oversight

Improvements Needed in the Administration of Farmers Home Administration's Water and Waste Disposal Program

Published by the Government Accountability Office on 1977-09-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                         DOCUMENT RESUME
03504 - [A2493620]

Improvements Needed in the Administration of Farmers Home
Administration's Water and Waste Disposal Program. CED-77-116;
B-114P73. Septembel 1, 1977. 20 pp.
Report to Secretary, Department of Agriculture; by Henry
Eschwege, Director, Ccamunity and Economic Development Div.
Issue Area: Domestic Rousing and Community Development (2100);
    Environmental Protection Programs (2200) Water and ater
    Related Programs (2500).
Contact: Community and Economic Development Div.
Budget Function: Community and egional Development: Area and
    Regional Development (452).
Congressional Relevance: House Committee on Agriculture; Senate
    Committee on Agriculture, Nutrition, and Forestry.
Authority: Consolidated Farm and Rural Development Act, as
    amended (7 U.S.C. 1926 (Supp. V); 7 U.S.C. 1983 (Supp. V)).
    Federal Property and AdmiListrative Services Act of 1949 (40
    U.S.C. 471 et seq.).
          Lack of documentation prevents determination as to
whetter the Farmers Home Administratin (PmHA) is complying with
the "credit elsewhere" provision of tLe water and waste disposal
program. Borrowers' files are not always reviewed to determine
the ability of borrowers to refinance their water and waste
disposal clans.   Findings/Conclusions: Borrowers were not
requested to efinance their lcans, and it could not be
determined whether borrowers were being asked to seek credit
elsewhere, agency requirements for using reserve funds to repair
cr replace system components did not insure that water and waste
disposal systems would remain viable for the loan repayment
period.   Recommendations: The Secretary of Agriculture should
direct the dministrator of the FmHA to make recommendations to
the Congress concerning the reasonableness of the statutory
credit elsewhere provision as it applies to nonpublic water and
waste disposal borrowers; reguire State offices to document all
credit elsewhere determinations in borrowers' files and to
reiiew periodically water and waste loans for refinancing
through other credit sources; establish procedures requiring
that reserve funds consider the useful life and future
replacement costs o system components; insure that all
borrowers meet reserve fund provisions placed on them; stop
using the percentage-of-construction-cost method of compensating
engineers and require that all engineering fees be a fixed
amount; and establish procedures to require State or district
cff:ce audits of all final engineering fee payments to prevent
engineers from receiving fees in excess of allowable amounts.
(Author/SC)
            UNITED STA TES
u,s.   :.   GENERAL ACCOUNTING OFFICE




            Improvements Needed In The
            Administration Of Farmers Home
            Administration's Water And
            Waste Disposal Program
            Department of Agriculture
            Lack of documentation prevents determina-
            tion as to whether Farmers Home Adminis-
            tration is co nplying with the "credit else-
            where" povision of the water and waste
            disposal program. Borrowers' files are not
            always reviewed to determine ability of
            borrowers to refinance their water and waste
            disposal loans.

            Current requirements for maintaining reserve
            funds do not insure that a system will remain
            viable over the life of the loan.

            The agency's method of compensating en-
            gineers penalizes them for designing the most
            economical system and can result in an exes-
            sive cost for the system.




            CED-77-116
                                                    SEPTEMBER 1, 1977
                          UNITED STATES GENERAL ACCOUNTING OFFICE
                                  WASHINGTON, D.C.   20548


PROCUREMENT AND SYSTEM1
   ACQUISITION DIVISION



       B-114873

       The Honorable
       The Secretary of Agriculture

       Dear Mr. Secretary:

            This report iscusses Farmers Home Administration'ss
       water and waste disposal program and suggests ways to improve
       the administration of the pogram.

           We made this review to determine Farmers Home Administra-
      tion's effectiveness in administering the program to finance
      the constructior or improvement of water and waste disposal
      systems in rural areas.

             This report contains recommendations to yu on pages 12,
      13, 19, and 20. its you know, ection 236 of th! Legislative
      Reorganization Act of 1970 requires the head of a Federal
      agency to submit a written statement on actions taken on
      our recommendations to the House Committe on Government
      Operations and the Senate Committee on Governmental Affairs
      not later than 60 days after the date of the report and to
      the House and Senate Committees on Appropriations with the
      agency's first request for appropriations made morn than
      60 dayfs after the date of the report.

           We are sending copies of this report to the Director.
      Office of Management and Budget; the Assistant Secretary for
      Economic Development, Department of Commerce; the Administra-
      tor, Environmental Protection Agency; the Chairmen, House
      Committees on Government Operations and Agriculture; Senate
      Committees on Governmental Affairs and Appropriations,
      Subcommittee on Agriculture; and Senator James Abourezk
      and Congressman Bill Alexander. We are also sending
      copies to your Assistant Secretary for Rural Development;
      the Administrator, Farmers Home Administration; and the
      Director, Office of Audit.

                                            Sincerely yours,



                                            Henry Eschwege
                                            Director
 GENERAL ACCOUNTING OFFICE              IMPROVEMENTS NEEDED IN
 REPORT TO THE SECRETARY                THE ADMINISTRATION OF FARMERS
 OF AGRICULTURE                         HOME ADMINISTRATION'S WATER
                                        AND WASTE DISPOSAL PROGRAM
                                        Department of Agriculture
             D I G E S T

             GAO reviewed the Farmers Home Administration's
             water and waste disposal program in Arkansas,
             Louisiana, and Mississippi and found that:
             -- Lack o documentation prevents determination
                as to whether the Farmers Home Administra-
                tion is complying with the "credit elsewhere"
                provision of the water and waste disposal
                program. Brrowers' files are not always
                reviewed to determine ability of borrowers
                to refinance their water and waste disposal
                loans.

            -- Its requirements for reserve funds should
               consider the useful life and future re-
               placement costs of system components.
            -- Its procedures for compensating design engi-
               neers needed to be revised.
            GAO could not determine whether borrowers were
            being asked to seek credit elsewhere. (See
            pp. 4 to 6.) Borrowers were not requested to
            refinance their loans. (See pp. 8 to 9.) And
            agency requirements for usina reserve funds to
            replace and repair system components do nut
            insure that water and waste disposal systems
            will remain viable for the loan repayment pe-
            riod. (See pp. 9 to 11.)

            The Farmers Home Administration also permits
            engineers to receive a percentage of the actual
            construction cost as compensation for designing
            water and waste disposal systems. This not
            only removes incentive for engineers to cut
            costs when designing systems, but also permits
            engineering fees to increase as construction
            costs increase regardless of whether or not
            the engineer performs additional work. Al-
            though engineering fees are limited by
            individual State office schedules, fee


Iamjhjw   Upw removal, the report
cow       bohi be noted hereon      i                    CED-77-116
overpayments have resulted because these fee
schedules have not been adhered to. (See
pp. 14 to 19.)
In order to correct these problems, GAO recom-
mends that the Secretary of Agriculture should
direct the Administrator of the Farmers Home
Administration to:
-- Make recommendations to the Congress con-
   cerning the reasonableness of the statutory
   credit elsewhere provision as it applies to
   nonpublic water and waste disposal borrowers.
   (See p. 12.)
-- Require State offices to document all credit
   elsewhere determinations in borrowers' files
   and o review periodically water and waste
   loans for refinancing through other credit
   sources.  (See pp. 12 ad 13.)
-- Establish procedures requiring that reserve
   Funds consider the useful life and future re-
   ?lacement costs of system components. (See
   p. 13.)
-- Incure that all borrowers meet reserve fund
   p ovisions placed on them.  (See p. 13.)
-- Stop using the prcentage-of-construction-
   cost method of compensating engineers and
   require that all engineering fees be a fixed
   amount. (See p. 19.;
-- Establish procedures to require State or
   district office audits of all final engineer-
   ing fee payments to prevent engineers from
   receiving fees in excess of allowable
   amounts.  (See p. 20.)




                      ii
                  Contents


DIGEST
CHAPTER

   1       INTRODUCTION                              1
               Water and waste program               1
               Administering the program             2
               Scope of review                       3
          LACK OF DOCUMENTATION IN BORROWERS'
            FILES OF CREDIT ELSEWHERE PROVISION      4
              Compliance with credit
                elsewhere requirement                4
                  Use of interim financing           6
              Refinancing of water and
                waste disposal loans                 8
              Adequacy of system reserve
                requirements                         9
                  Borrowers' ability to acquire
                    and maintain adequate reserve
                    funds                           11
              Conclusions                           11
              Recommendations                       12
   3      METHOD OF DETERMINING ENGINEERING
            FEES SHOULD BE EVALUATED                14
              Percentage-of-construction method
                can result in increased costs       14
                  Control uer fees paid to
                    engineers                       18
              Conclusions                           19
              Recommendations                       19
                    ABBREVIATIONS

ASCE      American Society of Civil Engineers
EDA       Economic Development Administration
EPA       Environmentdl Protection Agency
FmHA      Farmers Home Administration
GAO       General Account ng Office
OA        Office of Audit
OGC       Office of General Counsel
                          CHAPTER 1

                          INTRODUCTION
     Section 306 of the Consolidated Farm and Rural
Development Act, as amended (7 U.S.C. 1926 (supp. V)),
author:eas the Secretary of Agriculture to make loans
and grants to finance the improvement and/or construction
of water and waste disposal systems in rural areas to
serve farmers, ranchers, farm tenants and laborers, and
other rural residents. The act defines a rural area as
any area in a city or town that has a populatior of 10,000
or less.
WATFR AND WASTE PROGRAM
     Responsibility for carrying out the water and waste
disposal program has been delegated to the Administrator,
2armers Home Administration (FmHA), undez the supervision
of the Assistant Secretary for Rural Development.

     The objective of the water and waste diEposal loan and
grant program is to help fiiencially needy communities that
lack water and waste disposal systems and that are not able
to develop such facilities with usual methods of financing.
FmHA gives priority to projects designed to remove serious
health hazards in rural areas.  Loans and grants may be made
to any association, including nonprofi- corpor-tions, muni-
cipalities, and public and quasi-public agencies to construct,
enlarge, or improve facilities hich store, treat, purify,
and distribute water or collect, treat, and dispose of waste
in rural areas.

     The act requires that the highest priority must be given
to rural communities with a population of 5,500 or less
where water systems have deteriorated or waste disposal sys-
tems are inadequate to meet the community's needs. Priority
is also given to projects that will enlarge, extend, or
otherwise modify systems to provide service to additional
rural residents and those which involve the merging of smaller
systems. Applicants for water and waste disposal loans must
be unable to obtain the needed funds from commercial or pri-
vate credit sources at reasonabJl rates ad terms.
     Water and waste disposal loans have a maximum repayment
period of 40 years or the useful life of the system, which-
ever is less, and bear interest at a rate of 5 percent.
The law also requires that projects receiving water and waste
disposal loans be consistent with development plans for
the community and comply with Federal, State, and local laws.



                             1
     Water and waste disposal loans, which are made and
serviced directly by FmHA, are financed from the Rural
Development Insurance Fund.  Certificates, representing
pools of loan notes, are sold by FmHA to the Federal Fi-
nancing Bank to replenish the fund.

     From 1940 through September 1976, FmHA obligated about
$3.4 billion in loan funds. For fiscal year 1977 FmHA was
authorized $750 million for water and waste disposal loans
including $150 million for loans to 24 States seriously
affected by prolonged drought.  As of September 30, 1976,
there were 7,496 active borrowers and an outstanding loan
balance of about $2.1 billion.

     Water and waste disposal grants may be made in conjunction
with a loan or separately and are used to reduce user rates
to a reasonable level.  In determininq the grant amount,
FmHA considers the (1) rates charged in other communities with
systems constructed at similiar costs and (2) median family
income in te community where the proposed project will be
located.  The grant aount may not exceed 50 percent of the
project cost.

     Grants wll not be made to projects where it has been
determined that the (1) area's population is likely to decline
below that for which the project was designed, (2) project
is not designed and constructed to meet present needs and to
provide for reasonable foreseeable growth, and (3) project is
inconsistent with either a comprehensive community water,
waste disposal, or other development plan or any approved
development plan.  The amount of water and waste disposal
grants may not exceed $300 million in any fiscal year.

     From inception of the water and waste grant program
in 1966 through September 1976, FmHA obligated about $646 mil-
lion in qrants.   For fiscal year 1977, FmH]A was appropriated
$275 million for water and waste disposal grants, including
$75 million for grants to 24 States seriously affected by
prolonged drought.

ADMINISTERING THE PROGRAM

     FmHA administers the water and waste disposal loan and
grant program through a national office in Washington D.C.;
a national finance office in St. Louis, Missouri; and a
field structure of State and county offices.  FmHA's national
office establishes general agency policies and provides guid-
ance to field offices.  The national finance office develops
and executes mHA's financial program and reporting require-
ments.



                              2
     The State offices, each headed by a State director, are
responsible for administering all FmHA programs and activities
in one or more States and for supervising county operations.
State offices provide program supervision and management
assistance to the county offices. The State office staffs
include program supervisors and specialists in such fields
as farming, engineering, architecture, and business. The
county offices make and service loans and grants at the
local level and provide technical guidance to the borrowers.

SCOPE OF REVIEW

     We made our review primarily at FmHA's national office
and State offices in Arkansas, Louisiana, and Mississippi.
We reviewed applicable laws, regulations, instructions, and
procedures; interviewed FmHA officials at the national and
State office levels; and examined agency records and borrower
files. We also reviewed regulations on engineering fees of
the Environmental Protection Agency (EPA) and the Economic
Development Administration (EDA), Department of Commerce.




                             3
                           CHAPTER 2
           LACK OF DOCUMENTATION IN BORROWERS'
           FILES OF CREDIT ELSEWHERE PROVISION
      The Consolidated Farm and Rural Development Act, as
amended, specifically requires that borrowers must be unable
to get credit from other sources at reasonable rates and
terms (7 U.S.C. 1983 (supp.V)) and must refinance their
loans through other sources when requested to do so by
the Government (7 U.S.C. 1983). The lack of documentation
in borrowers' files prevented us from determining whether
FmHA is complying with the "credit elsewhere" requirement.
Our review showed, however, that FmHA lacks Procedures for
water and waste disposal refinancing reviews and not all
borrowers' files are being examined to determine their
ability to refinance loans through other credit sources.
In addition, FmHA requirements concerning reserve funds for
replacing and repairing system components do not insure
that water and waste systems will remain viable for the loan
repayment period because the requirements do not consider
the useful life and future replacement cost of system com-
ponents.
COMPLIANCE WITH CREDIT ELSEWHERE REQUIREMENT

     Section 333 of the act (7 U.S.C. 1983 (supp. V)) requires
that water and waste disposal loans be made only to those  appli-
cants who certify, and the Secretary determines, that th-y are
unable to obtain sufficient credit elsewhere at reasonable rates
and terms. FmHA requires State offices to determine the availa-
bility of credit elsewhere for each applicant and to request
those applicants for which credit elsewhere appears available
to apply for such credit. Those applicants requested to
seek credit elsewhere must provide FmHA with evidence that
credit elsGwnere at reasonable rates and terms is not avail-
able before FmHA will continue to process the loan request.

     The results of our review showed that borrowers' files
did not always document FmHA's credit elsewhere determina-
tions. Therefore, we could not assure ourselves that FmHA
is complying with the credit elsewhere requirement or
determine the basis on which such determinations were made.
In addition, the credit elsewhere provision as it applies
to nonpublic bodies may not be feasible.

     In the three States we reviewed, State office officials
told us that usually only public bodies are required to seek




                             4
credit elsewhere--by attempting to sell their bonds on the
open market. According to thbse officials, nonpublic bodies
are not required to seek cLedit elsewhere when requesting an
initial loan, but may be requested to do so for a subsequent
loan in Arkansas and Louisiana depending on their financial
condition and the loan amount.
     FmHA officials in the three State offices told us that
ay applicant requested to seek credit elsewhere must provide
the State office with documentation that such credit is not
available. For public bodies this may be an opinion from a
bond counsel that a public body's bonds will not sell on the
open market, or evidence that the bonds were offered on the
open market and did not sell, such as the notice of bond sale.
We were told that for those nonpublic bodies requested to seek
credit elsewhere, a letter of rejection is required from the
credit institution.

     For applicants requested to seek credit elsewhere, we
noted that FmHA does not specify the number of credit insti-
tutions from which an applicant must seek credit, nor does
FmHA require that the rates and terms offered or denied
by the credit institutions must be shown on the rejection
letters. If the credit rates and terms are not included on
the rejection letters, we uestion how State offices can
determine that credit offered to the applicant was not
reasonable.
     To find out whether the State offices have made credit
elsewhere determinations and required applicants to seek
credit elsewhere, we reviewed State office files for 15 loans
approved in Arkansas and Mississippi. For the 12 loans for
which a credit elsewhere determination was needed, we found
evidence in only 1 instance where the State office determined
the availability of credit elsewhere. We found no evidence in
the files for the 11 remaining loans that the State office
determined that credit was or was not available elsewhere.

     An official in the Mississippi State office told us
that documentation is included in the loan file only if the
applicant is requested to seek credit elsewhere. This official
contended that the lack of documentation in the file does
not mean that the availability of credit elsewhere was not
determined. He said that if FmHA approved the loan, it was
understood that other credit was not available. Inasmuch
as FmHA is required to determine the availability of credit
elsewhere at reasonable rates anc terms for each applicant,
we believe that each file should contain complete documen-
tation that such a determination was made.




                            5
     This official also told us that the credit elsewhere
provision may increase the cost of projects for public bodies
required to use bonds as evidence of debt because State law
requires that public body bonds must be deliverable within 60
days of advertising and that this may result in public
bodies paying interest on funds before the funds are needed.
     However, officials in the Arkansas and Louisiana State
offices felt that the credit elsewhere provision for public
bodies is not a program hindrance. Louisiana officials said
that some public bodies are able to sell their bonds on the
open market and that the credit elsewhere provision prevents
them from routinely coming to FmHA for cheaper loans.
     Officials in the Louisiana and Mississippi State offices
told us that the credit elsewhere provision should be eliminated
for nonpublic bodies because credit is not available from
commercial sources. Louisiana banking officials told us that
banks would not be interested in making loans to either public
or nonpublic bodies for water and waste disposal systems and
that, in general, banks do not like to make loans with repay-
ment periods in excess of 10 years. One bank official told
us that Federal and State bank examiners have criticized banks
for holding long-term bonds. A savings and loar association
official said that the association cannot make loans for
water and waste disposal systems.
     FmHA should determine whether similiar views exist
among lenders in other States regarding water and waste
loans. If such views exist, it may not be reasonable to
require nonpublic bodies to seek credit elsewhere.
Use of interim financing

     FmHA regulations require that, whenever possible, water
and waste disposal loans exceeding $50,000 should be funded
on an interim basis during construction by commercirl sources
to preclude the necessity of multiple advances of FmHA funds.
Ordinarily, the requirement for using interim financing is
included in the letter sent to an applicant outlining condi-
tions the applicant must meet or agree to meet for FmHA
approval of the loan.

     Public and nonpublic borrowers in Arkansas and Mississippi
have used interim financing on water and waste projects cost-
ing more than $50,000. To determine whether interim financing
has been required, we reviewed 29 loans approved for 27 proj-
ects in these two States. We found that 15 projects under



                             6
construction at the time of our review were using interim
financing. There were three additional projects not under
construction for which FmHA was requiring interim financing.

     However, water and waste disposal borrowers in Louisiana
have used interim financing only on a limited basis. A
bond counsel in Louisiana told us that under State statute,
the type of public bodies FmHA deals with cannot use interim
financing. Although nonpublic bodies can use interim finan-
cing, an official of the State office told us that very few
have done so because the State office just accepted the fact
that interim financing at reasonable rates was not available.
This official told us that the State ffice did not require
written evidence from borrowers that interim financing was
not available.

     A bank official in Louisiana told us that banks may be
interested in making loans on an interim basis for water and
waste disposal systems. He believes that reasonable interest
rates can be negotiated with borrowers; however, he told us
that banks would require a statement from FmHA that upon
completion of system construction it will make the loan
to the borrower.

     The results of a recent FmHA survey of all the State
offices showed that 657 of the 1,608 projects under construc-
tion during calendar year 1976 did not use interim financing.
The State offices reported that interim financinq was not used
on 267 of the 657 projects because it was not available or
was not available at reasonable rates and terms. Of the
remaining 390 projects, 290 did not use interim financing
because of lack of legal authority and 86 did not because
the loans involved were less than $50,000. Specific reasons
were not given for the remaining 14 projects.

     Current FmHA regulations provide that when the interim
financing funds have been spent, the FmHA loan will be closed
and the loan proceeds used to retire the interim indebtedness.
Furthermore, banks providing interim financing are notified by
letter of this assurance and given information to show that
FmHA funds have been set aside for the loan.

     FmHA regulations do not require that borrowers shall
provide FmHA with evidence of their inability to obtain
interim financing at reasonable rates. Borrowers who claim
they are unable to obtain interim financing should be
required to provide FmHA with written documentation.




                            7
REFINANCING OF WATER AND WASTE
DISPOSAL LOANS

     Section 333 of the act also requires that borrowers
receiving water and waste disposal loans shall agree to
refinance their loans through other credit sources when
the Secretary determines that credit is available from
other sources at reasonable rates and terms. However,
in the three States we reviewed, no water and waste bor-
rowers have been asked to refinance their loans and no
borrowers have done so. Officials in the Arkansas and
Mississippi State offices indicated that borrowers have
not been asked to refinance their loans because credit
outside FmHA is not available. An official of the Arkansas
State office told us that only the larger public body
borrowers--municipalities over 5,500 population--that
have been operating for 15 to 20 years can acquire suffi-
cient equity to enable them to sell their bonds on the
open market to refinance their loans.

     Our reviews showed that in Louisiana water and waste
disposal loans were not reviewed to determine whether they
could be refinanced through credit sources other than FmHA.
It was not until August 1976, after our discussions with
State office officials, that the Louisiana State office
issued a bulletin requiring county offices to include water
and waste loans in their next regular loan refinancing review.

     FmHA's regulations establishing loan refinancing review
procedures do not specifically include water and waste loans.
The regulations require that the FmHA Finance Office shall
provide lists annually to the county offices of only those
emergency, operating, and real estate loans which should
be reviewed for refinancing through other credit sources.
Louisiana State office officials told us that a similar list
of water and waste disposal loans would be beneficial to
the review process.

     A bank official in Louisiana told us that bankers
would be interested in refinancing water and waste disposal
loans for periods of less than 7 years and that reasonable
rates could be negotiated.

     FmHA has no central source of information on the number
of water and waste disposal loans that have been refinanced
through other credit sources. Data given to us by each State
office pursuant to a special request showed that through
June 3, 1976, a total of 19 water and waste disposal loans




                            8
 had been refinanced through other credit sources,
                                                   10 of
 which were in Texas. The amounts refinanced in Texas
                                                       ranged
 from $11,800 to $404,600 and the loans had been outstanding
 from 5 to 12 years, Although we were not able to
                                                   determine
 the repayment periods of these refinanced loans, we
 that this demonstrates that credit may be available believe
                                                     and that
 certain loans might be refinanced.

      To better enable the Secretary to exercise
ity provided by the act's refinancing provision, the  author-
establish procedures for water and waste disposal FmHA  should
financing reviews. These procedures should specify loan   re-
                                                      how
often each water and waste loan should be reviewed
                                                     for re-
financing. Furthermore, FmHA should provide the county
offices with lists of those water and waste disposal
                                                       loans
which should be reviewed for refinancing. We believe
actions would enable FmHA to effectively determine      these
particular water and waste disposal loan could be   when   a
                                                   refinanced
through other sources at reasonable rates and terms.


ADEQUACY OF SYSTEM RESERVE REQUIREMENTS

     FmHA water and waste disposal loans may have a repayment
period of up to 40 years but cannot exceed the useful
the system. However, FmHA's current reserve fund       life of
                                                  requirements
for repairing and replacing system components do not
that a system will remain viable over the life of     insure
                                                  the
because the reserve amount is based on the loan debt loan
                                                      of the
system r ther than the useful life and future replacement
costs of system components.

     FmHA requires that the borrower must establish
fund or repairing and replacing system components; a reserve
or expanding the system; and when necessary, making improving
loan payments. FmHA requires borrowers to accumulateannual
maintain in this reserve account an amount             and
                                            equal to at least
one annual loan installment and to accumulate this
within lb years of operation. Public bodies may     amount
                                                  be xempt
from the reserve requirement if their FmHA loans are
                                                      secured
by general obligation bonds or other special assessment
                                                         bonds.
     FrmlA regulations do not specify which system components
are expected to be repaired and/or replaced from
                                                  the reserve
fund. FmHA State and national office officials told
the present reserve requirements enable the borrower us that
                                                      to cover
the cost of replacing low-cost system components,
motors and pumps. These officials told us, however,such as
the reserve accounts are not intended nor are they    that
                                                    adequate
to cover the cost of replacing major system components,
as wells and elevated storage tanks, and that FmHA       such
                                                    would make

                             9
subsequent loans to cover the replacement of these higl-cost
components.

     Since the loan repayment period is limited to the useful
life of the system or 40 years, we believe that the amount of
reserve to be maintained by the borrower for the repair and
replacement of system components should consider the seful
life and future replacement cost of those components expected
to be repaired and/or replaced during the life of the loan.
Only through this approach can FmHA be sure that the reserves
are adequate to cover future repairs and replacements and that
the system will remain viable over the life of the loan.
However, FmHA has not determined what is the useful life of
water and waste disposal systems and provides no guidance to
borrowers in establishing the life expectancy of their
systems.
     The Louisiana State office engineer told us that design
engineers could be required to include information on the
useful life of systems in the preliminary engineering reports.
The engineer felt that this would impress upon the borrower
the need for adequate reserves and provide the borrower with
the approximate time the components would have to be replaced.

     Requiring design engineers to include information on the
approximate useful life of system components would also
provide mHA with a more meaningful basis upon which to
base a system's reserve requirements. We believe that this
is one alternative FmHA should explore in establishing reserve
fund requirements that are based on the useful life of a
system and the future cost of system components expected
to be repaired or replaced.

     The loan debt of a system is not indicative of the funds
that will be needed to repair and replace system components.
Grants, which may equal 50 percent of the project cost,
reduce the amount of loan needed to finance the system.
Therefore, as the amount of the loan decreases, the reserve
amount also decreases because it is based on the system's
loan debt.
     Also, the period over which the loan is to be repaid
affects the reserve amount. In certain cases, State law
may limit public bodies to a repayment period less than the
40 years permitted by FmHA. Therefore, larger annual in-
stallments are required to retire the debt and, consequently,
larger reserve amounts are required.

     The following table shows for a hypothetical project
costing $500,000 the effect varying grant amounts and/or
repayment periods have on the amount of reserves a project
would be required to maintain.

                             10
Project    Grant       Loan       Repayment      Annual      Reserve
amount     amount      amount      period     installments   amount
$500,000   $     -     $500,000        40      $29,140       $29,140
 500,000       250,000 250,000         40       14,570        14,570
 500,000         -      500,000        30       32,525        32,525
 500,000       250,000 250,000         30       16,263        16,263
As shown, the reserve amount for a project costing the same
amount could vary from $14,570 to $32,525 depending on the
grant amount and the loan repayment period.

Borrowers' ability to acquire
and maintain adequate reserve funds
     Our review of the files for 63 borrowers showed that 41
had accumulated the reserves required as of the end of
their last fiscal year of operation. One borrower's loan
was secured by general obligation bonds and therefore was
not subject to the reserve requirement. For the 21 remaining
borrowers who did not have the required reserves, a complete
history of each borrower's reserve fund showing the amounts
transferred to the reserve, amounts expended from the reserve,
and reasons why the funds were expended was not readily avail-
able at the State offices. Of the 21 borrowers, 12 did not
transfer any funds to the reserve during their last fiscal
year of operation.
CONCLUSIONS

     Individuals reviewing borrower files have no way of know-
ing if the applicant was or was not able to secure credit
elsewhere. We believe that FmHA should document each borrower
file to show whether or not credit elsewhere was available.
     The credit elsewhere provision as it applies to nonpublic
applicants may not be feasible. Commercial lending officials
in one of the States reviewed indicated tnat lenders are not
interested in making loans for water and waste disposal
systems because of the long repayment period. If lenders
in other States have this view regarding water and waste
disposal loans, credit from sources outside FmHA may not be
available to nonpublic bodies. Therefore, a determination
should be made of the overall availability of credit to
nonpublic bodies to determine the feasibility of the credit
elsewhere provision as it applies to nonpublic borrowers.

     Although FmHA requires that interim financing should
be used on all loans of over $50,000, it has been used on a



                                  11
very limited basis in Louisiana. Although Louisiana
statute prevents public bodies from using interim
nonpublic bodies are free to use such financing butfinancing,
                                                     few have
done so because the State office assumed that interim
cing at reasonable rates was not available. However, finan-
                                                       it
appears to us that interim financing at reasonable rates
available. Therefore, all State offices should require is
written evidence from borrowers of their inability to
                                                       obtain
interim financing.

     The act requires that borrowers will refinance
loans through other credit sources when FmHA requeststheir
                                                       them
to do so after determining that commercial credit is
to the borrower at reasonable rates and terms.        available
                                                  owever, not
all State offices review borrowers' files to determine
ability to refinance loans through other credit sources their
request borrowers to refinance their loans. Also, FmHA or
                                                         has
not specifically included water and waste disposal loans
its refinancing review procedures. FmHA should insure      in
                                                        that
all water and waste disposal loans are periodically reviewed
for refinancing through other credit sources.

      Inasmuch as the reserve requirements established by FmHA
to repair and replace system components consider only
                                                       the
loan debt of a system and not the useful life and/or replace-
ment costs of components, there is no assurance that
                                                      the
reserve fund will be sufficient to keep the system viable
over the loin repayment period. A system's loan debt
indicative of the funds that will be needed or should is not
                                                       be
accumulated to repair and replace system components.
                                                       Grants
and repayment periods may reduce the loan debt of a system
to a point where systems costing approximately the same
construct have widely varying reserve requirerments. FmHAto
should determine what would constitute an adequate reserve
considering the useful life and future replacement cost
the components expected to need repair and/or replacement.of
Furthermore, FmHA should establish procedures to insure
                                                          that
borrowers meet reserve fund requirements.
RECOMMENDATIONS

     We recommend that the Secretary of Agriculture direct
the FmHA Administrator to:

     --Make recommendations to the Congress concerning
       the reasonableness of the credit elesewhere pro-
       vision as it applies to nonpublic water and waste
       disposal borrowers.

    -- Require the State offices to document all credit
       elsewhere determinations in borrowers' files.


                             12
-- Insure that all water and waste disposal loans are
   periodically reviewed for refinancing through other
   credit sources.
-- Require written documentation from borrowers in those
   States permitting interim financing that such financing
   at reasonable rates is not obtainable.
-- Establish procedures requiring that the reserve fund
   for water and waste disposal systems consider the
   useful life and future replacement cost of system
   components.
-- Insure that all borrowers meet reserve fund provisions
   placed on them.




                        13
                                    CHAPTER 3

                METHOD OF DETERMINING ENGINEERING FEES

                                SHOULD BE EVALUATED

     Farmers Home Administration permits engineers employed
to design water and waste disposal systems to receive a
percentage of the actual construction cosc: as compensation for
their services.  This compensation method penalizes an engineer
for designing an economical system and can result in an en-
gineer receiving additional compensation without performing
additional work. Also, although engineering fees are limited
by individual State office schedules, fee overpayments have
resulted because of nonadherence to these   chedules.

PERCENTAGE-OF-CONSTRUCTION METHOD
CAN RESULT IN INCREASED COSTS

     FmHA regulations require that engineering fees on FmHA
projects shall be reasonable; that is, not in excess of the
fees charged on similiar projects.  To insure that fees are
reasonable, FmHA has instructed State directors to approve
an attachment to be used with the engineering services
agreement showing maximum fee rates for professional engineer-
ing services.

        The following table shows the effective engineering       fee
rates    in the State of Arkansas as of August 1976.

   Total actual                     Table I (note a)     Table II
construction cost                       % of fee         % of fee

Less than       $      50,000               12.50         11.00
   50,000   -         100,000               11.25         10.00
  100,000   -         200,000                9.75          9.00
  200,000   -         300,000                9.00          8.25
  300,000   -         500,000                8.25          7.75
  500,000   -       1,000,000                7.50          7.00
1,000,000   -       2,000,000                6.75          6.50
2,000,000   -       4,000,000                6.50          6.25

a/Used for projects involving above-average engineering cost,
  such as complicated water or sewage treatment plants.

As shown, the engineer's fee on a project of average com-
plexity costing $400,000 to construct would amount to $31,000
(7.75 percent of $400,000).  However, if inflation should
increase the project's construction cost to $440,000, the
engineer's fee increases to $34,100 (7.75 percent of $440,000).



                                       14
     Permitting engineers to receive a percentage of the actual
construction cost as payment for their services not only removes
incentive for engineers to cut costs when designing systems, but
also permits engineering fees to increase as construction csts
increase regardless of whether or not the engineers perform
additional work.
      Our review of national office files for 18 water and
waste disposal projects in Arkansas that received subsequent
loans and/or grants in fiscal years 1975 and 1976 showed that
4 projects received additional funds totaling $118,400 to com-
plete the projects as originally planned. Of the $118,400,
about $10,300 represented increases in engineering fees. An
Arkansas State office official indicated that the additional
funds were for completing the projects as planned and did not
increase the number of users nor require additional engineering
work.

     During recent reviews of loans and grants made to associa-
tions in Kentucky for community facility projects, which in-
clude water and waste disposal systems, the Department of
Agriculture's Office of Audit (OA) noted that unnecessary de-
lays by the engineer in preparing the final plans and specifica-
tions and a change order for one project increased the pro-
ject's construction cost by $43,900 and the engineer's fee
by $6,100.  Inflation accounted for $35,000 of the increase
in construction costs.

     Data showed that a separate rate schedule was developed
by 40 of the 42 State offices for projects or portions of a
project that were unusually complex and required more extensive
design considerations and project supervision than normally
encountered on basic projects. This data showed that as of
July 1976, 1] of the State officer ;:-re using the rate sched-
ules of their State engineering societies and that 13 offices
developed their schedules in conjunction with the State engi-
neering societies.

     For 16 of the 18 remaining State offices, the rate sched-
ules were based on the engineering fee curves published in
the American Society of Civil Engineers (ASCE) Manual Number
45. The ASCE curves show the engineering fee rates recom-
mended for projects of average and above-average complexity.
Inasmuch as engineering fees will vary from State to State
because of engineers' salaries, other costs of doing business,
and general demand, State offices should be cautioned about
using fee schedules based on national averages. We were
unable to determine the basis for the rate schedules for
two State offices.




                            15
     Engineering rate schedules show that rates vary among
the 50 States and 2 territories. The following table shows
the range of rates and computed fees on water and waste
disposal projects costing $500,000.

                                   Enjineerins fees
                   Highest              Lowest           Averase__
T   ef    oect   Rate Amount       Rate      Amount   Rate Amount
Water            9.2    $46,000    5.2     $26,000     7.2   $36,100
Waste            9.36    46,800    5.8      29,300     7.8   39,000
In making our computations we assumed that the project was of
average complexity and used the applicable rate schedule ex-
cept in those cases where the State office had indicated that
the rate schedule for more complex projects was to be used.
The lowest rates for both water and waste disposal projects
were in Oklahoma. The highest rate for water projects was
in Iowa; the highest rate for waste disposal projects was
in Indiana.
     We recognize that engineering fees will vary from State
to State because of engineers' salaries, other costs of doing
business, and general demand for engineering services. We
question, however, whether these factors vary so much that
the engineering rate permitted by FmHA for a waste disposal
system costing $500,000 in Indiana is 9.36 percent, resulting
in a fee of $46,800, whereas the rate for a waste disposal
syscem costing the same amount in the neighboring State of
Illinois is 7.0 percent, resulting in a fee of about $35,400,
or a difference of $11,400.

     It should also be noted that in 24 States the resident
inspector receives a percentage of actual construction cost
as a fee. The resident inspector is usually provided by the
engineer and is responsible for overseeing day-to-day con-
struction of the project to insure that it is done properly
and that the plans and specifications are followed.
     Shortcomings of the percentage-of-construction method
for reimbursing engineers were discussed in our May 1975
report 1/ on reducing costs of Environmental Protection
Agency- (EPA-)funded waste treatment plants. The report
pointed out that this method penalizes engineers for designing
the most economical facilities because their fees are based
on actual construction costs. The report concluded that EPA



l/"Potential of Value Analysis For Reducing Waste Treatment
  Plant Costs" (RED-75-367, May 8, 1975).

                                  16
needs to revise its regulations and require municipalities
to use methods other than the percentage-of-construction-
cost method of procuring professional services for designing
waste treatment facilities before a successful cost control
program could be developed.

      In December 1975 EPA revised its regulations to prohibit
  ie use of cost-Flus-percentage-of-cost and percentage-of-
 onstruction-cost contracts for engineering services. The
regulations, which became effective in March 1976, emphasize
the negotiation process necessary to insure the best techni-
cal product at a fair and reasonable price. EPA's procedure
appears to be in line with the Federal policy established
in October 1972 whe. the Congress amended the Federal Pro-
perty and AdministraLive Services Act of 1949 (40 U.S.C.
471 et seq.) which is to publi.ly announce requirements for
architectural and engineering services and to negotiate the
contracts on the basis of demonstrated competence and quali-
fication for the type of professional services required and
at fair and reasonable prices.
     The Economic Development Administration (EDA), which
also makes loans and grants for water and waste disposal sys-
tems, has placed similiar curtailments on the use of the
percentage-of-construction-cost method. EDA's regulations
state that it is the ageicy's policy to require the use of
fixed-price or cost-ceiling contracts; agreements allowing
compensation to engineers based on a percentage-of-
construction cost generally are not acceptable. An EDA offi-
cial told us that EDA tries to stay away from the percentage-
cf-construction-cost method because it found that engineers
we:e getting paid additional fees without doing additional
work. This official told us that EDA regional offices use
the ASCE curves to determine reasonableness of proposed
engineering fees.

     FmHA State and national office officials in the three
States we visited seemed satisfied with the percentage-of-
construction-cost method of compensating engineers. The
Louisiana State office engineer told us that this is the
most equitable method and none of the other methods, such
as bidding, fixed-fee, etc., will provide better results.
An official of the Arkansas State Board of Health told us
that this method has always been used and no better one is
known.

     In December 1976 FmHA, in cooperation with EPA, developed
an engineering services agreement requiring that all enqi-
neering fees be a fixed price on all projects funded jointly
by the two agencies. In January 1977 FmHA revised the



                             17
engineering services agreement applicable to non-EPA-
funded projects to allow the engineer to be compensated by
either a fixed fee or a percentage of construction cost.
We have consistently advocated avoiding contracts for engi-
neering services based on a percentage of cost because it
gives engineers incentive to inflate costs for increasing
profits. Therefore, we believe that engineering fees on
all FmHA-financed projects should be a fixed amount.

Control over fees eaidtoengineers

     FmHA approves the engineering services agreement that
stipulates the fee to be paid to the engineer. In doing so,
FmHA assures itself that the fee is equal to or less than
the applicable fee rate on the State office engineering fee
schedule. FmHA may approve an engineering fee that exceeds
the schedule rate if supporting documentation justifies the
increased fee.

     We reviewed 10 projects in the Louisiana State office
that were completed n fiscal years 1975 and 1976 to deter-
mine whether the engineering fees paid as a percentage
of total construction cost exceeded the percentages allowed
on State office fee schedules.   For two of these projects
we found that engineering fees paid did exceed allowable
rates. In one case the engineer was paid $2,825 more than
he should have been because the county supervisor did not
properly compare the fee charged by the engineer with the
fee schedule attached to the engineering services agreement.
In the other case, the borrower and the design engineer
executed a nonstandard agreement for engineering services.
This agreement had an attached fee schedule showing higher
rates of compensation than the effective State office sched-
ule. We were told that this agreement was never reviewed
by the State office, and that the loan was closed apparently
without the State office's approval of any engineering con-
tract. As a result, the engineer received $1,800 more than
he would 'ave under the proper fee schedule. Later State
office .LLon resulted in the engineer returning the $2,825
overpayment to the system owner. However, in the other case,
the State office found that the system owner has no recourse
because the contract is legal and binding.

     Recent reviews of community facility projects in Kentucky
by the Department of Agriculture's OA show that engineering
fee overpayments are also occurring in that State. OA re-
ported that for one project FmHA did not adhere to the rate
schedule attached to the engineering services agreement, which
resulted in a $6,500 engineering fee overpayment. For another



                              18
project the State office failed to use the correct rate table,
resulting in the engineer's being overpaid about $1,500.
     FmHA instructions do not require that State offices
shall routinely review engineering fee payments to determine
whether or not overpayments occurred. As a result of our
review, the Louisiana State office made the five district
directors responsible for insuring that all engineering
services agreements are approved by the State office and
that payments to contractors and engineers are checked
against the contract :ate. These payments will be verified
by district and State office level staff on regular visits
to county offices. Similiar procedures should be required
in the other States to insure that engineering fee overpay-
ments do not occur.
CONCLUSIONS

     FmHA's practice of permitting engineers to be compensated
for their services on the basis of a construction cost per-
centage results in engineers receiving additional fees for no
additional work and removes the incentive for engineers to
cut costs when designing systems. FmHA's recent revision to
require only fixed-price fees on FmHA-EPA-funded projects will
do away with the increased engineering fees based solely on
increases in construction cost. FmHA should also require
that engineering fees on non-EPA-funded projects should be a
fixed amount.

     Some State offices are using national average engineering
fee rates for projects designed in their States. Such sched-
ules may not be representative of the actual going rate for
engineering services in these States and may need to be ad-
justed.

     Engineering fee overpayments have resulted because of
nonadherence to effective State office fee schedules.
Engineering fee payments may be best controlled by routine
audits by State or district office personnel before the final
engineering payment is made.

RECOMMENDATIONS

     We recommend that the Secretary of Agriculture direct
the FmHA Administrator to:

     --Stop using the percentage-of-construction-cost
       method of compensating engineers and require that
       all engineering fees be a fixed amount.




                            19
        -- Establish procedures to require State or district
           office audits of all final engineering fee payments
           to prevent engineers from receiving fees in excess
           of allowable amounts.




02872



                                 20