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Financial Audit of the Housingand Community DevelopmentCorporation of Hawaii

A Report to theGovernorand theLegislature ofthe State ofHawaii

THE AUDITORSTATE OF HAWAII

Report No. 01-14September 2001

Office of the Auditor

The missions of the Office of the Auditor are assigned by the Hawaii State Constitution(Article VII, Section 10). The primary mission is to conduct post audits of the transactions,accounts, programs, and performance of public agencies. A supplemental mission is toconduct such other investigations and prepare such additional reports as may be directed bythe Legislature.

Under its assigned missions, the office conducts the following types of examinations:

1. Financial audits attest to the fairness of the financial statements of agencies. Theyexamine the adequacy of the financial records and accounting and internal controls, andthey determine the legality and propriety of expenditures.

2. Management audits, which are also referred to as performance audits, examine theeffectiveness of programs or the efficiency of agencies or both. These audits are alsocalled program audits, when they focus on whether programs are attaining the objectivesand results expected of them, and operations audits, when they examine how wellagencies are organized and managed and how efficiently they acquire and utilizeresources.

3. Sunset evaluations evaluate new professional and occupational licensing programs todetermine whether the programs should be terminated, continued, or modified. Theseevaluations are conducted in accordance with criteria established by statute.

4. Sunrise analyses are similar to sunset evaluations, but they apply to proposed rather thanexisting regulatory programs. Before a new professional and occupational licensingprogram can be enacted, the statutes require that the measure be analyzed by the Officeof the Auditor as to its probable effects.

5. Health insurance analyses examine bills that propose to mandate certain healthinsurance benefits. Such bills cannot be enacted unless they are referred to the Office ofthe Auditor for an assessment of the social and financial impact of the proposedmeasure.

6. Analyses of proposed special funds and existing trust and revolving funds determine ifproposals to establish these funds are existing funds meet legislative criteria.

7. Procurement compliance audits and other procurement-related monitoring assist theLegislature in overseeing government procurement practices.

8. Fiscal accountability reports analyze expenditures by the state Department of Educationin various areas.

9. Special studies respond to requests from both houses of the Legislature. The studiesusually address specific problems for which the Legislature is seeking solutions.

Hawaii’s laws provide the Auditor with broad powers to examine all books, records, files,papers, and documents and all financial affairs of every agency. The Auditor also has theauthority to summon persons to produce records and to question persons under oath.However, the Office of the Auditor exercises no control function, and its authority is limited toreviewing, evaluating, and reporting on its findings and recommendations to the Legislature andthe Governor.

THE AUDITORSTATE OF HAWAIIKekuanao‘a Building465 S. King Street, Room 500Honolulu, Hawaii 96813

The Auditor State of Hawaii

OVERVIEWFinancial Audit of the Housing and Community DevelopmentCorporation of HawaiiReport No. 01-14, September 2001

Summary

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Recommendationsand Response

The Office of the Auditor and the certified public accounting firm of KPMG LLPconducted a financial audit of the Housing and Community DevelopmentCorporation of Hawaii, State of Hawaii for the fiscal year July 1, 1999 to June 30,2000. The audit examined the financial records and transactions of the corporation;reviewed the related systems of accounting and internal controls; and testedtransactions, systems, and procedures for compliance with laws and regulations.

We found deficiencies in the financial accounting and internal control practices ofthe corporation. These deficiencies included the corporation’s inadequate planningfor the implementation of its new information system that resulted in numerousdelays and additional costs to the corporation. The corporation still does not havean adequate understanding of the problems and has not formulated a strategic planto expedite completion of the system implementation. As a result, the corporationis unable to estimate the expected completion date of the project.

The corporation is not timely in its execution of some contracts resulting in theexecution of a design consultant contract 23 months after the funds becameavailable. Also, corporation management has failed to implement internal controlprocedures to ensure the accuracy of the calculation of the final operating subsidyfrom the federal government and the reconciliation of the final calculation to theestimated operating subsidy.

An extremely large number of applicants are on the waiting list for low-incomehousing and tenant rental assistance programs. At the rate at which the corporationis currently placing applicants in housing, a waiting period of two to seven yearsis likely. We also found that a required report was not submitted to the U.S.Department of Housing and Urban Development within the prescribed deadline,which could have resulted in a “freeze” of federal financial assistance. In addition,we found that there is an inadequate segregation of duties over the corporation’spetty cash fund.

We recommend that the corporation assess the status of the implementation of thenew information system, identify the causes of the problems associated with theimplementation, and develop a strategic plan to meet the objectives of theimplementation. The corporation should meet with Memory Lanes Systems Inc.and develop a work plan for completion of the information system implementationand should assign a project manager to oversee and monitor the project. Thecorporation should assess liquidating damages of $100/day against Memory LanesSystems Inc. The corporation should also develop a contingency plan shouldproblems arise and deadlines be missed.

Report No. 01-14 September 2001

Marion M. Higa Office of the AuditorState Auditor 465 South King Street, Room 500State of Hawaii Honolulu, Hawaii 96813

(808) 587-0800FAX (808) 587-0830

The corporation should complete capital improvement projects in a timely mannerand communication with the Board of Directors should be improved. Thecorporation should implement sufficient internal control procedures to ensure thatthe calculation of the actual operating subsidy is proper. Current and futureprojects should be monitored to ensure that they are efficiently and effectivelycompleted; methods should be developed to spur facilitated developments andassist in the placement of applicants in tenant rental-assisted units; and staffingworkloads and processes should be reviewed to ensure efficiency and effectiveness.Also, HUD reporting requirements should be adhered to and staff who areinvolved with the completion of HUD reports should be made aware of thesignificance of time deadlines. Finally, segregation of duties over the petty cashprocess could be improved.

The corporation generally agrees with most of our findings and recommendations.The corporation also indicated that it has implemented or are in the process ofimplementing all of our recommendations.

Financial Audit of the Housingand Community DevelopmentCorporation of Hawaii

Report No. 01-14September 2001

A Report to theGovernorand theLegislature ofthe State ofHawaii

Conducted by

The AuditorState of HawaiiandKPMG LLP

THE AUDITORSTATE OF HAWAII

Submitted by

Foreword

This is a report of the financial audit of the Housing and CommunityDevelopment Corporation of Hawaii, State of Hawaii for the fiscal yearJuly 1, 1999 to June 30, 2000. The audit was conducted pursuant toSection 23-4, Hawaii Revised Statutes, which requires the State Auditorto conduct postaudits of all departments, offices, and agencies of theState and its political subdivisions. The audit was conducted by theOffice of the Auditor and the certified public accounting firm of KPMGLLP.

We wish to express our appreciation for the cooperation and assistanceextended by officials and staff of the Housing and CommunityDevelopment Corporation of Hawaii, State of Hawaii.

Marion M. HigaState Auditor

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Table of Contents

Chapter 1 Introduction

Background .................................................................... 1Organization ................................................................... 2Objectives of the Audit .................................................. 5Scope and Methodology ................................................. 5

Chapter 2 Internal Control Deficiencies

Summary of Findings ..................................................... 7Numerous Problems Have Plagued Implementation

Efforts for the New Information System..................... 8Recommendations .........................................................11Capital Improvement Projects of $9.5 Million

Remain Incomplete After Three Years ..................... 11Recommendations .........................................................13Amounts Due From HUD Are Underreported ............. 13Recommendation ..........................................................14The Corporation Has Not Been Entirely Successful

in Fulfilling its Corporate Mission............................ 15Recommendation ..........................................................16The Delay in the Submittal of a Required Report

Could Have Resulted in a “Freeze” of FederalFinancial Assistance.................................................. 16

Recommendation ..........................................................16The Corporation’s Internal Controls Over the

Handling of Petty Cash Could Be Improved............. 17Recommendation ..........................................................17

Chapter 3 Financial Audit

Summary of Findings ................................................... 19Independent Auditors’ Report ...................................... 19Report on Compliance and on Internal Control Over

Financial Reporting Based on an Audit of FinancialStatements Performed in Accordance withGovernment Auditing Standards ...............................21

Description of Combined Financial Statements andSupplementary Information ...................................... 22

Notes to Combined Financial Statements .................... 24

vi

Response of the Affected Agency ........................................ 81

List of Exhibits

Exhibit A Combined Balance Sheet - All Fund Types andAccount Groups, June 30, 2000 ................................ 58

Exhibit B Combined Statement of Revenues, Expenditures,and Changes in Fund Balances - All GovernmentalFund Types and Expendable Trust Funds, Yearended June 30, 2000 .................................................. 60

Exhibit C Combined Statement of Revenues and Expenditures -Budget and Actual (Budgetary Basis) - Generaland Special Revenue Fund Types, Year endedJune 30, 2000 ............................................................ 61

Exhibit D Combined Statement of Revenue and Expenses -Proprietary Fund Types, Year endedJune 30, 2000 ............................................................ 62

Exhibit E Combined Statement of Fund Equity - ProprietaryFund Types, Year ended June 30, 2000 .................... 63

Exhibit F Combined Statement of Cash Flows - ProprietaryFund Types, Year ended June 30, 2000 .................... 64

List of Schedules

Schedule I Combining Balance Sheet - Special Revenue Funds,June 30, 2000 ............................................................ 66

Schedule II Combining Statement of Revenues, Expenditures,and Changes in Fund Balances (Deficit) - SpecialRevenue Funds, Year ended June 30, 2000 .............. 67

Schedule III Combining Balance Sheet - Enterprise Funds,June 30, 2000 ............................................................ 68

Schedule IV Combining Statement of Revenues and Expenses -Enterprise Funds, Year ended June 30, 2000 ............ 70

Schedule V Combining Statement of Changes in Fund Equity -Enterprise Funds, Year ended June 30, 2000 ............ 72

Schedule VI Combining Statement of Cash Flows - EnterpriseFunds, Year ended June 30, 2000 ............................. 73

Schedule VII Combining Balance Sheet - Revenue Bond Funds,June 30, 2000 ............................................................ 76

Schedule VIII Combining Statement of Revenues, Expenses, andChanges in Retained Earnings (AccumulatedDeficit) - Revenue Bond Funds, Year endedJune 30, 2000 ............................................................ 77

Schedule IX Combining Statement of Cash Flows - RevenueBond Funds, Year ended June 30, 2000 ................... 78

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Chapter 1: Introduction

Chapter 1Introduction

This is a report of our financial audit of the Housing and CommunityDevelopment Corporation of Hawaii, State of Hawaii. The audit wasconducted by the Office of the Auditor and the independent certifiedpublic accounting firm of KPMG LLP. The audit was conductedpursuant to Section 23-4, Hawaii Revised Statutes, which requires theState Auditor to conduct postaudits of the transactions, accounts,programs, and performance of all departments, offices, and agencies ofthe State of Hawaii (State) and its political subdivisions.

Act 350, Session Laws of the State of Hawaii 1997, consolidated theHawaii Housing Authority, State of Hawaii (HHA), the Housing Financeand Development Corporation (HFDC) and the Rental Housing TrustFund (RHTF) into a single housing entity, the Housing and CommunityDevelopment Corporation of Hawaii (corporation), effective July 1,1998. Previously, the HHA managed federal and state low-rent publichousing projects and subsidy programs, as well as facilities to assist thehomeless. The HFDC administered housing finance and developmentprograms to assist low and moderate-income renters and first-timehomebuyers. The RHTF financed affordable rental housing projects.

The corporation’s mission is to serve as a catalyst to provide Hawaii’sresidents with affordable housing and shelter opportunities in a balancedand supportive environment. To accomplish its mission, the corporationplans to 1) increase and preserve rental housing opportunities for low-income households and special needs groups in independent andsupportive living environments; 2) revitalize existing rental projectswhile promoting healthy neighborhoods and strong communities; 3)assist persons in housing programs and facilities administered by thecorporation to achieve higher levels of economic independence; 4)increase homeownership opportunities; and 5) improve the housingdelivery system through cost-effective management of governmentprograms and resources. During the fiscal year ended June 30, 2000, thecorporation managed 67 federal and 16 state projects that provided 5,407and 1,170 units, respectively, to low-income residents. In addition, thecorporation assisted approximately 25,400 low-income residents withtenant-based rental assistance under federal and state programs.

Background

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The corporation received approximately $96 million in state and federalfunds during fiscal year 2000. Approximately $64.8 million wasreceived from state appropriations and approximately $31.2 million wasreceived from the U.S. Department of Housing and Urban Development(HUD). HUD provides funds for the payment of principal and intereston notes and bonds and for subsidized housing assistance payments. Thenotes and bonds previously provided funding for the construction andmodernization of corporation-owned housing projects that were rented tolow-income families. Under the subsidized housing programs, privatelandlords rather than the corporation lease housing units to low-incometenants. The private landlords are paid rental subsidies directly by thecorporation using HUD funds.

The corporation is administratively attached to the state Department ofBusiness, Economic Development and Tourism. It is governed by aBoard of Directors comprised of nine members, of whom six areappointed by the governor and three are ex-officio members. Five publicmembers, four of which are appointed from each of the counties ofHonolulu, Hawaii, Maui and Kauai, and one participant in the federallow-income housing or Section 8 tenant based rental assistanceprograms, serve four-year staggered terms, except that the initialappointments shall be two members for four years, two members forthree years, and one member for two years. The sixth public membershall be the chairperson of the Rental Housing Trust Fund AdvisoryCommission who shall serve a concurrent term on the board. The threeex-officio members are the director of business, economic developmentand tourism; the director of human services; and the governor’s specialassistant for housing. The corporation is comprised of the Office of theExecutive Director, five staff offices, and four branches. Exhibit 1.1displays the corporation’s organizational structure. The primaryresponsibilities of these units are as follows.

The Office of the Executive Director is the focal point for the executionof the statutory provisions relating to housing management services,housing development, and the delivery of housing and housing activitiesto the State. The executive director is responsible for the overallmanagement of the corporation, including the uniform application ofpolicies, procedures, and practices as they relate to the responsibility ofthe State and the corporation to provide housing services to the people ofthe State.

The corporationreceives significantamounts of state andfederal funds

Organization

Office of the ExecutiveDirector

3


Housing and Communi tyDevelopment Corporat ion

of Hawaii

Board of DirectorsRental Housing Trust

Fund AdvisoryCommiss ion

Office of the ExecutiveDirector

Housing InformationOff ice

Administrat iveServices Off ice

Hearings Off icePlanning &

Evaluation Off iceCompl iance Off ice

Finance BranchDevelopment

Branch

PropertyManagement &

MaintenanceBranch

Housing ProgramsBranch

Exhibit 1.1Organizational Structure of the Housing and Community Development Corporation ofHawaii

4


Five staff offices provide support services to the corporation.

The Housing Information Office provides for regular communicationamong the corporation, other government and private entities, tenants ofpublic housing, and the general public regarding the corporation’sprograms, services, actions, plans, and policies. In addition, the officeestablishes and maintains a communications program in support ofpublic information and advocacy requirements under state law.

The Administrative Services Office provides corporation-wide fiscal,budgeting, purchasing, central files, personnel, and computer systemsservices in support of the corporation’s programs in accordance withstate, federal, and agency requirements.

The Hearings Office conducts and coordinates hearings, which involveresident disputes or evictions.

The Planning and Evaluation Office performs the overall planning,evaluation, and research activities for programs administered by thecorporation, and coordinates legislative activities for the corporation.

The Compliance Office performs activities to ensure the corporationmanages and operates programs in accordance with federal and staterequirements, and corporate policies and directives.

Four branches carry out the programs of the corporation.

The Finance Branch provides overall administration of the varioushousing financing programs of the corporation including the issuance oftax exempt and taxable bonds to finance mortgages, and the constructionand/or acquisition of rental housing projects. The branch also reviewsrequests for the financing of specific projects and makesrecommendations on the provision of loans and grants to developers,nonprofits, and contractors.

The Development Branch provides overall administration fordevelopment, construction management, and technical assistance onprojects assisted or developed by the corporation to increase housingopportunities for low and moderate-income households, elderly persons,and special needs groups. The branch also provides architectural andengineering reviews, inspection services, development tools, andfinancing assistance to eligible developers and contractors for thedevelopment of rental and for-sale housing, community redevelopment,infrastructure development, and the modernization, capital improvement,and repair and maintenance of existing facilities.

Staff Offices

Branches

5


The Property Management and Maintenance Branch performsmanagement and maintenance of assigned housing and homelessfacilities, vacant land, and equipment owned or managed by thecorporation; administers rent subsidy programs; and works directly withresidents in identifying their needs in order to assist them in coordinatingservices and programs to meet those needs.

The Housing Programs Branch is responsible for the needsassessment, development, grant application, and administration ofsupportive services programs and grants for families and residents of thecorporation’s housing projects and the homeless, with the goal ofbringing about self-sufficiency and economic independence. The branchalso provides resident and homeless related technical support andassistance to housing personnel servicing the individual housing projects,as well as to private and public agencies. The branch serves as liaisonfor the corporation with other agencies and community groups indeveloping strategies for resident and homeless related services and self-sufficiency programs.

1. To assess the adequacy, effectiveness, and efficiency of the systemsand procedures for the financial accounting, internal control, andfinancial reporting of the corporation; to recommend improvementsto such systems, procedures, and reports; and to report on thefinancial statements of the corporation.

2. To ascertain whether expenses or deductions and otherdisbursements have been made and all revenues or additions andother receipts have been collected and accounted for in accordancewith federal and state laws, rules and regulations, and policies andprocedures.

3. To make recommendations as appropriate.

We audited the financial records and transactions and reviewed therelated systems of accounting and internal controls of the corporation forthe fiscal year July 1, 1999 to June 30, 2000. We tested financial data toprovide a basis to report on the fairness of the presentation of thefinancial statements. We also reviewed the corporation’s transactions,systems, and procedures for compliance with applicable laws,regulations, and contracts.

We examined the existing accounting, reporting, and internal controlstructure and identified deficiencies and weaknesses therein. We made

Objectives of theAudit

Scope andMethodology

6


recommendations for appropriate improvements including, but notlimited to, the forms and records, the management information system,and the accounting and operating procedures.

The independent auditors’ opinion as to the fairness of the corporation’sfinancial statements presented in Chapter 3 is that of KPMG LLP. Theaudit was conducted from July 2000 through November 2000 inaccordance with generally accepted government auditing standards.

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Chapter 2: Internal Control Deficiencies

Chapter 2Internal Control Deficiencies

Internal controls are steps instituted by management to ensure thatobjectives are met and resources are safeguarded. This chapter presentsour findings and recommendations on the financial accounting andinternal control practices and procedures of the Housing and CommunityDevelopment Corporation of Hawaii, State of Hawaii (corporation).

We found several reportable conditions involving the corporation’sinternal control over financial reporting and operations. Reportableconditions are significant deficiencies in the design or operation of theinternal control over financial reporting that, in our judgment, couldadversely affect the corporation’s ability to record, process, summarize,and report financial data consistent with the assertions of management inthe financial statements.

We found the following reportable conditions:

1. The corporation did not adequately plan for the implementation of itsnew information system and may have underestimated its complexityand the required time commitment to successfully complete theproject. This has resulted in numerous delays and additional costs tothe corporation. Further, despite the problems encountered and theadditional resources utilized, the corporation still does not have anadequate understanding of the problems and has not formulated astrategic plan to expedite completion. As a result, the corporation isunable to estimate the expected completion date.

2. The 1997 and 1998 State of Hawaii (State) Legislatures appropriated$800,000 and $8.7 million, respectively, for the design andconstruction of roofing improvements for four State-owned low-income housing projects. For one of the projects, the corporationexecuted a design consultant contract 23 months after the fundsbecame available. Additionally, we were informed that the otherprojects faced similar delays.

3. Management has failed to implement internal control procedures toensure the accuracy of the calculation of the final operating subsidyand the reconciliation of the final to the estimated operating subsidy.Such lack of internal controls resulted in an error in the 1997 actualcalculation.

Summary ofFindings

8


We also identified three matters that we do not consider to be reportableconditions. We found that as of July 31, 2000 the waiting list for thelow-income housing and tenant rental assistance programs wasapproximately 7,200 and 5,800 applicants, respectively, which translatesinto a waiting period of two to seven years. These factors bring intoquestion whether the corporation has been able to fulfill its mission ofproviding Hawaii’s residents with affordable housing and shelteropportunities. We also found that a required report was not submitted tothe U.S. Department of Housing and Urban Development (HUD) withinthe prescribed deadline, which could have resulted in a “freeze” offederal financial assistance. In addition, we found that there is aninadequate segregation of duties over the corporation’s petty cash fund.

The corporation’s new information system was poorly planned andresulted in unplanned costs and questionable data. In April 1998, thecorporation commenced the process of implementing a new informationsystem. The new system would integrate various software modules tomanage functions such as housing application eligibility, public housing,rent subsidy programs, work orders, and comprehensive grants, as wellas accounting applications such as the general ledger, accounts payable,personnel, fixed assets, purchasing, and inventory. Once completed, thesystem is envisioned to handle virtually all of the corporation’s financialand tenant reporting requirements and move the corporation from amainframe system to a local area network based system. The newsystem was to replace the existing system developed in the 1980s,automate existing manual processes, and improve the overalleffectiveness of monitoring and compliance requirements. Under the oldsystem, data was not readily accessible by staff members and was notaccessible on the corporation’s local area network or wide area network.

The corporation hired a vendor, Memory Lane Systems, Inc. (MemoryLane), to implement the new information system. In an attempt tocontrol costs, the corporation elected to handle the project managementinternally. A committee was formed comprised of three primarymembers: the administrative services officer, the acting executiveassistant, and the data processing systems analyst. However, based onthe current status of the project, it appears that the corporation did notadequately plan for the project and underestimated the time commitmentrequired and the complexity of managing the implementation of such asystem.

Proper planning for contracted work protects the State’s limitedresources and ensures that project objectives are met. Proper planningentails the establishment of a project work plan that begins with acomprehensive list of tasks to accomplish. The project leader should

NumerousProblems HavePlaguedImplementationEfforts for the NewInformationSystem

Project was poorlyplanned

9


then identify the individuals responsible for reviewing each taskdeliverable. Task dependencies and relationships should be defined andanalyzed to determine the necessary sequence of tasks to maximizeefficiencies, estimated required hours to complete tasks, and specificresources assigned to specific tasks. Once these items have beenaccomplished, the work plan should be scheduled by task with start andend dates, required resources, and persons responsible. Anothercomponent of the work plan is the development of a contingency planshould problems arise and deadlines be missed. After forming the workplan, the corporation would then decide whether to manage the projectinternally or to contract a consultant. The corporation’s decision wouldbe based on the availability and experience of internal resources. Theproject work plan would ensure that the project progresses at anacceptable rate, payments to vendors are based on progress to date, andthe project meets budgets. Unfortunately, proper planning did not takeplace prior to implementation of the new information system resulting indelays and additional costs.

Memory Lane provided the corporation with a proposed work planlisting the tasks, start and end dates, the Memory Lane personnelresponsible, and the estimated total hours for completion. Thecorporation relied on Memory Lane to handle the implementation effortsand, as a result, did not develop and maintain its own project work plan.Additionally, the corporation did not enforce the milestones contained inMemory Lane’s work plan to ensure that the deliverables werecompleted in a timely manner. Additionally, a contingency plan was notdeveloped. As problems surfaced due to system modifications to fit thecorporation’s business structure and data conversion from the old systemto the Memory Lane system, the corporation did not formally classify orprioritize the problems, did not perform a high-level assessment of theproblems to determine the cause, and did not formulate a strategic workplan to resolve the problems. Additionally, the corporationunderestimated the complexity of the implementation project and thetime commitment involved. As a result, it was difficult for thecorporation to allocate sufficient resources to resolve the matters in atimely manner as problems arose.

Although the contractual completion date was October 30, 1999, andthere were no executed extensions, the project remains incomplete morethan a year after the contractual completion date. The contract withMemory Lane allows the corporation to assess Memory Lane forliquidating damages of $100 per day from the contractual completiondate. The corporation has not assessed Memory Lane for the liquidatingdamages, which totaled $57,900 as of May 31, 2001. In addition, thecorporation has not established a revised completion date, nor has itreached an agreement with Memory Lane on developing a revisedtimeframe.

Project completiondate delayed over oneyear

10


The delays have caused the corporation to expend unanticipatedresources for internal labor costs as well as payments to consultants. Asthe project has encountered various problems and delays, corporationpersonnel have expended significant time and energy on this projectwhile also performing their normal day-to-day duties andresponsibilities. The corporation has not been tracking or monitoring theamount of time that its personnel have spent on the project and is unableto estimate or quantify the internal cost of the project.

The delays also resulted in additional unplanned expenditures. The newinformation system, scheduled for completion in October 1999, is year2000 compliant. However, as the new information system remainedincomplete, the corporation entered into another consultant contract forapproximately $55,000 to ensure that the corporation’s existing systemwas year 2000 compliant. The corporation also paid another consultantapproximately $30,000 in the fiscal year ended June 30, 2000 and anadditional $22,600 between July 1, 2000 and April 30, 2001, for dataentry services because the corporation’s existing system does notinterface with the State’s system. The consultant is responsible forentering information related to invoices being paid from thecorporation’s system into a form that is transferable to the State’ssystem. The new information system should be able to interface with theState’s system thereby eliminating this step.

Lack of a corporation’s project work plan has hindered the corporation’sability to estimate the project’s percentage of completion. Accurateestimates of the project’s percentage of completion determines thenecessary payments to the vendor for the hardware, software, andimplementation. The corporation paid the vendor approximately$592,000 or 88 percent of the total contract amount as of August 2000,although the corporation estimated that the project was only 40 to 50percent complete at that time. The corporation is unable to explain thedisparity between the payments made and the estimated percentage ofcompletion, as there is no formal way to determine project completion.Furthermore, the vendor has submitted additional invoices amounting to$173,000, which exceed the contract amount by approximately $95,000,and the corporation expects to receive additional invoices in the future.These additional billings are associated with additional support andcustomized programming to match the corporation’s operations that werenot in the proposed scope but were deemed necessary. No change ordershave been executed since approved billings have not exceeded thecontract amount. The corporation has not paid nor approved theseadditional invoice requests; however, the vendor continues to work onthe project. Negotiations regarding the billings are taking place betweenthe corporation and Memory Lane.

Delays result inadditional unplannedcosts

Payments to thevendor are not in linewith the project’spercentage ofcompletion

11


The State’s Information and Communication Services Division (ICSD)requires all application development, requirements/selection, andreengineering projects to adhere to its system development lifecyclemethodology tool, Systems Development Methodology Structured (SDMStructured). At Memory Lane’s request, the corporation and MemoryLane obtained an exemption from ICSD to allow the agency to useMemory Lane’s methodology. Memory Lane’s methodology and theSDM Structured methodology are similar. However, one of theimplementation tasks required by SDM Structured is the running ofparallel processing prior to discontinuance of the old system to ensurethat the new system is processing information properly. Memory Lane’sprocess requires test runs by processing data from the old system in thenew system and reviewing the output. The corporation performedparallel processing only for the general ledger and accounts payablemodules, despite the fact that problems have been identified in othermodules of the new system, including the low-income public housingand state low-rent program modules. As a result, the integrity of the dataused to generate reports by the new system may be jeopardized.

We recommend that the corporation do the following:

• Assess the project’s status, identify the causes of the problems,and develop a strategic plan to meet project objectives.

• Meet with the vendor and develop a work plan for completion ofthe project. Include task descriptions, resource requirements,and deadlines.

• Assign a project manager to oversee and monitor the project.

• Develop a contingency plan should problems arise and deadlinesbe missed.

• Assess liquidating damages of $100/day against the vendor.

The corporation is responsible for the repair and maintenance of 16 state-owned low-income housing projects comprised of 1,170 units. Fundingfor the repair and maintenance of the projects is appropriated by theLegislature as capital improvement project funds through the State’sbudgeting process. Timely completion of capital improvement projectsis essential to ensuring the health, safety, and welfare of the tenants inthe state-owned low-income housing projects.

Disregard of standardmethodologyjeopardizes theintegrity of the data

Recommendations

CapitalImprovementProjects of $9.5Million RemainIncomplete AfterThree Years

12


The 1997 Legislature appropriated $800,000 for the design of theinstallation of improved roofing systems for four state-owned low-income housing projects comprised of 512 units. The 1998 Legislatureappropriated $8.7 million for the construction of these improvements.We reviewed the planning and monitoring of one of these projects,Puahala Homes, which consists of 128 units at a construction cost ofapproximately $2.6 million. The corporation executed a designconsultant contract in October 1999 approximately two years subsequentto the availability of funds. The project was completed in December2000. Moreover, we were informed that the other three projectsexperienced similar delays.

Significant delays in executing a design consultant contract can beattributed to poor communication between the board and the staff. Thecorporation received notification of the availability of the design fundsfrom the state Department of Budget and Finance on October 2, 1997.On February 20, 1998, the corporation’s Board of Directors (board)authorized the corporation to enter into a consultant contract with anarchitectural firm. The corporation’s Construction Management Unit II(CMS II) is responsible for the procurement process. However, theCMS II development administrator decided not to execute the consultantcontract that was approved by the board but instead to explore analternative procurement method. During this time, state agencies wereshifting to a performance based procurement (PBP) methodology inwhich agencies are more involved in the selection of the design of andmaterials used in the project. CMS II staff, under the direction of thedevelopment administrator, met with employees from the stateDepartment of Accounting and General Services (DAGS) who werefamiliar with PBP and were briefed by a representative of Arizona StateUniversity on the merits of PBP. Board members were also invited tothis meeting. The briefing and other similar meetings related to the PBPmethodology took place in early to mid-1999. Under the assumption thatthe board was in favor of adopting PBP methodology based on thebriefings and feedback, the development administrator directed the CMSII staff to request that the same architectural firm approved by the boardre-submit a proposal for consulting services based on PBP. The proposalwas received in August 1999. However, in October 1999, the boarddenied authorization of the PBP methodology based on the associatedcost of implementing the PBP system and the need for further assessmentbefore proceeding with PBP. The board instructed CMS II staff toobtain feedback on PBP from DAGS after one year’s implementation ofthe PBP method. As a result, the corporation executed a contract inOctober 1999 based on the original contract approved by the board inFebruary 1998, one year and eight months subsequent to its originalauthorization.

Failure to adequatelycommunicate with thecorporation’s Board ofDirectors delaysexecution of the designconsultant contractover 20 months

13


As corporation employees involved in the contracting of the designconsultant are no longer employed, we were unable to determine theextent of communications between the corporation and the board relatingto the choice of procurement method. However, it appears that thecorporation did not communicate with the board on this issue. There areno records or documentation of the existence of written communicationbetween the corporation and the board. The only reference made in theboard minutes is to the denial of the PBP methodology in October 1999.

As a result of the design contract delays, the award of the constructioncontract was delayed until May 22, 2000. Timelier and more effectivecommunications with the board might have allowed the corporation toaddress the board’s concerns prior to the October 1999 denial of theperformance based procurement.

The corporation did not request any capital improvements funds for thefiscal year ended June 30, 2000. This occurred despite the fact that over50 percent of the state-owned low-income housing projects are over 30years old and in need of substantial repair or rehabilitation. Theuntimely extension of the design contract has been cited as a factor in thepostponement of funding requests for other construction improvementprojects.

We recommend that the corporation should do the following:

• Complete capital improvement projects in a timely manner.

• Improve communication with the board. Inform the board of thestatus of all projects and any problems encountered, especially ifsignificant delays may result. Notify the board if any change ismade to a board-approved procurement method. Obtainguidance from the board with regard to oversight and whenissues should be identified for the board.

HUD is authorized to make annual contributions (operating subsidies)for the operation of public housing agency owned rental housingprojects. In the fiscal year ended June 30, 2000, the corporation receivedover $19 million as an operating subsidy from HUD. The operatingsubsidy is calculated in a two-step process. Prior to the beginning of thefiscal year, the corporation calculates an estimated operating subsidybased on historical information. This estimate is used by HUD to remitpayment to the corporation on a weekly basis. Subsequent to year end,

No capitalimprovements fundsrequested for fiscalyear ended June 30,2000

Recommendations

Amounts DueFrom HUD AreUnderreported

14


the corporation calculates the operating subsidy based on actual amountsand reconciles it to the estimated amount. The operating subsidy is thuscalculated by accumulating certain allowable project costs less anyoperating income of the project. Any difference is applied to futureoperating subsidies received from HUD.

The corporation does not have adequate internal controls to ensure thatthe calculation of the actual operating subsidy is proper. As a result,underreported amounts have been determined after the reporting of theoperating subsidy to HUD. A corporation budget analyst calculates theactual operating subsidy, reconciles it to the estimated operating subsidyand submits the required forms to HUD. A supervisory review of thefinal forms by an individual other than the preparer is not performed.The corporation focuses its efforts on the calculation of the estimatedoperating subsidy. The calculation of the actual operating subsidy doesnot undergo a review process similar to the one used for calculating theestimated operating subsidy, which includes reviews by a supervisor, theadministrative services officer, and the board. Due to the lack of reviewprocedures, the fiscal year 1997 actual operating subsidy was incorrectlycalculated, resulting in an under payment to the corporation ofapproximately $223,000. This amount, which should have increased thefiscal year 1999 operating subsidy, remains outstanding as of June 30,2000. Furthermore, because the 1997 actual operating subsidy waserroneously calculated, the estimated operating subsidies for 1999 and2000, utilizing the 1997 reported information, were also incorrect. Thisresulted in underpayments during fiscal year 1999 and 2000 ofapproximately $389,000 and $34,000, respectively. Theseunderpayments were reconciled in the respective years’ actual operatingsubsidy calculation. These errors were identified by the corporation’sindependent auditors as part of the fiscal year 1999 audit. Thecorporation has previously notified HUD, but has yet to implementsufficient internal controls to ensure that future calculations of the actualoperating subsidy are proper.

We recommend that the corporation implement sufficient internal controlprocedures to ensure that the calculation of the actual operating subsidyis proper. These procedures should be similar to those proceduresperformed on the estimated operating subsidy calculation, which includereviews by a supervisor, the administrative services officer, and theboard.

Recommendation

15


The mission of the corporation is “to serve as a catalyst to provideHawaii’s residents with affordable housing and shelter opportunities in abalanced and supportive environment.” To accomplish this, thecorporation must ensure that there is an adequate number of well-maintained affordable units available to Hawaii residents. The currentand projected unit inventory does not provide an adequate supply forHawaii residents.

As of July 31, 2000, we found that there were approximately 7,200 and5,800 applicants on the waiting list for low-income public housing andtenant rental assistance, respectively. Applicants may be on the waitinglist for more than one program. The number of applicants awaiting low-income public housing increased from May 1999 by approximately 850applicants. The number of applicants awaiting tenant rental assistancedecreased from May 1999 by 900 applicants; however, this was mainlybecause applications were no longer being accepted as of April 1999.For the period May 1999 to July 2000, the corporation was only able toplace 446 applicants in low-income public housing and 235 applicants intenant rental assistance units. Based on the number of placements andnew applicants during this period, it appears that the backlog willcontinue to increase each year.

The ability to place applicants in the low-income public housing andtenant rental assistance programs are based on several factors such as therequirements of the applicants and their ability to search for housing, theavailability of public and private low-income housing and funding fortenant rental assistance, the rental market, and general economicconditions. In 1997, the corporation made a significant policy shift inhow it addresses the availability of low-income public housing. Insteadof directly undertaking development projects, the corporation took on therole of a housing facilitator, assisting private developers and nonprofitentities in providing affordable housing in Hawaii through loans and taxcredits. The policy change was in response to the general housingmarket, the associated development risks, and the availability ofresources. As a result, the last state low-income public housing projectthat was completed by the corporation was in 1995. We found that thecorporation facilitated the completion of only one project totaling 99units in fiscal year 2000. Moreover, the corporation projects thecompletion in fiscal years 2001 and 2002 of two and eight projects,respectively, totaling 159 and 549 units, respectively. By 2002, a total of807 additional units are planned; however, as of July 2000, there were7,200 applicants on the waiting list for low-income public housing, andthe list continues to grow. It appears that the housing shortage will notbe alleviated in the next few years and applicants will continue to waitfor available housing. Furthermore, corporation personnel estimate that

The CorporationHas Not BeenEntirelySuccessful inFulfilling itsCorporate Mission

16


the current backlog results in a waiting period of two to seven years.This waiting period is a clear indication that the corporation has not beenentirely successful in fulfilling its corporate mission.

We recommend that the corporation monitor its current and futureprojects to ensure that they are efficiently and effectively completed;develop methods to spur facilitated developments and assist in theplacement of applicants in tenant rental-assisted units; and reviewstaffing workloads and processes to ensure efficiency and effectiveness.

The corporation receives a substantial amount of funds, approximately$17.1 million in fiscal year 2000, under the Comprehensive GrantProgram administered by HUD. These funds are used to upgrade andpreserve the corporation’s federal housing projects. As a participant inthis program, Section 968.330 of Title 24 of the Code of FederalRegulations and the HUD Comprehensive Grant Program Handbookrequire that the corporation file an annual performance and evaluationreport summarizing the status of all open grants by September 30 foreach year. If HUD does not record the receipt of the report within 30days after the due date of September 30, payments to the corporation willbe automatically suspended for the respective grants.

Because of the significant amount of funding received from this programas well as other programs administered by HUD, it is imperative that thecorporation file required reports within their respective time deadlines.We found that the corporation failed to comply with the performance andevaluation report filing deadline for September 30, 1999. We wereinformed by corporation personnel that HUD was notified prior toSeptember 30, 1999, that the corporation would not file the requiredreport on time. HUD’s response was that the corporation had 30 daysafter September 30 to file the report. However, we found that the reportwas submitted to HUD on November 11, 1999. While federal guidelinesclearly state that grant funds are automatically suspended for the periodsubsequent to October 30, it appears that no grant funds were actuallyfrozen as the corporation did not receive any notification from HUD.Fortunately, there were no requests to draw on grant funds during thisperiod. Nonetheless, a prolonged “freeze” could severely hinder thecorporation’s ability to effectively and efficiently manage its resources.

We recommend that the corporation adhere to HUD reportingrequirements and ensure that staff who are involved with completion ofthe reports are aware of the significance of the time deadlines.

Recommendation

The Delay in theSubmittal of aRequired ReportCould HaveResulted in a“Freeze” ofFederal FinancialAssistance

Recommendation

17


The corporation’s petty cash operations do not ensure internal controls todeter misuse or misappropriation. The corporation’s petty cashcustodian maintains a petty cash fund in an amount of $500 which isused for cash reimbursements less than $25. The fund is replenishedwhen the balance falls below $200, which occurs approximately threetimes per year. Disbursements from the petty cash fund must besupported by original receipts and approved by the petty cash custodian,the employee receiving the reimbursement, and an accountant. The pettycash custodian reconciles the cash and original receipts whenreplenishment requests are made.

The custodial and reconciliation functions of petty cash funds should beseparated to prevent misappropriation of assets. We found that thecorporation’s procedures lack monthly reconciliations and reviews of thepetty cash fund by an employee independent of the custodial function.Currently, the petty cash custodian performs both the custodial andreconciliation functions. In previous years, a corporation employeeindependent of the process performed periodic reviews of the petty cashfund. No irregularities were found. As a result of past experience andlimited personnel resources, the corporation discontinued these periodicreviews. However, the handling of cash provides the opportunity formisappropriation and appropriate internal controls should be establishedto deter any misappropriation of assets.

We recommend that the reconciliation of the petty cash fund or periodicreviews of the reconciliation procedures be performed by an employeeindependent of the petty cash process.

The Corporation’sInternal ControlsOver the Handlingof Petty CashCould BeImproved

Recommendation

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Chapter 3: Financial Audit

Chapter 3Financial Audit

This chapter presents the results of the financial audit of the Housing andCommunity Development Corporation of Hawaii, State of Hawaii(corporation) as of and for the fiscal year ended June 30, 2000. Thischapter includes the independent auditors’ report and the report oncompliance and on internal control over financial reporting based on anaudit of financial statements performed in accordance with GovernmentAuditing Standards as they relate to the corporation. It also displays thecorporation’s combined financial statements together with explanatorynotes and supplementary information.

In the opinion of KPMG LLP, based on their audit, the combinedfinancial statements present fairly, in all material respects, the financialposition of the corporation as of June 30, 2000, and the results of itsoperations and the cash flows of its proprietary fund types for the yearthen ended in conformity with accounting principles generally acceptedin the United States of America. KPMG LLP noted certain mattersinvolving the corporation’s internal control over financial reporting andits operations that the firm considered to be reportable conditions.KPMG LLP also noted that the results of its tests disclosed no instancesof noncompliance that are required to be reported under GovernmentAuditing Standards.

The AuditorState of Hawaii:

We have audited the accompanying combined financialstatements of the Housing and Community DevelopmentCorporation of Hawaii, State of Hawaii (corporation) as of andfor the year ended June 30, 2000. These combined financialstatements are the responsibility of the corporation’smanagement. Our responsibility is to express an opinion onthese combined financial statements based on our audit.

We conducted our audit in accordance with auditing standardsgenerally accepted in the United States of America and thestandards applicable to financial audits contained in GovernmentAuditing Standards, issued by the Comptroller General of theUnited States. Those standards require that we plan and perform

Summary ofFindings

IndependentAuditors’ Report

20


the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluatingthe overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

As discussed in note A to the combined financial statements, thecombined financial statements of the corporation are intended topresent the financial position, results of operations, and cashflows of only that portion of the funds and account groups of theState of Hawaii that is attributable to the transactions of thecorporation.

In our opinion, the combined financial statements referred toabove present fairly, in all material respects, the financialposition of the Housing and Community DevelopmentCorporation of Hawaii, State of Hawaii as of June 30, 2000, andthe results of its operations and the cash flows of its proprietaryfund types for the year then ended in conformity with accountingprinciples generally accepted in the United States of America.

In accordance with Government Auditing Standards, we havealso issued our report dated December 8, 2000 on ourconsideration of the corporation’s internal control over financialreporting and on our tests of its compliance with certainprovisions of laws, regulations, contracts, and grants. Thatreport is an integral part of an audit performed in accordancewith Government Auditing Standards and should be read inconjunction with this report in considering the results of ouraudit.

Our audit was performed for the purpose of forming an opinionon the combined financial statements of the corporation taken asa whole. The supplementary information included in SchedulesI through IX is presented for purposes of additional analysis andis not a required part of the combined financial statements. Suchinformation has been subjected to the auditing proceduresapplied in our audit of the combined financial statements and, inour opinion, is fairly stated in all material respects in relation tothe combined financial statements taken as a whole.

Honolulu, HawaiiDecember 8, 2000

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The AuditorState of Hawaii:

We have audited the combined financial statements of theHousing and Community Development Corporation of Hawaii,State of Hawaii (corporation), as of and for the fiscal year endedJune 30, 2000, and have issued our report thereon datedDecember 8, 2000. We conducted our audit in accordance withauditing standards generally accepted in the United States ofAmerica and the standards applicable to financial auditscontained in Government Auditing Standards, issued by theComptroller General of the United States.

ComplianceAs part of obtaining reasonable assurance about whether thecorporation’s combined financial statements are free of materialmisstatement, we performed tests of its compliance with certainprovisions of laws, regulations, contracts, and grants, includingapplicable provisions of the Hawaii Public Procurement Code(Chapter 103D of the Hawaii Revised Statutes) and procurementrules, directives, and circulars, noncompliance with which couldhave a direct and material effect on the determination ofcombined financial statement amounts. However, providing anopinion on compliance with those provisions was not anobjective of our audit and, accordingly, we do not express suchan opinion. The results of our tests disclosed no instances ofnoncompliance that are required to be reported underGovernment Auditing Standards. However, we noted animmaterial instance of noncompliance that we have reported tothe Auditor, State of Hawaii, in Chapter 2 of this report.

Internal Control Over Financial ReportingIn planning and performing our audit, we considered thecorporation’s internal control over financial reporting in order todetermine our auditing procedures for the purpose of expressingour opinion on the combined financial statements and not toprovide assurance on the internal control over financialreporting. However, we noted certain matters involving theinternal control over financial reporting and its operation that weconsider to be reportable conditions. Reportable conditionsinvolve matters coming to our attention relating to significantdeficiencies in the design or operation of the internal controlover financial reporting that, in our judgment, could adverselyaffect the corporation’s ability to record, process, summarize,

Report onCompliance andon Internal ControlOver FinancialReporting Basedon an Audit ofFinancialStatementsPerformed inAccordance withGovernmentAuditingStandards

22


and report financial data consistent with the assertions ofmanagement in the financial statements. Reportable conditionsare described in Chapter 2 of this report.

A material weakness is a condition in which the design oroperation of one or more of the internal control components doesnot reduce to a relatively low level the risk that misstatements inamounts that would be material in relation to the financialstatements being audited may occur and not be detected within atimely period by employees in the normal course of performingtheir assigned functions. Our consideration of the internalcontrol over financial reporting would not necessarily discloseall matters in the internal control that might be reportableconditions and, accordingly, would not necessarily disclose allreportable conditions that are also considered to be materialweaknesses. However, we believe that none of the reportableconditions described above are material weaknesses.

This report is intended solely for the information of the Auditor,State of Hawaii, and the management and the Board of Directorsof the corporation and is not intended to be and should not beused by anyone other than these specified parties.

Honolulu, HawaiiDecember 8, 2000

The following is a brief description of the combined financial statementsand supplementary information audited by KPMG LLP, which arelocated at the end of this chapter.

Combined Balance Sheet – All Fund Types and Account Groups(Exhibit A). This statement presents the assets, liabilities, and equity ofall fund types and account groups of the corporation at June 30, 2000.

Combined Statement of Revenues, Expenditures, and Changes inFund Balances – All Governmental Fund Types and ExpendableTrust Funds (Exhibit B). This statement presents the revenues,expenditures, and changes in fund balances for all governmental fundtypes and expendable trust funds of the corporation for the fiscal yearended June 30, 2000.

Description ofCombinedFinancialStatements andSupplementaryInformation

Combined financialstatements

23


Combined Statement of Revenues and Expenditures – Budget andActual (Budgetary Basis) – General and Special Revenue FundTypes (Exhibit C). This statement compares actual revenues andexpenditures of the corporation’s general and special revenue funds on abudgetary basis to the budget adopted by the State Legislature for thefiscal year ended June 30, 2000.

Combined Statement of Revenue and Expenses – Proprietary FundTypes (Exhibit D). This statement presents the revenue and expensesfor all proprietary fund types of the corporation for the fiscal year endedJune 30, 2000.

Combined Statement of Fund Equity – Proprietary Fund Types(Exhibit E). This statement presents the changes in fund equity for allproprietary fund types of the corporation for the fiscal year endedJune 30, 2000.

Combined Statement of Cash Flows – Proprietary Fund Types(Exhibit F). This statement presents the cash flows from operating, noncapital financing, capital and related financing, and investing activitiesfor all proprietary fund types of the corporation for the fiscal year endedJune 30, 2000.

Combining Balance Sheet – Special Revenue Funds (Schedule I).This schedule presents the assets, liabilities, and fund balances (deficit)of the special revenue funds of the corporation at June 30, 2000.

Combining Statement of Revenues, Expenditures, and Changes inFund Balances (Deficit) – Special Revenue Funds (Schedule II). Thisschedule presents the revenues, expenditures, and changes in fundbalances (deficit) of the special revenue funds of the corporation for thefiscal year ended June 30, 2000.

Combining Balance Sheet – Enterprise Funds (Schedule III). Thisschedule presents the assets, liabilities, and fund equity of the enterprisefunds of the corporation at June 30, 2000.

Combining Statement of Revenues and Expenses – Enterprise Funds(Schedule IV). This schedule presents the revenues and expenses of theenterprise funds of the corporation for the fiscal year ended June 30,2000.

Combining Statement of Changes in Fund Equity – EnterpriseFunds (Schedule V). This schedule presents the changes in fund equityof the enterprise funds of the corporation for the fiscal year endedJune 30, 2000.

Supplementaryinformation

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Combining Statement of Cash Flows – Enterprise Funds(Schedule VI). This schedule presents the cash flows from operating,non-capital financing, capital and related financing, and investingactivities of the enterprise funds of the corporation for the fiscal yearended June 30, 2000.

Combining Balance Sheet – Revenue Bond Funds (Schedule VII).This schedule presents the assets, liabilities, and fund equity (deficit) ofthe revenue bond funds of the corporation at June 30, 2000.

Combining Statement of Revenues, Expenses, and Changes inRetained Earnings (Accumulated Deficit) – Revenue Bond Funds(Schedule VIII). This schedule presents the revenues, expenses, andchanges in retained earnings (accumulated deficit) of the revenue bondfunds of the corporation for the fiscal year ended June 30, 2000.

Combining Statement of Cash Flows – Revenue Bond Funds(Schedule IX). This schedule presents the cash flows from operating,non-capital financing, capital and related financing, and investingactivities of the revenue bond funds of the corporation for the fiscal yearended June 30, 2000.

Explanatory notes which are pertinent to an understanding of thecombined financial statements and financial condition of the Housingand Community Development Corporation of Hawaii, State of Hawaii(corporation) are discussed in this section.

General

Chapter 201E, Hawaii Revised Statutes (HRS) and Act 337, SessionLaws of Hawaii (SLH) 1987, created the Housing Finance andDevelopment Corporation (HFDC). The HFDC was created to performhousing finance, housing development, and residential leaseholdfunctions. The Hawaii Housing Authority, State of Hawaii (HHA) wasorganized pursuant to the provisions of Chapter 356, HRS. The HHAwas created to provide safe and sanitary dwelling accommodations forlow and moderate income residents of Hawaii.

In accordance with Act 350, SLH, 1997, effective July 1, 1998, thefunctions and employees of HFDC as well as those of the HHA and theRental Housing Trust Fund (RHTF) were transferred to the newlycreated corporation. The purpose of Act 350, SLH, 1997, was toconsolidate all state housing functions previously administered by theHHA, the HFDC, and the RHTF. The corporation is a public body and a

Notes toCombinedFinancialStatements

Note A – Organizationand SignificantAccounting Policies

25


body corporate and politic and is, for administrative purposes only,considered to be a part of the state Department of Business, EconomicDevelopment and Tourism.

For financial reporting purposes, the corporation includes all funds andaccount groups that are controlled by or dependent on the corporation’sBoard of Directors. Control by or dependence on the corporation wasdetermined on the basis of statutory authority and monies flowingthrough the corporation to each fund or account group.

HUD Subsidized Programs

The Federal Low-Rent Program and the various Section 8 funds arereferred to collectively as the HUD Subsidized Programs and representthe contracts that the corporation has entered into with the U.S.Department of Housing and Urban Development (HUD). The FederalLow-Rent Program is used to account for corporation-owned housingprojects that are rented to low-income families. To provide for thedevelopment and modernization of low-rent housing units, thecorporation issues housing bonds and permanent notes. These bonds andnotes are payable by HUD and secured by annual contributions (note L).

HUD Subsidized Programs also include subsidized housing assistancepayments. Under these programs, low-income tenants lease housingunits directly from private landlords rather than from the corporation.Rental payment subsidies are paid directly to the private landlords by thecorporation using operating subsidies obtained from HUD.

The Federal Low-Rent Program includes all property and equipment,principally structures and improvements, acquired with the proceedsfrom notes and bonds collateralized by HUD.

Significant Accounting Policies

The accounting policies of the corporation utilized in the accompanyingcombined financial statements conform to generally accepted accountingprinciples (GAAP) applicable to governments as prescribed by theGovernmental Accounting Standards Board through its statements andinterpretations. The following is a summary of the significantaccounting policies.

1. Basis of Presentation

The financial transactions of the corporation are recorded inindividual funds and account groups that are reported by type in thecombined financial statements. The corporation accounts for andreports only its portion of those fund types and account groups

26


maintained by the State of Hawaii (State). The state Comptrollermaintains the accounts for all state funds and account groups andpublishes the State’s annual financial statements.

The accounts of the corporation are organized into funds, each ofwhich is considered a separate accounting entity. The operations ofeach fund are accounted for with a separate set of self-balancingaccounts that comprise its assets, liabilities, equity, revenues, andexpenditures or expenses. Account groups are used to establishaccounting control and accountability for the corporation’s generalfixed assets and general long-term obligations. Account groups arenot funds as they do not reflect available financial resources andrelated liabilities. Government resources are allocated to and areaccounted for in individual funds based on the purpose for whichthey are to be spent and the means by which spending activities arecontrolled.

The corporation uses the following fund types, funds, and accountgroups:

Governmental Fund Types

General fund – Accounts for all financial resources except thoserequired to be accounted for in another fund. This fund includes theRent Supplement, Security/Beautification, and the HomelessProgram.

Special revenue funds – Accounts for the proceeds of specificrevenue sources that are legally restricted to expenditures forspecified purposes. These funds include Section 8 Existing, NewConstruction Haili, Housing Voucher Program, New Construction,Drug Elimination Programs, Shelter Plus Care, Family InvestmentCenter, Youth Sports Program, Safe and Drug Free Schools andCommunities, Housing Opportunities for Persons with AIDSProgram, Economic Development and Support Services, andSupportive Housing Program.

Capital projects fund – Accounts for financial resources to be usedfor the acquisition or construction of major capital facilities otherthan those financed by the proprietary fund types.

Proprietary Fund Types

Enterprise funds – Accounts for operations that are financed andoperated in a manner similar to private business enterprises wherethe corporation has decided that periodic determination of revenuesearned, expenses incurred, and net income is appropriate for

27


management control and public accountability. The enterprise fundsinclude the Revenue Bond Funds, Dwelling Unit Revolving Fund(DURF), Homes Revolving Fund (HRF), Federal Low-RentProgram, and other funds that are not individually significant to thecombined financial statements.

Under the Revenue Bond Funds, proceeds from the bond issues areused to make below-market interest rate mortgage loans to personsand families of low to moderate income for the purchase of owner-occupied single-family and condominium dwellings; provide interimconstruction loans and permanent financing of affordable rentalhousing projects; and finance multifamily housing projects. Thesefunds include the Single Family Mortgage Purchase Revenue BondFund, the Multifamily Housing Revenue Bond Fund, the RentalHousing System Revenue Bond Fund (RHS), the State of HawaiiAffordable Rental Program (SHARP), and the University of HawaiiFaculty Housing Program Revenue Bond Fund.

The DURF was established for acquiring, developing, selling,leasing, and renting residential, commercial, and industrialproperties; and providing mortgage and interim financing.

The HRF was established for the purpose of developing andimplementing affordable housing development programs.

The Federal Low-Rent Program rents property and equipment,principally structures and improvements, acquired with the proceedsfrom notes and bonds collateralized by HUD to low-income families.

Internal service funds – Accounts for the financing of goods orservices provided by these funds to other funds of the corporation, orto other governmental units, on a cost-reimbursement basis. Thesefunds include Equipment Rental and Vehicle Rental.

Fiduciary Fund Types

Expendable trust fund – Accounts for assets held by the corporationin a trustee capacity.

Agency fund – Accounts for grants received for disbursement toother governmental units (secondary recipients).

Account Groups

General fixed assets account group – Accounts for all fixed assets ofthe corporation, other than those accounted for in the proprietaryfund types.

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General long-term obligation account group – Accounts for the long-term portion of accrued vacation, other than the amounts that arespecific liabilities of the proprietary fund types.

2. Basis of Accounting

Governmental Fund Types and Expendable Trust and Agency Funds

The accounting and financial reporting treatment applied to a fund isdetermined by its measurement focus. All governmental funds andexpendable trust funds are accounted for using a current financialresources measurement focus. With this measurement focus, onlycurrent assets and current liabilities generally are included on thecombined balance sheet. Operating statements of these funds presentincreases (i.e., revenues and other financing sources) and decreases(i.e., expenditures and other financing uses) in net current assets.

The corporation uses the modified accrual basis of accounting for thegeneral, special revenue, capital projects, and expendable trust andagency funds. Under the modified accrual basis of accounting,revenues and related current assets are recognized in the accountingperiod when they become both measurable and available to financeoperations of the fiscal year or liquidate liabilities existing at fiscalyear-end. Measurable means that the amount of the transaction canbe determined. Available means that the amount is collected in thecurrent fiscal year or soon enough after fiscal year-end to liquidateliabilities existing at the end of the fiscal year. Revenues susceptibleto accrual include federal grants and funds appropriated by the StateLegislature and allotted by the Governor.

Expenditures are recorded when the related fund liabilities areincurred.

Encumbrances are recorded obligations in the form of purchaseorders or contracts. The corporation records encumbrances at thetime purchase orders or contracts are awarded and executed.Encumbrances outstanding at year end are reported as reservations offund balances since they do not constitute expenditures or liabilities.

Proprietary Fund Types

All proprietary funds are accounted for on a flow of economicresources measurement focus. With this measurement focus, allassets and liabilities associated with the operation of those funds areincluded on the combined balance sheet. Fund equity (i.e., net totalassets) is segregated into contributed capital and retained earningscomponents. Proprietary fund type operating statements present

29


increases (e.g., revenues) and decreases (e.g., expenses) in net totalassets. The accounts of the proprietary fund types are reported underthe accrual basis of accounting. Under this method of accounting,revenues are recognized when they are earned and expenses arerecorded when they are incurred.

The proprietary fund types have not applied Financial AccountingStandards Board Statements and Interpretations issued afterNovember 30, 1989.

3. Cash and Cash Equivalents

Cash and cash equivalents for the purpose of the combined statementof cash flows include all cash and investments with originalpurchased maturities of three months or less.

4. Investments

Investments in repurchase agreements, U.S. government andmortgage-backed securities are generally carried at fair value.Investments in U.S. government securities, certificates of deposit,money market accounts, and repurchase agreements that have aremaining maturity, at time of purchase, of one year or less are statedat amortized cost. The change in fair value of investments isrecognized in the combined statement of revenues and expenses –proprietary fund types as “net decrease in the fair value ofinvestments.”

5. Inventories

Developments in Progress and Dwelling Units

Inventories consist of developments in progress and units availablefor sale. Units available for sale include constructed units,developed lots, and repurchased units available for sale.Developments in progress include construction in progress and landheld for future development. The corporation currently has threedevelopment projects in progress. These master planned communityprojects include Kapolei (Oahu), La’i’opua (Hawaii), and Leiali’i(Maui). Costs included in developments in progress relate toinfrastructure construction for these master planned communities.

Inventories are stated at the lower of cost or estimated net realizablevalue. All estimated carrying costs to the anticipated date ofdisposition are considered in the determination of estimated netrealizable value. Valuation allowances for estimated losses on unitsavailable for sale are provided when the total estimated carryingcosts exceeds the estimated net realizable value.

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The recognition of gains from the sale of units is dependent on anumber of factors relating to the nature of the property sold, theterms of the sale, and the future involvement of the corporation inthe property sold. If a real estate transaction does not meetestablished financial criteria, profit recognition is deferred andrecognized under the installment or cost recovery method until suchtime as the criteria are met.

6. Property and Equipment

Property and equipment recorded in the corporation’s proprietaryfund types are recorded at cost (net of accumulated depreciation).Property and equipment includes land owned by the corporation andleased to developers and homeowners. Interest costs incurred duringconstruction are capitalized.

Depreciation has been provided over the estimated useful lives usingthe straight-line method. The estimated useful lives are as follows:

Buildings and improvements 10 – 40 yearsEquipment, furniture, and fixtures 1 – 10 years

Depreciation recognized on assets acquired or constructed fromgrants or contributions is transferred to and deducted fromcontributed capital to the extent that contributed capital is available.

Property and equipment reported in the general fixed assets accountgroup are recorded at cost. Those assets were acquired orconstructed for general governmental purposes and were reported asexpenditures in the funds that financed the assets at acquisition. Nodepreciation is provided on those assets.

7. HUD Annual Contributions

The corporation receives annual contributions and subsidies fromHUD for operating the corporation’s housing assistance paymentprograms and the development and operation of low-income housingprojects. The corporation also receives annual subsidies from HUDfor housing assistance payments and operating deficits incurred inthe operation of the programs. Annual subsidies recorded in theproprietary fund types are recognized as nonoperating revenue uponnotification of approval from HUD and are accounted for in thecombined statement of revenues and expenses – proprietary fundtypes as HUD operating subsidy.

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8. Amortization

Issuance costs of revenue bonds are deferred and amortized ratablyover the term of the bond principal outstanding.

9. Vacation and Sick Pay

Employees are credited with vacation at a rate of 168 hours percalendar year. Accumulation of such vacation credits is limited to720 hours at calendar year end and is convertible to pay upontermination of employment. Liabilities for accumulated unpaidvacation are accrued at the end of each accounting period utilizingcurrent salary rates. Such vacation credits are recorded as accruedexpenses – other in the general long-term obligation account groupand the enterprise funds at the balance sheet date.

Unused sick leave may be accumulated without limit but can betaken only in the event of illness and is not convertible to pay upontermination of employment.

10. Allocated Costs

The corporation provides certain administrative services to itsvarious funds. The cost of these services is allocated to the fundsbased on estimates of the corporation.

11. Reservations of Fund Balances

The general and capital projects fund balances are reserved forcontinuing appropriations which are comprised of encumbrances andunencumbered allotment balances. Encumbrances representoutstanding commitments which generally are liquidated in thesubsequent fiscal year. Unencumbered allotment balances representamounts that have been released and made available forencumbrance or expenditure and are legally segregated for a specificfuture use. The expendable trust fund balance is reserved for otherspecific purposes.

12. Risk Management

Liabilities related to certain types of losses (including torts; theft of,damage to, or destruction of assets; errors or omissions; naturaldisasters; and injuries to employees) are reported when it is probablethat the losses have occurred and the amount of those losses can bereasonably estimated.

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13. Use of Estimates

The preparation of combined financial statements in conformity withGAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the combined financialstatements and the reported amounts of revenues and expendituresduring the reporting period. Actual results could differ from thoseestimates.

14. Total Columns on the Combined Financial Statements

The total columns on the accompanying combined financialstatements are captioned “memorandum only” to indicate that theyare presented only to facilitate financial analysis. Information inthose columns does not purport to present financial position, resultsof operations, or cash flows of the corporation in conformity withGAAP. Such data is not comparable to a consolidation. Interfundbalances and transactions have not been eliminated.

The budget of the corporation is a detailed operating plan identifyingestimated costs and results in relation to estimated revenues. The budgetincludes (1) the programs, services, and activities to be provided duringthe fiscal year, (2) the estimated revenues available to finance theoperating plan, and (3) the estimated spending requirements of theoperating plan. The budget represents a process through which financialpolicy decisions are made, implemented, and controlled. Revenueestimates are provided to the State Legislature at the time of budgetconsideration and are revised and updated throughout the fiscal year.Amounts reflected as budgeted revenues in the combined statement ofrevenues and expenditures – budget and actual (budgetary basis) –general and special revenue fund types are those estimates as compiledby the corporation and reviewed by the state Department of Budget andFinance. Budgeted expenditures are derived primarily from acts of theState Legislature and from other authorizations contained in the StateConstitution, the HRS, and other specific appropriation acts in variousSLH.

Expenditures of these appropriated funds are made pursuant to theappropriations in the biennial budget as amended by subsequentsupplemental appropriations. Budgetary control is maintained at thedepartmental level. Budget revisions and interdepartmental transfersmay be affected with certain executive and legislative branch approvals.

The general fund and certain special revenue funds have legallyappropriated annual budgets. The final legally adopted budget in the

Note B – Budgetingand Budgetary Control

33


combined statement of revenue and expenditures – budget and actual(budgetary basis) – general and special revenue fund types represent theoriginal appropriations, transfers, and other legally authorized legislativeand executive changes.

To the extent not expended or encumbered, general and special revenuefunds appropriations generally lapse at the end of the fiscal year or grantperiod for which the appropriations were made. The State Legislature orfederal government specifies the lapse dates and any other contingenciesthat may terminate the authorization for other appropriations. Knownlapses occurring in the year of appropriation, if any, are included in theamended budgets, and are netted against revenues in the combinedstatement of revenues and expenditures – budget and actual (budgetarybasis) – general and special revenue fund types.

A comparison of budgeted and actual revenues and expenditures of thegeneral and special revenue funds are presented in the combinedstatement of revenues and expenditures – budget and actual (budgetarybasis) – general and special revenue fund types. Differences betweenrevenues and expenditures reported on the budgetary basis and thosereported in accordance with GAAP are mainly due to revenues andexpenditures of unbudgeted funds and the different methods used torecognize resource uses. For budgeting purposes, resource uses arerecognized when cash disbursements are made or funds are encumbered.For financial statements presented in accordance with GAAP,expenditures are recognized when incurred and encumbrances are notreported as resources used.

A summation of the differences between revenues and expendituresreported on the budgetary basis and those reported in accordance withGAAP for the general and special revenue funds for the fiscal year endedJune 30, 2000 is as follows:

34


FundsSpecial

General Revenue

Excess of revenues and other financing sourceover expenditures – actual (budgetary basis) $ -- $ --

Reserved for encumbrances at fiscal year-end* 530,791 --Expenditures for liquidation of prior fiscal year

encumbrances (342,720) --Adjustment to accrual (81,453) --Other adjustments (224,840)Unbudgeted programs, net -- 82,568

Excess (deficiency) of revenues and other financingsource over expenditures and other financing use –GAAP basis $ (118,222) $ 82,568

*Amount reflects the encumbrance balance included in continuing appropriations.

The State maintains a cash pool that is available to all funds. TheDirector of Finance is responsible for the safekeeping of all monies paidinto the State Treasury. The Director of Finance may invest any moniesof the State, which in the Director’s judgment are in excess of theamounts necessary for meeting the immediate requirements of the State.Effective August 1, 1999, cash is pooled with funds from other stateagencies and departments and deposited with approved financialinstitutions or participants under the State Treasury Investment PoolSystem. Cash accounts that participate in the investment pool accrueinterest based on the average weighted cash balances of each account.At June 30, 2000, the corporation had approximately $174,528,000deposited in the State Treasury Investment Pool System.

In accordance with the implementation of the State Treasury InvestmentPool System, certain investments of the fund were deposited into theState Treasury in July 1999. These investments were treated as maturingon July 31, 1999 and deposited into the State Treasury as cash.

The State requires that the depository banks pledge, as collateral,government securities held in the name of the State for deposits notcovered by federal deposit insurance.

Cash, other than pooled cash, at a carrying value of approximately$19,931,000 is included in the combined balance sheet as cash, depositsheld in trust, and assets held by trustees under revenue bond programs.The corporation maintains its cash balances at several financialinstitutions located in the State. Accounts at each institution are insuredby the Federal Deposit Insurance Corporation (FDIC) up to $100,000.

Note C – Cash

35


The corporation’s deposits at year end were entirely covered by theFDIC insurance or by collateral held by the corporation’s agent in thecorporation’s name.

Investments can be categorized to give an indication of the level of riskassumed by the corporation at June 30, 2000. Category 1 includesinvestments that are insured or registered, or securities held by thecorporation or its agent in the corporation’s name. Category 2 includesuninsured and unregistered investments, with securities held by thecounterparty’s trust department or agent in the corporation’s name.Category 3 includes uninsured and unregistered investments, withsecurities held by the counterparty, or by its trust department or agent,but not in the corporation’s name.

The Revenue Bond Funds’ trust indentures authorize the trustees toinvest in certificates of deposit, money market funds, U.S. government oragency obligations, and repurchase agreements. Uninsured certificatesof deposit are required to be collateralized by investment securities of anequal or greater fair value. Repurchase agreements are generally treatedas collateral lending. The underlying securities for repurchaseagreements are required to be U.S. government or agency obligations ofan equal or greater fair value. The corporation monitors the fair value ofthese securities and obtains additional collateral when appropriate. AtJune 30, 2000, the underlying fair values of the securities approximatedcarrying amount. These investments are included on the combinedbalance sheet as assets held by trustees under revenue bond programs.

Investments at June 30, 2000 are summarized as follows:

Note D – Investments

Category Reported 1 2 3 amount Fair value

Investments excluding investments held by trustees under revenue bond programs:

Certificates of deposit and money market accounts $ 4,552,104 $ — $ 1,236,090 $ 5,788,194 $ 5,788,194

U.S. government securities 9,891,516 — — 9,891,516 9,891,516 Mortgage-backed securities 5,960,852 — — 5,960,852 5,960,852 20,404,472 — 1,236,090 21,640,562 21,640,562 Investments held by trustees under

revenue bond programs: Certificates of deposit and money market

accounts 30,277,973 — — 30,277,973 30,277,973 U.S. government securities 8,694,295 — — 8,694,295 8,676,238 Repurchase agreements 231,299,851 — — 231,299,851 231,299,851 Mortgage-backed securities 404,716,875 — — 404,716,875 404,716,875 Guaranteed investment contract 143,632 — — 143,632 143,632 675,132,626 — — 675,132,626 675,114,569 Total investments $ 695,537,098 $ — $ 1,236,090 $ 696,773,188 $ 696,755,131

36


Mortgage-backed securities by contractual maturity at June 30, 2000 areshown below. Expected maturities will differ from contractualmaturities because borrowers may have the right to prepay obligationswith or without prepayment penalties.

Fair value

Due after five years $410,677,727

Mortgage loans and other notes and loans receivable at June 30, 2000 arecomprised of the following:

Mortgage Notes andloans loans

Mortgage loans bearing interest at 0.00%to 14.50%, generally maturing within30 years $ 112,148,117 $ --

Development loans non-interest bearing,maturing in 2001 -- 292,173

Interim construction loans bearing interestat 7.50%, maturing in 2001 and 2003 -- 4,190,445

Promissory note bearing interest at 9.00%,due 2010 -- 426,100

$ 112,148,117 $ 4,908,718

Mortgage and development loans are collateralized by real property. TheRevenue Bond Funds’ mortgage loans are also subject to primarymortgage and mortgage pool insurance coverage that, subject toaggregate loss limitations, reimburses the corporation for all lossesincurred, if any, from the disposition of real property acquired throughforeclosure.

On June 30, 1998, the corporation executed a $25,000,000 interimconstruction loan agreement and an amended development agreementwith the developers of Village V (Iwalani) at Kapolei. The interim loanis collateralized by the project’s improvements and materials. Inaddition, as provided by the agreement, all unsold project land (125 lots)was conveyed back to the corporation. As units in Iwalani are completedand sold, the underlying 125 lots will be sold by the corporation at anindividual lot fee price of $29,574. These loans accrue interest at7.5 percent and mature in June 2001. At June 30, 2000, the total amountof interim construction loans outstanding on the Village V phasesapproximated $1,891,000.

Note E – MortgageLoans and Notes andLoans Receivable

37


During 1984, the corporation entered into a sales transaction with agroup of limited partnerships involving two housing projects owned bythe corporation and one owned by a related entity. The projects weresold for approximately $10,800,000, consisting of $350,000 in cash,$7,450,000 in mortgages and other secured notes, and approximately$3,000,000 in assumed debt. Since the limited partnership’s continuinginvestment is not considered adequate, the gain on the sale is beingrecognized on the installment method in the corporation’s RentalAssistance Fund (RAF). The gain resulting from the sale of thecorporation’s two housing projects of approximately $1,570,000 is beingrecognized as earned revenue when payments are received. The gainresulting from the sale of the related entity’s housing project ofapproximately $1,507,000 is being recognized as contributed capitalwhen payments are received. In December 1999, the corporationcollected the outstanding balances of two of the housing projects. As aresult, the corporation recognized approximately $503,000 of gain andapproximately $1,170,000 of contributed capital in the current year. Theremaining outstanding mortgage and loan balance and the remaining gainas of June 30, 2000 were approximately $912,000 and $623,000,respectively.

The $426,100 promissory note receivable from a developer isuncollateralized. On January 1, 2010, the corporation has the option toacquire certain improvements constructed by the developer. If thecorporation does not exercise the option, the entire principal balance andaccrued interest shall be paid over a period of 15 years in monthlyinstallments necessary to fully amortize the outstanding amount of thisnote.

University of Hawaii Faculty Housing Program Revenue Bond FundOn November 1, 1995, the corporation entered into a lease and subleaseagreement (Agreement) with the Board of Regents, University of Hawaii(University). Under the Agreement, the corporation leases the landunder the housing project from the University for an annual rent of $1and then subleases the leased land, buildings and improvements, andequipment back to the University. The University will make certainlease rental payments to the corporation, including amounts sufficient topay the principal, premium, if any, and interest on the bonds as the samebecome due and payable. The Agreement expires on June 30, 2026.Upon expiration of the Agreement, the ownership of the buildings andimprovements and equipment will revert to the University.

The following lists the components of the net investment in directfinancing lease as of June 30, 2000:

Note F – NetInvestment in DirectFinancing Lease

38


Total minimum lease payments to be received $ 35,015,049Less unearned interest income (16,062,969)

Net investment in direct financing lease $ 18,952,080

The future minimum lease payments to be received during thesubsequent five years are as follows:

Year ending June 30,2001 $ 1,242,0002002 1,237,0002003 1,237,0002004 1,236,0002005 1,239,000

Under the trust indentures between the corporation and the trustees forthe Single Family Mortgage Purchase Revenue Bonds, investment assetsand cash are required to be held by the trustees in various accounts andfunds, including debt service reserve accounts, loan funds, and mortgageloan reserve funds. The uses of these assets are restricted by the terms ofthe indentures. At June 30, 2000, the debt service reserves and mortgageloan reserves required by the indentures were as follows:

Single FamilyMortgage Purchase

Debt service reserve requirements $ 68,428,000Mortgage loan reserve requirements 5,818,489

$ 74,246,489

At June 30, 2000, approximately $67 million of investment securities, atcost, were being held in the debt service reserve funds. In August 2000,the corporation had the trustee transfer assets into the debt service fundsin amounts sufficient to meet the requirements of the indenture.

Under the trust indenture agreement between the corporation and thetrustee for the RHS and SHARP revenue bonds, the corporation isrequired to provide net revenues (as defined in the trust indentureagreement) together with lawfully available funds of at least 1.25 timesthe aggregate debt service on outstanding bonds during the bond year.Additionally, the corporation is to provide net revenues (as defined in thetrust indenture agreement) of at least 1.1 times the aggregate debt serviceon outstanding bonds during the bond year. At June 30, 2000, the RHSand SHARP revenue bond funds provided net revenues (as defined in the

Note G – RevenueBond Funds – ReserveRequirements

39


trust indenture agreement) together with lawfully available funds of 5.41and 11.45 times the aggregate debt service on outstanding bonds duringthe year, respectively, and net revenues (as defined in the trust indentureagreement) of 1.34 and 1.92 times the aggregate debt service onoutstanding bonds during the year, respectively. As per the trustindenture agreement, the RHS may use unrestricted assets of thecorporation’s other funds to calculate the ratio of net revenues andlawfully available funds to the aggregate debt service on outstandingbonds during the year.

The trust indenture agreement also requires that the mortgage loanreserves for these Revenue Bond Funds be funded from other than bondproceeds and, accordingly, the reserves have been funded bycommitment fees at June 30, 2000.

A summary of changes in general fixed assets for the fiscal year endedJune 30, 2000 is as follows:

Balance, Balance,July 1, 1999 Additions Deletions June 30, 2000

Land $ 1,515,410 $ -- $ -- $ 1,515,410Buildings and improvements 19,757,621 4,668,184 -- 24,425,805Equipment, furniture, and fixtures 1,021,195 -- -- 1,021,195Construction in progress 4,927,687 1,202,899 4,924,112 1,206,474

Property and equipment $27,221,913 $ 5,871,083 $ 4,924,112 $ 28,168,884

At June 30, 2000, property, plant, and equipment for the proprietary fundtypes consisted of the following:

Enterprise InternalFunds Service Funds Total

Land $ 61,603,391 $ -- $ 61,603,391Buildings and improvements 529,481,333 -- 529,481,333Equipment, furniture, and fixtures 9,274,361 2,428,036 11,702,397Construction in progress 14,805,049 -- 14,805,049

615,164,134 2,428,036 617,592,170Less accumulated depreciation 231,637,061 2,153,662 233,790,723

Net property and equipment $383,527,073 $ 274,374 $ 383,801,447

During the fiscal year ended June 30, 2000, the corporation executedcertain long-term leases with the tenants at Waiahole Valley.Accordingly, approximately $11.5 million of land held for sale under theDURF was reclassified to property and equipment (note R).

Note H – Property andEquipment

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Mortgages Payable

The Banyan Street Manor Project entered into a mortgage noteagreement in October 1976 in the amount of $1,727,800 with USGI, Inc.(insured by HUD). On September 1, 1996, Greystone ServicingCorporation, Inc. became the new servicing agent and mortgagee. Themortgage loan bears interest at 7.5 percent and is collateralized by therental property. Principal and interest are payable in monthlyinstallments of $11,370, maturing January 1, 2018. At June 30, 2000,the mortgage payable balance was $1,016,244.

The Wilikina Apartments Project (Wilikina) entered into a mortgagenote agreement in January 1977 in the amount of $3,535,500 with theState of Michigan Department of Treasury (insured by HUD). Inconnection with the purchase of Wilikina by the HHA WilikinaApartments Project, Inc., the HHA Wilikina Apartments Project, Inc.assumed the note. During the year, HHA Wilikina Apartment Projects,Inc. exercised its prepayment option, and fully paid the mortgage notebalance of $2,142,707 in the month of May 2000.

The Kekuilani Gardens Project (Kekuilani) entered into a mortgageagreement in December 1996 in the amount of $5,213,614 with the U.S.Department of Agriculture and Rural Development. The mortgage loanbears interest at 7.25 percent and is collateralized by the KekuilaniGardens. Principal and interest are payable in monthly installments of$11,509 and matures on December 1, 2046. At June 30, 2000, themortgage payable balance was $5,172,925.

Kekuilani also entered into an interest credit and rental assistanceagreement in December 1996 with the U.S. Department of Agricultureand Rural Development that reduces Kekuilani’s principal and interestpayments. During the period, Kekuilani realized approximately$256,000 of interest credit reducing the interest expense fromapproximately $376,000 to $121,000.

In addition, Kekuilani entered into a mortgage agreement inDecember 1996 in the amount of $696,267 with the RHTF. Themortgage loan bears interest at 1 percent and is collateralized by theKekuilani Gardens. Principal and interest are payable in monthlyinstallments of $1,475 and matures on January 1, 2047. At June 30,2000, the mortgage payable balance was $650,997.

Notes Payable

The corporation has three mortgage notes payable to the U.S.Department of Agriculture, Farmers Home Administration (FHA). Twonotes were originated in August 1976, and are payable in combinedmonthly installments of $2,207, including interest at 1 percent, with the

Note I – Mortgages andNotes Payable

41


final combined payment due in August 2009. The third note wasoriginated in October 1994, and is payable in monthly installments of$1,315 due in October 2027. The notes are secured by property andrental receipts. Notes payable to the FHA as of June 30, 2000 totaled$566,231.

During 1996, the SHARP borrowed $3.5 million from the RHTF andissued approximately $7 million of revenue bonds to purchase theKekuilani Courts Rental Housing project from an outside party. The fullamount of the non-interest bearing note shall become due and payableupon the earlier of June 30, 2027, or the redemption of all SHARPrevenue bonds associated with the Kekuilani Courts Rental Housingproject.

Notes payable also consists of a $171,327 unsecured promissory notepayable to an individual (the former owner of Banyan Street). The entireprincipal balance plus accrued interest, which accrues at the same rate asthe residual receipt funds held by USGI, Inc. (approximately4.08 percent for the year ended June 30, 2000), is due within 45 days offull payment of the 7.5 percent USGI, Inc. mortgage note collateralizedby HUD which matures on January 1, 2018.

The approximate maturities of mortgages and notes payable are asfollows:

Fiscal year ending June 30,2001 $ 124,0002002 130,0002003 137,0002004 145,0002005 153,000Thereafter 10,389,000

$ 11,078,000

Through June 30, 2000, approximately $1,873,935,000 of revenue bondshave been issued. The revenue bonds are payable from and securedsolely by the revenues and other monies and assets of the Revenue BondFunds and other assets of the corporation pledged under the indentures.

In August 1997 and June 1998, the corporation, through its SingleFamily Mortgage Purchase Revenue Bond Fund, issued $161,430,000and $164,060,000 of Single Family Mortgage Purchase Revenue Bonds,respectively. The 1997 and 1998 Series Bonds were issued to providefunds to purchase single pool mortgage-backed securities and to effect aredemption of $114,405,000 of certain bonds previously issued by thecorporation.

Note J – RevenueBonds Payable

42


The 1997 and 1998 refundings resulted in a difference between thereacquisition price and the net carrying amount of the old debt ofapproximately $2,500,000. This difference, reported in theaccompanying combined financial statements as a deduction from bondspayable, is being charged to operations through the year 2029.

In June 2000, the corporation, through its Single Family MortgagePurchase Revenue Bond Fund, issued $106,785,000 2000 Series A and$1,980,000 2000 Series B Single Family Mortgage Purchase RevenueBonds. The 2000 Series Bonds were issued to provide funds to purchasesingle pool mortgage-backed securities and to effect a redemption ofcertain bonds previously issued by the corporation. The net proceeds of$8,765,000 were used to purchase repurchase agreements. Thoserepurchase agreements were deposited with the Trustee to provide for theredemption of portions of the 1998 Series A, 1997 Series A, 1994 SeriesA, 1991 Series A and B, and 1990 Series A bonds, by July 1, 2000. As aresult, these bonds were considered to be in-substance defeased and theliability for those bonds was no longer reported.

The 2000 advanced refunding resulted in a difference between thereacquisition price and the net carrying amount of the old debt ofapproximately $30,000. This difference, reported in the accompanyingfinancial statements as a deduction from bonds payable, is being chargedto operations through the year 2008. The corporation completed theadvanced refunding to reduce its total debt service payments over thenext 30 years by approximately $880,000 and to obtain an economic gain(difference between the present value of the old and new debt servicepayments) of approximately $370,000.

Revenue bonds payable at June 30, 2000 consist of the followingissuances:

Single Family Mortgage Purchase revenue bonds:

1989 Series A:Serial bonds maturing annually through 2006 (7.25% to 7.55%) $ 120,000Term bonds maturing in 2010 and 2030 (7.63% and 7.80%) 1,600,000

1,720,000

1990 Series A:Serial bonds maturing annually through 2006 (7.10% to 7.60%) 1,370,000Term bonds maturing in 2011, 2020, and 2024 (7.80% to 8.00%) 8,215,000

9,585,000


14,680,000

43


1991 Series B:Term bonds maturing in 2017 and 2032 (6.90% and 7.00%) 21,445,000


127,685,000

1994 Series B:Term bonds maturing in 2014, 2018, and 2028 (5.70% to 5.90%) 87,285,000


100,805,000

1997 Series B:Serial bonds maturing annually from 2004 to 2010 (4.45% to 5.00%) 15,995,000Term bonds maturing in 2018 (5.45%) 29,405,000

45,400,000


143,000,000

1998 Series B:Term bonds maturing in 2029 (5.30%) 11,085,000

1998 Series C:Term bonds maturing in 2021 (5.35%) 4,060,000

2000 Series A:Serial bonds maturing from 2003 to 2013 (5.30% to 6.15%) 13,610,000Term bonds maturing in 2021, 2028, 2032, and 2033 (5.93% to

6.375%) 93,175,000

106,785,000

2000 Series B:Term bonds maturing in 2016 (6.00%) 1,980,000

Total Single Family Mortgage Purchase revenue bonds 675,515,000

Multifamily Housing revenue bonds:

1985 Series A (Tropicana West project) – term bonds maturing in2011 (fixed rate in accordance with the terms of the indenture,4.40% at June 30, 2000) 32,000,000

1999 Series (Manana Gardens Apartment project) – serial bondsmaturing in 2035 (6.30%) 3,750,000

Total Multifamily Housing revenue bonds 35,750,000

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RHS revenue bonds:

1989 Series A (Honokowai Kauhale project) – serial bonds maturingannually through 2025 (variable rate in accordance with the terms ofthe indenture, 4.95% at June 30, 2000) 15,500,000

1990 Series A (Kamakee Vista project) – serial bonds maturingannually through 2026 (variable rate in accordance with the terms ofthe indenture, 5.35% at June 30, 2000) 32,800,000

1990 Series B (Pohulani project) – serial bonds maturing annuallythrough 2026 (variable rate in accordance with the terms of theindenture, 5.35% at June 30, 2000) 35,100,000

1993 Series A (La’ilani project):Serial bonds maturing annually through 2006 (4.65% to 5.20%) 2,425,000Term bonds maturing in 2013 and 2019 (5.60% and 5.70%) 9,560,000

11,985,000

Total RHS revenue bonds 95,385,000

SHARP revenue bonds:

1993 Series A (Kauhale Kakaako project) – serial bonds maturingannually from 2001 through 2028 (variable rate in accordancewith the terms of the indenture, 4.65% at June 30, 2000) 30,700,000

1995 Series A (Kekuilani Courts Rental Housing project) – term bonds maturing on 2016, 2023, and 2031 (6.00%, 6.05%, and 6.10%) 6,835,000

Total SHARP revenue bonds 37,535,000

University of Hawaii Faculty Housing Program revenue bonds:

1995 Series:Serial bonds maturing annually through 2007 (4.35% to 5.00%) 2,545,000Term bonds maturing in 2017 and 2026 (5.65% and 5.70%) 14,255,000

Total University of Hawaii Faculty Housing Program revenuebonds 16,800,000

860,985,000

Deferred refunding amount (difference between reacquisition price and net carrying value of old debt) 2,073,707

Total Revenue Bonds $ 858,911,293

Interest on the Single Family Mortgage Purchase revenue bonds ispayable semi-annually. Interest on the Multifamily Housing revenuebonds is payable quarterly for the Tropicana West project and semi-annually for the Manana Gardens Apartment project. Interest on theRHS and SHARP revenue bonds are payable monthly except for theRHS 1993 Series A and SHARP 1995 Series A bond issues, which are

45


payable semi-annually. Interest on the University of Hawaii FacultyHousing Program revenue bonds is payable semi-annually.

The Single Family Mortgage Purchase and RHS revenue bonds withdesignated maturity dates, the Multifamily Housing 1999 Series revenuebonds, the SHARP 1995 Series A revenue bonds, and the University ofHawaii Faculty Housing Program revenue bonds may be redeemed at theoption of the corporation commencing in 1999 for the 1989 Series, 2000for the 1990 Series, 2001 for the 1991 Series, 2004 for the 1994 Series,and 2007 for the 1997 Series, subject to a redemption premium thatranges from 2 percent to zero; 2008 for the 1998 Series, subject to aredemption premium that ranges from 1.5 percent to zero; 2010 for the2000 Series, 2001 for the Multifamily Housing 1999 Series, subject to aredemption premium that ranges from 2 percent to zero; 2005 for theSHARP 1995 Series A subject to a redemption premium that ranges from2 percent to zero; and 2005 for the University of Hawaii Faculty HousingProgram 1995 Series subject to a redemption premium that ranges from 1percent to zero. The revenue bonds may also be redeemed withoutpremium prior to maturity, at the option of the corporation, as fundsbecome available from undisbursed bond proceeds, principal paymentsand prepayments of mortgages, excess amounts in the debt servicereserve account, or excess revenues (as defined in the bond indentures).The RHS and SHARP revenue bonds with variable interest rates may beredeemed early at face value at the option of either the bondholders orthe corporation during the variable interest rate period. Subsequent tothe variable interest rate period, the bonds may be redeemed early at theoption of the corporation subject to a redemption premium that rangesfrom 2 percent to zero. The Multifamily Housing revenue bonds relatedto the Tropicana West project are subject to redemption withoutpremium prior to maturity, from undisbursed bond proceeds, principalmortgage payments and prepayments, hazard insurance proceeds, orcondemnation proceeds received. The bonds currently bear interest at afixed rate. The bonds related to the Tropicana West project are subjectto a redemption premium that ranges from 3 percent to zero only uponconversion to a fixed rate.

During the fiscal year ended June 30, 2000, early redemptions totaled$13,040,000. The deferred bond issuance costs related to the earlyredemption of bonds are written off at the time an early redemption isapproved and are reflected as an extraordinary item in the combinedfinancial statements.

The approximate maturities and sinking fund requirements of revenuebonds are as follows:

46


Fiscal year ending June 30,2001 $ 2,185,0002002 10,505,0002003 12,045,0002004 13,095,0002005 14,060,000Thereafter 809,095,000

$ 860,985,000

Arbitrage Rebate

In order to ensure the exclusion of interest on the corporation’s RHSrevenue bonds, SHARP revenue bonds and Single Family MortgagePurchase 1989 Series A, 1990 Series A, 1991 Series A and B, and 1994Series A and B revenue bonds from gross income for federal income taxpurposes, the corporation calculates rebates due to the U.S. Treasuryannually. The rebates are calculated by bond series based on the amountby which the cumulative amount of investment income exceeds theamount that would have been earned had funds been invested at the bondyield. At June 30, 2000, the corporation determined that approximately$3,074,000 of rebates were due to the U.S. Treasury.

The general long-term obligation account group is used to account forthe long-term portion of the obligation for accrued vacation payable.The obligation changed during the fiscal year ended June 30, 2000 asfollows:

Accruedvacation payable

Balance at July 1, 1999 $ 248,221Net increase in accrued vacation 3,068

Balance at June 30, 2000 $ 251,289

The contributed capital of the DURF was funded with proceeds of$125,000,000 of state general obligation bonds, for which the principalpayments are being funded by the state general fund. These bonds arethe state’s general obligation and are not included in these combinedfinancial statements. The DURF, however, is required to reimburse thestate general fund for the interest portion of the debt service, at ratesranging from 3.85 percent to 5.5 percent. Interest cost incurred for thefiscal year ended June 30, 2000 was approximately $48,000.

Note K – General Long-Term Obligation

Note L – ContributedCapital

47


The annual interest requirements on the general obligation bonds as ofJune 30, 2000 are as follows:

Fiscal year ending June 30,2001 $ 39,4002002 26,7002003 13,500

$ 79,600

The contributed capital of the HUD Subsidized Programs in theenterprise funds includes HUD-guaranteed (bonds and loans) and HUD-direct debt incurred to finance development and modernization ofcorporation-owned housing projects. HUD, through its annualcontribution contract payments, is obligated to fund the debt servicerequirements, including housing bonds issued by the corporation. OnJuly 1, 1999, the corporation determined that approximately $27,000,000of certain HUD collateralized liabilities and HUD note payables did notconstitute debt of the corporation and, accordingly, have beenreclassified as contributed capital.

During the current year, the corporation determined that an enterprisefund had erroneously capitalized certain expenditures as fixed assets inthe prior years. In addition, certain fixed assets were not being properlydepreciated over their estimated useful lives. Accordingly, the beginningretained earnings balances and contributed capital balances as previouslyreported have been restated by approximately $18,659,000 and$27,806,000, respectively.

During 1997, the HRF transferred to the state Department of HawaiianHome Lands certain parcels of land currently being developed by thecorporation. Estimated future cost resulting from the development ofthese parcels of land will be recognized as contributions returned to theState when costs are incurred (note R).

The capital projects fund was established to account for capitalimprovement project appropriations received from the State. Uponcompletion, these projects are transferred to other funds or agencies.

Lease Commitments

The corporation leases land, buildings, and improvements under variousnoncancelable operating leases expiring at various dates through 2056.The land lease for the Banyan Street Manor Project contains the optionto purchase the fee-simple interest in the land at any time for a specifiedpercentage of fair market value at the time of purchase.

Note M – Fund Equity

Note N – Leases

48


The minimum rental commitments under operating leases are as follows:


$ 13,659,200

Rent expense for the fiscal year ended June 30, 2000 totaledapproximately $587,000.

Lease Rentals

The corporation leases approximately $20,000,000 of land to variousdevelopers and home buyers. The leases are generally for 55 years withthe last 25 years’ lease rent negotiated based on the fair market value ofthe land. Rent income for the fiscal year ended June 30, 2000 wasapproximately $344,000.

The future minimum lease rent from these operating leases at June 30,2000 is as follows:


$ 4,315,900

Loan Commitments and Guarantee

The corporation has outstanding commitments to purchase loans fromparticipating lenders of approximately $135,000,000 at June 30, 2000.

As of June 30, 2000, the corporation has filed an extension for filing itsschedules of mortgage payment credits with the bond trustees for theSingle Family Mortgage Purchase Revenue Bond Fund. Mortgagepayment credits are the amounts to be credited to particular mortgagors,if any, who voluntarily prepay their mortgage loans in the ensuing year.The credits are based on the amount by which cumulative nonmortgage

Note O – Commitmentsand Contingencies

49


investment income exceeds the cumulative cost of the related funds.Estimated mortgage payment credits at June 30, 1992 amounted toapproximately $102,000 of which approximately $84,143 was rebatedthrough June 30, 2000.

In accordance with the provision of the Development Agreement datedFebruary 14, 1997 for the Single Family phases of Villages 7 and 8 atKapolei, the corporation shall provide interim construction financing ofapproximately $67,000,000, subject to the satisfaction of certain termsand conditions of the Development Agreement. The term of the interimloan shall mature on the date which is 48 months from the effective dateof the Development Agreement and will accrue interest at 7.5 percent. InJuly 2000, the corporation approved an extension for the loan agreementuntil February 2001.

The corporation has guaranteed up to $40,000,000 of the mortgage loanssold by it to the Employees’ Retirement System of the State of Hawaii(ERS). Upon the 120th day of any delinquency or default, thecorporation is obligated to cure the arrearage of principal and interest orbuy back the delinquent loan. At June 30, 2000, the outstanding balanceof mortgage loans that have been sold to the ERS that are covered by theloan guarantee was approximately $2,308,000. At June 30, 2000, notesand loans receivable include approximately $309,000 of delinquent loanspurchased back from the ERS.

Construction Contracts

At June 30, 2000, the DURF had outstanding commitments to expendapproximately $1,577,000 for the construction and renovation of housingprojects and outstanding commitments to fund interim loans for variousprojects totaling approximately $10,574,000.

At June 30, 2000, the HRF had outstanding commitments forconstruction contracts related to three master-planned developmentprojects of approximately $11,873,000, of which approximately$11,159,000 will be funded by the DURF.

Development Costs

The corporation’s Board of Directors has approved funding ofdevelopment costs for the Leiali’i Master Planned Community project ofapproximately $68,000,000. As of June 30, 2000 approximately$41,442,000 has been expended, net of approximately $1,370,000 fromthe County of Maui for the wastewater system design and water systemand $1,753,000 from the state Department of Transportation (DOT) asreimbursements for Ikena Avenue.

50


The corporation’s Board of Directors approved funding of thedevelopment costs for the infrastructure construction for the La’i’opuaproject of approximately $40,600,000. As of June 30, 2000,approximately $19,802,000 has been expended, net of approximately $10million of reimbursements from DOT for certain expenditures.

Rental Assistance

The corporation’s Board of Directors approved a commitment by theRAF to provide maximum rental assistance subsidies of approximately$69,129,000 on various projects.

Torts

The corporation is involved in various actions, the outcome of which, inthe opinion of management and the state Department of the AttorneyGeneral, will not have a material adverse effect on the corporation’sfinancial position except for the Office of Hawaiian Affairs (OHA)lawsuit described below. Losses, if any, are either covered by insuranceor will be the liability of the State.

Workers’ Compensation Policy

The corporation has a retrospectively rated workers’ compensationinsurance policy. Based on available claim experience information, theminimum premium accrued for financial statement reporting purposesapproximates the corporation’s ultimate workers’ compensation cost.

Accumulated Sick Leave Pay

Sick leave accumulates at the rate of one and three-quarters workingdays for each month of service without limitation. It may be taken onlyin the event of illness and is not convertible to pay upon termination ofemployment. However, a state employee who retires or leavesgovernment service in good standing with 60 days or more of unusedsick leave is entitled to additional service credit in the ERS.Accumulated sick leave at June 30, 2000 amounted to approximately$5,290,000.

Deferred Compensation Plan

In 1984, the State established a deferred compensation plan that enablesstate employees to defer a portion of their compensation. The stateDepartment of Human Resources Development has the fiduciaryresponsibility of administering the plan. Deferred compensation is notavailable to employees until termination, retirement, death, or anunforeseeable emergency.

51


Litigation

In November 1994, OHA filed a claim against the corporation seekingdeclaratory and injunctive relief and for monetary damages pursuant toSections 632-1 and 66-1 of the HRS. The claim relates to certain cededlands located in Lahaina, Maui. OHA seeks the following relief: (1)barring the corporation from conveying and alienating the subject landfrom the public land trust and (2) finding any conveyance to a third partynot an agency of the State or its political subdivision in violation of theHawaii State Constitution.

In its claim, OHA also alleges that the corporation is in violation of theHRS Section 10-3.6 and Act 318, SLH 1992. In 1992, the Legislatureenacted Act 318, which sets forth a plan to compensate OHA for landfrom the public land trust which was to be conveyed from the stateDepartment of Land and Natural Resources (DLNR) to the corporationfor housing developments. Under Act 318, OHA is to be compensated20 percent of the fair market value of ceded lands. OHA maintains thatthe fair market value of the Lahaina ceded lands was determined in May1994. In November 1994, the ceded lands were conveyed from DLNR tothe corporation and a check for 20 percent of the fair market value of theproperty in the amount of $5,573,604 was presented to OHA. OHAclaims that a timely appraisal was not performed, 90 days before the dateof conveyance, and that the conveyance of the Lahaina property wasillegal. The payment was rejected by OHA and a liability remainsoutstanding as of June 30, 2000. In the event that OHA is not grantedthe injunctive and declaratory relief its seeks, OHA requests for a timelyreappraisal of the fair market value of the Lahaina ceded lands andpayment in accordance with Act 318. The corporation maintains that thefair market value was determined in August 1994 and therefore complieswith the requirements of Act 318.

In November 1994, several individuals filed a claim similar to the OHAclaim against DLNR and the corporation seeking to enjoin the sale ortransfer of certain ceded lands located in Lahaina, Maui, from the Stateto private individuals or entities. The claim alleges that the State doesnot have good marketable title of the ceded lands and any such sale ortransfer would constitute an illegal conversion of lands. The plaintiffsseek an injunctive relief barring the corporation from sale or transfer ofthe Lahaina ceded lands.

In response to the above claims, the state Department of the AttorneyGeneral issued, in July 1995, its opinion as to whether the State has legalauthority to sell or dispose of ceded lands. The attorney generalconcluded that the State has been and remains empowered to sell trustlands subject to the terms of the trust.

52


The above claims have resulted in delays in the Leiali’i and La’i’opuaMaster-Planned Community projects. The corporation is currentlyevaluating alternatives and remains optimistic and committed to theseprojects. The corporation will continue to work with innovation andcreativity to resolve these concerns fairly, while still delivering qualityhouses in quality communities. The ultimate outcome of these claimscannot be determined at this time. Accordingly, no provision for anyliability nor its effect on the projects’ net realizable value, if any, thatmay result upon adjudication, has been made in the accompanyingcombined financial statements.

In 1994, an action was filed by OHA against the State and variousunnamed parties claiming the State’s alleged failure to properly accountfor and pay to OHA monies due to OHA, under Article XII of the HawaiiState Constitution and Chapter 10 of the HRS, for occupation by theState on certain ceded lands, as more fully described below.

It has been alleged that payments received by the corporation for allprojects developed on ceded lands are subject to the above claim.However, the ultimate outcome of the litigation and its effect on thecorporation, if any, cannot be determined at this time. Accordingly, noprovision for any liability, if any, that may result from the resolution ofthis matter has been made in the combined financial statements.

Ceded Lands

OHA et al. v. State of Hawaii, Civil No. 94-0205-01 (First Circuit).The lands transferred to the United States by the Republic of Hawaii atHawaii’s annexation to the United States in 1898 are commonly referredto as the ceded lands. Upon Hawaii’s admission to the Union in 1959,title to ceded lands still held by the United States and to lands that theUnited States acquired by exchange for ceded lands after 1898 wasconveyed by the United States to the State. Section 5 of the AdmissionAct expressly provided that those lands were to be held by the State as apublic trust. Certain rental housing projects of the corporation aresituated on parcels of land that are to be held by the State as a publictrust under Section 5.

In 1978, the State Constitution was amended to expressly specify that thelands conveyed to the State as a public trust by the Admission Act wereto be held by the State as a public trust for native Hawaiians and thegeneral public, and to establish OHA to administer and manage theproceeds and income derived from the pro rata portion of the lands heldby the State for the betterment of native Hawaiians.

On January 14, 1994, OHA filed suit against the State alleging that theState failed to properly account for and fully pay the pro rata share of

53


proceeds and income derived from the lands of public trust establishedby the Admission Act and the 1978 amendments to the StateConstitution. OHA seeks an accounting of all proceeds, income, funds,and revenues derived from the lands since 1978, and restitution ordamages amounting to 20 percent of the proceeds and income derivedfrom (a) the lands since November 7, 1978, (b) the lands since June 16,1980, and (c) the lands under Act 304, SLH 1990, as well as interestthereon. The State has denied all of OHA’s substantive allegations, andasserted its sovereign immunity from suit and other jurisdictional andclaim-barring defenses.

In May 1996, OHA filed four motions for partial summary judgment asto the State’s liability to pay OHA 20 percent of monies from fourspecific sources, including rental housing projects of the corporationsituated on public trust lands. The State opposed those four motions.The State also filed a motion to dismiss on sovereign immunity grounds.

On October 24, 1996, the Circuit Court of the First Circuit of the State ofHawaii (First Circuit Court) denied the State’s motion to dismiss andgranted OHA’s four motions for partial summary judgment. The Statehas filed an interlocutory appeal to the Hawaii Supreme Court from bothorders. All other proceedings, including the trial previously scheduled tobegin on November 18, 1996, have been stayed pending the HawaiiSupreme Court’s disposition of the appeal.

OHA’s complaint and motions do not specify the State’s alleged failures,nor do they state the dollar amount of the claims. The First CircuitCourt’s October 24, 1996 order granting OHA’s motions for partialsummary judgment did not determine the amounts owing. The basis andmethodology for calculating any such amount are being disputed. OHAhas not provided complete information for its claims for the period from1981 through 1991, and has provided no information as to its claims forthe period from 1991 to the present. The expert witness retained byOHA in this case has estimated that the State’s potential liability for thefour sources specified in OHA’s summary judgment motions for theyears 1981 through 1991 (but not thereafter) to be not less than$178,000,000, of which approximately $9,200,000 is related to grossrental income derived by the corporation.

On June 30, 1997, the governor approved Act 329, SLH 1997. Thepurpose of this act was to achieve a comprehensive, just, and lastingresolution of all controversies relating to the proper management anddisposition of the lands subject to public trust, and of the proceeds andincome that the lands generate. The act also fixes the amount ofproceeds and income OHA will receive during the two-year period at$15.1 million per year, and requires the completion, continuedmaintenance, and use of a comprehensive inventory of the public trustlands.

54


OHA et al. v. HHA et al., Civil No. 95-2682-07 (First Circuit). OnJuly 27, 1995, OHA filed suit against the HHA and the state director offinance to secure additional compensation and an itemized accounting ofthe sums previously paid to OHA for five specifically identified parcelsof ceded lands, which were transferred to the HHA for rental housingprojects. Discovery is ongoing and no trial date has been set.

The State’s potential liability may be determined either (1) by the rulingby the Hawaii Supreme Court on the State’s interlocutory appeal and, ifsuch ruling is adverse to the State, the conclusion of any subsequent trialand related appeals, or (2) by legislation enacted as a result of theprocess set out in Act 329. Given all of the above, and the uncertaintiming of any final disposition of the case, the State is not able to predicteither the ultimate outcome of the case, or the magnitude of its potentialliability with any reasonable certainty. A legislative resolution orjudicial decision adverse to the State could have a material adverse effecton the state’s financial condition.

A legislative resolution or judicial decision adverse to the State couldhave a material adverse effect on the corporation’s financial condition ifan adverse resolution or decision against the State includes liability forgross rental income derived by the corporation from rental housingprojects situated on lands in the public trust and the liability is imposedupon the corporation. However, the ultimate outcome of the litigationand its effect on the corporation, if any, cannot be determined.Accordingly, no estimate of loss has been made in the accompanyingcombined financial statements of the corporation.

Employees’ Retirement System

Plan Description. All eligible employees of the state and counties arerequired by Chapter 88 of the HRS to become members of the ERS, acost-sharing multiple-employer public employee retirement plan. TheERS provides retirement benefits as well as death and disability benefits.The ERS issues a publicly available comprehensive annual financialreport that includes financial statements and required supplementaryinformation that may be obtained by writing to the ERS, City FinancialTower, 201 Merchant Street, Suite 1400, Honolulu, Hawaii 96813.

The ERS consists of a contributory plan and a noncontributory plan.Employees covered by Social Security on June 30, 1984 were given theoption of joining the noncontributory plan or remaining in thecontributory plan. All new employees hired after June 30, 1984, who arecovered by Social Security, are generally required to join thenoncontributory plan. Both plans provide a monthly retirementallowance based on the employee’s age, years of credited service, and

Note P – RetirementPlan

55


average final compensation (AFC). The AFC is the average salaryearned during the five highest paid years of service, including thevacation payment, if the employee became a member prior to January 1,1971. The AFC for members hired on or after this date is based on thethree highest paid years of service excluding the vacation payment. Allbenefits vest after five and ten years of credited service for thecontributory and noncontributory plans, respectively. All contributions,benefits, and eligibility requirements are governed by Chapter 88, HRS.

Funding Policy. Most covered employees of the contributory plan arerequired to contribute 7.8 percent of their salary. Police officers,firefighters, investigators of the department of the prosecuting attorneyand the attorney general, narcotics enforcement investigators, and publicsafety investigators are required to contribute 12.2 percent of theirsalary. The actuarial cost or funding method used to calculate the totalemployer contribution requirement was changed by Act 327 of theRegular Session of the 1997 Legislature to the Entry Age NormalActuarial Cost Method. Under this method, employer contributions tothe ERS are comprised of normal cost plus level annual paymentsrequired to liquidate the unfunded actuarial accrued liability over theremaining period of 18 years from July 1, 1998.

The contributions related to the corporation are included in personnelservices expense in the combined financial statements. Suchcontributions approximated $703,000 and $653,000 for the fiscal yearsended June 30, 2000 and 1999, respectively, which were equal to therequired contributions for each year.

In addition to providing pension benefits, the State provides certainhealth care and life insurance benefits to all employees hired prior toJuly 1, 1996 who retire from state employment on or after attaining age62 with at least 10 years of service or age 55 with at least 30 years ofservice under the noncontributory plan and age 55 with at least 5 years ofservice under the contributory plan. Retirees credited with at least tenyears of service, excluding sick leave credit, qualify for free medicalinsurance premiums; however, retirees with less than ten years mustassume a portion of the monthly premiums. All service-connecteddisability retirees who retired after June 30, 1984, with less than 10 yearsof service, also qualify for free medical insurance premiums. Free lifeinsurance coverage for retirees and free dental coverage for dependentsunder age 19 are also available. Retirees covered by the medical portionof Medicare are eligible to receive a reimbursement of a portion of thebasic medical coverage premiums.

For employees hired after July 1, 1996 who retire with fewer than 25years of service, the State shall pay to a fund a monthly contribution

Note Q – Post-Retirement Health Careand Life InsuranceBenefits

56


equal to one-half of the retired employee’s monthly Medicare or non-Medicare premium for certain medical benefits for retired employeeswith ten or more years of service; and 75 percent of the retiredemployee’s monthly Medicare or non-Medicare premium for retiredemployees with at least 15 but fewer than 25 years of service.

Contributions are based upon negotiated collective bargainingagreements, and are funded by the corporation as accrued.

The corporation’s general fund share of the post-retirement benefitsexpense for the fiscal year ended June 30, 2000 has not been separatelycomputed and is not reflected in the corporation’s combined financialstatements. The corporation’s enterprise funds’ and Section 8 specialrevenue funds’ share of the post-retirement health care and life insurancebenefits expense for the fiscal year ended June 30, 2000 was $740,000.

DLNR conveyed land to the corporation for the Kapolei project. Thecost of this land, $17,225,200, has been capitalized and charged to costof sales to the extent the units have been sold. The consideration for thisconveyance is reported as an advance from DLNR at June 30, 1998.During 1995, the corporation and DLNR agreed to exchange thecorporation’s fee-simple lands at Waiahole Valley in lieu of repaymentof the $17,225,200. However, in May 1998, representatives from thecorporation, DLNR and the state Department of the Attorney Generalmet to discuss the transfer of the Waiahole property. During themeeting, it was determined that the corporation would retain theWaiahole Valley property, execute long-term leases with the tenants atWaiahole Valley, and have no further obligation to DLNR. In April1999, the measures were approved by the Board of Land and NaturalResources and the $17,225,200 advance from DLNR was credited tocontributed capital.

In accordance with Act 95, SLH 1996, the corporation transferred certainparcels of land located within the Villages of La’i’opua on the island ofHawaii and Kapolei on the island of Oahu to the state Department ofHawaiian Home Lands. The properties were conveyed in 1997 andapproximately $8,175,000 of allocated costs were charged againstcontributed capital. Any estimated future costs of these parcels will berecognized as contributions returned to the State when costs are incurred.During the fiscal year ended June 30, 2000, approximately $727,000 ofcosts were incurred on these parcels and charged against contributedcapital. The estimated allocated project costs and allocated costsincurred for these parcels of land located in La’i’opua and Kapolei as ofJune 30, 2000 are approximately as follows:

Note R – Related PartyTransactions

57


Allocated Allocated costsproject cost incurred to date

La’i’opua $ 8,978,000 $ 1,827,000Kapolei 11,557,000 8,682,000

$ 20,535,000 $ 10,509,000

The RAF provides rent subsidies to certain lessees of the corporation’svarious projects. Total rent subsidies provided to lessees of thecorporation’s various projects approximated $1,338,000 during the fiscalyear ended June 30, 2000 and was recorded by the corporation as rentalincome in the RHS and the SHARP. In addition, the corporationrelocated its offices to the Pohulani building in September 1992, which isowned by the RHS. During the fiscal year ended June 30, 2000, the RHSrecorded rental income of approximately $9,400,000, of whichapproximately $791,200 was allocated as office rental expense to variousfunds of the corporation. In addition, the state Department ofAccounting and General Services (DAGS) incurred $826,500 in rent tothe RHS for leased space in the Pohulani building. The term of the leasewith DAGS is from September 1992 through August 2022. Theminimum annual rent is determined by multiplying the previous year’sminimum annual rent by 103 percent. The minimum annual rent for theinitial year was approximately $493,000.

On July 1, 2000, the corporation redeemed certain outstanding revenuebonds totaling $10,465,000, of which $1,270,000 were early redemptionsand $8,765,000 were refundings.

Note S – SubsequentEvents

58

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g, ~Q. "'.."

2 ~ ?;o;g.!j .5 .5 ~o .5 g' ;:'" -

'-' c --"' R J3 J3..~ o o

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~!j"O"" ~ " ~

"o-~~" .." ","""""".-"0 " '"~§~;:J~'"'

59

Exhibit BSTATE OF HAWAII

HOUSING AND COMMUNITY DEVELOPMENT CORPORATION OF HAWAII

Combined Statement of Revenues, Expenditures, and Changes inFund Balances -All Governmental Fund Types and Expendable Trust Funds

Year ended June 30, 2000

Total

(memorandumonly)

$ 21,263,581

64,799,049

229,361

11,532

86,303,523

25,117

86,328,640

Revenues:

Intergovernmental -HUD annual contributionsState allotted appropriations

interest

Other

$

FiduciaryGovernmental Fond Types Fund Type

Special Capital ExpendableGeneral Revenue Projects Trust

$ 21,263,581 $ $7,263,213 8,785,836

229,36111,532

21,504,4747,263,213

25,117

7,288,330

8,785,836

48,750,000

Total revenues

Other financing source -operating transfers in

Total revenues and other financing source 21,504,474

1,709,2674,039,341

541,20635,852

151,550494,179120,278

4542,905

7,095,032

311,520

7,406,552

17,912,723

1,470,8551,450,184

97,2341,166

474,8392,059

11,519

Expenditures"CuITent:

Housing assistance paymentsHomeless servicesPersonnel services (notes P and Q)AdministrationProfessional services

SecurityRepairs and maintenanceUtilitiesOther

Capital outlay (note H)

Total expenditures

Other financing use -operating transfers out to enterprise funds

Total expenditures and other financing use

Excess (deficiency) of revenues and other financingsource over expenditures and other financing use

Fund balance at July 1,1999

Fund balance at June 30, 2000

24,198

257

1,173,903

1,198,358

1,327

39,854,376

39,855,703

39,855,703

(118,222)

342,720

$ 224,498

See accompanying notes to combined financial statements.

60

19,621,9904,039,3412,012,0611,510,234

248,784495,3455%,701

2,51314,424

41,028,279

69,569,672

311,520

69,881,192

83,895

5,571,967

5,655,862

7,587,478

4,167,296

11,754,774

8,894,297

2,635,283

11,529,580

16,447 ,448

12,717,266

29,164,714

u:c:a~

~

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61

\Dor)r-..o 00--MO \DMMor)O -ori' : O 00.M-\DO O0'10'10'1 or) M..:; -.r:.::

Exhibit D

STATE OF HAWAIIHOUSING AND COMMUNITY DEVELOPMENT CORPORATION OF HAWAII

Combined Statement of Revenue and Expenses -Proprietary Fund Types


Total

(memorandum

only)

Internal

ServiceEnterprise

$ 49,973,2373,582,522

185,00032,218,410

(20,874,366)1,181,6966,136,243

72,402,742

$ $ 49,973,2373,582,522

185,00032,343,922

(20,874,366)1,181,6966,137,368

72,529,379

Operating revenues:InterestSales of landSales of unitsRental (notes F, N, and R)Net decrease in the fair value of investmentsConveyance taxOther

125,512

1,125

40,978,4046,336,5428,749,052

16,355,05514,018,7452,331,7272,371,130

351,724745,239469,286642,916

1,269,966325,920323,350177,79940,748

548,731289,022

4,507,5847,137,6991,151,8892,402,513

111,525,041

(39,122,299)

40,978,4046,336,5428,749,052

16,355,05514,142,2482,331, 7272,371,130

351,724745,239469,286652,909

1,269,966325,920323,350177,79940, 748

548, 731289,022

4,507,5847,137,6991,151,8892,403,387

111,659,411

(39,130,032)

Total operating revenues

Operating expenses:InterestCost of land soldProjectPersonnel services (notes P and Q)DepreciationHousing assistance paymentsAdministrationProvision for lossesLoan servicing feesLetter of credit feesProfessional servicesArbitrage rebate (note J)Trustee feesAmortization of deferred bond issuance costsAmortization of deferred refunding costMortgage insuranceSecurityInsuranceRepairs and maintenanceUtilitiesPayments in lieu of taxesOther

123,503

9,993

874

134,370

(7,733)

5,332,8209,909,680(416,394)

14,826,106

(24,296,193)

311,520

(23,984,673)

41,339 (24,254,854)

311,520

(23,943,334)

(68,459)

$ (24,053,132)

(68,459)

$ (24,011,793)

Total operating expenses

Operating loss

Nonoperating revenues and expenses:Interest incomeHUD operating subsidy and othersInterest expense

Total nonoperating revenues and expenses

Income (loss) before operating transfer andextraordinary item

Operating transfer in from general fund

Income (loss) before extraordinary item

Extraordinary item -loss from early redemption of revenuebonds payable

Net income (loss) $ ~


62

5,381,8929,909,680(416,394)

14,875,178

~-:0:="

~

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63

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V)

Exhibit F


Combined Statement ofCash Flows -Proprietary Fund Types


Total

(memorandumonly)

Internal

Service--.:!~nterprise

$ (39,122,299) $ (7,733) $ (39,130,032)

14,571,669(58,173)

(40,772,115)(869,023)

40,978,404355,278

20,874,366(1,116,856)

123,503

878

14,695,172(58,173)

(40,772,115)(869,023)

40,978,404355,278

20,874,366(1,116,856)

878

5,116,7455,986,4921,768,957(320,564)(486,149)

(6,508,509)288,960

9,9855,862,234

410,823(258,058)909,314

311537,532

1,866,17885,849

495,2991,269,966

(47,457)(677,508)

(1,667,420)

9,484,231

5,116,7455,986,4921,768,957(320,564)(486,149)

(6,313,645)288,960

9,9855,862,234

410,823(258,058)876,249

311537,532

1,866,17885,849

495,2991,269,966

(47,457)(677,508)

(1,667,420)

9,762,678

194,864

(33,065)

278,447

~

Cash flows from operating activities:Operating lossAdjustments to reconcile operating loss to net cash provided

by operating activities:Depreciation and amortizationGain on sale of landInterest on investmentsInterest on financing leaseInterest on revenue bondsProvision for lossesNet decrease in the fair value of investmentsLender commitment fees amortizedLoss on disposal of property and equipmentChanges in assets and liabilities:

Mortgage loans receivableNotes and loans receivableAccrued interest receivable on mortgages, notes, and loansTenant receivablesOther receivablesDue from other fundsDue from HUDDue from State of HawaiiInventoriesPrepaid expenses and other assetsDeposits held in trustAccounts payableAccrued interest payableAccrued other expensesDue to other fundsDue to HUD

Security depositsArbitrage rebate payableDeferred incomeDeferred gain on sale of units and landEstimated future costs of land sold

Net cash provided by operating activities

Cash flows from noncapital financing activities:Proceeds from sale of revenue bondsPrincipal paid on revenue bond maturities and redemptionsInterest paid on revenue bondsHUD operating subsidy receivedOperating transfers in from general fundBond issuance costs paidLender commitment fees receivedAdvances from other fundsContributions returned to State of Hawaii

Net cash provided by non capital financing activities

Subtotal, carried forward $

108,765,000(18,275,000)(32,806,915)

8,967,690311,520

(866,417)2,157,4154,303,226

(4,632)

72,551,887

82,036,118 $

108,765,000(18,275,000)(32,806,915)

8,967,690311,520

(866,417)2,157,4154,303,226

(4,632)

-72,551,887

64

278,447

Exhibit F


Combined Statement of Cash Flows -Proprietary Fund Types

Year ended June 30,2000

Enterprise

82,036,118

InternalService

278,447$

3,750,000(4,399,332)(8,525,688)

71,000(36,383)

(16,992,955)(2,305,572)16,343,144

(415,506)

(12,511,292)

3,750,000

(4,399,332)

(8,525,688)

71,000

(36,383)

(16,943,128)

(2,305,572)

16,343,144

(415,506)

(49.827)

(421,354,661)413,378,090

43,274,4191,240,1831,428, 739

37,966,770

107,541,423

84,502,156

$ 192,043,579

700,00040,768

$ 161,990,60630,052,973

$ 192,043,579

$

Subtotal, brought forward

Cash flows from capital and related financing activities:Proceeds from sale of revenue bondsPrincipal paid on revenue bond maturities and redemptionsInterest paid on revenue bondsProceeds from sale of landPrincipal payments on notes payableAcquisition of property and equipmentPrincipal payments on mortgage loansReceipts of capital grantsPayments of interest

Net cash used in capital and related financing activities

Cash flows from investing activities:Purchases of investmentsProceeds from investmentsInterest received on investmentsPayments received on direct financing leaseNet decrease in restricted deposits and funded reserves

Net cash provided by investing activities

Net increase in cash and cash equivalents

Cash and cash equivalents at July I, 1999

Cash and cash equivalents at June 30, 2000

Reconciliation of cash to cash and cash equivalents:CashCertificates of deposit and money market accounts

Cash and cash equivalents at June 30, 2000

Supplemental disclosure of noncash information:Transfers of property to State of HawaiiRecognition of gain on sale of housing project as

contributed capital

$

$ (727,166) $ $ (727,166)

$ 1,170,417 $ $ 1,170,417


65

Total(memorandum

only)

G 82,3 ]4,565

740,768

969,388

61,259

1,030,647

(421,354,661)414,078,09043,315,187

1,240,1831,428,739

38,707,538

108,510,811

84,563,415

; 193,074,226

66

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81

Comments onAgency Response

Response of the Affected Agency

We transmitted a draft of this report to the Department of Business,Economic Development and Tourism (department) on August 22, 2001.A copy of the transmittal letter to the department is included asAttachment 1. The response of the Housing and CommunityDevelopment Corporation of Hawaii (corporation) is included asAttachment 2.

The corporation generally agrees with our findings and has begun toaddress most of the findings and recommendations. We commend thecorporation for its efforts to address the findings and for alreadybeginning to implement some of the recommendations.

The corporation notes that it has taken corrective action to address theproblems related to the implementation of the new information system.A full-time project manager has been assigned to manage and overseethe project. The project’s status has been evaluated, deliverables havebeen reviewed, a contingency plan for completion is being developed,and the corporation is negotiating with the vendor to bring closure to theoriginal contract agreement.

The corporation agrees with the need for timely communications withthe corporation’s Board of Directors and the timely completion of capitalimprovement projects. The corporation notes that all projects identifiedin the audit as being incomplete have now been contracted out and mostof the projects have been completed or are near completion. Thecorporation has also established a prioritizing process for capitalimprovement projects and will be holding bi-weekly meetings to monitorthe status of projects for approval by the board.

The corporation notes that it has adequate internal control procedures inplace for reviewing the operating subsidy calculations and that theerroneous 1997 calculation was an isolated incidence. However, toprevent the occurrence of this type of error in the future, the corporationwill conduct more thorough supervisory reviews over the calculation ofthe actual subsidy.

The corporation also notes that it is doing its best to fulfill the corporatemission. Despite the various factors that have made achieving themission difficult, the corporation assures that it will continue to worktoward the goal of “providing Hawaii’s residents with affordable housingand shelter opportunities in a balanced and supportive environmentwithout discrimination.” The corporation will also continue working on

82

ensuring that all required reports are submitted to the federal governmentin a timely manner. Finally, segregation of duties related to the pettycash funds will be improved.

ATTACHMENT 1

MARION M. HIGA

State Auditor

STATE OF HAWAII

OFFICE OF THE AUDITOR

465 S. King Street, Room 500

Honolulu, Hawaii 96813-2917(808) 587 -0800

FAX: (808) 587-0830

August 22, 2001

copy

The Honorable Seiji F. Naya, DirectorDepartment of Business, Economic Developmentand Tourism

No. 1 Capitol District250 South Hotel StreetHonolulu, Hawaii 96813

Dear Dr. Naya:

Enclosed for your information are three copies, numbered 6 to 8 of our draft report, FinancialAudit of the Housing and Community Development Corporation ofHawaii. We ask that youtelephone us by Friday, August 24, 2001, on whether or not you intend to comment on ourrecommendations. If you wish your comments to be included in the report, please submit themno later than Friday, August 31, 2001.

The Governor and presiding officers of the two houses of the Legislature have also beenprovided copies of this draft report.

Since this report is not in final form and changes may be made to it, access to the report shouldbe restricted to those assisting you in preparing your response. Public release of the report willbe made solely by our office and only after the report is published in its final form.

Sincerely,

.'(J :.

~~.(/Marion M. Riga

State Auditor

Enclosures

83

ATTACHMENT 2

SHARYN L MIYASHIRO

EXECUTIVE DIRECTORBENJAMIN J. CAYETANOGOVERNOR

ROBERT J. HALL

EXECUTIVE ASSISTANTST J~ TE OF HAWAII

DEPARTMENT OF BUSINESS, ECO~~OMIC DEVELOPMENT AND TOURISM

HOUSING AND COMMUNITY DEVEl-OPMENT CORPORATION OF HAWAII

677 QUEEN STREET, SUITE 300

Honolulu, Hawaii 96813

FAX: (808) 587-0600

Ol:mO/1972

August 31,2001

RE VED

AuG 3! 405 PM '01

o;:c. !~)F .~;:: ;;,UDI10RSTATE Of HAWAII

Ms. Marion M. RigaState AuditorOffice of the AuditorKekuanaoa Building465 South King Street, Room 500Honolulu, Hawaii 96813

Subject: Reply to Draft Audit Report

Dear Ms. Riga:

I have read the draft Auditor's report and am plc~sed to inform you that a majority of therecommendations made in the report were already implemented by the Corporation prior to thecompletion of the audit. Regarding the items requiring attention as highlighted by your analysis,specific corrective actions taken include the following:

I) Information System

Corrective action has already been implemented to address the audit findings pertainingto the new Information system. Prior to the start of the audit, staff had already startedassessing the project's status and developing a contingency plan for completion. Afull-time project manager, with experien<:e in system implementation, was assignedspecifically to manage and oversee the project. Staff reviewed the deliverables for eachmodule and determined which issues remain unresolved, and should have the highestpriority. Ongoing negotiations with the vendor are focused on bringing closure to theoriginal contract agreement, and to ensure ongoing support for the system.Implementation of the system is anticipated to be completed by March 2002.

We are investigating the need to assess liquidated damages considering all the facts andconditions that affect the completion of the contract.

84

Ms. Marion M. RigaAugust 31,2001Page 2

2) CaQital ImQrovements Funds

We do not dispute that capital improvement projects should be completed in a timelymanner, and recognize that timely communications with the Corporation's Board is vitalto keep projects on track.

All capital improvement moneys identified in the audit report as being incomplete havenow been contracted out, and most of the projects have been completed or are nearcompletion. In addition, since the time of the delays, a prioritizing process has beenestablished that ranks capital improvement projects on a weighted basis based uponhealth and safety factors, and the necessity of the work being required. To improveproject implementation, bi-weekly meetings are held to monitor the status of projectsapproved by the Board.

3) Internal Controls

The corporation has adequate internal control pro4~edures in place to provide for thereview of the operating subsidy calculations. These procedures include a review by thepreparer's supervisor and the Administrative Services Officer, and are performed on boththe estimated and actual operating subsidy calculations. The estimated operating subsidycalculations are submitted to the Board in support ofa Board resolution required by U. S.Department ofHousing and Urban Development. The actual operating subsidycalculation does not require any Board action or resolution.

The erroneous 1997 actual operating subsidy was an isolated incident due to acomputational error rather than lack of the review procedures. There will be morethorough supervisory reviews to ensure that the calculation of the actual subsidy is

proper.

4) Lack of Success in Fulfilling the Cornoration' s Mi~

To imply that the Corporation has not been entirely successful in fulfilling its Corporatemission is incorrect and ignores the tremendous efforts we have undertaken to provideaffordable housing. I am concerned that a financial audit of a corporation wouldcomment on a "non-reportable" finding without due consideration of a wide variety ofmarket issues and economic and social conditions in the State. Further, there appears tobe no analysis ofwhat the size of the waiting list would be without the Corporation's

programs.

It is the goal and mission ofHCDCH "to serve as a catalyst to provide Hawaii's residentswith affordable housing and shelter opportunities iJrl a balanced and supportive

85

Ms. Marion M. Riga

August 31,2001

Page 3

environment without discrimination." To measure the success of the Corporation bylooking at just the wait lists in the continuum of the State's housing efforts from homelessassistance to homeownership for first-time homebuyers is not an accurate way to assessour performance.

HCDCH has worked with its partners in the private sector to help more than 8,900people make the transition to permanent housing during the past five years. Hawaii'shomeless program received national recognition in 1999 from the U.S. Department ofHousing and Urban Development as one: of the best in the nation.

Since 1995, the Rental Housing Trust Fund, the Low Income Housing Tax Credit andother HCDCH programs have provided more than $326 million in financial assistance anddevelopment incentives to private developers. Trus has made possible the developmentand preservation of 5,079 affordable rental housing units totaling $635 million indevelopment costs.

Also, since 1995, the Hula Mae program for first time homebuyers has provided over$400 million in mortgages for over 2,000 households with interest rates as low as 5.89%Another issue of$115 million is expected this Fall.

In a most exciting venture, the State has embarked on a major initiative to change thecharacter and quality of public housing by revitalizing more than 1,700 units in the Kalihi-Palama area -or about a third of the federal public housing units in Hawaii.

. Phase I ofKalihi Valley Homes along Likelike Highway is nearing completion andembodies the new character and quality of public housing.

. The groundbreaking of the Community Resource Center at Kuhio Park Terrace andKuhio Homes took place just this week. When completed a year from now, 50,000square feet of space for community and human services providers will offer economicdevelopment programs, culinary arts training, c:hildcare, a teen center, job training andreferral services and more for area residents.

. Since May of 1999 until June of this year, HCDCH has worked diligently inpartnership with residents and community leaders ofKuhio Park Terrace and KuhioHomes to plan for a new beginning. With a su4:Cessful acceptance of our HOPE VIgrant, HCDCH plans to demolish the two high..rise towers and replace them with aplanned community development. In its place, will be single family dwellings,townhomes, and a senior oriented mid-rise apartment building surrounded by opengreen space.

86

Ms. Marion M. Riga

August 31, 2001

Page 4

It is important to note that the lengthy wait list is symptomatic of a basic underlyingproblem, that is, a shortage of adequate public and private housing inventory dueprimarily to the high cost of development. The key issue is the lack of available rentalunits.

While we acknowledge that there has been some difficulty due to market conditions toplace applicants on the public housing aIld Section 8 wait lists, HCDCH hasaccomplished much in providing affordable housing opportunities in the State. Toaccelerate placement of persons on the waiting lists, a substantial amount of resourceswill be required to increase the inventory of affordable rentals.

5) Delay in Submitting a Federal reQort

In 1999, one report was submitted 11 days late to the Federal government. No paymentrequests were delayed as a result of this action.

Since that isolated incident, HCDCH has worked 1:0 ensure that all required reports aresubmitted in a timely manner .

6) Petty Cash Funds

The custodial and reconciliation functions of petty cash funds will be separated toimprove the handling of petty cash funds that are limited to $500. Furthermore, periodicreviews of the reconciliation procedures will be performed by an employee independentof petty cash process.

In closing, we acknowledge the findings and recommendations of the Auditor and have alreadyimplemented actions to improve corporate performance. With the limited resources available toour agency, we are proud of the accomplishments we havc~ made to date and will continue tolook toward improving upon our results.

Sincerely,

A~S~Yashiro

Executive Director

c: Dr. Seiji Naya

Board ofDirectors

87

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