Additionally, FHA insures 99 percent of the unpaid principal  balance plus accrued interest. HUD’s Decentralized Management Provides Field Offices Flexibility, but Varying Awareness of Underwriting and Monitoring Practices and Concerns Over Insufficient Staff Expertise Increase Program’s Potential Risks

While the decentralization of the program allows field offices some  flexibility in their specific practices, the results of our visits to five field  offices revealed differences in the extent to which field office staff were  aware of current program requirements. Further, while individual offices  had developed useful practices for implementing the program’s loan  underwriting and monitoring requirements, they lack a mechanism for  systematically sharing practices with other offices. We also found that field  office officials were concerned about adequate current or future levels of  staff expertise—a critical factor in avoiding unwarranted risk in the Section  232 program, in that health care facility loans are generally more  complicated and require specialized expertise compared with loans insured  under HUD’s other multifamily programs. FHA’s Coordination with States’ Oversight of Quality of Care for Section 232 Residential Care Facilities Is Limited

FHA requires field office officials, when processing applications for  Section 232 mortgage insurance from existing state-licensed facilities to  review the most recent annual state-administered inspection report for the  facilities, but does not require the continued monitoring of annual  inspection reports for state-licensed facilities once it has insured them. Four of the five HUD field offices we visited do not routinely collect annual  inspection reports for the insured facilities they oversee. However, program and industry trends show sources of  potential risks that could affect the future performance of the Section 232  portfolio and the GI/SRI Fund. The  Section 232 program is concentrated in several large markets and in loans  made by relatively few lenders. 5). Further, the model does not fully capture the effects on existing  loans to changes in market interest rates, and it uses proxy data that are  not comparable to the loans in the Section 232 program. HUD Uses a Model to Estimate Credit Subsidy Costs

Federal law requires HUD to estimate a credit subsidy for its loan  guarantees. HUD estimates a credit subsidy for each  loan cohort. HUD’s cash flow model does not explicitly consider differences in loan  performance between types of facilities, such as nursing homes, assisted  living facilities, and board and care facilities. Recommendations for Executive Action

To ensure that field offices are aware of and implement current  requirements and policies for the Section 232 Mortgage Insurance for  Residential Care Facilities program, and reduce risk to the GI/SRI Fund, we  recommend that the Secretary of Housing and Urban Development direct  the FHA Commissioner to take the following actions:   Revise the “Multifamily Asset Management and Project Servicing  Handbook” in a timely manner to include monitoring requirements  specific to Section 232 properties;  Establish a process for systematically sharing loan underwriting and  monitoring practices among field offices involved with the Section 232  program;  Assure, as part of the department’s strategic human capital management  efforts, sufficient levels of staff with appropriate training and expertise  for Section 232 loans;  Incorporate a review of annual inspection reports for insured Section  232 facilities that are subject to federal or state inspections, even in the  absence of a revised regulatory agreement; and   Complete and implement the revised regulatory agreements in a timely  manner. Factors potentially affecting prepayments. GAO staff who made major  contributions to this report are listed in appendix V.

Objectives, Scope, and Methodology

Our objectives were to examine (1) the Department of Housing and Urban  Development’s (HUD) overall management of the program, including loan  underwriting and monitoring; (2) the extent to which HUD’s oversight of  insured health care facilities is coordinated with the states’ oversight of the  quality of care provided by facilities; and (3) the financial implications of  the program to the General Insurance/Special Risk Insurance (GI/SRI)  Fund, including risk posed by program and market trends; and (4) how  HUD estimates the annual credit subsidy for the program, including the  factors and assumptions used. However, the proposed revisions  have been awaiting approval since August 2, 2004.
Why GAO Did This Study

Through its Section 232 program, the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) insures approximately $12.5 billion in mortgages for residential care facilities. In response to a requirement in the 2005 Consolidated Appropriations Conference Report and a congressional request, GAO examined (1) HUD's management of the program, including loan underwriting and monitoring; (2) the extent to which HUD's oversight of insured facilities is coordinated with the states' oversight of quality of care; (3) the financial risks the program poses to HUD's General Insurance/Special Risk Insurance (GI/SRI) Fund; and (4) how HUD estimates the annual credit subsidy cost for the program.

What GAO Found

While HUD's decentralized program management allows its 51 field offices flexibility in their specific practices, GAO found differences in the extent to which staff in the five field offices it visited were aware of current program requirements. For example, four offices were unaware of required addendums to the programs' standard regulatory agreement. Further, while individual offices had developed useful practices for loan underwriting and monitoring, they lacked a mechanism for systematically sharing such practices with other offices. Also, field office officials were concerned about adequate current or future levels of staff expertise--a critical factor in managing program risk in that health care facility loans are complicated and require specialized knowledge and expertise. FHA requires a review of the most recent annual state-administered inspection report for state-licensed facilities applying for program insurance, and recommends, but does not require, continued monitoring of such reports for facilities once it has insured them. Four of the five HUD field offices GAO visited do not routinely collect annual inspection reports for their insured facilities. While the reports are but one of several monitoring tools, they provide potential indicators of future financial risk. HUD has proposed revising its standard regulatory agreements to require insured facility owners or operators to submit annual inspection reports and to report notices of violations. However, the proposed revisions have been awaiting approval since August 2004, and the implementation date is uncertain. The Section 232 program accounts for only about 16 percent of the GI/SRI Fund's total unpaid principal balance, but program and industry trends pose potential risks to the Section 232 program and to the GI/SRI Fund. For example, in recent years the program has insured increasing numbers of assisted living facility loans and refinancing loans, for which there are limited data available to assess long-term performance. Other potential risk factors include increasing prepayments (full repayment before loan maturity) and loan concentration in several large markets and among relatively few lenders. Projected shifts in demand for residential care facilities could affect currently insured facilities and the overall market for the types of facilities that HUD insures under the program. To estimate the program subsidy cost, HUD uses a model to project cash flows for each loan cohort (the loans originated in a given fiscal year) over its entire life. HUD's model does not explicitly or fully consider certain factors, such as loan prepayment penalties, interest rate changes, or differences in loans to different types of facilities, and uses some proxy data that is not comparable to Section 232 loans. The model's exclusion of potentially relevant factors and it use of this proxy data could affect the reliability of HUD's credit subsidy estimates.