Small Business Administration: Accounting Anomalies and Limited Operational Data Make Results of Loan Sales Uncertain
Published: 2003-01-03T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Small Business Administration's (SBA) loan asset sales are being closely watched because similar sales are projected for other government agencies as a means of reducing loan assets and servicing costs. To assess the progress and effects of SBA's loan sales, GAO undertook this study to (1) describe the process for selling loans, (2) identify how lenders and borrowers have reacted to loan sales, (3) determine whether SBA is properly accounting for its loan sales and their subsequent impact on credit subsidy estimates, and (4) assess whether loan sales generated operational benefits for the agency. GAO did not determine whether SBA maximized proceeds from the loan sales.
section_title: What GAO Found
paragraphs: From August 1999 through January 2002, SBA held five loan asset sales, disposing of a total of $4.4 billion in disaster assistance home and business loans (85 percent) and regular business loans (15 percent). SBA created a sales process that has attracted investors and responded to their concerns. Lenders who participate in the 7(a) business loan guaranty program were also satisfied with the sales as an option for disposing of their defaulted loans. SBA relies on borrower inquiries and complaints to determine whether purchasers of the loans are using prudent loan servicing practices, as required in the loan sale agreements. However, information on borrowers' reactions to loan sales is incomplete, because SBA does not have a comprehensive process to capture the inquiries and complaints it receives. SBA incorrectly calculated the accounting losses on the loan sales and lacked reliable financial data to determine the overall financial impact of the sales. Further, because SBA did not analyze the effect of loan sales on its remaining portfolio, its reestimates of loan program costs for the budget and financial statements may contain significant errors. In addition, SBA could not explain significant declines in its loss allowance account for disaster loans. Until SBA corrects these errors and determines the cause of the precipitous decline in the loss allowance account, SBA's financial statements will likely be misstated, and the audit opinion on past financial statements may be incorrect. Further, the reliability of current and future subsidy cost estimates will remain unknown. These errors and the lack of key analyses also mean that congressional decisionmakers are not receiving accurate financial data to make informed decisions about SBA's budget and the level of appropriations the agency should receive. Our analysis of the operational benefits from loan sales suggests that some benefits that SBA reported either have not yet materialized or were overstated. SBA conducted a limited analysis of the impact of loan sales on its loan servicing centers, showing that loan servicing volume had been reduced. However, loan sales had a much greater impact on disaster loan servicing than on business loan servicing. Therefore, how the sales will help SBA realign its workforce in the small business programs remains unclear. It would be imprudent to continue SBA loan asset sales in the absence of reliable and complete information on the accounting and budgetary effects. A successful loan sales program is not solely about maximizing proceeds and attracting investors: it is also a means of improving an agency's ability to achieve its mission and to best serve the American people. Moreover, as the Office of Management and Budget (OMB) continues to encourage loan asset sales, it is important that agencies embarking on new loan asset sales programs have the capability to properly carry out and account for these activities.

section_title: Letter
paragraphs: In 1999, the Small Business Administration (SBA) began a loan asset sales  program, at the direction of Office of Management and Budget (OMB), to  reduce the amount of debt the agency owned and serviced. SBA’s loan asset  sales program is of particular interest because OMB has tentatively planned  loan asset sales at other federal credit agencies. OMB is interested in  increasing loan asset sales in order to improve the management of loan  assets and to transfer loan servicing responsibilities to the private sector.
SBA guarantees business loans through its lending partners in the 7(a)  program and makes direct loans for disaster assistance to individuals and  businesses. Before SBA began its loan asset sales program in 1999, the  agency had never sold large volumes of loans in bulk. More than $9 billion  in disaster assistance and other direct loans and defaulted business loan  guarantees were eligible for sale. As of January 2002, SBA had conducted  five sales, divesting itself of about 110,000 loans with an outstanding  balance of $4.4 billion. Approximately 85 percent of the loans SBA sold  were direct disaster assistance loans, most of which have below-market  borrower interest rates. When SBA originally made these loans, it received  appropriations to cover expected default costs as well as financing costs  related to offering below-market interest rates to borrowers. The subsidy  allowance account was established to cover these anticipated losses,  which generally range from $17 to $33 for every $100 that SBA lends. This  allowance indicates that the economic value of the loans is less than the  loan balance at inception. The difference between the outstanding loan  balance and the subsidy allowance is the net book value. When investors  determine the price they are willing to pay for SBA’s loans, they also  consider default risks and the low interest rate on most SBA disaster loans.  As a result, investors bid less than the outstanding balance owed on these  loans.
In determining whether or not to sell these loans, SBA estimated the  current value to the government, also known as the hold value, in  accordance with OMB Circular A-11. In essence, the hold value is the  expected net cash flows from the loans, discounted at today’s Treasury  rates. This differs from the net book value recorded on SBA’s books, which  is the expected net cash flows from the loans discounted using Treasury  rates in effect when the loans were disbursed. Therefore, the hold value  takes into account changes in interest rates since the loans were disbursed,  whereas the net book value does not. As a result, changes in interest rates  since the loans were disbursed will not affect the determination of the  benefit of a loan sale to the government based on the hold value. In  contrast, the accounting gain or loss on a loan sale—the net book value  compared with the sales proceeds—will be influenced by changes in  interest rates since the loans were disbursed.
SBA received about $2.7 billion in total proceeds and paid about $200  million in selling costs on its first five sales. These net proceeds exceeded  the hold values of the loans to SBA by about $606 million. However, as  discussed above, properly accounting for the sales and their subsequent  impact on loan program costs is more complex and could render a different  outcome regarding the accounting gain or loss. Our assessment of SBA’s  accounting treatment for these sales is discussed later in this report.
Because selling loans in bulk is a new and ongoing activity for SBA, and  OMB plans to expand loan sales in federal credit programs, you asked us to  conduct a broad review of the loan asset sales program. Specifically, you  asked us to (1) describe SBA’s process for selling loans, (2) identify how  lenders and borrowers have reacted to loan sales, (3) determine whether  SBA is properly accounting for its loan sales and their subsequent impact  on credit subsidy estimates, and (4) assess whether the loan sales are  generating operational benefits for the agency.
To respond to these reporting objectives, we reviewed strategic plans,  procedures, and other related documents that SBA used to plan and  manage the loan asset sales program; reviewed the results of the sales in  terms of types of loans sold, and proceeds; interviewed SBA officials,  contractors, investors, and lenders involved in the loan sale process;  reviewed and analyzed inquiries and complaints from borrowers; and  analyzed SBA data related to the impact of the loan sales on loan servicing  workloads and other benefits. We also analyzed relevant budget and  accounting data used to record the results of loan sales for both budgetary  and financial statement purposes, including reestimates of subsidy costs,  the values of loans sold, and proceeds and costs of sales. We compared  these data with the applicable guidance.
To assess SBA’s estimates of hold values for loans sold, we reviewed an  external validation of the hold model used for sales one through three that  was prepared by an SBA contractor, who concluded that the calculations  were accurate and reasonable. Since SBA changed to a more sophisticated  hold model after sale three, we also reviewed the methodology and  assumptions used in SBA's revised model to estimate hold values for loans  sold in sales four and five, and found the approach to be reasonable.  However, we did not audit the data used to calculate the hold values for  each sale and therefore did not conclude on the reasonableness of the hold  values for any of the sales. We discussed SBA’s budgeting and accounting  procedures for loan sales with the agency, with its independent auditor, and  with OMB officials. We reviewed SBA’s audited financial statements for  fiscal years 1999 through 2001 and related audit workpapers for fiscal years  2000 and 2001.
All of our analyses were based on data from the first five sales, which  occurred between August 1999 and January 2002. The sixth sale, held on  August 6, 2002, was not completed in time for us to include it in our  analyses, because transferring servicing of the loans to the purchasers and  completing accounting adjustments take several weeks after the sale date.  We did not determine whether SBA maximized loan sale proceeds. We  performed our review from January 2002 through October 2002 in  Washington, D.C.; Birmingham, Alabama; Little Rock, Arkansas; Los  Angeles and Santa Ana, California; Denver, Colorado; and Philadelphia,  Pennsylvania, in accordance with generally accepted government auditing  standards. Appendix I provides a detailed discussion of our scope and  methodology.
subsections: section_title: Background
paragraphs: The President’s fiscal year 1998 budget proposed that SBA begin selling  disaster and business loans that the agency was servicing and transition  from the direct servicing of loans to overseeing private-sector servicers.  Before its loan asset sales program began, SBA was servicing  approximately 300,000 loans, with a principal balance of over $9 billion.  About 286,000 of these loans, with a principal balance of $7 billion, were for  disaster assistance.
SBA’s loan asset sales program is part of a governmentwide initiative to  make loan asset sales a potential tool for improving the management of  federal credit programs. In the conference report accompanying the  Treasury, Postal, and General Government Appropriations Act, 1996,  congressional conferees directed OMB, in coordination with the federal  agencies involved in credit programs, to evaluate the potential for selling  loan assets to the private sector. Furthermore, the Debt Collection  Improvement Act of 1996 encourages federal agencies that provide loans to  sell delinquent debt when appropriate. In June 2002, OMB issued guidance  requiring agencies to analyze their loan portfolios and loan management  costs in order to determine whether privatizing functions such as loan  servicing by selling loan assets or outsourcing would produce greater  efficiencies. Other federal credit agencies have significantly larger loan  portfolios than SBA that could be available for loan sales, including the  Departments of Agriculture and Education, which held $78 billion and $96  billion, respectively, as of fiscal year 2001.
SBA’s loan sales include defaulted, formerly guaranteed 7(a) and 504  (development company) business loans and direct disaster assistance  loans. SBA provides small businesses with access to credit, primarily by  guaranteeing loans through its 7(a) and 504 programs. For the 7(a)  program, SBA guarantees up to 85 percent of the loan amount made by  private lenders to small businesses that are unable to obtain financing  under reasonable terms and conditions through normal business channels.  Under the 504 program, SBA provides its guaranty through certified  development companies—private nonprofit corporations—that sell  debentures that are fully guaranteed by SBA to private investors and lend  the proceeds to qualified small businesses for acquiring real estate,  machinery, and equipment, and for building or improving facilities. When a  7(a) or development company loan defaults, SBA pays the claim and either  relies on the lender to recover as much as it can by liquidating collateral or  takes over the loan servicing and liquidation. Because SBA has paid the  guaranty and thus owns the loan, these defaulted business loans—whether  liquidated by the lender or by SBA—may be included in SBA’s loan asset  sales.
SBA also makes loans directly to businesses and individuals trying to  rebuild in the aftermath of a disaster, and it primarily services these loans  directly. Most of the disaster assistance loans have low interest rates,  sometimes less than 4 percent, and long repayment terms of up to 30 years.  Interest rates on disaster loans vary, depending on the borrower’s ability to  obtain credit in the private sector. For example, if a borrower cannot obtain  credit elsewhere, the interest rate is typically below the market rate, but a  borrower who can obtain credit elsewhere is likely to receive a higher rate.  Since SBA owns the disaster loans, all disaster loans are eligible to be sold.
The Federal Credit Reform Act of 1990 was enacted to require agencies to  more accurately measure the government’s cost of federal loan programs  and to permit better cost comparisons, both among credit programs and  between credit and noncredit programs. The act gave OMB responsibility  for coordinating credit program cost estimates required by the act. OMB is  also responsible for approving all loan sales. Authoritative guidance on  preparing cost estimates for the budget and conducting loan sales is  contained in OMB Circular A-11, Preparation, Submission, and Execution  of the Budget. The Federal Accounting Standards Advisory Board  developed the accounting standard for credit programs, including loan  sales. This guidance is generally found in Statement of Federal Financial  Accounting Standards No. 2 (Statement 2), Accounting for Direct Loans  and Loan Guarantees, which became effective in fiscal year 1994. This  standard, which generally mirrors the Federal Credit Reform Act and  budget guidance, established accounting guidance for estimating the  subsidy cost of loan programs as well as recording loans and loan sales for  financial reporting purposes. The subsidy cost is the present value of  disbursements—over the life of the loan—by the government (loan  disbursements and other payments) minus estimated payments to the  government (repayments of principal, payments of interest, other  recoveries, and other payments).
For financial statement purposes, loans are reported at both the  outstanding balance and at the present value of their estimated net cash  inflows, known as the net book value, which is reported on the balance  sheet. The difference between these two amounts is the subsidy allowance,  which is reported along with the outstanding loan balance in the footnotes  of the financial statements. The allowance represents the cost of the loan  program that is not expected to be recovered from borrowers, including  default costs and financing costs from subsidizing below-market rate loans.  Statement 2 states that when loans are written off, the unpaid principal of  the loans is removed from the loans receivable balance and the same  amount is charged to the subsidy allowance. Prior to the write-off, the  uncollectible amounts should have been fully provided for in the subsidy  allowance through the subsidy cost estimate or reestimates.
Further, as part of implementing credit reform, agencies are required to  estimate the subsidy cost for budgetary purposes. Generally, these  estimates are updated or reestimated annually after the end of the fiscal  year to reflect any changes in actual loan performance since the estimates  were prepared, as well as any expected changes in assumptions related to  future loan performance. Changes in subsidy cost that are recognized  through reestimates are funded through permanent indefinite budget  authority.
Before a loan sale, as part of its approval process, OMB reviews the hold  value of the loans being sold as compared with their estimated market  value. A contractor that assists SBA with the loan sales estimates a  market value, which indicates the anticipated proceeds on the loan sale  based on current market trends and conditions, and the loans being sold.  Comparing the market value with the hold value determines whether it is  more beneficial for the government to hold or to sell the loans. However,  this determination does not take into account the impact of any changes in  administrative costs that results from the loan sales. The glossary at the  end of this report provides a list of commonly used terms related to credit  program budgeting and accounting.
section_title: SBA’s Sales Process Is Designed to Satisfy Investor Demands
paragraphs: SBA officials told us that the loan asset sale process is designed to  maximize SBA’s sales proceeds by attracting as many investors as possible  to the bidding process. The process can take 9 months or longer as  contractors, SBA field offices, and lending partners work together to  prepare loans for sale. For a sale to take place, SBA must have OMB’s  approval, which partly depends on an analysis of whether the expected  value of the loans to investors is greater than the estimated value to the  government. The price obtained for loans sold and investor interest in the  first five sales depended in part on the characteristics of the loan pools.
Large commercial and investment banks have purchased the performing  disaster assistance loans that make up the majority of SBA’s sale portfolio,  and primarily small investors have bought the nonperforming business  loans. Beginning with the first loan sale, SBA instituted a “lessons  learned” process to analyze and improve its efficiency and investor  satisfaction from sale to sale. Most investors interviewed by us or by SBA  contractors stated that SBA has responded to requests for more  information and is now providing the information needed to calculate bids.  Most investors also said that they plan to continue bidding on future sales.
subsections: section_title: Loan Sales Require Detailed Planning and an Investment of Resources
paragraphs: SBA’s asset sales team, which manages the loan asset sale program at SBA  headquarters, coordinates the efforts of contractors, SBA field offices, and  lending partners to execute a loan sale (fig. 1). Two financial advisers and a  due diligence contractor are involved in each sale. The program financial  adviser is hired on a multiyear contract to supervise the work of other  contractors and consult on strategic planning issues, such as sale design  and loan selection. A transaction financial adviser is also hired for each  sale, to provide marketing and to manage logistics. All participants in the  sales process must work closely together over the approximately 9 months  needed to carry out a loan sale and the 2 months required to close it out.
SBA and the program financial adviser select the loans for each sale, and  SBA’s servicing centers and district offices review them, removing any that  should not be sold, such as loans that are paid in full, are charged off as a  loss in SBA’s accounts, or are in litigation. Before every sale, SBA’s loan  asset sales team sends a detailed procedural notice to field offices to guide  them through every step. The guidance covers loans that should be  removed from the sale, loans that may be added, and procedures for  shipping the loan files when the list is finalized. SBA’s 7(a) lending partners  review SBA’s requests to sell defaulted 7(a) loans and provide consent at  their discretion. SBA’s field offices and 7(a) lenders send the final selection  of loan files to the due diligence contractor.
SBA’s due diligence is the most costly and probably the most important  element of the loan sale process. For sales three through five, due  diligence averaged 87 percent of total sales costs, which have reached up to  $32.7 million per sale, not including salaries and expenses for SBA  personnel. SBA officials told us, however, that money invested in due  diligence results in higher bids from investors. In part, due diligence is  costly because SBA’s loan information systems do not capture some data  that investors need to make a purchase decision, such as collateral  information. The due diligence contractor must collect this information  from the loan files and create electronic images of documents. Investors  also want reports such as current credit scores, property appraisals, and  broker price opinions, which the due diligence contractor orders before a  sale. The due diligence contractor extracts the key data elements from the  reports and loan files and enters them into a database that investors can  access.
The transaction financial adviser sorts the loans into relatively  homogeneous pools according to characteristics such as the type of loan,  the type of collateral, and the loan’s status (performing or nonperforming).  Loan pools vary in size to appeal to different types of investors. Large  commercial and investment banks have been the primary bidders on blocks  of loans (multiple pools with common characteristics), which have an  aggregate unpaid principal balance of at least $115.8 million. Smaller pools  of loans are also created so that other types of investors can compete in the  bidding. Between 14 and 25 investors bid in sales one through five, with a  total average of 4.2 bidders for both large blocks and smaller pools of loans.
Before SBA goes forward with a sale, SBA’s Office of the Chief Financial  Officer estimates the value to SBA of holding these loans to maturity or of  some other resolution, such as a prepayment or default. A “hold” model  was specifically designed to estimate the value to the government of the  loans selected for sale on a present value basis, discounted with current  interest rates. At the same time, the transaction financial adviser prepares a  market value estimate of what SBA would likely receive if it sold the loans  to the private sector. SBA compares these estimates to determine whether  selling the loans would provide a higher expected return than would  holding and servicing them. These estimates are provided to OMB for its  approval to go forward with a sale. For each of the five sales we reviewed,  the market value estimates were greater than SBA’s estimates of the hold  value, or value to government, and thus OMB approved each sale.
SBA officials and contractors explained that market value estimates have  exceeded hold values because investors are more efficient in collecting on  nonperforming loans than is the government, and investors take different  factors into account in valuing performing loans. As a result, investors  often place a higher value on these loans. According to SBA’s program  financial adviser, private-sector lenders service defaulted loans more  productively than the government because they have greater flexibility in  pursuing workouts, including the ability to treat borrowers differently  based on factors such as creditworthiness. SBA officials told us that private  investors value performing loans largely on the basis of what is recoverable  under the loan contract, including collateral. SBA, however, lends to  borrowers based on their ability to repay, and focuses on getting them to  make payments. Furthermore, compared with government agencies,  private-sector lenders have a greater number of portfolio management  strategies at their disposal, such as securitization. Securitization generally  yields a higher price than does selling a whole portfolio of loans, because  the seller can split up the portfolio to meet the demands of a wide range of  investors with varying levels of risk tolerance.
section_title: Sales Results and Investor Interest Depended in Part on the Loan Pools’ Characteristics
paragraphs: For each sale, SBA received proceeds from loans sold that exceeded the  estimated value to the government of the loans, as calculated by SBA’s hold  model. SBA’s proceeds as a percentage of the unpaid balances of the loans  sold have varied with each sale because, among other factors, the  characteristics of the loans sold differed with each sale. As shown in table  1, SBA’s return on the sales, expressed as gross proceeds as a percentage of  total unpaid principal balance, ranged from 44.1 percent to 73.6 percent in  the first five sales. Although SBA ultimately aimed to maximize proceeds,  the agency selected loans for sale according to its own constraints and  perceived market interests. In the first sale, SBA sold business loans that  SBA had made and serviced directly. According to SBA, most of these loans  were performing and secured by collateral. As shown in figure 2, disaster  assistance loans made up approximately 92 percent of all loans sold in the  other sales. Most disaster assistance loans have low interest rates—around  4 percent or lower. Because these loans have below-market interest rates,  they offer lower scheduled borrower payments than do similar loans with  higher interest rates. Therefore, investors price their bids to compensate  for the SBA loans’ lower scheduled payments. In sale two, SBA sold  disaster assistance loans for the first time, and according to SBA officials,  investors also priced their bids to account for the risk they saw in  purchasing an unfamiliar loan product. Furthermore, in sale two, SBA  focused on selling a large number of loans serviced by its offices in Guam,  Puerto Rico, and the Virgin Islands, where servicing was more difficult and  costly. In sale four, SBA primarily sold performing, secured disaster  assistance loans, in an effort to enable investors to securitize these loans  purchased from SBA.
SBA officials and investors told us that large investors, including  investment banks, have bought the performing disaster home loans, and  according to SBA, at least one investor is securitizing and trading them like  other mortgage-backed securities. Most of the 7(a) loans sold since sale  two have been nonperforming, and many were sold in smaller pools that  small investors can bid on, according to SBA officials. Two small investors  with whom we spoke have purchased these loans to try to return them to  performing status and resell them at a profit.
section_title: SBA Used Investor Feedback to Shape and Improve the Sales Process
paragraphs: From the outset of the loan asset sales program, SBA used feedback from  investors to shape and improve the sales process, with the aim of attracting  as many investors as possible and obtaining quality bids on loan pools. As  part of presale marketing, the transaction financial adviser consults with  potential investors to determine which loan offerings, loan data, and sale  procedures will yield the greatest interest. Investors are also surveyed after  the sales to obtain feedback to consider in planning future sales. SBA  officials told us that these surveys are an integral part of the lessons- learned process that SBA established for the close of each sale, to help the  agency target and address problems. According to SBA officials, analyzing  SBA’s processes and applying lessons learned have made SBA more  efficient in activities such as removing loans that do not meet sale criteria.  According to SBA officials, this process has reduced the number of loans  that investors have sold back to SBA for not meeting the conditions of the  agency’s representations and warranties. SBA officials also spoke with  investors to identify common concerns that may have been leading them to  discount their bids. According to SBA, after the early sales, many investors  reported that they wanted SBA to provide additional data, such as  borrower credit scores and lien information. SBA responded by adding  information to its database, including credit scores and lien information, to  reduce investor uncertainty about the quality of loans for sale.
The six investors with whom we spoke and most of the 42 survey responses  for sales four and five positively assessed SBA’s loan sale process. Most  investors stated that the loan pools are well organized and that SBA  provides the data they need to make informed bids. Furthermore, our  review of the information provided to investors found minimal problems  with the completeness of the data. The investors with whom we spoke  indicated that they will continue to bid on sales. Other investors  interviewed by the transaction financial adviser—including those who have  not bid in past sales—reported that they are interested in participating in  future sales. SBA officials believe that the refinement process and  provision of better data to investors has yielded higher bids.
section_title: Lenders Expressed Satisfaction with SBA’s Loan Sales, but SBA’s Data on Borrowers’ Reactions Was Incomplete
paragraphs: Lenders and borrowers also play a role in the loan sale process. Although  many 7(a) lenders that participated in SBA’s loan sales reported satisfaction  with the way in which the sales were conducted, borrowers’ reactions were  difficult to measure. An important factor in the reactions of both groups is  that lenders’ involvement is voluntary but borrowers’ is not. Lenders must  consent before SBA can sell business loans they made, while borrowers  have no choice. Most of the 7(a) lenders with whom we spoke said they are  satisfied with the loan sale process and the proceeds they are receiving on  loans they consented to sell. However, lenders’ participation in sales is  limited and driven by a practical decision: whether greater net returns will  result from selling the loan or from liquidating it. The reaction of borrowers  was difficult to assess because of weaknesses in SBA’s system for  collecting and following up on inquiries and complaints—its primary  method of ensuring that borrowers whose loans are sold are protected.
subsections: section_title: Most 7(a) Lenders with Whom We Spoke Are Satisfied with the Loan Sales
paragraphs: Lenders who participate in SBA’s 7(a) loan guaranty program have an  interest in the outcome of the sales, because they still have a stake in the  7(a) loans for sale. When a 7(a) loan defaults, SBA honors its loan guaranty,  paying the lender 75 to 85 percent of the unpaid principal balance.  Thereafter, the lender and SBA share any loan payments according to the  percentage set out in the guaranty. Therefore, SBA must obtain consent  from the lender before selling a defaulted 7(a) loan. We spoke with 12 7(a)  lenders who have all participated in more than one SBA loan sale, and 10  said that they had used the loan sales as an additional portfolio  management tool for nonperforming loans. According to 8 of the lenders  whom we interviewed, proceeds from the sales they participated in were  satisfactory; 2 lenders stated that SBA is obtaining market value for  nonperforming 7(a) loans. One lender stated that SBA sales have tapped a  market for nonperforming loans that his company would not otherwise be  able to access.
According to SBA, following the early sales lenders raised two concerns,  which the agency has since addressed. First, in the first four sales, lenders  did not know how to estimate the proceeds they would receive by selling  loans. And second, when some lenders received their shares of sales  proceeds, SBA did not clearly identify the price paid for each loan. These  practices resulted in accounting problems for the lenders. Beginning with  the fourth sale, SBA sent lenders one check and a list of the earnings from  each loan sold. Beginning with the fifth sale, SBA also began providing  information on returns from past sales to help lenders decide whether to  consent to sell loans. Four lenders we spoke with specifically noted that  SBA had made improvements to its loan sale process in areas such as  distributing sale proceeds and seeking consent to sell loans.
section_title: Expected Returns and Experience with Prior Sales Drive Lender Participation
paragraphs: Based on our discussions with 7(a) lenders and SBA district officials, we  identified two primary factors that drive lender participation in the sales:  whether the net returns from the sale are likely to exceed those from  liquidation, and whether proceeds from a previous sale met expectations.  Lenders’ consent to sell 7(a) loans must be given voluntarily, and most  lenders sell these loans only after trying to liquidate them. Three SBA  district officials and two lenders said that in the early sales, SBA lenders  did not have all the information they wanted about expected returns from  selling loans and therefore preferred not to sell them. A lack of control over  the loan sale process, timing of the sales, and distribution of the proceeds  can influence lenders’ expectations of net returns from selling loans rather  than liquidating. Lenders have no role in determining in which pools their  loans will be sold or whether bids are acceptable. Also, lenders must wait  until SBA’s bid day to sell loans, and the value of non–real estate collateral  generally declines as time passes. Finally, proceeds from SBA sales do not  arrive until almost 2 months after the sale, giving lenders greater incentives  to begin loan liquidation in order to try to recover money more quickly.
Lenders who have already begun investing resources in liquidation believe  they will maximize returns by continuing with their liquidation strategy.  Lenders are prepared to sell loans when they believe that their net returns  from investing resources in liquidation will no longer provide satisfactory  returns in comparison with selling loans. SBA officials confirmed that most  7(a) loans that lenders agree to sell have little value left in them.
According to SBA district office officials, some lenders have stopped  participating in loan sales because the proceeds from a previous sale did  not meet their expectations, and we spoke with one lender who confirmed  this statement. We also learned that some lenders who had stopped  participating in sales had not completed loan collection actions, such as  seizing collateral. Another disappointed lender we interviewed decided to  return to SBA loan sales, but only to sell loans after completing collection  efforts.
section_title: SBA Created Borrower Protections Addressing Loan Servicing and Disaster Assistance
paragraphs: Unlike lenders, SBA’s borrowers have little control over what happens to  their loans if SBA decides to sell them. However, SBA has built in some  safeguards to protect the integrity of the programs that provided the loans.  SBA’s loan programs, including loan servicing, are designed to help the  borrower stay in business or recover financially from a disaster. To protect  the public policy goals associated with these programs, SBA’s loan sales  agreements with purchasers require certification that the investors are  qualified to purchase and service the loans and will follow prudent loan  servicing practices. The loan sales agreement also prevents purchasers  from unilaterally changing the terms and conditions of the loans.
SBA made additional policy decisions concerning disaster loans. The  agency does not sell some disaster loans, including those issued to  borrowers currently residing in a federally declared disaster area and those  that are less than 2 years old. SBA decided it would sell disaster loans only  if they were more than 2 years old, because disaster loans typically require  more servicing in the first 2 years and sometimes must be increased to  cover exigencies, such as occurs with revised physical damage estimates.
section_title: Information on Borrowers Is Incomplete Because SBA’s Process for Documenting and Tracking Borrower Inquiries and Complaints Has Weaknesses
paragraphs: We were unable to validate the way in which borrowers have reacted to the  loan sales, because SBA could not provide a reliable estimate or  information on the number of borrowers who had contacted them about  their sold loans. Complete and reliable information on borrower  complaints is important, because SBA officials told us that they contacted  purchasers when a borrower complained about a servicing action to collect  additional information and determine whether a purchaser was breaching  the borrower protections. For example, in one case in which SBA was  receiving many complaints about one particular purchaser, SBA found  some evidence to suggest that the purchaser’s servicing employees were  overly aggressive or rude with some borrowers. In response, SBA  forwarded the specific complaints to the purchaser and requested that the  purchaser improve its handling of new loans.
One reason why SBA’s tracking system is ineffective is that borrowers with  questions or complaints can call or write to several different SBA offices,  or to a representative from Congress (fig. 3). Some SBA field office officials  told us that SBA does not provide them with clear guidance on how to  respond to or document such complaints. Officials from seven district  offices, three servicing centers, and two disaster area offices told us that  they had received calls and letters from borrowers who had concerns about  loans that had been sold. But the methods of documenting inquiries and  complaints varied across offices, except for congressional letters, which  were consistently forwarded to SBA headquarters.
In August 2001, SBA began providing a toll-free number for borrowers to  call with questions or complaints about loan sales. Borrowers were  informed about the toll-free number in a letter telling them how to contact  the new owner of their loan. However, field office staff did not receive any  guidance regarding the purpose and use of the toll-free number. Santa Ana  liquidation and loan servicing center staff who answer calls to the toll-free  number told us that initially they thought the number was only provided for  answering borrowers’ questions, and therefore they did not record  inquiries or complaints called in to this number. Therefore, we were unable  to collect a reliable sample of inquiries and complaints from this source.
We also could not validate the number of inquiries and complaints received  at headquarters. SBA officials at headquarters told us that, overall, SBA had  received about 300 inquiries or complaints from borrowers. However, when  we were provided with a database of these inquiries and complaints, there  were only 155. When we asked how SBA came up with the number 300,  officials told us that it was an estimate.
We also reviewed 50 complaints from a servicing center, the only field  office with whom we talked that could provide a record of phone calls and  letters from borrowers whose loans had been sold, to compare them with  the inquiries and complaints at headquarters.   Forty-five complaints  involved problems with purchasers during the servicing transfer period— for instance, some borrowers said that payment had not been posted, and  others had difficulty in modifying the terms of their loans. However, we  found that only 3 of the borrowers listed in 50 complaints from the  servicing center were reflected in the 155 borrower inquiries or complaints  we reviewed at SBA headquarters. An SBA official at headquarters told us  that the office had received some of the complaints from the center, but  acknowledged that they had not included these complaints in the files we  had reviewed.
Though we were unable to determine how many borrowers have contacted  SBA about their sold loans, we reviewed 133 of the 155 written inquiries  and complaints documented at headquarters, along with SBA’s written  responses, to identify the types of questions and problems borrowers may  have when their loans are sold. Our analysis showed that almost half (65)  were inquiries and concerns about their loans being sold, requests to buy  their own loans, or pleas to not have their loans sold. However, 47 of the  borrowers complained about a purchaser’s servicing action. SBA  responded in writing to the written inquiries and complaints we reviewed  at headquarters. More information on our review of these inquiries and  complaints is presented in appendix II.
section_title: SBA’s Accounting for Loan Sales and the Remaining Portfolio Was Flawed
paragraphs: SBA sold almost 110,000 loans with an unpaid principal balance of about  $4.4 billion in five loan sales from August 1999 through January 2002. We  reviewed the budgeting and accounting for these loan sales and found  errors that could significantly affect the reported results in the budget and  financial statements. Specifically, SBA (1) incorrectly calculated loan sales  losses reported in the footnotes to its financial statements; (2) did not  appropriately consider the effect of loan sales on its estimates of the cost of  the remaining portfolio, which could significantly affect its budget and  financial statement reporting; and (3) had significant unexplained declines  in its subsidy allowance for the disaster loan program. Despite these errors  and uncertainties, SBA’s auditor gave unqualified audit opinions on SBA’s  fiscal year 2000 and 2001 financial statements. We discussed these issues  with SBA’s auditors, who indicated that they are currently assessing the  cause of the unusual balance in the subsidy allowance account and, if  necessary, plan to reevaluate their audit opinions on the fiscal years 2000  and 2001 financial statements. Until SBA performs further analyses to  determine the full impact of these errors and uncertainties, the financial  effect of its loan sales and the reliability of current and future subsidy rates  will remain unknown.
subsections: section_title: SBA Improperly Calculated Losses on Loan Sales
paragraphs: Accounting records related to loan sales indicated that losses exceeded  $1.5 billion. However, this amount is overstated because of errors in the  way that SBA calculated the losses. Because of the lack of reliable financial  data available, we were unable to determine the financial effect of loan  sales on SBA’s budget and financial statements. These errors raise serious  concerns about the information related to the results of loan sales included  in the footnotes to the annual financial statements provided to OMB and  the Congress for decisionmaking purposes.
For accounting purposes, the gain or loss on a loan sale represents the  difference between the net book value (the outstanding loans receivable  balance less the subsidy allowance) of the loans sold and the net sale  proceeds. The accounting gain or loss differs from the hold value  calculation, discussed earlier, which indicates that the sales resulted in a  benefit to the government of about $606 million. This difference exists  because the benefit calculation—the difference between the hold value and  the net sales proceeds—is not designed to take into consideration changes  in interest rates from the time the loans were disbursed to the date of the  sale, while the accounting gain or loss, if properly computed, does take  these changes into account. The footnotes to SBA’s fiscal years 1999 and  2000 financial statements reported accounting losses of $75 million and  $600 million, respectively, on its loan sales. SBA did not separately disclose  in its financial statements the losses calculated on the two loan sales that  took place during fiscal year 2001. According to SBA’s accounting records,  the first five sales have resulted in total losses of more than $1.5 billion.
We reviewed the methodology SBA used to calculate the results of its loan  sales for accounting purposes and found significant errors that caused SBA  to overstate losses. When calculating whether loans are sold at a gain or at  a loss, agencies must estimate the portion of the subsidy allowance to  allocate to each loan sold in order to calculate the net book value for those  loans. Since SBA’s calculation of the net book value of the sold loans  exceeded the net proceeds from the sales, losses were calculated. Our  review of these calculations found that SBA’s estimates did not consider all  the appropriate cash flows when allocating the subsidy allowance to the  sold loans. For example, when calculating the gains or losses for the  disaster loan program, SBA failed to allocate a portion of the subsidy  allowance for financing costs associated with lending to borrowers at  below-market interest rates.
In addition, SBA incorrectly allocated the subsidy allowance for the  previously defaulted 7(a) and 504 loan guarantees. SBA used its estimated  net default cost, which considers first the probability of default and then  the estimated recovery rate after default. For example, if a $10,000  guaranteed loan has an estimated default rate of 10 percent and an  estimated recovery rate of 50 percent, the subsidy allowance allocated by  SBA would be $500 ( x .50). However, since sold guaranteed  loans have already defaulted, SBA should have used only the estimated  recovery rate for these loans, meaning that the subsidy allowance allocated  would be $5,000 ($10,000 x .50). Figure 4 illustrates the difference in the  calculated gain or loss resulting from this error. The left column, based on  SBA’s methodology, shows that the loan was sold for a $3,000 loss, while  the right column appropriately allocates the allowance based on expected  recoveries and results in a $1,500 gain.
SBA’s errors in calculating the losses on disaster loans and on previously  defaulted sold guaranteed loans, both resulted in overestimates of the net  book value of the sold loans and the losses that SBA reported in the  footnotes to its fiscal years 1999 and 2000 financial statements. Because of  the way in which the results of loan sales are incorporated into the budget  and the financial statements, the reestimates, if done properly, should have  corrected the effect from these errors.   However, as discussed below, we  found that the reestimates were not reliable.
section_title: Subsidy Cost Reestimates Are Unreliable
paragraphs: SBA did not conduct key analyses of either the loans sold or its remaining  loan portfolio in order to determine the impact of the sales on its  reestimates of program costs for its remaining loans. OMB’s budget  guidance directs agencies to make reestimates for all changes in cash flow  assumptions in order to adjust the subsidy estimate for differences  between the original estimated cash flows and the actual cash flows. SBA  officials acknowledged that analyses of the impact of loan sales on its  historical averages should be done. However, according to SBA officials,  the agency has lacked the appropriate historical data and resources to do  these necessary analyses. Because SBA did not assess the effect that loan  sales would have on its historical averages of loan performance, such as  when loans default or prepay, the agency does not know whether these  averages, which can significantly affect the estimated cost of a loan  program, reasonably predict future loan performance. As a result,  information in both the budget and financial statements related to the  reestimated cost of SBA’s loan programs cannot be relied upon.
SBA is generally required to update or “reestimate” loan program costs  annually. OMB Circular A-11 directs agencies to do reestimates for all  changes in cash flow assumptions. Thus, reestimates should include all  aspects of the original cost estimate, including prepayments, defaults,  delinquencies, and recoveries. These reestimates are done to adjust the  subsidy cost estimate for differences between the original cash flow  projections and the amount and timing of cash flows that are expected  based on actual experience, new forecasts about future economic  conditions, and other events that affect the cash flows.
Even after selling about $4.4 billion of loans, nearly half of its loan  portfolio, SBA has not analyzed the effect of loan sales on the estimated  cost of the remaining loans in its portfolio. SBA officials told us that loans  are selected for sale based on certain criteria, such as where the loan is  located or serviced, the type of collateral, or whether the loan is  performing. Since the loan selection process is not random—that is, all  loans do not have an equal chance of being selected—it is likely that the  loans sold will have different characteristics from those of the portfolio’s  historical averages prior to sales. Consequently, the characteristics of the  remaining loans may also differ substantially from the portfolio historical  averages prior to the sales. For example, during our analysis of the loans  that were sold, we determined that 84 percent of the $3.8 billion of disaster  loans sold were performing—meaning that payments were not more than  30 days delinquent. Selling mostly performing loans could conceivably  leave a disproportionate level of nonperforming loans in SBA’s portfolio.  Because SBA has not analyzed the effect of loan sales on its reestimates of  the remaining portfolio, it does not know if the percentages of remaining  performing and nonperforming loans are different from the historical  averages prior to the sales. A change in these percentages could indicate  that expected defaults in the remaining portfolio could be higher or lower  than current assumptions, based on historical data, suggest.
Another important loan characteristic is the average stated loan term. This  term is the contractual amount of time the borrower has to repay the loan.  SBA’s estimated costs of the disaster loan program are based on historical  average loan term assumptions of 16 years for business disaster loans and  17 years for home disaster loans. Based on our review of the disaster loans  sold in the first five sales, the average loan term was about 25 years.  However, SBA continued to use the average loan term assumptions of 16  and 17 years in its reestimates without doing the appropriate analysis to  determine whether these assumptions were still valid. Because of the large  number of loans sold, it is unlikely that the average loan terms for the  remaining loans are still 16 and 17 years, if in fact these are valid estimates  of the overall presale averages. Assuming that these assumptions are valid,  by selling longer-term loans, the average loan terms for the remaining  portfolio would be shorter. As a result, if there are no changes in any other  assumptions, the reestimated cost of the disaster loan program would be  less, since SBA would be subsidizing below-market rate loans for a shorter  period of time. Given the significant volume of loans sold since 1999, it is  important that SBA assess whether the characteristics of the remaining  portfolio are similar to the characteristics of the loans used to calculate the  averages used in the credit subsidy estimates. Relatively minor changes in  some cash flow assumptions—such as higher or lower default and recovery  rates, or changes in loan terms—can significantly affect the estimated cost  of the loan program and, therefore, the program’s budget.
We attempted to determine the effect of loan sales on the cost estimates of  the remaining portfolio. However, SBA could not provide us with timely,  basic information about the composition of its loan portfolio before and  after each sale, including the amount of loans that were current on  payments, delinquent, or in default. According to SBA, this information was  not readily available because of systems limitations and reconciliation  problems. Shortly before we concluded our work, SBA provided some  information about the quality of its portfolio before and after some of the  loan sales. However, because a gap of several months occurred between  the pre- and post-loan sales analyses, the data could not be reliably used to  determine the effect that loan sales were having on the quality of the  remaining portfolio.
section_title: The Subsidy Allowance Account Was Misstated
paragraphs: During our review of the accounting for loan sales, we noted that the  subsidy allowance account for the disaster loan program had an unusually  low balance. For a subsidized loan program, the subsidy allowance account  is generally the amount of expected losses on a group of loans related to  estimated defaults and financing costs from making below–market rate  loans. In effect, the subsidy allowance is the cost associated with the loans  that SBA does not expect to recover from borrowers. For financial  reporting purposes, the subsidy allowance reduces the outstanding loans  receivable balance to determine the amount that SBA expects to collect  from borrowers, known as the net loans receivable balance (or net book  value), which is shown on the balance sheet.
Table 2 summarizes the disaster loan program’s reported outstanding loans  receivable balance, the subsidy allowance balance, the net book value, and  the subsidy allowance as a percentage of the loans receivable balance for  fiscal years 1998 through 2001. The subsidy allowance compared with the  loans receivable balance decreased significantly in fiscal years 2000 and  2001, to the point of showing that the remaining portfolio of the disaster  program was expected to generate a profit. SBA could not provide support  for the balance or explain the reason for this anomaly.
While Table 2 shows a rapid decrease in the subsidy allowance over the 2- year period between fiscal years 2000 and 2001, most of the decrease  actually occurred in fiscal year 2000, but was masked by an adjustment  made during the fiscal year 2000 financial statement audit. Before SBA had  made the audit adjustment, discussed below, the subsidy allowance for the  disaster program was about $91 million for fiscal year 2000. This balance  was $838 million, or about 90 percent, less than the $929 million balance for  fiscal year 1999, while loans receivable outstanding decreased by only $354  million, or about 6 percent. SBA could not explain why the subsidy  allowance reduction occurred.
In order to restore the subsidy allowance to a more reasonable balance at  the end of fiscal year 2000, in agreement with its auditors, SBA increased  the subsidy allowance balance by recording an audit adjustment that was  essentially meant to reflect the expected impact of loan sales on the  reestimates prepared in fiscal year 2000, which did not factor in the effects  of loan sales. This increased the reported cost of the disaster loan  program by $414 million. Since the amount of the adjustment was based on  SBA’s erroneous calculations of loan sales losses, previously discussed, the  amount of the adjustment was incorrect. During fiscal year 2001, SBA  reversed the audit adjustment and revised its reestimates to include cash  flows related to loan sales. Our review of the fiscal year 2001 disaster loan  program reestimates indicated that loan sales increased the reported cost  of the program by about $292 million. However, this amount is also likely  misstated because, as previously mentioned, the reestimates did not  consider the specific characteristics of the loans sold or the loans  remaining in the portfolio.
The unexplained decline in the subsidy allowance continued in the fiscal  year 2001 financial statements, where SBA reported a negative balance in  the subsidy allowance for the disaster loan program. As illustrated in table  2, this balance no longer reduced the amount SBA expected borrowers to  repay—it actually increased the expected repayments from borrowers and  indicated that the loan program was profitable. However, because the  program is subsidized, with estimated default and financing costs  exceeding the amount of interest borrowers are expected to pay, it should  not be showing an expected profit. Based on SBA’s most recent  reestimates, the subsidy cost of this program ranges from 17 percent to 33  percent, and thus the balance for the subsidy allowance account appears to  be significantly misstated. As in the prior year, SBA could not explain the  unusual balance. SBA officials told us they were currently working with  their auditors to determine the cause of these unusual balances.
While neither we nor SBA could determine the specific cause of this  unusual balance, several possibilities exist. As previously mentioned, a  failure to consider the characteristics of the loans sold or of those  remaining in SBA’s portfolio could contribute to the unusual balance.  Another possibility is that SBA could have incorrectly reduced its subsidy  allowance account balance by writing off loan amounts that are still  collectible. This would mean that both the loans receivable outstanding  balance and the subsidy allowance account would be misstated, but not the  net book value. Yet another possibility is that SBA may have  underestimated the cost of its disaster loan program because the cash flow  assumptions used to estimate the subsidy cost did not reflect the true  characteristics or performance of its loan portfolio. If SBA had  underestimated its losses on disaster loans, it would not have put enough  into the subsidy allowance account to cover these losses, and the subsidy  allowance would be depleted as loans were written off against it until there  was a negative balance. This could mean that SBA did not request an  appropriation large enough to cover the cost of the loan program, and that  the difference would be made up through the reestimates, which are  covered by permanent indefinite budget authority. It is also possible that a  combination of these and other errors may have occurred. Regardless of  the reason, because SBA does not currently know why the anomalies are  occurring, the disaster loan program’s subsidy estimates for the budget and  financial statements cannot be relied on.
Despite the significant, unexplained decline in the subsidy allowance and  the errors in calculating the losses on loan sales, SBA received an  unqualified or “clean” audit opinion on its fiscal years 2000 and 2001  financial statements. An unqualified audit opinion indicates that the  balances in the financial statements are free of significant errors, known as  material misstatements. As previously mentioned, SBA’s auditor attempted  to adjust the anomalies in the subsidy allowance during the fiscal year 2000  financial statement audit. However, the adjustment was based on the  previously described erroneous loss calculation. For the fiscal year 2001  audit, SBA’s auditor performed a number of audit procedures related to the  disaster loan program subsidy allowance account. For example, the auditor  evaluated the methodology and formulas used to calculate reestimates,  assessed data used to calculate key cash flow assumptions, and reviewed  various internal controls over the subsidy estimation process. However,  this work did not appear to focus on determining the cause of the unusual  negative balance of the account, which, contrary to the fact that this is a  subsidized loan program, would indicate that these loans were expected to  generate a profit. The auditor’s workpapers indicated that the auditor had  agreed, in discussions with SBA management, that if the “methodology and  data were materially correct, we  would conclude that the  resulting subsidy reserve  would be materially correct for  financial statement reporting purposes.” The workpapers also indicated  that, “whatever the results of the reestimates are, as long as the  methodology is sound and supportable, we  would not  consider the balance  anything other than  ‘natural.’”
Although SBA’s auditor may have recognized some of the errors we  identified, it did not determine the cause of the unusual balance and  propose the necessary audit adjustments, nor did it modify its audit report  as appropriate. In such situations, when auditors cannot determine  whether a balance is fairly stated because sufficient reliable supporting  documentation is not available, audit standards call for auditors to qualify  their opinion or issue a disclaimer of opinion. We discussed these issues  with SBA’s auditors and they indicated that they are currently assessing the  cause of the unusual balance in the subsidy allowance account and, if  necessary, plan to reevaluate their audit opinions on the fiscal years 2000  and 2001 financial statements.
section_title: Loan Sales Have Reduced SBA’s Loan Servicing Volume, but Other Operational Benefits May Be Overstated
paragraphs: SBA reported that loan asset sales had benefited the agency’s operations by  reducing loan servicing, and that this reduction in loan servicing volume  should help allocate resources to other areas necessary to achieving SBA’s  mission and help the agency to manage its loan portfolio more effectively.  Though we found that loan servicing volume had declined for SBA disaster  home loan centers, the effect on regular business loans was less clear.  Furthermore, despite these reductions in loans servicing volumes, SBA had  not yet redeployed staff to more mission-critical activities, such as lender  oversight and business outreach. SBA has also reported that the loan sales  have prompted borrowers to pay their loans in full, revealed  inconsistencies in the application of the agency’s servicing procedures, and  highlighted weaknesses in its information system. We found some support  to show that the loan sales had produced portfolio management  efficiencies. But we also found that some of the benefits SBA had reported  began before the loan sales program, or could have been caused by other  factors.
subsections: section_title: Reductions in Loan Servicing Volumes Have Been Greatest for Disaster Loans
paragraphs: The loan asset sales have reduced SBA’s servicing and liquidation workload  for disaster loans at the disaster home loan servicing centers, but they have  had little impact on regular business loans, such as 7(a) loans, at the  commercial servicing centers and district offices. SBA had stated that  reductions in loan servicing and liquidation workloads would be one of the  loan sales program’s most significant benefits, as the growth in loan volume  and the continuing decline in staff had compromised its ability to  adequately service a growing portfolio. During the 1990s, SBA’s portfolio of  7(a) business and disaster loans grew dramatically. For example, from 1990  through 1996, SBA’s annual volume of 7(a) loan approvals increased from  19,907 to 52,729. Disaster assistance loan approvals varied from year to  year, depending on the number and severity of disasters. However, in 1994  SBA’s loan approvals for disaster assistance loans increased to over  125,000, primarily because of the Northridge earthquake in California—a  significant jump from the levels of the previous 4 years, when loan  approvals ranged from about 12,000 to 59,000. Servicing and liquidating  loans account for large operating expenses for SBA, reaching  approximately $85 million a year, according to SBA’s fiscal year 2001  Accountability and Performance report. Servicing and liquidating loans  currently involve approximately 186 employees at six servicing centers and  employees at 70 district offices, who also perform other loan management  functions.
SBA’s disaster home loan servicing centers have seen a much greater  reduction in the number of loans they service than have the commercial  loan servicing centers. According to SBA’s limited analysis, the number of  loans serviced at SBA’s disaster home loan servicing centers decreased by  17 percent from January 1999 through March 2002 (fig. 5), and SBA’s  analysis of the servicing centers shows that if more loans are sold, SBA  may be able to reduce and consolidate its loan servicing resources for  disaster home loans. However, SBA’s analysis also shows that the number  of loans at SBA’s commercial loan servicing centers fell by less than 0.5  percent over the same time period. Though the sales have reduced the  number of disaster business loans, most of the loans in the commercial  loan servicing centers are from the 7(a) program and are not put up for sale  until they default. SBA officials told us that lenders do not always consent  to sell the 7(a) loans that SBA would like to sell. Moreover, one commercial  loan director explained that servicing performing loans can require as  much if not more work than can nonperforming loans, as businesses  frequently seek additional financing and therefore want to modify the  terms of their loans. For this reason, the growth of the 7(a) program has  offset the number of loans sold in the commercial loan centers.
Since the loan sales began, SBA has been able to reduce the number of  employees at the servicing centers (fig. 6). However, one of the problems  SBA hoped to address with loan asset sales was to reduce its loan servicing  volume to a level that matches its staffing capacity. Since the  implementation of the loan sales, the number of loan servicing staff has  fallen faster than have loan volumes for most of SBA’s loan servicing  centers. According to SBA officials, the reduction in employees at SBA is  driven more by employee departures, retirements, and the hiring freeze  than by reductions in servicing volumes form the loan sales. As a result, the  number of loans serviced per employee increased on average by 14 percent  at the disaster home loan centers and by 23 percent at the commercial  centers (fig. 6). Only one of the disaster home loan servicing centers has  experienced a reduction in the number of loans serviced per employee. The  disparity between staff attrition and loan volumes is especially problematic  at SBA’s commercial loan servicing centers, where the number of loan  servicing employees has fallen by 19 percent and loan volumes have  remained unchanged.   The analysis we reviewed did not address how these  employee reductions or any other operational effects may translate into  cost savings.
Officials from most of the seven district offices that we visited had mixed  views about the effect of the loan sales on their own loan servicing  portfolios. Some district office officials told us that the first two sales had  significantly reduced their portfolios, and that subsequent sales continue to  reduce the number of disaster loans they have to liquidate. When a disaster  loan is more than 90 to 150 days delinquent, the servicing center can  forward it to the appropriate district office for possible liquidation. District  offices may also liquidate defaulted 7(a) and development company loans,  or may assist lenders in doing so. However, loan sales have had a much  smaller effect on the SBA’s 7(a) portfolio at the district offices we visited.  District office officials with whom we spoke said that they have had to  continue assisting lenders with liquidation or liquidate loans themselves, in  addition to reviewing loans for possible sale. The data we reviewed on the  district offices’ portfolio of loans in liquidation status for the most part  supported what the district officials had told us. For example, the South  Florida district office portfolio of disaster assistance loans shrank from 768  loans in September 1997 to 92 loans in August 2002.   But all of the district  offices we included in our review had experienced growth in the number of  defaulted 7(a) loans that they were helping lenders to service or liquidate,  or that they were monitoring.
section_title: The Effects of Loan Sales on Workforce Realignment Have Been Mixed
paragraphs: The role of loan asset sales in facilitating SBA’s workforce realignment may  be smaller than was initially expected. SBA had reported that loan asset  sales would help the agency move employees out of loan servicing  positions to more mission-critical positions, such as lender oversight and  outreach to small businesses. But since most of the loans sold have been  from the disaster home loan servicing centers, the overall reduction in loan  volume has not translated into job reassignments for district office staff.  Officials from two district offices wondered how they would benefit from  the reduction in workloads at the disaster home loan servicing centers,  since the center employees are funded by appropriations for disaster  assistance, and most of the district offices are funded by appropriations for  business loan programs. Most officials from the district offices and  servicing centers told us that they have not been able to reassign servicing  and liquidation staff to nonservicing activities such as lender oversight or  outreach to small businesses. Moreover, training opportunities to prepare  for reassignment have been limited, with only the South Florida district  office telling us that they have participated in such training.
However, loan sales may facilitate SBA’s long-term efforts to consolidate its  loan servicing and liquidation functions into fewer service centers. SBA  recently reported in its draft 5-year workforce transformation plan that it  would consolidate its loan servicing and liquidation functions into fewer  service centers. This plan also stated that SBA intends to continue its loan  asset sales program, to reduce the agency’s overall loan portfolio and  workload at some locations.
section_title: Loan Sales Have Affected the Ways in Which SBA Manages Its Loan Portfolio, but So Have Other Factors
paragraphs: According to SBA officials, the process of selling loans, particularly the  intensive due diligence process and the field office review of loans selected  for the sales, makes loan servicing more timely and consistent across the  agency. For example, when defaulted loans are selected for sale, agency  staff must determine whether anything collectible remains on the loan. If  not, the loan is charged off. In these cases, SBA recognizes a loss on the  loan and removes it from the receivable accounts. And if SBA is in the  process of working out a compromise with a borrower on a loan that is  selected for sale, the impending sale prompts agency staff and borrowers  to complete the compromise before the sale date. The process of reviewing  loans before they are sold undoubtedly provides some benefit to the agency  in terms of bringing inconsistencies to light and forcing decisions on some  loans. However, we also found that the loan sales alone were probably not  responsible for all the benefits SBA reported.
In May 2002, SBA testified that of the loans selected for the first four sales,  over 9,880 loans totaling about $382 million had been paid in full, 702 loans  totaling $107 million had entered into compromise agreements, and 7,549  loans totaling about $632 million had been charged off. SBA provided data  to us showing that since the loan sales began in 1999, the percentage of  loans paid in full ranged from 10.35 to 11.30 percent, and that the  percentage of loans written off had ranged from 4.97 to 5.98 percent.  However, SBA data also showed that before the loan asset sales—from  fiscal year 1997 through fiscal year 1998—the rate of loans paid in full and  charged off had already been increasing. For example, the percentage of  loans paid in full increased from 8.8 percent in fiscal year 1997 to 10.46  percent in fiscal year 1998. Thus, some of the positive effects of the loan  sales reported by SBA could have been caused by other factors, including  changes in the economy such as lower interest rates, which would prompt  people to refinance their mortgages. Officials at SBA’s Birmingham disaster  home loan servicing center told us that borrowers who refinanced their  mortgages often consolidated their loans and paid off their disaster loans,  even though their disaster loans had low interest rates.
Other benefits of the sales cited in SBA’s official statements or by SBA  officials included the highlighting of inconsistencies in the ways that field  staff applied SBA’s servicing procedures, and the identifying of weaknesses  in the agency’s information systems. For example, SBA officials at  headquarters told us that as a result of inconsistencies found in the loan  files during preparations for the sales, SBA had held a meeting of all the  servicing center managers to discuss the inconsistencies and to clarify  policies and procedures for loan servicing. Though field office staff told us  that they had not substantially changed the ways in which they serviced  loans because of problems uncovered by the sales, some employees  provided examples of how they had modified some of their work  processes. For example, officials at one servicing center told us that they  had begun to check the accuracy of certain items, such as maturity date,  when a new loan file arrived.
Similarly, SBA officials told us that the due diligence process for the loan  sales had revealed that the agency’s information management system for its  loan portfolio did not include data that investors value, such as updated  information on types of collateral and lien positions. These variables were  being included in plans to upgrade the agency’s information systems.  However, field office employees at one of the servicing centers told us that  they had complained about the fact that these items were not included in  SBA’s information systems long before the loan sales began. Whether the  loan sales will have an actual impact on improving SBA’s information  systems is still unclear. At the time of our review, SBA was still having its  field offices and due diligence contractor compile information on the loans  from the paper files and had not yet upgraded its information systems to  capture information such as the current status of collateral and lien  positions.
section_title: Conclusions
paragraphs: SBA had never sold loans in bulk loan sales before undertaking the current  program. SBA’s loan sales are being closely watched, because OMB plans to  expand similar sales to other federal credit programs, such as those  provided by the Departments of Agriculture and Education. The impact of  SBA’s sales on the agency and the scope of the benefits they provide to the  government can help OMB in providing guidance on similar sales programs  in the future. The sales have had some success in attracting investors,  giving lenders a choice in disposing of defaulted loans, and reducing SBA’s  servicing workload for disaster assistance loans. But other effects are  difficult to measure, because SBA lacks a comprehensive system to  document and track all borrower inquiries and complaints after loans are  sold; faulty accounting and reporting methods obscure the actual financial  and budgetary impact of the loan sales; and a thorough analysis of benefits  and other effects on agency operations has not been done.
The lack of a comprehensive process for identifying borrower inquiries and  complaints suggests that SBA may be unable to adequately enforce  borrower protections. From the limited inquiries and complaints we were  able to review, some borrowers had clearly experienced servicing problems  after SBA sold loans to investors. While SBA did track and follow up on  some inquiries and complaints, it did not have a comprehensive process to  collect and document the complaints received at the field offices. As a  result, the agency may not know how many complaints have actually been  registered or whether some private lenders’ actions are in conflict with  SBA’s public policy goals.
Since SBA incorrectly calculated the losses on its loan sales and lacks  reliable financial data, we were unable to determine the financial impact of  SBA’s loan sales on its budget and financial statements. Further, because  SBA did not analyze the effect of loan sales on its remaining portfolio, its  reestimates of loan program costs for the budget and financial statements  may contain significant errors. Until SBA corrects these errors and  determines the cause of the precipitous decline in the subsidy allowance  account, SBA’s financial statements will likely be misstated, and the audit  opinion on past financial statements may be incorrect. Further, the  reliability of the current and future subsidy cost estimates will remain  unknown. These errors and the lack of key analyses also mean that  congressional decisionmakers are not receiving accurate financial data to  make informed decisions about SBA’s budget and the level of  appropriations the agency should receive.
Finally, some of the operational benefits of the loan sales have not yet been  realized, or may be overstated. Most of the reductions in loan servicing  volume have occurred at SBA’s disaster home loan servicing centers. SBA’s  commercial servicing centers and district offices that primarily serve small  businesses are still involved in servicing loans, primarily because SBA has  not been able to sell as many defaulted 7(a) loans, because lenders do not  always consent to sell these loans and SBA employees continue to assist  lenders or take over the servicing from lenders when a loan becomes  delinquent. As a result, SBA has not been able to free up the resources it  had hoped to reallocate to mission-critical areas, such as outreach to small  businesses. Though SBA has conducted limited analysis on the impact of  loan sales on its servicing centers and portfolio activity, a more thorough  evaluation is needed to determine the agencywide effects of the loan sales  and the cost savings to the agency.
It would be imprudent to continue SBA loan asset sales in the absence of  reliable and complete information on the accounting and budgetary effects  of the sales. A successful loan sales program is not solely about maximizing  proceeds and attracting investors: it is also a means of improving an  agency’s ability to achieve its mission and to best serve the American  people. Moreover, as OMB continues to encourage loan asset sales, it is  important that agencies embarking on new loan asset sales programs have  the capability to properly carry out and account for these activities.
section_title: Recommendations
paragraphs: We make several recommendations to the Administrator of the Small  Business Administration, in order to provide accurate and reliable  information about how the sales affect SBA’s borrowers, financial  statements, budget, and operations.
To ensure that SBA has complete information to enforce borrower  protections in its loan sale agreements and has reliable information to  report to Congress on how borrowers are reacting to the sales, we  recommend that the Administrator develop procedures for documenting  and processing inquiries and complaints from borrowers, and provide  guidance to the field offices about implementing them.
To address the errors and weaknesses in SBA’s accounting and budget  reporting, we recommend that the Administrator take the following actions  before conducting additional loan asset sales:  Correct the errors in SBA’s loss calculations for loan sales one through  five, and adjust the fiscal years 2000 and 2001 financial statements.
Perform the necessary analyses to assess the effect of loan sales on the  reestimates, to determine whether the cash flow assumptions in SBA’s  model reasonably predict future loan performance.
Perform the necessary analyses to determine and correct the cause of  the unexplained decline in the subsidy allowance account, and make the  relevant adjustments to the fiscal years 2000 and 2001 financial  statements, as appropriate.
We also recommend that the Inspector General, in conjunction with SBA’s  financial statement auditors, assess the impact of any identified errors in  the financial statements and determine whether previously issued audit  opinions for the fiscal years 2000 and 2001 financial statements need to be  revised.
Finally, to provide Congress and SBA with a better understanding of the  impact of loan sales on SBA’s operations, we also recommend that the  Administrator conduct a more comprehensive evaluation of the loan sales’  impact on the agency and the cost savings from the sales.
section_title: Agency Comments
paragraphs: We requested comments from SBA, SBA’s Inspector General, and Cotton  and Company, SBA’s independent financial statement auditor, on a draft of  this report.   The Chief Financial Officer for SBA, the Acting Inspector  General, and Cotton and Company provided their comments in writing,  which are presented in their entirety in appendixes III, IV, and V,  respectively.
SBA generally agreed in its comments with the overall findings and  recommendations in this report. In response to our recommendation on  tracking borrower inquiries and complaints, SBA stated that the agency is  preparing guidance for distribution to all field offices that will clarify how  borrower inquiries and complaints are to be handled. This guidance will  include information on SBA’s toll-free number. In addition, SBA stated that  it is establishing a designated electronic mail account for use by all SBA  employees, to record borrower comments and forward them to  headquarters; developing a database to track borrower inquiries and  complaints and any other inquiries generated by the sale of loans; and  improving the documentation and tracking of inquiries and complaints  made through its toll-free number.
In its comments regarding our findings and recommendations on the  accounting and budgetary anomalies, SBA stated that it is actively engaging  a contractor to help resolve these issues and has worked extensively with  its independent auditor to identify causes and options for resolving the  issues we identified. Additionally, SBA stated that the accounting and  budgetary guidance is general in nature and requires interpretation.
SBA did not respond specifically to our recommendation to conduct a more  thorough analysis of the impact of loan sales on agency operations.
SBA requested that we delay issuance of the report until March 2003. By  then, it hoped to have determined the causes of the accounting and  budgetary problems, and to be able to propose an appropriate methodology  for resolving them. Though we appreciate the desire to provide a plan of  action for addressing these problems in our final report, it is not our policy  to delay issuance of our reports until problems we have identified are  resolved. SBA also stated that the report did not portray the complexity  and unique problems faced in implementing the loan sales program. We  agree that SBA faced a complex and difficult endeavor when it  implemented the loan sales program. In the introduction to the report, we  stated that SBA had never before conducted bulk loan sales. Furthermore,  the first section of our report is intended to reflect the complexity of the  loan sales process and includes a detailed discussion of what is involved in  conducting a sale, including a time line that shows that the process can  take almost a year to complete. This section and the background section  also describe the variety and number of loans sold. SBA also noted that the  report did not reflect the fact that SBA responds in writing to all written  inquiries and complaints from borrowers; therefore, we added a statement  in the report reflecting the fact that SBA had responded in writing to the  written inquiries and complaints we reviewed at headquarters.
The Inspector General also agreed with our recommendations and is  working with Cotton and Company and SBA management to determine the  magnitude of the errors in SBA’s fiscal years 2000 and 2001 financial  statements. The Inspector General stated that Cotton and Company has  informed the IG’s office that the audit opinion on the fiscal years 2000 and  2001 financial statements should no longer be relied upon, as they may be  materially incorrect because of the errors identified in this report. The  comments also stated that Cotton and Company plans to withdraw its  unqualified audit opinion on those financial statements, and to issue  disclaimers of opinion.
Cotton and Company, SBA’s independent financial statement auditor,  agreed with our findings and did not specifically comment on our  recommendations. However, Cotton and Company also stated that the  report would be more fair and balanced if we further elaborated on the  inherent risks and complexities associated with accounting estimates and  loan sales. Cotton and Company also stated that it believes there is a lack  of comprehensive implementation guidance on credit subsidy and loan sale  cost estimates. Additionally, Cotton and Company stated that (1) our prior  reviews of its work did not identify the problems discussed in this report,  and (2) we did not determine the specific causes of these errors. Further,  Cotton and Company elaborated on some of the audit work it had done.
We agree with Cotton and Company’s and SBA’s statements that accounting  for and auditing estimates of loan program costs and loan sales are  complex, and we describe these complexities in the background section of  this report.
Regarding the adequacy of existing guidance on preparing and auditing  credit subsidy estimates and loan sales, we used guidance that currently  exists in OMB Circular A-11, Preparation, Submission, and Execution of  the Budget; SFFAS No. 2, Accounting for Direct Loans and Loan  Guarantees (effective fiscal year 1994); Technical Release 3, Preparing  and Auditing Direct Loan and Loan Guarantee Subsidies under the  Federal Credit Reform Act (issued July 31, 1999; and Statement of Auditing  Standard 57, Auditing Accounting Estimates (effective January 1989), in  performing our assessment of SBA’s accounting for loan sales and the  credit subsidy estimates. These documents provide considerable guidance  to agencies while still providing the flexibility necessary to be applicable to  a wide variety of credit programs. For example, Appendix B to SFFAS No. 2  contains technical explanations and illustrations related to estimating loan  program costs and loan sales—including guidance for calculating changes  in a loan’s book value, guidance for calculating the gain or loss, and the  impact that loan sales have on various financial statement accounts, such  as the allowance for subsidy. Further, Technical Release 3 provides  guidance on auditing estimates of loan program costs, including assessing  internal controls and inherent risks, as well as suggested audit steps and  analytical review procedures.
While further elaboration may be helpful, the errors we identified in the  financial statements and the related footnotes were primarily related to  fundamental flaws in the application of existing guidance rather than to  insufficient guidance. In addition, the anomalies in the disaster loan  subsidy allowance account were known to Cotton and Company, and SBA  provided no viable explanation for these anomalies.
Regarding prior GAO reviews of Cotton and Company’s related audit work,  these reviews were part of our governmentwide consolidated financial  statement audit and were designed to focus on issues that could be  significant to the consolidated financial statements of the federal  government. Because the materiality of the consolidated financial  statements far exceeds the level of what is material to SBA, these reviews  were far less detailed than what was conducted for this report. Further,  loan sales were not significant to the governmentwide financial statements  and, therefore, were excluded from the scope of the prior GAO reviews.  However, it should be noted that prior GAO reviews of Cotton and  Company audit work at SBA going as far back as 1997 raised concerns  about its audit scope and methodology in the credit subsidy area, and  offered suggestions for improvement on both a formal and an informal  basis.
Although we did identify specific errors in the calculation of the loss on  loan sales reported in the financial statements, we agree that we did not  identify the cause of the negative balance in the disaster loan subsidy  allowance account. We were unable to identify the cause because SBA  lacked some of the fundamental information necessary to enable us to do  so. This missing information, which should have been made available for  the financial statement audit, included an aging of the delinquent and  defaulted loans by year of loan commitment, detailed reconciliations of the  allowance for subsidy, and an analysis of the impact that loan sales had on  the estimated performance of the remaining loan portfolio. Because this  type of information was not available at the time of our review or of Cotton  and Company’s audit, it was not possible either for us, Cotton and  Company, or the SBA to determine the cause of the anomalies in the  disaster loan subsidy allowance account. We understand that SBA is now  working on preparing this information.
Regarding the elaboration of audit work that Cotton and Company  provided, we saw this work when we reviewed the auditor’s workpapers,  and we provided a summary of this work in the body of the report.
Unless you publicly announce its contents earlier, we plan no further  distribution until 30 days after the date of this report. At that time, we will  send copies of the report to the Chairman of the Senate Committee on  Small Business and Entrepreneurship, the Chairman and Ranking Minority  Member of the House Committee on Small Business, other interested  congressional committees, the Administrator of the Small Business  Administration, and the Director of the Office of Management and Budget.  We will make copies available to others on request. This report will also be  available at no charge on the GAO Web site at http://www.gao.gov.
Please contact us at (202) 512-8678 if you or your staff have any questions.  Additional contacts and staff acknowledgments are listed in appendix VI.
section_title: Scope and Methodology
paragraphs: In preparing this report, we focused on the first five of SBA’s six loan asset  sales. The unpaid principal balance of the loans sold in these sales  represents about 87 percent of all the loans SBA sold from August 1999  through August 2002. The sixth sale was not completed in time to be  included in our analysis because purchasers do not begin servicing the  loans and accounting adjustments are not complete until several weeks  after the sale date.
To describe SBA’s loan sale process, we reviewed a variety of documents  related to planning and conducting a loan sale, including strategic plans,  guidance, and procedures. We also collected data on the types of loans sold  and the proceeds that SBA received from the sales, and we interviewed  SBA officials and contractors. Our interviews with SBA officials took place  at headquarters and at several SBA field offices that participate in the loan  sales process, including two disaster home loan servicing centers, one  commercial loan servicing center, and seven district offices. We selected a  mix of large and small field offices around the country, based on the size of  the loan portfolio and the number of loans sold. An additional  consideration for three of the district offices we selected was their  proximity to the finance center and the three servicing centers we visited.  We also interviewed the financial adviser who advises SBA on its overall  strategy for selling loans; the financial advisers hired to conduct the first,  third, and fifth sales; and the due diligence contractor for the first four  sales.
To confirm that SBA’s loan sale process was working as described, we  reviewed the loan information in the bidder information packages and  interviewed investors. To confirm that SBA was providing relatively  complete data to investors, we evaluated the loan data provided to  potential investors in the bidder information packages. Specifically, we  tested the data’s completeness for several key fields, such as interest rate,  outstanding balance, and maturity date. For investor feedback about the  loan sale process, we interviewed six investors and reviewed 42 responses  to surveys conducted by SBA’s Transaction Financial Advisers of investors  who had participated in sales four and five. We selected a mix of large and  small investors with a variety of experiences with the sales, including  investors who had won, lost, or just requested information but declined to  bid. In our interviews we asked investors to evaluate aspects of SBA loan  sales, including data they had received about loans for sale,  communications they had had with SBA and its contractors, the loan sales  process, and the organization of loan pools. We also asked whether the  investors planned to participate in future sales. Although we attempted to  contact a cross section of investors, the comments we received cannot be  generalized to a larger group.
To determine how SBA loan asset sales affect 7(a) lenders, we reviewed the  lenders’ role in the loan sale process and interviewed officials representing  lenders that had participated in at least one sale. We selected a mix of 12  small and large lenders based on 7(a) lending volume, asset size, and  location. In our interviews we asked lenders to evaluate their experience  with SBA’s loan sale process, describe how they made the decision to  participate in the sales, and discuss their level of satisfaction with the  proceeds. Although we attempted to contact a cross section of lenders,  their comments cannot be generalized to a larger group. We did not  interview any certified development companies that make 504 loans,  because the only 504 loans that were sold did not require consent from the  lender. To obtain additional feedback on SBA’s loan sale process, we spoke  with officials representing the National Association of Government  Guaranteed Lenders and the National Association of Development  Companies, which represent SBA 7(a) lenders and certified development  companies that make 504 loans, respectively.
To determine how borrowers reacted when their loans were sold, we  reviewed borrower inquiries and complaints documented by SBA and the  process for documenting and processing these inquiries and complaints. To  determine the types of inquiries and complaints borrowers have, we  reviewed 133 of 155 borrower inquiry and complaint letters filed at  headquarters since the first loan sale in August 1999. We collected  information that included the date and type of inquiry or complaint (for  example, questions about a loan sale or complaints about a servicing action  by a purchaser) and the name of the purchaser (if available). We prepared a  summary of SBA’s written response. We also interviewed SBA officials at  headquarters and field offices (three servicing centers, seven district  offices, and two disaster area offices) about the types of inquiries and  complaints they receive from borrowers and about SBA’s process for  handling these complaints. In addition, we asked staff at field offices  whether they had forwarded borrower complaints to headquarters or  documented the complaints. We reviewed a nonstatistical sample of  complaints from the third, fourth, and fifth sales drawn for us by staff at  one of the disaster home loan servicing centers to determine whether the  information in borrower complaints received at field offices was accurately  represented in headquarters records. Specifically, we compared the names  on the complaints we received from the disaster home loan servicing  center with the names on the complaints at headquarters. We also reviewed  the complaints logged through the toll-free number, but these data were  limited because SBA staff did not begin logging the complaints from this  number until April 2002.
To evaluate SBA’s budgeting and accounting for loan sales, we assessed  SBA’s compliance with various budget and accounting guidance, including  OMB Circular A-11, Preparation, Submission, and Execution of the  Budget; Statement of Federal Financial Accounting Standard Statement  No. 2, Accounting for Direct Loans and Loan Guarantees; and U.S.  Government Standard General Ledger, Account Transactions. Specifically,  we analyzed SBA’s cash flow models to reestimate subsidy costs for the  disaster loan program and the 7(a) and 504 loan guarantee programs, in  order to determine the effect of loan sales on the cost of each program for  the budget. We evaluated characteristics of loans sold as compared with  cash flow assumptions used to reestimate the costs of SBA’s loan programs.  To assess SBA’s estimates of hold values for loans sold, we reviewed an  external validation of the hold model used for sales one through three that  was prepared by an SBA contractor, who concluded that the calculations  were accurate and reasonable. Since SBA changed to a more sophisticated  hold model after sale three, we also reviewed the methodology and  assumptions in SBA's revised model used to estimate hold values for loans  sold in sales four and five, and we found the approach to be reasonable.  However, we did not audit the data used to calculate the hold values for  each sale, and therefore did not conclude on the reasonableness of the hold  values for any of the sales. We reviewed SBA’s accounting related to the  balances of the loans sold, proceeds and costs of the sales, and calculations  of gains or losses on sales to determine whether SBA considered all  appropriate cash flows in these calculations. We discussed SBA’s budgeting  and accounting procedures for loan sales with SBA and OMB officials,  Federal Accounting Standards Advisory Board staff, and SBA’s independent  auditors. We also reviewed SBA’s audited financial statements for fiscal  years 1999 through 2001 and examined workpapers from SBA’s auditor for  fiscal years 2000 and 2001.
Finally, to assess the ways in which SBA benefited from loan sales, we  reviewed official statements, including testimony, press releases, and other  documents that cited benefits related to loan servicing reductions, staff  realignment, and loan portfolio management efficiencies. To confirm these  benefits, we reviewed and analyzed trend data on SBA’s loan servicing  workloads to determine how the loan sales had affected SBA’s loan  servicing workloads and staffing. We reviewed and analyzed data on loan  activity, including prepayments and charge-offs, before and after the loan  asset sales began. We also interviewed SBA officials at headquarters and  field offices to obtain their views on how SBA has benefited from the sales.  We did not independently verify the accuracy of the loan servicing and loan  portfolio data provided by SBA, because we were interested only in the  trends before and after the loan sales began.
We performed our review from January 2002 through October 2002 in  Washington, D.C., and several other locations across the country, listed  below, in accordance with generally accepted government auditing  standards.
subsections: section_title: SBA Field Locations We Visited
paragraphs: Birmingham, Alabama Little Rock, Arkansas Santa Ana, California Los Angeles, California Denver, Colorado Miami, Florida (telephone interview) Philadelphia, Pennsylvania Birmingham, Alabama (disaster home loan servicing) Santa Ana, California (disaster home loan servicing and liquidation)  Little Rock, Arkansas (commercial loan servicing)
Denver, Colorado  Niagara Falls, New York (telephone interview)  Fort Worth, Texas (telephone interview)
section_title: Types of Borrower Inquiries and Complaints Received by SBA
paragraphs: We reviewed 133 of the 155 inquiries or complaints SBA had documented  from August 1999 through April 2002, to identify the types of concerns and  problems borrowers faced when their loans were sold.  From our review,  we determined that borrowers generally contact SBA about loans that have  been sold for one of two reasons:  they have a question or concern about why SBA is selling their loan, or  they want to purchase their loan rather than have SBA sell it to the  private sector; or  they want to modify their loan and have a complaint about the  purchaser’s procedures or treatment.
Almost half (65) of the 133 letters from borrowers that we reviewed at  headquarters involved questions about why loans were being sold, requests  to buy a loan discounted lower than the unpaid principal balance, or pleas  that the loan not be sold.  Forty-seven letters referred to purchasers’  servicing actions.  Twenty-three of these letters involved disagreements or  frustration with servicing decisions the new purchaser had made, such as  refusing to subordinate or release collateral, or imposing a fee to  complete a servicing action such as subordination.  Another 18 letters came  from borrowers who wanted to defer payments or change the amount of  their monthly payment because of financial problems, and felt they were  not getting appropriate treatment from the purchaser of their loan.  Six of  the letters complained about problems that occurred while SBA was  transferring the loan to the purchaser.  For example, some borrowers found  that purchasers had not properly applied their loan payments during the  servicing-transfer period.  Nineteen of the remaining 21 letters came from  borrowers who wanted SBA to subordinate, release collateral, or  compromise on a loan’s payment or terms, and who were told that SBA had  sold the loan and thus could no longer service it.
section_title: Comments from the Small Business Administration
section_title: Comments from the Inspector General of the Small Business Administration
section_title: Comments from Cotton and Company
section_title: GAO Contacts and Acknowledgments
subsections: section_title: Contacts
paragraphs: For questions regarding this report, please contact Davi D’Agostino at (202)  512-8678 or Linda Calbom at (202) 512-9508.
section_title: Acknowledgments
paragraphs: Additional staff making major contributions to this report were Dan Blair,  Marcia Carlsen, Jay Cherlow, Heather Dunahoo, David Eisenstadt, Edda  Emmanuelli-Perez, Katie Harris, DuEwa Kamara, Kay Kuhlman, and Paul  Thompson.
section_title: Glossary
paragraphs: The following is a group of terms commonly used in credit budgeting and  accounting. The definitions for many of these terms are equally applicable  to direct loans and loan guarantees.
subsections: section_title: GAO’s Mission
paragraphs: The General Accounting Office, the investigative arm of Congress, exists to  support Congress in meeting its constitutional responsibilities and to help improve  the performance and accountability of the federal government for the American  people. GAO examines the use of public funds; evaluates federal programs and  policies; and provides analyses, recommendations, and other assistance to help  Congress make informed oversight, policy, and funding decisions. GAO’s  commitment to good government is reflected in its core values of accountability,  integrity, and reliability.
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section_title: To Report Fraud, Waste, and Abuse in Federal Programs
section_title: Public Affairs