[Federal Register Volume 64, Number 92 (Thursday, May 13, 1999)]
[Notices]
[Pages 26222-26230]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-11914]
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_______________________________________________________________________
Part VII
Department of Housing and Urban Development
_______________________________________________________________________
Public Housing Assessment System; Financial Condition Scoring Process;
Notice
Federal Register / Vol. 64, No. 92 / Thursday, May 13, 1999 /
Notices
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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
[Docket No. FR 4509-N-04]
Public Housing Assessment System; Financial Condition Scoring
Process
AGENCY: Office of the Director of the Real Estate Assessment Center,
HUD.
ACTION: Notice.
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SUMMARY: This notice provides additional information to public housing
agencies and members of the public about HUD's process for issuing
scores under the Financial Condition Indicator of the Public Housing
Assessment System (PHAS).
FOR FURTHER INFORMATION CONTACT: For further information contact Wanda
Funk, the Real Estate Assessment Center, Department of Housing and
Urban Development, 1280 Maryland Avenue, SW, Suite 800, Washington DC,
20024; telephone Customer Service Center, 1-888-245-4860 (this is a
toll free number). Persons with hearing or speech impairments may
access that number via TTY by calling the Federal Information Relay
Service at (800) 877-8339. Additional information is available from the
REAC Internet Site http://www.hud.gov/reac.
SUPPLEMENTARY INFORMATION:
Purpose of This Notice
The purpose of this Notice is to provide additional information
about the scoring process for PHAS Indicator #2, Financial Condition.
Under the PHAS, the financial condition score is based on financial
information reported to HUD according to generally accepted accounting
principles (GAAP). GAAP classifies accounting data according to
standard definitions. Of the total points available for a PHAS score, a
PHA may receive up to 30 points under the PHAS Indicator #2. The
financial condition score is included in the aggregate PHAS score.
The chart below shows the six components that constitute the
Financial Condition Indicator and their assigned points.
Financial Condition Indicator
------------------------------------------------------------------------
Scoring components Measurement Points
------------------------------------------------------------------------
Quick Ratio (QR)................ Short-term liquidity.... 9
Months Expendable Fund Balance Adequacy of reserves.... 9
(MEFB).
Days Receivable Outstanding Ability to collect 4.5
(DRO). payments of tenant
receivables.
Occupancy Loss (L).............. Ability to realize 4.5
potential rental income.
Expense Management (EM)......... Ability to control 1.5
various expenses,
including utilities,
administrative,
maintenance, general
and non-routine
expenses.
Net Income as a Percentage of Profitability against 1.5
Fund Balance (N). the current year's
operations.
------------------------------------------------------------------------
The values of the six components of the Financial Indicator
calculated from the financial data comprise the overall financial
assessment of the PHA. The components and their relative importance to
the total financial score are the result of studies of PHA financial
performance and of industry portfolio management techniques to identify
the most appropriate financial measures to gauge a PHA's financial
position and financial management. These components represent measures
that are appropriate benchmarks in any residential real estate
environment. The scoring assigned within each component is based on the
distributions of that component's values and the relative relationship
between the components and the PHA's overall financial performance.
Under the PHAS, the components that make up the Financial Condition
Indicator are approached in the same manner for GAAP as they were for
non-GAAP financial information although the thresholds may change as a
result of the conversion to GAAP. For example, a good Quick Ratio under
the current basis of accounting (non-GAAP) for a small PHA may be 6 to
1 and receive the maximum 9 points. In contrast, under GAAP a good
Quick Ratio may be 5 to 1 and also get the maximum 9 points. Thus, to
the extent that a PHA's performance relative to its peers does not
change, its score will not be affected by the conversion to GAAP. The
GAAP conversion schedule by PHAs fiscal year end, shown below, is
reprinted from the PHAS final rule published on September 1, 1999.
GAAP Conversion Schedule
------------------------------------------------------------------------
Unaudited GAAP
Fiscal year end dates for PHAs financial data Audit reports
to HUD by: due to HUD by:
------------------------------------------------------------------------
9/30/99................................. 11/30/99 6/30/00
12/31/99................................ 2/28/00 9/30/00
3/31/00................................. 5/31/00 12/31/00
6/30/00................................. 8/31/00 3/31/01
------------------------------------------------------------------------
GAAP Reporting Method
Financial data for GAAP scoring is currently collected in paper
form from audited financial data submitted by PHAs and entered into a
database by REAC staff. PHAs, with fiscal years ending September 30,
1999, and later, will submit their unaudited financial data
electronically using the Financial Data Schedule (FDS), within 60 days
of their fiscal year end. This submission will be reviewed by REAC for
reasonableness. To the extent that an audit is required for a PHA under
OMB Circular A-133, a PHA will submit its audited data using the FDS
within nine months of the fiscal year end.
Program Funds
The PHAS financial assessment is based on the entity-wide
operations of a PHA, which includes financial information on Section 8,
Community
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Development Block Grants, and other HUD funding in its calculations, as
well as funds from non-HUD sources.
GAAP Scoring Approach
Under PHAS, the components of the PHAS Financial Indicator were
developed that both fairly and accurately assess a PHA's financial
performance and financial management. As part of the development, the
components were tested to establish the correlation between PHA
performance under each component and the fiscal health of a PHA. As
part of the development, PHAs were evaluated and assigned scores based
a PHA's performance relative to its peers. In other words, all PHAs as
a group determine the mean score and each PHA is then ranked
accordingly. This peer assessment approach, which was formulated
following extensive economic and financial analysis, examination of
well-accepted business principles, and discussions with PHA industry
representatives and PHA staff, provides an equitable means of measuring
the financial performance of PHAs.
Comparable Scoring Systems
HUD's financial scoring process is similar to those already
undertaken in the mortgage housing and securities industries. Fannie
Mae, the mortgage housing industry leader, developed an assessment
system with financial indicators similar to those contained in HUD's
financial assessment of PHAs, such as vacancy, reserve balances, and
net income. Like HUD, Fannie Mae uses these indicators to rank
properties and identify those which require further attention. In the
securities area, Standard & Poors conducts peer assessment of a
company's operational capabilities and cash flows relative to their
peers. Among federal agencies, the Department of Health and Human
Services (HHS) contracts with state and local entities to perform
financial audits of nursing homes and hospitals participating in the
federal Medicare program. Based on these financial audits, HHS
determines the continued eligibility of these health service providers
in the Medicare program.
GAAP Scoring Processes
GAAP-based scores are produced using data contained in the
Financial Data Schedule (FDS). The GAAP-based financial data are first
used to calculate six financial components that measure various aspects
of financial health, such as short-term liquidity, expense management,
and collection of receivables. Each PHA is awarded points for each
component according to its performance relative to its peers. Peer
groupings are established according to the size of the PHA, based on
the number of public housing units operated. Peer groupings are as
follows:
Very Small (0-49 units)
Small (50-249 units)
Low Medium (250-499 units)
High Medium (500-1249 units)
Large (1250 + units)
A PHA is assigned a score for each of the six components of the
Financial Indicator based on its component value relative to its peers.
The minimum number of points (zero) and the maximum number of points
can each be achieved over a range of values. This system allows PHAs to
target a range of values which they want to avoid and target one value
which they should strive to achieve. Aside from these extremes, points
are assigned to component values along a continuous linear function.
This means that each component value will receive a different number of
points. This system (``semi-continuous scoring'') ensures that points
are awarded equitably to PHAs along the distribution of component
values because, in most cases, small differences in component values
result in only small differences in the scores of the individual
components. Therefore, two PHAs of a similar size whose values for its
financial condition components are in close proximity will receive only
slightly different scores to capture their performance relative to each
other.
The number of points assigned to each component value or range of
values is based on where the thresholds for that component are set. The
thresholds separate distinct ranges of scores along the distribution of
component values. The thresholds and their associated scores are
estimated based on well-accepted business principles and statistical
distributions of values within the peer groupings of the PHAs.
Business Principles
Scoring of certain of the components follows generally recognized
business principles. These principles indicate that there are certain
absolute thresholds below which component values are clearly
financially unacceptable and component values below that point should
result in a score of zero. These principles are used in scoring the
Quick Ratio and Months Expendable Fund Balance components. For both of
these components, a value of less than one is financially unacceptable,
regardless of PHA size, and therefore merits a score of zero.
Statistical Distributions
The remaining thresholds are estimated by examining the
distributions of component values by peer group. For the four most
significant components (Quick Ratio, Months Expendable Fund Balance,
Days Receivable Outstanding, and Occupancy Loss), thresholds are set
such that approximately 50 percent of the distribution receives the
maximum number of points, as long as 50 percent of the distribution
have acceptable values for the component. Thus, the highest number of
points are awarded to the PHAs whose financial measures are most
reasonable both relative to their peers and in an absolute business
sense. The specific percentiles that make up this 50 percent of PHAs
are established by identifying natural breakpoints along the
distributions. For example, for the Quick Ratio and Months Expendable
Fund Balance, these breakpoints fall at approximately the 30th and 80th
percentiles. The remaining two components (Expense Management and Net
Income as a Percentage of Fund Balance) assign zero points to PHAs that
fall only in the extreme outer ranges of the distribution of values,
and award 1.5 points to the remaining PHAs.
Audit Information
The information collected from the annual audit report pertains to
the type of audit opinion, details of the audit opinion, and the
presence of reportable conditions and material weaknesses. This
information will be used as a basis for accepting or adjusting
financial component scores. If the auditor's opinion is other than
unqualified, points will be deducted from the financial components to
determine the PHA's financial score. The points have been established
by REAC using a system that considers the seriousness of the audit
qualification and limits the deducted points to a reasonable portion of
the PHA's available score.
Reportable conditions and material weaknesses are considered to be
audit flags, alerting REAC to an internal control weakness or an
instance of noncompliance with Federal laws and regulations. These
flags also have the potential to adjust the PHA's financial component
scores, based on the seriousness of the reported issue. REAC will
review the audit and internal control flags to determine the
significance as it directly pertains to the assessment of the PHA's
financial condition. If the flag has no effect on the financial
components or the overall financial condition of the PHA as it
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relates to the PHAS assessment, the score will not be adjusted.
There are two types of adjustments related to audited financial
information. The first type deals with material differences between the
unaudited and audited financial information reported to HUD. The second
deals with the audit flags and reports that result from the audit
itself.
The purpose of a comparison of the ratios and scores resulting from
the current year's unaudited Financial Data Schedule submission to the
ratios and scores resulting from the current year's audited submission
is to:
Identify material changes in ratio calculation results
and/or scores from the unaudited submission to the audited submission;
Identify PHA's that consistently provide materially
different data from their unaudited submission to their audited
submission;
Assess or alleviate penalties associated with the
inability to provide reasonably accurate unaudited data within the
required time period.
This review process will only be performed for the audited
submission. In addition, it is only applicable to PHAs whose overall
PHAS designation (high, standard or troubled) was reclassified to a
lesser designation based on the audited submission and the
reclassification was necessary because of a material change in the
reported financial data affecting one or more of the six components.
Materiality for purposes of this review is based on a formula within
PHAS and varies based on the size and funding level of the PHA.
Therefore, the materiality threshold may vary from PHA to PHA, even
within the same peer group.
REAC views the transmission of materially inaccurate unaudited
financial data as a more serious condition than the late submission of
unaudited data. Therefore, the penalties assessed for material
differences between the unaudited and audited submission have been
designed to encourage PHAs to assure financial data is as reliable as
possible at the 60 day submission. The penalties to be assessed are
based on the significance of the reclassification, assuming the
financial data reported meets the materiality threshold. For each
designation level that the PHA has been reduced, points will be
deducted from the PHA's overall FASS score. The following table
summarizes the point reductions.
------------------------------------------------------------------------
Percent of
Designation reclassification FASS points
deducted
------------------------------------------------------------------------
High to Standard........................................... 1
High to Marginal........................................... 2
High to Troubled........................................... 3
Standard to Marginal....................................... 1
Standard to Troubled....................................... 2
Marginal to Troubled....................................... 1
------------------------------------------------------------------------
The FASS system will automatically deduct the applicable points and
this reduction will trigger the REAC analyst review.
The purpose of a review of the audit and internal control flags is
to adjust the financial score as a result of the audit. These flags are
collected by using the OMB A-133 Data Collection Form. This form is
completed by the PHA both for the unaudited and audited submissions. At
the time of the unaudited submission the form is used as a self-
assessment tool and should reflect the PHA's knowledge of their
financial and internal control condition and should acknowledge their
understanding of what the auditor will report. In the PHAS final rule,
HUD discussed the review of audit and internal control flags as
follows, and also included the following chart. (See 63 FR 46607,
September 1, 1998.)
As part of the analysis of the financial health of the PHA
including assessment of the potential or actual waste, fraud or
abuse at a PHA, HUD will look to the Audit Opinion to provide an
additional basis for accepting or adjusting financial indicator
scores. The following is a summary of the types of audit opinions
and the number of total financial points that will be deducted if a
PHA receives such an audit opinion from its IPA:
------------------------------------------------------------------------
PHAS points
Type of flag deducted
------------------------------------------------------------------------
Unqualified Opinion........................................ 0
No audit opinion........................................... 30
Adverse opinion............................................ 30
Disclaimer of opinion...................................... 30
Qualified opinion.......................................... *
Going concern opinion...................................... 30
Material weakness in internal control...................... *
Reportable condition....................................... *
Findings of non-compliance and/or questioned costs......... *
Indicator outlier analyses................................. *
------------------------------------------------------------------------
*Note: See subsequent table titled ``Audit Flags and Tier
Classification'' for FASS points to be deducted.
If the OMB A-133 Data Collection Form indicates that the auditor's
opinion will be other than unqualified, PHAS will automatically deduct
the appropriate points based on the above table. The points have been
established by REAC using a three-tier system. The tiers are meant to
give consideration to the seriousness of the audit qualification and to
limit the deducted points to a reasonable portion of the PHA's total,
actual score. The tiers, as established by REAC, are also defined
below.
Audit Flag Tiers
------------------------------------------------------------------------
Tier FASS points deducted
------------------------------------------------------------------------
Tier 1............................ Maximum reduction: Lesser of 30
points or 100 percent of the PHA's
total unadjusted FASS score.
Tier 2............................. Maximum reduction: 3 points or 10
percent of the PHA's total
unadjusted FASS score.
Tier 3............................. Maximum reduction: 1.5 points or 5
percent of the PHA's total
unadjusted FASS score. This
maximum is cumulative and not to
be assessed for each audit or
internal control flag.
------------------------------------------------------------------------
Audit Flags and Tier Classifications
------------------------------------------------------------------------
Audit flag Tier classification
------------------------------------------------------------------------
Unqualified opinion.......................... None
No audit opinion............................. Tier 1
Adverse opinion.............................. Tier 1
Disclaimer of opinion........................ Tier 1
Qualified opinion:
1. GAAP qualifications
Change in accounting principle.. Tier 3
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Change in accounting estimate... Tier 3
Change in accounting method..... Tier 3
Departures from GAAP............ Tier 2
Financial statements using Tier 1
basis other than GAAP.
Exclusion of alternate Tier 2
accounting for an account or group
of accounts.
Inconsistently applied GAAP..... Tier 2
Omissions/Inadequate Disclosure. Tier 2
2. GASS--Scope Limitations................... Tier 2
Imposed by management........... Tier 2
Imposed by circumstance......... Tier 3
Year 2000 (add back)............ Tier 3
3. Report on major program compliance........ Tier 3
4. Report on internal control................ Tier 3
Accounting principles used caused the Tier 2
financial statements to be materially
misstated.
Inadequate records........................... Tier 2
Going concern................................ Tier 1
Material noncompliance disclosed............. Tier 2
Internal control weakness....... Tier 3
Compliance...................... Tier 3
Opinion on Supplemental Tier 3
schedules.
Reportable condition
Internal control................ Tier 3
Compliance...................... Tier 3
------------------------------------------------------------------------
The graphs shown in Appendix 1 depict the approximate GAAP-based
scoring functions used for each of the six components of the Financial
Indicator.
Appendix 2 provides estimated GAAP-based threshold values and
associated scores for each component and peer group, based on the data
pool as of April 15, 1999. These GAAP thresholds are preliminary and
are based upon financial data obtained for a limited number of PHAs
currently reporting under GAAP. The thresholds established for GAAP-
based scores will be re-assessed on a quarterly basis to ensure their
statistical validity as the data collected indicates a shift in
distributions and any modifications to the thresholds will be
communicated through a Notice. However, the financial components and
component calculations will remain the same and the component scores
for a PHA will continue to be established on a peer assessment basis.
Thus, if a PHA's performance remains consistent relative to its peers,
the PHA's score will not be affected by threshold changes.
Dated: May 6, 1999.
Barbara L. Burkhalter,
Deputy Director, Real Estate Assessment Center.
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[FR Doc. 99-11914 Filed 5-12-99; 8:45 am]
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