oversight

The City of Yonkers, New York, Had Weaknesses in the Administration of its Section 108 Loan Guarantee Program

Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-03-06.

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

                                                                Issue Date
                                                                      March 06, 2009
                                                                Audit Report Number
                                                                       2009-NY-1009




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



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


SUBJECT: The City of Yonkers, New York, Had Weaknesses in the Administration of its
         Section 108 Loan Guarantee Program


                                   HIGHLIGHTS

 What We Audited and Why

             We audited the City of Yonkers, New York’s (the City) administration of its
             Section 108 Loan Guarantee program. We selected the City based upon a risk
             assessment of Section 108 loan recipients monitored by the U.S. Department of
             Housing and Urban Development (HUD) New York City Office of Community
             Planning and Development, and discussion with that office’s director, who raised
             concerns about the City’s program. The objectives of our audit were to determine
             whether the City (1) disbursed Section 108 loan program funds for eligible costs
             in accordance with applicable HUD rules and regulations, and (2) maintained a
             financial management system that adequately safeguarded funds and prevented
             misuse.

 What We Found
             The City disbursed program funds for Section 108 loan program eligible activities
             in accordance with HUD rules and regulations, and maintained a financial
             management system that adequately safeguarded funds. However, there were
             weaknesses in controls over the administration of the program that resulted in
             inadequate monitoring and reporting to HUD. Specifically, the City did not (1)
             adequately document data on compliance with the job creation and retention
             provisions of borrower loan agreements, (2) consistently monitor and report on
           the use of loan proceeds, (3) properly maintain its loan repayment account, and
           (4) notify HUD when loan collateral was changed or loans defaulted, These
           deficiencies occurred because City officials were unaware of program
           requirements. As a result, the City lacked assurance that loan job creation and
           retention goals were achieved, loan disbursements were used for eligible
           purposes, and loan repayments would be sufficient to meet the City’s future loan
           repayment obligations. In addition, HUD was not made aware of changes to loan
           collateral and defaulted loans, which could have affected its financial interest.

What We Recommend


           We recommend that the director of HUD’s New York Office of Community
           Planning and Development instruct the City to strengthen its controls to (1)
           monitor and verify loan recipients’ compliance with job creation and retention
           requirements, (2) obtain and review borrower documentation for expenditure of
           loan proceeds to ensure loan proceeds are used for eligible purposes, (3) properly
           maintain loan repayment records, and (4) report changes in loan collateral and
           defaults to HUD.

           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 and at an exit conference
           held on February 20, 2009. We provided a copy of the draft report to City
           officials and requested their written comments by February 26, 2009, which we
           received on that date. City officials generally agreed with our findings and agreed
           to implement action responsive to the recommendations. 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: The City had Weaknesses in the Administration of its Section 108   6
               Loan Guarantee Program




Scope and Methodology                                                             11

Internal Controls                                                                 12



Appendixes
   A. Schedule of Section 108 Loans Administered by the City                      14
   B. Auditee Comments and OIG’s Evaluation                                       15




                                             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 a source of financing to
cities and counties 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 grantee of current and future CDBG funds. Additional security can be required to assure
repayment of guaranteed obligations, and is determined on a case-by-case basis and can include
assets financed by the guaranteed loan. Section 108 loans may be for terms up to 20 years.

CDBG rules and requirements apply when determining project eligibility. All projects and
activities must meet the CDBG primary objective that 70 percent of the funds used benefit low
and moderate-income persons, as well as 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.

The City of Yonkers’ (the City), a CDBG entitlement recipient, established its Section 108 Loan
Guarantee Program in 1996 in accordance with the CDBG objective to principally benefit low
and moderate income persons through job creation and retention. The City established a five
member loan committee consisting of the Commissioner of Finance, Commissioner of Planning
and Development, Director of Economic Development, City Council Majority Leader, and City
Council Minority Leader, to review and approve loan applications. The Office of Economic
Development administers the City’s Section 108 Program. This Office recently experienced
staff turnover; consequently both the director and the loan manager have occupied their positions
for less than two years and one year, respectively. The files and records related to the program
are maintained in City Hall, located at 40 South Broadway, Yonkers, New York.

The Office of Economic Development administers both direct loans and loans from its economic
development loan pool. To obtain HUD approval for a direct loan, the City submits an
application containing information regarding a specific proposal for funding, including financial
data related to the developer, project site, and discussion of how the proposed project meets
national objectives and public benefit. The application is reviewed at both the HUD field and
headquarters offices. To gain approval to use loan funds from the economic development loan
pool, the City submits an abbreviated application to the HUD field office notifying HUD of the
loan guarantee amount requested, along with program guidelines, such as maximum or minimum
loan size, and how each project to be funded will be assessed for eligibility, national objectives,
and public benefit. During the audit period from January 1, 2005 through December 31, 2007
the City awarded almost $23 million in section 108 loan guarantee funds for 24 loans, 5 of which
were direct loans and 19 were from the loan pool. Twelve of the 24 loans are current (see
appendix A for the status of each loan).

We audited the City’s Section 108 Loan Guarantee Program based upon a risk assessment of
Section 108 Loan Guarantee Program recipients monitored by HUD’s New York City Office of
Community Planning and Development, and discussion with the field office director, who
expressed concern about the City’s program. The objectives of our audit were to determine
whether the City (1) disbursed Section 108 loan program funds for eligible costs in accordance


                                                 4
with the applicable HUD rules and regulations, and (2) maintained a financial management
system that adequately safeguarded funds and prevented misuse.




                                              5
                                RESULTS OF AUDIT

Finding: The City had Weaknesses in the Administration of its Section
         108 Loan Guarantee Program
Although, the City disbursed funds for eligible activities under the Section 108 Loan Guarantee
Program, it had weaknesses in controls over the administration of its program that resulted in
inadequate monitoring and reporting to HUD. Specifically, the City did not (1) adequately
document data on compliance with the job creation and retention provisions of borrower loan
agreements, (2) consistently monitor and report on the use of loan proceeds, (3) properly
maintain its loan repayment account, and (4) notify HUD when loan collateral was sold or loans
defaulted. These deficiencies occurred because City officials were unaware of program
requirements. As a result, the City lacked assurance that loan job creation and retention goals
were achieved, loan disbursements were used for eligible purposes, and loan repayments would
be sufficient to meet future obligations. In addition, HUD was not made aware of changes to
loan collateral and defaulted loans.


 Inadequate data on jobs created

              While a primary purpose of the City’s Section 108 Loan Program is to create jobs,
              the City did not establish adequate procedures to obtain and verify documentation
              that loan recipients were complying with loan job creation and retention
              provisions. Regulations at 24 CFR (Code of Federal Regulations) 570.506(b)
              require that the City maintain records to demonstrate compliance with CDBG job
              creation and retention requirements. Regulations at 24 CFR (Code of Federal
              Regulations), Section 570.506(b)(5)(i) and Section 570.506 (b)(5)(ii) specify that
              when an activity is determined to benefit low and moderate income persons,
              documentation should include a written commitment from the business indicating
              that low and moderate income persons received first consideration for the jobs.

              In July 2007 the HUD field office advised the City that its documentation to
              support the number of jobs created and retained in its Section 108 loan program
              was inadequate. At that time, the City had not implemented procedures to collect
              data from loan recipients on the number of jobs created and retained. As a result
              of HUD’s observation, the City developed a form for loan recipients to report
              annually on the number of jobs created and retained. However, the data collected
              was inadequate because it did not distinguish between jobs created and retained,
              nor specify the various income levels of those individuals that benefitted from the
              jobs as required. Further, the City had not yet responded to HUD’s August 6,
              2008 letter requesting that the City review documentation for all Section 108
              funded projects to determine the number of jobs created and retained. City
              records reported that the 24 loans administered by the City created and retained
              209 of a planned 1,915 jobs; however, this data was not verified by the City.



                                               6
Inadequate monitoring and
reporting on the use of loan
proceeds
         The City had weaknesses in the monitoring and reporting of the status of loans.
         First, the City did not consistently obtain and review documentation on the use of
         loan proceeds. Regulations at 24 CFR (Code of Federal Regulations) part
         570.506 (h) provide that the City maintain documentation to support how the
         funds provided to an entity are expended. Review of each of the loan files for the
         24 loans administered by the City disclosed that ten loan files did not have
         invoices, contracts or other supporting documentation to show how the loan
         proceeds were disbursed, and one loan file could not be found. The deficiency
         occurred because the City was unaware of the requirement to obtain and maintain
         such documentation. Without this documentation, the City cannot be assured that
         the loan proceeds were used for their intended purpose.

         Second, the City did not routinely conduct site visits as required by its procedures.
         The City’s Section 108 Policy and Procedures Manual, Section VIII, C 2 provides
         that a site visit to loan recipients be conducted at least annually. These visits are
         considered essential in checking levels of inventory or work-in-progress,
         observing work completed, and interviewing the borrower. Review of 24 loan
         files disclosed that two annual site visits were conducted prior to the start of our
         review. However, after the start of our review, between June 2008 and October
         2008, the City completed site visits for 8 of the 12 current loans. City officials
         said that they will conduct site visits as required by section VIII, C2 of its policies
         and procedures.

         Third, the City did not provide its loan committee with reports on the status of its
         loans. The City’s Section 108 Policy and Procedures Manual, Section II, C 11,
         requires that the City report quarterly to the loan committee on the status and
         impact of the projects approved for Section 108 loans. However, the loan files
         lacked documentation that quarterly reports were prepared and provided. As a
         result, the loan committee is unaware of the status of the loans it approved.
         Further, while a City official advised that loan write-offs be approved by the loan
         committee, documentation of such approval was lacking for three loans that were
         written off. Also, one loan, which defaulted in 2002, had not been sent to the loan
         committee for approval to write-off its remaining balance. A city official said that
         approval to write off the loan would be on the agenda for the next loan committee
         meeting. This official further said that the loan committee meets on an as needed
         basis; however, the committee has not met since November 2006.

         Fourth, regulations at 24 CFR (Code of Federal Regulations) part 570.506
         provide that sufficient records be maintained to enable the secretary to determine
         whether the recipient has met the requirements of this part. However, the City did
         not maintain adequate Section 108 loan program records. In its July 2007
         monitoring review HUD cited the City for having disorganized files, and as of the
         end of our field work, the City had not responded to HUD’s August 6, 2008 letter,
         for which a response was due within 45 days, requesting that it confirm that its

                                           7
            loan files were reorganized. During our review, the City began to more
            efficiently organize its files; however, one file could not be found and officials
            had to contact the City’s consultant and attorney for information about the loan.

  Loan repayment account not
  properly maintained


            Paragraph 6 of the contract between the City and HUD for loan guarantee
            assistance from the economic development loan pool and from each direct loan
            provides that the City should maintain a repayment account for each direct loan
            and one account for all economic development loan pool loans. All borrower
            repayments should be deposited into these accounts and funds for direct and
            economic loan pool loans should be maintained separately to ensure that there are
            sufficient funds to repay all obligations to HUD. However, the City maintained
            one repayment account into which all borrower payments were commingled. As a
            result, the City could not individually account for each economic development
            loan pool and direct loan in the repayment account. This occurred because the
            City was unaware of the requirement to maintain separate accounts. Without such
            an accounting, the City lacks assurance that funds from one direct loan are not
            being used to pay obligations on another direct or loan pool loan. For instance,
            during our audit period, the City paid HUD $274,248 from this account to meet
            obligations due on a direct loan; however the borrower had made no payments to
            the City. In addition, the City received $384,930 as a settlement on two loans that
            defaulted, for which the City will ultimately have to pay the full amount.
            Therefore, funds may be inadequate to meet the City’s future repayment
            obligation on each of these loans, and the City may need to use its CDBG or other
            sources of funds.

HUD not notified of collateral
changes and defaults

            The City did not inform HUD when collateral on two loans was changed.
            Regulations at 24 CFR (Code of Federal Regulations) 570.705(b) (3) require that
            any additional security pledged on a loan be identified in the loan guarantee
            assistance contract between HUD and the City. However, the City did not notify
            HUD when it sold property that was pledged as collateral for a loan to a new
            borrower. Additionally, section 15 (c) (D) of the contract for loan guarantee
            assistance between HUD and the City requires that HUD approve any alternative
            collateral or security arrangements implemented after loan approval. Contrary to
            this, the City allowed a borrower on a loan executed through the loan pool to
            substitute a pledge of common stock in place of the previously approved collateral
            of a security interest in the property, and a mortgage on a vacant waterfront
            parcel, without notifying HUD. This occurred because the City lacked controls to
            ensure that HUD was notified. As a result, HUD was unaware of the change in
            collateral and was unable to evaluate whether its interest was adequately
            protected.


                                              8
             In addition, Section 15 (e) of the contract for loan guarantee assistance between
             the City and HUD requires the City to promptly notify HUD in writing whenever
             an event occurs which constitutes a default under any of the security documents
             pertaining to a business loan. However, the City did not notify HUD as required
             when any of its eight loans defaulted. This occurred because the City was
             unaware of the requirement to notify HUD. As a result, HUD was unaware of the
             defaults and could not assess the extent to which its interest may have been
             harmed.

Conclusion


             The City generally disbursed Section 108 loan program funds for program
             intended activity in accordance with HUD rules and regulations, and maintained a
             financial management system that adequately safeguarded funds; however, the
             City had weaknesses in controls over administration of the program.
             Strengthening these controls would provide greater assurance that loan job
             creation and retention provisions are being achieved, loan disbursements are used
             for eligible purposes, loan repayments would be sufficient to meet its obligations,
             and HUD is made aware of changes to loan collateral and defaulted loans. These
             weaknesses are attributed to the City being unaware of the program regulations.

Recommendations

             We recommend that the director of HUD’s New York Office of Community
             Planning and Development instruct the City of Yonkers to strengthen controls by
             developing procedures to:

             1A.    Require loan recipients to report on, and provide supporting
                    documentation to verify, the number of jobs created and retained by
                    income level for each loan awarded.

             1B.    Consistently obtain and review documentation on the use of loan proceeds
                    to ensure that loan recipients are using loan funds for eligible purposes.

             1C.    Ensure compliance with its own procedures that require quarterly reports
                    to the City’s loan committee so that the committee is aware of the status of
                    loans outstanding.

             1D.    Ensure that documentation is maintained to support the approval and
                    write-off of loan balances.

             1E.    Establish and maintain adequate loan files and records, and provide
                    assurance to HUD that the issues in its August 6, 2008 letter to the City
                    regarding loan files and job creation documentation were properly
                    addressed.


                                              9
1F.   Maintain separate bank accounts for each direct loan and one account for
      the loan pool as required to ensure that borrower repayments are
      appropriately accounted for and safeguarded.

1G.   Report any sales or changes in loan collateral, as well as any loan defaults,
      to HUD as required so that HUD can be aware of conditions affecting its
      interest in the loans.




                               10
                        SCOPE AND METHODOLOGY

We performed our audit work from April 2008 through November 2008 at the City’s Office of
Economic Development located at 40 South Broadway, Yonkers, New York. The review covered
the period January 1, 2005 through December 31, 2007, and was extended as necessary. To
accomplish our objectives, we

        Reviewed HUD regulations at 24 CFR 570 Sub part M to gain an understanding of the
         Section 108 Loan Guaranteed Program history, objectives, and policies and procedures.

        Reviewed the City’s Section 108 Loan Guaranteed Program policies and procedures,
         consolidated plan, and independent auditor’s report for fiscal year ended 2007, to
         determine compliance with HUD regulations.

        Interviewed officials from the City’s Office of Economic Development, Finance
         Department, and the City’s consultant for the Section 108 program.

        Reconciled loans recorded on the City’s records with that of HUD to ensure the
         City’s record of loans matched HUD’s records.

        Reviewed files for each of the 24 loans the City administered during our audit period
         to document the basis upon which loans were approved, assess the effectiveness of
         the City’s monitoring of loan activity, and compliance with HUD regulations and its
         own procedures.

        Reviewed bank statements, bank reconciliations, and general ledgers related to the
         City’s section 108 loan program, to ensure that the City’s bank balance reconciled
         with the City’s general ledger balance.

We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objectives. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objectives.




                                               11
                        INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following controls are achieved:

       Program operations,
       Relevance and reliability of information,
       Compliance with applicable laws and regulations, and
       Safeguarding of assets and resources.

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



 Relevant Internal Controls


               We determined that 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.




                                                12
Significant Weaknesses


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

               The City did not have adequate controls over the validity and reliability of
               data when its officials did not collect information and documents to verify
               jobs created and retained, the income levels of those that benefitted from the
               jobs, and documentation to substantiate the use of loan proceeds (See finding).

               The City did not have adequate controls over compliance with laws and
               regulations when loan files and records were not adequately maintained, HUD
               approval for the substitution of collateral on two Section 108 loans was not
               requested, and bank accounts were not maintained as required (See finding).




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                                                          APPENDIXES

Appendix A
                                   Section 108 Loans Administered by the City

                                                                                                           Jobs to be
            Loan        HUD
                                           Loan                                                             created       Jobs     Job Goals
            Type       Approval                                  Project                Current Status
  Loan                                    Amount                                                              and       reported     Met
             1/          Date
                                                                                                            retained
                                                         Purchase
              D        5/29/2001         $1,000,000                                         Current           45          52         Yes
    1                                                    equipment
    2         D        7/18/2002         $3,000,000      Construct a Plaza                  Current           115          4          No
                                                         Renovate a
              D        9/27/2001         $3,000,000                                      Paid In Full         N/A         N/A        N/A
    3                                                    building
    4                                                    Additional funds for
              D        3/3/2004          $3,000,000                                         Current           250         60          No
                                                         loan 3
    5                                                    Develop restaurant
              D        8/17/2007           $950,000                                         Current           45           0        N/A 2/
                                                         and ferry landing
    6                                                    Acquire land for a
             LP        2/16/1999           $800,000                                         Current           580         14          No
                                                         technology facility
    7        LP        7/17/2000           $125,000      Expand restaurant                  Current           10           8          No
    8                                                    Purchase
             LP        5/31/2000           $105,000                                         Current            3           6         Yes
                                                         equipment
    9
             LP        5/22/2000           $130,000      Construct an office                Current            4           4         Yes
   10        LP        6/8/2000            $265,000      Acquire a building                 Current           14           2          No
   11                                                    Purchase
             LP        3/28/2002           $700,000                                         Current           20          18          No
                                                         equipment
   12                                                    Develop a
             LP        5/25/1999         $2,850,000      restaurant and                     Current           65          28          No
                                                         office space
   13                                                    Additional funds for
             LP        4/1/2000            $250,000                                         Current           N/A         N/A        N/A
                                                         loan 12
   14                                                    Purchase current
             LP        7/25/1997           $200,000                                       Paid In Full        11          12         Yes
                                                         premises
   15
             LP        4/3/2001            $112,500      Buy out partners                 Paid In Full         3           0          No
   16                                                                                        Default
             LP        10/1/1996           $375,000      Expand business                                      30           0          No
                                                                                       Settled($284,930)
   17                                                                                       Default-
             LP        4/1/1997            $180,000      Expand business                                       9           0          No
                                                                                       Settled($100,000)
   18                                                    Purchase                       Default (unpaid
             LP       12/12/1997             $99,000                                                           5           0          No
                                                         equipment                          $72,000)
   19                                                    Acquire a building             Default-Paid In
             LP         4/28/03            $950,000                                                           19           0          No
                                                         and land                             Full
   20                                                    Purchase inventory             Default-unpaid
             LP        2/1/2002            $165,000                                                           90           0          No
                                                         and equipment                    ($165,000)
   21        LP        11/1/2000         $3,400,000      Acquire property                Paid In Full         520          1          No
   22        LP        8/10/2001           $800,000      Acquire property               Default-in court      100          0          No
   23                                                    Purchase                         Default-in
             LP        6/11/1998           $270,000                                                           14           0          No
                                                         equipment                        collection
   24                                                    Acquire additional               Default-in
             LP        4/22/2002           $250,000                                                            8           0          No
                                                         inventory                        collection
            Total                       $22,976,500                                                          1,915        209

1/ D= direct loan; LP= loan pool loan
2/ Timeframe to create jobs has not expired; goal is not included in the 1,915 total




                                                                        14
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         15
        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         16
        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1



Comment 2



Comment 1

Comment 3




Comment 4

Comment 1




                         17
        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1



Comment 1




                         18
                           OIG Evaluation of Auditee Comments

Comment 1     The actions of City officials are responsive to our audit recommendations.

Comment 2     HUD’s correspondence requested a response within 45 days and support for the
              number of jobs reported as created and retained. There was no documentation
              that such a response and documentation was provided and at the exit conference
              HUD officials did not acknowledge a telephone response.

Comment 3 City officials agreed with the recommendation, but noted that 10 site visits had
          been completed. Accordingly, since two site visits were prior to the start of our
          field work the report has been changed to reflect that 8 site visits were completed
          after the start of our review.

Comment 4     The City’s procedures provide that the loan committee be provided quarterly loan
              status reports. City officials stated that a loan status update is provided at loan
              committee meetings, however, the committee has not met since November 2006
              and there was no evidence that status reports were provided to the committee
              since that time.




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