SBA Disaster Loan Program
Accounting Anomalies Resolved but Additional Steps Would Improve Long-Term Reliability of Cost Estimates Gao ID: GAO-05-409 April 14, 2005In response to a January 2003 GAO report that identified significant anomalies in the Small Business Administration's (SBA) disaster loan accounts and raised serious concerns about its ability to account for loan sales and estimate program costs, SBA conducted an extensive analysis to identify causes of the anomalies and implemented a number of corrective actions. In light of SBA's actions, GAO undertook a follow-up review to (1) describe the nature of the deficiencies SBA identified, (2) determine whether its corrective actions resolved the deficiencies, and (3) assess whether its procedures provide a reasonable basis for future credit estimates.
SBA took prompt action with a comprehensive review of its financial records and systems to identify the deficiencies related to accounting for its disaster loans and loan sale program. SBA's review found (1) the cash flow model used to estimate the cost of the disaster loan program was unreliable and underestimated the cost, (2) the model used to determine whether sales were beneficial had errors and incorrectly indicated that loans were sold at gains, (3) incorrect loan values used to calculate the results of loan sales led to inaccurate reporting in SBA's financial statements, and (4) incomplete tools provided by OMB to calculate interest payments on borrowings from Treasury resulted in excess payments to Treasury and an insufficient balance in SBA's financing account and subsidy allowance. To resolve these deficiencies, SBA implemented a number of corrective actions during fiscal years 2003 and 2004. To address the first three, SBA developed a new cash flow model to estimate the costs and loan values for the disaster loan program. This improved the agency's ability to prepare more reliable cost estimates and determine the gain or loss on prior loan sales. To address the fourth deficiency, SBA analyzed its interest payments to Treasury and found that it had overpaid by about $134 million. SBA included this amount in its reestimates for the disaster loan program to correct prior interest payments and also implemented a different approach to update or "reestimate" its cost estimates, which will adjust its transactions with Treasury going forward. However, until OMB updates its tools for computing these interest payments, other credit agencies may also be over- or underpaying interest to Treasury. Further, SBA improved its policies and procedures to help ensure that future loan program cost estimates will be reasonable. For example, SBA implemented new standard operating procedures for calculating reestimates and prepared documentation to support the rationale and basis for key aspects of the cash flow model. However, because of the complexities associated with estimating loan program costs, additional actions by SBA would help improve the long-term reliability of cost estimates. These include (1) further documentation of the model and disaster data to readily provide for knowledge transfer between staff and contractors to help ensure proper maintenance, updating, and running of the model; (2) periodic assessments of the model's ability to predict loan performance; and (3) additional procedures to ensure the disaster data used in the model are tested to verify and document that they are reliable. In addition, there may be opportunities to improve the model with additional variables, such as financial strength of borrowers, as well as revisions to simplify the estimation process that warrant further consideration by SBA.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-05-409, SBA Disaster Loan Program: Accounting Anomalies Resolved but Additional Steps Would Improve Long-Term Reliability of Cost Estimates
This is the accessible text file for GAO report number GAO-05-409
entitled 'SBA Disaster Loan Program: Accounting Anomalies Resolved but
Additional Steps Would Improve Long-Term Reliability of Cost Estimates'
which was released on May 17, 2005.
This text file was formatted by the U.S. Government Accountability
Office (GAO) to be accessible to users with visual impairments, as part
of a longer term project to improve GAO products' accessibility. Every
attempt has been made to maintain the structural and data integrity of
the original printed product. Accessibility features, such as text
descriptions of tables, consecutively numbered footnotes placed at the
end of the file, and the text of agency comment letters, are provided
but may not exactly duplicate the presentation or format of the printed
version. The portable document format (PDF) file is an exact electronic
replica of the printed version. We welcome your feedback. Please E-mail
your comments regarding the contents or accessibility features of this
document to Webmaster@gao.gov.
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed
in its entirety without further permission from GAO. Because this work
may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this
material separately.
Report to Congressional Requesters:
April 2005:
SBA Disaster Loan Program:
Accounting Anomalies Resolved but Additional Steps Would Improve Long-
Term Reliability of Cost Estimates:
GAO-05-409:
GAO Highlights:
Highlights of GAO-05-409, a report to congressional requesters:
Why GAO Did This Study:
In response to a January 2003 GAO report that identified significant
anomalies in the Small Business Administration‘s (SBA) disaster loan
accounts and raised serious concerns about its ability to account for
loan sales and estimate program costs, SBA conducted an extensive
analysis to identify causes of the anomalies and implemented a number
of corrective actions. In light of SBA‘s actions, GAO undertook a
follow-up review to (1) describe the nature of the deficiencies SBA
identified, (2) determine whether its corrective actions resolved the
deficiencies, and (3) assess whether its procedures provide a
reasonable basis for future credit estimates.
What GAO Found:
SBA took prompt action with a comprehensive review of its financial
records and systems to identify the deficiencies related to accounting
for its disaster loans and loan sale program. SBA‘s review found (1)
the cash flow model used to estimate the cost of the disaster loan
program was unreliable and underestimated the cost, (2) the model used
to determine whether sales were beneficial had errors and incorrectly
indicated that loans were sold at gains, (3) incorrect loan values used
to calculate the results of loan sales led to inaccurate reporting in
SBA‘s financial statements, and (4) incomplete tools provided by OMB to
calculate interest payments on borrowings from Treasury resulted in
excess payments to Treasury and an insufficient balance in SBA‘s
financing account and subsidy allowance.
To resolve these deficiencies, SBA implemented a number of corrective
actions during fiscal years 2003 and 2004. To address the first three,
SBA developed a new cash flow model to estimate the costs and loan
values for the disaster loan program. This improved the agency‘s
ability to prepare more reliable cost estimates and determine the gain
or loss on prior loan sales. To address the fourth deficiency, SBA
analyzed its interest payments to Treasury and found that it had
overpaid by about $134 million. SBA included this amount in its
reestimates for the disaster loan program to correct prior interest
payments and also implemented a different approach to update or
’reestimate“ its cost estimates, which will adjust its transactions
with Treasury going forward. However, until OMB updates its tools for
computing these interest payments, other credit agencies may also be
over- or underpaying interest to Treasury.
Further, SBA improved its policies and procedures to help ensure that
future loan program cost estimates will be reasonable. For example, SBA
implemented new standard operating procedures for calculating
reestimates and prepared documentation to support the rationale and
basis for key aspects of the cash flow model. However, because of the
complexities associated with estimating loan program costs, additional
actions by SBA would help improve the long-term reliability of cost
estimates. These include (1) further documentation of the model and
disaster data to readily provide for knowledge transfer between staff
and contractors to help ensure proper maintenance, updating, and
running of the model; (2) periodic assessments of the model‘s ability
to predict loan performance; and (3) additional procedures to ensure
the disaster data used in the model are tested to verify and document
that they are reliable. In addition, there may be opportunities to
improve the model with additional variables, such as financial strength
of borrowers, as well as revisions to simplify the estimation process
that warrant further consideration by SBA.
What GAO Recommends:
GAO is making five recommendations to SBA to help ensure that future
subsidy cost estimates are reliable. GAO is also making two
recommendations to OMB to help ensure that agencies make correct
interest calculations for financing accounts.
SBA stated that our recommendations were appropriate and that it
already has work underway to address several of them. OMB agreed with
our recommendations and stated that it would work with agencies to
correct interest transactions with Treasury.
www.gao.gov/cgi-bin/getrpt?GAO-05-409.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Linda Calbom at (202) 512-
9508 or calboml@gao.gov.
[End of section]
Contents:
Letter:
Results In Brief:
Background:
SBA Identified Major Deficiencies in Models and Methodologies Used to
Account for the Disaster Loan Program:
SBA Has Taken Corrective Actions to Resolve Identified Deficiencies:
New Policies and Procedures Will Help Ensure Future Estimates Are
Reasonable, but Additional Procedures and Documentation Are Needed:
Conclusions:
Recommendations for Executive Action:
Agency Comments:
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Comments from the Small Business Administration:
Appendix III: Comments from the Office of Management and Budget:
Appendix IV: GAO Contact and Staff Acknowledgments:
GAO Contact:
Acknowledgments:
Figures:
Figure 1: Calculation of Subsidy Cost for Direct and Guaranteed Loans:
Figure 2: Program and Financing Account Transactions for Direct Loans:
Figure 3: Disaster Subsidy Allowance as a Percent of the Loan Balance
Outstanding, Fiscal Years 1996 through 2004:
Letter April 14, 2005:
The Honorable Olympia J. Snowe:
Chair, Committee on Small Business and Entrepreneurship:
United States Senate:
The Honorable Todd R. Platts:
Chairman:
The Honorable Edolphus Towns:
Ranking Minority Member:
Subcommittee on Government Management, Finance, and Accountability:
Committee on Government Reform:
House of Representatives:
The Honorable Marsha Blackburn:
House of Representatives:
In 1999, the Small Business Administration (SBA) began a loan asset
sales program at the direction of the Office of Management and Budget
(OMB) to reduce the amount of loans the agency owned and serviced. A
primary objective of the sales was to maximize proceeds, with a goal
for each sale to be financially beneficial to the government. The loans
eligible for sale were disaster assistance and other direct loans and
defaulted business loan guarantees. Between fiscal years 1999 and 2003,
SBA conducted seven sales, divesting itself of about 166,000 loans with
an outstanding balance of about $5.7 billion. Approximately 86 percent
of the amount sold was disaster assistance loans.
Our January 2003 report[Footnote 1] on SBA's first five loan sales
identified significant anomalies in SBA's disaster loan accounts and
raised serious concerns about its ability to properly account for its
loan sales and to estimate the costs associated with its remaining
disaster loan portfolio for budget and accounting purposes.[Footnote 2]
In response to our findings and recommendations, SBA and its
contractors (hereinafter referred to as SBA) conducted an extensive
analysis of its accounting and budgeting for its loan sales and
disaster loan program and implemented a number of corrective actions
during fiscal years 2003 and 2004, including the development of a new
cash flow model to estimate the cost of the disaster loan program for
budget and financial reporting purposes.
In light of these events, we were asked to conduct a follow-up review
to assess SBA's corrective actions. Specifically, our objectives were
to (1) describe the nature of the deficiencies SBA's analysis
identified that contributed to the disaster loan accounting anomalies,
(2) identify corrective actions taken by SBA and assess whether these
actions resolved the identified deficiencies, and (3) determine whether
SBA's new cash flow model and procedures for the disaster loan program
provide a reasonable basis for future credit subsidy estimates.
To address these objectives, we reviewed SBA's analysis of its
accounting and budgeting for its disaster and loan sales programs and
analyzed SBA's corrective actions, including the new cash flow model to
estimate costs for the disaster loan program. We also assessed the
sufficiency of its policies and procedures to estimate program costs
and its corrective actions based on applicable guidance. We provided
SBA a draft of this report and OMB a draft of applicable sections of
this report for review and comment. SBA and OMB provided written
comments, which are reprinted in appendix II and III, respectively. We
performed our work in accordance with generally accepted government
auditing standards in Washington, D.C. from April 2004 through March
2005. Our scope and methodology are discussed in greater detail in
appendix I.
Results In Brief:
As a result of extensive analyses, SBA identified four key deficiencies
related to the disaster loan program accounting anomalies. First, major
flaws in the cash flow model used to estimate the cost of the disaster
loan program, including erroneous loan-term assumptions, led to, among
other things, a negative balance in the disaster loan subsidy
allowance. In effect, this meant that the program cost more than
estimated. Second, errors and inconsistencies in another model, called
the hold model, which was used to determine whether sales were
financially beneficial, caused SBA to undervalue the loans sold by
about 30 percent, according to SBA. This led SBA officials to operate
on the premise that they were selling disaster loans for gains, when in
fact the agency was selling them at a loss. Third, incorrect loan
values used to calculate the results of loan sales led to inaccurate
results disclosed in SBA's financial statements. Finally, interest
rates used to determine interest payments on borrowings from Treasury
that provide financing for the disaster loan program were inconsistent
with the interest rates used to estimate the cost of the program
because of incomplete tools provided by OMB. This resulted in SBA
overpaying interest to Treasury and an insufficient balance in SBA's
financing account and subsidy allowance.
To resolve these deficiencies, SBA implemented a number of corrective
actions during fiscal years 2003 and 2004. SBA developed a new cash
flow model to estimate the cost of the disaster loan program, which
improved the agency's ability to prepare more reliable estimates of the
loan program's cost, and to calculate appropriate values for loans sold
to use in determining the actual gain or loss on prior loan sales. This
new model can also be used in lieu of a separate hold model to
calculate loan values to use in determining whether any future loan
sales would be financially beneficial. Further, SBA analyzed its prior
interest payments to Treasury to determine the effect of using
inconsistent interest rates to estimate subsidy costs and to calculate
interest payments to Treasury. These analyses showed that SBA overpaid
interest to Treasury by about $134 million. SBA included this amount in
its reestimates for the disaster loan program to correct prior interest
payments and also implemented a different approach to update or
"reestimate" its cost estimates, which will adjust SBA's transactions
with Treasury to correct for the inconsistency going forward. However,
until OMB updates its tools for computing these interest payments,
other credit agencies may also be over-or underpaying interest to
Treasury.
In addition to implementing these corrective actions, SBA improved its
policies and procedures to help ensure that future loan program cost
estimates will be reasonable. For example, SBA developed and
implemented new standard operating procedures for reestimating program
costs and established an internal review and documentation process for
its reestimates. These controls represent important improvements.
However, we identified some additional actions by SBA that would help
ensure the long-term reliability of cost estimates. These include (1)
further documentation of the cash flow model and disaster data to
readily provide for knowledge transfer between staff and contractors to
help ensure proper maintenance, updating, and running of the model; (2)
procedures requiring periodic assessments of the model's ability to
predict loan performance; and (3) additional procedures to ensure the
disaster data used in the model are tested to verify and document that
they are reliable. In addition, there may be opportunities to improve
the model with additional variables, such as the financial strength of
borrowers, as well as revisions to simplify the estimation process,
that warrant further consideration by SBA.
We are making recommendations to SBA to address these issues, as well
as to OMB to address the completeness of the tools used to calculate
interest payments to Treasury. SBA acknowledged that these were
appropriate recommendations and stated that it already has work
underway to address several of them. OMB agreed with our
recommendations and stated that it would work with agencies to correct
interest transactions with Treasury.
Background:
SBA provides small businesses with access to credit, primarily by
guaranteeing loans through its 7(a) and 504 programs.[Footnote 3] SBA
also makes loans directly to businesses and individuals trying to
rebuild in the aftermath of a disaster, and it primarily services these
loans directly. Substantially all of the disaster assistance loans have
below-market interest rates and repayment terms of up to 30 years.
Interest rates on disaster loans vary, depending on the borrower's
ability to obtain credit in the private sector.
The President's fiscal year 1998 budget proposed that SBA begin selling
disaster and business loans that the agency was servicing and
transition from servicing loans directly to overseeing private-sector
servicers. Before its loan asset sales program began, SBA was servicing
approximately 300,000 loans, with a principal balance of over $9
billion. About 286,000 of these loans, with a principal balance of $7
billion, were disaster assistance loans.
SBA, as well as other credit agencies, is required to account and
budget for its credit programs in accordance with the Federal Credit
Reform Act of 1990[Footnote 4] (FCRA). FCRA was enacted to require
agencies to more accurately measure the government's cost of federal
credit programs and to permit better cost comparisons, both among
credit programs and between credit and noncredit programs. The act gave
OMB responsibility for coordinating credit program estimates required
by the act. Authoritative guidance on preparing cost estimates for the
budget and conducting loan sales is contained in OMB Circular A-11,
Preparation, Submission, and Execution of the Budget. The Federal
Accounting Standards Advisory Board[Footnote 5] developed accounting
standards for credit programs. This guidance is generally found in
Statement of Federal Financial Accounting Standards No. 2, Accounting
for Direct Loans and Loan Guarantees, which became effective in fiscal
year 1994. This standard, which generally mirrors FCRA and budget
guidance, established accounting guidance for estimating the subsidy
cost of loan programs, as well as recording loans and loan sales for
financial reporting purposes.
According to FCRA, the actual and expected costs of federal credit
programs should be recognized in budgetary reporting. The accounting
standard also requires these costs to be recognized for financial
reporting. To determine the expected cost of a credit program, agencies
are required to predict or estimate the future performance of the
program on a cohort[Footnote 6] basis. This cost, known as the subsidy
cost, is the net present value[Footnote 7] of disbursements by the
government minus estimated payments to the government over the life of
the loan or loan guarantee, excluding administrative costs. Figure 1
presents the cash flows included in the subsidy cost calculation for
direct and guaranteed loans.
Figure 1: Calculation of Subsidy Cost for Direct and Guaranteed Loans:
[See PDF for image]
[End of figure]
FCRA established a special budgetary accounting system to record the
budget information necessary to implement credit reform. Loans and loan
guarantees made on or after October 1, 1991--the effective date of
credit reform--use the (1) program and (2) financing accounts to handle
credit transactions.[Footnote 8] The program account is included in
budget totals, receives separate appropriations for the administrative
and subsidy costs of a credit program, and records the budget authority
and outlays for these costs. The program account is used to pay the
associated subsidy cost to the financing account when a direct or
guaranteed loan is disbursed. The financing account, which is
nonbudgetary,[Footnote 9] is used to collect the subsidy cost from the
program account, borrow from Treasury to provide financing for loan
disbursements, and record the cash flows associated with direct loans
or loan guarantees over their lives, including loan disbursements,
default payments to lenders, loan repayments, interest payments,
recoveries on defaulted loans, and fee collections. Figure 2 shows the
flow of program and financing accounts transactions for a direct loan
program.
Figure 2: Program and Financing Account Transactions for Direct Loans:
[See PDF for image]
[End of figure]
FCRA requires that the rate of interest charged by Treasury on lending
to financing accounts be the same as the final discount rate[Footnote
10] used to calculate the net present value of cash flows when
estimating the subsidy cost of a credit program. The final discount
rate for a cohort of loans is determined based on interest rates
prevailing during the period that the loans are disbursed. Once the
loans for a cohort are substantially disbursed (at least 90 percent),
the final discount rate for that cohort is determined, and this rate is
to be used for financing account interest calculations. The same rate
is required to be used to calculate subsidy costs and interest on the
financing account, so that the financing account will break even over
time as it uses its collections to repay its Treasury borrowing. OMB
provides tools for agencies to use to calculate interest on the
financing account.[Footnote 11]
To estimate the cost of credit programs, agencies first estimate the
future performance of direct and guaranteed loans, using cash flow
models, when preparing their annual budgets. The data used for these
budgetary estimates are generally updated or "reestimated" annually as
of the end of the fiscal year to reflect any changes in loan
performance since the estimates were prepared, as well as any expected
changes in assumptions related to future loan performance. Increases in
subsidy costs that are recognized through reestimates are funded
through permanent indefinite budget authority.
Before SBA could proceed with a loan sale, OMB had to approve it. This
approval was based primarily on whether or not the sale was expected to
be financially beneficial to the government, meaning that the estimated
proceeds were expected to be greater than the estimated value of
holding the loans. SBA estimated the current value to the government of
holding the loans, also known as the "hold value," in accordance with
OMB Circular A-11. The hold value is the expected net cash flows from
the loans, discounted at current Treasury rates.[Footnote 12] This
differs from the net book value recorded on SBA's books, which is the
expected net cash flows from the loans discounted using Treasury rates
in effect when the loans were disbursed. Therefore, the hold value
takes into account changes in interest rates since the loans were
disbursed, whereas the net book value does not.
Our January 2003 report on SBA's first five loan sales highlighted
accounting anomalies related to its disaster loans and loan sales
program. Specifically, SBA incorrectly calculated the accounting losses
on the loan sales it disclosed in its financial statements and lacked
reliable financial data to determine the overall financial impact of
the sales. Further, because SBA did not analyze the effect of loan
sales on its remaining portfolio, its reestimates of loan program costs
for the budget and financial statements may have contained significant
errors. In addition, SBA could not explain significant declines in its
subsidy allowance for disaster loans.
In response to our findings, SBA took immediate action to begin the
process of identifying the deficiencies that contributed to the
disaster loan accounting anomalies, including unexplained significant
declines in its subsidy allowance. A team of financial experts,
including contractors and staff from the Office of the Chief Financial
Officer, was assembled to conduct detailed reviews of financial records
and systems related to the disaster and loan sales programs. Several
diagnostic-type analyses were performed, including detailed
reconciliations of the subsidy allowance and testing of alternative
versions of the cash flow model used to estimate the cost of the
disaster loan program. In January 2003, SBA hired IBM Business
Consulting Services (IBM) to help determine reasons for the abnormal
balance in the disaster loan program's subsidy allowance and to
identify recommendations for correcting any deficiencies noted. IBM
assisted SBA in a detailed review of SBA's accounting and budgeting for
the disaster loan program and its loan sale procedures. IBM summarized
the results of this review in a March 2003 report. According to SBA
officials, the core diagnosis of the problems was completed by April
2003 with the submission and analysis of the report from IBM.
SBA Identified Major Deficiencies in Models and Methodologies Used to
Account for the Disaster Loan Program:
SBA and its contractors identified four key deficiencies related to the
disaster loan program accounting anomalies. These were (1) major flaws
in the cash flow model used to estimate the cost of the disaster loan
program, (2) errors and inconsistencies in the model used to determine
whether sales were beneficial, (3) incorrect loan values used to
calculate the results of loan sales, and (4) inconsistencies between
the interest rates used to estimate subsidy costs and the interest
rates used to determine interest payments to Treasury.
Cash Flow Model Used to Estimate Costs for the Disaster Loan Program
Was Flawed:
The methodology SBA's cash flow model used to estimate costs for the
disaster loan program assumed that a single illustrative loan with
characteristics based on overall portfolio averages could serve as a
proxy for all loans and reasonably estimate cash flows for an entire
cohort of loans, which included sold and unsold loans. This methodology
could have produced reasonable cash flow estimates, even considering
loan sales, if all loans had similar characteristics. However, this was
not the case, and flaws in this methodology became apparent once SBA
began substantial loan sales and the loans sold had different
characteristics than the loans not sold. For example, the sold loans
tended to have longer borrower repayment periods, or loan terms, than
the loans not sold. Therefore, the sold loans would have had subsidized
interest for a longer period of time and would have cost more. Because
the single illustrative loan did not take into consideration these
differences when estimating cash flows, the model had problems
reestimating the cost of the program.
In addition to the basic flaw in the methodology, SBA incorrectly
calculated the single illustrative loan's average loan-term assumptions
used in the cash flow model. SBA estimated costs of the disaster loan
program using average loan-term assumptions of 16 years for business
disaster loans and 17 years for home disaster loans. In our January
2003 report, we raised concerns about the validity of these
assumptions, as our review of disaster loans sold indicated an average
loan term of about 25 years. SBA's loan-term assumptions were based on
the number of loans, rather than the dollar value of loans disbursed,
and therefore was a straight average rather than a weighted average.
However, SBA found that, for all disaster loans, the average loan term,
based on the dollar value of loans disbursed, was 23 years. Therefore,
the model, which used loan terms of 16 and 17 years, did not consider
cash flows for the full term of the loans. Given that the borrower
interest rates on these loans were generally below market rates and
less than SBA's cost of borrowing from Treasury to finance its loans,
understating the loan term also understated the program costs.
According to SBA, this caused the model to underestimate the cost of
the disaster loan program by 6 to 7 percent.
Further, during the reestimate process, SBA did not update the
estimated principal and interest with actual collection amounts, which
resulted in inaccurate data being used to calculate costs. These flaws
related to the methodology, loan-term assumptions, use of inaccurate
data, and other problems, resulted in unreliable subsidy cost estimates
and reestimates for the disaster loan program. Collectively, the
problems with SBA's cash flow model resulted in significant
underestimates of the cost of the program, which was ultimately
reflected in the negative balance in the disaster loan subsidy
allowance. The negative balance would occur for programs that are
expected to be profitable, which would not be expected for the disaster
loan program, or when the allowance is overspent, meaning that the
program cost far more than estimated.
The Model Used to Determine Whether Loan Sales Were Beneficial Was Also
Flawed:
When SBA sold loans, it used another model, called the hold model, to
estimate the value to the government of holding the loans scheduled for
sale until they were repaid, either at or before maturity. The hold
model considered the same possible cash flows as the cash flow model
used to estimate the cost of the program, including principal and
interest collections, prepayments, delinquencies, defaults, and
recoveries. However, the hold model differed from the cash flow model
because it was constructed using a different methodology. The hold
model measured loans individually whereas the cash flow model, as
previously discussed, used a single-loan approach. In addition,
expected defaults were determined differently, which caused the hold
model to produce higher default rates than the cash flow model.
Further, the hold model used economic variables and performance
indicators and the cash flow model did not. As a result of these
differences, the two models produced different results. While the hold
model's conceptual design was superior to the cash flow model, it too
contained serious flaws that produced misleading results.
For example, the hold model erroneously used assumptions in determining
the amount of recoveries expected on defaulted loans. The recovery
assumptions were taken from the cash flow model used to estimate the
cost of the program. These assumptions were calculated based on actual
recoveries as a percentage of the value of loans disbursed and,
therefore, should have been applied based on the value of loans
disbursed. The hold model, however, erroneously applied this percentage
to estimated defaulted loan amounts, therefore calculating a far lower
amount of estimated recoveries than was appropriate, which made the
value of holding the loans seem much lower. Collectively, problems with
SBA's hold model caused it to undervalue the loans it sold by about 30
percent, according to disclosures in SBA's fiscal year 2003 financial
statements. As a result, at the time of the sales the hold model
indicated that it was financially beneficial to sell the loans when in
fact it was not.
Incorrect Loan Values Were Used to Calculate the Results of Loan Sales
Disclosed in SBA's Financial Statements:
While SBA's hold model indicated at the time of the sales that SBA had
gains on loan sales, SBA concurrently disclosed losses on loan sales in
its financial statements based on yet another set of flawed
calculations. As reported by us in our January 2003 report and in the
report issued by IBM in March 2003, when SBA calculated the results of
loan sales for purposes of its financial statements, it incorrectly
estimated the portion of the subsidy allowance to allocate to each loan
sold in order to calculate the value on its books for the loans it had
sold (net book value). For example, when calculating the net book value
for the disaster loans that were sold, SBA did not allocate a portion
of the subsidy allowance for financing costs associated with lending to
borrowers at below-market interest rates. Given that a large portion of
the subsidy cost was related to providing below-market borrower
interest rates, this omission resulted in a significant overestimate of
the net book value of the loans sold and, therefore, a significant
overestimate of the losses SBA disclosed in its financial statements
related to the sale of its disaster loans. Even though SBA calculated
losses for the financial statements, it still operated on the premise
that loans were sold at gains when considering changes in interest
rates, which the hold model was purportedly designed to do.
Interest Rates Used to Calculate Interest Payments to Treasury Were not
Consistent with Those Used to Estimate Subsidy Costs:
The final deficiency that SBA identified in its disaster loan program
accounting related to inconsistencies in the interest rates it used to
estimate its subsidy costs versus those used to calculate its interest
payments to Treasury. A direct loan program, including the disaster
loan program, funds its lending to borrowers with the subsidy cost it
receives through appropriations and from borrowing from Treasury.
Because the borrowing is expected to be repaid with collections from
borrowers, borrowing is not a budgeted cost to the program and is
accounted for in the program's financing account. FCRA requires that
the rate of interest charged to the financing account on the agency's
borrowing be the same as the interest rate used to discount cash flows
(discount rate) when estimating the subsidy cost for a program. The
equality of these rates is fundamental to achieving the proper balance
in the financing account. If subsidy cost calculations are accurate and
the proper interest rates used, the financing account will break even
over time as it uses collections from borrowers to repay Treasury
borrowings.
SBA, in coordination with OMB, found that the tools provided to
agencies to calculate interest for the financing account did not adjust
the amount of interest paid by the financing account while the loans
were disbursing. The discount rate used to estimate the subsidy cost is
not final until the loans in a cohort are substantially disbursed (at
least 90 percent), which, for the disaster program, generally may take
at least 2 years. When the loans are substantially disbursed, and the
final discount rate is fixed, the reestimate process retroactively
adjusts the subsidy costs to reflect the final discount rate.
SBA and other agencies must make annual interest payments to Treasury
while the loans are disbursing, although the final interest rate has
not yet been determined. Thus in the early years of a cohort, before
the loans are substantially disbursed, an interim interest rate is used
to calculate interest payments. However, the tools provided by OMB to
calculate interest between the financing account and Treasury do not
retroactively adjust prior interest earnings or payments to reflect the
final interest rate. This failure to adjust prior interest payments to
reflect the final interest rate resulted in excess payments to Treasury
and an insufficient balance in SBA's financing account and subsidy
allowance, since the interest payments impact both. This omission in
the tools OMB provides to all agencies that disburse or guarantee
loans[Footnote 13] could result in a disconnect between the amounts
required to be earned from or paid to Treasury to make the financing
account whole, and the actual amounts earned or paid. Consequently,
agencies' financing account balances and subsidy allowance may be over-
or understated.
SBA Has Taken Corrective Actions to Resolve Identified Deficiencies:
Following its analysis and identification of deficiencies, SBA
developed a new cash flow model to estimate the cost of the disaster
loan program. This improved the reliability of the disaster program
cost estimates and corrected the abnormal balance in the subsidy
allowance for the disaster loan program. In addition, SBA analyzed its
prior interest payments to determine the effect of using inconsistent
interest rates to calculate its estimated subsidy costs and interest
payments to Treasury, and implemented a different approach to
reestimate program costs. These corrective actions helped SBA achieve
an improved audit opinion on its fiscal year 2004 and restated fiscal
year 2003 financial statements.
New Cash Flow Model Improves SBA's Ability to Reasonably Estimate
Program Costs and Determine Loan Sale Results:
In fiscal year 2003, SBA's contractor developed a new cash flow model
to calculate subsidy cost estimates and reestimates for the disaster
loan program. In contrast to the prior model's flawed single loan
approach to estimate the cash flows, the new model was designed to
estimate cash flows individually for each loan. This design facilitates
calculating loan values for loans sold to determine gains or losses on
loan sales and, if SBA schedules additional loan sales, could also be
used to calculate loan values for determining whether these sales would
be financially beneficial to the government, thus negating the need for
a separate hold model. Application of the model enabled SBA to
retroactively determine the results of its prior loan sales and to
correct the abnormal balance in its subsidy allowance.
During the development of the new cash flow model, SBA analyzed the
available disaster loan data, including loan performance information,
loan terms, disaster type and magnitude, and regional information, as
well as certain economic data, such as unemployment, gross domestic
product, and interest rates. Based on these analyses, the data that
best predicted default and prepayment behavior--two important cash
flows for the disaster loan program--were selected to use as variables
in the model. The model segments the loan portfolio into groups of
loans based on the final variables selected, which were (1) the age of
the loan, (2) the type of borrower (home or business), (3) the size of
the loan, (4) the type of disaster loan (economic injury or physical
damage), and (5) the length of the grace period. Based on these
variables, there are a total of 162 groups of loans used to segment the
disaster loan portfolio.
On a loan-by-loan basis, the cash flow model estimates the expected
principal and interest payments based on loan contract terms. Then the
model estimates deviations from these expected payments for
delinquencies, charge-offs, and prepayments. These deviations are
calculated based on historical averages of loan performance for each
group of loans. Lastly, the model estimates recoveries on charged-off
loans based on historical averages. The model's methodology is based on
the assumption that the behavior of loans in the future, taking several
important loan characteristics into account, will be similar to loans
in the past. However, as discussed later, if future loans are made to
substantially different types of borrowers, such as those with better
or worse financial strength, or have substantially different loan
terms, changes to the model would be required to correctly consider
these new characteristics in the cash flow estimates.
Throughout the development of the model, SBA documented several
analyses of the performance and characteristics of its disaster loans
and the model's ability to predict loan performance. In addition to its
own analyses, SBA contracted with Ernst & Young LLP (E&Y) to conduct an
independent review of the model. E&Y reviewed the model documentation
and computer code, and reviewed SBA's testing and validation analyses.
E&Y summarized its observations and findings in two reports issued in
November[Footnote 14] and December 2003.[Footnote 15] E&Y noted that
the model can be expected to perform reasonably well for reestimates of
existing loans and to produce stable estimates over time given the
model's emphasis on long-term averages. In addition, E&Y stated that
given the limitation of what can be known about future loans, the model
takes a reasonable approach to estimating costs of future loans for
budget purposes. E&Y also noted that the model achieves SBA's objective
to consistently value individual loans for reestimates and loan sales.
Based on our review of the model, its documentation, and the reports
issued by E&Y, we concluded that the new model provides a sound basis
to estimate costs and improved SBA's ability to prepare more reliable
and reasonable cost estimates for the disaster loan program. When SBA
used this new model for the first time to reestimate the cost of the
disaster loan program, it resulted in a reestimate indicating increased
costs of over $1 billion as of the end of fiscal year 2003. As shown in
figure 3, the adjustment to increase these costs on SBA's books helped
bring the disaster loan program's subsidy allowance to a positive
balance and more in line with expectations for this type of subsidized
program. In SBA's fiscal year 2004 financial statements, the subsidy
allowance was reported to be about $613 million, or about 20 percent,
of the $3 billion outstanding balance of the disaster loan program.
Given that the estimated cost of the program generally ranges from $16
to $36 for every $100 that SBA lends, this balance is within the
expected range. SBA also used the new model to recalculate the results
of its prior disaster loan sales and determined that the sales resulted
in losses, or increased budgetary costs, of over $900 million.
Figure 3: Disaster Subsidy Allowance as a Percent of the Loan Balance
Outstanding, Fiscal Years 1996 through 2004:
[See PDF for image]
[End of figure]
Analysis of Interest Payments and Change in Approach to Reestimate
Costs Addressed Interest Rate Inconsistency:
To resolve the inconsistency in the interest rates used to calculate
interest on its financing account borrowing from Treasury and the
interest rates used to discount cash flows when estimating subsidy
costs, SBA completed a detailed analysis of its interest transactions
with Treasury. SBA recalculated what its interest payments would have
been based on the final (rather than the interim) interest rates and
determined that it overpaid Treasury by about $128.6 million and $5.6
million as of the end of fiscal years 2003 and 2004, respectively.
These amounts were included in SBA's reestimates for the disaster loan
program and corrected SBA's interest transactions for the fiscal years
1992 through 2003 cohorts.[Footnote 16]
Also in fiscal year 2004, SBA implemented a new approach to reestimate
costs, called the balances approach.[Footnote 17] Because the balances
approach determines the amount of the reestimate based on a comparison
of resources in the financing account and expected future cash flows,
the approach automatically adjusts the financing account and subsidy
allowance for any inconsistency in interest rates going forward.
Other agencies that disburse or guarantee loans would also be affected
by this interest rate inconsistency, which could result in
misstatements in their accounts. However, the significance of this
issue cannot be determined without extensive analyses similar to SBA's
analysis because a number of factors influence how the inconsistency
would impact other agencies' accounts, including balances in financing
accounts and the length of time a program takes to substantially
disburse its loans. OMB has notified agencies of the flaw in the tools
and outlined plans to issue a comprehensive revised reestimate tool
that resolves this problem.[Footnote 18] Until updated tools are
provided, agencies will continue to make incorrect interest payments
that could result in financing accounts having excess or insufficient
funds and misstatements in financial statement reporting accounts for
credit programs.
SBA's Corrective Actions Helped It Achieve an Improved Audit Opinion:
SBA's corrective actions helped it achieve an improved audit opinion
for its fiscal year 2004 financial statements. Earlier, SBA's auditor
withdrew its unqualified opinions on SBA's fiscal years 2000 and 2001
financial statements and issued a disclaimer of opinion for fiscal year
2002, in part, because of issues identified in our January 2003 report.
While progress was made in addressing these issues during fiscal year
2003, the auditor also issued a disclaimer of opinion on SBA's fiscal
year 2003 financial statements. The auditor reported that because SBA
was late in completing reestimates and preparing its financial
statements, among other things, the auditor did not have adequate time
to resolve reservations related to SBA's disaster loan program,
including abnormal balances in the subsidy allowance and a difference
in interest rates SBA used to estimate subsidy costs and calculate
interest payments to Treasury.
Subsequently, SBA continued to implement its corrective actions, which
the auditor assessed as part of the fiscal year 2004 financial
statement audit. SBA received a mixed opinion--a combination of
unqualified and qualified opinions--on its fiscal year 2004 financial
statements,[Footnote 19] which represented an improvement over the
disclaimer it received for fiscal year 2003. In addition, SBA received
an unqualified opinion on its restated fiscal year 2003 balance
sheet.[Footnote 20] SBA's auditor did not cite any issues related to
previously identified problems with the disaster program or the new
disaster cash flow model in these audit opinions.[Footnote 21]
New Policies and Procedures Will Help Ensure Future Estimates Are
Reasonable, but Additional Procedures and Documentation Are Needed:
In addition to implementing the corrective actions to resolve the
accounting anomalies, SBA also implemented new policies and procedures
to help ensure that future loan program cost estimates will be
reasonable, including (1) the development and implementation of new
standard operating procedures for calculating reestimates; (2) the
preparation of documentation to support the rationale and basis for key
aspects of the cash flow model; (3) a process to coordinate the
preparation of cost estimates between budget, accounting, and program
staff; and (4) a revised reestimate approach. However, additional
documentation of the new cash flow model would help ensure proper
operation and maintenance of the model. Further, over time it will be
important for SBA to continue to assess the model's ability to predict
loan performance. In addition, there may be opportunities to improve
the model, as well as simplify the estimation process, that warrant
further consideration by SBA. Lastly, additional procedures to test the
disaster data used in the model will help ensure their reliability.
New Policies and Procedures Strengthened Internal Controls:
During fiscal years 2003 and 2004, SBA enhanced its policies and
procedures by implementing several of the internal control practices
identified in federal accounting guidance that will help it ensure that
future cost estimates are reliable and reasonable.[Footnote 22] SBA
developed and implemented standard operating procedures for calculating
its reestimates based on federal accounting guidance. These procedures
established an internal review process and standardized steps that must
be performed and documented as part of the reestimate process. Steps
included ensuring that the correct cash flow model files are used,
verifying that the model appropriately reflects the program's
structure, documenting any technical changes to the model, updating
actual data and estimated cash flows in the model, and reviewing the
reasonableness of the estimated cash flows. The procedures also call
for the cash flow model to be reviewed by an outside party. The
supporting documentation for the reestimates was provided to SBA's
financial statement auditor during the fiscal year 2004 audit. The
auditor noted in its report on internal controls that the adherence to
a set of standard operating procedures for calculating reestimates,
along with improved documentation and an effective internal review
process, were critical to SBA's success in meeting key milestone dates
and completing the audit process within accelerated financial reporting
deadlines.
SBA also established other important internal control practices
identified in the guidance. During the development of the new cash flow
model, SBA documented key analyses and decisions regarding the model's
methodology. For example, SBA compared the characteristics of the loans
sold to the loans kept and developed an approach within the new model
to take those differences into account when estimating loan
performance. It also documented the basis for selecting the model's
methodology and variables, the assumptions and calculations in the
model, and results of testing the model's ability to predict cash flow
estimates. This documentation helps support the rationale and basis for
key aspects of the model that provide important cost information for
budgets and financial statements.
SBA has also established procedures to coordinate the preparation of
cost estimates among budget, accounting, and program offices. This will
help ensure that the estimates are reviewed and prepared with the
proper information. Further, as previously discussed, SBA implemented
the balances approach for reestimates. This approach will help ensure
that SBA's account balances are in line with expected future cash
flows. These practices and the other practices discussed above will
help ensure that anomalies such as those we identified during our last
review do not go undetected or uncorrected.
Additional Documentation, Analysis, and Testing Would Improve Long-Term
Reliability of Cost Estimates:
While SBA resolved its accounting anomalies related to the disaster
loan program and made important improvements to its policies and
procedures, we found that additional enhancements to internal controls
would help ensure the long-term reliability of future cost estimates.
Further, strengthening internal controls will help SBA identify
potential problems in the future and sustain the progress it has
already made.
Even though SBA completed substantial documentation for the new cash
flow model, we found that this documentation was not sufficient to
readily provide for knowledge transfer between staff and contractors to
help ensure proper maintenance and updating of the model. For example,
the documentation does not specify what is done to prepare the data for
use in the model and does not always clearly indicate the data sources.
In addition, SBA's documentation to explain the files used to run the
model and update the data used in the model was not complete. For
example, in SBA's documentation of the files and steps used to run the
cash flow model, out of a total of 19 steps, 6 steps had no
explanations of the process and another 2 were not complete and
indicated that someone who was no longer employed at SBA was to provide
the information.
Improved documentation is particularly important because SBA relied on
a contractor to help develop the new cash flow model for the disaster
loan program and has recently experienced significant turnover in staff
responsible for preparing cost estimates. Without complete and detailed
documentation on how to maintain the model, update it with additional
data, and run it, it will be more difficult for current SBA staff to
fully understand the model, which could result in future errors in the
cash flow estimates.
Thorough documentation of the model is even more important given the
complexity associated with its calculation process. E&Y noted in its
review, and we agree, that the model's complexity creates an ongoing
challenge related to transparency and maintenance. Because complexity
increases the risk of errors occurring, SBA could benefit from
continuing to evaluate whether there are opportunities to simplify the
estimation process with model revisions or alternative estimation
methodologies.
There may also be opportunities to improve the model with additional
variables. When estimating loan performance, the new model does not use
data related to the financial strength of borrowers. Because this kind
of information has been shown to be useful in predicting loan
performance, such as defaults and prepayments, incorporating this type
of information could improve the model's estimates. Further, additional
detailed data on borrower financial strength and loan collateral, among
other things, may improve the model's effectiveness for supporting any
future loan sales. According to SBA officials, beginning in fiscal year
2003 SBA began collecting credit scores for disaster loan borrowers.
Once these newer loans have sufficient historical data, SBA will be
able to evaluate the usefulness of these data as a potential variable
to predict loan performance.
In addition to opportunities to improve the model, SBA could also
enhance its procedures to ensure that the model's estimates reasonably
predict future loan performance. While SBA has completed testing of the
model's ability to predict loan performance, it is important that SBA
establish a process to help ensure this testing continues routinely and
that causes of any significant variances are identified and addressed.
For example, as stated earlier, if future loans are made to
substantially different types of borrowers or have substantially
different loan terms, changes to the model would be required to
correctly consider these new characteristics in the cash flow
estimates. Routine testing would help identify this type of change.
While the new cash flow model provides SBA with a sound approach to
estimate costs for the disaster loan program, additional verification
procedures would provide better assurance that data used by the model
are reliable. Federal accounting guidance requires agencies to
accumulate sufficient, relevant, and reliable supporting data that
provide a reliable basis for estimates of future loan performance.
Because SBA's old cash flow model used data from SBA's Main On-Line
System for Tracking Evaluation and Response (MONSTER) database which
contains summary information, most of its detailed data reliability
assessments and reconciliation practices revolved around MONSTER. For
example, SBA maintains a reconciliation that tracks loans in MONSTER
with its general ledger at a cohort level. However, the new model uses
data from MONSTER and loan-level data from SBA's Electronic Loan
Information Processing System (ELIPS) database. SBA officials indicated
that plans are to continue to move away from using MONSTER. While SBA
routinely reconciles its ELIPS database at a high level, as it moves
toward using ELIPS data for estimating its disaster program costs, it
is important that SBA reconcile and test the data at the level used in
the model.
Conclusions:
SBA took prompt action to identify the deficiencies related to its
disaster and loan sale programs with a comprehensive review of its
financial records. The corrective actions it then took established a
basis for reliable and reasonable cost estimates. At the same time, the
complexities associated with estimating costs for these programs will
require continued attention. Without enhancements to the model's
documentation, additional procedures to test data reliability, and
continued testing and analysis of the model, SBA may find it difficult
to fully sustain the progress it has made. Further, improved tools from
OMB would help SBA and other agencies ensure proper calculation of
interest costs related to their credit programs.
Recommendations for Executive Action:
We are making five recommendations to SBA and two to OMB. To help
ensure that future subsidy cost estimates are reliable, we recommend
that the SBA Administrator take the following five actions.
* Develop additional documentation of the new disaster cash flow model
to help facilitate proper operation, maintenance, and updating of the
model.
* Study the value of incorporating additional variables in the new
disaster cash flow model, such as detailed information on the financial
strength of borrowers.
* Establish policies and procedures to routinely test the new disaster
cash flow model's ability to predict loan performance by comparing the
model's predictions to actual loan performance and to identify and
address the causes of any significant variances.
* Consider possible revisions to the model and/or alternative
methodologies that would simplify the estimation process.
* Establish additional procedures to test and document the reliability
of the data used in the new cash flow model for the disaster loan
program.
To help ensure that agencies make correct interest calculations for
financing accounts, we recommend that the OMB Director take the
following two actions.
* Update the tools provided to agencies for adjusting financing account
interest transactions once a final interest rate is determined for a
cohort.
* Provide instructions to agencies on making retroactive corrections to
financing account interest transactions based on final interest rates
for a cohort.
Agency Comments:
In written comments reprinted in appendix II, SBA stated that these
were appropriate recommendations and that it already has work underway
to address several of them. In written comments reprinted in appendix
III, OMB agreed with our recommendations and stated that it would work
with agencies to correct interest transactions with Treasury. SBA and
OMB also provided technical comments, which we have incorporated as
appropriate.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from its date. At that time, we will send copies of this report to the
Ranking Minority Member of the Senate Committee on Small Business and
Entrepreneurship, other appropriate congressional committees, the
Administrator of the Small Business Administration, and the Director of
the Office of Management and Budget. Copies will also be made available
to others upon request. In addition, the report will be available at no
charge on the GAO Web site at [Hyperlink, http://www.gao.gov].
If you or your staffs have any questions about this report, please
contact me at (202) 512-9508 or [Hyperlink, calboml@gao.gov]. Major
contributors to this report are acknowledged in appendix IV.
Signed by:
Linda M. Calbom:
Director:
Financial Management and Assurance:
[End of section]
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
To describe the nature of the deficiencies SBA identified that
contributed to the disaster loan program accounting anomalies, we
reviewed the report prepared by IBM that summarized the detailed review
of SBA's accounting and budgeting for its disaster loan program and its
loan sale procedures performed by SBA and IBM, and a variety of
documents prepared by SBA that summarized the issues found. We also
reviewed OMB Circular A-11 and FCRA to determine the criteria for
calculating interest payments to Treasury on borrowing. We also
interviewed SBA and OMB officials, SBA's financial statement auditor,
and a contractor with SBA.
To identify the corrective actions taken and assess whether these
actions resolved the identified deficiencies, we:
* obtained and assessed the new cash flow model used to estimate the
cost of the disaster loan program and its various supporting
documentation;
* obtained an understanding of how the model works by reviewing SBA's
summary of the behavior equations, the production system documentation,
and assumptions made in the model;
* analyzed the model's methodology, including choice of statistical
technique and variables included in the analysis, and determined that
they were appropriate and reasonably related to the prediction of cash
flows of disaster loans;
* replicated certain components of the model, such as the process used
to segment the portfolio into groups of loans and predict future loan
performance;
* assessed SBA's logistic regression used to determine and support the
variables used in the model to verify that the variables selected were
statistically significant;
* reviewed (1) SBA's testing of the cash flow model for biases; (2)
SBA's comparison of the loans sold and the loans kept; (3) E&Y's
reports summarizing its independent reviews of the model, including
procedures performed, findings, and observations; and (4) SBA's
financial statement auditor's assessment of SBA's model, its
reestimates, and its revised loan sale loss calculation;
* obtained SBA's analysis of its interest payments to Treasury and
verified the calculations;
* reviewed SBA's fiscal year 2004 financial statements summarizing the
implementation of the balances approach to reestimate costs;
* interviewed SBA officials, an SBA contractor, and SBA's financial
statement auditor; and:
* interviewed OMB officials to obtain an understanding of their efforts
to update the tools agencies use to calculate interest on financing
account balances.
To determine whether SBA's new cash flow model and procedures for the
disaster loan program provide a reasonable basis for future subsidy
cost estimates, we interviewed SBA officials and a contractor to obtain
an understanding of SBA policies and procedures for estimating subsidy
costs. We reviewed supporting documentation related to its procedures,
including the standard documentation template used to support its
reestimates for its fiscal year 2004 financial statements, the various
documentation prepared to support the model, and the reliability of
data from SBA's computer systems. Based on SBA's procedures and
documentation, we assessed the sufficiency of SBA's estimation process
based on federal accounting guidance that identifies internal control
practices that help ensure that future cost estimates are reliable and
reasonable. We also reviewed SBA's financial statement auditor's
reports on internal controls for fiscal years 2003 and 2004. The
checking of key components, along with our review of SBA's
documentation and E&Y's evaluation of the model, provided a sufficient
level of understanding to conclude on its approach and ability to
produce more reliable and reasonable cost estimates for the disaster
loan program. To identify any additional steps SBA could take to
improve the long-term reliability of its model, we considered
additional types of variables that might enhance SBA's approach. As
part of this analysis, we reviewed academic literature on default
modeling and discussed alternative variables and modeling techniques
with the contractor SBA used to develop the model. Based on these
assessments, our assessment of the model, and E&Y's findings and
observations on the cash flow model, we identified opportunities SBA
could explore to enhance its procedures to improve the long-term
reliability of its cost estimates.
We provided SBA a draft of this report and OMB a draft of applicable
sections of this report for review and comment. SBA and OMB provided
written comments, which are reprinted in appendix II and III,
respectively. They also provided technical comments, which we have
incorporated as appropriate. We performed our work in accordance with
generally accepted government auditing standards in Washington, D.C.
from April 2004 through March 2005.
[End of section]
Appendix II: Comments from the Small Business Administration:
U.S. SMALL BUSINESS ADMINISTRATION:
WASHINGTON DC, 20416:
APR 12 2005:
Ms. Linda Calbom:
General Accountability Office:
Washington, DC 20548:
Dear Ms. Calbom:
This letter provides the U.S. Small Business Administration's (SBA)
response to the draft report prepared by the General Accountability
Office (GAO) titled, "Accounting Anomalies Resolved but Additional
Steps Would Improve Long-Term Reliability of Cost Estimates." We
appreciate the opportunity to comment on the report.
Overall, we believe the report fairly represents the work completed by
SBA to address the deficiencies related to its accounting and budgeting
for its disaster loans and loan sale program. As GAO reports, SBA took
prompt action to diagnose and remedy this complex and highly technical
problem. We believe the analyses we completed to diagnose the problem
and the ongoing improvements we are making in our subsidy modeling
processes meet the "best practices" standard for federal credit
accounting and budgeting. SBA is proud of its accomplishments in this
area and they reflect the Agency's overall commitment to improved
financial management.
The report includes five recommendations for SBA to help ensure that
future subsidy cost estimates produced by the new disaster cash flow
model are reliable. The recommendations are: (1) develop additional
documentation of the model; (2) study the value of incorporating
additional variables into the model; (3) routinely test the model's
ability to predict loan performance; (4) consider options for
simplifying the model, and (5) conduct additional testing and
documentation of the data used in the model.
Generally, we agree that these are reasonable recommendations. Indeed,
these recommendations would be appropriate for virtually all Federal
credit models. SBA already has work underway which will address several
of the recommendations, including: expanding the documentation of the
model and related data, testing model assumptions, and obtaining loan
data directly from SBA's Electronic Loan Information Processing System.
Again, SBA appreciates the opportunity to comment on this report.
Sincerely,
Signed by:
Thomas Dumaresq:
Chief Financial Officer:
[End of section]
Appendix III: Comments from the Office of Management and Budget:
EXECUTIVE OFFICE OF THE PRESIDENT:
OFFICE OF MANAGEMENT AND BUDGET:
WASHINGTON, D.C. 20503:
April 13, 2005:
Ms. Linda Calbom:
Government Accountability Office:
Washington, DC 20548:
Dear Ms. Calbom:
Thank you for the opportunity to comment on your draft report
addressing a flaw in the Treasury interest calculations for SBA's
Disaster Loan program.
We appreciate the research that GAO has put into the report. As you are
aware, OMB has been working with SBA on this issue, and the method of
correction, from the time that the flaw was first identified in the
Disaster Loan program. We agree with your conclusions that there must
be a plan to correct this flaw, and will work with other affected
agencies to calculate its impact on their credit program subsidy cost
estimates. As you noted in the report, we have already informed
agencies of the flaw's existence, and have released a planned timetable
for implementing corrections to the tools used to make financing
account interest calculations.
Thank you again for the opportunity to comment on your draft report.
Sincerely,
Signed by:
Richard P. Emery, Jr.:
Assistant Director for Budget:
[End of section]
Appendix IV: GAO Contact and Staff Acknowledgments:
GAO Contact:
Linda Calbom, (202) 512-9508:
Acknowledgments:
In addition to the above, Marcia Carlsen, Lisa Crye, Austin Kelly,
Beverly Ross, Kara Scott, and Brooke Whittaker made key contributions
to this report.
(190125):
FOOTNOTES
[1] Our review also included determining whether the loan sales
generated operational benefits for SBA and identifying how borrowers
and lenders reacted to the sales.
[2] GAO, Small Business Administration: Accounting Anomalies and
Limited Operational Data Make Results of Loan Sales Uncertain, GAO-03-
87 (Washington, D.C.: January 2003).
[3] The 7(a) program is established under section 7(a) of the Small
Business Act (15 U.S.C. § 636). The 504 program is established under
Title V of the Small Business Investment Act of 1958 (15 U.S.C. § 695
et seq).
[4] Federal Credit Reform Act of 1990, Pub. L. No. 101-508, title XIII,
§ 13201 (a) (Nov. 5, 1990); 2 U.S.C. §§ 661-661f.
[5] The board establishes generally accepted accounting principles for
federal entities.
[6] A cohort includes those direct loans or loan guarantees of a
program for which a subsidy appropriation is provided in a given year
even if the loans are not disbursed until subsequent years.
[7] Present value is the worth of the future stream of returns or costs
in terms of money paid immediately. In calculating present value,
prevailing interest rates provide the basis for converting future
amounts into their "money now" equivalents.
[8] A liquidating account was established to handle credit transactions
on a cash basis for pre-credit reform loans and loan guarantees.
[9] Nonbudgetary accounts may appear in the budget document for
information purposes, but are not included in the budget totals for
budget authority or budget outlays.
[10] For loans made or guaranteed in fiscal year 2001 and thereafter,
the discount rate is based on interest rates on marketable zero-coupon
Treasury securities with the same maturity from the date of
disbursement as the cash flow. For loans made or guaranteed before
fiscal year 2001, the discount rate is based on a disbursement-weighted
average of interest rates for marketable Treasury securities with
similar maturities as the loans or loan guarantees.
[11] For loan guarantee programs that do not borrow from Treasury, the
financing account receives the subsidy cost from the program account
and holds these funds to serve as a reserve against future loan
guarantee defaults or other costs. FCRA requires that these funds,
referred to as uninvested funds, earn interest from Treasury at the
same rate as the discount rate used to calculate the present value when
estimating the subsidy cost.
[12] The hold value of the loans selected for sale represents the
estimated value to the government of continuing to hold the loans until
they are repaid, either at or before maturity. It is designed to be a
decisional tool used to determine whether or not it is currently
advantageous to sell loans. The hold value is calculated on a present
value basis, with future payments discounted at current Treasury
interest rates in order to reflect current market conditions in the
decision-making process.
[13] This discussion of the inconsistency with the interest rates used
to calculate interest on the financing account explains the problem as
it relates to a direct loan program that borrows from Treasury.
Guarantee loan programs would have a similar problem with interest
earnings calculated on uninvested funds held in the financing account
that serve as a reserve for the payment of future loan defaults or
other payments.
[14] Ernst & Young LLP, Independent Review of the SBA Disaster Loan
Program Subsidy Model Part I (Nov. 21, 2003).
[15] Ernst & Young LLP, SBA Disaster Loan Model Review, Part II (Dec.
12, 2003).
[16] The calculation as of the end of fiscal year 2003 corrected prior
interest payments for the fiscal years 1992 - 2001 cohorts. The
calculation as of the end of fiscal year 2004 corrected the prior
interest payments for the fiscal years 2002 and 2003 cohorts. Without a
comprehensive solution, this would be an ongoing process needed to
correct prior interest payments once cohorts become substantially
disbursed and the final interest rates are known.
[17] Current OMB guidance allows agencies to use either the
"traditional approach" or the "balances approach" to reestimate costs.
Both approaches will produce similar results as long as cohort cash
flows and transactions with Treasury are properly recorded in the
financing account and actual performance is properly included in the
cash flow model. To validate the results obtained with the balances
approach, SBA reconciled the differences between the two approaches.
According to SBA, after the reconciliation, the two approaches produced
cost estimates that differed by less then .005 percent of
disbursements.
[18] Agencies were alerted to the flaw and future changes to the tools
used to calculate subsidy cost estimates and reestimates in an e-mail
from OMB dated April 1, 2005.
[19] For fiscal year 2004, SBA received an unqualified audit opinion on
its statement of budgetary resources and a qualified audit opinion on
all its other statements.
[20] As part of the fiscal year 2004 audit, SBA's restated fiscal year
2003 balance sheet was re-audited in order to determine whether opening
balances for fiscal year 2004 were reliable. The statements of net
cost, financing, and changes in net position were also restated, but
were not re-audited.
[21] The qualifications of the audit opinions on most of SBA's
statements for fiscal year 2004 related primarily to new concerns over
SBA's estimated loan guarantee cash flow activity for the second half
of fiscal year 2004, which was necessary to accommodate the accelerated
financial reporting due date.
[22] In January 2004, the Federal Accounting Standards Advisory Board's
Accounting and Auditing Policy Committee issued Technical Release 6,
Preparing Estimates for Direct Loan and Loan Guarantee Subsidies under
the Federal Credit Reform Act Amendments to Technical Release 3:
Preparing and Auditing Direct Loan and Loan Guarantee Subsidies under
the Federal Credit Reform Act, which provides guidance to agencies on
preparing subsidy cost estimates.
GAO's Mission:
The Government Accountability Office, the investigative arm of
Congress, exists to support Congress in meeting its constitutional
responsibilities and to help improve the performance and accountability
of the federal government for the American people. GAO examines the use
of public funds; evaluates federal programs and policies; and provides
analyses, recommendations, and other assistance to help Congress make
informed oversight, policy, and funding decisions. GAO's commitment to
good government is reflected in its core values of accountability,
integrity, and reliability.
Obtaining Copies of GAO Reports and Testimony:
The fastest and easiest way to obtain copies of GAO documents at no
cost is through the Internet. GAO's Web site ( www.gao.gov ) contains
abstracts and full-text files of current reports and testimony and an
expanding archive of older products. The Web site features a search
engine to help you locate documents using key words and phrases. You
can print these documents in their entirety, including charts and other
graphics.
Each day, GAO issues a list of newly released reports, testimony, and
correspondence. GAO posts this list, known as "Today's Reports," on its
Web site daily. The list contains links to the full-text document
files. To have GAO e-mail this list to you every afternoon, go to
www.gao.gov and select "Subscribe to e-mail alerts" under the "Order
GAO Products" heading.
Order by Mail or Phone:
The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or
more copies mailed to a single address are discounted 25 percent.
Orders should be sent to:
U.S. Government Accountability Office
441 G Street NW, Room LM
Washington, D.C. 20548:
To order by Phone:
Voice: (202) 512-6000:
TDD: (202) 512-2537:
Fax: (202) 512-6061:
To Report Fraud, Waste, and Abuse in Federal Programs:
Contact:
Web site: www.gao.gov/fraudnet/fraudnet.htm
E-mail: fraudnet@gao.gov
Automated answering system: (800) 424-5454 or (202) 512-7470:
Public Affairs:
Jeff Nelligan, managing director,
NelliganJ@gao.gov
(202) 512-4800
U.S. Government Accountability Office,
441 G Street NW, Room 7149
Washington, D.C. 20548:
