Issue Date
December 21, 2010
Audit Report Number
2011-NY-1004
TO: William T. O’Connell, Director, Community Planning and Development
Division, 2CD
FROM: Edgar Moore, Regional Inspector General for Audit, 2AGA
SUBJECT: The City of Binghamton, NY, Did Not Always Administer Its Section 108 Loan
Program in Accordance With HUD Requirements
HIGHLIGHTS
What We Audited and Why
We audited the operations of the City of Binghamton, NY (City), pertaining to its
administration of its Community Development Block Grant (CDBG) Section 108
Loan Guarantee program. We selected the City for review because of concerns
regarding a defaulted Section 108 loan. The objectives of our audit were to
determine whether the City (1) administered its Section 108 loan program
effectively, efficiently, and economically in accordance with applicable rules and
regulations; (2) used Section 108 loan proceeds on eligible activities that met a
national objective of the program; and (3) expended additional CDBG funds for
subsequent Section 108 loan repayments and other related costs that were
necessary, reasonable, and in accordance with all applicable contracts, agreements
and Federal regulations.
What We Found
The City did not ensure that its Section 108 loans and related activities were
administered effectively, efficiently, and economically in accordance with
applicable rules and regulations and that loan proceeds were expended on eligible
activities that met a national objective of the program. In addition, the City did
not ensure that additional expenditures of CDBG funds for subsequent Section
108 loan repayments and other related costs were necessary, reasonable, and in
accordance with all applicable contracts, agreements, and Federal regulations.
Consequently, significant CDBG funds were disbursed for Section 108 debt
repayments, and future CDBG funds will be required until the Section 108 debts
have been fully paid. Therefore, the ability to provide program benefit to low-
and moderate-income residents of the City has been diminished.
What We Recommend
We recommend that the Director of HUD’s Buffalo Office of Community Planning
and Development instruct the City to (1) establish a Section 108 repayment
account and repay more than $1.5 million in hotel sales proceeds that were used
for City expenses from non-Federal funds; (2) transfer the $81,561 in hotel sales
proceeds that remains in the City’s trust account to the established Section 108
repayment account; (3) submit documentation to justify the use of more than $2.4
million in CDBG funds to pay for Regency Hotel Section 108 debt so that HUD
can make an eligibility determination; and (4) establish controls to ensure that
Section 108 loan proceeds are at all times adequately safeguarded, collateral for
Section 108 loans is continually protected until all loan funds have been repaid,
the provisions of all Section 108 loan contracts and agreements are followed and
promptly enforced, and Section 108 loan activities meet a national objective of
the program.
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 October 6, 2010.
We held an exit conference on October 28, 2010, and City officials provided their
written comments on November 1, 2010, 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.
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TABLE OF CONTENTS
Background and Objectives 4
Results of Audit
Finding 1: The City Failed To Properly Administer Its Regency Hotel 5
Section 108 Loan Activity
Finding 2: The City Failed To Properly Administer Its Hotel DeVille 11
Section 108 Loan Activity
Scope and Methodology 17
Internal Controls 18
Appendixes
A. Schedule of Questioned Costs and Funds To Be Put to Better Use 20
B. Auditee Comments and OIG’s Evaluation 21
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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 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: (1) principally benefit low- and moderate-income persons,
(2) assist in eliminating or preventing slums and blight, or (3) assist with community
development needs having a particular urgency. Section 108 guaranteed loans may be for terms
of up to 20 years.
The City of Binghamton, NY (City) is a CDBG entitlement recipient that previously applied for
and received two Section 108 guaranteed loans to pursue physical and economic revitalization
projects. The two Section 108 guaranteed loans reviewed during the audit were primarily for
economic development projects with the goal of job creation. They involved a hotel construction
project, consisting of both Section 108 loan and Urban Development Action Grant (UDAG)
funding, and another hotel refinancing and improvement project, consisting of both private and
Section 108 loan funding. The files and records related to the City’s Section 108 Loan
Guarantee program are maintained in City Hall, located at 38 Hawley Street, Binghamton, NY.
We audited the City’s Section 108 Loan Guarantee program because of concerns regarding a
defaulted Section 108 loan. The objectives of the audit were to determine whether the City (1)
administered its Section 108 loan program effectively, efficiently, and economically in
accordance with applicable rules and regulations; (2) used Section 108 loan proceeds on eligible
activities that met a national objective of the program; and (3) expended additional CDBG funds
for subsequent Section 108 loan repayments and other related costs that 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 Regency Hotel
Section 108 Loan Activity
The City failed to properly administer its Regency Hotel Section 108 loan activity. Specifically,
it (1) failed to monitor the $10.6 million lease and cure defaults in a timely manner, (2) violated a
number of provisions of its Section 108 contract with HUD, (3) misused Section 108 program
income intended for debt obligations, and (4) failed to ensure that the hotel met the required
national objective of job creation. We attribute these deficiencies to the City’s failure to
establish adequate controls over safeguarding assets, as required by CDBG regulations at 24
CFR (Code of Federal Regulations) Part 85. Consequently, the City (1) was obligated to pay a
Section 108 loan balloon payment of $4.5 million, (2) deprived other CDBG activities of the use
of more than $2.4 million in CDBG funds used to pay down the Section 108 loan, (3) failed to
establish a Section 108 loan repayment account and fund it with more than $2.5 million in sales
proceeds/program income, (4) misused $1.5 million in program income for City expenses to
operate the hotel and put another $81,561 in program income into a City trust account instead of
a Section 108 loan repayment account, and (5) failed to ensure that the program activity met the
CDBG national objective of job creation.
Background
In 1985, the City combined a $7.3 million Section 108 loan with $3.3 million in
UDAG funding and loaned $10.6 million to a developer to construct a hotel in
downtown Binghamton. The City, which technically owned the hotel, then leased
the hotel back to the developer to recoup the $10.6 million. The lessee was to
repay the loan and would then be allowed to purchase the hotel for $1. By 1991,
the lessee had defaulted on taxes and rent/lease payments, being delinquent on at
least $189,000 in Section 108 payments and more than $500,000 in property
taxes, including penalties and interest. Technically, the borrower was in a major
default of the lease agreement(s), but no further action was taken by the City.
Instead, the City began a series of subagreements, extensions, and forgiveness of
debt, although the Regency Hotel was operating at a loss.
For example, in 1993 the City arranged for the hotel developer/lessee to borrow
another $560,000 from the Binghamton Local Development Corporation to cover
a $732,000 payment to the City for the Section 108 loan. The extent of the hotel’s
financial problems was further illustrated in 1993, when the City again agreed to
accept $481,915 in delinquent taxes, interest, and penalties over 10 years with no
interest. The City could have taken legal action, since the developer/lessee was
already in default of the lease agreement to pay the City. However, it was not
until October 2005, despite more than 10 years of default issues, that the City
formally sent a letter and declared the developer/lessee to be in default. By
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December 2006, the City had taken full possession of the hotel from the
developer. The City became the hotel’s owner and operator. While trying to sell
the hotel, the City executed an operating agreement with a hotel management firm
in February 2007. During the years 2007 and 2008, the City lost hundreds of
thousands of dollars operating the hotel.
The City finally sold the hotel in 2009 and received $2.5 million up front, less
closing costs and broker fees. The buyer was to pay the remaining $4.1 million of
the $6.6 million purchase price in October 2009; however, the new buyer of the
hotel filed for bankruptcy and did not make the $4.1 million payment. In April
2010, the City again retook ownership of the hotel and was attempting to resell it.
Meanwhile, the City was obligated to pay a $4.5 million balloon payment in
August 2010 on the Section 108 loan. However, in July 2010, HUD allowed the
City to refinance the $4.5 million interim note. In August 2010, the City paid
$500,000 using the hotel sale proceeds that were improperly placed into a City
trust account. The new HUD- approved repayment schedule is as follows
Principal due date Repayment amount
August 1, 2010 $ 500,000
August 1, 2011 1,000,000
August 1, 2012 1,000,000
August 1, 2013 1,000,000
August 1, 2014 1,025,000
The following subsections describe the deficiencies and reportable conditions in
detail.
City Fails To Monitor Regency
Hotel and Cure Defaults
The City failed to adequately monitor the loan and enforce the terms of the
leasehold mortgage and mortgage note. The developer technically defaulted on
lease terms and taxes during the 1990s. However, the City failed to take
appropriate actions to protect HUD’s collateral and instead restructured the
Section 108 debt and even loaned the developer additional HUD funds to make
Section 108 loan payments that were in default. In October 2005, the City sent a
letter to the developer declaring default of the loan. This was the first known
default notice issued by the City, despite experiencing more than 10 years of
borrower default issues. As a result, the City’s CDBG program was burdened
with making more than $2.4 million in Section 108 loan repayments to the
detriment of other potential low- and moderate- income activities that could have
been funded under the CDBG program. Further, the City jeopardized the HUD
collateral for Section 108 by not taking the appropriate action in a timely manner
to cure the defaults. CDBG regulations at 24 CFR 85.40 provide that grantees are
6
responsible for managing the day-to-day operations of grant- and subgrant-
supported activities.
The leasehold mortgage and related agreements further required that the
developer keep adequate books and records of account and furnish the City with
audited financial statements and other information as the City may require.
Nonetheless, there was no evidence to show that adequate financial data of the
developer had been obtained or reviewed by the City. The only financial
statements submitted by the hotel were for the years 1999 and 1998, and they
were unaudited. Further, there were a number of related party loans and
transaction detailed in these financial statements and their accompanying notes.
There was no evidence that the City had analyzed, investigated, or otherwise
determined the effect of the hotel’s transactions on the legal arrangements
between the City and hotel or the possible effect of the hotel’s ability to pay the
City under its lease obligations. At a minimum, the City should have conducted
monitoring to determine why loan payments were not being made. For example,
the City should have determined whether the developer had adequate cash flows
and reserves to make the loan payments.
City Violates Its Section 108
Loan Contract
Contrary to its Section 108 loan contract, the City failed to establish a loan
repayment account and did not maintain adequate financial and programmatic
records on the loan receivable from the developer pertaining to the extent of
CDBG funding used to repay the Section 108 debt. The Section 108 loan contract
requires that all amounts pledged as security for repayment of the note, including
program income, as defined by regulations at 24 CFR 570.500(a), shall be
deposited immediately on receipt into a separate identifiable custodial account
(the “Loan Repayment Account”) with a financial institution the deposits or
accounts of which are federally insured. The City was unable to provide
accounting records identifying the bank account used to deposit its Section 108
program income funds. According to available City records, the City used at least
$2.4 million in CDBG funds to repay the hotel’s Section 108 debt, depriving its
local program of funding intended to benefit low- and moderate-income residents.
In addition, the City further violated its Section 108 contract when it sold the
hotel and failed to place more than $2 million in sales proceeds into a Section 108
loan repayment account. Instead, the funds were placed into a City trust account
and generally used for expenses that were the obligation of the City, as described
further below. The City violated regulations at 24 CFR 85.20(b)(3), which
require that effective control and accountability be maintained for all grant and
subgrant cash, real and personal property, and other assets. Grantees and
subgrantees must adequately safeguard all such property and must ensure that it is
used solely for authorized purposes.
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City Misuses Section 108
Program Income
Contrary to a 2007 operating agreement with a hotel management group, the City
did not cover the operating shortfalls and did not pay all property taxes for the
Regency Hotel when it was owned and operated by the City. In February 2009, a
new owner obtained control of the hotel, paying the City $2.5 million up front,
less closing costs. The remaining $4.1 million of the $6.6 million sales price was
due in October 2009. The City then used the program income to pay the hotel’s
operating expenses and back taxes that were its responsibility as owner under the
operating agreement. According to available closing documents and records,
sales proceeds were used as follows:
Used for hotel operating costs/losses $ 549,463
Used for real property taxes $ 974,105
(includes interest and penalties)
Total $1,523,568
The $1.5 million in sales proceeds should be reimbursed to an established Section
108 repayment account from non-Federal funds. In addition, as of May 2010, at
least $581,561 of the sales proceeds remained in the City’s trust account. In
August 2010, the City used $500,000 of the sales proceeds towards repaying the
loan in accordance with the new refinancing agreement with HUD. Thus, the
remaining $81,561 in the trust account should be put to better use and used to pay
Section 108 debt payments. The City assumed ownership of the hotel’s losses
and/or profits when it took title to operate the hotel in 2007. Therefore, City
funds should have been used to fund the potentially unlimited operating losses
incurred at the hotel. The deficiencies can be attributed to the City’s failure to
adequately safeguard HUD assets.
In addition, the Section 108 contract provides that program income derived from
the sale or lease of any real property acquired with the Section 108 funds is
pledged as security for repayment of the note(s). The Section 108 contract
requires that said program income and pledged funds be deposited immediately
into a separate and identifiable bank account as trustee for HUD to be used only
for paying Section 108 principal and interest.
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Job Creation Goals Not
Achieved
The City could not provide adequate documentation supporting that the activity
met a national objective of the program. Under the terms of the UDAG and
Section 108 loan agreements, the developer agreed that the use of these funds
would create 230 jobs within 18 months of project completion and that at least 51
percent of the jobs would be provided to low- to moderate-income persons.
However, only 131 jobs were created, and there was no evidence to support that
these jobs had been verified by the City as meeting the low- and moderate-income
requirements. In addition, failure to create the jobs is equivalent to a default on
the mortgage note, and the principal sum and all unpaid interest may be declared
immediately due and payable. Regulations at 24 CFR 570.200(a)(2) provide that
each recipient under the Entitlement and HUD-administered Small Cities
programs must ensure and maintain evidence that each of its activities assisted
with CDBG funds meets one of the three national objectives as contained in its
certification. Criteria for determining whether an activity addresses one or more
of these objectives are provided in 24 CFR 570.208. Despite provisions of the
mortgage agreement, the City could not provide documented evidence that any of
the 230 jobs had been created and that they met the low- and moderate-income
requirement. Therefore, the City could not demonstrate that a national objective
for this activity was accomplished.
Conclusion
The City did not properly administer the Regency Hotel Section 108 activity.
Deficiencies identified include that the City (1) failed to monitor the $10.6 million
lease and cure defaults in a timely manner, (2) violated its Section 108 contract
with HUD, (3) improperly accounted for and misused Section 108 program
income, and (4) failed to ensure that the hotel activity met the national objective
of job creation. Consequently, the City (1) was obligated to pay a Section 108
loan balloon payment of $4.5 million, (2) deprived other CDBG activities of the
use of more than $2.4 million in CDBG funds to pay Section 108 debt, (3) failed
to establish a Section 108 loan repayment account and fund it with more than $2.5
million in sales proceeds/program income, (4) misused $1.5 million in program
income for City expenses to operate the hotel and put another $581,561 in
program income into a City trust account instead of a Section 108 loan repayment
account, of which $81,561 currently remains, and (5) failed to ensure that the
program activity met the CDBG national objective of job creation. We attribute
these deficiencies to the City’s failure to establish adequate controls over
safeguarding assets, as required by Federal regulations at 24 CFR Part 85.
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Recommendations
We recommend that the Director of HUD’s Buffalo Office of Community
Planning and Development instruct the City to
1A. Submit documentation to justify the use of $2,403,393 in CDBG funds to
pay the Regency Hotel’s Section 108 debt so that HUD can make an
eligibility determination. For any costs determined to be ineligible, HUD
should require the City to reimburse the CDBG program from non-Federal
funds.
1B. Establish a Section 108 loan repayment account for the Regency Hotel
program income, as required by the Section 108 contract.
1C. Place any proceeds from a resale of the Regency Hotel asset into the
Section 108 repayment account.
1D. Repay from non-Federal funds the $1,523,568 in hotel sales proceeds that
were used for City expenses to the established Section 108 loan repayment
account.
1E. Transfer the $81,561 in hotel sales proceeds that currently remains in the
City trust account to the established Section 108 loan repayment account,
so that these funds can be put to better use.
1F. Use the funds from the Section 108 loan repayment account to pay all
future Section 108 payments that are due in accordance with the HUD-
approved refinancing agreement. Should the account contain less than the
$4.5 million required payments, the City should pay the balance from non-
Federal funds.
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Finding 2: The City Failed To Properly Administer Its Hotel DeVille
Section 108 Loan Activity
The City failed to properly administer its Hotel DeVille Section 108 loan activity. Specifically,
it failed to (1) ensure the validity of the borrower’s personal guaranties, (2) ensure the adequacy
of its underwriting of the Section 108 loan, (3) enforce leasehold mortgage terms and properly
monitor loan activities in a timely manner, (4) adequately document or support the foreclosure
sale of the property, and (5) ensure that the hotel met the required national objective of job
creation. We attribute these deficiencies to the City’s failure to establish adequate controls over
safeguarding assets, as required by Federal regulations at 24 CFR Part 85. Consequently, the
City (1) compromised HUD’s collateral position by not safeguarding assets; (2) expended more
than $1.7 million in CDBG funds to repay the Section 108 loan, thus preventing other potential
low- and moderate-income activities from participating in the program; (3) did not collect
$169,525 in back property taxes; (d) was unable to provide assurance that the purchase price of
$1.55 million represented a fair and equitable sales price for the property; and (5) failed to ensure
that the program activity met the CDBG national objective of job creation.
Background
In July 1992, the City applied to HUD for a Section 108 loan totaling $1.4 million
to be used for the refinancing and improvement of the current Hotel DeVille. In
April 1993, a leasehold mortgage was executed between the City and Old City
Hall Associates (developer), a New York limited partnership. The Section 108
loan proceeds were disbursed by the City to the developer and Binghamton
Savings Bank on April 28, 1993. Semiannual repayments of the Section 108 loan
principal and interest were scheduled to begin in February 1994 and were to
continue until August 2013.
The deficiencies identified relating to this loan were as follows.
City Fails To Ensure the
Validity of the Borrower’s
Personal Guaranties
The City failed to ensure that the borrower’s personal guaranties were valid or
enforceable by initially agreeing to a letter of credit guarantee that was
substantially less than the amount of the loan. As a result, HUD’s collateral
position was compromised, and assets were not properly safeguarded as required
by CDBG regulations at 24 CFR 85.20(b) (3).
To protect HUD’s collateral and to induce the City to lend the Section 108 loan
proceeds to the developer, the City required personal guarantees from each
developer partner guaranteeing prompt and full payment of the developer’s
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mortgage note to the City in the amount of $1.4 million. Therefore, in April
1993, each partner of the developer executed personal guarantees with the City.
However, based on State of New York Supreme Court documents, dated January
18, 2002, before April 1993, the City and developer had agreed that as further
security for the loan and in addition to the leasehold mortgage, the developer
would provide a letter of credit equal to 1 year’s principal and interest payments
(stipulated to be $120,000). On June 1, 1992, the City Council passed a
resolution, later approved by the mayor, authorizing the City to provide the loan
on these terms. Eventually this matter was brought before the State of New York
Supreme Court as part of the City’s breach of contract action, which sought to
recover more than $1 million from the developer’s partners, which had
individually guaranteed payment of the $1.4 million debt. The court ultimately
decided that the City was entitled to recover from the developers the $120,000 it
would have acquired, in the event of a default by the developer, had the developer
met the requirements outlined in the City ordinance by providing a letter of credit
in an amount equal to 1 year’s principal and interest payments.
Consequently, due to the City’s actions and the manner in which it obtained
personal guaranties from the developer’s partners, HUD’s collateral position on
the Section 108 loan was materially compromised. Instead of having personal
guarantees equal to the $1.4 million Section 108 loan, the City’s lack of
management controls over processing the loan and safeguarding assets resulted in
guarantees of only $120,000 found to be enforceable by the court.
City Fails To Ensure the
Adequacy of Section 108 Loan
Underwriting
The City failed to ensure the adequacy of its underwriting of the Section 108 loan.
As a result, costs that were not necessary or reasonable were charged to the
CDBG program contrary to the provisions of Office of Management and Budget
Circular A-87.
The Section 108 loan activity for the Hotel DeVille project was underwritten by
the City’s Economic Development Department staff, which recommended that a
$1.4 million permanent subordinate mortgage loan be approved contingent on
approval from HUD. Although the loan was approved and the Section 108
proceeds were disbursed to the developer in April 1993, the developer did not
submit its first payment due to the City on February 1, 1994. The developer made
only one partial payment of $26,851 due to the City on August 1, 1994. In
addition, the developer made no payments for any amounts due after the August
1, 1994, payment. Therefore, the developer technically defaulted on the terms of
its leasehold mortgage and mortgage note within months of receiving the Section
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108 loan proceeds. Consequently, since the developer failed to make the initial
loan repayment, the adequacy of the City’s underwriting of the project, which
recommended that the activity was feasible and worthy of funding, is
questionable. As a result, the City expended more than $1.7 million in CDBG
funds to repay the Section 108 loan, thus preventing other potential low- and
moderate-income activities from participating in the program. The graphic below
details the payment sources for the payments made through June 2010.
Hotel DeVille Section 108 loan payment sources
for combined principal and interest payments through June 2010
1.3% -
$26,851
18.5% -
$396,022
80.2% -
$1,715,933
Developer Funds Sales Proceeds Program Income
City CDBG Funds
City Fails To Enforce Mortgage
Terms and Monitor Activities in
a Timely Manner
Contrary to Federal regulations, the City failed to enforce leasehold mortgage
terms and properly monitor the developer activities associated with the loan in a
timely manner. The developer technically defaulted on the terms of its leasehold
mortgage and mortgage note within months of receiving the Section 108 loan
proceeds as evidenced by its failure to make the initial loan repayment due in
February 1994. Despite this failure, the City did not issue a notice of default to
the developer until June 1998, more than 4 years after the first payment was due
on the loan. In addition, the leasehold mortgage required that the developer keep
adequate books and records of account and furnish the City with financial
statements and other information as the City may require. Nonetheless, there was
no evidence in the files nor could the City locate documentation to show that the
financial data of the developer were obtained or reviewed by the City after the
disbursement of the Section 108 loan proceeds. The monitoring and review of the
developers’ financial data would be particularly important in this circumstance
since the developer made only one partial payment on the loan. At a minimum,
13
the City should have conducted monitoring to determine why loan payments were
not being made. Regulations at 24 CFR 85.40 provide that grantees are
responsible for managing the day-to-day operations of grant- and subgrant-
supported activities to ensure compliance with applicable Federal requirements
and that performance goals are achieved. The City should have determined
whether the developer had adequate cash flows and reserves to make the loan
payments. In addition, the leasehold mortgage required the developer to pay for
all taxes, assessments, and water rates levied or assessed against the mortgaged
property. However, as of August 1998, $169,525 in back taxes remained unpaid.
Consequently, by failing to enforce the terms and conditions of the leasehold
mortgage and note in a timely manner, the City was unable to collect the
$169,525 in back property taxes.
City Fails To Document or
Support the Reasonableness of
the Foreclosure Sale
The City did not adequately document or support the foreclosure sale of the hotel
property. This deficiency is attributed to a lack of established controls to ensure
that adequate financial records were maintained and that assets were adequately
safeguarded as required by regulations at 24 CFR 85.20.
In June 1998, after several years of nonpayment on the loan by the developer, the
City provided the developer a notice of default. In December 1998, a deed of
surrender from the developer to the City was executed. After foreclosure, the
City decided to sell the hotel property for $1.55 million in December 1998 to
Binghamton Associates. However, the City was unable to provide documented
evidence that it actively marketed the property for sale or that it had the property
appraised before the sale. Rather, a City ordinance authorizing the sale stated that
the hotel property was not needed by the City for City-related purposes and the
purchase price of $1.55 million represented a fair price for the hotel property.
Despite this assertion, the City’s files contained an appraisal for the hotel
property, dated August 1992. This appraisal was needed as support for approving
and making the Section 108 loan, and it indicated that the current market value of
the property at that time was $4.6 million.
The City also was unable to provide us with official closing documents for the
sale; however, noncancelled copies of closing checks were provided that indicated
the following distribution of the December 1998 sales proceeds:
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Check # Payee Amount Description
004115 BSB Bank and Trust $ 1,050,000 Balance due on first mortgage
004117 City of Binghamton 59,363 Taxes, water, and sewer
004118 City of Binghamton 10,791 Taxes
004119 City of Binghamton 2,729 Water and sewer
004123 City of Binghamton 35,000 Attorney fees
004125 City of Binghamton 396,021 108 loan payments
$ 1,553,904 Total sales proceeds
Although closing check #004125 listed above shows that the $396,021 in sales
proceeds would be earmarked for Section 108 loan repayments, the City was
unable to provide accounting records identifying the bank account used to deposit
the funds or evidence of the disbursement of such funds to make payments on the
outstanding loan. Consequently, the City was unable to provide assurance that the
purchase price of $1.55 million represented a fair and equitable sales price for the
property or that HUD’s collateral in the property was adequately protected.
Regulations at 24 CFR 85.20(b)(2) provide that grantees and subgrantees must
maintain records, which adequately identify the source and application of funds
provided for financially assisted activities. Further, these records must contain
information pertaining to grant or subgrant awards and authorizations,
obligations, unobligated balances, assets, liabilities, outlays or expenditures, and
income.
City Fails To Document or
Verify the Number of Jobs
Created
The City could not provide adequate documentation to support the number of jobs
created by the activity. We attribute this deficiency to the City’s lack of
established controls to ensure and maintain evidence that each of its activities
assisted with CDBG funds met one of the three national objectives required by
regulations at 24 CFR 570.200.
The developer had agreed, under the terms of the mortgage note, that the use of
funds would create at least 34 jobs within 2 years of the date of the note and that
at least 51 percent of the jobs would be provided to low- to moderate-income
persons. Despite this provision, the City could only provide documentation to
support that nine full-time jobs were created. However, no evidence or
documentation was provided by the City to show that these jobs had been
verified. Nonetheless, the nine jobs claimed to have been created fell far short of
the 34 jobs required to be created in accordance with the mortgage note.
Consequently, the City failed to ensure that the program activity met the CDBG
national objective of job creation. Regulations at 24 CFR 570.200(a)(2) provide
that each recipient under the Entitlement and HUD-administered Small Cities
programs must ensure and maintain evidence that each of its activities assisted
15
with CDBG funds meets one of the three national objectives as contained in its
certification. Criteria for determining whether an activity addresses one or more
of these objectives are provided at 24 CFR 570.208.
Conclusion
The City failed to properly administer its Hotel DeVille Section 108 loan activity.
Deficiencies identified included that the City failed to (1) ensure the validity of
the borrower’s personal guaranties, (2) ensure the adequacy of its underwriting of
the Section 108 loan, (3) enforce leasehold mortgage terms and properly monitor
loan activities in a timely manner, (4) adequately document or support the
foreclosure sale of the property, and (5) ensure that the hotel activity met the
required national objective of job creation. Consequently, the City (1)
compromised HUD’s collateral position by not safeguarding assets, (2) expended
more than $1.7 million in CDBG funds to repay the Section 108 loan and keep the
loan current, thus preventing other potential low- and moderate-income activities
from participating in the program, (3) did not collect $169,525 in back property
taxes, (4) was unable to provide assurance that the purchase price of $1.55 million
represented a fair and equitable sales price for the property, and (5) failed to
ensure that the program activity met the CDBG national objective of job creation.
We attribute these deficiencies to the City’s failure to establish adequate controls
over safeguarding assets, as required by Federal regulations at 24 CFR Part 85.
Recommendations
We recommend that the Director of HUD’s Buffalo Office of Community
Planning and Development instruct the City to
2A. Establish controls to ensure that Section 108 loan proceeds are at all times
adequately safeguarded against waste and loss.
2B. Establish controls to ensure that any future Section 108 loan applications
are carefully underwritten before approval and disbursement of funds.
2C. Establish controls to ensure that collateral for Section 108 loans is
sufficient to cover the full amount of the loan to ensure that all loan funds
will be repaid.
2D. Establish controls to ensure that the provisions of all contracts and
agreements related to Section 108 loans are followed and promptly
enforced.
2E. Establish controls to ensure that Section 108 loan activities meet a national
objective of the program.
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SCOPE AND METHODOLOGY
We performed our onsite audit work at the City’s offices, located in Binghamton, NY, between
January and July 2010. Our audit scope covered the period January 1, 2007, through December 31,
2009. To accomplish our objectives, we
Reviewed applicable HUD regulations, the Code of Federal Regulations, and other
requirements and directives that govern the Section 108 Loan Guarantee program.
Reviewed the City’s applicable policies and procedures used to administer its Section 108
loan activities.
Reviewed the City’s action plans, grant agreements, and agreements between the City and
its developers, including verifying whether national and project objectives were met.
Gathered historical background information on the City’s economic development activities.
Interviewed City personnel responsible for administration of its Section 108 Loan Guarantee
program.
Interviewed HUD Financial Management Division staff.
Obtained and reviewed documentation from the City’s corporation counsel pertaining to any
litigation, underway or pending, relative to the Section 108 Loan Guarantee program.
Reviewed HUD’s monitoring reports and files for the City’s CDBG and HOME Investment
Partnerships programs, including verifying any reported corrective actions.
Reviewed all costs charged to the CDBG program that were related to the Section 108 Loan
Guarantee program, along with the supporting documentation.
The City applied for and received two Section 108 guaranteed loans to pursue physical and
economic revitalization projects. The two Section 108 guaranteed loans reviewed during our
audit were primarily for economic development projects with the goal of job creation, including
a hotel construction project, consisting of $7.3 million in Section 108 loan funds and $3.3 million
in UDAG funding, and another hotel refinancing and improvement project, consisting of both
private funds and $1.4 million in Section 108 funding.
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.
17
INTERNAL CONTROLS
Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to
Effectiveness and efficiency of operations,
Reliability of financial reporting, and
Compliance with applicable laws and regulations.
Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals, and objectives. Internal controls 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:
Effectiveness and efficiency of operations - Policies and procedures that
management has implemented to reasonably ensure that a program meets its
objectives.
Reliability of financial reporting - 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 applicable laws and regulations - Policies and procedures
that management has implemented to reasonably ensure that resource use is
consistent with laws and regulations.
We assessed the relevant controls identified above.
A deficiency in internal control exists when the design or operation of a control does
not allow management or employees, in the normal course of performing their
assigned functions, the reasonable opportunity to prevent, detect, or correct (1)
impairments to effectiveness or efficiency of operations, (2) misstatements in
financial or performance information, or (3) violations of laws and regulations on a
timely basis.
18
Significant Deficiencies
Based on our review, we believe that the following items are significant deficiencies:
The City did not have adequate controls over effectiveness and efficiency of
operations when it did not establish adequate controls to ensure that
Section 108 loan activities achieved a national objective of the program
and that assets were properly safeguarded (see findings 1 and 2).
The City did not have adequate controls over its reliability of financial
reporting, as it could not provide accounting records to support the sources
and uses of funds for the two Section 108 activities (see findings 1 and 2).
The City did not have adequate controls over compliance with laws and
regulations, as it did not always comply with HUD regulations while
disbursing CDBG and program income funds (see finding 1).
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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 $2,403,393
1D $1,523,568
1E $81,561
1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
that the auditor believes are not allowable by law; contract; or Federal, State, or local
policies or regulations.
2/ 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 the 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. These amounts include reductions in outlays, deobligation of funds,
withdrawal of interest, costs not incurred by implementing recommended improvements,
avoidance of unnecessary expenditures noted in preaward reviews, and any other savings
that are specifically identified. In this instance, if the City implements our
recommendation to place the remaining sales proceeds into the established Section 108
loan repayment account, HUD can be assured that these funds will be properly used to
repay the Section 108 loan debt.
20
Appendix B
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
Comment 1
Comment 2
21
Ref to OIG Evaluation Auditee Comments
Comment 2
Comment 3
Comment 4
Comment 5
22
Ref to OIG Evaluation Auditee Comments
Comment 5
Comment 6
Comment 7
Comment 7
Comment 7
23
Ref to OIG Evaluation Auditee Comments
Comment 7
Comment 7
Comment 8
Comment 9
24
Ref to OIG Evaluation Auditee Comments
Comment 9
Comment 10
25
OIG Evaluation of Auditee Comments
Comment 1 Officials for the City contend that the recommendation instructing them to submit
documentation to HUD to justify the use of more than $2.4 million in CDBG
funds to pay for the Regency Section 108 debt falsely gives the perception that
such documentation was not made available at the time of the audit. However,
the officials’ contention is not the issue raised in the report. The issue is that OIG
recommends the City provide HUD with documentation to justify the necessity
and reasonableness of using CDBG funds for the Section 108 debt. During the
audit we determined that the City failed to properly administer its Regency Hotel
Section 108 loan activity by not monitoring and curing defaults in a timely
manner, violating the provisions of the Section 108 contract, misusing program
income, and failing to ensure the activity fully met the required national objective
of job creation. Further, at no point in the audit report is it stated that the City
could not provide detail of the actual payment invoices.
Comment 2 Officials for the City contend that adequate accounting records were provided
identifying the bank account used to deposit its Section 108 program income
funds from the sale of the Regency Hotel. However, the records that were
provided to account for the sales proceeds were not adequate. Not only were the
proceeds not properly deposited into a required custodial account titled “Loan
Repayment Account”, but also the monies were apparently deposited into a
citywide trust account that contains mostly non-federal funds. Given this fact,
there is no reasonable assurance that the records provided included the full extent
of the use of the proceeds. Moreover, the support for the use of the proceeds
consisted of mostly schedules and journal entries.
Comment 3 Officials for the City object to using all remaining sales proceeds from the
Regency Hotel sale to pay down the $4.5 million Section 108 debt and then using
non-federal funds to cover any balance that remains. However, the City is
required by the Section 108 contract to use all sale proceeds for the Section 108
debt. We acknowledge that program regulations allow CDBG funds to be used
for Section 108 loan repayments, however, the use of such CDBG funds to repay
the Regency loan may not have been necessary had the City exercised its
fiduciary responsibility to safeguard HUD assets. The City failed to adequately
administer the loan and enforce the loan provisions. Specifically, the City
allowed the developer to ignore nearly all of the loan conditions for many years,
without any substantial action by the City to enforce the provisions of the loan
agreement. As such, during the resolution process HUD should consider the
City’s failure to properly monitor the activity over the years and help determine
the best course of action that would allow the City to cease using CDBG funds for
the hotels operating losses.
Comment 4 Officials for the City provide background information and cite the economic
success of the Regency Hotel, emphasizing that the hotel employed 100 to 150
people and currently employs over 70 people. However, we would like to point
26
out that the hotel was supposed to create 230 jobs from the use of the HUD
funding. In addition, procedures should have been set up to ensure that the
program income earned was applied to help reduce the Section 108 debt.
Comment 5 Officials for the City state that the CDBG allocations and program income
derived from the sale or lease of the property (i.e. hotel) are pledged as collateral
for the Section 108 loan, and that they did not pledge their general fund for the
hotel or repayment of the debt. The results of our audit do not dispute these facts.
Nevertheless, since CDBG funds were not geared to pay for the operations of the
hotel a more viable method needs to be devised to find a better way to use the
CDBG funds.
Comment 6 Officials for the City state that the Regency Hotel had various operating and
accounting issues over a 20 year period and that some accounting procedures
were not followed, as confirmed by our audit. The officials further contend that
neither the City nor HUD took any action regarding the oversight shortcomings.
We remind the officials that they are responsible for the proper and prudent
administration and oversight of their HUD funded programs, and now is the time
to provide a stronger effort to determine a way to better utilize the CDBG funds.
Comment 7 Officials for the City provided a history of events occurring with the Regency
Hotel and state that they continuously sought to sell the property upon taking
possession and that they elected to keep the hotel operating pending a sale. They
agree that CDBG funds should not be used to finance an ongoing operation that is
losing money, and contend that the best way to safeguard the Regency Hotel asset
was to operate the hotel. Officials believe that their decision to operate the
Regency Hotel was made to maximize the sale price of the hotel for the benefit of
federal and local taxpayers. We do not dispute that City officials attempted to
operate and then sell the hotel; however, we remind the City officials that it was
their decision to continue hotel operations. This may have been a viable option
for the City at the time; however, HUD was not a contractual partner to the
operating losses of the hotel. As such, going forward City Officials need to
reassess the situation considering the losses and come up with a more viable
means of spending CDBG funds
Comment 8 Officials for the City state that their intent to operate the hotel was never
concealed from HUD. The officials’ further state that they are aware that the
CDBG funds act as collateral on the loan, but deem it unfair that the City should
pay for the operating expenses and back taxes from their general fund. The fact
that the officials informed HUD of some details does not alleviate the City from
abiding by its Section 108 contract and operating agreement for the hotel. The
Section 108 contract requires that the program income be used only for paying
Section 108 principal and interest. The City did not adhere to its own operating
agreement with the hotel operator, whereby the City was required to fund from
local dollars all taxes and operating losses. Moreover, HUD was not a party to
27
the City’s decision to operate the Regency Hotel and CDBG funds should not
have been used to fund its operating loss.
Comment 9 Officials for the City assert that the program income from the sale of the property
necessarily includes the expenses required to sell the hotel. The City seems to
confuse the HUD collateral for the hotel debt with operating losses incurred by
the City. Again we remind the officials that it was their decision to operate the
hotel and now because it is operating at a loss this does not mean that a lender (in
this instance, HUD) would allow collateral that has been pledged for debt to be
used for operations.
Comment 10 Officials for the City conclude that the City should not be eligible for projects of
this nature until it establishes oversight procedures similar to the Binghamton
Local Development Corporation’s (BLDC) controls. Further, the officials request
that HUD recognize their decisions to maximize the sale price of the Regency
Hotel, and not require the City to repay HUD the operating losses and real estate
taxes associated with the sale of the Regency Hotel. While we surveyed certain
activities of the BLDC and found that the BLDC’s loan portfolio appeared to be
generally current with few write-offs, the BLDC operations were not included in
the scope of our audit, thus we offer no opinion on the adequacy of the BLDC’s
management controls; however CDBG funds should not have been expended on
the hotel’s operations.
28
The City of Binghamton, NY, Did Not Always Administer Its Section 108 Loan Program in Accordance With HUD Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-12-21.
Below is a raw (and likely hideous) rendition of the original report. (PDF)