An audit of defaulted Small Business Administration loans found the agency did too little to prevent fraud and ensure that borrowers used the money appropriately.

More than 7,800 SBA loans valued at $1.2 billion-or 5% of the agency's portfolio-were in liquidation as of April 1996. Of those loans, 1,100 were in liquidation within two years of their approval, the study found.

"Anytime a loan defaults in the early stages, the lenders should take a look at the borrowers' books to find out what happened," said Peter McClintock, the SBA's assistant inspector general for auditing.

The audit is another blemish for an agency that bankers gripe about but increasingly rely on as they expand their financing options for small- business owners.

The SBA Inspector General Office studied 17 loans that went into default two years after they were approved. In those cases, the SBA ended up spending $9.9 million to honor its loan guarantees.

The audit found indications of fraudulent loan applications with half the loans and concluded the SBA staff and the lenders did not adequately monitor the use of credit lines to ensure they were used for the purpose indicated on the loan application.

But James W. Hammersley, the SBA acting associate administrator for financial assistance, said the study did not accurately reflect the quality of the agency's loan portfolio.

"Seventeen loans is not a representative sample of anything," Mr. Hammersley said. "It's just anecdotal evidence and not enough to make policy changes on."

Mr. Hammersley said SBA field officers review loan applications and lenders who issue credit lines should make sure customers use them properly.

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