Performance Audit Report 


The SBA Did Not Effectively Manage Defaulted Disaster Loans 


to Maximize Recovery from 2006 to 2011 


Final Report 


For Official Use Only 


September 27, 2013 Report Number 13-18 

U.S. Small Business Administration 


Office of Inspector General 


Washington, D.C. 20416 


FINAL REPORT TRANSMITTAL 

REPORT No. 13-18 

DATE: September 27, 2013 

To: John A. Miller 

Director, Office of Financial Program Operations 

SUBJECT: 	 The SBA Did Not Effectively Manage Defaulted Disaster loans to Maximize Recovery 

from 2006 to 2011 

This report presents the results of our audit of the National Disaster Loan Resolution Center's 

operations. Our audit objectives were to determine whether the Small Business Administration 

National Disaster Loan Resolution Center: (1) effectively managed delinquent disaster loans to 

maximize recovery and minimize losses, (2) complied with applicable laws and regulations, and (3) had a 

mission aligned with Federal debt collection objectives. 

We conducted this audit in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence 

to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings and conclusions based on our 

audit objectives. 

We request that you provide your management decision for each recommendation on the attached 

SBA Form 1824, Recommendation Action Sheet, by October 3D, 2013. Your decision should identify the 

specific actions taken or planned for each recommendation and the target dates for completion. 

We appreciate the courtesy and cooperation of the Office of Financial Program Operations during this 

audit. If you have any questions concerning this report, please call me at (202) 205-6586 or 

Terry Settle, Director, Credit Programs Group, at (703) 487-9940 . 

... 


lsi 

Robert A. Westbrooks 

Deputy Inspector General 
What DIG Audited 

The objectives of this audit were to determine 

whether the National Disaster Loan Resolution Center 

(NOLRe): (1) effectively managed delinquent disaster 

loans to maximize rewvery and minimize losses, (2) 

complied with applicable laws and regulations, and (3) 

had a mission aligned with Federal debt collection 

objectives. 

To accomplish these objectives, we evaluated the 

NDLRC operations overall, including its monitoring and 

tracking of delinquent debts recovered and the debt 

collection training it provided for staff. 

Add itionally, we reviewed a statistically valid, random 

sample of 65 loans of the 9,035 loans the NOLRC 

charged off between June 2006 and June 2011. We 

tested the loans to determine whether the NOLRC 

used all required collection tools, including: (1) 

transferring all borrowers and guarantors for the 

defaulted debts to Treasury for cross serviCing 

(collection) and offset; (2) analyzing the loans for 

potential debt restructuring (workouts) in accord ance 

with the Standard Operating Procedures; (3) 

liquidating the collateral; (4) renewing the Uniform 

Commercial Code (UCe) financing statements to 

preserve the SBA's security interest in non-real estate 

collateral, and (5) approving offers-in-compromise for 

unpaid loan balances, in accordance with the SOP. 

We also obtained a list of all loans the NOLRC charged 

off from June 2006 to June 2011 that were 

inappropriately designated to prevent transfer to 

Trea su ry cross servicing because the loans had real 

estate collateral. 

What DIG Found 

We determined that the NOLRC did not effectively 

manage delinquent disaster loans to maximize 

recovery and minimize losses. During the five-year 

period from June 2006 through June 2011, we 

estimate that the NDLRC charged off at least 

$752.6 millionl in defaulted disaster loans without 

1 We based this estimate upon the lower bound of the statistical 

error rate pl"ojedions. Therefore, this figure pro~ides the most 

cons r~a ti ve estimate for err:lf rate occurrence and monetary 

using all appropriate collection tools to maximize 

recove ry. 

Specifically, the NDLRC did not: (1) transfer all nonexempt delinquent debts to Treasury cross servicing 

and offset; (2) analyze most delinquent debts for 

workout and restructuring potential; (3) liquidate loan 

collateral; (4) renew UCC financing statements to 

retain SBA's lien priority in non-real estate collatera l; 

or, (5) refer offer-in-compromise settlement s for 

debts above $500,000 to the Headquarters Claims 

Review Committee. 

DIG Recommendations 

The DIG recommended seven corrective actions. We 

addressed these actions to the Director, Office of 

Financial Program Operations. 

Management Response and Actions Taken 

The SBA agreed with four of the seven 

recommendations in this report and stated that it has 

ta ken steps to address many of the recommendations. 

Specifically, SBA management stated that it: (1) is 

working with Treasury to develop a new process for 

the transfer of collateralized debt to Treasury; (2) will 

evaluate existing management controls to ensure 

legally enforceable debts are transferred to Treasury 

appropriately; (3) offered training related to 

performing workouts; (4) will provide additional 

training for applicable staff; (5) developed and 

implemented a charge-off checklist; (6) will develop a 

plan to ensure security agreement expiration dates 

are identified and tracked, and security agreements 

are renewed prior to their lapse dates; and P) will 

update its Standard Operating Procedures for Disaster 

Loan Servicing and Liquidation by September 3D, 2013. 

Additionally, the NDlRC created a foreclosure team to 

manage the foreclosure and liquidation of real estate 

assets associated with defaulted loans. In February 

2012, the NDLRC began to initiate foreclosures. 

impact. Refer to Appendix II, Sampling Methodology, of this report 

for further details. 
Table of Contents 

Introduction ................................................................................................................................4 


RESULTS ......................................................................................................................................8 


FINDING: Ineffective Management Resulted in the SBA not Maximizing Recovery for $752.6 


Million in Defaulted Disaster Loans . ........................................................................................ 8 


$373.1 Million Designated to Block Transfer to Treasury Due to Management Collateral 


Policy ................................................................................................................................ 10 


Recommendation 1 ........................................................................................................... 13 


$149 Million Not Transferred to Treasury Cross Servicing-Unrelated to Collateral Policy ... 13 


$264.4 Million Not Transferred to Treasury for Offset ........................................................... 14 


Recommendation 2 ........................................................................................................... 14 


$363.8 Million Charged Off without Proper Workout Analysis ............................................... 15 


Recommendation 4 ........................................................................................................... 17 


$83 Million in Collateral Not Liquidated by NDLRC Prior to Charge-Off .................................. 18 


Recommendation 5 ........................................................................................................... 20 


Lien Priority in Non-Real Estate Collateral Lost for Loans with Balances Totaling At Least $40.3 


Million .................................................................................................................................. 20 


Recommendation 6 ........................................................................................................... 21 


$10.5 Million Loan Improperly Settled................................................................................... 21 


Recommendation 7 ........................................................................................................... 22 


NDLRC Operations Were Not Designed to Achieve Effective Debt Recovery .............................. 22 


Recommendation 8 ........................................................................................................... 25 


Management Actions Taken and in Progress ......................................................................... 25 


Conclusion ............................................................................................................................ 26 


Appendix I: Scope and Methodology ........................................................................................ 34 


Appendix II: Sampling Methodology......................................................................................... 38 


Appendix III: List of Exceptions ................................................................................................. 40 


Appendix IV: Management Comments ..................................................................................... 42 


Exhibit I: Treasury Memorandum Approving Workout Exemption ............................................ 52 


Exhibit II: Treasury Memorandum Explaining Support for Workout Exemption ......................... 55 


Exhibit III: Treasury Letter Confirming Debts with Collateral Not Exempt from Treasury Cross 


Servicing ................................................................................................................................... 60 

Introduction 

This is the third in a series of reports presenting the overall results of our audit of the 

effectiveness of the Small Business Administration's National Disaster Loan Resolution 

Center (NDlRC) operations. Our first report addressed the NDLRC's non-compliance 

with the Debt Collection Improvement Act for loans in liquidation inventory with 

principal balances totaling $171.1 million. Our second report addressed the need for 

the Office of Financial Program Operations to renew the Uniform Commercial Code 

Financing statements for disaster loans with principal balances totaling $5.6 million. 

For additional information about these reports, please see Appendix 1. 

Objectives, Scope and Methodology 

Our audit objectives were to determine whether the NDLRC: (1) effectively managed 

delinquent disaster loans to maximize recovery and minimize losses; (2) complied with 

applicable laws and regulations; and (3) had a mission aligned with Federal debt 

collection objectives. 

To accomplish these objectives, we evaluated the NDLRC operations overall, including 

its monitoring and tracking of delinquent debts recovered and the debt collection 

training it provided for staff. During the audit, we conducted two site visits at the 

NDLRC and interviewed key personnel. We also conducted telephone interviews of 

some NDLRC staff and of SBA management responsible for oversight of the NDLRC. 

Additionally, we reviewed a statistically valid, random sample of 65 loans of the 9,035 

loans the NDLRC charged off between June 2006 and June 2011. We tested the loans to 

determine whether the NDLRC used all required collection tools, including:(1) 

transferring all borrowers and guarantors for the defaulted debts to Treasury for cross 

servicing (collection) and offset; (2) analyzing the loans for potential debt restructuring 

(workouts) in accordance with the Standard Operating Procedures; (3) liquidating the 

collateral; (4) renewing the Uniform Commercial Code (UCC) financing statements to 

preserve the SBA's security interest in non-real estate collateral; and (5) approving 

offers-in-compromise for unpaid loan balances, in accordance with the SOP. We also 

obtained a list of all loans the NDLRC charged off from June 2006 to June 2011 that were 

inappropriately designated to prevent transfer to Treasury cross servicing because the 

loans had real estate collateral. 

We conducted our review between April 2011 and February 2013. We conducted this 

performance audit in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our findings and 

conclusions based on our audit objectives. We believe that the evidence obtained 

provides a reasonable basis for our findings and conclusions based on our audit 

objectives. 

4 
Background 

The Small Business Administration 

The mission of the Small Business Administration (SBA or the Agency) under the Small 

Business Act, as amended, is to maintain and strengthen the Nation's economy by 

enabling the establishment and vitality of small businesses and assisting in the economic 

recovery of communities after disasters. 

Disaster Assistance 

The Disaster Loan program plays a vital role in the aftermath of disasters by providing 

long-term, low-interest loans to affected homeowners, renters, businesses of all sizes, 

and non-profit organizations. Following a disaster, the SBA offers disaster victims 

(1) home loans to repair or replace damaged real estate or personal property, 

(2) business loans to repair or replace damaged property, and (3) economic injury 

disaster loans to provide business working capital during disaster recovery. 

According to the Code of Federal Regulations2 or CFR, the SBA requires borrowers to 

pledge avai lable collateral to the SBA to secure the loan if the loan amount exceeds 

$14,000 for disaster home loans or physical business loans, and $5,000 for economic 

injury loans. The collateral for a disaster home loan may include the damaged property, 

a replacement property, and other property owned by the borrower. The collateral for 

a business loan may include business assets such as machinery and equipment, furniture 

and fixtures, inventory, and accounts receivables in addition to real estate collateral. 

During loan origination, SBA's Processing and Disbursement Center is responsible for 

securing the loan with the best avai lable collateral. 

Disaster l.oan Servicing and Liquidatian 

The SBA disaster loan servicing centers located in Birmingham, Alabama, and EI Paso, 

Texas perform routine loan servicing actions. They also are responsible for issuing late 

payment notices, initiating automated telephone ca lls to borrowers, and working with 

delinquent borrowers to provide repayment arrangements and deferrals 

(postponement in payments). 

When a delinquent borrower does not resume loan payments, disaster loan servicing 

center staff may charge off3 the loan if it is unsecured or the loan balance is $25,000 or 

less. The disaster loan servicing centers transfer all secured loans with balances over 

$25,000 to the SBA's National Disaster Loan Resolution Center (NDLRC) located in Santa 

Ana, California. 

Formerly known as the Santa Ana Disaster Home Loan Servicing Center and Di saster 

Liquidation Office, the NDLRC discontinued home loan servicing in April 2006. 

The internal memorandum establishing the NDLRC stated that it was dedicated to: 

1 13 CFR 123.11. 


l Charge off is the process by which SBA r&ognizes a loss and removes the uncoll&tible account from its acti ve r&eivable accounts. 


5 
(I) working out payment arrangements on seriously delinquent loans, (2) liquidating 

loan collateral, and, (3) overseeing litigation of disaster and business loans. 

The NDLRC issues demand letters to primary borrowers, garnishes some borrowers' 

wages in order to collect delinquent debts, and refers some debtors to the Department 

of Justice (DOJ) for litigation. It is responsible for liquidating any loan collateral with 

value if there is no reasonable prospect of the borrower repaying the loan. Following 

liquidation of loan collateral with value, the NDLRC is responsible for charging off the 

loan. According to the loan Liquidation and Acquired Property Standard Operating 

Procedure,4 charge off is justified when the SBA has completed all required liquidation 

and collection actions, and further collection of any substantial portion of the debt is 

doubtful. 

The Debt Collection Improvement Act of 1996 

One of the primary purposes of the Debt Collection Improvement Act of 1996 (DCIA) is 

"to maximize collections of delinquent debts owed to the Government by ensuring quick 

action to enforce recovery of debts and the use of all appropriate collection tools." 

An additional purpose of the DCIA is to consolidate debt collection activities within the 

government to minimize the government's delinquent debt collection costs. The DCIA 

centrali zed delinquent debt collection at the United States Department of the Treasury 

(Treasury), requiring Treasury to pursue delinquent debts that are not actively being 

collected by Federal creditor agencies, a program known as cross servicing. 

Treasury Cross Servicing 

When Federal agencies refer delinquent debts to Treasury for cross servicing, they 

relinquish all responsibility for servicing or collecting the debts. In order to accomplish 

the transfer of delinquent debts to Treasury for cross servicing, the SBA first charges off 

these debts. Treasury then uses a variety of collection tools to collect a debt once an 

agency refers it to the cross-servicing program. The tools Treasury uses include: 

• 	 Treasury demand letters; 

• 	 telephone calls between debtors and Treasury personnel to negotiate 

repayment arrangements; 

• 	 credit bureau reporting; 

• 	 referral to at least one private collection agency; 

• 	 administrative wage garnishment; 

• 	 referral to the Department of Justice for litigation; and, 

• 	 reporting of unpaid debts to the Internal Revenue Service as potential income to 

the debtor. 

Treasury Offset 

The DCIA also established a centrali zed process at Treasury known as the "Treasury 

Offset Program," or TOP. The TOP offsets government payments due to borrowers, 

• sOP so 512, effedive Oecember 1,1997, page 18·2. 

6 
such as income tax refunds and social security payments, and redirects them to Federal 

creditor agencies to which the borrower owes a delinquent debt. When agencies 

submit delinquent debts to Treasury for cross servicing, Treasury also submits the debts 

to TOP. Transferring all delinquent debts to Treasury for cross servicing and offset 

when they become over 180 days delinquent ensures that the SBA complies with the 

DCIA and facilitates the collection of funds owed to the taxpayers. 

Debts Exempt from Mandatory Transfer to Treasury 

The DelA states that agencies must refer all debts delinquent more than 180 days to 

Treasury Financial Management System for cross servicing and offset. However, there 

are some exceptions to this requirement. Specifically, the DCIA states that the 

requirement to transfer debts to Treasury excludes those that: 

(1) are in litigation or foreclosure, or 

(2) will be disposed of under an asset sales program within one year, or 

(3) have been referred to a private collection contractor, or 

(4) have been referred to a debt collection center, or 

(5) will be collected by internal offset within 3 years, or 

(6) are a class of debts specifically determined by the Secretary of Treasury at 

the request of the Agency head. 

Treasury has also exempted debts in wage garnishment, which meet certain criteria, 

from mandatory transfer. Additionally, in January 2000, Treasury granted the SBA a 

specific exemption from transferring debts in active workout status. According to a 

January 3,2000, memorandum from the Fiscal Assistant Secretary of Treasury to the 

SBA (Exhibit II), active workout status means that the SBA is attempting to bring the 

debt current with debt servicing tools (such as rescheduling or deferment of payments), 

rather than liquidating or foreclosing on the collateral for the debt. 

If a debt is exempt from transfer to Treasury cross servicing, the SBA identifies it with a 

unique code, called the loan-status comment code, prior to charging off the loan. 

Thi s code is used to block the loan from automated transfer by the SBA Portfolio 

Management Treasury System when the charge off occurs. 

Review of Internal Controls 

Internal control includes the plan, policies, methods, and procedures adopted by 

management to meet its missions, goals, and objectives. It includes the systems for 

measuring, reporting, and monitoring program performance. Internal control serves as 

a defense in safeguarding assets and in preventing and detecting errors, fraud, 

noncompliance with provisions of laws, regulations, contracts or grant agreements, or 

abuse.s 

Effective December 1, 1997, Standard Operating Procedure (SOP) 50 512, Loan 

Liquidation & Acquired Property, was the primary internal control governing the SBA 

sGAO.12.331G Go~ernment Auditing StandardS. 

7 
loan liquidation activities. We tested the NDlRC's compliance with various internal 

controls provided by SOP 50 51 2. We determined that the NDlRC did not consistently 

comply with these controls. Specifically, we identified control breakdowns related to 

repayment arrangements (workouts), the liquidation of collateral, and offers-incompromise. 

We identified numerous other internal control weaknesses at the NDlRC. 

Implementing the recommendations in this report will address the identified internal 

control weaknesses and improve the Agency's recovery of delinquent debt associated 

with disaster loans. 

Nature of limited or Omitted Information 

We did not omit information due to confidentiality or sensitivity, nor were there 

limitations to information obtained during the audit. 

RESULTS 

FINDING: Ineffective Management Resulted in the SBA not Maximizing 

Recovery for $752.6 Million in Defaulted Disaster Loans 

We determined that the NDlRC did not effectively manage delinquent disaster loans to 

maximize recovery and minimize losses. The NDlRC did not use all of the appropriate 

collection tools required by the Debt Collection Improvement Act (DCIA) or its own 

Standard Operating Procedures prior to charging off delinquent and defaulted disaster 

loans. Specifically, the NDlRC did not: 

(1) transfer all of the debts to Treasury for cross servicing and collection, or 

offset; 

(2) analyze all of the loans for the potential of offering a workout in accordance 

with its standard operating procedures; 

(3) liquidate loan collateral; 

(4) renew the financing statements necessary to retain the SBA's lien position in 

the collateral for some loans; or 

(5) refer compromise offers for debts in excess of $500,000 to the Headquarters 

Claims Review Committee (HCRe) for approval as required by the NDLRC's 

standard operating procedures. 

We estimate that between June 2006, when the NDlRC became operational in its 

present form, and June 20ll, it did not maximize recovery for at least 7,198 loans with 

balances totaling approximately $752.6 million. 6 The exact amount the SBA could have 

recovered if it had taken all of the above listed actions is not readily quantifiable. 

However, the SBA can sti ll recover a portion of the balances of the charged off loans by 

• We based this estimate upon the lower bound of the statistical error rate projections. Therefore, this figure provides the most 

conservative estimate for error rate occurrence and monetary impact. Refer to Appendix II, Sampling Methodology, of this report 

for further de:ails. 

8 
referring these debts to Treasury for cross servicing and offset. Based upon estimated 

collection rates provided by Treasury, the SBA could recover approximately 

$22.3 million' if it transfers all of the charged off loans to Treasury cross servicing. 

Additionally, the SBA could also recover $6 million if it now transfers all of the debts for 

offset. We further estimate that the SBA could recover another $11.3 million over the 

next two years by ensuring that all charged off disaster debts are transferred to 

Treasury for cross servicing and offset.s 

One purpose of the DCIA is to ensure that Federal agencies "maximize collections of 

delinquent debts owed to the Government by ensuring quick action to enforce recovery 

of debts and the use of all appropriate collection tools." Further, the Office of 

Management and Budget Circular A-129, Policies for Federal Credit Programs and NonTax Receivables, requires each agency to use the full range of available and appropriate 

delinquent debt collection techniques. However, we determined that the NDLRC did 

not use the full range of appropriate debt collection techniques. 

We reviewed a statistically valid, random sample of 65 of the 9,035 loans the NDLRC 

charged off between June 2006 and June 2011. Based upon our review of the loan file 

documentation and related electronic Loan Accounting System information, we 

concluded that the NDLRC did not maximize recovery for 61 of the 65 loans from our 

audit sample. The NDLRC could not recover the outstanding balances for the remaining 

four loans from our audit sample because these debts were discharged in bankruptcy. 

We determined that the NDLRC did not use all collection tools required by the DCIA or 

its own SOPs prior to charging off the 61 loans. Therefore, the NDLRC did not maximize 

recovery for those loans in our sample. 

The table below identifies the underlying reasons the NDLRC did not succeed in 

maximizing recovery. First, the table provides the dollar value of the loans the NDLRC 

designated to block their transfer to Treasury Cross Servicing due to management's 

collateral policy. The table also identifies the collection actions the NDLRC did not 

perform for some delinquent disaster loans and the dollars associated with those loans. 

Additionally, the table indicates actions the NDLRC should have taken to protect the 

SBA's lien position in collateral and to ensure that it maximized dollars recovered 

through settlement offers.9 

7 Based upon Treasury's estimated tolledion rates. the SBA tould potentially r~over approximately $15.9 million ($373.1 million x 

4.27 pertent) through cross servicing from the charged off loans not referred due to collateral and an additional $6.4 million ($ 149 

million x 4.27 percent) through cr oss servicing from t he charged off loans that did not have associated collateral. 


8 We estimate that the 5BA will rEM:over an additional $6.4 million ($373.1/60 months x 24 months x 4.27 pertent) over the next two 


years by discontinuing its practice of blocking the transfer of loans with real estate collateral to Treasury crOiS servicing. 


Additionally ......e estimate the SBA will recover $2.5 million ($149 million /60 x 24 x 4.27 percent) over the next two years by ensuring 


all debts without collateral are transferred to Treasury cross servicing. We further estimate that the SBA wi ll r~over $2.4 million 


($264.4/60 x 24 x 2.26 percent) over the next two years if it transfers all defaulted disaster debts to Treasury for offset. 


' We identified multiple errors associated with each of the loans in the statistical sample we reviewed. Therefore, we did not 


aggregate the dollar values repcxted into a single total. 


9 
Tablc I Munetary Impa(t Assod:lIcd Ilith NDLRC Debt RcwI'cry Errors 

Causes for Not Mallimizing Delinquent Debt Recovery 

Designated to Blod Transfer to Treasury Cross Servidng Due to Management 

Collateral Policv 

Not Transferred to Treasury Cross Servicing - Unrelated to Collateral Poli(V 

Not Transferred to Treasury Offset 

Loan Not Analyzed for Workout/Restructuring Potential Per SOP 

Requirements 

Loan Collateral Not Liquidated 

UCC Finandng Statements Not Renewed to Retain Lien Position in Collateral 

Dffer·in·Compromise Settlements Above $500,000 Not Referred to HeRe 

Charged Off Dollars 

Associated with 

Specific Causes 

(in Millions) 

$373.1 

$149.0 

$264.4 

$363.8 

$ 83.0 

$40.3 

$10.5 

We concluded that the NDLRC did not maximize recovery for delinquent and defaulted 

disaster loans prior to charging them off because SBA management did not: 

(1) fully adhere to the Debt Collection Improvement Act or existing controls, 

including Standard Operating Procedures; 

(2) include requirements of the DelA in the SOP; 

(3) provide oversight of loan collateral, or have an effective Management 


Information System to monitor and track the collateral; 


(4) align the NDLRC mission with Federal debt collection objective~; or, 

(5) ensure that management and staff performance goals emphasized effective 

debt recovery. 

$373.1 Million Designated to Block Transfer to Treasury Due to Management 

Collateral Policy 

A primary purpose of the DCIA is to "maximize collections of delinquent debts owed to 

the Government by ensuring quick action to enforce recovery of debts and the use of all 

appropriate collection tools." Further, the DCIA requires agencies to transfer all legally 

enforceable, non-exempt debts delinquent over 180 days to Treasury for cross servicing 

and offset. However, the SBA implemented a management policy to prevent the 

transfer of defaulted disaster loans with real estate collateral to Trea~ury for cross 

servicing and collection action. At the time of charge off, the NOLRC abandoned the 

loan collateral, but flagged all disaster loans with real estate collateral and coded them 

with the loan-status comment code to prevent the SBA's Portfolio Management 

Treasury system from transferring the debts to Treasury for cross servicing. This policy 

did not fully comply with the DCIA requirements. 

We obtained a list of 9,035 loans with principal balances totaling $762.7 million the 

NDLRC charged off between June 2006 and June 2011 from the SBA Office of the Chief 

Information Officer. From these loans, we extracted those the NDLRC designated as 

having real estate collateral to prevent their transfer to Treasury cross servicing 

10 
following charge off. The NDLRC used a loan-status comment code that indicated the 

presence of real estate collateral, intended to block the transfer of these debts. 

We determined that during the five-year period, the NDLRC designated 3,887 loanswith principal balances totaling $373. 1 million-to block their transfer to Treasury cross 

servicing. Management believed the loans were exempt from transfer because the SBA 

had real estate liens securing the loans. 

The SBA Based its Collateral Policy on Interpretation of a Treasury Memorandum 

Management developed its policy of not transferring defaulted debts with collateral to 

Treasury because of its interpretation of letters it received from Treasury in 

January 2000. One letter granted the SBA a specific exemption from transferring debts 

in active workout status (see Exhibit I). Because of the way the Treasury letter to the 

SBA was phrased, management interpreted it to imply that all loans with collateral were 

exempt from transfer to Treasury for cross servicing. 

A second letter from Treasury noted that: 

In a letter dated November 23, Department ofJustice strongly asserted that 

collateralized debt should not be referred for cross servicing prior to foreclosure 

because cross-servicing collection actions risk compromising the Government's 

ability to collect against the collateral. 

However, the NDLRC had already charged off the 3,887 loans it designated with the 

loan-status comment code to block transter to Treasury. According to the loan 

liquidation SOP,tO charge off is justified when the SBA has completed all required 

liquidation and collection actions and further collection of any substantial portion of the 

debt is doubtful. Therefore, the NDlRC was unlikely to foreclose or liquidate any loan 

collateral for the 3,887 charged off disaster loans it did not transfer to Treasury. 

According to the SOP, the NDLRC should have completed all required liquidation and 

collections actions prior to charge off and the charge off action would only be justified if 

further collection of any substantial portion of the debt was doubtful. By charging off 

the loans, the NDlRC indicated that it had completed all required liquidation and 

collection efforts and it deemed the loans uncollectible. 

Additionally, Federal statutesll require that agencies initiate collection actions on 

delinquent debts within six years. If more than six years from either the date of 

delinquency or date of demand for payment elapse, generally, the Government no 

longer has the legal right to litigate to collect these debts.12 Therefore, the SBA must 

ensure that it promptly transfers all delinquent debts to Treasury for collection. 

Since the SBA does not use private collection agencies as a collection tool, it is critical 

that it transfer delinquent debts to Treasury cross servicing for collection. 

The Treasury letter exempting the SBA from referring delinquent debtsto cross 

servicing if they are in active workout (Exhibit I) stated that: 

10 sOP so SI 2, effective December 1, 1997. 


"28 USC Section 241S (a). 


li The statute of limitations does not apply to foreclosure actions. 


11 
Once SBA determines that a workout is not feasible and, in the case of 

collateralized laans, completes its liquidation/foreclosure, any remaining 

delinquent debts remain subject to the DC/A's mandatory transfer provisions. 

Thus, according to the letter, after the SBA liquidates collateral with value, should the 

loan balance not be paid-in-full, the SBA must transfer the unsatisfied portion of the 

debt to Treasury. The Treasury letter concluded that: 

Additionally, all other debts over 180 days delinquent are subject to mandatory 

transfer to Treasury under the DCIA, unless 0 specific statutory or regulatory 

exemption applies. 

The January 2000 letter that Treasury provided the SBA to clarify its decision to exempt 

loans in active workout status from transfer to Treasury (see Exhibit II) stated that: 

In attempting to restructure or otherwise workout its delinquent business loans, 

SBA is attempting to keep the small business in operation.. premature 

determinations to liquidate or foreclose would interfere with the program goal 

ofkeeping the small business operational. 

We believe the guidance Treasury provided to the SBA supported the Agency's strategy 

to offer borrowers an opportunity to work out a satisfactory repayment arrangement 

rather than foreclosing and liquidating loan collateral within the initial 180 days of 

delinquency. According to Treasury, in the case of business loans, not liquidating 

collateral prematurely would help keep small businesses operational. However, the 

3,887 defaulted loans that were designated to block their transfer to Treasury because 

the loans had real estate collateral were loans charged off by the SBA. Therefore, the 

SBA was unlikely to provide these borrowers with future workout opportunities or 

liquidate the loan collateral. 

The DIG contacted Treasury to determine if its letter had granted the SBA an exemption 

from referring collateralized delinquent debts to Treasury for cross servicing. Treasury 

indicated that the only special exemption it had granted to the SBA was from 

transferring debts in workout status. 

Subsequently, the DIG facilitated a meeting between Treasury officials and SBA 

management on February 7, 2013. The purpose of this meeting was for Treasury to 

clarify that the Agency is required to send all debts delinquent over 180 days to Treasury 

for cross servicing, whether or not the debts have associated collateral. Treasury 

officials confirmed that although Treasury did grant the SBA a specific exemption from 

the requirement to transfer delinquent debts in workout status, it did not grant the SBA 

an exemption from transferring collateralized debts. 

At the request of the DIG, Treasury provided written confirmation that the only 

exemption from transferring delinquent debts it granted to the SBA applied to debts in 

workout status. In this letter, Treasury stated that it understood how the SBA may have 

interpreted its previous written guidance to imply that debts with collateral did not have 

12 
to be transferred for cross servicing. The letter also stated that it is working with SBA 

management to facilitate transfer of collateralized debt. (See Exhibit III). 

Treasury management indicated a willingness to work cooperatively with the SBA to 

address any concerns the Agency may have regarding the transfer of loans with 

collateral. At the February 7, 2013, meeting, Treasury management stated they would 

transfer any specific collateralized loan back to the SBA upon request in order for the 

SBA to liquidate the collateral. In its March 1, 2013, letter to the DIG, Treasury stated it 

would not release any SBA liens without receiving SBA's prior consent. These measures 

indicate Treasury's intent to facilitate SBA's compliance with the DCIA. 

Recommendation 1 

We recommend that the Director, Office of Financial Program Operations, mandate that 

the NDlRC comply with the DelA and, develop, and implement management controls 

and processes related to debts, to ensure 

a. That all eligible charged off loans now designated with loan status comment code 

"66" are transferred to Treasury for cross servicing promptly. 

b. That the NDlRC does not designate loans charged off in the future to block their 

transfer to Treasury for cross servicing because the loans have un-liquidated real 

estate collateral. 

$149 Million Not Transferred to Treasury Cross Servicing-Unrelated to Collateral 

Policy 

We performed a review of a statistical sample of 65 loans the NDlRC charged off 

between June 2006 and June 2011 to determine if the SBA transferred them to Treasury 

for cross servicing and offset as required. The SBA did not transfer 20 of the 65 loans 

due to the automated system failure to transfer some loans or the lack of a monitoring 

process for loans in litigation after charging off the loans. We estimate the SBA did not 

transfer approximately $149 million in defaulted debt to Treasury for cross servicing and 

collection due to these deficiencies. 

The NDlRC's practice was to rely upon the Portfolio Management Treasury System to 

transfer, successfully, all debts designated for transfer to Treasury. This mainframe 

computer system uses batch processing to select loans for transfer to Treasury. 

The NDlRC had no reconciliation process in place to verify that Treasury received all 

debts intended for cross servicing and collection. Although the NDlRC intended for the 

SBA to transfer 11 of those 20 loans to Treasury, the transfer process was unsuccessful 

and Treasury did not receive the debts. The NDlRC did not utilize Treasury's system to 

verify that it received the debts, nor were the debts manually entered into Treasury's 

system. Further, NDlRC management did not know that Treasury had a system that the 

NDlRC staff could access to verify that the debts were successfully transferred. Had 

the NDlRC management known about the Treasury system, they could have trained the 

staff to use it to verify that Treasury received all debts intended for transfer to Treasury. 

Therefore, when NDlRC staff recognized that Treasury had not received the debts, with 

13 
appropriate training, they could have manually entered the debts into the Treasury 

system for cross servicing and collection. 

The SBA did not transfer 4 of the 20 loans from our review sample to Treasury for cross 

servicing and collection, as required, because the NDLRC also lacked controls to monitor 

loans in litigation after loan charge off. Specifically: 

• 	 Two loans designated as "in litigation" involved bankruptcy of one or more, but 

not all, of the borrowers or guarantors. Currently, when the SBA codes a loan to 

indicate that there is an associated bankruptcy, the accounting system prevents 

the transfer of all associated borrowers and guarantors to Treasury for 

collection. This problem was previously identified in an audit of the SBA's 

financial statements, performed by an external accounting firm. According to 

the accounting firm's November 2011 Management Letter, which provided 

updates on the progress of the issues identified in its 2010 Financial Statement 

Audit, the SBA is taking steps to correct this issue. 

• 	 After the judge dismissed the bankruptcy for one loan in our sample, the SBA 

never transferred the debt to Treasury for collection. 

• 	 The NDLRC intended to refer the final loan to legal counsel for litigation; 

therefore, the loan was designated as "in litigation" to prevent transfer to 

Treasury for collection. However, the NDlRC never referred the loan for 

litigation or transferred it to Treasury for collection. 

We could not determine the reason the NDLRC did not transfer the fi ve remaining loans 

of the 20 loans not transferred to Treasury cross servicing. 

$264.4 Million Not Transferred to Treasury for Offset 

In addition to reviewing the sample of 65 charged off loans to determine whether the 

SBA transferred them to Treasury for cross servicing, we also verified whether the SBA 

referred the debtors for these loans to Treasury offset. 13 We determined that the SBA 

was required to transfer debtors for 53 of the 65 loans to Treasury for offset. However, 

the SBA did not refer one or more debtors for 29 of these 53 loans, approximately 55 

percent, to Treasury for offset. We estimate that the SBA did not refer all debtors for 

2,257 loans, totaling at least $264.4 million, for offset as required. Therefore, Treasury 

was unable to offset any Federal benefits that these defaulted borrowers may have 

been receiving. 

Recommendation 2 

We recommend that the Director, Office of Financial Program Operations, mandate that 

the NDlRC comply with the DCIA by developing and implementing management controls 

and processes related to debts, to ensure 

a. 	 The Transfer of all legally enforceable debts already charged off. to Treasury for 

cross servicing. 

U The Treasury offset program offsets government payments due to borrowers, such as income taK refunds and social s&urity 

payments, and redireds them to Federal creditor agencies to which the borrower owes a delinquent debt. 

14 
b. 	 That all debtors associated with charged off legally enforceable debts, required to 

be transferred to Treasury for cross servicing and offset, are successfully 

transferred. 

c. 	 Monitoring of loans in litigation after charge off, to confirm transfer to Treasury for 

collection if litigation is dismissed. 

Recommendation 3 

This recommendation was consolidated with recommendation two after receiving SBA 

Management's comments to the draft report. 

$363.8 Million Charged Off without Proper Workout Analvsis 

We estimate that between June 2006 and June 2011 the NDLRC charged off 3,028 loans 

with balances estimated to be at least $363.8 million, without providing a proper 

workout analysis. The loan liquidation and Acquired Property SOP14 required staff 

to: (1) work with the borrower to structure a workout whenever feasible; (2) determine 

whether restructuring the repayment plan would help the borrower pay the debt, and 

(3) determine if the borrower's cash flow could support the workout plan. However, 

based upon our review of a statistical sample of 65 charged off loans, the NDLRC did not 

always comply with these requirements. Further, from the 65 loans reviewed, we 

determined that 18 of the borrowers contacted the SBA because they were unable to 

make their loan payments. The NDlRC, however, did not offer to restructure the loans 

for 16 of the 18 borrowers. Further, only 2 of the 18 borrowers were offered the 

opportunity to restructure their loans. We also concluded that the NDlRC did not 

determine if the borrower's cash flow could support a workout plan for any of the 18 

borrowers who contacted the SBA for help. 

Workouts 

Of the 18 primary borrowers who contacted the NDLRC to request a workout, none 

received a restructured repayment plan as permitted by the SOP. We determined that 

of the 18 borrowers: 

• 	 14 borrowers were provided an informal workout-the opportunity to make 

three payments and have their loan returned to regular servicing; 

• 	 two borrowers were offered a workout as required by the SOP-the 

opportunity to permanently restructure their loan terms; however, the 

borrowers never completed the necessary paperwork; and, 

• 	 two borrowers contacted the NDlRC and specifically requested a workout; 

however, there is no evidence that the NDlRC responded to the borrower's 

requests. The NDlRC appears to have charged off the loans off without calling 

the borrowers or otherwise responding to their requests for a workout. 

The SBA's standard process was to issue multiple collection notices that instructed 

delinquent borrowers to contact the SBA ifthey were unable to make their disaster loan 

payments. However, these notices did not specifically offer repayment arrangements, 

or offer to restructure the delinquent borrowers' SBA disaster loans. We determined 

"SOP 50 S12, Effedive December 1, 1997, page S-l. 

15 
that in practice, borrowers had to contact the SBA and specifi ca lly request help in order 

to receive a "workout." 

We further determined the NDlRC generally considered a workout as initiated 

whenever the borrower verbally agreed to resume payments. The NDl RC provided 

guidance to staff in a written document entitled "Liquidation Collection Program" as a 

tool for ensuring that staff took all required actions prior to loan charge off. 

The Liquidation Collection Program did not conform to the SOP. Instead, it instructed 

the l oan Specialist to contact the borrower and get a commitment to a "workout of 

three consecutive payments." 

Generally, once the borrower successfully made three loan payments, the NDlRC 

practice was to return the loan to regular servicing. When initiating these informal 

"workouts," the NDlRC staff did not analyze the borrower's cash flow or repayment 

ability, or evaluate whether restructuring the repayment terms would help the 

borrower(s) pay the debt, as required by the SOP. The NDlRC staff did not address the 

underlying cause of payment delinquency or analyze the loans to determine whether 

they could reschedule the debt and reduce the borrower's monthly payment s. 

The NDLRC ultimately charged off the 14 loans from our audit sample whose borrowers 

made three payments and had their loans returned to regular servicing. These 

borrowers did not continue to make regular monthly payments; therefore, these 

informal "workout" attempts were not effective in ensuring the borrowers continued to 

pay their SBA disaster loans. 

Loan Restructuring and Cash Flow Analysis 

The NDlRC did not determine whether restructuring the loans would help the 

borrowers repay the debts or if the borrowers' cash flow could support the workout 

plan for these loans. This occurred due to a lack of management controls, oversight, 

and staff training. Had the NDLRC evaluated each borrower's financial position and 

offered a customized loan workout, we believe the Agency may have been able to 

recover some debts rather than charge them off. 

Federal regulations state that if a borrower is unable to pay SBA loan installments in a 

timely manner for reasons substantiall y beyond the borrower's control, he may request 

that the SBA suspend the loan payments, extend the maturit y, or both,lS For one 

business loan in our audit sample eligible for a workout, the primary guarantor sent the 

SBA a letter requesting the opportunity to settle the debt for less than the full balance. 

However, we found no evidence the NDlRC responded to the letter. In addition, the 

NDlRC did not request the financial statements in order to assess repayment abi lity 

prior to charge off. The term for this charged off loan was 12 years and 7 months. 

Since the company was still operational, the NDlRC could have extended the loan term 

to 30 years and may have recovered the principal balance of $470,301. Instead, the 

NDlRC charged off this loan. 

15 13 CFR 123.16. 

16 
During the audit, we learned that neither NDLRC management nor staff received formal 

training in credit management, debt collection, managing Federal receivables, Agency 

policies and procedures, or making repayment arrangements. In addition, management 

and staff were unfamiliar with the Treasury Managing Federal Receivables Guide (the 

Guide), which addressed many of these topics. Further, the NDLRC did not have 

controls to ensure that staff performed all required steps-including offering all 

borrowers and guarantors a workout in accordance with the SOP-prior to loan charge 

off. For example, the NDLRC did not have a workout checklist or a procedure in place 

requiring a supervisor to verify that the staff performed all of the actions required in the 

SOP prior to loan charge off. 

The NDLRC did not identify or track the number of workout arrangements made with 

borrowers, or the dollars recovered from them. Without measuring the number of 

workouts offered and performed over time, or the associated dollars recovered due to 

workouts, the Agency did not have a viable method for assessing whether workouts 

resulted in significant recovery of delinquent debt. 

Agency Workout Groups 

The Treasury Managing Federal Receivables Guide states that agency workout groups 

are established for the sole purpose of resolving troubled debts. The Guide further 

states the agency may consider establishing a workout group if the volume and 

amount of its debts are large enough to warrant a special "problem account" 

department. Although the NDLRC charged off principal balances totaling approximately 

$762.7 mi llion dollars in defaulted debt from June 2006 through June 2011, the NDLRC 

did not have a group specifically assigned to perform workouts. Instead, all Loan 

Specialists assigned to work delinquent and defaulted loans at the NDLRC were 

responsible for initiating workouts for homeowners and businesses, regardless of their 

knowledge or experience. 

According to the Guide, workout groups should have the authority to decide on the 

appropriate actions necessary to maximize debt recovery, including rescheduling debt. 

Strategies developed by workout groups should be case specific; however, the workout 

group should establish policies that outline options for handling various debt problems. 

Furthermore, the Guide states that workout groups consist of loan officers, legal staff, 

and accounting personnel. Team members should have working knowledge and 

abilities in credit management and debt collection, business law, accounting, agency 

policies and procedures, liquidation proceedings, collateral appraisal, and management 

policies and procedures. They also should have communication and interpersonal skills. 

Recommendation 4 

We recommend that the Director, Office of Financial Program Operations, develop and 

implement management controls and processes related to workouts, to ensure 

a. 	 An assessment is made to determine the feasibility of establishing a 

workout group for the sole purpose of resolving troubled debts and, if 

feasible, establish such a group. 

17 
b. 	 The NDlRC staff takes all required actions prior to charging off the loan, 

including offering the borrower a workout, evaluating the loan for 

potential restructuring, analyzing borrower repayment abi lity, and 

providing workout terms to the borrower in writing. Evidence that all of 

these actions were taken should be included in the loan file. 

c. 	 The Liquidation Coflection Program and all related guidance conform to 

the SOP governing NDlRC operations and the liquidation of disaster 

loans. 

d. 	 All staff receives formal training in credit management, debt 

restructuring, debt collection, the Treasury Managing Federal 

Receivables Guide, and Agency policies and procedures. 

e. 	 That a system is establ ished for tracking the performance of workouts 

to measure the dollars recovered and determine whether workouts 

result in significant recovery of delinquent debt. 

$83 Million in Collateral Not liquidated by NOLRC Prior to Charge-Off 

Based upon the sample of 65 loans reviewed, we estimate that the NDLRC charged off 

loans with associated real estate collateral having a value of at least $E5.5 mi llion. 

In addition, we estimate that the NDLRC also charged off loans with associated business 

collateral having a value of at least $17.5 million without liquidating this collateral prior 

to charging off the loans. We were unable to obtain evidence that the NDLRC 

liquidated any collateral, either real estate or business, since its inception in 2006. 

This occurred due to inadequate management controls and oversight. 

We determined that 20 of the 65 charged off loans we reviewed had associated real 

estate collateral with equity. The NDlRC, however, charged these loans off without 

liquidating the real estate collateral. Further,5 of the 20 loans with real estate collateral 

also had non-real estate collateral. An additional eight loans had only non-real estate 

collateral, yet the NDLRC did not liquidate any of these asset s. At the time of charge off, 

the estimated value of the real estate collateral for the 20 sample loans was 

approximately $2 mi llion and the unpaid balances for these loans totaled approximately 

$6.1 mi llion. Based upon the results of our sample review, we estimate that the NDlRC 

charged off at least 1,398 loans without liquidating the associated real estate collateral. 

We estimate the net collateral value of these assets was at least $65.5 mi llion at the 

time of charge off. The NDlRC could potentially have recovered at least $65.5 mill ion 

for the benefit of the taxpayers, since this value was net of anticipated foreclosure and 

resa le expenses. 

We also determined that the NDLRC automatically charged off all loans with 

manufactured home collateral without considering whether it could recover a portion of 

the loan balance by liquidating the collateral. The NDlRC charged off the loans 

regardless of whether the manufactured home was real estate or personal property. 

In March 2006, the Chief of Portfolio Management approved a request from what was 

then the Santa Ana Liquidation Center not to liquidate manufactured or mobi le homes 

that were personal property. The NDlRC staff was unable to distinguish whether the 

manufactured homes included in the sample of loans we reviewed were personal 

property or real estate. Therefore, it charged off the loans whether the collateral was 

18 

real or personal property. We determined that four of the seven manufactured homes 

from our audit sample were real property with positive value that the NDLRC could have 

potentially recovered through liquidation. 

We determined that 13 of the 65 loans in our review sample had non-real estate 

collateral, such as machinery and equipment, inventory, and accounts receivable, at the 

time of charge off. Although the NDLRC made no effort to value or liquidate this 

collateral, we were able to estimate the associated collateral value for 4 of the 13 loans. 

At the time of charge off, the non-real-estate collateral for these four loans had a value 

of approximately $873,702. The NDlRC may have recovered al" or a portion of this 

value, had it attempted to liquidate the non-real estate collateral for these loans. 

We were unable to estimate the value of the non-real estate collateral not liquidated for 

the remaining nine charged off loans due to a lack of documentation in the loan files. 

Therefore, it was not possible to determine the amount of additional funds that the 

NDlRC may have recovered if it had valued and liquidated the associated non-real 

estate collateral for these loans. However, we were able to project that the NDlRC 

charged off at least 206 loans with non-real estate collateral having a value of at least 

$17.5 million without liquidating this collateral prior to charge off. We based this 

projection upon the loans from our audit sample for which the loan files indicated a 

value for the non-real estate collateral prior to the NDlRC charging off the loan. 

This dollar amount is understated because we could not determine the value of all of 

the non-real estate collateral associated with the charged off loans we reviewed. 

The Treasury Managing Federal Receivables Guide states that the agency should take 

action to liquidate collateral when it becomes apparent that a debtor will not or cannot 

repay. Consistent with the Guide, SOP 50 51 2 states that if voluntary resolution of the 

delinquent account is not possible the staff should: (1) proceed with action against any 

collateral; (2) identify assets against which a judgment might be enforced; and, 

(3) establish a general estimate of recovery. However, the NDLRC did not provide its 

staff formal training regarding liquidation requirements or the evaluation of non-real 

estate collateral for potential recovery. Additionally, the NDlRC did not use the formula 

specified in the SOP to evaluate the equity in the collateral. 

On August 6,2008, NDlRC management requested approval from the Chief of Portfolio 

Management to waive the requirement to prepare a liquidation plan for loans with nonreal estate collateral. The Chief of Portfolio Management approved this waiver the 

same day. Subsequently, the Santa Ana NDLRC discontinued the practice of evaluating 

or liquidating business assets pledged as loan collateral. However, there is no evidence 

that the NDlRC performed analysis to support the decision not to liquidate business 

collateral, such as obtaining the average liquidation value of the business assets or 

comparing the liquidation values to liquidation costs. Because the NDLRC did not 

support its decision not to liquidate any business collateral, we question the validity of 

the decision. 

19 

Recommendation 5 

We recommend that the Director, Office of Financial Program Operations, develop and 

implement management controls and processes related to liquidation, to ensure the 

NDlRC: 

a. Evaluates all loan collateral (both real estate and other assets) for 

liquidation potential within 180 days of the loan becoming delinquent. 

b. Initiates liquidation action for all loan collateral (both real estate and other 

assets) within 180 days of the loan becoming delinquent if liquidation will 

result in recovery of a portion of the debt (and the costs of liquidation do 

not significantly exceed the anticipated recovery amount). 

c. liquidates all collateral with a recoverable val ue prior to loan charge off. 

d. Creates and maintains historical records of the collateral liquidated and 

dollars recovered resulting from the liquidation of all collateral (both real 

estate and other assets). 

e. Discontinues the practice of charging off al l defaulted loans secured by 

manufactured housing without first evaluating the collateral for potential 

recovery. 

f. Monitors and tracks all loan collateral (both real estate and non-real estate) 

associated with each loan assigned to the NDlRC 

g. Tracks the total real estate and non-real estate collateral available for 

liquidation from the loans assigned to the NDLRC 

h. Process of monitoring real estate and non-real estate collateral avai lable for 

liquidation includes the capability to compare the dollars recovered through 

liquidation to the total collateral value. 

i. Provides clear explanations for any variances between anticipated and 

actual dollars recovered through liquidation. 

j. Staff responsible for liquidating collateral receives collateral evaluation 

training. 

Lien Priority in Non-Real Estate Collateral Lost for Loans with Balances 

Totaling At Least $40.3 Million 

From the statistical sample of 65 loans reviewed, we determined that the Uniform 

Commerci al Code (UCC) Financing Statement16 lapsed for 8 of 16 loans with non-real 

estate collateral. Four of these lapsed while the loans were assigned to the NDlRC. 

As a result, we estimate the SBA lost its lien priority in its security interest in non-real 

estate collateral for at least 43 loans with balances totaling at least $40.3 mi llion during 

the five-year period from June 2006 through June 2011. This occurred because the 

NDlRC did not have a process for tracking UCC financing statement expiration dates or 

renewing the statements. We determined that the four remaining financing statements 

had lapsed while they were in regular servicing, prior to transfer to the NDlRC 

' "Filing a document call ed a UCC·l Financing Statement s&ures a lender's lien against a borrower for sp&ifi: coll ateral used as 

payment to tre lender. The filing of a UCC·l to s&ure coll ateral is termed "perfecting" a li en. 

>0 
The SBA requires disaster loan borrowers to provide collateral for loans above certain 

thresholds. 17 This collateral may be real estate, personal property, or both. The SBA 

establishes its rights to collateral-other than real estate-with a security agreement, 

which creates a lien and identifies what the SBA may do in the event the borrower fails 

to repay the disaster loan. Under the security agreement the SBA may, for example, 

seize and sell collateral after a default. The SBA does not need a court order to take 

collateral subject to a security agreement after a borrower's default. 

Most UCC financing statements expire five years from the date of filing. Therefore, five 

years from the file-stamped date, a lien might no longer be enforceable under the UCC. 

To extend the creditor's lien position beyond the expiration date, a creditor must file a 

UCC-3 Amendment within six months of the original UCC financing statement's 

expiration date. To preserve its lien position in non-real estate collateral, the SBA must 

renew UCC financing statements or another creditor-without notice of SBA's liencould obtain a superior lien position. Should the SBA lose its superior lien position, 

there may be no equity remaining in the asset for the SBA to recover in the event the 

loan defaults. 

Although the Office of the Chief Information Officer provides the Servicing Centers a 

partial list of UCC financing statements that are due to lapse, the list does not identify all 

loan collateral. Currently, the SBA does not have a database or other management 

information system that contains information regarding the collateral associated with 

each loan. Therefore, we were unable to estimate the value of the collateral for which 

the security interest was lost by the Servicing Centers. 

Recommendation 6 

We recommend that the Director, Office of Financial Program Operations ensure that 

the Disaster Loan Servicing Centers and the NDLRC develop and implement a process to 

ensure that 

a. All security agreement expiration dates associated with assigned disaster 

loans are identified and tracked, and the agreements are renewed prior to 

their lapse or expiration dates. 

b. The Disaster Loan Servicing Centers provide the NDLRC the anticipated 

security agreement expiration dates for loans transferred from the centers 

to the NDLRC. 

$10.5 Million Loan Improperly Settled 

The NDLRC accepted a settlement18 of $100,000 to release the SBA's lien on the sole 

guarantor's residence and his unconditional loan guaranty for a business loan with a 

balance of $10.8 million. In addition to offering the SBA a settlement of $100,000, the 

guarantor also facilitated the sale of two real estate properties for which the SBA held 

" 13 CFR 123.11 requires borrowers to pledge available collateral to the SBA to secure the loan if the loan amount exceeds $14,000 


for disaster heme loans or physical business loans and $5,000 for economic injury loans. 


18 According to SOP 50-S2-1, the terms "compromise~ or "settlement~ can be used interchangeability or to~ether to mean the 


resolution of a debt for less than the amount due through mutual agreement between the debtor and the SBA. 


Z1 
senior liens. The SBA received approximately $244,000 from the sale of the two 

properties. An unpaid loan balance of $10.5 million remained following the receipt of 

these proceeds. According to the SOP, the NDLRC was not authorized to approve the 

guarantor's settlement offer. 

According to SOP 50 51 2, the Santa Ana Disaster Loan Servicing and Liquidation Office, 

which is now the NDlRC, can approve compromises of principal amount forgiven of up 

to $500,000. When claims exceed $500,000, the Headquarters Claims Review 

Committee (HCRe) approval is required. Therefore, the NDlRC exceeded its authority 

by approving the settlement. According to the SOP, the NDLRC should have referred the 

settlement offer to the HCRe. The NDlRC did not have controls in place to ensure that 

the loan was referred to the HCRC as required by the SOP. 

We believe the complexity of the settlement offer in question, and the fact that the 

unpaid disaster loan balance exceeded $10.5 million, indicated that the settlement offer 

should have been elevated to the Headquarters Claims Review Committee, as required 

by the SOP. 

Recommendation 7 

We recommend that the Director of the Office of Financial Program Operations 

a. 	 Implement controls to ensure the NDLRC only approves offer-in-compromise 

settlements as authorized by the Standard Operating Procedures. 

NDLRC Operations Were Not Designed to Achieve Effective Debt 

Recovery 

Management did not design NDLRC operations to maximize delinquent debt recovery. 

While the NDlRC performed some debt collection actions, it had no strategy to 

maximize overall recovery or recovery for individual loans. The NDlRC's mission was 

not aligned with the Federal debt collection objectives specified in the DCIA. 

Furthermore, the NDLRC did not have fundamental policies, procedures, and practices 

that would enable the SBA to maximize debt recovery. During the audit, we observed 

that management oversight of the NDLRC was limited. Specifically, SBA management 

did not: 

• 	 measure the overall performance of the NDLRC; 

• 	 maintain records or perform analysis indicating whether the NDlRC or its individual 

staff succeeded in recovering debts; 

• 	 monitor or track staff debt recovery performance results for assigned loans; 

• 	 ensure that loans intended for transfer to Treasury for cross servicing were 

transferred; 

• 	 ensure that all legally enforceable, non-exempt debts delinquent over 180 days 

were transferred to Treasury cross servicing and offset as required by the DCIA; 

• 	 monitor the volume or success of workouts the NDlRC performed, or ensure they 

were performed in accordance with written guidance provided in its standard 

operating procedures; 

Z2 
• 	 ensure the NDlRC liquidated collateral; 

• 	 provide oversight to ensure the NDlRC or disaster loan servicing centers renewed 

financing statements to maintain the SBA's security interest in non-real estate 

collateral; 

• 	 provide controls to ensure the NDlRC approved offer-in-compromises settlements 

only wi thin the parameters specified in its written procedures; or, 

• 	 detect breaches of the internal controls. 

According to OMB Circular A-l23, programs must operate and resources must be used 

consistent with agency missions, in compliance with laws and regulations, and with 

minimal potential for waste, fraud, and mismanagement. Effective organization, 

policies, and procedures, commonly referred to as internal control, are tools to help 

program and financial managers achieve results and safeguard the integrity of their 

programs. 19 We believe that the weak control environment that pervaded all of 

NDlRC's operations adversely affected the agency's ability to maximize delinquent debt 

recovery. 

NDlRC's Mission Not Aligned with Federal Debt Collection Objectives 

The SBA did not design the NDlRC to achieve the Federal debt collection objectives 

specified by the DCIA. These objectives are to maximize recovery of delinquent debts, 

ensure quick action to enforce debt recovery, and use all appropriate collection tools. 

We were unable to identify any written guidance instructing the NDlRC to comply with 

these DCIA objectives. The April 2006 memorandum that established the NDlRC did not 

fully address the DCIA debt collection objectives. While it addressed two of the 

collection tools agencies may use to recover delinquent debts, it did not address nine 

other available collection tools.

20 Similarly, the SOP governing NDlRC operations did not 

specifically address the DCIA objectives. 

As previously described, the SBA did not use all appropriate collection tools to maximize 

recovery, such as transferring all delinquent debts to Treasury for cross servicing and 

offset, liquidating all collateral with value, or rescheduling debts in accordance with the 

SOP. 

Staff Uncertain of NDlRC's Mission 

Interviews of the NDlRC staff indicated that some employees were uncertain of the 

purpose or mission of the NDlRC, or their role in accomplishing it. We interviewed 

various staff members and asked them to explain the mission of the NDlRC. 

We received a variety of responses, some indicating that the mission was to "resolve 

loans." Additionally, the 2010 NDLRC Employee Desk Reference Guide stated that the 

objective of the NDlRC is to bring problem loans to resolution. However, the Desk 

Reference Guide did not define the meaning of " bring problem loans to resolution." 

190MB Circular A·1B 


wThe Treasury Managing Federal Receivables Guide lists delinquent debt collection tools available to Federal agencies. 


Z3 
Likewise, the Personal Business Commitment Plans for the NDLRC Director and staff did 

not contain performance objectives related to maximizing debt recovery, enforcing 

quick action to recover debts, or ensuring the use of all collection tools. Instead, these 

plans contained requirements that emphasized customer service. 

NDLRC Management Could Not Provide Basic Performance Information 

Based upon the results of our audit work, we concluded the NDlRC did not meet the 

DCIA objective to maximize recovery. At the outset of the audit, NDLRC management 

was unable to provide data that identified or specified the dollars the NDLRC recovered 

through its collection efforts. Therefore, management did not have the necessary 

information to determine whether the NDLRC maximized recovery for the delinquent 

debts that the NDLRC serviced. However, during the course of the audit, management 

developed a methodology intended to identify the dollars recovered. 21 

As noted in our Management Advisory22 issued July 9, 2012, the SBA did not ensure 

quick action to enforce recovery for its current inventory of delinquent disaster loans. 

Specifically, approximately 39 percent of the loans in current inventory on 

December 31, 2011, totaling $171 million were in excess of 180 days delinquent, but the 

SBA had not transferred the debts to Treasury for cross servicing and collection. 

The Advisory also noted that the NDLRC had a backlog of 736 assets associated with 

loans totaling approximately $80.2 million in current inventory that it had identified for 

foreclosure. Although the NDLRC identified the loan collateral for liquidation between 

2006 and 2011, it had taken no further action. 

NDLRC Policies and Procedures Were Inadequate 

Standard Operating Procedures are a fundamental internal control used to 

communicate management directives regarding daily operations to all levels of an 

organization. Typically, management makes specific changes to the operating 

procedures in advance of implementation and incorporates them into the written 

procedures. This ensures they are easily accessible by all staff and that all functional 

groups within the entity are aware of the procedures approved for use at any given 

time. 

Prior to November 1, 2011, the primary management control governing NDLRC 

operations and liquidation activities was SOP 50 SI 2. However, the SBA did not 

incorporate the requirements of the Debt Collection Improvement Act of 1996 into the 

SOP. The SOP did not provide guidance for ensuring quick action to enforce debt 

recovery or require the use of all appropriate collections tools. In particular, the SOP did 

not provide controls for ensuring that the Agency transferred all non-exempt debts over 

180 days delinquent to Treasury for cross servicing and offset, as required by the DCIA. 

U OFPO provided the OIG with re<overy data for the NDlRC following the audit. However, we did not verify the accuracy of the 

information. 

" DIG Report 12·14, The Small Business Administration Did Nat Maximize Recovery for S171 Million in Delinquent Disaster Loons in 

Liquidation 

24 
Originally, SOP 50 51 2 applied to all SBA loans, including disaster loans. However, 

on November 15, 2010, the SBA issued a revised SOP 50 51 3 providing updated 

guidelines for liquidation of SBA loans, with the exception of disaster loans. 

On November 19, 2010, the SBA Administrator issued Policy Memorandum 5000-1186 

that directed the Agency to adhere to the policy and procedures contained in 

SOP 50 51 2 for disaster loan liquidation until a new SOP was issued. This policy 

memorandum expired November 1, 2011, and to date, the SBA has not issued a revised 

SOP governing disaster loan liquidation or NDLRC operations. 

Furthermore, during our audit, the NDLRC modified several procedures without 

incorporating them into the SOP. The NDLRC management informally communicated 

the revised procedures to staff via email. For example, the NDLRC modified the 

procedure it used to determine the recoverable value of real estate assets. The new 

formula differed from the approved formula specified in the SOP. However, the NDLRC 

implemented the new formula without incorporating it into the SOP and without formal 

approval. We believe this practice undermines the relevance of the SOP and 

compromises the internal control environment. 

Recommendation 8 

We recommend that the Director, Office of Financial Program Operations 

a. Re-evaluate the structure and design of the NDLRC to ensure that its 

operations are designed to maximize recovery of delinquent debts. 

b. Develop and publish a clear mission statement tor the NDLRC that clearly 

aligns with Federal debt collection objectives. 

c. Update the SOP, governing delinquent disaster loan collection and asset 

liquidation to incorporate the Federal debt collection objectives and 

requirements specified by the DCIA. 

d. Establish a performance management process that emphasizes effective 

debt recovery. 

e. Ensure that routine procedural changes, such as modifying the formula for 

evaluating collateral, are incorporated into the SOP. 

Management Actions Taken and in Progress 

As a result of the audit, the Office of Financial Program Operations developed an ad hoc 

management report quantifying the dollars the Agency recovered for delinquent 

disaster loans assigned to the NDLRC. 

In October 2011, the NDlRC created a foreclosure team to manage the foreclosure and 

liquidation of real estate assets associated with defaulted loans. As of January 2012, the 

NDLRC had nearly 700 loans in foreclosure inventory it had identified for foreclosure 

between 2006 and 2011. In February 2012, the NDlRC began to initiate foreclosures 

and implemented a process to monitor and track them. As of November 2012, the 

NDLRC staff informed us that they had initiated foreclosure for approximately 75 real 

estate collateral assets and had successfully foreclosed on seven of them. Some loans 

were removed from the foreclosure list due to payment in full of the loan balance, 

>5 

determination that the collateral no longer had recoverable value, or a borrower 

workout. 

According to the Center Director, the NDlRC foreclosure efforts resulted in a number of 

borrowers making an initial "good faith" payment and committing to resume making 

regular payments to avoid foreclosure. The NDlRC director stated tha t the assigned 

l oan Specialist would monitor the loans for six months to ensure that the borrowers 

continue to make regular payments. However, thi s foreclosure process pertains only to 

loans in current inventory, not previously charged off loans wi th collateral. 

Further, SBA management also stated that it is working with Treasury to develop a new 

process for the transfer of collaterali zed debt to Treasury, has developed a charge-off 

checklist, and has already offered some training to staff. 

Conclusion 

The NDLRC did not effectively manage delinquent disaster loans to maximize debt 

recovery and minimize losses. During the five-year period from June 2006 through June 

2011, the NDlRC charged off approximately $752.6 mill ion without using all appropriate 

collection tools. Specifi ca lly, the NDlRC did not refer all borrowers and guarantors to 

Treasury for cross servicing and offset, did not liquidate real estate or business 

collateral, and did not analyze all delinquent disaster loans for the potential to 

restructure them in accordance with the SOP. 

The NDLRC's lack of focus on maximizing delinquent debt recovery indicates that SBA's 

approach to oversight and management of the NDLRC needs to be strengthened. 

The NDLRC did not have a stated mission, effective policies and procedures, trained 

staff, or basic performance data to indicate what amount, if any, of the delinquent and 

defaulted disaster debt it had recovered. Significant improvements are needed in order 

to ensure the NDLRC maximizes debt recovery and minimizes losses. 

Agency Comments and Office of Inspector General Response 

On May 7, 2013, we provided a draft copy of thi s report to SBA management for 

comment. On June 17, 2013, SBA management provided a formal response, which is 

included in its entirety in Appendix IV. A summary of management's comments and our 

response follows. 

The SBA agreed with four of the seven recommendations in this report and stated that it 

has taken steps to address many of the recommendations. Specifi cally, SBA 

management stated that it: (1) is working with Treasury to develop a new process for 

the transfer of collaterali zed debt to Treasury; (2) will evaluate existing management 

control s to ensure legally enforceable debts are transferred to Treasury appropriately; 

(3) offered training rel ated to performing workouts; (4) will provide additional training 

for applicable staff; (5) developed and implemented a charge-off checklist; (6) wi ll 

develop a plan to ensure securit y agreement expirati on dates are identified and tracked, 

and security agreements are renewed prior to their lapse dates; and (7) wi ll update its 

>6 

Standard Operating Procedures for Disaster Loan Servicing and Liquidation by 

September 30, 2013. 

The Agency partially agreed with two recommendations. Whi le the Agency agreed to 

transfer loans now designated with loan status comment code "66" that blocked the 

transfer of these debts to Treasury for collection, it disagreed to transfer these debts 

immediately. The Agency intends to re-evaluate these charged off loans with collateral. 

It intends to determine whether the collateral has increased in value and could be 

liquidated or if the borrower can resume payments, enter into a workout, or settle the 

debt before transferring the debts to Treasury for collection. Similarly, the Agency also 

agreed to develop and implement a process for liquidation, but stated that it would first 

conduct a cost-benefit analysis to evaluate whether specific recommended controls 

were cost effective. 

The SBA's management did not concur with recommendation number seven. Thi s 

recommendation advised the Director of OFPO to ensure the NDLRC only approves 

settlements as authorized by the Standard Operating Procedures. The SBA stated that 

the Small Business Act grants the SBA Administrator the authority to settle SBA claims 

without limitation. Therefore, Department of Justice approval is not needed for the SBA 

to accept an offer in compromise on loans with balances exceeding $1 million (unless 

the loan is already in litigation). 

Management's comments indicated that recommendation number three was a 

duplication of recommendation number two. Recommendation number three included 

in our draft report pertained to the need for the SBA to ensure that it refers all legally 

enforceable debts to Treasury for offset, while recommendation number two applied to 

the transfer of debts to Treasury for cross servicing. To address management's 

concerns, we have consolidated recommendations two and three in the final report. 

General Agency comments and the OIG responses are summarized in Table 2 below. 

T~b c 2 AgclII:Y Cummcnts antl OIG Resptlnse 

Agency Comments DIG Response 

The title of the audit report is misleading because it 

leads the reader to believe that the SBA had a 

reasonable chance to recover $752.6 million from 

defaulted disaster loans. This amount is actually the 

remaining unpaid loan balance on non-performing 

disaster loans. The statement assumes that a 100 

percent recovery on distressed loans, secured 

mainly by junior liens, is a legitimate possibility. QIG 

cannot support this assumption and does nol offer a 

reasonable alternative, rather it leaps to the 

conclusion, without statistical evidence that transfer 

to Treasury for cross·servicing would result in 

complete recovery of the defaulted loan balances. 

We have revised the title of the final report to 

address the agency's concerns that the title was 

misleading. 

27 
Agency CommentsThe OIG continues to assert that 

the Agency is not in compliance with the DCIA 

referral requirements for defaulted loans with 

collateral. The SBA's policy was consistent with the 

Agency-specific exemptions letter the SBA received 

from Treasury. The OIG's (lssertion of noncompliance is unfounded. 

Moreover, all eligible delinquent loans, including 

collateralized debt, were referred to the TOP. 

OIG ResponseWe made minor revisions to our 

report to place more emphasis on our finding that 

the NOLRC did not effectively manage delinquent 

disaster loans to maximize rec:)very and minimize 

losses and slightly less emphasis on the agency's 

I(lek of eompli(lnee with the DeIA. Speeifie(llly, the 

assertion regarding the SBA's noncompliance with 

the DCIA was removed from the Executive Summary 

of the report. Further, in the body of the report, 

rather than stating that SBA's policy udid not comply 

with the DCIAu

, we revised the wording to state 

Uthe policy did not fully comply with the DCIA 

requirements." While Treasury, in its letter dated 

March 1, 2013, stated it understood how the SBA 

could have interpreted its January 2000 letter to 

imply that debts with collateral were exempt from 

the transfer requirement, the letter further stated 

that Treasury and the SBA agreed that the SBA 

would begin transferring collateralized debts to 

Treasury for collection. According to the letter, 

Treasury does want the SBA to transfer all eligible, 

delinquent debts, including debts with collateral, in 

effect bringing the SBA into full compliance with the 

DCIA. 

At the time of our audit work, Treasury's records of 

TOP referrals, obtained from Treasury OMS staff, 

did not include a record of all eligible delinquent 

d~utur~ fur 29 uf S3Iu,lJ1~ frum uur ~Iatbtically valid 

audit sample, indicating that the SBA did not refer 

all eligible debtors to TOP. We verified that TOP 

had received only eligible debts. As stated on page 

15 of the report, we did not verify the transfer for 

12 of the loans because the borrowers were not 

eligible for transfer to TOP. We did not include 

deceased borrowers and borrowers in litigation 

status, including bankruptcy, because these 

borrowers are ineligible for tr;nsfer to TOP. 

OIG disclosed that no additional analysis took place OFPO misunderstood the DIG's statement. We had 

to determine whether or not these debtors had already determined whether or not the transfer 

standard exemptions from mandatory transfer to should have occurred; i.e. whether or not there was 

Treasury. SBA and all federal agencies are a standard exemption. However, as stated in the 

statutorily barred from referring borrowers in report, we determined that thE' SBA was required to 

exempted classes. The most common exempted transfer debtors for 53 of the 65 loans in our audit 

clgses include borrowers that have filed sample to TOP. The SBA did not refer one or more 

bankruptcy, are facing foreclosure or other litigation debtors for 29 of the 53 loans. 

proceedings, and borrowers that have settled their 

debts. This is another example where, without due 

diligence, a blanket statement is misleading. 

The SBA plans to evaluate charged off loans to We estimate there are over 5,000 charged-off loans 

determine if the equity position has improved to the with real estate collateral that the NDLRC staff 

point where the property can be foreclosed upon would be required to re-evaluate under the SBA's 

before transfer to Treasury cross-servlclng. This proposed plan. Some of these loans have multiple 

plan was discussed at a meeting with the SBA, the pieces of associated collateral. Currently, the N DlRC 

OIG, and Treasury in February 2013. The OIG's has a staff of five people assigned to evaluate real 

recommendation to immediately transfer all estate collateral for equity and potential 

charged off debts not previously transferred to foreclosure. In addition, there is a large number of 

'8 

Treasury is inconsistent with the SBA's plan. loans still assigned to the NDlRC, not charged off. 

that the NDLRC has flagged for potential 

foreclosure. Therefore, we question the feasibility 

of a staff of five reviewing the loan collateral on 

5,000 charged off loans in a reasonable amount of 

time (lnd will request (I 5pe(ific pl(lll of (I(tion by 

SBA to ensure effective resolu,ion during our audit 

follow up process. 

On page 7. the OIG lists the many tools that Page 7 of the report provides background 

Treasury utili zes in the cross-servicing program. DIG information regarding the tools Treasury uses 

neglected to mention that the SBA also utilizes during cross servicing. In response to 

multiple collection tools. including demand letters, management's comments, however, we have also 

SBA-initiated telephone calls with borrowers and the identified in the background section the various 

negotiation of repayment arrangements, credit collection tools used by the SBA. 

bureau reporting, administrative wage garnishment, 

referral to the Department of Justice for litigation, 

and reporting of unpaid debts to the Internal 

Revenue Service. 

On page 11, the OIG indicated that the NDLRC 

abandons collatera l at the time of charge-off. This is 

an incorrect statement. Only cu rrent efforts to 

recover on real estate collateral are abandoned due 

to insufficient equity. but the lien on the collateral is 

not released. It is SBA's full intention to review 

these loans after time to identify potential equity or 

lien positions improvements. 

We identified 18 loans from the statistical sample of 

6S charged-off loans for which the NDLRC 

concluded that the collateral had no value. In all 18 

cases, the 327 form that justified the charge-off 

action stated "abandon collateral and charge-off 

loan" as the "cause" for the action. Ten of the 18 

loans were coded "66" to prevent the transfer of 

the debts to Treasury cross servicing and collection. 

On page 12, the OIG makes an erroneous Page 12 of the report does not refer to foreclosure. 

as>umption that with respect to enforced debt The statute of limitations we referred to was in 

collection, either through foreclosure or suits regard to initiating collection H tions, including 

against obligors or guarantors, the Agency must sue bringing suit for a deficiency Judgment whenever 

within 6 years of default. There is currently much the creditor agency is unable to recover the full loan 

case precedent, including most of the United States balance via foreclosure and liquidation of the 

Courts of Appeal that holds there is no statute of collateral. However, based ujXln management's 

limitations for foreclosure actions brought by the comment, we have added a footnote to page 12 of 

Federal government. the report to clarify that there is no statute of 

limitations on foreclosure actions. 

'9 

Agency CommentsOn page 26, the OIG identifies a OIG ResponseStandard Operacing Procedures are a 

Policy Notice that indicated UUntii the issuance of fundamental internal control intended to 

this SOP (SOP 50 52 2), the disaster loan liquidation communicate management's directives and provide 

policy and procedures contained in SOP 50 512 will guidance to staff. The SOP governing the NDlRC 

remain in full force and effect.u While that policy was last updated in December 1997. While the OIG 

notke has expired, the Office of Cilpitill Access hils hils been updilted on the stiltus of the SOP, we 

reported annually on the status of SOP 50 52 2 continue to maintain our position that a new SOP is 

issuance, which is currently expected for completion imperative to this process. 

in September 2013. 

On page 18, the OIG describes their sample of 18 

loans, of which 14 were transferred to servicing 

after making 3 on time payments, but were 

subsequently charged off. However, as of April 30, 

2013, OFPO conducted a review of the entire 

population of loans returned to servicing by the 

NDLRC between Ju ly 1, 2011 and June 30, 2012. The 

review found that 1,737 of 2,201 loans, or 79%, 

remained in servicing or were paid in fu ll, as 

indicated in the following chart. Of these loans, only 

6% were charged off. 

The scope of the audit included loans the NDlRC 

charged off between June 2006 and June 2011. Our 

audit findings were consistent with an analysis 

performed by the NDlRC in February 2011. The 

NDlRC conducted an audit of 100 loans. According 

to the NDlRC Director, the result s indicated that 50 

percent of the loans currently assigned to the 

NDlRC were previously assigned and then returned 

to regular servicing. These loans were at the NDLRC 

for the second time. We recognize that the NDLRC 

may have made changes to their processes 

subsequent to completion of our audit fieldwork. 

Recommendation 1 

Management Comments 

OFPO partiall y concurs with this recommendation. Treasury and OFPO are currently 

developing a new process for the transfer of collateralized debt. The new process will 

allow Treasury to aggressively collect these debts without compromising future equity 

positions on real estate collateral. However, OF PO stated that the immediate transfer 

of charged off loans coded 1/66" is neither prudent nor reasonable as the economy has 

improved and loans need to be reviewed to determine ifthe equity situation has 

improved and either the borrower can resume payments, enter a workout or 

compromise, or the property ca n be foreclosed upon before transfer to Treasury cross 

servicing. As indicated in the narrative above, thi s was discussed as the plan at the 

February 2013 meeting. OFPO will develop a plan to transfer the charged off debt 

coded 1/66" in a prudent manner and continue to update the OIG on the progress of thi s 

process development. 

DIG Response 

Management's comments were partially responsive to the recommendation. 

We commend the SBA on working with Treasury to facilitate the transfer of charged off 

loans with collateral to Treasury cross servicing. However, the NDlRC cu rrently has a 

staff of five people assigned to evaluate real estate collateral for equity and potential 

foreclosure. In addition, there is a large number of loans sti ll assigned to the NDlRC, not 

charged off, that the NDlRC has fl agged for potential foreclosure. Therefore, we 

question the feasibi lity of a staff of five reviewing the loan collateral on 5,000 charged 

30 
off loans in a reasonable amount of time. We will request a specifi c plan of action by 

the SBA to ensure effecti ve resolution during our audit follow up process. 

Recommendation 2 

Management Comments 

OFPO concurs with thi s recommendation. After completion of the process development 

references in recommendation 1, OFPO will evaluate existing management controls to 

ensure legall y enforceable debts are transferred to Treasury appropriately and develop 

controls as necessary. 

DIG Response 

Management' s comments are responsive to the recommendation; however, 

management has not provided a target date for implementation. A target date for 

implementation is necessary and will be obtained during our audit follow up process. 

Recommendation 3 

Management Comments 

Thi s audit recommendation is a duplication of recommendation #2. 

DIG Response 

In response to management's comments, we have consolidated recommendations two 

and three from the draft report. These recommendations now appear as 

recommendation number two in this final report. 

Recommendation 4 

Management Comments 

OFPO concurs with thi s recommendati on. Staff has been offered training on multiple 

occasions, including training from the Department of Treasury on Debt Collecti on in FY 

2012. OFPO will continue to coordinate additional training for applicable staff 

members. Additionall y, a charge-off checklist has been developed since the audit and is 

in use by Santa Ana NDLRC staff to ensure all necessary actions take place prior to 

charge-off. Ofthose objectives not addressed, OFPO will develop an implementation 

plan by August 30, 2013. 

DIG Response 

Management' s comments were responsive to the recommendati on. 

31 
Recommendation 5 

Management Comments 

OFPO partially concurs with this recommendation. OFPO will conduct a review of each 

objective and conduct a cost benefit analysis, if applicable, to determine inclusion in the 

implementation plan. An implementation plan will be developed by August 3D, 2013. 

OIG Response 

Management's comments are partially responsive to the recommendation. 

According to the memorandum that created the NDlRC, it is responsible for managing 

the liquidation of all loan collateral with value. All of the steps included in the 

recommendation are essential for effectively managing and liquidating loan collateral. 

We continue to maintain our position that each recommended control should be fully 

implemented and do not believe conducting a cost benefit analysis is necessary. Thi s 

recommendation will be resolved during the audit follow-up process. 

Recommendation 6 

Management Comments 

OFPO concurs with this recommendation and will develop an implementation plan by 

August 30, 2013. 

OIG Response 

Management's comments were responsive to the recommendation. 

Recommendation 7 

Management Comments 

OFPO disagrees with this recommendation as the assertion in the draft audit report 

indicates that all offers in compromise for loans exceeding $1,000,000 must be handled 

by the Department of Justice. Under the Small Business Act 15 U.s.C, 634(b) the SBA 

Administrator is given independent compromise (Le. settlement) authority to settle SBA 

claims without limitation. Therefore, OOJ approval is not needed except when the case 

is in litigation as they have authority in those situations. 

OIG Response 

The OIG agrees that the Small Business Act gives the SBA the authority to settle SBA 

claims without limitation. However, according to SOP 50 512, effective 

32 
December 1, 1997, when a claim exceeds $500,000, the NDLRC must refer the 

settlement offer to the Headquarters Claims Review Committee (HCRe). Therefore, the 

NDlRC exceeded its authority by approving the settlement. The NDlRC did not have 

controls in place to ensure that the loan was referred to the HCRC as required by the 

SOP. 

We have revised our finding to note the requirement for the NDlRC to refer claims over 

$500,000 to the HCRC, not to DOJ. 

Recommendation 8 

Management Comments 

OFPO concurs with this recommendation. In February 2011, SBA initiated a disaster 

loan servicing process improvement effort, which explored several efforts for 

improvement. Among those improvements were those identified by the OIG. 

Additionally, SBA is updating its policies, including the Standard Operating Procedures 

for Disaster loan Servicing and liquidation, which we anticipate will be cleared and in 

use by the end of fiscal year 2013. OFPO will review these recommended objectives and 

prepare an implementation plan by August 30, 2013. 

OIG Response 

Management's comments are responsive to the recommendation and implementation 

will be monitored during the audit follow-up process. 

33 
Appendix I: Scope and Methodology 

Our audit objectives were to determine whether the Small Business Administration (SBA) 

National Disaster loan Resolution Center (NDlRC): (1) effectively managed delinquent disaster 

loans to maximize recovery and minimize losses, (2) complied with applicable laws and 

regulations, and (3) had a mission aligned with Federal debt collection objectives. 

Evaluation of Effectiveness of Management of Delinquent Disaster Loans 

To determine whether the NDLRC effectively managed delinquent disaster loans to maximize 

recovery and minimize losses, we conducted site visits at the NDLRC in May and July 2011, 

conducted multiple interviews of NDLRC management and staff, and reviewed various records. 

We also requested copies of managerial exception reports used at the NDLRC; however, the 

staff indicated that there were none. 

Additionally, we obtained a spreadsheet from the Office of the Chief Information Officer (OClO) 

containing all loans the NDlRC charged off from June 2006 through June 2011. We used the 

spreadsheet from OCIO to obtain a statistically valid random sample of 65 loans, stratified by 

principal balance. The interest associated with the universe of charged off loans was not 

identified in the spreadsheet provided by OICIO that we used to select a random sample of loans 

for review. However, during our review of the sample items, we identified the associated 

interest and it was included in the projected amounts. We then reviewed actual loan files and 

the related l oan Accounting System information to determine whether the NOLRC maximized 

recovery prior to charge off. 

We also reviewed the 65 sampled loans to determine: 

(1) 	 the loan detail, including whether the loan was a business or home loan; 

(2) 	 the principal and interest amount charged off; 

(3) 	 the history of events that occurred for the loan, for example, bankruptcy, foreclosure by 

the first lien holder, probate, non-payment of property taxes, etc.; 

(4) 	 whether the borrowers and guarantors associated with each loan were provided with a 

workout in accordance with SOP 50 51 2; 

(5) 	 whether the NDLRC approved an offer-in compromise settlement for the loan in 


accordance with SOP 50 51 2; 


(6) 	 whether there was collateral associated with the loan; 

(7) 	 if there was non-real estate collateral (business assets), whether the NOLRC and the 

servicing center had renewed the UCC fi nancing statements to preserve SBA's priority 

interest in the collateral; and, 

(8) 	 whether the NOLRC liquidated collateral with value associated with the loan. 

This report identifies our statistical projections of the total dollars for which the NDlRC did not 

maximize recovery due to variou s NDLRC errors. Based upon the errors we observed by 

reviewing a statistically valid, random sample of 65 loans the NDLRC charged off between June 

2006 and June 2011, we projected the total number of loans and the corresponding total loan 

balances, including principal and interest that the NDlRC processed with errors. These errors 

included: (1) not referring all debtors associated with the loan to Treasury for cross servicing 

and offset, (2) not analyzing all of the loans for workout potential in accordance with the SOP, 23 

(3) not liquidating loan collateral with value prior to loan charge off, (4) not renewing UCC 

11 sOP 50 S1 2, effective ecem r 1, 1997. 

34 
Appendix I: Scope and MethodologV 

financing statement s to preserve the SBA's lien priority in non-real estate collateral, and (5) not 

referring loans with balances over $500,000 to the HeRe for approval of compromise offers as 

required by SOP SO 51 2. 

From our review of the sample of 65 loans, we observed that the NDl RC staff routinely 

designated all loans with real estate collateral with a specific loan status comment code ("66") 

intended to prevent the loans from transfer to Treasury cross servicing following charge off. 

Therefore, we ana lyzed the spreadsheet with all loans the NDlRC had charged off between 

June 2006 and June 2011 to identify loans the NDlRC coded to prevent transfer to Treasury 

cross servicing because the loans had associated real estate collateral. We then totaled the 

number and associated dollar value of these loans. 

This report identifies the actual total number of loans and associated actual total principal 

balances the NDLRC coded with a specific loan status comment code ("66" ) intended to block 

the transfer of the loans t o Treasury cross servicing. 

We excluded loans with loan-status-comment code "66" from our statistica l projections related 

to Treasury cross servicing transfer errors the NDLRC made for the 65 loans in our audit sample. 

This allowed us to report the actual number of loans and associated dollar val ue that the NDLRC 

coded as having real estate collateral to block their transfer to Treasury, separately from other 

Treasury cross servicing errors the NDLRC made. 

During our review of the sample of loans, if the loan had associated real estate collateral, we 

computed the recoverable equity value using the formula specified in SOP 50 51 2. We then 

compared our collateral analysis results with the one performed by the NDLRC, if any. 

We also made a determination regarding whether the loan had associated collateral that the 

NDLRC should have liquidated. We reviewed the information contained in the Centralized Loan 

Chron System (CLCS) comments for pertinent details. 

We determined whether each loan in our audit sample had associated non-real estate collateral. 

We reviewed the loan file information to determine t he value of associated non-real estate 

collateral, if the loan file noted any value. We also determined whether the financi ng statement 

used to secure the non-real estate collateral was still in effect, or had lapsed. If the financing 

statement had lapsed, we determined whether it lapsed while the loan was assigned to the 

NDLRC or to t he disaster loan-servicing center. 

Evaluation of NDLRC Compliance with Laws and Regulations 

Using the stat isti ca lly valid random sample of 65 loans, we reviewed actual loan fil es to 

determine whether the NDLRC's recovery efforts were consistent with Federal laws, regulations 

and other guidelines, such as the Treasury Managing Federal Receivables Guide. We also 

verified whether the actions performed for each loan in the audit sample were conducted in 

accordance with internal guidance specified in SOP 50 51 2. 

In addition, we obtained access to the Treasury database system containing all loans transferred 

to Treasury t o determine whether each borrower and guarantor fo r the 65 loans in our audit 

sample were transferred to Treasury for cross servicing and collection. We contacted the 

35 
Appendix I: Scope and MethodologV 

Treasury SBA liaison to determine whether the loans in the audit sample were referred to 

Treasury for offseL 

Evaluation of NDLRC Mission Alignment with Federal Debt Collection Objectives 

To evaluate whether or not the NDLRC mission was aligned with Federal debt collection 

objectives, we interviewed managerial staff responsible for oversight of the NDLRC. We also 

interviewed managerial and other staff assigned to the NDlRC to ascertain their perspective on 

the mission of the NDLRC. We also obtained and reviewed the internal memorandum used to 

establish the NDlRC. We reviewed the tasks outlined in the memorandum to determine if they 

conformed to Federal laws and regulations. 

We requested the NDlRC performance goals and individual performance objectives for the staff 

to determine whether they contained goals for overall dollar recoveries, number or dollar value 

of loans to place in workout status or to liquidate. The NDLRC itself had no performance 

objectives; therefore, no analysis could be performed. However, we did analyze the staff 

Personal Business Commitment Plans to determine whether they contained performance 

objectives related to debt recovery. 

Additionally, we obtained and reviewed the NDLRC's formal training records for the most recent 

fiscal year to determine whether the staff received training in Federal credit management or 

debt collection, agency regulations, or Standard Operating Procedure 50 51 2, the agency's 

written procedures that pertain to loan liquidation. 

Finally, we requested the dollars recovered by the NDLRC; however, there were no reports 

available containing NDLRC recoveries. The only available report tallied dollars recovered by 

Treasury via offset together with dollars recovered by the NDLRC. Subsequently, management 

developed a report to use on an ad hoc basis that compiled the dollars attributed to the NDLRC. 

We did not verify the accuracy of the data contained in this report because it was supplied to 

OIG at the end of the audit, after the exit briefing had already taken place. 

Use of Computer-Processed Data 

The SBA Office of the Chief Information Officer (OCIO) provided us with a spreadsheet 

containing a list of all disaster loans charged off by the Santa Ana NDlRC, the Birmingham 

Disaster Loan Servicing Center, and the EI Paso Disaster Loan Servicing Center from June 2006 to 

June 2011. The data contained in this spreadsheet was extracted from the loan Accounting 

System. 

The NDlRC provided several spreadsheets containing monthly records of the NDlRC current 

inventory of assigned loans, referred to as the "Manager's Report." The information contained 

in the Manager's Report was extracted from SBA's loan accounting system. The loan accounting 

system is audited annually by an external accounting firm and no material issues related to the 

loan accounting system data were identified. Therefore, we considered the data to be reliable 

for the purposes of our review. 

36 
Appendix I: Scope and MethodologV 

We analyzed the Manager's Report containing the NDLRC current inventory as of 

December 31, 2011 to identify assigned loans in excess of 180 days delinquent that should have 

been transferred to Treasury for cross servicing in accordance with the Debt Collection 

Improvement Act. We also analyzed the report to determine how many of the loans were 

designated for foreclosure and administrative wage garnishment. Additionally, we analyzed it to 

obtain the age of the loans containing the foreclosure designation. 

Prior Coverage 

Four prior OIG Audit Di vis ion reports identified findings related to the SBA's delinquent disaster 

debt collection. 

• 	 Audit Report Number 12-05, SBA's FY 2011 Financial Statement Audit, issued 


December 15, 2011. 


• 	 Audit Report Number 11-05, Audit ofSBA's FY 2010 Financia/Statements Management 

Letter, issued December 15, 2010. 

• 	 Audit Report Number 7-26, Audit of Liquidation ofDisaster Loans, issued June I, 2007. 

• 	 Evaluation Report Number 5-3-H-004-006, SBA Loan Servicing and Debt Collection 

Activities, issued March 31, 1995. 

37 
Appendix II: Sampling Methodology 

In order to determine whether the NDlRC maximized recovery for loans assigned between 

June 2006 and June 2011, we first obtained the universe of disaster loans charged off between 

June 2006 and June ZOl1 from SBA's Office of the Chief Information Officer. We then identified 

the loans assigned to the NDI RC office code at the time of charge off. Next, we consulted a 

professional statistician in order to obtain a stati stically valid sample of loans charged off by the 

NDLRC during the five ~year period beginning June 2006 and ending June 2011. 

The statistician consultant extracted a sta tistically valid, random sample of 65 loans, stratified by 

the principal loan balance, drawn fro m the uni verse of 9,035 loans the NDLRC charged off 

between June 2006 and June 2011. After analyzing the documentation for the loans in our 

sample as described in Appendix I, Scope and Methodology, we provided the statistician 

consultant with the results of our loan sample review. The loan documentation for the sample 

of 6S loam we reviewed contained the associated interest for each of the loans. We provided 

the interest amounts to the statistician for projection purposes for the 61 loans for which we 

identified processing errors. The statistician then provided the lower and upper error limit, 

including principal and interest, at a 9S percent confidence level for attributes we selected. 

The statistician consultant also provided point estimates for the errors we identified. 

However, we did not use the point estimates to project the number or dollar value of errors the 

NDLRC made for the loans we reviewed. Because the lower limit provides the most 

conservative estimate for error rate occurrence and associated dollars, we chose to use it for 

the error projections presented in this audit report. 

The tdbte below summarizes the audit projections provided by the statistician consultant for the 

sample of 6S loans we reviewed. 

Table 3 Treasury Tramfer and Referral Error Projcl:tions for Sample Loam Rc, icnctl 

Error Projections for 6S Sample Loans Reviewed24 

Exception Type 

Point 

Estimate 

Lower 

Bound 

(95%CI) 

Upper 

Bound 

(95%CI) 

Summary • 

Exceptions for 

All Loans in 

Review Sample 

Loans with Exceptions (Number) 8,191 7,198 9,184 

Loans with Exceptions (Dol/oris) $845,093 $752,597 $937,589 

Loans Not Processed Timely (Number) 6,740 5,427 8,053 

Treasury 

Referral 

Exceptions - No 

Real Estate 

Designation in 

Loan 

Accounting 

System 

Loans Not Transferred to Treasury Cross Servicing (Number) 2,908 1,454 4,361 

Loans Not Transferred to Treasury Cross Servicing (00Ilar/6

) $263,058 $149,047 $377,069 

Loans Not Referred to Treasury Offset (Number) 3,785 2,257 5,314 

Loans Not Referred to Treasury Offset (Ool/ars27) $392,266 $264,353 $520,178 

l-I Dollars values are in m lIions. 


2j The dollar value of the estimate includes principal and interest. 


16 The dollar value of the estimate includes principal and interest. 


" The dollar value of the estimate includes principal and interest. 


38 
Appendix II: Sampling MethodologV 

a Table- -I Other Error Projc-clions for 65 S~lmrlc wans Rl' \ ' j{"\\cte 

Exception Type 

Point 

Estimate 

Lower 

Bound 

(9::;')6Cl) 

Upper 

Bound 

(95%CI) 

Workout Loans with Non-SOP Compliant Workout (Number) 4,514 3,028 5,999 

Exceptions 

loans with Non-SOP Compliant Workout iDol/o,-l9) $485,539 $363,843 $607,235 

loans with Business (Non-Real Estate) Collateral Not 

Liquidated (Number) 708 206 1,210 

Collateral 

Business (Non-Real Estate) Collateral Asset Value at Charge 

Off (Dollars) $57,134 $17,452 $ 96,815 

Exceptions Loans with Real Estate Assets Not Liquidated (Number) 2,756 1.398 4,113 

Real Estate Collateral Asset Value ilt Charge Off (Do l/ars) $140,331 $55,5:20 $215,142 

Loans with Real Est ate and Business Assets Not Liquidated 

(Doflars)lO $377,516 $251,767 $503,266 

UCC Exceptions 

loans· UCC Lapsed at NDLRC (Number) 212 43 381 

loans· UCC Lapsed at NDLRC (Dollars)lI $113,011 $40,254 $185,769 

28 DoHars values are in millions. 


19 The doHar value of the estimate indudes principal and interest. 


l<) The doHar value of the estimate includes principal and interest. 


) 1 The dollar value of the estimate includes principal and interest. 


39 
Appendix III: List of Exceptions 

-


All 

Borrowers UCC Financing 

Transferred All Borrowers UCC Financing Statements 

to Treasury Referred to Workout Real Business Statements Renewed by 

Cross Treasury Analysis Estate Collateral Renewed by Disaster 

Sample Loan # Servicing Offset Performed Liquidated Liquidated ND~ C Servicing 

1 NO N/A N/A N/A N/A N/A '" 2 NO NO N/A N/A N/A '" '" 


3 N/A N/A N/A N/A N/A N/A N/A

4 N/A N/A N/A N/A N/A N/A N/A 

5 NO NO N/A N/A N/A N/A '" 

6 NO NO NO N/A N/A N/A N/A

, NO NO NO NO N/A N/A N/A 

S NO NO N/A N/A N/A N/A '" 


9 NO NO N/A N/A N/A N/A '" 

10 N/A N/A N/A NO N/A N/A N/A 

11 NO N/A N/A N/A N/A '" '" 


II NO NO N/A N/A N/A N/A '" 


II NO NO N/A N/A N/A N/A '" 
 14 NO NO N/A N/A N/A N/A '" 

15 NO NO NO N/A N/A N/A '" 

16 FOIAEx.4 NO N/A NO N/A N/A N/A '" 


n NO NO NO N/A N/A N/A N/A 

18 NO NO N/A N/A N/A N/A '" 19 NO NO NO NO N/A N/A N/A

20 NO NO NO N/A N/A N/A N/A

II NO NO NO N/A NO N/A N/A

II NO N/A N/A N/A N/A '" '" 

2l NO NO N/A N/A N/A N/A '" 


24 NO NO NO N/A NO N/A N/A

2S NO NO NO N/A N/A N/A N/A

26 NO NO NO N/A N/A N/A N/A

l> NO NO NO N/A N/A N/A '" 

28 N/A NO N/A NO N/A N/A N/A

29 NO NO N/A N/A N/A N/A '" 

30 N/A N/A N/A N/A N/A N/A N/A

II NO NO NO NO N/A N/A N/A

32 N/A NO N/A N/A NO N/A N/A 

40 
Appendix III: List of Exceptions 

Table 5 Exceptions tOr Sample Loans Rc\'icwcd, by EXl'cplion TyJX: 

Sample Loan # 

All 

Borrow".. 

Transferred 

to Treasury 

Cross 

Servicing 

All 

Borrowers 

Referred to 

Treasury 

Offset 

Workout 

Analysis 

Performed 

Real Estate 

Liquidated 

Busineu 

Collateral 

Liquidated 

"" Financing 

Statements 

Renewed by 

NOlRe 

UCC 

Financing 

Statements 

Renewed by 

Disaster 

Servicing 

3l 

FOIAEx.4 

'" ' /A '/A '/A '0 '0 ' /A 

34 '0 '0 '0 '0 '/A '/A '0 

" '0 '0 '0 '/A '/A '/A 'iA 

" '0 '" '" '0 '0 '/A '/A 

37 '" '/A '/A '/A '/A '/A 'iA 

38 '0 '" '0 '/A '/A '/A ' /A 

39 '0 '/A '" '0 '/A '/A 'iA 

40 '0 '0 '" '/A '/A '/A '/A 

41 '0 '0 '0 '0 '/A '/A 'iA 

42 '0 '" '0 '0 '/A '/A 'iA 

" '0 '" '" '0 '0 '/A ' /A 

44 '0 '0 '0 '/A '0 '/A 'iA 

4S '0 '" '0 '/A '/A '/A ' /A 

46 '0 '" '/A '0 '/A '/A 'iA 

47 '/A '/A '/A '/A '/A '/A 'iA 

48 '" '0 '" '/A '0 '/A '/A 

49 '0 '" '0 '/A '/A '/A 'iA 

so '/A '0 '/A '/A '/A '0 ' /A 

51 '/A '" '0 '/A '0 '/A 'iA 

52 '0 '" '" '0 '/A '/A 'iA 

53 '0 '0 '/A '0 '0 '/A '/A 

54 '0 '0 '" '0 '0 '/A '0 

55 '" '0 '0 '/A '0 '/A '0 

56 '0 '0 '0 '/A '0 '0 'iA 

57 '0 '0 '0 '/A '/A '/A '/A 

58 '/A '/A '0 '/A '0 '/A 'iA 

59 '" '" '" '/A '/A '/A 'iA 

60 '0 '" '0 '0 '0 '/A '0 

61 '0 '0 '" '/A '0 '0 ' /A 

62 '/A '" '/A '/A '/A '/A '/A 

63 '0 '" '0 '/A '/A '/A 'iA 

64 '" '/A '0 '/A '/A '/A 'iA 

6S '" '/A '0 '/A '/A '/A '/A 

41 
Appendix IV: Management Comments 

42 

U .S . S MALL B USINESS ADMINISTRATION 


WASHINGTON, D.C. 20416 


MEMORANDUM 

June 17, 2013 

To: John K. Needham 

Assistant Inspector General for Auditing 

From: John A. Miller 

Director, Office of Financial Program Operations 

Subject: Response to Draft Report on Project No. 11802 

The Office of Financial Program Operations (OFPO) has reviewed the Office oflnspector 

General's (OIG) draft audit report and has several comments below. While OFPO is open to 

receiving constructive feedback recommending operational improvements, OFPO takes 

exception with the manner in which this report was written. The report is overly lengthy and 

contains factually incorrect and misleading statements, not the least of which is the report title. It 

also provides narrow directives rather than useful and actionable recommendations. In addition, 

OFPO takes exception with the adversarial manner in which the audit was conducted, and is of 

the opinion that a collaborative discourse would have provided a more useful audit 

report. OFPO welcomes the chance to change the audit relationship with the OIG to a positive 

one in which both sides are willing to discuss differences. While improvements are possible, the 

report fails to mention the valuable work that is being done at the National Disaster Loan 

Resolution Center (NDLRC); namely, upholding the disaster loan program's mission of assisting 

disaster victims while maintaining good stewardship oftaxpayer funds. 

The Small Susiness Administration's (SSA) Disaster Loan Programs are the primary form of 

federal assistance for the repair and rebuilding of non-farm, private sector disaster losses, and are 

the only form ofSSA assistance offered to homeowners and renters. SSA's focus, with respect 

to disaster loans, is to remedy the effects of natural disasters, while maximizing recoveries and 

minimizing losses to the taxpayer. Due to the nature ofthe program, SSA's collateral position is 

weaker than it typically is in SBA's guaranteed loan programs, thus loan recoveries are more 

difficult. It is for these reasons that SBA offers every delinquent borrower ample opportunity for 

repayment relief, such as loan term restructure, workout, and payment deferments, prior to 

resorting to enforced collection, including foreclosure or transfer to the U.S. Department of 

Treasury (Treasury) for collection. 

Treasury recognized the unique nature of SSA 's disaster loans when it granted an Agencyspecific exemption from the statutory requirement to transfer nontax debts to Treasury for 

43 
collection. This exemption is described in a letter dated January 3, 2000, to SBA from th 

Treasury Under Secretary of Domestic Finance. The letter is attached as Exhibit "A," and is 

supported by an mternal Treasury memorandum, also attached as Exhibit "B." These documents 

are referred to in the OIG draft audit report and in our response. 

The Treasury memorandum, Exhibit "B," provides the rationale for the exemption as follows: 

"Disaster loans are authorized by law, and obtained by debtors, to help 


victims of disaster recover from earthquakes, fires, floods, hurricanes, 


tornadoes or other significant devastation. SBA points out that " .. 


because of the slow economic recovery process resulting from widespread 


devastation in many disaster locations .. . the workout process cannot 


always be completed within 180 days ofinitial delinquency .. " 


Accordingly, premature determinations to accelerate or liquidate disaster 


loans would interfere with the program goal of assisting disaster victims to 


overcome the effects of the disaster.. 


Additionally.. . the Department ofJustice (001) strongly asserted that 


collateralized debt should not be referred for cross-servicing prior to 


foreclosure because cross-servicing coll ection actions risk compromising 


the Government's ability to coll ect against the collateral. To the extent the 


subject class of debts is coll ateralized, DOJ ha s indicated that the 


Government's financial interests would be best protected by granting an 


exemption." (Exhibit D) 


The title of this audit report, "The SBA Did Not Effectively Manage Defaulted Disaster Loans to 

Maximize Recovery on $752.6 Million in Loans from 2006 to 20 II The SBA Did Not 

Effectively Manage Defaulted Disaster Loans to Maximize Recovery on $752.6 Million in Loans 

from 2006 to 20 11" is misleading. It leads the reader to believe that the SBA had a reasonable 

chance to recover $752.6 Million from defaulted disaster loans. This amount, $752.6 million, is 

actually the remaining unpaid balance of delinquent, non-performing disaster loans at the time of 

the audit. It does not indicate the recoverable value, or estimated market value, of the loans 

based upon the collateral status and repayment strength of the obligor(s). The statement assumes 

that a 100 percent recovery rate on a distressed loan portfolio, secured mainly by junior liens 

with little or no equity, is a legitimate possibility. OIG cannot snpport this assnmption and 

does not otTer a reasonable alternative, rather, it leaps to the conclusion, wit/Wilt any 

reference to statistical el,hlence that transfer to Treasury for cross-servicing would result in 

complete recovery of the defaulted loan balances. 

In order to realistically assess the NRDLC 's effectiveness at maximizing recoveries and 

minimizing losses, OFPO conducted an analysis of recovery data on loans resolved (Charged Off 

or Paid In Full) in the NRDLC during fiscal years 2011 and 2012. The ana lysis focllsed on 932 

loans with a combined default balance of$78.3 million that were either (1) referred to the 

Treasury Offset Program (TOP) initiall y then transferred to Debt Management Service (OMS), 

or cross-servicing, after real estate coll ateral was liquidated, and (2) loans in which collateral was 

liquidated prior to charge off, and were referred to DMS immediately upon charge otT. The 

44 

analysis found that SBA' s recoveries on this group of loans totaled $20.2 million, whi ch equates 

to a recovery rate of26 percent. Of that amount $ 16 million, or80 percent, of the recoveries 

were generated by SBA. These facts show the NRLDC 's effectiveness at mi nimizing taxpayer 

losses by utilizing internal Agency collection tools in conjunction with those of Treasury's 

Financial Management Service. While process Improvements and improved etticiencies are 

possible, this strategy and its results should not be summarily dismissed. 

Additionally, the DIG asserts that the SBA' s policy of not referring loans with real estate 

coll ateral for cross servicing is out of compliance with the Debt Collection Improvement Act 

(DCIA) of 1996. The SBA' s policy was based upon interpretation ofthe January 3, 2000 

Agency-specific exemption letter from Treasury (Exhibit "A" ) that states, "Once SBA 

determines that a workout is not feasible, and in the case of coll ateralized loans, completes its 

liquidation/foreclosure, any remaining delinquent debts remain subject to DCIA's mandatory 

transfer provisions." The DIG' s assertion is incorrect and appears to be based upon the DIG' s 

own interpretation ofthe letter. This despite the fact that just recently, in a letter dated March I, 

2013 to the DIG, Treasury's Assistant Commissioner of Debt Management Services stated that 

SBA' s interpretation of the January 3, 2000 exemption letter was understandable: 

"Based on the language in the [SBA exemption] letter, we understand how 

SBA could have interpreted the letter as having exempted all collateralized 

debts from the transfer requirement. Following an inquiry from your 

office [DIG] and discussions with SBA Director John Miller, Office of 

Financial Program Operations, and his staff in Jan uary 2013 , Treasury and 

SBA agree that SBA will begin transferring collateralized debts to 

Treasury for coll ection when SBA has determined that foreclosure on the 

coll ateral is not feasible. SBA can provide additional details about this 

process." (Exhibit C) 

After a number of discussions with OIG personnel, they continue to assert the Agency is not in 

compli ance with the DCIA referral requirements for defaulted loans with collateral. As already 

noted, this position is untenable given Treasury' s position as expressed in their letter to SBA 

quoted above. The SBA's policy that was in place at the time ofthe audit was consistent with 

the Agency-specific exemption letter SBA received, and OIG's assertion of non -compli ance is 

unfounded. Moreover, all eligible delinquent loans, including coll ateralized debt, were referred 

to the TOP. 

TOP is the most effective collection tool at Treasury, as evidenced by Treasury data that shows 

60 percent ofrecoveries on loans referred for cross-servicing were generated through the offset 

program. The audit report correctly states that all non-exempt delinquent loans are transferred to 

TOP regardless of collateral status. The report further states that one or more debtors in 

approximately S5 percent ofthe loan sampled were not referred to TOP. In recent follow-up 

conversations with the OIG auditors, OIG disclose(1 t/tat no mlt/itionll/llnll/ysis took place to 

determine whether or not these (febtors had stam/art! exemptions from IIwndatory trtmsfer to 

Treasury. SBA and all federal agencies are statutoril y barred from referring borrowers in 

exempted classes. The most common exempted classes include borrowers that have filed 

bankruptcy, are facing foreclosure or other litigation proceedings, and borrowers that have 

settled their debts. This is another example where, without due diligence, a blanket statement is 

45 
misleading. SBA views TOP as an extremely effective tool to collect delinquent debt, and 

strive s to utili ze the program whenever possible. 

SBA maintains a close working relationship with Treasury's Financial Management Service with 

the goal of maintaining compliance with federal debt collection guidelines, and as such, is 

continually revising debt collection poli cies and procedures in order to efficiently coll ect 

delinquent debt and minimize taxpayer losses. After recent discussions, SBA and Treasury are 

instituting a process to refer SBA collateralized debts with minimal or no equity for crossservicing. The new process will allow Treasury to aggressively collect these debts without 

compromising future equity positions on real estate collateral. As the new process takes shape, it 

is in the best interest of the taxpayer, and the disaster victims, to develop a plan to evaluate these 

loans and determine ifthe borrower's financial condition has improved to the point where they 

are able to resume payments, enter a workout, or settle their debt. SBA wi ll also evaluate the 

loans to determine if equity position has improved to the point where the property can be 

foreclosed upon before transfer to Treasury cross-servicing. This plan was discussed at a 

meeting with SBA, the DIG, and Treasury in February 2013 but is, however, inconsistent with 

the recommendation made in this audit report. 

Finally, OFPO identified several inconsistencies and/or inaccuracies in this document. In 

particular, the following are a few statements needing immediate clarification in the draft audit 

report. 

• 	 On page 7, the OIG lists the many tools that Treasury utilizes in the cross-servicing 

program. DIG neglected to mention that the SBA also utilizes multiple coll ection tools, 

including, demand letters, SBA-initiated telephone calls with borrowers and the 

negotiation of repayment arrangements, credit bureau reporting, administrative wage 

garnishment, referral to the Department ofJustice for litigation, and reporti ng of unpaid 

debts to the Internal Revenue Service as potential income to the debtor (of which the 

information is supplied by Treasury but SBA executes issuance of the 1099c). 

• 	 On page II , the DIG indicated that the NDLRC abandons collateral at the time of chargeofT. This is an incorrect statement. Only current efforts to recover on real estate 

collateral are abandoned due to insufficient equity, but the lien on the collateral is not 

released. It is SBA's full intention to review these loans after time to identify potential 

equity or lien position improvements. In SOP 50 52 I and SOP 50 5 I 2, states, "Charge 

off is the process by which SBA recognizes a loss and removes the uncollectible account 

from its acti ve receivable accounts. A charge off does not affect SBA's rights to collect the 

loan from the borrower and does not reduce SBA's ability to proceed with any available 

remedy. " 

• 	 On page 12, the DIG makes an erroneous assumption that with respect to enforced debt 

coll ection, either through foreclosure or suits against obligors or guarantors, the Agency 

must sue within 6 years of default. There is currently much case precedent, including 

most of the United States Courts of Appeal that holds that there is no statute of 

limitations for foreclosure actions brought by the federal government. So foreclosure 

suits would not be barred long after the 6 years. A number of the decisions involve SBA 

loans. It is also erroneous to automatically conclude that 6 years from the date of default 

a deficiency suit is barred. A number of varying circumstances in cases give SBA some 

leeway to avoid a statute oflimitations problem. For example, correspondence sent by the 

46 
debtor or guarantor may be construed as a reaffirmation ofthe debt, such as compromise 

offers that we did not accept, or failed workouts the restart the running of the statute of 

limitations. At least one state allows coll ection ofthe debt for those amortization 

payments that are outside the limitation period. Therefore, it is too simplistic to assume a 

debt is not enforceable if it has been in default for 6 years. 

• 	 On page 26, the OIG identifies a Policy Notice that indicated that "Until the issuance of 

this SOP [SOP 50 52 2], the disaster loan liquidation policy and procedures contained in 

SOP 50 51 2 will remain in full force and effect." Whil e that policy notice has expired, 

the Office of Capital Access, of which OF PO is a component office, has reported 

annuall y on the status ofthe SOP 50 52 2 issuance, which is expected for completion in 

September 2013 . Additionall y, the OIG has received regular updates since 20 10 

regarding this disaster loan SOP update - most recently in March 0[2013 . 

• 	 On page 18, the OIG describes their sample of 18 loans, of which 14 were transferred to 

servicing after making 3 on time payments, but were subsequently charged ofT. 

However, as of April 30, 20 13, OF PO conducted a review ofthe entire population of 

loans returned to servicing by the NDLRC between July I , 20 II and June 30, 20 12The 

review found that 1,737 of2,20 1 loans, or 79%, remained in servicing or were paid in 

full , as indicated in the following chart. Of these loans, only 6% were charged ofT. 

Status of Santa RTS 

7/1/11 - 6/30/12 

SBA and OFPO value the OIG's role as an independent, objective resource for useful 

recommendations that lead to operational improvements and increased vigilance in the protection 

oftaxpayer fund s, and welcomes constructive feedback in these areas as they are critical 

components of meeting the SBA mission. The report presents a series of recommendations, with 

34 instructional sub-recommendations, many of which the SBA has implemented or is in the 

process of implementing. Some recommendations may be too prescriptive to allow the SBA the 

flexibility to manage operations and balance limited resources. This is not conducive to good 

management and does not lend itself usefully for the application of process improvement. The 

best results are achieved when the OIG and SBA work together to identify deficiencies and a 

plan to implement corrective actions in support ofthe Agency's mission. 

Taking into account the above narrative, OFPO is providing additional information in response 

to the OIG recommendations as follows: 

I. 	 We recommend that the Director, Office ofFinancilll Program Operation.'i mam/llfe that 

the NDL RC comply with the DCIA, del'elop, lIml implement 1Il1l1lfigement controls and 

47 

processes related to DEBTS, to ensure 

a. 	 That all charged offloans now designated with loan status comment code "66" are 

transferred to Treasury for cross servicing immediately. 

b. 	 That the NDLRC does not designate loans charged offin the future to block their 

transfer to Treasury for cross servicing because the loans have un-liquidated real 

estate collateral. 

OFPO partially concurs with this recommendation. Treasury and OFPO are currently 

developing a new process for the transfer of collateralized debt. The new process will allow 

Treasury to aggressively collect these debts without compromising future equity positions on real 

estate collateral. Additionally, the immediate transfer of charged off loans coded "66" is neither 

prudent nor reasonable as the economy has improved and loans need to be reviewed to determine 

if the equity situation has improved and either the borrower can resume payments, enter a 

workout or compromise, or the property can be foreclosed upon before transfer to Treasury cross 

servicing. As indicated in the narrative above, this was discussed as the plan at the February 

2013 meeting. OFPO will develop a plan to transfer the charged off debt coded "66" in a 

prudent manner and continue to update the OIG on the progress of this process development. 

2. 	 We recommend that the Director, Office ofFinancial Program Operations mandate that 

the NDLRC comply with the DCJA by developing and implementing management controls 

andprocesses related to DEBTS, to ensure 

a. The Transfer ofall legally enforceable debts, already charged off, to Treasury for cross 

servlcmg. 

b. That all debtors associated with charged offlegally enforceable debts, required to be 

transferred to Treasury for cross servicing, are successfully transferred. 

c. Monitoring ofLoans in litigation after charge off, to confirm transfer to Treasury for 

collection iflitigation is dismissed. 

OFPO concurs with this recommendation. After completion ofthe process development 

references in recommendation 1, OFPO will evaluate existing management controls to ensure 

legally enforceable debts are transferred to Treasury appropriately and develop controls as 

necessary. 

3. We recommend that the Director, Office ofFinancial Program Operations mandate 

that the NDLRC complies with the DCJA by developing and implementing management 

controls andprocesses related to DEBTS, to ensure 

a. 	 The Transfer ofall legally enforceable debts, already charged off, to Treasury for cross 

servlcmg. 

b. 	 That all debtors associated with charged offlegally enforceable debts required to be 

transferred to Treasury for cross servicing are successfully transferred. 

c. 	 Monitoring ofLoans in litigation after charge off, to confirm transfer to Treasury for 

collection iflitigation is dismissed. 

This audit recommendation is duplication of recommendation #2. See response above. 

48 
4. We recommend that the Director, Office ofFinancial Program Operations, develop 

and implement management controls andprocesses related to WORKOUTS, to ensure 

a. 	 An assessment is made to determine the feasibility ofestablishing a workout group for 

the sole purpose ofresolving troubled debts and, iffeasible, establishes such a group. 

b. 	 Staffconsistently determines whether restructuring a delinquent loan would help the 

borrowers repay when providing a workout. 

c. 	 That NDLRC staffascertains whether the borrower's cash flow is adequate to satisfy 

the terms ofthe workout plan when determining whether a workout should be 

provided. 

d. 	 The Liquidation Collection Program and all related guidance conform to the SOP 

governing NDLRC operations and the liquidation ofdisaster loans. 

e. 	 All staffreceives formal training in credit management, debt restructuring, debt 

collection, the Treasury Managing Federal Receivables Guide, andAgency policies 

andprocedures. 

f 	 All necessary actions are taken prior to charge offofthe loan, including offering the 

borrower a workout, evaluating the loan for potential restructuring, analyzing 

borrower repayment ability, andproviding workout terms to the borrower in writing. 

g. 	 That a system is established for tracking the performance ofworkouts to measure the 

dollars recovered and determine whether workouts result in significant recovery of 

delinquent debt. 

OFPO concurs with this recommendation. Staff has been offered training on multiple occasions, 

including training from the Department of Treasury on Debt Collection in FY2012. OFPO will 

continue to coordinate additional training for applicable staff members. Additionally, a chargeoff checklist has been developed since the audit and is in use by Santa Ana NDLRC staff to 

ensure all necessary actions take place prior to charge-off. Ofthose objectives not addressed, 

OFPO will develop an implementation plan by August 30,2013. 

5. We recommend that the Director, Office ofFinancial Program Operations develop and 

implement management controls andprocesses related to LIQUIDATION, to ensure the 

NDLRC: 

a. 	 Evaluates all loan collateral (both real estate and other assets) for liquidation potential 

within 180 days ofthe loan becoming delinquent. 

b. 	 Initiates liquidation action for all loan collateral (both real estate and other assets) 

within 180 days ofthe loan becoming delinquent ifliquidation will result in recovery of 

a portion ofthe debt (and the costs ofliquidation do not significantly exceed the 

anticipated recovery amount). 

c. 	 Liquidates all collateral with a recoverable value prior to loan charge off. 

d. 	 Creates and maintains historical records ofthe collateral liquidated and dollars 

recovered resulting from the liquidation ofall collateral (both real estate and other 

assets). 

e. 	 Discontinues the practice ofcharging offall defaulted loans secured by manufactured 

housing without first evaluating the collateral for potential recovery. 

f. 	 Monitors and tracks all loan collateral (both real estate and non-real estate) associated 

49 

with each loan assigned to the NDLRC 

g. Maintains historical records indicating the pertinent loan details for which collateral 

was liquidated, including the dollars recovered from liquidation. 

h. Tracks the total real estate and non-real estate collateral available for liquidation from 

the loans assigned to the NDLRC 

I. Process ofmonitoring real estate and non-real estate collateral available for 

liquidation includes the capability to compare the dollars recovered through 

liquidation to the total collateral value. 

J. 	 Provides clear explanations for any variances between anticipated and actual dollars 

recovered through liquidation. 

k. 	 StO:.ffresponsiblefor liquidating collateral receives collateral evaluation training. 

OFPO partially concurs with this recommendation. OFPO will conduct a review of each 

objective and conduct a cost benefit analysis, if applicable, to determine inclusion in the 

implementation plan. An implementation plan will be developed by August 30, 2013. 

6. We recommend that the Director, Office ofFinancial Program Operations ensure that 

the Disaster Loan Servicing Centers and the NDLRC develop and implement a process to 

ensure that 

a. 	 All security agreement expiration dates associated with assigned disaster loans are 

identified and tracked so they are renewed prior to their lapse or expiration dates. 

b. 	 The Disaster Loan Servicing Centers provide the NDLRC the anticipated security 

agreement expiration dates for loans transferred from the centers to the NDLRC 

OFPO concurs with this recommendation and will develop an implementation plan by August 

30,2013. 

7. 	 We recommend that the Director ofthe Office ofFinancial Program Operations 

a. 	 Implement controls to ensure the NDLRC only approves offer-in-compromise 

settlements as authorized by the Standard Operating Procedures. 

OFPO disagrees with this recommendation as the assertion in the draft audit report indicates that 

all offers in compromise for loans exceeding $1,000,000 must be handled by the Department of 

Justice. Under the Small Business Act 15 U. S. C 634 (b) the SBA Administrator is given 

independent compromise (i.e. settlement) authority to settle SBA claims without limitation. 

Therefore, DOJ approval is not needed except when the case is in litigation as they have 

authority in those situations. 

8. 	 We recommend that the Director, Office ofFinancial Program Operations 

a. 	 Re-evaluate the structure and design ofthe NDLRC to ensure that its operations are 

designed to maximize recovery ofdelinquent debts. 

b. 	 Develop andpublish a clear mission statement for the NDLRC that clearly aligns with 

Federal debt collection objectives. 

50 
c. Updllte the SOP, governing detinquent llisaster 101ln collection lmd asset tiquit/ation to 

incorporllte the Federal debt collection objectiJ'e!:i anti requirements spec~fied by the 

DC/A. 

d. Establish 1I perjormllnce manllgement process that emphasize ... ejJectiJ'e debt recOl'ery. 

e. Ensure that routine procedural changes, such a.\· mod~fying the/ormula/or 

el'lt/IUlting collateral, are incorporatell into the SOP. 

OF PO concurs with this recommendation. In February 20 11 , SBA initiated a disaster loan 

servicing process improvement effort, which explored several efforts for improvement. Among 

those improvements were those identified by the OIG. Additionally, SBA is updating its 

policies, including the Standard Operating Procedures for Disaster Loan Servicing and 

Liquidation, which we anticipate will be cleared and in use by the end of fiscal year 20 13. 

OF PO will review these recommended objectives and prepare an implementation plan by August 

30, 20 13. 

Please let us know if you need additional information or have any questions regarding our 

response. 

51 

Exhibit I: Treasury Memorandum Approving Workout Exemption 

S2 

_ _ _ 

DEPARTM€NT OF THE TREASURY 

WASI"(INGTQN, O,C, 

J.nuuy 1, 1000 

Mr, John L, Gray 

A.ssociafc Deputy Administrator for Capital Access 

U,S. Small 3wines!l Administration 

Wasbiwon DC 20416 _____ ::r.~. 

Dear _" ;..--­

We have reviewed your request the Small Business Administration (SBA) be dc.sigualed a 

debt collection center, and also a substlCJuc:nt request for an eJternption &om the maadalory 

transfer of debt provi$ions oCthe Debt Collection Improvement Act of 1996 (OCIA), AlthQugh 

we have not designated SBA as a debt coUection ccnter, we have approved SBA's roquest for an 

exemption from mandatory transferofdisaster and regular busin~s loans over 180 days 

delinquent that are in active wolkout. 

The decisioa to deny SBA's October ]0, 1997, requ~r,. which was supplemented by information 

subrnined on ApollO, 1998, to be designated adebt cotlection center for putposes of servicing 

SBA's debts is based on the rcsuJU of the evaluation conducted by the Fina.r,cial ManagetTlenl 

Service (FMS) st.1ffand b.u bceIl communicated to your stalT, fMS' detennination W&> 

subsequently reviewed and confirmed by Ihe Awtication R~ew Committee. which i$ 

comprised of officials from the Departmental Offices ofTIUSUS)' and the Department of Justice, 

The'decision jj cons.irtc:nt with the broad mandate and the responsibility granted to Treasury 

under the OCLA to provide centraliUJd administration iJld ovcnight ofthe delinquenl debt 

collection program. 

During the ~view and analysis ofthe request to be designated as a debt collection center, FMS 

worked with SBA to better Wldentand SBA ~s and to identify appropriate solutions, FMS 

encouraged SBA to review its debt portfolio and «Insider whether, for certain debts. an 

~emption from the DCIA requirement to transfa debt 10 TfUSWYwas more appropria1c: than 

receivinSlpproval as & debt center, Subsequent to those discllssions, FMS received your letter 

dated March 26. 1999, requesting an'exemption for certain SeA debt over 180 days delillquent, 

As permitted under the OC~ I approve yoU( request (or cJtemption from ma.nd.al:ory transfer of 

disaster.and regular business loans over lBO days delinquent that are in active workout. The 

ex.ernption TOquest was evaluated based on standanis and bctors descnCed in FMS' rule 

concerning the Transfer ofDebt5 to Treasury fo r Collection, published in the Federal Register on 

ApriI2B. 1999. Based on that evaluation, we determined tha1 mandatory transfer oflh.cse debts 

would interfere with program goals, and, in the case ofcollateralized debt, would nol be inlhr: 

best interests of the United Statco, 

S3 

~e 2 - Mr. lohn L. Gray 

This exemption applies only to the specific class ofdebts id~tified above. Once SDA 

dctc:m:lines [bat a workout is not fqsible and, in the case ofcoUatcraliud IQ8llS, complet~s its 

liquid&tioalforcclosuto, all) remaining delittqUl!llt debts f(.RJain :!Ubject to the DC(A' s mandatory 

transfer provisions. Additionally, aU other dcbb OVer 180 days delinquent are Nbjet.t to 

mandatory IJ"aD.'IIfer to Treasury unckt the OClA. urue.u ... specific. statutory Dr rcgub.tory 

CICem.priOIl applies. 

We Itlok. forward. to your coo.tizlued cooperation iI3 we complete the implementation oflhc debt 

coUection authorities under the DCIA. 

~l /1 ) 

FOIAEx.6 

OffYJle:nsler 

Una&- Secretary for Domestic Finance 

cc: Donald Hammond 

St CveD, App 

KAthleen Haggetty 

S4 
Exhibit II: Treasury Memorandum Explaining Support for Workout Exemption 

ss 


Page 2 - Small Business Administration's Requests 

The DCIA authorizes the Secretary of the TreasW)' to designate debt collection centers on the 

basis of their performance in collecting delinquent debt. In December 1996, the Financial 

Management Service (FMS) published policies, standards, and procedures for agency application 

to become a debt collection center (FMS Guidelines). The FMS Guidelines allow for two levels 

of application: 1) application for designation as a debt collection center for purposes of collecting 

agen.:y.owned debts, referred to in the FMS Guidelines as a waiver, and 2) application for 

designation as a debt collection center for collecting agency-owned and other Federal debts, 

referred to as cross-servicing. Both designations are intended to recognize that certain Federal 

debts have unique servicing requirements, and tranSfer to FMS for collection may nOt be cost· 

effective. 

We ire recommending denial of SBA 's request to be designated a debt collection cenler for the 

following reasons: 

(I) 	 SBA's compliance with the OCIA requirement to b'ansfer debts 10 TreasW)' for collection 

(cross-servicing) enhances and supplements SBA's debt collection activities without 

interfering with SBA's debt collection process. SBA has transferred S647M of debt to 

FMS, resulting in collections of $S.6M as ofScptember 30, 1999. 

(2) 	 SBA's use of private collection contractors declined priO£ to its participation in crossservicing, indicating that SBA is not maximizing its use ofprivate collection contractors. 

All debts tefmed 10 FMS for cross-servicing may be referred 10 private collection 

contractors under the new Government-wide contraCt. 

(3) 	 The absence of any unique servicing requirements was a critical factor in the evaluation. 

The Application Review Corrunin«, which is comprised of officials from the Departmental 

Offices ofTreasW)' and the Department of Justice, concurred with FMS' recommendation to 

deny the waiver request. 

While the letter denying SBA 's debt collection center application was proceeding through the 

approval process, SBA submitted a letter dated March 26, 1999, requesting an exemption from 

cross.servicing for a class of debts over 180 days delinquent thaI are in aClive workout The 

exemptioll request was submitted in the event that SBA's debt collection celllCt application was 

denied. The exemption request covers delinquent disaster and business loans that are in active 

workout 

Based on the factors detailed below, we recommend that SBA 's second request be granted. 

57 

Page 3 - Small Business Admininration', Reque5u 

The DClA. =lWres the heads of Fedef&lagencies to transfer debts owed to the United States 

which more thM ISO days delinquent to Treasury fot debt collection action. The OClA 

eontWns specific statutory exemptions from mandatory transfer of delinquent debts to Treasury 

for debts that (I) are in litigation or foreclosure; (2) will be disposed of under M asset sales 

program; (3) have been referred to a private collection conlrletor; (4) have been refetTed to a 

TrelUUry-desigruued debt collection center; add (5) will be collected under internal offset within 

) years. Additionally, the DCIA authori:teS the Secretary afthe Treasury to exempt any other 

class I)f debts from mandatory transfet to Treuury upon the request of an agency or otherwise. 

~)l U.S.C. § 3711(g). 

FMS issued a finall'l.lle concerning "Transfer of Debts to Treuury for Colleetion." (See 64 FR 

2290~, April2S, 1999; codified at 31 CFR 2S5.12) The final rule established the s!lUIdard for 

consideration ofexemptions from mandatory ttansfer as whether such exemption is in the best 

utterests ofthe Go\"eITl.I1lent, considering the following factors: ( I) protection ofthe 

Government', financial inlerC5ts; (2) interference with the goals ofthe program under which !he 

debts arose; IIlId (3) consistency with the purposes ofme OClA. 

SSA IwJ req~sted an exemption for debts ....iUch are more than ISO days delinq~nt which are i.'1 

active workout, thai is, where SBA il attempting to bring the debts curttnt with debt $CJVicing 

tools (such 1$ rescheduling or deferment ofpaymenl$), rather than liquidating or foreclOSing on 

the de;ts. SBA reported that as of December 3 1, 1998, there were $88 million of delinquent 

debts ...ruth fell into this category. Approximately 83 pen:ent ofthe subject dan of dew 

consis:ed of delinquent disaster loans ($7) million· $22 million in home loans and $51 million 

in business loaruo). The remaining 17 percent ($IS million) represented debts nom SUA's 

regular bwiness programs. 

SBA also reported that as ofCY 1995, 5.6 percent ($2.IS6 billion) ofSSA'5 $39 billion portfolio 

of di.re~ and gu&nlIIteed loan obligatiOns consisted of debt.!! over J80 days delinquent. Ofthc 

$2.IS6 billion ofdebts over ISO days delinquent, approximately 96 percent ($2.098 billion) was 

either (I) In1nsferred to TreasurylFMS in accordan~ with the DCIA ($578 million. 26.44 

percem), or (2) exempt from mandatory transfer I.D Treasury ($ 1.494 billion in 

liquidationlforeelosure, and $26 million serviced by private lenders.lthird parties· 69.S1 percent). 

These JtlltislieJI indicate that exemption ofthe delinquent disaster and business loan debu would 

afTeet relatively small amounts of SBA 's overall portfolio (.pproximately 0.22 percent), and of 

SBA'~ debt.!! over 180 days delinquent (approximately 4 peKent). These are the most current 

data .vailable from SBA. 

Disaster loans are authorized by law, and obtained by debtors, to help victims ofdisaslen recover 

from c.:uthqunlc:~, fires, floods, hurricanes, tornadoes or other significant devastation. SBA 

points 0111 chal ..... because ofthe slow economic recovery process resulting from ....idespread 

deva.sts:ion in many disaster locatiolUl ... the workOllt process cannot always be completed within 

58 

Page 4 - Small Business Administration's Requests 

180 days of initial delinquency .... " Acconfin&!y, premature determinations 10 accelerale or 

liquidate disaster loans ....."Ould interfere v.ith the program goal of assisting disaster vietims to 

O\'ereome the effects of the disaster. 

Similarly, in attempting to restructure or other.o.rise workout its delinquent business low, SSA is 

attemp1ing to keep the small business in operation. Finaneial analysis, development of an 

aeeeptable bUJiness plan and loan restlUcture oce.uionally cannot be completed in 180 days of 

default. While these loans are all collateralized, premarurc determinations to liquidatc or 

foreelosc would interfere with the program goal of keeping the small business operational. 

Additionally, in a letter dated NO\'ember 23, 1998, concurring in Ihe denial of SBA 's application 

for debt eollection center designmion. the Department oflustice (D01) strongly asserted that 

collateralized debt should not be referred for cross.servicing prior to foreclosW"C beeause erouservieing collection attioll!l risk compromising the Go\'emment's ability to collect against the 

collateral. To the extent the subject e1ass of debts is collateralized, DOl has indicated WIthe 

Govtrmlent's financial interests would be best protected by granting an e}[emption. 

Considering all applicable factors, it is in the best intere5ts orlhe Govenuneot to grant SSA's 

request for an c)(cmption from the statutory requirement to transfer the identified e1ass ofdcbts to 

Treaswy for eollection attion. 

Attachment 

59 

Exhibit III: Treasury letter Confirming Debts with Collateral 


Not Exempt from Treasury Cross Servicing 


60 

DEPARTMENT OF THE TREASURY 


FINANCIA L MANAGEMENT SERVICE 


WASHINGTON. D.C. 20227 


Mlu'Ch 1, 2013 

Mr. John K. Needham 

A$si5taPt illij)tCtor General for AlJditing 

Office of Inspeclor General 

U.S. Small Business Admini5trIltKln 

Dear Mr. Needham, 

rhis letter addresses your question concerning an exemption granted by tbe U.S. Dcpa.rtmcnt oftlle T~tuy 

(Treasury) 10 the Small Business Administntion (SBA) from the staMory requin::mcnt to lransfer delinquent 

oontax debts to Treasury for collection. The Debt Collection Improvement Act of 1996 (OCIA) perally 

requires Federal agencies to transfer noolax debts more tban 180 days delinqUCllt to the U.S. Department of 

the Treasury (Treasury) for collcx.'1ion. By letter dated January J, 2000, Treasury approve« SDA's request for 

an exemption from mandatory transfer of disaster and regular business loans over 180 days delinquent that 

are in tetio.'e workout. At the liJ1'e. Treasury detcnnined ,,* maodalory transfer ofthese dt:bls would 

interfere with program goals and. in tbe CIIst ofeolJllr.erali7.ed debt, would not be in the best interests oftile 

United Stales. 

Based on the language in the letter, we understand Dow SBA could have interpreted tbe letter as having 

exempted .11 collateralized debts from the transr« requirement. FollowinS an inquiry (rom your offICe a.nd 

discussions wilh SBA Director John Miller, Office of Financial Program Opcrtltions. and his st&1f in JIUIWlr)' 

201 J, Treasury and SBA agree that SBA will begin transferring collateralized debts to Treasury for 

collection when SBA has determined that foreclosul"t'l on the coltatml i9 001 feasible. SSA can provide 

additiOllal details about this procCS9. 

Treasury al\d SOA staff are ....-atking together to facilitate the transfer 10 Tn:asuf)' for eolkc;tion all eligible 

collaterali7.ed dehu. on preliminary pl.nning discu.uions, we C;II;PCCI transfcr1 to ber,in in Spring 20 13, 

Because thege debts are oollateralited, Tn!ti-ury and SBA agree that Treasut)' will not compromise any debts 

without approval from SUA, This process will allow SBA 10 determine whether the compromise value is 

greAter than potential collection ....Jue &om eollateralliquidatiOft. TreWlury IlI\d SBA will continue to assess 

the efTeeth'eness "fthis approach with respeet to compromising the colJatetalized debts in !his portfolio. 

We look forward to continuing OUt debt oollection partnership with SBA. 

Sincerely. 

FOIA Ex. 6 

Jcffrq- J. Scbnllocli. 

Assistant Commissioner 

Debe Management Services 

cc: John A. Miller 

61