Farmers Home Administration's Business and Industrial Loan Program Can Be Improved

Published by the Government Accountability Office on 1977-09-30.

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

                         DCCUME-T FEYUM3

03'760 - [A2794033]
Faitcers Hone duinisirationes Business and Industrial Loan
Prograv can Be Iproeod. CDP-77-126; B-114873. September 30,
19'77. 65 pp. + 4 afrcdices (12 pp.).

Report to the Congress; by Elmer B. Stdats, Comptroller General.
Issue Area: Domestic Housing and Community Development (2190).
Contact: Community and Economic Devealopent Dii.
Budget Panction: Ccssunity and Regional Develosent: Area and
    Regional Develop ent (452).
Organization Concerned: Farmers ose Administration.
Congressional Relevance: ouse Committee on Agriculture; Senate
   committee on Agriculture, Nutrition, and Forestry; Congress.
Authority: Rural Developsent Act of 1972 (P.L. 92-419).
   Consclidated 'arn and Rural Development   ct, as amended   (7
   U.S.C. 1932 (Supp. II)).
         The business and industrial loan program of the armuers
Hose Administration (FmHA) was established to help to save and
create jobs i   rural areas. The Congress appropriated and the
agency obligated about $550 illion in loans during fiscal years
1974 and 1975, of which $117 million was designated for programs
in Alabaaa, Arkansas, Georgia, Louisiana, Mississippi, and
Tenncssee. Fineings/Conclusions    IThe Congress needs accurate
data to judge te prcgrau's effectiveness. Although the agency
reported that 29,800 jobs were saved and created in fiscal year
1975, data supplied by the borrowers on approved loans showed
that only about 11,100 jobs were saved and created. The higher
number included figures for loans which had not been approved or
which had been deobligated as of June 30, 1976. Further, the job
data supplied by borrowers for 27 loans reviewed was overstated
by sore than 100%. he agency is developing a management
information system for all its programs, but the accuracy of the
information put into the system needs to be veritied.
Recommendations: The FPHA could take a number cf actions to ore
accurately report accomplishments so that the Congress can
better determine the program's effectiveness, improve loan
application assessments, provide better loan servicing, and
increase guidance to borrowers. In addition, action could be
taken to attain enough qualified staff. (Author/SC)


   Farmers Home Administration's
   Business And Industrial Loan
   Program Can Be Improved
  Creation of job-producing businesses
  key to rural development. To this          is the
  business and industrial loan programend, the
  Farmers Home Admin;stratt,;, Department   of the
  of Agriculture, helps to save and create
  rural areas.                             jobs in

  The agency could take a number of
                                    actions to
      --more accurately report accomplish-
        ments so that the Congress can better
        determine the program's effectiveness,
      --improve loan application assessments,
      --provide better loan servicing, and
      --increase guidance to borrowers.
 Also, action could be taken to attain
 qualified starf.

                                                      SEPTEMBER 30, 1977
                           WASHINGTON. D.C. 24


To the President of the Senate and the
Speaker of the Hcuse of Representatives
     This report describes our review of the Farmers Home
Administration's business and industrial loan program. Be-
cause of the important role this relatively new program can
play in developing rural areas, we sought to assess the
agency's administration of the program and to determine what
improvements are needed to make it more effective.

     This review was made pursuant to the Budget and Account-
ing Act, 1921 (31 U.S.C. 53), ad the Accounting and Auditing
Ace of 1950 (31 U.S.C. 67).

     We are sending copies of this report to the Director,
Office of Management and Budget; the Secretary of Agriculture;
and the Administrator, Small Business Administration.

                                   Comptroller General
                                   of the United States
                                   PROGRAM CAN BE IMPROVED
          The Farmers Home Administration can improve
          its business and industrial loan program to

          -- measure and report more accurately program
         --better assess proposed loans,
         -- provide better loan servicing and management
            assistance to borrowers, and
         -- attain enough qualified staff.
         The program, initially carried out during
         harsh economic conditions, has helped rural
         areas by saving existing jobs or creating
         new ones; however, several problems need the
         attention of management.

         The Congress appropriated and the agency obli-
         gated about $550 million in loans during fis-
         cal years 1974-75. Alabama, Arkansas, Georgia,
         Louisiana, Mississippi, and Tennessee accounted
         for loans of about $117 mill'on (21 percent)
         during this time. The report looks at the
         program in these States.

        The Congress needs accurate data to judge the
        program's effectiveness.
        Although the agency reported that 29,800 jobs
        were saved and created in fiscal year 1975,
        data supplied by the borrowers on approved
        loans showed that only about 11,100 obs
        were saved and created. The higher number
        included figuzes for loans which had not been
        approved or which had been deobligated as of
        June 30, 1976. Further, the job data supplied
        by borrowers for 27 loans reviewed was over-
        stated by more th   100 percent. (See pp. 6
        to 11.)

  5.L   Upcn removal, the report
                  e                                  CED-77-126
Management needs more and better data to
effectively evaluate the program. The agency
is developing a management information system
for all its programs, but the accuracy of the
employment data and other information put into
the system needs to be verified. Also, the
quality of the jobs saved and created should
be reported.  (See pp. 11 and 12.)
Criteria for determining what investment
should be made to save or create a job and
analysis and verification of data submitted
by loan applicants are needed for the pro-
gram to do the most sood. For loans reviewed,
investment per job saved or created ranged
from $1,600 to $90,000 using the job data
submitted by borrowers, and from $1,300 to
$200,000 using actual employment data. (See
pp. 12 and 13.)
Specific recommendations for more accurately
reporting data and for saving and creating
the most jobs are on page 14.

Does the loan applicant have a good chance of
succeeding? This question must be answered
before making loans. Regulations governing
loan evaluation procedures need to be clari-
fied and procedures need to be followed.
More experienced staff and clearer instruc-
tions would reduce loan processing time (an
average of 252 days for loans GAO reviewed)
and, at the same time, increase the quality
of the loans approved.  (See pp. 17 to 21.)
Better analysis of a loan applicant's finan-
cial condition and the economic feasibility
of a proposed project would better indicate
that the businesses financed can succeed.
Although the loans reviewed were outstanding
for relatively short periods--from 8 to 26
months--several businesses either had gone out
of business, filed for bankruptcy, fallen be-
hind on their loan payments, or operated with-
out profit.  (Eee pp. 21 to 28.)

  To make sure the applicants
  collateral to repay loans in have enough
                                cases of default,
  the agency should
  -- require that appraisals be made
                                      by independ-
     ent appraisers and reviewed by
                                     agency person-
  --provide additional guidance on
    methods used, and
 -- obtain more accurate data on
                                  the net worth
    of borrowers and others personally
    teeing the repayment of loans.      guaran-
                                     (See pp. 28
   to 3.)
 Loans which merely transfer the
                                  risk of loss
 from banks and other creditors
                                 to the agency
 should not be approved.   (See pp. 32 and 33.)
 Recommendations directed at (1)
 loan evaluations, (2) better establishing
 loan security, and (3) eliminating
 loans which transfer loan risks     the use of
 are on pages 38 and 39.          to the agency


Borrowers' problems can be identified
analyzed better. For example:         and

-- Lenders need to promptly notify
                                   the agency
   of borrowers' delinquencies.
-- The agency and the lenders need
                                    to analyze
   borrowers' financial statements
   quickly and effectively and make
   quent and better planned visits more fre-
                                    to bor-
-- The agency needs to establish
   the use of loan proceeds to seeprocedures on
   are used as authorized. (See pp. that they
                                      42 to
Because agency and lender personnel
                                     lack the
time and/or expertise to effectively
borrowers, the agency should set      assist
aided by consultants, to provide up a  staff,

assistance. (See pp. 50 to 54.)   Specific
recommendations are on pages 56 and 57.
When starting the program, the agency filled
most positions with personnel with agricul-
tural backgrounds. This is still being done
even though
--the former Administrator stated that experi-
  ence in the agency's lending programs was
  not the type being sought,
--the need for staff with more diverse back-
  grounds had been brought to the agency's
  attention, and
-- agriculturally oriented programs accounted
   for only about 30 percent of the agency's
   fiscal year 1976 expenditures.
The agency has not followed fully the recom-
mendation of the Senate Committee on Appro-
priations that staffing levels keep pace with
loan and grant activity.   See pp. 61 to 64.)
Recommended actions for attaining the staff
needed are on page 64.

The agency agrees with GAO on the general im-
provements needed in the program and cited
actions taken and planned to achieve these
improvements. The agency did disagree with
some speif'c recommended actions and GAO's
position on these matters is contained in
the report.
The agency's comments are incorporated in
pertinent sections of te report and included
as appendix III.


DIGEST                                                      i

      1    INTRODUCTION                                     1
               Business and industrial loan
                 program                                    1
               Administering the program
               Program implementation, funding, and         3
                 loan status                                4
               Scope of reviw
               Effect of the ec.omy on the
                 program                                    5
              uverstatement of program accomplish-      6
                ments                                   6
                  Accomplishments should be categor-
                     ized by loans closed and in
                    process                             7
                  Reported accomplishments based on
                    overstated job data provided by
                    borrowers                           8
                  FmHA's management information
              Criteria needed in judging reasonable-   11
                ness of loan investment required to
                save and create jobs
              Recommendations                          13
             Agency comments and our evaluation        14
              Loan processing procedures               17
              Businesses' potential for success not    17
                adequately evaluated
                  Need for improvements in obtain-     21
                    ing and analyzing financial data
                  Economic and technical feasibility   23

              Need for improvements in determin-
                ing adequacy of loan security          28
                  Appraisal procedures                 29
                  Personal guarantees                  31
              Loans used for refinancing purposes
                should not be used to reduce
                lenders' exposure to loss on prior
                loans                                 32
              Conclusions                             37
              Recommendations                         38
              Agency comments and our evaluation      39
              Better and more timely information
                needed on borrowers' problems and
                progress                              42
                  More timely notification of
                    borrower delinquency needed       43
                  Borrowers' financial statements
                    could be more effectively used
                    as loan servicing tool            44
                  Visits to borrowers                 47
                  FmHA monitoring of lender opera-
                    tions                             48
              Better control needed over use of
                loan proceeds                         49
              Improvements needed in management
                assistance program                    50
              Conclusions                             54
              Recommendations                         56
              Agency comments and our evaluation      57
            RESOLVED                                  61
              Conclusions                             64
              Recommendation                          64
              Agency comments and our evaluation      64
      I    Schedule of loans reviewed by GAO            66
  II       Comparison of employment data reported
             to the Congress with actual at time
             of our visit                               67
 III       Letter dated July 27, 1977, from the
             Farmers Home Administration               68
  IV       Principal Department of Agriculture
             officials responsible for administering
             activities discussed in this report       77
B&I        business and idustrial
DOL        Department of Labor
FmHA       Farmers Home Administration
GAO        General Accounting Office
SBA        Small Business Administration
USDA       United States Department of Agriculture
                           CHAPTER 1

      Through recent legislation, the Nation
 to revitalizing and developing rural          has been committed
 achieving a balanced national growth. areas  as  a means of
 mitment, the Congress enacted on Aug-st As  part  of that coin-
 Development Act of 1972 (Public Law      30,  1972,  the Rural
 cipal trust is toward providing jobs9-419). The act's prin-
                                        an increased business
 income in rural America through ericouragelQnt
 rialization and increased business               of rural indust-
                                     activity .- I income.
      Section 310B(a) of the Consolidated
 Development Act, as amended by section      Farm and Rural
 opment Act of 1972 (7 U.S.C. 1932        118  of the Rural Devel-
                                    (Supp. II, 1972)), author-
 ized the Secretary of Agriculture
                                   to guarantee, insure, or
make direct loans to public, private,
 izations or individuals for improving, or cooperative organ-
                                          developing, or
financing business, industry, and
the economic climate in rural areas.             and improving
the Consolidated Act, as amended (7     Section   306(a)(7) of
                                      U.S.C. 1926 (Supp. II,
1972)), defines a rural area, for purposes
to private business enterprises, as            of loans and grants
in the outer boundary of any city     any  area  that is not with-
50,000 or more and its immediately having   a population  of
urbanizing areas with a population adjacent urbanized and
                                    density of more than 100
perqons per square mile.

     The Secretary f Agriculture
for carrying out the business and delegated responsibility
                                  industrial (B&I) loan
program to the Administrator, Farmers
(FmHA), under the supervision of the Home Administration
for Rural Development.                Assistant Secretary

       The primary purpose
economic climate in rural of  the program is to improve the
                           areas by saving existing
creating new jobs. In addition, FmHA                 and/or
other program purposes include encouraging        stated that
rural industry and increasing the           and  stimulating
of funds into, rural communities.  tax base of, and the flow
                                    These purposes are to be
achieved by assisting and encouraginq
making loans to commercial business    local lenders in
                                     and industrial enter-
prises to expand or locate their operations
areas.                                       in rural
     Two types of loans have been made under the program--
guaranteed and insured. A guaranteed loan is made by an
approved lending institution with FmHA guaranteeing to pay
up to 90 percent of the principal and interest of the out-
standing loan balance to the lender in case the borrower
defaults. Lenders are responsible for servicing loans
guaranteed by FmHA, including all actions necessary to
collect the indebtedness and to protect the loan security.
An insured loarn is made and serviced directly by FmHA. These
loans are made available to applicants, including public
ties, which are unable to obtain loans elsewhere at reason-
able interest rates and terms.

     Guaranteed and insured loans may be used for:

     -- Business and industrial construction, conversion,
        acquisition, repair, and modernization.
      -Purchase o." land, machinery, equipment, supplies,
       materials, furniture, and fixtures.

     -- Startup costs and working capital.
     -- Refinancing debt, when refinancing results in a
        sound loan and protects the Government's interest.
     Maximum loan terms are 30 years for loans made to pur-
chase land and to construct, improve, or purchase buildings
and permanent fixtures; 15 years for loans made to pr-
chase machinery and equipment; and 7 years for loans made
for working capital. Maximum loan terms for loans made
refinance debt vary with the estimated life of the collateral
securing the loan. Interest rates charged for guaranteed
loans are agreed upon by the lender and applicant while
interest rates for insurec loans are based on rates paid
the U.S. Treasury on obligations of similar maturity.
     In determining which loan applications and prrjects
be funded, FmHA has established, in the following order, will
priorities for projects which will:

    -- Save existing jobs.
    -- Enlarge, extend, or otherwise improve existing
       businesses and industries.
    --Create the highest number of permanent employment

      -- Contribute to the overall economic sability
                                                      of the
         rural areas but generate little or no permanent
         employment opportunities beyond the owner-entrepreneur.

      FmHA administers the program through a national
 quarters office in Washington, D.C.; a national       head-
 in St. Louis, Missouri; and a field structure    finance  office
 county offices.                               of  State  and

      At the national level, an Assistant Administrator
 responsible for overseeing the program, and             is
                                             also for pro-
viding leadership and program direction, formulating
coordinating policies, analyzing and projecting        and
and trends, and evaluating program effectiveness.program   needs
business and industrial oan division, headed        The
reporting to the Assistant Administrator, is by a director
                                              responsible for
developing and recommending program operating
procedures; coordinating and working with otherplans and
public interest groups, and professional and
societies in promoting and managing the program;
ing program ealuations at State and county        and conduct-
national finance office develops and executesoffices.  The
financial an program accounting and reporting FmHA's
      FmHA's 42 State offices, each headed
are responsible for administering all FmHA by a director,
                                            programs and
activities in one or more States and for supervising
office operations. The day-to-day operations           county
                                               of the
at the State level are carried out by a supervisory    program
specialist who may be assisted by one or more         loan
specialists. The supervisory loan specialist
for overseeing all facets of the program at    is responsible
                                             the State level
including loan processing and approval, monitoring
lenders'loan servicing activities, and providing    of
assistance to borrowers.                          management

     Although not an administrative level, FmHA
directors who are responsible for assisting     has district
                                            from 6 to 10
county offices.
     FmHA has about 1,800 county offices, each headed
supervisor, which serve as the focal point              by a
program as well as other FmHA programs. Thefor the  B&I
visor serves as the local contact person for county  super-
                                             FmHA and

 performs loan processing and servicing activities, provides
 technical assistance and guidance to loan applicants,
 promotes and publicizes FmHA programs locally.        and


     Proposed regulations to implement the program
published in the Federal Register in June 1973 and were
regulations in October 1973. Funds were appropriated
the Congress in October 1973 and the first loans were by
obligated in December 1973.

     During fiscal yeirs 1974-75, the Congress appropriated,
and FmHA obligated, $550 million in loan authorizations.
The following schedule shows the status of the 'oans
                                                     as of
June 30, 1975.

                          Number            Amount
Loans closed (note a)      299             $ 86.8
Loans in process           545              436.9
Loans deobligated           93               26.3
     Total                 937             $550.0
a/Loans which FmHA has contracted to make or guarantee.

     At June 30, 1975, FmHA had an unfunded backlog of about
1,000 requests for a total of aut $1 billion of financial
assistance. An FmHA official tod us, however, that
figure could be misleading because it included requests
for reasons such as ineligibility, would not be funded. which,

     For fiscal years 1976-77, the Congress appropriated
additional $787.5 million in loan authority (this amount an
included $87.5 million for the transitional quarter
through September 30, 1976). For fiscal year 1978, July  1
Congress increased the appropriation to $1 billion in
authority.                                            loan


     We reviewed the operation and administration of
program at the national headquarters and the finance the
and in six State offices--Alabama, Arkansas, Georgia,
Louisiana, Mississippi, and Tennessee. During fiscal
1974-75, the six State offices had obligated about $117years

 million in loan authority, or about 21 percent of the
 national total. The following schedule shows the status of
 the loans as of June 30, 1975.

                           Number               Amount

Loans closed                66                 $ 22.5
Loans in process            89                   88.0
Loans deobligated           30                    6.2
      Total                185                 $116.7
     We selected for detailed review 35 of the 66 closed
loans, or about 53 percent of the loans made in the six
States. These 35 loans were made 'o 34 borrowers. To obtain
a more current reading on FmHA's loan processing procedures,
we also reviewed 10 loans in process at June 30, 1975.   (See
app. I for a list of the loans reviewed.)   In making our re-
view we interviewed agency officials and represe) *atives of
lending institutions, State and local government,, and other
community groups and organizations; reviewed laws, regulations,
policies, and FmHA procedures; and examined agency and lender
records. We visited projects, interviewed borrowers, and
examined borrower records. We also hired a consultant to
assist us in determining the adequacy of FmHA's and the
lenders' evaluations of the loans reviewed.

     The implementation of the B&I program in fiscal year
1974 coincided with a downturn in the overall economy which
adversely affected the business community. During the first
2 years in which the program was in operation,
was experiencing a severe recession and, at the the Nation
                                                 same time,
unusually high inflation and interest rates.

     Although the effect that the state of the economy
on the program cannot be precisely measured, we believe had
in judging the overall effectiveness of the program,
consideration should be given to the fact that the program
was implemented during a time of high interest rates, soft
consumer demand, low profit margins and curtailed capital
expenditures. Had the overall economy been stronger, more
businesses in better financial condition may have sought
B&I loans and provided FmHA a larger universe from which
loans could have been selected. Further, a stronger economy
may have alleviatei some of the financial problems of the
firms that obtained loans.

                           CHAPTER 2
      FmHA provided the Congress with information
the accomplishments achieved through its           overstating
                                          business and
industrial loan program. More accurate
enable the Congress to better judge the data   is needed to
                                         overall effective-
ness of this relatively new program and to
                                            determine whether
the accomplishments being achieved are commensurate
investment being made and whether changes              with the
and/or funding levels should be made. To   in  program  operation
                                           provide  the  Congres.
with more accurate data, FmHA should
     -- include as program accomplishments the
                                                number of
        jobs reportedly saved and created for only
        loans actually made rather than including those
        for loans that are in process or that have job data
     -- verify and analyze the job data provided
                                                 by can
        applicants to assure its accuracy and reasonableness,
     --determine and report on the actual number
                                                 of jobs saved
       and created by the businesses assisted.
     FmHA has established no formal criteria
the reasonableness of the investment required to determine
create jobs in approving loans. Such criteria to save and/or
that the limited resources available are        is needed so
projects which will save and/or create the        to those
                                           most jobs.

     During joint hearings held in January
1976 by House and Senate subcommittees, 1/ and February
                                           FmHA reported
that during fiscal years 1974-75 it obligated
million in loan authorizations which resulted about $550
48,900 jobs saved and created. The program    in about

l/Subcommittee on Conservation and Credit
  Committee on Agriculture and Subcommittee the House
                                             on Rural
  Development of the Senate Committee on Ag:iculture
  Forestry.                                           and

data reported ty FmHA was overstated because (1) data was
included for loans not yet made and for loans that were
deobligated, (2) there was duplicate counting of the loans
obligated, ad (3) the number of jobs reported to be saved
and created by the loans was based on data provided by
borrowers which was overstated.
     FmHA reported that 29,800 jobs would be saved and
created by the loans obligated during fiscal year 1975;
however, only 37 percent of these loans were closed as of
June 30, 1976. According to data provided by the borrowers,
the closed loans saved and created about 11,100 jobs, about
37 percent of that reported. As discussed below, comparable
job data for loans obligated during fiscal year 1974 could
not be determined.
     Further, we found that the job data provided by the
borrowers was overstated. Using the borrowers' data, FmHA
reported that 1,881 jobs were saved and created by 27 of the
35 closed loans we reviewed. (Information on the number of
jobs reported to the Congress to have been saved and
created by the remaining eight loans was not available.)
We determined, however, that the actual number of full-time
jobs saved and created by the 27 loans was 920, about 49
percent of that reported.
Accomplishments should be categorized
by loans closed and in process

     In reporting program accomplishments to the Congress,
we believe it would be more meaningful if FmHA categorized
the data by loans closed and in process. Loans deobligated
and those counted more than once should be deleted from
accomplishment data.
     Although FmHA reported that funds were obligated for
937 loans during fiscal years 1974-75, some loans were
counted two or more times. Eliminating such duplications,
we determined that the actual number of loans for which
FmHA obligated funds was 856, a difference of 81 loans from
that reported. FmHA officials advised us that corrective
action is being taken to eliminate the duplicative counting
of loans, The status of the 856 loans as of June 30, 1976,
is shown below.

Loan status         Number     Percent     Amount       Percent
Closed               375           44      $129.2         23
In process           311           36       334.7         61
Deobligated          170           20        86.0         16
    Total            856       100         $549.9        100
     Although FmHA maintained information on the number of
jobs saved and/or created for individu:l loans obligated
during fiscal year 1974, the data was :ncomplete and, there-
fore, we could not determine the number of jobs which should
be deleted from the program accomplishment data for that year.
For loans obligated during fiscal year 1975, FmHA reported to
the Congress that 29,800 jobs were saved and created. However,
most of the loans were either still in process or had been
deobligated as of June 30, 1976. As shown below, the 183
closed loans, according to data provided by the borrowers,
saved and created about 11,100 jobs, or about 37 percent of
that reported.

                                           Number of
                                           jobs saved
Loan status as of     Number              and created
  June 30,-1976      of oans    Percent     (note a)    Percent
  Closed               183          37      11,100        37
  In process           242          50      14,800        50
  Deobligated           64          13       3,900        13
     Total          b/ 489         100      29,800      100
a/The number of jobs reported is based on data supplied by
  the borrowers.
b/Represents unduplicated loans.

     In reporting on program accomplishments to the Congress,
we believe that information on the number of jobs expected
to be saved and created by the loans in process should be
shown separately from the data for approved loans because no
jobs are saved or created until the loan is closed. Job data
for deobligated loans should not be shown at all.
Reorted accomplishments based on overstated
 ob data provided by borrowers
    The reported number of jobs saved and created by the

program is obtained by FmHA from information supplied to it
by loan applicants with little or no verification or analysis
to determine whether it is accurate and reasonable. Such
verification and analysis is needed not only to report accur-
ately on program accomplishments but also to determine whether
the loan investment per job saved or created is reasonable
in reaching a decision on loan approvals. Further, FmHA
should obtain information on the actual number of jobs saved
and created, 1 year after the loans are closed, so that com-
parisons between anticipated and actual program accomplish-
ments can be made, evaluated, and reported on.

     Loan applicants provide employment data to FmHA on a
number of different forms. The information provided by
existing businesses shows the number of people employed at
the time the form is completed--this number is used to report
on the jobs to be saved. Poth existing and new businesses
provide information on the anticipated number of new jobs the
loan will create initially, 1-year after the loan is closed,
and when operating at full capacity.

      We were able to determine the source of the job data
 reported to the Congress for only 27 of the 35 closed loans
 reviewed. These loans were reported to have saved and
created 1,881 jobs. Through discussions with the borrowers
 and selected verification of payroll records,
determined that the actual number of jobs savedhowever, we
                                                 and created
at the time of our visits to the borrowers in terms of
full-time job equivalents was 920, or about 49 percent of
the total reported.   (See app. II.)  We determined that the
remaining eight closed loans actually saved and created 181
jobs, whereas the borrowers, when applying for the loans,
said that they would save and create 306 jobs.
      No one form was consistently used as the source of the
job data reported to the Congress. Also, no one employment
figure was consistently used; i.e., for some loanb the
estimated number of jobs to be created initially was used
and for others it was the estimated number to be created
1 year after loan closing or when operating at full capacity.
Other problems noted were that

     --the employment data provided to FmHA on 25 loans made
       to 24 existing businesses, i.e., the actual number
       of people employed at the time of application, were
       incorrect in 12 cases and
    --no distinction was made between full-time and sasonal
      or part-time employees for 15 of 16 loans made to

       businesses employing seasonal or part-time employees.
     Also, 4 of the 24 borrowers who obtained loans for ex-
isting businesses told us that the loans were for the trans-
fer of ownership and, therefore, no jobs were actually saved.
In determining the actual number of jobs saved and created,
however, we included the employees of the four businesses.

     The following examples illustrate some of the problems
in reporting program accomplishments.

    -- One borrower reported that his firm employed 200
       people at the time of loan application and estimated
       it would employ 400 people ; year later. At the
       time of our visit, 22 months after the loan was
       closed, the firm was going out of business and
       employed only 15 people.
    --In another case the borrower reported that his firm
      employed 14 people. This figure was accepted by
      FmHA without verification. At the time of our visit,
      about 15 months after the loan was closed, the firm
      employed 13 seasonal employees and one full-time
      employee. The borrower told us that this was about
      the same situation as when the loan was approved.
      The full-time equivalent for the seasonal employees,
      who worked only 2 months of the year, would be two
      jobs. Therefore, in reporting jobs saved and in
      considering this loan for approval, it would have
      been more accurate to show that the loan saved 3
      full-time job equivalents rather than 14 jobs.

    -- Although FmHA considered one loan made to an
       existing business as having saved and created 12
       jobs (no breakout was available between jobs saved
       and created), the borrower told us that the loan
       did not save any jobs but rather merely enabled him
       to buy the firm--that is, the loan was made to
       transfer the ownership of a viable business. He
       said that one new job had been created. We do
       not believe loans made to transfer ownership should
       be routinely treated as having saved jobs. This
       procedure resu.ts in overstating program accomp-
       lishments and, because loans made to save jobs re
       to be given first priority, could result in giving
       priority to a loan of this type over another which
       would actually save and/or create jobs.

     To provide the Congress with more accurate data, we
believe FmHA should verify and analyze the job data submitted
by loan applicants and obtain and report on the actual number
of jobs saved and created by the borrowers 1 year after they
have received the loans.
FmHA's management information system
     We discussed the need for overall program accomplishment
data with a U.S. Department of Agriculture (USDA) official
in August 1975. Subsequent to this discussion, FmHA began
requiring State offices to prepare monthly reports showing
summary information on the number of jobs saved and
created, the number and dollar amounts of loans categorized
by size of population, 1/ and the number and amounts of loans
deobligated and the reasons for the deobligations. No informa-
tion is obtained, however, on the quality of jobs saved and
created; i.e., whether the jobs are part-time or seasonal
and the amount of wages and salaries paid.

     FmHA currently has underway a long-range effort to
develop a unified management information system covering all
of its programs. As part of this system, which is expected
to be operational sometime after November 1978, FmHA intends
to develop criteria for monitoring the impact and assessing
the effectiveness of the B&I program. Some of the informa-
tion the system is to provide includes
     -- number of jobs saved and created in relation to
        loan amounts invested;

     -- location and size of populations served by the pro-
        jects financed;
     -- industrywide statistics, including financial ratios,
        for use in comparing proposed projects against
        industry trends;
     --amount of losses incurred relative to other FmHA
       programs; and
     -- ages and amounts of loan repayment delinquencies.

I/The act requires that priority be given to communities
  with a population of 25,000 or less.

     The system should help provide management with the data
necessary to evaluate overall program effectiveness. We
believe, however, tat action should be taken so that the
information put into the system, particularly on jobs saved
and created, is accurate and that information is obtained
showing the quality of the jobs saved and created.

     FmHA has no formal loan approval criteria to use in
determining what a reasonable investment should be to save
or create one job. As a result, loan funds are not necessarily
applied in a way to save and create the maximum number of jobs.
Using the job data shown on the borrowers' applications, the
investment per job ranged from about $1,600 to $90,000 for
the 35 closed loaas reviewed. Using the actual job data for
those borrowers whose businesses were viable at the time of
our visits, the investment ranged from about $1,300 to
$200,000 per job.

     Without (1) verifying the accuracy of the number of jobs
reported as saved and (2) analyzing the reasonableness of
estimates of jobs to be created by loan applicants and com-
paring this to loan approval criteria, loans could be
approved which require extremely high investments per job
saved or created. Using the actual data at the time of
our visits for the first two examples cited on page 10,
the investment required for each job saved or created was
about $66,700 and $200,000, respectively. No calculation
was made for the last example which involved a $480,000 loan
made to transfer the ownership of the business.

     In making our review at FmHA headquarters, we learned
that FmHA's Utah State office obligated $30 million in
fiscal year 1975 for a loan which the applicant estimated
would create 100 jobs, an investment of $300,000 per job.
Although a USDA official told us in August 1975 that FmHA
would probably not guarantee the loan, it had not been
deobligated as of August 1977. If deobligated, FmHA would
lose the use of these loan authorizations because they can-
not now be reobligated.

     The above examples demonstrate the need for FmHA to
obtain accurate job data ana to develop and use loan
investment approval criteria, particularly when compared to
the criteria used by the Economic Development AdniLnistration,

 Department of Commerce, in operating
 program--a maximum of $10,000 and     its business loan
 Another loan investment figure     a target of $6,000 per job.
                                often cited by FmHA and other
 USDA officials is $20,000 per job.
      Although USDA's Economic Research
 information showing which types          Service had developed
                                  of industries and businesses
 create the most jobs for the lowest
 used this data to develop loan       investment, FmHA has not
 or to otherwise maximize the impact          approval criteria
 and creating jobs by gi'ing priority of  the  program in saving
 which are the most lor intensive.     to  loans  for businesses

      FmHA needs to establish uniform
so that program accomplishment        policies and procedures
                                data is systematically gathered,
evaluated, and reported. More
data is needed to make informedaccurate program accomplishment
effectiveness of the program,    judgments on (1) the overall
                               (2) whether the program
achievements are adequate in relation
made, and (3) what, if any, changes    to the investment being
program and/or level of funding.     should be made to the

      Instructions should De established
 officials at the State and county         requiring FmHA
 lyze job data suomitted by loan    levels  to verify and ana-
 accuracy and reasonableness. To applicants   to insure its
effective in meeting its major    make  the  program  more
creating jobs, better job data, objective of saving and
criteria, is needed for reaching along with loan approval
                                  knowledgeable decisions at
the State and national office levels
should or should not be approved.      as to whether
                                     The instructions ashould
also require FmHA personnel to
year after the loans are made tofollow up with borrowers 1
of jobs saved and created so that determine the actual number
anticipated and actual program     comparisons between
                                accomplishments   can be made,
evaluated, and reported on.
     Action has been and is being
management with the program data taken by FmHA to provide
                                  needed to evaluate the
overall effectiveness of the program.
however, increased efforts are          As discussed above,
accuracy of the data obtained.  needed to help insure the
obtained on the quality          Also, information should be
                        of the jobs saved and created
help evaluate the effectiveness                        to
                                 of the program.

     FmHA should obtain and disseminate to its State and
county offices information as to which industries and
businesses are labor intensive and encourage its staff
use this data to judge the reasonableness of job data sub-
mitted by loan applicants.


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

     -- Develop and issue instructions requiring that (1)
        job data submitted by loan applicants be verified
        and analyzed, (2) information o the actual number
        of obs saved and/or created by the loans and on the
        quality of such jobs be obtained and presented to
        the Congress, and (3) program accomplishment data
        presented to the Congress be categorized by loans
        made and in process rather than on the basis of
        loan obligation data.
     -- Establish criteria for loan approval which relate
        dollars invested to jobs saved and/or created.
     -- Obtain and disseminate information as to which
        industries and businesses are labor intensive for
        use in judging reasonableness of job data submitted
        by loan applicants.

     In commenting on a draft of our report (see
FmHA agreed with the need to verify job data. Theapp.  III),
said that this will be emphasized in training sessions
                                                        and that
instructions will be issued to the State directors to
ate applicants' job projections and, for the loans made,
review borrowers' job data during field isits to their to
and offices. FmHA said that it will implement a manual plants
porting system to provide the needed job data suggested
our report and that when the unified management information
system is implemented, it will be able to provide updated
reports on employment figures for management and the Congress.

     FmHA said that there appears to be the implication in
our report that FmHA deliberately overstated the accomplish-
ments of the program, which is absolutely not true. The
agency said that when a new program is started, it is
impossible to accurately report the actual number of jobs

 saved or created because many of the loans have not been
 closed. Therefore, the agency said it has always eported
 the number of dollars obligated and the number of jobs
 and created as reported by the applicant.

     Our report does not address the question of whether
?mHA deliberately overstated the accomplishments of the
gram. As our repor? states, however, we believe that      pro-
reporting on orogr,.I accomplishments to the
mation on the number of jobs expected to be Congiess,
                                             saved and
created by the loans in process should be shown separately
from the data for approved loans and that job data for
obligated loans should not be shown at all. While the
formation is not available to do this for the first yearin-
the program, it is available for subsequent years.         of

     On July 8, 1977, PmHA issued a memorandum to its State
directors setting forth the actions to be taken as a
of our report.                                        result
                (A copy of FmHA's memorandum is attached to
its comments on our report--see app. III.)  In its memoran-
dum, FmHA said that for an application having a high
cost ratio, the loan file should be documented with the
reasons for recommending its approval, the priority
on the application, and the supplemental benefits that
accrue to the community's eccnomy in which the project will
be located.                                             will

      rmHA said that although it has indicated to its per-
sonnel during training sessions that a $20,000 loan invest-
ment per job is aerirable it disagrees with our recommendation
that criteria be stablished for loan approval relating
dollars nvested to jobs saved and/or created. FmEA
that:                                                 stated

     "* * * The creation of permanent stable jobs, effect
     on the tax base, flow of funds into the community,
     and other beneficial effects on the community will
     also be evaluated and used as criteria for loan
     consideration in determining which projects will
     be funded. A maximum job cost figure would pre-
     clude loans in many areas that have natural re-
     sources, the development of which would require
     substantial fixed asset costs."

     We appreciate the concerns raised by FmHA and believe
the proposed instructions to its State directors may be
beneficial. Nevertheless, in view of the fact that the
program's major objective is to improve the economic

climate of rural areas by saving and/or creating jobs, we
believe formnal criteria is warranted. This is not to say,
however, that exceptions to such criteria could not be pro-
vided for.

     Iln commenting on our recommendation to obtain and
disseminate information to its field offices as to which
industries and businesses are labor intensive for use in
judging the reasonableness of job data submitted by loan
applicants, FmHA said that distributing such information to
field personnel would serve no useful purpose because t.le
disadvantages would outweigh the benefits. It did not say
what these disadvantages would be.

                             CHAPTER 3

     FmHA needs to improve its loan evaluation policies and
procedures to attain its goal of approving only quality loans.
Although FmHA has improved and refined its procedures and
personnel have gained experience since the program was im- its
plemented in October 1973, further refinements to its pro-
cedures are needed along with greater assurance that FmHA
personnel have the time and capability to adequately carry
out the required procedures.
     We believe that clearer instructions and more experienced
staff would reduce loan processing time--which averaged
days for the 35 loans we reviewed -and increase the quality
of loans approved. Actions are needed so that

     -- FmHA and lender personnel responsible for evaluating
        loans obtain and analyze the financial and economic
        data necessary to determine the soundness and economic
        feasibility of the businesses financed,
     -- the methods followed in appraising property securing
        loans are adequate to determine the fair-market
        value of the property and that adequate analyses
        are made of the financial condition of loan
        guarantors, and
     --lenders' exposure to loss on prior loans are not
       reduced through loans guaranteed by FmHA.
     Clearer instructions setting forth the responsibilities
of the applicants, lenders, and FmHA personnel could assist
in processing loans more effectively and efficiently.
loan processing procedures, which can be involved and The
complicated, are outlined below.

     Generally, lenders assist applicants in preparing and
processing applications for guaranteed loans. Ordinarily,
a preapplication letter is submitted prior to submitting
formal application to FmHA. Among other things, the pre-
application letter includes a brief description of the
proposed project, including information on the employment

opportunities to be generated. The applicant may also provide
copies of any available feasibility studies, financial state-
ments, or other pertinent information at this time. Since
April 1975, FmHA has permitted applicants, at their option,
to omit the preapplication step and submit a completed appli-
cation form.

     In an effort to coordinate Federal, State, and local
government efforts, applicants are ordinarily required to
obtain clearance from State and local governments for loans
of more than $100,000. Smaller loans for projects that have
no significant impact outside the local community are exempt
from this approval process.
      During fiscal yars 1974-75, all loans had to be pro-
cessed through FmHA's national office. The preapplication
and accompanying data were reviewed at the FmHA State office
and, if the proposed project appeared feasible, information
on the loan was submitted to the national office for its
review. Generally, at this time the applicant was requested
to provide FmHA with the necessary data for forwarding to the
Department of Laoor (DOL) so that it could, as required by
section 118 of the Rural Development Act of 1972 (7 U.S.C.
1932), certify that the loan would not result in a transfer
of employment or business from one area to another and that
it would not result in an overproduction of products or
services in the area.
     Currently FmHA State offices can approve loans for
which the guaranteed indebtedness does not exceed $500,000
without prior review and concurrence by the national office.
The State office can also approve loans for which the
guaranteed indebtedness does not exceed $750,000, provided
the loan has been reviewed and concurred with by an
official designated by the national office. The national
office must review and concur with approving all loans for
which the guaranteed indebtedness exceeds $750,000 and with
all insured loans, regardless of the amount.
     The average and range of processing time required for
each stage of the loan approval process is shown on the
next page.

                                         Loan processing time
                              Number            (days)
                             of loans
Loan processing stage        reviewed    Average            Range
Preapplication to State      a/ 32         87            11 to 234
  office approval
State office approval to     b/ 33         36            10 to   91
  national office
National office concur-      c/ 34         61             2 to 176
  rence to conditional
Conditional commitment       d/ 35         61             1 to 251
  to loan closing (ex-
  cluding construction
     Total (excluding             35      252        74 to 551
        construction time)
a/The preapplication stage was omitted for one loan and we
  were unable to determine the processing time required for
  this stage for two loans.
b/We were unable to determine the processing time required
  for this stage for two loans.
c/We were unable to determine the processing time required
  for this stage for one loan.

d/FmHA officials stated that they have little or no control
  over the length of time required for this stage which
  primarily involves actions by applicants and lenders.
     Our review of the loan files and discussions with lenders,
borrowers, and FmHA officials indicated that the following
factors contributed to delays in processing lcan applications:
     -- FmHA regulations were unclear and frequently changed.

    -- FmHA personnel were inexperienced, inadequately trained,
       and unable to handle the work load.
    -- Applicants experienced difficulties in finding lenders
       willing to make loans.

     -- National office review was lengthy.
     -- Borrowers and lenders did not supply needed informa-
        tion in a timely manner.
We believe that more experienced staff and clearer
could have helped minimize loan processing time and,
                                                     at the
same time, increased the quality of the loans approved.
recognize that some of these problems occurred because    We
program was relatively new and that clearer regulations
more experienced staff should decrease the loan processing
time in the future.

     The following examples
and complications experiencedillustrate some of the difficulties
                               in processing a loan.

     A $300,000 loan guaranteed by FmHA in June 1975 required
282 days to process. Some of the major factors contributing
to the length of processing time are discussed below.

    -- The borrower submitted the application about 2 months
       after submitting the preapplication material.
       According to the borrower, an FmHA official was under
       the mistaken impression that FmHA had contacted him
       earlier and asked that the application be submitted.
    -- The State office required about 113 days to review
       and approve the application. The record showed that
       this process was delayed because of the need to
       obtain additional information from the borrower and
       the lender.
    -- The FmHA national office required about 19 days to
       review the loan. This process was delyed somewhat
       because the State office had submitted incomplete
       information to the national office.
    -- FmHA guaranteed the loan about 2 months after
       issuing the conditional commitment to guarantee
       the loan. A delay in this process occurred because
       FmHA did not ask the borrower to submit the pro-
       jected cash flow statements with the preapplication
       or application material but rather waited until
       after the loan was conditionally approved.

      -- Part of the delay in processing the
                                              loan occurred
         because FmHA did not obtain and submit
         to DOL for its certification after      the material
                                             receiving the
         preapplication but rather waited until
                                                 about 6
         months later. DOL certification required
         months.                                    about 3

      A $63,000 loan guaranteed
 233 days to process, excluding by FmHA in April 1975 required
                                project construction time.
 Some of the major factors contributing
                                        to delays in processing
 are discussed below.

      --A delay of about 1 month occurred
                                            because the
         county supervisor did not submit all
         mation with the preapplication and    required infor-
         the State office had to request it. time was lost when

      -- A delay of about 2 months occurred
                                             because the county
         supervisor submitted incomplete information
         application and the State office had         with the
                                               to return the
         application for completion.
     -- A delay of about 1 month occurred
                                          in final approval
        because of the need to wait for character
        on the borrowers and the DOL certification.clearances
     -- A delay of about ]-1/2 months occurred
                                               because the
        lender incorrectly prepared the loan
     -- The county supervisor and the State
                                            B&I loan
        specialist said their inexperience and
        training contributed to delays in processing
        loan.                                        this
     We noted a number of weaknesses in
                                        the loan evaluations
made by FmHA and the lenders. Correction
is needed if FmHA is to achieve its       of these weaknesses
                                    goal of making only
quality loans. FmNA and lender personnel
approving the leans did not               responsible for

    -- obtain required financial data--both
       projected,                           historical and

      -- obtain updated financial data before approving loans,
      -- qustion sales and profit projections of applicants
         w.    appeared overly optimistic and/or inadequately
      -- adequately determine why existing businesses were
         operating at a loss or experiencing problems,
      -.   require applicants to contribute sufficient equity
           to the businesses,
      -- adequately evaluate applicants' management capability
         or market analysis,
      -- obtain sufficient information to make a complete
         adequate evaluation, and
      -- effectively use consultants in evaluating loans.

       Some of the problems
 because FmHA pers nnel and noted above apparently occurred
                             lenders were not sufficiently
 familiar with FmHA's regulations and instructions
                                                     on evalu-
 ating proposed loans. In interviews with the FmHA
 supervisors and lenders involved in the lcans reviewed,
 were told by 24 of the 32 lenders and 22 of the 33
vizors that they were not familiar enough with FmHA   sups--
 feasibility requirements to comment on their adequacy.project
comments received from FmHA personnel as to why FmHA         Other
ments were not followed were that they did not believe
data was needed and that they did not have                  the
                                             sufficient time
to obtain and/or analyze the data.
      Other reasons for the problems noted appeared to be
that the FmHA regulations and instructions were silent
vague on the types of data to be obtained and the
to be used i.n evaluating proposed                  techniques
lenders and 11 of the supervisors loans.    In fact, 22 of the
                                    interviewed told us that
they elieved there was a need for FmHA to develop
handbook which, among other things, would describe a lenders
lender's responsibilities for making and servicing the
      The loans reviewed had been made for relatively short
periods of tme at the time of our visits to the borrowers--
from 8 to 26 months. (See app. I.) Because of this,
                                                          it is

 difficult to accurately gage the effect the
                                              noted loan
 evaluation weaknesses will have on the success
 the loans in terms of poviding lasting benefits or failure of
 communities. Several of the borrowers, however, to the rural
 perienced financial difficulties at the time      had ex-
                                               of our visits
 as follows.
      -- One borrower closed his business loan was
                                                    paid in
         full) and another was in the process of going
         of business after their businesses failed.
      -- One borrower had filed for bankruptcy.

      -- Four borrowers (including the borrower who
                                                    had filed
         for bankruptcy) were delinquent on their loan
         ments from 47 to 161 days.                    pay-

      -- Because of unprofitable operations, one
         changed his manufacturing operations from
         homes to cabinets and trunks, another had mobile
         part of his business premises, and another to lease
         his business.
Need for improvements in obtaining
and analyzing financial data
     Reviewing and analyzing a business' financial
an important element in judging its potential      data is
                                              for success.
Recognizing this, FmHA requires existing businesses,
applying for a loan, to submit audited financial     when
for the latest 3 fiscal years.                   statements

     Of the 25 loans we reviewed which were made
businesses, however, the financial statements     to existing
tained for all 3 fiscal years in 16 cases      were not ob-
                                          and statements ob-
tained for 21 of the loans were not audited
                                             as required.
Further, the financial data reviewed was generally
current. The elapsed time between the period
latest financial statements obtained by FmHA covered by the
                                              for review and
the dates the loans were closed averaged 193
from 61 to 455 days.                          days and ranged

     Loan applicants for both existing and new
required to provide FmHA with 3 -year projected businesses are
loss and cash flow statements along with a       profit and
upon which the projections are based. These list  of assumptions
along with the financial statements submitted
businesses, are to be reviewed by FmHA and     by existing
                                            lenders for loan

approval purposes. Adequate analysis of this data is crucial
in determining whether a business will generate sufficient
cash flow and income to be viable.
      For 24 of the 35 closed loans reviewed, projected
financial statements were not obtained in 4 cases and the
statements did not cover the required 3-year period in 20
cases. Further, in 29 of the 31 cases where projected state-
ments were received for all or part of the 3-year period, the
assumptions upon which they were based were either inadequate
or were not obtained. We do not believe projections can be
fully and adequately analyzed without knowing the assumptions
upon which they are based.
     Furthermore, even in those cases where the required
financial statements were obtained, they were not always
adequately reviewed dnd evaluated by FmHA and the lenders.
In some cases we found that the projections were based on
erroneous data and in some cases the projections appeared to
be unrealistic when compared to the business' sales and pro-
fits of prior years.
     For example, in the case of a $14,000 loan approved in
August 1974, the applicant submitted financial projections
for a -year period only, and the projected earnings were
overstated because the income was not reduced by the cost of
goods to be sold.
     In the case of a $560,000 loan approved in October 1974,
FmHA personnel did not question the basis for the applicant's
projections even though projected sales were about 590 percent
above those actually achieved in the prior 10-month period.

     In the case of a $1.7 million loan in process as of June
30, 1975 (closed in November 1975), the State office, in
replying to a national office inquiry, stated that "the
applicant's projections and assumptions are of significant
validity to be realistic and attainable." This statement is
questionable when a comparison of the projections to prior
achievements is made as shown on the next page. Further, no
support or rationale was used to explain how the optimistic
sales and profit projections shown on the next page would be

                                               Amount of profit
   Fiscal year          Amount of sales          or loss (-)
 1974   (actual)          $ 6,963,469
 1975   (actual)                                  $  -785,053
                            7,167,030              -1,264,606
 1976   (projected)        13,000,000
 1977   (projected)        16,000,000               1,470,000
 1978   (projected)                                 2,190,000
                           18,000,000               2,510,000
       Another area which indicated that
                                         FmHA and lenders were
 not adequately reviewin and/or considering
 was in regard to FmHA's requirement           financial data
 sufficient tangible assets in the    that applicants have
                                    business. In this regard,
 FmHA's regulations provide that applicants
 quired to have a minimum of 10 percent      normally be re-
 business unless other credit factors    equity   1/ in the
 centage. For 6 of the 35 loans we     warrant  a  higher per-
 10-percent equity requirement was reviewed, however, thr
 loans, the applicant actually had not met. For 2 of the 6
                                    a negative equity, i.e.,
 his liabilities exceeded his assets.
      One example in which a borrower did
                                            not have the minimum
 equity required involved a $175,000
July 1974. An unaudited balance       loan  P-Ir:?  guaranteed in
 1973, the latest data available tosheet dated December 31,
approval, showed that the company FmHA at the time of loan
$91,200 and liabilities of about had assets of about
                                  $89,000, or an equity of
about $2,200 (2.4 percent). This
undercapitalized condition in that showed a significantly
creditors the borrower had only $1 for vety $40 owed
                                     inve ted in the business.
      In February 1975, FmHA made an insured
The last audited financial statements            loan of $900,000.
showed an equity of 1.8 percent in      prior    to loan approval
                                    May 1973, unaudited
statements showed an equity of 4.4
in April 1975, 2 months after loan percent in May 1974, and
equity was nine-tenths of 1 percent.approval, the reported

     To be of maximum use to FmHA in
loans, financial statements should be audited to and approving
                                                  help in-
sure the reliability of the data
                                 presented. Also, the most
current statements available should
in making informed judgments about be obtained to assist
                                    loan approvals. The

l/Equity is defined as the difference
  liabilities, or the net wort', of   between the assets and
                                    a business.

 following schedule shows that FmHA did not, in many instances,
 use current and reliable data in reaching final decisions
 approving the 25 loans made to existing businesses.       in

 Number of days between dates
    of current state-                     Number of statements
 ments and dates loans approved        Audited   Unaudited   Total
           Under 100                     1               4       5
           101 to 200                    2               6       8
           201 to 300                    -               8       8
           301 to 400                    1               1       2
           401 to 500                    1                       1
                                                    19       a/ 24
a/We were unable to determine whether or not one statement
  was audited.
     The loan of $1.7 million discussed on pages 24 and 25
serves as an example of FmHA personnel not obtaining         also
dering the latest financial data available. The loan  ana  consi-
guaranteed by FmHA in November 1975. Although FmHA personnel
were made aware that audited financial statements of the
cant's operations for the fiscal year ending June 30,     appli-
were available and differed materially from the prior
statements, they were not obtained and reviewed before
loan was approved. An FmHA official, when asked whetherthe
recalled being made aware of this information, indicated he
to us that he had but said that he did not obtain or review
the statements because he was extremely busy about the
this loan was closed. The material changes in the applicant's
financial condition are shown below.

                   Period covered by financial statements
                                   9-month period ending
             FY 1973     FY 1974      3/31/75 note a)     FY 1975
Net worth $2,159,697      $1,387,369          $289,810       $   122,763
Net loss     365,049        785,053          Not shown        1,264,606
a/Unaudited statements.
     FmHA regulations provide that lenders are accountable
making and servicing loans in a manner that will properly
protect FmHA's interest. The regulations provide that

are responsible for conducting certain investigations
necessary to determine the soundness of the loan and that
the contract of guarantee is unenforceable if it is determined
that the lender did not comply with its loanmaking respon-
         a-rte these requiremients, however, for all of the 32
guarinfted loans reviewed, the lenders either had not per-
formed any detailed analysis or had not provided FmHA
documentation on their analyses. Documentation of any analy-
sis made by the lenders is necessary to enable FmHA to deter-
mire whether a lender has adequately fulfilled its loan evalu-
ation responsibilities and to assist FmHA in judging the sound-
ness of the loan.
Economic and technical feasibility studies

     FmHA regulations require lenders to submit to FmHA an
acceptable economic and technical feasibility study covering
(1) engineering matters, (2) adequacy and required training
of management personnel and labor supply, (3) adequacy and
sources of raw materials and supplies, (4) adequacy of
buildings, land development, and transportation, (5) market
analysis, and (6) adequacy of power, water, and waste dis-
posal services.

     In reviewing the 35 loans, we found that there was a
wide range in the degree of sophistication and quality f
the feasibility studies performed. For example, in the case
of a loan made to establish a restaurant, the market analysis
was limited to FmHA personnel questioning several local
leaders about the need for a restaurant, while in other cases,
more comprehensive market analyses were made. We believe
there is a need for additional guidance to obtain more
uniformity in the quality of the studies, particularly market
analyses and assessments of management capability.

     Market analyses include a review of such matters as
marketing agreements and contracts, sales trends of the firm
and the industry, and surveys to determine supply and demand.
These matters were no,; always considered by FmHA and the
lenders in approving the loans we reviewed. In six cases
the applicants' prior sales did not support projections and
in three cases publications on industry trends were not

      For example, a Department of Commerce publication
available prior to FmHA's approval of a $110,000 loan
June 1975 to a foreign car dealer stated that sales     in
cars had decreased substantially and would decrease  of  foreign
The State B&I loan specialist, however, did not consult
or any similar publication. The borrower gave up          this
car dealership franchise in April 1976, citing depressedforeign
foreign car sales as a major reason for his failure.
though the borrower continued selling used cars and     Al-
payments were current as of December 1976, he told   his  loan
he plans to go out of business entirely.            us  that

     Management capability should
evaluated more thoroughly by FmHA have been questioned or
                                  and/or the lender for nine
of the loans reviewed. For example, although analyses
applicants' financial statements revealed problems,     of
                                                     such as
lack of profits, inadequate working capital, and under-
capitalization--factors indicative of management weaknesses--
these matters were not always addressed so that corrective
action could be taken. The two loa.ls discussed in
on pages 33 through 37 illustrate some of these problems.

     Since July 1974, FmHA has required that feasibility
studies be made by independent recognized consultaCts
all loans of $1 million or more. FmHA may grant exemptions
to this requirement when the credit factors of the
are such that a sound credit determination can be applicant
without an independent study. The costs of feasibility
studies are to be paid by the applicants and may be
in the loan amount requested.

      Five of the 35 closed loans and 5 of the 10 loans
process that we reviewed were for $1 million or more.   in
6 of these 10 loans FmHA waived the requirement for     For
independent feasibility study. There were factors, an
which raise questions as to whether FmHA's exemption however,
for credit worthiness were met. In the case of two criteria
loans, for example, the applicants did not meet the of the six
equity requirement.                                  10-percent


     FmHA regulations require that B&I loans be fully secured
by collateral and that, usually, the personal and corporate

guarantee / of the borrower will also be obtained. The
regulations, however, do not require that appraisals of
collateral be made by independent appraisers, nor do they
provide guidance on the types of appraisal methods to be used.
Further, in at least 5 of the 45 cases reviewed, FmHA pers-
onnel did not adequately review and analyze the value assigned
to the collateral. Also, FmHA personnel did not always
adequately review and verify the financial data submitted in
conjunction with personal and corporate guarantees.

Appraisai procedures
     FmHA regulations provide that property serving as
collateral for loans will be appraised by a qualified ap-
praiser to determine its "current value." FmHA personnel
generally make the appraisals for insured loans. For
guaranteed loans, lenders are responsible for determining
that the appraisers used are adequately qualified and
experienced. In evaluating loans for approval, FmHA pers-
onnel are required to determine whether the collateral is
sufficient to reasonably assure the repayment of the loan
in case of default.
     For many of the loans reviewed, those closed and in pro-
cess, FmHA did not adequately review the qualifications and/
or independence of the appraiser. For 9 of the 45 loans,
the appraisal was made by an official of the lending institu-
tion and in 3 cases by individuals employed by the borrower.
In 2 of the 9 instances where the appraisal was made by the
lender, the lenders' exposure to loss on prior loans made
to the applicant was reduced.  (See pp. 32 and 33 for a
discussion of reductions in exposure to losses.)
     For the remaining 33 loans, all or part of the collater-
al was appraised by independent appraisers in 25 cases and
cost or book value was used in lieu of appraisals in 8
cases. FmHA regulations do not specify or provide guidance
on the types of appraisal methods acceptable, nor do they
provide guidance on the use of cost data in lieu of appraisals
and the extent to which such cost data is to be verified.

1/A personal guarantee is, in effect, a pledge of one's
  personal assets to repay the loan in case of default.
  Where a parent corporation is involved, a corporate
  guarantee may be required.

     The above problems, when coupled with lack of an adequate
review and analysis of the values assigned collateral by FmHA
personnel, can result in questionable values. The following
example illustrates the need for additional guidance on the
types oL acceptable appraisal methods and the need for FmHA
personnel to be more deligent in reviewing and analyzing

      In March 1975 FmHA guaranteed a $2.2 million loan to re-
fir.ance the existing debt of a manufacturer. In February
1975 an independent appraiser reported that the collateral,
made up of land, buildings, and equipment, had the same $5.5
million "in-use market value" as it had when he previously
appraised it in February 1973.

     The appraiser, in making the 1973 appraisal, stated that
his appraisal was based on the income appraisal method and a
major assumption was that the firm would continue profitable
operations. However, in January 1975, about 1 month before
the updated appraisal was made, the firm's reported loss for
the prior 9-month period was about $1.3 million. We believe
that this and other significant factors affecting the ap-
praisal could have been uncovered by FmHA personnel had they
more carefully reviewed the appraisal.
     Furthermore, the lender obtained a third appraisal in
May 1976 after the firm filed a petition for bankruptcy.
This appraisal established the "current-market value" f the
property at $1.3 million. On the basis of this value FmHA
could lose up to about $900,000, i.e., 90 percent of the
difference between the outstanding loan balance of about
$2.3 million in April 1976 and the estimated market value of
$1.3 million. 1/

     This example illustrates the need for FmHA to provide
guidance to its personnel on the different types of appraisal
methods which are acceptable. We believe that for loan
security purposes, appraisal methods designed to arrive at
fair-market values would be most appropriate.

     In seven cases in which cost or book valte was used to
establish the value of collateral, there was little or no

1/In our update of this matter in August 1977, an agency
  official told us that the property was sold during fore-
  closure for $700,000.

 cost verification made. On the other hand,
                                              for one insured
 loan the county supervisor approved individual
 for loan funds covering expenditures made in    requisitions
                                               conjunction with
 the project.

 Personal guarantees

      FmHA regulations provide that personal guarantees
 borrowers and others having a substantial               of
 business will usually be required. Guarantees      in  the
                                                of parent,
 subsidiary, or affiliated companies may also
                                              be required.
      The regulations provide that the
will be required in sufficient amounts personal
 repayment of the loan and provide adequate reasonably   assure
                                             security. The
personal guarantee requirement may be waived
certain instances where the proposed grantors  by FmHA in
the guarantee. Guarantors are required to          cannot provide
current financial statements showing their   provide   FmHA with
                                             personal net worth.
      For nearly all of the 45 loans reviewed, FmHA
did not adequately review and verify the financial     personnel
mitted by the guarantors. For example, we              data sub-
where the reported figure for the guarantor'sfound  12  instances
                                                personal net
worth included his interest in the firm receiving
                                                     the loan
which, according to FmHA's regulations, should
cluded. We believe this information would        not be in-
covered had FmHA personnel adequately reviewed been dis-
guarantors' financial statements. The followingthe
illustrates this point.                             example

     In June 1975, FmHA guaranteed a $110,000 loan.
guarantor's financial statements showed               The
                                        his personal net
worth to be about $216,000; however, about
amount represented his interest in the firm $176,000 of this
                                             receiving the
loan. The guarantor's personal net worth
                                           for loan purposes,
therefore, was only about $40,000.
     Also, financial statements submitted by
were not current and were not updated before the guarantors
                                             the loan was
approved. The average number of days between
the statements submitted and the dates 33 of the dates of
loans were approved was 211 days, and ranged the 35 closed
440 days. For the two remaining closed loans from 14 to
obtain personal guarantees.                   FmHA did not

     In September 1974 FmHA revised its regulations to provide
that loans would not ordinarily be made to refinance debts,
except that, with national office approval, loans could be
so used when necessary for the success of a project nd
arrangements for continuing the debt could not be maze.

     FmHA revised its regulations again in December 1975 to
allow loans for refinancing debts of sound projects when
determined necessary to stabilize the economic base of the
rural area and increase or maintain employment. In evaluating
loans for refinancing debt, FmHA personnel are to determine
whether the loan is essential to restructure the applicant's
debts, enabling the business to succeed rather than merely
converting an unsound loan to a guaranteed basis or to bail
out lenders having such loans.

     Despite the rather rigid FmHA requirements, loans were
frequently made to refinance debts. Nineteen of the 35
guaranteed loans closed at the time of our review resulted
in reducing exposure to losses by participating lenders and
repayment of debts to other lenders and creditors. The
following schedule shows for the 19 loans the lenders' and
creditors' exposures before and after the loan guarantee.

                  Exposure before   Exposure after   Reduction in
                  loan guarantee    loan uarantee      exposure
  lenders              $ 9.5            $1.6            $ 7.9
Other lenders
  and creditors          6.0              -                  6.0
    Total             $15.5             $1.6            $13.9
     An example of a lender's reduced exposure involved a
loan of $500,000 guaranteed by FmHA in May 1975. About
$345,000 of the loan proceeds were used t refinance existing
debt owed the lender, thereby reducing the- lender's exposure
to loss by about $295,000 as shown on the next page.

            Exposure before loan           $345,000
            Less exposure after
              loan (10 percent of
              $500,000)                      50,000
               Reduction                   $295,000
As discussed on page 50, the use of the loan proceeds to
reduce the lender's exposure appeared to be contrary to FmHA's
understanding of how the funds were to be used.

     The following two examples are discussed in detail to
present a more complete description of some of the problems
involved in evaluating loans.
     Example 1--On March 24, 1975, FmHA guaranteed a $2.2
million loan to an existing business to refinance the follow-
ing outstanding debts:  $900,000 to the lead lender of the
guaranteed loan, $800,000 to a participating lender in the
guaranteed loan, and $500,000 to other creditors.

     FmHA's decision to guarantee the loan was based, in
part, on its review of the business' independently audited
financial statements for the 3-year period ending March 31,
1974; projected sales and profit and cash flow figures for
the 3-year period ending August 31, 1977; an independent
appraiser's report on the value of the collateral securing
the loan; and unaudited personal financial statements of the
     Financial statements FmHA obtained before guaranteeing
the loan showed that the business, as of March 31, 1974, was
undercapitalized in that the stockholders' equity was about
8 percent rather than te 10 percent required by FmHA
regulations. Because of this, FmHA and the lender required
the applicant to convert, by March 31, 1975, about $500,000
of debts owed to its stockholders to preferred stock.

     In reviewing the projected sales and income figures,
FmHA did not question the projected sales for the 1-year
period ending August 1975, which were 18-percent higher than
the company's prior year sales, even though the applicant
failed to provide FmHA with its assumptions supporting the
projected figures. Information available at the time of
FmHA's review indicated that there was an industrywide
decline in sales of the company's major project.  Despite

 the lower than required equity and the absence
 to support projected sales, FmHA waived the    of assumptions
                                             requirement for
 an independent feasibility study.

      Although updated financial data was available
 FmHA conditionally guaranteed and approved the       before
 1975, FmHA's decision to guarantee the loan was loan  in March
 financial data which was almost 1 year old.      based  on
                                              The  updated
cial data showed that the firm's financial situation         finan-
riorated during the 1-year period. An unaudited         had  dete-
nancial statement for the 9-month period ending    interim   fi-
1975, showed that the firm's net worth had plungedJanuary   4,
$614,000 to a negative net worth of about $670,000, from
had decreased from about $15.3 million to about        sales
                                                  $12.7 million
(annualized basis), costs of goods sold were
than actual sales, and the firm incurred      about $50,000 less
                                          a net loss of about
$1.3 million. Also, a major credit service classified
September 1974 the financial condition of the
"unbalanced" and commented that debt exceeded firm as
than 10 to 1.                                  equity by more

     FmHA did not follow up on the agreement that
convert $500,000 owed to its stockholders to       the firm
We found that the agreement was not fully complied      stock.
                                                    with in
that only about $270,000 was converted. We believe
should have assured compliance before guaranteeing FmHA
                                                    the loan.
      As discussed on page 30, FmHA
the collateral made in February 1973accepted an appraisal of
                                      and updated in February
1975 which was based on in-use market
market value. The appraiser used the value   rather than fair-
                                       income appraisal method
and stated in his appraisal report that this
contingent condition. In fact, the February was an important
                                              13, 1975, update
was based on the assumption that the firm would
                                                 continue pro-
fitable operations. However, the 9-month interim
statement through January 4, 1975, showed a $1.3   financial
loss. After the firm filed for bankruptcy,        million
which was made in May 1976, established the a third appraisal
value" of the collateral at $1.3 million, or "current-market
                                              $4.2 million
less than the $5.5 million appraised value accepted
less than 16 months earlier.                         by FmHA

     Two of the six banks participating in the guaranteed
loan had reductions in exposure to loss--the
which made a $800,000 loan and a second bank lead lender
                                             which made a
$100,000 loan.

      The loan guarantee reduced lenders'
 exposure by about $2.1 million as shown and other creditors'

                         lenders (note a)      Other
                       Lender     Lender B   creditors     Total
 Exposure before loan $928,110    $806,806
 Less exposure after                         $508,267    $2,243,183
   loan                 80,000      10,000                   90,000
     Reduction        $848,110    $796,806   $508,267    $2,153,183
 a/Lender A, the lead lender, loaned the
                                          applicant $800,000
   and lender B loaned the applicant $100,000.
   $1.3 million of the loan was made by          The remaining
                                         four participating lenders
   who had no reduction in exposure to loss.

     The firm filed for bankruptcy in February
                                               1976 and liqul-
dation losses to the Government appear
     Example 2--On July 24, 1974, FmHA guaranteed
loan to an existing business to be used            a $175,000
for plant expansion, $67,000 for working as follows:   $67,000
for debt retirement.                      capital, and  $41,000

      FmHA's decision to guarantee the loan
                                            was based on pre-
application material; the favorable performance
try, including the number of businesses          of the indus-
ations; the lender's determination       expanding their oper-
                                    that the loan was sound;
and on the value of the collateral pledged
the loan.                                   as security for

     The preapplication package includeu
prepared by a Mississippi State agency, certain material
cial statement covering a 4-month period,an unaudited finan-
income and cash flow statements, and       2-year projected
                                     a projected balance sheet
for the first year of operation.
     Although FmHA based its decision, in
                                           part, on the mate-
rial prepared by the State agency and
that the business operation was sound, the lender's opinion
                                        an official of the
State agency that prepared the material
neither evaluated the feasibility        told us that the agency
                                  of the loan nor the firm's
financial data, but rather merely assembled
mation and helped the applicant in his       application infcr-
                                        dealings with FmIIA.
The lender told us that his opinion regarding
                                               the soundness

of the loan was based on the information pesented by the
State agency. The lender also said that the loan was marginal
but thought assistance was warranted because (1) the appli-
cant w;as a good customer, (2) the loan would be used to create
jobs, (3) there was a demand for the firm', roduct, and (4)
the business would be an asset to the community.

     The 4-month financial statement submitted with the pre-
application (only statement available because the business
was organized in September 1973) was unaudited and unsigned
and apparently was not evaluated by the lender or FmHA. Our
review of the statement showed that the firm was undercapi-
talized in that its net equity was less than 3 percent rather
than the 10 percent required by FmHA. In addition, the state-
ment showed a bank overdraft of more than $17,000.
     In reviewing the projected sales and income, neither the
lender nor FmHA questioned the projected sales for the 1-year
period ending December 31, 1974, of $2.2 million although
actual sales for the 4-month period ending December 31, 1974,
were only about $100,000. The applicant did not furnish FmHA
the assumptions supporting the projected figures, but did
state that the firm planned to establish new product lines
and double its operating capacity.
     We believe the lender and FmHA should have questioned
this statement based on the 4-month financial tatement
which showed an undercapitalized position and profit of only
about $1,200. Also, the lender and FmHA should have questioned
the projected sales figures based on available information
which showed that the industry was experiencing a slowdown
and that several competitors in the surrounding vicinity had
been found to be experiencing problems due to the depressed
     FmHA did not update the financial data of the business
between the time of preapplication and loan approval, about
7 months. Had FmHA updated the economic and financial condi-
tion, it would have learned that (1) due to a truck strike
the business could not ship its product and, as a result,
lost ts largest customer, (2) a shortage of working capital
was adversely affecting its manufacturing operations, (3)
bank overdrafts were common, and (4) the business was losing
     In April 1975 the lender considered initiating foreclo-
sure proceedings because the borrower was delinquent on his
loan repayments. However, at the time of our visit in June

 1976 the borrower had managed to bring
 current by leasing part of the premises  his loan payments
                                           to other firms.
       The collateral securing the loan
 $230,000 which, if accurate, would      was appraised at about
                                     be sufficient to prevent
 any, losses to the Government in case
 guarantee was also obtained from       of default. A personal
                                   the applicant.
      About $75,000 of the loan proceeds
 existing debts to the lender, thereby   was used to repay
 potential exposure to loss from $75,000        the lender's
 of its $175,000 guaranteed loan).       to $17,500 (10 percent

      FmHA, in order to achieve its goal
 and to provide for more lasting economic of making quality loans.
 areas, should take action to (1)          benefits to rural
                                  further revise, clarify, and
 strengthen its regulations and instructions
 approval procedures and (2) see that         governing loan
                                      its procedures are
      Definitive criteria for determining
 potential for success is needed.            a loan applicant's
                                     Unless FmHA and lenders
 adequately analyze and verify
 many of the weaknesses observedinformation   applicants submit,
 Because each loan presents a number    continue  to occur.
                                       of different circumstances,
 however, FmHA must emphasize to its
                                       personnel and participa-
 ting lenders that each loan applicant's
and projections must be adequately          financial statements
                                      analyzed and all question-
able items challenged and clarified.
of each analysis should be documented. Furthermore, the results
      FmHA and lenders must obtain sufficient
including updated and independently              information,
                                       audited financial state-
ments and projected sales, profit,
supported by assumptions to permit and csh flow statements
of a business' potential for success.an adequate evaluation
to incorporate into its procedures        Moreover, FmHA needs
                                     the variots techniques,
such as financial ratio analyses,
                                    to be used in evaluating
and approving loans.

     To attain greater uniformity in the
ations of loan applicants'               quality of evalu-
                           financial data and overall economic
feasibility, FHA should develop
                                 a handbook for lenders. The
handbook should set forth FmHA's
                                 requirements for lean appro-
val and clearly state the responsibilities
this process.                              of the lenders in

     Regarding economic feasibility studies, FmEA needs to
provide additional guidance on what constitutes an adequate
study, stressing particularly management capability and market
analysis, and closely monitor all loan applications for $1
million and over to see that the regulations requiring feasi-
bility studies by independent consultants are followed. Also,
FmHA should require feasibility studies by independent con-
sultants for loans of less than $1 million which could be
considered marginal, i.e., one where the applicant is experi-
encing losses, has inadequate security, does not have suffi-
cient equity, etc.
     To see that collateral securing loans is adequate,
appraisers should be independent and required to use appraisal
methods designed to establish fair-market values. In those
instances where cost data is used in lieu of an appraisal
to determine the value of the collateral, such cost data
should be adequately verified and reviewed for accuracy.
Further, all appraisals should be analyzed by FmHA personnel
experienced with appraisals to determine whether the proce-
dures followed in arriving at the appraised value were ade-

     In determining whether personal guarantees provide the
loan security necessary, the most accurate and current data
available on the guarantor's personal net worth must be
obtained. To accomplish this, FmHA personnel should review
and verify the data provided by the guarantors in their finan-
cial statements.
      FmHA approved a number of loans involving the refinancing
of debts of participating lenders and payments to other len-
ders and creditors. Some of these approvals were questionable
because they reduced the participating lenders' exposure to
loss or bailed out lenders and creditors which were in a posi-
tion to sustain a loss. Sich questions o£ lender bailouts
could be eliminated by requiring participating lenders to
maintain the same level of exposure they had on any prior
loans being paid with the proceeds of loans guaranteed by

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

        -- Emphasize to FmHA personnel
                                        and lenders the need to
           follow prescribed loan evaluation
           applicants to submit all needed     procedures, require
           current financial data, fully     information--including
          provided, and document their analyze the information
                                         justification for recom-
          mending loan approval, including
          questionable items and the          an explanation of any
                                      disposition made thereof.
       -- Clarify guidelines on how
          should analyze and verify Fmw"A personnel and lenders
                                     information borrowers submit
          and develop a lenders handbook
          ders' responsibilities in        setting forth the len-
          loans.                     approving   and servicing

       -- More closely monitor loans
          lion or more to see that     being approved for $1 mil-
          feasibility studies by independent regulations requiring
          more closely followed and             consultants are
          by independent consultants  require  feasibility  studies
          $1 million which are of marginalloans of lass than
      -- Revise the regulations governing
         that (1) appraisals of collateral appraisals to require
         guaranteed loans be made              used to secure
         pendent of                 by  appraisers  that are inde-
         methods be both  the
                     used whichborrower  and lender, (2) appraisal
                                 are designed to arrive at
         fair-market value of property                        the
         (3) adequate verification        serving  as collateral,
                                     of the
         serving as collateral be required cost of the property
         is to be used in lieu of an          when such cost
        appraisals be analyzed by      appraisal,   and (4) all
        ence in appraisal methods FmHA personnel with experi-
                                     and techniques.
     -- Emphasize to FmHA personnel
                                       the need to review and
        verify current financial data
        providing personal guarantees. of borrowers and others
     -- Require that lenders participating
        by FmHA maintain the same              in loans guaranteed
                                    level of exposure they had
        on prior loans.

     FmHA said that many of the
by our report have been improved program deficiencies indicated
training of personnel, revision considerably by further
                                 of its regulations in December
1975, and the use of a new
July 1976. It said that these       summary frm developed in
ther by the instructions issued actions will b enforced fur-
                                 on July 8, 1977, to State

directors. FmHA said also that the completion of the project
summary by its personnel assures that the most important
credit factors have been considered and documented for each
loan.   (The project summary calls for information on projected
employment, market analysis, management capability, financial
statements on past and projected operations, type and value of
loan collateral, applicant repayment ability, lender servicing
plan, and field personnel's comments and recommendations
concerning loan approval.)

     FmHA said that it (1) will assess the need for a lenders
handbook setting forth lenders' responsibilities in approving
and servicing loans and (2) agreed with our recommendations
concerning feasibility studies.

      In commenting on our recommendations concerning apprais-
als, FmHA said that it has revised its regulations to require
the use of qualified appraisers and that its forms provide for
the use of fair-market values. FmHA said that for small
loans, its regulations provide flexibility for estimating mar-
ket value by lenders and FmHA personnel because costs for
professional appraisals on such loans could be prohibitive.
It said that it is also conducting training courses on how
to evaluate appraisals.

     FmHA's revised regulations neither require the use of
independent appraisers nor do they provide guidance on the
circumstances under which independent appraisers should be
used. In view of our findings that FmHA personnel accepted
appraisals made by officials of lending institutions--inclu-
ding those whose exposure to loss was rduced--and of bor-
rowers' firms, we believe that further guidance is warranted
concerning the need to use independent appraisers. Regarding
FmHA's comments on possible exceptions for small loans, we
would point out that Government agencies operating housing
loan programs (including FmHA), which involve relatively
small loans, require that appraisals be made by their own
personnel, personnel of other Government agencies, or by
independent apraisers.

     FmHA agreed that current financial statements are desir-
able and should be secured at the time the application  is
accepted but indicated, however, that this was difficult in
some cases because the processing time for its loans is
sometimes lengthy. FmHA said that it requires lenders to
certify prior to the issuance of the guarantee that there
has been no adverse change in the borrower's financial condi-
tion. FmHA also said that its field staff was advised of the

importance of reviewing and analyzing current financial
statements of guarantors by the July 8 memorandum to its
State directors.

     FmHA said that while it agrees with us that in refinan-
cing debts it is desirable to keep the lender from reducing
its exposure, as a practical matter, this is not always fea-
sible. FmHA explained that many small communities have only
one bank and that if it prohibited lenders from reducing
their exposure, many businesses would cease to exist because
of a lack of financing. Such a prohibition, FmHA said, may
lead to forcing borrowers to change lenders to avoid regula-
tion requirements and also could eliminate the ability of
banks to'provide a line of credit for short term financing
needs due to lending limits or bank liquidity. Nevertheless,
in its July 8 memorandum, FmHA advised its State directors
that in cases where the lender is reducing its exposure,
the loan file should be carefully documented and that refinan-
cing must make good economic sense and save existing
     If FmHA is to continue the practice of guaranteeing loans
which result in reductions in lenders' exposure to loss,
we believe that, as a minimum, FmHA should require that such
loans be approved at the national office level and that the
reasons why it was not feasible to require the lender to main-
tain the same level of exposure be documented.

                          CHAPTER 4

                     CHANCES OF SUCCESS

     FmHA could increase its chances that business and indus-
trial loans will provide lasting benefits to rural communities
by improving its loan servicing and management assistance
efforts. More effective measures are needed for (1) the timely
identification of actual and potential problems of borrowers
and the analysis of such problems to determine their causes
and possible solutions, (2) assurance that loan proceeds are
used only for approved and authorized purposes, and (3) the
development of a management assistance program.

     An effective loan servicing program designed to result
in quality loans requires that early identification of actual
and potential problems so that corrective actions can be taken.
Improvements needed in this aspect of FmHA's B&I loan program
     -- prompt notification of borrower delinquencies by
        lenders to FmHA,

     -- an effective followup system so that borrowers submit
        required financial statements,

     --a documented evaluation of borrowers' financial
       statements by lenders,
     -- more timely and effective analysis of borrowers'
        financial statements by FmHA, and

     -- more frequent and better planned visits to borrowers
        by both lenders and FmHA personnel.
     Lenders have the primary responsibility for servicing
guaranteed loans, including obtaining and analyzing borrower
financial statements and protecting and monitoring security.
FmHA is responsible for supervising the loan servicing per-
formed by the lenders and for servicing the insured loans it

     According to FmHA the primary purpose of loan servicing
is to prevent problems. FmHA maintains that prompt followup
on delinquent payments and early recognition and solution of
problems are keys to resolving delinquencies.
     The lenders' servicing role appeared to be limited pri-
marily to collecting and overseeing loan repayments. Little
or no effort was made by lenders to document any analyses of
borrowers' financial statements or of the results of any
visits to borrowers' businesses. These problems occurred, in
part at least, because some of the lenders were not adequately
aware of their responsibilities--three of the lenders we
visited did not even have copies of FmHA's regulations and
others told us that they were not familiar enough with the
regulations to comment on their adequacy.
     FmHA has no formalized method of supervising the lenders'
loan servicing role. FmHA personnel sometimes visited len-
ders, but FmHA regulations neither require nor discuss visits
to lenders, nor do they prescribe any other procedures for
providing adequate supervision.
     FmHA personnel are also required to obtain and analyze
borrowers' financial st.tements. Although this duplicates
the lenders' responsibilities, we believe it is highly desir-
able considering that FmHA has no assurance that the lenders
are performing this function adequately and that FmHA is
responsible for up to 90 percent of any loss incurred. How-
ever, 30 of the 33 supervisors interviewed told us that they
lacked sufficient time to service loans adequately.
     The benefits of FmHA's analyses of financial statements
were diminished, however, because the statements were not
received or reviewed in a timely manner. Several of the FmHA
supervisors told us that they lacked the time to follow up
on overdue statements and several of the loan specialists
told us that their workload preveited them from promptly
reviewing the statements received. Fourteen of the super-
visors we questioned said that they were not sufficiently
trained or experienced to service B&I loans adequately.
More timely notification of
borrower delinquency needed
     A clear signal that borrowers may be experiencing prob-
lems and need assistance is sounded when they fail to make
loan repayments on time. Lenders and FmHA must react promptly
and effectively to such warnings to have an effective loan
servicing program which will help keep losses to a minimum.

     We found four cases where lenders either did not notify
FmHA of delinquencies or did not notify it in a timely manner,
i.e., within 60 days after the due date. In fact, such noti-
fication was not a requirement until December 10, 1975, when
FmHA began requiring lenders to agree to notify the agency
when a borrower is 30 days past due on a payment and is un-
likely to bring his account current within 60 days, or if
the borrower has not provided the required financial state-
ments or is otherwise in default.

     The requirement is lacking, however, in that it does not
establish a precise time within which a lender must notify
FmHA of a borrower's delinquency nor does it prescribe any
penalty for noncompliance. Rather, the requirement makes noti-
fication contingent upon the lender's judgment as to whether
the borrower is unlikely to bring his account current within
60 days. Establishing a preciae cutoff period for notifica-
tion would eliminate any question about the lender's respon-
sibility and his compliance ith the lender's agreement.
Borrowers' financial statements could be more
effectively used as loan servicing tool
     Our review showed that:
     -- lenders were not adequately analyzing borrowers' finan-
        cial statements;
     -- financial statements were not being rtieived timely or,
        in some cases, at all;
     -- nearly all State and county offices visited lacked an
        adequate system to determine when financial statements
        were overdue and when followup action could be taken
        to obtain them:
     -- FmHA personnel were not timely analyzing financial
        statements and preparing the resultant "spread
        sheets;" and
     -- many annual financial statements were not audited as
     Recognizing the need to obtain and review borrowers'
financial statements, FmHA's initial regulations provided that
lenders would require borrowers, with loans of $100,000 or
more, to submit audited financial statements annually and,
at a minimum, 6-month interim financial statements signed by

 the borrower or his representative.
                                       According to an official
 of the national office, unaudited
 quired from borrowers with loans annual statements are re-
                                   of less than $100,000.
      FmHA regulations revised in September
 the submission of financial statements      1974 required that
 reports, other than the required        and other management
                                   annual statements, be on a
 basis and frequency acceptable to
 FmHA. The regulations indicated the borrower, lender, and
                                   that in some cases monthly
 statements may be necessary, but
 submitted at least semiannually.  required that statements be

     FmHA's current regulations provide
statements be required for new business  that monthly financial
businesses needing close monitoring.     enterprises and those
schedule agreed on is made part of     The statement submission
                                   the contractual agreement
between mhA and the lender as well
the lender and the borrower.         as the agreement between

     To see that the borrowers' statements
quately analyzed, the national office,       were being ade-
instructions requiring that certain      in July 1974, issued
                                     key data included on
the financial statements be analyzed
This analysis is documented on a      by State office personnel.
mitted to the national office for spread  sheet and sub-
     To be of maximum use in monitoring
financial statements must be received    borrowers' operations,
manner. Also, any analysis of the      and reviewed in
                                    financial statementsa timely
be documented and made a part of
                                  the borrowers' loan records
for future reference and comparison,
                                      and the results of the
analysis should be brought to the
for any corrective actions required.         of the borrowers

     The lenders e visited generally
                                      did not use the finan-
cial statements effectively in monitoring
rowers' operations. We found that         and analyzing bor-

    -- generally little r no effort was
       receipt of financial statements somade to monitor the
       could be taken to obtain them in   that followup action
                                        a timely manner,
    -- nine lenders said they did not
                                      analyze financial state-
       ments because they lacked the time
       and                                and/or the expertise,

    -- lenders provided FmHA with written
                                          comments on only
       3 of 64 financial statements obtained
                                             from borrowers
       with guaranteed loans.

 Lenders will have to establish monitoring systems
                                                    if they are
 to comply with the contractual provision to notify
                                                     FmHA when
 borrowers do not provide required financial statements.

      Cf 67 financial statements received by FmHA for the
 closed loans (3 financial statements were from             35
 with insured loans), 24 were received within 60 days
 ending date of the period covered by the statements, of the
 received in over 60 days, and the date received could 32 were
 determined for 11. Further, 56 statements that were not be
 not been received, 42 of which were overdue for more due had
 60 days.                                              than

      Of the six FmHA State offices visited, only one had
developed and implemented a systematic method of monitoring
financial statement due dates so that followup action
be taken to receive those oerdue. The monitoring
in the one State office called for sending a notice system
supervisor for any audited statements not received to the
60 days of the ending date of the period covered andwithin
unaudited statements not received within 30 days of for any
date.                                                the ending

     Twenty-one of the 33 county offices we visited
systematically monitoring the receipt of financial were not
One county supervisor told us that he had established
toring system but was too busy to implement it.        a mcni-

     FmHA regulations prescribe a county office management
system to assist in planning, organizing, and accomplishing
county office activities. As part of this system,
                                                    a card
file with pertinent information is maintained for
rower. This system, if used properly, could alert: each bor-
visors to the need for followup action on overdue   the super-
     The problems observed involving the receipt of the
cial statements were compounded by the delay or absence finan-
statement analysis by FmHA.                             of

     The State offices visited had prepared and submitted
the required spread sheet analyses to the national
                                                    office on
only 30 of the 67 financial statements they received.
30 spread sheets prepared, 7 were submitted in over     Of the
Of the 37 statements for which no spread sheets were 60 days.
20 had been on hand for over 60 days.

      Recognizing the need for reliable information,
 regulations require that the annual statements        FmHA
 with loans of $100,000 or more e audited by     of  borrowers
 public accountants. This requirement, however,independent
 plied with for 14 of the 25 annual statements    was not com-
 from borrowers with loans of $100,000 or more. FmHA  received
 FmHA generally took no corrective action when    Furthermore,
                                                the borrowers
 submitted unaudited annual statements.
 Visits to borrowers

      /isits to borrowers are an important aspect
servicing program. Although FmHA regulations       of a loan
visits to borrowers before December 1975, it   encouraged
                                              was not until
then that such visits were required. Some
by FmHA and lender personnel in connection  visits  were made
                                            with  the 35 loans
reviewed. The visits, however, were infrequent,
and lacked comprehensiveness. Further, visit       sporadic,
seldom documented.                             results were

     The value of obtaining and analyzing borrower
statements by FmHA and the lenders is diminished    financial
priate followup action is not taken. Once         when  appro-
problems are identified, visits could be useful        or actual
such problems with the borrowers and reach       to discuss
                                            agreement on cor-
rective actions to be taken. Also, visits
necessary to inspect the physical condi orn to borrowers are
                                             of the plant and
equipment and any property serving as collateral.

     In December 1975 FmHA revised its regulations
its personnel, accoripanied by lenders if possible, to require
borrowers in accordance with the following          to visit
     -- Monthly for new businesses until the business
        ilized.                                       is stab-

     -- At least quarterly for businesses less than
                                                    3 years
     --At least annually for businesses more than
                                                    3 years old.
     -- As often as needed for businesses requiring
     To increase
should establish the effectiveness
                 guidelines on the of visits, we believe FmHA
                                   matters to be considered
by FmHA and lender personnel. One of these
                                            matters should
be a discussion on the views of FmHA and lenders

the results of their analyses of the borrowers' financial
statements. Furthermore, FmHA should require that the results
of such visits be documented, particularly any agreements
reached to resolve actual or potential problems.
     The following examples illustrate some of the situations
concerning visits to borrowers.
     -- In April 1974 FmHA guaranteed a $40,000 loan to an
        existing business. The county supervisor made three
        visits to the business during the 22-month period
        after the loan was made, one visit was made to discuss
        the business in general and two were made to inquire
        about overdue financial statements.
     -- In July 1974 FmHA guaranteed a $25,000 loan to an
        existing business. No visits were made by FmHA per-
        sonnel during the 21-month period after the loan was
        made. Although the lender told us he had visited the
        business four times, the borrower said the lender had
        never visited him.
     -- In March 1975 FmHA guaranteed a $505,800 loan to a
        new business. No visits were made by FmHA personnel
        during the 11-month period after the loan was made.
        Although the lender told us he had visited the busi-
        ness one time, the borrower told us he could not
        recall a visit by the lender.

FmHA monitoring of lender operations
     Lenders have primary responsibility for evaluating and
approving loans as well as servicing the loans once they are
made. FmHA personnel are to supervise the lenders to see
that they carry out their responsibilities adequately. FmHA
needs to establish a formalized monitoring process to ade-
quately accomplish its supervisory role and see that the
lenders carry out their responsibilities effectively.
      In carrying out their supervisory roler FmHA personnel
do, to some degree, review and evaluate lender operations,
although this is not their primary objective. FmHA personnel
generally had frequent contacts with lenders during the loan
evaluation process, and in this regard some review and evalua-
tion of lender operations is being made, if only in an informal
manner. Once the loans were made, however, FmHA contacts with
lenders were minimal and, hence, little information was ob-
tained regarding the lenders' loan servicing role. Furthermore,

 no provision is made to provide feedback
 on the effectiveness with which lender. to top management
                                          perform their re-
 sponsibilities on a formalized basis.

      FmHA did not verify whether loan proceeds
 accordance with approved and authorized           were used in
 the 35 loans we reviewed. Further,        purposes  for 11 of
 provide any guidance on the manner   FmHA  regulations  do not
 ceeds from guaranteed and insured   in which  the  use of pro-
                                    loans will be controlled.
      Loans should be approved for specific
 to enhance a business' chances of success. purposes   designed
                                              Once these pur-
 poses are agreed on, appropriate controls
                                            are needed so that
 borrowers use the loan proceeds accordingly.
 also needed so that the loan proceeds           Controls are
 authorized by law and FmHA regulation. are used  for purposes

      FmHA requires lenders to agree that
be used in accordance with its regulationsloan proceeds will
listed on the borrower's loan application. and the purposes
however, require the lenders                 FmHA does not,
ceeds are disbursed. Further,to regulations
                                 advise it on how loan pro-
the manner in which FmHA will assure        are silent on
                                      itself that the proceeds
for guaranteed and insured loans are
authorized.                             ed as approved and

     We were unable to determine whether
used as approved and authorized by         the proceeds were
it was not clearly stated in writingFmHA in four cases because
be used and/or there were inadequate exactly how they were to
penditures made with loan proceeds. records supporting ex-
true for loans made to existing businesses was particularly
ten document showing how the proceeds        when the only writ-
loan application which merely shows    were  to be used was the
                                     the amount
funds to be used for each of the following       of the loan
acquisition, new buildings or plant          categories:  land
ment, working capital, acquisition construction, debt pay-
and equipment, and other.           and/or repair of machinery

     On the other hand there were
over the use of loan proceeds was four instances where control
                                   good. This was particularly
true in two instances where documentation
which tne loan funds would be used         on the manner in
loan closing.                       was obtained at time of

     The following examples illustrate some of the problems
we noted in regard to the loans where the use of loan proceeds
were either questionable and/or not verified by FmHA.

     FmHA guaranteed a loan for $500,000 in May 1975. Accor-
ding to the loan application, about $430,000 was to be used
for working capital. In January 1975 the State office advised
the national office that the working capital portion of the
loan was needed to finance inventory, raw materials, and
accounts receivable and that no part of the proceeds for
working capital was to be used to pay off debts the borrower
then owed the lender. This restriction on the use of the pro-
ceeds was not, however, made a formal condition of the loan
     Although FmHA's loan file did not show how the proceeds
were used, in reviewing the borrower's financial statements
we noted that about $469,000 of current liabilities was paid,
indicating that the borrower's prior debts to the lender were
also paid. We brought this matter to the attention of an
FmHA official who in turn asked the lender whether the loan
proceeds had been used to repay the prior debts. The lender
advised FmHA by letter dated April 1, 1976, that about $345,000
of the loan proceeds was used to repay the borrower's prior
     FmHA guaranteed a $1.25 million loan on October 1, 1975.
The borrower owned a manufacturing division which was located
in a rural area and a sales and shipping facility located in
an urban area. The loan application indicated that the loan
was to be used for the rural facility.

     In notes to the borrower's financial statement covering
the 2-year period ending August 31, 1975, the auditor stated
that the borrower, in anticipation of the $1.25 million
loan, obtained interim financing of $700,000 of which $577,000
was used to repay debts owed in connection with the urban
sales and shipping facility. In view of the fact that the
FmHA guarantee loan proceeds were then used to cover the
interim financing, the loan proceeds were used for an ineli-
gible purpose because they were used for a business operation
located in an urban area.
     FmHA has no management assistance program as such, but
instead relies on its State office loan specialists and county

 supervisors as well as lenders to assist borrowers with their
 problems. Neither FmHA personnel nor the lenders, however,
 appear to have the necessary time and/or expertise to provide
 effective management assistance.

     Among other responsibilities, the State office loan
specialists are to see that borrowers receive adequate guid-
ance in carrying out approved management practices, including
the proper use of credit, income, and other resources. Accor-
ding to an FmHA official, this can be done by the loan spe-
cialists themselves or by supervisors and lenders.

     In implementing the program, FmHA established a position
of supervisory loan specialist in each of its 42 State  offices.
By December 1973 the 42 positions were filled mostly by
sonnel from within the agency. FmHA also established a per-
specialist position and authorized each State office to fill
this position in July 1975. The majority of these positions
were also filled by personnel from within the agency.
     All but one of the supervisory and nonsupervisory loan
specialists (referred to herein collectively as loan spe-
cialists) in each of the six State offices we visited had
received both the basic and advanced 1-week financial analysis
courses provided by FmHA. According to FmHA, the objective
of the basic course is to assist the individual to obtain
thorough knowledge of credit and financial analysis, including
an understandir 9 of the structure, operations, management,
unique problems and trends of a business operation. The       and
tive of the advanced course is to provide the individual
a knowledge of advanced conceptual approaches to credit and
financial analysis and to further develop his or her credit

     This training, although limited, may be adequate to
enable loan specialists to analyze   business' operations
and financial data to detect major problems. Once detected,
however, arrangements must be made to assist the borrower
solving the problem. It is not clear                       in
                                         ither loan specialists
have the time and/or training and experience needed to assist
in the solution of the more complex problems which could

     The loan specialists we interviewed often told us that
they lacked the ti   to adequately service the loans. This
problem will be compounded as additional loans are approved.
The loan specialists also face a logistics problem in assis-
ting borrowers who are located throughout the State(s) served.

       The supervisors also appeared to lack the
 and/or experience to provide borrowers with      time, training,
 management assistance. Thirty-two of the     any  degree of
                                            33 supervisors
 we questioned during the period of February
 had academic backgrounds in agriculture,     through July 1976
                                           while only about
 four had any background in business and economics.
 more,                                                 Further-

      -- only 10 supervisors had attended FmHA's
                                                 basic credit
         and financial analysis course and none had
         the advanced course;                       attended

      -- 30 supervisors said that they did not have
         time to provide adequate loan servicing;
      -- 14 said additional personnel, such as loan
         are needed to service the loans.
      In implementing the program,
its appropriated loan authority to FmHA decided to use most of
                                    guarantee loans which are
made and serviced by lenders rather than
which are made and serviced by FmHA. The to make insured loans
of most of the lenders we visited, however,loan servicing role
                                             was limited pri-
marily to collecting and overseeing loan
if they desired to provide management     repayments.  Even
ful they could in view of the fact thatassistance, it is doubt-
                                         17 of the 31 lenders
interviewed indicated to us that they did
and/or expertise to provide borrowers with not have the time
assistance. This was particularly true for any degree of such
lenders.                                     the small rural

     We believe FmHA should develop some means
management assistance to borrowers in need      of providing
This could be done by developing its own    of such assistance.
                                          counseling program
or by arranging for other organizations
                                         and groups to provide
this service.
      For example, the Small Business Administration
a management assistance program available              (SBA) has
borrowers alike. On June 30, 1976, SBA     to  SBA and  non-SBA
                                         employed about 320
management assistance counselors. During
                                           fiscal year 1976,
SBA's management assistance counselors had
counseling sessions. SBA also has outside about 64,000
                                            consultant groups
providing management assistance to small
                                          businesses. These
groups had about 143,000 counseling sessions
                                              during fiscal
year 1976. Most of the counseling sessions conducted
SBA and its consultants were with non-SBA                by

      The SBA consultants providing management
 listed below.                                 assistance are

      -- Service Corps of Retired Executives
         an organization of retired business executives This is
         volunteer their services to help small
         solve their problems.                   business  owners

      -- Active Corps of Executives (ACE). This
         zation of volunteers drawn from-the ranks an organi-
         executives in industry, trade associations,of active
         institutions, and the professions.           educational

      -- Small Business Institute (SBI). This
                                               is a program
         which provides faculty-supervised management
         to small businesses by university graduate   counseling
                                                    and under-
         graduate students.
      -- The Call Contract Program. This program employs
         sultants                                          con-
                  to provide management and technical assistance
         to small business owners who are eligible under
         EconomicOpportunity Act of 1964.                 the

      --The Professional Association Pro ram.
                                                Under this pro-
        gram members of professional associations,
        the National Association of Accountants,    such as
        management and technical assistance to    provide
        on a voluntary basis.                   small businesses

     The following examples illustrate some
                                            of the types of
problems experienced by borrowers which,
                                         with some assistance,
could possibly have been dealt with more
      FmHA guaranteed a $560,000 loan to a mobile
 facturer in October 1974. The borrower            home manu-
                                         discontinued  its
mobile home operation less than 6 months
loL because of decreased sales and began after getting the
cabinets and trunks. After getting the
                                         loan, the firm
incurred severe losses and its assets
continued to increase, resulting in a declined while its debts
worth. The firm had experienced similarlarge negative net
                                          problems before
receiving the FmHA guaranteed loan. Therefore,
management assistance could have been detected the need for
                                                and dealt with
at the time of loan approval as provided
tions.                                    for in FmHA regula-

     The loan specialist said that the firm's
could not continue to maintain the operation. present business
                                               Despite this

opinion and he firm's history of problems, neither FmHA
nor the lendfr made any effort to provide management assis-
tance to the borrower. The lender and the FmHA county
supervisor told us that they were not qualified to provide
management assistance to the borrower.

     FmHA guaranteed a $45,000 loan in March 1974 to the owner
of a farm supply store. In May 1976 the borrower was 3 months
delinquent on his loan repayments. Because the business did
not generate sufficient income, the borrower had taken a part-
time job. His wife operated the business in his absence.

     The loan specialist attributed the business' financial
troubles to poor management. He said that the borrower had
more experience in sales than with management. Moreover,
the lender told us that he required a guaranteed loan because
the borrower lacked managerial capabilities. Despite the
business' financial problems and the doubts about the bor-
rower's management ability, neither FmHA nor the lender
provided the borrower any management assistance.
     FmPA guaranteed a $500,000 loan in May 1975. The bor-
rower became delinquent 4 months after receiving the loan.
His difficulties arose due to decreased sales and increased
inventory costs.

     In September 1975 the lender and the FmHA county super-
visor considered asking SCORE to help the borrower, but did
not. The lender notified FmHA in November 1975 that the loan
would be in srious trouble unless "drastic measures" were
taken. FmHA asked the lender to determine what should be
to help the borrower overcome his problems. Although the done
borrower was 5 months delinquent by January 1976, no deci-
sion was reached on the action to be taken to assist the

     In March 1976 a meeting was held betweer FmHA, the len-
der, and the borrower in which it was decided that the lender
would consider deferring the monthly loan payments for prin-
cipal if the borrower's problems continued. No specific
actions were agreed to, however, concerning the manner in
which the borrower's problems would be resolved.

     Effective loan servicing and management assistance
grams are needed so that the businesses financed and the pro-
saved and created through FmHA's business and industrial jobs

  program are permanent. To do
                                this FmHA needs to obtain
  better and more timely information
                                      on borrowers' problems
  and progress and establish a management
                                            assistance program.
       Lenders must be fully aware of
                                       their servicing responsi-
 bilities particularly on such
                                matters as obtaining ana analy-
 zing borrowers' financial statements,
 businesses, and assisting borrowers     visiting borrowers'
 This guidance should be included      with  their problems.
                                   in the lenders handbook
 we are recommending FmHA develop.
 policies and procedures governing   FmHA should establish
                                    its supervisory role to see
 that the lenders carry out their
 quate manner.                     responsibilities in an ade-

       To see that
 tion of borrowers'lenders provide FmHA
                     delinquencies, FmHA with timely notifica-
                                          should revise the
 lender's agreement to prescribe
 lenders to provide notification, a definite cutoff period for
 impose a penalty upon lenders      and to help attain compliance,
 fication.                      who  fail t provide such noti-

      To make more effective use
statements as a loan servicing of borrowers' financial
                                 tool, FmHA State and county
offices should obtain and analyze
                                    borrower financial state-
ments in a timely manner. Also,
pendently audited financial statementsrequirement for inde-
so that the data obtained is reliable. should be enforced
county offices that are unable            Those State and
responsibilities because of the to fully carry out their
should advise the national officelack of an adequate staff
                                    of this so that corrective
actions can be taken.
       FmHA and lender visits to borrowers
 sporadic, and lacked comprehensiveness.       were infrequent,
 its regulations in December 1975              Although FmHA revised
 to borrowers, because so many       to  require  periodic visits
                                 of the supervisors told us
 that they lacked the time to adequately
of 33 supervisors interviewed--it             service loans--30
whether this requirement can          is  questionable  as to
fore, FmHA should closely monitorfully implemented. There-
that the staffing is sufficient       this requirement to see
                                   to make the requzrgd visits.
      So that comprehensive reviews
                                       are made duri, visits,
FmHA should provide the supervisors
list of what is to be accomplished and lenders with a check-
visits should include an inspection during these visits. Such
cussion of the results of the           of collateral and a dis-
lender of the borrower's financial          made by FmHA and the

     To see that loan proceeds are used in accordance with
approved and authorized purposes, borrowers should be required
to specify in writing how the loan proceeds are to be used
and be required to submit settlement sheets showing how the
proceeds were disbursed. In this way FmHA can see to it
that the proceeds are used as authorized.

     Although an effective loan servicing program will identi-
fy borrower problems so that corrective actions can be taken,
some borrowers do not possess the management capability needed
to deal with the problems identified. FmHA should develop a
formalized management assistance program to provide borrowers
with assistance. The program should include a staff of manage-
ment assistance counselors to provide assistance to borrowers
to be augmented, when necessary, by outside consultant ogan-
     We recommend that the Secretary of Agriculture direct the
FmHA Administrator to:

     -- Provide additional guidance to lenders on their loan
        servicing responsibilities.
     -- Require lenders to notify FmHA of a default by a bor-
        rower within a specified number of days and impose a
        penalty for noncompliance.
     -- Establish policies and procedures governing the super-
        vision and review of lenders' loan servicing opera-
    -- Obtain better and more timely information on borrower
       operations by (1) requiring county offices to imple-
       ment a system of monitoring borrower financial state-
       ments so that followup action can be taken to obtain
       any statements not submitted on time and (2) estab-
       lishing time frames for State office personnel to
       follow in performing the required analyses of financial
       statements received. State and county offices unable
       to perform these or other required tasks because of
       inadequate staffing should be required to advise the
       Administrator of this fact so that corrective actions
       can be taken.

       -- Require the enforcement of
          annual financial statements the   requirement that
                                       of borrowers with
          of $100,000 or more be adited                     loans
          lic accountants and emphasize by independent pub-
          borrowers that borrowers failing the lenders and
         ment are in default of their loan to meet this require-
      ---Monitor personnel efforts to
                                        comply with requirements
         concerning visits to borrowers'
         mine whether staffing levels        businesses to deter-
                                        need to be adjusted    in
         order to make the required visits.
      -- Provide additional guidance
         accomplished through visits on    the objectives to be
                                      to borrowers made by
         supervisors and lenders.
      -- Require (1) borrowers to specify
         written loan agreement how loan as part of their
         (2) lenders to provide FmHA with proceeds will be used,
                                           detailed data showing
         how the loan proceeds were disbursed,
        personnel to verify that proceeds       and (3) FmHA
        dance with the loan agreement.      are used in accor-

      -- Develop a formalized management
         including the establishment of assistance program
         assistance counselors. Agreementsstaff of management
         sultant firms should be entered     with outside con-
         the service to borrowers in      into to help provide

     In commenting
out the duties and on our report, FmHA said that it
                   responsibilities of the          has set
der's agreement. As discussed              lender in the en-
                               earlier it is also considering
the development of a lenders handbook.
      In commenting on our recommendation
 lenders notify it when borrowers           to require that
loan repayments for a specified are delinquent on their
                                  number of days, FmHA said
that its regulations requiring
loan repayments are 30 days pastlenders  to notify FmHA when
be brought current within          due and are not likely to
                           60 days, provides the lender latl-
tude in working out problem loans
unnecessary correspondence and      and eliminates a lot of
FmHA said that (1) it is stated servicing  problems. Further,
                                  in the lender's agreement
that improper servicing of the
paying the request for loss     loan could lead to FmHA's
                             settlement and (2) its regula-not
tions provide for debarment of
loans properly.                 lenders who do not service

      As stated in the report, FmHA's requirement makes
 notification of delinquencies contingent upon the lender's
 judgment as to whether the borrower is unlikely to bring his
 account current within 60 days. We believe that the present
 regulation would, in effect, encourage lenders to wait the
 full 60 days prior to notifying FHA of delinquencies and
 FmHA would find it difficult to impose a penalty on a lender
 that did not notify it of a delinquency in less than 60 days.
      In contrast, under SBA's regulations a lender must agree
to notify SBA of delinquencies within 45 days of the due
If the lender fails to do so, SBA will not reimburse the
der for the interest earned from the date of default (delin-
quency) to the date the notice of default was received by
SBA when a lender places a demand on SBA to purchase the
guaranteed portion of the loan. Also, SBA regulations provide
that it

     " * * * shall not purchase the guaranteed percentage
     unless SBA shall first determine that said delay in
     notification of default did not cause any substantial
     harm to the Government.   * * *"
     SBA's regulations are more in line with what we believe
is needed to adequately protect the Government's interest.
That is, a precise period of time within which the lender
must notify FmHA of delinquencies should be specified in
the agreement between FmHA and the lender, including a
provision setting forth those penalties that will be im-
posed for failing to provide the required notification with-
in the specified period.

     FmHA did not specifically state whether or not it agreed
with us that policies and procedures governing the super-
vision and review of lenders' loan servicing operations
be established. It did say, however, that it had implemented
a system whereby national office personnel review field
for compliance with FmHA regulations and loan conditions offices
also make periodic reviews of lenders.
     In commenting on our recommendations to obtain better
and more timely information and on enForcing the require-
ments for audited financial statements, FmHA said the regu-
lations now set forth appropriate loan servicing monitoring
and provide for the monitoring of the receipt of audited
statements. FmHA said also that a field visit guide was
being developed to strengthen the review of borrowers' records
(FmHA attached a draft of the guide to its comments--see
III) and that it will continue to emphasize the need to

 and analyze borrowers' financial statements in a timely manner
 in its training programs and monitoring efforts.

     Further, in its July 8 memorandum, FmHA advised its
State directors of the need to implement appropriate follow-
up systems at State and county office levels to assure receipt
of the required financial statements.

     Concerning field visits to borrowers' businesses,   FmHA
said it believes that at present funding levels it has   ade-
quate staff to properly monitor the loans and that the   uniform
monitoring procedures being developed will help assure   that
its objectives for the visits are met.

     On the basis of our review, we believe it is at least
questionable as to whether FmHA has adequate staff to imple-
ment its procedures concerning visits to borrowers. Parti-
cularly in view of the fact that nearly all of the county
supervisors we interviewed said that they lacked the time
to adequately service loans.

     Concerning the verification of loan proceeds FmHA stated:
     "Our regulations provide that the district director
     will make an audit of the borrower immediately prior
     to the issuance of the guarantee. As a part of this
     audit, he is required to verify that funds will be
     used for authorized purposes by checking the issuance
     of checks with the loan purposes specified in the
     application. Also, the lender certifies in the len-
     der's agreement that funds will be used for authorized
     purposes. Subsequent field visits would disclose any
     irregularities in use of funds."
.n addition, in its July 8 memorandum FmHA
directors to instruct the district directorsadvised the tate
                                              of the impor-
tance of the preguarantee audit to assure that the loan funds
are used for the authorized purposes approved when the appli-
cation was reviewed and that the loan will produce the desired

     FmHA's actions should help improve the problems found
during our audit regarding the use of loan proceeds. However,
we believe our recommendations are still valid in that they
provide for a more complete solution. For example, we had
difficulty in verifying that loan proceeds were used as in-
tended for some loans because of a lack of any documentation
specifying what was intended. Unless borrowers are required

to specify in writing how the loan proceeds will be used, the
district directors may face the same problem in their audits.
     FmHA agreed with our recommendation oncerning the
establishment of a formal management assistance program and
said that it believes that many of the SBA programs would
be useful in providing management assistance to borrowers.

                               CHAPTER 5
                                         NEEDING TO BE RESOLVED
        The program
   more effectively could   have been implemented
   insure that it had a   FmH.   taken the necessary and  operated
                                                       actions to
   trained employees;     sufficient   staff of experienced
  with FmHA personnel however,     most staff positions        or
                        having agricultural backgrounds.  were filled

        FmHA has instituted training
  and many have taken one                 programs for its personnel,
  credit analysis courses.   or  both  of  two -week financial
  program and the fact          Because of the complexity         and
                         that   the needs of the program     of  the
  mediate, we believe the                                   were im-
                            staff should have been
  to a greater degree with personnel                   supplemented
  in making business                       having prior experience
       The need for adequate
 cal skills had been brought staffing with more diverse techni-
 others in the past on         to FmHA's attention by
                        several                        us and
 made several recommendations occasions. For example, we
 the business and industrial regarding the implementation of
 report 1/ to the Congress, loan program in a May 1973
 such action as is necessary one of which was that FmHA take
cient staff of experienced to insure that it have a suffi-
implement the program.       or trained employees
                                                   to properly
of a report 2/ we issued FmHA personnel needs were the subject
ded that, until FmHA       in September 1975 wherein
                      hires                           we conclu-
skilled employees, it        and trains enough technically
the newer rural development not be able to effectively implement
basis.                        programs on more than
                                                     a limited
      In implementing the program,
and industrial loan division        FmHA established
1973 which was staffed         t the national level a business
                        with three professional       in August
of June 30, 1976, this                           employees. As
7 of whom were hired    division had 12 professional
                      from other Federal agencies      employees,
organizations because                              and  private
                       of their business loan

l/"Ways to Improve Effectiveness
   Programs" (B-114873,            of Rural Business Loan
                         May 2, 1973).
2 /"Personnel
   to Help Farmers Home Improvements Initiated or Needed
                         Administration Meet Its
   Missions" (RED-76-16,                         Expanded
                          Sept. 10, 1975).

     Staffing at the State level also began in May 1973 and
by December 1973 business loan specialists had been appointed
in each of the 42 State offices. Nearly all these positions
were filled by promoting or reassigning FmHA employees, most
of whom lacked experience in making business and industrial
type loans. In fact, an FmHA official indicated that all
loans had to be processed through the national office during
the first 2 years of the program's life primarily because of
the lack of experience and training of State office personnel.

     To help correct this situation, the former Administrator
of FmHA authorized each State director to iire an additional
loan specialist effective July 7, 1975. In advising the State
directors of this action, the former Administrator said that
persons assigned to these positions should have strong com-
mercial lending backgrounds, such as that possessed by key
bank officials. Further, he said that credit experience in
FmHA lending programs was not what was being sought because
the new B&I loan program is quite different from FmHA's
other programs.
     Nevertheless, of the 27 people hired to fill these posi-
tions as of October 31, 1976, only 3 were hired from outside
the agency. FmHA officials cited employee opposition and
resistance to hiring non-FmHA personnel to fill these posi-
tions as the major factor for FmHA's limited success in this
     Historically, FmHA's practice has been to hire persons
with agriculture-related education and/or experience for
county offices and to train them in administering FmHA pro-
grams. This practice has resulted in most FmHA employees
having agricultural backgrounds although agriculturally orien-
ted programs accounted for only about 30 percent of FmHA
loan and grant expenditures in fiscal year 1976.

     As the former Administrator indicated, credit experience
in FmHA programs would not necessarily be sufficient to
qualify for a loan specialist position in the B&I program.
Not only are the loan purposes quite different but the size
of the loans made are much larger. There are no maximum
amounts prescribed for B&I loans and many loans are made for
over $1 million, whereas farm ownership and operating loans,
for example, are limited by law to $100,000 and $50,000
     FmHA staffing levels have not kept pace with its overall
loan and grant activity. Between June 30, 1973, and June 30,

1976, FmHA's full-time permanent staff decreased from 7,161
to 6,860 employees, or about 3 percent, while the amount of
loans and grants made increased from about $3.8 billion to
$5.4 billion, or about 42 percent, and outstanding loan
balances increased from $9°6 billion to $18.5 billion, or
about 93 percent.

     A comparison of FmHA full-time permanent staff, by
organizational le-,el, as of June 30, 1973, and June 30, 1976,

                    Number of full-time
                    permanent employees
Organization                                      Increase
   level         June 30, 1973    June 30, 1976   decrease (-)
Hieadquarters        268                317          49
Finance office       462                376        -86
State                894                976          82
District            295                 280        -15
County            5,242               i911        -331
    Total         7,161               6,860       -301
The decrease in full-time employees was offset to some degree
by an increase of about 700 part-time permanent employees.
We could not categorize the part-time employees by organi-
zational level because FmHA records do not show this informa-

     The Congress recognized the need for FmHA to increase
its full-time permanent staff by appropriating $12 million
more than the amount requested by the administration in the
fiscal year 1976 budget. The report of the Senate Committee
on Appropriations specifically stated the Committee's recom-
mendation that the additional funds were needed to provide
more adequate staffing. Subsequently, a Member of Congress
stated his understanding that it was intended hat the
additional funds be used to hire between 750 and 1,000 addi-
tional full-time permanent employees. However, contrary to
the Committee's recommendation as well as the Member's under-
standing as to the intended purpose of te additional funds,
only about $4 million of this amount was expended in hiring

400 full-time, 200 part-time, and 100 temporary employees.
The remaining funds were used for pay increases, travel ex-
penses, postage expenses, and training. For the fiscal year
1977 budget, the administration proposed no changes in FmHA's
full-time staffing level. Nevertheless, the Congress appro-
priated about $7.8 million more than that requested by the
administration for salaries and expenses.

      FmHA has assisted many businesses to save and create jobs
in rural areas. As this report p',ints out, however, problems
exist which are in need of management attention. To solve
these problems and increase the overall effectiveness of the
program, FmHA must have a sufficient number of qualified
staff. The Congress has appropriated additional moneys to
help provide the staff needed. FmHA must take the necessary
action to see that its future hiring efforts are directed to
acquiring employees with the technical backgrounds needed
to fully implement its newer programs, such as the B&I pro-

     We recommend that the Secretary of Agriculture direct
the FmHA AdministratoL to take such actions as are necessary
so that employees hired in the future have the educational
and technical backgrounds needed to more adequately imple-
ment its programs.

     In commenting on our report, FmHA stated:

    "This program was implemented at a time when FmHA was
    instructed to make a reduction in personnel of 10 per-
    cent. It was very difficult to justify to FmHA
    employees the hiring of outside talent under these con-
    ditions. The agency has continually been updating its
    requirements for loan officers. When the program was
    first implemented, the use of FmHA personnel was an
    expeditious means of staffing for the program.
    "We would like to take issue with the audit's conclu-
    sion. The fact that we met all allocation allotments
    each year with a reasdnable delinquency rate, we
    believe, points to an outstanding job performed by
    those loan specialists with primarily agricultural

     backgrounds. It must be noted that all these loan
     officers had prior lending experience in housing,
     community programs, and farmer programs. Present
     and future training courses and FmHA personnel
     development programs were designed to provide for
     further evelopment of B&I loan officers.

     "We agree that under ideal conditions personnel
     with a commercial loan background would be desir-
     able. FmHA has implemented a 2-year graduate
     program in financial management leading to an
     advanced degree. This program is designed to pro-
     vide future mnagement for the agency and properly
     trained personnel to implement the various FmHA
     programs and respective objectives.'
     While we can sympathize with FmHA's statement that it
would find it difficult to justify to FmlHA employees the
hiring of outside talent at a time when it was instructed
to make a 10-percent reduction in personnel, we believe that
in implementing any new program, an agency's first consider-
ation must be to insure that the program will be operated
as efficiently and effectively as possible. The most im-
portant ingredient to accomplishing this objective is staff--
toth in number and quality.

     Our report points out a number of problems experienced
in operating the B&I program. We believe that similar prob-
lems may be avoided or minimized in the future if FmHA takes
the action necessary to attain a sufficient number of
qualified staff.

APPENDIX I                                                                           APPENDIX I
                                 SCHEDULE OF LOANS REVIEWED BY GAO

                                                                 At time of AO visit (note a)
                                   Date closed                    Months in
                                       or              New or     operation
   Loan                             obligation        existing      since         Payment
  number               Amount        approved         business   loan closed      status
       Loans closed as of June 30., 1975

    1              $ 1,371,456          2/75          New             12             Current
    2                    40,000         4/74          Existing        22
    3                  505,800          3/75          New             11
    4                   60,000         11/74                          11
    5                  900,000.         2/75                          12
    6                  359,000          2/75          Existing        13
    7                  300,000          2/74                         25
    8                   63,000          4/75          New            11
   9                   560,000        10/74           Existing       18           b/ Current
  1C                   817,053          3/75                         14              Delinquent
  11                   110,000          6/75                         10           c/ Current
  12                   500,000          6/75                         10              Current
  13                   351,000          2/75          New            12
  14                   250,000          4/75          Existing       11
  15                2,200,000           3/75                         15           d/ Delinquent
  16                   500,000          5/75                           9             Delinquent
  17                   400,000        12/74                          14              Current
  18                   600,000        11/74                          15
  19                1,400,000         12/74              "           14
  20                   300,000         6/75                            8
  21                    45,000         3/74           New            26              Delinquent
 22                 2,697r266          *7/74          Existing       21              Current
 23                     25,000         7/74                          21
 24                   170,000          8/74                          21
 25                     30,000         7/74                          21
 26                   100,000         10/74           New            19              Paid in full
 27                     14,000         8/74           Existing       20              Current
 28                     19,000         4/75           New            10           e/ Paid in full
 29                   480,000          6/75           Existing       12              Current
 30                 1,000,000          9/74                          22           e/ Paid in full
 31                     10,000         1/75                          17              Current
 32                   175,000          7/74                          23
 33                   200,000          2/75           New            17
 34 (note f)          300.000          2/75           Existing       16
 35 (note f)          600,000          5/75                          13
      Total       $17 452 575

  Loans in process as of June 30,      1975
 36               $ 1,800,000         6/75            Existing       10              Current
 37                  6,400,000        6/74
 38                  1,250,000        5/75                                 Not visited
 39                  1,700,000        4/75
 40                     85,700        6/75
 41                     86,350        4/75            New
 42                     85,000        3/75
 43                  3,000,000        4/75            Existing
 44                    650,000        4/75            New
 45                _   4000o00        4/75
      Total       S15,457,050

      Total      $32   909 625

 a/GAO visits were made during the period February-July 1976.

 b/Although the loan was current, the company had experienced
                                                              financial difficulties
   and was no longer in the business for which the loan was made.

 c/Although the loan was current, the company had experienced
                                                              financial difficulties
   and was in the process of going out of business.

 d/The company had filed a bankruptcy petition.

 e/The loan was repaid after the business failed.

 f/Loan numbers 34 and 35 were made to the same borrower.

                                                       APPENDIX II
                                OG    RESS         THE CNGRESS
                    WITH ACTUAL AT TIME
                                        OF OUR VISIT

                                Number    Number over
                               employed   or under(-)
                  Employment   at time                   Number of
                                          employment    months since
                   reported     of our
         Loan                              reported     loan closed
                    to the      visit
        number     Congress                 to the       at time of
                               (note a)    Conres        our visit
     1                 100
     2                              31        -69
                          5           3                      12
     4                                          -2           22
                          5           7
     5                  75                       2           11
     7                              42        -33
                        42          16                      12
     8                                        -26           25
                          5           4
     9                  44                     -1           11
   10                               13       -31
                        43         83                       18
   11                     7                    40           14
   12 (note b)                       1         -6
                        30         24                       10
   13                                          -6           10
                         7         15
   14                  38                       8           12
  15                               92         54
                     900           20                       11
  16                                       -880            15
                       70          15       -55
  17                   47                                    9
  18                               40         -7
                       14           3                      14
  19 (note c)          97                   -11            15
  20 (note c)                     80        -17
                       32         42                       14
  221                                         10             8
                        3           3
  22                 220                     -             26
 23 (note c)                    298           78
                      11            4                     21
 24                   20                     -7           21
 25                              19          -1
                        7          6                      21
 26                   16                     -1           21
 27                              12          -4
                      25         11                       19
 28                                         -14           20
 29 (note c)            6        -           -6
                      12         36                       10
                                             24           12
         Total     1,881       920        -961
a/GAO visits were made
  Part-time and seasonalduring the period February-July 1976.
  equivalents.            employees are shown
                                              as full-time
b/Employment reported
  ployed applies only to the Congress and the number em-
                          new jobs created by this
  borrower had 59 employees
                             when the loan was made.loan. The
c/Although we show the
                        number of employees at
  visit, the borrower told
  to transfer ownership     us that the purpose the time of our
                                                 of the loan was
  were actually saved. of the business and therefore no jobs

APPENDIX III                                                                          APPENDIX III

                                  FARMERS HOME ADMINISTRATION
                                       WAuINGTON. D.C.     02RO

    Mr. Henry Eschwege
    Director, Community and Economic
      Development Division
    U.S. General Accounting Office
    Washington, DC 20548                                                  JUL 27 1977

    Dear Mr. Eschwege:

    This is in response to your letter forwarding draft copies of the audit
    conducted on the business and industrial loan program.

    The Farmers Home Administration agrees with GAO in the improvements
    needed in this program as set forth in the digest of the report. FHA
    appreciates that the audit recognizes that this program was implemented
    at a time when we were i one of the worst recessions in this country's
    history. However, there is one other important factor that influenced the
    beginning of this program that was omitted. When this program was
    implemented, FmHA was ordered to make a 10 percent reduction in VmHA

    Our comments will be made in the same order ac the various sections in
    the draft audit report were presented:

    Chapter II

    The verification of job data is a part of the loan evaluation and should
    be done in every case. We will emphasize this fact in our upcoming
    training meetings, will issue instructions to our state directors to verify
    job projections and later provide for review of job data on subsequent
    field visits with appropriate documentation made in the loan file. FmHA
    will implement a manual reporting system to provide the needed job data
    suggested by this report. When the agancy UMIS system is implemented,
    we will be able to provide updated reports on employment figures for
    management and Congress.

    There appears to be the implication in the audit that PmHA deliberately
    overstated the accomplishments of the program. ThSl is absolutely not
    true. When a new program is started, it is almost impossible to accurately
    report the actual number of jobs created or saved because many of the loans
    have not been closed and the construction completed.   herefore, FHA has
    always reported the number of dollars obligated and the umber of jobs
    saved and created as reported by the applicant.

                  Farmers Home Admnistration is an Equal Opportunity Lender.
                   Complaints of racial or ethnic discrimination should be sent to:
                      Secretary of Agriculture Wshington, D.C. 20250

APPENDIX III                                                       APPENDIX          III

  ,his agency has indicated to all B&I personnel in its training meetings
  that a $20,000 per job investment is desirable. We disagree with the
  report recommendation that a dollar job cost figure should be established.
  The creation of permanent stable jobs, effect on the tax base, flow of
  funds into the community, and other beneficial effects on the community
  will also be evaluated and used as criteria for loan consideration in
  determining which projects will be funded. A maximum job cost figure
  would preclude loans in many areas that have natural resources, the
  development of which would require substantial fixed asset costs. We
  do not believe information on labor intensive industries distributed to
  field personnel would serve any useful purpose as the disadvantages are
  greater than the benefits.

  Chapter III

      1. Many of the areas pointed out by this audit report indicating
 deficiencies have been improved considerably by further training of
 personnel and by a total revision of the regulations in December 1975
 and use of the new project summary form developed in July 1976 (see
 attached project summary). This will be enforced further by instructions
 to the field (see attached letter). The completion of th' project summary
 by FmHA personnel assures that the most important credit factors have been
 considered and documented for each loan. ISee GAO note, p. 76.]

 On August 4, 1976, FmHA revised its application form (see attached). Part
 of the form requires the lender to analyze the application and set forth
 its recommendations. Also, a lender's agreement (see attac:ed) sets
 forth detailed certifications by the lender and loan servicing requirements.
 We will assess the teed for a lender's handbook.[See GAO note, p.          76   ]
     2. We agree with the recommendation of this report.   We will monitor
 this closer.

     3. We have revised our regulations to require qualified appraisals
 and our forms do provide for fair market values. On small loans,
 regulations provide flexibilit for estimating market value by lenders
 and FA   because costs for professional appraisals on small loans could
 be prohibitive. We are also conducting courses to teach our persounel
 how to evaluate appraisals.

 We agree that current financial statements are desirable and they are
 secured at the time the application is accepted. However, the processing
 time for our loans issometimes lengthy. To help in this regard, we
 require the lender to certify prior to the issuance of the guarantee that
 there has been no adverse change in the borrower's financial condition.
 We have instructed our field staff of the importance of reviewing and
 analyzing current financial statements of guarantors (see attached letter).

                                                                        APPENDIX III

    Analysis of cost of property
                                 is considered by the loan reviewer.
    has accountants, engineers and                                    FmHA
                                   architects who assist the loan
    determining the value of property.                            reviewer in

        4. We agree with the report
                                     that in refinancing debts it
    to keep th lender from reducing                                is desirable
                                     its exposure. However, as a
   matter, this is not always feasible.                            practical
   only one bak and a prohibition         In many small communities
                                    against the lender reducing its there is
   would cause many businesses to                                     exposure
   This might lso lead to forcing cease to exist through lack of financing.
                                     orrowers to change lenders to
   regulation equirements.                                          avoid
                                could also eliminate the ability
   to prcvide a line of credi for                                  of  the bank
                                   short-term financing needs due
   limits or bank liquidity.                                        to lending

   Chapter   V
        1. FmHA has set out in the lender's
   r-   -nsibilities of the lender.              agreement the duties and
                                        The regulations provide that
   A.       MInHA when the loan is 30 days past                        the lender
   to be .:rought current within 60               dle and the loan is not likely
                                       days. We feel that this gives
   latitule in working out problem                                      the lender
                                       loans and eliminates a lot of
   correspondence and servicing                                       unnecessary
                                   problems. It is clearly tated
  agreement that improper servicing                                  in the lender's
  paying the request f                   of the loan could lead to FeHA's
                             loss settlement. FbHA does have                not
  debarment of lenders who do not                               regulations for
                                      service loans properly.
       2.   FRHA has implemented a system
  National Office loan officers.             for review of field offices by
                                      The review includes but is not
  checkirg loan dockets for compliance                                 limited to
  established prior to loan approval. with FmHA regulations and conditions
  are made of the lender.                   In addition, periodic field reviews

     3. The regulations now set forth
                                        appropriate Joan servicing monitoring.
 The lender has the primary responsibility
 in process of development a field          to service the loans. FmHA has
                                   visit guide which will strengthen
 agency's review of borrowers'                                         he
  We are in agreement with the
                                audit tnat borrowers' financial
  should be obtained in a timely
                                  manner and analyzed promptly stateagerts
 an early warning system. This                                   to provide
                                  requirement has been in our regulations
 from the beginning of the program.
 our training programs and monitoring We will continue to emphasize this in
                                        of state office operations.
      4. FmHA regulations do require
 This is address3ed in the lender's    annual audited financial tatements.
                                     agreement and the loan agreement
 the borrower and lender.    FhnHA regulations d provide for            between
 of the receipt of these statements                            the monitoring
                                      and the len.dr's comments after
 have been analyzed.                                                    they

APPENDIX      III                                                   APPENDIX III

       5. At present funding levels, FmHA
   properly monitor its loans. As mentionedfeels it has adequate staff to
                                             above, we are establishing
   uniform monitoring procedures to assure
                                           that FmHA objectives will be

       6. Our regulations provide that the district
   audit of the borrower immediately prior to           director will make an
                                               the issuance of the guarantee.
   As a part of this audit, i is required to
   for authorized purposes by checking the issuance that funds will be used
                                                      of checks with the loan
   purposes specified in the application.
                                           Also, the lender certifies in the
   lender's agreement that funds will be used
  Subsequent field visits would disclose any for authorized purposes.
                                               irregularities in use of funds.
       7. We gree with the report that
  a more formalized menagement assistanceFmHA  should have as one of its goals
                                           progran for borrowers. Many of
  the Small Business Administration assistance
                                                 pograms, we feel, would be
  useful. At the present time, FHA has used
  us with problem loans in a number of specific outside  consultants to help
                                                  cases. We had funds in our
  budget to hire qualified consultants on a
                                             retainer basis who would be
  available when needed; however, we were
                                           unable to do this due to procurement
  regulations prohibiting the hiring of onsultants
                                                       on this basis.

  Chapter V

 This program was implemented at a time when
                                              FHA was instructed to make a
 reduction in personnel of 10 percent. It
                                            was very difficult to justify to
 FmHA employees the hiring of outside talent
 agency has continually been updating its     under these conditions. The
                                           requirements for loan officers.
 When th-! program was first implemented, the
                                              use of FmHA personnel w   an
 expeditious means of staffing for the program.

 We would like to take issue with the audit's
                                              conclusion.   Thefact that we
 met all allocation allotments each year with
 we believe, points to an                     a reasonable delinquency rate,
                          outstanding job performed by those loan
 with primarily agricultural backgrounds.                           specialists
                                            It must be noted that all these
 loan officers had prior ending experience
                                              in housing, community programs,
 and farmer programs.  Present and future training courses and
 development programs were designed to pro.-ide                  FmHA personnel
                                                 for further development of B&I
 loan officers.

 We agree that Lnder ideal conditions personnel
 ground would be esirable.                      with a commercial loan back-
                             FmHA has implemented a 2 -year graduate program
 in financial mua ___.; leading to an advanced
 designed to provide future management for      degree.   This program is
                                           the agency and properly trained
 personnel to imp:cment the varivus FHA programs
                                                  and respective objectives.


APPENDIX       III                                                                         APPENDIX III
                                     FARMERS HOME ADMINIqTRATION
                                           WAS.NGTONn.   D.C.   20250

                                                                                    July 8,   1977
    SUBJECT:     Business and Industry Loan Making and Servicing
                 (General Accounting Office Audit)

         TO:     All State Directors

   As you probably know, the General Accounting Office (GAO) has recently
   completed an indepth audit of our business and industrial (B&I) loan
   program. The audit covered the years 1974-75 and included the review of
   the National Office, Finance Office, and six State Offices, which repre-
   sented about 21 percent of our total B&I program.

   It was noted that many areas of our program need to be improved    In
   order for us to continue toward our goal of improving service tc our
   applicants, borrowers, and lenders, and providing for a more efficient
   organization, the following major areas need to be reevaluated and

        1. Document the file completely with the analysis of the lo'a.
   This includes, among other things, completely filling out the Form
   FmHA 449-29, "Project Summary," including the recommendations of the
   County Supervisor and District Director. This procedure is to be
   -ollowed whether a State or National Office review of the project is
   required. It is essential that our applications are properly analyad.
   In the future, any ircomplete project summaries forwarded to the National
   Office will be returned with the file without rtview.

        2. If personal or corporate guarantees are obtained for the
   project, make sure you review their current financial statements,
   including   close examination of the garantor's net worth. Copies of
   these financial statements should be in the file together with the loan
   officer's comments and evaluations.

        3. Carefully document the file on those cases where the lender is
   requesting refinancing, and particularly where the lender is reducLing
   his exposure on existing loans. Keep in mind that refinancing must make
   good economic sense and will, in fact, save existing employmeat.

        4. In servicing loans, be sure that the lender and borrower fully
   realize the importance of our requirements to monitor periodic borrower's
   financial statements. Timely review of the financial statements and
   their analysis with proper documentation in the file is imperative as a
   means of early detection of potential problem loans. Appropriate
   followup systems need to be implemented at State and county levels to
   assure FmHA's receipt of the borrcer's periodic and annual audit
   financial statements.

                      farme'rs Horn,me Adnmtlitratlion is anrEqual Opportunity Lender.
                        Complaints o r ial or clthnrf dise rirnnation shoul be rent to:
                             .',,r tarlv ,[ .4'i, tI/ltt,,' I' ,;illthm,,,. I).(. '025.)

APPENDIX    III                                                         APPENDIX   III

         5. Instruct the District Director of the importance of the
    preguarantee audit. Loan funds must be used for the authorized
    approved when the application was reviewed. This audit is FmHA'spurposes
    ance that the funds obligated and the purposes stated will produceassur-
    desired results. The audit must incluie the review requirements    the
    forth in Section 1980.454 of FmHA Inrtruction 1980-E.

          6. Verify the job projections. This is part of the loan analysis.
    Job projections should tie in ith the rpplicart's projected salaries
    and wages as reflected on the financial statements. Also, keep
    the Job cost ratio. We had indicated earlier in our training      in mind
    that a rule o 'h.umb of $20,000 per job investment is desirable,meetings
    do not want to establish a definite dollar figure.                 but we
                                                         hould an application
    have a high job cost ratio, document the file with the reabsons
    recommending the application, the priority you placed on the     for
    and the                                                       application,
            supplemental benefits that will accrue to the economy
                                                                  in the
    local community.

          7. We   eed to reCuce our loan processing time to
                                                          a more reasorable
   level. The GCO report indicated that the average processing
                                                                time of
   loans reviewed was 252 days, of which an average of 61 days covered
   period of time from which National Office concurrence was given      the
   State issuing the cnditional commitment. Also, between issuance to  the
   conditional commitment and loan closing (excluding construction of the
   was an average of 61 days. The following schedule reflects some time)
   average processing times:                                        of the

   rrom preapplication to State Office approval               87 days
   State Office approval to
     National Office concurrence                              36 days
   National Office concurrence to
     Issuance of conditional commitment                       61 days
   Conditional commitment to loan closing
     (excludes construction)                                  61 days
        8. On periodic field visits, make sure that requirements of the
   loan agreement are being met. Document the files on crrent
   versus company projections at loan closing, phy!.cal appearance
   business, business payroll, taxes, inventories, and special
                                                                   of the
   etc.  We w .1 be working on a guide to assist you in this area.
   I expect you to follow through with implementing the necessary
   and training to meet the deficiencies noted.


APPENDIX III                                                        APPENDIX III

 FmHA Instruction 1980-E
 Page 1

                       Business and Industrial Loan Program

                                Field Visit Reportc
 I    GENERAL. The following may be used by te County Supervisor, District
 Director B&I Chief or other designated FmHA empluyee as a guide for   the
 preparation of the field visit reports as required in 1980.469 Administrative.
 This guide does not replace Form FmHA 424-12 "Inspection Report," which
 used in accordance with FmHA Instruction 424.1.

II   INITIAL FIELD VISIT. At the initial field visit the reviewer should
discuss with the Lender the following items:

     A    Any special requirements of the Lender's Loan Agreement which need
monitoring by the lender.

      B    Lender's servicing responsibilities as outlined in Form FmHA 449-35
with attention to Lender'c analysis and follow-up of borrower's financial
statements; annual audit report, arranging schedule for future fiield
visits and responsibilty to notify FmHA promptly of delinquency or problem

III SUBSEQUENT FIELD VISITS. Reviewer should be particularly aware f
significant changes i the borrowers operat ons and financial position.

IV PRIOR REVIEW OF FILE. before going on field visit briefly review the
loan file and the latest field visit report.

V    PROBLZH AND DELINQUENT LOANS. The reviewer is responsible to promptly
notify the tate Director of problem or delinquent loans.

VI   ADDITIONAL INFORMATION. Financial Statements, newspapers or magazine
artiles,. charts, etc. may be attached t the report.

VII CONCLUSIONS AND RECOMMENDATIONS. hake constructive commentq and
suggestions to assist others in making decsion on servicing actions. Comments
should include the reviewers opinion on how the Lender is perforlung his
servicing responsibilities.

 APPENDIX III                                                               APPENDIX III

  PmHA Instruction 1980-E
  Guide 1
  Page 2

                        Business and Industrial ,Toan Program
                                 Field Visit Report
  Report Number
                                                            Date of Visit
  (Use consecutive order beginning with No.    )
                                                     Borrower's ID No.
 Name of Borrower:

            Street                                 County                        State
 Fiscal Year End:

 Persons present or contacted on visit:

 Original Amount of Loan $                 Present Princpal Balance $
 Is loan(s) current?          If no e.plain

 Number of jobs projected at time of application
                                                (See Form FImHA 449-22)
number of jobs _               (Verify by reviewing Borrower's quarterly FICA
reports, payroll records or personal count.)


Latest Annual Local,   State and Federal Taxes borrower is paying $-

Latest Annual Payroll $

Are the premises and facilties maintained in
                                             an c    erly, clean and safe
manner?        If no explain.

Is the inventory (raw materials and finished)
                                              properly stored and
protected?             If no, explain.

APPENDIX III                                                      APPENDIX III

                                                      FmHA Instruction 19V1O-E
                                                                      Gui e 1
                                                                       Page 3

   Is the business experiencing any problems in obtaining the necessary rw
   materials or marketing f its products or services?

   Does the overall operation appear to be functioning smoothly , or does it
   appear disorganized?

   Are there any labor union problems, civil suits, tax or creaitor's actions
   taken against he borrower?

   Has there been any change in methods of production, products or terms of

   Is the borrower providing adequate financial statements to the lender for
   his analysis?

   Is the bookkeeping system adequate?

   Review and attach latest financial statements. Comment on sales, inventory
   and profit trends, accounts receivables and payables,debt payments, etc.

   General Comments: (May include information on recent fires, damages, flooos,
   new competition, new construction or development significant changes in
   area which effects the business, any new loans made to borrower, changes
   in management, other problems, etc.)

   Conditions and recommendations:

                                                   County Supervisor

                                                   District Director

 GAO note:      The attached project summary, application
                form, and lender's agreement referred to have
                been deleted bcause of their volume.

APPENDIX IV                                          APPENDIX IV

                   DISCUSSED IN THIS REPORT

                                           Tenure of office
                                           From          To
    Bob S. Bergland                    Jan.   1977    Present
    John A. Knebel                     Nov.   1976    Jan. 1977
    John A. Knebel (acting)            Oct.   1976    Nov. 1976
    Earl L. Butz                       Dec.   1971    Oct. 1976
  DEVELOPMENT (note a):
    Alex P. Mercure                    Apr.   1977    Present
    Vacant                             Feb.   1977    Apr. 1977
    William H. Walker II               Dec.   1975    Feb. 1977
    James E. Bostic, Jr. (acting)      July   1975    Dec. 1975
    William W. Erwin                   Jan.   1973    July 1975
    Thomas K. Cowden                   May    1969    Jan. 1973
    Gordon Cavanaugh                   June   1977    Present
    Denton E. Sprague (acting)         Apr.   1977    June 1977
    Frank W. Naylor (acting)           Jan.   1977    Apr. 1977
    Frank B. Elliott                   Aug.   1973    Jan. 1977
    Frank B. Elliott (acting)          Mar.   1973    Aug. 1973
    Vacant                             Feb.   1973    Mar. 1973
    James V. Smith                     Mar.   1969    Feb. 1973

a/Until January 1973 the title of this position was Assistant
  Secretary of Agriculture for Rural Development and Conser-