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41–658 PDF 2008

S. HRG. 110–504

SBA LENDER OVERSIGHT: PREVENTING LOAN

FRAUD AND IMPROVING REGULATION OF

LENDERS

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS

AND ENTREPRENEURSHIP

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

NOVEMBER 13, 2007

Printed for the use of the Committee on Small Business and Entrepreneurship

(

Available via the World Wide Web: http://www.access.gpo/gov/congress/senate

(II)

COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

JOHN F. KERRY, Massachusetts, Chairman

CARL LEVIN, Michigan

TOM HARKIN, Iowa

JOSEPH I. LIEBERMAN, Connecticut

MARY LANDRIEU, Louisiana

MARIA CANTWELL, Washington

EVAN BAYH, Indiana

MARK PRYOR, Arkansas

BENJAMIN L. CARDIN, Maryland

JON TESTER, Montana

OLYMPIA J. SNOWE, Maine,

CHRISTOPHER S. BOND, Missouri

NORMAN COLEMAN, Minnesota

DAVID VITTER, Louisiana

ELIZABETH DOLE, North Carolina

JOHN THUNE, South Dakota

BOB CORKER, Tennessee

MICHAEL B. ENZI, Wyoming

JOHNNY ISAKSON, Georgia

NAOMI BAUM, Democratic Staff Director

WALLACE HSUEH, Republican Staff Director

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CONTENTS

Page

OPENING STATEMENTS

Kerry, The Honorable John F., a United States Senator from Massachusetts .. 1

Snowe, The Honorable Olympia J., a United States Senator from Maine ......... 4

Cardin, The Honorable Benjamin, a United States Senator from Maryland ..... 6

WITNESS TESTIMONY

Preston, The Honorable Steven C., Administrator, U.S. Small Business Administration, Washington, DC ............................................................................ 7

Thorson, Eric M., Inspector General, U.S. Small Business Administration,

Washington, DC ................................................................................................... 32

Tannenhauser, Robert F., chairman, Business Loan Express, LLC, New York,

New York .............................................................................................................. 46

Wilkinson, Anthony R., president and chief executive officer, National Association of Government Guaranteed Lenders, Inc., Stillwater, Oklahoma ....... 56

Baird, James, Executive Director, Bay Area Development Company, and vice

chairman, Legislative Affairs Committee, National Association of Development Companies, Walnut Creek, California ...................................................... 68

ALPHABETICAL LISTING AND APPENDIX MATERIAL SUBMITTED

Baird, James

Testimony .......................................................................................................... 68

Prepared Statement ......................................................................................... 70

Brickman, Jim

Prepared Statement ......................................................................................... 130

Cardin, Hon. Benjamin

Opening Statement ........................................................................................... 6

Dinsmore, Frank F.

Prepared Statement ......................................................................................... 146

Einhorn, David

Prepared Statement ......................................................................................... 133

Isakson, Hon. Johnny

Post-hearing questions posed to Hon. Steven C. Preston and subsequent

responses ....................................................................................................... 108

Kerry, Hon. John F.

Opening Statement ........................................................................................... 1

Post-hearing questions posed to Hon. Steven C. Preston and subsequent

responses ....................................................................................................... 92

Post-hearing questions posed to Eric Thorson and subsequent responses .. 109

Post-hearing questions posed to Robert Tannenhauser and subsequent

responses ....................................................................................................... 124

Preston, Hon. Steven C.

Testimony .......................................................................................................... 7

Prepared Statement ......................................................................................... 10

Response to post-hearing questions from:

Senator Kerry ............................................................................................ 92

Senator Snowe ........................................................................................... 100

Snowe, Hon. Olympia J.

Opening Statement ........................................................................................... 4

Post-hearing questions posed to Hon. Steven C. Preston and subsequent

responses ....................................................................................................... 100

Page

IV

—Continued

Post-hearing questions posed to Eric Thorson and subsequent responses .. 116

Tannenhauser, Robert F.

Testimony .......................................................................................................... 46

Prepared statement .......................................................................................... 49

Response to post-hearing questions from Senator Kerry and subsequent

responses ....................................................................................................... 124

Thorson, Eric M.

Testimony .......................................................................................................... 32

Prepared Statement ......................................................................................... 34

Response to post-hearing questions from:

Senator Kerry ............................................................................................ 109

Senator Snowe ........................................................................................... 116

Senator John Thune .................................................................................. 123

Thune, Hon. John

Post-hearing questions posed to Eric Thorson and subsequent responses .. 123

Wilkinson, Anthony R.

Testimony .......................................................................................................... 56

Prepared Statement ......................................................................................... 59

COMMENTS FOR THE RECORD

Brickman, Jim, real estate developer and investor .............................................. 130

Einhorn, David, president and co-founder, Greenlight Capital, Inc .................... 133

Dinsmore, Frank F., chief executive officer, REsource Capital, Real Estate

Financing for Growing Businesse ....................................................................... 146

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SBA LENDER OVERSIGHT: PREVENTING LOAN

FRAUD AND IMPROVING REGULATION OF

LENDERS

TUESDAY, NOVEMBER 13, 2007

UNITED STATES SENATE,

COMMITTEE ON SMALL BUSINESS

AND ENTREPRENEURSHIP,

Washington, DC.

The Committee met, pursuant to notice, at 10:32 a.m., in room

428–A, Russell Senate Office Building, the Honorable John F.

Kerry (Chairman of the Committee) presiding.

Present: Senators Kerry, Cardin, and Snowe.

OPENING STATEMENT OF THE HONORABLE JOHN F. KERRY,

CHAIRMAN, SENATE COMMITTEE ON SMALL BUSINESS AND

ENTREPRENEURSHIP, AND A UNITED STATES SENATOR

FROM MASSACHUSETTS

Chairman KERRY. Good morning. This hearing of the Small Business Committee will come to order. I thank everybody for being

here and I thank you for your patience. We had a vote, obviously,

but we thought it was more important to begin the hearing after

the vote rather than interrupting the hearing, and so I appreciate

everybody’s indulgence. This way, we will be able to go straight

through because there are no more votes until after lunch, and

therefore, we can have an uninterrupted hearing, which is what

both Senator Snowe and I prefer to do.

Let me emphasize a couple of things about this hearing. I know

there have been some questions from some parties about why we

should have a hearing like this. Senator Snowe and I and all the

Members of this Committee manage a Committee that works in a

very bipartisan way and try very hard to keep the politics off the

table.

The bottom line is that the Congress—as a separate and co-equal

branch of government, which sometimes people have to be reminded of—has a major responsibility as to how we spend the taxpayers’ money, as to what happens to the programs we put into

law, and we are often the critical oversight arm in making certain

that those laws are carried out, that the intent of Congress is, in

fact, the intent of the American people—it is not our intent. It is

who we represent, and we have the responsibility to make sure

that intent is, in fact, carried out and that we are presenting the

American people with the best governance possible. That is what

we owe them. And sometimes this city has an ability to get up on

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an arrogant high horse and forget why we are here and who puts

us here and what our obligations are.

So the purpose of this hearing is not politics. The purpose of this

hearing is not ‘‘gotcha.’’ The purpose of this hearing is to figure out

how—with the help of the SBA’s Office of Inspector General, which

was created in order to have transparency and accountability and

effectiveness—how the SBA’s lending partners and our committee

can improve the agency’s lender oversight and prevent fraud in the

SBA’s small business lending programs.

No one is here to suggest that this is somehow pervasive or that

it is more—we don’t know that situation. We are here to explore

the one situation that we know and those things that have been

talked about by the Inspector General over the course of time.

And the timing of this hearing, frankly, couldn’t be more important. Everybody is aware of what is happening in the economy. Everybody understands the difficulties with the subprime lending and

mortgages and what is happening to credit as a consequence. And

the whole purpose of the SBA is to help small businesses access

credit and be able to move in the marketplace and get capital.

So we see now a credit crunch, somewhat caused by the mortgage subprime crisis and people in the country losing their homes.

Small businesses, therefore, feel the impact from that in a lot of

different ways, and many get their credit from their homes. At

least one in three small business owners say that they are now

being adversely impacted by this credit crisis.

Secondary market premiums are down 25 percent, so banks are

tightening up their loans for everyone, including entrepreneurs.

That means that the government-backed loans, the very rationale

for the existence of the SBA and the very rationale for 7(a) and 504

programs and so forth are even more important right now, much

more important.

SBA loans provide capital to small firms that can’t access credit

through the normal channels, and if all of a sudden people start

to have doubts about that marketplace, you can have a problem, a

cascading kind of problem, and we want to avoid that. We also

want to make sure that we are reaching those people who we have

always tried to target, who are the minorities and women and veterans and others for whom the SBA has a particular mission.

So we are here today to discuss SBA lender oversight and, you

can’t avoid some discussion of the fraud scheme that was carried

out by a bad actor from Business Loan Express in their Troy,

Michigan branch and a small group of people. I emphasize we don’t

know the depths. It is obviously important because it resulted in

$76 million in fraudulent SBA loans. So we need to know what

happened. We all need to know this. We need to know how it happened. We need to know what is being done to prevent it in the

future.

The hearing is not intended to hurt Business Loan Express nor

any other entity, but that is not to say also that there isn’t a legitimate standard of accountability, because people need to answer for

their employees. That is just a normal course of business and this

should be no different.

We need to understand how no one noticed or reported a high

number of bad SBA loans coming out of the branch, and today’s

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hearing is an opportunity for the company to tell its side of the

story, including their rationale for cutting back on small business

lending, which they announced recently.

And let me just say, I greatly regret the loss of jobs that is going

to go with the company’s announcement. The SBA lending community is a close-knit community, and I know this has created concern

within that community, even some regret in some parties. We obviously hope that everybody lands on their feet in this judgment that

has been made and what happens.

Another aspect of today’s hearing is the SBA Inspector General’s

report generated by its audit of the lender oversight procedures

and resources. SBA requested that much of the IG’s report be redacted before it was made public, including most of the IG’s recommendations. It is hard to understand why those recommendations and the agency’s plans to address the IG’s findings were redacted. Frankly, this is highly unusual. The SBA and BLX have

based their requested redactions on claims of trade secret protections, the deliberative process privilege, and the bank examination

privileges, which can be legitimate reasons for redactions if applied

correctly.

However, even if SBA had the legal right, I question whether all

of the information blacked out needs to be redacted. It seems like

an overreach and has probably created more problems than it has

solved. So I think in the interest of having more transparency of

SBA’s oversight activities, not less, Mr. Administrator, we have

been very complimentary of you throughout the process and very

encouraging for the initiatives that you have brought, but I think

SBA could have handled this particular issue more effectively. I

think the agency needs to improve its oversight with more transparency.

Let me also comment, the BLX report is not the only report relevant to the SBA’s oversight. In the past 5 years, the SBA IG has

issued more than 60 reports on general lender oversight issues and

SBA procedures related to justified payments of guarantees on defaulted SBA loans. Also, the IG has examined the transfer of the

purchase responsibility from the 69 district offices to the Herndon

Center.

Now, some of the problems we are going to discuss here today

demonstrate that the agency may have been excessive or harsh or

even irresponsible in dismantling the loan functions in the district

offices so quickly. They didn’t have the Herndon Center adequately

established to take on centralization and they underestimated the

necessary staff and training requirements. It also came at a personal cost to almost 200 people who lost their jobs or were uprooted

in haste. From what at least we hear, and I am open to evidence

to the contrary, but certainly from what we hear, that has contributed to low morale in some quarters. It has created unnecessary instability over the last couple of years for lenders on liquidation and

purchases of loans.

Furthermore, the Administration’s budget request—and I think

this is felt by most Members of, I think unanimously, on the Committee—the budget requests have simply been insufficient and unreasonable for staffing and funding the centralized offices and district offices. Simple logic says that you can’t go from a budget of

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almost $1 billion to $600 million, while nearly doubling your loan

portfolio from about 51,000 loans in 2002 to almost 100,000 loans

in 2006 and still claim to have the labor-intensive personal oversight necessary to know what those loans are doing, unless you

have created some new magical virtual system, which we have yet

to understand.

You are not saving money, if by scrimping on staff responsible

for loan oversight, you end up enabling sloppy lenders to do poor

underwriting and allow the agency to make improper and inaccurate payments on defaulted loans. In fact, an audit by the IG,

issued in May, states that the SBA’s lax review of purchase requests of defaulted loans resulted in $36 million in erroneous payments on unjustified purchases on bad loans.

To round out the discussion, we are going to hear from Jim Baird

and Tony Wilkinson representing the 504 Certified Development

Company lenders and the 7(a) lenders. These lenders have a stake

in this process, and they ought to be part of the discussion, and

part of that discussion involves information sharing.

As the SBA tries to predict and identify problem loans, they

should share with the lenders which ones they deem to be at risk,

so that they can take action to prevent a default, or even a lapse

in currency.

Senator Snowe got a lot of these issues right in the lender oversight legislation that she introduced recently, and I very much appreciate her work and her knowledge with respect to this. I was

glad to join her in introducing that, and with that, I turn to Senator Snowe.

OPENING STATEMENT OF THE HONORABLE OLYMPIA J.

SNOWE, A UNITED STATES SENATOR FROM MAINE

Senator SNOWE. Thank you very much, Mr. Chairman, and also

thank you for holding this hearing to conduct oversight over the

Small Business Administration’s ability to detect and prevent

fraudulent loans. Your longstanding leadership is certainly critical

at this juncture, and as you said, this hearing couldn’t be more

timely given the economic situation that we find ourselves in in

this country and the degree to which small businesses do depend

on the Small Business Administration for loans, and ultimately,

the creation of jobs.

I also want to thank Administrator Preston and Inspector General Thorson for being here and all the other witnesses. I appreciate their willingness to help us better understand the challenges

that the Small Business Administration is confronting with respect

to the SBA’s loan monitoring and lender oversight activities.

As Ranking Member of this Committee, I find the SBA’s history

of SBA’s lender oversight issues unacceptable. It is my hope, this

morning, that we will probe how and why the Government has inappropriately allowed loan fraud and poor loan underwriting to

occur at the Business Loan Express Corporation, BLX, Innovative

Bank, and in 44 out of 45 of the Small Business Express and Community Express loan files reviewed by the Office of Inspector General.

These three cases reveal the ineffectiveness of the SBA’s current

oversight activity. I fear that unless the SBA is able to dramatiVerDate 11-MAY-2000 15:36 Sep 24, 2008 Jkt 041658 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 C:\DOCS\41658.TXT DianeA PsN: DianeA
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cally improve its lender oversight, escalating losses and fees will

drive lenders and borrowers away from these key loan programs.

This will seriously hamper and harm the ability of small businesses to access capital to grow, but also—regrettably—it would reverse the very mission of these programs. Currently, the SBA has $80 billion in outstanding loans issued

to small businesses, many of which are new startup companies

without longstanding credit histories. When they apply for an SBA

loan, the loan officer must determine if the company meets the

needs to obtain an SBA loan, including having a sufficient cashflow to repay the terms of the loan.

Unfortunately, as the IG report demonstrates, a number of loan

officers have failed to perform their due diligence and have improperly underwritten loans without verifying that loans can be repaid

and that borrowers can meet all the criteria necessary to qualify

for an SBA loan. It is an irrefutable established truth that poor

loan underwriting directly leads to loan defaults, fraud, and other

deficiencies. This is a reality that we need to address here at the

hearing today.

Although the SBA has recently undertaken a number of efforts

to improve its lender oversight activities—these are steps in the

right direction—they are no substitute for the strides that are absolutely an imperative. Simply put, not enough is being done by the

SBA, and that must change.

To enhance its oversight in the performance of the 7(a) and the

504 loan portfolios, it is incumbent upon the SBA to improve the

quality of lenders’ underwriting and to make doing so a fundamental and absolute priority. That progress should begin with

three things: First, effectively and thoroughly auditing lenders’

loan files during onsite reviews; second, harnessing technology to

help lenders meet the SBA’s underwriting requirements; and finally, streamlining the initial application loan review process.

Mr. Administrator, today I hope we can hear from you about

your clear and concise plan to work with the SBA Inspector General and immediately improve the SBA’s lender oversight process.

As I mentioned earlier, there is a history of problems within the

SBA. Now, I know much of it occurred before your tenure, but nevertheless, there has been a long history of lender oversight difficulties. We have had numerous hearings and numerous reports—as

the Chairman cited—and yet we still find ourselves at this juncture

where we are finding fraudulent loans to the magnitude and degree

of millions and millions of dollars. Just with BLX alone, it was

more than $200 million.

Additionally, the SBA must increase the transparency of its oversight activities and measurements. The SBA has failed to provide

participating lenders with much of the criteria the agency uses to

determine whether portfolios are sound or substandard. Again, this

is an issue that we heard repeatedly from lenders with respect to

the failure of the SBA to present the criteria and the standards by

which the Agency measured lenders’ portfolios. It goes without saying, this lack of transparency hinders the SBA’s oversight capability and encourages participating lenders to be justifiably critical

of the agency’s ability to accurately assess portfolio quality and

conduct effective oversight.

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That is why, earlier this month, Chairman Kerry and I introduced legislation that I hope will codify the SBA’s standards for

portfolio quality and enhance the transparency of measurements

that the SBA must use to evaluate lenders. This is timely legislation. Hopefully, Mr. Chairman, we in the Committee can mark this

up this year so that we can address these issues as effectively and

efficiently as possible.

Finally, I am also concerned by the large redactions within the

SBA Inspector General’s report that were done at the request of

the Small Business Administration. It seems to me, at this point,

given the amount and the totality of fraudulent loans with BLX—

there have been, in fact, 76 fraudulent BLX loans worth $76 million—it underscores the necessity for both SBA and the Inspector

General to work in a collaborative fashion. We need a report that

doesn’t have the kind of redactions that we are facing here today.

The SBA cannot stifle the SBA’s Inspector General’s critical

voice, or hide from the public’s view suggestions on how to improve

lender oversight. Given the history of the SBA on this very question, there has to be an urgency and an imperative on the part of

the Small Business Administration to address these issues; more

importantly, to correct them and to prevent this kind of catastrophic event from reoccurring. Ultimately, these types of failures

can impinge upon the ability of small businesses to access needed

loan guarantees. Ultimately, this can hurt our economy as small

companies will or will not create jobs, depending on small businesses’ ability to secure those loans. If you think about SBA being

the net creator of jobs in this country, then clearly the effectiveness

of the SBA’s lender oversight has a direct consequence and correlation to small businesses’ access to loans.

I hope we can address all of these issues here today, Mr. Chairman.

Chairman KERRY. Absolutely. We hope to and I thank you for

that important statement. Thank you very much.

Senator Cardin, do you have any opening statement you want to

make quickly before we start? I want to try to——

OPENING STATEMENT OF THE HONORABLE BENJAMIN L.

CARDIN, A UNITED STATES SENATOR FROM MARYLAND

Senator CARDIN. Mr. Chairman, let me just thank you and Ranking Member Snowe for your comments and convening this hearing.

I concur with the comments that have been said.

Let me just make a very quick point to Administrator Preston.

I am not satisfied by the manner in which the agency has conducted oversight or outreach when dealing with the fraudulent

loans that we are talking about today, but also outreach to make

sure we have the right quality of loans against those groups that

have been denied the opportunity historically and the need for capital, the minority businesses, first-generation businesses, and

women-owned businesses.

So, I think we are not only concerned about the oversight to

make sure the fraudulent loans don’t have any place, but that the

capital is available to help small businesses grow and produce the

jobs that are critically important to our economy, and I look forward to today’s hearing. Thank you.

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Chairman KERRY. Thank you, Senator Cardin.

As we begin this—and this will apply to each of the panels—I

mentioned the issue of the redactions and the question of the assertion of a legal privilege with respect to them. While we are looking

at and examining thoroughly the question of their appropriateness,

I nevertheless will respect if somebody here feels that some answer

is going to tread on the assertion of those privileges, and declines

to respond. We certainly will respect that here, and I simply ask

you to tell us what you believe the basis of your claim is, and we

will proceed forward from there.

So Administrator Preston, thank you for being here. You have

served in your role since July of 2006, and you have come to this

job with about 25 years of experience in financial operational leadership, so we look forward to your observations and hopefully continued progress.

STATEMENT OF THE HONORABLE STEVEN C. PRESTON, ADMINISTRATOR, U.S. SMALL BUSINESS ADMINISTRATION,

WASHINGTON, DC

Mr. PRESTON. Great. Thank you. Thank you, Senator Kerry.

Thank you for setting that context for the hearing, Ranking Member Snowe, as well, Senator Cardin. Obviously, we are here to talk

about a very important——

Chairman KERRY. Let me just say, if I may interrupt you for a

minute——

Mr. PRESTON. Yes.

Chairman KERRY.I know you had asked maybe to testify afterwards, et cetera. What I would like to do—and I put the others on

notice, because we are here to get information and facts, not to provide just a platform for everybody—so after Administrator Preston

testifies, I asked him if he would stay around, listen to the other

testimony; and I am going to give him the privilege of inserting

himself into the dialog at any point that he deems it necessary, and

we will have a good discussion.

Mr. PRESTON. Well, what I plan to do is leave my head of Capital

Access, as well as our General Counsel here, who are much more

familiar with the details of the redactions and those sorts of things

than I am.

Chairman KERRY. Is your microphone on?

Mr. PRESTON. Yes, it is. Can you hear me OK?

Chairman KERRY. Yes.

Mr. PRESTON. All right. Well, thank you very much. Obviously,

this is an important topic. We have about $67 billion worth of 7(a)

and 504 loans in the marketplace. Our guarantee represents about

$53 billion. Obviously, that number has grown significantly, especially just in the last 5 or 6 years.

A I listened to your comments, I think it is very important for

us to look at the historical context in terms of the issues we are

talking about, when they occurred, and the progress the agency has

made. I hope we will be able to make some progress in talking

about that because, I think we have made a lot of progress, although I do think we have a lot more to make.

As you are aware, we administer our 7(a) loan guarantee program through participating banks, credit unions, and through other

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lenders, many of whom get varying levels of delegated authority to

make those loans. We are responsible for oversight of about 5,000

lenders, but about 674 have preferred lender authority.

In 2003, the GAO reported that the SBA had made significant

progress in developing lender oversight, but that much more was

necessary. In particular, the GAO recommended that SBA measure

the financial risk of lenders’ portfolios, qualitatively assess the

lenders’ performance, and clarify its enforcement authority.

Since that report, SBA has established extensive credit risk management programs that cover both onsite and offsite portfolio review. Those are a very significant change from our prior review

process. The offsite review and monitoring program features sophisticated risk rating measurements developed by a nationally

recognized provider of commercial credit scores and performance

models. The information allows SBA to compare lenders within a

peer group, while helping lenders monitor their performance within

our portfolio. SBA also provides a risk rating based on the consolidation of individual loan credit quality and overall portfolio performance information, which is an indicator that allows the lenders

to take corrective action where necessary.

The onsite process is qualitative analysis of credit administration, policies, procedures, and controls that relate to the SBA loans,

as well as portfolio performance conducted to provide more in-depth

reviews of individual loans and verify the lender adherence to our

policies.

For our supervised lenders, we contract with an independent examiner, the Farm Credit Administration, for detailed safety and

soundness and portfolio performance evaluations. These reviews

are just part of our increased oversight activities. In addition, we

conduct post-purchase reviews to inspect loan files after SBA has

honored its guarantee to ensure all procedures and documentation

are correct. SBA has developed a more independent supervision

and enforcement process. A new lender oversight board, which includes the Deputy Administrator, the CFO, as well as the AA for

Capital Access, regularly review our enforcement actions to make

sure that they follow our guidelines and that performance standards are being met.

The Office of Credit Risk Management also has numerous tools

available to enforce its performance standards. It can reduce the

length of the PLP and other delegated authorities to mitigate risk.

It has the ability to conduct more frequent onsite reviews. We work

with management to resolve deficiencies through correction action

plans, through required quarterly monitoring, and obviously in the

more severe circumstances, we can pull their PLP status or their

authority to make SBA loans at all.

I think our progress shows that we are taking responsibility seriously. We appreciate our responsibility for portfolio performance

and also our desire to reduce fraud. Fraud usually occurs by exception, but we nonetheless are taking measures to prevent that occurrence. We are working cooperatively with our lending partners to

ensure that they have in place policies and procedures to identify

and prevent fraud. We are also considering other analytical tools

that will support our ability to detect it and refer it more effectively.

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With respect to the proposed regulation, we are certainly not

resting on our efforts to improve oversight. On October 31, we published in the Federal Register a proposed comprehensive lender

oversight rule to enhance the roles and responsibility of our Office

of Credit Risk Management. The rule would codify many of the existing processes for on- and offsite reviews as well as risk ratings.

It also provides new enforcement actions, oversight processes, controls, especially for SBA supervised lenders.

The proposed rule addresses recommendations from the GAO report and Inspector General on clear policies and procedures for enforcement and will specify how lenders have to maintain satisfactory portfolio performance. In addition, the proposed rule will enhance reporting for SBA lenders to aid SBA in monitoring and assessing their performance.

Recently, the IG issued a report regarding SBA’s credit risk practices focused on BLX. We appreciate the efforts of the IG to help

SBA continue to improve its processes and procedures with regard

to credit risk management and to reduce fraud. My written testimony submitted for the record and my letter to you, Mr. Chairman,

fully detail our concerns regarding that report.

The Committee is likely to hear some issues relating to our lender review and examination fee from the industry partners today. I

do want to point out that those fees enable us to perform onsite

and offsite risk management of the portfolio. The amount is

charged at a reasonable progressive—based on a reasonable progressive system linked to the size and relative risk of those portfolios. In addition, the fees simply cover the cost of the reviews. As

such, many of our lenders will not be charged any fee, and when

assessed, the fees are modest compared to other financial regulators. We would be happy to provide you with analysis to show

that.

For offsite reviews, we will be charging a simple annual fee of

$73 per million in the portfolio. These reviews provide information

on portfolio performance and the bulk of the information is shared

with the lender. We also provide lenders with the factors that comprise the risk rating calculation and their individual component

ratings, as well as their peer group ratings and their portfolio averages of the components. That is one of the many tools that we use

to oversee the portfolio.

We are particularly sensitive to the need to minimize fees whenever practical. The fees are fully detailed in our notices that reflects the actual cost of the agencies and do not substitute for administrative costs.

We have made significant progress to improve and increase lender oversight. As I mentioned before, I think that will continue to

improve. It is an evolving process. That oversight will support a

strong portfolio and I believe it will increase our ability to reach

more small businesses. We believe that a strengthened management is crucial to the operation of our portfolio in an evolving marketplace.

So thank you for the opportunity to discuss our oversight and I

look forward to your questions.

[The prepared statement of Mr. Preston follows:]

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Chairman KERRY. Thank you, Mr. Administrator. Why don’t we

start with a 7-minute round and we will obviously probably go

around a couple of times.

Let me start with the larger picture first. I mentioned in my

opening statement the issue of the overall budget and manpower,

which concerns the Committee a lot. Is it not a handicap to have

a doubling of your loan capacity and a reduction in oversight personnel?

Mr. PRESTON. Well, I think the reduction in personnel primarily

occurred in the field at the SBA, and many of those resources were

moved to centralized activities——

Chairman KERRY. Right, but isn’t the field where you get an opportunity to be able to interact and really take a group of loans at

the local level and get a sense of what is happening to them?

Mr. PRESTON. I think at the field level, we do a lot in outreach.

We can get a sense of local lenders. But people in field offices were

actually processing loans and making credit decisions which basically left us in a situation where we had a broadly dispersed set

of credit activities taking place around the country, rather than

having them be located in a single facility or a single set of facilities, which provide for much more standardization of practices,

much greater ability to audit those standards, and a much better

ability to institute quality standards.

Chairman KERRY. What about—I mean, that might in theory

work, but what about the complaints and the observations that it

has never been adequately staffed and has not been able to deal

with a centralized burden?

Mr. PRESTON. Well, I think those are very valid criticisms of the

agency.

Chairman KERRY. Isn’t that personnel related and budget related?

Mr. PRESTON. Senator, I think it is—the challenges in that operation are well beyond just personnel issues. I think when the agency centralized those activities, the standards were not put in place.

I don’t think the processes were efficient to the degree that they

need to be. And I don’t believe that we put in place metrics, performance standards, or communication back to other lenders to

help them understand what was happening.

That is all stuff we are in the process of doing, and in fact, I

spoke in front of hundreds of lenders at the National Association

of Government Guaranteed Lenders Conference last month, and I

have spoken with hundreds across the country directly to talk specifically about the challenges we have in that operation. We have

a very clear pathway forward that hits on—I won’t bore you with

the details, but a number of issues that we think will dramatically

improve the responsiveness, the speed of execution, the support of

lenders, and the interaction with our field network.

Chairman KERRY. Well, that is welcome news, and I think it is

terrific that you have that kind of a comprehensive——

Mr. PRESTON. We would be happy to come by and brief you all

on the details of that.

Chairman KERRY. I think it would be good for the staff to get a

sense of exactly where that implementation process is. In the

meantime, let us assume you had those standards and you have

16

the sort of centralized operational initiatives in place that you just

listed. I think there were three or four of them. Do you have

enough personnel to carry that out?

Mr. PRESTON. Yes, I believe we will have enough personnel to

carry that out.

Chairman KERRY. You believe you do?

Mr. PRESTON. I believe we do. We have looked at our staffing levels. You all were good enough to increase our budget last year. We

have hired people in our processing centers with the additional

budget we received from Congress, and at this point, we believe it

is adequate. But certainly, this is not an area that I am interested

in skimping in at all.

Chairman KERRY. Well, also you mentioned in your testimony—

it just caught my ear—the issue of pulling the authority from a

lender in circumstances. Have you ever pulled the authority completely?

Mr. PRESTON. Oh, yes. I think last year, somewhere between 6

and 7 percent of our PLP lenders did not have their authority reviewed.

Chairman KERRY. Can you give us, maybe in writing, we can get

a little background on those——

Mr. PRESTON. Yes.

Chairman KERRY [continuing]. Circumstances and numbers. And

in your testimony, you talk about the SBA’s oversight as a whole,

and we have just been discussing it a little bit. You described implementing the offsite monitoring through Dun and Bradstreet that

forecasts whether a loan is at risk of default. Witnesses on the

third panel will testify that that program collects data already

available from the lenders and the agency’s loan servicing contractor, and it arrives at currency and default rates that differ

greatly from the lender’s actual performance, and that is not transparent. And then once it predicts that loans will go bad, SBA

doesn’t tell the lenders which loans could be in trouble so that they

could proactively move on those and try to mitigate against the potential of default.

So when you say the system, and this is your quote, ‘‘enables the

SBA to take corrective action,’’ it is a corrective action that reacts

to the default rather than proactively moving to prevent it. I wonder, don’t you think SBA would be better off moving proactively

and altering that?

Mr. PRESTON. Well, yes, I think it is important to understand

that the decisionmaking process and the rating criteria is much

more complex than any one score we get from one place. We look

at a handful of things. We look at predictive scores based on widely

available information on individual lenders, and we kind of look at

that in an aggregated basis and that sort of provides a predictive

quality. In addition, we look at historically what is happening in

people’s purchase rates. We look at changes in those rates to see

if there are more recent trending issues to face.

All that information is provided to people, to lenders, on a portal

called the Lender Portal. They get information on all of those areas

so they understand how they are doing, not only in a vacuum, but

how they are doing relative to similar institutions. So they get a

significant amount of information.

17

I think the issue with the lending community right now is primarily that we don’t go down and actually pull individual credit

scores on their individual loans and then give it to them. Those are

widely available tools in the industry. Contractually, we don’t have

the ability to do that with a third party. We would certainly look

at potentially providing that for people in the future.

Chairman KERRY. Is that really the heart of what I asked? I

mean, isn’t the question more, if you have been given a very specific prediction that a loan is going to go bad through this loan contracting, loan servicing entity, why would you not then have the

transparency that relays that to the lender so the lender could get

involved directly?

Mr. PRESTON. Yes. I think the way it works is if you have hundreds of loans in your portfolio, based on the relative weighting of

different credit qualities in that portfolio, it comes out with a

macro estimate of the percentage of loans that are likely to go bad,

given how many loans are kind of in a lower tier or a higher tier

or middle tier. So I don’t think we would go down to the individual

level and say, these four loans are expected to go bad. It more looks

at the blend of credit scores.

Chairman KERRY. Is that a warning bell? I mean, can you segregate those that are at the lower end?

Mr. PRESTON. Oh, absolutely. I mean, you could get a list of companies—yes. This is what I was saying, you could get a list of companies in that lower credit tier and those are just based on, like

I said, there are many kind of firms out there that do these types

of ratings, most of which may not very dramatically. We don’t have

the ability right now to provide that detailed data to the lenders.

Chairman KERRY. Why?

Mr. PRESTON. We don’t have the ability to do it contractually

right now, but we would look at doing that in the future if they

would like those lists.

Chairman KERRY. Isn’t that what you would want to do with an

onsite review?

Mr. PRESTON. Well, an onsite review, I think, you know, we really are——

Chairman KERRY. That is a more in-depth review, correct?

Mr. PRESTON. Yes. We are pulling credit files. I know some people don’t think we do that. Under the new processes, we pull credit

files. We look at their management practices, whether or not they

are complying with policies, so that is a different kind of review.

Chairman KERRY. Why has the IG suggested and others, even

the lenders have suggested that that, quote, ‘‘in-depth review’’ is

actually nothing more than a kind of paper check-off process? That

is their perception from——

Mr. PRESTON. Well, I think there are a couple of things. Number

one, I think this process has evolved over time. I am not aware of

the IG making that claim, but if he has, I would be happy to understand that better. I would also be happy to have our head of

Capital Access come up and walk you through fully what we do on

the onsite process.

Chairman KERRY. Well, there is a contention here, and I think

it will be stated here today, that the SBA has a need to verify the

18

borrowers’ financial claims and to make sure the collateral is legitimate and the equity injection is legitimate and so forth.

Mr. PRESTON. Yes. Those things all contribute to credit quality,

obviously. They have made those injections. If we look at the collateral, if we look at the credit quality. Now, that having been said,

Senator, I would be the first one to say, especially if it is coming

from the industry, if people are coming forward and saying, we are

looking at your new process, what you are doing onsite, and we

think you should bolster it in one way or another. We would love

to understand that in more detail, and so I think we welcome that

kind of input.

Chairman KERRY. Senator Snowe.

Senator SNOWE. Thank you, Administrator Preston, for your comments here this morning. I think it is a real question of, a sense

of urgency about implementing an oversight strategy. This has

been a historical problem with the Small Business Administration

and ultimately can have such negative consequences for both the

SBA and those small firms who depend on SBA loans guarantees.

After reading the IG’s report, I think it is important to make sure

that their recommendations are implemented. If they are not implanted, we need to know why in a timely fashion.

Mr. PRESTON. Yes.

Senator SNOWE. I am concerned. We objected to the Herndon

Center consolidation. I did as Chair of this Committee and Senator

Kerry did, as well. I think all of us did because of the concern that

it was going to lead to serious problems, which it did. At that time,

we objected to the understaffing of SBA that has ultimately led to

many of these problems. Another pressing issue has been that the

Small Business Administration has placed an emphasis on loan

growth and not overseeing the quality of those loans. I realize why

this is all being done, because obviously we want to help small

businesses. Yet at the same time, we have a public interest obligation that we must uphold here.

BLX underscores one of the questions and issues that I have.

Why didn’t you take remedial steps with respect to BLX? I mean,

why weren’t there any remedies or any penalties? Why didn’t you

revoke their preferred lender status, for example? Because as the

Inspector General’s report indicates, there doesn’t seem to be very

few terminations or revocations. This enables lenders to essentially

ignore SBA’s delegated lending authority requirements because

they do not suffer any material consequences.

What are the SBA policies for imposing penalties? Where is the

accountability? What is the standard for accountability when we

have the magnitude of the failures we are talking about? They are

broad with respect to BLX. The fact that the SBA would repurchase more than $270 million of potentially bad loans from BLX,

on top of everything else, I think is serious and consequential. So

why aren’t you setting forth policies on the issue of what penalties

for lenders who fail to meet specific and clear requirements? These

types of policies would clearly be a disincentive for bad behavior.

Mr. PRESTON. Yes. Let me just make one comment before I jump

into that. You should know that I am very directly personally engaged in the Herndon issues we have and the reengineering. I am

personally on calls every week, going through the project plans,

19

going through the progress, talking to lenders about it. So this is

something, I think is going to be a good news story for us in the

coming months, and I feel very good about that.

On the BLX, you are asking more of a question about policy, and

so let me take a step back and say when we have an issue with

a lender, we have a lot of things that we can do. First of all, obviously, we look at credit quality. If credit quality goes down, we take

a very hard look at the policies in place, the practices, the credit

administration, what they are doing onsite.

The kinds of things we can do over time, first of all, I think we

begin to do more frequent, more intensive reviews when we see

these situations. Number two, we put in place very specific corrective action plans. We try to look at what the root causes at a lender

and put in place corrective action plans. Then at some point, if

things don’t work out, we have the ability to pull the PLP status.

The other thing we can do is at the back end. If we are looking

at the loans that we purchase, because of our guarantee if a loan

has gone delinquent. We look at those loans to ensure that they

have followed our policies and our procedures and that those loans

have been done correctly. And if they haven’t, we can withhold all

or a portion of that guarantee.

What the new regulations do, and it gets right to your point because I think you are onto something very important, is we have

to have clear standards in place. We have to have clear enforcement opportunities in place. And in Herndon and in those facilities

where we purchase those loans, we also have to have clear policies

and practices and procedures in place that are enforced and get

those things to work together.

I think that a lot of what we saw with this particular lender happened, you know, a few years ago. I think even during that period

of time, since then, we have made a good deal of progress and I

think we have made a good deal of progress in the last year. I really think in the next year to 18 months, we will make a good deal

more progress.

Senator SNOWE. Why can’t it be sooner than that? I just don’t understand why it can’t be sooner.

Mr. PRESTON. Well, let me just give you an example. I know one

of the criticisms of the industry has been that we haven’t done

enough onsite reviews, which I think is valid. A few years ago, we

had the ability—the lenders paid for those reviews. We went a couple of years where there were no charges and that was a budgetary

issue. Now that we can charge again, we will be going through onsite reviews every 2 years. So what we will see—and we have already kicked that up so that the engines are kind of geared up to

do those more intensive reviews to provide that better oversight.

The analytical information is better, and then the enforcement actions will be clearer under the new regulations.

Senator SNOWE. Well, so how many lenders have had their status

revoked?

Mr. PRESTON. Last year, it was about 7 percent—between 6 and

7 percent of the lenders that had that delegated authority. In reference to Senator Kerry’s request, we would be happy to provide

you a list and you can get the numbers.

20

Senator SNOWE. Well, no, I think it is important to revoke preferred status because it provides a disincentive, you know, for this

kind of behavior. When you look at the extent of problems with

BLX—and BLX was over a period of time, I mean, it wasn’t a limited period of time, it was over many years, between 2001 through

2006—there were $76 million worth of fraudulent loans, 27 arrests,

multiple convictions, and SBA purchase of up to $272 million worth

of questionable loans.

Mr. PRESTON. Yes, let me comment on a couple of those things.

I think it is real important for us to understand the difference as

well as the connection between broad loan portfolio quality, which

just has to do with the ongoing quality of the credit decisions you

are making, and fraud. Certainly in the case of BLX there was a

highly sophisticated group of people within that institution, in a

bank among borrowers. Obviously, high levels of fraud can affect

credit quality, but those are two very different sets of activities and

need to be treated as such.

Senator SNOWE. Well, I understand that, but on the repurchases,

why isn’t the SBA documenting and verifying the information prior

to the loans being made? I mean, that is one of the critical issues

here. I mean, we have heard too much of it. We have had 15 reports over this last year-and-a-half regarding many issues, and I

would like to have the Committee be informed in exactly how many

of those recommendations in those SBA IG reports the SBA has followed. I think that is absolutely critical.

Mr. PRESTON. Yes.

Senator SNOWE. We need to know. These IG reports are done for

a reason. Now, I am not saying that every recommendation is essential and there may be some problems with some of the recommendations. But clearly, they have got to be considered in a

manner that is more than lip service.

Mr. PRESTON. We would look forward to coming up and working

on that.

Senator SNOWE. And so that is the concern. We have 15 reports—I just think it is important to understand that—in this last

year-and-a-half, with a number of recommendations that have, I

think, yet to be implemented on lender oversight activities by the

Small Business Administration. So I think it is important. So I

would like to see exactly what the SBA has done to follow up on

those recommendations.

And the last issue, because I know my time is running out, is on

the projected repurchase rate, the rate of defaults the SBA projects

will occur in lenders’ portfolios over the next year. Now, for this

last quarter that ended in September, the SBA projects that repurchases in lenders’ portfolios will increase by as much as 167 percent, potentially. Now, that 167 percent is a decrease from the previous quarter where the SBA projected that defaults would increase within lenders’ portfolio by 240 percent. How does the SBA

justify those predictions?

Mr. PRESTON. I am not sure what you are referring to, Senator.

Is that—are you talking about a particular lender, or——

Senator SNOWE. No, the SBA’s analysis of predicted loan repurchase rate.

Mr. PRESTON. OK. I am not——

21

Senator SNOWE. This last quarter, the SBA projected that repurchase rates would increase between 9 to 167 percent——

Mr. PRESTON. Yes. I would have to look at that. We have generally, in the last several years, seen our credit performance actually much better. We are beginning to see some trends come out

of the current credit markets which are a little concerning, but generally over the last several years, our credit performance has been

pretty good.

Senator SNOWE. OK. Again, this is based on the SBA’s projected

default rate. If loan default increased dramaatically, what will you

do to address the defaults on this high number of loans that could

be in this category? So we would like to have an answer to that,

as well.

Mr. PRESTON. Great.

Senator SNOWE. OK. Thank you.

Chairman KERRY. Thank you, Senator Snowe.

Senator Cardin.

Senator CARDIN. Thank you, Mr. Chairman.

Administrator Preston, your response to Senator Kerry’s question

about having adequate resources in order to conduct oversight review of loans seems to be at odds with the Inspector General’s testimony, and I just really want to give you a chance to respond. I

know you said that you will stay here during the hearing, but the

Inspector General states that SBA has had a 25 percent reduction

in personnel since 2001, while loan production has increased by

more than 100 percent over that same period. SBA’s Office of Credit Risk Management, formerly the Office of Lender Oversight, has

not had a significant staff increase and is currently operating with

less than its authorized number of personnel.

As a result, it cannot perform the type of analysis that might detect fraud schemes and isolate high-risk situations, or investigate

lenders with high default rates, and the Inspector General goes on

to state the sheer volume of guaranteed purchase requests that the

agency must process with current staffing levels, combined with

the agency’s goal of paying lenders in a timely manner, has resulted in the careless purchase reviews that fail to identify loan deficiencies.

Now, Senator Kerry asked you specifically as to whether you had

the staff necessary, and your——

Mr. PRESTON. I think I said yes, right? Didn’t I say yes?

Senator CARDIN. You disagree with the Inspector General?

Mr. PRESTON. Well, I think the Inspector General is looking at

a historical set of events. I can comment on any of those statements that you would like. We had a 25 percent reduction that primarily hit the field offices. We are talking about centralized loan

purchasing activities. So some of those people were moved from the

field to a centralized activity. I think that is what Senator Snowe

was talking about. The process of moving them from the field to

the center and setting up that center provided the agency with a

tremendous number of challenges. That was done 4 or 5 years ago.

That has led, in part, to the backlog and some of the challenges in

these purchasing activities.

Senator CARDIN. Would you take issue with the fact that you

cannot detect fraud schemes because of personnel shortages and

22

that you have a careless purchase review system to identify loan

deficiencies because of staff deficiencies?

Mr. PRESTON. Yes. I think the careless purchase review issue

gets to the same issue of that centralization process and that is

what we are addressing right now. Where you had loan review activities having taken place around the country, those are being

brought into a centralized facility. The process of that centralization, a number of years ago, was not done in a way—I believe, and

I am sure our IG believes—that provided the right kind of oversight practices, policies, training, all the stuff you need to do to

make sure it is a tight process. That is very much what we are all

about addressing right now. So I think the IG is current on some

very important issues, but I also believe they are the issues we are

addressing.

The other thing I would mention is our reviews. Our onsite reviews of these banks, are performed through a third party, so they

are not dependent on our personnel levels. For example, the Farm

Credit Administration does the onsite reviews for small business

lending institutions. So that is not dependent on our staffing level.

The staffing issue has to do with when we get all these purchases

in and all these loans get sent to us for review; we need to review

them at the back end. I think we have made a tremendous amount

of progress in addressing that, but we are not there yet. I think it

is going to take us another 6 to 8 months to get there.

Chairman KERRY. Senator Cardin, if you will permit——

Senator CARDIN. Sure.

Chairman KERRY [continuing]. This will not come out of your

time, but while we are on the topic, I just want to come back. The

Inspector General’s report of May 8, 2007, specifically says, ‘‘Staffing problems and an overly aggressive emphasis on expediting and

increasing purchase production at the (Herndon) center’’—now we

are talking about the center—‘‘has adversely impacted the quality

of purchase decisions.

For example, the high rate of staff turnover in 2006 left the center with unfilled vacancies and largely inexperienced loan officers

to review purchase requests. Because supervisor vacancies were

not filled, the center had 3 individuals to perform supervisory oversight of nearly 3,000 purchase reviews. Consequently, supervisors

either did not review purchase requests performed by inexperienced loan officers or did not identify deficiencies the officers

missed.

The level of erroneous payments will likely increase given that

SBA has not fully resolved staffing issues at the center and has

launched a major initiative to grow the 7(a) portfolio by 15 percent

in 2007. Increasing the loan guarantee portfolio without identifying

how the existing and additional workloads will be accommodated

places Government funds at increased risks.’’

Mr. PRESTON. Yes.

Chairman KERRY. It seems to——

Mr. PRESTON. I think there are either some mistakes—yes, there

are some mistakes in those comments. First of all, there is no 15

percent goal for 2007. We, with concurrence in the field, provided

a 15 percent goal for a 2-year period, 2007 and 2008, which was

23

later reduced to roughly 10 percent, working through it with the

field.

Chairman KERRY. So it is a 10-percent increase, not 15?

Mr. PRESTON. It was originally 15 percent over 2 years——

Chairman KERRY. Right. Now it is——

Mr. PRESTON. Now it is about 10 percent over 2 years, roughly

speaking.

Chairman KERRY. I think the same——

Mr. PRESTON. In addition——

Chairman KERRY [continuing]. Issue still applies, and we can

quibble on the percentage of the increase——

Mr. PRESTON. But you know, Senator, it is so important in looking at this to understand where the breakdowns were and why. I

think we have had some real challenges, and I think the IG has

noted these in that Herndon operation. It has not been functioning

well. There are backlogs out there and it is something that——

Chairman KERRY. But you have been asked if you have adequate

staff. I mean, I am not trying to have a——

Mr. PRESTON. It is not a staffing—we have added staff.

Chairman KERRY. You had adequate staffing levels?

Mr. PRESTON. We have added—we are hiring staff. We will have

adequate staff. It is much more an issue of process efficiency, consistent standards, good communication with our banks, which we

have not had in that facility. In addition, most of the purchases—

and I think this is the issue the IG was looking at—most of those

packages that come in from banks come in wrong. There is a tremendous amount of rework. We don’t have the paperwork. We have

not done our job in going to banks and communicating to them how

they need to do these packages, getting them right at the front end,

and turning that around quickly.

So there are a lot of—that is why I hesitate to get into the detail

here because we went into a lot of issues. There are a lot of very

classical—I hate to say it that way—business sort of engineering

challenges that have been in place here and I think we are addressing them. But like I said, I would be happy to get up here periodically. We can come up every month and show you the progress.

The other thing I do want to say is we have been very transparent about this issue. I have spoken to the industry. I have spoken widely to our people about it. We have gotten the numbers out

there as sort of a rallying cry to get this thing fixed.

Chairman KERRY. Let me yield back to Senator Cardin. I

appreciate——

Senator CARDIN. No, that was very helpful, Mr. Chairman. I just

point out that the Inspector General indicates that because of staffing deficiencies, the backup to analyze whether these purchases of

guarantees were proper or not is not there. So it seems like you

don’t have the information necessary to make the right judgments

because of the personnel levels, at least that is what the conclusion

of the Inspector General is.

I would feel more comfortable with your response if I just hadn’t

completed a hearing in Maryland where we were going over your

outreach efforts, your personnel that you have in the field that you

now say you are bringing back. When you look at the procurement

center representatives, and I understand you are going to increase

24

those numbers modestly, but we need a significant increase in services in the field if SBA is going to be able to carry out its principal

function to facilitate small businesses in dealing with Government

procurement and elsewhere because we are not meeting our goals.

We haven’t met any one of our goals, as your reports point out, on

Government procurement.

So if you are taking resources away from the field, I am not exactly sure we are going to be able to meet the needs there. I can

tell you, by the additional procurement offices, centers that you are

scheduled to open, if every one of them opened in Maryland, I

would be satisfied. But I understand that is for nationwide.

We are in desperate need of help in our small business community from SBA, and I have been told over and over again that a

significant part of the problem is the resources that you have within your agency, and it seems to me I would like to have the Administrator advocating for the type of services needed to our small

business community and I am concerned as to whether you have

the adequate resources to carry out and correct the failure of our

agencies to meet procurement goals, let alone oversight of the loan

activities. It seems like this is a continuing problem within the

agency.

Mr. PRESTON. Right. Well, there are a couple of things, I think,

to mention here. The reduction in staff that I think Senators

Snowe and Kerry were talking about was a centralization process

that ended a couple of years ago. I have increased our staff in the

field by 50 people in this past year. We promoted another 50 people. We have accelerated the hiring of PCRs in the field by 15 to

18 percent. Unfortunately, we have had some retirements and

movements that have kind of moved us in the other direction.

But what I would tell you is my allocation of resources to the

field last year and this year have, for the first time in a while,

turned us toward that growth trajectory now in the field. The field

has reacted very, very favorably toward it.

The other thing we are doing is, which we haven’t done, is we

are significantly increasing training, specifically in procurement to

support our ability to be effective in helping those small businesses

in the contracting picture, providing greater tools to other Federal

agencies to find those small businesses. And I will also say—a little

advertisement here—the scorecard we put out there, the new recertification rule we had issued, and a number of the other measures

we have taken are raising the bar for Federal agencies and they

are reacting by coming our way saying, how can we meet our goals?

It has been very helpful for us.

So I think we are seeing a higher degree of interest across the

Government to engage with small business and we have—there is

a little bit of a lag when you authorize these positions and you get

them in the field, but we have begun adding those positions in the

field.

Senator CARDIN. Thank you, Mr. Chairman.

Chairman KERRY. Thank you very much, Senator Cardin. I appreciate it.

In relation to the BLX case, Mr. Administrator, the Committee

has been told that the SBA paid about $28.4 million on guarantees,

loans underwritten by one loan officer. Is that unusual? Is that a

25

red flag in and of itself in any way, that one loan officer in one

branch in Detroit, Michigan—it seems like a lot of money for one

loan officer in a branch——

Mr. PRESTON. I don’t know. That authority was delegated to

them as a PLP lender, so the credit decisions——

Chairman KERRY. Do you know what the average is or what the

expectation would be per loan officer? Is there any kind of measurement or metric on that?

Mr. PRESTON. That would be within the bank institution if there

were a metric.

Chairman KERRY. SBA wouldn’t have an oversight? I mean,

aren’t there some red flags for irregularities?

Mr. PRESTON. I think there are red flags for irregularities. The

number of loans made by a loan officer, I don’t know if that would

be an irregularity. Especially in a lot of these lending institutions,

people are very active in obviously extending capital. So I don’t

know.

Chairman KERRY. Maybe that is something you might want to

look at and make some judgment about. I mean, I think it would

be interesting to know what that norm is or whether that is, in

fact, a red flag that ought to be established. But can you tell the

Committee what value Dun and Bradstreet provides that can’t be

obtained by the SBA working with the FDIC, or the Office of

Comptroller of the Currency, the National Credit Union Administration, or Federal Reserve Board?

Mr. PRESTON. Yes. First of all, we would love to be working with

those agencies more.

Chairman KERRY. Say that again?

Mr. PRESTON. We would love to be working with those agencies

more. We would love to partner with them more effectively. I think

it would reduce some of the burden to the lenders.

What I would tell you is most—when a bank regulator comes

into a large institution with a broad portfolio, they are looking at

safety and soundness, they are looking at capital adequacy. Obviously, they do look at the loan portfolio. Typically, we are a relatively small subset of that portfolio. We go in, we specifically look

much more deeply at the SBA loan portfolio, their adherence to our

regulations, and their practices and procedures specifically relating

to eligibility and those types of things.

So there is both the issue of our concentrating more heavily on

our pool of loans, as well as making sure that they comply with

unique standards as a Government guarantor rather than them as

an independent lender.

Chairman KERRY. With respect to the BLX situation, I mean, obviously both BLX and SBA consider themselves victims of the

fraud, and on some levels that is obvious and true. But to what degree might there have been signs that BLX should have picked up

on and/or SBA? I mean, can you sort of share with us what the

SBA knew and when it began to know it and what action it took?

Mr. PRESTON. There were loans that our people in Detroit referred to the IG. Ultimately, I know the IG worked with the U.S.

Attorney based on work the U.S. Attorney was doing, I believe

based on——

26

Chairman KERRY. Do you know what first flagged it within the

SBA in terms of the referral?

Mr. PRESTON. Senator, I don’t specifically recall. I personally

know some of the people who told me about it, but I don’t recall

what they said were the indicators. But I think the overwhelming

indicator that now, in the cold light of day, is many of these loans

were to a particular industry, which doesn’t always mean something negative. It can mean that a particular lender has expertise

and is doing a good job reaching out to a particular industry. But

that was done—that is before a lot of these activities were centralized, so I think it was primarily based on that, but we can get back

to you on it.

Chairman KERRY. OK. I would appreciate that.

Mr. PRESTON. Now ultimately, when it was found, it was based

on, I think, Secret Service out there doing a different investigation—the IG can comment on this.

Chairman KERRY. What specific steps have you taken to prevent

it from happening? Please share with us some of what you learned

from it.

Mr. PRESTON. Well first of all, I think it is important, for all of

us to understand that generally, when fraud is perpetrated of this

type, although it is bad for all of us and none of us like it, the one

who ends up losing financially is the lending institution. You know,

in cases of negligence like this, we don’t cover it. So BLX is paid

to cover initial losses that were detected, has set up additional

funding to cover future losses, and is reviewing all loans going into

the secondary market and coming out of it before we make any

purchases to ensure that they are not part of this scheme. So I

think it is important to understand that from a taxpayer perspective, we are protected to the extent that we don’t cover those types

of fraudulent activities.

Now, what we have begun to do is to work with other regulators

to see the types of analytical tools they use, whether they look at

industry concentrations and other types of factors to improve our

ability to refer those loans to the IG and highlight them back to

the lending institutions.

Chairman KERRY. Well, when you found out about the scheme,

staff from the agency came to brief the Committee, which we appreciate, but ultimately—but you talked at that time about the

tough disciplinary measures that were going to be taken against

BLX, and then ultimately the agency entered into closed negotiations with the companies and really kept the details of any disciplinary actions confidential. What happened between that briefing

and sort of the tough stance and then the private negotiations and

the privacy with respect to——

Mr. PRESTON. I am not aware of the chronology, and unfortunately, I can’t comment on that. Perhaps one of my colleagues can.

What I would tell you is I didn’t really view this as a negotiation,

as much as our coming in as a regulator and an oversight body,

providing our view on what we thought we needed to do.

The other thing is—my understanding is that you had a pretty

full briefing on the decisions we made. Certainly I know, in the IG

report, you all received a fully unredacted copy. So if there is any

27

lack of transparency between the agency and the Committee, I

would like to understand kind of where you thought that was.

Chairman KERRY. Well, we are happy to share that with you,

and I think there may be a little bit here. But coming back to this

initial question, I mean, you said Secret Service or somebody related part of another investigation, et cetera. I think the question

sort of hanging over the Committee a little bit—and potentially it

ought to be hanging over the SBA—is sort of why didn’t the SBA

discover this? What is the mechanism in place for knowing that

these kinds of loans don’t take place?

Mr. PRESTON. Yes.

Chairman KERRY. I mean, how do we get a sufficient of scrutiny

within the system——

Mr. PRESTON. Yes. The mechanisms that should be in place that

I think are increasingly in place and will even more increasingly

be in place are the following: I think, first of all, as we do onsite

reviews, as we begin to look at practices and procedures, look at

some individual loans, that match with portfolio performance that

should be able to give us some indicators if there is a widespread

ring of fraud. Second, as we purchase those loans in Herndon and

elsewhere, when we do the reviews of the actual files, that should

also provide us insight.

I would highlight here, though, that this was a pretty sophisticated ring of people. You had people in the institution, people in

a bank falsifying equity injections, cashiers’ checks—individual borrowers part of this scheme. Roughly 15 people were involved, and

I think it is very difficult for a regulator to be able to get ahead

of that type of sophistication. I think it is very important for us to

look at the internal practices of those lenders to make sure that

they get caught.

Like I said, once again, I do take some comfort in the fact——

Chairman KERRY. Are you not involved in the remedy component

of this with respect to BLX, that you are not sure of the chronology

and you are——

Chairman KERRY. I mean, as Administrator, are you directly

going to be involved in determining what the——

Mr. PRESTON. In most cases, I wouldn’t sit on the committee that

determines remedies and issues for our lenders. In the BLX case,

I have been——

Chairman KERRY. Well, isn’t it unusual to have a $70-plus-million-dollar fraud?

Mr. PRESTON. Right. In the BLX case—early on, I was actively

involved in the discussions on what I thought the next step should

be. My view was a couple of things. Number one, I wanted to absolutely ensure that the taxpayer was protected and that to the extent that these issues—that we protected ourselves from that perspective. Let us leave it at that.

I think the other issue—this is where I think we continue to rely

on trying to balance our judgment—is when you look at something

like this. At what point is the issue behind you, and at what point

is the issue continuing, and how do you weigh that against whether

or not you want to in any way restrict capital to small businesses?

Those are the kinds of factors we consider.

28

Chairman KERRY. Mr. Administrator, I do have a number of

other questions, but the time is pushing us here and we have two

other panels, so I am going to leave the record open and we are

going to submit some questions to you in writing, if we may. We

are not trying to burden you or anything, but we do want the

record to be complete and appropriate.

Let me turn to Senator Snowe.

Senator SNOWE. Very quickly, Mr. Chairman——

Chairman KERRY. No, take your time.

Senator SNOWE I will be short because of time, but it really does

get back to the fundamental responsibility of the Small Business

Administration to conduct oversight activities and to do so aggressively.

Mr. PRESTON. Yes.

Senator SNOWE. Are you suggesting that there is no way to set

in place procedures to detect fraud, for example?

Mr. PRESTON. No. I think what I am saying is we are a couple

steps removed from the process by virtue of what we do as an external guarantor. So what we need to do is look for indicators

where then we can take those loans and find patterns to pursue.

Then in the purchase process look for individual loans to highlight

and then refer those to the IG.

So no, there are certainly things we can do to be a more effective

referrer of concerns to the IG, but ultimately, I think the most important thing we can do is make sure that the institutions involved

in the processes and our programs have processes in place to catch

that on their end since ultimately, that is where it happens. Ultimately, they are the ones that suffer the loss. I think we all obviously are impacted by it. It is a terrible thing.

So no, Senator, I think there are ways that we can improve it

and ways to address it. I just think it is important that each player

in this process understands how they can be effective, given what

they have access to and what their roles are.

Senator SNOWE. But you have a number of remedies at your disposal to take action, do you not? I mean, you have a number of

remedies, corrective measures——

Mr. PRESTON. Oh, absolutely.

Senator SNOWE [continuing]. Legally and otherwise, I mean, in

terms of——

Mr. PRESTON. Absolutely.

Senator SNOWE [continuing]. Either the review process and taking legal actions against someone or an entity——

Mr. PRESTON. Actions, working with them on their plans to improve their internal processes, working—yes, any number of actions.

Senator SNOWE. Well, but it gets back to where you can be preemptive and preventive. Obviously, one of the issues is verifying

the documentation of many of these loans at the outset——

Mr. PRESTON. Exactly.

Senator SNOWE [continuing]. And then looking at this repurchasing rate. That is a huge predictor of potential problems, and

I don’t think I understand if any corrective measures are taken to

avert that.

29

Mr. PRESTON. Well, I think a couple of things. I think, first of

all, getting the purchase process as tight as possible so that we

have a standardized review process. We have a standardized process for getting things referred, and then secondarily it really is in

the broader oversight process.

The only thing I do want to say, though, before I leave, and this

may be opening up a bit of a Pandora’s box, but one of the things

we do not do is we do not—we obviously have a portfolio of risk.

All lenders are not created equal in terms of what they do. We may

have some lenders that look primarily at startup companies. Other

large lenders have heavily diversified portfolios.

And I think it is also important as we look at performance in

these portfolios to understand whether or not these lenders are

taking our mission forward and what that implies for credit risk.

That is a very complex set of issues that I don’t think we fully understand at this point. I am not sure that everybody should be subjected to the exact same rating system, because ultimately, we are

trying to reach people in this country who have a hard time getting

access to credit.

And so what I would expect to do in the coming months, as we

look at this regulation, is to build our understanding of that issue

as well.

Senator SNOWE. But I think you have a number of road maps,

including the Inspector General’s report, this one and the 15 others

along the way in the last year and a half. I mean, there are road

maps to taking corrective measures immediately and putting in

place certain procedures that are predictable and provide certainty.

Mr. PRESTON. Right——

Senator SNOWE. Just going back, in the Herndon situation, you

have roughly 4,000 unprocessed loans? That would mean someone

would be required to review over 20 repurchase requests a day. So

you have to resolve that backlog, which is what you had to do——

Mr. PRESTON. Which is what we are working on——

Senator SNOWE [continuing]. In post-Hurricane Katrina and so

on.

Mr. PRESTON. Right.

Senator SNOWE. But here we go again. And so this tells me——

Mr. PRESTON. This is a problem that has been building for 5 or

6 years——

Senator SNOWE. I know. That is the problem.

Mr. PRESTON. So I just want you to——

Senator SNOWE. That is why you sense the frustration here, because it has got to be either something is not working and we have

got to find out what it is. I agree with you, and I have been sitting

here for——

Mr. PRESTON. Right. No. I think the Herndon backlog issue has

been building for many years and now it is coming down to——

Senator SNOWE. We objected to it.

Mr. PRESTON. Based on the corrective measures we are taking,

so——

Senator SNOWE. I know, so——

Mr. PRESTON. I don’t want anyone to leave here with the view

that we are going in the wrong direction. I do think these are complicated, big issues, and I think addressing them requires some

30

real work. I think we are making a lot of progress, and we already

have, and I think when you look at our proposed regulations, a lot

of those do incorporate the GAO and the IG recommendations.

Senator SNOWE. According to a 2006 report, again by the Inspector General, the SBA improperly repurchased 44 of the 45 Small

Business Express and Community Loans sampled because the SBA

did not obtain the required lender to submit all necessary documentation required to make proper purchase decisions. That is a

high rate of deficiency in that group, there is no question. The Inspector General estimates that roughly $130 million in disbursements on 2,729 loans purchased before February 1, 2005 were not

properly reviewed by the SBA.

Senator SNOWE. Are we avoiding that now?

Mr. PRESTON. That is really part and parcel of the Herndon

issue. The thing I would say is that doesn’t mean that those were

loans that ultimately we shouldn’t have purchased. It implies

that——

Senator SNOWE. They were all part of the Herndon Center——

Mr. PRESTON. Well, it says that you might not have had all the

documentation you were supposed to get.

Senator SNOWE. Are we avoiding it for the future? I know what

we are going through. Are we avoiding it for the future?

Mr. PRESTON. No. We are doing a lot of heavy lifting right now

to fix this, and frankly, we would be, like I said, happy to take your

staff through the detail of any of this stuff, because like I said, I

think this is going to be a very positive story.

Senator SNOWE. I think for the Committee, I think we need it for

the Committee.

Mr. PRESTON. Yes.

Senator SNOWE. I think we need to know where we stand.

Mr. PRESTON. Yes. We will——

Senator SNOWE. I think we have to have some time lines here,

because——

Mr. PRESTON. We have got time lines——

Senator SNOWE [continuing]. With the volume of what SBA does,

it has got to be loan quality, as well as loan volume. We understand some of the risks inherent——

Mr. PRESTON. But Senator, as anyone in my row behind me will

tell you, we have time lines, deliverables, metrics, and milestones

on virtually everything at the agency right now. So we will be

happy to do that for you.

Senator SNOWE. One other question that I have. It is on the

Women Procurement Program——

Mr. PRESTON. Yes.

Senator SNOWE [continuing]. For women-owned businesses. You

said it would be implemented by the end of the fiscal year. It has

been more than 2,500 days now. In 2000, this was established and

it remains unimplemented——

Mr. PRESTON. Right.

Senator SNOWE [continuing]. By the Small Business Administration, and you said by the end of the fiscal year. That is coming

along——

Mr. PRESTON. I said I would do everything I could. Yes. It has

been a very frustrating process. I know it has been more frusVerDate 11-MAY-2000 15:36 Sep 24, 2008 Jkt 041658 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 C:\DOCS\41658.TXT DianeA PsN: DianeA
31

trating for you because you preceded me, and we are in interagency

process once again. I am very hopeful that by the end of the year,

we will have something to go public with. But——

Chairman KERRY. Actually, Mr. Administrator, if you recall, we

have a January 18 commitment on that, remember? We had a specific—you weren’t here. Who made that? It was—I am trying to remember who made—your Associate Administrator for Entrepreneurial Development was here, Mr. Prakash, is that it?

Mr. PRESTON. Oh, OK.

Chairman KERRY. He guaranteed this Committee in open testimony that this will be implemented and done by January 18 in its

entirety, and we agreed to have an oversight hearing here at the

end of January, after the 18th, in order to review that to make

sure it has been met. What I would like to do is add this other stuff

to that and have an agreement, and I would like your agreement

that you would personally be here with whomever you think is important from the agency so we can have an update on all of these

issues, the disaster program——

Mr. PRESTON. Right.

Chairman KERRY [continuing]. And the 7(a) reforms that you are

putting in place, and, of course, the Women’s Procurement program

which we have been waiting 61⁄2 years for.

Mr. PRESTON. Yes. I would like to come over here when we have

something to announce on Women’s Procurement. I am pretty

hopeful by that time we will have something to announce on Herndon and on——

Chairman KERRY. He made a commitment to this Committee. We

will get the language to you. If accountability is going to mean anything, we will get the language to you.

Mr. PRESTON. OK. Yes. On disaster, we can come over tomorrow.

We have got everything you could ever want on that right now.

Chairman KERRY. Seven years on the procurement program.

Senator SNOWE. Two thousand five hundred and seventeen days,

to be exact.

Chairman KERRY. Thank you, Mr. Administrator.

Mr. PRESTON. All right. Thank you.

Chairman KERRY. We appreciate it.

Senator SNOWE. Thank you.

Chairman KERRY. Can I ask the Inspector General, please, Eric

Thorson, if you would come for the panel.

Mr. Thorson, you have previously served as the Chief Investigator for the Senate Permanent Subcommittee on Investigations

and the Senate Committee on Finance and we are grateful for your

observations and reports and we welcome your testimony.

If you could try to summarize, we have questions and obviously

we are very familiar with it, so if you could summarize and move

on.

Mr. THORSON. Yes, sir.

Chairman KERRY. Thanks.

STATEMENT OF ERIC M. THORSON, INSPECTOR GENERAL, U.S.

SMALL BUSINESS ADMINISTRATION, WASHINGTON, DC

Mr. THORSON. Chairman Kerry and Ranking Member Snowe, I

appreciate being here this morning.

32

On the morning of January 9, 2007, as a result of a lengthy investigation, special agents from the Office of Inspector General,

with the help of the Secret Service, began a sweep in Detroit,

Michigan, resulting in the arrest of 18 individuals. Among those arrested were former BLX executive vice president Patrick Harrington and former Huntington National Bank vice president Deborah Lazenby. Mr. Harrington was charged with making at least 76

fraudulent SBA guaranteed loans totaling about $76 million. We

believe this is the largest 7(a) loan fraud scheme in SBA history.

Both Mr. Harrington and Ms. Lazenby have plead guilty. So far,

our investigation has resulted in the indictment of 27 individuals,

of which 3 are currently international fugitives. This criminal investigation is continuing with further indictments expected.

These rather dramatic events raise questions about SBA’s oversight of its lenders and led our auditors to review SBA’s oversight

of BLX from 2001 to 2006. This audit focused on how SBA monitored BLX during this period and whether SBA took effective actions. It was not an audit of BLX.

In summary, we found that SBA was aware of recurring performance and compliance issues, but there were few consequences for

its performance problems. We believe that the high rate of default

and other problems with BLX loans presented undue financial risk

to SBA and therefore merited in-depth reviews of the defaulted

loans as well as possible suspension of SBA’s preferred lender status, which allows BLX to approve loans with virtually no prior review by SBA.

Despite problems with BLX’s loans, however, SBA continued to

renew the delegated PLP lending authority and to honor guaranteed purchase requests without taking any additional precautions,

paying out $272.1 million in guarantees between 2001 and 2006.

Quite simply, SBA did not hold the lender accountable for its performance problems.

While SBA has been slow to develop its lender oversight program, we acknowledge that they have taken significant steps,

which are identified in my written statement.

Despite these efforts, we believe the deficiencies we observed in

SBA’s handling of BLX are symptomatic of systemic issues that

have restricted the effectiveness of SBA’s oversight. These issues

fall into five categories.

First, SBA has focused on the quantity of loans, not the quality.

SBA sets goals for loan production, but not for loan quality or lender performance. This emphasis on production has created an environment where it may be difficult to take corrective action against

the large lenders when doing so might jeopardize the attainment

of SBA’s goals. We believe SBA may have been reluctant to take

enforcement action against BLX because it is among SBA’s top ten

lenders in the value of loans dispersed.

Second, SBA has delegated broad loan-making authority to lenders without making corresponding increases in its monitoring and

oversight efforts. Currently, more than 87 percent of SBA loans are

made using delegations of authority with minimal oversight by

SBA. While SBA has assumed more risk and has taken some important measures to monitor lender performance, it has not fully

implemented compensating controls to mitigate that risk.

33

Third, reductions in personnel over the past 5 years have diminished the agency’s capacity to provide oversight at a time when it

is growing its loan portfolio. SBA personnel have been reduced by

25 percent since 2001, while loan production has increased more

than 100 percent during this time. SBA has not adequately staffed

its lender oversight office and does not analyze loans to detect

fraud schemes or identify high-risk situations.

Also, significant backlogs exist involving thousands of lender requests for SBA payments on defaulted loans, some going back 6

years. An inadequate review of these defaulted loans have failed to

identify loan deficiencies. Although SBA is taking steps to revamp

the purchase review process, it recently determined that more than

50 percent of all backlogged 7(a) purchase packages were missing

significant documents. In addition, untimely reviews by SBA limit

the OIG’s ability to effectively investigate and prosecute criminal

fraud.

Fourth, a conflict of interest exists between SBA’s lender advocacy and oversight roles. The Office of Capital Access is responsible

for promoting loan growth and lender participation, but at the

same time, is also conducting lender oversight and enforcement.

These functions are incompatible and should be separated to preclude organizational conflicts of interest.

Fifth, SBA has not focused on fraud detection. Although the size

of SBA’s loan portfolio and its reliance on lenders for loan making

has made SBA’s loan programs vulnerable to fraud, SBA has made

only limited efforts to detect fraud. OIG investigations have found

that loan agents, or packagers, perpetrate schemes on multiple

loans causing losses of tens-of-millions of dollars. This was evident

in the above-mentioned arrest. OIG has for years recommended

that the agency track loan agent involvement so that quick action

can be taken to prevent losses if fraud is detected. However, agency

efforts to track loan agents have thus far been ineffectual.

Finally, let me briefly address questions regarding our audit report and the numerous redactions it contains. This report is a rather unusual circumstance because it necessarily discusses the actions of a private sector company and agency deliberations. I have

great respect for Mr. Borchert, the SBA General Counsel, so when

his office asserted that the redactions were needed to protect agency privileges and agency operational practices, we accepted those

concerns. Simply put, we do not wish to cause any harm to the

agency and, in fact, strongly desire to make it better. Although we

do not necessarily agree with the legal explanation for some of the

redactions, the safest path was to post the report with SBA’s requested redactions.

I appreciate the opportunity to talk about our report today, and

I also want to acknowledge the presence today of Mr. James Hudson and Debra Ritt who were responsible for the excellent report

that you have in front of you. Thank you.

[The prepared statement of Mr. Thorson follows:]

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36

37

38

39

40

Chairman KERRY. Thank you very much, Mr. Thorson. First of

all, let me thank you for keeping your promise to this Committee,

which we don’t take lightly, which was the notion that you would

fulfill these responsibilities with independence and to the best of

your ability to protect the public interest, and I think you really

have done that and are doing that, and so we welcome the report.

We certainly welcome any explanation the SBA may have to the

contrary. We are here to find facts, not to pick winners, and so we

would love to hear some of those things to the contrary. But I think

the observations that you have made are not insignificant, and

they are certainly important to understanding what is and isn’t

happening.

Let me just ask you up front if you could perhaps share with us,

for a moment, on this issue of staffing and personnel and the questions Senator Cardin asked and I asked—can you just share with

the Committee what your perception is about where the SBA is at

this point in its ability to track fraud?

Mr. THORSON. In the area of staffing, obviously the fact that

there is a backlog would address that question——

Chairman KERRY. I was struck by that. You just said a very significant backlog.

Mr. THORSON. Right. You have two different aspects here that

you could address, and one, of course, is the effect of having this

backlog exist and being able to deal with it and get rid of it. The

other is to detect fraud, and those are really two very different

issues.

One of our concerns is that, in the desire to get rid of the backlog, it is almost human nature to do a more cursory review——

Chairman KERRY. Push things through rapidly——

Mr. THORSON [continuing]. Of the files in order to move them

out, and we understand that. We don’t expect—this office certainly

does not expect SBA to do an in-depth review of every single loan

file. That is not practical. But where you can target, where you can

find problems, there are a number of parameters that we could

throw out here and discuss about how to identify the targets where

you need to focus your efforts——

Chairman KERRY. Have you memoed the various responsible parties to that effect?

Mr. THORSON. There was a report done in February, among others.

Chairman KERRY. February of this year?

Mr. THORSON. Yes. But what we want to do is to get people to

focus on where the effort needs to be made, and occasionally—not

always, not in every case—do an in-depth review and look at what

is there. We don’t expect, for instance, the auditors to identify that

in the case that I mentioned to you, there were phony cashier’s

checks creating evidence of equity injection, that these were phony

checks. We don’t expect that. But what we do expect is for there

to be elements to alert people to possible fraud and, therefore, we

can then take it from there and investigate it.

But it all comes down to the idea of staffing the purchase reviews

so that you do get a good look at what has gone on with these

loans. It may not involve fraud. It just may be that they didn’t really fulfill all the requirements that were required of them when they

41

granted that loan. They are making credit decisions on behalf of

the U.S. Government. The Government is backing those credit decisions and we need to make sure that we are living up to—or that

the lenders are living up to their responsibilities.

Chairman KERRY. Do you have perhaps a two most important

change list, or three, whatever it is, that you think the SBA ought

to undertake in order to improve the oversight and prevention of

future fraud?

Mr. THORSON. Rather than two, I would probably say there are

four. The two that I just mentioned were: identify where your problems are and target those problems; second of all, devote the

amount of resources to it that is necessary to do a timely review.

The third one would be to do occasional in-depth reviews in that

target area so that you can—not every case, but where you can

really find out what kind of product these lenders are giving you.

And then the fourth one is accountability, that is to take some action based on what you are finding.

When you find that there are problems here with any lender,

whether it is BLX or anybody else, be prepared to take some sort

of action against that lender to, not to put them out of business,

but to bring them around so that they will begin to improve their

process.

Chairman KERRY. Now, your report said that since 2001, the

SBA has identified recurring problems in the performance of BLX,

is that correct?

Mr. THORSON. Yes, sir.

Chairman KERRY. Can you relate what those recurring problems

identified were?

Mr. THORSON. I think they range anywhere from credit issues,

how they administer credit, to analyzing the ability to repay. Is the

package complete, were the elements that were required by SBA,

were they complied with? Then, of course, you have any issue of

fraud that may be present.

Chairman KERRY. Why was the investigation of BLX initiated?

Mr. THORSON. You mean the criminal investigation, or the audit?

Chairman KERRY. The criminal.

Mr. THORSON. The criminal investigation was actually started

back around 2002 by allegations that were made from a number of

sources, some of which I believe you have statements from, that are

commonly referred to as short-sellers. The SBA did investigate a

lot of those issues, but didn’t find that there were enough specifics

there to be able to bring a criminal case. There were other issues

that developed along the way on the non-fraud side of it, which was

an issue in 2002, which suggested that there were problems with

loans; and then in 2005, the OIG issued a Management Advisory

Report detailing, I think it was seven loans in violation of SBA procedures and material misstatements to SBA. In fact, to their credit,

BLX offered to repay one of those loans, but for some reason, SBA

sent them an e-mail stating that they were being too hard on themselves; and they didn’t need to do that. The criminal investigation

was pretty much——

Chairman KERRY. You have got to come again with that one.

Mr. THORSON. I am sorry?

Chairman KERRY. You have got to hit me again with that one.

42

Mr. THORSON. OK.

Chairman KERRY. The SBA did what? They wrote them back and

said, don’t worry?

Mr. THORSON. That is the information—neither myself nor Mr.

Preston was with SBA at that time, but that is the information I

have, yes.

Chairman KERRY. It is my understanding that you have a second

report underway now. Is that because your judgment is that nonbank lenders and their oversight warrant additional concern from

your office?

Mr. THORSON. Yes, also the fact that we are not—this audit report was not really on BLX. We used it as sort of a case study because of the criminal case, but what we wanted to do was to focus

on the SBLCs, Small Business Lending Companies, and make a determination, is this widespread—are these problems as big as we

may think they are, or is this an isolated incident? It seemed only

natural that we would expand the report to look at other SBLCs,

as well.

Chairman KERRY. And as you know better than anybody, the

public version of your July 11, 2007 report was only released this

past month. Why did it take so long after the official completion

of the report for it to be released?

Mr. THORSON. Why did it take so long until what?

Chairman KERRY. For it to be released publicly.

Mr. THORSON. Primarily because of the debate on the redactions.

We were dealing with both the attorneys for BLX, as well as the

General Counsel of the agency——

Chairman KERRY. Who insisted on those redactions? Did you insist on them? Did the SBA——

Mr. THORSON. I am the one who made the decision to go ahead

and put it out with the redactions that you see before you.

Chairman KERRY. Who insisted on the redactions?

Mr. THORSON. The General Counsel’s Office was one. The BLX

attorneys did.

Chairman KERRY. The General Counsel——

Mr. THORSON. We rejected the claims of the company, but I did

accept the redactions from the General Counsel’s Office.

Chairman KERRY. In your opinion, are all of the redactions legally supportable?

Mr. THORSON. No, but in fairness to their office—I am not an attorney—I used common sense when I looked at some of these and

made my decisions on that.

Chairman KERRY. Was there any reason——

Mr. THORSON. We also have our own counsel, though——

Chairman KERRY. Can you explain why three of your recommendations would be redacted?

Mr. THORSON. I am still having a hard time with that one. They

gave a legal reason for each of the redactions and I accepted those

because of——

Chairman KERRY. Did your recommendations specifically mention any potential trade secret or anything specific to a company

or anything specific that would fall under——

Mr. THORSON. No.

Chairman KERRY [continuing]. The three exclusions stated?

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Mr. THORSON. No. Actually, they are—after you read it, I think

you would pretty much come to the conclusions of what those recommendations would be just simply from reading the report. I

think it is pretty common knowledge that we have taken—in fact,

in my own statement, we have taken issue with the PLP status of

BLX as it progressed. I mean, things like that would be a pretty

normal situation for the office to recommend.

Chairman KERRY. Senator Snowe.

Senator SNOWE. Thank you again, Mr. Thorson, for your very

sensitive and thorough work with respect to these critical issues

and troubling ones, frankly. As you know, these longstanding

issues are my deepest concern. I know that Chairman Kerry shares

the same concerns as to whether or not the Small Business Administration is in a position to take the corrective measures that are

essential to preventing similar problems in the future. I guess

while there may be some distinctions obviously between fraudulent

actions, and just having measures in place to make sure that they

are following correct procedures; nevertheless, there is an ability to

establish procedures that would ultimately detect fraud, a potential

risk for fraud——

Mr. THORSON. Right.

Senator SNOWE [continuing]. And when you talk about 50 percent of some of the loans, is that what you are reviewing now? Are

you saying that 50 percent of these loans don’t have accurate documentation at the Herndon Center?

Mr. THORSON. Yes.

Senator SNOWE. Fifty percent?

Mr. THORSON. The problem with that is not only can we not really get a good feel for what some of these packages contain as we

may look at them, but it also prevents the agency from really understanding whether or not the package was complete at the time

it was made, whether or not they can, if they see problems to go

back against the lender and get the money back in an improper

payment—recovery of an improper payment.

Senator SNOWE. Well, what you heard this morning from Administrator Preston in response to questions, do you feel that the Small

Business Administration is in a position of taking the measures

necessary to begin to address many of these issues? You have obviously issued a number of reports over the last year-and-a-half.

Have any of these recommendations been implemented or adopted

by the SBA? Finally, what is your response to what you heard here

today with respect to the responses by the Administrator to your

report?

Mr. THORSON. In my written statement, we outlined the steps

that the agency was taking, and we certainly applaud that. I guess

it falls to the normal task of an IG to look at those as they progress

through time and make sure that they work and that they accomplish what they were designed to do. It is going to take a little bit

of time. Most of these are new. So we want to take a look at these

over time to make sure that these steps are effective and doing

what they were designed to do. But we certainly admire the fact

that they have put these steps in place and are making these efforts.

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Senator SNOWE. Do you think in both verifying the loans at the

outset, as well as addressing the issues I mentioned, the repurchase rate as a predictor of the potential for loan default becomes

a critical indicator?

Mr. THORSON. Absolutely, yes. You obviously have two types of

reviews here, the pre-reviews which are done before—in this case—

before BLX can sell the loan on the secondary market, and then

you have the post-purchase reviews which are done after the

money is paid out on a defaulted loan. So in each of those cases,

what you really want to do is to learn what you can about—you

can learn obviously about the package individually, but you can

also learn a great deal about the lender and the way they are operating in the SBA guaranteed environment.

Senator SNOWE. Could you understand why they continued to

renew the status of BLX? I mean——

Mr. THORSON. No. It is——

Senator SNOWE [continuing]. In reading the report here, it really

truly is mystifying and disconcerting.

Mr. THORSON. It is really one of the things that we had a hard

time with, and I understand the agency’s concern about affecting

their business, and the argument was made, I believe, by BLX that

it would put them out of business. I personally don’t believe that

is true, but then again, I haven’t seen all that was presented to

them; so there is a legitimate concern for that as I do understand

it.

But the other concern that they have to have is to make sure

that when you have given a company—in this case—or a bank, or

anybody, the right to make credit decisions on behalf of the Government because that is who is backing these loans, we expect the

money to come back. We need to get that money back. And therefore when you do that, the primary concern has got to be that we

have trusted that lender to use good judgment, to use good banking

procedures, and to make good loans, and therefore we shouldn’t

have these kind of problems. How many ways can you hold them

accountable? There are not many, but one of them is that big one.

That is the PLP status.

Senator SNOWE. I couldn’t agree more. That is something that we

are going to have to clearly focus on, as you are recommending, established policies for penalties—that has to be abundantly clear

and evident. The Small Business Administration must be prepared

to invoke those penalties and consequences——

Mr. THORSON. Right.

Senator SNOWE [continuing]. On troubled lenders——

Mr. THORSON. And in fairness to the agency——

Senator SNOWE. We gave the preferred lender status to expedite

the loan approval process, to make it easier, remove barriers, so on

and so forth, but commensurate with that was a fiduciary responsibility to the American taxpayer, and that hasn’t happened and——

Mr. THORSON. Right. In fairness to them, one of the things the

Agency points out is that they will shorten the time span for the

PLP renewal. But if it is always renewed, that doesn’t really seem

to have any effect. If you can count on the fact—and in one case

we notice it was even renewed retroactively—it really has no effect.

You can pretty well count on the fact that you have got it. But it

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is one of the very few ways to really hold the lender accountable

and to force them to move more toward compliance with your policies and procedures.

Senator SNOWE. You have mentioned, I understand, that SBA

does not treat all lenders with troubled portfolios the same; the

small lenders with poor performance often have the renewal of

their preferred lending authority denied, but in other cases, large

lenders with the same problems do not. Is that true? I mean, do

you see that?

Mr. THORSON. Yes.

Senator SNOWE. You do? So there is a disparate approach to

small lenders versus large, and it is all due to volume, again——

Mr. THORSON. It would probably be good to be able to try and

provide you some exact numbers which I honestly don’t have today.

But that is the case. And in fact, I think one of the questions asked

earlier of the Administrator was how many did you revoke, and if

that is true, then what happened here? This was—I have got to believe—a pretty bad example of what can happen, and if this didn’t

result in revocation, then why did the others? Or another question

is, how many of those that were revoked were due to other Federal

regulatory agency actions, and not exclusively because SBA took

action?

Senator SNOWE. Finally, in your estimation, given the analysis

and investigations that you have conducted, do you believe that

BLX is the norm, potentially the norm, or the exception?

Mr. THORSON. No, I don’t think this is a normal situation. I think

what it is right now is we don’t know where this is going. I will

tell you the Troy, Michigan office is closed, but the investigation is

ongoing. So as far as the criminal case, that is about all we can

really tell you. But this has been an interesting situation.

Senator SNOWE. Well, thank you. Thank you, Mr. Thorson.

Chairman KERRY. Thank you, Mr. Thorson. Thank you, Senator

Snowe. It is an interesting situation. Obviously, all of us hope it

is merely a singular individual situation and that it doesn’t point

to a larger issue. It obviously is incumbent on a whole bunch of

folks to make certain of that——

Mr. THORSON. Right.

Chairman KERRY [continuing]. And that is the job of—your job,

to some degree, Mr. Thorson, but it is particularly the job of the

SBA itself and the lending institutions. They are going to have to

take a look at their own processes to guarantee that an awfully important program doesn’t get jeopardized as a consequence of what

we all hope is a singular individual, a sort of aberration, and that

is obviously our hope.

So I thank you for testifying today. As I said, the record will remain open. We may have a few more questions in writing, but we

thank you very much for being here today.

Mr. THORSON. Thank you.

Chairman KERRY. Could I invite the third panel, please, Mr. Bob

Tannenhauser, chairman of Business Loan Express; Anthony

Wilkinson, president of the National Association of Guaranteed

Government Lenders; and Jim Baird, executive director of the Bay

Area Development Company and vice chairman of the Legislative

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nies, all of whom are involved in and are deeply affected by the testimonies of the prior two panels and what we are talking about.

Thank you, folks. I appreciate you being here. Before we begin,

let me just emphasize something. I want to reiterate. Mr.

Tannenhauser, I want to make certain that you understand and

the public understands that your invitation here is not intended to

put some kind of undue or inappropriate focus on BLX, and personally, I know you take great pride in the leadership of your company

and in your effort to help small business owners.

I fully want to respect the fact that this Committee exists for the

purpose of helping small businesses. Our objective is to expand access to affordable financing for small businesses, and since this

story broke, the Committee has taken a very measured approach

to the news, asking the questions about the SBA oversight and reaction, but leaving the disciplinary decisions entirely to the SBA,

and I think we have refrained from any sort of public bashing sessions. As you know, we have never recommended for or against

radical calls for BLX to lose its preferred lender status, delegated

loan privileges, or to cease BLX’s ability to sell SBA loans on the

secondary market.

BLX’s representatives and employees have stated many times

that BLX has been unfairly beaten up in the press as a result of

the actions of one of its lending officers and that the SBA’s IG report is unbalanced and inaccurate. So this is your opportunity to

share with us your perspective and your side of the story and we

look forward to having a good, healthy discussion here.

Mr. Baird and Mr. Wilkinson, we look forward to your input on

this overall situation and the issues that have been discussed here

this morning, so thank you very much, each of you, for being here.

Mr. Tannenhauser, why don’t you lead off and we will go right

down the line. If you could all summarize. I want to give you adequate time, but your full testimonies will be placed in the record

as if read in full.

STATEMENT OF ROBERT F. TANNENHAUSER, CHAIRMAN,

BUSINESS LOAN EXPRESS, LLC, NEW YORK, NEW YORK

Mr. TANNENHAUSER. Giving a brief summary. Chairman Kerry,

Ranking Member Snowe, Members of the Committee, thank you for

inviting me here today. I am Robert Tannenhauser, chairman of

the board and formerly president and CEO of Business Loan Express, LLC, known as BLX, a national non-bank lender.

BLX is a leading participant in the SBA’s loan programs, having

made more than 9,000 SBA loans totaling more than $3.6 billion

since 1994. BLX has played a critical role in the SBA’s 7(a) program, which is specifically designed to help borrowers who cannot

otherwise obtain credit. Since 2001, approximately 77 percent of

BLX’s SBA loans have been made to minorities, women, veterans,

and borrowers in low- to moderate-income areas.

Even though SBA lending is inherently higher risk, BLX has a

robust performance record. We have consistently maintained loss

rates well below SBA industry averages by strong underwriting

and collateralizing our loans with real estate. For the past 6 years,

BLX has been audited annually by the Farm Credit AdministraVerDate 11-MAY-2000 15:36 Sep 24, 2008 Jkt 041658 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 C:\DOCS\41658.TXT DianeA PsN: DianeA
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tion. SBA has taken into account the results of those audits in renewing BLX’s PLP status.

BLX has no financial incentive to condone fraud and every incentive to avoid it. BLX generally retains at least a 25 percent stake

in each loan and remains liable to the SBA for the remaining 75

percent if fraud or mistakes occur in our loan processes.

In January 2007, indictments were unsealed charging five individuals, including a former BLX office employee with fraud in originating SBA guaranteed loans. Last month, that employee—former

employee, Pat Harrington—pleaded guilty to one count of conspiracy and one count of perjury. It is an understatement to say

that this has been a difficult chapter in BLX’s history, and I am

personally saddened and disappointed by the misconduct of our

former employee. I wish we had become aware of his activities earlier. Our records indicate that Farm Credit Administration reviewed several of these loans going back almost 4 years with no indication to us of fraud. Obviously, such wrongdoings are difficult to

detect.

Well before the indictments, a nationally known law firm was engaged to conduct an internal investigation of our Detroit office.

BLX also made a business decision to stop originating gas station

loans in Detroit and removed Mr. Harrington as head of the office

and from loan originations. By September 2006, we had closed the

Detroit office and severed our relationship with Mr. Harrington.

BLX is a victim, not a perpetrator, of this fraudulent scheme.

When the indictments were announced, before any findings of

wrongdoing were made, BLX pledged to reimburse the SBA for any

losses incurred as a result of the fraudulent activities by current

or former BLX employees. BLX paid more than $8 million to the

SBA and placed another $10 million in escrow. BLX has incurred

significant losses of its own, writing off $9.8 million on loans that

the Government asserts were fraudulent originated by our former

employee in Detroit.

BLX is a very different company today than it was when these

fraudulent activities began many years ago. We have invested millions of dollars and countless hours enhancing our internal controls.

I would now like to comment on the OIG report, which I believe

is fundamentally flawed. The OIG did not itself audit BLX, but

rather, relied on audits conducted by the Farm Credit Administration. The OIG report paints an inaccurate picture by excluding the

Farm Credit auditors’ ultimate findings and conclusions which

strongly support the SBA’s decision to renew BLX’s PLP status. Instead, the OIG simply cited a few subsidiary comments in the

Farm Credit audits to support an apparently preconceived conclusion.

Unfortunately, I cannot provide more detail because criminal

laws prohibit lenders from disseminating the contents of Farm

Credit audits. I urge you to request copies of the audit reports. I

am confident that after reviewing them, as well as BLX’s written

response to the OIG, you will conclude that the OIG report is replete with inaccuracies and inconsistencies.

I appreciate the opportunity to testify today, and I want to state

in the strongest terms that BLX is committed to preventing fraud

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in the loan process. We welcome engagement with the Congress

and our regulators in this endeavor. Thank you.

[The prepared statement of Mr. Tannenhauser follows:]

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Chairman KERRY. Thank you, Mr. Tannenhauser. I appreciate it.

Mr. Wilkinson.

STATEMENT OF ANTHONY R. WILKINSON, PRESIDENT AND

CHIEF EXECUTIVE OFFICER, NATIONAL ASSOCIATION OF

GOVERNMENT GUARANTEED LENDERS, INC., STILLWATER,

OKLAHOMA

Mr. WILKINSON. Thank you, Mr. Chairman, Ranking Member

Snowe. I appreciate the opportunity to testify today on SBA’s lender oversight efforts.

We recognize the benefit of quality lender oversight and support

its implementation. Since the introduction of Federal credit reform,

our member institutions have witnessed the impact that portfolio

performance has on subsidy rates and program fees. We are acutely

aware that when individual lenders do not engage in appropriate

loan underwriting, servicing, and internal control practices, the results to the program can be detrimental in terms of the future costs

to borrowers and lenders. Therefore, it is in my members’ individual and collective interests that SBA engages in a sustained, effective lender oversight program. That said, a quality lender oversight program cannot guarantee that it will detect or prevent all

fraudulent activities.

In regards to BLX, I would like to just throw out a couple of

numbers to put the information today in perspective. Since the

start of credit reform, lenders and borrowers have paid in excess

of $1 billion in fees more than were necessary to offset the cost of

this program. During the time period that Mr. Tannenhauser referenced, over 500,000 loans have been made for something like $61

billion, which leads me to the conclusion that this has been a statistically insignificant event in terms of the entire portfolio.

We applaud Mr. Tannenhauser for his attention to this fraud

issue and his willingness to minimize the agency’s losses, and it is

unfortunate that small business has lost a staunch minority advocate and the industry has lost a corporate partner that has historically supported SBA’s goal of reaching underserved markets.

A quality lender oversight program should provide a cost effective, statistically valid means of detecting increased risk in the

overall SBA portfolio, as well as in individual lender portfolios. Initially, this is typically accomplished with a properly functioning offsite monitoring program. Upon detection of adverse trends, the

oversight program should direct an onsite review of the institution’s asset quality and lending practices to validate concerns, provide corrective actions, or issue enforcement direction.

We do not believe the current offsite monitoring program being

developed by the SBA will meet its intended objective. The SBA already has access to significant amounts of data relating to historical loan performance, delinquencies, and lender activity. However,

it does not appear that this information is routinely utilized as part

of an early warning risk assessment system.

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The SBA is instead relying upon a Dun and Bradstreet computer

program that forecasts a percentage of loans in a lender’s portfolio

at high, moderate, and low risk of default. Unfortunately, the forecast criteria, as well as the specific loans identified as high-risk are

never shared with the lender. The lender is unable to determine

whether it agrees with the analysis; and if it does agree, to take

appropriate action. Our desire is not to know the precise formula

for determining a lender’s rating. However, we do expect sufficient

detailed information that will help us implement corrective action

and reduce the portfolio risk.

In addition, the SBA is requiring the participating lenders to pay

for this Dun and Bradstreet program through separate fees. Lenders were not provided sufficient information to determine if they

are receiving any value for this cost. Moreover, portfolio performance forecasts by the Dun and Bradstreet model are highly questionable and appear unreliable.

The results of the ongoing offsite analysis should be supplemented with onsite reviews for any participating lenders deemed to

be high risk. It is imperative that the onsite activity provides timely feedback and meaningful analysis to the participating banks and

the SBA. It is an established fact that the bank and credit union

industries already have substantial lender oversight from its respective regulators.

NAGGL believes that before initiating its own onsite lender activities, the SBA should be required to demonstrate that it is adding value to current Federal and State oversight efforts and not

just duplicating existing efforts and costs. It would appear reasonable for the SBA to work with the existing regulatory agencies to

accomplish its onsite examination objectives and ensure consistent

application of examination procedures by regulatory experts to provide safety and soundness testing of SBA portfolios.

Under the current fee structure for the lender oversight program,

the SBA has based the monitoring costs on a lender’s outstanding

guaranteed balance versus a proper risk-based fee structure. SBA’s

evidence reflects the greatest risk in low-volume lenders and nonfederally regulated lenders. The SBA should reassess its fee structure under a risk-based allocation and not have the most active

participants bear the cost of under-performing high-risk lenders.

Mr. Chairman, I would like to congratulate you and Senator

Snowe on the introduction of S. 2288, a bill that would significantly

improve SBA’s lender oversight function without unduly increasing

the regulatory burden on lenders. We believe that S. 2288 is a

major step forward in improving lender oversight.

Also, the SBA has just published a 35-page proposed rule on

lender oversight. The primary focus appears to be enforcement actions and not safety and soundness standards and we will submit

a formal letter of comment on the proposed rule at a later date.

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Despite the need for adequate lender oversight, the performance

of the SBA portfolio has been good. If standardized banking calculations are applied to the SBA loss data, the annual net loss rate

in the SBA 7(a) program would be in range of 0.4 to 0.5 percent.

And looking at the FDIC Web site this week, their quarterly banking profile shows that in the second quarter of 2007, the conventional bank loss rate was 0.5 percent. Given the high-risk nature

of the SBA loans, this loss rate reflects the lending community’s desire and ability to effectively minimize the program’s taxpayer cost

while meeting its public policy objective of making credit available

to the small business community.

Mr. Chairman, I would be pleased to answer any questions.

[The prepared statement of Mr. Wilkinson follows:]

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Chairman KERRY. Thank you, Mr. Wilkinson. That was important testimony and we appreciate it.

Mr. Baird.

STATEMENT OF JAMES BAIRD, EXECUTIVE DIRECTOR, BAY

AREA DEVELOPMENT COMPANY, AND VICE CHAIRMAN, LEGISLATIVE AFFAIRS COMMITTEE, NATIONAL ASSOCIATION OF

DEVELOPMENT COMPANIES, WALNUT CREEK, CALIFORNIA

Mr. BAIRD. Chairman Kerry, Ranking Member Snowe, thank you

for the opportunity to appear before you to talk about this important subject. I am Jim Baird, the executive director of Bay Area

Employment and Development Company of Walnut Creek, California, and the vice chair of Legislative Affairs for NADCO, the National Association of Development Companies for Legislative Affairs.

Our industry has a significant and ongoing interest in maintaining the highest standards of industry oversight and loan program

performance. The purpose of my remarks today are not to tear

down the efforts that SBA has made to date, but to try to add comments to strengthen the oversight program of the SBA.

Obviously, over the last 4 years, there have been dramatic program changes and dramatic growth in the 504 program. This has

been growth in both number of loans, dollars of loans, and economic development impacts of the program. But this growth magnifies the importance and also the danger of growing a program

without optimal oversight in place.

The 504 oversight program has evolved and is evolving, but it is

still lacking in several important ways. For example, the Office of

Credit Risk Management reviews the credit and eligibility of all the

loans that they audit in their routine onsite audits. However, they

review these factors independent of one another. I can’t overstate

the importance of taking a look at the whole, the adequacy of the

overall project structure. To me, it is analogous to analyzing all the

separate parts of a car without taking the time to ask if the car

runs.

In PCLP, there are also significant lost oversight opportunities.

PCLP has grown dramatically, but it has grown in only a few markets of the country and only by a small portion of CDCs participating in the program. There are rampant rumors of PCLP lenders

doing 504 loans that are not properly underwritten. PCLP lenders

are routinely providing 100-percent loan-to-value financing without

any reasonable basis for doing so and rumored to be and obtaining

SBA approval with incomplete information, incomplete analysis,

and incomplete underwriting.

So how do we improve PCLP oversight? I would suggest we take

a look at some of the processes in place at the Sacramento Loan

Processing Center. They have been operating in an environment of

substantially increasing volume while having substantially decreasing staff. They have developed a very efficient method of loan program overview called the Abridged Submission Method, or ASM.

In this process, CDCs submit limited packages rather than whole

packages, but are required on 48 hours’ notice and on a random

basis to submit complete packages to Sacramento for review and

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lems before they occur, and lenders never know which loans are

going to be chosen, so they are always acting diligent in order to

preserve their status, whether it is ALP or ASM, or whatever their

CDC status is.

However, the chronic staff shortages that have occurred in the

Sacramento Loan Processing Center have caused, even for ALP

lenders, the ASM program to be suspended. Somehow, we need to

find the resources to fully staff the Sacramento Loan Processing

Center. We need to fully staff the center so that it can reinstate

the ASM program and so that it can, for the first time, apply the

ASM audit process to PCLP lenders.

Comments have already been made on the D&B model, which in

my opinion, looking at the big picture, represents an agency attempt to use modern technology and apply it to portfolio management, which is a good thing. It is a good direction, but there are

issues with it, and we have already gone through. I would suffice

it to say that we need disclosure and daylight, number one, to see

if the model actually works; and number two, to allow lenders and

CDCs to put the data to productive use.

We need the passage of S. 1256 and S. 2288. After 27 years, for

the first time, S. 1256 defines the structure and expectations for

the 504 program and its participants, and it is a critical foundation

to establish proper 504 loan oversight. S. 2288, as introduced by

the Ranking Minority Member and Chair, will also dramatically

improve loan oversight. It also authorizes oversight fees, and we

are concerned about the effect of those fees, particularly on small

and rural CDCs. We would like to work with the Committee on this

provision, but in our opinion, both bills need to be adopted in this

session to strengthen oversight and NADCO endorses both bills.

The newly proposed loan oversight regulation is something that

we are going to need some time to go through, given its recent introduction and its length, frankly. Our preliminary concerns are

that it seems to identify the D&B system as the sole system of

CDC initial oversight and it also requires compliance of CDC audits, with OMB Circular A–133, which would have substantial cost

effects for all CDCs, and again, particularly small and rural CDCs.

We believe it would drive many of them out of the program. The

regulatory finding of no significant impact on CDCs or on small

business is, frankly, in error.

In summary, there is currently no liquidation or default crisis

whatsoever in the 504 program. We are here today to try to offer

suggestions to improve oversight and enforcement, and we hope to

continue to work closely with the Committee and the agency to obtain the best possible practices.

I would like to thank the Chairman and the Ranking Minority

Member for holding this hearing and we would be happy to answer

any questions you have.

[The prepared statement of Mr. Baird follows w/attachment:]

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Chairman KERRY. Thank you, Mr. Baird. We certainly appreciate

the testimony and the observation, obviously, that you think that

the program is fundamentally sound and not in any kind of liquidation crisis, and I think that is very important news for people to

know and understand.

Mr. Wilkinson, I want to cut to the sort of heart of this thing,

in a way, if we can a little bit. I think your observation about the

default rate relative to the total portfolio measured against the

commercial industry is an important one. So let me ask you sort

of a summary question, in a sense, about that. Are you satisfied

that the procedures in place within the SBA itself and/or the lender

structure are sufficient to protect the taxpayer dollar with respect

to these loans?

Mr. WILKINSON. Well, one of the benefits that we have in the——

Chairman KERRY. You gave some recommendations. Maybe you

want to highlight the most important ones that would either guarantee that, if you don’t, or——

Mr. WILKINSON. We have the benefit in the 7(a) program in that

almost all of our members are regulated institutions who have to

deal with OCC, FDIC, NCUA, so they already have systems in

place for their entire institutions. So that is a benefit that we get

in the 7(a) program.

Chairman KERRY. How do you feel—what about the non-bank

lenders?

Mr. WILKINSON. Not having been through each of their institutions, that would be a tough call, but it does look like that could

be where the SBA is trying to put in place some of the regulations

that we as bankers have been subjected to for quite some time.

Chairman KERRY. Is it your judgment that the program would be

advantaged by having some additional oversight in that regard? I

mean, you have heard the testimony today. You have obviously followed this issue. What is your judgment as to procedures already

in place?

Mr. WILKINSON. Again, having gone through a good part of my

career in the commercial banking world, when we get an onsite review from a bank examiner, it is a very detailed loan-specific report

that is also a management tool, so that we get an independent look

at the loans and they come through and really make a judgment

on the asset quality and it puts us in a position to then take actions to correct what they might see as a deficiency that we hadn’t

seen before. So it is a very useful tool and that is not something

we get with the Dun and Bradstreet model that gives us a score

that we don’t know how it was derived, or what it means, and it

does not provide a management tool, yet we get the privilege of

paying for it.

Chairman KERRY. But specifically with respect to the SBA, your

written testimony says that in the current onsite review process,

the SBA is essentially looking for the completeness of the file——

Mr. WILKINSON. The bulk of the——

Chairman KERRY [continuing]. Not for the——

Mr. WILKINSON. Quality of the asset.

Chairman KERRY [continuing]. The quality of the asset.

Mr. WILKINSON. That would be correct. The bulk of the onsite

review——

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Chairman KERRY. Is that a problem?

Mr. WILKINSON. Well, it is——

Chairman KERRY. I mean, is that the extent of SBA’s job? Does

the other fall to somebody else? Are we missing something? Are we

going down the wrong track here?

Mr. WILKINSON. Well, we would prefer to see more review of the

asset. Is it a quality asset? What problems do you see, as opposed

to, do we have this certain form in the file? I mean, that is something that if there is documentation missing, should the loan ever

go into default, that SBA would say, hey, you didn’t get a mortgage. You didn’t get a UCC. You caused us harm. We will repair

the guarantee.

Chairman KERRY. And you also believe—I think you asserted

that there ought to be better coordination between the SBA oversight and the other oversight entities?

Mr. WILKINSON. Absolutely. The bank examiners are already in

the bulk of 7(a) lenders. We would like to see the SBA work with

the agencies and perhaps come up with a cooperative way that perhaps the banking agencies could expand their reviews to cover

what SBA would need.

Chairman KERRY. Mr. Tannenhauser, I appreciate your testimony. I know that BLX and the SBA both consider themselves essentially to have been victims of a fraud here, and obviously, you

were in the sense that one of your employees took a flyer. But the

question is, where do you believe—what judgment do you make

about the company’s own sort of processes? You have spent a lot

of money, and you have talked about the things you have done to

try to correct that. Were there some signs that you believe that

BLX should have picked up on [such] as $28 million in repurchases

of loans originating out of one branch, all for the same kind of industry, i.e., gas stations? Was there something here that you think

might have been done more effectively, or do you just think this

was so hard to peg that somehow it escaped scrutiny?

Mr. TANNENHAUSER. Well, Senator, the issue of the performance

in the Detroit office is something that we had looked at early on,

and they did specialize in making loans to borrowers in the gas station/convenience store industry, and primarily these borrowers

were of Middle Eastern descent. We looked at the performance of

these loans and especially we were concerned after 9/11. Was there

any impact as a result of that? And we did monitor the performance pretty clearly. And as a result of that, we did shut down the

gas station operations well before any indication of fraud or wrongdoing came to light.

Also, prior to that, we conducted a—had an independent investigation of the Detroit office, which we utilized in making our decisions. We also removed Mr. Harrington as head of the office and

from loan originations.

Chairman KERRY. What prompted that? What was the——

Mr. TANNENHAUSER. That was strictly loan performance. We historically do close down offices and terminate business development

officers on a performance basis, again, with no indication of fraud,

but we are in business to make good loans and if people are giving

us loans that don’t perform well, that doesn’t serve us very well,

nor the program.

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Chairman KERRY. But you nevertheless kept him on?

Mr. TANNENHAUSER. We kept him on—well, he had a contract

and there was no reason under his contract to terminate him, but

we did keep him on in a role which took him out of the loan origination process.

Chairman KERRY. Does BLX monitor the performance of loans by

branch?

Mr. TANNENHAUSER. Yes, we do. We monitor it by branch. We

monitor it by underwriter. We monitor it by closer. We monitor it

by referral sources. And, in fact, we keep a blacklist of referral

sources that we no longer do business with, some of which were involved in this fraud.

Chairman KERRY. So in other words, you break them out, your

loans from other loans, such as USDA and other non-Government

guaranteed loans?

Mr. TANNENHAUSER. Yes. Well, we slice and dice in every possible way we can. We have been dedicated to process improving

since 2000——

Chairman KERRY. Were the SBA loans the bulk of the Troy office

loans?

Mr. TANNENHAUSER. Yes, they were, but there were conventional

loans, also, which I believe were alleged to be involved in the fraud

and which we take the full loss.

Chairman KERRY. When did BLX first notice that they were oneindustry focused?

Mr. TANNENHAUSER. We knew that right away. The Troy

office——

Chairman KERRY. Did you also know they were linked to one

specific employee?

Mr. TANNENHAUSER. Well, he was head of the office. The Troy office came to us as a merger. BLX is really an amalgamation of four

different companies and the Troy office came to us in a merger of

one of these companies that we integrated and their primary focus

was gas station/c-store loans. Mr. Harrington was really the rain

maker for that office.

Chairman KERRY. With respect to the settlement agreement between you and the SBA, it requires you, number one, to cover any

losses to the SBA related to the Troy, Michigan fraud, and two, to

repurchase the guaranteed portion of BLX loans that default after

being sold in the secondary market if they are related to the fraud

scheme. So you have to repurchase——

Mr. TANNENHAUSER. No, actually, I believe it requires us to repurchase any loans that default after March 6 in the secondary

market.

Chairman KERRY. So in effect, was this obligation an obligation

that you assumed under the law, or was it an obligation that was

required of you as part of the settlement with the SBA itself?

Mr. TANNENHAUSER. No, this was not required in the law. This

was negotiated in connection with the settlement agreement.

Chairman KERRY. Now, initially, when the fraud was first discovered, BLX hired a law firm to look into the lending of that branch.

What were the findings of that and what prompted you to do that?

Mr. TANNENHAUSER. Well, the independent investigation by this

law firm occurred prior to any indication of fraud. The reason we

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did that is there were several—we had been foreclosing on several

loans and several of the borrowers had, over the course of, I think,

2 or 3 years, several of the borrowers had put in counter-claims alleging wrongdoing on the part of Mr. Harrington. So we engaged

a nationally known law firm to conduct an independent investigation of the office.

Chairman KERRY. Did they find at that point any fraudulence in

those loans?

Mr. TANNENHAUSER. No, they didn’t. They found no evidence of

wrongdoing. In fact, in the lawsuits, they were disposed of with no

finding of wrongdoing, either. But that did not stop us from shutting down the Detroit gas station operations because of performance.

Chairman KERRY. What did you see that caused you to move in

and to shut it down? What was it that you saw?

Mr. TANNENHAUSER. Well, we do gas station/convenience store

loans all over the country and the performance of the loans from

the Detroit office was well below the performance levels we had

been seeing elsewhere, so——

Chairman KERRY. So this was a performance-related return on

investment decision?

Mr. TANNENHAUSER. That is correct. I mean, I believe as late as

December 2005, we were under the impression that Mr. Harrington

was a witness on behalf of the prosecution investigating certain of

the loans, not a target of the investigation.

Chairman KERRY. Now, here you are. What is the total business

that you have been doing with the SBA?

Mr. TANNENHAUSER. We have done over $3.6 billion worth of

loans.

Chairman KERRY. And what percentage of your business is that?

Mr. TANNENHAUSER. I am sorry?

Chairman KERRY. Of the overall business you do.

Mr. TANNENHAUSER. Oh, that is the bulk of the business, although lately we have been moving more toward a conventional

loan product, and that is becoming the majority of our——

Chairman KERRY. Now, here you are, sort of an important player

in a small family of—this will be my last question; I just want to

get to you, Senator Snowe—you have been the key player in this

effort and this is an aberration, according to you and other folks.

So the question I think looms large, why have you effectively said

you are going to get out of the 7(a) business?

Mr. TANNENHAUSER. The problem, Senator, is really the confluence of several events over this past year which have really

made it extremely expensive for us to remain in the business. One

of the events is obviously the impact of the Detroit indictments and

the plea, the cost of us complying with the March 6 agreement with

the SBA, the delay in our ability to securitize our SBA

unguaranteed portions, which we didn’t get permission until the

end of August, and of course as you are obviously aware, the capital markets disintegrated by then, so we couldn’t get those off. Our

obligation to repurchase loans, which we will continue even if we

are in the business or out of the business, creates a situation where

we keep these loans on our balance sheet now at the highest possible cost of funds to us. We are not a bank, so we have to borrow

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to make loans. The delay in selling the guaranteed portion of the

loans until after reviews by Deloitte and others keeps these loans

on our balance sheet longer. Again, we are paying the highest possible rate that we can. And, of course, the increased cost of credit

to us as a lender that needs to access the credit markets have all

really caused us to think about scaling down, at least temporarily,

our operations in the SBA business.

We regret having to do this because we are dedicated to serving

this community and we have been servicing minority borrowers

throughout our existence, and I think we are one of the larger

members——

Chairman KERRY. Well, we are certainly very sensitive to that

and we certainly want to acknowledge that. I think there is a component of this that if this is a narrow and singular individual kind

of event, one hates to see an entire operation diminished as a consequence of that and we ought to try to be smart about how we go

forward with that.

Let me cede to Senator Snowe.

Senator SNOWE. Thank you, Mr. Chairman, and I will just ask

a few questions. Mr. Tannenhauser, just to follow up, I notice in

your testimony that you felt that the Inspector General’s report

was inaccurate and incomplete. Am I right in saying that?

Mr. TANNENHAUSER. Yes, that is what I testified to.

Senator SNOWE. OK. You raised your eyebrows and I thought

maybe——

Mr. TANNENHAUSER. No, no. That is correct.

Senator SNOWE. And because they excluded the Farm Credit Administration’s analysis, I gather, of your operation, as well?

Mr. TANNENHAUSER. Yes, and——

Senator SNOWE. And also obviously for the confidential information that has been redacted from the report, and we understand all

that. But in the IG’s report, it did indicate that there were recommendations to not renew the preferred lender status for BLX.

Mr. TANNENHAUSER. Again——

Senator SNOWE. So it wasn’t an indiscriminate analysis, I don’t

think, from that standpoint.

Mr. TANNENHAUSER. If I may, Senator, again, this is one of the

issues that I take with the report as far as the inaccuracy and the

incomplete presentation, and I will go back to maybe a little bit of

that to correct what I believe is a misconception in what Tony said.

Farm Credit does a very, very complete review when they come

into a non-bank lender. They spend approximately 6 weeks, seven

or eight people going through our files who safety and soundness

audit review our files for loans for credit quality, make recommendations. The reports that they issue over this 5 to 6-year period consistently supported renewal of our PLP status. Yes, we domake mistakes. There are human errors. But in these reports, I believe if you review them, you will see that they acknowledge that

we address the issues that are presented, that we consistently take

steps to improve the quality of our loans and our processes.

Now, with respect to what the IG set forth about guidelines in

the Sacramento Center, those are at odds with what were the

benchmarks in place under the lender oversight SOP and those

were not generally the benchmarks that we used. For some reason,

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they used these benchmarks, which are not the ones used for PLP

renewal, and applied it against BLX when with other lenders they

used different benchmarks.

So I believe that perhaps they may have been confused about

what the actual benchmarks were, and if they had used the real

lender oversight benchmarks, they would find that we did comply

with them and were entitled to renewal of our PLP status.

If I can further state, that is not all that we went through when

our PLP status was renewed. We spent countless hours with the

SBA going over our portfolio performance, reconciling our numbers

with them, showing them the improvements that we have made

over the years. This was not just an idle rubber stamp. They spent

time and effort, and believe me, after the year we had, I am no

great fan of the SBA, but they did their job in overseeing us. So

I can’t criticize them for that.

Senator SNOWE. Well, would the Farm Credit Administration

have done anything any different, I mean, in terms of evaluating

something that raised a real concern? I mean, you can understand

from a public interest standpoint——

Mr. TANNENHAUSER. Well, again, Senator, I urge you to read the

Farm Credit report——

Senator SNOWE. I will.

Mr. TANNENHAUSER [continuing]. And read the conclusions and

they will—I believe you will find that they support our contention

that our lending practices were safe and sound and that we were

one of the lenders in the industry that deserved to have PLP

status——

Senator SNOWE. The IG report raises significant issues that had

surfaced with BLX. I mean, wouldn’t you say from the standpoint

of the Government that those would be legitimate interests to be

concerned about?

Mr. TANNENHAUSER. Well, there will always be issues raised because when you do the volume of loans that we do, there will always be human error—excuse me, there will always be mistakes.

We do take the steps necessary to address those mistakes when we

become aware of them and we do constantly try and improve our

processes. That was discussed at length with the SBA during our

renewal process and they took that into account and——

Senator SNOWE. No, I understand that they might have taken it

into account. What I am saying is that you understand from a public perspective, I mean, representing the public’s interest and the

American taxpayers, that there would be some serious issues.

Would you not view those issues that manifested itself back then

on the part of BLX might have been a precursor, a predictor for

some of the problems that emerged ultimately? Did you see that as

a bad sign, or did people in your organization see it as a bad sign

in any way, or just that?

Mr. TANNENHAUSER. We are always concerned with a high purchase rate, but we make loans to a segment of the population that

is higher risk. However, our loss rate is significantly lower than the

industry averages, so that is the real risk to the Government and

we have maintained that over the 10 to 14 years that we have been

doing this, and that is really—no one has taken that into account

and everybody seems to ignore that fact. What is the risk to the

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Government? How much money are you going to lose on the loan?

Well, guess what. On BLX’s loans, the loss rates are below the industry averages.

So you can pick a particular statistic and say, oh, this company

is doing terribly, but you have to take the overall picture and I believe that is what Farm Credit did and I believe that is what SBA

did, and I don’t believe that is what the Inspector General did. And

I don’t say they did it with malice or for any reason other than perhaps they didn’t have access to those facts and records.

Senator SNOWE. Again, you can understand what is at risk here,

ultimately. We have a public obligation to the American taxpayer

to explore those issues, to have the Inspector General provide an

independent evaluation. Consequently, we have to make sure that

we are doing our jobs in pursuing these negative activities. Obviously, when you have fraudulent activities emerge, it is certainly

going to garner attention in addition to everything else to making

sure that we have got appropriate procedures in place. That is our

public obligation.

I thought it was interesting that you said the IG report was incomplete. We will look at the Farm Credit Administration report.

But I think you should know that others at the SBA saw serious

issues emerging with BLX. That is what I need to bring to your attention based on the IG report now——

Mr. TANNENHAUSER. Absolutely. Again——

Senator SNOWE. That is what I am saying——

Mr. TANNENHAUSER. There is no question, but you have to

look——

Senator SNOWE. Reservations within the SBA were not indiscriminate. They were based on the factors that they were considering at the time.

Mr. TANNENHAUSER. Well, some areas we do less loans. You may

have a higher repurchase rate in that area. I mean, there are different aspects. But if you take our portfolio performance as a

whole, I think you will find that it is quite satisfactory.

Senator SNOWE. I appreciate that, and I know that you are taking remedial measures and hiring an independent party to evaluate

all of your procedures.

You also mentioned in your testimony that BLX agrees to make

SBA whole. Where does that stand now?

Mr. TANNENHAUSER. Well, where it stands now is we have paid

them over $8 million. I believe there was one loan which Mr. Harrington pleaded to which was not in the original eight. We will be

making them whole on that. And to the extent that there are any

other loans in which fraud is found, there is a $10-million escrow

plus we are obligated beyond that. So the SBA will not lose money

as a result of fraud by any of our employees. We will lose that

money.

Senator SNOWE. Thank you, and I think that is important, as

well, in all of that. So you stand prepared to reimburse the Government for any losses that occur——

Mr. TANNENHAUSER. Absolutely, and that obligation is there

whether we continue to make loans in the program or not.

Senator SNOWE. OK. Well, I think that is an important issue.

Thank you.

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Mr. Wilkinson, you mentioned in your testimony about SBA’s

projected repurchase rates, between the actual and projected. I

gather from what you are saying is that the SBA consistently provides inaccurate projected repurchase rates compared to what is actual and in reality?

Mr. WILKINSON. SBA issues what is called a portal report, and

I was able to get the portal reports on the entire 7(a) portfolio

going back in time for 18 months and was able to go back and

look—and I forget the exact date, but say at 3/31/06 where they

predicted that defaults, or there would be a repurchase rate of X

over the next 12 months, well, when 3/31/07 rolled around, we went

and said, OK, what was our actual repurchase rate, and it was 25

percent less than what had been predicted, and that has now happened quarter and quarter. So it appears that whatever is in this

Dun and Bradstreet predictive model, it is overestimating defaults.

Senator SNOWE. So what would be the basis? They are using a

Dun and Bradstreet model.

Mr. WILKINSON. That is where that number comes from.

Senator SNOWE. So it becomes less, in your estimation, less reliable?

Mr. WILKINSON. I don’t know what we could rely on out of that

number. I mean, we just—I don’t know what is in the model, don’t

know how that number is derived, and thus far, comparing actual

performance to their previous predictions, they are at least 25 percent off.

Senator SNOWE. Well, it is interesting because of what I mentioned earlier in the question to Administrator Preston that there

are projected increases from 9 to 167 percent by the SBA’s lender

monitoring system.

Mr. WILKINSON. I don’t have the actual numbers in front of me,

but the Dun and Bradstreet model had predicted about a 2.3 percent repurchase rate, and I believe our actual number came in

around 1.6, quite a bit less than what had been predicted.

Senator SNOWE. So obviously, if that is the case as you are saying, that——

Mr. WILKINSON. And that would be a gross repurchase rate. You

would net out from that any recoveries we would get from liquidation of collateral.

Senator SNOWE. From what you heard here this morning in

terms of the questions and answers in Administrator Preston’s and

Inspector General Thorson’s responses, where do you think the

SBA stands in terms of being prepared and able to provide effective

oversight and monitoring?

Mr. WILKINSON. They are a lot better today than they were just

a few short years ago. So there has been improvement. One of our

concerns is that the agency’s budget is continually cut, and they

now continue to rely on an outsource function and then try to pass

those fees along to the lending community. So our fees have gone

up dramatically, and rather than SBA staff handling the review

functions, they now outsource that, which some would argue leads

to inconsistent application.

Senator SNOWE. So we have argued for years about the staffing.

Mr. WILKINSON. Absolutely.

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Senator SNOWE. Ultimately, this lack of staffing will produce consequences.

Mr. WILKINSON. They can only cut so far.

Senator SNOWE. I know. Exactly. One of the issues that emerges

consistently is underwriting. I want Mr. Baird to comment on underwriting. Is the SBA’s underwriting sufficient? Is there enough

guidance or standards or criteria? If not, what can be done to improve it?

Mr. BAIRD. I think that what we can do first and foremost to affect and improve 504 underwriting is to fully staff the Sacramento

Loan Processing Center. I hate to sound like a broken record here,

but that is really critical. We have taken the 200 processing loan

officers and support staff in 69 district offices and compressed them

into about 15 people in Sacramento, and they are 15 of the hardestworking people that you will find in Government, but they have

had problems keeping that office staffed, I think in part because of

the workload, perhaps in part because the positions may be rated

at lower levels than they need to be rated to retain staff. Then

there have been issues replacing staff who have left. The result is

trying to do so much more with so much less that it just can’t be

done.

Senator SNOWE. OK. Well, thank you all very much. I appreciate

it. Thank you, Mr. Chairman.

Chairman KERRY. Thank you so much, Senator Snowe.

So in other words, something is wrong here. There is either a gap

in the Administrator’s understanding of what he needs, or there is

a gap in the availability of people out there, one or the other. Mr.

Baird.

Mr. BAIRD. Yes.

[Laughter.]

Chairman KERRY. I respect your reluctance to comment.

Just a last question, Mr. Baird. You say lenders are not adhering

to SBA guidelines?

Mr. BAIRD. Yes. I think that with all of the changes that the 504

program has gone through, opening up all the markets to Statewide competition, CDCs going into contiguous States, the centralization of the processing, and just basically competitive pressures, I think that all those have contributed to—caused CDCs and

to some extent their lending partners to start competing against

one another with credit criteria and underwriting criteria, and that

is not really the proper role of the CDC.

The proper role of the CDC for a, let us say a more challenging

small business credit, part of our role is to put credit where the private sector alone won’t provide it. But for, let us say a tougher

project, rather than providing 95 or 100, or even 90 percent financing without additional collateral, one of the critical roles of the

CDC is to balance the interest of the small business concern and

the community and the SBA in a fiscally responsible manner and

it takes the right policy and it takes, in my opinion, optimal oversight in order to make sure that abuses in underwriting aren’t happening for the competitive advantages of certain CDCs.

Chairman KERRY. Very important observation, and the Committee will take note of it. What I would like to do is ask the SBA

and IG to respond to these observations in writing for the ComVerDate 11-MAY-2000 15:36 Sep 24, 2008 Jkt 041658 PO 00000 Frm 00093 Fmt 6633 Sfmt 6633 C:\DOCS\41658.TXT DianeA PsN: DianeA
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mittee as part of this record. We will leave the record open in order

to submit additional questions in writing so that this record is complete.

We have just run out of time. Both Senator Snowe and I have

to be at our respective caucuses, but I do want to emphasize the

need in these next days to complete this record and get some responses to some of the comments that have been made and various

specifics so we can kind of chase down the hard facts here.

So we thank you, all of you. Mr. Baird, Mr. Wilkinson, Mr.

Tannenhauser, I know this is not the most pleasant experience in

the world, going over some of this stuff, but on the other hand, it

is very important for the Committee and very important to the taxpayers and to all of us to understand how the SBA can do a better

job and we need to do that.

Thank you. We stand adjourned.

[Whereupon, at 1:12 p.m., the Committee was adjourned.]

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APPENDIX MATERIAL SUBMITTED

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Additional Snowe Questions

Question

In April 2007, the Federal Deposit Insurance Corp. (FDIC) issued a cease and desist

order to Oakland-based Innovative Bank, which makes SBA Express and Community Express loans, among other services. The FDIC order directed Innovative Bank

to cease following ‘‘unsafe and unsound’’ banking practices. Though there are numerous media reports about the FDIC’s efforts to reign in Innovative Bank’s questionable lending practices, none of the reports mentioned any oversight activity by

SBA. Did SBA’s oversight mechanism detect a problem with Innovative Bank’s loan

practices? If so, what was SBA’s response?

SBA Response

As you know, SBA’s Office of Credit Risk Management monitors the SBA loan program performance of SBA Lenders and responds as needed. In general, financial institution examination information is confidential in accordance with law. Accordingly, SBA’s actions with respect to Innovative Bank cannot be disclosed publicly.

However, to assist the Committee in their oversight function, SBA is forwarding the

financial institution examination information that you requested under separate letter to facilitate its confidential treatment together with a confidential explanation

of the Agency’s information and actions.

Ouestion

What has the SBA done to coordinate with FDIC, or the other bank regulators, to

otherwise improve its oversight strategy in situations like these?

SBA Response

SBA has discussed the need to share information about regulated SBA lenders with

FDIC and other regulators, and we continue to work with them in an effort to improve . communications between SBA and the regulators in matters concerning our

lenders.

Questions for the Record

Lender Oversight Hearing

Senator Johnny Isakson

Question

Administrator Preston, would you please clarify what action(s) the Associate Administrator of the Office of Entrepreneurial Development stated to the U.S. Small Business Committee would be completed by 1/18/08?

Response

Not available at time of printing.

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