oversight

The City of San Diego, California Did Not Administer Its Community Development Block Grant Program in Accordance with HUD Requirements When Funding the City's Redevelopment Agency Projects

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-12-30.

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

                                                                Issue Date
                                                                    December 30, 2008
                                                                Audit Report Number
                                                                     2009-LA-1005




TO:        William Vasquez, Director, Community Planning and Development, 9FD



FROM:      Joan S. Hobbs, Regional Inspector General for Audit, 9DGA

SUBJECT: The City of San Diego, California Did Not Administer Its Community
         Development Block Grant Program in Accordance with HUD Requirements
         When Funding the City’s Redevelopment Agency Projects


                                   HIGHLIGHTS

 What We Audited and Why

      We selected the City of San Diego’s (City) Community Development Block Grant
      (CDBG) program for audit in response to a hotline complaint. The citizen complainant
      alleged that the City’s Redevelopment Agency (Agency) had received loans from the
      City’s CDBG program dating back to the 1970s and that the loans had accumulated
      interest in violation of applicable U.S. Department of Housing and Urban Development
      (HUD) rules and regulations. Our main objective was to address the citizen complaint
      and determine whether the City administered its CDBG loans issued to the Agency in
      accordance with HUD rules and regulations.


 What We Found


      The City failed to properly administer its CDBG funds provided to the Agency in
      accordance to HUD requirements. For the 35 redevelopment projects sampled as part of our
      review, almost $13 million in CDBG costs was questionable, including more than $1.8
      million in ineligible and $11 million in unsupported costs.
    The City did not enter into required agreements with the Agency or list the projects in the
    action plan or subsequent amendments to HUD and failed to monitor the project activities as
    required by HUD regulations.

    The City also issued legitimate loans to the Agency to fund 35 CDBG activities for eight
    project areas using mostly program income funds. However, it failed to execute loan
    agreements and repayment schedules for the CDBG loans issued to the Agency with an
    overall principal balance of more than $63 million and an accumulated interest balance of
    more than $76 million. The Agency did not make consistent good faith efforts to repay the
    CDBG loans to the City and primarily used the debt to leverage/obtain state tax increments.


What We Recommend

    We recommend that the Director of the Office of Community Planning and Development
    require the City to

           Pay back more than $1.8 million plus any applicable interest to HUD from
           nonfederal funds for CDBG project costs determined to be ineligible.
           Provide supporting documentation for unsupported redevelopment project
           activities or reimburse its program more than $11 million from nonfederal funds.
           Execute written interagency agreements and loan agreements with the Agency for
           outstanding loans totaling more than $139 million.
           Implement written procedures and controls to ensure timely payments on CDBG
           loans, that the City and the Agency adequately monitor CDBG activity and
           maintain adequate supporting documentation, and all future redevelopment
           projects are included in the action plan or amendments.

    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 a draft report to City officials on November 19, 2008 and requested their
    response by December 8, 2008. We discussed the results of our review during the audit
    and at an exit conference on December 2, 2008. City officials provided their written
    comments on December 8, 2008. They generally disagreed with the draft report findings.
    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 City Failed to Properly Administer Its CDBG Funds Provided to   6
                  the Redevelopment Agency.

       Finding 2: The City Did Not Execute Loan Agreements and Failed to Ensure       13
                  Repayment of Outstanding CDBG Loans.

Scope and Methodology                                                                 18

Internal Controls                                                                     20

Appendixes
  A.   Schedule of Questioned Costs and Funds to be Put to Better Use                 21
  B.   Auditee Comments and OIG’s Evaluation                                          22
  C.   Schedule of Ineligible and Unsupported Costs by Project/Activity               45
  D.   Schedule of Administrative Deficiencies by Project/Activity                    46
  E.   Schedule of Outstanding Redevelopment Loans/Reloans                            47
  F.   Schedule of Outstanding CDBG Debt – Central Imperial                           48
  G.   Schedules for CDBG Loan Repayment Estimates                                    49
  H.   Criteria                                                                       50




                                             3
                         BACKGROUND AND OBJECTIVES

The Community Development Block Grant (CDBG) program was established by Title I of the
Housing and Community Development Act of 1974 (Public Law 93-383). The program provides
grants to state and local governments to aid in the development of viable urban communities.
Governments are to use grant funds to provide decent housing and suitable living environments
and to expand economic opportunities, principally for persons of low and moderate income. To
be eligible for funding, every CDBG-funded activity must meet one of the program’s three
national objectives.

        (1)    Benefit low-and moderate-income persons.
        (2)    Aid in preventing or eliminating slums or blight, or
        (3)    Address a need with a particular urgency because existing conditions pose a serious
               and immediate threat to the health or welfare of the community.

The City of San Diego
The City of San Diego (City) is a CDBG entitlement recipient and according to the U.S.
Department of Housing and Urban Development (HUD) Integrated Disbursement and Information
System,1 the City has received an average of $17.9 million (excluding program income) in CDBG
funds annually during the past eight years. These funds are available to support a variety of
activities directed at improving the physical condition of neighborhoods by providing housing or
public improvements/facilities, fostering economic development by providing technical and
financial assistance to local businesses, creating employment, or improving services for low- and/or
moderate-income households.

The City is a diverse city of urban and suburban communities. Eight council districts participate in
the City’s CDBG program. Several nonprofit organizations also receive CDBG funds from the City
to help carry out activities. Until fiscal year 2007, the City’s Community Services Division
administered the CDBG program and was in charge of overseeing and monitoring subgrantees, as
well as directly delivering CDBG-funded activities. Currently, the Department of City Planning
and Community Investment is responsible for the administration of the CDBG program. This
newly constituted department combines planning, economic development, and redevelopment to
integrate the City’s development strategy, policies, and visioning processes with some of its
major implementation tools. It is organized into four divisions, Community Planning, Urban
Form Planning, Economic Development, and Redevelopment each led by a deputy director. The
Economic Development division manages the City’s CDBG program.

The City’s Redevelopment Agency
The Redevelopment Agency (Agency) was created by the city council in 1958 to alleviate
conditions of blight in older, urban areas by state authority defined in California’s Health and
Safety Code (section 33000-et.seq.), also known as the California Community Redevelopment
Law.
1
 The Integrated Disbursement and Information System is a real-time, mainframe-based computer application used
by grantees to enter, maintain, and report on projects and activities that support HUD’s community planning and
development formula grant programs including CDBG.


                                                       4
The Redevelopment Division of the Community and Economic Development Department serves
as staff to the Agency. The Agency oversees 17 redevelopment project areas, encompassing
more than 8,000 acres. In addition, it administers seven project area committees that advise the
Agency regarding plan adoption and project implementation activities. An additional two
corporations assist the Agency with redevelopment activities.

   (1) Southeastern Economic Development Corporation is an independent corporation in
       charge of all redevelopment activities within a seven-square-mile area immediately east
       of downtown San Diego, in the community known as southeastern San Diego.
       Established in 1981 by the City, it is responsible for four adopted redevelopment project
       areas and one study area.

   (2) Centre City Development Corporation is a public, nonprofit corporation created by the
       City to staff and implement downtown redevelopment projects and programs. Formed in
       1975, the corporation serves on behalf of the Agency as the catalyst for public-private
       partnerships to facilitate redevelopment projects adopted pursuant to redevelopment law.
HUD’s 2007 Review of City’s CDBG Program
HUD’s Office of Community Planning and Development performed a monitoring review in
fiscal year 2007 and identified several problems with the City’s administration of the CDBG
program, including (1) no single audits performed by the City since fiscal year 2004, (2) lack of
supporting documentation, and (3) no minimum funding amounts for sub-recipients. To help
address the problems with the CDBG program, the City’s mayor transferred administration
responsibilities from the Community Services to the Economic Development department on July
1, 2007. The City’s economic development deputy director informed us that the city council has
since had hearings on CDBG reform. The City was trying to put together a comprehensive plan
for reform to address problems identified by HUD and the City. The City has an interim reform
(remedial approach) plan to address HUD findings and concerns that will keep the CDBG
program compliant for fiscal year 2009 and will develop a comprehensive program that will be
put into full implementation for fiscal year 2010. The comprehensive program will include
policies and procedures for allocations, monitoring, etc. The goal is to have one group plan
CDBG allocations and remove this responsibility from the city council and mayor’s office.

We acknowledge that the deputy director overseeing the CDBG program administration, at the
time of our audit, dedicated a great deal of his time and effort to correcting the City’s CDBG
program’s administrative deficiencies. Since his taking responsibility for the CDBG program,
redevelopment projects have not been CDBG funded, and the number of sub-recipients has
decreased due to the establishment of a minimum sub-recipient amount of $25,000, which should
allow the City to administer the CDBG program more efficiently.
Objectives
We audited the City’s CDBG program in response to a HUD Office of Inspector General (OIG)
hotline complaint. Specifically, the complaint focused on unpaid loans issued to the City’s
Agency using CDBG funds. Our main objective was to address the citizen complaint and to
determine whether the City administered its CDBG loans issued to the Agency in accordance
with HUD rules and regulations.



                                                5
                                        RESULTS OF AUDIT


Finding 1: The City Failed to Properly Administer CDBG Funds
           Provided to the Agency
The City failed to properly administer CDBG funds provided to the Agency in accordance with
HUD requirements. We determined that more than $1.8 million in CDBG cost was ineligible,
$5.1 million where the eligibility was questionable and unsupported, and an additional $6 million
was not adequately supported. The City failed to (1) execute interagency/interdepartment
agreements; (2) list the projects in the action plan submitted to HUD or submit appropriate
amendments; and (3) monitor the project activities to determine whether the costs were
reasonable, allowable, allocable, and eligible. We attribute this condition to the City’s failure to
follow HUD requirements and the lack of proper policies and procedures. As a result, the City
failed to ensure that nearly $13 million in CDBG funds was used in compliance with program
requirements to ensure appropriate benefit to low- and moderate-income persons.



    Ineligible CDBG Redevelopment
    Project Costs


         The City failed to review CDBG costs to determine whether the costs were reasonable,
         allowable, allocable, and eligible. We reviewed all 35 of the City’s CDBG loans
         originated between fiscal years 2000 and 2007 and determined that more than $1.8
         million was spent for ineligible purposes/activities on 9 projects2, including Central
         Imperial, Southcrest, and Crossroads activities. Each of the following items was
         recorded in HUD’s Integrated Disbursement and Information System as “planning.”
         Although 24 CFR 570.208(d)(4) states CDBG funds expended for planning costs under
         Sec. 570.205 and Sec. 570.206 will be considered as addressing the national objectives,
         we determined these costs were not for eligible planning activities.

                  Project #1 (Central Imperial) - $144,993 was used for acquisition and not for
                  planning. Regulations at 24 CFR 570.205 state that eligible planning activities do
                  not include project implementation costs. As an acquisition, it would also be
                  ineligible due to the area’s not being primarily residential.
                  Project #7 (Central Imperial) – nearly $1.3 million was also used for acquisition
                  and not for planning.




2
  In addition to the 9 projects being ineligible, they were also unsupported due to the lack of (1) agreements, (2)
identification in the action plan/amendments, and (3) monitoring (see the Unsupported CDBG Redevelopment
Project Costs section below).


                                                           6
                  Project #9 (Central Imperial) - $2,020 was not an allowable expense because
                  engineering costs are not eligible planning expenses according to 24 CFR
                  570.205(a)(4)iii, nor was it an approved preaward cost under 24 CFR 570.200(h).
                  Project #13 (Central Imperial) - $5,064 in nonplanning costs was unallowable,
                  since planning activities specifically exclude project implementation costs
                  according to 24 CFR 570.205(a)(6)(5).
                  Project #15 (Southcrest) - $4,118 was for expenses incurred during a Southcrest
                  Park Plaza commemoration festival, which is not a planning activity according to
                  Office of Management and Budget (OMB) Circular A-87, attachment B-14. In
                  addition, $21,873 was for general government services, which is also not a
                  planning activity and according to (OMB) Circular A-87, attachment B-19, is
                  unallowable.
                  Project #22 (Central Imperial) - $67,002 was not used for planning but for general
                  administration costs and not allowable under 24 CFR 570.205.
                  Project #27 (Crossroads) - $33,911 in reviewed costs was ineligible because the
                  costs were not approved preaward costs according to 24 CFR 570.200(h).
                  Project #29 (Crossroads) - $1,200 in media/advertising costs was ineligible under
                  OMB Circular A-87, attachment B(1)(f). The expense items were not geared to a
                  specific project but to the City in general.
                  Project #34 (Central Imperial) - $235,578 in costs was not for eligible planning
                  activities but for general administration, which is not allowed under 24 CFR
                  570.205.


    Eligibility of Central Imperial was
    Questionable


         All expenditures related to the Central Imperial projects listed below, totaling $5.1
         million, were questionable under their recorded national objective of benefitting low- and
         moderate-income persons in an area. Regulations at 24 CFR [Code of Federal
         Regulations] 570.208(a)(1)(i) states that an activity that serves an area that is not
         primarily residential in character shall not qualify under this criterion. Based on
         information from the Southeastern Economic Development Corporation, the Central
         Imperial redevelopment project area is only 32 percent residential, which is not primarily
         residential. Insufficient supporting documentation was provided to demonstrate the
         projects met the national objective. Therefore, the total combined cost of more than $5.1
         million for these 10 projects must be supported or repaid.3

                  Project #4 - $145,000 used for public facilities and improvements
                  Project #5 - $275,207 used for public facilities and improvements
                  Project #10 - $93,625 used for commercial/industrial land acquisition/disposition

3
  In addition to the eligibility of the 10 Central Imperial projects being questionable, they were also unsupported due
to the lack of (1) agreements, (2) identification in the action plan/amendments, and (3) monitoring (see the
Unsupported CDBG Redevelopment Project Costs section below).


                                                           7
            Project #11 - $717,264 used for other commercial/industrial improvements
            Project #12 - $500,000 used for other commercial/industrial improvements
            Project #18 - $352,000 used for other commercial/industrial improvements
            Project #24 - $1.1 million used for commercial/industrial land
            acquisition/disposition
            Project #25 - $502,042 used for other commercial/industrial improvements
            Project #28 - $340,040 used for commercial/industrial infrastructure development
            Project #31 - $1.1 million used for public facilities and improvements

Unsupported CDBG Redevelopment
Project Costs

     The City failed to (1) execute interagency/interdepartment agreements, (2) list the
     projects in the action plan submitted to HUD or submit amendments to include the
     projects, and (3) monitor the project activities (including maintenance and review of
     CDBG exclusive project files to ensure eligibility) for all redevelopment projects
     utilizing CDBG funds. As a result, the remaining $6 million in costs attributable to the
     35 projects was unsupported (see appendix C for results by project).

Lack of Project Agreements
with the Agency


     Since the Agency, the Centre City Development Corporation, and the Southeastern
     Economic Development Corporation were designated by the City’s CDBG administration
     to undertake redevelopment activities assisted with CDBG funds, they are components
     (local public agencies) of the City government. Therefore, according to 24 CFR
     570.501(a), as “public agencies/units of local government,” they are subject to the same
     requirements as sub-recipients of grant funds.

     Regulations at 24 CFR 570.503(a) and (b) state that a recipient shall sign a written
     agreement with the sub-recipient or public agency, as provided by 24 CFR 570.501(a),
     before disbursing any CDBG funds to a sub-recipient, and at a minimum, the written
     agreement shall include provisions on a statement of work, records and reports, program
     income, uniform administrative requirements, other program requirements, and
     suspension and termination clauses. However, the City improperly disbursed nearly $13
     million for all 35 redevelopment projects and recorded them as interest-bearing loans
     without executing an agreement containing the minimum project activity information
     required by HUD regulations. Without the required agreements, HUD could not
     determine the intended project scope, budget, and basis for assessing the City’s grant
     administration performance.

     During the course of our audit, the City’s CDBG administrator informed us that the
     Agency’s projects did not submit any type of application, agreement, or contract to the
     CDBG administration office.


                                              8
         These actions were usually initiated by city council approval of an Agency request to
         fund the loans. According to the program administrator, the direction that she had been
         given was that the City did not need to require an application because redevelopment
         projects were assumed, by prior management, to be eligible for CDBG funds.

    Projects Not Listed in the Action Plan and
    Amendments Not Submitted

         The City failed to list the projects in the consolidated action plan submitted to HUD, and
         amendments were not recorded to include the projects as required. The action plan is a
         planning document required by HUD as an application for federal formula grant funds,
         listing and describing activities to be undertaken and a strategy for carrying out HUD
         programs to provide a basis for assessing performance. We reviewed the
         consolidated/action plans for fiscal years 2000 through 2007 to determine whether the
         projects in our sample of 35 Agency project activities were listed in the action plan and
         whether an amendment was submitted for those projects that were not listed in the action
         plan. The consolidated/action plans for fiscal years 2000 through 2007 did not list 34 of
         35 projects4 from our sample project activities selection. Most of the consolidated plans
         reviewed had a broad overview of the various redevelopment project areas within the
         City, but they did not list specific project activities funded by CDBG during those fiscal
         years.

         In addition, none of the reviewed action plans contained amendments indicating that
         funding was available and allocated to any of the 35 projects/activities in our sample. We
         were told by HUD’s Office of Community Planning and Development and the City’s
         CDBG administration that action plan amendments were not submitted to HUD during
         our audit period. According to 24 CFR 91.505(a), the grantee shall amend the approved
         action plan whenever one of the following decisions is made: (1) to make a change in its
         allocation priorities or a change in the method of distribution of funds; (2) to carry out an
         activity, using funds from any program covered by the consolidated plan (including
         program income), not previously described in the action plan; or (3) to change the
         purpose, scope, location, or beneficiaries of an activity. All 35 reviewed
         projects/activities fell within at least one of those three categories as shown through the
         examples below.

             (1) To make a change in its allocation priorities or a change in the method of
                 distribution of funds.

                  The amount of $100,000 was reallocated from Council District 7 CDBG funds to
                  the Crossroads project area survey. Agency and City resolutions specifically
                  stated that the funds were for Agency and consultant staff costs and related
                  expenses for the feasibility study of the Crossroads redevelopment survey area.


4
  The only project listed in the action plan was project number 35, listed as Grantville redevelopment survey for
fiscal year 2006, which did not receive CDBG funds.


                                                          9
           The action plans for fiscal years 2001 and 2002 did not contain the Crossroads
           project activity above, and there was no subsequent amendment or notification
           sent to HUD.

        (2) To carry out an activity, using funds from any program covered by the
            consolidated plan (including program income), not previously described in the
            action plan.

           Of the 35 reviewed projects, 34 fell under this category, since they all used CDBG
           funds, and were not previously described in the action plan, nor were amendments
           or notifications sent to HUD to include any of them after HUD’s approval of the
           plan.

        (3) To change the purpose, scope, location, or beneficiaries of an activity.

           City Resolution R-293165, dated May 30, 2000, authorized the reprogramming of
           $90,000 previously allocated to public facilities – neighborhoods for the Wall of
           Excellence project, changing the beneficiary of the activity to Central Imperial -
           North Creek Site. The action plans for fiscal years 2000 and 2001 did not contain
           the Central Imperial project/activity above and there was no subsequent
           amendment or notification sent to HUD.

    Since the City failed to include the projects in the consolidated/action plan and
    amendments were not submitted, HUD did not receive a description of the activities to be
    undertaken nor the strategy to be used for carrying out the CDBG program to provide a
    basis for assessing performance.

Monitoring Not Performed and
CDBG Records Not Maintained


    The City failed to monitor the project activities and did not maintain CDBG exclusive
    files for any of the 35 projects, contrary to 24 CFR 85.40(a), which states that grantees
    must monitor grant- and subgrant-supported activities to ensure compliance with federal
    requirements and the achievement of performance goals. The City did not perform any
    type of project monitoring on any of the 35 reviewed projects, despite statements in the
    consolidated annual performance and evaluation reports to HUD that there was
    monitoring of CDBG activity.

    No Agreements or Monitoring Reports Prepared

    Since the City failed to execute inter-agency/inter-department agreements (see above)
    with the Agency for all 35 reviewed redevelopment project activities, it did not have: a
    description of the work to be performed, a schedule for completing the work, and a
    CDBG budget for each project. According to 24 CFR 570.503(b), these items shall be in
    sufficient detail to provide a sound basis for the recipient to effectively monitor



                                             10
performance under the agreement. The absence of project monitoring occurred because
the City did not follow CDBG regulations to obtain the required information from the
Agency before the disbursement of the CDBG funds in order to have a sound basis to
monitor project/activity performance.

The City did not have any type of monitoring or progress reports for any of the reviewed
redevelopment projects. The Agency’s current deputy director stated that she had not
seen any CDBG monitoring reports and did not know whether any existed. While
working at the Centre City Development Corporation, she also did not see or create any
CDBG monitoring reports. Without monitoring reports, HUD had no assurance that
CDBG funds were used properly and in compliance with pertinent rules and regulations.

City Not Reviewing Costs for CDBG Eligibility and Lack of Centralized Records

Neither the City nor the Agency reviewed redevelopment costs for CDBG eligibility. In
addition, the files and records related to the City’s CDBG program were not maintained
at one central location, and neither the City’s CDBG administration nor the Agency
maintained CDBG exclusive records for the redevelopment project areas.

The Agency’s finance specialist stated that he was not aware of an eligibility process for
loans administered by the City or the Agency and did not know what documentation
would be required by HUD rules and regulations. The only documents that would be
maintained with a particular project were the mayoral action or council action and the
staff report stating the general purpose of the funding with little detail. The Agency was
uncertain about all of the CDBG rules because CDBG is not an Agency program, and the
Agency was more concerned with state redevelopment law. Although each project area
had a project manager that kept working files, the files were not geared toward CDBG
but toward redevelopment as a whole. According to the Agency’s accountants, the
Agency did not review costs submitted by project managers to see whether they were
CDBG eligible, and the costs were not submitted to the City’s CDBG program
administration office.

The CDBG administrator added that one of the problems was that when redevelopment
loans were approved and allocated by city council members and the Agency, they did not
go through the City for eligibility or approval. As a result, there were no project files in
the City’s CDBG administration office. In addition, the current City accountant in charge
of the reimbursements requested by the Agency did not get involved with HUD rules and
regulations and strictly dealt with the accounting. The City’s CDBG administration was
disconnected from the redevelopment loans process, allowing the Agency to spend
CDBG funds at will, while not following HUD requirements.

The CDBG redevelopment loans were administered so poorly that Southeastern
Economic Development Corporation staff managing four redevelopment projects areas
were not aware that most of the loans issued by the City were actually funded through the
CDBG program.




                                        11
Conclusions

     The City failed to properly administer its CDBG funds provided to the Agency in
     accordance with HUD requirements. The City did not comply with applicable HUD rules
     and regulations while disbursing CDBG funds to the Agency. Consequently, almost $13
     million was disbursed for ineligible and unsupported redevelopment project activities (see
     appendix D for administrative deficiencies by project). Proper monitoring and the
     enforcement of CDBG requirements were not possible without adequate interagency
     agreements between the City and the Agency. We attribute this deficiency to the City’s
     weak management controls over compliance with HUD regulations. As a result, the City
     could not ensure that the Agency’s redevelopment projects using CDBG funds were
     properly administered in compliance with pertinent HUD CDBG requirements or ensure
     maximum benefit to low-income residents.

Recommendations

     We recommend the Director of the Los Angeles Office of Community Planning and
     Development require the City to:
     1A. Pay $1,806,770 plus any applicable interest to HUD from nonfederal funds for
         CDBG project costs determined to be ineligible.

     1B. Provide supporting documentation indicating that all CDBG program regulations
         were followed and national objectives were met for the redevelopment project
         activities determined to be questionable and/or unsupported or reimburse HUD
         $11,183,193 from nonfederal funds.

     1C. Execute written interagency agreements with the Agency for current projects and
         develop and implement procedures to ensure that future projects are included in the
         action plan or subsequent amendments in compliance with HUD requirements.

     1D. Develop and implement written procedures and controls to ensure that the City and
         the Agency maintain adequate supporting documentation to show that CDBG
         program requirements are followed and national objectives are met for all current
         and future redevelopment projects.

     1E. Develop and implement written procedures and controls to ensure that the City and
         the Agency adequately monitor CDBG activity for compliance with federal
         regulations.




                                              12
Finding 2: The City Did Not Execute Loan Agreements and Failed to
           Ensure Repayment of Outstanding CDBG Loans
The City failed to execute loan agreements and make good faith efforts to collect payment on
CDBG loans and the associated interest on these loans issued to the Agency. The Agency’s
outstanding debt from these loans was used to leverage/obtain state tax increment funds. This
condition occurred due to the lack of controls over the City’s CDBG program and because the
City’s focus was geared toward obtaining tax increment funds from the state in accordance with
California redevelopment law and not the rules and regulations governing CDBG entitlement
funds. As a result, the City did not maximize its CDBG community development activity and its
use of the substantial monetary benefits that should have been derived from its $139 million debt
owed to the CDBG program.



    Tax Increment Process and
    Statement of Indebtedness


         Tax increments are authorized under Article XVI, section 16, of the California State
         Constitution and are regulated by California redevelopment law. Since 24 CFR
         570.200(f) states that CDBG activities may be undertaken by one or more public
         agencies5 through loans, subject to local law, state redevelopment law must be followed
         when distributing loans for the purpose of obtaining tax increments.

         Tax increment is the primary source of revenue that redevelopment agencies have to
         undertake redevelopment projects. It is based on the premise that a revitalized project
         area will generate more property taxes than were produced in the area before
         redevelopment. Any increases in property value, as assessed because of change of
         ownership or new construction in the area, will increase tax revenue generated. This
         increase is the tax increment that goes to the Agency. Redevelopment agencies are
         entitled to collect the tax increment on the acreage they redeveloped to repay the debt
         involved in the project and to reinvest in redevelopment activities within the project area.

         When a new redevelopment project is adopted, it typically has no revenue for the initial
         operating year. Until the redevelopment agency incurs debt, it is not entitled to receive
         tax increment revenue. However, entering into debt with no revenue stream for collateral
         is difficult. To resolve this dilemma, most redevelopment agencies with new project
         areas enter into loan or general services agreements with their city so as to immediately
         “create” debt. The amount of tax increments received is calculated using the statement of
         indebtedness, which is an annual certification of all outstanding debt of an agency.

5
 Public agencies include the Agency, the Southeastern Economic Development Corporation (a nonprofit arm of the
Agency), and the Centre City Development Corporation (a nonprofit arm of the Agency).


                                                      13
         Each agency must annually certify the amount of outstanding debt in order for the state to
         determine how much tax increment funds an agency is entitled to in a given year.
         Generally, the more debt an agency has, the more tax increment funds will be received.


    City Established and Certified
    CDBG Loans


         The City loaned CDBG funds to the Agency’s redevelopment projects (see finding 1 for
         eligibility of their use). They were not supported by notes documenting the obligations;
         rather, the liabilities were authorized through City and Agency board resolutions
         identifying the instruments as loans to be repaid as funding became available and
         establishing an interest rate.6

         We received the statements of indebtedness submitted to the state of California for fiscal
         years 2001 through 2008.7 The outstanding balances for each of the CDBG loans were
         included in each statement, separated by project area. Each statement contained multiple
         certifications, one for each project area, certifying that all debt was included. The
         certifications reviewed were signed by the city comptroller, acting comptroller, or
         assistant city comptroller. According to California redevelopment law, Health and Safety
         Code, section 33765(h)(1), the statement of indebtedness constitutes prima facie evidence
         of the loans, advances, or indebtedness of the agency and, therefore, represents a legally
         binding document that the debt has been incurred and is owed. As a result, the CDBG
         instruments listed in each of these statements were loans, not grants or other type of
         financial assistance, and the purpose of the tax increments was to help pay these
         obligations.

         In addition, the City’s overall treatment of its loans to the Agency consistently identified
         them as actual debt of the Agency as evidenced by the:

                  Inclusion of all outstanding CDBG debt in the Agency’s annual audited financial
                  statements for fiscal years 2003 to 2005.8

                  Creation and maintenance of annual CDBG debt schedules by the City’s Office of
                  the Auditor and Comptroller to track the outstanding principal and interest
                  balances, and

                  Inclusion of the CDBG Loans in the annual City budget and recognition by the
                  Office of the Independent Budget Analyst that the debt was outstanding and
                  payable.


6
  The basis for computation of interest on these loans is the “prime rate” as printed in the Wall Street Journal on the
first Monday following January 1 of the calendar year in which the fiscal year begins plus 2 percent on the
outstanding principal loan balance only.
7
  The fiscal year 2006 statement was not provided by the City.
8
  The financial audit statements for fiscal years 2006 and 2007 were past due at the time of our audit.


                                                          14
    CDBG Funds Used for
    Leveraging/Obtaining Tax
    Increments

         The City and Agency recorded the CDBG loan funds as debt to increase their total
         liabilities and therefore, increase their ability to receive tax increment funding from the
         State of California. The Agency received well over $500 million in tax increment funds
         between fiscal years 2000 and 2007. CDBG represented nearly 20 percent in the
         Agency’s total debt9 in fiscal year 2007, illustrating how instrumental CDBG debt has
         been in obtaining tax increment funds.

         Debt payments were primarily only made so that the Agency could pass tax increment
         funds between an established project area and a separate project area that lacked tax
         increment funds or the ability to obtain secured financing. If the City received a payment
         from the Agency, it was usually applied to the accumulated interest balance so that the
         principal amount was not reduced, allowing interest to continually accumulate on the
         entire principal amount and, thus, maximize the amount of recorded debt. As a result, the
         City and the Agency were primarily using the CDBG funds to leverage/obtain tax
         increments from the state.

         Leveraging is not listed as a CDBG-eligible activity and does not meet any of the three
         CDBG national objectives under 24 CFR Part 570. The purpose of CDBG loans’ being
         used as a leveraging tool was verified through interviews with City officials. This
         activity was further evidenced through the City’s concern with state redevelopment law
         and general failure to follow CDBG requirements (see finding 1). In addition, the City
         repeatedly indicated that it might waive the outstanding CDBG loans10 and the associated
         program income due to the program once tax increment funding was exhausted for the
         project areas.

         The City and its Agency used the CDBG program primarily to create debt with little
         regard for HUD rules and regulations. Leveraging of this sort without proper payment
         terms and an adequate eligibility process (see finding 1) is unacceptable, as it greatly
         diminishes the mission of the CDBG program by promoting leveraging/obtain tax
         increments over CDBG-eligible development activities.




9
  The Agency held more than $700 million in debt for fiscal year 2007, as certified to the state. Nearly 20 percent
represents CDBG debt, with ratios of CBDG debt to total debt ranging from 1 to 89 percent for individual project
areas.
10
   The City stated that it considered the CDBG loans to be subordinate to bonds and other secure financing.


                                                         15
     Lack of Repayment on
     Outstanding CDBG Loans


         As of June 30, 2007, a total of 14 project areas and 2 survey areas had outstanding
         amounts on loans generated using CDBG funds, with an overall principal balance of
         more than $63 million and an accumulated interest balance of more than $76 million
         (see appendix C). In fiscal years 2006 and 2007, the City did not require or receive a
         single payment on the principal from the Agency for any of its outstanding CDBG loans.
         In addition, many long-outstanding loans had not received any payment. Since 1976, the
         City had distributed 236 CDBG loans to the Agency. Of the 236 loans, 212 (90 percent)
         remained outstanding, and 24 (10 percent) had been paid in full. Of the 212 outstanding
         loans, 209 (98.6 percent) had not received a payment on principal, and only three loans
         (1.4 percent of total outstanding) had received payments on principal, totaling $926,148.
         The outstanding CDBG loans break down as follows:

                 Eight loans originated in the 1970s had outstanding principal and interest balances
                 of more than $5.8 million and $14 million, respectively.

                 55 loans originated in the 1980s had outstanding principal and interest balances of
                 more than $22.6 million and $38.6 million, respectively.

                 108 loans originated in the 1990s had outstanding principal and interest balances
                 of more than $21.5 million and $19.3 million, respectively.

                 41 loans originated in the 2000s had outstanding principal and interest balances of
                 more than $13 million and $4 million, respectively.

         The Central Imperial project area is one example in which the City failed to collect
         payment on outstanding CDBG loans (see appendix F). The CDBG loans for the Central
         Imperial project area, all originated between 1985 and 2005, accumulated large interest
         balances without a single payment on principal or interest. The CDBG debt represented
         65 percent of all outstanding debt for the Central Imperial project area. The Central
         Imperial project area collected well over $6 million dollars in tax increment funds
         between fiscal years 2000 and 2007.11

         Regulations at 24 CFR 570.501(a) require the City to follow subrecipient rules and
         regulations, and 24 CFR 570.503 requires that agreements be executed before the
         disbursement of CDBG funds, including loan agreements. Therefore, the City and the
         Agency must take the steps necessary to create debt schedules, execute loan agreements,
         and begin making good faith efforts to pay down both principal and interest into the
         CDBG program income fund to be used for CDBG-eligible activities. We estimate that
         the expected annual amount that should be repaid is more than $8.2 million.

11
  The tax increment revenue is based on figures obtained through the statements of indebtedness for years 2001
through 2008, except for 2006, which was not provided by the City.


                                                        16
     This amount represents an increase of more than $7.2 million over the $1 million average
     annual amount already repaid by the Agency between fiscal years 2000 and 2007 (see
     Scope and Methodology section and appendix A for computations).

Conclusions

     The City issued CDBG loans to the Agency as a mechanism to leverage/obtain state tax
     increment funds without executing loan agreements or making good faith efforts to repay
     the City’s CDBG program funds to be used for other CDBG activities. Although the City
     received sporadic payments on some of the outstanding CDBG loans, most remained
     unpaid. The City’s management focused on obtaining tax increment funds from the state
     and failed to follow CDBG requirements. As a result, the City recorded a large amount of
     continually increasing debt owed to the CDBG program that might not be returned, while
     receiving a substantial monetary benefit not subject to CDBG requirements, thereby
     providing no assurance that it used CDBG funds for their intended purpose or maximized its
     ability to carry out eligible community development activities. The City should develop and
     implement procedures and controls to ensure timely payments on CDBG loans to ensure
     receipt of CDBG program income.


Recommendations


     We recommend that the Director of the Los Angeles Office of Community Planning and
     Development require the City to

     2A. Execute loan agreements between the City and its Agency indicating specific loan
         terms for repayment of the loans totaling $139,201,997 ($63,072,960 principal and
         $76,129,037 interest), which would result in an estimated additional recovery of
         $7,266,104 in CDBG program income over the first year.

     2B. Develop written policies and procedures to ensure timely payments on CDBG loans
         of both principal and interest and that the resulting program income is appropriately
         recorded and used for eligible activities in accordance with HUD’s requirements.




                                             17
                        SCOPE AND METHODOLOGY

We performed our audit work at the City’s offices located at 1200 3rd Avenue, Suite 1400, San
Diego, California. Our review generally covered the period July 1, 2000, through June 30, 2007.
We performed the audit work between April 3, 2007, and September 28, 2008.

To accomplish our audit objectives, we

           Reviewed the City’s applicable internal controls;
           Reviewed relevant HUD regulations and OMB circulars;
           Reviewed the City’s CDBG policies, procedures, and practices;
           Interacted with appropriate personnel of HUD’s Office of Community Planning and
           Development Los Angeles field office and reviewed relevant HUD files and
           drawdown activity in HUD’s Integrated Disbursement and Information System;
           Reviewed the City’s consolidated action plans and consolidated annual performance
           and evaluation reports from fiscal years 2000 to 2007 as well as financial audit and
           single audit reports;
           Selected a nonstatistical sample of 35 projects from fiscal years 2000 to 2007, which
           included all CDBG loans funded within that period, and reviewed project city council
           resolutions, documents containing loan/reloan approvals, and related expenditure
           reports for each project;
           Reviewed and tested the City’s records of selected projects to test whether (a) costs
           were eligible and adequately supported as required by HUD regulations and (b) the
           City and the Agency carried out these projects in accordance with HUD requirements;
           Interviewed key personnel from the City of San Diego, Redevelopment Agency,
           Southeastern Economic Development Corporation, and a former Centre City
           Development Corporation official
           Reviewed outstanding loans issued to the Redevelopment Agency by the City to
           identify and document interest and principal amounts for CDBG exclusive funded
           loans/reloans dating back to 1978
           Reviewed applicable California redevelopment law and statements of indebtedness
           certified by the City and submitted to obtain tax increment funds.

We examined City spreadsheets listing CDBG funded loans dating back to 1978 with an overall
outstanding principal amount of $63,072,960 and an accumulated interest totaling $76,129,037.
As of June 30, 2007, the City had used CDBG funds to reimburse the Agency’s costs for 35 of
36 redevelopment project activities during the period from fiscal years 2000 through 2007. One
activity was never funded (Grantville #35). We selected all of the project activities with the
exception of one (Pacific Beach), originated and funded between fiscal years 2000 and 2007.
We also reviewed the appropriations ledger for 34 of the 35 projects listing the resolution
numbers for the allotment amounts, the direct payment voucher or transaction number for each
individual expense, and the total amount expended.




                                              18
From the appropriations ledger, we selected a nonstatistical sample of disbursement transactions
for 34 project activities. We requested, obtained, and reviewed the supporting documentation
provided by the Agency to determine whether the activity met one of the national objectives, the
activity was a CDBG-eligible activity, and the reimbursed costs were eligible and reasonable.
Sampled project expenditures included 16 Central Imperial project area activities (1, 4, 5, 7, 9,
10, 11, 12, 13, 18, 22, 24, 25, 28, 31, and 34), six Southcrest project area activities (14, 15, 17,
19, 23, and 26), three Crossroads project area activities (20, 27, and 29), one Marina/Centre City
East District activity (3), one City Heights project area activity (6), and one North Park project
activity (21). Due to the bulk of documentation provided by the City and overall lack of
necessary support for the other sample items reviewed, we did not review the specific
expenditures requested for the Grantville project area activities (30, 32, 33, and 35) and the
Barrio Logan project area activities (2, 8, and 16).

We estimated funds to be put to better use attributable to the increase in Redevelopment Agency
loan repayments was $7.2 million (see appendix A). To determine the increase we compared the
expected annual loan repayment to the average actual loan repayment.

We based the expected annual loan repayment on the average interest rate used by the City
during our audit period. Between fiscal years 2000 and 2007, there were substantial fluctuations
of the interest rate applied by the City to outstanding CDBG loan principal, ranging between six
and 11 percent. Therefore, we applied the average interest rate of 8.34 percent, as it represents a
reasonable estimate of potential future interest rates that may be applied. We used a standard
payment model (using the rate, payment term, and present value) on the existing principal of
$63,072,960 and interest of $76,129,037 (see appendix G). We estimated a 30-year loan term
because it appeared to be a reasonable period for the repayment of long term debt (note that the
City or HUD may choose different loan terms). Also, much of the debt has been outstanding for
a number of years, some dating back to the 1970s. In addition, the City’s October 9, 2008
budget analyst report estimated its time limit to receive tax increments to pay debt at between
2022 and 2050 depending on the project, with an average date of around 2039, about 30 years
from now. No interest was applied to the existing interest balance as the City does not charge
interest on accumulated interest balances. Altogether, we determined an expected annual CDBG
loan payment of $8,273,748.

We then reduced the expected annual loan repayment by the average actual loan repayment
during our audit period, as we would expect the Agency to continue at that rate of payment if not
for our audit. The actual average annual repayment between fiscal years 2000 and 2007 was
$1,003,894, including all payments of principal and interest (see appendix G). The difference
between the expected annual loan repayment and the actual average loan repayment was
therefore $7,269,854. Our funds to be put to better use estimate was limited to one year of the
anticipated recovery to remain conservative.

We performed our survey and audit fieldwork from January through September 2008 at the
City’s economic development offices in San Diego, California. We conducted our audit in
accordance with generally accepted government auditing standards.




                                                 19
                              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:
                 Controls over program operations as they relate to the monitoring of CDBG
                 activities and management of CDBG funds.
                 Controls over the validity and reliability of data.
                 Controls over compliance with laws and regulations.
                 Controls over the safeguarding of resources as they relate to the disbursement
                 of CDBG funds.

       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, the following items are significant weaknesses:

                  The City failed to properly administer its CDBG program when providing
                  loans to its Agency (see finding 1).

                  The City failed to execute loan agreements and make adequate attempts to
                  receive payment on outstanding CDBG loans (see finding 2).




                                                20
                                     APPENDIXES

Appendix A

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

      Recommendation             Ineligible 1/    Unsupported 2/     Funds to be put
          number                                                      to better use 3/
             1A                   $1,806,770
             1B                                       $11,183,193
             2A                   _________            _________         $7,269,854
            Total                 $1,806,770          $11,183,193        $7,269,854



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.

2/   Unsupported costs are those costs charged to a HUD-financed or HUD-insured program
     or activity when we cannot determine eligibility at the time of audit. Unsupported costs
     require a 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/   Recommendations that funds be put to better use are estimates of amounts that could be
     used more efficiently if an OIG recommendation is implemented. These amounts include
     reductions in outlays, deobligation of funds, withdrawal of interest subsidy costs not
     incurred by implementing recommended improvements, avoidance of unnecessary
     expenditures noted in preaward reviews, and any other savings that are specifically
     identified. For recommendation 2A, the $7,269,854 in funds to be put to better use
     represents the estimated annual amount of combined principal and interest the Agency
     should pay to the CDBG fund to fully pay down the outstanding loan balance within a
     reasonable period, less the average amount being repaid by the City on the loans. More
     specifically, the annual repayment amount under a 30-year term with an interest rate of
     8.34 percent (the City’s average interest rate on the loans between 2000 and 2007)
     applied to the principal would be $8,273,748. We have reduced this amount by the
     average annual amount that was repaid ($1,003,894) to the fund over our audit period
     (fiscal years 2000 through 2007) to arrive at the $7,269,854 in funds to be put to better
     use. To be conservative, we have limited the funds to be put to better use to the
     additional recovery of program income that would be received over a one-year period.
     See the Scope and Methodology section and Appendix G for additional details.


                                                 21
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                         22
Comment 1




Comment 2




Comment 3




            23
Comment 3




Comment 3




Comment 3




Comment 4




Comment 5




            24
Comment 5




Comment 2




Comment 6




Comment 7




            25
Comment 7




Comment 7


Comment 8



Comment 1



Comment 1



Comment 1




            26
Comment 9




Comment 10




             27
Comment 11




Comment 12




Comment 9



Comment 13

Comment 14




             28
29
Comment 2
and
Comment 3




            30
Comment 2
and
Comment 3




            31
32
Comment 5




            33
34
Comment 5




            35
36
Comment 6




            37
Comment 6




            38
Comment 6




            39
                  OIG Evaluation of Auditee Comments

Comment 1   The City agreed that it has not been complying with program requirements and
            stated that the Mayor and the City Council have enacted some major reforms in
            the City’s CDBG program. Although we acknowledge that the City is taking
            steps to address its problems with the program, none of the listed reforms address
            the issues that we found with regard to the Redevelopment Agency projects.

            The City also indicated that all the redevelopment projects were completed as
            intended and believes that almost all its CDBG expenditures went to projects that
            met one or more of the CDBG national objectives. However, there was
            insufficient documentation available to show this was the case. According to 24
            CFR 570.501(b), the recipient is responsible for ensuring that CDBG funds are
            used in accordance with all program requirements.

Comment 2   We provided the City numerous opportunities to provide supporting
            documentation, and issued a demand letter on June 6, 2008 to obtain all relevant
            documentation. We conducted a complete and thorough analysis of the support
            provided by the City. The City did not provide any documentation detailing the
            area served by the Central Imperial redevelopment project area, nor did City
            officials mention it until the exit conference. In fact, the documents provided by
            the City for the Central Imperial projects failed to even mention the specific
            projects being funded by CDBG funds within the Central Imperial redevelopment
            area. In two interviews with high ranking City and Southeastern Economic
            Development Corporation employees, we were told that CDBG funds spent in
            Central Imperial amounted to a waste of funds and were not assisting low/mod
            persons.

            Due to the lack of City controls, the Redevelopment Agency was able to use the
            CDBG funds as a spending account to pay various unsupported costs with no
            clear indication the activity was for the CBDG program. 24 CFR 570 has specific
            rules in place to prevent CDBG from becoming a spending account. Agreements,
            monitoring, and reviews must be in place and completed in an orderly and timely
            fashion to ensure that CDBG funds are spent according to HUD rules and
            regulations. However, the City did not complete any of the steps required by
            HUD. Our review and analysis cannot be based on assumptions of the area
            served, but on facts and the documents provided. Given only the documents
            provided during our review, we made an ineligibility determination.

            However, given the City’s current claims that it can demonstrate it met the
            national objective by showing the area served was residential, we have modified
            the report to reclassify the Central Imperial project costs from ineligible to
            unsupported, as we agreed to consider at our exit conference with City officials.




                                            40
            [Note: this has resulted in our removing $5.1 million in ineligible costs from
            recommendation 1A, eliminating recommendation 1B of the draft report, and
            renumbering the subsequent finding 1 recommendations].

Comment 3   We agree that 24 CFR 570.208(a)(1) does not require that the area benefitted be
            coterminous with an officially recognized boundary. However, the officially
            recognized boundary, the Central Imperial redevelopment project area, was the
            only boundary detailed by the City during our audit. The Central Imperial
            redevelopment project area is not primarily residential, a fact not disputed by the
            City.

            We examined the map provided by the City in their response detailing the area
            served in relation to the Central Imperial redevelopment project area (see picture
            below). However, the map provided by the City only details a portion of the
            Central Imperial redevelopment project area (area outlined in blue) and the
            Southeastern Economic Development Corporation’s sphere of influence (area
            outlined in black). The area filled in blue (also outlined in red) is the entire
            Central Imperial redevelopment project area and the area reviewed in our audit.




            The Central Imperial map and land use analysis provided by the City are not
            sufficient to fully support the areas served by the Central Imperial projects (note
            that the land use analysis was not provided during the course of field work and
            was recently conducted to retroactively qualify projects). The City must submit
            thorough and complete documents, satisfying all applicable regulations, to HUD
            indicating eligibility for each individual project (national objective and activity),
            project scope, budget, and expenditures.


                                              41
Comment 4   While California Redevelopment Law may allow for a city to not include the area
            served, regulations at 24 CFR 570.208(a)(1) and 24 CFR570.506 requires the area
            served to be defined and documented. The City’s response further emphasizes
            our conclusion that more consideration has been given to California
            Redevelopment Law than to meeting HUD CDBG requirements.

Comment 5   Central Imperial projects were qualified under the national objective of assisting
            low/mod persons in a specific area through the activity of special economic
            development. Documents required by not provided during our audit include:
                   24 CFR 570.208(a)(1) – area is primarily residential
                   24 CFR 570.209(b) – evidence that a minimum level of public benefit was
                   obtained;
                   24 CFR 570.506 – boundaries of the service area, income characteristics
                   of families and unrelated individuals in the service area;

            The City has conceded it did not prequalify any of its projects as required by 24
            CFR 570.200. As to meeting the national objective of eliminating slum/blight,
            the City would have to show that it adhered to regulations at 24 CFR 570.208(c)
            and 24 CFR 570.506(b)(8), not the California redevelopment standards. The
            attachment provided by the City was insufficient to show this was the case. In
            addition, if the City cannot show that it met the national objective originally
            submitted to HUD, it would be inappropriate to retroactively apply a new
            objective, as this is required to be performed at the outset of each project before
            funds were spent.

Comment 6   As discussed in comments 1 through 3 above, we have adjusted the report to
            reclassify the Central Imperial projects from ineligible to unsupported.
            However, the worksheets provided in the City’s response (shown on pages 37
            through 39 of this report) were created in response to our audit and not the
            original documentation provided by the City. The practice of creating support
            after funds are spent is inappropriate. As a result, we find the retroactive
            worksheets insufficient and unacceptable.

Comment 7   Our review was based on documentation provided. The projects in questions
            were originally charged to the CDBG program and presented to HUD as planning
            projects, and were therefore reviewed as such. While the City contends the
            Central Imperial project number one is eligible as an acquisition project, it was
            originally qualified and presented to HUD as a planning activity. Acquisition is
            not an eligible planning activity according to 24 CFR 570.205(a)(4). The Central
            Imperial project was qualified as planning, bypassing the need to document a
            national objective.

            The OIG finds that approving CDBG funds for a specific activity and using the
            funds for a completely different activity, is an unacceptable practice. The CDBG
            regulations have a process in place that must be adhered to in order to ensure
            funds are used according to HUD rules and regulations.


                                             42
Comment 8     We disagree with the City’s contention that it merely “misclassified” projects as
              planning. We found, based on documentation and interviews with City and
              Agency staff, that the CDBG planning activity has often been used as a way to
              charge miscellaneous costs to CDBG. The practice in question was the result of a
              lack of controls, and a City environment where the use of the CDBG planning
              classification as a nonspecific spending account was considered acceptable.
              During the exit conference, the City’s Deputy Director of Economic Development
              agreed the attitude of previous CDBG staff was loose and lacked knowledge of
              CDBG rules and regulations.

Comment 9     Although generally outside the scope of our audit, we cannot agree with the City’s
              assertion that early year expenditures of CDBG funds were for CDBG eligible
              activities that went through the City’s CDBG process. As described by our report
              and agreed to by the City, redevelopment projects were not submitted through the
              normal CDBG process and were not supported with required documentation. The
              City did not follow HUD rules or regulations when approving and processing
              redevelopment projects.

              We also disagree with the City’s claim that CDBG funds were not used as a
              leveraging tool to obtain state tax increments. While the intent of the City may
              not have been leveraging alone, the City’s actions rendered CDBG funds recorded
              as loans as a leveraging tool to improve their ability to obtain tax increment funds.

Comment 10 We agree with the City that the CDBG program can be used in conjunction with
           redevelopment funds when all applicable rules and regulations are followed.
           However, as reflected in finding one, the eligibility of activities funded with
           CDBG loans is still in question.

Comment 11 We agree with the City that each project area must be given individual
           consideration when determining the repayment of CDBG loans.

              However, we disagree with the City’s portrayal of the redevelopment repayment
              process. California Redevelopment Law imposes a time limit when a
              redevelopment agency can repay debt, not a time period, i.e. 10 years, when they
              should repay debt. An agency can repay debt at any point for a project area, up to
              ten years after the effective date of the project area. For project areas adopted
              prior to December 31, 1993, an agency has up to 50 years (40 years plus 10 year
              extension) to repay debt, depending on the redevelopment plan (Health and Safety
              Code 33333.6). For project areas adopted after January 1, 1994, an agency has up
              to 45 years, depending on the redevelopment plan, to repay debt (Health and
              Safety Code 33333.2). The dates may be earlier based on the project area
              timeframes provided in each redevelopment plan.




                                               43
Comment 12 The City characterized our recommendation as “forcing repayment.” Our
           recommendation is for the City to create loan agreements with specific terms, and
           on page 8 of the City’s response, it agrees to create loan agreements between the
           City and the Agency indicating specific loan terms. We agree that the loan terms
           may vary based on the specific redevelopment project area and tax increment
           revenue. No evidence has been provided to show a repayment schedule will harm
           the revitalization effort, and if done properly and according to CDBG rules and
           regulations, it will ensure a constant flow of funds to continue to develop low-
           and moderate-income communities and to eliminate blight through the reuse of
           program income.

Comment 13 No documentation or analysis has been submitted to show that only 1.04 percent
           of the tax increment received was attributable to CDBG debt.

Comment 14 Leveraging is not listed as a CDBG-eligible activity under 24 CFR 570. The
           City’s action of disregarding HUD rules and regulations, and general lack of
           repayment on outstanding CDBG loans, resulted in our description of the City’s
           CDBG loan process as a leveraging tool.




                                            44
Appendix C
Schedule of Ineligible and Unsupported Costs by Project/Activity




                                                      45
Appendix D
   Schedule of administrative deficiencies by project/activity




                                                       46
Appendix E

Schedule of outstanding CDBG redevelopment loans




                                       47
Appendix F

 Outstanding CDBG Debt – Central Imperial




    Table Note: The City did not receive a single payment on principal or interest for the CDBG loans
    represented in the project area above.




                                                       48
Appendix G
                Schedules for CDBG Loan Repayment Estimates

                    Interest Rate Applied by City to CDBG Loans

                               Fiscal year        Interest rate
                                  2000                9.75%
                                  2001               10.50%
                                  2002               11.00%
                                  2003               6.75%
                                  2004               6.25%
                                  2005               6.00%
                                  2006               7.25%
                                  2007               9.25%
                         Average interest rate       8.34%

       Estimated Annual Repayment Necessary to Repay Loans Within 30 Years




     Average CDBG Loan Repayments and Estimated Funds to be Put to Better Use




                                             49
Appendix H

                                          CRITERIA
Federal (HUD) Regulations at 24 CFR

85.40(a) states that grantees are responsible for managing the day-to-day operations of grant- and
subgrant-supported activities. Grantees must monitor grant- and subgrant-supported activities to
ensure compliance with applicable federal requirements and that performance goals are being
achieved. Grantee monitoring must cover each program, function, or activity.

91.505(a) states that the jurisdiction shall amend its approved consolidated plan whenever it
makes one of the following decisions: (1) to make a change in its allocation priorities or a
change in the method of distribution of funds; (2) to carry out an activity, using funds from any
program covered by the consolidated plan (including program income), not previously described
in the action plan; or (3) to change the purpose, scope, location, or beneficiaries of an activity.

570.200(a) states that an activity may be assisted in whole or in part with CDBG funds only if it
meets certain requirements. The first requirement specifies that each activity must meet the
eligibility requirements of Section 105 of the Act. Another requirement stipulates that the grant
recipient must certify that its projected use of funds has been developed so as to give maximum
feasible priority to activities which will carry out one of the national objectives of benefit to low-
and moderate-income families, aid in the prevention or elimination of slums or blight, or meet
other community development needs having a particular urgency because existing conditions
pose a serious and immediate threat to the health or welfare of the community when other
financial resources are not available to meet such needs. Consistent with the foregoing, each
recipient must ensure and maintain evidence that each of its activities assisted with CDBG funds
meets one of the three national objectives as contained in its certification.

570.200(f) states that CDBG activities may be undertaken by one or more public agencies
through loans, subject to local law.

570.200(h) states that before the effective date of the grant agreement, a recipient may incur
costs or may authorize a sub-recipient to incur costs, then after the effective date of the grant
agreement, pay for those costs using its CDBG funds, provided that the activity for which the
costs are being incurred is included in a consolidated plan, action plan, or an amended
consolidated plan or action plan (or application under subpart M of this part) before to the costs
are incurred.

570.205(a)(4)iii states that planning activities consist of all costs of data gathering, studies,
analysis, and preparation of plans and the identification of actions that will implement such
plans, including but not limited to other plans and studies such as individual project plans
(excluding engineering and design costs related to a specific activity which are eligible as part of
the cost of such activity under sections 570.201-570.204).




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570.205(a)(6) states that among eligible planning activities are policy, planning, management,
and capacity building activities which will enable the recipient to (1) determine its needs; (2) set
long-term goals and short-term objectives, including those related to urban environmental
design; (3) devise programs and activities to meet these goals and objectives; (4) evaluate the
progress of such programs and activities in accomplishing these goals and objectives; and (5)
carry out management, coordination, and monitoring of activities necessary for effective
planning implementation but excluding the costs necessary to implement such plans.

570.207(a)(2) states that expenses required to carry out the regular responsibilities of the unit of
general local government are not eligible for assistance except as otherwise specifically
authorized.

570. 208(a)(1)(i) states that an activity with a national objective benefitting low- and moderate-
income persons in an area (LMA) that serves an area that is not primarily residential in character
shall not qualify under this criterion.

570. 208(d)(4) states that CDBG funds expended for planning and administrative costs under
Sec. 570.205 and Sec. 570.206 will be considered to address the national objectives.

570.501(a) states that one or more public agencies, including existing local public agencies, may
be designated by the chief executive officer of the recipient to undertake activities assisted by
this part. A public agency so designated shall be subject to the same requirements as are
applicable to sub-recipients.

570.501(b) states that the recipient is responsible for ensuring that CDBG funds are used in
accordance with all program requirements. The use of designated public agencies, sub-
recipients, or contractors does not relieve the recipient of this responsibility. The recipient is
also responsible for determining the adequacy of performance under sub-recipient agreements
and procurement contracts and for taking appropriate actions when performance problems arise.
When a unit of general local government is participating with or as part of an urban county or as
part of a metropolitan city, the recipient is responsible for applying to the unit of general local
government the same requirements as are applicable to sub-recipients.

570.503(a) states that before disbursing any CDBG funds to a sub-recipient, the recipient shall
sign a written agreement with the sub-recipient. The agreement shall remain in effect during any
period during which the sub-recipient has control over CDBG funds, including program income.

570.503(b) states that at a minimum, the written agreement with the sub-recipient shall include
the following provisions: (1) statement of work, (2) records and reports, (3) program income, (4)
uniform administrative requirements, (5) other program requirements, (6) suspension and
termination, and (7) reversion of assets. For the statement of work, the agreement shall include a
description of the work to be performed, a schedule for completing the work, and a budget.

570.504(a) requires the grantee to record receipt and expenditure of program income as part of
the financial transactions of the grant program.




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570.506(a), (b), and (h) require each recipient to establish and maintain sufficient records to
enable the HUD Secretary to determine whether the recipient has met the requirements of this
part.

    (a) The recipient shall maintain records which provide a full description of each activity
        assisted with CDBG funds, including its location and the amount of CDBG funds
        budgeted, obligated, and expended for the activity.

    (b) The recipient shall maintain records which demonstrate that each activity undertaken
        meets one of the criteria used to determine whether a CDBG-assisted activity complies
        with one of more of the national objectives.

    (h) Recipients shall maintain evidence to support how the CDBG funds provided to such
        entities are expended. Such documentation must include, to the extent applicable,
        invoices, schedules containing comparisons of budgeted amounts and actual
        expenditures, construction progress schedules signed by appropriate parties, and/or other
        documentation appropriate to the nature of the activity.

OMB Circular A-87, attachment A, states that to be allowable under federal awards, costs
must be necessary and reasonable for proper and efficient performance and administration of
federal awards. A cost is reasonable if, in its nature and amount, it does not exceed what a
prudent person would incur under the circumstances prevailing at the time the decision was
made. In determining reasonableness of a given cost, consideration shall be given to (a) whether
the cost is of a type generally recognized as ordinary and necessary for the operation of the
governmental unit or the performance of the federal award; (b) the restraints or requirements
imposed by such factors as sound business practices; arms length bargaining; federal, state, and
other laws and regulations; and terms and conditions of the federal award; (c) market prices for
comparable goods or services; (d) whether the individuals concerned acted with prudence in the
circumstances, considering their responsibilities to the governmental unit, its employees, the
public at large, and the federal government; and (e) significant deviations from the established
practices of the governmental unit which may unjustifiably increase the federal award’s cost.

OMB Circular A-87(14), attachment A states that costs of entertainment, including
amusement, diversion, and social activities and any costs directly associated with such costs
(such as tickets to shows or sports events, meals, lodging, rentals, transportation, and gratuities)
are unallowable.

OMB Circular A-87(19), attachment B states that the general costs of government are
unallowable (except as provided in section 43 of this appendix, travel costs). These costs include
(1) salaries and expenses of the office of the governor of a state or the chief executive of a
political subdivision or the chief executive of federally recognized Indian tribal government; (2)
salaries and other expenses of a state legislature county supervisor, city council, school board,
etc., whether incurred for purposes of legislation or executive direction; (3) costs of the judiciary
branch of a government; (4) costs of prosecutorial activities unless treated as a direct cost to a
specific program if authorized by program statute or regulation (however, this does not preclude
the allowability of other legal activities of the attorney general); and (5) costs of other general



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types of government services normally provided to the general public, such as fire and police,
unless provided for as a direct cost under a program statute or regulation.

City Policies and Procedures

The city council’s policy on CDBG funds states that it is the policy of the city council to allocate
CDBG funds in accordance with the following standards: (1) selection and implementation of
program activities must meet the congressional intent of the program and the specific eligibility
requirements as outlined by HUD and (2) priorities of the Capital Improvements Program will be
developed irrespective of whether the City is to receive CDBG funds. CDBG funds, if received,
are to be used to supplement the City’s Capital Improvements Program and not as a substitute for
other City funds.

The City’s consolidated annual performance and evaluation report for fiscal year 2006 (pages 33
and 34) stated that the City’s nonhousing programs supported with federal entitlement funds and
subject to the consolidated plan would be monitored to ensure compliance with the respective
program requirements of the specific funding source. The City’s approach to monitoring is an
ongoing process involving continuous communication with and evaluation of grant recipients
(nonprofit organizations, other governmental agencies, City departments).

The City performs the following monitoring functions:

           Make available to grant recipients (i.e., nonprofit organizations) general information
           on specific federal funds program requirements (i.e., OMB circulars, program
           regulations),
           Review all grant recipients’ reimbursement requests through desk audits to ensure
           that specific program requirements are met,
           Review and determine eligibility of all applications according to specific federal
           funds criteria, and
           Provide technical assistance to grant recipients in various program areas.

The monitoring process involves frequent telephone contacts, written communications, analysis
of reports and audits, desk audits, on-site monitoring, and meetings. The City’s goal is to ensure
compliance with specific program requirements for the applicable funding source. The primary
goal of monitoring is to identify deficiencies and promote corrections to improve, reinforce, or
augment grant recipients’ performance.




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