United States General Accounting Office

GAO Report to the Chairman, Committee on

Small Business, U.S. Senate

June 1998 SMALL BUSINESS

ADMINISTRATION

Few Reviews of

Guaranteed Lenders

Have Been Conducted

GAO/GGD-98-85

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-278633 

June 11, 1998

The Honorable Christopher S. Bond

Chairman, Committee on Small Business

United States Senate

Dear Mr. Chairman:

This report contains the results of our review of the Small Business

Administration’s (SBA) oversight of lenders participating in its 7(a) loan

program1

 and its efforts to comply with the preferred lender review

requirements of the Small Business Programs Improvement Act of 1996

(SBPIA).2

 The 7(a) loan program is intended to serve small business

borrowers who cannot otherwise obtain financing under reasonable terms

and conditions from the private sector. In fiscal year 1997, 7(a) loan

approvals totaled nearly $9.5 billion.

In discussions with your office, we agreed to determine (1) how SBA

conducts on-site reviews to monitor participating lenders’ compliance

with its 7(a) loan program policies and procedures and (2) what actions

SBA is taking to comply with the preferred lender oversight provisions of

SBPIA. To address these objectives, we conducted work at SBA’s

headquarters in Washington, D.C.; 5 of the 69 SBA district offices—3 of the

largest, a medium, and a smaller sized office in terms of the number of

loans outstanding; SBA’s Preferred Lender Review Branch in Kansas City,

Missouri; and its Sacramento Loan Processing Center in Sacramento,

California.

Background The 7(a) program is SBA’s largest lending program and its primary vehicle

for providing small businesses with access to credit. The program is

intended to serve small business borrowers who could not otherwise

obtain credit under suitable terms and conditions from the private sector.

Under the program, SBA provides guarantees of up to 80 percent on loans

made by participating lenders. During fiscal year 1997, 7(a) loan approvals

totaled nearly $9.5 billion—the highest level of loan approvals in the

program’s history. This was an increase of 23 percent over the $7.7 billion

in loan approvals in fiscal year 1996. The total for 7(a) loans outstanding,

as of December 31, 1997, was $21.5 billion.

1

Section 7(a) of the Small Business Act (15 U.S.C.§636(a)) authorized this loan guarantee program.

2

12 U.S.C.§1452(d).

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SBA’s 7(a) lenders have been given additional authority and responsibility

over their 7(a) portfolios. According to SBA, it is in transition from its

direct involvement in loan guarantees to increased reliance on private

sector lenders to fulfill its mission. Within the 7(a) program, there are

three classifications of lenders—regular, certified, and preferred. Although

SBA completely analyzes regular lenders’ loans and decides on their

guarantee, certified lenders are expected to perform a complete credit

analysis. Preferred lenders are given full authority to determine eligibility

and creditworthiness and to approve loans without prior review by SBA.

Certified and preferred lenders are to have their status renewed at least

every 2 years by SBA. At the end of 1997, according to SBA, there were

approximately 6,000 lenders participating in the 7(a) program—about

4,750 regular, 800 certified, and 450 preferred lenders. In 1997, the

percentage of loans accounted for by preferred lenders represented about

30 percent of 7(a) loan approvals and 50 percent of loan dollar volume.

Participating lenders charge borrowers fees to obtain SBA loan guarantees,

and the borrowers repay the loans through payments to the lenders. To be

eligible for a 7(a) loan guarantee, lenders are required to document that

borrowers are unable to obtain financing under reasonable terms and

conditions through normal business channels. In the event of a default, SBA

purchases an agreed-upon share of the unpaid balance of the loan. The

maximum exposure allowable for SBA on a guaranteed loan is $750,000

unless otherwise authorized by statute for a specific loan program.

To participate in the 7(a) program, lenders must meet certain basic

requirements, including (1) having staff experienced in commercial

lending, (2) maintaining a good character and reputation, and (3) having

the financial capacity to disburse funds on loans. In addition, SBA

regulations require that lenders be subject to supervision and examination

by a state or federal regulatory authority acceptable to SBA. According to

SBA, for a period prior to January 1982, it licensed a number of

nondepository institutions, known as Small Business Lending Companies

(SBLC), that are not subject to state or federal supervision or examination

other than oversight conducted by SBA. SBA’s regulations provide that, to

meet its regulatory oversight requirement, these entities are to be subject

to periodic audits by SBA’s Office of Inspector General. According to SBA, it

licensed 16 SBLCs, and 12 are currently active in the 7(a) program as

preferred lenders. As of December 31, 1997, SBLCs accounted for about

19 percent of outstanding 7(a) loans.

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Results in Brief Prior to December 1997, SBA’s operating procedures for the 7(a) program

required annual on-site reviews of lenders having more than three

outstanding guaranteed loans. We could not determine from the district

offices’ files which lenders met this criterion and should have been

reviewed. However, in five SBA district offices we visited, about 96 percent

of the lenders had not been reviewed by SBA in the past 5 years. Further,

for some lenders that had participated in the program for more than 25

years, we found no evidence that they had ever been reviewed. Without

conducting periodic on-site lender reviews, SBA has no systematic means

to help ensure that lenders’ actions do not render loans ineligible,

uncreditworthy, or uncollectible, thus increasing the risk of loss to the

agency. Such monitoring is particularly important as the agency moves

from direct involvement in loan approvals to increased reliance on

participating lenders to perform the approval and other functions related

to the loan process. In addition, in the last 5 years, SBA’s Inspector General

conducted audits at only 3 of the 12 current SBLCs that operate as preferred

lenders.

Beginning December 1997, SBPIA required SBA to review preferred lenders

annually or more frequently. SBPIA did not change the oversight

requirements for regular and certified lenders. As of May 1998, SBA was in

the process of implementing a central review program for preferred

lenders, but SBA had not yet conducted any reviews because of delays in

developing the program. Although the central review program may offer a

more comprehensive and systematic approach to assessing lender

compliance with SBA’s standards, it is too early to tell how successful the

program will be until reviews are conducted and information on the

program is available.

SBA Policy Requires

Periodic Reviews of

Lender Performance,

but Few Have Been

Done

Within SBA’s headquarters, the Office of Financial Assistance has

responsibility for developing the policies and procedures that govern the

7(a) loan program. SBA’s 69 district offices are responsible for

implementing the 7(a) program, including maintaining oversight of

participating lenders’ compliance with SBA’s loan standards. The district

offices report to the Headquarters Office of Field Operations and provide

it with information on loan default rates and recoveries from liquidations.

The district offices are not required to report on their lender oversight

activities.

According to SBA’s operating procedures, on-site reviews of lenders’

policies and practices are a central mechanism for ensuring that lenders

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B-278633 

are processing loans according to its standards. Prior to December 1997,

the procedures required district offices to conduct annual reviews of

participating lenders having more than three outstanding SBA guaranteed

loans. The current policy requires a review at least once every 3 years for

regular and certified lenders with three or more loans and annually for

preferred lenders.

The objective of the reviews is to determine whether lenders are

complying with SBA’s 7(a) loan policies and procedures. The emphasis of

the reviews is to be on inspecting lenders, using a checklist, to determine

whether they have fulfilled requirements, such as documenting loan

collateral and credit files. Reviewers are to determine, for example,

whether collateral has been obtained and properly secured and whether

required insurance has been obtained. Without conducting periodic lender

reviews, SBA has no systematic means to evaluate lenders’ determinations

of loan eligibility, creditworthiness, or collectibility, thus increasing the

risk of loss to the agency. In addition, reviews could also help deter

lenders from extending guaranteed loans to applicants who could obtain

funding through other means. Such monitoring becomes more important

as the agency moves from direct involvement in each loan guarantee

transaction to increased reliance on participating lenders in processing,

servicing, and liquidating loans.

In spite of the policy requiring periodic reviews of participating lenders,

SBA had conducted few on-site reviews of the 7(a) lenders in the district

offices included in our review. In the 5 district offices we visited, SBA staff

had not conducted reviews of 778 of 812 lenders,3

 or about 96 percent, in

those districts in the past 5 years: 1993 through 1997. As shown in table 1,

four of the five district offices we visited reviewed fewer than 3 percent of

their participating lenders in that period of time.

3

SBA’s policy required annual on-site reviews of lenders having more than three outstanding loans. We

could not determine from the district offices’ files which lenders met this criterion and should have

been reviewed.

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Table 1: Comparison of Lenders

Receiving On-Site Reviews to Total

Lenders for Selected Districts,

1993-1997

District

Total

lenders

Lenders

reviewed Percent

Kansas City, MO 300 1 0.3

Los Angeles, CA 199 0 0

Richmond, VA 191 2 1.0

Sacramento, CA 43 1 2.3

San Francisco, CA 79 30 38.0

Total 812 34 4.2

Source: GAO analysis of SBA files.

The Los Angeles District Office, the largest district office for loan

approvals in fiscal year 1997, had not performed any on-site reviews in the

last 5 years; and the Richmond District Office had conducted two during

the same period. However, the San Francisco District Office had reviewed

61 percent of its preferred lenders, 82 percent of the certified lenders, and

20 percent of the regular lenders during the same time period.

In the 5 district offices, of the 744 lenders that had been in the program at

least 1 year, we found no evidence that 625 had ever been reviewed since

they began participating in the 7(a) program. Also, there was no

documentation in the files to indicate that some lenders that had

participated in the program for over 25 years had ever been reviewed. For

example, one lender in the Los Angeles District Office had become a

regular lender in 1980 and a preferred lender in 1987 and had never been

reviewed by SBA. Another lender in the Kansas City District was certified

over 29 years ago, but there was no documentation to indicate that it had

ever been reviewed. The records at the 5 district offices also indicated

that, of 147 lenders that entered the program between October 1, 1992, and

September 30, 1996, only 3 were reviewed.

Our analysis of the files did not indicate that any specific types of

lenders—regular, certified or preferred—received special emphasis in the

review process. Table 2 shows the lenders reviewed in the past 5 years by

the type of lender for each district.

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Table 2: Lenders’ Reviews, by Type,

for Selected Districts

Preferred Certified Regular

Number of lenders reviewed since 1993-1997

District Reviewed/Total Reviewed/Total Reviewed/Total

Kansas City, MO 1/11 0/8 0/281

Los Angeles, CA 0/53 0/19 0/127

Richmond, VA 2/16 0/6 0/169

Sacramento, CA 1/7 0/5 0/31

San Francisco, CA 11/18 9/11 10/50

Source: GAO analysis of SBA files.

SBA’s procedures state that reviews can be waived but that this waiver

privilege should be used only when workload priorities preclude

conducting a review. During the last 5 years, three of the five districts we

had visited waived some field reviews. According to file documentation,

the Kansas City District Office waived 182 reviews because of higher

priority work, and the Los Angeles District Office waived 147 reviews

because staff were not available. The San Francisco District Office waived

68 reviews for a number of reasons, including that the balances due on

lenders’ loans outstanding were low; lenders’ offices were not located in

the district; and the quality of lenders’ 7(a) loan portfolios was considered

good by the district staff.

District officials also told us that, although on-site reviews are not

regularly performed, they do maintain contact with lenders through a

number of mechanisms: telephone contact; periodic training seminars; and

SBA visits to lenders to discuss the loan program, changes in SBA

procedures, or a specific loan. For example, the Richmond District Office

made 15 visits to lenders in 1997 to explain changes in SBA’s liquidation

procedures; the Kansas City District Office’s records showed that staff

made 25 visits to 22 lenders in the last 5 years, primarily to promote the

7(a) loan program.

When SBA conducted on-site reviews, SBA’s checklist was used by staff, and

they found deficiencies in lenders’ compliance with SBA’s loan standards.

These deficiencies included inadequate loan collateral, loans written with

maximum maturities with no documentation as to why lesser maturities

would not be proper, and loans lacking documentation that credit was not

otherwise available to borrowers.

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Factors Affecting

Oversight Operations

SBA district directors told us that staff downsizing had made it difficult to

conduct on-site reviews of lenders. In the five districts we reviewed,

increases in the number of loan approvals ranged from 24 to 255 percent

from the beginning of fiscal year 1994 to the end of fiscal year 1997. During

the same period, the Sacramento and San Francisco districts had staffing

increases, while the other three districts experienced staff reductions. In

Los Angeles, loan approvals increased from 973 to 2,073, while staff size

decreased from 49 to 40.

In addition, the district directors said that the agency’s emphasis on

promoting the growth of small businesses and increasing the number of

loans to groups that have been underserved by the private marketplace

had resulted in less emphasis on oversight issues. The district offices are

responsible for both promoting the interests of small businesses and, at

the same time, conducting oversight of participating lenders to ensure the

integrity of the program. District officials told us that they find it difficult

to maintain a balance between these objectives because they are given

explicit annual goals by SBA headquarters for increasing the number of

loans to categories of the population that have been underserved by the

marketplace.

SBA officials told us that, in addition to goals for loan volume and program

promotion, SBA has annual goals related to loan performance. These

performance goals may not measure the effectiveness of SBA oversight

activities for two basic reasons. First, most loan defaults do not occur

during the year a loan is originated. Second, and more importantly, for any

one district office, economic conditions in the district have a major impact

on default rates from previously originated loans, and this is true even in

districts where SBA may perform effective oversight.

We also noted that neither SBA’s headquarters program office nor its Office

of Field Operations monitors field offices’ compliance with the lender

review requirement or requires district offices to provide headquarters

with information on the extent to which they are doing lender reviews and

on the results of lender reviews. In addition, SBA does not have a

mechanism to evaluate how well reviews are done. However, SBA is

piloting a Quality Service Review program that assesses field office

activities, including whether lender reviews are being performed. In 1997,

when SBA began the program, it reviewed the operations of 13 district

offices and plans to conduct 20 reviews in 1998. The objective of the

reviews is to ensure that critical program risks areas are reviewed;

employees are motivated, informed, and treated fairly; customers are

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satisfied with the delivery of SBA’s programs; and SBA’s relationships with

its partners are healthy. SBA plans to review each district office’s

operations every 3 years.

SBA Is Planning Actions to

Improve Lender Oversight

SBA officials told us that they recognize the need to adequately oversee

lender compliance with its standards, are in the process of evaluating the

oversight function, and will decide what changes are needed in the

agency’s oversight of 7(a) lenders. According to SBA’s Five-Year Strategic

Plan (fiscal year 1998-fiscal year 2002), dated September 30, 1997, SBA has

a fiduciary responsibility to monitor the performance of lenders and to

take steps against those lenders who are not performing in a manner

consistent with the laws and regulations governing SBA’s programs. In this

regard, SBA plans, among other things, to develop a protocol for lender

oversight that begins with the gathering and analysis of performance data

from participating lenders and to establish loan program credit standards,

as well as mission standards to measure lender performance.

One element of SBA’s oversight plans is the development of a loan

monitoring system to support off-site monitoring of lenders. The system is

also intended to help support SBA’s oversight of increased lender

responsibility for servicing loans. In a June 27, 1997, report4

 on SBA’s

efforts to develop the system and a congressionally mandated risk

management database, we concluded that SBA had not performed the

essential planning needed to provide a basis for Congress to fund the

development of the loan monitoring system. SBA disagreed with our

recommendation to delay funding the system’s development until the

necessary planning was completed. However, Congress, in the Small

Business Reauthorization Act of 1997,5

 mandated that SBA complete the

planning steps and required it to report on its progress by June 1998. The

act also requires us to evaluate SBA’s report for compliance with the

mandate.

SBA Is Implementing

a Preferred Lender

Review Program

Prior to the enactment of SBPIA, SBA decided to consolidate its processes

for managing the preferred lender program. SBPIA required SBA to

implement a program to provide a review, at least annually, of each lender

participating in the Preferred Lenders Program. The requirement was

based on this Committee’s concern about SBA’s past failure to provide

4

Small Business Administration: Better Planning and Controls Needed for Information Systems

(GAO/AIMD-97-94, June 27, 1997).

5

P.L. 105-135, 111 Stat. 2592 (1997).

Page 8 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
B-278633 

timely and regular reviews of lenders participating in the 7(a) loan

program.

In April 1995, SBA consolidated the processes for preferred lender

certification, approval for geographic expansion, and renewal of preferred

lender status in its Sacramento Processing Center. In October 1995, SBA

decided to develop a centralized preferred lender review process in its

Kansas City, Missouri, Review Branch. In addition, SBA has incorporated

the preferred lender oversight requirements that were included in SBPIA,

which became effective on September 30, 1996. The act required SBA to

establish a preferred lender review program not later than 90 days after

the act became law. The review program is to include annual or more

frequent assessments of the participation of lenders in the program,

including defaults, loans, and the recoveries of loans that lenders make

under the program.

The stated objectives of SBA’s new preferred lender review program are to

determine (1) whether preferred lenders are processing, servicing, and

liquidating loans according to SBA standards, and (2) whether such lenders

should continue to participate in the preferred lender program. The review

requirements are to be more extensive than those governing on-site

reviews of regular and certified lenders. According to SBA’s Preferred

Lender Program review manual, reviews are to focus on a sample of loans

approved by lenders and a sample of loans for which lenders have taken

servicing or liquidation actions. The reviews are also to include an

assessment of lenders’ loan policies and procedures, their internal routine

and controls, and any responses to previous reviews.

The preferred lender reviews are to be conducted by a review team

comprising an SBA Review Branch representative and one or more contract

reviewers. SBA contracted with a private sector partner to provide support

for the review and oversight activities. Contract reviewers are to conduct

the reviews of lenders’ SBA loans under the supervision of an SBA

representative. The review team is to be responsible for reviewing lenders’

loan policies and practices, their internal routine and controls, and any

responses to previous reviews. Contractor costs are to be reimbursed

directly to the contractor through a fee assessed to preferred lenders when

they are reviewed. The fees are to be based on the number of preferred

lender program loan approvals and are projected to range between $1,800

and $23,000. SBA plans to review, by the end of fiscal year 1998, all

preferred lenders that had originated at least one loan under the program

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in fiscal year 1997. These reviews are to be done either on-site or off-site,

depending on the loan volume of the lenders.

As of the end of March 1998, SBA staff conducted nine preliminary reviews

to test the review methodology and determine the length of time needed to

conduct on-site reviews. In commenting on a draft of this report, SBA

stated that the reviews are under way, with 60 off-site reviews started in

early May and on-site reviews to commence in mid-May. SBA’s Review

Branch plans to conduct reviews of each lender institution by the end of

fiscal year 1998 as required by SBPIA. The preferred lender review program

may offer a more comprehensive and systematic approach to assessing

lender practices. However, it is too early to tell how successful it will be

until reviews are conducted and information on the program is available.

Lender Oversight and

Economic Conditions

Affect Financial Risks

On-site lender reviews are an essential element to ensure that participating

SBA 7(a) lenders are complying with SBA loan standards and thereby

mitigating risks to SBA. When a financial institution provides a loan to a

borrower, credit risk (i.e., the possibility of financial loss resulting from

default by the borrower) is present over the life of the loan. In a 1997 study

conducted under contract to SBA, defaults on 7(a) loans were found to

occur most often 3 to 5 years after origination.6

 Therefore, default rates

observed through off-site monitoring during a current period of time do

not indicate whether a lender is currently following prudent lending

practices. In addition, economic and business conditions affecting small

business borrowers affect loan performance on loans made by all lenders,

including those that follow more prudent lending practices. The SBA loan

performance study found that default rates for 7(a) loans originated in the

1986 through 1990 time period were in the 20-percent range. According to

the study, default rates have declined since 1990. The decline is consistent

with the strong performance of the national economy over the past 5 to 6

years.7

 In the future, if economic conditions were to become less

favorable, such conditions would likely place upward pressure on 7(a)

default rates.

6

Walker & Company, Independent Study of 7(a) and 504 Loan Programs for the Eleven Cohort Years

Ended September 30, 1996 (June 16, 1997).

7

Likewise, the number of problem financial institutions insured by the Federal Deposit Insurance

Corporation (FDIC) and failures of those institutions have both declined over the past 6 years,

consistent with the strong performance of the national economy. In 1991, FDIC defined 1,426

institutions with assets of $819 billion as problem institutions; in 1997, the respective measures were

92 institutions with assets of $7 billion. In 1991, 271 FDIC-insured financial institutions with assets of

$142 billion failed; in 1997, the respective measures were 1 institution with assets of $27 million.

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Although lenders who follow prudent practices for originating and

servicing 7(a) loans can experience defaults, such risks to SBA would be

expected to be lower than risks associated with lenders following less

prudent practices. In order to monitor lenders without conducting on-site

reviews, SBA has tended to rely on information from individual 7(a) loans

provided at the time of application and at the time of liquidation on loans

that default. These data do not provide systematic information on the

extent to which each lender follows prudent lending practices, for two

basic reasons: (1) even the most prudent lenders make loans that default,

and (2) prudent lending requires observation of lender practices and

collecting information over the life of performing and defaulted loans.

Furthermore, over time, SBA has delegated greater authority and

responsibility to all lenders and a larger proportion of lenders have

become preferred lenders.

Careful oversight by the institution’s board, stockholders, and regulators

can help ensure prudent lending practices. Many 7(a) lenders are regulated

by financial institution regulators, such as the Office of the Comptroller of

the Currency (OCC), Office of Thrift Supervision (OTS), Federal Deposit

Insurance Corporation (FDIC), and Federal Reserve Board (FRB). These

regulators provide risk-focused supervision to help ensure that financial

institutions under their supervision have sufficient controls for risk

management as well as other practices that foster safe and sound

operations. In addition, these regulators have a continuing examination

presence that helps them monitor changes in the institution’s lending

practices and scope future examinations to emphasize activities that may

entail higher risks.

Although financial institution regulators help ensure safe and sound

operations, their oversight does not necessarily ensure that 7(a) portfolios

are managed prudently. According to an OCC official, in providing

risk-focused supervision, examiners would not necessarily focus on a

regulated institution’s 7(a) portfolio unless it were identified as

endangering the overall soundness of the financial institution. Therefore,

from SBA’s perspective, lenders subject to such regulation still require

effective SBA oversight.

Perhaps of greater importance, the SBLCs licensed by SBA are generally not

subject to oversight by financial institution regulators.8 SBLCs are

nondepository lending institutions that are licensed by SBA. To satisfy SBA’s

8

To the extent that any of these SBLCs are, or become, subsidiaries of bank holding companies, they

could be subject to FRB oversight. We did not analyze the implications of such potential oversight

during the course of this assignment.

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supervision and examination requirement, SBLCs are subject to direct

supervision and examination by SBA. SBA regulations provide that SBLCs are

subject to periodic audits by SBA’s Inspector General and that SBA will

assess the cost of the audit, based on asset size, against the SBLC, except

for the first audit.9

 In the last 5 years, SBA’s Inspector General conducted

audits at three SBLCs. Audits at two of the SBLCs involved a review of their

lending practices for compliance with SBA’s requirements. The audit at one

of these SBLCs concluded that the SBLC was in compliance with applicable

SBA requirements. The second audit concluded that the SBLC’s originating

and servicing of SBA loans needed improvement, and that some required

internal controls had not been implemented. The third audit was requested

by an SBA district office and was limited to a review of three guaranteed

loans. The audit concluded that one of the three loans did not qualify for

the guarantee, and that interest collected by the lender should have been

returned to SBA.

In the future, it is possible that economic conditions could become less

favorable and that such conditions then could place upward pressure on

7(a) default rates. SBA’s knowledge of how prudently each lender’s 7(a)

portfolio is managed and how the portfolio would perform under less

favorable economic conditions is more limited without on-site reviews. In

addition, effective oversight of SBLCs could help SBA assess how prudently

their overall operations are managed and how these institutions would

perform under less favorable economic conditions.

Conclusions In the five district offices included in our review, SBA had not conducted

the regular, periodic reviews of lender compliance with its 7(a) loan

standards as required under its operating procedures. Without such

systematic oversight, SBA cannot ensure that participating lenders are

complying with its loan standards and thereby mitigating risks to the

agency. In addition, SBA does not have clear organizational responsibilities

and mechanisms in place to ensure that information on the lender review

process is collected, reported, and analyzed. Without such information,

SBA cannot measure and monitor the impact of its oversight of lenders’

compliance with its loan policies and procedures.

As of the end of March 1998, SBA was in the process of implementing its

centralized review program for preferred lenders, but it had not yet

conducted any reviews. It had developed and tested a review methodology

and is planning to conduct annual reviews of preferred lenders as required

9

13 C.F.R.§120.475.

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by SBPIA. In commenting on a draft of this report, SBA stated that the

planned reviews were under way. SBA’s preferred lender review program

should provide improved oversight of preferred lender practices.

The audits conducted at three SBLCs in the last 5 years do not appear to

satisfy SBA’s audit frequency and continuing supervision and examination

requirement. Because these SBLCs are not subject to supervision or

examination by a financial institution regulator, we believe oversight by

SBA is especially important.

SBA officials told us that they recognize the need to adequately oversee

lenders’ compliance with its 7(a) loan standards and are planning actions

to improve oversight of lenders’ practices; however; it is too early to tell

how successful the initiatives will be.

Recommendations We recommend that the Administrator of the Small Business

Administration ensure that the required 7(a) lender oversight reviews are

conducted. In this regard, the Administrator should establish

organizational responsibilities and a mechanism for ensuring that

information on the lender review process is collected, reported, and

analyzed. This information should be useful in assessing the results of the

review process and determining whether additional initiatives may be

needed.

We also recommend that the Administrator develop and implement a

mechanism to satisfy its supervision and examination function for SBLCs.

Agency Comments

and Our Evaluation

We requested comments on a draft of this report from SBA, which provided

written comments that are reproduced in appendix I. SBA’s comments did

not specifically address our recommendations, but they stated that the

funds it has requested for loan system modernization are essential for it to

institute the oversight we endorse in the report. In general, SBA also

expressed a concern that the report may give an incomplete picture of its

oversight activities.

SBA stated that it was important to highlight the improvement in the credit

quality of its loan portfolio. It stated that, although the excellent economy

has contributed to this improvement, SBA believed that its recent changes

to the 7(a) program have mitigated the degree of vulnerability to an

economic downturn. These changes included increasing lenders’

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economic interest in loans and revising program operating procedures. We

acknowledged in the report that SBA’s default rates have declined, but it

was beyond our scope either to determine how much of this decline is

based on the state of the economy or on SBA’s practices or to project how

its portfolio would likely perform under less favorable economic

conditions.

SBA commented that the results of our review at 5 of its district offices are

not necessarily representative of activities throughout the 69 SBA district

offices. We visited the Los Angeles and San Francisco, California, and

Kansas City, Missouri, district offices because they are three of the largest

districts in terms of the number of loans outstanding. We also visited a

medium and a smaller sized office—Sacramento, California, and

Richmond, Virginia, respectively. We do not know how representative

these offices are. SBA’s district offices are not required to report on their

lender oversight activities, and the resulting lack of information regarding

on-site reviews makes it difiicult to determine whether the districts we

visited were representative or not.

SBA commented that, although it has placed a high priority on improving

oversight, on-site lender reviews have a limited role. SBA stated that, other

than on-site reviews, it performs oversight in a number of other ways,

which it states provide a systematic means of mitigating risk imposed as a

result of lenders’ decisions. That is, it verifies eligibility in all loan

decisions, considers lender performance in decisions to relicense certified

and preferred lenders, and reviews loans when a lender requests an SBA

purchase. SBA said that it is also modernizing its loan system as part of its

efforts to improve its monitoring of individual loans and individual

lenders. We agree that these activities, including off-site monitoring,

provide a measure of oversight; however, they do not provide the type of

systematic assessment of a lender’s practices that periodic on-site reviews

provide. Our experience in evaluating financial institution regulators

indicates that off-site monitoring is helpful when it is used to perform risk

assessments to target on-site reviews, but that it is not an effective

substitute for such reviews. In addition, we are reporting on SBA’s

noncompliance with its own requirement for lender oversight reviews.

SBA’s operating procedures state that on-site lender reviews are necessary

to maintain the integrity of its loan programs and are a critical component

of its oversight requirement.

SBA said it was also working with banking regulatory agencies, which

examine the vast majority of its lenders, to explore opportunities for

Page 14 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
B-278633 

partnership in regulation and oversight and for them to play an important

role in examining its lenders’ overall performance in making creditworthy

loans. As the report states, although financial institution regulators help

ensure lenders’ safe and sound operations, their oversight does not

necessarily ensure that 7(a) portfolios are managed prudently. In addition,

it should be noted that SBA currently has no access to the findings of

examinations conducted by bank regulators.

With regard to SBLCs, which are not subject to supervision and

examination by a state or federal financial regulatory authority, SBA said

that, in addition to specific audits by its Inspector General, oversight is

provided in a number of ways, including a requirement that SBLCs submit

annual audited financial statements. We agree that audited financial

statements can help examiners focus on specific aspects of a financial

institution in its on-site examinations. However, the purposes of external

audits and safety and soundness examinations differ and are guided by

different standards and methodologies. For example, federal financial

regulators require examiners to evaluate the adequacy of methodologies

used by financial institution auditors to estimate loan loss reserves.

Scope and

Methodology

As requested by the Chairman of the Senate Committee on Small Business,

our objectives were to determine (1) how SBA conducts on-site reviews to

monitor participating lenders’ compliance with its 7(a) loan program

policies and procedures, and (2) what actions SBA is taking to comply with

the preferred lender oversight provisions of the Small Business Programs

Improvement Act of 1996.

To determine how SBA has assessed whether lenders are managing loans

according to its standards, we examined SBA’s standard operating

procedures relating to reviews of regular and certified lenders, as well as

its manual for examining preferred lenders. We reviewed other related

guidance pertaining to the 7(a) loan program and interviewed staff from

SBA headquarters, Office of Inspector General, and 5 of the 69 SBA District

Offices. We also interviewed staff from the Sacramento Loan Processing

Center in Sacramento, California, and the Preferred Lender Review Branch

in Kansas City, Missouri. Finally, to obtain a perspective on the extent to

which SBA field offices have conducted assessments of lender compliance,

we reviewed lender files from the five SBA district offices. We visited the

Los Angeles and San Francisco, California, and Kansas City, Missouri,

district offices because they are three of the largest districts in terms of

the number of loans outstanding. We also visited a medium and a smaller

Page 15 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
B-278633 

sized office—the Sacramento, California, and Richmond, Virginia, offices,

respectively. We also selected these district offices to visit to help

conserve travel funds.

To determine SBA’s compliance with the preferred lender oversight

requirements of SBPIA, we reviewed documentation relating to SBA’s

implementation of a centralized review program for preferred lenders. We

discussed the program with staff from SBA headquarters and the Preferred

Lender Review Branch in Kansas City. We also reviewed reports of

reviews of preferred lenders that were done on a test basis by the Kansas

City Review Branch.

We conducted our work in Washington, D.C.; Los Angeles, Sacramento,

and San Francisco, California; Kansas City, Missouri; and Richmond,

Virginia, between September 1997 and March 1998 in accordance with

generally accepted government auditing standards.

As arranged with your office, unless you publicly announce the contents of

this letter report earlier, we plan no further distribution until 14 days after

its issue date. At that time, we will send copies of this report to the

Ranking Minority Member of the Committee on Small Business; the

Chairmen and Ranking Minority Members of other interested

congressional committees; the Administrator, Small Business

Administration; the Director, Office of Management and Budget; and other

interested parties. Copies will also be made available to others upon

request.

Please contact me or Bill Shear at (202) 512-8678 if you or your staff have

any questions. Major contributors to this report are listed in appendix II.

Sincerely yours,

Thomas J. McCool

Director, Financial Institutions

 and Markets Issues

Page 16 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
Page 17 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
Contents

Letter 1

Appendix I 

Comments From the

Small Business

Administration

20

Appendix II 

Major Contributors to

This Report

23

Tables Table 1: Comparison of Lenders Receiving On-site Reviews to

Total Lenders for Selected Districts, 1993-1997

5

Table 2: Lenders’ Reviews, by Type, for Selected Districts 6

Abbreviations

FDIC Federal Deposit Insurance Corporation

FRB Federal Reserve Board

OCC Office of Comptroller of the Currency

OTS Office of Thrift Supervision

SBA Small Business Administration

SBLC Small Business Lending Company

SBPIA Small Business Programs Improvement Act of 1996

Page 18 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
Page 19 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
Appendix I 

Comments From the Small Business

Administration

Page 20 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
Appendix I 

Comments From the Small Business

Administration

Page 21 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
Appendix I 

Comments From the Small Business

Administration

GAO note: We did not

reproduce the enclosure.

Page 22 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
Appendix II 

Major Contributors to This Report

General Government

Division

William B. Shear, Project Director

Lamont J. Kincaid, Project Manager

John J. Strauss, Deputy Project Manager

Melissa Duvall, Intern

Office of the General

Counsel

Rosemary Healy, Senior Attorney

San Francisco Field

Office

Bruce K. Engle, Evaluator

(233524) Page 23 GAO/GGD-98-85 SBA Reviews of Guaranteed Lenders
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