Appendix A to Part 570 - Guidelines and Objectives for Evaluating Project Costs and Financial Requirements
24:3.1.1.3.3.17.1.1.1 : Appendix A
Appendix A to Part 570 - Guidelines and Objectives for Evaluating
Project Costs and Financial Requirements
I. Guidelines and Objectives for Evaluating Project Costs and
Financial Requirements. HUD has developed the following
guidelines that are designed to provide the recipient with a
framework for financially underwriting and selecting CDBG-assisted
economic development projects which are financially viable and will
make the most effective use of the CDBG funds. The use of these
underwriting guidelines as published by HUD is not mandatory.
However, grantees electing not to use these underwriting guidelines
would be expected to conduct basic financial underwriting prior to
the provision of CDBG financial assistance to a for-profit
business. States electing not to use these underwriting guidelines
would be expected to ensure that the state or units of general
local government conduct basic financial underwriting prior to the
provision of CDBG financial assistance to a for-profit
business.
II. Where appropriate, HUD's underwriting guidelines recognize
that different levels of review are appropriate to take into
account differences in the size and scope of a proposed project,
and in the case of a microenterprise or other small business to
take into account the differences in the capacity and level of
sophistication among businesses of differing sizes.
III. Recipients are encouraged, when they develop their own
programs and underwriting criteria, to also take these factors into
account. For example, a recipient administering a program providing
only technical assistance to small businesses might choose to apply
underwriting guidelines to the technical assistance program as a
whole, rather than to each instance of assistance to a business.
Given the nature and dollar value of such a program, a recipient
might choose to limit its evaluation to factors such as the extent
of need for this type of assistance by the target group of
businesses and the extent to which this type of assistance is
already available.
IV. The objectives of the underwriting guidelines are to
ensure:
(1) that project costs are reasonable;
(2) that all sources of project financing are committed;
(3) that to the extent practicable, CDBG funds are not
substituted for non-Federal financial support;
(4) that the project is financially feasible;
(5) that to the extent practicable, the return on the owner's
equity investment will not be unreasonably high; and
(6) that to the extent practicable, CDBG funds are disbursed on
a pro rata basis with other finances provided to the project.
i. Project costs are reasonable. i. Reviewing costs for
reasonableness is important. It will help the recipient avoid
providing either too much or too little CDBG assistance for the
proposed project. Therefore, it is suggested that the grantee
obtain a breakdown of all project costs and that each cost element
making up the project be reviewed for reasonableness. The amount of
time and resources the recipient expends evaluating the
reasonableness of a cost element should be commensurate with its
cost. For example, it would be appropriate for an experienced
reviewer looking at a cost element of less than $10,000 to judge
the reasonableness of that cost based upon his or her knowledge and
common sense. For a cost element in excess of $10,000, it would be
more appropriate for the reviewer to compare the cost element with
a third-party, fair-market price quotation for that cost element.
Third-party price quotations may also be used by a reviewer to help
determine the reasonableness of cost elements below $10,000 when
the reviewer evaluates projects infrequently or if the reviewer is
less experienced in cost estimations. If a recipient does not use
third-party price quotations to verify cost elements, then the
recipient would need to conduct its own cost analysis using
appropriate cost estimating manuals or services.
ii. The recipient should pay particular attention to any cost
element of the project that will be carried out through a
non-arms-length transaction. A non-arms-length transaction occurs
when the entity implementing the CDBG assisted activity procures
goods or services from itself or from another party with whom there
is a financial interest or family relationship. If abused,
non-arms-length transactions misrepresent the true cost of the
project.
2. Commitment of all project sources of financing. The
recipient should review all projected sources of financing
necessary to carry out the economic development project. This is to
ensure that time and effort is not wasted on assessing a proposal
that is not able to proceed. To the extent practicable, prior to
the commitment of CDBG funds to the project, the recipient should
verify that: sufficient sources of funds have been identified to
finance the project; all participating parties providing those
funds have affirmed their intention to make the funds available;
and the participating parties have the financial capacity to
provide the funds.
3. Avoid substitution of CDBG funds for non-Federal financial
support. i. The recipient should review the economic
development project to ensure that, to the extent practicable, CDBG
funds will not be used to substantially reduce the amount of
non-Federal financial support for the activity. This will help the
recipient to make the most efficient use of its CDBG funds for
economic development. To reach this determination, the recipient's
reviewer would conduct a financial underwriting analysis of the
project, including reviews of appropriate projections of revenues,
expenses, debt service and returns on equity investments in the
project. The extent of this review should be appropriate for the
size and complexity of the project and should use industry
standards for similar projects, taking into account the unique
factors of the project such as risk and location.
ii. Because of the high cost of underwriting and processing
loans, many private financial lenders do not finance commercial
projects that are less than $100,000. A recipient should
familiarize itself with the lending practices of the financial
institutions in its community. If the project's total cost is one
that would normally fall within the range that financial
institutions participate, then the recipient should normally
determine the following:
A. Private debt financing - whether or not the
participating private, for-profit business (or other entity having
an equity interest) has applied for private debt financing from a
commercial lending institution and whether that institution has
completed all of its financial underwriting and loan approval
actions resulting in either a firm commitment of its funds or a
decision not to participate in the project; and
B. Equity participation - whether or not the degree of
equity participation is reasonable given general industry standards
for rates of return on equity for similar projects with similar
risks and given the financial capacity of the entrepreneur(s) to
make additional financial investments.
iii. If the recipient is assisting a microenterprise owned by a
low- or moderate-income person(s), in conducting its review under
this paragraph, the recipient might only need to determine that
non-Federal sources of financing are not available (at terms
appropriate for such financing) in the community to serve the low-
or moderate-income entrepreneur.
4. Financial feasibility of the project. i. The public
benefit a grantee expects to derive from the CDBG assisted project
(the subject of separate regulatory standards) will not materialize
if the project is not financially feasible. To determine if there
is a reasonable chance for the project's success, the recipient
should evaluate the financial viability of the project. A project
would be considered financially viable if all of the assumptions
about the project's market share, sales levels, growth potential,
projections of revenue, project expenses and debt service
(including repayment of the CDBG assistance if appropriate) were
determined to be realistic and met the project's break-even point
(which is generally the point at which all revenues are equal to
all expenses). Generally speaking, an economic development project
that does not reach this break-even point over time is not
financially feasible. The following should be noted in this
regard:
A. some projects make provisions for a negative cash flow in the
early years of the project while space is being leased up or sales
volume built up, but the project's projections should take these
factors into account and provide sources of financing for such
negative cash flow; and
B. it is expected that a financially viable project will also
project sufficient revenues to provide a reasonable return on
equity investment. The recipient should carefully examine any
project that is not economically able to provide a reasonable
return on equity investment. Under such circumstances, a business
may be overstating its real equity investment (actual costs of the
project may be overstated as well), or it may be overstating some
of the project's operating expenses in the expectation that the
difference will be taken out as profits, or the business may be
overly pessimistic in its market share and revenue projections and
has downplayed its profits.
ii. In addition to the financial underwriting reviews carried
out earlier, the recipient should evaluate the experience and
capacity of the assisted business owners to manage an assisted
business to achieve the projections. Based upon its analysis of
these factors, the recipient should identify those elements, if
any, that pose the greatest risks contributing to the project's
lack of financial feasibility.
5. Return on equity investment. To the extent
practicable, the CDBG assisted activity should provide not more
than a reasonable return on investment to the owner of the assisted
activity. This will help ensure that the grantee is able to
maximize the use of its CDBG funds for its economic development
objectives. However, care should also be taken to avoid the
situation where the owner is likely to receive too small a return
on his/her investment, so that his/her motivation remains high to
pursue the business with vigor. The amount, type and terms of the
CDBG assistance should be adjusted to allow the owner a reasonable
return on his/her investment given industry rates of return for
that investment, local conditions and the risk of the project.
6. Disbursement of CDBG funds on a pro rata basis. To the
extent practicable, CDBG funds used to finance economic development
activities should be disbursed on a pro rata basis with other
funding sources. Recipients should be guided by the principle of
not placing CDBG funds at significantly greater risk than non-CDBG
funds. This will help avoid the situation where it is learned that
a problem has developed that will block the completion of the
project, even though all or most of the CDBG funds going in to the
project have already been expended. When this happens, a recipient
may be put in a position of having to provide additional financing
to complete the project or watch the potential loss of its funds if
the project is not able to be completed. When the recipient
determines that it is not practicable to disburse CDBG funds on a
pro rata basis, the recipient should consider taking other steps to
safeguard CDBG funds in the event of a default, such as insisting
on securitizing assets of the project.
[60 FR 1953, Jan. 5, 1995]