February 15, 2005

Owner

Address

Address

Address

## Subject: Mark to Market (M2M) Full Restructure Financial Reporting and Compliance

*Dear (Owner/Agent) and/or Owner's CPA:*

On October 1, 2004 HUD created the Office of Affordable Housing
Preservation (OAHP) as the successor to OMHAR in the administration of
the Mark to Market (M2M) program, including oversight of the portfolio
of HUD-held Mortgage Restructuring Notes ("MRNs") and Contingent
Repayment Notes "(CRNs"), and the portfolio of similar notes from the
Portfolio Reengineering Demonstration Program ("Demo Notes"). In this
capacity OAHP routinely reviews post-M2M property operations and
financial reporting to ensure accurate calculation of surplus cash and
resulting payments on the MRNs, CRNs, and Demo Notes.

We address below some unique accounting issues associated with this
portfolio. A letter covering important and substantially different
topics in post-M2M accounting was sent last year. Based on feedback, and
a significantly lower incidence of M2M accounting errors in the 2003
financials, the Q&A proved timely and useful to owners and accountants
as they prepared Annual Financial Statements (the letter is available on
OAHP's website at:
[http://www.hud.gov/offices/hsg/omhar/owners/postm2m.doc]{.underline} );
we trust that the following will be equally valuable. \[Most of the
issues addressed here are not applicable to projects restructured under
the Portfolio Reengineering Demonstration Program; please send
Demo-specific questions to resourcedesk@oahp.net.\]

1\. **Q: *If earned, when can I take distribution of CRP and IPF
payments, and must I wait for permission from HUD to do so? ***

CRP is made in monthly payments from property funds to the owner as
earned, assuming all preconditions are met, including that "all Project
expenses are paid." IPF is payable to the owner at the end of the
accounting year, assuming all preconditions have been met. None of these
payments require explicit permission in advance from HUD. However, by
submitting an AFS reflecting that IPF was earned, or that CRPs were
paid, the owner is certifying that those preconditions were met. (See
also the 2004 Q&A for clarification of CRP and IPF preconditions and
calculation.) Improper CRP/IPF payments are violations of the Regulatory
Agreement (Rider) and can result in enforcement remedies including
acceleration of the MRN/CRN. Additionally, improper payment may result
in the issuance by HUD of an audit or management finding that, until
resolved, would prohibit payment of future CRP and IPF.

If a financial review by HUD concludes that CRP and/or IPF were paid
when preconditions had *not* been met, any improperly distributed
amounts will have to be repaid to the project accounts, which will
increase the Surplus Cash and resulting payments due on the Mortgage
Restructuring Note. The owner will be invoiced for any amounts due on
the Note that result from such a review and recalculation, and these
amounts become due and payable when invoiced. An adjusted computation of
Surplus Cash must be included in the following year's AFS (do not
re-file the AFS for the year in question).

2\. **Q: *My M2M Restructuring and post-M2M Section 8 contract call for
annual OCAF adjustments to rents, as well as Reserve for Replacements
deposits. How do these occur? How do I account for them?***

Post-M2M rents are expected to increase, and are limited in increase, by
the OCAF. Adjustments will be processed as provided in the HAP contract
and the Section 8 Renewal Guide; the annual adjustment process must be
initiated by the property owner. The Renewal Guide also requires an
annual OCAF adjustment to the Reserve for Replacement (R4R) deposits
(except in the few cases where the sole source of the R4R deposits is
the reuse of fixed-stream Section 236 IRP funds). This adjustment will
be reflected annually on form 9250, provided to the owner by the
Multifamily Project Manager.

3\. **Q*: How should owners manage withdrawals from the Reserve for
Replacements, so as not to adversely impact Surplus Cash in a post-M2M
project?***

Generally, properties will achieve Surplus Cash over time when they are
operating with positive cash flow, but there are timing issues that can
affect Surplus Cash, especially in the year following the M2M closing.
Owners wishing to take the benefit of the IPF and CRP should consider,
for example, that restricted escrows (such as the Reserve for
Replacements and the Rehabilitation Escrow) are *not* included in
available cash for calculating Surplus Cash, therefore:

-   Reserve for Replacement withdrawals must be **approved** by HUD or
    its authorized agent **before** the end of the fiscal period or the
    effect will be to diminish Surplus Cash;

-   Rehabilitation expenditures that are covered by the Rehabilitation
    Escrow must have been reimbursed **before** the end of the fiscal
    year to have a neutral effect on Surplus Cash;

-   If insured loss reimbursements can be managed to achieve
    reimbursement before the end of the fiscal period, this will also
    neutralize the otherwise negative effect on Surplus Cash;

As a result, while owners should not change their physical management
and operation of the property in consideration of these issues, they may
find it advisable to manage the submissions for reimbursement to
reasonably assure that there are not large reimbursements in process at
the end of the fiscal period.

4\. **Q*: After closing the M2M restructure I sold the subject project
via a Transfer of Physical Assets (TPA). Am I required to file a partial
year AFS for the year in which the TPA was completed? Can I collect a
partial year CRP and IPF? Am I required to include a Surplus Cash
Schedule in the partial year AFS, and am I obligated to make an MRN
payment if there is Surplus Cash?***

Yes, you are required to file a partial year AFS because all closed Full
M2M projects are subject to a M2M Regulatory Agreement. The seller's
obligation to file a partial year AFS is also referenced in the TPA
Application (HUD-92266). The seller's partial year AFS should cover the
period from the beginning of the fiscal year to the day before the
property transfer closes. Note that the TPA [purchaser]{.underline} is
also required to submit a partial year AFS to cover from the date the
property transfer closes until the end of the purchaser's fiscal year
end. The CRP and IPF, if earned, are prorated for the portion of the
year reported; a Calculation of Surplus Cash must be completed as of the
date of sale, and a payment to the MRN must be made per the terms of the
Note if Surplus Cash was available as of the date of TPA.

5\. **Q. *In the year of the M2M closing, how do I account for the
prorated portions of the year pre- and post-M2M, and how do I calculate
Surplus Cash for the partial year?***

In the full year *after* a M2M closing, the old rules regarding
distributions and accrued distributions no longer apply. The old
regulatory agreement is set aside, and the owner must follow the rules
in the M2M documents. In the year of M2M closing, however, the owner is
subject to both the original regulatory requirements *and* the new M2M
requirements. The owner has two accounting options available during the
year of closing:

1.  The owner may choose to follow the new M2M requirements for the
    entire year. If this option is chosen, surplus cash would be
    computed at the end of the year and any surplus cash would be
    distributed in accordance with the M2M documents. Please note, the
    Incentive Performance Fee must be prorated; The owner would only be
    entitled to a fee based on gross collections beginning from the date
    of the M2M closing through the end of the fiscal year.

2.  The owner may choose to perform a special computation of surplus
    cash as of the date of M2M closing. This special computation of
    surplus cash would allow the owner to take any distributions they
    may be entitled to under the old regulatory agreement. The special
    computation would be in addition to the year-end computation of
    surplus cash. Both computations must be a part of the audited
    financial statements, and must be reported to HUD via the Real
    Estate Assessment Center's FASS system. The owner would report the
    special computation using the FASS account numbers S1400-010 through
    S1400-250, the account numbers normally associated with a semiannual
    computation of surplus cash. If the special computation indicates
    that the owner is entitled to a distribution, then the amount
    available for distribution should be counted as a current obligation
    on the year-end computation of surplus cash. This will prevent the
    funds from being subject to the MRN payment calculation. The owner
    may distribute these funds any time during the next fiscal year.

**Exception:** If the M2M closing occurs during the last half of the
fiscal year, the owner may be entitled to a mid-year distribution under
the existing regulatory agreement. In these instances, the audited
financial statements would contain 3 computations of surplus cash (the
semiannual computation, the special M2M closing computation, and the
yearend computation). The owner would use the semiannual surplus cash
FASS account numbers to report the semiannual computation. The special
M2M closing computation would have to be submitted as part of the notes
to financial statements.

6\. **Q. *How are accrued interest and unpaid principal balance of the
M2M Mortgage Restructuring Notes and Contingent Repayment Notes
reflected in the AFS?***

Any MRN / CRN principal balance that is to be paid from current Surplus
Cash should be shown as a short term obligation in the AFS (FASS account
2172 Other Mortgages Payable Short Term). The long term portion of the
unpaid principal balance of MRN / CRN should be reflected in the AFS
(FASS account 2232)*.* The accrued interest on the MRN / CRN should be
shown in FASS account 2132 -- Accrued Interest Payable -- Other
mortgages.

7\. **Q*: How should Capital Recovery Payments (CRPs) be reflected in
the AFS?***

In the AFS, the owner's investment (on which the CRPs provide a return)
is treated as a loan, with the interest rate and term determined in the
M2M underwriting. Each monthly payment is treated as having principal
and interest portions. CRP payments during a fiscal year are reported on
the Statement of Cash Flows in FASS accounts S1200-417 (principal
portion) and S1200-195 (interest portion). At the end of a fiscal year,
the loan will have a remaining principal balance (some of which is to be
paid within twelve months and is reflected as a current liability
reflected in FASS account 2179, with the balance being a long term
liability reflected in FASS account 2329). If any payments have become
due but have not been paid as of fiscal year end, there will also be
accrued interest payable, which should be shown in FASS account 2139 --
Accrued Interest Payable -- Capital Recovery Payment (M2M). CRP payments
that are due but that have not been paid may be included as obligations
on the computation of surplus cash only if, as of fiscal year end, the
preconditions for payment had been satisfied.

Accountants are asked to make use of footnotes regarding CRPs, including
the M2M closing date, the original amount of the owner's investment, the
interest rate, the number of payments, and the payment amount. The
footnote should also note the number of payments that have come due, the
number of payments that were made during the fiscal year, and the total
number of payments that have been made (from the M2M closing through the
end of the fiscal year).

8\. **Q. *How, where, and when do I send payments for my M2M Note (MRN
-- Mortgage Restructuring Note, or CRN -- Contingent Repayment Note)?
***

MRN or CRN payments are due within 10 days of the AFS due date. The
mailing address is included in each MRN and CRN; Payments should be
**payable to FHA**, and sent to the Chicago payment lockbox at :

> Multifamily Payment Service Center
>
> PO Box 70764
>
> Chicago, IL 60673

All payments should clearly identify the property name and FHA number,
and the nature of the payment (P&I payment for which accounting year,
R4R deposit, etc).

9\. **Q: *I have received correspondence from HUD contractors on
post-M2M issues.* *Has HUD engaged contractors to assist in the review
and analysis of AFS and M2M Notes payments?***

Yes. Representatives from HUD contractors may directly contact a
property owner only when expressly directed to do so by HUD. RER
Solutions, Inc. (and its subcontractor Value Recovery Group), have been
retained as OAHP's portfolio management advisor, responsible for
financial review and analysis of projects to ensure appropriate
calculation of Surplus Cash and subsequent MRN and CRN payments.

DP Services, Inc. has been retained as the notes servicer and cash
manager for the M2M Notes portfolio, responsible for monthly statements,
billings and collections, and collection and management of escrows when
HUD's note is in first lien position. If HUD's analysis of submitted
financials results in recalculated Surplus Cash and MRN/CRN payments,
supplemental billings for amounts due will be from DP Services, Inc., or
directly from HUD.

10\. **Q. *If there is additional information regarding explanations or
calculations of accounts, can those be included in the footnotes, and
will those be accessible to HUD and OAHP?***

HUD and its contractors find supplemental footnote information in the
annual financial statement filings very valuable in understanding
underlying calculations and accounting treatment of M2M items.
Accountants are strongly encouraged to make use of footnotes in the AFS
for all projects. For projects closed prior to 2000 in the Portfolio
Reengineering Program Demonstration program, explanations of the
calculation of "Net Cash" are very helpful in reconciling Notes
payments.

The M2M Regulatory Agreement and Notes cause very few changes to
property accounting, however it is important to understand how to
implement and account for the post-M2M financial structure; This
guidance is offered as a resource in that regard. For more information
on the M2M process, visit the OAHP website at
[http://www.hud.gov/offices/hsg/omhar/]{.underline} . For questions
regarding financial statement filing via the FASS system, contact the
REAC Technical Assistance Center (TAC) at 800-245-4860 or
[http://www.hud.gov/offices/reac/support/tac.cfm]{.underline}

Sincerely,

Charles H. Williams

Deputy Assistant Secretary

Office of Affordable Housing Preservation