[House Hearing, 108 Congress] [From the U.S. Government Publishing Office] WHY IS SBA LOSING GROUND ON FINANCIAL MANAGEMENT? ======================================================================= HEARING before the SUBCOMMITTEE ON GOVERNMENT EFFICIENCY AND FINANCIAL MANAGEMENT of the COMMITTEE ON GOVERNMENT REFORM HOUSE OF REPRESENTATIVES ONE HUNDRED EIGHTH CONGRESS FIRST SESSION __________ APRIL 29, 2003 __________ Serial No. 108-49 __________ Printed for the use of the Committee on Government Reform Available via the World Wide Web: http://www.gpo.gov/congress/house http://www.house.gov/reform ______ 89-351 U.S. GOVERNMENT PRINTING OFFICE WASHINGTON : 2003 ____________________________________________________________________________ For Sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpr.gov Phone: toll free (866) 512-1800; (202) 512�091800 Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001 COMMITTEE ON GOVERNMENT REFORM TOM DAVIS, Virginia, Chairman DAN BURTON, Indiana HENRY A. WAXMAN, California CHRISTOPHER SHAYS, Connecticut TOM LANTOS, California ILEANA ROS-LEHTINEN, Florida MAJOR R. OWENS, New York JOHN M. McHUGH, New York EDOLPHUS TOWNS, New York JOHN L. MICA, Florida PAUL E. KANJORSKI, Pennsylvania MARK E. SOUDER, Indiana CAROLYN B. MALONEY, New York STEVEN C. LaTOURETTE, Ohio ELIJAH E. CUMMINGS, Maryland DOUG OSE, California DENNIS J. KUCINICH, Ohio RON LEWIS, Kentucky DANNY K. DAVIS, Illinois JO ANN DAVIS, Virginia JOHN F. TIERNEY, Massachusetts TODD RUSSELL PLATTS, Pennsylvania WM. LACY CLAY, Missouri CHRIS CANNON, Utah DIANE E. WATSON, California ADAM H. PUTNAM, Florida STEPHEN F. LYNCH, Massachusetts EDWARD L. SCHROCK, Virginia CHRIS VAN HOLLEN, Maryland JOHN J. DUNCAN, Jr., Tennessee LINDA T. SANCHEZ, California JOHN SULLIVAN, Oklahoma C.A. ``DUTCH'' RUPPERSBERGER, NATHAN DEAL, Georgia Maryland CANDICE S. MILLER, Michigan ELEANOR HOLMES NORTON, District of TIM MURPHY, Pennsylvania Columbia MICHAEL R. TURNER, Ohio JIM COOPER, Tennessee JOHN R. CARTER, Texas CHRIS BELL, Texas WILLIAM J. JANKLOW, South Dakota ------ MARSHA BLACKBURN, Tennessee BERNARD SANDERS, Vermont (Independent) Peter Sirh, Staff Director Melissa Wojciak, Deputy Staff Director Rob Borden, Parliamentarian Teresa Austin, Chief Clerk Philip M. Schiliro, Minority Staff Director Subcommittee on Government Efficiency and Financial Management TODD RUSSELL PLATTS, Pennsylvania, Chairman MARSHA BLACKBURN, Tennessee EDOLPHUS TOWNS, New York STEVEN C. LaTOURETTE, Ohio PAUL E. KANJORSKI, Pennsylvania JOHN SULLIVAN, Oklahoma MAJOR R. OWENS, New York CANDICE S. MILLER, Michigan CAROLYN B. MALONEY, New York MICHAEL R. TURNER, Ohio Ex Officio TOM DAVIS, Virginia HENRY A. WAXMAN, California Mike Hettinger, Staff Director Larry Brady, Professional Staff Member Amy Laudeman, Clerk Mark Stephenson, Minority Professional Staff Member C O N T E N T S ---------- Page Hearing held on April 29, 2003................................... 1 Statement of: Calbom, Linda, Director of Financial Management and Assurance, U.S. General Accounting Office.................. 10 Dumaresq, Thomas A., Chief Financial Officer, Small Business Administration............................................. 32 Hayward, Charles, partner, Cotton & Co....................... 53 McClintock, Peter, Deputy Inspector General, Small Business Administration............................................. 40 Menth, Bill, consultant to Cotton & Co.'s SBA Audit Team for fiscal year 2002, postaudit consultant to SBA.............. 63 Letters, statements, etc., submitted for the record by: Calbom, Linda, Director of Financial Management and Assurance, U.S. General Accounting Office: Followup questions and responses......................... 87 Prepared statement of.................................... 13 Dumaresq, Thomas A., Chief Financial Officer, Small Business Administration, prepared statement of...................... 34 Hayward, Charles, partner, Cotton & Co., prepared statement of......................................................... 55 McClintock, Peter, Deputy Inspector General, Small Business Administration, prepared statement of...................... 42 Menth, Bill, consultant to Cotton & Co.'s SBA Audit Team for fiscal year 2002, postaudit consultant to SBA, prepared statement of............................................... 65 Platts, Hon. Todd Russell, a Representative in Congress from the State of Pennsylvania, prepared statement of........... 4 Towns, Hon. Edolphus, a Representative in Congress from the State of New York, prepared statement of................... 7 WHY IS SBA LOSING GROUND ON FINANCIAL MANAGEMENT? ---------- TUESDAY, APRIL 29, 2003 House of Representatives, Subcommittee on Government Efficiency and Financial Management, Committee on Government Reform, Washington, DC. The subcommittee met, pursuant to notice, at 2 p.m., in room 2154, Rayburn House Office Building, Hon. Todd Russell Platts (chairman of the subcommittee) presiding. Present: Representatives Platts, Blackburn and Towns. Staff present: Mike Hettinger, staff director; Dan Daly, counsel; Larry Brady and Kara Galles, professional staff members; Amy Laudeman, clerk; Mark Stephenson, minority professional staff member; and Cecelia Morton, minority office manager. Mr. Platts. A quorum being present, this hearing of the Subcommittee on Government Efficiency and Financial Management will come to order. Welcome, everyone, here today, and I appreciate everyone's participation. As 1 of the 24 Chief Financial Officer Act agencies, the Small Business Administration [SBA], has been required to produce agencywide audited annual financial statements since fiscal year 1996, and has been required to produce audited financial statements with respect to its loan programs since fiscal year 1991. Since 1996, SBA has consistently received a clean opinion from their auditors on their agencywide financial statements. However, recently SBA's auditors issued a disclaimer on the fiscal year 2002 financial statements and chose to withdraw its clean opinions on SBA's financial statements for fiscal years 2001 and 2000. This turnaround occurred in part as a result of the findings described in the General Accounting Office report entitled, ``Small Business Administration: Accounting Anomalies and Limited Operational Data Make Results of Loan Sales Uncertain.'' As part of the subcommittee's continuing oversight into the financial health of the CFO Act agencies, we have asked the General Accounting Office, representatives of the SBA, and SBA's independent auditors to come before us today to discuss the current status of the financial accounting situation at SBA. Our hearing today will address the findings of the GAO report as well as look forward at the remediation efforts underway within SBA to rectify this situation. Last year, at the request of Senator Christopher Bond, GAO conducted a broad review of SBA's loan asset sales program. GAO analyzed the way SBA accounted for five loan asset sales, disposing of a total of $4.4 billion in disaster assistance home and business loans from August 1999 through January 2002. GAO determined that SBA incorrectly calculated accounting losses on the loan sales and lacked reliable financial data to determine the overall financial impact of the sales. SBA's accounting for the loan sales was flawed to such a degree that SBA was showing a profit on its disaster relief loans, a very unlikely scenario. In part, as a result of the accounting inaccuracies uncovered by GAO, SBA auditors, Cotton & Co., issued a disclaimer on SBA's financial statements for fiscal year 2002 and withdrew the clean audit opinions on SBA's financial statements for fiscal years 2001 and 2000. Furthermore, the Office of Management and Budget reported as part of the President's executive branch Management Scorecard for 2002 that SBA actually deteriorated on its score for improving financial performance since last year. OMB's explanation of the score cited the challenges that SBA faces in accounting for its loan sales, meeting accounting performance standards and measuring risk in its loan portfolio more accurately. SBA's Chief Financial Officer and its inspector general both generally agree with the overall findings and recommendations in the GAO report, and the Chief Financial Officer has contracted with a consulting firm to assist them in determining where they made their mistakes in accounting for the loan sales. The Inspector General's Office is also working with Cotton & Co. to determine the magnitude of the errors in SBA's financial statements for fiscal year 2001 and 2000. The situation at SBA raises serious questions about the quality of the financial management of SBA's loan asset sales. It also demonstrates a point that is consistently raised by GAO and OMB: Sound financial management requires more than clean audit opinions. I was gratified when I read an advance copy of the Deputy Inspector General McClintock's testimony that he candidly discusses how flawed SBA's financial management systems are, and if the systems were not so flawed, perhaps SBA would have clean audit opinions today. The SBA has the opportunity now to reevaluate its management of the loan asset sales and to move forward with solutions that will result in sustainable long- term improvements to their financial management efforts. Our witnesses here today will help to shed light on the financial management situation at SBA, and, again, we are very pleased and grateful for your participation in today's hearing. We are pleased to have Linda Calbom, who is a Director with the Financial Management and Assurance Team at the General Accounting Office; Thomas Dumaresq, who is Chief Financial Officer at SBA; Peter McClintock, who is the Deputy Inspector General at SBA; Mr. Charles Hayward, who has worked on the SBA audit as a partner with Cotton & Co.; and Bill Menth, who is a consultant that has been working on this situation with both Cotton & Co. and SBA. I know that my fellow committee members join me in looking forward to your testimonies, and I'm pleased now to yield to the gentleman from New York, the ranking member, Mr. Towns, for the purpose of making an opening statement. [The prepared statement of Hon. Todd Russell Platts follows:] [GRAPHIC] [TIFF OMITTED] T9351.001 [GRAPHIC] [TIFF OMITTED] T9351.002 Mr. Towns. Thank you very much, Mr. Chairman. Thank you for holding this hearing today on SBA's financial management problems. The information presented to us on SBA is certainly troubling; however, I am pleased that the agency has acknowledged its errors and is ready to confront those mistakes. It seems that they are sincere about, making the necessary changes to prevent a similar situation from happening again. Having key members from SBA along with the consultants in the GAO to discuss the agency's financial statement is a good starting point. Although today's hearing is focusing on SBA, it could very well be taking place on several of the over 24 CFO Act agencies. As many of you know, the SBA received clean audit opinions in 2000 and 2001 before errors were discovered that invalidated those findings. So it is entirely possible that an agency which got a clean audit this year does not really have all of its financial cards in order. As we learn more about what went wrong at SBA and what we can do to prevent it from happening again, it is critical that we apply those lessons learned to other agencies. With that said, I do believe it is important that this committee zero in on SBA and its own specific problems. Small business is the backbone of our economy, producing 75 percent of all new jobs and employing half the private-sector work force. Minority and women-owned firms are the fastest-growing segment of this business community. Over a 5-year period the number of minority-owned firms have increased at a rate four times greater than all other firms in the United States and have grown their receipts by 60 percent. This success is in part due to the availability of loan assistance from the SBA. With these statistics in mind, I believe it is critical that the agency solve its financial management problems. Our economy and especially our minority entrepreneurs need a healthy SBA in order to flourish. Thank you, Mr. Chairman. I yield back the balance of my time, and I'm anxious to hear from the witnesses. Mr. Platts. Thank you, Mr. Towns. [The prepared statement of Hon. Edolphus Towns follows:] [GRAPHIC] [TIFF OMITTED] T9351.003 [GRAPHIC] [TIFF OMITTED] T9351.004 [GRAPHIC] [TIFF OMITTED] T9351.005 Mr. Platts. I would like now to ask each witness to stand and any other persons who will be advising you during your testimony to stand, raise your right hands, and we will issue the oath together and then proceed with testimony. [Witnesses sworn.] Mr. Platts. Thank you, and the clerk will note that all witnesses affirm the oath. I'd like to now proceed directly to the testimonies. Ms. Calbom, we'll begin with you, followed by Mr. Dumaresq, then Mr. McClintock, Mr. Hayward and Mr. Menth. The subcommittee appreciates the very substantive written testimonies that you provided to us in advance, and each has been submitted as part of the record. Because of the detail and the importance of the items we are going to be discussing today, I would like to extend to each of you 10 minutes as opposed to the customary 5 for your opening statements, and then we'll proceed to questions. Ms. Calbom, the floor is yours. STATEMENT OF LINDA CALBOM, DIRECTOR OF FINANCIAL MANAGEMENT AND ASSURANCE, U.S. GENERAL ACCOUNTING OFFICE Ms. Calbom. OK. Thank you, Mr. Chairman, Mr. Towns, Mrs. Blackburn. I'm pleased to be here today to discuss the results of our review of SBA's accounting for its loan sales and the cost of its credit programs. My testimony today is going to summarize the findings in the report we issued in January of this year, which you've referred to, Mr. Chairman. I'll also just briefly touch on other financial management issues that were identified by SBA's auditors during their audit of the fiscal year 2002 financial statements. Our review disclosed that SBA has fundamental problems with accounting for its credit programs, particularly the disaster loan program. These problems became more and more evident as SBA carried out its loan sales. Loan sales didn't actually cause the problems, but did bring them to light sooner than may have otherwise occurred. SBA began its loan sales activity around the end of fiscal year 1999 and to date has sold well over half of its direct loan portfolio, the bulk of which represents disaster loans. As these sales have occurred, a steep decline in the subsidy allowance account for disaster loans, which is meant to cover the cost of the program, has also occurred. This decline is graphically depicted on the chart that we've got here and up on the overheads. It's also on the highlights page of my written testimony. As you can see, the subsidy allowance account eventually went negative in 2001, and then continued to go even further negative in 2002. A negative balance in a subsidy allowance account would only ever make sense if a profit was expected from the program, which was not the case for the highly subsidized disaster loan program. In this case the negative balance likely means that more reserves were being taken out of the account than had ever been put in to cover the cost of the program. While SBA and its consultants are still analyzing the cause of this anomaly, it appears that one of the key problems is that the average loan term used to calculate the subsidy cost was too short. SBA had estimated the average loan term for disaster loans to be 16 to 17 years. Based on our review of the disaster loans sold in the first five sales, the average loan term was more like 25 years. This is a very significant difference when you're dealing with a program like disaster loans where you have interest rates that are below market and, therefore, the longer the loan term, the more costly the program. We also found other problems during our review of SBA loan sales, the first of these being that the estimated accounting losses on the sales were incorrectly calculated. We reviewed the methodology SBA used to calculate these losses and found significant errors in how the subsidy allowance was allocated to the loans that were sold, thereby misstating the losses on the sales. Theoretically this type of error would have been corrected when SBA reestimated the cost of its loan programs, which they're generally required to do on an annual basis. These reestimates are done to adjust the cost of the programs for any changes in the key assumptions that went into the original cost estimates. However, we also found as part of our review that SBA's reestimates of subsidy costs were unreliable. At the time of our review, even after selling nearly half of its loan portfolio, SBA had not analyzed the effect of the loans sales on the estimated costs of the remaining portfolio. Therefore they did not know if their original assumptions about the characteristics of the portfolio were still valid. Despite the significant unexplained decline in the subsidy allowance and the other issues I've just outlined, SBA received unqualified or ``clean opinions'' on its fiscal year 2000 and 2001 financial statements. We discussed these issues with SBA's auditors, and they have since reevaluated and withdrawn their unqualified opinions for 2002 and 2001. SBA's inability to account for its loan sales or adequately reestimate the cost of loans not sold, combined with other financial management issues, led the auditors to issuing a disclaimer of opinion on SBA's fiscal year 2002 financial statements. Other issues identified during the fiscal year 2002 audit that impacted the opinion included problems in accounting for pre-1992 loan guarantees and uncertainties surrounding the balance in the Master Reserve Fund, which is maintained by SBA's fiscal agent as part of its administration of the 7(a) secondary market program. The auditor reported material internal control weaknesses related to these and other issues, including SBA's financial reporting process. According to the auditors, SBA continued to experience widespread difficulties in producing accurate, timely and adequately supported financial statements. In closing, Mr. Chairman, SBA's financial management deficiencies are quite severe and point to an inability to provide full accountability for taxpayer funds provided to the agency for carrying out its programs. We made a number of recommendations in our January report covering these matters as they related to loan sales and subsidy cost estimates. The SBA agreed with our recommendations and contracted with an independent consulting firm to assist them in completing a more detailed analysis of their loan sale accounting and cost estimation procedures. Based on our recent discussions with SBA officials, we understand that they are making good progress in identifying potential causes of the problems and actions to address them, and we look forward to assessing the results of these activities. Thanks, Mr. Chairman. Mr. Platts. Thank you, Ms. Calbom. [Note.--The GAO report entitled, ``Small Business Administration, Accounting Anomalies and Limited Operational Data Make Results of Loan Sales Uncertain,'' may be found in subcommittee files.] [The prepared statement of Ms. Calbom follows:] [GRAPHIC] [TIFF OMITTED] T9351.006 [GRAPHIC] [TIFF OMITTED] T9351.007 [GRAPHIC] [TIFF OMITTED] T9351.008 [GRAPHIC] [TIFF OMITTED] T9351.009 [GRAPHIC] [TIFF OMITTED] T9351.010 [GRAPHIC] [TIFF OMITTED] T9351.011 [GRAPHIC] [TIFF OMITTED] T9351.012 [GRAPHIC] [TIFF OMITTED] T9351.013 [GRAPHIC] [TIFF OMITTED] T9351.014 [GRAPHIC] [TIFF OMITTED] T9351.015 [GRAPHIC] [TIFF OMITTED] T9351.016 [GRAPHIC] [TIFF OMITTED] T9351.017 [GRAPHIC] [TIFF OMITTED] T9351.018 [GRAPHIC] [TIFF OMITTED] T9351.019 [GRAPHIC] [TIFF OMITTED] T9351.020 [GRAPHIC] [TIFF OMITTED] T9351.021 [GRAPHIC] [TIFF OMITTED] T9351.022 [GRAPHIC] [TIFF OMITTED] T9351.023 [GRAPHIC] [TIFF OMITTED] T9351.024 Mr. Platts. And before we go to our next testifier, I apologize. I wanted to recognize our vice chair, the gentlelady from Tennessee, Marsha Blackburn. Thank you for being with us. STATEMENT OF THOMAS A. DUMARESQ, CHIEF FINANCIAL OFFICER, SMALL BUSINESS ADMINISTRATION Mr. Dumaresq. Chairman Platts, Mr. Towns and other members of the subcommittee, first of all, I apologize for my voice. I woke up, and it seems to have gone away. On behalf of the SBA and Administrator Barreto, I want to thank you for the opportunity to speak today about the SBA's financial statements. I am Tom Dumaresq, SBA's Chief Financial Officer. First, I want to emphasize that Administrator Barreto is committed to good and sound financial management. He changed the leadership team in the Office of the Chief Financial Officer because he determined that a fresh look at the agency's financial systems and procedures was necessary. Shortly after he was confirmed, he became aware of problems with the timeliness and accuracy of financial data, the progress of the implementation, and appropriateness of expenditures on a loan monitoring system and issues surrounding loan asset sales. I was appointed CFO in March 2002 with a mandate from the Administrator to correct these problems. Jennifer Main, a senior management consultant and former employee of the Office of Management and Budget with extensive Credit Reform Act experience, was hired as the new Deputy CFO in September 2002. With the support of Administrator Barreto, the new CFO team quickly identified the primary financial management problems that is the subject to this hearing as well as other critical financial management issues. We were working to address these issues before the GAO fiscal year 2002 audit reports were issued, and I am very confident based on progress so far that the three issues that form the basis of the disclaimer will be resolved before the fiscal year 2003 financial statements are submitted. SBA IG has the responsibility for obtaining an independent audit of SBA's financial statements annually. Since 1991, the IG has employed Cotton & Co. LLP as its auditor. Since 1996, SBA had been given unqualified opinions from the auditors. We are here today because SBA received a disclaimed opinion on its fiscal year 2002 statements. I would point out, however, that the key issues raised in the fiscal year 2002 audit have been elements of SBA's financial statements since 1999, and only this year did the auditor determine that these issues merited the disclaimed opinion. It is not SBA's treatment of these issues that has changed, but rather the auditor's perspective regarding their significance. We agree with the auditors' recommendations; however, it is important to recognize that the changed audit opinion does not reflect a decline in the quality of our financial statements, but rather a more in-depth assessment by the auditor of what has been in our financial statements for a number of years. The asset sale issue is very complex, and the available guidance is very limited. It is fair to say that both the fiscal year 2002 financial statement audit and the January 2003 GAO audit provided helpful information, but ultimately we recognize that the answer to the problem will come from the CFO staff supported by a highly qualified team of outside consultants. SBA has been aggressively pursuing an answer to this problem since the fall of fiscal year 2002. SBA held its first asset sale in August 1999. Since then, SBA has conducted a total of seven asset sales and plans to continue the program, but only if it is determined to be in the government's best interest. As early as the fall of fiscal year 2000, SBA was aware that the accounting for the asset sales was resulting in losses on the financial statements rather than gains as calculated under the asset sales model. In 2001, GAO was asked to look at this anomaly, which resulted in their January 2003 report. There are two distinct issues that SBA is working to resolve. The first issue is discrepancy between the accounting system which tracks program costs and the budget models which are used to forecast the lifetime loan program cost. The second issue is the discrepancy between the asset sales hold model, which estimates the value to government of loans to be sold, and the budget model. Results from our asset sales program have indicated that while the sales were profitable when measured against the hold model value estimates, the proceeds from the sale caused an increase in program costs as measured by the budget model. We believe we have made good progress in resolving these issues, but it's too preliminary to go into detail about our findings. I can say that SBA is determined that going forward there must only be one model. The single model must have the functionality to provide both the traditional budget results as well as the loan level value to government estimates that the hold model had provided previously. Although we have made significant progress, we will not be able to determine the impact of asset sales on the cost of the disaster loan program until the new baseline subsidy model is completed and validated. We anticipate completion of the model, including review and validation, by the end of this fiscal year. In conclusion, I can assure you that SBA is taking the necessary steps to address the issues raised by GAO and the auditor and expects to have them resolved by the time the fiscal year 2003 audit is completed. I believe that we have learned a great deal as we work through the asset sale issue. We hope to work with OMB and GAO to share our experience with our agency involved in asset sales. Thank you, and I'm happy to answer any questions. Mr. Platts. Thank you, Mr. Dumaresq. [The prepared statement of Mr. Dumaresq follows:] [GRAPHIC] [TIFF OMITTED] T9351.025 [GRAPHIC] [TIFF OMITTED] T9351.026 [GRAPHIC] [TIFF OMITTED] T9351.027 [GRAPHIC] [TIFF OMITTED] T9351.028 [GRAPHIC] [TIFF OMITTED] T9351.029 [GRAPHIC] [TIFF OMITTED] T9351.030 Mr. Platts. Mr. McClintock. STATEMENT OF PETER McCLINTOCK, DEPUTY INSPECTOR GENERAL, SMALL BUSINESS ADMINISTRATION Mr. McClintock. Good afternoon, Chairman Platts, Mr. Towns, Mrs. Blackburn. Your letter of invitation asked me to address five issues, which I will do. You asked for our reaction to the findings in the GAO report. In brief, the GAO report identified significant issues which may have affected the fair presentation of SBA's fiscal year 2000-2001 financial statements. Of the issues identified, we believe the disaster loan subsidy model's shortcomings have the greatest impact on SBA's financial statements. The subsidy estimate and reestimates prepared by SBA directly and indirectly affect all of the accounting anomalies noted. GAO recommended that we and our financial statements auditors assess the impact of identified misstatements and determine whether previously issued audit opinions need to be revised. We agree with GAO's recommendations. From our preliminary assessment of actions to date, it appears that SBA is taking appropriate steps to correct the problems. However, much work remains, and it always has to be reviewed. You asked for our reaction to the issuance of a disclaimer of opinion by our auditors on the 2002 financial statements and the withdrawal by the auditors of their opinions for the 2000 and 2001 statements. Based on the lack of information to verify certain financial statement amounts, we believe that a disclaimer was appropriate for the 2002 audit. Regarding the 2000 and 2001 statements, Cotton & Co. withdrew its opinions based on the findings in the GAO's report and the resulting uncertainty of some of the financial statement amounts. We agree with Cotton's decision to withdraw their opinions and ensure that SBA made appropriate disclosures. The subcommittee also asked for our reaction to the scoring of SBA's financial management for 2002 and 2001 in the President's Management Scorecard. While not familiar with all the details for scoring, we believe the 2002 score of red was appropriate. SBA's 2002 appears to be directly related to Cotton's disclaimer of opinion. In 2001, SBA received a yellow score. While SBA had received a clean opinion in 2001, Cotton noted material weaknesses and reportable conditions in SBA's reporting process and related system controls. Also, for both years, SBA was not in substantial compliance with the Federal Financial Management Improvement Act of 1996. These problems appear to meet the criteria for a red score. You asked how the OIG is responding to these problems. We have worked closely with Cotton and the CFO to ensure that the correct process was followed in withdrawing past opinions. We also initiated a review to understand the process that had been used in the past for loan sales accounting. This review is ongoing. We have also taken steps to strengthen the audit process. First, we asked Cotton for a plan for the 2003 audit with specific emphasis on credit reform. Cotton's plan includes retaining additional credit reform expertise, increasing involvement by one of their partners with recognized credit reform experience, and retaining an outside expert to review their credit reform testing. Second, we are increasing our monitoring of the financial statement audit. To strengthen our own credit reform knowledge, we have enlisted the help of GAO to guide us in monitoring the credit reform aspects of the audit, and we will train appropriate OIG staff in Federal credit reform accounting. Third, the CFO, Cotton and OIG will form a working group to have open and candid discussions about audit issues as they arise. Last, the SBA Administrator recently decided to create an audit committee for the agency to advise and oversee financial management within SBA. You asked us to identify the challenges SBA faces to improve financial management. SBA faces a number of challenges. Its loan accounting system has been in use since the 1970's and is programmed in COBOL. SBA incurs substantial risk because the system is close to the end of its useful life, and it faces loss of contractor support within the next few years. Further, the system cannot be easily modified to adapt to accounting changes and rules. In fiscal year 2002, Cotton identified financial system information security weaknesses related to authorization, completeness, accuracy and integrity of processing data files. While SBA has made substantial progress in this area over the years, this area requires continued vigilance. In October 2001, SBA implemented the Joint Accounting and Administrative Management System [JAAMS]. While JAAMS has some improved features, it does not fully support the U.S. Standard General Ledger, and it does not provide for integration of SBA's disparate accounting systems. SBA has recognized that JAAMS does not fully meet its needs and is looking for alternatives. SBA continues to rely heavily on its Financial Reporting Information System [FRIS]. FRIS consolidates the results of various accounting systems and generates the financial statements. FRIS consists of a number of automated and manual processes. This process has yet to result in SBA producing timely, accurate and complete financial statements. In summary, many of the SBA financial reporting problems are related to outdated and cumbersome systems. Again, thank you for the opportunity, and I'd be pleased to answer any questions you have. Mr. Platts. Thank you. [The prepared statement of Mr. McClintock follows:] [GRAPHIC] [TIFF OMITTED] T9351.031 [GRAPHIC] [TIFF OMITTED] T9351.032 [GRAPHIC] [TIFF OMITTED] T9351.033 [GRAPHIC] [TIFF OMITTED] T9351.034 [GRAPHIC] [TIFF OMITTED] T9351.035 [GRAPHIC] [TIFF OMITTED] T9351.036 [GRAPHIC] [TIFF OMITTED] T9351.037 [GRAPHIC] [TIFF OMITTED] T9351.038 [GRAPHIC] [TIFF OMITTED] T9351.039 [GRAPHIC] [TIFF OMITTED] T9351.040 [GRAPHIC] [TIFF OMITTED] T9351.041 Mr. Platts. Mr. Hayward. STATEMENT OF CHARLES HAYWARD, PARTNER, COTTON & CO. Mr. Hayward. Good afternoon, Chairman Platts and members of the subcommittee. I submitted a written statement of today's testimony, and rather than summarize that statement per se, what I'd rather do is to reformulate my testimony right now in a way that would address the four key points that the committee wants to talk about today. I'll address these points in turn. First of all, however, I would like to preface my remarks by informing the subcommittee that my input today reflects our assessments as of January 29, 2003. That is the close of our audit field work, and we have not done any substantive audit testing since that date. Right now I would like to get into your questions, your four questions, and my inputs to those questions as best as I can. The subcommittee's first question: What are the fundamental flaws with SBA's accounting for loan sales? We've had Pete and Tom speak to that already. I'd just like to say that during the 2002 audit, we learned that shortcomings with SBA's disaster modeling were the basic flaw. Bill Menth will speak in a few minutes about this flaw, which led to two kinds of inaccuracies, neither of which could be readily quantified by management during the relatively short period of the 2002 audit. The first effect of this flaw was that SBA's unsold loans could not be valued correctly, and SBA's subsidy costs for loans not sold could not be accurately reestimated. The second effect of this flaw was that reliable and accurate values for loan sale losses could not be computed. These two effects were embodied in our audit reports, reflected in our disclaimer of opinion, and addressed in greater detail in GAO's report. SBA has, as I mentioned--has spoken to its evaluation of GAO's report for purposes of assuring itself that all corrective actions are taken as soon as possible and, in any event, in time for Cotton & Co. to adequately assess corrective action. I can only say at this time that SBA's reaction appears consistent with its desire to be responsive to us and GAO. The subcommittee's second question: What did SBA learn from the consultants it hired to help solve the problems with loan asset sales? I think it's fair to say that it appears to us that SBA has gone a long way toward answering this question in the testimony just given. Bill, I might add, will supplement that point. I wish, however to make two points. The first point I'd like to make is that some of our audit evidence supporting our clean opinions for 2002 and 2001 was based on our conclusions drawn from reviewing available reports prepared by SBA's credit modeling consultants. These reports found that the subsidy modeling estimates were reasonable and free from material deficiencies, and those reports addressed most or all of the models, particularly the disaster loan model. While the body of our audit evidence with respect to the 2000 and 2001 modeling was broader than these consultants reports, I simply want to make the point that such reports, these consultants reports, did influence our work. Second, I want to point out that while we have not been privy to the latest report by IBM, we understand that report goes a long way as a positive first step toward the necessary corrective action on SBA's part. The subcommittee asked a third question: How does SBA plan to rectify the situation and make sustainable long-term improvements to its financial management? Again, I think SBA has done a much better job of addressing this question than I can. I would simply like to say that appearances here today and from the testimony that I've seen indicate that SBA will undertake the necessary actions to rectify this situation and make sustainable long-term credit improvements as soon as it can. Its plans to meet these goals this year are ambitious. Fourth, why did SBA receive clean opinions in fiscal years 2001 and 2000 when its accounting for loan asset sales was flawed? I'd like to start by saying that credit reform is an extremely complex area involving a number of disciplines'-- accounting, modeling, statistics, and economics. Beginning in 2000, the partial cohort asset sales exacerbated those complexities and brought to light the problems so that they were clear to everybody involved here at this table. In our 2000 and 2001 audits, we recognized that these compounded complexities existed, and we completed extraordinary procedures to test the methodology and the underlying data. Those are the two key steps under audit standards with respect to accounting estimates. The modeling flaws that are now apparent escaped our detection. Many expert eyes have looked at the estimation models and methodologies over the years, and I must say that the flaws that escaped our attention, escaped other persons' detections as well. But I want to emphasize that the responsibility for our audit opinion is ours and ours alone. With--when the inaccuracies in the estimates became evident last year, I want to also say that we did what was required under the standards. We took steps in cooperation with SBA to prevent continued reliance on the financial statements, and we withdrew--we asked SBA to make clear to potential readers that they should not rely on either our audit opinions for those years or the agency's financial statements. Now, withdrawing an opinion is not something that the firm took lightly, and we certainly will not take that lightly. We intend to learn from that withdrawal in the future. In doing audits for more than 22 years, Cotton & Co. has never before had to withdraw reliance on an audit opinion, and in this case we've done what we believe to be the right things. In closing, I hope that is a good start for allowing you to understand our perspective. Thanks for listening, and I'd be happy to answer questions. Mr. Platts. Thank you. [The prepared statement of Mr. Hayward follows:] [GRAPHIC] [TIFF OMITTED] T9351.042 [GRAPHIC] [TIFF OMITTED] T9351.043 [GRAPHIC] [TIFF OMITTED] T9351.044 [GRAPHIC] [TIFF OMITTED] T9351.045 [GRAPHIC] [TIFF OMITTED] T9351.046 [GRAPHIC] [TIFF OMITTED] T9351.047 [GRAPHIC] [TIFF OMITTED] T9351.048 [GRAPHIC] [TIFF OMITTED] T9351.049 Mr. Platts. Mr. Menth. STATEMENT OF BILL MENTH, CONSULTANT TO COTTON & CO.'S SBA AUDIT TEAM FOR FISCAL YEAR 2002, POSTAUDIT CONSULTANT TO SBA Mr. Menth. Mr. Chairman, members of the committee, good afternoon. I join with others in thanking you for the opportunity to discuss SBA's loan assets sales and financial reporting. Before presenting my testimony, I should state that I have worked in three capacities related to SBA's credit programs. From 1986 through 2001, I worked with the Office of Management and Budget, where I had a substantial role in implementing credit reform. My time at OMB included a significant amount of work specifically with SBA's credit programs. I retired from OMB in 2001. From June 2002 through January 2003, I was an advisor to the audit team for Cotton & Co. In that capacity I contributed to the analysis of the disaster loan sales in the Master Reserve Fund, which in turn contributed to the disclaimed opinion. Then in March 2003, several weeks after the audit engagement was concluded, SBA contracted with me to advise them on the resolution of the disaster loan issue. Today my testimony will focus on three themes drawn from my experience with the 2002 financial audit: first, on the role of credit estimates in financial statements; second, on the current state of standards and guidance for estimates used in accounting for the loan asset sales; and third, on the need to help other Federal agencies benefit from SBA's recent experience. You've already heard that SBA's financial statements received a disclaimed opinion, largely, though not exclusively, because the gain or loss on $5 billion in loan sales could not be stated accurately. I will add a few details to what you've heard already to lay a basis for a point I wish to make. Briefly, a loan sale results in a gain when the net proceeds from the sale exceed the book value and a loss when the opposite is true. In that equation the net proceeds are calculated using actual cash transactions. However, the book value, contrary to what the name might suggest, is a present value calculation of the estimated cash-flows that would have taken place if the loans had been kept rather than sold. In drawing attention to the distinction between actual accounting for cash transactions and cash-flow estimates, I wish to emphasize where we must look for solutions. The disclaimed opinion was due to the errors--the disclaimed opinion was not due to errors in the accounting for the cash proceeds. The problems resulted from the faults in the statistical models used by SBA. The fundamental defect is the inability to estimate specifically the remaining cash-flows of the loans sold and, therefore, the book value of the sale. Therefore, the problems must be resolved by placing--by replacing the existing disaster loan model with a new model that meets all standards, both explicit and implied, and provides cash-flow estimates on a loan-by-loan basis. This is what SBA has engaged me to assist them in doing. The distinction between estimates and actual accounting for cash transactions is important for another reason. While there are well-developed standards for actual cash transactions, the standards for estimates, especially those related to loan sales, do not have the same degree of evolution and refinement. This leads to my second theme. In recent years the disaster loan model has been subject to a wide review. In addition to SBA staff and SBA auditors, the model is reviewed by outside firms to validate its methods, and by OMB and by GAO. I am not aware of any instance where the fundamental defect was identified. The failure to identify that defect despite the time and talent available is curious indeed. In my view, it cannot be attributed to a lack of seriousness of purpose or a shortfall in professional capabilities. In fact, I have a high professional regard for all those that were involved in the matter. Instead I would like to suggest another explanation: that the standards and guidance for credit estimates did not evolve as quickly as was needed. In particular, while guidance was provided under one heading for cash-flow estimates and under another heading for loan sales, there's little guidance provided regarding the incremental requirements for cash-flow estimates when they are used for loan sales. I believe it is fair to say that as a result of SBA's experience, that more explicit guidance can be given now regarding loan sales. Had the need for such guidance been apparent earlier, I believe it would have been made available. In any case, I trust the experience will have a beneficial effect on the evolution of standards and guidance. My final theme is a suggestion for how other credit agencies can benefit from SBA's experience. Other agencies are currently selling loan assets; additional agencies may sell them in the future. I would encourage the development of a lessons learned document--I don't believe I'm unique in this-- in which all of the parties, SBA, OMB, GAO, SBA's auditors, contribute freely. Thank you. I'll look forward to your questions. [The prepared statement of Mr. Menth follows:] [GRAPHIC] [TIFF OMITTED] T9351.050 [GRAPHIC] [TIFF OMITTED] T9351.051 [GRAPHIC] [TIFF OMITTED] T9351.052 Mr. Platts. Thank you, Mr. Menth, and all of our witnesses for your testimonies. I think one of the things that came through in your oral testimony here today and your written testimonies is the partnership that's come out of what's been discovered about the modeling problems and how that's translated; and clearly, with GAO, with the CFO at SBA, the inspector general, the auditors that you're working hand in hand with each other to try to learn from what went wrong and then have a positive result not just for SBA, but as was just referenced for other agencies involved in loan sales as well. That's certainly what we're hoping, that this hearing will kind of further bring light to that effort and allow all in the Federal Government to benefit from this process. For the most part, as we turn to questions, we'll follow the 5-minute rule for each committee member. And after we've done the first round, we'll certainly be glad to come back around then. With there being a small number of us here, if you need a little extra time as we go through that first round, that's fine. I'm going to begin with a question really for the whole panel. Given the issues that have been identified now and that you're seeking to resolve, and to prevent the modeling problems in the past and have a more accurate model, would you recommend that there should be no loan sales done at all, not just by SBA, but by other Federal agencies, until this additional guidance is solidified and then put out there and a better model is in hand; or in the alternative, that we at least have--my understanding in trying to get a handle on this is that the sale of partial cohorts as opposed to a complete package of cohorts maybe compounded the problems that occurred. So would you support either of those alternatives, or do you think that we can go forward without one of those being adopted? Ms. Calbom. We'll go in order then, I guess. Mr. Platts. That's the easiest probably. Ms. Calbom. Bill will get to think a long time about his answer. I guess, you know, this is a very complicated issue as we've all been talking about, and we haven't even begun to even scratch the surface of the complexities. But as far as additional sales going on, we recommended in our report that SBA needed to get their accounting squared away before they would carry on additional sales. I think when you're talking about other agencies, they need to have the demonstrated ability to do the type of calculations that are necessary to properly account for these loan sales. I mean, it might be a suggestion that some kind of a dry run be done with an agency, again, to be sure that they can actually do this. But the complexity of the partial cohort certainly, at SBA, made it more difficult. The way that they do their modeling, they really aren't able to directly allocate the allowance on a partial cohort basis, so it does make it even more complicated. Mr. Dumaresq. I guess the only thing I'd say is that the problems that we're experiencing with asset sales are related very specifically to the sale of disaster home loans, which are low-interest, direct government loans. We also sold some 7(a) business loans that had defaulted, and we didn't see the same problem. GAO recognized some problems with our accounting that we corrected, but we don't see the same anomalies coming up on that side. My point would be that I don't think that our experience necessarily should lead to other agencies stopping loan sales. I do think that they should certainly do their homework as they're doing this and thoroughly evaluate the results of the sale after it takes place to make sure that they have a good handle on what the actual costs are and whether it's consistent with their estimates. The cohorts certainly would have made it easier, but it seems to me that we have enough data available to us to analyze the results of the sales and the remaining portfolio, and I would presume that other agencies would, too. So it's possible to do, but I think that it really has to be done with a thorough evaluation of the results and the costs. Mr. McClintock. I would tend to agree with Tom. I can't speak for other agencies, but I would strongly recommend that SBA not do anything until we fully understand what all the consequences are of the sales that we've already had. And there are some issues that will come out of this in terms of both funding the losses and also issues in terms of funding the contractors that SBA hires to facilitate these sales. The assumption is that we have to enter into contracts in order to do the due diligence aspects of a loan sale, and the money that we use to pay those contractors actually comes out of the proceeds. Part of the process is that we make a determination-- whether it's been right or wrong, we make a determination of whether we will receive enough value for the loans that we're selling in order to proceed. If we end up in a position where we have to make the determination that we do not receive enough value, then we don't proceed with the loan sales. But we've funded millions of dollars up front with contractors in order to determine--in order to prepare for the sale. Those types of questions are kind of peripheral to the accounting issues. It gets more into the management issues in terms of how an agency runs its programs and so forth. As for partial cohorts versus full cohorts, certainly the accounting would be simpler under full cohorts. I'm sure you would have others that would argue that if they were restricted in selling just cohort loans, that they wouldn't maximize the value that they received for loans. So there's a tradeoff in terms of the simplified accounting versus maximizing results. Mr. Platts. Mr. Hayward, did you want to say something? Mr. Hayward. I do. I see that we're a little bit over on time, but I would like to say a couple of things briefly. As to the first question, as Pete said, I think that we get into some programmatic issues that we as auditors don't directly involve ourselves in in the financial statement scope. I would add, however, that I've heard nothing that I disagree with along down the lines. I think as a taxpayer it may very well be prudent to relook at whether we should--SBA should continue to sell these loans here without knowing further information. As to the second point, Pete hit what I was going to say, and that is there needs to be balance. I think this answer is a little bit too rigid to say that, yes, we should sell it by cohort. Mr. Platts. Quick followup before I yield to Mr. Towns. Mr. Dumaresq, when you emphasize with SBA or other agencies that continual evaluation that is now clear as far as the models, is it giving you an accurate reflection? What would be your best estimate as far as why that did happen with SBA, that we had 50 percent or so of the loan sales occur before having some review; you know, after 20 percent or 30 percent that we went so far forward before saying, hey, we need to do a review, or something came to light that told us that we had to do a review? It seems like that's when it prompts you. We were pretty far along before we did that type of evaluation that you're talking about. Mr. Dumaresq. I guess--that's a difficult question for me to answer. Mr. Platts. I realize your timing and when you came in, and trying to look back, you know, it's---- Mr. Dumaresq. I'd say two things. First, the results--and I don't think we've raised this before, but the fact that the asset sales proceeds were less than the net present value shown on the financial statements was a theoretically possible outcome, and so it was not a situation where the fact that we showed a loss on the financial statement after sale too immediately would have raised the red flag necessarily. On the other hand---- Mr. Platts. A theoretical possibility, wouldn't that probably tell you that your model for assessing the book value then is skewed? I mean, that would tell you something's off there if you can--it is possible, but there is still going to be a problem somewhere, in the value assessment. Mr. Dumaresq. Let me say this: When I came on board, shortly after coming on board, I was made aware of the fact that this situation existed, that we were showing very large losses, and as rapidly as we could employ the resources to do it, I asked for an evaluation of the loans sold versus the loans held and whether the results we were seeing actually supported the presumption that there was no impact on the subsidy rate. I don't know why that wasn't done earlier, nor whether it was appropriate earlier, but that was what I felt was appropriate as soon as I found out what the situation was. Mr. Platts. OK. Thank you. I now yield to Mr. Towns for the purpose of questions. Mr. Towns. Thank you very much, Mr. Chairman. And I don't want you to think I'm involved in terms of wanting to blame somebody, but I really want to make certain that I understand the reason for the mistakes. Was it the complexity of the sales, or was it just a lack of expertise within the agency? Or is there something that we need to do on this side to be able to assist you in correcting? To Mr. Dumaresq. Mr. Dumaresq. I guess I'd say that it's difficult--I wouldn't necessarily characterize what happened as being the result of errors or mistakes in the sense that it was a situation where the wrong data was input or something like that. What you have here under credit reform is a situation where models are developed to estimate costs. They are only estimates. And these, the estimates that we were using, turned out to be not accurate enough to deal with the sale of these assets and weren't accurate enough to accurately assess the cost of the program. Now, over a period of time, the way credit reform is supposed to work, on an annual basis there is a reestimate that's done with actual data. So it is a kind of a self- correcting process. You know, it--it is a very complex set of circumstances. I think some of the best people in the field were available to SBA and were drawn in as consultants and reviewed the different components. To really get a handle on this problem, you had to look at the results across the three areas, across the whole model that was predicting what the asset sale would bring, subsidy model that was estimating the cost of the loan program and the accounting. It seems like each one of those different elements had been reviewed in detail individually, but as a group the overall answer, all together, the answer was clearly needed further evaluation, and that additional step wasn't taken. So, like I say, it is a very complex set of circumstances, and as soon as I came in and became aware of the situation, we started to address it. Mr. Towns. Right. I think the point I'm saying, do you feel comfortable that you have the expertise within the agency to deal with this problem? And can you really correct it? And I think you said something about reaching out and getting consultants. But even in order to do that, you still have to have a certain amount of expertise within the agency. Do you feel that you have that? Let me just tell you where I'm going with this. You know, I don't want to--you know, a lot of times we sit over here on this side and blame--you know, is there anything that we need to do here as Members of the U.S. Congress to help you, to assist you in making the corrections that need to be made? Because I'm troubled by the fact that evidently you have to stop for a while and make all these corrections, make all these changes. In the meantime, you know, people that need the service will not be getting it. Mr. Dumaresq. Well, I don't think there will be any impact on the program delivery at SBA because of that. Mr. Towns. Well, I thought Mr. McClintock mentioned the fact that maybe there should be a delay. Am I quoting you right? Mr. McClintock. Correct. But it really relates more to funding issues and---- Mr. Towns. That's service. Mr. McClintock. Right. Mr. Towns. In my neighborhood. Mr. Dumaresq. Well, none of the loan programs would be impacted in any way. Mr. Towns. OK. Mr. Dumaresq. In other words, we're engaged here in the sale of loans after they've been made. Mr. Towns. Right. Mr. Dumaresq. So, before we sold loans, we serviced them in-house, and we're continuing to do that. Mr. Towns. So this will not stop or will not delay in any way. Mr. Dumaresq. No. No. There's no impact on SBA's programs. Mr. Towns. Ms. Calbom, do you want to add something on that? Ms. Calbom. I think what Mr. Dumaresq is saying is that basically it's not slowing down their activity as far as making new loans, but what it is slowing down is packaging of those loans and then selling them to other buyers who would then service them. So as far as providing the funds out there in the small business community, it wouldn't impact that. What it does impact, then, ultimately is who is servicing the loans, and it impacts how much of SBA's resources that they devote to carrying out the loan servicing function. The more loans they sell, then theoretically the less of their resources that they have to devote to servicing those loans. Mr. Towns. Right. I guess, Mr. Hayward, how did your firm miss what seemed to be such a major accounting problem? How did you miss it? Mr. Hayward. Well, I think we missed it in the context of some of the complexities involved, some of the inherent risk that we've got here to deal with short milestones. And I think notwithstanding those two factors that we did do extensive tests of these balances. We had statistical people at our side back in 2002 and 2001 to thoroughly go through these models. We looked at the outside consultants' reports that unanimously, I think it's fair to say, painted a picture that there were no problems conceptually with these models. So I think Congressman Towns, that we see here a situation where we perhaps could have been more skeptical in the circumstances, but by the same token, I think we have a substantial body of audit evidence to support our conclusions, which at the time we felt were reasonable. Mr. Towns. I guess the question I wanted to ask, can we safely say that this will not happen again? I mean, that's where I'm trying to go. Mr. Hayward. Well, we're taking steps to assure that this won't happen. Pete, I think, referred to a number of those steps, and they are always referred to in our words, in our testimony. In brief, those steps are to increase substantially the amount of inputs from a recognized credit reform expert that we have on staff and also the independent partner on the engagement. Her name is Cathy Nocera. Second, we will be bringing onto the engagement a recognized ``name'' credit reform expert to manage that side of the audit. Now, there's two parts to managing that side of the audit, Congressman Towns. The first side is evaluating the models and whether they are sound, and the second side is to evaluate the corresponding accounting. These are two different disciplines that we need to bring and that we will bring. Last, we want to have our work peer-reviewed by a credit reform expert that has been uninvolved in the audit to date. We intend to bring this person on late--well, midpoint in the audit to make sure that we have mutual understandings of the expectations here for that person. Again, this person is independent. And then later in the audit we will feed that person our conclusions that--as we see them so that person can criticize and maybe draw some constructive changes if they're appropriate to our conclusions. So we are taking specific steps to minimize, if not eliminate, this possibility. Mr. Towns. Thank you very much, Mr. Chairman. I see my time has expired. Mr. Platts. I now yield to Mrs. Blackburn for the purpose of questioning the witnesses. Mrs. Blackburn. Thank you, Mr. Chairman, and thank you to the panel for being with us today. We appreciate this very much. Ms. Calbom, thank you for the report, your book. I wish I'd had this a little bit sooner. It does have some great information in it. I'm going to go to page 12 of this report, and, Mr. Dumaresq, I'm going to address you the first question. Let's talk for a moment, if you will, please, sir, about who is buying these loans. Mr. Dumaresq. The loans are actually purchased by large financial institutions for the most part. There are some small financial institutions who've bid on some of the pools that we've seen. Mrs. Blackburn. OK. Great. Thank you. Now, let's talk. I'll continue with you, if you will, please, sir. What is the liability or the responsibility that the SBA bears for the inaccuracies and maybe flawed due diligence in that sale? Mr. Dumaresq. You mean with the purchaser, the ultimate purchaser? Mrs. Blackburn. Yes. Mr. Dumaresq. That's not something that I deal with regularly, we can get an answer for you and submit it later on. Mrs. Blackburn. OK. Did the SBA or its auditors consult with the risk assessment experts during this sale, the loan sales evolution? Mr. Dumaresq. Yes, there are financial experts that are on contract with the program, people as they're formulating the sales, putting what belongs together and throughout the entire process. And we also use consultants in the Office of the Chief Financial Officer to develop our models and the full rates and other things. Mrs. Blackburn. OK. Are you aware of the type of due diligence that the purchasers of the loans are engaged in? Mr. Dumaresq. I know that they do their own due diligence, and SBA does due diligence prior to the sale as well. I'm not completely familiar with what they do. Mrs. Blackburn. OK. Then looking at page 14 of the report, the middle paragraph there says, ``SBA's due diligence is the most costly and probably the most important element of the loan sale process.'' Mr. Dumaresq. Yes, that's correct. There is a significant effort that goes into making the loan data, information from the loan files, available electronically to the potential bidders, so that they can get a good idea of what they're bidding on. And that's proved to be the most costly part of the asset sales. Mrs. Blackburn. OK. And is the percentage correct, that it can be even as much as 87 percent of the total sales cost? Mr. Dumaresq. That, I believe, is correct. Mrs. Blackburn. That is correct. OK. Anyone else have any comment on that? No? Absolutely not? OK. I did have, either Ms. Calbom or Mr. Dumaresq on this, how much is it going to end up costing us to address the situation with the SBA and the loan program? What do you anticipate the total cost to be? Because we've heard from Mr. Hayward, we have the outside consultants, some more people are being brought on, what type of expenditure, and then also what type--timeframe are we looking at to get this straightened out? Mr. Dumaresq. We do not anticipate a situation where we would be asking for an additional appropriation the way--under Credit Reform we have an unlimited, perpetual appropriation that we draw against as we determine or find the cost estimate during the annual reestimates. Mrs. Blackburn. Just a minute. Would you say that, again, did you say you have an unlimited? Mr. Dumaresq. Right. Ms. Calbom. Mrs. Blackburn, I think--were you asking about the cost of hiring consultants and others to analyze the problem? Mrs. Blackburn. Absolutely. Mr. Dumaresq. I'm sorry; I misunderstood. Right now, we're just in the process of awarding contracts for this, and I would say--I think the best thing to do would be maybe to provide you that information subsequent to the hearing. I'd rather give you an accurate assessment of what it will cost us. Mrs. Blackburn. OK. Have you reduced any of your employee numbers at the SBA in order to allow for the additional cost of this? Are you making any personnel adjustments? Mr. Dumaresq. We are not making any personnel adjustments specifically to cover the cost of this, no. Mrs. Blackburn. OK. All right. And what kind of responsibility exists, Mr. McClintock, coming to you, page 3 of your testimony where you're talking about the 1992 loan guarantees. Mr. McClintock. The question? Mrs. Blackburn. Pre-1992, what kind of responsibility exists there? Or tell me what you think can be done about that. It sounds like you've gone back, you looked, there was a true problem that was there. Is there any way to go back and rectify part of that? Mr. McClintock. I think the problem for the pre-1992 loans concerns the basis for the accounting estimate that's entered into the records. Mr. Hayward probably can describe it better than me, but it's basically an allowance for loss account and the CFO's office estimates what that is. I believe during the audit that there was not sufficient documentation for the auditors to really assess the validity of the estimate. Mrs. Blackburn. Mr. Hayward. Mr. Hayward. Yes, Mrs. Blackburn, there were two problems, one of which was resolved during the audit. The first problem with those pre-1992 loans was that the accounting had been historically done on budgetary bases and not also on proprietary bases. That problem was adjusted in the financial statements during the audit. The second problem is, as Pete indicated, with the sufficiency and objective verifiability of the loss allowance corresponding with these loans that, once purchased, would default, and SBA, I believe, is working on that. And I, personally, I do not think that is a, is a problem whose solutions, which should and will drag on more than 1 year, I think that's imminently solvable, in other words, this year. Mrs. Blackburn. As I wrap up, Mr. Hayward, I will go back to this first question I asked about any reliability or any responsibility that SBA may bear for due diligence that would be considered to be flawed. Due diligence by the customers who are buying these loans, is there any responsibility there? Mr. Hayward. Well, I hope I understand your question correctly. It's my understanding that the SBA does perform substantial due diligence, and it's my further understanding that we, as part of our audits, do look at that. In recent years we've had Mr. John Murphy look at that. He is an ex vice- president in the banking industry, and he has substantial experience with due diligence assessments. Mrs. Blackburn. Thank you, sir. Mr. Hayward. You're welcome. Mr. Platts. I'm going to followup on that and make sure, in trying to get to the due diligence of the purchasers of the loans, what goes into making the book value, you know, how accurate the model is in coming up to what is estimated. I mean, the purchasers obviously are trying to make sure they're getting a good deal. So what are they doing differently or were they doing differently than SBA was doing in saying, ``Hey, this is a good deal, and we're really going to be able to collect 50 percent more than we're going to pay here.'' They obviously had to have a, do have a model in place that they use. Is that something that the SBA has gone into, the private sector, people who were purchasing loans and say, ``What are you using to value our loans?'' So you're actually going to those who have been engaged in loan purchase transactions? Mr. Dumaresq. I know that our asset sales group has done quite a bit of research on what the buyers do as far as due diligence, and what they're looking for as far as the loans that we're selling. I do not think I'm in a position to really give a definitive answer to you on what the results of that have been. Mr. Platts. If you could followup in writing with us. Mr. Dumaresq. Sure. Mr. Platts. That would be great. It's kind of learning from the reality of the marketplace, is what those borrowers are looking at and how they're making assessments, certainly as it relates to the book-value assessment that's going on. And that kind of translates as a followup on the questioning about the annual reestimates, that ideally there would be kind of a self- correcting process here. Given that the loans, the five sales in question were, I believe, in 1999 to 2002, what went wrong in those reestimates? Because GAO said that those reestimates were not really found to be very reliable. Why were they not? We're actually looking at true numbers, here's what we valued, here's actually what we got. So we're too high, too low? What went wrong that those reestimates were not very credible and helpful? So that the second and third, actually, it would be second and third because if it's an annual reestimate, you're not going to have all that information for all of them, but what maybe did not happen that maybe should have? Let's start with you, and then have GAO. Mr. Dumaresq. Maybe Bill Menth is a better person to speak to that. Mr. Menth. Mr. Chairman, I'd like to make sure I understand your question correctly. Reestimates, let us suppose you have a cohort from 1992 which expects to have a remaining life of, say, another 30 years because some of the loans in there were 40-year loans, approximately. The reestimate has two parts, a large part and a small part. The small part is the replacement of estimates with actual data for the 1 year just completed. The large part is the revaluation of the estimates for the remaining, now, 29 years. And the difficulties with disaster loan reestimates were largely due to the problem with the reestimates of the remaining years that were not yet actual, rather than 1 year that became an actual. Mr. Platts. Maybe I'm misunderstanding that reestimate. I was understanding or believing that it was really the value that the market's going to place on these type of loans that you learn from the actual price paid. So if you reestimate going forward, that you have a little better idea what the market's going to bear as you get to your next sale to have a more accurate book value, to line up better with the market. Maybe I'm misunderstanding how those reestimates can really be used or what they offer you. Mr. Menth. I think that's an important question to answer clearly. I'll take a minute to do it. Reestimates are not a market-to-market transaction or calculation. When a loan is sold, that's an important piece of information about the value of those loans, and if the book value of the loans that were just sold was substantially different from the sales price, it's certainly an indication that there's some sort of a difference that needs to be analyzed and resolved. There are some very good reasons why bid prices can be substantially below the book value of loans. One of the most prominent is that bidders will take into account their administrative costs in the price that they bid. The government does not take administrative costs into account in its book value. For the disaster loans, these are all small face-value loans. The servicing cost of a loan, of course, is independent of the face amount of the loan. So when you have a large number of small face-value loans, the administrative costs can be substantial and can create a spread between the bid price and the book-value price. That does not indicate that the government has undervalued the loans, but rather there's an apples-to-oranges type comparison. Even so, it's important if, for example, bids come in at 50 cents on the book-value dollar, that the differences between the book value and the bids be reconciled, to see if perhaps there's something being told you that suggests a revaluation of the original subsidy be made. Mr. Platts. By the end of the day I will--you're already experts. You know the area. We'll be better experts, maybe, or trying to be. That maybe translates to another followup in why we started the sale, as opposed to servicing, in the first place. And it really goes to Mr. Towns' question about suspending the sales, not the fact that, Mr. Dumaresq, you say you really want the facts about the loans being issued. I'm assuming the reason we went to the sales in 1999 was because it was in the best interest of the taxpayer, because we're going to get a better return for the taxpayer by selling them and doing away with them, rather than keeping them in-house and servicing them in-house. So that the intent was sales will generate better return, less cost to operate the program because we get more money, better profit from the sale of it than servicing. So if that's accurate, that's why we went to sales instead of servicing. If we suspend sales now for some period of time, indefinite at this point, it seems that we're getting a lesser return which means we're going to have a more costly program, which either means we need more money from the general fund, or you're going to be able to offer fewer program benefits to the public looking for the assistance. Am I missing something here, I guess, is the question? Mr. Dumaresq. If I understand, then what we're finding is that the problem is that the asset sales may not actually give us the benefits that we thought that they would. In other words, our concern is that the asset sales are not keeping our costs constant, they may be increasing the cost, or may not be. We are not sure yet. We have to finish our evaluation, but unless we can show that there is a benefit to asset sales, we need to delay until we can show that. Mr. Platts. That's the followup, and if you could submit, as you complete that review, submit that conclusion you've come to, to the committee as well, that would be helpful. With us being the Government Efficiency and Financial Management Subcommittee that we're--is it in the best interest to actually have these sales? The cynic in me would look back to 1999 and say that in the short-term, this helps our books because it gets a lump sum of money into the Treasury. So in the short- term, it makes the books look better for the Treasury. Although, long-term, if we do the analysis, it's really not in the best interest to sell for a flat fee. It's better to keep it, service it. So I would certainly be very interested, and the committee would be interested, in what that analysis leads you to believe. Because it sounds like that's what you're doing as to whether you really want to return to sales at all or go back to pre-1999 and return to an in-house servicing and no sales. Is that an accurate assessment of what you've stated? Mr. Dumaresq. Of course, there are other possibilities. Yes, we want to find out whether the sales are beneficial or not, and the GAO touched on it in their report. Are there other operational benefits; are we reducing our servicing costs; are the sales beneficial; and are they reducing our servicing costs? Unless we can determine those clearly, then there's no point in going forward with them. And right now, we do not feel we can make that determination, and we want to get to the bottom of it before we go forward. Mr. Platts. I guess I have more followup questions, but in fairness, I'm going to yield to Mr. Towns. Mr. Towns. I'm sure happy you asked that question, because, you know, I was trying to figure that out, how this would not affect your mission. I got the impression or the feel that it would cut down on the amount that you could actually handle. That's not true? Help me understand this. Mr. Dumaresq. Well, up until 1999 we serviced all of the disaster loans in-house. Mr. Towns. Right. Mr. Dumaresq. At that point, we started selling well, the first sale was not disaster loan but business loans, but subsequently, we started selling disaster loans. We also started what was called a 30 percent home loan disaster servicing pilot where we took 30 percent of the disaster loan portfolio and contracted servicing out to a large business. The objective, I think, of the asset sales and the contracting pilot was to find out what was the most efficient way for us to handle the servicing and servicing of our loan portfolio. To me, what we found, what's clear, in my own opinion, is that there are tremendous economies of sale in servicing loans and that unless--so it would be better to either contract out or sell the entire portfolio than it is to contract out or sell pieces of a portfolio. What we found on the asset sale side is that the costs that we were incurring for servicing were not going down as quickly as the--as you might expect, given the percentage of the portfolio that we were selling. Similarly, when we contracted out 30 percent of the portfolio, our costs remained relatively constant, and we didn't see as much of a decline because we had to maintain our in-house infrastructure that was used to service the loans. So I think moving forward, we have to get to the, to come to a determination on what the best way to handle this loan portfolio is. The objective is to get to the lowest cost, most efficient way to service the loans and service the people that receive those loans, ultimately. Mr. Towns. Yes. Mr. McClintock. Mr. McClintock. May I add one small thing to this? As we said, most of these loans that we've sold are disaster loans. Disaster loan making is performed by our Office of Disaster Assistance. Servicing of those loans is performed by our Office of Financial Assistance. So it's two different groups within SBA. Therefore, the folks that actually make the loans aren't impacted at all by loan sales. The services are there. Our Disaster people respond just as they always have and have the loans issued very promptly and timely. So it's really the housekeeping at the back end of the process that is involved and it could be affected by the loan sales. It's the people in rooms with thousands and thousands of files of paper who, who either make changes to various terms of the loans, the collateral, accept the payments and so forth. It's the administrative costs that potentially could be reduced. The program aspects of making the loans wouldn't be impacted at all. Mr. Towns. So if for any reason I did not sell any, that would not affect you. Wouldn't that stop them from making them? Mr. McClintock. Disaster loans are made in response to disasters, and there's clear criteria as to---- Mr. Towns. I understand that, but I want to have a real serious discussion on this issue. I understand disaster and I understand the loan and I just think that if nothing is moving, it seems to me it might still hinder the process in terms of who would be able to get, I just think that on the other end, it would be a little more difficult to process. Mr. McClintock. On the front end? Mr. Towns. Yes. Mr. McClintock. They're separate functions, done by separate groups within SBA. Mr. Towns. And they do not talk to each other? That's a real problem. Mr. McClintock. The former Disaster Director said, ``Every loan I make is a good loan and the other office has to service it, and if it goes bad, it's because of the bad servicing.'' There are separate groups and the formulation of the loan, the loan approval is all done by--we have four different area offices and all they do is the front end of the loan. It's the servicing, the back end of the loan is done by either the contractor Tom mentioned or by servicing offices SBA has in other locations. Mr. Towns. OK. Let me just sort of raise this quickly, Mr. Chairman. Last year SBA actually deteriorated on a score for improving financial performance from the previous year. In addition to the loan asset sale problem, OMB raised questions about SBA's ability to meet accounting performance standards and measure risk in its loan portfolio more accurately. What steps are you taking to address these issues as well? Mr. Dumaresq. We've developed a plan to address all of the issues that were raised in the independent auditor's report and the GAO report moving forward, and we think that the plan will result in us clearing up those issues before the audit this year. Mr. Towns. You feel very comfortable about that? Mr. Dumaresq. I do, I do. I really do. We're totally committed to resolving the issues that have been raised. We have some challenges; there's no question about it. There's a lot on the plate, but we feel pretty confident that we can resolve the issues that have been raised this year. Mr. Towns. Do you want to comment on that, Ms. Calbom? Ms. Calbom. Based on the discussions we've had with Mr. Dumaresq and others, we feel that they are on the right track, or looking at the right things. We have not had the opportunity to go in and really study the analysis that they have performed to date or the work that their consultants have done. I think the key is going to be that it is a thorough analysis, and that it has actually identified all the problems, because this is not a matter of just one problem. I think it's a matter of a number of problems that occurred, and so you just have to be sure that you found all the real issues that are impacting this, double-check it, do some reasonableness tests, check and double-check your assumptions. But as far as what they have told us they're doing, we feel like they're on the right track. Mr. Towns. Thank you very much. Mr. Chairman, I yield. Mr. Platts. Thank you. Mr. Towns, Chair yields to Mrs. Blackburn for the purpose of questioning. Mrs. Blackburn. Thank you, Mr. Chairman. Ms. Calbom, I know that there are other agencies, USDA and HUD, that are engaged in loan sales, and I'm sure we could say there are plenty of lessons here that can be learned and applied there, but my question is this, is there a model in one of those agencies that could also be applied to the SBA to help them get on a firm footing? Ms. Calbom. Well, you know, we have not really studied in detail the loan sales that those other agencies have been carrying out, and I kind of go back to something I said before--I do not think loan sales caused the problems that SBA has. I think they brought them to light sooner than they would otherwise have been brought to light. I think the problems really had to do with, in general, how they were setting aside their allowances for their losses on their loans and then going in and checking to see if those allowances were adequate as they went along. Now, whether they would have sold loans or not, the bottom line is, if you did not put enough aside to begin with for the costs of those loans, then you're going to fall short at some point and selling the loans actually forced them to recognize those losses sooner than they would have had to otherwise. Mrs. Blackburn. OK. Mr. Dumaresq, on page 2 of your testimony, your statement, where you said, ``The changed IR opinion does not reflect a decline in the quality of our financial statements, but rather a more in-depth assessment by the auditor of what has been in our financial statements for a number of years,'' and I think this brings me back to a question that I asked and Congressman Towns has also touched on, you know, how far, how far back does the problem go and is there--are you washing your hands and saying that it was there and we did not deal with it? Mr. Dumaresq. No. Mrs. Blackburn. So we're changing our behavior going forward or are you saying here is a way to go back and try to make this work as best we can. Mr. Dumaresq. The reason we make that statement is that we want to make it clear that it is a difficult situation. We also want to make clear that we have not changed the fundamental processes and that we have financial controls in place at the agency. We do not in any way disagree with the disclaimer, but we think that the disclaimer is primarily based on the asset sales issue which truly came to light this year or was viewed in this way this year. And we feel it's important for everyone to be aware that we still have an ongoing, robust financial management system at SBA. We're continuing to use the same financial controls that we've had for the past several years. I think the clean audit opinions that the agency got for the 6-year period, were valid to a very large extent and that's the point we're trying to make here. We do not want anyone to think that we've just stopped employing our financial controls as we go forward. On the other hand, we recognize the seriousness of the issues that have been raised and we're committed to dealing with them as we move forward. Mrs. Blackburn. And at this point, how often are you all re-evaluating your loan portfolio? Mr. Dumaresq. You mean re-estimating the portfolio? Mrs. Blackburn. Uh-huh. Mr. Dumaresq. Re-estimates are done annually, but right now, we are again engaged in a more detailed process particularly related to the disaster loan portfolio, where we're looking at the entire portfolio, including what was sold, and comparing with what was kept. So that's a much more detailed analysis than the normal reestimating process. Mrs. Blackburn. OK. Thank you. Mr. Platts. Mr. Dumaresq, I'd like to followup on that question. When we talked about your analysis of the whole issue of loan sales versus in-house servicing of those loans. When you talked about contracting out 30 percent, that was contracting out the servicing? Mr. Dumaresq. Contracting out the servicing. Mr. Platts. As part of the ongoing review now, are you factoring in your decision whether to not go forward with anymore sales and just do all servicing, the possibility of contracting out all of the servicing of all your loans? In the sense, have you talked about it's an economy of scales issue? That is, is getting rid of 30 percent going to save a lot because you have all the infrastructure? Whereas, if you contracted 100 percent of the servicing of the loans, then you would not have the infrastructure, so that would make a different comparison on whether it would be good for tax payers or not? Is that part of your review? Mr. Dumaresq. I think, right now, we're focused on trying to figure out what the impact of the asset sales that we've had has been. What was the financial impact on the agency as a result of those sales, and that's a first step. I think we still believe that asset sales can be a very beneficial thing for the government. It seem likes it could reduce our ongoing operational costs and free up resources for other purposes. We have to make sure that's, in fact, the case and once we do that, I think we will consider all the options and try and determine what the best, most efficient, way to handle the portfolio is. Mr. Platts. In trying to prevent the problems with the sales in the past happening again in the future, the administrator has talked about the audit committee and, Mr. McClintock, you referenced it in your testimony. Can you give us an update, where is that proposal, what are the specifics, who would make up the committee? Is there any of that type of detail available yet that you could share with us? Mr. McClintock. No, actually, the decision to do this was made just within the last week or two but our plan is to coordinate with OMB. We have spoken with them. They have offered their assistance in terms of defining what a committee should do, identifying possible candidates to serve on that committee. An audit-committee concept is only in place at a handful of agencies. I believe GAO has one and the FDIC has one. There are several agencies that are exploring establishing audit committees. OMB has been promoting the concept over the last 2 or 3 years. So in terms of assessing what happened and trying to come up with ways of overcoming this type of situation in the future, we thought an audit committee would be a good idea, and so we presented the proposal to the administrator. He said, ``Good idea, let us go with it.'' So it's something that's in the very early stages, but it will be up and going within the next few months. Mr. Platts. What type, a few months is your estimate there? Mr. McClintock. We really have not even gotten that far in terms of doing it, but---- Mr. Dumaresq. We're actively pursuing it right now. We are trying to figure out what the rules are, what we have to do. We want to get an audit committee up and running as quickly as possible, as we can---- Mr. Platts. As you flush out the specifics of the committee, the make-up, the parameter, if you could share that with the subcommittee, that would be helpful. And the reference to GAO, if, Ms. Calbom, you could give us kind of an overview, if possible, of what your audit committee does, how it's made up and how it's been working, that would be helpful. Ms. Calbom. We've actually got several consultive committees that work with GAO. Our audit committee is involved in our financial statement audit, and I'm not particularly involved in that function. So I could not really give you the details on the make up and whatnot, but we'd be happy to provide that information for the record. Mr. Platts. Maybe more directly to SBA, as you mentioned you're dealing with OMB is that, is it inferred that since you're aware of GAO's audit committee, that you're looking at what they have done as a model or possible model. Mr. McClintock. I'm sure we will look at GAO. I've heard Mr. Walker, the Comptroller General, talk about his audit committee, and I know he's very happy with it, and maybe he'll identify a person or two that could help us out. But we will certainly look at the structure they use, as well as any other committee within the government. I think we would probably have to follow the Advisory Committee Rules. There are actually laws on how far an advisory committee goes and what their participation would be. Mr. Platts. Maybe that kind of leads to the next question, the interaction between GAO and SBA on the audit committee is on the issue of the IBM review? That's my understanding, is a draft or preliminary review has been conducted as far as recommendations and given GAO is playing kind of a pretty helpful role here in identifying some of the challenges with the loan sales issue, is there a pretty open dialog between the two agencies right now, with regarding IBM's findings and recommendations that, as you're looking at those findings you're asking GAO for their commentary based on their involvement in this process? Mr. Dumaresq. We had a meeting, I think just last week, and we shared the findings of IBM. We have not shared the report itself because the IBM report is just a standard report that we ask for at the end of a contract. We believe it's predecisional, and it's actually only a piece of what's been going on. IBM has been working in support of internal SBA staff to come up with a series of recommendations and testing different hypotheses. Mr. Platts. What would be the harm in just sharing the report? I mean, what risk is there to just share the entire report rather than just summarizing it? Mr. Dumaresq. Well, as I say, we're happy to make all of the information in the report available to GAO and we have. Mr. Platts. So you will share the report? Mr. Dumaresq. Right now, the agency's position is that the report is predecisional, and we have not released it. We can reconsider that or look at that decision again. Mr. Platts. It just seems, given the role and as we started this hearing today about this partnership between GAO, SBA and your auditors, congressional oversight such as this hearing, of all working together for that end result being a good program, well, serving the people of our Nation, and GAO's quite significant role, even identifying some of the problems, it seems it would be the earlier you have them involved in the analysis of those findings, the better. I certainly would encourage and hope that you give my request, that you just openly share that information with GAO, serious consideration to do that sooner rather than later, to allow that dialog to continue in a positive way and just avoid the perception that there's something that you do not want to just lay out on the table. Mr. Dumaresq. I understand that, totally understand. Mr. Platts. I assume that would be helpful as you continue, GAO continues, to look at the changes that are being contemplated in your analysis of what SBA's doing. Ms. Calbom. Yes, Mr. Chairman, we would want to look at that report. We would want to look at all the analysis that SBA is doing, you know SBA really has indicated to us that they are really leading the charge on this, and they're using the consultants to work with them. And so all the analysis they have done, we will want to look at when we eventually do this followup work. We do believe we have access to that information, and we did talk about that with the agency at our meeting and requested that we be able to proceed in having that access. Mr. Platts. My hope is that access will be, as we're all seeking that same common goal at the end of the day, that we just allow that to move forward in a positive way. I have more questions but, Mr. Towns, did you have other questions? Mr. Towns. I have questions I'd like to ask. Let me ask you, I guess, Mr. Hayward. I guess I'm trying to figure out your role now. Are you still working to be able to put safeguards in place? Are you still involved or you just said, there's a problem and you're out? Are you still, I'm trying to make certain you are still involved in terms of safeguards? The point is that I want to know what is your role, now that--recognizing there's a serious problem, are you involved in consulting and working with them in trying to work out and solve the problem, or are you out? Mr. Hayward. Well, in the first place, I'm actively involved in working toward some solutions here, to the absolute extent I'm able to do so and still retain my independence from SBA from management. Let me be clear. Mr. Towns. I understand that, but I'm saying that recognizing there's a problem, are they consulting with you in terms of correcting the problem, are you being talked to? I understand your role, but the point is that, you know, are they talking to you in terms of how this might be fixed? Mr. Hayward. Well, yes, sir. It's a two-way street. I have every right to ask as many penetrating questions as I think are appropriate, and conversely, management has shown, in the past, at least some decent cooperation with me to--in sharing its-- candidly sharing some of its concerns. So I believe the answer to your question is, yes and it's, it's multidimension--it's a two-way street, going back to the original statement. Mr. Towns. Right, you answered my question. The last question would be to you, Ms. Calbom. How can we apply what happened at SBA to other CFO's at agencies? Ms. Calbom. Well, I guess as far as other credit agencies, one of the key things, and something that GAO has looked at and recommended in some past reports we did some years ago, is, you know, you really have to make sure that you look at your models and that you're continuously updating the assumptions, challenging those assumptions, like, is my average loan life I've used in coming up with my cost, is that a reasonable loan life? Am I properly considering the amount of defaults that could occur? All those kinds of things that go into the costs of the loan programs, that you have to continuously update those and be challenging the original assumptions that you had, that was one of the big problems that appears that SBA had in some of our models, that some of those original assumptions were not right. And as I was mentioning before, the loan sales really brought that to light quite quickly. So if there's one lesson that certainly would come to the top in my head. That's just in general. Now, on the loan sales. I know that other folks on the panel have some thoughts on that, too. But I would say that before any agency starts to embark on loan sales, they really have to have their house in order as far as being able to properly account for, you know, the program to begin with, but then have the sophistication to be able to take on the added complexity of the loan sales. Mr. Towns. All right. Thank you very much. I yield back, Mr. Chairman. Mr. Platts. Thank you, Mr. Towns. For Mr. Hayward and Mr. Menth, your audit report noted that SBA has weaknesses in compiling the financial statements and based on your long history with SBA, is it your position that to get to those clean audit opinions that have been issued, and prior to the 2000 year were pretty consistently issued as clean audits, was it the result of good processes in place all year, or more, that end of the year Herculean effort to make everything to fit together and to get to a position that allowed for a clean audit to be achieved? And I ask you that because when we've had the Comptroller General testify, his emphasis in the area of financial management and improving is that we have a structure in place that, at the end of the year he basically punched a button and it puts out what you need. As opposed to, go through the whole year, and then at the end of the year, you're scrambling every year to get the data you need to show that you're in good shape. Which would be your position of SBA's year in and year out practices, more good process or more end of the year scramble? Mr. Hayward. Well, absent any change to our recommendations, I would have to say that we could expect some more heroism this year. We have made recommendations that are designed to lessen the heroism, so to speak, and more, more accurately to address the situation that you've addressed in your opening remarks, that is clean opinion is no indicator of sound financial systems. I'd have to say that, in the context of the Federal Government, we have a number of agencies that are in the same boat as SBA. We have a situation where we've got a FRIES general ledger system that captures data that are needed to be crosswalked to the financial statements and the FRIE System. While functional, I think it's fair to say, requires a little bit too much labor to make it work. I think that our recommendations involving additional QC, particularly with respect to the first draft of the financial statements, will make it easier on both us and SBA in dealing with the short period of time that we've got after those first statements are issued to reach closure here. Let me just repeat myself. I'm simply trying to convey that absent any change, with respect to our recommendations, I think that we can expect heroism, but in my experience with Tom, I believe he will be implementing some substantive responses to our recommendations. Mr. Platts. And that's the hope of our efforts as a committee and the oversight role, is kind of dovetailing with the Comptroller General that focus be not just achieving that year end clean bill of health, but that we put in place the process that is more automatic, and it's not heroism at the end of the year and, you know, the focus here has been very much on the loan sale aspect, but as has been identified that's kind of brought to light maybe some broader challenges, and that structural change in some of the recommendations you make that will hopefully allow structure to be in place for a year in, year out clean audits being issued without problems. Mr. Towns, did you have any other questions? I'm going to move just to a closing and first, I want to thank all of our witnesses for your preparation and testimony here today and the followup information that you will be providing us, very helpful, very insightful, and a personal thank you to your efforts, whether it be as Federal employees or private-sector contractors working with Federal Government, for your efforts in trying to serve our constituents in good fashion. I appreciate your work. I also want to thank both majority and minority staff members for their efforts in putting together the hearing, and we'll look forward to continuing to work as committee members and staff with each of you here today, as we continue to kind of watch the process as it goes forward, as you work as a team to have SBA's financial reports in good shape, and we can get from that red light in that, to the yellow, to green and get back to the clean, unqualified audits being issued. Procedurally, we'll hold the record open for 2 weeks from this date for those who may want to forward additional submissions for possible inclusion, and this meeting stands adjourned. [Whereupon, at 3:55 p.m., the subcommittee was adjourned.] [Additional information submitted for the hearing record follows:] [GRAPHIC] [TIFF OMITTED] T9351.053 [GRAPHIC] [TIFF OMITTED] T9351.054 [GRAPHIC] [TIFF OMITTED] T9351.055 [GRAPHIC] [TIFF OMITTED] T9351.056 [GRAPHIC] [TIFF OMITTED] T9351.057 [GRAPHIC] [TIFF OMITTED] T9351.058 [GRAPHIC] [TIFF OMITTED] T9351.059 [GRAPHIC] [TIFF OMITTED] T9351.060