[Federal Register Volume 78, Number 24 (Tuesday, February 5, 2013)]
[Rules and Regulations]
[Pages 8330-8344]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-02404]



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Vol. 78

Tuesday,

No. 24

February 5, 2013

Part V





Department of Housing and Urban Development





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24 CFR Part 242





Federal Housing Administration (FHA): Hospital Mortgage Insurance 
Program--Refinancing Hospital Loans; Final Rule

  Federal Register / Vol. 78, No. 24 / Tuesday, February 5, 2013 / 
Rules and Regulations  

[[Page 8330]]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 242

[Docket No. FR-5334-F-02]
RIN 2502-AI74


Federal Housing Administration (FHA): Hospital Mortgage Insurance 
Program--Refinancing Hospital Loans

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

ACTION: Final rule.

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SUMMARY: This rule revises the regulations governing FHA's Section 242 
Hospital Mortgage Insurance Program (Section 242 program) for the 
purpose of codifying, in regulation, FHA's implementation of its 
authority to refinance existing loans of hospitals without FHA-insured 
mortgages, without conditioning the exercise of such authority on the 
expenditure of funds for construction or renovation. Hospitals with 
FHA's Section 242 mortgage insurance may refinance existing debt under 
section 223(a)(7) of the National Housing Act, and such refinancing 
under section 223(a)(7) is not conditioned upon the hospital 
undertaking new construction or renovation. When credit availability 
contracted considerably in 2008, FHA, in 2009, commenced the exercise 
of its authority to refinance the capital debt of hospitals without 
section 242 mortgage insurance. FHA exercised this authority through 
notices issued on July 1, 2009, and February 22, 2010. FHA initiated 
rulemaking to make this refinancing authority a permanent part of the 
Section 242 regulatory program through a January 29, 2010, proposed 
rule, which solicited comment on HUD's implementation of this 
refinancing authority to date.
    This final rule provides for codification in regulation of HUD's 
refinancing of existing debt and acquisitions for non-FHA insured loans 
of hospitals without conditioning such refinancing and acquisition on 
new construction or renovation. This rule makes certain changes to the 
regulations proposed January 2010 in response to public comments 
submitted on the proposed rule and further consideration of issues by 
HUD.

DATES: Effective Date: March 7, 2013.

FOR FURTHER INFORMATION CONTACT: Roger E. Miller, Deputy Assistant 
Secretary for Healthcare Programs, Office of Healthcare Programs, 
Office of Housing, Department of Housing and Urban Development, 451 7th 
Street SW., Washington, DC 20410-8000; telephone number 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 Relay Service 
at 800-877-8339 (this is a toll-free number).

SUPPLEMENTARY INFORMATION:

I. Executive Summary

A. Purpose of the Regulatory Action

    FHA's Section 242 program, by insuring the mortgages of hospitals, 
serves as credit enhancement, offering borrowers the opportunity to 
issue bonds up to the equivalent of an ``AA'' or ``AAA'' rating, 
receive lower interest rates, lower monthly debt service costs, and 
borrow funds for renovations or new construction. This rule amends the 
Section 242 program regulations to exercise statutory authority to 
insure refinancing to hospitals that do not have FHA-insured mortgages, 
and to do so without conditioning such refinancing on new construction 
or renovation. While HUD has long had the authority to provide such 
refinancing, HUD had taken the position that, for hospitals without 
FHA-insured mortgages, private capital for refinancing debt was 
sufficient, and the demand for refinancing existing debt was not as 
great as the need for financing new construction, renovation and 
rehabilitation, and equipment purchases. However, when the credit 
markets became more restrictive in 2008, hospitals, organizations 
representing hospitals, and members of Congress appealed to HUD to use 
its authority to help hospitals without FHA-insured financing to 
refinance their debt. In 2009, HUD commenced exercising this authority, 
initially by notice. This rulemaking, which commenced with a January 
29, 2010, proposed rule, reflects HUD's commitment to make the 
refinancing of debt of hospitals without FHA-insured mortgages a 
permanent part of the Section 242 program. In doing so, HUD will 
provide, through clear requirements, including eligibility requirements 
for the refinancing, a needed source of funding for hospitals that will 
aid in reducing interest rates, eliminating restrictive debt covenants, 
and stabilizing the hospital's financial situation so that the hospital 
can continue to provide healthcare to the community it serves.

B. Summary of the Major Provisions of the Regulatory Action

    Consistent with implementation to date, this rule allows for 100 
percent of the mortgage amount to be used for refinancing, with less 
than 20 percent eligible to be used for construction and/or equipment. 
The rule establishes threshold requirements that are designed to 
determine the need of the hospital for the refinancing that would not 
be available through other sources, and to eliminate from eligibility 
hospitals with poor financial performance. The rule requires that 
applicants for refinancing must provide a description of any repairs, 
renovations, and/or equipment to be financed with mortgage proceeds and 
how those repairs, renovations, and/or equipment will affect the 
hospital. The rule allows for insurance of advances in cases where 
there is a need for advances to fund construction activities and the 
purchase of equipment. The rule revises the existing application 
process to minimize burden and to also minimize the possibility that 
meritorious applicants will be eliminated before their application is 
given full consideration. The rule also adds terminology, based on 
experience to date, to facilitate understanding how the Section 242 
program works.

C. Costs and Benefits

    This rule will not address all financing needs of hospitals. The 
program is not designed for the entire industry of 5,000 hospitals. The 
pool of applicants is limited by eligibility restrictions. The goal of 
the rule is to assist those hospitals saddled with unexpectedly high 
interest rates and where refinancing is urgently needed for the 
hospital to continue to remain open and adequately serve its 
surrounding community.
    HUD expects the rule to result in a $1.26 million transfer per year 
per healthcare facility. The estimate of healthcare facilities assisted 
per year under the Section 242 program is 10 facilities, resulting in 
an aggregate annual impact is $12.59 million. A multiyear scenario, in 
which the number of participants increases to 17, yields an aggregate 
annualized transfer to hospitals of $17.63 million by the third year of 
the program. HUD estimates that this program will raise net receipts of 
the Federal Government by $79 million (from $79 million to $158 
million). Costs of the rule include up-front application costs, which 
may be as high as $870,000 per applicant but which are likely to be 
much lower given that non-FHA insured lenders impose transaction costs 
as well. HUD does not have enough information to quantify or evaluate 
the opportunity costs or distortionary effects of the program.
    The primary benefit of this rule is to keep hospitals with a high 
degree of

[[Page 8331]]

financial strength operating in their communities. Allowing refinancing 
can reduce the probability of default and the expected social cost of 
hospital foreclosure. If closure of a hospital were to occur, the 
negative economic impacts would be drastic. In addition to loss of 
needed healthcare options, hospitals are among the largest employers in 
their communities. Therefore the benefits of this rule can be twofold--
maintaining needed healthcare services in a community as well as 
avoiding loss of jobs.

II. Background--The Section 242 Hospital Mortgage Insurance Program

    Section 242 of the National Housing Act (12 U.S.C. 1715z-7) 
authorizes FHA to insure mortgages to finance the construction or 
rehabilitation of public or private nonprofit and proprietary 
hospitals, including insurance for major movable equipment, as well as 
to refinance existing debt. Section 242 of the National Housing Act 
(NHA) provides this authority to FHA to: (1) assist in maintaining the 
availability of hospitals needed 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 (see 12 U.S.C. 1715z-7(a)); and (2) encourage the 
provision of comprehensive health care, including outpatient and 
preventive care, as well as hospitalization. In the case of public 
hospitals, section 242 of the NHA is designed to encourage programs to 
provide healthcare services to all members of a community regardless of 
ability to pay. (See 12 U.S.C. 1715z-7(f).)
    The regulations for the Section 242 program are codified in 24 CFR 
part 242. Prior to the refinancing changes proposed to the Section 242 
program in 2009, HUD had taken the position that, for hospitals without 
FHA insured mortgages, private capital for refinancing debt was 
sufficient, and that the demand for refinancing debt was not as great 
as the need for financing for new construction, renovation and 
rehabilitation, and equipment purchases. In fact, HUD has long had the 
authority, under section 223(f) of the NHA,\1\ to provide for 
refinancing of hospital debt to hospitals without FHA insured mortgages 
without conditioning such refinancing on new construction or renovation 
(See 12 U.S.C. 1715n(f)).
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    \1\ Section 223(f)(1) of the National Housing Act provides that 
``Notwithstanding any of the provisions of this Act, the Secretary 
is authorized, in his discretion, to insure under any section of 
this title a mortgage executed in connection with the purchase or 
refinancing of an existing multifamily housing project or the 
purchase or refinancing of existing debt of an existing hospital (or 
existing nursing home, existing assisted living facility, existing 
intermediate care facility, existing board and care home, or any 
combination thereof).'' (12 U.S.C. 1715n(f).)
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    When the credit crisis emerged, both the hospital industry and 
congressional members, commencing in 2009, urged HUD to use its 
statutory authority under section 223(f) to provide refinancing to 
hospitals without FHA insured mortgages. HUD responded to the credit 
crisis promptly by implementing its authority through notice, Housing 
Notice H-09-05, issued July 1, 2009, which was amended and superseded 
by Housing Notice H-10-06, issued February 22, 2010. On January 29, 
2010 (at 75 FR 4964), HUD published a proposed rule to commence the 
process to provide for permanent regulatory codification of its 
refinancing authority, and to seek public comment on the HUD's 
implementation of its 223(f) refinancing authority, as set out in the 
Housing notices.
    The January 29, 2010, rule proposed to establish in regulation the 
criteria and procedures set forth in notice, by which HUD would 
refinance hospital debt under section 223(f). The preamble to the 
January 29, 2010, proposed rule sets out in detail the proposed changes 
to HUD's regulations in 24 CFR part 242 to implement its section 223(f) 
refinancing authority, referred to in this preamble as Section 242/
223(f) refinancing.

III. Overview of Key Changes Made at Final Rule Stage

    HUD is making several changes to the January 29, 2010, proposed 
rule in response to public comment, HUD's experience in administering 
its refinancing authority to date, and further consideration of issues 
by HUD.
Changes Made in Response to Public Comment
    Key changes made to the proposed rule by this final rule in 
response to public comment include the following. The final rule:
     Adopts certain new definitions that describe the costs 
that can be insured under the Section 242 program. Adds definitions of 
``acquisition'' and ``refinancing'' to the definitions of activities 
eligible for insurance. The proposed rule listed ``acquisition'' and 
``refinancing'' as eligible categories, but did not include definitions 
for these terms. Including definitions in the final regulation is 
intended to facilitate borrower's understanding of the distinctions 
between the financing categories.
     Adds a definition of ``capital debt'' in part in response 
to comments requesting that HUD provide flexibility to allow certain 
financing costs approved by HUD to be included as part of a refinancing 
mortgage. HUD is including a definition of ``capital debt'' as ``the 
outstanding indebtedness used for the construction, rehabilitation, or 
acquisition of the physical property and equipment of a hospital, 
including those financing costs approved by HUD. This gives HUD the 
flexibility to approve certain financing costs associated with a 
refinancing as part of the refinancing mortgage. Examples of financing 
costs are found in the definition of ``soft costs'', as provided in the 
discussion below.
     Reorganizes Sec.  242.16 to consolidate certain paragraphs 
and divide other. Additionally, revises certain threshold factors that 
make an initial determination of a hospital's eligibility for Section 
242/223(f) refinancing, which are designed to enhance screening for 
applicant eligibility for Section 242/223(f) refinancing and assure 
that HUD is assisting hospitals that merit serious consideration based 
on need and financial strength. The revision to the threshold factor 
includes a supplement to the factor that requires the hospital to have 
an aggregate operating margin of at least zero percent, and an average 
debt service coverage ratio of at least 1.40, when calculated from the 
three most recent annual audited financial statements. The 
supplementary provision to this factor provides that in performing such 
calculations, if HUD finds that performance in one of the three years 
was affected by exceptional, one-time events that substantially altered 
financial performance, HUD may calculate three-year performance based 
on the four most recent years with the unusual year omitted.
     Requires, consistent with current practice, that the 
inspection fee be paid no later than at the time of initial 
endorsement.
     Provides a sliding scale for inspection fees that is 
developed based upon the mortgage amount attributable to the newly 
defined ``hard costs.''
     Specifies insurance upon completion when advances are not 
needed for limited rehabilitation.
     Revises requirements for the Sec.  242.16(d) application 
process to introduce more flexibility for applicants and minimize the 
possibility that meritorious applicants will be screened out.

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Changes Initiated by HUD Based on Section 242/223(f) Refinancing 
Experience to Date
    In addition to changes that HUD is making at this final rule stage 
in response to public comments, and which are discussed in detail in 
Section III of this preamble, HUD is making the following changes at 
this final rule stage based on HUD's experience to date in implementing 
the Section 242/223(f) refinancing authority.
    To complement a definition of ``hard costs'' contained in the 
proposed rule, the final rule adds a new definition of ``soft costs'' 
and, to complement the definition of ``substantial rehabilitation,'' 
adds a definition of ``limited rehabilitation'' incorporating into the 
regulation terms that reflect these categories of Section 242/223(f) 
refinancing.
Definitions (Section 242.1)
    Soft Costs. Based on HUD's experience to date administering its 
Section 242/223(f) refinancing authority, and in response to questions 
from refinancing applicants about the scope of ``hard costs,'' HUD 
determined that it would be helpful to specify those costs that 
constitute ``soft costs.'' Accordingly, the final rule defines ``soft 
costs'' as follows: ``Soft costs means reasonable and customary legal, 
organizational, consulting, and such other costs associated with 
effecting the proposed project and its financing or refinancing, 
including, but not limited to, interest capitalized during 
construction, permanent financing fees, initial service charge, tax, 
title and recording expenses, special tax assessments, Allowance to 
Make Project Operational (AMPO),\2\ insurance costs during 
construction, FHA fees and charges including application, commitment 
and inspection fees; mortgage insurance premium for advances during 
construction, prepayment penalties associated with retiring the 
hospital's existing bonds; and termination costs for interest rate 
protection facilities that are integrated into the original financing, 
as applicable.''
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    \2\ Allowance to Make Project Operational (AMPO) 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 24 CFR 242.43.
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    Limited rehabilitation. HUD is also including a definition of 
``limited rehabilitation'' in this final regulation, which describes 
categories of construction costs distinguishable from substantial 
rehabilitation. As noted, in Sec.  242.91(b)(2) of the January 29, 
2010, proposed rule, the proceeds of any refinancing can be employed to 
pay for repairs totaling less than 20 percent of the mortgage amount. 
The final rule adopts the numeric criteria for repairs that were 
included in the proposed regulation as the definition of ``limited 
rehabilitation.''
Funds and Finances; Deposits and Letters of Credit (Section 242.49)
    This section establishes the requirements mortgagees must meet for 
funds deposited to support the project. HUD did not receive public 
comment on this issue. However, in the course of operating the Section 
242 program over the last several years, HUD has found that some 
mortgagees are not able to hold funds on behalf of the mortgagor. 
Several state healthcare finance agencies have mentioned this problem 
to HUD with respect to the Mortgage Reserve Fund defined in codified 
Sec.  242.1, stating that, under their state laws, state healthcare 
finance agencies are not authorized to hold such funds. In such cases, 
the deposits must be with a depository acceptable to the mortgagee and 
HUD. HUD recognizes the issues involved in the state law requirements, 
and accordingly is modifying its regulations in Sec.  242.49 to specify 
that the depository which has the funds, rather than the mortgagee, 
will be legally responsible in those cases.
Maximum Mortgage Amounts and Cash Equity Requirements (Section 242.23)
    This section establishes the maximum mortgage amounts and cash 
equity amounts for mortgages insured under Section 242/223(f). The 
proposed rule revised the maximum mortgage amount to provide that the 
amount would not exceed the cost to refinance the existing indebtedness 
as defined in Sec.  242.23. The final rule retains the proposed rule 
language but revises this provision to incorporate the terms that are 
being newly defined in this rule.

IV. Discussion of Public Comments and HUD Responses

    The public comment period on the proposed rule closed March 30, 
2010, and HUD received seven comments. The public commenters included 
national trade associations involved in healthcare financing, national 
and state hospital and healthcare associations, national associations 
of healthcare financial management professionals, law professors, and 
attorneys who are active in the field. Although one commenter supported 
the rule as proposed, the remaining six commenters submitted 
suggestions for changes to the manner in which HUD implements its 
Section 242/223(f) refinancing authority. The changes suggested by the 
commenters included expansion of the program by, among other things, 
relaxing the threshold financial screening tests to allow more 
hospitals to meet the eligibility requirements for financing, covering 
additional costs, and permitting the leasing of hospitals with Section 
242 financing to operators.
    HUD did not receive comments on the following sections of the 
proposed rule: Sec. Sec.  242.4; 242.15; 242.16(b)(3) and (b)(6); 
242.16(d); and 24 CFR 242.17(a)(2). While Section 242.15 is not revised 
in this final rule, the other sections are revised in the final rule to 
be consistent with HUD changes to definitions or other elements of the 
final rule.
Definitions (Section 242.1)
    The proposed rule added the following three definitions to 24 CFR 
part 242: ``hard costs,'' ``Section 242/223(f),'' and ``substantial 
rehabilitation.'' The definition of ``Section 242/223(f)'' was included 
as an easy way to refer to HUD's refinancing authority under section 
223(f) of the NHA as applied to hospitals financed under section 242 of 
the NHA. The term ``hard costs'' was defined to mean the costs of the 
construction and equipment, including construction-related fees such as 
architect and construction manager fees. The term ``substantial 
rehabilitation'' was defined to address ``cases where the hard costs of 
construction and equipment are equal to or greater than 20 percent of 
the mortgage amount.'' HUD did not receive any comments on these terms 
and the final rule adopts these definitions without change.
    Commenters proposed changes to other definitions included in the 
proposed rule, and suggested that additional terms be defined. HUD has 
adopted certain of the commenters' recommendations and made some 
additional changes to other definitions to reflect adoption of the new 
terms. Accordingly, the final rule includes several new terms beyond 
those included in the proposed rule: ``acquisition,'' ``capital debt,'' 
``limited rehabilitation,'' ``refinancing,'' and ``soft costs.'' In 
addition, HUD is revising definitions already in the current 
regulations to respond to the inclusion

[[Page 8333]]

of these categories in the terms ``construction,'' ``project,'' and 
``substantial rehabilitation.''
    Comment: Include definitions for ``acquisition,'' ``capital debt,'' 
and ``refinancing.'' Commenters recommended adding definitions for the 
terms ``acquisition,'' ``capital debt'' and ``refinancing'' to ensure 
clarity with respect to the indebtedness eligible for Section 242/
223(f) refinancing.
    A commenter suggested adding a definition of acquisition as 
follows: ``Acquisition'' means the purchase by an eligible mortgagor of 
an existing hospital facility and ancillary property associated 
therewith.''
    A commenter was particularly concerned that the term ``capital 
debt'' be defined to confirm that termination costs for ``interest rate 
protection facilities \3\'' (such as fixed to variable interest rate 
swaps used as a hedge against rising variable interest rates) 
constitutes a type of debt eligible for refinancing. The commenter 
stated that the 2007-2008 collapse of the auction rate and variable 
rate markets had created significant issues for those hospitals which 
had used ``interest rate protection facilities'' to achieve savings, 
because they were not shown as ``debt'' on hospital financial 
statements under Generally Accepted Accounting Principles (GAAP) \4\ 
methodology. The commenter submitted that instead Internal Revenue 
Service guidance should be used to categorize these transactions. In 
addition, the commenter further stated that ``termination costs'' for 
interest rate protection facilities should be considered the functional 
equivalent of prepayment premiums due in connection with the early 
redemption of capital debt. The commenter stated that those prepayment 
premiums are routinely permitted as eligible program costs by HUD in 
connection with the refinancing of capital debt in the basic Section 
242 construction program.
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    \3\ An interest rate swap is a derivative in which one party 
exchanges a stream of interest payments for another party's stream 
of cash flows. Interest rate swaps can be used by hedgers to manage 
their fixed or floating assets and liabilities. They can also be 
used by speculators to replicate unfunded bond exposures to profit 
from changes in interest rates. Interest rate swaps are very popular 
and highly liquid instruments.
    \4\ The common set of accounting principles, standards and 
procedures that companies use to compile their financial statements. 
GAAP are a combination of authoritative standards (set by policy 
boards) and simply the commonly accepted ways of recording and 
reporting accounting information.
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    A commenter suggested including the following definition of 
``refinancing'': ``Refinancing means the discharging of the existing 
capital debt of a hospital.''
    HUD Response: HUD has added new definitions to clarify the types of 
costs that would be eligible for Section 242/223(f) refinancing. Rather 
than adopt other recommendations of the commenters pertaining to new 
definitions, HUD has developed alternative definitions that define the 
categories of eligible costs which applicants must identify in their 
applications. The definitions and HUD responses are outlined as 
follows:
    Acquisition: As recommended by a commenter, HUD has defined 
``acquisition'' to mean ``the purchase by an eligible mortgagor of an 
existing hospital facility and ancillary property associated with the 
facility.'' Through this definition, the purchase of the hospital and 
such items as medical equipment and ambulances will be eligible for 
financing under HUD's Section 242 program.
    Capital Debt: For some time, HUD has recognized the risks inherent 
in interest rate protection facilities. Consequently, the regulations 
at Sec.  242.63 that address additional indebtedness and leasing 
prohibit hospitals with FHA-insured loans from engaging in such 
transactions without prior HUD approval. Specifically, the regulations 
provide that ``the mortgagor shall not enter into any * * * derivative-
type transactions, except in conformance with policies and procedures 
established by HUD.'' Also, HUD will maintain its policy that hospitals 
with interest rate protection facilities seeking FHA-insured financing 
must terminate those facilities in order to be eligible for a mortgage 
insurance commitment.
    Therefore, to address the request for a definition of ``capital 
debt'' and to provide a definition that also addresses HUD's policy 
concerns, the final rule defines ``capital debt'' as ``the outstanding 
indebtedness used for the construction, rehabilitation, or acquisition 
of the physical property and equipment of a hospital, including those 
financing costs approved by HUD.'' Examples of financing costs are 
reasonable and customary legal, organizational, consulting, and such 
other costs associated with effecting the proposed project and its 
financing or refinancing, including, but not limited to, interest 
capitalized during construction; permanent financing fees; initial 
service charge; tax; title and recording expenses; special tax 
assessments; AMPO; insurance costs during construction; FHA fees and 
charges, including application, commitment and inspection fees; 
mortgage insurance premium for advances during construction; prepayment 
penalties associated with retiring the hospital's existing bonds; and 
termination costs for interest rate protection facilities that are 
integrated into the original financing. This gives HUD the flexibility 
to consider a range of financing costs associated with the refinancing 
mortgage.
    In this regard, HUD also revises the definition of ``construction'' 
to mean ``the creation of a new or replacement hospital facility, the 
substantial rehabilitation of an existing facility, or the limited 
rehabilitation of an existing facility. The cost of acquiring new or 
replacement equipment may be included in the cost of construction.'' 
HUD adds a definition for ``limited rehabilitation,'' which is defined 
as ``additions, expansion, remodeling, renovation, modernization, 
repair, and alteration of existing buildings, including acquisition of 
new or replacement equipment in cases where the hard costs of 
construction and equipment are less than 20 percent of the mortgage 
amount.''
    Refinancing: In this final rule, HUD is largely adopting the 
commenter's definition of ``refinancing.'' The final rule defines 
``refinancing'' as the discharging of the existing capital debt of a 
hospital through entering into a new debt.
Eligible Hospitals (Section 242.4)
    HUD's codified regulation in Sec.  242.4, entitled ``Eligibility 
for insurance and transition provision,'' provides that a hospital to 
be financed with an FHA insured mortgage shall involve the construction 
of a new hospital or the substantial rehabilitation (or replacement) of 
an existing hospital. The proposed rule expanded eligibility for 
insurance to include ``refinancing of the capital debt of an existing 
hospital pursuant to section 223(f) of the NHA (Section 242/223(f)).''
    At this final rule stage, HUD changes the heading of Sec.  242.4 to 
read simply ``Eligible hospitals'' and revises the definition of 
eligible hospitals to accommodate the new definitions of ``limited 
rehabilitation,'' ``acquisition,'' and ``refinancing'' that are being 
added by this final rule.
Applications (Section 242.16)
    HUD's existing regulation at Sec.  242.16(a)(2)(ii) provides that 
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 determines, based on the audited financial data, 
that the hospital has achieved a financial turnaround resulting in a 
debt service coverage ratio

[[Page 8334]]

of at least 1.40 in the most recent year.\5\ Section 242.16(a)(2)(ii) 
further provides that, 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 service 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 service to determine the debt service 
coverage ratio, hospitals must have an average debt service coverage 
ratio of 1.40 or greater.
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    \5\ Debt Service Coverage Ratio (DSC).The debt service coverage 
ratio measures a hospital's ability to pay interest and principal 
with cash generated from current operations. A high coverage ratio 
indicates that an institution is in a good financial position to 
meet its long-term obligations (including its FHA-insured loan) and 
service its debt. Higher values are preferable.
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    In implementing its Section 242/223(f) refinancing authority, HUD 
relied on the existing threshold factors in Sec.  242.16(a)(2). HUD 
stated that to receive consideration for Section 242/223(f) 
refinancing, a hospital must meet two financial thresholds. First, the 
hospital must have a 3-year aggregate operating margin of at least zero 
percent and a 3-year average debt service coverage ratio of at least 
1.40. Second, the hospital must demonstrate that its financial 
performance would be materially improved by refinancing its existing 
capital debt. The hospital must also demonstrate that it provides an 
essential healthcare service to the community in which it operates. The 
inclusion of these threshold factors to determine hospitals eligible 
for consideration for Section 242/223(f) refinancing was designed to 
assure that HUD is assisting those hospitals that merit serious 
consideration based on their financial strength and on need--theirs and 
that of the communities they serve.
    In implementing its Section 242/223(f) refinancing authority, HUD 
took a conservative approach intended to attract those hospital 
applicants that already meet the minimum operating margin and debt 
service coverage ratios required for application approval under the 
current Section 242 program. Under the existing Section 242 
regulations, HUD also looks at financial feasibility. As implemented 
for Section 242/223(f) refinancing, HUD established a threshold 
requirement to determine the hospital's need for refinancing that would 
not be available through nongovernmental sources. This threshold 
requirement would also screen out hospitals that would have little or 
no chance of having a formal application approved, based on their 
financial performance.
    As noted earlier in this preamble, HUD revised, at this final rule 
stage, the structure of Sec.  242.16 and in the discussion that follows 
strives to distinguish the applicable paragraph in the proposed rule 
and the redesignated paragraph in the final rule.
    Comment: Calculation of operating margin excludes qualified 
applicants. A commenter stated that using a 3-year average to calculate 
the operating margin \6\ and debt service coverage ratio has the 
potential to exclude well-qualified providers. The commenter stated 
that temporary declines in these ratios might be a direct result of the 
recent economic downturn and credit market crisis. The commenter 
suggested that many providers might need to exit a financing 
arrangement in which the interest rate has already increased 
substantially due to problems in the credit market, causing a decrease 
in operating margin and debt service coverage ratio. The commenter 
suggested that using a 5-year average would provide a more accurate 
picture of a hospital's performance and financial stability.
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    \6\ Operating margin is the ratio of operating income divided by 
operating expense.
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    Another commenter stated that the recasting of debt service in 
proposed Sec.  242.16(a)(3)(ii), which involves recalculating the 
operating margin and debt service coverage with a projected interest 
rate rather than the historical rate, should be a mandatory rather than 
an optional requirement to avoid the arbitrary application of this 
threshold limitation in the cases of otherwise eligible projects that 
would benefit under the new program.
    HUD Response: With respect to the suggestion made by the first 
commenter, HUD recognizes that extending the time period to calculate 
the operating margin and debt service coverage may moderate 
vacillations caused by economic variability and interest rate 
fluctuations, but HUD finds a 3-year average to present a reasonable 
and preferred time frame for evaluating potential borrowers.
    In response to the second commenter's concern, HUD has revised 
proposed Sec.  242.16(a)(3)(iii) (now Sec.  242.16(a)(3)(ii) in the 
final rule) to make the recasting mandatory rather than optional. It is 
HUD's position that the commenter's concern is addressed by the 
provision that if the operating margin and debt service coverage 
thresholds are not met, HUD will recast the operating margin and debt 
service coverage ratio for prior periods by using the estimated 
projected interest rate in lieu of the historical interest rate. HUD 
agrees that this will provide a uniform standard that will result in an 
equitable standard evaluation of the financial strength of the 
hospital.
    Comment: More flexible screening criteria needed. A commenter 
suggested that HUD adopt more flexible threshold criteria. 
Specifically, the commenter stated that the requirement that hospitals 
meet three of seven benchmarks will prevent FHA from considering some 
meritorious applications that either narrowly miss some of the 
benchmarks, or that could establish legitimate financial need but under 
different criteria. The commenter requested that FHA consider accepting 
evidence that (1) the hospital provides access to essential health 
services, (2) the hospital has few alternative vehicles for affordable 
refinancing, and (3) the financial health of the hospital depends on 
refinancing.
    HUD Response: The requirement that a hospital meet only three out 
of seven benchmarks provides considerable flexibility for a hospital to 
pass the threshold screening. In particular, potential program 
applicants should recognize that one of the seven benchmarks provides 
applicants with an opportunity to supplement their application with 
unique, specific materials to support their need for refinancing. 
Specifically, Sec.  242.16(a)(3)(vi)(B)(7) of this final rule (Sec.  
242.16(a)(3)(iv)(B)(7) of the proposed rule) states that ``there are 
other circumstances that demonstrate that the hospital's financial 
performance would be materially improved by refinancing its existing 
capital debt.''
    However, to improve flexibility and to reduce the possibility that 
meritorious hospitals will be screened out, HUD has made the following 
changes:
    Section 242.16(a)(3)(iv) in the proposed rule stated that ``The 
hospital must demonstrate that its financial health depends upon 
refinancing its existing capital debt * * *'' This requirement could be 
read to mean that the hospital must be in desperate financial trouble 
to qualify, which was not HUD's intent. Therefore, the wording of Sec.  
242.16(a)(3)(iv) in this final rule has been changed to: ``The hospital 
must document that * * * its financial performance would be materially 
improved by refinancing its existing capital debt.'' Where the same 
language appears in Sec.  242.16(a)(3)(vi)(B))(7) of this final rule, 
the same change is made.
    Section 242.16(a)(3)(iv)(B) in the proposed rule would have 
required the hospital to demonstrate that ``there are few alternative 
affordable financing

[[Page 8335]]

vehicles available to the hospital.'' HUD has retained this provision, 
with minor edits, and the provision is now found in Sec.  
242.16(a)(3)(vi)(A) of this final rule.
    Section 242.16(a)(3)(iv)(B)(6) in the proposed rule would have 
required that ``The hospital is party to overly restrictive or onerous 
bond covenants.'' Because ``overly restrictive or onerous'' is not 
defined and could be interpreted as referring to only the very worst 
covenants (from a hospital's point of view), this wording has been 
replaced by the following: ``The hospital is party to bond covenants 
that are substantially more restrictive than the Section 242 mortgage 
covenants,'' and this provision is now in Sec.  242.16(a)(3)(vi)(B)(6) 
in this final rule.
    These changes will provide more flexibility to hospitals in meeting 
the threshold requirements while still indicating that the hospitals 
have a strong business need to refinance.
    Comment: Expand the definition of service beyond health service. A 
commenter submitted that Sec.  242.16(a)(3)(iv) of the proposed rule 
would have required HUD to determine that the hospital provide ``an 
essential service'' to a hospital's community. The commenter stated 
that an overly narrow interpretation of the undefined term ``service'' 
to apply only to medical considerations may inadvertently limit sponsor 
eligibility. The commenter stated that hospitals provide other 
significant community benefit services, such as employment, 
neighborhood stability, community health initiatives, and civic 
educational programs. Another commenter stated that hospitals in urban 
areas that serve discrete and insular communities, such as HIV or 
mental health patients, meet a special need. The commenter stated that 
closure of hospitals that treat these illnesses would create hardship 
for those sectors of the communities.
    HUD Response: If a hospital ceases to operate and its community 
suffers no inadequacies in essential medical services as a result, 
there is good reason to believe that there was no market need for the 
hospital in the first instance. HUD has statutory authority to assist 
in 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. (See 12 U.S.C. 1715z-7(a).) 
Consistent with this authority, it is HUD's position that while 
hospitals provide other community benefits, the medical services 
provided by hospitals must be the focus in considering the need for a 
facility. Accordingly, in the proposed rule, HUD offered language in 
Sec.  242.16(a)(3)(iv) consistent with the language in currently 
codified regulations in Sec.  242.16(a)(1), Market Need, which 
emphasizes the healthcare services provided by the hospital. However, 
to eliminate any possible ambiguity, the final rule revises Sec.  
242.16(a)(3)(iv) to include the word ``healthcare'' before ``service'' 
and, therefore, confirm that the test of ``essential service'' applies 
to healthcare services.
    Comment: Applicants should meet several of the threshold screening 
elements. A commenter suggested that a typographical correction is 
needed to insert an ``and'' after proposed Sec.  242.16(a)(3)(iv)(B) 
and before Sec.  242.16(a)(3)(iv)(C).
    HUD Response: HUD agrees with the commenter and adopted the 
recommendation. However, in the final rule, the ``and'' is now found 
after 242.16(a)(3)(vi)(A) and before Sec.  242.16(a)(3)(vi)(B). 
Inserting the word ``and'' clarifies that a hospital demonstrating that 
its financial health depends upon refinancing would have to document 
all elements of the threshold test rather than individual discrete 
elements. Specifically, the hospital would have to document that (1) 
the community would suffer from inadequate access to an essential 
service that the hospital provides, (2) there are few alternative 
financing vehicles, and (3) three of the additional seven criteria are 
met. Review of all of these elements will assure that there will be 
strong justifications for the refinancing.
    Comment: Expand the covenant test to include the hospital system. A 
commenter stated that the concept of ``overly restrictive or onerous'' 
covenants in proposed Sec.  242.16(a)(3)(iv)(C)(6) is appropriate in 
determining the need for refinancing, and suggested clarifications to 
cover situations in which a hospital is subject to such covenants as a 
member of a system and not independently.
    HUD Response: Because ``overly restrictive or onerous'' is not 
defined and could be interpreted as referring to only the very worst 
covenants (from a hospital's point of view), this wording has been 
replaced by the following: ``The hospital is party to bond covenants 
that are substantially more restrictive than the Section 242 mortgage 
covenants,'' and this provision is now in Sec.  242.16(a)(3)(vi)(B)(6) 
in this final rule.
    Comment: Provide a separate threshold test for acquisitions. One 
commenter stated that the threshold requirements in proposed Sec.  
242.16(a)(3) provide guidance for determining the need for a 
``refinancing.'' The commenter stated that its application to 
``acquisitions'' requires clarification.
    HUD Response: The same requirements that apply to the basic Section 
242 program apply to acquisitions. Therefore, changes have been made in 
this final rule to clarify that the basic Section 242 program 
requirements apply to acquisitions. These clarifying amendments are 
made in the following sections: Sec. Sec.  242.1, 242.4, 242.17, and 
242.23 to reflect appropriate differences.
    Comment: Market Need study requirements should be revised. Section 
242.16(b)(5) of the proposed rule provided that the study of market 
need may not be required, subject to HUD's discretion, for an 
application for Section 242/223(f) mortgage insurance. However, HUD 
anticipated that, in most cases, this study would be required. In 
addition, although HUD may determine not to require a study of market 
need with respect to a Section 242/223(f) refinance transaction, HUD 
will always consider market need in the preliminary threshold 
requirement phase, as discussed in Sec.  242.16(b)(5). In the proposed 
rule, HUD emphasized that market need varies from case to case.
    A commenter stated that needy hospitals would be screened out 
because of the strong emphasis the threshold requirements put on the 
financial strength of a hospital. The commenter contended that the 
language demonstrates that the program is not focused on helping the 
most struggling hospitals, even though they are the hospitals most 
likely serving the neediest populations. The commenter suggested that 
the market need study should include a more detailed look at discrete, 
vulnerable populations.
    HUD Response: HUD declines to adopt the commenter's recommendation. 
Section 242 is a mortgage insurance program, not a grant program. As an 
insurance program, there is a need to weigh the public benefit provided 
by a hospital facility against the risk that the hospital may not be 
able to meet its mortgage debt service obligations. While the program 
emphasizes market need, the program also emphasizes--and must--
emphasize financial strength of the hospital.
    Comment: Need analysis should address refinancing and hard costs. 
The proposed rule at Sec.  242.16(b)(5) provides that a study of market 
need may be required in the case of a Section 242/223(f) refinancing. A 
commenter expressed recognition that a market need analysis for new 
construction projects is required, but submitted that a sponsor's 
compliance with the

[[Page 8336]]

threshold requirements under Sec.  242.16(a)(3) should be sufficient to 
establish the need for the refinance portion of the project. The 
commenter recommended that HUD bifurcate its need analysis into two 
parts. The first inquiry would be the need for the refinancing portion, 
and the second would be the need for the ``hard costs'' portion of the 
project, if any. The commenter stated that, if the threshold 
requirements of Sec.  242.16(a)(3) are satisfied, the hospital should 
be deemed to have satisfied the need requirement as to the refinance 
portion of the proposed project.
    HUD Response: The assessment of market need should be consistent in 
the Section 242 program and not vary according to the amount of 
refinancing versus hard costs proposed for insured financing.
    Section 242.16(d) was revised in this final rule to specify that an 
application for Section 242/223(f) mortgage insurance shall be on an 
approved FHA form submitted jointly by an approved mortgagee and the 
prospective mortgagor. HUD has determined, at this point, that 
specifying this requirement is not necessary, and that the current 
regulatory requirements are sufficient. The proposed revision 
eliminates the name of the HUD office that takes these applications in 
order to eliminate the need for future regulatory changes if the name 
of the office is revised.
Commitments (Section 242.17)
    Section 242.17(a) (Issuance of Commitment) of the proposed rule 
included a new paragraph (a)(2) that provided, in the case of an 
application for Section 242/223(f) refinancing and where advances are 
not needed for funding any limited rehabilitation of the hospital, a 
commitment for insurance upon completion shall include the mortgage 
amount, interest rate, mortgage term, date of commencement of 
amortization, and other requirements pertaining to the mortgage.\7\ The 
final rule retains new paragraph (a)(2) with a modification to 
accommodate inclusion of limited rehabilitation.
---------------------------------------------------------------------------

    \7\ Note that since there is an existing paragraph (a)(2) in 
Sec.  242.17, the existing paragraph ((a)(2)) and the paragraphs 
that follow will be redesignated accordingly). This rule amends 
Sec.  242.17(b) (Type of Commitment) to provide that in the case of 
a commitment for Section 242/223(f) insured refinancing, the 
commitment will provide for insurance upon completion.
---------------------------------------------------------------------------

    Section 242.17(a) provides for insurance of advances in cases where 
there is a need for advances to fund construction activities and the 
purchase of equipment. This type of insurance is provided for section 
242 projects and section 242 projects insured pursuant to section 241of 
the NHA. Section 241 insures mortgage loans to finance repairs, 
additions, and improvements to multifamily rental housing and 
healthcare facilities with FHA-insured first mortgages or HUD-held 
mortgages. However, in section 242 projects insured pursuant to section 
223(f), the circumstances of each case will determine whether the 
commitment will be for insurance of advances or insurance upon 
completion. In a pure refinancing or acquisition, or a refinancing with 
minor limited rehabilitation that can be funded from operations and 
cash reserves, there is no need for advances and the commitment will be 
for insurance upon completion. However, if a significant portion of the 
mortgage proceeds (subject to the 20 percent limitation) is to be used 
for limited rehabilitation, and the hospital cannot fund these from its 
own cash, then the commitment may provide for insurance of advances.
    Comment: Require insurance upon completion when advances are not 
needed for construction. A commenter submitted that the proposed 
language in Sec.  242.17(b) appeared somewhat inconsistent with the 
language of Sec.  242.17(a)(2), which states: ``In the case of an 
application for Section 242/223(f) insurance where advances are not 
needed for funding any limited rehabilitation, a commitment for 
insurance upon completion will be issued.'' The commenter states that 
there is no provision for HUD discretion in Sec.  242.17(a)(2), but 
there is allowance for HUD discretion in proposed in Sec.  242.17(b), 
which provided HUD discretion for issuing the commitment. The commenter 
suggested that language of Sec.  242.17(b) be revised to eliminate HUD 
discretion in those instances where insured advances are not needed for 
funding limited rehabilitation approved by HUD.
    HUD Response: HUD agrees with the commenter and has added language 
to Sec.  242.17(b) to clarify that HUD shall issue the commitment.
    Comment: Make insurance upon completion available for acquisitions. 
A commenter suggested that HUD clarify in Sec.  242.17(b) that the 
option of insurance upon completion should be made available for 
acquisition as well as refinancing transactions. The commenter 
suggested that an advantage of insurance upon completion is that it 
could potentially enable a determination to be made in advance of loan 
closing that the FHA-insured loan will qualify for Real Estate Mortgage 
Investment Conduit (REMIC) securitization and the lower interest rates 
that REMIC status provides. The commenter suggested that this potential 
advantage should be made available for acquisition as well as 
refinancing transactions.
    HUD Response: As a result of the commenter's suggestion, HUD has 
reexamined its proposed rule language. HUD agrees that the option of 
insurance upon completion should, consistent with HUD's statutory 
authority, be expanded beyond refinancing transactions to acquisition 
transactions.\8\ Accordingly, HUD has revised the commitment language 
in Sec.  242.17 to cover acquisitions. A corresponding change is also 
made in paragraph (b) of Sec.  242.39 (Insurance Endorsement). HUD is 
refraining from commenting on the impact of these changes for REMIC 
eligibility of the insured loans as interpretation of the tax code does 
not fall within HUD's statutory authority.
---------------------------------------------------------------------------

    \8\ Section 223(f)(1) of the National Housing Act provides that 
``Notwithstanding any of the provisions of this Act, the Secretary 
is authorized, in his discretion, to insure under any section of 
this title a mortgage executed in connection with * * * the purchase 
or refinancing of existing debt of an existing hospital (or existing 
nursing home, existing assisted living facility, existing 
intermediate care facility, existing board and care home, or any 
combination thereof).'' (12 U.S.C. 1715n(f).).
---------------------------------------------------------------------------

Inspection Fee (Section 242.18)
    The proposed rule included an amendment to Sec.  242.18 to provide 
that, in the case of mortgages insured under Section 242/223(f), the 
inspection fee shall be paid at endorsement, as provided in Sec.  
242.39, which is discussed below. In the traditional Section 242 
program, the inspection fee is generally 50 basis points on all loans. 
This fee covers such activities as review of architectural plans and 
specifications, and periodic inspection during construction. For 
applicants seeking refinancing only, an inspection fee that would 
involve generally no more than a site visit by HUD architects and 
engineers will not exceed 10 basis points on the loan.
    Comment: Pay the inspection fee no later than the time of initial 
endorsement. A commenter suggested that the inspection fee be paid no 
later than the time of initial endorsement because many projects 
involve precommitment or early start of construction work.
    HUD Response: HUD agrees with this recommendation. The language 
change is consistent with FHA's current procedures. FHA currently 
charges an inspection fee if precommitment or early start work is 
undertaken prior to initial endorsement.
    Comment: Modify the inspection fee to account for hard costs. A 
commenter

[[Page 8337]]

stated that the proposed language in Sec.  242.18 limits the inspection 
fee amount only in connection with projects which have no applicable 
hard costs. The commenter suggested that this would mean that the full 
50 basis point inspection fee would otherwise apply, even if the hard 
costs were minimal; e.g., 1 percent of the commitment amount. The 
commenter suggested that an additional inspection fee, if any, should 
be based on the amount of actual hard costs exclusive of equipment, 
calculated at five dollars per thousand dollars of the hard costs.
    HUD Response: HUD agrees that the inspection fee should better 
reflect the portion of the mortgage amount that will be used for hard 
costs. In the basic Section 242 program, in which hard costs must 
amount to 20 percent or more of the mortgage amount, the maximum 
inspection fee of 50 basis points is routinely charged. For a pure 
refinancing with zero hard costs, the proposed rule set a maximum 
inspection fee at 10 basis points (reflecting that even with no hard 
costs, the facility must be inspected to assess its condition). HUD has 
determined that where hard costs are between zero and 20 percent, an 
inspection fee that is between 10 and 50 basis points would be 
reasonable, and accordingly is including a schedule in the final rule. 
However, HUD does not agree to exclude the cost of equipment from 
``hard costs.'' Equipment is included in ``hard costs'' for the basic 
Section 242 program and equipment should also be included for 
refinancing. Major medical equipment has implications for facility 
design, and can complicate review of plans and construction. 
Accordingly, HUD has revised the inspection fees to correlate with hard 
costs.
Maximum Mortgage Amounts and Cash Equity Requirements (Section 242.23)
    One of the key changes proposed to the regulations in 24 CFR part 
242 is the change proposed to Sec.  242.23, which establishes the 
maximum mortgage amounts and cash equity amounts for mortgages insured 
under Section 242/223(f). The proposed rule revised the maximum 
mortgage amount to provide that the amount would not exceed the cost to 
refinance the existing indebtedness as defined in Sec.  242.23. The 
final rule adopts this language but revises this formula to coordinate 
those provisions with the new definitions.
    Comment: Modify the financing terms to coordinate with the new 
definitions. Section 242.23(a) and new paragraphs (b) and (c) 
identified the amounts that would be included in the Section 242/223(f) 
loan. A commenter stated that further clarification was needed to 
coordinate those provisions with the definitions that commenters 
proposed be included in the final rule. (Please see earlier discussion 
under ``Definitions'' of Section IV of the preamble, in which 
commenters recommended that the final rule define additional terms such 
as ``acquisition,'' ``capital debt,'' and ``refinancing.'')
    HUD Response: HUD agrees with the commenter's general concerns, and 
has revised applicable definitions to specify potential costs in Sec.  
242.23(a), which establishes the adjusted mortgage amount for 
rehabilitation projects, and Sec.  242.23 (b), which establishes the 
adjusted mortgage amount for refinancing and acquisitions.
    This final rule revises paragraph (a) of Sec.  242.23 to reflect 
the definition of the new term ``capital debt'' and revises new 
paragraph (b) of Sec.  242.23, which was included in the proposed rule 
to reflect new terminology defined in this rule. In this final version, 
language has been added to paragraph (b), which uses new definitions 
for ``soft costs'' and replaces ``indebtedness'' with ``capital debt'' 
in the list of items that will provide the total mortgage amount in a 
rehabilitation project with an existing mortgage. Paragraph (b) is 
further revised in the final rule to cover acquisitions, and address 
the categories of hard and soft costs.
Mortgage Lien Certifications (Section 242.35)
    This section requires the mortgagor to notify HUD in writing of 
unpaid liens prior to initial or final endorsement of the mortgage 
note. Although the proposed rule did not contain a revision to this 
section, the final rule modifies the mortgagor's responsibilities to 
include notification of liens in conection with limited rehabilitation, 
which term is defined by this final rule.
Insurance Endorsement (Section 242.39)
    The final rule amends Sec.  242.39 to divide this regulatory 
section into two main parts. The existing section is designated as 
paragraph (a) and entitled ``New Construction/Substantial 
Rehabilitation.'' A new paragraph (b), entitled ``Section 242/223(f) 
Refinancing/Acquisition,'' is proposed to be added to address the 
Section 242/223(f) process. The Section 242/223(f) process, as 
presented in the proposed rule, provided that, in cases that do not 
involve advances of mortgage proceeds, endorsement shall occur after 
all relevant terms and conditions have been satisfied, including, if 
applicable, completion of any limited rehabilitation, or upon assurance 
acceptable to the FHA that all required limited rehabilitation will be 
completed by a date certain following endorsement. Proposed new 
paragraph (b) provided that, in cases where advances of mortgage 
proceeds are used for limited rehabilitation, endorsement shall occur 
as described in Sec.  242.39(a) (Insurance Endorsement) for the initial 
endorsement for new construction/substantial rehabilitation.
    The final rule adopts these provisions, with modifications to 
include the new categories of definitions and to address the 
commenter's concerns about insurance upon completion described in the 
following section.
    Comment: Make the option of insurance upon completion available for 
acquisition. As noted previously under the comments to Sec.  242.17(b), 
a commenter suggested that the final rule clarify that the option of 
insurance upon completion of any rehabilitation should be made 
available for acquisition as well as refinancing transactions. The 
commenter stated that an advantage of insurance upon completion is that 
it could potentially enable a determination to be made, in advance of 
loan closing, that the FHA-insured loan will qualify for REMIC 
securitization and the lower interest rates that REMIC provides. The 
commenter stated that this potential advantage should be made available 
for acquisition as well as refinancing transactions.
    HUD Response: HUD agrees that there is no reason to limit the 
option of insurance upon completion to refinancing transactions. 
Therefore, in this final rule, HUD has revised this regulatory section, 
as was Sec.  242.17, to include acquisitions. These changes do not 
address the commenter's statements regarding REMIC eligibility as 
interpretation of the tax code is not within HUD's statutory authority.
Early Commencement of Work (Section 242.45)
    Comment: Remove the 2-year aging requirement. A commenter submitted 
that in Sec.  242.45 (Early Commencement of Work), the requirement that 
existing capital debt be at least 2 years old is a serious threshold 
impediment to many hospitals that need, and would otherwise be eligible 
for, Section 242/223(f) refinancing. The commenter suggested language 
that, if added to Sec.  242.45(b), would allow hospitals with 
construction less than 2 years old to apply for mortgage insurance on 
the same basis as hospitals whose structures are more than 2 years old.
    The commenter stated that they had no disagreement with the basic 
purpose of Sec.  242.45(b), which was initially

[[Page 8338]]

implemented by HUD in connection with its sections 221(d)(4)/223(f) and 
232/223(f) multifamily and skilled nursing programs. The commenter 
stated that it understood that HUD's rationale was to preclude projects 
that were intentionally constructed with conventional short-term bank 
financing in order to avoid prevailing wage, inspections, and other 
federal construction requirements from using a section 223(f) loan as a 
source of refunding the sponsor's conventional financing with long-term 
FHA fixed rate debt.
    The commenter suggested that hospitals that had and have no 
intention of avoiding HUD construction requirements should not be 
restricted. The commenter stated that any conclusion to the contrary 
would directly conflict with the proposed rule's public purpose to 
``contribute to alleviating financial stress on hospitals and 
maintaining the availability of hospitals in many communities.'' The 
commenter submitted that conditioning eligibility on the 2-year rule 
developed for an entirely different fact pattern would contravene this 
intention.
    The commenter stated that the FHA Commissioner has waived a similar 
requirement in the multifamily housing program to address the lack of 
refinancing alternatives in the current marketplace.\9\ The commenter 
suggested extending a similar policy to hospitals where a hospital can 
demonstrate that there was no attempt to circumvent federal 
requirements.
---------------------------------------------------------------------------

    \9\ Copies of these documents and other HUD notices are 
available on HUD's Web page http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/notices/hsg.
---------------------------------------------------------------------------

    HUD Response: HUD declines to adopt the commenter's recommendation. 
The change would encourage developers to build facilities with 
conventional short-term bank financing in order to avoid prevailing 
wage, inspections, and other federal construction requirements, then 
attempt to refinance their short-term debt with long-term FHA-insured 
financing. The commenter suggests that only applicants who had no 
intention of avoiding the federal requirements would be allowed. HUD 
should not be put in the difficult, if not impossible, position of 
judging intent. It is HUD's position that if a hospital can demonstrate 
that it has no access to capital--so that the hospital may refinance to 
lower its debt-service burden and secure permanent long term 
financing--other than an FHA insured loan, the hospital may request a 
waiver of Sec.  242.45(b) in connection with its request for a 
preliminary review. Addressing these situations with waivers allows HUD 
to assess the unique circumstances presented by a hospital and make a 
determination whether granting of a waiver would be appropriate.
Labor Standards (Section 242.55)
    Comment: Remove the Davis-Bacon requirements for refinancing. The 
January 29, 2010, rule proposed an amendment to Sec.  242.55(c) to 
reflect that the labor standards referenced in that regulatory section, 
Davis-Bacon requirements, were applicable to a refinancing loan under 
section 223(f) of the NHA. The commenter proposed that financing be 
provided if the mortgagor provides a certification or other evidence 
that construction was undertaken in good faith without intent to avoid 
any requirement of section 242.
    HUD Response: HUD determined that Davis-Bacon requirements were 
presently inapplicable to limited rehabilitation in connection with 
refinancing and, accordingly, is removing this language in the final 
rule.
Leasing of Hospital (Section 242.72)
    Comment: Establish an Operating Lease Ownership structure to meet 
REMIC requirements. A commenter stated that in cases where insurance of 
advances is needed for a project (whether in the basic Section 242 new 
construction/substantial rehabilitation program or with respect to 
Section 242/223(f) refinancing or acquisition) the existing regulations 
prevent HUD from implementing a solution that would permit the insured 
loans to become REMIC eligible.
    The commenter stated that the so-called ``80 percent test'' of the 
Internal Revenue Service provides that, as of loan origination, the 
value of real property securing the FHA-insured loan must be at least 
equal to 80 percent of the loan amount. The commenter stated that the 
problem is that, with insurance of advances, there is a time lag 
between the date of initial endorsement and the date upon which the 
certification of costs of improvements funded with loan advances 
becomes incontestable (final endorsement), during which time the value 
of the underlying real property can change. The commenter stated that 
since one cannot be assured as of the initial endorsement date whether 
the loan will be in compliance at the later final endorsement date, the 
REMIC sponsor will not provide a pricing commitment to the FHA lender 
reflective of REMIC eligibility and the lender in turn cannot pass on 
the benefit of REMIC pricing to the hospital borrower.
    The commenter suggested an ``alternative test'' for REMIC 
securitization which would provide that an obligation ``is principally 
secured by an interest in real property if substantially all of the 
proceeds of the obligation were used to acquire or to improve or 
protect an interest in real property that, at the origination date, is 
the only security for the obligation* * *''
    The commenter suggested that FHA-insured loans could qualify under 
the alternative test if Sec.  242.72 would permit a hospital to 
separate ownership of real property from non-real property (i.e., 
equipment). The commenter stated that this would involve an operating 
lease ownership structure where substantially all of the section 242 or 
section 242/223(f) loan proceeds would be used for financing real 
estate owned by the mortgagor and for improvements made to real estate. 
The commenter stated that the operator, not the mortgagor, would own 
the hospital equipment used in operating the hospital. The commenter 
stated that no non-real estate assets would be pledged as security for 
the loan, nor would any loan proceeds be used to pay for non-real 
estate costs.
    HUD Response: HUD declined to adopt the commenter's 
recommendations. Limiting security to real estate assets would expose 
FHA to unacceptable risk of loss in the event of an insurance claim. 
Accordingly, there is no change Sec.  242.72 as currently codified in 
the CFR.
Eligibility of Refinancing Transactions (Section 242.91)
    The proposed rule amended Sec.  242.91 to consolidate existing 
Sec.  242.91 into a new paragraph (a) and to add a new paragraph (b) to 
provide that a mortgage given to refinance the debt of an existing 
hospital under section 242 of the NHA could be insured pursuant to 
section 223(f) of the NHA. The proposed new paragraph (b) also provided 
that a mortgage could be executed in connection with the purchase or 
refinancing of an existing hospital without substantial rehabilitation. 
In addition, new paragraph (b) provided that the FHA Commissioner 
should prescribe such terms and conditions as the Commissioner deemed 
necessary to assure that: (1) the refinancing is employed to lower the 
monthly debt service costs (taking into account any fees or charges 
connected with such refinancing) of such existing hospital; (2) the 
proceeds of any refinancing would be employed only to: (a) Retire the 
existing indebtedness; (b) pay for limited rehabilitation totaling less 
than 20 percent of the mortgage amount; and

[[Page 8339]]

(c) pay the necessary cost of refinancing on such existing hospital; 
(3) such existing hospital is economically viable; and (4) the 
applicable requirements of section 242 for certificates, studies, and 
statements have been met.
    In response to comments submitted on this regulatory section, HUD 
made several revisions at the final rule stage, as described in this 
discussion of Sec.  242.91.
    Comment: Revise the calculation of debt service costs. One 
commenter suggested three additions to provide details on the 
calculation of the monthly debt service cost savings required by Sec.  
242.91(b)(1). First, the commenter suggested that HUD exclude the 
monthly debt service on the new 242/223(f) insured loan attributable to 
any new hard costs included in the insured loan. Second, the commenter 
suggested that HUD consider additional factors that will predictably 
increase monthly debt service on the loan to be refinanced above the 
monthly payment in effect at the time of the commitment, such as 
default interest rates upon the expiration of any credit enhancement 
facility. Third, the commenter suggested that, if the existing capital 
debt to be refinanced consists of more than one loan, the determination 
of debt service cost savings take into account the weighted average of 
the monthly debt service payments of the loans to be refinanced.
    HUD Response: HUD notes that the commenter's second point is 
addressed elsewhere in the regulations. HUD declines to adopt the 
commenter's other suggestions. Namely, Sec.  242.16(a)(3) already 
provides that refinancing candidates demonstrate that the interest rate 
is very likely to increase by one percentage point within one year of 
the date of application. Although they do not appear unreasonable, HUD 
has determined that the issues concerning exclusion of the monthly debt 
service on the new 242/223(f) insured loan attributable to hard costs 
and issues related to refinancing multiple loans should be addressed in 
subsequent guidance. Accordingly, this section has only been revised 
from the proposed regulation to reflect the newly adopted definitions 
of capital debt and limited rehabilitation.

V. Applicability of Revised Part 242 Regulations

    This final rule, when issued and in effect, will apply to 
applications submitted for Section 242/223(f) refinancing authority 
following the effective date of the rule.

VI. Findings and Certifications

Regulatory Review--Executive Orders 12866 and 13563

    Under Executive Order 12866 (Regulatory Planning and Review), a 
determination must be made whether a regulatory action is significant 
and therefore, subject to review by the Office of Management and Budget 
(OMB) in accordance with the requirements of the order. Executive Order 
13563 (Improving Regulations and Regulatory Review) directs executive 
agencies to analyze regulations that are ``outmoded, ineffective, 
insufficient, or excessively burdensome, and to modify, streamline, 
expand, or repeal them in accordance with what has been learned.'' 
Executive Order 13563 also directs that, where relevant, feasible, and 
consistent with regulatory objectives, and to the extent permitted by 
law, agencies are to identify and consider regulatory approaches that 
reduce burdens and maintain flexibility and freedom of choice for the 
public.
    With respect to Executive Order 12866, this rule was determined to 
be a ``significant regulatory action'' as defined in section 3(f) of 
the Executive Order (although not an economically significant 
regulatory action, as provided under section 3(f)(1) of the Executive 
Order). The final rule will not have costs, benefits, or transfers 
greater than $100 million.
    As discussed in this preamble, this rule revises the regulations 
governing FHA's Section 242 Hospital Mortgage Insurance Program for the 
purpose of codifying, in regulation, FHA's implementation of its 
authority that allows hospitals to refinance existing loans and provide 
for acquisitions, without requiring such actions only in conjunction 
with the expenditure of funds for construction or renovation. The 
section 223(f) is not designed for the entire industry of 5,000 
hospitals. The pool of applicants is limited by eligibility 
restrictions. At the time the proposed rule was published on January 
29, 2010 (75 FR 4964), industry experts estimated that FHA would 
receive from 25 to 40 applications during the first year that Section 
242/223(f) refinancing was offered. In fact, FHA received only 15 
preliminary stage applications, and most of those were eliminated based 
on a failure of the hospital to meet the threshold requirements in 
Section 242. FHA issued only one insurance commitment for Section 242/
223(f) refinancing in the amount of $29 million.
    For this final rule, HUD expects the rule to result in a $1.26 
million transfer per year, per hospital, and if refinancing is provided 
to over 10 hospitals, the aggregate annual impact is $12.59 million. A 
multiyear scenario, in which the number of participants increases to 
17, yields an aggregate annualized transfer to hospitals of $17.63 
million by the third year of the program. HUD estimates that this 
program will raise net receipts of the Federal Government by $79 
million (from $79 million to $158 million). Costs of the rule include 
up-front application costs, which may be as high as $870,000 per 
applicant but which are likely to be much lower given that non-FHA 
insured lenders impose transaction costs as well. HUD does not have 
enough information to quantify or evaluate the opportunity costs or 
distortionary effects of the program
    With respect to Executive Order 13563, HUD is offering needed 
refinancing authority to hospitals without FHA-insured loans. By 
offering this product to such hospitals, the hospitals are able to 
reduce their capital costs by refinancing into a lower interest rate 
loan through the proposed program. The opportunity to refinance to 
lower interest rates can also make the difference of whether a hospital 
can continue operating in the community it serves. The opportunity for 
an FHA-insured loan to refinance existing debt can reduce a hospital's 
probability for default and possible foreclosure and thereby also 
reduce the social welfare loss, in healthcare services and in jobs that 
result from foreclosure.
    The complete regulatory impact analysis (also referred to as a 
cost-benefit analysis) is published at www.regulations.gov along with 
this final rule, under docket number FR-5334-F-02.
    The docket file is available for public inspection at 
www.regulations.gov under docket number FR-5334-F-02.

Paperwork Reduction Act

    The information collection requirements contained in this final 
rule have been submitted for review and approval by OMB under the 
Paperwork Reduction Act of 1995 (PRA) (44 U.S.C. 3501 et seq.). The 
information collection requirements for the Hospital Mortgage Insurance 
(Section 242) program are assigned OMB control number 2502-2602. The 
information collection requirements in this final rule do not introduce 
new information collection requirements but make modifications to 
existing requirements to reflect the inclusion of regulatory text to 
provide refinancing for hospitals without existing FHA-insured 
mortgages. The sections in this rule that contain the current 
information collection requirements and the estimated adjusted

[[Page 8340]]

time to fulfill each requirement that is affected by this rule are set 
forth in the following table. The following table includes only the 
revisions to burden hours affected by the codification of the changes 
to HUD's regulations included in this rule to implement Section 223(f) 
refinancing and acquisition for hospitals.
    Recently, HUD conducted a review of the paperwork burden associated 
with the hospital mortgage insurance program. As a result of that 
review, there were changes to the number of respondents, frequency of 
response, burden hours per response, and hourly cost per response for 
many data collection items affecting various aspects of the program. 
HUD believes that the changes lead to a much more realistic estimate of 
burden hours. A modified supporting statement incorporating the results 
of HUD's review shows, for the same assumed annual volume of 15 Section 
242 applications, 74,825 annual burden hours for an annual cost of 
$7,471,875. This modified estimate of burden hours and cost became the 
new baseline against which program changes, or changes in program 
volume, were assessed.
    This final rule contains provisions that increase the number of 
applications for Section 242 refinancing. HUD expects initially to 
insure five Section 242/223(f) loans per year, increasing application 
volume from 15 to 20, and is changing some forms and procedures. When 
the modified estimates of burden hours and cost are applied to the 
additional volume, the results are 98,819 burden hours for an annual 
cost of $9,882,200. These are the numbers that appear in the modified 
Supporting Statement OMB Number 2502-0602 that HUD has submitted for 
OMB approval. These information collection documents can be found at 
http://www.reginfo.gov/public/do/PRAMain.
    The difference between the 15 applications and the 20 applications 
is an additional 23,994 burden hours and $2,410,325 in cost. This is 
the PRA impact of introducing Section 223(f) refinancing and 
acquisition loans as part of the Section 242 hospital mortgage 
insurance program and processing five additional Section 242/223(f) 
applications per year.

----------------------------------------------------------------------------------------------------------------
                                                    Respondent                     Average time
     CFR Section (related forms referenced)          universe      Total annual   per response**   Total annual
                                                    (mortgages)     responses*        (hours)     burden hours**
----------------------------------------------------------------------------------------------------------------
                                Subpart B--Application Procedures and Commitments
----------------------------------------------------------------------------------------------------------------
242.16. Applications--Prepare full application                20              20           4,664          93,280
 for hospital mortgage insurance. (HUD-92013-
 HOSP)..........................................
242.17. Commitments--Review HUD insurance                     20              40              18             720
 commitment. Negotiate desired changes with HUD,
 and accept commitment. (HUD-92453, HUD-92432,
 HUD-92580).....................................
----------------------------------------------------------------------------------------------------------------
                                        Subpart C--Mortgage Requirements
----------------------------------------------------------------------------------------------------------------
242.35. Mortgage lien certifications. Paragraph               20              40               1              40
 (d) requires the mortgagor to notify HUD in
 writing of all unpaid obligations in connection
 with the mortgage transaction, among other
 things. (Information is provided to HUD in a
 letter, not a form)............................
----------------------------------------------------------------------------------------------------------------
                                      Subpart D--Endorsement for Insurance
----------------------------------------------------------------------------------------------------------------
242.39 Request final endorsement (HUD-92023)....              20              20             1.5              30
----------------------------------------------------------------------------------------------------------------
* The total annual response assumes15 Section 242 loans (including Section 241 supplemental loans and Section
  223(a)(7) refinancing loans) and 5 Section 223(f) refinancing or acquisition loans.
**The average response times for the sections of the rule are based on a review of recent program applications.
  The resulting increases in total annual burden hours reflect the adjusted average response time and the
  increase in the loan volume of five additional loans due to 223(f).

    All estimates include the time for reviewing instructions, 
searching existing data sources, gathering or maintaining the needed 
data, and reviewing the information.
    The docket file is available for public inspection. For information 
or a copy of the submission to OMB, contact Colette Pollard at 202-708-
0306 (this is not a toll free number) or via email at 
[email protected].
    In accordance with the Paperwork Reduction Act, 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 OMB control number.

Environmental Impact

    A Finding of No Significant Impact (FONSI) with respect to the 
environment 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 
FONSI remains applicable to this final rule and is available for public 
inspection at www.regulations.gov under docket number FR-5334-F-02.

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 would 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 (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. At the proposed rule 
stage, HUD certified that this rule, if issued in final, would not have 
a significant economic impact on a substantial number of small 
entities, within the meaning of the Regulatory Flexibility Act (See 75 
FR 4969). HUD continues to stand by its findings on this issue.
    This final rule will expand the availability of financing for 
hospitals and healthcare facilities, both large and small, by FHA's 
offer of Section 242/

[[Page 8341]]

223(f) refinancing. HUD defines a small hospital entity similar to the 
definition used by the Centers for Medicare and Medicaid Services, U.S. 
Department of Health and Human Services, as a hospital of 50 or fewer 
beds. As noted earlier in this preamble, hospitals, large or small, are 
eligible for Section 242/223(f) refinancing. HUD has approached 
development of its eligibility for section 223(f) refinancing to take 
into consideration criteria that all hospitals, large or small, can 
meet. The basis for FHA's implementation of its refinancing authority, 
as has been discussed in this preamble, is to assist hospitals that 
provide valuable services needed by the communities in which they are 
located, and for which other refinancing sources are not available. It 
is HUD's position that the criteria presented in this rule strikes the 
appropriate balance.

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 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.

List of Subjects in 24 CFR Part 242

    Hospitals, Mortgage insurance, Reporting and recordkeeping 
requirements.

    Accordingly, for the reasons described in the preamble, HUD amends 
24 CFR part 242 to read as follows:

PART 242--MORTGAGE INSURANCE FOR HOSPITALS

0
1. The authority citation for 24 CFR part 242 is revised to read as 
follows:

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


0
2. In Sec.  242.1, definitions for ``acquisition,'' ``capital debt,'' 
``hard costs,'' ``limited rehabilitation,'' ``refinancing,'' ``Section 
242/223(f), and ``soft costs,'' are added in alphabetical order, and 
the definitions of ``construction,'' ``project,'' and ``substantial 
rehabilitation'' are revised to read as follows:


Sec.  242.1  Definitions.

* * * * *
    Acquisition means the purchase by an eligible mortgagor of an 
existing hospital facility and ancillary property associated therewith.
* * * * *
    Capital debt means the outstanding indebtedness used for the 
construction, rehabilitation, or acquisition of the physical property 
and equipment of a hospital, including those financing costs approved 
by HUD.
* * * * *
    Construction means the creation of a new or replacement hospital 
facility, the substantial rehabilitation of an existing facility, or 
the limited rehabilitation of an existing facility. The cost of 
acquiring new or replacement equipment may be included in the cost of 
construction.
* * * * *
    Hard costs means the costs of the construction and equipment, 
including construction-related fees such as architect and construction 
manager fees.
* * * * *
    Limited rehabilitation means additions, expansion, remodeling, 
renovation, modernization, repair, and alteration of existing 
buildings, including acquisition of new or replacement equipment, in 
cases where the hard costs of construction and equipment are less than 
20 percent of the mortgage amount.
* * * * *
    Project means the construction (which may include replacement of an 
existing hospital facility), or the substantial or limited 
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 the term ``project'' is used.
* * * * *
    Refinancing means the discharging of the existing capital debt of a 
hospital through entering into new debt.
* * * * *
    Section 242/223(f) refers to a loan insured under Section 242 of 
the Act pursuant to Section 223(f) of the Act.
* * * * *
    Soft costs means reasonable and customary legal, organizational, 
consulting, and such other costs associated with effecting the proposed 
project and its financing or refinancing, including, but not limited 
to, interest capitalized during construction; permanent financing fees; 
initial service charge; tax; title and recording expenses; special tax 
assessments; AMPO; insurance costs during construction; FHA fees and 
charges, including application, commitment, and inspection fees; 
mortgage insurance premium for advances during construction; prepayment 
penalties associated with retiring the hospital's existing bonds; and 
termination costs for interest rate protection facilities that are 
integrated into the original financing, as applicable.
    Substantial rehabilitation means additions, expansion, remodeling, 
renovation, modernization, repair, and alteration of existing 
buildings, including acquisition of new or replacement equipment, in 
cases where the hard costs of construction and equipment are equal to 
or greater than 20 percent of the mortgage amount.
* * * * *

0
3. In Sec.  242.4, the section heading and paragraph (a) are revised to 
read as follows:


Sec.  242.4  Eligible hospitals.

    (a) The hospital to be financed with a mortgage insured under this 
part shall involve the construction of a new hospital, the substantial 
rehabilitation (or replacement) of an existing hospital, the limited 
rehabilitation of an existing hospital, the acquisition of an existing 
hospital, or the refinancing of the capital debt of an existing 
hospital pursuant to Section 223(a)(7) or Section 223(f).
* * * * *

0
4. Section 242.15 revised to read as follows:


Sec.  242.15  Limitation on refinancing existing indebtedness.

    (a) 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.
    (b) In the case of a loan insured under Section 242/223(f), there 
is no requirement for hard costs. However, if there are hard costs, 
such costs must total less than 20 percent of the total mortgage 
amount.


0
5. Amend Sec.  242.16 as follows:
0
a. Revise paragraph (a)(2)(ii), redesignate paragraphs (a)(3) through 
(a)(5) as (a)(4) through (a)(6), and add new paragraph (a)(3).
0
b. Revise redesignated paragraph (a)(6) introductory text.

[[Page 8342]]

0
c. Revise paragraphs (b (3), (5), and (6) and paragraph (d) to read as 
follows:


Sec.  242.16  Applications.

    (a) * * *
    (2) * * *
    (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 1.4 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 service 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 service to determine the debt service coverage ratio, hospitals 
must have an average debt service coverage ratio of 1.4 or greater.
    (3) Threshold requirements--refinancing candidates. For an 
application to be considered for refinancing pursuant to Section 
223(f), a hospital must meet the following requirements in lieu of 
those described in paragraph (a)(2) of this section:
    (i) The hospital must have an aggregate operating margin and 
average debt service coverage ratio as follows:
    (A) The hospital must have an aggregate operating margin of at 
least zero percent, when calculated from the three most recent annual 
audited financial statements.
    (B) The hospital must have an average debt service coverage ratio 
of at least 1.4 when calculated from the three most recent annual 
audited financial statements; or
    (ii) If the requirements of paragraphs (a)(3)(i)(A) and/or (B) of 
this section are not satisfied, HUD will recast the operating margin 
and debt service coverage ratio for prior periods by applying its 
estimate of the projected interest rate at the time the mortgage is 
expected to close in lieu of the historical interest rate(s).
    (iii) In performing the calculations called for in paragraphs 
(a)(3)(i)(A) and (B) of this section, if HUD finds that performance in 
one of the three years was affected by exceptional, one-time events 
that substantially altered financial performance, HUD may calculate the 
three-year performance based on the four most recent years with the 
unusual year omitted.
    (iv) The hospital must document that it provides an essential 
healthcare service to the community in which it operates and that its 
financial performance would be materially improved by refinancing its 
existing capital debt.
    (v) The hospital may show that it provides an essential healthcare 
service to the community in which it operates by submitting an analysis 
quantifying how the community in which it presently operates would 
suffer from inadequate access to an essential healthcare service that 
the hospital presently provides if the hospital were no longer in 
operation.
    (vi) The hospital may show that its financial performance would be 
materially improved by providing documentation of the following:
    (A) There are limited comparable affordable refinancing vehicles 
available to the hospital; and,
    (B) The hospital meets three of the following seven criteria:
    (1) The proposed refinancing would reduce the hospital's total 
operating expenses by at least 0.25 percent;
    (2) The interest rate of the proposed refinancing would be at least 
0.5 percentage points less than the interest rate on the debt to be 
refinanced;
    (3) The interest rate on the debt that the hospital proposes to 
refinance has increased by at least one percentage point at any time 
since January 1, 2008, or is very likely to increase by at least one 
percentage within one year of the date of application;
    (4) The hospital's annual total debt service is in excess of 3.4 
percent of total operating revenues, based on its most recent audited 
financial statement;
    (5) The hospital has experienced a withdrawal or expiration of its 
credit enhancement facility, or the lender providing its credit 
enhancement facility has been downgraded, or the hospital can 
demonstrate that one of these events is imminent;
    (6) The hospital is party to bond covenants that are substantially 
more restrictive than the Section 242 mortgage covenants; and
    (7) There are other circumstances that demonstrate that the 
hospital's financial performance would be materially improved by 
refinancing its existing capital debt.
* * * * *
    (6) Preapplication meeting. The next step in the application 
process is the preapplication meeting (this step is optional, at HUD's 
discretion, in Section 242/223(f) cases). 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 and refinancing, if any; 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:
* * * * *
    (b) * * *
    (3) A description of the project, the business plan of the 
hospital, and how the project will further that plan, or, for 
applications pursuant to Section 223(f), a description of any limited 
rehabilitation to be financed with mortgage proceeds and how that 
limited rehabilitation will affect the hospital;
* * * * *
    (5) A study of market need and financial feasibility, addressing 
the factors listed in paragraphs (a)(1)(ii) and (a)(2), or (a)(3) of 
this section, (whichever applies), with assumptions and financial 
forecast clearly presented. The study should be prepared by a certified 
public accounting firm acceptable to HUD. In the case of an application 
for Section 242/223(f) mortgage insurance, the study may not be 
required to address market need and there may be no requirement for 
involvement of a certified public accounting firm;
    (6) Architectural plans and specifications in sufficient detail to 
enable a reasonable estimate of cost (not applicable to a Section 242/
223(f) application, except when architectural plans and specifications 
are requested by HUD);
* * * * *
    (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 FHA.
* * * * *

0
6. In Sec.  242.17, paragraphs (a)(2), (a)(3), (a)(4), and (a)(5) are 
redesignated as paragraphs (a)(3), (a)(4), (a)(5), and (a)(6) 
respectively, a new paragraph (a)(2) is added. and paragraph (b) is 
revised to read as follows:


Sec.  242.17  Commitments.

    (a) * * *
    (2) In the case of an application for Section 242/223(f) insurance 
where advances are not needed for funding any limited rehabilitation: a 
commitment for insurance upon completion, reflecting the mortgage 
amount, interest rate, mortgage term, date of commencement of 
amortization, and other requirements

[[Page 8343]]

pertaining to the mortgage and to any limited rehabilitation;
* * * * *
    (b) Type of commitment. The commitment will provide for the 
insurance of advances of mortgage funds during construction. In the 
case of a commitment for Section 242/223(f) insured refinancing or 
acquisition financing of an existing hospital, the commitment shall 
provide for insurance upon completion unless insured advances are 
needed for funding any limited rehabilitation approved by HUD, in which 
case the commitment shall provide for insurance of advances.
* * * * *
0
7. Section 242.18 is revised to read as follows:


Sec.  242.18  Inspection fee.

    (a) 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 no later than the time of initial 
endorsement.
    (b) In the case of mortgages where the applicant is seeking only 
refinancing or acquisition, the inspection fee will not exceed 10 basis 
points on the loan. For applicants seeking a loan for refinancing or 
acquisition that also involves limited rehabilitation, the commitment 
shall provide for an inspection fee according to the following 
schedule:

------------------------------------------------------------------------
                                                   Inspection fee limit
         Hard cost % of mortgage amount               (basis points)
------------------------------------------------------------------------
Less than 5%...................................                       10
5% or greater but less than 10%................                       20
10% or greater but less than 15%...............                       30
15% or greater but less than 20%...............                       40
20% or greater.................................                       50
------------------------------------------------------------------------


0
8. In Sec.  242.23, paragraph (a)(2)(ii) is revised, paragraphs (b) and 
(c) are redesignated as (c) and (d) respectively, and new paragraph (b) 
is added to read as follows:


Sec.  242.23  Maximum mortgage amounts and cash equity requirements.

    (a) * * *
    (2) * * *
    (ii) Such portion of the capital debt as does not exceed 90 percent 
of HUD's estimate of the fair market value of such land and 
improvements prior to substantial rehabilitation.
* * * * *
    (b) Section 242/223(f) refinancing and acquisition--additional 
limits. (1) In addition to meeting the requirements of Sec.  242.7, if 
the hospital's existing capital debt is to be refinanced by the insured 
mortgage (i.e., without a change in ownership or with the hospital sold 
to a purchaser who has an identity of interest as defined by the 
Commissioner with the seller), the maximum mortgage amount must not 
exceed the cost to refinance the existing indebtedness, which will 
consist of the following items, the eligibility and amounts of which 
must be determined by the Commissioner:
    (i) The amount required to pay off the existing capital debt;
    (ii) The estimated hard costs, if any, totaling less than 20 
percent of the mortgage amount; and
    (iii) Soft costs that would normally be allowable in a Section 242 
insured loan.
    (2) In addition to meeting the requirements of Sec.  242.7, if 
mortgage proceeds are to be used for an acquisition, the maximum 
mortgage amount must not exceed the cost to acquire the hospital, which 
will consist of the following items, the eligibility and amounts of 
which must be determined by the Commissioner:
    (i) The actual purchase price of the land and improvements or HUD's 
estimate (prior to repairs, renovation, and/or equipment replacement) 
of the fair market value of such land plus the replacement cost of 
improvements, whichever is the lesser;
    (ii) The estimated hard costs, if any, totaling less than 20 
percent of the mortgage amount; and
    (iii) Soft costs that would normally be allowable in a Section 242 
insured loan.
* * * * *

0
9. In Sec.  242.35, paragraph (d) is revised to read as follows:


Sec.  242.35  Mortgage lien certifications.

* * * * *
    (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, limited rehabilitation, or 
substantial rehabilitation of the project, or the purchase of the 
equipment financed with mortgage proceeds.


0
10. Section 242.39 is revised to read as follows:


Sec.  242.39  Insurance endorsement.

    (a) New construction/substantial rehabilitation. 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 (a)(2) of this section.
    (1) 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.
    (2) 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.
    (b) Section 242/223(f) refinancing/acquisition. (1) In cases that 
do not involve advances of mortgage proceeds, endorsement shall occur 
after all relevant terms and conditions have been satisfied, including, 
if applicable, completion of any limited rehabilitation, or upon 
assurance acceptable to the Commissioner that all limited 
rehabilitation will be completed by a date certain following 
endorsement.
    (2) In cases where advances of mortgage proceeds are used to fund 
limited rehabilitation, endorsement shall occur as described in 
paragraph (a) of this section immediately above, for new construction/
substantial rehabilitation.
    (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.


0
11. In Sec.  242.49, paragraph (a) is revised to read as follows:


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

[[Page 8344]]

the mortgagee or a depository acceptable to the mortgagee and HUD. Any 
such deposit shall be held in a separate account for and on behalf of 
the mortgagor, and shall be the responsibility of that mortgagee or 
depository.
* * * * *

0
12. In Sec.  242.55, paragraph (c) is revised to read as follows:


Sec.  242.55  Labor standards.

* * * * *
    (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 Act made in 
connection with a loan insured under this part) shall receive 
compensation at a rate not less than one and one-half 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.
* * * * *

0
13. Section 242.91 is revised to read as follows:


Sec.  242.91  Eligibility of refinancing transactions.

    (a) Refinancing an FHA-insured mortgage. 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:
    (1) Principal amount. The principal amount of the refinancing 
mortgage shall not exceed the lesser of:
    (i) The original principal amount of the existing insured mortgage; 
or
    (ii) The unpaid principal amount of the existing insured mortgage, 
to which may be added loan closing charges associated with the 
refinancing mortgage, and costs, as determined by HUD, of improvements, 
upgrading, or additions required to be made to the property.
    (2) Debt service rate. The monthly debt service payment for the 
refinancing mortgage may not exceed the debt service payment charged 
for the existing mortgage.
    (3) 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.
    (4) Minimum loan amount. The mortgagee may not require a minimum 
principal amount to be outstanding on the loan secured by the existing 
mortgage.
    (b) Refinancing capital debt not insured by FHA. A mortgage given 
to refinance the capital debt of an existing hospital that is not 
insured under section 241 or section 242 of the Act may be insured 
under this subpart pursuant to Section 223(f) of the National Housing 
Act. The mortgage may be executed in connection with the purchase or 
refinancing of an existing hospital without substantial rehabilitation. 
A mortgage insured pursuant to this subpart shall meet all other 
requirements of this part. The FHA Commissioner shall prescribe such 
terms and conditions as the FHA Commissioner deems necessary to assure 
that:
    (1) The refinancing is employed to lower the monthly debt service 
costs (taking into account any fees or charges connected with such 
refinancing) of such existing hospital;
    (2) The proceeds of any refinancing will be employed only to retire 
the existing capital debt; pay for limited rehabilitation totaling less 
than 20 percent of the mortgage amount; and pay the necessary cost of 
refinancing on such existing hospital;
    (3) Such existing hospital is economically viable; and
    (4) The applicable requirements of Section 242 for certificates, 
studies, and statements have been met.

    Dated: January 29, 2013.
Carol J. Galante,
Assistant Secretary for Housing--Federal Housing Commissioner.
[FR Doc. 2013-02404 Filed 2-4-13; 8:45 am]
BILLING CODE 4210-67-P