oversight

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)

                                                                 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.




                                            2
                            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




                                             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 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

                                                 5
            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.

                                              7
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.




                                               8
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.




                                               9
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.




                                           10
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


                                                 11
           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

                                           12
            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:




                                            14
            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.



                                              16
                         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).




                                              19
                                   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