AR-02-03: Commonwealth Development Authority - Audit of Loans Receivable as of September 30, 2001 (Issued 9/20/02)

Summary

This report presents the results of the Office of the Public Auditor's audit of the Commonwealth Development Authority's Development Corporation Division (DCD) loan receivables as of September 30, 2001. The objectives of our audit were to determine whether: (1) DCD loans receivable were delinquent, (2) borrower collateral was sufficient to cover outstanding balances, and (3) DCD rules and regulations were complied with. This audit was conducted in accordance with Government Auditing Standards issued by the Comptroller General of the United States.

Commonwealth Development Authority

Since its inception in 1986, CDA, through DCD has provided agricultural, fishing, commercial and real estate loans to qualified borrowers. This has helped create new businesses, expand existing ones, create jobs and broaden the CNMI's tax base. DCD has also encouraged the development of technical expertise in business and financial management by working with government and private groups, and providing training services. As of September 30, 2001, DCD had 231 outstanding loans receivable of over $34.7 million from private sector borrowers. Of this, $11.4 million, or 33 percent, represents doubtful accounts that may not be collectible.

As of September 30, 2001, borrowers for 131 of DCD's 231 loan accounts were delinquent in making scheduled payments. Of the 131 delinquent accounts, 94 loan accounts or 72 percent were delinquent in excess of 90 days. Our review of 51 selected accounts indicates that the high delinquency rate was due to inter-related factors such as: (1) CDA's practice of granting high risk loans to borrowers with questionable capacity to repay; (2) CDA's practice of granting loans to borrowers without fully determining project feasibility; (3) CDA's practice of granting questionable loan remedies such as repeated loan revisions, unrealistic loan work out agreements, and non-foreclosure of delinquent loans; and lastly (4) the presence of unfavorable economic conditions that affected borrower repayment ability. As a result, over $11 million in past due loan repayments is considered delinquent.

DCD loans receivable should be covered by collateral adequate to secure CDA's interest. OPA found that three of 51 selected loans with 33 borrowers were inadequately secured because collateral had either not been verified or was insufficient in amount. This condition occurred because CDA had not strictly implemented loan security measures in accordance with DCD rules and regulations. As a result, as of September 30, 2001, CDA was exposed to possible loan losses of about $800,000 in loan principal. The total appraised value of the collateral securing the four loans was about $420,000. However, due to the prevailing economic condition, the actual market value of the properties may decrease even further.

Conclusions and Recommendations

DCD loans receivable are at risk because of the high percentage of delinquent borrowers, insufficient and unverified collateral, violations of DCD rules and regulations, and the recent overall economic decline in the CNMI. Accordingly, we recommend that:

1. The CDA Board develop and follow procedures and guidelines that would provide managers and board members sufficient basis to:
    
   • prohibit the approval of loans to borrowers having no capacity to repay. CDA should seriously consider prospective borrowers' past collection problems and defects in credit ratings when evaluating loan applications;
      
   • prohibit the granting of supplemental loans to highly delinquent borrowers as this circumvents the loan payment process, with the borrower using the additional loan proceeds to update his or her loan;
      
   • prohibit granting loan remedies to highly delinquent borrowers. CDA should approve loan revisions sparingly, and discourage repeated and routine approval of loan revisions as this practice masks delinquent borrowers by making their loans appear current;
      
   • help enforce the foreclosure of collateral of delinquent borrowers;
      
   • prohibit borrowers from substituting or selling mortgaged collateral unless they use the proceeds to repay outstanding loans; and
      
   • require that updated appraisal reports of collateral be obtained before initial and supplemental loans are granted. Also, appraisals of collateral property should be updated whenever the outstanding loan amounts have increased substantially.
      
2. The CDA issue a policy memorandum reminding management and Board members to strictly enforce DCD rules and regulations concerning the: (a) 20 percent equity requirement, (b) 20-year maximum loan term, (c) conflicts of interest, and (d) insurance requirements and any civil and criminal penalties for failure to do so.
    
3. The CDA and the Attorney General's Office continue to take necessary legal action to foreclose collateral of borrowers' highly delinquent loans.

Based on CDA's responses dated August 28, 2002 and September 20, 2002 to our draft report, we consider Recommendations 1 through 3 as resolved. The additional information or actions required to consider the recommendations closed are presented in Appendix B.

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