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With Scrutiny on Lender, Questions on Oversight

By Gilbert M. Gaul
Washington Post Staff Writer
Wednesday, December 5, 2007

By all appearances, Bill Russell Oil Co. did not seem like a good candidate to get a multimillion-dollar loan guarantee from the U.S. Department of Agriculture. The Rector, Ark., company owned by Bill and Sandra Russell had been locked in costly lawsuits with distributors. It was being investigated for its leaky underground storage tanks. Several of its gas stations were in disrepair, including one that had been leveled by a tornado.

Yet in June 2000, the USDA made it possible for the company to get a $3 million loan by agreeing to cover up to 80 percent of the loss if the loan went bad.

And the loan quickly went bad, costing taxpayers millions.

The fall of Bill Russell Oil sheds light on questionable lending practices and spotty oversight in the USDA's Business and Industry Guaranteed Loan Program, which seeks to foster development by backing loans in rural areas.

Bill Russell Oil's loan was arranged by a New York-based lender, now known as Business Loan Express, or BLX, a holding of Allied Capital and one of the biggest players in government-guaranteed loans. BLX earned fees for arranging and servicing loans and could make even more money reselling the federally guaranteed portions of its loans to other lenders. If the loans went bad, the government paid most of the cost of the cleanup, as it did in the case of Bill Russell Oil.

A Washington Post analysis found that from 2001 to 2006, the USDA had to pay $34 million to buy back 13 BLX loan guarantees -- representing one of every five USDA-backed loans made by BLX. The 13 loans included some to companies that were in and out of bankruptcy, saddled with tax bills, or struggling in declining industries.

A Maryland gas station operator received a $3 million guaranteed loan but soon lost its license for failing to pay millions in gasoline taxes. It defaulted on the loan and filed for bankruptcy two years later. A Pennsylvania mushroom farm received a $3.4 million loan while in bankruptcy and a loan of $1.7 million a few years later. It filed for bankruptcy again this year and is now defunct. A Hanover, Pa., wallpaper manufacturer with mounting losses got a $3 million guaranteed loan in November 2000. It filed for bankruptcy in 2005 and closed.

In each case, USDA officials relied on BLX employees to investigate the borrowers, conducting little due diligence on their own. Now, with questions being raised about BLX loans to Bill Russell Oil and others, USDA officials have turned to their inspector general to audit the company's entire portfolio of loans. BLX could be asked to pay back millions.

In January, an executive in the firm's Troy, Mich., office was indicted on charges of loan fraud involving more than $70 million in Small Business Administration-guaranteed loans. He later pleaded guilty, and BLX agreed to reimburse the agency up to $10 million in losses while undergoing independent review of any new loans.

Last month, Allied Capital announced that BLX was "significantly de-emphasizing" its government-guaranteed loan business to focus on conventional small-business and real estate loans. It cited "the difficulties BLX has experienced."

BLX referred a Post reporter seeking an interview to a public relations firm, which stopped returning calls after an initial conversation.

The USDA's Business and Industry Guaranteed Loan Program is the largest of the agency's economic development efforts in support of rural development. It is available to businesses in areas with populations below 50,000. The maximum loan is $25 million, and most loans carry an 80 percent government guarantee.

USDA officials stress that the purpose of the program is to support banks so they will be encouraged to fund rural development. "Our client is the bank, not the borrower," said William Hagy, deputy administrator for business programs.

Until 1996, USDA employees helped review loans and determine the credit quality of the borrowers. That year, primary responsibility for conducting due diligence was shifted to the lenders. Now, USDA employees review lenders' analyses but do not investigate borrowers.

Since the program's inception in 1974, nearly 2,700 loans have resulted in losses. Defaults have cost taxpayers $1.46 billion to date on $13.8 billion in loans. The 10.6 percent loss rate is nearly double that of the Small Business Administration's most popular loan-guarantee program and far higher than the rate for commercial lenders.

Hagy said: "The program is not a lender of last resort. These are by statute supposed to be quality credit. . . . They [lenders] are supposed to treat this the same way as a commercial loan."

A Struggling Company

Bill Russell Oil, headquartered in Rector, a community of 2,000 in northeast Arkansas near the Missouri border, operated 20 gas stations split almost equally between the two states. In December 1999, the Missouri Department of Revenue revoked Bill Russell Oil's motor fuel license, so it could no longer sell gasoline at its nine retail outlets in the state. A spokesman said the agency is prohibited by state law from revealing the reasons for its action.

Around that time, Bill Russell Oil paid two gasoline distributors a total of $536,000 in court judgments in business disputes.

Bill Russell Oil was also struggling to bring its gas stations up to environmental standards. In April 2000, the U.S. Environmental Protection Agency identified 62 violations involving the company's underground storage tanks and proposed a penalty of $314,558, records show.

Still, just two months later, USDA officials agreed to back a $3 million loan to the company from New York-based BLC Commercial Capital Corp., a predecessor to BLX. Bill Russell Oil said the money would help to create four jobs and save 11 others.

Shirley A. Tucker, the USDA's director of business programs in Arkansas, said her office relied on the borrower and the lender to certify that Bill Russell Oil met all environmental requirements. Tucker added that she did not learn about the EPA investigation until she read about it in a local newspaper several months after the loan guarantee was approved. "I was surprised," she said. "Under the conditional agreement, it was up to the lender to bring that to our attention."

While the lender was responsible for the due diligence on the loan application, USDA employees could still deny any loan they viewed as too risky. Initially, the Arkansas office questioned Bill Russell Oil's "ability to generate the volume" of business that its owner "claimed he was going to generate," Tucker said. But the office allowed the company and the lender to rework the numbers. The loan then met "the minimum requirements" for approval.

"We second-guessed ourselves," Tucker said. "We probably should have stuck with our gut."

After the guarantee was approved in June 2000, the New York loan company resold it to another lender, a common industry practice. Bill Russell Oil quickly fell behind on the loan and stopped making payments, interviews and records show. It was declared delinquent in March 2001. And that June, the holder of the guarantee demanded that the USDA buy it back. The cost: $2.5 million, including interest.

"It was hard to see how a loan could go south so fast," Tucker said. Later, she went to look at some of the gas stations herself. "We found some didn't have electricity on the day we closed the loan. There was no way they were operating," she said.

Bill and Sandra Russell have moved and could not be located for comment.

In 2003, Tucker's office asked the USDA's inspector general to investigate the Bill Russell Oil loan. In a lengthy September 2005 audit, the investigators reported numerous "irregularities" in the way BLX handled the loan. They charged that the lender overstated Bill Russell Oil's property values, inaccurately claimed that 95 percent of the gas stations were operating -- at least five out of 20 were closed -- and failed to disclose the scope of the company's environmental problems.

The inspector general recommended that the USDA bar BLX from its loan-guarantee program and demand that the lender reimburse it the $2.5 million for the Bill Russell Oil loan. Now, the USDA is awaiting the outcome of the inspector general's audit of the BLX portfolio before deciding what steps, if any, to take. Hagy cited the Small Business Administration fraud investigation, Bill Russell Oil and several other BLX loans in requesting a full-blown audit.

"Several things started to boil up, and concerns were raised," he said. "We decided we better get the office of inspector general to review their total performance. It's a major undertaking."

Meanwhile, BLX is continuing to liquidate Bill Russell Oil's gas stations. But it is unlikely that the sale will make the government whole. The USDA's share of the sale of the nine Missouri properties was just $74,400. "It wasn't much money when you look at it," Tucker said.

Tucker said USDA officials are also frustrated that BLX was slow to develop a liquidation plan. The state office wrote letters to the company "basically in 2001," she said, but had no authority to force the issue. "Yeah, we're the government, but we really don't have any enforcement. We can't put them in jail."

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