oversight

CDBG Program, City of Reading, PA

Published by the Department of Housing and Urban Development, Office of Inspector General on 1996-08-08.

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

                                 U.S. Department of Housing and Urban Development
                                                    Wanamaker Building, Suite 1005
                                                              100 Penn Square East
                                                       Philadelphia, PA 19107-3380

                                                District Inspector General for Audit




August 8, 1996

                                             Audit Related Memorandum
                                             No. 96-PH-250-1820


MEMORANDUM FOR:   Joyce Gaskins, Director, Office of Community
                    Planning and Development, Pennsylvania State
                    Office, 3AD



FROM:   Edward F. Momorella, District Inspector General
          for Audit, Mid-Atlantic, 3AGA


SUBJECT:   Community Development Block Grant Program
           Economic Development Activities
           City of Reading, Pennsylvania



                           INTRODUCTION

We performed a limited review of the City of Reading's (Grantee's)
Economic Development Activities funded through the Community
Development Block Grant Program. The purpose of the review was to
determine whether the Grantee's internal controls were sufficient
to achieve program objectives and safeguard program assets.
Specific objectives were to determine whether the Grantee adhered
to HUD guidelines for performing financial feasibility analyses;
documented eligibility and national objectives determinations; and,
performed follow-up monitoring to assure the program achieves the
intended public benefit in terms of jobs creation and retention.

We performed our review during March and June 1996, and covered the
period March 1, 1994 to February 28, 1996. The review was extended
to other periods when appropriate. We reviewed documentation and
interviewed staff in the HUD Philadelphia Office and at the
Grantee's Bureau of Development and Inspections. Specifically, we
reviewed   the   Grantee's  loan   underwriting   and   collections
guidelines, interviewed Grantee staff responsible for administering
the program, and reviewed seven of the 23 loans closed since
November 1990 for compliance with HUD and Grantee requirements.
The selected loans totaled $505,000, or eight percent of the total
dollar amount of loans closed during the audit period.
Visit the Office of Inspector General's World Wide Web site at http://www.hud.gov/oig/oigindex.html



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                                                SUMMARY

Based on our testing we determined that the Grantee adhered to HUD
guidelines   for   performing   financial  feasibility   analyses,
documented eligibility and national objectives determinations and
performed follow-up monitoring to assure that the loans achieved
the intended public benefits in terms of jobs created or retained.
The Grantee's controls were also adequate to achieve program
objectives for economic development activities and safeguard
related assets, except for two specific weaknesses involving loan
underwriting and servicing.

The internal control weaknesses involve the underwriting of loans
to borrowers who are or were delinquent on previous loans and the
handling of loan payments mailed to the Grantee's office, for which
we recommended that the Grantee revise its procedures in order to
strengthen controls in these areas (Attachment 1).

We discussed the draft finding with the Director of the Grantee's
Bureau of Development and Inspections at an exit conference on June
21, 1996. The Grantee provided a written response to the draft
finding on June 24, 1996 (Attachment 2).      The Director did not
disagree with the draft finding but expressed concern that it did
not fully describe the Grantee's loan underwriting and approval
process, especially the role that City Council plays in approving
each loan.    The Director was also concerned that the finding
addressed only the loans to two specific borrowers but did not
relate the overall results of our review of the Grantee's economic
development loan program.

Because the conditions cited in this memorandum require corrective
action, the finding will be controlled in accordance with HUD
Handbook 2000.6 REV-2, Audits Management System.

Within 60 days please give us, for each recommendation made in the
memorandum, a status report on: (1) the corrective action taken; or
(2) the proposed corrective action and the date to be completed; or
(3) why action is considered unnecessary. Also, please furnish us
copies of any correspondence or directives issued because of the
review.

                                              BACKGROUND

The Grantee's CDBG-funded economic development activities are
administered by the Bureau of Development and Inspections through
a program called the Fund for Revitalization and Development
(FRED). The objective of the program is to provide low interest
rate financing to businesses which create and retain employment
opportunities for low-to moderate-income residents and help enhance
the City of Reading's tax base. Loans made available through this
program have funded new construction, property acquisition,
building renovation and rehabilitation, machinery and equipment and
interim financing. Loan repayments are deposited into a revolving
fund in order to make new loans to other borrowers. Each new loan
must be presented to and approved by City Council.




                                                                 3


Since December 1982 the Grantee has made 57 FRED loans totaling
approximately $13.2 million. As of April 1996, 39 of the 57 loans
were active, nine were paid off by the borrowers and nine were
written off after the borrowers went out of business.

The City of Reading is governed by a Mayor and a seven member City
Council. The Mayor is Paul J. Angstat. The Director of the Bureau
of Development and Inspections is Ronald E. Miller. FRED program
records are located at City Hall, 815 Washington Street, Reading,
Pennsylvania.

Should you have any questions, please contact Richard J. DeCarlo,
Assistant District Inspector General for Audit, at (215) 656-3401.


Attachments

1. Finding
2. Grantee Comments
3. Distribution
                                                      Attachment 1
                                                      Page 1 of 2

Finding 1 - The Grantee Should Improve Internal Controls over Loan
            Underwriting and Servicing.

The Grantee's internal controls should be improved in order to
correct weaknesses in two specific areas involving loan
underwriting and servicing. Strengthening these controls will help
prevent loan defaults and improve accountability over loan
payments.

24   CFR   85.20(b)(3)   requires  that   effective  control   and
accountability must be maintained for all grant and subgrant cash,
real and personal property, and other assets.        Grantees and
subgrantees must adequately safeguard all such property and must
assure that it is used solely for authorized purposes.

The internal control weaknesses that we observed were as follows:

Staff Analysis of Loan Applications from Previous Borrowers Should
Be Improved.

The Grantee's staff did not give sufficient weight to evidence of
financial problems experienced by two businesses which obtained
second or third loans through the Grantee's Fund for Revitalization
and Economic Development (FRED). Although the Grantee's staff had
evidence that loan payments due from these borrowers either had
been or were currently delinquent, written staff analyses did not
adequately describe the problems causing these delinquencies or
provide reasonable explanations showing how these problems could be
overcome.   A staff memorandum that concerned one of the loan
applications for additional assistance actually noted that "there
is no thought-out business plan, nor good solid explanation on how
the funds are to be used, why revenue missed projections by 45%".

Because these two businesses were not in sound financial condition
before applying for additional financing, one went into bankruptcy
after it received a third loan from the Grantee and the other was
unable to increase sales and hire additional employees, as
promised.   In August 1995, this latter borrower agreed to an
amendment which reduced payments for a six month period on both
loans to interest plus $25 for principal on each loan, which
represented less than 10 percent of the total payments due on these
loans each month.

We realize that economic development activities are inherently
risky, since some borrowers will not be successful and loan
defaults will result.     When such borrowers either go out of
business or are unable to expand as planned, the Grantee will not
achieve the anticipated public benefits, such as the creation or
retention of a specific number of jobs.       However, evidence of
delinquency on previous loans is a strong indication that the
borrower's business is probably failing. Unless a thorough staff
analysis can show that other factors or unique circumstances caused
a borrower to miss scheduled loan payments on previous loans, or
that the granting of more assistance will reverse an unfavorable
long term trend, additional loans to already delinquent borrowers
are questionable at best.



                                                      Attachment 1
                                                      Page 2 of 2


Controls Over Loan Payments Should Be Improved.

The Grantee's fiscal officer opens mail containing loan payment
checks, while also maintaining accounting records for loans
receivable.    Information from the checks is used to update
individual loan records and prepare a five-part voucher. The
unendorsed checks and three voucher copies are then sent to the
City Treasurer's office, which endorses the checks and prepares the
bank deposits. Because loan payments are handled in this manner,
there is a potential that check lapping or some other defalcation
could occur.

A good system of internal control requires that the responsibility
for maintaining accounts or loans receivable records be separated
from the responsibility for opening mail and handling loan
payments. In this case, controls could be improved by requiring
that mail containing loan payments be sent directly to the City
Treasurer's office, where a summary listing of checks and money
orders could then be prepared and sent to the Bureau of Inspections
and Development. If this is not possible, then an employee in the
Bureau of Inspections and Development other than the fiscal officer
should open all mail and simply list the checks and money orders
before they are given to the fiscal officer.

Grantee Response

The Grantee generally agreed with the finding and recommendations,
but expressed concern that the finding did not describe the
procedures which require that staff analyze and evaluate loan
applications before they are presented, at public hearings, to City
council which must give final approval. The Grantee also noted
that the finding described problems associated with specific loans
to two borrowers but did not disclose the overall results of our
review of the Grantee's economic development loan portfolio.

Recommendations

We recommend that you direct the Grantee to:

A.   Implement procedures to assure that written staff analyses
     identify the causes for borrower delinquencies on previous
     loans, and that additional loans are not given to borrowers
     whose businesses are failing, unless they have creditable
     plans to reverse long-term unfavorable trends.

B.   Monitor the borrower cited in the finding who continues to
     operate, and periodically increase his loan payments based on
     increases in net income.
C.   Revise procedures for opening mail and updating loan records,
     to assure that these functions are performed by different
     individuals.
                                                     Attachment 3


                         Distribution


Secretary's Representative, 3AS
Internal Control & Audit Resolution Staff, 3AFI
Director, Office of Community Planning and Development, 3AD
Assistant to the Deputy Secretary for Field Management, SDF (Room
 7106)
Audit Liaison Officer, HF (Room 5132) (5)
Acquisitions Librarian, Library, AS (Room 8141)
Chief Financial Officer, F (Room 10164) (2)
Deputy Chief Financial Officer for Operations, FO (Room 10164) (2)
Associate General Counsel, Office of Assisted Housing and
 Community Development, CD (Room 8162)
Assistant Director in Charge, US GAO, 820 1st ST. NE Union Plaza,
 Bldg. 2, Suite 150, Washington, DC 20002
 Attn: Mr. Cliff Fowler
Mr. Ronald E. Miller, Director, Bureau of Development and
Inspections,   City   Hall,   815   Washington  Street,   Reading,
Pennsylvania, 19601-3690
CC: OSWALD
    CIANCI

3AGA:DECARLO:AMP:08/05/96
 Correspondence
 Code             3AGA
 Concurrence      DECARLO
 Date
                        REPORT NAME:      Community Development Block Grant Program
                                          Economic Development Activities
                                          City of Reading, Pennsylvania
                        REPORT NO:        96-PH-250-1820
                        ISSUE DATE:       August 8, 1996




                       REGIONAL OFFICE (NON-OIG)
Secretary's Representative, Mid-Atlantic, 3AS                                         1

Internal Control & Audit Resolution Staff, 3AFI                                       1

Director, Office of Community Planning and Development, 3AD                           1

                        HEADQUARTERS (NON-OIG)
Assistant to the Deputy Secretary for Field Management,                               1
SDF (Room 7106)

Audit Liaison Officer, HF (Room 5132)                                                 5

Acquisitions Librarian, Library, AS (Room 8141)                                       1

Chief Financial Officer, F (Room 10164)                                               2

Deputy Chief Financial Officer for Operations,                                        2
FO (Room 10164)

Associate General Counsel, Office of Assisted Housing and                             2
Community Development, CD (Room 8162)

                             HEADQUARTERS (OIG)

James M. Martin, Director, Research & Planning                                        1
 Division, GAP (Room 8180)

Michael R. Phelps, Acting Assistant Inspector General, GA                             1
(Room 8286)

Central Files, (Room 8254)                                                            2

Semi-Annual Report Coordinator, (Room 8254)                                           1

                       DISTRIBUTION OUTSIDE HUD

Mr. Ronald E. Miller, Director, Bureau of Development and                             1
Inspections, City Hall, 815 Washington Street,
Reading, Pennsylvania 19601-3690

Assistant Director in Charge, US GAO, 820 1st St. NE Union                             2
Plaza, Bldg. 2, Suite 150, Washington, DC 20002                                       24
Attn: Mr. Cliff Fowler

From:
Edward F. Momorella, DIGA, Mid-Atlantic
Wanamaker Building, Suite 1005
100 Penn Square East
Philadelphia, PA 19107-3380