Small Business Administration
Loan Accounting and Other Financial Management Issues Impair Accountability Gao ID: GAO-03-676T April 29, 2003Recently, the Small Business Administration's (SBA) auditors withdrew their unqualified audit opinions on SBA's fiscal year 2000 and 2001 financial statements and issued disclaimers of opinion. The auditors also issued a disclaimer of opinion on SBA's fiscal year 2002 financial statements. This turn of events was primarily due to flaws in the way SBA accounted for its loan sales and for the remaining portfolio. There were also several other issues affecting SBA's fiscal year 2002 audit, including key internal control weaknesses and systems that did not substantially comply with the Federal Financial Management Improvement Act. The information GAO presents in this testimony, which is discussed in greater detail in our January 2003 report, Small Business Administration: Accounting Anomalies and Limited Operational Data Make Results of Loan Sales Uncertain (GAO-03-87), is intended to assist Congress in assessing the current status of financial accountability at SBA.
Since August 1999, SBA held seven loan asset sales, disposing of a total of $5.8 billion in disaster assistance and business loans. Our review of the budgeting and accounting for the first five loan sales found errors that could significantly affect the reported results in SBA's budget and financial statements. We found that SBA (1) incorrectly calculated losses on loan sales 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. The subsidy allowance eventually declined to a negative balance, which indicated that SBA expected profits on its subsidized disaster loans. 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these issues with SBA's auditors, who have since reassessed the unusual balance in the subsidy allowance account and withdrawn their unqualified audit opinions on the fiscal year 2000 and 2001 financial statements. The agency's inability to properly account for its loans sold and not sold, combined with several other financial management issues, led the auditors to issue a disclaimer of opinion on SBA's fiscal year 2002 financial statements. Until SBA corrects its financial management deficiencies, the agency's financial accounting and budgetary reporting will be unreliable. Based on recent discussions with SBA officials, we understand that they are making progress in identifying the sources of the loan accounting problems and in determining corrective actions.
GAO-03-676T, Small Business Administration: Loan Accounting and Other Financial Management Issues Impair Accountability
This is the accessible text file for GAO report number GAO-03-676T
entitled 'Small Business Administration: Loan Accounting and Other
Financial Management Issues Impair Accountability' which was released
on April 29, 2003.
This text file was formatted by the U.S. General Accounting Office
(GAO) to be accessible to users with visual impairments, as part of a
longer term project to improve GAO products' accessibility. Every
attempt has been made to maintain the structural and data integrity of
the original printed product. Accessibility features, such as text
descriptions of tables, consecutively numbered footnotes placed at the
end of the file, and the text of agency comment letters, are provided
but may not exactly duplicate the presentation or format of the printed
version. The portable document format (PDF) file is an exact electronic
replica of the printed version. We welcome your feedback. Please E-mail
your comments regarding the contents or accessibility features of this
document to Webmaster@gao.gov.
Testimony :
Before the Subcommittee on Government Efficiency and Financial
Management, Government Reform Committee, House of Representatives:
For Release on Delivery
Expected at 2 p.m. EDT
April 29, 2003:
SMALL BUSINESS ADMINISTRATION:
Loan Accounting and Other Financial Management Issues Impair
Accountability:
Statement of Linda M. Calbom, Director
Financial Management and Assurance:
GAO-03-676T:
GAO Highlights:
Highlights of GAO-03-676T, a testimony before the Subcommittee on
Government Efficiency and Financial Management, Government Reform
Committee, House of Representatives
Why GAO Did This Study:
Recently, the Small Business Administration‘s (SBA) auditors withdrew
their unqualified audit opinions on SBA's fiscal year 2000 and 2001
financial statements and issued disclaimers of opinion. The auditors
also issued a disclaimer of opinion on SBA's fiscal year 2002 financial
statements. This turn of events was primarily due to flaws in the way
SBA accounted for its loan sales and for the remaining portfolio.
There were also several other issues affecting SBA's fiscal year 2002
audit, including key internal control weaknesses and systems that did
not substantially comply with the Federal Financial Management
Improvement Act. The information GAO presents in this testimony, which
is discussed in greater detail in our January 2003 report, Small
Business Administration: Accounting Anomalies and Limited Operational
Data Make Results of Loan Sales Uncertain (GAO-03-87), is intended to
assist Congress in assessing the current status of financial
accountability at SBA.
What GAO Found:
Since August 1999, SBA held seven loan asset sales, disposing of a
total of $5.8 billion in disaster assistance and business loans. Our
review of the budgeting and accounting for the first five loan sales
found errors that could significantly affect the reported results in
SBA‘s budget and financial statements. We found that SBA (1)
incorrectly calculated losses on loan sales 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. As shown in the
figure, the subsidy allowance eventually declined to a negative
balance, which indicated that SBA expected profits on its subsidized
disaster loans.
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 have since
reassessed the unusual balance in the subsidy allowance account and
withdrawn their unqualified audit opinions on the fiscal year 2000 and
2001 financial statements. The agency‘s inability to properly account
for its loans sold and not sold, combined with several other financial
management issues, led the auditors to issue a disclaimer of opinion on
SBA‘s fiscal year 2002 financial statements. Until SBA corrects its
financial management deficiencies, the agency‘s financial accounting
and budgetary reporting will be unreliable. Based on recent
discussions with SBA officials, we understand that they are making
progress in identifying the sources of the loan accounting problems
and in determining corrective actions.
What GAO Recommends:
GAO is not making new recommendations in this testimony, but in a past
report has made specific recommendations aimed at addressing the
deficiencies in the accounting for loan asset sales and the remaining
portfolio.
www.gao.gov/cgi-bin/getrpt?GAO-03-676T.
To view the full testimony, click on the link above.
For more information, contact Linda Calbom at (202) 512-9508 or
calboml@gao.gov.
[End of section]
Mr. Chairman and Members of the Subcommittee:
I am pleased to be here today to discuss the status of financial
management at the Small Business Administration (SBA). Recently SBA's
auditor withdrew its unqualified audit opinions on SBA's fiscal year
2000 and 2001 financial statements and issued disclaimers of opinion.
The auditor also issued a disclaimer of opinion on SBA's fiscal year
2002 financial statements. This turn of events was primarily due to
flaws we identified in the way SBA accounted for its loan sales and for
the remaining portfolio. There were also several other issues affecting
SBA's fiscal year 2002 financial statement audit, including key
internal control weaknesses and systems that did not substantially
comply with the Federal Financial Management Improvement Act (FFMIA). I
will discuss all of these issues today which, when combined, point to
an overall lack of financial accountability at SBA.
SBA's Accounting for Loan Sales and the Remaining Portfolio was Flawed:
This January, we reported[Footnote 1] that SBA had 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.[Footnote 2] Our
review of the budgeting and accounting for these loan sales found
errors that could significantly affect the reported results in SBA's
budget and financial statements.
We found that SBA (1) incorrectly calculated losses on loan sales
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[Footnote 3] for the
disaster loan program. Until SBA makes the necessary corrections to its
procedures to estimate the cost of its credit programs, including the
effect of its loan sales, the reliability of the current and future
subsidy rates will remain unknown. We understand that SBA is taking
steps to address the issues we identified, including working with a
consulting firm to perform a detailed analysis of its loan sale
accounting and cost estimation procedures.
SBA Improperly Calculated Losses on Loan Sales:
Accounting records related to SBA's first five loan sales indicated
that losses exceeded $1.5 billion. However, this amount is overstated
because of errors in the way SBA calculated the losses. Because of the
lack of reliable financial data, 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 that SBA provided to the Office of
Management and Budget (OMB) and the Congress for decision-making
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 minus the subsidy allowance) of the loans sold and the net sale
proceeds.[Footnote 4] The footnotes to SBA's fiscal year 1999 and 2000
financial statements reported accounting losses of $75 million and $600
million, respectively, on its loan sales. SBA did not separately
disclose the losses calculated on the two loan sales that took place
during fiscal year 2001.[Footnote 5] According to SBA's accounting
records, the first five sales resulted in total losses of more than
$1.5 billion.
Prior to a loan sale, an estimate of the loans' current value to the
government or "hold value" is calculated to determine what the loans
are worth to the government in the event that the loans are held to
maturity or some other resolution, such as prepayment or
default.[Footnote 6] This hold value is compared to an estimate of the
expected net sale proceeds to determine if it is advantageous for the
loans to be sold.[Footnote 7] After a sale, the hold value is compared
to the actual net sale proceeds to determine whether or not and by how
much the government benefited from the sale. SBA determined that the
first five loan sales resulted in a $606 million benefit to the
government.[Footnote 8] This benefit calculation differs from the
accounting gain or loss because the benefit calculation 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.
We reviewed the methodology SBA used to calculate the results of its
loan sales for accounting purposes and found significant errors. When
calculating whether loans are sold at a gain or 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 loans sold 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. Doing so would have reduced the amount of
loss that SBA reported on the loan sales.
In addition, SBA incorrectly allocated the subsidy allowance for the
previously defaulted 7(a) and 504 guaranteed loans, which could
materially distort the gain or loss. 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). Therefore, the net book
value calculated for the loan would be $9,500. However, since
guaranteed loans sold have already defaulted, it is not appropriate to
apply the estimated default rate of 10 percent. SBA should have applied
only the estimated recovery rate of 50 percent for these loans, and the
subsidy allowance allocated would be $5,000 ($10,000 x .50) and the net
book value calculated for the loan would be $5,000. Figure 1
illustrates the difference in the calculated gain or loss resulting
from this error if the previously defaulted loan were sold for $6,500.
The left column, based on SBA's incorrect 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, a difference of $4,500 for this example of a $10,000
guaranteed loan sold.
Figure 1: Gain / Loss Calculation on Previously Defaulted Guaranteed
Loans Sold:
[See PDF for image]
[End of figure]
SBA's errors in calculating the losses on disaster loans and previously
defaulted guaranteed loans sold both resulted in overestimates of the
net book value of the loans sold and the losses that SBA reported in
the footnotes to its fiscal year 1999 and 2000 financial statements.
Because of the way the results of loan sales are incorporated in the
budget and the financial statements, the reestimates, if done properly,
should have corrected the impact of these errors. However, as I discuss
next, the reestimates were not reliable.
Subsidy Cost Reestimates are Unreliable:
SBA did not conduct key analyses of the loans sold and those remaining
in its portfolio so it could determine how the sales affected 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, they
told us they lacked the appropriate historical data and resources to
perform these analyses. Because SBA did not assess the effect loan
sales would have on its historical averages of loan performance, such
as when loans default or prepay, the agency did 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 had not analyzed the effect of loan sales on the
estimated cost of the remaining loans in its portfolio. SBA officials
told us 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 had different
characteristics than 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 leave a
disproportionate level of nonperforming loans in SBA's portfolio.
Because SBA had not analyzed the effect of loan sales on the
characteristics of its 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 stated loan term. This
term is the contractual amount of time borrowers have to repay their
loans. 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 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. Based on our recent discussion with SBA officials,
their detailed analysis of the cost estimation procedures for the
disaster loan program found that, among other things, the average loan
term assumption should have been greater. Relatively minor changes in
some cash flow assumptions, such as higher or lower default and
recovery rates and changes in loan terms, can significantly affect the
estimated cost of the loan program and therefore the program's budget.
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 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 1 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 2002. The reported
subsidy allowance compared to 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. This declining trend continued into fiscal year
2002. SBA could not provide support for the balance or explain the
reason for this anomaly.
Table 1: Reported Loans Receivable Balances of SBA's Disaster Loan
Program:
Dollars in millions.
Loans receivable Outstanding; Fiscal year 1998: $5,614; Fiscal year
1999: $5,659; Fiscal year 2000: $5,305; Fiscal year 2001: $3,293;
Fiscal year 2002: $3,110.
Less / (plus): subsidy allowance balance; Fiscal year 1998: $1,502;
Fiscal year 1999: $929; Fiscal year 2000: $505; Fiscal year 2001:
($77); Fiscal year 2002: ($522).
Net book value; Fiscal year 1998: $4,112; Fiscal year 1999: $4,730;
Fiscal year 2000: $4,800; Fiscal year 2001: $3,370; Fiscal year 2002:
$3,632.
Subsidy allowance as a percentage of loans receivable balance; Fiscal
year 1998: 26.8%; Fiscal year 1999: 16.4%; Fiscal year 2000: 9.5%;
Fiscal year 2001: (2.3%); Fiscal year 2002: (16.8%).
Source: SBA.
[End of table]
Table 1 shows a rapid decrease in the reported subsidy allowance
between fiscal year 2000 and 2001. Most of this decrease actually
occurred in fiscal year 2000, but was masked by an adjustment made
during the fiscal year 2000 financial statement audit. Before SBA made
the audit adjustment, 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.
In order to restore the subsidy allowance to a more reasonable balance
at the end of fiscal year 2000, in agreement with its auditor, 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 9] This increased the
reported cost of the disaster loan program by $414 million in fiscal
year 2000. Since the amount of the adjustment was based on SBA's
erroneous calculations of loan sale losses, as 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.
However, this amount is also likely misstated because, as I 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
shown in table 1, this allowance account 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 show an expected profit, and thus
the balance for the subsidy allowance account appears to be
significantly misstated.[Footnote 10] As in the prior year, SBA could
not explain the unusual balance. Based on our review of SBA's fiscal
year 2002 financial statements, the unexplained trend continued and the
negative balance of the subsidy allowance (expected profit) increased
to $522 million.
While the objective of our work was not to determine the specific cause
of the unusual balance, several possibilities exist. As previously
mentioned, not considering 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 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. For example, as I
previously discussed, SBA used average loan term assumptions of 16 and
17 years to estimate the cost of the disaster loan program. However,
based on recent discussions with SBA officials, they have found that
the average loan term should have been greater. Underestimating the
loan term would mean that SBA did not put enough into the subsidy
allowance account to cover interest costs associated with these loans
and the subsidy allowance would be depleted as these costs were written
off against it until there was a negative balance. From a budgetary
perspective, this could mean that SBA did not request an appropriation
large enough to cover the cost of the loan program.
Despite the significant, unexplained decline in the subsidy allowance
and the errors in calculating the losses on loan sales, SBA received
unqualified or "clean" audit opinions on its fiscal year 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, they did not determine the cause of the unusual balance and
propose the necessary audit adjustments or modify their 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[Footnote 11] call for
auditors to either qualify their opinion with the noted exception or
issue a disclaimer of opinion, meaning that the auditor was unable to
obtain satisfaction that the financial statements are fairly stated and
therefore does not express an opinion. We discussed these issues with
SBA's auditor and they have since reevaluated and withdrawn their
unqualified audit opinions on SBA's fiscal year 2000 and 2001 financial
statements and issued disclaimers of opinion.
In response to our findings, SBA contracted with an independent
consulting firm to complete a more detailed analysis of its loan sale
accounting and cost estimation procedures to determine the cause of the
unusual balance in the subsidy allowance account. We recently met with
SBA officials to discuss the steps taken to date to address the issues
we identified. We understand that SBA, working with the consultants,
has identified a number of issues related to the methods and
assumptions used to estimate the cost for the disaster loan program.
While we have not had an opportunity to analyze their findings in
detail, based on our previous work, several of the issues they
identified, including the understated average loan term, appear to be
plausible causes of the decline in the subsidy allowance for the
disaster loan program.
Results of Fiscal Year 2002 Financial Statement Audit:
SBA's inability to account for its loan sales or adequately reestimate
the cost of loans not sold, combined with other financial management
issues, led to the auditors issuing a disclaimer of opinion on SBA's
fiscal year 2002 financial statements. I will now briefly discuss the
disclaimer of opinion, the internal control weaknesses they reflect,
and the consequences of these weaknesses regarding compliance with
FFMIA.
Disclaimer of Opinion:
The disclaimer of opinion for fiscal year 2002 was primarily due to
three issues: (1) SBA's disaster loan modeling contained deficiencies
and was no longer adequate for determining the costs of disaster loans
sold or reestimating the cost of loans not sold, (2) SBA did not
present future expected default costs on pre-1992 loan
guarantees[Footnote 12] or determine the correct valuation of related
balances, and (3) SBA could not ensure that the balance in the Master
Reserve Fund[Footnote 13] residual asset or liability was reliable.
As I've previously discussed, SBA's inability to determine the cost of
loans sold or adequately reestimate the cost of loans not sold could
materially affect amounts reported in the budget and the financial
statements. SBA and its consultants had not completed their analysis of
SBA's loan sale accounting and cost estimation procedures prior to the
completion of the fiscal year 2002 audit. Therefore, SBA was not able
to provide sufficient evidence to its auditors to support certain
amounts reported and disclosures made in its fiscal year 2001 and 2002
financial statements, thereby limiting the scope of the audit and
leading to the disclaimer of opinion.
Additionally, SBA did not present future expected default costs on pre-
1992 loan guarantees. SBA made several adjusting entries to both the
fiscal year 2002 and fiscal year 2001 financial statements in an effort
to correct this. However, SBA did not have a calculation methodology to
determine its expected future default costs and related liability or to
support the adjustments made. Therefore, SBA could not provide
sufficient documentation that the liability balance of $116 million as
of September 30, 2002, was fairly stated.
The final issue contributing to SBA's disclaimer related to the Master
Reserve Fund. SBA's fiscal and transfer agent maintains the Master
Reserve Fund to facilitate operation of the secondary market
program[Footnote 14] for 7(a) Business Loans, a loan guarantee program
for small businesses that would otherwise be unable to obtain financing
at reasonable rates. The Master Reserve Fund receives payments from
lenders who have SBA-guaranteed loans and makes payments to the
investors in the secondary market program. In fiscal year 2002, SBA
estimated that there was a potential future deficit (shortfall
resulting from payments to investors exceeding payments from lenders)
in the range of zero to $18.3 million required to liquidate the
obligations in the 7(a) secondary market. This potential deficit
contrasted with fiscal year 2001 where an estimated excess of $68
million was reported.
According to SBA's auditor, SBA used samples of Master Reserve Fund
activity for fiscal years 2002 and fiscal year 2001 to estimate the
year-end balances. The samples were small and differed in important
respects from the total population of loans. Thus, the sampling was not
entirely representative of the loan population and did not provide
sufficient evidence that the estimate of the Master Reserve Fund
balance was fairly stated.
Internal Control Weaknesses:
The study and evaluation of the system of internal control over
financial reporting are included as part of the financial statement
audit under generally accepted auditing standards. Internal control is
an integral component of an agency's management that provides
reasonable assurance that the following objectives are being achieved:
(1) effectiveness and efficiency of operations, (2) reliability of
financial reporting, and
(3) compliance with applicable laws and regulations.[Footnote 15]
Internal control serves as the first line of defense in safeguarding
assets and in preventing and detecting errors and fraud. As federal
policymakers and program managers continually seek to better achieve
agencies' missions and program results, they seek ways to improve
accountability. A key factor in achieving these outcomes and minimizing
operational problems is the implementation of appropriate internal
control.
Internal control over financial information is evaluated during the
audit, and the auditor is required to communicate to the agency any
condition that represents a significant deficiency in internal
controls--referred to as a reportable condition.[Footnote 16] A
material internal control weakness is a reportable condition that does
not reduce to a relatively low level the risk that errors, fraud, or
noncompliance involving significant amounts may occur and not be
detected in a timely manner by employees in the normal course of
performing their assigned functions. SBA's auditor identified five
material weaknesses and one reportable condition.
As I previously stated, SBA received a disclaimer of opinion from its
auditor in fiscal year 2002 primarily due to three issues, and each of
these issues resulted from a material weakness in their internal
controls. SBA's auditor reported material weaknesses relating to (1)
disaster loan modeling, (2) the liability for loan guarantees and
related accounts for pre-1992 loan commitments, and (3) the Master
Reserve Fund, all of which I have discussed. The fourth material
weakness related to SBA's financial reporting process. According to
SBA's auditor, SBA continued to experience widespread difficulties in
producing complete, accurate, timely, and adequately supported draft
and final financial statements, including footnotes. The auditor stated
that additional attention is needed to ensure that a fully effective
quality assurance process is documented and in place. The auditor
further stated that SBA's difficulties with financial reporting may be
attributable to devoting insufficient resources to the process,
particularly the quality control process.
The fifth material weakness was due to funds control weaknesses. For
example, the auditor reported that SBA established invalid undelivered
orders in its liquidating funds and did not return all unobligated
balances in its liquidating funds to the general fund at the end of the
fiscal year. Also, SBA did not have sufficient funds controls in place
to ensure that payments for defaulted 7(a) loan guarantees did not
exceed authorized amounts or to ensure that obligations were not
incurred against anticipated budgetary resources. These shortcomings
increase the risk that SBA may violate the Antideficiency Act.[Footnote
17]
Finally, while SBA has continued to improve internal controls over its
information system environment in certain areas, the auditor reported
that further improvement is needed to ensure a sound information system
control environment. This internal control deficiency was included as a
reportable condition in the auditor's 2002 report on internal controls.
Weaknesses were reported in all six categories of general computer
controls.[Footnote 18] General computer controls create the environment
in which application systems and controls operate. During a financial
statement audit, the auditor focuses on general controls for the
agency's major computer facilities and systems supporting a number of
different computer applications, such as major data processing
installations or local area networks. If general computer controls are
weak, as is the case at SBA, they severely diminish the reliability of
controls associated with individual applications.
Federal Financial Management Improvement Act of 1996:
SBA's auditor also concluded that SBA's systems did not substantially
comply with the Federal Financial Management Improvement Act of 1996
(FFMIA). FFMIA is a measure of an agency's ability to incorporate into
its financial management system accounting standards and reporting
objectives established for the federal government, so that all assets,
liabilities, revenues, expenses, and the full costs of programs and
activities can be consistently and accurately recorded, monitored, and
uniformly reported. Substantial noncompliance with FFMIA indicates that
SBA's financial management systems do not routinely provide reliable,
useful, timely, and consistent information to fulfill its
responsibility of being accountable to the public and of providing
timely financial information to manage on a day-to-day basis.
SBA's financial management systems in fiscal year 2002 did not
substantially comply with all three aspects of FFMIA: (1) federal
financial management systems requirements, (2) federal accounting
standards, or (3) the U.S. government standard general ledger (SGL) at
the transaction level.
SBA's auditor noted that SBA was not in substantial compliance with
federal financial management systems requirements because its core
financial system is not able to provide complete, reliable, timely and
consistent financial information on programs to enable management to
fulfill its responsibility to the public and to provide timely
information for managing current operations. Also, access control,
segregation-of-duties, and other general control weaknesses exist in
SBA's information systems controls. Additionally, funds control
deficiencies exist as is evidenced in SBA's material weakness in that
area.
The auditor concluded that SBA did not substantially comply with
federal accounting standards because it cannot support the reported
cost of loans sold, the reestimates of the subsidy for loans not sold,
or the liability for pre-1992 loan guarantees. SBA also cannot support
the balance in the Master Reserve Fund.
Finally SBA's auditor concluded that SBA's financial systems did not
substantially comply with the SGL at the transaction level. During
fiscal year 2002, SBA modified its Financial Reporting Information
System but did not detect in a timely manner an error created by the
modification. SBA also experienced problems that resulted in the
posting of invalid information to the system when it converted to its
current Oracle-based administrative accounting system.
In closing, Mr. Chairman, SBA's financial management deficiencies are
quite severe and point to an inability to provide full accountability
for taxpayer funds provided to the agency for carrying out its
programs. Until these deficiencies are corrected, SBA's financial
accounting and budgetary reporting will be unreliable. In our January
2003 report, we made a number of recommendations to SBA covering these
matters related to accounting for loan sales. SBA agreed with our
recommendations, and we understand that they are making progress
identifying potential causes of these deficiencies and actions to
address them. We look forward to assessing the results of these
activities.
Mr. Chairman, this concludes my statement. I would be happy to answer
any questions you or other members of the subcommittee may have.
Contact and Acknowledgments:
For information about this statement, please contact Linda Calbom,
Director, Financial Management and Assurance, at (202) 512-9508, or
Julia Duquette, Assistant Director, at (202) 512-5131. You may also
reach them by e-mail at calboml@gao.gov or duquettej@gao.gov. Other
individuals who made key contributions to this testimony include Marcia
Carlsen and Lisa Crye. Numerous other individuals made contributions to
the work supporting this testimony.
(190092):
FOOTNOTES
[1] U.S. General Accounting Office, Small Business Administration:
Accounting Anomalies and Limited Operational Data Make Results of Loan
Sales Uncertain, GAO-03-87 (Washington, D.C.: Jan. 3, 2003).
[2] SBA has held two additional loan sales that were not included in
our review. In August 2002, SBA held its sixth sale, which included
about 30,000 loans with an outstanding balance of $657 million. The
seventh sale took place in December 2002 and consisted of about 29,000
loans with an outstanding balance of $682 million. In all seven sales
SBA has sold about 169,000 loans with an outstanding balance of $5.8
billion.
[3] For a subsidized loan program, the subsidy allowance account
generally represents the subsidized portion - the amount of expected
losses related to estimated defaults and financing costs from making
below-market rate loans - assumed by the federal government. The
subsidy allowance account is subtracted from the loans receivable
balance on the balance sheet to arrive at the net loan amount expected
to be repaid.
[4] OMB Circular A-11 defines net sale 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.
[5] SBA also did not disclose any gain or loss on the two loan sales,
number 5 and 6, which took place during fiscal year 2002 in its
financial statements for that year.
[6] The hold value is calculated on a present value basis, meaning the
worth of a future stream of returns or costs in terms of money paid
immediately. In calculating the hold value, interest rates from the
most recent President's budget at the time the estimate is prepared
provide the basis for converting future amounts into their "money now,"
or present value, equivalents.
[7] OMB reviews these calculations as part of its approval process for
SBA to conduct a loan sale.
[8] 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.
[9] 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.
[10] Based on SBA's reestimates for its fiscal year 2001 financial
statements, the subsidy cost of this program ranged from $17 to $33 for
every $100 the federal government lends, depending on the interest
rates in effect when the loans were made.
[11] Statements on Auditing Standards, AU §508 paragraphs 22 and 23.
[12] Pre-1992 loan guarantees are loan guarantees committed prior to
October 1, 1991. The accounting standard requires that the liabilities
of pre-1992 loan guarantees be recognized when it is more likely than
not that the loan guarantees will require a future cash outlaw to pay
default claims.
[13] The 7(a) secondary market program, one of SBA's business loan
programs, is administered by an agent of SBA. Payments for this program
flow through the Master Reserve Fund.
[14] The secondary market program was created to increase the
attractiveness of small business lending to the lending community.
Through this market, lenders are able to sell the guaranteed portion of
SBA guaranteed loans to investors, thereby improving the lenders'
liquidity and increasing the yield on the nonguaranteed portion of the
SBA loan.
[15] Standards for Internal Control in the Federal Government, (GAO/
AIMD-00-21.3.1) Washington, D.C.: November 1999)
[16] A reportable condition is a significant deficiency in the design
or operation of internal controls that could adversely affect the
organization's ability to provide reasonable assurance on the
reliability of its financial reporting, performance reporting, and
compliance with laws and regulations.
[17] The Antideficiency Act, among other things, prohibits the making
of expenditures or the incurring of obligations prior to or in excess
of appropriations.
[18] The six general control categories are: (1) entity-wide security
program control, (2) access control, (3) application software
development and program change control, (4) system software control,
(5) segregation-of-duty control, and (6) service continuity control.
