The loan program provides communities and states with a way of leveraging their CDBG awards to obtain additional resources for financing larger community revitalization projects without waiting for the actual CDBG award. The loans can have repayment terms of up to 20 years. In the loan program, as in the CDBG program, communities and states must use their loan proceeds only for activities that meet one or more of three national objectives: (1) benefit low- and moderate-income people—that is, households earning less than 80 percent of the local area’s median income; (2) aid in the prevention and elimination of slums or blight; or (3) meet other urgent community development needs. In addition, the loan proceeds must be used to help finance one or more of the activities cited in section 108 of the 1974 act. These activities include, among others, the acquisition of real property; the rehabilitation of real property, either publicly owned or acquired; housing rehabilitation and preservation; and economic development. Although current and future CDBG grants are the principal collateral for loans, since 1995, communities have had to provide additional collateral. To meet this requirement, HUD has generally approved loans only for those activities expected to generate a cash flow that would allow the community to repay the guaranteed loan. A 1994 amendment to the program expanded the list of eligible activities to include the acquisition and restoration of public facilities, which would generally not produce a cash flow to repay the debt. In addition to revenue generated from the project, communities and states may designate tax revenues or other revenue sources as the additional collateral. The Treasury has never had to use public funds to fulfill the federal guarantee, according to HUD’s 1996 Consolidated Annual Report to Congress. Eligible applicants include the CDBG grantees: (1) entitlement communities—generally cities designated as central cities of metropolitan statistical areas, other cities with populations of at least 50,000, and qualified urban counties—that are directly responsible for administering their grants and (2) nonentitlement communities—smaller communities, including many rural communities whose CDBG programs are administered by the state. Nonentitlement communities became eligible for the loan program through the Cranston-Gonzalez National Affordable Housing Act of 1990. Both HUD headquarters and field offices play a role in managing the loan program. Generally, headquarters provides final approval; negotiates loan terms with applicants; and, through HUD’s fiscal agent, arranges for the sale of the loans. The fiscal agent acts as a trustee under contract to HUD and, among other duties, collects loan payments from the communities and notifies HUD to take funds from communities’ CDBG allotment when payments are not received. Field offices assist communities and states in preparing applications, make recommendations to headquarters to approve or deny loans, and monitor funded activities. HUD has financial monitoring procedures to safeguard against communities’ or states’ defaulting on their loans. HUD’s fiscal agent must receive the loan payment 5 days before it is due. Payments are due either semiannually or quarterly. If the payment is not received, the fiscal agent notifies the HUD headquarters program office, which contacts the cognizant community or state. If the fiscal agent does not receive payment within 72 hours of the payment’s due date, HUD will make the loan payment using funds from the community’s or state’s CDBG allocation. When payments are made late, HUD will credit the community’s or state’s CDBG allocation. Between fiscal years 1994 and 1996, communities and states used the loan program in far greater numbers than ever before. Over this period, HUD approved nearly 60 percent of all the funds loaned, for a total of $2.63 billion. From the program’s inception through September 1996, HUD made 930 commitments to guarantee loans totaling $4.4 billion. Figure 1 shows the number of approved loan commitments from 1978—when the first loan application was approved—through September 1996. Entitlement communities used the program significantly more than nonentitlement communities. About 38 percent of entitlement communities have received 884 loan guarantees totaling $4.2 billion. Nonentitlement communities in 16 states have received 46 loan guarantees totaling $235 million. Even though the program has recently experienced significant growth, the level of loan commitments has always been below the level approved by the Congress. For example, in fiscal year 1995—the program’s most active year—HUD approved $1.8 billion in commitments, while the Congress had appropriated $2.1 billion in commitments for that fiscal year. Figure 2 shows the level of commitments approved by the Congress and actual loan commitment levels through September 1996. According to HUD and associations representing community development officials, EDI grants encouraged communities to make greater use of the loan program. HUD provided $369 million in EDI grants from fiscal year 1994 through September 1996. However, according to these officials, the program continues to be underutilized because (1) many communities and states are reluctant to pledge their future CDBG funds as collateral for the loans, as the 1974 act, as amended, requires, and (2) collateral requirements imposed in 1995 and new procedural guidelines are likely to make communities even more reluctant to use the program. Recent growth in the use of the loan program was primarily stimulated by the introduction of EDI grants in fiscal year 1994, according to HUD and associations representing community development officials. HUD provided EDI grants for 123 out of the 395 loan commitments made between fiscal years 1994 and 1995. These EDI grants totaled $369 million. (App.1 provides detailed information on EDI grants approved during fiscal years 1994 through 1995.) The EDI grants enhance the program’s use because the communities and states can use the grant funds in a number of ways to cover the costs of administering the program, such as creating a loss reserve and writing down loan rates to businesses financing projects within the program. By helping to finance some of the projects’ costs, the grant money also strengthens the economic feasibility of the assisted projects. According to one CDBG entitlement community, the ability to receive an EDI grant along with a loan commitment from the loan fund was the key factor making it possible for the community to take out the loan. If not for the EDI grant, this community would have sought funds from alternative lending sources or issued bonds itself. Communities may use their EDI grants in different ways. For example, in 1994, Los Angeles was awarded a $300 million loan commitment—the largest single loan amount granted under this program—to establish and assist in funding a community development bank. The bank’s mission is to stimulate economic development that will create and/or retain jobs for Los Angeles’ low- and moderate-income families. In addition to the loan commitment, the city was awarded a $100 million EDI grant, bringing the bank’s total reserves to $400 million. The bank will provide loans, loan guarantees, venture capital investments, grants, and technical assistance to area businesses. In another instance, Kingston, New York, was awarded a $3.7 million loan to establish two revolving loan funds, one to rehabilitate housing and one to assist small businesses that are locating or expanding at a former IBM facility. In addition to the loan commitment, the city was awarded a $555,000 EDI grant to establish a revolving loan fund offering below-market interest rates for small businesses and a loan loss reserve. Even though communities and states generally view the loan program favorably, they have concerns about the current collateral requirements and the proposed guidance to communities on the collateral to be used when providing third-party loans. As the law requires, communities and states must pledge current and future CDBG grants as the principal collateral for their loan. According to officials from five of six associations that represent community development officials, the collateral requirements are a concern for their members. For example, one association representative told us that while many of the association’s members who used the program viewed it positively, the overall membership was slow to use the program because of the requirement to pledge future CDBG grants. Beginning in February 1995, HUD required all communities and states to pledge collateral beyond their CDBG grant. Previously, only communities and states that had loan repayment terms for 10 years or longer and, in some cases, loans with shorter repayment periods (such as those with “balloon” payments), had to pledge additional collateral. HUD’s new requirement was in response to the Credit Reform Act of 1990 and resulting directives from the Office of Management and Budget (OMB). The 1990 act required agencies to calculate subsidy costs for loan guarantee programs. This cost is the amount of appropriation an agency must have in order to cover anticipated losses in the program. In calculating this cost, OMB told HUD that it cannot use future CDBG grants as the only source of collateral for the loan. If additional collateral were not required, the subsidy cost on the loan program would be prohibitively high. According to HUD’s requirements, for loans that financed some type of tangible item, such as a building or equipment, the items themselves can serve as additional collateral. For public infrastructure activities, additional collateral will generally come from income related to CDBG activities, such as interest from repayments of housing rehabilitation loans. As a final option, communities can pledge revenues from future tax collections. In addition to concerns about collateral, association officials questioned the proposed more stringent guidelines on third-party loans, such as loans that communities make to businesses. HUD plans to issue draft guidance for review and comment on the procedures that communities and states may follow in granting loans from the loan program to third parties. The proposed guidelines would seek to minimize third-party default rates by using commercial lending practices as the benchmark for the communities’ own loan activities.