US Department of the Interior,
Office of Inspector General
Audit Report on the Marshall Islands Development Bank, Republic of the Marshall Islands
MARSHALL ISLANDS DEVELOPMENT BANK, REPUBLIC OF THE MARSHALL ISLANDS
REPORT NO. 99-I-952
Mr. Donald Capelle
Chairman, Board of Directors
Marshall Islands Development Bank
Post Office Box 1048
Republic of the Marshall Islands
Majuro, MH 96960
Subject: Audit Report on the Marshall Islands Development Bank, Republic of the Marshall Islands (No. 99-i-952)
Dear Mr. Capelle:
This report presents the results of our review of the operations of the Marshall Islands Development Bank of the Republic of the Marshall Islands. The objective of our audit was to determine whether (1) Compact Section 111 and 211 funds were used efficiently and effectively in accordance with the intent of the Compact and (2) loans and interest receivables were properly accounted for and effectively collected. The audit was requested by the U.S. Ambassador to the Republic of the Marshall Islands.
We concluded that the Marshall Islands Development Bank did not comply with provisions of the Compact of Free Association, Federal and Republic laws, Bank policies and guidelines, and operating procedures applicable to the Bank's operations and the use of funds provided by the United States. Specifically, we found that:
As a result, potential Bank revenue from outstanding loans totaling $6.8 million appears to be uncollectible, and loans of another $6.9 million may become uncollectible. The unavailability of this $13.7 million has prevented the Bank from issuing new commercial loans from Compact funds since July 1996 and from meeting its legally mandated purpose to "promote the development and expansion of the economy of the Marshall Islands." Also, because of ineffective collection enforcement, additional loans totaling $838,000 appear to be uncollectible, and loans of another $3.3 million may become uncollectible. The Bank also lost an estimated $7,500 by not charging management fees. Further, (1) payments totaling $214,938 received on Economic Development Loan Fund loans were deposited into the Bank's local revenue accounts and (2) loan balances and loan payments totaling $167,950 were transferred to and/or combined with loans from other financing sources and were not available for new loans to be made pursuant to the established purposes of the Economic Development Loan Fund. We made 11 recommendations to you, as the Chairman of the Bank's Board of Directors, to correct the deficiencies identified.
Based on your August 27, 1999, response (Appendix 3) to the draft report, we consider Recommendations A.4, B.4, and B.5 resolved and implemented and Recommendations A.2, A.3, B.1, and B.3 resolved but not implemented. Accordingly, the unimplemented recommendations will be referred to the Assistant Secretary for Policy, Management and Budget for tracking of implementation. Also based on the response, we consider Recommendations C.1 and C.2 unresolved and request additional information for Recommendations A.1 and B.2 (see Appendix 4).
Section 5(a) of the Inspector General Act (Public Law 95-452, as amended) requires the Office of Inspector General to list this report in its semiannual report to the Congress. Therefore, please provide a response, as required by Public Law 97-357, to this report by November 10, 1999. The response should be addressed to our Pacific Field Office, 415 Chalan San Antonio, Baltej Pavilion - Suite 306, Tamuning, Guam 96911. The response should provide the information requested in Appendix 4.
We appreciate the assistance provided by the staff and management of the Development Bank during the conduct of our audit.
Earl E. Devaney
cc: President, Republic of the Marshall Islands
Managing Director, Marshall Islands Development Bank
FINDINGS AND RECOMMENDATIONS
Title 10, Sections 807 and 808, of the Revised Code states that the Cabinet of the Republic of the Marshall Islands will appoint the members of the Bank's Board of Directors, nominate the Chairman of the Board, and appoint the Bank's Managing Director. Title 10 of the Revised Code was amended in 1993 to reduce the "exceptional degree of direction" that the Republic of the Marshall Islands Government provided over the Bank's operations by removing the requirements that (1) the Bank's Board should "serve at the pleasure of the Cabinet," (2) amendments of the Bank's By-Laws should be approved by the Cabinet, and (3) the Bank's policies and guidelines also should be approved by the Cabinet.
As of November 30, 1998, the Bank had received funding of about $17.5 million from the United States for economic loan programs. These funds were primarily from Sections 111 and 211 of the Compact of Free Association between the United States and the Republic of the Marshall Islands, which became effective on October 21, 1986. Although the Marshall Islands Development Authority initially had responsibility for $10 million provided for the Compact Section 111 Investment Development Fund, the Bank's enabling legislation transferred responsibility for these funds to the Bank. Additionally, in 1992 the Republic initially loaned, and later granted to the Bank as contributed capital, $5 million received from revenue bonds that were secured by Compact Section 211 funds. The Bank funded its operating expenses from interest earnings and loan origination fees.
The single audit report of the Marshall Islands Development Bank for fiscal year 1997 stated that, as of December 31, 1997, the Bank had loans receivable totaling $17.8 million and a related allowance for doubtful accounts of $12 million, which resulted in net loans receivable of $5.8 million. The single audit report also stated that the Bank had contributed capital of $17.5 million and an accumulated unreserved retained earnings deficit of $10.4 million. Finally, the Bank reported calendar year 1997 interest income of $1 million and an operating loss of $722,000, which was an increase from the calendar year 1996 operating loss of $517,000.
The Bank's fiscal year 1999 operating budget totaled $649,518, including $92,416 for the salaries and related costs of six Bank employees who were assigned to two loan programs administered by the Majuro Office, Rural Development, U.S. Department of Agriculture. As of November 30, 1998, the Bank had 16 employees, excluding the employees at Rural Development, as follows: 1 secretary, 7 loan officers, 6 accounting personnel, a Finance Manager, and a Managing Director.
To obtain information on the processing, administration, and collection of loans, we interviewed officials and/or reviewed loan records at the Majuro offices of the Marshall Islands Development Bank, Ministry of Foreign Affairs, and Auditor General; the United States Embassy; an independent public accounting firm; the Majuro Office, Rural Development, U.S. Department of Agriculture; and two attorneys in private practice who had performed services for the Bank. We also interviewed officials of the Western Pacific Region, Rural Development, U.S. Department of Agriculture, located at Hagatna, Guam.
Our review was made, as applicable, in accordance with the "Government Auditing Standards," issued by the Comptroller General of the United States. Accordingly, we included such tests of records and other auditing procedures that were considered necessary under the circumstances.
As part of the audit, we evaluated the system of internal controls related to the financial and operational management of the Marshall Islands Development Bank to the extent that we considered necessary to accomplish the audit objective. Based on our review, we identified internal control weaknesses in the areas of issuing commercial loans, accounting for outstanding loans, protecting loan collateral, collecting delinquent loans, and complying with a special accounting agreement. These weaknesses are discussed in the Findings and Recommendations section of this report. Our recommendations, if implem
ented, should improve the internal controls in these areas.
**FOOTNOTES** :The 1993 amendments were based on a 1992 report entitled "Institutional Strengthening of the Marshall Islands Development Bank," issued by an Australian planning and training consultant firm. The report stated, "The MIDB [Marshall Islands Development Bank] Act allows for an exceptional degree of direction by [the] Government [of the Marshall Islands]. Government intervention is pervasive and dominates the Bank's lending program. At the same time, the relationship with Government inhibits MIDB from exercising its developmental role and its commercial judgement. MIDB has no real prospect of developing as a [development financing institution] unless it is allowed to operate at arms length from Government. The MIDB Board has approved revisions to the MIDB Act drafted by the consultants. The revisions provide the necessary framework for MIDB's development along the lines of other [development financing institutions]. No change to the By-laws is considered necessary. It is recommended that: the MIDB Act be amended as a pre-requisite to any real reform of the Bank."
Section 211(b) of the Compact of Free Association states, "The annual expenditure of the grant amounts specified for the capital account in Section 211(a) . . . shall be in accordance with the official overall economic development plans provided by those Governments [of the Compact States] and concurred in by the Government of the United States." In addition, the implementing agreement for Compact funds provided under Section 111 (c) of U.S. Public Law 99-239, Article II, paragraph 6, states, "The Fund is intended to further close economic and commercial relations between the United States and the Marshall Islands, to encourage investment and productive participation in economic development in the Marshall Islands by citizens and commercial enterprises of the United States and the Marshall Islands, particularly through joint ventures between United States and Marshall Islands citizens and commercial enterprises, . . . and to encourage the private sector employment and training of citizens of the Marshall Islands and the productive utilization of the natural resources, manpower resources, and other resources of the Marshall Islands."
Title 10, Section 810(1), of the Marshall Islands Revised Code states, "The [Marshall Islands Development] Bank's activities shall be designed to strengthen the nation's economic base, increase employment and production, improve standards of housing, promote exports, and reduce the country's dependence on imports and foreign aid." Section 810(2) of the Revised Code states, "In carrying out its functions the Bank shall have due regard for the general economic policies and plans of the Government of the Marshall Islands and to the general objectives of the Investment Development Fund." Section 812 of the Revised Code further states, "The [Bank's] Policies and Guidelines will be made public and will be strictly adhered to."
Paragraph 5 of the Bank's Policies and Guidelines (adopted by the Republic's Cabinet on April 13, 1989) states, "As a development finance institution, the Bank will carry out its operations according to sound commercial, banking practice." Paragraph 7 of the Guidelines states, "The Bank will provide financial assistance to those projects, which on the basis of its own analysis, are assessed as technically feasible, economically justifiable, financially viable and profitable." Further, Paragraph 10 of the Guidelines states, "In order to reduce the concentration of risk, the Bank will seek, as far as possible, to diversify its portfolio by sectors of operation and by avoiding inappropriately large investment in any one project. As a general rule, no loan or guarantee provided by the Bank to any single borrower, or equity participation in any single enterprise shall exceed ten percent (10%) in aggregate of the net worth of the Bank, however, this general rule will be exercised at the discretion of the Board."
Section 16 of the Constitution of the Republic of the Marshall Islands, which became effective on May 1, 1979, states, "The Government of the Republic of the Marshall Islands recognizes the right of the people to responsible and ethical government and the obligation to take every step reasonable and necessary to conduct government in accordance with a comprehensive code of ethics." The Republic's Ethics in Government Act of 1993 (codified at Title 3, Chapter 17, of the Marshall Islands Revised Code) became effective on September 21, 1993. Title 3, Section 1704(5), of the Revised Code states, "Public officials and Government employees shall not use public office for private gain." Section 1704(12) states, "Public officials and Government employees shall endeavor to avoid any actions creating the appearance that they are violating the law or ethical standards set forth in this Chapter." Prior to September 1993, the Republic did not have a comprehensive code of ethics.
The Bank had 48 commercial loans (originally totaling $18.5 million) that were funded by Compact Section 111 and 211(b) funds and administered by the Bank. Of those 48 loans, we reviewed a judgmental sample of 21 loans (originally totaling $14 million) that had outstanding balances, including accrued interest, totaling $13.6 million as of November 30, 1998. We evaluated the status of the 21 loans and the financial/economic basis for approval of the loans, including the purpose of each loan as it related to the two 5-year official economic development plans issued by the Republic for the periods during which the loans were approved. Of the 21 loans reviewed, 1 loan was current, 18 loans were delinquent an average of 46.3 months, and 2 loans (which had been delinquent) were exchanged for common stock of the borrowing organization.
Based on our review of documents in the loan files and discussions about the loans with the Bank's Chairman of the Board and Managing Director, we noted, for 17 loans (11 to business organizations and 6 to government entities), that they had been issued as follows: 11 loans (5 loans to businesses and 6 to government entities) were issued based on the direct or indirect direction from government officials, 3 loans were issued to businesses owned by relatives of senior-level government officials, and 3 loans were issued to businesses owned by elected government officials. At least 3 of the 17 loans were made for purposes that were not clearly within the scope and intent of the Republic's 5-year economic development plans. The Chairman of the Board and the Managing Director stated that "the Bank issued some loans based on political direction and influence" and that such loans "may not have been made under normal circumstances." As a result of issuing loans without performing thorough financial analyses, requiring additional collateral or other guarantees, and complying with the Bank's lending guidelines, the Bank, as of November 30, 1998, appears to have lost $6,621,645 on seven of the loans and is at risk of losing an additional $6,442,610 in potential revenues on three other loans. In addition, for six of the seven remaining loans, revenues were also lost or at risk because the Bank's inadequate collection efforts allowed the loans to become delinquent (see "Collection Practices" in Finding B). The 17 loans and lost or potentially lost revenues are detailed in Table 1.
Table 1. Questionable Loans Original Principal Nov. 1998 Potential Date Loan Loan Amount Outstanding Lost Lost Purpose of Loan Signed Amount Paid Balance Revenues Revenues Loans to Businesses: Rental Housing 11/24/89 $631,025 $15,913 $615,112 0 0 Hotel 01/12/90 123,174 120,385 126,235* 00 Fishing 10/02/90 132,000 0 208,021 00 Entertainment Complex 10/11/90 314,029 0 439,680 0 0 Office Building 01/04/91 4,913,549 0 6,032,124 0 $6,032,124 Fishing 05/27/92 450,000 0 649,193 $349,1930 Manufacturing 07/24/92 101,754 6,331 101,442 0 0 Entertainment Complex 06/09/93 1,103,769 23,658 1,218,346 0 0 Fishing 06/28/93 188,000 0 254,323 254,3230 Fishing 07/09/93 65,474 0 84,360 84,3600 Rental Housing 01/20/94 232,976 0 257,539 0 0 Subtotal $8,255,750$166,287 $9,986,375 $687,876$6,032,124 Loans to Government Related Entities: Fishing Partnership 06/15/88$1,000,000 0 $1,835,467 $1,557,677 0 Fishing Partnership 01/27/89 178,331 $81,050 145,795 123,595 0 Air Marshall Islands 03/15/91 933,321 0 ** 1,350,809 0 Air Marshall Islands 04/01/92 2,000,000 0 ** 2,901,688 0 Development Authority 10/20/93 185,000 0 $222,851 0 $222,851 Majuro Government 06/13/95 208,522 18,270 219,660 0 187,635 Subtotal $4,505,174 $99,320 $2,423,773 $5,933,769 $410,486 Total $12,760,924$265,607$12,410,148$6,621,645$6,442,610 __________*On May 30, 1996, the Bank combined this loan with the $97,994 balance of an earlier delinquent loan for the same hotel project. **On May 31, 1995, the Bank exchanged the two loans for common stock of the airline. The amounts shown as "Lost Revenues" are the amounts that would have been outstanding, including accrued interest, if the loans had not been exchanged for stock.
The details of 7 of the 17 loans listed in Table 1 are discussed as follows:
Regarding methods of safeguarding the Bank's interests, Paragraph 20 of the Bank's Policies and Guidelines states that the Bank "may require the applicant for a loan, guarantee or equity participation that is over $15,000 to provide a business plan or feasibility study indicating the technical, economic and financial feasibility [of the business]"; Paragraph 24 states that the Bank "shall use its best endeavors to ensure that the financial requirement for the completion and commissioning of the project is covered, including, if appropriate, allowance for cost overruns"; and Paragraph 25 states that the "Bank shall secure its loans or guarantees by appropriate collateral coverage and guarantees from its borrowers in accordance with sound banking practices." Also, Paragraph 34 states, "The Bank shall decide on a scheme for loan repayment which shall be incorporated into the loan agreement. The repayment period of a loan, including a grace period, where appropriate, will be determined taking into account: . . . the Bank's own interest to recover principal in as a short a time as possible for the optimum use of its funds to maximize the turnover of its portfolio." In addition, Section 3.2.4 of the Bank's Operating Manual stap> "Financial analysis" refers to the assessment of each and every potential borrower who may come to the Bank for assistance . . . . The OBJECTIVES of financial analysis p> To judge whether an existing enterprise is solvent. . . . To assess the ability of the business to prosper and meet its present commitments, PLUS any new [Bank] loan commitments when they fall due. . . . To make some judgement of the net (or residual) value of assets that may be available to the Bank as collateral for any loan . .p> The ultimate purpose of astute financial analysis is to ensure REALISTIC BUDGETING which, in turn, will demonstrate whether or not a project has prospects of being commercially viable and thus may warrant a Bank loan. In compiling Bank budgets lending staff must ap> Apply their knowledge of other similar projects. . . . Make use of any industry research data that may be available, and certainly judge carefully such things as site/location and management potentp> Despite these requirements and guidelines, the files for only 8 of the 21 commercial loans we reviewed contained financial analyses. These analyses were of varying degrees of complexity and all appeared (based on the absence of Bank-related comments or notations) to have been submitted by the loan applicants. In addition, the eight analyses included what we believe were either unrealistic assumptions or analytical information that was too general to apply to the specific loan requests. Further, none of the 21 loan files included a record of a separate financial analysis by the Bank or a Bank critique of the analyses submitted by the applicants. According to Bank personnel, the Bank did not always perform thorough credit and financial analyses of prospective commercial borrowers and did not document reviews that were performed because management did not require these actions to be taken and had not provided personnel adequate training and supervision to accomplish these tasks. As a result, the Bank's management did not appear to have had access to the information needed to evaluate the prospects for repayment of proposed loans. As a consequence of the Bank not conducting adequate financial analyses to determine the feasibility of proposed projects and the credit worthiness of loan applicants, delinquent loans totaling $176,256 appeared to be uncollectible and additional loans totaling $431,004 were also at risk of becoming uncollectible.
1. Request the Board of Directors to revise the Bank's Policies and Guidelines to require that development loans be granted in conformance with the applicable goals and objectives contained in the Republic's 5-year economic development plans as a condition of approval.
2. Submit a formal request to the Republic's Cabinet to amend the Bank's enabling legislation so that the number of government officials is reduced and the number of private business representatives appointed to the Bank's Board of Directors is increased and to require formal acknowledgment and approval by the Bank's Board of Directors of any loan applications subject to possible political influence. In that regard, written statements should be required by voting Board members that they had no conflicts of interest and that they were not aware of any financial risks related to politically influenced loans.
3. Submit a formal request to the Republic's Cabinet to require that the Board of Directors of Air Marshall Islands include at least one member who represents the Marshall Islands Development Bank.
4. Ensure that the Bank's Managing Director provides training in financial analysis to the Bank's Senior Loan Officer, requires that independent financial analyses be performed for all loan applications, and reviews and formally approves such financial analyses.
Marshall Islands Development Bank Response and Office of
Inspector General Reply
In the August 27, 1999, response (Appendix 3) to the draft report from the Bank's Chairman of the Board, the Bank concurred with the four recommendations. Based on the response, we consider Recommendation 4 resolved and implemented and Recommendations 2 and 3 resolved but not implemented and request additional information for Recommendation 1 (see Appendix 4).
The statement that information in one example in the draft was "inaccurate" is incorrect. However, we have revised the example to clarify that (1) we were referring to the date of the final disbursement on the loan (October 22, 1992), not the date on which the loan was signed, and (2) the loan was 63 months delinquent as of November 30, 1998, not as of September 1, 1993.
Regarding the Bank's statement that two additional contracts were used to secure the repayment of the two loans to the borrower, this information was not in the Compact-funded loan file provided to us during the audit, nor was it provided in response to our inquiries for information concerning the Republic-funded loan. Additionally, we did not review the files of Republic-funded loans because the loans did not involve United States-sourced funds. Based on the information provided with the response, we have deleted reference to the delinquency of the Republic-funded loan. However, Bank officials did not mention any other contracts during audit discussions on this loan. If these contracts were used to justify the approval of the Compact-funded loan, this information should have been included in the Compact-funded loan file and referred to as part of a financial analysis of the loan, which was not performed.
Regarding the financial status of the Compact-funded loan and the Republic-funded loan, the Bank listed seven payments, totaling $100,396.17, with the inference that these payments were applied to the Compact-funded loan. However, the Bank's accounting records showed that only two payments, totaling $8,185.62, of the seven payments were applied to the Compact-funded loan. Consequently, the other five payments, totaling $92,210.55, were apparently applied to the Republic-funded loan. Further, based on the Bank's accounting records as of November 30, 1998, the Compact-funded loan's outstanding principal balance was $131,416, which, when subtracted from the initial loan amount of $160,632, results in a total of $29,216 in principal having been paid on this loan. In addition, according to the Bank's accounting records as of March 12, 1999, the most recent payment the Bank applied to the Compact-funded loan was made on September 1, 1993. Therefore, we still consider the remaining balance of $176,256, including accrued interest, to be potentially uncollectible.
We have addressed the issue of the Bank's autonomy through Recommendation 2.
Regarding the Investment Development Fund Advisory Board, we do not believe that the Advisory Board had or would have had a significant impact on the issues discussed in the report. According to the Compact, the Advisory Board's duties and responsibilities include providing "advice and guidance" on the evaluation of proposals and recipients of distributions from the Investment Development Fund and assisting in other programs designed to attract investment in the Republic. Also, as noted in the Bank's response, the only advice apparently given by the Board resulted in a "project that was a failure" with related losses of $1.7 million in principal and interest. Further, regarding the appointment of United States representatives to the Advisory Board, during our audit, we contacted United States, Republic, and private entities in our efforts to obtain records relating to the actions of the Advisory Board and to determine what actions had been taken to appoint United States representatives to the Board in 1993 or subsequent to 1993. We were unsuccessful in obtaining any documentation other than the Republic President's April 26, 1993, letter referred to in the response. However, by December 31, 1993 (the end of the Bank's fiscal year), the Advisory Board would have had few decisions to make on loans because most available funds were committed. As of that date, the Investment Development Fund had 31 loans, totaling $12.3 million (including unpaid interest), and of that number, 17 (55 percent) loans were delinquent.
**FOOTNOTES** :The 21 loans that we reviewed included 2 loans made to Air Marshall Islands (a government-owned airline) that were subsequently exchanged for common stock of the airline. If the two loans had not been exchanged for common stock, they would have had outstanding balances totaling $4.3 million as of November 30, 1998. Because the Bank's audited financial statements for 1997 reported the airline's stock as having no value, we included the $4.3 million that would have been outstanding on the loans as "Lost Revenues" in Table 1 and as "Unrealized Revenues" in Appendix 1.
:The amount of this loan was subsequently increased to $933,321 by the capitalization of accrued interest totaling $83,321.
:The exchange with the Bank was initiated in August 1994 by the airline's Board of Directors, which included the Republic's now-deceased President and three Cabinet ministers. The exchange reduced the airline's outstanding debt by $3.5 million and increased its equity by the same amount.
:The airline reported a fiscal year 1997 operating loss of $2.9 million, with total operating revenues of $7.7 million.
:The loans consisted of the original loan of $474,169, an additional loan amount of $64,651, and interest capitalizations of $18,590 and $73,615.
:Although we consider the outstanding balance of $615,112 on this loan to be at risk of loss, we did not include it in Appendix 1 as part of the monetary impact for Finding A because it is included in the discussion and the monetary impact for Finding B.
Paragraph 25 of the Bank's Policies and Guidelines states, "The Bank shall secure its loans or guarantees by appropriate collateral coverage and guarantees from its borrowers in accordance with sound banking practices." Section 3.3.2 of the Bank's Operating Manual states:
When arrears do occur, it is most important to quickly identify why, and then complete appropriate and timely action to return the account to current status e.g. obtain the repayment/s, reschedule the repayment/s, rehabilitate the project, or sell off assets. The monitoring and control of arrears, plus the education of borrowers in good credit habits, is a most important part of the role of all Bank lending staff. . . . Arrears may be caused by the client/project when borrowers will not pay or cannot pay.
For client-caused arrears, the Manual continues:
Borrowers who will not pay are those who have sufficient funds to meet the agreed repayments, but choose not to pay. In all such cases, prompt and firm action needs to be taken in order to show the borrower that the Bank means to enforce the loan agreement. . . . This type of borrower does not warrant any leniency from the Bank . . . and after two reminders and one warning letter the Bank should proceed to realize upon its securities.
Further, Section 188.8.131.52 of the Manual states:
The accepted basis for classifying the status of delinquent accounts is: . . . Two Months up to Three Months - third contact MUST be a Bank visit to the project to undertake a full review and report back, Over Three Months - generally regarded as hard-core arrears with deep seated problems needing careful, consistent, and positive follow-up, Over Twelve Months - non-performing loans where debt recovery is most definitely in doubt. . . . Only careful and constant attention to arrears monitoring will maintain proper control of the Bank's loan portfolio, protect [the Bank's] capital, and allow the Bank to continue on with its primary role as a major catalyst for development in [the Republic of the Marshall Islands].
In addition, loan agreements between borrowers and the Bank specify that upon default by the borrowers, the Bank can "take possession of the [loan] collateral or render it unusable; . . . Sell or dispose of collateral by sale and pursuant to the law; . . . Foreclose on any real property or appropriate personal property in accordance with law; . . . and Pursue any and all other remedies available under law or equity to enforce the term of this Loan Agreement."
To evaluate the Bank's collection practices, we selected a judgmental sample of 115 of the Bank's 509 recorded loans (see Appendix 2), including loans from each category of the Bank's Federally funded loan programs. The 115 loans had original loan amounts totaling $15.5 million and, as of November 30, 1998, consisted of 23 paid-off loans and of 92 active loans with outstanding balances totaling $18.7 million, including accrued interest. Of the 92 outstanding loans, 49 loans, totaling $18.2 million as of November 30, 1998, were delinquent (32 loans delinquent 1 year or more and 17 loans delinquent less than 1 year). Based on our review of the loan payment history and the age of the loans, we believe that the Bank will not be able to collect amounts due for 34 of the 49 delinquent loans. (The 34 loans consisted of 31 of the 32 loans that were delinquent 1 year or more and 3 of the 17 loans that were delinquent less than 1 year.) However, in Finding A, we questioned the Bank's ability to collect 8 of these 34 loans, with outstanding balances totaling $8,970,836. Therefore, to avoid duplicate counting, we included in the monetary impact reported in Appendix 1 only the remaining 26 loans, with uncollectible or potentially uncollectible balances totaling $3,896,575, as shown in Table 2.
Table 2. Delinquent Loans With Lost or Potential Lost Revenues Original Nov. 1998 Potential Loans Loans Loan Outstanding Lost Lost Source and Type of Loan ReviewedQuestioned Amount Balances Revenues Revenues Compact 111- Investment Development16 7 $3,304,378 $3,749,829 $439,680 $2,671,126 Compact 211 - Commercial 5 3 622,697 782,227 0 433,004 Compact 211 - Housing 34 4 60,201 55,674 13,475 42,199 Trust Territories - Economic Development20 12 439,417297,091176,476 120,615 USDA - Housing Preservation 36 0 0 0 0 0 USDA - Rural Development 4 0 0 0 0 0 Total 115 26 $4,426,693 $4,884,821 $629,631 $3,266,944We reviewed the files for 18 nonhousing loans that were among the 49 delinquent loans and determined that the file for only 1 of the 18 loans included any comments explaining why the loan was delinquent (the file stated "management weaknesses"). In addition, none of the files for the 49 delinquent loans included a financial analysis of the delinquent borrower, a collection plan, or documentation that the Bank had attempted to seize loan collateral or had initiated court action. We asked two attorneys who had worked with the Bank to collect delinquent loans whether the Bank could successfully seize property and/or take other court action to collect delinquent accounts. The attorneys stated that the enforcement of the security agreements would likely be upheld in the Republic's courts but added that the Bank had never filed a court action to enforce the agreements. The Bank's Managing Director also stated that the Bank had not taken legal action against delinquent borrowers. By not using all available legal means to collect delinquent loans, the Bank appears to have lost $629,631 and placed another $3,266,944 at risk of loss. For example:
File Documentation. The Bank did not include sufficient documentation in the loan files to support that property used as loan collateral was adequately protected and that required loan processing procedures and collection actions were performed. Based on our review of 21 commercial loan files and 70 housing loan files, we determined that none of the 91 files included documents providing (1) the entire payment history, delinquency status, and aging of the loans; (2) narrative comments on major loan actions (such as loan amendments and meetings with delinquent borrowers); and (3) evidence of supervisory reviews. In addition, the loan files for neither the 21 commercial loans nor the 34 Compact Section 211 housing loans included documents showing that current insurance coverage existed on the property used for loan collateral. According to Bank loan officers, documentation was not included because they had not received adequate followup training on retaining documentation on insurance coverage and the loan files were not subject to routine supervisory monitoring. The Senior Loan Officer also stated that much of his time was devoted to managing returned properties. According to the Bank's Managing Director, many of the housing borrowers could not afford insurance, and the Bank was therefore attempting to include funds to pay for the cost of insurance in the initial amounts of future loans. As a result, the Bank lost $208,021 on at least one loan because loan collateral was not insured.
Specifically, although the Chattel Mortgage Security Agreement used by the Bank required that borrowers carry insurance on collateral used as surety for their bank loans, a 50-foot fishing boat with fishing equipment, which was partially financed by a Bank loan, was not insured and was considered a total loss when it burned about 10 months after the borrower obtained the loan. The Bank's Managing Director stated that during this period, smaller boats could not get insurance in the Republic and that the Bank had required the borrower to include as collateral for this loan a small hotel that was also used as collateral for a separate $137,000 hotel loan. Although we could not determine the value of the mostly wooden hotel, we determined, based on our site visit, that the hotel was not in operation and needed extensive repairs before any rooms could be rented. As of November 30, 1998, the borrower had not made any payments on the loan and owed a total of $208,021, including accrued interest. We believe that the Bank should more adequately protect its interests by requiring alternate unpledged collateral for the loans.
Computerized Accounting System. The Bank did not operate a computerized accounting system that was adequate to effectively administer its outstanding loans. A 1997 consultant study funded by the Asian Development Bank discussed the need to correct deficiencies in the Bank's computerized accounting system and made recommendations for improvement. Bank officials said that the recommendations were not implemented because the Bank's management did not agree with the conclusions of the study. However, the Bank's Managing Director and its Finance Manager agreed that the Bank's computerized accounting system was old and needed improvements. As a result, Bank personnel and management and Bank Directors could not readily determine the status of the Bank's loan portfolio to help ensure that personnel initiated appropriate collection actions on delinquent loans. Examples of the Bank's ineffective system of loan administration are as follows:
As of November 30, 1998, the Bank had entered into management agreements with six delinquent borrowers of either Compact Section 111 Investment Development Loan Funds or former Trust Territories Economic Development Loan Funds to manage the properties that were used to secure the loans until the loans were paid off. With the Bank collecting revenues from the properties and using the revenues to make payments on the delinquent loans, the number of loan delinquencies was decreasing at the time of our audit. However, for five of the six agreements, the Bank had not required the borrowers to reimburse the Bank for its property management costs. We estimated that using a management fee of 10 percent of collected revenues, the Bank could have collected management fees of about $7,500 during 1998, which would have defrayed some of the Bank's operating expenses.
We recommend that the Chairman of the Board of Directors, Marshall Islands Development Bank, ensure that the Bank's Managing Director:
1. Enforces the loan provisions for seizing loan collateral for loans that are significantly delinquent.
2. Provides refresher training in loan file maintenance to all loan personnel and amends the Bank's Policies and Guidelines to require regular supervisory reviews of files on loans that are delinquent.
3. Assigns property management responsibilities to Bank personnel other than loan officers who are responsible for collecting delinquent loans.
4. Performs an assessment of the Bank's computerized systems and develops a plan of action to upgrade the systems to meet the identified needs. Any upgrades should include correcting errors in the loan files (both automated and manual) and providing training on the upgraded systems.
5. Prepares standard wording to be used in all Bank management agreements with borrowers which specifies that monthly charges (such as a percentage of monthly collections) should be assessed for property management and amends existing management agreements to include such wording.
Marshall Islands Development Bank Response and Office of
Inspector General Reply
In the August 27, 1999, response (Appendix 3) to the draft report from the Bank's Chairman of the Board, the Bank concurred with the five recommendations. Based on the response, we consider Recommendations 4 and 5 resolved and implemented and Recommendations 1 and 3 resolved but not implemented and request additional information for Recommendation 2 (see Appendix 4).
:One of the 32 loans was excluded because it appeared to be collectible, even though it had been delinquent for 22 months.
:We did not perform this review on the 4 U.S. Department of Agriculture Rural Development loans in our sample because the funds on each of these loans had not been disbursed at the time of our audit and on the 20 Trust Territories Economic Development loans in our sample because these loans were issued by the Bank's predecessor bank and did not relate to the Bank's current operations.
U.S. Public Law 88-487 (Pacific Islands Trust Territory - Economic and Social Development), dated August 22, 1964, established a development fund grant for the Trust Territory of the Pacific Islands. The amount of the fund was increased on March 21, 1972, by U.S. Public Law 92-257 (Trust Territory of the Pacific Islands) to a total of $5 million. Public Law 92-257 was codified in Title 48, Sections 1688 through 1693, of the U.S. Code Annotated. Section 1689 states that the use of the grant depends on the government of the Trust Territory preparing a plan that "shall provide among other things for a revolving fund to make loans or to guarantee loans to private enterprise." Section 1690 established basic loan and guarantee requirements, and Section 1691 states that the "plan provided for in section 1689 of this title shall set forth such fiscal control and accounting procedures as may be necessary to assure proper disbursement, repayment, and accounting for such funds." The Agreement reiterated the statements in Sections 1689 through 1691.
The Bank did not account for and report on loans financed by the United States-funded Economic Development Loan Fund in a separate revolving fund, as required by Federal law. Instead, the Bank included at least 54 of these loans with other loans financed by Republic funds. According to the Bank's Financial Manager, when the 54 loans were transferred to the Bank in 1989, the Bank's management did not realize that these loans had special accounting requirements. Therefore, the Bank did not establish a separate revolving fund for the loans. The oldest listing of these loans available from the Bank, dated December 31, 1989, identified 54 loans with total outstanding balances of almost $1.3 million and 6 loans with zero balances. Of the 54 loans, we reviewed 20 loans with balances totaling $687,476 as of December 31, 1989, and determined that through November 30, 1998, the Bank had collected a total of $214,938 on these loans but had accounted for these collections as Republic revenues and not as Economic Development Loan Fund revenues. As a result, the Bank could not ensure that the $214,938 was or would be used for loans in compliance with the requirements of the Economic Development Loan Fund program, as required by the Agreement and United States law.
In two instances, the Bank transferred borrowers' Economic Development Loan Fund account balances to the same borrowers' accounts under other funds, which was contrary to the requirements set forth in the "Agreement." According to the Bank's Financial Manager, the loan balances were transferred to assist in collection efforts, and the Bank's management did not realize that these loans should have been accounted for separately. Details of the transferred loans were as follows:
On May 30, 1996, the Bank transferred another borrower's entire Economic Development Loan Fund account balance of $121,912 ($97,994 in principal and $23,918 in accrued interest) to the borrower's loan account in the Compact Section 111 Investment Development Fund. Subsequent to the transfer, the borrower paid an estimated $18,597 on this loan.
We recommend that the Chairman of the Board of Directors, Marshall Islands Development Bank, ensure that the Bank's Managing Director:
1. Establishes a separate revolving fund to account for loans made with Economic Development Loan Funds; computes all payments collected from borrowers since 1988; and deposits these funds, as well as all future Loan Fund payments, to this fund.
2. Returns the two loan balances related to the two transfers to the revolving loan fund established in accordance with Recommendation 1; computes all payments collected from borrowers since 1988; and deposits these funds, as well as all future Loan Fund payments, to the revolving fund.
Marshall Islands Development Bank Response and Office of
Inspector General Reply
In the August 27, 1999, response (Appendix 3) to the draft report from the Bank's Chairman of the Board, the Bank said that its independent auditors "at no time" had "brought up" the combining of the former Trust Territories Economic Development Loan program with loans funded by the Republic "as an issue of concern to be corrected" and that "further reviews" of the Economic Loan Fund were needed before the two recommendations could be implemented. Based on the response, we consider Recommendations 1 and 2 unresolved (see Appendix 4).
Based on our review of actions taken by the Bank's Board of Directors and other information relating to outstanding loans assumed by the Bank at the time of its establishment, we determined that certain loans labeled by the Bank as "old loans" were Federally funded Economic Development loans. Our discussions with Bank officials and the Bank's independent auditors and our subsequent review of working papers from a prior single audit of the Bank confirmed that the Bank had erroneously reported the Economic Development loans as Republic-funded loans. The Bank subsequently located and provided us with a list of Economic Development loans as of December 31, 1989, which we then provided to the Bank's independent auditors. The independent auditors' resident representative in Majuro, who had performed the most recent Bank audits, said that when his firm began auditing the Bank, there was no indication in the Bank's records that the subject loans were anything but Republic loans. The auditors' representative stated that this issue would be addressed in the calendar year 1998 audit, which was in process at the time of our discussion.
:A "revolving fund" is an "account that is repeatedly expended, replenished, and then expended again." (Barron's Dictionary of Accounting Terms)
CLASSIFICATION OF MONETARY AMOUNTS* Potential Funds To Be Put To Unrealized Additional Finding Area Revenues Revenues Better Use A. Issuance of Commercial Loans Political Considerations$6,621,645 $6,442,610 Financial Analyses 176,256 431,004 B. Collection of Delinquent Accounts Collection Practices 629,631 3,266,944 Loan Records 208,021 Property Management 7,500 C. Economic Development Loan Fund Loan Payments $214,938 Transferred Accounts 167,950 Total $7,635,553 $10,148,058 $382,888 *All amounts represent Federal funds.
MARSHALL ISLANDS DEVELOPMENT BANK OUTSTANDING LOANS BY U.S. FUNDING SOURCES AS OF NOVEMBER 30, 1998 Total Total Number Amount Amount Funding Source and Bank Fund Title of Loans Loaned Owed* Compact of Free Association: Section 111, Investment Development Fund 30 $11,770,484 $13,781,100 Section 211, Bond Proceeds Fund: Commercial Loans 8 905,696 1,034,419 Housing Loans 130 2,531,156 1,292,315 Trust Territory of the Pacific Islands: Economic Development Loan Fund 54** 1,273,751** 417,343 U.S. Department of Agriculture: Housing Preservation Grant Fund 281 492,939 122,896 Rural Development Fund 4 56,000 56,000*** Sub-Total 507 $17,030,026 $16,704,073 Compact of Free Association Fund Loans Converted to Air Marshall Islands Stock: Section 111, Investment Development Fund1 $850,000 $1,350,809**** Section 211, Bond Proceeds Fund 1 2,000,000 2,901,688**** Total 509 $19,880,026 $20,956,570 _________________ *The current amounts owed were not available from the Bank's accounting system and are based on our audit calculations. **The number of loans and loan amounts are based on the recorded outstanding balances as of December 31, 1989. ***These loans had not been finalized as of November 30, 1998, and no payments had been made on them. ****These amounts include delinquent principal and interest that were converted into stock effective December 31, 1994, plus estimated interest from January 1, 1995, through November 30, 1998.
Page 1 of x MARSHALL ISLANDS DEVELOPMENT BANK RESPONSE --------------------------------------------------
STATUS OF AUDIT REPORT RECOMMENDATIONS --------------------------------------------------- Finding/Recommendation Reference Status Action Required Provide the target date A.1 Management and the title of the concurs; official responsible additional for revising the Bank's information policies and Guidelines needed. to require that Compact-funded development loans are A.2 and A.3 Resolved; in conformance with the not Republic's 5-year implemented.economic plans. No further response to the Office of Inspector General is required. The recommendations will be referred to the Assistant Secretary for A.4 Policy, Management and Implemented. Budget for tracking of B.1 implementation. Resolved; However, we request not that copies of the implemented. Cabinet's responses to the Bank's requests be provided to our office. No further action is required. No further response to the Office of Inspector General is required. The recommendation will be referred to the Assistant Secretary for Policy, Management and Budget for tracking of implementation. However, we request that a sample copy of the revised loan documents be provided to our office. Page 2 of 2 ---------------------------------------------------------- Finding/Recommendation Action Reference Status Required Provide the target date and B.2 Management the title of the official concurs; responsible for amending additional the Bank's Policies and information Guidelines to require needed. supervisory reviews of files on delinquent loans. However, we request that a copy of the revised B.3 Resolved; Policies and Guidelines be not provided to our office. implemented. No further response to the Office of Inspector General is required. The recommendation will be referred to the Assistant Secretary for Policy, Management and Budget for B.4 and B.5 tracking of implementation. Implemented.However, a copy of the C.1 and C.2 documentation showing when Unresolved.a property manager has been assigned should be provided to our office. No further action is required. Reconsider the recommendations, and provide responses indicating concurrence or nonconcurrence. If concurrence is indicated, provide action plans that include target dates and titles of the officials responsible for (1) establishing a separate revolving fund for former Trust Territories loans and (2) depositing into the fund all loan payments and the two loan transfers made since 1988 and all future loan payments.
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