a

GAO

United States Government Accountability Office

Report to Congressional Addressees

May 2006 RESIDENTIAL CARE 

FACILITIES 

MORTGAGE 

INSURANCE 

PROGRAM

Opportunities to 

Improve Program and 

Risk Management

GAO-06-515
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

May 2006

RESIDENTIAL CARE FACILITIES 

MORTGAGE INSURANCE PROGRAM 

Opportunities to Improve Program and 

Risk Management 

Highlights of GAO-06-515, a report to 

congressional addressees

Through its Section 232 program, 

the Department of Housing and

Urban Development’s (HUD)

Federal Housing Administration 

(FHA) insures approximately $12.5 

billion in mortgages for residential 

care facilities. In response to a

requirement in the 2005

Consolidated Appropriations 

Conference Report and a 

congressional request, GAO

examined (1) HUD’s management

of the program, including loan

underwriting and monitoring; (2) 

the extent to which HUD’s 

oversight of insured facilities is 

coordinated with the states’ 

oversight of quality of care; (3) the 

financial risks the program poses

to HUD’s General

Insurance/Special Risk Insurance 

(GI/SRI) Fund; and (4) how HUD

estimates the annual credit subsidy

cost for the program.

What GAO Recommends

GAO recommends, among other 

things, that the HUD Secretary 

establish a process for sharing 

practices among field offices, 

assure appropriate levels of staff 

with appropriate expertise, and

incorporate reviews of federal or 

state inspection reports into loan 

monitoring. GAO also

recommends that HUD explore 

factoring additional information 

into its credit subsidy model. In 

written comments, HUD agreed 

with all of GAO’s recommendations

except exploring the value of 

adding certain factors to its credit 

subsidy model. 

While HUD’s decentralized program management allows its 51 field offices 

flexibility in their specific practices, GAO found differences in the extent to 

which staff in the five field offices it visited were aware of current program 

requirements. For example, four offices were unaware of required 

addendums to the programs’ standard regulatory agreement. Further, while 

individual offices had developed useful practices for loan underwriting and 

monitoring, they lacked a mechanism for systematically sharing such 

practices with other offices. Also, field office officials were concerned about

adequate current or future levels of staff expertise—a critical factor in 

managing program risk in that health care facility loans are complicated and 

require specialized knowledge and expertise. 

FHA requires a review of the most recent annual state-administered 

inspection report for state-licensed facilities applying for program insurance, 

and recommends, but does not require, continued monitoring of such 

reports for facilities once it has insured them. Four of the five HUD field 

offices GAO visited do not routinely collect annual inspection reports for 

their insured facilities. While the reports are but one of several monitoring 

tools, they provide potential indicators of future financial risk. HUD has 

proposed revising its standard regulatory agreements to require insured 

facility owners or operators to submit annual inspection reports and to 

report notices of violations. However, the proposed revisions have been 

awaiting approval since August 2004, and the implementation date is 

uncertain. 

The Section 232 program accounts for only about 16 percent of the GI/SRI 

Fund’s total unpaid principal balance, but program and industry trends pose 

potential risks to the Section 232 program and to the GI/SRI Fund. For 

example, in recent years the program has insured increasing numbers of 

assisted living facility loans and refinancing loans, for which there are 

limited data available to assess long-term performance. Other potential risk 

factors include increasing prepayments (full repayment before loan 

maturity) and loan concentration in several large markets and among 

relatively few lenders. Projected shifts in demand for residential care 

facilities could affect currently insured facilities and the overall market for 

the types of facilities that HUD insures under the program. 

To estimate the program subsidy cost, HUD uses a model to project cash 

flows for each loan cohort (the loans originated in a given fiscal year) over 

its entire life. HUD’s model does not explicitly or fully consider certain 

factors, such as loan prepayment penalties, interest rate changes, or 

differences in loans to different types of facilities, and uses some proxy data

that is not comparable to Section 232 loans. The model’s exclusion of 

potentially relevant factors and it use of this proxy data could affect the 

reliability of HUD’s credit subsidy estimates. 

www.gao.gov/cgi-bin/getrpt?GAO-06-515.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact David G. Wood 

at (202) 512-6878 or WoodD@gao.gov. 
Page i GAO-06-515 Residential Care Facilities

Contents

Letter 1

Results in Brief 3

Background 7

HUD’s Decentralized Management Provides Field Offices Flexibility, 

but Varying Awareness of Underwriting and Monitoring Practices 

and Concerns Over Insufficient Staff Expertise Increase 

Program’s Potential Risks 9

FHA’s Coordination with States’ Oversight of Quality of Care for 

Section 232 Residential Care Facilities Is Limited 16

Program and Industry Trends Show Sources of Potential Risks to the 

GI/SRI Fund 18

HUD’s Model for Estimating Credit Subsidy Costs Excludes Some 

Potentially Relevant Factors 28

Conclusions 36

Recommendations for Executive Action 38

Agency Comments and Our Evaluation 39

Appendixes

Appendix I: Objectives, Scope, and Methodology 43

Appendix II: Information on the Application Processing, Underwriting, 

and Oversight of Section 232 Loans 48

Appendix III: HUD Officials Addressed Some Issues Raised by the Agency’s 

Inspector General in 2002, but Several Key Items Remain 

Unresolved 52

Appendix IV: HUD’s Use of Proxy Data for Refinance Loans 57

Appendix V: Comments from the Department of Housing and Urban 

Development 60

Appendix VI: GAO Contact and Staff Acknowledgments 63

Figures Figure 1: The Section 232 Program Comprises a Relatively Small 

Part of the GI/SRI Fund 19

Figure 2: Overall 5- and 10-Year Claim Rates for the Most Recent 

Cohorts of the Section 232 Program Are Among the 

Highest Historical Claim Rates 21

Figure 3: The 5-Year Claim Rate for New Construction Loans Has 

Increased in the Most Recent Cohort for Which Claim 

Rate Data Are Available 23
Contents

Page ii GAO-06-515 Residential Care Facilities

Figure 4: The 5-Year Claim Rates for Assisted Living and Board and 

Care Facilities Have Increased in the Most Recent 

Cohorts for Which Claim Rate Data Are Available 24

Figure 5: Section 232 Properties Are Concentrated in Several 

States 26

Figure 6: Initial Credit Subsidy Estimates for Section 232 Program 

New Construction and Substantial Rehabilitation Loans 

and for Section 232 Program Refinance and Purchase 

Loans Have Not Indicated a Need for Subsidies 30

Figure 7: Conditional Claim Rates Are Different for Section 232 and 

Section 207 Refinance Loans 58

Figure 8: Conditional Prepayment Rates are Different for Section 

232 and Section 207 Refinance Loans 59

Abbreviations

CON Certificate of Need

DAP Development Application Processing

FASAB Federal Accounting Standards Advisory Board

FASS Financial Assessment Subsystem

FHA Federal Housing Administration

GI/SRI General Insurance/Special Risk Insurance 

HUD U.S. Department of Housing and Urban Development

LQMD Lender Quality Management Division

MAP Multifamily Accelerated Processing

OMB Office of Management and Budget

TAP Traditional Application Processing

OPIIS Online Property Integrated Information Suite

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Page 1 GAO-06-515 Residential Care Facilities

United States Government Accountability Office

Washington, D.C. 20548

A

May 24, 2006 Letr

Congressional Addressees

Through its Section 232 Mortgage Insurance for Residential Care Facilities 

program (Section 232 program), the Department of Housing and Urban 

Development’s (HUD) Federal Housing Administration (FHA) insures 

mortgages for nursing homes, assisted living facilities, board and care 

homes, and intermediate care facilities. As of December 31, 2005, the 

program insured mortgages with an unpaid principal balance of 

approximately $12.5 billion.1

 The program insures HUD-approved private 

lenders against financial losses from loan defaults; insured loans can be 

used to finance the purchase, construction, or rehabilitation of a facility, 

enable borrowers to refinance projects that do not need substantial 

rehabilitation, or to install fire safety equipment.

For budget and accounting purposes, the Section 232 program is part of 

HUD’s General Insurance/Special Risk Insurance (GI/SRI) Fund; other 

programs in the GI/SRI Fund provide mortgage insurance for various types 

of multifamily housing projects and for hospitals. HUD is required to 

annually estimate the subsidy cost, or the cost to the federal government of 

guaranteeing credit to residential care facilities over the life of the loans.2

This estimate requires FHA to forecast future cash flows associated with 

the loans, which can be influenced by factors that are associated with the 

potential risks facing the program’s loan portfolio. 

While private lenders may finance the purchase or construction of nursing 

homes, public funding, including Medicare and Medicaid, has accounted 

for an increasing percentage of spending on nursing home care.3

 For 

example, in 2000 Medicare and Medicaid financed 39 percent of the nation’s 

1

Based on data from the HUD’s F47 multifamily database.

2

Pursuant to the Federal Credit Reform Act of 1990, HUD must annually estimate the credit 

subsidy cost for all of its loan guarantee programs. 

3

Medicare is the federal health care program for the elderly and people with disabilities. In 

addition to other health services, Medicare covers up to 100 days of nursing home care 

following a hospital stay. Medicaid is the joint federal-state health care financing program 

for certain categories of low-income individuals, including elderly and disabled individuals. 

Medicaid also pays for long-term care services, including nursing home care. 
Page 2 GAO-06-515 Residential Care Facilities

spending on nursing home care, up 28 percent from 1990.4 In 2004, 

Medicare accounted for 14 percent and Medicaid accounted for 44 percent 

of the nation’s spending on nursing home care, and the total of all public 

funds, including Medicare and Medicaid, accounted for approximately 61 

percent.5

 Federal and state governments share responsibility for oversight 

of nursing homes that participate in the Medicare and Medicaid programs. 

The U.S. Department of Health and Human Services defines standards that 

nursing homes must meet to participate in the Medicare and Medicaid 

programs and contracts with states to conduct annual inspections.6

Generally, states license nursing homes (and in some cases related 

facilities) and oversee their operations through inspections.

The 2005 Consolidated Appropriations Conference Report mandated that 

we review the design and management of two FHA mortgage insurance 

programs —those for the Section 232 program and the Section 242 Hospital 

Mortgage Insurance program.7

 In addition, the Ranking Member of the 

Subcommittee on Housing and Transportation, Senate Committee on 

Banking, and others requested that we review several aspects of the 

Section 232 program. Accordingly, this report provides both the results of 

the mandated review and our response to the request. Specifically, we 

examined: (1) HUD’s management of the program, including loan 

underwriting and monitoring; (2) the extent to which HUD’s oversight of 

insured residential care facilities is coordinated with the states’ oversight 

of the quality of care provided by those facilities that are subject to state 

licensing or inspection; (3) the financial implications of the program to the 

GI/SRI Fund, including risk posed by program and market trends; and (4) 

how HUD estimates the annual credit subsidy for the program, including 

the factors and assumptions used. In addition, we examined HUD’s action 

in response to a HUD Inspector General report that concluded that HUD’s 

4

GAO, Nursing Homes: Quality of Care More Related to Staffing than Spending, GAO-02-

431R (Washington, D.C.: June 13, 2002), 1.

5

GAO analysis of data from the U.S. Department of Health and Human Services, Centers for 

Medicare & Medicaid Services.

6

While we refer to these inspections as annual, every nursing home receiving Medicare or 

Medicaid payments must undergo a standard inspection survey not less than once every 15 

months, and the statewide average interval for these surveys must not exceed 12 months.

7

We provided the results of the mandated study of the Hospital Mortgage Insurance program 

in GAO, Hospital Mortgage Insurance Program: Program and Risk Management Could be 

Enhanced, GAO-06-316 (Washington, D.C.: Feb. 28, 2006).
Page 3 GAO-06-515 Residential Care Facilities

Office of Housing did not have adequate controls to effectively manage the 

Section 232 program; this information is summarized in appendix III. 

To address these objectives, we reviewed program manuals and 

documentation of loan processing procedures and underwriting 

requirements and analyzed program financial data that we tested and found 

reliable for our purposes.8

 In examining HUD’s management of the 

program, we focused on how underwriting and loan monitoring activities 

were carried out through visits to five of HUD’s field offices (Atlanta, 

Georgia; Buffalo, New York; Chicago, Illinois; Los Angeles, California; and 

San Francisco, California), where we interviewed program officials and 

obtained relevant documents in each office.9

 We also reviewed 

documentation of the model HUD uses to estimate program subsidy costs, 

applicable program laws, regulations, and policy statements. We obtained 

relevant program documentation and interviewed headquarters officials in 

HUD’s Office of Multifamily Development and Office of Asset Management 

and HUD’s Office of Evaluation and Office of Inspector General. We also 

interviewed representatives of residential care associations; lenders with 

loans insured by the program, as well as other private lenders that offer 

non-FHA-insured residential care loans; and representatives of nursing 

homes and assisted living facilities. Our review did not include an 

evaluation of the need for the Section 232 program. See appendix I for 

more detailed information on our objectives, scope, and methodology. 

We conducted our work in Washington, D.C., and the HUD field office 

locations noted above between February 2005 and April 2006 in accordance 

with generally accepted government auditing standards. 

Results in Brief While HUD’s decentralized management of the Section 232 program allows 

field offices some flexibility in their specific practices, in our visits to five 

field offices we found a lack of awareness of some current program 

requirements, potentially useful loan underwriting and monitoring 

8

Underwriting refers to the process of determining the risk of particular loan applications.

9

We selected these locations on the basis of several factors for each office, including (1) the 

historical claim rates experienced among loans processed, (2) the volume and dollar 

amounts of loans, (3) insurance application processing times, and (4) discussions with HUD 

officials. Because we did not select the offices randomly, we do not know the extent to 

which they are representative of all HUD’s field offices that process Section 232 program 

loans.
Page 4 GAO-06-515 Residential Care Facilities

practices developed in individual offices that were not systematically 

shared with other offices, and concerns by field office managers about 

current or future levels of staff expertise. For example, four of the field 

offices were not aware of a notice that disqualifies potential Section 232 

borrowers if they have had a bankruptcy in their past, and four offices were 

unaware of required addendums to the programs’ standard regulatory 

agreement regarding certain state licensing requirements for nursing 

homes. While individual offices had developed useful practices for 

implementing the program’s loan underwriting and monitoring 

requirements, they lacked a mechanism for systematically sharing 

practices with other offices. For example, two field offices included asset 

management staff-–persons that monitor and oversee a loan after it has 

been insured—in the underwriting stages of loans to better assess their 

risks, while the other field offices did not. We also found that field office 

officials were concerned about adequate current or future levels of staff 

expertise—a critical factor in avoiding unwarranted risk in the Section 232 

program, in that health care facility loans are generally more complicated 

and require more specialized knowledge and expertise compared with 

loans insured under HUD’s other multifamily programs. Lack of awareness 

of current requirements and insufficient staff expertise can contribute to 

the program insuring loans with increased risks. 

FHA’s coordination with states’ oversight of residential care facilities’ 

quality of care provided to residents is limited. FHA requires field office 

officials to review the most recent annual state administered inspection 

report for existing state-licensed facilities as part of the application. HUD 

recommends, but does not require, that officials continue monitoring 

annual inspection reports for a residential care facility once it is insured, 

particularly if the officials do not perform an on-site management review 

(an examination of operations, occupancy, financial management, and 

possible quality of care issues) of the facility. Four of the five HUD field 

offices we visited do not routinely review annual inspection reports for the 

insured facilities they oversee; further, HUD field offices conduct a limited 

number of management reviews of Section 232 facilities. While annual 

inspection reports are but one of several means of monitoring insured 

properties, FHA’s limited use of them may lead the agency to miss potential 

indicators of risk for some of its insured loans. Because serious quality of 

care deficiencies can have a variety of implications that affect cash flow 

streams, ranging from a related reduction in occupancy to the more direct 

financial implications such as civil money penalties and loss of licensing 

and reimbursements, they may ultimately affect a facility’s ability to repay 

the loan. Some private lenders told us they use the annual state inspection 
Page 5 GAO-06-515 Residential Care Facilities

reports in coordination with other financial indicators to assess the 

financial risk of loans to facilities subject to state inspections. HUD is in the 

process of revising its residential care facility regulatory agreements—

which establish loan conditions applicable to an owner and potential 

operator—to require owners or operators to (1) submit to HUD annual 

inspection reports and (2) report to HUD any notices of inspection 

violations. However, the proposed revisions have been awaiting approval 

since August 2004, and it is not clear when the revised agreements will be 

approved. 

Although the Section 232 program is a small component of the GI/ SRI 

Fund—representing approximately 16 percent of the total unpaid principal 

balance—program and industry trends may pose financial risks to the fund. 

For example:

• In recent years, HUD has insured increasing numbers of mortgages that 

are refinances of existing loans, as well as loans for assisted living 

facilities. Because these types of loans are relatively new to the 

portfolio, there are limited data to observe long-term claim trends, 

making their risk difficult to assess. However, the 5-year claim rate (the 

portion of loans leading to a claim within 5 years of origination) was 

significantly higher for more recent assisted living facility loans.

• The proportion of loans that terminate due to prepayment within 10 

years of origination is increasing. Prepayment occurs when a borrower 

pays a loan in full before the loan reaches maturity. As more borrowers 

prepay their loans, HUD loses future cash flows of premiums. Such 

losses could be offset to some extent, in that prepayments may 

ultimately result in fewer claims.

• Program loans are concentrated in several states and among relatively 

few lenders. As of 2005, five states (California, Illinois, Massachusetts, 

New York, and Ohio) accounted for 51 percent of active loan amounts, 

with one state—New York—representing 24 percent. Further, while a 

total of 109 lenders held active loans, just 6 held over half of the active 

loan portfolio. Geographic concentration makes the program vulnerable 

to swings in regional economic conditions, while concentration among 

lenders potentially makes the program more vulnerable if one or a few 

large lenders encounters financial difficulty. 

In addition, industry developments and uncertainty in the funding of the 

Medicaid and Medicare programs pose potential risks. Projected shifts in 
Page 6 GAO-06-515 Residential Care Facilities

demand for residential care facilities could affect not only the facilities 

currently insured by HUD but also the overall market for the particular 

types of facilities that HUD insures under the program. 

To estimate the subsidy cost of the Section 232 program, HUD uses a cash 

flow model to project the expected cash flows for all of these loans over 

their entire life. The cash flow model uses assumptions based on historical 

and projected data to estimate the amount and timing of claims, 

subsequent recoveries from these claims, prepayments, and premiums and 

fees paid by the borrower. We found that HUD’s model does not explicitly 

consider certain factors such as loan prepayment penalties or lockouts (the 

period of time during which prepayment is prohibited), which can affect 

whether and when a loan is prepaid and may also show changes in the risk 

of claim and expected collections of premiums. HUD’s cash flow model 

also does not fully capture the effects on existing loans when market 

interest rates change, nor explicitly consider differences in loan 

performance between different types of facilities. Furthermore, the model 

includes some proxy data with borrower characteristics and performance 

that is not comparable to Section 232 loans. The model’s exclusion of 

potentially relevant factors and its use of this proxy data could affect the 

reliability of HUD’s credit subsidy estimates. 

This report contains recommendations to HUD designed to ensure that 

field offices understand and implement current program requirements, 

including sharing practices among field offices. We also recommend that 

HUD incorporate reviews of annual inspection reports for nursing homes 

and other residential care facilities into its loan monitoring process, 

complete its proposed revision to the residential care facility regulatory 

agreement in a timely manner, and consider including additional variables 

and methods in its credit subsidy modeling. We provided a draft of this 

report to HUD and received written comments from the Assistant Secretary 

for Housing, which are discussed later in this report and in appendix V. In 

its response, HUD generally concurred with our recommendations 

intended to ensure that field offices are aware of and implement current 

program requirements and policies, but disagreed with most parts of our 

recommendation related to HUD’s credit subsidy model. Specifically, HUD 

did not agree to consider factoring additional information into its credit 

subsidy model including prepayment penalties and restrictions, initial loanto-value and debt service coverage ratios, and the ratio of contract rates 

and market rates. Because we believe that factoring such information into 

the credit subsidy model could be useful, we did not modify our 

recommendation. 
Page 7 GAO-06-515 Residential Care Facilities

Background Section 232 of the National Housing Act, as amended, authorizes FHA to 

insure mortgages made by private lenders to finance the construction or 

renovation of nursing homes, intermediate care facilities, board and care 

homes, and assisted living facilities.10 Congress established the Section 232 

program in 1959 to provide mortgage insurance for the construction and 

rehabilitation of nursing homes. The Housing and Community 

Development Act of 1987 expanded the program to allow for the insuring of 

refinancing or purchase of FHA-insured facilities and, in 1994, HUD issued 

regulations implementing legislation to expand the program to allow for 

the insuring of assisted living facilities and the refinancing of loans for 

facilities not previously insured by FHA. Since 1960, FHA has insured 4,372 

loans through the Section 232 program in all 50 states, the District of 

Columbia, the U.S. Virgin Islands, and Puerto Rico. As of the end of fiscal 

year 2005, there were 2,054 currently insured loans. 

FHA does not insure all residential care facilities, as there are 

approximately 16,500 nursing home facilities and over 36,000 assisted living 

facilities in operation.11 We did not identify any private mortgage insurance 

that is currently available for loans made to nursing homes or other similar 

facilities. According to HUD officials, in recent times, the Section 232 

program exists, in part, to support the market for residential care facilities 

when the private market is reluctant to finance such projects due to market 

conditions. The loans are advantageous to borrowers because they are 

nonrecourse loans whereby the lender (in this case the lender and the 

insurer, FHA) has no claim against the borrower in the event of default and 

can only recover the property. The loans are also generally long term (in 

some cases up to 40 years) and, according to HUD and lender officials, 

10According to HUD’s “Section 232 Mortgage Insurance for Residential Care Facilities 

Handbook,” nursing homes are those facilities that provide accommodation for persons 

who are not acutely ill and not in need of hospital care but require skilled nursing care and 

related medical services. Intermediate care facilities provide for the accommodation of 

persons who require minimum, but continuous care, and do not require skilled nursing 

services. In this report, we use the term “nursing home” to include facilities providing skilled 

and/or intermediate care services. Assisted living facilities are facilities for residents who 

need assistance with activities of daily living. Board and care facilities provide room, board, 

and continuous protective oversight.

11Based on 2003–2005 data in GAO, Nursing Homes: Despite Increased Oversight, 

Challenges Remain in Ensuring High-Quality Care and Resident Safety, GAO-06-117

(Washington, D.C.: Dec. 28, 2005), 60, and 2004 data in Robert Mollica and Heather JohnsonLamarche, State Residential Care and Assisted Living Policy: 2004 (National Academy for 

State Health Policy, March 2005), 1-2.
Page 8 GAO-06-515 Residential Care Facilities

offer an interest rate that is, in many cases, lower than what private lenders 

offer for non-FHA insured loans made to nursing homes and other similar 

facilities. Additionally, FHA insures 99 percent of the unpaid principal 

balance plus accrued interest. 

HUD administers the Section 232 program through its field offices, with 

HUD headquarters oversight. HUD’s field structure consists of 18 Hub 

offices and 33 program centers. Generally, each Hub office has a number of 

program centers that report to it. Program centers administer multifamily 

programs within the states in which they are located or portions thereof. 

Hub offices also administer multifamily programs, as well as augment the 

operations of and coordinate workload between their program centers. 

Under Medicaid, states set their own nursing home payment rates 

(reimbursement rates), and the federal government provides funds to 

match states’ share of spending as determined by a federal formula. Within 

broad federal guidelines, states have considerable flexibility to set 

reimbursement rates for nursing homes that participate in Medicaid but are 

required to ensure that payments are consistent with efficiency, economy, 

and quality of care.12 Under Medicare, skilled nursing facilities receive a 

federal per diem payment that reflects the resident’s care needs and is 

adjusted for geographic differences in costs.

1242 U.S.C. §1396a(a).
Page 9 GAO-06-515 Residential Care Facilities

HUD’s Decentralized 

Management Provides 

Field Offices 

Flexibility, but Varying 

Awareness of 

Underwriting and 

Monitoring Practices 

and Concerns Over 

Insufficient Staff 

Expertise Increase 

Program’s Potential 

Risks

While the decentralization of the program allows field offices some 

flexibility in their specific practices, the results of our visits to five field 

offices revealed differences in the extent to which field office staff were 

aware of current program requirements. Further, while individual offices 

had developed useful practices for implementing the program’s loan 

underwriting and monitoring requirements, they lack a mechanism for 

systematically sharing practices with other offices. We also found that field 

office officials were concerned about adequate current or future levels of 

staff expertise—a critical factor in avoiding unwarranted risk in the Section 

232 program, in that health care facility loans are generally more 

complicated and require specialized expertise compared with loans insured 

under HUD’s other multifamily programs. Lack of awareness of current 

requirements and insufficient staff expertise can contribute to insuring 

loans with increased risks. Both factors are related to recommendations 

made in the HUD Office of Inspector General’s 2002 report that HUD has 

not fully addressed (see app. III for further information on weaknesses 

identified by HUD’s Inspector General). 

Some Field Offices Were 

Not Aware of All Current 

Program Requirements 

FHA has numerous underwriting requirements for loans insured under the 

Section 232 program; for example, facilities must provide evidence of 

market need; a (real estate) appraisal; and be in compliance with limits on 

loan-to-value and debt service coverage ratios.13 FHA also requires a variety 

of reviews for monitoring Section 232 loans. (Loan underwriting and 

monitoring requirements, which can involve fairly complex reviews and 

analyses, are described in more detail in app. II.) 

According to HUD headquarters officials, the field offices that administer 

the Section 232 program are required to follow all program statutes and 

regulations, but the decentralization of the program allows field offices 

some flexibility in their specific practices. For example, individual field 

offices can designate how to staff the underwriting and monitoring of 

Section 232 loans, depending on such factors as loan volume relative to 

other multifamily programs, to fully utilize resources. HUD headquarters 

provides guidance on program policies and requirements; when necessary, 

reviews applications for certain types of loans, such as those submitted by 

13Loan-to-value is a ratio of the amount of the loan as a percentage of the property’s value or 

sales price. Debt service coverage ratio is the ratio of the property’s annual net operating 

income to the annual debt service. 
Page 10 GAO-06-515 Residential Care Facilities

nonprofit entities; and provides technical assistance or additional guidance 

and support if contacted by field offices. HUD headquarters staff also 

conduct Quality Management Reviews, which are management reviews of 

field offices administering HUD programs and services. For these reviews, 

evaluators visit offices and coordinate subsequent reports. The process 

also involves reporting the status of follow-up corrective actions. While not 

focused on the Section 232 program, this process helps to oversee the 

program by reviewing the management of the field offices that administer 

it.

We found that the five field offices that we visited varied in their 

understanding and awareness of policies related to the Section 232 

program. For example, staff in two field offices said that their standard 

regulatory agreement (that serves as the basic insurance contract and 

spells out the respective obligations of FHA, the lender, and the borrower) 

did not include language that would require operators of insured facilities 

to submit financial statements on new loans.14 According to officials at 

HUD headquarters, field offices should be using language requiring these 

financial statements. HUD and most lender officials we interviewed told us 

that operator financial statements provide information on the legal entity 

operating the facility in cases where the borrower and the operator of the 

residential care facility are different entities. These officials also stated 

that, in such situations, borrower financial statements may not disclose 

expenses, income, and other financial information, and may only show the 

transactions between the borrower and operator, thus making operator 

financial statements a necessity. Also, HUD’s Inspector General identified 

HUD’s lack of a requirement for operators to submit financial statements 

electronically to be part of an internal control weakness for the Section 232 

program. 

Additionally, we found that the field offices that we visited were not always 

aware of specific notices that established new requirements or processes 

for the Section 232 program. For example:

• Four of the five field offices that we visited were not aware of a notice 

that disqualifies potential Section 232 borrowers if they have had a 

bankruptcy in their past. According to a HUD headquarters officials, this 

14Officials in one field office explained that they had previously required operators to submit 

financial statements and were planning to resume following this requirement.
Page 11 GAO-06-515 Residential Care Facilities

policy is intended to protect HUD from insuring a potentially risky loan 

based on a borrower’s financial history.

• Officials at four of the five field offices we visited did not know about 

required addendums to the regulatory agreement regarding state 

licensing requirements for nursing homes. HUD developed these 

addendums to place a lien on a property’s operational documents, such 

as a Certificate of Need and state licenses, to prevent operators from 

taking these documents with them upon termination of a property’s 

lease.15 Without these documents, a facility may not be able to operate 

and, consequently, the property’s value would be greatly diminished. 

According to HUD headquarters officials, HUD headquarters 

communicates changes in the Section 232 program’s policies and 

procedures to field offices in a variety of ways besides sending formal 

notices. For example, HUD headquarters also posts some notices on a 

“frequently-asked questions” section of a Web site available to field offices, 

lenders, attorneys, and others.16 HUD headquarters officials also conduct 

nationwide conference calls with the field offices in which various HUD 

multifamily programs, including the Section 232 program, are discussed. 

The conference calls are conducted separately for loan development staff 

and asset management staff that work, respectively, on the underwriting 

and monitoring of loans. HUD headquarters officials stated that these 

conference calls provide a forum to disseminate information to the field 

offices and for individual field offices to discuss any issues, questions, or 

concerns regarding any multifamily programs, including the Section 232 

program. 

HUD headquarters officials stated that they plan to address the lack of 

awareness we observed by updating the “Multifamily Asset Management 

and Project Servicing Handbook” to clarify current policies and 

requirements for the Section 232 program. HUD is also planning to update 

the handbook to address the 2002 HUD Inspector General report that 

identified that HUD's current handbook was not specific to Section 232 

15A Certificate of Need is a state regulatory process that requires residential health care 

facilities to receive state approval before offering certain new or expanded health care 

services.

16According to headquarters officials, the Web site includes notices related to loan insurance 

applications processed under the Multifamily Accelerated Processing (MAP) system, which 

includes the majority of Section 232 loan applications. 
Page 12 GAO-06-515 Residential Care Facilities

nursing home operations. However, HUD officials told us the updates to the 

handbook would not be completed until the proposed revisions to the 

applicable regulatory agreements have been approved. The proposed 

revisions have been awaiting approval since August 2004, and it is not clear 

when the revised agreements will be approved. 

Field Offices Do Not 

Systematically Share 

Information on Practices

As discussed earlier, field offices have some flexibility in practices that 

they use in administering the Section 232 program. In our visits to five field 

offices, we found a variety of practices that could be useful in the 

underwriting and monitoring of Section 232 loans if shared with other field 

offices. However, currently, HUD does not have systematic means by which 

to share this information among field offices.

Officials in two of the five field offices we visited identified specific 

practices they had developed to carry out loan underwriting requirements. 

For example:

• Asset management staff, whose focus is monitoring the performance of 

loans that are already insured, are asked to review a variety of 

documents submitted in the underwriting process, such as financial 

statements and information on the occupancy of the facility. 

• In one of the offices, staff members may contact relevant state officials, 

just before the closing of a loan, to verify that the state has not identified 

any quality of care deficiencies since the facility submitted the 

application for mortgage insurance.

• Officials in one office stated that they conduct an additional review 

before approving a loan application for mortgage insurance to ensure 

that all required steps, such as mortgage credit analysis and valuation, 

have been properly performed.

According to the officials in these two offices, it is necessary to take these 

additional steps in order to adequately underwrite a loan under this 

program. They stated that the additional steps result in the better screening 

of loan risk and could result in the rejection of a risky loan they might 

otherwise approve.

We found a similar variety of practices in the monitoring of Section 232 

loans. In some cases, field offices we visited had taken additional steps 

beyond those required by HUD. For example:
Page 13 GAO-06-515 Residential Care Facilities

• While HUD requires a review of the annual financial statements of 

insured facilities, two field offices that we visited require monthly 

financial accounting reports from facilities either for the first year of the 

loan or until the facility has reached stable occupancy. 

• Two field offices had developed their own specialized checklists for 

monitoring Section 232 loans. These checklists were specifically 

designed for the oversight of residential care facility loans and included 

items such as the facility’s replacement reserve accounts and 

professional liability insurance, among other items. 

• One of the offices had established a Section 232 working group, where 

underwriting and asset management staff met periodically to discuss 

loans in the portfolio and issues related to the overall management of 

the program in the field office. Additionally, three of the five field offices 

we visited had specialized staff with expertise in overseeing residential 

care facility loans. These were asset management staff whose primary 

or sole responsibility was oversight of the Section 232 portfolio.

• While HUD headquarters officials stated that they do not require 

management reviews of Section 232 facilities, three of the five field 

offices we visited conducted management reviews on some part of their 

Section 232 portfolios. 

• One field office obtained the state annual inspection reports on its 

Section 232 facilities on a regular basis. 

According to officials in these offices, the unique characteristics associated 

with residential care facilities make the additional measures necessary. 

Officials in field offices we visited that had developed these specific 

practices stated that the practices result in better underwriting and 

monitoring of loans and could potentially help to prevent claims. However, 

HUD field offices do not have a systematic means by which to share 

information with other field offices about practices they have developed. 

While field office officials can raise concerns and issues through 

conference calls with HUD headquarters officials, most explained that 

these conference calls are not particularly designed for field offices to 

share practices with other field offices. Officials in the five field offices that 

we visited told us that they occasionally contact their counterparts in other 

field offices regarding loan processing or asset management questions or 

issues. Additionally, officials in some field offices said that they 
Page 14 GAO-06-515 Residential Care Facilities

occasionally see their counterparts at regional lender conferences. 

However, aside from these forms of contact, there was no systematic 

method by which to learn about other field office practices. Consequently, 

officials in one field office are likely to be unaware of additional steps or 

practices taken by another field office that are intended to help officials 

improve underwriting or monitoring of Section 232 loans. Officials at all 

field offices that we visited told us that they could benefit from the sharing 

of such practices regarding underwriting and monitoring procedures 

established by different offices.

Officials Cited Concerns 

about Adequate Levels of 

Staff Expertise

Officials in two of the five field offices stated that a lack of expertise on 

residential care facility loans, either in underwriting or loan oversight, is a 

current concern in their office. They specifically noted a lack of expertise 

in residential care facilities and their overall management. Officials in all of 

the field offices that we visited stated that additional training on Section 

232 loans would be beneficial to provide more knowledge and expertise, as 

there has been very little Section 232-specific training. In its 2002 report, 

HUD’s Office of Inspector General also identified that field office project 

managers did not have sufficient training on reviewing Section 232 loans 

and dealing with the issues unique to Section 232 properties. 

All of the private lenders we interviewed—those that offer non-FHA 

insured loans to residential care facilities and face similar risks to FHA—

had a specialized group that conducted the underwriting of these loans. All 

of the individuals that conducted the underwriting of these loans were part 

of a health care lending unit that focused exclusively on loans made to 

health care facilities. According to the lenders, they believed it was 

necessary to have specialized staff underwriting such loans due to the 

unique nature of lending money to a facility that was designed for a 

residential health care business. Additionally, almost all of the private 

lenders we interviewed had specialized staff that monitored their 

residential care facility loans. According to lender staff we interviewed, 

nursing home and assisted living facility loans require an understanding of 

the market, trends, expenses, income, and other such unique 

characteristics associated with these types of facilities.

While officials in only two of the five offices expressed concern about the 

expertise of current staff, officials in all field offices we visited stated that 

they are concerned about the ability to adequately staff the Section 232 

program in the next 5 years. They stated that as older staff retire in the next 

5 years or so, any expertise that such staff currently have will take time to 
Page 15 GAO-06-515 Residential Care Facilities

replace. All of the field offices that we visited staffed the underwriting 

process for Section 232 loans similar to that of other multifamily programs, 

based on workload and staff resources. However, while two field offices 

assigned their Section 232 properties, along with other multifamily 

properties, to general asset management staff for oversight, three field 

offices designated specific staff to oversee Section 232 properties. This was 

due to the latter field office officials’ belief, similar to that of the private 

lenders we interviewed, that the properties require a certain level of 

knowledge and expertise associated with residential care facilities. 

Expertise in Section 232 loans allows for a better understanding of the 

distinct issues associated with oversight of residential care facilities. In one 

of the offices that had general asset management staff overseeing the 

portfolio, eight project managers shared responsibility for monitoring 

Section 232 properties in conjunction with other multifamily program 

properties. In contrast, in one of the offices with staff designated 

specifically for the Section 232 program, one member of the asset 

management staff was responsible for the entire Section 232 portfolio. 

Officials from the two field offices that have experienced staff specialized 

in monitoring Section 232 loans stated that they are concerned about losing 

their specialized staff over time and acknowledged that they will need to 

find replacements in order to continue to adequately monitor Section 232 

loans. Their concern stems in part from the fact that Section 232 facilities, 

unlike other multifamily properties, require specialized knowledge and an 

understanding of the marketing, trends, and revenue streams associated 

with residential care facilities.

According to officials in all of the field offices that we visited, monitoring of 

Section 232 loans, when compared with other FHA-insured multifamily 

programs, requires additional measures. Section 232 loans contain a 

complex business component—the actual assisted living service or the 

nursing service operating in a facility—making them different from other 

multifamily programs that are solely realty loans. Consequently, for Section 

232 loans, field office officials monitor the financial health of the business, 

including expenses, income, and other such items. Some field office 

officials also stated that it is important to monitor the operator to ensure 

that the facility is adequately managed. Additionally, some field office 

officials stated that to ensure the facility is generating enough income, they 

have to monitor Medicare and Medicaid reimbursement rates, as well as 

occupancy rates.

According to HUD headquarters officials, as part of its overall strategic 

human capital efforts, HUD is currently assessing the loss of human capital 
Page 16 GAO-06-515 Residential Care Facilities

in field offices over time. However, this effort is not focused on the Section 

232 program specifically but is intended to examine general human capital 

issues and needs.

FHA’s Coordination 

with States’ Oversight 

of Quality of Care for 

Section 232 Residential 

Care Facilities Is 

Limited

FHA requires field office officials, when processing applications for 

Section 232 mortgage insurance from existing state-licensed facilities to 

review the most recent annual state-administered inspection report for the 

facilities, but does not require the continued monitoring of annual 

inspection reports for state-licensed facilities once it has insured them. 

Four of the five HUD field offices we visited do not routinely collect annual 

inspection reports for the insured facilities they oversee. While such 

reports are but one of several means of monitoring insured properties, 

FHA’s limited use of them may lead the agency to overlook potential 

indicators of risk for some of its insured loans.

FHA Requires Some 

Coordination with States’ 

Oversight of Quality of Care 

for Section 232 Residential 

Care Facilities 

State inspections or surveys of residential care facilities may stem from 

state licensing requirements or the facilities’ participation in Medicare or 

Medicaid. Nursing homes are state licensed, while states vary in their 

licensing requirements for assisted living facilities. The Department of 

Health and Human Services’ Centers for Medicare & Medicaid Services 

requires that nursing homes receiving Medicare and Medicaid funding be 

federally certified, and all certified facilities are subject to annual federal 

inspections administered by the states. State survey agencies, under 

agreements between the states and the Secretary of Health and Human 

Services, conduct the annual federally required inspections. To complete 

the annual inspections, teams of state surveyors visit Medicare and 

Medicaid participating facilities and assess compliance with federal facility 

requirements, particularly whether care and services provided meet the 

assessed needs of the residents. These teams also assess the quality of care 

provided to residents of the facilities, looking at indicators such as 

preventing avoidable pressure sores, weight loss, or accidents. Overall, 

annual inspections provide a regular review of quality of care by officials 

with relevant backgrounds, such as, registered nurses, social workers, 

dieticians, and other specialists. For facilities that are applying for 

mortgage insurance under the Section 232 program, FHA requires a copy of 

the state license needed to operate the facility and a copy of the latest state 

annual inspection report on the facilities’ operation. 
Page 17 GAO-06-515 Residential Care Facilities

HUD’s “Multifamily Asset Management and Servicing Handbook” 

recommends that, once nursing home loans are insured under the program, 

HUD officials responsible for loan monitoring continue to review state 

annual inspection reports if they do not undertake management reviews of 

the facility. Management reviews focus on an insured facility’s financial 

indicators and general management practices, but, particularly if 

conducted on-site, could provide some information on issues related to the 

quality of care at a facility. Because of their wider scope, however, 

management reviews would not likely go into the same depth on quality of 

care issues as annual inspections. HUD headquarters officials told us that 

the handbook’s recommendation applies to all Section 232 facilities; 

further, HUD headquarters officials stated that management reviews for 

Section 232 properties should be conducted based on need and available 

resources. We found that two of five field offices we visited did not 

regularly conduct any regular management reviews and did not review 

annual inspection reports during loan monitoring. Of the three field offices 

that did conduct management reviews on some Section 232 properties, one 

also reviewed annual inspection reports during loan monitoring. 

Additionally, the offices that did not review annual inspection reports had 

little direct interaction with the state agencies. Private lenders overseeing 

non-FHA insured residential care facilities told us that they regularly 

conduct various levels of management reviews and review annual 

inspection reports on a consistent basis.

FHA has emphasized the importance of ongoing coordination with state 

oversight agencies in its proposed revisions to its regulatory agreements, 

which require owners or operators of insured facilities to report any state 

or federal violations to FHA. HUD’s proposed revisions to the regulatory 

agreements also include a requirement that the owner or operator provide 

HUD with copies of annual inspection reports that can be used as part of 

loan monitoring. However, the proposed revisions to the regulatory 

agreements have yet to be approved. 

FHA’s Limited Coordination 

with States on Oversight 

Issues May Lead to Missed 

Identification of Risk 

Indicators 

Serious quality of care deficiencies can have a variety of implications that 

affect cash flow streams, ranging from a related reduction in occupancy to 

the potential for civil money penalties and loss of licensing and 

reimbursements. Consequently, quality of care concerns can ultimately 

affect a facility’s financial condition. For many Section 232 properties, in 

particular nursing homes, state oversight of quality of care helps to 

determine whether a facility is licensed and eligible to receive Medicaid 

and Medicare reimbursements. This is particularly important to the Section 
Page 18 GAO-06-515 Residential Care Facilities

232 program because, as noted earlier in this report, Medicaid and 

Medicare reimbursements typically account for a significant portion of 

nursing home income. 

Federal or state annual inspection reports, to the extent that they are 

available for facilities, provide regular evaluations of nursing homes and 

other residential care facilities. As discussed earlier, annual inspections 

provide a review of quality of care by officials with relevant backgrounds. 

In a 2005 report, we found inconsistencies across states in conducting 

surveys and state surveyors understating serious deficiencies in quality of 

care.17 Nonetheless, annual inspection reports serve as an important 

indicator of a property’s risk related to problems with the quality of care to 

residents. 

Annual inspection reports, coupled with other information such as facility 

staffing profiles, resident turnover, and data from financial statements, 

could assist HUD’s field offices in overseeing loan performance. 

Additionally, reviewing facilities’ quality of care records over time, as well 

as any corrective action plans needed to come into compliance with state 

and federal quality of care requirements could further the field offices’ 

ability to identify loan performance risks. The reports may also prompt 

HUD field office officials to communicate with federal or state nursing 

home regulatory agencies for further information on facilities that appear 

to be high risk. These agencies may have available information on civil 

money penalties and sanctions, which serve as additional indicators of 

quality of care risk. Private lenders we spoke with acknowledged that 

annual inspection reports provided insight into the management of a 

facility and coupled with other information could help to assess financial 

risk. 

Program and Industry 

Trends Show Sources 

of Potential Risks to 

the GI/SRI Fund

The Section 232 program represents a relatively small share of the broader 

GI/ SRI Fund. However, program and industry trends show sources of 

potential risks that could affect the future performance of the Section 232 

portfolio and the GI/SRI Fund. FHA uses a number of tools to mitigate risk 

to the program and to the fund. 

17See GAO-06-117, 4.
Page 19 GAO-06-515 Residential Care Facilities

The Section 232 Program 

Represents a Small 

Percentage of the GI/SRI 

Fund

The Section 232 program is a relatively small share of the total GI/SRI 

Fund. HUD estimated that the program would represent only about 5.3 

percent of the fund’s fiscal year 2006 commitment authority.18 Similarly, the 

Section 232 program represents a little less than 16 percent or a little more 

than $12.5 billion of the nearly $80 billion in unpaid principle balance in the 

GI/SRI Fund (see fig. 1). Despite its small size, a significant worsening in 

the performance of the Section 232 program could negatively affect the 

performance of the GI/SRI Fund. The extent, though, of the impact on the 

overall performance of the GI/SRI Fund would depend upon numerous 

factors including changes in the size and performance of the other 

programs in the fund. 

Figure 1: The Section 232 Program Comprises a Relatively Small Part of the GI/SRI 

Fund

Note: Numbers have been rounded to closest whole number. 

18The GI/SRI Fund’s commitment authority represents the maximum aggregate amount of 

loans that can be guaranteed under the programs in the fund.

5%

95%

2006 total commitment authority

Section 232

Remaining GI/SRI Fund

Total unpaid principal balance as of

December 31, 2005

16%

84%

Source: GAO analysis of HUD fiscal year 2006 budget and data from F47 

(a HUD multifamily housing database) as of December 31, 2005.
Page 20 GAO-06-515 Residential Care Facilities

Program Trends Show 

Sources of Potential Risk 

As discussed below, several trends exist within the Section 232 program 

that pose potential risks to the Section 232 portfolio and, therefore, to the 

GI/SRI Fund. 

Higher Claim Rates for Recent 

Loan Cohorts 

To identify potential trends in loan performance, we analyzed 5- and 10-

year claim rates for Section 232 loans based on data that spanned from 

fiscal year 1960 through the end of fiscal year 2005, for the entire portfolio, 

as well as by type of loan purpose and type of insured facility. The analysis 

of the entire portfolio showed that the 10-year claim rates for more recent 

loan cohorts (loans originated between 1987 and 1991 and loans originated 

between 1992 and 1996) ranked among the highest historical cohort claim 

rates (see fig. 2).19 The 5-year claim rate for loans originated between 1997 

and 2001 also ranked among the highest historical cohort claim rates. A 

continued increase in claim rates could have a negative effect on the 

performance of the GI/SRI Fund. 

19In our analysis of Section 232 loan data, we grouped loans into cohorts (loans originated in 

a given fiscal year) of approximately 5 fiscal years of loans. This was done to allow for a 

more meaningful analysis given the small number of Section 232 loans endorsed per fiscal 

year. We analyzed 5- and 10-year claim and prepayment rates because more claims and 

prepayments take place within 10 years of loan endorsement. 
Page 21 GAO-06-515 Residential Care Facilities

Figure 2: Overall 5- and 10-Year Claim Rates for the Most Recent Cohorts of the 

Section 232 Program Are Among the Highest Historical Claim Rates

Changes in Claim Rates by Loan 

Purpose

Section 232 loans can have a loan purpose in one of two categories—new 

construction/substantial rehabilitation loans or refinance/purchase loans. 

New construction loans are for loans that involve the construction of a new 

residential care facility. Substantial rehabilitation loans are for loans that 

meet HUD criteria for substantial rehabilitation of a residential care facility, 

such as two or more building components being substantially replaced. 

Purchase loans are for loans in which the borrower is acquiring an existing 

residential care facility, while refinance loans are the refinancing of an 

existing HUD insured loan or a loan not previously insured by HUD. As 

described earlier in the report, HUD began to allow for the refinancing of 

FHA-insured facilities and non-FHA insured facilities in 1987 and 1994, 

respectively. When analyzing Section 232 loan data by loan purpose, we 

found that new construction/substantial rehabilitation loans have a higher 

5-year claim rate than refinance/purchase loans for the most recent cohort 

Source: GAO analysis of data from F47 (a HUD multifamily housing database) as of the end of fiscal year 2005.

5-year claim rate

10-year claim rate

Claim rate

Loan cohort fiscal years

0

5

10

15

20

1997-

2001

1992-

1996

1987-

1991

1982-

1986

1977-

1981

1972-

1976

1966-

1971

1960-

1965
Page 22 GAO-06-515 Residential Care Facilities

for which data are available (see fig. 3).20 New construction/substantial 

rehabilitation loans originated between 1997 and 2001 also have the highest 

historical 5-year cohort claim rate for these type of loans. Because of the 

higher claim rates in recent years, continued monitoring will be important. 

In contrast, the number of refinance and purchase loans endorsed in the 

last 5 years is more than double those endorsed in the previous 5 years. The 

future impact of the refinance and purchase loans on the overall 

performance of the Section 232 program is uncertain since they have 

existed for a shorter period of time and thus there is currently limited data 

available to assess the relative risk of claims.

20We are reporting 5-year claim rates rather than 10-year claim rates when comparing 

refinance loans because HUD insured its first refinance loans in 1992. As a result, there are 

limited data available for 10-year claim rates. 
Page 23 GAO-06-515 Residential Care Facilities

Figure 3: The 5-Year Claim Rate for New Construction Loans Has Increased in the 

Most Recent Cohort for Which Claim Rate Data Are Available

Changes in Claim Rates by 

Facility Type

As discussed earlier in the report, HUD insures different types of 

residential care facilities that include nursing homes, intermediate care 

facilities, assisted living facilities, and board and care facilities. Assisted 

living facilities are relatively new to the portfolio, and the number of these 

loans have been increasing. Our analysis of Section 232 loan data by facility 

type found that board and care facilities had a slightly higher 10-year claim 

rate than nursing home facilities in the most recent cohorts; however, these 

loans remain a very small percentage of the active portfolio and are being 

made in decreasing numbers. There are limited data to observe claim 

trends on assisted living facilities, making their risk difficult to assess, but 

the 5-year claim rates for assisted living facilities have increased 

significantly in the most recent cohort years for which claim rate data are 

available (see fig. 4). A continued high claim rate in assisted living facilities 

could negatively affect the performance of the Section 232 program and the 

Claim rate

Source: GAO analysis of data from F47 (a HUD multifamily housing database) as of the end of fiscal year 2005.

New construction/substantial rehabilitation loans

Refinance/purchase loans

Loan cohort fiscal years (total loans)

1997-

2001

(360, 446)

1992-

1996

(392, 125)

1987-

1991

(248)

1982-

1986

(225)

1977-

1981

(222)

1972-

1976

(269)

1966-

1971

(487)

1960-

1965

(344)

0

3

6

9

12

15
Page 24 GAO-06-515 Residential Care Facilities

GI/SRI Fund. However, lenders and HUD officials told us that, although 

assisted living facilities had high claim rates in the past, they believe the 

market has stabilized and lessons have been learned.

Figure 4: The 5-Year Claim Rates for Assisted Living and Board and Care Facilities 

Have Increased in the Most Recent Cohorts for Which Claim Rate Data Are Available

Increase in Loan Prepayments Another observable trend is the increase in the portion of loans in each 

cohort that is prepaid. (Prepayment occurs when a borrower pays a loan in 

full before the loan reaches maturity.) There have been 1,688 prepayments 

in the Section 232 program from 1960 through the end of fiscal year 2005 

and loans that terminate do so overwhelmingly because of prepayment. 

Moreover, the proportion of loans that terminate due to prepayment within 

10 years of origination is increasing. Specifically, the 10-year prepayment 

rates for the three most recent cohorts for which 10-year claim rates are 

Claim rate

Source: GAO analysis of data from F47 (a HUD multifamily housing database) as of the end of fiscal year 2005.

Loan cohort fiscal years (total loans)

Board and care facilities

Assisted living facilities

Nursing home/intermediate care facilities

0

3

6

9

12

15

1997-

2001

(539, 250, 88)

1992-

1996

(440, 36, 84)

1987-

1991

(246, 0, 21)

1982-

1986

(231)

1977-

1981

(226)

1972-

1976

(274)

1966-

1971

(497)

1960-

1965

(344)
Page 25 GAO-06-515 Residential Care Facilities

available are more than double that of some earlier cohorts. As more 

borrowers prepay their loans, HUD loses future cash flows from premiums; 

thus, higher prepayment rates will likely make the net present value of cash 

flows decrease. However, the decrease could be offset to the extent that 

higher prepayment rates result in fewer claims (a prepaid loan cannot 

result in a claim).

Concentration of Loans Market concentration also poses some risks to the GI/SRI Fund. The 

Section 232 program is concentrated in several large markets and in loans 

made by relatively few lenders. As of 2005, five states (California, Illinois, 

Massachusetts, New York, and Ohio) held 51 percent of active Section 232 

loan dollars and 38 percent of active loan properties (see fig. 5). New York 

holds close to 24 percent of the active loan dollars in the portfolio. This is 

an improvement since 1995 when we found that eight states accounted for 

70 percent of the portfolio, and New York accounted for 32 percent of the 

portfolio. However, the current market concentration could still pose risk 

to the portfolio if a sudden market change took place in one or more of the 

states with a larger percentage of the insured Section 232 loans. We also 

found significant loan concentration among a small group of lenders. While 

a total of 109 lenders held active loans, 6 hold over half of the active loan 

portfolio. GMAC Commercial Mortgage Corporation holds more than 17 

percent of all active mortgages in the Section 232 program, the single 

largest share of any lender. This concentration among lenders potentially 

makes the program more vulnerable if one or a few large lenders encounter 

financial difficulty. 
Page 26 GAO-06-515 Residential Care Facilities

Figure 5: Section 232 Properties Are Concentrated in Several States 

Note: Active loan dollars are from F47 as of the end of calendar year 2005, and number of loans are 

from F47 as of the end of fiscal year 2005. This also does not include one loan for which property state 

information was not available in F47. Numbers have been rounded to closest whole number.

Industry Faces 

Uncertainties

The Section 232 program may also face risks from trends in the residential 

care industry at large that include uncertainty about sources of revenue 

and occupancy. Nursing home revenue is generated in large part from the 

Medicare and Medicaid programs, which make up 58 percent of national 

nursing home spending. Private lenders we interviewed that offer nonFHA-insured residential care facility loans explained that one of the 

primary reasons their loans are shorter-term loans than those of HUD is 

due to their perception of the potential, long-term uncertainty in the 

funding of the Medicaid and Medicare programs, which generally account 

for a large share of patient payments in nursing homes. We and others have 

reported that Medicare and Medicaid spending may not be sustainable at 

5%

6%

7%

9%

24%

49%

Active loan dollars Number of loans

Massachusetts

Ohio

California

Illinois

New York

Remaining

states and

territories

5%

6%

7%

11%

9%

62%

Ohio

California

Illinois

New York

Remaining

states and

territories

Source: GAO analysis of data from F47 (a HUD multifamily housing database).

Massachusetts
Page 27 GAO-06-515 Residential Care Facilities

current levels.21 In our 2003 report on the impact of fiscal pressures on 

state reimbursement rates, however, we found that even in states that 

recently faced fiscal pressures, reimbursement rates remained largely 

unaffected.22 At that time, we concluded that any future changes to state 

reimbursement rates remain uncertain. If program cuts occur in federal 

spending on Medicaid that result in shifting costs from the federal 

government to state governments, states could contain costs by taking a 

number of steps, including freezing or reducing reimbursement rates to 

providers. An ongoing tension exists, however, between what federal and 

state governments and the nursing home industry believe to be reasonable 

Medicare and Medicaid reimbursement rates to operate efficient and 

economic facilities that provide quality care to public beneficiaries. As the 

federal and state governments face growing long-term financial pressure on 

their budgets, these budgetary pressures may have some spillover effects 

on Medicare and Medicaid revenue streams for the nursing home industry. 

Uncertainty also exists about the future demand for residential care 

facilities and the corresponding effects on occupancy. As the number of 

Americans aged 65 and older increases at a rapid pace, lenders we 

interviewed projected an increased need for residential care facilities.23

Industry officials also noted a rise in alternatives to nursing home care, 

such as assisted living facilities and home and community-based care 

options. As patients choose alternative care options, traditional nursing 

homes may face occupancy challenges. Overall, these changes to the 

nursing home facilities patient base may lower occupancy and income 

levels for nursing homes, including those in the Section 232 portfolio. 

However, these changes may positively affect the occupancy and income 

levels of other types of residential care facilities, including those in the 

Section 232 portfolio. 

21GAO, 21st Century: Reexaming the Base of the Federal Government, GAO-05-325SP

(Washington, D.C.; Feb. 1, 2005), 33-35; GAO, Long-Term Care Financing: Growing 

Demand and Cost of Services Are Straining Federal and State Budgets, GAO-05-564T

(Washington, D.C.; Apr. 27, 2005), 7; Fitch Ratings, 2005 Non-Profit Hospitals and Health 

Care Systems Forecast (New York, NY: Jan. 20, 2005), 8.

22GAO-04-143, 3.

23GAO, Aging Issues: Related GAO Products in Calendar Years 2001 and 2002, GAO-04-

275R (Washington, D.C.: Nov. 21, 2003), 1.
Page 28 GAO-06-515 Residential Care Facilities

FHA Uses a Number of 

Tools to Mitigate Risks

As described elsewhere in this report, FHA uses a number of tools to 

mitigate risks to the program and to the GI/SRI Fund. These tools include 

imposing requirements prior to insuring loans to help prevent riskier loans 

from entering the Section 232 portfolio. FHA also uses various tools—such 

as reports on physical inspections of facilities, and financial and other 

information captured in data systems—to monitor the status of insured 

facilities and the performance of their loans. Additionally, FHA officials use 

quality control reviews to mitigate the risk for the program as a whole using 

two processes: Quality Management Reviews and Lender Qualifications 

and Monitoring Division reviews (the latter reviews are described in app. 

II). 

HUD’s Model for 

Estimating Credit 

Subsidy Costs 

Excludes Some 

Potentially Relevant 

Factors

HUD’s model for estimating annual credit subsidies—which incorporates 

assessments of various risks that loan cohorts will face and includes 

assumptions consistent with the Office of Management and Budget (OMB) 

guidance—does not explicitly consider the impacts of some potentially 

important factors. These factors include: variables to capture the impact of 

prepayment penalties or restrictions on prepayments, the loan-to-value 

ratio and debt service coverage ratios of Section 232 properties at the time 

of loan origination and differences between types of residential care 

facilities. Further, the model does not fully capture the effects on existing 

loans to changes in market interest rates, and it uses proxy data that are 

not comparable to the loans in the Section 232 program. As a result, HUD’s 

model for estimating the program’s credit subsidy may result in over- or 

underestimation of costs. 

HUD Uses a Model to 

Estimate Credit Subsidy 

Costs

Federal law requires HUD to estimate a credit subsidy for its loan 

guarantees. The credit subsidy cost is the estimated long-term cost to the 

government of a loan guarantee calculated on a net present value basis and 

excluding administrative costs. HUD estimates a credit subsidy for each 

loan cohort. This estimate reflects HUD’s assessment of various risks, 

based in part on the performance of loans already insured. Since 2000, HUD 

has annually estimated two credit subsidy rates for the Section 232 

program, reflecting its two largest risk categories: loans for new 
Page 29 GAO-06-515 Residential Care Facilities

construction and substantial rehabilitation, and loans for refinance and 

purchase loans.24 HUD uses an identical methodology for each estimate. 

To estimate the initial subsidy cost of the Section 232 program, HUD uses a 

cash flow model to project the cash flows for all identified loans over their 

expected life. The cash flow model incorporates regression models and 

uses assumptions based on historical and projected data to estimate the 

amount and timing of claims, subsequent recoveries from these claims, 

prepayments, and premiums and fees paid by the borrower. The regression 

models incorporate various economic variables such as changes in GDP, 

unemployment rate, and 10-year bond rates. The model also has broken out 

claim and prepayment data into new construction and refinance loans 

since these loans are expected to perform differently. 

HUD inputs its estimated cash flows into OMB’s credit subsidy calculator, 

which calculates the present value of the cash flows and produces the 

official credit subsidy rate. A positive credit subsidy rate means that the 

present value of cash outflows is greater than inflows, and a negative credit 

subsidy rate means that the present value of cash inflows is greater than 

cash outflows. For the Section 232 program, cash inflows include 

premiums and fees, servicing and repayment income from notes held in 

inventory, rental income from properties held in inventory, and sale income 

from notes and properties sold from inventory. Cash outflows include claim 

payments and expenses related to properties held in inventory. 

Since HUD began estimating the initial subsidy cost of the Section 232 

program, it has estimated that the present value of cash inflows would 

exceed the outflows. As a result, the initial credit subsidy rates for the 

Section 232 program were negative. However, estimates from more recent 

years showed that the negative subsidy rates on new construction and 

substantial rehabilitation loans have generally been shrinking, meaning 

that the projected difference between the program’s cash inflows and cash 

outflows was decreasing. In HUD’s most recent estimate (for the fiscal year 

2007 cohort), the estimated cash inflows exceed the estimated cash 

outflows by a considerably greater margin than in any previous year’s 

estimate. This may reflect increased premiums for Section 232 loans; the 

President’s proposed budget for fiscal year 2007 specifies increases in 

24For purposes of tracking Section 232 loans in its databases, HUD groups together 

refinance and purchase loans. Similarly, it also groups together new construction and 

substantial rehabilitation loans.
Page 30 GAO-06-515 Residential Care Facilities

mortgage insurance premiums for almost all FHA programs, including 

increasing the rate for Section 232 refinance and new construction loans to 

80 basis points from 57 basis points. Figure 6 shows changes in the initial 

estimated credit subsidy rate over time for both loan categories. 

Figure 6: Initial Credit Subsidy Estimates for Section 232 Program New Construction and Substantial Rehabilitation Loans and 

for Section 232 Program Refinance and Purchase Loans Have Not Indicated a Need for Subsidies

Note: Initial credit subsidy estimates were not available for 1997 for new construction and substantial 

rehabilitation loans and for 1996-1999 for refinance and purchase loans.

Features of the Credit 

Subsidy Model May Lead to 

Unreliable Credit Subsidy 

Estimates 

HUD’s model for estimating credit subsidy rates incorporates numerous 

variables, but the model’s exclusion of potentially relevant factors and its 

use of proxy data from another FHA loan program may negatively affect 

the quality of the estimates. Including additional information in the model 

could enhance the predictive value of the model. 

-5

-4

-3

-2

-1

0

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Credit subsidy rate

Fiscal year

Refinance/purchase loans

New construction/substantial rehabilitation loans

Source: GAO analysis of OMB federal credit supplement data (1996-2007).

N/A
Page 31 GAO-06-515 Residential Care Facilities

Prepayment Penalties or 

Restrictions

According to some economic studies, prepayment penalties, or penalties 

associated with the payment of a loan before its maturity date, can 

significantly affect borrowers’ prepayment patterns.25 This is also 

important for claims, since if a loan is prepaid it can no longer go to claim. 

HUD’s model does not explicitly consider the potential impact of 

prepayment penalties or restrictions, even though they can influence the 

timing of prepayments and claims and collections of premiums. According 

to FHA officials, FHA does not place prepayment penalties on FHA-insured 

nursing home loans. However, according to the Section 232 program’s 

regulations, a lender can impose a prepayment penalty charge and place a 

prepayment restriction on the mortgage’s term, amount, and conditions.26

We reviewed a sample of Section 232 loans and found that prepayment 

penalties and restrictions were consistently applied to these loans.27 

According to FHA officials and mortgage bankers, prepayment restrictions 

on Section 232 loans typically range from 2 to 10 years of prepayment 

restrictions and 2 to 8 years of prepayment penalties. While FHA does not 

specifically maintain data on insured residential care facility financing 

terms, prepayment restrictions are specified on the mortgage note, which is 

available to FHA. Incorporation of such data into the Section 232 program’s 

credit subsidy rate model could refine HUD’s credit subsidy estimate by 

enhancing the model’s ability to account for estimated changes in cash 

flows as a result of prepayment restrictions. 

According to HUD officials responsible for HUD’s cash flow model, 

prepayment penalties and restrictions are not incorporated into the model 

because HUD does not collect such data. HUD officials added that even 

though the cash flow model does not explicitly account for prepayment 

penalties and restrictions, its use of historic data implicitly captures trends 

that may occur as a result of prepayment penalties and restrictions. The 

25Jesse M. Abraham and H. Scott Theobald, “A Simple Prepayment Model of Commercial 

Mortgages,” Journal of Housing Economics, vol. 6 no. 1, (1997); Austin Kelly; V. Carlos 

Slawson, Jr., “Time-Varying Mortgage Prepayment Penalties,” Journal of Real Estate 

Finance and Economics, vol. 23, no. 2, (2001); Qiang Fu, Michael LaCour-Little, and Kerry 

D. Vandell, “Commercial Mortgage Prepayments Under Heterogeneous Prepayment Penalty 

Structures,” vol. 25, no. 3 (2003). 

26The regulations also state that prepayment restrictions and penalty charges must be 

acceptable to the FHA Commissioner.

27We analyzed prepayment restrictions from the mortgage notes of 32 projects with loan 

payments beginning in 2001 to 2005. 
Page 32 GAO-06-515 Residential Care Facilities

model’s projections are influenced by the average level of prepayment 

protection in the historical data but not by the trend. If prepayment 

penalties and other restrictions have changed over time in the past, or 

change in the future, then not incorporating this information could lead to 

less reliable estimates. 

Debt Service Coverage Ratio at 

Point of Loan Origination

Initial debt service coverage ratios are another important factor that may 

affect cash flows, as loans with lower initial debt service coverage ratios 

may be more likely to default and result in a claim payment. HUD’s cash 

flow model does not consider the initial debt service coverage ratio of 

Section 232 loans at the point of loan origination. By initial debt service 

coverage ratio, we are referring to the projected debt service coverage ratio 

that is considered during loan underwriting. According to the HUD official 

responsible for HUD’s cash flow model, the initial debt service coverage 

ratio of a residential care facility is not included as a part of the cash flow 

model because it (1) is not a cash flow, (2) does not vary, and (3) has no 

predictive value. We agree that a debt service coverage ratio is not a cash 

flow. However, initial debt service coverage ratios potentially affect 

relevant cash flows, as do other factors that are included in HUD’s model 

but are also not cash flows to HUD, such as prepayments. For example, the 

model considers estimated prepayments because they potentially affect 

future cash inflows from fees and future cash outflows from claim 

payments. 

Our analysis of available projected debt service coverage ratios, which 

include the amount of new debt being insured, shows that these ratios 

varied from 1.1 to 3.6.28 All other factors being equal, loans with debt 

service coverage ratios of 3.6 are generally considered to have less risk 

than a loan with only a 1.1 debt service coverage ratio. 

Economic theory suggests that the debt service coverage ratio is an 

important factor in commercial mortgage defaults. However, empirical 

studies show mixed results regarding the significance of the impact of debt 

service coverage ratios upon commercial mortgage defaults. Some studies 

indicate that debt service coverage ratios are meaningful factors in 

modeling default risk and are helpful in predicting commercial mortgage 

28We analyzed debt service coverage ratios from the underwriting reports of 42 projects that 

applied for mortgage insurance between fiscal years 2000 and 2006. 
Page 33 GAO-06-515 Residential Care Facilities

terminations.29 Other studies find initial debt service coverage ratios to be 

statistically insignificant in modeling commercial mortgage defaults.30

These mixed results may be the consequence of relatively small sample 

sizes and model specification issues.

Loan-to-Value Ratio at Point of 

Loan Origination

Initial loan-to-value ratios are another important factor that may affect cash 

flows, as loans with higher initial loan-to-value ratios may be more likely to 

default and result in a claim payment. By initial loan-to-value ratio, we are 

referring to the projected loan-to-value ratio that is considered during loan 

underwriting. HUD’s cash flow model also does not consider the initial 

loan-to-value ratio of Section 232 loans at the point of loan origination. 

According to the HUD official responsible for HUD’s cash flow model, the 

initial loan-to-value ratio of a Section 232 property is not included as a part 

of the cash flow model because it does not vary and has no predictive 

value. However, our analysis of available projected loan-to-value ratios, 

which include the amount of new debt being insured, shows that these 

ratios varied from 66 percent to 95 percent.31 All other factors being equal, 

loans with loan-to-value ratios of 66 percent are generally considered to 

have less risk than a loan with only a 95 percent loan-to-value ratio. While 

economic theory suggests that the loan-to-value ratio is an important factor 

in commercial mortgage defaults, empirical studies show mixed results 

regarding its significance. Some studies indicate that loan-to-value ratios 

are meaningful factors in modeling default risk and are helpful in predicting 

29Athanasios Episcopos, Andreas Pericli, and Jianxun Hu, “Commercial Mortgage Default: A 

Comparison of Logit with Radial Basis Function Networks,” Journal of Real Estate Finance 

and Economics, vol. 17, no. 2, (1998); and Wayne R. Archer, Peter J. Elmer, David M. 

Harrison, and David C. Ling, “Determinants of Multifamily Mortgage Default,” Real Estate 

Economics, vol. 30, no. 3 (2002).

30Brian A. Cochetti, Honeying Deng, Bin Gao, and Rui Yao, “The Termination of Commercial 

Mortgage Contracts Through Prepayment and Default: A Proportional Hazard Approach 

with Competing Risks,” Real Estate Economics; vol. 30, no. 4 (2002); Kerry D. Vandell, 

Walter Barnes, David Hartzell, Dennis Kraft, and William Wendt, “Commercial Mortgage 

Defaults: Proportional Hazards Estimation Using Individual Loan Histories,” Journal of the 

American Real Estate and Urban Economics Association, vol. 21, no. 4 (1993).

31We analyzed loan-to-value ratios from the underwriting reports of 42 projects that applied 

for mortgage insurance between fiscal years 2000 and 2006. 
Page 34 GAO-06-515 Residential Care Facilities

commercial mortgage terminations.32 Other studies find initial loan-to-value 

ratios to be statistically insignificant in modeling commercial mortgage 

defaults.33 These mixed results may be the consequence of relatively small 

sample sizes and model specification issues. 

Types of Facilities Insured and 

Changes in Interest Rates

The model’s ability to reliably forecast claim rates may be enhanced by 

incorporating a variable indicating facility type into the regression analysis. 

HUD’s cash flow model does not explicitly consider differences in loan 

performance between types of facilities, such as nursing homes, assisted 

living facilities, and board and care facilities. However, when looking at the 

most recent cohorts for which 5-year claim rates are available, our analysis 

found the 5-year claim rates for assisted living facilities to be significantly 

higher than the 5-year claim rates for nursing homes (6.7 percent 5-year 

claim rate for nursing homes versus 13.6 percent for assisted living 

facilities). 

In addition, we found that HUD’s cash flow model generally incorporates 

the interest rate on the individual loans (the contract rate) and the 

prevailing market interest rate (captured by the 10-year bond rate) as 

separate variables. Economic theory suggests, when modeling mortgage 

terminations, that considering these two variables jointly as a single 

variable in the form of a ratio is the best way to capture the effects on 

existing loans when market interest rates change.34 For example, if market 

rates fall below the contract rate on existing Section 232 loans, then it may 

become more attractive for borrowers to prepay. However, if market rates 

32Y. Deng, J. Quigley, and A. Sanders, “Commercial Mortgage Terminations: Evidence from 

CMBS,” University of Southern California (2004); Athanasios Episcopos, Andreas Pericli, 

and Jianxun Hu, “Commercial Mortgage Default: A Comparison of Logit with Radial Basis 

Function Networks,” Journal of Real Estate Finance and Economics vol. 17, no. 2, (1998); 

and Office of Federal Housing Enterprise Oversight, “Risk-Based Capital Regulation: Second 

Notice of Proposed Rulemaking,” Federal Register 64 (1999).

33Wayne R. Archer, Peter J. Elmer, David M. Harrison, and David C. Ling, “Determinants of 

Multifamily Mortgage Default,” Real Estate Economics, vol. 30, no. 3 (2002); B. Ambrose and 

A. Sanders, “Commercial Mortgage-Backed Securities: Prepayment and Default,” Journal of 

Real Estate Finance and Economics, vol. 26, no. 2 and 3.

34Scott Richard and Richard Roll, “Prepayments on Fixed-rate Mortgage-backed Securities,” 

Journal of Portfolio Management, Spring 1989. Additionally, we found other studies which 

include market rate and contract rate as a ratio in the modeling of mortgage terminations. 

These studies include B. Ambrose and A. Sanders, “Commercial Mortgage-Backed 

Securities: Prepayment and Default,” Journal of Real Estate Finance and Economics, vol. 

26, no. 2 and 3; and Qiang Fu, Michael LaCour-Little, and Kerry D. Vandell, “Commercial 

Mortgage Prepayments Under Heterogeneous Prepayment Penalty Structures,” 25, 3 (2003). 
Page 35 GAO-06-515 Residential Care Facilities

fall but remain above the contract rates, then it may not become more 

attractive for borrowers to prepay. Using a ratio captures the distinction 

between these two examples because it considers the relative cost to the 

borrower of the mortgage given the contract rate, as compared to the 

mortgage with the market interest rate. By generally considering the 

contract rate and market interest rate separately, HUD potentially loses the 

ability to capture this distinction and predict large responses when market 

rates fall and small responses when market rates rise.35

Use of Proxy Data HUD’s use of Section 207 loans as a proxy for Section 232 refinance loans 

could lead to less reliable credit subsidy estimates for the Section 232 

program. HUD uses certain Section 207 loans—refinance loans for existing 

multifamily housing properties—as proxy data for the claim regression for 

Section 232 refinance loans. The Section 207 loans are not residential 

health care facility loans. According to HUD officials, HUD uses the Section 

207 loans because there are insufficient data on Section 232 refinance 

loans. A HUD official told us that Section 207 loans were selected as proxy 

data because they are refinance loans and because they have similar 

performance to the Section 232 refinance loans, as indicated by the 

cumulative claim rates they calculated. 

Consideration of the basis for using proxy data is important. When using 

the experience of another agency or a private lender as a proxy, the Federal 

Accounting Standards Advisory Board (FASAB) suggests that an agency 

explain why this experience is applicable to the agency's credit program 

and examine possible biases for which an adjustment is needed, such as 

different borrower characteristics.36 HUD could reasonably be expected to 

follow the FASAB guidance when using data from a different program at 

HUD. HUD told us that they did not compare borrower characteristics for 

Section 207 loans and Section 232 loans. A HUD official told us that HUD 

agreed that they would not expect borrowers of Section 207 loans to have 

similar characteristics to borrowers of Section 232 loans. 

35One of HUD’s regressions calculates the difference between contract rates and market 

rates. Considering the difference between the contract rate and the market rate is better 

than considering the rates separately, but is still not as strong an approximation as using a 

ratio. See Richard and Roll.

36FASAB is responsible for promulgating accounting standards for the U.S. government, and 

these standards are recognized as generally accepted accounting principles for the federal 

government. FASAB developed standards for agencies regarding the basis for supporting 

cash flow assumptions for loan guarantee programs.
Page 36 GAO-06-515 Residential Care Facilities

HUD analyzed the comparability of Section 207 and Section 232 refinance 

loans using cumulative claim rate analysis, but we question the 

methodology the agency used to make this comparison. Additionally, we 

compared the refinance loans for each of the programs by calculating 

conditional claim and prepayment rates as well as 5-year cumulative claim 

and prepayment rates, and we found significant differences between the 

programs (see app. IV for a further description of HUD’s methodology and 

our comparison of the two programs). 

We question HUD’s use of Section 207 loans as a proxy for Section 232 

loans, given the differences we observed. We cannot fully estimate the 

overall impact on the credit subsidy estimate, and the effects of the claim 

and prepayment rates could partially offset each other. The higher 

prepayment rates for Section 207 loans could lead to HUD underestimating 

future revenues for Section 232 loans (HUD would project that many of 

these loans would terminate, although they would actually remain active 

and pay premium revenue to HUD.) The lower claim rates on Section 207 

loans could result in HUD estimating that fewer of its Section 232 loans 

would result in a claim and thus lead it to underestimate future costs. 

In the future, more data will be available on the actual performance of 

Section 232 refinance loans that can be used in estimating credit subsidy 

needs. To avoid using questionable proxy data in the interim, one possible 

approach, among others, would be to use a simpler estimation method, 

such as using average claim and prepayment rates over time as is done in 

estimating credit subsidy rates for the Section 242 Hospital Mortgage 

Insurance program.

Conclusions The Section 232 program is the only source of mortgage insurance for 

residential care facilities. Accordingly, it is important to ensure good 

program and risk management practices. While some field offices we 

visited had adopted practices to better manage risks of their Section 232 

loans, varying awareness of program requirements and insufficient levels 

of staff expertise contribute to increased financial risk in the Section 232 

program loan portfolio and thus the GI/SRI Fund. HUD has numerous 

underwriting and monitoring guidelines and policies to manage the risks of 

Section 232 loans. However, to the extent that field office staff do not 

accurately implement current underwriting and monitoring guidelines and 

policies, they potentially allow loans with unwarranted risks to enter the 

portfolio and may miss opportunities to identify problems with alreadyinsured loans early enough to help prevent claims. Revising the 
Page 37 GAO-06-515 Residential Care Facilities

“Multifamily Asset Management and Project Servicing Handbook” to 

include monitoring requirements specific to the Section 232 program, as 

the Office of Inspector General noted in its 2002 report, would help in this 

regard. So too would the sharing of additional practices, such as involving 

asset management staff in the underwriting process, undertaken by some 

field offices to better manage risks in their program loans. Moreover, 

adequately training staff to develop expertise on residential care loans and 

industry could help assure proper underwriting and oversight of Section 

232 loans, which tend to be more complex than those in other HUD 

multifamily programs. Field office officials’ concerns about their existing 

levels of staff expertise heighten the need for appropriate guidance and 

additional training specific to the Section 232 program, while the potential 

loss of specialized staff within the next 5 years underscores the need for 

HUD, in the context of its strategic human capital efforts, to assure 

adequate program expertise in the future. 

Although HUD recommends that field offices obtain and review annual 

inspection reports for licensed facilities insured by the program, four of 

five offices we visited did not do so. By not routinely using, in combination 

with other performance indicators, the results of annual inspection reports 

on insured facilities subject to such inspections, HUD may be missing 

important indicators of problems that could result in claims that might 

otherwise have been prevented. Reviewing inspection reports is also a 

means of obtaining relevant information about insured facilities that have 

not been the subject of FHA management reviews. HUD’s long-proposed 

revisions to its residential care facility regulatory agreement recognize the 

potential usefulness of information on state-administered inspections by 

requiring that owners or operators report inspection violations and supply 

HUD with copies of annual inspection reports. The proposed revisions 

would also address a number of the internal control weaknesses identified 

by the HUD Inspector General’s 2002 report, but it remains unclear when 

the proposed revisions will be approved, leaving the program exposed to 

identified weaknesses in the interim. 

While the Section 232 program represents a relatively small portion of the 

GI/SRI Fund, it faces risks that could affect the performance of the loan 

portfolio and the fund. HUD uses a number of tools to mitigate risks, and it 

will be important to continue monitoring program trends and industry 

developments. Recent increases in the numbers of assisted living facility 

loans and refinance loans are a source of uncertainty, in that there is as yet 

little data with which to assess their long-term performance. Similarly, 

industry trends and the availability of future Medicaid and Medicare funds 
Page 38 GAO-06-515 Residential Care Facilities

are sources of uncertainty, and heighten the need for HUD to have 

sufficient staff expertise with which to monitor future developments that 

could affect the program and ultimately the GI/SRI Fund.

HUD’s model for estimating the program’s credit subsidy incorporates 

assessments of various risks that loan cohorts face, but it does not 

explicitly consider certain factors that could result in over- or 

underestimation of costs. These factors include prepayment penalties, 

lockout provisions, facility type, loan-to-value ratio, the debt service 

coverage ratio of loans at commitment, and the ratio of contract rates to 

markets rates, which some economic studies suggest are potentially useful 

in modeling risks. Including such factors could enhance the credit subsidy 

estimates and provide HUD and the Congress with better cost data with 

which to assess the program. Additionally, HUD’s use of Section 207 

refinance loans, which we do not find to be a good proxy for Section 232 

refinance loans, could specifically contribute to over- or underestimation of 

the credit subsidy for the refinance loans in the program.

Recommendations for 

Executive Action

To ensure that field offices are aware of and implement current 

requirements and policies for the Section 232 Mortgage Insurance for 

Residential Care Facilities program, and reduce risk to the GI/SRI Fund, we 

recommend that the Secretary of Housing and Urban Development direct 

the FHA Commissioner to take the following actions: 

• Revise the “Multifamily Asset Management and Project Servicing 

Handbook” in a timely manner to include monitoring requirements 

specific to Section 232 properties;

• Establish a process for systematically sharing loan underwriting and 

monitoring practices among field offices involved with the Section 232 

program;

• Assure, as part of the department’s strategic human capital management 

efforts, sufficient levels of staff with appropriate training and expertise 

for Section 232 loans;

• Incorporate a review of annual inspection reports for insured Section 

232 facilities that are subject to federal or state inspections, even in the 

absence of a revised regulatory agreement; and 
Page 39 GAO-06-515 Residential Care Facilities

• Complete and implement the revised regulatory agreements in a timely 

manner. 

To potentially improve HUD’s estimates of the program’s annual credit 

subsidy, we recommend that the Secretary of Housing and Urban 

Development explore the value of explicitly factoring additional 

information into its credit subsidy model, such as prepayment penalties 

and restrictions, debt service coverage and loan-to-value ratios of facilities 

as they enter the program, facility type, and the ratio of contract rates to 

market rates. We also recommend that the Secretary of Housing and Urban 

Development specifically explore other means of modeling the 

performance of Section 232 refinance loans. 

Agency Comments and 

Our Evaluation

We provided a draft of this report to HUD for their review and comment. In 

written comments from HUD’s Assistant Secretary for Housing-Federal 

Housing Commissioner, HUD generally concurred with our 

recommendations intended to ensure that field offices are aware of and 

implement current program requirements and policies. However, the 

agency disagreed with most parts of our recommendation related to HUD’s 

credit subsidy model. The Assistant Secretary’s letter appears in appendix 

V. 

HUD stated that it has initiated a full review of the Section 232 program and 

that GAO’s recommendations related to ensuring that field offices are 

aware of and implement current requirements are being incorporated into 

plans for revising the program. More specifically, HUD stated that it:

• will draft and implement changes to the program handbook;

• will initiate staff training and assure that staff is adequately trained in 

underwriting and servicing policies; and

• plans to prepare a report addressing state and federal inspections, 

among other things, to enhance FHA participation in and oversight of 

insured health care mortgages.

HUD also provided a timeline by which to complete and implement the 

revised regulatory agreements.

Concerning our recommendation that HUD explore the value of explicitly 

factoring in additional information into its credit subsidy model, HUD 
Page 40 GAO-06-515 Residential Care Facilities

stated that it agreed to take into account differences among types of 

residential care facilities in its modeling, when it has sufficient historical 

data and if the data indicate that loan performance varies sufficiently by 

type of facility. However, HUD disagreed with considering other factors we 

suggested, as follows:

• Initial loan-to-value and debt service coverage ratios. HUD stated that 

(1) studies we cited in our draft report found these ratios to be 

statistically insignificant in predicting commercial mortgage defaults 

and (2) that data are unavailable for this analysis. We agree, as our draft 

report stated, that economic studies have shown mixed results 

regarding the significance of the impact of loan-to-value and debt 

service coverage ratios on commercial mortgage defaults, with some 

studies finding them to be significant predictors and others finding them 

to be insignificant predictors. We further stated that these mixed results 

may be the result of small sample sizes and model specification issues. 

Nevertheless, we continue to believe that HUD should explore the value 

of factoring initial loan-to-value ratio and debt service coverage ratio 

into its credit subsidy model, and we did not change our 

recommendation. Regarding the second point, HUD has the data for 

analyzing loan-to-value and debt service coverage ratios in individual 

loan files and could include these data in its credit subsidy modeling by 

creating an electronic record of this information either for its entire 

portfolio or for a sample of the portfolio. Consequently, we did not 

change the recommendation.

• Factors potentially affecting prepayments. HUD disagreed with our 

suggestion that its credit subsidy model does not fully capture the 

effects of prepayment penalties, stating that its use of historical data 

captures the effect of prepayment penalties on project owners’ behavior. 

However, as we stated in the draft report, HUD’s use of historic data 

would not fully capture trends related to changes in prepayments. HUD 

also stated that it has tested using the difference between mortgage 

interest rates and the 10-year Treasury bond rates in its modeling of 

prepayments. However, our recommendation was to consider a ratio of 

these two interest rates, not the difference. As we noted in our report, 

economic theory suggests that the use of a ratio is the best way to 

capture the effects on existing loans when market interest rates change. 

Consequently, we did not change the recommendation.

• Use of Section 207 loans as proxy data for refinance loans. HUD stated 

that it did not believe that the differences between Section 207 and 
Page 41 GAO-06-515 Residential Care Facilities

Section 232 loans that our report noted justify concerns that residential 

care refinance loans are being improperly modeled and noted a lack of 

available data. We agree that sufficient relevant data on Section 232 

refinance loan performance do not yet exist, but we continue to 

question the use of Section 207 loan data as a proxy. While we did not 

change the recommendation, we added language to our report 

suggesting that, until enough Section 232 refinance loan data are 

available, one possible approach, among others, would be to use a 

simpler estimation method, such as using average claim and prepayment 

rates over time as is done in estimating credit subsidy rates for the 

Section 242 Hospital Mortgage Insurance program. 

We are sending copies of this report to the Secretary of the Department of 

Housing and Urban Development (HUD). We also will make copies 

available to others upon request. In addition, the report will be available at 

no charge on the GAO Web site at http://www.gao.gov.

If you or your staff have any questions about this report or need additional 

information, please contact me at 202-512-8678 or woodd@gao.gov. Contact 

points for our offices of Congressional Relations or Public Affairs may be 

found on the last page of this report. GAO staff who made major 

contributions to this report are listed in appendix V. 

David G. Wood, Director

Financial Markets and Community Investment
Page 42 GAO-06-515 Residential Care Facilities

List of Congressional Addressees

The Honorable Christopher Bond

Chairman

The Honorable Patty Murray

Ranking Member

Subcommittee on Transportation, 

Treasury, the Judiciary, Housing and Urban 

Development, and Related Agencies

Committee on Appropriations

United States Senate 

The Honorable Jack Reed

Ranking Minority Member

Subcommittee on Housing and Transportation

Committee on Banking, Housing, and Urban Affairs

United States Senate

The Honorable Joe Knollenberg

Chairman 

The Honorable John W. Olver

Ranking Member

Subcommittee on Transportation, Treasury, and

Housing and Urban Development, The Judiciary,

District of Columbia, and Independent Agencies

Committee on Appropriations

House of Representatives

The Honorable Lincoln Chafee

United States Senate

The Honorable Patrick Kennedy

House of Representatives

The Honorable James Langevin

House of Representatives
Page 43 GAO-06-515 Residential Care Facilities

Appendix I

Objectives, Scope, and Methodology AAppenednxidexiIs

Our objectives were to examine (1) the Department of Housing and Urban 

Development’s (HUD) overall management of the program, including loan 

underwriting and monitoring; (2) the extent to which HUD’s oversight of 

insured health care facilities is coordinated with the states’ oversight of the 

quality of care provided by facilities; and (3) the financial implications of 

the program to the General Insurance/Special Risk Insurance (GI/SRI) 

Fund, including risk posed by program and market trends; and (4) how 

HUD estimates the annual credit subsidy for the program, including the 

factors and assumptions used. In addition, we examined HUD’s action in 

response to a HUD Inspector General report that concluded that HUD’s 

Office of Housing did not have adequate controls to effectively manage the 

Section 232 program; this information is summarized in appendix III.

To examine HUD’s overall management of the Section 232 program, we 

obtained and reviewed program manuals, guidance, and documentation, 

including the “MAP Guide,” HUD’s Section 232 “Mortgage Insurance for 

Residential Care Facilities Handbook,” and HUD’s “Multifamily Asset 

Management and Project Servicing Handbook,” for loan processing 

procedures, underwriting policies and requirements, and oversight policies 

and requirements. We also interviewed HUD officials at HUD headquarters 

who are responsible for providing guidance and policies on loan 

underwriting and oversight and three private lenders that offered FHAinsured Section 232 loans. In addition, we conducted site visits to five HUD 

field offices (Atlanta, Georgia; Buffalo, New York; Chicago, Illinois; Los 

Angeles, California; and San Francisco, California) and conducted 

interviews with HUD officials, including the Hub or acting Hub director, 

appraisers, mortgage credit analysts, and project managers that are 

responsible for Section 232 loan applications, underwriting, and oversight, 

as well as other Federal Housing Administration (FHA) programs. We 

gathered relevant program documentation from each site visit. We also 

interviewed an official from one of HUD’s Multifamily Property Disposition 

Centers during our site visit to Atlanta. To capture a variety of Section 232 

loan activity, we selected five HUD field offices on the basis of (1) the 

volume of Section 232 loans the field office had processed during fiscal 

year 2004 up to September 2005; (2) the dollar amount of Section 232 loans 

processed in the field office during fiscal year 2004 up to September 2005; 

(3) the timeliness of processing Section 232 loans during the last 2 years; 

(4) historical claim-rate data for the field office—that is, the rate at which 

Section 232 loans processed by the field office have gone to claim; (5) 

HUD’s suggestions for field office site visits; and (6) geographical 

dispersion. 
Appendix I

Objectives, Scope, and Methodology

Page 44 GAO-06-515 Residential Care Facilities

To better understand how private lenders that do not participate in the 

Section 232 program manage risks, we interviewed five private lenders that 

offered non-FHA insured loans to residential health care facilities. We also 

interviewed representatives of three residential care facilities with FHAinsured Section 232 loans to better understand the borrowers perspective 

of the Section 232 program.

To examine the extent to which HUD coordinated with states’ oversight of 

quality of care provided by facilities, we reviewed FHA requirements for 

conducting management reviews and reviewing annual inspection reports. 

We also interviewed officials in FHA’s Office of Multifamily Development 

and Office of Asset Management and field office officials about policies for 

coordination between FHA and state residential care oversight and rate 

setting agencies, as well as policies for review of annual inspection reports. 

In addition, we interviewed private lenders of FHA-insured and non-FHA 

insured residential care facilities to better understand common industry 

practices for coordination between lenders and state residential care 

oversight and rate setting agencies. 

To examine the financial risks that the program poses to the GI/SRI Fund, 

we interviewed and obtained documentation from HUD’s Office of 

Evaluation and analyzed HUD data on program portfolio characteristics, 

including number of loans by cohort, current insurance in force, 

geographic and lender concentration of loans, and claims. We also analyzed 

HUD data used for their refinance credit subsidy regression model. 

Specifically:

• To obtain the number of active and terminated loans and claim rate 

history, we analyzed data from extracts of HUD’s F47 database, a 

multifamily database. We obtained extracts from HUD in May 2005, 

September 2005, and February 2006. Unless otherwise indicated, all 

analyses from the F47 data in the report utilized the May 2005 extract 

with subsequent updates from the other extracts and was current as of 

the end of fiscal year 2005. To assess the reliability of the F47 database 

extract, we reviewed relevant documentation, interviewed agency 

officials who worked with the database, and conducted manual data 

testing, including comparison to published data. Because of the small 

number of loans endorsed in individual fiscal years, we conducted 

analyses of cohorts that were created by combining data from 5 to 6 

fiscal years. For claim rate analyses, we analyzed 5- and 10-year claim 

rates for the data based on the date of loan termination. 
Appendix I

Objectives, Scope, and Methodology

Page 45 GAO-06-515 Residential Care Facilities

• Our analyses found 13 loans for which facility type information was not 

able to be determined from the extract. FHA administrators were able to 

determine the facility type for all but one of these loans using the 

Development Application Processing (DAP) system. This one 

terminated loan was excluded from facility type endorsement and claim 

rate analysis and, therefore, had little impact on this report. We also 

determined final endorsement date information to be missing from 799 

records. Our analyses only used initial endorsement date information 

for which data was available for every record; therefore, there was no 

impact on this report. We also determined there were nine loans for 

which the facility type information was incorrect based on the 

endorsement date.1

 FHA administrators checked in the DAP system and 

confirmed the correct facility type for these loans; therefore, there was 

no impact on the report. We determined the data to be sufficiently 

reliable for analysis of number of active and terminated loans, as well as 

claim rates. 

• To determine the proportion of the Section 232 Mortgage Insurance 

program’s commitment authority to the larger GI/SRI Fund’s 

commitment authority, we reviewed HUD’s fiscal year 2006 budget. 

• To determine the proportion of the Section 232 Mortgage Insurance 

program’s unpaid principal balance to the larger GI/SRI Fund unpaid 

principal balance, we obtained the GI/SRI Fund’s unpaid principal 

balance as of December 31, 2005 from HUD’s Office of Evaluation. We 

also analyzed data from HUD’s Multifamily Data Web site, which is 

extracted from HUD’s F47 database, to determine the unpaid principal 

balance of Nursing Home Mortgage Insurance program loans as of 

December 31, 2005.2

• To determine the geographic concentration of loan properties in the 

program, we analyzed data current as of the end of fiscal year 2005 from 

our extract of HUD’s F47 database. Our analysis determined property 

state data was missing for 270 project numbers. FHA administrators 

informed us that loans endorsed more than 20 years ago, before 

1

These nine loans were coded as assisted living facility loans in F47. However, these loans 

were endorsed prior to HUD insuring assisted living facilities in 1994.

2

Department of Housing and Urban Development, “Insured Multifamily Mortgages 

Database,” Multifamily Data, http://www.hud.gov/offices/hsg/comp/rpts/mfh/mf_f47.cfm

(downloaded Feb. 24, 2006). 
Appendix I

Objectives, Scope, and Methodology

Page 46 GAO-06-515 Residential Care Facilities

electronic records were maintained, may have missing data that is 

unavailable. Our analyses of geographic concentration of loan 

properties utilized only one record with missing property state data; 

therefore, there was little impact on our findings. We determined the 

data to be sufficiently reliable for analysis of geographic loan 

concentration. 

• To determine the geographic concentration of loan dollars in the 

program we analyzed data current as of December 31, 2005, from HUD’s 

Multifamily Housing Data Web site. 

• To determine prepayment history in the program, we analyzed data from 

our F47 extract, current as of the end of fiscal year 2005. We also 

analyzed 5-and 10-year prepayment rates for the data based on the date 

of loan termination.

• To determine the appropriateness of using Section 207 refinance loans 

as proxy data in the Section 232 refinance loan credit subsidy estimate 

regression model, we analyzed data from several extracts from HUD’s 

Office of Evaluation. The extracts contained the loan data used by HUD 

to calculate cumulative claim rates for Section 232 and 207 refinance 

loans for loans endorsed from fiscal year 1992 through fiscal year 2005. 

The extracts did not include termination codes for all terminated loans. 

We determined termination code data for these loans from HUD data 

current as of December 31, 2005, from HUD’s Multifamily Housing Data 

Web site. We also combined the extracts to include all loans in one 

larger extract. In addition, we performed manual data reliability 

assessments of these extracts and determined that three loans should 

not have been included in the extracts because they had section of the 

act codes that were not within the parameters of our analysis as defined 

by the notes included in HUD’s extracts. These loans were not included 

in our analysis and, therefore, had no impact on our findings. We 

determined the data to be sufficiently reliable for analysis of the 

comparability of Section 207 refinance loans to Section 232 refinance 

loans. 

We conducted a literature review and interviewed numerous officials of 

lenders, residential care associations, and HUD to obtain information on 

risks due to health care market trends. We also searched for Inspectors 

General and agency reports through HUD Web sites. Finally, we conducted 

a search on our internal Web site to identify previous work on the Section 

232 program. 
Appendix I

Objectives, Scope, and Methodology

Page 47 GAO-06-515 Residential Care Facilities

To determine how HUD estimates the annual credit subsidy rate for the 

program, we reviewed documentation of HUD’s credit subsidy estimation 

procedures, reviewed the cash flow model for the program, and we 

interviewed program officials from HUD’s Office of Evaluation and 

program auditors from the Office of Management and Budget (OMB). We 

also compared the assumptions used in HUD’s cash flow model with 

relevant OMB guidance and reviewed economic literature on modeling 

defaults to identify factors that are important for estimation. Additionally, 

we analyzed data provided by HUD field offices on initial loan-to-value 

ratios and debt service coverage ratios (at the time of loan application). We 

obtained the credit subsidy rates from the Federal Credit Supplement of 

the United States Budget.

To review the actions HUD has taken in response to the HUD Inspector 

General’s 2002 report on the Section 232 program, we interviewed officials 

in HUD’s Office of Inspector General. In addition, we reviewed the HUD 

Inspector General’s 2002 report, as well as HUD’s Management Plan Status 

Reports for Implementation of Recommendation 1A of audit 2002-KC-0002. 

We also interviewed HUD headquarters officials, as well as field office 

officials during our site visits. 

Our review did not include an evaluation of underwriting criteria or the 

need for the program. We conducted our work in Atlanta, Georgia; Buffalo, 

New York; Chicago, Illinois; Los Angeles, California; San Francisco, 

California, and Washington, D.C., between February 2005 and April 2006, in 

accordance with generally accepted government auditing standards.
Page 48 GAO-06-515 Residential Care Facilities

Appendix II

Information on the Application Processing, 

Underwriting, and Oversight of Section 232 

Loans ApendxiI

Application Processing and 

Underwriting for Section 

232 Loans

The Department of Housing and Urban Development (HUD) currently 

processes a majority of the Section 232 loans using the Multifamily 

Accelerated Processing (MAP) program and processes some loans under 

Traditional Application Processing (TAP). Under MAP, the lender conducts 

the underwriting of the loan and submits a package directly to the Hub or 

program center for mortgage insurance. The Hub or program center 

reviews the lender’s underwriting and makes a decision whether or not to 

provide mortgage insurance for the loan. New construction and substantial 

rehabilitation loans require a preapplication meeting where HUD reviews 

required documentation up front. Under TAP, HUD, not the lender, is 

primarily responsible for the underwriting of the loan and determines 

whether or not to accept the loan. 

FHA has numerous underwriting requirements for loans made under the 

Section 232 program. Some examples include:

• Requiring documentation of a state-issued Certificate of Need (CON) for 

skilled nursing facilities and intermediate care facilities, and in states 

without a certificate of needs procedure, an alternative study of market 

needs and feasibility.

• Requiring an appraisal of the facility (prepared by the lender under the 

MAP program) and a market study with comparable properties.

• Reviewing current or prospective operators of the residential care 

facility and ensuring that they meet certain standards. For example, 

FHA has a requirement that operators of an assisted living facility have a 

proven track record of at least 3 years in developing, marketing, and 

operating either an assisted living facility or a board and care home.1

• For new construction facilities specifically, FHA requires a business 

plan along with an estimate of occupancy rates and prospective 

reimbursement rates with the percentage of population for patients 

whose costs are reimbursed through Medicare and Medicaid.

• For existing facilities applying for a refinance loan, FHA requires the 

submission of vacancy and turnover rates and current provider 

agreements for Medicare and Medicaid, 3 years of balance sheet and 

1

U.S. Department of Housing and Urban Development, Notice H 97-01, 4. 
Appendix II

Information on the Application Processing, 

Underwriting, and Oversight of Section 232 

Loans

Page 49 GAO-06-515 Residential Care Facilities

operating statements, as well as the latest inspection report on the 

project’s operation.2

• Requiring limits on loan-to-value and debt service coverage ratios, ratios 

identified by field office officials we interviewed as two of the more 

important financial ratios in the underwriting process. For example, for 

Section 232 loans, the loan-to-value ratio cannot exceed 90 percent for 

new construction loans, and 85 percent loan-to-value for refinance 

loans.3

For loans processed under MAP, HUD field office officials are required to 

use MAP Guide checklists to ensure that lenders follow FHA’s underwriting 

requirements. These checklists contained guidelines for reviewing lender 

submissions and overall parameters that an application must meet. For 

example, field office officials use an appraisal review checklist in the MAP 

Guide to ensure that the submitted market study complies with MAP 

requirements. For applications processed under TAP, field office officials 

stated that they use similar checklists to the ones included in the MAP 

Guide as the MAP Guide incorporates many of the Section 232 

underwriting requirements.

For MAP loans, HUD headquarters has a Lender Qualifications and 

Monitoring Division (LQMD) that conducts reviews of loans. LQMD is 

responsible for evaluating lender qualifications and lender performance. It 

reviews and ultimately approves lenders requesting MAP lender approval 

for loan underwriting. The division reviews a sample of lenders when a 

loan has defaulted or there is a need for additional lender oversight. While 

LQMD reviews are not specific to the Section 232 program, they help to 

monitor lenders participating in the program and ultimately help to reduce 

the number of risky loans that enter the portfolio.

2

According to the MAP Guide, the latest state residential care facility agency’s report on the 

project’s operation is required. The MAP Guide provides mortgage insurance program 

descriptions, mortgagor and lender eligibility requirements, application requirements, HUD 

underwriting standards for all technical disciplines, construction administration 

requirements, and closing instructions.

3

When determining the maximum insurable mortgage, HUD also has requirements regarding 

the acquisition costs and net earnings. For nonprofit mortgagors, the loan-to-value cannot 

exceed 95 percent for new construction loans and 90 percent for refinance loans.
Appendix II

Information on the Application Processing, 

Underwriting, and Oversight of Section 232 

Loans

Page 50 GAO-06-515 Residential Care Facilities

Oversight and Monitoring of 

Section 232 Loans

FHA requires field office staff to conduct a number of reviews for oversight 

of Section 232 loans. For example, staff address noncompliance items that 

are identified by HUD’s Financial Assessment Sub-System (FASS) for each 

facility. Noncompliance items can include items such as unauthorized 

distribution of project funds or unauthorized loans from project funds. 

Using information from the annual financial statement, FASS’s computer 

model statistically calculates financial ratios, or indicators, for each facility, 

and applies acceptable ranges of performance, weights, and thresholds for 

each indicator. FASS then generates a score for each facility based on these 

indicators, and this financial score represents a single aggregate financial 

measure of the facility. However, a HUD draft contractor study found that 

FASS did not adequately account for the unique nature of nursing homes in 

the Section 232 portfolio and, therefore, was a poor predictor of a nursing 

home going to claim. Field office officials we interviewed also review 

physical inspections conducted by HUD’s Real Estate Assessment Center 

(REAC), which is responsible for conducting physical assessments of all 

HUD-insured properties. Officials also ensure that the professional liability 

requirement for facilities is met and conduct file reviews to identify any 

activities that warrant additional oversight.4

 Additionally, officials in each 

field office we visited stated that they are required to monitor projects in 

HUD’s Real Estate Management System, the official source of data on 

HUD’s multifamily housing portfolio that maintains data on properties and 

to conduct risk assessments on their properties at least once a year to 

identify those facilities that are designated as troubled or potentially 

troubled based on their physical inspection, financial condition, and other 

factors. 

Field offices also varied in the utilization of HUD’s Online Property 

Integrated Information Suite (OPIIS), a centralized resource for HUD 

multifamily data and property analysis. According to officials at HUD 

headquarters, field office officials can use OPIIS to conduct a variety of 

portfolio analysis and view risk assessments on their properties to better 

assist them in overseeing their portfolios. For example, OPIIS contains an 

Integrated Risk Assessment score that combines financial, physical, loan 

payment status history, and other data into a score that can be used to 

4

In April 2001, HUD issued Notice H01-03, titled “Review of Health Care Facility Portfolios 

and Changes to the Section 232 Programs.” Section X of the notice established the 

requirement that HUD-insured health care facilities maintain professional liability 

insurance. Housing Notice 04-15 lists the requirements for professional liability insurance 

for owners and operators of health care facilities.
Appendix II

Information on the Application Processing, 

Underwriting, and Oversight of Section 232 

Loans

Page 51 GAO-06-515 Residential Care Facilities

identify at-risk properties and prioritize workloads. However, four of the 

five field offices that we visited did not frequently use OPIIS. Some of these 

offices used the system to develop risk rankings for their properties or in 

trying to obtain data about a property, but none of them regularly used the 

system for the monitoring of Section 232 loans. The one field office that 

utilized OPIIS more frequently did so because the system partly 

incorporates a loan risk and rankings system that the field office had 

previously developed for its own use. Officials in this field office stated that 

an issue with OPIIS is that it is not designed to capture important, specific 

financial information that is unique to some Section 232 loans, such as 

expenses on food or medication.
Page 52 GAO-06-515 Residential Care Facilities

Appendix III

HUD Officials Addressed Some Issues Raised 

by the Agency’s Inspector General in 2002, but 

Several Key Items Remain Unresolved ApendxiI

In a 2002 report, the Department of Housing and Urban Development’s 

(HUD) Inspector General found that HUD’s Office of Housing did not have 

adequate controls to effectively manage the Section 232 program.1

 Because 

of these weaknesses, the Inspector General found that HUD lacked 

assurance of the effective operation of Section 232 properties. The 

Inspector General noted that the Office of Housing had already taken steps 

to develop an action plan to address the weaknesses identified by a task 

force, but that time frames had not yet been established. The Inspector 

General recommended that the Office of Housing establish specific time 

frames for implementing the corrective actions for the 10 weaknesses 

identified by the task force and that it monitor the actions to ensure timely 

and effective completion. 

HUD officials developed a plan to correct the 10 control weaknesses 

identified by the Office of Housing, which included the current status of 

each action and specific target dates to complete the corrective actions. 

According to the Inspector General, HUD has taken action to address 2 of 

the 10 control weakness findings identified by the Office of Housing Task 

force and for which the Inspector General recommended that timelines for 

corrective actions be established.

The eight unresolved control weaknesses identified by the Office of 

Housing task force are all contingent upon approval of the proposed 

revisions to the regulatory agreements. However, the proposed revisions 

have been awaiting approval since August 2, 2004. According to HUD 

officials, the delay is a result of numerous administrative issues, which 

include changes in FHA management and extended public comment 

periods. 

The addressed control weaknesses and respective corrective actions 

involved loan underwriting. The Inspector General agreed with the Office 

of Housing task force, which found that HUD’s underwriting process for 

Section 232 properties needed to be strengthened and that HUD needed to 

complete market studies and background checks of applicants as part of 

the process. The Inspector General also agreed with the Office of Housing 

task force’s finding of potential problems associated with the nonrecourse 

nature of HUD Section 232 loans. In particular, it found that HUD needed to 

1

Department of Housing and Urban Development, Office of Inspector General, Nationwide 

Survey of HUD’s Office of Housing Section 232 Nursing Home Program, 2002-KC-0002 

(Kansas City, Missouri, 2002).
Appendix III

HUD Officials Addressed Some Issues Raised 

by the Agency’s Inspector General in 2002, 

but Several Key Items Remain Unresolved

Page 53 GAO-06-515 Residential Care Facilities

strengthen the regulatory agreements and underwriting process for Section 

232 loans if these mortgages were to remain nonrecourse and to avoid 

potential increase in the portfolio claim rate. HUD addressed these findings 

by adding requirements for operators, reviews of operators’ financial 

statements, and professional liability insurance. Furthermore, applications 

for projects that are considered marginal are rejected.

The eight remaining control weaknesses for which HUD has not fully 

completed its corrective actions are as follows: 

HUD lacks a handbook detailing monitoring requirements for nursing 

homes and assisted living facilities. The Inspector General found that 

HUD did not have a handbook specific to the Section 232 program 

monitoring requirements ensuring that all facilities follow the applicable 

regulatory agreements and state and federal requirements. In our site visits 

to five field offices, we found inconsistencies in the extent to which 

oversight procedures were followed, such as requiring operators to submit 

financial statements. HUD plans to include Section 232 project monitoring 

requirements in the “Multifamily Asset Management and Project Servicing 

Handbook” once the proposed revisions to the applicable regulatory 

agreements have been approved. In addition, HUD headquarters officials 

told us that they plan to issue updated guidance on loan oversight for 

Section 232 properties while awaiting approval of the proposed revisions to 

the regulatory agreements.

HUD’s regulatory agreement does not include specific requirements for 

Section 232 properties. The Inspector General found that the regulatory 

agreement for owners lacked requirements for Section 232 properties, such 

as compliance with Medicare and Medicaid guidelines. The Inspector 

General also found inconsistencies between the requirements for facilities 

operated by the owners and those operated by a separate entity. The 

Inspector General recognized that these omissions created an inability for 

HUD to control the activities of operators and ultimately created risk to the 

General Insurance/Special Risk Insurance Fund. HUD’s proposed revisions 

to the regulatory agreements have provisions that address these concerns; 

however, they are still awaiting approval. 

The Financial Assessment Subsystem (FASS) does not allow the owner 

and operator to submit annual financial statements electronically, 

denying HUD the ability to use the financial check and compliance 

feature in the system. The Inspector General found that the Real Estate 

Assessment Center’s (REAC) FASS did not include all Section 232 
Appendix III

HUD Officials Addressed Some Issues Raised 

by the Agency’s Inspector General in 2002, 

but Several Key Items Remain Unresolved

Page 54 GAO-06-515 Residential Care Facilities

properties. Furthermore, operators were not required to submit annual 

financial statements electronically through the system. HUD headquarters 

officials agreed that, while operators are unable to submit annual financial 

statements electronically, FASS has allowed electronic submissions from 

owners since the system’s inception. However, the Inspector General found 

that because operator financial statements are not required to be submitted 

electronically, HUD is unable to utilize the financial and compliance checks 

performed within the system to identify and follow up on deficiencies. 

HUD plans to modify FASS to allow electronic submission of operator 

financial statements; however, implementation has been delayed by 

funding problems and approval of the proposed revision to the operator 

regulatory agreement. 

The Office of Housing needs to improve monitoring and legal tools to 

provide early indication of possible default. The Office of Housing task 

force identified a need for improved monitoring and legal tools to provide 

early indication of potential default. To better understand issues related to 

monitoring loans, HUD’s Office of Evaluation completed several studies on 

Section 232 program performance.2

 As of April 2006, all of these studies 

remain in draft form. Also, to aid in monitoring, HUD has proposed 

revisions to the applicable regulatory agreements to require that owners 

and operators submit annual inspection reports and inform HUD of state or 

federal violations. These reports can be an early indicator of quality of care 

concerns and possible claim. However, the proposed revisions to the 

regulatory agreements have not been made final. 

The Office of Housing staff needs additional training on servicing 

nursing homes and assisted living facilities. The Inspector General 

identified that project managers did not have sufficient training on 

reviewing Section 232 properties and dealing with the issues unique to 

Section 232 properties. HUD’s management plan states that, as of 

September 2004, REAC has conducted financial statement analysis for 

HUD hubs for the last 2 fiscal years. HUD has also proposed training 

specific to Section 232 program financial analysis upon approval of 

revisions to the applicable regulatory agreements and subject to the 

2

These studies include: FHA, Review of HUD Disposition and Asset Management Practices 

(Draft), May 12, 2004; Proposed Benchmark Report Containing Per Unit Multifamily 

Expense and Revenue Data for 75 MSAs, (Draft), Aug. 2, 2004; Effect of Rising Insurance 

Costs on FHA-Insured Multifamily Mortgages (Draft), Mar. 16, 2004; and Analysis of FHA 

Endorsed Mortgages Presented for Claim in FY 2003 (Draft), May 14, 2004.
Appendix III

HUD Officials Addressed Some Issues Raised 

by the Agency’s Inspector General in 2002, 

but Several Key Items Remain Unresolved

Page 55 GAO-06-515 Residential Care Facilities

availability of funds. However, HUD headquarters officials stated that there 

were very limited funds available for training. 

Certain conditions lead to loss of Certificate of Need (CON) or license. 

The HUD Inspector General identified that, in some states, the CON and 

operating licenses may not transfer with the property. Consequently, an 

operator may hold these operational documents and take them with them 

upon termination of the lease. Without these documents, a facility is not 

viable as a residential care facility and its value is significantly diminished. 

This presents a large risk to HUD should the loan go to claim or should 

HUD have to acquire the property. HUD’s proposed revisions to the 

applicable regulatory agreements address this concern by categorizing 

these operational documents as part of the mortgaged properties.

Receivables need to be included in the relevant legal documents to 

strengthen HUD's control over assets of the property in case of regulatory 

agreement violations.3 The Inspector General established that the Section 

232 security agreement language was too broad to ensure that all property 

assets are covered by the mortgage. To address this concern, HUD 

proposed revisions to the applicable regulatory agreements to include 

receivables in the personalty pledged as security for the mortgage. 

Additionally, HUD proposed added language in the owner regulatory 

agreement requiring the owner to execute a security agreement and 

financial statement upon all items of equipment and receivables. 

Field offices do not have consistent procedures for using different 

addendums for mortgages, regulatory agreements, and security 

agreements. The Office of Housing’s task force found inconsistencies in the 

field offices’ use of legal agreements between HUD and owners and 

operators, such as differing addendums to mortgages, regulatory 

agreements, and security agreements. We also found similar discrepancies 

during our five site visits. For example, only one office used addendums to 

HUD’s legal agreements to prevent operators from keeping these 

operational documents once the lease terminates. HUD has proposed 

revisions to the regulatory agreements, and once they are approved and 

implemented all offices will use the same legal documentation. In the 

3

Receivables are the value of services billed to third-party payors that have yet to be 

received. An example of receivables is the value of Medicare services billed to the federal 

government that have not yet been reimbursed.
Appendix III

HUD Officials Addressed Some Issues Raised 

by the Agency’s Inspector General in 2002, 

but Several Key Items Remain Unresolved

Page 56 GAO-06-515 Residential Care Facilities

interim, HUD headquarters officials told us they plan to provide field 

offices with updated guidance on Section 232 loan oversight. 
Page 57 GAO-06-515 Residential Care Facilities

Appendix IV

HUD’s Use of Proxy Data for Refinance Loans ApendxiIV

As discussed earlier in this report, we question the Department of Housing 

and Urban Development’s (HUD) use of Section 207 loans as a proxy for 

Section 232 loans in the claim regression that is part of HUD’s credit 

subsidy estimates. This appendix provides greater detail on our analysis. 

HUD’s Comparison Did Not 

Allow for Differences in the 

Age of Loans

Cumulative claim rates are generally compared for a set period of time and 

for loans from the same years of origination. However, HUD calculated the 

cumulative claim rates without making these adjustments, which 

confounds claim differences between programs with differences due solely 

to timing. HUD calculated the cumulative claim rates for each program by 

taking the total number of loans that went to claim during a 14- year time 

period and dividing this by the total number of loans in that same time 

period. In this case, HUD was comparing a program that has been 

expanding over time, the Section 232 program, with a program that has had 

less loan volume in recent years, the Section 207 program. From 1992 to 

1998, HUD insured 1,434 Section 207 loans. From 1999 to 2005, HUD 

insured 870 Section 207 loans. As a result, HUD has been comparing the 

claim rate of loans that have had very little time in which to default 

(Section 232 loans had an average age of 4 years) with the claim rate of 

loans that have had substantial time in which to default (Section 207 loans 

had an average age of 7.5 years). A comparison between two programs’ 

claim rates should allow for differences in the age of the loans. HUD 

officials also told us that they have not analyzed the comparability of these 

two loan types in terms of their prepayment rates.

Substantial Differences 

Exist between Section 207 

and Section 232 Loans

To examine the comparability of the Section 207 and Section 232 loans, we 

compared the conditional claim and prepayment rates of the two types of 

loans. An analysis of conditional claim and prepayment rates compares 

claim and prepayment probabilities for loans of the same age, so that 

comparisons based on loans of widely varying ages are avoided. 

We found that the Section 207 loans generally had lower and, in some 

cases, significantly lower conditional claim rates than the Section 232 

loans. The differences were greater in the later years when loans more 

often go to claim. (see fig. 7). For example, the conditional claim rate for 

Section 207 loans in fiscal year 8 was .14 percent as compared with a 

conditional claim rate of 3.88 percent for Section 232 loans in fiscal year 8. 
Appendix IV

HUD’s Use of Proxy Data for Refinance Loans

Page 58 GAO-06-515 Residential Care Facilities

Figure 7: Conditional Claim Rates Are Different for Section 232 and Section 207 

Refinance Loans

Note: Through year 8, there are at least 200 loans in each category of loan for each conditional claim 

rate year. Beyond year 8, the loan numbers are small (particularly for Section 232 loans), and 

conclusions are less reliable. 

We found that Section 207 loans had generally higher, and sometimes 

significantly higher, conditional prepayment rates compared to Section 232 

loans. The differences were greater in the later years when loans more 

often are prepaid. (see fig. 8). For example, the conditional prepayment 

rate for Section 207 loans in fiscal year 8 was 21.72 percent as compared to 

a conditional prepayment 11.25 percent for Section 232 loans in fiscal year 

8 (making the conditional prepayment rate for the Section 207 loans 93 

percent higher than the conditional prepayment rate for Section 232 loans). 

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Percentage claim rate

Year

Section 232

Section 207

Source: GAO analysis of data from HUD's Office of Evaluation and from F47 (a HUD multifamily housing database) as of the 

end of fiscal year 2005.
Appendix IV

HUD’s Use of Proxy Data for Refinance Loans

Page 59 GAO-06-515 Residential Care Facilities

Figure 8: Conditional Prepayment Rates are Different for Section 232 and Section 

207 Refinance Loans

Note: Through year 8, there are at least 200 loans in each category of loan for each conditional 

prepayment rate year. Beyond year 8, the loan numbers are small (particularly for Section 232 loans), 

and conclusions are less reliable. 

Additionally, we examined and compared cumulative 5-year claim and 

prepayment rates. Section 207 loans had a 5-year cumulative claim rate of 3 

percent, while for the Section 232 loans it was approximately 6.7 percent. 

The 5-year cumulative prepayment rate for Section 207 loans was about 27 

percent, while for Section 232 loans it was about 11 percent. 

0

10

20

30

40

50

60

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Percentage prepayment rate

Year

Section 232

Section 207

Source: GAO analysis of data from HUD's Office of Evaluation and from F47 (a HUD multifamily housing database) as of the 

end of fiscal year 2005.
Page 60 GAO-06-515 Residential Care Facilities

Appendix V

Comments from the Department of Housing 

and Urban Development ApendxiV
Appendix V

Comments from the Department of Housing 

and Urban Development

Page 61 GAO-06-515 Residential Care Facilities
Appendix V

Comments from the Department of Housing 

and Urban Development

Page 62 GAO-06-515 Residential Care Facilities
Page 63 GAO-06-515 Residential Care Facilities

Appendix VI

GAO Contact and Staff Acknowledgments ApendxiVI

GAO Contact David G. Wood (202) 512-8678

Staff 

Acknowledgments

In addition to the individual named above, Paul Schmidt, Assistant 

Director; Austin Kelly; Tarek Mahmassani; John McGrail; Andy Pauline; 

Carl Ramirez; Richard Vagnoni; Wendy Wierzbicki; and Amber YanceyCarroll made key contributions to this report. 

(250238)
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