Peach Tree Terrace Apts, Yuba City, CA

Published by the Department of Housing and Urban Development, Office of Inspector General on 1996-03-08.

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

                    U.S. Department of Housing and Urban Development
                                Office of Inspector General
                               450 Golden Gate Avenue, P.O. Box 36003
                                 San Francisco, California 94102-3448

                                           March 8, 1996

                                                                       AUDIT RELATED MEMORANDUM

MEMO TO: William F. Bolton, Director, Multifamily Housing Division, Sacramento Area Office,

FROM:         David A. McCargar, Assistant District Inspector General for Audit, 9AGA

SUBJECT:      Peach Tree Terrace Apartments
              Multifamily Mortgagor Operations
              Yuba City, California

We completed a review of Peach Tree Terrace Apartments to identify instances of assets used in
violation of the regulatory agreement governing project operations. We found that loan repayments
exceeding surplus cash were made to the general partners.

Peach Tree Terrace (FHA project 136-35617) is a multifamily housing development located in Yuba
City, California. The mortgage loan is insured by HUD under Section 221(d)4 of the National Housing
Act. HUD gave final endorsement to the project in 1981. The project is owned by Peach Tree Terrace
General Partnership. FPI Management, Inc., located in Sacramento, California, manages the project.
Project operations are governed by a regulatory agreement with HUD in consideration of the mortgage

We made this review to determine if project assets were used in violation of the regulatory agreement.
For our principal methodologies, we:

              analyzed the project's audited financial statements for fiscal years 1992 to 1994,

              interviewed HUD staff, the managing general partner, and management agent staff,

              reviewed HUD's asset management files, project records maintained by the manage-
              ment agent, and records provided by the managing general partner, and

              gained an understanding of the internal control structure. We did not conduct tests to
              determine control effectiveness because it was not necessary for the limited objective
              of our review.

The review covered activities from January 1992 to August 1995. We did the field work in September

During the three years ended December 31, 1994, project funds were used to repay $69,677 of the
partner's loans to the project. These repayments violated HUD's requirements by being premature
and exceeding allowable limits by $17,495. Thus, the repayments increased the risk that assets would
not be available to properly maintain the project or service the HUD-insured loan. The managing gen-
eral partner claimed he was unaware that HUD requirements were violated.

LIMITATIONS ON REPAYMENTS . Repayments of notes payable to partners may only be made from sur-
plus cash or with the prior approval of HUD. In consideration for mortgage insurance, the owner
agreed to abide by paragraph 8(b) of the regulatory agreement which states:

       "Owners shall not without the prior permission of the Secretary assign, transfer,
       dispose of, or encumber any personal property of the project, including rents, or pay
       out any funds except from surplus cash, except for reasonable operating expenses
       and necessary repairs."

Repayment of advances is not considered to be an operating expense. HUD handbook 4370.2 REV-
1, chapter 2-11, explains the requirements on advances. It stipulates:

       "Advances made for reasonable and necessary operating expenses may be paid from
       surplus cash at the end of the annual or semi-annual period. . . Repayment of owner
       advances when the project is in a non-surplus cash position will subject the owner to
       criminal and civil monetary penalties."

Thus, repayments of any owner loans or advances to the project should not exceed the available
surplus cash.

REPAYMENTS MADE TO PARTNERS . The general partners advanced the project $508,346 between
1983 and 1991. After 1991, the partners were repaid a portion of these advances. These repayments
occurred when the project had surplus cash deficiencies or exceeded the surplus amount as shown

                                Surplus                                  Repayments in
                     Fiscal      Cash        During           Loan         Excess of
                      Year      Balance      Fiscal       Repayments       Available
                     Ended    (Deficiency)    Year         to Partners   Surplus Cash
                     1991         $(1,477)   1992             $14,000          $14,000
                     1992           4,150    1993              42,650           38,400
                     1993          (4,468)   1994              13,027           13,027
                     1994         (23,089)

Although the repayments were disclosed in the audited financial statements, the public accounting firm
performing the audits failed to disclose the repayments as a compliance finding.

REPAYMENTS INCREASED THE SURPLUS CASH DEFICIENCY . If the excess repayment of $14,000 in
1992 had not been made and subsequent repayments were limited to surplus cash, the allowable
repayments would have been $18,150 for 1993 and $34,032 in 1994. Thus, the net total of excessive
repayments would be $17,495 ($69,677 less $52,182). If the excess repayments had not been made,
the surplus cash deficiency would have been reduced from $23,089 to $5,594.

Because of subsequent cash shortfalls, the partners advanced $5,000 on August 16, 1995 at the
request of the management agent. Based on the unaudited trial balance as of December 31, 1995,

the surplus cash deficiency grew slightly during 1995 even though the partners had advanced the

On August 10, 1995, HUD requested that excess distributions be reimbursed to the project. The
managing general partner's reply showed that he was unaware that the repayment of advances
required surplus cash. No further repayments have been made since HUD notified the owner that loan
repayments require surplus cash or be approved by the Department.

We recommend that you:

       A.     Require the partners to return $12,495 ($17,495 less $5,000 advance in 1995). If the
              partners do not return the funds in a timely manner, advise us so that other avenues can
              be explored to recover the funds.

       B.     Inform the accounting firm that performed the audits about HUD's regulations dealing
              with the repayment of advances and the firm's responsibility to report any violations as
              a finding.

Within 60 days, please furnish us a status report on the recommendations stating (1) the corrective
action taken, (2) the proposed clearance action and the date to be completed, or (3) why action is not
considered necessary. Also, please furnish us copies of any correspondence or directives issued that
are related to the review.

We received written comments from the project owner's managing general partner. The partner said
that he informed the accounting firm about HUD's requirements governing advances and that the
excess repayments would be repaid within 90 days. The partner's response begins on the next page.

If you have any questions, please call senior auditor Mark Pierce at (415) 436-8101.



Director, Multifamily Housing Division, Sacramento Area Office, HUD
Chief, Multifamily Asset Management Branch, Sacramento Area Office, HUD
Office of Comptroller, Texas State Office, HUD
Director, Office of Multifamily Housing Management, HUD
Housing-FHA Comptroller, HUD
Director, Participation and Compliance Division, HUD
Director, Division of Housing Finance Analysis, HUD
Assistant to the Deputy Secretary for Field Management, HUD
Deputy Assistant to the Secretary for Field Management, HUD
Chief Financial Officer, HUD
Deputy Chief Financial Officer for Finance, HUD
U.S. General Accounting Office
Peach Tree Terrace General Partnership
FPI Management, Inc.