RHS is a component of Rural Development, a mission area within Agriculture that was created when the department was reorganized in 1994. RHS provides a wide array of housing services to rural residents and often offers more favorable loan terms and conditions than other federal housing programs. The agency delivers services through an extensive network of field offices. In September 1997, Rural Development completed a conversion of its direct SFH loan servicing from a dispersed nationwide network of more than 2,000 field offices to Agriculture’s new Central Servicing Center. The center is responsible for servicing the department’s entire direct SFH loan portfolio, which totaled about $17 billion at the close of fiscal year 2000. Through its SFH programs, RHS provides highly subsidized direct loans to rural households with very low and low incomes, guaranteed loans to households with low and moderate incomes, and grants and direct loans for housing repairs to households with very low incomes. Under the guaranteed SFH loan program, RHS agrees to reimburse approved private lenders for up to 90 percent of the principal advanced to a borrower in the event the borrower defaults. In recent years, RHS’s guaranteed SFH loan program has expanded, with the reported outstanding principal due on the guaranteed SFH loan portfolio increasing from about $3 billion in fiscal year 1996 to more than $10 billion at the end of fiscal year 2000. Our objectives were to determine whether (1) RHS was promptly referring eligible SFH loans to FMS for collection action, (2) any obstacles were hampering RHS from referring eligible SFH loans to FMS, and (3) RHS was appropriately using exclusions from referral requirements. To determine whether RHS is promptly referring eligible SFH loans to FMS for collection action, we interviewed officials responsible for identifying eligible SFH loans and referring them to FMS. We also reviewed pertinent policies, procedures, and reports related to RHS loan referrals, including Treasury instructions for preparing the TROR and RHS internal delinquency reports. To determine whether any obstacles were hampering RHS from referring eligible SFH loans, we interviewed RHS officials and obtained and reviewed relevant documents, including the agency’s debt- referral schedule and Agriculture’s request to Treasury to exempt delinquent SFH loans from referral for cross-servicing for up to a year after liquidation of collateral. We also reviewed responses to questions about RHS’s debt collection practices that you submitted to the deputy secretary of agriculture in October 2001. We used information from the responses to clarify or augment our report, where appropriate. A scope limitation prevented us from determining whether RHS’s exclusions of about $182 million of direct SFH loans from referral requirements were appropriate. RHS officials told us that the agency did not retain supporting documentation (a list of individual loans, including loan amounts, for each exclusion category) for the $182 million of direct SFH loans excluded from referral to FMS. Without such documentation, we could not independently verify that amounts excluded for forbearance or appeals, bankruptcy, and foreclosure were accurate or met established criteria. We conducted our review from November 2000 through October 2001 in accordance with U.S. generally accepted government auditing standards. We did not independently verify the reliability of certain information that RHS provided to us (e.g., debts more than 180 days delinquent and debts classified as currently not collectible (CNC) and information in RHS’s loan-accounting and loan-servicing systems). We requested written comments on a draft of this report from the secretary of agriculture or her designated representative. Rural Development provided Agriculture’s response and Rural Development’s letter is reprinted in appendix I. Since the passage of DCIA in April 1996, RHS has referred a minimal amount of direct SFH loans to FMS for cross-servicing. As of September 30, 2000, RHS reported about $383 million of direct SFH loans delinquent more than 180 days. Because of a software deficiency that prevented automated identification of direct SFH loans eligible for cross-servicing and an agency plan to obtain an exemption from referring direct SFH loans for cross-servicing, RHS had referred virtually no delinquent SFH loans for cross-servicing as of September 30, 2000. However, as of the same date, RHS reported having referred about $201 million of direct SFH loans to FMS for TOP. Beginning in April 2001, RHS began manually referring a small number of direct SFH loans—approximately 100 a month—to FMS for cross-servicing. However, this effort, discussed in more detail later in this report, is an extremely limited measure and results in referrals of only a small fraction of the agency’s eligible delinquent SFH loans. Since DCIA’s enactment, several obstacles have seriously impeded RHS’s implementation of the act’s referral requirements. Because of a software deficiency that has existed since fiscal year 1997, Agriculture’s automated loan-servicing system cannot identify loans that are eligible and should be referred for cross-servicing. As a result, RHS referred virtually no direct SFH loans to FMS for cross-servicing through September 30, 2000, and only minor amounts through September 30, 2001. An additional obstacle was RHS’s application for—and unrealistic expectation of receiving—an exemption from Treasury that would have allowed the agency to delay referring direct SFH loans to FMS for cross-servicing for up to a year after liquidation of a loan’s collateral. Based on its expectation that the exemption request would be approved on an after-the-fact basis, RHS classified all of its delinquent direct SFH loans as excluded from referral requirements in its September 30, 2000, TROR. Finally, RHS understated loan amounts that are eligible for referral in two respects. First, the agency included in its reporting of delinquent debts only the delinquent portions of installment loans rather than the total unpaid loan balances as required by Treasury. Second, RHS did not take action until recently to recognize losses on guaranteed SFH loans as nontax federal debt. Until these steps are completed, RHS cannot use the collection tools provided under DCIA to pursue collection directly from debtors on guaranteed SFH loans. During fiscal years 1996 and 1997, RHS converted its loan-servicing system, which serviced a portfolio of more than 700,000 direct SFH loans, from a decentralized servicing network of more than 2,000 field offices to a single, automated loan-servicing location—Agriculture’s Central Servicing Center. The main automated system is a commercial off-the-shelf loan-servicing system that required modification if it was to perform the unique functions associated with the direct SFH loan program, such as identifying direct SFH loans eligible for cross-servicing. If the system is to perform this function, it must, for example, be capable of determining the status of any collateral, because all collateral must be liquidated prior to a loan’s referral to FMS for cross-servicing. According to RHS officials, RHS has been unable since the conversion to readily identify direct SFH loans that are eligible for referral to FMS for cross-servicing because the necessary software was not completed prior to conversion. RHS nevertheless completed the conversion in fiscal year 1997 because the agency did not want to delay implementation of the new system. RHS plans to complete the system software in April 2002 and has stated that the software modifications will facilitate identification of loans for cross-servicing. In April 2001, while we were performing our fieldwork, RHS began an interim process to manually identify direct SFH loans eligible for cross- servicing. Agency officials advised us, however, that relatively few referrals for cross-servicing are likely to be made before completion of the software because the interim manual process is tedious and labor- intensive. According to RHS’s debt-referral schedule, only about 100 to 200 loans are to be referred each month, and as of September 30, 2001, the agency had referred 599 direct SFH loans to FMS for cross-servicing. The current manual process creates an overwhelming challenge for the agency because of the large volume of loans potentially eligible for cross-servicing. RHS officials said that all direct SFH loans eligible for TOP will have to be reviewed for cross-servicing eligibility. As of September 30, 2000, RHS had referred 23,032 direct SFH loans to FMS for TOP. According to RHS’s debt- referral plan as of the completion of our fieldwork, the agency intends to refer about 30 percent of eligible direct SFH loans to FMS for cross- servicing in fiscal year 2002. The 30 percent referral level takes into account the increased rate of referrals RHS expects will result from the planned April 2002 completion of loan-servicing software that will permit automated identification of direct SFH loans eligible for cross-servicing. RHS made no attempts prior to April 2001 to manually identify and refer direct SFH loans eligible for cross-servicing. According to agency officials, RHS did not attempt manual identification because the agency was in the process of requesting an exemption from Treasury that would allow it to service direct and guaranteed SFH loans internally for up to 1 year after liquidation of collateral. Liquidation could, in some cases, occur years after a loan became delinquent. Treasury officials told us that the department had informal discussions with Agriculture officials concerning the planned request. They said Treasury discouraged Agriculture from submitting a formal request because Treasury did not believe an exemption was warranted. Nevertheless, Agriculture submitted a formal request for an exemption on behalf of RHS in November 2000. Although Treasury officials stated that the department had never formally or informally approved the request, RHS reported in its September 30, 2000, TROR that Treasury had approved the request.