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Report to Congressional Committees: 

February 2006: 

Hospital Mortgage Insurance Program: 

Program and Risk Management Could Be Enhanced: 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-06-316]: 

GAO Highlights: 

Highlights of GAO-06-316, a report to congressional committees: 

Why GAO Did This Study: 

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. 

What GAO Found: 

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. 

FHA Hospitals Remain Concentrated in the Northeast as of December 2005: 
Active Loan Dollar Amount and Number of Loans by State: 

[See PDF for image] 

[End of figure] 

What GAO Recommends: 

GAO recommends that the HUD Secretary ensure that program performance 
measures are useful, update the program handbook, develop a formal 
geographic diversification strategy, and explore adding factors to 
HUD’s credit subsidy model. HUD agreed with GAO’s recommendations but 
said that the report did not adequately emphasize the program’s 
accomplishments. 

www.gao.gov/cgi-bin/getrpt?GAO-06-316. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact David G. Wood at (202) 
512-6878 or WoodD@gao.gov. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

FHA's Selection Process Includes Additional Steps Compared with Private 
Insurers, but Monitoring Techniques Are Similar: 

Agencies Coordinate Key Activities, but FHA Does Not Track Most 
Performance Measures: 

Potential Risks Exist Although FHA Has Mitigation Strategies in Place: 

HUD's Model for Estimating Credit Subsidy Costs Excludes Potentially 
Relevant Factors: 

Conclusions: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendixes: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: FHA and HHS' Responsibilities in FHA's Hospital Mortgage 
Insurance Program Loan Cycle: 

Appendix III: FHA Assessed Performance Using 2 of 22 Performance 
Measures Included in the 2002-2005 Memorandum of Agreement: 

Appendix IV: Comments from the Department of Housing and Urban 
Development: 

Appendix V: Comments from the Department of Health and Human Services: 

Appendix VI: GAO Contact and Staff Acknowledgments: 

Table: 

Table 1: Number of New Loans Insured through the Hospital Mortgage 
Insurance Program Since 2001: 

Figures: 

Figure 1: FHA Did Not Process Most Hospital Mortgage Insurance 
Applications within Targeted Time Frame: 

Figure 2: Hospital Mortgage Insurance Program Comprises a Relatively 
Small Part of the GI/SRI Fund: 

Figure 3: Proportion of FHA Hospital Loans That Have Been Insured Less 
Than 10 Years: 

Figure 4: Selected Median Financial Indicators Show Varying Levels of 
Risk: 

Figure 5: Selected Median Financial Indicators Show High Levels of Risk 
for Priority Watch List Hospitals: 

Figure 6: FHA Loans Remain Concentrated in the Northeast as of December 
2005: Active Loan Dollar Amount and Number of Loans by State: 

Figure 7: Applications for Hospital Mortgage Insurance are 
Geographically Dispersed as of December 2005: Application Dollar Amount 
and Number of Applications by State: 

Figure 8: FHA-Insured Hospitals Have Medicare and Medicaid Payers among 
Their Patient Discharges: 

Figure 9: Credit Subsidy Rates for the Hospital Mortgage Insurance 
Program Have Generally Not Indicated a Need for Subsidies: 

Abbreviations: 

AE: Account Executive: 

CAH: Critical Access Hospitals: 

CMS: Centers for Medicare & Medicaid Services: 

FHA: Federal Housing Administration: 

GI/SRI: General Insurance/Special Risk Insurance: 

HHS: Department of Health and Human Services: 

HMIMIS: Hospital Mortgage Insurance Management Information System: 

HUD: Department of Housing and Urban Development: 

MOA: Memorandum of Agreement: 

OMB: Office of Management and Budget: 

PART: Program Assessment Rating Tool: 

PMG: Program Management Group: 

PWL: Priority Watch List: 

Letter February 28, 2006: 

The Honorable Christopher Bond: 
Chairman: 
The Honorable Patty Murray: 
Ranking Member: 
Subcommittee on Transportation, Treasury, the Judiciary, Housing and 
Urban Development, and Related Agencies: 
Committee on Appropriations: 
United States Senate: 

The Honorable Joe Knollenberg: 
Chairman: 
The Honorable John W. Olver: 
Ranking Member: 
Subcommittee on Transportation, Treasury, and Housing and Urban 
Development, The Judiciary, District of Columbia, and Independent 
Agencies: 
Committee on Appropriations: 
House of Representatives: 

The 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.[Footnote 1] 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.[Footnote 2] 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. 

Results in Brief: 

The Hospital Mortgage Insurance Program insures the mortgages of 
hospitals that are financially riskier than those that can obtain 
private insurance, but it shares some management techniques with 
private insurers. While FHA's process for reviewing mortgage insurance 
applications includes more steps, such as a preapplication meeting and 
review by an independent consultant, and generally takes longer, FHA 
officials believe these extra steps are justified given the generally 
riskier nature of the hospitals applying. Once it insures a hospital 
mortgage, FHA monitors the loan using many of the same techniques that 
private insurers use. For example, both FHA and private insurers 
identify the riskiest loans in their portfolios for closer monitoring. 
They also periodically review hospital financial statements and 
management activities and can require hospitals experiencing financial 
difficulties to use consultants for needed expertise. 

FHA and HHS work together throughout the process of reviewing mortgage 
insurance applications and monitoring active loans, guided by a 
multiyear Memorandum of Agreement between the two agencies. However, 
FHA has not used the agreement's performance measures to manage the 
program, and its program guidance is not up to date. FHA and HHS use 
joint working groups to carry out certain activities. For example, 
client service teams, which can be composed of HHS staff, FHA staff, or 
both, review application materials. Also, senior FHA and HHS officials 
meet weekly to discuss insurance applications, as well as insured 
hospitals that are experiencing difficulties. While the agencies 
coordinate in program implementation, FHA does not collect data to 
track most of the performance measures, including those for coordinated 
or HHS-delegated tasks. For example, one performance measure is 
designed to capture the soundness of the analysis of a hospital's 
application, but FHA does not collect data to assess this performance 
measure. Other performance measures are not measurable or objective. 
According to FHA, the measures are intended to communicate 
expectations, and it has not tracked most performance measures because 
there have not been enough problems to warrant a tracking system. 
Finally, FHA has not updated the program handbook, which contains 
program eligibility requirements, policies, and procedures, since 1984. 

The Hospital Mortgage Insurance Program is small compared with other 
programs in the GI/SRI fund--accounting for about 7 percent of the 
amount of all active loans insured by the fund--and the losses from 
claims have been relatively low. The program has not experienced a 
claim since 1999. Despite the program's relatively small size, some 
program and market trends may pose risks. For example, the geographic 
concentration of insured hospitals located in the state of New York, 
while decreasing, makes the program vulnerable to state policies and 
regional economic conditions. In addition, literature on hospital 
industry market trends generally predicts reductions in hospital 
revenues along with increasing capital needs--conditions that could 
increase the risk of FHA insured loans going to claim. FHA has 
established mitigation strategies to address some potential risks. For 
example, FHA requires hospitals to establish cash reserve funds equal 
to 2 years worth of mortgage payments. These funds may be used to help 
hospitals through temporary financial crises and prevent their lenders 
from filing an insurance claim. Also, FHA's identification of its 
riskiest hospitals enables the agency to prioritize those hospitals 
that need additional monitoring and assistance. In addition, since 
1999, FHA has had goals for geographically diversifying the hospital 
mortgage insurance portfolio. Though it has made efforts to diversify 
the portfolio, FHA does not have a formal strategy for reaching its 
diversification goals. 

HUD uses a model for estimating annual credit subsidies, or program 
costs over the life of the outstanding loans insured, that does not 
explicitly consider the impacts of some potentially important factors. 
HUD's model--an important tool for estimating the cost of the hospital 
program to the government--incorporates factors and assumptions about 
how the loans will perform, including estimated claim and recovery 
rates, which are consistent with guidance issued by the Office of 
Management and Budget (OMB). Although the number of claims paid since 
the program's inception is small, HUD assumes that the lenders for some 
active hospitals will file claims for insurance and, therefore, 
increases its estimated claim rate. In 10 of the 14 years that HUD has 
been estimating the cost of the hospital program under credit reform, 
HUD has calculated a negative subsidy rate, meaning that estimated cash 
inflows (including fees, premiums, and recoveries on defaulted loans) 
have been greater than estimated cash outflows (including claims and 
certain program expenses). HUD's model does not explicitly consider the 
potential impacts of prepayment penalties or restrictions, which can 
influence cash flows through the timing of prepayments, collection of 
premiums, and claims. HUD's model also does not consider the initial 
debt-service coverage ratios of hospitals (an indicator of a borrower's 
ability to make regular mortgage payments) at the point of loan 
origination when estimating future claims, although, according to some 
economic studies, this ratio is an important factor in modeling default 
risk. HUD does not include these factors in its model because, 
according to HUD, it does not collect data on prepayment restrictions 
and because debt-service coverage ratios, among other things, do not 
vary. We found that data on prepayment restrictions are readily 
available to FHA. Further, our analysis of projected debt-service 
coverage ratios for hospitals that applied for mortgage insurance 
between 2002 and 2005 found that these ratios varied (with the highest 
being over twice that of the lowest) and thus can be useful in 
assessing relative risk. 

This report contains recommendations designed to improve FHA's 
management of the Hospital Mortgage Insurance Program and reduce risks 
associated with the geographic concentration of the portfolio. We 
provided draft copies of this report to HUD and HHS. In its response, 
HUD's Assistant Secretary for Housing concurred with our 
recommendations and noted actions that it plans to take. HUD also 
stated that the report did not adequately emphasize the program's 
accomplishments. HHS concurred with HUD's observations. 

Background: 

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.[Footnote 
3] 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.[Footnote 4] 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. 

Table 1: Number of New Loans Insured through the Hospital Mortgage 
Insurance Program Since 2001: 

Fiscal year: 2005; 
Loans insured: 11. 

Fiscal year: 2004; 
Loans insured: 6. 

Fiscal year: 2003; 
Loans insured: 7. 

Fiscal year: 2002; 
Loans insured: 1. 

Fiscal year: 2001; 
Loans insured: 2. 

Source: FHA. 

[End of table] 

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.[Footnote 5] 

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.[Footnote 6] 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 fiscal year.[Footnote 7] 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. 

FHA's Selection Process Includes Additional Steps Compared with Private 
Insurers, but Monitoring Techniques Are Similar: 

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.[Footnote 8] 
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.[Footnote 9] 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.[Footnote 10] 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.[Footnote 11] 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.[Footnote 12] 

Agencies Coordinate Key Activities, but FHA Does Not Track Most 
Performance Measures: 

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. 

FHA and HHS Coordinate Their Client Screening, Application Review, and 
Loan Monitoring Activities: 

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.[Footnote 13] 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.[Footnote 14] 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. 

FHA Has Not Used Performance Measures to Manage the Program: 

The fiscal years' 2002-2005 MOA between FHA and HHS provides for FHA to 
establish performance measures and use them to evaluate tasks.[Footnote 
15] 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). 

Figure 1: FHA Did Not Process Most Hospital Mortgage Insurance 
Applications within Targeted Time Frame: 

[See PDF for image] 

[End of figure] 

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.[Footnote 16] 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.[Footnote 17] 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.[Footnote 18] (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. 

Program Guidance Is Not Up to Date: 

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.[Footnote 19] 

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.[Footnote 20] 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.[Footnote 21] 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.[Footnote 22] Maintaining current 
documentation is an internal control that would benefit both those 
interested in the program and those that administer the program. 

Potential Risks Exist Although FHA Has Mitigation Strategies in Place: 

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. 

The Hospital Program Accounts for a Relatively Small Share of the 
Broader GI/SRI Fund, and Has Recovered a Majority of All Claims: 

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.[Footnote 23] 
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. 

Figure 2: Hospital Mortgage Insurance Program Comprises a Relatively 
Small Part of the GI/SRI Fund: 

[See PDF for image] 

[End of figure] 

Loan Performance and Market Trends Reveal Sources of Potential Risks: 

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).[Footnote 24] 

Figure 3: Proportion of FHA Hospital Loans That Have Been Insured Less 
Than 10 Years: 

[See PDF for image] 

[End of figure] 

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.[Footnote 25] 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. 

Figure 4: Selected Median Financial Indicators Show Varying Levels of 
Risk: 

[See PDF for image] 

[A] The N for debt-service coverage ratio differs slightly. It is 36 in 
2000, 41 in 2001, 42 in 2002, 44 in 2003, and 49 in 2004. 

[End of figure] 

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. 

Figure 5: Selected Median Financial Indicators Show High Levels of Risk 
for Priority Watch List Hospitals: 

[See PDF for image] 

[End of figure] 

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. 

Figure 6: FHA Loans Remain Concentrated in the Northeast as of December 
2005: Active Loan Dollar Amount and Number of Loans by State: 

[See PDF for image] 

[End of figure] 

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).[Footnote 26] 

Figure 7: Applications for Hospital Mortgage Insurance are 
Geographically Dispersed as of December 2005: Application Dollar Amount 
and Number of Applications by State: 

[See PDF for image] 

[End of figure] 

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.[Footnote 27]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. 

Industry Trends Pose Risks to Hospitals, Including Those with FHA 
Insured Mortgages: 

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.[Footnote 28] If program cuts occur in 
Medicaid, for example, states may take cost containment measures to 
reduce spending.[Footnote 29] Such measures may include frozen, or 
reduced, reimbursement rates to providers and restrictions on 
eligibility for these programs.[Footnote 30]In addition, the number of 
Medicare enrollees is projected to increase as baby-boomers age and 
become Medicare-eligible.[Footnote 31] 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.[Footnote 32] (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. 

Figure 8: FHA-Insured Hospitals Have Medicare and Medicaid Payers among 
Their Patient Discharges: 

[See PDF for image] 

Note: More than 90 percent of these data have undergone basic edit 
checks; however, Centers for Medicare & Medicaid Services (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, only 49 of the 
59 FHA hospitals active as of October 2005 had provided data for 2003. 

[End of figure] 

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.[Footnote 33] 
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.[Footnote 34] 

Hospitals throughout the health care sector face increasing capital 
demands, yet many have limited access to capital according to hospital 
industry literature.[Footnote 35]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.[Footnote 36] 

FHA Uses Tools to Mitigate Risk: 

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.[Footnote 37] 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 hospital representatives; 

* 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;[Footnote 38] 

* requiring insured hospitals to maintain compliance with key 
agreements between the hospital and FHA and monitoring these 
agreements;[Footnote 39] and: 

* considering insured hospitals that fail to meet certain financial 
criteria for placement on the priority watch list.[Footnote 40] 

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 program; and: 

* 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. 

HUD's Model for Estimating Credit Subsidy Costs Excludes Potentially 
Relevant Factors: 

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.[Footnote 41] 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.[Footnote 42] 
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.[Footnote 43] 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. 

Figure 9: Credit Subsidy Rates for the Hospital Mortgage Insurance 
Program Have Generally Not Indicated a Need for Subsidies: 

[See PDF for image] 

[End of figure] 

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.[Footnote 44] 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.[Footnote 45] 

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.[Footnote 46] 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.[Footnote 47] Other studies 
indicate that initial debt-service coverage ratios are meaningful 
factors in modeling default risk and are helpful in predicting 
commercial mortgage terminations.[Footnote 48] 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. 

Conclusions: 

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. 

Recommendations for Executive Action: 

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. 

Agency Comments and Our Evaluation: 

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 [Hyperlink, 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 
[Hyperlink, 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. 

Signed by: 

David G. Wood, Director: 
Financial Markets and Community Investment: 

[End of section] 

Appendixes: 

Appendix I: Objectives, Scope, and Methodology: 

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.[Footnote 49] 

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.[Footnote 50] 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.[Footnote 51] 

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. 

[End of section] 

Appendix II: FHA and HHS' Responsibilities in FHA's Hospital Mortgage 
Insurance Program Loan Cycle: 

Development: Conduct preliminary review of hospital proposed for 
insurance; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Provide applicant guidance and feedback (including 
preapplication conference); 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: Conduct initial site visit to hospital; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: Review and approve construction plans, specifications, and 
contracts; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): No. 

Development: Engage independent feasibility consultant; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Account Executive and review team recommend approval or 
disapproval to the Program Management Group (PMG)[A]; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: PMG recommends approval or disapproval to the FHA 
management[B]; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: FHA management recommends approval or disapproval to the 
FHA Commissioner; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: FHA Commissioner makes final decision on whether to 
insure; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Make final underwriting determinations, conduct any needed 
legal reviews, issue firm commitment, close, and initially endorse 
loan; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Conduct preconstruction conference, monitor construction 
work, and process requests for advances of mortgage proceeds; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): No. 

Development: Review cost certification, inform lender of maximum 
insurable mortgage amount, and process final advance; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): No. 

Development: Arrange final closing and finally endorse mortgage; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Loan management; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): No. 

Development: Account Executive monitors hospital's performance by 
periodically reviewing financial and utilization data; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: 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); 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: Approve or disapprove special requests and loan 
modifications; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Develop and carry out strategies for helping a troubled 
hospital improve its financial condition and for preventing or curing 
defaults; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: Engage consultant to review finances and operations of a 
troubled hospital and to make recommendations for a financial 
turnaround plan; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Review quality and condition of insured hospital loan 
portfolio; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Determine the amount of liability for loan guarantees and 
credit subsidy rates; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Assignment; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): No. 

Development: Receive/process assignment of loan and pay insurance 
claim; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Review assigned hospital's operational performance and 
financial condition and conduct site visits as needed; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: Account Executives receive, review, and recommend to FHA 
management approval or disapproval of proposed workout agreements, 
mortgage modifications, or note sales; 
Department of Health and Human Services (HHS): Yes; 
Federal Housing Administration (FHA): Yes. 

Development: Bill for and collect mortgage payments; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Disposition; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): No. 

Development: Analyze hospital's situation, evaluate alternative uses, 
secure appraisal, make decision to foreclose, and arrange and hold 
foreclosure sale; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: 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; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Development: Develop marketing plan, advertise, and sell hospital; 
Department of Health and Human Services (HHS): No; 
Federal Housing Administration (FHA): Yes. 

Source: FHA Hospital Mortgage Insurance Program staff. 

[A] The Account Executive can be an FHA or HHS staff member. The review 
team, or Client Service Team, can consist of FHA and/or HHS staff. The 
PMG consists of both senior FHA and HHS staff. 

[B] FHA's Director of the Office of Insured Health Care Facilities. 

[End of table] 

[End of section] 

Appendix III: FHA Assessed Performance Using 2 of 22 Performance 
Measures Included in the 2002-2005 Memorandum of Agreement: 

Performance measure: 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; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No . 

Performance measure: Preliminary information is provided within 2 
business days of inquiry; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Time from receipt of complete application to 
decision letter. Process 75% of complete applications within 120 days 
of receipt; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? Yes. 

Performance measure: There are no instances of incomplete applications 
being received because applicant was not informed of application 
requirements; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: 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; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: 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; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Problems do not arise during the construction 
period because of significant inconsistencies between contract 
documents; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Preconstruction meetings are thorough and do not 
precipitate delays in application processing for our customers; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Monthly inspection reports support the items and 
amounts included in monthly draws; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Change orders are documented and recommendations 
are supportable; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Length of time between the team's receipt of 
monthly requisition package and submission of the team's analysis and 
payment recommendation to HUD; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Hospital construction project is completed on time 
and within budget, unless mitigating factors outside HHS's control 
prevent this from happening; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: 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; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Final recommendation package is complete, 
documented, and supportable if any issues or challenges are raised in 
relation to the construction phase of the project; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: 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; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: 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; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: AE's should not be "blindsided" by local, state, 
and national developments that affect the viability of customers; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: Each customer meeting the conditions above for 
inclusion on the Priority Watch List (PWL) should be included on the 
PWL reports provided to HUD; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: HHS's work should assist HUD's goal of zero claim 
payments; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: 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; 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? Yes. 

Performance measure: "Same as for insured loans;" 
Coordinated task: Yes; 
Task delegated to the Department of Health and Human Services (HHS): 
No; 
Measured by the Federal Housing Administration (FHA)? No. 

Performance measure: 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; 
Coordinated task: No; 
Task delegated to the Department of Health and Human Services (HHS): 
Yes; 
Measured by the Federal Housing Administration (FHA)? No. 

Source: HHS, Office of Special Programs, Memorandum of Agreement 
between the Department of Housing and Urban Development (HUD) and the 
Department of Health and Human Services (HHS), 2001. 

Note: Some performance measures refer to tasks that can be done by 
either FHA or HHS officials, which we refer to as "coordinated tasks." 
Other performance measures apply to tasks specifically for HHS, which 
we refer to as "HHS-delegated tasks." 

[End of table] 

[End of section] 

Appendix IV: Comments from the Department of Housing and Urban 
Development: 

U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT: 
ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER: 
WASHINGTON, DC 20410-8000: 

FEB - 9 2006:  

David G. Wood, Director: 
Financial Markets and Community Investment: 
United States Government Accountability Office: 
441 G Street, NW: 
Washington, DC 20548: 

Re: Draft report - Hospital Mortgage Insurance Program: 

Dear Mr. Wood: 

This responds to Ms. Lisa Moore's letter of January 23, 2006, to US 
Department of Housing and Urban Development (HUD) Secretary Alphonso 
Jackson, requesting comments on GAO's draft report on the Hospital 
Mortgage Insurance Program. At the request of US Department of Health 
and Human Services (HHS) Secretary Michael O. Leavitt, comments from 
HHS have been incorporated into this response. 

I would like to thank you for the positive comments on the program and 
the helpful suggestions that are included in the report. However, as 
discussed below, we believe that the report could place more emphasis 
on what HUD has accomplished since the GAO last reviewed the program in 
February 1996. The report's critique of procedural and technical 
matters is allowed to overshadow the program's very real 
accomplishments: 

* The geographic concentration of HUD's portfolio of insured hospital 
mortgages in New York State has been reduced from 89 percent in 2000 to 
61 percent today, through an aggressive outreach and diversification 
effort. Further reductions will occur as HUD processes the pipeline of 
new loan applications. Diversification is occurring because HUD has 
pursued a multifaceted marketing strategy that includes presenting 
program information at a variety of hospital industry forums, providing 
training to mortgage lenders in various regions, adapting program 
requirements to the needs of Critical Access Hospitals, permitting 
physician-owned hospitals that comply with regulations governing self- 
referrals to use the program, streamlining procedures to reduce 
processing times and increase user-friendliness, and providing program 
information to national and regional publications. 

* In the last ten years, FHA has insured an additional 49 hospital 
mortgages. This has provided $3.5 billion in needed capital financing 
to finance the construction and improvements of hospitals in 21 states, 
including 5 critical access hospitals serving rural areas and 
facilities in inner cities and other economically distressed areas. 
This not only provides valuable employment opportunities, but improves 
health care for generally underserved populations. 

* The FHA's hospital program has incurred only one claim out of 149 
mortgages at risk during the past ten years. This was accomplished 
despite the fact that the program makes credit available to hospitals 
that pose a financial risk greater than those served by private 
insurance. 

* Although HUD is accountable, it has worked in partnership with the 
Department of Health and Human Services to streamline and make more 
effective the review of loan applications. It has also strengthened the 
management of the portfolio of insured loans to avoid mortgage 
defaults, including offering comprehensive and intensive assistance to 
financially weak hospitals. To make this possible, HUD has expanded the 
Office of Insured Health Care Facilities from five to eleven staff 
members with extensive experience in hospital finance and management 
and will soon add a twelfth staff member. 

We believe these improvements merit a careful assessment and evaluation 
in terms of program and risk management as directed in the 
Appropriations Committee report. 

Critiques of Process Overshadow Program Results: 

While the draft report mentions the diversification statistics, I am 
concerned that its tone and substance fail to recognize what HUD has 
accomplished and continues to accomplish. For example, in the section 
"Results in Brief' the report states: "While FHA has goals to diversify 
the hospital insurance portfolio, and has made some efforts to do so, 
it does not have a formal strategy to achieve these goals." In fact, 
FHA has made more than "some efforts" toward diversification. 
Diversification has been a top program goal for many years, as 
evidenced in documents provided to your reviewers. The statistics show 
that diversification is occurring steadily. However, the draft report's 
emphasis on the absence of a formal written strategy overshadows FHA's 
real accomplishments. 

Likewise, the draft report criticizes FHA for having performance 
measures in its interagency agreement with HHS that are not 
quantifiable or that are not measured on a regular basis. While this 
critique may be valid, it is allowed to overshadow the success that HUD 
and HHS have had in creating a "hand in glove" relationship that is 
unusual for two cabinet-level agencies with different priorities and 
cultures. The report does state in the section titled "Agencies 
Coordinate Key Activities, but FHA Does Not Track Most Performance 
Measures" that program participants find coordination between FHA and 
HHS to be "generally seamless." However, that observation is missing 
from the "Results in Brief' section at the front of the report, which 
will be more widely read than the entire document. 

A third example in which the report understates FHA's accomplishments 
is found in the "Results in Brief' section, which states: "Finally, FHA 
has not updated the program handbook, which contains program 
eligibility requirements, policies, and procedures, since 1984." This 
is true and is a valid criticism. While the eligibility requirements 
and policies in the handbook are generally still applicable, the 
procedures have changed considerably, and the handbook must be updated. 
However, the language in the draft report infers that HUD has not 
maintained current policies and procedures, which is not the case. The 
handbook is only one of a number of documents that provide program 
guidance. In fact, HUD has made continuous efforts to clarify program 
requirements and procedures, including updating the Applicant's Guide, 
developing the Application Process Checklist, and publishing a 
Mortgagee Letter. Establishment of a preliminary review process and 
distribution of the "Minimum Criteria for Consideration" have clearly 
communicated HUD's eligibility requirements. Further, HUD has 
redesigned the program web page to include substantially more 
information for lenders and hospitals. 

HUD suggests that GAO consider presenting a more balanced view of 
program and risk management in the "Results in Brief' section. 

Comments on Risk Factors: 

In its discussion of potential risks, the draft report discusses a 
number of risk factors in the HUD insured portfolio and in the hospital 
industry in general. HUD is mindful of the factors that can cause 
hospital financial performance to decline, including factors discussed 
in the report. However, the Department offers the following comments on 
some of the factors that are cited as causes for concern: 

* The draft report states: "For instance, the 43 New York hospitals 
currently insured through FHA rely heavily upon reimbursement through 
Medicare and Medicaid, making them vulnerable to state and federal cuts 
in these programs." While true, 

the statement implies that New York hospitals are especially vulnerable 
to Medicare and Medicaid cuts. In fact, nationwide in 2003, 52 percent 
of discharges were attributable to Medicare and Medicaid patients, 
slightly more than the 49 percent in New York. Potential cuts in 
reimbursement from these programs are a risk factor in all states. 

* A second concern expressed in the draft report is that the commission 
appointed by the governor of New York to identify hospitals for closure 
or restructuring could recommend closure or restructuring of hospitals 
in the FHA portfolio, presenting the risk of an insurance claim. While 
this scenario is possible, HUD believes it is unlikely because the 
commission is required to consider the effect on lenders and 
bondholders in making its decisions. Although the commission is charged 
with making recommendations to restructure, the governor and 
legislature have committed $1 billion of state funds over 4 years to 
assist restructuring efforts and improvements to healthcare information 
technology. These funds will assist the industry to restructure 
including consideration of debt. For a number of reasons, HUD believes 
that the State will avoid actions that would precipitate default on a 
HUD-insured mortgage that backs State-issued hospital bonds. In fact, 
New York State, through its Department of Health and the Dormitory 
Authority of the State of New York (DASNY), has a history of helping 
its hospitals avoid defaults. [NOTE] Furthermore, the FHA claim rate in 
the State, approximately one percent, is half of FHA's claim rate on 
hospital loans nationwide. 

NOTE: DASNY helps hospitals avoid defaults by providing low or no 
interest loans to improve efficiency and fund critical turnaround 
plans. DASNY also closely monitors and advises troubled hospitals and 
develops short-and long-term business plans. Most notably, along with 
HUD and the New York State Department of Health, DASNY helped Saint 
Vincent Catholic Medical Centers, Ellis Hospital, and Kingsbrook Jewish 
Medical Center avoid defaults. 

* HUD shares the concern in the draft report that a large insurance 
claim resulting from a default on a large New York mortgage (or for 
that matter, a large mortgage in any state) poses a risk to the 
program. However, the report might note that the hospital given as an 
example (HUD's largest single exposure at $828 million) is a 
financially sound, well-endowed institution that poses a low risk of 
default. 

Comment on Processing Time: 

On the issue of processing times for applications, the interpretation 
of the data that GAO extracted from the program information system can 
be misleading. In the section on FHA's selection process, the draft 
report says that it took an average of 265 days to process the 11 
applications for hospital mortgage insurance endorsed in fiscal year 
2005. Unfortunately, HUD's tracking system does not currently capture 
"time outs" in the application review process that occur when the 
applicant must deal with issues that were not foreseen at the time the 
application was submitted, and which are beyond HUD's control. For 
example, the processing of the application for the University of New 
Mexico Hospital was delayed for several months after HUD received the 
application because the hospital encountered difficulty securing a 
lease on Native American land needed for the project. Furthermore, 
after beginning the review process of applications for Bucyrus 
Community Hospital and the Medical University Hospital Authority, the 
scope or cost of these projects were changed by the hospital, 
necessitating new feasibility studies. For these three projects, the 
delay ranged from approximately 90 days to 255 days. 

Hospital projects are complex in nature, and there are many factors 
that can delay even a carefully planned project such as those mentioned 
above. HUD has strengthened its preliminary review procedures to 
require lenders and hospitals to develop solutions to identified 
problems before they submit an application. The preliminary review also 
increases program efficiency and reduces processing time because it 
eliminates from consideration, early in the process, those hospitals 
that do not qualify for the program. However, there will still be cases 
in which substantive issues arise during the underwriting process that 
may take some time to resolve. In the final report, HUD requests that 
GAO mention that processing times include suspensions of processing for 
matters beyond HUD's control. 

Response to Conclusions: 

HUD takes strong exception to the sentence: "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 performance measures or collected the information 
needed to assess performance." HUD believes that program results 
indicate that the program is fulfilling the public purpose for which it 
was designed and that it is doing so on a financially self-sustaining 
basis. Since program inception, 341 hospital loans have been insured 
for a total of $11.9 billion, enabling hospitals in 41 states and 
Puerto Rico to obtain affordable financing for construction and 
modernization projects. By insuring projects that the private industry 
will not insure, Section 242 has enabled the provision of urgently 
needed health care services to the medically underserved, and spurred 
economic growth in those communities. Furthermore, the results have 
been accomplished at no net cost to the taxpayers; in fact, the 
hospital program has been a net contributor to the insurance fund. HUD 
requests that the "Conclusions" section be modified to present a more 
balanced picture that does not allow technical and procedural issues to 
overshadow real program accomplishments. More discussion on performance 
measures is found below. 

Responses to Recommendations: 

Recommendation: Establish measurable and objective performance measures 
for the hospital program and collect appropriate information to 
regularly assess performance against the measures. 

Response: HUD agrees on the importance of measurable and objective 
performance measures. At a high level, HUD has two performance measures 
for the program, both of which are measurable and objective: 

1. Geographically diversify the portfolio by expanding program activity 
in all regions in order to reduce the risk associated with portfolio 
concentration in New York and to provide greater benefit to communities 
nationwide. 

2. Maintain or reduce the program's historical claim rate of two 
percent of the amount of insurance written. 

In addition, HUD has tracked two "customer service" performance 
measures, achievement of which can help bring about geographic 
diversification by making the program more attractive to lenders and 
hospitals: 

3. Process 75 percent of complete applications within 120 days of 
receipt. 

4. Process 75 percent of complete loan modification requests within 30 
days of receipt. 

HUD agrees that the measures for evaluating the performance of HHS 
under the interagency agreement are in some cases subjective and not 
easily measured, and that in other cases they could be measured, but 
are not. Although the performance measures in the interagency agreement 
were primarily meant to communicate HUD's expectations to HHS, HUD 
recognizes the value of performance measurement in both program 
administration and contract (interagency agreement) administration. The 
program office will work with HUD's Office of Policy Development and 
Research in order to develop the appropriate measures and implement 
data collection procedures to evaluate both program and contract 
administration. 

Recommendation: Update the program handbook to make publicly available 
current eligibility requirements, policies, and procedures. 

Response: While HUD does not agree that current eligibility 
requirements, policies, and procedures are unavailable to the public, 
it does recognize the need to consolidate those items in a new 
handbook. A new final rule governing the hospital program is being 
developed following the public comment period. That rule will provide 
the basis for the detailed guidance that will be promulgated in a new 
handbook. HUD's goal is to have the handbook in clearance by the end of 
calendar year 2006. 

Recommendation: 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. 

Response: Although HUD has pursued a diversification strategy as 
discussed above, it agrees that a formal strategy would be useful and 
will formalize its strategy. 

Recommendation: To potentially improve HUD's estimates of the program's 
annual credit subsidy rate, explore the value of explicitly factoring 
additional information, such as prepayment penalties and restrictions 
and the initial debt service coverage ratio of hospitals as they enter 
the program into the credit subsidy model. 

Response: HUD welcomes GAO's suggestions that HUD revisit the 
calculation of the credit subsidy. In fact, the Department annually 
reviews the cash flow models that are used to estimate program 
performance and calculate subsidy rates. In addition, these models are 
reviewed by the independent auditor of the FHA financial statement and 
by OMB. Each year the models are updated for the latest loan 
performance statistics and suggestions for methodological improvements 
are considered. HUD will include GAO's suggestions in this ongoing 
process of attempting to utilize the most sound and accurate modeling 
techniques to estimate the cost of its mortgage insurance programs. 

With respect to GAO's suggestion that the initial debt service coverage 
(DSC) ratio be incorporated as a factor in credit subsidy modeling, HUD 
would note that two of the studies cited in the footnotes in the report 
as technical support for this suggestion actually found this factor to 
be statistically insignificant in predicting commercial mortgage 
defaults. In any event, HUD does take into account the contemporaneous 
(not initial) DSC ratio in determining which currently insured hospital 
mortgages are financially troubled. This contemporaneous DSC ratio 
comes from the annual (audited) financial statements submitted by the 
hospital owners. It is not clear why HUD should consider using the 
initial DSC ratio in addition to-the contemporaneous DSC ratio in 
making its artificial default adjustments for the hospital program. 

Finally, HUD disagrees with the statement that "FHA estimates that 
hospital loans are most likely to experience a claim during their 10th 
insured year" and that since the majority of hospital loans are less 
than 10 years old, they are only now reaching a period when most claims 
occur. There appears to be a misunderstanding, because 70 percent of 
the claims and slightly more than 70 percent of the dollar amount of 
claims paid occurred prior to the 10th year. The relatively small 
population of loans and even smaller number of claims does not provide 
a statistically significant basis for predicting claims by loan age. 

Conclusion: 

HUD has no fundamental disagreements with GAO's suggested improvements 
to the Section 242 hospital mortgage insurance program. HUD will pursue 
implementation of improvements along the lines suggested. HUD has a 
request to make of GAO with respect to the draft report, that positive 
program results be given the prominence they deserve. We suggest 
revising the "What GAO Found", "Results in Brief", and "Conclusions" 
sections of the final report to include this information, and changing 
the title of the report, "Program and Risk Management Could Be 
Enhanced", to reflect the accomplishments HUD has made since the last 
GAO report was completed in 1996. 

Technical comments and corrections to the draft report are enclosed. If 
you or your staff have any questions, please contact Michael Wells at 
202-401-0450. 

Sincerely, 

Signed by: 

Brian D. Montgomery: 

Assistant Secretary for Housing - Federal Housing Commissioner: 

Enclosure: 

[End of section] 

Appendix V: Comments from the Department of Health and Human Services: 

DEPARTMENT OF HEALTH & HUMAN SERVICES: 
Health Resources and Services Administration: 

FEB 9 2006: 

TO: David G. Wood: 

Director, Financial Markets and Community Investment: 
U.S. Government Accountability Office: 

FROM: Administrator: 

SUBJECT: Government Accountability Office Draft: "Hospital Mortgage 
Insurance Program and Risk Management Could be Enhanced" 

(Code # GAO-06-316): 

HRSA is pleased to comment on the GAO draft report under the terms of 
the Interagency Agreement between the Departments of Housing and Urban 
Development (HUD) and Health and Human Services (HHS) dated August 9, 
2005. Under the agreement, "HUD is responsible for communication with 
other Federal agencies and members of Congress" on the hospital 
mortgage insurance program. Moreover, while HHS plays an important role 
in assisting HUD administer the program, HRSA wishes to speak in unison 
with HUD and incorporate HHS' comments with HUD, which is the agency 
statutorily responsible for the Program's management. Accordingly, we 
have shared our comments with HUD, reviewed HUD's response, and concur 
with HUD's observations and recommendations. 

We wish to take this opportunity to express our appreciation on the 
positive findings of the draft report and are pleased that the GAO 
found that "FHA (Federal Housing Administration) and HHS appear to work 
together reasonably well in carrying out their respective roles in 
administering the program." 

We appreciate the opportunity to have participated in this most 
important project to HUD and the GAO. Please contact William Tan at 301-
443-5997 if you have any questions or require additional information. 

Signed by: 

Betty James Duke: 

[End of section] 

Appendix VI: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

David G. Wood (202) 512-8678: 

Staff Acknowledgments: 

Individuals making key contributions to this report included Alison 
Martin, Lisa Moore, David Pittman, Minette Richardson, Paul Schmidt, 
and Julie Trinder. 

(250239): 

FOOTNOTES 

[1] 2 U.S.C secs. 661-661f. In this report, we refer to the requirement 
of the act as "credit reform." 

[2] The results of our study on the nursing home insurance program will 
be provided in a separate report. 

[3] The Hospital Mortgage Insurance Program supplemented the Hill- 
Burton Program. Under Hill-Burton, HHS, formerly the Department of 
Health, Education, and Welfare, made loan guarantees and direct loans 
to hospitals for construction and modernization projects. 

[4] FHA was insuring 74 mortgages for 59 hospitals as of December 2005. 

[5] In a cash pay transaction, FHA will pay approximately 90 percent of 
the claim within a few days of when the mortgage is assigned to FHA. 
The remaining 10 percent is generally paid at a later date, after FHA 
has completed its due diligence in processing the claim and the title 
passes to FHA. Debentures are financial instruments with 20-year terms 
issued by FHA that pay interest semiannually. Interest on the debenture 
is used to pay principal and interest on the bonds. 

[6] Present value is the worth of the future stream of cash inflows and 
outflows, as if they had occurred immediately. Calculating present 
value for credit reform requires the utilization of the interest rate 
on a marketable zero-coupon Treasury security with the same maturity 
from the date of disbursement as the cash flow provides the basis for 
converting future amounts into their "money now" equivalents. Net 
present value is the present value of estimated future cash inflows 
minus the present value of estimated future cash outflows. 

[7] A cohort refers to all direct loans and loan guarantees obligated 
in a given fiscal year. 

[8] This figure is based on the number of days elapsed from the point 
that a complete application has been received to the point that HUD 
makes a decision to either commit to insuring the project, or rejects 
the application. 

[9] While FHA requires applicants to provide data showing historical 
and projected debt-service coverage ratios, and monitors this ratio for 
insured hospitals, it does not explicitly factor the ratio into its 
forecast of loan performance when estimating credit subsidies. This 
issue is discussed in more detail later in this report in the section 
on FHA's credit subsidy model. 

[10] FHA's Regulatory Agreement contains covenants, or requirements 
that must be adhered to. In addition, FHA can require hospitals to 
adhere to supplemental covenants. 

[11] This figure does not include financial feasibility study reviews, 
which are done as a part of FHA's application review process. 

[12] According to FHA, hospitals can also be required to hire 
consultants if they fail to meet certain minimum financial ratios, 
incur a significant adverse difference between budgeted and actual 
performance, or experience significant adverse changes in reimbursement 
rates. 

[13] The MOA in effect during the period of our review covered fiscal 
years 2002 through 2005. A new Interagency Agreement became effective 
for fiscal years 2006-2010. 

[14] For every hospital that applies to or is insured by the program, 
FHA designates an account executive to provide information about the 
program, assist the hospital, and monitor the hospital and its market. 

[15] Beginning in fiscal year 2006, HHS is responsible for delivering 
an annual report to FHA detailing its performance against each of the 
measures in the Interagency Agreement. 

[16] A loan modification refers to any action a hospital takes that 
requires HUD's consent under the terms of the Regulatory Agreement. 

[17] GAO, The Results Act: An Evaluator's Guide to Assessing Agency 
Annual Performance Plans, GAO/GGD-10.1.20 (Washington, D.C.: April 
1998), 14. 

[18] GAO, Managing for Results: Enhancing Agency Use of Performance 
Information for Management and Decision Making, GAO-05-927 (Washington, 
D.C.: Sept. 9, 2005), 7. 

[19] GAO, Standards for Internal Control in the Federal Government, 
GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999), 18. 

[20] A Certificate of Need is a state-issued designation of the market 
need for a hospital. 

[21] CAHs, designated by states and HHS, are rural hospitals that, as 
of January 2004, may operate up to 25 beds for acute care and receive 
cost-based reimbursement from Medicare. CAHs were exempted from the 
requirement that no more than 50 percent of the total patient days 
during any year are customarily assignable to the categories of: 
chronic convalescent and rest, drug and alcoholic, epileptic, mentally 
deficient, mental, nervous and mental, or tuberculosis through July 31, 
2006. 

[22] FHA and HHS staffs compile updates to policies and procedures in 
an internal manual available only to FHA and HHS employees. According 
to FHA, this document is not meant to replace the Mortgage Insurance 
Handbook for Hospitals. 

[23] "Fiscal Year 2006 Federal Credit Supplement of the United States 
Government; Table 2--Loan Guarantees: Subsidy Rates, Commitments, and 
Average Loan Size" (Washington, D.C.: Office of Management and Budget, 
February 2005), http://www.gpoaccess.gov/usbudget/fy06/cr_supp.html 
(downloaded Oct. 6, 2005). 

[24] This figure was calculated for all currently active FHA hospitals 
that had loans endorsed from 1996 through 2005. 

[25] Financial ratios for active hospitals were compared with FHA 
criteria used to determine financial health of program applicants 
listed in the underwriting guidelines in the hospital insurance manual. 

[26] The 24 applications in development are those that HUD considers to 
be in the application pipeline. These include applications that are 
still under development and have not yet been received by HUD for 
review. 

[27] According to Centers for Medicare & Medicaid Services (CMS) data, 
of the total patient discharges for insured New York hospitals, 21 
percent were reimbursed by Medicaid and 29 percent by Medicare. 

[28] GAO, 21ST Century Health Care Challenges: Unsustainable Trends 
Necessitate Reforms to Control Spending and Improve Value presented 
before the Citizens' Health Care Working Group, Salt Lake City, Utah, 
on July 22, 2005, 8. 

[29] Medicaid program cuts of $4.8 billion over 5 years are included in 
the pending Deficit Reduction Omnibus Reconciliation Act of 2005 
(S.1932). Should it be enacted, the act's provisions include increasing 
cost-sharing for Medicaid beneficiaries and allowing states to reduce 
benefits. 

[30] Fitch Ratings, 2005 Non-Profit Hospitals and Health Care Systems 
Forecast (New York, NY: Jan. 20, 2005), 8. 

[31] Ibid. According to the United States Bureau of the Census, baby 
boomers are those people born in the post-World War II period from 1946 
through 1964. 

[32] The term discharge refers to the formal release of a patient by a 
hospital; this includes the termination of a period of hospitalization 
by disposition to a nursing home or home care. Medicare discharges 
refer to hospital reimbursement through Medicare, and Medicaid 
discharges refer to hospital reimbursement through Medicaid. 

[33] Fitch Ratings, 2005 Non-Profit Hospitals and Health Care Systems 
Forecast (New York, NY: Jan. 20, 2005), 6; Standard & Poors,U.S. Not- 
For-Profit Health Care 2005 Median Ratios: Improvement Continues Across 
the Rating Spectrum (New York, NY: July 20, 2005), 10; Moody's 
Investors Service, Not-For-Profit Healthcare Sector: 2004 Industry 
Outlook (New York, NY: January 2004), 9-10. 

[34] GAO, Speciality Hospitals: Information on National Market Share, 
Physician Ownership, and Patients Served, GAO-03-683R (Washington, 
D.C.: Apr. 18, 2003), 6. 

[35] Healthcare Financial Management Association, Financing the Future 
Report 1: How are Hospitals Financing the Future? Access to Capital in 
Health Care Today (Westchester, IL: 2003), 1; Moody's Investors 
Service, Not-For-Profit Healthcare: Capital Access: Moody's Answers the 
Five Most Frequently Asked Questions on Capital Planning (New York, NY: 
September 2004), 1. 

[36] Standard and Poor's, New York Health Care: Low Hospital Ratings, 
Weak Access to Capital (New York, NY: May 11, 2004), 1. 

[37] While hospitals should meet certain criteria in terms of their 
debt-coverage ratio and other financial ratios, if the hospital cannot 
do so, but can demonstrate that its financial performance has been 
improving in recent years, it may still be considered by FHA for 
mortgage insurance. 

[38] The reserve fund may be used to pay debt service on the mortgage 
until the insurance proceeds or debenture payments are received from 
FHA. According to FHA guidelines, hospitals may borrow from this fund 
with FHA's permission. 

[39] When an insured hospital breaks a covenant, FHA requires the 
hospital to take corrective action so that the loan is in compliance 
with the covenant. For example, a hospital may be required to hire a 
consultant to help it identify and resolve the issues that led to its 
noncompliance. 

[40] According to FHA policy, the following circumstances should be 
used as flags to trigger closer evaluation of a hospital's financial 
status: a missed principal or interest payment; significant losses from 
adverse revenue or expense trends over time, or a major one-time loss; 
poor liquidity; and a negative cash flow over debt service 
requirements. 

[41] Three hundred forty-one loans have been insured over the life of 
the program, as of Dec. 31, 2005. 

[42] While the term "default" refers to the status of a loan when a 
mortgage payment is late and "claim" refers to the filing of a claim 
for insurance, HUD uses the term "artificial default methodology" to 
refer to its methodology for increasing the number of expected claims 
for insurance. 

[43] Inclusion on the priority watch list is based in part on financial 
criteria, including a current debt service coverage ratio of less than 
1.10. This criterion serves as a flag but is not a determinant for 
inclusion on the priority watch list. 

[44] Jesse M. Abraham and H. Scott Theobald, "A Simple Prepayment Model 
of Commercial Mortgages," Journal of Housing Economics, vol. 6, no. 1 
(1997); Austin Kelly, V. Carlos Slawson, Jr., "Time-Varying Mortgage 
Prepayment Penalties," Journal of Real Estate Finance and Economics, 
vol. 23, no. 2 (2001); Qiang Fu, Michael LaCour-Little, and Kerry D. 
Vandell, "Commercial Mortgage Prepayments Under Heterogeneous 
Prepayment Penalty Structures," The Journal of Real Estate Research 
vol. 25, no. 3 (2003). 

[45] The regulations also state that prepayment restrictions and 
penalty charges must be acceptable to the FHA Commissioner. 

[46] We analyzed projected debt-service coverage ratios from the 
underwriting reports of 13 hospitals that applied for mortgage 
insurance between 2002 and 2005. 

[47] Brian A. Ciochetti, Yongheng Deng, Bin Gao, and Rui Yao, "The 
Termination of Commercial Mortgage Contracts Through Prepayment and 
Default: A Proportional Hazard Approach with Competing Risks," Real 
Estate Economics; vol. 30, no. 4 (2002); Kerry D. Vandell, Walter 
Barnes, David Hartzell, Dennis Kraft, and William Wendt, "Commercial 
Mortgage Defaults: Proportional Hazards Estimation Using Individual 
Loan Histories," Journal of the American Real Estate and Urban 
Economics Association, vol. 21, no. 4 (1993). 

[48] Athanasios Episcopos, Andreas Pericli, and Jianxun Hu, "Commercial 
Mortgage Default: A Comparison of Logit with Radial Basis Function 
Networks," Journal of Real Estate Finance and Economics vol. 17, no. 2 
(1998); Wayne R. Archer, Peter J. Elmer, David M. Harrison, and David 
C. Ling, "Determinants of Multifamily Mortgage Default," Real Estate 
Economics, vol. 30, no. 3 (2002). 

[49] The Association of Financial Guaranty Insurers is the trade 
association representing 11 insurers and reinsurers of municipal bonds 
and asset-backed securities. 

[50] Assistant Secretary for Housing-Federal Housing Commissioner, 
Department of Housing and Urban Development, Report to the Committees 
on Appropriations on the Section 242 program, Aug. 12, 2004. 

[51] For the years 1992 and 1993, the credit subsidy rate for the 
Hospital Mortgage Insurance Program was not reported in the Federal 
Credit Supplement. 

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