[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


                                 ______

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                            WASHINGTON : 2003
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                     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:]

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    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:]

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    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:]

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    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:]

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    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:]

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    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:]

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    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:]

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    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:]

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