United States General Accounting Office

GAO Report to the Subcommittee on Benefits,

Committee on Veterans’ Affairs, House

of Representatives

March 1999 INTERNAL

CONTROLS

VA Lacked

Accountability Over Its

Direct Loan and Loan

Sale Activities

GAO/AIMD-99-24

GAO United States

General Accounting Office

Washington, D.C. 20548

Accounting and Information

Management Division

B-280807 

March 24, 1999

The Honorable Jack Quinn

Chairman

The Honorable Bob Filner

Ranking Minority Member

Subcommittee on Benefits

Committee on Veterans’ Affairs

House of Representatives

As part of our responsibility to audit the consolidated financial statements

of the U.S. Government for fiscal years 1997 and 1998, we participated in

the Department of Veterans Affairs (VA) Office of Inspector General (OIG)

audit of the VA’s Housing Credit Assistance (HCA) program. In its report on

VA’s fiscal year 1997 financial statements, the VA OIG described several

deficiencies that contributed to the VA receiving a qualified opinion on

those statements. Among the areas of concern was the level of control and

accountability over HCA’s direct loan and loan sale activities. Specifically,

the OIG

• was unable to conclude that the $3 billion loans receivable account

balance of the direct loan portfolio was fairly stated because of inadequate

controls and incomplete records and

• identified a number of errors in recording loan sale transactions, including

inaccurate and untimely recording of loan sales and improper accounting

of loan guarantees.

VA is working to address the internal control weaknesses identified in the

audit of its fiscal year 1997 financial statements, but many of the internal

control weaknesses that prompted the qualified opinion have not yet been

satisfactorily resolved.

As you requested, this report describes weaknesses in the level of VA’s

accountability and control over HCA’s direct loan and loan sale activities

and recommends actions needed to improve VA’s internal control

environment and financial and budgetary reporting for these activities.

Results in Brief VA did not have appropriate management and operational controls in place

to maintain accountability over its direct loan and loan sale activities. VA

provided little oversight of contractors that were managing billions of

dollars of assets on its behalf and did not ensure that revenues and

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expenses were accurate or that cash receipts were deposited promptly in

Treasury accounts.

When VA outsourced the servicing of its direct loan portfolio to a

contractor in fiscal year 1997, it did not adequately plan or manage the

transfer. It concurrently shut down its automated direct loan system and

surrendered almost all hard copy loan records to the contractor without

retaining basic information needed to confirm or reconcile the number

and value of loans serviced by the contractor. As a result, VA was unable to

appropriately manage its loan portfolio, including knowing the

composition and value of its loan portfolio, reconciling cash flows, or

properly monitoring the contractor’s work.

Further, the data transferred to the contract servicer, which up to that

point had been maintained by more than 40 VA regional offices, was

incomplete and inconsistent. This immediately created loan servicing

problems. There were delays in allocating payments to borrowers’

accounts and in paying property taxes on behalf of borrowers as well as

property taxes on VA-owned houses. Also, some borrowers did not receive

year-end statements showing interest paid that would be needed for filing

tax returns.

VA lacked assurance that receipts from loans were properly collected and

allocated to borrowers’ accounts, and did not determine the propriety of

property tax expenses associated with VA-owned property and,

accordingly, could not be confident that appropriate amounts were

transmitted to the government. For example, VA reimbursed the contractor

for property tax expenses without verifying that such expenses were

appropriate and at the correct amount. In addition, VA lacked a basis for

properly reconciling the financial activity reported by the contractor to the

data recorded in VA’s general ledger.

VA’s relationship with its contractor had cash management implications. VA

had allowed the contractor to open an interest bearing account and retain

interest earned on government funds held by the contractor. VA also

authorized the contractor to retain receipts until payments could be

allocated. In addition, provisions of the servicing agreement called for the

contractor to transfer loan payment collections to Treasury on a monthly

rather than a daily basis, substantially delaying submission of such

collections to the federal government. Both the servicing agreement and

VA’s subsequent authorizations to the contractor resulted in a violation of

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federal law and the Treasury Financial Manual concerning timely deposits

of collections.

Regarding VA’s loan sale activity—in which VA packages some of its direct

loans into a trust and sells shares in the trust to investors with a guarantee

of full payment of principal and interest—we found that VA’s failure to

timely monitor the contractors that service the loans, representing roughly

$9 billion since 1992, allowed servicing inefficiencies and improper actions

by two servicers to cause financial losses to VA. For example, delayed

reporting of loan liquidations by two servicers resulted in excessive

payments to investors. Another servicer was charging unauthorized sales

management and referral fees to realtors who listed foreclosed properties

for sale. VA officials estimated that these two problems had cost VA more

than $6 million.

We found that VA’s financing and accounting for the guarantees associated

with loan sales in effect masked both the existence of the estimated

liability for defaulted loans as well as the sources of funds being used to

finance those liabilities. Until 1997, VA had not reported or disclosed the

loan sales in its financial statements or budget reports or requested

funding to cover the cost of these guarantees. For example, VA funded

initial cash reserves maintained by its trustee with loan sale proceeds and

did not record this transaction in its financial records. VA also improperly

directed its trustee to use the unreported investment income from some of

the earlier trusts to replenish the reserves to finance the guarantee costs

associated with more recent trusts. When that income became insufficient

to cover the growing guarantee costs, VA used appropriated funds for such

purposes, but lacked the information to accurately tie those costs to the

fiscal year when the loans were sold (guarantees issued). Thus, it could

not properly reflect costs consistent with the underlying principles of

credit reform.1

VA has started efforts to address these deficiencies. For example, it has

developed an action plan and recently contracted with a consulting firm to

bring its financial and budgetary reporting into compliance with credit

reform.

1

We use the term “credit reform” to encompass the (1) Federal Credit Reform Act of 1990, which

generally requires that agencies calculate and record the net present value of loans and loan

guarantees in its credit programs and include the net cost to the government in the budget,

(2) Statement of Federal Financial Accounting Standards No. 2, Accounting for Direct Loans and Loan

Guarantees, and (3) OMB Circulars A-11 and A-34, which provide guidance to agencies for budget

formulation and execution. For additional information on credit reform implementation, see

GAO/AIMD-99-31, Credit Reform: Key Credit Agencies Had Difficulty Making Reasonable Loan

Program Cost Estimates, January 29, 1999.

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Background VA reported in its fiscal year 1997 Accountability Report that the HCA

program, managed by the Veterans Benefits Administration (VBA) under

the direction of the Under Secretary for Benefits, had over $69 billion in

guarantees outstanding on mortgages with a face value of $198 billion. The

primary objectives of the HCA program are to:

• assist veterans, certain reservists, and active duty personnel in obtaining

home mortgage loans from private lenders;

• assist veterans in avoiding foreclosures; and

• deliver loan guarantee benefits as efficiently as possible.

The loan guaranty activity is the primary activity within the HCA program.

VA partially guarantees the loans in lieu of veterans making substantial

down payments and meeting other conditions generally applicable to

conventional mortgage transactions. VA reports that it guarantees

approximately 200,000 loans per year to veterans, certain reservists, and

active duty personnel.

VA, through the HCA program, has responsibility for two secondary

activities described in detail in this report. These activities, intended to

mitigate HCA program losses, are (1) a direct loan activity with a portfolio

valued at over a reported $3 billion as of September 30, 1997, and (2) a

loan sale activity where a reported $1 billion of loans from the direct loan

portfolio are packaged into trusts and sold to investors each year. (See

figure 1.) When a financial institution notifies VA that a veteran’s loan is in

danger of foreclosure, VA may provide assistance to the veteran by

assuming the loan and modifying the terms. The veteran then has a direct

loan payable to VA rather than to the financial institution. This loan

becomes part of VA’s direct loan portfolio. VA estimated that it assumes

2,700 to 3,000 such loans per year.

VA also has the option of allowing foreclosure and paying the claim

resulting from VA’s guarantee. In cases where VA pays the claim, VA’s

involvement ends at this point. However, in approximately 80 percent of

such cases, VA purchases the mortgaged property, having determined that

it can recover part of its costs by reselling the property. At the end of fiscal

year 1997, VA reported more than 16,000 such properties in foreclosure

proceedings.

When these properties are resold, VA uses the proceeds to reduce the cost

of the loan guaranty activity. A VA property may be sold for cash or offered

with a 30-year, fixed rate mortgage. These mortgages are referred to as

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vendee loans. VA reported that it sells approximately 80 percent of its

properties with vendee loans and estimates that it will generate

approximately 18,000 of such loans per year. Although veterans have

preference in the bidding process for these properties, vendee loan

financing is available to all qualified borrowers. The assumed loans and

vendee loans together constitute the majority of VA’s direct loan portfolio.

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Figure 1: Processes Supporting VA

Guaranteed Loans in the Housing

Credit Assistance Program

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Three times a year, VA selects marketable loans from its direct loan

portfolio. The loans are packaged into a trust, and shares in the trust are

sold to private investors through private sector underwriters with a

guarantee of prompt payment of principal and interest owed. VA backs the

guarantee with the full faith and credit of the U.S. Government. With each

sale, a new trust is created, and each trust is to have a cash reserve based

on the size of the portfolio sold and the terms of the sales agreement. VA

reported that since 1992 it has sold approximately $9 billion of loans in

this manner. Before 1992, VA sold loans under a different financing

structure wherein VA retained a percentage of the ownership in the trusts.

As a result of these pre-1992 loan sales, VA reports that it holds an

investment valued at $318 million.

In response to a growing recognition of federal financial management

problems, the Congress enacted a series of laws designed to improve

financial management and the quality and use of cost data in

decision-making. To address the deficiencies in recognizing the cost of

credit programs, the Federal Credit Reform Act of 1990 (Credit Reform

Act) was enacted as part of the Omnibus Budget Reconciliation Act of

1990. The Credit Reform Act was intended to ensure that the full cost of

credit programs would be reflected in the budget so that the executive

agencies and the Congress could consider these costs when making

budget decisions.

Objectives, Scope,

and Methodology

Our objectives were to assess the level of control and accountability over

VA’s HCA direct loan and loan sale activities. To address our objectives, we

reviewed the VA OIG’s audit documentation on the loans receivable and

liability for loan guarantee line items, and interviewed VA officials from the

HCA program, accounting, and budget offices. We discussed the processes

for managing credit activities and recording related financial information.

We compared VA’s accounting practices to federal accounting standards

and industry standards. We interviewed staff at the nation’s largest

portfolio manager of residential housing loans to obtain information on

management and monitoring processes.

We analyzed VA’s internal memoranda regarding planning for the transfer

of the direct loan portfolio to an outside servicer, and interviewed VA staff

at headquarters and regional offices as well as contractor staff. We

assessed VA’s monitoring of contractors’ work in the direct loan and loan

sale activities and reviewed VA’s monitoring reports. We also reviewed a

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1996 report on internal controls over loan sales, for which VA contracted

with a consulting firm.

We briefed VA’s management on the deficiencies in the HCA program

uncovered in the audit of the fiscal year 1997 financial statements, for

which the OIG issued a qualified opinion. We also obtained and reviewed

information from VA about the current status of corrective actions on the

reported issues.

We conducted our work from September 1997 through January 1999 in

accordance with generally accepted government auditing standards.

We requested written comments on a draft of this report from the

Secretary or his designee. The Secretary of Veterans Affairs provided us

with written comments, which are discussed in the “Agency Comments”

section and are reprinted in appendix I.

VA Lacked

Accountability and

Control Over Its

Direct Loan Portfolio

VA did not effectively plan or carry out the transfer of its direct loan

portfolio to an outside contractor for servicing in fiscal year 1997.

Although outsourcing loan servicing is common, VBA officials did not

sufficiently consider the control implications of transferring such a

significant asset to an outside contractor.

An effective internal control structure is as important, if not more

important, under outsourced loan servicing arrangements than when loan

servicing is performed in house. While the authority for daily operations

has been shifted to a private sector entity, cognizant agency officials

remain responsible for the efficient, effective, and economical

management of the outsourced activity. In this case, VA was responsible

for determining the adequacy of the servicer’s internal control

environment, as well as establishing and maintaining its own data or data

sources for comparison purposes to allow it to be confident that the

activity is being managed in the best interest of the federal government. As

of September 1998, about 15 months after the transfer, VA was unable to

fully account for the number, value and status of direct loans in its

inventory, and had been receiving payments through the servicer for

several hundred loans that could not be matched to either servicer or VA

loan account records. VA had not yet established adequate controls over

cash collected or disbursed on its behalf by the contractor and was unable

to properly reconcile the cash flows reported by the contractor to those

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recorded in VA’s general ledger. In addition, there were serious delays in

depositing receipts to VA’s account at Treasury.

Furthermore, VA had transferred incomplete and inconsistent loan data to

the contractor. This situation contributed to the contractor’s problems in

servicing the loans and resulted in inconveniences to some borrowers. For

example, there were delays in allocating payments to some borrowers’

accounts and in paying property taxes on their behalf as well as paying

property taxes on VA-owned houses.

Inadequate Planning for

Outsourcing

VA officials stated that in outsourcing the servicing of the direct loans in

June 1997, they saw an opportunity to replace outdated systems2

 and

concurrently to reduce staff. Rather than managing the loan portfolio out

of more than 40 independent regional offices, the direct loan portfolio

would be serviced by a private-sector contractor, in cooperation with VA’s

regional office in Indianapolis. The outsourcing was also seen as a way to

better meet the cost data requirements for federal credit programs, since

the contractor’s systems offered the ability to code all loans and

associated expenses and revenues by the loan origination year, necessary

information for satisfying the Credit Reform Act. Because the same data

are required for financial reporting, the outsourcing was also seen as a

way of enabling compliance with federal accounting standards.

The outsourcing plan called for VA to transfer its direct loan portfolio to a

contractor that would provide computer facilities and programs for

servicing. The contractor also received records related to property still

owned by VA and awaiting sale. The winning bidder, Computer Data

Systems, Incorporated. (CDSI) (hereafter referred to as the contractor), had

a commercial system, called the Loan Servicing Automated Management

System (LSAMS), to process, service and account for mortgage loans. CDSI

subcontracted with Seasons Mortgage Group (SMG) (hereafter referred to

as the servicer) to service the loan portfolio, a function consisting of

collecting and allocating mortgage payments from borrowers, pursuing

delinquent accounts, maintaining custody of escrow accounts, paying

property taxes and hazard insurance for borrowers, and transferring

revenue to Treasury for crediting to VA accounts. In addition, the servicer

was to pay property taxes related to VA-owned property. (See figure 2.)

2

Starting in fiscal year 1986, the inadequacy of VA’s portfolio loan system, implemented in 1964, was

reported as a material weakness in VA’s Federal Managers’ Financial Integrity Act (FMFIA) reports.

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Figure 2: Contractors Involved in VA’s

Direct Loan and Loan Sale Activities

In preparation for the transfer, VA supplied CDSI with a list of the data fields

in VA’s Portfolio Loan System (PLS), including those containing borrower

names and addresses, amounts for principal, escrow and outstanding

balance, and status of payments of property taxes and hazard insurance.

CDSI then mapped3 those fields onto the fields in LSAMS in preparation for

the initial transfer of loan records. VA created a tape of the information in

PLS and sent the tape to CDSI to be loaded onto LSAMS. VA also created a tape

of information from its Property Management System (PMS) to provide CDSI

with information on VA-owned properties for which it would be paying

property taxes.

VA Did Not Retain Records

to Account for the Number

and Status of Loans

As discussed later, even though the loan data originally submitted to the

contractor were not adequate for servicing purposes, VA was able to

reconcile contractor and agency records on the 24,000 loans with an

outstanding balance of $1.2 billion4

 that were initially transferred.

However, its ability to reconcile and to provide assurance regarding the

accuracy of contractor data in LSAMS deteriorated almost immediately.

Right after the data transfer, VA shut PLS down, eliminating its most

3

Mapping involves matching the fields (e.g., loan number) from one database to the fields in another

database.

4

The $1.2 billion represents only the outstanding balances on loans transferred to CDSI. For financial

statement reporting, the $3 billion loans receivable account balance includes the outstanding balance

for loans, VA-owned property, and accrued interest.

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comprehensive source of automated information on its direct loan

portfolio. Concurrently, VA management instructed staff at the regional

offices to send all hard-copy loan files to the servicer, except the originals

of property deeds and deeds of trust that document the loans. The intent

was to aid in SMG’s loan servicing. According to VA officials, although the

regional offices included an inventory of loan information with the files

they sent, regional staff were not advised to retain a copy of the inventory,

nor did they do so. Three months after the transfer, the regional offices we

visited had retained only a few files, aside from the original mortgage and

title documents, regarding the loans originated in their offices.

Data Quality Problems There were immediate problems with SMG’s ability to service borrowers’

accounts because of inconsistencies in how name and address information

had been recorded by regional offices. The data transferred had not been

critically reviewed to determine whether it would meet the contractor’s

data requirements, nor had the data been cleaned up prior to transfer to

LSAMS. As a result, what would typically have been a straightforward

procedure for developing a mailing list to send loan coupons to borrowers

led to serious problems. Loan coupons were sometimes misaddressed

because of name problems (e.g., “Mr. Smith John” instead of “Mr. John

Smith”) or address problems (e.g., the mortgaged property addresses

instead of where borrowers actually lived). In some cases, insufficient

information resulted in SMG not being able to contact borrowers at all. All

of these factors contributed to delays in payments being made, increasing

VA’s financial risk. Meanwhile, borrowers were not getting information

they needed. VA officials informed us that they were not able to send IRS

Form 1098, the 1997 Mortgage Interest Statement tax form, to some

borrowers by January 31, 1998.

A major reason for the extent of the inaccurate and incomplete data was

the presumption that VA regional offices had consistently and completely

entered the data into PLS. Although the regional offices had administered

the direct loan portfolio for more than 30 years, we found that VA did not

adequately involve them in planning for the transfer or adequately advise

them of procedures to be followed after the transfer. Prior to outsourcing,

VA’s regional offices entered loan information in PLS according to their own

preferences, because VA had not established standardized procedures. For

example, some regional offices used PLS for certain loan information while

maintaining other loan-related data elsewhere. Among the data that were

not consistently entered in PLS were real estate tax data. This was because

each regional office worked with a limited number of taxing jurisdictions

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and some regional offices may have it found more convenient to maintain

the data elsewhere.

SMG staff soon realized that in many cases they lacked basic information

about amounts and deadlines for taxes due on VA-financed properties.

Within a few months of the transfer, SMG staff notified VA that they could

not ensure that property taxes would be paid on time and in full on every

property. Although the contract clearly stated that late payment penalties

were the servicer’s responsibility, VA acknowledged that it had contributed

to the delays and VA agreed to pay all penalties for late taxes. According to

VA officials, during fiscal year 1998, these penalties amounted to $26,000 to

$27,000 per month. VA told us that, prior to outsourcing, it had paid

approximately $6,000 per month for penalties for late taxes. As of

January 1999, VA and SMG were discussing available options for reducing

late-payment penalties.

Concurrently, in the months immediately following the outsourcing, VA

was experiencing difficulties in accounting for the loans in the direct loan

portfolio. As regional staff continued to foreclose on VA-financed

properties, take back foreclosed properties, resell properties with new

mortgages, and assume veterans’ loans, there were serious timeliness and

accuracy problems in getting the necessary information to CDSI/SMG. As a

result, LSAMS started presenting an incomplete picture of the loans in VA’s

portfolio. The major breakdown was the delay in VA providing data to SMG

on loans that VA assumed when borrowers defaulted. As of September 30,

1998, LSAMS data showed that the assumed loans represented

approximately 53 percent of the value of VA’s direct loan portfolio. VA data

showed that assumed loans often went unrecorded for extended periods

because it frequently took months and even years for VA staff to receive

final documents from financial institutions. In addition,VA did not

thoroughly review the data for accuracy.

The process under which VA assumes a guaranteed loan has proven to be

an extended task. It includes purchasing the loan from the financial

institution that holds it and then typically modifying the loan terms, such

as interest rates or repayment periods. Prior to the outsourcing

arrangement, VA regional staff serviced assumed loans, collected the initial

payments, and entered these loans in PLS.

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SMG would not accept assumed loans in its system unless and until the

loans were fully established.5

 After the transfer, assumed loans were not

being recorded in any automated system until they were fully established.

Since regional offices maintained paper files for assumptions in progress,

there was no overall central reporting mechanism to establish visibility,

and therefore accountability, over these loans.

VA has developed procedures for loan assumptions that VA officials believe

will shorten the time it takes for it to assume VA defaulted guaranteed

loans. These procedures include required settlement dates for all assumed

loans within 60 days after VA approves the loan assumption request. By

refusing to pay supplemental claims after 60 days, VA believed that it would

increase the incentive for lenders to transfer all necessary documentation

promptly.

Over the period of our fieldwork, data on assumed loans was recorded by

VA’s regional staff on a multipage form, which was reviewed by the

Portfolio Loan Oversight Unit (PLOU) staff in Indianapolis before being

entered into LSAMS. We found that PLOU’s review was not an in-depth

assessment, since PLOU staff maintained no loan files and were, therefore,

unable to check the accuracy of important items such as payment amount,

outstanding principal, amortization and escrow amount. PLOU staff

informed us that they checked that all fields on the sheets were filled in

and that the correct fiscal year was entered for the assumption. If errors in

this basic information were found on the data sheets, PLOU staff returned

the sheets to the regional offices for correction. As of September 1998,

PLOU staff told us that they were having an error rate of up to 40 percent

for these data sheets. This error rate further delayed loans and their

associated cash payments from being recorded in LSAMS records and VA’s

general ledger, and understated the loans receivable balance. As discussed

in a later section of this report dealing with cash management problems,

such errors also resulted in delays in cash receipts for the federal

government.

In July 1998, VA issued instructions to the regional offices to have the

multipage form reviewed by their respective finance departments, since

they have access to the vital information, before the form is sent via

electronic mail to PLOU. As of December 1998, a PLOU official told us that

the error rate had dropped substantially but was still about 5 to 6 percent.

5

A loan is established when VA has a modification agreement with the veteran and has received all

necessary documents pertaining to the loan.

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VA also experienced problems in transmitting to LSAMS reliable data on

properties previously owned by VA which had been recently sold with VA

direct financing, referred to as vendee loans. Previously, there had been an

electronic link between VA’s Property Management System (PMS)6

 and PLS,

so that as VA-owned properties were resold with VA direct financing, that

information would update PLS. After the shut-down of PLS, VA created a

temporary arrangement whereby a staff member would download vendee

loan information monthly from PMS and transmit it to LSAMS for entry.

Under this system problems such as duplicate loan numbers, which delay

servicing of the loans, were not detected until the monthly transfer. As of

October 1998, VA was developing an automated file transfer system with

CDSI, which is intended to give VA the means to transfer this information to

LSAMS automatically each month.

All of these problems negatively affected allocation of payments to the

appropriate accounts. During the period of our review, we found that SMG

was regularly receiving loan payments, which for the most part referenced

a loan number, but SMG could not match the payments to the accounts of

any borrowers in LSAMS or VA’s records. In some cases, as many as 10

months of unallocated payments were involved. In September 1998, VA

continued to receive payments for 289 loans that could not be found in

SMG’s database. VA officials told us that no records of the loans involved

could be found within LSAMS or in paper files at regional offices. At that

time, unallocated payments totaled over $541,000 for these 289 loans. Our

analysis of these 289 loans showed that VA had received at least two

payments for 154 of these loans. VA was unable to explain the nature of

these loans or why they had not been recorded. Lengthy delays in getting

loan data into LSAMS increased the risk that borrowers may not have been

making payments on some loans and that neither the servicer nor VA

would be aware of it.

VA officials reported that as of December 4, 1998, they had reduced the

unallocated loan payments to approximately $160,000 and were initiating a

new procedure to further reduce this total. The new procedures require

the servicer to (1) hold, without depositing, loan payments that could not

be allocated to a specific borrower’s account and (2) return the loan

payments to the borrower in cases where two or more payments were

unallocated, or part of the loan number was missing, unless either VA had

instituted the paperwork for the loan in process or the servicer had

received e-mail instructions from one of the regional offices regarding the

borrower.

6

PMS tracks program costs on property owned by VA as a result of foreclosure.

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This new procedure, however, does not address the underlying problem of

VA’s incomplete direct loan portfolio and creates additional cash

management problems. By not depositing these checks, the federal

government may not be receiving cash that it is owed. Common practice in

the mortgage banking industry is to establish a suspense account for

unresolved items and to deposit the checks in the bank until the

appropriate research is completed and the items are allocated to the

proper accounts. Creating suspense accounts heightens the visibility over

the extent of the problem and establishes a control mechanism for

resolving open items. This technique also would help ensure that loans

originating in the regional offices are recorded in VA’s loan database.

Inadequate Controls Over

Assets and Cash in the

Direct Loan Portfolio

Many of the problems that followed outsourcing, including the breakdown

in the control environment for loan assets and cash, could have been

avoided or mitigated if VA had developed a loan origination database. For

example, in the mortgage banking industry such a database is commonly

used to manage portfolios of direct loans and loans sold with a guarantee

that are serviced by other entities. The database generally contains all loan

information needed to amortize a loan, including origination date, original

and current loan balance, interest rate, payment date, and term of the loan.

Additional information includes the borrower’s name, property and

borrower’s address, borrower’s social security number and escrow

balance on every direct loan and loan guarantee. Using a similar database

as a management control for its direct loan program, VA would be able to

forecast expected cash flows, and reconcile cash receipts, disbursements,

and loan activity with servicer records. Discrepancies between VA and

servicer’s data then could be investigated and reconciled promptly.

Furthermore, VA, in the absence of such a database, did not confirm the

validity and accuracy of collections and disbursements reported by the

contractor by alternative means, such as examining SMG’s bank statements,

lockbox statements, or tax invoices. Without some kind of verification

procedure, based on its own or third party information, VA did not have an

independent source of data against which to test and validate the

legitimacy of collection and expense amounts reported by SMG. As a result,

VA had no way of knowing whether SMG was collecting all payments that

were due or whether VA was reimbursing SMG for only valid expenses.

Insufficient

Documentation to Perform

Reconciliations

In VA’s reconciliation at the end of September 1998, reflecting CDSI’s entries

through June 1998, VA could not reconcile differences between contractor

and VA records. For example, there was a difference of almost $4 million

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for loan principal outstanding. Since VA does not have either a complete

list of loans, or information on adjustments made by CDSI or the regional

offices, VA could not determine whether this difference was due to errors,

irregularities or merely timing differences.

Cash Management

Problems

Under the terms of the servicing agreement, SMG established an

interest-bearing bank account in its name for the deposit of all loan

payments made by VA’s borrowers. As payments were received, SMG

attempted to apply payments to the appropriate borrowers’ accounts and

allocate payments to principal, interest, and escrow amounts. The contract

called for SMG to remit by wire to VA on the third business day of each

month the total sum of funds collected, including all principal and interest

due, with respect to payments received by SMG during the previous month.

In addition, VA allowed SMG to defer remittance of any receipts that could

not be allocated to loan accounts. VA also allowed SMG to keep all of the

interest accrued in this account which, essentially, resulted in additional

compensation to SMG. The Contracting Officer’s Technical Representative

(COTR)7

 told us that since the contract did not specifically require SMG to

remit to VA unallocated funds until they were allocated or to remit interest

earned on this account, these practices were permissible.

These unallocated funds included funds for which SMG could identify the

loan account, but, for a variety of reasons, SMG did not allocate. This pool

of unallocated funds remained high throughout the period of our

fieldwork. For example, in October 1997, 3 months after SMG began

servicing the direct loan portfolio, SMG reported $3.2 million in unallocated

funds. When we questioned VA officials about the reasons for this large

amount, they attributed it to “the float.” They explained that loan payoffs,

which required only a few days to be allocated, represented the majority of

the unallocated funds, and that because new payoffs were constantly

being added, the balances of unallocated amounts in SMG’s account

remained relatively stable.

While our limited testing did confirm that the majority of these unallocated

funds were loan payoffs and the amount of unallocated funds remained

relatively high but stable, we also found that loan payoffs did not always

clear in a few days. For example in September 1998, we requested from

SMG schedules of unallocated funds on deposit as of August 31, 1998, and

February 28, 1998. On the February schedule, SMG reported over

7

A COTR is designated as VA’s authorized representative for technical monitoring and other functions

of a technical nature not involving a change to the scope, price, terms, or conditions of the contract.

The COTR is responsible for certifying as to the satisfactory delivery of service.

Page 16 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

$2.5 million in unallocated funds of which loan payoffs represented

$1.6 million, or 64 percent of the total. We traced loan payoffs from the

February schedule to the payoffs on the unallocated schedule of August

1998. We found that approximately $618,000, or 37 percent of the loan

payoff amounts on the February 1998 schedule were still unallocated 6

months later.

Allowing the contractor to deposit these federal collections in its account

and the delays in transferring funds to federal accounts violates federal

law. An important statute governing federal fiscal management is 31 U.S.C.

3302(b), known as the “miscellaneous receipts” statute. Section 3302(b)

requires that government officials and agents of the United States

government receiving money on behalf of the government from any source

shall deposit the money in the general fund of the Treasury as soon as

practicable without deduction for any charge or claim. As a result of

section 3302(b), officials and agents of the government may retain and use

funds they receive, rather than depositing them in the general fund of the

Treasury, only if authorized by another law.

Subsequent legislation, the Credit Reform Act requires that cash flows to

the government resulting from direct loan obligations or loan guarantee

commitments made prior to October 1, 1991, go to the credit of the

program’s liquidating account at Treasury, which is a budgetary account.

The act also requires that cash flows to the government resulting from

direct loan obligations or loan guarantee commitments beginning

October 1, 1991, go to the nonbudgetary financing account at Treasury

associated with the related credit program. In this regard, VA has not

provided us and we have not identified any statute that authorized VA to

contractually or otherwise permit SMG to retain the interest earned on

these government moneys as a form of compensation, instead of crediting

the interest to the appropriate VA account.

Section 3302 also addresses the timing of deposits to the Treasury. Section

3302(c) requires that a person having custody of public money deposit the

money in the Treasury, or in a depository designated by the Secretary of

the Treasury, not later than the third day after the custodian receives the

money. Subsection (c) also authorizes the Secretary of the Treasury to

prescribe a greater or lesser period for deposit. The Treasury Financial

Manual states that depositors should deposit funds in Federal Reserve

Banks unless otherwise authorized, and that deposits should be made

daily.8 VA did not request Treasury to designate a depository before it

8

See I TFM Sections 4010, 4015.

Page 17 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

authorized SMG to establish a bank account and remit funds to VA only once

a month. Had SMG, instead, deposited the funds it collected in a Federal

Reserve Bank for credit to the liquidating and financing account on a daily

basis, no interest would have accrued to SMG on the deposit of payments

made on VA loans. To the extent SMG earned interest on the loan payments

it received, VA should have had SMG remit the amount of interest to VA for

credit to the appropriate liquidating and financing accounts. Because VA

permitted SMG to retain interest on loan payments SMG was not entitled to

receive under law or contract, these amounts should now be recovered.

In comparison to VA’s contractual arrangement with CDSI/SMG, we looked at

the practices of Fannie Mae, the nation’s largest portfolio manager, which

regularly uses private-sector servicers for its direct loans. We found that as

a means of maximizing its interest income while controlling cash flow,

Fannie Mae requires servicers to remit cash receipts at a minimum on a

daily basis, and more frequently if collections exceed $2,500.

Noncash Adjustments

Were Made Without

Oversight

Noncash adjustments represent changes made to principal loan balances

without cash payments or disbursements being made. After transferring

loans to SMG for servicing, the regional offices continued to submit

noncash adjustments to SMG to change the outstanding loan balances of

borrowers’ accounts. In ordinary business practice of financial

institutions, noncash adjustments are unusual events that require an

explanation by the person making the adjustment and the approval of a

supervisor. Yet VA regional staff were permitted to forward noncash

adjustments regularly, causing principal balances to go up and down,

without proper approvals or documentation. For example, during

October 1997, SMG recorded approximately $250,000 in noncash

adjustments requested by the regional offices. As a result, VA lacked

assurance that changes were legitimate and that funds were not being

misdirected. When we advised VA management of these activities, it

promptly instituted a formal review process for all changes, which

required documentation, supervisory approval, and PLOU authorization.

VA Lacked

Accountability and

Control Over Its Loan

Sale Activity

Three times a year, VA selects marketable loans from its direct loan

portfolio, packages them, and sells them to investors through an

underwriter in order to recoup costs for the HCA program. These loans are

sold with a guarantee of payment of principal and interest and are backed

by the full faith and credit of the United States. Since fiscal year 1992, the

funding for this type of guarantee has been subject to the Credit Reform

Page 18 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

Act and OMB’s guidance but, until recently, VA had not complied with the

requirement to estimate the future liability related to these loan sales and

to include the estimated cost of the liability in its annual budget request to

the Congress. VA also had not been disclosing and properly accounting for

these sales and the associated liability created by the guarantees in its

financial statements as required by federal accounting standards.

Furthermore, VA had not established an effective control environment for

monitoring the servicing on these loans.

Since the mid-1980’s, VA has engaged the services of an investment banking

firm to sell securities backed by marketable loans in the direct loan

portfolio.9

 Each of the sales has a separate trust agreement, which calls for

a separate cash reserve associated with each trust based on the size of the

portfolio sold and the terms of the sales agreement. Initially, VA funded

these cash reserves from a portion of the proceeds VA received from the

sale of loans as stipulated in the sales agreement.

Each trust has a loan servicer to collect monthly payments from the

borrowers and perform other traditional loan servicing functions,

including handling defaults, foreclosures, and routine payoffs. VA has hired

the trust department of a major bank10 to serve as the trustee/custodian for

all of these trusts. (See figure 2.) The trustee/custodian manages the trusts,

maintains the custody of all funds (including VA’s cash reserves), pays the

certificate holders, reports to taxing authorities, and provides investors

relevant data needed for filing their annual tax returns.

In practice, the servicer deposits receipts from the servicing activities in a

depository account managed by the trustee/custodian. The

trustee/custodian subsequently transfers these funds to its distribution

account to pay investors. When funds in the distribution account are

insufficient to pay investors, the trustee/custodian transfers funds from

VA’s cash reserve account into the distribution account.

Because the loans are sold with guarantees to maximize the sales yield, VA

has a contingent liability to the certificate holders as long as these loans

remain outstanding. To the extent that loans default and aggregate cash

flows are inadequate to pay investors and trust expenses, the guarantee

feature comes into play. Because of this guarantee, VA has a responsibility

and vested interest in monitoring the servicer and trustee/custodian

9

Purchasers buy certificates representing a percentage of ownership in the trust. The certificates are

collateralized collectively by all of the loans in the portfolio and guaranteed by the U.S. government.

10Banker’s Trust of California is the trustee/custodian for all of the trusts.

Page 19 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

activities to maximize the cash flow from loan servicing operations and to

minimize expenses.

Little Oversight Over Loan

Servicers and the

Trustee/Custodian

Although the sales contract requires VA to replenish cash reserves when

needed, in our opinion, an effective control environment requires on-site

monitoring of contractors to ensure that the transactions reported are

reasonable and appropriate. OMB provides guidance to credit agencies to

evaluate and enforce servicers’ performance. This guidance states that

agencies should undertake biennial on-site reviews of their contractors

where possible, but recommends annual on-site reviews for all lenders and

servicers with substantial loan volume.11 The OMB guidance states that

agencies are to manage federal credit programs to ensure that federal

assets are protected and that losses are minimized in relation to the social

benefits provided by credit programs.

VA did not comply with OMB guidance, and the trustee/custodian and the

four servicers used by VA operated with little oversight. For example,

although VA had been selling loans in a trust structure since the late 1980’s,

it did not begin monitoring its servicers until 1994. As of October 1998, it

had only reviewed three of its four servicers, and no servicer had been

reviewed more than once. Further, VA had never reviewed the

trustee/custodian.

At one servicer, VA found procedural problems it characterized as not

resulting in any significant cost to the government. However, the other two

servicers had servicing inefficiencies and had engaged in unauthorized

practices. VA’s reports on those servicers estimated that the two most

serious findings cited had cost VA more than $6 million over the period of

the trusts they were servicing. Specifically,

• Servicers were not reporting cash receipts resulting from loan

liquidations12 in a timely manner to the trustee/custodian. As a result, the

trustee/custodian was not aware that principal and interest payments to

investors were to be correspondingly reduced. Another salient factor is

that servicer fees are calculated as a percentage of outstanding loan

principal being serviced. Thus, any delays in reporting liquidations would

result in both excessive payments to investors as well as servicer fees

11OMB Circular A-129 (as revised 1/11/93), Policies for Federal Credit Programs and Non-Tax

Receivables.

12Loan liquidations are the proceeds of the sale of property from a defaulted mortgage.

Page 20 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

unless they were timely detected and appropriate adjustments made to

both investor payments and servicer fees.

• One servicer was charging certain sales management and referral fees to

realtors who listed foreclosed properties for sale. Such practices were not

authorized under the servicing agreement. In its monitoring report, VA

stated that the realtors who paid the fee to the servicer had, in effect,

agreed to sell the property for a lesser net commission than VA actually

paid. The servicer received the increment, which, according to VA’s report,

ranged from 1 percent to 1.3 percent, thus increasing VA costs and

reducing net sale proceeds.

In response to these monitoring efforts, VA officials told us that they are

negotiating recovery of estimated losses of federal revenues with the

servicers involved. They also told us that while VA had not realigned any of

the existing servicing responsibilities, it was channeling all new servicing

work to the entity for whom monitoring efforts had not revealed any

significant problems.

Inadequate Management

Involvement in

Relationship With

Trustee/Custodian

One trustee handles the custodial arrangements for all 31 of the trusts

originated from loan sales dating back to 1988, with reported outstanding

balances of approximately $7 billion as of September 1998. Through the

conclusion of our fieldwork, VA management had taken little action to

oversee the relationship with the trustee/custodian, including management

of the cash reserves and the flow and sharing of critical financial and

budgetary data associated with trust operations. In essence, the loan sale

activity functioned as a stand-alone project, removed from input and

oversight by management, accounting, or budget staff. Financial data were

not adequately shared with staff who needed to review and record them in

VA’s accounting and budget records.

One individual at VA was in charge of all operational and administrative

phases of the loan sale activity, which included preparing the loan sale

documents, calculating the value of the loan portfolio to be sold,

authorizing payments to the trustee/custodian for requested amounts

when cash reserves fell below contractual levels, and receiving financial

reports the contractors generated. In our opinion, such a broad scope of

authority without a strong supervisory presence exposes VA to excessive

risk that improprieties could occur and not be detected, and that

important activities could be neglected. Our 1983 Standards for Internal

Controls in the Federal Government, issued pursuant to the Federal

Financial Managers’ Integrity Act of 1982 to be followed by federal

Page 21 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

agencies, outlines key control objectives and explains specific techniques

for achieving those objectives. Not achieving the goals for two of these

objectives, separation of duties and supervision, contributed to the

observed weaknesses in loan sale activities and reporting.

This situation was a factor in VA not detecting or reversing a key decision

that authorized the trustee/custodian to report financial data within the

trusts on a consolidated basis. The contract with the trustee/custodian

required that the reports to VA provide details for each trust that would

satisfy data requirements for both credit program administration and

financial reporting considerations. A report on the internal controls in the

loan sale activity by a consultant cited the trustee/custodian’s

consolidation of financial reporting for the 12 trusts originated between

1992 and 1996 as a key factor in VA not having the level of detail required to

comply with credit reform requirements. Consolidated, rather than trust

by trust, reporting masked the performance of individual trusts and

eliminated critical data for reasonably estimating program costs under the

Credit Reform Act as well as for reliably reporting on financial statements.

VA Did Not Properly

Account for Loan Sales

and Subsequent Financial

Activity

In addition, VA did not have processes in place to ensure that relevant

reporting from servicers and the trustee/custodian was channeled to

appropriate VA offices. Since all reporting from the trustee/custodian came

to one individual, there needed to be a process for the individual to

provide the reported information to other VA officials who needed the

information for accounting, budgeting, and other purposes. However, we

determined that the accounting staff did not have copies of any of the loan

sales agreements and that the information they had on the loan sale

activity was incomplete because it had either not been forwarded to them

or they had not requested it.

This lack of data on loan sales and related transactions was a factor in

accounting and financial reporting errors. Our review of the accounting

treatment of the loan sale transactions showed that the entries were not in

accordance with adopted federal accounting standards and related

guidance. Specifically:

• VA incorrectly calculated and classified gains and losses on loan sales,

• VA was not estimating and recording the liability for the guarantee on the

loans sold at the time of sale, and

• the reserves held by the trustee/custodian were not recorded in VA’s

general ledger.

Page 22 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

This accounting treatment indicated a lack of familiarity with some

elements of proper accounting for credit transactions. Not recording the

liability and reserves would suggest that VA had no further responsibility

for these loans or a continuing interest in the appropriate servicing of the

loans and maintenance of the cash reserves, which is not the case.

After we advised VA that its accounting and budgetary reporting did not

accurately reflect the loan sales or the contingent liability, VA, in

consultation with OMB, estimated a subsidy and recorded an additional

expense as an aggregate adjustment for future losses and related liability

for the loan sales not recorded between 1992 and 1997. Because the

adjustment was made to the financial statement line item for the direct

loan activity and was aggregated with other adjustments related to direct

loans, we were unable to determine what portion of this $376 million

adjustment was related to the loan sale activity.13

In September 1998, VA contracted with a private-sector firm to develop a

model for estimating the liability for the loan sales, and to reconstruct all

necessary historical information. The firm agreed to research and correct

the missing or improperly recorded financial information and produce

auditable records supporting the information recorded.

Replenishment of Reserves

Not Financed Properly

Periodically, the trustee/custodian asked VA to replenish the cash balances

for the individual trusts to designated levels. VA did not follow the Credit

Reform Act and related requirements when identifying the sources of the

funds to satisfy the underlying federal guarantees. As noted above, VA had

been initially funding the reserve for each trust from the proceeds of the

loan sale transaction. It had not accounted for the source of the cash used

to fund the reserves or estimated and recognized the liability associated

with the federal guarantee. Also, VA was not reporting subsequent

replenishment of the cash reserves or disclosing the funding source.

Under the Credit Reform Act, in order to fund the guarantees, VA should

have estimated its future liability for satisfying guarantees on the loans

sold and included it in annual budget requests to the Congress. In addition,

VA should have notified both OMB and Treasury to set up program and

financing accounts for guarantees made beginning October 1, 1991. These

13The subsidy cost related to these trusts was recorded as part of the direct loan program. However,

OMB Circular A-11 requires that the related subsidy cost for loans sold with a guarantee be included as

part of the loan guarantee program. For fiscal year 1999, VA plans to include the subsidy cost for the

loans sold in the appropriate program.

Page 23 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

accounts are used to record the appropriation for the net cost to the

government for the guarantee, record the sale transactions, and track the

subsequent activity for the loans sold. Annually, VA should have

reestimated the liability and included any reestimate in its budget and

financial statements.

Instead, VA had been financing those replenishments off the books.

Specifically, VA did not record the interest income or the replenishments of

the reserve in its accounting records. For several precredit reform loan

sales, VA reported that it had retained investments valued at $318 million as

of September 30, 1997. We found that VA had been improperly using the

income from those investments to finance replenishment of the reserves

for trust agreements initiated after 1991 (those subject to credit reform

requirements). VA officials told us that since the income from all of the

trusts flowed to the same trustee/custodian, they had instructed the

trustee/custodian to use the investments to finance replenishments for the

post-1991 trusts. The Credit Reform Act clearly stipulates that income

arising from pre-1992 credit activities must be used only to offset expenses

arising from those same activities. Such income is not to be used to offset

expenses for post-1991 activities, which is what VA routinely did.

VA exclusively relied on income from the pre-1992 investments to replenish

the reserves of post-1991 trusts until fiscal year 1997, when income from

that source became insufficient. At that juncture, VA started using funds

from the direct loan financing account to replenish the trust reserves in

fiscal years 1997 and 1998.

For fiscal year 1997, VA transferred $14 million to the trustee/custodian to

augment cash reserves from the 1997 cohort14 of its direct loan financing

account15 because, as described above, it had not set up the appropriate

financing mechanism to finance those losses. In 1998, VA transferred

another $40 million from the 1998 cohort in its direct loan financing

account to replenish the reserves.

14As described in OMB Circular No. A-34, a cohort applies to post-1991 direct loans and loan

guarantees committed by a program in the same fiscal year even if disbursements occur in subsequent

fiscal years. Accounting and other records must be maintained separately for each cohort within the

program’s financing account. Any payment for losses from the financing account must be applied to

the cohort in which the original loan was disbursed.

15Under the Federal Credit Reform Act of 1990, a financing account is the nonbudgetary account or

accounts associated with each credit program account, which holds balances, receives the subsidy

cost payment from the credit program account, and includes all other cash flows to and from the

government resulting from post-1991 direct loans or loan guarantees.

Page 24 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
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While VA had started to shift to post-credit-reform financing sources for the

post-1991 trusts replenishments, it did not have the information that would

enable charging the cost of replenishing the related reserves to the proper

fiscal years (cohorts). Financing all the losses incurred for any particular

year from just one cohort is contrary to the basic concept outlined in OMB’s

Circular A-11, implementation guidance for the Credit Reform Act, which

attempts to accurately account for costs by the fiscal year in which the

activity was originated. VA officials are currently in discussion with

Treasury officials on establishing the appropriate funding mechanism for

the guarantee on loans sold.

Conclusions The purpose of the loan sale and direct loan activities discussed in this

report is to provide opportunities for mitigating losses on defaulted

VA-guaranteed loans in the HCA program, where reported guarantees

outstanding total $69 billion. VA has not been successful in moving to

outsourcing arrangements for these activities. It has not yet instituted

adequate safeguards over either the assets or the cash flows managed by

private contractors. Until it establishes an adequate evaluation base and

more stringent monitoring activities, it will provide little assurance to

others that the HCA programs are being run prudently. Instituting the kinds

of controls employed by major owners of housing loan portfolios is

necessary and would help in forming the basis for good program

management and reliable data for reporting financial and budgetary

results.

Recommendations In order to effectively manage loan assets and the cash flows associated

with VA’s direct loans, we recommend that the Secretary of Veterans

Affairs direct the Under Secretary for Benefits to:

• Provide a basis for monitoring and controlling loan and property assets

and any related cash flows managed by contractors by establishing a

database for direct loans, through the development of a complete

inventory of all loans originated. The database should be similar to the

information systems in place at major owners of housing loan portfolios.

Benchmarking with major owners of housing loan portfolios should offer

perspective in the data requirements and capabilities offered by such

systems for creating an adequate control environment for overseeing both

in-house activities as well as outsourced functions.

• Implement processes to allow immediate improvements in VA’s capability

to monitor contractor servicing of direct loans and disbursements related

Page 25 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
B-280807 

to VA-owned properties. These improvements would include periodically

obtaining tax bills for VA-owned properties from independent sources and

comparing this information to that in its Property Management System to

validate servicer requests for reimbursement of expenses.

• Develop a centralized database to immediately record loans in the process

of being assumed by VA in order to establish timely and thorough visibility

over those assets and to facilitate transferring such information to the

contract servicer expeditiously.

• Reconcile all loan records in the contractor’s database to VA’s general

ledger on a monthly basis, by the end of the following month.

• Continue to develop standardized policies and procedures intended to

ensure completeness, consistency, and accuracy of data obtained and

recorded concerning individual loans and properties. Implement quality

assurance steps to ensure the accuracy of this data.

• Adhere to federal legislation and guidance regarding cash management.

Servicers should be instructed to remit all proceeds to VA’s Treasury

accounts daily upon receipt. Further, VA should recoup the total interest

earned on SMG’s account balances from the inception of VA’s contract with

CDSI/SMG.

• Establish suspense accounts, and a control account in VA’s general ledger,

to record all collections that cannot be allocated to specific loan accounts.

Regarding gaining operational and accounting control over loan sale

activities, the Secretary of Veterans Affairs should direct the Under

Secretary for Benefits to:

• Complete the reconstruction of the historical data for the loan sales, the

resulting trusts, and financing for the required reserve accounts for each

trust.

• Establish adequate separation of duties and supervision over VA staff

involved in all loan sale operational and administrative activities.

• Develop and implement procedures to ensure that relevant data from

servicers and the trustee/custodian are provided promptly to VA offices

responsible for managing or recording trust activities and transactions.

• Record loan sale transactions and all subsequent activity associated with

the trusts consistent with federal accounting standards and any related

guidance. This would include:

• making appropriate accounting adjustments to accurately reflect the

results of prior years’ transactions and

• recording all financial transactions relating to trust activities, including

those associated with the original sale, the establishment of the

reserves, drawdowns to satisfy the federal guarantee, subsidy

Page 26 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
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reestimates, and replenishments to satisfy trust agreement provisions as

well as revenue from trust investments and assets.

Finally, we recommend that the Secretary of Veterans Affairs direct the

Under Secretary for Benefits to:

• Establish and implement adequate monitoring activities of outsourced

activities to include both direct loans and VA property servicing as well as

activities associated with the loan sales. These efforts should be designed

to comply with OMB Circular A-129 and be stringent, given the risks

inherent in the existing servicing environment.

• Disclose cash flows related to loan sales and related guarantees in VA’s

budget records, calculate and report the cost of direct loans and loan

guarantees, and budget for the subsidy and administrative cost of the loans

and guarantees in accordance with the Credit Reform Act and OMB Circular

A-11.

Agency Comments

and Our Evaluation

In commenting on a draft of this report, VA concurred with 11 of our 13

recommendations and agreed to implement them as part of its current

effort to correct direct loan and loan sale records. Of the remaining two

recommendations, VA disagreed with one, and reserved agreement pending

a legal opinion on the other.

VA characterized the financial management weaknesses presented in this

report as being relatively minor. We disagree. By any measure, the

problems we identified are material financial and management control

weaknesses. The problems discussed in this report are so pervasive that

they resulted in qualified opinions by VA’s Office of the Inspector General

on VA’s financial statements for both fiscal years 1997 and 1998. The

$3 billion in loans and VA-owned property and $9 billion in potential

liability on loan sales represent guaranteed loans previously serviced by

private lenders that went into default and were acquired by VA. VA now

bears the primary responsibility for insuring prudent management of these

assets, in an effort to recoup losses and to preclude additional losses on

the properties for which loans were originally guaranteed.

VA stated that it had initiated a number of corrective actions. In our report,

we recognize that VA is taking good first steps to correct these problems,

and our recommendations for improvements are intended to assist the

agency in attaining the level of accountability and control envisioned in

the growing body of financial and program management legislation.

Page 27 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
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VA did not concur with our recommendation that it test the validity of

contractor billings for property taxes paid on VA’s behalf. VA stated that its

Portfolio Loan Oversight Unit uses the Property Management System to

verify these payments. We agree that verifying VA ownership of property in

order to determine whether VA had any responsibility for taxes on

individual properties is a good first step. However, the thrust of our

recommendation is that VA verify that amounts paid for property taxes

were accurate. As pointed out in our report, VA could accomplish this by

obtaining tax data through readily available means. The verification could

be accomplished efficiently by testing selected transactions that provided

a statistically valid sample. Verifying the amounts in sample transactions

would provide adequate assurance that the billings from the contractor

were reasonable.

Finally, VA pledged to modify its processes to adhere to cash management

principles established in federal legislation and other guidance. It did not

take issue with our view that federal law does not authorize VA to

contractually or otherwise permit the contractor to retain interest earned

by depositing federal collections in the contractor’s account. Regarding

the matter of recouping of interest earned by the contractor, VA neither

concurred nor disagreed with our recommendation, stating that its

General Counsel is reviewing the issue of recoupment.

We are sending copies of this report to Senator Arlen Specter, Senator Ted

Stevens, Senator Robert C. Byrd, Senator Fred Thompson, Senator Joseph

Lieberman, Senator John D. Rockefeller IV, Representative C. W. Bill

Young, Representative Lane Evans, III, Representative Bob Stump,

Representative David Obey, Representative Dan Burton, and

Representative Henry A. Waxman in their capacities as Chairmen or

Ranking Minority Members of Senate and House Committees. We are also

sending copies to Togo D. West, Jr., Secretary of Veterans Affairs, the

Honorable Jacob J. Lew, Director of the Office of Management and

Budget, and the Honorable Joseph Thompson, Under Secretary for

Benefits of the Department of Veterans Affairs. Copies will be made

available to others upon request. If you have any questions or wish to

discuss the issues in this report, please contact me at (202) 512-4476.

Major contributors to this report are listed in appendix II.

Gloria L. Jarmon

Director, Health, Education and Human Services,

 Accounting and Financial Management Issues

Page 28 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Page 29 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Contents

Letter 1

Appendix I 

Comments From the

Department of

Veterans Affairs

32

Appendix II 

Major Contributors to

This Report

39

Glossary 40

Figures Figure 1: Processes Supporting VA Guaranteed Loans in the

Housing Credit Assistance Program

6

Figure 2: Contractors Involved in VA’s Direct Loan and Loan Sale

Activities

10

Abbreviations

CDSI Computer Data Systems, Incorporated

CDSI/SMG Computer Data Systems, Incorporated/Seasons Mortgage

Group

COTR Contracting Officer’s Technical Representative

FMFIA Federal Managers’ Financial Integrity Act

GAO General Accounting Office

OIG Office of Inspector General

OMB Office of Management and Budget

HCA Housing Credit Assistance Program

LGY Loan guaranty activity

LSAMS Loan Servicing Automated Management System

PLOU Portfolio Loan Oversight Unit

PLS Portfolio Loan System

PMS Property Management System

SFFAS Statement of Federal Financial Accounting Standards

SMG Seasons Mortgage Group

USC United States Code

VA Department of Veterans Affairs

VBA Veterans Benefits Administration

Page 30 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Page 31 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix I 

Comments From the Department of

Veterans Affairs

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

Page 32 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix I 

Comments From the Department of

Veterans Affairs

See comment 1.

Page 33 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix I 

Comments From the Department of

Veterans Affairs

See comment 2.

See comment 3.

Page 34 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix I 

Comments From the Department of

Veterans Affairs

See comment 4.

Page 35 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix I 

Comments From the Department of

Veterans Affairs

Page 36 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix I 

Comments From the Department of

Veterans Affairs

Page 37 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix I 

Comments From the Department of

Veterans Affairs

The following are GAO’s comments on the Department of Veterans Affairs’

letter dated February 24, 1999.

GAO Comments 1. See “Agency Comments and Our Evaluation” section.

2. When VA uses the term “refunded” loans, it is describing a transaction

more commonly known as “assumed” loans. We chose to use the term

most understandable to readers outside of VA.

3. Reconciliations are a basic control for financial management and

accountability. The failure of VA to achieve timely and complete

reconciliations of its direct loan records with the contractor’s indicates a

systemic problem with the flow of accounting information. The dollar

amount involved is less significant than the fact that the reconciliations

cannot be performed successfully. VA has the responsibility to its

borrowers to ensure that their loan balances are accurate.

4. VA is responsible for ensuring the propriety and legality of services it

contracts for, and the practices to be employed.

Page 38 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Appendix II 

Major Contributors to This Report

Accounting and

Information

Management Division,

Washington, D.C.

Alana Stanfield, Assistant Director

Elizabeth Kreitzman, Audit Manager

Mel Mench, Senior Assistant Director

Maria Zacharias, Communications Analyst

Christina Quattrociocchi, Senior Auditor

Suzanne Lightman, Auditor

Office of General

Counsel

Jeffrey A. Jacobson, Assistant General Counsel

Page 39 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Glossary

Assumed loans - Loans which were originally guaranteed by VA and held

by private lenders. After the lenders notified VA of intent to foreclose, VA

took over the loans from the lender and became the creditor to the

veterans involved. VA may modify the terms of the loan with the veteran

during the assumption.

Cash reserve fund - The fund created during a loan sale and financed by

VA. VA retains ownership of cash in the fund. The fund is used to pay VA’s

guarantee of principal and interest as well as other expenses.

Cohort - As described in OMB Circular No. A-34, a cohort includes all loans

obligated or loan guarantees committed by the program in the same fiscal

year, even if disbursements occur in subsequent fiscal years. Cohort

accounting applies to post-1991 direct loans and loan guarantees.

Accounting and other records must be maintained separately for each

fiscal year within the program’s financing account. Any payment for losses

from the financing account must be applied to the fiscal year in which the

original loan was disbursed.

Computer Data Systems, Incorporated (CDSI) - The primary

contractor that services VA’s direct loan portfolio. It provides computer

facilities and the servicing programs.

Credit reform - Refers to the collective requirements as set forth in

(1) the Federal Credit Reform Act of 1990, which generally requires that

agencies calculate and record the net present value for credit programs

and include the cost to the government in the budget, (2) Statement of

Federal Financial Accounting Standard No. 2, Accounting for Direct Loans

and Loan Guarantees, and (3) OMB Circulars A-11 and A-34.

Direct loan activity - Actions relating to the creation, recording, and

servicing of VA’s direct loan portfolio. The majority of direct loans are

classified as either assumed or vendee loans. (See these terms for further

explanation.)

Established loan - An assumed loan for which VA has a modification

agreement with the veteran and has received all necessary documents

pertaining to the loan.

Financing account - The nonbudget account or accounts associated with

a credit program account, which holds balances, receives the subsidy cost

payment from the credit program account, and includes all other cash

Page 40 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Glossary

flows to and from the government resulting from post-1991 direct loans or

loan guarantees.

Housing credit assistance program - A function of VA concerned with

housing credit activities. Its objectives are to assist veterans, certain

reservists, and active duty personnel in obtaining mortgage loans; assist in

avoiding foreclosures; and deliver the loan guarantee benefit as efficiently

as possible.

Loan guaranty activity - Actions related to providing a partial guaranty

of loans made by private lenders to veterans and service members to

purchase and retain homes, including claim payments, loan assumptions,

and property acquisition and management.

Loan sale activity - Actions related to the sale by VA of loans from its

direct loan portfolio. The loans are packaged into a trust and sold with a

guarantee of repayment of principal and interest.

Loan Servicing Automated Management System (LSAMS) - Loan

servicing program provided by CDSI that processes and accounts for

mortgage loans for VA’s direct loan portfolio.

Pre-1992 loan sale investments - Investments VA holds from loan sales

prior to 1992 which continue to generate income.

Outsourcing - The process of contracting for performance of a function

previously performed in-house, such as direct loan servicing.

Portfolio Loan Oversight Unit (PLOU) - A VA entity that oversees the

direct loan portfolio servicer’s functions and reconciles the general ledger

accounts related to the direct loan portfolio.

Qualified opinion - A opinion which states that, except for the effects of

the matter(s) to which the qualification relates, the financial statements

present fairly, in all material respects, the financial position, results of

operations, and cash flows of the entity in conformity with generally

accepted accounting principles.

Seasons Mortgage Group - A subcontractor to CDSI that services VA’s

direct loan portfolio.

Page 41 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
Glossary

Servicer - A private sector entity that performs servicing functions for VA’s

loan sale and direct loan activities. For the direct loans, the servicer

collects and allocates mortgage payments from borrowers, pursues

delinquent borrowers, maintains custody of escrow accounts, and pays

taxes on VA-owned properties. The servicers for the loan sale activity are

responsible for managing the loan portfolio of sold loans, accounting for

individual loans in the portfolio, collecting mortgage payments,

maintaining escrow accounts, foreclosing on delinquent borrowers,

maintaining and selling foreclosed property, and reporting financial results

of these activities to the trustee/custodian.

Subsidy cost - The government’s estimated net costs, in present value

terms, of direct or guaranteed loans over the entire period the loans are

outstanding. For direct or guaranteed loans disbursed during a fiscal year,

a subsidy expense is recognized. The amount of the subsidy expense

equals the present value of estimated cash outflows over the life of the

loans minus the present value of estimated cash inflows.

Trust - A structure in which investors are issued certificates that

represent shares in the cash flows from loans sold by VA. The trust is

administered by a trustee/custodian.

Trustee/custodian - A financial institution VA contracts with in

connection with the loan sale activity. The trustee/custodian manages the

trusts created by the sale and is responsible for maintaining the custody of

all funds (including VA’s cash reserves), paying certificate holders, and

filing with taxing authorities. The trustee/custodian is also responsible for

reporting to VA financial activity within the trusts and other information as

requested by VA.

Vendee loan - A mortgage loan made by VA for the purchase of VA-owned

property.

(919300) Page 42 GAO/AIMD-99-24 VA Direct Loan and Loan Sale Activities
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