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GAO-02-323R: 

United States General Accounting Office: 
Washington, DC 20548: 

February 1, 2002: 

The Honorable Marge Roukema: 
Chairwoman: 
Subcommittee on Housing and Community Opportunity: 
House of Representatives: 

Subject: Multifamily Housing Finance: Funding FHA's Subsidized Credit 
Programs: 

Dear Madam Chairwoman: 

To facilitate the construction and rehabilitation of multifamily 
rental housing, several programs administered by the Federal Housing 
Administration (FHA) provide lenders with mortgage insurance, or 
guarantees, for multifamily loans. To cover the costs of some of these 
programs (credit subsidy costs), Congress provides budget authority as 
part of FHA's budget each fiscal year.[Footnote 1] FHA estimates the 
subsidy cost of each program by calculating a credit subsidy rate that 
takes into account factors such as fees, defaults, and recoveries. FHA 
then applies this subsidy rate to the total dollar amount of mortgages 
the agency anticipates insuring under each program to estimate the 
total subsidy cost. Although the agency's programs are aimed at 
different types of projects, a single budget account covers all the 
programs. In fiscal year 2001, as in earlier years, FHA provided 
guarantees for all multifamily projects—regardless of program—on a 
first-come, first-served basis until the total budget authority for 
the multifamily programs was exhausted. FHA had obligated 
approximately $81 million of the $101 million of its credit subsidy 
budget authority for the fiscal year by April 2001 and suspended 
issuing commitments for additional loans under the multifamily 
programs requiring credit subsidy.[Footnote 2] For fiscal year 2002, 
FHA made some adjustments to the credit subsidy rates for certain 
multifamily programs. 

In response to your request, we (1) identified the reasons the subsidy 
budget authority was used earlier than expected and assessed the 
impact of FHA's suspension of its insurance programs on projects 
needing credit subsidy, (2) described how FHA estimates the dollar 
amount of the mortgages it anticipates insuring, (3) assessed the 
reasonableness of the methodology FHA used in estimating fiscal year 
2002 credit subsidy rates, and (4) described the reasons for the 
revisions to these rates for fiscal year 2002. We focused on programs 
administered under Sections 221(d)(3), 221(d)(4), and 241(a) of the 
National Housing Act because they were initially expected to require 
more subsidy budget authority than other programs in fiscal year 2001. 

Summary: 

The primary reason FHA obligated most of its fiscal year 2001 subsidy 
budget authority by April 2001 was the unexpectedly high demand—-five 
times FHA's estimate—-for mortgage insurance under the 221(d)(3) 
program.[Footnote 3] Because this program, which is limited to 
nonprofit developers and cooperatives, has a higher subsidy rate than 
other programs, the increased demand caused FHA to obligate its 
subsidy budget authority more quickly than it would have for other 
less costly programs. According to FHA officials, some of the 
unanticipated demand for the 221(d)(3) program occurred because 
developers that were essentially for-profit entities were partnering 
with nonprofits to participate in the program—developers that should 
have participated in FHA's 221(d)(4) program, which has a lower credit 
subsidy rate and is designed to serve for-profit entities. FHA has 
since taken action designed to insure that this situation does not 
happen in the future. When most of the fiscal year 2001 credit subsidy 
budget authority was obligated, FHA placed a number of multifamily 
projects on a waiting list until funding became available. Most of 
these projects were funded using the remaining budget authority and 
credit subsidy from projects approved earlier that were later 
terminated or required less subsidy than expected, according to FHA. 

According to FHA officials, the agency estimates the total dollar 
amount of mortgages it expects to insure each year under its 
multifamily insurance programs on the basis of the last year's levels. 
These estimates are then adjusted for inflation, the capacity of the 
field offices to process loan applications, and any changes or proposed
changes to the programs. The estimated total amounts of insured loans 
often differ from actual levels, reflecting both the difficulty of 
estimating future mortgage activity and the fact that FHA approves 
loans on a first-come, first-served basis. 

As part of our review of the methodology used to calculate the fiscal 
year 2002 credit subsidy rates for the 221(d)(4), 221(d)(3), and 
241(a) programs, we assessed the cash flow model used to calculate the 
subsidy rates, tested underlying historical data for key cash flow 
assumptions,[Footnote 4] and assessed the reasonableness of key cash 
flow assumption values. We found that the estimation process and types 
of data used to calculate the fiscal year 2002 credit subsidy rates 
for these programs were reasonable and complied with existing guidance 
from the Office of Management and Budget (OMB) and federal accounting 
standards. 

The fiscal year 2002 credit subsidy rate calculations for these 
programs reflect a number of changes from the fiscal year 2001 
calculations. These changes include an annual premium increase for the 
221(d)(4) program, an anticipated increase in the use of the note 
sales program to dispose of acquired 221(d)(3) loans, and a change in 
the mix of loans included in the estimation process for the 241(a) 
program. According to FHA officials, FHA is currently analyzing the 
potential impact that various changes in economic conditions and 
program design have had on loan performance and the methods FHA should 
use to estimate subsidy rates. Additional changes to future subsidy 
rate estimates may result from these analyses. 

Background: 

FHA offers multifamily mortgage insurance to facilitate the 
construction and substantial rehabilitation of multifamily rental 
housing, including for-profit, nonprofit, and cooperative projects. 
Nonprofit and cooperative sponsors apply for insured mortgages under 
Section 221(d)(3) of the National Housing Act; for-profit developers 
apply under Section 221(d)(4), the largest of FHA's multifamily 
insurance programs. The third program, Section 241(a), provides 
supplemental loan guarantees for repairs, additions, and improvements 
to multifamily rental housing and health care facilities that already 
have FHA-insured or HUD-held mortgages. 

The programs do not lend money directly; instead, they insure loans 
made by FHA-approved private lenders. Loans insured under the 
221(d)(3) and 221(d)(4) programs are unique in the industry because 
they combine construction and permanent financing. They also have the 
benefit of offering a fixed interest rate over the long term (up to 40 
years). The terms of the 221(d)(3) program are somewhat more favorable 
than those of its for-profit counterpart, permitting a maximum insured 
loan of up to the lesser of 100 percent of the project's replacement 
cost or 95 percent of net income for debt servicing. For the 221(d)(4) 
program, the maximum insured loan is limited to the lesser of 90 
percent of replacement cost or the amount that can be serviced by 90 
percent of net income. Borrowers negotiate interest rates with lenders. 

Supplemental guarantees under the 241(a) program are designed to 
extend the economic life of projects, keeping the projects 
competitive, and to finance the replacement of obsolete equipment. The 
loans may not exceed 90 percent of the estimated value of the 
improvements and additions. 

The Federal Credit Reform Act (FCRA) of 1990 requires agencies to 
estimate the long-term cost to the government of extending or 
guaranteeing credit (the subsidy cost). Agencies calculate these costs 
by multiplying the expected dollar amount of loans by that program's 
credit subsidy rate.[Footnote 5] When FHA obligates funds to insure a 
loan, this rate is used to determine the subsidy cost of insuring it. 
New FHA multifamily housing loan insurance obligations can only be 
made to the extent budget authority to cover the cost is provided in 
appropriation acts. 

The primary federal accounting standard for credit programs[Footnote 
6] generally mirrors guidelines for how agencies estimate credit 
subsidy rates under FCRA and OMB guidance, including OMB Circular A-
11, Preparation and Submission of Budget Estimates, and OMB Circular A-
34, Instructions on Budget Execution. Therefore, the subsidy cost 
included in FHA's financial statements should be based on the same 
data and process used to calculate subsidy costs for the agency's 
budget. Because the financial statements are subject to audit, this 
mirroring helps provide integrity to the budget estimates, as long as 
consistency is maintained between the processes used to estimate 
subsidy costs for both the budget and financial statements. Further 
guidance on estimating subsidy rates is provided in Technical Release 
3, Preparing and Auditing Direct Loan and Loan Guarantee Subsidies 
under the Federal Credit Reform Act (Technical Releases).[Footnote 7] 

Unexpected Demand for the 221(d)(3) Program Led to the Early Depletion 
of Multifamily Subsidies, Delaying New Lending: 

By April 2001, FHA had obligated $81 million of its $101 million 
fiscal year 2001 subsidy budget authority for projects funded under 
the General and Special Risk Insurance Program Account,[Footnote 8] 
primarily because of unexpectedly high demand for its nonprofit 
program, Section 221(d)(3).[Footnote 9] According to FHA officials, 
some of this demand consisted of loan applications from entities that 
should have been considered under FHA's Section 221(d)(4) program, 
which has a lower credit subsidy rate and is intended for for-profit 
entities. When FHA obligated most of its fiscal year 2001 budget 
authority, it placed a number of multifamily projects on a waiting 
list. 

FHA Obligated its Budget Authority Early for Multifamily Programs 
Because of a Surge in 221(d)(3) Lending: 

In fiscal year 2001, FHA insured five times the dollar amount of 
mortgages it had expected for the 221(d)(3) program—roughly $250 
million, compared with the $49 million estimate. Because the 221(d)(3) 
program had a 17.22 percent subsidy rate, FHA obligated $43 million, 
or about 40 percent of its subsidy budget authority, to insure $250 
million in loans. FHA had estimated that it would use less than 10 
percent of its subsidy budget authority for this program. In 
comparison, the 221(d)(4) program had a significantly lower subsidy 
rate of 3.35 percent, allowing FHA to insure about five times the 
amount of mortgages it insured under the 221(d)(3) program using a 
similar amount of subsidy budget authority (figure 1). 

Figure 1: FHA's Estimated and Actual Obligations for 241(a), 
221(d)(3), and 221(d)(4) Programs in Fiscal Year 2001: 

[Refer to PDF for image: vertical bar graph] 

Program: 241(a); 
Estimated: $12 million; 
Actual: $2 million. 

Program: 221(d)(3); 
Estimated: $9 million; 
Actual: $43 million. 

Program: 221(d)(4); 
Estimated: $77 million; 
Actual: $47 million. 

Source: HUD. 

[End of figure] 

FHA has traditionally approved multifamily projects for all insurance 
programs on a first-come, first-served basis. FHA officials explained 
that they do not want to be placed in the position of judging whether 
projects insured under one program should be funded before projects 
insured under a different program or to choose between projects within 
a program. The conference committee report on HUD's fiscal year 2002 
appropriation legislation[Footnote 10] specifies the level of credit 
subsidy budget authority the conferees expect each of FHA's subsidized 
multifamily insurance programs to use during fiscal year 2002. FHA 
officials say they are planning to operate under the report's 
specifications, which require the agency to obligate funds according 
to the specified limits. Under this allocation, high demand for one 
program would not affect the availability of credit subsidy budget 
authority for other programs. FHA officials stated they plan to seek 
the flexibility to make adjustments on a program-by-program basis, 
depending on actual demand. 

The unanticipated increase in demand for the 221(d)(3) program was 
fueled in part by loan applications from nonprofit borrowers that, 
according to FHA, lacked the recommended experience, working capital, 
or both. These organizations depended on for-profit entities to 
provide the lacking resources or capacity. During a July 2001 
congressional hearing, the FHA commissioner testified that some of 
these projects should have been treated as having for-profit sponsors. 
These projects, therefore, would not have qualified for mortgage 
insurance under the 221(d)(3) program, which is limited to nonprofit 
entities. 

Specifically, in February 2001 an FHA review of 18 of 24 loans insured 
during fiscal year 2001 under the 221(d)(3) program found that 
nonprofit entities with little experience in real estate development 
and low levels of capital were receiving insured loans. It reviewed 
the available documentation for these projects and questioned the 
eligibility of almost half. In nearly all of the cases it reviewed, 
FHA found that field office staff had not done any type of formal 
review. FHA officials attributed this problem in part to staff in 
field offices who lacked experience with the 221(d)(3) program. The 
FHA reviewer recommended that FHA develop more specific guidelines for 
determining eligibility. 

FHA took a number of actions to ensure that only eligible entities 
received funding under the program. In February 2001, FHA required its 
field staff to provide headquarters with information on the 
eligibility of all 221(d)(3) applications. On March 2, 2001, FHA 
required approval from headquarters before field offices could issue 
firm commitments. In May 2001, FHA issued a directive requiring field 
staff to review the relevant program handbook and guidance. However, 
FHA officials say they have no basis for taking action against the 
developers of approved projects that should have been treated as for-
profit, since the relationship between the for-profit and nonprofit 
entities was identified in the applications submitted to FHA field 
offices. 

Depletion of Funding for Multifamily Programs Delayed or Halted 
Pending Projects: 

When FHA obligated most of its fiscal year 2001 budget authority, it 
placed a number of multifamily projects on a waiting list known as the 
"queue."[Footnote 11] Between April 2001 and September 2001, it placed 
48 projects on the queue. Of these projects, 31 (65 percent) received 
funding before the end of the fiscal year, 3 were terminated, and 14 
remained on the queue at the end of the fiscal year. Of the 14 
projects that remained on the queue, 10 were 221(d)(4) projects, 
nearly all of which were approved in fiscal year 2002.[Footnote 12] 
Four projects that continued to require credit subsidy were also 
carried over to fiscal year 2002. FHA is in the process of approving 
credit subsidy requests for three, and the field office is awaiting 
the developer's acceptance of the higher annual premium before 
requesting credit subsidy for the fourth project, according to FHA. 

According to industry officials, the suspension of FHA's subsidized 
insurance programs affected their ability to finance certain projects. 
One industry official said that his company had applied for FHA 
backing for large projects but had either abandoned the projects or 
was seeking financing elsewhere. Another official noted that alternate 
financing is difficult to obtain for high-risk projects and, in some 
instances, an FHA-insured mortgage is the only source of capital for 
such projects. This official noted that FHA has become the "insurer of 
last resort" for such projects. According to industry officials, 
project sponsors may expend as much as $400,000 and spend months of 
preparation time to complete forms, develop exhibits, and meet other 
requirements. 

Several of the top originators of FHA loans expressed an unwillingness 
to begin processing loans for the FHA programs requiring subsidy 
because of the most recent suspension and the possibility of future 
suspensions. Industry officials told us that developers have an 
especially hard time dealing with the "on-again, off-again" nature of 
the multifamily insurance programs. The officials added that, because 
of uncertainty about FHA financing, some developers may not seek FHA 
mortgage insurance in the future. 

FHA Uses Prior Lending Levels to Estimate Its Future Needs: 

The process of preparing the federal budget requires that FHA submit 
estimates of the dollar amount of mortgages it anticipates insuring 
for the multifamily programs 2 years in advance. According to FHA 
officials, the estimates are based on the actual amount of loans 
insured during the most recent fiscal year and are adjusted for 
inflation and other factors, such as planned or proposed changes to 
the programs and the field staff's capacity to process loan 
applications. In 1999, for example, FHA officials said that the agency 
generated the estimated dollar amount of mortgages it expected to 
insure in fiscal year 2001, taking into account the impact of a fully 
implemented Multifamily Accelerated Processing (MAP).[Footnote 13] 
However, the estimated dollar amount of 221(d)(3) mortgages it 
expected to insure in fiscal year 2001 was the same as the actual 
amount of mortgages it insured under the program 2 years earlier, in 
fiscal year 1999. We could not verify the process used for estimating 
the dollar amount of mortgages FHA expects to insure. 

Estimates of the dollar amount of mortgages FHA expects to insure for 
each multifamily program should be viewed with caution. Industry 
representatives and FHA officials noted that forecasting the dollar 
amount of mortgages expected in a Oven year is difficult at best, 
largely because of the role of interest rates, which can significantly 
influence demand for credit and are often volatile. The forecasting 
difficulties are compounded by the narrow focus and small volumes of 
some of the programs and the need to make estimates so far in advance. 
Regardless, FHA programs operate on a demand basis—that is, loans are 
approved on a first-come, first-served basis. As a result, the 
estimated and actual dollar amounts FHA insures often diverge widely 
(fig. 2). In some years, FHA insures more loans for a particular 
program than it had estimated for the budget; in other years, it 
insures fewer. For example, in each of the last 4 years the actual 
amount of mortgages FHA insured under the 221(d)(4) program differed 
from the estimate by at least 25 percent. 

Figure 2: Estimated and Actual Dollar Amount of Mortgages Insured for 
the 221(d)(3), 221(d)(4), and the 241(a) Programs, Fiscal Years 1997-
2001: 

[Refer to PDF for image: 3 vertical bar graphs] 

New construction for apartments (nonprofit) 221(d)(3): 

Fiscal year: 1997; 
Estimated: $46 million; 
Actual: $25 million. 

Fiscal year: 1998; 
Estimated: $44 million; 
Actual: $42 million. 

Fiscal year: 1999; 
Estimated: $27 million; 
Actual: $49 million. 

Fiscal year: 2000; 
Estimated: $82 million; 
Actual: $103 million. 

Fiscal year: 2001; 
Estimated: $49 million; 
Actual: $252 million. 

New construction for apartments (for profit) 221(d)(4): 

Fiscal year: 1997; 
Estimated: $1.5 billion; 
Actual: $1.6 billion. 

Fiscal year: 1998; 
Estimated: $1.0 billion; 
Actual: $2.0 billion. 

Fiscal year: 1999; 
Estimated: $1.4 billion; 
Actual: $2.2 billion. 

Fiscal year: 2000; 
Estimated: $1.9 billion; 
Actual: $1.4 billion. 

Fiscal year: 2001; 
Estimated: $2.3 billion; 
Actual: $1.5 billion. 

Supplemental loans for apartments 241(a): 

Fiscal year: 1997; 
Estimated: $150 million; 
Actual: $92 million. 

Fiscal year: 1998; 
Estimated: $100 million; 
Actual: $24 million. 

Fiscal year: 1999; 
Estimated: $110 million; 
Actual: $51 million. 

Fiscal year: 2000; 
Estimated: $22 million; 
Actual: $29 million. 

Fiscal year: 2001
Estimated: $54 million; 
Actual: $13 million. 

Source: HUD. 

[End of figure] 

FHA's Process for Estimating Credit Subsidy Rates for Fiscal Year 2002 
Was Reasonable: 

FHA calculated the credit subsidy rates included in the fiscal year 
2002 president's budget using a cash flow model with numerous cash 
flow assumptions about future loan performance. These cash flow 
assumptions were related to premium receipts, claim payments when 
loans default, and recoveries on claims over the life of the loan 
guarantees to be obligated during fiscal year 2002. Cash flow 
assumptions were based on historical loan performance dating as far 
back as the 1960s and, in some cases, on management's informed 
opinion.[Footnote 14] As part of our review, we assessed the cash flow 
model, tested underlying historical data for key cash flow 
assumptions, and assessed the reasonableness of key cash flow 
assumption values. Based on our analysis, we found that the estimation 
process and types of data used to calculate the fiscal year 2002 
credit subsidy rates for the 221(d)(4), 221(d)(3), and 241(a) programs 
were reasonable and complied with existing OMB guidance and federal 
accounting standards. In addition, FHA used the same cash flow model 
and key cash flow assumptions for its financial statement credit 
subsidy estimates. These credit subsidy estimates and their supporting 
data were audited by FHA's independent public accountants as part of 
the fiscal year 2000 financial statement audit and were determined to 
be reasonable.[Footnote 15] 

Various Changes in Program Design and Estimation Methodology Affected 
Subsidy Rates for the Fiscal Year 2002 President's Budget: 

For each year's president's budget, agencies submit subsidy rates that 
represent current expectations of future loan performance. These rates 
can vary significantly from year to year, especially as programs or 
the methodology used to estimate subsidy rates change. The estimated 
subsidy rates in the fiscal year 2002 president's budget for the 
221(d)(4) and 221(d)(3) programs were lower than they were the year 
before, while the subsidy rate for the 241(a) program was higher. 

The rate for the 221(d)(4) program decreased from 3.35 percent in 
fiscal year 2001 to negative 0.14 percent in the fiscal year 2002 
president's budget.[Footnote 16] This decrease was caused primarily by 
a 30 basis point[Footnote 17] increase to the annual premium. Because 
the annual premium increase resulted in a negative subsidy for the 
program, credit availability for 221(d)(4) loan guarantees will not be 
constrained by available budget authority. 

The 221(d)(3) program's subsidy rate decreased from 17.22 percent in 
fiscal year 2001 to 10.30 percent in the fiscal year 2002 president's 
budget, primarily because of an increase in estimated recoveries on 
defaulted loans. According to FHA officials, estimated recoveries 
increased due to an expected resurgence of FHA's note sales program, 
which generally results in higher recovery rates than FHA's other 
recovery methods. The subsidy rate for the 221(d)(3) program in the 
fiscal year 2002 president's budget reflects management's intention to 
sell all 221(d)(3) defaulted loan guarantees through the note sales 
program. 

The 241(a) program's subsidy rate increased from 22.08 percent in 
fiscal year 2001 to 29.31 percent in the fiscal year 2002 president's 
budget, primarily because of a change in the mix of loans used to 
estimate future claim payments. The 241(a) program provides 
supplemental loan guarantees to borrowers for both multifamily rental 
housing and health care facilities. The historical loan performance of 
the program's two types of borrowers differs significantly. According 
to FHA officials, for the fiscal year 2002 president's budget, loan 
guarantees associated with the better-performing 241(a) health care 
borrowers were budgeted primarily with the Section 232 Health Care and 
Nursing Homes Program and the Section 242 Hospital Program. As a 
result, the multifamily rental housing loan guarantees, which cost 
more than those for health care, were no longer offset by the stronger 
loan performance of the health care facilities loan guarantees. This 
change increased the estimated defaults for the remaining 241(a) loan 
guarantees. 

After submitting the fiscal year 2002 president's budget, FHA 
officials decided to increase the annual premium associated with other 
multifamily programs, including the 221(d)(3) and 241(a) programs, 
also by 30 basis points. Since the increase in the annual premium is a 
change in contract terms, FCRA and OMB guidance allows for subsidy 
rates to be revised. Accordingly, FHA will commit loan guarantees 
during fiscal year 2002 at subsidy rates that are lower than those 
reflected in the president's budget. As a result, FHA will be able to 
make more loan guarantees with the budget authority provided by 
Congress. 

According to FHA officials, FHA is currently analyzing the potential 
impact that various other changes in economic conditions and program 
design, including the Tax Reform Act of 1986[Footnote 18] and changes 
in underwriting standards, may have had on loan performance and 
methods FHA should use to estimate subsidy rates. Additional changes 
to future subsidy rate estimates may result from these analyses. 

Agency Comments: 

We provided a draft of this correspondence to the Department of 
Housing and Urban Development (HUD) for its review and comment. We 
received written comments and technical suggestions on the draft 
correspondence from the Federal Housing commissioner and his staff. 
The commissioner agreed with the report's findings about the 
reasonableness of the fiscal year 2002 credit subsidy rates for FHA's 
multifamily programs. Where appropriate, we also incorporated 
technical suggestions made by HUD. 

Scope and Methodology: 

To identify the factors that led FHA to suspend its subsidized 
multifamily insurance programs and the impact on loan activity, we 
interviewed FHA officials. We also interviewed several mortgage 
bankers and industry association officials to identify the impact on 
the participants when the credit subsidy was suspended. In addition, 
we reviewed and analyzed the waiting list or "queue" that was 
generated when most of the credit subsidy budget authority was 
obligated earlier than expected in order to identify the types of 
programs, the dollar amounts requested, and the number of projects 
that were waiting for credit subsidy. We also reviewed FHA mortgagee 
letters, budget information, and HUD program information. 

To describe how FHA estimates the expected loan levels for certain 
multifamily insurance programs and FHA's process for approving 
requests for credit subsidy, we interviewed FHA program officials and 
OMB personnel. 

To determine the reasonableness of the methodology used to calculate 
the credit subsidy rates submitted with the fiscal year 2002 
president's budget for the 221(d)(4), 221(d)(3), and 241(a) programs, 
we assessed the process used to estimate credit subsidy rates, the 
cash flow model, and key cash flow assumptions used to estimate the 
credit subsidy rates. Specifically, we discussed the overall 
estimation process with FHA officials. We used work performed as part 
of FHA's annual financial statement audit after verifying that the 
same cash flow model and key cash flow assumptions were used to 
calculate the budget and financial statement estimates. We reviewed 
the work of the outside auditor that related to the estimated costs of 
FHA's credit programs as a part of the fiscal year 2000 financial 
statement audit based on criteria set forth in Technical Release 3 and 
Statement of Auditing Standards Number 57, Auditing Accounting 
Estimates. The outside auditor's procedures included, among other 
things, (1) assessing the cash flow model for mathematical accuracy, 
(2) testing historical data used as a basis for cash flow assumptions 
to determine that it was relevant and reliable, (3) verifying the 
process used to accumulate historical data and calculate cash flow 
assumptions, and (4) assessing the reasonableness of key cash flow 
assumption values. Since FHA's outside auditor assessed the 
reasonableness of key cash flow assumptions related to the multifamily 
programs that were the most material to FHA's financial statements, 
which did not include the 221(d)(3) program, we performed similar 
procedures on the 221(d)(3) program based on the same criteria. We 
also compared the process and types of data FHA used to estimate the 
credit subsidy rates to applicable OMB guidance, including OMB 
Circulars A-11 and A-34. 

We discussed the causes of changes in subsidy rates from the fiscal 
year 2001 and the fiscal year 2002 president's budgets with FHA 
officials. We obtained documentation for assumption values that 
differed between the two president's budgets. Using FHA's cash flow 
model and cash flow assumptions, we verified the explanations of 
changes in subsidy rates provided by FHA officials. 

We conducted our work in Washington, D.C. between September 2001 and 
January 2002 in accordance with generally accepted government auditing 
standards. 

As agreed with your office, unless you publicly release its contents 
earlier, we plan no further distribution of this letter until 30 days 
from its issuance date. At that time, we will send copies of this 
letter to the secretary of HUD and the director of OMB. We will make 
copies available to others on request. The report will also be 
available on the General Accounting Office's (GAO) home page at 
[hyperlink, http://www.gao.gov]. 

If you have any questions regarding this letter, please contact me; 
Mathew Scire, assistant director, at 202-512-8678; or Dan Blair, 
assistant director at 202-512-9401. This assignment was conducted 
under the direction of Sharon Pickup. Key contributors to this 
assignment were Marcia Carlsen, Emily Chalmers, Joe Hunter, Irv 
McMasters, and LaSonya Roberts. 

Sincerely yours, 

Signed by: 

Thomas J. McCool: 
Managing Director, Financial Markets and Community Investment: 

[End of section] 

Footnotes: 

[1] The credit subsidy cost is the net present value of the estimated 
long-term costs to the federal government of extending or guaranteeing 
credit, calculated over the life of the loan and excluding 
administrative costs. Budget authority is the authority provided by 
law to enter into financial obligations that will result in immediate 
or future outlays involving federal funds. The Federal Credit Reform 
Act of 1990 (Pub. L. No. 101-508) requires that the budget authority 
for the credit subsidy cost be available before FHA guarantees any 
loans. 

[2] Field offices could continue issuing FHA firm commitments for 
projects, conditioned upon the future availability of credit subsidy 
budget authority. On June 4, 2001, FHA discontinued authorizing 
commitments requiring credit subsidy. 

[3] In 3 of the last 8 fiscal years, FHA obligated the credit subsidy 
budget authority for loan guarantees earlier than expected. 

[4] The key cash flow assumptions are the assumptions that have the 
greatest impact on the credit subsidy estimate. 

[5] The credit subsidy rate is the government's estimated long-term 
cost, excluding administrative costs, as a percentage of the amount of 
loans disbursed or guaranteed. The rate is calculated on a net present 
value basis over the life of the loans guaranteed in a given fiscal 
year. 

[6] The Federal Accounting Standards Advisory Board developed the 
primary accounting standard for credit programs, Statement of Federal 
Financial Accounting Standards Number 2, Accounting for Direct Loans 
and Loan Guarantees. 

[7] The Federal Accounting Standards Advisory Board's Accounting and 
Policy Committee issued Technical Release 3 in July 1999. 

[8] FHA offers a range of insurance programs under this account, 
including multifamily, hospitals, and specialized single-family 
programs. 

[9] Of the $81 million, $12 million was used to insure loans left in 
the pipeline from fiscal year 2000. 

[10] H.R. Conf. Rep. No. 107-272 at 112 (2001). 

[11] The queue is a chronological listing of requests for credit 
subsidy and is maintained until more subsidy budget authority becomes 
available. 

[12] Section 221(d)(4) projects approved in fiscal year 2002 do not 
require credit subsidy. According to FHA officials, FHA has committed 
to insure 97 projects under this program between October 1, 2001 and 
January 24, 2002. 

[13] MAP is a standardized system that is intended to permit lenders 
to process loan applications quickly and uniformly. 

[14] Informed opinion refers to the judgment of agency staff or others 
who make subsidy estimates based on their programmatic knowledge, 
experience, or both. Informed opinion is considered an acceptable 
approach under Technical Release 3 when adequate historical data do 
not exist. 

[15] Since the president's budget is generally prepared 2 years in 
advance, credit program cost estimates for the fiscal year 2000 
financial statements and fiscal year 2002 president's budget were 
prepared during approximately the same time period and should be based 
on the same data. 

[16] A negative subsidy occurs when the subsidy costs are less than 
zero—that is, the present value of cash inflows to the government 
exceeds the present value of cash outflows. 

[17] A basis point equals .01 of 1 percent. 

[18] The Tax Reform Act of 1986, Pub. L. No. 99-514, made the tax 
treatment of rental housing less favorable. Provisions directly 
affecting real estate include changes in tax rates, capital gains 
rates, depreciation, and limitations on the deduction of losses and 
interest paid on funds borrowed to invest in real estate. Certain 
provisions of the act were retroactive in that they affected the tax 
treatment of existing investments. 

[End of section]