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entitled 'SBA Disaster Loan Program: Accounting Anomalies Resolved but 
Additional Steps Would Improve Long-Term Reliability of Cost Estimates' 
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Report to Congressional Requesters:

April 2005:

SBA Disaster Loan Program:

Accounting Anomalies Resolved but Additional Steps Would Improve Long- 
Term Reliability of Cost Estimates:

GAO-05-409:

GAO Highlights:

Highlights of GAO-05-409, a report to congressional requesters:

Why GAO Did This Study:

In response to a January 2003 GAO report that identified significant 
anomalies in the Small Business Administration’s (SBA) disaster loan 
accounts and raised serious concerns about its ability to account for 
loan sales and estimate program costs, SBA conducted an extensive 
analysis to identify causes of the anomalies and implemented a number 
of corrective actions. In light of SBA’s actions, GAO undertook a 
follow-up review to (1) describe the nature of the deficiencies SBA 
identified, (2) determine whether its corrective actions resolved the 
deficiencies, and (3) assess whether its procedures provide a 
reasonable basis for future credit estimates. 

What GAO Found:

SBA took prompt action with a comprehensive review of its financial 
records and systems to identify the deficiencies related to accounting 
for its disaster loans and loan sale program. SBA’s review found (1) 
the cash flow model used to estimate the cost of the disaster loan 
program was unreliable and underestimated the cost, (2) the model used 
to determine whether sales were beneficial had errors and incorrectly 
indicated that loans were sold at gains, (3) incorrect loan values used 
to calculate the results of loan sales led to inaccurate reporting in 
SBA’s financial statements, and (4) incomplete tools provided by OMB to 
calculate interest payments on borrowings from Treasury resulted in 
excess payments to Treasury and an insufficient balance in SBA’s 
financing account and subsidy allowance. 

To resolve these deficiencies, SBA implemented a number of corrective 
actions during fiscal years 2003 and 2004. To address the first three, 
SBA developed a new cash flow model to estimate the costs and loan 
values for the disaster loan program. This improved the agency’s 
ability to prepare more reliable cost estimates and determine the gain 
or loss on prior loan sales. To address the fourth deficiency, SBA 
analyzed its interest payments to Treasury and found that it had 
overpaid by about $134 million. SBA included this amount in its 
reestimates for the disaster loan program to correct prior interest 
payments and also implemented a different approach to update or 
“reestimate” its cost estimates, which will adjust its transactions 
with Treasury going forward. However, until OMB updates its tools for 
computing these interest payments, other credit agencies may also be 
over- or underpaying interest to Treasury. 

Further, SBA improved its policies and procedures to help ensure that 
future loan program cost estimates will be reasonable. For example, SBA 
implemented new standard operating procedures for calculating 
reestimates and prepared documentation to support the rationale and 
basis for key aspects of the cash flow model. However, because of the 
complexities associated with estimating loan program costs, additional 
actions by SBA would help improve the long-term reliability of cost 
estimates. These include (1) further documentation of the model and 
disaster data to readily provide for knowledge transfer between staff 
and contractors to help ensure proper maintenance, updating, and 
running of the model; (2) periodic assessments of the model’s ability 
to predict loan performance; and (3) additional procedures to ensure 
the disaster data used in the model are tested to verify and document 
that they are reliable. In addition, there may be opportunities to 
improve the model with additional variables, such as financial strength 
of borrowers, as well as revisions to simplify the estimation process 
that warrant further consideration by SBA. 

What GAO Recommends:

GAO is making five recommendations to SBA to help ensure that future 
subsidy cost estimates are reliable. GAO is also making two 
recommendations to OMB to help ensure that agencies make correct 
interest calculations for financing accounts. 

SBA stated that our recommendations were appropriate and that it 
already has work underway to address several of them. OMB agreed with 
our recommendations and stated that it would work with agencies to 
correct interest transactions with Treasury. 

www.gao.gov/cgi-bin/getrpt?GAO-05-409. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Linda Calbom at (202) 512-
9508 or calboml@gao.gov. 

[End of section]

Contents:

Letter:

Results In Brief:

Background:

SBA Identified Major Deficiencies in Models and Methodologies Used to 
Account for the Disaster Loan Program:

SBA Has Taken Corrective Actions to Resolve Identified Deficiencies:

New Policies and Procedures Will Help Ensure Future Estimates Are 
Reasonable, but Additional Procedures and Documentation Are Needed:

Conclusions:

Recommendations for Executive Action:

Agency Comments:

Appendixes:

Appendix I: Objectives, Scope, and Methodology:

Appendix II: Comments from the Small Business Administration:

Appendix III: Comments from the Office of Management and Budget:

Appendix IV: GAO Contact and Staff Acknowledgments:

GAO Contact:

Acknowledgments:

Figures:

Figure 1: Calculation of Subsidy Cost for Direct and Guaranteed Loans:

Figure 2: Program and Financing Account Transactions for Direct Loans:

Figure 3: Disaster Subsidy Allowance as a Percent of the Loan Balance 
Outstanding, Fiscal Years 1996 through 2004:

Letter April 14, 2005:

The Honorable Olympia J. Snowe: 
Chair, Committee on Small Business and Entrepreneurship: 
United States Senate:

The Honorable Todd R. Platts: 
Chairman: 
The Honorable Edolphus Towns: 
Ranking Minority Member: 
Subcommittee on Government Management, Finance, and Accountability: 
Committee on Government Reform: 
House of Representatives:

The Honorable Marsha Blackburn: 
House of Representatives:

In 1999, the Small Business Administration (SBA) began a loan asset 
sales program at the direction of the Office of Management and Budget 
(OMB) to reduce the amount of loans the agency owned and serviced. A 
primary objective of the sales was to maximize proceeds, with a goal 
for each sale to be financially beneficial to the government. The loans 
eligible for sale were disaster assistance and other direct loans and 
defaulted business loan guarantees. Between fiscal years 1999 and 2003, 
SBA conducted seven sales, divesting itself of about 166,000 loans with 
an outstanding balance of about $5.7 billion. Approximately 86 percent 
of the amount sold was disaster assistance loans. 

Our January 2003 report[Footnote 1] on SBA's first five loan sales 
identified significant anomalies in SBA's disaster loan accounts and 
raised serious concerns about its ability to properly account for its 
loan sales and to estimate the costs associated with its remaining 
disaster loan portfolio for budget and accounting purposes.[Footnote 2] 
In response to our findings and recommendations, SBA and its 
contractors (hereinafter referred to as SBA) conducted an extensive 
analysis of its accounting and budgeting for its loan sales and 
disaster loan program and implemented a number of corrective actions 
during fiscal years 2003 and 2004, including the development of a new 
cash flow model to estimate the cost of the disaster loan program for 
budget and financial reporting purposes. 

In light of these events, we were asked to conduct a follow-up review 
to assess SBA's corrective actions. Specifically, our objectives were 
to (1) describe the nature of the deficiencies SBA's analysis 
identified that contributed to the disaster loan accounting anomalies, 
(2) identify corrective actions taken by SBA and assess whether these 
actions resolved the identified deficiencies, and (3) determine whether 
SBA's new cash flow model and procedures for the disaster loan program 
provide a reasonable basis for future credit subsidy estimates. 

To address these objectives, we reviewed SBA's analysis of its 
accounting and budgeting for its disaster and loan sales programs and 
analyzed SBA's corrective actions, including the new cash flow model to 
estimate costs for the disaster loan program. We also assessed the 
sufficiency of its policies and procedures to estimate program costs 
and its corrective actions based on applicable guidance. We provided 
SBA a draft of this report and OMB a draft of applicable sections of 
this report for review and comment. SBA and OMB provided written 
comments, which are reprinted in appendix II and III, respectively. We 
performed our work in accordance with generally accepted government 
auditing standards in Washington, D.C. from April 2004 through March 
2005. Our scope and methodology are discussed in greater detail in 
appendix I. 

Results In Brief:

As a result of extensive analyses, SBA identified four key deficiencies 
related to the disaster loan program accounting anomalies. First, major 
flaws in the cash flow model used to estimate the cost of the disaster 
loan program, including erroneous loan-term assumptions, led to, among 
other things, a negative balance in the disaster loan subsidy 
allowance. In effect, this meant that the program cost more than 
estimated. Second, errors and inconsistencies in another model, called 
the hold model, which was used to determine whether sales were 
financially beneficial, caused SBA to undervalue the loans sold by 
about 30 percent, according to SBA. This led SBA officials to operate 
on the premise that they were selling disaster loans for gains, when in 
fact the agency was selling them at a loss. Third, incorrect loan 
values used to calculate the results of loan sales led to inaccurate 
results disclosed in SBA's financial statements. Finally, interest 
rates used to determine interest payments on borrowings from Treasury 
that provide financing for the disaster loan program were inconsistent 
with the interest rates used to estimate the cost of the program 
because of incomplete tools provided by OMB. This resulted in SBA 
overpaying interest to Treasury and an insufficient balance in SBA's 
financing account and subsidy allowance. 

To resolve these deficiencies, SBA implemented a number of corrective 
actions during fiscal years 2003 and 2004. SBA developed a new cash 
flow model to estimate the cost of the disaster loan program, which 
improved the agency's ability to prepare more reliable estimates of the 
loan program's cost, and to calculate appropriate values for loans sold 
to use in determining the actual gain or loss on prior loan sales. This 
new model can also be used in lieu of a separate hold model to 
calculate loan values to use in determining whether any future loan 
sales would be financially beneficial. Further, SBA analyzed its prior 
interest payments to Treasury to determine the effect of using 
inconsistent interest rates to estimate subsidy costs and to calculate 
interest payments to Treasury. These analyses showed that SBA overpaid 
interest to Treasury by about $134 million. SBA included this amount in 
its reestimates for the disaster loan program to correct prior interest 
payments and also implemented a different approach to update or 
"reestimate" its cost estimates, which will adjust SBA's transactions 
with Treasury to correct for the inconsistency going forward. However, 
until OMB updates its tools for computing these interest payments, 
other credit agencies may also be over-or underpaying interest to 
Treasury. 

In addition to implementing these corrective actions, SBA improved its 
policies and procedures to help ensure that future loan program cost 
estimates will be reasonable. For example, SBA developed and 
implemented new standard operating procedures for reestimating program 
costs and established an internal review and documentation process for 
its reestimates. These controls represent important improvements. 
However, we identified some additional actions by SBA that would help 
ensure the long-term reliability of cost estimates. These include (1) 
further documentation of the cash flow model and disaster data to 
readily provide for knowledge transfer between staff and contractors to 
help ensure proper maintenance, updating, and running of the model; (2) 
procedures requiring periodic assessments of the model's ability to 
predict loan performance; and (3) additional procedures to ensure the 
disaster data used in the model are tested to verify and document that 
they are reliable. In addition, there may be opportunities to improve 
the model with additional variables, such as the financial strength of 
borrowers, as well as revisions to simplify the estimation process, 
that warrant further consideration by SBA. 

We are making recommendations to SBA to address these issues, as well 
as to OMB to address the completeness of the tools used to calculate 
interest payments to Treasury. SBA acknowledged that these were 
appropriate recommendations and stated that it already has work 
underway to address several of them. OMB agreed with our 
recommendations and stated that it would work with agencies to correct 
interest transactions with Treasury. 

Background:

SBA provides small businesses with access to credit, primarily by 
guaranteeing loans through its 7(a) and 504 programs.[Footnote 3] SBA 
also makes loans directly to businesses and individuals trying to 
rebuild in the aftermath of a disaster, and it primarily services these 
loans directly. Substantially all of the disaster assistance loans have 
below-market interest rates and repayment terms of up to 30 years. 
Interest rates on disaster loans vary, depending on the borrower's 
ability to obtain credit in the private sector. 

The President's fiscal year 1998 budget proposed that SBA begin selling 
disaster and business loans that the agency was servicing and 
transition from servicing loans directly to overseeing private-sector 
servicers. Before its loan asset sales program began, SBA was servicing 
approximately 300,000 loans, with a principal balance of over $9 
billion. About 286,000 of these loans, with a principal balance of $7 
billion, were disaster assistance loans. 

SBA, as well as other credit agencies, is required to account and 
budget for its credit programs in accordance with the Federal Credit 
Reform Act of 1990[Footnote 4] (FCRA). FCRA was enacted to require 
agencies to more accurately measure the government's cost of federal 
credit programs and to permit better cost comparisons, both among 
credit programs and between credit and noncredit programs. The act gave 
OMB responsibility for coordinating credit program estimates required 
by the act. Authoritative guidance on preparing cost estimates for the 
budget and conducting loan sales is contained in OMB Circular A-11, 
Preparation, Submission, and Execution of the Budget. The Federal 
Accounting Standards Advisory Board[Footnote 5] developed accounting 
standards for credit programs. This guidance is generally found in 
Statement of Federal Financial Accounting Standards No. 2, Accounting 
for Direct Loans and Loan Guarantees, which became effective in fiscal 
year 1994. This standard, which generally mirrors FCRA and budget 
guidance, established accounting guidance for estimating the subsidy 
cost of loan programs, as well as recording loans and loan sales for 
financial reporting purposes. 

According to FCRA, the actual and expected costs of federal credit 
programs should be recognized in budgetary reporting. The accounting 
standard also requires these costs to be recognized for financial 
reporting. To determine the expected cost of a credit program, agencies 
are required to predict or estimate the future performance of the 
program on a cohort[Footnote 6] basis. This cost, known as the subsidy 
cost, is the net present value[Footnote 7] of disbursements by the 
government minus estimated payments to the government over the life of 
the loan or loan guarantee, excluding administrative costs. Figure 1 
presents the cash flows included in the subsidy cost calculation for 
direct and guaranteed loans. 

Figure 1: Calculation of Subsidy Cost for Direct and Guaranteed Loans:

[See PDF for image] 

[End of figure] 

FCRA established a special budgetary accounting system to record the 
budget information necessary to implement credit reform. Loans and loan 
guarantees made on or after October 1, 1991--the effective date of 
credit reform--use the (1) program and (2) financing accounts to handle 
credit transactions.[Footnote 8] The program account is included in 
budget totals, receives separate appropriations for the administrative 
and subsidy costs of a credit program, and records the budget authority 
and outlays for these costs. The program account is used to pay the 
associated subsidy cost to the financing account when a direct or 
guaranteed loan is disbursed. The financing account, which is 
nonbudgetary,[Footnote 9] is used to collect the subsidy cost from the 
program account, borrow from Treasury to provide financing for loan 
disbursements, and record the cash flows associated with direct loans 
or loan guarantees over their lives, including loan disbursements, 
default payments to lenders, loan repayments, interest payments, 
recoveries on defaulted loans, and fee collections. Figure 2 shows the 
flow of program and financing accounts transactions for a direct loan 
program. 

Figure 2: Program and Financing Account Transactions for Direct Loans:

[See PDF for image] 

[End of figure] 

FCRA requires that the rate of interest charged by Treasury on lending 
to financing accounts be the same as the final discount rate[Footnote 
10] used to calculate the net present value of cash flows when 
estimating the subsidy cost of a credit program. The final discount 
rate for a cohort of loans is determined based on interest rates 
prevailing during the period that the loans are disbursed. Once the 
loans for a cohort are substantially disbursed (at least 90 percent), 
the final discount rate for that cohort is determined, and this rate is 
to be used for financing account interest calculations. The same rate 
is required to be used to calculate subsidy costs and interest on the 
financing account, so that the financing account will break even over 
time as it uses its collections to repay its Treasury borrowing. OMB 
provides tools for agencies to use to calculate interest on the 
financing account.[Footnote 11]

To estimate the cost of credit programs, agencies first estimate the 
future performance of direct and guaranteed loans, using cash flow 
models, when preparing their annual budgets. The data used for these 
budgetary estimates are generally updated or "reestimated" annually as 
of the end of the fiscal year to reflect any changes in loan 
performance since the estimates were prepared, as well as any expected 
changes in assumptions related to future loan performance. Increases in 
subsidy costs that are recognized through reestimates are funded 
through permanent indefinite budget authority. 

Before SBA could proceed with a loan sale, OMB had to approve it. This 
approval was based primarily on whether or not the sale was expected to 
be financially beneficial to the government, meaning that the estimated 
proceeds were expected to be greater than the estimated value of 
holding the loans. SBA estimated the current value to the government of 
holding the loans, also known as the "hold value," in accordance with 
OMB Circular A-11. The hold value is the expected net cash flows from 
the loans, discounted at current Treasury rates.[Footnote 12] This 
differs from the net book value recorded on SBA's books, which is the 
expected net cash flows from the loans discounted using Treasury rates 
in effect when the loans were disbursed. Therefore, the hold value 
takes into account changes in interest rates since the loans were 
disbursed, whereas the net book value does not. 

Our January 2003 report on SBA's first five loan sales highlighted 
accounting anomalies related to its disaster loans and loan sales 
program. Specifically, SBA incorrectly calculated the accounting losses 
on the loan sales it disclosed in its financial statements and lacked 
reliable financial data to determine the overall financial impact of 
the sales. Further, because SBA did not analyze the effect of loan 
sales on its remaining portfolio, its reestimates of loan program costs 
for the budget and financial statements may have contained significant 
errors. In addition, SBA could not explain significant declines in its 
subsidy allowance for disaster loans. 

In response to our findings, SBA took immediate action to begin the 
process of identifying the deficiencies that contributed to the 
disaster loan accounting anomalies, including unexplained significant 
declines in its subsidy allowance. A team of financial experts, 
including contractors and staff from the Office of the Chief Financial 
Officer, was assembled to conduct detailed reviews of financial records 
and systems related to the disaster and loan sales programs. Several 
diagnostic-type analyses were performed, including detailed 
reconciliations of the subsidy allowance and testing of alternative 
versions of the cash flow model used to estimate the cost of the 
disaster loan program. In January 2003, SBA hired IBM Business 
Consulting Services (IBM) to help determine reasons for the abnormal 
balance in the disaster loan program's subsidy allowance and to 
identify recommendations for correcting any deficiencies noted. IBM 
assisted SBA in a detailed review of SBA's accounting and budgeting for 
the disaster loan program and its loan sale procedures. IBM summarized 
the results of this review in a March 2003 report. According to SBA 
officials, the core diagnosis of the problems was completed by April 
2003 with the submission and analysis of the report from IBM. 

SBA Identified Major Deficiencies in Models and Methodologies Used to 
Account for the Disaster Loan Program:

SBA and its contractors identified four key deficiencies related to the 
disaster loan program accounting anomalies. These were (1) major flaws 
in the cash flow model used to estimate the cost of the disaster loan 
program, (2) errors and inconsistencies in the model used to determine 
whether sales were beneficial, (3) incorrect loan values used to 
calculate the results of loan sales, and (4) inconsistencies between 
the interest rates used to estimate subsidy costs and the interest 
rates used to determine interest payments to Treasury. 

Cash Flow Model Used to Estimate Costs for the Disaster Loan Program 
Was Flawed:

The methodology SBA's cash flow model used to estimate costs for the 
disaster loan program assumed that a single illustrative loan with 
characteristics based on overall portfolio averages could serve as a 
proxy for all loans and reasonably estimate cash flows for an entire 
cohort of loans, which included sold and unsold loans. This methodology 
could have produced reasonable cash flow estimates, even considering 
loan sales, if all loans had similar characteristics. However, this was 
not the case, and flaws in this methodology became apparent once SBA 
began substantial loan sales and the loans sold had different 
characteristics than the loans not sold. For example, the sold loans 
tended to have longer borrower repayment periods, or loan terms, than 
the loans not sold. Therefore, the sold loans would have had subsidized 
interest for a longer period of time and would have cost more. Because 
the single illustrative loan did not take into consideration these 
differences when estimating cash flows, the model had problems 
reestimating the cost of the program. 

In addition to the basic flaw in the methodology, SBA incorrectly 
calculated the single illustrative loan's average loan-term assumptions 
used in the cash flow model. SBA estimated costs of the disaster loan 
program using average loan-term assumptions of 16 years for business 
disaster loans and 17 years for home disaster loans. In our January 
2003 report, we raised concerns about the validity of these 
assumptions, as our review of disaster loans sold indicated an average 
loan term of about 25 years. SBA's loan-term assumptions were based on 
the number of loans, rather than the dollar value of loans disbursed, 
and therefore was a straight average rather than a weighted average. 
However, SBA found that, for all disaster loans, the average loan term, 
based on the dollar value of loans disbursed, was 23 years. Therefore, 
the model, which used loan terms of 16 and 17 years, did not consider 
cash flows for the full term of the loans. Given that the borrower 
interest rates on these loans were generally below market rates and 
less than SBA's cost of borrowing from Treasury to finance its loans, 
understating the loan term also understated the program costs. 
According to SBA, this caused the model to underestimate the cost of 
the disaster loan program by 6 to 7 percent. 

Further, during the reestimate process, SBA did not update the 
estimated principal and interest with actual collection amounts, which 
resulted in inaccurate data being used to calculate costs. These flaws 
related to the methodology, loan-term assumptions, use of inaccurate 
data, and other problems, resulted in unreliable subsidy cost estimates 
and reestimates for the disaster loan program. Collectively, the 
problems with SBA's cash flow model resulted in significant 
underestimates of the cost of the program, which was ultimately 
reflected in the negative balance in the disaster loan subsidy 
allowance. The negative balance would occur for programs that are 
expected to be profitable, which would not be expected for the disaster 
loan program, or when the allowance is overspent, meaning that the 
program cost far more than estimated. 

The Model Used to Determine Whether Loan Sales Were Beneficial Was Also 
Flawed:

When SBA sold loans, it used another model, called the hold model, to 
estimate the value to the government of holding the loans scheduled for 
sale until they were repaid, either at or before maturity. The hold 
model considered the same possible cash flows as the cash flow model 
used to estimate the cost of the program, including principal and 
interest collections, prepayments, delinquencies, defaults, and 
recoveries. However, the hold model differed from the cash flow model 
because it was constructed using a different methodology. The hold 
model measured loans individually whereas the cash flow model, as 
previously discussed, used a single-loan approach. In addition, 
expected defaults were determined differently, which caused the hold 
model to produce higher default rates than the cash flow model. 
Further, the hold model used economic variables and performance 
indicators and the cash flow model did not. As a result of these 
differences, the two models produced different results. While the hold 
model's conceptual design was superior to the cash flow model, it too 
contained serious flaws that produced misleading results. 

For example, the hold model erroneously used assumptions in determining 
the amount of recoveries expected on defaulted loans. The recovery 
assumptions were taken from the cash flow model used to estimate the 
cost of the program. These assumptions were calculated based on actual 
recoveries as a percentage of the value of loans disbursed and, 
therefore, should have been applied based on the value of loans 
disbursed. The hold model, however, erroneously applied this percentage 
to estimated defaulted loan amounts, therefore calculating a far lower 
amount of estimated recoveries than was appropriate, which made the 
value of holding the loans seem much lower. Collectively, problems with 
SBA's hold model caused it to undervalue the loans it sold by about 30 
percent, according to disclosures in SBA's fiscal year 2003 financial 
statements. As a result, at the time of the sales the hold model 
indicated that it was financially beneficial to sell the loans when in 
fact it was not. 

Incorrect Loan Values Were Used to Calculate the Results of Loan Sales 
Disclosed in SBA's Financial Statements:

While SBA's hold model indicated at the time of the sales that SBA had 
gains on loan sales, SBA concurrently disclosed losses on loan sales in 
its financial statements based on yet another set of flawed 
calculations. As reported by us in our January 2003 report and in the 
report issued by IBM in March 2003, when SBA calculated the results of 
loan sales for purposes of its financial statements, it incorrectly 
estimated the portion of the subsidy allowance to allocate to each loan 
sold in order to calculate the value on its books for the loans it had 
sold (net book value). For example, when calculating the net book value 
for the disaster loans that were sold, SBA did not allocate a portion 
of the subsidy allowance for financing costs associated with lending to 
borrowers at below-market interest rates. Given that a large portion of 
the subsidy cost was related to providing below-market borrower 
interest rates, this omission resulted in a significant overestimate of 
the net book value of the loans sold and, therefore, a significant 
overestimate of the losses SBA disclosed in its financial statements 
related to the sale of its disaster loans. Even though SBA calculated 
losses for the financial statements, it still operated on the premise 
that loans were sold at gains when considering changes in interest 
rates, which the hold model was purportedly designed to do. 

Interest Rates Used to Calculate Interest Payments to Treasury Were not 
Consistent with Those Used to Estimate Subsidy Costs:

The final deficiency that SBA identified in its disaster loan program 
accounting related to inconsistencies in the interest rates it used to 
estimate its subsidy costs versus those used to calculate its interest 
payments to Treasury. A direct loan program, including the disaster 
loan program, funds its lending to borrowers with the subsidy cost it 
receives through appropriations and from borrowing from Treasury. 
Because the borrowing is expected to be repaid with collections from 
borrowers, borrowing is not a budgeted cost to the program and is 
accounted for in the program's financing account. FCRA requires that 
the rate of interest charged to the financing account on the agency's 
borrowing be the same as the interest rate used to discount cash flows 
(discount rate) when estimating the subsidy cost for a program. The 
equality of these rates is fundamental to achieving the proper balance 
in the financing account. If subsidy cost calculations are accurate and 
the proper interest rates used, the financing account will break even 
over time as it uses collections from borrowers to repay Treasury 
borrowings. 

SBA, in coordination with OMB, found that the tools provided to 
agencies to calculate interest for the financing account did not adjust 
the amount of interest paid by the financing account while the loans 
were disbursing. The discount rate used to estimate the subsidy cost is 
not final until the loans in a cohort are substantially disbursed (at 
least 90 percent), which, for the disaster program, generally may take 
at least 2 years. When the loans are substantially disbursed, and the 
final discount rate is fixed, the reestimate process retroactively 
adjusts the subsidy costs to reflect the final discount rate. 

SBA and other agencies must make annual interest payments to Treasury 
while the loans are disbursing, although the final interest rate has 
not yet been determined. Thus in the early years of a cohort, before 
the loans are substantially disbursed, an interim interest rate is used 
to calculate interest payments. However, the tools provided by OMB to 
calculate interest between the financing account and Treasury do not 
retroactively adjust prior interest earnings or payments to reflect the 
final interest rate. This failure to adjust prior interest payments to 
reflect the final interest rate resulted in excess payments to Treasury 
and an insufficient balance in SBA's financing account and subsidy 
allowance, since the interest payments impact both. This omission in 
the tools OMB provides to all agencies that disburse or guarantee 
loans[Footnote 13] could result in a disconnect between the amounts 
required to be earned from or paid to Treasury to make the financing 
account whole, and the actual amounts earned or paid. Consequently, 
agencies' financing account balances and subsidy allowance may be over- 
or understated. 

SBA Has Taken Corrective Actions to Resolve Identified Deficiencies:

Following its analysis and identification of deficiencies, SBA 
developed a new cash flow model to estimate the cost of the disaster 
loan program. This improved the reliability of the disaster program 
cost estimates and corrected the abnormal balance in the subsidy 
allowance for the disaster loan program. In addition, SBA analyzed its 
prior interest payments to determine the effect of using inconsistent 
interest rates to calculate its estimated subsidy costs and interest 
payments to Treasury, and implemented a different approach to 
reestimate program costs. These corrective actions helped SBA achieve 
an improved audit opinion on its fiscal year 2004 and restated fiscal 
year 2003 financial statements. 

New Cash Flow Model Improves SBA's Ability to Reasonably Estimate 
Program Costs and Determine Loan Sale Results:

In fiscal year 2003, SBA's contractor developed a new cash flow model 
to calculate subsidy cost estimates and reestimates for the disaster 
loan program. In contrast to the prior model's flawed single loan 
approach to estimate the cash flows, the new model was designed to 
estimate cash flows individually for each loan. This design facilitates 
calculating loan values for loans sold to determine gains or losses on 
loan sales and, if SBA schedules additional loan sales, could also be 
used to calculate loan values for determining whether these sales would 
be financially beneficial to the government, thus negating the need for 
a separate hold model. Application of the model enabled SBA to 
retroactively determine the results of its prior loan sales and to 
correct the abnormal balance in its subsidy allowance. 

During the development of the new cash flow model, SBA analyzed the 
available disaster loan data, including loan performance information, 
loan terms, disaster type and magnitude, and regional information, as 
well as certain economic data, such as unemployment, gross domestic 
product, and interest rates. Based on these analyses, the data that 
best predicted default and prepayment behavior--two important cash 
flows for the disaster loan program--were selected to use as variables 
in the model. The model segments the loan portfolio into groups of 
loans based on the final variables selected, which were (1) the age of 
the loan, (2) the type of borrower (home or business), (3) the size of 
the loan, (4) the type of disaster loan (economic injury or physical 
damage), and (5) the length of the grace period. Based on these 
variables, there are a total of 162 groups of loans used to segment the 
disaster loan portfolio. 

On a loan-by-loan basis, the cash flow model estimates the expected 
principal and interest payments based on loan contract terms. Then the 
model estimates deviations from these expected payments for 
delinquencies, charge-offs, and prepayments. These deviations are 
calculated based on historical averages of loan performance for each 
group of loans. Lastly, the model estimates recoveries on charged-off 
loans based on historical averages. The model's methodology is based on 
the assumption that the behavior of loans in the future, taking several 
important loan characteristics into account, will be similar to loans 
in the past. However, as discussed later, if future loans are made to 
substantially different types of borrowers, such as those with better 
or worse financial strength, or have substantially different loan 
terms, changes to the model would be required to correctly consider 
these new characteristics in the cash flow estimates. 

Throughout the development of the model, SBA documented several 
analyses of the performance and characteristics of its disaster loans 
and the model's ability to predict loan performance. In addition to its 
own analyses, SBA contracted with Ernst & Young LLP (E&Y) to conduct an 
independent review of the model. E&Y reviewed the model documentation 
and computer code, and reviewed SBA's testing and validation analyses. 
E&Y summarized its observations and findings in two reports issued in 
November[Footnote 14] and December 2003.[Footnote 15] E&Y noted that 
the model can be expected to perform reasonably well for reestimates of 
existing loans and to produce stable estimates over time given the 
model's emphasis on long-term averages. In addition, E&Y stated that 
given the limitation of what can be known about future loans, the model 
takes a reasonable approach to estimating costs of future loans for 
budget purposes. E&Y also noted that the model achieves SBA's objective 
to consistently value individual loans for reestimates and loan sales. 

Based on our review of the model, its documentation, and the reports 
issued by E&Y, we concluded that the new model provides a sound basis 
to estimate costs and improved SBA's ability to prepare more reliable 
and reasonable cost estimates for the disaster loan program. When SBA 
used this new model for the first time to reestimate the cost of the 
disaster loan program, it resulted in a reestimate indicating increased 
costs of over $1 billion as of the end of fiscal year 2003. As shown in 
figure 3, the adjustment to increase these costs on SBA's books helped 
bring the disaster loan program's subsidy allowance to a positive 
balance and more in line with expectations for this type of subsidized 
program. In SBA's fiscal year 2004 financial statements, the subsidy 
allowance was reported to be about $613 million, or about 20 percent, 
of the $3 billion outstanding balance of the disaster loan program. 
Given that the estimated cost of the program generally ranges from $16 
to $36 for every $100 that SBA lends, this balance is within the 
expected range. SBA also used the new model to recalculate the results 
of its prior disaster loan sales and determined that the sales resulted 
in losses, or increased budgetary costs, of over $900 million. 

Figure 3: Disaster Subsidy Allowance as a Percent of the Loan Balance 
Outstanding, Fiscal Years 1996 through 2004:

[See PDF for image] 

[End of figure] 

Analysis of Interest Payments and Change in Approach to Reestimate 
Costs Addressed Interest Rate Inconsistency:

To resolve the inconsistency in the interest rates used to calculate 
interest on its financing account borrowing from Treasury and the 
interest rates used to discount cash flows when estimating subsidy 
costs, SBA completed a detailed analysis of its interest transactions 
with Treasury. SBA recalculated what its interest payments would have 
been based on the final (rather than the interim) interest rates and 
determined that it overpaid Treasury by about $128.6 million and $5.6 
million as of the end of fiscal years 2003 and 2004, respectively. 
These amounts were included in SBA's reestimates for the disaster loan 
program and corrected SBA's interest transactions for the fiscal years 
1992 through 2003 cohorts.[Footnote 16]

Also in fiscal year 2004, SBA implemented a new approach to reestimate 
costs, called the balances approach.[Footnote 17] Because the balances 
approach determines the amount of the reestimate based on a comparison 
of resources in the financing account and expected future cash flows, 
the approach automatically adjusts the financing account and subsidy 
allowance for any inconsistency in interest rates going forward. 

Other agencies that disburse or guarantee loans would also be affected 
by this interest rate inconsistency, which could result in 
misstatements in their accounts. However, the significance of this 
issue cannot be determined without extensive analyses similar to SBA's 
analysis because a number of factors influence how the inconsistency 
would impact other agencies' accounts, including balances in financing 
accounts and the length of time a program takes to substantially 
disburse its loans. OMB has notified agencies of the flaw in the tools 
and outlined plans to issue a comprehensive revised reestimate tool 
that resolves this problem.[Footnote 18] Until updated tools are 
provided, agencies will continue to make incorrect interest payments 
that could result in financing accounts having excess or insufficient 
funds and misstatements in financial statement reporting accounts for 
credit programs. 

SBA's Corrective Actions Helped It Achieve an Improved Audit Opinion:

SBA's corrective actions helped it achieve an improved audit opinion 
for its fiscal year 2004 financial statements. Earlier, SBA's auditor 
withdrew its unqualified opinions on SBA's fiscal years 2000 and 2001 
financial statements and issued a disclaimer of opinion for fiscal year 
2002, in part, because of issues identified in our January 2003 report. 
While progress was made in addressing these issues during fiscal year 
2003, the auditor also issued a disclaimer of opinion on SBA's fiscal 
year 2003 financial statements. The auditor reported that because SBA 
was late in completing reestimates and preparing its financial 
statements, among other things, the auditor did not have adequate time 
to resolve reservations related to SBA's disaster loan program, 
including abnormal balances in the subsidy allowance and a difference 
in interest rates SBA used to estimate subsidy costs and calculate 
interest payments to Treasury. 

Subsequently, SBA continued to implement its corrective actions, which 
the auditor assessed as part of the fiscal year 2004 financial 
statement audit. SBA received a mixed opinion--a combination of 
unqualified and qualified opinions--on its fiscal year 2004 financial 
statements,[Footnote 19] which represented an improvement over the 
disclaimer it received for fiscal year 2003. In addition, SBA received 
an unqualified opinion on its restated fiscal year 2003 balance 
sheet.[Footnote 20] SBA's auditor did not cite any issues related to 
previously identified problems with the disaster program or the new 
disaster cash flow model in these audit opinions.[Footnote 21]

New Policies and Procedures Will Help Ensure Future Estimates Are 
Reasonable, but Additional Procedures and Documentation Are Needed:

In addition to implementing the corrective actions to resolve the 
accounting anomalies, SBA also implemented new policies and procedures 
to help ensure that future loan program cost estimates will be 
reasonable, including (1) the development and implementation of new 
standard operating procedures for calculating reestimates; (2) the 
preparation of documentation to support the rationale and basis for key 
aspects of the cash flow model; (3) a process to coordinate the 
preparation of cost estimates between budget, accounting, and program 
staff; and (4) a revised reestimate approach. However, additional 
documentation of the new cash flow model would help ensure proper 
operation and maintenance of the model. Further, over time it will be 
important for SBA to continue to assess the model's ability to predict 
loan performance. In addition, there may be opportunities to improve 
the model, as well as simplify the estimation process, that warrant 
further consideration by SBA. Lastly, additional procedures to test the 
disaster data used in the model will help ensure their reliability. 

New Policies and Procedures Strengthened Internal Controls:

During fiscal years 2003 and 2004, SBA enhanced its policies and 
procedures by implementing several of the internal control practices 
identified in federal accounting guidance that will help it ensure that 
future cost estimates are reliable and reasonable.[Footnote 22] SBA 
developed and implemented standard operating procedures for calculating 
its reestimates based on federal accounting guidance. These procedures 
established an internal review process and standardized steps that must 
be performed and documented as part of the reestimate process. Steps 
included ensuring that the correct cash flow model files are used, 
verifying that the model appropriately reflects the program's 
structure, documenting any technical changes to the model, updating 
actual data and estimated cash flows in the model, and reviewing the 
reasonableness of the estimated cash flows. The procedures also call 
for the cash flow model to be reviewed by an outside party. The 
supporting documentation for the reestimates was provided to SBA's 
financial statement auditor during the fiscal year 2004 audit. The 
auditor noted in its report on internal controls that the adherence to 
a set of standard operating procedures for calculating reestimates, 
along with improved documentation and an effective internal review 
process, were critical to SBA's success in meeting key milestone dates 
and completing the audit process within accelerated financial reporting 
deadlines. 

SBA also established other important internal control practices 
identified in the guidance. During the development of the new cash flow 
model, SBA documented key analyses and decisions regarding the model's 
methodology. For example, SBA compared the characteristics of the loans 
sold to the loans kept and developed an approach within the new model 
to take those differences into account when estimating loan 
performance. It also documented the basis for selecting the model's 
methodology and variables, the assumptions and calculations in the 
model, and results of testing the model's ability to predict cash flow 
estimates. This documentation helps support the rationale and basis for 
key aspects of the model that provide important cost information for 
budgets and financial statements. 

SBA has also established procedures to coordinate the preparation of 
cost estimates among budget, accounting, and program offices. This will 
help ensure that the estimates are reviewed and prepared with the 
proper information. Further, as previously discussed, SBA implemented 
the balances approach for reestimates. This approach will help ensure 
that SBA's account balances are in line with expected future cash 
flows. These practices and the other practices discussed above will 
help ensure that anomalies such as those we identified during our last 
review do not go undetected or uncorrected. 

Additional Documentation, Analysis, and Testing Would Improve Long-Term 
Reliability of Cost Estimates:

While SBA resolved its accounting anomalies related to the disaster 
loan program and made important improvements to its policies and 
procedures, we found that additional enhancements to internal controls 
would help ensure the long-term reliability of future cost estimates. 
Further, strengthening internal controls will help SBA identify 
potential problems in the future and sustain the progress it has 
already made. 

Even though SBA completed substantial documentation for the new cash 
flow model, we found that this documentation was not sufficient to 
readily provide for knowledge transfer between staff and contractors to 
help ensure proper maintenance and updating of the model. For example, 
the documentation does not specify what is done to prepare the data for 
use in the model and does not always clearly indicate the data sources. 
In addition, SBA's documentation to explain the files used to run the 
model and update the data used in the model was not complete. For 
example, in SBA's documentation of the files and steps used to run the 
cash flow model, out of a total of 19 steps, 6 steps had no 
explanations of the process and another 2 were not complete and 
indicated that someone who was no longer employed at SBA was to provide 
the information. 

Improved documentation is particularly important because SBA relied on 
a contractor to help develop the new cash flow model for the disaster 
loan program and has recently experienced significant turnover in staff 
responsible for preparing cost estimates. Without complete and detailed 
documentation on how to maintain the model, update it with additional 
data, and run it, it will be more difficult for current SBA staff to 
fully understand the model, which could result in future errors in the 
cash flow estimates. 

Thorough documentation of the model is even more important given the 
complexity associated with its calculation process. E&Y noted in its 
review, and we agree, that the model's complexity creates an ongoing 
challenge related to transparency and maintenance. Because complexity 
increases the risk of errors occurring, SBA could benefit from 
continuing to evaluate whether there are opportunities to simplify the 
estimation process with model revisions or alternative estimation 
methodologies. 

There may also be opportunities to improve the model with additional 
variables. When estimating loan performance, the new model does not use 
data related to the financial strength of borrowers. Because this kind 
of information has been shown to be useful in predicting loan 
performance, such as defaults and prepayments, incorporating this type 
of information could improve the model's estimates. Further, additional 
detailed data on borrower financial strength and loan collateral, among 
other things, may improve the model's effectiveness for supporting any 
future loan sales. According to SBA officials, beginning in fiscal year 
2003 SBA began collecting credit scores for disaster loan borrowers. 
Once these newer loans have sufficient historical data, SBA will be 
able to evaluate the usefulness of these data as a potential variable 
to predict loan performance. 

In addition to opportunities to improve the model, SBA could also 
enhance its procedures to ensure that the model's estimates reasonably 
predict future loan performance. While SBA has completed testing of the 
model's ability to predict loan performance, it is important that SBA 
establish a process to help ensure this testing continues routinely and 
that causes of any significant variances are identified and addressed. 
For example, as stated earlier, if future loans are made to 
substantially different types of borrowers or have substantially 
different loan terms, changes to the model would be required to 
correctly consider these new characteristics in the cash flow 
estimates. Routine testing would help identify this type of change. 

While the new cash flow model provides SBA with a sound approach to 
estimate costs for the disaster loan program, additional verification 
procedures would provide better assurance that data used by the model 
are reliable. Federal accounting guidance requires agencies to 
accumulate sufficient, relevant, and reliable supporting data that 
provide a reliable basis for estimates of future loan performance. 
Because SBA's old cash flow model used data from SBA's Main On-Line 
System for Tracking Evaluation and Response (MONSTER) database which 
contains summary information, most of its detailed data reliability 
assessments and reconciliation practices revolved around MONSTER. For 
example, SBA maintains a reconciliation that tracks loans in MONSTER 
with its general ledger at a cohort level. However, the new model uses 
data from MONSTER and loan-level data from SBA's Electronic Loan 
Information Processing System (ELIPS) database. SBA officials indicated 
that plans are to continue to move away from using MONSTER. While SBA 
routinely reconciles its ELIPS database at a high level, as it moves 
toward using ELIPS data for estimating its disaster program costs, it 
is important that SBA reconcile and test the data at the level used in 
the model. 

Conclusions:

SBA took prompt action to identify the deficiencies related to its 
disaster and loan sale programs with a comprehensive review of its 
financial records. The corrective actions it then took established a 
basis for reliable and reasonable cost estimates. At the same time, the 
complexities associated with estimating costs for these programs will 
require continued attention. Without enhancements to the model's 
documentation, additional procedures to test data reliability, and 
continued testing and analysis of the model, SBA may find it difficult 
to fully sustain the progress it has made. Further, improved tools from 
OMB would help SBA and other agencies ensure proper calculation of 
interest costs related to their credit programs. 

Recommendations for Executive Action:

We are making five recommendations to SBA and two to OMB. To help 
ensure that future subsidy cost estimates are reliable, we recommend 
that the SBA Administrator take the following five actions. 

* Develop additional documentation of the new disaster cash flow model 
to help facilitate proper operation, maintenance, and updating of the 
model. 

* Study the value of incorporating additional variables in the new 
disaster cash flow model, such as detailed information on the financial 
strength of borrowers. 

* Establish policies and procedures to routinely test the new disaster 
cash flow model's ability to predict loan performance by comparing the 
model's predictions to actual loan performance and to identify and 
address the causes of any significant variances. 

* Consider possible revisions to the model and/or alternative 
methodologies that would simplify the estimation process. 

* Establish additional procedures to test and document the reliability 
of the data used in the new cash flow model for the disaster loan 
program. 

To help ensure that agencies make correct interest calculations for 
financing accounts, we recommend that the OMB Director take the 
following two actions. 

* Update the tools provided to agencies for adjusting financing account 
interest transactions once a final interest rate is determined for a 
cohort. 

* Provide instructions to agencies on making retroactive corrections to 
financing account interest transactions based on final interest rates 
for a cohort. 

Agency Comments:

In written comments reprinted in appendix II, SBA stated that these 
were appropriate recommendations and that it already has work underway 
to address several of them. In written comments reprinted in appendix 
III, OMB agreed with our recommendations and stated that it would work 
with agencies to correct interest transactions with Treasury. SBA and 
OMB also provided technical comments, which we have incorporated as 
appropriate. 

As agreed with your offices, unless you publicly announce its contents 
earlier, we plan no further distribution of this report until 30 days 
from its date. At that time, we will send copies of this report to the 
Ranking Minority Member of the Senate Committee on Small Business and 
Entrepreneurship, other appropriate congressional committees, the 
Administrator of the Small Business Administration, and the Director of 
the Office of Management and Budget. Copies will also be made available 
to others upon request. In addition, the report will be available at no 
charge on the GAO Web site at [Hyperlink, http://www.gao.gov]. 

If you or your staffs have any questions about this report, please 
contact me at (202) 512-9508 or [Hyperlink, calboml@gao.gov]. Major 
contributors to this report are acknowledged in appendix IV. 

Signed by:

Linda M. Calbom: 
Director: 
Financial Management and Assurance:

[End of section]

Appendixes:

Appendix I: Objectives, Scope, and Methodology:

To describe the nature of the deficiencies SBA identified that 
contributed to the disaster loan program accounting anomalies, we 
reviewed the report prepared by IBM that summarized the detailed review 
of SBA's accounting and budgeting for its disaster loan program and its 
loan sale procedures performed by SBA and IBM, and a variety of 
documents prepared by SBA that summarized the issues found. We also 
reviewed OMB Circular A-11 and FCRA to determine the criteria for 
calculating interest payments to Treasury on borrowing. We also 
interviewed SBA and OMB officials, SBA's financial statement auditor, 
and a contractor with SBA. 

To identify the corrective actions taken and assess whether these 
actions resolved the identified deficiencies, we:

* obtained and assessed the new cash flow model used to estimate the 
cost of the disaster loan program and its various supporting 
documentation;

* obtained an understanding of how the model works by reviewing SBA's 
summary of the behavior equations, the production system documentation, 
and assumptions made in the model;

* analyzed the model's methodology, including choice of statistical 
technique and variables included in the analysis, and determined that 
they were appropriate and reasonably related to the prediction of cash 
flows of disaster loans;

* replicated certain components of the model, such as the process used 
to segment the portfolio into groups of loans and predict future loan 
performance;

* assessed SBA's logistic regression used to determine and support the 
variables used in the model to verify that the variables selected were 
statistically significant;

* reviewed (1) SBA's testing of the cash flow model for biases; (2) 
SBA's comparison of the loans sold and the loans kept; (3) E&Y's 
reports summarizing its independent reviews of the model, including 
procedures performed, findings, and observations; and (4) SBA's 
financial statement auditor's assessment of SBA's model, its 
reestimates, and its revised loan sale loss calculation;

* obtained SBA's analysis of its interest payments to Treasury and 
verified the calculations;

* reviewed SBA's fiscal year 2004 financial statements summarizing the 
implementation of the balances approach to reestimate costs;

* interviewed SBA officials, an SBA contractor, and SBA's financial 
statement auditor; and:

* interviewed OMB officials to obtain an understanding of their efforts 
to update the tools agencies use to calculate interest on financing 
account balances. 

To determine whether SBA's new cash flow model and procedures for the 
disaster loan program provide a reasonable basis for future subsidy 
cost estimates, we interviewed SBA officials and a contractor to obtain 
an understanding of SBA policies and procedures for estimating subsidy 
costs. We reviewed supporting documentation related to its procedures, 
including the standard documentation template used to support its 
reestimates for its fiscal year 2004 financial statements, the various 
documentation prepared to support the model, and the reliability of 
data from SBA's computer systems. Based on SBA's procedures and 
documentation, we assessed the sufficiency of SBA's estimation process 
based on federal accounting guidance that identifies internal control 
practices that help ensure that future cost estimates are reliable and 
reasonable. We also reviewed SBA's financial statement auditor's 
reports on internal controls for fiscal years 2003 and 2004. The 
checking of key components, along with our review of SBA's 
documentation and E&Y's evaluation of the model, provided a sufficient 
level of understanding to conclude on its approach and ability to 
produce more reliable and reasonable cost estimates for the disaster 
loan program. To identify any additional steps SBA could take to 
improve the long-term reliability of its model, we considered 
additional types of variables that might enhance SBA's approach. As 
part of this analysis, we reviewed academic literature on default 
modeling and discussed alternative variables and modeling techniques 
with the contractor SBA used to develop the model. Based on these 
assessments, our assessment of the model, and E&Y's findings and 
observations on the cash flow model, we identified opportunities SBA 
could explore to enhance its procedures to improve the long-term 
reliability of its cost estimates. 

We provided SBA a draft of this report and OMB a draft of applicable 
sections of this report for review and comment. SBA and OMB provided 
written comments, which are reprinted in appendix II and III, 
respectively. They also provided technical comments, which we have 
incorporated as appropriate. We performed our work in accordance with 
generally accepted government auditing standards in Washington, D.C. 
from April 2004 through March 2005. 

[End of section]

Appendix II: Comments from the Small Business Administration:

U.S. SMALL BUSINESS ADMINISTRATION: 
WASHINGTON DC, 20416:

APR 12 2005:

Ms. Linda Calbom:
General Accountability Office: 
Washington, DC 20548:

Dear Ms. Calbom:

This letter provides the U.S. Small Business Administration's (SBA) 
response to the draft report prepared by the General Accountability 
Office (GAO) titled, "Accounting Anomalies Resolved but Additional 
Steps Would Improve Long-Term Reliability of Cost Estimates." We 
appreciate the opportunity to comment on the report.

Overall, we believe the report fairly represents the work completed by 
SBA to address the deficiencies related to its accounting and budgeting 
for its disaster loans and loan sale program. As GAO reports, SBA took 
prompt action to diagnose and remedy this complex and highly technical 
problem. We believe the analyses we completed to diagnose the problem 
and the ongoing improvements we are making in our subsidy modeling 
processes meet the "best practices" standard for federal credit 
accounting and budgeting. SBA is proud of its accomplishments in this 
area and they reflect the Agency's overall commitment to improved 
financial management.

The report includes five recommendations for SBA to help ensure that 
future subsidy cost estimates produced by the new disaster cash flow 
model are reliable. The recommendations are: (1) develop additional 
documentation of the model; (2) study the value of incorporating 
additional variables into the model; (3) routinely test the model's 
ability to predict loan performance; (4) consider options for 
simplifying the model, and (5) conduct additional testing and 
documentation of the data used in the model.

Generally, we agree that these are reasonable recommendations. Indeed, 
these recommendations would be appropriate for virtually all Federal 
credit models. SBA already has work underway which will address several 
of the recommendations, including: expanding the documentation of the 
model and related data, testing model assumptions, and obtaining loan 
data directly from SBA's Electronic Loan Information Processing System.

Again, SBA appreciates the opportunity to comment on this report. 

Sincerely,

Signed by: 

Thomas Dumaresq: 
Chief Financial Officer: 

[End of section]

Appendix III: Comments from the Office of Management and Budget:

EXECUTIVE OFFICE OF THE PRESIDENT: 
OFFICE OF MANAGEMENT AND BUDGET: 
WASHINGTON, D.C. 20503:

April 13, 2005:

Ms. Linda Calbom:
Government Accountability Office: 
Washington, DC 20548:

Dear Ms. Calbom:

Thank you for the opportunity to comment on your draft report 
addressing a flaw in the Treasury interest calculations for SBA's 
Disaster Loan program.

We appreciate the research that GAO has put into the report. As you are 
aware, OMB has been working with SBA on this issue, and the method of 
correction, from the time that the flaw was first identified in the 
Disaster Loan program. We agree with your conclusions that there must 
be a plan to correct this flaw, and will work with other affected 
agencies to calculate its impact on their credit program subsidy cost 
estimates. As you noted in the report, we have already informed 
agencies of the flaw's existence, and have released a planned timetable 
for implementing corrections to the tools used to make financing 
account interest calculations.

Thank you again for the opportunity to comment on your draft report.

Sincerely, 

Signed by: 

Richard P. Emery, Jr.: 
Assistant Director for Budget: 

[End of section]

Appendix IV: GAO Contact and Staff Acknowledgments:

GAO Contact:

Linda Calbom, (202) 512-9508:

Acknowledgments:

In addition to the above, Marcia Carlsen, Lisa Crye, Austin Kelly, 
Beverly Ross, Kara Scott, and Brooke Whittaker made key contributions 
to this report. 

(190125):

FOOTNOTES

[1] Our review also included determining whether the loan sales 
generated operational benefits for SBA and identifying how borrowers 
and lenders reacted to the sales. 

[2] GAO, Small Business Administration: Accounting Anomalies and 
Limited Operational Data Make Results of Loan Sales Uncertain, GAO-03- 
87 (Washington, D.C.: January 2003). 

[3] The 7(a) program is established under section 7(a) of the Small 
Business Act (15 U.S.C. § 636). The 504 program is established under 
Title V of the Small Business Investment Act of 1958 (15 U.S.C. § 695 
et seq). 

[4] Federal Credit Reform Act of 1990, Pub. L. No. 101-508, title XIII, 
§ 13201 (a) (Nov. 5, 1990); 2 U.S.C. §§ 661-661f. 

[5] The board establishes generally accepted accounting principles for 
federal entities. 

[6] A cohort includes those direct loans or loan guarantees of a 
program for which a subsidy appropriation is provided in a given year 
even if the loans are not disbursed until subsequent years. 

[7] Present value is the worth of the future stream of returns or costs 
in terms of money paid immediately. In calculating present value, 
prevailing interest rates provide the basis for converting future 
amounts into their "money now" equivalents. 

[8] A liquidating account was established to handle credit transactions 
on a cash basis for pre-credit reform loans and loan guarantees. 

[9] Nonbudgetary accounts may appear in the budget document for 
information purposes, but are not included in the budget totals for 
budget authority or budget outlays. 

[10] For loans made or guaranteed in fiscal year 2001 and thereafter, 
the discount rate is based on interest rates on marketable zero-coupon 
Treasury securities with the same maturity from the date of 
disbursement as the cash flow. For loans made or guaranteed before 
fiscal year 2001, the discount rate is based on a disbursement-weighted 
average of interest rates for marketable Treasury securities with 
similar maturities as the loans or loan guarantees. 

[11] For loan guarantee programs that do not borrow from Treasury, the 
financing account receives the subsidy cost from the program account 
and holds these funds to serve as a reserve against future loan 
guarantee defaults or other costs. FCRA requires that these funds, 
referred to as uninvested funds, earn interest from Treasury at the 
same rate as the discount rate used to calculate the present value when 
estimating the subsidy cost. 

[12] The hold value of the loans selected for sale represents the 
estimated value to the government of continuing to hold the loans until 
they are repaid, either at or before maturity. It is designed to be a 
decisional tool used to determine whether or not it is currently 
advantageous to sell loans. The hold value is calculated on a present 
value basis, with future payments discounted at current Treasury 
interest rates in order to reflect current market conditions in the 
decision-making process. 

[13] This discussion of the inconsistency with the interest rates used 
to calculate interest on the financing account explains the problem as 
it relates to a direct loan program that borrows from Treasury. 
Guarantee loan programs would have a similar problem with interest 
earnings calculated on uninvested funds held in the financing account 
that serve as a reserve for the payment of future loan defaults or 
other payments. 

[14] Ernst & Young LLP, Independent Review of the SBA Disaster Loan 
Program Subsidy Model Part I (Nov. 21, 2003). 

[15] Ernst & Young LLP, SBA Disaster Loan Model Review, Part II (Dec. 
12, 2003). 

[16] The calculation as of the end of fiscal year 2003 corrected prior 
interest payments for the fiscal years 1992 - 2001 cohorts. The 
calculation as of the end of fiscal year 2004 corrected the prior 
interest payments for the fiscal years 2002 and 2003 cohorts. Without a 
comprehensive solution, this would be an ongoing process needed to 
correct prior interest payments once cohorts become substantially 
disbursed and the final interest rates are known. 

[17] Current OMB guidance allows agencies to use either the 
"traditional approach" or the "balances approach" to reestimate costs. 
Both approaches will produce similar results as long as cohort cash 
flows and transactions with Treasury are properly recorded in the 
financing account and actual performance is properly included in the 
cash flow model. To validate the results obtained with the balances 
approach, SBA reconciled the differences between the two approaches. 
According to SBA, after the reconciliation, the two approaches produced 
cost estimates that differed by less then .005 percent of 
disbursements. 

[18] Agencies were alerted to the flaw and future changes to the tools 
used to calculate subsidy cost estimates and reestimates in an e-mail 
from OMB dated April 1, 2005. 

[19] For fiscal year 2004, SBA received an unqualified audit opinion on 
its statement of budgetary resources and a qualified audit opinion on 
all its other statements. 

[20] As part of the fiscal year 2004 audit, SBA's restated fiscal year 
2003 balance sheet was re-audited in order to determine whether opening 
balances for fiscal year 2004 were reliable. The statements of net 
cost, financing, and changes in net position were also restated, but 
were not re-audited. 

[21] The qualifications of the audit opinions on most of SBA's 
statements for fiscal year 2004 related primarily to new concerns over 
SBA's estimated loan guarantee cash flow activity for the second half 
of fiscal year 2004, which was necessary to accommodate the accelerated 
financial reporting due date. 

[22] In January 2004, the Federal Accounting Standards Advisory Board's 
Accounting and Auditing Policy Committee issued Technical Release 6, 
Preparing Estimates for Direct Loan and Loan Guarantee Subsidies under 
the Federal Credit Reform Act Amendments to Technical Release 3: 
Preparing and Auditing Direct Loan and Loan Guarantee Subsidies under 
the Federal Credit Reform Act, which provides guidance to agencies on 
preparing subsidy cost estimates. 

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