[Federal Register Volume 62, Number 47 (Tuesday, March 11, 1997)]
[Proposed Rules]
[Pages 11284-11295]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-6024]


      

[[Page 11283]]

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Part V





Department of Housing and Urban Development





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24 CFR Part 570



Community Development Block Grant Program for States; Revisions to 
Program Income Requirements and Miscellaneous Amendments; Proposed Rule

Federal Register / Vol. 62, No. 47 / Tuesday, March 11, 1997 / 
Proposed Rules

[[Page 11284]]



DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 570

[Docket No. FR-4067-P-01]
RIN 2506-AB82


Community Development Block Grant Program for States; Revisions 
to Program Income Requirements and Miscellaneous Amendments; Notice of 
Proposed Information Collection Requirements

AGENCY: Office of the Assistant Secretary for Community Planning and 
Development, HUD.

ACTION: Proposed rule.

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SUMMARY: This rule contains proposed changes to several sections of the 
regulations for the Community Development Block Grant (CDBG) Program 
for States. This proposed rule would streamline and update the 
regulations with regard to recent statutory changes, clarify the 
program income requirements, and correct other identified deficiencies 
in the State CDBG regulations. This proposed rule would also provide 
States additional flexibility in their administration of the program.

DATES: Comments due date: May 12, 1997.

ADDRESSES: HUD invites interested persons to submit comments regarding 
this proposed rule to the Rules Docket Clerk, Office of General 
Counsel, Room 10276, Department of Housing and Urban Development, 451 
Seventh Street, SW, Washington, DC 20410. Communications should refer 
to the above docket number and title. Facsimile (FAX) comments are not 
acceptable. A copy of each communication submitted will be available 
for public inspection and copying between 7:30 a.m. and 5:30 p.m. 
weekdays at the above address.
    HUD also invites interested persons to submit comments on the 
proposed information collection requirements in this proposed rule. 
Comments must refer to the above docket number and title, and must be 
sent to the Office of Information and Regulatory Affairs, Office of 
Management and Budget, Attention: Desk Officer for HUD, Washington, DC 
20503.

FOR FURTHER INFORMATION CONTACT: Steve Johnson, Assistant Director, 
State & Small Cities Division, Room 7184, Department of Housing and 
Urban Development, 451 Seventh Street, SW, Washington, DC 20410; 
telephone number (202) 708-1322 (this number is not toll-free). 
Hearing- or speech-impaired persons may access the number via TTY by 
calling the Federal Information Relay Service at (800) 877-8339. FAX 
inquiries (but not comments on the rule) may be sent to Mr. Johnson at 
(202) 708-2575 (this number is not toll-free).

SUPPLEMENTARY INFORMATION

Background

    This proposed rule would revise the regulations for the State 
Community Development Block Grant Program (24 CFR part 570) to respond 
to problems HUD has identified in the program, to implement a 1992 
statutory change to the Housing and Community Development Act of 1974 
(the Act) (42 U.S.C. 5301-5320), to implement changes resulting from 
the Cash Management Improvement Act, and to provide additional 
flexibility to States in implementing their programs. Specifically, 
this rule contains: (1) Proposed changes to the requirements governing 
Federal grant payments to States; (2) Various proposed changes to the 
program income requirements, including the situations in which income 
earned on grant funds must be remitted to the U.S. Treasury; (3) A 
proposed change regarding revolving funds; (4) The proposed application 
of the Entitlement regulations governing lump-sum drawdowns to the 
State program; (5) The proposed application of the Entitlement 
regulations governing the use of escrow accounts for rehabilitation of 
residential properties to the State program; (6) A proposed change to 
the conflict of interest requirements; (7) A proposed change regarding 
use of CDBG funds outside the jurisdiction of the recipient; and (8) A 
proposed change to the general provisions regarding a State's 
administrative flexibility. Each of these proposed changes is described 
below.

Federal Grant Payments

    Section 570.489(c) of the State CDBG regulations describes the 
requirements concerning Federal grant payments to States. Pursuant to 
the Treasury Department's regulations in 31 CFR part 205, States and 
units of general local government must minimize the elapsed time 
between receipt of Federal funds and their disbursement for grant 
activities. This regulation was based on the provisions of the 
Intergovernmental Cooperation Act (31 U.S.C. 6503).
    The Intergovernmental Cooperation Act has been superseded by the 
Cash Management Improvement Act of 1990, as amended in 1992 (31 U.S.C. 
3335, 6503), which made several fundamental changes to the manner of 
Federal-State payments. The Treasury Department amended the 
implementing regulations in 31 CFR part 205 on December 21, 1992 (57 FR 
60676). Under the new regulations, States and the Treasury Department 
enter into agreements covering all Federal programs over a certain 
threshold funding level. Through these agreements, States select 
specific payment techniques that are designed to prevent delays between 
drawdown and disbursement of funds. For programs that are below the 
threshold, States must use alternative procedures to prevent delays 
between drawdown and disbursement of funds. In 1995, only two States' 
CDBG allocations fell below the threshold.
    Section Sec. 570.489(c)(2) of the State CDBG regulations provides 
that interest earned by units of local government on funds held pending 
disbursement is not program income, and they must generally return such 
interest to the U.S. Treasury. The paragraph further provides, however, 
that States generally do not have to return interest earned during the 
time between receipt of funds and disbursement to local governments.
    The December 21, 1992 amendments to 31 CFR part 205 render some of 
Sec. 570.489(c) obsolete. Therefore, rather than repeat the 
requirements for States in the State CDBG regulations, Sec. 570.489(c) 
of this proposed rule would simply refer to the more detailed 
requirements in 31 CFR part 205. However, this proposed rule would 
retain the existing requirement that States ensure that units of local 
government also minimize the time between receipt of CDBG funds and 
their disbursement, by moving the provision to the program income 
requirement section (Sec. 570.489(e)). This proposed move is further 
discussed in the Program Income Requirements section of this preamble, 
below.

Program Income Requirements

    The proposed changes to the program income provisions that are 
described in this section of the preamble respond to the amendments of 
the Housing and Community Development Act of 1992 (the 1992 Act) (Pub. 
L. 102-550, approved October 28, 1992; 106 Stat. 3672), HUD Inspector 
General recommendations, and an opinion issued by the Comptroller 
General of the United States.

Implementation of 1992 Statutory Amendments

    The State CDBG regulations currently provide for several situations 
in which program income received by a unit of

[[Page 11285]]

general local government after closeout of its grant from the State 
would not be subject to the program income requirements in 
Sec. 570.489(e). However, the 1992 Act amended section 104(j) of the 
Housing and Community Development Act of 1974 (42 U.S.C. 5304(j)) to 
provide that the use of program income must be governed by all normal 
CDBG program requirements for as long as the program income exists. 
(Another statutory change, along with several regulatory initiatives, 
was reflected in the CDBG Program Economic Development Guidelines final 
rule, published on January 5, 1995 (60 FR 1922)). At that time, HUD 
noted that further regulatory changes were forthcoming to implement 
fully the 1992 amendments to the Act. With this amendment in the 1992 
Act regarding post-closeout program income, Congress intended to expand 
the coverage of program requirements to all repayments that are 
classified as program income. This amendment applies to all program 
income generated by grants made by States from funds in Fiscal Year 
(FY) 1993 and later.
    A major problem that States face in implementing the statutory 
amendment is that a community may continue to generate and use program 
income long after the initially-funded activity is completed. States 
generally close out grants to local governments upon completion of the 
initially-funded activities, though closeouts may be conditioned upon 
the satisfactory completion of certain other actions, such as 
submission of an audit or fulfillment of job creation requirements. 
This new statutory provision significantly extends States' 
responsibilities in tracking program income. To provide as much 
flexibility as possible within the constraints of the law, HUD proposes 
to allow States to demonstrate compliance with this requirement in the 
following ways:
    (1) States may maintain contractual relationships with units of 
general local government for as long as there is program income to be 
tracked. Since, in some cases, receipt of program income by a local 
government may be sporadic, a State could craft its contractual 
agreements so that they terminate once a local government has exhausted 
its program income, and re-activate upon receipt of new program income 
at some future date.
    (2) States may require local governments to obtain advance State 
approval of a local plan to expend program income, in the absence of a 
more formal contractual relationship. This arrangement may be well-
suited for States that presently use a ``conditional closeout'' 
process, in which a grant recipient has program income on hand at the 
time of grant closeout or receives program income after closeout of the 
grant that generated the program income.
    (3) States may seek HUD approval of an alternative method for 
demonstrating compliance. HUD intends that field offices, not 
Headquarters, would grant such approval.
    States may select different approaches for different types of grant 
recipients. For example, a State that distributes some of its funds on 
a formula basis and some on a competitive basis might select option 
number 1, above, for those units of local government that receive 
funding every year, and option number 2 for other grant recipients. A 
State might also blend the first two options by requiring a plan for 
the use of program income by local governments as part of its 
contractual agreement with units of general local government.
    Program income is a significant resource in the State CDBG program, 
and it constitutes a major multiplier of the benefits that the CDBG 
program provides to citizens and beneficiaries. For example, during 
Fiscal Years 1992-1994, the cumulative amount of program income 
received by all States averaged over $43.2 million per year; that is 
more than double the average yearly allocation amount to States during 
that period ($20.2 million). This represents only that portion of 
program income that was returned to the States by units of general 
local government. HUD has not previously required States to report on 
program income retained at the local level. However, consistent with 
the 1992 amendments, HUD now proposes in Sec. 570.489(e)(4) to require 
States' annual performance reports to include the use of program income 
held by local governments.
    HUD recognizes that implementation of this statutory change may 
significantly affect the reuse of a large dollar volume of income 
retained by local governments. Because States have not previously 
reported to HUD on locally-retained income (whether classified as 
program income or as miscellaneous revenue), HUD cannot accurately 
predict the financial implications of this proposed rule change. HUD 
welcomes comments on the amount of income that will now be subject to 
program income requirements, and on resulting effects on what such 
funds are used for.

Continuing Applicability of Previous Regulations

    In the last few years, there have been a succession of regulatory 
changes to the State CDBG program income requirements. Presently, 
States must administer multiple sets of requirements, each of which 
applies to program income received during different time periods. 
Program income received prior to December 9, 1992 was subject to the 
requirements laid out in various policy memoranda issued subsequent to 
the issuance of amended State CDBG regulations on April 8, 1982 (47 FR 
15297). HUD formalized those policies in a final rule published in the 
Federal Register on November 9, 1992 (57 FR 53397). Program income 
generated from grants made by States with Fiscal Year 1993 and later 
funds is subject to the 1992 statutory amendments as well as the 
requirements of the November 9, 1992 final rule. Finally, the January 
5, 1995 CDBG Program Economic Development Guidelines final rule (60 FR 
1922) included an expanded list of revenues that are not considered 
program income.
    States have reported that tracking different requirements as they 
apply to different funding years is complicated and time-consuming, 
especially for program income retained at the local level. Repayments 
of loans made from one grant to a given community may be subject to 
different requirements than repayments of loans made from a subsequent 
year's grant to the same community. This results in an increased 
record-keeping burden on both the State and local governments. The 
complexity and burden are compounded when program income is used to 
make additional loans, which, in turn, generate more program income. It 
is not clear to some States whether program income is subject to the 
requirements in effect at the time the State awarded the initial grant 
to the locality, or to the requirements in effect when the program 
income is received.
    To address this confusion, HUD is proposing to clarify the 
continuing applicability of previous program income requirements to 
program income retained by localities. (The problem does not occur with 
program income returned to States for redistribution. Since State-held 
program income is redistributed according to the method of distribution 
in effect at the time that it is redistributed, such program income is 
treated the same as a State's regular allocation of funds for that 
year; this includes being subject to the same other CDBG program 
requirements.) This proposed rule would provide that program income 
that results from an activity funded from FY 1992 and earlier funds 
remains subject to the requirements as they currently exist. The new 
provision in this proposed rule

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would apply to FY 1993 and later funds. If a local government 
commingles program income from pre-1993 grants with program income from 
a newer grant, the new provision in this proposed rule would apply to 
all the program income, as the local government would not be able to 
distinguish which income came from which grant.
    Some States have reported that reducing the number of different 
program income requirements would also simplify compliance with the 
requirements. In response to these suggestions, this proposed rule 
would provide an alternative to the ``continuing applicability'' 
provision described in the previous paragraph. States would have the 
option of applying these new provisions to all program income held by 
units of local government, regardless of the source year of the funding 
that generated the program income. Subjecting all outstanding locally-
held program income to these proposed requirements would greatly 
simplify the tracking of program income and would reduce confusion over 
which set of requirements applies to which program income dollars. 
However, the proposed requirements would be more restrictive. 
Application of the new requirements to pre-FY 1993 funding could mean 
that some funds would be reclassified as program income rather than 
miscellaneous revenue, which could reduce local governments' 
flexibility in expending such funds. Furthermore, applying the new 
rules to previously-generated program income would probably require 
amending the existing grant contracts with units of local government, 
which would reduce any staff time savings resulting from simplified 
tracking of program income.
    However, the potential administrative benefits to States and local 
governments may outweigh the negative impact of reduced local 
flexibility in enough cases to justify this option. HUD particularly 
welcomes comments on the practical implications of this option, on the 
net savings of staff time resulting from the option, and the effects on 
State grant recipients.

Miscellaneous Improvements and Updates

    States have requested several clarifications of the program income 
requirements, and HUD has discovered other areas that call for 
regulatory redress. In substantially updating the program income 
requirements contained in Sec. 570.489(e), HUD is proposing to 
incorporate the following changes.
    (1) Selling off loan portfolios in order to expedite the receipt of 
program income. In order to maximize available financial resources, 
communities are increasingly selling portfolios of loans on the 
secondary market, or selling obligations secured by loan portfolios. 
Several communities have recently requested HUD's approval to ``net 
out'' of the proceeds from such sales the various legal and other costs 
that are incurred when a grantee sells or securitizes a portfolio. 
There are similarities between such situations and the currently-
allowed provision whereby costs incidental to the generation of program 
income from the rental or use of CDBG-assisted real or personal 
property may be netted out of the gross income received. Therefore, 
this proposed rule would amend Sec. 570.489(e)(1) (vi) and (vii) to 
allow legal and other costs associated with the sale or securitization 
of CDBG-funded loans to be netted out before the amount of program 
income is determined. This provision, however, would be limited to 
costs that are not already eligible as general administrative costs of 
either the State or the unit of general local government.
    (2) $25,000 per year exception. Section 104(j) of the Act allows 
the Secretary to exempt from the program income requirements amounts 
that are so small that the tracking thereof would pose an 
administrative burden. In the CDBG Program Economic Development 
Guidelines final rule (January 5, 1995; 60 FR 1922), HUD raised this 
threshold in Sec. 570.489(e)(2) from $10,000 to $25,000 per year per 
unit of general local government. Some confusion apparently exists over 
how to apply this threshold. This proposed rule would revise the 
wording of this paragraph slightly to clarify that this threshold 
applies only to program income retained by a unit of general local 
government and its subrecipients; the threshold applies separately to 
each unit of local government. As with the currently-existing rule, 
this provision would not apply to program income that a unit of local 
government earns but returns to the State.
    (3) Remission of grant funds. This proposed rule would add 
Sec. 570.489(e)(2)(v), listing certain types of interest earnings that 
are not considered to be program income. Two of these provisions would 
respond to HUD Inspector General findings and implement an opinion of 
the Comptroller General of the United States that income generated by 
an ineligible CDBG-assisted activity must be returned to the U.S. 
Treasury. Since, in the context of the Comptroller General opinion, 
eligibility includes meeting a national objective, this provision 
should invoke a sharpened grantee focus on successful outcomes; 
interest generated from CDBG-funded loans could only be kept by the 
grantee when the assisted activities meet the national objective 
requirements.
    The third provision (at Sec. 570.489(e)(2)(v)(C)) requiring that 
most interest earned by units of general local government on grant 
advances (prior to disbursement of the funds for activities) be 
returned to the U.S. Treasury, already appears in the State CDBG 
regulations at Sec. 570.489(c)(2). Concordant with the proposed 
revision of Sec. 570.489(c) (described above), this proposed rule would 
move the requirement to Sec. 570.489(e)(2)(v) to complete the listing 
of what is not program income. This proposed rule would simultaneously 
update this provision to note that interest earned on escrow accounts, 
unlike interest earned on lump sum drawdowns, must be returned to the 
Treasury.
    HUD issued comparable provisions in a final rule for the 
Entitlement CDBG program, published on November 9, 1995 (60 FR 56893). 
In responding to public comments in that rulemaking, HUD provided 
guidance on the extent and applicability of these provisions. Readers 
with a particular interest in these provisions may wish to read the 
preamble to the November 9, 1995 final rule (60 FR 56892).
    (4) Program income generated by loans to subrecipients. This 
proposed rule would clarify, in Sec. 570.489(e)(2)(iv), that units of 
general local government may receive program income from subrecipients, 
while eliminating any double-counting of program income received 
through that process. This proposed rule would classify such repayments 
as ``transfer[s] of program income.'' If the funds used by a 
subrecipient to make principal or interest payments on a CDBG loan it 
received from a unit of general local government consist solely of 
program income received by the subrecipient, no amount of those 
payments to the grantee represents ``new income'' to the grantee's CDBG 
program as a whole. If, however, the subrecipient uses non-CDBG funds 
to make the principal or interest payments, those payments to the local 
government are ``new income'' to the CDBG program; this proposed rule 
would not affect the treatment of such payments. HUD added a similar 
provision to the Entitlement program regulations in the November 9, 
1995 final rule (60 FR 56893).
    (5) Program income retained at the local level. Section 104(j) of 
the Act

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allows a State to require that a unit of general local government pay 
the State any income to be used by the State to fund additional 
eligible community development activities, except that the State must 
waive this requirement to the extent that such income is applied to 
``continue the activity from which such income is derived.''
    HUD gives States the flexibility to define the phrase ``continue 
the activity from which such income is derived.'' HUD is aware of 
situations in which States found that a unit of local government failed 
to use program income in accordance with other program requirements, or 
was not making any efforts to expend its program income to continue the 
activity. HUD does not believe that Congress intended the above 
provision to override other programmatic requirements to the extent 
that a community must be allowed to retain the program income in 
egregious cases. This proposed rule, in Sec. 570.489(e)(3)(ii)(A), 
would clarify that a State's definition of what constitutes 
``continuing the activity from which such income is derived'' can 
include consideration of whether the program income is not being used 
(or is unlikely to be used) to continue the activity in a timely manner 
or in accordance with other program requirements.
    In some situations, a State may determine that a unit of local 
government will use program income to continue the activity from which 
the income is derived, but that the amount of program income on hand 
exceeds projected cash needs for the near future. For example, 
community Y has a demand for about two housing rehabilitation loans per 
month, but has enough program income on hand to fund 10 average-sized 
loans. A State could require the unit of local government to return 
some or all the program income to the State's CDBG program income 
account until such time as it is needed by the local government. The 
State could disburse these funds to other units of general local 
government in the meantime rather than drawing funds from its line of 
credit.
    When the local government needs its program income, the State could 
disburse the funds from the program account, or as necessary draw an 
equivalent amount from the State's line of credit for disbursal to the 
local government. This would increase the effective ``buying power'' of 
a State's CDBG funds, because the funds would be expended sooner. The 
reduced interest losses to the U.S. Treasury would be a potential side 
benefit, as States would need to draw funds from their line of credit 
somewhat less frequently. States would have the flexibility to define 
the time period over which cash needs for program income would be 
projected, and the appropriate level of program income that could be 
retained in the local government's own program account.
    (6) State administrative costs. States may include program income 
in the base of funds against which they may deduct $100,000 plus up to 
2 percent for State administrative costs. This is easily done for 
program income that is returned to the State, as those funds are 
already in the State's hands. States may find it more difficult to 
claim a portion of locally-held program income within their 
administrative costs allowance. Therefore, this proposed rule would 
provide, in Sec. 570.489(e)(3)(ii), that a State could require a unit 
of general local government to return, for the State's use, up to 2 
percent of program income retained at the local level.

Revolving Loan Funds

    Revolving funds are typically established and administered in the 
following manner. A loan is made with CDBG funds (e.g., to a business 
to expand). Payments on that loan (i.e., principal, interest, or both) 
constitute program income that is credited as CDBG program income on 
the local government's books and held in an account independent of 
other program accounts. The program income in that account, including 
interest earned on the funds while on deposit pending their reuse, 
becomes the source of financing for additional loans of the same type. 
Hence, the term ``revolving fund'' has been used to describe such a 
fund. Revolving funds are used most frequently in connection with 
housing rehabilitation and economic development projects that involve 
loans.
    A number of States have found regional revolving loan funds to be 
an efficient means of collecting and redistributing program income held 
at the local level. Such loan funds are often operated by a non-or 
quasi-governmental organization that administers programs as a 
subrecipient of the local government(s) to which HUD awarded grants. 
(Since these regional entities are usually not units of general local 
government, they may not directly receive CDBG funding.) Any program 
income they administer still belongs to the unit(s) of general local 
government whose grant(s) generated the program income. Successive 
reuses of program income must continue to be traceable back to 
individual localities' grants. This presents a problem if a regional 
loan fund is administering program income generated by multiple 
communities' grants.
    Regional loan fund operators may wish to use program income to fund 
activities anywhere in their service area, regardless of which 
community the program income belongs to. However, while units of 
general local government may use CDBG funds for activities outside 
their jurisdictional boundaries, each such community must determine 
that it is meeting its community development needs by doing so. It may 
be difficult for community A to reasonably conclude that its citizens 
benefit by having its program income used for an activity in community 
B, 60 miles away.
    Despite these problems, HUD supports efforts to establish regional 
loan funds. Economies of scale can often be achieved in the 
administration of such programs. Regional economic development efforts 
may be more cognizant of the regional nature of rural economies, and 
better positioned to act accordingly. Assessing the benefits of 
individual economic development projects may also make sense from a 
regional perspective, as employees of businesses in rural communities 
frequently commute from residences in other communities.
    To provide flexibility, the present State CDBG regulations in 
Sec. 570.489(f)(2) offer three options regarding revolving loan funds. 
First, States may make awards to combinations of governments. Under 
such an arrangement, program income can be reused within the 
jurisdiction of any of the participating local governments. Second, if 
both the activities and the regional entity that carries out the 
activities qualify under section 105(a)(15) of the Act, repayments 
generated from these activities are not within the definition of 
``program income,'' and so are not subject to program requirements. 
Third, a State may itself operate a statewide revolving fund to 
redistribute to units of general local government program income 
returned to the State.
    This proposed rule, in Sec. 570.489(f)(2), would expand upon this 
third option by allowing a State to operate one or more revolving funds 
on a regional or statewide basis. Providing that the State determines 
that the program income will not be used to continue the same activity, 
a State can presently require program income generated from grant-
funded activities to be returned to the State. With the proposed 
change, a State could, in essence, designate a regional revolving loan 
fund as a ``State'' revolving fund. A State could, pursuant to this 
proposal, require such program

[[Page 11288]]

income to be repaid to a State-designated regional revolving fund. The 
State could then contract with a regional entity to administer the fund 
(including the distribution of program income to local governments) on 
behalf of the State. Because the program income belongs to the State, 
the regional entity could, under the auspices of the State and its 
method of distribution, distribute it to any other eligible unit of 
local government covered by the regional revolving fund. The community 
whose initial grant generated the program income would have no further 
responsibility for the reuse of the program income. Subsequent 
repayments of program income would belong to the State, rather than 
belonging to a unit of local government, and the regional fund entity 
could award the funds, on behalf of the State, to units of general 
local government anywhere within the region. Any State choosing this 
approach would, of course, need to describe its process in the method 
of distribution contained in its consolidated plan.

Lump Sum Drawdowns

    Section 104(h) of the Act allows units of local government to make 
lump sum drawdowns of CDBG funds to establish revolving loan funds for 
property rehabilitation activities. Paragraph (2) of that section 
requires HUD to establish standards governing lump sum drawdowns. Such 
standards exist in the CDBG Entitlement program regulations in 
Sec. 570.513; however, HUD has never created comparable regulations for 
the State CDBG program. This proposed rule would amend Sec. 570.513 so 
that its requirements could apply both to the Entitlement CDBG program 
and the State CDBG program; certain adaptations would be necessary to 
recognize the States' review and determination responsibilities, which 
HUD itself fulfills in the Entitlement program. With this proposed 
rule, HUD does not intend to make any substantive changes to the 
requirements of Sec. 570.513 as they apply in the Entitlement program.
    HUD reminds States that use of lump sum drawdowns is limited to the 
rehabilitation of privately-owned properties. This can include 
residential, commercial, and industrial properties; however, this would 
not include other forms of economic development assistance. Interest 
earned on lump sum drawdowns is classified as program income, and so is 
not subject to the return-of-interest provision in the existing 
Sec. 570.489(c)(2) and the proposed Sec. 570.489(e)(2)(v).

Use of Escrow Accounts for Rehabilitation

    Similarly, Sec. 570.511 allows Entitlement communities to establish 
escrow accounts for funding loans and grants for the rehabilitation of 
privately-owned residential property. Again, HUD has never created 
comparable regulations for the State CDBG Program. This proposed rule 
would amend Sec. 570.511 so that its requirements could apply both to 
the Entitlement CDBG program and the State CDBG program, including 
appropriate adaptations respecting the role of States. With this 
proposed rule, HUD does not intend to make any substantive changes to 
the requirements of Sec. 570.511 as they apply in the Entitlement 
program.
    Paragraph (c) of Sec. 570.511 of the Entitlement regulations 
concerns remedies for noncompliance. That paragraph gives HUD the 
authority to require a recipient to discontinue the use of escrow 
accounts. As adapted to apply to the State CDBG program in this 
proposed rule, the paragraph would indicate that States have authority 
under Sec. 570.492(b) to discontinue a local government's use of escrow 
accounts if a State determines that a unit of general local government 
has failed to use an escrow account in accordance with Sec. 570.511.
    The escrow accounts provision is more limited in applicability than 
the lump sum drawdown provision; escrow accounts may be utilized only 
for the rehabilitation of primarily residential privately-owned 
properties. Furthermore, interest earned on grant funds placed in 
escrow accounts is not program income; it must be returned to the U.S. 
Treasury.

Conflict of Interest Provisions

    HUD recently amended the conflict of interest provisions in the 
Entitlement program regulations (Sec. 570.611) in a final rule 
published on November 9, 1995 (60 FR 56893). The amendments to 
Sec. 570.611 in the November 9, 1995 final rule were in response to 
public comments HUD received on the conflict of interest requirements 
during the course of the rulemaking.
    The State CDBG conflict of interest provisions in Sec. 570.489(h) 
date from a November 9, 1992 final rule (57 FR 53397). In today's 
proposed rule, HUD would make minor changes to these provisions to make 
them consistent with Sec. 570.611 of the CDBG Entitlement regulations.
    The introductory discussion of Sec. 570.489(h)(2) describes the 
general principle concerning conflicts of interest as applicable 
``[e]xcept for eligible administrative or personnel costs.'' HUD 
deleted this introduction from the Entitlement program regulations in 
the November 9, 1995 final rule, based on public comments that 
expressed confusion over the phrase. Several commenters described 
potentially troublesome situations that could arise from the inclusion 
of the phrase. HUD is not aware of any problems that have arisen in the 
State CDBG program as a result of the present wording. However, to 
promote consistency of regulatory approach between the two programs, 
this proposed rule would delete the reference to administrative or 
personnel costs from the regulations for the State program. HUD 
specifically requests comments from interested parties on what effect 
(if any) this deletion would have on the program. Commenters may wish 
to read the preamble to the November 9, 1995 final rule for further 
discussion of this issue (60 FR 56901).
    This proposed rule would make several other wording changes in 
Sec. 570.489(h)(2) concerning prohibited conflicts of interest. These 
changes would eliminate a redundant phrase, eliminate confusion over 
what sort of benefit a person might receive in a contract that would be 
nonfinancial in nature, and clarify that family ties of greatest 
concern are those with immediate family members.

Spending Funds Outside the Jurisdiction of the Recipient

    This portion of the proposed rule would revise Sec. 570.486(b). 
Under the existing regulations, CDBG-funded activities may serve 
beneficiaries living outside the jurisdiction of the unit of general 
local government if the unit of government determines that the activity 
is meeting its needs under the Act. Two emerging trends suggest that 
further regulation in this area is appropriate. In both situations, 
citizens may not be aware that funds that were supposed to benefit one 
community are being spent to benefit another.
    First, States and units of general local government are 
increasingly using regional organizations to administer revolving loan 
funds on behalf of local governments. These regional entities, which 
may administer grants from multiple localities, often seek the 
flexibility to use program income generated from these grants anywhere 
within their service area, regardless of which community's grant 
generated the program income. This presents a problem. Local 
governments cannot completely abdicate to regional entities their 
responsibility to ensure that program income generated from their

[[Page 11289]]

grant is used to meet the community's needs.
    Second, HUD is aware of a number of situations in which States 
awarded or planned to award a grant to one community, but the benefits 
of the activities would occur in a different community or throughout a 
much larger area. In some cases, one small community would receive a 
grant for an activity that would be carried out on a regional or even 
statewide basis. In other cases, suburban communities would receive 
funding for projects, and the principal benefit would accrue to a 
nearby Entitlement community. HUD does not believe it is appropriate 
for one community to serve as a ``flag of convenience'' grant recipient 
when only a small portion of the benefits will accrue to residents of 
that jurisdiction. In such situations, the more appropriate approach is 
for a State to make a grant to a ``combination of governments,'' as is 
specifically provided for in the Act. In situations involving 
activities located in Entitlement communities, HUD believes it is 
appropriate for Entitlement communities to participate in funding such 
projects commensurate with the benefits their citizens receive.
    This proposed rule would add to the existing regulations a 
requirement that reasonable benefits must accrue to residents within 
the jurisdiction of the grant recipient. Since HUD is aware that 
activities located outside a State grant recipient's jurisdiction may 
indeed provide substantial benefits to the citizens within the 
jurisdiction, this proposed rule would not prohibit such activities. 
The rule would simply require that the State grant recipient consider 
whom the funds will benefit; in making a determination that such a 
project meets the community's needs, the community should ensure that 
the benefits to its residents are sufficient to justify the project. 
HUD would not question the determination (or the State's acceptance 
thereof) unless it is clearly unreasonable. This proposed rule would 
not limit the amount or percentage of funds that may assist such an 
activity, and should not affect joint efforts by cities and counties to 
benefit their residents. The recipient would be responsible for 
determining the reasonableness of the benefits in such cases. A 
parallel change was recently finalized in the CDBG Entitlement 
regulations, in the November 9, 1995 final rule (60 FR 56892).

State Authority to Impose Additional Provisions

    This proposed rule would add a new provision to reinforce States' 
administrative flexibility. This new provision would authorize States 
to apply to participating units of general local government additional 
requirements or requirements that are more restrictive than those 
established by HUD. Such authority is implicit in the States' ability 
to administer the CDBG program, but HUD has never explicitly stated 
this in the regulations. States cannot impose any additional 
requirements that would be plainly inconsistent with the Act or with 
other statutory or regulatory provisions that apply to the State CDBG 
program. HUD proposes this provision in association with several of 
today's other proposed changes to portray more clearly State 
responsibilities and authority.

Findings and Certifications

Paperwork Reduction Act Statement

    The information collection requirements in Sec. 570.489(e)(4) of 
this proposed rule have been submitted to the Office of Management and 
Budget (OMB) for review under section 3507(d) of the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3507(d)) and 5 CFR 1320.11. An agency 
may not conduct or sponsor, and a person is not required to respond to, 
a collection of information unless the collection displays a valid 
control number.
    As required under 5 CFR 1320.8(d)(1), HUD and OMB are seeking 
comments from members of the public and affected agencies concerning 
the proposed collection of information to:
    (1) Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information will have practical utility;
    (2) Evaluate the accuracy of the agency's estimate of the burden of 
the proposed collection of information;
    (3) Enhance the quality, utility, and clarity of the information to 
be collected; and
    (4) Minimize the burden of the collection of information on those 
who are to respond; including through the use of appropriate automated 
collection techniques or other forms of information technology, e.g., 
permitting electronic submission of responses. Interested persons are 
invited to submit comments according to the instructions in the Dates 
and Addresses sections in the preamble of this proposed rule.
    This document also provides the following information:
    Title of Proposal: Revisions to State CDBG Program Income 
Requirements and Miscellaneous Amendments.
    OMB Control Number: HUD is seeking OMB approval for the information 
collection requirements identified in this proposed rule. OMB will 
assign a control number for these State CDBG program information 
collection requirements upon granting approval. This proposed 
information collection would be in addition to the information 
collection requirements presently contained in the consolidated plan 
and covered under control number 2506-0117.
    Description of the Need for the Information and Proposed Use: This 
rule proposes to revise the program income requirements governing the 
State CDBG program, along with miscellaneous other changes.
    Form Numbers: Not applicable. No forms are required by HUD in the 
State CDBG program.
    Members of Affected Public: States, units of general local 
government.
    Estimation of the Total Number of Hours Needed to Prepare the 
Information Collection including Number of Respondents, Frequency of 
Response, and Hours of Response:
    Changes in State CDBG requirements affect both State and local 
government staff. State staff review reports submitted by local 
governments, make on-site compliance reviews, and report to HUD on the 
uses of CDBG funds. Local government staff collect information to 
demonstrate compliance with program requirements and report to the 
State on the use of funds.
    Two proposed changes in this rule would affect the amount of time 
spent by States and local governments in administering CDBG funds: 
locally-held program income subject to all CDBG requirements for as 
long as it exists; and States reporting on locally-held program income 
in their Consolidated Plan Reports. Several factors determine the 
burden that these proposed changes would impose on States and local 
governments. Housing rehabilitation and economic development activities 
are more likely to generate program income than are public facilities 
or public service activities. Activities that provide loans are more 
likely to generate program income than are activities providing grants 
or forgivable loans. The number, size, rate, and terms of loans made 
determine the amount of program income generated per year.
    Some States require locally-retained program income to be used in 
compliance with some or all CDBG program income requirements, whether 
or not HUD's regulations require such compliance. In those States, the 
proposed rule will result in little or no additional local compliance 
burden. However, additional staff time will be needed by the States 
themselves to

[[Page 11290]]

report to HUD on the use of such program income.
    The following figures represent additional increments of time and 
cost beyond those normally involved in the State CDBG program. In 
developing these estimates, HUD consulted with a representative sample 
of States; the figures represent a melding of HUD estimates with 
States' estimates to produce a national average.
    All States together fund about 3,000 grants per year, consisting of 
about 11,000 activities. However, only about 20 percent of these 
activities are of types that are likely to generate income. As noted 
above, many of those income-generating activities are either not 
subject to program income requirements, or are already subject to 
program income requirements and will see no change under the proposed 
rule. Thus, HUD believes the number of State grants that will be 
subject to additional recordkeeping and reporting efforts is a 
relatively small portion of all State grants.
    States make new grant awards to units of local government every 
year; however, States' grant contracts with units of general local 
government usually remain in force for several years. The burden 
estimates shown for local governments thus represent the net burden 
increase over the duration of its contractual relationship with the 
State, rather than annual figures. The burden estimates for States are 
average annual figures.

----------------------------------------------------------------------------------------------------------------
                                                                     Number of      Total hours                 
                 Burden of collection frequency                     respondents    per response     Total hours 
----------------------------------------------------------------------------------------------------------------
Local recordkeeping and reporting to state on program income:                                                   
    Ongoing.....................................................             550              60          33,000
State recordkeeping and reporting on program income:                                                            
    Annually....................................................              49              80           3,920
                                                                 -----------------------------------------------
      Total.....................................................             599  ..............          36,920
----------------------------------------------------------------------------------------------------------------

Executive Order 12866

    The Office of Management and Budget (OMB) reviewed this proposed 
rule under Executive Order 12866, Regulatory Planning and Review, 
issued by the President on September 30, 1993. OMB determined that this 
proposed rule is a ``significant regulatory action,'' as defined in 
section 3(f) of the Order (although not economically significant, as 
provided in section 3(f)(1) of the Order). Any changes made in this 
rule subsequent to its submission to OMB are identified in the docket 
file, which is available for public inspection between 7:30 a.m. and 
5:30 p.m. in the Office of the Rules Docket Clerk, Office of General 
Counsel, Room 10276, Department of Housing and Urban Development, 451 
Seventh Street, SW, Washington, DC.

Environmental Impact

    A Finding of No Significant Impact with respect to the environment 
has been made in accordance with HUD regulations at 24 CFR part 50, 
which implement section 102(2)(C) of the National Environmental Policy 
Act of 1969. The Finding of No Significant Impact is available for 
public inspection during regular business hours in the Office of the 
Rules Docket Clerk, Office of General Counsel, Room 10276, Department 
of Housing and Urban Development, 451 Seventh Street, SW, Washington, 
DC 20410.

Regulatory Flexibility Act

    The Secretary, in accordance with the Regulatory Flexibility Act (5 
U.S.C. 605(b)), has reviewed this proposed rule before publication and 
by approving it certifies that this proposed rule does not have a 
significant economic impact on a substantial number of small entities. 
The proposed rule is limited to the effecting of relatively minor 
procedural amendments that would update the State CDBG regulations to 
recognize statutory amendments and clarify the regulations to address 
past confusion.

Executive Order 12612, Federalism

    The General Counsel, as the Designated Official under section 6(a) 
of Executive order 12612, Federalism, has determined that the policies 
contained in this proposed rule will not have substantial direct 
effects on States or their political subdivisions, or the relationship 
between the Federal Government and the States, or on the distribution 
of power and responsibilities among the various levels of government. 
As a result, the proposed rule is not subject to review under the 
order. The proposed rule is limited to making relatively minor 
procedural amendments that would update the State CDBG regulations to 
recognize statutory amendments and clarify the regulations to address 
past confusion. In general, this proposed rule would provide more 
flexibility and clarity in the regulations for States and units of 
general local government.

Executive Order 12606, The Family

    The General Counsel, as the Designated Official under Executive 
Order 12606, The Family, has determined that this proposed rule does 
not have potential for significant impact on family formation, 
maintenance, and general well-being, and, thus, is not subject to 
review under the order. No significant change in existing HUD policies 
or programs will result from promulgation of this proposed rule, as 
those policies and programs relate to family concerns.

Unfunded Mandates Reform Act

    Title II of the Unfunded Mandates Reform Act of 1995 (UMRA) (Pub. 
L. 104-4, approved March 22, 1995; 109 Stat. 48) establishes 
requirements for Federal agencies to assess the effects of their 
regulatory actions on State, local, and tribal governments and the 
private sector. This proposed rule would not impose any Federal 
mandates on any State, local, or tribal governments, or on the private 
sector within the meaning of the UMRA. The provisions of this proposed 
rule would primarily clarify program procedures or provide States 
additional flexibility in administering block grant funds.

List of Subjects in 24 CFR Part 570

    Administrative practice and procedure, American Samoa, Community 
development block grants, Grant programs--education, Grant programs--
housing and community development, Guam, Indians, Lead poisoning, Loan 
programs--housing and community development, Low and moderate income 
housing, New communities, Northern Mariana Islands, Pacific Islands 
Trust Territory, Pockets of poverty, Puerto Rico, Reporting and 
recordkeeping requirements, Small cities, Student aid, Virgin Islands.

    Accordingly, for the reasons stated in the preamble, 24 CFR part 
570 is proposed to be amended as follows:

[[Page 11291]]

PART 570--COMMUNITY DEVELOPMENT BLOCK GRANTS

    1. The authority citation for part 570 continues to read as 
follows:

    Authority: 42 U.S.C. 3535(d) and 5300-5320.

    2. Section 570.480 is amended by adding a new paragraph (e) to read 
as follows:


Sec. 570.480  General.

* * * * *
    (e) A State may, in its administration of the program, apply 
additional or more restrictive provisions to units of general local 
government participating in the State's program, providing that such 
provisions are not plainly inconsistent with the Act or other statutory 
or regulatory provisions applicable to the State CDBG program.
    3. Section 570.486 is amended by revising paragraph (b) to read as 
follows:


Sec. 570.486  Local government requirements.

* * * * *
    (b) Activities serving beneficiaries outside the jurisdiction of 
the unit of general local government. CDBG-funded activities may serve 
beneficiaries outside the jurisdiction of the unit of general local 
government that receives the grant, provided that reasonable benefits 
from the activity will accrue to residents within the jurisdiction of 
the grant recipient, and provided that the unit of general local 
government determines that the activity is meeting its needs in 
accordance with section 106(d)(2)(D) of the Act (42 U.S.C. 
5306(d)(2)(D)).
    4. Section 570.489 is amended by:
    a. Revising paragraph (c);
    b. Revising paragraph (e);
    c. Revising the first sentence of paragraph (f)(2);
    d. Revising paragraphs (h)(2) and (h)(3);
    e. Adding a new paragraph (n); and
    f. Adding a new paragraph (o); to read as follows:


Sec. 570.489  Program administrative requirements.

* * * * *
    (c) Federal grant payments. The State's requests for payment, and 
the Federal Government's payments upon such requests, must comply with 
31 CFR part 205. The State must use procedures to minimize the time 
elapsing between the transfer of grant funds and disbursement of funds 
by the State to units of general local government. Units of general 
local government must also use procedures to minimize the time elapsing 
between the transfer of funds by the State and disbursement for CDBG 
activities.
* * * * *
    (e) Program income. (1) For the purposes of this subpart, ``program 
income'' is defined as gross income received by a State, a unit of 
general local government, or a subrecipient of a unit of general local 
government that was generated from the use of CDBG funds, except as 
provided in paragraph (e)(2) of this section. When income is generated 
by an activity that is only partially assisted with CDBG funds, the 
income must be prorated to reflect the percentage of CDBG funds used 
(e.g., a single loan supported by CDBG funds and other funds; a single 
parcel of land purchased with CDBG funds and other funds). Program 
income includes, but is not limited to, the following:
    (i) Proceeds from the disposition by sale or long term lease of 
real property purchased or improved with CDBG funds;
    (ii) Proceeds from the disposition of equipment purchased with CDBG 
funds;
    (iii) Gross income from the use or rental of real or personal 
property acquired by the unit of general local government or a 
subrecipient of a unit of general local government with CDBG funds, 
less the costs incidental to the generation of the income;
    (iv) Gross income from the use or rental of real property, owned by 
the unit of general local government or a subrecipient of a unit of 
general local government, that was constructed or improved with CDBG 
funds, less the costs incidental to the generation of the income;
    (v) Payments of principal and interest on loans made using CDBG 
funds, except as provided in paragraph (e)(2)(iv) of this section;
    (vi) Proceeds from the sale of loans made with CDBG funds, less 
legal and other costs associated with the sale of loans that are not 
otherwise eligible under sections 105(a)(13) or 106(d)(3)(A) of the Act 
(42 U.S.C. 5305(a)(13), 5306(d)(3)(A));
    (vii) Proceeds from the sale of obligations secured by loans made 
with CDBG funds, less legal and other costs associated with the sale of 
obligations that are not otherwise eligible under sections 105(a)(13) 
or 106(d)(3)(A) of the Act (42 U.S.C. 5305(a)(13), 5306(d)(3)(A));
    (viii) Interest earned on funds held in a revolving fund account;
    (ix) Interest earned on program income pending disposition of the 
income;
    (x) Funds collected through special assessments made against 
properties owned and occupied by households not of low and moderate 
income, if the special assessments are used to recover all or part of 
the CDBG portion of a public improvement; and
    (xi) Gross income paid to a unit of general local government or 
subrecipient from the ownership interest in a for-profit entity 
acquired in return for the provision of CDBG assistance.
    (2) ``Program income'' does not include the following:
    (i) Any income received by a unit of general local government and 
its subrecipients during a twelve-month period, provided that the total 
of such income is less than $25,000. (This provision does not apply to 
funds paid to the State for redistribution to other units of local 
government.)
    (ii) Amounts generated by activities that are eligible under 
section 105(a)(15) of the Act (42 U.S.C. 5305(a)(15)) and are carried 
out by an entity under the authority of section 105(a)(15) of the Act;
    (iii) Amounts generated by activities that are financed by a loan 
guaranteed under section 108 of the Act (42 U.S.C. 5308) and meet one 
or more of the public benefit criteria specified in 
Sec. 570.482(f)(3)(v), or are carried out in conjunction with a grant 
under section 108(q) of the Act (42 U.S.C. 5308(q)) in an area 
determined by HUD to meet the eligibility requirements for designation 
as an Empowerment Zone or Enterprise Community pursuant to either 24 
CFR part 597, subpart B or 7 CFR part 25, subpart B (as applicable). 
Such exclusion does not apply if CDBG funds are used to repay the 
guaranteed loan. When such a guaranteed loan is partially repaid with 
CDBG funds, the amount generated must be prorated to reflect the 
percentage of CDBG funds used. Amounts generated by activities financed 
with loans guaranteed under section 108 of the Act (42 U.S.C. 5308) 
that are not defined as ``program income'' will be treated as 
miscellaneous revenue and will not be subject to any of the 
requirements of this part. However, such treatment does not affect the 
right of the Secretary to require the Section 108 borrower to pledge 
such amounts as security for the guaranteed loan. The determination 
whether such amounts constitute program income is governed by the 
provisions of the contract required at Sec. 570.705(b)(1).
    (iv) Payments of principal and interest made by a subrecipient to a 
unit of general local government, toward a loan from the local 
government to the subrecipient, when program income received by the 
subrecipient is being

[[Page 11292]]

used for such payments. (By making such payments, the subrecipient is 
deemed to have transferred program income to the unit of general local 
government.)
    (v) Interest earned on the following; such interest must be 
remitted to HUD for transmittal to the U.S. Treasury, and will not be 
reallocated under section 106 (c) or (d) of the Act (42 U.S.C. 5306 
(c), (d)):
    (A) Interest earned on loans or other forms of assistance provided 
with CDBG funds that are used for activities determined by HUD either 
to be ineligible or to fail to meet a national objective in accordance 
with the requirements of Secs. 570.482 or 570.483, or section 105(a) of 
the Act (42 U.S.C. 5305(a)), or that fail substantially to meet any 
other requirement of this subpart or the Act;
    (B) Interest earned on the investment of amounts reimbursed to the 
CDBG program account prior to the use of the reimbursed funds for 
eligible purposes; and
    (C) Interest earned by units of general local government on grant 
funds before disbursement of the funds for activities, except that the 
unit of general local government may keep interest payments of up to 
$100 per year for administrative expenses and may deduct service 
charges for escrow accounts pursuant to paragraph (o) of this section. 
(Interest earned on lump sum deposits pursuant to paragraph (n) of this 
section is not subject to the provisions of paragraph (e)(2)(v)(C) of 
this section.)
    (3) (i) Program income paid to the State. Except as described in 
paragraph (e)(3)(ii)(A) of this section, the State may require the unit 
of general local government that receives or will receive program 
income to return the program income to the State. Program income that 
is paid to the State is treated as additional CDBG funds subject to the 
requirements of this subpart. Except for program income retained and 
used by the State for administrative costs under Sec. 570.489(a), 
program income paid to the State must be distributed to units of 
general local government in accordance with the method of distribution 
in the action plan under 24 CFR part 91 that is in effect at the time 
the program income is distributed. To the maximum extent feasible, the 
State must distribute program income before it makes additional 
withdrawals from the Treasury, except as provided in paragraph (f) of 
this section.
    (ii) Program income retained by a unit of general local government. 
The State may permit the unit of general local government that receives 
or will receive program income to retain the program income. In any 
case in which the State allows the unit of general local government to 
retain program income, the State may require the unit of local 
government to pay to the State an amount not to exceed 2 percent of the 
program income received, for use by the State in accordance with 
Sec. 570.489(a).
    (A) The State must permit the unit of general local government to 
retain the program income if the program income will be used to 
continue the activity from which it was derived.
    (1) The State will determine when an activity will be considered to 
be continued. In making such a determination, the State may consider 
whether the unit of local government is or will be unable to comply 
with the requirements of paragraph (e)(3)(ii) of this section or other 
requirements of this part, and whether the program income-funded 
activity is unlikely to be completed within a reasonable time period.
    (2) When the State determines that the program income will be used 
to continue the activity from which it was derived, but that the amount 
of program income held by the unit of local government exceeds 
projected cash needs for the near future, the State may require the 
local government to return all or part of the program income to the 
State's line of credit until such time as the program income is needed 
by the unit of general local government.
    (B) Program income that is received and retained by the unit of 
general local government is treated as additional CDBG funds and is 
subject to all applicable requirements of this subpart for the duration 
of the program income's existence. The State has the option of 
selecting its approach for demonstrating compliance by units of local 
government with this paragraph (e)(ii)(B). The three approaches from 
which the State may select are:
    (1) Maintaining contractual relationships with units of local 
government for the duration of the existence of the program income.
    (2) Requiring advance State approval of either a State grant 
recipient's plan for the use of program income, or of each use of 
program income by grant recipients.
    (3) With prior HUD approval, other approaches that demonstrate that 
the State will ensure compliance with the requirements of this subpart 
by units of local government.
    (C) The provisions of paragraph (e)(3)(ii)(B) of this section apply 
to all activities funded with funds from fiscal year (FY) 1993 and 
later. All activities funded with FY 1992 and earlier funds are subject 
to Sec. 570.489(e)(3)(ii) as it existed immediately before [INSERT 
EFFECTIVE DATE OF FINAL RULE]. At its option, a State may apply the 
provisions of paragraph (e)(3)(ii)(B) of this section to FY 1992 and 
earlier funds.
    (D) The State must require units of general local government, to 
the maximum extent feasible, to disburse program income that is subject 
to the requirements of this subpart before requesting additional funds 
from the State for activities, except as provided in paragraphs (f), 
(n), and (o) of this section.
    (4) The State must report on the receipt and use of all program 
income (whether retained by units of local government or paid to the 
State) in its annual performance and evaluation report.
    (f) * * *
    (2) The State may establish one or more revolving funds to 
distribute funds to units of general local government throughout a 
State or a region of the State to carry out specific, identified 
activities. * * *
* * * * *
    (h) * * *
    (2) Conflicts prohibited. The general rule is that no persons 
described in paragraph (h)(3) of this section, who exercise or have 
exercised any functions or responsibilities with respect to CDBG 
activities assisted under this subpart or who are in a position to 
participate in a decisionmaking process or gain inside information with 
regard to such activities, may obtain a financial interest or benefit 
from the activity, or have a financial interest in any contract, 
subcontract, or agreement with respect thereto, or the proceeds 
thereunder, either for themselves or for those with whom they have 
immediate family or business ties, during their tenure or for one year 
thereafter.
    (3) Persons covered. The conflict of interest provisions in 
paragraph (h)(2) of this section apply to any person who is an 
employee, agent, consultant, officer, or elected official or appointed 
official of the State, or of a unit of general local government, or of 
any designated public agencies, or subrecipients that are receiving 
funds under this part.
* * * * *
    (n) Lump sum drawdowns. The requirements for States and units of 
general local government regarding lump sum drawdowns to finance 
property rehabilitation activities are in Sec. 570.513.
    (o) Use of escrow accounts for rehabilitation of privately owned 
residential property. The requirements for States and units of general 
local

[[Page 11293]]

government regarding the use of escrow accounts for rehabilitation of 
privately owned residential property are in Sec. 570.511.
    5. Section 570.511 is revised to read as follows:


Sec. 570.511  Use of escrow accounts for rehabilitation of privately 
owned residential property.

    (a) Limitations. A recipient may withdraw funds (or, as applicable, 
a State may allow units of general local government to withdraw funds) 
from its letter of credit for immediate deposit into an escrow account 
for use in funding loans and grants for the rehabilitation of privately 
owned residential property. The following limitations apply to the use 
of escrow accounts for residential rehabilitation loans grants closed 
after September 7, 1990. (For the State CDBG program, the following 
limitations apply to the use of escrow accounts for residential 
rehabilitation loans and grants closed after [INSERT EFFECTIVE DATE OF 
FINAL RULE]):
    (1) The use of escrow accounts under this section is limited to 
loans and grants for the rehabilitation of primarily residential 
properties containing no more than four dwelling units (and accessory 
neighborhood-scale nonresidential space within the same structure, if 
any, e.g., a store front below a dwelling unit).
    (2) An escrow account must not be used unless the contract between 
the property owner and the contractor selected to do the rehabilitation 
work specifically provides that payment to the contractor shall be made 
through an escrow account. No deposit to the escrow account can be made 
until after the contract has been executed between the property owner 
and the rehabilitation contractor.
    (i) For the CDBG Entitlement program, the escrow account must be 
maintained by the recipient, by a subrecipient as defined in 
Sec. 570.500(c), by a public agency designated under Sec. 570.501(a), 
or by an agent under a procurement contract governed by the 
requirements of 24 CFR 85.36.
    (ii) For the State CDBG program, the escrow account must be 
maintained by the unit of general local government, by an agent under a 
procurement contract governed by the requirements of Sec. 570.489(g), 
or by a nonprofit entity authorized under section 105(a)(15) of the Act 
(42 U.S.C. 5305(a)(15)).
    (3) All funds withdrawn under this section must be deposited into 
one interest earning account with a financial institution. Separate 
bank accounts may not be established for individual loans and grants.
    (4) The amount of funds deposited into an escrow account must be 
limited to the amount expected to be disbursed within 10 working days 
from the date of deposit. If the escrow account, for whatever reason, 
at any time contains funds exceeding 10 days' cash needs, the recipient 
must immediately transfer (or, as applicable, the State must ensure 
that a unit of general local government immediately transfers) the 
excess funds to its program account. In the program account, the excess 
funds must be treated as funds erroneously drawn in accordance with the 
requirements of U.S. Treasury Financial Manual, paragraph 6-2075.30.
    (5) Funds deposited into an escrow account must be used only to pay 
the actual costs of rehabilitation incurred by the owner under the 
contract with a private contractor. Other eligible costs related to the 
rehabilitation loan or grant, e.g., the recipient's (or, as applicable, 
the unit of general local government's) administrative costs (as 
defined for the Entitlement CDBG program under Sec. 570.206) or 
rehabilitation services costs under Sec. 570.202(b)(9) if applicable, 
are not permissible uses of escrowed funds. Such other eligible 
rehabilitation costs must be paid under normal CDBG payment procedures 
(e.g., from withdrawals of grant funds under the recipient's (or 
State's, as applicable) letter of credit with the Treasury).
    (b) Interest. Interest earned on escrow accounts established in 
accordance with this section, less any service charges for the account, 
must be remitted to HUD (for transmittal to the U.S. Treasury) at least 
quarterly but not more frequently than monthly. Interest earned on 
escrow accounts is not required to be remitted to HUD to the extent the 
interest is attributable to the investment of program income.
    (c) Remedies for noncompliance. If HUD determines that a recipient 
has failed (or, as applicable, if a State determines that a unit of 
general local government has failed) to use an escrow account in 
accordance with this section, HUD may, in addition to imposing any 
other sanctions provided for under this part, require the recipient to 
discontinue the use of escrow accounts, in whole or in part (or, as 
applicable, the State may, under the authority of Sec. 570.492(b), 
require the unit of general local government to discontinue the use of 
escrow accounts, in whole or in part).
    6. Section 570.513 is revised to read as follows:


Sec. 570.513  Lump sum drawdown for financing of property 
rehabilitation activities.

    Subject to the conditions prescribed in this section (and section 
104(h) of the Act (42 U.S.C. 5304(h), as applicable)), recipients may 
draw down funds (or, as applicable, States may allow units of general 
local government to draw down funds) from the letter of credit in a 
lump sum to establish a rehabilitation fund in one or more private 
financial institutions for the purpose of financing the rehabilitation 
of privately owned properties. The fund may be used in conjunction with 
various rehabilitation financing techniques, including loans, interest 
subsidies, loan guarantees, loan reserves, or such other uses as may be 
approved by HUD consistent with the objectives of this section. The 
fund may also be used for making grants, but only for the purpose of 
leveraging non-CDBG funds for the rehabilitation of the same property.
    (a) Limitation on drawdown of grant funds. (1) The funds that a 
recipient deposits (or, as applicable, that a State allows a unit of 
general local government to deposit) to a rehabilitation fund must not 
exceed the grant amount that the recipient (or State, as applicable) 
reasonably expects will be required, together with anticipated program 
income from interest and loan repayments, for the rehabilitation 
activities during the period specified in the agreement with the 
financial institution(s) (described in paragraph (b)(2) of this 
section), based on:
    (i) Prior level of rehabilitation activity; or
    (ii) Rehabilitation staffing and management capacity during the 
period specified in the agreement to undertake activities; or
    (iii) For purposes of the State CDBG program only, estimated demand 
for rehabilitation activity.
    (2) No grant funds may be deposited under this section solely for 
the purpose of investment, notwithstanding that the interest or other 
income is to be used for the rehabilitation activities.
    (3) The recipient's (or, as applicable, the unit of general local 
government's) rehabilitation program administrative costs and the 
administrative costs of the financial institution may not be funded 
through lump sum drawdown. Such costs must be paid from periodic letter 
of credit withdrawals in accordance with standard procedures or from 
program income, other than program income generated by the lump sum 
deposit.
    (b) Standards to be met. The following standards apply to all lump

[[Page 11294]]

sum drawdowns of CDBG funds for rehabilitation:
    (1) Eligible rehabilitation activities. The rehabilitation fund 
must be used to finance the rehabilitation of privately owned 
properties (including the acquisition of properties for rehabilitation) 
eligible under the general policies in Sec. 570.200, if applicable, and 
the specific provisions of either Sec. 570.202 or Sec. 570.203, if 
applicable; or, for purposes of the State CDBG program, as eligible 
under section 105 (a)(4), (a)(5), (a)(14), (a)(15) or (a)(17) of the 
Act (42 U.S.C. 5305(a)).
    (2) Requirements for agreement. The recipient (or unit of general 
local government, as applicable) must execute a written agreement with 
one or more private financial institutions for the operation of the 
rehabilitation fund. The agreement must specify the obligations and 
responsibilities of the parties, the terms and conditions on which CDBG 
funds are to be deposited and used or returned, the anticipated level 
of rehabilitation activities by the financial institution, the rate of 
interest and other benefits to be provided by the financial institution 
in return for the lump sum deposit, and such other terms as are 
necessary for compliance with the provisions of this section. Except 
for purposes of the State CDBG program, upon execution of the 
agreement, the recipient must provide a copy to the HUD field office 
for its records and use in monitoring; the recipient must also provide 
to HUD any modifications made during the term of the agreement. For 
purposes of the State CDBG program, a State may require State approval 
of any local agreement or modification.
    (3) Period to undertake activities. The agreement must be fully 
executed before the lump sum deposit is made. Except for purposes of 
the State CDBG program, the agreement must provide that the 
rehabilitation fund may only be used for authorized activities during a 
period of no more than two years. For purposes of the State CDBG 
program, States may set maximum time limits on the duration of lump sum 
drawdown agreements, but in no case can an agreement remain in effect 
after the date that a grant to a unit of general local government is 
closed out; the agreement must specify the time period for which the 
agreement is in effect.
    (4) Time limit on use of deposited funds. (This paragraph (b)(4) of 
this section does not apply to the State CDBG program). Use of the 
deposited funds for rehabilitation financing assistance must start 
(e.g., first loan must be made, subsidized or guaranteed) within 45 
days of the deposit. In addition, substantial disbursements from the 
fund must occur within 180 days of the receipt of the deposit. (Where 
CDBG funds are used as a guarantee, the funds that must be 
substantially disbursed are the guaranteed funds.) For a recipient with 
an agreement specifying two years to undertake activities, the 
disbursement of 25 percent of the fund (deposit plus any interest 
earned) within 180 days will be regarded as meeting this requirement. 
If a recipient with an agreement specifying two years to undertake 
activities determines that it has had substantial disbursement from the 
fund within the 180 days although it had not met this 25 percent 
threshold, the justification for the recipient's determination must be 
included in the program file. If a recipient does not start using the 
funds within 45 days, or substantial disbursement from such fund does 
not occur within 180 days, the recipient may be required by HUD to 
return all or part of the deposited funds to the recipient's letter of 
credit.
    (5) Program activity. Recipients (or States, as applicable) must 
review the level of program activity under each agreement on a yearly 
basis. If activity is substantially below that anticipated, the 
recipient must return program funds to its letter of credit (or the 
State must require that the unit of general local government return 
program funds to the State's letter of credit, as applicable).
    (6) Termination of agreement. (i) In the case of substantial 
failure by a private financial institution to comply with the terms of 
a lump sum drawdown agreement under the Entitlement CDBG program, the 
recipient must terminate its agreement, provide written justification 
for the action, withdraw all unobligated deposited funds from the 
private financial institution, and return the funds to the recipient's 
letter of credit.
    (ii) For purposes of the State CDBG program, a State must develop 
and implement standards to ensure that, in cases of substantial failure 
by a private financial institution or a unit of general local 
government to comply with the terms of a lump sum drawdown agreement, 
all unobligated deposited funds will be withdrawn from the private 
financial institution and returned to the State's letter of credit.
    (7) Return of unused deposits. At the end of the period specified 
in the agreement for undertaking activities, all unobligated deposited 
funds must be returned to the recipient's (or State's, as applicable) 
letter of credit unless the recipient (or unit of general local 
government, as applicable) enters into a new agreement conforming to 
the requirements of this section. In addition, the recipient (or State, 
as applicable) must reserve the right to withdraw any unobligated 
deposited funds as required by HUD (or, for purposes of the State CDBG 
program, as determined by HUD or the State) in the exercise of 
corrective or remedial actions authorized under Secs. 570.910(b), 
570.911, 570.912, or 570.913 (or, for purposes of the State CDBG 
program, under this section, Secs. 570.492, 570.493, 570.495, or 
570.496).
    (8) Rehabilitation loans made with non-CDBG funds. If the deposited 
funds or program income derived from deposited funds are used to 
subsidize or guarantee repayment of rehabilitation loans made with non-
CDBG funds, or to provide a supplemental loan or grant to the borrower 
of the non-CDBG funds, the rehabilitation activities are considered to 
be CDBG-assisted activities subject to the requirements applicable to 
such activities, except that repayment of non-CDBG funds is not treated 
as program income.
    (9) Provision of consideration. In consideration for the lump sum 
deposit by the recipient (or unit of general local government, as 
applicable) in a private financial institution, the deposit must result 
in appropriate benefits in support of the recipient's (or, as 
applicable, unit of general local government's) rehabilitation program. 
Minimum requirements for such benefits are:
    (i) Recipients (or units of general local government, as 
applicable) must require the financial institution to pay interest on 
the lump sum deposit.
    (A) The interest rate paid by the financial institution cannot be 
lower than three points below the rate on one-year Treasury obligations 
at constant maturity.
    (B) When an agreement sets a fixed interest rate for the entire 
term of the agreement, the rate should be based on the rate at the time 
the agreement is executed.
    (C) The agreement may provide for an interest rate that would 
fluctuate periodically during the term of the agreement, but the 
established rate cannot be lower than three points below the rate on 
one-year Treasury obligations at constant maturity.
    (ii) In addition to the payment of interest, the financial 
institution must provide at least one of the following benefits:
    (A) Leverage of the deposited funds so that the financial 
institution commits private funds for the loans in the rehabilitation 
program in an amount substantially in excess of the amount of the lump 
sum deposit;
    (B) Commitment of private funds by the financial institution for

[[Page 11295]]

rehabilitation loans at below market interest rates, at higher than 
normal risk, or with longer than normal repayment periods; or
    (C) Provision of administrative services in support of the 
rehabilitation program by the participating financial institution at no 
cost or at lower than actual cost.
    (c) Program income. Interest earned on lump sum deposits and 
payments on loans made from such deposits are program income and, 
during the period of the agreement, must be used for rehabilitation 
activities under the provisions of this section.
    (d) Outstanding findings. Notwithstanding any other provision of 
this section, a recipient may not enter into a new agreement (or, as 
applicable, a State may not allow a unit of general local government to 
enter into a new agreement) during any period of time in which an audit 
or monitoring finding on a previous lump sum drawdown agreement remains 
unresolved.
    (e) Prior notification. (This paragraph (e) of this section does 
not apply to the State CDBG program.) The recipient must submit written 
notification to the HUD field office of the amount of funds to be 
deposited with a private financial institution, before making the 
deposit under the provisions of this section.
    (f) Recordkeeping requirements. (This paragraph (f) of this section 
does not apply to the State CDBG program.) The recipient must maintain 
in its files a copy of the written agreement and related documents 
establishing conformance with this section and concerning performance 
by a financial institution in accordance with the agreement.

    Dated: March 5, 1997.
Howard Glaser,
Acting Assistant Secretary for Community Planning and Development.
[FR Doc. 97-6024 Filed 3-10-97; 8:45 am]
BILLING CODE 4210-29-P