Small Business Administration
Progress Made but Improvements Needed in Lender Oversight Gao ID: GAO-03-90 December 9, 2002The Small Business Administration (SBA) has increased its reliance on private lenders to provide small businesses with access to credit. The 7(a) program is SBA's largest business loan program, and SBA has established a preferred lender program (PLP) in which eligible lenders make 7(a) loans without prior SBA approval. SBA guaranteed $9.9 billion in 7(a) loans in 2001. Because lenders are exercising greater autonomy in making 7(a) loans, effective lender oversight is essential to SBA's success in achieving its mission. GAO evaluated SBA's 7(a) lender oversight and reviewed its organizational alignment for conducting PLP and Small Business Lending Company (SBLC) oversight.
SBA has made progress in developing its lender oversight program, but conducts only a cursory review of lenders' processes rather than a qualitative assessment of their decisions with regard to borrowers' creditworthiness and eligibility. The "credit elsewhere" standard--a test to determine whether the borrower can obtain credit without the SBA guarantee--is broad, making a meaningful assessment of lenders' decisions difficult. Although SBA has identified appropriate elements for an effective lender oversight program, it has been slow to incorporate all of the elements. For example, SBA does not adequately measure the financial risk PLP lenders pose to its portfolio and has not developed enforcement policies and procedures. SBA has also been slow to implement program improvements for its oversight of SBLCs, for which it has additional safety and soundness regulatory authority. SBA's lender oversight function does not have the organizational independence or resources necessary to accomplish its goals. Two offices perform lender oversight from within the Office of Capital Access (OCA), whose other responsibilities include lending program promotion and management, thus presenting a possible conflict. Additionally, split responsibilities within OCA, and limited resources, have impeded SBA's ability to complete certain oversight responsibilities, such as the completion of review reports, which could result in increased risk to its portfolio.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-03-90, Small Business Administration: Progress Made but Improvements Needed in Lender Oversight
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Report to the Ranking Minority Member, Committee on Small Business and
Entrepreneurship, U.S. Senate:
United States General Accounting Office:
GAO:
December 2002:
SMALL BUSINESS ADMINISTRATION:
Progress Made but Improvements Needed in Lender Oversight:
GAO-03-90:
GAO Highlights:
Highlights of GAO-03-90, a report to the Ranking Minority Member,
Committee on Small Business and Entrepreneurship,
United States Senate
Why GAO Did This Study:
The Small Business Administration (SBA) has increased its reliance on
private lenders to provide small businesses with access to credit.
The 7(a) program is SBA‘s largest business loan program, and SBA
has established a preferred lender program (PLP) in which eligible
lenders make 7(a) loans without prior SBA approval. SBA guaranteed
$9.9 billion in 7(a) loans in 2001. Because lenders are
exercising greater autonomy in making 7(a) loans, effective lender
oversight is essential to SBA‘s success in achieving its mission.
GAO evaluated SBA‘s 7(a) lender oversight and reviewed its
organizational alignment for conducting PLP and Small Business
Lending Company (SBLC) oversight.
What GAO Found:
SBA has made progress in developing its lender oversight program, but
conducts only a cursory review of lenders‘ processes rather than a
qualitative assessment of their decisions with regard to borrowers‘
creditworthiness and eligibility. The ’credit elsewhere“ standard”a
test to determine whether the borrower can obtain credit without the
SBA guarantee”is broad, making a meaningful assessment of lenders‘
decisions difficult. Although SBA has identified appropriate elements
for an effective lender oversight program, it has been slow
to incorporate all of the elements. For example, SBA does not
adequately measure the financial risk PLP lenders pose to its
portfolio and has not developed enforcement policies and procedures.
SBA has also been slow to implement program improvements for its
oversight of SBLCs, for which it has additional safety and soundness
regulatory authority.
SBA‘s lender oversight function does not have the organizational
independence or resources necessary to accomplish its goals. Two
offices perform lender oversight from within OCA, whose other
responsibilities include lending program promotion and management,
thus presenting a possible conflict. Additionally, split
responsibilities within OCA, and limited resources, have impeded SBA‘s
ability to complete certain oversight responsibilities, such as the
completion of review reports, which could result in increased risk to
its portfolio.
What GAO Recommends:
SBA should
* incorporate strategies into its review process to adequately
measure the financial risk lenders pose to SBA and develop specific
criteria for the ’credit elsewhere“ standard;
* provide policies and procedures for enforcement actions against
preferred lenders and SBLCs; and
* separate the lender oversight function from the Office of
Capital Access (OCA) and provide it with clear authority
and guidance.
SBA disagreed with part or all of two recommendations and is
considering issues raised in others.
www.gao.gov/cgi-bin/getrpt?GAO-03-90.
To view the full report, including the scope and methodology, click on
the link above. For more information, contact Davi D‘Agostino,
Director, FMCI, on (202) 512-8678, or d‘agostinod@gao.gov.
Contents:
Letter:
Results in Brief:
Background:
Lender Oversight Is Not Achieving All of Its Goals:
SBA's Organizational Alignment Does Not Adequately Support SBA's Lender
Oversight Functions:
Conclusions:
Recommendations:
Agency Comments:
Objectives, Scope, and Methodology:
Appendix I: Opportunities for Small Business Lending Company Program
Enhancement Identified by the Farm Credit Administration:
Portfolio Management:
Financial Performance and Condition:
Appendix II: GAO Letter of Inquiry to the Small Business
Administration:
Appendix III: Comments from the Small Business Administration:
Tables:
Table 1: SBA Loan Performance Benchmarks and Definitions:
Table 2: Proposed PLP Review Rating Elements:
Figures:
Figure 1: SBA District Offices and Processing and Servicing Centers in
the United States:
Figure 2: SBA Preferred Lending and Review Processes:
Figure 3: Number of PLP Lenders and Reviews Performed for the First
through Fourth Year:
Figure 4: SBA Lender Review Fee Format:
Figure 5: SBA's Process for Nomination, Renewal, and Expansion of PLP
Status:
Figure 6: Preferred Lender Oversight Responsibilities within OCA:
Figure 7: SBA's Headquarters Organization Chart:
Abbreviations:
FCA: Farm Credit Administration:
LMS: Loan Monitoring System:
NAGGL: National Association of Government Guaranteed Lenders:
OCA: Office of Capital Access:
OFA: Office of Financial Assistance:
OFHEO: Office of Federal Housing Enterprise Oversight:
OFO: Office of Field Operations:
OLO: Office of Lender Program:
PLP: Preferred Lenders Program:
SBA: Small Business Administration:
SBLC: Small Business Lending Company:
SBPIA: Small Business Programs Improvement Act of 1996:
SOP: Standard Operating Procedures:
United States General Accounting Office:
Washington, DC 20548:
December 9, 2002:
The Honorable Christopher S. Bond
Ranking Minority Member
Committee on Small Business and Entrepreneurship
United States Senate:
Dear Senator Bond:
The mission of the Small Business Administration (SBA) is to maintain
and strengthen the nation's economy by aiding, counseling, assisting,
and protecting the interests of small businesses and by helping
individuals and small businesses recover from disasters. SBA has a
total portfolio of about $44 billion, including $39 billion in direct
and guaranteed small business loans and other guarantees and $5 billion
in disaster loans.[Footnote 1] Providing small businesses with access
to credit is a major avenue through which SBA strives to fulfill its
mission. The 7(a) loan program, which is authorized by Section 7(a) of
the Small Business Act, is SBA's largest business loan
program.[Footnote 2] The 7(a) program is intended to serve small
business borrowers who cannot otherwise obtain financing under
reasonable terms and conditions from the private sector. This report
contains the results of our review of SBA's oversight of lenders
participating in its Preferred Lenders Program (PLP), in which lenders
make loans guaranteed by SBA under Section 7(a) without prior SBA
review or approval. In fiscal year 2001, 7(a) loan approvals totaled
approximately $9.9 billion, of which preferred lenders made $5.3
billion. Prior to making SBA guaranteed loans, preferred lenders must
make determinations regarding borrowers' creditworthiness and
eligibility for SBA assistance. A key eligibility decision that lenders
must make before approving a loan is whether a small business could
obtain credit on similar terms without an SBA guaranty. SBA then
reviews preferred lenders to assess their compliance with SBA rules and
regulations. Lender oversight has become increasingly important to SBA
as the agency has evolved from making loans to depending on lending
partners, primarily banks,[Footnote 3] to make SBA guaranteed loans to
small businesses.
You requested that we review SBA's oversight of its 7(a) lenders,
particularly those participating in the PLP. As you requested, we (1)
evaluated SBA's 7(a) lender oversight program to determine its likely
success in achieving its goals and (2) reviewed SBA's organizational
alignment for conducting preferred lender and Small Business Lending
Company (SBLC) oversight.[Footnote 4]
We analyzed SBA's oversight of its 7(a) lenders, particularly for
preferred lenders, some of whom are SBLCs, licensed by SBA to make only
7(a) loans. In conducting our work, we defined oversight to include
SBA's process for reviewing preferred lenders for compliance with SBA
guidance and for evaluating them for initial and continued
participation in the PLP. We focused our reviews in part to follow up
on recommendations made in our June 1998 report, where we found that
SBA was doing few reviews of its preferred lenders.[Footnote 5] We
reviewed recent developments in SBA's oversight of SBLCs, which account
for approximately 19 percent of outstanding 7(a) loans, because we had
previously identified improvements needed in SBLC oversight in a
November 2000 report.[Footnote 6] We analyzed PLP review guidance,
review and lending data to the extent that is was available, and a
sample of PLP and SBLC review reports. To evaluate their experiences in
SBA's oversight program, we interviewed SBA headquarters and regional
staff. We also interviewed PLP lenders and representatives of the
National Association of Government Guaranteed Lenders.
Results in Brief:
SBA has made progress in developing its lender oversight program, but
it has not fully developed effective oversight programs that assess
lenders' decisions on borrowers' creditworthiness and eligibility and
the impact of lenders' decisions regarding risk posed to SBA's
portfolio. SBA has identified appropriate elements for an effective
lender oversight program; however, it has been slow to change programs
and procedures to fully incorporate all of the elements. Risk
management issues have become more critical for SBA as its current loan
programs focus on partnering with banks that make loans guaranteed up
to 85 percent by SBA. However, SBA has not yet consistently
incorporated adequate measures of financial risk into the PLP review
process or the SBLC examination program, two key loan and lender
oversight tools. A key to SBA's successful management of its loan
portfolio and achievement of its mission is its ability to ensure that
lenders are complying with SBA rules and regulations when making 7(a)
loans. However, the current PLP review process, which is used to ensure
compliance, involves a cursory review of documentation maintained in
lenders' loan files rather than a qualitative assessment of borrower
creditworthiness or eligibility. Moreover, SBA has not developed clear
enforcement policies, for preferred lenders or SBLCs, specifically
describing its response in the event that its reviews uncover
noncompliance. In addition, SBA is not consistent in how it funds the
cost of its lender oversight, resulting in questionable funding
arrangements that could limit SBA's flexibility in managing its program
and its overall accountability. SBA has taken steps to make the PLP
more streamlined and to manage the program consistently, particularly
for large national lenders, but some lenders we interviewed complained
that program participation can be confusing and administratively
burdensome.
Although SBA has listed the oversight of its lending partners as a key
priority of the agency, the function does not have the necessary
organizational independence or resources to accomplish its goals. In
our past work analyzing organizational alignment and workload issues,
we have described the importance of tying organizational alignment to a
clear and comprehensive mission statement and strategic plan, and
providing adequate resources to accomplish the mission. SBA's lender
oversight functions are carried out by two different offices within the
Office of Capital Access (OCA), which also promotes and implements
SBA's lending programs, thereby presenting a possible conflict because
PLP promotion and operations are housed in the same office that
assesses lenders' compliance with SBA safety and soundness and mission
requirements. Split responsibilities within OCA and limited resources
have impeded SBA's ability to complete certain oversight
responsibilities, which could result in heightened risk to its
portfolio or lack of comprehensive awareness of portfolio risk. In
congressional testimony describing an SBA workforce transformation
plan, a senior SBA official announced that SBA will centralize all
lender oversight functions within headquarters.
This report contains four recommendations. In general, we recommend
that SBA (1) improve its review process, (2) clarify its enforcement
authority, (3) make the PLP program more accessible, and (4) better
emphasize lender oversight in its organizational alignment.
We obtained written comments on a draft of this report from SBA's
Associate Deputy Administrator for Capital Access. SBA's comments are
discussed near the end of this report, and its letter is reprinted in
appendix III. SBA did not explicitly state that it agreed or disagreed
with our recommendations. However, in specific comments on the four
recommendations, SBA essentially disagreed with part or all of two
recommendations and said that it was reviewing the issues we presented
in the other two. SBA disagreed with our recommendation that it develop
specific criteria to apply to the credit elsewhere standard but said it
was considering approaches to better assess the financial risk lenders
pose and to make qualitative assessments of its lenders' performance
and lending decisions. SBA disagreed with our recommendation to
separate lender oversight functions and responsibilities from OCA.
Regarding our recommendations that SBA should, through regulation,
develop clear policies and procedures for taking enforcement action and
continue to explore ways to assist large national lenders to
participate in the preferred lender program, SBA said that it was
considering the best way to address the issues we raised.
Background:
In pursuing its mission of aiding small businesses, SBA provides small
businesses with access to credit, primarily by guaranteeing loans
through its 7(a) and other loan programs, and provides entrepreneurial
assistance through partnerships with private entities that offer small
business counseling and technical assistance. SBA also administers
various small business procurement programs, which are designed to
assist small and small disadvantaged businesses in obtaining federal
contracts and subcontracts. SBA also makes loans to businesses and
individuals trying to recover from a disaster.
At the beginning of fiscal year 2003, SBA had 3,026 permanent employees
and 1,221 temporary employees for disaster assistance work. In the last
10 years, SBA has changed its organization and how it delivers
services. In response to budget reductions, SBA streamlined its field
structure during the 1990s, downsizing its 10 regional offices, moving
the workload to either district offices or headquarters offices, and
eliminating most of the regions' role as an intermediate management
layer between headquarters and the field. About three-quarters of SBA's
staff are assigned to the agency's field locations, which include 10
regional offices, 70 district offices as well as various other field
locations. In addition to its federal workforce, SBA's infrastructure
includes over one thousand resource partners located nationwide who
provide technical and advisory assistance to small businesses. Figure 1
shows SBA district offices and processing and servicing centers.
Figure 1: SBA District Offices and Processing and Servicing Centers in
the United States:
[See PDF for image]
[End of figure]
SBA has changed the approach in its lending programs to delegating more
authority to lenders for making loans that it guarantees rather than
approving loans that lenders make. SBA's loan programs have also been
the focus of a major organizational change with the creation of centers
to process and service the majority of these loans--work that was once
handled largely by district office staff. Processing and servicing of
about three-quarters of SBA-guaranteed loans was handled in centers
instead of district offices in 2000.
Under the 7(a) program, SBA provides guarantees of up to 85 percent on
loans made by participating lenders. Within the 7(a) program, there are
three classifications of lenders--regular, certified, and preferred
lenders. SBA continues to provide final approval of loans made by its
regular lenders through the district offices. Certified lenders have
the authority to process, close, service, and may liquidate SBA
guaranteed loans. SBA gives priority to applications and servicing
actions submitted by certified lenders and will provide expedited loan
processing or servicing. Preferred lenders are given full authority to
make loans without prior SBA approval, making their own assessments of
eligibility and creditworthiness. However, lender-approved preferred
loans are submitted to SBA's Sacramento Processing Center, which, among
other things, verifies that the lender has documented certain
eligibility requirements, issues a loan number, and processes the loan
guaranty. The Sacramento Processing Center, one of eight processing
centers SBA maintains to process various types of loans, does all loan
processing for PLP loans. Preferred lenders tend to be the largest 7(a)
lenders, and they account for slightly over half of 7(a) lending. Less
than 1 percent of 7(a) lenders account for greater than 50 percent of
7(a) loan dollar volume outstanding. According to SBA staff, most of
these lenders are PLP lenders.
While SBA has delegated loan authorities to certified and preferred
lenders, SBA still manages them by periodically authorizing or renewing
certified or preferred lender status. SBA regulations state that
certified and preferred lenders are to have their status renewed at
least every 2 years by SBA. At the end of August 2002, SBA had over 400
preferred lenders. The district offices use the same review checklist
used for reviews of preferred lenders to review non-PLP lenders.
In addition to managing lender status, SBA exercises more direct lender
oversight through its review process. The Small Business Programs
Improvement Act of 1996 (SBPIA) requires SBA to review program
participation by preferred lenders annually or more
frequently.[Footnote 7] SBPIA did not change the oversight requirements
for regular and certified lenders, which, according to SBA's standard
operating procedures, are currently reviewed every 3 years. For
preferred lenders, SBA has developed a review program that includes
annual reviews of all PLP lenders who made preferred loans during the
previous year. The objectives of the reviews are to determine (1)
whether preferred lenders process, service, and liquidate loans
according to SBA standards and (2) whether such lenders should continue
to participate in the program. To make these determinations, SBA's
lender review staff, which includes contract reviewers and SBA staff,
analyze lenders' policies and review the documents in lenders' loan
files for a sample of loans.
SBA originally managed the PLP lender oversight program through its
Office of Financial Assistance (OFA), an office that is part of OCA. In
fiscal year 1999, SBA created a new office, the Office of Lender
Oversight (OLO), to ensure consistent and appropriate supervision of
SBA's lending partners. OLO, which is also part of OCA, is responsible
for managing all headquarters and field office activities regarding
lender reviews, including safety and soundness examinations of SBLCs,
issuing review and examination reports to the lenders and SBLCs,
evaluating new programs, and recommending changes to existing programs
to assess risk potential. OLO is also responsible for evaluating
existing oversight regulations, policies and procedures; monitoring
changes in accounting, banking, and financial industries that may
affect their lenders; and recommending appropriate modification of SBA
lender oversight policy. The PLP Review Branch located in Kansas City,
Missouri was made part of OLO. It coordinates reviews with lenders and
contract reviewers, participates in reviews, reviews contractor
reports, prepares the review reports, and conducts exit meetings with
the lenders. Figure 2 illustrates SBA's preferred lending and review
processes.
Figure 2: SBA Preferred Lending and Review Processes:
[See PDF for image]
[End of figure]
While OLO is responsible for many oversight functions, OFA has still
retained some oversight responsibilities. OFA's current role in lender
oversight is to provide final approval of lenders' PLP status. As noted
previously, for a period of 2 years or less, lenders are granted PLP
status in specific SBA districts. OFA collects information about the
lender prepared by the Sacramento Processing Center, with input from
one or more of SBA's 70 district offices, and decides whether to renew
a lender's PLP status or to grant status in an additional district. OFA
may also discontinue a lender's PLP status.
Other lenders participating in the 7(a) program are subject to a
different oversight regime. Specifically, SBA divides SBLC program
functions between OLO and OFA. OLO is responsible for SBLC on-site
examination, and OFA handles day-to-day program management and
policymaking. Ultimate responsibility for enforcement of corrective
actions rests with OCA. As participants in the 7(a) program, SBLCs are
subject to the same review requirements as other 7(a) lenders, and they
are also subject to safety and soundness oversight by SBA. For a period
prior to 1982, SBA licensed 14 SBLCs to promote its efforts to increase
the availability of financial assistance to small businesses.[Footnote
8] Of the 14 SBLCs currently active in SBA's 7(a) loan program, 12 are
certified as preferred lenders. SBLCs account for about 19 percent of
outstanding 7(a) loans. SBA regulates SBLCs on the basis of its
determination that the Small Business Act provided the Administrator
with broad powers to promulgate and enforce rules and regulations for
lenders participating in the 7(a) program. Since fiscal year 1999, SBA
has had an agreement with the Farm Credit Administration (FCA)[Footnote
9] to conduct safety and soundness examinations of the SBLCs.[Footnote
10]
Lender Oversight Is Not Achieving All of Its Goals:
SBA has identified goals for its lender oversight program that are
consistent with appropriate standards for an oversight program;
however, SBA has not yet established a program that is likely to
achieve them. Since our last review, SBA has made progress in
developing its lender oversight program, but there are still areas in
need of improvement if SBA is to develop a successful program. SBA has
highlighted risk management in its strategy to modernize the agency;
however, PLP reviews are not designed to evaluate financial risk, and
the agency has been slow to respond to recommendations made for
improving its monitoring and management of financial risk--posing a
potential risk to SBA's portfolio. PLP reviews are designed to
determine lender compliance with SBA regulations and guidelines;
however, they do not provide adequate assurance that lenders are
sufficiently assessing eligibility and creditworthiness of borrowers.
Although SBA has identified problems with preferred lenders' or SBLCs'
lending practices, it has not developed clear policies describing its
enforcement response to specific conditions. Thus, it is not clear what
actions SBA would take to ensure that preferred lenders or SBLCs
address any weaknesses in their lending programs. SBA has oversight
responsibilities regarding different types of lending institutions with
different charters, and its arrangements for funding its reviews vary.
These varying arrangements result in questions of propriety and a lack
of consistency that could limit SBA's flexibility and accountability in
conducting reviews, and in differences in the costs that lenders must
bear for their oversight. Although the process for certifying lenders
for PLP status--another means by which SBA oversees lenders--has become
better defined and more objective, some lenders told us they continue
to experience confusing and inconsistent procedures during this process
due to varying recommendations from field offices.
SBA Recognizes Appropriate Elements of Oversight:
Various SBA officials and publications have pointed to the importance
of developing an oversight program that ensures that its lending
partners minimize the risk of loss to SBA while making loans to
eligible borrowers who require SBA assistance. For example, SBA's
current Strategic Plan states that the goal of risk management has
become more critical as loan-making and other functions have been
outsourced and refers to the need "to protect taxpayers' interests and
to ensure the long-term viability of our lending programs."[Footnote
11] To evaluate the effectiveness of SBA's lender oversight program, we
considered, with some modification as appropriate, elements that we
have cited as appropriate for an oversight program to ensure that a
financial institution carries out its public purpose or mission and
operates in a safe and sound manner. [Footnote 12] These elements
include the authority to:
* establish rules and regulations,
* examine and monitor all aspects of operations,
* set and define minimum capital requirements, and:
* take enforcement action to ensure compliance.
These elements apply, to varying degrees, to SBA's oversight of
preferred lenders and SBLCs. We discussed these elements with SBA
officials who also agree that, with modification, they are appropriate
to SBA's responsibility to oversee its lending partners. One
significant modification is that SBA is not the primary safety and
soundness regulator for most PLP lenders, which are banks regulated by
federal financial institution regulators, such as the Office of the
Comptroller of the Currency. SBA's responsibility and authorities are
therefore focused on the SBA loan portfolio of such lenders. SBLCs,
however, do not have regulators other than SBA. Therefore, SBA is
responsible for examining the financial condition of SBLCs as well as
their compliance with PLP policies and procedures. SBA is responsible
for defining minimum capital requirements for SBLCs. In summary, all
four of the elements of oversight noted above apply to SBA's oversight
of SBLCs, and the elements--with the exception of setting capital
requirements--apply to SBA's oversight of the 7(a) portfolio of other
preferred lenders.
We evaluated SBA's oversight of PLP lenders and SBLCs in light of the
elements of oversight that we have identified in past work and that are
listed above. As described below, SBA possesses authorities consistent
with the above-described elements and has identified planned
improvements designed to better incorporate the elements into its
oversight program. However, SBA has not yet implemented many of the
planned improvements, without which, the PLP and SBLC oversight program
will continue to be inadequate and fall short of stated goals.
SBA Has Made Progress in Developing Its Lender Oversight Function:
Since our June 1998 report, SBA has responded to a number of
recommendations for improving lender oversight by developing guidance,
establishing OLO and doing more reviews.[Footnote 13] SBA developed
"Standard Operating Procedures" (SOP) for oversight of SBA's lending
partners and the "Loan Policy and Program Oversight Guide for Lender
Reviews" in October 1999.
SBA established OLO in fiscal year 1999 to coordinate and centralize
the lender review processes for PLP and SBLC oversight. OLO created a
Reviewer Guide to provide direction to all personnel engaged in the PLP
review process, and OLO officials said they conduct training for all
SBA staff involved in conducting preferred lender reviews. OLO
officials told us that in an effort to effectively oversee and monitor
SBA lenders, they seek to use a strategy of evaluating risk generated
by the lender to the SBA portfolio, work with SBA program offices to
manage PLP oversight operations, and plan to conduct regular and
systematic portfolio analysis using a new loan monitoring system (LMS).
SBA has been developing the LMS to enhance its ability to monitor and
analyze borrower and lender risk and conduct off-site
monitoring.[Footnote 14] SBA's OIG has delegated the SBLC examination
function to OLO. To minimize the number of visits SBLCs receive during
a year, starting in April 2002, OLO combined PLP reviews with SBLC
examinations performed by the FCA.
In an effort to improve the lender review process, SBA developed an
automated, 105-item checklist that is designed to make its analysis
more objective. Lender reviews, including PLP, are based on reviewers'
findings using a lender questionnaire and a review checklist. SBA
guidance explains that this automated format ensures an objective
scoring process in that each question is given an answer of "yes,"
"no," or "n/a," and assigned a specific weight. The final score for PLP
reviews is automatically calculated by the checklist and results in a
compliance rating based on a four-tier system. SBA's ratings, from
highest to lowest, include "substantially in compliance," "generally in
compliance," "minimally in compliance," and "noncompliance.":
The lender questionnaire addresses a lender's organizational structure
and oversight, policy, and controls. The PLP checklist is divided into
four sections analyzing different elements of the lender's operations
for making 7(a) loans:
* processing, forms, eligibility, credit analysis;
* due diligence, authorization, closing;
* servicing, liquidation; and:
* oversight, policy, and controls.
Answers of "n/a" do not count in the scoring process. Individual
elements in the checklist refer to the presence of specific documents
or analyses, such as financial statements and required SBA forms, that
loan files must contain according to SBA guidance. Although guidance
states that eligibility and credit questions are generally weighted
more heavily than other questions, the reviewers' assessment of these
components is cursory, as we discuss in more detail later. SBA
officials said that prior to the implementation of the automated
worksheet scoring process, PLP reviews were done in a narrative format
and reviewer's assessments of lender performance were subjective. They
noted that the new format makes the reviewer's assessment of lenders
more consistent and objective. However, without a more substantive
method of evaluating lender performance, this approach does not provide
a meaningful assessment.
SBA has also increased the number of PLP reviews performed. In June
1998, we reported that SBA had not reviewed 96 percent of 7(a) lenders,
including preferred lenders, in the districts we visited. SBA's review
year runs from April 1 to the end of March of the next year.[Footnote
15] In its first review year, beginning April 1, 1998, SBA performed
277 reviews out of 327 preferred lenders that approved a preferred loan
in the previous fiscal year. In its fourth review year, which ended
March 29, 2002, SBA performed 385 reviews out of 449 preferred lenders.
SBA officials commented that they believe they reviewed 100 percent of
PLP lenders. The difference in the number of lenders and the number of
reviews performed is attributable, officials stated, to the
consolidation of reviews of multiple lenders with the same parent
company.
Figure 3: Number of PLP Lenders and Reviews Performed for the First
through Fourth Year:
[See PDF for image]
[End of figure]
SBA's Lender Oversight Does Not Adequately Focus on Financial Risk:
While elements of SBA's oversight program touch on the financial risk
posed by preferred lenders, including SBLCs, weaknesses in the program
limit SBA's ability to focus on, and respond to, current and future
financial risk to their portfolio. Neither the PLP review process nor
SBA's off-site monitoring efforts adequately focus on the financial
risk posed by PLP and other lenders to SBA. SBA oversight of SBLCs is
charged with monitoring how SBLCs administer their credit programs,
identifying potential problems, and keeping SBA losses to an acceptable
level. However, SBA's progress in reporting examination results in a
timely manner and implementing other program improvements limits the
effectiveness of SBA's SBLC oversight.
PLP Reviews Are Not Designed to Evaluate Financial Risk:
SBA officials stated that PLP reviews are strict compliance reviews
that are not designed to measure the PLP lenders' financial risk. Our
review and that of SBA's OIG confirmed this. The PLP review serves as
SBA's primary internal control mechanism to determine whether preferred
lenders are processing, servicing, and liquidating loans according to
SBA standards and whether such lenders should participate in the
delegated programs. While there are optional questions that touch on
the financial risk of a given loan, review staff are not required to
answer them; and SBA guidance explicitly states that the answers to the
questions are for research purposes only and are not to be considered
in making any determinations about the lender. We observed responses to
these questions in only 3 of the 15 final PLP reports we reviewed.
By not including an assessment of the financial risk posed by
individual lenders during PLP reviews, SBA is missing an opportunity to
gather information that could assist it in predicting PLP lenders'
future performance, thereby better preparing SBA to manage the risk to
its portfolio. In its report on PLP lender oversight, the SBA OIG
suggested that financial risk and lender-based risk should be
considered as part of a comprehensive oversight program.[Footnote 16]
While PLP lenders other than SBLCs all have a primary financial
regulator that periodically examines their operations for safety and
soundness, it is still important for SBA to assess the risk posed by
these lenders' SBA portfolios. Because the SBA portfolio of these
lenders is government guaranteed and because these portfolios would not
likely be large enough to pose a significant risk to the bank's overall
safety and soundness, the portfolio of SBA guaranteed loans may not
receive attention from the institution's primary regulator under its
risk-based examination approach. As a result, the risks of each
lender's SBA portfolio to SBA may not be evaluated. SBA should also be
concerned about the general condition of its lending partners so that
SBA does not lose the lender as a partner in providing access to credit
for small businesses. Therefore, it is essential that SBA assess and
manage the risk posed by its lenders' SBA portfolios. SBA staff told us
that although they do not interact with other federal financial
regulators, review staff incorporates additional information such as
bank call data, any publicly disclosed enforcement actions, press
releases, and internal SBA information in assessing PLP lenders.
SBA's Off-Site Monitoring Efforts Are Not Consistently Used to Assess
Risk:
SBA's off-site monitoring efforts do not adequately assess the
financial risk posed by PLP and other lenders. SBA currently uses loan
performance benchmarking and portfolio analysis to serve as its primary
tools for off-site monitoring. SBA officials stated that loan
performance benchmarks are based on financial risk and serve as a
measure to address a lender's potential risk to the SBA portfolio.
However, we found that the benchmarks were not consistently used for
this purpose. The loan performance benchmarks were developed by SBA's
Risk Management Committee to serve as parameters for measuring
satisfactory performance by lenders in the delivery of SBA loan
programs and for field offices to prioritize lender reviews. [Footnote
17] The five categories of loan performance benchmarks are based on a
loan status report that lenders are required to complete monthly and
submit to a private contractor. The information is then consolidated
and sent back to SBA for inclusion in the lender evaluation worksheet
used during the PLP certification process, (discussed later in more
detail). Table 1 lists the loan performance benchmarks and definitions.
Table 1: SBA Loan Performance Benchmarks and Definitions:
Benchmark: Currency rate; Definition: Percentage of loans that are 0 to
30 days past due in scheduled payments.
Benchmark: Delinquency rate; Definition: Percentage of loans over 60
days delinquent, including those in liquidation compared with total
outstanding ("active") loan portfolio.
Benchmark: Default rate; Definition: Percentage of loans purchased,
compared with total loans disbursed by a lender, consisting of the
active portfolio plus paid-in-fulls and charge-offs.
Benchmark: Liquidation rate; Definition: Percentage of loans in
liquidation status, compared with a lender's total active portfolio.
Benchmark: Loss rate; Definition: Amount or number of charge-off loans
relative to total disbursed, excluding paid-in-full and charge-offs.
Source: SBA SOP.
[End of table]
We found that the use of loan performance benchmarks varied across
district offices. Some district office officials used the benchmarks to
periodically discuss performance with lenders, while others did not
place much emphasis on the benchmarks except, to prioritize non-PLP
lender reviews and acknowledge them during completion of the lender
evaluation worksheet. SBA OIG recommended in its September 2001 report
that an assessment of loan performance benchmarks should be included as
part of the PLP review process because the benchmarks provide some
assessment of risk. OLO responded that it is currently redesigning the
PLP review process and will consider this recommendation during the
redesign, which is discussed in more detail later in this report.
OLO does not perform routine analysis of SBA's portfolio to assess
financial risk. Having primary lender oversight responsibility, OLO
should be able to provide a sufficient level of financial risk
monitoring. Prior to the establishment of OLO, the Risk Management
Committee was responsible for tracking trends and other relevant lender
oversight data in the SBA portfolio. SBA officials stated that once
implemented, the LMS would serve as the primary database for producing
consistent lender oversight reports and tracking trends. Staff
currently produces ad-hoc reports to analyze aggregate lending data to
look for trends and try to anticipate risk. For example, staff prepared
a briefing for the Risk Management Committee in the Fall of 2001, which
analyzed loan concentrations by industry and percentages of loans made
by different types of lenders. OLO officials said that in the future,
this type of analysis of industry and geographic concentrations to
assess risk would become a routine part of off-site monitoring. While
these are positive initiatives, such analysis has not been done on a
routine basis.
OLO officials commented that due to limited resources their primary
focus has been on individual lender oversight and analysis. However,
OLO has recently added resources, including one staff member charged
with responsibility for portfolio analysis and reporting. A template
for monthly reporting has been developed and is being reviewed by
various program offices. SBA officials noted that the loan monitoring
system, which is now being developed, is intended to provide OLO with
expanded data analysis capabilities. In the interim, data analysis is
limited because OLO staff must use different databases that are not
integrated. Therefore the analysis is labor intensive. During our work,
we requested rating and benchmark data for a 5-year period, but OLO was
only able to provide it for 2 years. SBA commented that this was
because OLO assumed responsibility for analyzing benchmark data in the
past 2 years. Prior to that time, benchmark data was analyzed in OFA.
When OLO assumed this responsibility, it approached the analysis
differently. To obtain comparable data in prior years, a database would
need to be constructed from stored data from the loan accounting
system.
SBA Is Redesigning Its PLP Reviews to Better Assess Financial Risk:
OLO officials said that as the office continues to evolve, they are
looking for ways to improve lender oversight to better assess and
manage financial risks to SBA. In addition to enhancing off-site risk
monitoring of lender performance, OLO officials announced at an April
2002 conference of lenders that they planned to redesign the PLP review
process. With the assistance of an outside contractor, OLO has
developed a PLP review program that would focus on compliance,
performance, and operations of PLP lenders. The elements of the
proposed new process, described at the conference and by OLO officials
at other times, would include a review of portfolio performance,
origination and processing, portfolio administration, servicing,
compliance, and liquidation. SBA would produce a lender rating based on
these elements (see table 2).
Table 2: Proposed PLP Review Rating Elements:
Rating Elements: Portfolio performance; Definition: Growth rates of the
lender's volume of SBA originations and outstanding SBA loans serviced,
current delinquency and repurchase rates, liquidation rates, and other
key risk-related factors.
Rating Elements: Origination and processing; Definition: Material
shortcomings as a result of origination and processing that could
increase the likelihood of borrower default and/or delinquency.
Rating Elements: Portfolio administration; Definition: Proper
documentation of material information concerning the loans made.
Established policies and procedures to protect the financial soundness
of the lender's SBA portfolio including their proper implementation.
Rating Elements: Servicing; Definition: Material shortcomings as a
result of servicing that could increase the likelihood of borrower
default and/or delinquency.
Rating Elements: Compliance; Definition: The lenders demonstrated
ability to comply with SBA requirements concerning elements of the loan
process that could affect the SBA's financial risk and eligibility
determinations on whether a loan qualifies for an SBA guarantee.
Rating Elements: Liquidation; Definition: Factors that could affect the
recovery on the loan, such as attainable price, limits on expenses
incurred in the liquidation process, and proper legal authority to
carry out the liquidation.
Source: SBA Office of Lender Oversight.
[End of table]
In contrast to the automated scoring of the 105-item checklist used in
reviews currently; scores would be developed only for the six proposed
categories and would be rolled up into a general rating based on the
individual category ratings. OLO officials said that the guidance for
implementing the proposed new review process is currently being
developed, and it could be implemented in early 2003.
SBA Has Not Eliminated Weaknesses in SBLC Oversight that Pose a
Potential Risk to the SBA Portfolio:
SBA has not eliminated weaknesses in the oversight of SBLCs, cited by
GAO and SBA's OIG, that continue to limit the effectiveness of SBLC
oversight, thereby not taking action that could mitigate the risk to
SBA's portfolio. FCA conducts broad-based examinations and evaluates
each SBLC's capital adequacy, asset quality, management, earnings, and
liquidity. The examinations are similar to safety and soundness
examinations performed by bank and Government Sponsored Enterprise
regulators. Currently, the FCA staff responsible for SBLC safety and
soundness examinations also perform the same PLP reviews at SBLCs that
SBA performs using contractors at preferred lenders with the same
review checklist that is used for all 7(a) lenders. Upon the completion
of its examinations, FCA provides a draft report on its findings to SBA
for review and comment. Upon receipt of comments from SBA, FCA provides
a final report to SBA, which, in turn, issues a final report to the
SBLC.
We and SBA's OIG found that final SBLC examination reports were not
issued in a timely manner. In a March 2002 report,[Footnote 18] SBA's
OIG reported that final reports from FCA's fiscal year 2001 SBLC
examinations were not issued until February 2002, 10 months after the
first draft report from FCA was received by OLO. Our work also
confirmed these findings. We found that OLO does not maintain standards
for the timeliness of its issuance of examination reports. However, it
has recently developed draft customer service goals that call for SBLC
examination reports to be finalized within 90 days of receipt of a
draft report from FCA. As of August 2002, none of the examination
reports from fiscal year 2002 had been issued. According to information
provided by OLO in November 2002, seven examination reports had been
finalized by FCA from fiscal year 2002 and were issued. The three
remaining examinations were conducted at the end of the fiscal year and
the reports are in varying stages of completion, according to SBA.
According to the OIG, because of the delays in finalizing the reports
and SBA's policy to delay any necessary enforcement actions until final
reports are issued, two SBLCs were allowed to continue operating in an
unsafe and unsound manner, despite early identification of material
weaknesses during the fiscal year 2001 SBLC examinations. The
effectiveness of any examination program is measured, to a large
degree, on its ability to identify and promptly remedy unsafe and
unsound conditions that may exist at the regulated entity. By delaying
the reporting of such conditions and the initiation of remedial action,
SBA has significantly limited the effectiveness of its oversight
program for SBLCs.
SBA has been slow to implement recommendations from FCA for improving
the SBLC examination program. In addition to examining the SBLCs, FCA
was asked by SBA to provide its observations and recommendations for
changes it believed were needed in the SBLC program. Each year FCA
provides its views in a comprehensive summary report. In FCA's
September 1999 report, it made 15 recommendations, 12 of which SBA
agreed to implement.[Footnote 19] For example, FCA recommended that SBA
require the SBLCs to implement loan risk-rating systems, independent
internal credit review processes, and to clarify its regulations
governing capital requirements for the SBLCs. We reviewed the reports
for fiscal years 2000 and 2001. In those reports, FCA made additional
recommendations with which SBA has agreed. The 2001 report lists 11
recommendations, which included 8 recommendations from the 1999 report
and 2 from the 2000 report. As we discuss later in this report, SBA
officials explained that limited resources have contributed to the
delay in implementation of many of these recommendations. Appendix I
lists FCA's 11 recommendations from the 2001 report.
PLP Reviews Do Not Provide Adequate Assurance that Lenders Are
Sufficiently Assessing Eligibility and Creditworthiness:
The current PLP review involves a cursory review of documentation
maintained in lenders' loan files rather than a qualitative assessment
of lenders' decisions on eligibility or creditworthiness. A thorough
PLP review process is key to an effective oversight program. PLP
lenders are responsible for all decisions regarding eligibility and
creditworthiness as well as confirming that all PLP loan closing
decisions are correct and in compliance with all requirements of law
and SBA regulations. It is also important for SBA to conduct a
meaningful assessment of lenders' determinations because the "credit
elsewhere" requirement[Footnote 20] is broad and therefore subject to
interpretation. SBA officials stated that while conducting PLP reviews,
contract staff are only required to review loan files for completeness
and required documentation. Review staff rely on the lender's
attestations rather than independent assessments of loan file
documentation.
Credit Elsewhere Requirements Are Difficult to Assess:
Assessing whether a borrower is eligible for 7(a) assistance is
difficult because the requirements are broad and variable, making a
qualitative assessment of a lender's decision by a trained reviewer all
the more important. The credit elsewhere provision is a standard that
is particularly difficult to assess and one that must be determined
prior to assessing credit factors. SBA regulations require the lender
to attest to the borrower's demonstrated need for credit by determining
that the desired credit is unavailable to the borrower on reasonable
terms and conditions[Footnote 21] from nonfederal sources without SBA
assistance, taking into consideration the prevailing rates and terms in
the community in or near where the applicant conducts business, for
similar purposes and periods of time.[Footnote 22] SBA guidance also
requires preferred lenders to certify that credit is not otherwise
available by signing a credit elsewhere statement to substantiate their
compliance with SBA credit elsewhere rules and to retain the
explanation in the borrower file.[Footnote 23] SBA provides guidance on
factors that may contribute to a borrower being unable to receive
credit elsewhere. Generally these factors relate to weaknesses in the
borrower's credit or that the loan would exceed policy limits of the
preferred lender. Specifically, these factors include the following:
* The business requires a loan with a longer maturity than the lender's
policy permits;
* The requested loan exceeds either the lender's legal limit or policy
limit, regarding amounts loaned to one customer;
* The lender's liquidity depends upon selling the guaranteed portion of
the loan on the secondary market;
* The collateral does not meet the lender's policy requirements because
of its uniqueness or low value;
* The lender's policy normally does not allow loans to new ventures or
businesses in the applicant's industry; and:
* Any other factors relating to the credit that, in the lender's
opinion cannot be overcome except by receiving a guaranty.
Based on these criteria, the credit elsewhere test could always be
satisfied by structuring an SBA guaranteed loan so that its terms and
conditions differ from those available on the commercial market. As a
result, these loans could be made available to businesses that could
obtain credit elsewhere on reasonable market terms and conditions,
although not the same terms and conditions offered with the SBA
guarantee.
SBA officials stated that the credit elsewhere requirements are
designed to be so broad as to not limit a lender's discretion and allow
flexibility, depending upon geographic region, economic conditions, and
type of business. For example, SBA officials said that when credit is
more readily available, businesses that require SBA assistance might be
held to a different standard, thereby making it more difficult to
obtain the SBA guaranty than when credit is tighter. Nonetheless, the
flexibility that lenders have along with the difficulty in assessing
lenders' credit elsewhere decisions further support the need for
developing specific criteria for a credit elsewhere standard. These
changes would facilitate a more qualitative assessment of eligibility
decisions made by preferred lenders.
PLP Reviews Do Not Qualitatively Assess a Lender's Credit Analysis:
Because it is a cursory review of documents in the file, the PLP review
does not qualitatively assess a lender's credit decision. Preferred
lenders are required to perform a thorough and complete credit analysis
of the borrower and establish repayment terms on the loan in the form
of a credit memorandum. SBA guidance requires at a minimum, discussion
in the credit memorandum of a borrower's capitalization or proof that
the borrower will have adequate capital for operations and repayment,
as well as capable management ability.[Footnote 24] SBA officials said
that lender review staff focus on the lender's process for making
credit decisions rather than the lenders' decision. SBA officials said
that it is unlikely that the review would result in a determination
that the loan should not have been made. An SBA official stated that
review staff would not perform an in-depth financial analysis to assess
the lender's credit decision and that a lender's process would only be
questioned in the case of missing documentation. For example, review
staff would cite a lender if it did not document the borrower's
repayment ability. This official said additional training would be
required for lender review staff to make more qualitative assessments
of loan documentation during the review process.
Some lenders criticized the lack of technical expertise of contract
review staff. The lenders stated that review staff was unable to
provide additional insight into material compliance issues during the
review because of a lack of technical knowledge of the underwriting
process and requirements. For example, one lender told us he was cited
for not signing a credit elsewhere statement, but the reviewer did not
evaluate a financial statement in the file substantiating the credit
elsewhere assessment.
SBA Has Not Developed Clear Enforcement Policies for Preferred Lenders
or SBLCs:
SBA has authority to suspend or revoke a lender's PLP status for
reasons that include unacceptable loan performance; failure to make
enough loans under SBA's expedited procedures, and violations of
statutes, regulations, or SBA policies.[Footnote 25] However, SBA has
not developed policies and procedures; that describe circumstances
under which it will suspend or revoke PLP authority or how it will do
so. SBA guidance does not include specific follow-up procedures for PLP
lenders that receive poor review ratings but does discuss recommended
patterns of follow-up. SBA officials said that, in practice,
transmittal letters request action plans to address deficiencies for
any ratings of minimally in compliance and not in compliance. In
addition, lenders with ratings of not in compliance are to receive
follow-up reviews 6 months after the regular review is conducted. SBA
officials explained that because they want to encourage lenders to
participate in PLP, they prefer to work out problems with lenders, and
therefore rarely terminate PLP status. Another example of this approach
applies to training offered by SBA to lenders with compliance problems.
SBA district offices are required to offer training to the lenders, but
the lenders are not required to take it. Where a lender persists in
noncompliance, SBA will generally allow the status to expire, rather
than terminating it. However, without clear enforcement policies, PLP
lenders cannot be certain of the consequences of certain ratings; and,
in addition, they may not take the oversight program seriously.
In November 2000, we recommended that the SBLC examination program
could be strengthened by clarifying SBA's regulatory and enforcement
authority regarding SBLCs. Although it has the authority to do so, SBA
has yet to develop, through regulation, clear policies and procedures
for taking supervisory actions. By not expanding the range of its
enforcement actions--which it can do by promulgating regulations--SBA
is limited in the actions it can take to remedy unsafe and unsound
conditions in SBLCs. SBA regulations only provide for revocation or
suspension of an SBLC license for a violation of law, regulation, or
any agreement with SBA. Without less drastic measures, SBA has a
limited capability to respond to unsatisfactory conditions in an SBLC.
Unlike SBA, federal bank and thrift regulators use an array of
statutorily defined supervisory actions, short of suspension or
revocation of a financial institution's charter or federal deposit
insurance, if an institution fails to comply with regulations or is
unsafe or unsound.
SBA's Review Funding Mechanisms Are Questionable:
SBA's current arrangement for funding its reviews and assessing fees on
lenders is inconsistent and raises questions of propriety, fairness,
and accountability. SBA has contracted with an outside firm to perform
PLP reviews. SBA has decided not to use its appropriations to pay the
contractor that performs PLP reviews. Instead, PLP lenders pay fees
directly to the contractor. At present, the extent to which SBA has
authority to engage in this process is unclear and is the subject of
additional work we are performing beyond the scope of this report.
However, the arrangement raises questions, beyond its legality, about
appropriateness and fairness. SBA funds oversight of the remainder of
its 7(a) lenders, without assessing a fee, from its appropriations. PLP
reviews are not funded by appropriated funds, thus allowing an
increasingly important agency function to circumvent direct oversight
of the budget process. This raises additional questions about the
appropriate funding mechanism for SBA's lender reviews. This funding
arrangement with its contractor also limits SBA's flexibility in
managing its lender reviews because fees are set and paid prior to the
commencement of a PLP review based on the planned scope of the review.
SBA's Authority to Have Preferred Lenders Pay for Contractor Reviews Is
Unclear:
SBPIA required SBA to review preferred lenders annually or more
frequently. Under the terms of a contract, which SBA negotiated with
the firm that conducts PLP reviews on behalf of SBA, PLP lenders pay a
PLP review fee directly to the contractor prior to the commencement of
the review in order to cover the costs of the review. SBA guidance
states that the annual fee structure is to be negotiated between SBA
and the contractor and published each year.[Footnote 26] The fee
structure consists of a schedule listing the fee that a lender will pay
the contractor for its review, based on the number of loans in the
sample to be reviewed by the contractor. Prior to a review, SBA
determines the sample size, based on the lender's prior year's lending,
and notifies the lender of the fee, instructing the lender to pay the
fee to the contractor prior to the commencement of the review. The fees
cover contractor salaries, travel, and administrative expenses.
SBA has elected not to fund the contract out of its appropriations.
Instead, SBA has negotiated a contract under which the lenders pay a
fee directly to the contractor. SBA officials explained that a major
reason for the current arrangement with the contractor is that SBA is
not authorized to keep the review fees, and it would have to turn the
fees collected over to the U.S. Treasury.[Footnote 27] SBA officials
stated that they have requested Congress to authorize SBA to keep
review fees to provide more flexibility in running its program. Without
such authorization, SBA officials said they must have the lenders pay
fees directly to the contractor so that those fees can be used to fund
the PLP reviews. However, we note that SBA could have funded the
contract out of its appropriations, since SBA and the U.S. government
are the primary beneficiaries of the PLP reviews.
At present, the extent of SBA's authority to have such an arrangement
is unclear. SBA said it has the authority to assess PLP lenders a fee
but cannot retain any fees it collects. Section 5(b)(12) of the Small
Business Act authorizes SBA to impose, retain, and use fees
specifically authorized by law or which were in effect on September 30,
1994.[Footnote 28] The extent to which this provision or another
statute authorizes SBA to institute this arrangement is unclear and is
an issue beyond the scope of this report. Appendix II contains a
reprint of a letter we have sent to SBA requesting additional
information on this arrangement.
SBA Funds Oversight of Many 7(a) Lenders Without a Fee:
In contrast to the PLP fee arrangement, SBA funds its reviews of its
other lenders from appropriated funds. These reviews include the
following:
* safety and soundness examinations and PLP reviews of SBLCs performed
under agreement by FCA,[Footnote 29]
* reviews of regular 7(a) lenders performed by SBA district office
staff, and:
* follow-up PLP reviews performed by SBA staff for PLP lenders that
receive an unsatisfactory rating.
Figure 4 illustrates the various lender reviews, funding sources, and
review arrangements.
Figure 4: SBA Lender Review Fee Format:
[See PDF for image]
[End of figure]
The current arrangement raises issues of fairness because some lenders
pay for their SBA oversight while others do not.
Agencies' Oversight Activities May Be Funded in Several Different Ways:
Congress has created a range of structures in which agencies fund their
oversight activities through the use of fee collections, assessments,
or other sources of funding rather than on appropriations from the
Treasury's general fund. The variations among these agencies can be
attributed to how and when Congress makes the fees available to an
agency and how much flexibility Congress gives an agency in using its
collected fees without further legislative action. For some agencies,
such as FCA and the Office of Federal Housing Enterprise Oversight
(OFHEO), Congress limits the amount of assessments to be collected and
made available through provisions in annual appropriations acts. In
contrast, Congress provided permanent budget authority to the federal
banking agencies--Federal Reserve System, Office of the Comptroller of
the Currency, Office of Thrift Supervision, Federal Deposit Insurance
Corporation, and National Credit Union Administration--allowing these
agencies to use all the funds collected without further legislative
action. One factor in determining who pays for oversight costs is
considering who is the primary beneficiary of the oversight.
As we noted earlier, the role of SBA regarding PLP lenders specifically
and 7(a) lenders in general, is different from that of the regulators
listed above, with the exception of SBLCs. SBA's lender oversight is
intended to provide assurance that PLP lenders are properly following
SBA policies and procedures. Therefore, PLP reviews are done primarily
to benefit SBA and the U.S. government.[Footnote 30] While allowing SBA
to fund its oversight operations through fees or assessments on all of
its lending partners would provide it with enhanced flexibility and the
ability to charge its lenders more equitably, it would also limit
congressional control of the oversight activity. Congress could give
SBA greater budget flexibility but still maintain some degree of
control over its funding level by placing a variety of limitations on
SBA's offsetting collections, for example by designating fees for SBA's
use, but limiting amounts to those appropriated annually; specifying
the amount of fees to be collected; and specifying the purpose for
which fees can be used.
To maximize SBA's accountability for the lender oversight function and
ensure that it becomes the agency priority that SBA's own strategic
plan suggests it should be, another option would be for Congress to
explicitly designate in the appropriations act the amount that SBA is
to devote for that purpose. SBA would then be responsible for tracking
the expenditure of those funds. Ultimately Congress must decide the
appropriate funding mechanism for SBA and how it is to be applied among
its various lenders.
SBA's Current Funding Arrangement Limits the Flexibility of the
Program:
The way in which SBA covers the costs of its lender oversight limits
the flexibility of the program. As SBA redesigns the PLP review process
to perform more meaningful reviews, continuing to use a contractor with
a predetermined review charge could limit SBA's flexibility to pursue
oversight issues that require more scrutiny than was initially planned.
SBA would have to develop a way to compensate the contractor to more
fully evaluate issues that raise concern upon initial review. Another
factor that limits SBA's flexibility is SBA's practice of determining
the loan sample to be reviewed based on the prior year's lending. This
could lead to inappropriate sample sizes in instances where lenders
significantly increase their lending level from one year to the next.
SBA officials said that the agency's lack of authority to retain review
fees could limit its flexibility in managing the redesigned PLP review
program in the future as well. The current arrangement could force SBA
to consider cost rather than oversight priorities in managing how costs
are allocated and the way reviews are conducted.
SBA's Process for Administering PLP Status Presents Lenders with
Challenges:
OFA has taken a number of steps to make the administration of lenders'
PLP status more objective and transparent to lenders that qualify for
the program. However, some lenders we interviewed indicated that they
do not understand decisions made regarding their PLP status and that
going through the process can be administratively challenging,
particularly for larger lenders that operate in multiple SBA districts.
Going forward, OFA is faced with the challenge of balancing the needs
of its primary customers, small businesses, against the needs of its
lenders--upon which SBA relies to make preferred loans.
SBA Grants PLP Status on a District-by-District Basis:
SBA's preferred lender certification process begins when a district
office serving the area in which a lender's office is located nominates
the lender for preferred status or when a lender requests a field
office to consider it for PLP status. The district will then request
performance data regarding the lender from SBA's Sacramento Processing
Center. The processing center then provides the district office with
data required to fill in part of a worksheet developed for the
nomination process. The district office then sends the completed
worksheet, along with other required information, back to the
processing center. The processing center analyzes the nomination and
sends it with a recommendation to OFA for final decision. Figure 5
illustrates SBA's process for lender nomination, renewal, and expansion
of PLP status.
Figure 5: SBA's Process for Nomination, Renewal, and Expansion of PLP
Status:
[See PDF for image]
[End of figure]
According to SBA's SOP, in making its decision, OFA considers whether
the lender, (1) has the required ability to process, close, service,
and liquidate loans; (2) has the ability to develop and analyze
complete loan packages; and (3) has a satisfactory performance history
with SBA. OFA also considers whether the lender shows a substantial
commitment to SBA's "quality lending goals," has the ability to meet
the goals, and demonstrates a "spirit of cooperation" with SBA.
OFA and district office staff said that although district offices do
not provide final approval of PLP status for lenders in their
districts, they generally play an important role and district input is
given significant weight. Most of the district office staff we
interviewed believed that they had considerable influence on OFA's
decision regarding a lender's PLP status.
If OFA approves a lender's nomination, it will designate the area in
which the lender can make PLP loans and will approve preferred status
for a term not to exceed 2 years. If OFA does not approve the
nomination, the Sacramento Processing Center will notify the lender and
district office with an explanation of why the nomination was not
approved. SBA's SOP states that the lender has no right of appeal to
SBA. In its comments on this report, SBA noted that the lender can
appeal SBA's decision to Federal District Court. According to SBA's
procedures, if the lender wants to reapply for PLP status it must wait
at least 1 year from the date of the refusal before reapplying to the
district office.[Footnote 31] SBA officials commented, however, that
lenders may reapply once they have addressed the issues that caused the
refusal. When a PLP lender's status expires, OFA may renew it as a PLP
lender for an additional 2-year term, or less, if circumstances such as
an unsatisfactory review rating dictate. SBA has recently begun to
coordinate lenders' PLP reviews with their PLP renewals, allowing SBA
to consider its current review of PLP lenders' loans, policies, and
procedures as part of its decision.
A PLP lender may request an expansion of the territory in which it can
process PLP loans by submitting a request to the Sacramento Processing
Center. The processing center will obtain the recommendation of each
district office in the area into which the PLP lender would like to
expand its PLP operations. The processing center will forward the
district recommendations to OFA for a final decision.
Some PLP Lenders Identified Concerns with the PLP Certification
Process:
Lenders we interviewed had varying experiences in gaining and
maintaining their PLP status. While some lenders expressed general
satisfaction with the process and their understanding of it, others
cited problems. For example, several PLP lenders we interviewed said
that they had their PLP status declined in a specific district,
although they had already achieved PLP status in other districts. In
some instances, lenders said that they did not understand why they had
been turned down, in light of their proven performance. These lenders
commented that some district offices were not open to working with
lenders from outside their districts while others were. In our
interviews with district offices, we sometimes heard differing
descriptions from district office officials on the level of commitment
required of a lender who wished to gain PLP status in their district.
Some district officials said that a lender had to maintain a physical
presence in the district, while others disagreed. However, all district
office officials expressed the need for some regular discussion with a
lender to understand the lender's commitment to the district.
Larger lenders, as well as the National Association of Government
Guaranteed Lenders (NAGGL), noted the administrative burden of
maintaining relationships with many of the 70 district offices to
maintain PLP status. The lenders noted that to receive and maintain PLP
status in a given district, it is generally necessary to meet at least
annually with district office staff to discuss status and plans for
future lending. For some large national lenders, this can amount to 40
or more visits per year. In response to this concern, NAGGL has
recommended a national PLP status based on a uniform national standard
to ease the administrative burdens on large national lenders that
account for the largest volume of PLP lending.
District Office Staff Maintain that Local Involvement Is Key to PLP's
Success:
District office officials that we interviewed generally acknowledged
that they want to understand a lender's plans for their district before
agreeing to endorse a lender that wishes to gain PLP status in their
district. District officials explained that PLP status is an important
marketing tool for lenders and that, as advocates for the credit needs
for small businesses in their districts, the district office officials
see PLP status as a "carrot" to be used to encourage lenders to make a
sufficient volume of loans to their district. They suggest that a
"national" PLP lender might make a large volume of PLP loans
nationwide, but none in their district. The officials reason that
without a district-by-district PLP status, district offices would lose
an important tool for encouraging lenders to respond to credit needs in
their districts.
SBA Designed the Lender Evaluation Worksheet and Lender's Liaison
Program to Improve the Process for PLP Lenders:
To hold lenders to a uniform national standard while maintaining
individual district office's preferences and reinforcing their
relationships with PLP lenders, SBA developed a lender evaluation
worksheet to facilitate the nomination, expansion, and renewal
processes. According to SBA officials, the worksheet, introduced in
September 2000, is a formula-driven spreadsheet to be used by district
offices in making their recommendations regarding PLP status for
lenders.[Footnote 32] The worksheet was further refined, and a new
version was introduced in April 2002. The worksheet replaces the former
procedure that involved written recommendations from district
officials; however, it continues to award points based on sometimes
subjective criteria, such as the district office's assessment of the
lender's SBA marketing and outreach efforts rather than the formulas in
the spreadsheet. Where this is the case, district office staff is
required to provide written justification for the points it awards.
SBA developed the Lender Liaison program, managed by its Office of
Field Operations (OFO), to assist large national lenders in managing
relationships with SBA. The program was formally introduced in December
1999; but according to OFA staff, the program took another 6 months to
implement. The program involves the assignment of a single SBA
official, generally a district director, to act as a liaison to a large
national lender. In the event that a large lender should experience
difficulty in managing its PLP status, it would have a single SBA
official to call to assist in resolving any problems. OFO staff said
that feedback they have received from lenders indicated that they like
the program, finding it useful for resolving difficulties. Two of the
lenders we interviewed participated in the program, and both expressed
satisfaction with it. SBA has designated lender liaisons for 20 PLP
lenders. Additionally, OFO has developed a proposal to make the program
permanent and expand the program to 50 additional lenders. An OFO
official explained that OLO identified 70 lenders who have PLP status
in 6 or more districts and could benefit from the program.
SBA's Organizational Alignment Does Not Adequately Support SBA's Lender
Oversight Functions:
SBA's current structure does not adequately support lender oversight.
In our past work analyzing organizational alignment and workload
issues, we have described the importance of tying organizational
alignment to a clear and comprehensive mission statement and strategic
plan, and providing adequate resources to accomplish the mission. SBA
has established OLO and developed standard operating procedures for
lender oversight; but OLO still shares responsibility for some
oversight functions with OFA and operates at staffing levels that OLO
staff have said hampers their ability to accomplish necessary oversight
tasks, sometimes resulting in significant delays that pose a potential
risk to the agency. Without a clear division of responsibilities or
accountability and the elimination of potential conflicts, the
effectiveness of SBA's lender oversight is hindered.
We Have Outlined Necessary Elements for Successful Organizational
Alignment:
In our past work analyzing organizational alignment and workload issues
at SBA and other agencies' efforts to improve management and
performance, we have described the importance of tying organizational
alignment to a clear and comprehensive mission statement and strategic
plan. By organizational alignment, we mean the integration of
organizational components, activities, core processes, and resources to
support efficient and effective achievement of outcomes. For example,
we noted how agency operations can be hampered by unclear linkage
between an agency's mission and structure, but greatly enhanced when
they are tied together.[Footnote 33] We have also noted the importance
of human capital in achieving mission outcomes. We have identified
human capital management challenges in key areas, which include the
following:
* undertaking strategic human capital planning and organizational
alignment and:
* acquiring and developing staffs whose size, skills, and deployment
meet agency needs.[Footnote 34]
We have also noted in our past work the importance of separating safety
and soundness regulation, as well as mission regulation, from the
function of mission promotion.[Footnote 35] While SBA's role regarding
PLP lenders is slightly different from that of a safety and soundness
regulator, the principle that an oversight function should be
organizationally separate, maintaining an arm's length relationship
from a program promotion function, still applies to SBA.
SBA's Current Organization for Lender Oversight Results in Decreased
Accountability and Potential Conflicts:
SBA officials have said and written that lender oversight is becoming
an increasing priority for SBA; however, the function is not housed in
an independent office with the exclusive role of providing lender
oversight. OLO was created within OCA in fiscal year 1999 to ensure
consistent and appropriate supervision of SBA's lending partners;
however, OCA has other objectives, including the promotion of PLP to
appropriate lenders. OFA, also part of OCA, is responsible for
providing overall direction for the administration of SBA's lending
programs, including working with lenders to deliver lending programs,
including 7(a), and developing loan policies and standard operating
procedures. Figure 6 shows the organization of preferred lender
oversight under OCA.
Figure 6: Preferred Lender Oversight Responsibilities within OCA:
[See PDF for image]
[End of figure]
OFA's lender oversight role is to provide final approval of lenders'
PLP status and to take necessary enforcement actions against SBLCs.
Part of OFA's program promotion role is determining whether or not
lenders should participate in the program. Thus the only explicit
enforcement authority--the authority to revoke PLP status--resides with
OFA rather than OLO. The presence of both OFA and OLO within OCA does
not afford the oversight function an arm's length position from the
promotion function. The organizational arrangement presents a potential
conflict, or at least the appearance of a conflict, between the desire
to encourage lender participation in PLP and the need to evaluate
lender performance (with the potential for discontinuing lenders'
participation in PLP). In congressional testimony describing an SBA
workforce transformation plan, a senior SBA official announced that SBA
will centralize all lender oversight functions within headquarters.
Figure 7: SBA's Headquarters Organization Chart:
[See PDF for image]
[End of figure]
Poorly Aligned Resources Hinder PLP and SBLC Oversight Effectiveness:
Evidence of overlapping responsibilities and poorly aligned resources
can be seen in delays SBA has experienced in completing certain tasks
associated with lender oversight. These delays could hamper PLP and
SBLC oversight effectiveness by delaying corrective action that might
arise from review findings. Since some, but not all, responsibility for
the lender oversight function migrated from OFA to OLO, both offices
continue to mingle responsibilities for certain functions. The division
of responsibility between OFA and OLO has created the need for more
interoffice coordination to complete certain tasks. For example, we
found substantial delays in finalizing PLP review reports and, as noted
earlier, in SBLC examination reports. In the sample we reviewed, we
found that PLP review reports were issued an average of 156 days after
the completion of the review. In two cases, it took more than 300 days
to complete the reports. OLO officials explained that they did not have
any published standards for report timeliness, but that they had
developed draft "customer service" goals for fiscal year 2003 that
called for review reports to be issued to the lender within 90 days of
the completion of the review.
SBA's OIG concluded that the delays in completing SBLC reports were at
least partially due to poor coordination between OLO and OFA, both of
which were involved in reviewing the reports. OLO and OFA,
respectively, are responsible for oversight and management of the SBLC
program. As previously stated, OLO is responsible for SBLC on-site
examination and off-site monitoring, while OFA handles day-to-day
program management, policymaking, and enforcement of corrective
actions. Coordination between the two offices; however, was not
formally established and simply evolved over time. OIG said that this
informal structure contributed, in part, to the delays in issuing the
fiscal year 2001 examination reports. OLO staff said that limited
staffing also contributed to delays. OLO began operations with three
headquarters staff members in fiscal year 2000; and at the beginning of
fiscal year 2002, they had six staff members. In the last quarter of
fiscal year 2002, OLO staff increased to 10, and 2 additional positions
have since been filled, for a total staff of 12. The Kansas City Review
Branch operates with 10 staff. Overall, OCA currently operates with 415
staff.
To assist in establishing lines of authority between OLO and OFA and
formalizing coordination between the two offices, the OIG recommended
the development of a "supervisory committee."[Footnote 36] To date, SBA
has not implemented this recommendation. As we stated earlier, delays
in reporting examination findings limit the accuracy of the findings
when they are finally reported; and, in the meantime, the institution
could have corrected or magnified the extent of weaknesses the
examination identified. SBA's OIG also noted that delays in issuing
final examination reports to SBLCs also delays any remedial action SBA
might take.
To enhance its SBLC oversight, SBA announced in 2000 that it intended
to establish an off-site monitoring process for the SBLC program.
According to OLO officials, this is still under development. OLO
officials said delays in developing the LMS have contributed to their
delays.
As noted earlier, OLO has not yet responded to our earlier
recommendation to develop enforcement policies or to recommendations
from FCA for improving its SBLC oversight. OLO officials have said that
they are working on developing the enforcement policies and on
implementing the FCA recommendations with which they agree, but again
suggested that limited staff resources have contributed to the amount
of time it has taken to complete actions in these areas.
Conclusions:
As SBA's reliance on lending partners has increased, so has the
importance of its lender oversight. In response to our past
recommendations, SBA has done much to improve its lender oversight
function. However, without continued improvement to better enable SBA
to assess the financial risk posed by 7(a) loans and to ensure that its
lending partners are making loans to small businesses that are
eligible, SBA will not have a successful lender oversight program. The
credit elsewhere standard is broad, making a meaningful assessment of
lenders' decisions difficult. Moreover, SBA has not developed policies
and procedures that clearly state SBA's actions regarding noncompliance
by PLP lenders. While SBA has developed an examination program for
SBLCs, its ability to appropriately respond to examination findings to
remedy unsafe and unsound conditions continues to be limited by unclear
enforcement authority and an inability to complete basic oversight
tasks. By not completing these tasks, SBA could be allowing unsafe and
unsound conditions to persist that could pose an unacceptable and
unnecessary risk to its 7(a) loan portfolio.
Because it provides lenders with autonomy in making 7(a) loans, PLP is
key to SBA's strategy of shifting more of its workload from itself to
its lending partners to fulfill its mission of providing small business
with access to credit. SBA has made improvements in its process for
managing lenders' PLP status by making the process more objective and
facilitating communication with larger lenders, who account for most
PLP loan volume. Some large national PLP lenders continue to face
challenges in dealing with multiple district offices' varying needs,
but SBA will have to balance the concerns of PLP lenders against the
need to ensure that currently underserved small business customers in
all districts are served.
SBA has taken a number of significant steps to develop its lender
oversight function but has not made the commitment in the way of
organizational independence or human capital investment. This is
important in order to ensure SBA's success in developing an effective
lender oversight function that achieves SBA's goals of protecting SBA
from undue financial risk while ensuring that its assistance is
provided to eligible small businesses.
Recommendations:
To improve PLP and SBLC oversight, we recommend that the SBA
Administrator:
* incorporate strategies into its review process to adequately measure
the financial risk lenders pose to SBA, develop specific criteria to
apply to the credit elsewhere standard, and perform qualitative
assessments of lenders' performance and lending decisions.
* provide, through regulation, clear policies and procedures for taking
enforcement actions against preferred lenders and SBLCs in the event of
continued noncompliance with SBA's regulations. Specifically, the
Administrator of SBA should adopt regulations that would clearly define
SBA authority to take enforcement actions and specify conditions under
which supervisory actions would be taken,
* continue to explore ways to assist large national lenders to
participate in the PLP. These efforts could include further development
and implementation of SBA's Lender Liaison program and continued
attention to standardizing the PLP certification process and enhancing
its transparency, as was done with the development of the Lender
Evaluation Worksheet to assist lenders in their interactions with
district offices, and:
* separate lender oversight functions and responsibilities from OCA,
including those currently done by OFA, such as responsibility for
revoking preferred lender status and establish clear authority and
guidance for OLO, or its successor office, that states, at a minimum,
its program responsibilities and planned staffing for those
responsibilities. This would provide an oversight office with greater
autonomy within SBA to match the growing importance of lender oversight
in achieving SBA's goal of ensuring that PLP lenders make loans to
eligible borrowers while properly managing the financial risk to SBA.
Agency Comments:
We requested SBA's comments on a draft of this report and the Associate
Deputy Administrator for Capital Access provided written comments that
are presented in appendix III. SBA did not explicitly state that it
agreed or disagreed with our recommendations. In specific comments on
the four recommendations, however, SBA essentially disagreed with part
or all of two recommendations and said that it was "working to address"
or considering issues we presented in the other two.
SBA said it was considering additional approaches to assess the
financial risk that lenders pose and to allow for qualitative
assessments of its lenders, but disagreed with our recommendation that
it develop specific criteria to apply to the credit elsewhere standard.
SBA cited its current safety and soundness examinations of SBLCs as an
example of its efforts to assess financial risk. We agree, and our
draft report noted the scope of the examinations of these special
preferred lenders. In addition, SBA stated that its current reviews of
preferred lenders do assess some degree of financial risk but that
review reports may not indicate such an assessment unless a dollar
amount of risk could be identified. Only 3 of the 15 PLP review reports
that we reviewed provided any evidence of such an assessment and, as
stated in our report, SBA's review guidance does not require such an
assessment. In addition, SBA officials told us during the course of our
work that PLP reviews are strict compliance reviews that are not
designed to measure the PLP lenders' financial risk. With regard to
developing specific criteria to apply to the credit elsewhere standard,
SBA provided cites to law, regulation, and its SOP that discuss the
credit elsewhere standard. We analyzed these sources in reaching our
conclusion that the credit elsewhere standard is broad, making a
meaningful assessment of lenders' decisions difficult. To make the
assessment of lenders' decisions more meaningful, SBA should develop
more specific criteria to apply to the credit elsewhere standard.
Regarding our recommendation that SBA provide, through regulation,
clear policies and procedures for taking enforcement action, SBA said
that it was working diligently to address the concerns we expressed on
this issue. We note that our November 2000 report on the need for SBA
to strengthen oversight of SBLCs included this same recommendation for
the SBLC oversight program. Similarly, in response to our
recommendation that it continue to explore ways to assist large
national lenders to participate as preferred lenders, SBA said it was
reviewing the issues identified in our draft and considering how best
to address them.
SBA appears to have disagreed with our recommendation to separate
lender oversight functions and responsibilities from OCA, but its
comments did not specifically respond to the recommendation. Instead,
SBA emphasized that the senior executives heading OLO and OFA
independently report to the head of OCA and restated that lender review
functions were transferred from OFA to OLO in 2000. Nevertheless, SBA
did not address issues such as the apparent conflict of interest in
having oversight, certification, and promotion functions within the
same office (OCA). In addition, the comments did not address delays in
finalizing preferred lender review reports and SBLC examinations due to
lack of coordination between the two offices. We continue to maintain
that the current structural alignment and overlapping responsibilities
of oversight functions, such as lender oversight and certification,
within these two offices hinders effective oversight and presents the
appearance of a conflict, given the promotional and programmatic
responsibilities of OFA and OCA.
SBA stated in its comment letter that it identified a number of
inaccuracies in our draft report. However, these were mostly technical
corrections, which we incorporated as appropriate in this report. SBA's
letter is reprinted in appendix III.
Objectives, Scope, and Methodology:
To evaluate SBA's 7(a) lender oversight program, we analyzed SBA's
oversight of its 7(a) lenders, particularly for preferred lenders, some
of whom are SBLCs licensed by SBA to make only 7(a) loans. In
conducting our work, we defined oversight to include SBA's process for
reviewing preferred lenders for compliance with SBA guidance and for
evaluating them for initial and continued participation in the PLP. We
analyzed PLP review guidance, review and lending data to the extent
that it was available, and a sample of PLP and SBLC review reports. We
reviewed annual summary reports to SBA prepared by FCA that describe
FCA's overall conclusions and recommendations from examining SBLCs. We
interviewed SBA headquarters staff from OLO and OFA and regional staff,
including a sample of 11 district offices and the Sacramento Processing
Center. We also interviewed a sample of 10 PLP lenders to evaluate
their experiences in SBA's oversight program. The sample included a
geographically diverse group of large, medium, and small lenders, by
loan volume. We also interviewed representatives of the National
Association of Government Guaranteed Lenders.
To evaluate SBA's organizational alignment for conducting preferred
lender and SBLC oversight, we reviewed SBA's fiscal year 2003 Budget
Request and Performance Plan and draft Workforce Transformation Plan,
as well as past GAO and SBA OIG work. We evaluated management
information that tracked OLO's report completion as well as staffing
data. We interviewed OLO, OFA, and OIG officials. We also interviewed
the FCA official responsible for overseeing its SBLC examination
function, carried out under contract with SBA.
We conducted our work in Washington, D.C.; Kansas City, Missouri;
Sacramento, California; Salt Lake City, Utah; and Baltimore, Maryland,
between March and September 2002, in accordance with generally accepted
government auditing standards.
Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days after the date of this
report. At that time, we will send copies of this report to the
Chairman of the Senate Committee on Small Business and Entrepreneurship
and the Chairman and Ranking Minority Member of the House Committee on
Small Business, other interested congressional committees, and the
Administrator of the Small Business Administration. We will make copies
available to others on request. In addition, this report will also be
available at no charge on our homepage at http://www.gao.gov.
Please contact me at (202) 512-8678, dagostinod@gao.gov or Kay Harris
at (202) 512-8415, harrism@gao.gov if you or your staff have any
questions. Major contributors to this report were Thomas Conahan and
Toayoa Aldridge.
Davi M. D'Agostino:
Director, Financial Markets and Community Investment:
Signed by Davi M. D'Agostino:
[End of section]
Appendix I: Opportunities for Small Business Lending Company Program
Enhancement Identified by the Farm Credit Administration:
Beginning in fiscal year 1999, the Small Business Administration (SBA)
contracted with the Farm Credit Administration (FCA) to examine the 14
Small Business Lending Companies (SBLC). At the end of each examination
cycle, FCA provides a Comprehensive Summary Report (Report) to SBA that
summarizes its examination activities and results for the year and also
identifies opportunities for program enhancement. In its report for
fiscal year 2001, FCA listed 11 items or recommendations in this
section, all of which SBA agreed to implement. Eight of the
recommendations initially appeared in FCA's 1999 Report, while two
appeared in the 2000 Report. The fiscal year 2001 Report notes that
while SBA may have initiated some actions to address issues from
previous years, a complete resolution has not yet been effected.
The issues that appear in the fiscal year 2001 Report, are listed below
by categories that appear in the FCA Reports. The year in which the
issue was initially raised is indicated in parentheses.
Portfolio Management:
* SBLCs should implement dynamic loan risk rating systems that
correlate with the uniform classification system outlined in the SBLC
Examination Handbook and report the results to the board management and
SBA. Such a system is necessary to effectively identify, monitor, and
manage loan risks on an aggregated program basis (1999).
* SBLCs should implement independent internal credit review (ICR)
processes to validate the reliability of the risk rating system. An
effective ICR process will also ensure that credit administration and
other internal credit controls are implemented as required by the board
and management. Some of the larger institutions had such an independent
review process, but most had processes that were not comprehensive or
were not independent (1999).
* SBLCs should be encouraged to develop additional underwriting
standards for significant segments of their portfolios. In addition,
the SBLCs should develop a mechanism that tracks noncompliance with
underwriting standards. This would assist the board and management in
their assessment of risk exposure and in establishing risk parameters
(1999).
* SBA should provide clear definitions for measuring delinquent loan
volume. Some institutions continue to report delinquency rates based on
the "interest paid-through" date versus the more traditional definition
of "next payment due" date. Clarifying the definition of what
constitutes a delinquent loan will promote consistency and a more
accurate picture of risk in the SBLCs' portfolios (2000).
* Consider requiring the SBLCs to consolidate (as needed) borrower
business and personal financial statements as part of loan underwriting
to improve the analysis of loan risk exposure. Also, while the loan
authorization requires the submission of financial statements on an on-
going basis, SBA should provide the SBLCs some means to enforce this
requirement (1999).
* SBLCs should continue to implement appropriate internal controls to
ensure accurate, consistent and timely submission of loan information
in 1502 reports.[Footnote 37] Many SBLC officials continue to indicate
a need for clearer and more concise SBA report requirements and
definitions of the key reporting elements (1999).
* SBLCs should implement an appraisal review process (2001).
Financial Performance and Condition:
* Require quarterly financial reporting that conforms to Generally
Accepted Accounting Principles in the reports provided to SBA by the
SBLCs. More frequent reporting combined with uniform standards would
allow proactive monitoring of developing trends. Additional benefits
could include fewer examination resources devoted to financial review
and the ability to perform objective analysis and comparisons among the
SBLCs (2000).
* Strengthen general oversight and monitoring of SBLC financial
condition, especially oversight of compliance with minimum capital
requirements. SBA regulations and other guidance do not require SBLCs
to provide ongoing certifications of compliance with the minimum
capital requirements (1999).
* Determine the reasonableness of the process for valuing SBLC
servicing rights. Valuation of servicing rights is a key factor in
assessing the financial position of institutions. Since the value of
servicing rights contributed over one half of the capital in some SBLCs
and were in excess of 100 percent of capital in two SBLCs, the
assumptions underlying the processes for establishing their value
should be validated. SBA may also wish to establish limits on the
amounts of the servicing rights asset that may be counted toward
capital calculations (1999).
* Consider modifying SBA capital regulations to address capital
adequacy, capital structure, and define what components constitute
regulatory capital. In addition, capital regulations should require
increased levels of capitalization for more volatile assets, such as
servicing rights (1999).
[End of section]
Appendix II: GAO Letter of Inquiry to the Small Business
Administration:
United States General Accounting Office Washington, DC 20548:
Via Fax:
October 23, 2002:
Ms. Louise Wilson:
Chief, Financial Reviews Branch Office of Financial Administration
Office of the Chief Financial Officer Small Business Administration
Washington, D.C. 20416:
Re: GAO Review of SBA's Lender Oversight:
Dear Ms. Wilson:
As you know, GAO is conducting a review of SBA's oversight of lenders
that participate in the Preferred Lender Program (PLP) (job code
250060). SBA's regulations provide for SBA review of a PLP lender's
performance and the assessment of a fee to cover the costs of the
review.[NOTE 1] During our review, SBA officials told us that SBA does
not conduct these reviews directly, but instead contracts with third
parties to perform PLP reviews. SBA negotiates a fee structure with the
contractor and, based on that structure, the PLP pays the contractor a
fee to cover the cost of the review. Although our review has related
primarily to the effectiveness of SBA's oversight policies and
practices, we have identified several issues regarding fees assessed to
PLP lenders and the structure of this aspect of the PLP program.
In connection with our analysis of SBA's authorities we have submitted
questions to Diane Wright of your General Counsel's office and
requested SBA's views on those issues. We initially e-mailed questions
on October 10, in response to which SBA requested clarification and an
indication of our timeframes and on Friday, October 18, we provided
additional clarification of those questions. Yesterday, October 22, Ms.
Wright advised our attorney that SBA officials may be available to meet
next week with GAO representatives to discuss the questions, but that
fixing a date and time depends on the yet uncertain schedules of SBA
personnel. As discussed with Ms. Wright, we are available to meet to
discuss these issues as soon as possible. Accordingly, we have
requested SBA's views on the following matters.
1. SBA regulations provide for the assessment of fees for performance
reviews of PLPs (13 CFR 120.454) and audits of SBLCs (13 CFR 120.475).
What is the statutory authority for each regulation? If SBA relied on
section 5 (b)(12) of the Small Business Act, 15 U.S.C. 634(b)(12),
please cite the law specifically authorizing the fees.
2. The SBA contracts with third parties to conduct PLP performance
reviews. What are SBA's reasons for having contractors perform PLP
reviews? What is SBA's authority for contracting with third parties to
conduct PLP reviews?
3. A PLP is assessed for the review. Who assesses the fee - SBA or the
contractor who performs the review? If the third party assesses the
fee, what statutory provision authorizes SBA to delegate assessment of
the fee to the third party contractor?
4. Who receives the review fee from the PLP - SBA or the contractor who
performs the review? Does SBA have authority to collect the review fees
directly and then pay the contractor for the review? If so, please
identify the authority. If SBA has such authority but does not collect
the fee, please explain why.
5. If the SBA were to collect the PLP review fee, would SBA have
authority to retain or spend the fee, or would SBA be required to
deposit the funds into miscellaneous receipts at the Treasury pursuant
to 31 U.S.C. 3302(b)? If SBA has authority to retain the fees, please
identify the pertinent statutory authority.
6. Does SBA have an appropriation account that is available for the
purpose of paying for PLP performance reviews and oversight? Which
account is available? Have any PLP performance reviews/oversight been
funded from this or other accounts available to SBA?
We would like to receive your response by November 25, 2002. We would
appreciate receiving copies of any documents related to or supporting
the information requested. Please provide any other information you
consider relevant to this matter. In view of the timetable for
publication of our report, it appears that the specific information
provided in response to the questions will not be addressed in the
report. However, based on the resolution of our questions, our further
inquiry into this matter may be appropriate. If you have any questions
about this letter, please contact me (202/512-8678) or Katie Harris,
Assistant Director (202/512-8415).
Sincerely yours,
Davi M. D'Agostino
Director, Financial Markets and Community Investment:
Signed by Davi M. D'Agostino:
NOTES:
[1] 13 CYR § 120.454 (2002):
[End of section]
Appendix III: Comments from the Small Business Administration:
U.S. SMALL BUSINESS ADMINISTRATION WASHINGTON, D.C. 20416:
OFFICE OF THE ADMINISTRATOR:
Ms. Davi M. D'Agostino Director,
Financial Markets and Community Investment
U.S. General Accounting Office
441 G Street, N.W.
Washington, D.C. 20548:
NOV 14 2002:
Dear Ms. D'Agostino:
Thank you for the opportunity to review and comment on the draft report
entitled "Continued Improvements Needed in Lender Oversight" (GAO-03-
90).
In the past, the General Accounting Office (GAO) has provided
constructive guidance to the Small Business Administration (SBA) with
regard to the lender oversight function. We appreciate your continued
support and acknowledgement that SBA has
made progress in developing and implementing its lender oversight
program. As you have noted in your report, actions by the Agency to
address several of your recommendations are already underway.
Lender oversight is an important priority for SBA. As SBA continues to
delegate more authority to its lenders, lender oversight provides a
critical control in that process. We have added additional staff
resources to the Office of Lender Oversight and have focused the
agency's Loan Monitoring System (LMS) on the lender oversight and risk
management components. Once operational, LMS will expand and enhance
our data analysis capabilities and provide a critical means by which
the Agency will perform oversight and risk management.
As we discussed in meetings with your staff, we appreciate GAO's
recommendations with regard to expansion of the lender review process
and development of enforcement mechanisms. SBA is considering these
recommendations as well as other options. We have, however, noted a
number of inaccuracies contained in the draft report. Enclosed with
this letter is SBA's response to the findings and recommendations in
the draft report, including technical corrections and comments. We are
making significant progress in the development and implementation of
our lender oversight program, are proud of what we have accomplished,
and the steps we have taken and are taking are reducing the risk of
loss to the taxpayers.
Enclosed are our specific responses to the recommendations included in
the draft report and our technical corrections and comments. If you
have any questions, please
contact Richard Spence, Assistant Administrator for Congressional and
Legislative Affairs, at 202-205-6700.
Sincerely,
Ronald E. Bew:
Associate Duty Administrator for Capital Access:
Signed by Ronald E. Bew:
Enclosure:
Response by:
The Small Business Administration:
Draft Audit Report Continued Improvements Needed In Lender Oversight:
I. SBA Response to GAO Recommendations:
Recommendation 1 - Incorporate strategies into its review process to
adequately measure the financial risk lenders pose to SBA, develop
specific criteria to apply to the credit elsewhere standard, and
perform qualitative assessments of lenders' performance and lending
decisions.
Response - SBA is assessing the need to fully incorporate the financial
risk concept into the examination process and to perform qualitative
assessments of lenders' performance and lending decisions. A number of
practices we have in place address these recommendations. First, the
safety and soundness examinations of Small Business Lending Companies
(SBLCs) conducted on SBA's behalf by the Farm Credit Administration
(FCA) are, at their core, identifying the financial risk these lenders
pose to SBA. A primary component of the examinations is an asset
quality review that assesses financial risk. SBLCs generate and hold
approximately 20% of SBA's loans. Second, in the PLP lender reviews
some degree of financial risk is assessed. If collateral or security
exceptions are identified, the potential financial risk is estimated
and included in the report. The fact that there was no financial risk
assessed and included in the report, does not indicate that an
assessment was not made but, rather, that there was no dollar amount of
financial risk specifically identified. SBA is considering another
approach to lender reviews that may provide additional assessment of
financial risk and allow for a qualitative assessment of lenders'
performance and credit operations.
In response to the recommendation that SBA develop specific criteria to
apply to the credit elsewhere standard, SBA points out that the Small
Business Act ("Act"), SBA regulations and SBA Standard Operating
Procedures already contain such criteria and guidance. Specifically,
Sections 3(h) and 18(b)(2) of the Act, Sections 120.101 and Section
20.102 of SBA regulations, and SOP 50 10(4)(E) provide sufficient
guidance.
Recommendation 2 - Provide, through regulation, clear policies and
procedures for taking enforcement actions against preferred lenders and
SBLCs in the event of continued non-compliance with SBA's regulations.
Specifically, the Administrator of SBA should adopt regulations that
would clearly define SBA authority to take enforcement actions and
specify conditions under which supervisory actions would be taken.
Response - SBA is working diligently to address the concerns expressed
on this issue.
Recommendation 3 - Continue to explore ways to assist large national
lenders to participate in the PLP. These efforts could include further
development and implementation of SBA's Lender Liaison program and
continued attention to standardizing the PLP certification process and
enhancing its transparency, as was done with the development of the
Lender Evaluation Worksheet to assist lenders in their interactions
with District Offices.
Response - We are reviewing the issues identified with regard to large
national PLP lenders and are considering the best approach to address
them. We believe that the District Offices play an important role in
lender relations and management and are assessing a number of options
to assist these lenders in a meaningful way.
Recommendation 4 - Separate lender oversight functions and
responsibilities from the Office of Capital Access (OCA), including
those currently done by the Office of Financial Assistance such as
responsibility for revoking preferred lender status, and establish
clear authority and guidance for the Office of Lender Oversight (OLO),
or its successor office, that states, at a minimum, its program
responsibilities, and planned staffing for those responsibilities. This
would provide an oversight office with greater autonomy within SBA to
match the growing importance of lender oversight in achieving SBA's
goal of ensuring that PLP lenders make loans to eligible borrowers
while properly managing the financial risk to SBA.
Response - SBA has already separated the lender oversight function from
the Office of Financial Assistance (OFA). To that end, SBA created OLO
as separate from OFA in 1999 and transferred the examination and lender
review functions from OFA to OLO in 2000. As a result, lender reviewers
no longer report to OFA and OLO does not report to OFA. The Associate
Administrator for Lender Oversight is a member of the Senior Executive
Service on the same level as the head of OFA. Both executives
independently report to the Associate Deputy Administrator for Capital
Access.
FOOTNOTES
[1] As of September 30, 2001.
[2] 15 U.S.C. § 636 (2000).
[3] Other types of financial institutions, such as savings banks, are
lending partners. In this report we refer to all financial institutions
that make 7(a) loans as banks.
[4] SBLCs, which make only 7(a) loans, are privately owned and managed,
nondepository lending institutions that are licensed and regulated by
SBA but not generally regulated or examined by financial institution
regulators.
[5] U.S. General Accounting Office, Small Business Administration: Few
Reviews of Guaranteed Lenders Have Been Conducted, GAO/GGD-98-85
(Washington, D.C.: June 1998).
[6] U.S. General Accounting Office, Small Business Administration:
Actions Needed to Strengthen Small Business Lending Company Oversight,
GAO-01-192 (Washington, D.C.: November 2000).
[7] The assessment is to include, among other things, defaults, loans,
and recoveries of loans made by the lender. P. L. No. 104-208, Div. D,
Title 1, § 103 (h), 110 Stat. 3009-728 (1996) (codified at 15 U.S.C. §
634 note).
[8] SBA initially authorized 16 SBLC licenses, but only 14 of the
licenses were used to establish institutions.
[9] FCA is an independent agency within the executive branch of the
U.S. government; it is responsible for the regulation of the Farm
Credit System institutions. One of FCA's primary functions is to
examine System institutions for safety and soundness and their
compliance with applicable law and regulation. FCA also contracts with
other government agencies to provide examination services.
[10] Legal authority for auditing the operations of SBLCs lies with
SBA's Office of Inspector General (OIG). OIG delegated this authority
to OLO.
[11] U.S. Small Business Administration, SBA Strategic Plan, FY 2001--
FY 2006.
[12] [.] U.S. General Accounting Office, Government Sponsored
Enterprises: A Framework for Limiting the Government's Exposure to
Risks, GAO/GGD-91-90 (Washington, D.C.: May 1991).
[13] GAO/GGD-98-85.
[14] In a September 4, 2002, briefing to the Committee on Small
Business and Entrepreneurship, U.S. Senate, we reported that SBA has
set October 2004 as the preliminary completion date for its LMS lender
oversight initiative.
[15] SBA officials explained that the initial date of its contract with
the vendor that conducts PLP reviews began on April 1, and they have
since used this as the beginning of their review year.
[16] The SBA Inspector General defines financial risk as the composite
risk posed by loans and guarantees actually booked to SBA's portfolio
and how they perform over time, and defines lender-based risk as the
potential financial injury due to the lender's failure to perform its
role properly. Audit Report PLP Oversight Process, Report Number 1-19,
SBA OIG, September 27, 2001.
[17] The committee is composed of the Associate Administrator of each
division within SBA.
[18] SBA OIG, Improvements Are Needed in the Small Business Lending
Company Oversight Process, Report No. 2-12, March 20, 2002.
[19] We listed the 15 recommendations in our November 2000 report.
[20] Section 7(a) of the Small Business Act states that "no financial
assistance shall be extended if the applicant can obtain credit
elsewhere." 15 U.S.C. Section 636(a).
[21] The SBA regulations do not further define "reasonable terms and
conditions."
[22] 13 C.F.R. Section 120.101
[23] SBA SOP 50-10(4)(E).
[24] SBA SOP 50-10(4).
[25] 13 C.F.R. § 120.455 (2002).
[26] The most recent fee guidance was published for the third review
year, effective June 2000.
[27] Under 31 U.S.C. § 3302(b), an official or agent of the federal
government receiving money for the government generally must deposit
the money in the U.S. Treasury, without deduction for any charge or
claim.
[28] 5 U.S.C. § 634(b)(12)(2000 & Supp. 2002) SBA's regulation 13
C.F.R. §120.454 states that "SBA may charge the PLP lender a fee to
cover the costs of this review."
[29] As a government entity, FCA can only receive funding from another
government agency; therefore, SBLCs cannot pay FCA directly the way
other preferred lenders pay contractors performing the reviews.
[30] Lenders indirectly benefit from the reviews because compliance
with program requirements is necessary to maintain PLP status.
[31] SBA SOP 50-10(4).
[32] The worksheet was also designed for recommendations regarding
SBAExpress or CommunityExpress status for lenders, which are pilot
programs under PLP.
[33] U.S. General Accounting Office, Small Business Administration:
Current Structure Presents Challenges for Service Delivery, GAO-02-17
(Washington, D.C.: October 2001).
[34] Also included are leadership continuity and succession planning,
and creating results-oriented organizational cultures. U.S. General
Accounting Office: Managing For Results: Next Steps to Improve the
Federal Government's Management and Performance, GAO-02-439T
(Washington, D.C.: February 15, 2002).
[35] U.S. General Accounting Office: Federal Housing Finance Board:
Actions Needed to Improve Regulatory Oversight, GAO/GGD-98-203
(Washington, D.C.: September 1998).
[36] U.S. Small Business Administration, Office of the Inspector
General, Action Memorandum, March 20, 2002, Report No. 2-12. The IG
report cites OMB Circular No. A-129, Policies for Federal Credit
Programs and Non-tax Receivables as requiring agencies with federal
credit programs to submit its reports of lender reviews to such a
supervisory committee.
[37] These are monthly loan reports to SBA's contractor for compiling
aggregate loan information. The report includes items such as interest
rates, guaranteed portion of loan, and next installment due date.
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