oversight

Small Business Administration: Progress Made but Improvements Needed in Lender Oversight

Published by the Government Accountability Office on 2003-04-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                            United States General Accounting Office

GAO                         Testimony
                            Before the Committee on Small Business
                            and Entrepreneurship, U.S. Senate


For Release on Delivery
Expected at 9:30 a.m. EDT
Wednesday, April 30, 2003   SMALL BUSINESS
                            ADMINISTRATION
                            Progress Made but
                            Improvements Needed in
                            Lender Oversight
                            Statement of Davi M. D'Agostino
                            Director, Financial Markets and Community Investments




GAO-03-720T
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Madam Chair and Members of the Committee:

I am pleased to be here today at this roundtable to discuss the results of
our work on the Small Business Administration’s (SBA) oversight of its
7(a) loan program lenders, particularly those who participate in the
Preferred Lenders Program or PLP. SBA delegates full authority to
preferred lenders to make loans without prior SBA approval. In fiscal year
2002, preferred lenders approved 55 percent of the dollar value of all 7(a)
loans—about $7 billion. Small businesses are certainly a vital part of the
nation’s economy. According to SBA, they generate more than half of the
nation’s gross domestic product and are the principal source of new jobs
in the U.S. economy. In turn, SBA’s mission is to maintain and strengthen
the nation’s economy by aiding, counseling, assisting, and protecting the
interests of small businesses. Providing small businesses with access to
credit is a major avenue through which SBA strives to fulfill its mission.
Strong oversight of lenders by SBA is needed to protect SBA from
financial risk and to ensure that qualified borrowers get 7(a) loans. SBA
has a total portfolio of about $46 billion, including $42 billion in direct and
guaranteed small business loans and other guarantees.1 Because SBA
guarantees up to 85 percent of the 7(a) loans made by its lending partners,
there is risk to SBA if the loans are not repaid. SBA must ensure that
lenders provide loans to borrowers who are eligible and creditworthy to
protect the integrity of the 7(a) program.

Our statement today is based on the report we issued December 9, 2002,
Small Business Administration: Progress Made but Improvements
Needed in Lender Oversight (GAO-03-90). The report and our remarks will
focus on our evaluation of (1) SBA’s 7(a) lender oversight program and (2)
SBA’s organizational alignment for conducting oversight of preferred
lenders and Small Business Lending Companies (SBLC).2 In addition, we
will comment on SBA’s latest response to our findings and
recommendations.3 Our overall objective is to provide the Committee with
information and perspectives to consider as it moves forward on SBA
reauthorization.


1
As of September 30, 2002.
2
 SBLCs, which make only 7(a) loans, are privately owned and managed, nondepository,
lending institutions that are licensed and regulated by SBA but not generally regulated or
examined by financial institution regulators.
3
Hector Barreto, SBA Administrator, letter to The Honorable Susan Collins, Chair,
Committee on Government Affairs, U.S. Senate, March 12, 2003.



Page 1                                                                        GAO-03-720T
              In analyzing SBA’s oversight of its preferred lenders, we defined oversight
              to include both SBA’s reviews of preferred lenders for compliance with
              SBA rules and regulations and SBA’s evaluations of lenders to decide their
              initial and continued participation in the PLP. We focused our reviews in
              part to follow up on recommendations made in our June 1998 report,
              where we found that SBA was doing few reviews of its preferred lenders.4
              We analyzed a sample of review reports and PLP guidance, and review and
              lending data to the extent that they were available. We also interviewed
              SBA headquarters and regional staff, PLP lenders, and representatives of
              the National Association of Government Guaranteed Lenders.


              SBA has made progress in developing its lender oversight program, but
Summary       there are still areas in need of improvement. While SBA has identified
              appropriate elements for an effective lender oversight program, it has been
              slow to change programs and procedures to fully incorporate all of these
              elements. In addition, financial risk management issues have become more
              critical for SBA, as its current loan programs focus on partnering with
              lenders, primarily banks, that make loans guaranteed up to 85 percent by
              SBA. However, our work showed that

          •   SBA had not yet consistently incorporated adequate measures of financial
              risk into the PLP review process or the SBLC examination program.

          •   The current PLP review process, which SBA uses to ensure compliance
              with the program mission, rules, and regulations, involves a cursory
              review of documentation maintained in lenders’ loan files rather than a
              qualitative assessment of borrower creditworthiness or eligibility.

          •   SBA’s standards for borrower eligibility (the “credit elsewhere”
              requirement) are broad and therefore subject to interpretation.

          •   SBA had not developed clear enforcement policies for preferred lenders or
              SBLCs that would specifically describe its response in the event that
              reviews discover noncompliance or safety and soundness problems.




              4
               U.S. General Accounting Office, Small Business Administration: Few Reviews of
              Guaranteed Lenders Have Been Conducted, GAO/GGD-98-85 (Washington, D.C.: June
              1998).



              Page 2                                                                GAO-03-720T
•   SBA had been slow to finalize and issue SBLC examination reports.5 In
    addition, SBA had been slow to respond to recommendations for
    improving the SBLC examination program.

    Without continued improvement to better enable SBA to assess the
    financial risk posed by 7(a) loans and to ensure that its lending partners
    are making loans to eligible small businesses, SBA will not have a
    successful lender oversight program.

    Although SBA has listed the oversight of its lending partners as an agency
    priority, the function does not have the necessary organizational
    independence or resources to accomplish its goals. In our past work
    analyzing organizational alignment and workload issues, we have
    described the importance of (1) tying organizational alignment to a clear
    and comprehensive mission statement and strategic plan and (2) providing
    adequate resources to accomplish the mission. However, two different
    offices—Lender Oversight and Financial Assistance, both of which are in
    the Office of Capital Access (OCA)—carry out SBA’s lender oversight
    functions (see fig. 1). OCA also promotes and implements SBA’s lending
    programs. This alignment presents a possible conflict because PLP
    promotion and operations are housed in the same office that assesses
    lender compliance with SBA safety and soundness and mission
    requirements. Additionally, split responsibilities within OCA and limited
    resources have impeded SBA’s ability to complete certain oversight
    responsibilities, which could result in heightened risk to its portfolio or
    lack of comprehensive awareness of portfolio risk.

    Our report made recommendations to improve SBA’s oversight of its
    lenders. Specifically, we recommended that SBA:

•   incorporate strategies into its review process to adequately measure the
    financial risk lenders’ portfolios of guaranteed SBA loans pose to SBA,

•   develop specific criteria to apply to the credit elsewhere standard used to
    determine borrower eligibility,




    5
     Since 1999, SBA has had an agreement with the Farm Credit Administration (FCA) to
    conduct safety and soundness examinations of the SBLCs. FCA is an independent agency
    within the executive branch; it regulates Farm Credit System institutions. FCA also
    contracts with other government agencies to provide examination services.



    Page 3                                                                  GAO-03-720T
•   perform qualitative assessments of lenders’ performance and lending
    decisions,

•   clarify its enforcement authority and specify conditions under which it
    would take enforcement action,

•   make the preferred lender program more accessible to large national
    lenders, and

•   better emphasize lender oversight in its organizational alignment to
    provide an oversight office with greater autonomy within SBA to match
    the growing importance of lender oversight.

    SBA essentially disagreed with part or all of our recommendations for
    improving its assessments of lenders, said that it was “working to address”
    issues we raised about enforcement and accessibility of the preferred
    lender program, and disagreed with our recommendation to separate
    lender oversight functions and responsibilities from preferred lender
    program management functions.




    Page 4                                                         GAO-03-720T
             Figure 1: Preferred Lender Oversight Responsibilities within OCA




             The 7(a) loan program, which is authorized by Section 7(a) of the Small
Background   Business Act, is SBA’s largest business loan program.6 It is intended to
             serve small business borrowers who otherwise cannot obtain financing
             under reasonable terms and conditions from the private sector. In
             administering the 7(a) program, SBA has evolved from making guaranteed
             loans directly to depending on lending partners, primarily banks.7 Under
             7(a), SBA provides guarantees of up to 85 percent on loans made by
             participating lenders.

             Within 7(a), there are three classifications of lenders—regular, certified,
             and preferred. SBA evaluates and grants preferred lender status to 7(a)


             6
             15 U.S.C. § 636 (2000).
             7
              Other types of financial institutions, such as savings banks, are lending partners. In this
             statement, we refer to all financial institutions that make 7(a) loans as banks.



             Page 5                                                                          GAO-03-720T
lenders after receiving nominations and reviews from its 70 district offices
and a regional processing center. Of the three categories, preferred lenders
have the most autonomy in that they can make loans without prior SBA
review or approval. Most preferred lenders are banks that have their own
safety and soundness regulators, such as the Office of the Comptroller of
the Currency. Those regulators, however, may not focus on the 7(a) loans
that SBA guarantees when they examine the bank. The other preferred
lenders, which are SBLCs, have no regulator other than SBA—making SBA
oversight more critical. As of August 2002, SBA had over 400 preferred
lenders. To give you an idea of this program’s scope, in fiscal year 2002,
7(a) loan approvals totaled approximately $12.2 billion, of which preferred
lenders approved $6.7 billion. However, preferred lending activity is
concentrated in a few larger institutions. Less than 1 percent of 7(a)
lenders account for more than 50 percent of 7(a) dollar volume
outstanding. According to SBA, most of these lenders are preferred
lenders.

Two offices within SBA have primary responsibility for 7(a) lender
oversight—the Office of Lender Oversight (OLO) and the Office of
Financial Assistance (OFA). OLO is responsible for many oversight
functions, such as managing all headquarters and field office activities
regarding lender reviews. However, OFA has retained some oversight
responsibilities. OFA’s current role in lender oversight is to provide final
approval of lenders’ PLP status. Lenders are granted PLP status in specific
SBA districts for a period of 2 years or less. OFA collects information
about the lender prepared by the Sacramento Processing Center, with
input from one or more of SBA’s 70 district offices, and decides whether to
renew a lender’s PLP status or to grant status in an additional district. OFA
may also discontinue a lender’s PLP status.

Other lenders participating in the 7(a) program are subject to a different
oversight regime. Specifically, SBA divides SBLC program functions
between OLO and OFA. OLO is responsible for SBLC on-site examination,
and OFA handles day-to-day program management and policymaking.
Ultimate responsibility for enforcement of corrective actions rests with
OCA. As participants in the 7(a) program, SBLCs are subject to the same
review requirements as other 7(a) lenders, and they are also subject to
safety and soundness oversight by SBA.




Page 6                                                           GAO-03-720T
                           SBA has identified goals for its lender oversight program that are
Lender Oversight Is        consistent with appropriate standards for an oversight program; however,
Not Achieving All of       SBA had not yet established a program that is likely to achieve them. Since
                           our last review, SBA had made progress in developing its lender oversight
Its Goals                  program, but there are still areas in need of improvement if SBA is to
                           develop a successful program. SBA has highlighted risk management in its
                           strategy to modernize the agency; however, PLP reviews are not designed
                           to evaluate financial risk, and the agency has been slow to respond to
                           recommendations made for improving its monitoring and management of
                           financial risk—posing a potential risk to SBA’s portfolio. PLP reviews are
                           designed to determine lender compliance with SBA regulations and
                           guidelines, but they do not provide adequate assurance that lenders are
                           sufficiently assessing eligibility and creditworthiness of borrowers.

                           Although SBA has identified problems with preferred lender and SBLC
                           lending practices, it has not developed clear policies that would describe
                           enforcement responses to specific conditions. Thus, it is not clear what
                           actions SBA would take to ensure that preferred lenders or SBLCs address
                           lending program weaknesses. Although the process for certifying lenders
                           for PLP status—another means by which SBA oversees lenders—has
                           become better defined and more objective, some lenders told us they
                           continue to experience confusing and inconsistent procedures during this
                           process due to varying recommendations from field offices.


SBA Has Made Progress in   Since our June 1998 report, SBA has responded to a number of
Developing Its Lender      recommendations for improving lender oversight by developing guidance,
Oversight Function         establishing OLO, and doing more reviews. SBA developed “Standard
                           Operating Procedures” (SOP) for oversight of SBA’s lending partners and
                           the “Loan Policy and Program Oversight Guide for Lender Reviews” in
                           October 1999.

                           SBA established OLO in fiscal year 1999 to coordinate and centralize
                           lender review processes for PLP and SBLC oversight. OLO created a
                           “Reviewer Guide” for personnel engaged in PLP reviews and does training
                           for all SBA staff involved in conducting preferred lender reviews. OLO
                           officials said that to effectively oversee and monitor SBA lenders, they also
                           evaluate lender-generated risk to the SBA portfolio, work with SBA
                           program offices to manage PLP oversight operations, and plan to conduct
                           regular and systematic portfolio analysis using a new loan monitoring
                           system. Additionally, to minimize the number of visits SBLCs receive
                           during a year, OLO combined PLP reviews with SBLC examinations
                           performed by FCA.

                           Page 7                                                          GAO-03-720T
                          In another effort to improve the lender review process, SBA developed an
                          automated, 105-item checklist that is designed to make its analysis more
                          objective. The questionnaire addresses lender organizational structure,
                          policies, and controls, but the answers are provided in a “yes-no” format
                          and generally refer to the presence or absence of specific documents. SBA
                          noted that the format makes assessments of lenders more consistent and
                          objective. However, we note that without a more substantive method of
                          evaluating lender performance, this approach does not provide a
                          meaningful assessment.

                          SBA also has increased the number of PLP reviews performed. In June
                          1998, we reported that SBA had not reviewed 96 percent of 7(a) lenders,
                          including preferred lenders, in the districts we visited. SBA reviewed 385
                          reviews of 449 preferred lenders in its 2001-- 2002 review year.8


SBA’s Lender Oversight    While elements of SBA’s oversight program touch on the financial risk
Does Not Adequately       posed by preferred lenders, including SBLCs, weaknesses in the program
Focus on Financial Risk   limit SBA’s ability to focus on, and respond to, current and future financial
                          risk to their portfolio. Neither the PLP review process nor SBA’s off-site
                          monitoring efforts adequately focus on the financial risk posed by
                          preferred and other lenders to SBA. SBA oversight of SBLCs is charged
                          with monitoring how SBLCs administer their credit programs, identifying
                          potential problems, and keeping SBA losses to an acceptable level.
                          However, SBA’s progress in reporting examination results in a timely
                          manner and implementing other program improvements limits the
                          effectiveness of SBA’s SBLC oversight.

                          SBA officials stated that PLP reviews are strict compliance reviews that
                          are not designed to measure the lenders’ financial risk. Our review and
                          that of SBA’s Inspector General (IG) confirmed this. The PLP review
                          serves as SBA’s primary internal control mechanism to determine whether
                          preferred lenders are processing, servicing, and liquidating loans
                          according to SBA standards and whether such lenders should participate
                          in the programs. While the review has questions that touch on the financial
                          risk of a given loan, review staff are not required to answer them; and SBA
                          guidance explicitly states that the answers to the questions are for



                          8
                           SBA’s review year runs from April 1 to March 31. SBA officials explained that the initial
                          date of its contract with the vendor that conducts PLP reviews began on April 1, and they
                          have since used this as the beginning of their review year.



                          Page 8                                                                       GAO-03-720T
                         research purposes only and are not to be considered in making any
                         determinations about the lender. By not including an assessment of the
                         financial risk posed by individual lenders during PLP reviews, SBA is
                         missing an opportunity to gather information that could help predict PLP
                         lenders’ future performance, thereby better preparing SBA to manage the
                         risk to its portfolio. The SBA IG also suggested that financial risk and
                         lender-based risk should be considered as part of a comprehensive
                         oversight program.9

                         SBA’s off-site monitoring efforts do not adequately assess the financial risk
                         posed by PLP and other lenders. SBA currently uses loan performance
                         benchmarking and portfolio analysis to serve as its primary tools for off-
                         site monitoring. While SBA officials stated that loan performance
                         benchmarks are based on financial risk and serve as a measure to address
                         a lender’s potential risk to the SBA portfolio, we found that the
                         benchmarks were not consistently used for this purpose.10 In addition, we
                         found that OLO does not perform routine analysis of SBA’s portfolio to
                         assess financial risk. At the time of our review, staff produced ad-hoc
                         reports to analyze aggregate lending data to look for trends and to try to
                         anticipate risk.


SBA Has Not Eliminated   Currently, FCA staff responsible for SBLC safety and soundness
Weaknesses in SBLC       examinations also perform PLP reviews at SBLCs—these reviews are the
Oversight That Pose a    same ones that SBA contractors perform at preferred lenders and employ
                         the same review checklist.11 Upon the completion of its examinations, FCA
Threat to the SBA        provides a draft report to SBA for comment, incorporates any changes,
Portfolio                and then provides a final report to SBA, which, in turn, issues a final report
                         to the SBLC.



                         9
                          The SBA Inspector General defines financial risk as the composite risk posed by loans and
                         guarantees actually booked to SBA’s portfolio and how they perform over time, and defines
                         lender-based risk as the potential financial injury due to the lender’s failure to perform its
                         role properly. U.S. Small Business Administration, Office of Inspector General, Audit
                         Report PLP Oversight Process, Report Number 1-19, (Washington, D.C.: September 27,
                         2001).
                         10
                          The five benchmarks are ratios for currency, delinquency, default, liquidation, and loss.
                         Each is defined in SBA’s SOP.
                         11
                          FCA conducts broad-based examinations and evaluates each SBLC’s capital adequacy,
                         asset quality, management, earnings, and liquidity. The examinations are similar to safety
                         and soundness examinations performed by bank and government-sponsored enterprise
                         regulators.


                         Page 9                                                                         GAO-03-720T
SBA has not eliminated weaknesses in SBLC oversight, which were cited
by us and the SBA IG. We, and the SBA IG, found that final SBLC
examination reports were not issued in a timely manner. SBA’s IG
reported that final reports for fiscal year 2001 SBLC examinations were
not issued until February 2002, 10 months after OLO received the first
draft report from FCA.12 Our work confirmed these findings. We found that
OLO does not maintain standards for the timely issuance of examination
reports. However, OLO has recently developed draft customer service
goals calling for SBLC examination reports to be finalized within 90 days
of receipt of a draft report from FCA. However, as of August 2002, none of
the examination reports from fiscal year 2002 had been issued. According
to the IG, because of the delays in finalizing the reports and SBA’s policy
to delay any necessary enforcement actions until final reports are issued,
two SBLCs were allowed to continue operating in an unsafe and unsound
manner, despite early identification of material weaknesses during fiscal
year 2001 examinations. The effectiveness of any examination program is
measured, to a large degree, on its ability to identify and promptly remedy
unsafe and unsound conditions. By delaying reporting and remedial action,
SBA has significantly limited the effectiveness of its SBLC oversight
program.

SBA has been slow to implement recommendations from FCA for
improving the SBLC examination program. In addition to examining
SBLCs, FCA was asked by SBA to provide recommendations for changes
in the SBLC program. Each year FCA provides its views in a
comprehensive report. FCA’s September 1999 report made 15
recommendations, 12 of which SBA agreed to implement.13 We reviewed
the reports for fiscal years 2000 and 2001, in which FCA made additional
recommendations with which SBA agreed. Yet, the 2001 report still lists 8
recommendations from the 1999 report and 2 from the 2000 report. SBA
officials explained that limited resources have contributed to the delay in
implementation of many of these recommendations.




12
 U.S. Small Business Administration, Office of Inspector General, Improvements Are
Needed in the Small Business Lending Company Oversight Process, Report No. 2-12
(Washington, D.C.: March 20, 2002).
13
 We listed the 15 recommendations in our November 2000 report. See U.S. General
Accounting office, Small Business Administration: Actions Needed to Strengthen Small
Business Lending Company Oversight, GAO-01-192 (Washington, D.C.: November 2000).



Page 10                                                                   GAO-03-720T
PLP Reviews Do Not               Assessing whether a borrower is eligible for 7(a) assistance is difficult
Provide Adequate                 because the requirements are broad and variable, making a qualitative
Assurance That Lenders           assessment of a lender’s decision by a trained reviewer all the more
                                 important. SBA regulations require a lender to attest to the borrower’s
Are Sufficiently Assessing       demonstrated need for credit by determining that the desired credit is
Eligibility and                  unavailable to the borrower on reasonable terms and conditions from
Creditworthiness                 nonfederal sources without SBA assistance.14 These “credit elsewhere”
                                 provisions are particularly difficult to assess and must be determined prior
                                 to assessing other credit factors.15 SBA guidance also requires preferred
                                 lenders to certify that credit is not otherwise available and to retain the
                                 explanation in the borrower file.16 SBA does provide guidance on factors
                                 that may contribute to a borrower being unable to receive credit
                                 elsewhere. Factors that lenders should consider include the following:

                             •   The business requires a loan with a longer maturity than the lender’s
                                 policy permits;

                             •   The requested loan exceeds either the lender’s legal limit or policy limit,
                                 regarding amounts loaned to one customer;

                             •   The lender’s liquidity depends upon selling the guaranteed portion of the
                                 loan on the secondary market;

                             •   The collateral does not meet the lender’s policy requirements because of
                                 its uniqueness or low value;

                             •   The lender’s policy normally does not allow loans to new ventures or
                                 businesses in the applicant’s industry; and

                             •   Any other factors relating to the credit that in the lender’s opinion cannot
                                 be overcome except by receiving a guaranty.

                                 Based on these criteria, the credit elsewhere test could always be satisfied
                                 by structuring an SBA guaranteed loan so that its terms and conditions
                                 differ from those available on the commercial market. As a result, these


                                 14
                                  The SBA regulations do not further define “reasonable terms and conditions.” See also 13
                                 C.F.R. Section 120.101.
                                 15
                                  Section 7(a) of the Small Business Act states that “no financial assistance shall be
                                 extended if the applicant can obtain credit elsewhere.” 15 U.S.C. Section 636(a).
                                 16
                                  SBA SOP 50-10(4)(E).



                                 Page 11                                                                        GAO-03-720T
loans could be made available to businesses that could obtain credit
elsewhere on reasonable market terms and conditions, although not the
same terms and conditions offered with the SBA guarantee.

SBA officials stated that the credit elsewhere requirements are designed to
be broad so as to not limit a lender’s discretion and allow flexibility,
depending upon geographic region, economic conditions, and type of
business. For example, SBA officials said that when credit is more readily
available, businesses that require SBA assistance might be held to a
different standard, thereby making it more difficult to obtain the SBA
guarantee than when credit is tighter. Nonetheless, the flexibility that
lenders have along with the difficulty in assessing lenders’ credit
elsewhere decisions further support the need for developing specific
criteria for a credit elsewhere standard. These changes would facilitate a
more qualitative assessment of eligibility decisions made by preferred
lenders.

Moreover, because it is a cursory review of documents in the file, the PLP
review also does not qualitatively assess a lender’s credit decision.
Preferred lenders are required to perform a thorough and complete credit
analysis of the borrower and establish repayment terms on the loan in the
form of a credit memorandum. SBA guidance requires, at a minimum,
discussion in the credit memorandum of a borrower’s capitalization or
proof that the borrower will have adequate capital for operations and
repayment, as well as capable management ability.17 SBA officials said that
lender review staff focus on the lender’s process for making credit
decisions rather than the lender’s decision. SBA officials said that it is
unlikely that the review would result in a determination that the loan
should not have been made. An SBA official stated that review staff would
not perform an in-depth financial analysis to assess the lender’s credit
decision and that a lender’s process would only be questioned in the case
of missing documentation. For example, review staff would cite a lender if
it did not document the borrower’s repayment ability.

Some lenders we interviewed criticized the lack of technical expertise of
contract review staff. The lenders stated that review staff was unable to
provide additional insight into material compliance issues during the
review because of a lack of technical knowledge of the underwriting
process and requirements. For example, one lender said he was cited for


17
 SBA SOP 50-10(4).



Page 12                                                        GAO-03-720T
                         not signing a credit elsewhere statement, but the reviewer did not evaluate
                         a financial statement in the file substantiating the credit elsewhere
                         assessment.

                         To improve PLP and SBLC oversight, we recommended that SBA
                         incorporate strategies into its review process to adequately measure the
                         financial risk lenders pose to SBA, develop specific criteria to apply to the
                         credit elsewhere standard, and perform qualitative assessments of lender
                         performance and lending decisions. SBA stated that it believes the existing
                         statutes, regulations, policies, and procedures provide sufficient guidance
                         to lenders. These are the same sources we analyzed and found to be broad,
                         making a qualitative assessment of a lender’s decisions difficult. SBA has
                         responded that it does measure financial risk of SBLCs through the safety
                         and soundness examinations conducted by FCA and that the PLP lender
                         reviews do estimate some degree of financial risk. We had noted both of
                         these measures in our December 9, 2002 report. We also noted that SBA
                         had not acted on suggestions that FCA had made to enhance SBA’s
                         oversight of SBLCs. Only 3 of 15 preferred lender review reports that we
                         reviewed provided any evidence of such an assessment. And, we note,
                         SBA’s review guidance does not require such a review. Thus, our
                         recommendations remain open.


SBA Has Not Developed    SBA has authority to suspend or revoke a lender’s PLP status for reasons
Clear Enforcement        that include unacceptable loan performance; failure to make enough loans
Policies for Preferred   under SBA’s expedited procedures; and violations of statutes, regulations,
                         or SBA policies.18 However, SBA has not developed policies and
Lenders and SBLCs        procedures that describe circumstances under which it will suspend or
                         revoke PLP authority or how it will do so. SBA guidance does not include
                         specific follow-up procedures for PLP lenders that receive poor review
                         ratings, but it does discuss recommended patterns of follow-up. SBA
                         officials said that, in practice, they request action plans to address
                         deficiencies for any ratings of “minimally in compliance” and “not in
                         compliance.” In addition, lenders with ratings of not in compliance are to
                         receive follow-up reviews. SBA officials explained that because they want
                         to encourage lenders to participate in PLP, they prefer to work out
                         problems with lenders, and therefore rarely terminate PLP status. And,
                         where a lender persists in noncompliance, SBA will generally allow the
                         status to expire, rather than terminating it. However, without clear


                         18
                          13 C.F.R. § 120.455 (2002).



                         Page 13                                                         GAO-03-720T
                           enforcement policies, PLP lenders cannot be certain of the consequences
                           of certain ratings and they may not take the oversight program seriously.

                           In November 2000, we recommended that the SBLC examination program
                           could be strengthened by clarifying SBA’s regulatory and enforcement
                           authority regarding SBLCs. Although it has the authority to do so, SBA has
                           yet to develop, through regulation, clear policies and procedures for taking
                           supervisory actions. By not expanding the range of its enforcement
                           actions—which it can do by promulgating regulations—SBA is limited in
                           the actions it can take to remedy unsafe and unsound conditions in SBLCs.
                           SBA regulations only provide for revocation or suspension of an SBLC
                           license for a violation of law, regulation, or any agreement with SBA.
                           Without less drastic measures, SBA has a limited capability to respond to
                           unsatisfactory conditions in an SBLC. Unlike SBA, federal bank and thrift
                           regulators use an array of statutorily defined supervisory actions, short of
                           suspension or revocation of a financial institution’s charter or federal
                           deposit insurance, if an institution fails to comply with regulations or is
                           unsafe or unsound.

                           We recommended that SBA provide, through regulation, clear policies and
                           procedures for taking enforcement actions against preferred lenders and
                           SBLCs in the event of continued noncompliance with SBA’s regulations.
                           Most recently, SBA has responded that it does have clear policies and
                           procedures; however, the agency intends to expand upon them. We will
                           continue to followup and monitor SBA’s response to this recommendation.


SBA’s Process for          SBA’s preferred lender certification process begins when a district office
Administering PLP Status   serving the area in which a lender’s office is located nominates the lender
Presents Lenders with      for preferred status or when a lender requests a field office to consider it
                           for PLP status. The district will then request performance data regarding
Challenges                 the lender from SBA’s Sacramento Processing Center. The processing
                           center then provides the district office with data required to fill in part of a
                           worksheet developed for the nomination process. The district office sends
                           the completed worksheet, along with other required information, back to
                           the processing center. The processing center analyzes the nomination and
                           sends it with a recommendation to OFA for final decision.

                           According to SBA’s SOP, in making its decision, OFA considers whether
                           the lender (1) has the required ability to process, close, service, and
                           liquidate loans; (2) has the ability to develop and analyze complete loan
                           packages; and (3) has a satisfactory performance history with SBA. OFA
                           also considers whether the lender shows a substantial commitment to

                           Page 14                                                            GAO-03-720T
SBA’s “quality lending goals,” has the ability to meet the goals, and
demonstrates a “spirit of cooperation” with SBA.

OFA and district office staff said that although district offices do not
provide final approval of PLP status for lenders in their districts, they
generally play an important role and district input is given significant
weight. Most of the district office staff we interviewed believed that they
had considerable influence on OFA’s decision regarding a lender’s PLP
status.

A PLP lender may request an expansion of the territory in which it can
process PLP loans by submitting a request to the Sacramento Processing
Center. The processing center will obtain the recommendation of each
district office in the area into which the PLP lender would like to expand
its PLP operations. The processing center will forward the district
recommendations to OFA for a final decision.

Lenders we interviewed had varying experiences in gaining and
maintaining their PLP status. While some lenders expressed general
satisfaction with the process and their understanding of it, others cited
problems. For example, several PLP lenders we interviewed said that they
had their PLP status declined in a specific district, although they had
already achieved PLP status in other districts. In some instances, lenders
said that they did not understand why they had been turned down, in light
of their proven performance. These lenders commented that some district
offices were not open to working with lenders from outside their districts
while others were. In our interviews with district offices, we sometimes
heard differing descriptions from district office officials on the level of
commitment required of a lender who wished to gain PLP status in their
district. Some district officials said that a lender had to maintain a physical
presence in the district, while others disagreed. However, all district office
officials expressed the need for some regular discussion with a lender to
understand the lender’s commitment to the district.

Larger lenders, as well as the National Association of Government
Guaranteed Lenders (NAGGL), noted the administrative burden of
maintaining relationships with many of the 70 district offices to maintain
PLP status. The lenders noted that to receive and maintain PLP status in a
given district, it is generally necessary to meet at least annually with
district office staff to discuss status and plans for future lending. For some
large national lenders, this can amount to 40 or more visits per year. In
response to this concern, NAGGL has recommended a national PLP status
based on a uniform national standard to ease the administrative burdens

Page 15                                                           GAO-03-720T
on large national lenders that account for the largest volume of PLP
lending.

District office officials that we interviewed generally acknowledged that
they want to understand a lender’s plans for their district before agreeing
to endorse a lender that wishes to gain PLP status in their district. District
officials explained that PLP status is an important marketing tool for
lenders. As advocates for the credit needs of small businesses in their
districts, the district office officials see PLP status as a “carrot” to
encourage lenders to make a sufficient volume of loans to their district.
They suggest that a “national” PLP lender might make a large volume of
PLP loans nationwide, but none in their district. The officials reason that
without a district-by-district PLP status, district offices would lose an
important tool for encouraging lenders to respond to credit needs in their
districts.

To hold lenders to a uniform national standard while maintaining
individual district office’s preferences and reinforcing their relationships
with PLP lenders, SBA developed a formula-driven lender evaluation
worksheet to facilitate the nomination, expansion, and renewal processes.
The worksheet replaces the former procedure that involved written
recommendations from district officials; however, it continues to award
points based on sometimes subjective criteria, such as the district office’s
assessment of the lender’s SBA marketing and outreach efforts, rather
than the formulas in the spreadsheet. Where this is the case, district office
staff are required to provide written justification for the points awarded.

SBA has a Lender Liaison program, managed by its Office of Field
Operations (OFO), to assist large national lenders in managing
relationships with SBA. The program involves the assignment of a single
SBA official, generally a district director, to act as a liaison to a large
national lender. In the event that a large lender should experience
difficulty in managing its PLP status, it would have a single SBA official to
call to assist in resolving any problems. OFO staff said that feedback they
have received from lenders indicated that they like the program, finding it
useful for resolving difficulties. Two of the lenders we interviewed
participated in the program, and both expressed satisfaction with it. SBA
has designated lender liaisons for 20 PLP lenders and, at the time of our
review, intended to expand the program to 50 additional lenders. OLO
identified 70 lenders who have PLP status in 6 or more districts and could
benefit from the program.




Page 16                                                           GAO-03-720T
                       We recommended that SBA continue to explore ways to assist large
                       national lenders to participate in the PLP. SBA has indicated that they are
                       reviewing the issues we identified with regard to large national lenders
                       and considering the best approach to address the issues. We will continue
                       to followup with SBA and monitor its response on this matter.


                       In our past work analyzing organizational alignment and workload issues
SBA’s Organizational   at SBA and other agencies’ efforts to improve management and
Alignment Does Not     performance, we have described the importance of tying organizational
                       alignment to a clear and comprehensive mission statement and strategic
Adequately Support     plan. By organizational alignment, we mean the integration of
SBA’s Lender           organizational components, activities, core processes, and resources to
                       support efficient and effective achievement of outcomes. For example, we
Oversight Functions    noted how agency operations can be hampered by unclear linkage
                       between an agency’s mission and structure, but greatly enhanced when
                       they are tied together.19 We have identified human capital management
                       challenges in key areas, which include undertaking strategic human
                       capital planning and developing staffs whose size, skills, and deployment
                       meet agency needs.20 We have also noted the importance of separating
                       safety and soundness regulation and mission evaluation from the function
                       of mission promotion. While SBA’s role regarding PLP lenders is slightly
                       different from that of a safety and soundness regulator, two principles still
                       apply to SBA. First, oversight and program evaluation functions should be
                       organizationally separate and maintain an arm’s-length relationship from
                       program promotion. And second, in evaluating program compliance, SBA
                       needs to weigh the financial risks to the federal government along with the
                       7(a) program’s mission to provide credit to those who cannot get it
                       elsewhere.

                       SBA officials have said and written that lender oversight is becoming an
                       increasing priority for SBA; however, the function is not housed in an
                       independent office with the exclusive role of providing lender oversight.
                       OLO was created within OCA in fiscal year 1999 to ensure consistent and



                       19
                        U.S. General Accounting Office, Small Business Administration: Current Structure
                       Presents Challenges for Service Delivery, GAO-02-17 (Washington, D.C.: October 2001).
                       20
                        Also included are leadership continuity and succession planning, and creating results-
                       oriented organizational cultures. U.S. General Accounting Office, Managing For Results:
                       Next Steps to Improve the Federal Government’s Management and Performance,
                       GAO-02-439T (Washington, D.C.: February 15, 2002).



                       Page 17                                                                    GAO-03-720T
appropriate supervision of SBA’s lending partners; however, OCA has
other objectives, including the promotion of PLP to appropriate lenders.
OFA, also part of OCA, is responsible for providing overall direction for
the administration of SBA’s lending programs, including working with
lenders to deliver lending programs, including 7(a), and developing loan
policies and standard operating procedures.

OFA’s lender oversight role is to provide final approval of lenders’ PLP
status and to take necessary enforcement actions against SBLCs. Yet, in its
promotion role, OFA works with lenders to deliver lending programs. Thus
the only explicit enforcement authority—the authority to revoke PLP
status—resides with OFA rather than OLO. The presence of both OFA and
OLO within OCA does not afford the oversight function an arm’s-length
position from the promotion function. The organizational arrangement
presents a potential conflict, or at least the appearance of a conflict,
between the desire to encourage lender participation in PLP and the need
to evaluate lender performance (with the potential for discontinuing
lenders’ participation in PLP).

Evidence of overlapping responsibilities and poorly aligned resources also
can be seen in delays SBA has experienced in completing certain tasks
associated with lender oversight. As noted previously, these delays could
hamper effective PLP and SBLC oversight by delaying corrective action
that might arise from review findings. Since some, but not all,
responsibility for the lender oversight function migrated from OFA to
OLO, both offices continue to mingle responsibilities for certain functions.
The division of responsibility between OFA and OLO has created the need
for more interoffice coordination to complete certain tasks. For example,
we found substantial delays in finalizing PLP review reports and, as noted
earlier, in SBLC examination reports.

SBA’s IG concluded that the delays in completing SBLC reports were at
least partially due to poor coordination between OLO and OFA, both of
which were involved in reviewing the reports. OLO and OFA, respectively,
are responsible for oversight and management of the SBLC program. OLO
is responsible for SBLC on-site examination and off-site monitoring, while
OFA handles day-to-day program management, policymaking, and
enforcement of corrective actions. Coordination between the two offices,
however, was not formally established and simply evolved over time. The
IG said that this informal structure contributed, in part, to the delays in
issuing the fiscal year 2001 examination reports. OLO staff said that
limited staffing also contributed to delays. For example, OLO began



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                  operations with 3 headquarters staff in fiscal year 2000, a number that
                  increased to 12 by December 2002.

                  We recommended that SBA separate lender oversight functions and
                  responsibilities from OCA, including those currently done by OFA. This
                  would provide an oversight office with greater autonomy within SBA to
                  match the growing importance of lender oversight in achieving SBA’s goal
                  of ensuring that PLP lenders make loans to eligible borrowers while
                  properly managing the financial risk to SBA. While SBA did not respond
                  directly to this recommendation prior to the December 2002 publication of
                  our report, it recently stated in a response to congressional committees
                  that it believes OLO has adequate independence. In addition, SBA
                  maintains there is an advantage to having both OLO and OFA within the
                  same office and working in concert. SBA did state, in March 2003, that it
                  was in the process of drafting policies and procedures governing OLO
                  program responsibilities. We plan to follow-up with SBA on its response to
                  this recommendation.


                  Madam Chair, Members of the Committee, this concludes my prepared
                  statement. I would be happy to answer any questions at this time.

                  For information on this statement, please contact Davi D’Agostino,
Contacts and      Director, Financial Markets and Community Investment, at (202) 512-8678
Acknowledgments   or Katie Harris, Assistant Director, at (202) 512-8415. You may also reach
                  them by E-mail at dagostinod@gao.gov or harrism@gao.gov. Other
                  individuals who made key contributions to this testimony include Toayoa
                  Aldridge, Tom Conahan, and Barbara Roesmann.




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