oversight

HUD Did Not Provide Effective Oversight of Section 202 Multifamily Project Refinances

Published by the Department of Housing and Urban Development, Office of Inspector General on 2014-02-19.

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

 OFFICE OF AUDIT
 REGION 2
  1
 NEW YORK-NEW JERSEY




         U.S. Department of Housing and Urban
       Development, Office of Multifamily Housing
               Programs, Washington, DC

       HUD’s Oversight of Section 202 Multifamily
             Housing Project Refinances




2014-NY-0001                            FEBRUARY 19, 2014
                                                        Issue Date: February 19, 2014

                                                        Audit Report Number: 2014-NY-0001




TO:            Mark Van Kirk
               Director, Office of Multifamily Asset Management, HTG

               //SIGNED//
FROM:          Edgar Moore
               Regional Inspector General for Audit, New York-New Jersey Region, 2AGA

SUBJECT:       HUD Did Not Provide Effective Oversight of Section 202 Multifamily Project
               Refinances


    Attached is the U.S. Department of Housing and Urban Development (HUD), Office of
Inspector General (OIG), final results of our review of HUD’s oversight of Section 202
multifamily housing project refinances.

    HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on
recommended corrective actions. For each recommendation without a management decision,
please respond and provide status reports in accordance with the HUD Handbook. Please furnish
us copies of any correspondence or directives issued because of the audit.

    The Inspector General Act, Title 5 United States Code, section 8L, requires that OIG post its
publicly available reports on the OIG Web site. Accordingly, this report will be posted at
http://www.hudoig.gov.

   If you have any questions or comments about this report, please do not hesitate to call me at
(212) 264-4174.
                                           February 19, 2014

                                           HUD Did Not Provide Effective Oversight of Section 202
                                           Multifamily Housing Project Refinances




Highlights
Audit Report 2014-NY-0001


 What We Audited and Why                    What We Found

We audited the U.S. Department of          HUD did not have adequate controls to ensure that all
Housing and Urban Development’s            Section 202 refinancing resulted in economical and
(HUD) oversight of Section 202             efficient outcomes. Specifically, (1) HUD did not
multifamily housing project refinances     ensure that at least half the debt service savings that
as part of the Inspector General’s goal    resulted from refinancing were used to benefit tenants
of promoting fiscal responsibility and     or reduce housing assistance payments, (2) consistent
financial accountability. Our objective    accountability for the debt service savings was not
was to determine whether HUD had           always maintained, and (3) some refinancing were
adequate controls to ensure that Section   processed for projects that had negative debt service
202 refinancing was conducted in an        savings, which resulted in higher debt service costs
effective and efficient manner.            than before the refinancing. These deficiencies were
                                           due to HUD’s lack of adequate oversight and
                                           inconsistent nationwide policy implementation
  What We Recommend
                                           regarding debt service savings realized from Section
                                           202 refinancing activities. As a result, millions of
We recommend that HUD (1) develop dollars in debt service savings were not properly
and implement consistent nationwide        accounted for and available, the savings may not have
policies for oversight and monitoring of been used to benefit tenants or for the reduction of
debt service savings, thereby ensuring     housing assistance payments, and some refinanced
that at least $21 million per year is used projects ended up costing HUD additional housing
to benefit tenants or reduce housing       assistance payments because of the additional cost for
assistance payments; (2) direct field      debt service.
offices to account for and analyze debt
service savings and when possible,
require the savings to be used to offset
housing assistance payments; and (3)
implement procedures to ensure that
refinancings comply with the
requirement to generate positive debt
service savings.
                            TABLE OF CONTENTS

Background and Objective                                                3

Results of Audit
      Finding: HUD Did Not Provide Effective Oversight of Section 202   4
               Multifamily Project Refinances

Scope and Methodology                                                   12

Internal Controls                                                       13

Appendixes
A.    Schedule of Funds To Be Put to Better Use                         15
B.    Auditee Comments and OIG’s Evaluation                             16
C.    Criteria                                                          22




                                            2
                           BACKGROUND AND OBJECTIVE

The U.S. Department of Housing and Urban Development’s (HUD) Office of Multifamily Housing
Programs is responsible for the overall management, development, direction, and administration of
HUD’s multifamily housing programs. Within the Office of Multifamily Housing Programs, the
Office of Asset Management is responsible for the oversight of multifamily project assets after their
development.

Under the Office of Asset Management, the Field Asset Management Division is responsible for
matters affecting the condition and management of the properties; dealing with property ownership
and sales issues; and processing requests for refinancing of Federal Housing Administration (FHA)-
insured mortgages, HUD-held mortgages, and Section 202 direct loans.1

Public Law 106-569, dated December 27, 2000, governs the refinancing of Section 202 projects into
Federal Housing Administration (FHA) insurance under section 223(f). HUD Notice H 2002-16
implemented the public law and indicated that at least 50 percent of debt service savings had to be
used for the benefit of the tenants or rehabilitation or modernization of the project. Therefore, debt
service savings realized from refinancing for longer terms at reduced interest rates could have been
used to reduce rents or housing assistance payments.

Public Law 111-372, dated January 4, 2011, was implemented by Notice H 2012-8 on May 4, 2012.
The major changes in the new policy included eliminating the requirement to escrow debt service
savings and the requirement that at least 50 percent of the annual savings be made available for
specific purposes benefiting the tenants.

Our audit objective was to determine whether HUD had adequate controls to ensure that Section
202 refinancing was conducted in an effective and efficient manner.2




1
 Section 202 direct loans are long-term loans made by HUD to nonprofit borrower corporations formed to provide rental
assistance for elderly and handicapped persons. As such, these HUD loans do not have mortgage insurance.
2
  Standards for Internal Control in the Federal Government, published by the U.S. Government Accountability
Office in 1999, definition and objectives section, states that internal controls should provide reasonable assurance
that the objectives of the agency are achieved in several categories, including effectiveness and efficiency of
operations and the use of the entity’s resources.


                                                           3
                                RESULTS OF AUDIT


Finding: HUD Did Not Provide Effective Oversight of Section 202
         Multifamily Project Refinances

HUD did not have adequate controls to ensure that all Section 202 refinancing resulted in
economical and efficient outcomes. Specifically, (1) HUD did not ensure that at least half of the
debt service savings that resulted from the refinancing were used to benefit tenants or reduce
housing assistance payments, (2) consistent accountability for the debt service savings was not
always maintained, and (3) some refinancing were processed for projects that had negative debt
service savings, which resulted in higher debt service costs than before the refinancing. These
deficiencies were due to HUD’s lack of adequate oversight and inconsistent nationwide policy
implementation regarding debt service savings realized from Section 202 refinancing
activities. As a result, millions of dollars in debt service savings were not properly accounted
for, available savings may not have been used to benefit tenants or for the reduction of housing
assistance payments, and some refinanced projects ended up costing HUD additional housing
assistance payments because of the additional costs for debt service.


 Fifty Percent of Debt Service
 Savings Were Not Always Used
 To Benefit Tenants or Reduce
 Housing Assistance Payments


               HUD did not have effective oversight and monitoring to ensure that all Section
               202 refinancings resulted in economical and efficient outcomes. Many projects
               realized significant annual budget savings when they refinanced their Section 202
               loans and obtained a new FHA-insured loan. In addition, many projects not only
               benefited from huge increases in cashflow from debt savings, but continued to
               receive substantial rent increases. Thus, HUD did not have an effective strategy
               for realizing possible savings of housing assistance payment subsidies from the
               refinancings. Verification of project records at three field offices revealed that
               HUD had not implemented procedures to ensure that debt service savings were
               used to benefit tenants or reduce housing assistance payments.

               The public law provides that the HUD Secretary must make available at least 50
               percent of the annual savings resulting from reduced Section 8 or other rental
               housing assistance contracts in a manner that is advantageous to the tenants,
               including reducing the rents of the unassisted tenants in a prorata sharing of the
               savings from the refinancing. Therefore, the public law implies that annual
               savings in debt service costs from the refinancing would result in lower costs for
                                                 4
            Section 8 and housing assistance, which should be used to benefit tenants.
            Despite the public law’s allowance for debt service savings to reduce or offset
            housing assistance and thus save millions of dollars in housing subsidies, there
            was no mechanism to ensure that this was done. Using computer-assisted audit
            techniques, we extracted information on Section 202 projects that had been
            refinaced from HUD’s iREMS (Integrated Real Estate Management System). We
            calculated that for 971 Section 202 projects refinanced since 2002, there was a
            total of at least $42.1 million in annual debt service savings.

            Therefore, at least half of this amount, or $21 million per year, could and should
            have been used to benefit tenants and for future reductions in the housing
            assistance payments provided to these projects. The total debt service savings
            over the years for projects refinanced before 2012 are calculated to be at least
            $183.3 million, and a significant amount of these funds could have been available
            to reduce housing assistance payments or offset rent increases.

            HUD headquarters officials concurred with our concern that under the old policy,
            projects accumulated large debt savings account balances despite having agreed to
            use the funds for items eligible under that policy. HUD headquarters officials
            indicated that they would meet on this issue and planned to provide guidance to
            the field offices on this matter. HUD headquarters staff also wanted to ensure that
            all HUD field offices addressed this issue consistently. Under the new May 2012
            policy, HUD officials believed that the debt savings would be better addressed
            since the savings would become part of the budget-based rent calculations.

Consistent Accountability for
Debt Service Savings Was Not
Maintained

            HUD did not implement consistent and effective nationwide policies and
            procedures for tracking debt service savings. For the three field offices reviewed,
            each office administered the savings in a different manner. For example, one
            field office required projects to escrow the savings while not reducing the costs,
            two field offices did not properly account for and track the savings, and one field
            office allowed refinancings with negative debt service savings. As a result, there
            was a lack of control over and inconsistent accountability for the actual and
            planned uses of the funds.

            The results of our audit work at the three HUD field offices are described below.

            Buffalo, NY, HUD Multifamily Office

            We examined and analyzed data from all Buffalo office Section 202 projects that
            had been refinanced into FHA insurance since 2002. There were 39 such projects
                                             5
processed under Public Law 106-569 and HUD Notice H 2002-16. In addition,
the Buffalo office had 19 projects that were in the “pipeline” at the time of our
fieldwork, being processed under the new Public Law 111-372 and HUD Notice
H 2012-8, dated May 4, 2012.

Projects Required To Escrow Debt Service Savings

The Buffalo office had 39 Section 202 direct loans that refinanced and were
required by the Buffalo office to escrow the debt service savings. The projects
would then need to request HUD approval to draw down and use the funds. For
these projects, HUD officials informed us that the annual debt service savings
were more than $1.8 million. The balance in the debt savings accounts as of
November 2012 was more than $3 million. However, it appeared that these funds
were not needed by the projects for current or operational needs as they were
available to be drawn down, much like in a reserve for replacement account.
Many projects had plans to use the debt savings but sometimes did not follow the
plan, providing further evidence that the debt savings were not needed by the
projects. Therefore, HUD needs to address this issue as the more than $3 million
in unused debt savings could be put to better use if HUD follows the public law
by offsetting housing assistance payments with the savings.

The following are two examples of projects refinanced from the Buffalo office.

Project Number 014-11145

This project is a 40-unit subsidized Section 202 project that refinanced in 2006.
The Buffalo office calculated the annual debt service savings to be $32,400 per
year. Rather than offsetting housing assistance payments with a portion of the
savings, HUD required the project to deposit the entire $32,400 into a debt service
savings escrow account. HUD also required the project to submit a 5-year plan
for the proposed uses of the escrowed debt savings. However, the owners did not
follow the 5-year plan and used only a small portion of the debt savings for items
that appeared to be eligible under Public Law 106-569.

Consequently, as of February 2013, the escrow account contained more than
$139,000 in unused debt service savings. These funds amounted to excess
housing assistance payment subsidies that were not needed by the project, but
HUD had no mechanism for using these funds for a housing assistance payment
offset. In addition, the project had a reserve for replacement balance of more than
$273,000. Finally, the project continued to receive large rent increases to cover
operating costs, including a 7.3 percent rent increase in 2009.




                                 6
Project Number 014-11162

This project is a 151-unit subsidized Section 202 project that refinanced in 2009.
The Buffalo office calculated the annual debt service savings to be $168,341 per
year. These funds were also deposited into a debt service savings escrow account.
This particular project had not used any of the savings for eligible costs, despite
having a 5-year plan to use all of the funds primarily on remodeling the units,
including the replacement of refrigerators and stoves. The project had more than
$561,000 in debt savings in an escrow account as of March 12, 2013. However,
although the project had available debt service savings, it continued to receive
rent increases, with a 2.4 percent rent increase in June 2009 and a 4 percent rent
increase in June 2010.

Buffalo officials did not receive updated policy direction regarding how to use the
debt savings reserves. Therefore, HUD needs to explore the possibility of saving
these funds by using the reserves to offset monthly housing assistance costs.
Collectively, at the Buffalo office, the 39 projects were required to escrow more
than $1.8 million per year, and the balance in the debt savings accounts was more
than $3 million as of Novermber 2012. Since these funds did not appear to have
been needed by the projects for current or operational needs, HUD needs to
address how to recapture these unnecessary funds and save housing assistance
payment subsidies and develop a plan for how to effectively use the annual $1.8
million in debt savings that continues to accrue.

HUD Buffalo Pipeline Projects Showing Debt Savings

For the 19 Section 202 projects in the pipeline that were being processed under
Public Law 111-372, or the “new,” policy, the Buffalo office did not have the
projects maintain escrows for debt savings as this was not required. HUD staff
calculated the annual debt savings for these 19 projects to be $625,293. This
amount could be available for a reduction in housing assistance payments or rents
since (as proven under the old policy) projects were able to save the total debt
savings in escrow accounts and operate and pay their costs without using the debt
savings. In addition, most of the projects had adequate reserve for replacement
balances and would not appear to need the funds for replacement since noncritical
repairs were made with loan proceeds at the time of FHA closing.

Pittsburgh, PA, Multifamily Office

The Pittsburgh office provided us a listing of 58 Section 202 projects that were
refinanced from 2003 through November 30, 2012. All 58 projects generated
annual debt service savings as required by the public law, amounting to more than
$2 million per year, collectively.



                                 7
                 Pittsburgh officials did not properly ensure that the debt service savings from the
                 refinances were accounted for and used as intended by the public law. While they
                 required, in writing, the projects to deposit the debt service savings into their
                 respective residual receipts accounts, the balance in the accounts was not tracked
                 or controlled. The office acknowledged that the accounts could contain surplus
                 cash in addition to the debt service savings.

                 The Pittsburgh office then made the projects request approval for the use of
                 residual receipts. However, from 2003 through 2012, many of the projects
                 accumulated large balances in their residual receipts accounts. While the
                 Pittsburgh office required the projects to submit a form HUD-9250 to release
                 funds from their residual receipts accounts, the office had no record of the uses or
                 balances of debt savings at each project.

                 We calculated that in the years since the respective closings of refinances, the
                 Pittsburgh Section 202 projects had generated at least $9.8 million in annual debt
                 service savings3. These are funds that technically either could have been used for
                 housing assistance payment offsets or should have been tracked for other
                 allowable uses.

                 Below is an example of a Section 202 project refinanced by the Pittsburgh office.

                 Project Number 033-11072

                 This project is a 50-unit subsidized Section 202 project that refinanced in 2007.
                 The Pittsburgh office calculated the annual debt service savings to be $66,698. It
                 sent the project owner a letter requiring that the debt savings of $66,698 per year
                 be deposited into the project’s residual receipts account. A review of iREMS
                 showed that $66,698 (annual debt service savings) was deposited as required into
                 the residual receipts account. However, the Pittsburgh office did not have
                 procedures in place to ensure that uses of debt savings from the residual receipts
                 account were (at least 50 percent) to benefit tenants as required under the public
                 law for Section 202 refinance transactions. Thus, by the end of 2012, this project
                 had accumulated more than $330,000 in its residual receipts account, indicating
                 that most of the annual debt savings remained unused.

                 According to the new HUD policy, under Notice H 2012-14, entitled “Use of
                 New Regulation, Section 8 Housing Assistance Payments (HAP) Contracts
                 Residual Receipts to Offset Project-Based Section 8 Housing Assistance
                 Payments,” the Pittsburgh office had recently started making housing assistance
                 payment offsets from owners’ residual receipts accounts. This change was based
                 on the HUD policy of not maintaining more than $250 per unit in the residual
                 receipts account. As a result, in December 2012, HUD officials offset a
3
 The total debt service savings were calculated by multiplying the annual debt service savings for each refinanced
project by the number of years since the closing for the refinancing.
                                                         8
                   scheduled housing assistance payment by taking $34,778 from the residual
                   receipts account, based upon the new HUD policy of using excess residual
                   receipts for housing assistance payment offsets.

                   Pittsburgh officials confirmed that these housing assistance payment offsets
                   occurred at projects that refinanced before the new policy was in effect and that
                   these residual receipts consisted primarily of debt service savings at many
                   projects. They informed us that they would continue to offset the monthly
                   housing assistance payments for this project from residual receipts. Pittsburgh
                   officials also offset housing assistance payments at other projects with residual
                   receipt balances that might contain large amounts of debt service savings. HUD
                   needs to look at this issue nationally to ensure that housing assistance payments
                   are offset in this manner by all field offices and document how much of the
                   excess residual receipts is from debt savings.

                   Detroit, MI, Multifamily Office

                   The Detroit office refinanced 78 Section 202 projects into FHA insurance from
                   2003 through November 30, 2012. While most of the projects had a positive
                   annual debt savings as required by the pubic law, the Detroit office processed at
                   least 12 projects that resulted in negative annual debt savings; that is, the
                   refinancing resulted in a higher debt sevice payment and a need for additional
                   housing assistance payment subsidies.

                   For the projects with debt service savings, the Detroit office did not execute debt
                   service savings agreements or have the projects escrow the savings since this was
                   not required by the notice. However, we asked Detroit officials how the office
                   tracked the use of debt service savings for compliance with the uses under the
                   public law and found that the Detroit office did not track the debt savings for the
                   projects.

                   We calculated that more than $14.3 million in debt service savings4 related to 78
                   projects that were refinanced over an 8-year period had not been accounted for by
                   the Detroit office and represented funds that could be put to better use if they
                   were used to offset increases in housing assistance payments.

                   We tested 6 of the 78 projects during our site visit. An example is described
                   below.

                   Project Number 044-11105

                   This project is a 146-unit subsidized Section 202 project that refinanced in 2006.
                   The project had significant debt savings as a result of the refinancing. The Detroit

4
    See footnote 3 for computation method.
                                                    9
            office, at our request, calculated the annual debt service savings to be $98,823.
            However, Detroit officials informed us that the office did not track the uses of
            debt savings but, rather, that debt savings flowed to residual receipts. Although
            the project had to request approval from HUD for the use of residual receipts,
            there was no assurance that the funds would be used to benefit tenants or reduce
            housing assistance payments.

            We calculated that the project had received at least $592,940 in extra funds from
            the debt savings since the refinance date. Yet the project had only $82,514 in its
            residual receipts account as of December 31, 2012. This means that $510,426 in
            debt savings was expended without accountability regarding the use of the funds.
            Further, in addition to the extra nearly $100,000 in available funding per year, the
            project had been approved for rent increases amounting to 7.4 percent since the
            date of refinance, costing even more in housing assistance payment subsidies.

Some Refinanced Projects
Resulted in Negative Debt
Service Savings


            HUD’s Detroit office refinanced at least 12 Section 202 projects that had negative
            annual debt service savings, although the public law did not allow for this until
            the 2011 amendment and HUD implemented the change with a May 2012 housing
            notice. The 2000 Public Law 106-569 (American Homeownership and Economic
            Opportunity Act), Section 811, Prepayment and Refinancing, paragraph (a)(2),
            provides that “the prepayment may involve the refinancing of the loan if such
            refinancing results in a lower interest rate on the principal of the loan for the
            project and in reductions in debt service related to such loan.” The 2011 Public
            Law 111-372, Section 201, amended the cited 2000 public law and indicated that
            refinancing is authorized with negative debt service savings only in cases in
            which a project assisted with a loan under Section 202 carries an intererst rate of 6
            percent or lower. In addition, a data search of iREMS showed that HUD
            processed at least 160 FHA mortgages from 2002 through 2011 that had an
            increase in debt service payments from their Section 202 payments; that is,
            negative debt savings. We calculated that these FHA loans cost the taxpayers at
            least $19 million per year in additional housing assistance payment subsidies. As
            a result, HUD needs to implement procedures to ensure that all future Section 202
            refinancings comply with the requirement to generate positive debt service
            savings or the limited exception to this requirement related to 6 percent or lower
            interest rates.




                                             10
Conclusion

             HUD did not have effective oversight and monitoring to ensure that all Section
             202 refinancings resulted in economical and efficient outcomes. Half of the debt
             services savings were not always used to benefit tenants or reduce housing
             assistance payments, consistent accountability for the debt service savings was
             not always maintained, and some refinancings were processed for projects that
             had negative debt service savings, which resulted in higher debt service costs than
             before the refinancing. As a result, millions of dollars in debt service savings
             were not properly accounted for, available debt service savings was not always
             used to benefit tenants or for the reduction of housing assistance payments, and
             some refinanced projects ended up costing HUD additional housing assistance
             payments because of the additional costs for debt service. We attribute this
             condition to HUD’s lack of adequate oversight and inconsistent nationwide policy
             implementation regarding debt service savings realized from Section 202
             refinancing activities.

Recommendations

             We recommend that the Director, Office of Multifamily Asset Management,

             1A     Clarify, develop or issue policies and procedures as needed to ensure that
                    the calculation and use of any Section 202/223(f) refinancing savings is to
                    benefit project purposes or reduce housing assistance payments and is
                    supported by appropriate monitoring and accounting for these savings,
                    thus resulting in funds to be put to a better use of $21,097,996.

             1B     Require that each Hub or field office review its refinanced Section
                    202/223(f) projects for debt service savings amounts, utilizing data
                    provided from this audit for possible additional debt service savings.
                    Where legally possible each Hub or field office should identify, account
                    for by project, and use these amounts for current and future opportunities
                    benefiting tenants or to fund reductions in housing assistance payments.

             1C.    Implement procedures to ensure that all future Section 202 refinancings
                    comply with the requirement to generate positive debt service savings or
                    the limited exception to this requirement related to 6 percent or lower
                    interest rates.




                                             11
                         SCOPE AND METHODOLOGY

Our audit period covered January 1 through December 31, 2012. We conducted our fieldwork at
the HUD multifamily program centers in Buffalo, NY, and Pittsburgh, PA, and the Detroit, MI,
hub between October 2012 and July 2013.

To accomplish our objective, we

      Reviewed applicable laws and regulations, policies and procedures, HUD notices and
       guidance, and internal controls relating to Section 202 refinancing activities.

      Obtained, reviewed, and analyzed HUD multifamily data for Section 202 refinanced
       projects.

      Interviewed HUD headquarters and field office management and staff responsible for
       oversight of Section 202 project refinancing.

      Obtained, reviewed, and analyzed hardcopy and electronic project documentation
       nationwide and at the three program centers and hubs visited during the audit.

We relied on computer-processed data for providing background information on the Section 202
projects that were refinanced during our audit period. We performed a minimal level of testing
and found the data to be adequate for our purposes.

We used computer assisted audit techniques to extract and analyze information on Section 202
projects that had been refinaced from iREMS and also reviewed data on all Section 202
refinancing transactions nationwide from 2003 through 2012 to determine the annual and
cumulative amounts of debt service savings, we conducted detailed testing of all Section 202
refinancing transactions at three field offices that had large volumes of project refinancing from
2003 through 2012, including Buffalo, NY, Pittsburgh PA, and Detroit MI.

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
objective(s). We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                                12
                              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
               objective:

                     Program operations – Policies and procedures that management has
                      implemented to reasonably ensure that a program meets its objectives.

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

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

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

               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.
                                                 13
Significant Deficiencies

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

                   Program operations – HUD did not have adequate controls to ensure that
                    program objectives would be met as the three field offices reviewed
                    administered debt service savings resulting from the refinancings
                    differently, thereby reducing the likelihood that program objectives would
                    be attained (see finding).

                   Compliance with laws and regulations – HUD had not implemented
                    adequate controls to ensure that the use of debt service savings was
                    consistent with laws and regulations as the savings may not have been
                    used to benefit tenants or reduce housing assistance payments (see
                    finding).

                   Safeguarding resources – HUD had not implemented adequate controls to
                    ensure that debt service savings were adequately safeguarded against waste,
                    loss, and misuse as the savings were not tracked or properly accounted for
                    at two of the field offices (see finding).




                                              14
                                   APPENDIXES

Appendix A

     SCHEDULE OF FUNDS TO BE PUT TO BETTER USE

                                              Funds to be
     Recommendation
                                              put to better
         number
                                                 use 1/

            1A                                   $21,097,996




1/   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 HUD implements our recommendation,
     it will ensure that the annual debt service savings of more than $21 million will be
     properly safeguarded and used as intended for allowable purposes to benefit the projects,
     tenants, or both and reduce or offset future housing assistance payments.




                                            15
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




                         16
Ref to OIG Evaluation   Auditee Comments




Comment 3




Comment4




Comment 5



Comment 6


Comment 7

Comment 8




                         17
Ref to OIG Evaluation   Auditee Comments




Comment 9




Comment 10




                         18
                         OIG Evaluation of Auditee Comments

Comment 1   The objectives cited when we began our review were our survey objectives,
            which are normally broad; however, after the survey we normally refine the
            objectives. Thus, our audit objective was to determine whether HUD had
            adequate controls to ensure that Section 202 refinancing was conducted in an
            effective and efficient manner. For our audit objective we found that HUD did
            not have adequate controls to ensure that all Section 202 refinancings resulted in
            economical and efficient outcomes. These deficiencies were due to HUD’s lack
            of adequate oversight and inconsistent nationwide policy implementation
            regarding debt service savings realized from Section 202 refinancing activities.

Comment 2   HUD indicated that as a result of another programmatic effort over $159 million
            and $37 million of residual receipts had been used to fund the cost of Housing
            Assistance Payments in fiscal years 2013 and 2014 respectively to date. HUD
            indicated that Housing Notice 2012-14 made this possible. We agree that HUD
            has taken action to apply excess residual balances, which also include debt service
            saving to fund Housing Assistance Payments and this is mentioned in the report
            (review of the Pittsburgh Office Refinances). However, HUD has not ensured
            that this policy, as it relates to debt service savings, was properly implemented in
            all field offices; as each field office reviewed handled debt service savings
            differently.

Comment 3   Public Law 106-569 provides that upon execution of the refinancing of a project,
            the HUD Secretary shall make available at least 50 percent of the annual savings
            resulting from reduced Section 8 or other rental housing assistance contracts in a
            manner that is advantageous to the tenants, including reducing the rents of the
            unassisted tenants in a prorata sharing of the savings from the refinancing.
            Therefore, the public law implied that annual savings in debt service costs from
            the refinancing would result in lower costs for Section 8 and housing assistance,
            which should be used to benefit tenants. Despite the public law’s allowance for
            debt service savings to reduce or offset housing assistance and thus save millions
            of dollars in housing subsidies, there was no mechanism to ensure that this was
            done. The total debt service savings over the years for projects refinanced before
            2012 are calculated to be at least $183.3 million, and a significant amount of these
            funds (50% or $91.75 million) could have been available to reduce housing
            assistance payments or offset rent increases. This amount which was available for
            reducing or offsetting housing assistance payment are in addition to the annual
            debt service savings we conservatively reported in the funds to be put to better use
            section of the report.

Comment 4   The next to last paragraph on page 7 that refers to projects that the Buffalo, New
            York HUD Office processed under Public Law 111-372, the “new policy” is
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              reflected correctly. HUD’s Public Housing staff calculated the annual debt
              service savings for the 19 projects financed under the new policy to be $625,293.
              Thus, all debt service savings should be used in calculating the annual housing
              assistance payment budget, as this is a national issue for which HUD should
              consider having all field offices use to offset housing assistance payments.

Comment 5     We did not say eliminate the debt service savings escrow accounts, however, we
              encourage HUD to work with project owners to review the debt service savings in
              the escrow accounts and help determine what action can be taken to use these
              funds to benefit tenants and reduce housing assistance payments, as part of the
              audit resolution process.

Comment 6     We did not say that debt service savings should be used as they are being accrued.
              What we are saying is that although the debt service savings were required to be
              deposited in the residual receipts account, these funds were not tracked and there
              is no record of how the debt service savings were used. Some projects had
              accumulated very large residual receipts balances, which could indicate that most
              of the debt service saving had not be used to reduce housing assistance payments
              or to benefit tenants.

Comment 7     It is possible that debt service savings may have resulted in lower rent increases
              but this cannot be substantiated as there was a lack of accountability as to how the
              funds were used. Furthermore, we noted that one project received a total of 7.4
              percent in rent increases while having almost $100,000 of additional funding from
              the debt service savings, which resulted in additional Housing Assistance
              Payments.

Comment 8     Twelve projects in the Detroit Office were approved for refinancing although they
              resulted in negative debt service savings. HUD indicated that about half of these
              projects had rent savings and that there were mitigating considerations for the
              others. Public Law 106-569 Section 811 (a)(2) provided that the Secretary shall
              approve the prepayment of any indebtedness if the refinancing results in a lower
              interest rate on the principal of the loan and reductions in the debt service on the
              loan. Thus, there was no provision for approving projects for refinancing if they
              did not meet these requirements.

Comment 9     We revised recommendation 1A based on HUD’s comments but kept the original
              recommendation 1E, which is now 1C, because HUD needs to comply with the
              requirement to generate positive debt service savings or the limited exception to
              this requirement related to 6 percent or lower interest rates, as this issue was not
              addressed in HUD’s proposed recommendations

Comment 10 We combined the original recommendations 1B, 1C and 1D into the current
           recommendation 1B as suggested by HUD but kept the funds to be put to better
           use in the current revised recommendation 1A. The funds to be put to better use
                                               20
are an annual recurring amount of debt service savings if HUD implements our
recommendation; it will ensure that the annual debt service savings of more than
$21 million will be properly safeguarded and used as intended for allowable
purposes to benefit the projects, tenants, or both and reduce or offset future
housing assistance payments.




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     Appendix C

                                               CRITERIA

     The public law related to the refinancing of multifamily Section 202 projects into FHA insurance
     under section 223(f) is as follows. Public Law 106-569, specifically, Title VIII, Housing for
     Elderly and Disabled Families, published on December 27, 2000, contained Subtitle A,
     Refinancing for Section 202 Supportive Housing for the Elderly. Included in the law was the
     statement “…the [HUD] Secretary shall approve the prepayment of any indebtedness to the
     Secretary relating to any principal and interest under the loan as part of a prepayment under
     which (1) the project sponsor agrees to operate the project until the maturity date of the original
     loan under terms at least as advantageous to existing and future tenants…, and (2) the
     prepayment may involve refinancing of the loan if such refinancing results in a lower interest
     rate on the principal of the loan for the project AND in reductions in debt service related to such
     loan.” There were no provisions in the 2000 law for refinancings that resulted in higher debt
     service or negative debt service savings.

     Another provision in the Act, entitled “Use of Unexpended Amounts,” stated, “Upon execution
     of the refinancing for a project pursuant to this section, the Secretary shall make available at least
     50 percent of the annual savings resulting from reduced Section 8 or other rental housing
     assistance contracts in a manner that is advantageous to the tenants, including (1) not more than
     15 percent of the cost of increasing the availability or provision of supportive services, which
     may include the financing of service coordinators and congregate services; (2) rehabilitation,
     modernization, or retrofitting of structures, common areas, or individual dwelling units; (3)
     construction of an addition or other facility in the project, including assisted living facilities (or,
     upon the approval of the Secretary, facilities located in the community where the project sponsor
     refinances a project under this section, or pools shared resources from more than one such
     project) or (4) rent reduction of unassisted tenants residing in the project according to a pro rata
     allocation of shared savings resulting from the refinancing.”

     The law did not prohibit HUD from using at least 50 percent of the debt savings for housing
     assistance payment offsets and implied that the refinance savings would result in reduced Section
     8 or housing assistance payments. In August 2002, HUD issued Notice H 2002-16, which
     provided guidance on implementing the public law and included language similar to the law as
     stated above. The notice provided, in part, as follows:

     Use of project-based Section 8 contract savings

A.   Upon approval of the refinancing of a project under this Notice and recordation of the Section
     202 Use Agreement, the Secretary shall make available at least 50 percent of the annual savings
     resulting from reduced Section 8 or other rental housing assistance contracts in a manner that is
     advantageous to the tenants-specifying the 4 items listed above.


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HUD did not provide for what to do with the remaining savings (the other 50 percent) from
refinancings or in what manner or how long to make 50 percent of the housing assistance savings
available to the projects. In addition, while the notice referred to the savings as “Section 8
Contract savings,” our fieldwork showed that it is commonly referred to as “debt service
savings.”

Public Law 111-372 resulted in changes to the above requirements for refinancing Section 202
loans and was implemented by Notice H 2012-8 on May 4, 2012. The major changes in the new
policy included eliminating the requirement to escrow debt service savings and the requirement
that at least 50 percent of the annual savings be used for specific purposes benefiting the tenants.

Notice H 2012-8, dated May 4, 2012, requires projects to quantify annual debt savings, but there
is no provision for the use of the savings. The new notice applies only to projects that had not
been approved for refinancing by HUD as of May 4, 2012. In addition, both the public law and
the notice allow the refinancing of Section 202 projects without reductions in debt service
(negative debt savings) but only for refinancings approved after May 4, 2012, and meeting
certain other provisions, which are specified in the notice.




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