[Federal Register Volume 72, Number 228 (Wednesday, November 28, 2007)]
[Rules and Regulations]
[Pages 67524-67560]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-22406]



[[Page 67523]]

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

Part IV





Department of Housing and Urban Development





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



24 CFR Parts 200 and 242



Revisions to the Hospital Mortgage Insurance Program; Final Rule

  Federal Register / Vol. 72, No. 228 / Wednesday, November 28, 2007 / 
Rules and Regulations  

[[Page 67524]]


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

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Parts 200 and 242

[Docket No. FR-4927-F-02]
RIN 2502-AI22


Revisions to the Hospital Mortgage Insurance Program

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

ACTION: Final rule.

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

SUMMARY: This final rule revises the regulations governing HUD's 
mortgage insurance program for hospitals. The rule updates and 
incorporates some earlier provisions that currently are not published 
as part of the Federal Housing Administration (FHA) regulations. 
Further, the rule adds new provisions to make them consistent with 
current industry practices. The rule also codifies the relevant 
regulations that address hospital mortgage insurance in one part, 
thereby making the regulations more user-friendly.

DATES: Effective Date: January 28, 2008.

FOR FURTHER INFORMATION CONTACT: Roger E. Miller, Director, Office of 
Insured Health Care Facilities, Department of Housing and Urban 
Development, 451 Seventh Street, SW., Room 9224, Washington, DC 20410-
8000; telephone (202) 708-0599 (this is not a toll-free number). 
Hearing- and speech-impaired persons may access this number through TTY 
by calling the Federal Information Relay Service at (800) 877-8339 
(this is a toll-free number).

SUPPLEMENTARY INFORMATION:

I. The January 10, 2005, Proposed Rule

    On January 10, 2005, HUD published a proposed rule intended to 
revise HUD's hospital mortgage insurance regulations. The proposed rule 
(70 FR 1750 et seq.) describes in detail the background and purpose of 
the hospital mortgage insurance regulation.
    The January publication proposed eliminating references to hospital 
mortgage insurance in 24 CFR part 200, and proposed codifying the 
entire program in 24 CFR part 242. As a result, users of the regulation 
would be able to find everything they need in one location, and the 
rule would avoid unnecessary repetition.
    The number of applications for hospital mortgage insurance has 
increased recently, and one purpose of this new rule is to respond to 
this increase with more detailed and complete regulatory guidance. The 
new details in the proposed regulation reflect HUD's actual experience 
with the hospital mortgage insurance industry, as well as statutory 
developments that have taken place in the last few years. The result is 
a new proposed comprehensive program of mortgage insurance for 
hospitals to replace the current, much less detailed regulations.

II. This Final Rule

    This final rule follows publication of the January 10, 2005, 
proposed rule, and takes into consideration the public comments 
received. The public comment period for this proposed rule closed on 
March 11, 2005. HUD received comments from four commenters on a wide 
variety of issues related to the proposed rule. Commenters included a 
hospital industry trade association, a financing company, and two 
individuals. The final rule makes a number of changes to the proposed 
rule based on the comments received. The following pages present a 
short, section-by-section description of the changes HUD made in the 
final rule to clarify terminology, conform to a statutory change, and 
address public comments.

Section 242.1 Definitions

    The final rule adds new definitions for the following terms: 
``AMPO'' (Allowance for Making Project Operational); ``applicant''; 
``construction''; ``days of cash on hand,'' in order to clarify 
terminology used in the definition of ``surplus cash''; ``most recent 
audited financial statement''; ``net income''; ``Secretary''; ``service 
area''; and ``substantial rehabilitation.''
    The final rule deletes the definitions of ``Commissioner'' and 
``working capital'' because they are no longer needed. ``Commissioner'' 
is not used in the final rule. ``Working capital'' has been replaced by 
the more commonly understood phrase, ``initial operating capital.''
    The final rule clarifies terminology that was in the proposed rule. 
Commenters found the term ``credit instrument'' confusing, so this 
final rule uses the term ``mortgage note'' instead. For ``Debt service 
coverage ratio,'' the formula has been adjusted to include excess of 
revenues over expenses as an option for net income, and to take into 
account amortization expense. The definition of ``identity of 
interest'' has been revised to include examples in order to provide 
improved guidance. The term ``mortgagee'' has been clarified. The term 
``operating revenue'' has been revised to state that, at HUD's 
discretion, additional items beyond those specifically mentioned, and 
that have been historically and reliably received, may be considered 
operating revenue for underwriting purposes. ``Preapplication meeting'' 
has been revised to clarify that the meeting includes HUD, the 
potential mortgagee, and the potential mortgagor. The definition of 
``project'' has been clarified by using another defined term, 
``substantial rehabilitation,'' and by specifying that construction may 
include replacement of an existing facility.
    The definition of ``surplus cash'' has been clarified by defining 
the phrase ``days of cash on hand,'' which commenters found unclear, 
and by defining some terms used in the definition. In addition, instead 
of using the concept of cash earned, as proposed, the definition now 
considers surplus cash to be the cash remaining after certain 
conditions have been met.

Section 242.4 Eligible Hospitals: Transition Provisions

    The final rule adds a new paragraph (b) to clarify when the 
regulations of part 242, as revised by this final rule become 
applicable, and revises the heading of this section to reflect the 
addition of transition provisions.

Section 242.13 Parents and Affiliates

    The final rule clarifies that the purpose of assurances, 
guarantees, or collateral is to protect HUD's interests.

Section 242.15 Limitation on Refinancing of Existing Indebtedness

    The final rule has substituted the word ``capital'' for ``long-
term,'' because there may be instances where it is necessary to finance 
short-term debt.

Section 242.16 Applications

    The final rule clarifies an exception to the 3-year positive 
operating margin requirement for hospitals in a turnaround situation. 
Under the exception, only one year is required to submit an application 
and 2 consecutive years of positive operating margin are required for 
application approval. The final rule replaces the word ``applicant'' 
with the words ``mortgagor or mortgagee'' in Sec.  242.16(a)(4)(i) to 
reflect that both may expend resources in preparing an application.
    Section 242.16(b)(6) is revised to take account of the fact that, 
as a commenter stated, complete architectural plans may not be 
available at this stage. In the final rule, architectural plans are to 
be filed with the application ``in sufficient detail to enable a 
reasonable estimate of cost.''
    A reference to a 12-month timeframe for a decision on an 
application in Sec.  242.16(f) has been removed in

[[Page 67525]]

response to a comment that the timeframe could imply that a 12-month 
wait for a decision is usual, and thereby discourage applicants. While 
HUD cannot promise a specific timeframe for its review, the agency 
endeavors to respond more promptly than 12 months.

Section 242.21 Refund of Fees

    This section along with Sec.  242.45(e) is revised to make clear 
that the portion of inspection fees paid for early commencement of work 
is not refundable.

Section 242.23 Maximum Mortgage Amounts and Cash Equity Requirements

    Section 242.23(c) is revised to permit a private nonprofit or 
public mortgagor, at HUD's discretion and subject to 24 CFR 242.49, to 
provide equity in the form of a letter of credit. Also, the rule is 
revised to clarify that cash equity is in addition to property, plant, 
and equipment.

Section 242.24 Working Capital

    The final rule clarifies that HUD did not intend to make an initial 
cash deposit a mandatory requirement. Whether such a deposit is 
required will depend in each case on the borrower's financial strength.

Section 242.26 Agreed Interest Rate

    The final rule clarifies that different interest rates may be 
applicable to a project; for example, construction and permanent loan 
rates can differ.

Section 242.28 Allowable Costs for Consultants

    Recognizing that hospital projects can have long planning times, 
this rule changes, from one year to 2 years, the time limit for 
allowing consultant's costs prior to the application.

Section 242.31 Accumulation of Accruals

    The final rule is slightly revised to provide greater flexibility 
for mortgagors in purchasing fire and hazard insurance.

Section 242.33 Covenant for Malpractice, Fire, and Other Hazard 
Insurance

    This final rule adopts language requiring the mortgagor to maintain 
adequate malpractice, fire, and hazard coverage acceptable to the 
mortgagee and HUD.

Section 242.35 Mortgage Lien Certifications

    The final rule is revised so that, in exceptional cases, certain 
personalty may be excluded from the mortgaged property or the insured 
lender may take a secondary lien position on it.

Section 242.37 Mortgage Prepayment

    The final rule permits the 30-day advance notice of intent to 
prepay the mortgage to be extended with HUD approval.

Section 242.39 Insurance Endorsement

    Section 242.39(c) incorporates subpart B of 24 CFR part 207, 
covering contract rights and obligations of the mortgagor, mortgagee, 
and HUD, into this rule. The cross-reference in Sec.  202.94 of the 
proposed rule is therefore no longer needed and is removed in this 
final rule.

Section 242.43 Application of Cost Savings

    The proposed rule required that any cost savings be used to reduce 
the mortgage and the mortgagor's equity contribution proportionally. 
Under this final rule, the mortgagor can elect to have a greater 
proportion of the savings go to mortgage reduction.

Section 242.45 Early Commencement of Work

    The final rule expands this provision to allow for early site 
preparation. It also provides that the cost of structures may be 
refinanced with insured mortgage proceeds if the work was completed 
more than 2 years before application. Where advance approval is sought 
for early site work and construction activity, HUD will require that 
key elements of an application be filed first, with the understanding 
that the remainder of the application will follow.

Section 242.49 Funds and Finances: Deposits and Letters of Credit

    Section 242.49(a) is revised to give a fuller explanation of the 
mortgagor's deposit.

Section 242.50 Funds and Finances: Off-Site Utilities and Streets

    For clarity, Sec.  242.50 has been modified to specify that there 
must be adequate funds available to cover cost of off-site utilities 
and streets.

Section 242.51 Funds and Finances: Insured Advances and Assurance of 
Completion

    This section is revised so that the amount of surety for completion 
is related to the construction contract (or Guaranteed Maximum Price, 
in the case of construction management) rather than the accepted bid 
price.

Section 242.53 Excluded Contractors

    Section 242.53(c) has been revised in this final rule to provide 
for remedial and enforcement actions other than refusing to insure 
further advances.

Section 242.54 Nondiscrimination

    HUD is revising Sec.  242.54 in this final rule to clarify that the 
section does not affect the eligibility of women's and children's 
hospitals for this program.

Section 242.58 Books, Accounts, and Financial Statements

    The final rule allows for the use of Governmental Accounting 
Standards in addition to Generally Accepted Accounting Principles 
because a number of hospitals use Government Accounting Standards.

Section 242.62 Releases of Lien

    The final rule provides that HUD may set thresholds ``or other 
standards'' for the sale, disposition, transfer, or encumbrance of 
property securing a lien under this program.

Section 242.74 Smoke Detectors

    This section is revised to provide that smoke detectors must comply 
with local law.

Section 242.76 Title Evidence

    The final rule is revised to state that the title policy shall 
include as insureds not only HUD and the Secretary, but their 
successors and assigns.

Section 242.89 Supplemental Loans

    This section has been revised to permit refinancing of debt 
incurred in connection with early commencement of work performed in 
accordance with the requirements of this rule.

III. Discussion of Public Comments on the January 10, 2005, Proposed 
Rule

    The issues that commenters addressed were numerous. Therefore, this 
discussion organizes the comments into general comments and those 
addressed to specific sections of the proposed rule. The latter are 
organized by section order for convenience.

General Comments

    Comment: The rule should be re-issued as an interim final rule and 
additional comments regarding ``any material concerns that remain after 
publication'' should be solicited. This is particularly important, 
since HUD policy tends to prohibit discussion about the rule after the 
close of the comment period.
    Response: HUD believes that the public comment process provided 
sufficient opportunity for comment on the proposed rule.
    Comment: The proposed rule was not adaptable and flexible enough 
for the hospital industry. This commenter stated that ``the Proposed 
Rule may inadvertently limit the application of a

[[Page 67526]]

longstanding and effective underwriting approach to Section 242 
financing, which recognizes the organic and evolving nature of hospital 
delivery services.'' This is because hospital services are typically 
delivered in an ``evolving regulatory and service environment'' 
reflecting ``particular needs of a facility's service area as well as 
technological developments and revenue changes dictated by federal and 
state reimbursement rules.'' Adaptable underwriting standards will 
become more necessary as the program involves hospitals in new 
geographical areas. Absent needed flexibility, the ability of hospitals 
to participate in this needed program could be severely limited.
    Response: HUD viewed the lack of explicit, published underwriting 
standards to be a weakness. A principal reason for publishing the 
proposed rule was to correct this weakness, so that potential 
participants can know in advance what HUD's basic underwriting 
standards are and to avoid wasting time and money on applications with 
little or no chance of being approved.
    Comment: In order to make the program sufficiently flexible, HUD 
should move portions of the rule to informal program guidance. This 
non-regulatory, more flexible approach has worked well in other FHA 
programs.
    Response: HUD views the program as being sufficiently flexible to 
accommodate a wide range of circumstances.
    Comment: What is HUD's policy with regard to interest rate swaps?
    Response: The mortgagor may not engage in interest rate swaps or 
other derivative-type transactions, except in conformance with policies 
and procedures to be established by HUD. HUD does not believe that the 
detailed policies and procedures need to be included in the rule. 
However, after consideration of this comment, HUD is adding clarifying 
language in the final rule at Sec.  242.63, so that the section reads:

    The mortgagor shall not enter into any long-term debt, short-
term debt (including receivables/line of credit financing), 
equipment leases, or derivative-type transactions, except in 
conformance with policies and procedures established by HUD.

    Comment: ``Since loan to cost is based on the value of the 
mortgaged property I feel it is not applicable for periods beyond the 
date of closing. Distributions of equity if a concern should be a 
separate covenant if deemed a risk factor.''
    Response: HUD assumes the commenter is referring to the definition 
of surplus cash, because of the reference to distributions of equity. 
Distributions of equity are controlled by Sec. Sec.  242.65 and 242.66. 
There is a separate loan covenant in the loan documents based upon 
these sections.

Comments on Specific Sections

Revisions to Part 200
1. Section 200.24
    Comment: One commenter stated that, as a practical matter, this 
section eliminates Sec.  223(f) and part 242 refinancing for non-FHA 
insured loans, an unfortunate and unnecessary consequence. The rule 
should allow otherwise financially sound non-FHA hospitals access to 
much-needed debt service savings in a rapidly eroding low-interest rate 
climate when they have no present need for new capital improvements. 
This change would also allow FHA to realize additional fees and 
Mortgage Insurance Premium (MIP) revenues without related construction 
or start-up risk. This commenter stated that the application of Section 
223(f) to FHA's multifamily programs has been determined to be sound 
enough to permit a program MIP reduction. A 223(f)/242 program would be 
equally successful.
    A commenter stated that if the proposed deletion of Section 223(f) 
authority, which is currently in regulations, is adopted, and if at a 
subsequent date FHA determines Section 223(f) for hospitals to be in 
the public interest, FHA will face a difficult and time-consuming 
regulatory process to implement that result. This commenter states that 
there is no public policy benefit gained by deleting Section 223(f)/242 
financing authority and that existing regulations should remain in 
effect.
    Response: The reference to section 223(f) of the National Housing 
Act, 12 U.S.C. 1715n(f), in 24 CFR part 200, was never intended to 
provide program authority. Should the Department decide to implement 
section 223(f) for hospitals, explicit regulations would be required to 
provide program structure. HUD is not prepared to issue such 
regulations at this time, although it could consider doing so at a 
later date.
    Comment: FHA's ``Operating Loss Loans'' authority has been deleted 
from the draft regulations. The commenter recommends that it be 
reinstated.
    Response: With respect to Section 223(d), HUD's policy has been not 
to authorize any 223(d) loans for hospitals, and none have ever been 
authorized. The exclusion of Section 223(d) from the rule is consistent 
with that policy.
2. Section 200.40 HUD Fees
    Comment: Section 223(f)/242 authority should be kept in effect by 
adding the following text from current regulations to Sec.  200.40(c):

    For a mortgage being insured under Section 242 of the Act (12 
U.S.C. 1715z-7), an application fee of $1.50 per thousand dollars of 
the amount loaned shall be paid to HUD at the time the hospital 
application is submitted to the Department and the balance thereof 
no later than initial endorsement.

    Response: For the same reasons discussed in connection with 
comments regarding hospital loans under section 223(f) of the National 
Housing Act, HUD is not adopting this suggested change.
Subpart A--General Eligibility Requirements
3. Section 242.1 Definitions
    Comment: The term ``applicant'' should be defined as to whether the 
term is meant to apply to the lender or mortgagor throughout the 
regulations. The ``applicant'' should be the mortgage lender.
    Response: HUD agrees that ``applicant'' should be defined because 
of the possibility of confusion between the roles of lender and 
mortgagor. Therefore, a definition of ``applicant'' has been added.
    Comment: The term ``application'' should be defined.
    Response: HUD sees no need for a definition of this term; 
``application'' is commonly understood in the industry.
    Comment: The definition of cash should include operating cash, 
short-term investments, and funded depreciation accounts. By 
definition, this would exclude all trusteed accounts. Days of operating 
expenses should be defined as total operating expenses minus 
depreciation and interest.
    Response: The comment appears to be a reference to the calculation 
of ``days of cash on hand,'' a term appearing in the definition of 
``surplus cash.'' In order to clarify this term, a definition of ``days 
of cash on hand'' has been added as a separate definition.
    Comment: The definition of ``chronic convalescent and rest'' should 
be revised to delete the terms ``respite care services,'' ``hospice 
services,'' and ``rehabilitation services.'' Instead, the definition of 
``chronic convalescent and rest'' should be tied directly to the types 
of services provided in the Section 232 program. There is no evidence 
that the term ``chronic care'' set forth in the National Housing Act 
(NHA) includes respite care, hospice, or rehabilitation, particularly 
when delivered on an independent basis and not in

[[Page 67527]]

connection with chronic convalescent patients. The proposed definition 
would appear to exclude revenues received from these services from 
inclusion in the calculation of acute care patient days for purposes of 
determining whether a proposed project meets the NHA's 50 percent 
chronic care bed limitation.
    Response: The inclusion of respite, hospice, and rehabilitation 
patient days in the definition of ``chronic convalescent and rest'' is 
consistent with the language in the introductory paragraph of the 
statute. That language would preclude patient days for such services 
from being counted for the purpose of calculating hospital eligibility 
based on patient days under the statute's ``50 percent rule.'' The 
statute, 12 U.S.C. 1715z-7(a), states:

    The purpose of this section is to assist the provision of 
urgently needed hospitals for the care and treatment of persons who 
are acutely ill or who otherwise require medical care and related 
services of the kind customarily furnished only (or most 
effectively) by hospitals.

    Respite, hospice, and chronic rehabilitation services are not acute 
care services and do not require the services furnished only (or most 
effectively) by hospitals. Typically, these services are not provided 
in hospital beds, but rather in sub-acute settings. These services are 
most accurately included in the broad category, specified in the 
statute, of ``chronic convalescent and rest'' and, in some cases of 
rehabilitation, in the excluded categories of ``drug and alcoholic'' 
and ``mentally deficient.''
    Comment: The rule should include a definition of ``commitment.''
    Response: HUD sees no need for a definition; the concept of a HUD 
mortgage insurance commitment is well understood in the industry.
    Comment: The rule should include a definition of ``credit 
instrument.''
    Response: Where the term ``credit instrument'' appeared in the 
proposed rule, HUD has substituted the term ``mortgage note'' in this 
final rule for clarity.
    Comment: A commenter stated that the definition of ``debt service 
coverage ratio'' should be revised to remove the second and third 
sentences, which reference a high coverage ratio. These sentences are 
unnecessary and potentially problematic. The proposed definition 
suggests that absent a ``high debt service coverage ratio,'' which is 
undefined, a project is ineligible. The language potentially conflicts 
with specific coverage standards set forth in Sec.  242.16, and as such 
there would appear to be no need for a nonspecific policy statement of 
this type. At a minimum, a cross-reference should be made to Sec.  
242.16 to avoid interpretation conflicts.
    This commenter also stated that the commenter presumes that the 
formula in the definition describes the formula currently in use.
    Response: HUD agrees that the second and third sentences are 
potentially problematic and has removed them. The formula in the 
definition has been clarified, as follows: Debt Service Coverage Ratio 
(total debt service coverage on all long-term capital debt) equals:
[GRAPHIC] [TIFF OMITTED] TR28NO07.051

    Comment: A commenter states that the rule should add a phrase to 
the definition of ``hospital'' to accommodate possible future changes, 
as follows:

    Hospital means a facility that has been proposed for approval or 
has been approved by HUD under the provisions of this subpart, as 
this definition may be modified from time to time pursuant to the 
Act. * * *

    The commenter states that possible future changes may include, for 
example, an extension of the exclusion of Critical Access Hospitals 
from the 50 percent acute care requirement beyond its current 2006 
sunset, or the elimination of the 50 percent rule in its entirety.
    Response: The definition of ``hospital'' is statutory, as is the 
exclusion of critical access hospitals from the 50 percent rule. (See 
12 U.S.C. 1715z-7(b)(1).) At the time of the comment period on the 
proposed rule, the statutory exemption for Critical Access Hospitals 
ended in 2006. On July 10, 2006, the exemption for Critical Access 
Hospitals was extended through July 31, 2011. The relevant portion of 
this final rule has been conformed to that statutory change. HUD does 
not believe further definition is necessary.
    Comment: The definition of ``identity of interest'' should be 
modified as follows to permit identity of interest transactions subject 
to additional underwriting criteria, and to give HUD the ability to set 
the criteria:

    Identity of interest means a relationship that must be disclosed 
and may be either prohibited or subject to additional underwriting 
or criteria pursuant to the requirements of HUD or the Regulatory 
Agreement.

    Response: HUD does not believe that this concept needs to be 
explicitly stated. HUD has the authority to waive provisions in the 
Regulatory Agreement for good cause. However, for clarity, HUD includes 
examples of identity of interest relationships in the definition in 
this final rule.
    Comment: The definition of ``mortgagee or lender'' should be 
revised to remove material regarding trust indentures, and to expand 
the definition to include the ``proposed lender with respect to an 
application for commitment.'' Regarding the indenture, the commenter 
states that indentures, in the sense the industry uses the term, are 
not involved, and that the FHA mortgagor would not be a party to the 
indenture (the commenter states that ``indenture'' means a contract 
between a government bond issuer and a bond trustee for loans financed 
through tax-exempt revenue bonds). The suggested revised definition 
would read as follows:

    Mortgagee or Lender means the proposed lender with respect to an 
application for a commitment and/or the original lender under a 
mortgage, and its successors and assigns, which is the holder of the 
governing mortgage and other related credit instruments (All 
official contacts and actions by HUD shall be with or through a HUD-
approved lender).

    Response: The reference to ``trust indenture'' in the proposed rule 
derived from an obsolete reference. HUD does not insure trust 
indentures. Therefore, use of the term ``trust indenture'' would be 
confusing because many mortgages are funded with bond issues, pursuant 
to trust indentures. Therefore, this final rule changes the definition 
of ``mortgagee'' to:

    The original lender under a mortgage, and its successors and 
assigns, including the holders of mortgage notes issued under a 
trust mortgage or deed of trust, pursuant to which such holders act 
by and through a trustee therein named.

    Comment: The first sentence of the proposed definition of 
``mortgage reserve fund'' should be revised to read:

    Mortgage Reserve Fund means a trustee-held account for the 
benefit of the

[[Page 67528]]

Commissioner to which the mortgagor contributes funds required by 
HUD and from which withdrawals must be approved by HUD.

    Response: The mortgage reserve fund is not only for the benefit of 
HUD, it is also for the benefit of the hospital to preserve the value 
of the hospital and to help prevent default. In order to clarify this 
purpose, the first sentence has been modified to state, ``Mortgage 
reserve fund means a trust account, or an account held by the 
mortgagee, for and on behalf of the mortgagor, to which the mortgagor 
contributes funds required by HUD and from which withdrawals must be 
approved by HUD.''
    Comment: The second and third sentences of the definition of ``non-
operating revenues and expenses'' should be revised, as follows:

    Examples of items classified as non-operating are State and 
Federal income tax, general contributions, gains and losses from 
investments, and unrestricted income from non-designated endowment 
funds, and income from related entities received by a hospital 
sponsor. Classification of items as operating or non-operating shall 
be in accordance with generally accepted accounting principles or 
other applicable accounting standards.

    Response: The suggestion is to insert ``non-designated'' before 
endowment funds to make the wording state that ``unrestricted income 
from non-designated endowment funds'' is excluded from operating 
income. HUD does not agree and would consider unrestricted income from 
all endowment funds to be non-operating revenue.
    The commenter suggests that generally accepted accounting 
principles determine classification of operating and non-operating 
revenue and that investment income should be included in operating 
income. It is true that some endowment funds generate income for the 
general benefit of the hospital. However, the income these funds 
generate, depending on the type of investment and market conditions, 
are subject to variance and may not be available for servicing the 
mortgage in future periods. There is no direct corresponding expense 
associated with the investment income that can be eliminated if the 
investment income decreases. Therefore, this final rule retains the 
wording without change.
    Comment: One commenter suggests a minor editorial revision to the 
definition of ``operating revenue'' under the heading of ``operating 
margin,'' to add the phrase ``but not limited to'' after ``including'' 
in the parenthetical example.
    Response: HUD agrees that the items listed were intended to be 
examples and not an exclusive list.
    Comment: The rule should add a definition of ``acute care patient 
days'' and provide for adjustment of ancillary non-bed hospital 
services to an acute care patient day.
    Response: This term is not used in the rule and no definition is 
necessary. Also, HUD believes that the calculation of adjusted patient 
days is at a level of detail that is not necessary to include in the 
regulation.
    Comment: A portion of the definition of ``personalty'' (from the 
third sentence beginning ``Generally, intangibles * * *'' to the end) 
should be revised, as follows:

    Generally, intangibles shall also include all cash and cash 
escrow funds which are not otherwise pledged in connection with 
obligations of the mortgagor outstanding at initial endorsement, 
such as, but not limited to: depreciation reserve fund or mortgage 
reserve fund accounts, bank accounts, residual receipt accounts, all 
unrestricted contributions, donations, gifts, grants, bequests and 
endowment funds by donors, and all other revenues and accounts 
receivable from whatever source paid or payable. All personalty 
shall be securitized with appropriate UCC filings and any excluded 
personalty shall be indicated in the Regulatory Agreement and the 
Security Agreement.

    The commenter states that the language regarding otherwise-pledged 
obligations should be added to provide an exception for funds pledged 
at or prior to initial endorsement in connection with bond-related 
obligations (such as construction fund negative arbitrage) issued to 
fund the FHA loan or in connection with other outstanding obligations 
of the mortgagor described in the FHA application. The qualifier of 
``unrestricted'' should be added because under state law, donor 
restricted funds may be governed by terms and conditions set by the 
donor.
    Response: HUD does not believe it is necessary to narrow the 
definition of ``personalty,'' because Sec.  242.64 already permits 
exclusions for specific personalty.
    Comment: One commenter suggests a minor clarification to the 
definition of ``preapplication meeting'' to specify that a potential 
applicant in this case is a mortgagor or lender, while elsewhere in the 
rule the term should refer to a mortgagee. The commenter suggests 
clarification of these usages.
    Response: HUD has clarified the definition.
    Comment: The definition of ``preliminary review letter'' should be 
revised, as follows:

    Preliminary Review Letter means a letter from HUD to a potential 
mortgagee communicating the result of the Preliminary Review. The 
letter may: (1) State that an application for mortgage insurance 
would result in a rejection and provide the reasons for this 
determination, (2) state that there are factors that need to be 
further developed before a determination as to acceptability of a 
project for Preliminary Review may be made, or (3) state that no 
factors that would cause an application to be rejected have been 
identified, and therefore there appears to be no bar to the 
applicant proceeding to submit an application for insurance.

    The commenter states that, even though an early determination of 
eligibility is desirable, the definition ``may be unnecessarily 
severe'' as proposed, and that the rule should provide for further 
discussion or the submission of additional materials at an early stage, 
which may present HUD with sufficient evidence to reverse an initial 
rejection. Also, the term ``next step'' is too vague and should be 
specified.
    Response: HUD agrees that ``potential applicant'' in the first 
sentence should be replaced. HUD has replaced that term with ``proposed 
mortgagee or mortgagor.'' This language allows HUD to receive and 
fulfill requests for a preliminary review not only from proposed 
mortgagees, but also from proposed mortgagors (hospitals) that are 
seeking to determine if they are viable candidates for an insured loan, 
before they retain a mortgage lender.
    HUD does not believe it necessary to insert the language the 
commenter proposes as clause (2), because communication often takes 
place between the mortgagee and HUD to clarify matters during the 
preliminary review and because there is already flexibility in Sec.  
242.16 for HUD to reconsider a negative determination.
    HUD agrees that the phrase ``the next step in the application 
process'' is vague and has replaced it in this final rule with ``a 
preapplication meeting.''
    Comment: The definition of ``project'' should be revised as follows 
to include the soft costs of construction (interest, taxes, MIP, etc.), 
as follows:

    Project means the construction (which may include a replacement 
of an existing hospital facility), rehabilitation, modernization, 
expansion, or renovation of an eligible hospital, including 
equipment, which has been proposed for approval or has been approved 
by HUD under the provisions of this subpart, including the financing 
and refinancing of existing indebtedness and other related costs in 
connection therewith, if any, plus all related activities involved 
in completing the improvements to the property.

    Response: In reviewing the definition of ``project,'' HUD realized 
that the word

[[Page 67529]]

was used to mean different things in different places. In several 
instances, the proposed rule used ``project'' when referring to the 
hospital or mortgagor. This usage derives from HUD's multifamily 
housing programs, in which ``project'' is used to refer not only to the 
construction project and the financing thereof, but also to the ongoing 
operations of the residential rental business during the life of the 
loan. For clarity, this final rule makes a distinction between 
``project'' as defined here and ``hospital'' or ``mortgagor.''
    HUD also considered the use of terms such as ``modernization,'' 
``renovation,'' and ``expansion.'' The final rule uses the term 
``substantial rehabilitation'' to encompass all of these activities, 
and a definition of this term has been added in Sec.  242.1.
    Finally, HUD believes that the definition of ``project'' is not the 
appropriate place to introduce the concept that a construction project 
includes soft costs.
    Therefore, the definition of ``project'' has been revised to 
specify the meaning of the word in all contexts in which it is used in 
the rule, and to conform the definition to the final rule's definition 
of ``substantial rehabilitation.''
    Comment: The definition of ``regulatory agreement'' should be 
modified to include lessees of the mortgagor, if applicable, as 
regulated entities under the regulatory agreement. The commenter cites 
the Shoshone Medical Center as an example.
    Response: HUD disagrees. As a general policy, leasing of the entire 
hospital is not contemplated. However, HUD does have the authority to 
approve leasing, on a case-by-case basis, for good cause, as was 
demonstrated in the example offered.
    Comment: One commenter suggests revisions as follows to the 
proposed definition of ``security instrument'' and also questions 
whether the definition is required, given that there is also a proposed 
definition of ``mortgage.''

    Security instrument means a mortgage, deed of trust or any other 
document evidencing security for the indebtedness represented by a 
note endorsed for insurance by HUD and shall be deemed to be the 
mortgage as defined by the National Housing Act, as amended, 
implementing regulations, and HUD directives.

    Response: HUD believes that the definition of ``security 
instrument'' is adequate, and that it is inappropriate to include 
discussion of the note in this definition.
    Comment: A commenter asked whether the rule could provide a 
definition of what constitutes the service area, and stated that some 
hospitals serve patients from all over the country or all over the 
state, although most of their patients come from the nearby surrounding 
community.
    Response: In order to avoid ambiguity, a definition of ``service 
area'' is added to Sec.  242.1 of this final rule.
    Comment: The definition of ``state'' should be revised to change 
``Virgin Islands'' to ``United States Virgin Islands.''
    Response: HUD agrees, and this final rule adopts this change.
    Comment: The definition of ``surplus cash'' is a departure from 
existing practice, particularly when proprietary sponsors are involved, 
in that it would no longer permit distributions of cash earned in prior 
periods that a mortgagor elected not to distribute. To eliminate this 
problem, surplus cash would be better defined in terms of cash 
remaining as opposed to cash earned in a fiscal period. This change 
would be in accordance with HUD Circular 4615.2 and HUD's draft 
applicant's guide. In addition, the commenter suggests changes to give 
HUD more flexibility to set standards. The commenter also proposes 
enlarging the ``days in accounts receivable'' portion of the test 
because, historically, many hospitals are unable to meet the proposed 
test. Accordingly, this commenter suggests the following revised 
language:

    Surplus Cash means any cash in the applicable fiscal period or 
prior fiscal periods, including accounts receivable, remaining after 
the following have been achieved:
    (1) Mortgage payments for the preceding 12 months have been made 
when due, including any grace period;
    (2) There is a Debt Service Coverage Ratio greater than or equal 
to 1.50 or such other ratio as HUD may deem appropriate;
    (3) Days in Accounts Receivable are less than or equal to 100 or 
such other day count as HUD may deem appropriate;
    (4) Days in Accounts Payable are less than or equal to 120 or 
such other day count as HUD may deem appropriate;
    (5) The Mortgage Reserve Fund is compliant with the scheduled 
balance;
    (6) All income, property, and statutory employer payroll taxes 
and employee payroll withholding contributions have been deposited 
as required;
    (7) The Current Ratio is greater than or equal to 1.50 or such 
other ratio as HUD may deem appropriate;
    (8) Days of cash on hand are greater than or equal to 15 days or 
such other day count as HUD may deem appropriate; and
    (9) The payment of:
    (i) All sums due or currently required to be paid under the 
terms of the Mortgage Note and Regulatory Agreement due on the first 
day of the month following the end of the applicable fiscal period, 
including, without limitation, in the Mortgage Reserve Fund or any 
other reserves as may be required by HUD; and
    (ii) All other current obligations of the hospital (accounts 
payable except for a 100 day exception and accrued, unescrowed 
expenses), unless funds for payment are set aside or HUD has 
approved deferment of payment.

    Response: The addition of the qualifiers, ``or as HUD shall deem 
appropriate,'' negates the intended purpose of this rule to make clear 
the minimum financial standards applicable to hospitals with insured 
loans. With respect to ``surplus cash,'' HUD agrees that cash earned in 
prior periods that a mortgagor elected not to distribute would be 
included and that ``surplus cash'' should be defined as earned cash 
remaining as opposed to cash earned in a fiscal period.
    This final rule also adds language to the definition requiring the 
hospital to meet particular minimum equity requirements and restricting 
distributions until those requirements are met. The final rule 
clarifies that the most recent audit required under the regulatory 
agreement, in conjunction with the effect of the distribution on the 
interim financial statements, will provide the basis for limitations on 
distributions. Items 9(i) and 9(ii) of the proposed definition were 
deleted as being duplicative. Accordingly, the final rule revises the 
definition of ``surplus cash.''
    Comment: One commenter stated: ``We feel that 21 and 15 are very 
low standards. We would suggest it be raised to 30 days.''
    Response: HUD assumes that this comment is meant to refer to the 15 
days of cash on hand portion of the definition of ``surplus cash'' in 
the proposed rule. HUD agrees that 15 days cash on hand is a very low 
standard and has increased it to 21 days cash on hand. HUD considered 
the commenter's suggestion to increase the days of cash on hand to 30. 
However, HUD did not believe it necessary to raise the standard that 
high. The increase to 21 days strengthens the prior standard, provides 
sufficient liquidity to make a payroll, and is currently met by 50 
percent of the hospitals in the HUD portfolio.
    Comment: One commenter stated that ``average payment period'' would 
be a better measure to use in this definition.
    Response: HUD assumes that the commenter was referring to the use 
of the term ``days in accounts payable'' in the definition of ``surplus 
cash.'' The measure ``average payment period'' has become the standard 
in the industry because it is more comprehensive and less subject to 
manipulation. HUD

[[Page 67530]]

agrees to the substitution of this measure for ``days in accounts 
payable.''
    Comment: One commenter suggests that the definition of ``working 
capital'' be deleted because it is used only once in the rule (Sec.  
242.24).
    Response: HUD agrees with the comment. This final rule removes the 
definition of ``working capital'' in favor of a phrase that is better 
understood, ``initial operating capital,'' and revises the title of 
Sec.  242.24 to ``Initial Operating Costs.''
4. Section 242.3 Encouragement of Certain Programs
    Comment: One commenter states that everything after the word 
``hospitalization'' should be deleted because the language ``is neither 
an eligibility requirement of the Act.* * *nor, to our knowledge, a 
statement of current FHA policy.'' The commenter is concerned that this 
language may be interpreted as a mandatory underwriting requirement, 
making otherwise eligible projects ineligible.
    Response: The language that the commenter requests be deleted is 
indeed a requirement stated in the statute, 12 U.S.C. 1715z-7(f). This 
section states that:

    The activities and functions provided for in this section shall 
be carried out by the agencies involved so as to encourage programs 
that undertake responsibility to provide comprehensive health care, 
including outpatient and preventive care, as well as 
hospitalization, to a defined population, and, in the case of public 
hospitals, to encourage programs that are undertaken to provide 
essential health care services to all residents of a community 
regardless of ability to pay.

    HUD's underwriting reflected this requirement in the past and will 
continue to do so in the future. HUD included the words ``and certain 
not-for-profit hospitals'' after ``in the case of public'' in 
recognition of the role that many not-for-profit hospitals fulfill in 
providing indigent care in areas where there are no public hospitals or 
in which public hospital capacity is limited. In response to the 
commenter's concern about mandatory underwriting requirements, HUD 
notes that encouragement of the provision of comprehensive health care 
to a population does not mean that a hospital is ineligible because it 
does not plan to provide comprehensive care or does not plan to provide 
services to all residents regardless of ability to pay. It does mean, 
however, that HUD should consider the provision of care and the role 
that a proposed hospital would play across the service area.
5. Sections 242.4 and 242.5 Eligible Hospitals and Eligible Mortgagees
    Comment: Section 242.4 should be revised to conform to the 
definition of ``project'' by adding the phrase ``modernization, 
expansion, or renovation'' before the phrase, ``of an existing 
hospital.''
    Response: The definition of ``project'' has been revised in 
response to other public comments to mean the ``construction or 
substantial rehabilitation'' of an eligible hospital. This change also 
addresses the issue cited by this commenter. In addition, HUD has added 
a paragraph on transition to these regulations.
    Comment: The title to Sec.  242.5 should be revised to read 
``Eligible mortgagees/lenders.''
    Response: HUD agrees, since this title reflects the terminology 
used in the final rule.
6. Section 242.7 Maximum Mortgage Amounts
    Comment: The following phrase should be added after the word 
``installed'' and before the period at the end of the sentence:

* * *and other related project development costs, including but not 
limited to capitalized interest and Commissioner approved fees.

    Response: HUD intended this section to outline broadly the maximum 
mortgage amount as a percentage of replacement cost. The level of 
detail sought by the commenter is outside the scope of this section.
7. Section 242.9 Physician Ownership
    Comment: The last sentence of this section, as proposed, would 
require an ``unqualified legal opinion'' regarding compliance with 
applicable federal law. An unqualified legal opinion is difficult to 
obtain, and ``an opinion satisfactory to HUD'' would be a more 
appropriate standard.
    Response: HUD has been able to obtain unqualified legal opinions on 
all professionally owned hospitals since the decision to accept these 
sponsors into the program was made in January 2003. It would take an 
inordinate amount of time and expertise for staff to perform the due 
diligence reflected in an unqualified opinion. The unqualified opinion 
benefits mortgagors that otherwise would have to obtain an opinion from 
the Inspector General at the Department of Health and Human Services 
(HHS). Therefore, in the best interests of the program, HUD shall 
retain the requirement of an ``unqualified legal opinion.''
8. Section 242.10 Eligible Mortgagors
    Comment: Lessees of mortgagors should also be included for the same 
reason as in the definition of ``regulatory agreement.'' The commenter 
also states that the section should be revised to read in its entirety:

    The mortgagor shall be a public mortgagor (e.g., an owner of a 
public facility), a private nonprofit corporation or association, or 
a profit-motivated mortgagor meeting the definition of ``hospital'' 
in Sec.  242.1. The mortgagor or a lessee of the mortgagor shall be 
approved by HUD and shall possess the powers necessary and 
incidental to operating a hospital. Eligible proprietary or profit-
motivated mortgagors may include for-profit corporations, limited 
partnerships, and limited liability corporations and companies.

    The commenter states that ``natural persons, joint ventures and 
general partnerships'' are eligible mortgagors in other FHA insurance 
programs and is unaware of any program or legal basis for excluding 
such ownership forms from Section 242 eligibility if underwriting 
criteria are otherwise met. The sentence beginning ``for new 
organizations'' should be deleted and ``treated as a program, not a 
regulatory requirement.'' Finally, it would also seem inappropriate 
that stockholders of a privately held corporation should be required to 
admit other parties to its board of directors (although it may be 
considered for advisory board purposes), or to otherwise require that 
private corporations be treated as public entities. The term ``broad 
community participation'' is undefined, may be difficult to precisely 
define, and should be treated in a ``more flexible, case by case non-
regulatory fashion.''
    Response: Generally, this section states the statutory requirements 
for an eligible hospital mortgagor. Regarding the statement that 
lessees of mortgagors should also be included, the National Housing Act 
makes it clear that HUD can insure mortgages where long-term ground 
leases are involved. However, HUD generally prohibits leases of the 
entire hospital. In those rare instances where a lease is necessitated 
by local law, HUD will continue to evaluate each situation on a case-
by-case basis.
    The comments also suggest striking the latter portion of the 
section. This wording was carefully developed and HUD believes that 
there is considerable wisdom in not permitting mortgagor entities with 
other obligations that could interfere with the operation and stability 
of the hospital. The same is true of ensuring the continuity of the 
mortgagor entity so that a legal entity is in place for as long as HUD 
insures a mortgage loan. Finally, HUD does not agree that the language 
in this section

[[Page 67531]]

requires that private corporations be treated as public entities.
9. Section 242.11 Regulatory Compliance Required
    Comment: One commenter suggests minor editorial changes, as 
follows:

    An application for insurance of a mortgage under this part shall 
be considered only in connection with a hospital that is in 
substantial compliance with regulations of the Department of Health 
and Human Services and the applicable State governing the operation 
and reimbursement of hospitals. A hospital that is under 
investigation by any State or Federal agency for statutory or 
regulatory violations is not eligible so long as the investigation 
is unresolved, unless HUD determines that the investigation is minor 
in nature, that is, the investigation is unlikely to result in 
substantial liabilities or of otherwise substantially harming the 
creditworthiness of the hospital.

    Response: HUD adopts these minor clarifying changes to the final 
rule. Noncompliance with HHS and state regulations can result in 
significant liabilities and can increase the risk of suspension or 
cutoff of reimbursements from federal or state payors, significantly 
increasing the risk that the hospital will default on the FHA-insured 
mortgage loan.
10. Section 242.13 Parents and Affiliates
    Comment: One commenter suggests editorial revisions, as follows:

    As a condition of issuing a commitment, HUD may require 
corporate parents, affiliates, or principals of the proposed 
mortgagor to provide assurances, guarantees, or collateral with 
respect to the mortgage loan. HUD may also require financial and 
operational information on the parent, other businesses owned by the 
parent, or affiliates of the proposed mortgagor and may also require 
a parent or affiliate to agree that it will not take any actions 
which could impact the financial viability of the hospital and its 
ability to repay the mortgage loan.

    Response: HUD agrees that more language is needed to clarify the 
first sentence ending in ``collateral.'' However, the suggested 
language is too narrow. In the final rule, the sentence is revised to 
read, ``As a condition of issuing a commitment, HUD may require 
corporate parents, affiliates, or principals of the proposed mortgagor 
to provide assurances, guarantees, or collateral to protect HUD's 
interests.'' HUD interprets the second suggested revision also as 
narrowing HUD's ability to protect its interests. Thus, the existing 
language in the second sentence will be kept.
11. Section 242.14 Mortgage Reserve Fund
    Comment: One commenter suggests editorial revisions, as follows:

    As a condition of issuing a commitment, HUD may require 
establishment of a Mortgage Reserve Fund (MRF), a trustee-held 
account to which the mortgagor will contribute and from which 
withdrawals must be approved by HUD. The mortgagor shall be required 
to make contributions to the MRF such that, with fund earnings, the 
MRF will build to one year of debt service at five years following 
commencement of amortization, increasing thereafter to two years of 
debt service on and after ten years following commencement of 
amortization according to a schedule established by HUD, unless HUD 
determines that a different schedule of contributions is appropriate 
based on the mortgagor's risk profile, reimbursement structure, or 
other characteristics. In particular, hospitals that receive cost-
based reimbursement may be required to have MRFs that build to more 
than two years of debt service. Expenditures from the fund may be 
made for such purposes, including the payment of debt service as HUD 
may determine or in accordance with the mortgagor's MRF Schedule. 
Upon termination of insurance, the balance of the MRF shall be 
returned to the mortgagor provided that all obligations to HUD have 
been met.

    Response: The benefit of the MRF has been tested over time, and its 
availability has afforded hospitals in financial distress the time and 
relief needed to effectuate a turnaround. For that reason, HUD 
disagrees with the suggested substitution of the word ``shall'' with 
``may.'' The availability of an MRF has served HUD, the mortgagee, and 
the mortgagor well, and this final rule continues to require it.
    With respect to expenditures from the fund, HUD believes that the 
original language is clear on its face and that the additional wording 
is likely to result in confusion and misinterpretation as to the 
primary intent of the MRF, which is for the payment of debt service.
    HUD concurs that the inclusion of ``following commencement of 
amortization'' clarifies the MRF funding requirement and has made the 
appropriate change.
    Also, the final rule removes the text in the first sentence 
following the second comma, because the revised definition of 
``mortgage reserve fund'' makes this language redundant.
12. Section 242.15 Limitation on Refinancing of Existing Indebtedness
    Comment: One commenter states that the restriction to long-term 
debt should be removed and that 15 percent rather than 20 percent of 
the mortgage must be used for hard costs. As to the former suggestion, 
the change is necessary to permit loans to fund projects completed 
prior to initial endorsement and financed on the basis of short-term 
rather than long-term loans. As to the latter, the 20 percent 
requirement is not a statutory requirement, and the lower standard will 
allow ``otherwise necessary'' projects to be able to utilize the 
program. The revised language would read as follows:

    Some existing debt may be refinanced with the proceeds of a 
section 242 insured loan; however, at least 15 percent of the amount 
of the mortgage must be used to fund the hard costs of construction, 
equipment and mortgageable costs and expenses related thereto, 
including but not limited to interest, taxes and other Commissioner 
approved fees typically included in a commitment.

    Response: By deleting but not replacing ``long-term,'' the proposed 
revision would permit any existing debt to be refinanced, such as 
operating debt. This would be contrary to the intended purpose of the 
program to insure the financing of capital projects. However, HUD 
understands that there may be cases where it would be appropriate to 
refinance some short-term capital debt. Therefore, HUD has substituted 
the word ``capital'' for ``long-term.'' Reducing the 20 percent 
requirement to 15 percent would blur the distinction between Section 
242 and Section 223(f), which HUD is not implementing for hospitals 
through this rule, and HUD does not agree to this revision.
Subpart B--Application Procedures and Commitments
1. Section 242.16 Applications
    Comment: One commenter asks whether HUD determines the need or the 
state CON (Certificate of Need) process does, and states that the rule 
should clarify this issue.
    Response: HUD conducts the same analysis of need whether or not the 
state has a CON process. There is wide variation in the methods CON 
states use to decide whether or not to issue a certificate. HUD 
believes that the Act's required need assessment is best performed 
using a method that is applied consistently to hospitals in all states. 
Should the state's CON process and HUD's assessment of need reach 
differing conclusions on the need for a proposed project, HUD will 
review the case closely to determine if its conclusion should be 
changed.
    Comment: One commenter suggests a variety of substantive and 
editorial changes to this section. The commenter would revise Sec.  
242.16(a)(1), as follows:

    (a) The process for approval of an application shall include 
consideration of the following financial and programmatic factors.

[[Page 67532]]

    (1) Market need. The approval process shall include an analysis 
of the market need of the proposed project, on a market-wide basis, 
the impact of the proposed facility on, and its relationship to, 
other health care facilities and services; the number and percentage 
of any excess beds; and demographic projections.
    Generally, except in cases acceptable to HUD, Section 242 
insurance may support start-up hospitals or major expansions of 
existing hospitals only if existing hospital capacity or services 
are not adequate to meet the needs of the population in the service 
area.
    (i) If the State has an official procedure for analyzing need 
for hospitals, HUD shall require that such procedure be followed 
before the application for insurance is submitted, and that the 
application shall document that need has also been established under 
that procedure; provided that in circumstances acceptable to HUD, an 
application may be submitted and review commenced prior to the 
issuance of such State approval.

    Response: The commenter suggests deletion of the requirement that 
HUD consider the impact of the proposed facility on other health care 
facilities that ``have a disproportionate share of Medicaid and 
uninsured patients,'' because it is not a program requirement.
    However, the statute, 12 U.S.C. 1715z-7, requires HUD to administer 
the program ``so as to encourage programs that undertake responsibility 
to provide comprehensive health care including outpatient and 
preventive care, as well as hospitalization, to a defined population. * 
* * Disproportionate share hospitals are a critical element in 
providing such care, acting as a ``safety net'' for care of the 
uninsured. These hospitals typically use profitable product lines to 
subsidize unprofitable activities in a practice known as ``cost 
shifting.'' A new project that takes profitable business away from a 
disproportionate share hospital can have the effect of reducing its 
ability to provide comprehensive health care to the local population. 
For this reason, HUD believes that it should pay particular attention 
to the impact of a proposed project on disproportionate share 
hospitals. Also, see HUD's response to comments on Sec.  242.3.
    The commenter also stated that ``in circumstances acceptable to 
HUD'' the rule should allow for an application to be submitted prior to 
issuance of official state approval. The commenter stated that as the 
program gets broader national application, there will be instances 
where it is ``prudent and equitable'' to begin the review of an 
application before a certificate of need is issued, ``particularly when 
it is reasonably inferred that a certificate of need will eventually be 
issued and the mortgagor is willing to pay the required application fee 
to reimburse FHA's costs.'' The commenter stated that this concern is 
``particularly important in the context of the extensive construction 
periods associated with hospital projects, as well as the impact of 
escalating costs on project feasibility.''
    However, HUD interprets the statute, 12 U.S.C. 1715z-7, to require 
that the certificate of need will be submitted as part of the 
application.
    Comment: One commenter stated that Sec.  242.16(a)(2) should be 
revised, as indicated:

    Operating margin and debt service coverage ratio. (i) Hospitals 
with an aggregate operating margin of less than 0.00 when calculated 
from the three most recent annual audited financial statements are 
not eligible for section 242 insurance, unless HUD determines, based 
on the financial data in those statements or other financial 
criteria or empirical information acceptable to HUD, that the 
hospital has achieved a financial turnaround resulting in a positive 
operating margin in the most recent year, calculated using 
classifications of items as operating or non-operating in accordance 
with guidance that shall be provided in accordance with generally 
accepted accounting principles or HUD is satisfied based on other 
available financial information or evidence acceptable to HUD that 
the project constitutes a reasonable underwriting risk.

    The commenter stated that this change would permit flexibility, for 
example, in cases such as Critical Access Hospital applications where 
prior financial statements were allowed to be retroactively restated to 
reflect unusual circumstances such as prospective cost plus 
reimbursement. The commenter stated that negative historical operating 
margins may not always be relevant to a determination of a facility's 
prospective viability. For example, a hospital may have had an 
historical negative operating margin substantially, if not solely, as a 
result of excessive debt service, which may be fully eliminated through 
the proposed FHA financing. Similarly, a proposed mortgagor may be 
trying to reposition a struggling hospital and new or rehabilitated 
facilities, and equipment may enable that facility to compete more 
effectively, deliver services more efficiently, provide a higher 
quality of services, or offer new services without which a needed 
facility might never be able to improve its financial posture. The 
commenter states that negative historical margins should not result in 
automatic disqualification.
    Response: HUD believes that in almost all cases, the proven ability 
to operate in the black is an essential prerequisite for consideration 
for mortgage insurance. Hospitals transitioning from the prospective 
payment system to cost-based reimbursement may recast financial results 
to present them as if they had been receiving cost-based reimbursement 
in prior years. In unusual circumstances, the applicant can request a 
waiver of the regulatory requirement for a positive operating margin.
    Comment: The commenter states that there is no requirement that a 
start-up hospital (without an operating history) meet an historical 
operating margin test. To apply the standard automatically to an 
existing facility would seem discriminatory when, in fact, the new FHA 
financing may in and of itself allow the facility in question to meet 
or exceed required standards. HUD should also consider giving special 
financial consideration to Critical Access Hospitals, sole community, 
and disproportionate share providers where other financing options are 
prohibitively expensive or unavailable.
    Response: It is true that start-up hospitals have no operating 
history to examine, and for that reason other factors become more 
important in HUD's review of the potential start-up mortgagor. However, 
when a hospital has an operating history, HUD must examine that history 
in evaluating the hospital's creditworthiness. HUD believes that 
demonstrated ability to operate in the black is the single most 
important indicator of financial strength and ability to repay debt. 
Note that an exception to the 3-year positive average operating margin 
may be granted in demonstrated financial turnaround situations.
    This exception has been clarified in Sec.  242.16(a)(2)(i). A 
hospital that has achieved a financial turnaround resulting in a 
positive operating margin in the most recent year may be considered 
eligible to apply for section 242 insurance. However, HUD does not 
anticipate approving an application unless the hospital has achieved 
two consecutive years of positive operating margin immediately prior to 
issuance of an insurance commitment. Accordingly, the following 
sentence has been added to the end of Sec.  242.16(a)(2)(i):

    In any event, HUD shall not issue an insurance commitment for 
any hospital that has not achieved two consecutive years of positive 
operating margin immediately prior to issuance of the commitment.

    Comment: Section 242.16(a)(2)(ii) should be revised, as follows:

    (ii)(A) Hospitals with an average debt service coverage ratio of 
less than 1.25 in the three most recent audited years are not 
eligible for section 242 insurance unless HUD

[[Page 67533]]

determines, based on the audited financial data, that the hospital 
has achieved a financial turnaround resulting in a debt service 
coverage ratio of at least 1.25 in its prior 12 month period, or 
other period acceptable to HUD, or HUD is satisfied based on other 
available financial information or evidence acceptable to HUD, that 
the project constitutes a reasonable underwriting risk.
    (B) In cases of refinancing at a lower interest rate, HUD may 
authorize the use of the projected debt service requirement in lieu 
of the historical debt in calculating the debt service coverage 
ratios for each of the prior three years. In cases where HUD 
authorizes the use of the projected debt service requirement in lieu 
of the historical debt to determine the debt service coverage ratio, 
hospitals must have an average debt service coverage ratio of 1.40 
or greater, or such lesser ratio as may be acceptable to HUD.

    As to the first of these suggested changes, the commenter stated 
that the 1.40 standard should be revised to reflect the ``underlying 
1.25 standard,'' particularly in situations where special financial 
consideration may be warranted, as described above. As to the allowance 
of a lesser debt service ratio, such a change would help promote 
flexibility as described above.
    Response: HUD believes that the cash that was available 
historically to service debt is an important factor in considering a 
hospital's ability to service debt in the future. A debt service 
coverage ratio of 1.25 is considered quite low. The prospective debt 
service coverage ratio of 1.40 is generally the minimum HUD will 
tolerate in its underwriting of a mortgage insurance application. It is 
also quite low. The reason HUD will consider applications for hospitals 
with such low debt service coverage is that the Department recognizes 
its role in providing affordable financing to needed hospitals that are 
not financially robust enough to be of interest to private insurers. 
However, HUD believes that to accept even lower ratios would not be 
prudent.
    Comment: Sections 242.16(a)(3) and (4) should be revised, as 
indicated:

    (3) Financial Feasibility. The process for reviewing an 
application shall include an analysis of the financial feasibility 
of the proposal, i.e., an analysis indicating that it is probable 
that the proposed mortgagor will be able to meet its debt service 
requirements during the period projected. It includes analysis of 
the reimbursement structure of the proposed hospital (including 
patient/payer mix); actions of competitors; and the probable 
projected impact on the proposed hospital of general health care 
system trends, such as the development of alternative health care 
delivery systems and new reimbursement methods. In addition to 
historical operating margin, analysis of financial feasibility 
includes, but is not limited to, evaluation of the following 
factors. The application must address, and HUD will review, each of 
the following factors:
    (i) Current and projected gains from operations and a manageable 
debt load using reasonable assumptions;
    (ii) Current average debt service coverage ratio over a period 
determined acceptable by HUD of 1.25 or higher and projected debt 
service coverage ratio of 1.40 or higher, or such lesser ratio as 
may be acceptable to HUD;
    (iii) Cushion in the balance sheet sufficient to demonstrate the 
ability to withstand short periods of net operating losses without 
jeopardizing financial viability;
    (iv) Patient utilization forecasts (including average length of 
stay, case intensity, discharges, area-wide use rates) that are 
consistent with the hospital's historical trends, future service 
mix, market trends, population forecasts, and business climate;
    (v) The hospital's demonstrated ability to position itself to 
compete in its marketplace;
    (vi) Organizational affiliations or relationships that help 
optimize financial, clinical, and operational performance;
    (vii) Management's demonstrated ability to operate effectively 
and efficiently, and to develop effective strategies for addressing 
problem areas;
    (viii) Systems in place to monitor hospital operations, 
revenues, and costs accurately and in a timely manner;
    (ix) A Board that is appropriately constituted and provides 
effective oversight;
    (x) Required licensures and approvals; and
    (xi) Favorable ratings from the Joint Commission on 
Accreditation of Healthcare Organizations or other organization 
acceptable to HUD.
    (4) Preliminary Review. A Preliminary Review is a general 
overview of the acceptability of a potential mortgagor performed at 
the request of a lender, to identify any factors that would likely 
cause an application to be rejected, should an application be 
submitted.
    (i) The purpose of the preliminary review is for HUD to identify 
any obvious factors that would cause an application to be rejected, 
before the potential mortgagor expends the resources needed to 
prepare an application and before HUD expends resources to review 
it. The lender shall submit a preliminary information package to HUD 
that provides evidence of statutory eligibility, market need, 
financial strength, and such other documentation as HUD may require.
    (ii) If HUD identifies factors that would cause an application 
to be rejected, HUD shall issue a Preliminary Review Letter 
notifying the potential applicant that an application for mortgage 
insurance would result in a rejection and providing the reasons for 
this decision. Also, no further request from the proposed applicant 
for a Preliminary Review shall be entertained for a period of one 
year from the date of HUD's notification. HUD may grant an exception 
to this one-year limitation if, during the year, there is a major 
change in the circumstances that caused HUD to determine that the 
project would be rejected or if additional material information is 
provided with respect to the reasons on which a rejection is based 
and which justifies reconsideration of an adverse Preliminary Review 
Letter. For example, if the sole reason for HUD's determination was 
the hospital's failure to meet the historical operating margin test, 
and a new audited annual financial statement contains results that 
would cause the hospital to meet the test, then the lender may 
request a new Preliminary Review within one year of HUD's 
notification.

    As to the projected debt service coverage ratio, the commenter 
stated that application of the proposed 1.40 standard for these 
purposes without a provision permitting Commissioner discretion to 
accept a lower projection, particularly where the FHA calculation 
deletes earnings and contributions, may preclude otherwise viable 
hospitals from program eligibility. As to the suggested change 
regarding consideration of additional material information, the 
commenter cited fairness given the potential one-year bar.
    Response: The commenter had a number of suggestions. First, the 
commenter proposed language that says the application review will 
include an ``analysis of the financial feasibility of the hospital'' 
instead of a ``determination of the financial feasibility.'' HUD 
believes this change is unnecessary, as the meaning of 
``determination'' is discussed immediately thereafter.
    The commenter suggests using ``during the period projected'' 
instead of ``during the life of the proposed mortgage'' when 
highlighting the period in which HUD will determine financial 
feasibility. This change is accepted.
    The commenter suggested lowering the standard of the debt service 
coverage requirement by adding language stating that HUD may consider a 
lesser ratio. HUD rejects this response; please see the response to the 
previous comment on Sec.  242.16(a)(2)(ii) for more information.
    The commenter suggests requiring that only lenders (as opposed to a 
hospital, a financial consultant representing a hospital, or a lender) 
request a preliminary review. HUD has, in the past, accepted requests 
for preliminary reviews from hospitals and consultants. In some cases, 
hospitals wish to assess their eligibility prior to retaining a 
mortgage banker. HUD will keep the existing language and notes that 
pre-application meetings for projects with a positive preliminary 
review require the participation of the proposed mortgagor's mortgage 
banker.
    The commenter suggests replacement of the word ``applicant'' in 
(4)(i) with the word ``mortgagor.'' HUD has replaced ``applicant'' with 
the words ``mortgagor or mortgagee'' to reflect that

[[Page 67534]]

both may expend resources in preparing an application.
    The commenter suggests adding language further describing under 
what circumstances HUD may reconsider an adverse preliminary review. In 
its current form, the ``Commissioner may grant an exception * * * if 
there is a major change in circumstances that caused'' the rejection. 
Specifically, the commenter suggests adding ``or if additional material 
information is provided with respect to the reasons on which a 
rejection is based and which justifies reconsideration of an adverse 
Preliminary Review.'' HUD considers this added language to be 
repetitive. Thus, the existing language will remain.
    Comment: In accordance with a comment to Sec.  242.1, above, the 
term ``mortgagor'' should be substituted for the term ``applicant'' in 
proposed Sec.  242.16(a)(5).
    Response: HUD agrees that the term ``mortgagor'' is clearer and the 
change has been made.
    Comment: One commenter stated as to Sec.  242.16(b)(6) that the 
following should be added to the current ``architectural plans and 
specifications'': ``* * * to the extent available when the application 
is filed.'' The commenter stated that usually architectural plans are 
not available when the application is submitted.
    Response: HUD does not intend to require that complete 
architectural plans and specifications be submitted when a complete 
application is received. However, the addition of language stating that 
the drawings and specifications may be submitted ``to the extent 
available when the application is filed,'' as suggested by the 
commenter, is insufficient. Accordingly, the language in 242.16(b)(6) 
will be changed, as follows: ``Architectural plans and specifications 
in sufficient detail to enable a reasonable estimate of cost.''
    Comment: One commenter stated that Sec.  242.16(b)(8) should be 
revised, as indicated:

    If the State has an official procedure for determining need for 
hospitals, evidence that such procedure has been followed and that 
need has been established under that procedure; provided that as set 
forth in Section 242.16(a)(1)(i) hereof, HUD may allow an 
application to be filed in certain circumstances acceptable to HUD.

    Response: The additional language is not necessary since HUD 
interprets the statute, 12 U.S.C. 1715z-7, to require that the 
certificate of need will be submitted as part of the application.
    Comment: One commenter stated that Sec.  242.16(b)(9) should be 
revised, as indicated:

    If HUD has authorized the Department to conduct the 
environmental study required as a condition of mortgage insurance, 
evidence of compliance with Federal and State environmental 
regulations; if HUD has not commissioned such study, the study shall 
be commissioned and completed prior to the issuance of a commitment.

    Response: HUD does not perform the initial environmental site 
assessment; this is the responsibility of the mortgagor or mortgagee. 
The application must include a Phase I environmental report and, if 
Phase I indicates that further study is required, evidence and results 
of the further study.
    Comment: One commenter stated that Sec.  242.16(e) should be 
revised, as indicated:

    Complete application. Only materially complete applications will 
be processed. Except as otherwise provided in this subpart, partial 
applications cannot be processed. Upon determination that an 
application is complete, HUD shall issue a Completeness Letter to 
the applicant stating that the application is complete. Such letter 
shall be issued within two weeks of the receipt of an application 
which is in compliance with this section.

    The commenter states that the term ``technically complete'' is 
unnecessarily vague and that ``materially complete'' is an appropriate 
and common industry standard.
    Response: Regarding the first comment, HUD does not see an 
advantage in using the term ``materially'' complete over 
``technically'' complete. Maintaining the term ``technically'' is a 
higher standard that will ensure applications are deemed complete only 
when all the information has been received in a satisfactory form. In 
certain cases, HUD will deem an application complete when only very 
minor items are missing and the applicant has agreed to supply HUD with 
these items in less than 2 weeks' time.
    Concerning the second change, HUD will not commit to a 2-week 
deadline for the return of a Completeness Letter. It is an internal 
guideline that staff will make every effort to meet; however, factors 
beyond HUD's control may at times prevent the Department from meeting 
that guideline.
    Comment: The last sentence of Sec.  242.16(f) should be revised, as 
indicated:

    (f) * * *. It is the intent to communicate HUD's decision with 
respect to a project as promptly as possible after receipt of a 
completed application in the form of a Commitment Letter or a 
Rejection Letter, but HUD shall be under no obligation to issue such 
letter within a predetermined timeframe.

    The commenter stated that, although the completion of a Section 242 
application is not subject to predictable timeframes and that 
unreasonable borrower expectations have been created when timeframes 
have been expressed, the inclusion of a 12-month timeframe standard 
will be extremely detrimental to the program and discouraging to 
borrowers. As a practical matter, the simple and clear statement 
suggested above would allow FHA to accomplish its objectives without 
the negative and dispiriting implication represented by a 12-month 
timeframe.
    Response: HUD agrees that referencing a 12-month timeframe may 
discourage borrowers by causing them to believe that 12 months are 
routinely required. That reference has been removed.
2. Section 242.17 Commitments
    Comment: Section 242.17(a)(1) should be revised to permit insurance 
upon completion, as well as insurance upon advances. According to the 
commenter, this would maintain ``maximum levels of flexibility to deal 
with the multiple and unique circumstances of healthcare providers.''
    Response: Insurance upon completion was considered by HUD, but left 
out of the rule. HUD has never had a request for insurance upon 
completion and does not have procedures in place to allow applicants to 
use this procedure. Therefore, the final rule has not been changed to 
include insurance upon completion.
    Comment: Section 242.17(c)(2) should be revised to permit 
commitments to be extendable beyond 180 days with the approval of HUD. 
The commenter states that a commitment period of more than 180 days may 
occasionally be required to permit a mortgagor to comply with 
commitment terms and conditions and to complete arrangements in 
connection with the financing of the insured loan, particularly when 
the financing source is revenue bond proceeds.
    Response: After 6 months, factors such as construction costs, 
interest rates, the hospital's actual financial performance, and others 
that were considered by HUD as reasons for issuing a commitment, can 
change. Substantial resource expenditure can be involved in HUD's re-
evaluation of the financial feasibility of the project in light of 
changing circumstances. Further, an analysis of insured hospital 
mortgages that were initially endorsed during the prior 3 years 
indicates that in only one case did the hospital require more than 6 
months between commitment and initial endorsement.

[[Page 67535]]

Therefore, HUD believes that if the mortgagor cannot be prepared to go 
to initial endorsement within 6 months after receiving a commitment, 
and later determines that it is ready to proceed to initial 
endorsement, the procedures described in Sec.  242.20 should be 
followed to request a reopening of an expired commitment. For these 
reasons, HUD does not adopt this comment.
    Comment: Section 242.17(d) should be revised, as indicated:

    Commitment fee. A commitment fee which, when added to the 
application fee, will aggregate $3.00 per thousand dollars of the 
amount of the loan set forth in the commitment, shall be paid at or 
prior to initial endorsement.

    Response: It is possible that an applicant who receives a 
commitment may find other means of financing prior to initial 
endorsement. Under the commenter's proposal, HUD would not collect a 
commitment fee in this case. HUD sees no need to encourage a situation 
where HUD does not collect a commitment fee after expending 
considerable resources in review of an application.
3. Section 242.18 Inspection Fee
    Comment: Section 242.18 should be revised, as indicated:

    The commitment may provide for the payment of an inspection fee 
in an amount not to exceed $5 per thousand dollars of the commitment 
amount. In determining the amount of such inspection fee, HUD shall 
consider the amount of the loan that is being applied to the 
refinancing of the hospital's existing indebtedness. The inspection 
fee shall be paid at the time of initial endorsement or in the case 
of a start of construction prior to initial endorsement, such 
earlier time as HUD may require.

    The commenter states that, unlike most multifamily housing 
projects, Section 242 hospital mortgages often include refinancing 
components substantially exceeding new construction costs and related 
expenses. To charge the inspection fee on the full mortgage amount in 
such cases would seem inappropriate. HUD Handbook 4480.1 specifies that 
in the case of rehabilitation or reconstruction of an existing 
structure, the HUD-FHA Inspection Fee is computed on the cost of new 
improvements and mortgageable equipment. The commenter states that 
specific language to this effect should be included in the new 
regulation.
    Response: Regardless of the amount of the refinancing, HUD's 
mortgage on the property demands that it perform a full inspection of 
the property. Because of the complexity of hospital facilities, the 
inspection involves a great amount of work regardless of whether there 
is a refinancing component. The inspection fee reflects this effort. 
Basing the inspection fee on the full amount of the proposed mortgage 
is consistent with long-standing practice. The final rule, therefore, 
retains the proposed language concerning inspection fees.
4. Section 242.19 Fees on Increases
    Comment: Section 242.19 should be revised, as indicated:

    (a) Increase in commitment prior to endorsement. An application, 
filed prior to initial endorsement, for an increase in the amount of 
an outstanding commitment, shall be accompanied by an additional 
application fee of $1.50 per thousand dollars computed on the amount 
of the increase requested. Any increase in the amount of a 
commitment shall be subject to the payment of an additional 
commitment fee which, when added to the additional application fee, 
will aggregate $3.00 per thousand dollars of the amount of the 
increase. The additional commitment fee shall be paid at initial 
endorsement of the related mortgage increase. If an inspection fee 
was required in the original commitment, an additional inspection 
fee shall be paid in an amount not to exceed $5.00 per thousand 
dollars of the costs of construction represented in the increase in 
commitment. The additional inspection fee shall be paid at the time 
of initial endorsement.
    (b) Increase in mortgage between initial and final endorsement. 
Upon an application, filed between initial and final endorsement, 
for an increase in the amount of the mortgage, by amendment, 
supplemental consolidated mortgage or by substitution of a new 
mortgage, an additional application fee of $1.50 per thousand 
dollars computed on the amount of the increase requested shall 
accompany the application. The approval of any increase in the 
amount of the mortgage shall be subject to the payment of an 
additional commitment fee which, when added to the additional 
application fee, will aggregate $3.00 per thousand dollars of the 
amount of the increase granted. If an inspection fee was required in 
the original commitment, an additional inspection fee shall be paid 
in an amount not to exceed $5.00 per thousand dollars of the amount 
of the increase granted based on the amount of construction set 
forth in the mortgage increase ratio. The additional commitment and 
inspection fees shall be paid within 30 days after the date that the 
increase is granted or at the endorsement of such mortgage increase 
by HUD.

    Response: Delay of payment of the additional commitment and 
inspection fees is not in the best interest of the program, for the 
reasons given in the responses to comments on Sec. Sec.  242.17(d) and 
242.18. The proposed change to add ``supplemental consolidated 
mortgage'' has been implemented by adding ``consolidation agreement'' 
in Sec.  242.19(b). The remaining changes proposed to this section have 
not been included in the final rule for reasons described above.
5. Section 242.20 Reopening of Expired Commitments
    Comment: One commenter states that this section should be revised 
to permit waiver of the reopening fee ``solely on grounds acceptable to 
HUD.''
    Response: In the proposed regulation, a commitment expires after 90 
days and may be extended to 180 days. If a commitment expires, the 
proposed rule provides that within 90 days of expiration, the applicant 
may request a reopening. In this case, 6 to 9 months will have passed 
since the original commitment. With the passage of so much time, the 
basis for HUD's issuance of the commitment may no longer be valid. HUD 
would have to review changes in construction cost, interest rates, 
actual performance of the hospital, and other factors to determine 
whether to grant the request for reopening. That review would require 
an expenditure of HUD resources, for which a fee is appropriate. HUD 
believes that a waiver process would not be productive. Therefore, HUD 
does not adopt the comment.
6. Section 242.21 Refund of Fees
    Comment: The regulation should address whether the portion of the 
inspection fee that is related to pre-commitment work or early start is 
refundable if the conditions described in Sec.  242.21 are met as the 
government has expended resources prior to the initial closing at the 
request of the hospital.
    Response: The inspection fee in the case of early commencement of 
work will be non-refundable. For a full discussion of issues concerning 
early commencement of work, see the response to comments on Sec.  
242.45, as well as the final version of that section.
7. Section 242.22 Maximum Fees and Charges by Mortgagee

    Commenter: The subject section should be revised, as indicated:

    The mortgagee may collect from the mortgagor a total financing 
fee for origination and placement of a mortgage loan in an amount 
not to exceed five and one half percent of the original principal 
amount of the mortgage, as agreed upon by mortgagee and mortgagor 
and approved by HUD. Any additional charges or fees, unless paid 
from non-mortgage sources, collected from the mortgagor shall be 
subject to prior approval of HUD and shall be disclosed in the 
Mortgagee's Certificate.

    This commenter states that, as a practical matter, the traditional 
multifamily separate categorization of

[[Page 67536]]

FHA financing fees as origination and placement have been effectively 
eliminated in the Section 242 program, where such fees are often 
aggregated into a single financing fee. This aggregate approach has 
been particularly helpful for hospital loans financed with tax-exempt 
revenue bonds, where placement-related costs are generally higher than 
those for taxable financings and origination fees are lower. FHA should 
consider describing the fee structure as a single aggregate line item 
not to exceed 5.5 percent.
    Response: Current policy in the Section 242 program is to limit 
financing and placement fees to a total of 3.5 percent, with an 
exception to allow a total of 5.5 percent, on a case-by-case basis, 
when so requested by the mortgagee. The proposed rule brings the 
Section 242 program in agreement with all other Multifamily Mortgage 
Insurance programs. The maximum financing fee the mortgagee may charge 
is 3.5 percent of the mortgage amount, with a maximum of 2 percent for 
the initial financing charge and the remainder of the 3.5 percent for 
the permanent financing fee.
    Higher fees up to 5.5 percent are permissible in bond transactions. 
Where the proposed financing is through the sale of either taxable or 
tax-exempt bonds, the maximum financing fees allowable in the mortgage 
computation and recognizable for cost certification purposes is 5.5 
percent of the mortgage amount. Any cost beyond the 5.5 percent must be 
paid from sources outside the mortgage.
    The maximum financing fee the mortgagee may retain for its own 
account is 3.5 percent (for the initial financing fee and permanent 
financing fee, as indicated above). The remaining 2 percent (or such 
greater percentage as may result from the lender reducing its maximum 
retainable 3.5 percent fee) may be used to offset the cost of bond 
fees.
    Comment: In some states, for example New York, state and local 
governments charge fees in connection with tax-exempt revenue bonds and 
certificates of need. Therefore, HUD should consider a separate 
capitalized line item for state and local government fees.
    Response: A new capitalized line item to cover such costs would be 
beyond the scope of the proposed rule.
8. Section 242.23 Adjusted and Reduced Mortgage Amounts
    Comment: One commenter states that rehabilitation projects under 
this section should explicitly include project expansion, and suggests 
inserting language in Sec.  242.23(a) and Sec.  242.23(a)(2)(i) to this 
effect. Additionally, in Sec.  242.23(a)(3)(ii), the commenter states 
that the phrase ``value of'' should be deleted.
    Response: The term ``substantial rehabilitation'' is broad and 
encompasses projects that expand the facility. See comments and 
responses to Sec.  242.4 and to the definition of ``project'' at Sec.  
242.1. The first occurrence of the phrase ``value of'' in proposed 
Sec.  242.23(a)(3)(ii) was superfluous and is removed in this final 
rule.
    Comment: Section 242.23(c) on cash equity should be revised, as 
indicated:

    Cash equity. Depending upon the financial circumstances of each 
hospital facility, HUD shall have the discretion to evaluate, on a 
case-by-case basis, the amount of cash equity that a mortgagor must 
supply in addition to the value of plant, property and equipment and 
other values recognized as loan security in the commitment process. 
Exercise of this discretion shall never cause a loan to exceed 90 
percent of estimated replacement cost, although it may cause it to 
be less than 90 percent. The equity contribution may not be made 
from borrowed funds. A private nonprofit or public mortgagor, but 
not a proprietary mortgagor, in the mortgagee's discretion and 
subject to 24 CFR 242.49, may provide any such required equity in 
the form of a letter of credit or surety bond issued by an insurance 
company acceptable to HUD.

    The commenter states that historically, nonprofit hospitals have 
been permitted to post required non-PPE (property, plant, and 
equipment) equity at Initial Endorsement in the form of a letter of 
credit, a privilege stated in Section 242(d) of the NHA. The commenter 
states that the letter of credit privilege should be augmented to 
permit equity to be posted in the form of ``surety bonds'' issued by an 
acceptable insurance company such as AMBAC, FGIC, MBIA, or FSA. The 
surety bond alternative would represent an opportunity for institutions 
to fund equity at more competitive costs.
    Response: HUD agrees with the suggested changes to the first and 
second sentences. However, HUD does not agree to delegate to the 
mortgagee the determination of the form the equity should take. Nor 
does HUD agree that surety bonds are an acceptable form of equity. Such 
delegation and use of surety bonds for equity do not offer the level of 
protection the Department considers necessary.
    Sec.  242.23(c) is revised as indicated:

    Cash equity. Depending upon the financial circumstances of each 
hospital facility, HUD shall have the discretion to evaluate, on a 
case-by-case basis, the amount of cash equity that a mortgagor must 
supply in addition to the value of plant, property, and equipment 
and other values recognized as loan security in the commitment 
process. Exercise of this discretion shall never cause a loan to 
exceed 90 percent of estimated replacement cost, although it may 
cause it to be less than 90 percent. The equity contribution may not 
be made from borrowed funds. A private nonprofit or public 
mortgagor, but not a proprietary mortgagor, in HUD's discretion and 
subject to 24 CFR 242.49, may provide any such required equity in 
the form of a letter of credit.

    To further clarify Sec.  242.23, HUD has changed its title to 
``Maximum Mortgage Amounts and Cash Equity Requirements.''
9. Section 242.24 Working Capital
    Comment: The title of this section should be revised to ``Reserve 
for start-up costs.''
    Response: The title is changed to ``Initial Operating Costs,'' as 
discussed in the response to a comment on the definition of ``Working 
Capital'' in proposed Sec.  242.1.
    Comment: The section should be revised, as indicated:

    In the case of a new hospital or a hospital expansion, HUD shall 
establish, on a case-by-case basis, the amount of capital, if any, 
that must be deposited in cash, a letter of credit or surety bond 
(or any combination thereof) to be available to the new hospital 
upon commencement of operations. Generally, the working capital 
other than AMPO shall not be borrowed funds unless HUD determines 
that there are offsetting financial strengths to compensate for the 
risk associated with borrowing.

    The term ``hospital expansion'' as used in this section is unclear 
and the mandatory nature of the section is a concern. If the term 
``expansion'' includes substantial rehabilitation, cash (or letters of 
credit) capital escrows are often not required, depending on the 
borrower's financial wherewithal. Moreover, even if the term does not 
include substantial rehabilitation, but only new construction or an 
expansion, the mandatory nature of the requirement would not be 
necessary if existing operations demonstrated that such capital was 
available from other sources. The commenter states that AMPO (Allowance 
to Make Project Operational) in the case of nonprofit sponsors would 
also be a source of such capital. The commenter suggested that the 
phrase ``if any'' be added to allow for a case-by-case determination 
based on the general financial condition of a sponsor.
    Response: HUD did not intend to make an initial cash deposit a 
mandatory requirement. The amount of cash deposit, or whether HUD will 
require such a deposit at all, depends on the borrower's financial 
strength and will be a case-by-case determination.

[[Page 67537]]

For this reason, HUD agrees with the addition of ``if any.''
    HUD disagrees with the notion of allowing the use of surety bonds, 
as HUD does not believe that they provide sufficient protection. HUD 
also believes that the commenter's treatment of AMPO is correct, and 
this final rule adds a definition of AMPO to Sec.  242.1.
Subpart C--Mortgage Requirements
1. Section 242.25 Mortgage Form and Disbursement of Mortgage Proceeds
    Comment: Section 242.25(b) should be revised, as indicated:

    Disbursement of mortgage proceeds. The mortgagee shall be 
obligated, as a part of the mortgage transaction, to disburse the 
principal amount of the mortgage in accordance with the governing 
building loan agreement acceptable to HUD in the case of a 
construction or rehabilitation mortgage and in the case of 
refinancing of mortgages without construction or rehabilitation, in 
accordance with procedures acceptable to HUD.

    Response: The commenter assumes that Sec.  242.25(b) of the 
regulation intends to implement section 223(f) of the National Housing 
Act, 12 U.S.C. 1715n(f), which is not the case. The proposed language 
is clear and is retained in this final rule.
2. Section 242.26 Agreed Interest Rate
    Comment: The term ``rate'' in this section should be revised to 
``rate or rates'' to reflect the fact that construction and permanent 
interest rates often differ, as well as to allow for circumstances that 
arise, when a state agency (for example, the New York Department of 
Health) requires that refinanced debt be repaid pursuant to a schedule 
shorter than the FHA amortization period. In either event, it is 
understood that the project interest rate will not exceed the rate 
stated in the governing FHA commitment.
    Response: HUD agrees that more than one rate may be applicable, and 
therefore makes the suggested change in this final rule.
3. Section 242.27 Maturity
    Comment: The maturity date should be up 35 years, rather than the 
proposed 25. The commenter states that, as a means of reducing a 
hospital's monthly debt service burden, Section 242 (and Section 241) 
amortization periods should approach those used in multifamily housing 
programs, including nursing homes. Although the amortization of Section 
242 loans has historically been 25 years, that standard is not a 
requirement of the NHA. Moreover, other FHA programs, including FHA's 
Section 232 program, permit post-construction amortization periods as 
long as 40 years post-amortization, thereby permitting lower annual 
debt service as well. The commenter states that longer amortization 
periods are commonly used in non-FHA commercial hospital finance 
programs.
    Response: Congress has always understood the maximum term to be 25 
years and it has been 25 years since the inception of the program, when 
it was established by regulation. It was deliberately set at 25 when 
rental project terms were 30 to 40 years, because hospitals become 
obsolete faster and the equipment (a major component) ages much faster. 
HUD believes that these reasons support continuation of the current 
policy, as stated in the proposed rule.
4. Section 242.28 Allowable Costs for Consultants
    Comment: Section 242.28 should be revised, as indicated:

    Consulting fees for work essential to the development of the 
project may be included in the insured mortgage. Allowable 
consulting fees include those for analysis of market demand, 
expected revenues, and costs; site analysis; architectural and 
engineering design; fees paid in connection with obtaining a state 
required certificate of need and other governmental required fees; 
and such other fees as HUD may determine to be essential to project 
development. Fees for work performed more than one year prior to 
preliminary review of a proposed application are not allowable 
unless such work is directly attributable to and for the benefit of 
the project as determined by HUD, such as architectural fees. Fees 
for work performed by any party with an identity of interest with 
the proposed mortgagor or mortgagee are not allowable unless such 
fees are determined to be reasonable by HUD.

    The commenter disagrees with the one-year limitation and believes 
that in certain situations the limitation may be unreasonable, 
particularly in connection with fees for project architects, debt 
capacity, financial feasibility or planning consultants, and 
construction managers. These firms are often retained for project 
development purposes prior to the one-year limitation.
    Response: With respect to certificate of need and other government 
fees, see the response to the second comment on Sec.  242.22, regarding 
fees. In addition, HUD considered the commenter's suggestion regarding 
fees paid in connection with obtaining a state-required Certificate of 
Need. The fees associated with conducting a feasibility study to 
determine need for construction or substantial rehabilitation of a 
hospital, as part of the Certificate of Need process, are not 
includable as costs in the insured mortgage. This step pertains to the 
submission of an application to the state to determine if the proposed 
project is required to serve the health needs of the community. 
However, fees associated with a Study of Market Need and Financial 
Feasibility can be included in the insured mortgage, because the HUD-
required study is used primarily by HUD to determine the need for the 
hospital and the ability of the hospital to service its mortgage debt.
    With respect to the one-year limitation, HUD notes that in some 
cases several years can pass between preliminary review and application 
submission, making it difficult to verify the relevance to the 
application and the cost of consultant services. However, recognizing 
that hospital projects can require long lead times for planning, HUD 
has increased the proposed one-year limitation to 2 years in this final 
rule. With respect to identity of interest, HUD believes that 
consultants by their very nature should be independent of the mortgagor 
and the mortgagee. For these reasons, this final rule does not adopt 
the commenter's suggested changes concerning identity of interest 
consultants.
5. Section 242.29 Payment Requirements
    Comment: Section 242.29 should be revised to include interest in 
arrears, as follows:

    The mortgage shall provide for payments including interest in 
arrears on the first day of each month in accordance with an 
amortization plan agreed upon by the mortgagor, the mortgagee and 
HUD.

    Response: HUD does not consider this level of detail to be 
necessary in the final rule.
6. Section 242.31 Accumulation of Accruals
    Comment: One commenter states that Sec.  242.31(b) should be 
revised to permit greater flexibility in purchasing fire and hazard 
insurance, as follows:

    The mortgage shall provide for such equal monthly payments by 
the mortgagor to the mortgagee as will amortize the ground rents, if 
any, and the estimated amount of all taxes, water charges, special 
assessments, and fire and other hazard insurance premiums, within a 
period ending one month prior to the dates on which the same become 
delinquent. The mortgage shall further provide that such payments 
shall be held by the mortgagee, for the purpose of paying such items 
before they become delinquent. The mortgage shall also make 
provision for adjustments in case such estimated amounts shall prove 
to be more, or less, than the actual amounts so paid therefore by 
the mortgagor. Notwithstanding the foregoing, in

[[Page 67538]]

certain circumstances, a mortgagor may purchase required fire and 
hazard insurance through a consortium of affiliated institutions or 
related organizations or in the case of public institutions, through 
required state purchasing arrangements. In such circumstances, the 
mortgage accrual requirement may be modified to reflect such 
circumstances.

    The commenter states that in some situations, property insurance 
may be purchased and paid for through a consortium of affiliated 
hospitals or a state system under state required arrangements, and the 
rule should allow for this flexibility.
    Response: The commenter's point is well taken and HUD agrees to the 
language proposed for addition, with a change in the last sentence, as 
follows:

    In such circumstances, the mortgage accrual requirement may be 
modified to reflect circumstances in which it is inappropriate for 
the mortgagee to collect monthly payments and to make payments on 
behalf of the mortgagor.
7. Section 242.33 Covenant for Malpractice, Fire, and Other Hazard 
Insurance
    Comment: FHA's required mortgage form, a real estate-oriented 
security document, appropriately requires insurance coverage related to 
real and personal property interests that secure repayment of a loan. 
Malpractice insurance on the other hand is not real estate-related and 
would be more appropriately covered in the project Regulatory 
Agreement. The commenter also notes that malpractice insurance may on 
occasion be covered in part under self-insurance vehicles. Flexibility 
should be allowed for those purposes, as well. Finally, the concept of 
``adequate * * * coverage'' should be clarified, possibly to reflect 
the advice of an insurance consultant or other experienced industry 
expert.
    Response: Regardless of local practice, HUD must be able to require 
an assurance that adequate malpractice coverage be maintained. This 
final rule adopts language requiring the mortgagor to maintain adequate 
coverage acceptable to the mortgagee and HUD. This language will 
maintain flexibility while protecting the mortgagee and the insurance 
fund.
    Comment: Commenter (3) stated that there should be language 
included to ensure that appropriate amounts of insurance are funded. 
State pools should be acceptable, and offshore insurance accounts 
should be acceptable if approved by HUD. Risk retention groups and 
captive insurance companies should also be acceptable if approved by 
HUD. The regulation should address whether or not the insurance 
carriers meet minimum rating standards.
    Response: The language of the final rule provides sufficient 
flexibility to consider alternative sources of insurance, and to 
provide that insurance is adequate and acceptable.
8. Section 242.35 Mortgage Lien Certifications
    Comment: Section 242.35 should be deleted in the final rule, 
because the certifications required are more in the nature of legal 
opinions to be rendered by counsel in the jurisdiction where a project 
is located. If the section is not deleted, it should be revised to 
provide for such exclusions, liens, and security instruments as are 
acceptable to HUD. In accordance with existing practice, exceptions 
should be provided for such items as prior leased equipment, utility 
easements, and other title exceptions acceptable to HUD.
    Response: HUD sees no reason to exclude certain property from the 
mortgage lien. The language in the final rule is needed to implement 
the statute and fully protect the interests of HUD. However, the 
proposed language of this section is changed in this final rule so that 
in exceptional cases certain personalty may be excluded from the 
mortgaged property or the insured lender may take a secondary lien 
position on it. Also, the final rule removes the requirement for formal 
certification.
9. Section 242.37 Mortgage Prepayment
    Comment: Section 242.37(a) should be revised, as follows:

    Prepayment privilege. Except as provided in paragraph (c) of 
this section or otherwise established by HUD, the mortgage note or 
credit instrument shall contain a provision permitting the mortgagor 
to prepay the mortgage note or credit instrument in whole or in part 
upon any interest payment date, after giving the mortgagee a minimum 
of 30 days notice in writing in advance of its intention to so 
prepay.

    The purpose of these revisions is to provide for alternative notice 
requirements where required to comply with investor financing 
arrangements. For example, in order to obtain AA/AAA ratings for bonds 
that provide the source to finance Section 242 mortgages, prepayments 
must be bankruptcy-proof (held for periods between 90 and 125 days, 
depending on state or federal law). In order for mortgage prepayments 
to be protected, therefore, a longer notice and tendering period should 
be permitted.
    Response: HUD has retained the language in Sec.  242.37(a), but in 
order to accommodate the scenario that the commenter identifies has 
added a sentence permitting HUD to extend the notice.
    Comment: The term ``mortgage'' in this section should be revised to 
read ``mortgage note or credit instrument.''
    Response: ``Mortgage'' is a defined term in the rule. HUD considers 
the existing definition of ``mortgage,'' which includes appropriate 
credit instruments, to be sufficient, and it is not necessary to repeat 
the definition with each individual usage of the word.
    Comment: One commenter stated that Sec.  242.37(b)(1) should be 
deleted because ``the provision is virtually unknown in the commercial 
sector and may affect the marketability of the FHA debt in secondary 
markets, particularly in the case of tax-exempt bonds, resulting in 
higher than necessary interest rates.'' Additionally, the commenter 
stated that the rule or an accompanying publication should contain 
additional guidance regarding acceptable prepayment restrictions and 
premiums to eliminate ``field office counsel uncertainty.'' The terms 
and conditions should be similar to those for multifamily projects and 
should provide for Commissioner exceptions where warranted to deal with 
investor market conditions and preferences.
    Response: This concern is addressed in 242.37(c), which provides 
that the mortgage may contain prepayment restrictions acceptable to HUD 
in the case of mortgage-backed securities or bond funding.
    Comment: Section 242.37(d) should be revised to read ``mortgage 
default'' instead of ``default.''
    Response: HUD needs to have the ability to take the appropriate 
action if there are regulatory agreement defaults, not only a mortgage 
default. Thus, the broad proposed language (``default'' as opposed to 
``mortgage default,'' as suggested) is maintained in the final rule.

Subpart D--Endorsement for Insurance

1. Section 242.39 Insurance Endorsement
    Comment: The term ``credit instrument'' used in the section is 
undefined and at a minimum should include a mortgage or deed of trust 
note or other evidence of indebtedness secured by a mortgage. The 
commenter also suggested editing Sec.  242.39(c) to read, as follows:

    Contract rights and obligations. HUD and the mortgagee or lender 
shall be bound from the date of initial endorsement by the 
provisions of the Contract of Mortgage Insurance set forth in 
subpart B of Section 207 of 24 CFR part 200.


[[Page 67539]]


    Response: HUD has replaced the term ``credit instrument'' with 
``mortgage note,'' to be consistent with the definition of ``mortgage'' 
in Sec.  242.1. HUD agrees with the suggestion to revise Sec.  
242.39(c). That revision, which is adopted in this final rule, makes 
proposed Sec.  242.94 unnecessary; therefore, that section is omitted 
from this final rule.
2. Section 242.43 Application of Cost Savings
    Comment: One commenter states that this section should be revised, 
as indicated:

    Any cost savings identified through the cost certification 
process shall be used to:
    (a) Reduce the principal amount of the mortgage and the 
mortgagor's cash equity contribution proportionally or in such other 
manner as may be approved by HUD subject to the program's 90 percent 
loan to cost requirement, and/or
    (b) Fund in whole or part, any additional construction, 
modernization, rehabilitation, purchase of equipment or costs 
related thereto approved by HUD.

    The commenter states that in addition to proportional allocation, 
the rule should allow HUD to allocate higher amounts to project equity 
based on the financial circumstances of a particular mortgagor, 
provided that the loan-to-cost ratio is sustained. In some 
circumstances, particularly where mortgagor liquidity may be an issue 
post-construction, this result may be of benefit both to FHA and the 
hospital. In other cases, mortgagors may have voluntarily committed 
more equity to project construction than FHA would have required.
    Response: HUD agrees that a proportional reduction of the mortgage 
amount and the equity contribution should not necessarily be the 
mortgagor's only option. The final rule would allow the mortgagor, at 
HUD's sole discretion, to elect to apply a greater percentage of the 
cost savings to reduce the principal amount of the mortgage. The 
mortgagor should not be required to borrow funds that are not needed 
for the project. HUD does not agree that higher amounts should be 
allocated to project equity, because to do so would amount to using 
borrowed funds for working capital, which is not a permitted use of 
mortgage proceeds. Additionally, HUD has revised Sec.  242.43(b) to 
make that section consistent with the definition of ``substantial 
rehabilitation'' in this final rule.
Subpart E--Construction
1. Section 242.45 Early Commencement of Work
    Comment: One commenter states that a new Sec.  242.45(a) entitled 
``Pre-application work'' should be added and that a number of other 
revisions to the section should be made. The entire section would read, 
as follows:

    (a) Pre-application work. (1) Project work may be undertaken and 
completed by the mortgagor prior to filing an application. Such work 
must meet all applicable local and state requirements for the type 
of work undertaken and completed and be at the sole risk and 
responsibility of the mortgagor. At the discretion of HUD, and upon 
such terms as HUD may prescribe, a loan made to mortgagor in 
connection with such work may be refinanced from mortgage loan 
proceeds, or, in the alternative, HUD, in its sole discretion, may 
recognize all or part of such cost as a mortgagor contribution to 
any equity requirement set forth in the commitment.
    (2) With the prior approval of HUD, pre-application work that 
will not be completed before the filing of an application may be 
undertaken by mortgagor at its sole risk and responsibility, 
provided that all applicable local, state and federal requirements, 
including the payment of prevailing wages, environmental review 
under Sec.  242.79, inspections by appropriate federal agencies, 
payment of FHA inspection fees, and such other requirements as may 
be imposed by HUD are met as if such work were to be approved for 
mortgage insurance. If, with HUD's approval, a loan to mortgagor in 
connection with such pre-application work will be re-financed with 
mortgage proceeds, that work must be completed to the satisfaction 
of HUD before initial endorsement of the mortgage loan. If, with 
HUD's approval, such project work will continue beyond the date of 
initial endorsement, the expense of such work may, in HUD's sole 
discretion, be included in the mortgage loan or recognized in whole 
or in part as a mortgagor contribution to any equity requirement set 
forth in the commitment, upon such terms and conditions as HUD may 
prescribe.
    (b) Pre-commitment work. After an application has been filed, 
but prior to the issuance of a commitment by HUD, the mortgagor may 
request for good cause the commencement of work on the project 
within legal guidelines and State law. Such work, and the request 
therefor, shall be subject to the same requirements, conditions and 
provisions set forth in Section 242.45(a)(2).
    (c) Early Start. Subsequent to the issuance of a commitment, if 
the mortgagor requests the commencement of the project, the work may 
commence after the review of the request by HUD, including the 
environmental review under Section 242.79, and the agreement to 
certain conditions by the mortgagor. Prior to the initial 
endorsement, the work is accomplished at the sole risk of the 
mortgagor.
    (d) Prepayment of inspection fee. The mortgagor shall pay the 
inspection fee to HUD before pre-application work pursuant to 
Section 242.45(a)(2), pre-commitment or early start work commences.
    (e) Work started prior to application submission. HUD has the 
sole discretion to allow such work to be incorporated into the 
application if, except for work undertaken and completed as set 
forth in Section 242.45(a)(1), HUD has reviewed and approved the 
drawings and specifications and has inspected the work.
    (f) No expressed or implied intent. Approval to proceed under 
paragraphs (a), (b), and (c) of this section shall in no way be 
construed as indicating any intent, expressed or implied, on the 
part of HUD to approve, disapprove, or make any undertaking or 
promise whatsoever with respect to the application or with respect 
to any commitment for mortgage insurance. Any work under paragraphs 
(a), (b) and (c) of this section shall be accomplished at the sole 
risk and responsibility of the mortgagor.

    These revisions would allow for work on an insured hospital to be 
done at various times, including prior to an application being filed. 
The commenter states that at various times over the course of many 
years of dealing with the Section 242 program, there has been a need 
for hospitals to begin different types of project-related construction 
or preparation for such construction for a host of reasons. For 
example, in some cases construction needed to be commenced early in 
order to preserve favorable bids from subcontractors or to be ``under 
roof'' before the onset of winter weather. In other, more complicated 
phased construction situations, overall completion timing depended on 
the timely sequential start of each phase, particularly if patient, 
office, or other service ``decanting'' from one building to another was 
required. This was particularly true if a building within a fully 
operational hospital needed to be vacated before it could be 
rehabilitated, expanded, or demolished to make way for a new structure. 
In other instances, state or local governmental requirements came into 
play; for example, the expiration of a building permit or a certificate 
of need if work were not started by a particular date. The impact of 
rising interest rates and construction costs has also been a factor in 
a hospital's decision to undertake and finance pre-application or pre-
commitment work (and FHA's decision to approve such work), since such 
work is at the hospital's risk and expense with no assurance that FHA 
financing will be available at a later date. Finally, nonprofit 
hospitals involved in fund-raising campaigns to cover required Section 
242 equity and other requirements (or to avoid mortgage loans greater 
than might otherwise be necessary) have learned that donor interest and 
levels of

[[Page 67540]]

philanthropy will often be higher if potential benefactors can see 
tangible evidence of new construction or rehabilitation through early 
construction activity.
    All of these considerations have been addressed by HHS and FHA over 
the years in one form or another as the basis of approving various 
arrangements for early construction within the confines of governing 
regulations and statute. Congress also appears to have recognized one 
of these concerns, the timing of fund-raising activities, by permitting 
letters of credit in lieu of cash to be utilized to fund project equity 
by public and nonprofit sponsors under Section 242(d) of the NHA.
    Beginning in the early 1980s and continuing to date, a series of 
HUD opinions and approvals (starting with those for South Nassau 
Communities Hospital) have been issued to permit variations of pre-
application, pre-commitment, and early start work without artificial or 
unnecessary restrictions beyond meeting governing law, regulations, or 
other requirements reasonably established to protect the soundness of 
the mortgage insurance program. The Committee's proposed revisions to 
Section 242.45 are intended to assure that policies approved to date 
for these purposes are continued, as well as to provide latitude for 
reasonable policy adjustments to be made in the future on a case-by-
case basis, so long as they comport with federal, state, and local 
requirements and do not increase FHA's insurance risk.
    Response: HUD understands that there are situations such as those 
described by the commenter in which it is to the advantage of the 
proposed mortgagor to begin construction prior to receipt of an 
insurance commitment. At the same time, HUD is concerned that a 
regulation encouraging such work could result in pre-application and 
pre-commitment work becoming the rule rather than the exception. 
Gradually, the focus of the program could become insurance upon 
completion. HUD's long-standing policy has been not to implement 
insurance upon completion for Section 242. A second concern is that 
HUD's authority to expend resources on reviews and inspections of 
construction is questionable in cases where HUD has received no 
application.
    HUD believes that there is a solution that addresses HUD's concerns 
while permitting limited project construction to be started in cases 
such as those described in the comment. That solution would be for the 
mortgagee and mortgagor together to file an application consisting, at 
minimum, of: The approved FHA form, the application and inspection 
fees, a project description, architectural plans and specifications for 
the initial construction, previous participation review information, a 
Phase I environmental report, and a certificate of need for the pre-
commitment work if required by the state. The remainder of the 
application could be submitted at a later date. The application would 
be accompanied by a request for the initial construction to be financed 
with insured mortgage proceeds and assurance that, should the full 
application be denied, the mortgagor will not experience significant 
financial hardship.
    With respect to construction completed prior to application, HUD 
does not intend to implement insurance upon completion, as stated 
above. However, HUD recognizes that hospitals are dynamic entities that 
have a need for construction or rehabilitation from time to time, and 
that a proposed mortgagor may have completed construction or 
rehabilitation in the recent past. HUD believes that a reasonable 
balance is achieved by allowing completed construction or 
rehabilitation to be refinanced with insured mortgage proceeds if the 
work was completed more than 2 years before application. The cost of 
work completed less than 2 years before application could be refinanced 
only with a regulatory waiver on a case-by-case basis.
    Therefore, this final rule substantially revises Sec.  242.45 to 
provide for early commencement upon a minimal application and 
assurance. The final rule also provides for the refinancing opportunity 
for work completed more than 2 years prior to the application.
2. Section 242.47 Insured Advances for Building Components Stored Off-
Site
    Comment: One commenter states that Sec.  242.47(b)(3) should be 
revised as follows:

    Storage costs, if any, shall be borne by the contractor (which 
shall include a construction manager).

    Response: HUD does not believe that this provision should be 
limited to the construction manager form of construction, but rather 
that it should apply generally.
    Comment: Section 242.47(d)(1)(ii) should be revised to provide that 
the mortgagee ``or its counsel'' may make the warranty regarding the 
security instruments.
    Response: This final rule does not adopt this comment. 
Historically, HUD has required such warranties to be made by the 
mortgagee itself, since HUD's contractual relationship is directly with 
the mortgagee. The representation is made by the mortgagee in the 
mortgagee's certificate.
    Comment: In the last sentence of Sec.  242.47(d)(4), the phrase 
``insurance of components'' should be revised to ``insurance of 
advances for components.''
    Response: HUD agrees with the change suggested by the comment, 
because the resulting language is more precise.
3. Section 242.49 Funds and Finances: Deposits and Letters of Credit
    Comment: One commenter states that this section should be revised, 
as indicated:

    (a) Deposits. Where HUD requires the mortgagor to make a deposit 
of cash or securities, such deposit (other than the Mortgage Reserve 
Fund or other funds held for the benefit of HUD) shall be with the 
mortgagee or a depository acceptable to the mortgagee. The deposit 
shall be held by or for the benefit of the mortgagee in a special 
account or by the depository under an appropriate agreement approved 
by HUD.
    (b) Letter of credit or surety bond. Where the use of a letter 
of credit or surety bond is acceptable to HUD in lieu of a deposit 
of cash or securities, the letter of credit shall be issued to the 
mortgagee by a banking institution with a National Rating Agency 
acceptable to HUD in the BBB category or its industry equivalent or 
equivalent or by another entity acceptable to HUD and shall be 
unconditional and irrevocable and a surety bond shall be issued to 
the mortgagee by an insurance company with the rating of a National 
Rating Agency acceptable to HUD in the BBB category or its industry 
equivalent. The mortgagee shall be responsible to HUD for collection 
under the letter of credit or surety bond.
    (c) Mortgagee not issuer. The mortgagee of record, unless a 
trustee in connection with bonds issued to fund the FHA mortgage 
loan, may not be the issuer of the letter of credit without the 
prior written consent of HUD.

    The commenter's suggestion of a letter of credit option is in 
accordance with the comment to Sec.  242.23. The commenter stated that 
the surety bond option would ``represent an opportunity for 
institutions to fund equity at more competitive costs.''
    The commenter suggested revision to the allowed rating agencies 
because there are other rating agencies. The commenter mentioned two 
other national rating agencies specifically, and stated that there may 
be other acceptable ones. Moreover, the commenter stated, requiring an 
AA rating may limit the availability and increase the cost of credit 
facilities. The commenter stated that FHA recently amended its Section 
232 liability

[[Page 67541]]

insurance requirements to permit a rating in the AM Best (a liability 
insurance company rating agency) B++ category. The commenter suggested 
that analogous criteria could be applied in this instance.
    The commenter stated that the proposed requirement to 
``immediately'' meet a demand for payment is troublesome, and that such 
an immediate timeframe has not been previously established for this 
purpose. The commenter stated that HUD should consider a reasonable 
timeframe, for example, that the funds are available when needed for 
the intended purposes.
    Response: HUD agrees with the concept of including more explanatory 
language about the mortgagor's deposit in 242.49(a), but this final 
rule adopts slightly different language, which HUD believes is more 
accurate than the language suggested by the comment.
    In response to comments to Sec.  242.23(c), HUD stated that surety 
bonds are not an acceptable form of equity, and do not offer the level 
of protection the Department considers necessary. For this reason, the 
commenter's suggestion to allow the use of surety bonds in 242.49(b) is 
not accepted in this final rule.
    The commenter also suggested changing the allowable credit quality 
of an acceptable letter of credit provider to B++. Because of the 
multiplicity of entities that provide ratings and the lack of 
uniformity among them, HUD has decided to provide in the rule that the 
lender can choose a financial institution acceptable to it. The lender 
is responsible for ensuring that any letter of credit is tantamount to 
cash. HUD has revised Sec.  242.49(b) accordingly.
    The commenter also suggested deleting the last sentence of Sec.  
242.49(b). HUD views the letter of credit the same as cash, and 
believes that the lender must have cash available when cash is 
necessary, so the final rule retains the proposed rule language.
4. Section 242.50 Funds and Finances: Off-Site Utilities and Streets
    Comment: This section should be revised to allow the cash escrow to 
be in the form of a letter of credit or surety bond. The commenter also 
stated that ``the application of the sentence beginning `Where such 
assurance' seems unclear. If mortgage proceeds are to be retained for 
these purposes without an offsetting cash or cash equivalent deposit 
with mortgagee at closing, in certain (e.g. where a mortgagor failed to 
provide needed cash at a later date), there would not be enough funds 
to complete the FHA project (sic).''
    Response: With respect to surety bonds, HUD does not believe that 
surety bonds provide adequate protection (see also response to comment 
to Sec.  242.23). For clarity, Sec.  242.50 has been modified to 
specify that there must be adequate funds available to cover cost of 
off-site utilities and streets regardless of whether the funds come 
from escrow or mortgage proceeds for land, or both.
5. Section 242.51 Funds and Finances: Insured Advances and Assurances 
of Completion
    Comment: Section 242.51(a) should be revised, as indicated:

    Where the estimated cost of construction, expansion or 
rehabilitation is more than $500,000, the mortgagor shall furnish 
assurance of completion in the form of corporate surety bonds for 
payment and performance, each in the minimum amount of 100 percent 
of the construction contract or Guaranteed Maximum Price in the case 
of construction management satisfactory to HUD and consistent with 
assurances permitted in connection with multifamily housing 
projects.

    Response: The first sentence is changed to ``* * * cost of 
construction or substantial rehabilitation * * *'' because expansion is 
included in the term ``substantial rehabilitation'' as defined in Sec.  
242.1 in this final rule. The substance of the additional suggested 
change has been incorporated into the revised language in this final 
rule.
6. Section 242.53 Ineligible Contractors
    Comment: Section 242.53(b), which prohibits identity of interest 
contracts, should be deleted, because identity-of-interest construction 
contracts are generally permitted in FHA multifamily programs so long 
as the contract is based on cost-plus, cost-certified methodology. 
Although this is an unlikely scenario in the Section 242 program, the 
structure should nevertheless be permitted.
    Response: HUD believes allowing identity-of-interest projects would 
introduce unnecessary risks.
    Comment: One commenter states that Sec.  242.53(c) should be 
revised to remove the provision that allows HUD to refuse to insure 
advances, as well as make a conforming change by deleting the cross-
reference to paragraph (b) of that section.
    The commenter states that, although it agrees that FHA should have 
recourse in the event of inappropriate contracting, the list of 
eligible contractors is maintained and established by the federal 
government and not by mortgagors or lenders. Moreover, as part of the 
application process, FHA can screen contractors for these purposes 
before initial endorsement. As such, a remedy involving a refusal to 
insure further advances after endorsement not only appears unnecessary, 
but worse still, may precipitate extremely undesirable results and 
possibly jeopardize the completion of the project and the availability 
of secondary financing that provides the source of construction funds.
    A still more serious problem would result if under these 
circumstances the mortgagee's funding obligation under the related 
Building Loan Agreement were not also terminated with FHA consent; 
otherwise, the mortgagee would continue to have a funding obligation 
under the governing Building Loan Agreement, but no ability to fund the 
loan. In other words, if FHA were to exercise this type of privilege, 
FHA would most likely have to agree to process an insurance claim if 
insured advances were withheld by FHA.
    The termination of advances would be particularly problematic in 
cases financed with tax-exempt revenue bonds, the proceeds of which 
must be invested at initial endorsement so as to keep the bonds fully 
current until monies are disbursed through the FHA mortgage, and 
interest accruing on the mortgage is thereupon due for these purposes. 
Delays in disbursement could result in potential bond defaults and 
certainly impact the costs of financing. Because agencies of the 
federal government establish and maintain the list of ineligible 
contractors and review and approve construction contracts and 
contractor eligibility as part of the application process, any FHA 
remedies in this instance should be structured to avoid harm to 
mortgagors, lenders, or the project involved.
    Response: HUD agrees with the commenter's concern. In order to 
provide for the completion of projects and to protect the insurance 
fund, proposed Sec.  242.53(c) has been revised in this final rule to 
provide for remedial and enforcement actions other than refusing to 
insure further advances.
Subpart F--Nondiscrimination and Wage Rates
1. Section 242.54 Nondiscrimination
    Comment: The provisions on sex and age discrimination should be 
removed because women and children's hospitals are eligible for federal 
and state reimbursement; however, the reference to ``sex'' and ``age'' 
in the regulation, absent clarification, may preclude such facilities 
from being eligible under this program.

[[Page 67542]]

    Response: The provisions on civil rights are required by federal 
law and cannot be removed from the rule. HUD is revising Sec.  242.54 
in this final rule to clarify that the section does not affect the 
eligibility of women's and children's hospitals for this program.
Subpart G--Regulatory Agreement, Accounting and Reporting, and 
Financial Requirements
1. Section 242.56 Form of Regulation
    Comment: The term ``mortgagor'' in the third sentence should be 
revised as ``mortgagor'' (and/or its lessee, if any) where it occurs:

    * * * The mortgagor (and/or its lessee, if any) shall be subject 
to monitoring by HUD and the U.S. Department of Health and Human 
Services, and their agents, employees, and contractors, on an 
ongoing basis for the life of the insured mortgage to ensure against 
the risk of default, and the mortgagor (and/or its lessee, if any) 
must make its financial records available to the monitoring agencies 
upon request.

    This suggestion is in accordance with similar comments made with 
respect to the definition of ``regulatory agreement'' and Sec.  242.10.
    Response: As discussed in the response to the comment to Sec.  
242.10, HUD will consider a lease in the rare instances when it is made 
necessary by state or local law. However, HUD does not consider this 
situation common enough to require specific regulatory language in the 
final rule. No addition of language to include lessees will be made. 
This final rule makes a technical correction to the last sentence to 
clarify that monitoring may be conducted by various agents and 
contractors on HUD's behalf.
2. Section 242.57 Maintenance of Hospital Facility
    Comment: The section should be revised to add lessees, as follows:

    The mortgagor (and/or its lessee, if any) shall maintain the 
hospital's grounds and buildings and the equipment financed with 
mortgage proceeds in good repair and shall promptly complete such 
repairs and maintenance as HUD considers necessary.

    Response: The final rule does not add language regarding lessees 
for the reason stated in the response to comments on Sec.  242.56.
3. Section 242.58 Books, Accounts, and Financial Statements
    Comment: The section should be revised throughout to include 
mortgagors ``and/or their lessees, if any.''
    Response: The final rule does not add language regarding lessees 
for the reason stated in the response to comments on Sec. Sec.  242.10 
and 242.56.
    Comment: Proposed Sec.  242.58(b)(ii) should be revised, as 
follows:

    (ii) Quarterly unaudited financial reports, within 60 days 
following the end of each quarter of the mortgagor's (and/or its 
lessee, if any) fiscal year if requested by HUD.

    Response: In HUD's experience, 40 days is sufficient time for 
mortgagors to prepare, review, and submit interim financial statements.
    Comment: Proposed Sec.  242.58(b)(iv) should be revised to make the 
board-certified financial results due within 180 days following the 
close of the fiscal year, rather than 120 days.
    Response: In HUD's experience, 120 days is a sufficient time frame.
    Comment: Proposed Sec.  242.58(f) should be revised where it 
requires books and records to be maintained in accordance with 
Generally Accepted Accounting Principles (GAAP) to allow flexibility. 
In the first sentence, the commenter would add the following phrase 
after ``(GAAP)'': ``* * * or such other accounting principles as may be 
customary for such persons and acceptable to HUD.'' Some managers and 
public facilities may use different accounting rules.
    Response: Some governmental hospitals use accounting rules under 
Governmental Accounting Standards. Therefore, the final rule permits 
the use of Governmental Accounting Standards.
    Comment: The regulatory agreement provides: ``If the Mortgagor has 
any business or activity other than the project and operation of the 
mortgaged property, it shall maintain all income and other funds of the 
project segregated from any other funds of the mortgagor and segregated 
from any funds of any other corporation or persons.'' This requirement 
does not appear in the proposed regulation. The commenter asked whether 
this omission is a change in policy.
    Response: This requirement is included in the regulatory agreement, 
and is therefore legally effective and binding on program participants. 
Participants in HUD's programs are expected to comply with regulatory 
agreements and contracts pertinent to the programs in which they 
participate, as well as with program rules. There is no change in 
policy as to the requirement of segregation of funds.
4. Section 242.61 Management
    Comment: Proposed Sec.  242.61(a) should be revised to eliminate 
the provision for termination without cause and substitute in its place 
a requirement that termination be for cause and without penalty. The 
``without cause'' provision would result in fewer qualified companies 
being willing to make the investment required to undertake the 
management of a project. Second, management fees in view of the 
uncertainties of termination without cause would likely be 
significantly higher than otherwise. There would seem to be no 
legitimate policy objective to justify a termination without cause in 
such instances.
    Also, the commenter states that it will be difficult if not 
impossible for FHA to be given the right to terminate existing 
agreements (often on a multi-year basis) in place prior to initial 
endorsement.
    Response: In the past, this clause has served the program well and 
HUD has received no indications that management companies are less 
willing to manage a hospital, nor that management fees are increased as 
a result of this clause. HUD needs to be in a position to move quickly 
and decisively. For agreements existing at the time of commitment, HUD 
does not require termination but does require an amendment to permit 
termination by HUD with or without cause.
    Comment: The introductory paragraph of Sec.  242.61 and Sec. Sec.  
242.61(a) and 242.61(b) should be revised to include lessees of 
mortgagors, in accordance with other similar comments.
    Response: As discussed in the response to the comment in Sec.  
242.10 and other similar comments, HUD will consider leases in the rare 
instances in which local law makes them necessary; however, this 
situation is not common enough to merit inclusion in the final rule.
    Comment: The section should be clarified to apply to a management 
agreement executed in connection with an entire facility and not 
specified services such as pharmacy, cafeteria, or laundry.
    Response: HUD believes the language ``for management of the 
hospital'' is clear and would not preclude contracts for management of 
ancillary services such as pharmacy, cafeteria, or laundry.
    Comment: The term ``principals'' used in Sec.  242.61(b) should be 
defined. In the case of proprietary mortgagors, the term should not 
include shareholders.
    Response: 24 CFR 24.995 defines ``principal'' and the term is also 
well understood in the mortgage insurance industry. No additional 
definition is required.
5. Section 242.62 Releases of Lien
    Comment: The first sentence of Sec.  242.62 should be revised as 
shown below, and the second sentence, dealing

[[Page 67543]]

with partial releases of lien, should be deleted:

    The mortgagor shall not sell, dispose of, transfer, or permit to 
be encumbered any security property without the prior approval of 
the lender and Commissioner, subject to thresholds or such other 
standards HUD may establish for the approval requirement.

    The commenter states that the determination required for partial 
releases of liens should be made by HUD, which was responsible for the 
original determination for these purposes in the pre-commitment 
process, as lenders, particularly bond trustees or lenders by 
assignment and not involved in loan origination, will more than likely 
lack the expertise for these purposes.
    Response: The words ``or such other standards'' have been added, as 
suggested. With respect to the second point on partial releases, HUD 
believes that the lender should have the capability to make this 
decision, subject to prior approval by HUD.
6. Section 242.63 Additional Indebtedness and Leasing
    Comment: This section should be revised to include the mortgagor's 
lessees, in accordance with other similar comments.
    Response: HUD does not believe lease situations warrant inclusion 
in the final rule. See previous response to comments on Sec. Sec.  
242.10 and 242.56.
7. Section 242.64 Current and Future Property
    Comment: The requirement that ``all current or future property or 
personalty * * * on or off the mortgaged real estate * * * will be 
considered as part of the HUD-insured hospital and subject to all 
provisions of the HUD regulatory agreement'' is ``troublesome'' and 
should be reconsidered. In many instances, this requirement precludes a 
hospital from making timely business decisions and arranging for 
financing with respect to acquisitions or off-site properties that 
might complement the business plan of the FHA facility, particularly 
given the timeframe sometimes required to obtain required FHA approval. 
Hospitals, for example, frequently purchase residential space for 
nurses and doctors and frequently purchase office buildings in 
peripheral areas to maintain market share and the like. Future 
purchases for these purposes and the ability to mortgage such ventures 
should be permitted.
    Flexibility should be included in this requirement. While this 
requirement is appropriate for on-site property, when off the mortgage 
site and independent of hospital operations, the requirement is more 
problematic and should be eliminated or, alternatively, made subject to 
particular pre-determined financial ratios or standards for release 
that would allow a transaction to move forward without additional FHA 
consent.
    Response: Even though hospitals meeting particular economic 
thresholds have the power under the regulatory agreement and covenants 
to acquire and transfer particular property without the prior written 
approval of HUD, the regulation does clearly and properly indicate that 
HUD will regulate the operation of the hospital and will not permit 
hospitals to acquire property that is crucial to the operation of the 
hospital, but to which the lender and/or HUD would not have access in 
the event of default and foreclosure. Therefore, there is no change to 
the final rule as a result of this comment.
    Comment: The last sentence of this paragraph should be revised to 
allow HUD's first lien to be subordinated as acceptable to HUD. Other 
provisions of these regulations permit exceptions to FHA's first lien 
requirement based on Commissioner discretion. The requirement in this 
sentence should parallel those provisions.
    Response: It is not legally possible for HUD to subordinate its 
first lien position on a Sec.  242 mortgage. Section 242(b)(2) of the 
Act, 12 U.S.C. 1715z-7(b)(2), states that ``mortgage'' shall have the 
meaning stated in 12 U.S.C. 1713(a). That section defines ``mortgage'' 
as ``a first mortgage on real estate in fee simple.'' Therefore, HUD 
must have a first lien position on hospital mortgages under this 
program. For clarity, the wording of the first sentence of Sec.  242.64 
has been slightly revised.
8. Section 242.66 Affiliate Transactions
    Comment: The phrase ``with affiliates'' should be added at the 
beginning of the first sentence after ``Transactions.''
    Response: HUD agrees with the suggested change, as it clarifies the 
meaning. Also, the last phrase, ``in accordance with such policies and 
procedures as HUD shall prescribe,'' is removed in this final rule as 
superfluous.
Subpart H--Miscellaneous Requirements
1. Section 242.68 Disclosure and Verification of Social Security and 
Employer Identification Numbers
    Comment: The word ``applicants'' should be deleted and 
``mortgagors'' used instead.
    Response: While a similar change has been made elsewhere in the 
rule, in this section it is inappropriate. The language being 
referenced specifically quotes the requirements of 24 CFR 5.210 et 
seq., which refers to ``applicants for and participants in'' covered 
programs, rather than mortgagors. This final rule revises Sec.  242.68 
slightly to make this usage clear.
2. Section 242.72 Leasing of Hospital
    Comment: One commenter states that this section should be revised 
to permit leasing of an entire hospital, including lease-back 
transactions, with HUD's consent. The specific language would be as 
follows:

    Leasing of a hospital in its entirety is prohibited without 
Commissioner consent. Notwithstanding this prohibition, any proposal 
in which leasing (and related subleasing back to lessor, or 
transactions of a similar nature) of the entire facility is a factor 
due to State, county or other governmental law prohibitions against 
the mortgaging of health care facilities by such State, county or 
other governmental entities shall be considered on a case-by-case 
basis. Also, leasing of a hospital that has an existing Section 242 
insured loan is permitted if HUD determines that leasing is 
necessary to reduce the risk of default by a financially troubled 
hospital.

    The commenter states that the prohibition of operator lessees, with 
the exception of publicly owned entities, should be eliminated, and the 
eligibility of projects with operating leases should be permitted for 
all forms of sponsorship on a case-by-case basis, whether nonprofit, 
public, or proprietary owners. Language that precludes nonprofit and 
proprietary sponsors from utilizing an operating lease approach, 
particularly when that arrangement has legitimate functional advantages 
and the proposed project otherwise complies with FHA financial 
standards, discriminates against these other forms of ownership and is 
inconsistent with statutory policy that permits financing for each of 
these ownership forms. The commenter states that operator lease 
arrangements have been routinely permitted in the case of proprietary 
and nonprofit sponsors in the Section 232 program and that there is no 
public policy served by a prohibition against these types of sponsors 
when the public interest can be protected and an operator properly 
regulated by FHA.
    Response: See responses to comments on Sec.  242.10 and Sec.  
242.56.
3. Section 242.74 Smoke Detectors
    Comment: This section should be removed because not only may the 
rule conflict with state or local requirements,

[[Page 67544]]

but because the specific requirement may be superseded by evolving 
technology or law.
    Response: The section is amended to read:

    Each occupied room must include such smoke detectors as are 
required by law.

4. Section 242.75 Title Requirements
    Comment: This section should be revised as follows, in accordance 
with comment to Sec.  242.72 above to permit hospital leaseholds.

    In order for the mortgaged property, including leasehold 
estates, to be eligible for insurance, HUD shall determine that 
marketable title thereto is vested in the mortgagor, lessee, or 
lessor, as appropriate, as of the date the mortgage is filed for 
record. The title evidence shall be examined by HUD and the 
endorsement of the credit instrument for insurance shall be evidence 
of its acceptability.

    Response: HUD does not adopt this comment in the final rule for the 
reasons stated in response to comments on Sec. Sec.  242.10 and 242.56.
5. Section 242.76 Title Evidence
    Comment: The second sentence of Sec.  242.76(a) should be revised 
to read:

    The policy shall name as the insureds the mortgagee and the 
Secretary of Housing and Urban Development, their successors and 
assigns, as their respective interests may appear.

    Response: The final rule adds ``successors and assigns,'' as 
suggested.
6. Section 242.77 Liens
    Comment: One commenter stated that Sec.  242.77(a) should be 
revised to allow parity liens, as follows:

    An inferior or parity lien made or held by a Federal, State, or 
local government instrumentality;

    The commenter stated that such liens have been approved in at least 
two cases, one involving another federal agency, the former federal 
Farmers Home Loan Administration, with the other involving another FHA 
loan, and that flexibility for such limited purposes should be 
provided.
    Response: HUD has no statutory authority to insure loans that are 
on a parity basis with other loans.
    Comment: Section 242.77(b) should be revised, as follows:

    An inferior lien required in connection with a supplemental loan 
insured pursuant to section 241 or Section 223(a)(7) of the Act;

    Response: HUD disagrees with the comment. Including Sec.  223(a)(7) 
would be confusing because these financings must have first liens, with 
the exception of those made pursuant to Section 241 loans.
    Comment: Section 242.77(c) should be revised to incorporate state 
law considerations, as follows:

    An inferior or superior lien on equipment as may be approved in 
connection with an equipment leasing program approved by HUD, as 
required by governing state law, in connection with existing 
financed equipment at the time of initial endorsement or as may or 
as otherwise may be approved by HUD.

    The commenter states that in New York, for example, as a matter of 
law, equipment purchased pursuant to a lease-purchase or purchase money 
arrangement will be superior to the insured mortgage, albeit upon the 
payoff of the underlying financing, the equipment could be covered by 
the FHA lien instruments.
    Response: HUD believes this section is sufficiently flexible, as 
written.
7. Section 242.89 Supplemental Loans
    Comment: This section should be revised to include refinancing of 
indebtedness resulting from the early start of construction:

    A loan, advance of credit, or purchase of an obligation 
representing a loan or advance of credit made for the purpose of 
financing improvements or additions (including the refinancing of 
any indebtedness incurred in connection with the early start of 
construction of such improvements or additions) to a hospital 
covered by a mortgage insured under this section of the Act or for a 
Commissioner-held mortgage, or equipment for a hospital, may be 
insured pursuant to the provisions of section 241 of the Act and 
under the provisions of this part as applicable and such additional 
terms and conditions as established by HUD. See subpart B of 24 CFR 
part 241 with respect to the contract of mortgage insurance for all 
loans insured under section 241 of the Act. See 24 CFR part 241, 
subpart C, for energy improvements.

    Response: In order to make this section consistent with the final 
rule provisions on early commencement of work and refinancing of 
indebtedness, HUD has added the suggested parenthetical phrase with 
modification: ``(including the refinancing of any indebtedness incurred 
in connection with the early commencement of work on such improvements 
or additions, subject to the requirements of Sec. Sec.  242.15 and 
242.45).''
8. Section 242.91 Eligibility of Refinancing Transactions
    Comment: The discussion in Sec.  242.91(c) is confusing regarding 
the term length of a section 223(a)(7) loan. It appears from the 
reading that in particular cases, the term could be 35 years if the 
current mortgage has 23 years remaining, plus the additional 12 years.
    Response: HUD has determined that the language should remain 
unchanged. HUD may approve a term up to 12 years beyond the remaining 
term of the existing mortgage if it is determined that the longer term 
is necessary to ensure the economic viability of the hospital and to 
make an insurance claim less likely.

Findings and Certifications

Information Collection Requirements
    The information collection requirements contained in Sec. Sec.  
242.16, 242.35, 242.58, 242.61, and 242.68 have been approved by the 
Office of Management and Budget in accordance with the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3501-3520) and assigned OMB Control 
Number 2502-0518. 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 currently valid control number.
Environmental Impact
    A Finding of No Significant Impact with respect to the environment 
for this final rule was made at the proposed rule stage in accordance 
with HUD regulations at 24 CFR part 50, which implement section 
102(2)(C) of the National Environmental Policy Act of 1969 (42 U.S.C. 
4332(2)(C)). The Finding of No Significant Impact remains applicable, 
and is available for public inspection between 8 a.m. and 5 p.m. 
weekdays in the Regulations Division, Office of General Counsel, 
Department of Housing and Urban Development, 451 Seventh Street, SW., 
Room 10276, Washington, DC 20410-5000.
Unfunded Mandates Reform Act
    The Unfunded Mandates Reform Act of 1995 (2 U.S.C. 1531-1538) 
(UMRA) establishes requirements for federal agencies to assess the 
effects of their regulatory actions on state, local, and tribal 
governments and on the private sector. This rule does not impose a 
federal mandate on any state, local, or tribal government, or on the 
private sector, within the meaning of UMRA.
Regulatory Flexibility Act
    The Regulatory Flexibility Act (RFA) (5 U.S.C. 601 et seq.), 
generally requires an agency to conduct a regulatory flexibility 
analysis of any rule subject to notice and comment rulemaking 
requirements, unless the agency certifies that the rule will not have a 
significant economic impact on a substantial number of small entities.
    There are no anti-competitive discriminatory aspects of the rule 
with

[[Page 67545]]

regard to small entities, and there are not any unusual procedures that 
would need to be complied with by small entities. The rule revises the 
regulations under the mortgage insurance program for hospitals to 
update and improve the efficiency of the program.
    Therefore, this final rule will not have a significant economic 
impact on a substantial number of small entities, and an initial 
regulatory flexibility analysis is not required.
Executive Order 13132, Federalism
    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial direct compliance costs on state and local 
governments and is not required by statute, or the rule preempts state 
law, unless the agency meets the consultation and funding requirements 
of section 6 of the Executive Order. This final rule does not have 
federalism implications and does not impose substantial direct 
compliance costs on state and local governments nor preempt state law 
within the meaning of the Executive Order.
Regulatory Planning and Review
    OMB reviewed this rule under Executive Order 12866, Regulatory 
Planning and Review. OMB determined that this rule is a ``significant 
regulatory action,'' as defined in section 3(f) of the order (although 
not an economically significant regulatory action under the order). The 
docket file is available for public inspection in the Regulations 
Division, Office of General Counsel, 451 Seventh Street, SW., Room 
10276, Washington, DC 20410-0500.

Catalog of Federal Domestic Assistance

    The Catalog of Federal Domestic Assistance number is 14.128.

List of Subjects

24 CFR Part 200

    Administrative practice and procedure, Claims, Equal employment 
opportunity, Fair housing, Home improvement, Housing standards, Lead 
poisoning, Loan programs--housing and community development, Mortgage 
insurance, Organization and functions (Government agencies), Penalties, 
Reporting and recordkeeping requirements, Social Security, Unemployment 
compensation, Wages.

24 CFR Part 242

    Hospitals, Mortgage insurance, Reporting and recordkeeping 
requirements.

0
Accordingly, for the reasons described in the preamble, HUD amends 24 
CFR parts 200 and 242 to read as follows:

PART 200--INTRODUCTION TO FHA PROGRAMS

0
1. The authority citation for part 200 continues to read as follows:

    Authority: 12 U.S.C. 1702-1715z-21; 42 U.S.C. 3535(d).


0
2. Section 200.24 is revised to read as follows:


Sec.  200.24  Existing projects.

    A mortgage financing the purchase or refinance of an existing 
rental housing project under section 207 of the Act, or for refinancing 
the existing debt of an existing nursing home, intermediate care 
facility, assisted living facility, or board and care home, or any 
combination thereof, under section 232 of the Act, may be insured 
pursuant to provisions of section 223(f) of the Act and such terms and 
conditions established by HUD.


0
3. Section 200.25 is revised to read as follows:


Sec.  200.25  Supplemental loans.

    A loan, advance of credit or purchase of an obligation representing 
a loan or advance of credit made for the purpose of financing 
improvements or additions to a project covered by a mortgage insured 
under any section of the Act or Commissioner-held mortgage, or 
equipment for a nursing home, intermediate care facility, board and 
care home, assisted living facility, or group practices facility, may 
be insured pursuant to the provisions of section 241 of the Act and 
such terms and conditions established by HUD.

0
4. 24 CFR 200.40 is amended by revising paragraphs (c), (d), and (f) as 
follows:


Sec.  200.40  HUD fees.

* * * * *
    (c) Application fee--conditional commitment. For a mortgage being 
insured under section 223(f) of the Act (12 U.S.C. 1715n), an 
application-commitment fee of $3 per thousand dollars of the requested 
mortgage amount shall accompany an application for conditional 
commitment.
    (d) Application fee--firm commitment: General. An application for 
firm commitment shall be accompanied by an application-commitment fee 
which, when added to any prior fees received in connection with 
applications for a SAMA letter or a feasibility letter, will aggregate 
$5 per thousand dollars of the requested mortgage amount to be insured. 
The payment of an application-commitment fee shall not be required in 
connection with an insured mortgage involving the sale by the 
government of housing or property acquired, held, or contracted 
pursuant to the Atomic Energy Community Act of 1955 (42 U.S.C. 2301 et 
seq.).
* * * * *
    (f) Fees on increases--in general. This section applies to all 
applications except applications involving hospitals, which are covered 
in 24 CFR part 242.
    (1) Increase in firm commitment before endorsement. An application, 
filed before initial endorsement (or before endorsement in a case 
involving insurance upon completion), for an increase in the amount of 
an outstanding firm commitment, shall be accompanied by a combined 
additional application and commitment fee. This combined additional fee 
shall be in an amount that will aggregate $5 per thousand dollars of 
the amount of the requested increase. If an inspection fee was required 
in the original commitment, an additional inspection fee shall be paid 
in an amount computed at the same dollar rate per thousand dollars of 
the amount of increase in commitment as was used for the inspection fee 
required in the original commitment. When insurance of advances is 
involved, the additional inspection fee shall be paid at the time of 
initial endorsement. When insurance upon completion is involved, the 
additional inspection fee shall be paid before the date construction is 
begun; or, if construction has begun, it shall be paid with the 
application for increase.
    (2) Increase in mortgage between initial and final endorsement. 
Upon the filing of an application between initial and final 
endorsement, for an increase in the amount of the mortgage, either by 
amendment or by substitution of a new mortgage, a combined additional 
application and commitment fee shall accompany the application. This 
combined additional fee shall be in an amount that will aggregate $5 
per thousand dollars of the amount of the increase requested. If an 
inspection fee was required in the original commitment, an additional 
inspection fee shall accompany the application in an amount not to 
exceed the $5 per thousand dollars of the amount of the increase 
requested.
    (3) Loan to cover operating losses. In connection with a loan to 
cover operating losses (see Sec. 200.22), a combined application and 
commitment fee of $5 per thousand dollars of the amount of the loan 
applied for shall be

[[Page 67546]]

submitted with the application for a firm commitment. No inspection fee 
shall be required.
* * * * *

0
5. Part 242 is revised to read as follows:

PART 242--MORTGAGE INSURANCE FOR HOSPITALS

Subpart A--General Eligibility Requirements
Sec.
242.1 Definitions.
242.2 Program financial self-sufficiency.
242.3 Encouragement of certain programs.
242.4 Eligible hospitals; transition provisions.
242.5 Eligible mortgagees/lenders.
242.6 Property requirements.
242.7 Maximum mortgage amounts.
242.8 Standards for licensure and methods of operation.
242.9 Physician ownership.
242.10 Eligible mortgagors.
242.11 Regulatory compliance required.
242.13 Parents and affiliates.
242.14 Mortgage reserve fund.
242.15 Limitation on refinancing existing indebtedness.
Subpart B--Application Procedures and Commitments
242.16 Applications.
242.17 Commitments.
242.18 Inspection fee.
242.19 Fees on increases.
242.20 Reopening of expired commitments.
242.21 Refund of fees.
242.22 Maximum fees and charges by mortgagee.
242.23 Maximum mortgage amounts and cash equity requirements.
242.24 Initial operating costs.
Subpart C--Mortgage Requirements
242.25 Mortgage form and disbursement of mortgage proceeds.
242.26 Agreed interest rate.
242.27 Maturity.
242.28 Allowable costs for consultants.
242.29 Payment requirements.
242.30 Application of payments.
242.31 Accumulation of accruals.
242.32 Covenant against liens.
242.33 Covenant for malpractice, fire, and other hazard insurance.
242.35 Mortgage lien certifications.
242.37 Mortgage prepayment.
242.38 Late charge.
Subpart D--Endorsement for Insurance
242.39 Insurance endorsement.
242.40 Mortgagee certificate.
242.41 Certification of cost requirements.
242.42 Certificates of actual cost.
242.43 Application of cost savings.
Subpart E--Construction
242.44 Construction standards.
242.45 Early commencement of work.
242.46 Insured advances--building loan agreement.
242.47 Insured advances for building components stored off-site.
242.48 Insured advances for certain equipment and long lead items.
242.49 Funds and finances: deposits and letters of credit.
242.50 Funds and finances: off-site utilities and streets.
242.51 Funds and finances: insured advances and assurance of 
completion.
242.52 Construction contracts.
242.53 Excluded contractors.
Subpart F--Nondiscrimination and Wage Rates
242.54 Nondiscrimination.
242.55 Labor standards.
Subpart G--Regulatory Agreement, Accounting and Reporting, and 
Financial Requirements
242.56 Form of regulation.
242.57 Maintenance of hospital facility.
242.58 Books, accounts, and financial statements.
242.59 Inspection of facilities by Commissioner.
242.61 Management.
242.62 Releases of lien.
242.63 Additional indebtedness and leasing.
242.64 Current and future property.
242.65 Distribution of assets.
242.66 Affiliate transactions.
242.67 New corporations, subsidiaries, affiliations, and mergers.
Subpart H--Miscellaneous Requirements
242.68 Disclosure and verification of Social Security and Employer 
Identification Numbers.
242.69 Transfer fee.
242.70 Fees not required.
242.72 Leasing of hospital.
242.73 Waiver of eligibility requirements for mortgage insurance.
242.74 Smoke detectors.
242.75 Title requirements.
242.76 Title evidence.
242.77 Liens.
242.78 Zoning, deed, and building restrictions.
242.79 Environmental quality determinations and standards.
242.81 Lead-based paint poisoning prevention.
242.82 Energy conservation.
242.83 Debarment and suspension.
242.84 Previous participation and compliance requirements.
242.86 Property and mortgage assessment.
242.87 Certifications.
242.89 Supplemental loans.
242.90 Eligibility of mortgages covering hospitals in certain 
neighborhoods.
242.91 Eligibility of refinancing transactions.
242.92 Minimum principal loan amount.
242.93 Amendment of regulations.

    Authority: 12 U.S.C. 1709, 1710, 1715b, and 1715u; 42 U.S.C. 
3535(d).

Subpart A--General Eligibility Requirements


Sec.  242.1  Definitions.

    As used in this subpart, the following terms shall have the meaning 
indicated:
    Act means the National Housing Act (12 U.S.C. 1701 et seq.).
    Affiliate means a person or entity which, directly or indirectly, 
either controls or has the power to control or exert significant 
influence on the other, or a person and entity both controlled by a 
third person or entity, which may be a parent entity. Indicia of 
control include, but are not limited to: Interlocking management or 
ownership, identity of interests among family members, shared 
facilities and equipment, common use of employees, or a business entity 
organized following the suspension or debarment of a person or entity 
that has the same or similar management, ownership, or principal 
employees as the suspended, debarred, ineligible, or voluntarily 
excluded person or entity or as defined in the Medicare reimbursement 
regulations.
    AMPO (Allowance for Making Project Operational) relates to 
nonprofit projects and means a fund that is primarily for accruals 
during the course of construction for mortgage insurance premiums 
(MIPs), taxes, ground rents, property insurance premiums, and 
assessments, when funds available for these purposes under the Building 
Loan Agreement have been exhausted; and also for allocation to such 
accruals after completion of construction, if the income from the 
hospital at that time is insufficient to meet such accruals. AMPO may 
also be used for such other purposes as approved by HUD. Any balance 
remaining unused in the fund at final endorsement will be treated in 
accordance with Sec.  242.43.
    Applicant means a HUD multifamily-approved lender that would be the 
mortgagee of record.
    Chronic convalescent and rest means skilled nursing services, 
intermediate care services, respite care services, hospice services, 
rehabilitation services, and other services of a similar nature.
    Construction means the creation of a new or replacement hospital 
facility, which may include the cost of acquisition of new or 
replacement equipment in the cost of construction.
    Days of cash on hand means the number of days of operating cash 
available to the hospital, calculated pursuant to standards determined 
by HUD.
    Debt service coverage ratio is a measure of a hospital's ability to 
pay interest and principal with cash generated from current operations. 
Debt service ratio is calculated as follows: Debt Service Coverage 
Ratio (total debt service coverage on all long-term capital debt) 
equals the excess of revenues over expenses (not-for-profit) or net 
income (for-profit) plus interest expense plus

[[Page 67547]]

depreciation expense plus amortization expense, all divided by current 
portion of long-term debt (including capital leases) from the previous 
year's audited financial statement plus interest expense. The 
calculation can be expressed as:
[GRAPHIC] [TIFF OMITTED] TR28NO07.052

    Hospital means a facility that has been proposed for approval or 
has been approved by HUD under the provisions of this subpart, and:
    (1) That provides community services for inpatient medical care of 
the sick or injured (including obstetrical care);
    (2) Where not more than 50 percent of the total patient days during 
any year are customarily assignable to the categories of chronic 
convalescent and rest, drug and alcoholic, epileptic, mentally 
deficient, mental, nervous and mental, and tuberculosis, except that 
the 50 percent patient day restriction does not apply to Critical 
Access Hospitals (hospitals designated as such under the Medicare Rural 
Hospital Flexibility Program) between January 28, 2008 and July 31, 
2011.
    (3) That is a facility licensed or regulated by the state (or, if 
there is no such state law providing for such licensing or regulation 
by the state, by the municipality or other political subdivision in 
which the facility is located) and is:
    (i) A public facility owned by a state or unit of local government 
or by an instrumentality thereof, or owned by a public benefit 
corporation established by a state or unit of local government or by an 
instrumentality thereof;
    (ii) A proprietary facility; or
    (iii) A facility of a private nonprofit corporation or association.
    Identity of interest means a relationship that must be disclosed 
and may be prohibited pursuant to the requirements of the Regulatory 
Agreement. Examples of a prohibited Identity of Interest relationship 
are, but are not limited to, a financial or family relationship between 
the mortgagor (which includes but is not limited to an officer, 
director, or partner of the mortgagor) and general contractor, 
subcontractor, seller of the land or property, any consultants, or 
other parties to the transaction.
    Mortgage means such classes of first liens as are commonly given to 
secure advances on, or the unpaid purchase price of, real estate under 
the laws of the state in which the real estate is located, together 
with any mortgage note secured thereby. The mortgage may be in the form 
of one or more trust mortgages or mortgage indentures or deeds of trust 
securing notes, bonds, or other mortgage notes; and, by the same 
instrument or by a separate instrument, it may create a security 
interest in the personalty, including, but not limited to, the 
equipment, whether or not the equipment is attached to the realty, and 
in the revenues and receivables of the hospital.
    Mortgagee or lender means the original lender under a mortgage, and 
its successors and assigns, including the holders of mortgage notes 
issued under a trust mortgage or deed of trust pursuant to which such 
holders act by and through a trustee therein named. (All official 
contacts and actions by HUD shall be with or through a HUD-approved 
lender.)
    Mortgagor means the original borrower under a mortgage and its 
successors and assigns.
    Mortgage Reserve Fund means a trust account, or an account held by 
the mortgagee, for and on behalf of the mortgagor, to which the 
mortgagor contributes and from which withdrawals must be approved by 
HUD. The purpose of the fund is to provide HUD a means to assist the 
hospital to avoid mortgage defaults and to preserve the value of the 
mortgaged property and the hospital's business.
    Most recent audited financial statement means the audited financial 
statement required under the regulatory agreement for the prior fiscal 
year.
    Net income means the net income of a for-profit entity, or, in the 
case of a nonprofit entity, the excess of revenues less expenses.
    Non-operating revenues and expenses are those revenues and expenses 
not directly related to patient care, hospital-related patient 
services, or the sale of hospital-related goods. Examples of items 
classified as non-operating are state and federal income tax, general 
contributions, gains and losses from investments, unrestricted income 
from endowment funds, and income from related entities.
    Classification of items as operating or non-operating shall follow 
written guidance by HUD.
    Operating margin is operating income divided by operating revenue, 
where:
    (1) Operating revenue is the revenue from the core patient care 
operations of the hospital. It includes revenues from the provision of 
such items as patient care (including, but not limited to, hospital-
based nursing home and physicians' clinics); transfers from temporarily 
restricted accounts that are used for current operating expenses; and 
patient-related activities such as the operation of the cafeteria, 
parking facilities, television services to patients, sale of medical 
scrap or waste, etc. (Additional sources of revenue, which are 
classified as non-operating, are excluded from this measure, provided, 
however, at HUD's discretion, that revenue that has historically been 
received reliably and is expected to continue to be received may be 
considered operating revenue for underwriting purposes); and
    (2) Operating income is operating revenue minus operating expenses, 
where operating expenses are the expenses incurred in providing patient 
care, including such items as salaries, supplies, and the cost of 
capital.
    Parent means an organization or entity that controls or has a 
controlling interest in another organization or entity.
    Personalty means all furniture, furnishings, equipment, machinery, 
building materials, appliances, goods, supplies, tools, books, records 
(whether in written or electronic form), computer equipment (hardware 
and software) and other tangible or electronically stored personal 
property (other than fixtures) that are owned or leased by the borrower 
or the lessee now or in the future in connection with the ownership, 
management, or operation of the land or the improvements or are located 
on the land or in the improvements, and any operating agreements 
relating to the land or the improvements, and any surveys, plans, 
specifications, and contracts for architectural, engineering, and 
construction services relating to the land or the improvements, chooses 
in action and all other intangible property and rights relating to the 
operation of, or used in connection with, the land or the improvements, 
including all governmental permits relating to any activities on the 
land. Personalty also includes all tangible and intangible personal 
property used for health care

[[Page 67548]]

(such as major movable equipment and systems), accounts, licenses, bed 
authorities, certificates of need required to operate the hospital and 
to receive benefits and reimbursements under provider agreements with 
Medicaid, Medicare, state and local programs, payments from health care 
insurers and any other assistance providers (``Receivables''); all 
permits, instruments, rents, lease and contract rights, and equipment 
leases relating to the use, operation, maintenance, repair, and 
improvement of the hospital. Generally, intangibles shall also include 
all cash and cash escrow funds, such as but not limited to: 
Depreciation reserve fund or mortgage reserve fund accounts, bank 
accounts, residual receipt accounts, all contributions, donations, 
gifts, grants, bequests, and endowment funds by donors, and all other 
revenues and accounts receivable from whatever source paid or payable. 
All personalty shall be securitized with appropriate UCC filings and 
any excluded personalty shall be indicated in the Regulatory Agreement.
    Preapplication meeting means a meeting among HUD, a potential 
mortgagee (applicant), and a potential mortgagor for mortgage insurance 
where there has been a positive Preliminary Review of the proposed 
project. The preapplication meeting is an opportunity for the potential 
mortgagee and mortgagor to summarize the proposed project, for HUD to 
summarize the application process, and for issues that could affect the 
eligibility or underwriting of the proposed loan to be identified and 
discussed.
    Preliminary Review Letter means a letter from HUD to a potential 
applicant communicating the result of the Preliminary Review. The 
letter may state that an application for mortgage insurance would 
probably not be successful and provide the reasons for this 
determination, or state that no factors that would cause an application 
to be rejected have been identified, and therefore there appears to be 
no bar to the applicant proceeding to a preapplication meeting.
    Project means the construction (which may include replacement of an 
existing hospital facility) or substantial rehabilitation of an 
eligible hospital, including equipment, which has been proposed for 
approval or has been approved by HUD under the provisions of this 
subpart, including the financing and refinancing, if any, plus all 
related activities involved in completing the improvements to the 
property. However, in particular closing documents, ``project'' may be 
used to mean the mortgagor entity, the operation of the mortgagor, the 
facility, or all of the mortgaged property, depending on the context in 
which it is used.
    Regulatory Agreement means the agreement under which all mortgagors 
shall be regulated by HUD, as long as HUD is the insurer or holder of 
the mortgage, in a published format determined by HUD, and such 
additional covenants and restrictions as may be determined necessary by 
HUD on a case-by-case basis.
    Secretary means the Secretary of Housing and Urban Development or 
his or her authorized representatives.
    Security instrument means a mortgage, deed of trust, and any other 
security for the indebtedness, and shall be deemed to be the mortgage 
as defined by the National Housing Act, as amended, implementing 
regulations, and HUD directives.
    Service area means that geographical area, identified by zip codes, 
from which a substantial majority of a hospital's patients derive.
    State includes the several states, Puerto Rico, the District of 
Columbia, Guam, the Trust Territory of the Pacific Islands, American 
Samoa, and the United States Virgin Islands.
    Substantial rehabilitation means additions, expansion, remodeling, 
renovation, modernization, repair, and alteration of existing 
buildings, including acquisition of new or replacement equipment.
    Surplus Cash means any cash earned in the applicable fiscal period, 
including accounts receivable and equity balance, remaining after all 
of the following conditions have been met:
    (1) Final endorsement of the HUD-insured note has occurred;
    (2) Mortgage payments for the preceding 12 months have been made 
when due, including any grace period;
    (3) The Debt Service Coverage Ratio is greater than or equal to 
1.50 in the most recent audited financial statements and as of the date 
of distribution;
    (4) Days in Accounts Receivable are less than or equal to 80 in the 
most recent audited financial statements and as of the date of 
distribution;
    (5) The average payment period is less than or equal to 80 in the 
most recent audited financial statements and as of the date of 
distribution;
    (6) The Mortgage Reserve Fund (MRF) is fully funded as of the date 
of the distribution in conformity with the MRF schedule;
    (7) All income, property, and statutory employer payroll taxes and 
employee payroll withholding contributions (including penalties and 
interest, if applicable) have been deposited as of the date of the 
distribution, as required;
    (8) The Current Ratio is greater than or equal to 1.50 in the most 
recent audited financial statements and immediately after the 
distribution;
    (9) Days of cash on hand are greater than or equal to 21 days in 
the most recent audited financial statements and immediately after the 
distribution;
    (10) The distribution may not be more than 50 percent of Net Income 
as reflected in the most recent audited financial statements, unless 
the Mortgagor has an equity financing ratio equal to or greater than 20 
percent in the most recent audited financial statements and immediately 
after the distribution; and
    (11) The Equity less any assets excluded from the mortgaged 
property is greater than 0.00 in the most recent audited financial 
statements and immediately after the distribution is made. As used in 
this definition:
    ``Most recent audited financial statements'' refers to the audited 
financial statement required under section 242.58 for the prior fiscal 
year;
    ``Net Income'' means Net Income for for-profit entities; Excess of 
Revenues over Expenses for not-for-profit entities; and Excess of 
Revenues over Expenses before Capital Grants, Contributions, and 
Additions to Permanent Endowment for governmental entities; and
    ``Equity financing ratio'' means (Equity less any assets excluded 
from the mortgaged property)/(total assets less any assets excluded 
from the mortgaged property). Equity is defined as Equity for a for-
profit entity, Total Net Assets for not-for-profit entities, and Total 
Net Assets for governmental entities.


Sec.  242.2  Program financial self-sufficiency.

    The Commissioner shall administer the Section 242 program in such a 
way as to encourage financial self-sufficiency and actuarial soundness; 
i.e., to avoid mortgage defaults and claims for insurance benefits in 
order to protect the mortgage insurance fund.


Sec.  242.3  Encouragement of certain programs.

    The activities and functions provided for in this part shall be 
carried out so as to encourage provision of comprehensive health care, 
including outpatient and preventive care as well as hospitalization, to 
a defined population, and in the case of public and certain not-for-
profit hospitals, to encourage programs that are undertaken to provide 
essential health care services to all residents of a community 
regardless of ability to pay.

[[Page 67549]]

Sec.  242.4  Eligibility for insurance and transition provision.

    (a) The hospital to be financed with a mortgage insured under this 
part shall involve the construction of a new hospital or the 
substantial rehabilitation (or replacement) of an existing hospital.
    (b) This part applies only to applications for FHA mortgage 
insurance submitted after a pre-application meeting (as defined in 
Sec.  242.1) with HUD that occurred on and after January 28, 2008. 
HUD's regulations and practices prior to January 28, 2008 apply to 
applications for FHA mortgage insurance submitted after a pre-
application meeting that occurred before January 28, 2008.


Sec.  242.5  Eligible mortgagees/lenders.

    The lender requirements set forth in 24 CFR part 202 regarding 
approval, recertification, withdrawal of approval, approval for 
servicing, report requirements, and conditions for supervised 
mortgagees, nonsupervised mortgagees, investing mortgagees, and 
governmental and similar institutions, apply to these programs.


Sec.  242.6  Property requirements.

    The mortgage, to be eligible for insurance, shall be on property 
located in a state, as defined in Sec.  242.1. The mortgage shall cover 
real estate in which the mortgagor has one of the following interests:
    (a) A fee simple title;
    (b) A lease for not less than 99 years that is renewable; or
    (c) A lease having a term of not less than 50 years to run from the 
date the mortgage is executed.


Sec.  242.7  Maximum mortgage amounts.

    The mortgage shall involve a principal obligation not in excess of 
90 percent of HUD's estimate of the replacement cost of the hospital, 
including the equipment to be used in its operation when the proposed 
improvements are completed and the equipment is installed.


Sec.  242.8  Standards for licensure and methods of operation.

    The Secretary shall require satisfactory evidence that the hospital 
will be located in a state or political subdivision of a state with 
reasonable minimum standards of licensure and methods of operation for 
hospitals, and satisfactory assurance that such standards will be 
applied and enforced with respect to the hospital.


Sec.  242.9  Physician ownership.

    Ownership of an interest in the mortgagor by physicians or other 
professionals practicing in the hospital is permitted within limits 
determined by HUD to avoid insurance risks that may be associated with 
such ownership. The Commissioner shall determine if the proposed 
mortgagor will be at low risk for violation of regulations of the U.S. 
Department of Health and Human Services, other federal regulations, and 
state regulations governing kickbacks, self-referrals, and other issues 
that could increase the risk of eventual default. The Commissioner's 
determination shall be based on an unqualified legal opinion as to 
compliance with applicable federal law, among other considerations.


Sec.  242.10  Eligible mortgagors.

    The mortgagor shall be a public mortgagor (i.e., an owner of a 
public facility), a private nonprofit corporation or association, or a 
profit-motivated mortgagor meeting the definition of ``hospital'' in 
Sec.  242.1. The mortgagor shall be approved by HUD and shall possess 
the powers necessary and incidental to operating a hospital. Eligible 
proprietary or profit-motivated mortgagors may include for-profit 
corporations, limited partnerships, and limited liability corporations 
and companies, but may not include natural persons, joint ventures, and 
general partnerships. Any proposed mortgagor must demonstrate that it 
has a continuity of organization commensurate with the term of the 
mortgage loan being insured. For new organizations, or those whose 
continuity is necessarily dependent upon an individual or individuals, 
broad community participation is required.


Sec.  242.11  Regulatory compliance required.

    An application for insurance of a mortgage under this part shall be 
considered only in connection with a hospital that is in substantial 
compliance with regulations of the Department of Health and Human 
Services and the regulations of the applicable state governing the 
operation and reimbursement of hospitals. A hospital that is under 
investigation by any state or federal agency for statutory or 
regulatory violations is not eligible so long as the investigation is 
unresolved, unless HUD determines that the investigation is minor in 
nature; that is, the investigation is unlikely to result in substantial 
liabilities or to otherwise substantially harm the creditworthiness of 
the hospital.


Sec.  242.13  Parents and affiliates.

    As a condition of issuing a commitment, HUD may require corporate 
parents, affiliates, or principals of the proposed mortgagor to provide 
assurances, guarantees, or collateral to protect HUD's interests. The 
Commissioner may also require financial and operational information on 
the parent, other businesses owned by the parent, or affiliates of the 
proposed mortgagor and may also require a parent or affiliate to be 
regulated by HUD as to certain actions that could impact on the 
insurance of a mortgage loan for the benefit of the hospital.


Sec.  242.14  Mortgage reserve fund.

    As a condition of issuing a commitment, HUD shall require 
establishment of a Mortgage Reserve Fund (MRF). The mortgagor shall be 
required to make contributions to the MRF such that, with fund 
earnings, the MRF will build to one year of debt service at 5 years 
following commencement of amortization, increasing thereafter to 2 
years of debt service on and after 10 years following commencement of 
amortization according to a schedule established by HUD, unless HUD 
determines that a different schedule of contributions is appropriate 
based on the mortgagor's risk profile, reimbursement structure, or 
other characteristics. In particular, hospitals that receive cost-based 
reimbursement may be required to have MRFs that build to more than 2 
years of debt service. Expenditures from the fund are made at HUD's 
sole discretion or in accordance with the mortgagor's MRF Schedule. 
Upon termination of insurance, the balance of the MRF shall be returned 
to the mortgagor, provided that all obligations to HUD have been met.


Sec.  242.15  Limitation on refinancing existing indebtedness.

    Some existing capital debt may be refinanced with the proceeds of a 
section 242 insured loan; however, the hard costs of construction and 
equipment must represent at least 20 percent of the total mortgage 
amount.

Subpart B--Application Procedures and Commitments


Sec.  242.16  Applications.

    (a) Application process--(1) Market Need. The approval process 
entails a determination of the market need of the proposal and 
stresses, on a market-wide basis, the impact of the proposed facility 
on, and its relationship to, other health care facilities and services 
(particularly other hospitals with mortgages insured under this part 
and hospitals that have a disproportionate share of Medicaid and 
uninsured patients or provide a substantial amount of charity care); 
the number and percentage of any excess

[[Page 67550]]

beds; and demographic projections. Generally, Section 242 insurance may 
support start-up hospitals or major expansions of existing hospitals 
only if existing hospital capacity or services are clearly not adequate 
to meet the needs of the population in the service area.
    (i) If the state has an official procedure for determining need for 
hospitals, HUD shall require that such procedure be followed before the 
application for insurance is submitted, and that the application 
document that need has also been established under that procedure.
    (ii) The following factors are relevant in evaluating market need 
for the project and should be addressed, as applicable, in the study of 
market need and feasibility submitted with the application. Because 
each hospital presents a unique situation, there is no formula or 
cutoff level that applies to all applications:
    (A) Service area definition;
    (B) Existing or proposed hospital;
    (C) Designation as sole community provider, Critical Access 
Hospital, or rural referral center;
    (D) Community-wide use rates (discharges and days/1000);
    (E) Statewide use rates (for benchmarking purposes);
    (F) Current population and 5-year projection by age cohort;
    (G) Staffed versus licensed beds;
    (H) Applicant hospital's occupancy rate;
    (I) Competitors' occupancy rates;
    (J) Outpatient volume;
    (K) Availability of emergency services;
    (L) Teaching hospital status;
    (M) Services offered by hospitals in the service area;
    (N) Migration of patients out of the service area;
    (O) Planned construction at other facilities in the region;
    (P) Historical market share by major service category;
    (Q) Disproportionate Share Hospital designation; and
    (R) Distance to other hospitals.
    (2) Operating margin and debt service coverage ratio. (i) Hospitals 
with an aggregate operating margin of less than 0.00 when calculated 
from the three most recent annual audited financial statements are not 
eligible for Section 242 insurance, unless HUD determines, based on the 
financial data in those statements, that the hospital has achieved a 
financial turnaround resulting in a positive operating margin in the 
most recent year, calculated using classifications of items as 
operating or non-operating in accordance with guidance that shall be 
provided in written directives by HUD. In any event, HUD shall not 
issue an insurance commitment for any hospital in a turnaround 
situation that has not achieved 2 consecutive years of positive 
operating margin immediately prior to issuance of the commitment.
    (ii) Hospitals with an average debt service coverage ratio of less 
than 1.25 in the 3 most recent audited years are not eligible for 
Section 242 insurance, unless HUD determines, based on the audited 
financial data, that the hospital has achieved a financial turnaround 
resulting in a debt service coverage ratio of at least 1.40 in the most 
recent year. In cases of refinancing at a lower interest rate, HUD may 
authorize the use of the projected debt service requirement in lieu of 
the historical debt in calculating the debt service coverage ratios for 
each of the prior 3 years. In cases where HUD authorizes the use of the 
projected debt service requirement in lieu of the historical debt to 
determine the debt service coverage ratio, hospitals must have an 
average debt service coverage ratio of 1.40 or greater.
    (3) Financial Feasibility. The approval process entails a 
determination of the financial feasibility of the proposal, i.e., a 
determination that it is probable that the proposed mortgagor will be 
able to meet its debt service requirements during the period projected. 
It includes analysis of the reimbursement structure of the proposed 
hospital (including patient/payer mix); actions of competitors; and the 
probable projected impact on the proposed hospital of general health 
care system trends, such as the development of alternative health care 
delivery systems and new reimbursement methods. In addition to 
historical operating margin, determination of financial feasibility 
includes, but is not limited to, evaluation of the following factors, 
which the application must address and which HUD will review:
    (i) Current and projected gains from operations and a manageable 
debt load using reasonable assumptions;
    (ii) Current debt service coverage ratio of 1.25 or higher and 
projected debt service coverage ratio of 1.40 or higher;
    (iii) Cushion in the balance sheet sufficient to demonstrate the 
ability to withstand short periods of net operating losses without 
jeopardizing financial viability;
    (iv) Patient utilization forecasts (including average length of 
stay, case intensity, discharges, area-wide use rates) that are 
consistent with the hospital's historical trends, future service mix, 
market trends, population forecasts, and business climate;
    (v) The hospital's demonstrated ability to position itself to 
compete in its marketplace;
    (vi) Organizational affiliations or relationships that help 
optimize financial, clinical, and operational performance;
    (vii) Management's demonstrated ability to operate effectively and 
efficiently, and to develop effective strategies for addressing problem 
areas;
    (viii) Systems in place to monitor hospital operations, revenues, 
and costs accurately and in a timely manner;
    (ix) A Board that is appropriately constituted and provides 
effective oversight;
    (x) Required licensures and approvals; and
    (xi) Favorable ratings from the Joint Commission on Accreditation 
of Healthcare Organizations or other organizations acceptable to HUD.
    (4) Preliminary Review. A Preliminary Review is a general overview 
of the acceptability of a potential mortgagor performed at the request 
of a hospital, a financial consultant representing a hospital, or a 
lender, to identify any factors that would likely cause an application 
to be rejected, should an application be submitted.
    (i) The purpose of the preliminary review is for HUD to identify 
any obvious factors that would cause an application to be rejected, 
before the potential mortgagor or mortgagee expends resources to 
prepare one. The hospital, financial consultant, or lender shall submit 
a preliminary information package to HUD that provides evidence of 
statutory eligibility, market need, financial strength, and such other 
documentation as HUD may require. The scope of the preliminary review 
does not include approval of any specific site in the community.
    (ii) If HUD identifies factors that would cause an application to 
be rejected, HUD shall issue a Preliminary Review Letter notifying the 
potential applicant that an application for mortgage insurance would 
probably not be successful and providing the reasons for this decision. 
Also, no further request from the proposed applicant for a Preliminary 
Review shall be entertained for a period of one year from the date of 
HUD's notification. HUD may grant an exception to this one-year 
limitation if, during the year, there is a major change in the 
circumstances that caused HUD to determine that the project would be 
rejected. For example, if the sole reason for HUD's determination was 
the hospital's failure to meet the historical operating margin test, 
and a new audited annual financial statement contains results that 
would

[[Page 67551]]

cause the hospital to meet the test, then the lender may request a new 
Preliminary Review within one year of HUD's notification.
    (iii) If HUD does not identify any factors that would cause an 
application to be rejected, HUD shall issue a Preliminary Review Letter 
advising the potential applicant that there appears to be no bar to the 
applicant's proceeding to the next step in the application process, 
provided that if a complete application is not received by HUD within 
one year following the date of HUD's letter, another Preliminary Review 
may be required, at HUD's discretion, before the application process 
may proceed.
    (iv) The Commissioner's determination in the preliminary review 
phase that no factors have been identified that would cause an 
application to be rejected shall in no way be construed as an 
indication that a subsequent application will be approved.
    (5) Preapplication meeting. The next step in the application 
process is the preapplication meeting. At HUD's discretion, this 
meeting may be held at HUD Headquarters in Washington, DC, or at 
another site agreeable to HUD and the potential applicant. The 
preapplication meeting is an opportunity for the potential mortgagor to 
summarize the proposed project, for HUD to summarize the application 
process, and for issues that could affect the eligibility or 
underwriting of the project to be identified and discussed to the 
extent possible. Following the meeting, HUD may:
    (i) Advise the potential applicant that there appears to be no bar 
to submitting an application for mortgage insurance; or
    (ii) Identify issues that must be resolved before a full 
application should be submitted for processing.
    (b) Application contents. The application for mortgage insurance 
shall include exhibits that follow such guidance as to content and 
format that HUD shall provide from time to time. The application shall 
include:
    (1) A description of the proposed sources and uses of funds;
    (2) A description of the mortgagor entity, its ownership structure, 
and its directors and managers;
    (3) A description of the project, the business plan of the 
hospital, and how the project will further that plan;
    (4) Historical audited financial statements and interim year-to-
date financial results (for existing hospitals);
    (5) A study of market need and financial feasibility, addressing 
the factors listed in paragraphs (a)(1)(ii), (a)(2), and (a)(3) of this 
section, with assumptions and financial forecast clearly presented, and 
prepared by a certified accounting firm acceptable to HUD;
    (6) Architectural plans and specifications in sufficient detail to 
enable a reasonable estimate of cost;
    (7) Evidence that the hospital will be located in a state or 
political subdivision of a state with reasonable minimum standards of 
licensure and methods of operation for hospitals and satisfactory 
assurance that such standards will be applied and enforced with respect 
to the hospital;
    (8) If the state has an official procedure for determining need for 
hospitals, evidence that such procedure has been followed and that need 
has been established under that procedure;
    (9) A Phase I environmental report; and
    (10) Such other exhibits as HUD shall require based upon the facts 
pertaining to the particular case.
    (c) Fee. An application fee of $1.50 per thousand dollars of the 
amount of the loan to be insured shall be paid to HUD at the time the 
application is submitted to HUD for approval.
    (d) Filing of application. An application for insurance of a 
mortgage on a project shall be submitted on an approved FHA form by an 
approved mortgagee and by the sponsors of such project to the FHA 
Office of Insured Health Care Facilities.
    (e) Complete application. Only technically complete applications 
will be processed. Partial applications cannot be processed. Upon 
determination that an application is complete, HUD shall issue a 
Completeness Letter to the applicant stating that the application is 
complete.
    (f) Application Review. Upon receipt of a complete application, HUD 
shall evaluate the application to determine if eligibility, market 
need, financial feasibility, and compliance with applicable regulations 
(including but not limited to federal environmental regulations, wage 
rate regulations, and health care regulations) have been demonstrated, 
and to evaluate any other factors, including but not limited to risk to 
the Insurance Fund, that should be considered in determining if the 
application for mortgage insurance should be approved. As a part of 
this review, HUD may solicit the advice of private consultants and 
expert staff in the Department of Health and Human Services and other 
federal agencies. Based on review of the complete application, HUD may 
request additional information from the applicant. The timeliness of 
the applicant's submission of the additional information may affect the 
approval or disapproval of the application. The Commissioner's decision 
shall be communicated in the form of a Commitment Letter or a Rejection 
Letter. HUD will not issue a Commitment Letter until HUD completes the 
environmental review under 24 CFR 242.79.


Sec.  242.17  Commitments.

    (a) Issuance of commitment. Upon approval of an application for 
insurance, a commitment shall be issued by HUD setting forth the terms 
and conditions under which an insurance endorsement shall be issued for 
the hospital. The commitment shall include the following:
    (1) A commitment for insurance of advances reflecting the mortgage 
amount, interest rate, mortgage term, date of commencement of 
amortization, and other requirements pertaining to the mortgage and 
construction project;
    (2) HUD's computation of the replacement cost and maximum insurable 
mortgage amount;
    (3) Financial requirements for closing;
    (4) Approval covenants, including any special conditions that must 
be satisfied prior to initial endorsement;
    (5) Mortgage Reserve Fund Agreement.
    (b) Type of commitment. The commitment will provide for the 
insurance of advances of mortgage funds during construction.
    (c) Term of commitment. (1) The initial commitment shall be issued 
for a period of 90 days.
    (2) The term of a commitment may be extended in such manner as HUD 
may prescribe, provided, however, that the combined term of the 
original commitment and any extensions do not exceed 180 days.
    (d) Commitment fee. A commitment fee that, when added to the 
application fee, will aggregate $3 per thousand dollars of the amount 
of the loan set forth in the commitment, shall be paid within 30 days 
of the date of issuance of the commitment. If such fee is not paid 
within this 30-day period, the commitment shall automatically 
terminate.


Sec.  242.18  Inspection fee.

    The commitment may provide for the payment of an inspection fee in 
an amount not to exceed $5 per thousand dollars of the commitment. The 
inspection fee shall be paid at the time of initial endorsement.


Sec.  242.19  Fees on increases.

    (a) Increase in commitment prior to endorsement. An application, 
filed prior

[[Page 67552]]

to initial endorsement, for an increase in the amount of an outstanding 
commitment, shall be accompanied by an additional application fee of 
$1.50 per thousand dollars computed on the amount of the increase 
requested. Any increase in the amount of a commitment shall be subject 
to the payment of an additional commitment fee which, when added to the 
additional application fee, will aggregate $3 per thousand dollars of 
the amount of the increase. The additional commitment fee shall be paid 
within 30 days after the date of the amended commitment. If the 
additional commitment fee is not paid within 30 days, the commitment 
novation providing for the increased amount will automatically 
terminate and the previous commitment will be reinstated. If an 
inspection fee was required in the original commitment, an additional 
inspection fee shall be paid in an amount not to exceed $5 per thousand 
dollars of the amount of increase in commitment. The additional 
inspection fee shall be paid at the time of initial endorsement.
    (b) Increase in mortgage between initial and final endorsement. 
Upon an application, filed between initial and final endorsement, for 
an increase in the amount of the mortgage, either by amendment, 
consolidation agreement, or by substitution of a new mortgage, an 
additional application fee of $1.50 per thousand dollars computed on 
the amount of the increase requested shall accompany the application. 
The approval of any increase in the amount of the mortgage shall be 
subject to the payment of an additional commitment fee which, when 
added to the additional application fee, will aggregate $3 per thousand 
dollars of the amount of the increase granted. If an inspection fee was 
required in the original commitment, an additional inspection fee shall 
be paid in an amount not to exceed $5 per thousand dollars of the 
amount of the increase granted. The additional commitment and 
inspection fees shall be paid within 30 days after the date that the 
increase is granted.


Sec.  242.20  Reopening of expired commitments.

    An expired commitment may be reopened if a request for reopening is 
received by HUD no later than 90 days after the date of expiration of 
the commitment. The reopening request shall be accompanied by a fee of 
50 cents per thousand dollars of the amount of the expired commitment. 
A commitment that has expired because of failure to pay the commitment 
fee may be reopened only upon payment of the commitment fee and the 
reopening fee. If the reopening request is not received by HUD within 
the required 90-day period, a new application accompanied by an 
application fee must be submitted. If a commitment for an increased 
amount has expired because of failure to pay an additional commitment 
fee based on the amount of the increase, the reopening fee shall be 
computed on the basis of the amount of the commitment increase rather 
than on the amount of the original commitment.


Sec.  242.21  Refund of fees.

    Commitment, inspection, and reopening fees (but not application 
fees) may be refunded, in whole or in part, if HUD determines that the 
construction or financing of the project has been prevented because of 
condemnation proceedings or other legal action taken by a government 
body or public agency, or in such other instances as HUD may determine 
as being beyond the control of the applicant and resulting from no 
fault of the applicant. A transfer fee may be refunded only in such 
instances as HUD may determine. However, the portion of the inspection 
fee paid in connection with early commencement of work is not 
refundable.


Sec.  242.22  Maximum fees and charges by mortgagee.

    The mortgagee may collect from the mortgagor the amount of the fees 
provided for in this subpart. The mortgagee may also collect from the 
mortgagor an initial service charge not to exceed 2 percent of the 
original principal amount of the mortgage to reimburse the mortgagee 
for the cost of closing the transaction. A permanent financing fee not 
to exceed 3.5 percent may be collected from the mortgagor; however, the 
combined initial service charge and permanent financing fee may not 
exceed 5.5 percent in bond transactions and 3.5 percent in all other 
transactions. Any additional charges or fees collected from the 
mortgagor shall be subject to prior approval of HUD and shall be 
clearly disclosed in the Mortgagee's Certificate.


Sec.  242.23  Maximum mortgage amounts and cash equity requirements.

    (a) Adjusted mortgage amount--rehabilitation projects. A mortgage 
financing the rehabilitation of an existing hospital shall be subject 
to the following limitations, in addition to those set forth in Sec.  
242.7:
    (1) Property held unencumbered. If the mortgagor is the fee simple 
owner of the property and the ownership is not encumbered by an 
outstanding indebtedness, the mortgage shall not exceed 100 percent of 
HUD's estimate of the cost of the proposed rehabilitation.
    (2) Property subject to existing mortgage. If the mortgagor owns 
the property subject to an outstanding indebtedness, which is to be 
refinanced with part of the insured mortgage, the mortgage shall not 
exceed the total of the following:
    (i) The Commissioner's estimate of the cost of rehabilitation, plus
    (ii) Such portion of the outstanding indebtedness as does not 
exceed 90 percent of HUD's estimate of the fair market value of such 
land and improvements prior to rehabilitation.
    (3) Property to be acquired. If the property is to be acquired by 
the mortgagor and the purchase price is to be financed with a part of 
the insured mortgage, the mortgage shall not exceed 90 percent of the 
total of the following:
    (i) The Commissioner's estimate of the cost of rehabilitation, plus
    (ii) The actual purchase price of the land and improvements or 
HUD's estimate (prior to rehabilitation) of the fair market value of 
such land and improvements, whichever is the lesser.
    (b) Reduced mortgage amount--leaseholds. In the event the mortgage 
is secured by a leasehold estate rather than a fee simple estate, the 
value or replacement cost of the property described in the mortgage 
shall be the value or replacement cost of the leasehold estate (as 
determined by HUD), which shall in all cases be less than the value or 
replacement cost of the property in fee simple.
    (c) Cash equity. Depending on the financial circumstances of each 
hospital facility, HUD shall have the discretion to evaluate, on a 
case-by-case basis, the amount of equity that a mortgagor must supply 
in addition to the value of plant, property, and equipment and other 
values recognized as loan security in the commitment process. Exercise 
of this discretion shall never cause a loan to exceed 90 percent of 
estimated replacement cost, although it may cause it to be less than 90 
percent. The equity contribution may not be made from borrowed funds. A 
private nonprofit or public mortgagor, but not a proprietary mortgagor, 
in HUD's discretion and subject to 24 CFR 242.49, may provide any such 
required equity in the form of a letter of credit.


Sec.  242.24  Initial operating costs.

    In the case of a new hospital or a hospital expansion, HUD shall 
establish, on a case-by-case basis, the amount of initial operating 
capital, if any, that must be deposited in cash or a letter of credit 
(or combination) to be available to the new hospital upon commencement

[[Page 67553]]

of operations. Generally, the initial operating capital other than AMPO 
shall not be borrowed funds unless HUD determines that there are 
offsetting financial strengths to compensate for the risk associated 
with borrowing.

Subpart C--Mortgage Requirements


Sec.  242.25  Mortgage form and disbursement of mortgage proceeds.

    (a) Mortgage form. The mortgage shall be:
    (1) Executed on a form approved by HUD for use in the jurisdiction 
in which the property covered by the mortgage is situated; the form 
shall not be changed without the prior written approval of HUD.
    (2) Executed by an eligible mortgagor.
    (b) Disbursement of mortgage proceeds. The mortgagee shall be 
obligated, as a part of the mortgage transaction, to disburse the 
principal amount of the mortgage to (or for the account of) the 
mortgagor or to his or her creditors for his or her account and with 
his or her consent.


Sec.  242.26  Agreed interest rate.

    (a) The mortgage shall bear interest at the rate or rates agreed 
upon by the mortgagee and the mortgagor.
    (b) The amount of any increase approved by HUD in the mortgage 
amount between initial and final endorsement in excess of the amount 
that HUD had committed to insure at initial endorsement shall bear 
interest at the rate agreed upon by the mortgagee and the mortgagor.


Sec.  242.27  Maturity.

    The mortgage shall have a maturity not to exceed 25 years from the 
date amortization begins.


Sec.  242.28  Allowable costs for consultants.

    Consulting fees for work essential to the development of the 
project may be included in the insured mortgage. Allowable consulting 
fees include those for analysis of market demand, expected revenues, 
and costs; site analysis; architectural and engineering design; and 
such other fees as HUD may determine to be essential to project 
development. Fees for work performed more than 2 years prior to 
application are not allowable. Fees for work performed by any party 
with an identity of interest with the proposed mortgagor or mortgagee 
are not allowable.


Sec.  242.29  Payment requirements.

    The mortgage shall provide for payments on the first day of each 
month in accordance with an amortization plan agreed upon by the 
mortgagor, the mortgagee, and HUD.


Sec.  242.30  Application of payments.

    All payments to be made by the mortgagor to the mortgagee shall be 
added together and the aggregate amount thereof shall be paid by the 
mortgagor each month in a single payment. The mortgagee shall apply 
each payment received to the following items in the following order:
    (a) Premium charges under the contract of mortgage insurance;
    (b) Ground rents, taxes, special assessments, and fire and other 
hazard insurance premiums;
    (c) Interest on the mortgage; and
    (d) Amortization of the principal of the mortgage.


Sec.  242.31  Accumulation of accruals.

    (a) The mortgage shall provide for payments by the mortgagor to the 
mortgagee on each interest payment date of an amount sufficient to 
accumulate, in the hands of the mortgagee one payment period prior to 
its due date, the next annual MIP payable by the mortgagee to HUD. Such 
payments shall continue only so long as the contract of insurance shall 
remain in effect.
    (b) The mortgage shall provide for such equal monthly payments by 
the mortgagor to the mortgagee as will amortize the ground rents, if 
any, and the estimated amount of all taxes, water charges, special 
assessments, and fire and other hazard insurance premiums, within a 
period ending one month prior to the dates on which the same become 
delinquent. The mortgage shall further provide that such payments shall 
be held by the mortgagee, for the purpose of paying such items before 
they become delinquent. The mortgage shall also make provision for 
adjustments in case such estimated amounts shall prove to be more, or 
less, than the actual amounts so paid therefore by the mortgagor. 
Notwithstanding the foregoing, in particular circumstances, a mortgagor 
may purchase required fire and hazard insurance through a consortium of 
affiliated institutions or related organizations or, in the case of 
public institutions, through required state purchasing arrangements. In 
such circumstances, the mortgage accrual requirement may be modified to 
reflect circumstances in which it is inappropriate for the mortgagee to 
collect monthly payments and to make payments on behalf of the 
mortgagor.


Sec.  242.32  Covenant against liens.

    The mortgage shall contain a covenant against the creation by the 
mortgagor of any liens against the property, except for such liens as 
may be approved by HUD.


Sec.  242.33  Covenant for malpractice, fire, and other hazard 
insurance.

    The mortgage shall contain a covenant binding the mortgagor to 
maintain adequate liability, fire, and extended coverage insurance on 
the property. The mortgage shall also contain a covenant binding the 
mortgagor to maintain adequate malpractice coverage. All coverage shall 
be acceptable to the mortgagee and HUD.


Sec.  242.35  Mortgage lien certifications.

    At initial and/or final endorsement of the mortgage note, each of 
the following requirements must be met:
    (a) The mortgage is the first lien upon and covers all of the 
property used in the operation of the entire hospital;
    (b) The property upon which the improvements have been made or 
constructed and the equipment financed with mortgage proceeds are free 
and clear of all liens other than the insured mortgage and such other 
secondary liens as may be approved by HUD;
    (c) The Security Agreement and Uniform Commercial Code filings 
establish a first lien on the personalty of the mortgagor, including 
but not limited to equipment acquired with mortgage proceeds or 
otherwise not subject to a prior lien;
    (d) The mortgagor has notified HUD in writing of all unpaid 
obligations in connection with the mortgage transaction, the purchase 
of the mortgaged property, the construction or rehabilitation of the 
project, or the purchase of the equipment financed with mortgage 
proceeds.


Sec.  242.37  Mortgage prepayment.

    (a) Prepayment privilege. Except as provided in paragraph (c) of 
this section or otherwise established by HUD, the mortgage shall 
contain a provision permitting the mortgagor to prepay the mortgage in 
whole or in part upon any interest payment date, after giving the 
mortgagee a 30-day notice in writing in advance of its intention to so 
prepay. The 30-day notice may be extended with the prior written 
approval of HUD.
    (b) Prepayment charge. The mortgage may contain a provision for 
such charge, in the event of prepayment of principal, as may be agreed 
upon between the mortgagor and the mortgagee, subject to the following:
    (1) The mortgagor shall be permitted to prepay up to 15 percent of 
the original principal amount of the mortgage in any one calendar year 
without any such charge.
    (2) Any reduction in the original principal amount of the mortgage 
resulting from the certification of cost, which HUD may require, shall 
not be

[[Page 67554]]

construed as a prepayment of the mortgage.
    (c) Prepayment of bond-financed or GNMA-securitized mortgages. 
Where the mortgage is given to secure GNMA mortgage-backed securities 
or a loan made by a lender that has obtained the funds for the loan by 
the issuance and sale of bonds or bond anticipation notes, or both, the 
mortgage may contain a prepayment restriction and prepayment penalty 
charge acceptable to HUD as to term, amount, and conditions.
    (d) HUD override of prepayment restrictions. In the event of a 
default, HUD may override any lockout, prepayment penalty, or 
combination of penalties in order to facilitate a partial or full 
refinancing of the mortgaged property and avoid a claim.


Sec.  242.38  Late charge.

    The mortgage may provide for the collection by the mortgagee of a 
late charge in accordance with terms, conditions, and standards of HUD 
for each dollar of each payment to interest or principal more than 15 
days in arrears, to cover the expense involved in handling delinquent 
payments. Late charges shall be separately charged to and collected 
from the mortgagor and shall not be deducted from any aggregate monthly 
payment.

Subpart D--Endorsement for Insurance


Sec.  242.39  Insurance endorsement.

    Initial endorsement of the mortgage note shall occur before any 
mortgage proceeds are insured, and the time of final endorsement shall 
be as set forth in paragraph (b) of this section.
    (a) Initial endorsement. The Commissioner shall indicate the 
insurance of the mortgage by endorsing the original mortgage note and 
identifying the section of the Act and the regulations under which the 
mortgage is insured and the date of insurance.
    (b) Final endorsement. When all advances of mortgage proceeds have 
been made and all the terms and conditions of the commitment have been 
met to HUD's satisfaction, HUD shall indicate on the original mortgage 
note the total of all advances approved for insurance and again endorse 
such instrument.
    (c) Contract rights and obligations. The Commissioner and the 
mortgagee or lender shall be bound from the date of initial endorsement 
by the provisions of the Contract of Mortgage Insurance stated in 
subpart B of part 207, which is hereby incorporated by reference into 
this part.


Sec.  242.40  Mortgagee certificate.

    At initial endorsement, the mortgagee shall execute a Mortgagee 
Certificate in a form prescribed by HUD.


Sec.  242.41  Certification of cost requirements.

    Before initial endorsement of the mortgage for insurance, the 
mortgagor, the mortgagee, and HUD shall enter into an agreement in form 
and content satisfactory to HUD for the purpose of precluding any 
excess of mortgage proceeds over statutory limitations. Under this 
agreement, the mortgagor shall disclose its relationship with the 
builder, including any collateral agreement, and shall agree:
    (a) To execute a Certificate of Actual Costs, upon completion of 
all physical improvements on the mortgaged property.
    (b) To apply any cost savings in accordance with the provisions 
below.


Sec.  242.42  Certificates of actual cost.

    (a) The mortgagor's certificate of actual cost, in a form 
prescribed by HUD, shall be submitted upon completion of the physical 
improvements to the satisfaction of HUD and before final endorsement, 
except that in the case of an existing hospital that does not require 
substantial rehabilitation and where the commitment provides for 
completion of specified repairs after endorsement, a supplemental 
certificate of actual cost will be submitted covering the completed 
costs of any such repairs. The certificate shall show the actual cost 
to the mortgagor, after deduction of any kickbacks, rebates, trade 
discounts, or other similar payments to the mortgagor, any of its 
officers, directors, stockholders, partners, or other entity member 
ownership, of construction and other costs, as prescribed by HUD.
    (b) The Certificate of Actual Cost shall be verified by an 
independent certified public accountant or independent public 
accountant in a manner acceptable to HUD.
    (c) Upon HUD's approval of the mortgagor's certification of actual 
cost, such certification shall be final and incontestable except for 
fraud or material misrepresentation on the part of the mortgagor.


Sec.  242.43  Application of cost savings.

    At the sole discretion of HUD, any cost savings shall be used to:
    (a) Reduce the principal amount of the mortgage and the mortgagor's 
cash equity contribution proportionally, unless the mortgagor elects to 
have a greater portion of the savings used to reduce the mortgage; and/
or
    (b) Fund any additional construction or substantial rehabilitation 
approved by HUD.

Subpart E--Construction


Sec.  242.44  Construction standards.

    Work designed and performed under this section shall conform to the 
standards adopted by HUD, which, at a minimum, shall include the 
``Guidelines for Construction and Equipment of Hospital and Medical 
Facilities,'' which is regularly updated and published by the American 
Institute of Architects.


Sec.  242.45  Early commencement of work.

    (a) Site preparation. Prior to or following the submission of an 
application, the mortgagor may request for good cause the commencement 
of certain limited site preparation for the project within legal 
guidelines and state law. Such work can commence only after the review 
of the work and concurrence by HUD, including the environmental review 
under 24 CFR 242.79, previous participation review, and the agreement 
to certain conditions by the applicant. HUD will not approve such 
request until it has completed the environmental review under 24 CFR 
242.79. The work must meet all requirements and guidelines as if it 
were approved for mortgage insurance and is to be accomplished at the 
sole risk of the mortgagor.
    (b) Construction completed prior to application. Structures 
completed more than 2 years prior to application are eligible to be 
refinanced with insured mortgage proceeds.
    (c) Pre-commitment work. Subsequent to submission of an application 
but prior to the issuance of a commitment or denial by HUD, the 
hospital and lender may request for good cause the commencement of 
certain necessary early site work and limited construction activity in 
connection with the improvements, within legal guidelines and state 
law. This work must be requested by both the hospital and the lender to 
be approved. Such work may be eligible to be financed with insured 
mortgage proceeds if the application is approved and the work complies 
with all specified conditions of HUD as set forth in a written 
agreement between the hospital and HUD. It is understood that in some 
cases the application submitted in order for pre-commitment work to 
begin may not be complete in all respects. However, at a minimum, the 
application shall include the approved FHA application form, the 
application fee (based on the amount of the total proposed insured 
loan), the inspection fee (based on the cost of the pre-

[[Page 67555]]

commitment work), a project description of the pre-commitment work and 
its relation to the total project, and plans and specifications for the 
proposed pre-commitment work in sufficient detail to allow HUD to 
conduct its architectural and engineering review and obtain the 
necessary previous participation information and evidence of compliance 
with federal and state environmental regulations. Such work can 
commence only after the review of the work and concurrence by the 
lender and HUD, including previous participation review. HUD will not 
approve such request until it has completed the environmental review 
under 24 CFR 242.79. The work must meet all requirements and guidelines 
as if it were approved for mortgage insurance and is to be accomplished 
at the sole risk of the hospital. A request shall be accompanied by 
documentation required by HUD. That documentation shall include:
    (1) A justification explaining the urgent and compelling 
circumstances that make it necessary to begin construction without 
waiting for the application process to run its course. The 
justification must specify the harm the hospital would suffer from 
waiting.
    (2) A plan detailing how the hospital will finance the limited 
construction if the application for mortgage insurance is denied.
    (3) A statement that financing the limited construction by means 
other than a HUD-insured mortgage in the event the application is 
denied will impose no significant financial hardship on the hospital. 
The statement shall be accompanied by supporting historical and 
projected financial data.
    (4) A statement that the hospital recognizes that HUD's agreement 
to include the cost of the limited construction in a subsequently 
approved application does not in any way indicate that the application 
will be approved.
    (5) A resolution of the governing body (or, at HUD's discretion, 
the executive committee of the governing body) of the mortgagor 
attesting to paragraphs (c)(1) through (4).
    (d) Early Start. Subsequent to the issuance of a commitment, if the 
hospital and lender request the commencement of the project, the work 
may commence after the review and approval of the request by HUD, 
including the agreement by the hospital and the lender to any 
conditions that HUD may require. Any work undertaken prior to the 
initial endorsement shall be at the sole risk of the hospital.
    (e) Prepayment of inspection fee. The hospital shall pay a non-
refundable inspection fee to HUD before the work described in paragraph 
(c) or (d) of this section commences. The fee shall be based on the 
amount of the pre-commitment and/or early start work requested to be 
included in the insured mortgage loan.
    (f) No expressed or implied intent. Approval to proceed under 
paragraphs (c) or (d) of this section shall in no way be construed as 
indicating any intent, expressed or implied, on the part of HUD to 
approve, disapprove, or make any undertaking or promise whatsoever with 
respect to the application or with respect to any commitment for 
mortgage insurance. Any work under paragraphs (c) or (d) of this 
section shall be undertaken at the sole risk and responsibility of the 
hospital.


Sec.  242.46  Insured advances--building loan agreement.

    Prior to the initial endorsement of the mortgage for insurance, the 
mortgagor and mortgagee shall execute a building loan agreement, 
approved by HUD, setting forth the terms and conditions under which 
progress payments may be advanced during construction. To be covered by 
mortgage insurance, or to be included as an eligible cost, each 
progress payment involving mortgage proceeds and the owner's equity 
requirement shall be approved by HUD.


Sec.  242.47  Insured advances for building components stored off-site.

    (a) Building components. In insured advances for building 
components stored off-site, the term building component shall mean any 
manufactured or pre-assembled part of a structure that HUD has 
specifically identified for incorporation into the property and has 
designated for off-site storage because it is of such size or weight 
that:
    (1) Storage of the number of components required for timely 
construction progress at the construction site is impractical, or
    (2) Weather damage or other adverse conditions prevailing at the 
construction site would make storage at the site impractical or unduly 
costly.
    (b) Storage. (1) An insured advance may be made for up to 90 
percent of the invoice value (to exclude costs of transportation and 
storage) of the building components stored off-site, if the components 
are stored at a location approved by the mortgagee and HUD.
    (2) Each building component shall be adequately marked so as to be 
readily identifiable in the inventory of the off-site location. Each 
component shall be kept together with all other building components of 
the same manufacturer intended for use in the same project for which 
insured advances have been made and separate and apart from similar 
units not for use in the project.
    (3) Storage costs, if any, shall be borne by the contractor.
    (c) Responsibility for transportation, storage, and insurance of 
off-site building components. The general contractor of the insured 
mortgaged property shall have the responsibility for:
    (1) Insuring the components in the name of the mortgagor while in 
transit and storage; and
    (2) Delivering or contracting for the delivery of the components to 
the storage area and to the construction site, including payment of 
freight.
    (d) Advances. (1) Before an advance for a building component stored 
off-site is insured: (i) The mortgagor shall:
    (A) Obtain a bill of sale for the component;
    (B) Give the mortgagee a security agreement; and
    (C) File a financing statement in accordance with the Uniform 
Commercial Code; and
    (ii) The mortgagee shall warrant to HUD that the security 
instruments are a first lien on the building components covered by the 
instruments except for such other liens or encumbrances as may be 
approved by HUD.
    (2) Before each advance for building components stored off-site is 
insured, the mortgagor's architect shall certify to HUD that the 
components, in their intended use, comply with HUD-approved contract 
plans and specifications. Under those circumstances permitted by HUD in 
which there is no architect, compliance with the HUD-approved contract 
plans and specifications shall be determined by HUD.
    (3) Advances may be made only for components stored off-site in a 
quantity required to permit uninterrupted installation at the site.
    (4) At no time shall the invoice value of building components being 
stored off-site, for which advances have been HUD insured, represent 
more than 50 percent of the total estimated construction costs for the 
insured mortgaged project as specified in the construction contract. 
Notwithstanding the preceding sentence and other regulatory 
requirements that set bonding requirements, the percentage of total 
estimated construction costs insured by advances under this section may 
exceed 25 percent but not 50 percent if the mortgagor furnishes 
assurance of completion in the form of a corporate

[[Page 67556]]

surety bond for the payment and performance each in the amount of 100 
percent of the amount of the construction contract. In no event will 
insurance of advances for components stored off-site be made in the 
absence of a payment and a performance bond.
    (5) No single advance that is to be insured shall be in an amount 
less than $10,000.


Sec.  242.48  Insured advances for certain equipment and long lead 
items.

    The Commissioner may allow advances for certain pieces of equipment 
or other construction materials for which a manufacturer, fabricator, 
or other source requires an interim payment(s) in order to assure the 
timely manufacture or fabrication and delivery to the project site. 
Such advances can be made only if a bill of sale or an invoice 
describes the material or equipment and its completion and delivery 
dates in no uncertain terms, and that such displayed timetable is 
necessary to meet the requirements of the overall construction schedule 
cited in the construction contract.


Sec.  242.49  Funds and finances: deposits and letters of credit.

    (a) Deposits. Where HUD requires the mortgagor to make a deposit of 
cash or securities, such deposit shall be with the mortgagee or a 
depository acceptable to the mortgagee. Any such deposit shall be held 
in a separate account for and on behalf of the mortgagor, and shall be 
the responsibility of the mortgagee.
    (b) Letter of credit. Where the use of a letter of credit is 
acceptable to HUD in lieu of a deposit of cash or securities, the 
letter of credit shall be issued to the mortgagee by a banking 
institution acceptable to the lender. The mortgagee shall be 
responsible to HUD for collection under the letter of credit. In the 
event a demand for payment thereunder is not immediately met, the 
mortgagee shall forthwith provide a cash deposit equivalent to the 
undrawn balance of the letter of credit.
    (c) Mortgagee not issuer. The mortgagee of record may not be the 
issuer of the letter of credit without the prior written consent of 
HUD.


Sec.  242.50  Funds and finances: off-site utilities and streets.

    The Commissioner shall require assurance of completion of off-site 
public utilities and streets in all cases, except where a municipality 
or other public body has by agreement acceptable to HUD agreed to 
install such utilities and streets without cost to the mortgagor. Where 
such assurance is required, it shall be either in the form of a cash 
escrow deposit or the retention of a specified amount of mortgage 
proceeds by the mortgagee, or both. In any case, the amount of deposit 
or retained cash (or both) must be sufficient to cover the cost of off-
site utilities and streets. If a cash escrow is used, it shall be 
deposited with the mortgagee or with an acceptable trustee or escrow 
agent designated by the mortgagee. If mortgage proceeds are used, the 
mortgagee shall retain under terms approved by HUD, rather than 
disburse at the initial closing of the mortgage, a sufficient portion 
of the mortgage proceeds allocated to land in the project analysis. As 
additional assurance, HUD may also require a surety company bond or 
bonds.


Sec.  242.51  Funds and finances: Insured advances and assurance of 
completion.

    (a) Where the estimated cost of construction or substantial 
rehabilitation is more than $500,000, the mortgagor shall furnish 
assurance of completion in the form of corporate surety bonds for 
payment and performance, each in the minimum amount of 100 percent of 
the construction contract (or Guaranteed Maximum Price, in the case of 
construction management) and each satisfactory to HUD.
    (b) All types of assurance of completion shall be on forms approved 
by HUD. All surety companies executing a bond and all parties executing 
a personal indemnity agreement must be satisfactory to HUD.
    (c) A mortgagee may prescribe more stringent requirements for 
assurance of completion than the minimum requirements provided for in 
this section.


Sec.  242.52  Construction contracts.

    (a) Awarding of contract. A contract for the construction or 
rehabilitation of a hospital shall be entered into by a mortgagor, with 
a builder selected by a competitive bidding procedure acceptable to 
HUD.
    (b) Form of contract. The construction contract shall be: A lump 
sum form providing for payment of a specified amount; a construction 
management contract with a guaranteed maximum price, the final costs of 
which are subject to a certification acceptable to HUD; a design-build 
contract with terms and certification requirements acceptable to HUD; 
or such other form of contract as may be acceptable to HUD.
    (c) Competitive bidding. A competitive bidding procedure acceptable 
to HUD must be used in the selection of bidders to perform work or 
otherwise provide service to the project, the costs of which are 
included in any form of construction contract cited in paragraph (b) of 
this section. Fixed equipment not included in the construction 
contract, and movable equipment, may be purchased by securing 
quotations or by using competitive bidding procedures.


Sec.  242.53  Excluded contractors.

    (a) Contracts relating to the construction of the project shall not 
be made with any person or entity that has been excluded from 
participation in federal programs, including but not limited to: A 
general contractor, a subcontractor, or construction manager (or any 
firm, corporation, partnership, or association in which such 
contractor, subcontractor, or construction manager has a substantial 
interest). Before entering into contracts with any such person or 
entity, owners must consult the government-wide list of excluded 
parties, and any list of excluded parties maintained by HUD.
    (b) Contracts relating to the construction of the project shall not 
be made with a general contractor that has an identity of interest, as 
defined by HUD, with the mortgagor or mortgagee.
    (c) If HUD determines that a contract has been made contrary to the 
requirements of paragraphs (a) or (b) of this section and so notifies 
the mortgagee, HUD will require the contractor or construction manager 
to cost-certify and may require other remedial action in addition to 
taking enforcement action, as HUD deems appropriate.

Subpart F--Nondiscrimination and Wage Rates


Sec.  242.54  Nondiscrimination.

    Hospital facilities financed with mortgages insured under this part 
must be made available without discrimination as to race, color, 
religion, sex, age, disability, or national origin. Hospitals must be 
operated in compliance with all applicable civil rights laws and 
regulations, including 24 CFR part 200, subpart J (Equal Employment 
Opportunity), and the Americans with Disabilities Act (42 U.S.C. 12101 
et seq.). Racially restrictive covenants are per se illegal and their 
use is prohibited. The aforesaid provisions regarding age and sex 
discrimination do not affect the eligibility of hospitals for women and 
children.


Sec.  242.55  Labor standards.

    (a) Projects financed under this part (except under 24 CFR 242.91) 
must comply with the prevailing wage rates determined under the Davis-
Bacon Act

[[Page 67557]]

(40 U.S.C. 3141 et seq.), and U.S. Department of Labor regulations in 
29 CFR parts 1, 3, and 5 for compliance with labor standards laws, in 
accordance with section 212 of the Act, provided that supplemental 
loans under section 241 of the Act made in connection with loans 
insured under this part are subject to labor standards requirements in 
the same manner and to the same extent as mortgages insured under 
section 242 of the National Housing Act.
    (b) The requirements stated in 24 CFR part 70 governing HUD waiver 
of Davis-Bacon prevailing wage rates for volunteers apply to hospitals 
with mortgages insured under this part.
    (c) Each laborer or mechanic employed on any facility covered by a 
mortgage insured under this part (except under 24 CFR 242.91, but 
including a supplemental loan under section 241 of the National Housing 
Act made in connection with a loan insured under this part) shall 
receive compensation at a rate not less than 1.5 times the basic rate 
of pay for all hours worked in any workweek in excess of 8 hours in any 
workday or 40 hours in the workweek.
    (d) Project commitments, contracts, and agreements, as determined 
by HUD, and construction contracts and subcontracts, shall include 
terms, conditions, and standards for compliance with applicable 
requirements set forth in 29 CFR parts 1, 3, and 5 and section 212 of 
the Act.
    (e) No advance under a loan or mortgage that is subject to the 
requirements of section 212 shall be eligible for insurance unless 
there is filed with the application for the advance a certificate as 
required by HUD certifying that the laborers and mechanics employed in 
construction of the project have been paid not less than the wage rates 
required under section 212.

Subpart G--Regulatory Agreement, Accounting and Reporting, and 
Financial Requirements


Sec.  242.56  Form of regulation.

    As long as HUD is the insurer or holder of the mortgage, all 
mortgagors shall be regulated by HUD through the use of a regulatory 
agreement in a published format determined by HUD and such additional 
covenants and restrictions as may be determined necessary by HUD on a 
case-by-case basis. In addition, all mortgagors shall be subject to the 
provisions of 24 CFR part 24 and such other enforcement provisions as 
may be applicable. The mortgagor shall be subject to monitoring by HUD 
and its agents and contractors, on an ongoing basis for the life of the 
insured mortgage to ensure against the risk of default, and the 
mortgagor must make its financial records available to HUD and its 
agents and contractors upon request.


Sec.  242.57  Maintenance of hospital facility.

    The mortgagor shall maintain the hospital's grounds, buildings, and 
the equipment financed with mortgage proceeds in good repair, and shall 
promptly complete such repairs and maintenance as HUD considers 
necessary.


Sec.  242.58  Books, accounts, and financial statements.

    (a) Books and accounts. The mortgagor's books and accounts relating 
to the operation of the physical facilities of the hospital shall be 
established in a manner satisfactory to HUD, and shall be kept in 
accordance with the requirements of HUD as long as the mortgage is 
insured or held by HUD.
    (b) Financial reports. The mortgagor shall file with HUD:
    (i) Annual audited financial statements in accordance with the 
guidance below;
    (ii) Quarterly unaudited financial reports, within 40 days 
following the end of each quarter of the mortgagor's fiscal year;
    (iii) If requested by HUD, monthly financial reports within 40 days 
following the end of each month;
    (iv) Board-certified annual financial results within 120 days 
following the close of the fiscal year (if the annual audited financial 
statement has not yet been filed with HUD) and at such other times as 
HUD may designate on a case-by-case basis; and
    (v) Such other financial and utilization reports as HUD may 
require.
    (c) Audits. (1) Not-for-profit organizations shall conduct audits 
in accordance with the Consolidated Audit Guide for Audits of HUD 
Programs (Handbook 2000.04) and OMB Circular A-133 (Audits of states, 
local governments, and nonprofit organizations).
    (2) For-profit organizations shall conduct audits in accordance 
with the Consolidated Audit Guide for Audits of HUD Programs (Handbook 
2000.04).
    (d) Changes in accounting policies. The annual audited financial 
statements shall identify any changes in accounting policies and their 
financial effect on the balance sheet and on the income statement.
    (e) Compliance reporting. The mortgagor shall instruct the auditor 
of the annual financial statement to include in its report an 
evaluation of the mortgagor's compliance with the Regulatory Agreement.
    (f) Books of management agents. The books and records of management 
agents, lessees, operators, managers, and affiliates, as they pertain 
to the operations of the hospital, shall be maintained in accordance 
with Generally Accepted Accounting Principles (GAAP) or Governmental 
Accounting Standards and shall be open and available to inspection by 
HUD, after reasonable prior notice, during normal office hours, at the 
hospital or other mutually agreeable location. Every contract executed 
on behalf of the hospital with any of the aforesaid parties shall 
include the provision that the books and records of such entities shall 
be properly maintained and open to inspection during normal business 
hours by HUD at the hospital or other mutually agreeable location.
    (g) Medicare cost reports. Upon request, the mortgagor shall 
provide to HUD a copy of the Medicare Cost Report most recently 
submitted to the Centers for Medicare and Medicaid Services (an agency 
of the Department of Health and Human Services), along with related 
financial documents.


Sec.  242.59  Inspection of facilities by Commissioner.

    The mortgaged property (including buildings and equipment) and the 
books, records, and documents relating to the operation of the physical 
facilities of the hospital shall be subject to inspection and 
examination by HUD or its authorized representative at all reasonable 
times.


Sec.  242.61  Management.

    The mortgagor shall provide for management of the hospital in a 
manner satisfactory to HUD.
    (a) Contract Management. The mortgagor shall not execute a 
management agreement or any other contract for management of the 
hospital without HUD's prior written approval. Any management agreement 
or contract shall contain a provision that it shall be subject to 
termination without penalty and with or without cause, upon written 
request by HUD addressed to the mortgagor and management agent.
    (b) Principals. HUD shall have the authority to require that any 
principals of the mortgagor, including but not limited to board members 
of a corporate entity, be removed, substituted, or terminated for cause 
upon written request by HUD addressed to the mortgagor.
    (c) Employees. HUD shall have the authority to require that any key 
management employees of the

[[Page 67558]]

mortgagor (as defined and determined solely by HUD) be terminated for 
cause upon written request by HUD addressed to the mortgagor.
    (d) Procedures upon receipt of request under paragraphs (a) through 
(c) of this section. Upon receipt of such requests under paragraphs (a) 
through (c) of this section, the mortgagor shall immediately terminate 
said management agreement, principals, or employees within the shortest 
applicable period HUD determines appropriate and shall make 
arrangements satisfactory to HUD for ongoing proper management of the 
hospital.


Sec.  242.62  Releases of lien.

    The mortgagor shall not sell, dispose of, transfer, or permit to be 
encumbered any security property without the prior approval of the 
lender and Commissioner, subject to thresholds or such other standards 
as HUD may establish for the approval requirement. Where there is a 
partial release of lien, the lender must make a determination, subject 
to prior review and approval by HUD, that the remaining or replacement 
property subject to the first lien provides adequate security for the 
remaining principal indebtedness.


Sec.  242.63  Additional indebtedness and leasing.

    The mortgagor shall not enter into any long-term debt, short-term 
debt (including receivables or line of credit financing), equipment 
leases, or derivative-type transactions, except in conformance with 
policies and procedures established by HUD.


Sec.  242.64  Current and future property.

    All current or future property (including personalty) of the 
mortgagor on or off mortgaged real estate (except that specifically 
restricted by donors or specifically excluded by HUD) will be 
considered as part of the HUD-insured hospital and subject to all 
provisions of the HUD regulatory agreement. All equipment acquired by 
the hospital following initial endorsement and at any time during the 
term of the loan shall become subject to the lien of the security 
agreement and any Uniform Commercial Code Financing Statements filed 
pursuant to the security agreement, unless the mortgagor specifically 
requests and HUD, for good cause, approves subordination of the lien of 
the insured mortgagee on specific personalty for specific periods of 
time. The first lien on the realty (as defined in the regulatory 
agreement and as identified in the security instrument) cannot be 
subordinated in whole or in part.


Sec.  242.65  Distribution of assets.

    The Commissioner shall establish financial thresholds and 
procedures for the distribution of surplus cash and other assets. 
Surplus cash that meets the definition in 24 CFR 242.1, or cash that 
has been expressly approved for distribution by HUD, may be distributed 
to other organizations formally affiliated with the mortgagor, a parent 
organization with which the mortgagor is also affiliated, partners, or 
stockholders, in accordance with those financial thresholds and 
procedures set forth in the regulatory agreement. Other assets may be 
distributed to other organizations formally affiliated with the 
mortgagor, a parent organization with which the mortgagor is also 
affiliated, partners, or stockholders, in accordance with those 
financial thresholds and procedures set forth in the regulatory 
agreement, and in accordance with the release of lien conditions in 24 
CFR 242.62, if applicable.


Sec.  242.66  Affiliate transactions.

    Transactions with affiliates that are arms-length are permitted as 
specified in the Regulatory Agreement. Transactions with affiliates 
that are not arms-length are not permitted except with the prior 
written approval of HUD.


Sec.  242.67  New corporations, subsidiaries, affiliations, and 
mergers.

    The mortgagor shall not establish, develop, organize, acquire, 
become the sole member of, or acquire an interest sufficient to require 
disclosure on the audited financial statements of the mortgagor, in any 
corporation, subsidiary, or affiliate organization other than those 
with which the mortgagor was affiliated as of date of application, 
without the prior approval of HUD. The mortgagor shall obtain HUD's 
written approval for all future mergers.

Subpart H--Miscellaneous Requirements


Sec.  242.68  Disclosure and verification of Social Security and 
Employer Identification Numbers.

    The requirements set forth in 24 CFR part 5, regarding the 
disclosure and verification of Social Security Numbers and Employer 
Identification Numbers, and Employer Identification Numbers by 
``applicants for and participants in'' assisted mortgage and loan 
insurance and related programs, apply to this program.


Sec.  242.69  Transfer fee.

    Upon application for review of a transfer of physical assets or the 
substitution of mortgagors, a transfer fee of 50 cents per thousand 
dollars of the outstanding principal balance of the mortgage shall be 
paid to HUD. A transfer fee is not required if both parties to the 
transfer transaction are not-for-profit or public organizations.


Sec.  242.70  Fees not required.

    The payment of an application, commitment, inspection, or reopening 
fee shall not be required in connection with the insurance of a 
mortgage involving the sale by the Secretary of any property acquired 
under any section or title of the Act.


Sec.  242.72  Leasing of hospital.

    Leasing of a hospital in its entirety is prohibited. 
Notwithstanding this prohibition, any proposal in which leasing of the 
entire facility is a factor due to state law prohibitions against the 
mortgaging of health care facilities by state entities shall be 
considered on a case-by-case basis. Also, leasing of a hospital that 
has an existing Section 242-insured loan is permitted if HUD determines 
that leasing is necessary to reduce the risk of default by a 
financially troubled hospital.


Sec.  242.73  Waiver of eligibility requirements for mortgage 
insurance.

    The Secretary may insure under this part, without regard to any 
limitation upon eligibility contained in this subpart, any mortgage 
assigned to him or her in connection with payment under a contract of 
mortgage insurance, or executed in connection with a sale by him or her 
of any property previously insured under this part and acquired 
subsequent to a claim.


Sec.  242.74  Smoke detectors.

    Each occupied room must include such smoke detectors as are 
required by law.


Sec.  242.75  Title requirements.

    In order for the mortgaged property to be eligible for insurance, 
HUD shall determine that marketable title thereto is vested in the 
mortgagor as of the date the mortgage is filed for record. The title 
evidence shall be examined by HUD and the endorsement of the mortgage 
note for insurance shall be evidence of its acceptability.


Sec.  242.76  Title evidence.

    Upon insurance of the mortgage, the mortgagee shall furnish to HUD 
a survey of the mortgage property, satisfactory to HUD, and a policy of 
title insurance covering the property, as provided in

[[Page 67559]]

paragraph (a) of this section. If, for reasons HUD considers to be 
satisfactory, title insurance cannot be furnished, the mortgagee shall 
furnish such evidence of title in accordance with paragraph (b) or (c) 
of this section as HUD may require. Any survey, policy of title 
insurance, or evidence of title required under this section shall be 
furnished without expense to HUD. The types of title evidence are:
    (a) A policy of title insurance issued by a company and in a form 
satisfactory to HUD. The policy shall name as the insureds the 
mortgagee and the Secretary of Housing and Urban Development, and their 
successors and assigns, as their respective interests may appear. The 
policy shall provide that upon acquisition of title by the mortgagee or 
the Secretary, it will continue to provide the same coverage as the 
original policy, and will run to the mortgagee or the Secretary, as the 
case may be.
    (b) An abstract of title satisfactory to HUD, prepared by an 
abstract company or individual engaged in the business of preparing 
abstracts of title, accompanied by a legal opinion satisfactory to HUD 
as to the quality of such title, signed by an attorney-at-law 
experienced in the examination of titles.
    (c) A Torrens or similar title certificate.


Sec.  242.77  Liens.

    The hospital must be free and clear of all liens other than the 
insured mortgage, except that the property may be subject to a lien as 
provided by terms and conditions established by HUD, as follows:
    (a) An inferior lien made or held by a federal, state, or local 
government instrumentality;
    (b) An inferior lien required in connection with a supplemental 
loan insured pursuant to section 241 of the Act;
    (c) An inferior or superior lien on equipment as may be approved in 
connection with an equipment leasing program approved by HUD;
    (d) An inferior or superior lien on accounts receivable as approved 
by HUD as collateral for a line of credit or other borrowing by a 
hospital insured under this part that has extraordinary needs such as 
cash flow difficulties; or
    (e) Similar liens otherwise approved by HUD.


Sec.  242.78  Zoning, deed, and building restrictions.

    The project when completed shall not violate any material zoning or 
deed restrictions applicable to the project site, and shall comply with 
all applicable building and other governmental codes, ordinances, 
regulations, and requirements.


Sec.  242.79  Environmental quality determinations and standards.

    Requirements set forth in 24 CFR part 50, ``Protection and 
Enhancement of Environmental Quality,'' 24 CFR part 51, ``Environmental 
Criteria and Standards,'' and 24 CFR part 55, ``Floodplain 
Management,'' governing environmental review responsibilities (as 
applicable) and any additional environmental standards, reviews, or 
determinations required by HUD apply to this program.


Sec.  242.81  Lead-based paint poisoning prevention.

    Requirements set forth in 24 CFR part 35 apply to this program.


Sec.  242.82  Energy conservation.

    Construction, mechanical equipment, and energy and metering 
selections shall provide cost-effective energy conservation in 
accordance with standards established by HUD.


Sec.  242.83  Debarment and suspension.

    The requirements set forth in 24 CFR part 24 apply to this program.


Sec.  242.84  Previous participation and compliance requirements.

    The requirements set forth in 24 CFR part 200, subpart H, apply to 
this program.


Sec.  242.86  Property and mortgage assessment.

    The requirements set forth in 24 CFR part 200, subpart E, regarding 
the mortgagor's responsibility for making those investigations, 
analysis, and inspections it deems necessary for protecting its 
interests in the property apply to these programs.


Sec.  242.87  Certifications.

    Any agreement, undertaking, statement, or certification required by 
HUD shall specifically state that it has been made, presented, and 
delivered for the purpose of influencing an official action of the FHA, 
and of HUD, and may be relied upon by HUD as a true statement of the 
facts contained therein.


Sec.  242.89  Supplemental loans.

    A loan, advance of credit, or purchase of an obligation 
representing a loan or advance of credit made for the purpose of 
financing improvements or additions (including the refinancing of any 
indebtedness incurred in connection with the early commencement of work 
on such improvements or additions, subject to the requirements of 
Sec. Sec.  242.15 and 242.45) to a hospital covered by a mortgage 
insured under this section of the Act or for a Commissioner-held 
mortgage, or equipment for a hospital, may be insured pursuant to the 
provisions of section 241 of the Act and under the provisions of this 
part as applicable and such additional terms and conditions as 
established by HUD. See subpart B of 24 CFR part 241 with respect to 
the contract of mortgage insurance for all loans insured under section 
241 of the Act. See 24 CFR part 241, subpart C, for energy 
improvements.


Sec.  242.90  Eligibility of mortgages covering hospitals in certain 
neighborhoods.

    (a) A mortgage financing the repair, rehabilitation, or 
construction of a hospital located in an older declining urban area 
shall be eligible for insurance under this subpart, subject to 
compliance with the additional requirements of this section.
    (b) The mortgage shall meet all of the requirements of this 
subpart, except such requirements (other than those relating to labor 
standards and prevailing wages or environmental review) as are judged 
to be not applicable on the basis of the following determinations to be 
made by HUD.
    (1) That the conditions of the area in which the property is 
located prevent the application of certain eligibility requirements of 
this subpart.
    (2) That the area is reasonably viable, and there is a need in the 
area for an adequate hospital to serve low and moderate income 
families.
    (3) That the mortgage to be insured is an acceptable risk.
    (c) Mortgages complying with the requirements of this section shall 
be insured under this subpart pursuant to section 223(e) of the 
National Housing Act. Such mortgages shall be insured under and be the 
obligation of the Special Risk Insurance Fund.


Sec.  242.91  Eligibility of refinancing transactions.

    A mortgage given to refinance an existing insured mortgage under 
section 241 or Section 242 of the Act covering a hospital may be 
insured under this subpart pursuant to section 223(a)(7) of the Act. 
Insurance of the new, refinancing mortgage shall be subject to the 
following limitations:
    (a) Principal amount. The principal amount of the refinancing 
mortgage shall not exceed the lesser of:
    (1) The original principal amount of the existing insured mortgage, 
or
    (2) The unpaid principal amount of the existing insured mortgage, 
to which may be added loan closing charges associated with the 
refinancing

[[Page 67560]]

mortgage, and costs, as determined by HUD, of improvements, upgrading, 
or additions required to be made to the property.
    (b) Debt service rate. The monthly debt service payment for the 
refinancing mortgage may not exceed the debt service payment charged 
for the existing mortgage.
    (c) Mortgage term. The term of the new mortgage shall not exceed 
the unexpired term of the existing mortgage, except that the new 
mortgage may have a term of not more than 12 years in excess of the 
unexpired term of the existing mortgage in any case in which HUD 
determines that the insurance of the mortgage for an additional term 
will inure to the benefit of the FHA Insurance Fund, taking into 
consideration the outstanding insurance liability under the existing 
insured mortgage, and the remaining economic life of the property.
    (d) Minimum loan amount. The mortgagee may not require a minimum 
principal amount to be outstanding on the loan secured by the existing 
mortgage.


Sec.  242.92  Minimum principal loan amount.

    A mortgagee may not require, as a condition of providing a loan 
secured by a mortgage insured under this part, that the principal 
amount of the mortgage exceed a minimum amount established by the 
mortgagee.


Sec.  242.93  Amendment of regulations.

    The regulations in this subpart may be amended by HUD at any time 
and from time to time, in whole or in part, but such amendment shall 
not adversely affect the interests of a mortgagee or lender under the 
insurance on any mortgage or loan already insured, and shall not 
adversely affect the interests of a mortgagee or lender on any mortgage 
or loan to be insured on which HUD has issued a commitment to insure.

    Dated: October 24, 2007.
Brian D. Montgomery,
Assistant Secretary for Housing--Federal Housing Commissioner.
[FR Doc. E7-22406 Filed 11-27-07; 8:45 am]
BILLING CODE 4210-67-P