Report 2012-037 Summary - October 2012

Department of Housing and Community Development: Awards of Housing Bond Funds Are Appropriate, but Cash Balances Are High and Monitoring Continues to Need Improvement

HIGHLIGHTS

Our review of the activities related to the Housing and Emergency Shelter Trust Fund Acts of 2002 and 2006, which provide bonds (housing bonds), for use in financing affordable housing, highlighted the following:

RESULTS IN BRIEF

In 2002 and 2006 California voters passed the Housing and Emergency Shelter Trust Fund Acts (propositions 46 and 1C, respectively) to provide bonds (housing bonds) for use in financing affordable housing for low- to moderate-income Californians. The Department of Housing and Community Development (HCD) and the California Housing Finance Agency (CalHFA) primarily award, disburse, and monitor the housing bond funds received by various programs.

As of February 2012 HCD and CalHFA had awarded nearly all of the 2002 housing bond funds to recipients—such as low- to moderate-income individuals purchasing their first home and local entities and nonprofit corporations that construct or rehabilitate housing developments. However, for the housing bond funds authorized in 2006, although HCD and CalHFA made awards for 10 of the 13 programs in a timely fashion, we found that awards for three programs have been slow, which is generally due to circumstances surrounding the State's fiscal situation. However, both HCD and CalHFA have established and generally adhered to policies intended to ensure that only eligible applicants receive awards.

HCD, like several other state agencies and departments, has not distributed proceeds promptly from its bond sales. Specifically, HCD, which had a program fund balance of $796 million as of June 2012, requested and the Department of Finance (Finance) recommended bond sales that were in excess of HCD's cash needs at a time when California's credit rating was declining and interest-rate volatility was high. We estimate that the State paid, on average, roughly $49 million in interest annually on these excess funds while it was facing cash shortfalls. However, without these bond proceeds, the sustainability of certain housing bond programs likely would have been at risk. In particular, for most of HCD's housing bond programs, private lenders and banking institutions provide financing to sponsors, comprising entities qualified to construct or manage housing developments, for the construction of housing projects. Once the sponsor successfully completes the housing project, the sponsor uses its HCD award to assist in repaying its construction financing. Various state officials representing HCD, Finance, and the State Treasurer's Office (state treasurer) explained that key stakeholders, including private lenders and banking institutions, cited significant concerns regarding the State's ability to honor its awards given the economic crisis at the time. In fact, state officials believed that without selling bonds in excess of immediate cash needs, and thereby demonstrating to the financial institutions that the State had the ability to disburse cash to sponsors to repay construction loans, many of the housing bond programs would have been suspended, or halted altogether. When we asked HCD and Finance to provide us with documentation demonstrating the various stakeholders' concerns, or the amount of bonds Finance ultimately recommended that the state treasurer sell, they could provide only limited support and explained that they had not retained much of the documentation that existed at one time. Without such documentation, HCD and Finance are hindered in their ability to adequately respond to questions from stakeholders or members of the public regarding the need for the excess cash balance and the resulting interest the decision has cost the State. Nevertheless, our review indicated that while Finance's policy decision to sell bonds in excess of immediate cash needs may have contributed to the State's financial strain, the reasons for doing so appear to have some merit.

Although HCD and CalHFA have established procedures for monitoring the majority of sponsors' use of funds and ensuring that occupants of bond-funded housing meet eligibility requirements, HCD still needs to consistently follow monitoring procedures for sponsors that participate in certain programs. For instance, it had not fully addressed concerns we raised in our 2009 audit regarding its monitoring of sponsors in the CalHome Program during the disbursement phase—the time period between the initial awarding of funds and the final disbursement. Specifically, we raised concerns that HCD did not follow its procedures for approving bond fund advances greater than 25 percent of the total award. Although HCD stated that it would follow such procedures, which would include the logging of advances on a central tracking report, during our current review we found that it did not require staff to centrally track all funding advances, as specified in HCD's CalHome Procedure Manual. Rather, advances are tracked in the individual project files and the CalHome Program manager explained that, as of January 2011, HCD no longer makes advances greater than 25 percent. However, given that the CalHome Program has made more than 450 awards, without centrally tracking all advances, the CalHome Program could not readily identify to which sponsors, if any, it disbursed funds in excess of 25 percent prior to January 2011, nor could it readily demonstrate that it had not made advances in excess of 25 percent since that time. Additionally, in our 2009 report, we found that HCD did not always ensure that recipients submitted quarterly status reports for its CalHome and Building Equity and Growth in Neighborhoods (BEGIN) programs, as required in its regulations. HCD uses these reports, in part, to assess the performance of program activities. In our current review, we found that HCD continues to lack sufficient controls to ensure that sponsors submit quarterly status reports. As a result, HCD cannot adequately ensure that sponsors use housing bond funds only for allowable activities and to support targeted populations.

Further, we identified that HCD needs to improve its monitoring efforts during the completion phase—or the period from final payment to the completion of all contract requirements by the recipient. For instance, for one of the seven programs we reviewed—the BEGIN Program—HCD had not finalized and implemented procedures to ensure that sponsors fulfilled all contract requirements. According to the manager of the BEGIN Program, HCD has not conducted site visits due to staff limitations, travel restrictions, and a lack of on-site monitoring protocols. Nevertheless, the lack of established monitoring procedures for the completion phase of the program is surprising given that this program has been in existence for more than 10 years.

We reported in 2009 that HCD developed monitoring procedures for its projects completed under its CalHome Program by adopting a risk-based, on-site monitoring approach. However, during our current audit we found that although HCD had implemented our recommendation in early 2010, it discontinued use of the assessment for the CalHome Program because it was believed to be too subjective and ineffective in identifying high-risk sponsors. Currently, program staff judgmentally decide which sponsors warrant an on-site visit, and the program manager approves the choice. As a result, HCD lacks assurance that staff are using consistent criteria and are selecting the highest risk sponsors in determining which ones warrant an on-site visit.

RECOMMENDATIONS

Going forward, to the extent Finance or HCD believes the State needs to issue bonds in excess of cash needs, it should perform and document an analysis demonstrating the appropriateness of the bond sale amount and the circumstances.

HCD should continue its efforts to monitor sponsors that receive awards of housing bond funds by doing the following:

AGENCY COMMENTS

HCD and Finance agree with the audit report's recommendations and indicated that they are moving forward to implement them. In fact, HCD outlined steps it has already taken, or plans to take, to implement the report's recommendations. Additionally, while the audit report did not contain recommendations to CalHFA, it agreed with the report's conclusions.