Small Business Administration
Accounting Anomalies and Limited Operational Data Make Results of Loan Sales Uncertain Gao ID: GAO-03-87 January 3, 2003The Small Business Administration's (SBA) loan asset sales are being closely watched because similar sales are projected for other government agencies as a means of reducing loan assets and servicing costs. To assess the progress and effects of SBA's loan sales, GAO undertook this study to (1) describe the process for selling loans, (2) identify how lenders and borrowers have reacted to loan sales, (3) determine whether SBA is properly accounting for its loan sales and their subsequent impact on credit subsidy estimates, and (4) assess whether loan sales generated operational benefits for the agency. GAO did not determine whether SBA maximized proceeds from the loan sales.
From August 1999 through January 2002, SBA held five loan asset sales, disposing of a total of $4.4 billion in disaster assistance home and business loans (85 percent) and regular business loans (15 percent). SBA created a sales process that has attracted investors and responded to their concerns. Lenders who participate in the 7(a) business loan guaranty program were also satisfied with the sales as an option for disposing of their defaulted loans. SBA relies on borrower inquiries and complaints to determine whether purchasers of the loans are using prudent loan servicing practices, as required in the loan sale agreements. However, information on borrowers' reactions to loan sales is incomplete, because SBA does not have a comprehensive process to capture the inquiries and complaints it receives. SBA incorrectly calculated the accounting losses on the loan sales 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 contain significant errors. In addition, SBA could not explain significant declines in its loss allowance account for disaster loans. Until SBA corrects these errors and determines the cause of the precipitous decline in the loss allowance account, SBA's financial statements will likely be misstated, and the audit opinion on past financial statements may be incorrect. Further, the reliability of current and future subsidy cost estimates will remain unknown. These errors and the lack of key analyses also mean that congressional decisionmakers are not receiving accurate financial data to make informed decisions about SBA's budget and the level of appropriations the agency should receive. Our analysis of the operational benefits from loan sales suggests that some benefits that SBA reported either have not yet materialized or were overstated. SBA conducted a limited analysis of the impact of loan sales on its loan servicing centers, showing that loan servicing volume had been reduced. However, loan sales had a much greater impact on disaster loan servicing than on business loan servicing. Therefore, how the sales will help SBA realign its workforce in the small business programs remains unclear. It would be imprudent to continue SBA loan asset sales in the absence of reliable and complete information on the accounting and budgetary effects. A successful loan sales program is not solely about maximizing proceeds and attracting investors: it is also a means of improving an agency's ability to achieve its mission and to best serve the American people. Moreover, as the Office of Management and Budget (OMB) continues to encourage loan asset sales, it is important that agencies embarking on new loan asset sales programs have the capability to properly carry out and account for these activities.
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-03-87, Small Business Administration: Accounting Anomalies and Limited Operational Data Make Results of Loan Sales Uncertain
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Report to the Ranking Minority Member, Committee on Small Business and
Entrepreneurship, U. S. Senate:
January 2003:
Small Business Administration:
Accounting Anomalies and Limited Operational Data Make Results of Loan
Sales Uncertain:
GAO-03-87:
GAO Highlights:
Highlights of GAO-03-87, a report to the
Ranking Minority Member, Committee on
Small Business and Entrepreneurship,
U.S. Senate
Why GAO Did This Study:
SBA‘s loan asset sales are being closely watched because similar
sales are projected for other government agencies as a means of
reducing loan assets and servicing costs. To assess the progress and
effects of SBA‘s loan sales, GAO undertook this study to (1)
describe the process for selling loans, (2) identify how lenders and
borrowers have reacted to loan sales, (3) determine whether SBA is
properly accounting for its loan sales and their subsequent impact
on credit subsidy estimates, and (4) assess whether loan sales
generated operational benefits for the agency. GAO did not determine
whether SBA maximized proceeds from the loan sales.
What GAO Found:
From August 1999 through January 2002, SBA held five loan asset sales,
disposing of a total of $4.4 billion in disaster assistance home and
business loans (85 percent) and regular business loans (15 percent).
SBA created a sales process that has attracted investors and
responded to their concerns. Lenders who participate in the 7(a)
business loan guaranty program were also satisfied with the sales as
an option for disposing of their defaulted loans. SBA relies on
borrower inquiries and complaints to determine whether purchasers
of the loans are using prudent loan servicing practices, as required
in the loan sale agreements. However, information on borrowers‘
reactions to loan sales is incomplete, because SBA does not have
a comprehensive process to capture the inquiries and complaints it
receives. SBA incorrectly calculated the accounting losses on the
loan sales 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 contain significant errors. In addition, SBA could
not explain significant declines in its loss allowance account for
disaster loans. Until SBA corrects these errors and determines the
cause of the precipitous decline in the loss allowance account, SBA‘s
financial statements will likely be misstated, and the audit
opinion on past financial statements may be incorrect. Further, the
reliability of current and future subsidy cost estimates will remain
unknown. These errors and the lack of key analyses also mean that
congressional decisionmakers are not receiving accurate financial data
to make informed decisions about SBA‘s budget and the level
of appropriations the agency should receive.
Our analysis of the operational benefits from loan sales suggests
that some benefits that SBA reported either have not yet materialized
or were overstated. SBA conducted a limited analysis of the impact of
loan sales on its loan servicing centers, showing that loan servicing
volume had been reduced. However, loan sales had a much greater impact
on disaster loan servicing than on business loan servicing. Therefore,
how the sales will help SBA realign its workforce in the small
business programs remains unclear. It would be imprudent to continue
SBA loan asset sales in the absence of reliable and complete
information
on the accounting and budgetary effects.
A successful loan sales program is not solely about maximizing
proceeds and attracting investors: it is also a means of improving an
agency‘s ability to achieve its mission and to best serve the American
people. Moreover, as OMB continues to encourage loan asset sales, it is
important that agencies embarking on new loan asset sales programs have
the capability to properly carry out and account for these activities.
What GAO Recommends:
We recommend that, before doing more loan asset sales, SBA correct
the accounting and budgeting errors and misstatements. Also,
the Inspector General, with SBA‘s independent auditors, should
assess the impact of identified errors in the financial statements
and determine whether audit opinions for fiscal years 2000 and
2001 financial statements need to be revised. We also recommend
that SBA improve its tracking of borrower inquiries and complaints
and analyze the benefits and other effects on agency operations of the
sales. SBA generally agreed with our findings and recommendations
but did not respond to the recommendation to analyze the
operational effects of loan sales.
www.gao.gov/cgi-bin/getrpt?GAO-03-87.
To view the full report, including the scope and methodology, click on
the
link above. For more information, contact Davi M. D‘Agostino or Linda
M.
Calbom, (202) 512-8678.
Letter:
Results in Brief:
Background:
SBA‘s Sales Process Is Designed to Satisfy Investor Demands:
Lenders Expressed Satisfaction with SBA‘s Loan Sales, but SBA‘s Data on
Borrowers‘ Reactions Was Incomplete:
SBA‘s Accounting for Loan Sales and the Remaining Portfolio Was Flawed:
Loan Sales Have Reduced SBA‘s Loan Servicing Volume, but Other
Operational Benefits May Be Overstated:
Conclusions:
Recommendations:
Agency Comments:
Appendixes:
Appendix I: Scope and Methodology:
SBA Field Locations We Visited:
Appendix II: types of Borrower Inquiries and Complaints Received by
SBA:
Appendix III: Comments from the Samll Business Administration:
Appendix IV: Comments from the Inspector General of the Small
Business Administration:
Appendix V: Comments from Cotton and Company:
Appendix VI: GAO Contacts and Acknowledgements:
Contacts:
Acknowledgments:
Glossary:
Tables:
Table 1: Key Information on SBA‘s Loan Sales One through Five:
Table 2: Loan Receivable Balances of SBA‘s Disaster Loan Program:
Figures:
Figure 1: Time Line of a Loan Sale:
Figure 2: Total Balance of Loans Sold:
Figure 3: Outlets That SBA Borrowers Use for Inquiries and Complaints
about Loan Sales:
Figure 4: Gain / Loss Calculation on Previously Defaulted Sold
Guaranteed Loans:
Figure 5: Change in Loan Servicing Volume at the Disaster Home Loan and
Commercial Loan Servicing Centers:
Figure 6: Changes in Number of Employees and Workload per Employee at
Servicing Centers:
CFO: Chief Financial Officer:
OMB: Office of Management and Budget:
SBA: Small Business Administration:
SFFAS: Statement of Federal Financial Accounting Standards:
Letter January 3, 2003:
The Honorable Christopher S. Bond
Ranking Minority Member
Committee on Small Business and Entrepreneurship
United States Senate:
Dear Senator Bond:
In 1999, the Small Business Administration (SBA) began a loan asset
sales program, at the direction of Office of Management and Budget
(OMB), to reduce the amount of debt the agency owned and serviced.
SBA‘s loan asset sales program is of particular interest because OMB
has tentatively planned loan asset sales at other federal credit
agencies. OMB is interested in increasing loan asset sales in order to
improve the management of loan assets and to transfer loan servicing
responsibilities to the private sector.
SBA guarantees business loans through its lending partners in the 7(a)
program and makes direct loans for disaster assistance to individuals
and businesses. Before SBA began its loan asset sales program in 1999,
the agency had never sold large volumes of loans in bulk. More than $9
billion in disaster assistance and other direct loans and defaulted
business loan guarantees were eligible for sale. As of January 2002,
SBA had conducted five sales, divesting itself of about 110,000 loans
with an outstanding balance of $4.4 billion.[Footnote 1] Approximately
85 percent of the loans SBA sold were direct disaster assistance loans,
most of which have below-market borrower interest rates. When SBA
originally made these loans, it received appropriations to cover
expected default costs as well as financing costs related to offering
below-market interest rates to borrowers. The subsidy allowance account
was established to cover these anticipated losses, which generally
range from $17 to $33 for every $100 that SBA lends. This allowance
indicates that the economic value of the loans is less than the loan
balance at inception. The difference between the outstanding loan
balance and the subsidy allowance is the net book value. When investors
determine the price they are willing to pay for SBA‘s loans, they also
consider default risks and the low interest rate on most SBA disaster
loans. As a result, investors bid less than the outstanding balance
owed on these loans.
In determining whether or not to sell these loans, SBA estimated the
current value to the government, also known as the hold value,[Footnote
2] in accordance with OMB Circular A-11. In essence, the hold value is
the expected net cash flows from the loans, discounted at today‘s
Treasury rates. 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. As
a result, changes in interest rates since the loans were disbursed will
not affect the determination of the benefit of a loan sale to the
government based on the hold value.[Footnote 3] In contrast, the
accounting gain or loss on a loan sale--the net book value compared
with the sales proceeds--will be influenced by changes in interest
rates since the loans were disbursed.
SBA received about $2.7 billion in total proceeds and paid about $200
million in selling costs on its first five sales. These net proceeds
exceeded the hold values of the loans to SBA by about $606 million.
However, as discussed above, properly accounting for the sales and
their subsequent impact on loan program costs is more complex and could
render a different outcome regarding the accounting gain or loss. Our
assessment of SBA‘s accounting treatment for these sales is discussed
later in this report.
Because selling loans in bulk is a new and ongoing activity for SBA,
and OMB plans to expand loan sales in federal credit programs, you
asked us to conduct a broad review of the loan asset sales program.
Specifically, you asked us to (1) describe SBA‘s process for selling
loans, (2) identify how lenders and borrowers have reacted to loan
sales, (3) determine whether SBA is properly accounting for its loan
sales and their subsequent impact on credit subsidy estimates, and (4)
assess whether the loan sales are generating operational benefits for
the agency.
To respond to these reporting objectives, we reviewed strategic plans,
procedures, and other related documents that SBA used to plan and
manage the loan asset sales program; reviewed the results of the sales
in terms of types of loans sold, and proceeds; interviewed SBA
officials, contractors, investors, and lenders involved in the loan
sale process; reviewed and analyzed inquiries and complaints from
borrowers; and analyzed SBA data related to the impact of the loan
sales on loan servicing workloads and other benefits. We also analyzed
relevant budget and accounting data used to record the results of loan
sales for both budgetary and financial statement purposes, including
reestimates of subsidy costs, the values of loans sold, and proceeds
and costs of sales. We compared these data with the applicable
guidance.
To assess SBA‘s estimates of hold values for loans sold, we reviewed an
external validation of the hold model used for sales one through three
that was prepared by an SBA contractor, who concluded that the
calculations were accurate and reasonable. Since SBA changed to a more
sophisticated hold model after sale three, we also reviewed the
methodology and assumptions used in SBA‘s revised model to estimate
hold values for loans sold in sales four and five, and found the
approach to be reasonable.[Footnote 4] However, we did not audit the
data used to calculate the hold values for each sale and therefore did
not conclude on the reasonableness of the hold values for any of the
sales. We discussed SBA‘s budgeting and accounting procedures for loan
sales with the agency, with its independent auditor, and with OMB
officials. We reviewed SBA‘s audited financial statements for fiscal
years 1999 through 2001 and related audit workpapers for fiscal years
2000 and 2001.
All of our analyses were based on data from the first five sales, which
occurred between August 1999 and January 2002. The sixth sale, held on
August 6, 2002, was not completed in time for us to include it in our
analyses, because transferring servicing of the loans to the purchasers
and completing accounting adjustments take several weeks after the sale
date. We did not determine whether SBA maximized loan sale proceeds. We
performed our review from January 2002 through October 2002 in
Washington, D.C.; Birmingham, Alabama; Little Rock, Arkansas; Los
Angeles and Santa Ana, California; Denver, Colorado; and Philadelphia,
Pennsylvania, in accordance with generally accepted government auditing
standards. Appendix I provides a detailed discussion of our scope and
methodology.
Results in Brief:
A primary objective of SBA‘s loan sales is to maximize proceeds by
designing a sales process that attracts and satisfies investors. In
order to ensure that investors have all the information they need to
make informed bids, SBA has invested resources in developing a
carefully structured loan sale process. SBA field offices and servicing
centers review loan files to determine which loans can be sold,
although lenders must approve the sales of small business loans. A
contractor assembles the loan information for investors, and financial
advisers create loan pools and advertise the sales. Before a sale goes
forward, OMB must approve it. OMB generally approves the sale if the
estimate of the value to the government of holding the loans (based on
current interest rates) is less than the estimated market value
calculated by financial advisers. Beginning with the second sale, SBA
has offered primarily performing, secured disaster assistance loans
that share many of the characteristics of home mortgages and have
attracted mostly large commercial and investment banks. SBA has
consulted with investors since the loan sales began in order to
structure the sales in accordance with market demands, and it has
developed a ’lessons learned“ process to improve future sales. Most of
the investors with whom we spoke or whose survey responses we reviewed
responded favorably to the information that SBA provides about the
loans for sale and the organization of the loan pools. These investors
also reported that they plan to continue participating in SBA‘s sales.
Lenders with whom we spoke that had participated in the 7(a) business
loan guaranty program were satisfied with the loan sales. Most of the
lenders with whom we spoke were pleased with the proceeds from the
sales and viewed participating in the sales program as a useful way to
help manage their portfolios. Some of the lenders also noted that SBA
had improved certain aspects of the program since the first sale.
However, it was more difficult for us to determine the reaction of
borrowers whose business or disaster assistance loans were sold, as SBA
does not have a comprehensive process for documenting and tracking
borrower inquiries and complaints to ensure that borrower protections
are working. Borrower protections included in the loan sale agreements
are limited, requiring only that purchasers affirm they were qualified
to service the loans and agree to use prudent loan servicing practices.
These protections are intended to ensure that borrowers are not taken
advantage of or pressured to change a loan‘s terms or conditions. SBA‘s
primary mechanism for enforcing these protections is to follow up on
borrower inquiries and complaints, but we found that the agency did not
have a system in place to capture all the inquiries and complaints
received by headquarters or field offices. As a result, we could not
determine how many borrowers had actually contacted SBA with complaints
about the loan sales.
During our review of SBA‘s budgeting and accounting for loan
sales,[Footnote 5] we found errors that could significantly affect the
reported results in the budget and financial statements for fiscal
years 2000 and 2001. For example, SBA incorrectly calculated accounting
losses on loan sales, which were then reported in the footnotes to its
financial statements. Further, OMB budget guidance directs agencies to
make reestimates of program costs for all changes in cash flow
assumptions in order to adjust the subsidy estimate for differences
between the original estimated cash flows and the actual cash
flows.[Footnote 6] However, SBA did not conduct key analyses of either
the loans sold or its remaining portfolio, in order to determine the
impact of the loan sales on its reestimates of program costs for its
remaining loans. Because of the lack of reliable financial data, we
were unable to determine the actual gain or loss on SBA‘s loan sales
for the budget and financial statements. We also found that SBA had
significant unexplained declines in its disaster loan program subsidy
allowance account, to the point of showing that this subsidized program
was expected to generate a profit. Between fiscal years 1998 and 2001,
the balance in this account declined from $1.2 billion to a negative
$77 million--that is, by over 100 percent--while the outstanding loan
balance owed by borrowers declined by only 42 percent. SBA could not
provide support for the balance or explain the reason for this anomaly.
Despite these errors and uncertainties, SBA‘s auditor gave unqualified
audit opinions on SBA‘s fiscal years 2000 and 2001 financial
statements.[Footnote 7] We discussed these issues with SBA‘s auditors,
who indicated that they are currently assessing the cause of the
unusual balance in the subsidy allowance account and, if necessary,
plan to reevaluate their audit opinions on the fiscal years 2000 and
2001 financial statements. Until SBA performs further analyses to
determine the full impact of these errors and uncertainties, the
financial effect of its loan sales and the reliability of the current
and future subsidy rates will remain unknown, and congressional
decisionmakers will not receive the accurate financial data they need
to make informed decisions about SBA‘s budget and the level of
appropriations the agency should receive.
Though SBA has reported that its loan sales will help the agency
realign its workforce and improve the management of its loan portfolio,
these benefits either have not yet materialized or may be overstated.
SBA has said that loan asset sales are beneficial to the agency because
it does not have the capacity to service all of its loans. In addition,
the agency noted, selling loans should allow it to reallocate the
personnel who are servicing loans to functions that are more critical
to SBA‘s mission, such as lender oversight and outreach to small
businesses. We found that loan sales have most reduced the servicing
workloads for disaster assistance loans; they have had less of an
impact, however, on servicing workloads for 7(a) business loans, as
lenders did not always consent to sell these loans. Further, because
the reductions in loan servicing have involved disaster assistance
loans, it was unclear to what extent loan sales would help the agency
realign its workforce in the district offices that primarily serve
small businesses. We found some support for the other benefits SBA
identified, but other factors may also have contributed to some of
these outcomes. For example, SBA has reported that because of loan
asset sales, more borrowers have paid off their loans. However, the
increase in the number of loans paid off per year began prior to loan
asset sales, suggesting that some of these borrowers might have paid
off their loans regardless of whether a loan sale had occurred.
Although loan asset sales may be beneficial to the government, we were
unable to determine the accounting and budgeting effects of SBA‘s loan
asset sales because of problems identified in this report. This report
includes recommendations to SBA and its Inspector General. To provide
accurate and reliable information on the impact of the program and to
address the accounting and budgetary problems, we recommend that (1)
SBA improve the process for tracking borrower inquiries and complaints;
(2) SBA correct the accounting and budgeting errors and misstatements
before conducting additional loan sales; (3) the Inspector General work
with SBA‘s financial auditors to assess the impact of the errors in the
financial statements; and (4) SBA more thoroughly analyze the benefits
and other effects of the sales on agency operations.
We obtained written comments on a draft of this report from SBA‘s Chief
Financial Officer, from the Inspector General, and from Cotton and
Company, SBA‘s independent financial statement auditor. In commenting
on a draft of this report, SBA generally agreed with the overall
findings and recommendations, especially the need to better assess the
financial impact of SBA‘s loan sales program. SBA noted that it is
taking steps to address the process for documenting and tracking
borrower inquiries and complaints. SBA also stated that it is actively
engaging a contractor to help resolve the accounting and budgetary
issues, and that it has worked extensively with its independent auditor
to identify causes and options for resolving the issues we identified.
SBA did not specifically respond to our recommendation for a more
thorough analysis of the impact of loan sales on agency operations. SBA
requested that we delay issuance of the report until March 2003. By
then it hoped to have determined the causes of the accounting and
budgetary problems, and to be able to propose an appropriate
methodology for resolving them. Though we appreciate the desire to
provide a plan of action for addressing these problems in our final
report, it is not our policy to delay issuance of our reports until
problems we have identified are resolved.
The Inspector General also agreed with our recommendations and is
working with Cotton and Company and SBA management to determine the
magnitude of the errors in SBA‘s fiscal years 2000 and 2001 financial
statements. The Inspector General also stated that Cotton and Company
informed the IG office that the audit opinion on the fiscal years 2000
and 2001 financial statements should no longer be relied upon, as they
may be materially incorrect because of the errors identified in this
report. The comments also stated that Cotton and Company plans to
withdraw its unqualified audit opinion on those financial statements,
and to issue disclaimers of opinion.
Although Cotton and Company agreed with the findings of our report, it
stated that the report would be more fair and balanced if we further
elaborated on the inherent risks and complexities associated with
accounting estimates and loan sales. Cotton and Company also stated
that it believes there is a lack of comprehensive implementation
guidance for agencies on making credit subsidy and loan sale cost
estimates. We agree that accounting for and auditing credit subsidy
estimates and loan sales are inherently complex, and we describe these
complexities in the background section of the report. Further, the
errors we identified in the financial statements and the related
footnotes were primarily concerned with flaws in the application of
existing guidance rather than with insufficient guidance. In addition,
the anomalies in the disaster loan subsidy allowance account were
clearly apparent, and SBA was unable to provide a viable explanation
for these anomalies.
Background:
The President‘s fiscal year 1998 budget proposed that SBA begin selling
disaster and business loans that the agency was servicing and
transition from the direct servicing of loans 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 for disaster assistance.
SBA‘s loan asset sales program is part of a governmentwide initiative
to make loan asset sales a potential tool for improving the management
of federal credit programs. In the conference report accompanying the
Treasury, Postal, and General Government Appropriations Act,
1996,[Footnote 8] congressional conferees directed OMB, in coordination
with the federal agencies involved in credit programs, to evaluate the
potential for selling loan assets to the private sector. Furthermore,
the Debt Collection Improvement Act of 1996 encourages federal agencies
that provide loans to sell delinquent debt when appropriate.[Footnote
9] In June 2002, OMB issued guidance requiring agencies to analyze
their loan portfolios and loan management costs in order to determine
whether privatizing functions such as loan servicing by selling loan
assets or outsourcing would produce greater efficiencies. Other federal
credit agencies have significantly larger loan portfolios than SBA that
could be available for loan sales, including the Departments of
Agriculture and Education, which held $78 billion and $96 billion,
respectively, as of fiscal year 2001.
SBA‘s loan sales include defaulted, formerly guaranteed 7(a) and 504
(development company) business loans and direct disaster assistance
loans. SBA provides small businesses with access to credit, primarily
by guaranteeing loans through its 7(a) and 504 programs.[Footnote 10]
For the 7(a) program, SBA guarantees up to 85 percent of the loan
amount made by private lenders to small businesses that are unable to
obtain financing under reasonable terms and conditions through normal
business channels. Under the 504 program, SBA provides its guaranty
through certified development companies--private nonprofit
corporations--that sell debentures that are fully guaranteed by SBA to
private investors and lend the proceeds to qualified small businesses
for acquiring real estate, machinery, and equipment, and for building
or improving facilities. When a 7(a) or development company loan
defaults, SBA pays the claim and either relies on the lender to recover
as much as it can by liquidating collateral or takes over the loan
servicing and liquidation.[Footnote 11] Because SBA has paid the
guaranty and thus owns the loan, these defaulted business loans--
whether liquidated by the lender or by SBA--may be included in SBA‘s
loan asset sales.
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.[Footnote 12] Most of the disaster assistance loans have
low interest rates, sometimes less than 4 percent, and long 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. For example, if a borrower cannot obtain credit elsewhere, the
interest rate is typically below the market rate, but a borrower who
can obtain credit elsewhere is likely to receive a higher rate. Since
SBA owns the disaster loans, all disaster loans are eligible to be
sold.
The Federal Credit Reform Act of 1990 was enacted to require agencies
to more accurately measure the government‘s cost of federal loan
programs and to permit better cost comparisons, both among credit
programs and:
between credit and noncredit programs.[Footnote 13] The act gave OMB
responsibility for coordinating credit program cost estimates required
by the act. OMB is also responsible for approving all loan sales.
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 developed the accounting standard for credit
programs, including loan sales.[Footnote 14] This guidance is generally
found in Statement of Federal Financial Accounting Standards No. 2
(Statement 2), Accounting for Direct Loans and Loan Guarantees, which
became effective in fiscal year 1994. This standard, which generally
mirrors the Federal Credit Reform Act 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.[Footnote 15] The subsidy cost is the present value of
disbursements[Footnote 16]--over the life of the loan--by the
government (loan disbursements and other payments) minus estimated
payments to the government (repayments of principal, payments of
interest, other recoveries, and other payments).
For financial statement purposes, loans are reported at both the
outstanding balance and at the present value of their estimated net
cash inflows, known as the net book value, which is reported on the
balance sheet. The difference between these two amounts is the subsidy
allowance, which is reported along with the outstanding loan balance in
the footnotes of the financial statements. The allowance represents the
cost of the loan program that is not expected to be recovered from
borrowers, including default costs and financing costs from subsidizing
below-market rate loans. Statement 2 states that when loans are written
off, the unpaid principal of the loans is removed from the loans
receivable balance and the same amount is charged to the subsidy
allowance. Prior to the write-off, the uncollectible amounts should
have been fully provided for in the subsidy allowance through the
subsidy cost estimate or reestimates.
Further, as part of implementing credit reform, agencies are required
to estimate the subsidy cost for budgetary purposes. Generally, these
estimates are updated or reestimated annually after the end of the
fiscal year to reflect any changes in actual loan performance since the
estimates were prepared, as well as any expected changes in assumptions
related to future loan performance. Changes in subsidy cost that are
recognized through reestimates are funded through permanent indefinite
budget authority.
Before a loan sale, as part of its approval process, OMB reviews the
hold value of the loans being sold as compared with their estimated
market value.[Footnote 17] A contractor that assists SBA with the loan
sales estimates a market value, which indicates the anticipated
proceeds on the loan sale based on current market trends and
conditions, and the loans being sold. Comparing the market value with
the hold value determines whether it is more beneficial for the
government to hold or to sell the loans. However, this determination
does not take into account the impact of any changes in administrative
costs that results from the loan sales. The glossary at the end of this
report provides a list of commonly used terms related to credit program
budgeting and accounting.
SBA‘s Sales Process Is Designed to Satisfy Investor Demands:
SBA officials told us that the loan asset sale process is designed to
maximize SBA‘s sales proceeds by attracting as many investors as
possible to the bidding process. The process can take 9 months or
longer as contractors, SBA field offices, and lending partners work
together to prepare loans for sale. For a sale to take place, SBA must
have OMB‘s approval, which partly depends on an analysis of whether the
expected value of the loans to investors is greater than the estimated
value to the government. The price obtained for loans sold and investor
interest in the first five sales depended in part on the
characteristics of the loan pools. Large commercial and investment
banks have purchased the performing disaster assistance loans that make
up the majority of SBA‘s sale portfolio, and primarily small investors
have bought the nonperforming business loans.[Footnote 18] Beginning
with the first loan sale, SBA instituted a ’lessons learned“ process to
analyze and improve its efficiency and investor satisfaction from sale
to sale. Most investors interviewed by us or by SBA contractors stated
that SBA has responded to requests for more information and is now
providing the information needed to calculate bids. Most investors also
said that they plan to continue bidding on future sales.
Loan Sales Require Detailed Planning and an Investment of Resources:
SBA‘s asset sales team, which manages the loan asset sale program at
SBA headquarters, coordinates the efforts of contractors, SBA field
offices, and lending partners to execute a loan sale (fig. 1). Two
financial advisers and a due diligence contractor are involved in each
sale.[Footnote 19] The program financial adviser is hired on a
multiyear contract to supervise the work of other contractors and
consult on strategic planning issues, such as sale design and loan
selection. A transaction financial adviser is also hired for each sale,
to provide marketing and to manage logistics. All participants in the
sales process must work closely together over the approximately 9
months needed to carry out a loan sale and the 2 months required to
close it out.
Figure 1: Time Line of a Loan Sale:
[See PDF for image]
[End of figure]
SBA and the program financial adviser select the loans for each sale,
and SBA‘s servicing centers and district offices review them, removing
any that should not be sold, such as loans that are paid in full, are
charged off as a loss in SBA‘s accounts, or are in litigation. Before
every sale, SBA‘s loan asset sales team sends a detailed procedural
notice to field offices to guide them through every step. The guidance
covers loans that should be removed from the sale, loans that may be
added,[Footnote 20] and procedures for shipping the loan files when the
list is finalized. SBA‘s 7(a) lending partners review SBA‘s requests to
sell defaulted 7(a) loans and provide consent at their discretion.
SBA‘s field offices and 7(a) lenders send the final selection of loan
files to the due diligence contractor.
SBA‘s due diligence is the most costly and probably the most important
element of the loan sale process. For sales three through
five,[Footnote 21] due diligence averaged 87 percent of total sales
costs, which have reached up to $32.7 million per sale, not including
salaries and expenses for SBA personnel. SBA officials told us,
however, that money invested in due diligence results in higher bids
from investors. In part, due diligence is costly because SBA‘s loan
information systems do not capture some data that investors need to
make a purchase decision, such as collateral information. The due
diligence contractor must collect this information from the loan files
and create electronic images of documents. Investors also want reports
such as current credit scores, property appraisals, and broker price
opinions, which the due diligence contractor orders before a sale. The
due diligence contractor extracts the key data elements from the
reports and loan files and enters them into a database that investors
can access.
The transaction financial adviser sorts the loans into relatively
homogeneous pools according to characteristics such as the type of
loan, the type of collateral, and the loan‘s status (performing or
nonperforming). Loan pools vary in size to appeal to different types of
investors. Large commercial and investment banks have been the primary
bidders on blocks of loans (multiple pools with common
characteristics), which have an aggregate unpaid principal balance of
at least $115.8 million. Smaller pools of loans are also created so
that other types of investors can compete in the bidding. Between 14
and 25 investors bid in sales one through five, with a total average of
4.2 bidders for both large blocks and smaller pools of loans.
Before SBA goes forward with a sale, SBA‘s Office of the Chief
Financial Officer estimates the value to SBA of holding these loans to
maturity or of some other resolution, such as a prepayment or default.
A ’hold“ model was specifically designed to estimate the value to the
government of the loans selected for sale on a present value basis,
discounted with current interest rates. At the same time, the
transaction financial adviser prepares a market value estimate of what
SBA would likely receive if it sold the loans to the private sector.
SBA compares these estimates to determine whether selling the loans
would provide a higher expected return than would holding and servicing
them. These estimates are provided to OMB for its approval to go
forward with a sale. For each of the five sales we reviewed, the market
value estimates were greater than SBA‘s estimates of the hold value, or
value to government, and thus OMB approved each sale.
SBA officials and contractors explained that market value estimates
have exceeded hold values because investors are more efficient in
collecting on nonperforming loans than is the government, and investors
take different factors into account in valuing performing loans. As a
result, investors often place a higher value on these loans. According
to SBA‘s program financial adviser, private-sector lenders service
defaulted loans more productively than the government because they have
greater flexibility in pursuing workouts, including the ability to
treat borrowers differently based on factors such as creditworthiness.
SBA officials told us that private investors value performing loans
largely on the basis of what is recoverable under the loan contract,
including collateral. SBA, however, lends to borrowers based on their
ability to repay, and focuses on getting them to make payments.
Furthermore, compared with government agencies, private-sector lenders
have a greater number of portfolio management strategies at their
disposal, such as securitization.[Footnote 22] Securitization
generally yields a higher price than does selling a whole portfolio of
loans, because the seller can split up the portfolio to meet the
demands of a wide range of investors with varying levels of risk
tolerance.
Sales Results and Investor Interest Depended in Part on the Loan Pools‘
Characteristics:
For each sale, SBA received proceeds from loans sold that exceeded the
estimated value to the government of the loans, as calculated by SBA‘s
hold model. SBA‘s proceeds as a percentage of the unpaid balances of
the loans sold have varied with each sale because, among other factors,
the characteristics of the loans sold differed with each sale. As shown
in table 1, SBA‘s return on the sales, expressed as gross proceeds as a
percentage of total unpaid principal balance, ranged from 44.1 percent
to 73.6 percent in the first five sales. Although SBA ultimately aimed
to maximize proceeds, the agency selected loans for sale according to
its own constraints and perceived market interests. In the first sale,
SBA sold business loans that SBA had made and serviced directly.
According to SBA, most of these loans were performing and secured by
collateral. As shown in figure 2, disaster assistance loans made up
approximately 92 percent of all loans sold in the other sales. Most
disaster assistance loans have low interest rates--around 4 percent or
lower. Because these loans have below-market interest rates, they offer
lower scheduled borrower payments than do similar loans with higher
interest rates.[Footnote 23] Therefore, investors price their bids to
compensate for the SBA loans‘ lower scheduled payments. In sale two,
SBA sold disaster assistance loans for the first time, and according to
SBA officials, investors also priced their bids to account for the risk
they saw in purchasing an unfamiliar loan product. Furthermore, in sale
two, SBA focused on selling a large number of loans serviced by its
offices in Guam, Puerto Rico, and the Virgin Islands, where servicing
was more difficult and costly. In sale four, SBA primarily sold
performing, secured disaster assistance loans, in an effort to enable
investors to securitize these loans purchased from SBA.
Table 1: Key Information on SBA‘s Loan Sales One through Five:
Dollars in millions.
Unpaid principal balance; Sale 1: $332.1;
in millions: Sale 2: $1,200.7; Sale 3: $1,105.1;
in millions: Sale 4: $1,186.1; Sale 5:
$600.6.
Gross proceeds; Sale 1: $195.1;
Sale 2: $530.0; Sale 3: $662.5;
Sale 4: $873.3; Sale 5: $402.8.
Gross proceeds/Unpaid principal balance; Sale 1:
59%; Sale 2: 44%; Sale 3:
60%; Sale 4: 74%; Sale 5:
67%.
Estimated percentage of disaster loans secured;
Sale 1: n. a.; Sale 2: 88%;
Sale 3: 95%; Sale 4: 99%;
Sale 5: 76%.
Estimated percentage of disaster loans performing;
Sale 1: n. a.; Sale 2: 78%;
Sale 3: 82%; Sale 4: 89%;
Sale 5: 88%.
Estimated percentage of business loans secured;
Sale 1: 88%; Sale 2: 84%;
Sale 3: 94%; Sale 4: 84%;
Sale 5: 81%.
Estimated percentage of business loans performing;
Sale 1: 61%; Sale 2: 37%;
Sale 3: 32%; Sale 4: 36%;
Sale 5: 10%.
n. a. = not applicable:
Source: SBA.
[End of table]
Figure 2: Total Balance of Loans Sold:
[See PDF for image]
[End of figure]
SBA officials and investors told us that large investors, including
investment banks, have bought the performing disaster home loans, and
according to SBA, at least one investor is securitizing and trading
them like other mortgage-backed securities. Most of the 7(a) loans sold
since sale two have been nonperforming, and many were sold in smaller
pools that small investors can bid on, according to SBA officials. Two
small investors with whom we spoke have purchased these loans to try to
return them to performing status and resell them at a profit.
SBA Used Investor Feedback to Shape and Improve the Sales Process:
From the outset of the loan asset sales program, SBA used feedback from
investors to shape and improve the sales process, with the aim of
attracting as many investors as possible and obtaining quality bids on
loan pools. As part of presale marketing, the transaction financial
adviser consults with potential investors to determine which loan
offerings, loan data, and sale procedures will yield the greatest
interest. Investors are also surveyed after the sales to obtain
feedback to consider in planning future sales. SBA officials told us
that these surveys are an integral part of the lessons-learned process
that SBA established for the close of each sale, to help the agency
target and address problems. According to SBA officials, analyzing
SBA‘s processes and applying lessons learned have made SBA more
efficient in activities such as removing loans that do not meet sale
criteria. According to SBA officials, this process has reduced the
number of loans that investors have sold back to SBA for not meeting
the conditions of the agency‘s representations and warranties.[Footnote
24] SBA officials also spoke with investors to identify common concerns
that may have been leading them to discount their bids. According to
SBA, after the early sales, many investors reported that they wanted
SBA to provide additional data, such as borrower credit scores and lien
information. SBA responded by adding information to its database,
including credit scores and lien information, to reduce investor
uncertainty about the quality of loans for sale.
The six investors with whom we spoke and most of the 42 survey
responses for sales four and five positively assessed SBA‘s loan sale
process. Most investors stated that the loan pools are well organized
and that SBA provides the data they need to make informed bids.
Furthermore, our review of the information provided to investors found
minimal problems with the completeness of the data. The investors with
whom we spoke indicated that they will continue to bid on sales. Other
investors interviewed by the transaction financial adviser--including
those who have not bid in past sales--reported that they are interested
in participating in future sales. SBA officials believe that the
refinement process and provision of better data to investors has
yielded higher bids.
Lenders Expressed Satisfaction with SBA‘s Loan Sales, but SBA‘s Data on
Borrowers‘ Reactions Was Incomplete:
Lenders and borrowers also play a role in the loan sale process.
Although many 7(a) lenders that participated in SBA‘s loan sales
reported satisfaction with the way in which the sales were conducted,
borrowers‘ reactions were difficult to measure. An important factor in
the reactions of both groups is that lenders‘ involvement is voluntary
but borrowers‘ is not. Lenders must consent before SBA can sell
business loans they made, while borrowers have no choice. Most of the
7(a) lenders with whom we spoke said they are satisfied with the loan
sale process and the proceeds they are receiving on loans they
consented to sell. However, lenders‘ participation in sales is limited
and driven by a practical decision: whether greater net returns will
result from selling the loan or from liquidating it. The reaction of
borrowers was difficult to assess because of weaknesses in SBA‘s system
for collecting and following up on inquiries and complaints--its
primary method of ensuring that borrowers whose loans are sold are
protected.
Most 7(a) Lenders with Whom We Spoke Are Satisfied with the Loan Sales:
Lenders who participate in SBA‘s 7(a) loan guaranty program have an
interest in the outcome of the sales, because they still have a stake
in the 7(a) loans for sale. When a 7(a) loan defaults, SBA honors its
loan guaranty, paying the lender 75 to 85 percent of the unpaid
principal balance. Thereafter, the lender and SBA share any loan
payments according to the percentage set out in the guaranty.
Therefore, SBA must obtain consent from the lender before selling a
defaulted 7(a) loan. We spoke with 12 7(a) lenders who have all
participated in more than one SBA loan sale, and 10 said that they had
used the loan sales as an additional portfolio management tool for
nonperforming loans. According to 8 of the lenders whom we interviewed,
proceeds from the sales they participated in were satisfactory; 2
lenders stated that SBA is obtaining market value for nonperforming
7(a) loans. One lender stated that SBA sales have tapped a market for
nonperforming loans that his company would not otherwise be able to
access.
According to SBA, following the early sales lenders raised two
concerns, which the agency has since addressed. First, in the first
four sales, lenders did not know how to estimate the proceeds they
would receive by selling loans. And second, when some lenders received
their shares of sales proceeds, SBA did not clearly identify the price
paid for each loan. These practices resulted in accounting problems for
the lenders. Beginning with the fourth sale, SBA sent lenders one check
and a list of the earnings from each loan sold. Beginning with the
fifth sale, SBA also began providing information on returns from past
sales to help lenders decide whether to consent to sell loans. Four
lenders we spoke with specifically noted that SBA had made improvements
to its loan sale process in areas such as distributing sale proceeds
and seeking consent to sell loans.
Expected Returns and Experience with Prior Sales Drive Lender
Participation:
Based on our discussions with 7(a) lenders and SBA district officials,
we identified two primary factors that drive lender participation in
the sales: whether the net returns from the sale are likely to exceed
those from liquidation, and whether proceeds from a previous sale met
expectations. Lenders‘ consent to sell 7(a) loans must be given
voluntarily, and most lenders sell these loans only after trying to
liquidate them. Three SBA district officials and two lenders said that
in the early sales, SBA lenders did not have all the information they
wanted about expected returns from selling loans and therefore
preferred not to sell them. A lack of control over the loan sale
process, timing of the sales, and distribution of the proceeds can
influence lenders‘ expectations of net returns from selling loans
rather than liquidating. Lenders have no role in determining in which
pools their loans will be sold or whether bids are acceptable. Also,
lenders must wait until SBA‘s bid day to sell loans, and the value of
non-real estate collateral generally declines as time passes. Finally,
proceeds from SBA sales do not arrive until almost 2 months after the
sale, giving lenders greater incentives to begin loan liquidation in
order to try to recover money more quickly.
Lenders who have already begun investing resources in liquidation
believe they will maximize returns by continuing with their liquidation
strategy. Lenders are prepared to sell loans when they believe that
their net returns from investing resources in liquidation will no
longer provide satisfactory returns in comparison with selling loans.
SBA officials confirmed that most 7(a) loans that lenders agree to sell
have little value left in them.
According to SBA district office officials, some lenders have stopped
participating in loan sales because the proceeds from a previous sale
did not meet their expectations, and we spoke with one lender who
confirmed this statement. We also learned that some lenders who had
stopped participating in sales had not completed loan collection
actions, such as seizing collateral. Another disappointed lender we
interviewed decided to return to SBA loan sales, but only to sell loans
after completing collection efforts.
SBA Created Borrower Protections Addressing Loan Servicing and Disaster
Assistance:
Unlike lenders, SBA‘s borrowers have little control over what happens
to their loans if SBA decides to sell them. However, SBA has built in
some safeguards to protect the integrity of the programs that provided
the loans. SBA‘s loan programs, including loan servicing, are designed
to help the borrower stay in business or recover financially from a
disaster. To protect the public policy goals associated with these
programs, SBA‘s loan sales agreements with purchasers require
certification that the investors are qualified to purchase and service
the loans and will follow prudent loan servicing practices. The loan
sales agreement also prevents purchasers from unilaterally changing the
terms and conditions of the loans.
SBA made additional policy decisions concerning disaster loans. The
agency does not sell some disaster loans, including those issued to
borrowers currently residing in a federally declared disaster area and
those that are less than 2 years old. SBA decided it would sell
disaster loans only if they were more than 2 years old, because
disaster loans typically require more servicing in the first 2 years
and sometimes must be increased to cover exigencies, such as occurs
with revised physical damage estimates.
Information on Borrowers Is Incomplete Because SBA‘s Process for
Documenting and Tracking Borrower Inquiries and Complaints Has
Weaknesses:
We were unable to validate the way in which borrowers have reacted to
the loan sales, because SBA could not provide a reliable estimate or
information on the number of borrowers who had contacted them about
their sold loans. Complete and reliable information on borrower
complaints is important, because SBA officials told us that they
contacted purchasers when a borrower complained about a servicing
action to collect additional information and determine whether a
purchaser was breaching the borrower protections. For example, in one
case in which SBA was receiving many complaints about one particular
purchaser, SBA found some evidence to suggest that the purchaser‘s
servicing employees were overly aggressive or rude with some borrowers.
In response, SBA forwarded the specific complaints to the purchaser and
requested that the purchaser improve its handling of new loans.
One reason why SBA‘s tracking system is ineffective is that borrowers
with questions or complaints can call or write to several different SBA
offices, or to a representative from Congress (fig. 3). Some SBA field
office officials told us that SBA does not provide them with clear
guidance on how to respond to or document such complaints. Officials
from seven district offices, three servicing centers, and two disaster
area offices told us that they had received calls and letters from
borrowers who had concerns about loans that had been sold. But the
methods of documenting inquiries and complaints varied across offices,
except for congressional letters, which were consistently forwarded to
SBA headquarters.
Figure 3: Outlets That SBA Borrowers Use for Inquiries and Complaints
about Loan Sales:
[See PDF for image]
[End of figure]
In August 2001, SBA began providing a toll-free number for borrowers to
call with questions or complaints about loan sales.[Footnote 25]
Borrowers were informed about the toll-free number in a letter telling
them how to contact the new owner of their loan. However, field office
staff did not receive any guidance regarding the purpose and use of the
toll-free number. Santa Ana liquidation and loan servicing center staff
who answer calls to the toll-free number told us that initially they
thought the number was only provided for answering borrowers‘
questions, and therefore they did not record inquiries or complaints
called in to this number. Therefore, we were unable to collect a
reliable sample of inquiries and complaints from this source.
We also could not validate the number of inquiries and complaints
received at headquarters. SBA officials at headquarters told us that,
overall, SBA had received about 300 inquiries or complaints from
borrowers. However, when we were provided with a database of these
inquiries and complaints, there were only 155. When we asked how SBA
came up with the number 300, officials told us that it was an estimate.
We also reviewed 50 complaints from a servicing center, the only field
office with whom we talked that could provide a record of phone calls
and letters from borrowers whose loans had been sold, to compare them
with the inquiries and complaints at headquarters. Forty-five
complaints involved problems with purchasers during the servicing
transfer period--for instance, some borrowers said that payment had not
been posted, and others had difficulty in modifying the terms of their
loans. However, we found that only 3 of the borrowers listed in 50
complaints from the servicing center were reflected in the 155 borrower
inquiries or complaints we reviewed at SBA headquarters. An SBA
official at headquarters told us that the office had received some of
the complaints from the center, but acknowledged that they had not
included these complaints in the files we had reviewed.
Though we were unable to determine how many borrowers have contacted
SBA about their sold loans, we reviewed 133 of the 155 written
inquiries and complaints documented at headquarters, along with SBA‘s
written responses, to identify the types of questions and problems
borrowers may have when their loans are sold. Our analysis showed that
almost half (65) were inquiries and concerns about their loans being
sold, requests to buy their own loans, or pleas to not have their loans
sold. However, 47 of the borrowers complained about a purchaser‘s
servicing action. SBA responded in writing to the written inquiries and
complaints we reviewed at headquarters. More information on our review
of these inquiries and complaints is presented in appendix II.
SBA‘s Accounting for Loan Sales and the Remaining Portfolio Was Flawed:
SBA sold almost 110,000 loans with an unpaid principal balance of about
$4.4 billion in five loan sales from August 1999 through January 2002.
We reviewed the budgeting and accounting for these loan sales and found
errors that could significantly affect the reported results in the
budget and financial statements. Specifically, SBA (1) incorrectly
calculated loan sales losses reported in the footnotes to its financial
statements; (2) did not appropriately consider the effect of loan sales
on its estimates of the cost of the remaining portfolio, which could
significantly affect its budget and financial statement reporting; and
(3) had significant unexplained declines in its subsidy allowance for
the disaster loan program. Despite these errors and uncertainties,
SBA‘s auditor gave unqualified audit opinions on SBA‘s fiscal year 2000
and 2001 financial statements. We discussed these issues with SBA‘s
auditors, who indicated that they are currently assessing the cause of
the unusual balance in the subsidy allowance account and, if necessary,
plan to reevaluate their audit opinions on the fiscal years 2000 and
2001 financial statements. Until SBA performs further analyses to
determine the full impact of these errors and uncertainties, the
financial effect of its loan sales and the reliability of current and
future subsidy rates will remain unknown.
SBA Improperly Calculated Losses on Loan Sales:
Accounting records related to loan sales indicated that losses exceeded
$1.5 billion. However, this amount is overstated because of errors in
the way that SBA calculated the losses. Because of the lack of reliable
financial data available, we were unable to determine the financial
effect of loan sales on SBA‘s budget and financial statements. These
errors raise serious concerns about the information related to the
results of loan sales included in the footnotes to the annual financial
statements provided to OMB and the Congress for decisionmaking
purposes.
For accounting purposes, the gain or loss on a loan sale represents the
difference between the net book value (the outstanding loans receivable
balance less the subsidy allowance)[Footnote 26] of the loans sold and
the net sale:
proceeds.[Footnote 27] The accounting gain or loss differs from the
hold value calculation, discussed earlier, which indicates that the
sales resulted in a benefit to the government of about $606 million.
This difference exists because the benefit calculation--the difference
between the hold value and the net sales proceeds--is not designed to
take into consideration changes in interest rates from the time the
loans were disbursed to the date of the sale, while the accounting gain
or loss, if properly computed, does take these changes into account.
The footnotes to SBA‘s fiscal years 1999 and 2000 financial statements
reported accounting losses of $75 million and $600 million,
respectively, on its loan sales. SBA did not separately disclose in its
financial statements the losses calculated on the two loan sales that
took place during fiscal year 2001. According to SBA‘s accounting
records, the first five sales have resulted in total losses of more
than $1.5 billion.
We reviewed the methodology SBA used to calculate the results of its
loan sales for accounting purposes and found significant errors that
caused SBA to overstate losses. When calculating whether loans are sold
at a gain or at a loss, agencies must estimate the portion of the
subsidy allowance to allocate to each loan sold in order to calculate
the net book value for those loans. Since SBA‘s calculation of the net
book value of the sold loans exceeded the net proceeds from the sales,
losses were calculated. Our review of these calculations found that
SBA‘s estimates did not consider all the appropriate cash flows when
allocating the subsidy allowance to the sold loans. For example, when
calculating the gains or losses for the disaster loan program, SBA
failed to allocate a portion of the subsidy allowance for financing
costs associated with lending to borrowers at below-market interest
rates.
In addition, SBA incorrectly allocated the subsidy allowance for the
previously defaulted 7(a) and 504 loan guarantees. SBA used its
estimated net default cost, which considers first the probability of
default and then the estimated recovery rate after default. For
example, if a $10,000 guaranteed loan has an estimated default rate of
10 percent and an estimated recovery rate of 50 percent, the subsidy
allowance allocated by SBA would be $500 ([$10,000 x .10] x .50).
However, since sold guaranteed loans have already defaulted, SBA should
have used only the estimated recovery rate for these loans, meaning
that the subsidy allowance allocated would be $5,000 ($10,000 x .50).
Figure 4 illustrates the difference in the calculated gain or loss
resulting from this error. The left column, based on SBA‘s methodology,
shows that the loan was sold for a $3,000 loss, while the right column
appropriately allocates the allowance based on expected recoveries and
results in a $1,500 gain.
Figure 4: Gain / Loss Calculation on Previously Defaulted Sold
Guaranteed Loans:
[See PDF for image]
[End of figure]
SBA‘s errors in calculating the losses on disaster loans and on
previously defaulted sold guaranteed loans, both resulted in
overestimates of the net book value of the sold loans and the losses
that SBA reported in the footnotes to its fiscal years 1999 and 2000
financial statements. Because of the way in which the results of loan
sales are incorporated into the budget and the financial statements,
the reestimates, if done properly, should have corrected the effect
from these errors. However, as discussed below, we found that the
reestimates were not reliable.
Subsidy Cost Reestimates Are Unreliable:
SBA did not conduct key analyses of either the loans sold or its
remaining loan portfolio in order to determine the impact of the sales
on its reestimates of program costs for its remaining loans. OMB‘s
budget guidance directs agencies to make reestimates for all changes in
cash flow assumptions in order to adjust the subsidy estimate for
differences between the original estimated cash flows and the actual
cash flows. SBA officials acknowledged that analyses of the impact of
loan sales on its historical averages should be done. However,
according to SBA officials, the agency has lacked the appropriate
historical data and resources to do these necessary analyses. Because
SBA did not assess the effect that loan sales would have on its
historical averages of loan performance, such as when loans default or
prepay, the agency does not know whether these averages, which can
significantly affect the estimated cost of a loan program, reasonably
predict future loan performance. As a result, information in both the
budget and financial statements related to the reestimated cost of
SBA‘s loan programs cannot be relied upon.
SBA is generally required to update or ’reestimate“ loan program costs
annually. OMB Circular A-11 directs agencies to do reestimates for all
changes in cash flow assumptions. Thus, reestimates should include all
aspects of the original cost estimate, including prepayments, defaults,
delinquencies, and recoveries. These reestimates are done to adjust the
subsidy cost estimate for differences between the original cash flow
projections and the amount and timing of cash flows that are expected
based on actual experience, new forecasts about future economic
conditions, and other events that affect the cash flows.
Even after selling about $4.4 billion of loans, nearly half of its loan
portfolio, SBA has not analyzed the effect of loan sales on the
estimated cost of the remaining loans in its portfolio. SBA officials
told us that loans are selected for sale based on certain criteria,
such as where the loan is located or serviced, the type of collateral,
or whether the loan is performing. Since the loan selection process is
not random--that is, all loans do not have an equal chance of being
selected--it is likely that the loans sold will have different
characteristics from those of the portfolio‘s historical averages prior
to sales. Consequently, the characteristics of the remaining loans may
also differ substantially from the portfolio historical averages prior
to the sales. For example, during our analysis of the loans that were
sold, we determined that 84 percent of the $3.8 billion of disaster
loans sold were performing--meaning that payments were not more than 30
days delinquent. Selling mostly performing loans could conceivably
leave a disproportionate level of nonperforming loans in SBA‘s
portfolio. Because SBA has not analyzed the effect of loan sales on its
reestimates of the remaining portfolio, it does not know if the
percentages of remaining performing and nonperforming loans are
different from the historical averages prior to the sales. A change in
these percentages could indicate that expected defaults in the
remaining portfolio could be higher or lower than current assumptions,
based on historical data, suggest.
Another important loan characteristic is the average stated loan term.
This term is the contractual amount of time the borrower has to repay
the loan. SBA‘s estimated costs of the disaster loan program are based
on historical average loan term assumptions of 16 years for business
disaster loans and 17 years for home disaster loans. Based on our
review of the disaster loans sold in the first five sales, the average
loan term was about 25 years. However, SBA continued to use the average
loan term assumptions of 16 and 17 years in its reestimates without
doing the appropriate analysis to determine whether these assumptions
were still valid. Because of the large number of loans sold, it is
unlikely that the average loan terms for the remaining loans are still
16 and 17 years, if in fact these are valid estimates of the overall
presale averages. Assuming that these assumptions are valid, by selling
longer-term loans, the average loan terms for the remaining portfolio
would be shorter. As a result, if there are no changes in any other
assumptions, the reestimated cost of the disaster loan program would be
less, since SBA would be subsidizing below-market rate loans for a
shorter period of time.[Footnote 28] Given the significant volume of
loans sold since 1999, it is important that SBA assess whether the
characteristics of the remaining portfolio are similar to the
characteristics of the loans used to calculate the averages used in the
credit subsidy estimates. Relatively minor changes in some cash flow
assumptions--such as higher or lower default and recovery rates, or
changes in loan terms--can significantly affect the estimated cost of
the loan program and, therefore, the program‘s budget.
We attempted to determine the effect of loan sales on the cost
estimates of the remaining portfolio. However, SBA could not provide us
with timely, basic information about the composition of its loan
portfolio before and after each sale, including the amount of loans
that were current on payments, delinquent, or in default. According to
SBA, this information was not readily available because of systems
limitations and reconciliation problems. Shortly before we concluded
our work, SBA provided some information about the quality of its
portfolio before and after some of the loan sales. However, because a
gap of several months occurred between the pre-and post-loan sales
analyses, the data could not be reliably used to determine the effect
that loan sales were having on the quality of the remaining portfolio.
The Subsidy Allowance Account Was Misstated:
During our review of the accounting for loan sales, we noted that the
subsidy allowance account for the disaster loan program had an
unusually low balance. For a subsidized loan program, the subsidy
allowance account is generally the amount of expected losses on a group
of loans related to estimated defaults and financing costs from making
below-market rate loans. In effect, the subsidy allowance is the cost
associated with the loans that SBA does not expect to recover from
borrowers. For financial reporting purposes, the subsidy allowance
reduces the outstanding loans receivable balance to determine the
amount that SBA expects to collect from borrowers, known as the net
loans receivable balance (or net book value), which is shown on the
balance sheet.
Table 2 summarizes the disaster loan program‘s reported outstanding
loans receivable balance, the subsidy allowance balance, the net book
value, and the subsidy allowance as a percentage of the loans
receivable balance for fiscal years 1998 through 2001. The subsidy
allowance compared with the loans receivable balance decreased
significantly in fiscal years 2000 and 2001, to the point of showing
that the remaining portfolio of the disaster program was expected to
generate a profit. SBA could not provide support for the balance or
explain the reason for this anomaly.
Table 2: Loan Receivable Balances of SBA‘s Disaster Loan Program:
Dollars in millions.
Loans receivable outstanding; Fiscal year 1998:
$5,634; Fiscal year 1999: $5,659; Fiscal year 2000: $5,305; Fiscal year
2001: $3,293.
Less / (plus): Subsidy allowance balance; Fiscal
year 1998: $1,230; Fiscal year 1999: $929;
Fiscal year 2000: $505; Fiscal year 2001: ($77).
Net book value; Fiscal year 1998: $4,404;
Fiscal year 1999: $4,730; Fiscal year
2000: $4,800; Fiscal year 2001: $3,370.
Subsidy allowance as a percentage of loans receivable balance;
Fiscal year 1998: 21.8%; Fiscal year
1999: 16.4%; Fiscal year 2000: 9.5%;
Fiscal year 2001: (2.3%).
Source: SBA.
[End of table]
While Table 2 shows a rapid decrease in the subsidy allowance over the
2-year period between fiscal years 2000 and 2001, most of the decrease
actually occurred in fiscal year 2000, but was masked by an adjustment
made during the fiscal year 2000 financial statement audit. Before SBA
had made the audit adjustment, discussed below, the subsidy allowance
for the disaster program was about $91 million for fiscal year 2000.
This balance was $838 million, or about 90 percent, less than the $929
million balance for fiscal year 1999, while loans receivable
outstanding decreased by only $354 million, or about 6 percent. SBA
could not explain why the subsidy allowance reduction occurred.
In order to restore the subsidy allowance to a more reasonable balance
at the end of fiscal year 2000, in agreement with its auditors, SBA
increased the subsidy allowance balance by recording an audit
adjustment that was essentially meant to reflect the expected impact of
loan sales on the reestimates prepared in fiscal year 2000, which did
not factor in the effects of loan sales.[Footnote 29] This increased
the reported cost of the disaster loan program by $414 million. Since
the amount of the adjustment was based on SBA‘s erroneous calculations
of loan sales losses, previously discussed, the amount of the
adjustment was incorrect. During fiscal year 2001, SBA reversed the
audit adjustment and revised its reestimates to include cash flows
related to loan sales. Our review of the fiscal year 2001 disaster loan
program reestimates indicated that loan sales increased the reported
cost of the program by about $292 million.[Footnote 30] However, this
amount is also likely misstated because, as previously mentioned, the
reestimates did not consider the specific characteristics of the loans
sold or the loans remaining in the portfolio.
The unexplained decline in the subsidy allowance continued in the
fiscal year 2001 financial statements, where SBA reported a negative
balance in the subsidy allowance for the disaster loan program. As
illustrated in table 2, this balance no longer reduced the amount SBA
expected borrowers to repay--it actually increased the expected
repayments from borrowers and indicated that the loan program was
profitable. However, because the program is subsidized, with estimated
default and financing costs exceeding the amount of interest borrowers
are expected to pay, it should not be showing an expected profit. Based
on SBA‘s most recent reestimates, the subsidy cost of this program
ranges from 17 percent to 33 percent, and thus the balance for the
subsidy allowance account appears to be significantly misstated. As in
the prior year, SBA could not explain the unusual balance. SBA
officials told us they were currently working with their auditors to
determine the cause of these unusual balances.
While neither we nor SBA could determine the specific cause of this
unusual balance, several possibilities exist. As previously mentioned,
a failure to consider the characteristics of the loans sold or of those
remaining in SBA‘s portfolio could contribute to the unusual balance.
Another possibility is that SBA could have incorrectly reduced its
subsidy allowance account balance by writing off loan amounts that are
still collectible. This would mean that both the loans receivable
outstanding balance and the subsidy allowance account would be
misstated, but not the net book value. Yet another possibility is that
SBA may have underestimated the cost of its disaster loan program
because the cash flow assumptions used to estimate the subsidy cost did
not reflect the true characteristics or performance of its loan
portfolio. If SBA had underestimated its losses on disaster loans, it
would not have put enough into the subsidy allowance account to cover
these losses, and the subsidy allowance would be depleted as loans were
written off against it until there was a negative balance. This could
mean that SBA did not request an appropriation large enough to cover
the cost of the loan program, and that the difference would be made up
through the reestimates, which are covered by permanent indefinite
budget authority. It is also possible that a combination of these and
other errors may have occurred. Regardless of the reason, because SBA
does not currently know why the anomalies are occurring, the disaster
loan program‘s subsidy estimates for the budget and financial
statements cannot be relied on.
Despite the significant, unexplained decline in the subsidy allowance
and the errors in calculating the losses on loan sales, SBA received an
unqualified or ’clean“ audit opinion on its fiscal years 2000 and 2001
financial statements. An unqualified audit opinion indicates that the
balances in the financial statements are free of significant errors,
known as material misstatements. As previously mentioned, SBA‘s auditor
attempted to adjust the anomalies in the subsidy allowance during the
fiscal year 2000 financial statement audit. However, the adjustment was
based on the previously described erroneous loss calculation. For the
fiscal year 2001 audit, SBA‘s auditor performed a number of audit
procedures related to the disaster loan program subsidy allowance
account. For example, the auditor evaluated the methodology and
formulas used to calculate reestimates, assessed data used to calculate
key cash flow assumptions, and reviewed various internal controls over
the subsidy estimation process. However, this work did not appear to
focus on determining the cause of the unusual negative balance of the
account, which, contrary to the fact that this is a subsidized loan
program, would indicate that these loans were expected to generate a
profit. The auditor‘s workpapers indicated that the auditor had agreed,
in discussions with SBA management, that if the ’methodology and data
were materially correct, we [the auditor] would conclude that the
resulting subsidy reserve [allowance] would be materially correct for
financial statement reporting purposes.“ The workpapers also indicated
that, ’whatever the results of the reestimates are, as long as the
methodology is sound and supportable, we [the auditor] would not
consider the balance [of the subsidy allowance] anything other than
…natural.‘“:
Although SBA‘s auditor may have recognized some of the errors we
identified, it did not determine the cause of the unusual balance and
propose the necessary audit adjustments, nor did it modify its audit
report as appropriate. In such situations, when auditors cannot
determine whether a balance is fairly stated because sufficient
reliable supporting documentation is not available, audit standards
call for auditors to qualify their opinion or issue a disclaimer of
opinion.[Footnote 31] We discussed these issues with SBA‘s auditors and
they indicated that they are currently assessing the cause of the
unusual balance in the subsidy allowance account and, if necessary,
plan to reevaluate their audit opinions on the fiscal years 2000 and
2001 financial statements.
Loan Sales Have Reduced SBA‘s Loan Servicing Volume, but Other
Operational Benefits May Be Overstated:
SBA reported that loan asset sales had benefited the agency‘s
operations by reducing loan servicing, and that this reduction in loan
servicing volume should help allocate resources to other areas
necessary to achieving SBA‘s mission and help the agency to manage its
loan portfolio more effectively. Though we found that loan servicing
volume had declined for SBA disaster home loan centers, the effect on
regular business loans was less clear. Furthermore, despite these
reductions in loans servicing volumes, SBA had not yet redeployed staff
to more mission-critical activities, such as lender oversight and
business outreach. SBA has also reported that the loan sales have
prompted borrowers to pay their loans in full, revealed inconsistencies
in the application of the agency‘s servicing procedures, and
highlighted weaknesses in its information system. We found some support
to show that the loan sales had produced portfolio management
efficiencies. But we also found that some of the benefits SBA had
reported began before the loan sales program, or could have been caused
by other factors.
Reductions in Loan Servicing Volumes Have Been Greatest for Disaster
Loans:
The loan asset sales have reduced SBA‘s servicing and liquidation
workload for disaster loans at the disaster home loan servicing
centers, but they have had little impact on regular business loans,
such as 7(a) loans, at the commercial servicing centers and district
offices. SBA had stated that reductions in loan servicing and
liquidation workloads would be one of the loan sales program‘s most
significant benefits, as the growth in loan volume and the continuing
decline in staff had compromised its ability to adequately service a
growing portfolio. During the 1990s, SBA‘s portfolio of 7(a) business
and disaster loans grew dramatically. For example, from 1990 through
1996, SBA‘s annual volume of 7(a) loan approvals increased from 19,907
to 52,729. Disaster assistance loan approvals varied from year to year,
depending on the number and severity of disasters. However, in 1994
SBA‘s loan approvals for disaster assistance loans increased to over
125,000, primarily because of the Northridge earthquake in California-
-a significant jump from the levels of the previous 4 years, when loan
approvals ranged from about 12,000 to 59,000. Servicing and liquidating
loans account for large operating expenses for SBA, reaching
approximately $85 million a year, according to SBA‘s fiscal year 2001
Accountability and Performance report. Servicing and liquidating loans
currently involve approximately 186 employees at six servicing centers
and employees at 70 district offices, who also perform other loan
management functions.[Footnote 32]
SBA‘s disaster home loan servicing centers have seen a much greater
reduction in the number of loans they service than have the commercial
loan servicing centers. According to SBA‘s limited analysis, the number
of loans serviced at SBA‘s disaster home loan servicing centers
decreased by 17 percent from January 1999 through March 2002 (fig. 5),
and SBA‘s analysis of the servicing centers shows that if more loans
are sold, SBA may be able to reduce and consolidate its loan servicing
resources for disaster home loans. However, SBA‘s analysis also shows
that the number of loans at SBA‘s commercial loan servicing centers
fell by less than 0.5 percent over the same time period. Though the
sales have reduced the number of disaster business loans, most of the
loans in the commercial loan servicing centers are from the 7(a)
program and are not put up for sale until they default. SBA officials
told us that lenders do not always consent to sell the 7(a) loans that
SBA would like to sell. Moreover, one commercial loan director
explained that servicing performing loans can require as much if not
more work than can nonperforming loans, as businesses frequently seek
additional financing and therefore want to modify the terms of their
loans. For this reason, the growth of the 7(a) program has offset the
number of loans sold in the commercial loan centers.
Figure 5: Change in Loan Servicing Volume at the Disaster Home Loan and
Commercial Loan Servicing Centers:
[See PDF for image]
[End of figure]
Since the loan sales began, SBA has been able to reduce the number of
employees at the servicing centers (fig. 6). However, one of the
problems SBA hoped to address with loan asset sales was to reduce its
loan servicing volume to a level that matches its staffing capacity.
Since the implementation of the loan sales, the number of loan
servicing staff has fallen faster than have loan volumes for most of
SBA‘s loan servicing centers. According to SBA officials, the reduction
in employees at SBA is driven more by employee departures, retirements,
and the hiring freeze than by reductions in servicing volumes form the
loan sales. As a result, the number of loans serviced per employee
increased on average by 14 percent at the disaster home loan centers
and by 23 percent at the commercial centers (fig. 6). Only one of the
disaster home loan servicing centers has experienced a reduction in the
number of loans serviced per employee. The disparity between staff
attrition and loan volumes is especially problematic at SBA‘s
commercial loan servicing centers, where the number of loan servicing
employees has fallen by 19 percent and loan volumes have remained
unchanged. The analysis we reviewed did not address how these employee
reductions or any other operational effects may translate into cost
savings.
Figure 6: Changes in Number of Employees and Workload per Employee at
Servicing Centers:
[See PDF for image]
[End of figure]
Officials from most of the seven district offices that we visited had
mixed views about the effect of the loan sales on their own loan
servicing portfolios. Some district office officials told us that the
first two sales had significantly reduced their portfolios, and that
subsequent sales continue to reduce the number of disaster loans they
have to liquidate. When a disaster loan is more than 90 to 150 days
delinquent, the servicing center can forward it to the appropriate
district office for possible liquidation. District offices may also
liquidate defaulted 7(a) and development company loans, or may assist
lenders in doing so. However, loan sales have had a much smaller effect
on the SBA‘s 7(a) portfolio at the district offices we visited.
District office officials with whom we spoke said that they have had to
continue assisting lenders with liquidation or liquidate loans
themselves, in addition to reviewing loans for possible sale. The data
we reviewed on the district offices‘ portfolio of loans in liquidation
status for the most part supported what the district officials had told
us. For example, the South Florida district office portfolio of
disaster assistance loans shrank from 768 loans in September 1997 to 92
loans in August 2002. But all of the district offices we included in
our review had experienced growth in the number of defaulted 7(a) loans
that they were helping lenders to service or liquidate, or that they
were monitoring.
The Effects of Loan Sales on Workforce Realignment Have Been Mixed:
The role of loan asset sales in facilitating SBA‘s workforce
realignment may be smaller than was initially expected. SBA had
reported that loan asset sales would help the agency move employees out
of loan servicing positions to more mission-critical positions, such as
lender oversight and outreach to small businesses. But since most of
the loans sold have been from the disaster home loan servicing centers,
the overall reduction in loan volume has not translated into job
reassignments for district office staff. Officials from two district
offices wondered how they would benefit from the reduction in workloads
at the disaster home loan servicing centers, since the center employees
are funded by appropriations for disaster assistance, and most of the
district offices are funded by appropriations for business loan
programs. Most officials from the district offices and servicing
centers told us that they have not been able to reassign servicing and
liquidation staff to nonservicing activities such as lender oversight
or outreach to small businesses. Moreover, training opportunities to
prepare for reassignment have been limited, with only the South Florida
district office telling us that they have participated in such
training.
However, loan sales may facilitate SBA‘s long-term efforts to
consolidate its loan servicing and liquidation functions into fewer
service centers. SBA recently reported in its draft 5-year workforce
transformation plan that it would consolidate its loan servicing and
liquidation functions into fewer service centers. This plan also stated
that SBA intends to continue its loan asset sales program, to reduce
the agency‘s overall loan portfolio and workload at some locations.
Loan Sales Have Affected the Ways in Which SBA Manages Its Loan
Portfolio, but So Have Other Factors:
According to SBA officials, the process of selling loans, particularly
the intensive due diligence process and the field office review of
loans selected for the sales, makes loan servicing more timely and
consistent across the agency. For example, when defaulted loans are
selected for sale, agency staff must determine whether anything
collectible remains on the loan. If not, the loan is charged off. In
these cases, SBA recognizes a loss on the loan and removes it from the
receivable accounts. And if SBA is in the process of working out a
compromise with a borrower on a loan that is selected for sale, the
impending sale prompts agency staff and borrowers to complete the
compromise before the sale date. The process of reviewing loans before
they are sold undoubtedly provides some benefit to the agency in terms
of bringing inconsistencies to light and forcing decisions on some
loans. However, we also found that the loan sales alone were probably
not responsible for all the benefits SBA reported.
In May 2002, SBA testified that of the loans selected for the first
four sales, over 9,880 loans totaling about $382 million had been paid
in full, 702 loans totaling $107 million had entered into compromise
agreements, and 7,549 loans totaling about $632 million had been
charged off. SBA provided data to us showing that since the loan sales
began in 1999, the percentage of loans paid in full ranged from 10.35
to 11.30 percent, and that the percentage of loans written off had
ranged from 4.97 to 5.98 percent. However, SBA data also showed that
before the loan asset sales--from fiscal year 1997 through fiscal year
1998--the rate of loans paid in full and charged off had already been
increasing. For example, the percentage of loans paid in full increased
from 8.8 percent in fiscal year 1997 to 10.46 percent in fiscal year
1998. Thus, some of the positive effects of the loan sales reported by
SBA could have been caused by other factors, including changes in the
economy such as lower interest rates, which would prompt people to
refinance their mortgages. Officials at SBA‘s Birmingham disaster home
loan servicing center told us that borrowers who refinanced their
mortgages often consolidated their loans and paid off their disaster
loans, even though their disaster loans had low interest rates.
Other benefits of the sales cited in SBA‘s official statements or by
SBA officials included the highlighting of inconsistencies in the ways
that field staff applied SBA‘s servicing procedures, and the
identifying of weaknesses in the agency‘s information systems. For
example, SBA officials at headquarters told us that as a result of
inconsistencies found in the loan files during preparations for the
sales, SBA had held a meeting of all the servicing center managers to
discuss the inconsistencies and to clarify policies and procedures for
loan servicing. Though field office staff told us that they had not
substantially changed the ways in which they serviced loans because of
problems uncovered by the sales, some employees provided examples of
how they had modified some of their work processes. For example,
officials at one servicing center told us that they had begun to check
the accuracy of certain items, such as maturity date, when a new loan
file arrived.
Similarly, SBA officials told us that the due diligence process for the
loan sales had revealed that the agency‘s information management system
for its loan portfolio did not include data that investors value, such
as updated information on types of collateral and lien positions. These
variables were being included in plans to upgrade the agency‘s
information systems. However, field office employees at one of the
servicing centers told us that they had complained about the fact that
these items were not included in SBA‘s information systems long before
the loan sales began. Whether the loan sales will have an actual impact
on improving SBA‘s information systems is still unclear. At the time of
our review, SBA was still having its field offices and due diligence
contractor compile information on the loans from the paper files and
had not yet upgraded its information systems to capture information
such as the current status of collateral and lien positions.
Conclusions:
SBA had never sold loans in bulk loan sales before undertaking the
current program. SBA‘s loan sales are being closely watched, because
OMB plans to expand similar sales to other federal credit programs,
such as those provided by the Departments of Agriculture and Education.
The impact of SBA‘s sales on the agency and the scope of the benefits
they provide to the government can help OMB in providing guidance on
similar sales programs in the future. The sales have had some success
in attracting investors, giving lenders a choice in disposing of
defaulted loans, and reducing SBA‘s servicing workload for disaster
assistance loans. But other effects are difficult to measure, because
SBA lacks a comprehensive system to document and track all borrower
inquiries and complaints after loans are sold; faulty accounting and
reporting methods obscure the actual financial and budgetary impact of
the loan sales; and a thorough analysis of benefits and other effects
on agency operations has not been done.
The lack of a comprehensive process for identifying borrower inquiries
and complaints suggests that SBA may be unable to adequately enforce
borrower protections. From the limited inquiries and complaints we were
able to review, some borrowers had clearly experienced servicing
problems after SBA sold loans to investors. While SBA did track and
follow up on some inquiries and complaints, it did not have a
comprehensive process to collect and document the complaints received
at the field offices. As a result, the agency may not know how many
complaints have actually been registered or whether some private
lenders‘ actions are in conflict with SBA‘s public policy goals.
Since SBA incorrectly calculated the losses on its loan sales and lacks
reliable financial data, we were unable to determine the financial
impact of SBA‘s loan sales on its budget and financial statements.
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 contain significant errors. Until
SBA corrects these errors and determines the cause of the precipitous
decline in the subsidy allowance account, SBA‘s financial statements
will likely be misstated, and the audit opinion on past financial
statements may be incorrect. Further, the reliability of the current
and future subsidy cost estimates will remain unknown. These errors and
the lack of key analyses also mean that congressional decisionmakers
are not receiving accurate financial data to make informed decisions
about SBA‘s budget and the level of appropriations the agency should
receive.
Finally, some of the operational benefits of the loan sales have not
yet been realized, or may be overstated. Most of the reductions in loan
servicing volume have occurred at SBA‘s disaster home loan servicing
centers. SBA‘s commercial servicing centers and district offices that
primarily serve small businesses are still involved in servicing loans,
primarily because SBA has not been able to sell as many defaulted 7(a)
loans, because lenders do not always consent to sell these loans and
SBA employees continue to assist lenders or take over the servicing
from lenders when a loan becomes delinquent. As a result, SBA has not
been able to free up the resources it had hoped to reallocate to
mission-critical areas, such as outreach to small businesses. Though
SBA has conducted limited analysis on the impact of loan sales on its
servicing centers and portfolio activity, a more thorough evaluation is
needed to determine the agencywide effects of the loan sales and the
cost savings to the agency.
It would be imprudent to continue SBA loan asset sales in the absence
of reliable and complete information on the accounting and budgetary
effects of the sales. A successful loan sales program is not solely
about maximizing proceeds and attracting investors: it is also a means
of improving an agency‘s ability to achieve its mission and to best
serve the American people. Moreover, as OMB continues to encourage loan
asset sales, it is important that agencies embarking on new loan asset
sales programs have the capability to properly carry out and account
for these activities.
Recommendations:
We make several recommendations to the Administrator of the Small
Business Administration, in order to provide accurate and reliable
information about how the sales affect SBA‘s borrowers, financial
statements, budget, and operations.
To ensure that SBA has complete information to enforce borrower
protections in its loan sale agreements and has reliable information to
report to Congress on how borrowers are reacting to the sales, we
recommend that the Administrator develop procedures for documenting and
processing inquiries and complaints from borrowers, and provide
guidance to the field offices about implementing them.
To address the errors and weaknesses in SBA‘s accounting and budget
reporting, we recommend that the Administrator take the following
actions before conducting additional loan asset sales:
* Correct the errors in SBA‘s loss calculations for loan sales one
through five, and adjust the fiscal years 2000 and 2001 financial
statements.
* Perform the necessary analyses to assess the effect of loan sales on
the reestimates, to determine whether the cash flow assumptions in
SBA‘s model reasonably predict future loan performance.
* Perform the necessary analyses to determine and correct the cause of
the unexplained decline in the subsidy allowance account, and make the
relevant adjustments to the fiscal years 2000 and 2001 financial
statements, as appropriate.
We also recommend that the Inspector General, in conjunction with SBA‘s
financial statement auditors, assess the impact of any identified
errors in the financial statements and determine whether previously
issued audit opinions for the fiscal years 2000 and 2001 financial
statements need to be revised.
Finally, to provide Congress and SBA with a better understanding of the
impact of loan sales on SBA‘s operations, we also recommend that the
Administrator conduct a more comprehensive evaluation of the loan
sales‘ impact on the agency and the cost savings from the sales.
Agency Comments:
We requested comments from SBA, SBA‘s Inspector General, and Cotton and
Company, SBA‘s independent financial statement auditor, on a draft of
this report. The Chief Financial Officer for SBA, the Acting Inspector
General, and Cotton and Company provided their comments in writing,
which are presented in their entirety in appendixes III, IV, and V,
respectively.
SBA generally agreed in its comments with the overall findings and
recommendations in this report. In response to our recommendation on
tracking borrower inquiries and complaints, SBA stated that the agency
is preparing guidance for distribution to all field offices that will
clarify how borrower inquiries and complaints are to be handled. This
guidance will include information on SBA‘s toll-free number. In
addition, SBA stated that it is establishing a designated electronic
mail account for use by all SBA employees, to record borrower comments
and forward them to headquarters; developing a database to track
borrower inquiries and complaints and any other inquiries generated by
the sale of loans; and improving the documentation and tracking of
inquiries and complaints made through its toll-free number.
In its comments regarding our findings and recommendations on the
accounting and budgetary anomalies, SBA stated that it is actively
engaging a contractor to help resolve these issues and has worked
extensively with its independent auditor to identify causes and options
for resolving the issues we identified. Additionally, SBA stated that
the accounting and budgetary guidance is general in nature and requires
interpretation.
SBA did not respond specifically to our recommendation to conduct a
more thorough analysis of the impact of loan sales on agency
operations.
SBA requested that we delay issuance of the report until March 2003. By
then, it hoped to have determined the causes of the accounting and
budgetary problems, and to be able to propose an appropriate
methodology for resolving them. Though we appreciate the desire to
provide a plan of action for addressing these problems in our final
report, it is not our policy to delay issuance of our reports until
problems we have identified are resolved. SBA also stated that the
report did not portray the complexity and unique problems faced in
implementing the loan sales program. We agree that SBA faced a complex
and difficult endeavor when it implemented the loan sales program. In
the introduction to the report, we stated that SBA had never before
conducted bulk loan sales. Furthermore, the first section of our report
is intended to reflect the complexity of the loan sales process and
includes a detailed discussion of what is involved in conducting a
sale, including a time line that shows that the process can take almost
a year to complete. This section and the background section also
describe the variety and number of loans sold. SBA also noted that the
report did not reflect the fact that SBA responds in writing to all
written inquiries and complaints from borrowers; therefore, we added a
statement in the report reflecting the fact that SBA had responded in
writing to the written inquiries and complaints we reviewed at
headquarters.
The Inspector General also agreed with our recommendations and is
working with Cotton and Company and SBA management to determine the
magnitude of the errors in SBA‘s fiscal years 2000 and 2001 financial
statements. The Inspector General stated that Cotton and Company has
informed the IG‘s office that the audit opinion on the fiscal years
2000 and 2001 financial statements should no longer be relied upon, as
they may be materially incorrect because of the errors identified in
this report. The comments also stated that Cotton and Company plans to
withdraw its unqualified audit opinion on those financial statements,
and to issue disclaimers of opinion.
Cotton and Company, SBA‘s independent financial statement auditor,
agreed with our findings and did not specifically comment on our
recommendations. However, Cotton and Company also stated that the
report would be more fair and balanced if we further elaborated on the
inherent risks and complexities associated with accounting estimates
and loan sales. Cotton and Company also stated that it believes there
is a lack of comprehensive implementation guidance on credit subsidy
and loan sale cost estimates. Additionally, Cotton and Company stated
that (1) our prior reviews of its work did not identify the problems
discussed in this report, and (2) we did not determine the specific
causes of these errors. Further, Cotton and Company elaborated on some
of the audit work it had done.
We agree with Cotton and Company‘s and SBA‘s statements that accounting
for and auditing estimates of loan program costs and loan sales are
complex, and we describe these complexities in the background section
of this report.
Regarding the adequacy of existing guidance on preparing and auditing
credit subsidy estimates and loan sales, we used guidance that
currently exists in OMB Circular A-11, Preparation, Submission, and
Execution of the Budget; SFFAS No. 2, Accounting for Direct Loans and
Loan Guarantees (effective fiscal year 1994); Technical Release 3,
Preparing and Auditing Direct Loan and Loan Guarantee Subsidies under
the Federal Credit Reform Act (issued July 31, 1999; and Statement of
Auditing Standard 57, Auditing Accounting Estimates (effective January
1989), in performing our assessment of SBA‘s accounting for loan sales
and the credit subsidy estimates. These documents provide considerable
guidance to agencies while still providing the flexibility necessary to
be applicable to a wide variety of credit programs. For example,
Appendix B to SFFAS No. 2 contains technical explanations and
illustrations related to estimating loan program costs and loan sales-
-including guidance for calculating changes in a loan‘s book value,
guidance for calculating the gain or loss, and the impact that loan
sales have on various financial statement accounts, such as the
allowance for subsidy. Further, Technical Release 3 provides guidance
on auditing estimates of loan program costs, including assessing
internal controls and inherent risks, as well as suggested audit steps
and analytical review procedures.
While further elaboration may be helpful, the errors we identified in
the financial statements and the related footnotes were primarily
related to fundamental flaws in the application of existing guidance
rather than to insufficient guidance. In addition, the anomalies in the
disaster loan subsidy allowance account were known to Cotton and
Company, and SBA provided no viable explanation for these anomalies.
Regarding prior GAO reviews of Cotton and Company‘s related audit work,
these reviews were part of our governmentwide consolidated financial
statement audit and were designed to focus on issues that could be
significant to the consolidated financial statements of the federal
government. Because the materiality of the consolidated financial
statements far exceeds the level of what is material to SBA, these
reviews were far less detailed than what was conducted for this report.
Further, loan sales were not significant to the governmentwide
financial statements and, therefore, were excluded from the scope of
the prior GAO reviews. However, it should be noted that prior GAO
reviews of Cotton and Company audit work at SBA going as far back as
1997 raised concerns about its audit scope and methodology in the
credit subsidy area, and offered suggestions for improvement on both a
formal and an informal basis.
Although we did identify specific errors in the calculation of the loss
on loan sales reported in the financial statements, we agree that we
did not identify the cause of the negative balance in the disaster loan
subsidy allowance account. We were unable to identify the cause because
SBA lacked some of the fundamental information necessary to enable us
to do so. This missing information, which should have been made
available for the financial statement audit, included an aging of the
delinquent and defaulted loans by year of loan commitment, detailed
reconciliations of the allowance for subsidy, and an analysis of the
impact that loan sales had on the estimated performance of the
remaining loan portfolio. Because this type of information was not
available at the time of our review or of Cotton and Company‘s audit,
it was not possible either for us, Cotton and Company, or the SBA to
determine the cause of the anomalies in the disaster loan subsidy
allowance account. We understand that SBA is now working on preparing
this information.
Regarding the elaboration of audit work that Cotton and Company
provided, we saw this work when we reviewed the auditor‘s workpapers,
and we provided a summary of this work in the body of the report.
:
Unless you publicly announce its contents earlier, we plan no further
distribution until 30 days after the date of this report. At that time,
we will send copies of the report to the Chairman of the Senate
Committee on Small Business and Entrepreneurship, the Chairman and
Ranking Minority Member of the House Committee on Small Business, other
interested congressional committees, the Administrator of the Small
Business Administration, and the Director of the Office of Management
and Budget. We will make copies available to others on request. This
report will also be available at no charge on the GAO Web site at
http://www.gao.gov.
Please contact us at (202) 512-8678 if you or your staff have any
questions. Additional contacts and staff acknowledgments are listed in
appendix VI.
Sincerely yours,
Davi M. D‘Agostino, Director
Financial Markets and
Community Investment:
Signed by Davi M. D‘Agostino
Linda M. Calbom, Director
Financial Management and Assurance:
Signed by Linda M. Calbom
[End of section]
Appendix I: Scope and Methodology:
In preparing this report, we focused on the first five of SBA‘s six
loan asset sales. The unpaid principal balance of the loans sold in
these sales represents about 87 percent of all the loans SBA sold from
August 1999 through August 2002. The sixth sale was not completed in
time to be included in our analysis because purchasers do not begin
servicing the loans and accounting adjustments are not complete until
several weeks after the sale date.
To describe SBA‘s loan sale process, we reviewed a variety of documents
related to planning and conducting a loan sale, including strategic
plans, guidance, and procedures. We also collected data on the types of
loans sold and the proceeds that SBA received from the sales, and we
interviewed SBA officials and contractors. Our interviews with SBA
officials took place at headquarters and at several SBA field offices
that participate in the loan sales process, including two disaster home
loan servicing centers, one commercial loan servicing center, and seven
district offices. We selected a mix of large and small field offices
around the country, based on the size of the loan portfolio and the
number of loans sold. An additional consideration for three of the
district offices we selected was their proximity to the finance center
and the three servicing centers we visited. We also interviewed the
financial adviser who advises SBA on its overall strategy for selling
loans; the financial advisers hired to conduct the first, third, and
fifth sales; and the due diligence contractor for the first four sales.
To confirm that SBA‘s loan sale process was working as described, we
reviewed the loan information in the bidder information packages and
interviewed investors. To confirm that SBA was providing relatively
complete data to investors, we evaluated the loan data provided to
potential investors in the bidder information packages. Specifically,
we tested the data‘s completeness for several key fields, such as
interest rate, outstanding balance, and maturity date. For investor
feedback about the loan sale process, we interviewed six investors and
reviewed 42 responses to surveys conducted by SBA‘s Transaction
Financial Advisers of investors who had participated in sales four and
five. We selected a mix of large and small investors with a variety of
experiences with the sales, including investors who had won, lost, or
just requested information but declined to bid. In our interviews we
asked investors to evaluate aspects of SBA loan sales, including data
they had received about loans for sale, communications they had had
with SBA and its contractors, the loan sales process, and the
organization of loan pools. We also asked whether the investors planned
to participate in future sales. Although we attempted to contact a
cross section of investors, the comments we received cannot be
generalized to a larger group.
To determine how SBA loan asset sales affect 7(a) lenders, we reviewed
the lenders‘ role in the loan sale process and interviewed officials
representing lenders that had participated in at least one sale. We
selected a mix of 12 small and large lenders based on 7(a) lending
volume, asset size, and location. In our interviews we asked lenders to
evaluate their experience with SBA‘s loan sale process, describe how
they made the decision to participate in the sales, and discuss their
level of satisfaction with the proceeds. Although we attempted to
contact a cross section of lenders, their comments cannot be
generalized to a larger group. We did not interview any certified
development companies that make 504 loans, because the only 504 loans
that were sold did not require consent from the lender. To obtain
additional feedback on SBA‘s loan sale process, we spoke with officials
representing the National Association of Government Guaranteed Lenders
and the National Association of Development Companies, which represent
SBA 7(a) lenders and certified development companies that make 504
loans, respectively.
To determine how borrowers reacted when their loans were sold, we
reviewed borrower inquiries and complaints documented by SBA and the
process for documenting and processing these inquiries and complaints.
To determine the types of inquiries and complaints borrowers have, we
reviewed 133 of 155 borrower inquiry and complaint letters filed at
headquarters since the first loan sale in August 1999. We collected
information that included the date and type of inquiry or complaint
(for example, questions about a loan sale or complaints about a
servicing action by a purchaser) and the name of the purchaser (if
available). We prepared a summary of SBA‘s written response. We also
interviewed SBA officials at headquarters and field offices (three
servicing centers, seven district offices, and two disaster area
offices) about the types of inquiries and complaints they receive from
borrowers and about SBA‘s process for handling these complaints. In
addition, we asked staff at field offices whether they had forwarded
borrower complaints to headquarters or documented the complaints. We
reviewed a nonstatistical sample of complaints from the third, fourth,
and fifth sales drawn for us by staff at one of the disaster home loan
servicing centers to determine whether the information in borrower
complaints received at field offices was accurately represented in
headquarters records. Specifically, we compared the names on the
complaints we received from the disaster home loan servicing center
with the names on the complaints at headquarters. We also reviewed the
complaints logged through the toll-free number, but these data were
limited because SBA staff did not begin logging the complaints from
this number until April 2002.
To evaluate SBA‘s budgeting and accounting for loan sales, we assessed
SBA‘s compliance with various budget and accounting guidance, including
OMB Circular A-11, Preparation, Submission, and Execution of the
Budget; Statement of Federal Financial Accounting Standard Statement
No. 2, Accounting for Direct Loans and Loan Guarantees; and U.S.
Government Standard General Ledger, Account Transactions.
Specifically, we analyzed SBA‘s cash flow models to reestimate subsidy
costs for the disaster loan program and the 7(a) and 504 loan guarantee
programs, in order to determine the effect of loan sales on the cost of
each program for the budget. We evaluated characteristics of loans sold
as compared with cash flow assumptions used to reestimate the costs of
SBA‘s loan programs. To assess SBA‘s estimates of hold values for loans
sold, we reviewed an external validation of the hold model used for
sales one through three that was prepared by an SBA contractor, who
concluded that the calculations were accurate and reasonable. Since SBA
changed to a more sophisticated hold model after sale three,[Footnote
33] we also reviewed the methodology and assumptions in SBA‘s revised
model used to estimate hold values for loans sold in sales four and
five, and we found the approach to be reasonable. However, we did not
audit the data used to calculate the hold values for each sale, and
therefore did not conclude on the reasonableness of the hold values for
any of the sales. We reviewed SBA‘s accounting related to the balances
of the loans sold, proceeds and costs of the sales, and calculations of
gains or losses on sales to determine whether SBA considered all
appropriate cash flows in these calculations. We discussed SBA‘s
budgeting and accounting procedures for loan sales with SBA and OMB
officials, Federal Accounting Standards Advisory Board staff, and SBA‘s
independent auditors. We also reviewed SBA‘s audited financial
statements for fiscal years 1999 through 2001 and examined workpapers
from SBA‘s auditor for fiscal years 2000 and 2001.
Finally, to assess the ways in which SBA benefited from loan sales, we
reviewed official statements, including testimony, press releases, and
other documents that cited benefits related to loan servicing
reductions, staff realignment, and loan portfolio management
efficiencies. To confirm these benefits, we reviewed and analyzed trend
data on SBA‘s loan servicing workloads to determine how the loan sales
had affected SBA‘s loan servicing workloads and staffing. We reviewed
and analyzed data on loan activity, including prepayments and charge-
offs, before and after the loan asset sales began. We also interviewed
SBA officials at headquarters and field offices to obtain their views
on how SBA has benefited from the sales. We did not independently
verify the accuracy of the loan servicing and loan portfolio data
provided by SBA, because we were interested only in the trends before
and after the loan sales began.
We performed our review from January 2002 through October 2002 in
Washington, D.C., and several other locations across the country,
listed below, in accordance with generally accepted government auditing
standards.
SBA Field Locations We Visited:
District Offices:
Birmingham, Alabama
Little Rock, Arkansas
Santa Ana, California
Los Angeles, California
Denver, Colorado
Miami, Florida (telephone interview)
Philadelphia, Pennsylvania:
Loan Servicing Centers:
Birmingham, Alabama (disaster home loan servicing)
Santa Ana, California (disaster home loan servicing and liquidation)
Little Rock, Arkansas (commercial loan servicing):
Denver Finance Center:
Denver, Colorado:
Disaster Area Offices:
Niagara Falls, New York (telephone interview)
Fort Worth, Texas (telephone interview):
[End of section]
Appendix II: Types of Borrower Inquiries and Complaints Received by
SBA:
We reviewed 133 of the 155 inquiries or complaints SBA had documented
from August 1999 through April 2002, to identify the types of concerns
and problems borrowers faced when their loans were sold.[Footnote 34]
From our review, we determined that borrowers generally contact SBA
about loans that have been sold for one of two reasons:
* they have a question or concern about why SBA is selling their loan,
or they want to purchase their loan rather than have SBA sell it to the
private sector; or:
* they want to modify their loan and have a complaint about the
purchaser‘s procedures or treatment.
Almost half (65) of the 133 letters from borrowers that we reviewed at
headquarters involved questions about why loans were being sold,
requests to buy a loan discounted lower than the unpaid principal
balance, or pleas that the loan not be sold. Forty-seven letters
referred to purchasers‘ servicing actions. Twenty-three of these
letters involved disagreements or frustration with servicing decisions
the new purchaser had made, such as refusing to subordinate or release
collateral,[Footnote 35] or imposing a fee to complete a servicing
action such as subordination. Another 18 letters came from borrowers
who wanted to defer payments or change the amount of their monthly
payment because of financial problems, and felt they were not getting
appropriate treatment from the purchaser of their loan. Six of the
letters complained about problems that occurred while SBA was
transferring the loan to the purchaser. For example, some borrowers
found that purchasers had not properly applied their loan payments
during the servicing-transfer period. Nineteen of the remaining 21
letters came from borrowers who wanted SBA to subordinate, release
collateral, or compromise on a loan‘s payment or terms, and who were
told that SBA had sold the loan and thus could no longer service it.
[End of section]
Appendix III Comments from the Small Business Administration:
U.S. SMALL BUSINESS ADMINISTRATION WASHINGTON, D.C. 20416:
December 13, 2002:
Ms. Davi M. D‘Agostino Director:
Financial Markets and Community Investment U.S. General Accounting
Office:
441 G Street, N.W. Washington, DC 20548:
Ms. Linda M. Calbom Director:
Financial Management and Assurance U.S. General Accounting Office:
441 G Street, N.W. Washington, DC 20548:
Dear Ms. D‘Agostino and Ms. Calbom:
The purpose of this letter is to provide SBA‘s comments on the draft
GAO report titled, ’Accounting Anomalies and Limited Operational Data
Make Results of Loan Sales Uncertain“ (Report). The Report identifies a
range of complex accounting and budgeting issues associated with SBA‘s
Loan Sales Program. While we generally concur with the GAO‘s findings
and recommendations, especially the need to better assess the financial
impact of SBA‘s Loan Sales Program, we wish to point out that current
senior SBA management (including the new Chief Financial Officer (CFO)
team that the current SBA Administrator has put in place) became aware
of these issues and were working to solve them prior to learning of the
findings of the GAO audit. We are making every effort to resolve these
issues by the end of March 2003; therefore, we respectfully request
that GAO not finalize the Report until SBA completes this process.
Given that GAO itself could not identify the cause of the accounting
and budget anomalies, but instead suggested that additional analysis is
needed, we are concerned that readers may reach potentially premature
and inaccurate conclusions regarding these issues. In addition, we
believe the Report should clearly state that there is no indication
that SBA intentionally misrepresented the loan sale results on its
financial statements.
GAO recommendations regarding financial and budgetary issues:
The Report identifies apparent inconsistencies between the results
produced by the financial models used in connection with SBA‘s Disaster
Loan Program and its Loan Sales Program. The former management of the
Office of the CFO was aware of these seeming inconsistencies but was
unable to resolve them. SBA‘s fiscal year 2000 and
2001 financial statements included footnotes disclosing the book losses
and discussing the Loan Sales Program. In the Spring of 2002, the
current Administrator replaced the management team in the Office of the
CFO. The new management team was given clear direction to review and
modify operations, including to assess the financial and budgetary
impact of the Loan Sales Program. The Administrator directed the new
management team to ensure that the Office of the CFO consistently
produce timely, thorough, and accurate financial information that can
reliably be used to support the Agency‘s programs and decision-making.
Shortly after coming onboard, the new CFO team recognized the
importance of the loan sales budgeting and accounting issues, including
the potential impact of the sales on the subsidy rate for the Disaster
Loan Program. Under the CFO team‘s direction, SBA has undertaken a
rigorous review of all aspects of the issues, including those raised in
the Report. Specifically, we are looking at the methodology and
assumptions in the disaster loan subsidy model and hold model, the
characteristics (including performance) of the loans sold versus those
remaining in the portfolio, the value of the remaining portfolio, and
the detailed accounting transactions that have been recorded for each
cohort. This is a top priority of the Agency and we are devoting much
of our internal staff‘s time to ensuring that the issues are
satisfactorily resolved. In addition, we are engaging a contractor with
the expertise necessary to advise us regarding these complex matters.
We have also worked extensively with our independent auditor over the
past few months to analyze the potential causes of the inconsistencies
and to identify options for resolving the situation.
We are concerned that the Report fails to take into account or
appreciate the complex and unique problems faced and solved in
implementing the Loan Sales Program. These include the diverse nature
of the SBA loan portfolio that did not lend itself well to traditional
sale methods, the need to create a market for the portfolio, as well as
a host of attendant legal problems. It should also be noted that the
loan sales process begins between nine months to a year prior to the
actual bid date for each sale.
The following provides some background and context that we believe is
relevant but not included in the Report and also details SBA‘s past
efforts to resolve the issues identified in the Report. SBA has been a
government-wide leader in asset sales, as one of the few credit
agencies to conduct them under the credit reform guidelines. The SBA
Loan Sales Program presents unique challenges because of the diversity
of types of loans that are sold and the large number of loans that have
been sold in each of the sales. As GAO noted in its exit meeting with
SBA, this is not an area where extensive official implementation
guidance has been developed. The guidance that exists from the Office
of Management and Budget (OMB), the Federal Accounting Standards Board
(FASB), and others is general in nature and requires interpretation for
specific application and implementation.
SBA repeatedly sought the assistance of reputable outside experts to
interpret and apply the available guidance. SBA‘s loan sales process,
including the budgeting and accounting components, was developed with
the support and guidance of well qualified and recognized outside
contractors. The contractors who worked on various aspects of the
process included KPMG Consulting, Ernst & Young, Cushman & Wakefield,
Merrill Lynch, and others. In addition, OMB and GAO have been involved
in various aspects of the Loan Sales Program. Throughout the history of
the Program, it appears that SBA has followed all the guidance that was
available.
Indeed, such guidance and the available expertise have not been able to
resolve the unique problems presented by the Loan Sales Program. For
example, SBA retained PricewaterhouseCoopers, an independent
accounting firm, to look at the accounting and budgeting issues
relating to the Loan Sales Program. Officials from OMB were also
engaged to assess these issues. The results of the reviews were
inconclusive -the hold model, subsidy model, and accounting procedures
were found to be sound individually, but the inconsistencies between
them remained.
As stated above, the Agency‘s current management is working diligently
to resolve these inconsistencies and the other issues noted in the
Report that were left unresolved in the past.
GAO recommendation regarding programmatic issues:
The Report recommends that SBA develop a comprehensive process for
documenting and tracking borrower inquiries and complaints in order to
guide SBA field personnel, to enforce borrower protections in the loan
sale agreement, and to report accurately to Congress. SBA has already
taken a number of steps to improve this process and the Report should
reflect the fact that SBA has responded in writing to every written
complaint or inquiry submitted by a borrower, lender or member of
Congress.
Often these complaints and inquiries arise when a borrower requests an
accommodation from the purchaser that is outside the terms of the
underlying loan documentation. When a loan is sold, the borrower and
guarantors retain all the rights and obligations that they had when SBA
and the participating lender owned and serviced the loan. The purchaser
does not have any power to change the terms of the loan without the
borrower‘s consent. SBA cannot enforce these rights and protections on
behalf of the debtor, any more than SBA can collect the loan on behalf
of the purchaser. What SBA can do (and does) is ensure that the
purchasers can adhere to the servicing standards in each loan sale
agreement. In order to accomplish this, SBA accepts bids only from
entities that have demonstrated experience in the servicing of the
types of loans SBA sells and that follow standard commercial loan
servicing practices. In addition, when our assistance is requested, SBA
attempts to work with the parties to reach a resolution.
Furthermore, the Agency currently is preparing a Procedural Notice for
distribution to all Field Offices, Servicing Centers and Disaster Area
Loan Offices that will clarify how borrower inquiries and/or complaints
are to be handled so that a uniform process is utilized. This Notice
will also describe the (800) customer information line in the Santa Ana
Commercial Loan Servicing Center. It will explain the purpose of the
line, information available and types of borrowers that should be
transferred to that number.
In addition to the Procedural Notice, SBA is:
*Establishing a designated electronic mail account for use by all SBA
employees to record borrower comments and forward them to the Asset
Sales Team in Headquarters for documentation, tracking and possible
response.
*Developing a relational database maintained by the Asset Sales Team at
Headquarters to track borrower complaints, borrower inquiries,
Congressional inquiries, Freedom of Information Act requests or any
other inquiries generated due to the sale of loans.
*Implementing additional enhancements to the Santa Ana Disaster Home
Loan Customer Inquiry tracking system for recording borrower complaints
and inquiries.
Conclusion:
As you are aware from your own experience in reviewing the Loan Sales
Program, the causes of the budgetary and accounting issues raised in
the Report have proven to be difficult not only to identify but also to
resolve. As we noted above, we are hopeful of resolving these issues in
the next few months. Accordingly, we reiterate our request that you
withhold publication of a final version of the Report until we have
concluded our review and have provided you with our methodology for
resolving these issues.
We appreciate the opportunity to comment on the Report. We look forward
to providing you more information on the resolution of the issues
raised in the Report as soon as possible.
Sincerely,
Thomas A. Dumaresq Chief Financial Officer:
Signed by Thomas A. Dumaresq
[End of section]
Appendix IV: Comments from the Inspector General of the Small Business
Administration:
U.S. Small Business Administration Washington, D.C. 20416:
OFFICE OF INSPECTOR GENERAL:
December 13, 2002:
Ms. Davi M. D‘Agostino Director:
Financial Markets and Community Investment U. S. General Accounting
Office:
441 G Street, N. W. Washington, DC 20548:
Ms. Linda M. Calbom, Director:
Financial Management and Assurance U.S. General Accounting Office:
441 G Street, N. W. Washington, DC 20548:
Dear Ms. D‘Agostino and Ms. Calbom:
We have reviewed the General Accounting Office‘s (GAO) draft report
GAO-03-87, ’Accounting Anomalies and Limited Operational Data Make
Results of Loan Sales Uncertain. ’ GAO‘s report identified significant
errors in the Small Business Administration‘s (SBA‘s) accounting and
budgeting for loan sales which may have affected the fair presentation
of its Fiscal Year (FY) 2000 and 2001 financial statements.
Accordingly, GAO recommended that the Inspector General, in conjunction
with SBA‘s financial statement auditors, assess the impact of any
identified errors in the financial statements and determine whether
previously issued audit opinions for FY 2000 and 2001 need to be
revised. Further, GAO made several recommendations to SBA‘s
Administrator to provide accurate and reliable information about how
the sales affect SBA‘s financial statements, budget, and operations.
We agree with both the recommendation addressed to our office as well
as those recommendations addressed to the Administrator. With respect
to the recommendation addressed to our office, we are continuing to
work with Cotton and Company LLP (Cotton) and SBA management to
determine the magnitude of the errors in SBA‘s FY 2000 and 2001
financial statements and resulting impacts of those errors.
Additionally, Cotton has informed our office that the opinions on the
FY 2000 and 2001 financial statements should no longer be relied upon
as these statements may be materially incorrect due to the errors noted
in your report. Accordingly, Cotton plans to withdraw their unqualified
opinions on those financial statements and issue disclaimers of
opinion.
Federal Recycling ProgramPrinted on Recycled Paper:
Our office is working with Cotton and SBA to ensure affected parties
are notified and appropriate actions are taken.
We recognize that the recommendations addressed to the Administrator
are necessary to ensure that the issues noted in your report do not
continue to have a detrimental effect on SBA‘s loan sale program. As
acknowledged in the subject report, many of the errors GAO identified
need further analysis to determine the impact on the accuracy of the
financial statements. SBA and Cotton have been attempting to evaluate
the magnitude of these errors, but have yet to determine the extent of
any material misstatements in the FY 2000 and 2001 financial
statements. We will work with the Administrator to ensure these errors
are quantified and the underlying problems are adequately addressed.
Should you or your staff have any questions, please contact Robert G.
Seabrooks, Assistant Inspector General for Auditing, at (202) 205-7203.
Sincerely,
Signed by David R. Gray for:
Peter L. McClintock Acting Inspector General:
cc: Hector Barreto, Administrator:
Lloyd Blanchard, Chief Operating Officer Thomas Dumaresq, Chief
Financial Officer Ronald Bew, Associate Deputy Administrator for
Capital Access Herbert Mitchell, Associate Administrator for Disaster
Assistance Charles Hayward, Partner, Cotton and Company LLP:
[End of section]
Appendix V: Comments from Cotton and Company:
COTTON & COMPANY LLP:
December 13, 2002:
Ms. Linda Calbom Director:
Financial Management and Assurance U.S. General Accounting Office:
441 G Street, NW Washington, DC 20548:
Subject: GAO-03-87, Accounting Anomalies and Limited Operational Data
Make Results of Loan Sales Uncertain:
Dear Ms. Calbom:
We have reviewed the draft report cited above. We wish to comment on
the text under the caption SBA‘s Accounting for Loan Sales and the
Remaining Portfolio Was Flawed and on related material elsewhere in the
draft report. Among other things, these portions of GAO‘s report state
that SBA made errors in budgeting and accounting for loan sales that
could have significantly affected reported results in its budget and
financial statements. GAO‘s report also conveys that Cotton & Company
as SBA‘s auditor gave unqualified audit opinions on SBA‘s Fiscal Years
(FY) 2000 and 2001 financial statements, and that we are reevaluating
those opinions.
We agree with these statements. GAO‘s report will, however, provide a
more fair and balanced presentation of the facts and have a more
positive effect if it also explains the:
Need for and inherent risk associated with accounting estimates.
Inherent complexities in making credit reform estimates, particularly
loan sale cost estimates.
Lack of comprehensive implementation guidance provided to agencies in
these complex areas.
The need to strengthen authoritative implementation guidance is equal
in importance to issues noted in the draft GAO report.Further, the
importance of these points is illustrated by the fact that many
organizations and experts, including GAO, previously reviewed SBA‘s
estimation procedures year after year and did not identify an important
weakness in SBA‘s disaster loan model. That weakness made the output of
that model unreliable when substantial loan sales were undertaken and
contributed substantially to issues raised in the draft report. These
matters are addressed in more detail in the balance of this letter.
GAO‘s report should also make clear that no evidence exists that the
financial statements were intentionally misstated.
Accounting Estimates, While Necessary, Are Inherently Uncertain:
The auditing profession, through its guidance, has long recognized that
accounting estimates are both necessary and carry a higher degree of
risk than accounting information that consists solely of factual data.
Credit reform requires program managers to estimate the cost of loans
based on assumptions about loan performance. In this instance, SBA is
required to make assumptions about both the terms of loans that will be
made to individuals and businesses that have suffered losses from
natural disasters and about performance of these loans over time.
Such estimates could be made in many ways. OMB circulars and FASAB
accounting standards provide broad standards and principles stated in
conceptual terms. Auditors must, however, judge the reasonableness of
credit-reform estimates underlying financial statements in a context
where little or no practical guidance exists to help agencies make
them.
In the absence of published guidance, SBA, in consultation with others,
made a determination about specific requirements for a cash flow model
and developed one based largely on historical data. SBA‘s model, once
developed, subsequently was critically evaluated at various times as
follows:
SBA contracted with a number of reputable outside experts to provide
independent validations of the models. Those experts provided reports
of their results (which we evaluated without exception) that did not
mention the issues GAO now notes.
OMB staff annually reviewed and approved the models prior to each
year‘s budget submission.
GAO reviewed our work papers and the models and gave us advice on
testing the models (which we adopted).
Cotton & Company, as part of the financial statement audit, reviewed
the models according to auditing standards for accounting estimates.
How the Accounting Estimates Were Audited:
Recognizing the necessity and inherent uncertainty in accounting
estimates, we performed substantial evaluations of SBA‘s estimating
methods and tested their results. In the audit for FY 2000, we found
that book value losses on disaster loan sales were not included in the
disaster loan subsidy:
reestimates. To account for this cost, we recommended that the
financial statements include an imputed subsidy reestimate of $468
million, which was the estimated amount needed to cover these losses as
SBA had computed them. SBA accepted this recommendation and recorded an
adjustment within its financial statements.
In FY 2001 audit, we found that cash flow estimates included, for the
first time, effects of loan sales, but that these reestimates were
substantially smaller than expected based on previous work. To resolve
this apparent inconsistency and determine if it had caused the debit
balance in the allowance for subsidy cost, we requested that SBA
perform additional analysis of its subsidy estimates. That additional
analysis generally confirmed that the subsidy estimates were consistent
with balances in the financing account.
We believe that our audit work met professional auditing standards.
Indeed, GAO itself reviewed our work in these areas and, prior to the
subject report, did not bring this matter to our attention. Moreover,
GAO‘s draft report states that Cotton & Company, during its audit of
SBA‘s FY 2001 financial statements:
... performed a number of audit procedures related to the disaster loan
program subsidy allowance account. For example, the auditor evaluated
the methodology and formulas used to calculate reestimates, assessed
data used to calculate key cash flow assumptions, and reviewed various
internal controls over the subsidy estimation process.
The procedures GAO cites constitute the principal auditing procedures
required for auditing accounting estimates.
Post-Audit Discovery of Limitations in the Accounting Estimates:
We realize now that the methods used to estimate the disaster loan cash
flows have an important limitation. A key premise of the cash flow
model is that one illustrative loan can serve as an effective proxy for
all loans made to individuals, and another illustrative loan can do the
same for businesses. At the time that the single proxy premise was
adopted, loan sales were not anticipated. The effect of loan sales on
this premise was not considered until recently, even though OMB, GAO,
outside consultants, and Cotton & Company reviewed and thoroughly
evaluated the cash flow model.
General agreement now exists that the premise became inadequate when
substantial loan sales began. It did so because a single proxy loan
cannot produce realistic cash flows when the:
Portfolio is diverse.
Cost of any loan increases with the loan term (terms vary from 1 to 30
years). Average term of loans sold is several years longer than that of
the original portfolio.
Moreover, a single proxy cannot simultaneously represent loans sold and
loans kept. This led to imprecise estimates in both categories and
contributed substantially to the issues noted in the GAO report. Until
SBA revises its model, the effect of imprecise estimates on the
financial statements cannot be measured. As a result, we cannot
determine if they have a material effect on the financial statements.
Because of the subsequent discovery that SBA‘s estimates in the FYs
2000 and 2001 financial statements may not be materially correct, we
have concluded that our unqualified opinions on those financial
statements should no longer be relied upon. We are taking steps in
conformance with auditing standards and with SBA‘s assistance to
withdraw those opinions and issue disclaimers of opinion on those
financial statements.
Recommendations:
The fact that extensive reviews took place without disclosing this
problem suggests that there is insufficient information about how the
concepts related to loan sales should be applied in practice. The main
sources of guidance are OMB Circular A-11 and the FASAB accounting
standards (SFFAS Nos. 2 and 18 and Federal Financial Accounting and
Auditing Technical Release No. 3). These documents focus on broad
budgetary and accounting concepts and do not discuss implementation
issues in a systematic way. Technical Release 3, which provides
substantial and practical guidance in many areas, does not include
guidance regarding standards for cash flow estimates involving loan
sales or the treatment of loan sales generally.
Among other things, additional guidance is needed regarding:
How the book value of loans should be determined when cash flow
estimates are not made on a loan-by-loan basis (which is the most
common case).
Minimum requirements of cash flow estimates to meet loan sale
requirements.
The relationship between the calculation of a hold value for loan sales
and routine subsidy calculations for other purposes.
These are important topics, and they are central to the measurement of
the cost of federal credit programs in general and the cost of loan
sales in particular. We encourage further discussion of this subject
and will welcome the opportunity to make specific suggestions.
Looking forward, three things need to be done:
In the short term, agencies should be advised to determine if cash flow
models they used for initial subsidy estimates are adequate for
estimating the cost of loan sales. Such an advisory may help other
agencies avoid the problems identified in your report.
OMB and FASAB need to provide guidance on how the concepts laid out in
OMB circulars and FASAB accounting standards should be applied in
practice.
SBA needs to improve the cash flow model for disaster loans.
We commend GAO‘s effort in evaluating these complex and cutting-edge
issues. Actions taken as a result of this evaluation and report will be
valuable to other agencies and should improve the overall usefulness of
federal financial statements. Thank you for the opportunity to review
the report and provide our views.
Very truly yours,
By:
Charles Hayward, CPA, CFE, CGFM, CISA
Signed by Charles Hayward
[End of section]
Appendix VI: GAO Contacts and Acknowledgments:
Contacts:
For questions regarding this report, please contact Davi D‘Agostino at
(202) 512-8678 or Linda Calbom at (202) 512-9508.
Acknowledgments:
Additional staff making major contributions to this report were Dan
Blair, Marcia Carlsen, Jay Cherlow, Heather Dunahoo, David Eisenstadt,
Edda Emmanuelli-Perez, Katie Harris, DuEwa Kamara, Kay Kuhlman, and
Paul Thompson.
[End of section]
Glossary:
The following is a group of terms commonly used in credit budgeting and
accounting. The definitions for many of these terms are equally
applicable to direct loans and loan guarantees.
Cash flows:
Payments or estimates of payments to or from the government over the
life of a loan or group of loans. For direct loans, these may include
loan disbursements, repayments of principal, payments of interest,
prepayments, fees, penalties, defaults, and recoveries on defaulted
loans.
Cash flow assumptions:
All known and forecasted information about the characteristics and
performance of a loan or group of loans used to estimate future loan
performance. Examples include estimates of loan maturity, borrower
interest rates, default and delinquency rates, and the timing of cash
flow events, such as defaults and collections on defaulted loans.
Credit reform:
Refers to the collective requirements as set forth in (1) the Federal
Credit Reform Act of 1990, which generally requires that agencies
calculate and record the net present value cost of credit programs to
the government included in the budget, (2) the Statement of Federal
Financial Accounting Standard No. 2, Accounting for Direct Loans and
Loan Guarantees, and (3) OMB Circular A-11, Preparation, Submission,
and Execution of the Budget.
Gross proceeds:
Total amount received from investors as a result of the loan sales.
Hold value:
The estimated value of loans to the government if held to maturity or
resolution, stated on a net present value basis and discounted with
interest rates from the most recent President‘s budget at the time the
estimate is prepared. The hold value is a more detailed loan value
analysis than the credit subsidy estimate, because it specifically
considers the cash flows and characteristics of the loans for sale and
is calculated on a loan-by-loan basis.
Market value estimate:
An estimate of the anticipated proceeds from investors on loans for
sale based on current market trends and conditions, and the
characteristics of the loans being sold. A contractor who assists SBA
with the loan sales prepares the estimate.
Net book value:
An amount calculated by subtracting the subsidy allowance from the
outstanding loans receivable balance for a loan or group of loans.
Net proceeds:
Gross proceeds received from a loan sale less seller transaction costs
associated with conducting the sale (such as fees for underwriting,
rating agency work, legal advice, financial advice, and due diligence)
that are paid out of the gross sales proceeds rather than paid as
direct obligations by the agency.
Present value:
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.
Reestimates:
Revisions of the subsidy cost estimate based on information about the
actual performance of loans or other estimated changes in future cash
flows resulting from changes in economic conditions, other events, and
improvements in the methods used to estimate future cash flows.
Subsidy allowance:
Financial statement reporting account used to recognize the costs of a
loan program that are not expected to be recovered from borrowers,
including default costs and financing costs arising from subsidizing
below-market rate loans.
Subsidy cost:
The estimated long-term cost to the government of direct loans or loan
guarantees, calculated on a net present value basis, excluding
administrative costs. The subsidy cost is the present value of
disbursements by the government (loan disbursements and other payments)
minus estimated payments to the government (repayments of principal,
payments of interest, other recoveries, and other payments) over the
life of the loan.
Unpaid principal balance:
Amount of outstanding loan principal owed by borrowers (also known as
the loans receivable balance).
Unqualified opinion:
An auditor‘s opinion that states that the financial statements present
fairly, in all material respects, the financial position, results of
operations, and cash flows of the entity, in conformity with generally
accepted accounting principles.
FOOTNOTES
[1] In August 2002, SBA held its sixth sale of about 30,000 loans with
an outstanding balance of $657 million. Additional sales are planned.
[2] 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. The hold value is
calculated on a present value basis, with future payments discounted at
current interest rates. This is a detailed loan-by-loan analysis that
specifically considers the cash flows and characteristics of the loans
included in the sales.
[3] The hold value is designed to be a decisional tool used to
determine whether or not it is currently advantageous for SBA to sell
loans. The hold value is calculated using current Treasury interest
rates in order to reflect current market conditions in the
decisionmaking process.
[4] SBA‘s revised hold model was first used to estimate hold values for
sale four. Hold values from this more sophisticated model were
calculated at the loan level rather than being based on a loan pool
approach or averages, and the revised model‘s calculations were based
on the actual data from all loans selected for sale rather than on a
sample of data from the loans selected for sale.
[5] The accounting standards for loan programs were established to
mirror budget guidance. This mirroring allows for consistency between
loan program cost estimates and the results for the financial
statements and budget.
[6] Cash flow assumptions include known and forecasted information
about the characteristics and performance of a loan or group of loans
that are used to estimate future loan performance and program costs.
[7] An unqualified audit opinion indicates that the balances in the
financial statements are free of significant errors known as material
misstatements.
[8] H.R. Rep. No. 104-291 at 40-41 (October 25, 1995), to accompany
Pub. L. No. 104-52 (Nov. 19, 1995).
[9] Pub. L. No. 104-134, Title III, ch. 10, § 31001, 110 Stat.1321-358
(1996).
[10] The 7(a) program is established under section 7(a) of the Small
Business Act, 15 U.S.C. § 636 (2000 § Supp. 2002). The 504 program is
established under Title V of the Small Business Investment Act of 1958.
See 15 U.S.C. § 696 et seq. (2000 § Supp. 20002).
[11] Liquidation is the act of enforcing collection on a debt that has
defaulted by selling underlying securities that the borrower has
pledged as collateral. If collateral proceeds are insufficient to cover
the outstanding balance, lenders may pursue personal guarantees or
obligations provided by business owners or others in support of the
loan.
[12] SBA implemented a pilot, as mandated by the Small Business
Programs Improvement Act of 1996, to outsource 30 percent of the
servicing of its disaster home loan portfolio.
[13] Federal Credit Reform Act of 1990, Pub. L. No. 101-508 § 13201
(1990), 2 U.S.C. § 661 et seq. (2000 and Supp. 2002).
[14] The board was created by OMB, Treasury, and GAO to develop
accounting standards for the federal government.
[15] In accordance with the Federal Credit Reform Act of 1990, the
subsidy cost of loans does not include administrative costs of the
program.
[16] 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.
[17] Hold value is the estimated value of loans to the government in
the event that the loans were held to maturity or resolution, stated on
a present-value basis, discounted with interest rates from the most
recent President‘s budget at the time the estimate is prepared. This is
a more detailed loan value analysis than the credit subsidy estimate,
because it specifically considers the cash flows and characteristics of
the loans included in the sales and is calculated on a loan-by-loan
basis.
[18] Small investors are organizations, not individuals. SBA used this
term in documents and conversations with us to describe the more
moderately sized institutions bidding on loan sales.
[19] The goal of due diligence is to provide accurate information about
the loans for sale to potential investors so that they may make
informed bids.
[20] For example, if a borrower has multiple SBA loans and one is
selected for sale, the field offices are instructed to add the
borrower‘s additional loans to the list of loans for sale.
[21] SBA‘s loan sale process has evolved, and information provided by
SBA indicated that sales three through five better reflect SBA‘s
current sale process and selection of loans for sale than do sales one
and two.
[22] Securitization of loans is the process of aggregating similar loan
assets and dividing them into groups of investment instruments for
sales that investors will evaluate separately, according to levels of
risk.
[23] Similar loans refer to loans with comparable maturities,
prepayment risks, and default risks.
[24] Representations and warranties are a set of legally binding
statements by the seller that are intended to assure buyers that the
assets being sold meet certain qualitative expectations.
Representations and warranties are accompanied by obligations to ’cure“
conditions that are breaches of the original representations, as well
as by remedies available to the investor if the condition cannot be
cured. Such remedies may require a repurchase or substitution of an
obligation.
[25] The Real Estate Settlement Procedures Act (RESPA) requires that
loan servicers provide either a toll-free or collect call number for
home loan borrowers to call about servicing problems before and after
the loan is sold. 12 U.S.C. § 2605 (b), (c) (2000 § Supp. 2002). The
act does not specify how long the toll-free number should be
operational following the transfer of servicing.
[26] The subsidy allowance account represents the subsidized portion of
direct loans and defaulted guaranteed loans assumed by the federal
government. It is subtracted from the loans receivable balance on the
balance sheet to arrive at the net loan amount expected to be repaid.
[27] OMB Circular A-11 defines net sales proceeds in the context of
loan sales as the amounts paid by purchasers less all seller
transaction costs (such as underwriting, rating agency, legal,
financial advisory, and due diligence fees) that are paid out of the
gross sales proceeds rather than paid as direct obligations by the
agency.
[28] The fact that the average loan term of the loans sold to date,
which represents over half the loan portfolio, is 25 years could also
mean that the 16-and 17-year assumptions of the average loan term were
too short.
[29] Theoretically, had the reestimates factored in the loan sales, the
subsidy allowance account would have been appropriately adjusted,
regardless of any errors made in recording the calculated accounting
losses.
[30] The effects of loan sales on the reestimated cost of a loan
program differs from the results of loan sales based on the hold value
because the reestimates, similar to the accounting gains or losses of a
loan sale, are influenced by changes in interest rates from the time
the loans were disbursed to the date of the sale.
[31] Statements on Auditing Standards, AU §508, paragraphs 22 and 23.
[32] SBA has four disaster home loan servicing centers, located in New
York City, New York; Birmingham, Alabama; El Paso, Texas; and Santa
Ana, California, which service only disaster home loans. SBA also has
two commercial loan servicing centers, located in Little Rock,
Arkansas, and Fresno, California, which service 7(a) and development
company loans as well as disaster business loans.
[33] SBA‘s revised hold model was first used to estimate hold values
for sale four. Hold values from this more sophisticated model were
calculated at the loan level rather than based on a loan pool approach
or averages. The revised model‘s calculations were based on actual data
from all loans selected for sale rather than on a sample of data from
the loans selected for sale.
[34] We tried to review all of the inquiries and complaints documented
at headquarters and stored in two binders. However, we did not include
in our review additional follow-up letters from the same borrowers.
Furthermore, the database that SBA created after our review included
inquiries and complaints after April 2002, when we had reviewed the
inquiries and complaints at headquarters. Therefore, our 133 complaints
did not match exactly the 155 complaints in SBA‘s database.
[35] ’Subordination“ occurs when a lender allows a new or existing loan
to take a superior lien to another loan. For example, a borrower with
an SBA disaster home loan may want SBA or a lender to subordinate the
disaster loan to a new or refinanced home mortgage.
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