The 7(a) loan program, which is authorized by Section 7(a) of the Small Business Act, is SBA’s largest business loan program. It is intended to serve small business borrowers who otherwise cannot obtain financing under reasonable terms and conditions from the private sector. In administering the 7(a) program, SBA has evolved from making guaranteed loans directly to depending on lending partners, primarily banks. Under 7(a), SBA provides guarantees of up to 85 percent on loans made by participating lenders. Within 7(a), there are three classifications of lenders—regular, certified, and preferred. SBA evaluates and grants preferred lender status to 7(a) lenders after receiving nominations and reviews from its 70 district offices and a regional processing center. Of the three categories, preferred lenders have the most autonomy in that they can make loans without prior SBA review or approval. Most preferred lenders are banks that have their own safety and soundness regulators, such as the Office of the Comptroller of the Currency. Those regulators, however, may not focus on the 7(a) loans that SBA guarantees when they examine the bank. The other preferred lenders, which are SBLCs, have no regulator other than SBA—making SBA oversight more critical. As of August 2002, SBA had over 400 preferred lenders. To give you an idea of this program’s scope, in fiscal year 2002, 7(a) loan approvals totaled approximately $12.2 billion, of which preferred lenders approved $6.7 billion. However, preferred lending activity is concentrated in a few larger institutions. Less than 1 percent of 7(a) lenders account for more than 50 percent of 7(a) dollar volume outstanding. According to SBA, most of these lenders are preferred lenders. Two offices within SBA have primary responsibility for 7(a) lender oversight—the Office of Lender Oversight (OLO) and the Office of Financial Assistance (OFA). OLO is responsible for many oversight functions, such as managing all headquarters and field office activities regarding lender reviews. However, OFA has retained some oversight responsibilities. OFA’s current role in lender oversight is to provide final approval of lenders’ PLP status. Lenders are granted PLP status in specific SBA districts for a period of 2 years or less. OFA collects information about the lender prepared by the Sacramento Processing Center, with input from one or more of SBA’s 70 district offices, and decides whether to renew a lender’s PLP status or to grant status in an additional district. OFA may also discontinue a lender’s PLP status. Other lenders participating in the 7(a) program are subject to a different oversight regime. Specifically, SBA divides SBLC program functions between OLO and OFA. OLO is responsible for SBLC on-site examination, and OFA handles day-to-day program management and policymaking. Ultimate responsibility for enforcement of corrective actions rests with OCA. As participants in the 7(a) program, SBLCs are subject to the same review requirements as other 7(a) lenders, and they are also subject to safety and soundness oversight by SBA. SBA has identified goals for its lender oversight program that are consistent with appropriate standards for an oversight program; however, SBA had not yet established a program that is likely to achieve them. Since our last review, SBA had made progress in developing its lender oversight program, but there are still areas in need of improvement if SBA is to develop a successful program. SBA has highlighted risk management in its strategy to modernize the agency; however, PLP reviews are not designed to evaluate financial risk, and the agency has been slow to respond to recommendations made for improving its monitoring and management of financial risk—posing a potential risk to SBA’s portfolio. PLP reviews are designed to determine lender compliance with SBA regulations and guidelines, but they do not provide adequate assurance that lenders are sufficiently assessing eligibility and creditworthiness of borrowers. Although SBA has identified problems with preferred lender and SBLC lending practices, it has not developed clear policies that would describe enforcement responses to specific conditions. Thus, it is not clear what actions SBA would take to ensure that preferred lenders or SBLCs address lending program weaknesses. Although the process for certifying lenders for PLP status—another means by which SBA oversees lenders—has become better defined and more objective, some lenders told us they continue to experience confusing and inconsistent procedures during this process due to varying recommendations from field offices. Since our June 1998 report, SBA has responded to a number of recommendations for improving lender oversight by developing guidance, establishing OLO, and doing more reviews. SBA developed “Standard Operating Procedures” (SOP) for oversight of SBA’s lending partners and the “Loan Policy and Program Oversight Guide for Lender Reviews” in October 1999. SBA established OLO in fiscal year 1999 to coordinate and centralize lender review processes for PLP and SBLC oversight. OLO created a “Reviewer Guide” for personnel engaged in PLP reviews and does training for all SBA staff involved in conducting preferred lender reviews. OLO officials said that to effectively oversee and monitor SBA lenders, they also evaluate lender-generated risk to the SBA portfolio, work with SBA program offices to manage PLP oversight operations, and plan to conduct regular and systematic portfolio analysis using a new loan monitoring system. Additionally, to minimize the number of visits SBLCs receive during a year, OLO combined PLP reviews with SBLC examinations performed by FCA. In another effort to improve the lender review process, SBA developed an automated, 105-item checklist that is designed to make its analysis more objective. The questionnaire addresses lender organizational structure, policies, and controls, but the answers are provided in a “yes-no” format and generally refer to the presence or absence of specific documents. SBA noted that the format makes assessments of lenders more consistent and objective. However, we note that without a more substantive method of evaluating lender performance, this approach does not provide a meaningful assessment. SBA also has increased the number of PLP reviews performed. In June 1998, we reported that SBA had not reviewed 96 percent of 7(a) lenders, including preferred lenders, in the districts we visited. SBA reviewed 385 reviews of 449 preferred lenders in its 2001-- 2002 review year. While elements of SBA’s oversight program touch on the financial risk posed by preferred lenders, including SBLCs, weaknesses in the program limit SBA’s ability to focus on, and respond to, current and future financial risk to their portfolio. Neither the PLP review process nor SBA’s off-site monitoring efforts adequately focus on the financial risk posed by preferred and other lenders to SBA. SBA oversight of SBLCs is charged with monitoring how SBLCs administer their credit programs, identifying potential problems, and keeping SBA losses to an acceptable level. However, SBA’s progress in reporting examination results in a timely manner and implementing other program improvements limits the effectiveness of SBA’s SBLC oversight. SBA officials stated that PLP reviews are strict compliance reviews that are not designed to measure the lenders’ financial risk. Our review and that of SBA’s Inspector General (IG) confirmed this. The PLP review serves as SBA’s primary internal control mechanism to determine whether preferred lenders are processing, servicing, and liquidating loans according to SBA standards and whether such lenders should participate in the programs. While the review has questions that touch on the financial risk of a given loan, review staff are not required to answer them; and SBA guidance explicitly states that the answers to the questions are for research purposes only and are not to be considered in making any determinations about the lender. By not including an assessment of the financial risk posed by individual lenders during PLP reviews, SBA is missing an opportunity to gather information that could help predict PLP lenders’ future performance, thereby better preparing SBA to manage the risk to its portfolio. The SBA IG also suggested that financial risk and lender-based risk should be considered as part of a comprehensive oversight program. SBA’s off-site monitoring efforts do not adequately assess the financial risk posed by PLP and other lenders. SBA currently uses loan performance benchmarking and portfolio analysis to serve as its primary tools for off- site monitoring. While SBA officials stated that loan performance benchmarks are based on financial risk and serve as a measure to address a lender’s potential risk to the SBA portfolio, we found that the benchmarks were not consistently used for this purpose. In addition, we found that OLO does not perform routine analysis of SBA’s portfolio to assess financial risk. At the time of our review, staff produced ad-hoc reports to analyze aggregate lending data to look for trends and to try to anticipate risk. Currently, FCA staff responsible for SBLC safety and soundness examinations also perform PLP reviews at SBLCs—these reviews are the same ones that SBA contractors perform at preferred lenders and employ the same review checklist. Upon the completion of its examinations, FCA provides a draft report to SBA for comment, incorporates any changes, and then provides a final report to SBA, which, in turn, issues a final report to the SBLC. SBA has not eliminated weaknesses in SBLC oversight, which were cited by us and the SBA IG. We, and the SBA IG, found that final SBLC examination reports were not issued in a timely manner. SBA’s IG reported that final reports for fiscal year 2001 SBLC examinations were not issued until February 2002, 10 months after OLO received the first draft report from FCA. Our work confirmed these findings.