oversight

The Rhode Island Housing and Mortgage Finance Corporation, Providence, Rhode Island, Incorrectly Made More than $1.8 Million in Section 8 Subsidy Payments and Released More Than $900,000 from Restricted Residual Receipts Accounts

Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-07-06.

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

                                                                  Issue Date:
                                                                  July 6, 2006

                                                                  Audit Report Number:
                                                                  2006-BO-1009




TO:         Ellen R. Connolly, Director of Boston Multifamily Housing Hub, 1 AHMLA

FROM:       John A. Dvorak, Regional Inspector General for Audit, New England, 1AGA

SUBJECT: The Rhode Island Housing and Mortgage Finance Corporation, Providence,
           Rhode Island, Incorrectly Made More Than $1.8 Million in Section 8 Subsidy
           Payments and Released More Than $900,000 from Restricted Residual
           Receipts Accounts.


                                   HIGHLIGHTS

 What We Audited and Why

             At the request of the U.S. Department of Housing and Urban Development
             (HUD), we audited the Rhode Island Housing and Mortgage Finance Corporation
             (Corporation), a state housing agency located in Providence, Rhode Island. Our
             audit objectives were to determine whether the Corporation (1) correctly
             processed Section 8 housing assistance payment contract renewals and (2)
             released residual receipts to development owners and itself in violation of federal
             regulations.

 What We Found

             The Corporation incorrectly processed Section 8 housing assistance payment
             contract renewals for eight developments. It included debt service at incorrect
             levels and failed to reduce Section 8 contract rents. The inflated contract rents
             resulted in more than $1.8 million in Section 8 subsidy overpayments to the
             development owners. In addition, the Corporation did not recover the
             overpayments due to the failure of the owners to submit repayment plans on the
             advice of their legal counsel and because it was awaiting the outcome of our
             audit.
           The Corporation also violated federal regulations when it incorrectly interpreted
           those regulations and allowed two developments to use more than $900,000 in
           restricted residual receipts to pay financing fees to the Corporation, the
           Corporation’s affiliated Affordability Housing Trust, and one development owner.
           The Corporation believed using residual receipts in a refinancing transaction as an
           incentive to the owner to extend affordability use restrictions for another forty
           years was an appropriate use of project funds. It indicated that it had returned the
           funds with interest to the residual receipts accounts of the two developments.


What We Recommend


           We recommend that HUD require the Corporation to (1) actively pursue and
           recover just under $1.2 million in Section 8 subsidy overpayments from six
           development owners, (2) confirm that the Corporation returned more than $657,000
           in overpayments collected from two development owners to the appropriate
           accounts, (3) develop and implement procedures to ensure that HUD requirements
           governing the renewal of expiring Section 8 housing assistance payment contracts
           are followed, and (4) clarify its procedures to ensure residual receipts are restricted
           to authorized uses. Further, we recommend that HUD confirm that the
           Corporation returned more than $945,000 to the appropriate restricted accounts.

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

Auditee’s Response


           We provided the Corporation with a draft report on June 8, 2006, and held an exit
           conference on June 20, 2006. The Corporation provided written comments on
           June 28, 2006, in which it generally agreed with the conditions cited in our report
           findings, and suggested revisions to the tone and presentation of the report. In
           consideration of their concerns, we revised our report where appropriate.

           The complete text of the auditee’s response, along with our evaluation of that
           response, can be found in appendix B of this report.




                                              2
                            TABLE OF CONTENTS

Background and Objectives                                                       4

Results of Audit
      Finding 1: The Corporation Incorrectly Processed Contract Renewals That   5
      Resulted in More Than $1.8 Million in Section 8 Subsidy Overpayments
      Finding 2: The Corporation Violated Federal Regulations by Allowing Two   8
      Owners to Use Residual Receipts to Pay Financing Fees

Scope and Methodology                                                           10

Internal Controls                                                               11

Appendixes
   A. Schedule of Questioned Costs and Funds to Be Put to Better Use            12
   B. Auditee Comments and OIG’s Evaluation                                     13




                                            3
                      BACKGROUND AND OBJECTIVES

The Rhode Island Housing and Mortgage Finance Corporation (Corporation) is the state of
Rhode Island’s principal housing agency, operating several business lines including loan
origination, asset management, and loan servicing. The Corporation is a public entity established
in 1973 by the Rhode Island General Assembly. The Corporation was created to expand the
supply of housing available to persons of low and moderate income and to stimulate the
construction and rehabilitation of housing and health care facilities in the state of Rhode Island.
The Corporation is considered an operating unit of the state of Rhode Island.

The Corporation created the Affordability Housing Trust (Trust), a separate legal entity, pursuant
to a trust agreement initiated by the Corporation. The Trust is a private-purpose trust,
established to assist in activities that involve the creation and preservation of affordable housing
in the state of Rhode Island. All Trust resources, including income on investments and other
revenues, are held in trust for the benefit of private and not-for-profit organizations. There is no
requirement that any portion of the Trust’s resources be preserved as capital. The Trust
administers its affairs through its trustees, records its assets in segregated accounts, and
maintains financial records separate from the Corporation.

The U.S. Department of Housing and Urban Development (HUD) provides Section 8 rental
subsidies to the owners of certain mortgaged properties pursuant to a housing assistance payment
contract. The entity responsible for the administration of the Section 8 assistance pursuant to a
particular contract is the designated contract administrator. As of December 2005, the
Corporation acts as the contract administrator for 178 developments assisted under the Section 8
program.

Since its enactment, the Section 8 program has undergone several changes. Under one of those
changes, effective February 29, 1980, housing assistance payment contracts are categorized as
either old regulation or new regulation contracts. Developments with an initial application
before February 29, 1980, are subject to one set of regulations (old regulations), while
developments with a later initial application are subject to a separate set of regulations (new
regulations). A key difference is that the old regulation contracts and the applicable federal
regulations in effect for those pre-80 developments did not require the development owner to
account for project funds, did not limit distributions, and did not require the owner to establish
reserves to cover residual receipts and reserve for replacement accounts.

The audit objectives were to determine whether the Corporation (1) correctly processed Section
8 housing assistance payment contract renewals or (2) released residual receipts to development
owners and itself in violation of federal regulations.




                                                 4
                                       RESULTS OF AUDIT

Finding 1: The Corporation Incorrectly Processed Contract Renewals
That Resulted in More Than $1.8 Million in Section 8 Subsidy
Overpayments
The Corporation incorrectly processed Section 8 housing assistance payment contract renewals
for eight developments renewed under option four 1 of the Section 8 Renewal Policy Guidebook.
This occurred because, during the budget processing for each development, the Corporation did
not follow HUD regulations and included debt service at incorrect levels, which had the effect of
inflating the applicable contract rents. This deficiency was further impacted by the
Corporation’s incorrect belief that the development’s Section 8 contract rents could not be
reduced below their current levels. As a result, the Corporation made Section 8 subsidy
overpayments to the development owners totaling more than $1.8 million. The Corporation did
not recover the overpayments due to the failure of the owners to submit repayment plans on the
advice of their legal counsel and because it was awaiting the outcome of our review.


    Incorrectly Processed Renewals
    Resulted in More Than $1.8
    Million in Subsidy
    Overpayments

                  During a 2004 review, the HUD Rhode Island state office identified that the
                  Corporation had made errors in the Section 8 contract renewals processed for six
                  developments under option four. HUD asked that we review all developments the
                  Corporation renewed under option four. We identified 14 developments with
                  expiring contracts renewed under option four.

                  Our review of the 14 developments the Corporation renewed under option four
                  showed that the Corporation had identified subsidy overpayments totaling more
                  than $1.7 million for the six developments with contract renewal errors. The
                  errors occurred because the Corporation did not draft its own written policies and
                  procedures detailing the procedures to follow, and was not proactive in seeking
                  clarification from HUD regarding its own interpretation of HUD regulations. The
                  corporation included debt service at incorrect levels, including adding expired
                  debt service to the budget or including debt service for the entire year when it was
                  scheduled to mature during budget processing for each development. In addition,
                  the Corporation mistakenly believed that a development’s Section 8 contract rents

1
  Option four is one of six renewal options available to development owners detailed in the Section 8 Renewal
Policy Guidebook, developed to provide comprehensive guidance for renewing expiring Section 8 project-based
contracts. Under option four, the initial renewal rents are set at the lower or the current rents adjusted by the
published operating cost adjustment factor or the development’s budget, which is defined as the rent level required
to meet operating expenses.




                                                         5
             could not be reduced below their current levels and allowed the contract rents for
             each development to remain in effect.

             Our review of the other eight developments identified similar processing errors in
             two of those developments, resulting in Section 8 subsidy overpayments of
             $101,389. For all eight developments with contract renewal errors, there was
             more than $1.8 million in Section 8 subsidy overpayments, as detailed in the table
             below.

                Development contract number          Section 8 subsidy overpayment
              RI43H023023                                                   $654,460
              RI43H023005                                                   $358,731
              RI43H023021                                                   $326,290
              RI43H023022                                                   $232,510
              RI43H023052                                                   $160,082
              RI43H023078                                                    $98,579
              RI43H023032 and RI43H023040                                    $20,967
              RI43H023002                                                     $2,810
                          Total                                           $1,854,429



Subsidy Overpayments Were
Not Repaid

             Beginning in December 2004, the Corporation sent letters requesting repayment
             to the six development owners identified by HUD. However, the Corporation
             stated that the development owners, on the advice of their counsel, refused to
             submit repayment plans and that the issue was further complicated by the
             initiation of our audit. Therefore, the Corporation had not received repayment
             from any of the development owners before this audit. Following our audit, in
             March 2006, the Corporation again sent requests for repayment to the two
             additional development owners identified with contract renewal errors.
             Additionally, in May 2006, the Corporation began to actively seek repayment
             from the other six development owners and sent revised requests for repayment of
             the overpayments to these six owners. As of May 23, 2006, the Corporation
             received repayments from two development owners of $654,460, and $2,810
             respectively.

Conclusion


             The Corporation incorrectly processed Section 8 housing assistance payment
             contract renewals for eight developments renewed under option four of the
             Section 8 Renewal Policy Guidebook. HUD identified overpayments that
             resulted from contract renewal errors for six developments, but the Corporation




                                              6
          did not recover repayment of the overpayments due to the owner’s refusal to
          submit repayment plans pending completion of our audit and HUD’s review. The
          audit identified two other developments with overpayments, and the Corporation
          again began to actively seek repayment from the development owners totaling
          more than $1.8 million as a result of the audit.


Recommendations



          We recommend that HUD

               1A.    Require the Corporation to actively pursue and recover the $1,197,159
                      in Section 8 subsidy overpayments from the six development owners.

               1B.    Confirm that the Corporation returned $657,270 ($654,460 and
                      $2,810, respectively) to the appropriate accounts.

               1C.    Require the Corporation to develop and implement procedures to
                      ensure that HUD requirements governing the renewal of expiring
                      Section 8 housing assistance payment contracts are followed.




                                          7
                                RESULTS OF AUDIT


Finding 2: The Corporation Violated Federal Regulations by Allowing
Two Owners to Use Residual Receipts to Pay Financing Fees
In an effort to ensure the extension of affordability restrictions, the Corporation incorrectly
allowed two developments to use residual receipts to pay financing fees to the Corporation, the
Trust, and one owner in violation of federal regulations. This occurred because the Corporation
incorrectly interpreted federal regulations and believed the use of residual receipts in a
preservation refinancing transaction was an appropriate use of development funds.
Consequently, these two developments had $920,428 less in their residual receipts accounts. The
Corporation acknowledged its errors and indicated that it had the funds returned with interest to
the residual receipts accounts of the two developments.



 Restricted Residual Receipts
 Incorrectly Used in Refinancing
 Transactions

             Housing assistance payment contracts are categorized as either old regulation or
             new regulation contracts. Developments with an initial application before February
             29, 1980, are subject to one set of regulations (old regulation contracts or pre-80
             contracts), while developments with applications after this date are subject to a
             separate set of regulations (new regulation contracts or post-80 contracts). The old
             regulation contracts are far less restrictive and do not require residual receipts or
             replacement for reserve accounts. The new regulation contracts require that
             development owners establish residual receipts accounts and limit the use of funds
             within these accounts for reductions in housing assistance payments or for other
             project uses if the funds exceed the amount needed for project operations, reserve
             requirements, and permitted distributions.

             We reviewed 17 new regulation (post-80) contracts administered by the
             Corporation and found that they permitted two development owners to use the
             restricted residual receipts as part of the two developments’ refinancing transaction.
             The Corporation indicated that use of residual receipts for refinancing was an
             appropriate use because it provided an incentive to the two development owners to
             maintain the developments as affordable housing. Financing fees, however, are an
             expense of the ownership entity and not an appropriate project use. As part of these
             refinancing transactions, the Corporation allowed the release of residual receipts to
             pay $534,767 in preservation fees to the Trust, $291,802 in other financing fees,
             and $93,859 to one owner in violation of federal regulations, as shown in the table
             below.




                                                8
                                                           RI43H023124         RI43H023113              Totals

               Preservation fee to the Trust                     $149,106            $385,661            $534,767
               Other financing fees                                                  $291,802            $291,802
               Payment to owner                                                       $93,859             $93,859
                 Total ineligible expenditures                   $149,106            $771,322            $920,428


    Conclusion


               As part of a preservation transaction extending affordability restrictions, the
               Corporation incorrectly allowed two developments to use residual receipts to pay
               financing fees to the Corporation, the Trust, and one owner in violation of federal
               regulations. As a result of our audit, the Corporation indicated that it had the funds
               returned with interest to the residual receipts accounts of the two developments.


    Recommendations



             We recommend that HUD:

                      2A.      Require the Corporation to clarify its procedures to ensure residual
                               receipts are restricted to authorized uses.

                      2B.      Confirm that the Corporation returned $945,829 2 (repayment of
                               $920,428 and interest of $25,401) to the appropriate accounts.




2
  Of this amount, the Corporation indicated that it returned $149,106 in preservation fees plus interest of $4,587 to
the first development. The Corporation further indicated that it returned $385,661 in preservation fees plus interest
of $9,550 and $291,802 in other financing fees and $93,859 paid to the owner plus interest of $11,264 to the second
development.




                                                          9
                         SCOPE AND METHODOLOGY

To achieve our audit objectives, we

       ¾ Identified, obtained, and reviewed federal regulations and HUD
         handbooks/guidebooks pertaining to the Section 8 program.

       ¾ Met with and interviewed Corporation personnel and local HUD personnel from the
         multifamily office in Providence, Rhode Island.

       ¾ Reviewed legal correspondence and opinions concerning the requirement and
         treatment of residual receipts for both pre-80 and post-80 developments and sought
         additional guidance from the HUD Office of General Counsel.

       ¾ Reviewed the housing assistance payment contracts, renewal contracts, loan files,
         accounting data, and other records for selected developments.

       ¾ Reviewed 31 developments, including the housing assistance payment contract
         renewal processing for 14 developments renewing their expiring contracts under
         option four and the use and treatment of residual receipts for 17 post-80
         developments.

       ¾ Summarized our analyses.

We performed audit work at the Corporation’s office and at the HUD multifamily office in
Providence, Rhode Island, from October 2005 through April 2006. Our audit generally covered
the period January 1, 2003, through June 30, 2005, and was expanded as needed to meet our
objectives.

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




                                             10
                             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 management
                      implemented to reasonably ensure that the Section 8 contract renewal
                      process complies with HUD requirements and that the intended objectives
                      are met.

              •       Compliance with laws and regulations. Policies and procedures that
                      management implemented to reasonably ensure that its administration of
                      Section 8 developments is consistent with laws and regulations.

              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 items are significant weaknesses:

              •       Program operations. The Corporation does not have controls in place to
                      ensure that expiring Section 8 housing assistance payment contracts are
                      processed in compliance with HUD requirements and that the intended
                      objectives were met (see finding 1).




                                               11
                                   APPENDIXES

Appendix A

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

                         Recommendation            Ineligible 1/
                                number
                                       1A           $1,197,159
                                       1B             $657,270
                                       2B             $945,829


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
     polices or regulations.




                                            12
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION

Ref to OIG Evaluation   Auditee Comments




                         13
Ref to OIG Evaluation   Auditee Comments




Comment 1




                         14
Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




Comment 3




Comment 4



Comment 5




                         15
Ref to OIG Evaluation   Auditee Comments




Comment 5




Comment 6




Comment 7




                         16
Ref to OIG Evaluation   Auditee Comments




Comment 8




Comment 9




Comment 10




                         17
Ref to OIG Evaluation   Auditee Comments




Comment 11




Comment 12




                         18
                         OIG Evaluation of Auditee Comments

Comment 1   The Corporation acknowledged that errors occurred because incorrect debt
            service levels were included in the budget worksheets. Although we recognize
            and commend the Corporation's efforts to preserve affordable housing, we
            disagree that the report does not provide the proper context of the errors. The
            report continually states that the errors occurred during contract renewals and
            provides a footnote stating that option four is one of six renewal options available
            to development owners for renewing expiring Section 8 project-based contracts.
            The Corporation stated that, in the early 1990's, the Section 8 contract renewal
            process was a relatively new initiative for HUD and the Corporation. However,
            our audit period was between January 1, 2003 through June 30, 2005, and the
            contract renewals identified with errors in this report all took place within that
            period.

Comment 2   The Corporation stated that, in addition to a mutual lack of experience, the
            renewal guide was less than clear about how debt service was to be included in
            the rent calculation under Option 4 and provided examples of sections where they
            felt the renewal guide was not clear. The Corporation had the opportunity to
            contact the local HUD office for clarification on how to properly process contract
            renewals if it found the renewal guide to be unclear.

Comment 3   The Corporation stated that it completed the renewals based on their best
            interpretation of the materials and that their submissions to HUD revealed that the
            original debt service was included in the budget worksheets. Again, the
            Corporation had the opportunity to contact the local HUD office for clarification
            on how to properly process contract renewals. HUD relies on the Corporation, as
            the contract administrator, to properly renew expiring Section 8 contracts and set
            the new rent levels. HUD is only required to review and approve the new rents in
            instances where the rent increase is five percent or higher. Additionally, although
            there was a gap between the initial renewals and when HUD identified the errors,
            HUD identified the errors during a routine annual review. It is not unusual for
            HUD to identify errors during these reviews and that is why they are performed.

Comment 4   We recognize the Corporation's efforts in working with the local HUD office in
            an attempt to resolve the uncertainty surrounding the contract renewal process.
            Nonetheless, the issues were not resolved after HUD's initial disclosure in 2004
            and the local HUD office found it necessary to request our assistance in 2005.

Comment 5   The Corporation acknowledged that there were errors in the Option 4 contract
            renewal process, but suggested that the errors were more properly attributable to a
            lack of clarity in the renewal guide and accompanying documents. Again, the
            Corporation had the opportunity to contact the local HUD office for clarification
            on how to properly process contract renewals if it found the renewal guide to be
            unclear. Suggesting that the requirements were susceptible of a reasonable but




                                             19
              incorrect interpretation does not relieve the Corporation of its responsibilities as
              Contract Administrator.

Comment 6     Based on a review of the additional documentation provided at, and subsequent
              to, the exit conference, we amended the report to state that the Corporation did not
              recover the overpayments due to the owner’s failure to submit repayment plans
              and because it was awaiting the results of our audit. Additionally, we appreciate
              the Corporation's diligence to pursue the return of the subsidy overpayments from
              the remaining six developments as recommended.

Comment 7     We appreciate the Corporation's willingness to act on our recommendations and
              hope that the Corporation works with its local HUD office in reaching an
              acceptable management decision on our recommendations. The checklists and
              cross-training are both positive steps toward ensuring that expiring Section 8
              contracts are correctly renewed in accordance with HUD requirements.

Comment 8     We acknowledge that the Corporation recognized their error and that they
              returned the funds from their Affordable Housing Trust to the residual receipts
              account for each development, with interest. In accordance with recommendation
              2B, HUD should confirm the repayment.

Comment 9     The Corporation acknowledged that they permitted a portion of the residual
              receipts funds to be used as an additional source to benefit the owner in a
              financing transaction. We recognize that it is the Corporation's belief that using
              funds for this purpose is consistent with the regulatory directive that residual
              receipts funds be used to benefit the development. However, as detailed in
              finding 2, we disagree with their belief and stand by our conclusion that the use of
              residual receipts in a financing transaction does not benefit the development.


Comment 10 We recognize that the Corporation will no longer permit residual receipt funds to
           be used for the benefit of development owners absent approval by HUD on a
           case-by-case basis. We also recognize that the funds, with interest, have been
           returned to the appropriate residual receipts account. In accordance with
           recommendation 2B, HUD should confirm the repayment.

Comment 11 We appreciate the Corporation's willingness to act on our recommendations and
           hope that the Corporation works with its local HUD office in reaching an
           acceptable management decision on our recommendations.

Comment 12 We agree that the Corporation's actions were not in an effort to deceive HUD or
           to deliberately violate applicable regulations. We recognize that errors and
           inadvertent oversights occur. We also recognize that, at times, these errors and
           inadvertent oversights do result in a violation of applicable regulations, as detailed
           in our report. We appreciate the Corporation's candor and willingness to change
           as it continues its efforts to preserve the inventory of at-risk Section 8 housing.




                                                20