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89–351 PDF 2003

WHY IS SBA LOSING GROUND ON FINANCIAL

MANAGEMENT?

HEARING

BEFORE THE

SUBCOMMITTEE ON GOVERNMENT EFFICIENCY

AND FINANCIAL MANAGEMENT

OF THE

COMMITTEE ON

GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

APRIL 29, 2003

Serial No. 108–49

Printed for the use of the Committee on Government Reform

(

Available via the World Wide Web: http://www.gpo.gov/congress/house

http://www.house.gov/reform

(II)

COMMITTEE ON GOVERNMENT REFORM

TOM DAVIS, Virginia, Chairman

DAN BURTON, Indiana

CHRISTOPHER SHAYS, Connecticut

ILEANA ROS-LEHTINEN, Florida

JOHN M. MCHUGH, New York

JOHN L. MICA, Florida

MARK E. SOUDER, Indiana

STEVEN C. LATOURETTE, Ohio

DOUG OSE, California

RON LEWIS, Kentucky

JO ANN DAVIS, Virginia

TODD RUSSELL PLATTS, Pennsylvania

CHRIS CANNON, Utah

ADAM H. PUTNAM, Florida

EDWARD L. SCHROCK, Virginia

JOHN J. DUNCAN, JR., Tennessee

JOHN SULLIVAN, Oklahoma

NATHAN DEAL, Georgia

CANDICE S. MILLER, Michigan

TIM MURPHY, Pennsylvania

MICHAEL R. TURNER, Ohio

JOHN R. CARTER, Texas

WILLIAM J. JANKLOW, South Dakota

MARSHA BLACKBURN, Tennessee

HENRY A. WAXMAN, California

TOM LANTOS, California

MAJOR R. OWENS, New York

EDOLPHUS TOWNS, New York

PAUL E. KANJORSKI, Pennsylvania

CAROLYN B. MALONEY, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

DANNY K. DAVIS, Illinois

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

DIANE E. WATSON, California

STEPHEN F. LYNCH, Massachusetts

CHRIS VAN HOLLEN, Maryland

LINDA T. SANCHEZ, California

C.A. ‘‘DUTCH’’ RUPPERSBERGER, Maryland

ELEANOR HOLMES NORTON, District of

Columbia

JIM COOPER, Tennessee

CHRIS BELL, Texas

———

BERNARD SANDERS, Vermont

(Independent)

PETER SIRH, Staff Director

MELISSA WOJCIAK, Deputy Staff Director

ROB BORDEN, Parliamentarian

TERESA AUSTIN, Chief Clerk

PHILIP M. SCHILIRO, Minority Staff Director

SUBCOMMITTEE ON GOVERNMENT EFFICIENCY AND FINANCIAL MANAGEMENT

TODD RUSSELL PLATTS, Pennsylvania, Chairman

MARSHA BLACKBURN, Tennessee

STEVEN C. LATOURETTE, Ohio

JOHN SULLIVAN, Oklahoma

CANDICE S. MILLER, Michigan

MICHAEL R. TURNER, Ohio

EDOLPHUS TOWNS, New York

PAUL E. KANJORSKI, Pennsylvania

MAJOR R. OWENS, New York

CAROLYN B. MALONEY, New York

EX OFFICIO

TOM DAVIS, Virginia HENRY A. WAXMAN, California

MIKE HETTINGER, Staff Director

LARRY BRADY, Professional Staff Member

AMY LAUDEMAN, Clerk

MARK STEPHENSON, Minority Professional Staff Member

(III)

C O N T E N T S

Page

Hearing held on April 29, 2003 .............................................................................. 1

Statement of:

Calbom, Linda, Director of Financial Management and Assurance, U.S.

General Accounting Office ............................................................................ 10

Dumaresq, Thomas A., Chief Financial Officer, Small Business Administration ............................................................................................................ 32

Hayward, Charles, partner, Cotton & Co. ...................................................... 53

McClintock, Peter, Deputy Inspector General, Small Business Administration ............................................................................................................ 40

Menth, Bill, consultant to Cotton & Co.’s SBA Audit Team for fiscal

year 2002, postaudit consultant to SBA ...................................................... 63

Letters, statements, etc., submitted for the record by:

Calbom, Linda, Director of Financial Management and Assurance, U.S.

General Accounting Office:

Followup questions and responses ........................................................... 87

Prepared statement of ............................................................................... 13

Dumaresq, Thomas A., Chief Financial Officer, Small Business Administration, prepared statement of ..................................................................... 34

Hayward, Charles, partner, Cotton & Co., prepared statement of .............. 55

McClintock, Peter, Deputy Inspector General, Small Business Administration, prepared statement of ..................................................................... 42

Menth, Bill, consultant to Cotton & Co.’s SBA Audit Team for fiscal

year 2002, postaudit consultant to SBA, prepared statement of .............. 65

Platts, Hon. Todd Russell, a Representative in Congress from the State

of Pennsylvania, prepared statement of ...................................................... 4

Towns, Hon. Edolphus, a Representative in Congress from the State

of New York, prepared statement of ........................................................... 7

(1)

WHY IS SBA LOSING GROUND ON FINANCIAL

MANAGEMENT?

TUESDAY, APRIL 29, 2003

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON GOVERNMENT EFFICIENCY AND

FINANCIAL MANAGEMENT, COMMITTEE ON GOVERNMENT REFORM, Washington, DC.

The subcommittee met, pursuant to notice, at 2 p.m., in room

2154, Rayburn House Office Building, Hon. Todd Russell Platts

(chairman of the subcommittee) presiding.

Present: Representatives Platts, Blackburn and Towns.

Staff present: Mike Hettinger, staff director; Dan Daly, counsel;

Larry Brady and Kara Galles, professional staff members; Amy

Laudeman, clerk; Mark Stephenson, minority professional staff

member; and Cecelia Morton, minority office manager.

Mr. PLATTS. A quorum being present, this hearing of the Subcommittee on Government Efficiency and Financial Management

will come to order. Welcome, everyone, here today, and I appreciate

everyone’s participation.

As 1 of the 24 Chief Financial Officer Act agencies, the Small

Business Administration [SBA], has been required to produce agencywide audited annual financial statements since fiscal year 1996,

and has been required to produce audited financial statements with

respect to its loan programs since fiscal year 1991. Since 1996, SBA

has consistently received a clean opinion from their auditors on

their agencywide financial statements. However, recently SBA’s

auditors issued a disclaimer on the fiscal year 2002 financial statements and chose to withdraw its clean opinions on SBA’s financial

statements for fiscal years 2001 and 2000. This turnaround occurred in part as a result of the findings described in the General

Accounting Office report entitled, ‘‘Small Business Administration:

Accounting Anomalies and Limited Operational Data Make Results

of Loan Sales Uncertain.’’

As part of the subcommittee’s continuing oversight into the financial health of the CFO Act agencies, we have asked the General

Accounting Office, representatives of the SBA, and SBA’s independent auditors to come before us today to discuss the current status

of the financial accounting situation at SBA. Our hearing today

will address the findings of the GAO report as well as look forward

at the remediation efforts underway within SBA to rectify this situation.

Last year, at the request of Senator Christopher Bond, GAO conducted a broad review of SBA’s loan asset sales program. GAO anaVerDate 11-MAY-2000 11:28 Sep 26, 2003 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 D:\DOCS\89351.TXT HGOVREF1 PsN: HGOVREF1
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lyzed the way SBA accounted for five loan asset sales, disposing of

a total of $4.4 billion in disaster assistance home and business

loans from August 1999 through January 2002. GAO determined

that SBA incorrectly calculated accounting losses on the loan sales

and lacked reliable financial data to determine the overall financial

impact of the sales. SBA’s accounting for the loan sales was flawed

to such a degree that SBA was showing a profit on its disaster relief loans, a very unlikely scenario.

In part, as a result of the accounting inaccuracies uncovered by

GAO, SBA auditors, Cotton & Co., issued a disclaimer on SBA’s financial statements for fiscal year 2002 and withdrew the clean

audit opinions on SBA’s financial statements for fiscal years 2001

and 2000. Furthermore, the Office of Management and Budget reported as part of the President’s executive branch Management

Scorecard for 2002 that SBA actually deteriorated on its score for

improving financial performance since last year. OMB’s explanation of the score cited the challenges that SBA faces in accounting for its loan sales, meeting accounting performance standards

and measuring risk in its loan portfolio more accurately.

SBA’s Chief Financial Officer and its inspector general both generally agree with the overall findings and recommendations in the

GAO report, and the Chief Financial Officer has contracted with a

consulting firm to assist them in determining where they made

their mistakes in accounting for the loan sales. The Inspector General’s Office is also working with Cotton & Co. to determine the

magnitude of the errors in SBA’s financial statements for fiscal

year 2001 and 2000.

The situation at SBA raises serious questions about the quality

of the financial management of SBA’s loan asset sales. It also demonstrates a point that is consistently raised by GAO and OMB:

Sound financial management requires more than clean audit opinions.

I was gratified when I read an advance copy of the Deputy Inspector General McClintock’s testimony that he candidly discusses

how flawed SBA’s financial management systems are, and if the

systems were not so flawed, perhaps SBA would have clean audit

opinions today. The SBA has the opportunity now to reevaluate its

management of the loan asset sales and to move forward with solutions that will result in sustainable long-term improvements to

their financial management efforts.

Our witnesses here today will help to shed light on the financial

management situation at SBA, and, again, we are very pleased and

grateful for your participation in today’s hearing. We are pleased

to have Linda Calbom, who is a Director with the Financial Management and Assurance Team at the General Accounting Office;

Thomas Dumaresq, who is Chief Financial Officer at SBA; Peter

McClintock, who is the Deputy Inspector General at SBA; Mr.

Charles Hayward, who has worked on the SBA audit as a partner

with Cotton & Co.; and Bill Menth, who is a consultant that has

been working on this situation with both Cotton & Co. and SBA.

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I know that my fellow committee members join me in looking forward to your testimonies, and I’m pleased now to yield to the gentleman from New York, the ranking member, Mr. Towns, for the

purpose of making an opening statement.

[The prepared statement of Hon. Todd Russell Platts follows:]

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Mr. TOWNS. Thank you very much, Mr. Chairman. Thank you for

holding this hearing today on SBA’s financial management problems.

The information presented to us on SBA is certainly troubling;

however, I am pleased that the agency has acknowledged its errors

and is ready to confront those mistakes. It seems that they are sincere about, making the necessary changes to prevent a similar situation from happening again. Having key members from SBA along

with the consultants in the GAO to discuss the agency’s financial

statement is a good starting point.

Although today’s hearing is focusing on SBA, it could very well

be taking place on several of the over 24 CFO Act agencies. As

many of you know, the SBA received clean audit opinions in 2000

and 2001 before errors were discovered that invalidated those findings. So it is entirely possible that an agency which got a clean

audit this year does not really have all of its financial cards in

order. As we learn more about what went wrong at SBA and what

we can do to prevent it from happening again, it is critical that we

apply those lessons learned to other agencies.

With that said, I do believe it is important that this committee

zero in on SBA and its own specific problems. Small business is the

backbone of our economy, producing 75 percent of all new jobs and

employing half the private-sector work force. Minority and womenowned firms are the fastest-growing segment of this business community. Over a 5-year period the number of minority-owned firms

have increased at a rate four times greater than all other firms in

the United States and have grown their receipts by 60 percent.

This success is in part due to the availability of loan assistance

from the SBA.

With these statistics in mind, I believe it is critical that the

agency solve its financial management problems. Our economy and

especially our minority entrepreneurs need a healthy SBA in order

to flourish.

Thank you, Mr. Chairman. I yield back the balance of my time,

and I’m anxious to hear from the witnesses.

Mr. PLATTS. Thank you, Mr. Towns.

[The prepared statement of Hon. Edolphus Towns follows:]

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Mr. PLATTS. I would like now to ask each witness to stand and

any other persons who will be advising you during your testimony

to stand, raise your right hands, and we will issue the oath together and then proceed with testimony.

[Witnesses sworn.]

Mr. PLATTS. Thank you, and the clerk will note that all witnesses

affirm the oath.

I’d like to now proceed directly to the testimonies. Ms. Calbom,

we’ll begin with you, followed by Mr. Dumaresq, then Mr. McClintock, Mr. Hayward and Mr. Menth. The subcommittee appreciates

the very substantive written testimonies that you provided to us in

advance, and each has been submitted as part of the record.

Because of the detail and the importance of the items we are

going to be discussing today, I would like to extend to each of you

10 minutes as opposed to the customary 5 for your opening statements, and then we’ll proceed to questions.

Ms. Calbom, the floor is yours.

STATEMENT OF LINDA CALBOM, DIRECTOR OF FINANCIAL

MANAGEMENT AND ASSURANCE, U.S. GENERAL ACCOUNTING OFFICE

Ms. CALBOM. OK. Thank you, Mr. Chairman, Mr. Towns, Mrs.

Blackburn. I’m pleased to be here today to discuss the results of

our review of SBA’s accounting for its loan sales and the cost of its

credit programs. My testimony today is going to summarize the

findings in the report we issued in January of this year, which

you’ve referred to, Mr. Chairman. I’ll also just briefly touch on

other financial management issues that were identified by SBA’s

auditors during their audit of the fiscal year 2002 financial statements.

Our review disclosed that SBA has fundamental problems with

accounting for its credit programs, particularly the disaster loan

program. These problems became more and more evident as SBA

carried out its loan sales. Loan sales didn’t actually cause the problems, but did bring them to light sooner than may have otherwise

occurred.

SBA began its loan sales activity around the end of fiscal year

1999 and to date has sold well over half of its direct loan portfolio,

the bulk of which represents disaster loans. As these sales have occurred, a steep decline in the subsidy allowance account for disaster loans, which is meant to cover the cost of the program, has also

occurred. This decline is graphically depicted on the chart that

we’ve got here and up on the overheads. It’s also on the highlights

page of my written testimony. As you can see, the subsidy allowance account eventually went negative in 2001, and then continued

to go even further negative in 2002. A negative balance in a subsidy allowance account would only ever make sense if a profit was

expected from the program, which was not the case for the highly

subsidized disaster loan program. In this case the negative balance

likely means that more reserves were being taken out of the account than had ever been put in to cover the cost of the program.

While SBA and its consultants are still analyzing the cause of

this anomaly, it appears that one of the key problems is that the

average loan term used to calculate the subsidy cost was too short.

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SBA had estimated the average loan term for disaster loans to be

16 to 17 years. Based on our review of the disaster loans sold in

the first five sales, the average loan term was more like 25 years.

This is a very significant difference when you’re dealing with a program like disaster loans where you have interest rates that are

below market and, therefore, the longer the loan term, the more

costly the program.

We also found other problems during our review of SBA loan

sales, the first of these being that the estimated accounting losses

on the sales were incorrectly calculated. We reviewed the methodology SBA used to calculate these losses and found significant errors

in how the subsidy allowance was allocated to the loans that were

sold, thereby misstating the losses on the sales.

Theoretically this type of error would have been corrected when

SBA reestimated the cost of its loan programs, which they’re generally required to do on an annual basis. These reestimates are

done to adjust the cost of the programs for any changes in the key

assumptions that went into the original cost estimates. However,

we also found as part of our review that SBA’s reestimates of subsidy costs were unreliable. At the time of our review, even after

selling nearly half of its loan portfolio, SBA had not analyzed the

effect of the loans sales on the estimated costs of the remaining

portfolio. Therefore they did not know if their original assumptions

about the characteristics of the portfolio were still valid.

Despite the significant unexplained decline in the subsidy allowance and the other issues I’ve just outlined, SBA received unqualified or ‘‘clean opinions’’ on its fiscal year 2000 and 2001 financial

statements. We discussed these issues with SBA’s auditors, and

they have since reevaluated and withdrawn their unqualified opinions for 2002 and 2001.

SBA’s inability to account for its loan sales or adequately reestimate the cost of loans not sold, combined with other financial management issues, led the auditors to issuing a disclaimer of opinion

on SBA’s fiscal year 2002 financial statements. Other issues identified during the fiscal year 2002 audit that impacted the opinion included problems in accounting for pre-1992 loan guarantees and

uncertainties surrounding the balance in the Master Reserve Fund,

which is maintained by SBA’s fiscal agent as part of its administration of the 7(a) secondary market program. The auditor reported

material internal control weaknesses related to these and other

issues, including SBA’s financial reporting process. According to

the auditors, SBA continued to experience widespread difficulties

in producing accurate, timely and adequately supported financial

statements.

In closing, Mr. Chairman, SBA’s financial management deficiencies are quite severe and point to an inability to provide full

accountability for taxpayer funds provided to the agency for carrying out its programs. We made a number of recommendations in

our January report covering these matters as they related to loan

sales and subsidy cost estimates. The SBA agreed with our recommendations and contracted with an independent consulting firm

to assist them in completing a more detailed analysis of their loan

sale accounting and cost estimation procedures. Based on our recent discussions with SBA officials, we understand that they are

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making good progress in identifying potential causes of the problems and actions to address them, and we look forward to assessing

the results of these activities.

Thanks, Mr. Chairman.

Mr. PLATTS. Thank you, Ms. Calbom.

[NOTE.—The GAO report entitled, ‘‘Small Business Administration, Accounting Anomalies and Limited Operational Data Make

Results of Loan Sales Uncertain,’’ may be found in subcommittee

files.]

[The prepared statement of Ms. Calbom follows:]

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Mr. PLATTS. And before we go to our next testifier, I apologize.

I wanted to recognize our vice chair, the gentlelady from Tennessee, Marsha Blackburn. Thank you for being with us.

STATEMENT OF THOMAS A. DUMARESQ, CHIEF FINANCIAL

OFFICER, SMALL BUSINESS ADMINISTRATION

Mr. DUMARESQ. Chairman Platts, Mr. Towns and other members

of the subcommittee, first of all, I apologize for my voice. I woke

up, and it seems to have gone away.

On behalf of the SBA and Administrator Barreto, I want to

thank you for the opportunity to speak today about the SBA’s financial statements. I am Tom Dumaresq, SBA’s Chief Financial

Officer.

First, I want to emphasize that Administrator Barreto is committed to good and sound financial management. He changed the leadership team in the Office of the Chief Financial Officer because he

determined that a fresh look at the agency’s financial systems and

procedures was necessary. Shortly after he was confirmed, he became aware of problems with the timeliness and accuracy of financial data, the progress of the implementation, and appropriateness

of expenditures on a loan monitoring system and issues surrounding loan asset sales. I was appointed CFO in March 2002 with a

mandate from the Administrator to correct these problems. Jennifer Main, a senior management consultant and former employee

of the Office of Management and Budget with extensive Credit Reform Act experience, was hired as the new Deputy CFO in September 2002.

With the support of Administrator Barreto, the new CFO team

quickly identified the primary financial management problems that

is the subject to this hearing as well as other critical financial management issues. We were working to address these issues before

the GAO fiscal year 2002 audit reports were issued, and I am very

confident based on progress so far that the three issues that form

the basis of the disclaimer will be resolved before the fiscal year

2003 financial statements are submitted.

SBA IG has the responsibility for obtaining an independent audit

of SBA’s financial statements annually. Since 1991, the IG has employed Cotton & Co. LLP as its auditor. Since 1996, SBA had been

given unqualified opinions from the auditors. We are here today because SBA received a disclaimed opinion on its fiscal year 2002

statements. I would point out, however, that the key issues raised

in the fiscal year 2002 audit have been elements of SBA’s financial

statements since 1999, and only this year did the auditor determine that these issues merited the disclaimed opinion. It is not

SBA’s treatment of these issues that has changed, but rather the

auditor’s perspective regarding their significance.

We agree with the auditors’ recommendations; however, it is important to recognize that the changed audit opinion does not reflect

a decline in the quality of our financial statements, but rather a

more in-depth assessment by the auditor of what has been in our

financial statements for a number of years. The asset sale issue is

very complex, and the available guidance is very limited. It is fair

to say that both the fiscal year 2002 financial statement audit and

the January 2003 GAO audit provided helpful information, but ulVerDate 11-MAY-2000 11:28 Sep 26, 2003 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 D:\DOCS\89351.TXT HGOVREF1 PsN: HGOVREF1
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timately we recognize that the answer to the problem will come

from the CFO staff supported by a highly qualified team of outside

consultants.

SBA has been aggressively pursuing an answer to this problem

since the fall of fiscal year 2002. SBA held its first asset sale in

August 1999. Since then, SBA has conducted a total of seven asset

sales and plans to continue the program, but only if it is determined to be in the government’s best interest.

As early as the fall of fiscal year 2000, SBA was aware that the

accounting for the asset sales was resulting in losses on the financial statements rather than gains as calculated under the asset

sales model. In 2001, GAO was asked to look at this anomaly,

which resulted in their January 2003 report.

There are two distinct issues that SBA is working to resolve. The

first issue is discrepancy between the accounting system which

tracks program costs and the budget models which are used to forecast the lifetime loan program cost. The second issue is the discrepancy between the asset sales hold model, which estimates the value

to government of loans to be sold, and the budget model. Results

from our asset sales program have indicated that while the sales

were profitable when measured against the hold model value estimates, the proceeds from the sale caused an increase in program

costs as measured by the budget model.

We believe we have made good progress in resolving these issues,

but it’s too preliminary to go into detail about our findings. I can

say that SBA is determined that going forward there must only be

one model. The single model must have the functionality to provide

both the traditional budget results as well as the loan level value

to government estimates that the hold model had provided previously.

Although we have made significant progress, we will not be able

to determine the impact of asset sales on the cost of the disaster

loan program until the new baseline subsidy model is completed

and validated. We anticipate completion of the model, including review and validation, by the end of this fiscal year.

In conclusion, I can assure you that SBA is taking the necessary

steps to address the issues raised by GAO and the auditor and expects to have them resolved by the time the fiscal year 2003 audit

is completed. I believe that we have learned a great deal as we

work through the asset sale issue. We hope to work with OMB and

GAO to share our experience with our agency involved in asset

sales.

Thank you, and I’m happy to answer any questions.

Mr. PLATTS. Thank you, Mr. Dumaresq.

[The prepared statement of Mr. Dumaresq follows:]

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Mr. PLATTS. Mr. McClintock.

STATEMENT OF PETER McCLINTOCK, DEPUTY INSPECTOR

GENERAL, SMALL BUSINESS ADMINISTRATION

Mr. MCCLINTOCK. Good afternoon, Chairman Platts, Mr. Towns,

Mrs. Blackburn.

Your letter of invitation asked me to address five issues, which

I will do. You asked for our reaction to the findings in the GAO

report. In brief, the GAO report identified significant issues which

may have affected the fair presentation of SBA’s fiscal year 2000–

2001 financial statements.

Of the issues identified, we believe the disaster loan subsidy

model’s shortcomings have the greatest impact on SBA’s financial

statements. The subsidy estimate and reestimates prepared by

SBA directly and indirectly affect all of the accounting anomalies

noted.

GAO recommended that we and our financial statements auditors assess the impact of identified misstatements and determine

whether previously issued audit opinions need to be revised. We

agree with GAO’s recommendations. From our preliminary assessment of actions to date, it appears that SBA is taking appropriate

steps to correct the problems. However, much work remains, and

it always has to be reviewed.

You asked for our reaction to the issuance of a disclaimer of opinion by our auditors on the 2002 financial statements and the withdrawal by the auditors of their opinions for the 2000 and 2001

statements. Based on the lack of information to verify certain financial statement amounts, we believe that a disclaimer was appropriate for the 2002 audit. Regarding the 2000 and 2001 statements, Cotton & Co. withdrew its opinions based on the findings

in the GAO’s report and the resulting uncertainty of some of the

financial statement amounts. We agree with Cotton’s decision to

withdraw their opinions and ensure that SBA made appropriate

disclosures.

The subcommittee also asked for our reaction to the scoring of

SBA’s financial management for 2002 and 2001 in the President’s

Management Scorecard. While not familiar with all the details for

scoring, we believe the 2002 score of red was appropriate. SBA’s

2002 appears to be directly related to Cotton’s disclaimer of opinion. In 2001, SBA received a yellow score. While SBA had received

a clean opinion in 2001, Cotton noted material weaknesses and reportable conditions in SBA’s reporting process and related system

controls. Also, for both years, SBA was not in substantial compliance with the Federal Financial Management Improvement Act of

1996. These problems appear to meet the criteria for a red score.

You asked how the OIG is responding to these problems. We

have worked closely with Cotton and the CFO to ensure that the

correct process was followed in withdrawing past opinions. We also

initiated a review to understand the process that had been used in

the past for loan sales accounting. This review is ongoing.

We have also taken steps to strengthen the audit process. First,

we asked Cotton for a plan for the 2003 audit with specific emphasis on credit reform. Cotton’s plan includes retaining additional

credit reform expertise, increasing involvement by one of their

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partners with recognized credit reform experience, and retaining an

outside expert to review their credit reform testing.

Second, we are increasing our monitoring of the financial statement audit. To strengthen our own credit reform knowledge, we

have enlisted the help of GAO to guide us in monitoring the credit

reform aspects of the audit, and we will train appropriate OIG staff

in Federal credit reform accounting.

Third, the CFO, Cotton and OIG will form a working group to

have open and candid discussions about audit issues as they arise.

Last, the SBA Administrator recently decided to create an audit

committee for the agency to advise and oversee financial management within SBA.

You asked us to identify the challenges SBA faces to improve financial management. SBA faces a number of challenges. Its loan

accounting system has been in use since the 1970’s and is programmed in COBOL. SBA incurs substantial risk because the system is close to the end of its useful life, and it faces loss of contractor support within the next few years. Further, the system cannot

be easily modified to adapt to accounting changes and rules. In fiscal year 2002, Cotton identified financial system information security weaknesses related to authorization, completeness, accuracy

and integrity of processing data files. While SBA has made substantial progress in this area over the years, this area requires continued vigilance.

In October 2001, SBA implemented the Joint Accounting and Administrative Management System [JAAMS]. While JAAMS has

some improved features, it does not fully support the U.S. Standard

General Ledger, and it does not provide for integration of SBA’s

disparate accounting systems. SBA has recognized that JAAMS

does not fully meet its needs and is looking for alternatives.

SBA continues to rely heavily on its Financial Reporting Information System [FRIS]. FRIS consolidates the results of various accounting systems and generates the financial statements. FRIS

consists of a number of automated and manual processes. This

process has yet to result in SBA producing timely, accurate and

complete financial statements.

In summary, many of the SBA financial reporting problems are

related to outdated and cumbersome systems.

Again, thank you for the opportunity, and I’d be pleased to answer any questions you have.

Mr. PLATTS. Thank you.

[The prepared statement of Mr. McClintock follows:]

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Mr. PLATTS. Mr. Hayward.

STATEMENT OF CHARLES HAYWARD, PARTNER, COTTON &

CO.

Mr. HAYWARD. Good afternoon, Chairman Platts and members of

the subcommittee. I submitted a written statement of today’s testimony, and rather than summarize that statement per se, what I’d

rather do is to reformulate my testimony right now in a way that

would address the four key points that the committee wants to talk

about today. I’ll address these points in turn.

First of all, however, I would like to preface my remarks by informing the subcommittee that my input today reflects our assessments as of January 29, 2003. That is the close of our audit field

work, and we have not done any substantive audit testing since

that date.

Right now I would like to get into your questions, your four questions, and my inputs to those questions as best as I can. The subcommittee’s first question: What are the fundamental flaws with

SBA’s accounting for loan sales? We’ve had Pete and Tom speak to

that already. I’d just like to say that during the 2002 audit, we

learned that shortcomings with SBA’s disaster modeling were the

basic flaw. Bill Menth will speak in a few minutes about this flaw,

which led to two kinds of inaccuracies, neither of which could be

readily quantified by management during the relatively short period of the 2002 audit. The first effect of this flaw was that SBA’s

unsold loans could not be valued correctly, and SBA’s subsidy costs

for loans not sold could not be accurately reestimated. The second

effect of this flaw was that reliable and accurate values for loan

sale losses could not be computed. These two effects were embodied

in our audit reports, reflected in our disclaimer of opinion, and addressed in greater detail in GAO’s report.

SBA has, as I mentioned—has spoken to its evaluation of GAO’s

report for purposes of assuring itself that all corrective actions are

taken as soon as possible and, in any event, in time for Cotton &

Co. to adequately assess corrective action. I can only say at this

time that SBA’s reaction appears consistent with its desire to be

responsive to us and GAO.

The subcommittee’s second question: What did SBA learn from

the consultants it hired to help solve the problems with loan asset

sales? I think it’s fair to say that it appears to us that SBA has

gone a long way toward answering this question in the testimony

just given. Bill, I might add, will supplement that point.

I wish, however to make two points. The first point I’d like to

make is that some of our audit evidence supporting our clean opinions for 2002 and 2001 was based on our conclusions drawn from

reviewing available reports prepared by SBA’s credit modeling consultants. These reports found that the subsidy modeling estimates

were reasonable and free from material deficiencies, and those reports addressed most or all of the models, particularly the disaster

loan model. While the body of our audit evidence with respect to

the 2000 and 2001 modeling was broader than these consultants

reports, I simply want to make the point that such reports, these

consultants reports, did influence our work.

54

Second, I want to point out that while we have not been privy

to the latest report by IBM, we understand that report goes a long

way as a positive first step toward the necessary corrective action

on SBA’s part.

The subcommittee asked a third question: How does SBA plan to

rectify the situation and make sustainable long-term improvements

to its financial management? Again, I think SBA has done a much

better job of addressing this question than I can. I would simply

like to say that appearances here today and from the testimony

that I’ve seen indicate that SBA will undertake the necessary actions to rectify this situation and make sustainable long-term credit improvements as soon as it can. Its plans to meet these goals

this year are ambitious.

Fourth, why did SBA receive clean opinions in fiscal years 2001

and 2000 when its accounting for loan asset sales was flawed? I’d

like to start by saying that credit reform is an extremely complex

area involving a number of disciplines’—accounting, modeling, statistics, and economics. Beginning in 2000, the partial cohort asset

sales exacerbated those complexities and brought to light the problems so that they were clear to everybody involved here at this

table.

In our 2000 and 2001 audits, we recognized that these compounded complexities existed, and we completed extraordinary procedures to test the methodology and the underlying data. Those are

the two key steps under audit standards with respect to accounting

estimates. The modeling flaws that are now apparent escaped our

detection. Many expert eyes have looked at the estimation models

and methodologies over the years, and I must say that the flaws

that escaped our attention, escaped other persons’ detections as

well.

But I want to emphasize that the responsibility for our audit

opinion is ours and ours alone. With—when the inaccuracies in the

estimates became evident last year, I want to also say that we did

what was required under the standards. We took steps in cooperation with SBA to prevent continued reliance on the financial statements, and we withdrew—we asked SBA to make clear to potential

readers that they should not rely on either our audit opinions for

those years or the agency’s financial statements.

Now, withdrawing an opinion is not something that the firm took

lightly, and we certainly will not take that lightly. We intend to

learn from that withdrawal in the future. In doing audits for more

than 22 years, Cotton & Co. has never before had to withdraw reliance on an audit opinion, and in this case we’ve done what we believe to be the right things.

In closing, I hope that is a good start for allowing you to understand our perspective. Thanks for listening, and I’d be happy to answer questions.

Mr. PLATTS. Thank you.

[The prepared statement of Mr. Hayward follows:]

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Mr. PLATTS. Mr. Menth.

STATEMENT OF BILL MENTH, CONSULTANT TO COTTON &

CO.’S SBA AUDIT TEAM FOR FISCAL YEAR 2002, POSTAUDIT

CONSULTANT TO SBA

Mr. MENTH. Mr. Chairman, members of the committee, good

afternoon. I join with others in thanking you for the opportunity

to discuss SBA’s loan assets sales and financial reporting.

Before presenting my testimony, I should state that I have

worked in three capacities related to SBA’s credit programs. From

1986 through 2001, I worked with the Office of Management and

Budget, where I had a substantial role in implementing credit reform. My time at OMB included a significant amount of work specifically with SBA’s credit programs. I retired from OMB in 2001.

From June 2002 through January 2003, I was an advisor to the

audit team for Cotton & Co. In that capacity I contributed to the

analysis of the disaster loan sales in the Master Reserve Fund,

which in turn contributed to the disclaimed opinion. Then in March

2003, several weeks after the audit engagement was concluded,

SBA contracted with me to advise them on the resolution of the

disaster loan issue.

Today my testimony will focus on three themes drawn from my

experience with the 2002 financial audit: first, on the role of credit

estimates in financial statements; second, on the current state of

standards and guidance for estimates used in accounting for the

loan asset sales; and third, on the need to help other Federal agencies benefit from SBA’s recent experience.

You’ve already heard that SBA’s financial statements received a

disclaimed opinion, largely, though not exclusively, because the

gain or loss on $5 billion in loan sales could not be stated accurately. I will add a few details to what you’ve heard already to lay

a basis for a point I wish to make.

Briefly, a loan sale results in a gain when the net proceeds from

the sale exceed the book value and a loss when the opposite is true.

In that equation the net proceeds are calculated using actual cash

transactions. However, the book value, contrary to what the name

might suggest, is a present value calculation of the estimated cashflows that would have taken place if the loans had been kept rather than sold.

In drawing attention to the distinction between actual accounting

for cash transactions and cash-flow estimates, I wish to emphasize

where we must look for solutions. The disclaimed opinion was due

to the errors—the disclaimed opinion was not due to errors in the

accounting for the cash proceeds. The problems resulted from the

faults in the statistical models used by SBA. The fundamental defect is the inability to estimate specifically the remaining cashflows of the loans sold and, therefore, the book value of the sale.

Therefore, the problems must be resolved by placing—by replacing

the existing disaster loan model with a new model that meets all

standards, both explicit and implied, and provides cash-flow estimates on a loan-by-loan basis. This is what SBA has engaged me

to assist them in doing.

The distinction between estimates and actual accounting for cash

transactions is important for another reason. While there are wellVerDate 11-MAY-2000 11:28 Sep 26, 2003 Jkt 000000 PO 00000 Frm 00067 Fmt 6633 Sfmt 6633 D:\DOCS\89351.TXT HGOVREF1 PsN: HGOVREF1
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developed standards for actual cash transactions, the standards for

estimates, especially those related to loan sales, do not have the

same degree of evolution and refinement. This leads to my second

theme.

In recent years the disaster loan model has been subject to a

wide review. In addition to SBA staff and SBA auditors, the model

is reviewed by outside firms to validate its methods, and by OMB

and by GAO. I am not aware of any instance where the fundamental defect was identified.

The failure to identify that defect despite the time and talent

available is curious indeed. In my view, it cannot be attributed to

a lack of seriousness of purpose or a shortfall in professional capabilities. In fact, I have a high professional regard for all those that

were involved in the matter.

Instead I would like to suggest another explanation: that the

standards and guidance for credit estimates did not evolve as

quickly as was needed. In particular, while guidance was provided

under one heading for cash-flow estimates and under another heading for loan sales, there’s little guidance provided regarding the incremental requirements for cash-flow estimates when they are used

for loan sales.

I believe it is fair to say that as a result of SBA’s experience, that

more explicit guidance can be given now regarding loan sales. Had

the need for such guidance been apparent earlier, I believe it would

have been made available. In any case, I trust the experience will

have a beneficial effect on the evolution of standards and guidance.

My final theme is a suggestion for how other credit agencies can

benefit from SBA’s experience. Other agencies are currently selling

loan assets; additional agencies may sell them in the future. I

would encourage the development of a lessons learned document—

I don’t believe I’m unique in this—in which all of the parties, SBA,

OMB, GAO, SBA’s auditors, contribute freely.

Thank you. I’ll look forward to your questions.

[The prepared statement of Mr. Menth follows:]

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Mr. PLATTS. Thank you, Mr. Menth, and all of our witnesses for

your testimonies.

I think one of the things that came through in your oral testimony here today and your written testimonies is the partnership

that’s come out of what’s been discovered about the modeling problems and how that’s translated; and clearly, with GAO, with the

CFO at SBA, the inspector general, the auditors that you’re working hand in hand with each other to try to learn from what went

wrong and then have a positive result not just for SBA, but as was

just referenced for other agencies involved in loan sales as well.

That’s certainly what we’re hoping, that this hearing will kind of

further bring light to that effort and allow all in the Federal Government to benefit from this process.

For the most part, as we turn to questions, we’ll follow the 5-

minute rule for each committee member. And after we’ve done the

first round, we’ll certainly be glad to come back around then. With

there being a small number of us here, if you need a little extra

time as we go through that first round, that’s fine.

I’m going to begin with a question really for the whole panel.

Given the issues that have been identified now and that you’re

seeking to resolve, and to prevent the modeling problems in the

past and have a more accurate model, would you recommend that

there should be no loan sales done at all, not just by SBA, but by

other Federal agencies, until this additional guidance is solidified

and then put out there and a better model is in hand; or in the

alternative, that we at least have—my understanding in trying to

get a handle on this is that the sale of partial cohorts as opposed

to a complete package of cohorts maybe compounded the problems

that occurred. So would you support either of those alternatives, or

do you think that we can go forward without one of those being

adopted?

Ms. CALBOM. We’ll go in order then, I guess.

Mr. PLATTS. That’s the easiest probably.

Ms. CALBOM. Bill will get to think a long time about his answer.

I guess, you know, this is a very complicated issue as we’ve all

been talking about, and we haven’t even begun to even scratch the

surface of the complexities. But as far as additional sales going on,

we recommended in our report that SBA needed to get their accounting squared away before they would carry on additional sales.

I think when you’re talking about other agencies, they need to

have the demonstrated ability to do the type of calculations that

are necessary to properly account for these loan sales. I mean, it

might be a suggestion that some kind of a dry run be done with

an agency, again, to be sure that they can actually do this.

But the complexity of the partial cohort certainly, at SBA, made

it more difficult. The way that they do their modeling, they really

aren’t able to directly allocate the allowance on a partial cohort

basis, so it does make it even more complicated.

Mr. DUMARESQ. I guess the only thing I’d say is that the problems that we’re experiencing with asset sales are related very specifically to the sale of disaster home loans, which are low-interest,

direct government loans. We also sold some 7(a) business loans

that had defaulted, and we didn’t see the same problem. GAO recVerDate 11-MAY-2000 11:28 Sep 26, 2003 Jkt 000000 PO 00000 Frm 00072 Fmt 6633 Sfmt 6633 D:\DOCS\89351.TXT HGOVREF1 PsN: HGOVREF1
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ognized some problems with our accounting that we corrected, but

we don’t see the same anomalies coming up on that side.

My point would be that I don’t think that our experience necessarily should lead to other agencies stopping loan sales. I do

think that they should certainly do their homework as they’re

doing this and thoroughly evaluate the results of the sale after it

takes place to make sure that they have a good handle on what the

actual costs are and whether it’s consistent with their estimates.

The cohorts certainly would have made it easier, but it seems to

me that we have enough data available to us to analyze the results

of the sales and the remaining portfolio, and I would presume that

other agencies would, too.

So it’s possible to do, but I think that it really has to be done

with a thorough evaluation of the results and the costs.

Mr. MCCLINTOCK. I would tend to agree with Tom. I can’t speak

for other agencies, but I would strongly recommend that SBA not

do anything until we fully understand what all the consequences

are of the sales that we’ve already had. And there are some issues

that will come out of this in terms of both funding the losses and

also issues in terms of funding the contractors that SBA hires to

facilitate these sales. The assumption is that we have to enter into

contracts in order to do the due diligence aspects of a loan sale, and

the money that we use to pay those contractors actually comes out

of the proceeds. Part of the process is that we make a determination—whether it’s been right or wrong, we make a determination

of whether we will receive enough value for the loans that we’re

selling in order to proceed. If we end up in a position where we

have to make the determination that we do not receive enough

value, then we don’t proceed with the loan sales.

But we’ve funded millions of dollars up front with contractors in

order to determine—in order to prepare for the sale. Those types

of questions are kind of peripheral to the accounting issues. It gets

more into the management issues in terms of how an agency runs

its programs and so forth.

As for partial cohorts versus full cohorts, certainly the accounting

would be simpler under full cohorts. I’m sure you would have others that would argue that if they were restricted in selling just cohort loans, that they wouldn’t maximize the value that they received for loans. So there’s a tradeoff in terms of the simplified accounting versus maximizing results.

Mr. PLATTS. Mr. Hayward, did you want to say something?

Mr. HAYWARD. I do. I see that we’re a little bit over on time, but

I would like to say a couple of things briefly.

As to the first question, as Pete said, I think that we get into

some programmatic issues that we as auditors don’t directly involve ourselves in in the financial statement scope. I would add,

however, that I’ve heard nothing that I disagree with along down

the lines. I think as a taxpayer it may very well be prudent to

relook at whether we should—SBA should continue to sell these

loans here without knowing further information.

As to the second point, Pete hit what I was going to say, and that

is there needs to be balance. I think this answer is a little bit too

rigid to say that, yes, we should sell it by cohort.

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Mr. PLATTS. Quick followup before I yield to Mr. Towns. Mr.

Dumaresq, when you emphasize with SBA or other agencies that

continual evaluation that is now clear as far as the models, is it

giving you an accurate reflection? What would be your best estimate as far as why that did happen with SBA, that we had 50 percent or so of the loan sales occur before having some review; you

know, after 20 percent or 30 percent that we went so far forward

before saying, hey, we need to do a review, or something came to

light that told us that we had to do a review? It seems like that’s

when it prompts you. We were pretty far along before we did that

type of evaluation that you’re talking about.

Mr. DUMARESQ. I guess—that’s a difficult question for me to answer.

Mr. PLATTS. I realize your timing and when you came in, and

trying to look back, you know, it’s——

Mr. DUMARESQ. I’d say two things. First, the results—and I don’t

think we’ve raised this before, but the fact that the asset sales proceeds were less than the net present value shown on the financial

statements was a theoretically possible outcome, and so it was not

a situation where the fact that we showed a loss on the financial

statement after sale too immediately would have raised the red flag

necessarily. On the other hand——

Mr. PLATTS. A theoretical possibility, wouldn’t that probably tell

you that your model for assessing the book value then is skewed?

I mean, that would tell you something’s off there if you can—it is

possible, but there is still going to be a problem somewhere, in the

value assessment.

Mr. DUMARESQ. Let me say this: When I came on board, shortly

after coming on board, I was made aware of the fact that this situation existed, that we were showing very large losses, and as rapidly as we could employ the resources to do it, I asked for an evaluation of the loans sold versus the loans held and whether the results we were seeing actually supported the presumption that there

was no impact on the subsidy rate. I don’t know why that wasn’t

done earlier, nor whether it was appropriate earlier, but that was

what I felt was appropriate as soon as I found out what the situation was.

Mr. PLATTS. OK. Thank you.

I now yield to Mr. Towns for the purpose of questions.

Mr. TOWNS. Thank you very much, Mr. Chairman. And I don’t

want you to think I’m involved in terms of wanting to blame somebody, but I really want to make certain that I understand the reason for the mistakes. Was it the complexity of the sales, or was it

just a lack of expertise within the agency? Or is there something

that we need to do on this side to be able to assist you in correcting? To Mr. Dumaresq.

Mr. DUMARESQ. I guess I’d say that it’s difficult—I wouldn’t necessarily characterize what happened as being the result of errors

or mistakes in the sense that it was a situation where the wrong

data was input or something like that. What you have here under

credit reform is a situation where models are developed to estimate

costs. They are only estimates. And these, the estimates that we

were using, turned out to be not accurate enough to deal with the

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sale of these assets and weren’t accurate enough to accurately assess the cost of the program.

Now, over a period of time, the way credit reform is supposed to

work, on an annual basis there is a reestimate that’s done with actual data. So it is a kind of a self-correcting process. You know, it—

it is a very complex set of circumstances. I think some of the best

people in the field were available to SBA and were drawn in as

consultants and reviewed the different components. To really get a

handle on this problem, you had to look at the results across the

three areas, across the whole model that was predicting what the

asset sale would bring, subsidy model that was estimating the cost

of the loan program and the accounting. It seems like each one of

those different elements had been reviewed in detail individually,

but as a group the overall answer, all together, the answer was

clearly needed further evaluation, and that additional step wasn’t

taken.

So, like I say, it is a very complex set of circumstances, and as

soon as I came in and became aware of the situation, we started

to address it.

Mr. TOWNS. Right. I think the point I’m saying, do you feel comfortable that you have the expertise within the agency to deal with

this problem? And can you really correct it? And I think you said

something about reaching out and getting consultants. But even in

order to do that, you still have to have a certain amount of expertise within the agency. Do you feel that you have that?

Let me just tell you where I’m going with this. You know, I don’t

want to—you know, a lot of times we sit over here on this side and

blame—you know, is there anything that we need to do here as

Members of the U.S. Congress to help you, to assist you in making

the corrections that need to be made? Because I’m troubled by the

fact that evidently you have to stop for a while and make all these

corrections, make all these changes. In the meantime, you know,

people that need the service will not be getting it.

Mr. DUMARESQ. Well, I don’t think there will be any impact on

the program delivery at SBA because of that.

Mr. TOWNS. Well, I thought Mr. McClintock mentioned the fact

that maybe there should be a delay. Am I quoting you right?

Mr. MCCLINTOCK. Correct. But it really relates more to funding

issues and——

Mr. TOWNS. That’s service.

Mr. MCCLINTOCK. Right.

Mr. TOWNS. In my neighborhood.

Mr. DUMARESQ. Well, none of the loan programs would be impacted in any way.

Mr. TOWNS. OK.

Mr. DUMARESQ. In other words, we’re engaged here in the sale

of loans after they’ve been made.

Mr. TOWNS. Right.

Mr. DUMARESQ. So, before we sold loans, we serviced them inhouse, and we’re continuing to do that.

Mr. TOWNS. So this will not stop or will not delay in any way.

Mr. DUMARESQ. No. No. There’s no impact on SBA’s programs.

Mr. TOWNS. Ms. Calbom, do you want to add something on that?

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Ms. CALBOM. I think what Mr. Dumaresq is saying is that basically it’s not slowing down their activity as far as making new

loans, but what it is slowing down is packaging of those loans and

then selling them to other buyers who would then service them.

So as far as providing the funds out there in the small business

community, it wouldn’t impact that. What it does impact, then, ultimately is who is servicing the loans, and it impacts how much of

SBA’s resources that they devote to carrying out the loan servicing

function. The more loans they sell, then theoretically the less of

their resources that they have to devote to servicing those loans.

Mr. TOWNS. Right. I guess, Mr. Hayward, how did your firm miss

what seemed to be such a major accounting problem? How did you

miss it?

Mr. HAYWARD. Well, I think we missed it in the context of some

of the complexities involved, some of the inherent risk that we’ve

got here to deal with short milestones. And I think notwithstanding those two factors that we did do extensive tests of these balances. We had statistical people at our side back in 2002 and 2001

to thoroughly go through these models. We looked at the outside

consultants’ reports that unanimously, I think it’s fair to say,

painted a picture that there were no problems conceptually with

these models.

So I think Congressman Towns, that we see here a situation

where we perhaps could have been more skeptical in the circumstances, but by the same token, I think we have a substantial

body of audit evidence to support our conclusions, which at the

time we felt were reasonable.

Mr. TOWNS. I guess the question I wanted to ask, can we safely

say that this will not happen again? I mean, that’s where I’m trying to go.

Mr. HAYWARD. Well, we’re taking steps to assure that this won’t

happen. Pete, I think, referred to a number of those steps, and they

are always referred to in our words, in our testimony. In brief,

those steps are to increase substantially the amount of inputs from

a recognized credit reform expert that we have on staff and also

the independent partner on the engagement. Her name is Cathy

Nocera. Second, we will be bringing onto the engagement a recognized ‘‘name’’ credit reform expert to manage that side of the audit.

Now, there’s two parts to managing that side of the audit, Congressman Towns. The first side is evaluating the models and

whether they are sound, and the second side is to evaluate the corresponding accounting. These are two different disciplines that we

need to bring and that we will bring.

Last, we want to have our work peer-reviewed by a credit reform

expert that has been uninvolved in the audit to date. We intend to

bring this person on late—well, midpoint in the audit to make sure

that we have mutual understandings of the expectations here for

that person. Again, this person is independent. And then later in

the audit we will feed that person our conclusions that—as we see

them so that person can criticize and maybe draw some constructive changes if they’re appropriate to our conclusions.

So we are taking specific steps to minimize, if not eliminate, this

possibility.

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Mr. TOWNS. Thank you very much, Mr. Chairman. I see my time

has expired.

Mr. PLATTS. I now yield to Mrs. Blackburn for the purpose of

questioning the witnesses.

Mrs. BLACKBURN. Thank you, Mr. Chairman, and thank you to

the panel for being with us today. We appreciate this very much.

Ms. Calbom, thank you for the report, your book. I wish I’d had

this a little bit sooner. It does have some great information in it.

I’m going to go to page 12 of this report, and, Mr. Dumaresq, I’m

going to address you the first question. Let’s talk for a moment, if

you will, please, sir, about who is buying these loans.

Mr. DUMARESQ. The loans are actually purchased by large financial institutions for the most part. There are some small financial

institutions who’ve bid on some of the pools that we’ve seen.

Mrs. BLACKBURN. OK. Great. Thank you.

Now, let’s talk. I’ll continue with you, if you will, please, sir.

What is the liability or the responsibility that the SBA bears for

the inaccuracies and maybe flawed due diligence in that sale?

Mr. DUMARESQ. You mean with the purchaser, the ultimate purchaser?

Mrs. BLACKBURN. Yes.

Mr. DUMARESQ. That’s not something that I deal with regularly,

we can get an answer for you and submit it later on.

Mrs. BLACKBURN. OK. Did the SBA or its auditors consult with

the risk assessment experts during this sale, the loan sales evolution?

Mr. DUMARESQ. Yes, there are financial experts that are on contract with the program, people as they’re formulating the sales,

putting what belongs together and throughout the entire process.

And we also use consultants in the Office of the Chief Financial Officer to develop our models and the full rates and other things.

Mrs. BLACKBURN. OK. Are you aware of the type of due diligence

that the purchasers of the loans are engaged in?

Mr. DUMARESQ. I know that they do their own due diligence, and

SBA does due diligence prior to the sale as well. I’m not completely

familiar with what they do.

Mrs. BLACKBURN. OK. Then looking at page 14 of the report, the

middle paragraph there says, ‘‘SBA’s due diligence is the most costly and probably the most important element of the loan sale process.’’

Mr. DUMARESQ. Yes, that’s correct. There is a significant effort

that goes into making the loan data, information from the loan

files, available electronically to the potential bidders, so that they

can get a good idea of what they’re bidding on. And that’s proved

to be the most costly part of the asset sales.

Mrs. BLACKBURN. OK. And is the percentage correct, that it can

be even as much as 87 percent of the total sales cost?

Mr. DUMARESQ. That, I believe, is correct.

Mrs. BLACKBURN. That is correct. OK. Anyone else have any

comment on that? No? Absolutely not? OK. I did have, either Ms.

Calbom or Mr. Dumaresq on this, how much is it going to end up

costing us to address the situation with the SBA and the loan program? What do you anticipate the total cost to be? Because we’ve

heard from Mr. Hayward, we have the outside consultants, some

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more people are being brought on, what type of expenditure, and

then also what type—timeframe are we looking at to get this

straightened out?

Mr. DUMARESQ. We do not anticipate a situation where we would

be asking for an additional appropriation the way—under Credit

Reform we have an unlimited, perpetual appropriation that we

draw against as we determine or find the cost estimate during the

annual reestimates.

Mrs. BLACKBURN. Just a minute. Would you say that, again, did

you say you have an unlimited?

Mr. DUMARESQ. Right.

Ms. CALBOM. Mrs. Blackburn, I think—were you asking about

the cost of hiring consultants and others to analyze the problem?

Mrs. BLACKBURN. Absolutely.

Mr. DUMARESQ. I’m sorry; I misunderstood.

Right now, we’re just in the process of awarding contracts for

this, and I would say—I think the best thing to do would be maybe

to provide you that information subsequent to the hearing. I’d rather give you an accurate assessment of what it will cost us.

Mrs. BLACKBURN. OK. Have you reduced any of your employee

numbers at the SBA in order to allow for the additional cost of

this? Are you making any personnel adjustments?

Mr. DUMARESQ. We are not making any personnel adjustments

specifically to cover the cost of this, no.

Mrs. BLACKBURN. OK. All right. And what kind of responsibility

exists, Mr. McClintock, coming to you, page 3 of your testimony

where you’re talking about the 1992 loan guarantees.

Mr. MCCLINTOCK. The question?

Mrs. BLACKBURN. Pre-1992, what kind of responsibility exists

there? Or tell me what you think can be done about that. It sounds

like you’ve gone back, you looked, there was a true problem that

was there. Is there any way to go back and rectify part of that?

Mr. MCCLINTOCK. I think the problem for the pre-1992 loans concerns the basis for the accounting estimate that’s entered into the

records. Mr. Hayward probably can describe it better than me, but

it’s basically an allowance for loss account and the CFO’s office estimates what that is. I believe during the audit that there was not

sufficient documentation for the auditors to really assess the validity of the estimate.

Mrs. BLACKBURN. Mr. Hayward.

Mr. HAYWARD. Yes, Mrs. Blackburn, there were two problems,

one of which was resolved during the audit.

The first problem with those pre-1992 loans was that the accounting had been historically done on budgetary bases and not

also on proprietary bases. That problem was adjusted in the financial statements during the audit.

The second problem is, as Pete indicated, with the sufficiency

and objective verifiability of the loss allowance corresponding with

these loans that, once purchased, would default, and SBA, I believe, is working on that. And I, personally, I do not think that is

a, is a problem whose solutions, which should and will drag on

more than 1 year, I think that’s imminently solvable, in other

words, this year.

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Mrs. BLACKBURN. As I wrap up, Mr. Hayward, I will go back to

this first question I asked about any reliability or any responsibility that SBA may bear for due diligence that would be considered

to be flawed. Due diligence by the customers who are buying these

loans, is there any responsibility there?

Mr. HAYWARD. Well, I hope I understand your question correctly.

It’s my understanding that the SBA does perform substantial due

diligence, and it’s my further understanding that we, as part of our

audits, do look at that. In recent years we’ve had Mr. John Murphy

look at that. He is an ex vice-president in the banking industry,

and he has substantial experience with due diligence assessments.

Mrs. BLACKBURN. Thank you, sir.

Mr. HAYWARD. You’re welcome.

Mr. PLATTS. I’m going to followup on that and make sure, in trying to get to the due diligence of the purchasers of the loans, what

goes into making the book value, you know, how accurate the

model is in coming up to what is estimated.

I mean, the purchasers obviously are trying to make sure they’re

getting a good deal. So what are they doing differently or were they

doing differently than SBA was doing in saying, ‘‘Hey, this is a

good deal, and we’re really going to be able to collect 50 percent

more than we’re going to pay here.’’ They obviously had to have a,

do have a model in place that they use. Is that something that the

SBA has gone into, the private sector, people who were purchasing

loans and say, ‘‘What are you using to value our loans?’’ So you’re

actually going to those who have been engaged in loan purchase

transactions?

Mr. DUMARESQ. I know that our asset sales group has done quite

a bit of research on what the buyers do as far as due diligence, and

what they’re looking for as far as the loans that we’re selling.

I do not think I’m in a position to really give a definitive answer

to you on what the results of that have been.

Mr. PLATTS. If you could followup in writing with us.

Mr. DUMARESQ. Sure.

Mr. PLATTS. That would be great. It’s kind of learning from the

reality of the marketplace, is what those borrowers are looking at

and how they’re making assessments, certainly as it relates to the

book-value assessment that’s going on. And that kind of translates

as a followup on the questioning about the annual reestimates,

that ideally there would be kind of a self-correcting process here.

Given that the loans, the five sales in question were, I believe, in

1999 to 2002, what went wrong in those reestimates? Because GAO

said that those reestimates were not really found to be very reliable. Why were they not? We’re actually looking at true numbers,

here’s what we valued, here’s actually what we got. So we’re too

high, too low?

What went wrong that those reestimates were not very credible

and helpful? So that the second and third, actually, it would be second and third because if it’s an annual reestimate, you’re not going

to have all that information for all of them, but what maybe did

not happen that maybe should have? Let’s start with you, and then

have GAO.

Mr. DUMARESQ. Maybe Bill Menth is a better person to speak to

that.

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Mr. MENTH. Mr. Chairman, I’d like to make sure I understand

your question correctly.

Reestimates, let us suppose you have a cohort from 1992 which

expects to have a remaining life of, say, another 30 years because

some of the loans in there were 40-year loans, approximately. The

reestimate has two parts, a large part and a small part. The small

part is the replacement of estimates with actual data for the 1 year

just completed. The large part is the revaluation of the estimates

for the remaining, now, 29 years. And the difficulties with disaster

loan reestimates were largely due to the problem with the reestimates of the remaining years that were not yet actual, rather than

1 year that became an actual.

Mr. PLATTS. Maybe I’m misunderstanding that reestimate.

I was understanding or believing that it was really the value

that the market’s going to place on these type of loans that you

learn from the actual price paid. So if you reestimate going forward, that you have a little better idea what the market’s going to

bear as you get to your next sale to have a more accurate book

value, to line up better with the market. Maybe I’m misunderstanding how those reestimates can really be used or what they

offer you.

Mr. MENTH. I think that’s an important question to answer clearly. I’ll take a minute to do it.

Reestimates are not a market-to-market transaction or calculation. When a loan is sold, that’s an important piece of information

about the value of those loans, and if the book value of the loans

that were just sold was substantially different from the sales price,

it’s certainly an indication that there’s some sort of a difference

that needs to be analyzed and resolved.

There are some very good reasons why bid prices can be substantially below the book value of loans. One of the most prominent is

that bidders will take into account their administrative costs in the

price that they bid. The government does not take administrative

costs into account in its book value.

For the disaster loans, these are all small face-value loans. The

servicing cost of a loan, of course, is independent of the face

amount of the loan. So when you have a large number of small

face-value loans, the administrative costs can be substantial and

can create a spread between the bid price and the book-value price.

That does not indicate that the government has undervalued the

loans, but rather there’s an apples-to-oranges type comparison.

Even so, it’s important if, for example, bids come in at 50 cents

on the book-value dollar, that the differences between the book

value and the bids be reconciled, to see if perhaps there’s something being told you that suggests a revaluation of the original subsidy be made.

Mr. PLATTS. By the end of the day I will—you’re already experts.

You know the area. We’ll be better experts, maybe, or trying to be.

That maybe translates to another followup in why we started the

sale, as opposed to servicing, in the first place. And it really goes

to Mr. Towns’ question about suspending the sales, not the fact

that, Mr. Dumaresq, you say you really want the facts about the

loans being issued. I’m assuming the reason we went to the sales

in 1999 was because it was in the best interest of the taxpayer, beVerDate 11-MAY-2000 11:28 Sep 26, 2003 Jkt 000000 PO 00000 Frm 00080 Fmt 6633 Sfmt 6633 D:\DOCS\89351.TXT HGOVREF1 PsN: HGOVREF1
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cause we’re going to get a better return for the taxpayer by selling

them and doing away with them, rather than keeping them inhouse and servicing them in-house. So that the intent was sales

will generate better return, less cost to operate the program because we get more money, better profit from the sale of it than

servicing.

So if that’s accurate, that’s why we went to sales instead of servicing. If we suspend sales now for some period of time, indefinite

at this point, it seems that we’re getting a lesser return which

means we’re going to have a more costly program, which either

means we need more money from the general fund, or you’re going

to be able to offer fewer program benefits to the public looking for

the assistance.

Am I missing something here, I guess, is the question?

Mr. DUMARESQ. If I understand, then what we’re finding is that

the problem is that the asset sales may not actually give us the

benefits that we thought that they would. In other words, our concern is that the asset sales are not keeping our costs constant, they

may be increasing the cost, or may not be. We are not sure yet. We

have to finish our evaluation, but unless we can show that there

is a benefit to asset sales, we need to delay until we can show that.

Mr. PLATTS. That’s the followup, and if you could submit, as you

complete that review, submit that conclusion you’ve come to, to the

committee as well, that would be helpful. With us being the Government Efficiency and Financial Management Subcommittee that

we’re—is it in the best interest to actually have these sales? The

cynic in me would look back to 1999 and say that in the shortterm, this helps our books because it gets a lump sum of money

into the Treasury. So in the short-term, it makes the books look

better for the Treasury. Although, long-term, if we do the analysis,

it’s really not in the best interest to sell for a flat fee. It’s better

to keep it, service it.

So I would certainly be very interested, and the committee would

be interested, in what that analysis leads you to believe. Because

it sounds like that’s what you’re doing as to whether you really

want to return to sales at all or go back to pre-1999 and return to

an in-house servicing and no sales.

Is that an accurate assessment of what you’ve stated?

Mr. DUMARESQ. Of course, there are other possibilities.

Yes, we want to find out whether the sales are beneficial or not,

and the GAO touched on it in their report. Are there other operational benefits; are we reducing our servicing costs; are the sales

beneficial; and are they reducing our servicing costs? Unless we

can determine those clearly, then there’s no point in going forward

with them. And right now, we do not feel we can make that determination, and we want to get to the bottom of it before we go forward.

Mr. PLATTS. I guess I have more followup questions, but in fairness, I’m going to yield to Mr. Towns.

Mr. TOWNS. I’m sure happy you asked that question, because,

you know, I was trying to figure that out, how this would not affect

your mission. I got the impression or the feel that it would cut

down on the amount that you could actually handle.

That’s not true? Help me understand this.

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Mr. DUMARESQ. Well, up until 1999 we serviced all of the disaster loans in-house.

Mr. TOWNS. Right.

Mr. DUMARESQ. At that point, we started selling well, the first

sale was not disaster loan but business loans, but subsequently, we

started selling disaster loans. We also started what was called a 30

percent home loan disaster servicing pilot where we took 30 percent of the disaster loan portfolio and contracted servicing out to

a large business. The objective, I think, of the asset sales and the

contracting pilot was to find out what was the most efficient way

for us to handle the servicing and servicing of our loan portfolio.

To me, what we found, what’s clear, in my own opinion, is that

there are tremendous economies of sale in servicing loans and that

unless—so it would be better to either contract out or sell the entire portfolio than it is to contract out or sell pieces of a portfolio.

What we found on the asset sale side is that the costs that we

were incurring for servicing were not going down as quickly as

the—as you might expect, given the percentage of the portfolio that

we were selling.

Similarly, when we contracted out 30 percent of the portfolio, our

costs remained relatively constant, and we didn’t see as much of a

decline because we had to maintain our in-house infrastructure

that was used to service the loans.

So I think moving forward, we have to get to the, to come to a

determination on what the best way to handle this loan portfolio

is. The objective is to get to the lowest cost, most efficient way to

service the loans and service the people that receive those loans,

ultimately.

Mr. TOWNS. Yes. Mr. McClintock.

Mr. MCCLINTOCK. May I add one small thing to this?

As we said, most of these loans that we’ve sold are disaster

loans. Disaster loan making is performed by our Office of Disaster

Assistance. Servicing of those loans is performed by our Office of

Financial Assistance. So it’s two different groups within SBA.

Therefore, the folks that actually make the loans aren’t impacted

at all by loan sales. The services are there. Our Disaster people respond just as they always have and have the loans issued very

promptly and timely.

So it’s really the housekeeping at the back end of the process

that is involved and it could be affected by the loan sales. It’s the

people in rooms with thousands and thousands of files of paper

who, who either make changes to various terms of the loans, the

collateral, accept the payments and so forth. It’s the administrative

costs that potentially could be reduced. The program aspects of

making the loans wouldn’t be impacted at all.

Mr. TOWNS. So if for any reason I did not sell any, that would

not affect you. Wouldn’t that stop them from making them?

Mr. MCCLINTOCK. Disaster loans are made in response to disasters, and there’s clear criteria as to——

Mr. TOWNS. I understand that, but I want to have a real serious

discussion on this issue.

I understand disaster and I understand the loan and I just think

that if nothing is moving, it seems to me it might still hinder the

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process in terms of who would be able to get, I just think that on

the other end, it would be a little more difficult to process.

Mr. MCCLINTOCK. On the front end?

Mr. TOWNS. Yes.

Mr. MCCLINTOCK. They’re separate functions, done by separate

groups within SBA.

Mr. TOWNS. And they do not talk to each other? That’s a real

problem.

Mr. MCCLINTOCK. The former Disaster Director said, ‘‘Every loan

I make is a good loan and the other office has to service it, and

if it goes bad, it’s because of the bad servicing.’’

There are separate groups and the formulation of the loan, the

loan approval is all done by—we have four different area offices

and all they do is the front end of the loan. It’s the servicing, the

back end of the loan is done by either the contractor Tom mentioned or by servicing offices SBA has in other locations.

Mr. TOWNS. OK. Let me just sort of raise this quickly, Mr. Chairman.

Last year SBA actually deteriorated on a score for improving financial performance from the previous year. In addition to the loan

asset sale problem, OMB raised questions about SBA’s ability to

meet accounting performance standards and measure risk in its

loan portfolio more accurately. What steps are you taking to address these issues as well?

Mr. DUMARESQ. We’ve developed a plan to address all of the

issues that were raised in the independent auditor’s report and the

GAO report moving forward, and we think that the plan will result

in us clearing up those issues before the audit this year.

Mr. TOWNS. You feel very comfortable about that?

Mr. DUMARESQ. I do, I do. I really do.

We’re totally committed to resolving the issues that have been

raised. We have some challenges; there’s no question about it.

There’s a lot on the plate, but we feel pretty confident that we can

resolve the issues that have been raised this year.

Mr. TOWNS. Do you want to comment on that, Ms. Calbom?

Ms. CALBOM. Based on the discussions we’ve had with Mr.

Dumaresq and others, we feel that they are on the right track, or

looking at the right things. We have not had the opportunity to go

in and really study the analysis that they have performed to date

or the work that their consultants have done. I think the key is

going to be that it is a thorough analysis, and that it has actually

identified all the problems, because this is not a matter of just one

problem. I think it’s a matter of a number of problems that occurred, and so you just have to be sure that you found all the real

issues that are impacting this, double-check it, do some reasonableness tests, check and double-check your assumptions. But as far as

what they have told us they’re doing, we feel like they’re on the

right track.

Mr. TOWNS. Thank you very much. Mr. Chairman, I yield.

Mr. PLATTS. Thank you. Mr. Towns, Chair yields to Mrs.

Blackburn for the purpose of questioning.

Mrs. BLACKBURN. Thank you, Mr. Chairman.

Ms. Calbom, I know that there are other agencies, USDA and

HUD, that are engaged in loan sales, and I’m sure we could say

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there are plenty of lessons here that can be learned and applied

there, but my question is this, is there a model in one of those

agencies that could also be applied to the SBA to help them get on

a firm footing?

Ms. CALBOM. Well, you know, we have not really studied in detail the loan sales that those other agencies have been carrying out,

and I kind of go back to something I said before—I do not think

loan sales caused the problems that SBA has. I think they brought

them to light sooner than they would otherwise have been brought

to light. I think the problems really had to do with, in general, how

they were setting aside their allowances for their losses on their

loans and then going in and checking to see if those allowances

were adequate as they went along.

Now, whether they would have sold loans or not, the bottom line

is, if you did not put enough aside to begin with for the costs of

those loans, then you’re going to fall short at some point and selling the loans actually forced them to recognize those losses sooner

than they would have had to otherwise.

Mrs. BLACKBURN. OK.

Mr. Dumaresq, on page 2 of your testimony, your statement,

where you said, ‘‘The changed IR opinion does not reflect a decline

in the quality of our financial statements, but rather a more indepth assessment by the auditor of what has been in our financial

statements for a number of years,’’ and I think this brings me back

to a question that I asked and Congressman Towns has also

touched on, you know, how far, how far back does the problem go

and is there—are you washing your hands and saying that it was

there and we did not deal with it?

Mr. DUMARESQ. No.

Mrs. BLACKBURN. So we’re changing our behavior going forward

or are you saying here is a way to go back and try to make this

work as best we can.

Mr. DUMARESQ. The reason we make that statement is that we

want to make it clear that it is a difficult situation. We also want

to make clear that we have not changed the fundamental processes

and that we have financial controls in place at the agency. We do

not in any way disagree with the disclaimer, but we think that the

disclaimer is primarily based on the asset sales issue which truly

came to light this year or was viewed in this way this year.

And we feel it’s important for everyone to be aware that we still

have an ongoing, robust financial management system at SBA.

We’re continuing to use the same financial controls that we’ve had

for the past several years. I think the clean audit opinions that the

agency got for the 6-year period, were valid to a very large extent

and that’s the point we’re trying to make here. We do not want

anyone to think that we’ve just stopped employing our financial

controls as we go forward.

On the other hand, we recognize the seriousness of the issues

that have been raised and we’re committed to dealing with them

as we move forward.

Mrs. BLACKBURN. And at this point, how often are you all reevaluating your loan portfolio?

Mr. DUMARESQ. You mean re-estimating the portfolio?

Mrs. BLACKBURN. Uh-huh.

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Mr. DUMARESQ. Re-estimates are done annually, but right now,

we are again engaged in a more detailed process particularly related to the disaster loan portfolio, where we’re looking at the entire

portfolio, including what was sold, and comparing with what was

kept. So that’s a much more detailed analysis than the normal reestimating process.

Mrs. BLACKBURN. OK. Thank you.

Mr. PLATTS. Mr. Dumaresq, I’d like to followup on that question.

When we talked about your analysis of the whole issue of loan

sales versus in-house servicing of those loans. When you talked

about contracting out 30 percent, that was contracting out the servicing?

Mr. DUMARESQ. Contracting out the servicing.

Mr. PLATTS. As part of the ongoing review now, are you factoring

in your decision whether to not go forward with anymore sales and

just do all servicing, the possibility of contracting out all of the

servicing of all your loans? In the sense, have you talked about it’s

an economy of scales issue? That is, is getting rid of 30 percent

going to save a lot because you have all the infrastructure?

Whereas, if you contracted 100 percent of the servicing of the

loans, then you would not have the infrastructure, so that would

make a different comparison on whether it would be good for tax

payers or not? Is that part of your review?

Mr. DUMARESQ. I think, right now, we’re focused on trying to figure out what the impact of the asset sales that we’ve had has been.

What was the financial impact on the agency as a result of those

sales, and that’s a first step.

I think we still believe that asset sales can be a very beneficial

thing for the government. It seem likes it could reduce our ongoing

operational costs and free up resources for other purposes. We have

to make sure that’s, in fact, the case and once we do that, I think

we will consider all the options and try and determine what the

best, most efficient, way to handle the portfolio is.

Mr. PLATTS. In trying to prevent the problems with the sales in

the past happening again in the future, the administrator has

talked about the audit committee and, Mr. McClintock, you referenced it in your testimony. Can you give us an update, where is

that proposal, what are the specifics, who would make up the committee? Is there any of that type of detail available yet that you

could share with us?

Mr. MCCLINTOCK. No, actually, the decision to do this was made

just within the last week or two but our plan is to coordinate with

OMB. We have spoken with them. They have offered their assistance in terms of defining what a committee should do, identifying

possible candidates to serve on that committee.

An audit-committee concept is only in place at a handful of agencies. I believe GAO has one and the FDIC has one. There are several agencies that are exploring establishing audit committees.

OMB has been promoting the concept over the last 2 or 3 years.

So in terms of assessing what happened and trying to come up

with ways of overcoming this type of situation in the future, we

thought an audit committee would be a good idea, and so we presented the proposal to the administrator. He said, ‘‘Good idea, let

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us go with it.’’ So it’s something that’s in the very early stages, but

it will be up and going within the next few months.

Mr. PLATTS. What type, a few months is your estimate there?

Mr. MCCLINTOCK. We really have not even gotten that far in

terms of doing it, but——

Mr. DUMARESQ. We’re actively pursuing it right now. We are trying to figure out what the rules are, what we have to do. We want

to get an audit committee up and running as quickly as possible,

as we can——

Mr. PLATTS. As you flush out the specifics of the committee, the

make-up, the parameter, if you could share that with the subcommittee, that would be helpful.

And the reference to GAO, if, Ms. Calbom, you could give us kind

of an overview, if possible, of what your audit committee does, how

it’s made up and how it’s been working, that would be helpful.

Ms. CALBOM. We’ve actually got several consultive committees

that work with GAO. Our audit committee is involved in our financial statement audit, and I’m not particularly involved in that function. So I could not really give you the details on the make up and

whatnot, but we’d be happy to provide that information for the

record.

Mr. PLATTS. Maybe more directly to SBA, as you mentioned

you’re dealing with OMB is that, is it inferred that since you’re

aware of GAO’s audit committee, that you’re looking at what they

have done as a model or possible model.

Mr. MCCLINTOCK. I’m sure we will look at GAO. I’ve heard Mr.

Walker, the Comptroller General, talk about his audit committee,

and I know he’s very happy with it, and maybe he’ll identify a person or two that could help us out. But we will certainly look at the

structure they use, as well as any other committee within the government.

I think we would probably have to follow the Advisory Committee Rules. There are actually laws on how far an advisory committee goes and what their participation would be.

Mr. PLATTS. Maybe that kind of leads to the next question, the

interaction between GAO and SBA on the audit committee is on

the issue of the IBM review? That’s my understanding, is a draft

or preliminary review has been conducted as far as recommendations and given GAO is playing kind of a pretty helpful role here

in identifying some of the challenges with the loan sales issue, is

there a pretty open dialog between the two agencies right now,

with regarding IBM’s findings and recommendations that, as you’re

looking at those findings you’re asking GAO for their commentary

based on their involvement in this process?

Mr. DUMARESQ. We had a meeting, I think just last week, and

we shared the findings of IBM. We have not shared the report

itself because the IBM report is just a standard report that we ask

for at the end of a contract.

We believe it’s predecisional, and it’s actually only a piece of

what’s been going on. IBM has been working in support of internal

SBA staff to come up with a series of recommendations and testing

different hypotheses.

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Mr. PLATTS. What would be the harm in just sharing the report?

I mean, what risk is there to just share the entire report rather

than just summarizing it?

Mr. DUMARESQ. Well, as I say, we’re happy to make all of the information in the report available to GAO and we have.

Mr. PLATTS. So you will share the report?

Mr. DUMARESQ. Right now, the agency’s position is that the report is predecisional, and we have not released it. We can reconsider that or look at that decision again.

Mr. PLATTS. It just seems, given the role and as we started this

hearing today about this partnership between GAO, SBA and your

auditors, congressional oversight such as this hearing, of all working together for that end result being a good program, well, serving

the people of our Nation, and GAO’s quite significant role, even

identifying some of the problems, it seems it would be the earlier

you have them involved in the analysis of those findings, the better. I certainly would encourage and hope that you give my request, that you just openly share that information with GAO, serious consideration to do that sooner rather than later, to allow that

dialog to continue in a positive way and just avoid the perception

that there’s something that you do not want to just lay out on the

table.

Mr. DUMARESQ. I understand that, totally understand.

Mr. PLATTS. I assume that would be helpful as you continue,

GAO continues, to look at the changes that are being contemplated

in your analysis of what SBA’s doing.

Ms. CALBOM. Yes, Mr. Chairman, we would want to look at that

report. We would want to look at all the analysis that SBA is

doing, you know SBA really has indicated to us that they are really

leading the charge on this, and they’re using the consultants to

work with them. And so all the analysis they have done, we will

want to look at when we eventually do this followup work.

We do believe we have access to that information, and we did

talk about that with the agency at our meeting and requested that

we be able to proceed in having that access.

Mr. PLATTS. My hope is that access will be, as we’re all seeking

that same common goal at the end of the day, that we just allow

that to move forward in a positive way.

I have more questions but, Mr. Towns, did you have other questions?

Mr. TOWNS. I have questions I’d like to ask.

Let me ask you, I guess, Mr. Hayward. I guess I’m trying to figure out your role now. Are you still working to be able to put safeguards in place? Are you still involved or you just said, there’s a

problem and you’re out? Are you still, I’m trying to make certain

you are still involved in terms of safeguards? The point is that I

want to know what is your role, now that—recognizing there’s a serious problem, are you involved in consulting and working with

them in trying to work out and solve the problem, or are you out?

Mr. HAYWARD. Well, in the first place, I’m actively involved in

working toward some solutions here, to the absolute extent I’m able

to do so and still retain my independence from SBA from management. Let me be clear.

84

Mr. TOWNS. I understand that, but I’m saying that recognizing

there’s a problem, are they consulting with you in terms of correcting the problem, are you being talked to? I understand your role,

but the point is that, you know, are they talking to you in terms

of how this might be fixed?

Mr. HAYWARD. Well, yes, sir. It’s a two-way street. I have every

right to ask as many penetrating questions as I think are appropriate, and conversely, management has shown, in the past, at

least some decent cooperation with me to—in sharing its—candidly

sharing some of its concerns.

So I believe the answer to your question is, yes and it’s, it’s

multidimension—it’s a two-way street, going back to the original

statement.

Mr. TOWNS. Right, you answered my question.

The last question would be to you, Ms. Calbom. How can we

apply what happened at SBA to other CFO’s at agencies?

Ms. CALBOM. Well, I guess as far as other credit agencies, one

of the key things, and something that GAO has looked at and recommended in some past reports we did some years ago, is, you

know, you really have to make sure that you look at your models

and that you’re continuously updating the assumptions, challenging those assumptions, like, is my average loan life I’ve used in

coming up with my cost, is that a reasonable loan life? Am I properly considering the amount of defaults that could occur? All those

kinds of things that go into the costs of the loan programs, that you

have to continuously update those and be challenging the original

assumptions that you had, that was one of the big problems that

appears that SBA had in some of our models, that some of those

original assumptions were not right. And as I was mentioning before, the loan sales really brought that to light quite quickly.

So if there’s one lesson that certainly would come to the top in

my head. That’s just in general.

Now, on the loan sales. I know that other folks on the panel have

some thoughts on that, too. But I would say that before any agency

starts to embark on loan sales, they really have to have their house

in order as far as being able to properly account for, you know, the

program to begin with, but then have the sophistication to be able

to take on the added complexity of the loan sales.

Mr. TOWNS. All right. Thank you very much. I yield back, Mr.

Chairman.

Mr. PLATTS. Thank you, Mr. Towns.

For Mr. Hayward and Mr. Menth, your audit report noted that

SBA has weaknesses in compiling the financial statements and

based on your long history with SBA, is it your position that to get

to those clean audit opinions that have been issued, and prior to

the 2000 year were pretty consistently issued as clean audits, was

it the result of good processes in place all year, or more, that end

of the year Herculean effort to make everything to fit together and

to get to a position that allowed for a clean audit to be achieved?

And I ask you that because when we’ve had the Comptroller General testify, his emphasis in the area of financial management and

improving is that we have a structure in place that, at the end of

the year he basically punched a button and it puts out what you

need. As opposed to, go through the whole year, and then at the

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end of the year, you’re scrambling every year to get the data you

need to show that you’re in good shape.

Which would be your position of SBA’s year in and year out practices, more good process or more end of the year scramble?

Mr. HAYWARD. Well, absent any change to our recommendations,

I would have to say that we could expect some more heroism this

year. We have made recommendations that are designed to lessen

the heroism, so to speak, and more, more accurately to address the

situation that you’ve addressed in your opening remarks, that is

clean opinion is no indicator of sound financial systems.

I’d have to say that, in the context of the Federal Government,

we have a number of agencies that are in the same boat as SBA.

We have a situation where we’ve got a FRIES general ledger system that captures data that are needed to be crosswalked to the

financial statements and the FRIE System. While functional, I

think it’s fair to say, requires a little bit too much labor to make

it work. I think that our recommendations involving additional QC,

particularly with respect to the first draft of the financial statements, will make it easier on both us and SBA in dealing with the

short period of time that we’ve got after those first statements are

issued to reach closure here.

Let me just repeat myself. I’m simply trying to convey that absent any change, with respect to our recommendations, I think that

we can expect heroism, but in my experience with Tom, I believe

he will be implementing some substantive responses to our recommendations.

Mr. PLATTS. And that’s the hope of our efforts as a committee

and the oversight role, is kind of dovetailing with the Comptroller

General that focus be not just achieving that year end clean bill of

health, but that we put in place the process that is more automatic,

and it’s not heroism at the end of the year and, you know, the focus

here has been very much on the loan sale aspect, but as has been

identified that’s kind of brought to light maybe some broader challenges, and that structural change in some of the recommendations

you make that will hopefully allow structure to be in place for a

year in, year out clean audits being issued without problems.

Mr. Towns, did you have any other questions?

I’m going to move just to a closing and first, I want to thank all

of our witnesses for your preparation and testimony here today and

the followup information that you will be providing us, very helpful, very insightful, and a personal thank you to your efforts,

whether it be as Federal employees or private-sector contractors

working with Federal Government, for your efforts in trying to

serve our constituents in good fashion. I appreciate your work.

I also want to thank both majority and minority staff members

for their efforts in putting together the hearing, and we’ll look forward to continuing to work as committee members and staff with

each of you here today, as we continue to kind of watch the process

as it goes forward, as you work as a team to have SBA’s financial

reports in good shape, and we can get from that red light in that,

to the yellow, to green and get back to the clean, unqualified audits

being issued.

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Procedurally, we’ll hold the record open for 2 weeks from this

date for those who may want to forward additional submissions for

possible inclusion, and this meeting stands adjourned.

[Whereupon, at 3:55 p.m., the subcommittee was adjourned.]

[Additional information submitted for the hearing record follows:]

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