Daily Rules, Proposed Rules, and Notices of the Federal Government
Section 232 of the National Housing Act (12 U.S.C. 1715w) (Section 232) authorizes FHA to insure mortgages made by private lenders to finance the development of nursing homes, intermediate care facilities, board and care homes, and assisted living facilities (collectively, residential healthcare facilities). The Section 232 program allows for long-term, fixed-rate financing for new and rehabilitated properties for up to 40 years. Existing properties without rehabilitation can be financed with or without Ginnie Mae(r)
The maximum amount of the loan for new construction and substantial rehabilitation is equal to 90 percent (95 percent for nonprofit organization sponsors) of the estimated value of physical improvements and major movable equipment. For existing projects, the maximum is 85 percent (90 percent for nonprofit organization sponsors) of the estimated value of the physical improvements and major movable equipment.
As the need for residential care facilities increased, requests to FHA to make mortgage insurance available for such facilities also increased. As with any program growth, updates to regulations are needed to ensure that program requirements are sufficient to meet increased demand, and prevent mortgage defaults that not only impose a risk to the FHA insurance fund but can also jeopardize the safety and stability of Section 232 facilities and their residents. HUD's regulations governing the Section 232 program are primarily codified in 24 CFR part 232.
On May 3, 2012, HUD published a proposed rule at 77 FR 26218, in which it submitted, for public comment, revisions to the Section 232 program regulations. On May 3, 2012, HUD also published a notice at 77 FR 26304, which proposed revisions to the related documents used in the insurance of healthcare facilities under the Section 232 program. In the May 3, 2012, rule, HUD proposed regulatory revisions that would update terminology, require a single asset form of ownership, and reflect current policy and practices used in healthcare facility transactions today. The updates included in the proposed rule also included amendments to HUD's Uniform Financial Reporting Standards to include operators of projects insured or held by HUD as entities that must submit financial reports. In addition, in the May 3, 2012 rule, HUD proposed several revisions to strengthen borrower eligibility requirements, as well as HUD's oversight of the healthcare program and projects.
With respect to proposed revisions to the Section 232 documents, published in the May 3, 2012, notice, HUD will address public comments and advise of any changes through separate publication.
In response to comments, HUD made several changes to the regulatory text proposed by the May 3, 2012, rule. Key changes made at the final rule stage include the following:
This final rule adopts this recommendation. The final rule provides, at SS 232.11, that the long-term debt service reserve will be required only in cases where HUD determines a need for such a reserve. HUD anticipates that requiring a long-term debt service reserve will be the exception and not the norm. HUD may require such a reserve when underwriting determines there is an atypical long-term project risk. Atypical long-term risks could occur, for example, in circumstances in which there is an unusually high mortgage amount, or when some other risk mitigant, such as a master lease structure typically used in a portfolio transaction, is unavailable in a particular transaction.
* Provides for flexibility in SS 5.801 (uniform financial reporting standards) in the format and manner, as determined by HUD, that financial reports may be submitted to HUD, to the lender or other third party as HUD may direct;
* Adds language to SS 200.855, which was inadvertently omitted from the regulatory text but discussed in the preamble to the proposed rule at 77 FR 26222, and that exempted assisted living facilities, board and care facilities and intermediate care facilities from inspections by HUD's Real Estate Assessment Center (REAC) if the State or local government has a reliable inspection system in place.
* In SS 207.258, defines, in paragraph (a) the "Eligibility Notice Period," adds a new paragraph (a)(4) to provide for acknowledgment by HUD of the lender's election either to assign its mortgage or acquire and convey title to HUD, and removes language from the opening clause of paragraph (b)(1)(i), which was added in the update of the multifamily project rental regulations, but is no longer applicable;
* Removes the definition of "mortgaged property" in SS 232.9 of the proposed rule, as well as the definition section in new subpart F, SS 232.1003 of the proposed rule, because these terms are defined in the transactional documents and HUD agreed with commenters to limit transfer of certain terminology from the transactional documents to the regulations;
* Moves the definition of eligible operator set forth in the proposed rule to a separate regulatory provision at SS 232.1003, which establishes the eligibility requirements for operators in the Section 232 program;
* Withdraws the amendments proposed to be made to SS 232.251 regarding other applicable regulations, since the final rule addresses this issue in SS 232.1.
The public comment period for this rule closed on July 2, 2012, and HUD received 27 public comments through the
This section of the preamble presents significant issues, questions, and suggestions submitted by public commenters, and HUD's responses to these issues, questions, and suggestions.
Several commenters expressed their general support for the rule as improvements that are necessary and beneficial, stating that the rule provided the appropriate balance of risk mitigation while not overly burdening the borrower and operator or substantially altering demand for the program. Commenters also stated that several of the modifications, such as the limitation on REAC inspections and modification of the borrower surplus cash rules, were beneficial.
Notwithstanding the general support for the rule's objectives, one commenter objected to the rule overall, and other commenters offered suggested changes to several of the rule's provisions.
HUD is basing the transition period on the date for which a firm commitment has been issued and not on the date that the application for insurance is received, because significant barriers exist to applying the regulations based on the date for application for insurance. Applications are often less than fully complete when initially received and current program systems lack the capability to determine and memorialize when an application is deemed fully complete. HUD therefore believes that basing the transition period on issuance of the firm commitment is the correct approach.
Commenters stated that several of the proposed regulatory changes would limit program flexibility with respect to process improvements, such as those recently embraced by HUD, in administering the Section 232 programs and achieved through nonrulemaking documents. A commenter also stated that including the debt service reserve in the regulations is not the "best, most innovative, or least burdensome" method for achieving HUD's goals.
The proposed rule offered revisions to the reporting requirements of 24 CFR 5.801 to include operators of projects with mortgages insured or held by HUD under the Section 232 program as entities that must submit financial reports. Under current requirements, financial reports are submitted by borrowers, but not operators of Section 232 insured healthcare facilities. HUD had determined that the audited financial statements of a borrower were not sufficient to assess the financial status of a Section 232 project, because the viability of the project is heavily dependent on the operator's financial performance, and the financial statements of the operator should also be reviewed for an accurate assessment of the project's financial status.
The May 3, 2012, rule proposed to retain the longstanding requirement that owners submit audited financial statements annually and proposed to require operators to submit financial statements quarterly, covering separately the most recent quarter and the fiscal year to date.
The commenter also proposed that the financial reporting requirements set forth in this section should apply only to those projects that are governed by the new Section 232 loan documents and that received a firm commitment on or after the effective date of final regulations. The commenter suggested revised language in 24 CFR 5.802(d)(4) to limit the application of this section. The commenter stated that without this limiting language, the reporting standards would be retroactively applied to operators of existing insured projects that are not currently subject to these financial reporting requirements under the terms of the mortgage loan transaction documents and regulations in effect at the time the loan closed.
Due to the same need for effective financial oversight, HUD also declines to accept the commenter's recommendation to eliminate separate year-end operator quarterly and year-to-date reports when the borrower is also the operator. Operator reports will be submitted in separate systems that allow for more prompt submission than audited reports, and therefore HUD will receive timely and important trend information.
With respect to the commenter's statement that the requirements should be applied only to those projects that are governed by the new Section 232 loan documents and that received a firm commitment on or after the effective date of final regulations, HUD declines to adopt the change. As stated in the preamble to the proposed rule, HUD determined that the financial statements that HUD currently receives are insufficient to assess the financial status of a Section 232 project. The viability of the project is heavily dependent on the operator's financial performance, and this information is not currently part of financial reports on Section 232 projects. HUD is requiring this information to improve the accuracy of its assessment of a project's financial status, and thus the solvency of the fund. Application of these financial reporting requirements to existing facilities is consistent with authority provided in paragraph 3 of most, if not all of the existing operators' regulatory agreements that provide for the Secretary to request financial reports. This rule implements such a request through regulation. Receipt of these reports will significantly improve HUD's ability to manage and maintain the finances of the FHA insurance fund.
The proposed rule would have narrowed and streamlined the scope of Section 232 facilities that are routinely inspected by REAC. In particular, the proposed rule provided that facilities such as assisted living facilities and board and care facilities, and properties that are routinely surveyed pursuant to regulations of the Centers for Medicare and Medicaid Services, would not be subject to routine REAC inspections if the State or local government had a reliable and adequate inspection system in place. The remainder of the Section 232 properties would be inspected only when and if HUD determined, on a case-by-case basis and on the basis of information received, that inspection of such facility is needed to help ensure the protection of residents or the adequate preservation of the project.
Subpart B of the part 207 regulations addresses contract rights and obligations and the rights and duties of the mortgagee under contract of insurance, and HUD determined that certain revisions were necessary as part of its updating of regulations applicable to the Section 232 program.
The proposed rule's revisions to SS 207.255, "Defaults for purposes of insurance claim," included language defining the date of defaults. The proposed rule would have revised SS 207.255(a)(4) by clarifying the dates on which certain monetary and other defaults occur.
In the final rule, HUD also specifies that a covenant violation does not become a default for purposes of payment of an insurance claim until the lender has accelerated the debt and the borrower has failed to make that accelerated debt payment. Namely, the regulation now provides that for mortgages insured under Section 232, the date of default shall be considered as: (a) The first date on which the borrower has failed to pay the debt when due as a result of the lender's acceleration of the debt because of the borrower's uncorrected failure to perform a covenant or obligation under the regulatory agreement or security instrument; or (b) the date of the first failure to make a monthly payment, which subsequent payments by the borrower are insufficient to cover when applied to the overdue monthly payments in the order in which they become due.
Section 207(g) of the National Housing Act (12 U.S.C. 1713(g)) provides the authority for payment of a claim for mortgage insurance benefits. Pursuant to that statutory provision, there must be a monetary default in order for the mortgagee to become eligible to receive mortgage insurance benefits. Therefore, the date of default for purposes of payment of a claim, premised on a covenant violation, must be associated with a monetary default. A covenant violation does not become a default for purposes of payment of an insurance claim until the lender has accelerated the debt and the borrower has failed to make that accelerated debt payment. In light of the statutory language and pursuant to HUD's regulation at SS 207.255(b), a covenant violation does not become a default until after the mortgagee has accelerated the debt. Accordingly, the date of default referenced in SS 207.255(b)(5)(i) should be read to directly correlate to the default referenced in SS 207.255(b)(1)(ii); e.g., associated with the acceleration of the debt.
HUD did not propose any revisions to SS 207.255 in the May 3, 2012, proposed rule. Despite the fact that HUD did not seek comment on this section, one commenter proposed that HUD modify SS 207.255(b)(3) to remove the general reference, and limit it to SS 207.255(b)(1).
The May 3, 2012, rule proposed to modify SS 207.258, "Insurance claim requirements," by further clarifying in paragraph (a)(2) the applicability of the lockout and prepayment premium periods. The May 3, 2012, rule also proposed to modify SS 207.258(b)(1)(i) by clarifying the time period within which a mortgagee may elect to assign a mortgage insured under section 232 of the Act to the Commissioner.
In its review of the regulations in 24 CFR part 232, HUD noted that the regulations use both the terms "borrower" and "mortgagor." These terms have the same meaning, and to avoid any misunderstanding that they have different meanings, the May 3, 2012, rule proposed to substitute the term "borrower" for "mortgagor" throughout the part 232 regulations. That said, the healthcare financing and transactional documents for the Section 232 program may sometimes refer to the borrower as the "mortgagor," "lessor," and/or the "owner."
The May 3, 2012, rule proposed to revise the definition of eligible borrower to provide that the borrower shall be a single asset entity, determined acceptable to the Commissioner, and that possesses the power necessary and incidental to be operating the project. The proposed rule also provided that the Commissioner may approve an exception to this single asset requirement in limited circumstances based upon such criteria as specified by the Commissioner.
HUD identified one error in the proposed rule definition. Rather than stating "incidental to operating the project," HUD intended to state "incidental to owning the project," and this change should address several of the concerns by commenters about the definition of borrower, as discussed below.
The proposed rule provided that to be eligible for insurance under the Section 232 program, and except with respect to the regulatory provisions applicable to supplemental loans to finance purchase and installation of fire safety equipment (24 CFR part 232, subpart C), the borrower must establish, at final closing and maintain throughout the term of the mortgage, a long-term debt service reserve account.
Commenters stated that the cost of the required extra capital far exceeds the small amount of interest one earns when investing in the loan servicing account, given the cost of capital and the interest earned on the funds deposited. Several commenters stated that this would add incremental costs that would make the program noncompetitive with Fannie Mae, Freddie Mac, and the Rural Housing Service of the U.S. Department of Agriculture (USDA), commercial banks, and finance companies. A commenter further stated that this requirement defeats the purpose of the mortgage insurance premiums (MIP), which is already equivalent to an approximate 15 percent premium on the stated rate of interest. Commenters also stated that the proposal would contribute to adverse selection of FHA borrowers that would deprive FHA of the benefit of MIP payments on higher-quality lower-risk transactions.
Commenters also stated that the debt service reserve would not reduce the number or severity of mortgage insurance claims. Commenters stated that the requirement as proposed would be imposed on all properties whether or not they are well capitalized or are well performing. Commenters further stated that the debt service reserve was unnecessary, in particular, for those projects included in a master lease structure as that structure: (1) Results in all project funds being available to service the debt of a struggling project, and (2) provides a strong incentive to the operator to support the struggling project. The commenters also stated that under conventional loan standards, impositions of a debt service account are limited to under-performing loans.
Commenters further stated that maintaining a minimum balance throughout the life of the loan greatly extends the amount of time a borrower must restrict funds for this purpose.
Commenters stated that debt service reserves should not be required for SS 223(a)(7) (refinancing) loans because, in refinancing, the borrower will: (1) Reduce debt service costs, increase the debt service coverage ratio, and increase funding of the reserve for replacement and/or the completion of necessary repairs, and (2) will not have mortgage proceeds available to fund the debt service reserve because they are limited by the amount of the original insured mortgage.
Commenters stated that HUD should modify SS 232.11 to state that the long-term debt service reserve would be required at the discretion of HUD.
Several commenters also provided suggestions on how HUD may implement the long-term debt service reserve, if HUD chose to retain this requirement at the final rule stage. These suggestions include the following:
* The lender, not HUD, should recommend the reserve as part of the application for insurance and minimal reserves should be allowed for strong projects.
* The date of establishment of the debt service reserve should be flexible, rather than requiring the reserve to be established by the date of final closing.
* The entire reserve should be mortgageable even if the reserve results in a mortgage over the 80 percent loan-to-value (LTV) created during the conversion to Section 232 program financing. Commenters stated that this is common in the industry as cash secured lending is dollar for dollar and does not affect the collateral position. A commenter stated that HUD should allow the debt service reserve to be included as an eligible cost up to the 85 percent level.
* Flexibility should be allowed in the release of such reserves. Commenters stated that it is difficult for a borrower to agree to "HUD's sole discretion." Commenters stated that rights must be given to the lender and that the lender can use its discretion on release of reserves. Also, commenters stated that there should be some benchmarks that allow the borrower to tap into the funds such as: (a) A debt service coverage ratio (DSC) that is below 1.0 for some period of time or (b) a certain threshold of capital the borrower must have contributed before the reserve can be tapped.
* Use of the Master Lease agreement should be eliminated or reduced if a longer debt service reserve is established.
* Extend the time that HUD can require a lender to advance mortgage payments from 90 days to 180 days
* Allow borrowers, with lender approval, to consider funding the reserve with letters of credit.
* Establish the reserve in a handbook as opposed to a regulation.
* Remove the "long-term" qualification.
Commenters suggested that alternative strategies would have similar results. These included:
* Require debt service reserve payments under certain events such as a DSC below 1.0 or negative working capital with the reserve to be released and/or suspended upon some threshold of DSC being met.
* Require a debt service reserve payment in the event of a default of the regulatory agreement or of any pertinent loan document.
* Require the servicer to make debt service payments for some period of time before or otherwise extend the time before servicers can assign the mortgage to HUD, which the commenters stated would encourage servicers to implement early warning and workout strategies.
* Build in additional flexibility by, for example, adding language to give HUD the flexibility to allow for a reduction in the minimum balance required to be maintained in the debt service reserve and to allow for the release of funds in the debt service reserve in excess of the required amount.
Because HUD does not intend to require long-term debt service reserves across the board, there is no need to address the issue of refinanced loans. HUD anticipates that the use of a long-term debt service reserve will be rare (unlike the short-term debt service escrow account that has been frequently used in the Section 232 program, and which is not a mortgageable item). HUD envisions that a long-term debt service reserve will be necessary in circumstances in which underwriting indicates an atypical long-term risk. Examples of circumstances in which HUD may require the establishment of a long-term debt service reserve include an atypically high mortgage amount, or if a key risk mitigant (such as a master lease structure typically used in a portfolio transaction) is unavailable.
HUD declines to accept some of the commenters' recommendations, such as waiting to establish the long-term debt service reserve when the need arises, as such an approach would be imposed too late to serve a useful financial purpose. HUD has also determined to retain the "long-term" qualification to distinguish these accounts from short-term escrow accounts. HUD also determined to retain the minimum balance requirement contained in the proposed rule to assure that reserve funds are not diverted and are used for the intended purpose.
Subpart B of the part 232 regulations addresses contract rights and obligations and the rights and duties of the mortgagee under the contract of insurance. The May 3, 2012, rule proposed several changes to the subpart B regulations.
The proposed rule would have added a new SS 232.254 to provide that borrowers may, to the extent allowed in their transactional loan documents and applicable law, make and take distributions of mortgaged property under certain conditions. The proposed rule also included a definition of surplus cash.
Although previously, the borrower could take distributions only annually (or, in limited circumstances, semi-annually), the proposed rule would have allowed borrowers to take distributions more frequently, provided that, upon making a calculation of borrower surplus cash, no less frequently than semi-annually, such borrowers can demonstrate positive surplus cash in their semi-annual surplus cash calculation or repay any distributions made during the fiscal period if a negative surplus cash position is shown. HUD included language in the proposed rule to clarify that it does not intend to override existing transactional agreements.
The commenter further stated that when calculating surplus cash, accounts receivable and accounts receivable financing should either: (1) Both be included in the calculation, or (2) both be excluded from the calculation. The commenter stated that the best way to address this issue would be to exclude as a deduction any accounts receivable financing approved by HUD and to exclude accounts receivable from cash. The commenter stated that its proposed approach is the more conservative option as, due to the borrowing base requirements, the accounts receivable will be higher than accounts-receivable financing, so including it in the calculation would create more surplus cash than the method of calculation that HUD proposes. The commenter stated that its proposed approach would also be more consistent with normal and past experience, and has the additional benefit of being easier to administer because it does not require a determination of the age of accounts receivable, whether the accounts receivable are collectable or similar types of information.
A commenter suggested excluding the "amounts payable from escrows held pursuant to the mortgage" from the
The proposed rule would have added a new SS 232.256 to require that a borrower may not lease any portion of the project or enter into any agreement with an operator without HUD's prior written consent.
Commenters also stated that if HUD did not accept the suggestion to remove the requirement in its entirety, HUD should consider revisions that would add necessary flexibility to the regulation, such as giving HUD the ability to categorically permit certain types of leases across all projects through "Program Obligations," a concept expressed in the discussion of HUD's recent May 2011 rule on multifamily rental projects and in the notice advising of document changes to the multifamily rental project documents. Alternatively, commenters suggested that HUD approve project-specific leases on a case by-case basis.
Section 232.903 describes the maximum loan to value limits and the specific items that can be included as mortgageable items.
At the proposed rule stage, HUD defined the following terms in a proposed new SS 232.1003: identity of interest, management agent, operator, owner operator, and project. On further consideration, HUD determined that the term "operator" in proposed SS 232.1003 established Section 232 eligibility requirements for operators more than simply providing a definition for this term. With respect to the remaining terms, all of which are addressed in the transactional documents, HUD is removing these terms from the regulations, agreeing with commenters that the better location for these terms remains the transactional documents. Therefore, SS 232.1003 at this final rule addresses eligible operators only.
Although the final rule removes the definition section for new subpart F of part 232, several comments were submitted on the proposed definitions,
Other commenters stated that the single asset entity operator be recommended but not required. Commenters also recommended that the existing organizational structure remain in place in refinancing, given that such a structure is difficult to unwind.
In reviewing its portfolio of healthcare loans, HUD found that a large number of the operator entities in the Section 232 program are, in fact, single asset entities--for prudent business purposes not necessarily related to FHA-insured financing. The approach of these operator entities is also helpful to HUD's effort to assure that the operator's viability and accountability is not adversely affected by the operation of other businesses (as in the case, for example, of bankruptcy or other litigation). Nevertheless, HUD recognizes that there are operating entities in the industry that successfully operate multiple facilities without facility-specific operating entities. HUD did not intend to impede this practice where it is effective, and therefore, the proposed definition of "operator" also explicitly authorized HUD to approve "a non-single asset entity under such circumstances, terms and conditions determined and specified as acceptable by the Commissioner."
In SS 232.1003 of this final rule, which now only addresses eligible operators, HUD retains this language from the proposed rule and anticipates that in situations in which licensure or other issues make utilizing a separate operating entity problematic, a non-single asset operating entity will be approved.
Other commenters stated that the requirement for operators to be single asset entities is a significant change. They stated that they do not object to the language as proposed, because it provides appropriate flexibility for HUD to approve non-single asset entities. The commenters requested, however, that, prior to issuing further guidance in the form of a handbook or otherwise, there should be a conversation between HUD and the healthcare industry, as there are many situations in which it may not be possible or appropriate to have a single asset operator.
With respect to establishing dialogue with industry on regulatory and transactional document changes in the Section 232 program, HUD has a good record of reaching out to industry for its input, first in the context of updating the multifamily rental project regulations and transactional documents, and now in the updating of the Section 232 program regulations and transactional documents. HUD plans to continue with such outreach.