oversight

Urban Education Development Research and Retreat Center (UEDRARC), Philadelphia, PA

Published by the Department of Housing and Urban Development, Office of Inspector General on 2000-11-02.

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

         AUDIT REPORT




URBAN EDUCATION DEVELOPMENT RESEARCH
    AND RETREAT CENTER (UEDRARC)
      PHILADELPHIA, PENNSYLVANIA

              01-PH-241-1001

            NOVEMBER 2, 2000




        OFFICE OF AUDIT, MID-ATLANTIC
        PHILADELPHIA, PENNSYLVANIA
                                                                    Issue Date
                                                                           November 2, 2000
                                                                   Audit Case Number
                                                                            01-PH-241-1001




TO:            Joyce Gaskins, Director, Office of Community Planning and Development, 3AD




FROM:          Daniel G. Temme, District Inspector General for Audit, Mid-Atlantic, 3AGA

SUBJECT:       Audit of the Philadelphia Commercial Development Corporation’s (PCDC)
               Funding of the Urban Education Development Research and Retreat Center
               (UEDRARC) Rehabilitation Project

We completed an audit of PCDC’s loan assistance to UEDRARC, a non-profit entity which needed
financial help for a rehabilitation project. The audit included loan activity by PCDC and the
Philadelphia Industrial Development Corporation (PIDC). This report focuses on PCDC’s loan to
UEDRARC. The conditions we observed regarding the PIDC loan evaluation process, loan
servicing, and loan monitoring practices, are addressed in a separate report. Since Community
Development Block Grant (CDBG) funds were the source of the loan assistance, we wanted to
ensure the funds were used to meet a CDBG national objective. We also wanted to ensure that
PCDC used good business practices in making the loan, had effective controls for evaluating
requests for financial assistance, employed good loan oversight procedures, and took timely and
aggressive action to obtain loan recipient compliance with its loan requirements. Finally, we
wanted to assess the condition of the UEDRARC loan and determine UEDRARC’s present and
future financial capacity to meet the loan’s terms.

We determined that the CDBG funds loaned to UEDRARC for building rehabilitation met the
CDBG national objective of preventing or eliminating a slum and blighted condition. However,
despite meeting this national objective, we found that PCDC did not observe many of its procedures
in evaluating, authorizing, and servicing the loan. By not following prudent business practices and
its own loan evaluation and authorization procedures, PCDC unnecessarily jeopardized CDBG
funds totaling $550,000. The outcome is that PCDC now holds a severely non-performing loan
with little prospect the loan will become performing in the future.

Although we found PCDC had established controls for evaluating, authorizing, and monitoring its
loans, it appears PCDC did not follow these controls fully for the UEDRARC loan. PCDC needs to
document fully all waivers to its loan requests or procedures. Because PCDC violated its own
procedures and did not observe sound business practices for the UEDRARC Project, it put the
Management Memorandum


CDBG funds used for the loan at excessive risk. Therefore, in the event of a default by UEDRARC
which causes PCDC to write off the loan, we are recommending that the City of Philadelphia use
non-Federal funds to repay its CDBG Program for the loan portion written off as uncollectable.

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

Should you or your staff have any questions, please contact Thad Staniul, Assistant District
Inspector General for Audit, at (215) 656-3401.




01-PH-241-1001                           Page ii
Executive Summary
We completed an audit of the Philadelphia Commercial Development Corporation’s (PCDC)
funding of the Urban Education Development Research and Retreat Center (UEDRARC)
rehabilitation project. The objectives of the audit were to determine whether: Community
Development Block Grant (CDBG) funds were used to accomplish a national objective; the
UEDRARC Project met its objectives; and PCDC effectively administered the CDBG funds
provided to UEDRARC.

We noted positive effects from the UEDRARC Project. UEDRARC met a CDBG national
objective by eliminating a slum and blighted condition, and accomplished its mission to provide
an institutional environment encompassing programs designed to promote education, research,
employment training, and human development to serve the needs of Philadelphia’s African
American community. PCDC had designed good management systems and controls to provide
project oversight and to account for all the loan funds disbursed to the project. Despite having
these good controls, PCDC did not follow its own and HUD’s requirements, and did not use
prudent financial judgment in evaluating, approving, and administering its $550,000 loan to
UEDRARC - a high risk borrower. PCDC did not observe existing loan approval policies and
procedures; enforce its loan monitoring policy and procedures when administering the loan; and
take full advantage of available recourses when UEDRARC defaulted on its loan. As a result of
PCDC’s loan decision, it is likely PCDC will need to write off the loan to UEDRARC, depriving
other applicants of needed funds.


eral requirements.                  PCDC’s Board of Directors overruled their Vice President
  PCDC Did Not Follow its
                                    for Lending’s recommendation to reject the loan and
  Loan Approval
                                    bypassed their Loan Committee in providing the loan to
  Procedures
                                    UEDRARC.       Based on the Office of Housing and
                                    Community Development’s (OHCD) assurances of
                                    UEDRARC’s financial viability and a Pennsylvania State
                                    Senator’s encouragement, PCDC’s Board authorized the
                                    loan. The State Senator, who was a member of both
                                    PCDC’s and UEDRARC’s Boards of Directors, used his
                                    influence in PCDC’s loan decision making process.
                                    Despite individual Board members’ concerns, the Board
                                    authorized the loan, featuring unusually favorable terms
                                    including:   a loan amount exceeding the $100,000
                                    maximum amount, an interest rate of only 3½ percent, and
                                    a 96 month moratorium on principal payments. Finally,
                                    PCDC used a for-profit loan vehicle to provide the loan to
                                    UEDRARC, a non-profit organization.

                                    PCDC did not enforce its loan monitoring policy and
 PCDC Did Not Monitor
                                    procedures, and removed its loan officer from the loan
 The Project
                                    monitoring process. PCDC relied on the Philadelphia
                                    Industrial Development Corporation (PIDC) to monitor the
                                               Page iii                           01-PH-241-1001
Executive Summary


                         loan because PCDC lacked the resources to monitor the
                         project and the PCDC loan was subordinate to the PIDC
                         loan. We evaluated PIDC’s monitoring process and found
                         it to be ineffective.      Also, PCDC did not pursue
                         UEDRARC for annual financial statements required by the
                         loan agreement or a final audit of the project. UEDRARC
                         defaulted on the loan within a month of receiving loan
                         proceeds. As of March 13, 2000, UEDRARC had been
                         delinquent 50 of the 53 months of the loan term and was
                         $22,496.01 in arrears. PCDC never required UEDRARC to
                         prove it lacked the capability to make its loan payments.
                         PCDC did not take more forceful default action because of
                         outside pressure and the desire to see the project succeed.

                         The UEDRARC Project met a CDBG national objective by
 UEDRARC Project Was
                         eliminating a slum and blighted condition and met its goal by
 Not Financially Sound
                         creating an educational facility at its project location.
                         However, its ability to sustain this success is questionable.
                         UEDRARC currently lacks the resources to complete facility
                         renovations needed to increase revenue. Furthermore,
                         current operations do not generate sufficient revenue to cover
                         long term debt and operating expenses. During the 17
                         months ending May 31, 2000, UEDRARC experienced an
                         average monthly shortfall of $24,672.86 or a total of
                         $419,438.62 over the period. Due to its current financial
                         condition, it is unlikely that UEDRARC will be able to
                         obtain the funding for the remaining renovations. Without
                         this funding and the resulting increased revenue, it is
                         doubtful that UEDRARC will be able to repay its debt and
                         continue operations.

                         We recommended to HUD that PCDC comply with loan
 Recommendations
                         approval and administration policies and procedures and
                         loan agreements; document the reasons for circumventing
                         existing policies and procedures when approving and
                         administering loans; and require UEDRARC to obtain an
                         audit of the construction project.

                         We also recommended that, if PCDC writes off the loan,
                         HUD direct the City of Philadelphia to repay, to the City’s
                         CDBG Program, with non-Federal funds, the loan portion
                         written off as uncollectable.




01-PH-241-1001             Page iv
                                                        Executive Summary


Finding and       We discussed the results of our review with PCDC during
Recommendations   the audit and at an exit conference on September 22, 2000.
Discussed         By letter, dated October 4, 2000, the President/CEO of
                  PCDC provided a detailed response to the conditions and
                  recommendations discussed in the draft report. We have
                  included PCDC’s pertinent comments in the Finding   Finding
                  Section of this report. PCDC’s full response is included in
                  Appendix
                   Appendix  A.A




                   Page v                                   01-PH-241-1001
Executive Summary




                    (THIS PAGE LEFT BLANK INTENTIONALLY)




01-PH-241-1001                  Page vi
Table of Contents

 Management Memorandum                                     i


 Executive Summary                                       iii


 Introduction                                             1


 Finding

     High Risk Borrower’s Repayment of CDBG
     Funded Loan in Jeopardy                              5



 Management Controls                                     15


 Follow Up On Prior Audits                               17

 Appendices
     A Auditee Comments                                  19

      B Distribution                                     23




                             Page vii         01-PH-241-1001
Table of Contents


Abbreviations

       CDBG         Community Development Block Grant
       HUD          US Department of Housing and Urban Development
       OHCD         Office of Housing and Community Development
       PAID         Philadelphia Authority for Industrial Development
       PCDC         Philadelphia Commercial Development Corporation
       PIDC         Philadelphia Industrial Development Corporation
       SBRLF        Small Business Revolving Loan Fund
       UEDRARC      Urban Education Development Research and Retreat Center
       UEF          Urban Education Foundation




01-PH-241-1001                      Page viii
Introduction
UEDRARC was founded as a non-profit organization to acquire the property at 4601 Market
Street, rehabilitate the buildings, restructure the facility’s governance and management, and
attract appropriate new tenants. UEDRARC’s mission is to provide an institutional environment
in which programs designed to promote education, research, employment training, and human
development can serve the needs of Philadelphia’s African American community. UEDRARC is
governed by a 12-member Board of Directors having community, educational, civic, corporate,
and real estate development expertise.

In 1983, the Provident Mutual Life Insurance Company donated the property at 4601 Market
Street to the Urban Education Foundation (UEF) to develop an educational and training center
for West Philadelphia’s disadvantaged residents. In 1991, UEF filed for bankruptcy, State and
City officials were contacted to save the facility, and a reorganization plan was developed. The
reorganization plan provided for UEDRARC to purchase and redevelop the property.
UEDRARC, incorporated in 1991, was created to continue UEF’s goal of sustaining an
educational center at the 4601 Market Street location. On December 29, 1993, Meridian Bank
provided a $1.6 million loan to UEDRARC. UEDRARC agreed to pass the funds to UEF to pay
creditors and payroll, and to set up a loan interest reserve for UEDRARC. UEDRARC took
control of the property at that time but did not actually purchase the property until March 29,
1995.

The property required substantial physical improvements, including utility systems; heating,
ventilation, and air-conditioning systems; electrical systems; and asbestos removal. In April
1992, UEDRARC consultants estimated physical improvement costs at $4.55 million and
estimated the cost of total development efforts at $7.21 million. As work progressed, these
estimates increased due to additional renovation work and asbestos removal.

Funding for the UEDRARC Project came from several sources. From 1993 through 1997, the
Commonwealth of Pennsylvania provided two grants of $3.675 million through its
Redevelopment Authority Grant Program. PIDC provided six loans of $7.15 million, and PCDC
provided one loan of $550,000. PIDC and PCDC are funded through the City’s CDBG Program.
Also, Meridian Bank provided UEDRARC a $1.6 million loan. Funding from all sources totaled
$12.975 million ($6 million in HUD funds). UEDRARC used $4.1 million in subsequent loans
and grants to pay off earlier loans, which resulted in a net $8.875 million ($5.2 million in HUD
funds) in actual funding for the Project.

From 1995 through 1997, PIDC issued to UEDRARC three permanent loans totaling $4.65
million using CDBG and HUD Section 108 funds and three interim loans totaling $2.5 million
using CDBG and PIDC (City) funds. PIDC qualified using CDBG funds for UEDRARC
because the Project met the national objective of eliminating slum and blighted conditions.
PIDC disbursed its loan funds to UEDRARC based upon contractor invoices it received from
UEDRARC.




                                                Page 1                            01-PH-241-1001
Introduction


PCDC receives about $2.2 million a year in CDBG funding for operating expenses and loans. In
1993, the City of Philadelphia’s OHCD approached PCDC to fill the funding gap for the
UEDRARC Project. PCDC filled this gap by providing UEDRARC a $550,000 loan on March
29, 1995. The PCDC loan qualified for CDBG funding by meeting the elimination of slums and
blight national objective. PCDC disbursed its loan funds by issuing checks in the name of
UEDRARC and the contractor in response to contractor invoices received from UEDRARC.

In 1995, the Commonwealth of Pennsylvania provided two grants totaling $3.675 million to
UEDRARC through an agreement with the Philadelphia Authority for Industrial Development
(PAID), a division of PIDC. The Commonwealth provided its grants by reimbursing UEDRARC
based on UEDRARC proof of payments submitted to PAID and the Commonwealth. During
1997, the Commonwealth did a limited scope audit that included only one of the nine grant
disbursements it made to UEDRARC.

Even though UEDRARC had multiple funding sources, with funds delivered as loans and grants,
as reimbursements and advances, there was no overall audit done to cover all the funds provided
to the UEDRARC Project.


                                    The primary objectives of the audit were to determine
 Audit Objectives                   whether:

                                    •   UEDRARC:

                                        − accomplished a national objective;

                                        − was meeting its goals, could account for all funds
                                          and used the funds for appropriate purposes; and

                                    •   PCDC:

                                        − administered effectively its CDBG funds according
                                          to applicable laws, HUD regulations, loan
                                          documents, and other applicable directives;

                                        − evaluated objectively the feasibility        of   the
                                          UEDRARC Project, including:

                                                ♦ determining if the UEDRARC Project was
                                                  an effective use of CDBG funds; and

                                                ♦ determining if UEDRARC had the financial
                                                  wherewithal to sustain its operation long-
                                                  term.


01-PH-241-1001                            Page 2
                                                                 Introduction


                      − had management systems and controls to provide
                        effective oversight for the Project;

                      − monitored UEDRARC operation and rehabilitation
                        procedures;

                      − accounted for all funds provided for the Project;

                      − validated UEDRARC’s inability to make loan
                        payments; and

                      − took appropriate action to make loan payments
                        current.

                  We performed audit work from January 2000 to August
Audit Period      2000 and covered the period January 1992 through March
                  2000. We extended the review through June 2000 to
                  analyze UEDRARC’s more recent financial operating
                  condition.

                  We reviewed UEDRARC’s:
Audit Scope and
Methodology       •   compliance with the terms and conditions of the PCDC
                      loan agreements;

                  •   consultant’s procedures and controls for tracking
                      construction costs and compiling bills during the
                      construction process to determine whether effective
                      controls were in place; and

                  •   construction and operations’ accounting process to
                      determine whether UEDRARC accounted for all funds
                      received, used the funds for appropriate purposes, and
                      to determine UEDRARC’s current financial position.

                  We inspected the UEDRARC property and surrounding
                  area to: determine whether the project met its goals of
                  contributing to the community, becoming an anchor around
                  which other positive activities could generate, and
                  eliminating a slum and blight area in a section of West
                  Philadelphia; and identify benefits realized by the
                  community because of the UEDRARC activity.




                        Page 3                                 01-PH-241-1001
Introduction


                 We evaluated PCDC’s procedures and controls over its
                 loan approval, accounting, and loan monitoring processes
                 to determine whether they are effective and to ensure they
                 were used by responsible PCDC staff.

                 We reviewed the Commonwealth of Pennsylvania’s audit
                 of one of the nine grant disbursements made to UEDRARC
                 to determine the audit objectives, scope, and results. We
                 considered this information in formulating our audit scope.

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




01-PH-241-1001         Page 4
                                                                                      Finding 1


    High Risk Borrower’s Repayment of CDBG
            Funded Loan in Jeopardy
PCDC approved and administered a $550,000 loan to UEDRARC under its Small Business
Revolving Loan Fund (SBRLF) without observing its own and HUD requirements and did not
appear to use sound financial judgment in making the loan. Also, because PCDC did not have
resources to effectively monitor a project and loan the size of UEDRARC, PCDC relied on PIDC to
provide the necessary project oversight, which we later determined to be ineffective. Consequently,
PCDC holds a UEDRARC loan that is in default and has been delinquent 50 of the 53 months the
loan has been outstanding. Though the loan went into default, PCDC did not enforce loan default
procedures because of external pressure and a desire to see the project succeed. Finally,
UEDRARC’s difficult financial situation makes it impossible to satisfy its current loan
delinquencies and we are not optimistic regarding UEDRARC’s potential for becoming current in
the near future.


A. Loan Origination

                                     The City of Philadelphia, through its Department of
 SBRLF Funding and
                                     Commerce, provides about $2.2 million in CDBG funds
 Program Description
                                     annually to PCDC for operating expenses and loans. PCDC
                                     operates the SBRLF, among others. The purpose of the
                                     SBRLF is to foster economic growth within the City of
                                     Philadelphia by providing direct financial assistance to small
                                     businesses for expanding their operations. PCDC makes
                                     SBRLF loans to for-profit businesses to conduct economic
                                     development projects that will create or retain jobs and
                                     provide goods or services to benefit an area of mostly low and
                                     moderate income persons. PCDC used $550,000 in SBRLF
                                     funds to help finance UEDRARC.

                                     PCDC’s general loan requirements prescribed that, “The
 PCDC Loan Guidelines
                                     applicant must possess the requisite experience to successfully
                                     manage the business/project to be financed.” Further,
                                     according to the SBRLF section of the guidelines, the
                                     Department of Commerce and PCDC’s Loan Committee are
                                     responsible for reviewing loan applications and approving the
                                     loans. The guidelines stipulate that SBRLF loans were for the
                                     benefit of “for-profit” businesses. Also, the guidelines limited
                                     the maximum amount for SBRLF loans to $50,000 originally,
                                     later increased to $100,000 by the time of the UEDRARC
                                     loan. The guidelines allowed for exceptions to the dollar limit
                                     “for special economic development projects with high job

                                            Page 5                                    01-PH-241-1001
Finding 1


                          creation/retention prospects or strong community impact”.
                          The guidelines set 4½ percent as the SBRLF loan interest
                          floor.

                          PCDC did not observe several of its loan evaluation and
 Loan Approval
                          approval procedures in originating the UEDRARC loan. For
 Procedures Were Not
                          example, though the UEDRARC Board of Directors
 Followed
                          includes professionals from various fields, there was no
                          evidence that they had the requisite background and skills
                          necessary to undertake a project such as UEDRARC.
                          Further, there was no evidence that PCDC evaluated the
                          UEDRARC Board members with the intent of establishing
                          their capabilities to undertake a project of this type.

                          PCDC’s loan application review process requires the Vice
                          President for Lending to review and recommend the project
                          for presentation to the Loan Committee. After evaluating
                          the UEDRARC Project’s request for funding, the PCDC
                          Vice President for Lending rejected the request because he
                          perceived cash flow problems. The PCDC Board of
                          Directors overruled their Vice President for Lending’s
                          recommendation. Further, the Board bypassed the Loan
                          Committee and any reluctance the committee may have had
                          to approve the UEDRARC loan, by taking the authority
                          upon themselves to make the loan. In fact, the Board
                          granted UEDRARC unusually favorable terms. The more
                          favorable loan terms included:

                          •   an exception to the $100,000 maximum loan amount by
                              awarding UEDRARC a $550,000 loan.

                          •   a loan interest rate of 3½ percent as opposed to the normal
                              5½ percent rate.

                          •   a 96 month moratorium on loan principal payments when
                              other loan payments include interest and principal.

                          Finally, PCDC’s SBRLF loans are intended for for-profit
                          businesses, whereas UEDRARC is a non-profit entity.

                          Even though the PCDC Board of Directors awarded the loan,
 Board Members
                          individual members had reservations. Members of the PCDC
 Expressed Reservations
                          Board of Directors questioned UEDRARC’s ability to meet
 Concerning Loan
                          operating expenses for the building, let alone the additional
                          debt service burden for the project. In reviewing the

01-PH-241-1001                     Page 6
                                                                       Finding 1


                       application, the Board members noted that the prior owner of
                       the Project, who had similar aspirations for the building,
                       failed because the rent revenues generated were not sufficient
                       to cover the building’s high maintenance and operating
                       expenses. They questioned what had changed so drastically to
                       improve matters since the prior owner went into bankruptcy.

                       HUD Regulations at 24 CFR Part 85.12 recognized that
                       special provisions should be made for high risk recipients of
                       CDBG funds, and the UEDRARC Project clearly fell into this
                       category. HUD defined “high-risk” grantees as having a
                       history of unsatisfactory performance or being financially
                       unstable.      These provisions include:      payment on a
                       reimbursement basis; additional, more detailed financial
                       reports; and additional project monitoring. The UEDRARC
                       Project may have received heightened scrutiny because of the
                       risk, but this caution was eventually overcome.

                       To assuage Board member concerns, representatives of the
                       OHCD assured the PCDC Board that they had reviewed
                       UEDRARC’s financial information to support the loan
                       request and found it reasonable. Also, a Pennsylvania State
                       Senator, a member of PCDC’s and the applicant’s
                       (UEDRARC) Board of Directors, appealed to PCDC to find a
                       way to do the project rather than finding ways to turn it down.
                       Despite the reservations noted earlier, PCDC’s Board of
                       Directors ultimately approved the UEDRARC loan, but not
                       until OHCD agreed to increase PCDC’s level of CDBG
                       funding by the $550,000 loan amount.

                       The Pennsylvania State Senator planned to maintain a
Conflict of Interest
                       Senate office and a support office in the UEDRARC
                       building. PCDC asked the Philadelphia Divisional Deputy
                       City Solicitor for a legal opinion on this situation. The
                       Deputy City Solicitor stated that there was no conflict of
                       interest, provided UEDRARC leased the space at fair market
                       rents with comparable commercial terms, and the Senator
                       did not involve himself in the loan approval process.
                       Although the State Senator abstained from voting on the
                       project, he actively participated in the discussion preceding
                       PCDC’s Board of Directors’ vote. Though the Senator
                       eventually rented office space in the UEDRARC building at
                       rates comparable to other tenants, he clearly did not
                       disengage himself from the loan approval process.


                                Page 7                                 01-PH-241-1001
Finding 1



B.   Loan Monitoring

                        HUD Regulations at 24 CFR Part 85.40 require that grantees
 HUD Loan Monitoring
                        monitor grant and subgrant supported activities to assure
 Requirements
                        compliance with applicable Federal requirements and that
                        performance goals are being achieved. HUD Regulations at
                        24 CFR Part 570.501 stipulate that the grant recipient is
                        responsible for ensuring that CDBG funds are used in
                        accordance with all program requirements. The use of
                        designated public agencies, subrecipients, or contractors does
                        not relieve the recipient of this responsibility. The recipient is
                        also responsible for determining the adequacy of performance
                        under subrecipient agreements and procurement contracts.

                        PCDC established effective guidelines for overseeing the
 PCDC Loan Monitoring
                        progress of projects funded with PCDC loans and monitoring
 Guidelines
                        loan repayments. Specifically, PCDC Loan Policy and
                        Guidelines stipulate that the loan officer is responsible for
                        monitoring the repayment of loans and interacting with all
                        interested parties and departments. The Technical Assistance
                        Unit is to provide the Legal Department and Chief Loan
                        Servicer with written briefings, monitor project progress,
                        review financial statements, and recommend appropriate
                        actions. The Fiscal Department is to disburse funds as
                        requested by the loan officer and program manager, provide
                        the loan officer and program manager with bi-weekly status
                        reports of outstanding loans, receive payment from the
                        borrower, and make recommendations regarding the loan
                        portfolio. The Legal Department is to ensure borrower’s
                        compliance with regulations, initiate legal actions, assist in
                        monitoring of judgments and liens against borrowers, and take
                        other actions as appropriate.

                        Periodic financial statements from the loan recipient are
                        another valuable monitoring tool that PCDC’s procedures
                        required. PCDC’s Commitment Letter to UEDRARC, dated
                        March 21, 1995, required unaudited financial statements
                        within 30 days of the close of each calendar year. The
                        statements were to include balance sheet and profit and loss
                        statements.




01-PH-241-1001                   Page 8
                                                                       Finding 1


PCDC Relied On PIDC   PCDC did not employ its loan monitoring policy and
To Monitor Loan       procedures when administering the $550,000 SBRLF loan to
                      UEDRARC. Instead, PCDC relied on PIDC to monitor the
                      loan because PCDC did not have the resources necessary to
                      monitor a project of UEDRARC’s size and because PCDC’s
                      loan was subordinate to much larger PIDC financing.
                      Unfortunately, due to outside pressure and its desire to see the
                      project succeed, PIDC did not effectively monitor the Project
                      or take available default actions, which jeopardized PCDC’s
                      financial interest. Also, although PCDC guidelines required
                      that the loan officer monitor the loan repayment, PCDC
                      removed their loan officer from involvement in the process
                      and turned the payment approval process over to their Vice
                      President - Legal. PCDC did not enforce the terms of their
                      loan agreement requiring annual financial statements and did
                      not require a final audit of the Project’s construction costs.
                      The variable funding methods (advances and reimbursements)
                      used to finance the UEDRARC Project, received from
                      multiple sources (PCDC, PIDC, Commonwealth of
                      Pennsylvania, and Meridian Bank) heightened the need for a
                      final audit of construction costs.

                      UEDRARC defaulted on its loan immediately. PCDC’s
UEDRARC Loan
                      initial loan disbursement took place in October 1995, and
Payment History
                      UEDRARC’s first loan payment to PCDC was due in
                      December 1995. UEDRARC did not make its first payment
                      on the PCDC loan until January 23, 1997. As of March 13,
                      2000, UEDRARC had been delinquent 50 of 53 months of the
                      loan term, with arrears to March 13, 2000 totaling $22,496.01.
                      Though UEDRARC was in default of their PCDC loan, and
                      did not make their first loan payment until January 1997,
                      PCDC continued to disburse additional loan funds to
                      UEDRARC through September 1998. It appeared that PCDC
                      continued to disburse the funds while UEDRARC was in loan
                      default because it hoped UEDRARC would eventually
                      improve financially, and PCDC did not want to jeopardize the
                      Project by withholding loan funds. A PCDC official informed
                      us that these were the reasons PCDC did not take more
                      aggressive actions when UEDRARC went into loan default.

                      The Loan Policy and Guidelines listed a schedule of actions
Default Procedure
                      PCDC would take in the event of a loan default. These
Guidelines
                      guidelines included providing technical assistance, deferring
                      principal or interest payments, restructuring the loan, calling
                      in the note, obtaining a pledge of additional collateral, and

                               Page 9                                  01-PH-241-1001
Finding 1


                          legal action as alternatives in the event of a loan default.
                          Also, HUD Regulations at 24 CFR 570.501 specified that
                          grant recipients take appropriate action when performance
                          problems arise.

                          When UEDRARC defaulted on their loan, PCDC did not take
 PCDC Response to
                          full advantage of the recourses available to them in their Loan
 UEDRARC Default
                          Policy and Guidelines and loan agreements with UEDRARC.
                          They sent letters requesting payment and restructured the loan
                          to recover delinquent interest payments, but these measures
                          were ineffective. PCDC recently established a committee to
                          help UEDRARC with its loan repayment problems.
                          However, PCDC has yet to analyze UEDRARC’s financial
                          condition to determine its ability to make loan payments or
                          prospects to become current at some future date. We believe
                          PCDC did not act more forcefully when UEDRARC
                          defaulted on the loan because of outside pressure and the
                          desire to see the Project succeed.

C.     Loan Maintenance

                          HUD provides CDBG funds for many purposes. Grantees use
 Future Prospects for
                          the funds to achieve any one of three national objectives. One
 UEDRARC
                          of the CDBG national objectives is the prevention or
                          elimination of slum and blight conditions. UEDRARC met a
                          CDBG national objective by eliminating a slum and blight
                          condition. However, though UEDRARC was successful in
                          achieving this national objective, UEDRARC’s ability to
                          sustain this success in the long term as a viable project is
                          questionable. Further, by failing to pay back its CDBG loans,
                          UEDRARC continues to tie up funds that should be available
                          for other projects.

                          If new funding becomes available, UEDRARC plans to
                          continue renovating the remainder of its building to bring in
                          new tenants and thereby increase revenue. The increased
                          revenue is necessary if UEDRARC is to pay off its long-term
                          debt. Our review indicated that UEDRARC currently lacks
                          the resources to complete renovations to the building.
                          Furthermore, UEDRARC’s present operations do not generate
                          sufficient rental income to cover its long-term debt and
                          operating expenses. UEDRARC’s financial operations over
                          the last 17 months, from January 1999 through May 2000, are
                          summarized below:


01-PH-241-1001                     Page 10
                                                                Finding 1


                                               Monthly            Total
                                               Average
                 Expenses w/out loan pmt 1/      $139,354.97    $2,369,034.49
                 Plus, Loan Payment      2/         36,890.09      627,131.53
                 Expenses with loan pmt 1/        176,245.06     2,996,166.02
                 Less, Revenue           1/       151,572.20     2,576,727.40
                 Arrears                          $ 24,672.86   $ 419,438.62


                1/ Revenue and expense amounts were obtained from
                   UEDRARC’s accounting system and are unaudited.
                   Expenses included utilities, payroll, and maintenance
                   costs.

                2/ Amount includes payments to PCDC and PIDC.

                UEDRARC’s average monthly rent revenue covered its
                average monthly operating costs, but was not sufficient to also
                cover the required monthly loan payments to PCDC and
                PIDC. UEDRARC has experienced a $24,672.86 shortfall in
                average monthly revenue. Over the 17 month period the
                shortfall amounted to $419,438.62. Due to UEDRARC’s
                loan history and its current financial condition, it appears
                unlikely that UEDRARC will be able to obtain the funding
                necessary for the remaining planned renovations. Without
                this funding and the resultant expected increase in revenue
                from new tenants, it does not appear likely that UEDRARC
                will be able to successfully pay off its long-term debt and
                continue operations.

                Although PCDC’s effort to eliminate a slum and blight
                condition is admirable, it appears PCDC made a questionable
                loan decision in UEDRARC’s case. As a result of PCDC’s
                loan decision, it appears PCDC will eventually have to write
                off the loan to UEDRARC, depriving other applicants of
                needed funds.


                PCDC shared our concern that UEDRARC faces challenges
PCDC Comments   to sustaining its success. However, they disagreed with our
                assessment of PCDC’s participation in and their approval
                process for the UEDRARC Project, stating they served as a
                conduit for funding at the City of Philadelphia’s request and
                direction. They stated that their September 23, 1993 Board
                meeting established requirements for UEDRARC to provide a
                sound fiscal and management plan for the Board’s review,

                        Page 11                                 01-PH-241-1001
Finding 1


                     before the full Board would approve funding for the Project.
                     They stated the report mischaracterized the Board’s decision
                     not to refer the Project to the Loan Committee as an effort to
                     bypass the Loan Committee. They stated that the four
                     members of the Loan Committee are members of the Board,
                     and were present and voted in favor of funding the Project at
                     the September 23, 1993 meeting. They also stated that the
                     Chairman of the Board, who is also the Chairman of the Loan
                     Committee, was present when the full Board unanimously
                     approved the loan to UEDRARC at its August 3, 1994
                     meeting.

                     PCDC also disagreed with our conclusion that the
                     UEDRARC loan terms were unusually favorable. They stated
                     that although the terms of the loan were favorable, the senior
                     lenders’ (a group of local banks) loan structure dictated PCDC
                     only charge UEDRARC interest for ten years at 3 ¼ percent
                     per year for the PCDC loan. The stated terms were necessary
                     for the Project’s financial success.

                     Further, PCDC disagreed that the State Senator participated in
                     the loan approval process. They stated that he abstained from
                     voting on the UEDRARC Project at both meetings and did
                     not actively participate in the Board’s discussions of the loan.
                                                             Executive Summary


 OIG Evaluation of   PCDC’s SBLRF guidelines stipulate that PCDC’s Loan
 PCDC’s Comments     Committee is responsible for reviewing loan applications and
                     approving the loans. In the case of UEDRARC, the PCDC
                     Vice President for Lending recommended rejecting the
                     application based on perceived cash flow problems.
                     Subsequently, the application was presented directly to the
                     Board of Directors without ever going to the Loan Committee,
                     in effect bypassing the Loan Committee. We found no
                     documentation in minutes to any of the Board’s meetings or
                     elsewhere explaining why PCDC presented this application to
                     the full Board instead of to the Loan Committee. The minutes
                     to the September 23, 1993 meeting state the final commitment
                     of funding will be contingent upon the Board of Director’s
                     review and approval of a sound fiscal and managerial plan for
                     the Project. All four members of the Loan Committee were
                     present and voted to approve, in principal, the commitment of
                     funds for the UEDRARC Project, pending review of a fiscal
                     and managerial plan for the Project. However, at the August

01-PH-241-1001                Page 12
                                                                 Finding 1


                  3, 1994 meeting, when the Board approved the loan, the only
                  Loan Committee members present were the Chairman of the
                  Loan Committee and PCDC’s President. The two remaining
                  members of the Loan Committee were absent, and there was
                  no indication that they had reviewed the fiscal and managerial
                  plan. Because of the size of this Project and the impact it
                  would have on PCDC, as stressed by PCDC’s management
                  during numerous discussions with OIG staff, it appeared
                  unusual that PCDC would vote on a loan of this magnitude
                  without the full Loan Committee’s participation.

                  We do not dispute the fact that the terms of the UEDRARC
                  loan were necessary to the Project’s financial success. Our
                  purpose was to state the fact that compared to other PCDC
                  loans and PCDC’s SBRLF guidelines, the UEDRARC loan
                  was unusually favorable in terms of the loan amount, interest
                  rate, and principal moratorium.

                  The minutes to both Board meetings state the State Senator
                  abstained from voting on the UEDRARC Project. However,
                  the minutes and the notes for the minutes to the August 3,
                  1994 Board meeting clearly state that the State Senator
                  participated in the Board’s discussion prior to the vote. As
                  mentioned in the finding, the Philadelphia Divisional Deputy
                  City Solicitor stated that there was no conflict of interest
                  provided the Senator did not involve himself in the loan
                  approval process. Clearly, by participating in the discussion
                  leading to the Board’s vote, the Senator placed himself in a
                  conflict of interest position.



Recommendations   We recommend that HUD direct PCDC to:

                  1A.    Explain and document, in the applicable loan file, all
                         waivers to loan approval and administration policies
                         and procedures regarding the UEDRARC loan.

                  1B.    In the future, adequately explain and document, in
                         the corresponding loan files, the reasons for waivers
                         to the policies and procedures that govern its CDBG
                         funded loan programs.

                  1C.    Require UEDRARC to obtain an audit of the project
                         construction costs which accounts for funds provided
                         to the project from all funding sources including,

                          Page 13                                01-PH-241-1001
Finding 1


                        PCDC loans, PIDC loans, State of Pennsylvania
                        Grant Funds, and any other public and private funds
                        loaned, donated, or granted to the project.

                 In the event that UEDRARC’s default eventually causes
                 PCDC to write off the loan as uncollectable, we recommend
                 that HUD direct the City of Philadelphia to:

                 1D.    Repay to the City’s CDBG Program, with non-
                        Federal funds, the loan portion written off as
                        uncollectable.




01-PH-241-1001           Page 14
Management Controls
Management controls consist of a plan of organization and methods and procedures adopted by
management to ensure that resource use is consistent with laws, regulations, and policies.
Management controls include the processes for planning, organizing, directing, and controlling
program operations. They contain the control environment for risk assessment, information
systems, control procedures, communication, and measuring and monitoring program performance.


                                    In planning this audit, we evaluated the PCDC management
 Relevant Management
                                    controls related to our objectives to determine our audit
 Controls
                                    scope and procedures. We determined the following
                                    management controls were relevant to our audit objectives:

                                    •   Loan approval policy and procedures to ensure PCDC
                                        evaluated the feasibility of the UEDRARC Project,
                                        including whether the UEDRARC Project: was an
                                        effective use of CDBG funds; affected a national
                                        objective; and had the financial wherewithal to sustain
                                        its operations;

                                    •   Loan administration and accounting policy and
                                        procedures to ensure PCDC had the systems and controls
                                        to oversee the project and used the controls to monitor
                                        the project and account for the funds provided; and

                                    •   Policies and procedures to ensure that PCDC
                                        administered HUD funds in accordance with applicable
                                        laws, HUD regulations, loan documents, and other
                                        directives.

                                    A significant weakness exists if management controls do not
 Significant Weaknesses
                                    give reasonable assurance that resource use is consistent
                                    with laws, regulations, policies, and resources are
                                    safeguarded against waste, loss, and misuse.

                                    Our audit disclosed the following significant weaknesses:

                                    •   PCDC’s Board of Directors overrode loan approval
                                        policy and procedures to provide a loan with unusually
                                        favorable terms to a financially risky project (see Finding
                                        1).

                                    •   PCDC did not observe loan administration policies and
                                        procedures, including monitoring requirements and
                                        default procedures (see Finding 1).


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Management Controls




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01-PH-241-1001                       Page 16
Follow Up On Prior Audits
This is the first audit of PCDC’s funding of the UEDRARC Project by HUD’s Office of Inspector
General.




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Follow Up On Prior Audits




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01-PH-241-1001                      Page 18
                                          Appendix A


Auditee Comments




                             Executive Summary
                   Page 19                 01-PH-241-1001
Appendix A




                           Executive Summary
01-PH-241-1001   Page 20
                          Appendix A




          Executive Summary



Page 21                  01-PH-241-1001
Appendix A




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01-PH-241-1001                  Page 22
                                                                                Appendix B


Distribution
Director, Office of Community Planning and Development, 3AD
Secretary’s Representative, Mid-Atlantic, 3AS (Acting)
Audit Liaison Officer, 3AFI
Departmental Audit Liaison Officer, FM (Room 2206)
Deputy Chief Financial Officer for Finance, FF (Room 2202)
Director, Office of Budget, FO (Room 3270)
Acquisitions Librarian Library, AS (Room 8141)
The Honorable Fred Thompson, Chairman, Committee on Governmental Affairs, 340 Dirksen
       Senate Office Building, US Senate, Washington, DC 20510
The Honorable Joseph Lieberman, Ranking Member, Committee on Governmental Affairs, 706
       Hart Senate Office Building, US Senate, Washington, DC 20515
Ms. Cindy Fogleman, Subcommittee on Oversight and Investigations, Room 212, O’Neil House
       Office Building, Washington, DC 20515
Director, Housing and Community Development Issue Area, US GAO, 441 G Street, N.W.,
       Room 2474, Washington, DC 20548, Attn: Stanley Czerwinski
The Honorable Dan Burton, Chairman, Committee on Government Reform, 2185 Rayburn
       Building, House of Representatives, Washington, DC 20515
The Honorable Henry Waxman, Ranking Member, Committee on Government Reform, 2204
       Rayburn Building, House of Representatives, Washington, DC 20515
Mr. Steve Redburn, Chief, Housing Branch, Office of Management & Budget, 725 17th Street,
       N.W., Room 9226, New Executive Office Building, Washington, DC 20503
President, Philadelphia Commercial Development Corporation, 1315 Walnut Street, Suite 600,
       Philadelphia, PA 19107
Principal Staff




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