oversight

Small Business Administration's Compliance with Comptroller General's Decision on Purchase of Guaranteed Loans

Published by the Government Accountability Office on 1977-01-26.

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

                          DOCUOENT RBESBE
00022 - [A0751058]
([Sall Business Administration's Compliance with Cosptroller
General's Decision on Purchase of Guaranteed loans]. CED-77-26;
B-181432. January 26, 1977. 11 pp.
Report to Mitchell P. Sobelinski, Administrator, Snall Besiness
Administ-ation; by Henry Eschwege, Dirt*tor, Community and
Economic Development Div.
Contact: Community and Bconoaic Development Div.
74dget Function: Commerce azd Transportation: Other Advancement
    ant Regqulation of Commerce (i03).
Congressional Relevance: House Comnittec on Small Business;
    Senate Select Coamittee on Small uAimness.
           The Small Business Authority (SBA) la-ks authority to
 purchase guaranteed loans from banks which have not ccmplied
 with SeA regulations requiring notification of a borrower's
 delinquency within 30 days. The files for 80 guaranteed loans
 p.rchasee  a;.d !oumr loans rejected for purchase at SBA's Boston,
rVnsas City, and San Francisco district office- were examined,
 is were 106 randomly selected loan authorizat. \ purchases to
detervine the extent of compliance with this requlation.
Findirgs/Conclusions: The Boston and Kansas city District
Offices had riot made a satisfactory analysis of possible harm to
the Government from late delinquency notices. The loan
specialists at these offices were unable to explain .heir
serious harm determinations and were uncertain about
requirements for these determinations. The failure of SBA
procedures to instruct loan officers on how to determine the
effects of late delinquency notices may have contributed to the
inadequacy of these determinations. Twenty five loan purchares
were approved at washington headquarters without evidence of
compliance.     Recommendations: The Administrator of the s53
should review purchase documents in the accounting Operations
Division to determine whether an initial review for Aerious harm
vas made by district offices, and reexamine the effects of late
delinquency notice for all loans. (RRS)
                       UNiTrO STATES GENERAL ACCOUNTING OFFICE
                               WASHINGTON, D.C. 2054


COMMMUNITY AND EriOM


                                                            .JN2 6 1977
      B-181432
      The Honorable Mitchell P. Kobelinski
      Administrator, Small Business
        Administration
      Dear Mr. Kobelinski.
            We recently completed a review of the Small Business
      Administration's (SBA's) compliance with the Comptroller
      General's decision of February 19, 1976 (B-181432), on the
      purchase ot guaranteed loans. This decision requires, in
      part, that before purchasing a guaranteed loan which became
      delinquent before February 19, 1976, SBA must determine that
      a participating bank's failure to give SBA timely notice of a
      borrower's delinquency did not cause serious harm to the
      Gov; rnment.
          We reviewed tile files for 80 guaranteed loans purchased
     and 4 loans rejected for purchase from February 19, 1976,
     through May 31, 197 6, at SBA's Boston, Kansas City, and San
     Francisco district offices. These 80 purchased loans repte-
     sent about 7.6 percent of the 1,056 loans purchased at all
     district offices during this period. We also examined 106
     loan purchase authorilations selected at random from the
     files maintained by the Accounting Operations Division at SBA
     headquarters for all SBA regions. We also interviewed offi-
     cials at the SBA headquarters and at the Boston, Kansas City,
     and San Francisco district offices.
          We found that the Boston and Kansas City district offices
     had not made a satisfactory analysis of possible harm to the
     Government from late delinquency notices and that the Ac-
     counting Operations Division had certified to the propriety of
     loan purchases without evidence that 1he analysis required by
     the Comptroller General's decision had been made.
     BACKGROUND
          As a result of our review of the SBA's 7(a) loan program,
     we reported to the Congress, among other things, that banks
     which had made loans guaranteed by SBA often Aid not comply
     with a requirement that they notify SBA of a borrower's


                                                                   CED-77-26
B-181432

delinquency within 30 days. 1/ Even though SBA's regulations
and guarantee agreement made -compliance with this provision a
condition of SBA's liability to honor its guarantee, we found
that SBA was purchasing defaulted loans from banks which had
not notified SBA of borrowers' delinquency until an average
of almost 4 months had elapsed.
     In an October 3, 19/4, memorandum to regional and dia-
trict directors, SBA's Associate Administrator for Finance
and Investment described the damage done to SBA's loan serv-
icing efforts by late delinquency notification, as follows:
     "There is considerable evidence that the current
     [notification] procedures are too informal and
     have allowed the banks to become l1 in fulfill-
     ing the requirement of notice of 30 day default.
     This has resulted in numerous instances where the
     servicing office knows little or nothing about
     the account until we are called upon to purchas:e.
     It follows that many purchase .uarantees are be-
     yond effective assistance and immediately become
     liquidation cases."
      After considering the legal issues involved in this sit-
uation, the Comptroller General ruled on February 19, 1976,
that SBA lacked authority to purchase guaranteed loans from
banks which had not complied with SBA's regulations requiring
banks to notify SBA of a borrower's delinquency within 30
days.
     The Comptroller General's decision advised SEA that
     -- in view of SEA's long.-standing plractice of not insist-
        ing on strict compliance with the notification require-
        ment, GAO would not take exception to purchases of
        loans made before February 19, 1976 (the date of the
        decision);
     -- GAO would not take exception to purchases of loans
        which became delinquent before February 19 but which
        had not been purchased by that date if SEA made a
        case-by-case determination that the Government had not


1/"The Small Business Administration Needs to Improve Its
  7(a) Loan Program' (GGD-76-24, Feb. 23, 1976).



                               2
       been seriously harmed by failure to give timely
       notice; and
     -- GAO would take exception to purchases of loans which
        became delinquent on or after February 19 if the
        notice requirement had not been strictly complied
        with.
      On March 8, 1976, in response to the decision, SBA re-
vised its regulations govern:ing purchase of guaranteed loans.
The regulations provided that SBA would not purchase de-
faulted loans from a participating bank when the bank fails
to notify SBA of a borrower's delinquency within 90 days of
the beginning of such delinquency and that it would not it  pay
interest accrued on  a loan  when  a  bank fails to notify    of
delinquency within 45  days.   The   effective date of the regula-
tion was made retroactive to February 19, 1976. SBA made con-
forming changes to its loan guarantee agreement. Although
retroactive changes in statutory regulations are generally
not permissible, we concurred in this instance. We reasoned
that the zetroactivity here would not affect the basic legal
status of loans going into default on or after the date of
our decision but befoze actual adoption of the amendments
since the time lapse involved--February 19 to March 8--was
less than the 30 days required for notice under the prior
 regulations.
     On August 10, 1976, after our fieldwork was completed,
SBA again changed its delinquency notice regulations to re-
move tne forfeiture of the guarantee penalty, which it had
established in March, for not reporting a delinquency within
90 days. Instead, the new regulations provide that, if no-
tice is delaved beyond 45 days after the date of delinquency,
SBA should not purchase the loan until a serious harm deter-
mination is made. Thus, if SBA determines there was no
serious harm to the Government because of late no.ification
of default, the only penalty remaining for a late notifica-
tion is the loss of accrued interest.
     In an October 29, 1976, letter we informed hyou of how
our General Counsel believes the revised regulations affect
the purchas- of guaranteed loans. In summary, our General
Counsel considers the following standards to be applicable to
loans in various categories:

      1. SBA may not purchase a guaranteed loan which became
         delinquent prior to February 19, 1976 (but was no:
         purchased by tba' date), unless it determines that

                                 3
B-181432



           the participating bank's failure to provide a
           delinquency notice within 30 days did not cause seri-
           ous harm to the Government.

     2. SBA may not purchase a guaranteed loan which became
        delinquent on or after February .19, 1976, hut before
        August 10, 1976, unless it bas received a delinquency
        notice within 90 days of default.

     3. SBA may not pay interest accrued on loans which be-
        came delinquent on or after February 19, 1976, un-
        less notice is received within 45 days of default.

     4. SBA must make a serious harm determination on loans
        which became delinquent on or after August 10, 1976,
        unless notice is received within 45 days of default.

     After SBA revised its regulations on March 8, 1976, it
also revised its Standard Operating Procedure for loan serv-
i.ing to instruct loan officers on how to conform to the
Comptroller Ceneral's decision and its own regulations.
These procedures in effect at the time of our review listed
five factors which loan officers should consider in determin-
ing whether a bank': slow reporting of a borrower's delin-
quency had seriously harmed the Government. These five fac-
tors were:

     "1)   Deterioration or disposition of collateral
      2)   Intervening liens, judgments, taxes, etc.
      3)   Disposal of borrower/guarantor assets
      4)   Lapse of hazard, flood, or life insurance
      5)   Bankruptcy proceedings"

     The procedures required loan officers to indicate on
documents relating to loan purchase that either notice was
received as required or that after a careful review the loan
officer has determined that a late notice did not cause the
Government serious harm. These procedures, although modi-
fied in August 197;, remained basically tile same.

EFFECTS OF LATE NO':ICES
NOT FULLY DETERMINED

     At the Boston and Kansas City distr 4 ct offices, loan
specialists had not adequately considered whether late de-
linquency notices had harmed the Government's interests.
This was evident from the following:



                                 4
B-18i432


     -- 69 of the 64 loans we reviewed became delinquent prior
        to February 19, 1976. The files for 30 of theJe 69
        loans did not indicate that loan officers had done any
        analysis or investigation to support their determina-
        tions that the Government had not been harmed by late
        delinquency notices.
     -- 10 of these 69 loan files did not contain even the
        minimal evidence of a serious harm determination re-
        quired by SBA procedures--the loan specialist's cer-
        tification that such a determination had been made.
     -- Some loan specialists who recommended purchase of
        loans were unable to explain to us how they reached
        their findings on serious harm or they did not under-
        stand the circumstances in which this determination
        was required or the nature of the review to be per-
        formed.
     Loans may have been purchased at other SBA district
offices without a satisfactory analysis of whether late de-
linquency notice harmed the Government. This is indicated by
the failure of SBA procedures to adequately instruct loan
specialists on how to determine the effects of laze notice,
and by the absence of evidence of a serious harm analysis ill
purchase documents we reviewed at SBA headquarters. We fouri
at the headquarters that, o:: 106 randomly selected purchase
authorizations, 25 did not contain the statement required by
SBA procedures that the delinquency notice was timely or that
a careful review had been made of the effects .-, late notice.

     The following chart highlights the scope of our review at
the SBA district offices and some of the deficiencies noted.
                                       Kansas     San
                             Boston     City    Francisco   Total

Total loans reviewed           22        37         25        84

Loans delinquent before
  February 19, 1976            19
                              am=
                                         32         18        69
                                                              -

No deficiencies noted           2         9         18        29
Certification made but
  not documented               13        17          0        30
Required certification not
  male                             4      6          0        10


                               5
B-181432



Loan specialists unable to explain
serious harm determinaticns and
uncertain about requirements
for these determinations

     At the Kansas City district office, we reviewed 17 loans
which involved a late notice of a borrower's delinquency be-
ginning prior to February 19, 1976, and which contained no
documentation in the files as to a serious harm analysis.
We discussed each of these loans with the responsible loan
specialists. They were able tc specify some basis for their
opinion that the Government was not seriously harmed by the
late notices for 12 of the 17 loans.  They were not able to
explain satisfactorily how they reached this conclusion on
the other five loans.

      At the Boston district office, three loan specialists
told us they did not know they were required to consider the
five possible causes of injury to the Government before cer-
'i.fying that the Government had not been seriously harmed by
late delinquency notice.

     The Assistant District Director for Finance and Invest-
ment and the Chief of the Portfolio Management Division at
the Boston district office acknowledged that the district of-
fice was not complying with SBA Headquarters' directives on
determining whether the Government was harmed by late delin-
quency notices. We also discussed our finding with the
Assistant Regional Director for Finance and Investment in
Boston who subsequently sent a memorandum to district direc-
tors which stated, in part:

     "It is not enough to simply state the 'no serious
     harm' disclaimer. The loan officer must review
     the five items [listed in SEA procedures] concern-
     cerning collateral, liens, guarantors, insurance
     and bankruptcy and state the results of his review
     of those minimum items."

     Loan specialists at the Boston district office had also
misinterpreted SBA's procedures implementing the Comptroller
General's decision.  They believed that reporting a delin-
quency wichin 45 days was allowed for all loans purchased on
or after February 19, 1976, regardless of the date of delin-
quency.  However, this belief was in contravention to estab-
lished procedures. These procedures provide that a bank has
45 days to report a delinquency occurring on or after Febru-
ary 19, 1976, but only 30 days to report a delinquency occur-
ing prior to that date. As a result of this misunderstanding,

                               6
B-181432



three loans were purchased without the required serious harm
determination.  we reported our findings to a regional office
official who directed t,.at all purchases be reviewed for com-
pliance with SBA procedures and that loan specialists make
the serious harm determination in accordance with the proce-
dures.

Inadequate procedures for
determining serious hara-
     The failure of SBA procedures to instruct loan officers
on how to determine the effects of late delinquency notices
may have contributed to the inadequacies of these determina-
tions.  The procedures also do not require a reexamination
of serious harm determinations at the completion of loan
liquidation (the process ~f resorting to collate;.al or other-
wise enforcing collection) although the effects of late no-
tice may sometimes not be fully determinable until then.

     SBA procedures in effect at the time of our review did
not instruct loan specialists how to determine whether a late
delinquency notice seriously harmed the Government. The pro-
cedures stated that a review for serious harm should be made
and listed examples of harm (e.g., deterioration of collat-
eral) but did not advise loan specialists on the nature or
extent of the investigation they should perform.

     An SBA headquarters official told us that if documents
in the loan file do not indicate that the Government was
harmed by a late notice, physical inspection of the borrower's
place of bus ness and collateral was not required.  In our
opinion, a reliable determination of whether a late notice
caused serious harm to the Government cannot be made without
such an inspection. Officials of the SBA Kansas City region
agreed that a thorough analysis of the effect of a late de-
linquency notice would require an inspection of the borrow-
er's collateral.  In addition, a site inspection of collat-
eral would provide SBA an opportunity to evaluate the busi-
ness and decide on a proper course of action; e.g., to pro-
vide further assistance or secure the collateral to protect
the Government's interest.

     The need for cnsite inspection of collateral is illus-
trated by two loans we reviewed at the Kansas City district
office. These loans were made to one borrower.   SBA's share
of outstanding balances totaled about $14,500. The loans
were delinquent 129 and 90 days before SBA was notified.   A
loan officer recommended purchase of these loans on May 7,
1976, based on his review of documents in the loan files and

                              7
B-181432



his conclusion that the late delinquency notices had not
seriously harmed the Government. About 2 months later a loan
specialist visited the borrower's place of business and found
that much of the collateral was missing.

     SBA procedures require that a review for serious harm
be made at the time a bank requests purchase of a loan.
There is no explicit requirement that the serious harm deter-
mination be reexamined after loan liquidation even though a
final determination of the effects of a late notice may be
possible only after liquidation has occurred and the borrow-
er's collateral has been sold. The Chief of the Portfolio
Management Division at She San Francisco district office said
that an important element in assessing the impact of a late
delinquency notice was its effect on collateral but that the
sufficiency of a borrower's collateral was often not estab-
lished until after liquidation.

      A final review of the effeczs of a late delinquency
notice after liquidation would be useful since, even after
purchase of a guaranteed loan, SBA has the right to recover
losses attributable to the lender.

LOAN PURCHASES APPROVED IN WASHINGTON
WITHOUT EVIDENCE OF COMPLIANCE WITH THE
COMPTROLLER GENERAL'S DECISION1

     As noted earlier, we found that the loan files and pur-
chase authorizations for 10 of the 59 loans we examined at
the Boston and Kansas City district offices did not contain a
certification by a loan specialist that a serious harm deter-
mination had been made. The purchase of these loans was ap-
proved by certifying officers in the Accounting Operations
Division, SBA headquarters.  Although payment had already
been made on these loans, the chief of the division told us
that they would be referred back to the district offices for
a determination.

     In addition, in our review of 106 loan purchase author-
izations at SBA headquarters we found that 25 loans had been
approved for payment by certifying officers despite a lack
of evidence that they were approving payments lawful under
the Comptroller General's decision and SBA's own regulations.
The purchase documents submitted by district offices for
these 25 loans did not show that delinquency notices were
submitted on time o. that no serious harm resulted from late
submissions.



                              8
B-181432



     Since these 25 loans included loans from each of the 10
SBA regions, the problem of inadequate serious harm determi-
nations may be common throughout SBA offices.

PURCHASE OF LOANS SUBJECT TO TEE
 4- AND 90-DAY NOTICE REUIREMENTS
     As indicated on page 3, SBA revised its regulations on
March 8, 1976; to permit banks 45 days within which to report
a borrower's delinquency. Under the revised regulations SBA
would not pay accrued interest to a bank which did not report
within 45 days and would consider its guarantee commitment to
be terminated if a delinquency was not reported within 90
days. Tha new regulations applied to loans which became
delinquent on or after February 19, 1976.

     Our review included 12 such loans. In each case the bank
reported the borrower's delinquency within 45 days.

CONCLUSIONS

     A Comptroller General's decision and SBA procedures im-
plementing thil decision require that before purchasing a
guaranteed loan which became delinquent prior to February 19,
1976, SBA determine whether a bank's failure to provide a
timely notice of a borrower's delinquency seri)usly harmed the
Government. These determinations were often not made satis-
factorily at SBA's Boston and Kansas City district offices.
The same problem may exist at other SBA offices.

     Loan purchase authorizations did not indicate the basis
for loan specialists' conclusions that the Government was not
seriously harmed by late delinquency notices.   Some loan spe-
cialists could not explain their determinations  to us.

     Inadequate serious harm determinations resulted in part
from misunderstanding by loan specialists about when the de-
termination was required and how it should be performed. Al-
though SEA procedures re;ognize  that harm to the Government
can result from deterioration or  dissipation of collateral,
loan specialists were not required to physically inspect col-
lateral. Site inspection of collateral would also give SBA
information on how to further service the loan.

     Certifying officers in Washington have approved the
purchase of loans without evidence that the Comptroller Gen-
eral's decision was followed.


                              9
B-181432


     Even though a final determination of the effects of a
late notice may be possible only after the loan has been
through liquidation and the borrower's collateral has been
sold, SBA procedures do not require that serious harm deter-
minations be reevaluated at this time.
RECOMMENDATIONS TO THE ADMINISTRATOR

     To insure that determinations of the effects of late de-
linquency notices were made reliably by district offices on
loans already purchased and to enable SBA where appropriate
to exercise its right to recover losses attributable to the
lender, we recommend that SBA
      --review purchase documents in the Accounting Operations
        Division to determine whether an initial review for
        serious harm was made by district offices and resubmit
        loans to these offices where no determination is evi-
        dent and
      -- reexamine the effects of late delinquency notice for
         all loans at the completion of liquidation.
      With regard to loans rot yet purchased, we recommend that
SBA

      -- insure that loan specialists clearly understand when a
         review for serious harm should be made;
      -- provide additional instructions to district offices on
         methods of determining serious harm, including the
         need to physically inspect loan collateral;
      -- require loan specialists to document the basis for
         their determinations of serious harm; and
      -- instruct loan specialists to make a final evaluation
         for serious harm at the completion of loan liquidation.


     As you know, section 236 of the Legislative Reorganiza-
tion sct of 1970 r3quires the head of a Federal agency to sub-
mit a written statement on actions taken on our recommenda-
tions to the House and Senate Committees on Government Opera-
tions not later than 60 days after the date of the report and
to the House and Senate Committees on Appropriations with the


                              10
B-181432



agency's first Lequest for appropriations made more than 60
days after the date of the report.
     Copies of this report are being sent to the aforemen-
tione6 four committees; the applicable legislativ- ccmmittees;
and the Director, Office of Management and Budget.
    Thank you for the cooperation given to our staffs.

                              Sincerely yours,




                              Henry Eschwege
                              Director