[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]



 
                        SUBCOMMITTEE HEARING ON
                       IMPROVING THE SBA'S ACCESS
                      TO CAPITAL PROGRAMS FOR OUR
                       NATION'S SMALL BUSINESSES

=======================================================================

                    SUBCOMMITTEE ON FINANCE AND TAX
                      COMMITTEE ON SMALL BUSINESS
                 UNITED STATES HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                             MARCH 5, 2008

                               __________

                          Serial Number 110-76

                               __________

         Printed for the use of the Committee on Small Business


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


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                   HOUSE COMMITTEE ON SMALL BUSINESS

                NYDIA M. VELAZQUEZ, New York, Chairwoman


HEATH SHULER, North Carolina         STEVE CHABOT, Ohio, Ranking Member
CHARLIE GONZALEZ, Texas              ROSCOE BARTLETT, Maryland
RICK LARSEN, Washington              SAM GRAVES, Missouri
RAUL GRIJALVA, Arizona               TODD AKIN, Missouri
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
MELISSA BEAN, Illinois               MARILYN MUSGRAVE, Colorado
HENRY CUELLAR, Texas                 STEVE KING, Iowa
DAN LIPINSKI, Illinois               JEFF FORTENBERRY, Nebraska
GWEN MOORE, Wisconsin                LYNN WESTMORELAND, Georgia
JASON ALTMIRE, Pennsylvania          LOUIE GOHMERT, Texas
BRUCE BRALEY, Iowa                   DAVID DAVIS, Tennessee
YVETTE CLARKE, New York              MARY FALLIN, Oklahoma
BRAD ELLSWORTH, Indiana              VERN BUCHANAN, Florida
HANK JOHNSON, Georgia
JOE SESTAK, Pennsylvania
BRIAN HIGGINS, New York
MAZIE HIRONO, Hawaii

                  Michael Day, Majority Staff Director

                 Adam Minehardt, Deputy Staff Director

                      Tim Slattery, Chief Counsel

               Kevin Fitzpatrick, Minority Staff Director

                                 ______

                    Subcommittee on Finance and Tax

                   MELISSA BEAN, Illinois, Chairwoman


RAUL GRIJALVA, Arizona               VERN BUCHANAN, Florida, Ranking
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
BRAD ELLSWORTH, Indiana              STEVE KING, Iowa
HANK JOHNSON, Georgia
JOE SESTAK, Pennsylvania

        .........................................................

                                  (ii)

  
?

                            C O N T E N T S

                              ----------                              

                           OPENING STATEMENTS

                                                                   Page

Bean, Hon. Melissa...............................................     1
Buchanan, Hon. Vern..............................................     2

                               WITNESSES


PANEL I:
Zarnikow, Honorable Eric, Associate Administrator for Capital 
  Access, U.S. Small Business Administration.....................     4
Crawford, Mr. Christopher, President and Chief Executive Officer, 
  National Association of Development Companies..................     6
Mercer, Mr. Lee, President, National Association of Small 
  Business Investment Companies..................................     8
Betancourt, Mr. Daniel, President and Chief Executive Officer, 
  Community First Fund, on behalf of the Association for 
  Enterprise Opportunity.........................................    10
Wilkinson, Mr. Anthony, President and Chief Executive Officer, 
  National Association of Government Guaranteed Lenders..........    12

                                APPENDIX


Prepared Statements:
Bean, Hon. Melissa...............................................    27
Buchanan, Hon Vern...............................................    29
Zarnikow, Honorable Eric, Associate Administrator for Capital 
  Access, U.S. Small Business Administration.....................    30
Crawford, Mr. Christopher, President and Chief Executive Officer, 
  National Association of Development Companies..................    34
Mercer, Mr. Lee, President, National Association of Small 
  Business Investment Companies..................................    39
Betancourt, Mr. Daniel, President and Chief Executive Officer, 
  Community First Fund, on behalf of the Association for 
  Enterprise Opportunity.........................................    45
Wilkinson, Mr. Anthony, President and Chief Executive Officer, 
  National Association of Government Guaranteed Lenders..........    48

                                 (iii)

  


                   SUBCOMMITTEE HEARING ON IMPROVING
                      THE SBA'S ACCESS TO CAPITAL
                    PROGRAMS FOR OUR NATION'S SMALL
                               BUSINESSES

                              ----------                              


                        Wednesday, March 5, 2008

                     U.S. House of Representatives,
                               Committee on Small Business,
                                                    Washington, DC.
    The Subcommittee met, pursuant to call, at 2:00 p.m., in 
Room 2360 Rayburn House Office Building, Hon. Melissa Bean 
[chairwoman of the Subcommittee] presiding.
    Present: Representatives Bean and Buchanan.
    Also Present: Representative Velazquez.

              OPENING STATEMENT OF CHAIRWOMAN BEAN

    Chairwoman  Bean. Calling this hearing to order. Today the 
Committee will examine the SBA's lending and investment 
programs and what steps the agency is taking to strengthen 
these initiatives.
    This hearing is timely given concerns about the economy, 
particularly the tightening of credit availability following 
the subprime mortgage fallout. The access to capital is 
critical to small business, investment, growth, and 
competitiveness.
    The current down turn, rising loan foreclosures, and a 
falling housing market have caused financial institutions to 
tighten their credit standards. As a recent Federal Reserve 
survey confirms, more than 30 percent of lenders are raising 
their lending criteria for small firms.
    For entrepreneurs, the rising cost of capital can cause 
many to forego important purchases or expansion. This dampening 
effect has the potential to reduce entrepreneurial activity in 
the short term and further hinder economic growth over the long 
term.
    In this environment, the SBA's lending and investment 
programs played their most vital role as there was an 
opportunity to provide capital to businesses who can no longer 
access affordable private alternatives.
    Small businesses are the nation's largest employer and 
create roughly 80 percent of domestic job growth. Today's 
hearing seeks to determine what steps the SBA is taking to meet 
the needs of our nation's small businesses, making access to 
their loan programs easier.
    Recently, instead of providing crucial financing for small 
businesses, challenges facing the agency have resulted in 
reduced lender participation, lower loan volume to small 
businesses, and rising costs.
    As we will hear today, many of these developments are in 
the agency's flagship 7(a) loan program, the dollar amount of 
7(a) loans are decreasing, and the number of financial 
institutions participating in the program have been declining. 
A new 7(a) oversight fee has been added. And even more fees are 
proposed for next year. These new costs come at a time when 
small businesses can least afford them.
    Last year the House took action to address these concerns 
by passing H.R. 1332, a bill that I sponsor. At the same time, 
the agency's seed capital initiative, the SBIC's, participating 
securities program remains closed with little help of seeing 
new life. This program is critical to small business growth as 
sources of equity investment dry up quickly in economic down 
turns.
    Small high-growth entrepreneurs are left with fewer options 
for financing. Again, there are solutions on the table, 
including H.R. 3567, which creates a new start-up financing 
program that passed the House by a strong bipartisan vote.
    Further restricting access to capital, the administration 
proposed this year to increase the interest rates borrowers pay 
for microloans. This will have the effect of raising the cost 
of loans for low-income borrowers at a time when other options 
are not available.
    H.R. 3020, which was sponsored by Ranking Member Chabot, 
takes steps to modernize the program without raising the costs 
for low-income borrowers. This bill has also passed the House 
this session.
    While the Committee is working to advance these proposals 
in the Senate, several new laws have recently been enacted to 
provide low-cost small business loans for veterans and energy-
efficient technologies. These types of initiatives show great 
promise to get capital in the hands of entrepreneurs. And we 
look forward to the SBA's near-term implementation of them 
both.
    It is clear that SBA's lending and investment programs are 
an important tool for small businesses, particularly in a 
faltering economy. As businesses face challenges securing 
affordable financing, the commitment to modernize and 
strengthen these initiatives will provide necessary 
alternatives. Our hearing will call attention to the challenges 
facing these programs so that Congress can act quickly to 
provide the resources and reforms needed for the growth and 
expansion of our community businesses.
    I want to thank all of our witnesses who are here today in 
advance for your testimony and subject matter expertise and now 
recognize our ranking member for his opening statement.

               OPENING STATEMENT OF MR. BUCHANAN

    Mr.  Buchanan. I want to thank the Chair for yielding and 
for calling this hearing today on a matter important to 
millions of Americans. I would like to also extend my thanks to 
our witnesses, who have taken time out of their busy schedules 
to provide this Subcommittee with testimony today.
    Today too many small business entrepreneurs find themselves 
struggling in this volatile economy. They're entangled in 
government red tape, victimized by excessive frivolous 
litigation, or burdened by high cost of health care. But all of 
this is made worse when small businesses cannot access the 
capital it needs to start or expand an enterprise.
    The SBA 7(a) and the 504 lending programs are vital for the 
success of our nation's small businesses. It is evident that 
the number of lenders on the SBA financing program has 
decreased. And, of course, some of that decrease is 
attributable to the continuing consolidation of the banking 
industry.
    While the SBA is trying to increase participation in this 
program, it also has taken steps that make it tough by raising 
fees to lenders. This is one of the areas that I hope we can 
discuss a little bit more today.
    The good news is we have made important strides in this 
Committee over the past year. Chairwoman Bean sponsored and I 
support bipartisan legislation aimed at reducing lending fees 
and increasing small business access to capital.
    H.R. 1332 improves and strengthens the SBA program, 
successful program 7(a) and the CDC loan programs. This pivotal 
legislation enables the SBA financing programs to operate 
without subsidy. And that is important. Should tax dollars be 
appropriated, the bill would require these additional funds to 
be used to reduce borrowing fees.
    And, finally, regarding the SBA investment program, 
obviously a small business in short supply of needed capital is 
faced with the choice of either accumulating more debt in forms 
of loan or reducing its control of the company by selling stock 
to investors, but the SBA program in attracting investment are 
tough cases that are unclear and helpful. The business owners 
can be hit with enormous tax penalties if it sells its equity 
where small business investment can itself tax the public 
treasury if unforeseen loopholes are allowed to escape 
scrutiny.
    The SBA was created to help small business compete in good 
times and survive in tough times. The essential purpose of 
these hearings is to determine whether existing programs are as 
constituted fair to both the borrower and the lender and 
determine whether the cost of possible reforms do not unduly 
penalize the American taxpayer.
    I look forward to working with Chairwoman Bean to ensure 
that the SBA financing program operates as efficiently and as 
effectively as possible. Thank you, and I yield back.
    Chairwoman  Bean. Thank you.
    We will now move to testimony from our witnesses. Witnesses 
will have five minutes to deliver their prepared statements. 
The timer begins when the green light is illuminated. When one 
minute of time remains, the light will turn yellow. The red 
light will come on when time is up.
    Our first witness is the honorable Eric Zarnikow. In 
November of last year, Mr. Zarnikow was appointed as the 
Associate Administrator for SBA's Office of Capital Access. 
Prior to his appointment, he worked for Service Master back in 
Illinois, where we are both from, as the Senior Vice President, 
Chief Risk Officer, and Treasurer.
    Thank you. And you may now proceed.

      STATEMENT OF THE HONORABLE ERIC ZARNIKOW, ASSOCIATE 
  ADMINISTRATOR FOR CAPITAL ACCESS, ADMINISTRATOR, U.S. SMALL 
                    BUSINESS ADMINISTRATION

    Mr.  Zarnikow. Chairwoman Bean, Ranking Member Buchanan, 
thank you for inviting me here today to testify about the U.S. 
Small Business Administration's fiscal year 2009 budget for 
capital access programs. As you know, I am the Associate 
Administrator for Capital Access.
    The budget request for 2009 reflects the President's 
commitment to America's small businesses and supports 
Administrator Preston's reform agenda. Since 2001, the SBA 
programs have continued to grow while we have worked to 
streamline processes, make technological improvements, and 
develop tools that increase our effectiveness.
    The SBA continues to reach more small businesses through 
our loan programs and doing so at no subsidy cost to the 
taxpayer. In fiscal year 2007, the SBA provided funding to 
89,400 small businesses in the 7(a) and 504 loan programs.
    We look forward to continuing to work with the Committee to 
continue to improve access to SBA's services by the small 
business community. Our goal is to implement improvements that 
are employee-enabled, efficient, transparent, and effective.
    We are also focused on lender outreach and retention. We 
will continue to ensure capital access products and services 
are accessible to entrepreneurs in the nation's most under-
served markets: those with higher rates of unemployment and 
poverty and lower rates of economIC progress.
    The President's fiscal year 2009 proposal will support a 
total of $28 billion in lending authority for small business 
financing. The proposal requests authorizations of 17 and a 
half billion for the 7(a) program, 7 and a half billion for the 
504 program, 3 billion for the SBIC debenture program, and 25 
million for the microloan program.
    In 2007, we served more small businesses than ever before. 
In our two major loan programs, the numbers of gross approvals 
increased by 123 percent from fiscal year 2001 to over 110,000 
loans in fiscal year 2007.
    A recent Urban Institute study found that loans under the 
7(a) and 504 programs were more likely to go to minority-owned, 
women-owned, and start-up businesses, as compared to 
conventional small business loans.
    Zero subsidy policy in the 7(a), 504, and SBIC programs has 
allowed the agency to provide record levels of lending without 
the need for taxpayer-provided credit subsidy appropriations 
while maintaining fee rates consistent with historical levels. 
This policy has provided certainty and stability for the 7(a) 
loan program, which both borrowers and lenders agree is 
critical for this widely-used program while also reducing 
taxpayers' costs.
    In fiscal year 2007, more than 2,000 small businesses 
benefited from over 700 million in SBIC investments. The SBA is 
working to increase our outreach efforts by participating in a 
number of forums to heighten the visibility of SBIC programs 
within all market segments.
     Effectively managing agency resources devoted to SBA 
lending activity is another key priority, centralized 7(a) loan 
guaranty purchase and liquidation functions as well as 504 loan 
processing. Centralization allows for more consistent 
application of SBA's processes and procedures.
    Despite record growth in 2007, there is a decline in SBA 
lending year-to-date approvals for fiscal year 2008, constantly 
monitoring loan levels and working with lenders and small 
businesses to ensure that we continue to meet the needs of the 
small business community.
    And we are conducting a number of lender outreach and 
retention efforts. In fact, this morning we had an outreach 
event at the White House with lenders and senior administration 
officials. And we appreciate your agreeing to change or 
changing the time of this hearing.
    Additionally, we have provided lenders with new loan 
products to help them reach specific sectors of the small 
business community and will continue to work with lenders to 
find better ways to serve small businesses.
    We want to continue to strengthen and support lender 
oversight and risk management functions of the agency. The SBA 
has increased its on-site review of lenders from 55 in 2006 to 
80 in 2007. And we currently plan to do over 200 on-site 
reviews in 2008. We have also made improvements to our lender 
portal that is a key oversight tool used to monitor the lender 
portal or portfolio.
    Earlier this year we launched the pilot of the rural lender 
advantage initiative as a way to work with community lenders 
that are key to providing lending to economically distressed 
rural areas. This initiative simplifies application procedures 
and expands assistance to banks that do not regularly work with 
the SBA.
    Another product that we are very proud of is the Patriot 
Express loan initiative. This product of our 7(a) program 
provides capital to veterans, members of the National Guard and 
Reserve and their spouses. This was launched in June of last 
year. We have seen over $100 million of loans provided to 
veterans for this program.
    To expand capital to certain sectors of our economy in 
under-served communities, the agency has also proposed a change 
to zero subsidy for the microloan program. By changing the rate 
at which intermediaries borrow from the SBA from about 3.8 
percent to about 5.92 percent, intermediaries will continue to 
receive better-than-market rates of interest, and the SBA will 
be able to offer more loans to eligible intermediaries.
    The SBA also proposes shifting microloan technical 
assistance to our extensive network of existing resource 
partners. That has the potential of tripling the number of 
outlets available for micro enterprise lenders. In addition, we 
are in the process of rolling out online technical assistance 
for availability.
    Over 300 million of U.S. exports, about 30 percent of U.S. 
exports, are originated by small businesses, generating 
thousands of jobs and billions of dollars of income.
    International trade exposes American small businesses to 
new ways of doing business and from a technology and a 
management perspective making them more competitive. We have 
widened our staff with the Commerce Department to provide 
services to small businesses seeking exports.
    Chairwoman  Bean. If you could wrap up--
    Mr.  Zarnikow. Sure.
    Chairwoman  Bean. --because you are a little over time and 
votes have been called?
    Mr.  Zarnikow. In conclusion, 2007 was a year of 
significant accomplishments for the capital access programs. 
And with this budget request, we look forward to continuing to 
build on those successes. We would be glad to answer any 
questions that you have today.
    [The prepared statement of Mr. Zarnikow may be found in the 
Appendix on page 30.]

    Chairwoman  Bean. Thank you for your testimony.
    We are being called for a vote. So the Committee stands at 
recess subject to the call of the Chair. And then we will 
resume. Thank you.
    [Brief recess.]
    Chairwoman  Bean. We will call this hearing back to order 
and move to testimony from our next witness, which is Mr. 
Christopher Crawford, who is President and CEO of the National 
Association of Development Companies. NADCO was formed in 1981 
and provides legislative and regulatory support for the SBA's 
504 program on behalf of member-certified development 
companies, or CDCs.
    Thank you for being here.

  STATEMENT OF MR. CHRISTOPHER CRAWFORD, PRESIDENT AND CHIEF 
    EXECUTIVE OFFICER, NATIONAL ASSOCIATION OF DEVELOPMENT 
                           COMPANIES

    Mr.  Crawford. Thank you, Madam Chair.
    As you indicated, my name is Chris Crawford. I am the 
President of the National Association of Development Companies. 
NADCO represents some 260 certified development companies and 
another 200 affiliates. Together they provide more than 98 
percent of all 504 lending.
    I want to thank the Subcommittee for inviting me to comment 
on access to capital for small businesses. Given the credit 
crisis our country is now engulfed in, I can think of no better 
time than now to consider what our industry feels we need to, 
number one, get small businesses growing jobs again; and, 
number two, get SBA on the right track to help, rather than 
hinder, lenders.
    First I want to thank the Committee for its support for the 
last 20 years. With your help, we have been able to grow the 
program from under $200 million per year in 504 loans to this 
year something probably north of $6.5 billion with another $8 
billion in generally bank-originated first mortgages to go in 
our projects.
    First I would like to talk about the authorization level. 
504, as you know, is flat year to date, which, given the slide 
in loan demand for this country, is really pretty good. I 
expect loan volume to be a bit under 7 billion by the end of 
this fiscal year.
    SBA has asked for 7.5 billion for fiscal year 2009, which 
leaves 504 with too little expansion room if borrowers begin to 
utilize 504 more due to the existing and the continuing credit 
crunch. I ask this Committee to provide an authorization level 
of at least 8.5 billion for fiscal year 2009 or I believe we 
risk running out of money during that year.
    Five-o-four is a zero subsidy program. So there is 
absolutely no cost for adding loan authority to the President's 
budget. And I urge you to do so in fiscal year 2009.
    I would like to talk about fees. SBA decreased the annual 
borrower fee to zero for fiscal year 2009 but still placed 504 
in what is called a negative subsidy situation. That is, the 
program's other fees will be putting more money into the U.S. 
Treasury than 504 is actually projected to cost during '09. 
Even though it is only a small amount according to SBA, it is 
about $1.4 billion that small businesses could use to add jobs 
or buy equipment.
    Frankly, NADCO is appalled that SBA would needlessly take 
fees from small businesses during a recession. And we ask 
Congress to pass legislation to adjust our fees to exactly zero 
subsidy, not a negative subsidy.
    I would like to address CDC lender oversight. SBA issued a 
proposed regulation on lender oversight. And NADCO was one of 
many organizations to express concerns over this proposal. No 
one wants accurate, consistent oversight of 504 more than the 
CDC industry.
    We believe that to maintain low fees, SBA must ensure that 
CDCs meet the lending, servicing, and liquidation standards 
required of a zero subsidy program. However, this oversight 
process has one potentially fatal flaw: its reliance on an 
unproven database that attempts to identify potential 
defaulting borrowers years before they might possibly default. 
That is kind of like predicting the weather in Washington.
    SBA is currently seeking to renew this contract for this 
database. We urge this Congress to step in and demand an 
unbiased outside verification of this forecasting system by 
firms with both credit underwriting and financial modeling 
expertise. Two lending industries should not be held hostage 
and regulated through such an unproven process.
    I would like to touch on liquidation. Our default rate 
right now is about four percent, and our loss rate is barely 
two percent. However, as in previous recessions, defaults 
appear to be rising a bit. We obviously want to avoid what you 
might call a subprime scenario for 504. And that means there 
must be skilled personnel involved in liquidations and 
workouts.
    Unfortunately, SBA has, I believe, not hired a sufficient 
number of staff to work liquidations internally after having 
laid off virtually all of their liquidation staff approximately 
four years ago.
    Today SBA is not complying with the intent of the 106th 
Congress or even its own regulations by handling liquidations 
and reimbursing CDCs for their liquidation efforts. It appears 
that SBA has not budgeted for these funds for either this year 
or next year to reimburse CDCs for this cost. The result is 
going to be there are going to be very few people, industry 
people or SBA people, to perform liquidations on defaulted 
504s. I ask the Congress to pass legislation to require the SBA 
to allocate funds from increased recoveries to enable CDCs to 
handle liquidations.
    A recent study by the California State University has 
concluded that 504 returns $94 for every $1 of SBA 
administrative costs for 504. This is an incredible benefit 
ratio, but it works only if the program has accurate and 
consistent oversight and can recover its loan defaults that 
occur in the portfolio.
    NADCO asks the Committee to support these program needs and 
to quickly pass legislation to keep 504 on the right track. 
Thank you very much.
    [The prepared statement of Mr. Crawford may be found in the 
Appendix on page 34.]

    Chairwoman  Bean. Thank you for your testimony.
    Our next witness is Mr. Lee Mercer, who is President of the 
National Association of Small Business Investment companies. 
NASBIC has represented the SBIC industry since Congress 
established the program in 1958.

STATEMENT OF MR. LEE MERCER, PRESIDENT, NATIONAL ASSOCIATION OF 
              SMALL BUSINESS INVESTMENT COMPANIES

    Mr.  Mercer. Thank you, Madam Chair, Mr. Buchanan. Thank 
you for the opportunity to appear today to give NASBIC's 
recommendations for improving the SBA's access to capital 
programs. I have provided some background on the SBIC program 
in my written testimony but will jump immediately to our 
recommendations.
    First, improve the debenture SBIC program as it runs at a 
zero subsidy rate. The House Small Business Committee, the full 
Committee, has lead the way by securing passage by the full 
House of H.R. 3567, the Small Business Investment Expansion Act 
of 2007.
    The bill contains two provisions, sections 101 and 105, 
that are very important to both greater growth in the program 
and greater potential for each individual SBIC to help every 
small business in which it invests. Both provisions would make 
the program more attractive to private investors and to private 
management teams, thus leading to greater growth in the 
program. Neither provision has been opposed by the 
administration.
    Unfortunately, the counterpart Senate bill, S. 1662, is 
bogged down because of a hold place on the bill by a single 
Senator opposed to the SBIC program as a whole. We hope this 
can be remedied prior to the adjournment of this Congress.
    Second recommendation, revive the participating security 
program. Warren Buffett said this week, ``By any common sense 
definition, we are in a recession.'' That fact will make the 
availability of equity capital even more important to America's 
small businesses. Equity capital is the foundation upon which 
every company is built.
    As outlined in my testimony, the participating security 
program has been a great success in providing that equity 
capital, having provided 14 billion in equity investments since 
1994.
    Yes, the government will lose money on the program, a 
result of losses from the 2000 recession, when all investors 
lost money and SBICs no more than most. But the losses will be 
substantially less than projected by OMB.
    OMB says that the recoveries from participating security 
SBICs in liquidation will only be 35 percent. In fact, 
recoveries for fiscal year 2006 and fiscal year 2007 ran at 64 
percent, 83 percent more than forecast by OMB. Over $600 
million was recovered in just 2 years.
    What is debt? The Credit Reform Act of 1990 does not define 
the word ``debt.'' Absent a definition within the statute, 
words are subject to the Supreme Court-promulgated plain 
meaning rule of statutory construction. Words must be given 
their ordinary meaning.
    The word ``debt'' is defined in many ordinary contexts: a 
duty or obligation to pay money, a note or bond which 
represents an amount owed, a liability on a claim. Based on 
these definitions, both Generally Accepted Accounting 
Principles, GAAP, and SBA's own SBIC regulations require that 
participating securities be listed as debts on the financial 
statements of all participating security SBICs. How can the 
government have it both ways?
    Section 303 of the Small Business Investment Act makes it 
clear that a participating security is a debt for subsidy 
scoring. Section 303(g)(1) states, ``Participating securities 
shall be repaid not later than 15 years after their date of 
issuance.'' The section creates an unambiguous obligation to 
pay money on the claim created by the security.
    Section 303(g)(5) states, ``The only debt other than 
leverage a company issuing participating securities may have 
outstanding shall be temporary debt.'' The phrase ``only debt 
other than leverage'' is unambiguous. Congress considered both 
participating securities and debentures to be debts.
    Finally, 303(j) states, ``All fees, interest, and profits 
received by the administration under this section shall be 
included in the calculations made by the director of OMB to 
offset the cost as defined by the Federal Credit Reform Act of 
1990 to the administration of purchasing and guaranteeing 
debentures and participating securities.''
    Section 303(j) makes crystal clear the congressional intent 
that the securities issued under the program qualify for 
subsidy scoring. Only if qualified could receipts be used to 
offset costs. Since the Federal Credit Reform Act was passed 
eight years prior to the legislation creating the participating 
security program, it must be assumed, it has to be assumed, 
that Congress knew the law. If it did not intend participating 
securities to be debts for the purposes of the Federal Credit 
Reform Act, it would not have made the receipts deductible from 
costs in under 303(j).
    With OMB so wrong and so intransigent, a simple legislative 
change would revive the participating securities program. I 
have provided the language for that change in my testimony. It 
is very simple. It just says in the enabling act, 
``Participating securities guaranteed under this subsection 
shall be considered debt securities for all purposes related to 
the Federal Credit Reform Act.''
    Amending the Small Business Investment Act as suggested 
would correct the erroneous unjustifiable holding by OMB and 
CBO and again make the participating security program a very 
effective partner in providing scarce equity capital to 
America's small businesses.
    Thank you for your consideration.
    [The prepared statement of Mr. Mercer may be found in the 
Appendix on page 39.]

    Chairwoman  Bean. Thank you for your testimony.
    Next is Mr. Daniel Betancourt from the Community First 
Fund, established in 1992. It is a nonprofit community 
development financial institution serving a 13-county region in 
central Pennsylvania. Mr. Betancourt is also testifying today 
on behalf of the Association for Enterprise Opportunity. AEO's 
nearly 500 members are serving the needs of micro 
entrepreneurs.
    Thank you for being here.

    STATEMENT OF MR. DANIEL BETANCOURT, PRESIDENT AND CHIEF 
   EXECUTIVE OFFICER, COMMUNITY FIRST FUND, ON BEHALF OF THE 
             ASSOCIATION FOR ENTERPRISE OPPORTUNITY

    Mr.  Betancourt. Thank you, Chairwoman. Thank you, Ranking 
Member Buchanan.
    As you said, I chair the Association for Enterprise 
Opportunity. We have over 600 members. We are a leadership 
organization for micro enterprise. And many of our members have 
the SBA microloan program.
    I am also a practitioner. Our organization is a micro 
lending program in Pennsylvania.
    Thank you for the opportunity. I wanted to talk about the 
differences between the microloan program and the 7(a) and 
other SBA programs. Clearly the private sector, the banking is 
not serving the entrepreneurs as it relates to lending. The SBA 
microloan program is a very unique program. The 7(a) program, 
as I said, and the CommunityExpress do not serve this group.
    The unique thing about the program, as you know, it 
combines the business accounts and the technical assistance 
along with the lending. The thing that is interesting about 
this program is that the way that it works with organizations 
like ours, it provides our time to work with the entrepreneur 
to help them borrow the money from our organization, 
organizations like ours, as well as provide training at a low-
cost capital. In other words, the money that we borrow and the 
money that is granted to us allows us to do both of those 
things, training and to lend and re-lend.
    What we find is when banks try to lend to entrepreneurs 
that we lend to they get into trouble pretty quickly because 
you don't spend the amount of time or banks don't spend the 
time with these entrepreneurs. So it's critical to provide that 
time to them.
    Many of these businesses would not even be able to get 
financing. They wouldn't be able to get off the ground. The 
interesting thing is that the demographics of these 
entrepreneurs, 90 percent of our borrowers are low-to-moderate-
income borrowers.
    We are probably very unique, Community First Fund, in that 
we also have the 7(a) program, probably one of the few 
organizations in the country that offers the SBA microloan as 
well as a 7(a). And what we find is that our 7(a) borrowers are 
not low-to-moderate-income individuals. They're higher-wealth 
individuals, many of which have high credit scores, they have 
collateral, and they really don't need that type of program.
    As I said, this program, the SBA microloan, does provide 
that low capital to us. We are able to also--as you know, the 
requirement of the programs that we have to provide, a 15 
percent match, for loan loss reserves, I think and we think, 
the AEO thinks it is a good use of federal dollars. It has the 
lowest default rate of any SBA program, one percent default 
rate. Our organizations when we borrow, we pay back, even if 
our borrowers don't pay us because of that reserve fund that we 
have.
    The entrepreneurs are well-prepared to borrow from us. We 
spend that time with them with the technical assistance. And I 
think that is one of the key strengths of this program.
    And I really want to talk to you about the President's 
proposal here. He is recommending through the budget to 
eliminate the technical assistance portion as well as raising 
the rates the second year in a row. We think that this is 
unworkable.
    Organizations like ours, some of our borrowings are two to 
four percent. And we have to add a loan loss reserve rate to 
that. It would be a pretty high rate. You would have to raise 
the cap rates for us to be able to lend at the same rates. So 
that is going to be a burden to an organization like ours. We 
think it is going to be a burden to entrepreneurs.
    I want to say this for the record. We would have to pass 
those costs along to the entrepreneurs. And we think that this 
is going to be a real hardship on the entrepreneurs. We think 
this increased capital is going to provide less jobs. less 
people will use the program.
    The President, as I said, is also recommending to eliminate 
the technical assistance. Quite frankly, we don't know how we 
can just lend to entrepreneurs without providing that type of 
assistance. We don't think that it would work.
    I think there is a myth out there that if you find another 
technical assistance provider to provide technical assistance 
to our clients, that it will get paid back.
    This is a very important point. We have had in our own 
community,--and I won't mention names--we have had other 
technical assistance providers try to get us paid back. It just 
doesn't work. They don't have an incentive to get us paid back. 
Our money is out in the street. We are putting the risks out 
there. So we are going to do everything we can to get our money 
back.
    So I think that is a real myth to think that another 
organization can try to get our money back. I don't think a 
bank would ever. Well, they can outsource things, but, quite 
frankly, their incentive is to get paid back.
    The 7(a) program I think is a very good program. As I said, 
we have that. It's a different demographic. The microloan 
program in our particular case serves--at least our borrowers 
are 50 percent rural, 50 percent urban. Half of our clients are 
folks of color. Half are women. It is a very unique program. It 
is serving the population that you intended when you passed 
this.
    So I just wanted to say that we appreciate your support in 
the past. We are looking forward to working with you in the 
future. And thank you for this opportunity to talk with you. 
Thank you.
    [The prepared statement of Mr. Betancourt may be found in 
the Appendix on page 45.]

    Chairwoman  Bean. Thank you for your testimony.
    Mr. Anthony Wilkinson provides our last testimony before we 
go to questions and answers. Mr. Wilkinson is the President and 
CEO of the National Association of Government Guaranteed 
Lenders. NAGGL advocates for the interest of the small business 
lending community that utilizes SBA and other government-
guaranteed loan programs.

    STATEMENT OF MR. ANTHONY WILKINSON, PRESIDENT AND CHIEF 
     EXECUTIVE OFFICER, NATIONAL ASSOCIATION OF GOVERNMENT 
                       GUARANTEED LENDERS

    Mr.  Wilkinson. Thank you, Chairwoman Bean, Ranking Member 
Buchanan. I appreciate the opportunity to testify today.
    NAGGL is a trade association. We represent approximately 
700 banks, credit unions, non-depository lenders and service 
providers who participate in SBA's loan programs.
    Our membership generates approximately 80 percent of all of 
the 7(a) loan volume annually and a majority of the 504 first 
mortgage loans. But these are difficult times for participants 
of SBA loan programs. Lenders and small business owners are 
facing uncertain economic conditions, decreasing profitability, 
and rising expenses. Small business owners need access to 
capital to succeed. And the SBA offers the primary vehicle for 
delivering that much needed long-term capital.
    However, SBA loan volume is declining. The pool of active, 
participating lenders is shrinking. And lender fees and costs 
continue to rise.
    Unfortunately, the budget cuts for the SBA over the last 
few years have resulted in a shifting of the delivery cost to 
the small business owners and SBA's lending partners. So, 
instead of promoting capital access, the SBA's recent actions 
are exacerbating the problems for many small businesses and 
lenders.
    It has long been known that SBA through its loan programs 
is the single largest provider of long-term loans for our 
nation's small businesses. Recent independent reports show that 
these loans are a vital economic development and financing 
tool.
    The GAO recently did a report at the request of Senator 
Coburn. And the report found that we lend to minorities at 
three times the rate of conventional lending. 7(a) loans were 
larger and for longer-terms than conventional loans. Half of 
our loans were in under-served markets. Twenty-five percent of 
our loans went to start up in the year that they looked at. 
Today those are up over one-third of our loans are now to 
start-ups. And they also found that SBA and the Office of 
Management and Budget have overestimated our program subsidy 
costs.
    Another report was from the Urban Institute. This one was 
commissioned by SBA. And they found that SBA programs are more 
effective than conventional loans in reaching minorities, 
women, and start-ups. SBA loans are a key financing tool to 
credit-worthy borrowers that, nevertheless, do not meet 
conventional underwriting standards. And SBA loans in under-
served areas represent more than 36 percent of total loan 
approvals during the period reviewed.
    Even though the GAO and the Urban Institute independently 
confirmed the importance and the benefits of the 7(a) program, 
loan volume is declining at an alarming rate.
    With each passing week of this fiscal year, the problem has 
been getting worse. And in my testimony, there is a chart that 
shows the decline and how the decline is accelerating since the 
start of the fiscal year. October the 1st through February the 
15th, we are down almost 15 percent in the number of loans and 
over 7 percent in the dollar of loans.
    NAGGL has been actively communicating our concerns to the 
SBA regarding the declining loan volume and decreasing lender 
participation. Attached to my testimony are three letters. The 
first is dated December 17th and addresses our concerns about 
the excessive costs and effectiveness of SBA's lender oversight 
system.
    And I would like to add that I need to correct that 
testimony. As of this morning, I was hand-delivered a response 
to that letter from the SBA. So my testimony recites that I 
have not received one, but as of this morning I have.
    Our second letter is dated February the 25th and summarizes 
a survey of the NAGGL membership. NAGGL members clearly stated 
that the decline in 7(a) loan volume and lender participation 
is a result of decreased profitability of SBA lending due to 
lender fees and costs. SBA continues to state that fees are not 
an issue, even though their highest-volume participants say 
that fees are the top problem. I have not gotten a response to 
that letter yet, but that letter is only a week or so old.
    Our third letter is dated February the 25th also and 
addresses our concerns relating to the proposed rule on lender 
oversight that was published in the Federal Register. We 
provided comments relating to the technical components of the 
proposed rule as well as overall concerns as to the 
effectiveness of the oversight program.
    We are strong supporters of a strong lender oversight 
program. It needs to be accurate, beneficial, and cost-
efficient for both SBA and its lending partners. And without 
mutual accountability and support, the mission of the SBA for 
America's small businesses cannot be provided through the 
lending community. And each of these three letters, again, is 
included in their entirety.
    There are many factors involved with the decreasing 
profitability of 7(a) lending, lifted many of those on-site 
fees, off-site fees, delays in processing, lender purchase 
requests, lenders now being required to liquidate before they 
can request a guarantee being purchased. And the list goes on.
    Without reasonable profits, lender participation in the 
program will decline, as is now happening. In addition, 
lenders' ability to reinvest in their outreach efforts to small 
business owners and expand their infrastructure to meet 
communities' capital needs is severely diminished.
    At the very time the Federal Reserve is attempting to 
forestall a recession by reducing interest rates and by 
injecting liquidity in the banking system in an effort to 
persuade lenders to make credit available, the SBA's small 
business lending policies are being counterproductive.
    My five minutes are up. I will save the rest for another 
time.
    Chairwoman  Bean. If you want to just do a concluding 
statement, that's fine.
    Mr.  Wilkinson. Well, we have some concerns about lender 
oversight. And we can get into those in more details. I would 
say that our portfolio, even given our concerns about the 
oversight function at SBA, our portfolio is performing quite 
well.
    The loss rate in the 7(a) portfolio is running at about a 
half percent per year. We can find from the FDIC in their 
quarterly banking profile reports that that is what commercial 
lending, commercial loan loss rates are running right now. So 
our loss rate is comparing favorably, but we would still like 
to see a more cost-effective, efficient, transparent lender 
oversight system at SBA.
    [The prepared statement of Mr. Wilkinson may be found in 
the Appendix on page 48.]

    Chairwoman  Bean. Thank you for your testimony.
    I would actually like to start with Mr. Crawford with the 
first question that I have. As you know, the SBA has contracted 
with Dun and Bradstreet and Fair Issacs to create a loan-
monitoring tool that forecasts the performance and/or risk of 
the portfolio. Can you tell us if this is how most financial 
institutions would monitor risk in their own portfolios?
    Mr.  Crawford. That question might also be addressed to my 
esteemed compatriot Mr. Wilkinson since he is a banker. I 
suspect that that is not the case having talked to a number of 
banks with my own banking background way in the past. We did 
not attempt to forecast defaults in that manner.
    Especially using a database like Dun and Bradstreet, my 
concerns about D&B are--and I have owned two small businesses, 
and I have had personal experience with reporting to D&B or not 
reporting to D&B, as may be the case.
    When I got the D&B letter once a year, I generally threw it 
in the trash. I wasn't about to report my own financials to Dun 
and Bradstreet. There was no incentive to do that.
    I know that D&B collects a lot of data on tax payments. I 
know they collect a lot of data on utility payments. I would 
not suggest that that database is on a par with just the 
financial data that my own certified development companies 
maintain on our borrowers where they are required, actually, 
through SBA regulation to get certified financials each and 
every year. That seems to be probably a better way to keep 
track of the likelihood of repayment of a debt through actual 
financials.
    Chairwoman  Bean. All right. Thank you. And I guess I will 
do a follow-up with Mr. Wilkinson to get your perspective and 
also ask what sort of limitations you think that kind of system 
would have, particularly for larger SBA loans.
    Mr.  Wilkinson. Well, one of the problems we have with the 
current system--and I don't mean to pick on D&B. It's whatever 
contractor would happen to be sitting there--is the information 
is not transparent.
    The SBA's lending partners were not included or asked input 
when the current system was established. And our big problem is 
we don't know what's in the model We don't know how the model 
was developed. We don't know what inputs are going into the 
model.
    We are hearing that a lot of FICO scores are used. And, for 
my membership, they tell me FICO scores are fairly reliable up 
to loan sizes of about 150,000. Well, there is a significant 
number of our loans that are over 150,000.
    And I believe Mr. Crawford's near entire portfolio would 
exceed that number, which leads you to a conclusion of, well, 
how reliable is this information. But without transparency, 
it's really hard to know.
    I would also add that it is a very expensive system. This 
is a system that commercial banks do this kind of stuff all the 
time at a much, much lower cost.
    Chairwoman  Bean. Thank you.
    If I can ask you one other question? You talked about the 
survey of your members. And 67 percent of respondents stated 
that their institutions have tightened credit underwriting 
standards and 61 percent said they are seeing a decline in 
borrower loan demand. Is that what you would have expected or 
would you have expected the programs to pick up when the 
conventional market dries up?
    Mr.  Wilkinson. Well, typically what happens, we are 
somewhat counter-cyclical. So as difficult economic times hit, 
conventional lenders, you know, rein in their credit box. They 
shrink it down. And so there are more borrowers who would then 
fit into the SBA program. So in the past, we typically have an 
increasing loan volume at this time.
    Chairwoman  Bean. I am going to ask one question of each of 
you, and then I am going to turn it over to my good friend from 
Florida. You have made a number of substantive recommendations 
to Mr. Zarnikow, who is endeavoring to make sure he can provide 
all the resources and tools for you.
    But if I could ask you to just as sort of the top take-
away, the number one thing you would most like to see him 
address, what would that be? We will come right on down. And 
then we can go to you and let you respond to that.
    Mr.  Wilkinson. Start down here?
    Chairwoman  Bean. Yes. We will start with you.
    Mr.  Wilkinson. Boy. There are a number of items that we 
have shared with Mr. Zarnikow and his staff. But having 
recently done the survey, I can fall back on the responses of 
my members. And their number one response is that all fees, not 
just borrower fees, not just lender guaranty fees, but all fees 
associated with the program are too high. And it's hindering 
their participation.
    Chairwoman  Bean. Okay. Thank you.
    Mr. Betancourt?
    Mr.  Betancourt. I would just say maybe an acknowledgement 
that the program is going well. And I think the six years in a 
row of trying to eliminate a program that is meeting the 
target, in fact, and trying to raise the rates when we know 
that is going to be passed along to the borrowers and, quite 
frankly, an acknowledgement that the technical systems portion 
is really the key to getting paid back so that we can 
ultimately pay back the SBA.
    Chairwoman  Bean. Thank you.
    Mr. Crawford?
    Mr.  Crawford. Interestingly, 504 doesn't have a rate issue 
with the SBA. That may be surprising, but I repeatedly argue 
with the CFO that our rates may, in fact, be a little too low. 
And I worry about that.
    But if I were to ask Mr. Zarnikow for a couple of things, 
one, in spite of the comments I made about lender oversight, I 
believe it is absolutely vital that we have a solid lender 
oversight unit for the 504 program.
    We have no FDIC. CDCs are regulated, are overseen by only 
the SBA because we are a creature of the SBA. So I say a strong 
lender oversight is a must. Our greatest crisis today because 
we are in a recession according to Mr. Buffett is probably the 
lack of resources committed to liquidations and recoveries.
    Our liquidations clearly are going up. Our delinquencies 
are going up. If we don't get it under control and keep it 
under control at zero subsidy, you are going to see our fees 
begin to skyrocket. And next year I will complain about fees.
    Chairwoman  Bean. Thank you.
    Mr. Mercer?
    Mr.  Mercer. Thank you.
    Well, Mr. Zarnikow represents the administration. The 
administration has refused to ask for authorization of the 
participating security program because OMB, the administration, 
has held that a participating security is not a debt for the 
purposes of the Federal Credit Reform Act; whereas, the 
administration, represented by Mr. Zarnikow, says it is a debt 
and requires participating securities to list it as a debt on 
their financial statements. How can they have it both ways?
    I would point out that in the last recession, all venture 
capital shrunk by about 80 percent during--we're talking about 
equity investments shrunk by about 80 percent, I think, if I 
remember from my testimony correctly, during the recession; 
whereas, the participating security investments shrunk by I 
think 35 percent. I mean, it was the most constant source of 
equity capital during a recession, which we are now going into 
according to Mr. Buffett.
    So I guess I would say, how can the administration do what 
it is doing with a straight face? It just is intellectually 
dishonest.
    Chairwoman  Bean. So you would like to see some 
reconciliation of that. Thank you.
    Hold on one second.
    [Pause.]
    Chairwoman  Bean. Okay. I think it is only fair to let Mr. 
Zarnikow respond. Most of this was obviously in the testimony 
that had been provided to you in advance, but I thought to 
maybe summarize a couple of things that you could respond to 
would be a good way to go.
    Mr.  Zarnikow. Sure. I mean, I think as we look at our 
priorities, there are probably three areas that I would look at 
and address. One is lender outreach, where we want to make sure 
that we are communicating with lenders, getting input from 
them. We have held a number of roundtables, go out and meet 
with lenders to try and encourage them to utilize our programs, 
and also to get input from them on how we can be better 
partners in utilizing our programs. We have held a number of 
roundtables, including the one this morning, and have six to 
eight planned across the country over the next 60 days or so.
    I would also say one of my highest priorities is lender 
oversight and making sure we do have proposed regulations that 
are out there. We have gotten input from our industry trade 
partners, our trade associations. We are going to be going 
through our process of evaluating that input.
    I would say on the lender oversight system, that there are 
definitely some misconceptions about that. That system was 
really designed as an oversight tool for the SBA, not for a 
tool for individual lenders to manage their portfolio.
    These are all lenders who have other loans. The SBA 
typically is a small portion of their portfolio. And they have 
other tools to actually monitor their overall portfolio.
    The lender oversight system is really designed to as we 
focus on our oversight efforts and provide that balance narrow 
the universe of the thousands of lenders we have to those where 
we see the highest risk in the program.
    So I think there are some misconceptions about the system, 
although we are in the process of reprocuring as well. Clearly 
our centers are very important to all of our operations, 
whether it's loan origination, servicing, or liquidation. We 
are working on strategic plans related to each of our centers.
    We are looking at each of the functions. What are the 
staffing requirements of those functions as we look at 
anticipated volume going out into the future?
    We are also working on how can we be more effective and 
efficient as an agency utilizing technology, looking at policy 
changes or process changes, to make sure that we are 
appropriately staffed in our centers.
    Chairwoman  Bean. I guess sort of following their summaries 
to you on the technical assistance, is that something that you 
will be addressing? And what about reconciling that definition 
of debt?
    Mr.  Zarnikow. On the microloan program, we are supporters 
of the microloan program. We do believe that it should be done 
on a zero subsidy basis. And that is what we are proposing in 
the 2009 budget.
    As we look at technical assistance, we believe that there 
is a lot of technical assistance through our resource partners. 
And they service more than a million entrepreneurs each year. 
When you look at the microloan program, there are about 2,500 
microloans that are made each year. So we believe that the 
resource partners that are out there provide appropriate ways 
to deliver technical assistance to the micro borrowers.
    The microloan program with the technical assistance is a 
very expensive program. It costs over 85 cents on the dollar 
for each dollar that's loaned. We believe that there is a more 
efficient way to deliver that but support the program.
    Chairwoman  Bean. You do think you can move back to a zero 
subsidy versus negative subsidy?
    Mr.  Zarnikow. Well, the microloan program actually we 
believe would be zero subsidy. The negative subsidy is on--
    Chairwoman  Bean. That was the 504. That's right.
    Mr.  Zarnikow. --the 504 program. And as we look out, it is 
a very minor negative subsidy, about seven basis points. And, 
to put that into perspective on the average 504 loan, which is 
about a half million dollars, that negative subsidy is about 
$21 a year.
    So we don't believe that that's a significant impact to the 
borrower. As was mentioned earlier, we are seeing increases in 
delinquency in that portfolio. And as we look out over time and 
to the 2010 budget, we would expect that that negative subsidy 
would go away. I believe it is important to have stability of 
that program.
    Chairwoman  Bean. Thank you. And on the reconciling the 
different definitions within the administration?
    Mr.  Zarnikow. My understanding of that is that CDO and OMB 
have both made that determination, that it requires a 100 
percent subsidy.
    I am not an expert on federal budget law. I will let others 
address that further. We would say, though, that the 
participating securities program as it was in the past we think 
had some fundamental flaws in the structure of that program.
    As was mentioned earlier, it did result in some pretty 
significant losses for the SBA. There were situations where 
investors made significant returns while at the same time the 
SBA lost money. So we think that the structure of that program 
was fundamentally flaws.
    Chairwoman  Bean. Thank you.
    Ranking Member Buchanan is now recognized for five minutes 
of questioning. No. You are up for as long as you want to 
question.
    Mr.  Buchanan. Thank you, Madam Chair.
    Mr. Wilkinson, tell me a little bit of the profile of your 
association, the size banks? A billion assets or what's the 
typical profile? Where is the concentration of banks in 
general?
    Mr.  Wilkinson. The best way to explain that would be the 
makeup of my board. Let's see if I can remember this off the 
top of my head. We are eight small banks, five large banks, two 
CDCs, two service providers. I think I covered them all, but it 
runs the gamut.
    We have the small community banks or small lower community 
banks that tend to be the largest concentration of members and 
then large institutions, the Wells Fargos, the JP Morgan 
Chases; and all of the small business lending companies that 
would participate in the program as well.
    Mr.  Buchanan. Do you have any community banks? Did you 
mention that? Do you have--
    Mr.  Wilkinson. Yes. That's the largest single membership 
category is community banks.
    Mr.  Buchanan. Okay. And you are mentioning today that just 
your volume is down. Decreased lender participation. What is 
driving that? I mean, I know one thing. Being in Florida, a lot 
of banks are also under a lot of pressure, their capital. And 
they are having to shrink a lot of things that they are doing. 
I'm just wondering how much of that is where they are looking 
at really their whole portfolio in general or asset portfolio. 
I am just wondering how much of that is--
    Mr.  Wilkinson. It would be a whole list of things.
    Mr.  Buchanan. Yes.
    Mr.  Wilkinson. You know, there are much more costs being 
passed on to lenders and borrowers today than in the past. It 
is a more difficult economic time. Lenders have pulled in their 
range and have a little tighter credit standards. And there 
have been issues in the marketplace, such as an inverted yield 
curve, that has made lending more difficult.
    And there is a whole host of things that seem to have 
converged at one point. But clearly the fees and the costs are 
a major contributing factor.
    Mr.  Buchanan. You were talking about their lending 
criteria, tighter lending criteria. How much of that? How much 
of a proponent is that in what you said, do you think?
    Mr.  Wilkinson. Well, it probably shows up in the 7(a) 
program most in the SBA Express program, which is primarily a 
credit-scored product. And lenders as times became tough 
immediately changed their minimum credit score requirement to 
get conventional loans and for SBA loans.
    So you will see that as a subset of the 7(a) program, our 
SBA Express program is down quite a bit, quite substantially, 
in terms of numbers of loans, about 20 percent.
    Mr.  Buchanan. What about lenders giving to established 
franchise companies? Is that a big part of the business, a 
small part so you've got someone that comes to you that--
    Mr.  Wilkinson. It's some. I do not know off the top of my 
head volume of lending to franchises. That is not a subprogram 
number I have seen in quite some time.
    Mr.  Buchanan. But you don't know if they are aggressively 
lending to people interested in buying a franchise? I was just 
curious.
    Mr.  Wilkinson. Well, each lender has their own business 
plan as to the types of businesses they would like to finance 
from community banks that tend to be financed, all of them, to 
sometimes we have specialty lenders that would gear their 
program towards, say, a franchise operation. I know that there 
are some SBA lenders with franchise lending divisions. But I 
don't know what kind of volume franchise lending would total in 
the program.
    Mr.  Buchanan. I was just curious.
    Mr. Crawford, the CDC mentioned, what is the trend line on 
lending there? I think you covered it a little bit, but in 
terms of CDCs?
    Mr.  Crawford. Well, we are--you mean for long-term?
    Mr.  Buchanan. Yes.
    Mr.  Crawford. As I indicated, we are flat this year, which 
is kind of surprising. I have been through probably--I don't 
know--tony?--3 recessions in the last 18 years. I would have 
thought lending would still be running higher because, as Tony 
indicated, we are tending to be a counter-cyclical program.
    The banks will turn to an enhancement vehicle like 504 
fairly rapidly because they can lend 50 percent and still have 
a first lien position.
    I suspect we are in the early stages of recession if you 
want to call it that. And I suspect that there are a lot of 
small businesses that are sort of pulling back their horns to 
wait and see how their own businesses, their own revenue 
streams are going to go. And then I think that we will probably 
see some resumption of some small business lending later in the 
year.
    So I have real high hopes. That's why I indicated that I 
believe that we are going to run close to seven billion this 
year. And I am very concerned about next year because I think 
then our program's historic balance will kick in.
    And I think you will see banks turn to 504. And I don't 
want to be sitting there with $7 and a half billion in 
authority. It would be pretty rough for us. I assume that the 
SBA would have to cut off lending at some point.
    So I have high hopes that the program will get back on its 
historic growth pattern of 8 to 15 percent.
    Mr.  Buchanan. Mr. Mercer, on the SBICs, what has been the 
success rate in, say, the last five or six years of the SBICs?
    Mr.  Mercer. In terms of--
    Mr.  Buchanan. Venture funds, venture funds, small 
businesses.
    Mr.  Mercer. You're talking about the participating 
security funds?
    Mr.  Buchanan. Yes.
    Mr.  Mercer. Well, they stopped issuing licenses in 2004. 
So the program is ramping out of existence. There are about 160 
funds still in existence. Fewer and fewer are being put into 
liquidations, ones that have gone into liquidation are the ones 
that had problems associated with the 2000 recession.
    What will happen after September 30 of this year is 
anybody's guess because the funds that were licensed in, say, 
2002, 2003, 2004 were given at least the implicit, if not 
explicit, promise of leverage equal in most cases to two times 
their private capital.
    That leverage is going to be cut off, through no fault of 
those licensed SBICs, as of September 30 of this year. And no 
new leverage is being supplied. So it is really anybody's guess 
right now as to how those SBICs will be able to complete their 
business plans.
    Many of them are seeking private sources of capital and 
trying to negotiate and have in many instances negotiated with 
SBA to buy out SBA's positions. Others will probably be unable 
to do that. And whether they will fail or succeed for the lack 
of capital they will be faced with, it is too soon to tell.
    Mr.  Buchanan. Mr. Betancourt, do banks do many of these 
loans that you do in the microloans or is there a reason why 
they don't do them or are they just too high-risk or what has 
been your history with that? I mean, people have come to you 
compared to using a conventional bank.
    Mr.  Betancourt. If I can just expand upon the subsidy 
issue that the administrator talked about? Quite frankly, the 
reason why banks are not doing this is because you can't money 
off these loans. You are going to spend $4,000.
    In our case, every loan we spend 3-4 thousand dollars of 
our technical assistance time. We may earn $1,000 in interest. 
The loans are under 35,000. So if you have a $10,000 loan, you 
don't make enough interest to cover your costs.
    Hence, this partnership with the SBA of trying to not 
subsidize but invest monies so we can help this entrepreneur, 
so that's number one. The economies just don't work for banks.
    Number two, you have to help the client. There is a lot of 
work, credit repair, to understand the type of collateral that 
you need to use helping them with their business plan, et 
cetera, et cetera.
    And the other thing is I think--and the SBA did this 
research a number of years ago, I haven't seen it in a couple 
of years--that there are borrowers that don't go to banks 
because of their fear of being turned down. And so there is a 
psychological factor that we have to work through. Again, you 
are not going to see it in any bottom line.
    Mr.  Buchanan. And you are just talking about that one 
thing. I didn't realize until I started looking at some of 
this. I think 50 percent of people that are looking for loans, 
banks or car loans, don't qualify for conventional financing. 
There are probably different numbers, but it's the number I've 
heard.
    What percentage of the people you work with have where they 
can't probably go to a bank, you know, or can't get 
conventional finance would come to you or let's bad credit? I 
know that means a lot of different things. There is bad, and 
there is real bad. Your sense of--
    Mr.  Betancourt. The average credit score in our program a 
bank wouldn't even consider giving a loan. So I would say 90 
percent of the loans a bank wouldn't even consider.
    And we actually had a banker come in and say, ``We want to 
buy your portfolio. We want to buy your loans.'' When they went 
through our portfolio, they saw all of our loans were being 
paid. But when they looked at the profile, given the credit 
score and the collateral that we were holding, they weren't 
interested. We get that every once in a while.
    So that's more anecdotal, but I think that they just don't 
have the time, don't make enough money, and don't understand 
this type of lending. It's a real niche-type lending.
    Mr.  Buchanan. What has been your success rate in lending 
in the microloans area?
    Mr.  Betancourt. Our particular program is 97 percent 
payback. I would say nationally might be a five or ten percent 
charge-off. And, again, it's a one percent default rate because 
we put that reserve fund. The organizations are on the hook for 
any losses, not the SBA.
    Mr.  Buchanan. So you're saying of all the loans that you 
originate, you have a--what is the default rate?
    Mr.  Betancourt. Ninety-seven percent.
    Mr.  Buchanan. So you get 97 percent of people that pay the 
loans back?
    Mr.  Betancourt. I would say because, I mean, we look at 
microloan--
    Mr.  Buchanan. Security? What are they putting up, security 
or--
    Mr.  Betancourt. We're holding car titles, a second loan or 
a lien against their home, business assets. We pretty much do 
what a bank would do except the numbers and the economies are 
not as great. The equity might be zero, might be 100 percent 
financing that way. You might have equipment that's really not 
worth anything. But psychologically you tie them in. You help 
them.
    One thing that I found interesting is that when our 
borrowers don't pay the bank if there's a problem, they'll pay 
us because we have a very tight relationship. We spend a lot of 
time with them. So there is a real relationship that we build 
with that entrepreneur. And then we obviously encourage them to 
pay the bank as well.
    Mr.  Buchanan. Thank you, Madam Chair.
    Chairwoman  Bean. Thank you.
    I am pleased to note Chairwoman Velazquez has joined us. 
And we recognize her.
    Ms.  Velazquez. Thank you, Chairwoman, and thank you for 
holding this important hearing.
    Mr. Zarnikow, welcome to this position. And welcome to the 
Committee. I am glad that you were able to make it. So I would 
like to address my first question to you.
    You may know that Congress enacted two laws that created 
reduced-fee 7(a) programs. One was to promote energy-efficient 
projects. And the other was to assist veteran entrepreneurs.
    When the administrator came before the Committee on the 
budget, he said that the SBA is not implementing these 
provisions because he claims they need an appropriation.
    I have a copy of the two laws here. And I will ask if you 
can tell me, where is this, in any of these two laws, that 
there is an appropriation required to implement these two 
programs.
    Mr.  Zarnikow. My understanding is that that has been 
looked at and reviewed within the administration. And because 
these would be separate loan cohorts, there would be a subsidy 
that would be required in order to enact that portion of the 
bills.
    I would say that we are moving forward to implement the 
other provisions of bills.
    Ms.  Velazquez. But that would not require an 
appropriation?
    Mr.  Zarnikow. The other portions, that's correct.
    Ms.  Velazquez. My question to you--and I have to say that 
when the administrator said that it required an appropriation, 
i was really shocked because I thought that he didn't read the 
language of the law. In these two laws, there is no requirement 
for an appropriation.
    So even when you say that there is no funding and when I am 
saying that there is no funding required written into the law 
and you're maintaining that they need funding, my question is, 
given the fact that--and I think that you know that--the agency 
has the ability to transfer up to ten percent from a budgetary 
account to another account, my question is, will the SBA be 
willing to transfer up to ten percent from one of these 
accounts to another account, let's say, for example, the travel 
budget to partially fund the reduced fee loan program for 
veterans?
    Mr.  Zarnikow. You know, that is something that I would 
have to confer with my colleagues in the administration to be 
able to address. And we would be glad to respond back to your 
office.
    Ms.  Velazquez. You know, we here in Congress, we go to the 
floor. And we are always saying how grateful we are for the men 
and women in uniform. Those men and women are returning back 
home from Afghanistan and Iraq. We passed this law to help 
them. Mr. Buchanan worked quite hard on this legislation.
    So I hope that you will get back to us on that. And I will 
suggest, strongly suggest, that I think for the SBA, it should 
be more important to put money into the hands of veterans, 
rather than providing money for SBA's staff to go to 
conferences.
    Mr.  Zarnikow. We would be glad to respond to your 
question. I would also point out that last year we did roll out 
our Patriot Express product, which is specifically targeted 
towards veterans, reservists, and their spouses. And we have 
seen over 1,000 loans, made in that program for over 100. We do 
believe in supporting the people who are serving our country.
    Ms.  Velazquez. I want to follow up on a point that was 
made by Mr. Crawford in his testimony. He stated that the SBA 
has not compensated any CDCs for their work liquidating 
defaulted 504 loans, even though the agency is supposed to do 
so.
    Can you explain why your agency hasn't paid one single 
invoice from a CDC for their liquidation costs?
    Mr.  Zarnikow. We are in the process of working through an 
issue related to the 504 liquidation costs. We actually brought 
this to NADCO's attention in one of our many sessions that we 
worked together.
    I would say that we are committed to paying the CDCs for 
the work that they have done in connection with liquidations 
that they have already completed related to liquidations. We 
are working through internally an issue. And we have committed 
to get back and have a response to that issue and how we are 
going to run that going forward.
    Ms.  Velazquez. Did you request any money in the budget to 
do this?
    Mr.  Zarnikow. I would have to--
    Ms.  Velazquez. No. So there wasn't any money requested by 
SBA to do this. My question to you is, if you didn't request 
any money, how do you think you could pay it back?
    Mr.  Zarnikow. I think, once again, as I mentioned, we are 
in the process of working through this issue internally and 
expect to have it resolved within the next couple of weeks.
    I would also point out that we do have 504 liquidation 
staff in our Fresno and Little Rock centers who do work on 504 
liquidations. And the delegated liquidation program really 
represents around ten percent of the CDCs. It's a subset of the 
liquidation effort.
    Ms.  Velazquez. Mr. Crawford, I don't want to put you on 
the hot seat here, but when any of your members go through the 
process of liquidating and then go to the agencies and to the 
SBA and they don't get any money back, how do you think that 
will help your members?
    Mr.  Crawford. Well, as you know, my members are small not-
for-profit organizations generally. We have a couple of large 
CDCs but most are small. And they recognize that you can't have 
a loan program without having a recovery program to go with it.
    And so they have stepped up to the plate. They worked with 
the 106th Congress. They worked with you. They worked with SBA 
and agreed that they would shoulder the labor burdens of doing 
these recoveries because the SBA, as you know, four years ago 
laid off all their portfolio management staff. So there was no 
one to liquidate and recover on 504s other than a few people 
that were left over in some of the field offices.
    Now, the SBA has since added, whether the number is five or 
it's ten people, to the two liquidation centers. That is not 
the same as feet on the ground. If you have a default in Kansas 
City, someone that's in Fresno, California is not going to 
liquidate that loan. It's got to be somebody in Kansas City to 
do it, to go to the courthouse steps, to make the bid, to make 
sure the grass gets mowed, to make sure the locks get changed.
    And so you have got to have a local presence to do that. 
And we have been trying to convince the agency for--I don't 
know--six years that that was needed. And we are willing to 
step up to the plate and do it.
    But the servicing fees that CDCs make now are to service 
those loans. They are not to provide liquidations, workouts, 
and recoveries. And I will guarantee you that the whole 
industry cannot do this for free. There just isn't enough 
money. And so they have got to somehow be reimbursed for their 
direct costs or for their contractors. Otherwise the whole 
thing grinds to a halt.
    Ms.  Velazquez. Thank you, Mr. Crawford.
    Do you have any comments after that?
    Mr.  Zarnikow. I think I would repeat what I have said, 
which is this is an issue we are working through internally and 
developing a response.
    Ms.  Velazquez. Mr. Zarnikow, when vendors go to the 
members to get paid, what do you think they are to going to 
tell them?
    Mr.  Zarnikow. I think I mentioned that we have committed 
to pay whatever has already been incurred through this process.
    Ms.  Velazquez. Let me ask you. You mentioned how important 
lender outreach is for you. And, in fact, you held an average 
roundtable this morning, a lender roundtable this morning. And 
I was surprised to learn that you did not invite the National 
Association of Government Guaranteed Lenders to the roundtable. 
Can you explain to me why not?
    Mr.  Zarnikow. The lender roundtable was to work directly 
with some of the largest lenders around the country and some of 
our largest lenders. We have a very--
    Ms.  Velazquez. Is it the National Association of 
Government Guaranteed Lenders?
    Mr.  Zarnikow. We have regular dialogue with the National 
Association of Government Guaranteed Lenders.
    Ms.  Velazquez. What was the reason to exclude them if you 
are going to have a discussion about lending?
    Mr.  Zarnikow. We invited--
    Ms.  Velazquez. Mr. Wilkinson, do you believe that you 
could have provided the SBA with some useful input if you were 
invited to that roundtable?
    Mr.  Wilkinson. Well, I don't know the entire content of 
the discussion today, but we do represent a large number of 
lenders. We do make a significant majority of their 7(a) loans 
and a majority of their 504 firsts.
    I would say that I'm not aware of the attendee lists, 
although I am aware that two of the attendees that were there 
were on my board. I don't know who the other ones were.
    Ms.  Velazquez. I think that it would be useful for the 
next roundtable that you conduct that you invite as many 
people, stakeholders so that you hear what you want to hear but 
also the critiques and contributions that could be made in 
terms of making the programs more efficient.
    Thank you, Madam Chair.
    Chairwoman  Bean. Thank you, Chairwoman Velazquez.
    I wanted to just come back to Mr. Zarnikow. We talked a lot 
about the economy and the faltering economy and how the timing 
is really important. And so in your new job, you have 
tremendous priorities to address.
    Given that there has been the credit crunch that we have 
heard about and tightening up of lender standards, have you 
given your lenders particular guidance on how to adjust their 
own criteria for SBA loans?
    Mr.  Zarnikow. A couple of things I would say relative to 
that are that you keep in mind as you look at the larger 
picture, although the number of loans year to date in the 7(a) 
program are down about 15 percent, the dollars are down about 6 
percent compared to last year. Two thousand seven was a record 
year for lending in the 7(a) program. The year-to-date volume 
we are seeing is higher, really, than any year the past two 
years, which were record years. So, to put it in perspective, 
we are seeing a slight decline in lending volume coming off of 
record years.
    As we talk with lenders out there, we hear a number of 
things, one of which is demand for loans is down. And we hear 
that as a very common theme as we talk to lenders, that they 
have seen fewer applications. The demand for loans is down.
    As we talk to lenders, some of them have tightened credit 
standards. Others we talk to indicate they have not tightened 
credit standards. Where we have seen the biggest drop in volume 
in our program is in the smaller SBA Express program, which is 
primarily a credit-scored program. And what we have heard from 
some of the lenders in that program is that they have raised 
the bottom of their credit score box because what they found 
was the defaults were higher in that than they anticipated and, 
as a result, needed to adjust their credit standards.
    As you know, our programs or our loans are really all made 
through lending partners. So we don't actually establish or set 
their lending criteria. We do monitor them from an oversight 
perspective, but they actually set their own credit policy.
    Chairwoman  Bean. Okay. And, Mr. Wilkinson, did you want to 
comment?
    Mr.  Wilkinson. Yes, I did. I wanted to comment on the loan 
volume statistics. While it is true that 2007 might have had a 
slight number of loans on the increase, our dollar volume has 
slid steadily since fiscal year 2005, where we peaked with 15.2 
billion in approvals down to 14.53 down to 14.29. And we 
probably at the pace we are on will be well below 14 this year. 
So we have had a steady decline now for four years in the 
dollar volume of lending.
    Chairwoman  Bean. Thank you.
    As you probably heard, the bells are ringing. Votes have 
been called again. I had just one last question for the SBA, 
and then we can adjourn. And I appreciate all of your efforts 
and your testimony.
    The new lender oversight that you have talked about and to 
recoup the cost of monitoring the programs, you have added new 
fees. What do you think this new fee accomplishes for the SBA? 
And how does it benefit the portfolio since there has obviously 
been some rejection from others to that concept, and it is 
certainly limiting growth.
    Mr.  Zarnikow. Right. You know, obviously as we look at the 
mission of the SBA, it's to get capital to small businesses. 
And we balance that providing capital or getting capital to 
small businesses with having a healthy loan portfolio, which is 
important. So, therefore, we need to have an appropriate level 
of oversight.
    We are increasing the amount of on-site visits that we are 
doing as part of that oversight responsibility and to be able 
to increase the number of oversight visits to over 200 this 
year really needs--we need to charge the on-site fees as well 
as to recoup the cost of the off-site monitoring that we do.
    We did structure the fees so that over 80 percent of our 
lenders don't pay any fee at all. And over 90 percent of our 
lenders don't pay an on-site fee. So we have tried to manage 
that cost in a way that we call it a risk-based approach, where 
we have taken a look at where do we think the biggest risks are 
in our portfolio, where can we appropriately spend oversight 
dollars to manage that risk and provide a balance because we do 
understand that costs and fees are important.
    Any time you have fees, nobody likes to pay fees or wants 
to pay fees. So that those are important. So we have tried to 
structure the program on a risk-based approach to really 
address where we see the biggest areas of risk in a portfolio.
    Chairwoman  Bean. All right. Well, I thank you for your 
testimony and to all of you for weighing in on this important 
subject.
    I ask unanimous consent that members will have five days to 
submit statements and supporting materials for the record. 
Without objection, so ordered.
    This hearing is now adjourned.
    [Whereupon, at 3:51 p.m., the foregoing matter was 
concluded.]
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