Hospital Mortgage Insurance Program: Program and Risk Management Could Be Enhanced
Published: 2006-02-28T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Under its Hospital Mortgage Insurance Program, the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) insures nearly $5 billion in mortgage loans for the renovation or construction of hospitals that would otherwise have difficulty accessing capital. In response to a requirement in the 2005 Consolidated Appropriations Conference Report, GAO examined (1) the design and management of the program, as compared with private insurance, (2) the nature and management of the relationship between HUD and the Department of Health and Human Services (HHS) in implementing the program, (3) the financial implications of the program to the General Insurance/Special Risk Insurance (GI/SRI) fund, including risk posed by program and market trends, and (4) how HUD estimates the annual credit subsidy for the program, including the factors and assumptions used.
section_title: What GAO Found
paragraphs: The Hospital Mortgage Insurance Program insures the mortgages of hospitals that are generally riskier than those that can obtain private bond insurance. While FHA's process for reviewing mortgage insurance applications includes more steps and generally takes longer, the agency monitors active loans with many of the same techniques that private bond insurers use. Under a Memorandum of Agreement, FHA and HHS work together in a variety of ways to review mortgage insurance applications and monitor active loans. However, FHA does not collect data to assess program performance against most performance measures specified in the memorandum, some of which are not objective. Further, FHA has not kept its program handbook of policies and procedures for applicants, lenders, and others up-to-date. The hospital program is small compared with other programs in the GI/SRI fund, and the losses from claims have been relatively low. Despite the program's relatively small size, some program and market trends may pose risks. For example, 61 percent of the program's total insured, outstanding loan amount is concentrated in New York, which makes the program vulnerable to state policies and regional economic conditions. While FHA has goals to diversify the hospital insurance portfolio and has made efforts to do so, it does not have a formal strategy to achieve these goals. To estimate the credit subsidy cost, or program costs, over the life of the outstanding loans insured, HUD uses a model that incorporates factors and assumptions about how loans will perform, including estimated claim and recovery rates, which are consistent with federal guidance. However, HUD's model does not explicitly consider some factors, such as the potential impacts of prepayment penalties or restrictions, which according to some economic studies, are important in modeling default risk.

section_title: Letter
paragraphs: The Department of Housing and Urban Development (HUD), through the  Federal Housing Administration’s (FHA) Hospital Mortgage Insurance  Program, insures loans to finance the renovation or construction of  hospitals. Through an interagency agreement, the Department of Health  and Human Services (HHS) administers certain aspects of this program  based upon its health care and hospital expertise. The program is intended  to protect lenders against losses they might incur if hospitals fail to make  their mortgage payments. As of December 31, 2005, FHA reported that it  insured nearly $5 billion in outstanding mortgages under the program.
The Hospital Mortgage Insurance Program is one of several programs  included in FHA’s General Insurance/Special Risk Insurance (GI/SRI) fund;  other programs in the GI/SRI fund are much larger and include mortgage  insurance for various types of multifamily housing projects and for nursing  homes. Pursuant to the Federal Credit Reform Act of 1990, for budget  purposes HUD must annually estimate the credit subsidy for the program.
The credit subsidy cost for loan guarantees is the present value of cash  flows over the life of the loan from estimated payments by the government  (for defaults, delinquencies, and other payments) minus estimated  payments to the government (for loan origination and other fees, penalties,  and recoveries); it excludes administrative costs. Such estimates are  important indicators of the full cost of programs to the government.
The 2005 Consolidated Appropriations Conference Report mandated that  we review two FHA insurance programs—those for hospitals and nursing  homes. This report provides the results of our evaluation of the Hospital  Mortgage Insurance Program. For this report, we reviewed (1) the design  and management of the program, as compared with private insurance; (2)  the nature and management of the relationship between HUD and HHS in  implementing the program; (3) the financial implications of the program to  the GI/SRI fund, including risk posed by program and market trends; and  (4) how HUD estimates the annual credit subsidy for the program,  including the factors and assumptions used.
To address these objectives, we reviewed program manuals and  documentation of loan processing procedures and analyzed program  financial data, which we determined to be reliable for the purposes of our  review. We also reviewed documentation of HUD’s credit subsidy model  and applicable program laws, regulations, and policy statements. We  interviewed officials from FHA’s Office of Insured Health Care Facilities  and the Division of Facilities and Loans within HHS’ Health Resources and  Services Administration. We also interviewed health care and hospital  associations, mortgage and investment banking firms, rating agencies, and  private bond insurers. Our review of the hospital program did not include  an evaluation of underwriting criteria, construction monitoring, or the need  for the program. See appendix I for more detailed information on our  objectives, scope, and methodology.
We conducted our work in New York, New York; Chicago, Illinois;  Paterson, New Jersey; Rockville, Maryland; and Washington, D.C., between  February 2005 and January 2006 in accordance with generally accepted  government auditing standards.
subsections: section_title: Background
paragraphs: In 1968, the Congress added Section 242 to the National Housing Act  establishing the Hospital Mortgage Insurance Program to address a serious  shortage of hospitals and the need for existing hospitals to expand and  renovate. Through this program, FHA insures the loans lenders make for  the construction and renovation of hospitals.  Since the inception of the  program, FHA has insured 341 hospital mortgages for $11.9 billion in 42  states and Puerto Rico. As of the end of calendar year 2005, FHA was  insuring 74 hospital mortgages totaling nearly $5 billion.  The number of  loans insured annually has increased in recent years, from 2 in fiscal year  2001 to 11 in fiscal year 2005 (see table 1). According to the House report  accompanying the Hospital Mortgage Insurance Act of 2003, which revised  the standards for determining the need and feasibility for hospitals, as well  as eligibility requirements for small, rural hospitals, hospitals face  significant financial challenges when providing care to patients who are  covered by Medicare and Medicaid, as well as those that are uninsured. At  the same time, improvements in technology and health care knowledge  necessitate capital improvements such as additions and renovations to  existing buildings.
FHA’s Office of Insured Health Care Facilities and HHS’ Division of  Facilities and Loans coordinate to implement the hospital program. HUD  has statutory responsibility for the program based on the FHA’s experience  with promoting housing construction through  housing mortgage insurance  programs. As such, HUD is fully responsible for management of the  program, including developing and proposing legislation, policy  development, strategic planning, and approval of applications and loan  documents. The House Committee on Banking and Currency, in  recommending that HUD be given this responsibility, expected HUD to  draw upon HHS’s hospital expertise to devise standards for insuring  hospitals’ mortgages. Through an interagency agreement, HUD formally  delegates authority to HHS to assist in the review of applications for  mortgage insurance and the monitoring of insured loans. HHS is also given  full responsibility for construction monitoring. See appendix II for  additional information about FHA and HHS’s loan processing  responsibilities.
FHA’s Hospital Mortgage Insurance Program generally serves the segment  of the market consisting of hospitals that are too risky to obtain private  bond insurance but are strong enough to pass FHA’s underwriting tests.  Mortgage insurance, like private bond insurance, guarantees that lenders  will be paid if the hospital stops making payments on its loan. In addition,  both mortgage insurance and private bond insurance are forms of credit  enhancement and improve the credit rating of the underlying debt for the  insured entity, resulting in a lower interest rate for the loan. Hospitals with  FHA-insured mortgages automatically receive investment-grade ratings  (AA or AAA) because the reliability of the cash flows from the mortgage  note are rated on the insurer’s, not the hospital’s, ability to repay the debt.  Both FHA and HHS officials and private insurers agree that FHA’s Hospital  Mortgage Insurance Program serves a different market than private  insurers. According to FHA and HHS officials, FHA insures loans that are  too risky, too small, or too large for private insurers, or are located in a  market not served by private insurers.
For the Hospital Mortgage Insurance Program, if a hospital fails to make  any payment due under the mortgage, the mortgage is in default. If a default  continues for 30 days, the lender is entitled to receive benefits from FHA.  FHA may pay claims in either cash or debentures.
Federal agencies that provide direct loans or loan guarantees are required  by the Federal Credit Reform Act of 1990 to estimate the expected cost of  programs by estimating or predicting their future performance and  reporting the costs to the government in their annual budgets.  Such  estimates are important in that they more accurately measure the  government’s costs of federal loan programs and permit better cost  comparisons among different programs. Under credit reform procedures,  the cost of loan guarantees, such as mortgage insurance, is the net present  value of all expected future cash flows, excluding administrative costs.   For guarantees, cash inflows consist primarily of fees and premiums  charged to insured borrowers and recoveries on assets, and cash outflows  consist mostly of payments to lenders to cover the cost of claims. Agencies  discount projected future cash flows to the year in which the guaranteed  loan was disbursed. The discounted cash flows are the estimated budgetary  cost or gain of the cohort of loans obligated in a given fiscalyear. The net  present value of each cohort’s estimated cash flows is expressed as a  percentage of the volume of guaranteed loans in the cohort—that is, a  subsidy rate. Agency managers are responsible for accumulating relevant,  sufficient, and reliable data on which to base their credit subsidy estimates.
OMB has final responsibility for determining subsidy estimates, in  consultation with agencies.
section_title: FHA’s Selection Process Includes Additional Steps Compared with Private Insurers, but Monitoring Techniques Are Similar
paragraphs: FHA requires hospitals to take certain steps, both before they apply for  mortgage insurance and as a part of the application process, that private  insurers do not mandate. These additional steps are used because FHA  insures mortgages that are generally riskier than those using private bond  insurance. For example, before they apply for mortgage insurance, FHA  advises hospitals to compare their financial status with the program’s  minimum requirements. If they meet these requirements, FHA requires  hospitals to submit market and financial information so that FHA can make  a preliminary assessment about the project and determine whether to  conduct a preapplication meeting with the applicant to discuss the project.  None of the private insurers that we met with have similar preapplication  processes.
After these preapplication steps are met, FHA’s application process  includes additional steps compared with those of private bond insurers.  FHA requires hospitals to submit a financial feasibility study containing  historic and forecasted financial statements and ratios, a financing plan,  and information about market demand, among other things. In addition,  FHA hires consultants to evaluate the feasibility of each proposed project  as an additional, independent check on the viability of the project. While  the private bond insurers that we met with review the types of information  included in feasibility studies, they do not require hospitals to submit such  studies and do not hire consultants to assess the feasibility of proposed  projects.
FHA’s application process also includes a final level of review that is absent  from private bond insurer processes. After an application for mortgage  insurance has gone through underwriting and been reviewed by an  independent consultant, it is considered by the program management  group, a group of senior-level FHA and HHS staff. FHA also refers to this  group as its “credit committee.” Similarly, private bond insurers also  consider applications within a credit committee structure. However, while  private bond insurers make final insurance decisions through their credit  committees, FHA has an additional layer of review. Based upon input from  the program management group, the Director of FHA’s Office of Insured  Health Care Facilities makes a recommendation to the FHA Commissioner,  who then makes the final decision.
It generally takes FHA longer to process applications than it takes private  bond insurers. According to program data, it took FHA an average of 265  days to process the 11 applications for hospital mortgage insurance that it  endorsed in fiscal year 2005. According to the FHA, processing times vary  with the complexity of the project and may be affected by issues requiring a  hospital to rethink or resubmit its application, including issues that are  beyond HUD’s control. In contrast, according to the private bond insurers  and investment bankers that we interviewed, it generally takes private  insurers up to 60 days to process an insurance application, sometimes less.  While FHA’s average processing time is higher than private bond insurers, it  has decreased from an average of 399 days in fiscal year 1999.  According to  FHA, processing times have improved as a result of implementing the  preliminary review process, which disqualifies hospitals that don’t meet the  program’s minimum requirements.
FHA uses many of the same techniques that private insurers use to monitor  insured hospitals. Both FHA and private bond insurers identify the riskiest  hospitals in their portfolio for closer monitoring. Since November 1999,  FHA has placed on a priority watch list hospitals it determines are at risk of  having a claim filed within the next 12 months. FHA considers a hospital  for inclusion on the priority watch list if certain financial criteria are not  met. For example, if the ratio measuring a hospital’s ability to pay its  mortgage payments with cash generated from current operations (the debt  service coverage ratio) falls below an acceptable level, the hospital may be  placed on the watch list. A hospital can also be placed on the list if FHA  becomes aware of other conditions at the hospital, such as management or  personnel problems. As of December 2005, FHA data showed that 11 of the  59 insured hospitals are on this list, representing an unpaid (insured)  principal balance of approximately $762 million. Private insurers also  assess the risk of the hospitals that they insure in order to identify those  that should be monitored more closely. For example, one private bond  insurer explained that they monitor compliance with loan agreements by  reviewing financial statements, documentation of payer mix (i.e.,  proportion of  reimbursement from Medicare, Medicaid, private insurance,  etc.), and notices of litigation, among other things.
As a part of their monitoring efforts, both FHA and private bond insurers  monitor agreements that exist between themselves and the insured  hospital. These agreements specify the requirements that the insured  hospital must comply with in order to maintain the insurance. Agreements  may cover issues such as the debt-service coverage ratio; liquidity, or the  ability to convert assets to cash; and activities that a hospital cannot do  without approval by the insurer. Both FHA and private insurers require  hospitals to request waivers from agreement requirements if they are not  going to meet them. FHA and private insurers monitor hospitals’  compliance with these agreements through various means, such as by  evaluating changes in indicators of financial performance, as reported in  hospitals’ financial statements. For example, one private bond insurer  reported that it monitors hospitals’ cash on hand, and FHA monitors  hospitals’ debt-service coverage ratios. FHA and private insurers monitor  financial statements and other documentation quarterly and annually,  respectively, and more frequently for hospitals that are experiencing  financial difficulty. Both FHA and private insurers require hospitals that are  not in compliance to correct violations within specific time frames.
Both FHA and private insurers can require hospitals experiencing financial  difficulties to hire consultants. In some cases, FHA will pay for consultants  to identify and suggest solutions to hospitals’ financial difficulties.  According to FHA, since fiscal year 2000, it has paid $1.3 million for  consultant’s studies of 27 hospitals. However, FHA can also require  hospitals to hire and pay for consulting services on their own. Similarly,  private insurers can require hospitals to hire consultants to assist them  with identifying and addressing problems. The requirement for a hospital to  hire a consultant can be triggered if a hospital is not in compliance with its  loan agreements, according to both FHA and private bond insurers.
section_title: Agencies Coordinate Key Activities, but FHA Does Not Track Most Performance Measures
paragraphs: FHA and HHS coordinate key activities, including screening applicants,  underwriting loans, and monitoring insured hospitals. While FHA has  established performance measures for both coordinated tasks and tasks  delegated to HHS through an interagency agreement, it does not collect  data with which to assess most of these measures. FHA’s primary guidance  for the program has not been updated in over 20 years and, therefore, does  not reflect key changes in eligibility criteria.
subsections: section_title: FHA and HHS Coordinate Their Client Screening, Application Review, and Loan Monitoring Activities
paragraphs: FHA and HHS coordinate to implement the hospital program based upon  FHA’s experience with promoting housing construction through its housing  mortgage insurance programs and HHS’s hospital and health care  expertise. As previously noted, FHA is responsible for management of the  program and formally delegates certain responsibilities to HHS. A  Memorandum of Agreement (MOA) between FHA and HHS outlines the  duties and responsibilities of each agency in carrying out the Hospital  Mortgage Insurance Program, including coordinated activities and tasks  that FHA delegates to HHS. In accordance with this agreement, both FHA  and HHS staff are involved with the screening of applicants during the  preapplication meetings. FHA’s policy is to include senior FHA staff and  legal counsel, the account executive and client service team members  (both of which can be either FHA or HHS staff), and engineering staff from  HHS, among others, in such meetings. This policy helps insure that  preapplication discussions with applicants are coordinated between FHA  and HHS.
FHA and HHS also coordinate activities during the underwriting review  portion of the application process, which is the process used by FHA to  assess the risk of a potential loan to the GI/SRI fund. The nature of  coordination at this level depends on the staffing of the account executive  and client service team positions, since these positions can be filled by  either FHA or HHS staff or a combination of both. The account executive  and client service team are responsible for underwriting activities,  including analysis of the market and financial feasibility of the project. In  addition, HHS engineers review all design and construction aspects of the  proposed project. Appendix II presents the roles and responsibilities of  each agency in more detail.
FHA and HHS use regular meetings of the program management group to  coordinate additional activities. This group, composed of senior FHA and  HHS staff, meets weekly to assist account executives and client service  teams as they review applications for mortgage insurance and monitor  insured hospitals. Minutes of program management group meetings that we  reviewed show joint FHA and HHS discussion of new applications, as well  as issues associated with the existing portfolio. According to investment  bankers, hospital associations, consulting firms, and selected hospitals we  spoke with, coordination between FHA and HHS is generally seamless.
section_title: FHA Has Not Used Performance Measures to Manage the Program
paragraphs: The fiscal years’ 2002-2005 MOA between FHA and HHS provides for FHA  to establish performance measures and use them to evaluate tasks. While  the MOA between FHA and HHS contains 22 performance measures, FHA  has tracked actual performance for only 2 of these measures, 1 for  processing complete applications within 120 days, and 1 for processing  loan modification requests within 30 days. As a result, it is not possible to  evaluate how well the agencies perform in implementing the program.  According to FHA officials, the agency never intended to track these  measures, or use them as actual measures of performance, but rather to  show FHA’s expectations of HHS. Neither HUD’s fiscal year 2005  performance plan nor its performance and accountability report includes  other performance measures for this program.  Moreover, OMB did not  assess this program as a part of its fiscal year 2005 Program Assessment  Rating Tool (PART), which is used to assess the performance of federal  programs.  Appendix III provides more detailed information about the 22  performance measures contained in the MOA between FHA and HHS.
Analysis of the two performance measures for which data is collected  shows that FHA is not meeting its performance goals for those measures.  Based upon analysis of data from the Hospital Mortgage Insurance  Management Information System, we determined that FHA did not meet its  goal of processing 75 percent of hospital mortgage insurance applications  within 120 days. Although the FHA received no more than 10 applications  each year between fiscal years 2002 and 2005, FHA and HHS never  processed more than 2 within 120 days (see fig. 1).
In addition, according to FHA, the agency did not meet its goal of  processing at least 75 percent of loan modification requests within 30  days. However, analysis of available data shows that FHA and HHS  improved from processing 45 percent of loan modification requests  received in fiscal year 2002 within 30 days to processing 71 percent in fiscal  year 2005.
FHA has not tracked other performance measures related to activities that  are coordinated, or can be done, by both FHA and HHS staff. For example,  according to one performance measure, hospitals with a weakening  financial position should be identified early enough to allow time for the  account executive to provide technical assistance and undertake default  prevention measures. Since such hospitals are identified through the FHA’s  priority watch list system, these data are readily available for  measurement. Similarly, another performance measure is designed to  capture the soundness of analysis performed by client service teams, which  can include both FHA and HHS staff, in assessing insurance applications.  FHA has also not tracked this measure.
FHA also does not track performance measures of activities that it  delegates to HHS. For example, one measure is designed to capture the  number of complaints and compliments about HHS’s timeliness,  helpfulness, courtesy, and understanding. According to FHA, the agency  has not tracked this or other measures because it has not had enough  problems with HHS to warrant establishing a tracking system and that  establishment of such a system would be both an administrative burden  and a poor use of their resources. However, without collecting appropriate  information, FHA cannot quantify the input it receives about HHS. In  addition, FHA has not tracked performance measures related to  construction design and monitoring, which HHS is responsible for.  According to FHA, performance measures exist to indicate FHA’s  expectations of HHS’s performance, even though HHS’s performance is not  tracked.
Several of the performance measures contained in the agreement between  FHA and HHS lack the necessary characteristics of performance measures;  that is, they are not measurable or objective. As a result, they do not  provide useful information about the performance of the hospital program.  For example, the measures related to the number of complaints and  compliments about HHS are not measurable in that they do not specify a  quantifiable threshold for expected performance. As a result, even if FHA  tracked complaints, it is not possible to tell whether performance is  meeting expectations. Other goals lack objectivity in that they require  subjective judgment to assess program performance. As an example, one  performance measure indicates that “plans and specifications do not need  major revisions during the construction process because of significant  architectural or engineering errors.” Another indicator states that  “preconstruction meetings are thorough and do not precipitate delays in  application processing.”  In both cases, the performance measures require  subjective judgment, because they do not make explicit what constitutes  “major,” “significant,” or “thorough.” As we have previously reported, useful performance information is based upon measurable and objective  performance measures. If useful performance information is collected,  managers could use it to identify problems, try to identify the causes of  problems, and/or to develop corrective actions. (App. III provides a  complete list of the performance measures.)
While FHA does not track most of the performance measures outlined in  the MOA, FHA’s Hospital Mortgage Insurance Management Information  System captures a significant amount of quantitative and qualitative data  about the performance of the program, which could be incorporated into  measurable and objective performance measures. This system captures  key loan processing dates, financial performance data over time, and  documentation of internal meetings and actions performed by both  agencies to assist insured hospitals. Incorporation of this readily-available  data into meaningful performance measures would enable FHA to better  assess its management of the program.
FHA and HHS established a new interagency agreement covering fiscal  years 2006 through 2010, which includes many of the same measures as the  previous agreement, including those that are not measurable or objective.  The new agreement also includes a requirement that HHS provide FHA  with an annual report detailing its performance against each of the  performance measures in the agreement. However, this interagency  agreement does not specify whether and how FHA will track its own  performance against the measures.
section_title: Program Guidance Is Not Up to Date
paragraphs: FHA’s primary guidance for its hospital mortgage insurance program has  not been updated in over 20 years and does not reflect changes to the  program over that time. As a result, this document does not contain current  eligibility requirements, which may cause confusion for potential  applicants. In 1973, FHA published the Mortgage Insurance for Hospitals  Handbook and last updated the handbook in 1984. The purpose of the  handbook is to provide complete information about the processing of  hospital mortgage insurance, including basic program features and  requirements, to hospitals, lenders, sponsors, FHA and HHS personnel, and  all other interested parties. According to FHA, the Office of Insured Health  Care Facilities has not had adequate staff to revise the handbook and is  waiting for a proposed regulation to become final before revising it. Since  the handbook has not been updated since 1984, it does not contain current  eligibility requirements, policies, and processing procedures. As we have  previously reported, internal control standards applicable to federal  programs provide that information should be recorded and communicated  in a timely manner.
The handbook does not reflect key changes that the Hospital Mortgage  Insurance Act of 2003 made to the program. This act revised the existing  requirement that hospitals applying for FHA mortgage insurance have  either a Certificate of Need or a state-commissioned study of market need;  specifically, it provided that FHA would establish the means for  determining market need and feasibility for hospitals. In addition, the  2003 act exempted Critical Access Hospitals (CAH) from the requirement  that at least 50 percent of care must be for general acute-care patients.  According to one of the mortgage bankers that we met with, the handbook  causes confusion because hospitals are uncertain about requirements  applicable to them.
As we have previously reported, internal control standards provide that  information, such as changes in eligibility requirements and application  processing procedures, should be communicated in a timely manner. While  FHA publicly communicates program changes through Mortgagee Letters,  updating the Applicant’s Guide, distributing copies of its minimum criteria  for consideration, and updating its Web page, it has not incorporated all of  this updated information into the program’s handbook. All documentation,  including the handbook, should be updated in a timely manner.   Maintaining current documentation is an internal control that would  benefit both those interested in the program and those that administer the  program.
section_title: Potential Risks Exist Although FHA Has Mitigation Strategies in Place
paragraphs: The hospital program is a relatively small program within the broader  GI/SRI fund and has a record of recovering claims. Despite its small size,  both program and market trends show risks that could affect the hospital  portfolio. FHA has mitigation strategies in place to address some risks but  does not have a formal strategy to geographically diversify the hospital loan  portfolio.
subsections: section_title: The Hospital Program Accounts for a Relatively Small Share of the Broader GI/SRI Fund, and Has Recovered a Majority of All Claims
paragraphs: The Hospital Mortgage Insurance Program comprises a relatively small part  of the GI/SRI fund, representing about 2.9 percent of the GI/SRI’s fund’s  fiscal year 2006 total commitment authority. Moreover, the approximately  $5 billion in loans that FHA currently insures through the program is 6.5  percent of the $77 billion in unpaid principal balance of the fund (see fig.  2). In addition to being a financially small component of the broader GI/SRI  fund, the Hospital Mortgage Insurance Program has a record of recovering  more than two-thirds of all historical claims, and lenders have not made a  claim on an insured loan since 1999. Since the program’s inception in 1968,  there have been a total of 22 claims totaling $225 million. Of this amount,  FHA recovered 68 percent, or $153 million.
section_title: Loan Performance and Market Trends Reveal Sources of Potential Risks
paragraphs: In spite of the hospital program’s relatively small size and the relatively  good performance history of insured loans, analysis of both program and  market trends shows risks that could affect the future performance of the  hospital loan portfolio. For example, the average loan size insured through  the program has varied over time but has been increasing from about $26  million in 2002 to over $122 million in 2005. This growth creates financial  risk because a claim from one large loan could have a significant impact  upon the program.
In addition, the majority of the currently insured loans in FHA’s hospital  portfolio are less than 10 years old. According to HUD, 70 percent of claims  have historically occurred prior to a loan’s tenth year. Currently, the loans  that have been insured for less than 10 years have an aggregate unpaid  principal balance of $2.8 billion, representing about 57 percent of the  aggregate unpaid principal balance (see fig. 3).
Comparing FHA data on selected financial indicators with the criteria the  agency uses to determine the financial health of program applicants shows  some favorable trends but also indicates sources of potential financial risk  (see fig. 4). Specifically, our analysis of program data for calendar years  2000 to 2004 shows that some insured hospitals increased their ability to  meet their monthly and future mortgage payments. For example, the  median debt-service coverage ratio, a measure of a hospital’s ability to pay  its mortgage with cash generated from current operations, increased from  1.54 to 2.18. While a value of 2.18 for this ratio indicates a low level of risk,  according to FHA criteria, other financial indicators indicate medium levels  of risk. For example, the median number of days of cash on hand and the  median current ratio (which compares a hospital’s current assets to its  current liabilities) both improved, yet still indicate a medium level of risk to  the program. Finally, the median operating margin, which is indicative of a  hospital’s ability to control costs and expenses, improved between 2000  and 2004, yet indicates a medium level of risk based on FHA’s criteria.
Median financial indicators for the 11 hospitals that FHA has placed on its  priority watch list show much greater levels of risk when compared with  FHA’s underwriting guidelines (see fig. 5). For these hospitals, performance  as measured by all four selected indicators declined from 2000 to 2004.  Further, in 2004, three indicators showed a high level of risk, based on  FHA’s criteria. For example, according to FHA’s criteria, an applicant with  an operating margin of less than zero is considered high risk. The hospitals  on FHA’s priority watch list had median operating margin of -2.65 in 2004.  Similarly, according to FHA’s criteria, an applicant with less than 15 days of  cash on hand is also high risk, and hospitals on the priority watch list had a  median of 3.3 days of cash on hand in 2004. FHA recognizes that the high  risk levels of these selected financial indicators are among the reasons that  these hospitals are on its priority watch list and are, therefore, subject to  closer monitoring to reduce the risk of a claim.
Analysis of program data further shows that, while loans are increasingly  being insured outside of the Northeast, the program is still concentrated in  New York (see fig. 6). Though the percentage of the unpaid principal  balance concentrated in New York has decreased from 89 percent in 2000,  61 percent of the unpaid principal balance in the program remains  concentrated in New York in 2005. Of the 30 hospital loans that FHA has  insured since 2000, 21 are outside of New York, and 19 are outside of the  Northeast region. Since 2003, 5 of the loans insured were for CAHs.
Further, 24 out of 25 mortgage insurance applications in development at  the time of our study are located outside of the Northeast (see fig. 7).
Despite these strides, the high concentration of the program’s unpaid  principal balance in New York, as well as concentrations with single  borrowers with multiple loans, creates risks. New York hospitals insured  through FHA, like hospitals nationwide, rely heavily upon reimbursement  through Medicare and Medicaid.Since a portion of Medicaid funding  comes from states, any cuts made by the state of New York could have an  especially negative impact on the hospital program. Insured hospitals in  New York are also vulnerable to other state policies. For example, a task  force appointed by the Governor is in the process of identifying New York  hospitals for closure or restructuring. The Governor and state legislature  have committed state funds to assist in restructuring efforts, and the state  has had a history of helping its hospitals avoid defaults. Nevertheless, any  recommendations for the closure or restructuring of FHA-insured hospitals  may present the risk of an insurance claim. Further, some New York  hospitals have multiple loans insured through the program, one with  unpaid principal balances totaling approximately $828 million as of  December 2005. According to HUD’s comments on the draft of this report,  this hospital is a financially sound, well-endowed institution that poses a  low risk of default.
section_title: Industry Trends Pose Risks to Hospitals, Including Those with FHA Insured Mortgages
paragraphs: The hospital program may also face risks from changes in the health care  industry at large. According to industry literature, decreasing revenue  streams, increases in the number of uninsured patients, increased  competition from specialized facilities, and heightened capital needs are  some of the trends that affect all hospitals, including FHA-insured  hospitals.
We and others have reported that Medicare and Medicaid spending may not  be sustainable at current levels. If program cuts occur in Medicaid, for  example, states may take cost containment measures to reduce spending.  Such measures may include frozen, or reduced, reimbursement rates to  providers and restrictions on eligibility for these programs.In addition,  the number of Medicare enrollees is projected to increase as baby-boomers  age and become Medicare-eligible.These trends will affect all hospitals,  including FHA-insured hospitals, which generally have Medicare and  Medicaid patients in their payer mix. On average, Medicare discharges for  FHA-insured hospitals represented 29 percent of total discharges per  hospital, and Medicaid discharges represented 19 percent of total  discharges per FHA-insured hospital. (See fig. 8 for Medicare and  Medicaid discharges by state.) Stated another way, nearly 50 percent of the  reimbursement that program hospitals receive is through Medicare and  Medicaid.
Hospitals, including FHA-insured hospitals, must also contend with the  rising number of underinsured and uninsured patients, which place  demands on hospitals to provide care with little to no reimbursement.  According to the U.S. Census Bureau, the number of uninsured persons  rose from under 40 million people in 2000 to approximately 45 million  people in 2003. This trend may pose a risk to the program. In addition,  hospitals in New York, where the hospital mortgage insurance is  concentrated, serve a high proportion of uninsured patients.
Credit rating agencies state that competition is increasing in the health care  market as the type of care provided shifts to outpatient and specialty  hospitals, which provide profitable services, such as cardiology, surgery,  orthopedics, and diagnostic imaging. Specialty facilities providing these  services can take patients and revenue from general acute-care hospitals,  which supplement revenue shortfalls with profitable services after  providing needed, but unprofitable, services to the community. The growth  of specialty hospitals, such as ambulatory surgery centers, is strong. The  average number of specialty hospital openings has increased from 5  hospital openings in the 1960s to 27 hospital openings in the 2000-present  time period.
Hospitals throughout the health care sector face increasing capital  demands, yet many have limited access to capital according to hospital  industry literature.For example, hospitals face demand for outpatient  services, emergency room upgrades, and technological advancements,  which have significant up-front and maintenance costs. A reputable credit  rating agency estimates that information technology expenditures now  range between 20 to 30 percent of a hospital’s capital budget. Financially  weaker hospitals have less access to capital, yet often have pent-up capital  needs. According to a recent rating agency report, New York hospitals have  unmet capital needs as a result of their older infrastructure and because  they are generally financially weaker than the average hospital.
section_title: FHA Uses Tools to Mitigate Risk
paragraphs: FHA uses a variety of tools to mitigate risk in the hospital program. For  example, during its preliminary assessment of a hospital, FHA reviews the  hospital’s ability to pay its mortgage by analyzing its debt service coverage  ratio and determines if this ratio meets FHA’s minimum requirement. FHA  takes other steps when reviewing applications (as discussed previously)  designed to keep out excessively risky projects and also imposes  requirements on insured hospitals to control risks. These include    assessing the viability of projects at preapplication meetings with key   using a comprehensive underwriting process that assesses, among other  factors, past and projected financial performance and the demand for  the hospital’s services;   hiring an independent consultant to evaluate the feasibility of the  proposed project and its potential risk to the FHA;  requiring insured hospitals to establish a cash reserve fund sufficient to  cover 2 years of mortgage payments;   requiring insured hospitals to maintain compliance with key agreements  between the hospital and FHA and monitoring these agreements; and  considering insured hospitals that fail to meet certain financial criteria  for placement on the priority watch list.
FHA has also made some efforts to address the risks associated with the  geographic concentration of the program in New York. Since 1999, FHA has  had goals for geographically diversifying the hospital portfolio. Currently,  FHA’s goals for diversifying the portfolio include reviewing and processing  applications for projects in states other than New York. While the agency  does not have a formal strategy for marketing the program outside of New  York, it has made some efforts to diversify the hospital portfolio by  simplifying its application process for CAHs and providing rural hospital  associations with information about the program;    hiring an expert in rural hospitals;  visiting hospital association conferences to educate members about the   educating HUD field attorneys, mortgage bankers, and consultants  about the program.
HUD has also cooperated with requests for program information from the  trade media and assisted other researchers, which resulted in the  publication of articles and reports that provided information about the  advantages of the hospital program in financing capital projects. A formal  strategy, however, would provide the agency with a tool for  comprehensively planning for and executing activities that would lead to  the geographic diversification of the hospital portfolio. OMB guidance, for  example, requires that agencies include a description of the means and  strategies that will be used to achieve goals in their strategic plans. Such  strategies could include, for example, the processes, skills, technologies,  and various resources that will be used to achieve goals.
section_title: HUD’s Model for Estimating Credit Subsidy Costs Excludes Potentially Relevant Factors
paragraphs: HUD uses a model for estimating annual credit subsidies that does not  explicitly consider the impacts of some potentially important factors.  HUD’s model incorporates factors and assumptions about how loans will  perform, including estimated claim and recovery rates, which are  consistent with OMB guidance. HUD has generally calculated a negative  subsidy rate for the hospital program, meaning that estimated cash inflows  have been greater than estimated cash outflows. However, HUD’s model  does not explicitly consider the potential impacts of prepayment penalties  or restrictions when estimating prepayments, or the debt-service coverage  ratios of hospitals at the time of loan origination.
For budgeting purposes, agencies that make loans and provide loan  guarantees must estimate the costs to the government over the life of the  loans that will be insured, commonly referred to as the subsidy cost. In  order to estimate the subsidy cost of the Hospital Mortgage Insurance  Program, HUD uses a cash-flow model to project expected net cash flows  for all these loans over their entire life. HUD’s model is a computer-based  spreadsheet that uses assumptions based upon historical and projected  data to estimate the amount and timing of claims, subsequent recoveries  from these claims, as well as premiums and fees paid by the borrower.  In  addition, HUD does not consider prepayment penalties and restrictions  when it estimates the level and timing of prepayments, which affect  estimates of future claims and premiums.
HUD inputs its estimated cash flows into the OMB’s credit subsidy  calculator, which produces the official credit subsidy rate. A positive credit  subsidy rate means that the present value of cash outflows is greater than  inflows, and a negative credit subsidy rate means that the cash inflows are  estimated to exceed cash outflows. For the hospital program, cash inflows  include premiums and fees, servicing and repayment income from notes  held in inventory, rental income from properties held in inventory, and sale  income from notes and properties sold from inventory. Cash outflows  include claim payments and expenses related to properties and notes held  in inventory.
Since the hospital program’s inception, FHA has paid a total of 22 hospital  mortgage insurance claims. The last claim was filed in 1999. Because of the  small number of claims, HUD determined that claim rates based solely  upon the program’s historical claims experience would not be reliable. As  a result, HUD uses a methodology initially developed by OMB to increase  its estimated claim rate by assuming that the lenders for some active  hospitals would file claims for insurance. HUD refers to this methodology  as an artificial default. In determining which loans to artificially default,  HUD focuses on hospitals that generally have a higher risk of default, and  are therefore on FHA’s priority watch list. According to OMB officials, the  use of this artificial default accounts for the risk that exists due to the low  number of large size loans insured, potential changes in Medicare or  Medicaid reimbursement rates, and the geographic concentration of the  program in New York, which make the program vulnerable to regional  economic conditions.
In 10 of the 14 years that HUD has been estimating the cost of the Hospital  Mortgage Insurance Program under credit reform, HUD has estimated that  the present value of cash inflows from fees, premiums, and recoveries from  loans and properties sold would exceed the outflows from claim payments  and other expenses related to properties and notes held in inventory. As a  result, HUD calculated a negative credit subsidy rate for the hospital  program for these 10 years. In the other 4 years, HUD estimated positive or  no credit subsidy costs for the program. Figure 9 shows changes in the  credit subsidy rate from 1992 to 2005.
While HUD’s model includes assumptions that are consistent with OMB  guidance, such as assumptions on estimated claim and recovery rates and  an artificial default methodology to supplement the claim experience,  HUD’s model does not explicitly consider the potential impact of  prepayment penalties or restrictions, even though they can influence the  timing of prepayments and claims and collection of premiums. Inclusion of  initial debt-service coverage ratios, as a factor predictive of defaults and  claim rates into HUD’s cash-flow model for the hospital program, could  potentially enhance HUD’s estimate of the subsidy cost of the program.  According to some economic studies, prepayment penalties, or penalties  associated with the payment of a loan before its maturity date, can significantly affect borrowers’ prepayment patterns. In turn, prepayments  affect claims because if a loan is prepaid it can no longer go to claim.  According to FHA officials, FHA does not place prepayment penalties on  FHA-insured hospital loans. However, according to the hospital program’s  regulations, a mortgage loan made by a lender that has obtained the funds  for the loan through bonds can impose a prepayment penalty charge and  place a prepayment restriction on the mortgage’s term, amount, and  conditions.
According to FHA officials and mortgage bankers, prepayment restrictions  on hospital loans are generally in the form of 10-year restrictions on the  prepayment of bonds. While FHA does not maintain data specifically on  insured hospitals’ bond-financing terms, prepayment restrictions are  specified on the mortgage note, which is available to FHA. Moreover,  according to the Mortgage Insurance for Hospitals Handbook, FHA has  access to bond-financing terms because, upon completion of bond issues,  applicants are required to submit bond-related documents to FHA so that  FHA can verify that the fees, charges, and other costs previously approved  with respect to debt restructuring. Incorporation of such data into the  hospital program’s credit subsidy rate model could refine HUD’s credit  subsidy estimate by enhancing the model’s ability to account for estimated  changes in cash flows as a result of prepayment restrictions.
According to HUD officials responsible for HUD’s cash-flow model,  prepayment penalties and restrictions are not incorporated into the model  because HUD does not collect such data. HUD officials added that, even  though the cash-flow model does not explicitly account for prepayment  penalties and restrictions, its use of historic data implicitly captures trends  that may occur as a result of prepayment penalties and restrictions.  However, by not explicitly incorporating prepayment penalties or  restrictions into the cash-flow model, HUD’s model is less able to estimate  the impact of changes in prepayment patterns of current and future  cohorts.
HUD’s cash-flow model also does not consider the initial debt-service  coverage ratio of hospital loans at the point of loan origination. By initial  debt-service coverage ratio, we are referring to the projected debt-service  coverage ratio that is considered during loan underwriting. (HUD’s cash- flow model does consider the current debt-service coverage ratio of  insured hospitals through its artificial default methodology, which, as  previously explained, includes hospitals that are on FHA’s priority watch  list. This list may include insured hospitals if, based upon the last available  full year of data, their debt-service coverage ratio is below 1.10.)
According to the HUD official responsible for HUD’s cash-flow model, the  initial debt-service coverage ratio of a hospital at the point of loan  origination is not included as a part of the cash-flow model for the hospital  program because it (1) is not a cash flow, (2) does not vary, and (3) has no  predictive value. We agree that a debt-service coverage ratio is not a cash  flow. However, initial debt-service coverage ratios potentially affect  relevant cash flows, as do other factors that are included in HUD’s model  but are also not cash flows, such as prepayments. For example, the model  considers estimated prepayments because they potentially affect future  cash inflows from fees and future cash outflows from claim payments.  Initial debt-service coverage ratios are another important factor that may  affect cash flows, as loans with lower initial debt-service coverage ratios  may be more likely to default and result in a claim payment. They can also  be used to assess the financial health of either an applicant or a hospital in  the existing portfolio.
According to officials from FHA’s Office of Insured Health Care Facilities,  the projected debt-service coverage ratio is most meaningful for the third  or fourth year projected, when construction is most likely to be complete.  Our analysis of projected debt-service coverage ratios, which include the  amount of new debt being insured, shows that these ratios varied from 1.48  to 3.11 during the fourth year projected. All other factors being equal,  loans with a debt-service coverage ratio of 3.11 are generally considered to  have less risk than a loan with only a 1.48 debt-service coverage ratio.
Finally, we also found that economic studies show mixed results regarding  the significance of the impact of debt-service coverage ratios upon  commercial mortgage defaults. Some studies find initial debt-service  coverage ratios to be statistically insignificant in modeling commercial  mortgage defaults. Other studies indicate that initial debt-service  coverage ratios are meaningful factors in modeling default risk and are  helpful in predicting commercial mortgage terminations. Analysis of  initial debt-service coverage ratio information, which is available in  underwriting documents, may be used to identify trends or shifts in the  overall risk of the portfolios that should be considered when making credit  subsidy estimates. Further, current credit reform guidance calls for  agencies to use the best available data when preparing their credit subsidy  estimates.
section_title: Conclusions
paragraphs: The Hospital Mortgage Insurance Program plays an important role by  insuring loans for capital improvements at hospitals that, due to their  greater financial risks, would otherwise face difficulty in accessing capital.   FHA’s process for reviewing applications for mortgage insurance, while  somewhat lengthier and involving more steps compared with those of  private bond insurers, appears to be a reasonable response to the generally  riskier nature of the applicants. Further, the agency’s techniques for  monitoring insured hospitals are quite similar to those used by private  insurers, and the program has operated for several years without  experiencing an insurance claim.
FHA and HHS appear to work together reasonably well in carrying out their  respective roles in administering the program. However, it is difficult for  us, FHA’s managers, or the Congress to assess how well the agencies  perform in implementing the program because FHA has not established a  set of meaningful program performance measures or collected the  information needed to assess performance.  We have previously reported  on the importance of agencies’ collecting useful performance information.
If FHA collected useful performance information, such as information  based on measurable and objective performance measures, the agency’s  managers could use it to identify problems, try to identify the causes of  problems, and/or to develop corrective actions. Many program activities,  including those delegated to HHS, are recorded in FHA’s Hospital Mortgage  Insurance Management Information System, and data from this system  could be used to establish and monitor useful performance measures. In  addition, because FHA has not updated the program handbook since 1984,  hospitals, lenders, investment bankers, health care financing agencies, and  other interested parties do not have ready access to a consolidated source  of current program eligibility requirements, policies, and procedures. The  lack of a consolidated source of current information may cause confusion  and delay hospitals’ ability to prepare applications that meet FHA’s criteria.   Further, outdated guidance in federal programs is an internal control  weakness.
Although it represents a relatively small part of HUD’s GI/SRI fund, the  hospital program insures multimillion dollar loans that currently total  nearly $5 billion. The continued geographic concentration of insured  hospitals in the state of New York poses a source of financial risk to the  program. While this concentration has decreased from its high of 89  percent of outstanding insured principal balance in 2000, the current 61  percent represents a continuing concentration of credit risk. As a result,  the program is vulnerable to New York State policies, such as the  governor’s call to restructure hospitals, as well as regional economic  trends. While FHA has taken steps in the right direction, it does not have a  formal strategy or plan for geographically diversifying the hospital  portfolio, which could enhance current efforts to reach this goal.
HUD’s cash-flow model used to estimate annual credit subsidy rates  appears to be consistent with applicable OMB guidance; however, it does  not explicitly take into account potentially useful factors such as  prepayment penalties and restrictions or the initial debt-service coverage  ratio of new loan cohorts. Although the program has not experienced a  claim for insurance since 1999, the increasing size of loans insured,  geographic concentration in New York and the Northeast, and other factors  pose risks to the program. Including additional factors into HUD’s model  could potentially enhance the agency’s estimates of the subsidy cost of the  program, provide HUD and congressional decision makers with better cost  data to assess the program, and help assure that the program adequately  addresses financial risks.
section_title: Recommendations for Executive Action
paragraphs: To improve management of the Hospital Mortgage Insurance Program and  reduce potential risks to the GI/SRI fund, we recommend that the Secretary  of Housing and Urban Development direct the FHA Commissioner to take  the following three actions:  Establish measurable and objective performance measures for the  hospital program and collect appropriate information to regularly assess  performance against the measures.
Update the program handbook to make publicly available current  eligibility requirements, policies, and procedures.
Develop a formal strategy to geographically diversify its portfolio of  insured hospitals, including such elements as the processes, skills,  technologies, and various resources that will be used to reach  diversification goals.
To potentially improve HUD’s estimates of the program’s annual credit  subsidy rate, we recommend that the Secretary of Housing and Urban  Development explore the value of explicitly factoring additional  information, such as prepayment penalties and restrictions, as well as the  initial debt-service coverage ratio of hospitals, as they enter the program  into its credit subsidy model.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to HUD and HHS for their review and  comment. In written comments from HUD’s Assistant Secretary for  Housing–Federal Housing Commissioner, which incorporated comments  from HHS, HUD concurred with our four recommendations. However, the  agency disagreed with our presentation of certain aspects of the program,  commenting that the report’s “critique of procedural and technical matters”  overshadowed the program’s accomplishments. The Assistant Secretary’s  letter appears in appendix IV, and a letter from HHS appears in appendix V.
HUD expressed general agreement with the recommendations and noted  actions that it plans to take. Specifically, the agency agreed  to develop appropriate performance measures and implement data  collection procedures to evaluate both program and contract  administration;  with the need to consolidate updated eligibility requirements, policies,  and procedures into an updated handbook, and stated its intention to  have the handbook finalized by the end of 2006;  to develop a formal strategy to geographically diversify its portfolio of  insured hospitals, including such elements as the processes, skills,  technologies, and various resources that will be used to reach  diversification goals; and  to explore the value of explicitly factoring additional information, such  as prepayment penalties and the initial debt-service coverage ratio of  hospitals as they enter the program, during its annual review of cash  flow modeling techniques for the hospital program.
In disagreeing with our presentation of FHA’s efforts to diversify the  hospital portfolio, HUD commented that diversification has been a top  program goal for many years. Our draft report acknowledged that FHA has  had goals for geographically diversifying the portfolio since 1999 and  provided examples of FHA’s diversification efforts. However, in response to  the comments, we included additional examples of FHA’s efforts. HUD also  commented that the report does not appropriately emphasize the success  that HUD and HHS have had in working together to implement the hospital  program. Our draft report acknowledged the agencies coordinated  involvement with key meetings, underwriting, and monitoring. Further, as  the letter from HHS observes, our draft report concluded that the two  agencies appear to be working reasonably well together. Because we  believe the report accurately characterizes the relationship, we did not  change it. Finally, HUD commented that the report infers that (1) it has not  maintained current policies and procedures and (2) indicates that current  eligibility requirements, policies, and procedures are unavailable to the  public. Our draft report stated that the handbook does not contain current  eligibility requirements, policies, or processing procedures, and  acknowledged that FHA publicly communicates program changes through  Mortgagee Letters. Nevertheless, in response to HUD’s comments, we  revised the report to include additional examples of FHA’s efforts to  communicate changes in eligibility requirements, policies, and procedures.  We also continue to emphasize the value of updating all program  documentation, including the handbook.
HUD also offered comments regarding the report’s presentation of risks  facing the hospital program, including potential cuts in reimbursement  from Medicare and Medicaid, the potential for closures of hospitals in New  York stemming from a commission appointed by the Governor, and the  large size of some loans. We recognize that potential cuts in reimbursement  from the Medicare and Medicaid programs are a risk factor for hospitals in  all states; however, New York is unique among states in accounting for over  half of the hospital program’s insurance portfolio. We revised the report to  clarify that, due to this concentration, any cuts that the state of New York  makes to its Medicaid program could have an especially negative impact.  Regarding the New York Governor’s commission, we are aware that state  funds are available to assist in restructuring efforts, and that the Dormitory  Authority of the State of New York is committed helping its hospitals avoid  defaults. However, since there is no guarantee that FHA-insured hospitals  will be protected, we continue to believe that a recommendation for their  closure or restructuring may present the risk of an insurance claim. Finally,  we revised the report as HUD suggested to note that the largest single  exposure of $828 million is for a hospital that, according to HUD, poses a  low risk of default.
HUD commented that GAO’s presentation of processing times for  applications is misleading because it does not mention that there can be  periods of time in which HUD cannot continue to process applications due  to factors that applicants must address and are thus beyond HUD’s control.  Because HUD’s system for tracking application processing times does not  capture such periods of time, it is not possible for GAO to quantify their  impact. Further, the report notes that processing times vary with the  complexity of the project and may be affected by issues outside of HUD’s  control.
HUD took exception with our conclusion that it is difficult for us, FHA’s  managers, or the Congress to assess how well the agencies perform in  implementing the program because FHA has not established a set of  meaningful performance measures and stated a belief that program results  indicate that the program is fulfilling its purpose. While our report  acknowledges that the program has had a good performance history, the  creation and use of performance measures can be used by agency  managers to improve a program’s results. As we note in the report, analysis  of performance information helps managers identify problems, identify the  causes of problems, and develop corrective actions. In addition,  performance information can be used to develop strategies, identify  priorities, make resource allocation decisions, and identify more effective  approaches to program implementation.
HUD disagreed with our suggestion that it include such factors as initial  debt-service coverage ratio into its credit subsidy modeling and noted that  two of the studies that we cited found this ratio to be statistically  insignificant in predicting commercial mortgage defaults. Our draft report  in fact stated that economic studies have shown mixed results regarding  the significance of the impact of debt-service coverage ratios on  commercial mortgage defaults. However, we revised the report to explicitly  footnote studies that show initial debt-service coverage ratios to be  statistically insignificant and those that indicate that this ratio is a  meaningful factor in modeling default risk. We also note that the two  studies that found initial debt-service coverage ratios to be statistically  insignificant were both based on the same, small data set. We acknowledge  that HUD’s cash-flow model considers the current debt-service coverage  ratio of insured hospitals through its artificial default methodology.  However, our recommendation is to include the debt-service coverage  ratios at origination, so that the risk of loans at origination will be reflected  in the credit subsidy rates for the cohort.
Finally, our draft report stated that FHA estimates that hospital loans are  most likely to experience a claim during their tenth insured year. In its  comment, HUD stated that historically 70 percent of claims occurred prior  to a loan’s tenth year. The statement in our draft report was based on actual  historical conditional claim rate data. HUD subsequently provided  additional information, which explained that the conditional claim rate  peaked due to a single claim with multiple notes. As a result, we revised the  report to reflect additional information.
We are sending copies of this report to the Secretaries of the Departments  of Housing and Urban Development (HUD) and Health and Human  Services (HHS). We also will make copies available to others upon request.  In addition, the report will be available at no charge on the GAO Web site at  http://www.gao.gov.
If you or your staff have any questions about this report or need additional  information, please contact me at (202) 512-8678 or woodd@gao.gov.  Contact points for our Offices of Congressional Relations or Public Affairs  may be found on the last page of this report. GAO staff who made major  contributions to the report are listed in appendix VI.
section_title: Objectives, Scope, and Methodology
paragraphs: Our objectives were to review (1) the design and management of the  program, as compared with private insurance; (2) the nature and  management of the relationship between the Department of Housing and  Urban Development (HUD) and the Department of Health and Human  Services (HHS) in implementing the program; (3) the financial implications  of the program to the General Insurance/Special Risk Insurance (GI/SRI)  fund, including risk posed by program and market trends; and (4) how HUD  estimates the annual credit subsidy for the program, including the factors  and assumptions used.
To review the design and management of the Hospital Mortgage Insurance  Program we interviewed officials at both the Federal Housing  Administration’s (FHA) Office of Insured Health Care Facilities and the  Division of Facilities and Loans within HHS’ Health Resources and Services  Administration, and reviewed program policies, documentation of  application processes, laws, and regulations. To compare the program’s  design with that of private insurers, we met with private bond insurers and  the Association of Financial Guaranty Insurers, credit rating agencies,  mortgage and investment banking firms, hospital associations, and state  health care financing agencies in New York and New Jersey.
To describe how FHA and HHS coordinate the implementation of the  hospital program, we interviewed FHA and HHS officials about the  responsibilities for each agency in implementing the program. We also  reviewed the Memorandum of Agreement between FHA and HHS that  describes the division of duties and responsibilities between the two  agencies and organizational charts that depict FHA’s organization, HHS’s  organization, and the FHA-HHS interrelationship in program  administration. We analyzed the extent to which performance measures  related to interagency coordination were met by obtaining available data  from FHA and analyzing time frames for processing applications and loan  modification requests from the Hospital Mortgage Insurance Management  Information System (HMIMIS). We compared performance measures with  our criteria on performance measures and compared performance  measures in the 2002-2005 Memorandum of Agreement with the  performance measures in the 2006-2010 Interagency Agreement between  FHA and HHS to identify any changes.
To identify the financial implications of the program to the GI/SRI fund, we  interviewed and obtained documentation from FHA and HHS program  officials and analyzed FHA data on program portfolio characteristics,  including number and amount of loans by cohort, current insurance-in- force, and geographic concentration of loans, claims, and recoveries.  Specifically,  To obtain the number and amount of active and terminated loans, we  created a report from the HMIMIS database, which is updated monthly.  To assess the reliability of the HMIMIS data, we reviewed relevant  documentation, interviewed agency officials who worked with this  database, and conducted electronic testing of the data, including  frequency and distribution analyses. We determined the data to be  sufficiently reliable to obtain the number and amount of active loans. We  corroborated these data with the FHA’s 2004 report to the Congress. As  of December 2005, the administrators provided data from HUD’s F-47  database, a multifamily database, to show (1) that there were 59 active  hospitals with 74 active loans in the Hospital Mortgage Insurance  portfolio and (2) that there had been 341 loans in the portfolio since the  inception of the program. To assess the reliability of data from HUD’s F- 47 database, we reviewed HUD’s Hospital Mortgage Insurance Program  Functional Requirements Document, Procedures for Maintaining Group  Records, and other relevant documentation, interviewed agency  officials who worked with this database, and conducted electronic  testing of the data, including frequency and distribution analyses. Our  assessment showed that two loan records were lacking state data, and  one record was lacking hospital name data but were identified by a  unique project number. FHA administrators verified that these loans  were endorsed long before electronic loan records were maintained and  that they were unable to provide additional information. None of our  analyses utilized the missing data elements for the two projects;  therefore, there was no impact on this report. We determined the data to  be sufficiently reliable to describe the geographic concentration of loans  in the program.
To determine the proportion of the Hospital Mortgage Insurance  Program to the larger GI/SRI fund, we reviewed a spreadsheet provided  by HUD’s Office of Evaluation dated June 2005 on insurance-in-force for  the hospital program to that of the GI/SRI fund.
To determine the risk posed by insurance claims to the Hospital  Mortgage Insurance Program, we analyzed spreadsheets with historic  claims and recoveries data provided by HUD’s Office of Evaluation and  dated August 2005.
To determine the geographic concentration of loans and loan  prepayment history in the program, we analyzed data current as of  December 31, 2005, in an extract of HUD’s F-47 database. While we  obtained extracts from HUD’s F-47 database in April 2005, October 2005,  and December 2005, all analyses from F-47 data in the report utilize the  December 2005 extract only.
We also compared data on four financial ratios including debt service  coverage, days cash on hand, current, and operating margin ratios provided  from HMIMIS, current as of December 2005, with applicant criteria stated  in the Manual of the Hospital Insurance Program.
To determine how FHA manages program risks, we interviewed FHA and  HHS program officials and reviewed the Mortgage Insurance for Hospitals  Handbook and manual to determine steps taken by the agency during the  application and monitoring phases of the insurance process. We analyzed  cash inflows to the program from income from notes held in inventory,  rental income from properties held in inventory, sales income from notes,  and properties sold from inventory. We also reviewed documentation of  cash outflows, such as claim payments and expenses related to properties  and notes held in inventory. To assess risk based on geographic  concentration, we identified the state with the highest unpaid principal  balance insured by the program. Finally, to assess risk posed by the  geographic concentration of the program’s unpaid principal balance, we  extracted 2003 data from the Centers for Medicare & Medicaid Services  (CMS) database on Hospital Mortgage Insurance Program hospitals active  in 2005. We used CMS data to identify the number of discharged patients  whose services were paid for through the Medicare/Medicaid programs  from hospitals that have loans insured through the program. More than 90  percent of these data have undergone basic edit checks; however, CMS has  not yet determined whether these data require an audit. These data may  change as they undergo further review by CMS. In addition, CMS does not  enforce dates by which hospitals must report data. Thus, at the time of this  report, only 49 of the 59 active FHA hospitals had provided data for 2003.
We conducted a literature review and interviewed numerous officials of  rating agencies and hospital associations to obtain information on risks due  to health care market trends. We conducted the following academic  literature searches: (1) Google’s Scholar search engine using the terms  “hospital mortgage insurance,” “nursing home mortgage insurance,”  “hospital and default and FHA,” “nursing home and default and FHA”; (2)  PubMed Web site using the terms “hospital mortgage insurance” and  “nursing home mortgage insurance;” and (3) HUDuser.org Web site using  the terms “hospital mortgage insurance,” “nursing home mortgage  insurance,” and “Section 242.” We also searched for Inspectors General and  agency reports through HUD and HHS Web sites using the terms “Hospital  mortgage insurance” and “Section 242.” Finally, we conducted a search on  our internal Web site to identify previous work on the Section 242 program.  The terms “hospital,” “mortgage insurance,” and “Section 242” were used  for the period of January 1995 through March 2005.
To determine how HUD estimates the annual credit subsidy rate for the  program, we interviewed program officials from HUD’s Office of  Evaluation and program auditors from the Office of Management and  Budget (OMB), reviewed documentation of HUD’s credit subsidy  estimation procedures, and reviewed the cash-flow model for the program.  We also compared the assumptions used in HUD’s cash-flow model with  relevant OMB guidance and reviewed economic literature on modeling  defaults to identify factors that are important for estimation. Additionally,  we analyzed data provided by FHA on program hospitals’ projected debt- service coverage ratios (at the time of their loan application). HUD’s  Budget Office provided the program’s annual credit subsidy rates for 1992  and 1993, and we obtained this rate for years 1994-2005 from the Federal  Credit Supplement of the United States Budget.
Our review did not include an evaluation of underwriting criteria,  construction monitoring, or the need for the program. We conducted our  work in Albany, New York; Chicago, Illinois; New York, New York;  Paterson, New Jersey; Rockville, Maryland; and Washington, D.C., between  February 2005 and January 2006 in accordance with generally accepted  government auditing standards.
section_title: FHA and HHS’ Responsibilities in FHA’s Hospital Mortgage Insurance Program Loan Cycle
paragraphs: Department of Health  and Human Services  (HHS)
Administration (FHA)
Conduct preliminary review of hospital proposed for insurance.
Provide applicant guidance and feedback (including preapplication conference).
Review and approve construction plans, specifications, and contracts.
Engage independent feasibility consultant.
Account Executive and review team  recommend approval or disapproval to the  Program Management Group (PMG).
PMG recommends approval or disapproval to the FHA management.
FHA management recommends approval or disapproval to the FHA  Commissioner.
FHA Commissioner makes final decision on whether to insure.
Make final underwriting determinations, conduct any needed legal reviews, issue  firm commitment, close, and initially endorse loan.
Conduct preconstruction conference, monitor construction work, and process  requests for advances of mortgage proceeds.
Review cost certification, inform lender of maximum insurable mortgage amount,  and process final advance.
Arrange final closing and finally endorse mortgage.
Account Executive monitors hospital’s performance by periodically reviewing  financial and utilization data.
Account Executive will receive, review, and recommend to FHA management  approval or disapproval of special requests and loan modifications (for example,  partial release of security, transfer of physical assets, bond refundings, or major  capital projects)
Approve or disapprove special requests and loan modifications.
Develop and carry out strategies for helping a troubled hospital improve its  financial condition and for preventing or curing defaults.
Engage consultant to review finances and operations of a troubled hospital and to  make recommendations for a financial turnaround plan.
Review quality and condition of insured hospital loan portfolio.
Determine the amount of liability for loan guarantees and credit subsidy rates.
Receive/process assignment of loan and pay insurance claim.
Review assigned hospital’s operational performance and financial condition and  conduct site visits as needed.
Department of Health  and Human Services  (HHS)
Administration (FHA)
Account Executives receive, review, and recommend to FHA management  approval or disapproval of proposed workout agreements, mortgage  modifications, or note sales.
Analyze hospital’s situation, evaluate alternative uses, secure appraisal, make  decision to foreclose, and arrange and hold foreclosure sale.
Contract for management services and repairs, as needed, to protect asset if FHA  is mortgagee-in-possession or acquires hospital through foreclosure or deed-in- lieu.
Develop marketing plan, advertise, and sell hospital.
section_title: FHA Assessed Performance Using 2 of 22 Performance Measures Included in the 2002- 2005 Memorandum of Agreement
paragraphs: Services (HHS)
Administration (FHA)?
Number of complaints from customers about the HHS staff's  lack of helpfulness, timeliness, courtesy, understanding, etc.  Number of compliments received for HHS staff's helpfulness,  timeliness, courtesy, understanding, etc.
Preliminary information is provided within 2 business days of  inquiry.
Time from receipt of complete application to decision letter.  Process 75% of complete applications within 120 days of  receipt.
There are no instances of incomplete applications being  received because applicant was not informed of application  requirements.
Soundness of analysis. HUD may consider the following  evidence that the team's analysis was flawed: (1) deterioration,  within 2 yrs of the recommendation for approval, of the financial  condition of an approved applicant due to conditions that should  have been detected in the review, or (2) the ability of a  disapproved applicant to subsequently obtain insurance  elsewhere on similar terms and conditions within 6 months of  the recommendation for disapproval.
Plans and specifications do not need major revisions during the  construction process because of significant architectural or  engineering errors or omissions made prior to or during the  application process.
Problems do not arise during the construction period because of  significant inconsistencies between contract documents.
Preconstruction meetings are thorough and do not precipitate  delays in application processing for our customers.
Monthly inspection reports support the items and amounts  included in monthly draws.
Change orders are documented and recommendations are  supportable.
Length of time between the team's receipt of monthly requisition  package and submission of the team's analysis and payment  recommendation to HUD.
Hospital construction project is completed on time and within  budget, unless mitigating factors outside HHS's control prevent  this from happening.
Services (HHS)
Administration (FHA)?
Length of time between completion of construction and  recommendation for final endorsement. HHS accomplishes all  activities in a timely manner and provides assistance and works  with the hospital and contractor so as to minimize the length of  time between completion of construction and recommendations  for final endorsement.
Final recommendation package is complete, documented, and  supportable if any issues or challenges are raised in relation to  the construction phase of the project.
Customers with a weakening financial position should be  identified early enough to allow time for the Account Executive  (AE) to provide technical assistance and undertake default  prevention measures before a situation becomes an emergency.
Each AE will develop and maintain a file in HHS's office on each  customer with all pertinent information needed to evaluate the  customer's condition.
AE's should not be "blindsided" by local, state, and national  developments that affect the viability of customers.
Each customer meeting the conditions above for inclusion on  the Priority Watch List (PWL) should be included on the PWL  reports provided to HUD.
HHS's work should assist HUD's goal of zero claim payments.
Time from receipt of request to recommendation to HUD.  Performance target is to process at least 75% of complete loan  modification requests within 30 days of receipt.
HHS provides effective services to reduce or contain costs to  the FHA insurance fund for the following activities: (1) transition  into the HUD inventory; (2) stabilization of the hospital including  patient, physical, and financial concerns; (3) marketing; and (4)  disposition.
section_title: Comments from the Department of Housing and Urban Development
section_title: Comments from the Department of Health and Human Services
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: Individuals making key contributions to this report included Alison Martin,  Lisa Moore, David Pittman, Minette Richardson, Paul Schmidt, and Julie  Trinder.