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
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)