oversight

Multifamily Housing: HUD Missed Opportunities to Reduce Costs on Its Uninsured Section 8 Portfolio

Published by the Government Accountability Office on 1999-07-30.

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

                  United States General Accounting Office

GAO               Report to Congressional Committees




July 1999
                  MULTIFAMILY
                  HOUSING
                  HUD Missed
                  Opportunities to
                  Reduce Costs on Its
                  Uninsured Section 8
                  Portfolio




GAO/RCED-99-217
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Resources, Community, and
      Economic Development Division

      B-281431

      July 30, 1999

      Congressional Committees

      This report was prepared to comply with the requirements of section 532 of the 1998
      Appropriations Act for the Departments of Veterans Affairs and Housing and Urban
      Development, and Independent Agencies (P.L. 105-65, Oct. 27, 1997), which requires a GAO study
      of HUD’s portfolio of properties with Section 8 project-based rental assistance that are not
      insured by the Federal Housing Administration. As agreed, this report provides information on
      the Section 8 rental assistance provided to properties in HUD’s uninsured Section 8 portfolio, the
      financial benefits that may be available to state and local housing finance agencies under the
      Section 8 program, and the information HUD and the state agencies have on the physical and
      financial condition of the properties in their respective uninsured Section 8 project-based
      portfolios.

      We are sending copies of this report to congressional committees and subcommittees interested
      in housing; the Honorable Andrew M. Cuomo, Secretary of Housing and Urban Development;
      the Honorable Jacob Lew, Director of the Office of Management and Budget; and other
      interested parties. We will also make copies available to others upon request.

      If you or your staff have any questions about this report, please call me at (202) 512-7631. Key
      contributors to this report are listed in appendix VIII.




      Judy A. England-Joseph
      Director, Housing and Community
        Development Issues
B-281431

List of Committees

The Honorable Wayne Allard
Chairman
The Honorable John Kerry
Ranking Minority Member
Subcommittee on Housing and Transportation
Committee on Banking, Housing and Urban Affairs
United States Senate

The Honorable Christopher S. Bond
Chairman
The Honorable Barbara A. Mikulski
Ranking Minority Member
Subcommittee on VA, HUD and
  Independent Agencies
Committee on Appropriations
United States Senate

The Honorable Rick Lazio
Chairman
The Honorable Barney Frank
Ranking Minority Member
Subcommittee on Housing and
  Community Opportunity
Committee on Banking and Financial Services
House of Representatives

The Honorable James T. Walsh
Chairman
The Honorable Alan B. Mollohan
Ranking Minority Member
Subcommittee on VA, HUD and
  Independent Agencies
Committee on Appropriations
House of Representatives




                     Page 2                       GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
B-281431




           Page 3   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Executive Summary


             Section 8 rental housing assistance is the main form of federal housing
Purpose      assistance for the nation’s low-income residents. Section 8 assistance is
             tied either to units in specific properties (project-based assistance) or to
             families and individuals who live in affordable rental housing of their
             choice (tenant-based assistance). The residents of housing units that
             receive project-based assistance are required to pay a portion of their
             income for rent (generally 30 percent), while the Department of Housing
             and Urban Development (HUD) pays the balance. HUD provides Section 8
             project-based rental assistance to units in approximately 22,000
             multifamily properties, almost half of which are insured by HUD’s Federal
             Housing Administration (FHA). The remaining properties, which are not
             insured by FHA, are referred to collectively as HUD’s “uninsured” Section 8
             portfolio.

             A mandate for a study of the uninsured portfolio was included in HUD’s
             fiscal year 1998 appropriations bill (P.L. 105-65, Oct. 27, 1997).
             Accordingly, this report examines (1) the information HUD has on the
             Section 8 assistance provided to properties in the uninsured portfolio,
             (2) the financial benefits that may be available to state and local housing
             finance agencies that participate in the Section 8 program and the impact
             of these benefits on the Section 8 program’s costs, and (3) the information
             HUD and the state agencies have on the physical and financial condition of
             the properties in their respective uninsured Section 8 project-based
             portfolios.


             As of December 1998, according to HUD’s data, the uninsured Section 8
Background   portfolio consisted of 12,708 contracts between HUD and property owners.
             These contracts cover 632,216 assisted units associated with eight
             programs, including a state agency program. Most of these programs were
             established in the 1970s to develop housing for low-income households,
             using various types of financing and long-term (20- to 40-year) Section 8
             contracts. While some of the properties were financed by loans and grants
             from HUD, others were financed by bonds issued by state and local housing
             finance agencies (state and local agencies). All but one of the housing
             development programs were terminated in 1983 because of high costs, but
             many of the Section 8 contracts for properties developed through these
             programs are still in effect. HUD will continue to incur rental assistance
             costs until these contracts expire.

             During the late 1970s and early 1980s, the cost of bonds to finance housing
             development rose with interest rates to unprecedented levels. HUD



             Page 4                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                   Executive Summary




                   therefore authorized higher mortgage interest rates and higher rental
                   assistance payments to cover the higher bond financing costs, first in 1980
                   and then in 1981. Only the Section 8 contracts covered by the 1981
                   authorization required the agencies to refund (refinance) their bonds when
                   interest rates declined and to provide all of the savings (the difference
                   between the original and the current debt service costs) to the federal
                   government.

                   The Stewart B. McKinney Homeless Assistance Amendments Act of 1988,
                   enacted primarily to assist the nation’s homeless, included one section
                   (1012) that provided for the state agencies to share the bond refunding
                   savings that they were formerly required to return to the federal
                   government and to use these savings to provide affordable housing for
                   households with very low incomes. While section 1012 originally applied
                   only to refundings associated with Section 8 contracts covered by HUD’s
                   1981 authorization, an October 1992 amendment to section 1012
                   apparently provided for sharing the savings from refunding bonds
                   associated with other Section 8 contracts—savings that some state
                   agencies were generally accustomed to retaining.

                   In 1992 and 1993, HUD’s Office of the Inspector General released two
                   reports that examined whether bond-financed Section 8 properties were
                   refinanced as intended and if HUD realized the appropriate savings from the
                   bond refundings.1 The reports disclosed, among other things, that HUD had
                   not fully realized potential savings from bond refundings and identified
                   actions that HUD could take to realize additional savings.


                   According to HUD’s data, rental assistance payments for the uninsured
Results in Brief   Section 8 portfolio totaled over $3.3 billion in fiscal year 1998. A majority
                   of these payments—about $2.3 billion—were associated with the two
                   largest programs in the uninsured portfolio, one of which is the state
                   agency program. Although nationwide data were not available for
                   assessing the relationship of Section 8 rents to market rents, the design of
                   the program was such that Section 8 subsidies sometimes support higher
                   rents than the properties could command without federal assistance. The
                   federal government will continue to incur these high rental assistance
                   costs each year until its existing Section 8 contracts expire, generally from
                   within the next 5 years to about 20 years. Contracts in the state agency
                   program will generally be among the last to expire.

                   1
                     Interim Audit Report Bond Refundings of Section 8 Projects, Office of the Inspector General
                   (93-HQ-119-0004, Oct. 30, 1992) and Multi-Region Audit of Refunding of Bonds for Section 8 Assisted
                   Projects, Office of the Inspector General (93-HQ-119-0013, Apr. 30, 1993).



                   Page 5                                  GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Executive Summary




Under the Section 8 program, state and local agencies may derive financial
benefits, or savings, from refunding (refinancing) their tax-exempt bonds.
In addition, the agencies may receive one of two available fees for
administering their Section 8 contracts. The agencies are required to use
the savings from refunding their bonds, and in some cases may use a
portion of their fee, to provide affordable housing for low-income
residents within their jurisdictions. GAO found that HUD has not resolved
three long-standing issues associated with these financial benefits. As a
result, HUD has missed opportunities to reduce its Section 8 costs,
particularly in the state agency program. First, HUD has not issued
guidance to the state agencies on how to comply with the October 1992
amendment to section 1012 of the McKinney Act, which provides for the
agencies to share certain bond refunding savings with the federal
government. As a result, some state agencies have retained all of the
savings, which accrue annually, while other agencies have shared the
savings. Second, HUD has not provided clear guidance to the state and local
agencies for calculating rent increases after refunding bonds.
Consequently, the Section 8 rental assistance program is incurring excess
costs that could have been avoided. Finally, HUD has allowed some state
agencies to collect both of the available fees for administering their
Section 8 contracts, despite a 1980 HUD regulation prohibiting dual fees. As
a result, HUD has added, at a minimum, tens of millions of dollars to the
Section 8 program’s cost. HUD has known about these issues since at least
1992, when the Inspector General first reported on them, but it has not
acted quickly or effectively to resolve them. Thus, the federal government
has lost opportunities to share bond refunding savings and has incurred
excessive rental assistance and administrative fee payments. GAO makes
recommendations to HUD on each of these issues to reduce the Section 8
costs borne by the government (see ch. 3).

As of December 1998, HUD had limited information on the physical
condition of properties in the uninsured portfolio and no information on
their financial condition. According to the Department’s central database,
which included the results of inspections for about 63 percent of the
properties, most of the properties were in satisfactory or better physical
condition; however, these ratings were not based on objective criteria and
their reliability is therefore unknown. Ten state agencies, which monitor
about half of the properties in the state agency program,2 told GAO that
95 percent of the properties in their portfolios were in satisfactory or

2
 GAO surveyed 10 state agencies (California, Illinois, Maryland, Massachusetts, Michigan, Minnesota,
New Hampshire, Oregon, Tennessee, and Wisconsin) to obtain information on the methods they used
to monitor their properties and on the physical and financial condition of the properties. GAO also
visited 5 of the 10 agencies.



Page 6                                  GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                             Executive Summary




                             better physical condition. Moreover, according to these agencies, only a
                             very small fraction of their properties (under 4 percent) warranted special
                             monitoring because of financial or other problems. In mid-1998, HUD began
                             to establish centralized procedures, including objective rating criteria, to
                             improve the monitoring of multifamily properties in its uninsured and
                             other portfolios.



Principal Findings

Information on the           About 68 percent of the $3.3 billion in rental assistance for the uninsured
Uninsured Portfolio Varies   portfolio went to two of eight programs—the elderly/disabled loan
by Program                   program and the state agency program. The average per-unit costs for the
                             eight programs varied widely, primarily because of differences in the ways
                             properties were financed. The per-unit costs and, to a lesser extent,
                             tenants’ income levels determine the Section 8 rent subsidies that HUD
                             must pay for assisted units. For several of the programs, including the
                             state agency program, HUD’s subsidies tended to be high because (1) the
                             assisted rents were initially set above market levels to encourage the
                             production of affordable housing and (2) the formulas for automatic rent
                             increases (which, until recently, were provided each year) tended to be
                             generous, according to HUD. The Congress now prohibits automatic rent
                             increases for properties whose rents exceed the rent standards—called fair
                             market rents—that HUD develops annually for geographic locations, such
                             as large metropolitan areas. GAO determined that the Section 8 contract
                             rents for about 75 percent of the assisted units in the uninsured portfolio
                             exceeded HUD’s fair market rents. HUD’s fair market rents may not be the
                             same as actual market rents because they do not reflect the differences in
                             market value that may be found from one neighborhood to another within
                             a geographic location. However, nationwide data on rents for particular
                             neighborhoods were not available for assessing the relationship of Section
                             8 contract rents to market rents. Nevertheless, the history and design of
                             the Section 8 project-based program, together with information from two
                             states and a study of 53 bond-financed Section 8 properties,3 indicate that
                             some Section 8 contract rents exceed market rents in the uninsured
                             portfolio. When Section 8 contract rents exceed market rents, the Section
                             8 subsidies support higher rents than the properties generally could
                             command without federal assistance. Moreover, these high subsidy costs
                             will continue until the existing Section 8 contracts expire. While many of


                             3
                              HUD’s Local Multifamily Portfolio, John Nuveen & Co., Inc. (July 1997).



                             Page 7                                   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                            Executive Summary




                            the contracts will be expiring in the next 5 years, those in the state agency
                            program will generally expire in 10 to 20 years.


HUD Has Missed              HUD has not issued clear guidance to the state agencies on sharing savings
Opportunities to Reduce     with the federal government when they have refunded bonds associated
Costs in the State Agency   with certain Section 8 contracts covered by the October 1992 amendment
                            to section 1012 of the McKinney Act. While HUD has required the agencies
Program                     to share savings when their Section 8 contracts include explicit
                            requirements for providing savings to the government, it has not required
                            the agencies to share when their contracts do not include such
                            requirements. In April 1996, HUD tried to require the state agencies to share
                            their savings by publishing a regulation that was intended to establish the
                            applicability of the October 1992 amendment to all refundings by the state
                            agencies. However, because HUD omitted citations to two relevant
                            provisions of the McKinney Act, the regulation did not have its intended
                            effect. Moreover, in the view of the National Council of State Housing
                            Agencies and some state agencies, the amendment generally applies to
                            state agencies only when their Section 8 contracts specify that they are to
                            provide bond refunding savings to the government. GAO visited five state
                            agencies that refunded nearly all of their bonds in the mid-1990s. Three of
                            these agencies generally do not share bond refunding savings with the
                            federal government except when their contracts direct them to provide the
                            savings to the government. The other two agencies share savings with the
                            government whether or not their contracts direct them to provide the
                            savings to the government.

                            When bonds issued by state and local agencies have been refunded but
                            rents subsidized by the government under Section 8 contracts have not
                            been reduced to reflect the bond refunding savings, rent increases based
                            on HUD’s general method for calculating increases will be excessive.
                            Although the Inspector General recommended in 1992 that HUD take action
                            to prevent these excessive rent increases, HUD initially disagreed with the
                            recommendation, maintaining it did not have the authority to limit Section
                            8 rent increases. Then, in August 1997, HUD issued a notice establishing
                            procedures for considering the savings when calculating rent increases for
                            contracts that provided for returning the savings to the government.
                            However, the notice did not include a methodology for implementing the
                            procedures or an example of a calculation. Furthermore, the notice was
                            issued for 1 year, and HUD did not renew it when it expired. HUD officials
                            told GAO that renewing the notice should not have been necessary because
                            the procedures apply to rent increases over the lives of the Section 8



                            Page 8                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Executive Summary




contracts. Two of the five state agencies that GAO visited calculated rent
increases subject to the notice. One agency complied with it, and the other
did not.

HUD compensates the state and local agencies for administering their
Section 8 project-based rental assistance contracts. The state agencies are
entitled to receive either an annual contributions contract fee—a per-unit
fee provided by HUD—or an override fee—a fee that represents the
difference between an agency’s borrowing (bond issuance) and lending
rates.4 The agencies are not allowed to receive both fees, according to a
Section 8 regulation promulgated in 1980. Nevertheless, in 1992 the
Inspector General found, in reviewing the refunding of bonds associated
with Section 8 contracts, that some state agencies were receiving both fees
for administering their Section 8 contracts. One agency, for example,
received annual contributions contract fees of $634,000 and override fees
of $584,000 for administering the same Section 8 contracts during the same
period. The state agencies have argued, in essence, that they are entitled to
both fees because HUD effectively approved these fees when it approved
agreements between the Department and the agencies to share bond
refunding savings (called McKinney Act refunding agreements).5 To
resolve this issue for agencies whose refunding agreements it approved,
HUD required the agencies in 1996 to request waivers of its regulation
prohibiting dual fees. However, as of June 1999, HUD had not taken action
on these requests, and the agencies were continuing to receive dual fees.
In addition, HUD has not identified all agencies that are collecting dual fees
and has not taken any action when dual fees are being collected for
contracts that are not under refunding agreements approved by the
Department.




4
 Local agencies are not eligible for an override fee because they issue tax-exempt bonds under the
United States Housing Act of 1937 and are subject to HUD’s regulations. State agencies issue
tax-exempt bonds under the Internal Revenue Code.
5
 Refunding agreements identify the total savings that will become available from refunding bonds
associated with Section 8 contracts. The agreements specify the amounts that will be provided to the
agencies and to the federal government under section 1012 of the McKinney Act, as amended.



Page 9                                   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                             Executive Summary




HUD’s Information on the     While HUD requires annual physical inspections of the properties in its
Physical and Financial       uninsured portfolio, it did not, until recently, have objective criteria for
Condition of the Uninsured   ranking the properties’ condition. Thus, although the ratings in HUD’s
                             central database showed that most of the properties were in satisfactory
Portfolio Is Limited, but    or better physical condition, the ratings were subjective and their
State Agencies Report That   reliability was therefore limited. The 10 state agencies that GAO surveyed
Few Properties Have          reported that 95 percent of the properties, representing 97 percent of the
Problems                     apartment units, in their portfolios were in satisfactory or better physical
                             condition. Although all 10 agencies used HUD’s terms—superior,
                             satisfactory, below average, or unsatisfactory—to rate the physical
                             condition of their properties, their ratings were also subjective.
                             Consequently, the state agencies’ ratings are subject to the same
                             limitations as HUD’s.

                             Information on the financial condition of properties in the uninsured
                             portfolio is also limited. Although HUD requires annual audited financial
                             statements for properties in most of the uninsured programs, its central
                             database did not, as of December 1998, include information on the results
                             of these audits. As a result, overall conclusions on the financial status of
                             the uninsured portfolio cannot be drawn at this time. HUD does not require
                             the state agencies to assign a rating to the financial condition of their
                             properties. Nevertheless, 5 of the 10 state agencies that GAO surveyed had
                             rated the financial condition of their properties. These agencies reported
                             that about 97 percent of their properties were in satisfactory or better
                             financial condition. In addition, seven of the agencies had rated the overall
                             condition of their properties—assessing their management as well as their
                             physical and financial condition—and reported that 95 percent were in
                             satisfactory or better overall condition. Finally, the 10 state agencies
                             reported that fewer than 4 percent of the properties in their portfolios had
                             problems serious enough to warrant special monitoring attention.

                             In mid-1998, HUD established the Real Estate Assessment Center to collect
                             and analyze data on multifamily properties in several portfolios, including
                             the uninsured Section 8 portfolio; develop an objective system for rating
                             the physical condition of these properties; and analyze financial
                             information on the properties. Currently, trained contractors are
                             inspecting the properties using the Center’s new rating system, and many
                             property owners are required to submit audited financial statements to the
                             Department electronically by June 30, 1999.




                             Page 10                        GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                       Executive Summary




                       This report recommends that the Secretary of Housing and Urban
Recommendations        Development (1) clarify the requirements for state housing finance
                       agencies to share the savings from refunding bonds with the federal
                       government, (2) clarify and reissue HUD’s guidance on calculating rent
                       increases when savings have resulted from refunding bonds, and
                       (3) enforce the Section 8 regulation prohibiting dual fees.


                       GAO provided copies of a draft of this report to HUD and to the National
Agency Comments        Council of State Housing Agencies6 for review and comment. HUD
and GAO’s Evaluation   disagreed with GAO’s recommendation that it clarify the requirements for
                       state housing finance agencies to share the savings from refunding certain
                       bonds with the federal government. According to HUD, the
                       recommendation directs the Department to take action where its legal
                       authority is unclear and proposes that HUD retroactively recover savings
                       that state agencies have not shared. However, given that this issue has not
                       been resolved for over 6 years, GAO’s recommendation directs HUD to
                       determine whether the state agencies are required to share certain bond
                       refunding savings with the government and, if they are, whether the
                       Department can enforce the requirement prospectively. Therefore, GAO did
                       not change the recommendation. However, GAO recognizes that the draft
                       executive summary—which stated that HUD has not issued guidance to the
                       state agencies directing them to share certain bond refunding
                       savings—may have implied that the legal issue had been resolved. GAO
                       therefore revised this statement for clarity and greater consistency with
                       the discussion of this issue in the body of the report.

                       HUD questioned GAO’s support for the statement that, without clarification
                       of the McKinney Act’s shared savings provision, state agencies may retain
                       “tens of millions” of dollars that they could be legally required to share
                       with the government. GAO agrees with HUD that for contracts that do not
                       include a requirement for providing bond refunding savings to the
                       government, these savings will generally be smaller than for contracts that
                       do include this requirement. This is because the interest rates—and hence
                       the bond refunding savings—are generally lower for the contracts without
                       the requirement. GAO also agrees with HUD that the data needed to prepare
                       a comprehensive estimate of the potential savings are not available.
                       Therefore, GAO did not include an estimate of potential savings in the final


                       6
                        The National Council of State Housing Agencies is a national nonprofit organization that assists state
                       housing agencies in advancing the interests of lower-income and underserved people through the
                       financing, development, and preservation of affordable housing. Members operate in every state, the
                       District of Columbia, Puerto Rico, and the U.S. Virgin Islands.



                       Page 11                                   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Executive Summary




report and concluded that HUD may have missed opportunities to provide
additional bond refunding savings to the government.

HUD agreed with GAO’s recommendation on clarifying and reissuing its
guidance on calculating rent increases when savings have resulted from
refunding bonds and plans to implement the recommendation. While not
disagreeing with GAO’s recommendation that the Department enforce its
Section 8 regulation prohibiting dual fees, HUD indicated that it views the
dual fees as an incentive needed for state agencies to refund their bonds
and share the savings with the government. However, the agencies were
explicitly required by their Section 8 contracts to provide all of the savings
to the government in most instances when shared savings agreements
were executed. In addition, although the Department says that dual fee
transactions will return savings in excess of $150 million to the Treasury
over the life of the Section 8 contracts, it does not have the information
needed to determine whether these savings will be sufficient to offset the
excess costs of the dual fees provided to the agencies. GAO did not change
its recommendation in response to these comments.

Both HUD and the National Council of State Housing Agencies disagreed
with a statement in the draft report that the federal government’s costs are
higher than they should be when Section 8 rents exceed market rents. GAO
revised this statement to describe rather than evaluate the impact of the
Section 8 program’s design on the federal government’s subsidy costs. As
revised, the report says that when Section 8 contract rents exceed market
rents, the Section 8 subsidies support higher rents than the properties
generally could command without federal assistance.

Like HUD, the National Council disagreed with and misinterpreted GAO’s
recommendation that HUD clarify when state agencies are required to share
bond refunding savings with the government. According to the National
Council, GAO wrongly concluded that HUD has the authority to require state
agencies to share certain bond refunding savings with the federal
government. In fact, as discussed, the report recommends that the
Secretary determine whether the state agencies are required to share
certain bond refunding savings. Nevertheless, as discussed, GAO revised a
sentence in the executive summary that may have caused some confusion.
The National Council also disagreed with the report for not recognizing
that HUD effectively waived its prohibition of dual fees by approving bond
refunding transactions under which state agencies received both fees. As
the draft report stated, this is the position of the state agencies. However,




Page 12                        GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Executive Summary




HUD is required by statute to issue formal waivers when it does not enforce
a regulation such as the prohibition of dual fees.

HUD’s and the National Council’s comments and GAO’s evaluation of them
are discussed in more detail in chapters 2, 3, and 4 and in appendixes VI
and VII.




Page 13                       GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Contents



Executive Summary                                                                                    4


Chapter 1                                                                                           18
                       The Uninsured Section 8 Project-Based Portfolio                              18
Background             Bond Financing for Properties in the Uninsured Portfolio                     21
                       How Bond Refunding Savings Are Shared                                        24
                       Contract Administration Fees in the Uninsured Portfolio                      25
                       Objectives, Scope, and Methodology                                           26
                       Agency Comments                                                              27

Chapter 2                                                                                           28
                       Section 8 Expenditures and Per-Unit Costs Vary Widely by                     28
Section 8 Assistance     Program
Provided to            HUD’s Rent Standard Is Used to Limit Rent Increases, but                     32
                         Portfolio Data on Actual Market Rents Are Not Available
Properties in the      Section 8 Contracts for Programs in the Uninsured Portfolio Will             35
Uninsured Portfolio      Expire at Various Times
                       Agency Comments and Our Evaluation                                           36

Chapter 3                                                                                           38
                       Requirements for Sharing Refunding Savings Remain Unclear                    38
HUD Has Missed         HUD’s Guidance Has Not Eliminated Excess Section 8 Rent                      43
Opportunities to         Increases
                       HUD Has Not Enforced Its Prohibition of Dual Fees                            45
Reduce Its Costs in    Conclusions                                                                  50
the State Agency       Recommendations                                                              51
Program                Agency Comments and Our Evaluation                                           52




                       Page 14                      GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                         Contents




Chapter 4                                                                                             56
                         HUD and State Agencies Monitor Conditions to Ensure                          56
HUD’s Information on        Compliance With Federal Requirements
the Physical and         Information on the Physical and Financial Condition of                       57
                            Uninsured Section 8 Properties Was Limited
Financial Condition of   HUD Is Taking Action to Obtain More Reliable and Complete                    61
the Uninsured               Data on Its Portfolios
Portfolio Is Limited,    Agency Comments and Our Evaluation                                           63
but 10 State Agencies
Reported Few
Problems in Their
Portfolios
Appendixes               Appendix I: Information on the Size of the Uninsured Section 8               64
                           Portfolio
                         Appendix II: Information on the HUD Databases Used to Analyze                65
                           the Section 8 Uninsured Portfolio
                         Appendix III: Information on Section 8 Contract Rents and                    67
                           Expirations
                         Appendix IV: Size and Condition of the Uninsured Portfolio for 10            69
                           State Housing Finance Agencies
                         Appendix V: Results of Inspections Under HUD’s New Inspection                72
                           Program
                         Appendix VI: Comments From the Department of Housing and                     73
                           Urban Development
                         Appendix VII: Comments From the National Council of State                    81
                           Housing Agencies
                         Appendix VIII: GAO Contacts and Staff Acknowledgements                       86

Tables                   Table 1.1: Housing Development Programs in the Uninsured                     19
                           Section 8 Project-Based Portfolio
                         Table 2.1: Average Per-Unit Subsidy Cost, by Section 8 Program,              30
                           Fiscal Year 1998
                         Table 2.2: Percentage of Assisted Units With Section 8 Rents                 34
                           Exceeding HUD’s Fair Market Rents, by Program, in HUD’s
                           Uninsured Section 8 Portfolio, December 1998
                         Table I.1: Number of Uninsured Section 8 Properties, Contracts,              64
                           and Units, by Program, as of December 1998




                         Page 15                      GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
          Contents




          Table III.1: Percentage of Assisted Units Whose Section 8                     67
            Contract Rents Exceed HUD’s Fair Market Rents for Programs in
            HUD’s Uninsured Section 8 Portfolio, as of December 1998
          Table III.2: Percentage of Contracts Expiring Within Indicated                68
            Fiscal Year Ranges, by Program, as of December 1998
          Table IV.1: Numbers of Properties, Project-Based Section 8                    69
            Contracts, and Units in the Portfolios of the 10 State Agencies
            Reviewed by GAO
          Table IV.2: Physical Condition of Properties, as Rated by the 10              70
            State Agencies
          Table IV.3: Financial Condition of Properties, as Rated by Five               70
            State Agencies
          Table IV.4: Overall Condition of Properties, as Rated by Seven                71
            State Agencies
          Table IV.5: Number of Properties Receiving Special Monitoring                 71
            Compared With the Total Number of Properties for Each of the
            10 State Agencies
          Table V.1: Number of Properties Inspected by April 1999 and                   72
            Their Physical Condition Ratings

Figures   Figure1.1: Percentages and Numbers of Assisted Project-Based                  21
            Units, by Program
          Figure 2.1: Section 8 Contract Expenditures for Fiscal Year 1998,             29
            by Program
          Figure 2.2: Unit Rents Exceeding HUD’s Fair Market Rent Levels,               33
            December 1998
          Figure 2.3: Dates When Section 8 Contracts for Uninsured                      36
            Properties Will Expire
          Figure 4.1: Physical Condition of Properties, as Reported by 10               59
            State Agencies
          Figure 4.2: Financial Condition of Properties, as Rated by Five               60
            State Agencies
          Figure 4.3: Overall Condition of Properties, as Rated by Seven                61
            State Agencies

          Abbreviations

          FHA        Federal Housing Administration
          HUD        Department of Housing and Urban Development
          OIG        Office of the Inspector General
          PAS        Program Accounting System
          REMS       Real Estate Management System
          VA         Department of Veterans Affairs


          Page 16                       GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Page 17   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Chapter 1

Background


                Section 8 rental housing assistance, managed by the Department of
                Housing and Urban Development (HUD), is the main form of federal
                housing assistance for low-income residents. In fiscal year 1998, total
                Section 8 expenditures were about $15.5 billion. Under Section 8, residents
                in subsidized units generally pay 30 percent of their income for rent and
                HUD pays the balance. Section 8 rental assistance is tied either to units in
                specific properties (project-based assistance) or to families and
                individuals who live in affordable rental housing of their choice
                (tenant-based assistance). Some properties that received project-based
                assistance also received federal mortgage insurance through HUD’s Federal
                Housing Administration (FHA). The primary goal of the Section 8
                project-based program was to encourage developers to build or
                rehabilitate properties for lower-income families by providing rental
                assistance contracts for a negotiated number of units for periods ranging
                from 20 to 40 years. Authorized in 1974, project-based assistance was, with
                one exception, repealed by the Congress in 1983 because of its high cost.
                That exception was the assistance used to provide housing for the elderly
                and the disabled.

                Over half of HUD’s portfolio of approximately 22,000 multifamily properties
                that receive Section 8 project-based rental assistance do not receive
                federal mortgage insurance. Collectively, these properties are referred to
                as HUD’s uninsured Section 8 portfolio. A mandate for us to study this
                portfolio was included in HUD’s fiscal year 1998 appropriations bill (P.L.
                105-65, Oct. 27, 1997). The uninsured portfolio includes properties for the
                elderly and disabled that have been financed by direct loans and capital
                advances (grants) from HUD, as well as properties financed by state and
                local housing finance agencies, referred to as state and local agencies in
                this report.


                Eight programs provide rental assistance to residents of properties in the
The Uninsured   uninsured Section 8 project-based portfolio. As shown in table 1.1, five of
Section 8       the programs developed housing for low-income residents using varying
Project-Based   financing methods.

Portfolio




                Page 18                       GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                                      Chapter 1
                                      Background




Table 1.1: Housing Development
Programs in the Uninsured Section 8   Housing development
Project-Based Portfolio               programs with
                                      project-based rental                            Initial term of
                                      assistance                     Financing method Section 8 contract Program’s status
                                      Elderly/disabled loan          Government loans        20 years               Terminated in the
                                      program                        from HUD at                                    early 1990s;
                                                                     below-market                                   replaced with the
                                                                     interest rates that                            capital advance
                                                                     were established                               program
                                                                     annually by the
                                                                     Congress
                                      Elderly/disabled capital       Capital advances        5 or 20 years          Ongoing
                                      advance programa               (grants) from HUD       (depending on
                                                                                             when a property
                                                                                             was initially
                                                                                             developed)
                                      State agency program           State government        20 to 40 years         Terminated in 1983
                                                                     tax-exempt bonds
                                      New construction/              Various methods,        20 to 40 years         Terminated in 1983
                                      substantial rehabilitation     including local
                                      program                        government
                                                                     tax-exempt bonds
                                                                     and some state
                                                                     tax-exempt bonds
                                      Rural rental housing           Government loans        20 years               Terminated in
                                      program                        from the Rural                                 1983b
                                                                     Housing Service
                                                                     with a 1-percent
                                                                     interest rate
                                      a
                                       The rental assistance contracts under this program are not funded under the same
                                      appropriations account as the Section 8 rental assistance program, but the project-based
                                      assistance under this program is substantially the same as Section 8 project-based assistance
                                      except that the subsidy is limited to operating costs.
                                      b
                                       The Department of Agriculture continues to fund the Rural Rental Housing development
                                      program, but HUD no longer provides new Section 8 project-based assistance. The Rural
                                      Housing Service has its own rental subsidy program.



                                      The three remaining programs represented in the uninsured Section 8
                                      project-based portfolio were established in the 1980s to provide long-term
                                      rental assistance to existing properties that were formerly in FHA’s insured
                                      portfolio.1 Section 8 assistance was extended through these programs as a
                                      means of retaining affordable housing for low-income residents. First, the
                                      loan management set-aside program provided Section 8 rental assistance
                                      to financially troubled projects using 15-year Section 8 contracts. Second,

                                      1
                                       The uninsured portfolio also includes properties that receive rental assistance under HUD’s rental
                                      assistance payment and rent supplement programs (representing 371 contracts covering 30,250 units).
                                      These programs, which were precursors of the Section 8 program, are not discussed in this report.



                                      Page 19                                 GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Chapter 1
Background




the multifamily property disposition program also used 15-year contracts
to provide rental assistance to properties acquired by new owners through
foreclosures when borrowers defaulted on loans insured by FHA. Finally,
the housing preservation program provided rental assistance to property
owners who were approaching eligibility to pay off their mortgages as an
incentive for them to maintain some of the units in these properties as
affordable low-income housing. Preservation contracts were executed for
varying terms, depending on, among other things, the availability of
appropriations. The Department no longer funds new project-based
contracts under these three programs.

According to HUD’s data, as of December 1998, the uninsured Section 8
project-based portfolio consisted of 12,708 active contracts for 12,488
properties covering 632,216 assisted units. (See app. I for more detailed
information, by program, and app. II for a discussion of the databases we
used to identify the universe of uninsured Section 8 contracts.2 ) Figure 1.1
shows the number and percentage of assisted units in the uninsured
portfolio that are funded through each of the rental assistance programs. A
majority of the units in this portfolio—60 percent—are associated with the
elderly and disabled loan program and the state agency program.




2
 This universe includes 13,046 active contracts, 12,708 of which cover properties in the eight programs
discussed in this report.



Page 20                                  GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                                      Chapter 1
                                      Background




Figure1.1: Percentages and Numbers
of Assisted Project-Based Units, by                                                        Elderly & disabled loan (209,178)
Program
                                                                                           1%
                                                                                           Housing preservation (3,069)

                                                                                           5%
                                                                                           Loan management set-aside
                                                                                           (32,674)

                                                                                           6%
                                                                                           Elderly & disabled capital advance
                                                                                           (38,449)


                                                               •
                                                                    •


                                            • 33%                       •                  6%
                                                                                           Multifamily property disposition
                                                                            •              (39,829)


                                                                    14%
                                                                      •


                                                     27%
                                                       •


                                                                                           7%
                                                                                           Rural housing (44,788)

                                                                                           New construction & substantial
                                                                                           rehabilitation (91,435)

                                                                                           State agency (172,794)


                                      Note: Percentages do not add because of rounding.

                                      Source: HUD’s Real Estate Management System and Section 8 expiring contracts database, as of
                                      Dec. 1998.



                                      Some properties in the uninsured portfolio were financed by state and
Bond Financing for                    local housing finance agencies with the proceeds of bonds that are exempt
Properties in the                     from federal taxation. Specifically, during the 1970s and early 1980s,
Uninsured Portfolio                   tax-exempt bonds were used to finance the development of the 2,278
                                      properties in the state agency program and a portion of the 1,678




                                      Page 21                                   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Chapter 1
Background




properties in the new construction and substantial rehabilitation program.3
 State housing finance agencies (state agencies) generally issued bonds as
instrumentalities of the state under section 103 of the Internal Revenue
Code. Section 8 assistance for properties financed by state agencies was
generally approved from Section 8 funds allocated to these agencies and is
identified in HUD’s data systems under the state agency program. Local
agencies and instrumentalities (local agencies) generally issued
tax-exempt bonds under Section 11(b) of the United States Housing Act of
1937. The state and local agencies used the bond proceeds to provide
mortgages for constructing or substantially rehabilitating properties for
use as affordable housing for low-income people under the Section 8
program. The monthly mortgage payments are used to repay the bonds
with interest.

During the late 1970s and early 1980s, interest rates rose to unprecedented
levels. To continue the development of affordable rental housing despite
rising interest costs, HUD authorized special financing in 1980 and again in
1981. This special financing allowed for higher mortgage interest rates,
which then increased the costs of HUD’s Section 8 rental assistance. The
Section 8 contracts that received the special financing authorized in 1980
did not require state and local agencies to refund (refinance) their
high-interest bonds if interest rates later dropped. But as interest rates
remained high and HUD concluded that special financing would be required
for an extended period of time, the Department took steps to reduce
Section 8 costs in the future when interest rates declined. As a result, the
Section 8 contracts that received special financing beginning in
October 1981—called financing adjustment factor contracts—did require
state and local agencies to refund their bonds when interest rates fell and
provide the savings to the government. HUD also required property owners
with financing adjustment factor contracts to accept reduced Section 8
contract rents (subsidies) to reflect the decrease in borrowing costs
resulting from refunding the bonds.

In 1987, after interest rates started to decline, HUD asked the housing
agencies to refund the bonds associated with financing adjustment factor
contracts. The savings from bond refundings can be substantial. For
example, a local agency refunded bonds for three mortgage loans totaling
over $14 million. The savings from these refundings, which will be realized
over the lives of the mortgages, are estimated to be $6.4 million. These

3
 While the Section 8 contracts associated with properties financed by local agencies are included with
others under the overall new construction and substantial rehabilitation program, HUD’s Section 8
data do not identify those with bonds issued by local agencies. This program also includes some
properties financed by state agencies that were not processed under the state agency program.



Page 22                                  GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Chapter 1
Background




savings represent the difference between the cost of the mortgages needed
to repay the original bonds and the cost of the mortgages needed to repay
the refunded bonds.

The Congress, in passing the Stewart B. McKinney Homeless Assistance
Amendments Act of 1988, approved a provision that permitted state
agencies to keep half of the savings from refunding bonds associated with
financing adjustment factor contracts. While the McKinney Act provided
primarily for assistance to the nation’s homeless population, section 1012
created an incentive for the state agencies to refund bonds associated with
these contracts. Without the McKinney Act’s shared savings provision, the
state agencies would have been contractually required to provide
100 percent of the savings to the government.

As amended in April 1992, section 1012 extended this benefit to local
agencies. Finally, as amended in October 1992, the section provided for
state and local agencies and the federal government to share the savings
from refunding bonds associated with Section 8 contracts entered into
between 1979 and 1984. This period generally covered the contracts that
received special financing, including the financing adjustment factor
contracts, and some contracts that did not receive special financing.

In 1992 and 1993, HUD’s Office of the Inspector General (OIG) released two
reports that examined whether (1) bond-financed Section 8 properties
were refinanced as intended and (2) HUD realized the appropriate savings
from the bond refundings.4 The initial report, which included 18
recommendations, was issued as an interim report before the audit work
was completed because the Inspector General believed the potential for
cost savings and the need to improve internal controls warranted prompt
corrective action. The final report, issued on April 30, 1993, included six
additional recommendations. The reports disclosed, among other things,
that HUD had not fully realized potential savings from bond refundings and
identified actions that HUD could take to realize additional savings.

In January 1997, the Inspector General determined that HUD had not taken
the corrective actions it had agreed to take in response to several of the
key recommendations in these reports. Therefore, the Inspector General
reopened the recommendations. The reopened recommendations include
those addressing the extent to which agencies are required to share bond
refunding savings with the government, excess rent increases to owners,

4
  Interim Audit Report Bond Refundings of Section 8 Projects (OIG 93-HQ-119-0004, Oct. 30, 1992) and
Multi-Region Audit of Refunding of Bonds for Section 8 Assisted Projects (OIG 93-HQ-119-0013, Apr.
30, 1993).



Page 23                                 GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                     Chapter 1
                     Background




                     and dual fees for administering Section 8 contracts. As of June 1999, these
                     issues had not been effectively resolved. These issues are discussed
                     further in chapter 3.


                     To share the savings from refunding bonds, HUD enters into agreements
How Bond Refunding   with state and local agencies that identify (1) the total amount of savings
Savings Are Shared   that will become available as a result of the refundings and (2) the
                     amounts that will be provided to the agencies and to the federal
                     government each year throughout the lives of the Section 8 contracts. HUD
                     refers to the shared savings agreements as refunding agreements.
                     According to HUD’s data, as of September 30, 1998, the Department had
                     approved 245 refunding agreements that will provide $1.1 billion in bond
                     refunding savings over the lives of the Section 8 contracts, $633 million of
                     which is to be provided to the U.S. Treasury. In negotiating refunding
                     agreements with agencies, HUD reviews the agencies’ bond refunding
                     documents.5

                     The responsibility for making the shared savings payments varies,
                     depending on the method selected to share the savings. Two methods are
                     available for state and local agencies and the federal government to share
                     savings. The first, called the rent reduction method, reduces the federal
                     government’s Section 8 costs directly. Under this method, the mortgage is
                     refinanced and the Section 8 contract rents are reduced to reflect the new,
                     lower cost of bond financing. HUD periodically pays the agency its share of
                     the savings that accrue over the life of the mortgage and the Section 8
                     contract. A few agencies have used this method to share savings.

                     An alternative method of sharing savings, called the trustee sweep method,
                     is used by most state and local agencies that share savings, according to
                     HUD. Under this method, neither the mortgage nor the Section 8 contract
                     rents are reduced after the bond is refunded. Instead, an independent third
                     party—a trustee—receives the mortgage payments from the Section 8
                     property owners and uses these funds to repay the bond principal and
                     interest. The remaining balance (bond payments minus mortgage
                     payments) represents the savings from refunding the bonds. Semiannually,
                     the trustee pays the state or local agency its share of the savings and pays
                     the federal share to the U.S. Treasury. Thus, the federal government


                     5
                      State agencies issuing bonds under the Internal Revenue Code did not usually need HUD’s approval to
                     issue bonds. As a result, the Department generally does not review state agency bond transactions.
                     However, HUD does review the state agency bond refunding transactions associated with McKinney
                     Act refunding agreements.



                     Page 24                                 GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                      Chapter 1
                      Background




                      receives reimbursement for a portion of the excess financing costs being
                      borne by the Section 8 program.

                      Using the trustee sweep method eliminates the need for agencies to
                      refinance mortgages and amend their Section 8 contracts with owners and
                      for HUD to set up accounts to pay the state or local agencies their share of
                      the bond refunding savings. Thus, it imposes less of an administrative
                      burden on both the state agencies and the Department. According to HUD
                      officials, many agencies would not have participated in the refunding
                      program if the trustee sweep method had not been available. However, the
                      trustee sweep method allows Section 8 costs (expenditures) to remain
                      artificially high—that is, the costs continue to reflect the original high
                      interest rates. As is discussed further in chapter 3, the trustee sweep
                      method can result in excess rent increases for many contracts. This occurs
                      because many Section 8 contracts receive automatic rent increases on the
                      basis of a factor that is applied to total Section 8 costs—that is, to the debt
                      service as well as the operating costs.


                      State and local housing finance agencies that administer Section 8
Contract              contracts for HUD receive compensation for carrying out their
Administration Fees   administrative responsibilities. This compensation is paid to the agencies
in the Uninsured      for performing administrative tasks, such as conducting management
                      reviews of the Section 8 properties and inspecting the properties at least
Portfolio             annually. All of the agencies are eligible for what is called an annual
                      contributions contract fee. Alternatively, state agencies that finance
                      Section 8 property mortgages with the proceeds of state tax-exempt bonds
                      issued under the Internal Revenue Code may receive what is referred to as
                      an “override fee” instead of an annual contributions contract fee.

                      The annual contributions contract fee is generally a per-unit cost (equal to
                      3 percent of the annual fair market rent for a 2-bedroom unit) multiplied
                      by the number of units in the property. An override fee represents the
                      difference between the agency’s borrowing (bond issuance) and mortgage
                      lending rates. This difference, which the Internal Revenue Service refers to
                      as arbitrage, cannot exceed 1.5 percent for all of the properties the agency
                      has financed through the bond proceeds. Because local housing finance
                      agencies generally issued bonds under the United States Housing Act of
                      1937, they are not eligible for the override fee available to state housing
                      finance agencies under the Internal Revenue Code. Under a Section 8
                      regulation promulgated in 1980 (24 C.F.R. 883.606), a state housing finance




                      Page 25                        GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                     Chapter 1
                     Background




                     agency that chooses to collect an override fee cannot receive an annual
                     contributions contract fee.


                     Section 532 of the 1998 Appropriations Act for the Departments of
Objectives, Scope,   Veterans Affairs and Housing and Urban Development, and Independent
and Methodology      Agencies (P.L.105-65, Oct. 27,1997) requires that GAO submit a report to the
                     Congress on the uninsured Section 8 portfolio. Accordingly, this report
                     examines (1) the information HUD has on the Section 8 assistance provided
                     to properties in the uninsured portfolio, (2) the financial benefits that may
                     be available to state and local housing finance agencies that participate in
                     the Section 8 program and the impact of these benefits on the Section 8
                     program’s costs, and (3) the information HUD and the state agencies have
                     on the physical and financial condition of the properties in their respective
                     uninsured Section 8 project-based portfolios.

                     To determine what information the Department maintains on the Section 8
                     assistance provided to uninsured properties and the physical and financial
                     condition of these properties, we obtained several HUD databases that were
                     used to develop the information responding to these objectives and met
                     with officials from HUD’s Office of Housing and Office of the Chief
                     Financial Officer. (See app. II for additional information on the databases
                     used in this review.) We also obtained information from HUD officials on
                     the improvements the Department is implementing for monitoring the
                     physical and financial condition of its properties under the Real Estate
                     Assessment Center. We did not evaluate the effectiveness of HUD’s new
                     processes.

                     To develop information on the benefits available to state and local
                     agencies that participate in the uninsured Section 8 program and the
                     impact of these benefits on the Section 8 program’s costs, we interviewed
                     officials from HUD, state agencies, and the National Council of State
                     Housing Agencies. We sent a data collection instrument to state housing
                     finance agencies in Illinois, Maryland, Massachusetts, Minnesota, and New
                     Hampshire. We also reviewed HUD documents—including legal opinions,
                     regulations, notices, and handbooks—and literature on tax-exempt bonds
                     from bond-rating agencies.

                     To obtain information on the physical and financial condition of the
                     properties in the state agencies’ uninsured Section 8 project-based
                     portfolios, we selected five state agencies in addition to the five that
                     provided information on Section 8 benefits—California, Michigan, Oregon,



                     Page 26                        GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                  Chapter 1
                  Background




                  Tennessee, and Wisconsin. These 10 state agencies have portfolios of
                  varying sizes and serve different geographical regions, including rural and
                  urban areas. We sent a data collection instrument to the 10 state agencies
                  to obtain information on (1) their overall monitoring approaches and the
                  primary methods they use to evaluate the physical and financial condition
                  of their portfolios and (2) the physical and financial condition of the
                  uninsured Section 8 properties in their portfolios. In addition, we visited
                  the Illinois, Maryland, Massachusetts, Minnesota, and New Hampshire
                  agencies, where we discussed monitoring approaches, reviewed specific
                  project files, and obtained documentation on policies and procedures.

                  We conducted our work from August 1998 through July 1999 in
                  accordance with generally accepted government auditing standards.


                  We provided copies of a draft of this report to HUD and to the National
Agency Comments   Council of State Housing Agencies for review and comment.1 Their
                  comments, which are reproduced in appendixes VI and VII, are discussed
                  and evaluated as applicable in the remaining chapters of this report.




                  1
                   The National Council of State Housing Agencies is a national nonprofit organization that assists state
                  housing agencies in advancing the interests of lower-income and underserved people through the
                  financing, development, and preservation of affordable housing. Members operate in every state, the
                  District of Columbia, Puerto Rico, and the U.S. Virgin Islands.



                  Page 27                                   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Chapter 2

Section 8 Assistance Provided to Properties
in the Uninsured Portfolio

                      According to HUD’s data, rental assistance payments for the uninsured
                      Section 8 portfolio totaled over $3.3 billion in fiscal year 1998. A majority
                      of these payments—about $2.3 billion—were associated with the two
                      largest programs in the uninsured portfolio, the state agency and the
                      elderly/disabled loan programs. The average payment per rental unit
                      varied significantly from program to program, reflecting in large measure
                      the different financing methods used in the various programs. Complete
                      data were not available for comparing assisted rents to market rents—the
                      commonly accepted standard for assessing the reasonableness of rents.
                      Nevertheless, on the basis of information that is available, some assisted
                      rents exceed market rents. When Section 8 contract rents exceed market
                      rents, the Section 8 subsidies support higher rents than the properties
                      generally could command without federal assistance. Moreover, the
                      federal government will continue to incur these high rent costs each year
                      until its existing Section 8 contracts expire. These contracts will expire at
                      various times, from within the next 5 years to about 20 years. Contracts in
                      the state agency program will generally be among the last to expire.


                      Section 8 rental assistance payments for the uninsured portfolio totaled
Section 8             over $3.3 billion during fiscal year 1998. This amount represents net
Expenditures and      expenditures—that is, fiscal year 1998 expenditures to property owners
Per-Unit Costs Vary   minus any offsetting collections received during the period. As shown in
                      figure 2.1, about 68 percent of the portfolio’s rental assistance
Widely by Program     expenditures are distributed among the two largest programs in the
                      uninsured portfolio—the state agency program and the elderly/disabled
                      loan program.




                      Page 28                        GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                                        Chapter 2
                                        Section 8 Assistance Provided to Properties
                                        in the Uninsured Portfolio




Figure 2.1: Section 8 Contract
Expenditures for Fiscal Year 1998, by                                                       State agency ($1,193)
Program
                                                                                            1%
                                                                                            Housing preservation ($14)

                                                                                            2%
                                                                                            Elderly & disabled captial advance
                                                                                            ($57)

                                                                                            3%
                                                                                            Loan management set-aside ($97)


                                                                      •
                                                                          •                 6%
                                                                                            Rural housing ($192)
                                                                          •
                                               • 35%
                                                                              15%
                                                                               •




                                                               33%
                                                                 •


                                                                                            6%
                                                                                            Multifamily property disposition
                                                                                            ($194)

                                                                                            New construction & substantial
                                                                                            rehabilitation ($496)

                                                                                            Elderly & disabled loan ($1,124)


                                        Notes: Dollars are in millions.

                                        Percentages do not add because of rounding.

                                        Source: Extract of fiscal year 1998 expenditures and receipts from HUD’s Program Accounting
                                        System.




                                        The average per-unit subsidy costs for fiscal year 1998 for the eight
                                        programs also varied considerably. As shown in table 2.1, the average




                                        Page 29                                 GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                                      Chapter 2
                                      Section 8 Assistance Provided to Properties
                                      in the Uninsured Portfolio




                                      per-unit costs ranged from $1,492 for the elderly/disabled capital advance
                                      program to $6,903 for the state agency program.

Table 2.1: Average Per-Unit Subsidy
Cost, by Section 8 Program, Fiscal    Program                                                                 Average per-unit cost
Year 1998                             Elderly/disabled capital advance                                                         $1,492
                                      Loan management set-aside                                                                     2,966
                                      Rural housing                                                                                 4,281
                                      Housing preservation                                                                          4,696
                                      Multifamily property disposition                                                              4,870
                                      Elderly/disabled loan                                                                         5,374
                                      New construction/substantial rehabilitation                                                   5,421
                                      State agency                                                                                  6,903
                                      Source: Extract of fiscal year 1998 expenditures and receipts from HUD’s program accounting
                                      system.



                                      An important reason for the variation in average per-unit costs is that the
                                      programs were financed in different ways. For example, the federal
                                      government provides grants to develop properties under the
                                      elderly/disabled capital advance program. Because the government makes
                                      an investment up front, the Section 8 program’s subsidies need to cover
                                      only the operating costs for properties in this program. In contrast,
                                      properties under the other development programs were financed with
                                      mortgage loans. Their Section 8 subsidies are considerably higher because
                                      they must cover both the mortgage debt service and the operating costs.

                                      Another factor that affects the level of Section 8 subsidies is tenants’
                                      income. As discussed in chapter 1, residents generally pay 30 percent of
                                      their income for rent, and HUD pays the balance. As a result, differences in
                                      tenants’ income levels can influence the average per-unit costs for these
                                      programs. Thus, one factor contributing to the high per-unit costs in the
                                      state agency program may be the residents’ low income levels. According
                                      to the 10 state agencies we surveyed, about 93 percent of the households
                                      receiving Section 8 project-based rental assistance at their multifamily
                                      properties had very low incomes—defined by HUD as at or below
                                      50 percent of the local area’s median income.

                                      Officials from HUD’s Office of Housing, including the Directors for Business
                                      Products and Portfolio Management, identified these and other financing
                                      and programmatic differences, summarized below, that can affect the
                                      per-unit cost of the programs.



                                      Page 30                                GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
    Chapter 2
    Section 8 Assistance Provided to Properties
    in the Uninsured Portfolio




•   The state agency program allowed more flexibility than most of the other
    programs in setting initial contract rents. The rents could be higher than
    those permitted under HUD’s standard new construction/substantial
    rehabilitation Section 8 program. According to Office of Housing officials,
    the higher rent structure allowed the state agencies to develop properties
    that offered more amenities than the typical Section 8 property insured by
    FHA. In particular, the officials said, the higher rents allowed the state
    agencies to develop some properties in affluent suburban neighborhoods
    that were compatible with the housing in those neighborhoods. The
    officials also said that a number of state agency properties received a
    financing adjustment factor that allowed higher contract rents to support
    the high mortgage interest rates prevailing during the early 1980s.
•   The elderly/disabled loan program also allowed greater flexibility in
    setting initial contract rents, which often exceeded market rents. In
    addition, the properties were generally more costly to develop because
    they were mid-rise and/or high-rise buildings that provided more
    amenities, such as emergency call systems, than most of the other
    subsidized new construction/substantial rehabilitation properties. These
    higher costs are offset to some extent by below-market interest rates,
    which the Congress established annually for the program. Although
    interest rates were below market when the financing for the properties
    was approved, some of the rates are now higher than current market
    interest rates.
•   The rural housing program serves low-income persons, including the
    elderly and disabled, but properties under this program have lower
    per-unit costs than similar properties in HUD’s uninsured portfolio.
    According to HUD officials, the rural housing properties are older than the
    HUD properties and are built in rural areas, where construction costs are
    generally lower than in urban areas. In addition, the properties were
    financed with loans that generally had subsidized interest rates of
    1 percent.

    Each program’s per-unit costs reflect the influence of a variety of factors
    on the long-term costs of Section 8 rental assistance, and each program’s
    costs need to be evaluated in the context of these factors. Furthermore,
    the per-unit costs may not reflect all of the costs that the government
    incurs for some programs. For example, the per-unit costs for grant
    programs, such as the elderly/disabled capital advance program, and for
    interest subsidy programs, such as the rural housing program, do not
    include the costs of the federal grants or interest subsidies provided under
    these programs. Additional data—which may or may not be available for




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                        all of the programs—and in-depth analyses would be required to estimate
                        the total per-unit costs of these programs to the government.


                        The Congress, beginning in fiscal year 1995, limited the annual rent
HUD’s Rent Standard     increases that, until then, were automatic for many Section 8 properties.
Is Used to Limit Rent   Under this congressional limit, automatic rent increases are no longer
Increases, but          allowed for properties whose Section 8 contract rents exceed HUD’s rent
                        standard—fair market rents—unless the property owners provide
Portfolio Data on       independent studies showing that the Section 8 contract rents do not
Actual Market Rents     exceed actual market rents.1 To establish fair market rents, HUD annually
                        samples market rents for geographic areas, such as large metropolitan
Are Not Available       areas, and sets the fair market rent somewhat below the average for the
                        geographic area. In some cases, the area covered by HUD’s fair market rent
                        is too wide to reflect differences in the rents paid in different submarkets,
                        or neighborhoods, within the geographic area covered. By contrast,
                        market rents reflect the rents paid for comparable units in particular
                        neighborhoods. As a result, HUD’s fair market rents for Section 8 properties
                        may not reflect the actual market rents in neighborhoods where Section 8
                        properties are located.

                        According to HUD’s data, most of the rents for Section 8 units in the
                        uninsured portfolio exceed HUD’s fair market rents and are therefore
                        subject to the congressional limit on rent increases. As of December 1998,
                        the rents for 474,270 of 632,216 assisted units in the uninsured portfolio
                        exceeded fair market rents. These units represent 75 percent of the
                        assisted units in the uninsured portfolio. As shown in figure 2.2, for
                        22 percent of these 474,270 units, the Section 8 rents were greater than
                        160 percent of HUD’s fair market rents.




                        1
                        In the tenant-based section 8 program, fair market rents are used as limits for rents the Department
                        will subsidize.



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Figure 2.2: Unit Rents Exceeding
HUD’s Fair Market Rent Levels,
December 1998


                                          • 22%
                                                               26% •                  101-120% of FMR




                                              23%
                                               •
                                                              29% •                   121-140% of FMR




                                                                                      141-160% of FMR
                                                                                       Over 160% of FMR


                                   FMR=fair market rent

                                   Source: HUD’s Section 8 expiring contracts database, Dec. 1998.




                                   Among the uninsured programs, those that use Section 8 assistance to
                                   support property mortgages generally have rents that exceed fair market
                                   rents. Thus, most of the units in four of the housing development programs
                                   — the state agency, elderly/disabled loan, rural housing, and new
                                   construction/substantial rehabilitation programs—have Section 8 contract
                                   rents that exceed HUD’s fair market rents. These programs account for over
                                   80 percent of the assisted units in the entire uninsured inventory. As
                                   shown in table 2.2, the rents for between 72 and 91 percent of the units
                                   associated with the four programs exceeded HUD’s fair market rents. (See
                                   app. III, table III.1 for additional details on these rent levels by program.)




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Table 2.2: Percentage of Assisted
Units With Section 8 Rents Exceeding                                                                      Percentage of units with rents
HUD’s Fair Market Rents, by Program,   Program                                                              exceeding fair market rents
in HUD’s Uninsured Section 8           State agency                                                                                          91
Portfolio, December 1998
                                       Elderly/disabled loan                                                                                 88
                                       Rural housing                                                                                         86
                                       New construction/substantial rehabilitation                                                           72
                                       Preservation                                                                                          42
                                       Loan management set-aside                                                                             24
                                       Property disposition                                                                                  21
                                       Elderly/disabled capital advance                                                                       5
                                       Note: These data cover 12,288 of the 12,708 contracts in HUD’s uninsured portfolio for which
                                       data on rents and HUD’s fair market rents were available.

                                       Source: HUD’s Section 8 expiring contracts database, Dec. 1998.



                                       Because data on actual market rents for particular neighborhoods were
                                       not available for comparison with Section 8 contract rents, we could not
                                       determine to what extent the contract rents exceeded the actual market
                                       rents in this portfolio. However, some properties in the uninsured Section
                                       8 portfolio have rents in excess of actual market rents.

                                       When Section 8 contract rents exceed market rents, the Section 8
                                       subsidies support higher rents than the properties generally could
                                       command without federal assistance. In the uninsured portfolio, as in the
                                       FHA-insured portfolio, where HUD found that many of its Section 8 rents
                                       exceeded market rents,2 the assisted rents were initially set above market
                                       levels to encourage the production of new affordable housing. These rents
                                       were then increased automatically each year through the application of set
                                       formulas that, according to HUD, tended to be generous.3 A July 1997 study
                                       of 53 bond-financed properties, the majority of which are included in the
                                       uninsured Section 8 portfolio, reported that some of the properties had
                                       rents that were well above comparable market levels.4



                                       2
                                        Our 1996 report on HUD’s portfolio reengineering proposal discusses high rents in the FHA-insured
                                       portfolio, and a study by Ernst & Young for HUD on the potential cost to the government of reducing
                                       Section 8 rents in the insured portfolio to market rents. See Multifamily Housing: Effects of HUD’s
                                       Portfolio Reengineering Proposal (GAO/RCED-97-7, Nov. 1996).
                                       3
                                        A problem with automatic rent increases, according to Office of Housing officials, is that they allow a
                                       percentage increase in both operating costs and mortgage debt service, even though debt service is a
                                       fixed amount that does not increase.
                                       4
                                        HUD’s Local Multifamily Portfolio, John Nuveen & Co., Inc. (July 1997).



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                         In addition, since the Congress limited automatic Section 8 rent increases,
                         some owners have not requested rent increases. Officials at two of the five
                         state agencies we visited said they have not processed Section 8 rent
                         increases for owners because the Section 8 rents for properties in their
                         portfolios are generally higher than market rents. Officials at another state
                         agency we visited said that before the Congress limited automatic rent
                         increases, they had attempted to increase rents only for the uninsured
                         Section 8 properties in their portfolio that needed increases to cover their
                         costs. However, as long as the Section 8 program’s rules required
                         automatic annual rent increases, the agency had to provide them
                         according to a formula that sometimes provided more assistance than the
                         officials considered necessary.

                         Besides limiting automatic rent increases, the Congress has taken some
                         other steps to reduce high Section 8 costs. For example, the Congress
                         enacted “mark to market,” or multifamily portfolio reengineering,
                         legislation in 1997 to bring rents in the FHA-insured Section 8 portfolio in
                         line with market rents. Under this legislation, Section 8 contract rents are
                         to be reset to market levels and mortgage debt is to be reduced if
                         necessary to permit a positive cash flow. These efforts were designed not
                         only to reduce the costs of expiring Section 8 contracts but also to address
                         problems at financially and physically troubled projects, correct
                         management and ownership deficiencies, and preserve the affordability
                         and availability of low-income rental housing. More recently, in HUD’s fiscal
                         year 1998 appropriations legislation, the Congress placed limits on the
                         contract rents that will be allowed when Section 8 contracts in the
                         uninsured Section 8 portfolio expire and are renewed. According to the
                         legislation, contract renewal rents are authorized at the lower of (1) a level
                         that provides sufficient income to support rents based on actual costs
                         (budget-based rents) or (2) existing rents subject to a new adjustment
                         factor that allows increases on operating costs, in contrast to the current
                         factor that allows increases on both operating and debt service costs.


                         As discussed in chapter 1, the Section 8 contracts for properties in the
Section 8 Contracts      uninsured portfolio were initially made for periods ranging from 20 to 40
for Programs in the      years. Currently, the contracts covering 42 percent of the assisted units
Uninsured Portfolio      will expire by the end of 2004. However, a number of contracts in the
                         uninsured portfolio have 15 to 20 years remaining (see fig. 2.3). A majority
Will Expire at Various   of the assisted units—about 58 percent—are under contracts that will
Times                    expire between 2005 and 2038. As a result, the federal government will




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                                     continue to incur costs under these rental assistance contracts for many
                                     years.


Figure 2.3: Dates When Section 8
Contracts for Uninsured Properties                                                        1999-2004 (263,724 units)
Will Expire


                                                                 16% •                    2005-2009 (98,496 units)



                                          • 42%
                                                                     22% •                2010-2014 (137,589 units)




                                                          20% •                           2015-2021 (123,807 units)




                                                                                          1%
                                                                                          2022-2038 (6,805 units)


                                     Note: Excluded from this analysis are 1,795 units covered by 54 Section 8 contracts whose
                                     expiration dates are unknown.

                                     Percentages do not add because of rounding.

                                     Source: GAO’s analysis of HUD’s Section 8 expiring contracts database, Dec. 1998.




                                     From program to program, contracts will expire at different times. For
                                     example, the vast majority of the contracts for the loan management
                                     set-aside program and the rural housing program will expire between 1999
                                     and 2004, while most of the contracts for the state agency program will
                                     expire later–-between 2010 and 2021. (See app. III, table III.2, for
                                     additional information on when contracts will expire, by program.)


                                     In commenting on the draft report, HUD and the National Council disagreed
Agency Comments                      with our statement that the federal government’s costs are higher than
and Our Evaluation                   they should be when Section 8 rents exceed market rents. We revised this



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statement to describe rather than evaluate the impact of the Section 8
program’s design on the federal government’s subsidy costs. As the draft
report observed, HUD originally set Section 8 rents above market rents to
encourage the production of low-income housing and then automatically
increased the rents each year until 1995, using formulas that tended to be
generous. As a result, Section 8 rents sometimes exceed market rents.
While the draft report concluded that, in these instances, the program’s
costs are higher than they should be, the revised report observes that
when Section 8 rents exceed market rents, the Section 8 subsidies support
higher rents than the properties generally could command without federal
assistance.

HUD  further disagreed with our comparison of Section 8 rents with HUD’s
fair market rents. The draft report recognizes that HUD’s fair market rents
are not equal to market rents and describes the methodology used to set
the fair market rent for a particular area at a level below the average rent
for that area. Moreover, as the draft report states, national data on market
rents were not available. Despite their limitations, fair market rent data are
the only comparative rent data that HUD maintains for all Section 8
contracts. The Department itself compares fair market rents with Section
8 rents, posting the results in a database on its Internet Web site. In
addition, the Congress requires that fair market rents be used to limit
some Section 8 rent increases. Therefore, we did not revise the report in
response to this comment.

Finally, according to HUD, the draft report provided no evidence, apart
from the fair market rent data, that some Section 8 rents were higher than
market rents. However, in addition to noting the impact of the program’s
design on subsidy and rent levels, the draft report cited (1) a July 1997
study of 53 bond-financed Section 8 properties that found the rents for
some were well above comparable market levels, (2) officials at two state
agencies who said that the Section 8 rents for properties in their portfolios
were generally higher than market rents, and (3) an official at another
state agency who said that HUD’s former rent increase formula sometimes
required the agency to provide more rental assistance than the officials
considered necessary. In light of this evidence, we did not revise the
report in response to HUD’s comment.




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HUD Has Missed Opportunities to Reduce
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                    Financial benefits available to state and local agencies under the Section 8
                    program include savings from refunding bonds and a fee for administering
                    Section 8 contracts. Agencies use these benefits to provide affordable
                    housing for low-income residents in their states. We found that HUD has
                    not resolved three long-standing issues associated with these financial
                    benefits, missing opportunities to reduce its Section 8 costs. First, HUD has
                    not provided the state agencies with a clear interpretation of an
                    amendment to the McKinney Act that provides for agencies to share
                    savings with the government from refunding bonds associated with certain
                    Section 8 contracts. As a result, after refunding bonds, some state agencies
                    have retained all of the savings that accrue annually, while other agencies
                    have shared the savings with the government. Second, HUD has not
                    provided the agencies with clear guidance for calculating rent increases
                    after bonds have been refunded. Without such guidance, some agencies
                    have not reduced the costs of financing in their calculations and have thus
                    approved unduly high rent increases. Finally, some state agencies have
                    been collecting two fees for administering their Section 8 contracts,
                    despite a long-standing HUD regulation prohibiting dual fees. Because HUD
                    has not enforced its regulation, the federal government has provided
                    excess funding to state agencies for administering Section 8 contracts.
                    Taking action on each of these issues could reduce the Section 8 costs
                    borne by the federal government.


                    After more than 6 years, HUD has not clarified a provision for state
Requirements for    agencies to share certain bond refunding savings with the government.
Sharing Refunding   This provision is set forth in section 1012 of the McKinney Act, as
Savings Remain      amended in October 1992. On its face, the amendment appears to require
                    the state agencies to share savings; however, the National Council of State
Unclear             Housing Agencies and some state agencies maintain that the amendment
                    applies only to Section 8 contracts that explicitly give HUD the right to
                    bond refunding savings—that is, only to financing adjustment factor
                    contracts. While a HUD legal opinion stated that, on the basis of the express
                    language of the statute, the Department could apply the amendment to
                    state agencies for all contracts issued between 1979 and 1984, the
                    Department has not issued clear guidance to this effect. Over the years,
                    many state agencies have refunded bonds, often retaining all of the
                    savings. Meanwhile, HUD’s inaction has potentially deprived the federal
                    government of opportunities to share savings and reduce Section 8 costs.




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Section 1012 of the         Section 1012 of the Stewart B. McKinney Homeless Assistance
McKinney Act Provides for   Amendments Act of 1988 permitted state agencies to keep half of the
Sharing Bond Refunding      savings from refunding bonds associated with financing adjustment factor
                            contracts to provide affordable housing for households with very low
Savings                     incomes. Financing adjustment factor contracts required agencies to
                            refund high-interest bonds when interest rates declined and to provide all
                            of the interest savings to the federal government (see ch. 1). Without the
                            McKinney Act’s shared savings provision, the state agencies would have
                            been required to provide 100 percent of the savings to the government
                            under these contracts with HUD. The contracts also required property
                            owners to accept reduced Section 8 contract rents (subsidies) to reflect
                            the decrease in borrowing costs resulting from refunding the bonds.

                            In 1992, the Congress amended section 1012 twice. First, in April 1992, the
                            Congress expanded the shared savings provision for financing adjustment
                            factor contracts to local agencies. Then, in October 1992, the Congress
                            authorized both state and local agencies to share the savings from
                            refunding bonds associated with Section 8 contracts entered into between
                            calendar years 1979 and 1984. The Section 8 contracts executed during
                            this 6-year period include (1) the financing adjustment factor contracts,
                            (2) the contracts that received special financing authorized in 1980 when
                            interest rates were high but do not include a contractual requirement to
                            provide any bond refunding savings to the government, and (3) some
                            contracts that did not receive special financing.

                            Both of the 1992 amendments to section 1012 provided the local agencies,
                            which generally issued bonds under HUD’s regulations, with a new financial
                            benefit. Before the amendments were passed, HUD had required these
                            agencies to return all bond refunding savings to the government—whether
                            their Section 8 contracts required them to do so or not. After the
                            amendments were passed, the local agencies were entitled to half, rather
                            than none, of the savings. However, section 1012, as amended in
                            October 1992, if applied to state agencies, would reduce by half the
                            financial benefit that some state agencies are generally accustomed to
                            receiving for refunding bonds associated with all Section 8 contracts
                            except financing adjustment factor contracts. These state agencies
                            generally retain all of the savings except for financing adjustment factor
                            contracts.1 HUD officials said the Department does not have the leverage
                            over state agencies that it has over local agencies because it does not have

                            1
                             To preserve developments—avoid loan prepayments and conversions of Section 8 properties to
                            market-rate housing—one of the five state agencies in our study (Illinois) provided savings to some
                            property owners in the form of loans. These loans will be paid over time from Section 8 rental
                            assistance payments.



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                       the authority to review and approve most state bond issuances. HUD
                       officials also said that, in general, the state agencies receive wide latitude
                       and responsibilities under the Section 8 program while HUD’s role is
                       confined to receiving certifications that the program has been executed
                       and, occasionally, to auditing the agencies’ activities. HUD does, however,
                       review information on state agencies’ bonds before entering into
                       agreements (called refunding agreements) with the agencies to share bond
                       refunding savings with them under the McKinney Act.


HUD Never Resolved     We found that although the Department has expressly required the state
Uncertainty About      agencies to comply with the shared savings requirements in section 1012
Congressional Intent   covering financing adjustment factor contracts, it has not expressly
                       required the state agencies to comply with the shared savings provision in
                       the October 1992 amendment covering Section 8 contracts executed
                       between 1979 and 1984. HUD officials told us that many state agencies have
                       consistently questioned HUD’s authority to require the state agencies to
                       share savings from refundings that do not require HUD’s approval. HUD
                       officials also said that the scant legislative history of the October 1992
                       amendment focuses on providing a benefit to local agencies and says
                       nothing about the state agencies, raising a question as to whether the
                       Congress intended the amendment to affect the savings from refundings
                       that state agencies carry out under the Internal Revenue Code—refundings
                       that do not require HUD’s review and approval.

                       In May 1993, in response to a request from the Office of Housing, HUD’s
                       Office of the General Counsel issued a formal legal opinion addressing this
                       question. The legal opinion concluded that HUD could require the state
                       agencies to share savings from refundings associated with all contracts
                       covered by the October 1992 amendment. However, the May 1993 legal
                       opinion acknowledged that state housing finance agencies might challenge
                       HUD if the Department sought to enforce the clear facial reading of the
                       statute because the legislative history did not address state agencies. The
                       Office of Housing was concerned about the Department’s ability to prevail
                       in a lawsuit over the issue. From October 1992 until early 1996, the
                       Department took no steps to require the state agencies to share the
                       savings from refunding bonds associated with contracts that (1) received
                       the special financing authorized in 1980 but do not include a contractual
                       requirement to provide the bond refunding savings to the government or
                       (2) were entered into between 1979 and 1984 but did not receive special
                       financing.




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In April 1996, HUD published regulations that were intended to clarify the
rules that applied to state and local agencies. However, from the start, the
rulemaking caused confusion for the state agencies because HUD added
language to a section of the Code of Federal Regulations that otherwise
applies primarily to local agencies issuing bonds under the United States
Housing Act of 1937. The Office of Housing official in charge of the
rulemaking said that the new rule was intended to require state agencies to
begin sharing bond refunding savings in compliance with the October 1992
amendment. However, he and other HUD officials agreed that the
regulations did not meet their stated objective because of a typographical
error. Instead of citing two relevant paragraphs of the McKinney Act, the
published regulations cite two paragraphs that do not apply to state
agencies. The two relevant paragraphs that HUD intended to cite
(1) identify the universe of contracts subject to the shared savings
requirements as those issued between 1979 and 1984 and (2) specify the
purposes for which McKinney Act savings can be used. The Office of
Housing official in charge of bond refundings said that no state agencies
have initiated shared savings agreements for new bond refundings since
this regulation was passed.

In addition, HUD officials acknowledged that by (1) amending the rules that
generally applied only to local agencies and (2) not clearly stating in the
rulemaking that the Department was extending the requirements for
sharing savings to all state agency contracts covered by the October 1992
amendment to the McKinney Act, HUD might not have resolved the
confusion and controversy over this issue even if it had not made a
typographical error in the final rule. The HUD officials were uncertain how
to correct the rulemaking. HUD officials in the Office of the General
Counsel and the Office of Housing responsible for interpreting and
implementing the McKinney Act concluded that the question always
comes back to the question of what the Congress intended—and they
acknowledged that they did not know the answer to this important
question. Since the McKinney Act amendment was passed in 1992, a
number of state agencies have refunded bonds associated with Section 8
contracts issued between 1979 and 1984 and have not shared the savings
with the government. While we agree with HUD that the savings at issue
will generally be smaller than the savings for the financing adjustment
factor contracts, which supported mortgage rates as high as 12 and 13
percent, we believe that HUD may have missed opportunities to provide
additional bond refunding savings to the government. At the state agencies
we reviewed, mortgage rates supporting the refunded bonds that may be
subject to the McKinney Act varied, generally ranging between 7.25



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                         percent and 10 percent. Furthermore, the bond refunding savings for
                         contracts other than financing adjustment factor contracts that one state
                         agency shares with the federal government total about $14 million.


Extent to Which States   During the early to mid-1990s, state agencies were refunding the bonds
Share Bond Refunding     associated with Section 8 contracts to lower rates. For example, almost all
Savings Varies           of the bonds associated with contracts for Section 8 project-based
                         assistance at the five state agencies we visited were refunded during this
                         time. We found that the five agencies shared savings differently.
                         Specifically, the Illinois, Maryland, and Massachusetts agencies generally
                         share savings only for financing adjustment factor contracts, while the
                         Minnesota and New Hampshire agencies share savings for other contracts
                         as well.

                         While none of the five state agencies shared savings for all contracts
                         entered into between 1979 and 1984—the time period addressed in the
                         October 1992 McKinney Act amendment—some agencies shared savings
                         only for financing adjustment factor contracts while others shared savings
                         for these and other contracts entered into between 1979 and 1984.2 For
                         example, the Massachusetts agency shares savings for its 35 financing
                         adjustment factor contracts but does not share savings for the other 70
                         contracts entered into between 1979 and 1984. In contrast, the New
                         Hampshire agency shares savings for 38 of the 48 contracts associated
                         with refunded bonds that it entered into between 1979 and 1984. The 38
                         contracts include both financing adjustment factor and other contracts.

                         According to a HUD official, the agencies that shared savings for both
                         financing adjustment factor and other contracts entered into between 1979
                         and 1984 may have believed they were required to share savings under the
                         McKinney Act. We found, for example, that the Minnesota agency
                         determined that it was required to share savings both for financing
                         adjustment factor contracts and for contracts that received special
                         financing but did not explicitly require savings to be returned to the
                         government.

                         However, other states concluded, independently of HUD, that the McKinney
                         Act generally was applicable only to financing adjustment factor contracts.
                         For example, an official of the Maryland agency said that, according to the
                         agency’s bond counsel, except for financing adjustment factor contracts,

                         2
                          As discussed previously, HUD authorized higher interest rates and Section 8 subsidies, but only the
                         financing adjustment factor contracts require agencies to refund the related bonds when interest rates
                         decline.



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                        the shared savings requirements of the McKinney Act are applicable only
                        when the Section 8 property mortgage is refinanced after a bond has been
                        refunded—that is, when the contract reduction method (see ch. 1) is used.
                        A legal opinion from Maryland’s bond counsel, issued in 1996 in
                        conjunction with a bond refunding, discussed in detail the reasons for
                        believing that only financing adjustment factor contracts are subject to the
                        shared savings requirements of the McKinney Act. In concluding, the bond
                        counsel noted that HUD does not have any formal policy requiring the
                        states to share savings for contracts that do not have the financing
                        adjustment factor. The bond counsel said, however, that HUD might in the
                        future develop a policy for such refundings, which would require savings
                        to be shared and could be applied retroactively. While maintaining that the
                        state agency would likely prevail in a legal case on the issue, the bond
                        counsel acknowledged that a court could uphold such a claim by HUD.


                        HUD’s general method for calculating automatic rent increases for Section
HUD’s Guidance Has      8 properties does not consider the savings from bond refundings. To avoid
Not Eliminated          increased costs to the government from excessive rent increases to
Excess Section 8 Rent   owners when bonds have been refunded, in 1997, HUD issued a notice
                        requiring adjustments to the calculation of rent increases for financing
Increases               adjustment factor contracts. However, we found that the notice has
                        several serious shortcomings, and agencies’ compliance with and
                        understanding of this notice varies. As a result, the Section 8 program is
                        incurring excess costs that it could have avoided.


HUD’s Rent Increase     Issued on August 1, 1997, HUD Notice H 97-49 was intended to prevent
Notice Is Flawed        excessive rent increases following refundings of bonds associated with
                        financing adjustment factor contracts.3 The notice establishes a
                        requirement for (1) calculating the contract rents that would have resulted
                        if the Section 8 contracts and mortgages had been reduced to reflect the
                        bond refunding savings and (2) applying the annual Section 8 rent
                        adjustment factor to this calculation. However, the notice does not explain
                        the methodology for implementing the procedure, nor does it provide an
                        example of a calculation. In addition, the notice was issued for 1
                        year—until August 1998—and the Department let it lapse without renewing
                        it. While HUD officials told us that renewing the notice should not have
                        been necessary because the procedures apply to rent increases over the
                        lives of the Section 8 contracts, we do not believe the Department can

                        3
                         HUD Notice H 97-49 is titled Backing-Out Trustee Sweep Savings Before Calculating AAFs for
                        Projects Which Originally Received a FAF and Whose Bonds Were Refunded.



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                            hold its field office staff and state and local agency staff accountable for
                            complying with the requirements of notices that are no longer in effect.
                            Furthermore, we found that the Department’s general guidance on Section
                            8 rent increases, provided in notices H 97-14 and H 98-3, contained no
                            reference to the limit on rent increases contained in notice H 97-49.

                            The rent increase notice was issued 5 years after HUD’s Inspector General
                            reported, in 1992, that Section 8 contracts were receiving excessive rent
                            increases after bonds were refunded and recommended that the refunding
                            savings be backed out before the rent increases were calculated. In 1993,
                            the Department disagreed with the Inspector General’s recommendation,
                            citing a HUD legal opinion stating that HUD did not have the authority to
                            limit Section 8 increases. After the Inspector General reopened this
                            recommendation in 1997, the Department obtained a second legal opinion,
                            which found that HUD could limit the rent increases for financing
                            adjustment factor contracts.


Agencies’ Compliance With   Since HUD issued its notice, two of the five state agencies we visited have
HUD’s Rent Increase Limit   increased rents for financing adjustment factor Section 8 contracts. We
Varies                      found that the Minnesota Housing Finance Agency complied with the
                            notice for contracts subject to the limitation while the Massachusetts
                            Housing Finance Agency did not.

                            A Massachusetts Housing Finance Agency official told us in September
                            1998 that the agency did not adjust the rent increases because it had not
                            received the implementing information from HUD that the notice said
                            would be provided. A HUD assessment of compliance with the rent increase
                            notice, initiated in Feburary 1999, also found that the Massachusetts
                            Housing Finance Agency was not adjusting the rent increases for financing
                            adjustment factor contracts. The Massachusetts agency responded to HUD
                            that it had not complied with the notice because (1) it was not included in
                            the Department’s rent adjustment procedure notices, (2) it had expired in
                            August 1998, and (3) HUD had never provided the information required to
                            implement the notice. An internal HUD review has recently identified other
                            agencies that did not comply with the notice when they processed rent
                            increases subject to the notice.

                            Currently, the number of rent increases being processed for financing
                            adjustment factor contracts may be small because of other limits on
                            overall rent increases mandated by the Congress. However, many of the
                            state agency contracts will be in effect for the next 15 to 20 years, and the



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                            rent increase limits are therefore likely to become more applicable in the
                            future.


                            Even though HUD prohibits the collection of dual fees, some state agencies
HUD Has Not                 have been collecting them for at least 6 years with HUD’s knowledge. That
Enforced Its                is, some agencies have been collecting an annual contributions contract
Prohibition of Dual         fee and an override fee, although HUD’s regulations require state agencies
                            to choose only one of these fees for administering Section 8 contracts on
Fees                        behalf of the Department. As a result, HUD has added, at a minimum, tens
                            of millions of dollars to the Section 8 program’s costs. The Department is
                            attempting to resolve the issue for some of the agencies that have been
                            collecting dual fees for administering Section 8 contracts associated with
                            shared savings (refunding) agreements approved by HUD because of fee
                            information provided to the Department in this process. However, we
                            found that HUD has not identified all state agencies that receive dual fees
                            and has not taken any actions when dual fees are being collected for
                            contracts that are not subject to shared savings agreements with HUD.
                            Finally, HUD does not appear to have considered options for recovering the
                            override fee after it is no longer needed to secure the bonds.


HUD’s Regulation Allows     State and local housing finance agencies that administer Section 8
One of Two Types of Fees,   contracts for HUD receive compensation for carrying out their
and Agencies’ Charters      administrative responsibilities. While all of the agencies are eligible for an
                            annual contributions contract fee, provided by HUD, state agencies that
Limit the Fees’ Use         finance Section 8 property mortgages with the proceeds of state
                            tax-exempt bond proceeds issued under the Internal Revenue Code may
                            instead receive an override fee (see ch. 1). But whether an agency is
                            eligible for one or both fees, it is allowed to receive only one fee under a
                            Section 8 regulation promulgated in 1980 (24 C.F.R. 883.606).4

                            According to this regulation, a state housing finance agency that chooses
                            to collect an override fee cannot receive an annual contributions contract
                            fee. HUD first prohibited dual fees in 1977 when it indicated that it would
                            allow the state agencies to receive an annual contributions contract fee
                            only when the interest rates that they were charging on their Section 8
                            property mortgages were equal to the agencies’ cost of borrowing. HUD
                            expected the state agencies to take the annual contributions contract fee
                            only in the rare instances when they issued their bonds under HUD’s

                            4
                             According to HUD officials, the regulation can be waived by the Assistant Secretary for good cause
                            and in writing because it is not a statutory requirement.



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                          regulations, which do not permit an agency to charge more than its cost of
                          borrowing.

                          According to the National Council of State Housing Agencies, the charters
                          and authorizing statutes of state agencies restrict their spending to public
                          purpose programs, including the costs of administering those programs.
                          For example, the Minnesota agency said that all income from any source is
                          dedicated to providing affordable housing and covering the operating
                          costs necessary to fulfill its mission. Thus, the agency said, after covering
                          its operating costs and meeting its loan loss reserve requirements, it
                          invests the balance of its override fees in affordable housing activities.
                          Similarly, the Maryland agency said that it uses its override fees to pay the
                          debt service on its bonds and the direct costs associated with the bonds,
                          such as the legal fees. Each year, the agency determines how much of the
                          fees it can use for other purposes without jeopardizing its bond rating. The
                          excess revenue may be used only for affordable housing, community
                          development, and budgeted departmental operating costs.


HUD’s Response to the     In 1992 and 1993, HUD’s Inspector General reported that two state agencies
Dual Fee Issue Has Been   were receiving dual fees. For example, the Inspector General found that
Slow and Inconsistent     the Oregon state agency had received override fees of $584,000 and annual
                          contributions contract fees of $634,000 for the same Section 8 contracts
                          during the same period.5 The Inspector General recommended that HUD’s
                          Office of Housing (1) direct the field offices to ensure that annual
                          contributions contract fees are not allowed when override fees are being
                          collected and (2) determine the amount of dual fees HUD had paid to
                          agencies and require them to return the overpayment to the Department.
                          In response to the Inspector General’s recommendations, HUD identified a
                          number of state agencies that were receiving dual fees and sent letters in
                          August 1994 telling them to stop collecting dual fees unless they had
                          received a waiver of the regulation prohibiting dual fees.6 The Inspector
                          General closed the recommendations on the basis of this action.



                          5
                           The dual fees cover 11 projects from 1984 through June 30, 1992. The annual override fee for most of
                          this period was set at one-third of the maximum allowable amount (0.50 percent) and was increased to
                          the maximum (1.50 percent) when the bonds were refunded in 1990. The Inspector General estimated
                          that the higher override fee reduced the bond savings—and thus increased the override fee—by
                          $2.3 million.
                          6
                           We could not determine how many dual fee agencies HUD initially identified and sent letters to.
                          However, a memorandum from the National Council of State Housing Finance Agencies indicates that
                          14 agencies were to receive the letters. Subsequently, in 1996, HUD identified 17 agencies that it
                          believed receive dual fees.



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Six months later, however, in February 1995, HUD reversed its position,
stating that it would not enforce the dual fee prohibition for Section 8
financing adjustment factor contracts associated with bonds that had been
refunded with the Department’s approval.7 This letter said, however, that
all bond-financing proposals submitted to HUD in the future must comply
with the dual fee prohibition. According to HUD officials, the Department
changed its position after some state agencies questioned the
Department’s legal authority to enforce the dual fee prohibition. The
agencies pointed out that when HUD negotiated shared savings agreements
with them, it reviewed bond refunding documents that showed the
agencies would receive an override fee. The agencies maintain that the
documents provided HUD with the information needed to determine that
the agencies were also receiving annual contributions contract fees. The
agencies believe that HUD therefore implicitly or explicitly approved the
dual fees for these contracts when it approved their refunding agreements.

After finding that HUD had changed its position and was not going to
enforce the dual fee prohibition in existing cases, the Inspector General
reopened the recommendation. Also, in October 1996, the Inspector
General requested that HUD not process any waivers before the Inspector
General completed a corrective action verification that would be initiated
the following month on the bond refunding audits.

The debate between HUD and the Inspector General over the dual fee issue
has not been resolved. While HUD has required the 17 dual fee agencies it
identified to request waivers of the dual fee regulation and 14 agencies
have done so, HUD has approved only one waiver request—that of the
Oregon Housing Finance Agency. According to HUD officials, the
Department did not complete action on the remaining waiver requests
because in 1997 the Inspector General argued that the dual fee agencies
have created a valid debt to HUD and that under the Federal Claims
Collection Act, as amended, HUD requires approval from the Department of
Justice to waive its regulation prohibiting dual fees. In an October 1998
legal opinion, HUD’s Office of the General Counsel did not determine
whether the payment of dual fees created a debt to HUD. It did agree that if
a debt had been created, the Department would need approval from the
Department of Justice to waive the prohibition on dual fees.8


7
 In 1996, HUD told agencies that the Department would have to execute formal waivers of the dual fee
prohibition and therefore required them to request waivers of its regulation.
8
 Under the Federal Claims Collection Act of 1966, as amended, and implementing regulations, the
Department of Justice’s concurrence is required to terminate the collection of any claim exceeding
$100,000.



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                             In November 1998, we met with the Deputy Assistant Secretary for
                             Housing and other officials to determine the status of HUD’s actions. As a
                             result of this meeting, the Deputy Assistant Secretary established a team to
                             resolve the issue; however, as of June 1999, it had not been resolved, and
                             HUD has yet to take action on the waiver requests. According to HUD, the
                             program office (Housing) has asked the Office of the General Counsel for
                             advice on the options available to the Department for resolving the issue.


HUD Has Not Identified All   We found that HUD, in attempting to implement the Inspector General’s
Contracts or All Agencies    recommendation that it identify state agencies that receive dual fees, has
With Dual Fees               focused only on contracts that are subject to refunding (shared savings)
                             agreements with HUD. However, we found that the agencies also receive
                             dual fees for Section 8 contracts that are not subject to refunding
                             agreements. For example, four of the five state agencies we visited
                             received dual fees for 84 contracts with refunding agreements and about
                             139 contracts with no refunding agreements. The bonds associated with
                             most of these latter contracts have been refunded, and the agencies
                             receive override and administrative fees. According to HUD officials, if the
                             Department approves the agencies’ requests for waivers of the dual fee
                             prohibition, the approvals would cover only the dual fees associated with
                             contracts that require the agencies to share savings with the government
                             under refunding agreements with HUD. HUD would limit its approval to
                             these contracts because they alone provided the Department with an
                             opportunity to implicitly approve the dual fees.

                             We also found that the Department had not identified all of the state
                             agencies that receive dual fees. For example, although HUD had not linked
                             the Maryland agency with dual fees, we found that the agency had
                             received dual fees for 14 of its 35 Section 8 contracts. We confirmed that
                             HUD had correctly identified the Massachusetts, Minnesota, and New
                             Hampshire agencies as dual fee agencies.

                             In fiscal year 1998 alone, HUD paid these four state agencies over
                             $5.3 million in administrative fees, while the agencies were also receiving
                             override fees on the related bonds under the Section 8 program. Because
                             state agencies do not generally account for their override fees on a
                             project-by- project basis, we could not determine the amounts of the
                             related override fees associated with the Section 8 contracts for the four
                             states. However, we found that, in 1998, one agency received override fees
                             of close to $490,000 and administrative fees of almost $423,000 for the
                             same Section 8 contracts.



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                             Finally, an official at the Massachusetts agency—one of the dual fees
                             agencies identified by HUD that applied for a waiver in 1997—told us that
                             his agency does not believe it is violating HUD’s dual fee prohibition. The
                             official stated that HUD’s policy was applicable only when a bond’s original
                             financing was in place. The agency maintains that since the bonds have
                             been refunded, the prohibition no longer applies. Despite its position on
                             the legitimacy of receiving dual fees after bonds have been refunded, the
                             Massachusetts agency filed a waiver request with HUD in 1997 so that it
                             could continue to receive dual fees. Moreover, the agency received a letter
                             from the Department in 1995 indicating that future bond refunding
                             proposals must comply with the dual fee prohibition.9 Finally, in 1996 in
                             the Code of Federal Regulations, HUD reiterated its policy that the dual fee
                             prohibition applies to bond refundings (24 C.F.R. 811.110 (b)).


One Approved Waiver and      In June 1997, the Assistant Secretary for Housing-Federal Housing
Pending Waiver Requests      Commissioner approved the Oregon Housing and Community Service
Rely in Part on Pledges of   Department’s request for a waiver of the dual fee prohibition, relying in
                             large part on the Oregon agency’s pledges and uses of fee income.
Fees as Security for Bonds   According to the letter approving the waiver, the Oregon agency has
                             pledged both the override and the contract administration fees as security
                             for the bonds and this pledge is contained in official bond documents. The
                             letter said that HUD did not wish to upset the existing security
                             arrangements relied on by bond rating agencies and purchasers of the
                             bonds. The letter also recognized that the Oregon agency had allocated the
                             override fee to several affordable housing programs. The Assistant
                             Secretary also stated that in collecting duplicate fees, the Oregon agency
                             relied on decisions HUD made in processing and approving the bond
                             refunding transactions.

                             Most of the 14 waiver requests submitted by state agencies also state that
                             the documents provided to HUD for shared savings agreements indicated
                             that the state agencies would continue to collect both the override fees
                             permitted by the federal tax laws and the Section 8 administrative fees.
                             Many of the waiver request letters, including the Oregon letter, indicated
                             that the override fee was needed to support state housing programs but
                             was also restricted because it was pledged as security to the bondholders.



                             9
                              The 1995 letter said that HUD would not require compliance with the dual fee prohibition when HUD
                             had approved refunding agreements. As discussed above, in 1996, HUD required the agencies to
                             request waivers of the regulation. HUD is required by statute to issue a formal waiver when it does not
                             enforce a regulation.



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                  From discussions with state agencies, we understand that an override fee
                  may be restricted for a period of time but may become available to an
                  agency while a bond is still outstanding. Some states may use their
                  override fees for their housing programs or their expenses, while others
                  may keep the fees in their bond accounts, investing them to earn
                  investment income. The fee amounts remaining in the bond accounts
                  accrue to the agencies when the bonds are paid off. In 1997, at least one
                  HUD official asked whether the dual fee issue could be resolved by allowing
                  the state agencies to keep the override fees while required by bond
                  pledges and then require the agencies to return the fees to HUD. The
                  Department does not appear to have pursued this suggestion for resolving
                  the dual fee problem.

                  According to a 1997 study by a bond rating agency, state agencies have
                  built up equity over the last two decades in bond accounts associated with
                  Section 8 contracts primarily by accumulating override fees.10 Thus, the
                  financial outlook for state agencies’ Section 8 bonds was expected to
                  remain very strong, in large part because the agencies have sufficient
                  equity available in the event of significant increases in nonperforming
                  loans. For example, the study indicated that agencies typically had equity
                  in excess of 12 percent of the bonds outstanding. One agency’s equity
                  ($87 million) was equal to 56 percent of its outstanding bonds
                  ($154 million). The state agencies will generally continue to receive the
                  override fees annually throughout the terms of their Section 8 contracts,
                  many of which have another 15 to 20 years remaining.


                  For more than 6 years, HUD has missed opportunities to protect the federal
Conclusions       government’s interests and to reduce Section 8 rental assistance costs:

              •   Because HUD has not resolved the applicability of the October 1992
                  amendment of the McKinney Act to state agencies, the Department may
                  have missed opportunities for the government to obtain certain bond
                  refunding savings. If HUD determines that this provision is applicable to
                  state agencies and that it can begin to require them to share the bond
                  refunding savings, these savings will reduce the Section 8 costs that the
                  federal government will bear for many years to come.
              •   By taking so long to publish procedures for limiting Section 8 rent
                  increases after bonds have been refunded, HUD missed opportunities to
                  lower the Section 8 program’s long-term costs. Moreover, by failing to

                  10
                     Bonds Secured by Section 8 Subsidies – A Tale of Two Outlooks, Moody’s Investors Service,
                  Nov. 1997.



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                      ensure compliance with the procedures after publishing them in a notice,
                      allowing the notice to expire after 1 year, and not providing promised
                      guidance or examples of calculations for implementing the procedures,
                      HUD missed further opportunities to control the program’s costs.
                  •   Finally, by failing to enforce its regulation prohibiting dual fees, HUD has
                      added tens of millions of dollars to the Section 8 program’s costs. If
                      allowed to continue, the fee payments will unnecessarily increase the
                      program’s costs for the next 15 to 20 years. In the meantime, a bond
                      agency’s data indicate that the state agencies are accruing significant
                      amounts of equity from override fees that will be fully available to the
                      agencies when the bonds are paid off, if not sooner. In addition, HUD has
                      not identified all of the contracts or all of the state agencies receiving dual
                      fees. Because it did not recognize that some agencies were receiving dual
                      fees for contracts that are not subject to refunding agreements approved
                      by HUD, the Department missed opportunities to enforce the dual fee
                      regulation in these cases where, in the opinion of HUD officials, the
                      agencies do not have a basis for requesting waivers. Furthermore, Housing
                      officials do not appear to have considered options other than waiving the
                      dual fee prohibition. One such option would allow the agencies to
                      continue receiving both fees until the documented bond commitments
                      have been satisfied and then requiring the agencies to return the fees to
                      HUD. In this way, the government could limit the impact of the excess fee
                      costs on the Section 8 program.


                      We recommend that the Secretary of Housing and Urban Development
Recommendations       determine whether the state agencies are required, under the McKinney
                      Act, to share savings from refunding bonds associated with all contracts
                      entered into between 1979 and 1984. If so, the Department should revise
                      its applicable rules and regulations to clarify the requirements for sharing
                      bond refunding savings with the federal government. For contracts
                      associated with bonds that have already been refunded, HUD should
                      determine whether it can require the state agencies to begin sharing the
                      Section 8 savings they currently retain.

                      To ensure that state and local housing finance agencies comply with HUD’s
                      guidance on deducting bond refunding savings before calculating rent
                      increases, we recommend that the Secretary require the Department to
                      provide the state and local agencies with the appropriate methodology and
                      examples of calculations and ensure that the rule is kept current and
                      integrated into the Department’s guidance on annual Section 8 rent
                      increases.



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                     To eliminate excess costs from paying dual fees to state agencies
                     administering Section 8 rental assistance contracts, we recommend that
                     the Secretary require the Department to enforce its regulation prohibiting
                     dual fees unless there is a documented, sound, and equitable basis for
                     waiving the regulation. To enforce the regulation, the Department should
                     identify all Section 8 contracts for which state agencies receive both an
                     administrative fee under the Section 8 contract and an override fee,
                     including those contracts that are not subject to a refunding agreement
                     with HUD.


                     In commenting on the draft report’s discussion and recommendation
Agency Comments      concerning the applicability of the McKinney Act’s shared savings
and Our Evaluation   provision (section 1012, as amended in October 1992) to state agencies,
                     HUD says that the draft report and recommendation direct the Department
                     to take action where its legal authority is unclear. In fact, the draft report
                     recommended that HUD clarify its legal authority (determine whether the
                     state agencies are required, under the McKinney Act, to share savings from
                     refunding certain bonds with the government) and revise its rules and
                     regulations accordingly. However, we recognize that a statement in the
                     executive summary may have caused some confusion, and we have
                     revised it for clarity and greater consistency with our discussion in the
                     body of the report. Specifically, the draft executive summary said that HUD
                     has not issued guidance to the state agencies directing them to comply
                     with the October 1992 amendment to section 1012 of the McKinney Act,
                     which requires the agencies to share certain bond refunding savings with
                     the government. As is consistent with the discussion in this chapter, the
                     final report states that HUD has not issued guidance to the state agencies
                     on how to comply with the October 1992 amendment to section 1012 of
                     the McKinney Act, which provides for the agencies to share certain bond
                     refunding savings with the federal government.

                     Although HUD has not resolved the applicability of the McKinney Act
                     amendment to state agencies, HUD’s previous actions indicated that the
                     Department believed it could require state agencies to share these savings.
                     For example, the comments do not recognize that (1) the Department’s
                     Office of the General Counsel concluded that HUD could require state
                     agencies to comply with the shared savings provision and (2) HUD
                     attempted in 1996 to require the agencies, by regulation, to share these
                     savings. Today, more than 6 years after the shared savings provision was
                     amended, HUD has not clarified the provision’s applicability to the state
                     agencies. In the absence of a clear interpretation, some state agencies



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have retained the bond refunding savings, while others have shared the
savings with the government. Thus, HUD’s inaction may have deprived the
federal government of opportunities to share savings and reduce its
Section 8 costs.

In further commenting on this recommendation, HUD says that we
recommend that the Department retroactively recover the portion of the
bond refunding savings that some state agencies have retained in their
entirety. In fact, our recommendation is prospective, stating that if HUD
finds the agencies are required to share their savings, then it should
determine whether it can require them to begin sharing the savings they
currently retain.

In a final comment on this recommendation, HUD questions whether data
exist to support our statement that, without clarification of the McKinney
Act’s shared savings provision, state agencies may retain “tens of
millions” of dollars that they could be legally required to share with the
government. This figure, cited to convey the magnitude of the savings at
issue, was based primarily on information we had obtained on Section 8
bond refundings by state agencies with and without shared savings
agreements. It also considered the bond refundings savings, amounting to
millions of dollars annually, that two state agencies in our review share
with the government for contracts other than financing adjustment factor
contracts. Nonetheless, we agree with HUD that the savings for contracts
other than financing adjustment factor contracts will generally be smaller
than the savings for financing adjustment factor contracts, which
supported mortgage rates as high as 12 and 13 percent. For example, as
indicated in the final report, the mortgage rates for contracts other than
financing adjustment factor contracts at the state agencies we reviewed
generally range between 7.25 percent and 10 percent. We also agree with
HUD that the data needed to prepare a comprehensive estimate of the
potential savings are not available. We revised the final report to state that,
in our view, HUD may have missed opportunities to provide additional bond
refunding savings to the government to offset the related Section 8 costs,
and we deleted the estimate of potential savings.

In response to our recommendation that HUD ensure the currency of its
rule on deducting bond refunding savings before calculating rent increases
and integrate this rule into its guidance on annual Section 8 rent increases,
HUD agreed to reissue its expired notice and to evaluate the need for
cross-referencing other Section 8 rent directives. HUD also agreed to ensure
compliance with its rent-adjustment rule by providing state and local



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agencies and HUD field staff with clarifying instructions for compliance
with the notice.

In commenting on our recommendation that the Department enforce its
regulation prohibiting dual fees unless there is a documented, sound, and
equitable basis for waiving the regulation, HUD said that if the refunding
agreements it approved had been accompanied by executed waivers of the
dual fee prohibition, no dispute about dual fees would have arisen. We
agree with HUD that waivers, if executed in compliance with the
Department’s waiver rules and applicable federal laws, would have
avoided the issue. However, waivers have not been executed, and the
issue remains unresolved.

HUD also suggests that we consider the dual fee as an incentive that
encouraged state agencies to refund the bonds associated with their
Section 8 contracts and, hence, provide bond refunding savings to the
government. According to HUD’s estimate, these savings will exceed
$150 million over the lives of the contracts. Whether these savings will
offset the costs of the dual fees is unknown because neither the number of
state agencies that take dual fees nor the number of contracts associated
with dual fees is known. Nevertheless, we estimated in our draft report
that dual fees add tens of millions of dollars to the Section 8 program’s
costs. We based this estimate on the fees paid in 1998 to four state
agencies for administering contracts that are also associated with override
fees. As we indicated in the draft report, these fees totaled $5.3 million for
1 year. Most state agencies’ contracts will be in effect for another 10 to 20
years, and administrative fees, which are tied to unit costs, are likely to
increase. Thus, the dual fees for these four agencies alone will add tens of
millions of dollars to the Section 8 program’s costs. Furthermore, the draft
report indicates that 14 state agencies have requested waivers of the dual
fee prohibition and shows that HUD has not identified all state agencies
that receive dual fees. Thus, we believe our estimate of tens of millions of
dollars in dual fee costs is conservative. We revised the final report to say
that the dual fees have added, at a minimum, tens of millions of dollars to
the Section 8 program’s costs.

Finally, HUD does not indicate in its comments how it will identify the state
agencies that receive dual fees for Section 8 contracts that are not subject
to refunding agreements approved by HUD. As discussed in the report, HUD
officials said that, for these contracts, they had no basis for approving
waivers of the dual fee regulation. We urge the Department to respond




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expeditiously so that these fees do not continue to burden the Section 8
program.

In commenting on the draft report, the National Council of State Housing
Agencies disagreed with—but misstated—our conclusion and
recommendation about the McKinney Act’s requirements. According to the
Council, we wrongly concluded that HUD has the authority to require state
agencies to share certain bond refunding savings with the federal
government. In fact, the draft report recommended that the Secretary
determine whether the state agencies are required, under the McKinney
Act, to share certain bond refunding savings. This recommendation is
based on our conclusion that HUD has not provided the agencies with a
clear interpretation of the McKinney Act’s shared savings provision
(section 1012, as amended in October 1992), and, as a result, some state
agencies are sharing certain bond refunding savings with the government
while others are not. The Council also disagreed with the report for not
recognizing that HUD effectively waived its prohibition of dual fees by
approving refunding transactions under which state agencies receive both
fees. As the draft report clearly states, this is the position of the state
agencies. However, HUD is required to issue formal waivers when it does
not enforce a regulation such as the dual fee prohibition.




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Chapter 4

HUD’s Information on the Physical and
Financial Condition of the Uninsured
Portfolio Is Limited, but 10 State Agencies
Reported Few Problems in Their Portfolios
                       To monitor the physical and financial condition of properties in the
                       uninsured portfolio, HUD requires annual physical inspections and
                       generally requires annual audited financial statements. The 10 state
                       agencies we surveyed reported having monitoring policies and procedures
                       in place that conformed to HUD’s guidance. As of December 1998, HUD had
                       limited information on the physical and financial condition of the
                       uninsured portfolio. According to the Department’s central database, the
                       majority of the properties were in satisfactory or superior physical
                       condition; however, these ratings were not based on objective criteria, and
                       their reliability was therefore unknown. The 10 state agencies reported
                       that nearly all of the properties in their uninsured Section 8 portfolios
                       were in satisfactory or superior condition, yet their ratings, like HUD’s,
                       were subjective. Also as of December 1998, HUD’s database contained no
                       information on the financial condition of properties in the uninsured
                       portfolio. According to the 10 state agencies, a very small fraction of their
                       properties (under 4 percent) warranted special monitoring because of
                       financial or other problems. In mid-1998, HUD began to establish
                       centralized procedures, including objective rating criteria, to improve the
                       monitoring of multifamily properties in its uninsured and other portfolios.


                       HUD field offices currently administer about 80 percent of the uninsured
HUD and State          Section 8 housing assistance contracts, while state or local housing
Agencies Monitor       finance agencies generally administer the balance. Under their contracts
Conditions to Ensure   with HUD, the state and local agencies are responsible for monitoring the
                       physical and financial condition of the Section 8 properties in their
Compliance With        portfolios, as well as for evaluating other aspects of the properties’
Federal Requirements   management, such as their leasing and occupancy procedures. The
                       purpose of this monitoring is to ensure that property owners and
                       managers comply with the terms of their Section 8 subsidy contracts,
                       regulatory agreements, and other administrative requirements.

                       HUD requires annual physical inspections of properties in the uninsured
                       portfolio. According to HUD’s handbooks, HUD field staff, HUD contractors,
                       or state or local contract administrators should visit Section 8 properties
                       at least annually to perform physical inspections and to determine
                       whether property owners are providing decent, safe, and sanitary housing.
                       The physical inspections are to include examinations of buildings,
                       grounds, and mechanical systems. The 10 state agencies we surveyed
                       reported having policies and procedures in place for performing the
                       minimum number of physical inspections that HUD requires. In addition,
                       most of the agencies reported using HUD’s inspection forms to perform



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                         Chapter 4
                         HUD’s Information on the Physical and
                         Financial Condition of the Uninsured
                         Portfolio Is Limited, but 10 State Agencies
                         Reported Few Problems in Their Portfolios




                         these inspections. The agencies also said they usually increase the
                         frequency of their inspections when they identify unsatisfactory
                         conditions.

                         HUD requires most property owners to submit annual audited financial
                         statements to HUD or its contract administrators, who are then required to
                         perform oversight reviews.1 Besides reviewing the required financial
                         audits, state agencies reported using other procedures to monitor their
                         properties, such as examining operating reports, approving budgets and
                         rent increases, processing requests for using cash reserves, analyzing
                         monthly financial reports, and making on-site management assessments.
                         In addition, each agency identified methods it used to strengthen its
                         monitoring of properties with operating difficulties, such as financial
                         instability, physical and maintenance problems, and management or
                         ownership concerns.


                         Information on the physical and financial condition of uninsured Section 8
Information on the       properties was limited. We obtained information on the uninsured Section
Physical and Financial   8 portfolio as a whole from HUD’s central database. However, the
Condition of             information in this database on the properties’ physical condition was
                         subject to several limitations: Inspection results were reported for only
Uninsured Section 8      63 percent of the properties, 42 percent of the inspections were at least 3
Properties Was           years old, and the ratings assigned by inspectors were not based on
                         objective criteria. The database contained no information on the results of
Limited                  the annual financial audits that HUD requires. While the information on the
                         physical condition of properties in the 10 state agencies’ uninsured Section
                         8 portfolios was more recent—based primarily on inspections performed
                         in 1998—the ratings were also subjective because they were not based on
                         objective criteria. Five of the state agencies rated the financial condition of
                         their properties, and seven agencies rated the overall condition of their
                         properties, taking into account their management as well as their physical
                         and financial condition. The information provided by the state agencies is
                         presented in more detail in appendix IV.

                         The 10 state agencies we surveyed were responsible for monitoring 1,167
                         of the 2,278 properties that, as of December 1998, were in the uninsured




                         1
                         According to HUD officials, property owners who executed Section 8 contracts with HUD before 1980
                         may not be required to submit audited financial statements to HUD or its contract administrators.



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                             Chapter 4
                             HUD’s Information on the Physical and
                             Financial Condition of the Uninsured
                             Portfolio Is Limited, but 10 State Agencies
                             Reported Few Problems in Their Portfolios




                             Section 8 portfolios administered by 30 state agencies nationwide.2 About
                             43 percent of the 1,167 properties were designed specifically for the
                             elderly (41 percent) or the disabled (2 percent), and 57 percent of the
                             properties were designed for families or families and the elderly.


Most Properties Were         HUD’s information on the physical condition of properties in the uninsured
Reported in Good Physical    portfolio was limited. As of December 1998, HUD’s central database
Condition, but the Ratings   contained information on the results of inspections performed at 7,867
                             properties, or 63 percent of 12,488 properties in the uninsured portfolio.
Assigned During              The proportion of inspections reported for the uninsured programs ranged
Inspections Were of          from 29 percent for the elderly/disabled capital advance program to
Limited Use                  89 percent for the loan management set-aside program. However, for
                             42 percent of the uninsured properties, inspections had not been
                             performed within the past 3 years. According to the ratings assigned
                             during these inspections, 92 percent of the 7,867 properties were in
                             “satisfactory” or “superior” physical condition, while 6 percent were in
                             “below average” or “unsatisfactory” condition. However, these data
                             have limitations because, until very recently, HUD lacked uniform
                             standards for reporting the physical condition of its multifamily portfolio.
                             Without such standards, property ratings were assigned subjectively,
                             making comparisons among properties, field locations, and programs
                             difficult and questionable. HUD recognizes that without uniform and
                             objective physical inspection standards, the data are of limited use in
                             overseeing the portfolio. As discussed later in this chapter, the Department
                             has developed new property inspection standards designed to address the
                             shortcomings of the prior inspection standards.

                             The 10 state agencies we surveyed reported that 95 percent of the
                             properties in their portfolios were in satisfactory or superior physical
                             condition. (See fig. 4.1.) These properties represent 97 percent of the
                             apartment units in their portfolios. While all of the agencies used HUD’s
                             rating scale of superior, satisfactory, below average, or unsatisfactory to
                             classify the physical condition of their properties, they used their own
                             criteria and judgment to assign the ratings. As a result, the ratings are
                             difficult to compare and their reliability is unknown. (See app. IV, table
                             IV.2, for a state-by-state summary of the properties and units in each rating
                             category.)



                             2
                              The state agencies may also administer other Section 8 project-based contracts associated with
                             properties that were not included in the scope of this review, such as FHA-insured properties with
                             project-based assistance or moderate rehabilitation properties.



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                                      Chapter 4
                                      HUD’s Information on the Physical and
                                      Financial Condition of the Uninsured
                                      Portfolio Is Limited, but 10 State Agencies
                                      Reported Few Problems in Their Portfolios




Figure 4.1: Physical Condition of
Properties, as Reported by 10 State
Agencies                                                         •                           5%
                                                                                             Below average or unsatisfactory
                                                                                             (53 properties)
                                                                     21%
                                                                       •



                                                74%
                                                  •




                                                                                             Superior (244 properites)

                                                                                             Satisfactory (866 properties)


                                      Note: Information is based primarily on the results of the most recent (1998) physical inspections.

                                      Source: GAO’s analysis of information provided by the 10 state agencies.




HUD’s Database Has No                 Even though HUD requires property owners to submit annual audited
Information on the Results            financial statements, HUD’s central database contained no information on
of Financial Audits, but              the financial condition of the uninsured portfolio. As of December 1998,
                                      the database included dates relevant to the audited financial statements,
State Agencies Reported               such as when the audits were performed or when HUD received the
Few Financial Problems                statements. But the database did not contain the results of the audits. As a
                                      result, no conclusions can be drawn about the financial status of the
                                      uninsured portfolio.

                                      HUD does not require the state agencies to assign a rating to the financial
                                      condition of their properties. Nevertheless, 5 of the 10 agencies we
                                      surveyed—California, Michigan, New Hampshire, Tennessee, and
                                      Wisconsin—had rated the financial condition of their properties. As shown
                                      in figure 4.2, these five states reported that about 96 percent of the 474
                                      properties in their portfolios were in satisfactory, good, excellent, or
                                      superior financial condition while about 4 percent were in below average,
                                      poor, or unsatisfactory condition. (See app. IV, table IV.3, for a
                                      state-by-state summary of financial condition ratings.) Some of the
                                      underlying factors the agencies considered in evaluating a property’s



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                                     Chapter 4
                                     HUD’s Information on the Physical and
                                     Financial Condition of the Uninsured
                                     Portfolio Is Limited, but 10 State Agencies
                                     Reported Few Problems in Their Portfolios




                                     financial stability included cash reserve levels, cash flow, debt service
                                     coverage, operating expenses, and liquidity.


Figure 4.2: Financial Condition of
Properties, as Rated by Five State
Agencies
                                                              •                              4%
                                                                                             Below average, poor or
                                                                                             unsatisfactory (18 properties)


                                                                       37% •                 Superior or excellent (174
                                                                                             properites)
                                             59%
                                              •




                                                                                             Satisfactory or good (282
                                                                                             properties)


                                     Source: GAO’s analysis of information provided by the California, Michigan, New Hampshire,
                                     Tennessee, and Wisconsin housing finance agencies.




According to State                   Though not required by HUD, ratings of the overall condition of their
Agencies, Few Properties             properties were provided by 7 of the 10 state agencies we surveyed. To
Have Overall Operating               determine the overall condition of their properties, the state agencies
                                     generally considered the properties’ management and physical and
Problems or Require                  financial condition.3
Special Monitoring
                                     As shown in figure 4.3, the seven agencies reported that 95 percent of the
                                     666 properties in their portfolios were in satisfactory or better overall
                                     condition and that only 5 percent were in below average or unsatisfactory
                                     condition. According to the National Council of State Housing Agencies,
                                     the healthy overall physical and financial condition of the properties in the
                                     state agency portfolio is largely attributable to the successful asset
                                     management and oversight practices employed by the state agencies. (See
                                     app. IV, table IV.4, for a state-by-state summary of overall ratings.)

                                     3
                                      The Minnesota and Oregon agencies did not provide either financial or overall ratings for the 350
                                     properties in their portfolios because their monitoring systems did not collect information in ways that
                                     would allow them to do so.



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                                      Chapter 4
                                      HUD’s Information on the Physical and
                                      Financial Condition of the Uninsured
                                      Portfolio Is Limited, but 10 State Agencies
                                      Reported Few Problems in Their Portfolios




Figure 4.3: Overall Condition of
Properties, as Rated by Seven State
Agencies                                                       •                          5%
                                                                                          Below average or unsatisfactory
                                                                                          (35 properties)



                                                                      39% •               Satisfactory (258 properties)
                                            56%
                                              •




                                                                                          Superior, excellent, or above
                                                                                          average (373 properties)


                                      Source: GAO’s analysis of the overall condition ratings provided by the California, Illinois,
                                      Maryland, Massachusetts, Michigan, New Hampshire, and Tennessee housing finance agencies.




                                      In addition, the 10 state agencies reported that only 45—or fewer than
                                      4 percent—of the 1,167 properties in their portfolios warranted special or
                                      extra monitoring attention. The reasons cited for assigning properties to
                                      the special monitoring category included financial problems, deferred
                                      maintenance, occupancy issues, and/or concerns over management or
                                      ownership. Special monitoring usually involved increased oversight, such
                                      as additional site visits and evaluations, additional financial or operational
                                      reporting requirements, or specific workout agreements. (See app. IV,
                                      table IV.5, for data on each state’s special monitoring.)


                                      HUD is taking steps to improve the reliability and availability of its data on
HUD Is Taking Action                  the multifamily properties in its various portfolios, including both the
to Obtain More                        uninsured and insured Section 8 portfolios. In September 1998, HUD
Reliable and                          formed the Real Estate Assessment Center in Washington, D.C., to
                                      improve its processes for monitoring the physical and financial condition
Complete Data on Its                  of its properties. The Center has central responsibility for accumulating
Portfolios                            and analyzing the results of (1) the physical inspections of HUD’s properties
                                      nationwide and (2) the annual audited financial statements for HUD’s entire



                                      Page 61                               GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Chapter 4
HUD’s Information on the Physical and
Financial Condition of the Uninsured
Portfolio Is Limited, but 10 State Agencies
Reported Few Problems in Their Portfolios




portfolio. Multifamily asset managers will then use the results of these
analyses to develop oversight strategies for individual properties.

In the past, HUD lacked an objective system for classifying the results of
the physical inspections it requires for its multifamily uninsured and
insured properties. The Real Estate Assessment Center developed such a
system. The system uses a point scale to translate the results of an on-site
evaluation into an overall, quantitative rating for each property. HUD has
acquired and trained contractors to perform physical inspections using the
Center’s new inspection protocol. By the end of 1999, the Department
expects to have baseline data on over 30,000 multifamily properties,
including uninsured and insured Section 8 properties and insured
properties that do not receive Section 8 assistance.

At the end of April 1999, the contractors had completed physical
inspections at 4,513 properties under various multifamily housing
programs. Of 2,401 uninsured properties that were inspected, 39 percent
were in excellent condition, 46 percent were in good condition, 13 percent
were in fair condition, and 2 percent were in poor condition.4 (See app. V,
table V.1, for additional information on the results of the inspections.)

The Real Estate Assessment Center has also developed a central system
for analyzing financial information from the annual audited financial
statements that the owners of multifamily properties are required to
submit under the terms of their Section 8 housing assistance payment
contracts. The Center will compare this financial information with specific
performance ratios, compliance indicators, and other standards and
benchmarks for individual portfolios and for the industry as a whole. HUD
expects these comparisons to provide information that its field offices will
find useful in their monitoring and enforcement efforts. In general, the
owners of properties in the rural housing and state agency programs are
not required to report to the Center because they do not submit their
annual audited financial statements to HUD. The Center required all other
owners to submit their 1998 audited financial statement information by
June 30, 1999.




4
 About 61 percent of the 2,401 inspections were performed at properties in the elderly/disabled loan
portfolio, while the remainder were performed at other uninsured properties. The Real Estate
Assessment Center was unable to provide a breakdown showing how many of the remaining
properties were in the state agency portfolio of 2,278 Section 8 properties.



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                     Chapter 4
                     HUD’s Information on the Physical and
                     Financial Condition of the Uninsured
                     Portfolio Is Limited, but 10 State Agencies
                     Reported Few Problems in Their Portfolios




                     According to the National Council of State Housing Agencies, our draft
Agency Comments      report did not adequately stress the connection between the superior
and Our Evaluation   physical and financial condition of uninsured properties in the state
                     agency program and the state agencies’ management and oversight.
                     However, the scope of our review was not sufficient to link the condition
                     of the properties to the state agencies’ management and oversight.
                     Specifically, to satisfy the mandate, we agreed to determine how the state
                     agencies oversee the Section 8 properties in their portfolios and to provide
                     information on the physical and financial condition of the properties in 10
                     state agencies’ portfolios. These properties account for about 50 percent
                     of the properties in the state agency program. However, we included in the
                     final report the Council’s opinion that the physical and financial health of
                     the properties in the state agency portfolio is largely attributable to the
                     successful asset management and oversight practices employed by the
                     state agencies.




                     Page 63                              GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix I

Information on the Size of the Uninsured
Section 8 Portfolio

                                       This table provides additional information on the number of properties,
                                       contracts, and assisted units in the uninsured portfolio, broken out by the
                                       eight programs making up this portfolio.

Table I.1: Number of Uninsured
Section 8 Properties, Contracts, and                                                                                Total assisted
Units, by Program, as of               Program                               Properties            Contracts                 units
December 1998                          Elderly/disabled loan                      4,446                 4,451                209,178
                                       State agency                               2,278                 2,280                172,794
                                       New
                                       construction/substantial
                                       rehabilitation                             1,678                 1,708                 91,435
                                       Rural housing                              1,518                 1,525                 44,788
                                       Elderly/disabled capital
                                       advance                                    1,510                 1,510                 38,449
                                       Loan management
                                       set-aside                                    513                   678                 32,674
                                       Multifamily property
                                       disposition                                  521                   530                 39,829
                                       Housing preservation                           24                   26                  3,069
                                       Total                                     12,488                12,708                632,216
                                       Source: HUD’s Real Estate Management System (REMS) and Section 8 expiring contracts
                                       database, as of Dec. 1998.




                                       Page 64                              GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix II

Information on the HUD Databases Used to
Analyze the Section 8 Uninsured Portfolio

              This appendix provides more detailed information on the Department of
              Housing and Urban Development’s (HUD) databases we used to determine
              what information HUD has on the Section 8 assistance provided to, and the
              physical and financial condition of, the Section 8 properties that are not
              insured by HUD’s Federal Housing Administration (FHA).

              To develop information on the Section 8 assistance provided to uninsured
              properties, including data on expenditures, rents, and expiring contracts,
              we obtained three database files from HUD—two from the Office of
              Housing and one from the Office of the Chief Financial Officer. The first
              file from Housing, a database on Section 8 contracts expiring through the
              year 2038, included all insured and uninsured contracts receiving Section 8
              project-based assistance as of December 1998. The second file, a data
              extract from HUD’s Real Estate Management System (REMS)—the
              Department’s official source of information on multifamily
              housing—contained information on all active uninsured properties as of
              December 24, 1998, including information on the various programs that
              make up HUD’s uninsured Section 8 portfolio. The file from the Office of
              the Chief Financial Officer contained fiscal year 1998 expenditure and
              receipt data for all Section 8 contracts from the Department’s Program
              Accounting System (PAS). These three database files provided us with the
              information found in chapters 1 and 2.

              To determine the expenditures and per-unit costs associated with
              uninsured Section 8 contracts, we used PAS to calculate the net
              expenditures (expenditures minus receipts) during fiscal year 1998 for
              each of the eight primary programs in the portfolio. We then calculated the
              average per-unit subsidy cost for each program. After comparing the
              results of the two sets of calculations to identify any significant variances,
              we met with HUD officials to discuss the reasons for, and the factors
              potentially contributing to, those we found.

              We used HUD’s database of expiring Section 8 contracts and the data
              extract from REMS to provide information on the Section 8 contract and fair
              market rents for properties in the uninsured portfolio. To do this, we
              matched the universe of 12,708 uninsured contracts from REMS with
              corresponding information on the contract and fair market rents from the
              expiring Section 8 contracts database. For each of the eight programs, we
              then determined the percentage of units whose contract rents exceeded
              the fair market rents for their area. We also used the expiring contracts
              database to identify the expiration dates associated with project-based
              contracts in the uninsured portfolio. We then analyzed each contract’s



              Page 65                        GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix II
Information on the HUD Databases Used to
Analyze the Section 8 Uninsured Portfolio




expiration date to identify variances among the eight programs in the
uninsured portfolio.

To ascertain the physical and financial condition of the uninsured
properties, we matched the universe of uninsured properties in the data
extract from REMS with source tables in REMS that contained physical and
financial information. We included in our analysis only the results of the
most recent physical and financial reviews, excluding the results of older
reviews included in the tables for some properties. We then aged these
results for each of the programs in the portfolio. Although REMS contained
rating data from the physical inspections of many of the uninsured
properties in the portfolio, it did not contain corresponding information
from the financial reviews.

To ensure the reliability of the information in this report, we met with HUD
officials to discuss various data issues and reviewed selected data fields in
each of the three files for completeness, accuracy, and relevance. For
example, we found that some recently renewed contracts had not yet been
included in the universe of active uninsured contracts. We discussed this
issue with Housing officials, who developed a methodology to ensure that
these contracts were included in the active uninsured portfolio. We also
monitored efforts by the Multifamily Data Quality Task Force to identify,
measure, and fully verify “critical” Section 8 data elements in
REMS—some of which are used in this report. Such elements include data
on financing, units, and contract rents in the uninsured portfolio. To check
the expenditure and per-unit cost information for accuracy and
completeness, we matched the universe of active uninsured Section 8
contracts with the PAS expenditure data and tested the key data elements
to identify data that were missing or inaccurate. In 1997, HUD reported that
PAS was in compliance with the Federal Manager’s Financial Integrity Act.
In addition, HUD’s Office of the Inspector General examined funding and
expenditure data as part of its financial audit for fiscal years 1996-97 and
did not identify data errors associated with Section 8 contract
expenditures that were material to HUD’s financial statements. We also
reviewed the Department’s methodology for developing the ratios of
contract rents to fair market rents. On the basis of these reviews, we
determined that the data were sufficiently reliable to use in this study. We
made some minor adjustments—affecting 75 contracts—to the universe of
active uninsured Section 8 contracts. We discussed these changes with
HUD officials, who agreed that our adjustments were reasonable.




Page 66                            GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix III

Information on Section 8 Contract Rents
and Expirations

                                             This appendix provides more detailed information on (1) Section 8
                                             contract rents in relation to HUD’s fair market rents and (2) Section 8
                                             contract expirations for the uninsured portfolio.

                                             Table III.1 relates to table 2.2 in chapter 2, which identifies, for each of the
                                             programs in HUD’s uninsured Section 8 portfolio, the percentage of assisted
                                             Section 8 units whose Section 8 rents exceed HUD’s fair market rents. This
                                             table breaks out the overall percentage into four other categories, which
                                             show the extent to which the rents exceed the fair market rents.


Table III.1: Percentage of Assisted Units Whose Section 8 Contract Rents Exceed HUD’s Fair Market Rents for Programs in
HUD’s Uninsured Section 8 Portfolio, as of December 1998
                                                                Percentage of assisted units
                                With rents between          With rents          With rents
                                       101 and 120 between 121 and between 141 and             With rents over                Total with rents
                                     percent of fair 140 percent of fair 160 percent of fair 160 percent of fair               exceeding fair
Program                                market rents       market rents        market rents        market rents                  market rents
State agency                                     17                     24                     23                     28                    91
Elderly/disabled loan                            19                     23                     20                     25                    88
Rural housing                                    20                     31                     23                     12                    86
New construction/ substantial
rehabilitation                                   29                     22                     14                       8                   72
Preservation                                     27                     12                      4                       0                   42
Loan management set-aside                        19                      3                      0                       1                   24
Property disposition                             17                      3                      1                       0                   21
Elderly/disabled capital
advance                                           4                      1                      0                       0                    5
                                             Note: These data cover 12,288 of the 12,708 contracts in HUD’s uninsured portfolio for which
                                             data on rents and HUD’s fair market rents were available.

                                             Source: HUD’s Section 8 expiring contracts database, Dec. 1998.



                                             Table III.2 relates to figure 2.3 in chapter 2, which shows when uninsured
                                             Section 8 contracts will expire. This table breaks out the expiration dates
                                             for contracts in each of the programs that make up HUD’s uninsured
                                             Section 8 portfolio.




                                             Page 67                                 GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                                        Appendix III
                                        Information on Section 8 Contract Rents
                                        and Expirations




Table III.2: Percentage of Contracts
Expiring Within Indicated Fiscal Year   Program                    1999-2004           2005-2009          2010-2014         2015-2021
Ranges, by Program, as of               Loan
December 1998                           management
                                        set-aside                           99                  0                   0              0
                                        Rural housing                       97                  2                   0              2
                                        Preservation                        92                  0                   0              0
                                        Property
                                        disposition                         58                 29                 12               0
                                        New construction/
                                        substantial
                                        rehabilitation                      48                 16                 25              10
                                        Elderly/disabled
                                        loan                                41                 33                 25               1
                                        Elderly/disabled
                                        capital advance                     15                  4                 16              62
                                        State agency                         6                  8                 41              42
                                        Source: GAO’s analysis of HUD’s Section 8 expiring contracts database, Dec. 1998.




                                        Page 68                                  GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix IV

Size and Condition of the Uninsured
Portfolio for 10 State Housing Finance
Agencies
                                        This appendix augments chapter 4 by providing information on the size of
                                        each state agency’s uninsured portfolio, the physical and financial
                                        condition of properties in the portfolio, and the number of properties
                                        receiving special monitoring attention.

                                        Table IV.1 profiles the portfolios of the 10 state agencies we reviewed.

Table IV.1: Numbers of Properties,
Project-Based Section 8 Contracts,                                                      Section 8
and Units in the Portfolios of the 10   State agency               Properties           contracts         Total units Section 8 units
State Agencies Reviewed by GAO          California                         123                 129                 8,466       8,364
                                        Illinois                           120                 120             20,286         16,183
                                        Maryland                            57                  57                 5,179       4,705
                                        Massachusetts                      152                 152             17,731         16,526
                                        Michigan                           116                 116             19,425         19,020
                                        Minnesota                          232                 232             15,028         13,353
                                        New Hampshire                       63                  63                 2,268       2,244
                                        Oregon                             122                 122                 4,045       4,010
                                        Tennessee                           37                  37                 1,835       1,814
                                        Wisconsin                          145                 150             11,508         11,508
                                        Total                            1,167               1,178            105,741         97,727
                                        Source: GAO’s analysis of information provided by the 10 state agencies.



                                        Table IV.2 summarizes the physical condition ratings that the state
                                        agencies assigned to properties in their portfolios. Since the agencies used
                                        their own criteria in developing and assigning the ratings, it is difficult to
                                        compare the overall condition of their respective portfolios.




                                        Page 69                                  GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                                           Appendix IV
                                           Size and Condition of the Uninsured
                                           Portfolio for 10 State Housing Finance
                                           Agencies




Table IV.2: Physical Condition of Properties, as Rated by the 10 State Agencies
                                    Superior                Satisfactory                       Below average                  Unsatisfactory
State agency                Properties            Units        Properties        Units     Properties           Units   Properties         Units
California                             0               0               122       8,426                 1          40               0            0
Illinois                              89        13,583                  31       6,703                 0           0               0            0
Maryland                              15          1,855                 32       2,670                 7         528               3           96
Massachusettsa                         0               0               146     17,466                  6         265               0            0
Michigan                              29          4,326                 85     14,845                  2         254               0            0
Minnesota                             18          1,822                197     12,165              14            792               3           249
New Hampshire                          4            200                 59       2,068                 0           0               0            0
           b
Oregon                                26            965                 80       2,549             12            357               0            0
Tennessee                             20          1,082                 17         573                 0           0               0            0
Wisconsin                             43          3,872                 97       7,393                 4         237               1            6
Total                                244        27,705                 866     75,038              46           2,473              7           351
                                           a
                                            The Massachusetts agency rates the physical condition of its properties as meeting or not
                                           meeting the agency’s standards. Massachusetts officials agreed to our classification of the
                                           physical condition of these properties as “satisfactory” or “below average.”
                                           b
                                               Information was not available for four of Oregon’s properties.

                                           Source: GAO’s analysis of property condition ratings provided by the 10 state agencies.



                                           Table IV.3 summarizes the financial condition ratings assigned by 5 of the
                                           10 housing agencies.

Table IV.3: Financial Condition of
Properties, as Rated by Five State                                                                                               Below average,
Agencies                                                                               Superior or         Satisfactory or              poor, or
                                           State agency                                  excellent                   good         unsatisfactory
                                           California                                              0                    122                     1
                                           Michigan                                             109                       0                     7
                                                                   a
                                           New Hampshire                                          10                     44                     0
                                           Tennessee                                              15                     22                     0
                                                           b
                                           Wisconsin                                              40                     94                    10
                                           Total                                                174                     282                    18
                                           a
                                            New Hampshire did not provide ratings for nine properties.
                                           b
                                               Wisconsin did not rate one of its properties.

                                           Source: GAO’s summary of information provided by the five state agencies.




                                           Page 70                                       GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                                      Appendix IV
                                      Size and Condition of the Uninsured
                                      Portfolio for 10 State Housing Finance
                                      Agencies




                                      Table IV.4 summarizes the overall condition of properties in the portfolios
                                      of the seven state agencies that rated the overall condition of their
                                      properties. The agencies typically considered such factors as a property’s
                                      physical, financial, and management condition in assigning the ratings.

Table IV.4: Overall Condition of
Properties, as Rated by Seven State                                           Superior,
Agencies                                                                   excellent, or                            Below average or
                                      State agency                       above average               Satisfactory      unsatisfactory
                                      California                                         0                   122                        1
                                      Illinois                                          89                     29                       2
                                      Maryland                                          15                     30                      12
                                      Massachusettsa                                  137                       0                      13
                                      Michigan                                        109                       0                       7
                                      New Hampshire                                      9                     54                       0
                                      Tennessee                                         14                     23                       0
                                      Total                                           373                    258                       35
                                      a
                                      Massachusetts did not provide information on two properties.

                                      Source: GAO’s summary of information provided by the seven state agencies.



                                      Table IV.5 summarizes the number of properties receiving special
                                      monitoring attention by each state agency at the time of our inquiry.

Table IV.5: Number of Properties
Receiving Special Monitoring                                             Properties in the agency’s              Properties receiving
Compared With the Total Number of     State agency                                         portfolio              special monitoring
Properties for Each of the 10 State   California                                                     123                                1
Agencies
                                      Illinois                                                       120                                2
                                      Maryland                                                        57                                4
                                      Massachusetts                                                  152                                5
                                      Michigan                                                       116                                7
                                      Minnesota                                                      232                               11
                                      New Hampshire                                                   63                                2
                                      Oregon                                                         122                               12
                                      Tennessee                                                       37                                1
                                      Wisconsin                                                      145                                0
                                      Total                                                      1,167                                 45
                                      Source: GAO’s analysis of information on special monitoring provided by the 10 state agencies.




                                      Page 71                                GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix V

Results of Inspections Under HUD’s New
Inspection Program

                                    Table V.1 summarizes the results of the physical inspections completed
                                    under a new inspection program conducted by HUD’s Real Estate
                                    Assessment Center. These inspections were completed by the end of
                                    April 1999 at 4,513 of the properties in HUD’s portfolio of about 30,000
                                    insured and uninsured properties.

Table V.1: Number of Properties
Inspected by April 1999 and Their                        Number of
                                                         properties                                 Rating
Physical Condition Ratings
                                    Program              inspected              Poor               Fair          Good         Excellent
                                    Uninsured
                                        Elderly/
                                        disabled               1,462                 1%             10%              43%            46%
                                        All other
                                        uninsureda               940                 4%             19%              50%            27%
                                    Subtotal                   2,401
                                    Insured                    1,746                 3%             16%              51%            30%
                                    HUD-held                     366                 6%             27%              47%            20%
                                    Total/average              4,513                 3%             15%              48%            34%
                                    a
                                     The category “all other uninsured” can include properties in the state agency, new
                                    construction/substantial rehabilitation, rural housing, loan management set-aside, property
                                    disposition, and preservation programs. HUD could not provide us with information on the
                                    number of properties in each program included in this category.

                                    Source: HUD’s Real Estate Assessment Center.




                                    Page 72                                 GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix VI

Comments From the Department of Housing
and Urban Development

Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.




                             Page 73   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                 Appendix VI
                 Comments From the Department of Housing
                 and Urban Development




See comment 1.




See comment 2.




See comment 3.




See comment 4.




                 Page 74                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                 Appendix VI
                 Comments From the Department of Housing
                 and Urban Development




See comment 5.



See comment 6.




See comment 7.




See comment 8.




See comment 9.




                 Page 75                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                  Appendix VI
                  Comments From the Department of Housing
                  and Urban Development




See comment 6.




See comment 10.




See comment 11.




                  Page 76                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                  Appendix VI
                  Comments From the Department of Housing
                  and Urban Development




See comment 12.




See comment 13.




See comment 14.




                  Page 77                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix VI
Comments From the Department of Housing
and Urban Development




Page 78                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
               Appendix VI
               Comments From the Department of Housing
               and Urban Development




               The following are GAO’s comments on the Department of Housing and
               Urban Development’s letter dated July 13, 1999.


               1. The scope of the report reflects the requirements in Public Law 105-65
GAO Comments   for a GAO study on the uninsured Section 8 portfolio. The mandate did not
               call for an evaluation of the Section 8 rental assistance program. It did,
               however, focus on the three topics discussed in our report, including the
               information HUD has on the Section 8 assistance provided to properties in
               the uninsured portfolio and the physical and financial condition of these
               properties. To provide this information, we relied primarily on data that
               were available from the Department.

               2. See chapter 2, Agency Comments and Our Evaluation.

               3. See chapter 2, Agency Comments and Our Evaluation.

               4. The draft report contained information on the savings that bond
               refundings have provided to the government and on how the state
               agencies use their share of the savings. Chapter 1 of the draft report stated
               that as of September 30, 1998, the Department had approved 245 refunding
               agreements that would provide $1.1 billion in bond refunding savings over
               the lives of the Section 8 contracts. Of this amount, $633 million would be
               provided to the U.S. Treasury, and the remainder would be provided to
               state and local agencies. Furthermore, according to the draft report, the
               agencies use their bond refunding savings to provide affordable housing
               for low-income residents in their states. This information also appears in
               the final report.

               5. See chapter 3, Agency Comments and Our Evaluation.

               6. We do not agree with HUD that the report greatly exaggerates the
               practical leverage the Department has to extract savings from state and
               local housing agencies on transactions that HUD has no role in approving or
               carrying out. In fact, we believe that HUD has not effectively used the
               authority it does have to establish and enforce Section 8 program
               requirements. The Department believes that since the state agencies,
               unlike local agencies, do not need its approval to issue tax-exempt bonds,
               it cannot establish requirements for state agencies issuing bonds for
               Section 8 properties. We do not agree that this limitation exists. For
               example, at a minimum, the Department could require the state agencies
               to notify the Department when they plan to refund Section 8 bonds



               Page 79                         GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix VI
Comments From the Department of Housing
and Urban Development




associated with Section 8 properties. Such notification would provide the
Department with the information it needs to ensure compliance with
shared savings requirements. Furthermore, the Department would not
have to rely solely on the state agencies to obtain this information. State
and local bond activities are reported in national publications, such as The
Bond Buyer.1 This publicly available information would allow the
Department to monitor the state agencies’ compliance with a reporting
requirement, if necessary.

7. See comment 1 on the scope of this congressionally mandated study. We
also note that HUD’s assertions about the Section 8 program are not
supported by objective data. For example, as discussed in the report, the
portfolio reengineering program that the Congress recently established is
designed not only to reduce the costs of expiring Section 8 contracts
(reset them to market levels) but also to address problems at financially
and physically troubled projects and to correct management and
ownership deficiencies.

8. See chapter 3, Agency Comments and Our Evaluation.

9. See chapter 3, Agency Comments and Our Evaluation.

10. See chapter 3, Agency Comments and Our Evaluation.

11. The form and worksheets cited by HUD did not include examples of
calculations showing how to adjust rents after bonds have been refunded.
The form and worksheets were developed several years before the
Department introduced its rent adjustment policy.

12. See chapter 3, Agency Comments and Our Evaluation.

13. See chapter 3, Agency Comments and Our Evaluation.

14. This chronology of the dual fee issue, much of which appeared in our
draft report, does not alter the facts that 6 years have passed since the
Inspector General notified the Department of the dual fee situation and
HUD has not yet resolved this problem. In addition, HUD has neither
identified all of the agencies that receive dual fees nor taken steps to
identify and enforce its dual fee regulation in cases that are not covered by
refunding agreements. Therefore, we did not revise the report in response
to these comments.

1
 The Bond Buyer is a daily newspaper serving the municipal bond industry.



Page 80                                 GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix VII

Comments From the National Council of
State Housing Agencies

Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.




See comment 1.




See comment 2.




See comment 2.




See comment 3.




                             Page 81   GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                 Appendix VII
                 Comments From the National Council of
                 State Housing Agencies




See comment 1.




See comment 2.




                 Page 82                           GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                 Appendix VII
                 Comments From the National Council of
                 State Housing Agencies




See comment 2.




See comment 3.




                 Page 83                           GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
                 Appendix VII
                 Comments From the National Council of
                 State Housing Agencies




See comment 4.




                 Page 84                           GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
               Appendix VII
               Comments From the National Council of
               State Housing Agencies




               The following are GAO’s comments on the National Council of State
               Housing Agencies’ letter dated July 7, 1999.


               1. See chapter 2, Agency Comments and Our Evaluation.
GAO Comments
               2. See chapter 3, Agency Comments and Our Evaluation.

               3. See chapter 4, Agency Comments and Our Evaluation.

               4. The recommendations in the report provide the potential for HUD to
               achieve Section 8 savings by clarifying the applicability of a legal provision
               for sharing certain bond refunding savings with the government and by
               enforcing compliance with a HUD notice on rent increases and a HUD
               regulation prohibiting dual fees. The scope of the report reflects the
               requirements in Public Law 105-65 for a GAO study on the uninsured
               Section 8 portfolio. This mandate did not call for GAO to evaluate the
               impact of the congressional limit on certain Section 8 rent increases.
               Nevertheless, the Moody’s Investors Service report cited by the National
               Council did consider the impact of this limit and noted that no state
               agency’s bonds have been downgraded and none has been assigned a
               negative outlook because of it. Moody’s report characterized the outlook
               for almost $4.5 billion in state agencies’ outstanding debt as stable. In fact,
               according to the report, 122 Section 8 bond programs, which rely primarily
               on Section 8 project-based subsidies and account for over $4 billion in
               debt, received outstanding ratings. Additionally, Moody’s reported that it
               had upgraded eight state agencies’ Section 8 programs and given positive
               outlook ratings to another three programs because of their exceptionally
               strong credit characteristics. By contrast, Moody’s projected a negative
               outlook for about $305 million in local agencies’ outstanding Section 8
               debt, citing negative factors such as the rent increase limit and the risks
               inherent in single projects. According to the report, Moody’s downgraded
               15 local issues and gave negative outlook ratings to 10 local bond
               programs.




               Page 85                           GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
Appendix VIII

GAO Contacts and Staff Acknowledgements


                   Stanley J. Czerwinski, (202) 512-7631
GAO Contacts
                   Christine M.B. Fishkin, (202) 512-6895


                   In addition to those named above, Mark H. Egger, Elizabeth R. Eisenstadt,
Acknowledgements   Diana Gilman, Richard A. Hale, Mitchell B. Karpman, Lyle H. Lanier, John
                   T. McGrail, Anthony Radford, Joseph M. Raple, Rose M. Schuville, and
                   Don Watson made key contributions to this report.




(385713)           Page 86                       GAO/RCED-99-217 HUD’s Uninsured Section 8 Portfolio
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