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U. S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
WASHINGTON, D. C. 20410-8000

OFFICE OF THE ASSISTANT SECRETARY FOR
HOUSING-FEDERAL HOUSING COMMISSIONER
March 28, 1989
Mortgagee Letter 89-12
TO:  ALL APPROVED MORTGAGEES
ATTENTION:  Multifamily Mortgagees
SUBJECT:  Investment of Replacement Reserves and Residual
            Receipts in Tax-Exempt Securities
 
     HUD encourages, and in many programs requires, owners to invest
Replacement Reserve and Residual Receipts funds in order to offset
inflationary increases in repairs and replacement costs and to
enhance a project's financial condition.
 
     Mortgagee Letter 83-24  permitted the investment of Replacement
Reserves and Residual Receipts funds only in Treasury securities,
securities issued by a Federal agency, or deposits which are insured
by an agency of the Federal government.  While HUD encourages and
often requires the investment of these funds, provisions in the Tax
Reform Act of 1986 may prohibit mortgagors from offsetting taxable
interest earnings on these accounts with passive losses from a
project.  Thus, there may be a disincentive to invest in taxable
securities/accounts.
 
     For this reason, we have reevaluated Mortgagee Letter 83-24  and
have attempted to identify a tax-exempt security or securities which
could be used as an investment of Replacement Reserve and Residual
Receipts funds.  We have sought to identify secure, liquid
instruments, for which the return of principal and payment of
interest are assured, to the maximum possible extent.
 
     Effective immediately, in addition to the investments currently
permitted in Mortgagee Letter 83-24 , HUD will permit the purchase of
the following tax-exempt securities:
 
1.   AAA rated GNMA collateralized tax-exempt bonds.
2.   AAA rated prerefunded bonds.  These are bonds that originally
     may have been issued as general obligation or revenue bonds but
     are now secured, until the call date or maturity, by an "escrow
     fund" consisting entirely of direct U.S. government obligations
     that are sufficient for paying the bondholders.
 
_____________________________________________________________________
 
                                 2
 
NOTES OF CAUTION
 
1.   In order to assure that required amounts have been paid into
     the Replacement Reserves and Residual Receipts accounts, the
     actual costs (which in many cases may not be the face value) of
 
     these and other approved securities, must be shown on the
     project books.  In addition, details of these transactions
     should be disclosed in the footnotes to the Annual Financial
     Statement.
 
2.   When HUD approves disbursements from Replacement Reserves or
     Residual Receipts funds and the funds are invested in these
     and/or other permitted securities, mortgagees must, to the
     extent that reserves are available, assure that securities are
     sold in an amount which results in proceeds sufficient to cover
     the disbursement.
 
3.   Since the sale or redemption of these securities, as well as
     others already permitted, may result in cash proceeds of less
     than the amount invested, Chapter 4, Section 10, paragraphs
     1(c)(3) of Handbook 4350.1, SUPP 1 "Insured Project Servicing
     Handbook" applies.
 
4.   It is incumbent upon owners and managers, when making decisions
     on the purchase of these and other approved securities, to
     carefully consider the potential losses which may arise from
     sale or redemption of the securities.
 
5.   Since HUD is limiting the purchase of these securities to those
     that are AAA rated, HUD will not permit, as an operating cost,
     fees for a Financial Advisor to assist in selecting such
     securities for investment.
 
     Questions on the above may be addressed to your local HUD
office or the Office of Multifamily Housing Management, Planning and
Procedures Division, phone (202) 426-3944.  This is not a toll free
number.
 
                                   Sincerely yours,
 
                                  General Deputy Assistant Secretary
                                    for Housing