United States General Accounting Office
GAO Testimony
Before the Committee on Small Business, House of
Representatives
For Release
on Delivery
Expected at
SMALL BUSINESS
10 a.m. EDT
Wednesday ADMINISTRATION
July 16, 1997
Credit Subsidy Estimates
for the Sections 7(a) and
504 Business Loan
Programs
Statement of Judy A. England-Joseph,
Director, Housing and Community
Development Issues,
Resources, Community, and Economic
Development Division
GAO/T-RCED-97-197
Mr. Chairman and Members of the Committee:
We are pleased to be here today to discuss our review of the Small
Business Administration’s (SBA) estimates of credit subsidies for the
agency’s guaranteed business loan and certified development company
programs—more commonly called the “7(a)” and “504” programs,
respectively. As you know, the credit subsidy for these programs is the
estimated net cost (excluding administrative costs) to SBA in today’s
dollars of guaranteeing these loans over the entire time period in which
the loans are outstanding, which can range up to about 25 years. The
Federal Credit Reform Act of 1990 requires that SBA estimate these costs
for loans guaranteed after fiscal year 1991 so that they can be included in
the federal budget in the year in which the loan commitments are made.
These estimates, and any subsequent re-estimates, identify for the
Congress the amount of appropriations needed to cover the government’s
expected costs over the lives of the loans. In the President’s budget for
fiscal year 1997, SBA estimated that the costs of 7(a) and 504 program loans
to be made in fiscal year 1997 would be significantly higher than the costs
of loans made in fiscal year 1996, despite legislated program changes
designed to keep costs down.
Our statement today is based on our review of SBA’s estimates of credit
subsidies for the 7(a) and 504 programs that you requested in April of this
year as well as our ongoing work on such estimates in the major credit
agencies throughout the federal government. As requested, this statement
focuses on three questions: (1) How does SBA calculate the estimates of
credit subsidies for the 7(a) and 504 programs? (2) What factors accounted
for the increases in the estimated costs of the loans to be guaranteed by
these programs in fiscal year 1997? (3) What additional changes, if any, did
SBA make during the 1998 budget process when estimating the costs of its
loans? As agreed with your office, we did not assess the reliability of the
automated data on individual loans that SBA uses to generate its credit
subsidy estimates.
In summary, we found the following:
• SBA bases its estimate of the credit subsidy for each program on
projections of cash flows—that is, the amounts of cash that SBA expects to
take in and pay out during each year that the loans are outstanding. Cash
outflows occur when borrowers default on their loans and SBA pays claims
filed by lenders. Cash inflows occur when the collateral for defaulted
loans is liquidated and when borrowers and lenders pay mandatory fees to
Page 1 GAO/T-RCED-97-197
SBA. These cash flow projections are based largely on the historical
performance of the programs’ loans; however, SBA adjusts the projections
to reflect the estimated influence of changes in the programs’ provisions
and other factors. The cash flows are discounted to determine their net
present value using a computer model established and maintained by the
Office of Management and Budget (OMB).1
• The factors contributing to the increases in the estimated credit subsidy
rates for fiscal years 1997 differed somewhat between the two programs.
For the 7(a) program, SBA projected fewer recoveries (the amounts
realized when defaulted loans are liquidated) and less revenue from fees
than it had assumed in previous years. These changes, which accounted
for about 60 percent of the increase, resulted primarily from SBA’s use of a
new database on historical loan performance that expanded and improved
on existing data, according to SBA and OMB officials. In addition, an error in
applying SBA’s cash flow projections to OMB’s discounting model caused the
estimated credit subsidy rate for the 7(a) program to be even larger. This
error accounts for the remainder of the increase. On the basis of its
appropriated budget authority of $198.5 million, SBA announced that it
could guarantee an additional $2.47 billion in 7(a) loans because the credit
subsidy rate estimate should have been lower. For the 504 program, SBA
projected both more claims and fewer recoveries for defaulted loans than
it had assumed previously. As in the 7(a) program, these changes—which
account for all of the increase—resulted from SBA’s use of a more
extensive historical database.
• For the fiscal year 1998 budget request, SBA further revised its projections
of cash inflows and outflows for the two programs. For 7(a) loans, SBA
decreased its estimate of expected fee revenue, on the basis of data on
loans that are paid off prior to maturity, or “prepaid.” Because SBA would
have to cover more of the cost of loan defaults if revenues from fees are
less than originally expected, this change had an upward effect on the
subsidy rate estimate for the 7(a) program. For the 504 program, SBA
increased the estimated prepayments and slightly reduced expected claim
payments and recoveries. With these changes and a fee increase, SBA
estimated a credit subsidy rate of zero for new 504 loans.
The 7(a) and 504 programs are two of SBA’s primary programs for
Background enhancing small businesses’ access to credit. Under the 7(a) program, SBA
guarantees up to 80 percent of the amounts of loans made by private
lenders to small businesses that are unable to obtain financing under
1
Present value is the value today of a stream of payments in the future. In calculating the present value
of loan subsidy costs, prevailing interest rates for U.S. Treasury securities provide the basis for
converting future amounts into current dollar equivalents.
Page 2 GAO/T-RCED-97-197
reasonable terms and conditions through normal business channels. In
fiscal year 1996, SBA guaranteed about $7.3 billion in small business loans
through the 7(a) program. SBA’s guarantee transfers the major risk of
default from the lenders to SBA. When a loan guaranteed through the 7(a)
program defaults, SBA pays the lender’s claim by purchasing the
guaranteed portion of the unpaid balance of the loan.2 SBA then recovers as
much of the claim amount as it can through the liquidation of the small
business’ collateral.3 In return for its guarantee, SBA collects fees from 7(a)
lenders. SBA collects three types of fees for 7(a) loans: (1) an upfront fee
which lenders may collect from borrowers, (2) an annual fee charged to
lenders, and (3) a fee charged to lenders for certain 7(a) loans they sell
through the secondary market.4 According to SBA, about half of the 7(a)
loans made each year are sold through the secondary market.
Like the 7(a) program, the 504 program uses SBA guarantees to assist small
businesses. Under this program, SBA provides its guarantee through
certified development companies (CDC)—private, nonprofit corporations.
CDCs may sell debentures that are fully guaranteed by SBA to private
investors and lend the proceeds to qualified small businesses for acquiring
real estate, machinery, and equipment and for building or improving
facilities.5 These debentures funded about $2.4 billion in loans during fiscal
year 1996. If a small business defaults on its loan from the CDC, SBA pays a
claim filed through a central servicing agent, thereby ensuring that
investors receive full and timely payments. SBA recovers some of the claim
amount through the liquidation of the small business’ collateral. However,
projects financed with 504 loans typically involve a supplemental
mortgage from a private-sector lender who has a first lien on the collateral.
In return for guaranteeing 504 program debentures, SBA charges both
upfront and annual fees.
To help lower the federal cost of these programs, in October 1995 the
Congress enacted the Small Business Lending Enhancement Act of 1995
(P.L. 104-36). Among other things, the act (1) lowered the maximum
guaranteed portion of most 7(a) loans from 90 to 80 percent, (2) created
the annual fee charged to lenders and increased the upfront fee for 7(a)
loans, and (3) created the annual fee for the 504 program. The latter fee
2
The lender’s claim can include up to 120 days of accrued interest.
3
Collateral may be liquidated by either SBA or lenders. Liquidation is the process of converting assets
to cash.
4
Lenders may sell the guaranteed portion of 7(a) loans to investors. These investors are referred to as
the “secondary market” for the loans.
5
A debenture is an investment typically backed by the integrity of the borrower (but in this case, by
SBA) and documented by an agreement called an indenture.
Page 3 GAO/T-RCED-97-197
was increased on September 30, 1996 by the Small Business Programs
Improvement Act (P.L. 104-208).
We obtained information on how SBA’s credit subsidy estimates are
prepared primarily by interviewing officials from SBA and OMB. We
identified the factors accounting for the changes in the estimates primarily
by reviewing the automated cash flow spreadsheets underlying these
estimates. However, we did not verify the accuracy of the loan
performance data used in the spreadsheets. We also obtained information
through interviews with officials from the Congressional Budget Office
and the two major industry associations for the 7(a) and 504 programs.
For the 7(a) and 504 programs, SBA bases the estimates of credit subsidies
How Credit Subsidy for the loans guaranteed during a given year on projections of the cash
Estimates Are inflows and outflows likely to result from the loans.6 To project future
Currently Calculated cash flows, SBA first reviews available data on the cash flows it has
experienced with loans made in the past. SBA then estimates cash flows for
future “outyears”—the later years of the loans’ lives for which there are
not yet any historical data—and adjusts for recent program changes that
are expected to affect the cash flows. As part of the annual budget
process, SBA prepares these cash flow projections for loans to be made
during the budget year. An automated discounting model developed and
maintained by OMB and distributed to federal agencies converts the cash
flows prepared for all federal credit programs into the credit subsidy rate
estimates and budget authority requests that are presented in the
President’s budget. The estimated credit subsidy rates for SBA’s 7(a) and
504 programs are expressed as a percentage of the total amount of loans
or debentures to be disbursed.
Performance of Loans For each program, SBA bases the projected claim payments and recoveries
Made in the Past Is a Key for defaulted loans largely on the performance of the loans made in the
Factor in Projecting Future past. According to SBA and OMB officials, SBA uses data on the performance
of the loans made through the 7(a) and 504 programs since 1986.
Claims and Recoveries
SBA analyzes data on the portion of the loans made in each past year that
has defaulted and the amounts it has recovered since the loans were made.
SBA uses these data to compute an average claim rate and recovery rate for
each year in a loan’s life. For example, the average claim rate for 504 loans
in their first year is the average of the actual rates observed in the first
6
Neither program includes an interest rate subsidy.
Page 4 GAO/T-RCED-97-197
years of past loans; the average claim rate for 504 loans in their second
year is the average of the actual rates observed in the second years of past
loans; and so on. Unless SBA expects recent program changes to affect
future defaults, these cash flows of average historical data are SBA’s
estimates of claims and recoveries for new loans. In this way, SBA’s method
of projecting claims and recoveries for new loans gives equal weight to the
performance of loans made in the past, regardless of differences in the
volume of loans made during each year or their ages.
In addition, for 7(a) loans, SBA considers differentials in loan performance
by the type of the loan. Specifically, SBA calculates average claims and
recoveries, on the basis of actual historical data, for the various categories
of (1) the maturity of the loan, (2) the size of the loan, (3) the type of
lender,7 and (4) the percentage of the loan guaranteed by SBA. SBA then
uses these data to calculate an overall average claim rate and recovery rate
for the new loans. SBA does not conduct an analysis of loan type for the 504
program because the program is smaller and because there is less
variation in types of loans than in the 7(a) program.
SBA uses the actual historical averages as a basis for the expected claims
and recoveries during the first 11 years of the new loans’ lives.8 For the
later years of the new loans’ lives—the “outyears”—SBA projects claims
and recoveries through several methods. For 7(a) loans, SBA projects
claims through the 16th year after the loans are made and projects
recoveries through the 18th year. For the 12th and 13th years of the loans’
lives, SBA projects claims and recoveries by assuming a continuation of the
trend demonstrated by the historical data for the first 11 years and by
considering data on the performance during the 12th and 13th years of
loans made prior to 1986. For later years, SBA roughly estimates additional
claims and recoveries by considering the trend in the data for the first 13
years and by assuming that there will be at least some claims and
recoveries during each of these later years. SBA does not project claims and
recoveries beyond the 18th year because of the uncertainty of these
estimates and because the figures are likely to be very small, according to
7
SBA’s analysis by type of lender considers whether loans are made by preferred lenders, certified
lenders, or other lenders. Preferred and certified lenders receive full or partial delegation of authority
to approve loans.
8
SBA may also add outyear estimates to the historical data for each past year of loans before the data
are averaged. This procedure ensures that there are 11 years of performance data linked directly to
actual data for each past year of loans, even for loans made less than 11 years ago. SBA adds these
outyear estimates by assuming the same trends in claims and recoveries demonstrated by data for
older loans.
Page 5 GAO/T-RCED-97-197
SBA officials. Although the maximum maturity for 7(a) loans is 25 years,
the average maturity is about 12 years, according to OMB officials.
For 504 loans, SBA projects claims through the 16th year and recoveries
through the 22nd year. For years after the 11th, SBA roughly estimates
additional claims and recoveries by considering the trend in the historical
data for the first 11 years and by assuming that there will be at least some
claims and recoveries during each of these later years. Although the
maximum maturity for a 504 loan is 20 years, the average maturity is 19
years, according to OMB officials. SBA estimates cash flows for outyears so
that the estimated credit subsidy rate represents the expected federal cost
of all of the loans made during a year over their entire lives, not just the
years for which historical data are available.
Current Rates and For both the 7(a) and 504 programs, SBA bases its projections of revenues
Historical Data Are Used from fees primarily on the fee rates in effect at the time that program loans
to Project Future Fee are made and on the estimates, based on historical data, of annual
outstanding loan balances.
Revenues
For the 7(a) program, SBA projects revenues for each of the three types of
fees, as follows:
• The upfront fee is based on the original dollar amount of the guaranteed
portion of the loan. Because the fees vary according to the size of the
guaranteed portion, SBA calculates an average rate for upfront fees by
estimating the percentage of the new loans in each category of loan size.9
SBA’s projection of the cash flow from upfront fees is also based on the
collection of the upfront fee over the first two years of the loans’ lives,
rather than the entire amount in the first year, because not all loans are
disbursed during the first year.
• Annual fee revenue is based on estimated outstanding loan balances at the
end of each year of the life of the loans. SBA bases its estimates of
outstanding balances on historical data on the portion of balances
amortized each year and then subtracts the amount that it expects to pay
in claims and the amount of loans that it estimates will be prepaid. SBA
does not maintain data showing when 7(a) loans are prepaid. Instead, the
agency estimates prepayment rates and trends on the basis of the
historical prepayment data that it obtains for those 7(a) loans that are sold
9
This average also reflects the small number of 7(a) loans with maturities of less than one year. These
loans are charged a fee rate that does not vary with the size of the guaranteed portion. SBA estimates
that about one percent of all loans made each year have maturities of less than one year.
Page 6 GAO/T-RCED-97-197
through the secondary market.10 In this way, the actual data on
prepayments and claims for prior year loans helps SBA estimate how much
the outstanding principal balance on new loans will decline over the life of
the loans and thus how much it is likely to collect in revenues from the
annual fee.
• Similarly, SBA estimates the amount of secondary market fee revenues it
will collect by looking at historical data on loans sold through the
secondary market.
For the 504 program, projecting the cash flows from fees is slightly less
complicated because the upfront fee does not vary with the size of the
loan and there is no secondary market fee. SBA’s projection of upfront fees
is based on the rate in effect when the loans are made and the collection of
the fee during the first few years of the loans’ lives because not all loans
are disbursed during the first year. Like the 7(a) program, annual fee
revenues are based on the estimates of outstanding loan balances at the
end of each year during the life of the new loans. SBA bases its estimates of
outstanding balances on historical data on the portion of balances
amortized each year and then subtracts the amount of loans it expects to
default and the amount of loans that it estimates will be prepaid. SBA
maintains its own data on prepayments in the 504 program because of the
program’s prepayment penalty.
SBA Adjusts Cash Flows to Before converting the projected cash flows into an estimated credit
Reflect Changes in the subsidy rate, SBA may adjust them to reflect any recent program changes
Programs that are expected to reduce or increase future claim payments or
recoveries. For example, SBA adjusted its projected recoveries for loans
made through the 504 program in 1998 to reflect the impact of the agency’s
Liquidation Improvement Project—an effort designed to increase the
portion of SBA’s claim payments for defaulted loans that it recovers
through the liquidation of collateral.
Officials from SBA, OMB, and the two primary industry associations for the
7(a) and 504 programs have suggested several alternative methods SBA
could use to estimate future claims and recoveries. For example, SBA could
develop an econometric model which uses regression analyses to predict
future claims and recoveries based on factors such as forecasted interest
rates, economic growth, lender type, and loan size. According to a
government-wide task force, econometric modeling is the best way to use
10
According to SBA, the guaranteed portion of about half of the loans made through the 7(a) program
each year are sold through the secondary market. We did not determine whether these loans are
representative of all 7(a) loans made each year.
Page 7 GAO/T-RCED-97-197
historical data to estimate credit subsidies.11 Similarly, we have used
econometric models to forecast future loan performance in programs
operated by the Department of Veterans Affairs and the Department of
Housing and Urban Development due to their superior predictive
capabilities.12 While we believe that, over time, such analysis of loan
performance data may yield better estimates, we have not reviewed the
merits of any particular approach for SBA’s programs.
OMB’s Model Generates To generate an estimate of the credit subsidy rate, SBA’s cash flow
Estimates of the Credit projections for claims, recoveries, and fees assuming a certain amount of
Subsidy Rate business are run through OMB’s automated discounting model. This model
produces an estimate of the credit subsidy rate representing the net
present value of the federal costs expected per dollar loaned through the
program. This estimate is used to determine the amount of appropriations
necessary to cover the long-term costs of a given amount of loans.
During the preparation of each year’s budget submission, OMB examiners
typically work with SBA to refine its cash flow projections and subsidy
estimates. OMB may question the basis for SBA’s projected cash flows
and/or request an alternative set of cash flows based on different
assumptions. For example, during the past few years, SBA has expressed
interest in limiting the historical data used as a basis for projected cash
flows to loans made since 1989. According to SBA officials, recently
guaranteed loans are better predictors of future loan performance because
they reflect the changes made to strengthen SBA’s programs during the
1990s. On the other hand, OMB officials stated that the performance of
loans in the 1980s should be considered because these years include an
economic downturn, which could occur during the life of new loans. For
this reason, the older loans have been retained in the averages SBA uses to
estimate the subsidy costs of new loans. According to both OMB and SBA
officials, there may be a number of iterations leading up to the final
estimate of the credit subsidy rate and the associated request for budget
authority that are shown in the President’s budget.
In addition to estimating the credit subsidy rate for SBA-guaranteed loans,
the OMB model uses the cash flows prepared by SBA to report three
components of the estimate: (1) net defaults (claim payments minus
11
See Issue Paper 96-CR-7, May 1, 1996 of the Government-Wide Audited Financial Statements Task
Force.
12
See Homeownership: Appropriations Made to Finance VA’s Housing Program May be Overestimated,
GAO/RCED-93-173, Sept. 1993 and Mortgage Financing: FHA Has Achieved Its Home Mortgage Capital
Reserve Target, GAO/RCED-96-50, Apr. 1996.
Page 8 GAO/T-RCED-97-197
recoveries), (2) fees received, and (3) any other cash flows associated with
the program. By splitting the estimate into components, the model
indicates how each of the cash flows affects the overall credit subsidy rate
estimate.
In addition to requiring agencies to estimate the credit subsidies
associated with new government-backed loans, credit reform requirements
provide for subsequent re-estimates and modifications of credit subsidy
estimates. To calculate re-estimates, SBA uses a process very similar to the
one described above to project the cash flows associated with existing
loans. Re-estimates are calculated after the end of the fiscal year in which
the loans are guaranteed. However, the estimated credit subsidy rate may
be modified during that year to reflect enacted legislation and certain
administrative actions that alter the subsidy cost. A modification does not
include government actions permitted within the terms of existing
contracts or through other existing authorities. Furthermore, credit
subsidy estimates may not be revised mid-year due only to changes in
“forecast technical” assumptions, such as expected claims.
According to the President’s budget for fiscal year 1997, the estimated
Why the Estimated credit subsidy rate for the 7(a) program increased from 1.06 percent for
Credit Subsidy Rates loans made in 1996 to 2.68 percent for loans made in 1997. For the 504
Increased in 1997 program, the estimated rate increased from zero to 6.85 percent, assuming
no future program changes.13 The estimates for the 1997 loans were higher
largely because SBA modified the cash flow projections that it had used for
the fiscal year 1996 and earlier estimates. According to SBA and OMB
officials, SBA modified the cash flows to incorporate the results of an
intensive analysis of data on the performance of loans made in the past. In
addition, the fiscal year 1997 estimate for the 7(a) program was affected by
a spreadsheet error unnoticed by either SBA or OMB; without this error, the
estimated credit subsidy rate in SBA’s budget submission would have been
about 2.03 percent. Appendix III summarizes the factors responsible for
these changes in SBA’s estimates.
SBA Developed a New As part of its planned efforts to meet credit reform requirements, SBA
Loan Performance developed a loan performance database in 1995. The objectives of this
Database in 1995 effort were to (1) provide access to the data on historical loan
13
These are the “current services” credit subsidy estimates, according to the 1997 budget. The current
services estimate assumes no future changes to the programs.
Page 9 GAO/T-RCED-97-197
performance on a cohort basis14, (2) update the subsidy estimates on the
basis of the historical data, (3) allow SBA to analyze loan performance on
the basis of multiple-risk indicators, and (4) annually validate past subsidy
estimates. SBA officials used the database for the first time while preparing
the estimates of credit subsidy rates for the 1997 budget.
All estimates of credit subsidy rates for loans guaranteed prior to 1997 had
been based on the limited loan performance data resulting from a review
of the loan portfolio undertaken in 1991. According to SBA and OMB
officials, this 1991 review had several weaknesses. Most importantly, it did
not utilize transaction-based data, but rather relied on the interpretation of
changing loan balances over time to estimate loan performance.
Furthermore, it was based on data that were not easily identified by cohort
(i.e. by a particular year of loan guarantee commitments). In addition, the
results of the 1991 review were not updated to reflect the actual
performance of loans in fiscal years 1992 through 1995. According to SBA
officials, the new loan performance database—which is updated annually
to include recent data—corrected these problems. We did not assess the
quality of the data in SBA’s new loan performance database.
Revised Cash Flows and In 1995, when SBA prepared its 1997 budget request, the loan performance
Spreadsheet Error database confirmed earlier estimates that, during the life of each year’s
Contributed to Change in loans, SBA makes claim payments for defaulted loans equal to about
13 percent of the original loan disbursements.15 However, the database
7(a) Program Estimate also indicated that SBA recovers less of the claim amount through the
liquidation of loan collateral—about 50 percent rather than the 56 percent
indicated by the 1991 review. In addition, the analysis of the database
indicated that the timing of defaults was different than estimated in the
1991 review; specifically, a greater percentage of the defaults would occur
earlier. Incorporating this change slightly increased the estimates of credit
subsidy rates because the earlier a cash outflow occurs for SBA, the higher
the present value of the cost to SBA. These changes to the estimates of
claims and recoveries accounted for about 45 percent of the increase in
the fiscal year 1997 credit subsidy estimate.
A second factor, accounting for about 15 percent of the increase, was SBA’s
lowered forecast of revenues from fees. When preparing the fiscal year
14
In the case of SBA’s 7(a) and 504 programs, a “cohort” of loans consists of all of the loan guarantees
committed through each program during a given fiscal year.
15
Although we refer to claims throughout this statement as a percentage of the total dollar amount of
the loans disbursed, SBA typically defines the claim rate as a percentage of the SBA-guaranteed portion
of disbursements.
Page 10 GAO/T-RCED-97-197
1996 credit subsidy estimate, SBA had not accounted for the loss in annual
fee revenue that occurs when borrowers prepay their loans. (Because
annual fees are charged on outstanding loan balances, and prepayments
cause those balances to be lower than they would otherwise be,
prepayments effectively reduce SBA’s revenues from fees.) For the fiscal
year 1997 estimate, SBA added an estimate of prepayments. Furthermore,
SBA reduced its estimate of the amount of revenues it would receive
through the secondary-market fee, based on lower-than-expected revenue
from the first year of experience with the new fee.
Finally, an error in applying SBA’s cash flow projections to OMB’s
discounting model accounted for about 40 percent of the increase in the
credit subsidy estimate in 1997. This error caused the estimated credit
subsidy for the 7(a) program to be expressed as a percentage of the
guaranteed portion of the loans, rather than of their total face amount. SBA
projected that it would guarantee on average about 76 percent of the fiscal
year 1997 loan cohort. Because critical cells in SBA’s cash flow spreadsheet
were based on the number of dollars guaranteed instead of the number of
dollars disbursed (that is, the total face amount of the loans), SBA’s
estimated credit subsidy rate was higher by about 32 percent (1 divided by
0.76, the average guaranteed portion).
This error went unnoticed by both SBA and OMB officials responsible for
reviewing the 7(a) credit subsidy rate estimate. If SBA or OMB officials had
compared the component data generated by OMB’s discounting model for
the erroneous 1997 estimate with the components of the 1996 estimate,
they would have seen an unexplainable increase in the fee revenue
component (there was no increase in the fee rates charged). According to
standards developed by the Federal Accounting Standards Advisory
Board, subsidy estimate component data should be used to monitor and
make decisions about the federal government’s credit programs.16
On the basis of its appropriated budget authority of $198.5 million,17 SBA
announced that it could guarantee an additional $2.47 billion in 7(a) loans
because the credit subsidy rate estimate should have been lower. We are
currently reviewing the changes in estimates over time for selected
programs at five agencies as part of an assessment of the implementation
16
See Statement of Federal Financial Accounting Standards Number 2, Accounting for Direct Loans
and Loan Guarantees, August 23, 1993. These standards were developed by the Federal Accounting
Standards Advisory Board which is composed of representatives of the Department of the Treasury,
OMB, GAO, the Congressional Budget Office, several other federal agencies, and from the private
sector.
17
This figure includes an appropriation of $158 million and carryover budget authority of $40 million.
Page 11 GAO/T-RCED-97-197
of the Credit Reform Act. We are also preparing a report on OMB’s
automated discounting model. We expect to report on these efforts later
this year.
Revised Estimates of The analysis of the loan performance database of loans made through the
Claims and Recoveries 504 program in prior years showed more dramatic changes than for the
Caused Higher Subsidy 7(a) program. According to SBA officials, the 1991 review substantially
underestimated claim rates and overestimated recovery rates because it
Estimate for 504 Program did not consider a substantial portion of the 504 loan transactions. This
occurred because the 1991 review inaccurately assumed that the
accounting structure for the 7(a) and 504 programs was the same.
However, unlike the 7(a) program, 504 transactions may be recorded
under different identification numbers in SBA’s accounting system than the
original debenture. Because the 1991 review included only transactions
recorded under the original debenture’s identification number, it
erroneously omitted relevant data on claims and recoveries. According to
SBA officials, the new loan performance database corrects this error by
recognizing all transactions associated with the debentures made during
each year.
In the fall of 1995, SBA used the expanded historical data on the 504
program made available through the loan performance database in
preparing the fiscal year 1997 cash flow projections. SBA forecast that it
would (1) make claim payments during the life of a year’s loans equal to
about 19 percent of the face value of the loans, more than twice the
7 percent estimate indicated by the 1991 review, and (2) recover about
40 percent of the claim amount through the liquidation of loan collateral,
or about half of the 80 percent estimate indicated by the 1991 review. The
estimate of the total recovery rate in the 1997 cash flows should have been
even lower (33 percent), according to OMB and SBA officials.18 The
40-percent estimate was based on an error in accumulating the historical
data that was corrected when SBA prepared its 1998 estimates, according
to SBA officials.
18
Using a lower total recovery rate would have increased the credit subsidy rate estimate above the
6.85 percent rate estimated by SBA.
Page 12 GAO/T-RCED-97-197
Since the 1997 estimates were prepared, SBA has made additional revisions
Estimates for 1998 to its cash flow projections. For the 7(a) program, these changes resulted
Budget Reflect in an estimated subsidy rate of 2.32 percent, assuming no future program
Updates to Cash Flow changes, for loans to be made in 1998 and a re-estimate of the rate for
loans made in 1996 of 2.4 percent.19 In preparing these estimates, SBA did
Projections not repeat the spreadsheet error that had inflated the 1997 estimate.
Nevertheless, the estimates prepared during the 1998 budget process are
higher than the corrected budget request estimate (2.03 percent) for the
1997 loans because SBA reduced the expected fee revenues from these
loans. Specifically, SBA increased its estimate of prepayments—even
further than during preparation of the 1997 estimates.
SBA increased its estimate of prepayments because it obtained for the first
time historical data maintained by Bloomberg Financial Services on the
percentage of loans each year that were prepaid. These data are based
exclusively on 7(a) loans sold through the secondary market. When
preparing the 1997 estimates, SBA assumed that up to about 2.5 percent of
the amount of the loans outstanding each year would be prepaid.20
However, the historical data obtained from Bloomberg Financial Services
showed that in some years of their lives as many as 10 percent of the
amount of the loans could be expected to be prepaid.
In addition to changes in expected revenues from fees, SBA made small
changes to its claim payment and recovery forecasts. Specifically, SBA
(1) decreased its expected claim payments over the life of the loans from
about 13 percent of the loans’ face value to about 12 percent, on the basis
of additional historical data on loan performance in fiscal year 1996, and
(2) increased the total recovery rate from about 50 percent of expected
claim payments to about 51 percent over the life of the loans, on the basis
of recent successes in the Liquidation Improvement Project.
For the 504 program, SBA (1) increased estimated prepayments;
(2) lowered its expected claim payments for defaulted loans from about
19 percent of the loans’ face value to about 16 percent over the life of the
loans; and (3) lowered expected recoveries from 40 percent to 34 percent
of claims. When calculating the 34-percent recovery rate estimate, SBA
corrected the accumulation error discussed earlier and adjusted the
19
The previous estimate of the credit subsidy rate for loans made through the 7(a) program in 1996 was
1.06 percent.
20
Although we refer to prepayments as a percentage of the total dollar amount of the loans disbursed,
SBA typically defines prepayment rates as a percentage of the SBA-guaranteed portion of
disbursements.
Page 13 GAO/T-RCED-97-197
estimate upward to reflect the improvements in recoveries expected to
result from the Liquidation Improvement Project, according to SBA
officials. With these changes in expected revenue from fees, claims, and
recoveries, SBA re-estimated the credit subsidy rate for the loans made
through the 504 program in 1996 at 7.54 percent. The estimate for the 1998
loans is zero because the annual fees charged to borrowers and lenders
were increased dramatically after SBA prepared its budget request estimate
for the 1997 loans.21 With recoveries, these fees are expected to cover all
of the costs incurred by SBA for defaulted loans.
Mr. Chairman, this concludes my prepared remarks. We will be pleased to
respond to any questions that you or other Members of the Committee
might have.
21
This increase in the fee rate also prompted a lowering of the credit subsidy rate estimate for 504
loans made in 1997 from 6.85 percent (budget request) to zero (budget execution).
Page 14 GAO/T-RCED-97-197
Page 15 GAO/T-RCED-97-197
Appendix I
How Credit Subsidy Rate Estimates Are
Prepared
Claims and recoveries Fees
(-) (+) (+)
Estimate outstanding
Compute historical averages
balances
Compute initial
Add outyear estimates
revenue estimates
Adjust to reflect recent
program changes
Combine and discount by
applying OMB's model
Estimate of
credit subsidy
rate
Page 16 GAO/T-RCED-97-197
Appendix II
Primary Reasons for Changes in Credit
Subsidy Rate Estimates
7(a) 504
98
97
97
98
19
19
19
19
97
96
96
97
19
19
19
19
Lower estimated fees
based on data on prepayments
and/or secondary market fees
Lower estimated recoveries
based on expanded data
Higher estimated claims
based on expanded data
Higher annual fee rate
Spreadsheet error
Note: Based on the 1996 budget execution estimates and the 1997 and 1998 budget request (current
services) estimates.
Page 17 GAO/T-RCED-97-197
Appendix III
Changes in Cash Flow Projections
Table 3.1: Changes in Projections
Underlying SBA’s Estimates of the 7(a) 1996 1997 1998
Credit Subsidy (percent) (percent) (percent)
Fees
Prepaymentsa 0 Up to 2.5 in peak Up to 10 in peak
year year
Secondary-market 0.14 0.02 0.03
feesb
Claimsc 13 13 12
d
Recoveries 56 50 51
Other Spreadsheet error
inflated credit
subsidy estimate by
32 percent.
Credit subsidy 1.06f 2.68 (2.03)g 2.32
estimatee
a
Prepayments are shown as an annual percentage of the loans outstanding in the first 10 years.
(SBA typically shows prepayments differently—as a percentage of SBA’s share of outstanding
loans.)
b
Secondary market fees are shown as a percentage of the original disbursements.
c
Claims are shown as a percentage of the original disbursements. (SBA typically shows claims
differently—as a percentage of SBA’s share of disbursements.)
d
Recoveries are shown as a percentage of claims.
e
Estimates shown are the 1996 budget execution estimate and the 1997 and 1998 budget
request (current services) estimates.
f
Re-estimated at 2.40 percent in the 1998 budget.
g
Without the spreadsheet error, the 1997 budget request estimate would have been about
2.03 percent.
Source: GAO’s analysis of SBA’s and OMB’s data.
Page 18 GAO/T-RCED-97-197
Appendix III
Changes in Cash Flow Projections
Table 3.2: Changes in Projections
Underlying SBA’s Estimates of the 504 1996 1997 1998
Credit Subsidy (percent) (percent) (percent)
Fees
Prepaymentsa 0 0 Up to 4 in peak year
b
Annual fee rate 0.125 0.125 1.084
Claimsc 7 19 16
d
Recoveries 80 40 34
Credit subsidy 0.00f 6.85 0.00
estimatee
a
Prepayments are shown as an annual percentage of the loans outstanding in the first 10 years.
(SBA typically shows prepayments differently—as a percentage of SBA’s share of outstanding
loans.)
b
The annual fee rate is shown as a percentage of the loans outstanding annually.
c
Claims are shown as a percentage of the original disbursements. (SBA typically shows claims
differently—as a percentage of SBA’s share of disbursements.)
d
Recoveries are shown as a percentage of claims.
e
Estimates shown are the 1996 budget execution estimate and the 1997 and 1998 budget
request (current services) estimates. Although the 1996 and 1997 estimates are based on all
loans made through the 504 program, the 1998 estimate shown here excludes loans made
through the Defense Loan and Technical Assistance program.
f
Re-estimated at 7.54 percent in the 1998 budget.
Source: GAO’s analysis of SBA’s and OMB’s data.
(385675) Page 19 GAO/T-RCED-97-197
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Address Correction Requested
Small Business Administration: Credit Subsidy Estimates for the Sections 7(a) and 504 Business Loan Programs
Published by the Government Accountability Office on 1997-07-16.
Below is a raw (and likely hideous) rendition of the original report. (PDF)