Report 99139 Summary - May 2000

California Department of Veterans Affairs:

Changing Demographics and Limited Funding Threaten the Long-Term Viability of the Cal-Vet Program While High Program Costs Drain Current Funding

RESULTS IN BRIEF

A rapid decline in the population of eligible California veterans and limited funding threaten the long-term viability of the California Veterans Farm and Home Purchase Program (Cal-Vet program) of the Department of Veterans Affairs (department) while high program costs erode current funding. Because federal restrictions severely limit eligibility for the Cal-Vet program's major source of funding for loans, proceeds from tax-exempt Qualified Veterans Mortgage Bonds (QVMBs), demand for these loans will drop dramatically over the next 10 years. The program has two other sources of funding, Qualified Mortgage Bonds (QMBs) and unrestricted funds, but approval to issue QMBs is difficult to obtain and unrestricted funds are drying up. At the same time, excessive program costs are eroding available loan funds due to improper charges of administrative costs, lengthy loan processing times, and mismanaged implementation of an integrated information management system. Coupled with the program's short-term lending strategy, these conditions will dramatically diminish its value to most veterans by the end of the decade.

The Cal-Vet program provides loans to thousands of qualified veterans at below-market interest rates. Federal income tax restrictions limit eligibility for the more plentiful QVMB loans to veterans who actively served prior to January 1, 1977, and apply for their loans within 30 years after leaving the military. We project these restrictions will cause a steep 90 percent drop in eligibility over the next 10 years and that in 2010 only about 100 of the remaining eligible veterans will actually apply for a loan based on the Cal-Vet program's current market share. The department has lobbied Congress over the years to modify these restrictions, but it has so far been unsuccessful.

Younger veterans who do not meet the requirements of QVMB loans may be eligible for two other types of loans: those backed by proceeds from QMBs and loans from the department's unrestricted funds. Both of these loans rely on smaller pools of funding, which are also provided by the sale or refinancing of tax-exempt bonds. The department's current lending strategy is to increase the total value of its loan portfolio. For the eight-month period of July 1999 through February 2000, the program loaned $361 million, $25 million above its goal for the entire fiscal year. During this period, the program charged 5.95 percent interest for QMB loans and 6.65 percent for both QVMB and unrestricted loans. Because the program's interest rates are as much as 2 percent below-market interest rates, it is attracting many loan applicants; however, the frequency at which the department is now making loans will substantially exhaust the available QMB and unrestricted funds by 2006, with only residual recycled principal and interest from unrestricted funds available for loans.

In light of the limited sources of funding available for two of the three types of loans that the Cal-Vet program grants, the department should consider other strategies that would benefit more veterans over a longer period of time. Rather than offer loans at the lowest possible interest rates to eligible veterans, the department could raise interest rates to follow rises in market rates, keeping them slightly below market, or provide additional funding by blending taxable and tax-exempt bond proceeds to grant loans at rates higher than they are now but less than commercial rates. These strategies maintain the program's loan portfolio but would depress current demand for loans and preserve funds to enable more veterans to benefit from the program over time. Unfortunately, these options are limited in their continued ability to provide below-market interest rates and, therefore, are not a permanent solution to the continued viability of the program. For the department to continue to grant below-market interest rate mortgage loans to California veterans over the long term, the Legislature would need to create a new program funded by a new source.

Additional concerns in the Cal-Vet program are poor budget controls and a lack of consistency and efficiency in program operations. Improperly charged administrative expenses and inefficient loan processing deplete the already limited funds available for loans to veterans. Most significantly, department records indicate as much as $1.3 million of Cal-Vet program funds in a single year were paid for the costs of administrative staff who do not provide service to the program or for staff whose service to the program has not been documented. Based on a 1974 decision by the California Court of Appeal, the department has violated state bond law by charging the Cal-Vet program for such costs.

Over the last four years the department has improved its efficiency in many areas. These improvements include centralizing loan contract servicing, adopting new loan underwriting standards, instituting mortgage insurance, and improving its management of delinquent and foreclosed loan contracts. However, the department has not fully implemented other reengineering changes in the Cal-Vet program that it has identified as necessary to efficiently operate the program. Because the department has not completed its reengineering efforts, which include the centralization of its loan processing operations and implementation of workload standards for its field and headquarters offices, the average cost to process loan applications has increased, costs vary significantly by field office, and loan applications take longer to process than is common in the industry.

Another obstacle the department faces in controlling excessive program costs is implementing the Cal-Vet program's integrated information system (system). This system is intended to provide reliable program and financial information needed to operate the Cal-Vet program. However, even though the department has devoted significant time and money to get the system running, the system still does not meet its needs. The department has not tracked expenditures in a way that allow it to control costs by comparing its actual spending to bring the system on-line to its $2.8 million budget for these one-time costs. Moreover, the significant resources being spent on this extended project eat away at funding the department could otherwise use to support loans to veterans.

The implementation project has also been marred by problematic management. When key staff left in the middle of the project, management abandoned its original implementation plan and did not ensure staff adhered to prudent project implementation practices. Fifteen months after its original target date for implementation, the department must spend additional program resources to modify this system further to prevent errors. Even so, it cannot be certain that the system will properly maintain borrowers' file records and accurately accumulate program and financial data because it has not completed necessary testing. It failed to complete over half of the 358 tests it had originally planned to ensure the system worked properly, and it did not maintain adequate documentation of the conversion of loan files from the old system to the new. The department's continuing efforts to implement the system disrupted the Cal-Vet program's normal operations and caused additional workload for staff to correct errors in the accounting records and in borrowers' files maintained in the system.

Furthermore, the department has not adequately safeguarded the data stored in its system by following prudent procedures for approving, testing, and documenting changes to the system software, or provided adequate security over unauthorized system access to prevent the loss or misuse of information in the system. Adhering to proper procedures for making changes to system software and restricting employee access to the system is necessary to ensure all alterations are authorized and correct and to safeguard the program's information and assets. Most of the shortcomings we noted in the department's efforts to implement the system can be traced to a lack of commitment on the part of management to ensure the implementation was successful. To date, the department remains unable to generate the program and financial information it needs to operate the program effectively and efficiently.

RECOMMENDATIONS

The department should determine how to use its remaining limited funding to best serve California veterans in purchasing farms and homes. If it decides to continue its present strategy of using available funds to provide loans at the lowest possible interest rates, it should plan its operations for the future curtailment of new loan activity. If the department determines that veterans are best served with interest rates closer to market rates and expands its pool of funds accordingly with alternate financing methods, it should maintain current demographic data to identify veterans eligible for, and likely to participate in, the Cal-Vet program and adapt the program to provide home loans to the greatest number of qualifying veterans for as long as possible.

In the absence of sufficient tax-exempt financing to ensure the continued viability of the Cal-Vet program, the Legislature should consider using state funds to establish a new program to aid California veterans in purchasing farms and homes.

To stop further erosion of Cal-Vet program funds, the department should complete the steps necessary to ensure its direct and indirect administrative costs are properly and equitably charged to all programs served by administrative staff.

In addition, the department should identify the amount of Cal-Vet program funds it has used for activities outside the program and seek reimbursement from other appropriate state funds.

To further increase the efficiency and consistency in the Cal-Vet program's operations, and thereby reduce costs and improve loan processing times, the department should complete its reengineering efforts.

The department should convene a centralized implementation team to ensure that its system functions reliably. The team should include a project manager and a sponsor from the department's executive management team with the authority to allocate the necessary resources. Additionally, the department should contract with an outside consultant with experience in project management to oversee the team. The team should gather all data from prior implementation efforts, assess which tasks remain incomplete, and identify the steps needed to properly test the modules and system. In addition, the team should obtain the training necessary to design the program performance reports and financial reports the department needs to efficiently and effectively operate the Cal-Vet program.

The department should adequately safeguard program data and assets by implementing a security policy to limit system access to employees who are properly authorized and ensuring access is not incompatible with their other duties. Further, the department should follow proper procedures for making changes to system software.

AGENCY COMMENTS

While it disagrees with some of the conclusions we reached, the California Department of Veterans Affairs (department) concurs with the recommendations we made for Chapters 1 and 2 but believes it has adequately addressed our recommendations for Chapter 3. To provide clarity and perspective, our comments follow the department's response.


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