Small Business Administration
Additional Guidance on Documenting Credit Elsewhere Decisions Could Improve 7(a) Program Oversight Gao ID: GAO-09-228 February 12, 2009The Small Business Administration's (SBA) 7(a) program is intended to provide loan guarantees to small business borrowers who cannot obtain conventional credit at reasonable terms and do not have the personal resources to provide financing themselves. In fiscal year 2008, SBA guaranteed over 69,000 loans valued at about $13 billion. To assist in oversight of the 7(a) program, GAO was asked to (1) describe SBA's criteria and lenders' practices for determining that borrowers cannot obtain credit elsewhere and (2) examine SBA's efforts to ensure that lenders are complying with the credit elsewhere provision. To meet these objectives, GAO reviewed applicable statutes and guidance, visited 18 lenders and reviewed 238 of their loan files, reviewed 97 on-site lender review reports, and interviewed SBA officials. GAO's samples of lenders and loan files were not generalizable.
The Small Business Act and 7(a) program regulations and guidance allow lenders to use their conventional lending practices to determine whether borrowers can obtain credit elsewhere at reasonable terms. On the basis of a review of 238 loan files at 18 lenders, GAO observed that the most common reasons these lenders cited to substantiate that borrowers could not obtain credit elsewhere were that the borrower needed a longer maturity than the lender's policy permitted and the borrower's collateral did not meet the lender's requirements. These factors are two of the six listed in SBA's guidance as acceptable to substantiate that a borrower could not obtain conventional credit. SBA has issued little guidance on how lenders should document in their files that borrowers could not obtain credit elsewhere. Internal control standards for federal agencies specify that good guidance (information and communication) is necessary to help ensure the proper implementation of program rules. While SBA's guidance requires lenders to explain why the borrower could not obtain credit elsewhere in the loan file, it does not specify what exactly lenders should include in their explanations. Between October 2006 and March 2008, SBA reviewed 97 lenders and determined that 31 of them had failed to consistently document that borrowers met the credit elsewhere requirement or personal resources test. All but one of the lenders with whom GAO met documented their credit elsewhere decisions in some way; however, given the broad authority granted to lenders, the explanations were generally not specific enough to reasonably support the lender's conclusion that borrowers could not obtain credit elsewhere. A number of these lenders used a checklist that simply listed the six acceptable reasons cited in SBA's guidance for substantiating that a borrower could not obtain credit elsewhere and did not prompt them to provide more information specific to the borrower--for example, details on insufficient collateral. Absent detailed guidance on what exactly SBA wants lenders to document in their credit elsewhere determinations, lenders likely will continue to offer limited information in their files, making meaningful oversight of compliance with the credit elsewhere requirement difficult.
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-09-228, Small Business Administration: Additional Guidance on Documenting Credit Elsewhere Decisions Could Improve 7(a) Program Oversight
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Documenting Credit Elsewhere Decisions Could Improve 7(a) Program
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Report to Congressional Requesters:
United States Government Accountability Office:
GAO:
February 2009:
Small Business Administration:
Additional Guidance on Documenting Credit Elsewhere Decisions Could
Improve 7(a) Program Oversight:
GAO-09-228:
GAO Highlights:
Highlights of GAO-09-228, a report to congressional requesters.
Why GAO Did This Study:
The Small Business Administration‘s (SBA) 7(a) program is intended to
provide loan guarantees to small business borrowers who cannot obtain
conventional credit at reasonable terms and do not have the personal
resources to provide financing themselves. In fiscal year 2008, SBA
guaranteed over 69,000 loans valued at about $13 billion. To assist in
oversight of the 7(a) program, GAO was asked to (1) describe SBA‘s
criteria and lenders‘ practices for determining that borrowers cannot
obtain credit elsewhere and (2) examine SBA‘s efforts to ensure that
lenders are complying with the credit elsewhere provision. To meet
these objectives, GAO reviewed applicable statutes and guidance,
visited 18 lenders and reviewed 238 of their loan files, reviewed 97 on-
site lender review reports, and interviewed SBA officials. GAO‘s
samples of lenders and loan files were not generalizable.
What GAO Found:
The Small Business Act and 7(a) program regulations and guidance allow
lenders to use their conventional lending practices to determine
whether borrowers can obtain credit elsewhere at reasonable terms. On
the basis of a review of 238 loan files at 18 lenders, GAO observed
that the most common reasons these lenders cited to substantiate that
borrowers could not obtain credit elsewhere were that the borrower
needed a longer maturity than the lender‘s policy permitted and the
borrower‘s collateral did not meet the lender‘s requirements. These
factors are two of the six listed in SBA‘s guidance as acceptable to
substantiate that a borrower could not obtain conventional credit.
SBA has issued little guidance on how lenders should document in their
files that borrowers could not obtain credit elsewhere. Internal
control standards for federal agencies specify that good guidance
(information and communication) is necessary to help ensure the proper
implementation of program rules. While SBA‘s guidance requires lenders
to explain why the borrower could not obtain credit elsewhere in the
loan file, it does not specify what exactly lenders should include in
their explanations. Between October 2006 and March 2008, SBA reviewed
97 lenders and determined that 31 of them had failed to consistently
document that borrowers met the credit elsewhere requirement or
personal resources test. All but one of the lenders with whom GAO met
documented their credit elsewhere decisions in some way; however, given
the broad authority granted to lenders, the explanations were generally
not specific enough to reasonably support the lender‘s conclusion that
borrowers could not obtain credit elsewhere. A number of these lenders
used a checklist that simply listed the six acceptable reasons cited in
SBA‘s guidance for substantiating that a borrower could not obtain
credit elsewhere and did not prompt them to provide more information
specific to the borrower”for example, details on insufficient
collateral. Absent detailed guidance on what exactly SBA wants lenders
to document in their credit elsewhere determinations, lenders likely
will continue to offer limited information in their files, making
meaningful oversight of compliance with the credit elsewhere
requirement difficult.
What GAO Recommends:
GAO recommends that SBA issue more detailed guidance to lenders on how
to document their compliance with the credit elsewhere requirement. In
responding to a draft of this report, SBA stated that it would use
GAO‘s findings to create more specific guidance for lenders.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-09-228]. For more
information, contact William B. Shear at (202) 512-8678 or
shearw@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Program Design Allows Lenders to Use Their Conventional Lending
Policies to Make Credit Elsewhere Decisions:
Limited Guidance Impedes Effective Oversight of Lenders' Compliance
with the Credit Elsewhere Requirement:
Conclusions:
Recommendation for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: 7(a) Lending during the Credit Crisis:
Appendix II: Objectives, Scope, and Methodology:
Appendix III: Implications of Imposing a More Prescriptive Credit
Elsewhere Requirement:
Appendix IV: Comments from the Small Business Administration:
Appendix V: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Reasons Lenders Gave to Explain Why Borrowers Could Not Obtain
Credit Elsewhere:
Table 2: Impact of Loan Term on Annual Payment and Required Net
Operating Income:
Table 3: Number of 7(a) Loans to New Businesses by Lender:
Table 4: Number and Size of Lenders Interviewed in Each Selected
Location:
Figures:
Figure 1: Percentage of 7(a) and Conventional Loans by Loan Maturity
Category, Calendar Years 2001-2004:
Figure 2: Debt Service Coverage Ratios for Sample Borrowers:
Figure 3: Percentage of Loan Files SBA Reviewed That Did Not Include
Documentation for the Credit Elsewhere Requirement or Personal
Resources Test, October 1, 2006-March 31, 2008:
Figure 4: Examples of Corrective Actions Taken by Lenders to Address
Credit Elsewhere and Personal Resources Test Deficiencies:
Figure 5: Number and Dollar Amount of Approved 7(a) Loans as Reported
by SBA, Fiscal Years 2003-2008:
Abbreviations:
CDC: certified development company:
DSCR: debt service coverage ratio:
LAS: Loan Accounting System:
LIBOR: London Interbank Offered Rate:
OCRM: Office of Credit Risk Management:
PLP: preferred lender program:
SBA: Small Business Administration:
SBLC: small business lending company:
SOP: Standard Operating Procedure:
TALF: Term Asset-Backed Securities Loan Facility:
[End of section]
United States Government Accountability Office: Washington, DC 20548:
February 12, 2009:
The Honorable Thomas A. Carper:
Chairman:
Subcommittee on Federal Financial Management, Government Information,
Federal Services, and International Security: Committee on Homeland
Security and Governmental Affairs: United States Senate:
The Honorable Tom Coburn, M.D.
United States Senate:
The recent tightening of the credit markets has raised concerns about
the ability of small businesses to obtain credit and has increased
attention on alternative sources of credit for this segment of the
economy. The Small Business Administration (SBA) was created in 1953 to
assist and protect the interests of small businesses, in part by
addressing constraints in the supply of credit for these firms. The
7(a) program, named after the section of the Small Business Act that
authorized it, is SBA's largest business loan program.[Footnote 1] The
program is intended to serve creditworthy small business borrowers who
cannot obtain credit through a conventional lender at reasonable terms
and do not have the personal resources to provide financing themselves.
[Footnote 2] In fiscal year 2008, SBA guaranteed over 69,000 loans
valued at about $13 billion.[Footnote 3] The loan guarantee covers part
of a lender's losses in the event of a default, reducing the risk of
lending to small businesses that would otherwise not qualify for a
conventional loan. To streamline the lending process, SBA works with
lenders that have "delegated authority"--that is, the ability to make
credit determinations without prior review by SBA. According to SBA,
the majority of loans that it guarantees each year are made by lenders
with delegated authority.
Because the 7(a) program is intended to serve borrowers who cannot
obtain conventional credit at reasonable terms, lenders making 7(a)
loans must ensure that borrowers meet the "credit elsewhere"
requirement. This requirement stipulates that to receive 7(a) loans,
borrowers must not be able to obtain financing under reasonable terms
and conditions from conventional lenders.[Footnote 4] In addition,
because 7(a) borrowers must not have the personal resources to cover
the needed funding, lenders also must apply a "personal resources" test
to confirm that the desired funds are not available from any principal
of the business. Lenders may reject a small business's application for
a conventional loan for a variety of reasons. For example, a business
may need a loan with longer maturity than the lender's policy permits
or an amount that exceeds the lender's legal lending limit or policy
limit for a single customer. Lenders also may require more collateral
than a small business can offer or may not lend to start-ups or firms
in certain industries.
To assist you in overseeing the 7(a) program, you asked us to review
how lenders implement and SBA oversees the program's credit elsewhere
provision. Specifically, this report (1) describes SBA's criteria for
determining that borrowers cannot obtain credit elsewhere and practices
lenders employ to determine that borrowers cannot obtain credit
elsewhere and (2) examines SBA's efforts to ensure that lenders are
complying with the credit elsewhere provision.
To address these objectives, we reviewed applicable statutes and the
legislative history of the 7(a) program, SBA's regulations and guidance
for administering the program, our previous reports, and studies of the
program conducted by the SBA Inspector General and external
organizations. To determine lender practices for implementing the
credit elsewhere provision, we visited 18 lenders with delegated
authority and reviewed 238 of their approved applications for 7(a)
loans. We selected these lenders based on the size of their SBA loan
portfolios and geography, among other things. The number of files we
reviewed at each lender was based on the size of the lender's
portfolio; we reviewed more files at larger lenders than we did at
smaller lenders. While our samples of 18 lenders and 238 loans files
are nongeneralizable, they offer perspectives on how some lenders
implement the credit elsewhere provision. We interviewed SBA officials
and contractor staff to discuss lender oversight efforts and reviewed
all 97 on-site review reports completed between October 2006 and March
2008 and related correspondence and enforcement action data. Appendix
II discusses our scope and methodology in further detail.
We conducted our work in Atlanta, Georgia; Chicago, Illinois; Houston,
Texas; Los Angeles, California; New York City, New York; San Francisco,
California; and Washington, D.C., between February 2008 and February
2009 in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit
to obtain sufficient, appropriate evidence to provide a reasonable
basis for our findings and conclusions based on our audit objectives.
We believe that the evidence obtained provides a reasonable basis for
our findings and conclusions based on our audit objectives.
Results in Brief:
The Small Business Act and 7(a) program regulations and guidance allow
lenders to use their conventional lending practices to determine
whether borrowers can obtain credit elsewhere at reasonable terms. That
is, if a borrower does not meet the requirements of the lender's
conventional loan policy, the lender will assume that conventional
credit is unavailable to that borrower. The Small Business Act and its
business lending regulations specify that SBA shall provide business
loan assistance only to borrowers who cannot obtain credit elsewhere,
defining credit elsewhere as the availability of credit from nonfederal
sources on reasonable terms and conditions. SBA's primary operational
guidance for the 7(a) program--Standard Operating Procedure (SOP) 50-
10--builds upon the language of the statute and regulations by
outlining six reasons lenders can use to substantiate that a borrower
cannot obtain credit elsewhere. Together, the statute, regulations, and
guidance allow lenders to use their own conventional lending policies
to make case-by-case decisions about which borrowers need an SBA
guarantee. During our review of 238 files at 18 lenders, we observed
that the most common reasons these lenders cited to substantiate that
borrowers could not obtain credit elsewhere were that the borrower
needed a longer maturity than the lender's policy permitted and the
borrower's collateral did not meet the lender's requirements.
SBA has issued little guidance on how lenders should document in their
files that borrowers could not obtain credit elsewhere. Internal
control standards for federal agencies specify that good guidance
(information and communication) is necessary to help ensure the proper
implementation of program rules, including eligibility requirements.
[Footnote 5] According to SBA's SOP 50-10, lenders are required to
substantiate the reasons a borrower cannot obtain credit elsewhere at
reasonable terms and retain the explanation in the borrower's loan
file. However, the SOP does not specify what exactly lenders should
include in their explanations. SBA has not issued any other guidance on
documenting compliance with the credit elsewhere provision. SBA's own
on-site reviews of lenders--its primary means of assessing compliance
with the credit elsewhere requirement--indicated that documenting
credit elsewhere determinations was a problem. Between October 2006 and
March 2008, SBA determined that 31 of the 97 lenders reviewed had
failed to consistently document that borrowers met the credit elsewhere
requirement or personal resources test. The results of our file reviews
at 18 lenders, which included many lenders who were previously reviewed
by SBA, showed that all but one of the lenders had documented their
credit elsewhere decisions in some way. However, the explanations they
provided were generally not specific enough to reasonably support the
lender's conclusion that borrowers could not obtain credit elsewhere. A
number of these lenders used a checklist to document their decisions.
However, these checklists simply list the six acceptable reasons cited
in SOP 50-10 for substantiating that a borrower could not obtain credit
elsewhere and do not prompt them to provide more information specific
to the borrower--for example, how a longer maturity would improve a
business's ability to repay a loan or the details on insufficient
collateral. Such information could help support the lender's assessment
that the borrower could not obtain credit elsewhere. Absent detailed
guidance on what exactly SBA wants lenders to document in their credit
elsewhere determinations, lenders likely will continue to offer limited
information in their files, making meaningful oversight of compliance
with the credit elsewhere requirement difficult.
This report includes one recommendation designed to improve SBA's
oversight of compliance with the credit elsewhere provision. We
recommend that SBA issue more detailed guidance to lenders on how to
document their compliance with the credit elsewhere requirement. We
provided SBA with a draft of this report for its review and comment. In
written comments, SBA stated it would work with its incoming
administrative leadership to use our findings to create more specific
guidance for lenders.
Background:
The Small Business Act created SBA to aid, counsel, assist, and protect
the interests of small business concerns. The first version of Section
7(a) of the act empowered SBA to make loans to small businesses with
the restriction that "no financial assistance shall be extended —
unless the financial assistance applied for is not otherwise available
on reasonable terms." While there have been numerous amendments to
Section 7(a), the credit elsewhere restriction has remained, with
slight modifications. For instance, the phrase "credit elsewhere" was
introduced in 1981 and the provision was changed to read that "[n]o
financial assistance shall be extended pursuant to this subsection if
the applicant can obtain credit elsewhere."[Footnote 6] At the same
time, a definition of credit elsewhere was added.
The 7(a) program's legislative history emphasizes the program's role in
meeting the credit needs of certain small businesses. The legislative
basis for the program recognizes that the conventional lending market
is the principal source of financing for small businesses and that the
loan assistance that SBA provides is intended to supplement rather than
compete with that market. As the legislative history suggests,
conventional lending may not be a feasible financing option for some
small businesses under certain circumstances. The design of the 7(a)
program is consistent with the statute and its legislative history.
First, the loan guarantee limits the lender's risk in extending credit
to a small firm that may not have met the lender's own requirements for
a conventional loan. Second, the credit elsewhere requirement is
intended to provide some assurance that guaranteed loans are offered
only to firms that are unable to access credit on reasonable terms and
conditions in the conventional lending markets. Third, an active
secondary market for the guaranteed portion of a 7(a) loan allows
lenders to sell the guaranteed portion of the loan to investors,
providing additional liquidity that lenders can use for additional
loans.
Under the 7(a) program, SBA guarantees loans made by commercial lenders
to small businesses for working capital and other general business
purposes.[Footnote 7] These lenders are mostly banks, but some are
nondepository lenders, including small business lending companies
(SBLC)--nondepository lenders previously chartered by SBA to provide
7(a) loans to qualified small businesses. The guarantee assures the
lender that if a borrower defaults on a loan, the lender will receive
an agreed-upon portion (generally between 50 percent and 85 percent) of
the outstanding balance. For a majority of 7(a) loans, SBA relies on
lenders with delegated authority to process and service 7(a) loans and
to ensure that borrowers meet the program's eligibility requirements.
To be eligible for the 7(a) program, a business must be an operating
for-profit small firm (according to SBA's size standards) located in
the United States and meet the credit elsewhere requirement, including
the personal resources test.[Footnote 8]
SBA is not authorized to extend credit to businesses if the financial
strength of the individual owners or the firm itself is sufficient to
provide or obtain all or part of the financing or if the business can
access conventional credit. To assess whether borrowers can obtain
credit elsewhere, lenders must determine that the desired credit, for a
similar purpose and period of time, is unavailable to the firm on
reasonable terms and conditions from nonfederal sources without SBA
assistance, taking into consideration prevailing rates and terms in the
community or locale where the firm conducts business. Nonfederal
sources may include any lending institutions. In addition, lenders must
determine that the firm's owners are unable to provide the desired
funds from their personal resources. When applying this personal
resources test, the lender must assess the liquid assets of each owner
of 20 percent or more of the equity of the applicant company to
determine the overall dollar value of the allowable exemption, which is
defined as the amount of personal resources that do not have to be
injected into the business. The allowable exemption is determined on
the basis of the "total financing package." The total financing package
includes any SBA loans, together with any other loans, equity
injection, or business funds used or arranged for at the same general
time for the same project as the SBA loan. If the total financing
package:
* is $250,000 or less, the exemption is two times the total financing
package or $100,000, whichever is greater;
* is between $250,001 and $500,000, the exemption is one and one-half
times the total financing package or $500,000, whichever is greater;
or:
* exceeds $500,000, the exemption equals the total financing package or
$750,000, whichever is greater.
Once the exemption is determined, it is subtracted from the liquid
assets. If the result is positive, that amount must be injected into
the project.
When the 7(a) program was first implemented, borrowers were generally
required to show proof of credit denials (rejection documentation) from
no fewer than two banks that documented, among other things, the
reasons for not granting the desired credit. Similar requirements
remained in effect until 1985, when SBA amended the rule to permit a
lender's certification made in its application for an SBA guarantee to
be sufficient documentation.[Footnote 9] This certification requirement
remained when the rule was rewritten in 1996. SBA stated that requiring
proof of loan denials was demoralizing to small businesses and
unenforceable by SBA.
Within the 7(a) program, there are several delivery methods--including
regular 7(a), the preferred lender program (PLP), and SBAExpress. Under
the regular (nondelegated) 7(a) program, SBA makes the loan approval
decision, including the credit determination. Under PLP and SBAExpress,
SBA delegates to the lender the authority to make loan approval
decisions, including credit determinations, without prior review by
SBA. The maximum loan amount under the SBAExpress program is $350,000
(as opposed to $2 million for other 7(a) loans). The program allows
lenders to utilize, to the maximum extent possible, their respective
loan analyses, procedures, and documentation. In return for the
expanded authority and autonomy provided by the program, SBAExpress
lenders agree to accept a maximum SBA guarantee of 50 percent. (Other
7(a) loans have a maximum guarantee of 75 or 85 percent, depending on
the loan amount.) According to SBA, as of December 31, 2007, there were
672 PLP and 1,889 SBAExpress lenders. Of these, 603 lenders were
approved for both programs.
In the federal budget, the 7(a) program is currently a "zero subsidy"
program, meaning that the program does not require annual
appropriations of budget authority for new loan guarantees. To offset
some of the costs of the program, such as default costs, SBA assesses
lenders two fees on each 7(a) loan. The guarantee fee must be paid by
the lender at the time of loan application or within 90 days of the
loan being approved, depending upon the loan term. This fee is based on
the amount of the loan and the level of the guarantee, and lenders can
pass the fee on to the borrower. The ongoing servicing fee must be paid
annually by the lender and is based on the outstanding balance of the
guaranteed portion of the loan.
SBA's Office of Credit Risk Management (OCRM) is responsible for
overseeing 7(a) lenders, including those with delegated authority. SBA
created this office in fiscal year 1999 to ensure consistent and
appropriate supervision of SBA's lending partners.[Footnote 10] The
office is responsible for managing all activities regarding lender
reviews, preparing written reports, evaluating new programs, and
recommending changes to existing programs to assess risk potential.
Program Design Allows Lenders to Use Their Conventional Lending
Policies to Make Credit Elsewhere Decisions:
The Small Business Act and 7(a) program regulations give lenders
discretion to determine which borrowers cannot obtain credit elsewhere
and thus require an SBA guarantee. SBA's primary guidance for the 7(a)
program outlines six reasons lenders can use to substantiate that a
borrower cannot obtain credit elsewhere. Together, the statute,
regulations, and guidance allow lenders to use their own conventional
lending policies to determine which borrowers need an SBA guarantee.
Our file reviews showed that lenders most often cited the borrower's
need for a longer maturity, lack of collateral, and the age or type of
business as reasons for requiring an SBA guarantee.
SBA's Credit Elsewhere Requirement Gives Broad Authority to Lenders:
The Small Business Act specifies that SBA shall not make or guarantee
loans for borrowers who are able to obtain credit elsewhere.[Footnote
11] The statute defines credit elsewhere as:
"the availability of credit from non-Federal sources on reasonable
terms and conditions taking into consideration the prevailing rates and
terms in the community in or near where the concern transacts business,
or the homeowner resides, for similar purposes and periods of time."
Consistent with the statute, the governing regulations note that SBA
will guarantee loans only for applicants for whom the desired credit is
not otherwise available on reasonable terms from a nonfederal
source.[Footnote 12] According to SBA, the credit elsewhere requirement
was specifically designed to be broad in order not to limit lenders'
discretion and to allow for differences in geographic regions, economic
conditions, and types of businesses.
SBA's primary operational guidance for the 7(a) program--SOP 50-10--
builds upon the statute and regulations by outlining six reasons
lenders can use to substantiate that a borrower cannot obtain credit
elsewhere on reasonable terms.[Footnote 13] These reasons can be
divided into two groups: those that are specific to the borrower's
creditworthiness or business and those that are specific to the
lender's financial position and unrelated to a borrower's
creditworthiness or the availability of loans from other sources.
Reasons related to the borrower are that:
* The business needs a longer maturity than the lender's policy
permits.
* The collateral does not meet the requirements of the lender's
policies.
* The lender's policies normally do not allow loans to new businesses
or businesses in the applicant's industry.
* Any other factors relating to the credit that, in the lender's
opinion, cannot be overcome without the guarantee.
The lender may also use one of the following lender-related reasons:
The requested loan amount exceeds the lender's legal lending limit or
policy limit on the amount it can lend to one customer, or the lender's
liquidity depends upon selling the guaranteed portion of the loan on
the secondary market.[Footnote 14]
Lenders Assess Availability of Credit Elsewhere against Their Own
Underwriting Standards:
On the basis of interviews with a sample of lenders and reviews of a
sample of 7(a) loan files, we found that lenders evaluate a borrower's
ability to obtain credit elsewhere on reasonable terms against their
own conventional lending policies. This finding was generally
consistent with those of a recent Urban Institute report.[Footnote 15]
Lenders we visited most often cited the borrower's need for a longer
maturity, lack of collateral, and the age or type of business as
reasons for requiring an SBA guarantee.
Different Underwriting Policies Result in Different Lending Practices:
In practice, lenders evaluate a borrower's ability to obtain credit
elsewhere against their own conventional lending policies.[Footnote 16]
That is, if a borrower does not meet the requirements of the lender's
conventional loan policy, the lender will require an SBA guarantee (or
in some cases, deny the loan request). The criteria or thresholds
established in the lender's underwriting policies are representative of
the level of risk the lender is willing to assume on a loan. Many
factors influence lenders' risk tolerance levels, including the size of
the institution, its location, and its financial position. As a result,
lenders may focus on different types of lending or see certain types of
lending as being more central to their operations than others.
Our findings from interviews with a small, nongeneralizable sample of
18 lenders suggest that differences in lending practices could affect
how the credit elsewhere requirement was applied. Some of the lenders
said that they relied on automated underwriting systems that primarily
considered quantitative factors such as credit scores and financial
ratios to determine whether a borrower qualified for a conventional
loan or required a guarantee. But some other lenders said that they
also considered qualitative factors such as the borrower's relationship
with the bank--for example, the amount on deposit or a prior lending
history--when determining whether to extend conventional or guaranteed
credit.
An Urban Institute report on lenders' implementation of the credit
elsewhere requirement reached similar conclusions. On the basis of
interviews with 23 banks that originated both SBA and conventional
loans, the Urban Institute concluded that lenders that employed small
business credit-scoring models often had relatively straightforward
rules regarding the types of borrowers that were eligible for
conventional and guaranteed loans. However, it also noted that lenders
(in particular smaller lenders) that continued to use relationship
underwriting were less likely to have objective thresholds borrowers
had to meet in order to qualify for conventional financing.[Footnote
17]
Lenders Cite Similar Reasons to Substantiate Credit Elsewhere
Decisions:
Using information collected from 238 recently approved 7(a) loan files
from 18 lenders, we found that the most common reasons lenders cited to
substantiate that borrowers could not obtain credit elsewhere were (1)
that the business needed a longer maturity than the lender's policy
permitted, (2) that the borrower's collateral did not meet the lender's
policies, and (3) that the lender's policies did not normally allow
loans to new businesses or businesses in the applicant's industry (see
table 1).[Footnote 18]
Table 1: Reasons Lenders Gave to Explain Why Borrowers Could Not Obtain
Credit Elsewhere:
Reason: The business needs a longer maturity than the lender's policy
permits;
Number of times cited in selected files: 142.
Reason: The collateral does not meet the requirements of the lender's
policies;
Number of times cited in selected files: 110.
Reason: The lender's policies normally do not allow loans to new
businesses or businesses in the applicant's industry;
Number of times cited in selected files: 47[A].
Reason: The lender's liquidity depends upon selling the guaranteed
portion of the loan on the secondary market;
Number of times cited in selected files: 28[B].
Reason: The requested loan exceeds either the lender's legal lending
limit or policy limit regarding the amount it can lend to one customer;
Number of times cited in selected files: 1.
Reason: Other[C];
Number of times cited in selected files: 26.
Reason: Total;
Number of times cited in selected files: 354[D].
Source: GAO analysis of data from selected lenders.
[A] Forty of the 47 files cited "the lender's policies normally do not
allow loans to new businesses." The remaining 7 cited "the lender's
policies normally do not allow loans to businesses in the applicant's
industry."
[B] Two SBLCs and one bank cited "the lender's liquidity depends upon
selling the guaranteed portion of the loan on the secondary market" to
substantiate that borrowers could not obtain credit elsewhere. One SBLC
cited this reason 15 times, the other SBLC cited it 3 times, and the
bank cited it 10 times.
[C] Some of the other reasons lenders cited included an insufficient
credit score or blemished credit and lack of a down payment.
[D] The total number of reasons cited (354) exceeds the total number of
files we reviewed (238) because lenders can and sometimes did cite more
than one reason to substantiate that a borrower could not obtain credit
elsewhere.
[End of table]
The results of our file reviews generally were consistent with the
findings of the Urban Institute's report on lenders' implementation of
the credit elsewhere requirement. The Urban Institute concluded that
the most common reasons lenders cited to substantiate that borrowers
could not obtain credit elsewhere were that the business needed a
longer maturity than the lender's policy permitted and that the
borrower's collateral did not meet the lender's underwriting
requirements.[Footnote 19]
As table 1 shows, the most common reason that lenders we visited cited
to substantiate that a borrower could not obtain credit elsewhere was
that the borrower needed a longer term (maturity) than the lender could
provide with a conventional loan. In general, SBA-guaranteed loans
provide more generous terms to borrowers than conventional loans. In
2007, we found that almost 80 percent of 7(a) loans had maturities of
more than 5 years, compared with 5 years or less for an estimated 83
percent of conventional loans (see fig. 1).[Footnote 20]
Figure 1: Percentage of 7(a) and Conventional Loans by Loan Maturity
Category, Calendar Years 2001-2004:
[Refer to PDF for image: multiple vertical bar graph]
Maturity in years: 1 or less;
7(a) loans: 2%;
Conventional loans: 47%.
Conventional loan bracket: 45-50%.
Maturity in years: less than 1 to 3;
7(a) loans: 6%;
Conventional loans: 14%.
Conventional loan bracket: 10-15%.
Maturity in years: less than 3 to 5;
7(a) loans: 15%;
Conventional loans: 22%.
Conventional loan bracket: 18-24%.
Maturity in years: less than 5 to 7;
7(a) loans: 43%;
Conventional loans: 2%.
Conventional loan bracket: 0.5-2.5%.
Maturity in years: >7 to 10;
7(a) loans: 15%;
Conventional loans: 8%.
Conventional loan bracket: 6-9%.
Maturity in years: >10 to 20;
7(a) loans: 10%;
Conventional loans: 6%.
Conventional loan bracket: 4-7%.
Maturity in years: More than 20;
7(a) loans: 10%;
Conventional loans: 2%.
Conventional loan bracket: 1-3%.
Source: GAO analysis of SBA and Federal Reserve Board of Governors‘
data.
Note: The brackets on the conventional loans represent the 95 percent
confidence interval. See [hyperlink,
http://www.gao.gov/products/GAO-07-769] for more information.
[End of figure]
In general, longer terms mean lower payments, which allow borrowers to
service debt with a lower net operating income (see table 2).
Table 2: Impact of Loan Term on Annual Payment and Required Net
Operating Income:
Loan attributes: Loan amount;
Example: 1: $300,000;
Example: 2: $300,000;
Example: 3: $300,000;
Example: 4: $300,000.
Loan attributes: Interest rate (percent);
Example: 1: 8.0;
Example: 2: 8.0;
Example: 3: 8.0;
Example: 4: 8.0.
Loan attributes: Maturity (years);
Example: 1: 3;
Example: 2: 5;
Example: 3: 7;
Example: 4: 10.
Loan attributes: Annual payment (fully amortized);
Example: 1: $112,800;
Example: 2: $72,984;
Example: 3: $56,100;
Example: 4: $43,668.
Loan attributes: Net operating income necessary to meet debt service
payments (assumes 1.25 debt service coverage ratio);
Example: 1: $141,000;
Example: 2: $91,230;
Example: 3: $70,125;
Example: 4: $54,585.
Source: GAO analysis.
Note: Our analysis is similar to that presented in the January 2008
Urban Institute report referenced previously.
[End of table]
Many lenders with whom we spoke said that they generally required a
business to have an actual or projected debt service coverage ratio
(DSCR) of at least 1.10 to 1.25 to obtain a conventional or guaranteed
loan. DSCR is the ratio of net operating income (or cash flow) to debt
payments, with a lower ratio indicating less ability to meet debt
service payments. Our analysis of DSCRs showed that both the average
and the mean ratios for all borrowers in our sample were higher than
the 1.10 to 1.25 lender requirement (see fig. 2). We also found that
lenders sometimes deviated quite substantially from their required
minimums. In some instances, lenders provided loans to businesses with
low or negative ratios, suggesting that those borrowers compensated for
a lack of cash flow in the short term with collateral, for example. In
other instances, lenders provided loans to businesses with ratios well
above the minimum requirement, suggesting that factors other than cash
flow were behind the reasons for requiring an SBA guarantee.
Figure 2: Debt Service Coverage Ratios for Sample Borrowers:
[Refer to PDF for image: illustration]
Loan term: 7 years;
Number of files: 26;
Ratio range: -2.56 to 28.16;
Average ratio: 2.8;
Median ratio: 1.6.
Loan term: 10 years;
Number of files: 72;
Ratio range: 0.91 to 11.04;
Average ratio: 2.7;
Median ratio: 2.1.
Loan term: 25 years;
Number of files: 31;
Ratio range: 0.64 to 6.71;
Average ratio: 2.1;
Median ratio: 1.8.
Loan term: All loans;
Number of files: 185;
Ratio range: -4.83 to 28.16;
Average ratio: 2.4;
Median ratio: 1.8.
Source: GAO analysis of data from selected lenders.
Note: Of the 238 files we reviewed, 185 files included a DSCR. The
sample of loans is not representative of all loans made by the lenders
we visited. The files we reviewed generally were approved in calendar
years 2007 and 2008.
[End of figure]
Of the loans that we reviewed, 46 percent were cited as having
insufficient collateral (because of its low value or uniqueness) for a
conventional loan. SOP 50-10 stipulates that a 7(a) loan request cannot
be denied on the basis of inadequate collateral, noting that one of the
primary reasons lenders used the 7(a) program was to provide credit to
small businesses that could repay a loan but lacked the collateral
needed to cover it in case of default.[Footnote 21] One lender that we
interviewed required all conventional loans to be fully securitized. If
a borrower was unable to provide 100 percent collateral against the
value of the loan, the lender would require an SBA guarantee. Other
lenders had more lenient policies relating to collateral, allowing
borrowers to obtain conventional financing with more limited
collateral.
Finally, as shown in table 3, our review of lender files showed that
all but 2 of the 18 lenders made at least one 7(a) loan to a new
business, but that some made significantly more of these loans than
others. Many lenders we interviewed said that their conventional
lending policies prohibited them from making conventional loans to new
businesses.
Table 3: Number of 7(a) Loans to New Businesses by Lender:
Lender: 1;
Number of loans to new businesses: 3;
Number of loans to existing businesses: 12.
Lender: 2.
Number of loans to new businesses: 3;
Number of loans to existing businesses: 2.
Lender: 3.
Number of loans to new businesses: 3;
Number of loans to existing businesses: 11.
Lender: 4.
Number of loans to new businesses: 1;
Number of loans to existing businesses: 14.
Lender: 5.
Number of loans to new businesses: 0;
Number of loans to existing businesses: 5.
Lender: 6.
Number of loans to new businesses: 3;
Number of loans to existing businesses: 12.
Lender: 7.
Number of loans to new businesses: 1;
Number of loans to existing businesses: 3.
Lender: 8.
Number of loans to new businesses: 3;
Number of loans to existing businesses: 12.
Lender: 9.
Number of loans to new businesses: 1;
Number of loans to existing businesses: 14.
Lender: 10.
Number of loans to new businesses: 0;
Number of loans to existing businesses: 20.
Lender: 11.
Number of loans to new businesses: 6;
Number of loans to existing businesses: 9.
Lender: 12.
Number of loans to new businesses: 2;
Number of loans to existing businesses: 3.
Lender: 13.
Number of loans to new businesses: 2;
Number of loans to existing businesses: 3.
Lender: 14.
Number of loans to new businesses: 3;
Number of loans to existing businesses: 2.
Lender: 15.
Number of loans to new businesses: 5;
Number of loans to existing businesses: 16.
Lender: 16.
Number of loans to new businesses: 2;
Number of loans to existing businesses: 12.
Lender: 17.
Number of loans to new businesses: 17;
Number of loans to existing businesses: 3.
Lender: 18.
Number of loans to new businesses: 18;
Number of loans to existing businesses: 12.
Lender: All.
Number of loans to new businesses: 73 (31%);
Number of loans to existing businesses: 165 (69%).
Source: GAO analysis of data from selected lenders.
Note: The sample of loans is not representative of all loans made by
each of the lenders. The files we reviewed generally were approved in
calendar years 2007 and 2008.
[End of table]
Limited Guidance Impedes Effective Oversight of Lenders' Compliance
with the Credit Elsewhere Requirement:
A lack of guidance to lenders on how to document compliance with the
credit elsewhere requirement impedes SBA's oversight of compliance with
the requirement. SBA requires lenders to explain in a borrower's loan
file why the borrower could not obtain credit elsewhere on reasonable
terms, but its guidance does not provide specific information on what
lenders should include in their explanations. Our review of on-site
review reports completed during a recent six-quarter period found that
SBA determined that 31 of 97 lenders reviewed had not consistently
documented that borrowers met either the credit elsewhere requirement
or personal resources test. Although all but 1 of the 18 lenders with
delegated authority that we interviewed documented their credit
elsewhere decisions in some way, the explanations in the files we
reviewed were generally not specific enough to reasonably support the
lender's conclusion that borrowers could not actually obtain credit
elsewhere.
Guidance on Documenting Credit Elsewhere Decisions Is Limited:
Internal control standards for federal agencies and programs state that
good guidance (information and communication) is a key component of a
strong internal control framework.[Footnote 22] Internal controls are
an integral component of an organization's management that provides
reasonable assurance that the organization is meeting its objective of
ensuring compliance with applicable laws and regulations. For an entity
to run and control its operations, it must have relevant, reliable, and
timely communications relating to external as well as internal events.
Therefore, management should ensure that there are adequate means of
communicating with, and obtaining information from, external
stakeholders.
Although SBA's guidance requires lenders to document the reasons that
borrowers cannot obtain credit elsewhere, it does not specify what
exactly lenders should include in their explanations. The only guidance
in SOP 50-10 on documenting compliance with the requirement is a
sentence stating that the lender is required to substantiate the
factors that prevent the borrower from obtaining credit elsewhere and
retain the explanation in the small business applicant's file.[Footnote
23] SBA recently revised SOP 50-10 but did not change the guidance on
documenting compliance with the credit elsewhere requirement. According
to SBA, SOP 50-10 provides thorough guidance on what is required of
lenders for making the credit elsewhere determination and documenting
it in the file. To supplement the revised guidance, SBA has issued on
its Web site some frequently asked questions about the new SOP. To
date, no questions on the credit elsewhere requirement have been
posted.
SBA Reviews Have Identified Deficiencies in Documenting Compliance with
the Credit Elsewhere Requirement:
SBA's Office of Credit Risk Management is responsible for monitoring
and evaluating SBA lenders and implementing corrective actions as
necessary. Its primary means of ensuring compliance with the credit
elsewhere requirement is on-site reviews of large 7(a) lenders--those
lenders with outstanding balances on the SBA-guaranteed portions of
their loan portfolio amounting to $10 million or more.[Footnote 24] SBA
also conducts on-site reviews of large certified development companies
(CDC) that make 504 loans.[Footnote 25] According to SBA officials, the
7(a) and 504 lenders that SBA plans to review on site over a 2-year
period will account for about 85 percent of all guaranteed dollars.
[Footnote 26] SBA relies on a contractor to perform these on-site
lender reviews. According to SOP 51 00--SBA's guidance on on-site
lender reviews--the purpose of the on-site review is threefold: (1) to
enhance SBA's ability to gauge the overall quality of the lender's 7(a)
or 504 portfolio; (2) to identify weaknesses in an SBA lender's SBA
operations before serious problems develop that expose SBA to losses
that exceed those inherent in a reasonable and prudent SBA loan
portfolio; and (3) to ensure that prompt and effective corrective
actions are taken, as appropriate.[Footnote 27] In prioritizing lenders
for review, SBA primarily considers the following factors: portfolio
size, risk rating, date of last review, and findings from previous
reviews. In addition to assessing performance, SBA also prepares a
written report and follows up with the SBA lender to address weaknesses
or deficiencies identified during the review.
As part of these oversight reviews, the SOP requires SBA to determine
whether lender policies and practices adhere to SBA's credit elsewhere
requirement. This includes checking to see whether lenders have applied
a personal resources test to confirm that the desired funds were not
available from any principal of the business. With respect to the
credit elsewhere review, SBA's contractor explained that it checks to
see that the lender documented its credit elsewhere determination and
cited one of the six acceptable factors listed in SOP 50-10.[Footnote
28] However, it does not routinely assess the lender's support for its
credit elsewhere determination. Contract staff performing an on-site
review use a checklist that requires the examiner to answer yes or no
that "written evidence that credit is not otherwise available on terms
not considered unreasonable without guarantee provided by SBA" was in
the file and that the "personal resources test was applied and enforced
according to SBA policy." Contractor officials stated that when the
documentation standard is not met, the examiner will sometimes look at
the factual support in the file to independently determine whether the
credit elsewhere requirement or personal resources test was actually
met.
Our review of a sample of SBA's on-site review reports showed that SBA
determined that nearly a third of lenders had not properly documented
that borrowers met either the credit elsewhere requirement or the
personal resources test. We analyzed reports from all the on-site
lender reviews SBA conducted during a six-quarter period from October
2006 to March 2008 and found that 31 of the 97 lenders reviewed did not
consistently document that borrowers met the credit elsewhere
requirement or personal resources test.[Footnote 29] We had to perform
this analysis because, until very recently, SBA did not have a system
in which it recorded the results of on-site reviews.[Footnote 30] One
on-site review report we analyzed stated that "the credit elsewhere
assessment was missing in 24 percent of the cases reviewed." Another
report stated that "the lender failed to properly document the personal
resources test in 20 of the 22 cases reviewed." As shown in figure 3,
the percentage of files at each lender that were cited for not
including credit elsewhere documentation ranged from a low of 3 percent
to 89 percent. Similarly, the percentage of lender files that did not
include documentation of the personal resources test ranged from a low
of 3 percent to 100 percent.
Figure 3: Percentage of Loan Files SBA Reviewed That Did Not Include
Documentation for the Credit Elsewhere Requirement or Personal
Resources Test, October 1, 2006-March 31, 2008:
[Refer to PDF for image]
Lender: 1;
Percentage error, Credit elsewhere requirement: 0;
Percentage error, Personal resources test: 5.26.
Lender: 2;
Percentage error, Credit elsewhere requirement: 23.53;
Percentage error, Personal resources test: 0.
Lender: 3;
Percentage error, Credit elsewhere requirement: 6.9;
Percentage error, Personal resources test: 17.24.
Lender: 4;
Percentage error, Credit elsewhere requirement: 28;
Percentage error, Personal resources test: 4.
Lender: 5;
Percentage error, Credit elsewhere requirement: 0;
Percentage error, Personal resources test: 90.91.
Lender: 6;
Percentage error, Credit elsewhere requirement: 60;
Percentage error, Personal resources test: 60.
Lender: 7;
Percentage error, Credit elsewhere requirement: 6.45;
Percentage error, Personal resources test: 16.13.
Lender: 8;
Percentage error, Credit elsewhere requirement: 32.26;
Percentage error, Personal resources test: 32.26.
Lender: 9;
Percentage error, Credit elsewhere requirement: 16.67;
Percentage error, Personal resources test: 87.5.
Lender: 10;
Percentage error, Credit elsewhere requirement: 0;
Percentage error, Personal resources test: 95.
Lender: 11;
Percentage error, Credit elsewhere requirement: 20.83;
Percentage error, Personal resources test: 20.83.
Lender: 12;
Percentage error, Credit elsewhere requirement: 76.92;
Percentage error, Personal resources test: 88.46.
Lender: 13;
Percentage error, Credit elsewhere requirement: 11.11;
Percentage error, Personal resources test: 3.7;
Lender: 14;
Percentage error, Credit elsewhere requirement: 25.93;
Percentage error, Personal resources test: 85.19.
Lender: 15;
Percentage error, Credit elsewhere requirement: 24;
Percentage error, Personal resources test: 96;
Lender: 16;
Percentage error, Credit elsewhere requirement: 10;
Percentage error, Personal resources test: 10.
Lender: 17;
Percentage error, Credit elsewhere requirement: 58.33;
Percentage error, Personal resources test: 45.83.
Lender: 18;
Percentage error, Credit elsewhere requirement: 62.07;
Percentage error, Personal resources test: 68.97.
Lender: 19;
Percentage error, Credit elsewhere requirement: 32;
Percentage error, Personal resources test: 36.
Lender: 20;
Percentage error, Credit elsewhere requirement: 4;
Percentage error, Personal resources test: 16.
Lender: 21;
Percentage error, Credit elsewhere requirement: 3.23;
Percentage error, Personal resources test: 100.
Lender: 22;
Percentage error, Credit elsewhere requirement: 54.55;
Percentage error, Personal resources test: 0.
Lender: 23;
Percentage error, Credit elsewhere requirement: 3.7;
Percentage error, Personal resources test: 25.93.
Lender: 24;
Percentage error, Credit elsewhere requirement: 89.29;
Percentage error, Personal resources test: 28.57.
Lender: 25;
Percentage error, Credit elsewhere requirement: 37.5;
Percentage error, Personal resources test: 12.5.
Lender: 26;
Percentage error, Credit elsewhere requirement: 29.63;
Percentage error, Personal resources test: 3.7.
Lender: 27;
Percentage error, Credit elsewhere requirement: 0;
Percentage error, Personal resources test: 100.
Lender: 28;
Percentage error, Credit elsewhere requirement: 13.33;
Percentage error, Personal resources test: 3.33.
Lender: 29;
Percentage error, Credit elsewhere requirement: 67.86;
Percentage error, Personal resources test: 89.29.
Lender: 30;
Percentage error, Credit elsewhere requirement: 13.33;
Percentage error, Personal resources test: 10.
Lender: 31;
Percentage error, Credit elsewhere requirement: 54.55;
Percentage error, Personal resources test: 60.61.
Lender: All
Average Percentage error, Credit elsewhere requirement: 26;
Average Percentage error, Personal resources test: 42.
Source: GAO analysis.
[End of figure]
We also found that in each of the 31 cases where there was a finding,
SBA required the lender to take corrective action.[Footnote 31] When
conveying the results of an on-site review to a lender, SBA instructs
the lender to take corrective actions in response to any findings. The
lender then is required to respond to SBA with information on the
specific actions it plans to take. In subsequent correspondence with
the lender, SBA indicates whether the action taken in response to the
finding was satisfactory. As shown in figure 4, corrective actions
taken by the 31 lenders with credit elsewhere or personal resources
test findings included changes in their procedures to address
identified deficiencies, such as updating forms to reflect the credit
elsewhere requirement and personal resources test. In all 31 cases, SBA
determined that the actions taken by lenders were satisfactory.
Figure 4: Examples of Corrective Actions Taken by Lenders to Address
Credit Elsewhere and Personal Resources Test Deficiencies:
[Refer to PDF for image: illustration]
New form:
Updated policy and procedures;
Checklist: A, B, C.
* Change to credit elsewhere or personal resources test policy or
procedures, such as adopting a policy statement or changing the loan
approval process.
* Creating a new form such as "SBA Credit Elsewhere Rules Statement" or
"Personal Resources Calculation" or a closing checklist.
* Updating existing forms such as delineating a credit elsewhere
section in the lender's credit memo.
Source: GAO.
[End of figure]
In contrast to SBA's on-site review results, our file reviews revealed
that all but one of the lenders included some credit elsewhere
documentation in their loan files. We found that besides certifying on
the application that credit was not available on reasonable terms from
other sources, lenders generally summarized their credit elsewhere
determinations in the lender's assessment of the borrower, commonly
referred to as a "credit memo." SBA's on-site reviews appear to have
had some impact on lender documentation. The majority of lenders we
visited told us that SBA's contractor had conducted an on-site review
prior to our visit. In addition, representatives of two lenders told us
that their on-site reviews had resulted in corrective actions related
to the credit elsewhere requirement. An official from one lender stated
that it had developed formalized polices and procedures for its 7(a)
lending program and revised its forms and the format of the bank's
credit memo to help ensure that their credit elsewhere determinations
were documented. Officials representing the other lender stated that
they require a checklist for their SBAExpress loans to remind staff to
document credit elsewhere decisions.
Lenders' Documentation of Credit Elsewhere Decisions Generally Was Not
Specific Enough to Reasonably Support the Determination That Borrowers
Could Not Obtain Credit Elsewhere:
Although all but one of the lenders we visited documented their credit
elsewhere decisions in some way, our review of documentation provided
to support credit elsewhere decisions in 238 loan files showed that
most lenders did not provide detailed information on why borrowers
could not obtain credit elsewhere. For instance, a number of lenders we
met with used a checklist to document their credit elsewhere decisions.
These checklists allow lenders to select one or more of the six
acceptable factors outlined in SBA's SOP 50-10 that "demonstrate an
identifiable weakness in the credit of a borrower or exceed the policy
limits of the lender." However, they do not prompt lenders to provide
more specific information, such as how a longer maturity would improve
a business's ability to repay a loan or the details on insufficient
collateral.
Some lenders also documented their credit elsewhere decisions in credit
memos, but the information provided was generally not very specific.
Some examples of credit elsewhere statements in lender files included
the following:
* "[The lender] examined the availability of credit and determined that
the desired credit is unavailable to the Applicant on reasonable terms
and conditions without SBA assistance taking into consideration
prevailing rates and terms in the community in and near where the
applicant will be conducting business. Specifically, the Applicant
would not be able to obtain the proposed financing for this specific
purpose without federal assistance."
* "The terms and conditions offered are not available in the
marketplace without the assistance of the SBA guarantee."
* "Repayment capability requires maturity that exceeds [the lender's]
policy; value of available collateral is unacceptable; credit
unavailable through conventional loan without a lower loan-to-value
ratio."[Footnote 32]
As evidenced by the above examples, our review of loan files showed
that most lenders generally did not provide specific information about
the borrower in the statements they included in their explanations, nor
did they elaborate upon the items they indicated on the checklist. The
lack of details pertaining to the individual borrower or the lender's
financial condition raised questions about the usefulness of the credit
elsewhere documentation provided by lenders. Given the broad authority
granted to lenders, more information specific to the borrower's or the
lender's financial condition would help support the lender's assessment
that the borrower could not obtain credit elsewhere. For example, a
statement containing both the borrower's available collateral and the
amount of collateral the lender requires for a conventional loan would
support the conclusion that the "value of available collateral is
unacceptable."
However, one lender we visited provided more detailed information about
borrowers' credit/financial positions and the reasons that 7(a) loans
were more suitable than conventional loans, which provided greater
assurance that the borrower could not obtain credit elsewhere. In
addition to substantiating that the borrower could not obtain credit
elsewhere, the lender provided notes documenting why the borrower was
denied a conventional loan. For example:
* Credit elsewhere documentation: "Business is new and does not have
sufficient operating history." Conventional loan denial: "Length of
time in business and/or current management; inadequate cash flow;
delinquent past or present credit obligations with others; revolving
balances to revolving credit limits is high."
* Credit elsewhere documentation: "Business and personal scores are
below the conventional requirement." Conventional loan denial:
"Foreclosure, repossession, collection judgment, terms and conditions
requested are not offered on this product. Inadequate cash flow."
In addition, two other lenders provided more detailed information in
some instances. For example:
* "Credit is not available elsewhere due to the fact that the applicant
business is not fully secured by the liquidation value of the
collateral being pledged. In addition, there is only 1 year old
repayment ability from past operations and the applicant requires a
maturity greater than the 12 years that [the lender] will go out on
commercial loans."
* "[The lender] would not be willing to provide conventional financing
on this project at rates and terms acceptable to provide sufficient
cash flow for repayment. The fact that the applicants will be injecting
10 percent into the project and have requested a 20 year term does not
qualify for conventional financing under our present loan policy. We
would not be able to provide funds without the use of the SBA
guaranteed loan program."
The results of our file review show that most lenders tend to use
generic language to meet credit elsewhere compliance requirements,
making it difficult to determine with certainty whether borrowers could
not obtain credit elsewhere. When conducting oversight, SBA needs to
ensure that lenders are making loans only to borrowers that meet the
eligibility requirements of the program. In the absence of detailed
guidance on what exactly SBA wants lenders to document or a more
prescriptive credit elsewhere requirement, lenders will likely continue
to offer limited credit elsewhere statements in their files, making
meaningful oversight of compliance with the requirement difficult. For
more information on how SBA could create a more prescriptive
requirement and the implications of doing so, see appendix III.
Conclusions:
The 7(a) program is intended to serve creditworthy small business
borrowers who cannot obtain credit through a conventional lender at
reasonable terms and do not have the personal resources to provide it
themselves. In most cases, SBA relies on the lender to determine if a
borrower is eligible for a 7(a) loan, including determining whether the
borrower could obtain credit elsewhere. Relying on lenders with
delegated authority underscores the importance of SBA guidance and
oversight. However, SBA's lack of guidance to lenders on how to
document compliance with the credit elsewhere requirement impedes the
agency's ability to oversee compliance with the credit elsewhere
requirement.
SBA's guidance to lenders on documenting compliance with the credit
elsewhere requirement is limited. SOP 50-10 requires lenders to retain
explanations of their credit elsewhere determinations in borrowers'
loan files but does not specify the amount of detail lenders should
include in their explanations. Even with the lack of detail required,
the results of SBA's on-site reviews of 7(a) lenders--the agency's
primary means of ensuring compliance with the credit elsewhere
requirement--indicated that documenting credit elsewhere determinations
was a problem for some lenders. Our review of a recent six-quarter
period found that SBA had determined that nearly a third of the lenders
reviewed had not consistently documented that borrowers met the credit
elsewhere requirement or personal resources test. Further, the results
of file reviews we conducted at 18 lenders raise questions about the
usefulness of credit elsewhere documentation provided by lenders in
assessing compliance with the credit elsewhere requirement. We found
that lenders tended to provide general statements about a borrower's
ability to obtain credit elsewhere, generally citing just one of the
six acceptable factors listed in SOP 50-10 without customizing the
statement to fit the borrower or lender in question. This practice made
it difficult to reasonably conclude that borrowers met the credit
elsewhere requirement. The statute, regulations, and guidance allow
lenders to use their own conventional lending policies to make case-by-
case decisions about which borrowers need an SBA guarantee. Given the
broad authority granted to lenders, requiring documentation of the
analysis supporting their credit elsewhere decisions could help SBA
ensure that the eligibility requirement is being met. By collecting and
analyzing this additional information on how lenders are applying the
credit elsewhere standard, SBA could better ensure that lenders are
complying with the standard. Further, identifying promising practices
used by lenders to document their credit elsewhere determinations could
help SBA develop more specific guidance for lenders. Absent detailed
guidance on what exactly SBA wants lenders to document in their credit
elsewhere determinations, lenders will likely continue to offer limited
information in their files, making meaningful oversight of compliance
with the credit elsewhere requirement difficult.
Recommendation for Executive Action:
To improve SBA's oversight of lenders' compliance with the credit
elsewhere requirement, we recommend that the SBA Administrator issue
more detailed guidance to lenders on how to document their compliance
with the credit elsewhere requirement. As part of developing this
guidance, SBA could consider (1) requiring lenders to include the
analysis that supports their credit elsewhere determinations and (2)
identifying promising practices currently being used by lenders. After
revising its guidance, SBA also could consider collecting and analyzing
any additional information lenders are required to provide on how they
apply the credit elsewhere standard.
Agency Comments and Our Evaluation:
We requested SBA's comments on a draft of this report, and the
Associate Administrator of the Office of Capital Access provided
written comments that are presented in appendix IV. SBA stated that it
works to establish clear guidelines and standards that ensure
documented lender compliance without creating overly burdensome
paperwork. It also stated that it would work with its incoming
administrative leadership to use our findings to create more specific
guidance for lenders on documenting compliance with credit elsewhere
standards in a way that achieves this balance.
As agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies of this report
to the Chair and Ranking Member, Senate Committee on Small Business and
Entrepreneurship; Chairwoman and Ranking Member, House Committee on
Small Business; other interested congressional committees; and the
Acting Administrator of the Small Business Administration. The report
also will be available at no charge on the GAO Web site at [hyperlink,
http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-8678 or shearw@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. Key contributors to this report are
listed in appendix V.
Signed by:
William B. Shear:
Director, Financial Markets and Community Investment:
[End of section]
Appendix I: 7(a) Lending during the Credit Crisis:
Historically, the Small Business Administration's (SBA) 7(a) program
has been thought of as a countercyclical program or stimulus, meaning
that when conventional credit is tightened, lenders make broader use of
the guarantee program to serve the needs of small businesses. However,
during this most recent economic downturn, the number and value of
approved loans has decreased significantly (see fig. 5).
Figure 5: Number and Dollar Amount of Approved 7(a) Loans as Reported
by SBA, Fiscal Years 2003-2008:
[Refer to PDF for image: illustration]
Fiscal year: 2003;
Loans: 67,381;
Percentage change from previous year: Not applicable;
Dollars: $11.3 billion;
Percentage change from previous year: Not applicable.
Fiscal year: 2004;
Loans: 81,133;
Percentage change from previous year: 20%;
Dollars: $13.6 billion;
Percentage change from previous year: 20%.
Fiscal year: 2005;
Loans: 95,900;
Percentage change from previous year: 18%;
Dollars: $15.2 billion.
Percentage change from previous year: 12%.
Fiscal year: 2006;
Loans: 97,290;
Percentage change from previous year: 1%;
Dollars: $14.5 billion;
Percentage change from previous year: -5%.
Fiscal year: 2007;
Loans: 99,607;
Percentage change from previous year: 2%;
Dollars: $14.3 billion;
Percentage change from previous year: -1%.
Fiscal year: 2008;
Loans: 69,434;
Percentage change from previous year: -30%;
Dollars: $12.7 billion;
Percentage change from previous year: -11%.
Source: GAO analysis of SBA data.
[End of figure]
SBA and others have speculated as to the reasons for this decline.
* In October 2008, SBA issued a press release citing "a 'perfect storm'
of tightened credit by commercial lenders, declining creditworthiness,
and reduced demand for loans from small business borrowers uncertain
about the future" as the primary reasons for the substantial decrease
in 7(a) lending.[Footnote 33]
* Some lenders have said that the decline in premiums for selling
guaranteed portions of loans on the secondary market has reduced
incentives for those lenders who depend on premium income to make 7(a)
loans. By some estimates, premium rates have declined as much as 60
percent, resulting in significant reductions in income for SBA lenders.
* Others cited SBA's new oversight fees as a disincentive to begin or
continue 7(a) lending.[Footnote 34] According to SBA, lenders with 7(a)
portfolios of at least $10 million likely will pay oversight fees of
between $22,000 and $27,000.
* Finally, some lenders have said that the increased frequency with
which SBA has denied or reduced guarantees on defaulted loans for
failure to follow the rules for documenting loans has created
uncertainty among lenders over whether SBA will honor guarantees,
creating disincentives for lenders to participate in the program.
Although the degree to which these reasons may account for the steep
decline in 7(a) lending is unclear, SBA and Members of Congress have
implemented or proposed measures to stimulate lender and borrower
participation in the program.[Footnote 35] For example:
* SBA issued an interim rule allowing new SBA loans to be made with an
alternative base interest rate, the 1-month London Interbank Offered
Rate (LIBOR), in addition to the prime rate, which was previously
allowed. According to SBA, the prime and LIBOR rates have fluctuated
away from their historical relationship, typically 300 basis points,
squeezing SBA lenders out of the lending market because their costs are
based on the LIBOR rate.
* SBA has allowed a new structure for assembling SBA loans into pools
for sale in the secondary market. According to SBA, the enhanced
flexibility in loan pool structures can help affect profitability and
liquidity in the secondary market for SBA-guaranteed loans. Because the
average interest rate is used, these pools are easier for pool
assemblers to create, thus providing incentives for more investors to
bid on the loans.
* On November 24, 2008, the U.S. Department of the Treasury announced
that it would allocate $20 billion to back the creation of a $200
billion Term Asset-Backed Securities Loan Facility (TALF) at the
Federal Reserve Bank of New York. TALF will make loans to investors who
purchase asset-backed securities made up of small business loans
guaranteed by SBA, auto loans, student loans, or credit card loans.
According to SBA, this will make it easier for lenders to sell the
loans they make and use the proceeds of those sales to make new loans.
* Introduced on February 7, 2008, the Small Business Lending Stimulus
Act of 2008 (S. 2612) proposed to reduce 7(a) loan fees and authorize
appropriations to cover such fee reductions. Specifically, the bill
proposed to reduce fees on loans of less than $150,000 from 2 percent
to 1 percent, on loans between $150,000 and $700,000 from 3 percent to
2.5 percent, and on loans of over $700,000 from 3.5 percent to 3
percent.
* Introduced on November 19, 2008, the 10 Steps for a Main Street
Economic Recovery Act (S. 3705) proposed several measures to protect
and expand small business lending, including increasing the amount of
financing available to businesses under the 7(a) program from $2
million to $3 million, temporarily reducing fees to defray the cost of
borrowing for small businesses, and providing tax breaks to small
businesses.
[End of section]
Appendix II: Objectives, Scope, and Methodology:
In this report, we (1) describe SBA's criteria for determining that
borrowers cannot obtain credit elsewhere and practices lenders employ
to determine that borrowers cannot obtain credit elsewhere and (2)
examine SBA's efforts to ensure that lenders are complying with the
credit elsewhere provision.
To determine SBA's criteria for determining that borrowers cannot
obtain credit elsewhere, we reviewed applicable statutes, regulations,
and program guidance. For background on the 7(a) program and the credit
elsewhere provision, we reviewed the legislative history of the 7(a)
program, our previous reports, and studies of the program conducted by
the SBA Inspector General and external organizations.[Footnote 36] We
also interviewed officials from SBA's Office of Financial Assistance on
guidance provided to 7(a) lenders.
To determine the practices that lenders employ to meet the credit
elsewhere requirement, we visited 7(a) lenders located in and around
the following cities: Atlanta, Georgia; Chicago, Illinois; Houston,
Texas; Los Angeles, California; New York City, New York; San Francisco,
California; and Washington, D.C. During these site visits, we
interviewed officials at 18 lenders and reviewed 238 of their approved
7(a) loan applications. We selected these lenders to obtain a variety
in the types of 7(a) loans they made (preferred lender program [PLP]
and SBAExpress loans) and the size of their SBA loan portfolios. We
also considered geographic diversity. In addition, we interviewed
representatives of the National Association of Government Guaranteed
Lenders, the trade association for 7(a) lenders.
Using data obtained from SBA, we ranked 7(a) lenders in each of the
selected cities from largest to smallest based on the number of active
or outstanding 7(a) loans for each lender.[Footnote 37] With the
exception of Chicago and Washington, D.C., we contacted lenders in each
city in descending order until we achieved our quota (at least three in
each city).[Footnote 38] (See table 4.) For purposes of this report, we
considered small lenders to be those with 50 or fewer active or
outstanding 7(a) loans. We made three attempts to contact a lender
before moving on to the next lender on the list.
Table 4: Number and Size of Lenders Interviewed in Each Selected
Location:
City: Atlanta, Georgia;
Total number of lenders interviewed: 3;
Number of large lenders: 1;
Number of small lenders: 2.
City: Chicago, Illinois;
Total number of lenders interviewed: 1;
Number of large lenders: 0;
Number of small lenders: 1.
City: Houston, Texas;
Total number of lenders interviewed: 3;
Number of large lenders: 3;
Number of small lenders: 0.
City: Los Angeles, California;
Total number of lenders interviewed: 4;
Number of large lenders: 4;
Number of small lenders: 0.
City: New York City, New York;
Total number of lenders interviewed: 3;
Number of large lenders: 2;
Number of small lenders: 1.
City: San Francisco, California;
Total number of lenders interviewed: 3;
Number of large lenders: 2;
Number of small lenders: 1.
City: Washington, D.C.;
Total number of lenders interviewed: 1;
Number of large lenders: 1;
Number of small lenders: 0.
Source: GAO.
[End of table]
The applications we reviewed generally covered loans that were approved
within calendar years 2007 and 2008. The number of files we reviewed at
each lender was based on the size of the lender's portfolio and GAO
staff resources. On the basis of a pilot test at one lender, we
determined that we could review approximately 20 files during one site
visit. As a result, we reviewed between 5 and 25 of each lender's most
recently approved loans, depending on the size of the lender.[Footnote
39] To strengthen the accuracy of the collection of information from
lender files, we validated our data entry for 20 percent of all files
reviewed at each lender. The sample of lenders we visited was not
designed to be generalizable to the population of 7(a) lenders, nor was
the sample of loans at each lender designed to be generalizable to the
population of 7(a) borrowers at each lender.
To assess SBA's efforts to ensure lender compliance with the credit
elsewhere requirement, we reviewed excerpts from all 97 on-site lender
review reports completed from October 1, 2006, through March 31, 2008.
These excerpts documented SBA's assessment of the lenders' compliance
with the credit elsewhere requirement and personal resources test. We
also reviewed correspondence between SBA and the 31 lenders that had
credit elsewhere or personal resources test findings. This
correspondence detailed the corrective actions that the lenders had
implemented or agreed to implement to address the identified
deficiencies. We interviewed staff from SBA's Office of Credit Risk
Management on their oversight of 7(a) lenders and the SBA contractor
that performs the on-site reviews on steps taken during on-site reviews
to assess compliance with the credit elsewhere requirement and personal
resources test.
We conducted our work in Atlanta, Georgia; Chicago, Illinois; Houston,
Texas; Los Angeles, California; New York City, New York; San Francisco,
California; and Washington, D.C., between February 2008 and February
2009 in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit
to obtain sufficient, appropriate evidence to provide a reasonable
basis for our findings and conclusions based on our audit objectives.
We believe that the evidence obtained provides a reasonable basis for
our findings and conclusions based on our audit objectives.
[End of section]
Appendix III: Implications of Imposing a More Prescriptive Credit
Elsewhere Requirement:
SBA could revise the implementing regulations and guidance for the 7(a)
program to create a more prescriptive credit elsewhere requirement. For
example, SBA could establish some general guidelines describing
quantitative thresholds or ranges for cash flow and credit score that
lenders could consider when making 7(a) loans.[Footnote 40] The agency
could require lenders who made loans to borrowers who fell outside of
the recommended ranges to document the reasons for their decisions.
Further, additional guidelines could help lenders determine when it was
acceptable to cite reasons associated with the lending institution
itself to substantiate that a borrower could not obtain credit
elsewhere. In such a scenario, some of these reasons might apply only
to certain institutions. For example, only nondepository institutions,
such as small business lending companies (SBLC), might be allowed to
cite as a reason for extending 7(a) credit the need to sell the
guaranteed portion of the loan on the secondary market.
A more prescriptive credit elsewhere requirement would address some of
the challenges with the requirement as it is currently written. For
example, as previously discussed, a broad requirement allows lenders to
make case-by-base decisions about the types of borrowers that cannot
obtain credit elsewhere. Because different lenders have different
lending policies, the types of borrowers they serve under the program
also differ. The absence of well-defined eligibility criteria makes it
difficult for SBA to determine whether borrowers receiving 7(a) loans
actually could not obtain conventional credit. In addition, these
variations in lending policies and the types of borrowers served make
it challenging for SBA to collect relevant information for evaluations
of how well the 7(a) program is serving its intended mission. In a July
2007 report on the 7(a) program, we highlighted the need for SBA to
improve upon its current efforts to collect and evaluate performance
data for the 7(a) program.[Footnote 41] According to SBA, it is in the
process of developing additional performance measures.
A more prescriptive standard could be beneficial in light of proposals
that, if enacted, would reduce fees for borrowers and temporarily
change the program from a zero subsidy program to a positive subsidy
program.[Footnote 42] Such proposals have been made for reasons such as
expanding credit for small businesses during the current economic
downturn. According to SBA and lenders interviewed as part of an Urban
Institute report, the higher fees currently associated with the 7(a)
program act as a credit-rationing mechanism.[Footnote 43] They
explained that the higher fees deter borrowers who could obtain credit
elsewhere from participating in the program, as the fees associated
with conventional loans are significantly lower. However, if the fees
associated with the program were lowered or eliminated, the impact of
this rationing mechanism would be reduced. With the reduction of fees,
a more prescriptive credit elsewhere requirement that clearly outlines
which businesses are eligible for the 7(a) program could help to
minimize incentives for lenders to make loans to borrowers that have
access to credit elsewhere.
However, the increased burden on lenders resulting from a more
prescriptive credit elsewhere requirement could limit their
participation in the program and, as a result, decrease small
businesses' access to credit. In addition, a more prescriptive standard
could arbitrarily exclude some borrowers from obtaining guaranteed
credit but compel lenders to make loans to borrowers that they and the
market did not deem creditworthy. Finally, restricting lenders' ability
to cite their own reasons to substantiate that a borrower could not
obtain conventional credit might limit access to credit in some
communities, especially those with few lending institutions to supply
credit or those that rely on SBLCs--nondepository institutions with
delegated authority to make 7(a) loans.
[End of section]
Appendix IV: Comments from the Small Business Administration:
U.S. Small Business Administration:
Washington, DC 20416:
February 3, 2009:
Mr. William Shear:
Director, Financial Markets and Community Investment Issues:
U.S. Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Mr. Shear:
Thank you for the opportunity to comment on GAO's draft report---Small
Business Administration: Additional Guidance on Documenting Credit
Elsewhere Decisions Could Improve 7(a) Program Oversight.
We are very pleased to see that, in the draft report, GAO concludes
that our oversight efforts are making a difference and helping lenders
better understand and comply with the U.S. Small Business
Administration's (SBA) policies.
SBA works to establish clear guidelines and standards that ensure
documented lender compliance without creating overly burdensome
paperwork. The Agency will work with its incoming Administrative
leadership to use the findings presented by GAO to create more specific
guidance for lenders around documenting compliance with credit
elsewhere standards in a way that achieves this balance.
If you have any questions, please contact Tiffani Cooper, GAO Liaison
at (202) 205-6702.
Sincerely,
Signed by: [Illegible]
for: Eric R. Zarnikow:
Associate Administrator:
Office of Capital Access:
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
William B. Shear, (202) 512-8678 or shearw@gao.gov:
Staff Acknowledgments:
In addition to the individual named above, Paige Smith (Assistant
Director), Benjamin Bolitzer, Tania Calhoun, Marcia Carlsen, Emily
Chalmers, Janet Fong, Marc Molino, Carl Ramirez, Cory Roman, and
Jennifer Schwartz made contributions to this report.
[End of section]
Footnotes:
[1] In 1958, Congress withdrew the Small Business Act of 1953 and
enacted the substantially similar Small Business Act of 1958. Pub. L.
No. 85-536, 72 Stat. 384 (1958). Section 7(a) of the 1958 act, now
codified at 15 U.S.C. § 636(a), provides the authority for the 7(a)
program.
[2] In this report, a loan without a federal guarantee is called a
conventional loan, conventional credit, or a loan obtained from a
conventional lender.
[3] See appendix I for a discussion of 7(a) lending during the current
credit crisis.
[4] Reasonable terms and conditions are to be determined by the lender,
taking into consideration "the prevailing rates and terms in the
community in or near which the concern transacts business, or the
homeowner resides, for similar purposes and periods of time." 15 U.S.C.
§ 632(h).
[5] GAO, Standards for Internal Control in the Federal Government,
[hyperlink, http://www.gao.gov/products/GAO/AIMD-00-21.3.1]
(Washington, D.C.: November 1999).
[6] The Small Business Budget Reconciliation and Loan Consolidation/
Improvement Act of 1981, Pub. L. No. 97-35, title XIX, § 1902, 95 Stat.
767 (1981).
[7] Although SBA has limited legislative authority to make direct loans
to borrowers unable to obtain loans from conventional lenders, SBA has
not received any funding for these programs since fiscal year 1996.
[8] In establishing size standards, SBA considers economic
characteristics of the industry, including degree of competition,
average firm size, start-up costs and entry barriers, and distribution
of firms by size. It also considers growth trends, competition from
other industries, and other factors that may distinguish small firms
from other firms. SBA's size standards seek to ensure that a firm that
meets a specific size standard is not dominant in its field of
operation.
[9] By signing the loan guarantee application, the lender is certifying
that "without the participation of SBA to the extent applied for, we
would not be willing to make this loan, and in our opinion the
financial assistance applied for is not otherwise available on
reasonable terms."
[10] Prior to a reorganization in May 2007, the office was called the
Office of Lender Oversight.
[11] 15 U.S.C. § 636 (a)(1).
[12] 13 C.F.R. § 120.101. Neither the statute nor the regulations
specifically define "reasonable terms."
[13] SOP 50-10 defines "unreasonable terms" as the following: (1) debt
structured with a demand note or a balloon payment, (2) debt for which
the payments exceed the borrower's ability to pay, (3) debt with an
interest rate that is significantly above the market rate, (4) credit
card debt, and (5) interest-only term debt (SBA does not consider
interest-only lines of credit to have unreasonable terms). See SOP 50-
10(5), Lender and Development Company Loan Programs (Aug. 1, 2008),
127. SBA recently revised SOP 50-10, creating a new version 5 effective
August 2008.
[14] The legal lending limit for national banks is set forth at 12
U.S.C. § 84. Legal lending limits are generally high--12 U.S.C. § 84(a)
specifies that loans to one borrower generally cannot exceed 15 percent
of the bank's capital and that lenders can make additional loans to a
borrower totaling up to 10 percent of the bank's capital if those
additional loans are fully secured by "readily marketable collateral."
The legal lending limit also generally applies to Federal Deposit
Insurance Corporation-insured thrift institutions. See 12 U.S.C. §
1464(u). State law applies legal lending limits to state-regulated
banks. Lenders are permitted to sell the guaranteed portion of 7(a)
loans on the secondary market pursuant to 13 C.F.R. Part 120, Subpart
F. SOP 50-10 also specifies two "unacceptable factors," or factors
lenders cannot use to substantiate that a borrower could not obtain
credit elsewhere: (1) to address compliance with the Community
Reinvestment Act and (2) to refinance debt already on reasonable terms.
The Community Reinvestment Act of 1977 (12 U.S.C. § § 2901 et seq.) was
designed to encourage community banks and savings associations to meet
the needs of borrowers in all segments of their communities, including
low-and moderate-income neighborhoods, and was intended to reduce
discriminatory credit practices against such neighborhoods.
[15] See the Urban Institute, An Analysis of the Factors Lenders Use to
Ensure Their SBA Borrowers Meet the Credit Elsewhere Requirement, Final
Report (Washington, D.C.: January 2008). Appendix II contains a
technical assessment of this study.
[16] According to SBA guidance, "lenders must analyze each application
in a commercially reasonable manner, consistent with prudent lending
standards." See SOP 50-10(5), chapter 4, Credit Standards, Collateral,
and Environmental Policies.
[17] The Urban Institute described relationship underwriting as a
process during which a lender works with a small business customer in
order to provide the most appropriate types of financing, given the
firm's expected cash flow from operations.
[18] The sample of 18 lenders with whom we met was not statistically
representative and not large enough to generalize to all lenders. Nor
was the number of files we reviewed at each lender representative of
all borrowers served by each individual lender. The files we reviewed
generally were approved in calendar years 2007 and 2008.
[19] The Urban Institute noted an additional common reason lenders
cited to substantiate that borrowers could not obtain credit elsewhere:
For real estate loans, the borrower did not have sufficient equity for
the required down payment.
[20] GAO, Small Business Administration: Additional Measures Needed to
Assess 7(a) Loan Program's Performance, [hyperlink,
http://www.gao.gov/products/GAO-07-769] (Washington, D.C.: July 13,
2007).
[21] SOP 50-10(5), 174.
[22] [hyperlink, http://www.gao.gov/products/GAO/AIMD-00-21.3.1].
[23] SOP 50-10(5) is consistent with, but generally does not elaborate
upon, 13 C.F.R. § 120.101, which requires the lender to certify or
otherwise show that the desired credit is not available elsewhere.
Submission of an application to SBA by a lender constitutes
certification by the lender that it has examined the availability of
credit to the applicant, has based its certification upon that
examination, and has substantiation in its file to support the
certification. The SOP lists six factors that lenders can use to
substantiate compliance with the credit elsewhere requirement.
[24] SBA also conducts some on-site examinations of SBLCs with
outstanding balances of less than $10 million.
[25] The 504 loan program finances long-term fixed assets through a
combination of public and private sector financing. The 504 loans are
issued through a partnership with CDCs and private sector third-party
lenders. CDCs are nonprofit corporations certified and regulated by SBA
to package, process, close, and service 504 loans. SBA performs off-
site monitoring of about 4,500 smaller 7(a) and 504 lenders, but this
monitoring does not assess compliance with the credit elsewhere
requirement.
[26] According to SBA, it began performing on-site risk-based reviews
of 7(a) lenders in fiscal year 2005 and implemented fee-based reviews
in late fiscal year 2007. Over a 2-year period (fiscal years 2008 and
2009), SBA plans to review all large 7(a) lenders, subject to available
resources.
[27] See SOP 51 00, On-Site Lender Reviews/Examinations (Sept. 28,
2006).
[28] As previously mentioned, the six factors are (1) the business
needs a longer maturity than the lender's policy permits, (2) the
requested loan exceeds either the lender's legal lending limit or
policy limit regarding the amount that it can lend to a single
customer, (3) the lender's liquidity depends upon selling the
guaranteed portion of the loan on the secondary market, (4) the
collateral does not meet the lender's policy requirements, (5) the
lender's policy normally does not allow loans to new businesses or
businesses in the applicant's industry, or (6) any other factors
relating to the credit that, in the lender's opinion, cannot be
overcome except for the guarantee.
[29] The on-site review reports for 21 additional lenders identified
citations related to the credit elsewhere requirement or personal
resources test, but SBA determined that there were not enough citations
to warrant a finding.
[30] In late September 2008, SBA populated a database created to track
the results of on-site reviews performed from fiscal year 2005 to the
present. Because this database was developed at the end of our review,
we did not include an assessment of it in this report.
[31] A corrective action is a requirement placed upon a lender to
implement, modify, alter, change, or cease a component of its SBA
lending activity.
[32] The loan-to-value ratio is the percentage of a property's value
that is mortgaged. Higher loan-to-value ratios mean a higher risk for
the lender.
[33] SBA, Tightened Credit, Reduced Demand Push SBA Loan Volume Down in
FY 2008; Agency Works with Banks to Jumpstart Small Business Lending
(Oct. 30, 2008).
[34] In fiscal year 2007, SBA started charging 7(a) lenders fees to
cover the cost of on-site reviews. These fees are separate from the
guarantee fee and annual servicing fees that lenders pay.
[35] SBA, SBA Announces New Ways to Improve Small Business Access to
Credit (Nov. 13, 2008).
[36] This report cites findings from the Urban Institute, An Analysis
of the Factors Lenders Use to Ensure Their SBA Borrowers Meet the
Credit Elsewhere Requirement, Final Report (January 2008). In general,
we found that the authors of the study followed a reasonable
methodology in their interviews with 23 banks, given their objectives,
and that the study could be cited with some caveats. Although the Urban
Institute attempted to interview a cross section of lenders, it could
not guarantee that the sample was representative of all lenders.
Specifically, because only 23 of the 73 lenders agreed to interviews,
this raises the possibility that the other lenders would have given
different responses.
[37] We received data from SBA's Loan Accounting System (LAS) on all
lenders that made one or more SBA loans during fiscal years 2005-2007.
We previously performed testing on SBA's LAS and found the system and
data to be reliable. See [hyperlink,
http://www.gao.gov/products/GAO-07-769], Small Business Administration:
Additional Measures Needed to Assess 7(a) Loan Program's Performance
(Washington, D.C.: July 13, 2007). In addition, we performed
reliability testing on the data extraction we received from SBA,
including testing the extraction for missing and incomplete data, and
found the data to be reliable for purposes of selecting a sample of
lenders to interview for this report.
[38] We conducted a pilot test of our data collection instrument with
one lender in Washington, D.C. We attempted to contact and schedule
interviews and file reviews with three lenders in Chicago; however,
only one lender responded to our request.
[39] In only one case was the number of files requested not available.
As a result, we reviewed fewer files at that lender than our
methodology required.
[40] A personal credit score is generated by a mathematical formula
using information from a credit report. Personal credit scores can
range from 300 to 850. Lenders we spoke to do not consider any
variable, such as credit score or debt service coverage ratio (DSCR),
in isolation when making lending decisions. In fact, low credit scores
or DSCRs may be compensated for with more valuable collateral or
management experience, for example. Guidelines outlining quantitative
or other thresholds would have to be flexible enough so as not to
require lenders to make lending decisions based on one variable.
[41] [hyperlink, http://www.gao.gov/products/GAO-07-769].
[42] In fiscal year 2005, the 7(a) program became a zero subsidy
program, which means it is entirely funded by user fees and does not
receive an annual appropriation for new loan guarantees. However, the
conference report accompanying the bill to eliminate program subsidies
agreed to revisit the decision in the event of an economic downturn.
See Conf. Rep. No. 108-792, Making Appropriations for Foreign
Operations, Export Financing, and Related Programs for the Fiscal Year
Ending September 30, 2004, and for Other Purposes (Nov. 20, 2004)
(accompanying H.R. 4818, 108th Cong., 2nd Sess.) at 843. Introduced on
February 7, 2008, the Small Business Lending Stimulus Act of 2008 (S.
2612) proposed to reduce 7(a) loan fees and authorize appropriations to
cover such fee reductions. Specifically, the bill proposed to reduce
fees on loans of less than $150,000 from 2 percent to 1 percent, on
loans between $150,000 and $700,000 from 3 percent to 2.5 percent, and
on loans of over $700,000 from 3.5 percent to 3 percent. Introduced on
November 19, 2008, the 10 Steps for a Main Street Economic Recovery Act
of 2008 (S. 3705) contained a provision that would temporarily reduce
fees to defray the costs of borrowing for small businesses owners and
SBA lenders. If enacted, the bill would reduce fees for the 7(a)
program.
[43] See the Urban Institute, An Analysis of the Factors Lenders Use to
Ensure Their SBA Borrowers Meet the Credit Elsewhere Requirement, Final
Report (January 2008).
[End of section]
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