U.S. SMALL BUSINESS ADMINISTRATION
OFFICE OF INSPECTOR GENERAL
Washington, DC 20416
Advisory Memorandum Report
Issue Date: March 12, 2002
Report Number: 2-10
TO: Herbert L. Mitchell, Associate Administrator,
Office of Disaster Assistance
Michael C. Allen, Area Director,
Atlanta Disaster Office - Area 2
FROM: Robert G. Seabrooks,
Assistant Inspector General for Auditing
SUBJECT: Audit of Early Defaulted Disaster Loan [FOIA EX. 6]
The Office of Inspector General, Auditing Division, is conducting an ongoing
evaluation of Early Defaulted Disaster Loans. The results of early defaulted disaster loan
audits are being provided on each individual loan reviewed. Our results are intended to
bring deficient processing issues to your attention so that you can assess whether any
actions are needed to prevent similar issues in the future.
The Small Business Administration (SBA) disaster loan program is the primary
Federal disaster-assistance program for funding long-range recovery for victims of
hurricanes, floods, earthquakes, tornadoes, wild fires, and other physical disasters.
Disaster loans help business owners, individuals, and nonprofit organizations to fund
rebuilding, replace personal property, and compensate for economic injury. When disaster
victims need to borrow to repair or replace uninsured damages, the low interest rates and
long terms available from SBA make recovery affordable. Standard Operating Procedures
(SOP) 50 30 4 and 50 31 2 provide specific policy and procedural guidance for making
disaster loans.
SBA approved a $136,600 disaster loan to the [FOIA EX. 6] (borrowers) in
[FOIA EX. 6] to repair/replace damaged manufactured housing, personal property,
landscaping and cleanup and debris removal. Over a period of 28 months, from February
1999 to June 2001, the borrowers made payments of varying amounts culminating in a 6-
month delinquency. The loan was a collection problem starting with the 4th installment
payment due in May 1999. The loan was placed in liquidation in October 1999. Two
months after the Office of Inspector General field visit in June 2001, the borrowers made
five payments totaling $4,950 that brought the loan current.
Our audit was conducted during the period June through September, 2001. The
audit was conducted in accordance with government auditing standards.
OBJECTIVES & SCOPE
The objective of the audit was to determine whether the early loan default was
due to: SBA non-compliance with its policies and procedures, borrower non-compliance
with the loan agreement, or borrower misrepresentations.
We reviewed documents in the SBA loan file and interviewed the borrower.
Borrower tax returns, financial statements, and accounting records were examined.
Additionally, we analyzed the borrower’s credit report and searched SBA’s Delinquent
Loan Collection System (DLCS) database. Finally, the borrower’s cash flow and
repayment ability were recalculated.
RESULTS
The loan was brought current after our contact during the audit indicating that the
borrower may have had the ability to repay the loan. We identified four issues
warranting management's attention involving the following areas: (1) unverified
information relied on to determine borrower benefits; (2) use of loan proceeds for
unauthorized purposes; (3) lack of support for 80 percent of funds received, and (4) false
statements by the borrower which were not referred to the OIG. Details of the audit
results are discussed below.
1. Unverified Information Relied on to Determine Borrower Benefits
SBA provided excessive disaster benefits to the borrower because the loss verifier
and Supervisory Loss Verifier did not accurately record or verify the destroyed property
dimensions. As a result, the borrower received a disaster assistance loan greater than the
amount needed to replace his loss. Agency procedures do not preclude such a benefit
determination.
SOP 50 31 2, Instructions for Disaster Loss Verifiers, states that accurate
information and expeditious action by verifiers are necessary for efficient implementation
of the disaster loan program. Also, the supervisor is required to review and analyze
completed cases for compliance with SBA directives; quality of observation, calculations,
and conclusions; and substantiating data.
The loss verifier did not obtain accurate dimensions of the destroyed property
(mobile home). The verifer’s report, dated July 27, 1998, showed that he accepted
borrower provided dimensions of the destroyed mobile home as 2,592 square feet without
confirming evidence. The borrower provided figure was over inflated by 40 percent. The
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verifier’s report also contained the following statement, “Dimensions supplied by A
[Applicant]. Lot has been cleared." Based on the borrower provided figures, the verifier
calculated the replacement value of the mobile home at $96,749. In July 1998, the
verifier’s supervisor signed the report without comment.
We obtained the contract for the pre-disaster purchase of the mobile home from
the borrower and found the dimensions were actually 1,848 square feet. Disaster Area
Office-2 (DAO-2) management personnel agreed the verifier obtained the wrong square
footage and did not verify the dimensions. We were told that the dimensions should have
been verified through county tax collector records or other available information such as
insurance records or the mobile home purchase contract. At our request, DAO-2 officials
recalculated the replacement cost based on 1,848 square feet. Based on the revised square
footage, we were told that the borrower should have received $63,299 for the mobile
home replacement.
2. Loan Proceeds were not used for Authorized Purposes
SBA did not ensure the borrower always used proceeds for authorized purposes.
Although SBA initialed a Borrower Progress Certification (Form 1366) indicating SBA
supervisory review of use of proceeds, SBA officials were unable to explain why the
borrower misused proceeds to pay $2,693 for real estate taxes and $582 for homeowner’s
insurance.
The Form 1366 requires the borrower to use loan funds in accordance with the
Use-of-Loan-Proceeds paragraph of the Loan Authorization and Agreement. The
agreement required the borrower to use the proceeds solely to rehabilitate or replace
property damaged or destroyed by the disaster. SOP 50 30 4 Par. 95(c) requires SBA to
review the borrower’s Form 1366 and necessary receipts, to ensure proper use of proceeds
before authorizing further disbursement.
The borrow listed on Form 1366 that they had spent funds to pay for four years
of delinquent real estate taxes totaling $2,267; homeowner’s insurance in the amount of
$582; and 1998 real estate taxes totaling $426. Although SBA initialed the Form 1366 as
having been reviewed, we found no indication that the misuse was noted nor was the
borrower notified of the misuse. DAO-2 officials stated that the misuse should have been
noticed, a note made to the file, and the borrower instructed to cease future misuse.
13 Code of Federal Regulation 123.9 also gives SBA the ability to assess the borrower one
and a half times the procceds that were wrongfully misapplied. Proper review of loan
disbursements is a safeguarding control that helps ensure proceeds are used for their
intended purpose.
3. Accounting for Use of Loan Proceeds
The borrowers did not provide support for 80 percent of the funds received
through any of the five disbursements for this loan, nor did SBA ensure borrower
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accountability. As a result, SBA made subsequent disbursements that potentially
increased its vulnerability to additional borrower misuse of proceeds.
Borrowers are required to report how loan proceeds were used for at least 80
percent of funds received on the Borrower’s Progress Certification, SBA Form 1366,
before SBA authorizes subsequent disbursements.
Borrower reporting of use of funds for the 5 disbursements ranged from 0 to 75
percent. Further, there was no indication that SBA addressed these discrepancies before
making subsequent disbursements. The borrower accounted for only 48 percent of the
total funds disbursed. Although SBA increased its susceptibility to misuse of funds, we
determined the borrower used most of the proceeds as authorized. DAO-2 officials stated
it appeared they should have issued two-payee checks and sent the verifier back out to
confirm use of proceeds. Failure to effectively account for individual loan disbursements
increased the potential vulnerability for borrower misuse of proceeds.
4. The Borrower Made False Statements
The Borrower made a false statement by twice not disclosing four years of
delinquent real estate taxes. Though there was no opportunity to verify the truthfulness of
the borrower statement during the application process, SBA subsequently became aware
of the delinquent taxes during loan disbursement. SBA eventually permitted the borrower
to cure the problem, but did not refer the false statements issue to the Office of Inspector
General. SBA stated that the false statement was not material enough to warrant taking
action against the borrower. We have referred this matter to our Investigations Division.
SBA’s Home Loan Application, Section F Lines 13, states "All the information on
this application and any attachments is true to the best of my knowledge and you may rely
on it to provide disaster loan assistance. I understand that I could lose my benefits and
could be prosecuted by the U.S. Attorney for making false statements”. Additionally, the
Affidavit of Ownership to Real Property states “There are no unsatisfied judgements and
said premises are free from all leases, mortgages, taxes, assessments, liens, encumbrances
and claims, or interest of any other party”. SOP 50 30 4 Par. 10 states that questions about
truthfulness or accuracy of an application or supporting data and information should be
referred to the Office of Inspector General.
The contents of this report were discussed with the Atlanta Disaster Office on
August 23, 2001. We are not making recommendations relating to the above instances.
You should, however, maintain documentation of any actions you take to address the
above issues for future review and follow-up.
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