oversight

The City's Housing Program and the Role of the Housing Economic Development Financial Corporation, City of Kansas City, Missouri

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-08-11.

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

                                             Issue Date
                                                     August 11, 2004
                                             OIG Audit Case Number


                                                          2004-KC-1005
                                             CAO Project Number
                                                               12-2004




         TO:        William Rotert, Director, Office of              Wayne Cauthen, City Manager
                      Community Planning and                           City of Kansas City, Missouri
                      Development, 7D

                      /signed/                                        /signed/
         FROM:       Ronald J. Hosking, Regional Inspector           Mark Funkhouser, City Auditor
                       General for Audit, 7AGA                          City of Kansas City, Missouri


         SUBJECT:   The City’s Housing Program and the Role of the Housing and Economic
                    Development Financial Corporation, City of Kansas City, Missouri

                                            HIGHLIGHTS

          What We Audited & Why

                    The HUD Office of Inspector General and the City Auditor have issued two previous
                    joint reports on Kansas City’s housing programs. The first, Special Report: Kansas
                    City Needs a Housing Policy (April 2000), assessed the City’s overall approach to
                    providing affordable housing. The second, Review of Subrecipient Selection,
                    Monitoring and Reporting (July 2001), evaluated the City’s methods for
                    administering HUD funds in accordance with applicable rules. The reports
                    recommended the City develop a housing policy, including strategies and goals,
                    develop mechanisms for gathering information on housing conditions, and
                    strengthen processes for selecting and monitoring subrecipients.

                    Our prior work raised concerns about the Housing and Economic Development
                    Financial Corporation (HEDFC), the City’s largest subrecipient of federal
                    housing funds. Consequently, our original objective for this audit was to determine
                    whether HEDFC is using grant funds efficiently and effectively. However, while
                    planning the audit we concluded that the City continued to face problems we
                    found in our previous audits. Therefore, we expanded our audit scope to review
                    the City’s overall system for implementing housing policy and HEDFC’s role




Table of Contents
                    within the system. Accordingly, our sub-objectives were to answer these
                    questions:

                          •   What is the City’s system for implementing housing policy?
                          •   What is HEDFC’s role in the system?
                          •   How well has HEDFC carried out its role in the system?
                          •   Could changes in the system improve the City’s performance and ability
                              to meet its housing goals?

          What We Found


                    The federal government, City government and non-governmental agencies each
                    play a role in the City’s housing system, but no one party controls spending
                    decisions or is held accountable for housing production or meeting other goals.
                    The City spends a lot of money on housing – in fiscal year 2003 the Department
                    of Housing and Community Development paid vendors and contractors over $34
                    million – but the outcomes of the City’s investment are not readily apparent. The
                    City’s failure to set measurable objectives and its fragmented system for
                    administering housing funds contribute to higher than necessary administrative
                    costs; lack of information; poor communication; delays; and lack of
                    accountability for poor performance.

                    In addition, the City has failed to adequately define HEDFC’s role in providing
                    affordable housing. The scopes of work in the City’s contracts with HEDFC are
                    broad and the performance standards are vague. Consequently, the City’s
                    Housing and Community Development Department – which is responsible for
                    overseeing the contracts – and HEDFC have disagreed about whether
                    expenditures or activities are appropriate. By entering into vague contracts the
                    City cedes decisions about use of public funds to HEDFC and cannot fulfill its
                    responsibilities as a recipient of federal grant funds.

                    There are significant deficiencies in HEDFC’s operations: HEDFC lacks processes
                    for tracking and reporting operational and financial information; its computer
                    systems aren’t integrated; duplicate data are entered into several systems, which staff
                    does not reconcile; HEDFC’s policies and procedures don’t address tracking and
                    reporting information about the different types of loans or projects; supporting
                    documents for construction loans were not readily accessible, files contained
                    multiple copies of some documents, while some files and documentation were
                    missing altogether. We also found errors in the single family production report
                    presented to the Board and in a loans closed report prepared for us. These
                    deficiencies contribute to poor system performance and a lack of assurance that the
                    City is getting the best results for its money. Since HEDFC is an integral component
                    of the City’s housing program, financial and operational problems result in not just
                    underperformance for HEDFC, but for the system as a whole.


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                    The City needs to change its system to improve its ability to address housing
                    needs. A number of studies in recent years – including our previous joint audits –
                    have made recommendations to improve the City’s processes for administering
                    housing funds and HEDFC’s internal processes. However, serious problems
                    remain. We believe that the problems are systemic and cannot be solved without
                    addressing the system as a whole. The City should redesign its structure to
                    simplify administration, reduce administrative costs, and improve performance
                    and accountability.

         What We Recommended

                    We recommend that the City Manager reevaluate and revise the city’s processes for
                    developing housing policy and administering housing funds. The City Manager
                    should consider bringing some of the functions in-house and competitively award
                    the remaining services. At a minimum, the City’s process should:

                       •   Identify and address housing needs using the housing condition study
                           performed by the University of Missouri – Kansas City, or a similar effort.
                       •   Establish measurable goals and objectives.
                       •   Base funding decisions on specific, pre-identified needs.
                       •   Track and report annual progress in meeting the housing goals.
                       •   Incorporate specific scopes of work, goals and measurements in all contracts.
                       •   Develop monitoring procedures that ensure all entities receiving funding are
                           held accountable for meeting specific objectives.
                       •   Identify and “in-source” all functions that City staff can efficiently
                           perform.
                       •   Competitively award all services not performed in-house.

                    The City Manager should also require HEDFC to repay the $900,000 in Beacon Hill
                    program income it used without authorization and to repay the $600,000 balance
                    of the Westside Business Park Section 108 loan.

                    We recommend that the Director of HUD’s Office of Community Planning and
                    Development ensure the City develops and implements the procedures necessary to
                    ensure an effective and efficient housing program, and recovers from HEDFC the
                    $900,000 in Beacon Hill program income it used without authorization and the
                    $600,000 balance of the Westside Business Park Section 108 loan.




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          Findings and Recommendations
          Discussed


                     We provided discussion drafts of our audit report to the City Manager, the president
                     of HEDFC, and the regional director of HUD’s Office of Community Planning and
                     Development; and held exit conferences with HEDFC and the City Manager on July
                     6, 2004 and July 27, 2004 respectively. HEDFC and the City Manager provided
                     written comments to our findings on July 12, 2004 and July 14, 2004 respectively.
                     We revised the report where appropriate based on their comments. The complete
                     text of the comments and our evaluations of those comments are contained in
                     Appendices C and D.




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                                      TABLE OF CONTENTS

         Highlights                                                                                1

         Background                                                                                6

         Results of Audit
               1: The City’s system for administering housing funds is fragmented and too complex. 8

               2: The City has not clearly defined HEDFC's role in implementing housing policy.   21

               3: HEDFC’s operational deficiencies contribute to poor system performance.         28

         Objectives, Scope and Methodology                                                        37

         Internal Controls                                                                        38

         Follow-Up On Prior Audits                                                                40

         Appendices
            A. Practices in Other Cities                                                          41

            B. Schedule Of Questioned Costs And Funds To Be Put To Better Use                     44

            C. City Manager Comments and Auditor Evaluation                                       45

            D. HEDFC Comments and Auditor Evaluation                                              48

            E. Kansas City, Missouri Housing Survey Map                                           75

            F. Schedule of Payments to HEDFC By Fund, Contract Year Paid, and
                 Calendar Year Funds Were Encumbered                                              76




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                                                    BACKGROUND

         The City receives funds for housing and community development from the U.S. Department of
         Housing and Urban Development (HUD). The City uses the funds to assist eligible individuals
         to obtain housing; to construct or rehabilitate affordable housing; to redevelop blighted
         neighborhoods; and to create business and employment opportunities. The City’s Department of
         Housing and Community Development administers housing funds on behalf of the City,
         primarily by contracting with not-for-profit agencies. The Housing and Economic Development
         Financial Corporation (HEDFC) is the City’s largest subrecipient of housing funds.

         HEDFC is a not-for-profit organization incorporated in Missouri to receive and administer funds
         primarily to combat community deterioration and to secure adequate housing. HEDFC was formed
         in 1997 through a merger of the Housing Development Corporation and Information Center
         (HDCIC) and the Rehabilitation Loan Corporation (RLC). HEDFC’s articles of incorporation
         provide for designing, constructing, repairing, remodeling and removing structures; conducting
         housing related research; providing technical assistance to not-for-profit corporations; making loans
         or grants; acquiring, maintaining, managing, selling or transferring real or personal property;
         entering into contracts; borrowing or raising money; and investing its funds. A nine-member Board
         of Directors governs HEDFC. Board members serve 3-year terms. Successors are nominated and
         elected by the Board. By-Laws require a majority of Board members to be residents in investment
         areas, or members of targeted populations eligible to receive benefits of the corporation’s programs,
         but who are not direct or indirect recipients of program benefits.

         HEDFC, or its predecessor organization HDCIC, has been the City’s designated subrecipient of
         federal housing and community development funds for 29 years. The City contracts with HEDFC
         annually to provide loans and grants to eligible homebuyers; loans and grants for construction and
         rehabilitation of affordable housing; and economic development services. The City provided
         HEDFC with $52.2 million in fiscal years 2001 through 2003.1

         Exhibit 1. City Payments to HEDFC June 1, 2000, through May 31, 2003
          Fund                                                  2001            2002              2003
          Economic Development Initiative                  1,775,329       2,972,912           4,507,672
          Section 108 Loan Guarantee                       3,449,837       6,502,437          14,896,689
          CDBG                                             1,683,406       4,652,907           2,262,580
          HOME                                             2,618,528       4,135,242           2,752,399
          Total                                            9,527,100      18,263,498          24,419,339
         Source: City’s financial system.




                        Exhibit 2. City Payments to HEDFC by Fund 2001-2003

         1
             HEDFC’s fiscal year runs from June 1 through May 31.

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                         Economic Development                $8,598,892                 $9,255,913
                         Initiative
                         Section 108 Loan
                         Guarantee
                                                       $9,506,169
                         HOME

                         CDBG
                                                                                       $24,848,963

                    Source: City’s financial system.


         In addition, the City authorizes HEDFC to use program income, which includes payments of
         principal and interest on loans, proceeds from the sales of loans, proceeds from the sale or long-term
         lease of equipment or real property, and interest earned on program income. Use of program income
         is restricted to the purposes of the original grant. HEDFC collected $12 million in program income
         in fiscal years 2002 and 2003. City staff were unable to provide program income records for fiscal
         year 2001.

         Exhibit 3. Program Income Collected by HEDFC June 1, 2000, through May 31, 2003
          Fund                                                2001              2002                    2003
          CDBG Program Income                          Unavailable         4,548,475                 5,185,914
          HOME Program Income                          Unavailable         1,051,131                 1,223,560
          Total                                        Unavailable         5,599,606                 6,409,474
         Source: Summary of Federal Cash Transactions reports provided by Housing and Community Development.




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                                           RESULTS OF AUDIT

          Finding 1: The City’s System For Administering Housing Funds Is Fragmented And
          Too Complex


         The City still lacks an integrated strategy for implementing housing policy. We recommended in
         April 2000 that the City develop a clear, comprehensive housing policy including strategies and
         desired outcomes. The City took some steps toward assessing housing needs but has not yet
         developed a clear strategy for defining, identifying, and addressing housing needs. The current
         system for administering housing funds involves the federal government, City government and non-
         governmental agencies, but no one party controls spending decisions or is held accountable for
         housing production or meeting other goals. Under this fragmented system, the City awards federal
         grant funds to entities without a way to assess whether the system is fulfilling overall policy goals.
         Even if funds are used for eligible activities, the City hasn’t established a process to ensure that
         funds are used effectively.

         This fragmented system, combined with a lack of measurable goals and objectives, contributes to
         higher than necessary administrative costs; lack of information; poor communication; delays; and
         lack of accountability for poor performance. In short, the City’s system provides little assurance that
         the money it pays to vendors and contractors, which was $34 million in fiscal year 2003, will meet
         its housing needs.


         The City still needs a strategy to address housing needs and measurable
         goals to determine whether the strategy is working

                        We recommended in our April 2000 report that the City develop a clear,
                        comprehensive housing policy including strategies and desired outcomes. The City
                        took some steps toward assessing housing needs – the Mayor convened a task force
                        to develop policy recommendations, which the City Council adopted, and the City
                        contracted with the University of Missouri – Kansas City to conduct the 2001
                        Housing Assessment Survey. However, the City has not yet developed a strategy for
                        defining, identifying and addressing housing needs. The City’s 2003 Consolidated
                        Plan is not significantly different than the 1999 Consolidated Plan. The plan does
                        not specify measurable goals or objectives. It states how much money is expected by
                        source but contains no specific actions that are to be undertaken to achieve the City’s
                        housing goals. City staff told us they did not use the housing assessment data to
                        compile the plan.

                        The City Council adopted a housing policy. Following our 2000 audit, the
                        Mayor convened a committee of 33 people associated with various aspects of
                        housing development and asked them to discuss and make recommendations for a
                        new housing policy for Kansas City. The committee met from September to
                        November 2001 and wrote a proposed policy that defined some broad goals,

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                        policies, and outcomes. These provide broad criteria for evaluating housing
                        programs, but don’t identify specific, quantifiable benchmarks, nor do they target
                        efforts to the City’s most pressing needs. The City Council adopted the policy in
                        Resolution No. 011428.

                        Housing condition survey collected detailed information. The City collected
                        detailed information about housing conditions in 2001. The City contracted with
                        the Center for Economic Information at the University of Missouri-Kansas City to
                        conduct the 2001 Housing Conditions Survey. The survey rated residential
                        housing conditions by parcel, including the roof, foundation and walls, windows
                        and doors, exterior paint, sidewalks and drives, lawns and shrubs, and litter. In
                        total, this effort detailed the condition of about 85,000 parcels of property.

                        The City paid $316,000 for the study, but did not use it in developing or
                        administering the housing plan. See Appendix D for the map of the Kansas City,
                        Missouri, Neighborhood Housing Conditions Survey.

                        Housing plan did not significantly change. Despite these efforts, the City’s
                        2003 Consolidated Plan is not significantly different from the 1999 Consolidated
                        Plan.2 The City’s 2003 Consolidated Plan still does not specify measurable goals
                        or objectives. The plan states how much money is expected by source but
                        contains no specific actions that are to be undertaken to achieve the City’s
                        housing goals. The 2003 Consolidated Plan is consistent with the broad goals
                        described in Resolution No. 011428, but emphasizes community development
                        activities more than the Resolution, which emphasizes housing activities.
                        Housing Department staff told us that they did not use the 2001 survey condition
                        data in compiling the 2002 and 2003 consolidated plans. The acting director said
                        that they did try to use the data to target CDCs in certain census tracts in the 2004
                        plan.

         The City’s system for implementing housing policy is fragmented and
         complex


                        The City’s system for implementing housing policy is fragmented and too
                        complex. The federal government, City government and non-governmental
                        agencies each play a role in the City’s housing system, but no one party controls
                        spending decisions and entities are not held accountable for housing production or
                        meeting other goals. The flowchart on the following pages illustrates in detail
                        how this process works.


         2
          Kansas City Missouri’s 1999 Consolidated Housing and Community Plan; Approved by HUD May 1999, and
         Kansas City Missouri’s 2003 Consolidated Housing and Community Plan; Approved by HUD on May 2003.




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Exhibit 4. Kansas City’s Process for Implementing Housing Policy
      CPD                  City Finance                                    Neighborhood &                          DHCD
                                                         City                                                                                                      HEDFC
  (HUD Office of           Department                                          Housing              (Department of Housing & Community                 (Housing & Economic Development
Community Planning         (Office of Management        Council             Development                        Development)                                  Financial Corporation)
                                 & Budget)
 and Development)                                                            Committee                                                    Start
                                                                          Resolution is           Kansas City Housing Policy established
                                                                          approved, amended,      through:
Consolidated                                                              or rejected                  • FOCUS                                       HEDFC Contract Rehab apps approved
Plan is reviewed                                   The Consolidated                                    • U.S. Census Data
and approved.                                      Plan is approved                                    • Assessment of housing conditions           The contract assigns HEDFC to
                                                   and sent to the City                                • Resolution No. 011428                      carryout various “special projects”
                                                   Manager & Mayor                                                                                  (i.e. Beacon Hill, 18th and Vine,
                                                   for approval.                                                                                    etc.), provide technical assistance to
Letter is sent to                                                                                                                                   CDCs & act as a lender for both
the City indicating                                                                            The housing policy is used as a guide to             CDCs and Homebuyers.
that the                                                                                       develop Requests for Proposals (RFPs)
Consolidated Plan                                                                              in anticipation of how KC’s housing                   HEDFC assists the CDCs in
is approved.                                                                                   needs can best be met.                                drawing up applications for
                                                                                                                                                     financial assistance.
                                                                                                                                                     A “Commitment Letter” is
                                                                                               RFPs are communicated to the general                  issued indicating the amount of
                                                                                               public via, classified ads, public meetings           funds HEDFC will provide
                                                                                               (held @ City Hall), & the Citizen                     (usually 20% of the total cost)
                                                                                               Participation Guide.                                  and the number of units that
                                                                                                                                                     will be “taken out”.
                                                                                               Applications are scored according to
                                                                                               certain criteria stated in the Citizen
                                                                                               Participation Guide.                                           HOME          CDBG
                      Encumbrances are
                      recorded for costs                                                                                                                     Program      Program
                      outlined in the                                                          Recommendations are made to the                                Income       Income
                      Consolidated Plan                                                        Neighborhood & Housing and Development                       Program income must be
                      & Administrative                                                         Committee (based on the application scores)                         used first.
                      Contracts                                                                in the form of a resolution (basically a draft
                      .                                                                        of the consolidated plan).

                                                                                                                                                               Is there enough
                                                                     The Consolidated          The consolidated Plan is modified to reflect                       HOME or
                                                                     Plan is reviewed          the approved resolution.                                No     CDBG program         Yes
                                                    Consolidated     and presented to                                                                          income to cover
                                                    Plan is approved the City Council
                                                                                               By tradition (29 years), HEDFC is the                          the expenditure?
                          City Treasury             by the City      for approval.             City’s designated subrecipient for
CDBG Funds                                          Manager &
                                                                                               administering housing and economic
                                                    Mayor and sent
HOME Funds                                                                                     development activities funded by CDBG,
                                                    to CPD for final
                                                                                               HOME and other sources. HEDFC’s
                                                    approval.
                                                                                               Contract is drafted and sent to the                     May use    Must use
                                                                                               Neighborhood Housing and Development                   HOME funds CDBG funds
                                                                                               Committee for review.
                     Periodically the                                     Contracts are
                     City draws down                Contracts are         approved by the
                     funds from CPD to              approved.             committee and
                                                                                                                                                                 Homebuyer’s
                     reimburse the City                                   sent to the full                                                                     income is > 80%
                     Treasury.                                            Council for          Administrative Contracts for CDCs                        No                         Yes
                                                                                                                                                                 of the median
                                                                          approval.            & CBOs are drafted and sent to the                                    income
                                                                                               Neighborhood Housing and
                                                                                               Development Committee for review.


                                                                                               The Consolidated Plan and administrative                            Application
                                                                                                                                                              No                 Yes
                                                                                               contracts go into effect (usually June 1st).                        approved?
                                                    City Ordinances
                                                    are passed putting                                                                                       End
                                                    the Consolidated                           Data is entered into the IDIS system for                                    Draw Request
                                                                                               projects approved in consolidated plan.             HOME or CDBG            reviewed and
                                                    Plan &
                                                                                                                                                   entitlement funds       approved.
                                                    Administrative
                                                                                               Monitoring of HEDFC, CDCs, CBOs                     may be used.
IDIS system is                                      Contracts into
used to receive                                     effect.                                                                                                    Loan Committee reviews
and track project                                                                              Performance results related to the
                                                                                                                                                               the application
information                                                                                    consolidated plan are reported to CPD
submitted by      Expenditures are                                                             via the IDIS system.                                                Underwriting
DHCD.             recorded.
                                                                                               Draw requests reviewed and approved.                                    Homebuyer
                  Draw requests are
                                                                                               Payment to HEDFC is authorized.                     Entitlement         applies for 2nd
                  paid.
                                                                                                                                                   funds are           mortgage.
 Consolidated                                                                                                                                      requested
 Annual                                                                                                                                            from the City   Loan/Grant
 Performance and                                                                                                                                                   Proceeds are paid
 Evaluation Report                                                                                                                                                 to the borrower.
 (CAPER) is
                                                                                               Consolidated Annual Performance and
                                                                                               Evaluation Report (CAPER) is                                        Take Outs repay
 reviewed.                                                                                                                                        Payment received the other financial
                                                                                               submitted to CPD.
                                                                                                                                                  from the City    institution.
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     Exhibit 4 Continued.
         CDCs                                  LISC                       CBOs                  Other Financial                  Contractors /             Homeowners,
   (Community Development                                             (Community Based            Institutions                     Builders               Renters, Buyers,
                                          (Local Initiative                                                                    (i.e. Dean Claig, Gary
       Corporations)                                                    Organizations)        (i.e. Douglas Bank, Century                                  and Realtors
                                        Support Corporation)                                          Bank, etc.)                    Gable, etc.)


        Applications                   Applications               Applications                                               Apply for construction      Homeowners apply
                                                                                             Loan application is                                         at HEDFC for
        submitted in                   submitted in               submitted in                                               financing
                                                                                             reviewed:                                                   rehabilitation in
        response to RFPs               response to RFPs           response to RFPs           -Credit Check                                               order to improve
                                                                                             -Underwriting                                               their current living
                                                                                             -Verify Commitment Letter        Loan proceeds are used
                                                                                                                              to start construction.     conditions.
    Approved applicants               Approved applicants        Approved applicants         -Property is appraised
    are required to submit            are required to            are required to
    required                          submit required            submit required                                              Construction starts
    documentation to the              documentation to the       documentation to the                                                                     Renters apply for
                                                                                                                              Construction complete.      multifamily units
    City.                             City.                      City.
                                                                                                         Loan                                             created by CDCs /
                                                                                               Yes Approved? No                                           contractors.
                                                                                                                              The newly constructed
  Approved Administrative            Approved Administrative Approved                                                         units are inspected &
  Contract.                          Contract.               Administrative                                        End        reappraised.                Realtor should
                                                             Contract.                                                                                    check to see if the
                                                                                                                              Temporary Certificate of    homebuyer qualifies
   Housing       Other Activities Private funds are                                         Loan proceeds are paid to         Occupancy is attained.      for a “program
   Activities      & Services                                         Services are                                                                        unit”.
                                  raised locally                      performed.            borrower (either the CDC
                                                                                            or Builder).
  Development planning for                                                                                                   “Program units” are
  Single Family and/or Multi-             Matched with                                                                       ready to be sold (single
                                          nationally             Performance reports are                                                                   Realtor
  family units.                                                                                                              family) or leased
                                          raised funds.          submitted to DHCD as
                                                                                                                             (multifamily).
                                                                 required by contract
   Builder is selected                                                                                Construction
                                     LISC increases CDCs                                               Financing
  Development Plans are
  finalized. Acquisition &           capacity by making low
  Construction costs are             interest loans available.                                                                                            Homebuyer
                                                                                                       Mortgages                                          decides to
  determined
                                      Technical assistance                                                                                                purchase a
  Application for “Gap                provided to CDCs                                                                                                    “program unit”.
  Financing” (unusual site
  development costs plus any
  “Non-Mortgageable Costs”
  according to HOME & CDBG
  regulations) and “Take-Outs”
  (if unit is not sold within 20 days
  of the certificate of occupancy,
  HEDFC will pay off the loan).
                                                                                                                                                         Homebuyer applies
                                                                                                                                                         for a 1st mortgage
                                                                                                                                                         (80% of the sale price
                                                                                                                                                         of the home) at other
                                                                                                                                                         financial institution
                                                                                                                                                         & 2nd mortgage
                                                                                                                                                         (20% of the sales
            Does the CDC need to                                                                                                                         price) at HEDFC (in
            provide construction                                                                                                                         no particular order).
  Yes         financing for the      No
                  builder?



                                                                                                                                                             1st Mortgage
  Apply to other financial
                                                                                                                                                             2nd Mortgage
  institution to cover the “Hard
                                                                                              Loan application is
  Costs” of construction (usually
                                                                                              reviewed:
  80% of the total cost)
                                                                                              -Credit Check
                                                                                              -Underwriting
  CDCs utilize realtors to market                                                             --Verify   Commitment Letter
  the newly finished units
  Submit “Draw Request” in
  order to “Take Out” the
                                                                                                         Application
  Loan.                                                                                         Yes                  No
                                                                                                         approved?
                              No “take out”
                              necessary                                                                              End
          Unit sells within
           20 days of the                                                                  Loan Proceeds (80% of
            certificate of                                                                 the sale price) are paid to       The construction loan is
            occupancy?                                                                     the borrower                      repaid. HEDFC now holds
                                                                                                                             the note receivable.
                                      Monitoring efforts by DHCD
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                    Many parties are involved in the system. The federal government, City Council,
                    City departments, HEDFC, Community Development Corporations, and private
                    financial institutions and builders each play a role in implementing the City’s
                    strategy for addressing housing needs.

                    The federal government, City Council and City departments primarily provide
                    money, set policy and monitor policy implementation:

                    Exhibit 5. Government Roles in Administering Housing Funds
                     Agency                          Roles
                     HUD Office of Community         Responsible for approving the City’s Consolidated
                     Planning and Development        Plan, tracking project information in the IDIS system,
                     (CPD)                           making CBDG and HOME funds available to the City,
                                                     and reviewing the Consolidated Annual Performance
                                                     Evaluation Report (CAPER).
                     City Council                    Responsible for adopting the City’s Consolidated Plan
                                                     and approving City contracts for more than $250,000.
                     Neighborhood & Housing          Hears testimony on the staff’s proposed Consolidated
                     Development Committee (a        Plan and contracts and may amend the Plan or
                     standing committee of the City  contracts before passing them out of Committee for
                     Council)                        the full Council to consider.
                     City Housing and Community      Responsible for developing the Consolidated Plan,
                     Development Department          drawing up contracts, monitoring subrecipients and
                                                     contractors, and submitting the CAPER to HUD. The
                                                     department also disburses funds to CDCs, LISC,
                                                     CBOs for administrative costs, and to HEDFC for
                                                     administrative and program costs in accordance with
                                                     the Consolidated Plan and individual contracts.
                     City Finance Department         Responsible for encumbering funds for costs outlined
                                                     in the Consolidated Plan.
                    Source: Interviews with City Council members, HUD staff; reviewing related documents.




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                    Non-government agencies receive government funds to implement policies and
                    monitor implementation:

                    Exhibit 6. Private and Non-Profit Organizations’ Roles in Administering Housing Funds
                     Agency                             Roles
                     Housing and Economic               Acts as a lending institution for both CDCs and
                     Development Financial              homebuyers. Also responsible for providing technical
                     Corporation (HEDFC)                assistance to CDCs, promoting economic
                                                        development, and carrying out “special projects”:
                                                        large scale developments for which CDCs can’t
                                                        perform.
                     Community Development              Neighborhood-based not-for-profit organizations that
                     Corporations (CDCs)                work to revitalize their communities through new and
                                                        rehabilitated housing, commercial development,
                                                        neighborhood organizing, and a variety of residential
                                                        services.
                     Local Initiative Support           National not-for-profit corporation that provides grants,
                     Corporation (LISC)                 loans and equity investments to CDCs for
                                                        neighborhood development. LISC is based in New
                                                        York and operates in thirty-seven major cities across
                                                        the U.S., including Kansas City. National LISC
                                                        matches locally raised funds. The CDCs then
                                                        designate the funds to a variety of projects in their
                                                        respective neighborhoods.
                     Community Based                    Perform a variety of services for the community such
                     Organizations (CBOs)               as child development and senior citizen center
                                                        activities. CBOs generally do not perform housing-
                                                        related services, but may receive funding through the
                                                        Consolidated Plan.
                     Other Financial Institutions       Provide construction loans to CDCs and contractors in
                                                        addition to home loans to homebuyers.
                     Contractors/Builders               Build and rehabilitate houses under contract with
                                                        HEDFC or CDCs.
                    Source: Interviews with City Council members, HUD, Housing Department, HEDFC, LISC and CDC
                    staff; reviewing related documents.


                    Each year, the City develops an approved consolidated plan for implementing
                    housing policy. The process involves the City seeking proposals, identifying the
                    proposals that will be funded, submitting its plan to HUD for review, and then
                    funding the projects. Exhibit 7 summarizes how the City develops and implements
                    its annual plan.




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                    Exhibit 7. Developing and Implementing Kansas City’s Annual Consolidated Plan
                     Agency           Activity                                        Output
                     Housing          The Housing Department develops a               Request for Proposals
                     Department       request for proposals, based on Forging
                                      Our Comprehensive Urban Strategy,
                                      census data, the 2001 housing condition
                                      assessment, and housing policy goals
                                      adopted by council resolution.
                     CDCs, CBOs, Respond to the RFP with proposals.                   Proposals
                     general
                     contractors
                     and LISC
                     Housing          Reviews proposals, scoring them based on        Draft resolution for
                     Department       criteria from the Citizen’s Participation Plan. City Council
                                                                                      consideration
                     City Council     Considers and may amend the draft               Draft consolidated
                                      resolution.                                     plan as an adopted
                                                                                      resolution
                     Mayor and        Review and approve the adopted                  Draft approved
                     City Manager     consolidated plan.                              consolidated plan
                     HUD              Reviews the City’s consolidated plan.           Letter accepting the
                                                                                      consolidated plan
                     City Council     Considers the consolidated plan.                Consolidated plan
                                                                                      adopted by ordinance
                     Housing          Drafts contracts to fund administrative costs Draft contracts
                     Department       of organizations that submit proposals.
                     Housing          Drafts a contract with HEDFC, which, by         Draft contract
                     Department       tradition, doesn’t submit a proposal.
                     City Council     Considers and approves draft contracts by       Contracts approved by
                                      ordinance if the contract amount exceeds        ordinance.
                                      $250,000.
                    Source: Interviews with City Council members, HUD, Housing Department, HEDFC, LISC and CDC
                    staff; reviewing related documents.


                    The City doesn’t systematically identify needs. Instead of the City targeting
                    housing needs to address, the contractors and subrecipients drive this process because
                    the contractors and subrecipients determine which projects will be performed by
                    submitting their proposals. An effective process would have the City identify its
                    needs, then identify projects to address those needs, and then contract with parties that
                    can complete the projects.

                    The City hasn’t established clear lines of authority and responsibilities. The
                    fragmented system creates duplicate efforts, increasing costs and confusion. For
                    example, CDCs have to apply separately for administrative and program costs. CDCs
                    apply to the City for administrative costs then apply to HEDFC for program funding.
                    This duplicate effort can lead to confusion about who a CDC is accountable to. City
                    staff told us they have few options for addressing poor performance. HEDFC
                    management told us they’ve been forced to pay off CDC construction loans that
                    should never have been made. Exhibit 8 summarizes the construction and
                    rehabilitation process for single family homes.


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                     Exhibit 8. Constructing and Rehabilitating Single Family Housing
                      Agency           Activity                                       Output
                      Housing          Makes payments to CDCs and HEDFC               Payments
                      Department       based on contracts.
                      CDCs             Apply to HEDFC for financing projects          Development plans;
                                       included in consolidated plan                  agreements with
                                                                                      builders.
                      HEDFC            Reviews feasibility, provides technical        Commitment letter
                                       assistance if needed, determines grant
                                       financing necessary to cover “unusual”
                                       costs of construction in the urban core.
                      CDCs             Use commitment letter to obtain financing      Draw request to
                                       from a bank; begins project, submit invoices HEDFC;
                                       or requests for reimbursement to HEDFC as Periodic progress
                                       work progresses.                               reports to the Housing
                                                                                      Department
                      HEDFC            Reviews and approves draw requests.            Payments to vendors
                                       HEDFC is required to use CDBG and              and reimbursements
                                       HOME program income first, before              to CDCs
                                       requesting additional grant funds.
                      HEDFC            HEDFC requests funds from the City if          Request entitlement
                                       program income is insufficient to cover        funds from City
                                       expenditures.                                  Housing Department
                      Housing          Reviews HEDFC’s monthly financial reports Payments to HEDFC
                      Department       and bank statements. Reviews CDC
                                       progress reports.
                      CDCs             Once construction is completed, apply to       Draw request to
                                       HEDFC for “take-out” of loan.                  HEDFC
                      HEDFC            Approves payment.                              Pays construction
                                                                                      loan; holds mortgage
                                                                                      on property.
                      CDC              Markets and sells house. Provides the          Sales price
                                       sales price to HEDFC prior to closing.
                      HEDFC            Calculates difference between outstanding      Amount due on loan
                                       loan and sales price; writes off difference if
                                       house sells for less than amount due.
                      Buyer            Pays HEDFC at closing                          Payment
                     Source: Interviews with City Council members, HUD, Housing Department, HEDFC, LISC and CDC
                     staff; reviewing related documents.


                     Federal grant funds are awarded to entities in the system without a way to
                     determine whether the system is fulfilling the City’s goals. Even if funds are used
                     for eligible activities, the City hasn’t established a process to ensure that funds are
                     being used effectively.

         Fragmented, complex system increases costs, weakens accountability


                     The fragmented system along with a lack of clear performance goals contributes to
                     high administrative costs; lack of information and poor communication; delays;
                     lack of accountability; and creates an environment in which there is friction and
                     “finger-pointing” among the major players. Without clear performance criteria for

                                                        15


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                         making funding decisions and holding entities accountable, the City's system is
                         driven by the agencies that receive the money. Private agencies make decisions
                         about the use of public funds rather than the City.

                         Administrative costs are increased. According to HEDFC's audited financial
                         statement and the City's financial management system, the Housing Department
                         and HEDFC spent over $4.9 million on administrative costs in fiscal year 2003,
                         not counting the CDCs' administrative costs paid through city grants.
                         Administrative costs amounted to more than 40 percent of CDBG and HOME
                         funds for the year. Clearly defined lines of authority and areas of responsibility
                         would help ensure that administrative costs are held to a minimum, resulting in
                         more funds being available to address the City’s housing needs.

                         Decision makers lack adequate information. The City Council still lacks timely
                         and accurate information to make decisions. Council members told us that the
                         Housing Department provides information to the City Council’s Neighborhood
                         Development and Housing committee but the information has been inaccurate and
                         untimely and reports don’t reconcile. In addition, Council members are concerned
                         that the Housing Department and/or HEDFC have, in some cases, approved
                         funding for much larger amounts than originally approved by the Council. We
                         also reported in our July 2001 report that City housing officials did not provide the
                         City Council with adequate information to support decisions in awarding HUD
                         funds.

                         The Comprehensive Annual Performance Evaluation Report (CAPER) – required
                         by HUD to monitor the use of funds – provides inadequate information to assess
                         system performance. For example, the annual report doesn’t show the number of
                         units produced or the cost per unit, information that is readily available in annual
                         reports we reviewed from other cities.3 HEDFC management told us they have
                         this information, but the annual report is not their responsibility. HEDFC
                         management provided us with this information separately, but we couldn’t verify
                         its source.4

                         The lack of accurate information also contributed to the City’s $4.8 million
                         shortfall in CDBG and HOME programs in early 2004. The Housing Department
                         overestimated program revenue, and then the City appropriated funds based on
                         overstated revenues. Weaknesses in the Housing Department’s budgeting and
                         reporting processes exacerbated the problem, as the Housing Department hadn’t

        3
          We reviewed information from Boston, MA; Minneapolis, MN; Cleveland, OH; Indianapolis, IN, Springfield, MO;
        and St. Joseph, MO. We selected these cities because regional HUD directors identified them as having well
        performing systems for administering housing funds and their housing stocks are similar in age to Kansas City. We
        intended to compare Kansas City’s production and performance to these cities, but could not due to lack of
        information about Kansas City’s performance.
        4
          HEDFC staff provided unit and cost information in emails dated April 26, 2004, and May 3, 2004. Staff said that
        the data were from the 2001-2002 CAPER. We could not find similar information in the most recent (2002-2003)
        CAPER. The cost figures staff provided were not consistent with the total amount of payments HEDFC received
        from the City or with expenses reported in HEDFC’s audited financial statements.
                                                               16


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                          been held accountable to the City’s normal budgetary controls. For example, the
                          former City manager did not include Housing Department funds in formal
                          quarterly financial analyses. The City’s Office of Management and Budget
                          considered housing funds to be “continuing funds” and did not require an annual
                          reappropriation of unexpended funds. Therefore, the shortfall wasn’t found and
                          corrected. About $18 million that the City paid to HEDFC in contract year 2002-
                          03 was actually encumbered between January 1996 and December 2001. See
                          Appendix E for a schedule of funds paid by contract year and the year they were
                          encumbered. KPMG conducted a performance audit, released April 2004, to
                          determine the amount of the shortfall. KPMG made a number of recommendations
                          to the City to improve internal and external reporting, grants monitoring and
                          contracting and reimbursement processes.

                          Stakeholders complained of slow payments. CDCs, banks and HEDFC all
                          complained to us about slow payments:
                             • CDCs and vendors complained to us about slow payments from HEDFC.
                                We saw files with invoices submitted more than once and loans paid off
                                more than 60 days after approval. Delaying loan pay offs increases interest
                                costs needlessly.
                             • Representatives from three of four banks we talked to said they don’t work
                                with HEDFC because of slow turnaround time.
                             • HEDFC complained to us about slow payments from the City.

                          Untimely draw downs. The City’s single audits in the past three years have cited
                          untimely draw downs of federal funds as a concern. The City’s untimely draw
                          downs result in borrowing from other City funds or incurring unnecessary interest
                          costs and other fees. For example, the City’s decision to draw down funds from a
                          line of credit for the Beacon Hill development rather than using federal funds
                          resulted in up to $82,500 in unnecessary stand-by fees. While the interest incurred
                          is similar to the amount that would have been incurred using federal funds, the
                          stand-by fees are specific only to the line of credit financing.5

                          The system weakens accountability. The fragmented system weakens overall
                          accountability because control of spending and accountability for housing
                          production is not clearly defined. For example, the Housing Department doesn’t
                          hold CDCs accountable for poor housing production. Program managers haven’t
                          consistently completed quarterly monitoring reports. Staff had not done 2003
                          quarterly reports for 3 of the 6 CDCs we reviewed. Housing Department
                          management told us they have few options for addressing poor performance and
                          that the City Council will fund agencies regardless of performance.




        5
          The $10 million line of credit incurs a “stand-by” fee of 15 basis points due quarterly on the undrawn portion of the
        line of credit. Therefore, HEDFC is currently holding the $10 million dollar line of credit open at a cost of $7,500
        per quarter. From the time the loan was established (10/26/2001) through the current quarter (06/30/2004), that is a
        maximum expense of $7,500 per quarter for 11 quarters, or $82,500.
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                     HEDFC’s practice of “taking out” loans is another example of weakened
                     accountability. Upon approving a project, HEDFC provides the CDC with a
                     commitment letter to pay the bank. The CDC uses the commitment letter to get
                     private financing. HEDFC then pays off (“takes-out”) the loan three weeks after
                     the certificate of occupancy is issued if the house hasn’t sold. The “take-out”
                     practice rewards CDCs even if they’ve built housing that is less desirable. CDCs
                     lack the financial incentive to market the homes once the loan is taken out because
                     they no longer owe the bank. HEDFC management told us that they perform take-
                     outs to improve CDCs’ credit to allow them to obtain more financing. HEDFC
                     management also told us that the practice of take-outs has resulted in paying for
                     loans that should never have been made. As a result, homes are built or
                     rehabilitated but sell slowly. In December 2003, HEDFC had an inventory of 30
                     unsold homes (see also Finding 3).

                     Environment of mistrust. We observed “finger-pointing” and friction between
                     City and HEDFC staff. In interviews, staff from the City and HEDFC blamed each
                     other for problems. Back-and-forth correspondence between City and HEDFC
                     staff indicated a lack of responsiveness and delayed responses to requests for
                     information. In some cases the City and HEDFC had disagreements about
                     documentation and ownership of property. Staff also dispute responsibilities, with
                     HEDFC staff taking on responsibilities the City staff believe are their own and
                     vice versa.



         The City is required to have an adequate system

                     The City is responsible for using federal housing funds to achieve City goals and
                     national objectives. Federal regulations allow cities flexibility in deciding how to
                     spend HUD grant funds within established guidelines. However, federal
                     requirements also dictate that “Governmental units are responsible for the efficient
                     and effective administration of Federal awards through the application of sound
                     management practices… Each governmental unit… will have the primary
                     responsibility for employing whatever form of organization and management
                     techniques may be necessary to assure proper and efficient administration of
                     Federal awards.”

                     These requirements also stipulate that “a cost is reasonable if, in its nature and
                     amount, it does not exceed that which would be incurred by a prudent person
                     under the circumstances prevailing at the time the decision was made to incur the
                     cost. The question of reasonableness is particularly important when governmental
                     units or components are predominately federally-funded.”




                                                      18


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        The City must improve its system


                     A number of studies in recent years have raised concerns about the City’s
                     processes or HEDFC’s processes and made recommendations for improvement. In
                     the past, the City justified not changing the structure because an attorney in the
                     City’s Law Department had provided an oral opinion that the City was prohibited
                     from directly administering a loan program. The Law Department issued a written
                     opinion in October 2003 that the City is not prohibited from making loans as long
                     as there is a public purpose before public funds are loaned; the funding source
                     permits such a loan; and a recipient such as a CDC has empowered itself to receive
                     or use the loan funds for the purposes for which the loan is made.

                     We conclude that the City’s problems are systemic and cannot be solved without
                     addressing the system as a whole. The City should redesign its program to
                     simplify administration and/or reduce layers, as well as reduce costs.

        Recommendations


                     1A. We recommend that the City Manager reevaluate and revise the city’s
                         processes for developing housing policy and administering housing funds.
                         The City Manager should consider bringing some of the functions in-house
                         and competitively award the remaining services. At a minimum, the City’s
                         processes should:

                         •   Identify and address housing needs using the UMKC housing condition
                             study or a similar effort.
                         •   Establish measurable goals and objectives.
                         •   Base funding decisions on specific, pre-identified needs.
                         •   Track and report annual progress in meeting the housing goals.
                         •   Incorporate specific scopes of work, goals and measurements in all contracts.
                         •   Develop monitoring procedures that ensure all entities receiving funding are
                             held accountable for meeting specific objectives.
                         •   Identify and “in-source” all functions that City staff can efficiently
                             perform.
                         •   Competitively award all services that City staff does not perform.

                     1B. We recommend that the HUD Director, Office of Community Planning and
                         Development ensure the City develops and implements the procedures necessary
                         for an effective and efficient housing program. These changes should ensure that
                         the City’s processes:

                         •   Identify and address housing needs using the UMKC housing condition
                             study or a similar effort.

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                    •   Establish measurable goals and objectives.
                    •   Base funding decisions on specific, pre-identified needs.
                    •   Track and report annual progress in meeting the housing goals.
                    •   Incorporate specific scopes of work, goals and measurements in all contracts.
                    •   Develop monitoring procedures that ensure all entities receiving funding are
                        held accountable for meeting specific objectives.
                    •   Identify and “in-source” all functions that City staff can efficiently
                        perform.
                    •   Competitively award all services that City staff does not perform.




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        Finding 2: The City Has Not Clearly Defined HEDFC's Role In Implementing Housing
        Policy


        The City has failed to adequately define HEDFC’s role in providing affordable housing. The scopes
        of work in the City’s contracts with HEDFC are broad and the performance standards are vague.
        Consequently, the Housing Department – which is responsible for overseeing the contracts – and
        HEDFC have disagreed about whether expenditures or activities are appropriate and about the
        disposition of program income.

        By entering into vague contracts, the City cedes decisions about use of public funds to HEDFC and
        cannot fulfill its responsibilities as a recipient of federal grant funds.


        Contracts don’t adequately define HEDFC’s role

                        The City contracts annually with HEDFC to service the $90 million portfolio of
                        loans made with CDBG and HOME funds, make loans to CDCs to carry out
                        construction and rehabilitation projects consistent with the Consolidated Plan,
                        provide technical assistance to CDCs, and make loans to eligible home buyers.
                        The scope of work described in the current contract is broad. Under its annual
                        contract with the City6, HEDFC is to provide:

                        (1) Housing Loan and Development Programs: administering CDBG and HOME
                        funded housing development activities in designated areas; administering and
                        processing loans for specific multi-family projects (Chambers and Hanover
                        buildings and others as approved by the Housing director); financing, monitoring
                        and providing technical assistance for specific development projects (Columbus
                        Park In-Fill); assisting in redeveloping certain sites (Troostwood); acting as project
                        manager for certain sites (Holy Temple Homes, Guinotte Manor); and providing
                        predevelopment activities and lending services for Beacon Hill.

                        (2) Economic Development Services: provide the necessary services as a lender
                        and administrator of federally funded loans and grants to carry out economic,
                        commercial and industrial projects including 18th and Vine Redevelopment and
                        Heritage Business Park Renovation.

                        (3) Public Facilities Services: provide funding as authorized to specific agencies
                        for renovation projects.

                        (4) Home Ownership Counseling Services: enter into a cooperative agreement
                        with the Family Resource Center to provide home ownership counseling services
                        to potential HEDFC clients.


        6
          Consolidated Community, Housing, and Economic Development Programs and Administration, June 1, 2003
        through May 31, 2004.
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                    (5) Administrative and Regulatory Services: administer the housing programs,
                    prior contract activities, and all active loans from prior periods in accordance with
                    policies and procedures and federal regulations. HEDFC is authorized to approve
                    or reject loan applications based on determination of eligibility. HEDFC is
                    authorized to determine the final disposition of defaulted loans, including
                    foreclosure on properties and managing or renting acquired real estate.

                    These services are broadly defined and do not include specific, measurable goals.
                    For the most part, it is not possible to trace in the contract the resources devoted to
                    a specific program activity and the expected outcomes for the year.

                    Eligible activities are broadly defined. The contract describes eligible HOME
                    program activities as including construction of new affordable homes, purchase
                    and rehabilitation of existing homes, and the development of affordable housing by
                    Community Housing Development Organizations (CHDO). The contract
                    describes eligible CDBG program activities as including maintenance of vacant
                    land and structures prior to disposition, home ownership counseling services,
                    housing rehabilitation, new housing construction, multi-family housing
                    development, economic development, public facilities services, and planning and
                    administration activities.

                    The City hasn’t established clear performance standards for HEDFC. The
                    contract outlines performance goals from the Consolidated Plan – noting that in
                    order to achieve the goals, HEDFC will need to receive adequate applications from
                    borrowers and CDCs in sufficient numbers – and requires monthly progress
                    reports to be submitted to the City. However, the performance goals are vague.
                    The contract sets goals for numbers of loans and units but because housing
                    production spans contract years, it’s not clear whether a unit is counted more than
                    once – when the loan is approved, while the unit is under construction, and again
                    when the unit is complete. Neither City Housing nor HEDFC staff could clarify
                    what the goal means without doing “further research.” HEDFC’s president told us
                    that the contract authorizes a certain amount of spending and it isn’t possible to
                    produce the number of units called for with the funding provided.


                    Exhibit 9. 2003 Activities and Goals
                     Program/Activity                                                 Goal
                     Rehabilitation Loan Program                                       35 Loans
                     Home Ownership Assistance Programs                               120 Loans
                     Targeted Rehabilitation of Vacant Homes & New Construction       180 Units
                     Downtown Multi-Family Housing                                     75 Units
                     Total Housing Units                                              410 Loans
                     End Loan Closings                                                155 Loans
                     Loan Processing                                                  165 Applications
                    Source: Non-Municipal Agency Funding and Services Contract Housing and Community
                    Development Department and Housing and Economic Development Financial Corporation
                    Consolidated Community, Housing and Economic Development Programs and Administration,
                    contract no. 2003-002.



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                     The City has also contracted with HEDFC for additional services. For example,
                     the City entered into a cooperative agreement with HEDFC in February 2000 to
                     implement the Beacon Hill Housing Development Project. Under the agreement,
                     which is referred to in the annual contract, HEDFC is to coordinate with the
                     Beacon Hill task force to monitor its selection of a master developer, assess the
                     feasibility of the project plan, and perform predevelopment activities including
                     acquiring property and demolishing structures consistent with the plan. The
                     agreement requires HEDFC to submit reports to the City, but doesn’t specify any
                     performance standards.

                     Roles aren’t clear to other stakeholders. While most stakeholders perceive that
                     HEDFC’s primary role is to provide low or no interest loans and grants to eligible
                     home buyers and to CDCs to rehabilitate or construct homes in targeted areas, the
                     City also contracts with HEDFC to acquire and develop properties. Almost 80
                     percent of the funding the City paid to HEDFC in the 2002-03 contract year was
                     for direct development activities – $14.8 million in Section 108 funds and $4.5
                     million Economic Development Initiative grants out of a total of $24.4 million.
                     However, HEDFC doesn’t have policies and procedures in place for conducting
                     development activities. Other stakeholders believe that HEDFC’s role as a
                     developer is inconsistent with their role as a lending institution.

        City Housing and HEDFC disagree about the appropriate use of funds
        and other program issues.

                     Because the contracts aren’t clear, City Housing staff and HEDFC have disagreed
                     about the appropriate use of program income and whether expenditures or
                     activities were appropriate. HEDFC believes it is authorized to make certain
                     decisions, but City Housing staff believes it is not. For example, Housing staff
                     questions the amount of money spent on the Beacon Hill project and the costs of
                     rehabilitating two houses within the project. HEDFC has responded that the costs
                     were authorized and the activities within the scope of their contracts.

                     HEDFC spent more than authorized by contract on Beacon Hill. The City’s
                     contract with HEDFC authorized spending $10 million in Section 108 loan
                     guarantee funds and $1.25 million in Brownfields Economic Development
                     Initiative funds to:
                         • acquire vacant and blighted structures;
                         • abate known environmental contaminants;
                         • demolish dangerous or obsolete structures;
                         • relocate displaced residents;
                         • construct new housing; and
                         • rehabilitate existing housing.

                     HEDFC spent about $12.2 million on the Beacon Hill development between May
                     4, 2000, and December 31, 2003. City records show that only about $300,000 has
                     been drawn down from the Brownfields fund. Housing staff questions where the
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                    additional $1.8 million spent came from. HEDFC’s monthly financial reports
                    show that HEDFC spent about $900,000 in Beacon Hill program income on the
                    project. However, neither the current annual contract nor the Beacon Hill
                    cooperative agreement authorizes HEDFC to spend Beacon Hill program income.
                    HEDFC management told us that they could not control the costs on the project
                    because the City’s Law and City Planning and Development departments were
                    responsible for condemnation proceedings and negotiating the costs of properties.

                    HEDFC spent about $600,000 to rehabilitate two houses within the Beacon
                    Hill project. HEDFC selected two single family homes on Tracy Avenue to
                    renovate as model homes. HEDFC’s president told us that the rehabilitation
                    projects, while more expensive than intended, are part of an overall plan that the
                    City’s Housing Department doesn’t yet see. He said that investors are interested in
                    the properties – which are not yet for sale – but in the meantime they serve as
                    educational laboratories for developers and investors to see how older homes can
                    be restored and learn what not to do in order to keep costs down.
                    Exhibit 10. These photos show the front and back of 2523 Tracy. HEDFC spent
                    $327,999 restoring the home.
                    (5/7/04)




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                    Exhibit 11. These photos show the front and back of 2518 Tracy. HEDFC spent
                    $263,835 restoring the home. (5/7/04)




                    Contracts authorized use of public funds to rehabilitate housing. HEDFC’s
                    general counsel and director of lending wrote an opinion that the rehabilitation
                    activities were eligible under federal regulations and authorized by the City under
                    the 2001 and 2002 Consolidated Plans, HEDFC’s annual contracts with the City
                    for 2001 and 2002, the cooperative agreement for the Beacon Hill redevelopment,
                    as well as CBDG eligibility and State Historic Preservation guidelines. The City’s
                    Law Department reviewed the opinion and concurred that the agreements provide
                    HEDFC authority to acquire and restore properties without restriction on costs.

                    HEDFC failed to fully repay the Section 108 loan for the Westside Business
                    Park. HEDFC was required to fully secure the $7.1 million Section 108 Westside
                    Business District loan from HUD. The loan was supposed to be secured through
                    property obtained and improvements made to that property. The property was sold
                    to a developer and the sales proceeds should have gone toward repaying the
                    Section 108 loan. After much delay, HEDFC repaid the City most of the loan
                    amount but has yet to pay the outstanding balance of $597,388.

                    Monitoring focuses on compliance not effectiveness. In the absence of clear
                    performance standards, City Housing staff focuses monitoring efforts on technical
                    financial compliance of detailed transactions by reviewing bank statements and
                    supporting documents for individual payments. This is time-consuming for City
                    staff and frustrating for HEDFC. HEDFC management told us that City Housing
                    staff is narrowly interpreting HUD regulations in requiring HEDFC to use program
                    income before drawing down federal funds and cite this requirement as one of the
                    primary causes of their cash flow problem. However, Housing staff perceives that
                    they have little control over how HEDFC spends funds.


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                     By entering into vague contracts the City cedes decisions about use of public funds
                     to HEDFC and cannot fulfill its responsibilities as grantee. As the grantee, the
                     City is responsible under federal regulations for ensuring that use of the grant
                     funds will meet national objectives and that subrecipients comply with applicable
                     federal requirements and that performance goals are being achieved.

        Unclear role prevents adequate assessment of HEDFC’s effectiveness


                     HEDFC’s unfocused mission and poorly defined performance goals prevent
                     meaningful assessment of whether the agency is performing effectively. Other
                     system stakeholders believe that HEDFC should solely act as a lender rather than
                     developer.

                     HEDFC’s primary role is lending. Most stakeholders perceive that HEDFC’s
                     primary role is to act as a lender. The president of HEDFC described its primary
                     mission as providing assistance to low-income families in Kansas City’s urban
                     core through a variety of programs including loans for rehabilitation, and
                     construction of new housing and economic development. He said that HEDFC
                     occasionally acts as a developer for the City for large-scale projects because other
                     agencies lack the skills and capacity to fulfill this role.

                     Most funding has been for development activities. Almost 80 percent of the
                     funding HEDFC received from the City in the 2002-03 contract year was for direct
                     development activities – $14.9 million in Section 108 funds and $4.5 million
                     Economic Development Initiative grants. However, HEDFC doesn’t have policies
                     and procedures in place for conducting development activities.

                     Exhibit 12. City Payments to HEDFC by Fund, June 1, 2002, through May 31, 2003


                                                   9%
                                                                     CDBG
                                                        11%
                                                                     HOME


                                                                     Economic Development
                                  62%                    18%         Initiative
                                                                     Section 108




                     Source: City’s financial system.


                     Stakeholders we talked to perceive that HEDFC’s primary role should be to act as
                     a lender. Representatives of area CDCs that we talked to said that HEDFC has
                     multiple roles, primarily lending and developing. Representatives of 4 of the 5
                     CDCs we talked to told us that HEDFC should act solely as a lender and that it is a


                                                          26


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                    conflict of interest for HEDFC to act as a developer because they, in effect, make
                    loans or grants to themselves.

                    The City needs to ensure that each entity in the system has clear roles and
                    responsibilities. The City should establish mechanisms for holding each entity –
                    including HEDFC – accountable. Each contract should specify the scope of work
                    agreed to and how the City will know that the agreed upon work was completed.



        Recommendations


                    We recommend that the City Manager:

                    2A    Require HEDFC to repay the $900,000 in Beacon Hill program income it used
                          without authorization.

                    2B    Require HEDFC to repay the $600,000 balance of the Westside Business Park
                          Section 108 loan.

                    2C    Ensure that the scopes of work and performance standards in all housing
                          contracts are sufficiently clear so that the City can effectively manage, monitor
                          and report on the contractor’s performance. Contracts should clarify how much
                          discretion the contractor may exercise in carrying out activities on behalf of the
                          City.


                    We recommend that the HUD Director, Office of Community Planning and
                    Development:

                    2D    Ensure the City recovers from HEDFC the $900,000 in Beacon Hill program
                          income it used without authorization and reprograms the money to be used
                          for eligible activities.

                    2E    Ensure the City recovers from HEDFC the $600,000 balance of the Westside
                          Business Park Section 108 loan and reprograms the money to be used for
                          eligible activities.

                    2F    Ensure the City structures its future contracts with clear scopes of work and
                          performance standards so that the City can effectively manage and monitor
                          contractor performance.




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            Finding 3: HEDFC’s Operational Deficiencies Contribute To Poor System Performance

        HEDFC lacks processes for tracking and reporting operational and financial information; its
        computer systems aren’t integrated; duplicate data are entered into different systems, which staff does
        not reconcile; policies and procedures don’t address tracking and reporting information about the
        different types of loans or projects; supporting documents for construction loans were disorganized
        and not readily accessible, some files and documents were missing, and we found errors in reports.
        Although several previous studies have recommended HEDFC improve its procedures for tracking
        and reporting operations, problems remain.

        HEDFC’s financial position is weak. Liquidity ratios and cash flow coverage ratios decreased while
        debt ratio increased between 2000 and 2002. HEDFC’s cash position improved in 2003 with
        increased funding, but cash flow coverage was negative in three of the five years we reviewed.
        HEDFC experienced high interest expense relative to net income in some years and income and
        expenses fluctuated. These ratios reflect HEDFC’s financial dependence on the City.

        Since HEDFC is an integral component of the City’s housing program, these problems result in not
        just underperformance for HEDFC, but for the system as a whole. The system failed to meet housing
        production goals for the year ending May 31, 2003. The city’s annual contract with HEDFC called
        for 190 "loans or units" of targeted rehabilitation of vacant homes or new construction, but only 54
        houses were sold or completed. The houses also took a long time to sell once completed.


        HEDFC operational controls and processes are deficient


                           There are significant deficiencies in HEDFC’s operations:

                                •    HEDFC’s financial audit wasn’t timely. HEDFC's financial audit for the year
                                     ending May 31, 2003, was issued July 1, 2004. The auditor issued a qualified
                                     opinion because the scope of audit work was limited by missing
                                     documentation. Federal regulations and City code require agencies receiving
                                     funds to complete financial audits.
                                •    The financial audit identified six reportable conditions, four of which were
                                     material weaknesses.7 Material weaknesses included payments to vendors of
                                     about $329,000 that the auditors could not trace to executed contracts or
                                     purchase orders, adjustments to accounting records during the audit
                                     amounting to about $26.4 million, and adjustments to accounting records to
                                     reduce receivables based on the auditor’s verification of information from
                                     third parties. The auditors also questioned whether the spending to restore the

        7
          Housing and Economic Development Financial Corporation Financial Statements Together With Independent
        Auditor’s Report for the Year Ended May 31, 2002. A reportable condition is a deficiency in the design or operation of
        an entity’s internal control structure that could adversely affect the entity’s ability to record and report financial data. A
        material weakness is a significant deficiency in which the design or operation of specific internal controls does not ensure
        that errors or irregularities material to the financial statements will be detected promptly by employees in the normal
        course of their work.
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                             houses on Tracy was eligible under federal regulations due to conflicting
                             documentation.
                         •   The corporation’s computer systems aren’t integrated; duplicate data are
                             entered into different systems, which staff does not reconcile.
                         •   The corporation’s policies and procedures don’t address tracking and
                             reporting information about the different types of loans or projects.
                         •   Supporting documents for construction loans are not readily accessible. Files
                             contain multiple copies of some documents, while some files and
                             documentation are missing altogether.
                         •   Some reports are inaccurate. We found errors in the single family production
                             report presented to the Board and in a loans closed report prepared for us.
                         •   Board reports vary in format and content – it is difficult to gather consistent
                             information, especially about multi-family or special projects.
                         •   HEDFC does not use detailed program budgets, or compare actual program
                             expenditures to budgeted expenditures.
                         •   Grant funds were commingled. HEDFC deposited four HOME entitlement
                             payments totaling $230,157 into the CDBG income account in fiscal year
                             2003. Federal regulations require separate HOME and CDBG accounts.
                         •   HEDFC did not consistently document periodic on-site inspections of work
                             performed.
                         •   HEDFC did not consistently complete monitoring reports required under
                             City contracts.
                         •   HEDFC does not maintain perpetual, real-time inventory of assets.
                         •   HEDFC does not compare its performance to benchmarks or standards.
                         •   HEDFC does not market its programs to targeted users.

         Previous studies have noted similar operational problems


                      Two recent consultant reports and our July 2001 performance audit raised
                      concerns about HEDFC’s internal processes. However, we continue to see
                      problems, including inaccurate reports, missing information, disorganized files,
                      lack of common accounting practices, and little tracking of production progress.

                      At the City’s request, the National Congress for Community Economic
                      Development (NCCED) studied HEDFC as part of a review and analysis of the
                      City’s affordable housing programs. NCCED reported in August 2001 that
                      HEDFC’s internal processes and procedures lacked administrative discipline and
                      compromised the organization’s participation in financial transactions. The report
                      also concluded that HEDFC’s management information systems and procedures
                      for tracking and reporting operations required significant improvements. The
                      report recommended simplifying and standardizing internal procedures, rewriting
                      the policies and procedures manual, eliminating duplicative processes, and
                      automating paper processes to the extent possible.



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                    In April 2002, BKD, LLP performed an operations review of HEDFC’s internal
                    procedures and information technology, and assessed communication, procedures
                    and reporting between HEDFC and the City. The review made several
                    observations and recommendations to HEDFC management about the
                    organization’s problems with tracking and reporting information. BKD noted
                    significant problems with loan documents being lost. Each department (within
                    HEDFC) tended to maintain a separate file related to their piece of a given project
                    or loan, resulting in multiple copies of some documents and other documents
                    getting lost.

                    The study reported a lack of standardized written procedures for day-to-day
                    processing. Each department (within HEDFC) developed its own procedures,
                    tracking mechanisms, and software without considering the organization as a
                    whole. HEDFC maintained an unnecessary and time-consuming cash availability
                    report on a daily basis. HEDFC entered loan disbursement and payment records
                    twice into their accounting system. Financial reports to HEDFC Board of
                    Directors did not include enough explanatory language. HEDFC failed to
                    accomplish proper and timely reporting as required by the City, contractual
                    obligations, and regulatory agencies. The report recommended HEDFC:

                       •   establish a process to identify and ensure that documents are properly filed;
                       •   adopt detailed, written standardized procedures;
                       •   reconcile the loan ledger to the general ledger at least monthly until an
                           integrated system is implemented;
                       •   clarify contract terminology and standardize reporting requirements; and
                       •   look for ways to eliminate or automate manual processes

                    While BKD provided management a discussion draft in April 2002, the report was
                    never finalized or released publicly. HEDFC management disagreed with most of
                    the observations and recommendations.

                    Previous management letters accompanying HEDFC’s financial audits in fiscal
                    years 1999 through 2002 noted issues related to management controls including
                    individual loan balances not reconciled to the general ledger, inadequate
                    documentation in loan files, out-dated policies and procedures manuals, and
                    inadequate separation of duties.

                    Our July 2001 performance audit also raised concerns about HEDFC’s lack of an
                    integrated management information system. We noted that HEDFC created
                    reports from the accounting system, at least two stand-alone databases, and several
                    stand-alone spreadsheets. Maintaining these systems required duplicate data entry,
                    increasing the risk of data errors. We didn’t make specific recommendations to
                    HEDFC, but recommended that the Housing Department develop procedures for
                    overseeing subrecipients, including guidance on validating reported progress
                    through on-site reviews.


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        HEDFC’s financial condition has declined


                     HEDFC’s financial position is weak. Liquidity and cash flow coverage ratios
                     decreased while the corporation’s debt ratio increased between 2000 and 2002.
                     HEDFC’s cash position improved in 2003 with increased city funding, but cash flow
                     coverage was negative in three of the five years we reviewed – operations consumed
                     more cash than they generated. HEDFC experienced high interest expense relative to
                     net income in some years, and net income fluctuated. HEDFC’s general and
                     administrative expenses have been high and consistently exceeded budgets. These
                     ratios reflect that HEDFC is financially dependent upon the City and may be unable to
                     survive funding delays.

                     Ability to cover short-term needs declined since 2000. The quick ratio has
                     declined since 2000. Days cash on hand declined in 2002 but increased in 2003.
                     Liquidity ratios focus on whether an organization has enough cash and/or other
                     liquid resources to meet its obligations in the near term.

                     Exhibit 13. Liquidity Ratios Fiscal Years 1999-2003
                                           1999         2000        2001      2002        2003
                      Quick                     6.3               9.4   4.1       1.8         1.3
                      Days cash on              244           328       243      123         286
                      hand
                     Source: Audited financial statements.


                     Ability to cover long-term obligations has declined since 2000. HEDFC’s debt
                     ratio increased, primarily due to a $10 million line of credit with Fannie Mae to
                     finance development activities at Beacon Hill. HEDFC paid off the line of credit
                     in 2003 with Section 108 loan guarantee funds. HEDFC’s cash flow coverage has
                     decreased since 2000 and was negative in three of the five years we reviewed,
                     indicating that operations consumed more cash than they generated. HEDFC’s
                     times-interest-earned ratio shows large fluctuations, reflecting large fluctuations in
                     net income. The times-interest-earned ratio in 1999 was below 1.0, indicating that
                     not enough income was available to pay interest expenses. Leverage and coverage
                     ratios focus on whether an organization can meet its long-term obligations – the
                     debt ratio compares debt to total assets; cash flow coverage and times-interest-
                     earned ratios focus on the ability to make payments on debt. Jointly, these ratios
                     provide a picture of an organization’s solvency. Decreasing coverage ratios and
                     increasing debt indicate that HEDFC is financially weak and dependent upon the
                     City for funds.




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                      Exhibit 14. Leverage and Coverage Ratios Fiscal Years 1999-2003
                                          1999       2000         2001        2002                         2003
                       Debt                       .01               .01           .05            .10            .10
                       Times-                    0.91          13.65           11.25           1.23             1.5
                       interest-
                       earned
                       Cash flow                 -3.8               3.3           -8.8        -12.8             1.7
                       coverage
                      Source: Audited financial statements.


                      HEDFC’s general and administrative expense ratio has been high but has
                      decreased as expenses have increased.

                      Exhibit 15. Administrative Expense Ratio Fiscal Years 1999-2003
                                             1999       2000          2001       2002                       2003

                       General and                  0.56            0.70           0.31          0.17           0.15
                       administrative
                       expenses
                      Source: Audited financial statements .


                      HEDFC has exceeded its administrative budget by increasing amounts since fiscal
                      year 1999. HEDFC’s chief financial officer told us that they cover costs through
                      non-federal sources including fees, other grants, or lines of credit. The City has
                      held HEDFC’s funding for administration relatively constant in recent years.

                      Exhibit 16. Comparison of Budgeted to Actual Administrative Expenses
                                          1999             2000            2001           2002           2003
                  Budgeted
                  Administrative        1,685,000       1,635,000         1,750,000      1,600,000      1,649,950
                  expense
                  Actual
                  Administrative        1,705,790       2,072,218         2,053,543      2,209,654      2,429,193
                  expense
                  Administrative
                  expense in               20,790          437,218         303,543        609,654        779,243
                  excess of budget
                      Source: Audited financial statements.




       The City failed to meet affordable housing production goals


                      The City, HEDFC, and local community development corporations failed to meet
                      housing production goals for the year ending May 31, 2003. The system achieved
                      less than a third of its housing production goal and multi-family housing was not
                      completed. Single family houses took a long time to sell, once they were
                      complete.

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                            The City’s housing system achieved less than a third of its housing production
                            goals. The City’s contract with HEDFC for the fiscal year ending May 31, 2003,
                            established a goal of 190 "loans or units" of targeted rehabilitation of vacant
                            homes or new construction. According to HEDFC’s Single Family Housing
                            Production Report, the agency working with local CDCs completed 54 houses.
                            The report lists an additional 37 addresses where construction is underway; 20
                            addresses with a status of application/underwriting; 12 addresses with a status of
                            planning and development; 1 site acquisition; and 1 contractor selected.

                            As we reported in July 2001, the housing production report combines information
                            from prior years as well as the current year, preventing analysis of whether
                            subrecipients met the yearly contracted performance standards. All of the units
                            listed as sold or completed in 2003 were started in a prior period. However, even
                            counting all of the projects listed regardless of when they were started, the system
                            produced well below the goal of 190 units.

                            Exhibit 17. Number of Single Family Homes
                            Sold or Completed During 2002-03 Contract Year
                             Project Status            Units
                             Sold/Closed                     32
                             Sold                             6
                             Sold-Under Foreclosure           5
                             Sold-Under Contract              1
                             Construction Completed          14
                                               Total         58
                                        Unduplicated         54
                            Source: Single Family Housing Production
                            Report June 1, 2002 through June 1, 2003
                            attached to Board minutes 6/19/03.


                            The number of days until sale is long. The houses are taking a long time to sell.
                            We selected a representative sample of 9 of the 54 houses reported as completed in
                            the year ending May 31, 2003. One of the houses has not yet sold, although a
                            certificate of occupancy was issued in November 2001. The median number of
                            days between when HEDFC approved the CDC’s application for financing and the
                            sale of the home was 466 days.8 The median number of days between when the
                            City issued a certificate of occupancy or final inspection and the sale of the home
                            was 293 days.




        8
            This figure excludes two of the nine addresses for which HEDFC could not provide an application for funding.
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                          Exhibit 18. Time to Produce and Sell a Sample of Homes
                                                                                                          Days
                                                                                                         Between
                                                                                                        Application      Days
                                                                                       Days             Approved        Between
                                                                                      Between              And         Certificate
                                                                                     Application        Certificate        Of
                                                                                     Approved               Of         Occupancy
                           Address                          Type of Project           And Sale          Occupanc        And Sale
                                                                                                             y
                           2012 Olive                   New Construction                    --9             --9                   -3
                           4141 Tracy                   Rehabilitation                            441            148             293
                           4409 Paseo                   New Construction                          273            218              55
                           4415 Paseo                   New Construction                          466            465               1
                                                                                                              10
                           5325 Swope                   New Construction                          528      --             --10
                           6200 Tracy                   Rehabilitation                            492            113             379
                           7205 Askew                   New Construction                    --9             --9                  308
                           3901 Forest                  Rehabilitation                         221         --10           --10
                           4016 E 16th Terrace          New Construction                     144311           54111          90211
                          Sources: HEDFC project files; Jackson County Tax and Real Estate records, City Codes
                          Administration Department records.

                          Exhibit 19. These photos show two front views of 4016 E. 16th Terrace. This house has
                          not yet sold although a certificate of occupancy was issued in November 2001 (4/23/04).




                          Public funding per unit varied. The amount of public funding and appraised
                          values of the houses we sampled varied. One of the houses received no public


        9
          HEDFC was unable to provide an application for funding for our review.
        10
           City records did not show a certificate of occupancy or final inspection date.
        11
           This house has not sold, the figures are time elapsed through May 12, 2004.
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                     funding; the maximum was $81,462. The median public funding per unit was
                     $18,736. The ratio of direct public funding to appraised value varies significantly.

                     Exhibit 20. Ratio of Direct Public Funding to Appraised Value for a Sample of Homes
                                                                           Ratio of Funding
                                                    Public     Appraise    to Appraised
                      Address                      Funding     d Value     Value
                      2012 Olive                       6,557     118,000       $1.00:$18.00
                      4141 Tracy                      81,462      43,329        $1.00:$0.53
                      4409 Paseo                      19,893     102,000        $1.00:$5.13
                      4415 Paseo                      20,453     103,000        $1.00:$5.04
                      5325 Swope                      18,736     108,104        $1.00:$5.77
                      6200 Tracy                      52,303      59,390        $1.00:$1.14
                      7205 Askew                      17,673      92,000        $1.00:$5.21
                      3901 Forest                          0      11,904 Not applicable
                      4016 E 16th Terrace              4,483     145,000       $1.00:$32.35
                     Source: HEDFC project, disbursement, and cash receipt files; Jackson County Tax and Real Estate
                     records.


                     Multi-family housing not completed. The City’s contract with HEDFC for the
                     fiscal year ending May 31, 2003, also called for 99 units (2 loans) of downtown
                     multi-family housing. We didn’t see any reports in the Board minutes that multi-
                     family housing was completed during the 2002-2003 contract year. HEDFC’s
                     president told us that they made the loans, but they can’t make the developer do
                     the work.

        HEDFC met the target for number of home ownership assistance loans,
        but not for rehabilitation loans

                     The City’s contract with HEDFC for the fiscal year ending May 31, 2003, set
                     performance goals of 120 home ownership assistance loans and 40 rehabilitation
                     loans. HEDFC made more home ownership assistance loans and fewer
                     rehabilitation loans than called for in the contract. HEDFC made 15 rehabilitation
                     loans and 134 home ownership assistance loans (118 HOME and 16 CBDG). The
                     CBDG loans were made to families/individuals with higher than 80 percent of the
                     median income. HEDFC increased the number of consumer loans closed in 2002-
                     03 over prior years.

                     Exhibit 21. Number of Loans Closed by Type and Contract Year, June1, 2000 – May 31,
                     2003
                      Contract       CDBG       HOME        HOPE     Rehab     UDAG        Total
                      Period
                      2000-01              29         68          1       10         5         113
                      2001-02              35         86          1       21                   143
                      2002-03              16        118                  15                   149
                      Total                80        272          2       46         5         405
                     Source: Loans Closed June 1, 2000 through May 31, 2003 report provided by HEDFC.

                     Contract doesn’t define loan servicing performance goals. The City contracts
                     with HEDFC to service the portfolio of loans made with CDBG and HOME funds.
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                    HEDFC staff provides a monthly report to the Board on delinquent loan payments.
                    HEDFC’s overall default rate - measured as the percent of outstanding loans
                    delinquent for 90 days or more – was 7.4 percent in fiscal year 2003, which is
                    higher than the national average of about 2 percent for FHA mortgages. We
                    excluded HOME loans from the calculation because these loans are converted to
                    grants once the homeowner has remained in the home for an established period of
                    affordability. HOME loan recipients are only required to repay the loan if they
                    move or sell the home before the period of affordability is up. HEDFC’s default
                    rate on second mortgages was much higher than the overall rate. The average
                    monthly percent of second mortgage loans delinquent for 90 days or more was
                    18.6 percent in fiscal year 2003. The bulk of the delinquent second mortgage
                    accounts were 180 days or more delinquent.

                    Exhibit 22. Average Percent of Loans Delinquent June 2002 – May 2003
                                                              Number of Days Delinquent
                     Type of Loan          30         60        90       120      150         180 &     Total
                                                                                               over     90+
                     Rehabilitation        5.15%      2.37%      0.92%      0.60%     0.72%    2.27%     4.51%
                     Second Mortgage      10.63%      3.25%      1.50%      0.69%     0.57%   15.83%   18.58%
                     Overall               6.28%      2.55%      1.04%      0.62%     0.69%    5.07%    7.42%
                    Source: Monthly Delinquency Reports June 2002 through May 2003.




        Recommendations


                    We recommend that the City Manager:

                    3A    Clearly define the packages of housing services the City plans to contract for
                          and develop a competitive process to award all housing contracts.

                          As we recommended in findings 1 and 2, the City Manager should develop clear
                          scopes of work, clear performance standards, and methods for monitoring
                          contractors’ performance. Once these processes are in place, the City should
                          not enter into contracts with HEDFC unless HEDFC demonstrates an ability to
                          perform the work and is selected through a competitive process.




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                               Objectives, Scope and Methodology
        Our overall audit objective was to determine whether the Housing and Economic Development
        Financial Corporation (HEDFC) is using grant funds efficiently and effectively. Our sub-
        objectives were to determine the City's system for implementing housing policy; to determine
        HEDFC's role in the City's system for implementing housing policy; to determine how well
        HEDFC has carried out its role in the City's system for implementing housing policy; and to
        determine if changes in the City's system for implementing housing policy could improve the
        City's performance and ability to meet its housing goals.

        To meet our audit objectives, we interviewed City and HEDFC staff and officials, representatives
        from Community Development Corporations, and other contractors. We reviewed selected City
        and HEDFC files, financial records and correspondence. We reviewed the City’s Consolidated
        Housing and Community Development plans for the past five years, and reviewed contracts,
        monitoring reports, accounting records, and payments. We also compiled performance data to
        compare with other cities.

        We performed audit work from September 2003 through April 2004. The audit covered the period
        for HEDFC’s fiscal year 2003, or from June 1, 2002 through May 31, 2003. We conducted the
        audit in accordance with generally accepted government auditing standards.




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                                       INTERNAL CONTROLS

        Internal Control is an integral component of an organization’s management that provides reasonable
        assurance that the following objectives are being achieved:

           •   Effectiveness and efficiency of operations;
           •   Reliability of financial reporting; and
           •   Compliance with applicable laws and regulations.

        Internal controls relate to management’s plans, methods, and procedures used to meet its mission,
        goals, and objectives. Internal controls include the processes and procedures for planning,
        organizing, directing, and controlling program operations, and the systems put in place for measuring,
        reporting, and monitoring program performance.

        Relevant Internal Controls


                       We determined the following management controls were relevant to our audit
                       objectives:

                           •   The City's controls over spending of federal housing funds.
                           •   HEDFC’s controls over personnel recruiting and training.
                           •   HEDFC’s controls over loan marketing, origination, approval, and servicing.
                           •   HEDFC’s controls over performance management and reporting.
                           •   HEDFC’s controls over financial recording, management, and reporting.
                           •   HEDFC’s controls over asset management and safeguarding.
                           •   HEDFC’s controls over loan / grant approval.

                       We assessed the relevant controls identified above.

                       It is a significant weakness if internal controls do not provide reasonable assurance
                       that the process for planning, organizing, directing, and controlling program
                       operations will meet an organization’s objectives.

        Significant Weaknesses


                       As noted in Finding 1, the City’s system for administering housing funds is
                       fragmented and overly complex.

                       As noted in Finding 2, the City has not clearly defined HEDFC's role in
                       implementing housing policy.

                       As detailed in Finding 3, the Housing and Economic Development Financial
                       Corporation (HEDFC) does not have adequate internal controls.
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        Separate Communication of
        Minor Deficiencies


                    No minor deficiencies were provided to the auditee.




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                            FOLLOW-UP ON PRIOR AUDITS

                    The HUD Office of Inspector General and the City Auditor have issued two previous
                    joint reports on Kansas City’s housing programs . The first, Special Report: Kansas
                    City Needs a Housing Policy (April 2000), assessed the City’s overall approach to
                    providing affordable housing. The second, Review of Subrecipient Selection,
                    Monitoring and Reporting (July 2001), evaluated the City’s methods for
                    administering HUD funds in accordance with applicable rules. The reports
                    recommended the City develop a housing policy – including strategies and goals,
                    develop mechanisms for gathering information on housing conditions, and
                    strengthen processes for selecting and monitoring subrecipients. As explained in
                    the body of this report, the conditions reported in those reports still exist.

                    We reviewed the BKD audit report dated April 12, 2002 and noted that HEDFC's
                    organizational structure lacks a cooperative team focus, and management has
                    failed to achieve a successful merger. Also, the report noted that after the merger
                    it appeared that many of the employees of RLC were made subordinate to
                    employees of HDCIC. Employees in the organization appeared to have lost sight
                    of why they are there and what the mission of the organization is.

                    We reviewed the NCCED report and noted that HEDFC's organizational structure
                    did not encourage communication between and among organizational units or
                    vertical integration of processes. The report described how each unit in the
                    organization appears to operate autonomously with little knowledge of what the
                    other units do or how the operation of one unit affects the operation of the other
                    with respect to processing applications or administering loans. Also, HEDFC's
                    mission is a combination of the missions RLC and HDCIC had before the merger.
                    These two missions were not the same. As a result, HEDFC's programs and
                    procedures tend to be relatively complicated.




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                                                                                               Appendix A
                                       Practices in Other Cities
        We reviewed procedures in several cities that HUD regional directors characterized as “models”
        to identify practices that could improve the City's performance and ability to meet its housing
        goals. Following are some examples of practices implemented by other cities that could be
        beneficial to Kansas City.

        Widespread input into needs assessment

                     The City of San Francisco has several committees that meet to discuss what areas of
                     the City have the greatest need for CDBG and HOME funds. The City then uses a
                     committee to determine what amount of money will be available for each area.

                     The City of Indianapolis determines housing needs by requesting Citizen
                     Participation through surveys and town meetings. The City prioritizes these needs
                     and reviews the five-year plan.

        Request for proposals from all subrecipients

                     The City of San Francisco requests proposals from various Community
                     Development Corporations (CDCs) and holds public hearings before granting the
                     CDCs any spending authority.

                     The City of Indianapolis puts together selection criteria and advertises requests for
                     proposals. The staff reviews the proposals in teams of three and makes
                     recommendations to the Director who then sends them to the Mayor and City
                     Council for final approval. After a public comment period, they submit the
                     approved requests to HUD.

                     The City of Boston issues a request for proposal that meets the requirements for
                     both City applications as well as state applications for funding. The applicant
                     submits the one-stop application to the City, which in turn submits it to the state.
                     This process takes place twice per year; once for homeownership and once for
                     rental assistance. The City reviews the applications in house and scores each based
                     on pre-released scoring criteria. The application is then submitted to the state along
                     with the City's tentative housing commitments. They receive applications from both
                     for-profit and not-for-profit businesses, though most approvals go to CDCs.

        Required performance monitoring for all subrecipients


                     In San Francisco, after receiving their funding, the CDCs are required to provide
                     annual budgets to the City for the length of their agreement (usually 50-75 years).

                     In Indianapolis, the City writes contracts yearly and requires project sponsor
                     training prior to disbursing funds. The contracts are performance based and not
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                     reimbursed until certain benchmarks are reached. The benchmarks are based on a
                     timeline to prevent the CDCs from lagging in drawing down funds and to keep
                     production on schedule. Indianapolis developed their own standards that must be
                     met. They require a minimum of two bids for all work performed in excess of
                     $2,000 before it will be reimbursed. If work comes in more than 10% higher or
                     lower than the budgeted estimate, the staff will inspect the work before payment is
                     made. Additionally, The City monitors each project at least once per year. The
                     monitoring process begins with a written notice sent two weeks in advance. They
                     then complete an entrance with the Director, do some file reviews, and then
                     complete an exit conference. They then follow-up with a letter for documentation
                     purposes.

        Outsourcing by competitive bid

                     San Francisco outsources the management of its loan portfolio to an independent
                     company. They pay a nominal flat fee per loan per month. The independent
                     company handles the City's closings as well.

                     The City of Cleveland, puts their HOME funds up for bid yearly. Almost all of the
                     funds go to one agency every year. This agency has member groups that receive the
                     funds for long-term lease agreements. They fund long term lease periods for 15
                     years, when the tax credits expire. At this point, the renters take ownership. The
                     only compensation the independent agency gets is a small development fee that is
                     included in the City's administrative budget.

                     The City of Minneapolis outsources their residential finance program to an
                     independent company for administrative costs equal to approximately 10% of their
                     total budget. Additionally, Minneapolis has a sub-recipient agreement with another
                     agency to handle all of the mortgage foreclosures counseling and prevention
                     program for administrative costs equal to approximately 25% of their total budget.
                     This agreement calls for servicing a loan portfolio of 900 loans (as well as other
                     services) for an administration fee reimbursing actual expenses not to exceed a
                     certain dollar amount. This is the equivalent of a very nominal monthly fee per
                     loan. The contract contained very specific goals as well as detailed consequences if
                     the stated goals are not met.


        Maintaining good relationships with related entities



                     The City of Boston has developed a relationship with various banks where if the
                     bank does the initial intake and the City helps with assistance of closing costs or
                     down payments, the buyer gets a 1% discount on their rate.




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        Providing easy access to services for potential users

                     Additionally, the City of Boston has "Home Centers" in several spots all over the
                     City, targeting the needy areas that market the programs available to the lower
                     income eligibles. They do outreach such as attending community meetings,
                     providing information to libraries and other resource centers, etc. Before any
                     person receives assistance, they are required to go through an education program
                     where they receive a certificate of completion prior to applying for assistance.




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                                                                                                      Appendix B
                      Schedule of Questioned Costs and Funds Put to Better Use


        Recommendation                            Type of Questioned Cost                         Funds Put to
           Number                 Ineligible 1/    Unsupported 2/ Unnecessary/Unreasonable3/       Better Use 4/
                 2A                  $900,000
                 2B                  $600,000

             Totals                $1,500,000


        1/             Ineligible costs are costs charged to a HUD-financed or HUD-insured program or
                       activity that the auditor believes are not allowable by law, contract, or Federal, State,
                       or local policies or regulations.

        2/             Unsupported costs are costs charged to a HUD-financed or insured program or activity
                       and eligibility cannot be determined at the time of the audit. The costs are not supported
                       by adequate documentation or there is a need for a legal or administrative determination
                       on the eligibility of the cost. Unsupported costs require a future decision by HUD
                       program officials. This decision, in addition to obtaining supporting documentation,
                       might involve a legal interpretation or clarification of Departmental policies and
                       procedures.

        3/             Unnecessary/unreasonable costs are those, which are not generally recognized as
                       ordinary, prudent, relevant, and/or necessary within established practices.
                       Unreasonable costs exceed the costs that would be incurred by a prudent person in
                       conducting a competitive business.

        4/             Funds To Be Put To Better Use are quantifiable savings that are anticipated to occur if
                       an OIG recommendation is implemented, resulting in a reduced expenditure in
                       subsequent periods for the activity in question.




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                                                            Appendix C
                    City Manager’s Comments and Auditor’s
                                  Evaluation




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         Auditor’s Evaluation of Auditee

        The City Manager generally agreed with all audit recommendations. The City Manager’s
        Office has formed a Citizen’s Task Force to develop a more specific housing policy and is
        making significant changes to the City’s process for implementing that policy.




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                                                                Appendix D
                    HEDFC’s Comments and Auditor’s Evaluation




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  See Note 1




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    See Note 1




    See Note 2




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        See Note 3




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     See Note 4




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   See Note 5




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         Auditor’s Evaluation of Auditee

        The President and Chief Executive Officer of HEDFC recommended that all conclusions
        and many of the recommendations of the audit report be disregarded. While we did not
        address any recommendations to HEDFC, we did provide a draft audit report to HEDFC
        management for review and comment since we discuss HEDFC’s role within the city’s housing
        system as well as certain aspects of its performance. We did not request that they specifically
        respond to the findings that deal directly with the City’s housing system (findings 1 and 2).
        However, HEDFC provided extensive comments on those findings. In those comments, HEDFC
        disagreed with most of the content of the findings and reflected a strong desire to see the City
        maintain its program as it existed during our audit period. It is important to note that those
        comments come from the perspective of the recipient of most of the city’s housing funds. If
        implemented, the recommendations in this report will enable the City to exercise significantly
        more control over its program, and its program participants, including HEDFC. As a program
        participant, HEDFC has participated in Kansas City’s system for implementing housing programs
        under annual contractual agreements, but has no authority to speak for the city. The City Manager
        generally agreed with the findings and recommendations. We have included his response in
        Appendix C.

        Therefore, we focused our review on HEDFC’s response to the third finding, which deals with
        HEDFC’s financial viability and performance. We looked for assertions of fact in HEDFC’s
        response that contradict facts in our report. As such, we are not specifically responding to
        assertions that our statements were inaccurate without explanation. We are also not responding to
        assertions that our statements were inaccurate when there was also implicit acceptance (e.g.
        where the response said that they would try to improve in this area).

        For the most part, HEDFC’s response states that the findings are inaccurate and misleading, but
        does not provide facts that contradict our report. We noted the following assertions that
        contradict the facts in our report:


         Note 1       We did see project budgets in our review of a sample of files. However, we
                      distinguish between individual project budgets and detailed annual program or
                      operating budgets. The project budgets do not cover a specified time-period and
                      the source of funds is not clear. We did not see any roll-up of individual project
                      budgets that would clearly identify the planned source and use of funds overall for
                      a given time period.

         Note 2       Both HUD and the City (the parties with regulatory authority) cited the
                      commingling as a problem. HUD regulations require participating jurisdictions to
                      maintain separate accounts for CDBG and HOME trust funds. The city contract
                      defines these accounts as separate bank accounts (the definitions CDBG Program
                      Income Depository Account and HOME Trust Fund Account state that each is “a
                      single account, at a FDIC insured financial institution”). HEDFC does maintain
                      separate bank accounts for the different funds and in the instance described
                      deposited HOME funds into the CDBG account.

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         Note 3     When we say HEDFC doesn’t market its programs to users, we mean all people
                    who are eligible for the programs. We agree that HEDFC’s participation in HUD
                    workshops would educate some eligible people about the programs. However, an
                    adequate marketing effort would ensure that as many eligible people as possible
                    know about the programs and how to participate in them. The fact that HEDFC
                    spent all of the money has no bearing on whether people eligible for the programs
                    know they exist.

                    HEDFC’s response says that the Chambers project was completed in April 2003.
         Note 4
                    We say in our report that Board minutes did not provide information on multi-
                    family housing completed in contract year 2003. These two statements are not
                    contradictory. This point reinforces our conclusions that annual performance goals
                    are vague and it is hard to tell what the city is getting for its significant spending
                    on housing.

                    The annual contracts refer to HEDFC as a designated subrecipient, which is the
         Note 5
                    term HUD uses to describe agencies, authorities, or organizations receiving funds
                    from the grantee to undertake eligible activities. The primary distinction between
                    a contractor and a subrecipient is the method used for selecting the agency –
                    contractors are selected through a competitive process. City staff told us that
                    HEDFC is not required to submit an application to receive funding. Staff told us
                    that in the past, HEDFC submitted "Pro Forma Statements" that described the
                    sources and uses of funds for activities planned during the year. We asked for and
                    reviewed an example pro forma statement – it is not a response to an RFP.
                    HEDFC’s President agreed that HEDFC is not required to submit an application to
                    receive funding but said that in the last couple of years HEDFC has done so.




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                                                                Appendix E
                    Kansas City, Missouri, Housing Survey Map




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                                                                                                                                                    Appendix F

        Payments to HEDFC by Fund, Contract Year Paid, and Calendar Year Funds were Encumbered

              Year Paid                                                                           Calendar Year Funds Were Encumbered
               HEDFC                        FUND
             Contract Year                                         <>       1996      1997       1998       1999        2000       2001      2002     2003        Total
                   1       Economic Development Initiative-HUD                                             1,775,329                                             1,775,329
                           Grant
                   1       HOME Investment Fund                                                   21,400                                                            21,400
                   1       HUD Section 108 Loan Fund             250,000              668,367                          2,531,470                                 3,449,837
                   1       Community Development-26th Yr                                                                 989,096                                   989,096
                   1       Community Development-23rd                                            104,926                                                           104,926
                   1       Community Development-24th                                            212,283                                                           212,283
                   1       Community Development-25th                                                      377,101                                                 377,101
                   1       HOME Investment Fund 94                         250,000                17,627 1,798,950      530,551                                  2,597,128
                   2       Economic Development Initiative-HUD                       1,845,100           1,127,811                                               2,972,912
                           Grant
                   2       HUD Section 108 Loan Fund                                 2,130,060             4,371,980        397                                  6,502,437
                   2       Community Development-26th Yr                                                                810,404                                    810,404
                   2       Community Development-27th Yr                               26,544                                      859,254                         885,798
                   2       Community Development-22nd                                 118,283                                                                      118,283
                   2       Community Development-23rd                                 720,379    455,627                           447,000                       1,623,006
                   2       Community Development-24th                                            648,873                           500,000                       1,148,873
                   2       Community Development-25th                                                        66,542                                                 66,542
                   2       HOME Investment Fund 94                                                                     1,770,453 2,364,789                       4,135,242
                   3       Economic Development Initiative-HUD                       3,670,576              837,096                                              4,507,672
                           Grant
                   3       HUD Section 108 Loan Fund                                 3,200,880              871,173 8,324,636                       2,500,000 14,896,689
                   3       Community Development-27th Yr                                                                           750,500                       750,500
                   3       Community Development-28th Yr         350,000                                                                416,343                  766,343
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                   3       Community Development-23rd                                            198,386                                547,351                  745,737
                   3       HOME Investment Fund 94                                   80,400                                    35,152 2,636,847                2,752,399
                           Total                                 600,000 250,000 12,460,589 1,659,122 11,225,983 14,957,007 4,956,695 3,600,541     2,500,000 52,209,937

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