[Audit Report on the Pohnpei Local Office, Rural  Development Program, U.S. Department of Agriculture, Federated States of Micronesia]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 99-i-953

Title: Audit Report on the Pohnpei Local Office, Rural  Development
       Program, U.S. Department of Agriculture, Federated States
       of Micronesia



Date:  September 30, 1999




                  **********DISCLAIMER**********

This file contains an ASCII representation of an OIG report.
No attempt has been made to display graphic images or
illustrations. Some tables may be included, but may not resemble
those in the printed version.

A printed copy of this report may be obtained by referring to the
PDF file or by calling the Office of Inspector General, Division
of Acquisition and Management Operations at (202) 208-4599.

                  ******************************





U.S. Department of the Interior
Office of Inspector General


                                                  N-IN-FSM-001-99
AUDIT REPORT


POHNPEI LOCAL OFFICE,
RURAL DEVELOPMENT PROGRAM,
U.S. DEPARTMENT OF AGRICULTURE,
FEDERATED STATES OF MICRONESIA

REPORT NO. 99-I-953

SEPTEMBER 1999



Mr. Francis J. Blanco
State Director
Rural Development Program, Hawaii State Office
U.S. Department of Agriculture
Federal Building, Room 311
154 Waianuenue Avenue
Hilo, Hawaii 96720

Subject: Audit Report on the Pohnpei Local Office, Rural 
         Development Program, U.S. Department of Agriculture,
         Federated States of Micronesia (No. 99-i-953)

Dear Mr. Blanco:

This report presents the results of our audit of the Pohnpei
Local Office's administration of loans provided under the Direct
Single Family Housing Program.  The objective of the audit  was
to determine whether the Pohnpei Local Office complied with U.S.
Department of Agriculture loan and loan administration
procedures.  The scope of our review included Direct Single
Family Housing Program loans that were outstanding during fiscal
years 1997, 1998, and 1999 (through March 31, 1999).  The audit
was requested by the former Charge d'Affaires of the United
States Embassy in the Republic of the Marshall Islands.

Our audit disclosed that the Pohnpei Local Office of the Rural
Development Program was generally effective in making Direct
Single Family Housing Program loans to borrowers who were
eligible to participate in the loan program.  However, we found
that the Pohnpei Local Office made loans to 12 borrowers who
constructed or repaired houses that were subsequently used for
income-producing purposes and to 2 borrowers who constructed
houses that, in our opinion, exceeded what would be considered
"modest design" under program regulations.  

These deficiencies occurred because (1) the Pohnpei Local Office
and borrowers believed that the program regulations did not
prohibit borrowers from leasing their houses, (2) the terms and
conditions of the Real Estate Deed of Trust did not specifically
require borrowers to reside in their houses, and (3) the Pohnpei
Local Office did not adequately review loan documents and did not
comply with program regulations when it approved a loan to a
borrower who used the loan funds to construct commercial
property.  Regarding the design of the two houses, the Pohnpei
Local Office (1) did not believe that one of the houses was
unacceptably elaborate in design, (2) did not adequately monitor
the construction of one house, and (3) approved a loan that
exceeded the authorized maximum loan limit by $15,000.  As a
result, Direct Single Family Housing Program loan funds of
$506,690 were not available for making loans to borrowers who
were in need of safe and sanitary housing, three borrowers
improperly received payment subsidies of $8,032, and a loan of
$65,000 made to one borrower may be at risk.  In addition, Direct
Single Family Housing Program loan funds of $135,000 were
unavailable to other borrowers to construct houses that would
have been in compliance with program requirements.

We made nine recommendations for corrective actions to you, as
the State Director, Rural Development Program, Hawaii State
Office. Based on your August 10, 1999, response (Appendix 2) to
the draft report, we consider Recommendations A.3, A.6, B.1, and
B.2 resolved and implemented and Recommendation A.4 unresolved
and request additional information for Recommendations  A.1, A.2,
A.5, and B.3 (see Appendix 3).

Section 5(a) of the Inspector General Act (Public Law 95-452, as
amended) requires the Office of Inspector General to list this
report in its semiannual report to the Congress.  Therefore,
please provide a response, as required by Public Law 97-357, to
this report by November 5, 1999.  The response should be
addressed to our Pacific Office, 415 Chalan San Antonio, Baltej
Pavilion - Suite 306, Tamuning, Guam 96911.  The response should
provide the information requested in Appendix 3.

We appreciate the assistance provided by the staff and management
of the Pohnpei Local Office during the conduct of our audit.

                                          Sincerely,



                                          Earl E. Devaney
                                          Inspector General

cc: Rural Development Manager, Western Pacific, Guam
Community Development Manager, Pohnpei Local Office


CONTENTS


                                                     Page

INTRODUCTION......................................... 1

BACKGROUND........................................... 1
OBJECTIVE AND SCOPE.................................. 2
PRIOR AUDIT COVERAGE................................. 2

FINDINGS AND RECOMMENDATIONS......................... 3

A.  USE OF LOAN-FINANCED HOUSES...................... 3
B.  DESIGN OF LOAN-FINANCED HOUSES...................10

APPENDICES

1.   CLASSIFICATION OF MONETARY AMOUNTS..............13
2.   HAWAII STATE OFFICE RESPONSE ...................14
3.   STATUS OF AUDIT REPORT RECOMMENDATIONS..........19


INTRODUCTION


BACKGROUND

Title V of the Housing Act of 1949, as amended (42 U.S.C. 1471),
authorized the Secretary of the U.S. Department of Agriculture to
extend financial assistance, through the Farmers Home
Administration,[1] to owners of farms and other real estate in
rural areas for "the construction, improvement, alteration, or
repair of dwellings, related facilities, and farm buildings and
to rural residents, including persons who reside in reservations
or villages of Indian tribes, for such purposes and for the
purchase of buildings and the purchase of land constituting a
minimum adequate site, in order to enable them to provide
dwellings and related facilities for their own use."  Rural
Development is the branch of the U.S. Department of Agriculture
responsible for administering programs offered through the Rural
Housing Service, the Rural Utilities Service, and the Rural
Business-Cooperative Service.  

The Compact of Free Association of 1985 between the Government of
the United States and the Government of the Federated States of
Micronesia (Public Law 99-239) was approved on January 14, 1986.
As provided by Section 105(h)(1)(C) of the Compact, the United
States and the Federated States agreed to continue the operation
of Rural Development programs in each of the four states in the
Federated States.  Each of the Rural Development program local
offices, which are located on the island states of Pohnpei,
Chuuk, Kosrae, and Yap, has a Community Development Manager, who
is supervised by the Rural Development Manager for the Western
Pacific, who is located on Guam.  The Rural Development Manager
reports to the State Director, who is located in Hilo, Hawaii.

The Pohnpei Local Office is responsible for administering the
Direct Single Family Housing Loan and Grant programs in the State
of Pohnpei.  The Code of Federal Regulations (7 CFR 3550.2)
states:

The purpose of the direct [Rural Housing Service] single family
housing loan programs is to provide low- and very low-income
people who live in rural areas with an opportunity to own
adequate but modest, decent, safe, and sanitary dwellings and
related facilities.  The Section 502 program offers persons who
do not currently own adequate housing, and who cannot obtain
other credit, the opportunity to acquire, build, rehabilitate,
improve, or relocate dwellings in rural areas.  The Section 504
program offers loans to very low-income homeowners who cannot
obtain other credit to repair or rehabilitate their properties.

During fiscal year 1999, the Pohnpei Local Office had 2 locally
hired Federal employees (a Community Development Manager and a
Community Development Technician) and 18 employees paid by the
Federated States of Micronesia National Government and the
Pohnpei State Government.    For fiscal year 1999, the National
Government appropriated $185,000 and the State Government
appropriated $147,246 for salaries and other expenses of the
Pohnpei Local Office.

OBJECTIVE AND SCOPE

The objective of the audit was to determine whether the Pohnpei
Local Office complied with U.S. Department of Agriculture loan
and loan administration procedures.  The scope of our review
included Direct Single Family Housing loans that were outstanding
during fiscal years 1997, 1998, and 1999 (through March 31,
1999).  To obtain information on the processing and
administration of loans, we interviewed officials at the United
States Embassy, the Pohnpei Local Office, and the Office of the
Public Auditor for the Federated States of Micronesia, all on
Pohnpei; selected recipients of Direct Single Family Housing
Program loans, also on Pohnpei; and officials of the Western
Pacific Office on Guam.  In addition, we reviewed loan documents
maintained at the Pohnpei Local Office and computer listings of
borrower accounts provided by the Rural Development Program's
Centralized Servicing Center in St. Louis, Missouri, and made
site visits to the homes of selected Direct Single Family Housing
loan recipients on Pohnpei. 

Our review was made, as applicable, in accordance with the
"Government Auditing Standards," issued by the Comptroller
General of the United States.  Accordingly, we included such
tests of records and other auditing procedures that were
considered necessary under the circumstances.

As  part of the audit, we evaluated the system of internal
controls related to loan processing, construction monitoring,
loan collections, and loan servicing.  We did not identify any
major control weaknesses in the area of loan collections.
However, internal control weaknesses were identified in the areas
of loan processing, construction monitoring, and loan servicing.
These weaknesses are discussed in the Findings and
Recommendations section of this report.  Our recommendations, if
implemented, should improve the internal controls in these areas.

PRIOR AUDIT COVERAGE

During the past 5 years, the U.S. General Accounting Office and
the Office of Inspector General have not issued any audit reports
pertaining to the Pohnpei Local Office, Rural Development
Program, U.S. Department of Agriculture.

**FOOTNOTES**

[1]:The Federal Agriculture Improvement and Reform Act of 1996
changed the name of the Farmers Home Administration to Rural
Development.

FINDINGS AND RECOMMENDATIONS

A.  USE OF LOAN-FINANCED HOUSES

The Pohnpei Local Office made Rural Development Direct Single
Family Housing Program loans to borrowers who either constructed
or repaired houses that were subsequently used for
income-producing purposes.  Specifically, we found that 11
borrowers rented out their houses to generate income and one
borrower used loan funds to construct a building that was
partially used for commercial purposes.  The Code of Federal
Regulations (7 CFR 3550) states that loan funds are to be used by
borrowers for a permanent residence and not for income-producing
purposes.   However, officials at the Pohnpei Local Office and
borrowers said that they believed program regulations did not
prohibit borrowers from leasing their houses.  Also, the terms
and conditions of the Real Estate Deed of Trust did not
specifically require borrowers to reside in their houses.  In
addition, the Pohnpei Local Office did not adequately review loan
documents and did not comply with program regulations when it
approved a loan to a borrower who used loan funds to construct
commercial property.  As a result, Direct Single Family Housing
Program loan funds of $506,690 were not available to eligible
borrowers, payment subsidies of $8,032 were improperly received
by three borrowers, and a loan of $65,000 made to one borrower
may be at risk (the monetary impacts of these amounts are
presented in Appendix 1).

Residential Rental Properties

As of April 8, 1999, the Pohnpei Local Office had 109 Section 502
loans, with outstanding principal balances totaling $5.3 million,
and 1,691 Section 504 loans, with outstanding principal balances
totaling $6.3 million.  Of these loans, we judgmentally selected
for review a sample of 20 Section 502 loans, with outstanding
principal balances totaling $1.2 million, and 6 Section 504
loans, with outstanding principal balances totaling $68,421.  

We found that 11 of the 26 loan files reviewed (8 Section 502
loans, totaling $461,690, and 3 Section 504 loans, totaling
$45,000) were used to construct or repair houses that were used
as residential rental properties rather than as the borrowers'
primary residences.  According to the eight borrowers whom we
interviewed, they elected to rent out their houses because they
needed the income that would be generated by the leases.  In
addition, the borrowers told us that they did not know that the
Direct Single Family Housing Program prohibited them from leasing
their houses.  As a result, the 11 borrowers used their houses,
which were financed by loans totaling $506,690, as residential
rental properties, and 3 of the 11 borrowers improperly received
payment subsidies of $8,032 while collecting rental income on
their houses.  For example:

- An applicant requested and received a Section 502 loan of
$66,000 to construct a three-bedroom house, with monthly payments
of $440.  The application showed that the house would be used as
the applicant's primary residence.  The loan closing was held on
October 7, 1997, and the final inspection report stated that
construction of the house was completed on April 14, 1998.  The
loan file contained an entry in the running case record which
showed that, on May 21, 1998, the Pohnpei Local Office became
aware that the borrower was leasing his house.  However, the loan
file contained no documentation that the Pohnpei Local Office
took any action to obtain a copy of the lease agreement or
question the borrower about leasing his house.  At our request,
the Pohnpei Local Office's Community Development Manager
contacted the borrower and obtained a copy of the lease
agreement, which showed that on May 1, 1998, the borrower
executed a 1-year lease with a tenant at a monthly rental rate of
$2,500.  Consequently, the borrower realized a profit of $24,720
($2,500 less $440 times 12 months) from the lease of his
loan-financed house. 

- Another applicant requested and received a Section 502 loan of
$49,990 to construct a three-bedroom house, with monthly loan
payments of $309.  The  loan closing was held on February 15,
1994, and based on the final inspection report, construction of
the house was completed on June 28, 1994.  Because of the
borrower's low income, during the period of December 15, 1995,
through July 15, 1998, the borrower received monthly payment
subsidies from the Rural Development Program totaling $4,856,
which were used to reduce the amount of the borrower's monthly
loan payments.  Although the loan file did not contain any
indication that the house was rented out, we determined that the
borrower had executed two lease agreements with the same tenant
to rent out the house during the period of December 10, 1995,
through December 31, 1999, at a monthly rental rate of $500.  On
March 12, 1999, we discussed this loan with the Pohnpei Local
Office's Community Development Technician, who said that the
borrower's payment subsidy was terminated in July 1998 because
the Office learned that the borrower was leasing the house.  On
March 23, 1999, we interviewed the borrower to obtain copies of
the lease agreements and to determine why the house was leased.
The borrower told us that the house was rented because he was
"desperately in need of money."  Consequently, this borrower not
only realized $191 per month in rental income above his $309
monthly loan payment but also improperly received payment
subsidies totaling $4,856.

The Pohnpei Local Office's Community Development Manager stated
that he believed that the regulations did not prohibit borrowers
from leasing their houses but agreed that the regulations
prohibited borrowers from receiving  payment subsidies while
their houses were being rented out.  However, the Code of Federal
Regulations (7 CFR 3550.52(e)) states, "Loan funds may not be
used to: . . . Purchase or improve income-producing land or
buildings to be used principally for income-producing purposes."
The Code (7 CFR 3550.53) also states, "Applicants must agree to
and have the ability to occupy the dwelling on a permanent
basis."  In addition, Section 12 of the Real Estate Deed of
Trust[2] for the Federated States of Micronesia states that
"neither the property nor any portion thereof or interest therein
shall be leased, assigned, sold, transferred, or encumbered,
voluntarily or otherwise, without the written consent of the
Government [of the United States]."  None of the 11 borrowers who
subsequently rented out their loan-financed houses had obtained
written approval from the Rural Development Program.

We discussed, with an attorney from the Office of General
Counsel, U.S. Department of Agriculture, in San Francisco,
California,  the issue of borrowers renting out houses that had
been financed through Direct Single Family Housing Program loans.
The attorney stated that Rural Development may wish to consider
sending notices to the 11 borrowers to advise them that they had
violated the terms and conditions of their Real Estate Deeds of
Trust and instruct them to terminate the lease agreements with
their tenants and move into their houses.  The attorney also
suggested that Rural Development, to prevent the program from
being used improperly in the future, may wish to consider (1)
modifying the terms and conditions of the Real Estate Deed of
Trust  for the Federated States of Micronesia to require that the
house be owner occupied and (2) developing a separate document to
be used at loan closing that would require borrowers to certify
that they will reside in their houses unless they obtain express
written consent from Rural Development to lease their houses
because of hardship or other special circumstances.
Consequently, we believe that the Rural Development Program State
Office in Hawaii should review the 11 loans and seek assistance,
as necessary, from the Office of General Counsel, U.S. Department
of Agriculture, to correct this deficiency and to prevent the
Direct Single Family Housing Program in Pohnpei from being used
improperly in the future.

Commercial Property

We also found that a loan of $65,000 was approved for a borrower
who used part of the loan funds to complete the construction of
commercial property.  Specifically, on March 6, 1997, the Pohnpei
Local Office received an application for a Section 502 loan of
$65,000 from the Executive Director of the Pohnpei State Housing
Authority (the Trustee for Direct Single Family Housing Program
loans on Pohnpei).  The floor plans submitted by the Executive
Director showed that he planned to construct a two-story
building.  However, on May 6, 1997, the engineer at the Pohnpei
Local Office who reviewed the floor plans made an entry in the
loan file's running case record which stated that the floor plans
gave the appearance that the Executive Director intended to use
the first floor of the building for commercial purposes and the
second floor for residential purposes.  The engineer subsequently
visited the construction site and, on May 13, 1997, made another
entry in the running case record which stated that the Executive
Director "is intending for a commercial loan, not a regular rural
housing loan.  Therefore, I'm referring [the] case file to
supervisory personnel."  On the same date, the engineer made
another entry in the running case record which stated that after
inspecting the existing one-story structure, he concluded that
the structure was "unfinished and incomplete."  The loan file
also showed that the Executive Director subsequently submitted
revised floor plans which, based on our inspection, appeared
similar to the first set of plans submitted to the Pohnpei Local
Office except that handwritten captions had been entered on the
plans for the first floor rooms, labeling the rooms as "kitchen,"
"dining," "living," and "bedroom."

On March 22, 1999, the Pohnpei Local Office's former Community
Development Specialist who was involved in the processing of this
loan told us that the first floor of the building was constructed
prior to the approval of the loan.  However, the Community
Development Specialist told us that the construction "was
incomplete on the first floor and it needed additional work"
because the first floor had no electrical wiring, plumbing,
doors, or windows.  The Community Development Specialist also
said that the existing structure had cracks in the walls and
ceiling which had to be repaired and that support columns needed
to be added on the first floor to ensure that the structure could
support the weight of the second floor.  In addition, based on
the cost summary prepared for the construction of the building,
we determined that loan funds of at least $25,714 were to be used
to complete the construction of the first floor.  Nevertheless,
the Pohnpei Local Office accepted the floor plans and approved a
loan of $65,000.

On October 6, 1998, the Housing Authority's Executive Director
wrote a letter to the Community Development Manager that stated,
"Although it [the building] is substantially completed, there are
some things yet to be done to fully complete the building.  For
that reason, I have submitted an application for supplemental
funding."  Based on the scope of work provided by the Housing
Authority's Executive Director, some of the additional work on
the building was to include the installation of steel grilles
over the windows on the first floor; the construction of a bar
counter on the second floor; and the building of structures on
the roof of the building, including a bathroom and a nahs.[3]
However, on March 1, 1999, the Pohnpei Local Office disapproved
the Executive Director's loan request, stating that (1) the loan
funds were to be used for "unauthorized purposes," (2) the nahs
would not meet typhoon-resistance standards, and (3) the
structure was not being used primarily for residential purposes. 

Based on our review of the original floor plans, we agree that
the first floor of the building appeared to be designed for
commercial purposes.  However, to determine whether the first
floor of the building was used for commercial purposes, we
visited the property on March 24, 1999, and found that while the
second floor of the building was used for residential purposes,
the first floor was being used for commercial office space and a
bingo parlor.  We also noted that a nahs, restroom facilities,
kitchen sink, barbeque grill, and a decorative water fountain had
been constructed on the roof of the building.

During our review of the loan file, we also found that the
two-story building was constructed on land that had been leased
from the Pohnpei State Public Lands Authority.  The Lease of
Public Lands for Commercial Purposes, which covered the period of
January 16, 1973, through January 17, 2023,  provided the Housing
Authority Executive Director with the use of 1,178 square meters
of land at an annual rental rate of $353.  Article 1, Item 2, of
the lease agreement specified that the purpose of the lease was
to allow the tenant to provide "office space, restaurant & bar."
In addition, Article 2 of the lease stated, "The premises are
leased and shall be used, except with the express written consent
of the Authority, only for the commercial purposes specified in
Item 2."  However, we found no documentation in the loan file
that the Executive Director had obtained consent from the Lands
Authority to also use the land for residential purposes, for
which the second floor of the building was used.

In our opinion, the Pohnpei Local Office should not have approved
this loan to the Housing Authority Executive Director because (1)
the existing first floor was to be used for commercial purposes
and needed additional work before the second floor could be
constructed and (2) the lease agreement for the land on which the
building was constructed did not authorize the use of the land
for residential purposes.  In addition, we believe that because
of the Executive Director's position with the Pohnpei State
Housing Authority, he should have been aware of the restrictions
on the use of funds provided under the Direct Single Family
Housing Program.  Further, the entire $65,000 loan could be at
risk if the Lands Authority chooses to cancel the lease and takes
possession of the property.  Accordingly, we believe that the
Hawaii State Office should review the case file for this loan to
determine what actions should be taken to protect Rural
Development's and the Trustee's interests in the property.

Recommendations

We recommend that the State Director, Rural Development Program,
Hawaii State Office:

1.Conduct a review, with the assistance of the Office of General
Counsel, U.S. Department of Agriculture, of the loan files for
the 11 borrowers who used Direct Single Family Housing Program
loan funds to construct or repair houses that were used as
residential rental properties rather than as the borrowers'
primary residences and, if warranted, take appropriate actions
based on the results of the review.

2.Conduct a review of the loan file for the borrower who used
Direct Single Family Housing Program loan funds to construct a
structure that was partially used for commercial purposes to
determine what actions should be taken to protect Rural
Development's and the Trustee's interests in the property.

3.Instruct the Community Development Manager, Pohnpei Local
Office, to review all Section 502 and a sample of Section 504
loan files and make site visits to the houses to determine
whether borrowers are using their houses in accordance with
program regulations.

4.Develop written procedures to require that the Pohnpei Local
Office emphasizes to borrowers during the initial loan interview
that the purpose of the Direct Single Family Housing Program is
to provide borrowers with a permanent residence and perform
periodic site visits to borrowers' houses to determine whether
the houses are used in accordance with Program regulations.  The
written procedures should also provide the Pohnpei Local Office
with the steps needed for it to follow to prohibit borrowers from
using their houses for commercial purposes.

5.Request assistance from the Office of General Counsel, U.S.
Department of Agriculture, to modify the terms and conditions of
the Real Estate Deed of Trust for the Federated States of
Micronesia to include a requirement that loan-financed houses
should be owner occupied and develop a separate document to be
used at loan closing that will require borrowers to certify that
they will reside in their houses unless they obtain express
written approval from Rural Development to lease their houses
because of hardship or other special circumstances.

6.Instruct the Community Development Manager, Pohnpei Local
Office, to initiate collection actions against the three
borrowers who improperly received payment subsidies of $8,032.

Hawaii State Office Response and Office of Inspector General
Reply

In the August 10, 1999, response (Appendix 2) to the draft report
from the Director, Hawaii State Office, the State Office stated
general concurrence with all six of the recommendations.  Based
on the response, we consider Recommendations 3 and 6 resolved and
implemented and Recommendation 4 unresolved and request
additional information for Recommendations 1, 2, and 5 (see
Appendix 3).  

In addition, the State Office requested that the Office of
Inspector General provide a list of the names of the 12 borrowers
who used Direct Single Family Housing Program loan funds to
construct or repair houses that were used for commercial
purposes.  These names were provided to the State Office in a
letter dated September 3, 1999.

Recommendation 4.  Concurrence indicated.

Hawaii State Office Response.  The State Office included in its
response a copy of an August 10, 1999, memorandum from the State
Director to the Pohnpei Local Office's Community Development
Manager that instructed the Community Development Manager to
ensure that an Applicant Orientation Guide (Form RD 3550-23) is
signed by each applicant, the loan originator, and the Community
Development Manager and filed in the loan docket.  The State
Office stated that a similar form (Exhibit D of FmHA Instruction
1944-A) was used prior to the implementation of Form RD 3550-23,
and the State Office further stated that it believes that "it is
not the inadequacy of the existing documents, but the failure of
the Pohnpei Local Office to properly administer the programs and
the lack of close supervision of that office" that caused the
deficiencies cited in our audit.

Office of Inspector General Reply.  During our audit, we noted
that the Pohnpei Local Office was using Exhibit D of FmHA
Instruction 1944-A, which states that borrowers must personally
occupy their residences if they wish to receive a payment
subsidy.  In addition, Form RD 3550-23 requires borrowers to
obtain approval from Rural Development before they lease their
houses.  Also, the Real Estate Deed of Trust for the Federated
States of Micronesia includes restrictions similar to those shown
on Form RD 3550-23.  However, as stated in the finding, the
borrowers we interviewed stated that (1) they were unaware that
leasing their houses violated program requirements and (2) they
leased their houses because they needed the income.  Therefore,
the use of these forms did not ensure that borrowers complied
with program requirements.  Additionally, the State Director said
that the Pohnpei Local Office did not adequately administer and
supervise the program.  Therefore, our recommendation was focused
on enhancing the existing procedures by requiring the Community
Development Manager, Pohnpei Local Office, to (1) emphasize to
borrowers the requirement that they should live in any property
financed by a Rural Development loan, (2) conduct periodic site
visits to ensure that borrowers complied with this requirement,
and (3) take action against borrowers who used their loan
financed property for commercial or other nonresidential
purposes.  Because the State Office did not specifically address
these aspects of the recommendation, we consider it unresolved.

**FOOTNOTES**

[2]:Because the Constitution of Pohnpei restricts the acquisition
of permanent interest in real property to citizens of Pohnpei and
prohibits the sale of land except as authorized through local
statute, the Pohnpei Legislature enacted the Deed of Trust Act of
1987 to provide for the use of Real Estate Deeds of Trust
instruments, by which the Pohnpei Housing Authority would act as
trustee for financing agencies of the U.S. Government with the
authority to foreclose on property financed by United States
agencies.  Additionally, through a 1991 memorandum of
understanding between the Pohnpei Housing Authority and the
Farmers Home Administration (now Rural Development), the Pohnpei
Housing Authority agreed to maintain an escrow account of
$500,000 to serve as a reserve account to satisfy the trustee's
obligations to the Farmers Home Administration in the event of
default on a loan by a borrower.

[3]:A "nahs" is a thatched-roof structure used for recreational
purposes.

B.  DESIGN OF LOAN-FINANCED HOUSES

The Pohnpei Local Office made Rural Development Direct Single
Family Housing Program loans to borrowers who constructed houses
that exceeded what would be considered a modest house design on
the island of Pohnpei and made a loan to one borrower that
exceeded the maximum authorized loan amount by $15,000.  The Code
of Federal Regulations defines a "modest dwelling" for Rural
Development program loan purposes.  However, deficiencies
occurred because (1) the Community Development Manager, Pohnpei
Local Office, said that he did not believe one of the two houses
was elaborate in design, (2) the Pohnpei Local Office did not
adequately monitor at least one construction project to ensure
that the house was constructed in accordance with the approved
house plans, and (3) the Pohnpei Local Office did not comply with
the Section 502 loan limit established by the Hawaii State Office
when it approved a loan to one borrower.  As a result, Direct
Single Family Housing Program loan funds of $135,000 were not
available for other borrowers to construct houses under Program
requirements (see Appendix 1).

House Designs

Based on our review of 20 Section 502 loans, with outstanding
principal balances totaling $1.2 million, we found that three
loans, totaling $135,000, were made to two borrowers who used the
funds to construct houses that were not, in our opinion, "modest"
in design when compared with the typical residence observed on
the island of Pohnpei.  The Code of Federal Regulations (7 CFR
3550.57(a)), in defining a "modest dwelling," states, "The
property must be one that is considered modest for the area, must
not be designed for income providing purposes, must not have an
in-ground pool or have a cost in excess of the section 203(b)
limit of the National Housing Act unless [the Rural Housing
Service] authorizes an exception." 

On December 5, 1994, the Pohnpei Local Office received an
application for a Section 502 loan of $40,000.  In a September 2,
1996, written report on his review of the application and other
supporting documents in the loan file, the Community Development
Specialist stated, "The applicant with a family of 04 people are
presently living in a concrete dwelling which is not safe,
decent, & sanitary."  The Community Development Specialist's
written report also stated, "The proposal is to repair [a]
concrete residential dwelling of 2,275 square feet with 3
bedrooms and 2 bathrooms."  The loan closing was held on January
2, 1997, and based on the final inspection report on the house,
construction was completed on April 7, 1997.  However, our review
of the floor plans in the loan file disclosed that the two-story
house was to have a total of five bedrooms and a kitchen, a
dining room, a living room, and a family room on the first floor
and a kitchen, a dining room, and a family room on the second
floor.  Because the floor plans gave the appearance that the
house design exceeded what may be considered a modest house
design for Pohnpei, we made a site visit to the house.  Based on
the site visit, we concluded that the house was not of modest
design as compared with other residences on the island of
Pohnpei.

On April 9, 1996, the Pohnpei Local Office received an
application for a Section 502 loan of $75,000.  In an April 10,
1996, written report on their review of the application and other
supporting documents in the loan file, Pohnpei Local Office
officials stated that the applicant planned to construct a
three-bedroom, three-bathroom house of 2,892 square feet.  The
written report also stated, "The design is within  the
restriction set forth [for] a family of 6 and it appears that it
will meet the needs of this applicant."  The loan closing was
held on July 10, 1997, and a contract was executed on the same
date for construction of a one-story house at a cost of $75,000.  

According to the construction contract, the construction of the
house was to commence by August 26, 1997, and to be completed by
January 26, 1998.  However, construction was delayed because the
construction site was located at the top of a steep hill and some
of the heavy equipment needed during construction could not reach
the site.  Consequently, on August 8, 1997, the borrower
submitted to the Pohnpei Local Office another loan application
for an additional loan of $20,000 to construct a 215-foot by
16-foot driveway.  The loan was subsequently approved by the
Pohnpei Local Office, and on May 20, 1998, the borrower executed
a contract to construct the driveway.  Thus, the borrower
received a total of $95,000 to construct the house and the
driveway.

Our review of the floor plans in the loan file disclosed that the
design of the house appeared to exceed what would be considered a
modest house on the island of Pohnpei.  In addition, we noted a
May 23, 1998, entry in the running case record which stated that
the Pohnpei Local Office's engineer visited the construction site
and found that the design of the house had been changed to
include the construction of a second floor.  However, no action
was taken by the Pohnpei Local Office to stop the construction of
the second floor.  We also noted, based on documents in the loan
file, that the borrower had requested an additional loan of
$38,000 to complete the construction of the house.  However, in
an October 29, 1998, letter to the borrower, the Pohnpei Local
Office stated that "we are unable to approve your application on
the basis that your total indebtedness with the agency will
exceed the present authorized loan amount."  As a result of our
review of the loan file, on March 16, 1999, we visited the
construction site and found that a two-story house which appeared
to be more than modest was under construction.  In our opinion,
the Pohnpei Local Office should monitor the construction of
houses financed by Rural Development Program loans and require
that borrowers obtain the approval of the Office before making
changes to the approved construction plans.

In addition to the design of this house, the total $95,000 amount
of the two loans made to this borrower exceeded the $80,000
maximum loan amount that had been established by the Hawaii State
Office at the time the borrower applied for the second $20,000
loan in August 1997.  The Community Development Manager said that
this borrower was allowed to receive loans in excess of the
established limit because he had been told by a State Office
official during a July 1996 training session on Guam that the
maximum loan amount was going to be increased by the Hawaii State
Office.  The Community Development Manager also stated that he
had not received any notice of an increase but had processed the
$20,000 loan because he believed that, if the maximum authorized
loan amount had not been increased, the loan would have been
rejected by the Rural Development Program's automated loan
processing system.  However, the Rural Development Manager on
Guam told us that the automated loan processing system did not
have an edit check to detect loans in excess of the maximum
amount authorized and that the Community Development Manager was
responsible for ensuring that loans were within the allowable
limit.

Recommendations

We recommend that the State Director, Rural Development Program,
Hawaii State Office: 

1.Instruct the Community Development Manager, Pohnpei Local
Office, to ensure that houses of future loan applicants are of
modest design as compared with the typical residences on Pohnpei.

2.Instruct the Community Development Manager, Pohnpei Local
Office, to ensure that construction projects are closely
monitored and that any changes made by borrowers to the approved
house plans are reviewed and approved in advance by the Pohnpei
Local Office. 

3.Seek legal assistance from the Office of General Counsel, U.S.
Department of Agriculture, to determine the proper actions to
take to recover the $15,000 from the borrower who received loan
funds in excess of the allowable maximum.

Hawaii State Office Response and Office of Inspector General
Reply

In the August 10, 1999, response (Appendix 2) to the draft report
from the Director, Hawaii State Office, the State Office stated
general concurrence with all three recommendations.  Based on the
response, we consider Recommendations 1 and 2 resolved and
implemented and request additional information for Recommendation
3 (see Appendix 3).

APPENDIX 1 

CLASSIFICATION OF MONETARY AMOUNTS

-------------------------------------------------------
Funds To Be Put To Better Use*
Finding Areas
-------------------------------------------------------

A.  Use of Loan-Financed Houses                $514,722
                                                 65,000
Residential Rental Properties                   135,000
Commercial Property                            $714,722

B.  Design of Loan-Financed Houses

Totals
-------------------------------------------------------
-------------------------------------------------------




*Amounts represent Federal funds.

APPENDIX 2
Page 1 of 5

HAWAII STATE OFFICE RESPONSE

APPENDIX 3
Page 1 of 2


STATUS OF AUDIT REPORT RECOMMENDATIONS
------------------------------------------------------
Finding/Recommendation

Reference     Status     Action Required

A.1  Management Provide a target date concurs; for completing the
additional review of the 11 information borrowers who used
needed. Direct Single Family Housing Program loan funds to
construct or repair houses that were used as residential

A.2  Management rental properties. When concurs; completed, a
copy of the additional review results and the information actions
taken should be needed. provided to our office.

Provide a target date for completing the review of the borrower
who used Direct Single Family Housing Program

A.3  Implemented.loan funds to construct a structure that was

A.4  Unresolved.partially used for commercial purposes. When
completed, a copy of the results of the review and the actions
taken to protect Rural Development's and the Trustee's interests
in the property should be provided to our office.

No further action is required.

Reconsider the response to the recommendation. If concurrence is
indicated, provide an action  plan that includes the target date
and the title of the official responsible for implementation. If
nonconcurrence is indicated, provide reasons for the
nonconcurrence.

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

APPENDIX 3
Page 2 of 2

----------------------------------------------------
Finding/Recommendation
Action     Reference     Status     Required

A.5  Management Provide a target date and concurs; the title of
the official additional responsible for requesting information
assistance from the Office needed. of General Counsel to modify
the terms and conditions of the Real Estate Deed of Trust for the
Federated States of Micronesia and for developing a separate
document to be used at loan closing that will require borrowers
to certify that they will reside in their written approval from
Rural Development to lease their

A.6  Implemented.houses because of hardship or other special

B.1 and B.2  Implemented.circumstances. When completed, a copy of
the

B.3  Management modified Real Estate Deed of concurs; Trust and
the separate additional document should be provided information
to our office.needed. No further action is required.

No further action is required.

Provide a target date and the title of the official responsible
for requesting assistance from the Office of General Counsel to
determine the proper actions to take to recover the $15,000 from
the borrower who received loan funds in excess of the allowable
maximum amount.  When completed, a copy of the recommendations
made by the Office of General Counsel should be provided to our
office.
------------------------------------------------------





ILLEGAL OR WASTEFUL ACTIVITIES SHOULD BE REPORTED

TO THE OFFICE OF INSPECTOR GENERAL BY:

Sending written documents to:



Within the Continental United States

U.S. Department of the Interior
Office of Inspector General
1849 C Street,N.W.
Mail Stop 5341
Washington, D.C. 20240

Calling:

Our 24 hour
Telephone HOTLINE
1-800-424-5081 or
(202) 208-5300

TDD for hearing impaired
(202) 208-2420 or
1-800-354-0996



Outside the Continental United States


Caribbean Region

U.S. Department of the Interior
Office of Inspector General
Eastern Division- Investigations
1550 Wilson Boulevard
Suite 410
Arlington, Virginia 22209

Calling:
(703) 235-9221


North Pacific Region

U.S. Department of the Interior
Office of Inspector General
North Pacific Region
238 Archbishop F.C. F'lores Street
Suite 807, PDN Building
Agana, Guam 96910


Calling:
(700) 550-7428 or
COMM 9-011-671-472-7279