U.S. ENVIRONMENTAL PROTECTION AGENCY 

OFFICE OF INSPECTOR GENERAL 

Catalyst for Improving the Environment 

Special Report 

Innovative Techniques for State 

Monitoring of Revolving Funds Noted 

Report No. 08-P-0290 

 September 29, 2008 
Abbreviations 

DHEC Department of Health and Environmental Control (South Carolina) 

EPA U.S. Environmental Protection Agency 

IFA Indiana Finance Authority 

OIG Office of Inspector General 

OMB Office of Management and Budget 

SRF State Revolving Fund 

Cover photo:	 Service Reservoir #6 in Anchorage, Alaska, for which work was funded by 

the State Revolving Fund (photo courtesy Alaska Department of 

Environmental Conservation) 
 08-P-0290 

U.S. Environmental Protection Agency September 29, 2008 

Office of Inspector General 

At a Glance
 

Catalyst for Improving the Environment 

Why We Did This Review 

We conducted this special 

review to determine whether 

the States receiving State 

Revolving Funds comply with 

the subrecipient monitoring 

requirements of the Single 

Audit Act, Clean Water Act, 

and Safe Drinking Water Act. 

We also reviewed procedures 

the States use to prevent and 

detect fraud in the State 

Revolving Funds. 

Background 

The State Revolving Funds are 

the U.S. Environmental 

Protection Agency’s (EPA’s) 

largest programs, with 

approximately $74 billion in 

loans and other type of 

assistance outstanding as of 

June 30, 2007. About 

$1.5 billion was awarded in 

2008. The goal of subrecipient 

monitoring is to ensure projects 

meet performance goals and 

borrowers spend federal funds 

in accordance with the intent of 

the laws and regulations. 

For further information, 

contact our Office of 

Congressional and Public 

Liaison at (202) 566-2391. 

To view the full report, 

click on the following link: 

www.epa.gov/oig/reports/2008/ 

20080929-08-P-0290.pdf 

Innovative Techniques for State Monitoring of 

Revolving Funds Noted 

What We Found 

In general, the States we reviewed complied with subrecipient monitoring 

requirements. Our review identified several innovative techniques and 

procedures some States use to comply with the subrecipient monitoring 

requirements of the Single Audit Act, Clean Water Act, and Safe Drinking Water 

Act. Two States take advantage of current technology, such as e-mail and the 

Internet, to reduce the number of on-site inspections yet are able to track current 

construction activity. Two other States analyze subrecipient audit reports not 

only to track financial condition but also to make trend and ratio analyses to 

project on a subrecipient’s ability to repay a loan in the future. 

We did note two minor areas EPA should address. Only 59 percent of the States 

we reviewed identify the federal award information to the recipient, and EPA’s 

Annual Performance Evaluation should include an evaluation of the States’ 

subrecipient monitoring procedures. We suggest that EPA require all States to 

notify borrowers of federal award information to assure they can comply with the 

Single Audit Act. We also suggest that EPA include a review of how States 

monitor borrowers as part of its annual review procedures. 
UNITED STATES ENVIRONMENTAL PROTECTION AGENCY 

WASHINGTON, D.C. 20460 

OFFICE OF 

INSPECTOR GENERAL 

September 29, 2008 

MEMORANDUM 

SUBJECT:	 Innovative Techniques for State Monitoring of Revolving Funds Noted 

Report No. 08-P-0290 

FROM:	 Stephen J. Nesbitt 

 Assistant Inspector General for Investigations 

TO: Benjamin Grumbles 

Assistant Administrator, Office of Water 

This is our final report on the subject review conducted by the Office of Inspector General (OIG) 

of the U.S. Environmental Protection Agency (EPA). This special report does not contain any 

recommendations, but does include matters the OIG has identified that may be of benefit to other 

States. This special report represents the opinion of the OIG and the matters contained in this 

report do not necessarily represent the final EPA position. 

The estimated cost of this report – calculated by multiplying the project’s staff days by the 

applicable daily full cost billing rates in effect at the time – is $95,076. 

Action Required 

Because this report contains no recommendations, you are not required to respond to this report. 

We have no objections to the further release of this report to the public. This report will be 

available at http://www.epa.gov/oig. 

If you or your staff has any questions regarding this report, please contact me at (202) 566-0817 

or nesbitt.stephen@epa.gov, or William Dayton at 415-947-4509 or dayton.william@epa.gov. 
 

Innovative Techniques for 08-P-0290 

State Monitoring of Revolving Funds Noted 

Table of Contents 

Purpose................................................................................................................................. 1 

Background .......................................................................................................................... 1
 

Scope and Methodology ..................................................................................................... 2 

States Comply with Subrecipient Monitoring Requirements .......................................... 3 

Best Practices and Noteworthy Achievements................................................................. 4 

Minor Improvements Needed.............................................................................................. 8 

Status of Recommendations and Potential Monetary Benefits....................................... 10 

Appendix 

A Distribution ................................................................................................................ 11 
08-P-0290 

Purpose 

We conducted this review to determine the extent that States receiving State Revolving Funds 

(SRFs) are complying with subrecipient monitoring requirements established by the Clean Water 

Act, the Safe Drinking Water Act, and the Single Audit Act. To accomplish that goal, our 

review looked at how the States monitor subrecipients of SRF assistance. We also reviewed 

other procedures the States use, if any, to prevent and detect fraud at the local level 

Background 

The Clean Water Act of 1987 created the Clean Water SRF, while the Safe Drinking Water Act 

Amendments of 1996 created the Drinking Water SRF. The SRFs are permanent funds for the 

States that provide low-cost financing to local governments. Approximately 95 percent of the 

financial assistance made by the SRF’s is in the form of loans or guarantees for construction of 

traditional wastewater or drinking water facilities. The U.S. Environmental Protection Agency 

(EPA) provides the initial funding through capitalization grants. Both programs require the 

States to provide matching funds of 20 percent of the capitalization grant amount. 

The SRFs represent EPA’s largest program (about 50 percent of all assistance awards made by 

EPA), with 2008 funding levels of approximately $1.5 billion. As of June 2007, the Clean Water 

SRF had provided approximately $62.9 billion in financial assistance to local communities and 

the Drinking Water SRF approximately $11.0 billion. EPA has the responsibility to oversee the 

States, and ensure that States operate the SRF programs to meet the intent of the Clean Water 

Act and Safe Drinking Water Act. 

In response to a risk assessment conducted by the EPA Office of Inspector General’s (OIG) 

Office of Investigations,1

 EPA identified several areas of potential risk in the grants area. Major 

concerns included false claims, false statements, cost mischarging, product substitution, lack of 

proper oversight, and lack of 

internal controls. As shown in Figure 1: Grant Fraud Allegations 

Figure 1, false statements, false 

Bribery Conflict of claims, embezzlement, and financial 

6%

Conspiracy 

2%

False Claims 

24%

Mail Fraud 

2% 

Financial Theft 

23%

Wire Fraud 

1% 

4% Interest theft accounted for 81 percent of 

grant fraud allegations. As of Fiscal 

Year 2006, over 31 percent of all 

assistance agreement investigations False 

Statements the Office of Investigations 18% 

conducted involved SRFs. State Embezzlement 

and EPA personnel involved in the 16% 

SRF are the front-line defense 

against fraud to the extent that they Anti-Trust 

4% can recognize and report potential 

fraud. Source: OIG analysis. 

1

 Financial Fraud Criminal Risk Assessment, July 1, 2007. 

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The community is responsible for all aspects of the project, from concept, design, construction, 

and operations. Successful completion of a project requires the community to have procedures 

to manage and review all aspects of the project. One of the objectives of a system of internal 

controls is to safeguard the assets of an entity against loss and ensure that transactions are valid. 

Single Audit Act Established Subrecipient Monitoring 

Congress passed the Single Audit Act to improve auditing and management of federal 

funds provided to State and local governments. The Single Audit Act requires an 

organization-wide financial audit that includes all federal programs and an audit of the 

entity’s compliance with laws and regulations of each major federal program if the entity 

spends more than $500,000 in federal funds during the year. 

Office of Management and Budget (OMB) Circular A-133, “Audits of States, Local 

Governments, and Non-Profit Organizations,” sets audit and reporting standards for 

single audit reports. OMB’s Compliance Supplement, Part 3, identifies State 

responsibilities, monitoring activities typically performed, audit objectives, and suggested 

audit procedures. 

States are required to: 

•	 Identify the federal award information and applicable compliance requirements to 

the subrecipient. 

•	 Monitor the subrecipient’s use of federal awards through reporting, site visits, 

regular contact, or other means. 

•	 Ensure that subrecipients expending $500,000 or more in federal awards during 

the year have met the audit requirements of OMB Circular A-133. 

EPA Annual Reviews 

EPA’s responsibility for subrecipient monitoring is to oversee the States. EPA needs to 

understand how the States monitor the subrecipients, and determine whether the States 

comply with the subrecipient monitoring requirements of the Single Audit Act. The 

Clean Water Act and Safe Drinking Water Act require EPA to conduct an annual review 

to assess how a State meets the program objectives. The primary objectives of EPA’s 

annual review are to determine how the State meets the intent of the Clean Water Act and 

Safe Drinking Water Act, and evaluate the State’s performance. 

Scope and Methodology 

We conducted this performance audit in accordance with generally accepted government 

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

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

based on our audit objectives. We believe that the evidence obtained provides a reasonable basis 

for our findings and conclusions based on our audit objectives. 

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We conducted our audit field work from December 2007 to September 2008 in EPA 

Headquarters and Regions 4, 5, and 9. We sent a survey to all EPA regional SRF coordinators. 

We also prepared a survey that we sent to nine States to determine what specific procedures 

States used to monitor subrecipients. We received 13 responses to our State questionnaires. We 

also conducted site visits in four other States to determine how the particular State documented 

its subrecipient monitoring procedures. We interviewed several SRF coordinators and State 

personnel. 

We reviewed State-wide single audit reports for 26 States for fiscal years ended 2005 and 2006 

(the latest available) to determine how many of those States included audit findings on 

subrecipient monitoring. We also reviewed audits for States that conduct separate audits of the 

SRF program. 

We reviewed 87 investigative files for all investigations completed by the Office of Investigations 

between October 1, 2003, and September 30, 2007, that dealt with SRFs. These investigations 

included allegations against the community, a subcontractor, and various other matters. 

We issued a prior report that addressed SRF Best Practices, South Carolina State Revolving Fund 

Subrecipient Loan Monitoring (Report No. 2001-S-000745-000001), on October 12, 2000. 

States Comply with Subrecipient Monitoring Requirements 

In general, the States we reviewed complied with the subrecipient monitoring requirements of 

the Single Audit Act. As shown in Table 1, at least 82 percent of the States reviewed met the 

most critical elements of subrecipient monitoring, with the exception of identifying the federal 

award information. The States 

reviewed have systems and Table 1: Critical Monitoring Elements 

procedures in place that 

provide reasonable assurance 

to prevent or detect fraud or 

other irregularities. 

EPA’s annual review only 

checks to see if the States 

require an annual audit as part 

of the subrecipient monitoring 

process. All States surveyed 

Element States Percentage 

Award identification 

During the award monitoring: 

Regular contact and monitoring 

10 

16 

59 

94 

Review reimbursement requests 17 100 

Engineer/contractor certifications 16 94 

Site visits/project inspections 14 82 

Subrecipient audits 17 100 

Audit of State SRF 14 82 

Source: OIG analysis and visited require SRF 

borrowers to conduct financial 

statement audits. One of the most important functions of an audit is to review and test the 

controls in place. The auditor’s report on internal controls provides assurance that the controls 

are adequate, and the State can rely on the financial information presented by the community. 

While a financial statement audit may not prevent fraud, current auditing standards2 require that 

audits consider the possibility of fraud when planning the audit and designing audit tests. 

 Statement on Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit. 

3
 

2
08-P-0290 

States perform several tasks that EPA’s annual review does not review. Monitoring a project is 

an on-going process, and there are many different methods of monitoring besides requiring an 

annual audit (for example, how States reimburse borrowers). States we reviewed require that the 

borrowers submit invoices, contractor billings, and other documentation to support the request. 

The project manager then reviews the contractor and engineering billings for the technical 

aspects of the request, and must approve them before reimbursing the community. These 

procedures protect SRF assets and make sure the borrower and its contractors are progressing as 

planned, using specified materials, and billing for work actually completed. 

Best Practices and Noteworthy Achievements 

Our review disclosed several practices that may be of benefit to other States. These practices 

address common issues and concerns. Some of these practices deal with the technical or project 

side of the SRF, such as monitoring construction projects. Others deal with the financial end of 

the SRF, such as reviewing and analyzing financial reports. These practices help provide the 

States with the assurances that projects are being constructed according to the intent of the SRF, 

and that the subrecipients maintain the means to repay the loans according to the terms. The 

States that developed and implemented these “Best Practices” have offered to provide other 

interested States with whatever assistance they may need to implement similar procedures. 

Technical Best Practices 

A common comment in our surveys and site visits concerned project inspections. Several 

States cited the lack of personnel and limited travel funds as the main reasons they cannot 

conduct regular inspections. Rising fuel costs have increased airfares and vehicle costs 

dramatically, plus have reduced the number of flights or eliminated them altogether, 

especially to smaller market areas. The only alternative is to travel by car, which can 

involve hundreds miles and extensive travel hours, especially in the larger States. 

Adding in costs for lodging and several days to inspect just one project, some States 

stated it is not cost effective to send an engineer to inspect a project. Thus, the challenge 

facing States is how to cost effectively ensure that projects are completed according to 

the plans and specifications, as well as complying with monitoring requirements. 

The solution California and Alaska developed is to use technology in innovative ways 

that allow them to comply with the subrecipient monitoring requirements. California and 

Alaska use e-mail and the Internet to ensure that communities complete their projects 

according to the approved plans and specifications while limiting personnel and travel 

costs. 

California 

A project engineer in California developed a “Construction Report” several years ago that 

communities were required to complete on a monthly basis. These reports are generally 

in electronic form, and the community sends the report to the project manager via e-mail. 

While the Construction Report does not take the place of an actual on-site project 

inspection, it does provide detailed information so that the project manager can keep 

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08-P-0290 

abreast of construction progress, identify potential problems, and track time schedules. 

The Construction Report includes: 

•	 A summary of progress to date, including a detailed description of progress since 

the last report. 

•	 The percentage of construction that is complete, the percentage the contractor has 

billed, and the percentage of the schedule that has elapsed. 

•	 A listing of change orders, including amount of the change order, description of 

work performed, change in contract amount, and changes in the time schedule. 

•	 A discussion of problems encountered and proposed resolutions, a schedule for 

resolution of the problems, and an update on the status of previous problems. 

The resident engineer generally completes the Construction Report on behalf of the 

borrower. Most construction reports include photographs of the construction as 

completed. For example, photo 1, which was included in a recent Construction Report, 

shows workers finishing the 

bottom of a secondary 

clarifier at the Ellis Creek 

Water Recycling Facility, 

City of Petaluma, California. 

The photograph allows the 

project manager to see the 

construction activity in 

progress and the 

construction techniques and 

methods used. The project 

manager can then make an 

assessment on the 

percentage completed, and 

compare to progress 

payments made to date. 

Whether the project is across town or across the State, the efficiency of the Construction 

Report is apparent. This report has allowed project managers to track the progress of a 

project without incurring any additional costs in personnel or travel. Due to the success 

of the Construction Report, California includes the requirement to prepare and submit 

such reports in its loan agreements for all borrowers. The report documents work 

performed, and can help prevent potential problems in the future. Further, the project 

manager can request additional information if the manager has questions or concerns 

noted in the report. Using the Internet, the project manager can get the information 

within minutes instead of waiting until the next inspection. 

Several California communities also include progress and details of current construction 

projects on the Internet. For example, the City of Lompoc updates the progress of its 

wastewater plant upgrade monthly, and includes updates from March 2007 to the current 

Photo 1: Construction of secondary clarifier, City of Petaluma, 

 California (photo courtesy City of Petaluma). 

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08-P-0290 

month. The following is a sample of construction projects posted on official community 

internet Websites: 

http://www.cityoflompoc.com/departments/utilities/wastewater.htm 

http://www.reedley.com/publicworks/wastewater.htm 

http://www.cityofpetaluma.net/waterrecycling/construction.html 

Alaska 

While Alaska performs regular inspections, the size of Alaska, plus the fact that many 

locations are not accessible by road, severely limits how often Alaska conducts project 

inspections. Alaska project managers communicate with borrowers frequently by 

telephone, but Alaska officials said the development of e-mail has made the biggest 

difference in being able to track 

remote projects. Photo 2 shows 

construction activity at the Nome 

Water and Sewer Project, over 1,100 

miles from the project manager in 

Juneau. Alaska can obtain such 

information almost instantly by 

e-mail, and can address questions and 

problems quickly and efficiently. The 

ability to obtain written status reports 

quickly with attached documentation 

and photographs has minimized the 

need to travel into the field for 

inspections. Alaska uses these 

e-mails, documentation, and 

photographs as part of the official 

State files. 

Financial Best Practices 

All States included in our surveys require borrowers to conduct a single audit and submit 

the audit reports to the State. While States are expected to review the audit reports, the 

level of review varies widely among the States. Two States we reviewed (South Carolina 

and Indiana) perform extensive analyses of subrecipient financial statements and proactively use the financial information to help manage their loan portfolios. While the two 

States have different approaches to monitoring the financial aspects of the SRFs, they 

have common elements in that they both: 

• Take a pro-active role in reviewing and analyzing audits of subrecipients; 

• Use historical information to predict and prevent future problems from occurring; 

Photo 2: Nome Water and Sewer Project, Nome, 

Alaska (photo courtesy Alaska Department of 

Environmental Conservation). 

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08-P-0290 

•	 Contact the communities when the reviews show that key ratios are in danger of 

falling below State minimums, and 

•	 Actively work with communities to address potential problems. 

South Carolina 

South Carolina’s SRF program is jointly administered by the State’s Department of 

Health and Environmental Control (DHEC) and the South Carolina Water Quality 

Revolving Fund Authority, through the State Budget and Control Board’s Office of Local 

Government. DHEC is responsible for administering the technical and program activities 

of the SRF program, and the Office of Local Government is responsible for all financial 

and management functions, including credit approval and loan monitoring. This joint 

administration of the SRF maximizes the strengths and expertise of both DHEC and the 

Office of Local Government. We had issued a Best Practices report on South Carolina’s 

subrecipient monitoring practices in October 2000 (Report No. 2001-S-000745-000001). 

Revenues generated by the utility systems are the sole security for most SRF loans in 

South Carolina. Therefore, making good credit decisions and actively monitoring loans 

is particularly important for South Carolina’s SRF program. Credit decisions begin with 

an analysis for the loan approval process and end with the loan repayment. The process 

involves the following major stages: 

•	 Credit analysis: Determining the current and future financing needs of the 

borrower, how to meet these needs, how the borrower can repay the loan, and the 

key factors critical to repayment. 

•	 Loan Structuring: Determining how to structure the loan to meet the borrower’s 

needs while meeting SRF legal requirements and minimizing risks to the SRF. 

•	 Loan Monitoring: Designing a system to monitor and control the credit risk 

factors throughout the life of the loan. 

The Office of Local Government uses various means to monitor loan recipients. It 

analyzes the audited financial statements to make sure that the community still meets the 

established debt coverage, and that nothing has changed that would affect the 

community’s ability to repay the loan. A financial database is prepared that calculates 

and tracks a variety of key ratios and financial trends for each borrower. They also use a 

database to make projections for the next 4 years and, when they receive the actual 

information, compares to the projections. 

By continuously monitoring the financial condition of the borrower and making 

projections, program management can anticipate how potential changes may affect the 

borrower’s ability to repay the loan. Such projections help provide sufficient time to 

meet with the community and discuss possible courses of actions that will prevent 

problems in meeting the obligation. 

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Indiana 

The Indiana Finance Authority (IFA) operates Indiana’s SRF program. IFA has 

established a monitoring program that tracks all financial aspects of loans to ensure that 

borrowers conduct audits, maintain required debt coverage ratios, and can make 

scheduled loan payments according to the loan agreement. As IFA awards a new loan, it 

enters the loan information into a database to track when audits are due and notes the 

most recent loan closing date, status of the loan, date of most recent financial statements, 

and the auditor’s opinion on the most recent financial statements. 

IFA also has a system for ensuring that borrowers conduct audits when required. IFA 

sends a list to the Indiana State Board of Accounts (the State auditor), who will perform 

audits of communities at least every 3 years if they do not conduct an annual audit. IFA 

also tracks the amount of federal funds in each disbursement so the community, as well 

as IFA, can track when the OMB Circular A-133 threshold of $500,000 is met. They will 

also audit private borrowers under the Drinking Water SRF if requested. 

As IFA receives the financial statements, key financial information is entered and various 

ratios calculated. IFA analyzes net operating income, debt service (interest and 

principal), current ratios, user charges, and cash flow to see if the community is 

maintaining the required coverage. IFA also encourages new applicants to set up their 

debt service reserve with IFA’s trustee. As a result, IFA is able to monitor communities 

on a monthly basis. Moreover, IFA contacts all borrowers at least annually to ensure that 

borrowers maintain their debt service reserve balances. If the debt service ratio drops 

below IFA requirements, IFA will call the community and discuss options to get the ratio 

up to the agreed minimum coverage ratio. The options discussed may include reducing 

expenses, rate increases, or other means. In some cases, IFA may require that the 

community move its debt service funds to IFA’s trustee bank so it can have some control 

over any disbursements. 

Minor Improvements Needed 

Even though the States generally comply with the subrecipient monitoring requirements of the 

Single Audit Act, Clean Water Act, and Safe Drinking Water Act, certain improvements can be 

made, as discussed below. 

Award Identification 

The Single Audit Act requires that States inform assistance recipients of the Catalogue of 

Federal Domestic Assistance title and number, award name and number, award year, and 

name of federal agency. Only 10 of the 17 States surveyed include this required 

information in loan documents. While all States reviewed require subrecipients to 

conduct annual audits, the intent of this requirement is to ensure that SRF recipients are 

aware of when a single audit is required, and specific requirements imposed on them by 

federal laws, regulations, and grant provisions. 

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08-P-0290 

EPA Annual Review 

The purpose of EPA’s Annual Review is to assess how each State is meeting the intent of 

the Clean Water Act and Safe Drinking Water Act, and whether the State complies with 

applicable laws and regulations. EPA’s Annual Review guidance includes eight required 

program elements, nine financial elements, and three required elements for the set-aside 

funds in Drinking Water SRF. However, none of these required elements addresses the 

States’ subrecipient monitoring process. 

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Status of Recommendations and 

Potential Monetary Benefits 

POTENTIAL MONETARY 

RECOMMENDATIONS BENEFITS (in $000s) 

Planned 

Rec. Page Completion Claimed Agreed To 

No. No. Subject Status1 Action Official Date Amount Amount 

No recommendations 

1 O = recommendation is open with agreed-to corrective actions pending 

C = recommendation is closed with all agreed-to actions completed 

U = recommendation is undecided with resolution efforts in progress 

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08-P-0290 

Appendix A 

Distribution 

Office of the Administrator 

Assistant Administrator, Office of Water 

Agency Follow-up Official (the CFO) 

Agency Follow-up Coordinator 

Office of General Counsel 

Associate Administrator for Congressional and Intergovernmental Relations 

Associate Administrator for Public Affairs 

Audit Follow-up Coordinator, Office of Water 

Deputy Inspector General 

11