oversight

The Office of the Commissioner for Municipal Affairs Needs To Make Improvements in Administering Its Section 108 Loan Guarantee Program

Published by the Department of Housing and Urban Development, Office of Inspector General on 2014-12-05.

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

        Office of the Commissioner for
        Municipal Affairs, San Juan, PR
               Section 108 Loan Guarantee Program




Office of Audit, Region 4         Audit Report Number: 2015-AT-1001
Atlanta, GA                                        December 5, 2014
To:            María Ortíz, Director, Community Planning and Development, San Juan Field
               Office, 4ND


               //signed//
From:          Nikita N. Irons, Regional Inspector General for Audit, Atlanta Region, 4AGA
Subject:       The Office of the Commissioner for Municipal Affairs Needs To Make
               Improvements in Administering Its Section 108 Loan Guarantee Program




Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of the Office of the Commissioner for Municipal
Affairs’ Section 108 Loan Guarantee program.
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 8M, 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
404-331-3369.
                       Audit Report Number: 2015-AT-1001
                       Date: December 5, 2014

                       The Office of the Commissioner for Municipal Affairs Needs To Make
                       Improvements in Administering Its Section 108 Loan Guarantee Program




Highlights

What We Audited and Why
We audited the Office of the Commissioner for Municipal Affairs’ Section 108 Loan Guarantee
program as part of our strategic plan and based on the deficiencies noted during our recent
review of Municipal Affairs’ Section 108 Loan Guarantee program, concerning the slow
progress of the Vieques Sports Complex project. 1 The objectives of the audit were to determine
whether Section 108 loan program funds were effectively used to meet a Community
Development Block Grant (CDBG) program national objective and provide the intended benefits
and whether borrowers complied with loan contract and the U.S. Department of Housing and
Urban Development (HUD) requirements.

What We Found
Municipal Affairs did not ensure that borrowers completed three Section 108 Loan Guarantee
activities that showed signs of slow progress. As a result, HUD had no assurance that more than
$21 million awarded and disbursed for three Section 108-funded activities met a national
objective of the CDBG program and fully provided the intended benefits.
Section 108 loan program borrowers used more than $1 million for ineligible expenditures and
did not support the eligibility of more than $367,000 in program disbursements. In addition, loan
proceeds were not disbursed within the established timeframe, borrowers did not provide HUD
the required loan collateral, borrowers did not establish a financial management system in
accordance with HUD requirements, and investments were not fully collateralized. As a result,
HUD lacked assurance that funds were adequately accounted for, safeguarded, and used for
authorized purposes and in accordance with HUD requirements.

What We Recommend
We recommend that HUD (1) determine the eligibility of more than $20 million in unsupported
Section 108 program costs and activities that showed signs of slow progress and (2) require the
repayment of more than $1 million in ineligible expenditures.




1
    Audit memorandum number 2014-AT-1801, issued March 20, 2014
Table of Contents
Background and Objectives ....................................................................................3

Results of Audit ........................................................................................................5
         Finding 1: Section 108 Loan Guarantee-Funded Activities Did Not Meet Program
         Objectives........................................................................................................................... 5

         Finding 2: Loan Agreement Provisions and HUD Requirements Were Not
         Followed ............................................................................................................................. 9

Scope and Methodology .........................................................................................14

Internal Controls ....................................................................................................16

Appendixes ..............................................................................................................18
         A. Schedule of Questioned Costs .................................................................................. 18

         B. Auditee Comments and OIG’s Evaluation ............................................................. 19

         C. Schedule of Ineligible Disbursements...................................................................... 25




                                                                      2
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
grantee or the State of current and future CDBG funds. Section 108 obligations are financed
through underwritten public offerings and may be for terms of up to 20 years. A nonentitlement
public entity may apply for up to five times the latest approved CDBG amount received by its
State. 2

For purposes of determining project and activity eligibility, the CDBG rules and requirements
apply. All projects and activities must meet one of the following three national objectives of the
CDBG program: (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.

The Office of the Commissioner for Municipal Affairs is the lead agency in Puerto Rico charged
with the responsibility of overseeing the administration of the State allocation of CDBG program
funds. Municipal Affairs was created August 30, 1991, through the Commonwealth of Puerto
Rico Autonomous Municipalities Act of 1991. One of its responsibilities is to regulate, advise,
and give technical and professional assistance to municipalities in the areas related to their
organization, administration, and operations. In fiscal year 2014, The U.S. Department of
Housing and Urban Development (HUD) awarded Puerto Rico nearly $26.1 million in State
CDBG funds, distributed among 51 nonentitlement recipients.

Between 2006 and 2013, HUD approved more than $23 million in Section 108 loans to five
Puerto Rico nonentitlement recipients. The table below provides details of the five Section 108
loans.
    Municipality           Loan amount                                Loan purpose
     San Lorenzo                 $6,000,000 Acquisition of property and development of activity center
       Dorado                     5,500,000 Acquisition of property and development of hotel facilities
                                                Acquisition of property and development of multicultural
        Rincon                    4,850,000 activity center and aquatic park
        Camuy                     4,264,000 Development of hotel facilities
       Maunabo                    3,000,000 Development of sports and entertainment center
         Total                  $23,614,000




2
 A nonentitlement public entity represents a unit of general local government that does not receive CDBG funds
directly from HUD as part of the CDBG entitlement program.



                                                        3
The objectives of the audit were to determine whether Section 108 loan program funds were
effectively used to meet a CDBG program national objective and provided the intended benefits
and whether borrowers complied with loan contract and HUD requirements.




                                               4
Results of Audit

Finding 1: Section 108 Loan Guarantee-Funded Activities Did Not
Meet Program Objectives
Municipal Affairs did not ensure that borrowers completed three Section 108 Loan Guarantee
activities that showed signs of slow progress. This deficiency occurred because Municipal
Affairs did not implement adequate monitoring procedures for its Section 108 activities. As a
result, HUD had no assurance that more than $21 million awarded and disbursed for three
Section 108-funded activities met a national objective of the CDBG program and fully provided
the intended benefits.

Slow Progress Activities
More than $21 million was invested for three activities that reflected slow progress without
assurance that the activities would provide the intended benefits.

       San Lorenzo activity center - In July 2006, HUD approved a $6 million Section 108 loan
       to the Municipality of San Lorenzo for property acquisition and the development of an
       activity center that included movie theaters, bowling alleys, and other facilities.
       According to the loan agreement, all loan proceeds had to be withdrawn and disbursed by
       December 31, 2008.

       The Municipality’s Federal programs director informed us that the Municipality did not
       have the funds to complete the project as originally planned and that it had not found a
       private investor that could provide the additional financing needed to construct the
       activity center. We performed a site inspection of the activity center project in March
       2014 and confirmed that the project had not been completed. At the time of our
       inspection, the project site had been converted to a parking facility (see picture 1). The
       Municipality did not provide documentation showing that HUD approved the change in
       the scope of the project.




       Picture 1 - San Lorenzo activity center site converted to a parking facility



                                                 5
         More than 8 years had elapsed since HUD approved the Section 108 funds for the
         activity, and the intended benefits had not materialized. Based on this condition, HUD
         had no assurance that the San Lorenzo activity center project would fully meet CDBG
         program objectives and provide the intended benefits. Therefore, more than $7.9 million
         in Section 108 and CDBG funds invested in the project was unsupported. 3

         Dorado hotel facilities - In November 2006, HUD approved a $5.5 million Section 108
         loan to the Municipality of Dorado for property acquisition and the development of a 48-
         room hotel facility. According to the loan agreement, all loan proceeds had to be
         withdrawn and disbursed by February 29, 2008.

         The Municipality’s Federal programs director informed us that the Municipality did not
         have the funds necessary to develop the project as originally planned because of its high
         estimated construction cost and was revising the scope of the project. We performed a
         site inspection of the hotel project in June 2014 and confirmed that the construction had
         not started (see picture 2).




         Picture 2 - Dorado hotel project site

         More than 7 years had elapsed since HUD approved the Section 108 funds for the
         activity, and the intended benefits had not materialized. Based on this condition, HUD
         had no assurance that the Dorado hotel project would fully meet CDBG program
         objectives and provide the intended benefits. Therefore, more than $7.3 million in
         Section 108 and CDBG funds invested in the project was unsupported. 4

         Camuy hotel facilities - In March 2006, HUD approved a $4.2 million Section 108 loan
         to the Municipality of Camuy for the development of an 80-room hotel facility.
         According to the loan agreement, all loan proceeds had to be withdrawn and disbursed by
         December 31, 2008.



3
  The $7.9 million invested in the activity consisted of $6 million Section 108 loan proceeds plus $1.9 million in
CDBG funds used for loan repayments.
4
  The $7.3 million invested in the activity consisted of $5.5 million Section 108 loan proceeds plus $1.8 million in
CDBG funds used for loan repayments.



                                                           6
         The Municipality’s Federal programs director informed us that the Municipality did not
         have the funds necessary to develop the project because of its high estimated construction
         cost and was reviewing alternate projects to use the Section 108 funds. We performed a
         site inspection of the hotel project in March 2014 and confirmed that the construction had
         not started (see picture 3).




         Picture 3 - Camuy hotel project site

         More than 8 years had elapsed since HUD approved the Section 108 funds for the
         activity, and the intended benefits had not materialized. Based on this condition, HUD
         had no assurance that the Camuy hotel facility project would fully meet CDBG program
         objectives and provide the intended benefits. Therefore, more than $5.8 million in
         Section 108 and CDBG funds invested in the project was unsupported. 5

Lack of Monitoring Efforts
Municipal Affairs did not implement monitoring procedures for its Section 108 loan program.
The most recent monitoring review was performed in 2005. HUD regulations at 24 CFR (Code
of Federal Regulations) 570.710 assign the principal responsibility to the State CDBG grantees
to ensure compliance with all applicable requirements governing the use of the guaranteed loan
funds. Further, 24 CFR 570.492 provides that the State must review units of general local
government and in cases of noncompliance, take such actions as appropriate to prevent a
continuance of the deficiency, mitigate any adverse effects, and prevent a recurrence. Municipal
Affairs’ lack of monitoring efforts compromised the effectiveness of the Section 108-funded
activities in meeting a national objective of the CDBG program.

Conclusion
The deficiencies discussed above occurred because Municipal Affairs did not implement
monitoring procedures and controls to ensure that its activities met Section 108 Loan Guarantee



5
 The $5.8 million invested in the activity consisted of $4.26 million Section 108 loan proceeds plus $1.6 million in
CDBG funds used for loan repayments.



                                                          7
program objectives. As a result, HUD had no assurance that more than $21 million invested in
the Section 108-funded activities met a national objective of the CDBG program and fully
provided the intended benefits.
Recommendations
We recommend that the Director of the San Juan Office of Community Planning and
Development instruct Municipal Affairs to
        1A. Submit a plan for how it will proceed with respect to the Municipality of San
            Lorenzo activity center project, including a schedule that HUD can track to ensure
            its completion. HUD must reevaluate the feasibility of the activity and determine
            the eligibility of the $7,010,276 already invested. 6 If HUD determines that the
            activity has been canceled or is not feasible, Municipal Affairs must mitigate
            activity losses by committing any unused loan proceeds for future loan repayments.
        1B. Submit a plan for how it will proceed with respect to the Municipality of Dorado
            hotel project, including a schedule that HUD can track to ensure its completion.
            HUD must reevaluate the feasibility of the activity and determine the eligibility of
            the $7,369,000 already invested. If HUD determines that the activity has been
            canceled or is not feasible, Municipal Affairs must mitigate activity losses by
            committing any unused loan proceeds for future loan repayments.
        1C. Submit a plan for how it will proceed with respect to the Municipality of Camuy
            hotel project, including a schedule that HUD can track to ensure its completion.
            HUD must reevaluate the feasibility of the activity and determine the eligibility of
            the $5,474,376 already invested. 7 If HUD determines that the activity has been
            canceled or is not feasible, Municipal Affairs must mitigate activity losses by
            committing any unused loan proceeds for future loan repayments.
        1D. Conduct monitoring of the Section 108 activities with signs of slow progress to
            ensure that program objectives are met and provide the intended benefits.




6
  Total investments of $7,999,275 were adjusted to account for $988,154 questioned in recommendation 2A and
$845 in recommendation 2C.
7
  Total investments of $5,830,878 were adjusted to account for $436 questioned in recommendation 2A and
$356,066 in recommendation 2C.



                                                       8
Finding 2: Loan Agreement Provisions and HUD Requirements
Were Not Followed
Section 108 loan program borrowers used more than $1 million for ineligible expenditures and
did not support the eligibility of more than $367,000 in program disbursements. In addition, loan
proceeds were not disbursed within the loan agreement timeframes, borrowers did not provide
HUD the required loan collateral, borrowers did not establish a financial management system in
accordance with HUD requirements, and investments were not fully collateralized. These
deficiencies occurred because Municipal Affairs did not perform monitoring reviews of Section
108 borrowers to ensure compliance with the loan agreement and regulations. As a result, HUD
lacked assurance that funds were adequately accounted for, safeguarded, and used for authorized
purposes and in accordance with HUD requirements.

Program Disbursements Not Related to Approved Projects
Contrary to the loan agreement, more than $1 million in Section 108 loan proceeds was
disbursed to pay for expenditures that were not related to the approved Section 108 projects or
were used as a source of temporary financing to the unit of local government. Therefore, the
Section 108 Loan Guarantee program was charged with unnecessary costs that provided no
benefits and did not meet program objectives.

The Municipalities of San Lorenzo, Maunabo, and Camuy disbursed more than $589,000 in
Section 108 funds for costs that were not related to the approved projects and for ineligible bank
overdraft fees. Paragraph 1(a) of the loan agreement provided that funds could be withdrawn
from the guarantee loan funds account only for the payment of the costs of approved Section 108
activity, transfer to the loan repayment account, or the temporary investment of funds under the
contract. Regulations at 2 CFR 225, Appendix B, Paragraph 16 provide that fines and penalties
are unallowable program costs. Appendix C provides details of the ineligible disbursements.

In addition, the Municipality of San Lorenzo inappropriately transferred Section 108 loan
proceeds to its general fund account. Contrary to paragraph 1(a) of the loan agreement, between
December 2008 and February 2014, the Municipality made 30 transfers to the general fund
totaling more than $6.1 million. Its Federal program director informed us that the funds were
transferred to cover cash shortfalls in the general account and the Municipality was not aware
that such transactions were contrary to the loan agreement. The Municipality’s records showed
that it had returned most of the funds to its guarantee loan funds account but owed more than
$490,000.

Program Expenditure Eligibility Not Substantiated
Section 108 loan program borrowers did not support the reasonableness and allowability of more
than $367,000 in Section 108 program funds disbursed. Regulations at 2 CFR 225, Appendix A,
Paragraph C.1.b. provide that to be allowable under Federal awards, costs must be necessary,
reasonable, and adequately documented. Since proper supporting documentation was not
provided, HUD lacked assurance that funds were used for authorized purposes and in accordance
with HUD requirements. See table 1 for details of the unsupported disbursements.




                                                 9
                                            Check
   Municipality           Date             number              Amount                   Comment
   San Lorenzo         Dec. 6, 2007          110                  $845    No support provided
                                                                          Inspection services, support was not
                                                                          adequate to exclude other charges
     Maunabo          Apr. 11, 2008             32               10,929   not related to the approved project.
                      Jan. 23, 2009             32              112,320   No support provided
                      Sept. 18, 2009            34              131,500   No support provided
      Camuy           Mar. 18, 2010             35               23,441   No support provided
                      May 14, 2009              36                1,100   No support provided
                      Aug. 11, 2010             37               74,580   No support provided
                      Aug. 25, 2010             38               13,125   No support provided
                         Total                                 $367,840
Table 1
Unexpended Section 108 Loan Proceeds
Three Section 108 loan program borrowers did not expend loan proceeds before the loan
agreement deadline. The agreement for the Section 108 Loan Guarantee assistance, paragraph
1(a), required that all of the loan funds be withdrawn and disbursed by the borrower for the
approved activities by a specified date. Any funds remaining after the deadline were to be
transferred to an established loan repayment account. Despite this requirement, the borrowers
maintained unused Section 108 loan proceeds totaling more than $8.8 million.
HUD informed us that the borrower should make the transfer unless the funds were still needed
to carry out the approved activity. The borrower should either transfer the unexpended funds to
the repayment account or submit a request for extension to HUD. The borrowers did not transfer
the unused funds to the repayment account and did not provide evidence that it had requested an
extension from HUD. Table 2 provides details of the unexpended loan proceeds.

                    Loan        Disbursement           Bank balance as of
 Municipality      amount       deadline date             review date                       Comment
                                                                                The Municipality informed us that
                                                                                it was aware of the disbursement
    Dorado         $5,500,000   Feb. 29, 2008        $4,307,775   Apr. 30, 2014 deadline.
                                                                                The Municipality informed us that
                                                                                it was not aware of the
 San Lorenzo        6,000,000   Dec. 31, 2008          666,948    Feb. 28, 2014 disbursement deadline.
                                                                                The Municipality informed us that
                                                                                it was not aware of the
    Camuy           4,264,000   Dec. 31, 2008         3,826,760   Feb. 28, 2014 disbursement deadline.
    Total         $15,764,000                        $8,801,483
Table 2

Loan Collateral Not Provided in Accordance With Loan Agreement
The Section 108 loan program borrowers did not provide additional security to assure the
repayment of the debt obligation as required in paragraph 15 of the loan agreement. As a
condition for receiving Loan Guarantee assistance, the borrower was required to submit
additional security in the form of a sole first priority lien of real property within an established



                                                          10
timeframe. For one loan, the lien was filed more than 3 years after the deadline. For the other
three loans, the lien was overdue and was not filed by the borrower. As a result, HUD was at
risk of not being able to exercise appropriate remedies in the event of a borrower’s defaulting on
the Section 108 loan. Table 3 provides details of the overdue and late liens.

         Municipality          Lien deadline                             Comment
         San Lorenzo           Sept. 27, 2006         Lien not submitted to HUD
                               Nov. 17, 2011          Lien not submitted to HUD
                               June 18, 2012          Lien not submitted to HUD
             Dorado 8          Apr. 22, 2014          Lien not submitted to HUD
                               June 11, 2014          Lien not submitted to HUD
                               June 30, 2014          Lien not submitted to HUD
            Maunabo            Sept. 21, 2006         Lien not submitted to HUD
                                                      Lien filed in January 2010, more than 3 years
             Camuy             Sept. 21, 2006
                                                      after the deadline
         Table 3

Inadequate Accounting Records
The accounting records of the four Section 108 loan program borrowers did not reflect complete
and accurate financial information on program activities and did not permit the adequate tracing
of program receipts and expenditures. Regulations at 24 CFR 85.20(b) require recipients of
Federal awards to maintain financial records that are accurate, current, and complete and that
adequately identify the source and application of funds provided for assisted activities.
However, the borrowers did not maintain a financial management system that permitted the
tracing of funds to a level that ensured that such funds had not been used in violation of the
restrictions and prohibitions of applicable statutes. For example, the records maintained did not
properly account for program income, accounts receivable, and capital assets. The accounting
records also contained several instances of incorrect balances and transactions not recorded. The
Municipalities of San Lorenzo and Camuy did not maintain a general ledger for the Section 108
program. The accounting record maintained was a check register that contained incomplete and
inaccurate financial information. As a result, HUD lacked assurance that funds were adequately
accounted for, safeguarded, and used for eligible purposes.
Investments Not Fully Collateralized With Government Obligations
Section 108 loan program borrowers invested the loan proceeds in certificates of deposit at local
commercial banks without ensuring that they were fully collateralized with Government
obligations. Paragraph 1(a) of the loan agreement provided that any amount of Section 108 loan
proceeds deposited into a bank and in excess of the Federal deposit insurance limit must be fully
invested in Government obligations. 9 The Municipalities of Camuy and Dorado invested $7



8
  The Dorado activity involved the acquisition of five properties, and the liens were due within 5 business days of
the acquisition.
9
  The Federal insurance amount is currently limited to $250,000. Government obligations are defined as a direct
obligation of or any obligation for which the full and timely payment principal and interest is guaranteed by the



                                                           11
million in loan proceeds in certificates of deposit at commercial banks in Puerto Rico. HUD
informed us that the investment in certificates of deposit in excess of Federal insurance is not
permissible unless the excess is fully collateralized with Government obligations. However, the
borrowers did not provide evidence showing that these investments were fully collateralized with
Government obligations. As a result, HUD had no assurance that Federal funds were properly
safeguarded. Table 4 provides details of the Section 108 funds invested in certificates of deposit.

                                              Total amount invested in certificates
                       Municipality                   of deposit as of review date
                           Dorado                $3,500,000      April 30, 2014
                           Camuy                  3,500,000      March 6, 2014
                            Total                $7,000,000
                     Table 4

Lack of Monitoring
Municipal Affairs did not monitor Section 108 borrowers to ensure compliance with all
applicable requirements governing the use of Loan Guarantee funds. Its monitoring director
informed us that the most recent monitoring review of the Section 108 program was performed
in 2005. HUD’s regulations at 24 CFR 570.492 provide that the State must review units of
general local government and in cases of noncompliance, take such actions as appropriate to
prevent a continuance of the deficiency, mitigate any adverse effects, and prevent a recurrence.
Municipal Affairs’ lack of monitoring efforts compromised the effectiveness of Section 108-
funded activities, and HUD lacked assurance that funds were adequately accounted for,
safeguarded, and used for authorized purposes.

Conclusion
The deficiencies discussed above occurred because Municipal Affairs did not perform
monitoring reviews of its Section 108 loan program borrowers. As a result, HUD lacked
assurance that funds were adequately accounted for, safeguarded, and used for authorized
purposes and in accordance with HUD requirements.
Recommendations
We recommend that the Director of the San Juan Office of Community Planning and
Development instruct Municipal Affairs to

         2A. Recover from the borrowers and reimburse $1,080,242 to the applicable loan
             guarantee account from non-Federal funds for ineligible disbursements that were




United States of America, including but not limited to United States Treasury certificates of indebtedness and notes
and bonds –State and local government series, or certificates of ownership of the principal of or interest on direct
obligations of or obligations unconditionally guaranteed by the United States of America, which are held in trust by
a commercial bank that is a member of the Federal Reserve System and has capital and surplus in excess of $100
million.



                                                          12
             not related to the approved projects and used to finance local government
             operations.
       2B. Ensure that borrowers did not use Section 108 funds to finance local government
           operations and verify the return of any ineligible disbursement.
       2C. Obtain and submit supporting documentation showing the eligibility and propriety
           of $367,840 in disbursements or reimburse the loan guarantee account from non-
           Federal funds.
       2D. Ensure that the borrowers either transfer the unexpended Section 108 loan proceeds
           to the repayment account or submit a request for extension to HUD.
       2E. Ensure that the borrowers provide HUD the additional security requirements
           according to the loan agreement.
       2F. Ensure that borrowers develop and implement a financial management system in
           accordance with HUD requirements to ensure that program funds can be traced to a
           level that ensures that such funds have not been used in violation of the restrictions
           and prohibitions of applicable statutes.
       2G. Ensure that all Section 108 loan proceeds deposited at commercial banks are
           properly collateralized with Government obligations.
       2H. Conduct monitoring reviews of all Section 108 projects and ensure that borrowers
           comply with all loan agreement provisions and HUD regulations.
We also recommend that the Director of the San Juan Office of Community Planning and
Development
       2I.   Increase monitoring of Municipal Affairs’ performance in the administration of its
             Section 108 loan program. Consider imposing sanctions if Municipal Affairs does
             not demonstrate program progress.




                                                13
Scope and Methodology
The objectives of this audit were to determine whether Section 108 loan program funds were
effectively used to meet a national objective of the CDBG program and fully provided the
intended benefits and whether borrowers complied with loan contract and HUD requirements.

To accomplish our objectives, we

   •   Reviewed applicable laws, regulations, and relevant HUD program requirements,
       including the Section 108 loan contracts;

   •   Reviewed HUD Section 108 loan-related files, including the application for the loan,
       status reports, and disbursement information reported on loan proceeds and CDBG funds;

   •   Reviewed Municipal Affairs’ and borrowers’ project files and records;

   •   Reviewed HUD’s Integrated Disbursement and Information System reports;

   •   Conducted site inspections of the projects; and

   •   Interviewed HUD, Municipal Affairs, and municipality officials.

Between 2006 and 2013, HUD approved more than $23 million in Section 108 loans to five
nonentitlement recipients. We reviewed the five Section 108 loans to determine whether the
loan proceeds were used in accordance with the application and loan agreement and whether
activities provided the intended benefits.

The borrowers’ records reflected that more than $7.8 million in Section 108 loan proceeds were
disbursed between May 2007 and April 2014. We reviewed all the disbursements related to the
Section 108 projects of the Municipalities of Camuy, San Lorenzo, and Maunabo totaling more
than $6.4 million. We reviewed additional disbursements from the Municipality of Dorado with
amounts greater than $10,000. The sample resulted in 10 disbursements totaling more than $1.4
million. We did not review the disbursements related to the Municipality of Rincon because at
the time of our audit, Section 108 loan proceeds had not been transferred. More than $7.8
million in Section 108 loan program expenditures was reviewed to determine whether funds
were used for supported and eligible efforts.

To achieve our audit objectives, we relied in part on computer-processed data contained in
HUD’s information system. Although we did not perform a detailed assessment of the reliability
of the data, we performed a minimal level of testing and found the data adequate for our
purposes. We did not rely on computer-processed data contained in Municipal Affairs’ and
borrowers’ databases, nor were the data used to materially support our audit findings,



                                                14
conclusions, and recommendations. We did not select 100 percent of the items for testing, as the
selections made provided sufficient evidence for the findings presented. The results of the audit
apply only to items selected for review and cannot be projected to the universe or population.

The audit generally covered the period January 1, 2005, through December 31, 2013. We
conducted our fieldwork from February through August 2014 at Municipal Affairs’ offices in
San Juan, PR, and the borrowers’ offices in Camuy, Dorado, Maunabo, and San Lorenzo, PR.

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 objectives.




                                                15
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:

•   Program operations – Policies and procedures that management has implemented to provide
    reasonable assurance that a program meets its objectives, while considering cost
    effectiveness and efficiency.

•   Relevance and reliability of information – Policies and procedures that management has
    implemented to reasonably ensure that operational and financial information used for
    decision making and reporting externally is relevant, reliable, and fairly disclosed in reports.

•   Compliance with laws and regulations – Policies and procedures that management has
    implemented to reasonably ensure that program implementation is consistent with laws and
    regulations.

•   Safeguarding of assets – Policies and procedures that management has implemented to
    reasonably prevent and promptly detect unauthorized acquisition, use, or disposition of assets
    and resources.

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.




                                                  16
Significant Deficiencies
Based on our review, we believe that the following items are significant deficiencies:

•   Municipal Affairs did not implement adequate procedures and controls to ensure that
    activities provided the intended benefits and met a national objective of the CDBG program
    (see finding 1).

•   Municipal Affairs did not implement adequate monitoring efforts to ensure that Section 108
    loan borrowers complied with loan agreement provisions and regulations (see finding 2).




                                                 17
Appendixes

Appendix A


                          Schedule of Questioned Costs
                 Recommendation
                                  Ineligible 1/   Unsupported 2/
                     number
                         1A                                   $7,010,276
                         1B                                    7,369,000
                         1C                                    5,474,376
                         2A              $1,080,242
                         2C                                      367,840

                        Totals           $1,080,242          $20,221,492


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.




                                              18
Appendix B
             Auditee Comments and OIG’s Evaluation



Ref to OIG    Auditee Comments
Evaluation




Comment 1




                               19
             Auditee Comments
Ref to OIG
Evaluation




Comment 1




Comment 2



Comment 3


Comment 4




                            20
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




Comment 4




Comment 5


Comment 6


Comment 2


Comment 7


Comment 8




Comment 3




                               21
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




                               22
                         OIG Evaluation of Auditee Comments


Comment 1   Municipal Affairs stated that under the current program procedures borrowers
            maintain control of the Section 108 funds without its and HUD’s involvement. It
            also stated that it is in the process of establishing and adopting new procedures to
            address the deficiencies identified in the audit report.

            Contrary to the Municipal Affairs’ statements, the current regulations and
            program guidelines of the Section 108 program do not limit the ability of the State
            to monitor and properly track the use of program funds on behalf of the
            borrowers. HUD’s regulations at 24 CFR 570.492 provide that the State must
            review units of general local government and in cases of noncompliance, take
            such actions as appropriate to prevent a continuance of the deficiency, mitigate
            any adverse effects, and prevent a recurrence. Any new procedures the Municipal
            Affairs implements must comply with all HUD requirements.

Comment 2   We commend Municipal Affairs for recognizing the need of a work plan for the
            three activities with signs of slow progress to ensure program objectives are met.

Comment 3   We appreciate Municipal Affairs efforts to promptly initiate monitoring reviews
            of the Section 108 borrowers.

Comment 4   Municipal Affairs stated that some of the questioned costs were not authorized by
            the Section 108 loan agreement but are CDBG eligible expenditures. The loan
            agreements will be amended to include the questioned costs as part of eligible
            activities. Municipal Affairs requested that appendix C be renamed to
            unauthorized disbursements. In addition, it stated that it will coordinate the
            reimbursement of the Section 108 funds transferred to the general account.

            The Municipalities of San Lorenzo, Maunabo, and Camuy disbursed Section 108
            funds for costs that were not related to the approved projects. Paragraph 1(a) of
            the loan agreement provided that funds could be withdrawn from the guarantee
            loan funds account only for the payment of the costs of approved Section 108
            activity, transfer to the loan repayment account, or the temporary investment of
            funds under the contract. Therefore, more than $589,000 in Section 108 funds is
            ineligible. We did not modify the report and recommendations. Amendments to
            the loan agreement to make the questioned costs eligible after the facts must be
            evaluated by HUD. HUD must determine whether such amendment is
            permissible under the program and it must ensure that all HUD requirements,
            such as procurement, environmental, and citizen participation, were met.

Comment 5   We appreciate Municipal Affairs efforts to implement new monitoring procedures
            on the use and disposition of Section 108 funds.




                                              23
Comment 6   We appreciate Municipal Affairs efforts to require the borrowers to submit the
            documentation related to the unsupported disbursements and provide it to HUD
            for an eligibility determination. Any amounts determined ineligible by HUD
            should be reimbursed from non-Federal funds.

Comment 7   We appreciate Municipal Affairs efforts to ensure that Section 108 borrowers
            provide the additional security to assure the repayment of the debt obligation as
            required in paragraph 15 of the loan agreement.

Comment 8   We commend Municipal Affairs for recognizing the need for improving the
            financial management system of its non-entitlement borrowers.




                                              24
Appendix C
                         Schedule of Ineligible Disbursements
                                  Check
  Municipality       Date        number   Amount                      Comment
                                                        Disbursement for local road repairs
                  Feb.7, 2012     132      $133,965
                                                        not related to the approved project
                                                        Disbursement for local road repairs
                 Mar. 21, 2012    133          34,161   not related to the approved project
                                                        Disbursement for local road repairs
                 Mar. 29, 2012    134          70,734
                                                        not related to the approved project
                                                        Disbursement for local road repairs
                 May 25, 2012     135           3,795
                                                        not related to the approved project
   San Lorenzo
                                                        Disbursement for local road repairs
                 May 29, 2012     136          21,728
                                                        not related to the approved project
                                                        Disbursement for local road repairs
                 June 21, 2012    137       133,453
                                                        not related to the approved project
                                                        Disbursement for local road repairs
                  July 3, 2012    138          41,220
                                                        not related to the approved project
                                                        Disbursement for local road repairs
                  July 3, 2012    139          58,653
                                                        not related to the approved project
                                                        Disbursement for construction
                 Feb. 15, 2008    0001         32,267   patents and taxes not related to the
                                                        approved project
                                                        Disbursement for partial release of
                                                        10 percent retention of the
                 Mar. 18, 2008    0002           857
                                                        construction patents and taxes not
                                                        related to the approved project
                                                        Disbursement for release of 10
                                                        percent retention of patents and
                 Mar. 25, 2008    0005          2,728
                                                        local taxes not related to the
    Maunabo
                                                        approved project
                                                        Disbursement for construction of
                 Nov. 9, 2010     1003         53,593   baseball park not related to the
                                                        approved project
                                                        Disbursement for release of 10
                                                        percent retention of construction of
                 Sept. 1, 2011    1007          1,802
                                                        baseball park not related to the
                                                        approved project
                                                        Overdraft bank charges, ineligible
                     N/A          N/A            405
                                                        under 2 CFR Part 225
                                                        Overdraft bank charges, ineligible
     Camuy           N/A          N/A            436
                                                        under 2 CFR Part 225
                 Total                     $589,797




                                          25