Finding 1151171 (2024-001)

Finding Number: 2024-001 – RESERVE FOR REPLACEMENT FUNDS Program Title: Section 8 Project Based Cluster / Project Base Rental Assistance (PBRA) Name of Federal agency: U. S. Department of Housing and Urban Development (HUD) ALN Number: 14.195 Category Material weakness Compliance requirement N. Special Tests and Provisions Criteria Pursuant to Section 2(a) of the Regulatory Agreement, the Property is required to make monthly deposits to the reserve for replacements fund as required by HUD. The owner shall establish and maintain a replacement reserve to aid in funding extraordinary maintenance and repair and replacement of capital items. The replacement reserve funds must be deposited in an interestbearing account. All earnings including interest on the reserve must be added to the reserve. All disbursements from the reserve must be as approved or directed by HUD or the state agency. An amount as required by HUD shall be deposited monthly in the reserve fund in accordance with the Regulatory Agreement or HAP contract. Condition To secure and guarantee the payment and performance under a loan agreement, the Project pledged and assigned the restricted replacement reserve account and used it as collateral to obtain the loan. We did not observe any approval from HUD for such transaction. Cause As explained by management, they currently lack sufficient cash reserves to meet the covenantrequired reserves without leveraging HUD reserves as collateral for financing. To secure additional funding, they have initiated a transfer of reserves from the HUD account to the accounts required by Puerto Rico Popular Bank. While they acknowledge that HUD has granted them authorization limited to amounts payable under the HAP (Housing Assistance Payment) Contract, they argue that in their specific case, where the mortgage has been fully paid off, compliance with HUD regarding the reserves may no longer be necessary. Effect In an event of default on the loan agreement, the lender may authorize the application of the balance in such fund to the amount due or defaulted. Questioned Cost None since Project funds has not been disbursed. Context As of December 31, 2024, the Replacement Reserve fund and the capital improvement loan payable related with the pledge had a balance of $1,195,181 and $2,853,479, respectively. On May 31, 2024, the Project, the secured party, and HUD signed a consent from HUD to assign the HAP contract as security interest by the owner to the lender for a loan. However, such document also clarifies that consent to assignment does not signify that HUD or the contract administrator has reviewed, approved, or agreed to the terms of any financing or refinancing; to any term of the loan documents; or the terms of any assignment of the HAP contract by the owner to the lender as security for the loan. The consent for the loan does not change the terms of the HAP contract in any way. It does not alter the rights and obligations of HUD and the owner under the HAP contract, including the Project's operation under the Regulatory Agreement. Repeated finding This is not a repeat finding from the immediate previous audit. Recommendation We recommend that management ensure compliance with the HAP (Housing Assistance Payment) Contract terms and the Regulatory Agreement. Specifically, the creation or transfer of any security interest in the HAP Contract should be limited to amounts payable under the HAP Contract unless explicitly approved by HUD. Any security interest assignment should be done per the terms specified in the HAP contract and the regulatory agreement. It's important to review the HAP Contract thoroughly and consult legal or financial professionals to ensure proper compliance and understanding of the terms. The HAP Contract typically outlines the specific terms and conditions under which payments are made to the property owner or manager. These terms may include the amount of the Housing Assistance Payments, the duration of the contract, and other obligations and rights of the parties involved. By limiting security interests to amounts payable under the contract, you ensure that any financing or assignment is in line with these contractual terms. Views of responsible officials and planned corrective actions The Project’s management agrees with this finding. Please refer to the corrective action plan on page 40.