Small Business Administration: SBA Followed Appropriate Policies and Procedures for September 11 Disaster Loan Applications
Published: 2004-08-31T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Small Business Administration (SBA) played a key role in assisting small businesses affected by the September 11, 2001 terrorist attacks by providing over $1 billion in disaster loans to businesses that sustained physical damage or economic injury. Small businesses in the immediate areas of the attacks and others nationwide that suffered related economic injury were eligible to apply for disaster loans. SBA declined or withdrew about half of these loan applications. SBA's disaster loans are direct federal government loans provided at a subsidized interest rate. In response to concerns that more small businesses impacted by September 11 could have benefited from SBA's disaster loans, GAO conducted a review of its Disaster Loan Program. Specifically, GAO addressed the following questions: (1) Are the disaster program policies consistent with the law and the overall mission of SBA's Disaster Loan Program? (2) What were SBA's underwriting policies and criteria for September 11 Economic Injury Disaster Loans (EIDL) and how did they compare with those applied by nonprofit lenders that were active in New York City after September 11? (3) Did SBA correctly apply its policies and procedures in its disposition of September 11 EIDLs?
section_title: What GAO Found
paragraphs: SBA's policies and procedures for providing EIDLs are consistent with the Small Business Act: applicants must have suffered substantial economic injury as a result of a declared disaster, and SBA must determine that they are not able to obtain credit elsewhere. The act addresses some loan terms, such as length of maturity, but it does not specify underwriting criteria for SBA to follow. However, SBA's regulations contain underwriting criteria such as assessing an applicant's ability to repay the loan and obtaining collateral. SBA's underwriting requirements for September 11 EIDLs generally followed program guidelines and were similar to those of selected nonprofit organizations in New York City. Small businesses that were eligible to apply for SBA assistance were expected to meet standard requirements for documentation, creditworthiness, repayment ability, collateral, and character. These requirements are generally consistent with best practices published by lending industry experts and guidance issued by federal regulators. Changes made to address the unusual circumstances of the September 11 disaster were to eligibility and loan terms and not to loan underwriting criteria. The three nonprofit organizations in New York City that made September 11 disaster loans had requirements similar to SBA, but the nonprofits had some additional flexibility to address the needs of their small business constituents. GAO found that SBA followed its policies and procedures in making decisions for September 11 EIDLs. All of the files in our random, representative sample of declined or withdrawn applications contained documentation and analysis to support the SBA's determination. GAO's review of this sample also indicated that SBA followed its procedures for processing applications--such as supervisory review and notifying applicants of its decision and their right to have the application reconsidered. GAO's review of a small sample of approved loans also indicated that SBA followed its policies and procedures.

section_title: Letter
paragraphs: The Small Business Administration (SBA) played a key role in assisting  small businesses affected by the September 11, 2001 terrorist attacks. SBA  provided approximately $1.1 billion in disaster loans to businesses that  were physically damaged or had suffered a substantial economic injury as a  result of the attacks. Small businesses in the declared disaster areas  surrounding the World Trade Center and the Pentagon, as well as others  nationwide that had suffered economic injuries directly related to the  events of September 11, were eligible to apply for disaster loans. SBA  required eligible applicants to document the extent of their losses and  provide enough financial information for SBA to determine repayment  ability. SBA declined or withdrew those loan applications that its loan  officers determined did not meet its underwriting criteria. SBA’s disaster  loans are direct federal government loans provided at a subsidized interest  rate.
In previous work, we reported that SBA had declined or withdrawn about  half of approximately 24,000 post-September 11 applications for disaster  loans nationwide. In response to concerns that more small businesses  impacted by September 11 could have benefited from these loans, we  conducted a review of SBA’s Disaster Loan Program. Specifically, we  addressed the following questions: (1) Are the disaster program policies  consistent with the law and the overall mission of SBA’s Disaster Loan  Program? (2) What were SBA’s underwriting policies and criteria for  September 11 Economic Injury Disaster Loans (EIDL) and how did they  compare with those applied by nonprofit lenders that were active in New  York City after September 11? (3) Did SBA correctly apply its policies and  procedures in its disposition of September 11 EIDLs?
To determine whether SBA’s program policies are consistent with the law  and overall mission of SBA’s Disaster Loan Program, we reviewed the law  related to the program as well as SBA’s regulations and operating  procedures. To determine SBA’s underwriting policies and criteria for  September 11 EIDLs, we analyzed SBA’s policies and procedures for  approving, declining, and withdrawing disaster loans, and changes in its  policies and the law made after September 11. We discussed the provisions  of the law and SBA’s policies and procedures with SBA officials. We also  analyzed the underwriting policies and procedures of three selected  nonprofit lenders that provided loans to small businesses in New York after  September 11 and discussed the lenders’ policies with officials of the  respective organizations. In addition, we compared SBA’s underwriting  requirements with best practices for managing credit risk during the loan- making process of industry and banking regulators. To determine whether  SBA correctly applied its policies in the disposition of September 11 EIDL  applications, we reviewed a representative random sample of declined and  withdrawn September 11 EIDL application files drawn from all disaster  area offices, and a small sample of application files for approved  September 11 loans. The representative sample of declined and withdrawn  files allowed us to project to the universe of about 12,000 declined and  withdrawn EIDLs, but the small sample of approved loans did not allow us  to project to the universe of all approved loans, and we discuss only the  disposition of the 27 approved loans we reviewed. Appendix I contains a  detailed description of our scope and methodology. We conducted our  work between May 2003 and June 2004 in Atlanta, GA; New York, NY; and  Washington, D.C. in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
paragraphs: When a disaster occurs, staff from SBA’s Disaster Loan Program, the  Federal Emergency Management Agency (FEMA), and other government  agencies work together to assess the damage to the affected area and aid  household and business disaster victims. Either the President or the SBA  Administrator may issue a disaster declaration. When the President issues  a disaster declaration, FEMA specifies the immediate disaster area and  SBA determines which contiguous counties are eligible for federal  assistance. When SBA issues a disaster declaration, it specifies the  immediate disaster area and any contiguous counties that are eligible for  assistance. Unlike FEMA, which can provide some grants to residents in  the area of a disaster, SBA provides loans to households and businesses  affected by disasters. Once a disaster is declared, officials from one of  SBA’s four Disaster Area Offices—located in California, Georgia, New York,  and Texas—arrive at the disaster site and begin assisting victims. These  officials provide information about the disaster loan process, distribute  loan applications, and assist victims, if requested, in completing  applications. In response to the September 11 terrorist attacks, SBA  disaster program officials from around the country provided assistance to  the New York Disaster Area Office, which was the office primarily  responsible for providing assistance.
Depending on the nature of the disaster, SBA can provide businesses hurt  by a disaster with fixed-rate, low-interest loans to address physical  property damage and economic injuries. These low-interest loans are  subsidized by taxpayers through federal appropriations, and if the loans are  not repaid, the subsidy cost for disaster loans increases. SBA provides  loans to cover physical damage to both small and large businesses,  enabling them to repair or replace damaged real property, machinery,  equipment, fixtures, and inventory to begin restoring the property to its  pre-disaster condition. SBA provides EIDLs only to eligible small  businesses, allowing them to meet necessary financial obligations that  could have been met if the disaster had not occurred and to maintain  necessary working capital during the period that business activities are  affected by the disaster. For most disasters, SBA has primarily assisted  businesses with physical disaster loans. However, given the nationwide  economic impact resulting from the terrorist attacks of September 11, 2001,  EIDLs became SBA’s primary form of assistance. Of the approximately  24,000 September 11 disaster loan applications, SBA approved about  11,000, totaling $1.1 billion. Over 10,000 of these loans, amounting to $1  billion, were for EIDLs.
Under its statutory authority to provide economic injury disaster loans to  small businesses, SBA has established policies and procedures for  determining whether an applicant qualifies for a loan and the likely viability  of the loan, using pre-disaster financial information from the applicant.  SBA loan officers determine whether applicants meet agency criteria. SBA  loan officers may determine that applicants do not meet these criteria for  one or more of the following reasons:   lack of repayment ability;  unsatisfactory history on an existing or previous SBA loan;  unsatisfactory history on a federal obligation, such as taxes;  unsatisfactory debt payment history;  economic injury not substantiated;  business activity not eligible;  not a small business;  credit available elsewhere (for instance, from a commercial financial   recovery available from other sources, such as an insurance settlement;   failure to maintain required flood insurance on an SBA loan;  not a qualified business;  refusal to pledge collateral;  no direct link established between the business downturn and the  disaster (for September 11 EIDLs only); and  outstanding judgment for a federal debt.
When SBA does not receive all the required information or documentation  from an applicant, it withdraws the loan application. SBA also withdraws  applications when the Internal Revenue Service (IRS) has no record that  the applicant has filed income tax returns for 1 or more years or because  of an unresolved character issue (for example, an applicant’s criminal  activity). Additionally, an applicant may request that SBA withdraw its  application. After SBA declines or withdraws an application, the applicant  has 6 months to request reconsideration. SBA explains its reason(s) for not  approving the loan and the process for reapplying in correspondence to the  applicants.
In addition to SBA, several nonprofit organizations (nonprofits) in New  York City offered economic relief to small businesses in the area affected  by the events of September 11. The nonprofits that we contacted to discuss  their September 11 programs typically provide economic and technical  support to small, entrepreneurial, and nontraditional businesses such as  street vendors and taxi drivers, in New York City and generally receive  funding from private and public sources. Funding for their September 11  programs came from these sources as well as from federal grants allocated  to support such programs. All three nonprofits received grants from the  September 11th Fund and raised additional capital with the help of private  banks and partner organizations. Two of the three nonprofits reported  that they provided both grants and loans to small businesses, but all  provided working capital loans to help businesses meet short-term  obligations such as rents, salaries, and accounts payable. These working  capital loans were expected to help businesses weather expected recovery  periods of between 3 and 6 months. One nonprofit offered only low-interest  working capital loans of up to $150,000, while another reported providing  $900,000 in grants and $3.1 million in low-interest loans. The third nonprofit  reported providing $7.1 million in grants and no-interest loans, $12.4  million in low-interest loans, and $4 million in wage subsidies.
Small businesses in New York were also assisted by $3.5 billion in  Community Development Block Grant funding appropriated by Congress.  Congress earmarked at least $500 million of this funding to compensate  small businesses, nonprofits, and individuals for their economic losses.  This assistance included grants to compensate small businesses for some  of their losses, as well as payments to attract and retain small businesses in  an effort to revitalize the affected areas.
section_title: The SBA Disaster Loan Program’s Policies and Procedures Are Consistent with the Law and the Program’s Overall Mission
paragraphs: SBA’s policies and procedures for providing EIDLs are consistent with the  Small Business Act. The agency’s policies and procedures are consistent  with the two requirements specific to EIDLs. These requirements are that  applicants must have suffered a substantial economic injury as a result of a  covered disaster and that SBA must find that the applicant is not able to  obtain credit elsewhere. The act addresses some loan terms, such as length  of maturity, but it does not specify underwriting criteria for SBA to follow.  However, SBA’s regulations do contain underwriting requirements such as  assessing an applicant’s ability to repay the loan, credit history, and the  availability of collateral, as well as other requirements.
subsections: section_title: The Small Business Act Provides Little Specific Guidance on How SBA Should Manage Its Disaster Loan Program, Particularly in Providing EIDLs
paragraphs: The law provides for SBA to make loans to small business concerns that  have suffered a substantial economic injury as a result of a covered  disaster, provided that SBA finds that an applicant is not able to obtain  credit elsewhere. Although the law does not define substantial economic  injury for EIDLs, SBA’s regulations define it as economic harm to a  business concern that results in its inability to meet its obligations as they  mature or to pay its ordinary and necessary operating expenses. SBA may  provide an EIDL if it determines that an applicant has suffered a substantial  economic injury resulting from a disaster described in the act. For EIDLs,  the act describes four disaster scenarios: (i) a major disaster, declared by  the President of the United States; (ii) a natural disaster, as determined by  the Secretary of Agriculture; (iii) a disaster declared by SBA; and (iv) if no  disaster was declared under scenarios (i) through (iii), certification to SBA  by the Governor of a State that eligible concerns have suffered economic  injury as a result of a disaster and are in need of financial assistance which  is not available on reasonable terms in the stricken area.
Although the act specifies some terms for EIDLs, it does not specify  underwriting requirements. For example, the law states that the loans  should not exceed $1,500,000, unless the applicant is a major source of  employment in the impacted area or have more than a 30-year maturity  period. It also provides some specific interest rate requirements, based on  the year of the disaster. However, it does not specify underwriting criteria  for EIDLs. The act does not specify that EIDLs should be of sound value or  secured to provide reasonable assurance of repayment, as it does for SBA’s  general business loans. Additionally, the act does not specifically address  the issue of collateral for EIDLs, whereas it specifies that SBA not require  collateral for physical disaster business loans in the amount of $10,000 or  less.
section_title: SBA’s Regulations Specify Underwriting Criteria and Other Requirements for Disaster Loan Applicants
paragraphs: SBA’s regulations for EIDLs contain underwriting criteria that require,  among other things, a reasonable assurance of repayment, satisfactory  credit and character, and generally, collateral. The regulations state that  SBA must have reasonable assurance that all disaster loan applicants can  repay their loans from their personal or business cash flow. The regulations  also state that SBA is prohibited from lending to businesses with an  associate who is incarcerated, on probation, on parole, or who has been  indicted for a felony or a crime of moral turpitude. The regulations do not  elaborate on satisfactory credit, however, as discussed later, SBA’s policies  and procedures address these issues. For EIDLs greater than $5,000, SBA  regulations require that applicants provide collateral, although SBA will not  decline a loan if the applicant lacks a particular amount of collateral, as  long as it has reasonable assurance that the applicant can repay the loan.  However, SBA may decline or cancel a loan where the applicant refuses to  pledge available collateral when requested by SBA. SBA regulations also  specify eligibility requirements for the types of businesses that may obtain  an EIDL. The regulations exclude the following types of small businesses:  businesses engaged in lending, speculation, or investment;  consumer or marketing cooperatives;  businesses deriving more than one-third of gross annual revenue from   loan packagers that earn more than one-third of gross annual revenue  from packaging SBA loans;  businesses principally engaged in teaching, counseling or indoctrinating  religion or religious beliefs; and  businesses primarily engaged in political or lobbying activities.
SBA amended its regulations in October 2001, expanding eligibility to small  businesses outside the declared disaster area, applicable only to September  11 EIDLs. SBA made this change in recognition that the September 11  disaster had a widespread economic impact, beyond the boundaries of the  declared disaster areas in New York and Virginia. Under the new section of  the regulations, SBA agreed to provide EIDLs to businesses outside of the  declared disaster area if they could show that they suffered a substantial  economic injury as a direct result of the destruction at the World Trade  Center or the damage to the Pentagon, or any related federal actions (such  as the suspension of air travel) taken between September 11, 2001, and  October 22, 2001. The regulations specify that loss of anticipated profits  or a drop in sales is not considered substantial economic injury for  purposes of an EIDL under these provisions. Other than this change to  expand EIDL eligibility nationwide, SBA’s general regulatory requirements  for disaster loans, which we discuss more fully later in this report, applied  to September 11 EIDLs.
section_title: SBA’s Underwriting Criteria Followed Program Guidelines and Best Practices and Were Similar to Those of Nonprofits Offering Disaster Loans
paragraphs: SBA’s underwriting policies and criteria for September 11 EIDLs generally  followed established guidelines, even with the exceptions that were made  for this disaster, and were similar to those of selected nonprofits in New  York City. Small businesses that were eligible to apply for SBA loans were  expected to meet standard requirements for documentation,  creditworthiness, repayment ability, collateral, and appropriate character,  as determined by SBA. We found that SBA’s lending activities followed  best practices for private lending, as set out by industry experts. As we  reported previously, modifications to SBA’s Disaster Loan Program were  made to address the unusual circumstances surrounding the September 11  disaster and to respond to the concerns of affected small businesses.  However, the changes that were made were to eligibility and terms, not to  loan underwriting criteria. Finally, the three nonprofits that we reviewed  had requirements that were similar to SBA’s for documentation,  creditworthiness, and repayment ability, but their requirements differed for  collateral and appropriate character.
subsections: section_title: SBA EIDL Requirements for September 11 Generally Followed Program Guidelines
paragraphs: SBA used the same requirements for September 11 EIDLs as it would for  any other disaster. In accordance with the guidelines of the Disaster Loan  Program, SBA required small business applicants to provide the following:  personal financial statements for all principals with at least 20 percent  interest in the business and each general partner;  business tax records for the 3 most recent tax years and 1 year of   balance sheets and operating statements dated within 90 days of   monthly sales figures beginning 3 years before the disaster and  continuing through the most current month available.
Applicants were also required to undergo the standard credit analysis  required for the EIDL program. Since EIDLs are available only to small  businesses unable to obtain credit elsewhere, SBA administers its own test  to determine whether applicants are able to qualify for private funds under  reasonable terms and conditions, or if the applicant has the financial  capacity to recover without federal assistance. September 11 loan  applications were processed using SBA’s “credit elsewhere” test, a  combination of two formulas that looks at cash flow for debt servicing and  available net worth. Loan officers then used information provided in the  credit reports, balance sheets, and tax records to determine repayment  ability, based primarily on pre-disaster financial performance. SBA required  that EIDLs of more than $5,000 be secured by personal guaranties from all  business principals and by the “best available collateral.” SBA officials  stated that the best available collateral typically would be business or  personal real estate, since real estate is the only asset that will likely  maintain its value over the life of a 30-year SBA loan. In some cases, SBA  accepted other business property as collateral for smaller September 11  EIDLs, if it was the best available, according to SBA officials.
Finally, Disaster Loan Program guidelines require that SBA make a  character determination on all loan applicants in order to determine  eligibility for federal loans. By statute, SBA is required to deny loans to  persons convicted during the past year of a felony committed during a riot  or civil disorder and in connection with another declared disaster. SBA  uses specific program guidelines to make a character determination on  each loan applicant who has a prior arrest, indictment, or conviction or is  on parole or probation. Applicants are required to provide information on  any previous arrests or convictions.
section_title: SBA’s Program Policies Were Generally Consistent with Good Lending Practices
paragraphs: SBA’s guidelines for its Disaster Loan Program generally coincide with best  practices published by lending industry experts and guidance issued by  federal regulators. As stated previously, modifications that were made  specifically for the September 11 disaster did not affect the administration  of the program or underwriting criteria for EIDLs made to small businesses  nationwide. Disaster Loan Program requirements include specific and  clearly stated criteria and processes for analyzing credit and determining  repayment ability. Operating procedures for the program also detail  internal control and supervisory review directives.
According to experts, “a cornerstone of safe and sound banking is the  design and implementation of written policies and procedures related to  identifying, measuring, monitoring, and controlling credit risk. Such  policies should be clearly defined, consistent with prudent banking  practices and relevant regulatory requirements, and adequate for the  nature and complexity of the bank’s activities.” Further, in order to be  effective, credit policies must be communicated throughout the  organization, implemented through appropriate procedures, and monitored  and periodically revised to take into account changing internal and external  circumstances. We compared SBA’s policies and procedures with industry  best practices and regulatory guidance for extending credit. SBA’s policies  and procedures for its Disaster Loan Program in general and EIDLs in  particular are presented in SBA’s standard operating procedures and  related program memoranda. Underwriting criteria are clearly defined,  with specific formulas for SBA’s loan officers to use in evaluating credit risk  for each loan applicant. Industry standards also specify the importance of a  comprehensive analysis of a borrower’ s ability to repay the loan and  requiring a borrower to pledge collateral. SBA’s requirements for loan  guaranties and collateral and its analysis of applicants’ cash flow to  determine repayment ability are in line with industry guidance on  mitigating lender risk in individual credit transactions.   Modifications that  were made to eligibility and terms for September 11 EIDLs were  communicated throughout the agency in program memoranda. SBA  provided applications for the expanded program nationwide through its  resource partners. Our review of September 11 loan files also indicated  that SBA complied with its procedures for supervisory review of all loan  decisions.
section_title: Congress and SBA Approved Modifications in Key Areas of the Disaster Program
paragraphs: With the Defense Appropriations Act of 2002, Congress approved notable  modifications for this disaster that changed the terms for September 11  EIDLs for small businesses. These included increasing the maximum loan  limit from $1.5 million to $10 million and raising the maximum repayment  deferral period. SBA’s policy of a 4-month deferral period was increased  to 2 years, by legislation, for businesses in the immediate areas of the  disaster. EIDLs granted in the immediate areas of the disaster also did not  accrue interest during the 2-year deferral period.
By regulation, borrowers in the immediate disaster areas receiving  economic injury loans also had 2 years from the date of approval to apply  for additional funds or a modified loan, and borrowers in the expanded  area had 1 year. Borrowers would thus have sufficient time to assess  additional disaster-related damage that had not been detected or reported  at the time of the initial application.
Under its regulatory authority, SBA expanded eligibility for the September  11 disaster to businesses nationwide that were directly affected by the  terrorist attacks and subsequent federal actions such as airport closures  that resulted in business disruptions across the country. The expanded  program also addressed the needs of small businesses that depended on  other businesses and industries whose operations were suspended or  disrupted because of the disaster. Businesses in the expanded areas were  required to provide an economic injury statement. Applicants needed to  make a direct link between the economic downturn affecting their business  and the events of the disaster in order to qualify for loans under the  expanded program.
SBA made other accommodations for September 11 applicants, including  increasing the size limits for eligible businesses, expediting loan  processing, and providing translators to help non-English speaking  applicants. As we noted in a previous report, small business owners had  complained to Congress about some facets of the Disaster Loan Program.  These complaints prompted SBA and the Congress to modify the program.  First, because of the immediate and devastating effect on the travel  industry nationwide, SBA increased the business size standards for travel  agencies and certain other travel-related businesses. Applications that  were pending or had been previously declined or withdrawn solely on the  basis of the size of the business were automatically reconsidered, and SBA  adjusted the size determination date to the application acceptance date  instead of the date of the disaster. For travel agencies and other travel  businesses, the size standard was increased from $1 million to $3 million in  annual receipts, allowing larger businesses to qualify. Second, in an effort  to improve efficiency in processing the large number of EIDL requests for  September 11, particularly under the expanded program, SBA developed an  expedited process for reviewing loan applications. Under the expedited  process, applicants that did not qualify based on eligibility criteria or pre- disaster credit and repayment issues were declined early in the review  process. Loan officers were required to inform these applicants about the  abbreviated process, and applicants could ask to be reconsidered and  could submit additional documentation to justify their request. According  to SBA officials, expedited processing also allowed it to provide quick loan  approval to businesses within the declared disaster area in operation at the  time of application up to a maximum amount of $200,000 and those that  were not in operation because of the events of September 11, up to  $350,000. Expedited processing allowed businesses outside of the declared  disaster area meeting certain basic requirements to receive quick approval  for loan amounts up to $50,000. Third, in direct response to complaints  from small business owners in New York City with limited proficiency in  English, SBA made efforts to provide loan application documents in  languages other than English, including Spanish and Asian languages, and  to provide multilingual personnel at New York City application centers.  One SBA small business development center representative told us that  although this initiative was positive, interpreters who were not familiar  with business and financial jargon still faced limitations in communicating  adequately with some small business owners.
section_title: Nonprofit Lenders in New York City Had Similar Requirements for Disaster Loans
paragraphs: Three nonprofits in New York City that made September 11 disaster loans  had requirements similar to SBA’s, but the programs had some additional  flexibility to address the needs of their small business constituents (fig. 1).  One of the nonprofits reported ineligibility for SBA loans or not meeting  SBA’s requirements as one of its own criteria for application acceptance.  Another reported that its program was geared, in particular, toward small  businesses that had not qualified for significant loans from SBA or other  recovery loan programs. The existence of these nonprofit lenders provided  alternative economic injury assistance to small businesses in New York  City.
Like SBA, the nonprofits we spoke with had requirements for  documentation, creditworthiness, and repayment ability. All three  nonprofits required that applicants provide business financial statements,  business and personal tax records, credit reports, and a number of other  documents. One nonprofit requested, among other documents, corporate  bank statements, a business plan, insurance statements, and receipts and  invoices for expenses related to September 11. The same nonprofit  required that applicants commit to remaining in New York City and asked  for a current executed commercial lease. Another nonprofit said that  commitment to rebuilding in the area was a factor in the decisionmaking  process but did not include this factor in its eligibility requirements. Like  SBA, the nonprofits used credit reports and business financial statements  to determine an applicant’s level of past debt, management of past credit,  and likelihood of repaying the disaster loan. All of the nonprofits reported  that credit and repayment histories played an important role in the  decisionmaking process, but two of the nonprofits emphasized that  applicants were not declined solely on the basis of the information  provided in credit reports. One nonprofit considered the direct impact of  the disaster on a business’s ability to manage its recent credit, and another  reported that it made allowances for special circumstances such as illness  and divorce if applicants provided documentation and could show a  pattern of good faith efforts to address delinquencies.
Unlike SBA, all of the nonprofits had limited requirements for collateral  and reported that collateral was only requested on a case-by-case basis.  One nonprofit reported that collateral was not required, but was accepted  in lieu of a guaranty or cosigner for applicants who had been approved with  less than satisfactory pre-disaster credit. In such cases, collateral would be  accepted, even if it was not enough to secure the entire loan and would be  considered “psychological collateral.” Another nonprofit reported that  collateral was typically required when a business had a limited operating  history or highly unpredictable and inconsistent cash flow, and offered  unsecured loans up to $250,000. The third nonprofit reported that business  collateral was required on a case-by-case basis but provided no further  details. Two of the nonprofits indicated that they required personal  guaranties, with one specifying that owners with 20 percent or more  interest in the business would need to provide some guarantee. The third  nonprofit indicated that it also determined whether to ask for personal  guaranties on a case-by-case basis.
None of the nonprofits had a requirement similar to SBA’s for appropriate  character for their September 11 programs. One of the nonprofits indicated  that an applicant’s character was called into question if a written or verbal  account was inconsistent with the documentation provided.
section_title: SBA Followed Its Own Policies and Procedures in Making Determinations on September 11 Economic Injury Disaster Loans
paragraphs: In our review of SBA’s September 11 EIDL application files, we found that  SBA followed its own policies and procedures in determining whether to  provide loans to prospective borrowers. Our review of a representative  random sample of applications SBA declined or withdrew showed that all  of the 99 files contained the documentation and analysis needed to support  the determination. We also found that SBA followed its procedures for  processing loan applications, such as conducting supervisory reviews of  loan decisions, and made its determinations and notified applicants in a  timely manner. Our review of a small random sample of approved loans  also indicated that SBA followed its policies and procedures in granting  loans.
subsections: section_title: SBA Followed Its Policies and Procedures in Declining and Withdrawing Its September 11 Economic Injury Disaster Loan Applications
paragraphs: In all of the 99 loan files we reviewed in our representative random sample,  SBA correctly declined 70 and withdrew 29 of the applications. Overall,  SBA declined September 11 loan applications primarily because it  determined that the applicants were unlikely to be able to repay the loan.  While SBA can cite several reasons for declining a loan, it gave lack of  ability to repay as at least one of the reasons for declining 38 of the 70  declined loan applications that we reviewed. In these cases, SBA concluded  that the applicants’ income was insufficient to repay a disaster loan, given  existing debts and expenses, based on the analysis that loan officers  conducted using financial information provided by the applicant. Our  analysis of the universe of September 11 EIDLs revealed that SBA declined  4,513 applications, or more than half of all declined applications for lack of  repayment ability. For the 34 declined Expanded EIDL applications in our  sample, SBA declined 18 applications, or about half, because the applicants  failed to establish a direct link between their business downturn and the  events of September 11 or related federal actions, as SBA required of  applicants outside of the declared disaster areas. In the universe of  Expanded EIDLs, SBA declined 4,186 applications and 1,975 were declined  for this reason. For example, a small business in an airport that lost  revenue during the period in which air travel was suspended would have  been eligible for an SBA September 11 Expanded EIDL. However, a  business that simply showed losses after September 11 would not be  eligible for a loan.
SBA withdrew loan files primarily because the applicants had not filed  federal income tax returns. Of the 29 withdrawn loan applications in our  sample, SBA withdrew 16 for this reason. Following its usual procedures,  SBA requested the most recent 3 years of business tax records and 1 year of  personal tax records directly from IRS. According to a senior SBA official,  SBA has a special arrangement with IRS for obtaining federal tax  documentation for disaster loan applicants. IRS dedicates staff to  processing these requests, and the IRS staff work the same hours as the  SBA loan officers in order to provide the needed information as the loans  are processed. IRS provides SBA with transcripts of available returns or a  notification that no records could be found. SBA withdraws an application  if IRS has no record of the applicant’s tax return for at least a year and will  also generally withdraw an application when missing or incomplete  information prevents the loan officer from making a determination. Figure  2 provides additional information on the reasons SBA declined and  withdrew loan applications in our sample. Our analysis of the universe of  September 11 EIDLs revealed that SBA withdrew 1,294 applications, or  about 38 percent of all withdrawn applications, because IRS had no record  of tax returns for the applicants for 1 or more years.
We found technical errors in 2 of the 99 files we reviewed, although the  facts presented in the application files showed that SBA would not have  granted the loan, even if the errors had not been made. SBA declined one  application because the applicant owed federal income taxes and lacked  repayment ability, even though the applicant was a nonprofit and therefore  ineligible for an EIDL. SBA notified another applicant that it was declining  the application for policy reasons because the applicant was a subsidiary of  a foreign company and had no revenues in the United States. According to  an SBA official, SBA’s policies and procedures suggest that the application  could have also been declined for lack of repayment ability.
section_title: SBA Followed Its Procedures for Processing Declined and Withdrawn Loan Applications
paragraphs: In our review of declined and withdrawn loan files, we found that SBA  followed its policies and procedures for conducting supervisory reviews of  loan decisions and notifying applicants of the decisions and that the agency  generally processed applications in a timely manner. In all of the 99  declined and withdrawn files that we reviewed, an SBA supervisory loan  officer signed the loan officer’s report, which documents how the loan  officers came to the decision on the application. On many of the loan  officer’s reports, the supervisory loan officer made some notations  assessing the loan officer’s analysis of the application. Additionally, all of  the files contained correspondence to the applicant documenting SBA’s  decision that clearly described SBA’s reasons for declining or withdrawing  the application, the deficiencies in the application and additional  documentation required (if applicable), and the applicant’s right to have the  application reconsidered. We also found that SBA generally processed the  loan applications in a timely manner, as defined in SBA procedures. At the  time SBA processed the September 11 loans, its benchmark was to process  loan applications within 21 days. For most of the files that we reviewed,  SBA made a decision within 14 days of the application date (fig. 3). Our  analysis of the universe of all September 11 EIDLs found that SBA  processed declined files in an average of 11 days and withdrew files in an  average of 13 days.
section_title: SBA Also Followed Its Own Procedures for Approving September 11 Loans
paragraphs: Based on our review of a small sample of loan files, SBA also followed its  own policies and procedures in approving September 11 disaster loans.  However, this sample was not representative and cannot be projected to  the universe of September 11 EIDLs. In our review of 27 approved loan  files, we found that they contained all of the financial documentation and  underwriting analysis required to approve the loans, according to SBA’s  policies and procedures. However, we did find an error in one of the  approved loan files. In this case, an applicant had stated on his application  that he was the sole proprietor of his business and not a U. S. citizen. Under  these circumstances, SBA was supposed to request that the applicant  provide proof that he was a non-citizen national or qualified alien. Based  on evidence in the file, the applicant had not provided proof of his alien  status. As with our review of the declined and withdrawn files, the  approved loans all showed evidence of supervisory review.
Of the 27 approved loan files we reviewed, SBA had initially declined or  withdrawn eight. In these eight files, applicants had deficiencies similar to  those of the declined or withdrawn loan files we reviewed but were able to  address the deficiencies and reapply. For example, the applicants whose  files had been withdrawn because of income tax issues reapplied after  filing and paying federal income taxes, allowing SBA to approve the loans.  In one of the approved loan files we reviewed, SBA withdrew the  application for failure to file for federal income taxes. After the applicant  filed federal tax returns, SBA then declined the application for lack of  repayment ability and unsatisfactory history on a federal obligation, or  failure to pay federal income taxes. After setting up a payment plan with  the IRS and reducing expenses, the applicant reapplied and SBA approved  the loan. In another approved loan file, SBA initially declined the  application because the applicant had not substantiated the economic  injury. Based on SBA’s analysis of the applicant’s documentation, the  business would be able to meet its financial obligations without a loan.  However, the applicant provided further documentation to show that it had  lost contracts because of the September 11 disaster and that the loss of  business would have a negative effect on the firm over time. The additional  documentation allowed SBA to approve the loan.
section_title: Observations
paragraphs: Although SBA is not required to maintain specific underwriting criteria for  its Disaster Loan Program under the provisions of the Small Business Act,  we think that SBA’s policies are generally consistent with good lending  policies as reflected in industry best practices and regulatory guidance,  and, when properly applied, should help maintain the integrity of the  program. SBA’s underwriting procedures evaluate applicants’ credit risk  and analyze their ability to repay the loan. These procedures, along with  requiring collateral to secure the loans, help ensure that SBA fulfills its  mission in providing loans that will assist small businesses in recovering  from disasters. By assessing repayment ability, SBA can more effectively  use its resources to assist small businesses that are more likely to be able  to repay the loan, thus limiting the loan program’s cost to the government,  and therefore the taxpayer.
section_title: Agency Comments
paragraphs: We provided a draft of this report to SBA and received written comments  from the Associate Administrator For Disaster Assistance. SBA’s letter is  reprinted in appendix II. SBA agreed with the findings presented in this  report. In addition, SBA provided technical comments, which we  incorporated into this report as appropriate.
We will provide this report to appropriate congressional committees. In  addition, this report will be available at no charge on our web site at  http://www.gao.gov.
Please contact me at (202) 512-8678 or dagostinod@gao.gov or Katie Harris,  Assistant Director at (202) 512-8415 or harrism@gao.gov if you or your staff  have any questions about this report. Key contributors to this report were  Bernice Benta, Gwenetta Blackwell-Greer, Diane Brooks, Jackie Garza,  Fred Jimenez, and Carl Ramirez.
section_title: Scope and Methodology
paragraphs: To determine whether Economic Injury Disaster Loan (EIDL) program  policies are consistent with the law and overall mission of SBA’s Disaster  Loan Program, we reviewed the Small Business Act and SBA’s related  regulations. We determined what the provisions of the law require of SBA  in its operation of the program as well as SBA’s regulations and operating  procedures. We discussed our views on the laws, regulations, and operating  procedures with appropriate SBA officials.
To compare SBA’s underwriting policies and criteria for September 11  EIDLs with nonprofit lenders active in New York City after the disaster, we  reviewed SBA’s policies and criteria for approving, declining, and  withdrawing disaster loans, and amendments made after September 11. We  also compared SBA’s underwriting requirements with industry best  practices and banking regulators’ guidance for managing credit risk during  the lending process. We spoke with officials of nonprofit organizations  (nonprofits) that provided loans to small businesses in New York City after  September 11, and reviewed their underwriting policies and criteria. We  requested specific information on their loan programs to answer questions  regarding (1) eligibility requirements for each nonprofits’ program, (2) type  of documentation that was required to accompany a loan application, (3)  actual limits and terms associated with available loans, and (4) factors that  each nonprofit considered in making the decision to approve or decline an  application. We reviewed this information within each of the four  categories and compared it with SBA’s EIDL policies and criteria applicable  to post-September 11 lending.
To determine whether SBA correctly applied its policies in the disposition  of September 11 EIDL applications, we reviewed a representative random  sample of declined and withdrawn September 11 EIDL application files  across all disaster area offices, and a small sample of loan application files  for approved September 11 EIDLs. We developed a data collection  instrument containing key factors we identified in SBA’s standard operating  procedures and reviewed each loan application file to determine whether  there was evidence that the appropriate policies and criteria had been  applied in determining the disposition of each application. The  representative sample of declined and withdrawn files allowed us to  project to the universe of about 12,000 declined and withdrawn EIDLs. The  small sample of approved loans did not allow us to project to the universe  of all approved loans, and we discuss the disposition only of the files that  we reviewed.
We sampled from the original population of all 24,041 September 11  disaster loan applications. We selected a probability sample using a design  that was stratified by SBA’s four disaster area offices and whether or not  the loan application was declined or withdrawn. We also selected a smaller  simple random sample from among all of the accepted loan applications, as  a check to see how the loan files differed from those withdrawn or  declined. We assessed the reliability of SBA’s database, the Automated Loan  Control System, and found it acceptable for our purposes. Additional  details about our sampling methodology follow.
The sampling unit was the paper copy of a loan application file. The sample  sizes were estimated at the 95 percent level of confidence for a desired  precision of 6 percent. The sample size was estimated using a formula  appropriate for estimating an attribute in a stratified design. Within the  universe, some older application files had already been shredded. Under  SBA’s procedures, declined and withdrawn files that have been inactive for  2 years may be shredded. To account for this, the sample size was  increased slightly within each of the eight strata, in case one of these files  appeared in the random sample. However, none of the files in our sample  had been shredded—SBA was able to provide us with all of the files we  requested. Between the eight strata, a sample size of 103 was  proportionally allocated and then selected. The strata allocation and final  disposition of the sample are shown in Table 1.
In our loan application file reviews, we found that 4 of the 103 loan  application files sampled were physical injury disaster loans files, not EIDL  applications, and we excluded them as out of our study’s scope. In the  entire original population of 13,171 declined or withdrawn applications, we  found 808 corresponding out of scope records. In addition, there were 223  files that SBA indicated had been shredded. Therefore, the final study  population that we analyzed and to which our data collection instrument  sample is projected is 12,140.
Our confidence in the precision of the results from this sample is expressed  in 95-percent confidence intervals. The 95-percent confidence intervals are  expected to include the actual results for 95 percent of the samples of this  type. We calculated confidence intervals for our study results using  methods that are appropriate for probability samples of this type. For all of  the percentages presented in this report, we are 95-percent confident that  the results would have obtained, had we studied the entire population, are  within plus or minus 6 or fewer percentage points of our results, unless  otherwise noted.
We located and reviewed all 99 declined or withdrawn sampled files. We  also reviewed 27 of the 30 approved loans in our nonprobability sample.  SBA reported that three of the files in our sample were not readily available  because the loans had been paid in full by the borrower, and the loan files  had been placed in storage. To ensure accuracy of our file reviews, two  GAO analysts reviewed each of the loan files. Based on the reviews of  documentation in the files, we entered information into an automated data  collection instrument. We also conducted basic checks on the  programming and analysis of the file review data.
We conducted our work in Atlanta, GA; New York, NY; and Washington,  D.C., between May 2003 and June 2004 in accordance with generally  accepted government auditing standards.
section_title: Comments From Small Business Administration
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