[Federal Register Volume 65, Number 125 (Wednesday, June 28, 2000)]
[Notices]
[Pages 40008-40022]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-16154]



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Part IV





Department of Housing and Urban Development





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Public Housing Assessment System Financial Condition Scoring Process; 
Notice

Federal Register / Vol. 65, No. 125 / Wednesday, June 28, 2000 / 
Notices

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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Docket No. FR-4509-N-13]


Public Housing Assessment System Financial Condition Scoring 
Process

AGENCY: Office of the Director of the Real Estate Assessment Center, 
HUD.

ACTION: Notice.

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SUMMARY: This Notice provides additional information to public housing 
agencies and members of the public about HUD's process for issuing 
scores under the Financial Condition Indicator of the Public Housing 
Assessment System (PHAS), including GAAP-based threshold values and 
associated scores for each Financial Condition Indicator component and 
peer group based on the data pool as of June 30, 1999.
    This notice is an update of the Financial Condition Scoring Process 
notice on scoring that was published on June 23, 1999. This notice 
takes into consideration public comment received on the June 23, 1999 
notice and reflects the changes made to the PHAS regulations published 
on January 11, 2000, with certain corrections published on June 6, 
2000. The changes made to this notice are discussed in the 
Supplementary Information section of this notice.

FOR FURTHER INFORMATION CONTACT: For further information contact Wanda 
Funk, the Real Estate Assessment Center, Department of Housing and 
Urban Development, 1280 Maryland Avenue, SW, Suite 800, Washington, DC 
20024; telephone Technical Assistance Center, 1-888-245-4860 (this is a 
toll free number). Persons with hearing or speech impairments may 
access that number via TTY by calling the Federal Information Relay 
Service at (800) 877-8339. Additional information is available from the 
REAC Internet Site http://www.hud.gov/reac.

SUPPLEMENTAL INFORMATION

Background

    HUD published the first Public Housing Assessment System; Financial 
Condition Scoring Process Notice in the Federal Register (64 FR 26222) 
on May 13, 1999. On June 23, 1999, HUD republished the Notice (64 FR 
33700) to coincide with the June 22, 1999, publication of the Public 
Housing Assessment System proposed rule. In the June 23, 1999, Notice, 
HUD stated that any changes to the scoring process and any 
modifications to the thresholds will be communicated through a 
subsequent Federal Notice. Accordingly, this Notice updates the June 
23, 1999 Notice, and provides detailed information on the changes to 
the Financial Condition Scoring Process Notice. By this Notice, HUD is:

    <bullet> Adding an extra-large size PHA category for the entity-
wide assessment only
    <bullet> Revising the scoring methodology for the Expense 
Management component, including the addition of regional peer groups 
and a weighted average scoring approach.
    <bullet> Changing the calculation of Unit Months Available for 
the Occupancy Loss component to allow for additional exemptions.
    <bullet> Modifying the scoring penalty for PHAs with too high 
reserves and/or liquidity.
    <bullet> Changing the Net Income component threshold level.
    <bullet> Scoring Low Rent-only program for first year of 
scoring, with Entity-Wide scoring thereafter.
    <bullet> Changing financial submission deadlines.
    <bullet> Eliminating the ``marginal'' PHA designation level in 
order to be consistent with the PHAS Rule.
    <bullet> Changing the schedule for reevaluation of thresholds.

    These changes have been made based on the industry comments HUD 
received on the June 22, 1999, Public Housing Assessment System 
proposed rule, and on the input from the industry obtained during 
discussions by and among representatives from HUD, the PHAs, and 
industry groups.
    More specifically, the changes identified above are as follows:

Extra Large Size Category

    Each PHA is awarded points according to its performance relative to 
its peers. Peer groupings are established based on the number of units 
operated by the PHA. Since the publication of the June 23, 1999, 
Financial Condition Scoring Process Notice, the REAC has determined 
that there is a statistically significant difference between those PHAs 
administering between 1,250 and 9,999 units and those PHAs 
administering 10,000 or more units. Based on these statistical 
analyses, including the running of the Wald-Wolfowitz and Kolmogorov-
Smirnov tests, the REAC has concluded that there is sufficient 
statistical validity to support adding an extra-large size category for 
those PHAs administering more than 10,000 units. The REAC has left 
unchanged the other five size peer groupings. This only applies to the 
entity-wide assessment because there are not sufficient statistical 
observations for low-rent only scoring to differentiate an extra-large 
size category.

Expense Management/Utility Consumption Component

    The Expense Management/Utility Consumption (EM/UC) component 
measures the ability of a PHA to maintain its expense ratios at a 
reasonable level relative to its peers. Two changes have been made to 
this component. REAC's statistical analysis has shown that certain 
expenses vary substantially depending upon the region of the country in 
which the PHA resides. Therefore, in order to have a more equitable 
assessment of a PHA's expenses relative to its peers, REAC has 
developed new regional peer groupings for the EM/UC component, to 
supplement the size-based peer groups. Thus, a PHA will now be scored 
on EM/UC against a threshold that is calculated from all expense data 
in that PHA's similar size group and region. The regions have been 
based on the first number of the PHA's zip code.
    The second change that has been made to the EM/UC component is in 
the scoring approach. Previously, PHAs that were beyond the threshold 
on any one of the expense categories that comprised the EM/UC component 
received zero points for EM/UC. The revised scoring methodology instead 
uses a weighted average of all the expenses that comprise the EM/UC 
component and assigns points based on this summed amount. Thus, a PHA 
may have high expenses in one category, but may still receive 1.5 
points if its other expenses are reasonable relative to its peers. The 
weighted averages chart shown below is reproduced in Appendix 1.

------------------------------------------------------------------------
                       Expense category                          Weight
------------------------------------------------------------------------
Administrative................................................       .34
General Expenses..............................................       .33
Ordinary Maintenance..........................................       .10
Protective Services...........................................       .10
Tenant Services...............................................       .10
Utilities.....................................................       .03
                                                               ---------
    Total.....................................................      1.00
------------------------------------------------------------------------

Occupancy Loss Component

    The Occupancy Loss component of the Financial Condition Indicator 
measures the unit months leased as a percentage of total unit months 
available. In order to obtain a fully verifiable measure of this 
component, REAC originally allowed no exemptions to be taken for units 
held off-line by the PHA, as it was difficult to ensure the validity of 
the number of units or their intended use. However, following 
discussions with the industry, it is believed that allowing no 
exemptions may discourage PHAs from making decisions that improve their 
housing projects, such as modernizing units or providing resident 
services, such as day care facilities. Therefore, PHAs, when reporting 
their occupancy information

[[Page 40009]]

on the FDS for Unit Months Available, may exclude vacant units approved 
by HUD to be taken off-line for demolition, conversion, on-going 
modernization, and non-dwelling units.
    The change to the Occupancy Loss Component is set forth in Appendix 
1.

Modification to Current Ratio and Months Expendable Fund Balance 
Scoring

    The scoring methodologies for the Current Ratio (CR) and Months 
Expendable Fund Balance (MEFB) components of the Financial Condition 
Indicator award slightly less points to PHAs whose ratios indicate that 
their liquidity and/or expendable fund balance are too high. These PHAs 
fall beyond the 80th percentile of the peer group distribution of CR 
and/or MEFB values respectively. These PHAs can lose up to 1.5 points 
out of the 9 possible points for each of the two indicators. This 
system was established because HUD believes that PHAs with too high 
expendable fund balance and liquidity could be better utilizing their 
resources to improve the quality of housing or services to their 
residents. However, in recognition of PHAs who are performing well in 
their quality of housing and resident services, HUD has modified this 
scoring methodology. REAC will restore any points lost by PHAs for 
falling beyond the 80th percentile if:

--The PHA is a high performer under the Physical Assessment Subsystem,
    and
--The PHA is not required to submit a follow-up plan under the Resident 
Satisfaction Assessment Subsystem.

    The points restored will be added to the total PHAS score.
    The modification of the scoring penalty has been incorporated into 
Appendix 1.

Change to Net Income Component Threshold Level

    The Net Income (NI) component previously had a threshold of -10%; 
i.e. a PHA with a net loss for the year and positive expendable fund 
balance (EFB), and whose net loss was greater than 10% of its reserve 
(EFB) level would receive zero points. HUD recognizes that at times it 
is necessary for a PHA to draw down from its reserves (EFB) to take 
measures to improve its financial position. This action would, however, 
result in a less favorable NI ratio. Therefore, in order to provide 
more flexibility to PHAs in these measures, HUD has changed the NI 
threshold to -20%; i.e. a PHA with a net loss for the year and positive 
EFB is allowed to have loss up to 20% of its EFB levels before any 
point deductions are made to the NI component.
    This change to the Net Income component threshold level is 
incorporated in the indicator discussions in Appendix 1.

Low Rent-Only Assessment Versus Entity-Wide Assessment

    As a result of discussions among representatives from HUD, PHAs and 
industry groups, REAC has modified the first four quarters of scores to 
produce both low rent and entity-wide financial assessments. The Non-
GAAP Advisory Scores that have been produced for PHAs from 9/30/98 
through 6/30/99 have been based on financial information for PHAs' Low 
Rent Program only. The GAAP-based scoring of PHAS is intended to 
capture an assessment of the financial condition of a PHA as a whole, 
which would incorporate all program activities, i.e. an entity-wide 
assessment. However, in order to provide a parallel basis for 
comparison, the REAC has modified the assessment for the first year of 
scores. The first four quarters of scores (9/30/99 fiscal year ends 
through 6/30/00 fiscal year ends) will be based on GAAP Low Rent-only 
information. For the first three quarters, these scores will be 
advisory; for the last quarter, this score will be enforceable. GAAP-
based Entity-wide scores will also be produced, but used for advisory 
purposes only during the first four quarters. Thereafter, all scores 
will be based on an entity-wide assessment.
    There are two primary differences between the low rent only and the 
entity wide assessments. First, each assessment uses a different unit 
count for a PHA (low rent only units v. all program units), which may 
result in a PHA falling into different size peer groups depending on 
the level of its other program activity. Second, the low rent only 
assessment includes inter-program due from and due to line items as 
part of current assets and current liabilities. However, for the 
entity-wide assessment, these line items net to zero and thus are not 
included in neither the assets nor the liabilities for purposes of the 
overall assessment.

Financial Submission Deadlines

    PHAs with fiscal years ending September 30, 1999, and later, are 
required to submit their unaudited financial data electronically using 
the Financial Data Schedule (FDS) within two months of their fiscal 
year end. Because of the conversion to GAAP reporting, HUD will provide 
additional time for submission of the FDS for PHAs to ensure the most 
accurate GAAP reporting possible. For the first four quarters of 
reporting (9/30/99, 12/31/99, 3/31/00, and 6/30/00), every PHA will 
receive an automatic one month extension for submission of the FDS. 
Following the first four quarters, PHAs must submit within two months 
of their fiscal year end, with a 15 day grace period.

Removal of Marginal Designation Level

    The previous performance designation levels included a marginal 
designation for PHAs that received between 18 and 21 points out of the 
total 30 points attainable for the Financial Condition Indicator. This 
designation has been removed from the PHAS rule. The new performance 
designations are as follows:

------------------------------------------------------------------------
             Points received                        Designation
------------------------------------------------------------------------
Less than 18.............................  Troubled.
18 to 27.................................  Standard.
27 or more...............................  High.
------------------------------------------------------------------------

    The performance designations are set forth in Sec. 902.67 of the 
PHAS rule, published in the Federal Register on January 11, 2000.

Threshold Reevaluation Schedule

    The June 23, 1999 Financial Condition Scoring Process Notice 
indicated that thresholds would be reassessed on a quarterly basis. 
This schedule has been modified. See Appendices 2 and 3 for the 
thresholds. The thresholds listed in this Notice, which are based on a 
sample of PHAs reporting under GAAP prior to 9/30/99, will be used for 
all unaudited and audited financial submissions through June 30, 2000. 
At that point the thresholds will be reevaluated based on the full 
year's worth of unaudited and available audited GAAP data. Thereafter, 
REAC plans to keep the reevaluated thresholds constant for a three year 
period, unless there is a need for revisions.
    The chart below shows the six components that constitute the 
Financial Condition Indicator and their assigned points.

[[Page 40010]]



                                          Financial Condition Indicator
----------------------------------------------------------------------------------------------------------------
              Scoring components                                     Measurement                         Points
----------------------------------------------------------------------------------------------------------------
Current Ratio (CR)...........................  Liquidity..............................................       9.0
Number of Months Expendable Fund Balance       Adequacy of Reserves...................................       9.0
 (MEFB).
Tenant Receivables Outstanding (TRO).........  Ability to collect payments of tenant receivables......       4.5
Occupancy Loss (OL)..........................  Ability to maximize rental income......................       4.5
Expense Management (EM)/ Utility Consumption.  Ability to maintain expense ratios at a reasonable            1.5
                                                level relative to peers (adjusted for size and region).
Net Income or Loss as a percentage of          Profitability measured against the current year's             1.5
 Expendable Fund Balance (NI).                  operations.
----------------------------------------------------------------------------------------------------------------

    The values of the six components of the Financial Condition 
Indicator calculated from the financial data comprise the overall 
financial assessment of the PHA. The components and their relative 
importance to the total financial score are the result of studies of 
PHA financial performance and of industry portfolio management 
techniques to identify the most appropriate financial measures to gauge 
a PHA's financial position. These components represent measures that 
are appropriate benchmarks in any residential real estate environment. 
The score assigned to each component is based on the distributions of 
that component's values and the relative relationship between the 
components and the PHA's overall financial performance.
    Under the PHAS, the components that make up the Financial Condition 
Indicator are approached in the same manner for GAAP as they were for 
non-GAAP financial information although the thresholds may change as a 
result of the conversion to GAAP. For example, a good Current Ratio 
under the current basis of accounting (non-GAAP) for a small PHA may be 
6 to 1 and receive the maximum 9 points. In contrast, under GAAP a good 
Current Ratio may be 5 to 1 and also get the maximum 9 points. Thus, to 
the extent that a PHA's performance relative to its peers does not 
change, its score will not be significantly affected by the conversion 
to GAAP. The GAAP conversion schedule by a PHA's fiscal year end, shown 
below, is reprinted from the PHAS final rule published on September 1, 
1998.

                        GAAP Conversion Schedule
------------------------------------------------------------------------
                                                 Unaudited
                                                    GAAP        Audit
        Fiscal year end dates for PHAs           financial   reports due
                                                data to HUD  to HUD by--
                                                    by--
------------------------------------------------------------------------
9/30/99.......................................     11/30/99      6/30/00
12/31/99......................................      2/28/00      9/30/00
3/31/00.......................................      5/31/00     12/31/00
6/30/00.......................................      8/31/00      3/31/01
------------------------------------------------------------------------

Reporting Method

    PHAs with fiscal years ending September 30, 1999, and later, must 
submit their unaudited financial data electronically using the 
Financial Data Schedule (FDS), within two months of their fiscal year 
end. For the first four quarters of reporting (9/30/99, 12/31/99, 3/31/
00, and 6/30/00), each PHA has an automatic one month extension to 
submit the FDS. Following the first four quarters, PHAs must submit the 
FDS within two months of their fiscal year end, with a 15 day grace 
period. All submissions will be reviewed by REAC for completeness and 
reasonableness. To the extent that an audit is required for a PHA under 
OMB Circular A-133, or the PHA elects to have a financial statement 
audit pursuant to 24 CFR part 902, a PHA will submit its audited data 
using the FDS within nine months of the fiscal year end.

Program Funds

    The PHAS financial assessment is intended to be based on the 
entity-wide operations of a PHA, which includes financial information 
on Section 8, Community Development Block Grants, and other HUD funding 
in its calculations, as well as funds from non-HUD sources. However, in 
order to provide a parallel basis for comparison with the non-GAAP 
advisory scores produced during FY 1999, which have been based on PHAs' 
Low Rent program only, for the first four quarters of scores (9/30/99 
fiscal year ends through 6/30/00 fiscal year ends), REAC will produce 
scores based on GAAP Low Rent information only.
    For the first three quarters, these scores will be advisory; for 
the last quarter, this score will be enforceable. GAAP-based entity-
wide scores will also be produced over all four quarters, but used for 
advisory purposes only during this time. Thereafter, all scores will be 
enforceable and will be based on an entity-wide assessment only. This 
assessment schedule is summarized below:

------------------------------------------------------------------------
                                            Financial condition
             Quarter             ---------------------------------------
                                       Low-rent           Entity-wide
------------------------------------------------------------------------
9/30/99.........................  Advisory..........  Advisory.
12/31/99........................  Advisory..........  Advisory.
3/31/00.........................  Advisory..........  Advisory.
6/30/00.........................  Score.............  Advisory.
9/30/00 and beyond..............  N/A...............  Score.
------------------------------------------------------------------------

    While the two assessments remain primarily the same, the assessment 
of the low rent program only requires a different treatment of inter-
program transfers of funds. In the entity wide assessment, inter-
program transfers are not a factor because any ``due to'' amounts are 
balanced out by equal amounts ``due from'' other programs. In the 
assessment of the low rent program only, though, any funds borrowed 
from or lent to other programs must be taken into account as either a 
current asset or current liability for the low rent program. These line 
items are therefore included in the calculation of the Current Ratio, 
Months Expendable Fund Balance, and Net Income indicators in the low 
rent only scoring.

Scoring Approach

    Under PHAS, the components of the PHAS Financial Indicator were 
developed to both fairly and accurately assess a PHA's financial 
performance and financial management. As part of the development, the 
components were tested to establish the correlation between PHA 
performance under each component and the fiscal health of a PHA. PHAs 
were evaluated and assigned scores based on a PHA's performance 
relative to its peers. In other words, all PHAs as a group determine 
the mean score and each PHA is then ranked accordingly. This peer 
assessment approach, which was formulated following extensive economic 
and financial analysis, examination of well-accepted business 
principles, and discussions with PHA industry representatives and PHA 
staff, provides an equitable means of measuring the financial 
performance of PHAs.

[[Page 40011]]

Comparable Scoring Systems

    The HUD Peer Assessment system is not unique to REAC. Companies in 
the mortgage housing and securities industry, and federal agencies 
utilize similar systems in assessing their constituents. In the 
mortgage housing and securities industries, Fannie Mae, the mortgage 
housing industry leader, developed an assessment system with financial 
indicators similar to those contained in HUD's financial assessment of 
PHAs. These indicators include vacancy, reserve balances, and net 
income. Like HUD, Fannie Mae uses these indicators to rank properties 
and identify those which require further attention. In the securities 
area, Standard & Poor's conducts peer assessment of a company's 
operational capabilities and cash flows relative to their peers. Among 
federal agencies, the Department of Health and Human Services (HHS) 
contracts with state and local entities to perform financial audits of 
nursing homes and hospitals participating in the federal Medicare 
program.
    Based on these financial audits, HHS determines the continued 
eligibility of these health service providers in the Medicare program.

GAAP Scoring Processes

    GAAP-based scores are produced using data contained in the 
Financial Data Schedule (FDS). The GAAP-based financial data are first 
used to calculate the six financial components that measure various 
aspects of financial health, such as short term liquidity, expense 
management/utility consumption, and collection of tenant receivables. 
Each PHA is awarded points for each component according to its 
performance relative to its peers. Peer groupings are established 
according to the size of the PHA, based on the total number of units 
operated by the PHA, and for the expense management component, the 
geographic region in which it falls.
    Since the June 23, 1999 publication of the Federal Register Notice 
on the Public Housing Assessment System Financial Condition Scoring 
Process, the REAC has determined that there is a statistically 
significant difference between those PHAs administering between 1,250 
and 9,999 units and those PHAs administering 10,000 or more units. 
Thus, a new PHA size category has been added. The new size peer 
groupings are as follows:

Very Small (0-49 units)
Small (50-249 units)
Low Medium (250-499 units)
High Medium (500-1,249 units)
Large (1,250-9,999 units)
Extra-Large (10,000+ units)

    The size group in which a PHA falls may vary between the entity 
wide and the low rent scoring approaches. The entity wide assessment 
uses all units to designate a PHA's size category, whereas the low rent 
assessment counts only low rent units in the designation of size 
category. Thus, depending on each PHA's activity level in programs 
besides low rent, it may stay in the same size group or fall to a 
smaller size group for the purposes of the low rent assessment. In 
addition, because of this change in size category designation for a 
number of the PHAs, there was no longer a statistical distinction 
between the extra large and large size groups. Therefore, for the 
purposes of low rent only scoring, large and extra-large PHAs are 
scored using the same thresholds.
    In order to have a more equitable assessment of a PHA's expenses 
relative to its peers, REAC has developed new regional peer groupings 
for the expense management/utility consumption component, to supplement 
the size-based peer groups already in place. Thus, a PHA will now be 
scored on EM/UC against a threshold that is calculated from all expense 
data in that PHA's similar size group and region.
    The regions have been based on the first number of the PHA's zip 
code, and are divided as follows:

------------------------------------------------------------------------
             Region                               States
------------------------------------------------------------------------
0...............................  CT, MA, ME, NH, NJ, RI, VT
1...............................  DE, NY, PA
2...............................  DC, MD, NC, SC, VA, WV
3...............................  AL, FL, GA, MS, TN, RQ (including
                                   Virgin Islands)
4...............................  IN, KY, MI, OH
5...............................  IA, MN, MT, ND, SD, WI
6...............................  IL, KS, MO, NE
7...............................  AR, LA, OK, TX
8...............................  AZ, CO, ID, NM, NV, UT, WY
9...............................  AK, CA, HI, OR, WA, GQ
------------------------------------------------------------------------

Thresholds

    A PHA is assigned a score for each of the six components of the 
Financial Indicator based on its component value relative to its peers. 
The minimum number of points (zero) and the maximum number of points 
can each be achieved over a range of values. For example, on the 
current ratio, large PHAs receive zero points for a ratio that is less 
than one, while they receive nine points for a ratio between 2.3 and 
3.6. Therefore, PHAs can target one range of values that they want to 
avoid and target one range that they should strive to achieve. Aside 
from these ranges, points are assigned to component values along a 
continuous line. This means that each component value will receive a 
different number of points.
    This system (``continuous scoring'') ensures that points are 
awarded equitably to PHAs along the distribution of component values 
because, in most cases, small differences in component values result in 
only small differences in the scores of the individual components. 
Therefore, two PHAs of a similar size whose values for their financial 
condition components are in close proximity will receive only slightly 
different scores to capture their performance relative to each other. 
For example, a large PHA with a current ratio of 1.1 would receive 4.4 
points, while a PHA of the same size with a ratio of 1.2 would receive 
4.8 points.
    The number of points assigned to each component value or range of 
values is based on where the thresholds for that component are set. The 
thresholds separate distinct ranges of scores along the distribution of 
component values. The thresholds and their associated scores are 
estimated based on well-accepted business principles and statistical 
distributions of values within the peer groupings of the PHAs.

Business Principles

    Scoring of certain of the components follows generally recognized 
business principles. These principles indicate that there are certain 
absolute thresholds below which component values are clearly 
financially unacceptable and component values below that point should 
result in a score of zero. These principles are used in scoring the 
Current Ratio and Number of Months Expendable Fund Balance components. 
For both of these components, a value of less than one is financially 
unacceptable, regardless of PHA size, and therefore merits a score of 
zero.

Statistical Distributions

    The thresholds are estimated by examining the distributions of 
component values by peer group. For the four most significant 
components (Current Ratio, Number of Months Expendable Fund Balance, 
Days Receivable Outstanding, and Occupancy Loss), thresholds are set 
such that approximately 50 percent of the distribution receives the 
maximum number of points, as long as 50 percent of the distribution 
have acceptable values for the component. Thus, the highest number of 
points is awarded to the PHAs whose financial measures are most 
reasonable both relative to their peers and in an absolute business 
sense. The specific percentiles that make up

[[Page 40012]]

this 50 percent of PHAs are established by identifying natural 
breakpoints along the distributions. For example, for the Current Ratio 
and Number of Months Expendable Fund Balance, these breakpoints fall at 
approximately the 30th and 80th percentiles. The remaining two 
components (Expense Management and Net Income as a Percentage of Fund 
Balance) assign zero points to PHAs that fall only in the extreme outer 
ranges of the distribution of values, and award 1.5 points to the 
remaining PHAs. The scoring functions and thresholds derived from these 
distributions can be found in Appendices 1, 2, and 3.

Audit Adjustments

    There are two types of adjustments related to financial audit 
information. The first type deals with the audit flags and reports that 
result from the audit itself. Reportable conditions and material 
weaknesses are considered to be audit flags, alerting REAC to an 
internal control weakness or an instance of noncompliance with Federal 
laws and regulations. The second adjustment deals with material 
differences between the unaudited and audited financial information 
reported to HUD.

Audit Opinion and Flags

    As part of the analysis of the financial health of a PHA including 
assessment of the potential or actual waste, fraud or abuse at a PHA, 
HUD will look to the Audit Report to provide an additional basis for 
accepting or adjusting financial component scores. (See 63 FR 46607, 
September 1, 1998) The information collected from the annual audit 
report pertains to the type of audit opinion, details of the audit 
opinion, and the presence of reportable conditions and material 
weaknesses.
    If the auditor's opinion is anything other than unqualified, points 
will be deducted from the financial components to determine the PHA's 
financial score. The points to be deducted have been established by 
REAC using a system that considers the seriousness of the audit 
qualification and limits the deducted points to a reasonable portion of 
the PHA's available score.
    REAC will review audit flags to determine their significance as it 
directly pertains to the assessment of the PHA's financial condition. 
If the flag has no effect on the financial components or the overall 
financial condition of the PHA as it relates to the PHAS assessment, 
the score will not be adjusted. However, if the flags have an impact on 
the PHAS assessment, the PHA's financial component score will be 
adjusted, in accordance with the seriousness of the reported finding.
    These flags are collected by using the OMB A-133 Data Collection 
Form. The PHA completes this form for both the unaudited and audited 
submissions. At the time of the unaudited submission the form is used 
as a self-assessment tool and should reflect the PHA's knowledge of 
their financial and internal control condition and should acknowledge 
their understanding of what the auditor will report. In the PHAS final 
rule, published September 1, 1998, HUD discussed the review of audit 
and internal control flags as follows, and also included the following 
chart. (See 63 FR 46607, September 1, 1998).

------------------------------------------------------------------------
                                                             PHAS points
                        Type of flag                           deducted
------------------------------------------------------------------------
Unqualified Opinion........................................            0
No audit opinion...........................................           30
Adverse opinion............................................           30
Disclaimer of opinion......................................           30
Qualified opinion..........................................          (*)
Going concern opinion......................................           30
Material weakness in internal control......................          (*)
Reportable condition.......................................          (*)
Findings of non-compliance and/or questioned costs.........          (*)
Indicator outlier analyses.................................         (*)
------------------------------------------------------------------------
* Note: See table titled ``Audit Flags and Tier Classification'' for
  PHAS points to be deducted

    If the OMB A-133 Data Collection Form indicates that the auditor's 
opinion will be anything other than unqualified, PHAS will 
automatically deduct the appropriate points based on the above table. 
The points have been established by REAC using a three-tier system. The 
tiers are meant to give consideration to the seriousness of the audit 
qualification and to limit the deducted points to a reasonable portion 
of the PHA's total, actual score. The tiers, as established by REAC, 
are also defined below.

                            Audit Flag Tiers
------------------------------------------------------------------------
               Tier                         PHAS points deducted
------------------------------------------------------------------------
Tier 1............................  Maximum reduction: Lesser of 30
                                     points or 100 percent of the PHA's
                                     total unadjusted PHAS score.
Tier 2............................  Maximum reduction: Lesser of 3
                                     points or 10 percent of the PHA's
                                     total unadjusted PHAS score.
Tier 3............................  Maximum reduction: Lesser of 1.5
                                     points or 5 percent of the PHA's
                                     total unadjusted PHAS score. This
                                     maximum is cumulative and not to be
                                     assessed for each audit or internal
                                     control flag.
------------------------------------------------------------------------

Review of Audited Versus Unaudited Submission

    The purpose of a comparison of the ratios and scores resulting from 
the current year's unaudited Financial Data Schedule submission to the 
ratios and scores resulting from the current year's audited submission 
is to:
    Identify material changes in ratio calculation results and/or 
scores from the unaudited submission to the audited submission;
    Identify PHA's that consistently provide materially different data 
from their unaudited submission to their audited submission;
    Assess or alleviate penalties associated with the inability to 
provide reasonably accurate unaudited data within the required time 
period.
    This review process will only be performed for the audited 
submission.

Materiality and Penalty Assessment

    REAC views the transmission of materially inaccurate unaudited 
financial data as a serious condition. Therefore, PHAs are encouraged 
to assure financial data is as reliable as possible at the 2 month 
submission.
    A materiality penalty will be assessed for material differences 
between the unaudited and audited submissions. A material change is 
considered to be an overall FASS score decrease of three or more points 
from the unaudited to audited submission. The PHAS system automatically 
deducts the applicable points and this reduction triggers the REAC 
analyst's review.
    REAC may waive the materiality penalty if the PHA provides 
reasonable documentation of the material difference in its submission.
    A materiality penalty is considered a Tier 3 audit flag, and will 
result in a reduction of points as associated with all other Tier 3 
audit flags.
    The table below summarizes the audit flags and associated tier 
classifications.

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                  Audit Flags and Tier Classifications
------------------------------------------------------------------------
                   Audit flag                      Tier  classification
------------------------------------------------------------------------
Unqualified opinion............................  None.
No audit opinion...............................  Tier 1.
Adverse opinion................................  Tier 1.
Disclaimer of opinion..........................  Tier 1.
Qualified opinion:
    1. GAAP qualifications:....................
        <bullet> Change in accounting principle  Tier 3.
        <bullet> Change in accounting estimate.  Tier 3.
        <bullet> Change in accounting method...  Tier 3.
        <bullet> Departures from GAAP..........  Tier 2.
            Financial statements using basis     Tier 1.
             other than GAAP.
            Exclusion of alternate accounting    Tier 2.
             for an account or group of
             accounts.
            Inconsistently applied GAAP........  Tier 2.
            Omissions/Inadequate Disclosure....  Tier 2.
    2. GASS--Scope Limitations.................  Tier 2.
        <bullet> Imposed by management.........  Tier 2.
        <bullet> Imposed by circumstance.......  Tier 3.
        <bullet> Year 2000 (add back)..........  Tier 3.
    3. Report on major program compliance......  Tier 3.
    4. Report on internal control..............  Tier 3.
Accounting principles used caused the financial  Tier 2.
 statements to be materially misstated.
Inadequate records.............................  Tier 2.
Going concern..................................  Tier 1.
Material noncompliance disclosed...............  Tier 2.
    <bullet> Internal control weakness.........  Tier 3.
    <bullet> Compliance........................  Tier 3.
    <bullet> Opinion on Supplemental schedules.  Tier 3.
Reportable condition:
    <bullet> Internal control..................  Tier 3.
    <bullet> Compliance........................  Tier 3.
------------------------------------------------------------------------

Appendices

    The graphs shown in Appendix 1 depict the approximate GAAP-based 
scoring functions used for each of the six components of the Financial 
Indicator. Appendices 2 and 3 provide revised GAAP-based threshold 
values and associated scores for each component and peer group, based 
on the GAAP data pool as of June 30, 1999. Appendix 2 provides the 
GAAP-based thresholds that will be used for Low Rent-only scoring. 
Appendix 3 provides the GAAP-based thresholds that will be used for the 
entity-wide scoring.
    These thresholds, which are based on a sample of PHAs reporting 
under GAAP prior to 09/30/99 will remain in effect for all unaudited 
and audited PHA financial submissions for PHAs through fiscal years 
ending June 30, 2000. At that time, the thresholds will be reevaluated 
based on a full year of unaudited GAAP data and available audited data 
to ensure their statistical validity. Any revisions will be 
communicated through a Notice. Thereafter, REAC plans to keep the 
reevaluated thresholds constant for a three year period, unless it 
finds a need for revisions, at which time REAC will again make the 
revisions known by way of a Notice.

    Dated: June 20, 2000.
Donald J. LaVoy,
Director, Real Estate Assessment Center.
BILLING CODE 4210-01-P

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[FR Doc. 00-16154 Filed 6-27-00; 8:45 am]
BILLING CODE 4210-01-C