u.s. SMAll BUSINESS ADMINISTRATION 

OFFICE OF INSPECTOR GENERAL 

ADVISORY MEMORANDUM 

REPORT No. 12-11R 

DATE: 	 MARCH 23, 2012 

To: 	 John A. Miller 

Director, Office of Financial Program Operations 

SUBJECT: 	 High-Dollar Early-Defaulted Loans Require an Increased Degree of Scrutiny and 

Improved Quality Control at the National Guaranty Purchase Center 

This is the final in a series of memorandums related to our audit of twenty-five purchased 7(a) 

Recovery Ace loans. This memorandum summarizes the work completed on the twenty-five 

loans. It also serves to inform you of a finding not previously reported regarding the need for an 

increased degree of scrutiny and improved quality control on high-dollar early-defaulted loans 

at the National Guaranty Purchase Center (NGPC). This memorandum also includes an /lather 

Matter" section describing a deficiency we identified in one loan, which was not previously 

reported. 

The objective of the audit was to determine whether purchased 7(a) Recovery Act loans were 

originated, closed, and purchased in accordance with Small Business Administration (SBA) rules 

and regulations and commercially prudent lending standards. For this audit, we judgmentally 

selected the twenty-five 7(a) Recovery Act loans approved for $500,000 or more that had been 

purchased as of September 3D, 2010, and which defaulted within a short period of time after 

they were made. The total approved amount for these loans was approximately $27 million, 

and the SBA purchased its guaranteed share of the principal loan balances for approximately 

$21 million. 

In meeting the objective, we reviewed all origination, closing, and purchase actions as 

documented in the SBA and lender loan files. We also reviewed information in the SBA's Loan 

Accounting System and analyzed loan data. Furthermore, we interviewed current and former 

SBA officials at the NGPC to gain an understanding of the purchase review process, including the 

quality control review of early-defaulted loans. To assess the internal controls relevant to our 

audit objective, we reviewed the SBA's policies and procedures regarding loan origination, 

closing, and guaranty purchase. We conducted this audit between November 2010 and 

December 2011 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. 

1 American Recovery and Reinvestment Act of 2009, Public Law 111-5 
Summary of Work Completed 

Overall, we found that the SBA and its lenders originated, closed, and purchased 11 of the 25 

sampled loans in accordance with SBA rules and regulations and commercially prudent lending 

standards. Material deficiencies, however, were identified in 14 of the 25 early-defaulted loans 

selected for audit. These deficiencies resulted in questioned costs2 or recoverable guaranty 

payments3 totaling approximately $10.7 million.4 

Of these 14 loans, the Office of Inspector General (OIG) identified material deficiencies in 10 

loans while the SBA identified material deficiencies in four loans during its post purchase 

reviews (see Appendices I and II for a summary of the deficiencies identified on these loans). 

We previously reported our findings on 9 of the 10 loans in 2 separate audit reports (ROM 11-05 

and ROM 11-06)5 and our finding on the tenth loan is discussed below in the /lather Matter" 

section of this report. Recoveries totaling approximately $2.7 million are still outstanding for 

two of the four loans with deficiencies identified by the SBA. As a result, we recommended that 

the SBA notify the OIG of any denial, repair,6 or withdrawal of the purchase request by the 

lender on those loans to [Ex. 4] and [Ex. 4] The 

previously issued audit reports included recommendations to recover the questioned costs 

identified on 9 of the 10 loans with OIG identified deficiencies. Our second audit report, ROM 

11-06, also included recommendations to correct OIG identified SBA origination deficiencies. 

These reports did not, however, include recommendations to address deficiencies in the NGPC's 

purchase process, which are discussed herein. 

The NGPC was responsible for the purchase reviews on 9 of the 10 loans for which the OIG 

identified material deficiencies.7 The NGPC either made a purchase error or did not identify the 

deficiencies during its guaranty purchase reviews on six of the nine loans, resulting in improper 

payments totaling approximately $3.3 million. We noted that loan specialists did not always 

review high-dollar early-defaulted loans with the level of scrutiny necessary to identify all 

material deficiencies. Due to the high number of deficiencies identified and the resulting 

improper payments, we recommended that the SBA establish a specialized early default 

purchase review unit at the NGPC. 

The SBA incorporated a quality control review process into its purchase review process for earlydefaulted loans in response to our draft report for ROM 11-05. This quality control review 

process began on May 9, 2011 and ended on August 9, 2011. We determined, however, that 

2 For purposes of this memorandum, "questioned costs" are defined as costs questioned by the OIG, which were incurred as a 

result of material origination, closing, and purchase deficiencies made by lenders or the SBA. 

3 For purposes of this memorandum "recoverable guaranty payments" are defined as amounts that SBA has identified during 

post purchase reviews that should be recovered from the lender due to the lender's failure to handle a loan in a prudent 

manner or in compliance with SBA loan program requirements. 

4 Rounded to the nearest hundred thousand. 

S As part of this audit, we previously issued ROM 11-05, Material Deficiencies Identified in Four 7(0) Recovery Act Loans 

Resulted in $3.2 Million of Questioned Costs, June 29, 2011; and ROM 11-06, Material Deficiencies Identified in Five 7(0) 

Recovery Act Loans Resulted in $2.7 Million of Questioned Costs, August 22, 2011. 

6 The term "repair" means an agreement between SBA and a 7(a) lender as to a specific dollar amount to be deducted from 

the funds SBA pays on the lender's guaranty in order to fully compensate SBA for an actual or anticipated loss caused by the 

lender. 

7 The purchase review on the tenth loan to [Ex. 4] was performed at the SBA's Fresno Loan Servicing 

Center. 

2 

this process did not evaluate lender compliance with SBA eligibility and use of loan proceeds 

requirements. To address this gap in its quality control process, we recommended that the 

NGPC expand the scope of its quality control reviews of early-defaulted loans. 

Finally, we also recommended that the SBA seek recovery of $15,188 on the tenth loan with an 

OIG identified use of proceeds deficiency, which is presented in the IIOther Matter" section of 

this report. 

A draft copy of this memorandum was provided to the SBA for comment. The SBA agreed or 

partially agreed with all of the recommendations and made comments, proposed actions, or 

took actions that were responsive to OIG recommendations. 

Background 

The Recovery Act provided the SBA with $730 million to expand the Agency's lending and investment 

programs, create new programs to stimulate lending to small businesses, and conduct oversight of 

these programs. Of the $730 million received, $375 million was authorized for the SBA to (1) eliminate 

or reduce fees charged to lenders and borrowers for 7(a) and 504 loans, and (2) increase its maximum 

loan guaranty to 90 percent for eligible 7(a) loans.8 The Recovery Act and Office of Management and 

Budget guidance encouraged Offices of Inspectors General to conduct oversight of potential risks posed 

by Recovery Act programs implemented by their respective agencies. Accordingly, we conducted this 

audit due to concerns that (1) some lenders would not exercise due diligence in originating and closing 

loans given the 90 percent SBA guaranty reduced lender risk, and (2) the SBA would not properly 

underwrite some loans given the higher loan demand and resource constraints. 

The SBA is authorized under Section 7(a) of the Small Business Act to provide financial assistance 

to small businesses in the form of government-guaranteed loans. The SBA's 7(a) loans are made 

by participating lenders under an agreement to originate, service, and liquidate loans in 

accordance with SBA's rules and regulations and prudent lending standards. Some 7(a) loans 

are made by lenders using delegated authority, which undergo very limited review by SBA prior 

to loan disbursement. Others are subject to more extensive underwriting and eligibility review 

and approval by the SBA before the loan is disbursed. When a loan goes into default, the SBA 

will review the lender's actions on the loan to determine whether it is appropriate to pay the 

lender the guaranty (which SBA refers to as a guaranty IIpurchase"). Based on the number of 

deficiencies we identified on early-defaulted loans in this audit which were not identified in 

purchase reviews performed by the NGPC, the SBA implemented a process in which earlydefaulted loans may also be randomly selected for independent quality control reviews prior to 

completion of the guaranty purchase. Under SBA regulations9 the SBA is released from liability 

on the guaranty, in whole or in part, if the lender fails to comply materially with any SBA loan 

program requirement or does not make, close, service or liquidate the loan in a prudent 

manner. 

For certain loans, as authorized by the SBA on a case-by-case basis, lenders may sell the 

guaranteed portion of a loan to an investor on SBA's secondary market any time after the lender 

disburses the loan. If such a loan subsequently goes into default, the SBA is unconditionally 

8 The maximum guaranty for SBAExpress loans remained at 50 percent. 

9 13 Code of Federal Regulations (CFR) § 120.524. 

3 

obligated to pay the guaranty to the investor. However, the SBA will conduct what is called a 

IIpost purchase review" to identify lender imprudence or noncompliance with SBA loan program 

requirements, and seek repayment of the guaranty from the lender if material problems are 

found. Early-defaulted loans that were sold on the secondary market may also be randomly 

selected for a quality control review prior to completion of the post purchase review. 

Results 

High-Dollar Early-Defaulted Loans Require an Increased Degree of Scrutiny and 

Improved Quality Control at the NGPC 

Rigor ofPurchase Reviews at the NGPCfor High-Dol/ar Early-Defaulted Loans Can be Improved 

Based on our review of loan files and interviews with current and former NGPC officials during 

the course of this audit, we determined that the NGPC does not always review high-dollar earlydefaulted loans with the degree of scrutiny necessary to identify all material deficiencies. 

According to SBA procedures1o for early-defaulted loans, the SBA must review the lender's 

purchase package with the IIhighest degree of scrutiny." Additionally, the recommending official 

must determine whether the lender's failure to make or close the loan in accordance with SBA 

requirements or prudent lending practices allowed or contributed to the early default. If the 

SBA purchase review indicates that the lender's actions or omissions resulted in a material loss 

to the SBA, repair or denial of the guaranty is appropriate. 

The NGPC was responsible for the purchase reviews on 9 of the 10 loans we found to have 

material deficiencies. The NGPC made a purchase error and did not identify material eligibility, 

equity injection and use of proceed deficiencies on six of the nine loans. These errors resulted 

in improper payments totaling approximately $3.3 million. The six loans are annotated with an 

asterisk in Appendix I. For the remaining three loans that we found to have deficiencies, the 

NGPC either had not yet conducted its post purchase reviewll or the deficiencies were made by 

the SBA in approving the loans and therefore were not required to be evaluated during 

purchase review. 

We interviewed nine current and former NGPC loan specialists and supervisory loan specialists 

to discuss the process for conducting purchase reviews and determine why errors were made or 

material lender deficiencies were not identified during purchase review. Most of these NGPC 

loan specialists were either associated with one of the nine problem loans identified in this audit 

or to loans with similar deficiencies identified in previous audits. Every loan specialist we spoke 

to described the NGPC as a IIproduction facility." We found that, generally, most of the loan 

specialists felt that the production standards were reasonable based on the lIexpectations" of 

the NGPC. Some indicated, however, that there was pressure to make timely decisions and not 

enough time to complete an in-depth review, especially for those with underwriting 

backgrounds. Loan specialists stated it would take much more time to perform the level of 

10 Standard Operating Procedures (SOP) 50 51 3, Loan Liquidation, Chapter 22. 


11 The SBA's post purchase review on two loans fully agreed with our findings and recommendations to recover 


$543,946. 

4 

review necessary to identify all material deficiencies and informed us that the degree of scrutiny 

applied to early-defaulted loans is the same regardless of loan size. 

Loan specialists told us that they did not receive formal training when they started reviewing 

purchases; they only received on-the-job training by completing purchase reviews and receiving 

feedback from supervisory loan specialists. Based on the loan specialists' statements, however, 

we question the quality of the on-the-job training. Specifically, one loan specialist stated that 

supervisors had varying degrees of experience and did not consistently interpret SBA's policies 

and procedures. Additionally, a supervisory loan specialist stated that the supervisors did not 

have time to train the loan specialists assigned to them. Furthermore, when supervisory loan 

specialists explained their responsibilities to us, it was clear that each applied a different level of 

thoroughness when reviewing and approving the loan specialists' purchase review decisions. 

For two of the loans we identified with deficiencies, the cognizant loan specialists were not 

aware of the applicable program requirements, which caused them to miss the deficiencies. 

For two other loans, the cognizant loan specialists were not fully aware of their responsibilities 

in reviewing particular compliance areas and therefore, missed the deficiencies. 

Based on these interviews, we determined that errors were made and material lender 

deficiencies were not identified on the high-dollar early-defaulted loans due to the focus on 

production at the NGPC, a lack of training, and the loan specialists' unfamiliarity with SBA 

program requirements and purchase review responsibilities. 

When asked how early-defaulted loans are reviewed with the IIhighest degree of scrutiny," 

NGPC management stated that additional documentation is obtained and reviewed. This 

documentation includes the lender's credit memorandum, support for equity injection, and 

verification of financial information with Internal Revenue Service (IRS) tax transcripts. While 

our audit found that the NGPC is obtaining this additional documentation for early-defaulted 

loans, our analysis of loan files and interviews with loan specialists demonstrate that loan 

documentation in general is not reviewed with the level of scrutiny necessary to identify all 

material deficiencies on high-dollar early-defaulted loans. 

The NGPC's Quality Control Review Process for Early-Defaulted Loans Needs Improvement 

In response to our first audit report (ROM 11-05), which identified material lender 

noncompliance with equity injection and IRS tax verification requirements, the NGPC 

incorporated a temporary quality control review of early-defaulted loans into its purchase 

review process. This quality control review process began on May 9, 2011 and ended on 

August 9, 2011. The purpose was to provide the SBA with reasonable assurance that the 

purchase process was performing as intended and minimizing improper payments. During this 

90-day period, the NGPC quality control team reviewed 183 early-defaulted loans for 

compliance with equity injection and IRS tax verification requirements. The NGPC identified 

nine loans with deficiencies, of which eight were resolved through the lenders providing 

additional documentation. For the remaining loan, the lender was unable to resolve the 

deficiency and subsequently released the SBA from liability, resulting in a cost savings of 

$102,314. 

5 

Following the completion of the 90-day review, SBA officials stated they would continue to 

perform the early default quality control reviews on a random basis as part of the NGPC's 

purchase review process. We determined, however, that the NGPC's review checklist does not 

require an evaluation of eligibility and the use of loan proceeds to verify compliance with SBA 

rules and regulations. Our audit identified deficiencies on 4 of the 25 early-defaulted loans 

where the NGPC purchase review did not identify lender noncompliance with SBA eligibility or 

use of proceeds requirements. 12 In response to our previous reports, the SBA agreed with our 

findings on three of these loans, which resulted in questioned costs of $1. 7 million. The 

deficiency on the fourth loan resulted in questioned costs of $15,188 and is presented below. 

These findings demonstrate that the scope of the early default quality control reviews should be 

expanded to include a thorough evaluation of eligibility and use of proceeds, as these 

deficiencies would not have been identified under the current process. 

An additional concern regarding the NGPC's assessment of the quality and accuracy of lender 

underwriting was identified during this audit. Specifically, we are concerned that the NGPC's 

limited review of lender underwriting is not consistent with statutory and regulatory authority 

and is contrary to SBA procedures. This issue will be the subject of a separate limited scope 

review, which is currently being completed. 

Other Matter - Ineligible Use of Proceeds on One Loan 

We identified a deficiency on a loan to [Ex. 4] made by 

Pacific Mercantile Bank, which resulted in a $15,188 improper payment that should be 

recovered. As a lender in the Preferred Lender Program (PLPj, Pacific Mercantile Bank was 

permitted to process, close, service, and liquidate its loans with limited documentation and 

review by the SBA. 

On April 2, 2009, using PLP procedures, the lender approved an $810,000 loan to the borrower 

to payoff outstanding debt and for closing costs. Pacific Mercantile Bank disbursed this loan on 

April 13, 2009 and the borrower defaulted approximately six months later on October 15, 2009. 

Therefore, this loan qualifies as an early-defaulted loan in accordance with SBA policy. The SBA 

completed a purchase review, and on May 10, 2010, purchased the principal guaranty for 

$726,561. 

Our audit determined that the lender disbursed a portion of the loan proceeds for an ineligible 

purpose. According to SBA procedures, 13 loan proceeds may not be used to pay delinquent IRS 

withholding taxes, sales taxes, or other funds payable for the benefit of others. The lender 

disbursed $16,875 of loan proceeds to payoff a federal tax lien. The SBA guaranteed portion of 

these loan proceeds was $15,188. The federal tax lien notice found in the loan file indicated the 

lien resulted from the nonpayment of payroll withholding taxes. Therefore, this portion of the 

12 See Appendix I: Loans with Material Deficiencies Identified by the Office of the Inspector General (OIG), loan 

numbers [Ex. 4] [Ex. 4] , [Ex. 4] and [Ex. 4] . Loan numbers [Ex. 4] and [Ex. 4] 

also had eligibility or use of proceeds deficiencies, but the NGPC was not responsible for identifying these 

deficiencies prior to our audit. For one of these loans, the deficiency occurred during the SBA loan approval and 

therefore, was not required to be evaluated during the purchase review. For the second loan, the NGPC had not 

completed its post purchase review prior to our audit and therefore, did not have the opportunity to identify the 

deficiency. 

13 SOP 50 10 5(Al Lender and Development Company Loan Programs. 

6 

use of proceeds was ineligible. The lender should not have disbursed the funds for this use and 

the SBA should not have purchased this portion of the guaranty. The SBA should recover an 

improper payment of $15,188 based on the deficiency identified above. 

Conclusion 

The material deficiencies identified in 14 of the 25 purchased 7(a) Recovery Act loans selected 

for audit resulted in questioned costs or recoverable guaranty payments totaling approximately 

$10.7 million. 

Loan specialists at the NGPC made a purchase error and did not detect material lender 

deficiencies on six of the nine NGPC loans in which we identified deficiencies.14 Errors were 

made due to the focus on production at the NGPC, a lack of training, and loan specialists' 

unfamiliarity with SBA program requirements and purchase review responsibilities, which 

resulted in improper payments totaling approximately $3.3 million. The inadequate purchase 

reviews performed by the NGPC and the resulting improper payments demonstrate that highdollar early-defaulted loans pose a significant risk of loss to the SBA. 

Additionally, the limited scope of the quality control review process for early-defaulted loans 

did not evaluate compliance with SBA eligibility and use of loan proceeds requirements. 

Therefore, this process did not provide the SBA with reasonable assurance that the loan 

purchase process is performing as intended. 

Recommendations 

We recommend that the Director, Office of Financial Program Operations (OFPO): 

1. 	 Notify the OIG of any denial, repair or withdrawal of the guaranty on the loan made to 

[Ex. 4] which was reviewed by the SBA and warrants a possible recovery 

of $1,336,089, plus interest. 

2. 	 Notify the OIG of any denial, repair or withdrawal of the guaranty on the loan made to 

[Ex. 4] which was reviewed by the SBA and warrants a possible recovery of 

$1,330,708, plus interest. 

3. 	 Establish a specialized unit of well-trained, highly experienced loan specialists to perform 

purchase reviews with the level of scrutiny necessary to identify all material deficiencies on 

early-defaulted loans approved for $500,000 or more. 

4. 	 Expand the scope of the NGPC quality control reviews of early-defaulted loans to include a 

thorough review of eligibility and use of proceeds. 

5. 	 Seek recovery of $15,188, plus interest, from Pacific Mercantile Bank on the guaranty paid 

by the SBA for the loan to [Ex. 4] 

14 The six loans include the loan to Refrigerant Exchange Corp, which is presented as an Other Matter in this memorandum. 

7 

Agency Comments and Office of Inspector General Response 

On February 16, 2012, we issued a draft of this memorandum and provided it to the SBA for 

comment. On March 19, 2012, the SBA provided written comments, which are summarized 

below and contained in their entirety in Appendix III. The SBA agreed or partially agreed with all 

of the recommendations. The SBA's comments, proposed actions, and actions taken were 

responsive to the recommendations. 

Recommendation 1 

Notify the OIG of any denial, repair or withdrawal of the guaranty on the loan made to 

[Ex. 4] which was reviewed by the SBA and warrants a possible recovery of 

$1,336,089, plus interest. 

Management Comments 

The SBA fully agreed with our recommendation. However, the SBA stated that servicing of the 

loan was assumed by the FDIC after the originating lender was closed and placed into 

receivership on November 12, 2010. This was before the SBA's denial decision had been 

finalized. The FDIC does not recognize claims that were unfinalized as of the date of the 

receivership. Therefore, the SBA has no recourse against the FDIC. 

DIG Response 

The SBA's comments are responsive to the recommendation. 

Recommendation 2 

Notify the OIG of any denial, repair or withdrawal of the guaranty on the loan made to 

[Ex. 4] which was reviewed by the SBA and warrants a possible recovery of 

$1,330,708, plus interest. 

Management Comments 

The SBA fully agreed with our recommendation. The SBA made a notation in the chron system 

advising the NGPC to provide notice on any denial, repair, withdrawal or cancellation of 

guaranty resulting from the identified deficiencies to the OIG. The NGPC is also currently 

reviewing additional documentation the lender recently submitted to overcome the identified 

deficiencies. If the documentation provided by the lender does not overcome the stated 

deficiencies, the NGPC will request recovery from the lender. The OFPO will provide an update 

to the OIG by May 31, 2012. 

DIG Response 

The SBA's comments and proposed actions are responsive to the recommendation. 

8 

Recommendation 3 

Establish a specialized unit of well-trained, highly experienced loan specialists to perform 

purchase reviews with the level ofscrutiny necessary to identify all material deficiencies on 

early-defaulted loans approved for $500,000 or more. 

Management Comments 

The SBA partially agreed with our recommendation. The SBA stated that the OFPO and NGPC 

take seriously the need to allocate resources most effectively so that purchase reviews of high 

dollar loans are conducted consistent with policy, procedures and regulations, and sufficient to 

identify all material deficiencies on early-defaulted loans approved for $500,000 or more. The 

SBA also noted that the OFPO and NGPC must determine the means by which this will be 

accomplished while balancing the other vital work of the center. Furthermore, the SBA stated 

that addressing this recommendation will involve some reallocation of resources, staff training, 

staff skill augmentation, SOP changes, and internal controls. The OFPO and NGPC have begun 

the process of making these changes, and believe the process will be completed by September 

30,2012. 

DIG Response 

The SBA's comments are responsive to the recommendation. We will monitor the SBA's actions 

during the audit follow-up process to determine if the appropriate level of scrutinty is occurring 

on early defaulted loans approved for $500,000 or more. 

Recommendation 4 

Expand the scope of the NGPC quality control reviews of early-defaulted loans to include a 

thorough review of eligibility and use of proceeds. 

Management Comments 

The SBA fully agreed with our recommendation. The NGPC has recently incorporated the earlydefault quality control review into its all-encompassing random quality control reviews to 

ensure all applicable SBA policies and procedures are addressed during the purchase review 

process. 

DIG Response 

The SBA's comments and actions taken are responsive to the recommendation. 

Recommendation 5 

Seek recovery of $15,188, plus interest, from Pacific Mercantile Bank on the guaranty paid by 

the SBA for the loan to [Ex. 4] 

9 

Management Comments 

The SBA fully agreed with our recommendation. The NGPC will notify the lender of the 

deficiency by April 3D, 2012 and request repayment of $15,188 related to this deficiency by June 

30,2012. 

DIG Response 

The SBA's comments and proposed actions are responsive to the recommendation. 

Actions Required 

Please provide your management response for each recommendation on SBA Forms 1824, 

Recommendation Action Sheet, within 30 days from the date of this memorandum. Your 

responses should identify the specific actions taken or planned to fully address each 

recommendation and the target dates for completion. 

We appreciate the courtesies and cooperation of the Office of Capital Access during this audit. 

If you have any questions concerning this memorandum, please call me at 202-205-7390 or 

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

*** 

/S/ Original Signed 

John K. Needham 

Assistant Inspector General for Auditing 

10 

Appendix I. Loans with Material Deficiencies Identified by the OIG" 

# loan 

Number 

Borrower 

Name 

loan 

Type 

Deficiency 

Type (See 

legend) 

Deficiency 

Description 

Approved 

Amount 

Questioned 

Costs 

1 [Ex. 4] [Ex. 4] PLP A,D 

1) The lender did not 

adequately verify the 

source of $164,900 of 

equity allegedly 

injected into the 

business. 

2) The legitimacy of two 

promissory notes is 

questionable. 

3) Documentation in 

the loan file showed 

that the 25% owner of 

the selling corporation 

was also a manager of 

the buying company. 

$1,782,000 $1,445,021 ' 

2 [Ex. 4] [Ex. 4] PLP D 

1) The lender did not 

adequately verify and 

document the source 

for the $1 million of 

required equity 

injection. 

$1,700,000 $1,376,641 ' 

3 [Ex. 4] [Ex. 4] GP C 

1) The SBA did not 

consider the effect the 

borrower's affiliated 

business had on 

repayment ability. 

$1,350,000 $763,277 

4 [Ex. 4] [Ex. 4] GP A,C,E 

1) The effects of the 

borrower's affiliated 

businesses were not 

fully considered in 

determining the size 

and repayment ability 

of the borrower. 

2) The SBA purchased 

this loa n at a higher 

guaranty percentage 

than authorized. 

$1,290,000 $1,161,000' 

5 [Ex. 4] [Ex. 4] CLP B 

1) A portion of the loan 

refinanced debt 

originally used for floor 

plan financing. 

$1,074,000 $191,702' 

6 [Ex. 4] [Ex. 4] EWCP B 

1) The lender did not 

appropriately ensure 

that the loan proceeds 

were used as required 

in the loan 

authorization. 

$1,000,000 $106,802' 

7 [Ex. 4] [Ex. 4] PLP B 

1) Approximately 

$15,000 was used to 

payoff an IRS federal 

tax lien on withholding 

taxes. 

$810,000 $15,188' 

8 [Ex. 4] [Ex. 4] PLP C 1) The lender's cash 

flow analysis did not $675,000 $506,250 

11 

# loan 

Number 

Borrower 

Name 

loan 

Type 

Deficiency 

Type (See 

legend) 

Deficiency 

Description 

Approved 

Amount 

Questioned 

Costs 

consider the impact the 

two affiliated 

businesses would have 

on the borrower's 

repayment ability. 

9 [Ex. 4] [Ex. 4] PLP A 

1) The lender did not 

properly verify the 

accuracy of the seller's 

financial information as 

required in a change of 

ownership transaction. 

2) The project lacked 

feasibility because the 

borrower paid more for 

the business than it was 

worth due to an 

inadequate business 

valuation. 

$632,000 $37,696 

10 [Ex. 4] [Ex. 4] Patriot 

Express c 

1) The lender's credit 

analysis did not 

demonstrate a 

reasonable assurance of 

repayment/the 

projections were 

unreasonable. 

$500,000 $373,532 

Totals $10,813,000 $5,977,109 

Deficiency Type Legend: 

A. Eligibility 

B. Use of Proceeds 

C. Repayment Ability 

D. Equity Injection 

E. Improper Guaranty Amount 

1\ 	 Questioned costs amounts were determined as of audit report issuance and may not reflect the 

amounts that will actually be recovered by the SBA as a result of the audit follow-up process. 

* 	 Loans with errors made by the NGPC during purchase reviews. 

12 

Appendix II. Loans with Material Deficiencies Identified by the SBA 

# loan 

Number 

Borrower Name loan 

Type 

Deficiency 

Type (See 

legend) 

Approved 

Amount 

SBA's Share of the 

Outstanding 

Balance at Purchase 

Review 

1 [Ex. 4] [Ex. 4] GP A,B,C $1,500,000 $1,336,089 

2 [Ex. 4] [Ex. 4] GP A,B $1,500,000 $1,330,708 

3 [Ex. 4] [Ex. 4] PLP D,E $1,500,000 $1,339,171 

4 [Ex. 4] [Ex. 4] PLP A $900,000 $668,636 

Totals $5,400,000 $4,674,604 

Deficiency Type Legend: 

A. Use of Proceeds 

B. Equity Injection 

C. Site Visit 

D. Eligibility 

E. Loan Maturity 

13 

Appendix III. Agency Response 

u.s. SMALL BUSINESS ADMINISTRATION 

WASHINGTON, D.C. 20416 

MEMORANDUM 


March 19, 2012 


To: Peter L. McClintock 

Deputy Inspector General 

From: John A. Miller 

Director, Office of Financial Program Operations 

Subject: Response to Draft Advisory Memorandum on the High-Dollar Early-Default Loans 

Require an Increased Degree of Scrutiny and Improved Quality Control at the 

National Guaranty Purchase Center, Project No. 10508B 

Thank you for the opportunity to review the draft report. We appreciate the role ofthe Office of 

Inspector General (OIG) plays in assisting management in ensuring that these programs are 

effectively managed. 

The draft report is the final in a series of memorandums related to the OIG's audit oftwenty-five 

purchased 7(a) Early-Defaulted Recovery Act loans. The report summarizes the OIG's work 

completed on the twenty-five loans and also serves to inform SBA ofthe need for an increased 

degree of scrutiny and improved quality control on high-dollar early-defaulted loans at the 

National Guaranty Purchase Center (NGPC). 

The OIG noted concerns with the level of scrutiny NGPC loan specialists provide during 

purchase reviews of high-dollar early-defaulted loans. The OIG attributed the current level of 

scrutiny to NGPC's focus on production, lack oftraining, and loan specialists' unfamiliarity with 

SBA program requirements and purchase review responsibilities. Office of Financial Program 

Operations (OFPO) and NGPC recognize the importance training plays in ensuring loan 

specialists possess the knowledge and skills necessary to perform all purchase reviews with the 

utmost scrutiny while maintaining productivity standards. OFPO and NGPC plan to provide 

credit underwriting training to all NGPC purchase review staff. In addition, OFPO's quality 

control program offers monthly training sessions to all purchase review staff, and provides both 

general and individualized feedback based on quality control review results. OFPO and NGPC 

are confident the training and feedback provided to loan specialists will enhance their knowledge 

and skill in detecting material deficiencies in high-dollar early-defaults. 

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The OIG also noted concerns with the scope ofNGPC's early default quality control review 

process. The OIG's concerns revolved around the lack of evaluation for lender compliance with 

SBA eligibility and use ofloan proceeds during the NGPC's review of 183 early-defaulted loans 

between May 9, 2011 and August 9, 2011. SBA agrees that the quality control review for earlydefaulted loans should include evaluation of lender compliance with eligibility and use of loan 

proceeds requirements. NGPC has recently incorporated early-default quality control review 

measures into the existing random quality control review for all applicable loans. Therefore, all 

early-defaulted loans sampled for quality control review now undergo evaluation for lender 

compliance with SBA eligibility and use ofloan proceeds in addition to a thorough review of the 

lender credit memorandum, including repayment ability, support for equity injection and 

verification of financial information with IRS tax transcripts. 

Management's response to the recommendations in the draft report is noted as follows: 

1. Notify the OIG ofany denial, repair or withdrawal ofthe guaranty on the loan made to 

[Ex. 4] which was reviewed by the SBA and warrants a possible recovery 

of$1,336,089, plus interest. 

OFPO concurs with this recommendation. Servicing of this loan was assumed by FDIC after the 

originating lender was closed and placed into receivership on November 12, 2010, and before the 

SBA's denial decision had been finalized. FDIC does not recognize claims that were not 

finalized as of the date of the receivership. Therefore, SBA has no recourse against FDIC. 

2. Notify the OIG ofany denial, repair or withdrawal ofthe guaranty on the loan made to 

[Ex. 4] which was reviewed by the SBA and warrants a possible recovery of 

$1,330,708, plus interest. 

OFPO concurs with this recommendation and is in the process of taking the following actions: 

A notation was made in the chron system advising the NGPC to provide notice on any denial, 

repair, withdrawal or cancellation of guaranty resulting from the identified deficiencies to Office 

ofInspector General. NGPC is currently reviewing additional documentation the lender recently 

submitted to overcome the identified deficiencies. If the documentation provided by the lender 

does not overcome the stated deficiencies, NGPC will request recovery from the lender. OFPO 

will provide an update to the OIG by May 31,2012. 

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3. Establish a specialized unit ofwell-trained, highly experienced loan specialists to 

perform purchase reviews with the level ofscrutiny necessary to identify all material 

deficiencies on early-defaulted loans approvedfor $500,000 or more. 

OFPO partially concurs with this recommendation and plans to take the following actions: 

OFPO and NGPC take seriously the need to allocate resources most effectively so that purchase 

reviews of high dollar loans are conducted consistent with policy, procedures and regulations, 

sufficient to identify all material deficiencies on early defaulted loans approved for $500,000 or 

more. OFPO and NGPC must determine the means by which this will be accomplished while 

balancing all ofthe other vital work of the center. This will involve some reallocation of 

resources, staff training, staff skill augmentation, SOP changes, and internal controls. OFPO and 

NGPC have begun the process of making these changes, and believe the process will complete 

by September 30,2012. 

4. Expand the scope ofthe NGPC quality control reviews ofearly-defaulted loans to 

include a thorough review ofeligibility and use ofproceeds. 

OFPO concurs with this recommendation. 

NGPC has recently incorporated the early-default quality control review into its allencompassing random quality control reviews to ensure all applicable SBA policies and 

procedures are addressed during the purchase review process. 

5. Seek recovery of$15,188, plus interest, from Pac~fic Mercantile Bank on the guaranty 

paid by the SBAfor the loan to [Ex. 4] 

NGPC concurs with this recommendation and agrees the portion of loan proceeds used to pay 

delinquent IRS withholding taxes was an ineligible use of loan proceeds. NGPC will notify the 

lender of the deficiency by April 30, 2012 and request repayment of $15, 188 related to this 

deficiency by June 30, 2012. 

Again, thank you for the opportunity to review the draft report. Please let us know if you need 

additional information or have any questions regarding our response. 

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