oversight

The City of Newburgh, New York, Needs to Make Improvements in Administering Its Section 108 Loan Guarantee Program

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-11-07.

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

                                                                   Issue Date
                                                                      November 7, 2008
                                                                   Audit Report Number
                                                                      2009-NY-1001




TO:        Vincent Hom, Director, Community Planning and Development, 2ADM1



FROM:      Edgar Moore, Regional Inspector General for Audit, 2AGA

SUBJECT: The City of Newburgh, New York, Needs to Make Improvements in
         Administering Its Section 108 Loan Guarantee Program

                                   HIGHLIGHTS

 What We Audited and Why

            We audited the City of Newburgh, New York’s (City) administration of its
            Section 108 Loan Guarantee program. We selected the City for review based
            upon previous U.S. Department of Housing and Urban Development (HUD) on-
            site monitoring reviews and indicators from our internal audit of HUD’s
            monitoring of the Community Development Block Grant (CDBG) program,
            which identified concerns with the City’s administration of its various programs.
            The objectives of our audit were to determine whether the City ensured that (1)
            Section 108 loans and related activities were administered in compliance with
            CDBG program objectives and (2) subsequent CDBG funds used for Section 108
            loan repayments were necessary, reasonable, and in accordance with all
            applicable contracts, agreements, and federal regulations.

 What We Found
            Contrary to the loan agreement and regulations, the City failed to ensure that all
            Section 108 Loan Guarantee funds and related project costs pertaining to the
            Front Street Marina redevelopment project were proper, necessary, and fully
            supported. Specifically, the City (1) failed to enforce loan agreement provisions
            and adequately pursue loan collateral to satisfy the debt, (2) did not ensure that all
            funding sources were supported and documented, (3) unnecessarily used CDBG
            funds to repay the loan and deprived its activity from receiving program income,
           and (4) overpaid the developer for duplicate costs. These issues occurred because
           the City failed to properly administer its Section 108 loan program by not
           ensuring that all costs incurred were proper and in accordance with the Section
           108 agreements. As a result, the City’s CDBG program was deprived of funds
           that could have been used for other activities, and Economic Development
           Initiative (EDI) funds were improperly expended. Thus, the CDBG program will
           be hindered from effectively using future CDBG funds to provide maximum
           benefit to low- and moderate-income residents.

           In addition, the City did not achieve the primary objective of job creation for the
           industrial park project, loan proceeds remained unused in a bank account for more
           than seven years, possible collateral or program income for loan repayment was
           not pursued, and the City did not ensure that the industrial site was feasible for
           commercial development and job creation. As a result, the failure of the
           industrial park project had and will continue to have a large negative impact on
           the City’s CDBG program, as CDBG funds were used to repay the Section 108
           debt and additional CDBG funds were scheduled to retire the debt.

What We Recommend
           We recommend that the Director of HUD’s New York Office of Community
           Planning and Development instruct the City to (1) enforce the loan provisions on
           the marina redevelopment project within 90 days or reimburse the CDBG
           program from nonfederal funds the $449,817 used for debt repayment, (2) take
           appropriate actions against the marina developer and ensure that nonfederal funds
           are used to repay the remaining $1.3 million in future loan obligations, (3)
           reimburse the EDI program from nonfederal funds the $144,341 paid for
           ineligible duplicate costs, (4) establish a plan for the industrial park site within 90
           days or reimburse the CDBG program from nonfederal funds the approximate
           $1.8 million used for debt repayment, and (5) reprogram the approximate $1.7
           million in CDBG funds currently scheduled to be used for future repayments of
           the industrial park project loan.

           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 discussed the results of our review during the audit, provided a copy of the
           draft report to City officials, and requested their comments on August 11, 2008.
           We held an exit conference on September 3, 2008, and City officials provided
           their written comments on September 12, 2008, at which time they generally
           disagreed with our 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 Section 108 Loan for the   5
                 Front Street Marina Project

      Finding 2: The City’s Crystal Lake Project Remained Incomplete and               12
                 Failed to Achieve Program Objectives


Scope and Methodology                                                                  16

Internal Controls                                                                      17

Appendixes
   A. Schedule of Questioned Costs and Funds to Be Put to Better Use                   19
   B. Auditee Comments and OIG’s Evaluation                                            20




                                             3
                     BACKGROUND AND OBJECTIVES

The Section 108 Loan Guarantee program is the loan guarantee provision of the Community
Development Block Grant (CDBG) program. Section 108 loans provide grantees with a source
of financing for economic development, housing rehabilitation, public facilities, and large-scale
physical development projects. The principal security for the loan guarantee is a pledge by the
applicant public entity of its current and future CDBG funds. Additional security can also be
required to assure repayment of guaranteed obligations. The additional security requirements are
determined on a case-by-case basis but could include assets financed by the guaranteed loan.

For purposes of determining eligibility, the CDBG rules and requirements apply. As with the
CDBG program, all projects and activities must meet the CDBG’s primary objective, which is
that 70 percent of the funds used must benefit low- and moderate-income persons and one of the
following three national objectives: (a) principally benefit low- and moderate-income persons,
(b) assist in eliminating or preventing slums and blight, or (c) assist with community
development needs having a particular urgency. Section 108 guaranteed loans may be for terms
up to 20 years.

Section 108 guaranteed loan commitments can be paired with U.S. Department of Housing and
Urban Development (HUD) Economic Development Initiative (EDI) grants, which are grants
that directly enhance the security of Section 108 guaranteed loans or improve the viability of the
same Section 108-assisted project. EDI grants can be used to pay predevelopment costs of a
Section 108-funded project. EDI grants enable localities to carry out eligible economic
development activities in which public and private dollars can be leveraged to create jobs and
other benefits, especially for low- and moderate-income persons, and reduce the risk of potential
future defaults on Section 108 loan guarantee-assisted projects. Section 108 and EDI funds must
assist with the same project.

The City of Newburgh, New York (City), is a CDBG entitlement recipient that has applied for
and received several Section 108 guaranteed loans to pursue physical and economic
revitalization projects. The two major Section 108 guaranteed loans reviewed during our audit
were primarily for economic development projects with the goal of job creation, including a
marina project consisting of both Section 108 loan and EDI funding. The files and records
related to the City’s Section 108 Loan Guarantee program are maintained in City Hall, located at
83 Broadway, Newburgh, New York.

We audited the City’s Section 108 Loan Guarantee program based upon previous HUD on-site
monitoring reviews and indicators from our internal audit of HUD’s monitoring of the CDBG
program (Report No. 2008-NY-0001, issued December 31, 2007), which identified concerns
with the City’s administration of the CDBG program. The objectives of our audit were to
determine whether the City ensured that (1) Section 108 loans and related activities were
administered in compliance with CDBG program objectives and (2) subsequent CDBG funds
used for Section 108 loan repayments were necessary, reasonable, and in accordance with all
applicable contracts, agreements, and federal regulations.



                                                4
                                RESULTS OF AUDIT

Finding 1: The City Failed to Properly Administer Its Section 108 Loan
           for the Front Street Marina Project
Contrary to the loan agreement and regulations, the City failed to ensure that all Section 108
Loan Guarantee funds and related project costs pertaining to the Front Street Marina
redevelopment project were proper, necessary, and fully supported as required. Specifically, the
City (1) failed to enforce loan agreement provisions and adequately pursue loan collateral to
satisfy the debt, (2) did not ensure that all funding sources were supported and documented, (3)
unnecessarily used CDBG funds to repay the loan and deprived its activity from receiving
program income, and (4) overpaid the developer for duplicate costs. We attribute these issues to
the City’s failure to properly administer its Section 108 loan program by not ensuring that all
costs incurred were proper and in accordance with the Section 108 loan agreements. As a result,
the City was deprived of CDBG funds that could have been used for other activities within the
City, and EDI program funds were improperly used to pay for costs already paid for with Section
108 funds. Thus, the City’s CDBG program was negatively impacted and will continue to be
hindered from effectively using future CDBG funds to provide maximum benefit to low- and
moderate-income residents.



 Section 108 Loan Guarantee
 Application and Agreement

              In November 2000, the City formally applied for a $ 1 million Section 108
              guaranteed loan for the Front Street Marina redevelopment project. The City had
              already received preliminary approval for a $500,000 EDI grant to be combined
              with the Section 108 loan to assist with the marina project and related
              improvements. The total $1.5 million in HUD funding was loaned to a private
              developer for the development and construction of a 60-foot pier, a 72-slip marina
              (accommodating 144 boats), improvement of the municipally owned Newburgh
              Landing, and shoreline stabilization improvements. Although the entire Marina
              redevelopment project was to cost $2.85 million, the $1.5 million in HUD funds
              were intended to be repaid to the City by the developer. The sources and uses of
              the funds for the total project were as follows:

                      Sources of funds:
                      Section 108 loan             $ 1,000,000
                      EDI grant                        500,000
                      Clear Air/Water grant            450,000
                      State of New York (grant)        150,000
                      City of Newburgh (grant)         450,000
                      Equity                           300,000
                      Total                         $2,850,000

                                               5
                   Uses of funds:
                   Utilities                 $ 169,500
                   Pier construction           100,000
                   Marina installation         820,500
                   Site work                   290,000
                   Walkway                     900,000
                   Soft costs                  300,000
                   Newburgh Landing improv.    150,000
                   General costs-overhead/
                      profit                   120,000
                   Total                    $2,850,000

            In August of 2002, HUD and the City executed the contract for the $1 million
            loan under the Section 108 Loan Guarantee program and $500,000 in EDI grant
            funds. Key provisions of the agreement included that the City, to secure payment
            and performance of the secured obligations of the developer (obligor), would
            obtain the following collateral:

                   A second lien on the landside property and a first lien on the submerged
                   property.

                   All rights, titles, and interests of the developer to any leases covering the
                   properties.

                   A personal guaranty from the developer of all payments due under the
                   note.

            Further, the contract provided that a default under the note and contract would
            occur upon failure by the borrower to pay when due an installment of principal or
            interest on the note or failure to punctually and properly perform, observe, and
            comply with any covenant, agreement, or condition contained in the contract,
            security agreement, deed of trust, mortgage, assignment, guarantee, or other
            contract securing payment of indebtedness evidenced by the note.


Loan Agreement and Mortgage
for $1.5 Million with Developer


            Also in 2002, the City and the developer executed the $1.5 million loan
            agreement and related mortgage and note. Key provisions of these agreements
            included

                   No disbursements of loan proceeds were to be made by the City until the
                   developer had expended or deferred not less than $300,000 in equity funds
                   for eligible project costs. In addition, if total costs were less than the

                                              6
                  $2.85 million, the Section 108 and EDI loans would be reduced
                  proportionately on a ratio of 2 to 1 by $1.00 for each $1.00 of such
                  shortfall.

                  The term of the $1.5 million was for 10 years and was to commence no
                  later than December 31, 2002.

                  Within 90 days after the end of each fiscal year, the developer would
                  deliver to the City, as attested to by a certified public accountant, (1)
                  operating income and receipts from the marina, (2) a statement of net
                  annual cash flow, and (3) a statement of the developer’s equity.

                  Principal and interest would become due at the option of the City after
                  default in the payment of any installment of principal or of interest for 30
                  days after notice and demand.

                  Under a default, the City had the right to enter upon and to take possession
                  of the premises for the purpose of collecting the indebtedness and to let
                  the premises or any part thereof and apply the rents and profits after
                  payment of all necessary charges and expenses on account of such
                  indebtedness.


Loan Agreement Provisions Not
Enforced

           Despite the above requirements, the City failed to abide by and enforce the
           various contracts and agreements pertaining to the Front Street Marina
           redevelopment project completion and repayment of the loan. After receipt of the
           loan proceeds that were to be used to complete the Marina project, the developer
           (borrower) was required to begin making monthly loan payments in January 2003.
           However, monthly loan payments were never made, and the City failed to take
           effective action to remedy the situation. The first notification of overdue loan
           payments was not made until December 2005, more than two years after
           repayment was to begin. In addition, the notices sent to the developer contained
           inaccurate and incomplete loan repayment request information. Moreover, the
           City failed to declare the loan to be in default, although more than two years had
           passed since the first payment was due. Finally, the City failed to request
           financial statement information from the developer as required by the loan
           agreement. Specifically, in November of 2006, the City advised the developer
           that $175,000 was due and payable for years 2004 through and 2006. However,
           the letter sent was inaccurate as to the amounts owed and did not formally declare
           the loan in default, although no payments had been made in nearly four years.

           In March 2007, the City’s corporation counsel declared the developer to be in
           default. However, although the developer was more than four years behind in
           loan payments, the City did not demand that the total loan be repaid. The City

                                             7
           calculated that the total back interest and principal owed was $559,855 and
           demanded this payment by April 1, 2007. The City also requested that the
           developer provide the certified financial statements by April 1, 2007, for each
           fiscal year since 2003. However, the financial statements were not provided.

           In July of 2007, the City informed HUD that the first payment of $27,500 was
           received in May 2007; however, the City did not mention that the full payment
           due was $46,250. The City also informed HUD that the next payment was due in
           July, although the July payment date agreed to by the developer was already past
           due. In addition, the City informed HUD that annual audited financial statements
           were requested from the developer and should be received by August 2007, which
           was later than expected. Consequently, the City did not properly enforce the loan
           provisions with the marina developer.

           In December 2007, the City’s corporation counsel informed the developer that
           failure to either repay the loan by December 31, 2007, or the outstanding balance
           by January 2, 2008, would mean that the loan was in default and that the City
           would be left with no further recourse but to pursue legal action to secure these
           funds. The City’s corporation counsel did not provide an extension to this
           timeframe or a reconsideration of the terms. In March 2008, the City decided to
           enforce its rights and pursue the collateral specified under the loan agreement. A
           certified letter was sent to the developer demanding full payment of
           approximately $1.8 million for the Front Street Marina project.

           The City’s lack of timely and effective action in pursuing all remedies available to
           enforce the loan provisions, such as aggressively pursuing the loan collateral,
           allowed the project loan to remain unpaid for more than five years. As a result,
           the City elected to use its CDBG funding to make the Section 108 loan payments
           that were required to be made by the developer.

Funding Sources Not Supported
and Documented


           A review of the available documentation to support the approximate $2.85 million
           in costs related to the Front Street Marina Redevelopment disclosed that the City
           did not maintain evidence that the developer provided the $300,000 in required
           equity funds or that any of the other funding sources were provided before it
           disbursed the $1.5 million in Section 108 and EDI funds to the developer.
           Therefore, the City did not ensure compliance with the loan provisions requiring
           developer equity and that the Section 108 and EDI loans would be reduced
           proportionately on a ratio of 2 to 1 by $1.00 for each $1.00 of any shortfall in
           leveraged funding. This condition represents another example of the City’s not
           ensuring that its Section 108 loan program was administered in accordance with
           all requirements. As a result, the City had no assurance that the total required
           funding of $2.85 million was invested in the marina redevelopment project and
           that the use of the $1.5 million in HUD funds was necessary and appropriate.

                                            8
CDBG Program Harmed and
Program Income Not Realized


           Through February 2008, the City expended at least $449,817 in CDBG funding to
           repay Section 108 loan obligations. Although Section 108 loan payments are
           guaranteed with CDBG funding, the use of the CDBG funding for this purpose is
           not reasonable or necessary. CDBG regulations at 24 CFR (Code of Federal
           Regulations) 85.22 provide cost principles for determining allowable costs.
           Specifically, to be allowable under federal awards, costs must be necessary,
           reasonable, and adequately documented. The City’s failure to enforce the loan
           provisions resulted in the unnecessary and unreasonable use of CDBG funds to
           repay the project debts.

           According to City officials, the Front Street Marina project was operational and
           successful. Our recent inspection of the marina confirmed that it was open for the
           season and appeared to be successful as shown in the photographs of the
           waterfront below.




                                            9
             However, the failure of the City to adequately pursue and enforce collateral
             agreements with the developer caused the loss of CDBG funding. In addition, the
             City was deprived of the approximately $600,941 ($500,000 EDI loan to
             developer + $100,941 in interest) in program income resources that would be
             available from EDI loan repayments from the developer. Further, the CDBG
             program will continue to be negatively impacted in the future from the Section
             108 loan defaults. Future Section 108 loan debt payments will require $865,968
             in additional CDBG funds unless the City takes legal action to pursue the loan
             collateral.


Duplicate Project Costs
Overpaid

             In addition to the above, the City’s procedures for reviewing expenditures did not
             ensure that adequate supporting documentation was submitted and did not prevent
             double payments for certain costs. A payment of $144,341 in EDI funds made on
             December 2, 2002, represents a duplicate payment for costs already claimed for a
             vendor and paid with Section 108 loan funds. The voucher and attached
             statement from the vendor showed a final balance due of $144,341. However, the
             previous payment in Section 108 loan funds to the developer was also listed as
             payment in full to this vendor. Accordingly, the $144,341 overpayment is
             considered ineligible under program requirements and should be repaid. Thus,
             the repayment of the $144,341 overpayment would be considered program
             income to the City and the remaining balance due from the EDI loan would be
             $456,600 ($600,941-$144,341).


Conclusion

             The City failed to properly administer the Section 108 guaranteed loan for the
             Front Street Marina redevelopment. While the marina project appeared to be
             successful, the City failed to adequately pursue and enforce the loan and collateral
             agreements with the developer to repay the $1.5 million in HUD funding. In
             addition, the City did not ensure that all $2.85 million in funding sources was
             provided and adequately supported. Also, the City unnecessarily used $449,817
             in CDBG funds to repay the loan and deprived its activity of $600,941 in program
             income. Therefore, the City’s CDBG program will continue to be negatively
             affected, as future Section 108 loan debt will require $865,968 in additional
             CDBG funds. Further, the City overpaid the developer $144,341 in federal EDI
             funds for duplicate project development costs. We attribute these issues to the
             City’s failure to properly administer its Section 108 loan program. Thus, the
             City’s lack of proper oversight on the marina redevelopment project impacted its
             CDBG program, which will continue to be negatively affected if the City
             continues to use CDBG funds rather than pursue repayment from the developer or
             use nonfederal funds to repay the Section 108 guaranteed loan. Consequently, the



                                              10
          City’s ability to provide maximum benefit to low- and moderate-income residents
          was hindered.

Recommendations

          We recommend that the Director of HUD’s New York Office of Community
          Planning and Development instruct the City to

          1A.     Enforce the loan provisions on the Front Street Marina within 90 days and
                  reimburse the CDBG program from nonfederal funds the $449,817 used for
                  Section 108 debt repayment.

          1B.     Provide HUD with evidence that all funding sources for the Front Street
                  Marina project have been received or reduce the Section 108 and EDI loans
                  proportionately and repay the funds to HUD.

          1C.     Take appropriate action against the developer and ensure that nonfederal
                  funds are used to repay HUD the $1,322,568 in future Section 108 program
                  loan obligations ($865,968 due for the Section 108 loan and $456,600 due
                  for the EDI loan) so that future CDBG funds can be safeguarded and put to
                  better use.

          1D.     Reimburse HUD from nonfederal funds the $144,341 related to the ineligible
                  duplicate payments paid to the developer for marina-related expenses.

          1E.     Implement policies and procedures to ensure that all future Section 108
                  projects are administered in accordance with all approved applications, loan
                  agreements, and program requirements.




                                           11
Finding 2: The City’s Crystal Lake Project Remained Incomplete and
           Failed to Achieve Program Objectives
The City did not complete a $2.13 million Section 108 Loan Guarantee project to facilitate a
proposed light industrial park area known as Crystal Lake. The industrial park improvements
were not completed, and the primary objective of job creation was not realized. Also, $652,800
in Section 108 loan proceeds remained unused in a bank account for more than seven years,
which was contrary to the Section 108 loan contract. In addition, the City did not pursue
possible collateral or program income to use for Section 108 loan repayments as required by the
loan application and contract agreement with HUD. We attribute these conditions to the City’s
inadequate administration of its Section 108 loan program. Specifically, the City did not (1)
ensure that the commercial site was feasible for commercial development and job creation, (2)
amend its Section 108 loan program to reduce the funds needed, and (3) pursue collateral or
program income for loan repayment. As a result, the failure of the industrial park project had
and will continue to have a large negative impact on the City’s CDBG program, as at least $1.8
million in CDBG funds was used to repay the Section 108 debt and an additional $1.7 million in
CDBG funds was scheduled to retire the debt. Thus, not only were the objectives of the Section
108 loan program not met, but also the CDBG program and its intended benefit to low- and
moderate-income residents will be deprived of approximately $3.4 million.


    Background


                   In March 1999, the City applied for approximately $2.13 million in Section 108
                   Loan Guarantee assistance, which was approved in May of 1999.1 Approximately
                   $1.6 million was targeted to be used for infrastructure improvements, including
                   water, sewer, power, and street reconstruction, along Temple and Ellis Avenues
                   leading to the Crystal Lake industrial park site. This portion of the Section 108
                   loan proceeds was to meet the local and national objective of benefiting low- and
                   moderate-income persons by facilitating commercial development that would
                   create job opportunities.

    Industrial Park Incomplete and
    Not Feasible for Future
    Development

                   Of the approximately $1.6 million in Section 108 loan proceeds targeted for
                   infrastructure improvements to the Crystal Lake industrial park area, the City had
                   only expended $911,330 for the reconstruction of existing streets leading to the
                   Crystal Lake area. According to City officials, the project was to be suspended

1
    The approximate $2.13 million in Section 108 Loan Guarantee assistance consisted of $550,000 to purchase an
    aerial ladder fire truck for the city fire department and approximate $1.6 million for the improvements to the
    Crystal Lake industrial park area.



                                                          12
           until a suitable commercial developer could be identified. In the meanwhile, the
           City had been unable to attract development proposals and attributed the project’s
           failure to the difficulty of designing and constructing commercial buildings on the
           narrow parcels of land wedged between the lake and a hilly area known as Snake
           Hill. As a result, the primary objective of job creation had not been realized.

           Our inspection of the proposed commercial site confirmed the City’s concerns
           that the area was not feasible for commercial development. There was no road
           access, and the land tract was very narrow along the lake area. The photograph
           shown below was taken from the entry area of the proposed industrial park site
           and reflects the status of the site.




           The City did not adequately consider the difficulty of developing the Crystal Lake
           area before securing the Section 108 Loan Guarantee funds. Once the loan was
           received, the City proceeded to expend $911,330 on existing infrastructure and
           street improvements but did not pursue completion of the industrial park
           development and did not expend the remaining available Section 108 loan funds
           of $652,800. The partial work was completed years ago; however, the site
           remained undeveloped.


Section 108 Loan Proceeds
Unexpended in Violation of Loan
Agreement


           The contract for the Section 108 Loan Guarantee assistance required that all of the
           Crystal Lake loan funds be withdrawn and disbursed by the City for approved
           activities by June 1, 2001. Any funds remaining after June 01, 2001, were to be
           transferred to an established loan repayment account. Despite this requirement,
           the City maintained unused Section 108 loan proceeds totaling $652,800 in the



                                           13
             project bank account for more than seven years. The City did not have plans to
             use the funds to complete the project.

             Instead of using the $652,800 in unused proceeds to reduce the Section 108 loan
             debt, the City used more than $1.7 million in CDBG funds to make the scheduled
             loan repayments. Including interest, the project bank account contained more
             than $752,302. As a result, since the City did not plan to use these funds, the
             unused loan proceeds should be reimbursed to the CDBG program.

Collateral or Program Income
to Repay Section 108 Loan Debt
Not Pursued

             The City did not provide evidence that collateral or other sources of income were
             pursued or used to repay the Section 108 loan debt. Instead, the City used CDBG
             funds to make all of the Section 108 loan debt repayments. Although the City
             was not able to adequately account for all of the payments, at least $1.7 million in
             CDBG funds had been expended. Future debt payments will require the use of
             nearly $1.7 million in CDBG funds unless alternative methods of loan repayments
             are pursued.

             Regulations at 24 CFR 85.22 provide that to be allowable under federal awards,
             costs must be necessary, reasonable, and adequately documented. Since the City
             did not complete the project as described in its approved funding application and
             did not pursue available collateral or sources of program income as required, the
             use of CDBG funds is considered unreasonable and unnecessary.

Conclusion

             The failure of the City to adequately plan, execute, and complete the Crystal Lake
             industrial park project as agreed upon in the approved Section 108 Loan
             Guarantee application had a large negative impact on the City’s programs. The
             commercial site was not completed, and no job creation opportunities were
             realized. Moreover, several years later, the site remained virtually unusable for
             practical development and no collateral or sources of program income had been
             pursued to repay the Section 108 loan. We attribute these issues to the City’s not
             having policies and procedures to ensure that Section 108 loan activities are
             administered in accordance with all program requirements. As a result, at least
             $1.7 million in CDBG funds was used to repay the Section 108 debt, and nearly
             $1.7 million in CDBG funding will be required to retire the debt. Therefore, not
             only were the objectives of the Section 108 Loan Guarantee program not met, but
             the CDBG program and its intended benefit to low- and moderate-income
             residents will be deprived of approximately $3.4 million in needed CDBG funds.
             Accordingly, the use of the $1.7 million in CDBG funds is considered
             unreasonable and unnecessary, and the future scheduled use of nearly $1.7 million

                                              14
          in CDBG funds to retire this debt should be reprogrammed for other CDBG-
          eligible activities.

Recommendations

          We recommend that the Director of HUD’s New York Office of Community
          Planning and Development instruct the City to

          2A.     Reimburse the CDBG program, from nonfederal funds, the $752,302 in
                  unused Section 108 funds to reduce the CDBG funds already used to repay
                  part of the Section 108 loan.

          2B.     Establish a plan for the Crystal Lake industrial park site within 90-days or
                  reimburse the CDBG program from nonfederal funds the $1,002,849 used to
                  repay the Section 108 loan debt ($1,755,151 less $752,302 in unused Section
                  108 funds and interest).

          2C.     Pursue the loan collateral or sources of program income and use those funds
                  to repay the $1,690,177 required for future Section 108 loan repayments.
                  This would allow the City to reprogram the $1,690,177 in CDBG funds
                  scheduled to be used for future repayments of the industrial park project loan
                  and put these funds to better use for other CDBG-eligible activities.

          2D.     Establish and implement policies and procedures to ensure that all future
                  Section 108 projects are administered in accordance with all approved
                  applications, loan agreements, and program requirements.




                                            15
                         SCOPE AND METHODOLOGY

Our review focused on whether the City complied with applicable HUD regulations and all related
contracts and agreements pertaining to the administration of two Section 108 loans. To accomplish
our objectives, we reviewed relevant HUD regulations, contracts, and agreements. In addition, we
reviewed the City’s policies, procedures, and related agreements and interviewed key personnel
responsible for administration of the City’s Section 108 Loan Guarantee program and related
CDBG activities.

For fiscal years 1999 through 2007, the City received a total of $3,125,000 in Section 108 loan
funding authority and $500,000 in related EDI funding. At the time of our review, the City had
expended $2,472,200 on Section 108 loan activities consisting of the marina and industrial park
projects. The City had also expended the $500,000 in EDI funding for the marina project. We
reviewed the Section 108 loan and EDI expenditures and related supporting documents for the
activities to determine whether the expenditures met Section 108 and CDBG requirements, were
reasonable, and complied with all agreements and contracts. We examined the City’s internal
controls over its Section 108 Loan Guarantee program. We also conducted site visits to each
project to review the progress of the activities.

The review covered the period January 1, 2005, through December 31, 2007, and was extended as
necessary. We performed audit work from December 2007 through May 2008 at the City’s offices
in Newburgh, New York. The review was conducted in accordance with generally accepted
government auditing standards.




                                               16
                             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 has
                      implemented to reasonably ensure that a program meets its objectives.

                      Validity and reliability of data – Policies and procedures that management
                      has implemented to reasonably ensure that valid and reliable data are
                      obtained, maintained, and fairly disclosed in reports.

                      Compliance with laws and regulations – Policies and procedures that
                      management has implemented to reasonably ensure that resource use is
                      consistent with laws and regulations.

                      Safeguarding of resources – Policies and procedures that management has
                      implemented to reasonably ensure that resources are safeguarded against
                      waste, loss, and misuse.

              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.




                                               17
Significant Weaknesses


           Based on our review, we believe the following items are significant weaknesses:

               The City did not have adequate controls over its program operations when it did
               not implement adequate procedures to ensure that its Section 108 Loan
               Guarantee program would meet all program objectives (see findings 1 and 2).

               The City did not have adequate controls over the validity and reliability of
               data pertaining to the Section 108 loan repayments related to the marina
               project, as the supporting documentation was found to be incomplete and
               unreliable (see finding 1).

               The City did not have adequate controls over compliance with laws and
               regulations, as it did not always comply with HUD regulations while disbursing
               Section 108 and CDBG funds (see findings 1 and 2).

               The City did not have an adequate system to ensure that resources were properly
               safeguarded when ineligible and unsupported costs were charged to the program
               and when it did not maintain adequate supporting documentation (see findings 1
               and 2).




                                            18
                                         APPENDIXES

Appendix A

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

         Recommendation            Ineligible 1/   Unsupported      Funds to be put
                number                                      2/      to better use 3/
                       1A            $449,817
                       1C                                               $1,322,568

                       1D            $144,341
                       2A                                                  752,302
                       2B                            $1,002,849
                       2C                                               $1,690,177
                     Total           $594,158        $1,002,849         $3,765,047


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 Office of Inspector General (OIG) recommendation is
     implemented. This includes 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
     which are specifically identified. In this instance, if the City implements our
     recommendations of taking appropriate action to collect on future loan obligations and
     reprogramming funds targeted to repay future loan obligations, CDBG funds can be used
     for other eligible activities, thus ensuring a cost savings to its CDBG program.




                                             19
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                         20
Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




Comment 2




Comment 3




                         21
Ref to OIG Evaluation   Auditee Comments




Comment 4




Comment 4




                         22
Ref to OIG Evaluation   Auditee Comments




Comment 5




Comment 4

Comment 6




Comment 7




Comment 8




                         23
Ref to OIG Evaluation   Auditee Comments




Comment 9



Comment 10




Comment 11




Comment 12




Comment 13




                         24
Ref to OIG Evaluation   Auditee Comments




Comment 13



Comment 14




Comment 15




Comment 8




                         25
Ref to OIG Evaluation   Auditee Comments




Comment 16




Comment 8




Comment 17




Comment 6




                         26
Ref to OIG Evaluation   Auditee Comments




Comment 18




Comment 11




Comment 19




                         27
Ref to OIG Evaluation   Auditee Comments




Comment 19




Comment 20




Comment 21




Comment 22



Comment 23




                         28
Ref to OIG Evaluation   Auditee Comments




Comment 23


Comment 24




Comment 25




Comment 26




Comment 27




                         29
Ref to OIG Evaluation   Auditee Comments




Comment 27




Comment 28




Comment 29




                         30
Ref to OIG Evaluation   Auditee Comments




Comment 30




                         31
Ref to OIG Evaluation   Auditee Comments




Comment 30




                         32
                  OIG Evaluation of Auditee Comments

Comment 1   Officials for the City assert that the report does not conform to
            Government Auditing Standards and does not include criteria, condition,
            causes, effect, and recommendations. The officials request the redrafting
            of the report based upon their overall comments. The audit report
            complies with Government Auditing Standards and clearly states the
            criteria, condition, cause, effect, and recommendations for each finding.
            Moreover, the official’s overall comments and assertions are contrary to
            the facts and conclusions contained in the audit findings. The draft report
            is based on evidence obtained from interviews with City officials, review
            of Section 108 files, and our extensive knowledge of both the Section 108
            Loan Guarantee and Community Development Block Grant (CDBG)
            Programs. Thus, the officials have attempted to refute the audit report
            with extraneous language and terminology that do not address the core
            issues and conclusions of the report, which is that the City needs to
            improve its administration of its Section 108 Loan Guarantee Program.
            Accordingly, the report will not be modified.

Comment 2   Officials for the City state that a lawsuit was commenced on August 26,
            2008 against Marina Ops to enforce the loan agreement provisions and
            seek collection of the debt. Prior to initiating legal action, officials for the
            City assert that it pursued remedies by employing methods which are
            consistent with principles of standard commercial dealings of this kind.
            Such methods included formal demands, proposed payment plans, and
            negotiations of terms. The City’s actions are responsive to our findings;
            however, this action is not timely as mentioned in the finding. The lawsuit
            did not commence until over five years after the borrower first neglected
            to make loan payments and only after we began the audit and raised these
            issues with the City. Further, audits by the City’s Independent Public
            Accountant (IPA) also disclosed that the City failed to safeguard HUD
            assets by not requesting repayment from the third party marina developer
            in a timely manner.

Comment 3   Officials for the City state that the draft report is not accurate as to the
            amount owed by Marina Ops. They assert that the audit report states that
            $2.85 million is owed on the marina loan. Officials also contend that the
            language of the draft report seems to overlook or ignore that the City got a
            personal guarantee from the developer. The draft report clearly states that
            the total HUD funding for the project is $1.5 million; nevertheless, we
            added additional language to the report to clear any confusion. In
            addition, the draft report clearly states on page 6 that the City was required
            to obtain a personal guaranty from the developer; however, this does not
            appear to be relevant as the issue discussed in this section of the finding
            pertains to the City’s failure to adequately pursue loan collection and
            available collateral.


                                      33
Comment 4   Officials for the City assert that they have supported and documented all
            funding sources, in harmony with applicable Federal laws and rule. They
            state that their files have been audited as part of the City’s annual auditing
            process and are available for further inspection. Further, officials assert
            that they expended in excess of $1.5 million on the Marina project and
            provided a table detailing that over $3.2 million in total was invested in
            the Marina project, including the $1.5 million of HUD funding. However,
            our audit work found that the City was unable to fully support the $1.5
            million of HUD funding and provided no evidence of additional funding
            sources that would total $2.85 million. Further, in a March 2008 email,
            we requested an accounting for all of the $2.85 million of Marina costs
            and made repeated requests during the audit for all supporting
            documentation involving the total project costs of $2.85 million.
            Nevertheless, the requested documentation was never provided to us. If
            supporting documents are now available, it will be reviewed by the field
            office during the audit resolution process.

Comment 5   Officials for the City contend that there was a miscommunication
            regarding our request for project documentation, as the request for
            additional documentation was not clear. They contend that separate
            records were maintained by the City for various elements of the project.
            Nevertheless, as the finding stated, the City did not properly document and
            support all Marina project costs. However, the actions of the City to now
            have all files contain cross-references so that the necessary information is
            included and accessible, is responsive to our report.

Comment 6   Officials for the City assert that the developer did provide the required
            $300,000 of developer equity and that no violation of the loan provisions
            requiring a 2-to-1 ratio of Section 108 and EDI funds occurred. Further,
            the officials assert that the data on the Marina costs is attached directly to
            the vouchers and may have been overlooked by the auditor. The data on
            project-related costs was not overlooked by the auditor; the City never
            provided any evidence of developer equity. As such, since the City was
            unable to adequately support HUD funds and provide support for the
            leveraged funds, we have no assurance that the 2-to-1 ratio requirement
            was followed. Additional evidence, if available will be considered during
            the audit resolution process.

Comment 7   Officials for the City claim that they followed OMB Circular A-87 when
            paying costs and supporting the project activities and that all loan
            documents were submitted to, reviewed, and approved by HUD.
            However, the official’s claim of adherence to OMB Circular A-87 is not
            supported by the facts. The City failed to safeguard assets by not
            enforcing the loan agreements, and failed to obtain proper supporting
            documentation before disbursing all HUD funds. The audit report does
            not refute the fact that all loan documents were submitted to, reviewed,

                                      34
             and approved by HUD. The core issue raised in the report is that the City
             failed to abide by and enforce their own loan agreements; thus, the
             response from the officials has not addressed the facts.

Comment 8    Officials for the City state that there was no statutory or regulatory
             prohibition against the use of CDBG funds for Section 108 loan
             repayment and other municipal awardees of CDBG funds have used
             CDBG funds for similar purposes. The officials assert that our use of the
             terminology not reasonable or necessary is relative and not defined or
             placed in context. Consequently, the officials disagree with
             recommendation 1A. OIG fully recognizes and understands that
             regulations allow CDBG funds to be used for Section 108 loan
             repayments. This is not the issue raised in the report. The issue, as
             provided for in 24 CFR 85.22, is that the use of CDBG funds to repay the
             Marina loan was not necessary or reasonable. Specifically, the use of
             CDBG funds would not have been necessary had the City exercised their
             fiduciary responsibility to safeguard HUD assets. The Marina loan
             agreements executed by the City were clear in stating that the Marina
             developer would provide the loan repayment monies necessary to amortize
             the Section 108 debt, however, the City failed to adequately administer the
             loan and enforce loan provisions. In fact, even though the marina was
             earning income, the City allowed the developer to ignore nearly all of the
             loan conditions for many years, without any substantive action by the City
             to enforce the loan agreement. As such, our use of the terminology not
             reasonable or necessary is justified in the context presented, thus our
             conclusion that $449,817 in CDBG funds could have been used for other
             purposes had they not been used to repay the Section 108 debt that should
             have been paid by the developer. Accordingly, we recommend that the
             City enforce the loan provisions within 90 days and reimburse the CDBG
             program from nonfederal funds the $449,817 used for the Section 108 debt
             repayment.

Comment 9    Officials for the City state that CDBG expenditures were in fact necessary
             and adequately documented, and that HUD OIG’s inspection disclosed
             that the Marina was open and successful. The officials are apparently
             confused about the issue discussed in the finding, whereas, the fact that the
             Marina is open has nothing to do with the requirement for the City to
             enforce their loan agreements with the developer. Further, if the Marina is
             successful, this lends credence to the fact that the City should have
             aggressively enforced loan collection from the developer, rather than using
             CDBG funds to repay the debt.

Comment 10   Officials for the City state that Section 108 repayments are required to be
             made on a semi-annual basis, irrespective of whether program income is
             being received to support the payment. We agree with this fact, however,
             the official’s response does not address the issue discussed in the finding,



                                      35
             that the City could have avoided using CDBG funds, if it had properly
             managed and enforced their own loan agreements with the developer.

Comment 11   In disputing a duplicate payment made to benefit the developer; officials
             for the City describe their disbursement procedures, whereas the City is
             the payer to the developer and not the City’s Community Development
             Office. However, during the audit we were provided documentation
             which supports that a duplicate payment in the amount of $144,341 was
             made to the developer for the same project costs, which should be repaid.

Comment 12   Officials for the City question the audit statements pertaining to inaccurate
             and incomplete loan repayment requests sent to the developer. The
             officials contend that their notices sent to the developer were accurate and
             question the audit methodology followed. They further state that they
             were not informed of this concern. Our audit work found that the City
             provided inaccurate and incomplete information in their loan repayment
             requests and notices sent to the developer. For example, in December
             2005 the City informed the developer that $25,000 and $75,000 were due
             and payable for the years 2004 and 2005, respectively. However, the
             notice failed to mention the 2003 EDI payments due that were not made,
             the monthly interest only payments (at 3.75 percent) that were due during
             the first year, as well as the year 2 and year 5 monthly payments that are
             due on the Section 108 loan for the next 10 years, etc. The notices from
             the City to the developer do not address these required payments or the
             requirement for the developer to submit annual financial statements.
             Since the officials should have been able to review their own loan
             documents and compare them to the notices sent to the developer, we
             question the official’s contention that their notices sent to the developer
             were accurate.

             This information was brought to City officials’ attention during our audit.
             As such, our audit report statements are supported by detailed audit work,
             review, and analysis, such as noted in the examples above.

Comment 13   Officials for the City appear to be confused. They seem to think that we
             believe the entire $2.85 million is for the marina only and not the
             surrounding walkway. As such, to clarify the issue, when we refer to the
             total $2.85 million we have added the words marina redevelopment
             project. As discussed in the audit report, the total marina redevelopment
             project costs are $2.85 million. HUD funding towards the marina
             redevelopment project totaled $1.5 million.

Comment 14   Officials for the City contend that the Agreement between the City and
             HUD does not require that funding sources (other than HUD) be provided
             prior to disbursing Section 108 and EDI funds. However, the Section 108
             agreement with the Marina developer, executed on March 22, 2002,
             detailed that no disbursement of the Section 108 and EDI loan funds shall

                                      36
             be made until the developer has expended or deferred not less than
             $300,000 of equity funds for eligible costs of the project. Further, the
             agreement specified that in the event that total project costs were less than
             $2.85 million, the HUD funding shall be reduced on a ratio of 2:1 by
             $1.00 for each $1.00 of such shortfall. Despite numerous documented
             requests by the auditor, no evidence was provided during our audit to
             support that the developer provided the $300,000 of equity funds.

Comment 15   Officials for the City state that all communications between the City and
             HUD pertaining to the loan default reflect an accurate understanding of
             the situation at the time and that the City did not intentionally mislead
             HUD officials of the status of the loan. Nowhere in the audit report do we
             accuse the City of intentionally misleading HUD. However, our review of
             file evidence disclosed that on May 1, 2007, the City informed the
             developer that the first loan payment of $46,250 was due on May 14, 2007
             and a second payment on $25,000 was due on July 6, 2007. These
             payment requests by the City do not agree with the signed loan agreement
             terms. On July 16, 2007, the City wrote to HUD and stated that the first
             payment of $27,500 was made in May 2007 and that the next payment to
             the City is due in July. The City’s letter to HUD omitted the fact that the
             first payment in May, as per their request letter, was supposed to be in the
             amount of $46,250. An internal City memo, dated July 16, 2007, shows
             that the City was aware of the fact that the $27, 500 paid in May was only
             a partial payment of the total $46,250 due. Thus, the City contemplated
             asking for the remainder of the first loan payment due, but did not. Also
             omitted in the July 16, 2007 letter to HUD is the fact that the due date for
             the second loan payment of $25,000 had elapsed on July 6, 2007, 10 days
             prior. In fact, the developer never made this second payment. The facts
             as we have presented are readily available to the officials and are
             indicative of how the City has consistently failed to properly administer
             the Marina Redevelopment Project and loan.

Comment 16   Officials for the City question the basis and methodology of the audit
             report stating that it does not substantiate that the City’s ability to provide
             maximum benefit to low- and moderate-income residents was hindered.
             The officials contend that the actual use of Section 108 proceeds and EDI
             grant funds for the Marina project benefitted low-and moderate-income
             residents, including those who reside nearby or have a view or visit the
             waterfront. However, the facts presented by City officials do not address
             the core issues and conclusions of the report. The report clearly states that
             the City’s ability to provide maximum program benefit is hindered by the
             fact that $449,817 of CDBG funds has been used for Section 108 loan
             repayments and another $865,968 may be needed to repay future Section
             108 debt. Obviously, had the City properly administered its Section 108
             loan as described to HUD and memorialized in agreements with the
             developer, then the use of $449,817 would not have been necessary. We
             recognize that development projects occasionally fail and that sometimes

                                       37
             CDBG funds are needed to repay Section 108 debt that was intended to be
             repaid by a private developer. However, the City failed to adequately
             safeguard the asset (loan receivable) and failed to enforce the loan
             agreement provisions and collateral. If the City had successfully
             administered the loan, then CDBG funding for loan repayment would not
             have been needed and the City could have used CDBG funds to
             accomplish additional worthy projects.

Comment 17   In response to the request for further clarification of nonfederal funds,
             particularly in relation to monies recovered from the developer, we
             provide that any monies recovered from the Marina developer would
             constitute nonfederal funds.

Comment 18   Officials for the City state that EDI loan repayments are available to the
             City for future eligible uses and are independent of any considerations
             related to the CDBG program funds. However, unless the EDI loan
             repayments are needed as security for the repayment of the Section 108
             Loan debt, the EDI repayments will constitute program income under
             CDBG regulations.

Comment 19   Officials for the City assert that no showing has been made that the City’s
             administrative policies and procedures are inadequate to ensure
             compliance with all requirements of the Section 108 projects, including
             applications, loan agreements, support and documentation, fiscal
             procedures and program requirements. The assertion of the officials is
             contrary to the instances of noncompliance reported in the finding related
             to their Section 108 Marina Redevelopment loan project. The City did not
             comply with Section 108 program requirements and related agreements.

Comment 20   Officials for the City contend that they diligently and professionally
             assessed the Crystal Lake project site under the conditions which prevailed
             at the time and provided analysis describing the feasibility of the proposed
             development. The facts presented in the finding lead to the conclusion
             that the site was not feasible. The Section 108 application provided that
             the City would complete necessary infrastructure improvements and
             attract commercial development at Crystal Lake to create jobs.
             Approximately $1.6 million was targeted to complete this activity, but the
             City only expended $911,330 and suspended the extension of the Temple
             Avenue infrastructure to Crystal Lake until a suitable commercial
             developer could be identified. Thus, no jobs were created and more than
             seven years later, no commercial developer has been identified, and almost
             half of the targeted Section 108 loan funds remain unexpended. During
             the audit, it was explained to us that several proposed projects did not pan
             out, primarily because of the difficulty of designing and constructing
             commercial buildings on narrow parcels wedged in between the lake and
             Snake Hill. However, we remind the officials that these physical
             constraints at the project site existed before the City applied for Section

                                       38
             108 funding and should have alerted the City as to the difficulties of
             commercial development at the site.

Comment 21   Officials for the City state that they did not amend their Section 108 loan
             program to reduce the funds needed. While it is true that the City did not
             amend their Section 108 program, it is also true that the City violated their
             Section 108 Loan Contract by allowing $652,800 of unused proceeds plus
             $99,502 in interest to remain in the project bank account for over seven
             years.

Comment 22   Officials for the City state that the audit report misapprehends the nature
             of the project, in regards to the City not pursuing collateral or program
             income for loan repayment. We refer the officials to the City’s approved
             Section 108 loan application which provides that revenues generated by
             the sale of the used fire apparatus and the commercial development
             parcels will be placed in a secure account to be used to make subsequent
             loan payments. We were never provided evidence to support that the city
             exercised any of these options as promised. This is despite the fact that
             the City acknowledges that the Crystal Lake land parcels are owned by the
             City, and thus represent available collateral.

Comment 23   Officials for the City state that the $911,000 was used on eligible
             infrastructure improvements even though the ultimate project was not
             completed. Further, such use of funds is authorized under the program,
             and benefits those who are the target beneficiaries of the program. The
             officials contend that the audit report does not refer to any rule or practice
             referenced in law or code which prohibits such use of funds. The issue is
             not necessarily the use of the $911,000. The issue, as presented in the
             finding, is that the City violated their Section 108 agreement by not
             utilizing all of their loan proceeds as promised. After which, the City
             failed to pursue its collateral to repay the Section 108 loan and instead
             used CDBG funds. Further, it should be noted that the Section 108
             contract required the unused Section 108 loan proceeds of $652,800 to be
             used as loan repayment collateral, instead, the City allowed the proceeds
             to remain unused for over seven years, despite acknowledging that
             completion of the project is not feasible.

Comment 24   Officials for the City cite page 13, lines 7-11 of the audit report as
             confirmation that the commercial development of the proposed site was
             properly reconsidered. However, the section of the audit report cited
             actually states that an OIG inspection of the site confirmed the City’s
             concerns that the Crystal Lake area was not feasible for commercial
             development. Specifically, there is no road access, and the land tract is
             very narrow along the lake area. Thus, the conclusions reached should
             have been apparent to the City prior to the Section 108 loan application,
             which promised development and job creation.



                                       39
Comment 25   Officials for the City contend that there is no loan agreement in place
             between the City and any developer for this site. Also, they contend that
             collateral for this Section 108 debt was not required by HUD and assert
             that the auditor apparently did not understand the factual background of
             this project. We corrected the report to state the City did not use funds to
             repay the debt as required by the loan application and contract agreement
             with HUD. The loan application and contract agreement provide that
             revenues generated by the sale of the used fire apparatus and the
             commercial development parcels will be placed in a secure account to be
             used to make subsequent loan payments. We were never provided
             evidence to support that these funds were pursued as promised.

Comment 26   The actions of the City officials are responsive to our recommendation;
             however, they did not address what they will do with the balance of
             Section 108 funds not expended.

Comment 27   Officials for the City intend to apply for approval to modify the scope of
             the Crystal Lake industrial park project. The modified project will be
             taken under consideration and addressed during the audit resolution
             process.

Comment 28   Officials for the City state that 24 CFR 85.22 was satisfied in that, the
             funds were expended for necessary improvements and that the audit
             allegation regarding the use of CDBG funds as unnecessary and
             unreasonable is without support. We wish to make it clear that although
             collateral or other sources of income was promised to be used to repay the
             Section 108 loan related to the industrial park project, the City used
             CDBG funds instead. This was despite the fact that over $750,000 of
             unused Section 108 proceeds is available for repayments. It is based on
             these facts that we concluded that the use of CDBG funds may not have
             been necessary or reasonable.

Comment 29   Officials for the City assert that no showing has been made that the City’s
             administrative policies and procedures are inadequate to ensure
             compliance with all Section 108 projects. Officials also express openness
             toward different fiscal procedures or policies that may be recommended
             by HUD during consultation. Officials are reminded that the report
             findings show that the City did not comply with Section 108 program
             requirements and related agreements, as it relates to pursuing collateral or
             other sources of income to repay the loans instead of using CDBG funds.
             In addition, the projects were not completed as described to HUD in the
             approved application, and the City allowed over $752,000 of loan
             proceeds to remain unused for over seven years. Nevertheless, the
             officials desire to consult with HUD will be taken under consideration and
             addressed during the audit resolution process.




                                      40
Comment 30   Officials for the City reiterate that they have complied with the
             requirements of the Section 108 loan program and that the report is
             inaccurate, undefined, and unsupported. Further, officials state that the
             report fails to articulate the standards and criteria used to support the
             characterization of the City’s actions and procedures. The officials
             summarize many of their previous statements; however, their
             disagreement to the report is presented in general terms with little
             specifics or facts to support their position. In contrast, our report clearly
             provides the facts, criteria and documented evidence to support that
             contrary to the loan agreement and regulations, the City failed to ensure
             that all Section 108 Loan Guarantee funds and related project costs
             pertaining to the Front Street Marina redevelopment project were proper,
             necessary, and fully supported. In addition, the City did not achieve the
             primary objective of job creation for the industrial park project, loan
             proceeds remained unused in a bank account for more than seven years,
             possible collateral or program income for loan repayment was not
             pursued, and the City did not ensure that the industrial site was feasible for
             commercial development and job creation. As a result, the City’s CDBG
             program was deprived of funds that could have been used for other
             activities and will be hindered from effectively using future CDBG funds
             to provide maximum benefit to low-and moderate-income residents.




                                       41