oversight

Audit of SBA's Controls over 7(a) Loans Sold on The Secondary Market

Published by the Small Business Administration, Office of Inspector General on 2019-03-14.

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

                 AUDIT REPORT


        AUDIT OF SBA’S CONTROLS OVER 7(A)
       LOANS SOLD ON THE SECONDARY MARKET




MARCH 14, 2019                    REPORT NUMBER 19-07
                         EXECUTIVE SUMMARY                                                   Report
                                                                                             No. 19-07

                         AUDIT OF SBA’S CONTROLS OVER 7(A) LOANS                             March 14,
                                                                                             2019
                         SOLD ON THE SECONDARY MARKET

What OIG Reviewed                                      opportunities exist to strengthen controls to
                                                       further mitigate the risk of loss for loans sold on
This report presents the results of our audit of the   the secondary market. Specifically, we found that
Small Business Administration’s (SBA’s) controls       the Office of Credit Risk Management (OCRM) did
over loans sold on the secondary market. The SBA       not communicate the results of their secondary
secondary market program allows lenders to sell        market loan sale reviews to the National Guaranty
the guaranteed portions of their SBA 7(a) loans to     Purchase Center and the Commercial Loan
private investors at a premium to provide              Servicing Centers. Also, SBA did not always
expanded availability to capital for small             provide statutory reports to Congress timely, and
businesses. The fiscal transfer agent (FTA) for 7(a)   SBA’s lender guidance for the secondary market
loans that is contracted by SBA facilitates the sale   was outdated. Lastly, SBA did not properly
process and is responsible for various other           determine lender compliance with loan program
functions regarding the secondary market.              requirements for one of the loans reviewed.
Between fiscal years 2013 and 2017,
approximately 59,000 7(a) loans were approved,         As a result, there is a risk that SBA could improp-
disbursed, and sold on the secondary market,           erly purchase secondary market loans that OCRM
totaling $45 billion.                                  identified as having material noncompliance with
                                                       SBA requirements. Additionally, Congress may not
Our objectives were to determine the                   have the necessary information to make informed
effectiveness of SBA’s (1) controls to ensure that     decisions regarding SBA’s secondary market
quality loans were sold into the secondary market      operations, and new lenders may not have
and (2) review process to determine lender             consistent and updated guidance to ensure com-
compliance with program requirements on loans          pliance with SBA requirements. Finally, by
purchased off the secondary market.                    charging off an ineligible loan, SBA incurred a loss
                                                       of $130,173.
To answer our objectives, we interviewed SBA and
FTA officials to gain an understanding of the
                                                       OIG Recommendations
secondary market and their specific roles and
responsibilities. Through those interviews and         We made five recommendations that, if
reviews of randomly selected loans, we also            implemented, will strengthen SBA’s internal
gained an understanding of the controls                controls, enhance external communication, and
implemented to mitigate the risk of noncompliant       seek recovery of funds on an ineligible loan that
loans being sold on the secondary market and to        was charged off.
ensure that lenders complied with SBA loan
program requirements for defaulted loans               Agency Response
purchased off the secondary market.
                                                       Management agreed with the report findings and
Our overall scope of work covered fiscal years         all recommendations. Management stated they
2013 through 2017. However, based on our               will communicate material loan deficiencies to the
analysis and controls recently implemented by          appropriate loan centers via the loan system, for
SBA, we limited our sample selections to specific      both previously identified and future issues.
periods within that scope. Specifically, our           Management also stated they established a
random samples included 7(a) loans covering a          process to ensure timely submission of secondary
period between August 2015 and December 2017.          market annual reports, and they are currently
                                                       updating the Secondary Market Program Guide.
What OIG Found                                         Finally, regarding the ineligible loan, management
                                                       stated they will work with the lender to bring the
We determined that internal controls related to        loan into compliance; if the issues are not
the sale of loans into the secondary market and        overcome, SBA will seek recovery.
SBA’s reviews for lender compliance on defaulted
loans were generally effective. However,
                              U.S. SMALL BUSINESS ADMINISTRATION
                                  OFFICE OF INSPECTOR GENERAL
                                    WASHINGTON, D.C. 20416


                                                                          Final Report Transmittal
                                                                             Report Number: 19-07

DATE:          March 14, 2019

TO:            Linda E. McMahon
               Administrator

FROM:          Hannibal “Mike” Ware
               Inspector General

SUBJECT:       Audit of SBA’s Controls Over 7(a) Loans Sold on the Secondary Market

This report presents the results of our audit of the Small Business Administration’s (SBA’s) controls
over 7(a) loans sold on the secondary market. Our objectives were to determine the effectiveness of
SBA’s (1) controls to ensure that quality loans were sold into the secondary market and (2) review
process to determine lender compliance with program requirements on loans purchased off the
secondary market.

We considered management’s comments on the draft of this report when preparing the final report.
Management agreed with the findings and all recommendations.

We appreciate the courtesies and cooperation extended to us during this audit. If you have any
questions, please contact me at (202) 205-6586 or Andrea Deadwyler, Assistant Inspector General
for Audits, at (202) 205-6616.


cc: Pradeep Belur, Chief of Staff
    Christopher M. Pilkerton, General Counsel
    William Manger, Associate Administrator, Office of Capital Access
    John Miller, Deputy Associate Administrator, Office of Capital Access
    Dianna Seaborn, Director, Office of Financial Assistance
    Jihoon Kim, Director, Office of Financial Program Operations
    Susan Streich, Director, Office of Credit Risk Management
    Martin Conrey, Attorney Advisor, Legislation and Appropriations
    Timothy E. Gribben, Chief Financial Officer and Associate Administrator for Performance
      Management
    LaNae Twite, Director, Office of Internal Controls
Table of Contents
Introduction ............................................................................................................................................................................... 1
    The Secondary Market for Small Business Administration 7(a) Loans ....................................................... 1
    Secondary Market Portfolio Characteristics............................................................................................................ 1
    SBA Controls Over Loans Prior to Sale on the Secondary Market .................................................................. 1
    SBA’s Role in Defaulted 7(a) Loans Sold on the Secondary Market............................................................... 2
    Prior Work ............................................................................................................................................................................. 3
    Objectives ............................................................................................................................................................................... 3
Finding 1: Communication With SBA Loan Purchase Centers Could Prevent Improper Guaranty
Purchases .................................................................................................................................................................................... 4
    Recommendations.............................................................................................................................................................. 5
Finding 2: Providing Timely Congressional Reports is Essential to Ensure Congress Has Vital
Information for Its Decision Making................................................................................................................................ 6
    Recommendation................................................................................................................................................................ 6
Finding 3: Consistent Program Guidance Could Safeguard Program Integrity ............................................. 7
    Recommendation................................................................................................................................................................ 7
Finding 4: SBA’s Improper Review of a Loan Resulted in a Loss of $130,173 ............................................... 8
    Recommendation................................................................................................................................................................ 8
Analysis of Agency Response.............................................................................................................................................. 9
         Summary of Actions Necessary to Close the Recommendations ............................................................... 9
Appendix I: Objective, Scope, and Methodology ....................................................................................................... 10
    Use of Computer-Processed Data............................................................................................................................... 10
    Review of Internal Controls.......................................................................................................................................... 11
Appendix II: Questioned Costs ......................................................................................................................................... 12
Appendix III: Agency Comments ..................................................................................................................................... 13
Introduction

The Secondary Market for Small Business Administration 7(a) Loans

The Small Business Administration’s (SBA’s) 7(a) loan program provides small businesses access to
capital. SBA guarantees up to 90 percent for loans up to $5 million on private lender loans to
eligible small businesses. In the event that a borrower defaults, SBA will honor its guaranty if it
determines that the lender originated, closed, serviced, and liquidated the loan in accordance with
SBA’s loan program requirements.

The secondary market was established to provide greater liquidity to lenders, and thereby expand
the availability of commercial credit for small businesses. Lenders are allowed to sell the
guaranteed portions of their loans in the secondary market. The lender receives cash equal to the
amount of the guaranteed portion sold plus a market driven premium, while the investor gets an
interest earning security that is backed by the full faith and credit of the U.S. government. In fiscal
year (FY) 2016, approximately 64 percent of guaranteed loan dollars on the secondary market were
sold at a premium of at least 10 percent over par.

If a lender chooses to sell a loan on the secondary market, it enters into an agreement with the fiscal
transfer agent (FTA), the investor, and SBA. Once the sale has been finalized, the lender maintains
responsibility for servicing the loan in accordance with SBA loan program requirements. The FTA is
responsible for facilitating the sale of the loan to the investor, accounting for borrower payments,
and assisting with guaranty purchase if the loan defaults.

Secondary Market Portfolio Characteristics

Between FY 2013 and FY 2017, approximately 59,000 7(a) loans were approved, disbursed, and
sold on the secondary market, totaling $45 billion, which represented 48 percent of the total $93
billion in disbursed 7(a) loans. The average loan amount for loans sold on the secondary market
exceeded $760,000, which was nearly three times the average amount of $270,000 for non-
secondary market loans.

The total dollar outlays for secondary market purchases were 134 percent higher than non-
secondary market purchases between FY 2013 and FY 2017. Specifically, total dollar outlays for
defaulted loans purchased on the secondary market from FY 2013 through FY 2017 totaled
approximately $552 million. For the same period, defaulted loans not sold on the secondary market
totaled approximately $236 million.

The average loan amount and total dollar outlays for secondary market purchases exceed those of
non-secondary market loans. Based on the size, on a per loan basis, loans sold on the secondary
market would generally present greater risk to taxpayers.

SBA Controls Over Loans Prior to Sale on the Secondary Market

Before a loan can be sold on the secondary market, the lender must submit the loan to the FTA for
approval. SBA has established a risk-based review process to determine whether loans are eligible




                                                  1
to be sold. Loans submitted for sale approval are reviewed by the FTA via the SBA Form 1086. 1 On
the form, the lender is required to certify that, among other things, it

    1. underwrote, closed, and serviced the loan in a prudent manner and in accordance with all
       SBA loan program requirements;
    2. will not share any premium it received from the sale with a lender service provider,
       packager, or other loan referral source;
    3. fully disbursed the loan;
    4. did not issue a revolving loan or line of credit; and
    5. has no knowledge of a default or likelihood of a default by Borrower.

Once received from the lender, the FTA reviews the SBA Form 1086, note, and other documentation
to ensure information contained in the loan package is consistent with SBA’s loan origination
information. This limited review ensures the loan meets the requirements to be sold on the
secondary market.

For lenders under regulatory, state, or federal orders, SBA maintains a watch list. Lenders on this
watch list may request for a loan to be sold on the secondary market through the FTA. However,
due to the risk associated with these lenders, SBA’s Office of Credit Risk Management (OCRM)
conducts a detailed review of each loan to determine whether it complied with SBA requirements
and is eligible for sale.

SBA’s Role in Defaulted 7(a) Loans Sold on the Secondary Market

In the event that a borrower defaults, the lender may buy back the loan from the secondary market
investor. If the lender does not buy back the loan, SBA will purchase the loan from the secondary
market investor upon receipt of the required loan balance documentation. After SBA purchases a
loan from the secondary market, SBA must conduct a purchase review to determine whether the
lender complied with SBA loan program requirements. Once liquidation is complete, the lender is
required to submit a final report to indicate that the loan is ready for charge-off and potential
referral to the Treasury. Upon receipt of this documentation, SBA conducts the charge-off review to
determine whether all avenues of recovery were exhausted.

In response to an increasing number of outstanding purchase and charge-off reviews in FY 2014,
SBA initiated an inventory reduction project to reduce the outstanding number of purchase and
charge-off reviews. Specifically, SBA’s analysis indicated that the beginning inventory level was
approximately 16,000 outstanding charge-offs. SBA anticipated that the inventory reduction project
would decrease the inventory level by approximately 5,000 charge-offs within 18 months. SBA data
showed that more than 1,600 loans were charged off in a 2-month period (between August and
September 2015). See the figure below for a representation of the 2-month anomaly.




1SBA Form 1086 is a legally binding document, which includes the terms and conditions that govern the sale and all
subsequent servicing of the loan sold, which must be executed by the lender, registered holder (or investor), FTA, and
SBA.




                                                            2
Figure: Secondary Market Charge-Offs by Month (FY 2013–FY 2017)

  1,000
    900                                                                                                              August-15
    800                                                                                                                                                              September-15
    700
    600
    500
    400
    300
    200
    100
      -
                       January-13




                                                                      January-14




                                                                                                                      January-15




                                                                                                                                                                     January-16




                                                                                                                                                                                                                    January-17
                                               July-13




                                                                                              July-14




                                                                                                                                              July-15




                                                                                                                                                                                             July-16




                                                                                                                                                                                                                                            July-17
                                    April-13




                                                                                   April-14




                                                                                                                                   April-15




                                                                                                                                                                                  April-16




                                                                                                                                                                                                                                 April-17
          October-12




                                                         October-13




                                                                                                        October-14




                                                                                                                                                        October-15




                                                                                                                                                                                                       October-16
Source: SBA mainframe data.

Prior Work

A 2017 OIG report on SBA’s 2017 financial statements identified a significant deficiency related to
prepaid principal that was to be distributed to pool investors by the FTA. 2 The audit found that the
Secondary Market Guaranty program was not being executed in accordance with Federal Register
changes from 2004. Specifically, the changes implemented in 2004 required the FTA to disburse
any partial prepayments to the pool holders with the next scheduled payment. Previously, the FTA
would have held the partial prepayment in the Master Reserve Fund and distribute the prepayment
over the remaining life of the pool. OIG made and management agreed to the following two
recommendations:

    1. Enhance SBA’s complementary controls regarding the Secondary Market Guaranty program
       and relevant processes at the FTA.

    2. Monitor and perform procedures over service organization’s attestation report regarding
       user control considerations.

Recommendation 1 has been closed; however, recommendation two remains open with a
management action due date of September 2019.

Objectives

Our objectives were to determine the effectiveness of SBA’s (1) controls to ensure that quality loans
were sold into the secondary market and (2) review process to determine lender compliance with
program requirements on loans purchased off the secondary market.




2 OIG Report 18-03, Independent Auditors’ Report on SBA’s FY 2017 Financial Statements (November 14, 2017). The

report defined a significant deficiency as a deficiency, or a combination of deficiencies, in internal control that is less
severe than a material weakness, yet important enough to merit attention by those charged with governance.




                                                                                                                         3
Finding 1: Communication With SBA Loan Purchase Centers Could
Prevent Improper Guaranty Purchases

Based on our testing, we determined that OCRM’s review of loans sold on the secondary market
was generally effective. Specifically, OCRM developed an extensive checklist and completed detailed
reviews to determine whether loans were eligible for sale on the secondary market. Further, OCRM
denied 13 secondary market loan sale requests as a result of their reviews from May 2017 to
February 2018. Three of the denied loan sale requests were resubmitted with additional
information and subsequently approved. Eight of the remaining 10 loans had deficiencies related to
eligibility and closing. We believe these deficiencies represent issues that would warrant loan
guaranty denial consideration, should the loan default. However, OCRM officials did not
communicate their loan review results to the SBA loan centers responsible for guaranty purchases.

The Office of Management and Budget (OMB) establishes policies and procedures for justifying,
designing, and managing federal credit programs. It also establishes principles for designing and
improving program efficiency and effectiveness. 3 The Circular reads, “Departments and agencies
shall manage credit programs… in accordance with their statutory authorities and the provisions of
this Circular to protect the government’s assets and to minimize losses in relation to social benefits
provided.” Additionally, the Circular reads that to achieve those objectives, agencies shall “[e]mploy
robust diagnostic and reporting frameworks, including dashboards and watch lists, so that all levels
of the organization receive appropriate information to inform proactive portfolio management.”

OCRM’s mission is to maximize the efficiency of SBA’s lender programs by effectively managing
program credit risk. As part of its mission, OCRM maintains a secondary market watch list for
lenders that participate in SBA programs that are under a federal or state regulatory order. Once
the lender is placed on the watch list, the FTA is notified. When a lender that is on the watch list
requests for a loan to be sold on the secondary market, the FTA notifies OCRM. Subsequently, OCRM
requests and reviews loan documents to ensure the loan was originated and closed in accordance
with SBA loan program requirements.

Although OCRM established a watch list, and conducted secondary market loan sale reviews, they
did not communicate the results of the reviews to the National Guaranty Purchase Center and
Commercial Loan Servicing Centers to inform proactive portfolio management. This occurred
because OCRM did not believe they needed to communicate the results, and they didn’t have an
established process for doing so. As a result, there is risk that loan centers could improperly
purchase the guaranties on these loans.

During our followup discussions with OCRM officials, they indicated that they recently decided to
implement a process to note OCRM review results in the Centralized Loan Chron System. 4 However,
our subsequent review of the system determined that the deficiencies for the 10 denied loan sale
requests we reviewed were not recorded in the system. Therefore, we do not consider the process
implemented.




3   OMB Circular A-129, Policies for Federal Credit Programs and Non-Tax Receivables (January 2013).
4   The Centralized Loan Chron System provides a centralized repository for viewing and entering loan chron information.




                                                             4
Recommendations

We recommend that the Administrator direct the Director of the Office of Credit Risk Management
to:

   1. Communicate material loan deficiencies previously identified by OCRM secondary market
      loan sale reviews to the appropriate SBA loan purchase centers to mitigate the risk of
      improper guaranty purchases in the event of default.

   2. Establish a process to ensure that pertinent review results from future OCRM secondary
      market loan reviews are communicated to the appropriate SBA loan centers.




                                               5
Finding 2: Providing Timely Congressional Reports is Essential to Ensure
Congress Has Vital Information for Its Decision Making

SBA did not provide the 2016 and 2017 congressionally mandated secondary market reports to
Congress in a timely manner. Specifically, the responsible Office of Financial Assistance official
stated they provided the 2016 and 2017 reports to congressional staff during the fall of 2017 and
September 28, 2018, respectively. We noted that the 2017 report was provided approximately
6 months after the required due date. We could not determine the extent of the delay for the 2016
report because SBA did not provide the exact date they delivered the report to Congress. In
addition, SBA did not provide the reports to Congress for calendar years 2013, 2014, and 2015, as
required.

The Small Business Act requires SBA officials to submit a report on the secondary market
operations for the preceding year to the Committees on Small Business of the Senate and House of
Representatives by March 31 of each year. 5 The report must include the following:

       1. number and the total dollar amount of loans sold into the secondary market and the
          distribution of such loans by size of loan, size of lender, geographic location of lender,
          interest rate, maturity, lender servicing fees, whether the rate is fixed or variable, and
          premium paid;
       2. number and dollar amount of loans resold in the secondary market with a distribution by
          size of loan, interest rate, and premiums;
       3. number and total dollar amount of pools formed;
       4. number and total dollar amount of loans in each pool;
       5. dollar amount, interest rate, and terms on each loan in each pool, and whether the rate is
          fixed or variable;
       6. number, face value, interest rate, and terms of the trust certificates issued for each pool;
       7. use by the lender of the proceeds of sales of loans in the secondary market for additional
          lending to small business concerns (to the maximum extent possible); and
       8. analysis of the information reported in (1) through (7) to assess small businesses’ access to
          capital at reasonable rates and terms as a result of secondary market operations.

The SBA official stated the reports were not prepared and provided due to staffing issues. The
secondary market annual reports provide Congress vital information needed to establish baseline
statistics for the secondary market. SBA’s noncompliance in providing these reports as required
could negatively affect Congress’ ability to make informed decisions regarding SBA’s secondary
market, such as whether any changes are necessary to the established cap for secondary market
loan sales.

Recommendation

We recommend that the Administrator direct the Director of the Office of Financial Assistance to:

       3. Establish and implement controls to ensure secondary market annual reports are provided
          to Congress in a timely manner, as required.




5   15 U.S.C 639(h), Small Business Act.




                                                    6
Finding 3: Consistent Program Guidance Could Safeguard Program
Integrity

SBA standard operating procedure provides high-level information on the secondary market and
directs lenders that need additional program guidance, such as those new to selling on the
secondary market, to visit the FTA website. The FTA website includes the SBA Form 1086, bid
sheets, and prepayment certifications. One of the key documents provided to lenders to detail the
secondary market loan sale process is the Secondary Market Program Guide. However, SBA has not
updated this guide since it was created in August 1985. While SBA made a number of necessary
changes to standard operating procedures and lender notices since the guide was issued, program
management indicated that the recent changes need to be incorporated into the guide. SBA
management indicated that they anticipated completing and releasing an updated guide in FY 2019.

Internal control serves as the first line of defense in safeguarding assets and helps an entity run its
operations efficiently and effectively. Internal controls also help an entity comply with applicable
laws and regulations. Effective internal controls include management communicating necessary
quality information to achieve the entity’s objectives both internally and externally. 6

SBA did not prioritize updating the guide to ensure consistency with the updated requirements.
Without communicating consistent and updated information, SBA cannot ensure that its newer
lending partners have clear information to consistently comply with appropriate laws and
regulations.

Recommendation

We recommend that the Administrator direct the Director of the Office of Financial Assistance to:

       4. Update secondary market guidance to ensure that it aligns with current secondary market
          requirements.




6   Standards for Internal Control in the Federal Government (September 2014).




                                                            7
Finding 4: SBA’s Improper Review of a Loan Resulted in a Loss of
$130,173

After SBA purchases a loan from the secondary market, SBA must conduct a purchase review to
determine whether the lender complied with SBA loan program requirements. Once liquidation is
complete, the lender is required to submit a final wrapup report to indicate that the loan is ready
for charge-off and potential referral to the Treasury. Upon receipt of this documentation, SBA
conducts the charge-off review to determine whether all avenues of recovery were exhausted. Our
analysis of SBA data showed that more than 1,600 loans were charged off in a 2-month period
(between August and September 2015). Because of this anomaly, we selected a random sample of
20 loans that SBA completed charge-off reviews for during this timeframe.

Based on our reviews, we determined that SBA personnel adequately conducted charge-off reviews
for 19 of 20 loans. Specifically, the reviews contained documentation to support that SBA
completed the reviews, as required, and any identified issues were adequately resolved prior to
charge-off. However, SBA did not resolve an eligibility issue prior to charging off the remaining
loan. The loan was approved for $410,000. SBA honored the guaranty on the loan for $275,736, and
SBA subsequently charged off $130,173, which was a reduced amount due to other recoveries.

The initial legal reviewer identified that the loan had an eligibility deficiency. Due to the identified
deficiency, the loan was required to have a secondary legal review; however, the legal reviewer did
not address the eligibility deficiency. The approver documented that the initial legal reviewer
identified the eligibility deficiency but still closed the review. The charge-off reviewers did not
identify any outstanding issues and subsequently charged off the loan. In subsequent
correspondence, SBA officials indicated that they had determined the loan was ineligible, and they
planned to act accordingly.

An SBA official stated that the issue was not properly addressed because the legal reviewer
completed the wrong section of the purchase review, which resulted in an improper interpretation
of the legal reviewer’s decision by the approving official. Because SBA did not properly determine
lender compliance with loan program requirements, SBA incurred a loss of $130,173 on the loan
guaranty.

Recommendation

We recommend that the Administrator direct the Director of the Office of Financial Program
Operations to:

    5. Require the lender to bring the loan into compliance or, if not possible, seek recovery of
       $130,173 on the guaranty paid by SBA.




                                                   8
Analysis of Agency Response

Management agreed with the findings and all recommendations. Regarding recommendations 1
and 2, management stated they will communicate material loan deficiencies to the appropriate loan
centers via the loan system, for both previously identified and future issues. They also will establish
a process to ensure the future issues are communicated. In subsequent correspondence,
management stated they implemented these actions on February 28, 2019.

Management also stated it established a process to ensure timely submission of the secondary
market annual reports to Congress by March 31, 2019. They are currently updating the Secondary
Market Program Guide, which will be completed by December 31, 2019. Lastly, management is
working with the lender to bring the ineligible loan into compliance. If the issues are not overcome,
SBA will seek recovery. In subsequent correspondence, management stated they will implement
this action by January 31, 2020.

The Agency’s response is included in its entirety in appendix III.

Summary of Actions Necessary to Close the Recommendations

The following provides the status of the recommendations and necessary actions to close them.

   1. Resolved. SBA management agreed with our recommendation and plans to communicate
      material loan deficiencies previously identified in the secondary market loan sale reviews to
      the SBA loan purchase centers via comments in the loan system. This recommendation can
      be closed when management provides evidence that the identified material loan
      deficiencies are documented in the loan system.

   2. Resolved. SBA management agreed with our recommendation and plans to establish a
      process to ensure that pertinent results from future secondary market loan reviews are
      communicated via comments in the loan system to the appropriate loan centers. This
      recommendation can be closed when management provides evidence that the process is
      established and the results are communicated to the appropriate loan centers.

   3. Resolved. SBA management agreed with our recommendation and stated they established
      a process to ensure timely submission of secondary market annual reports to Congress. In
      subsequent correspondence, management stated they will implement this action by
      March 31, 2019. This recommendation can be closed when management provides evidence
      that the process is established and the reports are submitted timely, as required.

   4. Resolved. SBA management agreed with our recommendation and plans to update the
      Secondary Market Program Guide by December 31, 2019. This recommendation can be
      closed when management provides a copy of the updated guide and evidence that the guide
      is available to appropriate SBA personnel and lenders.

   5. Resolved. SBA management agreed with our recommendation and plans to work with the
      lender to bring the loan into compliance. If the issues are not overcome, SBA will seek
      recovery by January 31, 2020.




                                                  9
Appendix I: Objective, Scope, and Methodology

This report presents the results of our audit of SBA’s controls over loans sold on the secondary
market. Our objectives were to determine the effectiveness of SBA’s (1) controls to ensure that
quality loans were sold into the secondary market and (2) review process to determine lender
compliance with program requirements on loans purchased off the secondary market.

To accomplish our objectives, we reviewed Section 7(a) of the Small Business Act, CFR Title 13, and
OMB Circular A-129. 7 In addition, we reviewed various versions of SBA’s standard operating
procedures, informational notices, and procedural notices for policies and procedures related to the
secondary market. Additionally, we reviewed secondary market guidance and documentation to
gain an understanding of the internal controls in place. Further, we met with SBA officials to gain an
understanding of SBA’s role in the secondary market. We interviewed officials from the FTA to gain
an understanding of the FTA’s role in the secondary market, and we conducted numerous analyses
related to loans sold on the secondary market. Our scope of work covered fiscal years 2013 through
2017.

SBA data showed that more than 1,600 loans were charged off in a 2-month period (between
August and September 2015). Based on this anomaly, we selected and reviewed a random sample
of 20 loans that were charged off in this timeframe. We did not perform extensive OIG loan file
reviews; instead, we reviewed the charge-offs to determine whether SBA completed reviews, as
required, and whether identified issues were resolved prior to charge-off. We also selected and
reviewed a random sample of 10 OCRM secondary market loan sale reviews completed on loans
submitted for secondary market sale between March and December 2017. We reviewed these loans
to determine whether OCRM followed the appropriate process in determining whether the loans
were eligible to be sold on the secondary market. Finally, we selected and reviewed a random
sample of 10 FTA loan sale documentation packages for loans sold between October 2016 and
September 2017 to determine whether the FTA followed the appropriate process and the loans
were eligible to be sold on the secondary market.

We conducted this performance audit in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit to obtain sufficient,
appropriate evidence to provide a reasonable basis for our findings and conclusions based on our
audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objectives.

Use of Computer-Processed Data

We relied on information from SBA’s Mainframe Loan Accounting System and data from the
National Guaranty Purchase Center to conduct our analyses. Previous OIG engagements have
verified that the information maintained in Mainframe Loan Accounting System is reasonably
reliable. In addition, we conducted reliability tests by comparing the supplemental loan level data
provided by the National Guaranty Purchase Center to source documentation and determined it
was reasonably reliable. As a result, we believe the information obtained and used for the purposes
of this audit is reliable.




7   OMB Circular A-129, Policies for Federal Credit Programs and Non-Tax Receivables (January 2013).




                                                           10
Review of Internal Controls

SBA’s internal control systems standard operating procedure provides guidance on implementing
and maintaining effective internal control systems, as required by OMB Circular A-123. 8 OMB
Circular A-123 provides guidance to federal managers on improving the accountability and
effectiveness of federal programs and operations by establishing, assessing, correcting, and
reporting on internal controls. 9 To assess internal controls during the audit, we assessed the
control environment in which SBA reviewed and evaluated loans that were sold on the secondary
market. We interviewed SBA officials with the responsibility over the secondary market and SBA
officials involved with various aspects such as oversight and the purchase of defaulted loans from
the secondary market. We found that internal controls related to our audit objectives were
generally effective in mitigating risk in the secondary market.

In 2017, SBA self-reported a deficiency regarding prepaid principal that was to be distributed to
pool investors by the FTA. OIG Report 18-03 identified this as a significant deficiency and made two
recommendations to strengthen SBA’s controls over the secondary market. 10 However, the
deficient controls were not within the scope of this audit. Further, one of recommendations has
been closed.




8 SOP 00 02, Internal Control Systems (January 1986).
9 OMB Circular A-123, Management’s Responsibility for Enterprise Risk Management and Internal Control (July 15, 2016).
10 OIG Report 18-03, Independent Auditors’ Report on SBA’s FY 2017 Financial Statements (November 14, 2017).




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Appendix II: Questioned Costs

                      Questioned Costs for Secondary Market Charge-Off Sample

      Sample               Approval Amount      Purchase Amount       OIG Questioned Costs
        1                     $410,000              $275,736               $130,173
      Totals                  $410,000              $275,736               $130,173
Source: Generated from audit results.




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Appendix III: Agency Comments

                                U.S. SMALL BUSINESS ADMINISTRATION
                                       WASHINGTON, D.C. 20416




TO:             Hannibal M. Ware, Inspector General
                Office of Inspector General (OIG)

FROM:           Susan Streich
                Director, Office of Credit Risk Management (OCRM)

                Dianna Seaborn
                Director, Office of Financial Assistance (OFA)

                Jihoon Kim
                Director, Office of Financial Program Operations (OFPO)

SUBJECT:        Responses to Draft Report on SBA’s Controls Over Loans Sold on the Secondary
                Market

DATE:           February 12, 2019

The Office of Capital Access (OCA) Management appreciates the role of the Office of Inspector General
(OIG) plays in working with management in ensuring that our programs are effectively managed, and
for the feedback provided in this draft report.

This draft report presents the results of OIG’s audit of the Small Business Administration’s (SBA’s)
controls over loans sold on the secondary market.

OIG determined that internal controls related to the sale of loans into the secondary market and SBA’s
reviews for lender compliance on defaulted loans were generally effective. However, OIG stated that
opportunities exist to strengthen controls to further mitigate the risk of loss for loans sold on the
secondary market, therefore:

OIG made the following five recommendations and Management’s responses to the
recommendations in the draft report are noted as follows:


1. Communicate material loan deficiencies previously identified by OCRM secondary market loan
   sale reviews to the appropriate SBA loan purchase centers to mitigate the risk of improper
   guaranty purchases in the event of default.



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   Management substantially concurs with the report and recommendations.

    OCRM will communicate material loan deficiencies identified in the secondary market loan sale
    reviews to the SBA loan purchase centers via comments in the loan system.


2. Establish a process to ensure that pertinent review results from future OCRM secondary market
   loan reviews are communicated to the appropriate SBA loan centers.

   Management substantially concurs with the report and recommendations.

   OCRM will establish a process to ensure that pertinent results from future secondary market loan
   reviews are communicated via comments in the loan system to the appropriate loan centers.

3. Establish and implement controls to ensure secondary market annual reports are provided to
   Congress in a timely manner, as required.

   Management substantially concurs with the report and recommendations.

   OFA has established a process to ensure timely submission of secondary market annual report
   (March 31) as required by Statute.

4. Update secondary market guidance to ensure that it aligns with current secondary market
   requirements.

   Management substantially concurs with the report and recommendations.

   OFA is in the process of updating the Secondary Market Program Guide. The Guide will be
   completed no later than December 31, 2019.

5. Require the lender to bring the loan into compliance or, if not possible, seek recovery of $130,173
   on the guaranty paid by SBA.

   Management substantially concurs with the report and recommendations.

   After conducting a preliminary review, and absent additional information from the lender,
   deficiencies appear to exist. OFPO will notify the lender and work with the lender to obtain
   documentation to bring the loan into compliance. If the issues are not overcome, SBA will seek
   recovery from the lender.




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