.      Unsupported costs

                 The owner paid $2,390 to project employees for a
                 Christmas bonus equal to one weeks pay. According to the
                 agent, this was a common practice of the owner to pay
                 employees Christmas bonuses. In our opinion such
                 payments are questionable when the projects were in
                 default.



96-PH-212-1019            Page 8
                                                                    Finding 2



                   Unsupported landscaping, roofing and miscellaneous costs
                   previously presented were resolved based on the owner's
                   response to the draft finding.

                                     *   *   *    *

                   By not properly managing cash disbursements, the owner
                   paid ineligible and unsupported costs. This condition is
                   alarming in view of the financial distress of the projects.



Auditee Comments   A.     Ineligible Costs

                   1.     Servicing costs of tax-exempt bonds

                   The owner stated that these costs were allowable project
                   expense. The project received extensive benefits such as
                   reduced costs from the owner obtaining financing from tax-
                   exempt bonds, therefore, these costs were allowable.

                   2. Bond refunder transaction costs

                   The owner did not contemplate that these
                   costs would be paid by the owner or funded by surplus
                   cash. These costs were reasonable and necessary in order
                   to maintain the HUD mortgages in a current position.

                   3. Duplicate costs

                   The owner believed that painting units more than once a
                   year was not unreasonable.

                   The owner agreed with the duplicate costs for the bathroom
                   floor work and was requesting reimbursement from the
                   vendor.

                   B. Unsupported costs

                   The Christmas bonuses incurred were necessary and
                   reasonable to obtain the highest quality employees. The
                   costs were considered part of the employees compensation
                   package.




                           Page 9                                 96-PH-212-1019
Finding 2




OIG Evaluation of
Auditee Comments    A. Ineligible costs

                    1. Servicing costs of tax-exempt bonds

                    These costs were not eligible to be paid from project
                    operations. HUD Handbook 4370.2 REV-1, dated 5/92,
                    Chapter 4, Section 4-4 describes the 7000 account series.
                    Account 7700 (Trustee) is an account to record expenses
                    paid to an independent third party to manage long term debt
                    and protect both the interests of the lender and the
                    borrower. Expenses recorded to these accounts are
                    applicable to the mortgagor entities distinguished from
                    expenses necessary and reasonable to the operation of the
                    project. Owners may charge expenses included in the 7000
                    series against project operations only with the prior written
                    approval of HUD. HUD has not approved the servicing
                    costs.

                    2. Bond refunder transaction costs

                    As stated in the finding transaction costs were to be funded
                    by owner contributions and tax-exempt and taxable bonds
                    issued by the bond refunder. The $5,414 was an owner cost
                    not a project cost and remains ineligible.

                    3. Duplicate costs

                    We accept the owners rationale and the painting cost of
                    $420 is resolved. The $230 requires repayment to the
                    project.

                    B. Unsupported costs

                    As stated in the finding we question paying Christmas
                    bonuses when the projects were in default. However, if
                    such bonuses are part of a written compensation package
                    for the employees, it should be provided to HUD for
                    determining the eligibility of the costs.




96-PH-212-1019              Page 10
                                                                 Finding 2




Recommendations   We recommend the owner:

                  2A.   Reimburse the projects the ineligible $56,249.

                  2B.   Provide a copy of the employees compensation
                        package to HUD. HUD will evaluate and render a
                        decision on the eligibility of the questionable
                        Christmas bonuses of $2,390.




                         Page 11                               96-PH-212-1019
Finding 2




96-PH-212-1019   Page 12
Internal Controls
In planning and performing our audit, we considered the internal control systems of the
management of Oakmont North Apartments I, II, and III in order to determine our auditing
procedures and not to provide assurance on internal control.

Internal control is the process by which an entity obtains reasonable assurance as to achievement
of specified objectives. Internal control consists of interrelated components, including integrity,
ethical values, competence, and the control environment which includes establishing objectives,
risk assessment, information systems, control procedures, communication, managing change, and
monitoring.



                                      We determined that the following internal control
 Internal controls assessed
                                      categories were relevant to our objectives:

                                      •   Accounting records and reports
                                      •   Cash receipts and disbursements
                                      •   Tenants security deposits
                                      •   Section 8 Housing Assistance Payments
                                      •   Procurement

                                      A significant weakness exists if internal control does not
 Significant weaknesses
                                      give reasonable assurance that the entity's goals and
 found
                                      objectives are met; that resource use is consistent with laws,
                                      regulations, and policies; that resources are safeguarded
                                      against waste, loss, and misuse; and that reliable data are
                                      obtained, maintained, and fairly disclosed in reports. Based
                                      on our review, we believe the following items are
                                      significant weaknesses:

                                      •   Cash receipts and disbursements

                                      These weaknesses are detailed in the findings in this report.




                                              Page 13                                   96-PH-212-1019
Internal Controls




96-PH-212-1019      Page 14
Follow Up On Prior Audits
This is the first OIG audit of Oakmont North Apartments I, II, and III.




                                             Page 15                      96-PH-212-1019
Follow Up On Prior Audits




96-PH-212-1019              Page 16
                                                                                  Appendix A

Schedule of Ineligible and
Unsupported Costs
Finding Number            Ineligible 1/        Unsupported 2/
     1                  $298,281
     2                   56,249              $2,390
                       $354,530               $2,390




1/ Ineligible amounts are clearly not allowed by law, contract, or HUD policies or regulations.

2/ Unsupported amounts are not clearly eligible or ineligible, but warrant being contested for
   various reasons, such as the lack of satisfactory documentation to support eligibility.




                                            Page 17                                96-PH-212-1019
Appendix A




96-PH-212-1019   Page 18
                             Appendix A



                             Appendix B

Auditee Comments




                   Page 19   96-PH-212-1019
Appendix B




96-PH-212-1019   Page 20
          Appendix B




Page 21   96-PH-212-1019
Appendix B




96-PH-212-1019   Page 22
          Appendix B




Page 23   96-PH-212-1019
Appendix B




96-PH-212-1019   Page 24
          Appendix B




Page 25   96-PH-212-1019
Appendix B




96-PH-212-1019   Page 26
                                                                          Appendix B



                                                                          Appendix C

Distribution
Director, Multifamily Division, Virginia State Office, 3FHM
Internal Control & Audit Resolution Staff, 3AFI
Manager, Virginia State Office, 3FS
Assistant to the Deputy Secretary for Field Management, SDF (Room 7106)
Audit Liaison Officer, HF (Room 7228) (5)
Acquisitions Librarian, Library, AS (Room 8141)
Director, Participation & Compliance Division, HSLP (Room 9164)
Director, Division of Housing Finance Analysis, REF (Room 8212)
Chief Financial Officer, F (Room 10164) (2)
Deputy Chief Financial Office for Operations, FO (Room 10164) (2)
Assistant Director in Charge, US GAO, 820 1st St. NE Union Plaza,
 Bldg 2, Suite 150, Washington, DC 20002 (2)
President, Great Atlantic Management Co., Inc., Harbour Centre,
 2 Eaton Street, Suite 1100, Hampton, VA 23669