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Office of the City AuditorUSE Community Loan Services Contract, Internal Audit Report
August 2000

August 18, 2000

Stockton City Council

Internal Audit Summary- USE Community Loan Services Contract

In accordance with our 1999-00 audit plan, we have completed an audit of the USE Community Loan Services Contract. We conducted our audit in accordance with Generally Accepted Government Auditing Standards.

Our primary objective was to evaluate compliance with the above contract. We wanted to determine that sufficient controls were in place to assure loans were serviced in accordance with individual loan agreements and accounting information on customer transactions were reported accurately. We also determined whether correct balances were transferred to USE as of December 31, 1999 and whether procedures to reconcile loan receivable amounts to the City of Stockton general ledger were in place after January 1, 2000.

HRD has responsibility over transfer of loans to USE for service, receives monthly reports from USE on loan portfolio activity, and acts as liaison for the City of Stockton on matters relating to servicing of the portfolio. The City of Stockton Department of Administrative Services-Accounting Unit has oversight over the recording of loan activity and reconciliation of the loan receivable amounts reported by USE to the City of Stockton general ledger.

During the course of the audit, we offered suggestions to improve the effectiveness of the agreement, strengthening of internal controls and enhance the value of USE reports provided to HRD on loan portfolio activity. USE, HRD, and Administrative Service-Accounting Unit management and staff have been responsive in initiating corrective action and investigating ways of improving the efficiency and effectiveness of the agreement.

F. MICHAEL TAYLOR, CIA
CITY AUDITOR


original signed by:

FRANK DEMATTOS, CPA, MBA
INTERNAL AUDITOR

cc: Dwane Milnes, City Manager
Richard K. Denhalter, City Attorney
Katherine Gong Meissner, City Clerk
Steven Pinkerton, Director of Housing and Redevelopment
John Hinson, Administrative Services Officer
Delores Roach, Public Information Officer
Lynn Lankford, Deloitte & Touche LLP
The Record

INTERNAL AUDIT REPORT
USE COMMUNITY LOAN SERVICES CONTRACT

We have completed an audit of the USE Community Loan Services Contract as part of the 1999-00 Audit Plan. Our audit was performed in accordance with Generally Accepted Government Auditing Standards.

BACKGROUND

The City of Stockton has obtained funding for housing assistance primarily through the United States Department of Housing and Urban Development (HUD) programs and the City of Stockton Redevelopment Agency. Most assistance is distributed to qualified citizens through low interest loans secured by a promissory note and deed of trust. Occasionally, loans are made to entities or individuals performing housing rehabilitation or building multi-family structures in targeted areas. The City is often the lender of last resort for these individuals and entities due to their financial status and/or the area where housing assistance is targeted. HRD maintains a portfolio of housing rehabilitation, homebuyer, and special project loans. These loans have been funded over the years by Community Development Block Grants (CDBG), HOME Investment Partnership programs (HOME), and the City of Stockton Redevelopment Agency.

Since 1988, the loan portfolio has been serviced by one City employee. Because of the increased number of accounts being serviced and the complexity of structuring loan repayments to meet the needs of customers, HRD management feared the City would not have sufficient resources to manage the loan portfolio adequately. The lack of resources became more apparent when it was determined that the City’s software program used to record loan accounting activity was not Y2K compliant.

On July 26, 1999, the City Council authorized issuance of a Request for Proposal (RFP) from qualified firms who were capable of performing loan collection and related functions. On October 19, 1999, the City Council approved an agreement with United States Escrow Community Services Group of Downey, CA (USE) to provide loan services for the City of Stockton. The company has 25 years experience in providing loan servicing for specialized portfolios and currently serves over 125 community portfolios. The agreement remains in force for three years with the vendor maintaining an option to renew the agreement for an additional two years. The City of Stockton maintains the right to cancel the agreement by giving USE 120 days written notice.

The agreement calls upon USE to collect principal and interest on loan payments for the City. USE is required to collect payments from customers for impound account expenses such as county property taxes and homeowners insurance. Impound account payments are held in trust by USE until expenses come due. USE provides customers information on their loan status, annual analysis of impound accounts, administrative work on loan payoffs and fulfills reporting requirements on loan transaction activities as required by laws and regulations. Loan payments from customers go directly to USE. At the end of each month, USE produces a report of payment activities on loan accounts and remits monthly principal and interest payment collections to the City of Stockton. Large loan payoffs are to be remitted to the City within seven days of USE receiving the funds.

The City of Stockton loan portfolio consists of approximately 650 loans amounting to roughly $31,000,000. USE began servicing the loan portfolio as of January 1, 2000. Although USE sends reminder notices to customers on severely delinquent accounts, HRD retains responsibility for pursuing more aggressive collection actions on delinquent accounts. USE invoices the City on a monthly basis for loan services performed. The service rates charged to the City are established by the agreement and are based on the type of service USE performs for the loan customer.

Per the agreement, USE must maintain current insurance policies that name the City of Stockton on their endorsement for various types of insurance such as liability, workers compensation and errors and omissions.

The objective of this audit was to gain an understanding of the USE Community Loan Services Contract so that we could evaluate contract compliance. We wanted to determine if sufficient controls were in place to ascertain whether loan and impound payments were properly applied, impound expenses are paid when due and accounting information on USE monthly reports were accurate. We inquired whether internal controls were in place to assure loans originated by HRD were being serviced by USE. We sought to ascertain whether the City was receiving all principal & interest payments from loan customers timely and that invoices billed to the City from USE were for services rendered. We also wanted to identify opportunities for improving the effectiveness of the agreement for the City of Stockton. We used data collected from July 26, 1999 through April 30, 2000 for our evaluation. We limited our scope to interviews, observations, and analysis of available documentation.

METHODOLOGY

Insurance documents were gathered to verify that USE carried required insurance policies necessary to comply with the agreement. We interviewed HRD and Administrative Services personnel to gain an understanding of internal controls over the loan portfolio and we evaluated those controls. HRD personnel were interviewed to gain an understanding of how customer service issues are monitored and addressed.

RESULTS

• Loan accounts information transferred from the City’s in-house processing system to USE was completed in an appropriate manner.
• Loan and impound account payments are being properly applied.
• Impound account expenses are being paid when due by the vendor.
• Services for which the City has been billed have been provided.

Our work revealed some non-material differences in calculations and balance transfers that were corrected, or did not significantly affect operations.

We did identify opportunities to improve the quality of loan portfolio transaction reporting, monitoring, and customer service. We communicated our results to HRD management. Because part of our findings related to Administrative Services-Accounting Division, we also communicated our results to them as well. HRD, USE, and the Accounting Division responded on the above issues and took the following corrective actions:

• Inaccuracies were noted on the USE monthly reports particularly with the miscalculation of accrued interest receivable. HRD and USE reworked the transfer of accrued interest receivable balances as of 12/31/99 and reviewed amounts to assure the transfer was successfully completed. It was believed by both HRD and USE that a USE system problem occurred in the transfer of accrued interest receivable amount at 12/31/99. The USE Collections Status Report as of April 30, 2000 was reviewed to determine whether the accrued interest receivable amounts reported for each customer were now reflected accurately. We reviewed a sample of customers whose interest receivable amounts were previously calculated incorrectly. Based on our review of the sample, accrued interest receivable calculations appear reasonable with the exception of some multi-family dwelling loans for which accrued interest has not been updated since January 1, 2000. According to HRD, USE does not update accrued interest on some multi-family dwelling loans until the end of the year or until a payment has been made on the loan.

• The City of Stockton’s general ledger accounts recording loan receivables and an asset recording impound expenses paid by the City for loan customers does not reconcile to HRD and USE records as of December 31, 1999. The Administrative Services-Accounting Unit and HRD have determined that the difference resulted from loan payments that were applied to inappropriate general ledger accounts over the 25 year life of the program. Adjustments totaling $21,488 have posted to the approximately $31,000,000 loan receivable as of December 31, 1999. There are balancing procedures in place to ensure that the receivable and remaining receivable from impound expenses paid by the City on behalf of loan customers is segregated and reconciles to HRD and USE reports.

• The contract requires the vendor to remit collections to the City on a monthly basis. We found that monthly collections were not remitted until three weeks after the end of the month. HRD has communicated to USE issues regarding receipt of payments. Collections of principal and interest payments have taken up to three weeks after the end of the collection period to be remitted to the City. USE has indicated that they will improve their process in the future to keep the lag time down to one week.

In addition, we encourage HRD to continue investing a small amount of time monitoring information provided on USE reports. Tracking activity and amounts on key items at the end of the year for new loans added to the portfolio and multi-family loans may prevent errors on customer accounts from going undetected. We also support keeping files on customer complaints, issues, and evaluations while USE is performing their contractual obligations. This will assist HRD in determining whether the USE contract should be continued and/or modified at renewal dates.

NOTEWORTHY ACCOMPLISHMENTS

We would like to commend the management and staff of the Department of Housing and Redevelopment, Administrative Services, and USE Community Services, Inc. for their assistance on the audit. Their cooperation and diligence in answering our inquiries and pursuing action on issues were valuable to us during the course of our work.