oversight

Idaho Housing and Finance Association, Boise, Idaho, Made Improper Section 8 Subsidy Payments and Improperly Distributed $7.2 Million of Bond Refund Proceeds Under its Non-insured, Subsidized Multifamily Projects Program

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-09-16.

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

                                                                Issue Date
                                                                    September 16, 2005
                                                                Audit Report Number
                                                                    2005-SE-1008




TO:         Renee′ Greenman, Director, Multifamily Housing Hub, 0AH




FROM:       Joan S. Hobbs, Regional Inspector General for Audit, Region X, 0AGA

SUBJECT: Idaho Housing and Finance Association, Boise, Idaho, Made Improper Section 8
            Subsidy Payments and Improperly Distributed $7.2 Million of Bond Refund
            Proceeds Under its Non-insured, Subsidized Multifamily Projects Program


                                   HIGHLIGHTS

 What We Audited and Why

             At the request of the Region X Multifamily Hub, we audited Idaho Housing and
             Finance Association (Idaho Housing) due to concerns that it (1) may have
             improperly allowed owners to prepay the mortgages of subsidized projects
             without the U.S. Department of Housing and Urban Development’s (HUD)
             approval and (2) may not have properly implemented the conditions of HUD’s
             approval of its proposed bond refunding in 1994 and that the bonds may not have
             been refunded.

             Our overall audit objectives were to determine whether Idaho Housing followed
             federal regulations and HUD guidelines when it (1) allowed project owners to
             prepay project mortgages and (2) refunded bonds in 1994.

 What We Found


             Idaho Housing did not properly follow federal regulations and HUD guidelines
             when it allowed 10 project owners to prepay project mortgages. Prepayment
           caused the housing assistance payments contracts (contracts) to terminate, at
           which time the Section 8 subsidy amount should have been renegotiated with
           HUD. However, Idaho Housing continued to make subsidy payments to the
           projects after the contracts were terminated. This occurred because Idaho
           Housing misinterpreted the language in the contracts. As a result, HUD paid
           more than $8.5 million in subsidies in excess of fair market rents for these
           projects.

           In addition, we found that Idaho Housing did not properly follow federal
           regulations and HUD guidelines when it refunded bonds in 1994 as part of a loan-
           restructuring plan for subsidized projects. It (1) did not return HUD’s 50 percent
           share of the savings of $6,195,107 generated from the bond refunding for 30
           McKinney Act projects, and (2) it did not use $997,523 of its 50 percent of the
           McKinney Act savings appropriately. This occurred because Idaho Housing
           believed that HUD’s approval of the loan-restructuring plan allowed the agency to
           distribute the proceeds to the owners without regard to the McKinney Act
           provisions. In addition, Idaho Housing lacks the management controls to ensure
           that project owners receive only those distributions to which they are entitled. As
           a result, the McKinney Act savings were not available for HUD programs
           including those administered by Idaho Housing.


What We Recommend


           We recommend that Idaho Housing be required to reimburse HUD and its federal
           programs from nonfederal funds for excessive subsidy payments on the
           terminated contracts and for inappropriately distributed bond proceeds. In
           addition, we recommend that HUD require Idaho Housing to keep HUD apprised
           whenever a project owner prepays the mortgage on a project subject to the old
           regulations and that HUD renegotiate the terminated contracts. Further, we
           recommend that HUD require Idaho Housing to implement procedures to ensure
           the proper identification of old regulation and new regulation projects with
           respect to the applicable regulations and guidance.

           For each recommendation without a management decision, please respond and
           provide status reports in accordance with HUD Handbook 2000.06, REV-3.
           Please furnish us copies of any correspondence or directives issued because of the
           audit.

Auditee’s Response


           We provided Idaho Housing Finance Association a draft report on July 28, 2005,
           and held an exit conference on August 17, 2005. Idaho Housing provided written




                                            2
comments on September 7, 2005. Idaho Housing Finance Association disagreed
with most of the report. The complete text of the auditee’s response, along with
our evaluation of that response, can be found in appendix B of this report.




                                3
                              TABLE OF CONTENTS

Background and Objectives                                                            5

Results of Audit
        Finding 1: Idaho Housing Continued to Make Subsidy Payments to 10 Projects   7
        after the Contracts Were Terminated
        Finding 2: Idaho Housing Did Not Follow Federal Requirements Regarding the   11
        Distribution of $7.2 Million in Bond-Refunding Proceeds

Scope and Methodology                                                                14

Internal Controls                                                                    15

Appendixes
   A.    Schedule of Questioned Costs and Funds to Be Put to Better Use              17
   B.    Auditee Comments and OIG’s Evaluation                                       18
   C.   Ineligible Costs – HUD’s Portion of McKinney Act Savings                     40
   D.   Fifty Percent – Excess Distributions                                         41




                                               4
                      BACKGROUND AND OBJECTIVES

Idaho Housing and Finance Association (Idaho Housing) is Idaho’s housing finance agency. Idaho
Housing does not receive state-appropriated funds for its operations. Its mission is to provide
funding for affordable housing opportunities in Idaho communities where they are most needed
and when it is economically feasible.

Idaho Housing participates in the development, finance, management, and tenant support for 59
projects under an annual contributions contract with the U.S. Department of Housing and Urban
Development (HUD). Under this agreement, it functions as the agent for HUD in performing tasks
in these areas as the Section 8 subsidy contract administrator. Idaho Housing’s subsidy contract
administration responsibilities include program compliance functions, to ensure that HUD-
subsidized projects are serving eligible families at the correct level of assistance, and asset
management functions, to ensure the physical and financial health of the projects. It processes the
monthly housing assistance payments and is responsible for asset management functions, housing
assistance payment contract (contract) compliance, and monitoring functions. It performs
compliance reviews on these developments, including physical inspections and occupancy
reviews. It holds and administers the replacement reserve, residual receipts, and all other
appropriate escrow accounts for these projects and all other appropriate escrow accounts for
these projects. It also processes the monthly housing assistance payments.

The monthly housing assistance payments are based on contracts between the owner and Idaho
Housing. These contracts are categorized as either old regulation or new regulation. New
regulation projects are those with a signed agreement to enter into a contract on February 29, 1980,
or later.

Owners of old regulation projects are not limited as to the amount of distributions they may receive
from the project, except that the distribution may only be made after funds have been set aside for or
payment has been made for all project expenses. In addition, the contract for old regulation projects
states that it terminates on the date of the last payment of principal due on the permanent financing.

Pipeline projects are treated like old regulation projects with respect to distributions. Although
these projects are technically new regulation projects because the date of submission of the initial
application was during a time of transition for HUD regulations, HUD allowed the projects to opt
out of the limitation on distributions. Therefore, these projects, like old regulation projects, are
not limited with regard to distributions.

New regulation projects are of two types: nonprofit and profit-motivated. Owners of new
regulation nonprofit ownership projects are not entitled to distributions. Owners of profit-
motivated new regulation limited distribution projects may only receive 6 percent (projects with
elderly tenants) or 10 percent (family projects) of owner equity determined when the project was
constructed. Owners of profit-motivated projects that are family projects with 50 or fewer units
are exempt from the limitations on distributions. In this way, these projects are treated like old


                                                  5
regulation projects. Additionally, the contract for new regulation projects states that the contract
will remain in effect for at least 20 years, regardless of whether the mortgage is prepaid.

Our overall audit objective was to determine whether Idaho Housing followed federal regulations
and HUD guidelines when it allowed project owners to prepay project mortgages and when it
refunded bonds in 1994. We wanted to quantify any excess housing assistance payments made
to prepaid projects because of contract termination. We also wanted to quantify any
inappropriate equity takeouts on projects subject to the McKinney Act as well as other projects
with limited distributions.




                                                 6
                                  RESULTS OF AUDIT

Finding 1: Idaho Housing Continued to Make Subsidy Payments to 10
Projects after the Contracts Were Terminated
Idaho Housing made excessive subsidy payments to 10 old regulation projects after the contracts
terminated with the payoff of the projects’ permanent financing. Upon prepayment, the Section 8
subsidy should have been renegotiated with HUD. However, Idaho Housing continued to make
subsidy payments to these projects, even after the contracts were terminated. This occurred because
Idaho Housing misinterpreted the contracts to mean that as long as the project maintained financing
or was responsible for debt service (e.g., through a refinance with Idaho Housing or another
financial institution), the contracts remained in effect. As a result, the projects received more than
$8.5 million of HUD Section 8 rent subsidies in excess of fair market rents, thus denying funds to
subsidize other low-income individuals and families.



 Contracts Terminated as a
 Result of Prepayment



               We identified 10 old regulation projects in which the owners paid off the
               permanent financing provided by Idaho Housing. In accordance with Idaho
               Housing’s contracts, the subsidized rents for the 10 old regulation projects were
               increased yearly, using an annual adjustment factor published in the Federal
               Register. The annual adjustment factor increases continued until HUD issued
               Notice H 95-12 in March 1995, enacting a rent freeze for projects with rents in
               excess of fair market rents. This freeze remains in effect until such time as the
               projects are able to submit a comparison showing that market rents for unassisted
               housing in the same market area of similar age, type, and quality are more than
               105 percent of the current contract rent level for that unit type. The annual
               adjustment factor increases resulted in subsidized rents that were significantly
               higher than applicable fair market rents as follows:




                                                  7
      Percentage of actual subsidized rents over applicable fair market rents since July
      1, 1994, or date of prepayment (if later)

      Project                       Rent paid Fair market rent  Percentage of
                                                                overpaid subsidies
      Greenbriar                 $ 4,515,699        $ 3,174,590        142%
      Howard Place                 3,217,132          2,652,458        121%
      Market Lake                     84,589             54,970        154%
      Townhouses
      Oakridge                     3,439,875           1,984,761           173%
      Portneuf Towers                533,544             279,360           191%
      Ridgeview                    3,007,910           1,897,824           158%
      Sandcreek                    6,663,683           4,455,796           150%
      Shoreline Plaza              2,931,151           1,816,723           161%
      Tamarack                         7,676               4,848           158%
      Treehouse                    1,711,323           1,236,726           138%

            When the Idaho Housing loans were paid off, their housing assistance payment
            contracts were required to be automatically terminated as the contracts for old
            regulation projects state that the contract term shall not exceed “…a period
            terminating on the date of the last payment of principal due on the permanent
            financing.” Thus, the subsidy payments should have ceased until the contracts
            were renewed, extended, or renegotiated with HUD. This would have provided
            HUD the opportunity to lower the subsidies to be more in line with fair market
            rents. However, Idaho Housing did not always inform HUD of the prepayments
            and continued to make subsidy payments to each of the projects as though the
            existing contracts were still in effect. Further, federal regulations at 24 Code of
            Federal Regulations 883.307(b)(2) state that when financing documents are to be
            substantially changed and those changes affect the Section 8 program, the housing
            agency must submit the revised documents for review. Accordingly, whenever a
            project’s owner proposed to prepay or refinance the mortgage loan, Idaho
            Housing was required to submit the new financing documents to HUD for review
            because the prepayment terminated the project’s contract.

Idaho Housing Has Paid More
Than $8.5 Million in Excess of
Fair Market Rents

            We calculated the difference in the subsidy HUD paid for these projects and what
            the projects would have received at fair market rents. To make this calculation,
            we requested subsidy payment data from HUD. However, HUD was unable to
            provide us subsidy data earlier than the 1994-1995 fiscal year. Therefore, we
            calculated subsidies paid in excess of fair market rents from fiscal year 1995

                                               8
                 forward for those projects that were prepaid before that time and from the time of
                 prepayment for projects prepaid since 1995. As shown below, HUD has
                 unnecessarily made $8,554,527 in subsidy payments in excess of fair market rents
                 to Idaho Housing for the 10 prepaid projects.


Project                  Month/year          Amount Fair market Year end Overpayment
                          mortgage            paid 1     rent     adjustment 2 (a)-(b)-(c)
                        was paid off           (a)        (b)          (c)
Greenbriar 3          July 1993             $4,555,048 $3,174,590 $ 39,349 $1,341,109
Howard Place          April 1995             3,235,384  2,652,458        18,252       564,674
Market Lake
Townhouses            November 2003             84,589      54,970                     --          29,619
Oakridge 3            July 1993              3,467,118   1,984,761                27,242        1,455,115
Portneuf Towers       March 2004               533,544     279,360                     --         254,184
Ridgeview 3           July 1993              3,029,055   1,897,824                21,145        1,110,086
Sandcreek             March 1994             6,699,584   4,455,796                35,901        2,207,887
Shoreline Plaza       December 2000          2,999,071   1,816,723                67,920        1,114,428
Tamarack              December 2004              7,676       4,848                     --           2,828
Treehouse             January 1998           1,721,330   1,236,726                10,007          474,597
Totals                                     $26,332,399 $17,558,056              $219,816       $8,554,527


    Idaho Housing Misinterpreted
    Contract Language



                 Idaho Housing staff told us that the language in the contract was not sufficiently
                 clear on the subject of prepayment and the term of the contract. Consequently, they
                 misinterpreted the contract to mean that the projects were only required to maintain
                 permanent financing or have debt service.




1
  This is the total subsidy amount paid plus tenant rent since the mortgage was paid off.
2
  Subsidy returned to HUD by Idaho Housing after adjusting for actual occupancy rate.
3
  These projects were actually paid off some time before July 31, 1993, but Idaho Housing no longer had the actual
dates.




                                                         9
Recommendations




    We recommend that the director of multifamily housing

           1A. Require Idaho Housing to reimburse HUD $8,554,527 for excess subsidy
           payments made for projects that did not have a valid contract.

           1B. Require Idaho Housing to inform the local HUD office of future
           prepayments to ensure HUD has the opportunity to renegotiate the contract.

           1C. Renegotiate the terminated contracts with the owners and Idaho Housing,
           taking into consideration the condition of the projects and fair market rents to
           allow funds to be put to better use in the amount of $1,339,881 over the next year.




                                           10
Finding 2: Idaho Housing Did Not Follow Federal Requirements
Regarding the Distribution of $7.2 Million in Bond-Refunding Proceeds
Idaho Housing did not return 50 percent of McKinney Act savings to HUD for 30 new and old
regulation projects. The savings were generated from a 1994 bond-refunding and loan-
restructuring program for the Section 8 new construction projects financed by Idaho Housing.
Further, Idaho Housing did not always use its share of the savings in accordance with the
requirements of the 1992 amendments to the McKinney Act. This occurred because Idaho
Housing believed that HUD’s approval of the loan-restructuring plan allowed the agency to
distribute the proceeds to the owners without regard to the McKinney Act provisions.
Consequently, HUD did not receive its $6,195,107 share of the loan-restructuring savings, and
$997,523 of Idaho Housing’s share of the savings was unavailable for its low-income housing
programs.



Idaho Housing and Finance
Association Did Not Return
$6,195,107 in McKinney Act
Savings to HUD

              According to the 1992 amendments to section 1012 of the Stewart B. McKinney
              Homeless Assistance Amendments Act of 1988, HUD is required to return 50
              percent of the amounts recaptured by projects from bond refinancing to the state
              housing finance agency. This implies that the remaining savings belong to HUD.
              The returned funds must be used to provide housing for low-income persons
              under an approved McKinney Act refunding agreement and housing plan or to
              pay allowable owner distributions. Although the housing finance agency may use
              its 50 percent of the savings to pay allowable owner distributions, the U.S.
              Department of the Treasury share (HUD’s 50 percent of the savings) must be held
              harmless. HUD may not waive its portion of the savings.

              In May 1994, Idaho Housing received approval from HUD for its overall proposal
              to conduct a loan-restructuring program for the Section 8 new construction
              projects that it financed. Under the loan-restructuring program, Idaho Housing
              refunded the bonds from which the original loans to the projects were made,
              restructured the loans, and used the savings to reduce the interest on the project
              loans. This enabled Idaho Housing to increase the projects’ total loan principal
              amounts without raising the monthly payment amounts significantly and allowed
              owners to draw equity out of the projects without an increase in the subsidized
              rents.




                                              11
Thirty of the projects that went through the loan restructuring are regulated under
the 1992 McKinney Act amendments. The bond-refunding savings for these 30
projects totaled $12,390,213. However, Idaho Housing did not inform HUD that
the projects were McKinney Act projects in its loan-restructuring proposal and
did not submit McKinney Act refunding agreements and housing plans. If Idaho
Housing’s proposal had disclosed to HUD that the 30 projects were subject to the
McKinney Act, HUD would have required the savings to be used to reduce the
subsidized rents or to be deposited into trustee sweep accounts. Funds in the
trustee sweep accounts would then be split between HUD and Idaho Housing in
accordance with approved McKinney Act refunding agreements and housing
plans.

                 Unlimited Distribution Projects

Twenty-four of the McKinney Act projects do not have restrictions on owner
distributions. These projects are treated as old regulation projects and are not
limited with regard to owner distributions after all project expenses have been
paid. We determined it was appropriate for Idaho Housing to allow the
distribution to the owners but only from its portion of the savings. However,
$5,163,130 of the owner distributions of savings from the loan restructuring for
these 24 projects should have been available to HUD in the trustee sweep
accounts (see Appendix C).

                  Limited Distribution Projects

As a condition of HUD approval of the bond refund, Idaho Housing certified that
it would comply with federal regulations at 24 Code of Federal Regulations
883.306 with respect to limitations on distributions for any new regulation project
within the bond refund pool. Five of the McKinney Act projects are new
regulation limited distribution projects. According to federal regulations at 24
Code of Federal Regulations 883.306, the owners of these projects are limited as
to the distributions they may receive from the projects. Because these projects
serve elderly tenants, the owners of the projects are limited to distributions of 6
percent on equity.

One of the McKinney Act projects was originally an old regulation project.
However, in 1988, the owner of this project elected to amend the contract to adopt
subpart G of 24 Code of Federal Regulations 883, which incorporates a limitation
on distributions. The owner sold the project to The Housing Company, a
nonprofit company, in 1992. The Housing Company assumed the existing
mortgage and the contract, including amendments. As a nonprofit owner, The
Housing Company is not entitled to distributions of project assets under the 1988
contract amendment.




                                 12
          Contrary to the McKinney Act amendments, Idaho Housing distributed HUD’s
          $1,031,976 share of the McKinney Act savings and allowed $997,523 in
          excessive loan-restructuring program distributions to the owners of six projects
          (see Appendix D).

          Idaho Housing staff told us that since it has a mixed portfolio of both old and new
          regulation projects, employees must have mistaken new regulation projects for
          old regulation projects during the bond refund. As a result, some new regulation
          limited distribution projects received equity takeouts to which they were not
          entitled.

  HUD Should Have Received
  a Total of $6,195,007 in
  McKinney Act Savings



          Total McKinney Act savings of $6,195,007 that should have been returned to
          HUD include the $5,163,130 distributed to the owners of the projects that do not
          have limitations on distributions and the $1,031,977 distributed to owners that
          should not have received any distributions or should have received only limited
          distributions. These savings should have either been used to reduce Section 8
          subsidy payments to the projects or made available to HUD in a trustee sweep
          account.


Recommendations


          We recommend that the director of multifamily housing require Idaho Housing to

                  2A. Reimburse HUD from nonfederal funds $6,195,107 for its share of
                  the McKinney Act savings resulting from the 1994 bond refund.

                  2B. Reimburse its federal programs accounts from nonfederal funds the
                  $997,522 for its portion of the McKinney Act savings that was not
                  appropriately expended.

                  2C. Implement procedures to ensure the proper identification of old
                  regulation, new regulation, and McKinney Act projects to prevent the
                  further misclassification of projects, leading to excess (ineligible)
                  distributions.




                                          13
                        SCOPE AND METHODOLOGY

To achieve our audit objectives, we reviewed applicable federal regulations, HUD Handbooks,
Idaho Housing written policies and procedures, and project files for the 59 projects under the
annual contributions contract between Idaho Housing and HUD. In addition, we interviewed
local HUD staff and Idaho Housing staff. We performed audit work at Idaho Housing’s offices
in Boise, Idaho, and at the HUD Multifamily office in Seattle, Washington, from November
2004 through June 2005. Our audit generally covered the period January 1, 2001, through
December 31, 2004, and was expanded as needed.

We performed our review in accordance with generally accepted government auditing standards.




                                              14
                             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. They include the systems
for measuring, reporting, and monitoring program performance.



 Relevant Internal Controls
              We determined the following internal controls were relevant to our audit objectives:

                  •   Program operations – Policies and procedures that Idaho Housing has
                      implemented to reasonably ensure that a program meets its objectives and
                      that unintended actions do not result.
                  •   Compliance with laws and regulations – Policies and procedures that Idaho
                      Housing has implemented to reasonably ensure that resources used are
                      consistent with laws and regulations.
                  •   Safeguarding resources – Policies and procedures that Idaho Housing has
                      implemented to reasonably prevent or promptly detect unauthorized
                      acquisition, use, or disposition of resources.

              We assessed the relevant controls identified above.

              A significant weakness exists if management controls do not provide reasonable
              assurance that the process for planning, organizing, directing, and controlling
              program operations will meet the organization’s objectives.


 Significant Weaknesses


              Based on our review, we believe the following item is a significant weakness:




                                               15
•   Idaho Housing does not have controls in place to reasonably ensure that
    project funds are used consistent with federal regulations at 24 Code of
    Federal Regulations 883.306. Nor do management controls reasonably
    prevent or promptly detect the improper use of project resources (see
    finding 2).




                             16
                                    APPENDIXES

Appendix A

               SCHEDULE OF QUESTIONED COSTS
              AND FUNDS TO BE PUT TO BETTER USE

                  Recommendation              Ineligible 1/    Funds to be put
                         number                                 to better use 2/
                                  1A           $8,554,527
                                  1C                               $1,339,881
                                  2A            6,195,107
                                  2B              997,522

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/   “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an
     Office of Inspector General (OIG) recommendation is implemented, resulting in reduced
     expenditures at a later time for the activities in question. This includes costs not incurred,
     deobligation of funds, withdrawal of interest, reductions in outlays, avoidance of
     unnecessary expenditures, loans and guarantees not made, and other savings.




                                              17
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         18
19
Comment 1




Comment 2




Comment 3




            20
Comment 4




Comment 5




Comment 6



Comment 7




            21
Comment 5



Comment 8


Comment 6



Comment 9




            22
Comment 10




             23
Comment 11




Comment 12



Comment 13




Comment 14




             24
Comment 15




             25
Comment 16




Comment 14

Comment 13


Comment 14




             26
Comment 14




Comment 16




             27
Comment 17




Comment 13




Comment 18




             28
Comment 18




Comment 19



Comment 12
Comment 20


Comment 21




             29
Comment 21




Comment 22

Comment 23

Comment 12
Comment 24

Comment 23




             30
Comment 12
Comment 25




Comment 25




Comment 26




             31
Comment 27
Comment 28




Comment 29




             32
33
                      OIG Evaluation of Auditee Comments

Comment 1   The findings were discussed in detail with Idaho Housing and HUD during the
            course of the audit. Idaho Housing had the same time afforded to all other
            auditees to formulate its response. We provided Idaho Housing with written
            finding outlines in early July 2005 and sent our draft report to them on July
            28, 2005. We considered all of Idaho Housing’s positions raised at the exit
            conference and actually provided Idaho Housing a one week extension to their
            original due date to provide it more time to respond by September 7, 2005.

Comment 2   Our audit finding was not based upon HUD General Counsel’s June 23, 2002
            opinion. As noted in the report, the finding is based upon the requirements of
            the HAP contracts and federal regulations at 24 Code of Federal Regulations
            883.307(b)(2). Idaho Housing’s annual contributions contract with HUD
            states that it must comply and require owners to comply with the U.S.
            Housing Act of 1937 and all applicable regulations and requirements.

Comment 3   Although HUD never issued a formal notice stating that prepayment of old
            regulation project mortgages would terminate the contract, this should have
            been known by all owners as well as Idaho Housing. Within the contract
            itself, there is a provision that the contract terminates upon prepayment.
            Specifically, the contract states that the term of the contract ends on the date
            of the last payment of principal due on the permanent financing. Therefore,
            when a project is prepaid, the contract terminates.

Comment 4   Although the proposal to which Idaho Housing refers was discussed in Senate
            Testimony, it has not been formalized as a written HUD policy.

Comment 5   Our audit scope included only one of the ten projects to which Idaho Housing
            refers. We did not interfere with the sale and transfer of this project even though
            the prepayment would terminate the contract. This project was part of a package
            of nine other projects and it was our understanding that the deal would not go
            through without the inclusion of the project.

Comment 6   In order for HUD to stop funding the contracts due to contract termination, it
            would have to know that the projects were subject to the old regulations and
            that the projects were prepaid. However, as stated in the report, Idaho
            Housing did not always inform HUD of the prepayments and continued to
            make subsidy payments to each of the projects as though the existing contracts
            were still in effect.

Comment 7   We did not state that it was Idaho Housing or HUD’s obligation to renegotiate
            the rents with owners whose mortgages were prepaid. However, in the
            interest of maximizing the effectiveness of the Section 8 program, we are
            recommending rents be renegotiated because we believe this should have

                                          34
             been done. Lowering the Section 8 payments to market rates would have
             saved $8.5 million in subsidy payments that could have been used to provide
             rental assistance to additional low income persons.

Comment 8    We had no intention of questioning the entire amount of subsidy payments
             made after the contracts were terminated due to the refinancing. Subsequent
             to the termination of the HAP contracts, rental assistance was provided for the
             low income tenants of these projects. It would be unreasonable to recommend
             that Idaho Housing return the subsidies used to provide assistance at market
             rent rates. Consequently we are only recommending return of the subsidy
             paid in excess of fair market rents. These funds can then be used to provide
             rental assistance to other low income persons.

Comment 9    Idaho Housing should have known at the inception of the projects that the old
             regulation contracts terminate upon prepayment as this information is
             included in the project contracts. Further, Idaho Housing has had specific
             knowledge for nearly a year, since the HUD review in 2004, that old
             regulation contracts terminate upon prepayment. In spite of this knowledge, it
             has done nothing to rectify the situation. It has continued to make subsidy
             payments to each of the projects as though the existing contracts were still in
             effect. Therefore, we continue to recommend that Idaho Housing reimburse
             HUD for excessive subsidy payments made since the contracts terminated.

Comment 10   HUD Notice 95-7 also states that other HUD objectives in encouraging
             owners and housing finance agencies to refund bonds include reducing
             subsidy costs, recovering surpluses to which it is entitled, and improving
             projects’ physical condition. Further, Idaho Housing implies the owners of
             these projects would otherwise opt out of the Section 8 program if they were
             not allowed to refinance with an equity take-out. However, we found that out
             of the projects that were part of the bond refunding, only one has current total
             rent levels below fair market rents. Therefore, it does not seem likely that the
             owners would opt out of the program since they were unlikely to generate the
             level of income received from the Section 8 subsidy.

Comment 11   Idaho Housing staff told us that the equity take-out to the owners was
             determined by calculating the amount of debt service the project could support
             at the current level of subsidy provided by HUD. If this equity take-out had
             not been provided to the owners, the debt service on the loans could have been
             reduced by the amount of savings we reported.

Comment 12   We agree that Idaho Housing did not receive funds from the bond refunding.
             However, the equity take-out funds were not returned to the Section 8 projects
             as implied by Idaho Housing’s response. These funds were given to the
             property owners as an incentive to refinance.




                                          35
Comment 13   The HUD approval referred to by Idaho Housing did not indicate in any way,
             that Idaho Housing did not have to abide by the provisions in the McKinney
             Act. In addition, when asked, Idaho Housing could not provide any
             documentation showing that it informed HUD that the projects referred to in
             its proposal were McKinney Act projects. It also could not provide us any
             documentation that HUD knew what specific projects were to be part of the
             refunding. Thus, it appears HUD’s approval was most likely based upon
             incomplete information from Idaho Housing.

Comment 14   The Housing and Community Development Act of 1992 addresses Section
             1012 of the McKinney Act and it states that projects qualified for sharing
             savings from a bond refunding include any State financed projects,
             constructed or substantially rehabilitated under a Section 8 contract during any
             of the calendar years 1979 through 1984, and that are being refinanced. This
             section applies to both Financial Adjustment Factor and non- Financial
             Adjustment Factor projects.

Comment 15   We agree that Section 1012 of the McKinney Act encouraged, but did not
             require State Agencies to refund bonds. However, when the State Agencies
             refund bonds, the McKinney Act provides that one half of the savings belong
             to HUD. HUD clarified its policies in its Notice 95-7 stating that local issuers
             (like State agencies) could share in the savings upon the refunding of bonds as
             long as they enter into a McKinney Act Refunding Agreement and Housing
             Plan to identify how the savings would be used to provide housing for persons
             of very low income. Idaho Housing neither submitted refunding agreements
             and housing plans, nor did it use all the savings for allowable purposes.
             Although HUD disagreed with the GAO report in 1999, Federal regulations
             and, HUD's guidance, prior to this report, at 24 Code of Federal Regulations
             811.110(e) and HUD Notice 95-7 both require HUD and the housing finance
             agency to share in McKinney Act savings generated on bond refunds for non-
             financial adjustment factor as well as financial adjustment factor projects.
             Also, during the audit, we contacted HUD Headquarters program staff
             regarding McKinney Act projects and were told that Idaho Housing would
             have been required to set up a trustee sweep account and HUD would receive
             50 percent of the savings and Idaho Housing would receive the other 50
             percent or the rents would have to be reduced at the projects.

Comment 16   We agree that Section 1012 does not place an explicit requirement on the
             agency to refinance projects. However, this section states, “The Secretary
             shall make available to the State housing finance agency in the State in which
             a qualified project is located, or the local government or local housing agency
             initiating the refinancing of the qualified project, as applicable, an amount
             equal to 50 percent of the amounts recaptured from the project (as determined
             by the Secretary on a project-by-project basis).” Since 50 percent will be



                                          36
             made available to the housing finance agency, it is implied that the other 50
             percent should be returned to HUD.

Comment 17   Idaho Housing could not produce documentation supporting extensive
             discussions with HUD documentation when requested (see also Comment 13).

Comment 18   Idaho Housing states in one sentence that HUD intended that it should receive
             half of all savings from applicable refundings such as the refunding initiated
             by Idaho Housing and then says that HUD was reluctant to state clearly that
             the McKinney Act applied to these transactions. However, if one looks
             outside HUD Notice 95-7, and into the McKinney Act itself, one will see that
             the McKinney Act applies to these projects (see Comment 14).

Comment 19   In our opinion, the 1994 bond refunding represents an exceptional
             circumstance. Idaho Housing did not share the savings resulting from the
             bond refund with HUD and $6,195,107 was not available to provide rental
             assistance to additional low-income persons.

Comment 20   On May 12, 2004, HUD’s Office of Asset Management responded to Idaho
             Housing’s request for approval by restating the proposed terms of the
             refunding and loan restructuring, then referring Idaho Housing to the HUD
             Seattle office. Idaho Housing then wrote to the HUD Seattle office requesting
             written approval of the Modification Agreement and the Mortgage Loan and
             Refunding Commitment. The HUD Seattle office informed Idaho Housing
             that it was not willing to approve these documents due to several concerns
             including issues dealing with (1) McKinney Act savings, (2) renegotiation of
             subsidies upon the termination of the housing assistance payments contract,
             (3) distributions to owners of limited distribution projects, and (4) subsidies in
             excess of fair market rents. HUD’s Seattle office said it would entertain a
             revised proposal considering all of HUD’s concerns. There has been no
             further correspondence regarding this refunding.

Comment 21   The housing assistance payments contracts do not prohibit HUD from
             recapturing savings resulting from bond refunds as implied by Idaho Housing.
             In fact, the housing assistance payments contracts in question are silent on the
             issue. However, the annual contributions contract between Idaho Housing and
             HUD states that Idaho Housing must comply and require owners to comply
             with the U.S. Housing Act of 1937 and all applicable regulations and
             requirements. The McKinney Act is one such requirement (see Comment 14).

Comment 22   The GAO reported that some agencies shared savings from the bond
             refunding of non-Finance Adjustment Factor projects.

Comment 23   McKinney Act violations are a HUD program violation. As such, there is no
             general statute of limitations that applies broadly to claims brought pursuant
             to program violations.

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Comment 24    Idaho Housing mischaracterizes OIG’s intent with respect to this audit report.
             We are not working to punish or penalize program participants, but to ensure
             funds provided for low-income housing assistance are used effectively and
             free up funds to provide rental assistance to additional low income persons.

Comment 25   Idaho Housing staff told us that it calculated the amount of equity the owners
             could take out of the projects by determining the amount of debt service the
             projects could reasonably handle with the current level of HUD subsidy. The
             senior compliance manager said they used the cash flow in place and took out
             the estimated operating cost to determine the available debt service that the
             project could carry and the executive director said they wanted the debt
             service to stay the same so the housing assistance payments contracts
             wouldn’t need to be adjusted. Therefore, if Idaho Housing had refunded the
             bonds without any equity take-outs, the resulting debt service would have
             identified savings to HUD as shown in our report.

Comment 26   At the exit conference, Idaho Housing staff requested an explanation on how
             we calculated the questioned amount. We explained at that time that these
             projects are limited distribution projects that Idaho Housing allowed an equity
             take-out in excess of that limitation. At that time, Idaho Housing staff
             disagreed that the equity take-out constituted a distribution and therefore,
             distributions to owners were not in excess of the limitations. After our exit
             conference, we provided a schedule to Idaho Housing showing how we
             calculated the questioned amount. We also provided HUD’s definition of a
             distribution as “any withdrawal or taking of cash or any asset of the project
             other than for payment of reasonable expenses necessary to the operation and
             maintenance of the project.” In addition, in a discussion with Idaho Housing
             staff on April 19, 2005, we explained that Idaho Housing certified to HUD
             that it would comply with regulations at 24 Code of Federal Regulations
             883.306 with regard to limitations on distributions for any new regulation
             projects in the bond refunding pool. However, as shown in our report, it did
             not comply with this certification.

Comment 27   Idaho Housing, HUD, and the owner of the project amended the housing
             assistance payments contract in 1988 to adopt the new regulations at Subpart
             G of 24 Code of Federal Regulations 883. This subpart incorporates the
             limitation on distributions at 24 Code of Federal Regulations 883.306. Idaho
             Housing contends that the projects owners intended to opt out of the limitation
             on distributions. Further, Idaho Housing stated that there did not need to be
             any overt action to show that the owners opted out of the limitations.
             However, because the regulation specifically refers to the limitations and the
             amendment does not specifically opt out, we believe that this project is subject
             to the limitation. In addition, when the pipeline projects (old regulation
             projects that also adopted Subpart G) opted out of the limitations, there was an
             overt action to show that intent; i.e. the distribution limitation paragraphs were



                                          38
             crossed out of the housing assistance payments contracts that were signed by
             Idaho Housing, HUD, and the owner.

Comment 28   HUD Seattle staff explained to us that they told Idaho Housing that they might
             have to retract the listing of projects as one type or another and that they
             wanted the OIG to look into the matter further. The Seattle staff also
             explained that they felt they had to send something to Idaho Housing to stop
             the current inappropriate activities but made Idaho Housing aware that OIG
             would review the matter. Also, at the request of Idaho Housing, the OIG
             added Appendix D to the report to show the excess distributions for each
             project.

Comment 29   Idaho Housing again mischaracterizes OIG’s intentions. This audit and its
             findings were not undertaken as part of a policy battle with HUD. Contrary to
             this opinion, we initiated this audit at the request of the Region X Multifamily
             Hub due to concerns that Idaho Housing may not have properly implemented
             the conditions of HUD’s approval of the refund.




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Appendix C

INELIGIBLE COSTS – HUD’S PORTION OF MCKINNEY ACT SAVINGS
(Recommendation 2A)

HUD’s portion of McKinney Act savings
McKinney Act projects           Total McKinney Act          Ineligible
                                savings
1       Treated as old regulation projects
Burrell Street Station                            $854,433                   $427,216
Cherrywood Apartments                               863,744                   431,872
College Park Apartments                             213,494                   106,747
Franklin Grove                                      775,868                   387,934
Harrison Hills                                      402,245                   201,122
Hazel Park                                          624,790                   312,395
Parkview Center                                     289,220                   144,610
Pioneer Square Apartments                           891,479                   445,739
Richlin Townhouses                                  332,443                   166,221
Riverwood Apartments                                 18,178                     9,089
Saturn Apartments                                   973,775                   486,887
Shadow Mountain                                     294,803                   147,402
Southside Apartments                                 91,947                    45,974
Tamarack                                            434,930                   217,465
Wildwood                                            593,014                   296,507
Windwood                                            344,550                   172,275
Millcreek Apartments                                450,027                   225,014
Payette Plaza                                       218,750                   109,375
Van Engelen                                         183,869                    91,935
Adams Lane                                          235,658                   117,829
Meadowbrook                                         276,298                   138,149
Payette Townhouses                                  157,914                    78,957
Southdale Apartments                                210,945                   105,473
Snow Mountain                                       593,886                   296,943
2       New regulation limited distribution projects
Aspenwood                                           461,267                   230,633
C Street Manor                                      141,973                    70,986
Eagle Manor                                         527,829                   263,915
Silver Hills                                        249,395                   124,698
Westside Court                                      437,102                   218,551
3       Nonprofit projects
Owyhee Place Apartments                             246,387                    123,194
Totals                                      $ 12,390,213                 $   6,195,107




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Appendix D
FIFTY PERCENT – EXCESS DISTRIBUTIONS

                  McKinney                       Allowable          Excess
                  Act Savings     IHFA's 50%     Distribution     Distribution
Aspenwood          $461,267.00     $230,633.50      $6,764.00      $223,869.50
C Street Manor      141,973.00       70,986.50        7,137.00       63,849.50
Eagle Manor         527,829.00      263,914.50        9,101.00      254,813.50
Owhyee Place        246,387.00      123,193.50                -     123,193.50
Silver Hills        249,395.00      124,697.50        5,769.00      118,928.50
Westside Court      437,102.00      218,551.00        5,683.00      212,868.00
                 $2,063,953.00   $1,031,976.50    $34,454.00      $997,522.50




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