Small Business Administration:

Accounting Anomalies and Limited Operational Data Make Results of Loan Sales Uncertain

GAO-03-87: Published: Jan 3, 2003. Publicly Released: Jan 6, 2003.

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The 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.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: The Inspector General should, 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.

    Agency Affected: Small Business Administration

    Status: Closed - Implemented

    Comments: After assessing the errors GAO identified in SBA's financial statements related to SBA's credit program balances, SBA's financial statement auditor notified SBA in December 2002, that the fiscal years 2000 and 2001 financial statements and audit reports should no longer be relied upon. Furthermore, in January 2003, partly due to the issues GAO identified, SBA's auditor issued a disclaimer of opinion on SBA's fiscal years 2001 and 2002 financial statements.

    Recommendation: To address the errors and weaknesses in SBA's accounting and budget reporting, the Administrator should 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, before conducting additional loan asset sales.

    Agency Affected: Small Business Administration

    Status: Closed - Implemented

    Comments: SBA conducted a comprehensive review of its financial records and systems to identify the deficiencies related to the accounting for its disaster loans. SBA found, among other things, that the cash flow model used to estimate the cost of the disaster loan program was unreliable and underestimated the cost, which in turn contributed to the unexplained decline in the allowance account balance. To correct this deficiency, SBA developed a new cash flow model to estimate the cost of the disaster program. This new model improved the reliability of the disaster program cost estimates and corrected the abnormal balance in the allowance for the disaster loan program.

    Recommendation: To address the errors and weaknesses in SBA's accounting and budget reporting, the Administrator should 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 before conducting additional loan asset sales.

    Agency Affected: Small Business Administration

    Status: Closed - Implemented

    Comments: SBA conducted a comparison of the characteristics of the loans sold and the remaining loans. SBA used the results of this comparison during the development of a new cash flow model to estimate the costs of the disaster loan program to ensure that the cash flow model took into consideration loan characteristics that differed between the sold and kept loans. As a result, the new model's estimation methodology considers the effect of loans sold when calculating re-estimates for the program.

    Recommendation: To address the errors and weaknesses in SBA's accounting and budget reporting, the Administrator should correct the errors in SBA's loss calculations for loan sales one through five, and adjust the fiscal years 2000 and 2001 financial statements before conducting additional loan asset sales.

    Agency Affected: Small Business Administration

    Status: Closed - Implemented

    Comments: SBA established new methods to determine the gain or loss on its loan sales. This analysis showed that SBA lost nearly $1 billion on the loans it sold. SBA reported this revised information in its fiscal year 2003 financial statements.

    Recommendation: 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, the Administrator should develop procedures for documenting and processing inquiries and complaints from borrowers, and provide guidance to the field offices about implementing them.

    Agency Affected: Small Business Administration

    Status: Closed - Implemented

    Comments: SBA reported that it has (1) established an electronic mail account for use by all employees to record and forward borrower comments to SBA's Washington, D.C. office, (2) established a database to maintain and track these borrower comments, and (3) implemented enhancements to a tracking system used for residential borrower inquiries that is maintained in SBA's El Paso, Texas servicing center. SBA also reported that it drafted a procedural notice on a new process for handling borrower inquiries and complaints, but the notice was not issued because SBA canceled the loan asset sales program after conducting the analysis to respond to our other recommendations and found that the sales were not beneficial to SBA or the federal government.

    Recommendation: Finally, to provide Congress and SBA with a better understanding of the impact of loan sales on SBA's operations, the Administrator should conduct a more comprehensive evaluation of the loan sales' impact on the agency and the cost savings from the sales.

    Agency Affected: Small Business Administration

    Status: Closed - Implemented

    Comments: SBA established new methods to determine the gain or loss on its loan sales. This analysis showed that SBA lost nearly $1 billion on the loans it sold. Therefore, SBA determined that the loan asset sales had a negative impact on its operations and the agency decided to end its loan asset sales program.

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