[Federal Register Volume 62, Number 15 (Thursday, January 23, 1997)]
[Notices]
[Pages 3566-3581]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-1557]



[[Page 3565]]

_______________________________________________________________________

Part II





Department of Housing and Urban Development





_______________________________________________________________________



Fiscal Year 1997 Portfolio Reengineering Demonstration Program 
Guidelines; Notice

  Federal Register / Vol. 62, No. 15 / Thursday, January 23, 1997 / 
Notices  

[[Page 3566]]



DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Docket No. FR-4162-N-01]


Fiscal Year 1997 Portfolio Reengineering Demonstration Program 
Guidelines

AGENCY: Office of Assistant Secretary for Housing--Federal Housing 
Commissioner, HUD.

ACTION: Notice of Demonstration Program and Initial Guidelines.

-----------------------------------------------------------------------

SUMMARY: This Notice provides initial guidelines to implement a 
Demonstration Program authorized by the Departments of Veterans Affairs 
and Housing and Urban Development and Independent Agencies 
Appropriations Act, 1997 (Pub. L. No 104-204, 110 Stat. 2874, approved 
September 26, 1996) (``HUD FY 1997 Appropriations Act''). The 
Demonstration Program is directed at FHA-insured multifamily projects 
that have project-based Section 8 contracts with above market rents. 
The Demonstration Program is intended to explore various approaches for 
restructuring mortgages and taking other related actions in order to 
reduce the risk to the FHA insurance fund and lower subsidy costs while 
preserving housing affordability and availability.

FOR FURTHER INFORMATION CONTACT: George C. Dipman, Demonstration 
Program Coordinator, Office of Multifamily Housing, Department of 
Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 
20410-4000; Room 6106; Telephone (202) 708-3321. (This is not a toll-
free number.) Hearing or speech-impaired individuals may call 1-800-
877-8399 (Federal Information Relay Service TTY). Internet address: 
[email protected].

Supplementary Information:

I. Paperwork Reduction Act Statement

    The proposed information collection requirements contained in this 
notice have been submitted to the Office of Management and Budget (OMB) 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3501-3520). An agency may not conduct or sponsor, and a person 
is not required to respond to, a collection of information unless the 
collection displays a valid control number. The Department has 
requested emergency clearance of the collection of information 
described below:
    (1) Title of the Information collection proposal: Fiscal Year 1997 
Portfolio Reengineering Demonstration Program.
    (2) Summary of the collection of information: Each owner would 
submit to HUD, the owner's request to participate. An owner that is not 
within the jurisdiction of a Designee also may submit a request to HUD 
to proceed under the alternative processing in Section VIII.
    Thereafter, each owner would submit to HUD, a Designee, or a lender 
(under alternative processing), as appropriate, the following 
information: documents necessary to perform the underwriting; 
modifications to proposed Restructuring Commitments, and information 
relating to any appeal of a Restructuring Commitment, and evidence of 
having sent appropriate notices. The owner's must notify tenants, units 
of general local government, and, in certain cases, lenders at key 
points in the process.
    Under Designee Processing, each prospective Designee would submit 
to HUD a letter of interest together with evidence of its ability to 
meet the selection criteria (see Section VII.A.). If selected the 
Designee would submit a management plan detailing how it will carry out 
restructurings. If the Designee operates under the fee for service 
approach, it must submit to HUD, for each project, a detailed Business 
Plan containing the information specified in Section VII.B.1.a.(1) 
STAGE I. For a Designee operating under the joint venture approach, 
submissions to HUD on specific projects, in general, will be 
certifications and representations.
    Under Alternative Processing, each lender/servicer would submit to 
HUD a Business Plan detailing the terms of the restructuring proposal.
    (3) Description of the need for the information and its proposed 
use: The owner's request to participate is needed to initiate 
processing and to provide information necessary to ensure that the 
project meets statutory eligibility requirements to participate in the 
Demonstration Program. Notices to tenants, to units of general local 
government, and to lenders are intended to comply with statutory 
requirement for such notification and to obtain information that may 
provide for more informed decision making.
    (4) Description of the likely respondents, and proposed frequency 
of the response to the collection of information: Respondents will be 
(1) certain owners of FHA-insured projects that have expiring project-
based Section 8 contracts; (2) State housing finance agencies, housing 
agencies and nonprofits; and (3) FHA-approved lenders and servicers. 
The estimated number of respondents and frequency of the response is 
set out in the table in paragraph (5), below.
    (5) Estimate of the total reporting and recordkeeping burden that 
will result from the collection of information:

----------------------------------------------------------------------------------------------------------------
                                                Responses      Total                                            
     Information Collection        Number of       per         Annual     Hours per     Total       Guideline   
                                  respondents   respondent   responses     response     hours       reference   
----------------------------------------------------------------------------------------------------------------
Owner's request to participate..          275            1          275           .5        137  VI.A.          
Owner's notice to tenants, local          275            3          725          1.0        725  VI.D.          
 governments, and lenders of                                                                                    
 intent to participate.                                                                                         
Owner-supplied information                275            3          725          2.0      1,450  VI.F.          
 relating to underwriting.                                                                                      
Owner's summary to tenants,               275            3          725          1.5      1,088  V.H.           
 local governments, and lenders                                                                                 
 of Restructuring Commitment.                                                                                   
Owner's request to modify                 100            1          100          1.0        100  VI.I.          
 Restructuring Commitment.                                                                                      
Owner's summary to tenants,               100            3          300         2.75        825  VI.K.          
 local governments, and lenders                                                                                 
 of substantial modifications to                                                                                
 Restructuring Commitment.                                                                                      
Owner's notice to HUD of appeal           100            1          100          1.0        100  V.L.           
 of Restructuring Commitment.                                                                                   
Owner's summary to tenants,               100            3          300          1.0        300  V.L.           
 local governments, and lenders                                                                                 
 of the appeal of Restructuring                                                                                 
 Commitment.                                                                                                    
Letter of interest to                      25            1           25          1.0         25  V.II.A.        
 participate as a Designee.                                                                                     
Information to demonstrate                 25            1           25          2.0         50  V.II.A.        
 qualification as Designee.                                                                                     
Designee Management Plan........           25            1           25          8.0        200  VII.A.         
Designee Business Plan..........           25            1           25         40.0      1,000  VII.B.I.       
Lender/Servicer Business Plan...           75            1           75         40.0      3,000  VIII.          
                                 -------------------------------------------------------------------------------

[[Page 3567]]

                                                                                                                
Total annual burden.............  ...........  ...........  ...........  ...........      9,000  ...............
----------------------------------------------------------------------------------------------------------------

    In accordance with 5 CFR 1320.8(d)(1), the Department is soliciting 
comments from members of the public and affected agencies concerning 
the proposed collection of information to:
    (1) Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information will have practical utility;
    (2) Evaluate the accuracy of the agency's estimate of the burden of 
the proposed collection of information;
    (3) Enhance the quality, utility, and clarity of the information to 
be collected; and
    (4) Minimize the burden of the collection of information on those 
who are to respond; including through the use of appropriate automated 
collection techniques or other forms of information technology, e.g., 
permitting electronic submission of responses.
    Interested persons are invited to submit comments regarding the 
information collection requirements in this proposal. Comments must be 
received within seven (7) days from the date of this proposal. Comments 
must refer to the proposal by name and docket number (FR-4162) and must 
be sent to: Joseph F. Lackey, Jr., HUD Desk Officer, Office of 
Management and Budget, New Executive Office Building, Washington, DC 
20503.

II. Introduction

A. Background

    Over 800,000 housing units in approximately 8,500 projects have 
been financed with FHA-insured loans and supported by project-based 
Section 8 housing assistance payment (HAP) contracts. In many cases, 
these HAP contracts currently provide for rents which substantially 
exceed the rents received by comparable unassisted units in the local 
market. Starting in Fiscal Year (``FY'') 1996, those Section 8 
contracts began to expire, and Congress and the Administration provided 
one-year extensions of expiring contracts at a cost of over $200 
million. While annual HAP contract extensions for these projects 
maintain an important housing resource, they come at great expense. 
Every year more contracts expire, compounding the cost of annual 
extensions. In ten years, the annual cost of renewing Section 8 
contracts rises to approximately $7 billion, about one-third of HUD's 
current budget. If, however, the Section 8 assistance is reduced or 
eliminated, there is an increased likelihood that these projects will 
be unable to continue to meet their financial obligations including 
operating expenses, debt service payments, current and future capital 
needs.
    The FY 1997 renewal authority limits renewals of most Section 8 
project-based assistance contracts expiring in FY 1997 to 120% of Fair 
Market Rents and authorizes participation in an optional Demonstration 
Program by owners with properties that have FHA-insured mortgages whose 
rents are subject to the required reduction. The Demonstration Program 
will explore approaches to restructuring the debt secured by these 
properties while minimizing adverse impacts on tenants, owners and 
communities.
    These Program Guidelines describe the authority given to HUD under 
the Demonstration Program and explain how HUD plans to implement the 
Program. As the Department works with owners on restructuring project 
loans and as questions arise from affected parties, HUD may 
periodically provide additions and clarifications to these Guidelines.

B. Legislative Authority

    The Section 8 Contract Renewal Authority and this Portfolio 
Reengineering Demonstration Program are authorized by sections 211 and 
212, respectively, of the Departments of Veterans Affairs and Housing 
and Urban Development, and Independent Agencies Appropriations Act, 
1997 (Pub. L. 104-204, 110 Stat. 2874, approved September 26, 1996) 
(``HUD FY 1997 Appropriations Act'').
    Section 212 also repealed the demonstration program authorized by 
section 210 of Departments of Veteran Affairs and Housing and Urban 
Development, and Independent Agencies Appropriations Act, 1996 (110 
Stat. 1321) (``HUD FY 96 Appropriations Act''). Amounts made available 
under section 210, however, remain available through FY 1997 and the FY 
1997 Demonstration Program does not nullify any agreements or proposals 
that have been considered under the FY 1996 Demonstration Program. 
Proposals submitted under the FY 1996 Demonstration Program that were 
received by the Department prior to September 25, 1996 will continue to 
be processed by HUD. The Department is implementing the FY 1996 
Demonstration Program under notices published at 61 FR 34664, July 2, 
1996 and 61 FR 28757, July 25, 1996.

C. Outline of Notice

    The remaining sections of the Guidelines provide the following 
information:
    Section III. explains section 211 of the HUD FY 1997 Appropriations 
Act regarding renewals of up to one year for Section 8 contracts 
expiring during FY 1997 as they relate to the Demonstration Program.
    Section IV. provides an overview of the goals of the Demonstration 
Program provided for in section 212 of the HUD FY 1997 Appropriations 
Act, clarifies eligible and ineligible projects and gives specific 
substantive guidance on restructuring.
    Section V. discusses additional Demonstration Matters, such as, 
required consents, additional restructuring tools, and others.
    Section VI. sets forth the procedures which owners seeking to 
participate in the Demonstration Program will be required to follow and 
explains HUD processing.
    Section VII. provides guidance relating to the anticipated use of 
Designees in the Demonstration Program.
    Section VIII. provides guidance on Alternative Processing by 
lenders making new loans and by mortgagees or loan servicers where the 
existing FHA-insured loan is retained.
    Section IX. addresses other provisions of the Demonstration Program 
legislation such as participation of projects with post-FY 1997 
expirations and sunshine provisions.
    Section X. contains HUD's findings and certifications.
    The following is a table of contents for these Program Guidelines:

Table of Contents

I. PAPERWORK REDUCTION ACT STATEMENT
II. INTRODUCTION
    A. BACKGROUND
    B. LEGISLATIVE AUTHORITY
    C. OUTLINE OF NOTICE
III. SECTION 8 RENEWAL AUTHORITY

[[Page 3568]]

    A. SUMMARY OF SECTION 211 AS IT RELATES TO THE DEMONSTRATION 
PROGRAM
    B. RENEWALS OF SECTION 8 CONTRACTS WITH RENTS CURRENTLY ABOVE 
120% OF FAIR MARKET RENTS (FMR)
IV. DEMONSTRATION PROGRAM
    A. PURPOSE/GOALS
    B. ELIGIBLE PROJECTS
    1. General Eligibility
    2. Projects with Mix of Assisted and Unassisted Units
    3. Projects with Multiple Section 8 Contracts
    4. Projects with Public Financing
    C. INELIGIBLE PROJECTS
    1. Projects without FHA-Insured Loans
    2. Projects that Fail to Meet HQS Standards
    3. Disqualified Owners
    D. TRANSFER OF PROJECTS DISQUALIFIED FROM THE DEMONSTRATION 
PROGRAM
    E. DEMONSTRATION APPROACHES/UNDERWRITING
    1. Mandatory Demonstration Approaches
    a. Mortgage Restructuring
    (1) Supportable First Mortgage Loan
    (2) Second Mortgage Loan
    (3) Use of Net Cash Flow
    (4) Funding Rehabilitation Costs
    b. Debt Forgiveness
    (1) Amount of Debt Forgiveness
    (a) Statutory Maximum Amount of Debt Forgiveness
    (b) Formula for Computation of Debt Forgiveness Subject to 
Statutory Maximum
    (2) Use of Net Cash Flow
    (3) Funding of Rehabilitation Costs
    c. Budget-Based Rents
    (1) Application of Budget-Basing
    (2) Preference for Unique Projects
    (3) Calculation of Budget-Based Rents
    (4) Funding of Rehabilitation Costs
    2. Project Underwriting
    a. Purpose
    b. Method
    (1) Determination of Adjusted Net Operating Income
    (a) Estimation of Income
    (b) Estimation of Expenses
    (c) Determining the Level of Required Physical Improvements
    (d) Determination of Net Operating Income
    (2) Owner's Distribution from Net Cash Flow
V. ADDITIONAL DEMONSTRATION PROGRAM MATTERS
    A. REQUIRED CONSENTS
    B. ADDITIONAL RESTRUCTURING TOOLS
    1. Full or Partial Prepayment
    2. Sale or Transfer of HUD's Economic Interest
    3. Credit Enhancement
    4. Tenant-Based Section 8
    5. Removal of Restrictions
    6. Use of Accumulated Residual Receipts
    7. Payments by HUD
    C. STRUCTURES TO ADDRESS TAX LIABILITY
    D. SOURCES AND USES OF FUNDS UNDER THE DEMONSTRATION PROGRAM
    1. Sources of Funds
    2. Uses of Funds
    E. AFFORDABILITY REQUIREMENTS.
    1. Projects with Renewed or New HAP Contracts.
    2. Projects without Renewed or New HAP Contracts
    3. Long-Term Project Affordability
    4. Affordability Waiver Authority for Designees
    F. TENANT PROTECTIONS
    G. FUNDING AND UNIT LIMITATIONS
    H. TRANSFER OF PROJECTS
VI. DEMONSTRATION PROCESS
    A. OWNER'S REQUEST TO PARTICIPATE
    B. DEMONSTRATION AGREEMENT
    C. EXECUTION OF DEMONSTRATION AGREEMENT
    D. DELIVERY OF NOTICE TO PROJECT TENANTS, AFFECTED UNIT OF LOCAL 
GOVERNMENT AND LENDER(S)
    E. ASSIGNMENT OF RESTRUCTURING RESPONSIBILITY
    F. DUE DILIGENCE PERIOD
    1. Pre-Restructuring Conference with Owner
    2. Pre-Inspection Meeting at Project
    3. Due Diligence/Underwriting
    G. PREPARATION OF HUD'S RESTRUCTURING COMMITMENT
    H. NOTIFICATION OF PROJECT TENANTS, AFFECTED UNIT OF LOCAL 
GOVERNMENT AND PROJECT LENDER(S)
    I. OWNER RESPONSE TO HUD'S RESTRUCTURING COMMITMENT
    J. MODIFICATION OF RESTRUCTURING COMMITMENT
    K. ISSUANCE OF RESTRUCTURING COMMITMENT AFTER MODIFICATION
    L. OWNER APPEAL OF RESTRUCTURING COMMITMENT (IF APPLICABLE)
    M. CLOSING THE RESTRUCTURING TRANSACTION
VII. DESIGNEE SELECTION AND PROCESSING
    A. SELECTION CRITERIA TO DETERMINE QUALIFIED DESIGNEES
    B. ALTERNATIVE APPROACHES FOR DESIGNEE PARTICIPATION IN THE 
DEMONSTRATION PROGRAM
    1. Fee for Service With Performance Incentive
    a. Compensation Structure
    (1) Base Fee
    (2) Bonus Fee
    b. Processing
    2. Joint Venture Approach
    a. Compensation Structure
    b. Process
VIII. ALTERNATIVE PROCESSING
IX. OTHER PROVISIONS OF DEMONSTRATION PROGRAM LEGISLATION
    A. PARTICIPATION OF PROJECTS WITH POST-FY 1997 EXPIRATIONS
    B. SUNSHINE PROVISION
X. HUD FINDINGS AND CERTIFICATIONS
    A. ENVIRONMENTAL IMPACT
    B. EXECUTIVE ORDER 12612, FEDERALISM
    C. EXECUTIVE ORDER 12606, THE FAMILY

III. Section 8 Renewal Authority

A. Summary of Section 211 as It Relates to the Demonstration Program

    The Section 8 renewal authority and its implementation are fully 
described in Housing Notice H 96-89, dated October 15, 1996. The 
renewal authority, as it relates to the Demonstration Program, is 
summarized below.
    The FY 1997 renewal authority limits HAP contract renewals of most 
Section 8 project-based assistance contracts expiring in FY 1997 to 
120% of Fair Market Rents and authorizes participation in an optional 
Demonstration Program by owners with properties that have FHA-insured 
mortgages whose rents are subject to the required reduction. The 
Demonstration Program will explore approaches to restructuring the debt 
secured by these properties while creating the least disruption to 
tenants, owners and communities.

B. Renewals of Section 8 Contracts With Rents Currently Above 120% of 
Fair Market Rents (FMR)

    In general, owners of FHA-insured multifamily projects with Section 
8 contracts that expire in FY 1997 and whose rents in the aggregate 
exceed 120% of FMR, have two options for continuing in the Section 8 
program:
    (1) They can request that the contract be renewed for one year at 
gross rents, in the aggregate, not to exceed 120% of FMR; or
    (2) They can participate in the Demonstration Program.
    ``FMR'' are the Fair Market Rents (FMR) for the Section 8 Housing 
Assistance Payments Program. They are provided for specific geographic 
areas of the country, for dwelling units of varying sizes and are 
published in the Federal Register at least annually.
    ``In the aggregate'' means that the comparison of Section 8 rent to 
FMR is examined not unit-by-unit but for the Section 8-assisted units 
for the project as a whole. Specifically, the total rent revenue at 
100% occupancy for the Section 8-assisted units in the project using 
current gross rents (contract rents plus the utility allowance, if 
applicable) must exceed the total rent revenue at 100% occupancy for 
the Section 8-assisted units in the project using 120% of the FMR for 
each unit.
    Owners who choose Option (1) should refer to Housing Notice H 96-89 
dated October 15, 1996, which describes in detail the terms under which 
HUD will provide one-year extensions for expiring Section 8 contracts 
and to the memorandum from Assistant Secretary

[[Page 3569]]

for Housing--Federal Housing Commissioner dated November 1, 1996, 
entitled ``Clarifications of Procedures for Project-Based Section 8 
Contracts Expiring in Fiscal Year 1997.''
    Owners who select Option (2) should refer to the discussion in 
Sections IV. to IX. for further guidance.

IV. Demonstration Program

A. Purpose/Goals

    The purpose of the Demonstration Program is to test approaches that 
retain the critical affordable housing resource represented by the 
supply of FHA-insured Section 8 assisted housing and maintain it in 
good physical and financial condition, while at the same time reducing 
the cost of the ongoing Federal subsidy. In carrying out the 
Demonstration Program, HUD will work with willing owners and lenders to 
reduce both Section 8 rents and operating expenses to true market 
levels, and also provide for the project's capital improvement needs.
    The Demonstration Program will attempt to minimize involuntary 
displacement of tenants, adverse tax consequences to owners, and 
adverse effects on neighborhoods and communities, to maintain existing 
affordable housing stock in a decent, safe, and sanitary condition, and 
to encourage responsible ownership and management of property, in the 
least costly fashion. In determining how best to restructure a project, 
HUD and the owner will look for ways to balance these competing goals.

B. Eligible Projects

1. General Eligibility
    For a project to be eligible for the Demonstration Program, the 
owners must agree to participate. The projects must be subject to an 
FHA-insured mortgage and supported by project-based Section 8 HAP 
contracts with rent levels which, in the aggregate, exceed 120% of FMR. 
Preference will be given to projects with contracts expiring in FY 
1997.
2. Projects with Mix of Assisted and Unassisted Units
    A project will be eligible for the Demonstration Program regardless 
of whether all or only some of the units in the project are covered by 
a project-based Section 8 HAP contract.
3. Projects with Multiple Section 8 Contracts
    A project with multiple Section 8 contracts, one or more of which 
expires in FY 1997 and meets the requirements for the Demonstration 
Program, is eligible to participate in the Demonstration Program, and 
will also be given preference over other projects whose contracts 
expire after FY 1997.
4. Projects with Public Financing
    A project with primary financing that was provided by a public 
agency and is FHA-insured and that has a HAP contract expiring in FY 
1997 is eligible to participate in the Demonstration Program with the 
consent of the appropriate Housing Finance Agency and the owner.

C. Ineligible Projects

1. Projects without FHA-Insured Loans
    A project that does not have an FHA-insured loan will not be 
eligible to participate in the Demonstration Program. Some examples 
include: (i) A project whose FHA-insured loan has been assigned to HUD 
(ii) a project that is HUD-owned, (iii) a project financed solely with 
conventional financing, or (iv) a project with a direct HUD loan.
2. Projects that Fail to Meet HQS Standards
    A project that is otherwise eligible to participate in the 
Demonstration Program will be deemed ineligible if the project contains 
units which fail to meet Housing Quality Standards (HQS) at contract 
expiration and the owner has received adequate notice thereof and has 
been given the opportunity to cure HQS deficiencies in accordance with 
Chapter 6 of HUD Handbook 4350.1, Multifamily Asset Management and 
Project Servicing.
3. Disqualified Owners
    HUD also will not permit the owner to participate in the 
Demonstration Program if HUD determines that the owner of the 
multifamily housing project has engaged in materially adverse financial 
or managerial actions or omissions with regard to the project (or with 
regard to other similar projects if HUD determines that such actions or 
omissions constitute a pattern of mismanagement that would warrant 
suspension or debarment by HUD). Material adverse financial actions or 
omissions are any action or omission which lead to either owner default 
(monetary or technical), or a violation of one or more of the 
contractual obligations under the project's Regulatory Agreement or 
Section 8 HAP Contract. Violations may include, but are not limited to, 
submission of false statements or certifications to HUD, diversion of 
project funds, unauthorized distributions, and documented project 
mismanagement. HUD may renew the contract of a disqualified owner if 
the project is sold to a qualified purchaser.

D. Transfer of Projects Disqualified From the Demonstration Program

    When an owner or purchaser that is ineligible for the Demonstration 
Program for reasons described in Section IV.C. 2. and 3. wishes to 
voluntarily sell or transfer the property, the procedures that should 
be followed to facilitate the voluntary sale or transfer are described 
in Section V.H. To facilitate a transfer to a qualified purchaser, HUD 
may renew and transfer assistance that has not been renewed in the case 
of disqualified projects.

E. Demonstration Approaches/Underwriting

    This section sets forth the approaches by which projects in the 
Demonstration Program will be restructured and describes the 
underwriting procedures to be employed.
1. Mandatory Demonstration Approaches
    Under the Demonstration Program, HUD must utilize one or more of 
the following demonstration approaches (the ``Mandatory Demonstration 
Approaches'') with respect to each eligible project: (a) Mortgage 
Restructuring, (b) Debt Forgiveness, or (c) Budget-Based Rents. Other 
demonstration actions may be used with one or more of the Mandatory 
Demonstration Approaches.
    HUD will determine which of the Mandatory Demonstration Approaches 
is appropriate based upon, among other things, a calculation of the 
adjusted, i.e., market-based, net operating income (``NOI'') generated 
by the applicable project. In those cases in which the NOI is positive, 
the Mortgage Restructuring or Debt Forgiveness approaches generally 
will be used. If the NOI is negative, the Budget-Based Rents approach 
generally will be used.
    Further, HUD will determine what constitutes the Supportable Debt 
by applying a 1.10 or greater debt service coverage ratio, at the 
interest rate and term approved by HUD, to the adjusted NOI. HUD may 
require that the term and/or interest rate on the first mortgage loan 
be modified, subject to the consent of the mortgagee.
    The Supportable Debt may be adjusted, as necessary, to provide the 
minimum Owner's Distribution, as described in Sections IV.E.1.a.(3) and 
IV.E.1.b.(2), and/or to accommodate the payment of debt service on a 
rehabilitation loan. The Supportable Debt may, at HUD's option, also be 
adjusted if the security for the existing

[[Page 3570]]

FHA-insured loan includes vacant land or other non-income producing 
assets with additional market value.
    a. Mortgage Restructuring. Under the Mortgage Restructuring 
approach, the existing FHA-insured mortgage loan is divided into two 
parts: (i) A performing first mortgage loan, and (ii) a second mortgage 
loan payable out of Net Cash Flow.
    In most instances, the Mortgage Restructuring shall be accomplished 
by a partial or full prepayment of the existing FHA-insured mortgage 
loan.
    (1) Supportable First Mortgage Loan. The amount of the unpaid 
principal balance (``UPB'') of the supportable first mortgage loan 
after restructuring shall equal the Supportable Debt. The term 
Restructured First Mortgage as defined in this section is meant to be 
used only as a means of sizing the Second Mortgage Loan. It is not to 
be confused with the Supportable Debt, which is the amount of the 
adjusted, performing first mortgage loan. The Restructured First 
Mortgage Loan shall equal the Supportable Debt plus (i) All 
contributions made by the owner (and the owner's partners/investors) in 
connection with the restructuring, as determined by HUD, and (ii) all 
excess funds in the project's reserve for replacement account, and 
(iii) all funds in the project's residual receipts account and any 
other escrows and reserves, as determined by HUD, minus (ii) the 
rehabilitation costs approved by HUD, and (iii) the transaction costs 
approved by HUD.
    (2) Second Mortgage Loan. Unless otherwise required by HUD, the 
initial unpaid principal balance of the second mortgage loan will 
equal:
    (a) The outstanding balance of the existing FHA-insured mortgage 
loans(s); minus
    (b) The amount of the Restructured First Mortgage. Unless otherwise 
required by HUD, the second mortgage loan will bear interest at a rate 
not to exceed the long term applicable Federal rate, as set forth 
pursuant to section 1274(d) of the Internal Revenue Code of 1986 (26 
U.S.C. 1274(d)). Principal and interest on the second mortgage loan 
will be payable out of Net Cash Flow (discussed below), and unpaid 
interest will accrue. The second mortgage loan will be due upon the 
sale of the project or the refinancing of the first mortgage loan. 
Other terms and conditions of the second mortgage loan will be 
established in the restructuring process. HUD may, at its option, 
forgive, extend, or allow the assumption of all or a part of the second 
mortgage loan.
    (3) Use of Net Cash Flow. For purposes of the Mortgage 
Restructuring approach, ``Net Cash Flow'' means that portion of the NOI 
that remains after the payment of all required debt service payments on 
the first mortgage loan. Net Cash Flow shall be applied as follows: 
First, to payment to the holder of the first mortgage loan of any past 
due principal or interest, and required escrows and reserves, on such 
mortgage loan; second, to the extent of the remaining Net Cash Flow and 
after the owner has met the maintenance standards required by HUD, to 
payment to the owner of an annual owner's distribution of up to $25 per 
unit per month (the ``Owner's Distribution'') and, if applicable, to 
payment of an additional equity distribution to the owner equal to a 
cumulative 10% on any new cash equity invested by the owner in the 
project (the ``New Equity Distribution'') (Note: the proceeds from the 
sale of low-income housing tax credits (``LIHTCs''), and the balances 
of any residual receipts accounts and capital reserves, are excluded 
from consideration for purposes of determining the amount of the New 
Equity Distribution); and third, to the extent of the remaining Net 
Cash Flow, to be distributed equally between the owner and HUD. In the 
event of new equity investment by the owner in connection with a 
restructuring, HUD may waive some or all of the distribution of cash 
flow to HUD.
    (4) Funding Rehabilitation Costs. Rehabilitation costs will be 
financed with funds available in the project's residual receipts 
account and excess funds in the project's reserve for replacements 
account, as of the date of the Mortgage Restructuring. (Use of excess 
funds in the reserve account will be determined by the Demonstration 
Manager and will be net of funds required for the initial deposit to 
that account.) If rehabilitation costs exceed the amount of such 
available funds, the rehabilitation costs may be funded by (1) a 
contribution of cash equity from the owner's partners/investors, (2) 
the proceeds of a non-FHA-insured rehabilitation loan, and/or (3) to 
the extent that other sources of funds are unavailable, through a loan 
or grant from HUD.
    b. Debt Forgiveness. The Debt Forgiveness approach will be used, 
for good cause and upon request by the owner, to forgive a certain 
portion of the outstanding balance of an existing FHA-insured loan. 
This approach shall be accomplished through a partial or full 
prepayment of the existing FHA-insured mortgage loan. Under this 
approach, the owner may choose to keep the reduced FHA-insured mortgage 
loan in place, or refinance such loan with new debt and/or new equity. 
HUD will consider the owner's proposals that address how the forgiven 
debt shall be treated.
    (1) Amount of Debt Forgiveness. The amount of the debt that will be 
forgiven pursuant to the Debt Forgiveness Approach is equal to the 
lesser of (a) the maximum amount of debt forgiveness authorized under 
the 1997 Appropriations Act, as described in Section IV.E.1.b.(1) (a), 
and (b) the amount of debt forgiveness computed under the formula 
described in paragraph (b), below, of this Section IV.E.1.b.(1).
    (a) Statutory Maximum Amount of Debt Forgiveness. Under the HUD FY 
1997 Appropriations Act, the maximum amount of debt forgiveness is 
limited to that portion of the existing FHA-insured debt that exceeds 
the ``market value'' of the applicable project. The project's ``market 
value'' will be determined based upon an appraisal of the project's as-
is value prepared in accordance with the Uniform Standards of 
Professional Appraisal Practice (USPAP). The appraisal will take into 
consideration, among other factors, the current market rents for 
unsubsidized units in the local market area, the project's current 
operating expenses, any necessary reserves for long term capital 
replacements, any necessary rehabilitation costs (see Section 
IV.E.2.b.(1)(c)), and any anticipated costs relating to the transition 
of the project to market rents.
    (b) Formula for Computation of Debt Forgiveness Subject to 
Statutory Maximum. (i) If the FHA-insured mortgage loan will be 
refinanced with non-FHA-insured financing, the amount of debt 
forgiveness under this formula, unless otherwise required by HUD, will 
be:
    (1) The sum of (a) the outstanding balance of the existing FHA-
insured mortgage loan(s), (b) the rehabilitation costs approved by HUD, 
and (c) the transaction costs approved by HUD; minus.
    (2) The sum of (a) the UPB of any new financing(s) approved by HUD, 
(b) all contributions made by the owner (and the owner's partners/
investors) in connection with the restructuring, as determined by HUD, 
and (c) all excess funds in the project's reserve for replacement 
account, all funds in the project's residual receipts account, and any 
other escrows and reserves, as determined by HUD.
    (ii) If the FHA-insured mortgage loan is retained or refinanced 
with another FHA-insured loan, the amount of debt forgiveness under 
this formula, unless otherwise required by HUD, will equal:

[[Page 3571]]

    (1) The sum of (a) the outstanding balance of the existing FHA-
insured mortgage loan(s), (b) the rehabilitation costs approved by HUD, 
and (c) the transaction costs approved by HUD; minus
    (2) The sum of (a) the Supportable Debt (if the existing FHA-
insured loan is retained) or the UPB of the new FHA-insured 
financing(s), (b) all contributions made by the owner (and the owner's 
partners/investors) in connection with the restructuring, as determined 
by HUD, and (c) all excess funds in the project's reserve for 
replacement account, all funds in the project's residual receipts 
account, and any other escrows and reserves, as determined by HUD.
    The formula for computing the amount of debt forgiveness may be 
further adjusted, at HUD's option, if the security for the existing 
FHA-insured loan includes vacant land or other non-income producing 
assets with additional market value.
    (2) Use of Net Cash Flow. For purposes of the Debt Forgiveness 
approach, ``Net Cash Flow'' means that portion of the NOI that remains 
after the payment of all required debt service payments on the first 
mortgage loan and on the subordinate loan(s), if any. Net Cash Flow 
shall be applied as follows: First, to payment to the holder of the 
first mortgage loan and of any subordinate loans of any past due 
principal or interest, and required escrows and reserves, on such 
mortgage loan; second, to the extent of the remaining Net Cash Flow and 
after the owner has met the maintenance standards required by HUD, to 
payment to the owner of an annual owner's distribution of up to $25 per 
unit per month (the ``Owner's Distribution'') and, if applicable, to 
payment of an additional equity distribution to the owner equal to a 
cumulative 10% on any new cash equity invested by the owner in the 
project (the ``New Equity Distribution'') (Note: the proceeds from the 
sale of low-income housing tax credits (``LIHTCs''), and the balances 
of any residual receipts accounts and capital reserves, are excluded 
from consideration for purposes of determining the amount of the New 
Equity Distribution); and third, to the extent of the remaining Net 
Cash Flow, to be distributed equally between the owner and HUD. In the 
event of new equity investment by the owner in connection with a 
restructuring, HUD may waive some or all of the distribution of cash 
flow to HUD.
    (3) Funding of Rehabilitation Costs. If the FHA-insured mortgage 
loan will be refinanced with non-FHA-insured financing, the HUD 
approved rehabilitation costs will be financed with funds available in 
the project's residual receipts account and excess funds in the 
project's reserve for replacements account, as of the date of the Debt 
Forgiveness. If the rehabilitation costs exceed the amount of such 
funds, the rehabilitation costs may be funded by (a) a contribution of 
cash equity from the owner's partners/investors, and/or (b) the 
proceeds of the non-FHA-insured refinancing loan, and (c) to the extent 
that other sources of funds are unavailable, through a loan or grant 
from HUD.
    If the FHA-insured mortgage loan is retained or refinanced with 
another FHA-insured loan, the HUD approved rehabilitation costs will be 
financed with funds available in the project's residual receipts 
account and excess funds in the project's reserve for replacements 
account, as of the date of the Debt Forgiveness. If the rehabilitation 
costs exceed the amount of such funds, the rehabilitation costs may be 
funded by (1) a contribution of cash equity from the owner's partners/
investors, (2) the proceeds of a non-FHA-insured rehabilitation loan, 
(3) the proceeds of an FHA-insured rehabilitation loan, and/or (4) to 
the extent that other sources of funds are unavailable, through a loan 
or grant from HUD.
    For owners who want to refinance the original FHA-insured loan, 
mortgage insurance from the following FHA programs may be provided:
    (a) Section 223(f), acquisition and refinance with limited 
renovations--loan to value limit of 85 percent; or
    (b) Section 223(a)(7), refinance of an insured loan to lower the 
interest rate and to fund rehabilitation costs--loan limit is up to the 
original insured principal amount.
    c. Budget-Based Rents. The Budget-Based Rents approach will be 
used, in limited circumstances, to renew HAP contracts expiring in FY 
1997 for a period of up to one year at budget-based rents not to exceed 
the rent levels in the expiring HAP contract.
    (1) Application of Budget-Basing. The Budget-Based Rents approach 
is intended for projects in which the application of Mortgage 
Restructuring or Debt Forgiveness alone is infeasible. It is 
anticipated that the Budget-Based Rents approach will be used for the 
following types of projects:
    (a) If the project has a negative adjusted NOI, that is, the 
adjustment of rents to market levels would not enable the project to 
pay its reasonable and necessary operating expenses. Reasonable 
operating expenses, for these purposes, will not include the Owner's 
Distribution or New Equity Distribution.
    (b) If the project's market rents are higher than both 120% of the 
applicable FMRs and the gross rents (HAP contract rents plus any 
applicable utility allowance amounts), and restructuring may result in 
the displacement of tenants.
    (2) Preference for Unique Projects. HUD may give a preference to 
processing under the Budget-Based Rents approach to certain unique 
projects, such as those designated for occupancy by elderly families 
and those located in rural areas.
    (3) Calculation of Budget-Based Rents. Under the Budget-Based Rents 
approach, rents will be set at a level sufficient to support the 
aggregate amount of the applicable project's reasonable operating 
expenses, provided that such rents do not exceed the rents under the 
expiring HAP contract.
    For purposes of the Budget-Based Rents approach, a project's 
reasonable operating expenses shall include:
    (a) Reasonable and necessary operating expenses, including adequate 
annual contributions to the reserve for replacements account;
    (b) A reasonable return to the owner, based on the Owner's 
Distribution; and
    (c) Debt service payments that remain on the existing FHA-insured 
mortgage loan after principal reduction, if any.
    The amount of the reasonable operating expenses (and contributions 
to the reserve for replacements account) will be determined based upon 
an appraisal of the project prepared in accordance with the USPAP and a 
physical needs assessment.
    The rents set under the Budget-Based Rents Approach will be 
reevaluated each year prior to any further renewal of the HAP contract. 
Each annual HAP contract renewal is subject to Congressional 
appropriations.
    (4) Funding of Rehabilitation Costs. Under the Budget-Based Rents 
approach, the HUD approved rehabilitation costs will be financed with 
funds available in the project's residual receipts account and excess 
funds in the project's reserve for replacements account, as of the date 
the Budget-Based Rents are implemented. If the rehabilitation costs 
exceed the amount of such funds, the rehabilitation costs may be funded 
by a contribution of cash equity from the owner's partners/investors. 
For projects with a negative NOI at market rents, HUD may supplement 
the funds available for rehabilitation with a grant of up to $5,000 per 
unit, which amount may be

[[Page 3572]]

increased in extraordinary circumstances.
2. Project Underwriting
    a. Purpose. The purpose of demonstration project loan underwriting 
is to reduce annual section 8 contract renewal costs that result from 
subsidizing rents at above market levels. Projects in the Demonstration 
Program will be analyzed and restructured to bring their rents and 
expenses in line with the rents and expenses that are comparable to 
unassisted units in the local market area. The majority of projects 
will continue to receive project-based section 8 assistance at those 
market levels through one-year contract renewals, subject to annual 
appropriations. At the same time, FHA-insured first mortgages will be 
reduced to reflect changed project income.
    b. Method. HUD will first estimate a project's net operating income 
(NOI) by deducting operating costs, including reserves for replacement, 
from market rents. The NOI will be used to determine the Supportable 
Debt; that debt may be adjusted downward to accommodate the cost of 
scheduled repairs and to provide the minimum Owner's Distribution. HUD 
will determine the amount of first mortgage principal reduction by 
subtracting the supportable mortgage and other sources of funds from 
the unpaid principal balance of the original mortgage.
    For project loans restructured by HUD, project underwriting 
necessary for restructuring will be the responsibility of the 
Demonstration Manager, operating most often from selected HUD field 
offices and assisted by a Due Diligence Contractor. The Due Diligence 
Contractor will contract for appraisals, Physical Needs Assessments and 
any other reports as may be required by HUD.
    Appraisals must meet the standards and procedures of the Uniform 
Standards of Professional Appraisal Practice (USPAP), published by the 
Appraisal Standards Board of The Appraisal Foundation, as modified by 
HUD. The appraisal will be the basis for determining market income and 
expenses.
    (1) Determination of Adjusted Net Operating Income. The adjusted 
Net Operating Income (NOI) will be used to help determine which 
Demonstration Approach should be employed with respect to a particular 
project and to determine the size of the Supportable Debt. Computation 
of the adjusted Net Operating Income will require an analysis of the 
estimated income and expenses of each project after adjustment to 
market levels.
    (a) Estimation of Income. To estimate the total income of a 
project, HUD will analyze: (a) The expected rental revenues to be 
generated from operation of the project at market rents; (b) the 
anticipated vacancy rate for the project; and (c) any other income 
(e.g., income from laundry and parking facilities) that is expected to 
be generated by the project. The determination of market rent will 
assume the project has been rehabilitated to meet the requirements of 
the Physical Needs Assessment as described in Section IV.E.2.b.(1)(c). 
Market rents, for the purpose of underwriting, are the rents achievable 
in the immediate vicinity for comparable unassisted units in good 
condition.
    (b) Estimation of Expenses. For the purposes of project 
underwriting, total expenses will include: (1) Reasonable operating 
expenses; and (2) contributions to the reserve for replacement account.
    (i) Operating Expenses. It is the intent of this Demonstration 
Program that project operations be reevaluated in order to reduce 
operating costs where possible. HUD will analyze ordinary and necessary 
operating expenses for the project. The analysis will consider, among 
other factors, historical operating statements, owner input, and 
standard expenses by type and market. Project expenses will be compared 
to FHA-insured mortgage portfolio averages, other market data and 
industry standards published regularly by entities, including, but not 
limited to, the Institute for Real Estate Management (IREM).
    (ii) Reserves for Replacement. An allowance for scheduled 
contributions to the reserve for replacement account to fund ongoing 
capital needs will be included under gross expenses. The amount will be 
based on an inspection of the building and a schedule of improvements 
included in the Physical Needs Assessment.
    (c) Determining the Level of Required Physical Improvements. In 
determining the level of physical improvements a property requires, HUD 
will direct a Due Diligence Contractor to inspect the project and 
complete a Physical Needs Assessment.
    Participation in the Demonstration Program will not affect the 
responsibility of owners who undertake a rehabilitation program to 
comply with the accessibility requirements described at 24 CFR 8.23, 
Alterations of existing housing facilities, and 8.24, Existing housing 
programs, as applicable.
    The Physical Needs Assessment will be done in accordance with the 
Fannie Mae (FNMA) Physical Needs Assessment Guidance to the Property 
Evaluator for the Delegated Underwriting and Servicing (DUS) Program, 
as may be modified by HUD. This guide instructs the property evaluator 
to examine the condition of the building, including all its systems and 
components, and provide (1) a description of significant repair and 
replacement needs, both immediate and long-term, and (2) a description 
of any significant issues affecting tenants' health and safety.
    In addition, the Demonstration Manager will direct the Due 
Diligence Contractor to estimate the cost of any improvements necessary 
to enable the project to compete with similar but unsubsidized projects 
in its local market. The intent of physical improvement is not to 
reposition the property in the market place, but to create a product 
that is consistent with its original position in the market. In 
determining the amount of rehabilitation to be done, the Demonstration 
Manager will balance the need to enable the project to compete with 
similar but unassisted projects in its local market with the need to 
keep the rents as affordable as possible. The result should be a 
marketable project that competes on rents rather than on amenities.
    (d) Determination of Net Operating Income. Net Operating Income 
(NOI) is the amount of project income that remains after all operating 
expenses, including the contribution to the replacement reserve, have 
been estimated. It is calculated by deducting total expenses from total 
income.
    (2) Owner's Distribution from Net Cash Flow. In exchange for the 
payment it makes to reduce principal on the original mortgage, HUD will 
require owners to share Net Cash Flow dollar-for-dollar with HUD. As an 
incentive to maintain the property, however, the owner may receive an 
annual distribution of 100% of Net Cash Flow up to a ceiling equal to 
$25 per unit per month (``Owner's Distribution''); and also, where 
appropriate, a New Equity Distribution.
    The Owner's Distribution, in all cases, will be subordinate to the 
first mortgage and will be paid only to the extent that the cash flow 
to pay it is available. Any unpaid distributions will not accrue. 
Further, the Owner's Distribution will be held in an escrow account and 
paid to the owner only after HUD or its representative inspects the 
project and finds that all units are in substantial compliance with 
maintenance standards set forth by HUD as part of the restructuring 
agreement. Any owner who fails to deposit all Net Cash Flow

[[Page 3573]]

to the retention account will waive its rights to future distributions.
    In sizing the amount of supportable debt, HUD will make an 
adjustment so that Net Cash Flow on a pro forma basis is not less than 
$25 per unit per month. The adjustment will be made as follows:
    If Net Cash Flow is equal to or greater than or equal to $25 
dollars per unit per month, the distribution will not be deducted from 
debt service for the purpose of sizing the mortgage.
    If Net Cash Flow is less than the distribution of $25 per unit per 
month, the difference between the distribution and Net Cash Flow will 
be deducted from the amount of projected debt service, thus reducing 
the size of the supportable loan and insuring the availability of the 
Owner's Distribution.
    The Owner's Distribution must be earned and maintained thorough 
efficient management. It is not a guarantee. Adjustments to debt 
service and cash flow will be made only at initial underwriting; future 
adjustments to Owner's Distribution to offset rising operating costs 
will not be allowed by HUD. HUD, however, may make future adjustments 
to the $25 per unit per month ceiling to respond to inflation.

V. Additional Demonstration Program Matters

A. Required Consents

    The implementation of one or more of the Mandatory Demonstration 
Approaches shall be subject to receipt of all necessary third party 
consents. The owner and/or HUD as appropriate, shall be responsible for 
obtaining the consents from necessary parties. Guidance on projects 
with Ginnie Mae Mortgage Backed Securities will be provided in the 
future.

B. Additional Restructuring Tools

    In addition to the mandatory demonstration approaches described 
above, HUD has authority to take any of the following actions with 
respect to each project in the Demonstration Program:
1. Full or Partial Prepayment
    With the prior consent of the insured mortgagee, HUD may choose to 
make a full or partial prepayment to the holder of the FHA-insured loan 
prior to the date of any defaults.
2. Sale or Transfer of HUD's Economic Interest
    HUD may enter into contracts either to purchase reinsurance or to 
transfer to third parties HUD's economic interest in contracts of 
insurance or insurance premiums paid. HUD may not elect to do this for 
more than 5,000 units in the Demonstration Program during FY 1997. Any 
contract HUD executes under this paragraph shall require that 
associated units be maintained as low-income units for the life of the 
mortgage(s), unless HUD has waived this provision for good cause.
3. Credit Enhancement
    HUD may provide new FHA multifamily mortgage insurance, contract 
for reinsurance or provide other credit enhancement alternatives. HUD 
may also retain the existing FHA insurance on a restructured 
supportable first mortgage loan, or permit the use of the multifamily 
risk-sharing mortgage programs, as provided under section 542 (b) and 
(c) of the Housing and Community Development Act of 1992 (Pub. L. No. 
102-550; 106 Stat. 3794; 12 U.S.C. 1707 note), to the extent that 
appropriations or housing units are available. Unless otherwise agreed 
to by the project owner, not more than 25% of the units with expiring 
Section 8 contracts, in the aggregate, may be restructured during FY 
1997 without FHA insurance.
4. Tenant-Based Section 8
    With the consent of the owner of the project, and after consulting 
with tenants, HUD may substitute tenant-based Section 8 assistance for 
some or all of the units covered by a project's Section 8 rental 
assistance contract. This Section 8 tenant-based assistance, however, 
can be provided only where HUD has determined and certified that there 
is adequate, available, and affordable housing within the local area 
and that tenants will be able to use the Section 8 tenant-based 
assistance successfully.
    HUD may make this substitution for not more than 10% of the 
aggregate number of units in projects restructured during any one 
fiscal year.
5. Removal of Restrictions
    HUD, with the owner's consent and other parties' consent, as 
necessary, and after consulting with the tenants, may remove, modify or 
agree to the removal of any mortgage, regulatory agreement, project-
based assistance contract, use agreement, or restriction that had 
previously been imposed or required by HUD which would interfere with 
the ability of the project to operate without above-market rents. HUD 
may also remove any limitations previously imposed by HUD with respect 
to the distribution of a project's Net Cash Flow. It is HUD's intention 
after restructuring to eliminate the limited dividend distribution 
requirements, should they be currently required, and associated 
collection of residual receipts.
6. Use of Accumulated Residual Receipts
    HUD may require the owner to apply any accumulated residual 
receipts towards effecting the purposes of the Demonstration Program.
7. Payments by HUD
    HUD may enter into such agreements, provide such concessions, incur 
such costs, make such grants (including grants to finance approved 
rehabilitation costs) and other payments, and provide other valuable 
consideration, as HUD determines are reasonably necessary in order to 
enable owners, lenders, servicers, third parties and other entities to 
participate in the Demonstration Program.

C. Structures to Address Tax Liability

    Owners of projects undergoing restructuring may be exposed to tax 
consequences associated with cancellation of debt, and taxation of 
capital gains or ordinary income. It is the expressed desire of 
Congress that the Demonstration Program minimize, if possible, tax 
consequences to owners. Absent specific legislative relief, HUD will 
accept proposals from owners which include any tax motivated structure 
deemed by the owner to be acceptable to the Department of the Treasury 
that will limit or defer tax liability and which will not adversely 
affect a project's financial integrity or management.

D. Sources and Uses of Funds Under the Demonstration Program

1. Sources of Funds
    The funds which HUD anticipates using in connection with an owner's 
participation in the Demonstration Program may include the following:
    a. Funds in the project's residual receipts account;
    b. Excess funds in the project's reserve for replacements fund;
    c. New project financing, either FHA-insured or non-FHA-insured 
obtained by the owner;
    d. New equity to be contributed by new or existing owners and 
partners/investors (including additional capital contributions);
    e. New equity raised from a proposed sale or other disposition of 
the project (100% of the purchase price relating to any sale or other 
disposition must be supported by a third party USPAP appraisal);
    f. New equity raised from the sale of low-income housing tax 
credits;

[[Page 3574]]

    g. To the extent other sources of funds are not available, full or 
partial mortgage prepayments from HUD;
    h. To the extent required, as determined by HUD, direct loans or 
grants from HUD; and
    i. With respect to projects with Section 8 contracts expiring after 
FY 1997, the capitalized value of Section 8 project-based assistance in 
excess of market rents.
2. Uses of Funds
    Subject to the approval of HUD and, where required, to mortgagee 
approval, the permitted uses of such funds will include the following:
    a. Reduction or cancellation of existing FHA-insured debt and, 
where appropriate, other debt on the property approved by HUD, 
including a payment to an escrow account to be used for such purposes;
    b. Payment of delinquent taxes, insurance premiums and/or other 
amounts owing with respect to the project, including amounts necessary 
to remove liens or judgments;
    c. Payment of reasonable rehabilitation, renovation, maintenance or 
construction expenses necessary to meet the requirements of the 
Physical Needs Assessment;
    d. Payment of reasonable legal and other transactional costs 
(including title, survey, appraisals, etc.);
    e. Payment of reasonable fees and costs associated with obtaining 
new financing (including prepayment penalties, discounts, etc.);
    f. Payments of reasonable oversight fees for nonprofits to cover 
reasonable pre-development costs; and
    g. Relocation costs.

E. Affordability Requirements

1. Projects with Renewed or New HAP Contracts
    Unless otherwise waived by HUD for good cause, each project owner 
participating in the Demonstration Program that is provided with a new 
or renewed HAP contract (other than any temporary renewal provided 
during the Demonstration Program processing period) will be required 
for a period of up to 20 years from the date of closing of the 
Demonstration Restructuring, to accept each offer by HUD to renew the 
project's HAP contract. The terms and conditions of the HAP contract 
renewals shall be set forth in: (a) The Restructuring Commitment (as 
described in Section VI.G.) between HUD and the owner, and/or (b) an 
amendment to the renewed HAP contract. All such renewals shall be 
subject to annual Congressional appropriations.
2. Projects without Renewed or New HAP Contracts
    Unless otherwise waived by HUD for good cause, with respect to any 
project participating in the Demonstration Program that is not provided 
with a new or renewed HAP contract, the owner and HUD shall execute a 
Use Agreement in the same form as that described in Section V.E.1.; 
provided, however, that such Use Agreement shall also require the owner 
to accept Section 8 tenant-based certificates or vouchers from the 
project's existing tenants, to the extent such tenants choose to remain 
in the project, for a period, in the aggregate, of up to 20 years after 
the Demonstration Restructuring closing for the project occurs.
3. Long-Term Project Affordability
    When the Mortgage Restructuring or Debt Forgiveness approaches are 
used, the project will be required to comply with affordability 
requirements established by HUD. Unless otherwise agreed to by HUD, the 
affordability requirements shall remain in effect for a minimum of 20 
years from the date the Mortgage Restructuring or Debt Forgiveness is 
made effective. Affordability requirements shall be incorporated into a 
recorded Use Agreement.
    If statutorily permitted by the section of the National Housing Act 
under which the mortgage is insured, the affordability requirements 
will be the same as those of the Low-Income Housing Tax Credit program, 
namely, the project shall be required to maintain: (a) At least 20% of 
the units in the project with families whose adjusted income does not 
exceed 50% of the area median income, or (b) at least 40% of the units 
in the project with families whose adjusted income does not exceed 60% 
of the area median income. Affordability requirements may be waived by 
HUD for good cause.
4. Affordability Waiver Authority for Designees
    None of the affordability requirements in this Section V.E. may be 
waived by a Designee, except with express prior written approval of 
HUD.

F. Tenant Protections

    If the owner has provided the required notice, any eligible family 
residing in a project-based Section 8 assisted unit that is covered by 
an expiring contract that is not renewed will be offered tenant-based 
assistance as provided in Housing Notice H 96-89 prior to the date on 
which the project-based HAP contract expires. If the owner chooses not 
to request a renewal and if proper notice was not given, the owner must 
permit the tenants assisted by the expiring Demonstration Agreement to 
remain in their units for the full notice period without increasing the 
tenant portion of the rent under the Demonstration Agreement. Public 
housing authorities will be allocated additional HAP contract authority 
on an annual basis in order to assure that families so affected will be 
provided tenant-based Section 8 contracts. Public housing authorities 
will be responsible for administering the issuance of these tenant-
based Section 8 contracts.

G. Funding and Unit Limitations

    The funding limitation for the Demonstration Program is set at 
$40,000,000. This amount is comprised of $30,000,000 made available 
under section 210 of the Departments of Veterans Affairs and Housing 
and Urban Development and Independent Agencies Appropriations Act, 
1996, appropriated to remain available through September 30, 1997 and 
$10,000,000 appropriated under section 212 of the FHA Multifamily 
Demonstration Authority HUD 1997 Appropriations Act, appropriated to 
remain available until September 30, 1998. Total funds available are 
net of commitments made in the implementation of the FY 1996 Portfolio 
Reengineering Demonstration Program.
    The $40,000,000 shall include any credit subsidy costs associated 
with providing direct loans or mortgage insurance as well as costs of 
modifying and restructuring loans held or guaranteed by the Federal 
Housing Administration.

H. Transfer of Projects

    When the owner of a project in the Demonstration Program 
voluntarily transfers the property, HUD shall facilitate the transfer 
to tenant organizations, tenant-endorsed nonprofit organizations or 
public agency purchasers which are qualified to own and manage 
multifamily properties. HUD will give final approval to the selected 
purchaser upon the completion of the following selection process by the 
owner, and certification by the owner that this process has been 
followed. To facilitate a transfer to a qualified purchaser, HUD may 
transfer existing Section 8 project-based assistance to the purchaser 
or transferee. In the transfer of physical assets, demonstration 
project owners must follow the process below:
    1. The owner shall notify potential qualified tenant organizations 
and experienced tenant-endorsed nonprofit organizations or public 
agency

[[Page 3575]]

purchasers of the availability of the project for sale by:
    a. Mailing notices to eligible organizations;
    b. Placing notices in the major local newspaper(s) in the 
jurisdiction in which the project is located;
    c. Mailing notices to clearinghouse networks; or
    d. Using any other means of notification which HUD determines would 
be effective to notify potential qualified purchasers of the sale of 
the property.
    2. For the 90-day period beginning on the date of receipt by HUD of 
a notice of intent to transfer physical assets, the owner may accept a 
bona fide offer only from:
    a. A resident council intending to purchase the project and retain 
it as rental housing, certifying that it has the support of a majority 
of tenants;
    b. A tax-exempt nonprofit organization that has a record of service 
over at least five years of providing quality low-income housing and 
which has the support of a majority of tenants; or
    c. A qualified public agency.
    3. During this 90-day period, although offers may be made by other 
prospective purchasers, these offers may not be accepted by the owner 
until the expiration of the 90-day period. If no bona fide offer to 
purchase the project is made by any of these groups and accepted by the 
owner at the end of the 90-day period, which period may be extended by 
HUD for good cause, the owner may accept an offer to purchase the 
project from any qualified purchaser.

VI. Demonstration Process

    This section explains the Demonstration Program process that will 
be followed by HUD and project owners for eligible project loans. The 
Demonstration Program provides for both Designee Processing and 
Alternate Processing as well as direct HUD processing of Demonstration 
project loans.
    In the case of Designee processing, initial intake and referral to 
the appropriate Designee is the responsibility of HUD and thereafter 
the Designee is responsible for project management. (See Section VII. 
for further information on Designee Processing.)
    Owners seeking new first mortgage financing may bypass the majority 
of the HUD restructuring process and have the qualified lender perform 
the necessary underwriting and due diligence activities. In cases where 
the FHA loan is being retained, HUD may request the mortgagor or loan 
servicer to perform certain due diligence and underwriting of 
activities under certain conditions. (See Section VIII.)
    The following describes the restructuring process to be implemented 
directly by HUD.

A. Owner's Request to Participate

    To participate in the Demonstration Program, owners with Section 8 
contracts due to expire in FY 1997 must complete, execute and return to 
HUD, no later than 45 days prior to the expiration of their Section 8 
contract, a Request to Participate in the Demonstration Program (the 
Request to Participate). The Request to Participate should be in the 
form of a letter of interest which includes the name and address of the 
project and the date the Section 8 contract expires.
    Owners with contracts expiring within 45 days of the date of 
publication of these Guidelines who, therefore, cannot provide the full 
45 days of notice, must provide notice to HUD as soon as possible but 
not later than 45 days from the publication of these Guidelines. If the 
project has more than one Section 8 contract, the 45 days will be 
measured from the expiration date of the contract with the earliest 
expiration.
    Owners who do not submit the above Request to Participate on or 
before the required deadlines will not be eligible to participate in 
the Demonstration Program, unless compliance with the deadlines is 
waived by HUD for good cause. This Request to Participate should be 
addressed to the Director of Multifamily Housing in the HUD field 
office with jurisdiction over the project.

B. Demonstration Agreement

    Within ten business days of HUD's receipt of the owner's Request to 
Participate in the Demonstration Program, the field office Director of 
Multifamily Housing will prepare and send to the owner the following:
    1. A Demonstration Agreement which: (a) Sets forth the Owner's 
obligation to proceed in good faith to negotiate a Restructuring 
Commitment with HUD within 180 calendar days after execution of the 
Demonstration Agreement; (b) sets forth the Owner's obligation to 
provide all documents and information reasonably requested by HUD in 
order to enable the project to participate in the Demonstration 
Program; and (c) requires the owner to certify that it has provided the 
notice to the tenants, the Affected Unit of Local Government and the 
lender(s), as required in Section VI.D.;
    2. An Addendum to the Demonstration Agreement in the form of a 
Housing Assistance Payments Demonstration Renewal Contract, the form of 
which is included as Attachment 3(c) of the Housing Notice H 96-89 
dated October 15, 1996 (the HAP Renewal Contract),
    3. An attachment containing the name and address of the project, 
the Section 8 and FHA project numbers, the section of the National 
Housing Act under which the mortgage is insured, an owner or owner 
agent contact name, address and telephone and fax numbers, and unit 
type and rental information, consisting of contract rents, utility 
allowances, if any, and FMR's.

C. Execution of Demonstration Agreement

    In order to participate in the Demonstration Program, the owner 
will be required to execute and deliver the Demonstration Agreement to 
the Director of Multifamily Housing in the HUD field office with 
jurisdiction, no later than 10 business days prior to the Section 8 
contract expiration date. This deadline may be extended by the 
Demonstration Program Coordinator for good cause. HUD will execute the 
HAP Renewal Contract and Demonstration Agreement only after receipt of 
owner's evidence that proper notification to project tenants, the 
Affected Unit of Local Government and project lender(s) has been 
provided in accordance with Section VI.D.
    HUD will assign a Demonstration Program Tracking Number to the 
project after execution of the Demonstration Agreement.

D. Delivery of Notice to Project Tenants, Affected Unit of Local 
Government and Lender(s)

    Simultaneously with the delivery of the Request to Participate to 
HUD, the owner shall deliver notice of the owner's intention to 
participate in the Demonstration Program to: (a) The tenants residing 
in the project, (b) the chief official of the Affected Unit of Local 
Government having jurisdiction over the project, and (c) the mortgagee 
of the project's FHA-insured loan. The ``Affected Unit of Local 
Government'' is the smallest unit of general local government with 
jurisdiction in which the project is located.
    Notification to project tenants must be accomplished by delivery of 
notices to each project tenant and by posting the notice in at least 
two conspicuous public places in each building for a minimum of three 
(3) consecutive calendar days. If a tenant organization of project 
tenants exists which officially represents all tenants, notice may be 
provided to the tenants' organization

[[Page 3576]]

rather than to each tenant individually, but notice must still be 
posted in all project buildings as described in this paragraph.
    The notice to project tenants required under the Demonstration 
Program shall be in addition to the required one-year notice of Section 
8 contract expiration required under the section 8(c)(9) of the United 
States Housing Act of 1937 and HUD Notice H 96-89.
    The notice must also include:
    1. A copy of the ``Request to Participate'' provided by the owner 
to HUD, including the date of the Section 8 contract expiration;
    2. An explanation of tenant protections afforded.
    3. A statement that project tenants, the Affected Unit of Local 
Government and lender(s) have the opportunity to provide written 
comment. They are particularly encouraged to provide written comments 
on the project's physical needs and property management.
    4. A statement that comments should be sent to the Director of 
Multifamily Housing in the HUD field office with jurisdiction over the 
project and that written comments will be accepted for up to 45 days 
after the date of execution of the Demonstration Agreement.
    5. A statement that prior to the start of preparation of the 
Physical Needs Assessment for the project by a Due Diligence 
Contractor, a preinspection meeting will be held on site and that up to 
3 representatives each, of both project tenants and the Affected Unit 
of Local Government, and their technical consultants, if any, will be 
invited to this meeting. It should further indicate that the owner will 
provide a separate written 10 day notice of this meeting to the project 
lender(s), project tenants and to the chief official of the Affected 
Unit of Local Government. Any written comments received by the time of 
this meeting will be provided to the Due Diligence Contractor 
responsible for preparing the Physical Needs Assessment. The notice 
should advise that upon completion of the Physical Needs Assessment, 
one copy of the Assessment will be provided to the insured lender, 
project tenants and one copy to the chief official of the Affected Unit 
of Local Government.
    6. A statement that the owner will provide the project lender(s), 
project tenants and the chief official of the Affected Unit of Local 
Government with a brief summary of HUD's Restructuring Commitment.
    7. A statement that if the owner chooses to appeal the terms of a 
Restructuring Commitment, the owner will notify the project lender(s), 
project tenants and the chief official of the Affected Unit of Local 
Government in writing concurrently with its submission of the appeal to 
HUD. It will further advise these parties that they will have 20 days 
from the date of the appeal submission to provide written comments to 
HUD.
    8. In instances where lender consent is needed, a request that the 
lender state its willingness to participate in the Demonstration 
Program.
    9. A statement that the Affected Unit of Local Government is 
encouraged to apprise representatives of the local community and 
neighborhood of this notice.
    Evidence that proper notice was provided must be sent to the 
Demonstration Manager.

E. Assignment of Restructuring Responsibility

    Within 10 business days following HUD's receipt of the executed 
Demonstration Agreement from the owner, HUD will assign responsibility 
for the project either to a qualified Designee, whenever possible or, 
if there is no available Designee for the project location, to a HUD 
Demonstration Manager. (See Section VII. for Designee Processing.)
    In the case of HUD processing, the Demonstration Manager will 
operate most often out of selected field offices and will be assisted 
by a Due Diligence Contractor who will contract for appraisals, 
Physical Needs Assessments and any other reports as may be required by 
HUD. The Demonstration Manager will be responsible for:
    1. Working with the owner, a Due Diligence Contractor, project 
tenants, project Lender(s), the Affected Unit of Local Government, and 
others as necessary to accomplish the restructuring;
    2. Determining which of the demonstration approaches are 
appropriate for restructuring the project loan;
    3. Negotiating the terms and conditions of a Restructuring 
Commitment and related documents with the owner; and
    4. Coordinating the preparation, processing and closing of the 
Restructuring Commitment and the related documents.

F. Due Diligence Period

    Once the Demonstration Manager or the Designee is selected, the Due 
Diligence period will commence.
1. Pre-Restructuring Conference with Owner
    Promptly following the execution of the Demonstration Agreement by 
HUD and the owner, the Demonstration Manager will meet with the owner 
to discuss the owner's views with respect to the appropriate level of 
debt, market rents, operating costs, capital needs, preference for debt 
forgiveness, any of the additional restructuring tools listed in 
Section V.B., and any other related matters. At this conference, the 
owner's restructuring proposal, if any, may be presented and given 
initial review.
2. Pre-Inspection Meeting at Project
    Prior to the inspection of the property by a Due Diligence 
Contractor responsible for preparation of the Physical Needs 
Assessment, a pre-inspection meeting must be held on site. Participants 
will include, at a minimum, the HUD Demonstration Manager and Due 
Diligence Contractor, the owner or owner's representative, up to three 
representatives of the project tenants or their technical consultants, 
if any, and up to three representatives of the Affected Unit of Local 
Government. Local HUD field office representatives will also be invited 
to attend. The owner must provide a minimum of 10 days written notice 
of the meeting to project tenants, project lender(s), and the Affected 
Unit of Local Government.
3. Due Diligence/Underwriting
    Promptly following the execution of the Demonstration Agreement by 
HUD, the Demonstration Manager and Due Diligence Contractor will work 
closely with the owner to obtain the required information and perform 
the underwriting necessary to negotiate a restructuring commitment. The 
Demonstration Manager and Due Diligence Contractor will analyze the 
project's market rents and expenses, determine Net Operating Income, 
estimate the project's market value, and obtain any other information 
regarding the financial, physical, environmental, or other condition of 
the property he/she needs to negotiate a restructuring commitment with 
the owner.
    The owner must cooperate fully with the Demonstration Manager and 
Due Diligence Contractor during this process and must provide timely 
access to the property and to project documents as requested. In 
addition, within 14 calendar days of executing the Demonstration 
Agreement, the owner may submit to the Demonstration Manager a detailed 
estimate of project operating costs after restructuring is completed. 
Failure to cooperate is

[[Page 3577]]

grounds for terminating the Demonstration Agreement.
    HUD intends to develop additional administrative guidance for 
determining market rents, operating expenses, the level of 
rehabilitation required, the use of replacement reserve account 
balances, and other such matters.

G. Preparation of HUD'S Restructuring Commitment

    The Demonstration Manager, using the information produced during 
the Due Diligence phase of the Demonstration Process, will develop a 
Restructuring Commitment that utilizes one or more of the mortgage 
restructuring, forgiveness of debt, or budget-based rents approaches.
    The Restructuring Commitment will be presented in writing to the 
owner and the owner will be provided 30 calendar days to accept the 
Commitment or to submit a counter proposal to the Demonstration 
Manager.
    Any project rehabilitation or capital improvements financially 
supported or required by HUD must be processed in accordance with HUD's 
environmental review requirements in 24 CFR part 50, prior to HUD's 
presentation of the Restructuring Commitment. All projects must be in 
conformance with flood insurance purchase requirements, as applicable, 
in accordance with 24 CFR 50.4(b)(1).

H. Notification of Project Tenants, Affected Unit of Local Government 
and Project Lender(s)

    Upon receipt of the Restructuring Commitment, the owner shall 
deliver by mail a brief summary of the document to project tenants, the 
chief official of the Affected Unit of Local Government, and the 
lender(s), and submit evidence to the Demonstration Manager that proper 
notification was provided. If an organization of project tenants 
exists, which officially represents all tenants, notice may be provided 
to the tenants' organization rather than to each tenant individually. 
The Affected Unit of Local Government shall be requested to provide 
this notification to any representatives of local communities and 
neighborhoods that it chooses to inform.

I. Owner Response to HUD'S Restructuring Commitment

    Within 30 calendar days following the owner's receipt of HUD's 
Restructuring Commitment, the owner must either (i) execute the 
Restructuring Commitment (without modification) and return it to the 
Demonstration Manager; or (ii) notify the Demonstration Manager in 
writing of any modifications to the Restructuring Commitment that it 
requests prior to its execution. Should the owner accept the 
Restructuring Commitment, the execution of the commitment must be 
accompanied by any required third party consents. For example, these 
include the consent of the insured mortgagee and the consent of limited 
partners, if required under the terms of a limited partnership 
agreement.

J. Modification of Restructuring Commitment

    The Demonstration Manager shall, promptly following its receipt 
from the owner of any modifications to the Restructuring Commitment, 
work closely with the owner to review and evaluate all such 
modifications, resolve any issues, and prepare and deliver to the owner 
a revised Restructuring Commitment which reflects those modifications 
acceptable to HUD. Final negotiation of a Restructuring Commitment 
shall occur during a period not to exceed 40 calendar days after the 
Demonstration Manager's receipt of the owner's modifications, unless 
extended by HUD for good cause.

K. Issuance of Restructuring Commitment After Modification

    Upon receipt of the modified Restructuring Commitment, the owner, 
only if the changes are substantive and substantial, shall deliver a 
brief summary of the document to project tenants, the chief official of 
the Affected Unit of Local Government, and the lender(s) by mail and 
shall submit evidence to the Demonstration Manager that proper 
notification was provided. If a tenant organization of project tenants 
exists, which officially represents all tenants, notice may be provided 
to the tenants' organization rather than to each tenant individually. 
The Affected Unit of Local Government shall be requested to provide 
this notification to any representatives of local communities and 
neighborhoods that it chooses to inform.
    The owner will have 30 days from the date the Restructuring 
Commitment is delivered by HUD in which to execute that document and 
return it to HUD. This 30 day period may be extended by the Department.

L. Owner Appeal of Restructuring Commitment (if applicable)

    If, for any reason, an owner desires to appeal the modified 
Restructuring Commitment issued by HUD, an appeal must be submitted in 
writing to the Director of Multifamily Housing or Director of Housing, 
in the local field office, within 10 calendar days of the issuance date 
of the modified Restructuring Commitment.
    The written notice of appeal shall specifically state, in 
reasonable detail, the issues and bases upon which the owner seeks 
review. The Department will issue a written determination within thirty 
(30) calendar days of the date of the appeal.
    The owner must notify the project lender(s), project tenants and 
the chief official of the Affected Unit of Local Government in writing 
concurrently with its submission of the appeal to HUD. It will further 
advise that these parties will have 20 days from the date of the appeal 
submission to provide written comment to HUD. If an organization of 
project tenants exists, which officially represents all tenants, notice 
may be provided to the tenants' organization rather than to each tenant 
individually.
    If the appeal process results in a mutually satisfactory 
conclusion, HUD and the owner will execute a final version of the 
revised Restructuring Commitment. If HUD denies the owner's appeal, HUD 
will so notify the owner in writing. Upon such notification, the owner 
may execute the Restructuring Commitment as last revised by HUD, or may 
choose not to participate in the Demonstration Program.
    In cases where no restructuring agreement is reached and the 
Demonstration Agreement expires, the owner may request a one-year 
Contract renewal in accordance with section 211(b) of the HUD FY 1997 
Appropriations Act, as implemented by Housing Notice H 96-89. In most 
cases, the rents under the one-year renewal Contract will be set at 
120% of the applicable FMR. Section 211(b) (2) and (3) contain 
exemptions to the 120% limitation; if the project qualifies for one of 
these exemptions, rents would be maintained at current levels.
    If the owner chooses not to request a renewal, and if the 
appropriate notice has been provided, HUD will provide tenant-based 
assistance to all eligible families in accordance with Housing Notice H 
96-89.
    If the owner chooses not to request a renewal and if proper notice 
was not given, the owner must permit the tenants assisted by the 
expiring Demonstration Agreement to remain in their units for the full 
notice period without increasing the tenant portion of the rent under 
the Demonstration Agreement.

M. Closing the Restructuring Transaction

    Loan closing must occur within 60 days of execution of the 
Restructuring

[[Page 3578]]

Commitment. If necessary for closing, HUD will extend the HAP Renewal 
Contract by up to 60 calendar days. An additional extension period may 
be granted by HUD, if closing is delayed due to circumstances beyond 
the control of the owner. In no case may the HAP Contract be extended 
for more than 6 months if the Restructuring Commitment has not been 
executed.
    The Demonstration Manager will be responsible for coordinating the 
closing. Where the restructuring involves new FHA-insured financing, 
the closing must be completed in accordance with FHA processing 
requirements.

VII. Designee Selection and Processing

    HUD will provide qualified Designees the opportunity to enter into 
arrangements with HUD for restructuring Demonstration Program projects 
in their jurisdiction or service area. HUD will select qualified state 
housing finance agencies, housing agencies or nonprofit entities 
(Designees) to take responsibility for processing project restructuring 
under the Demonstration Program.

A. Selection Criteria to Determine Qualified Designees

    HUD's selection of qualified Designees will be made based on the 
criteria listed in the following paragraph. Interested state and local 
housing participants must submit letters of interest to HUD on or 
before February 15, 1997, and should include the potential Designee's 
geographic area of jurisdiction and its qualifications. Applicants who 
are already approved as FHA risk sharing lenders are not required to 
submit qualifications. Letters of interest must be accompanied by a 
letter of support from the Chief Elected Official of the area(s) of 
jurisdiction. Credentials will be screened and applicants will be 
selected on or before April 1, 1997. HUD may resolicit public entity 
applicants on or about April 15, and make selections on or about May 
31. HUD will accept late submissions only for areas that have not been 
assigned a Designee. However, for projects with Section 8 contracts 
that expire prior to February 15, 1997, on a case by case basis, HUD 
will assign these projects to Designees who have submitted Letters of 
Interest prior to February 15, 1997, for specific projects.
    Nonprofit Designees will be selected through a formal Request for 
Qualification (RFQ) process. The RFQ will be published in early 1997.
    The selection criteria on which the applicants will be rated are as 
follows:
    1. Demonstrated experience with multifamily loan restructurings;
    2. Demonstrated experience in multifamily financing, and asset/
property management experience relating to affordable multifamily 
housing;
    3. Demonstrated staff experience and capacity for managing a 
restructuring process for multifamily projects; and
    4. A history of stable, financially sound, and responsible 
administrative performance.
    These selection qualifications may be demonstrated either by the 
Designee applicant alone or in partnership with other entities with 
proven experience and capacity in this area. If a team approach is 
chosen, the Designee applicant must provide evidence of its ability to 
manage this type of team. Designee applicants are encouraged to develop 
partnerships with each other as well as with other private and public 
entities, including: (i) Financial institutions, (ii) mortgage 
servicers, (iii) the Federal National Mortgage Association, (iv) the 
Federal Home Loan Mortgage Corporation, (v) Federal Home Loan Banks, 
(vi) other state or local mortgage insurance companies or bank lending 
consortia, (vii) nonprofit and for-profit housing organizations.
    In its selection, HUD will give preference to qualified Designees 
that have had positive previous association with specific projects that 
may seek restructuring.
    Once a Designee is selected, it will then be responsible for 
processing all projects in the Demonstration Program in its area of 
jurisdiction, although in some circumstances, HUD and the Designee may 
agree to a more limited initial engagement. The Designee may choose to 
reject certain projects that represent extraordinary risk, which by 
mutual agreement can be retained by HUD. In the event the Designee 
rejects a project, responsibility for that project will be given to the 
Demonstration Manager. Until and unless a Designee is selected for an 
area, HUD will act as Designee.
    The management plan setting forth the manner in which the Designee 
will carry out the restructuring must be approved by HUD and will be 
attached as a provision of the contract to be entered into by the 
Designee and HUD.
    In the event that potential Designees with overlapping 
jurisdictions express interest and are determined to be qualified, they 
must first attempt to enter into an agreement as to how projects to be 
restructured will be allocated. This agreement must be executed by the 
Chief Elected Official of each jurisdiction. Until such time as 
agreement is reached, HUD will be responsible for processing 
demonstration projects in the affected service area.
    In the event qualified nonprofit entities desire to operate in 
areas where state or local agencies are acting as Designees, the 
nonprofit will be required to enter into a cooperation agreement with 
the relevant Designee with jurisdiction prior to participating in 
restructuring in that jurisdiction. Where more than one nonprofit 
desires to operate in a single geographic area, HUD will allocate 
projects based on their qualifications and familiarity with the local 
market area.
    Until such time as qualified Designees are selected for specific 
areas, HUD will be responsible for Demonstration Program 
implementation.

B. Alternative Approaches for Designee Participation in the 
Demonstration Program

    Designees may contract with HUD under one of two approaches:
1. Fee for Service With Performance Incentive
    a. Compensation Structure. Under this approach, the Designee will 
be paid on a uniform fee structure, to be established by HUD, which 
will include both a Base Fee and an incentive fee, called a Bonus Fee, 
as defined in the contract to be negotiated between HUD and the 
Designee.
    (1) Base Fee. The Base Fee will be earned and paid based on 
achievement of certain stages of performance as indicated below.
    Stages of Performance Criteria on which Base Fee will be earned:
Stage I: Submission of Detailed Business Plan
    Submission to HUD of a detailed Business Plan to include:
    (i) An outline of the ownership entity, loan documents (and bond 
documents, if applicable);
    (ii) Required third party approvals;
    (iii) A completed appraisal meeting the requirements of the Uniform 
Standards of Professional Appraisal Practice (USPAP), published by the 
Appraisal Standards Board of the Appraisal Foundation, as modified by 
HUD, incorporating data on operating expenses available from FHA and 
entities such as IREM;
    (iv) Underwriting analysis including assessment of market rents and 
operating expenses based on the appraisal, historical operating 
expenses, and determination of Net Operating Income, supportable 
financing, proposed principal reduction, rehabilitation financing, and 
owner input;

[[Page 3579]]

    (v) Assessment of rehabilitation needs;
    (vi) Description and rationale for the mandatory demonstration 
approach being selected;
    (vii) Evidence of proper notification to tenants, Affected Unit of 
Local Government and lender(s);
    (viii) Summary of comments received in the process and how they 
were addressed;
    (ix) Environmental issues;
    (x) Litigation issues;
    (xi) Tax issues;
    (xii) Public policy issues;
    (xiii) Written record of inquiries from public officials regarding 
the restructuring; and
    (xiv) Other issues as provided more specifically in further 
guidance to be provided by HUD. All information in the Business Plan is 
to be supported by the findings of the due diligence activities.
Stage II: Executed Restructuring Commitment
    Reach agreement on a post-appeal Restructuring Commitment or 
aggregate Commitments in the case of multiple project restructurings, 
executed by the Designee and owner within 180 days of the date of the 
contract between HUD and the Designee that:
    (i) Meets or exceeds net savings to government anticipated by the 
HUD cost saving model as adjusted and agreed to by HUD to accommodate 
project financing and public policy needs; and
    (ii) Achieves HUD's public policy objectives to be defined jointly 
by the Designee and HUD.
Stage III: Closing of the Transaction
    Close transaction based on a Restructuring Commitment within 60 
days of the execution of the Restructuring Commitment.
    (2) Bonus Fee. In addition to the Base Fee for Service, a Bonus Fee 
would be earned based on the following Bonus Objectives being achieved:
    (a) Amount of Savings to the Federal Government, based on the HUD 
model for credit scoring;
    (b) Timeliness. Closing the transaction in a period shorter than 
the projected 60 days after execution of the Restructuring Commitment; 
and
    (c) Achieving HUD and local Public Policy Objectives. Providing an 
exceptional solution to meeting HUD's public policy objectives, in 
HUD's sole estimation.
    b. Processing. Once a project in the Demonstration Program has been 
assigned by HUD to the Designee, the Designee will be responsible for 
accomplishing the restructuring of the project in a period of 180 days 
from the date of the Demonstration Agreement and closing in a period 
not to exceed 60 days from the execution of the Restructuring 
Commitment. The Designee's process for restructuring must be consistent 
with the authorizing legislation for the Demonstration Program and must 
meet mandatory Demonstration Program objectives including statutory 
notification requirements.
    The Designee will be required to seek HUD approval and the approval 
of the insured mortgagee and other necessary third parties at the three 
Stages described above in Section VII.B.1.a.(1). The Business Plan and 
the Final Restructuring Commitment will require HUD approval.
    As in direct HUD processing, the owner will have 10 calendar days 
from the issuance of the Restructuring Commitment to appeal, in 
writing, to the Director of Multifamily Housing in the HUD field office 
with jurisdiction, the terms Restructuring Commitment. The written 
notice of appeal shall specifically state, in reasonable detail, the 
issues and bases upon which the owner seeks review. Following the 
appeal, a modified Commitment may be issued by HUD. If needed, after 
signing a modified Commitment, the owner will qualify for an extension 
of the Demonstration HAP Contract. Failure to sign a Restructuring 
Commitment will result in the termination of the Demonstration 
Agreement and a reduction of project rents to 120% of FMR.
    Any project rehabilitation or capital improvements supported or 
required by HUD must be processed in accordance with HUD's 
environmental review requirements in 24 CFR part 50, prior to HUD's 
approval of a Designee's Detailed Business Plan. All projects must be 
in conformance with flood insurance purchase requirements, as 
applicable, in accordance with 24 CFR 50.4(b)(1). HUD will also execute 
the closing documents. Where full or partial mortgage prepayment from 
the FHA Insurance Fund or new FHA-insured financing is included in the 
restructuring, new regulatory agreements must be entered into.
    The Demonstration Program limits the number of units for which HUD 
may permit assignment of its insured position, enter into contracts to 
purchase reinsurance or otherwise transfer economic interest in the 
contracts of insurance to 5,000 units. HUD will approve requests from 
Designees to receive such assignment in the order in which they are 
received and subject to HUD's assessment of the benefit to the Federal 
Government and the timeliness of implementation. In the absence of 
designees for any geographic area, HUD may assume the role of designee 
and sub-contract the assignment of economic interest.
    The Demonstration Program also limits the number of units for which 
HUD may substitute tenant-based Section 8 assistance for project-based 
assistance to 10% of the aggregate number of units in projects 
restructured in any one fiscal year. HUD will approve requests for 
tenant-based assistance for projects that demonstrate new and 
innovative approaches to restructuring, subject to availability, given 
the 10% limitation.
    In the Designee's restructuring process, HUD will be the initial 
point of contact with owners and will be responsible for allocating 
projects to the selected Designee.
2. Joint Venture Approach
    a. Compensation Structure. HUD seeks joint venture arrangements in 
which nonprofit or public entity Designees assume some or all of HUD's 
risk of restructuring in exchange for a share of the savings to the 
Federal Government resulting from restructuring. In most cases, savings 
to the Government will be measured by comparing the cost to the 
Government that would occur if the project were not restructured and 
the first mortgage defaulted with the cost to the Government of the 
restructuring by the joint venture.
    The objective of the joint venture approach is to explore ways to 
significantly reduce HUD's administrative role while simultaneously 
advancing the interest of the Federal Government (taxpayers) in the 
restructurings. The risk of restructuring assumed by designees could 
include originating a new uninsured or partially insured loan, making a 
cash payment for the assignment of HUD's economic interest in insurance 
in force, or other form as designed and proposed by the Designee.
     In joint venture arrangements, the Designee investment can take 
the form of money, time, or credit exposure. The investment may be made 
directly by the Designee or by a partner of the Designee, such as those 
public and private entities listed in Section VII.A. The freedom of the 
Designee to control the transaction will be commensurate with the level 
of investment. HUD seeks to transfer sufficient risk and reward to the 
Designee to insure that HUD's objectives will be met with substantially 
reduced HUD monitoring and involvement. Ideally, HUD would not review 
interim

[[Page 3580]]

stages of the restructuring process and would accept the Designees' 
warranties, certifications and representations. It is possible that HUD 
would delegate all its powers to the designees including the ability to 
authorize full or partial mortgage prepayment and would rely solely on 
a post-restructuring audit to verify that the interests of the Federal 
Government were fairly represented in the transaction.
    Payments to Designees for fees, return on investment and, if 
applicable, administration of Section 8 will be funded from transaction 
proceeds, Section 8 appropriations and other funds as HUD may 
determine.
    b. Process. The Joint Venture Designees will be responsible for all 
decision making. HUD approvals will be based on representations and 
certifications made by the Designee. The Designee's process for 
restructuring must be consistent with the authorizing legislation for 
the Demonstration Program and must meet mandatory Demonstration Program 
objectives including statutory notification requirements and 
affordability requirements.
    Joint Venture Designees will indicate in their letter of interest 
or RFQ that they desire to handle, on a joint venture basis, some or 
all of the projects in their service areas whose owners opt to 
participate in the Demonstration Program. Once the joint venture is in 
place, HUD will assign the Designee demonstration projects. In its 
selection, HUD will give preference to qualified Designees that have 
had positive previous association with specific projects that may seek 
restructuring.
    After being selected by HUD, the Designees will meet with the 
Demonstration Program Coordinator and HUD financial advisors to develop 
a joint venture approach that is mutually satisfactory to HUD and the 
Designees. The approach with each Designee will be formally described 
in a joint venture agreement that will set forth Designee risk and 
authority, HUD oversight, a cost to government calculation model and a 
method of sharing savings to government with HUD and the Designee. The 
joint venture agreement shall provide that HUD shall complete its 
environmental review requirements under 24 CFR part 50, as applicable, 
prior to the entry of any restructuring commitment by HUD or binding 
HUD. The agreement shall also provide that all projects must be in 
conformance with flood insurance purchase requirements, as applicable, 
in accordance with 24 CFR 50.4(b)(1).
    The Demonstration Program limits the number of units for which HUD 
may permit assignment of its insured position, enter into contracts to 
purchase reinsurance or otherwise transfer economic interest in the 
contracts of insurance to 5,000 units. HUD will approve requests from 
Designees to receive such assignment in the order in which they are 
received and subject to HUD's assessment of the benefit to the Federal 
Government and the timeliness of implementation. In the absence of 
Designees for any geographic area, HUD may assume the role of Designee 
and sub-contract the assignment of economic interest.
    The Demonstration Program also limits the number of units for which 
HUD may substitute tenant-based Section 8 assistance for project-based 
assistance to 10% of the aggregate number of units in projects 
restructured in any one fiscal year. HUD will approve requests for 
tenant-based assistance for projects that demonstrate new and 
innovative approaches to restructuring, subject to availability, given 
the 10% limitation.

VIII. Alternative Processing

     The following alternative processing may also be used for projects 
that are not within the jurisdiction of a Designee.
     Within 10 days of execution of the Demonstration Agreement in the 
case of FY 1997 contract expirations, or upon submission of a 
restructuring proposal in the case of post-1997 contract expirations, 
and where the FHA loan is refinanced by a new loan with or without FHA 
insurance, owners may elect to engage an FHA approved lender or 
servicer to undertake some or all of the due diligence and underwriting 
described in these guidelines, subject to review and approval by the 
Demonstration Manager or the field office Multifamily Director. The 
lender/servicer shall submit to HUD a detailed Business Plan signed by 
the owner to include:
    A. An outline of the ownership entity and loan documents required 
for the restructuring proposal (and bond documents, if necessary);
    B. Third party approvals required;
    C. Completed appraisal meeting the requirements of the Uniform 
Standards of Professional Appraisal Practice (USPAP), published by the 
Appraisal Standards Board of the Appraisal Foundation, as modified by 
HUD, incorporating data on operating expenses available from FHA and 
entities such as IREM;
    D. Underwriting analysis including assessment of market rents and 
operating expenses based on the appraisal, proposed operating expenses, 
determination of NOI, supportable financing, proposed principal 
reduction, rehabilitation financing, owner input;
    E. Assessment of rehabilitation needs;
    F. Description and rationale for the mandatory demonstration 
approach to restructuring being selected;
    G. Evidence and certification of proper notification of tenants, 
Affected Unit of Local Government and lender(s) of the owner's intent 
to participate in the Demonstration Program, and a summary of comments 
received in the process and how they were addressed. The same process 
that HUD requires owners to follow for notification, outlined in 
Section VI.D., must be followed;
     H. Description of environmental issues, if any;
     I. Description of litigation issues and tax issues;
     J. Description of public policy issues;
     K. Written record of inquiries from public officials regarding the 
restructuring; and
     L. Other issues as provided more specifically in further guidance 
to be provided by HUD.
     All information in the Business Plan is to be supported by the 
findings of the due diligence activities.
     The restructuring Business Plan will be submitted to the 
Demonstration Manager and or Field Office Multifamily Director for 
approval. Any project rehabilitation or capital improvements supported 
or required by HUD must be processed in accordance with HUD 
environmental review requirements in 24 CFR part 50, prior to HUD's 
approval of the restructuring Business Plan. All projects must be in 
conformance with Flood Insurance purchase requirements, as applicable, 
in accordance with 24 CFR 50.4(b)(1). HUD will respond to the Business 
Plan in 30 days, after negotiating with the owner and lender, with a 
Restructuring Commitment. As in direct HUD processing, the owner will 
have 10 calendar days from the issuance of the Restructuring Commitment 
to appeal, in writing, to the Director of Multifamily Housing in the 
HUD field office with jurisdiction, the terms Restructuring Commitment. 
The written notice of appeal shall specifically state, in reasonable 
detail, the issues and bases upon which the owner seeks review. 
Following the appeal, a modified Commitment may be issued by HUD. If 
needed, after signing a modified Commitment, the owner will qualify for 
an extension of the Demonstration HAP Contract. Failure to sign a 
Restructuring Commitment will result in the termination of the 
Demonstration Agreement and a reduction of project rents to 120% of 
FMR.

[[Page 3581]]

     In cases where the FHA loan is being retained, HUD may request the 
mortgagee or loan servicer to perform due diligence activities and 
underwriting, in coordination with the Demonstration Manager, as 
currently permitted for certain mortgagees and servicers under FHA 
policies.

IX. Other Provisions of Demonstration Program Legislation

 A. Participation of Projects With Post-FY 1997 Expirations

    In the allocation of Demonstration Program funding resources, 
priority will be given to projects with Section 8 contracts expiring in 
FY 1997. Demonstration projects with contracts expiring after FY 1997 
will not be processed until (i) all projects with contracts expiring in 
FY 1997 have either closed on a Restructuring Commitment or the 
Demonstration Agreement has expired; or (ii) HUD determines that the 
proposed restructuring imposes no cost to the Federal Government as 
calculated using the rules established for implementation of the Budget 
Enforcement Act of 1990. In general, the determination of cost to 
government will compare the loss to the Government (cost to FHA) that 
would occur if the demonstration candidate were to have rents set in 
accordance with section 211(b) of the HUD FY 1997 Appropriations Act, 
to the cost to FHA of the proposed restructuring. If the restructuring 
of a project costs less, on a discounted basis, than the total costs if 
the project goes all the way through the default process (assuming 
project rents are reduced to 120% of FMR), then that project will be 
included in the Demonstration Program.
    Post-FY 1997 project owners may enter the Demonstration Program by 
submitting a letter of interest to the Demonstration Program 
Coordinator. The letter of interest must include the following:
    a. Project Name and Address;
    b. FHA Project Number;
    c. FHA Insurance Program;
    d. Unit Rental Information: Gross rent (contract rent plus utility 
allowance, if applicable) by unit type, number of total units and 
assisted units by unit type, owner estimate of market rents by unit 
type, gross rent as a percentage of FMR;
    e. HAP Expiration Date and a copy of the HAP contract and Section 8 
Identification Number;
    f. Loan Information: Unpaid Principal Balance of the FHA-insured 
mortgage(s), original principal amount, loan maturity date;
    g. Owner contact name, address, telephone number and fax number; 
and
    h. Management agent name, address, telephone number and fax number.
    Within 30 calendar days after HUD's receipt of letters of interest, 
HUD will respond to the owner with a calculation of probable cost or 
savings to government, based on the comparison described above. If the 
proposed restructuring appears to generate savings, it will be referred 
to a Designee or to a HUD Demonstration Manager for processing. At the 
same time, project tenants, Lender(s) and the Affected Unit of Local 
Government will be notified in the same manner as required for projects 
with Section 8 contracts expiring in FY 1997. This notice must be 
coordinated with the Field Office having program jurisdiction. HUD's 
restructuring processing for projects with post-FY 1997 expirations 
follows the same process the projects with FY 1997 expirations. 
Designee processing is discussed in Section VII of these Guidelines and 
Alternate processing is discussed in Section VIII.

B. Sunshine Provision

    In order that others may learn from the experience of the 
Demonstration Program, all proposals accepted by HUD to participate in 
the 1997 Demonstration Program may be posted on the Department's Web 
Page (www.hud.gov/fha/mfh/mfhsec8.html). The posted information will 
include, but not be limited to, the final restructuring commitment, 
detailed financial information regarding the asset and tenant issues. 
Owners will be requested to waive the provisions of the Privacy Act (5 
U.S.C. 552a) and the Trade Secrets Act (18 U.S.C. 1905).

X. HUD Findings and Certifications

A. Environmental Impact

    A Finding of No Significant Impact with respect to the environment 
has been made in accordance with HUD regulations at 24 CFR part 50, 
which implement section 102(2)(C) of the National Environmental Policy 
Act of 1969. The Finding of No Significant Impact is available for 
public inspection between 7:30 a.m. and 5:30 p.m. weekdays in the 
Office of the Rules Docket Clerk at the above address.

B. Executive Order 12612, Federalism

    The General Counsel, as the Designated Official for HUD under 
section 6(a) of Executive Order 12612, Federalism, has determined that 
the provisions in this notice are closely based on statutory 
requirements and impose no significant additional burdens on States or 
other public bodies. This notice does not affect the relationship 
between the Federal Government and the States and other public bodies 
or the distribution of power and responsibilities among various levels 
of government. Therefore, the policy is not subject to review under 
Executive Order 12612.

C. Executive Order 12606, The Family

    The General Counsel, as the Designated Official under Executive 
Order 12606, The Family, has determined that this notice does not have 
potential for significant impact on family formation, maintenance, and 
general well-being, and, thus, is not subject to review under the 
order. The notice implements a statutorily authorized demonstration 
program and is intended to find ways of reducing the impact on families 
that might otherwise be caused by the nonrenewal of Section 8 project-
based rental assistance.

    Dated: January 14, 1997.
Stephanie A. Smith,
General Deputy Assistant Secretary for Housing--Federal Housing 
Commissioner.
[FR Doc. 97-1557 Filed 1-22-97; 8:45 am]
BILLING CODE 4210-27-P