REPORT DIGEST ILLINOIS HOUSING DEVELOPMENT AUTHORITY FINANCIAL AUDIT FOR THE YEAR ENDED JUNE 30, 2018 Release Date: January 29, 2018 FINDINGS THIS AUDIT: 3 CATEGORY: NEW -- REPEAT -- TOTAL Category 1: 1 -- 1 -- 2 Category 2: 0 -- 1 -- 1 Category 3: 0 -- 0 -- 0 TOTAL: 1 -- 2 -- 3 FINDINGS LAST AUDIT: 2 Category 1: Findings that are material weaknesses in internal control and/or a qualification on compliance with State laws and regulations (material noncompliance). Category 2: Findings that are significant deficiencies in internal control and noncompliance with State laws and regulations. Category 3: Findings that have no internal control issues but are in noncompliance with State laws and regulations. State of Illinois, Office of the Auditor General FRANK J. MAUTINO, AUDITOR GENERAL To obtain a copy of the Report contact: Office of the Auditor General, Iles Park Plaza, 740 E. Ash Street, Springfield, IL 62703 (217) 782-6046 or TTY (888) 261-2887 This Report Digest and Full Report are also available on the worldwide web at www.auditor.illinois.gov INTRODUCTION This digest covers the Illinois Housing Development Authority (Authority) Financial Audit as of and for the year ended June 30, 2018. The Authority’s Compliance Examination (including the Single Audit) covering the year ended June 30, 2018 will be issued in a separate report at a later date. SYNOPSIS • (18-1) The Authority was unable to support the historical detail assumptions used in its allowance for loan loss calculation for the multi-family loan programs. Additionally, the Authority has not established adequate internal controls for ensuring the allowance for loan loss is properly calculated and presented in its financial statements. • (18-2) The Authority has not established adequate internal controls over the financial reporting of investments, including recording the fair market value of certain investments, properly classifying investments as current vs. noncurrent, and properly reporting investment activity within the statement of cash flows. • (18-3) The Authority has not established adequate internal controls over the financial reporting process, including the preparation of program loans receivable footnote disclosures and recording revenue and expense transactions within the Hardest Hit Fund. FINDINGS, CONCLUSIONS, AND RECOMMENDATIONS INADEQUATE ALLOWANCE FOR LOAN LOSS METHODOLOGY AND LOAN RATING REVIEW PROCESS The Authority was unable to support the historical detail assumptions used in its allowance for loan loss calculation for the multi-family loan programs. Additionally, the Authority has not established adequate internal controls for ensuring the allowance for loan loss is properly calculated and presented in its financial statements. During our audit, we reviewed the allowance for loan loss methodology for the multi- family loan program and noted the Authority could not produce an analysis supporting the rationale for its calculation of the loan loss reserve factors (probability of default and expected loss) that are used in its allowance for loan loss calculation. The Authority has not documented how the loan loss reserve factors for the multi- family loan programs have been historically calculated and over what period the probability of default is measured. Further, the Authority did not perform back-testing (typically performed on at least an annual basis) on its allowance for loan loss estimates for the multi-family loan programs to determine whether the allowance for loan loss produces estimates that have been historically sufficient to cover incurred losses over a period of time that aligns with the period used to estimate the probability of default values. Furthermore, during our testing of 43 multi-family loan relationships risk ratings (66 loans) as of June 30, 2018, we noted differences in the ratings determined by the Authority on their loan rating scale compared to our independent ratings determined during our review. We found the Authority’s risk ratings to be reasonable on 28 of the 43 relationships (46 of the 66 loans) and we found the Authority’s risk ratings to be unreasonable for 15 of the 43 relationships (20 of the 66 loans). Some of the differences in loan ratings are as follows: • 4 differences in Housing Trust Fund loan ratings resulted in an under reserve of $331,510 for the Illinois Affordable Housing Trust Fund. In response to this finding, the Authority reviewed the total population of Housing Trust Fund loans and determined they were under reserved by a total of $11,968,248. A proposed adjustment for this difference was recorded by the Authority. • 7 differences in HOME loan ratings resulted in an under reserve of $2,077,978 for the HOME Program Fund. In response to this finding, the Authority reviewed the total population of HOME Program loans and determined they were under reserved by a total of $9,735,868. A proposed adjustment for this difference was recorded by the Authority. • Five differences in Nonmajor governmental fund loan ratings resulted in an under reserve of $2,322,997 for the Nonmajor Governmental Funds. In response to this finding, the Authority reviewed the total population of Nonmajor Governmental Fund loans and determined they were under reserved by a total of $4,361,501. A proposed adjustment for these differences was recorded by the Authority. Additionally, in response to the differences noted above, the Authority reviewed the total population of Administrative Fund loans and determined they were under reserved by $754,928. A proposed adjustment for this difference was recorded by the Authority. (Finding 1, pages 81-83) This finding has been repeated since 2014 We recommended the Authority review its current policies and procedures to ensure the assumptions used in the allowance for loan loss calculation are appropriate and that loan ratings are calculated appropriately. Authority officials accepted the recommendation. (For the previous Authority response, see Digest Footnote #1.) INACCURATE FINANCIAL REPORTING The Illinois Housing Development Authority (Authority) has not established adequate internal controls over the financial reporting process of investments, including recording the fair market value of certain investments, properly classifying investments as current vs. noncurrent, and properly reporting investment activity within the statement of cash flows. During our audit of the financial statements as of June 30, 2018, we noted the Authority did not correctly record the fair market value for 18 of its discount note investment securities. As a result, the Authority's investment securities were understated by $173,723 within the Administrative Fund, $838,001 within the Mortgage Loan Program Fund, and $1,522,989 within the Single Family Loan Program Fund. A proposed adjustment for these differences was recorded by the Authority. In addition, we noted the Authority improperly classified its investments as follows: • Current and noncurrent investments within the Rental Housing Support Program Fund were improperly classified, resulting in a difference of $27,528,386 in each category. • Current and noncurrent investments within the Administrative Fund were improperly classified, resulting in a difference of $222,451,738 in each category. • Current and noncurrent restricted investments within the Administrative Fund were improperly classified, resulting in a difference of $24,785,338 in each category. • Current and noncurrent restricted investments within the Mortgage Loan Program Fund were improperly classified, resulting in a difference of $66,452,197 in each category. • Current and noncurrent restricted investments within the Single Family Loan Program Fund were improperly classified, resulting in a difference of $98,013,824 in each category. A proposed adjustment for these reclassifications was recorded by the Authority. In addition, we noted the Authority improperly reported investment purchases, proceeds from sales, and interest received on investments within the net cash provided by (used in) investing activities section of the statement of cash flows for the Administrative Fund, Mortgage Loan Program Fund, and Single Family Program Fund. A proposed adjustment for these differences was recorded by the Authority. (Finding 2, pages 84-87) We recommended the Authority review its current internal control policies and procedures to ensure investments are properly valued and classified in the general ledger and the financial statements, and to ensure investment activity is properly reported and presented in the financial statements. Authority officials accepted the recommendation. INACCURATE FINANCIAL REPORTING The Illinois Housing Development Authority (Authority) has not established adequate internal controls over the financial reporting process, including the preparation of program loans receivable footnote disclosures and recording revenue and expense transactions within the Hardest Hit Fund. During our audit of the financial statements as of June 30, 2018, we noted the following: • The Authority incorrectly reported program loans receivable disbursements and repayments within footnote 5 of the financial statements for the Mortgage Loan Program Fund (MLP) and Single Family Program Fund (SFP). The disbursements and repayments were incorrectly reported by $84,000 in the MLP and $3,807,000 in the SFP. A proposed adjustment for these reclassifications was recorded by the Authority. • The Authority incorrectly reported scheduled receipts of principal on gross program loans receivable in the Illinois Affordable Housing Trust Fund in the fiscal years subsequent to June 30, 2018 and thereafter, within footnote 5 of the financial statements, with differences ranging from $41,000 to ($210,000). A proposed adjustment for these reclassifications was not recorded by the Authority. • The Authority incorrectly reported scheduled receipts of principal on gross program loans receivable in the HOME Program Fund in the fiscal years subsequent to June 30, 2018 and thereafter, within footnote 5 of the financial statements, differences ranging from $19,000 to ($165,000). A proposed adjustment for these reclassifications was not recorded by the Authority. • The Authority incorrectly reported scheduled receipts of principal on gross program loans receivable in the proprietary funds in the fiscal years subsequent to June 30, 2018 and thereafter, within footnote 5 of the financial statements, with differences ranging from ($9,000) to $540,000. A proposed adjustment for these reclassifications was not recorded by the Authority. In addition, we noted the U.S. Department of Treasury conducted a review of the prior year Hardest Hit Fund activities and determined that $885,069 of expenses were improperly charged to the Hardest Hit Fund. In response to this review, the Authority improperly recorded an increase to Other Revenue within the Hardest Hit Fund instead of a decrease to General and Administrative expenditures. As a result, Other Revenue and General and Administrative expenditures were overstated by $765,228 within the Hardest Hit Fund. A proposed adjustment for this difference was recorded by the Authority. In addition, Other Revenue and General and Administrative expenditures were overstated by $119,841 within the Hardest Hit Fund. A proposed adjustment for this difference was not recorded by the Authority. (Finding 3, pages 88-90) This finding has been repeated since 2015. We recommended the Authority review its current internal control policies and procedures to ensure financial transactions are accurately reported in the general ledger and the financial statements, including footnote disclosures. Authority officials accepted the recommendation. (For the previous Authority response, see Digest Footnote #2.) AUDITOR’S OPINION Our auditors stated the financial statements of the Authority as of June 30, 2018, and for the year then ended, are fairly stated in all material respects. The financial audit was conducted by KPMG LLP. JANE CLARK Division Director This report is transmitted in accordance with Section 3-14 of the Illinois State Auditing Act. FRANK J. MAUTINO Auditor General FJM:TLK DIGEST FOOTNOTES #1 – Need To Improve Controls Over The Allowance For Loan Loss The Authority will continue to perform back testing to further support the assumptions used in the allowance for loan loss calculation. In addition, review of current policies, procedures, and controls will be completed to ensure assumptions are applied accurately and that ratings are adequately supported. The Authority notes the new loan loss reserve policy adopted by the Board of Directors was based on an analysis of actual losses incurred from June 30, 2002 to June 30, 2017. That analysis showed the multifamily loan portfolio had experienced 50 losses with an average aggregate write- off of approximately $1.7 million per year (or 0.13% of the portfolio). The Authority’s fiscal year 2017 estimated loan loss for the $1.2 billion multifamily portfolio was approximately $34 million (or 2.6% of the portfolio). #2– Inaccurate Financial Reporting The Authority will review the classifications for all current and non- current liabilities to ensure proper reporting. Additionally, the Authority made the appropriate change to the internal policies and procedures to adhere to GAAP.