[Federal Register Volume 65, Number 246 (Thursday, December 21, 2000)]
[Notices]
[Pages 80686-80695]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32380]



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Part V





Department of Housing and Urban Development





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Public Housing Assessment System; Financial Condition Scoring Process; 
Notice

  Federal Register / Vol. 65, No. 246 / Thursday, December 21, 2000 / 
Notices  

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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Docket No. FR-4509-N-17]


Public Housing Assessment System; Financial Condition Scoring 
Process

AGENCY: Office of the Assistant Secretary for Public and Indian 
Housing, and Office of the Director of the Real Estate Assessment 
Center, HUD.

ACTION: Notice.

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SUMMARY: This notice provides additional information to Public Housing 
Agencies (PHAs) and members of the public about HUD's process for 
issuing scores under the Financial Condition Indicator of the Public 
Housing Assessment System (PHAS). This notice includes generally 
accepted accounting principles (GAAP)-based threshold values and 
associated scores for each Financial Condition Indicator component and 
peer group based on all available data as of October 15, 2000. This 
notice also provides additional clarification to the two audit flag and 
tier classification charts.

DATES: December 21, 2000.

FOR FURTHER INFORMATION CONTACT: For further information contact the 
Real Estate Assessment Center (REAC), Attention: Wanda Funk, U. S. 
Department of Housing and Urban Development, 1280 Maryland Avenue, SW, 
Suite 800, Washington, DC 20024; telephone Technical Assistance Center, 
1-888-245-4860 (this is a toll free number). Persons with hearing or 
speech impairments may access that number via TTY by calling the 
Federal Information Relay Service at (800) 877-8339. Additional 
information is available from the REAC Internet Site at http://www.hud.gov/reac.

SUPPLEMENTARY INFORMATION:

I. Background

    HUD published the first Public Housing Assessment System; Financial 
Condition Scoring Process Notice in the Federal Register (64 FR 26222) 
on May 13, 1999. On June 23, 1999, HUD republished the notice (64 FR 
33700) to coincide with the June 22, 1999, publication of the Public 
Housing Assessment System proposed rule. Subsequently, HUD further 
revised the notice (65 FR 40008) to reflect additional changes to the 
financial scoring process on June 28, 2000. This notice is an update of 
the Financial Condition Scoring Process notice that was published on 
June 28, 2000. In the June 28, 2000, notice, HUD stated that any 
changes to the scoring process and any modifications to the thresholds 
would be communicated through a subsequent Federal Register notice. 
Accordingly, this notice updates the June 28, 2000, notice, and 
provides information on the revision made to the Financial Condition 
Scoring Process Notice. By this notice, HUD is revising the thresholds 
based on a full year's worth of unaudited and available audited GAAP 
data.
    This change has been made in accordance with the threshold 
reevaluation schedule set forth in the June 28, 2000, notice. The 
original thresholds were based on a sample of PHAs reporting under GAAP 
prior to September 30, 1999, and were used for all unaudited and 
audited financial submissions for fiscal year ends through June 30, 
2000. As of September 30, 2000, the thresholds were to be reevaluated 
based on a full year's worth of unaudited and available audited GAAP 
data. This notice provides the revised thresholds based on data 
collected as of September 30, 2000, which includes unaudited and 
audited submissions received during an entire fiscal year. Hereafter, 
the REAC plans to keep the reevaluated thresholds constant for a three 
year period, unless there is a need for revision. Please refer to 
Appendix 2 for the revised thresholds.

II. Financial Condition Indicator

    The chart below shows the six components that constitute the 
Financial Condition Indicator and their assigned points.

                      Financial Condition Indicator
------------------------------------------------------------------------
        Scoring Components                 Measurement           Points
------------------------------------------------------------------------
Current Ratio (CR)................  Liquidity................        9.0
Number of Months Expendable Fund    Adequacy of reserves.....        9.0
 Balance (MEFB).
Tenant Receivables Outstanding      Ability to collect               4.5
 (TRO).                              payments of tenant
                                     receivables.
Occupancy Loss (OL)...............  Ability to lease up units        4.5
                                     and maximize rental
                                     income.
Expense Management/Utility          Ability to maintain              1.5
 Consumption (EM/UC).                expense ratios at a
                                     reasonable relative
                                     level to peers (adjusted
                                     for size and region).
Net Income or Loss as a Percentage  Effect of current year           1.5
 of Expendable Fund Balance (NI).    operations on existing
                                     reserves.
------------------------------------------------------------------------

    The values of the six components of the Financial Condition 
Indicator calculated from the financial data comprise the overall 
financial assessment of the PHA. The components and their relative 
importance to the total financial score are the result of studies of 
PHA financial performance and of industry portfolio management 
techniques to identify the most appropriate financial measures to gauge 
a PHA's financial position. These components represent measures that 
are appropriate benchmarks in any residential real estate environment. 
The score assigned to each component is based on the distributions of 
that component's values and the relative relationship between the 
components and the PHA's overall financial performance.

Financial Assessment Focus

    The PHAS financial assessment is based on the entity-wide 
operations of a PHA, which includes financial information on Section 8, 
Community Development Block Grants, and other HUD funding in its 
calculations, as well as funds from non-HUD sources. GAAP-based scores 
as of September 30, 2000, are enforceable and will be based on an 
entity-wide assessment.

Scoring Approach

    Under PHAS, the components of the PHAS Financial Condition 
Indicator were developed to both fairly and accurately assess a PHA's 
financial performance and financial management. As part of the 
development, the components were tested to establish the correlation 
between PHA performance under each component and the fiscal health of a 
PHA. PHAs were evaluated and assigned scores based on a PHA's 
performance relative to its peers. In other words, all PHAs as a group 
determine the mean score and each PHA is then ranked accordingly. This 
peer assessment approach, which was

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formulated following extensive economic and financial analysis, 
examination of well-accepted business principles, and discussions with 
PHA industry representatives and PHA staff, provides an equitable means 
of measuring the financial performance of PHAs.

Comparable Scoring Systems

    The peer assessment process is not unique to the REAC. Companies in 
the mortgage housing and securities industries, and other Federal 
agencies utilize similar systems in assessing their constituents. 
Fannie Mae, the mortgage housing industry leader, developed an 
assessment system with financial indicators similar to those contained 
in HUD's financial assessment of PHAs. These indicators include 
vacancy, reserve balances, and net income. Like HUD, Fannie Mae uses 
these indicators to rank properties and identify those which require 
further attention. In the securities area, Standard & Poor's conducts 
peer assessment of a company's operational capabilities and cash flows 
relative to their peers. Among Federal agencies, the Department of 
Health and Human Services (HHS) contracts with state and local entities 
to perform financial audits of nursing homes and hospitals 
participating in the Federal Medicare program. Based on these financial 
audits, HHS determines the continued eligibility of these health 
service providers in the Medicare program.

III. GAAP Scoring Processes

    GAAP-based scores are produced using data contained in the 
Financial Data Schedule (FDS). The GAAP-based financial data is first 
used to calculate the six financial ratios that measure various aspects 
of financial health, such as short term liquidity, EM/UC, and 
collection of tenant receivables. Ratios are then translated into 
scores based on its component value relative to its peers. Peer 
groupings are established according to the size of the PHA, based on 
the total number of units operated by the PHA for all programs and 
activities. For the expense management component only, low-rent only 
information plus the geographic location in which it falls is utilized.
    The current size peer groupings are as follows:

Very Small (0-49 units)
Small (50-249 units)
Low Medium (250-499 units)
High Medium (500-1,249 units)
Large (1,250-9,999 units)
Extra-Large (10,000+ units)

    In order to have a more equitable assessment of a PHA's expenses 
relative to its peers, the REAC developed regional peer groupings for 
the EM/UC component, to supplement the size-based peer groups. Thus, a 
PHA is scored on EM/UC against a threshold that is calculated from all 
expense data in that PHA's similar size group and region. The regions 
are based on the first number of the PHA's zip code, and are divided as 
follows:

------------------------------------------------------------------------
                  Region                               States
------------------------------------------------------------------------
0.........................................  CT, MA, ME, NH, NJ, RI, VT.
1.........................................  DE, NY, PA.
2.........................................  DC, MD, NC, SC, VA, WV.
3.........................................  AL, FL, GA, MS, TN, RQ, VQ.
4.........................................  IN, KY, MI, OH.
5.........................................  IA, MN, MT, ND, SD, WI.
6.........................................  IL, KS, MO, NE.
7.........................................  AR, LA, OK, TX.
8.........................................  AZ, CO, ID, NM, NV, UT, WY.
9.........................................  AK, CA, HI, OR, WA, GQ.
------------------------------------------------------------------------

    For the EM/UC component, the size-based peer groups were combined 
into three groups (small, medium and large) for analysis purposes 
because there is not sufficient statistical observations to 
differentiate all six size-based peer groups.
    The minimum number of points (zero) and the maximum number of 
points (thirty) can each be achieved over a range of values. For 
example, on the Current Ratio, large PHAs receive zero points for a 
ratio that is less than one, while they receive nine points for a ratio 
between 1.8 and 3.9. Therefore, PHAs can target one range of values 
that they want to avoid and target one range that they should strive to 
achieve. Aside from these ranges, points are assigned to component 
values along a continuous line. This means that each component value 
will receive a different number of points.
    This system (``continuous scoring'') ensures that points are 
awarded equitably to PHAs along the distribution of component values 
because, in most cases, small differences in component values result in 
only small differences in the scores of the individual components. 
Therefore, two PHAs of a similar size whose values for their financial 
condition components are in close proximity will receive only slightly 
different scores to capture their performance relative to each other. 
For example, a large PHA with a Current Ratio of 1.1 would receive 5.4 
points, while a PHA of the same size with a ratio of 1.2 would receive 
5.9 points.
    The number of points assigned to each component value or range of 
values is based on where the thresholds for that component are set. The 
thresholds separate distinct ranges of scores along the distribution of 
component values. The thresholds and their associated scores are 
estimated based on well-accepted business principles and statistical 
distributions of values within the peer groupings of the PHAs.

Business Principles

    Scoring of certain components follow generally recognized business 
principles. These principles indicate that there are certain absolute 
thresholds below which component values are clearly financially 
unacceptable and component values below that point should result in a 
score of zero. These principles are used in scoring the Current Ratio 
and Number of Months Expendable Fund Balance components. For both of 
these components, a value of less than one is financially unacceptable, 
regardless of PHA size, and therefore merits a score of zero.

Statistical Distributions

    The thresholds are estimated by examining the distributions of 
component values by peer group. For the four most significant 
components (Current Ratio, Number of Months Expendable Fund Balance, 
Tenant Receivables Outstanding, and Occupancy Loss), thresholds are set 
such that approximately 50 percent of the distribution receives the 
maximum number of points, as long as 50 percent of the distribution 
have acceptable values for the component. Thus, the highest number of 
points is awarded to the PHAs whose financial measures are most 
reasonable both relative to their peers and in an absolute business 
sense. The specific percentiles that make this 50 percent of PHAs are 
established by identifying natural break points along the 
distributions. For example, for the Current Ratio and Number of Months 
Expendable Fund Balance, these break points fall at approximately the 
30th and 80th percentiles. The remaining two components (Expense 
Management and Net Income as a Percentage of Fund Balance) assign zero 
points to PHAs that fall only in the extreme outer ranges of the 
distribution of values, and award 1.5 points to the remaining PHAs. The 
scoring functions and thresholds derived from these distributions can 
be found in Appendices 1 and 2.

IV. Audit Adjustments

    Pursuant to 902.63(b)(2), the REAC calculates a revised FASS score 
once audited financial information is received. The revised FASS score,

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which is based on the audited information, can either increase or 
decrease the initial score that was based on the unaudited financial 
information. There are two types of adjustments to the audited score 
that relate to financial audit information. The first type deals with 
the audit flags and reports that result from the audit itself. 
Reportable conditions and material weaknesses are considered to be 
audit flags, alerting the REAC to an internal control weakness or an 
instance of noncompliance with Federal laws and regulations. The second 
adjustment deals with significant differences between the unaudited and 
audited financial information reported to HUD pursuant to 902.63(b)(1).

Audit Opinion and Flags

    As part of the analysis of the financial health of a PHA including 
assessment of the potential or actual waste, fraud or abuse at a PHA, 
HUD will look to the Audit Report to provide an additional basis for 
accepting or adjusting financial component scores (See 63 FR 46607, 
September 1, 1998). The information collected from the annual audit 
report pertains to the type of audit opinion, details of the audit 
opinion, and the presence of reportable conditions and material 
weaknesses.
    If the auditor's opinion is anything other than unqualified, points 
will be deducted from the PHA's audited financial score. The REAC will 
review audit flags to determine their significance as it directly 
pertains to the assessment of the PHA's financial condition. If the 
flag has no effect on the financial components or the overall financial 
condition of the PHA as it relates to the PHAS assessment, the audited 
score will not be adjusted. However, if the flags have an impact on the 
PHAS assessment, the PHA's audited score will be adjusted, in 
accordance with the seriousness of the reported finding.
    These flags are collected by using the OMB A-133 Data Collection 
Form. The PHA completes this form for both the unaudited and audited 
submissions. At the time of the unaudited submission the form is used 
as a self-assessment tool and should reflect the PHA's knowledge of 
their financial and internal control condition and should acknowledge 
their understanding of what the auditor will report.
    If the OMB A-133 Data Collection Form indicates that the auditor's 
opinion will be anything other than unqualified, points will be 
deducted from the PHAS score. The points have been established by the 
REAC using a three-tier system. The tiers are meant to give 
consideration to the seriousness of the audit qualification and to 
limit the deducted points to a reasonable portion of the PHA's total, 
actual score. The tiers, as established by the REAC, are defined below.

                            Audit Flag Tiers
------------------------------------------------------------------------
             Tier                         PHAS Points Deducted
------------------------------------------------------------------------
Tier 1.......................  100 percent of the PHA's total unadjusted
                                FASS score.
Tier 2.......................  10 percent of the PHA's adjusted FASS
                                score.
Tier 3.......................  Maximum of 5 percent of the PHA's
                                adjusted FASS score. This maximum is
                                cumulative and not to be assessed for
                                each Tier 3 audit or internal control
                                flag.
------------------------------------------------------------------------

    Each tier is assessed sequentially beginning with Tier 1; 
subsequent tier deductions are based on the initial score less any 
preceding tier deductions. Tier 3 audit flags are divided into levels 
which reflect the seriousness of the audit qualification and result in 
scoring adjustments based on the following criteria:
    Level 1--0.15 points per occurrence not to exceed three occurrences 
(.45 maximum point deduction).
    Level 2--0.15 points per occurrence not to exceed four occurrences 
(.6 maximum point deduction).
    Level 3--0.075 points per occurrence not to exceed six occurrences 
(.45 maximum point deduction).
    Please refer to the table at the end of this section, titled 
``Audit Flags and Tier Classifications,'' that lists audit flags and 
associated tier classifications.

Review of Audited Versus Unaudited Submission

    The purpose of a comparison of the ratios and scores resulting from 
the current year's unaudited Financial Data Schedule submission to the 
ratios and scores resulting from the current year's audited submission 
is to:
    1. Identify significant changes in ratio calculation results and/or 
scores from the unaudited submission to the audited submission;
    2. Identify PHAs that consistently provide significantly different 
data from their unaudited submission to their audited submission;
    3. Assess or alleviate penalties associated with the inability to 
provide reasonably accurate unaudited data within the required time 
period.
    This review process will only be performed for the audited 
submission.

Materiality and Penalty Assessment

    The REAC views the transmission of significantly inaccurate 
unaudited financial data as a serious condition. Therefore, PHAs are 
encouraged to assure financial data is as reliable as possible for 
their unaudited submissions.
    A significant change penalty will be assessed for significant 
differences between the unaudited and audited submissions. A 
significant difference is considered to be an overall FASS score 
decrease of three or more points from the unaudited to the audited 
submission. The PHAS system automatically deducts the significant 
change penalty from the audited score and this reduction triggers the 
REAC analyst's review.
    The REAC may waive the materiality penalty if the PHA provides 
reasonable documentation of the material difference in its submission. 
A materiality penalty is considered a Tier 3, level 2 audit flag, and 
will result in a reduction of points as associated with all other Tier 
3 audit flags.
    The table, below, summarizes the audit flags and associated tier 
classifications.

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                  Audit Flags and Tier Classifications
------------------------------------------------------------------------
                 Audit flag                      Tier classification
------------------------------------------------------------------------
Unqualified opinion........................  None
No audit opinion...........................  Tier 1
Adverse opinion............................  Tier 1
Disclaimer of opinion......................  Tier 1
Qualified opinion:
1. GAAP qualifications:
    A. Change in accounting principle......  Tier 3, Level 1
    B. Change in accounting estimate.......  Tier 3, Level 1
    C. Change in accounting method.........  Tier 3, Level 1
    D. Departure from GAAP.................  Tier 2
        (1) Financial statements using       Tier 1
         basis other than GAAP.
        (2) Exclusion of alternate           Tier 2
         accounting for an account or group
         of accounts.
        (3) Inconsistently applied GAAP
        (4) Omissions/Inadequate disclosure  Tier 2
2. GASS--Scope limitations.................  Tier 2
    A. Imposed by management...............  Tier 2
    B. Imposed by circumstance.............  Tier 2
    C. Year 2000 (add back)................  Tier 3, Level 1
3. Report on major program compliance......  Tier 3, Level 1
4. Report on internal control..............  Tier 3, Level 1
                                             Tier 3, Level 1
Accounting principles used caused the        Tier 2
 financial statements to be materially
 misstated.
Inadequate records.........................  Tier 2
Going concern..............................  Tier 1
Material noncompliance disclosed...........  Tier 2
    1. Internal control weakness...........  Tier 3, Level 2
    2. Compliance..........................  Tier 3, Level 2
    3. Opinion on supplemental schedules...  Tier 3, Level 2
Reportable condition:
    1. Internal control....................  Tier 3, Level 3
    2. Compliance..........................  Tier 3, Level 3
Significant change penalty.................  Tier 3, Level 2
------------------------------------------------------------------------

V. Appendices

    The graphs shown in Appendix 1 depict the approximate GAAP-based 
scoring functions used for each of the six components of the Financial 
Indicator. Appendix 2 provides revised GAAP-based threshold values and 
associated scores for each component and peer group, based on the GAAP 
data pool as of September 30, 2000. These thresholds, which are based 
on a full year of unaudited and available audited GAAP data, will 
remain in effect for all unaudited and audited PHA financial 
submissions for PHAs with fiscal year ends on or after September 30, 
2000, for a three year period, unless the REAC finds a need for 
revisions. Any revisions to the thresholds will be communicated through 
a Notice.

    Dated: December 13, 2000.
Harold Lucas,
Assistant Secretary for Public and Indian Housing.

Donald J. LaVoy,
Director, Real Estate Assessment Center.

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[FR Doc. 00-32380 Filed 12-20-00; 8:45 am]
BILLING CODE 4210-33-P