[Senate Hearing 110-504]
[From the U.S. Government Publishing Office]
S. Hrg. 110-504
SBA LENDER OVERSIGHT: PREVENTING LOAN
FRAUD AND IMPROVING REGULATION OF LENDERS
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON SMALL BUSINESS
AND ENTREPRENEURSHIP
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
NOVEMBER 13, 2007
__________
Printed for the use of the Committee on Small Business and
Entrepreneurship
Available via the World Wide Web: http://www.access.gpo/gov/congress/
senate
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COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
JOHN F. KERRY, Massachusetts, Chairman
CARL LEVIN, Michigan OLYMPIA J. SNOWE, Maine,
TOM HARKIN, Iowa CHRISTOPHER S. BOND, Missouri
JOSEPH I. LIEBERMAN, Connecticut NORMAN COLEMAN, Minnesota
MARY LANDRIEU, Louisiana DAVID VITTER, Louisiana
MARIA CANTWELL, Washington ELIZABETH DOLE, North Carolina
EVAN BAYH, Indiana JOHN THUNE, South Dakota
MARK PRYOR, Arkansas BOB CORKER, Tennessee
BENJAMIN L. CARDIN, Maryland MICHAEL B. ENZI, Wyoming
JON TESTER, Montana JOHNNY ISAKSON, Georgia
Naomi Baum, Democratic Staff Director
Wallace Hsueh, Republican Staff Director
C O N T E N T S
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Page
Opening Statements
Kerry, The Honorable John F., a United States Senator from
Massachusetts.................................................. 1
Snowe, The Honorable Olympia J., a United States Senator from
Maine.......................................................... 4
Cardin, The Honorable Benjamin, a United States Senator from
Maryland....................................................... 6
Witness Testimony
Preston, The Honorable Steven C., Administrator, U.S. Small
Business Administration, Washington, DC........................ 7
Thorson, Eric M., Inspector General, U.S. Small Business
Administration, Washington, DC................................. 32
Tannenhauser, Robert F., chairman, Business Loan Express, LLC,
New York, New York............................................. 46
Wilkinson, Anthony R., president and chief executive officer,
National Association of Government Guaranteed Lenders, Inc.,
Stillwater, Oklahoma........................................... 56
Baird, James, Executive Director, Bay Area Development Company,
and vice chairman, Legislative Affairs Committee, National
Association of Development Companies, Walnut Creek, California. 68
Alphabetical Listing and Appendix Material Submitted
Baird, James
Testimony.................................................... 68
Prepared Statement........................................... 70
Brickman, Jim
Prepared Statement........................................... 130
Cardin, Hon. Benjamin
Opening Statement............................................ 6
Dinsmore, Frank F.
Prepared Statement........................................... 146
Einhorn, David
Prepared Statement........................................... 133
Isakson, Hon. Johnny
Post-hearing questions posed to Hon. Steven C. Preston and
subsequent responses....................................... 108
Kerry, Hon. John F.
Opening Statement............................................ 1
Post-hearing questions posed to Hon. Steven C. Preston and
subsequent responses....................................... 92
Post-hearing questions posed to Eric Thorson and subsequent
responses.................................................. 109
Post-hearing questions posed to Robert Tannenhauser and
subsequent responses....................................... 124
Preston, Hon. Steven C.
Testimony.................................................... 7
Prepared Statement........................................... 10
Response to post-hearing questions from:
Senator Kerry............................................ 92
Senator Snowe............................................ 100
Snowe, Hon. Olympia J.
Opening Statement............................................ 4
Post-hearing questions posed to Hon. Steven C. Preston and
subsequent responses....................................... 100
Post-hearing questions posed to Eric Thorson and subsequent
responses.................................................. 116
Tannenhauser, Robert F.
Testimony.................................................... 46
Prepared statement........................................... 49
Response to post-hearing questions from Senator Kerry and
subsequent responses 124
Thorson, Eric M.
Testimony.................................................... 32
Prepared Statement........................................... 34
Response to post-hearing questions from:
Senator Kerry............................................ 109
Senator Snowe............................................ 116
Senator John Thune....................................... 123
Thune, Hon. John
Post-hearing questions posed to Eric Thorson and subsequent
responses.................................................. 123
Wilkinson, Anthony R.
Testimony.................................................... 56
Prepared Statement........................................... 59
Comments for the Record
Brickman, Jim, real estate developer and investor................ 130
Einhorn, David, president and co-founder, Greenlight Capital, Inc 133
Dinsmore, Frank F., chief executive officer, REsource Capital,
Real Estate Financing for Growing Businesse.................... 146
SBA LENDER OVERSIGHT: PREVENTING LOAN
FRAUD AND IMPROVING REGULATION OF LENDERS
----------
TUESDAY, NOVEMBER 13, 2007
United States Senate,
Committee on Small Business
and Entrepreneurship,
Washington, DC.
The Committee met, pursuant to notice, at 10:32 a.m., in
room 428-A, Russell Senate Office Building, the Honorable John
F. Kerry (Chairman of the Committee) presiding.
Present: Senators Kerry, Cardin, and Snowe.
OPENING STATEMENT OF THE HONORABLE JOHN F. KERRY, CHAIRMAN,
SENATE COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP, AND A
UNITED STATES SENATOR FROM MASSACHUSETTS
Chairman Kerry. Good morning. This hearing of the Small
Business Committee will come to order. I thank everybody for
being here and I thank you for your patience. We had a vote,
obviously, but we thought it was more important to begin the
hearing after the vote rather than interrupting the hearing,
and so I appreciate everybody's indulgence. This way, we will
be able to go straight through because there are no more votes
until after lunch, and therefore, we can have an uninterrupted
hearing, which is what both Senator Snowe and I prefer to do.
Let me emphasize a couple of things about this hearing. I
know there have been some questions from some parties about why
we should have a hearing like this. Senator Snowe and I and all
the Members of this Committee manage a Committee that works in
a very bipartisan way and try very hard to keep the politics
off the table.
The bottom line is that the Congress--as a separate and co-
equal branch of government, which sometimes people have to be
reminded of--has a major responsibility as to how we spend the
taxpayers' money, as to what happens to the programs we put
into law, and we are often the critical oversight arm in making
certain that those laws are carried out, that the intent of
Congress is, in fact, the intent of the American people--it is
not our intent. It is who we represent, and we have the
responsibility to make sure that intent is, in fact, carried
out and that we are presenting the American people with the
best governance possible. That is what we owe them. And
sometimes this city has an ability to get up on an arrogant
high horse and forget why we are here and who puts us here and
what our obligations are.
So the purpose of this hearing is not politics. The purpose
of this hearing is not ``gotcha.'' The purpose of this hearing
is to figure out how--with the help of the SBA's Office of
Inspector General, which was created in order to have
transparency and accountability and effectiveness--how the
SBA's lending partners and our committee can improve the
agency's lender oversight and prevent fraud in the SBA's small
business lending programs.
No one is here to suggest that this is somehow pervasive or
that it is more--we don't know that situation. We are here to
explore the one situation that we know and those things that
have been talked about by the Inspector General over the course
of time.
And the timing of this hearing, frankly, couldn't be more
important. Everybody is aware of what is happening in the
economy. Everybody understands the difficulties with the
subprime lending and mortgages and what is happening to credit
as a consequence. And the whole purpose of the SBA is to help
small businesses access credit and be able to move in the
marketplace and get capital.
So we see now a credit crunch, somewhat caused by the
mortgage subprime crisis and people in the country losing their
homes. Small businesses, therefore, feel the impact from that
in a lot of different ways, and many get their credit from
their homes. At least one in three small business owners say
that they are now being adversely impacted by this credit
crisis.
Secondary market premiums are down 25 percent, so banks are
tightening up their loans for everyone, including
entrepreneurs. That means that the government-backed loans, the
very rationale for the existence of the SBA and the very
rationale for 7(a) and 504 programs and so forth are even more
important right now, much more important.
SBA loans provide capital to small firms that can't access
credit through the normal channels, and if all of a sudden
people start to have doubts about that marketplace, you can
have a problem, a cascading kind of problem, and we want to
avoid that. We also want to make sure that we are reaching
those people who we have always tried to target, who are the
minorities and women and veterans and others for whom the SBA
has a particular mission.
So we are here today to discuss SBA lender oversight and,
you can't avoid some discussion of the fraud scheme that was
carried out by a bad actor from Business Loan Express in their
Troy, Michigan branch and a small group of people. I emphasize
we don't know the depths. It is obviously important because it
resulted in $76 million in fraudulent SBA loans. So we need to
know what happened. We all need to know this. We need to know
how it happened. We need to know what is being done to prevent
it in the future.
The hearing is not intended to hurt Business Loan Express
nor any other entity, but that is not to say also that there
isn't a legitimate standard of accountability, because people
need to answer for their employees. That is just a normal
course of business and this should be no different.
We need to understand how no one noticed or reported a high
number of bad SBA loans coming out of the branch, and today's
hearing is an opportunity for the company to tell its side of
the story, including their rationale for cutting back on small
business lending, which they announced recently.
And let me just say, I greatly regret the loss of jobs that
is going to go with the company's announcement. The SBA lending
community is a close-knit community, and I know this has
created concern within that community, even some regret in some
parties. We obviously hope that everybody lands on their feet
in this judgment that has been made and what happens.
Another aspect of today's hearing is the SBA Inspector
General's report generated by its audit of the lender oversight
procedures and resources. SBA requested that much of the IG's
report be redacted before it was made public, including most of
the IG's recommendations. It is hard to understand why those
recommendations and the agency's plans to address the IG's
findings were redacted. Frankly, this is highly unusual. The
SBA and BLX have based their requested redactions on claims of
trade secret protections, the deliberative process privilege,
and the bank examination privileges, which can be legitimate
reasons for redactions if applied correctly.
However, even if SBA had the legal right, I question
whether all of the information blacked out needs to be
redacted. It seems like an overreach and has probably created
more problems than it has solved. So I think in the interest of
having more transparency of SBA's oversight activities, not
less, Mr. Administrator, we have been very complimentary of you
throughout the process and very encouraging for the initiatives
that you have brought, but I think SBA could have handled this
particular issue more effectively. I think the agency needs to
improve its oversight with more transparency.
Let me also comment, the BLX report is not the only report
relevant to the SBA's oversight. In the past 5 years, the SBA
IG has issued more than 60 reports on general lender oversight
issues and SBA procedures related to justified payments of
guarantees on defaulted SBA loans. Also, the IG has examined
the transfer of the purchase responsibility from the 69
district offices to the Herndon Center.
Now, some of the problems we are going to discuss here
today demonstrate that the agency may have been excessive or
harsh or even irresponsible in dismantling the loan functions
in the district offices so quickly. They didn't have the
Herndon Center adequately established to take on centralization
and they underestimated the necessary staff and training
requirements. It also came at a personal cost to almost 200
people who lost their jobs or were uprooted in haste. From what
at least we hear, and I am open to evidence to the contrary,
but certainly from what we hear, that has contributed to low
morale in some quarters. It has created unnecessary instability
over the last couple of years for lenders on liquidation and
purchases of loans.
Furthermore, the Administration's budget request--and I
think this is felt by most Members of, I think unanimously, on
the Committee--the budget requests have simply been
insufficient and unreasonable for staffing and funding the
centralized offices and district offices. Simple logic says
that you can't go from a budget of almost $1 billion to $600
million, while nearly doubling your loan portfolio from about
51,000 loans in 2002 to almost 100,000 loans in 2006 and still
claim to have the labor-intensive personal oversight necessary
to know what those loans are doing, unless you have created
some new magical virtual system, which we have yet to
understand.
You are not saving money, if by scrimping on staff
responsible for loan oversight, you end up enabling sloppy
lenders to do poor underwriting and allow the agency to make
improper and inaccurate payments on defaulted loans. In fact,
an audit by the IG, issued in May, states that the SBA's lax
review of purchase requests of defaulted loans resulted in $36
million in erroneous payments on unjustified purchases on bad
loans.
To round out the discussion, we are going to hear from Jim
Baird and Tony Wilkinson representing the 504 Certified
Development Company lenders and the 7(a) lenders. These lenders
have a stake in this process, and they ought to be part of the
discussion, and part of that discussion involves information
sharing.
As the SBA tries to predict and identify problem loans,
they should share with the lenders which ones they deem to be
at risk, so that they can take action to prevent a default, or
even a lapse in currency.
Senator Snowe got a lot of these issues right in the lender
oversight legislation that she introduced recently, and I very
much appreciate her work and her knowledge with respect to
this. I was glad to join her in introducing that, and with
that, I turn to Senator Snowe.
OPENING STATEMENT OF THE HONORABLE OLYMPIA J. SNOWE, A UNITED
STATES SENATOR FROM MAINE
Senator Snowe. Thank you very much, Mr. Chairman, and also
thank you for holding this hearing to conduct oversight over
the Small Business Administration's ability to detect and
prevent fraudulent loans. Your longstanding leadership is
certainly critical at this juncture, and as you said, this
hearing couldn't be more timely given the economic situation
that we find ourselves in in this country and the degree to
which small businesses do depend on the Small Business
Administration for loans, and ultimately, the creation of jobs.
I also want to thank Administrator Preston and Inspector
General Thorson for being here and all the other witnesses. I
appreciate their willingness to help us better understand the
challenges that the Small Business Administration is
confronting with respect to the SBA's loan monitoring and
lender oversight activities.
As Ranking Member of this Committee, I find the SBA's
history of SBA's lender oversight issues unacceptable. It is my
hope, this morning, that we will probe how and why the
Government has inappropriately allowed loan fraud and poor loan
underwriting to occur at the Business Loan Express Corporation,
BLX, Innovative Bank, and in 44 out of 45 of the Small Business
Express and Community Express loan files reviewed by the Office
of Inspector General.
These three cases reveal the ineffectiveness of the SBA's
current oversight activity. I fear that unless the SBA is able
to dramatically improve its lender oversight, escalating losses
and fees will drive lenders and borrowers away from these key
loan programs. This will seriously hamper and harm the ability
of small businesses to access capital to grow, but also--
regrettably--it would reverse the very mission of these
programs.
Currently, the SBA has $80 billion in outstanding loans
issued to small businesses, many of which are new startup
companies without longstanding credit histories. When they
apply for an SBA loan, the loan officer must determine if the
company meets the needs to obtain an SBA loan, including having
a sufficient cash-flow to repay the terms of the loan.
Unfortunately, as the IG report demonstrates, a number of
loan officers have failed to perform their due diligence and
have improperly underwritten loans without verifying that loans
can be repaid and that borrowers can meet all the criteria
necessary to qualify for an SBA loan. It is an irrefutable
established truth that poor loan underwriting directly leads to
loan defaults, fraud, and other deficiencies. This is a reality
that we need to address here at the hearing today.
Although the SBA has recently undertaken a number of
efforts to improve its lender oversight activities--these are
steps in the right direction--they are no substitute for the
strides that are absolutely an imperative. Simply put, not
enough is being done by the SBA, and that must change.
To enhance its oversight in the performance of the 7(a) and
the 504 loan portfolios, it is incumbent upon the SBA to
improve the quality of lenders' underwriting and to make doing
so a fundamental and absolute priority. That progress should
begin with three things: First, effectively and thoroughly
auditing lenders' loan files during onsite reviews; second,
harnessing technology to help lenders meet the SBA's
underwriting requirements; and finally, streamlining the
initial application loan review process.
Mr. Administrator, today I hope we can hear from you about
your clear and concise plan to work with the SBA Inspector
General and immediately improve the SBA's lender oversight
process. As I mentioned earlier, there is a history of problems
within the SBA. Now, I know much of it occurred before your
tenure, but nevertheless, there has been a long history of
lender oversight difficulties. We have had numerous hearings
and numerous reports--as the Chairman cited--and yet we still
find ourselves at this juncture where we are finding fraudulent
loans to the magnitude and degree of millions and millions of
dollars. Just with BLX alone, it was more than $200 million.
Additionally, the SBA must increase the transparency of its
oversight activities and measurements. The SBA has failed to
provide participating lenders with much of the criteria the
agency uses to determine whether portfolios are sound or
substandard. Again, this is an issue that we heard repeatedly
from lenders with respect to the failure of the SBA to present
the criteria and the standards by which the Agency measured
lenders' portfolios. It goes without saying, this lack of
transparency hinders the SBA's oversight capability and
encourages participating lenders to be justifiably critical of
the agency's ability to accurately assess portfolio quality and
conduct effective oversight.
That is why, earlier this month, Chairman Kerry and I
introduced legislation that I hope will codify the SBA's
standards for portfolio quality and enhance the transparency of
measurements that the SBA must use to evaluate lenders. This is
timely legislation. Hopefully, Mr. Chairman, we in the
Committee can mark this up this year so that we can address
these issues as effectively and efficiently as possible.
Finally, I am also concerned by the large redactions within
the SBA Inspector General's report that were done at the
request of the Small Business Administration. It seems to me,
at this point, given the amount and the totality of fraudulent
loans with BLX--there have been, in fact, 76 fraudulent BLX
loans worth $76 million--it underscores the necessity for both
SBA and the Inspector General to work in a collaborative
fashion. We need a report that doesn't have the kind of
redactions that we are facing here today.
The SBA cannot stifle the SBA's Inspector General's
critical voice, or hide from the public's view suggestions on
how to improve lender oversight. Given the history of the SBA
on this very question, there has to be an urgency and an
imperative on the part of the Small Business Administration to
address these issues; more importantly, to correct them and to
prevent this kind of catastrophic event from reoccurring.
Ultimately, these types of failures can impinge upon the
ability of small businesses to access needed loan guarantees.
Ultimately, this can hurt our economy as small companies will
or will not create jobs, depending on small businesses' ability
to secure those loans. If you think about SBA being the net
creator of jobs in this country, then clearly the effectiveness
of the SBA's lender oversight has a direct consequence and
correlation to small businesses' access to loans.
I hope we can address all of these issues here today, Mr.
Chairman.
Chairman Kerry. Absolutely. We hope to and I thank you for
that important statement. Thank you very much.
Senator Cardin, do you have any opening statement you want
to make quickly before we start? I want to try to----
OPENING STATEMENT OF THE HONORABLE BENJAMIN L. CARDIN, A UNITED
STATES SENATOR FROM MARYLAND
Senator Cardin. Mr. Chairman, let me just thank you and
Ranking Member Snowe for your comments and convening this
hearing. I concur with the comments that have been said.
Let me just make a very quick point to Administrator
Preston. I am not satisfied by the manner in which the agency
has conducted oversight or outreach when dealing with the
fraudulent loans that we are talking about today, but also
outreach to make sure we have the right quality of loans
against those groups that have been denied the opportunity
historically and the need for capital, the minority businesses,
first-generation businesses, and women-owned businesses.
So, I think we are not only concerned about the oversight
to make sure the fraudulent loans don't have any place, but
that the capital is available to help small businesses grow and
produce the jobs that are critically important to our economy,
and I look forward to today's hearing. Thank you.
Chairman Kerry. Thank you, Senator Cardin.
As we begin this--and this will apply to each of the
panels--I mentioned the issue of the redactions and the
question of the assertion of a legal privilege with respect to
them. While we are looking at and examining thoroughly the
question of their appropriateness, I nevertheless will respect
if somebody here feels that some answer is going to tread on
the assertion of those privileges, and declines to respond. We
certainly will respect that here, and I simply ask you to tell
us what you believe the basis of your claim is, and we will
proceed forward from there.
So Administrator Preston, thank you for being here. You
have served in your role since July of 2006, and you have come
to this job with about 25 years of experience in financial
operational leadership, so we look forward to your observations
and hopefully continued progress.
STATEMENT OF THE HONORABLE STEVEN C. PRESTON, ADMINISTRATOR,
U.S. SMALL BUSINESS ADMINISTRATION, WASHINGTON, DC
Mr. Preston. Great. Thank you. Thank you, Senator Kerry.
Thank you for setting that context for the hearing, Ranking
Member Snowe, as well, Senator Cardin. Obviously, we are here
to talk about a very important----
Chairman Kerry. Let me just say, if I may interrupt you for
a minute----
Mr. Preston. Yes.
Chairman Kerry.I know you had asked maybe to testify
afterwards, et cetera. What I would like to do--and I put the
others on notice, because we are here to get information and
facts, not to provide just a platform for everybody--so after
Administrator Preston testifies, I asked him if he would stay
around, listen to the other testimony; and I am going to give
him the privilege of inserting himself into the dialog at any
point that he deems it necessary, and we will have a good
discussion.
Mr. Preston. Well, what I plan to do is leave my head of
Capital Access, as well as our General Counsel here, who are
much more familiar with the details of the redactions and those
sorts of things than I am.
Chairman Kerry. Is your microphone on?
Mr. Preston. Yes, it is. Can you hear me OK?
Chairman Kerry. Yes.
Mr. Preston. All right. Well, thank you very much.
Obviously, this is an important topic. We have about $67
billion worth of 7(a) and 504 loans in the marketplace. Our
guarantee represents about $53 billion. Obviously, that number
has grown significantly, especially just in the last 5 or 6
years.
A I listened to your comments, I think it is very important
for us to look at the historical context in terms of the issues
we are talking about, when they occurred, and the progress the
agency has made. I hope we will be able to make some progress
in talking about that because, I think we have made a lot of
progress, although I do think we have a lot more to make.
As you are aware, we administer our 7(a) loan guarantee
program through participating banks, credit unions, and through
other lenders, many of whom get varying levels of delegated
authority to make those loans. We are responsible for oversight
of about 5,000 lenders, but about 674 have preferred lender
authority.
In 2003, the GAO reported that the SBA had made significant
progress in developing lender oversight, but that much more was
necessary. In particular, the GAO recommended that SBA measure
the financial risk of lenders' portfolios, qualitatively assess
the lenders' performance, and clarify its enforcement
authority.
Since that report, SBA has established extensive credit
risk management programs that cover both onsite and offsite
portfolio review. Those are a very significant change from our
prior review process. The offsite review and monitoring program
features sophisticated risk rating measurements developed by a
nationally recognized provider of commercial credit scores and
performance models. The information allows SBA to compare
lenders within a peer group, while helping lenders monitor
their performance within our portfolio. SBA also provides a
risk rating based on the consolidation of individual loan
credit quality and overall portfolio performance information,
which is an indicator that allows the lenders to take
corrective action where necessary.
The onsite process is qualitative analysis of credit
administration, policies, procedures, and controls that relate
to the SBA loans, as well as portfolio performance conducted to
provide more in-depth reviews of individual loans and verify
the lender adherence to our policies.
For our supervised lenders, we contract with an independent
examiner, the Farm Credit Administration, for detailed safety
and soundness and portfolio performance evaluations. These
reviews are just part of our increased oversight activities. In
addition, we conduct post-purchase reviews to inspect loan
files after SBA has honored its guarantee to ensure all
procedures and documentation are correct. SBA has developed a
more independent supervision and enforcement process. A new
lender oversight board, which includes the Deputy
Administrator, the CFO, as well as the AA for Capital Access,
regularly review our enforcement actions to make sure that they
follow our guidelines and that performance standards are being
met.
The Office of Credit Risk Management also has numerous
tools available to enforce its performance standards. It can
reduce the length of the PLP and other delegated authorities to
mitigate risk. It has the ability to conduct more frequent
onsite reviews. We work with management to resolve deficiencies
through correction action plans, through required quarterly
monitoring, and obviously in the more severe circumstances, we
can pull their PLP status or their authority to make SBA loans
at all.
I think our progress shows that we are taking
responsibility seriously. We appreciate our responsibility for
portfolio performance and also our desire to reduce fraud.
Fraud usually occurs by exception, but we nonetheless are
taking measures to prevent that occurrence. We are working
cooperatively with our lending partners to ensure that they
have in place policies and procedures to identify and prevent
fraud. We are also considering other analytical tools that will
support our ability to detect it and refer it more effectively.
With respect to the proposed regulation, we are certainly
not resting on our efforts to improve oversight. On October 31,
we published in the Federal Register a proposed comprehensive
lender oversight rule to enhance the roles and responsibility
of our Office of Credit Risk Management. The rule would codify
many of the existing processes for on- and offsite reviews as
well as risk ratings. It also provides new enforcement actions,
oversight processes, controls, especially for SBA supervised
lenders.
The proposed rule addresses recommendations from the GAO
report and Inspector General on clear policies and procedures
for enforcement and will specify how lenders have to maintain
satisfactory portfolio performance. In addition, the proposed
rule will enhance reporting for SBA lenders to aid SBA in
monitoring and assessing their performance.
Recently, the IG issued a report regarding SBA's credit
risk practices focused on BLX. We appreciate the efforts of the
IG to help SBA continue to improve its processes and procedures
with regard to credit risk management and to reduce fraud. My
written testimony submitted for the record and my letter to
you, Mr. Chairman, fully detail our concerns regarding that
report.
The Committee is likely to hear some issues relating to our
lender review and examination fee from the industry partners
today. I do want to point out that those fees enable us to
perform onsite and offsite risk management of the portfolio.
The amount is charged at a reasonable progressive--based on a
reasonable progressive system linked to the size and relative
risk of those portfolios. In addition, the fees simply cover
the cost of the reviews. As such, many of our lenders will not
be charged any fee, and when assessed, the fees are modest
compared to other financial regulators. We would be happy to
provide you with analysis to show that.
For offsite reviews, we will be charging a simple annual
fee of $73 per million in the portfolio. These reviews provide
information on portfolio performance and the bulk of the
information is shared with the lender. We also provide lenders
with the factors that comprise the risk rating calculation and
their individual component ratings, as well as their peer group
ratings and their portfolio averages of the components. That is
one of the many tools that we use to oversee the portfolio.
We are particularly sensitive to the need to minimize fees
whenever practical. The fees are fully detailed in our notices
that reflects the actual cost of the agencies and do not
substitute for administrative costs.
We have made significant progress to improve and increase
lender oversight. As I mentioned before, I think that will
continue to improve. It is an evolving process. That oversight
will support a strong portfolio and I believe it will increase
our ability to reach more small businesses. We believe that a
strengthened management is crucial to the operation of our
portfolio in an evolving marketplace.
So thank you for the opportunity to discuss our oversight
and I look forward to your questions.
[The prepared statement of Mr. Preston follows:]
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Chairman Kerry. Thank you, Mr. Administrator. Why don't we
start with a 7-minute round and we will obviously probably go
around a couple of times.
Let me start with the larger picture first. I mentioned in
my opening statement the issue of the overall budget and
manpower, which concerns the Committee a lot. Is it not a
handicap to have a doubling of your loan capacity and a
reduction in oversight personnel?
Mr. Preston. Well, I think the reduction in personnel
primarily occurred in the field at the SBA, and many of those
resources were moved to centralized activities----
Chairman Kerry. Right, but isn't the field where you get an
opportunity to be able to interact and really take a group of
loans at the local level and get a sense of what is happening
to them?
Mr. Preston. I think at the field level, we do a lot in
outreach. We can get a sense of local lenders. But people in
field offices were actually processing loans and making credit
decisions which basically left us in a situation where we had a
broadly dispersed set of credit activities taking place around
the country, rather than having them be located in a single
facility or a single set of facilities, which provide for much
more standardization of practices, much greater ability to
audit those standards, and a much better ability to institute
quality standards.
Chairman Kerry. What about--I mean, that might in theory
work, but what about the complaints and the observations that
it has never been adequately staffed and has not been able to
deal with a centralized burden?
Mr. Preston. Well, I think those are very valid criticisms
of the agency.
Chairman Kerry. Isn't that personnel related and budget
related?
Mr. Preston. Senator, I think it is--the challenges in that
operation are well beyond just personnel issues. I think when
the agency centralized those activities, the standards were not
put in place. I don't think the processes were efficient to the
degree that they need to be. And I don't believe that we put in
place metrics, performance standards, or communication back to
other lenders to help them understand what was happening.
That is all stuff we are in the process of doing, and in
fact, I spoke in front of hundreds of lenders at the National
Association of Government Guaranteed Lenders Conference last
month, and I have spoken with hundreds across the country
directly to talk specifically about the challenges we have in
that operation. We have a very clear pathway forward that hits
on--I won't bore you with the details, but a number of issues
that we think will dramatically improve the responsiveness, the
speed of execution, the support of lenders, and the interaction
with our field network.
Chairman Kerry. Well, that is welcome news, and I think it
is terrific that you have that kind of a comprehensive----
Mr. Preston. We would be happy to come by and brief you all
on the details of that.
Chairman Kerry. I think it would be good for the staff to
get a sense of exactly where that implementation process is. In
the meantime, let us assume you had those standards and you
have the sort of centralized operational initiatives in place
that you just listed. I think there were three or four of them.
Do you have enough personnel to carry that out?
Mr. Preston. Yes, I believe we will have enough personnel
to carry that out.
Chairman Kerry. You believe you do?
Mr. Preston. I believe we do. We have looked at our
staffing levels. You all were good enough to increase our
budget last year. We have hired people in our processing
centers with the additional budget we received from Congress,
and at this point, we believe it is adequate. But certainly,
this is not an area that I am interested in skimping in at all.
Chairman Kerry. Well, also you mentioned in your
testimony--it just caught my ear--the issue of pulling the
authority from a lender in circumstances. Have you ever pulled
the authority completely?
Mr. Preston. Oh, yes. I think last year, somewhere between
6 and 7 percent of our PLP lenders did not have their authority
reviewed.
Chairman Kerry. Can you give us, maybe in writing, we can
get a little background on those----
Mr. Preston. Yes.
Chairman Kerry [continuing]. Circumstances and numbers. And
in your testimony, you talk about the SBA's oversight as a
whole, and we have just been discussing it a little bit. You
described implementing the offsite monitoring through Dun and
Bradstreet that forecasts whether a loan is at risk of default.
Witnesses on the third panel will testify that that program
collects data already available from the lenders and the
agency's loan servicing contractor, and it arrives at currency
and default rates that differ greatly from the lender's actual
performance, and that is not transparent. And then once it
predicts that loans will go bad, SBA doesn't tell the lenders
which loans could be in trouble so that they could proactively
move on those and try to mitigate against the potential of
default.
So when you say the system, and this is your quote,
``enables the SBA to take corrective action,'' it is a
corrective action that reacts to the default rather than
proactively moving to prevent it. I wonder, don't you think SBA
would be better off moving proactively and altering that?
Mr. Preston. Well, yes, I think it is important to
understand that the decisionmaking process and the rating
criteria is much more complex than any one score we get from
one place. We look at a handful of things. We look at
predictive scores based on widely available information on
individual lenders, and we kind of look at that in an
aggregated basis and that sort of provides a predictive
quality. In addition, we look at historically what is happening
in people's purchase rates. We look at changes in those rates
to see if there are more recent trending issues to face.
All that information is provided to people, to lenders, on
a portal called the Lender Portal. They get information on all
of those areas so they understand how they are doing, not only
in a vacuum, but how they are doing relative to similar
institutions. So they get a significant amount of information.
I think the issue with the lending community right now is
primarily that we don't go down and actually pull individual
credit scores on their individual loans and then give it to
them. Those are widely available tools in the industry.
Contractually, we don't have the ability to do that with a
third party. We would certainly look at potentially providing
that for people in the future.
Chairman Kerry. Is that really the heart of what I asked? I
mean, isn't the question more, if you have been given a very
specific prediction that a loan is going to go bad through this
loan contracting, loan servicing entity, why would you not then
have the transparency that relays that to the lender so the
lender could get involved directly?
Mr. Preston. Yes. I think the way it works is if you have
hundreds of loans in your portfolio, based on the relative
weighting of different credit qualities in that portfolio, it
comes out with a macro estimate of the percentage of loans that
are likely to go bad, given how many loans are kind of in a
lower tier or a higher tier or middle tier. So I don't think we
would go down to the individual level and say, these four loans
are expected to go bad. It more looks at the blend of credit
scores.
Chairman Kerry. Is that a warning bell? I mean, can you
segregate those that are at the lower end?
Mr. Preston. Oh, absolutely. I mean, you could get a list
of companies--yes. This is what I was saying, you could get a
list of companies in that lower credit tier and those are just
based on, like I said, there are many kind of firms out there
that do these types of ratings, most of which may not very
dramatically. We don't have the ability right now to provide
that detailed data to the lenders.
Chairman Kerry. Why?
Mr. Preston. We don't have the ability to do it
contractually right now, but we would look at doing that in the
future if they would like those lists.
Chairman Kerry. Isn't that what you would want to do with
an onsite review?
Mr. Preston. Well, an onsite review, I think, you know, we
really are----
Chairman Kerry. That is a more in-depth review, correct?
Mr. Preston. Yes. We are pulling credit files. I know some
people don't think we do that. Under the new processes, we pull
credit files. We look at their management practices, whether or
not they are complying with policies, so that is a different
kind of review.
Chairman Kerry. Why has the IG suggested and others, even
the lenders have suggested that that, quote, ``in-depth
review'' is actually nothing more than a kind of paper check-
off process? That is their perception from----
Mr. Preston. Well, I think there are a couple of things.
Number one, I think this process has evolved over time. I am
not aware of the IG making that claim, but if he has, I would
be happy to understand that better. I would also be happy to
have our head of Capital Access come up and walk you through
fully what we do on the onsite process.
Chairman Kerry. Well, there is a contention here, and I
think it will be stated here today, that the SBA has a need to
verify the borrowers' financial claims and to make sure the
collateral is legitimate and the equity injection is legitimate
and so forth.
Mr. Preston. Yes. Those things all contribute to credit
quality, obviously. They have made those injections. If we look
at the collateral, if we look at the credit quality. Now, that
having been said, Senator, I would be the first one to say,
especially if it is coming from the industry, if people are
coming forward and saying, we are looking at your new process,
what you are doing onsite, and we think you should bolster it
in one way or another. We would love to understand that in more
detail, and so I think we welcome that kind of input.
Chairman Kerry. Senator Snowe.
Senator Snowe. Thank you, Administrator Preston, for your
comments here this morning. I think it is a real question of, a
sense of urgency about implementing an oversight strategy. This
has been a historical problem with the Small Business
Administration and ultimately can have such negative
consequences for both the SBA and those small firms who depend
on SBA loans guarantees. After reading the IG's report, I think
it is important to make sure that their recommendations are
implemented. If they are not implanted, we need to know why in
a timely fashion.
Mr. Preston. Yes.
Senator Snowe. I am concerned. We objected to the Herndon
Center consolidation. I did as Chair of this Committee and
Senator Kerry did, as well. I think all of us did because of
the concern that it was going to lead to serious problems,
which it did. At that time, we objected to the understaffing of
SBA that has ultimately led to many of these problems. Another
pressing issue has been that the Small Business Administration
has placed an emphasis on loan growth and not overseeing the
quality of those loans. I realize why this is all being done,
because obviously we want to help small businesses. Yet at the
same time, we have a public interest obligation that we must
uphold here.
BLX underscores one of the questions and issues that I
have. Why didn't you take remedial steps with respect to BLX? I
mean, why weren't there any remedies or any penalties? Why
didn't you revoke their preferred lender status, for example?
Because as the Inspector General's report indicates, there
doesn't seem to be very few terminations or revocations. This
enables lenders to essentially ignore SBA's delegated lending
authority requirements because they do not suffer any material
consequences.
What are the SBA policies for imposing penalties? Where is
the accountability? What is the standard for accountability
when we have the magnitude of the failures we are talking
about? They are broad with respect to BLX. The fact that the
SBA would repurchase more than $270 million of potentially bad
loans from BLX, on top of everything else, I think is serious
and consequential. So why aren't you setting forth policies on
the issue of what penalties for lenders who fail to meet
specific and clear requirements? These types of policies would
clearly be a disincentive for bad behavior.
Mr. Preston. Yes. Let me just make one comment before I
jump into that. You should know that I am very directly
personally engaged in the Herndon issues we have and the
reengineering. I am personally on calls every week, going
through the project plans, going through the progress, talking
to lenders about it. So this is something, I think is going to
be a good news story for us in the coming months, and I feel
very good about that.
On the BLX, you are asking more of a question about policy,
and so let me take a step back and say when we have an issue
with a lender, we have a lot of things that we can do. First of
all, obviously, we look at credit quality. If credit quality
goes down, we take a very hard look at the policies in place,
the practices, the credit administration, what they are doing
onsite.
The kinds of things we can do over time, first of all, I
think we begin to do more frequent, more intensive reviews when
we see these situations. Number two, we put in place very
specific corrective action plans. We try to look at what the
root causes at a lender and put in place corrective action
plans. Then at some point, if things don't work out, we have
the ability to pull the PLP status.
The other thing we can do is at the back end. If we are
looking at the loans that we purchase, because of our guarantee
if a loan has gone delinquent. We look at those loans to ensure
that they have followed our policies and our procedures and
that those loans have been done correctly. And if they haven't,
we can withhold all or a portion of that guarantee.
What the new regulations do, and it gets right to your
point because I think you are onto something very important, is
we have to have clear standards in place. We have to have clear
enforcement opportunities in place. And in Herndon and in those
facilities where we purchase those loans, we also have to have
clear policies and practices and procedures in place that are
enforced and get those things to work together.
I think that a lot of what we saw with this particular
lender happened, you know, a few years ago. I think even during
that period of time, since then, we have made a good deal of
progress and I think we have made a good deal of progress in
the last year. I really think in the next year to 18 months, we
will make a good deal more progress.
Senator Snowe. Why can't it be sooner than that? I just
don't understand why it can't be sooner.
Mr. Preston. Well, let me just give you an example. I know
one of the criticisms of the industry has been that we haven't
done enough onsite reviews, which I think is valid. A few years
ago, we had the ability--the lenders paid for those reviews. We
went a couple of years where there were no charges and that was
a budgetary issue. Now that we can charge again, we will be
going through onsite reviews every 2 years. So what we will
see--and we have already kicked that up so that the engines are
kind of geared up to do those more intensive reviews to provide
that better oversight. The analytical information is better,
and then the enforcement actions will be clearer under the new
regulations.
Senator Snowe. Well, so how many lenders have had their
status revoked?
Mr. Preston. Last year, it was about 7 percent--between 6
and 7 percent of the lenders that had that delegated authority.
In reference to Senator Kerry's request, we would be happy to
provide you a list and you can get the numbers.
Senator Snowe. Well, no, I think it is important to revoke
preferred status because it provides a disincentive, you know,
for this kind of behavior. When you look at the extent of
problems with BLX--and BLX was over a period of time, I mean,
it wasn't a limited period of time, it was over many years,
between 2001 through 2006--there were $76 million worth of
fraudulent loans, 27 arrests, multiple convictions, and SBA
purchase of up to $272 million worth of questionable loans.
Mr. Preston. Yes, let me comment on a couple of those
things. I think it is real important for us to understand the
difference as well as the connection between broad loan
portfolio quality, which just has to do with the ongoing
quality of the credit decisions you are making, and fraud.
Certainly in the case of BLX there was a highly sophisticated
group of people within that institution, in a bank among
borrowers. Obviously, high levels of fraud can affect credit
quality, but those are two very different sets of activities
and need to be treated as such.
Senator Snowe. Well, I understand that, but on the
repurchases, why isn't the SBA documenting and verifying the
information prior to the loans being made? I mean, that is one
of the critical issues here. I mean, we have heard too much of
it. We have had 15 reports over this last year-and-a-half
regarding many issues, and I would like to have the Committee
be informed in exactly how many of those recommendations in
those SBA IG reports the SBA has followed. I think that is
absolutely critical.
Mr. Preston. Yes.
Senator Snowe. We need to know. These IG reports are done
for a reason. Now, I am not saying that every recommendation is
essential and there may be some problems with some of the
recommendations. But clearly, they have got to be considered in
a manner that is more than lip service.
Mr. Preston. We would look forward to coming up and working
on that.
Senator Snowe. And so that is the concern. We have 15
reports--I just think it is important to understand that--in
this last year-and-a-half, with a number of recommendations
that have, I think, yet to be implemented on lender oversight
activities by the Small Business Administration. So I think it
is important. So I would like to see exactly what the SBA has
done to follow up on those recommendations.
And the last issue, because I know my time is running out,
is on the projected repurchase rate, the rate of defaults the
SBA projects will occur in lenders' portfolios over the next
year. Now, for this last quarter that ended in September, the
SBA projects that repurchases in lenders' portfolios will
increase by as much as 167 percent, potentially. Now, that 167
percent is a decrease from the previous quarter where the SBA
projected that defaults would increase within lenders'
portfolio by 240 percent. How does the SBA justify those
predictions?
Mr. Preston. I am not sure what you are referring to,
Senator. Is that--are you talking about a particular lender,
or----
Senator Snowe. No, the SBA's analysis of predicted loan
repurchase rate.
Mr. Preston. OK. I am not----
Senator Snowe. This last quarter, the SBA projected that
repurchase rates would increase between 9 to 167 percent----
Mr. Preston. Yes. I would have to look at that. We have
generally, in the last several years, seen our credit
performance actually much better. We are beginning to see some
trends come out of the current credit markets which are a
little concerning, but generally over the last several years,
our credit performance has been pretty good.
Senator Snowe. OK. Again, this is based on the SBA's
projected default rate. If loan default increased
dramaatically, what will you do to address the defaults on this
high number of loans that could be in this category? So we
would like to have an answer to that, as well.
Mr. Preston. Great.
Senator Snowe. OK. Thank you.
Chairman Kerry. Thank you, Senator Snowe.
Senator Cardin.
Senator Cardin. Thank you, Mr. Chairman.
Administrator Preston, your response to Senator Kerry's
question about having adequate resources in order to conduct
oversight review of loans seems to be at odds with the
Inspector General's testimony, and I just really want to give
you a chance to respond. I know you said that you will stay
here during the hearing, but the Inspector General states that
SBA has had a 25 percent reduction in personnel since 2001,
while loan production has increased by more than 100 percent
over that same period. SBA's Office of Credit Risk Management,
formerly the Office of Lender Oversight, has not had a
significant staff increase and is currently operating with less
than its authorized number of personnel.
As a result, it cannot perform the type of analysis that
might detect fraud schemes and isolate high-risk situations, or
investigate lenders with high default rates, and the Inspector
General goes on to state the sheer volume of guaranteed
purchase requests that the agency must process with current
staffing levels, combined with the agency's goal of paying
lenders in a timely manner, has resulted in the careless
purchase reviews that fail to identify loan deficiencies.
Now, Senator Kerry asked you specifically as to whether you
had the staff necessary, and your----
Mr. Preston. I think I said yes, right? Didn't I say yes?
Senator Cardin. You disagree with the Inspector General?
Mr. Preston. Well, I think the Inspector General is looking
at a historical set of events. I can comment on any of those
statements that you would like. We had a 25 percent reduction
that primarily hit the field offices. We are talking about
centralized loan purchasing activities. So some of those people
were moved from the field to a centralized activity. I think
that is what Senator Snowe was talking about. The process of
moving them from the field to the center and setting up that
center provided the agency with a tremendous number of
challenges. That was done 4 or 5 years ago. That has led, in
part, to the backlog and some of the challenges in these
purchasing activities.
Senator Cardin. Would you take issue with the fact that you
cannot detect fraud schemes because of personnel shortages and
that you have a careless purchase review system to identify
loan deficiencies because of staff deficiencies?
Mr. Preston. Yes. I think the careless purchase review
issue gets to the same issue of that centralization process and
that is what we are addressing right now. Where you had loan
review activities having taken place around the country, those
are being brought into a centralized facility. The process of
that centralization, a number of years ago, was not done in a
way--I believe, and I am sure our IG believes--that provided
the right kind of oversight practices, policies, training, all
the stuff you need to do to make sure it is a tight process.
That is very much what we are all about addressing right now.
So I think the IG is current on some very important issues, but
I also believe they are the issues we are addressing.
The other thing I would mention is our reviews. Our onsite
reviews of these banks, are performed through a third party, so
they are not dependent on our personnel levels. For example,
the Farm Credit Administration does the onsite reviews for
small business lending institutions. So that is not dependent
on our staffing level. The staffing issue has to do with when
we get all these purchases in and all these loans get sent to
us for review; we need to review them at the back end. I think
we have made a tremendous amount of progress in addressing
that, but we are not there yet. I think it is going to take us
another 6 to 8 months to get there.
Chairman Kerry. Senator Cardin, if you will permit----
Senator Cardin. Sure.
Chairman Kerry [continuing]. This will not come out of your
time, but while we are on the topic, I just want to come back.
The Inspector General's report of May 8, 2007, specifically
says, ``Staffing problems and an overly aggressive emphasis on
expediting and increasing purchase production at the (Herndon)
center''--now we are talking about the center--``has adversely
impacted the quality of purchase decisions.
For example, the high rate of staff turnover in 2006 left
the center with unfilled vacancies and largely inexperienced
loan officers to review purchase requests. Because supervisor
vacancies were not filled, the center had 3 individuals to
perform supervisory oversight of nearly 3,000 purchase reviews.
Consequently, supervisors either did not review purchase
requests performed by inexperienced loan officers or did not
identify deficiencies the officers missed.
The level of erroneous payments will likely increase given
that SBA has not fully resolved staffing issues at the center
and has launched a major initiative to grow the 7(a) portfolio
by 15 percent in 2007. Increasing the loan guarantee portfolio
without identifying how the existing and additional workloads
will be accommodated places Government funds at increased
risks.''
Mr. Preston. Yes.
Chairman Kerry. It seems to----
Mr. Preston. I think there are either some mistakes--yes,
there are some mistakes in those comments. First of all, there
is no 15 percent goal for 2007. We, with concurrence in the
field, provided a 15 percent goal for a 2-year period, 2007 and
2008, which was later reduced to roughly 10 percent, working
through it with the field.
Chairman Kerry. So it is a 10-percent increase, not 15?
Mr. Preston. It was originally 15 percent over 2 years----
Chairman Kerry. Right. Now it is----
Mr. Preston. Now it is about 10 percent over 2 years,
roughly speaking.
Chairman Kerry. I think the same----
Mr. Preston. In addition----
Chairman Kerry [continuing]. Issue still applies, and we
can quibble on the percentage of the increase----
Mr. Preston. But you know, Senator, it is so important in
looking at this to understand where the breakdowns were and
why. I think we have had some real challenges, and I think the
IG has noted these in that Herndon operation. It has not been
functioning well. There are backlogs out there and it is
something that----
Chairman Kerry. But you have been asked if you have
adequate staff. I mean, I am not trying to have a----
Mr. Preston. It is not a staffing--we have added staff.
Chairman Kerry. You had adequate staffing levels?
Mr. Preston. We have added--we are hiring staff. We will
have adequate staff. It is much more an issue of process
efficiency, consistent standards, good communication with our
banks, which we have not had in that facility. In addition,
most of the purchases--and I think this is the issue the IG was
looking at--most of those packages that come in from banks come
in wrong. There is a tremendous amount of rework. We don't have
the paperwork. We have not done our job in going to banks and
communicating to them how they need to do these packages,
getting them right at the front end, and turning that around
quickly.
So there are a lot of--that is why I hesitate to get into
the detail here because we went into a lot of issues. There are
a lot of very classical--I hate to say it that way--business
sort of engineering challenges that have been in place here and
I think we are addressing them. But like I said, I would be
happy to get up here periodically. We can come up every month
and show you the progress.
The other thing I do want to say is we have been very
transparent about this issue. I have spoken to the industry. I
have spoken widely to our people about it. We have gotten the
numbers out there as sort of a rallying cry to get this thing
fixed.
Chairman Kerry. Let me yield back to Senator Cardin. I
appreciate----
Senator Cardin. No, that was very helpful, Mr. Chairman. I
just point out that the Inspector General indicates that
because of staffing deficiencies, the backup to analyze whether
these purchases of guarantees were proper or not is not there.
So it seems like you don't have the information necessary to
make the right judgments because of the personnel levels, at
least that is what the conclusion of the Inspector General is.
I would feel more comfortable with your response if I just
hadn't completed a hearing in Maryland where we were going over
your outreach efforts, your personnel that you have in the
field that you now say you are bringing back. When you look at
the procurement center representatives, and I understand you
are going to increase those numbers modestly, but we need a
significant increase in services in the field if SBA is going
to be able to carry out its principal function to facilitate
small businesses in dealing with Government procurement and
elsewhere because we are not meeting our goals. We haven't met
any one of our goals, as your reports point out, on Government
procurement.
So if you are taking resources away from the field, I am
not exactly sure we are going to be able to meet the needs
there. I can tell you, by the additional procurement offices,
centers that you are scheduled to open, if every one of them
opened in Maryland, I would be satisfied. But I understand that
is for nationwide.
We are in desperate need of help in our small business
community from SBA, and I have been told over and over again
that a significant part of the problem is the resources that
you have within your agency, and it seems to me I would like to
have the Administrator advocating for the type of services
needed to our small business community and I am concerned as to
whether you have the adequate resources to carry out and
correct the failure of our agencies to meet procurement goals,
let alone oversight of the loan activities. It seems like this
is a continuing problem within the agency.
Mr. Preston. Right. Well, there are a couple of things, I
think, to mention here. The reduction in staff that I think
Senators Snowe and Kerry were talking about was a
centralization process that ended a couple of years ago. I have
increased our staff in the field by 50 people in this past
year. We promoted another 50 people. We have accelerated the
hiring of PCRs in the field by 15 to 18 percent. Unfortunately,
we have had some retirements and movements that have kind of
moved us in the other direction.
But what I would tell you is my allocation of resources to
the field last year and this year have, for the first time in a
while, turned us toward that growth trajectory now in the
field. The field has reacted very, very favorably toward it.
The other thing we are doing is, which we haven't done, is
we are significantly increasing training, specifically in
procurement to support our ability to be effective in helping
those small businesses in the contracting picture, providing
greater tools to other Federal agencies to find those small
businesses. And I will also say--a little advertisement here--
the scorecard we put out there, the new recertification rule we
had issued, and a number of the other measures we have taken
are raising the bar for Federal agencies and they are reacting
by coming our way saying, how can we meet our goals? It has
been very helpful for us.
So I think we are seeing a higher degree of interest across
the Government to engage with small business and we have--there
is a little bit of a lag when you authorize these positions and
you get them in the field, but we have begun adding those
positions in the field.
Senator Cardin. Thank you, Mr. Chairman.
Chairman Kerry. Thank you very much, Senator Cardin. I
appreciate it.
In relation to the BLX case, Mr. Administrator, the
Committee has been told that the SBA paid about $28.4 million
on guarantees, loans underwritten by one loan officer. Is that
unusual? Is that a red flag in and of itself in any way, that
one loan officer in one branch in Detroit, Michigan--it seems
like a lot of money for one loan officer in a branch----
Mr. Preston. I don't know. That authority was delegated to
them as a PLP lender, so the credit decisions----
Chairman Kerry. Do you know what the average is or what the
expectation would be per loan officer? Is there any kind of
measurement or metric on that?
Mr. Preston. That would be within the bank institution if
there were a metric.
Chairman Kerry. SBA wouldn't have an oversight? I mean,
aren't there some red flags for irregularities?
Mr. Preston. I think there are red flags for
irregularities. The number of loans made by a loan officer, I
don't know if that would be an irregularity. Especially in a
lot of these lending institutions, people are very active in
obviously extending capital. So I don't know.
Chairman Kerry. Maybe that is something you might want to
look at and make some judgment about. I mean, I think it would
be interesting to know what that norm is or whether that is, in
fact, a red flag that ought to be established. But can you tell
the Committee what value Dun and Bradstreet provides that can't
be obtained by the SBA working with the FDIC, or the Office of
Comptroller of the Currency, the National Credit Union
Administration, or Federal Reserve Board?
Mr. Preston. Yes. First of all, we would love to be working
with those agencies more.
Chairman Kerry. Say that again?
Mr. Preston. We would love to be working with those
agencies more. We would love to partner with them more
effectively. I think it would reduce some of the burden to the
lenders.
What I would tell you is most--when a bank regulator comes
into a large institution with a broad portfolio, they are
looking at safety and soundness, they are looking at capital
adequacy. Obviously, they do look at the loan portfolio.
Typically, we are a relatively small subset of that portfolio.
We go in, we specifically look much more deeply at the SBA loan
portfolio, their adherence to our regulations, and their
practices and procedures specifically relating to eligibility
and those types of things.
So there is both the issue of our concentrating more
heavily on our pool of loans, as well as making sure that they
comply with unique standards as a Government guarantor rather
than them as an independent lender.
Chairman Kerry. With respect to the BLX situation, I mean,
obviously both BLX and SBA consider themselves victims of the
fraud, and on some levels that is obvious and true. But to what
degree might there have been signs that BLX should have picked
up on and/or SBA? I mean, can you sort of share with us what
the SBA knew and when it began to know it and what action it
took?
Mr. Preston. There were loans that our people in Detroit
referred to the IG. Ultimately, I know the IG worked with the
U.S. Attorney based on work the U.S. Attorney was doing, I
believe based on----
Chairman Kerry. Do you know what first flagged it within
the SBA in terms of the referral?
Mr. Preston. Senator, I don't specifically recall. I
personally know some of the people who told me about it, but I
don't recall what they said were the indicators. But I think
the overwhelming indicator that now, in the cold light of day,
is many of these loans were to a particular industry, which
doesn't always mean something negative. It can mean that a
particular lender has expertise and is doing a good job
reaching out to a particular industry. But that was done--that
is before a lot of these activities were centralized, so I
think it was primarily based on that, but we can get back to
you on it.
Chairman Kerry. OK. I would appreciate that.
Mr. Preston. Now ultimately, when it was found, it was
based on, I think, Secret Service out there doing a different
investigation--the IG can comment on this.
Chairman Kerry. What specific steps have you taken to
prevent it from happening? Please share with us some of what
you learned from it.
Mr. Preston. Well first of all, I think it is important,
for all of us to understand that generally, when fraud is
perpetrated of this type, although it is bad for all of us and
none of us like it, the one who ends up losing financially is
the lending institution. You know, in cases of negligence like
this, we don't cover it. So BLX is paid to cover initial losses
that were detected, has set up additional funding to cover
future losses, and is reviewing all loans going into the
secondary market and coming out of it before we make any
purchases to ensure that they are not part of this scheme. So I
think it is important to understand that from a taxpayer
perspective, we are protected to the extent that we don't cover
those types of fraudulent activities.
Now, what we have begun to do is to work with other
regulators to see the types of analytical tools they use,
whether they look at industry concentrations and other types of
factors to improve our ability to refer those loans to the IG
and highlight them back to the lending institutions.
Chairman Kerry. Well, when you found out about the scheme,
staff from the agency came to brief the Committee, which we
appreciate, but ultimately--but you talked at that time about
the tough disciplinary measures that were going to be taken
against BLX, and then ultimately the agency entered into closed
negotiations with the companies and really kept the details of
any disciplinary actions confidential. What happened between
that briefing and sort of the tough stance and then the private
negotiations and the privacy with respect to----
Mr. Preston. I am not aware of the chronology, and
unfortunately, I can't comment on that. Perhaps one of my
colleagues can. What I would tell you is I didn't really view
this as a negotiation, as much as our coming in as a regulator
and an oversight body, providing our view on what we thought we
needed to do.
The other thing is--my understanding is that you had a
pretty full briefing on the decisions we made. Certainly I
know, in the IG report, you all received a fully unredacted
copy. So if there is any lack of transparency between the
agency and the Committee, I would like to understand kind of
where you thought that was.
Chairman Kerry. Well, we are happy to share that with you,
and I think there may be a little bit here. But coming back to
this initial question, I mean, you said Secret Service or
somebody related part of another investigation, et cetera. I
think the question sort of hanging over the Committee a little
bit--and potentially it ought to be hanging over the SBA--is
sort of why didn't the SBA discover this? What is the mechanism
in place for knowing that these kinds of loans don't take
place?
Mr. Preston. Yes.
Chairman Kerry. I mean, how do we get a sufficient of
scrutiny within the system----
Mr. Preston. Yes. The mechanisms that should be in place
that I think are increasingly in place and will even more
increasingly be in place are the following: I think, first of
all, as we do onsite reviews, as we begin to look at practices
and procedures, look at some individual loans, that match with
portfolio performance that should be able to give us some
indicators if there is a widespread ring of fraud. Second, as
we purchase those loans in Herndon and elsewhere, when we do
the reviews of the actual files, that should also provide us
insight.
I would highlight here, though, that this was a pretty
sophisticated ring of people. You had people in the
institution, people in a bank falsifying equity injections,
cashiers' checks--individual borrowers part of this scheme.
Roughly 15 people were involved, and I think it is very
difficult for a regulator to be able to get ahead of that type
of sophistication. I think it is very important for us to look
at the internal practices of those lenders to make sure that
they get caught.
Like I said, once again, I do take some comfort in the
fact----
Chairman Kerry. Are you not involved in the remedy
component of this with respect to BLX, that you are not sure of
the chronology and you are----
Chairman Kerry. I mean, as Administrator, are you directly
going to be involved in determining what the----
Mr. Preston. In most cases, I wouldn't sit on the committee
that determines remedies and issues for our lenders. In the BLX
case, I have been----
Chairman Kerry. Well, isn't it unusual to have a $70-plus-
million-dollar fraud?
Mr. Preston. Right. In the BLX case--early on, I was
actively involved in the discussions on what I thought the next
step should be. My view was a couple of things. Number one, I
wanted to absolutely ensure that the taxpayer was protected and
that to the extent that these issues--that we protected
ourselves from that perspective. Let us leave it at that.
I think the other issue--this is where I think we continue
to rely on trying to balance our judgment--is when you look at
something like this. At what point is the issue behind you, and
at what point is the issue continuing, and how do you weigh
that against whether or not you want to in any way restrict
capital to small businesses? Those are the kinds of factors we
consider.
Chairman Kerry. Mr. Administrator, I do have a number of
other questions, but the time is pushing us here and we have
two other panels, so I am going to leave the record open and we
are going to submit some questions to you in writing, if we
may. We are not trying to burden you or anything, but we do
want the record to be complete and appropriate.
Let me turn to Senator Snowe.
Senator Snowe. Very quickly, Mr. Chairman----
Chairman Kerry. No, take your time.
Senator Snowe I will be short because of time, but it
really does get back to the fundamental responsibility of the
Small Business Administration to conduct oversight activities
and to do so aggressively.
Mr. Preston. Yes.
Senator Snowe. Are you suggesting that there is no way to
set in place procedures to detect fraud, for example?
Mr. Preston. No. I think what I am saying is we are a
couple steps removed from the process by virtue of what we do
as an external guarantor. So what we need to do is look for
indicators where then we can take those loans and find patterns
to pursue. Then in the purchase process look for individual
loans to highlight and then refer those to the IG.
So no, there are certainly things we can do to be a more
effective referrer of concerns to the IG, but ultimately, I
think the most important thing we can do is make sure that the
institutions involved in the processes and our programs have
processes in place to catch that on their end since ultimately,
that is where it happens. Ultimately, they are the ones that
suffer the loss. I think we all obviously are impacted by it.
It is a terrible thing.
So no, Senator, I think there are ways that we can improve
it and ways to address it. I just think it is important that
each player in this process understands how they can be
effective, given what they have access to and what their roles
are.
Senator Snowe. But you have a number of remedies at your
disposal to take action, do you not? I mean, you have a number
of remedies, corrective measures----
Mr. Preston. Oh, absolutely.
Senator Snowe [continuing]. Legally and otherwise, I mean,
in terms of----
Mr. Preston. Absolutely.
Senator Snowe [continuing]. Either the review process and
taking legal actions against someone or an entity----
Mr. Preston. Actions, working with them on their plans to
improve their internal processes, working--yes, any number of
actions.
Senator Snowe. Well, but it gets back to where you can be
preemptive and preventive. Obviously, one of the issues is
verifying the documentation of many of these loans at the
outset----
Mr. Preston. Exactly.
Senator Snowe [continuing]. And then looking at this
repurchasing rate. That is a huge predictor of potential
problems, and I don't think I understand if any corrective
measures are taken to avert that.
Mr. Preston. Well, I think a couple of things. I think,
first of all, getting the purchase process as tight as possible
so that we have a standardized review process. We have a
standardized process for getting things referred, and then
secondarily it really is in the broader oversight process.
The only thing I do want to say, though, before I leave,
and this may be opening up a bit of a Pandora's box, but one of
the things we do not do is we do not--we obviously have a
portfolio of risk. All lenders are not created equal in terms
of what they do. We may have some lenders that look primarily
at startup companies. Other large lenders have heavily
diversified portfolios.
And I think it is also important as we look at performance
in these portfolios to understand whether or not these lenders
are taking our mission forward and what that implies for credit
risk. That is a very complex set of issues that I don't think
we fully understand at this point. I am not sure that everybody
should be subjected to the exact same rating system, because
ultimately, we are trying to reach people in this country who
have a hard time getting access to credit.
And so what I would expect to do in the coming months, as
we look at this regulation, is to build our understanding of
that issue as well.
Senator Snowe. But I think you have a number of road maps,
including the Inspector General's report, this one and the 15
others along the way in the last year and a half. I mean, there
are road maps to taking corrective measures immediately and
putting in place certain procedures that are predictable and
provide certainty.
Mr. Preston. Right----
Senator Snowe. Just going back, in the Herndon situation,
you have roughly 4,000 unprocessed loans? That would mean
someone would be required to review over 20 repurchase requests
a day. So you have to resolve that backlog, which is what you
had to do----
Mr. Preston. Which is what we are working on----
Senator Snowe [continuing]. In post-Hurricane Katrina and
so on.
Mr. Preston. Right.
Senator Snowe. But here we go again. And so this tells me--
--
Mr. Preston. This is a problem that has been building for 5
or 6 years----
Senator Snowe. I know. That is the problem.
Mr. Preston. So I just want you to----
Senator Snowe. That is why you sense the frustration here,
because it has got to be either something is not working and we
have got to find out what it is. I agree with you, and I have
been sitting here for----
Mr. Preston. Right. No. I think the Herndon backlog issue
has been building for many years and now it is coming down to--
--
Senator Snowe. We objected to it.
Mr. Preston. Based on the corrective measures we are
taking, so----
Senator Snowe. I know, so----
Mr. Preston. I don't want anyone to leave here with the
view that we are going in the wrong direction. I do think these
are complicated, big issues, and I think addressing them
requires some real work. I think we are making a lot of
progress, and we already have, and I think when you look at our
proposed regulations, a lot of those do incorporate the GAO and
the IG recommendations.
Senator Snowe. According to a 2006 report, again by the
Inspector General, the SBA improperly repurchased 44 of the 45
Small Business Express and Community Loans sampled because the
SBA did not obtain the required lender to submit all necessary
documentation required to make proper purchase decisions. That
is a high rate of deficiency in that group, there is no
question. The Inspector General estimates that roughly $130
million in disbursements on 2,729 loans purchased before
February 1, 2005 were not properly reviewed by the SBA.
Senator Snowe. Are we avoiding that now?
Mr. Preston. That is really part and parcel of the Herndon
issue. The thing I would say is that doesn't mean that those
were loans that ultimately we shouldn't have purchased. It
implies that----
Senator Snowe. They were all part of the Herndon Center----
Mr. Preston. Well, it says that you might not have had all
the documentation you were supposed to get.
Senator Snowe. Are we avoiding it for the future? I know
what we are going through. Are we avoiding it for the future?
Mr. Preston. No. We are doing a lot of heavy lifting right
now to fix this, and frankly, we would be, like I said, happy
to take your staff through the detail of any of this stuff,
because like I said, I think this is going to be a very
positive story.
Senator Snowe. I think for the Committee, I think we need
it for the Committee.
Mr. Preston. Yes.
Senator Snowe. I think we need to know where we stand.
Mr. Preston. Yes. We will----
Senator Snowe. I think we have to have some time lines
here, because----
Mr. Preston. We have got time lines----
Senator Snowe [continuing]. With the volume of what SBA
does, it has got to be loan quality, as well as loan volume. We
understand some of the risks inherent----
Mr. Preston. But Senator, as anyone in my row behind me
will tell you, we have time lines, deliverables, metrics, and
milestones on virtually everything at the agency right now. So
we will be happy to do that for you.
Senator Snowe. One other question that I have. It is on the
Women Procurement Program----
Mr. Preston. Yes.
Senator Snowe [continuing]. For women-owned businesses. You
said it would be implemented by the end of the fiscal year. It
has been more than 2,500 days now. In 2000, this was
established and it remains unimplemented----
Mr. Preston. Right.
Senator Snowe [continuing]. By the Small Business
Administration, and you said by the end of the fiscal year.
That is coming along----
Mr. Preston. I said I would do everything I could. Yes. It
has been a very frustrating process. I know it has been more
frustrating for you because you preceded me, and we are in
interagency process once again. I am very hopeful that by the
end of the year, we will have something to go public with.
But----
Chairman Kerry. Actually, Mr. Administrator, if you recall,
we have a January 18 commitment on that, remember? We had a
specific--you weren't here. Who made that? It was--I am trying
to remember who made--your Associate Administrator for
Entrepreneurial Development was here, Mr. Prakash, is that it?
Mr. Preston. Oh, OK.
Chairman Kerry. He guaranteed this Committee in open
testimony that this will be implemented and done by January 18
in its entirety, and we agreed to have an oversight hearing
here at the end of January, after the 18th, in order to review
that to make sure it has been met. What I would like to do is
add this other stuff to that and have an agreement, and I would
like your agreement that you would personally be here with
whomever you think is important from the agency so we can have
an update on all of these issues, the disaster program----
Mr. Preston. Right.
Chairman Kerry [continuing]. And the 7(a) reforms that you
are putting in place, and, of course, the Women's Procurement
program which we have been waiting 6\1/2\ years for.
Mr. Preston. Yes. I would like to come over here when we
have something to announce on Women's Procurement. I am pretty
hopeful by that time we will have something to announce on
Herndon and on----
Chairman Kerry. He made a commitment to this Committee. We
will get the language to you. If accountability is going to
mean anything, we will get the language to you.
Mr. Preston. OK. Yes. On disaster, we can come over
tomorrow. We have got everything you could ever want on that
right now.
Chairman Kerry. Seven years on the procurement program.
Senator Snowe. Two thousand five hundred and seventeen
days, to be exact.
Chairman Kerry. Thank you, Mr. Administrator.
Mr. Preston. All right. Thank you.
Chairman Kerry. We appreciate it.
Senator Snowe. Thank you.
Chairman Kerry. Can I ask the Inspector General, please,
Eric Thorson, if you would come for the panel.
Mr. Thorson, you have previously served as the Chief
Investigator for the Senate Permanent Subcommittee on
Investigations and the Senate Committee on Finance and we are
grateful for your observations and reports and we welcome your
testimony.
If you could try to summarize, we have questions and
obviously we are very familiar with it, so if you could
summarize and move on.
Mr. Thorson. Yes, sir.
Chairman Kerry. Thanks.
STATEMENT OF ERIC M. THORSON, INSPECTOR GENERAL, U.S. SMALL
BUSINESS ADMINISTRATION, WASHINGTON, DC
Mr. Thorson. Chairman Kerry and Ranking Member Snowe, I
appreciate being here this morning.
On the morning of January 9, 2007, as a result of a lengthy
investigation, special agents from the Office of Inspector
General, with the help of the Secret Service, began a sweep in
Detroit, Michigan, resulting in the arrest of 18 individuals.
Among those arrested were former BLX executive vice president
Patrick Harrington and former Huntington National Bank vice
president Deborah Lazenby. Mr. Harrington was charged with
making at least 76 fraudulent SBA guaranteed loans totaling
about $76 million. We believe this is the largest 7(a) loan
fraud scheme in SBA history. Both Mr. Harrington and Ms.
Lazenby have plead guilty. So far, our investigation has
resulted in the indictment of 27 individuals, of which 3 are
currently international fugitives. This criminal investigation
is continuing with further indictments expected.
These rather dramatic events raise questions about SBA's
oversight of its lenders and led our auditors to review SBA's
oversight of BLX from 2001 to 2006. This audit focused on how
SBA monitored BLX during this period and whether SBA took
effective actions. It was not an audit of BLX.
In summary, we found that SBA was aware of recurring
performance and compliance issues, but there were few
consequences for its performance problems. We believe that the
high rate of default and other problems with BLX loans
presented undue financial risk to SBA and therefore merited in-
depth reviews of the defaulted loans as well as possible
suspension of SBA's preferred lender status, which allows BLX
to approve loans with virtually no prior review by SBA.
Despite problems with BLX's loans, however, SBA continued
to renew the delegated PLP lending authority and to honor
guaranteed purchase requests without taking any additional
precautions, paying out $272.1 million in guarantees between
2001 and 2006. Quite simply, SBA did not hold the lender
accountable for its performance problems.
While SBA has been slow to develop its lender oversight
program, we acknowledge that they have taken significant steps,
which are identified in my written statement.
Despite these efforts, we believe the deficiencies we
observed in SBA's handling of BLX are symptomatic of systemic
issues that have restricted the effectiveness of SBA's
oversight. These issues fall into five categories.
First, SBA has focused on the quantity of loans, not the
quality. SBA sets goals for loan production, but not for loan
quality or lender performance. This emphasis on production has
created an environment where it may be difficult to take
corrective action against the large lenders when doing so might
jeopardize the attainment of SBA's goals. We believe SBA may
have been reluctant to take enforcement action against BLX
because it is among SBA's top ten lenders in the value of loans
dispersed.
Second, SBA has delegated broad loan-making authority to
lenders without making corresponding increases in its
monitoring and oversight efforts. Currently, more than 87
percent of SBA loans are made using delegations of authority
with minimal oversight by SBA. While SBA has assumed more risk
and has taken some important measures to monitor lender
performance, it has not fully implemented compensating controls
to mitigate that risk.
Third, reductions in personnel over the past 5 years have
diminished the agency's capacity to provide oversight at a time
when it is growing its loan portfolio. SBA personnel have been
reduced by 25 percent since 2001, while loan production has
increased more than 100 percent during this time. SBA has not
adequately staffed its lender oversight office and does not
analyze loans to detect fraud schemes or identify high-risk
situations.
Also, significant backlogs exist involving thousands of
lender requests for SBA payments on defaulted loans, some going
back 6 years. An inadequate review of these defaulted loans
have failed to identify loan deficiencies. Although SBA is
taking steps to revamp the purchase review process, it recently
determined that more than 50 percent of all backlogged 7(a)
purchase packages were missing significant documents. In
addition, untimely reviews by SBA limit the OIG's ability to
effectively investigate and prosecute criminal fraud.
Fourth, a conflict of interest exists between SBA's lender
advocacy and oversight roles. The Office of Capital Access is
responsible for promoting loan growth and lender participation,
but at the same time, is also conducting lender oversight and
enforcement. These functions are incompatible and should be
separated to preclude organizational conflicts of interest.
Fifth, SBA has not focused on fraud detection. Although the
size of SBA's loan portfolio and its reliance on lenders for
loan making has made SBA's loan programs vulnerable to fraud,
SBA has made only limited efforts to detect fraud. OIG
investigations have found that loan agents, or packagers,
perpetrate schemes on multiple loans causing losses of tens-of-
millions of dollars. This was evident in the above-mentioned
arrest. OIG has for years recommended that the agency track
loan agent involvement so that quick action can be taken to
prevent losses if fraud is detected. However, agency efforts to
track loan agents have thus far been ineffectual.
Finally, let me briefly address questions regarding our
audit report and the numerous redactions it contains. This
report is a rather unusual circumstance because it necessarily
discusses the actions of a private sector company and agency
deliberations. I have great respect for Mr. Borchert, the SBA
General Counsel, so when his office asserted that the
redactions were needed to protect agency privileges and agency
operational practices, we accepted those concerns. Simply put,
we do not wish to cause any harm to the agency and, in fact,
strongly desire to make it better. Although we do not
necessarily agree with the legal explanation for some of the
redactions, the safest path was to post the report with SBA's
requested redactions.
I appreciate the opportunity to talk about our report
today, and I also want to acknowledge the presence today of Mr.
James Hudson and Debra Ritt who were responsible for the
excellent report that you have in front of you. Thank you.
[The prepared statement of Mr. Thorson follows:]
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Chairman Kerry. Thank you very much, Mr. Thorson. First of
all, let me thank you for keeping your promise to this
Committee, which we don't take lightly, which was the notion
that you would fulfill these responsibilities with independence
and to the best of your ability to protect the public interest,
and I think you really have done that and are doing that, and
so we welcome the report.
We certainly welcome any explanation the SBA may have to
the contrary. We are here to find facts, not to pick winners,
and so we would love to hear some of those things to the
contrary. But I think the observations that you have made are
not insignificant, and they are certainly important to
understanding what is and isn't happening.
Let me just ask you up front if you could perhaps share
with us, for a moment, on this issue of staffing and personnel
and the questions Senator Cardin asked and I asked--can you
just share with the Committee what your perception is about
where the SBA is at this point in its ability to track fraud?
Mr. Thorson. In the area of staffing, obviously the fact
that there is a backlog would address that question----
Chairman Kerry. I was struck by that. You just said a very
significant backlog.
Mr. Thorson. Right. You have two different aspects here
that you could address, and one, of course, is the effect of
having this backlog exist and being able to deal with it and
get rid of it. The other is to detect fraud, and those are
really two very different issues.
One of our concerns is that, in the desire to get rid of
the backlog, it is almost human nature to do a more cursory
review----
Chairman Kerry. Push things through rapidly----
Mr. Thorson [continuing]. Of the files in order to move
them out, and we understand that. We don't expect--this office
certainly does not expect SBA to do an in-depth review of every
single loan file. That is not practical. But where you can
target, where you can find problems, there are a number of
parameters that we could throw out here and discuss about how
to identify the targets where you need to focus your efforts--
--
Chairman Kerry. Have you memoed the various responsible
parties to that effect?
Mr. Thorson. There was a report done in February, among
others.
Chairman Kerry. February of this year?
Mr. Thorson. Yes. But what we want to do is to get people
to focus on where the effort needs to be made, and
occasionally--not always, not in every case--do an in-depth
review and look at what is there. We don't expect, for
instance, the auditors to identify that in the case that I
mentioned to you, there were phony cashier's checks creating
evidence of equity injection, that these were phony checks. We
don't expect that. But what we do expect is for there to be
elements to alert people to possible fraud and, therefore, we
can then take it from there and investigate it.
But it all comes down to the idea of staffing the purchase
reviews so that you do get a good look at what has gone on with
these loans. It may not involve fraud. It just may be that they
didn't really fulfill all the requirements that were required
of them when they granted that loan. They are making credit
decisions on behalf of the U.S. Government. The Government is
backing those credit decisions and we need to make sure that we
are living up to--or that the lenders are living up to their
responsibilities.
Chairman Kerry. Do you have perhaps a two most important
change list, or three, whatever it is, that you think the SBA
ought to undertake in order to improve the oversight and
prevention of future fraud?
Mr. Thorson. Rather than two, I would probably say there
are four. The two that I just mentioned were: identify where
your problems are and target those problems; second of all,
devote the amount of resources to it that is necessary to do a
timely review.
The third one would be to do occasional in-depth reviews in
that target area so that you can--not every case, but where you
can really find out what kind of product these lenders are
giving you. And then the fourth one is accountability, that is
to take some action based on what you are finding.
When you find that there are problems here with any lender,
whether it is BLX or anybody else, be prepared to take some
sort of action against that lender to, not to put them out of
business, but to bring them around so that they will begin to
improve their process.
Chairman Kerry. Now, your report said that since 2001, the
SBA has identified recurring problems in the performance of
BLX, is that correct?
Mr. Thorson. Yes, sir.
Chairman Kerry. Can you relate what those recurring
problems identified were?
Mr. Thorson. I think they range anywhere from credit
issues, how they administer credit, to analyzing the ability to
repay. Is the package complete, were the elements that were
required by SBA, were they complied with? Then, of course, you
have any issue of fraud that may be present.
Chairman Kerry. Why was the investigation of BLX initiated?
Mr. Thorson. You mean the criminal investigation, or the
audit?
Chairman Kerry. The criminal.
Mr. Thorson. The criminal investigation was actually
started back around 2002 by allegations that were made from a
number of sources, some of which I believe you have statements
from, that are commonly referred to as short-sellers. The SBA
did investigate a lot of those issues, but didn't find that
there were enough specifics there to be able to bring a
criminal case. There were other issues that developed along the
way on the non-fraud side of it, which was an issue in 2002,
which suggested that there were problems with loans; and then
in 2005, the OIG issued a Management Advisory Report detailing,
I think it was seven loans in violation of SBA procedures and
material misstatements to SBA. In fact, to their credit, BLX
offered to repay one of those loans, but for some reason, SBA
sent them an e-mail stating that they were being too hard on
themselves; and they didn't need to do that. The criminal
investigation was pretty much----
Chairman Kerry. You have got to come again with that one.
Mr. Thorson. I am sorry?
Chairman Kerry. You have got to hit me again with that one.
Mr. Thorson. OK.
Chairman Kerry. The SBA did what? They wrote them back and
said, don't worry?
Mr. Thorson. That is the information--neither myself nor
Mr. Preston was with SBA at that time, but that is the
information I have, yes.
Chairman Kerry. It is my understanding that you have a
second report underway now. Is that because your judgment is
that non-bank lenders and their oversight warrant additional
concern from your office?
Mr. Thorson. Yes, also the fact that we are not--this audit
report was not really on BLX. We used it as sort of a case
study because of the criminal case, but what we wanted to do
was to focus on the SBLCs, Small Business Lending Companies,
and make a determination, is this widespread--are these
problems as big as we may think they are, or is this an
isolated incident? It seemed only natural that we would expand
the report to look at other SBLCs, as well.
Chairman Kerry. And as you know better than anybody, the
public version of your July 11, 2007 report was only released
this past month. Why did it take so long after the official
completion of the report for it to be released?
Mr. Thorson. Why did it take so long until what?
Chairman Kerry. For it to be released publicly.
Mr. Thorson. Primarily because of the debate on the
redactions. We were dealing with both the attorneys for BLX, as
well as the General Counsel of the agency----
Chairman Kerry. Who insisted on those redactions? Did you
insist on them? Did the SBA----
Mr. Thorson. I am the one who made the decision to go ahead
and put it out with the redactions that you see before you.
Chairman Kerry. Who insisted on the redactions?
Mr. Thorson. The General Counsel's Office was one. The BLX
attorneys did.
Chairman Kerry. The General Counsel----
Mr. Thorson. We rejected the claims of the company, but I
did accept the redactions from the General Counsel's Office.
Chairman Kerry. In your opinion, are all of the redactions
legally supportable?
Mr. Thorson. No, but in fairness to their office--I am not
an attorney--I used common sense when I looked at some of these
and made my decisions on that.
Chairman Kerry. Was there any reason----
Mr. Thorson. We also have our own counsel, though----
Chairman Kerry. Can you explain why three of your
recommendations would be redacted?
Mr. Thorson. I am still having a hard time with that one.
They gave a legal reason for each of the redactions and I
accepted those because of----
Chairman Kerry. Did your recommendations specifically
mention any potential trade secret or anything specific to a
company or anything specific that would fall under----
Mr. Thorson. No.
Chairman Kerry [continuing]. The three exclusions stated?
Mr. Thorson. No. Actually, they are--after you read it, I
think you would pretty much come to the conclusions of what
those recommendations would be just simply from reading the
report. I think it is pretty common knowledge that we have
taken--in fact, in my own statement, we have taken issue with
the PLP status of BLX as it progressed. I mean, things like
that would be a pretty normal situation for the office to
recommend.
Chairman Kerry. Senator Snowe.
Senator Snowe. Thank you again, Mr. Thorson, for your very
sensitive and thorough work with respect to these critical
issues and troubling ones, frankly. As you know, these
longstanding issues are my deepest concern. I know that
Chairman Kerry shares the same concerns as to whether or not
the Small Business Administration is in a position to take the
corrective measures that are essential to preventing similar
problems in the future. I guess while there may be some
distinctions obviously between fraudulent actions, and just
having measures in place to make sure that they are following
correct procedures; nevertheless, there is an ability to
establish procedures that would ultimately detect fraud, a
potential risk for fraud----
Mr. Thorson. Right.
Senator Snowe [continuing]. And when you talk about 50
percent of some of the loans, is that what you are reviewing
now? Are you saying that 50 percent of these loans don't have
accurate documentation at the Herndon Center?
Mr. Thorson. Yes.
Senator Snowe. Fifty percent?
Mr. Thorson. The problem with that is not only can we not
really get a good feel for what some of these packages contain
as we may look at them, but it also prevents the agency from
really understanding whether or not the package was complete at
the time it was made, whether or not they can, if they see
problems to go back against the lender and get the money back
in an improper payment--recovery of an improper payment.
Senator Snowe. Well, what you heard this morning from
Administrator Preston in response to questions, do you feel
that the Small Business Administration is in a position of
taking the measures necessary to begin to address many of these
issues? You have obviously issued a number of reports over the
last year-and-a-half. Have any of these recommendations been
implemented or adopted by the SBA? Finally, what is your
response to what you heard here today with respect to the
responses by the Administrator to your report?
Mr. Thorson. In my written statement, we outlined the steps
that the agency was taking, and we certainly applaud that. I
guess it falls to the normal task of an IG to look at those as
they progress through time and make sure that they work and
that they accomplish what they were designed to do. It is going
to take a little bit of time. Most of these are new. So we want
to take a look at these over time to make sure that these steps
are effective and doing what they were designed to do. But we
certainly admire the fact that they have put these steps in
place and are making these efforts.
Senator Snowe. Do you think in both verifying the loans at
the outset, as well as addressing the issues I mentioned, the
repurchase rate as a predictor of the potential for loan
default becomes a critical indicator?
Mr. Thorson. Absolutely, yes. You obviously have two types
of reviews here, the pre-reviews which are done before--in this
case--before BLX can sell the loan on the secondary market, and
then you have the post-purchase reviews which are done after
the money is paid out on a defaulted loan. So in each of those
cases, what you really want to do is to learn what you can
about--you can learn obviously about the package individually,
but you can also learn a great deal about the lender and the
way they are operating in the SBA guaranteed environment.
Senator Snowe. Could you understand why they continued to
renew the status of BLX? I mean----
Mr. Thorson. No. It is----
Senator Snowe [continuing]. In reading the report here, it
really truly is mystifying and disconcerting.
Mr. Thorson. It is really one of the things that we had a
hard time with, and I understand the agency's concern about
affecting their business, and the argument was made, I believe,
by BLX that it would put them out of business. I personally
don't believe that is true, but then again, I haven't seen all
that was presented to them; so there is a legitimate concern
for that as I do understand it.
But the other concern that they have to have is to make
sure that when you have given a company--in this case--or a
bank, or anybody, the right to make credit decisions on behalf
of the Government because that is who is backing these loans,
we expect the money to come back. We need to get that money
back. And therefore when you do that, the primary concern has
got to be that we have trusted that lender to use good
judgment, to use good banking procedures, and to make good
loans, and therefore we shouldn't have these kind of problems.
How many ways can you hold them accountable? There are not
many, but one of them is that big one. That is the PLP status.
Senator Snowe. I couldn't agree more. That is something
that we are going to have to clearly focus on, as you are
recommending, established policies for penalties--that has to
be abundantly clear and evident. The Small Business
Administration must be prepared to invoke those penalties and
consequences----
Mr. Thorson. Right.
Senator Snowe [continuing]. On troubled lenders----
Mr. Thorson. And in fairness to the agency----
Senator Snowe. We gave the preferred lender status to
expedite the loan approval process, to make it easier, remove
barriers, so on and so forth, but commensurate with that was a
fiduciary responsibility to the American taxpayer, and that
hasn't happened and----
Mr. Thorson. Right. In fairness to them, one of the things
the Agency points out is that they will shorten the time span
for the PLP renewal. But if it is always renewed, that doesn't
really seem to have any effect. If you can count on the fact--
and in one case we notice it was even renewed retroactively--it
really has no effect. You can pretty well count on the fact
that you have got it. But it is one of the very few ways to
really hold the lender accountable and to force them to move
more toward compliance with your policies and procedures.
Senator Snowe. You have mentioned, I understand, that SBA
does not treat all lenders with troubled portfolios the same;
the small lenders with poor performance often have the renewal
of their preferred lending authority denied, but in other
cases, large lenders with the same problems do not. Is that
true? I mean, do you see that?
Mr. Thorson. Yes.
Senator Snowe. You do? So there is a disparate approach to
small lenders versus large, and it is all due to volume,
again----
Mr. Thorson. It would probably be good to be able to try
and provide you some exact numbers which I honestly don't have
today. But that is the case. And in fact, I think one of the
questions asked earlier of the Administrator was how many did
you revoke, and if that is true, then what happened here? This
was--I have got to believe--a pretty bad example of what can
happen, and if this didn't result in revocation, then why did
the others? Or another question is, how many of those that were
revoked were due to other Federal regulatory agency actions,
and not exclusively because SBA took action?
Senator Snowe. Finally, in your estimation, given the
analysis and investigations that you have conducted, do you
believe that BLX is the norm, potentially the norm, or the
exception?
Mr. Thorson. No, I don't think this is a normal situation.
I think what it is right now is we don't know where this is
going. I will tell you the Troy, Michigan office is closed, but
the investigation is ongoing. So as far as the criminal case,
that is about all we can really tell you. But this has been an
interesting situation.
Senator Snowe. Well, thank you. Thank you, Mr. Thorson.
Chairman Kerry. Thank you, Mr. Thorson. Thank you, Senator
Snowe. It is an interesting situation. Obviously, all of us
hope it is merely a singular individual situation and that it
doesn't point to a larger issue. It obviously is incumbent on a
whole bunch of folks to make certain of that----
Mr. Thorson. Right.
Chairman Kerry [continuing]. And that is the job of--your
job, to some degree, Mr. Thorson, but it is particularly the
job of the SBA itself and the lending institutions. They are
going to have to take a look at their own processes to
guarantee that an awfully important program doesn't get
jeopardized as a consequence of what we all hope is a singular
individual, a sort of aberration, and that is obviously our
hope.
So I thank you for testifying today. As I said, the record
will remain open. We may have a few more questions in writing,
but we thank you very much for being here today.
Mr. Thorson. Thank you.
Chairman Kerry. Could I invite the third panel, please, Mr.
Bob Tannenhauser, chairman of Business Loan Express; Anthony
Wilkinson, president of the National Association of Guaranteed
Government Lenders; and Jim Baird, executive director of the
Bay Area Development Company and vice chairman of the
Legislative Affairs Committee, National Association of
Development Companies, all of whom are involved in and are
deeply affected by the testimonies of the prior two panels and
what we are talking about.
Thank you, folks. I appreciate you being here. Before we
begin, let me just emphasize something. I want to reiterate.
Mr. Tannenhauser, I want to make certain that you understand
and the public understands that your invitation here is not
intended to put some kind of undue or inappropriate focus on
BLX, and personally, I know you take great pride in the
leadership of your company and in your effort to help small
business owners.
I fully want to respect the fact that this Committee exists
for the purpose of helping small businesses. Our objective is
to expand access to affordable financing for small businesses,
and since this story broke, the Committee has taken a very
measured approach to the news, asking the questions about the
SBA oversight and reaction, but leaving the disciplinary
decisions entirely to the SBA, and I think we have refrained
from any sort of public bashing sessions. As you know, we have
never recommended for or against radical calls for BLX to lose
its preferred lender status, delegated loan privileges, or to
cease BLX's ability to sell SBA loans on the secondary market.
BLX's representatives and employees have stated many times
that BLX has been unfairly beaten up in the press as a result
of the actions of one of its lending officers and that the
SBA's IG report is unbalanced and inaccurate. So this is your
opportunity to share with us your perspective and your side of
the story and we look forward to having a good, healthy
discussion here.
Mr. Baird and Mr. Wilkinson, we look forward to your input
on this overall situation and the issues that have been
discussed here this morning, so thank you very much, each of
you, for being here.
Mr. Tannenhauser, why don't you lead off and we will go
right down the line. If you could all summarize. I want to give
you adequate time, but your full testimonies will be placed in
the record as if read in full.
STATEMENT OF ROBERT F. TANNENHAUSER, CHAIRMAN, BUSINESS LOAN
EXPRESS, LLC, NEW YORK, NEW YORK
Mr. Tannenhauser. Giving a brief summary. Chairman Kerry,
Ranking Member Snowe, Members of the Committee, thank you for
inviting me here today. I am Robert Tannenhauser, chairman of
the board and formerly president and CEO of Business Loan
Express, LLC, known as BLX, a national non-bank lender.
BLX is a leading participant in the SBA's loan programs,
having made more than 9,000 SBA loans totaling more than $3.6
billion since 1994. BLX has played a critical role in the SBA's
7(a) program, which is specifically designed to help borrowers
who cannot otherwise obtain credit. Since 2001, approximately
77 percent of BLX's SBA loans have been made to minorities,
women, veterans, and borrowers in low- to moderate-income
areas.
Even though SBA lending is inherently higher risk, BLX has
a robust performance record. We have consistently maintained
loss rates well below SBA industry averages by strong
underwriting and collateralizing our loans with real estate.
For the past 6 years, BLX has been audited annually by the Farm
Credit Administration. SBA has taken into account the results
of those audits in renewing BLX's PLP status.
BLX has no financial incentive to condone fraud and every
incentive to avoid it. BLX generally retains at least a 25
percent stake in each loan and remains liable to the SBA for
the remaining 75 percent if fraud or mistakes occur in our loan
processes.
In January 2007, indictments were unsealed charging five
individuals, including a former BLX office employee with fraud
in originating SBA guaranteed loans. Last month, that
employee--former employee, Pat Harrington--pleaded guilty to
one count of conspiracy and one count of perjury. It is an
understatement to say that this has been a difficult chapter in
BLX's history, and I am personally saddened and disappointed by
the misconduct of our former employee. I wish we had become
aware of his activities earlier. Our records indicate that Farm
Credit Administration reviewed several of these loans going
back almost 4 years with no indication to us of fraud.
Obviously, such wrongdoings are difficult to detect.
Well before the indictments, a nationally known law firm
was engaged to conduct an internal investigation of our Detroit
office. BLX also made a business decision to stop originating
gas station loans in Detroit and removed Mr. Harrington as head
of the office and from loan originations. By September 2006, we
had closed the Detroit office and severed our relationship with
Mr. Harrington.
BLX is a victim, not a perpetrator, of this fraudulent
scheme. When the indictments were announced, before any
findings of wrongdoing were made, BLX pledged to reimburse the
SBA for any losses incurred as a result of the fraudulent
activities by current or former BLX employees. BLX paid more
than $8 million to the SBA and placed another $10 million in
escrow. BLX has incurred significant losses of its own, writing
off $9.8 million on loans that the Government asserts were
fraudulent originated by our former employee in Detroit.
BLX is a very different company today than it was when
these fraudulent activities began many years ago. We have
invested millions of dollars and countless hours enhancing our
internal controls.
I would now like to comment on the OIG report, which I
believe is fundamentally flawed. The OIG did not itself audit
BLX, but rather, relied on audits conducted by the Farm Credit
Administration. The OIG report paints an inaccurate picture by
excluding the Farm Credit auditors' ultimate findings and
conclusions which strongly support the SBA's decision to renew
BLX's PLP status. Instead, the OIG simply cited a few
subsidiary comments in the Farm Credit audits to support an
apparently preconceived conclusion.
Unfortunately, I cannot provide more detail because
criminal laws prohibit lenders from disseminating the contents
of Farm Credit audits. I urge you to request copies of the
audit reports. I am confident that after reviewing them, as
well as BLX's written response to the OIG, you will conclude
that the OIG report is replete with inaccuracies and
inconsistencies.
I appreciate the opportunity to testify today, and I want
to state in the strongest terms that BLX is committed to
preventing fraud in the loan process. We welcome engagement
with the Congress and our regulators in this endeavor. Thank
you.
[The prepared statement of Mr. Tannenhauser follows:]
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Chairman Kerry. Thank you, Mr. Tannenhauser. I appreciate
it.
Mr. Wilkinson.
STATEMENT OF ANTHONY R. WILKINSON, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, NATIONAL ASSOCIATION OF GOVERNMENT
GUARANTEED LENDERS, INC., STILLWATER, OKLAHOMA
Mr. Wilkinson. Thank you, Mr. Chairman, Ranking Member
Snowe. I appreciate the opportunity to testify today on SBA's
lender oversight efforts.
We recognize the benefit of quality lender oversight and
support its implementation. Since the introduction of Federal
credit reform, our member institutions have witnessed the
impact that portfolio performance has on subsidy rates and
program fees. We are acutely aware that when individual lenders
do not engage in appropriate loan underwriting, servicing, and
internal control practices, the results to the program can be
detrimental in terms of the future costs to borrowers and
lenders. Therefore, it is in my members' individual and
collective interests that SBA engages in a sustained, effective
lender oversight program. That said, a quality lender oversight
program cannot guarantee that it will detect or prevent all
fraudulent activities.
In regards to BLX, I would like to just throw out a couple
of numbers to put the information today in perspective. Since
the start of credit reform, lenders and borrowers have paid in
excess of $1 billion in fees more than were necessary to offset
the cost of this program. During the time period that Mr.
Tannenhauser referenced, over 500,000 loans have been made for
something like $61 billion, which leads me to the conclusion
that this has been a statistically insignificant event in terms
of the entire portfolio.
We applaud Mr. Tannenhauser for his attention to this fraud
issue and his willingness to minimize the agency's losses, and
it is unfortunate that small business has lost a staunch
minority advocate and the industry has lost a corporate partner
that has historically supported SBA's goal of reaching
underserved markets.
A quality lender oversight program should provide a cost
effective, statistically valid means of detecting increased
risk in the overall SBA portfolio, as well as in individual
lender portfolios. Initially, this is typically accomplished
with a properly functioning offsite monitoring program. Upon
detection of adverse trends, the oversight program should
direct an onsite review of the institution's asset quality and
lending practices to validate concerns, provide corrective
actions, or issue enforcement direction.
We do not believe the current offsite monitoring program
being developed by the SBA will meet its intended objective.
The SBA already has access to significant amounts of data
relating to historical loan performance, delinquencies, and
lender activity. However, it does not appear that this
information is routinely utilized as part of an early warning
risk assessment system.
The SBA is instead relying upon a Dun and Bradstreet
computer program that forecasts a percentage of loans in a
lender's portfolio at high, moderate, and low risk of default.
Unfortunately, the forecast criteria, as well as the specific
loans identified as high-risk are never shared with the lender.
The lender is unable to determine whether it agrees with the
analysis; and if it does agree, to take appropriate action. Our
desire is not to know the precise formula for determining a
lender's rating. However, we do expect sufficient detailed
information that will help us implement corrective action and
reduce the portfolio risk.
In addition, the SBA is requiring the participating lenders
to pay for this Dun and Bradstreet program through separate
fees. Lenders were not provided sufficient information to
determine if they are receiving any value for this cost.
Moreover, portfolio performance forecasts by the Dun and
Bradstreet model are highly questionable and appear unreliable.
The results of the ongoing offsite analysis should be
supplemented with onsite reviews for any participating lenders
deemed to be high risk. It is imperative that the onsite
activity provides timely feedback and meaningful analysis to
the participating banks and the SBA. It is an established fact
that the bank and credit union industries already have
substantial lender oversight from its respective regulators.
NAGGL believes that before initiating its own onsite lender
activities, the SBA should be required to demonstrate that it
is adding value to current Federal and State oversight efforts
and not just duplicating existing efforts and costs. It would
appear reasonable for the SBA to work with the existing
regulatory agencies to accomplish its onsite examination
objectives and ensure consistent application of examination
procedures by regulatory experts to provide safety and
soundness testing of SBA portfolios.
Under the current fee structure for the lender oversight
program, the SBA has based the monitoring costs on a lender's
outstanding guaranteed balance versus a proper risk-based fee
structure. SBA's evidence reflects the greatest risk in low-
volume lenders and non-federally regulated lenders. The SBA
should reassess its fee structure under a risk-based allocation
and not have the most active participants bear the cost of
under-performing high-risk lenders.
Mr. Chairman, I would like to congratulate you and Senator
Snowe on the introduction of S. 2288, a bill that would
significantly improve SBA's lender oversight function without
unduly increasing the regulatory burden on lenders. We believe
that S. 2288 is a major step forward in improving lender
oversight.
Also, the SBA has just published a 35-page proposed rule on
lender oversight. The primary focus appears to be enforcement
actions and not safety and soundness standards and we will
submit a formal letter of comment on the proposed rule at a
later date.
Despite the need for adequate lender oversight, the
performance of the SBA portfolio has been good. If standardized
banking calculations are applied to the SBA loss data, the
annual net loss rate in the SBA 7(a) program would be in range
of 0.4 to 0.5 percent. And looking at the FDIC Web site this
week, their quarterly banking profile shows that in the second
quarter of 2007, the conventional bank loss rate was 0.5
percent. Given the high-risk nature of the SBA loans, this loss
rate reflects the lending community's desire and ability to
effectively minimize the program's taxpayer cost while meeting
its public policy objective of making credit available to the
small business community.
Mr. Chairman, I would be pleased to answer any questions.
[The prepared statement of Mr. Wilkinson follows:]
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Chairman Kerry. Thank you, Mr. Wilkinson. That was
important testimony and we appreciate it.
Mr. Baird.
STATEMENT OF JAMES BAIRD, EXECUTIVE DIRECTOR, BAY AREA
DEVELOPMENT COMPANY, AND VICE CHAIRMAN, LEGISLATIVE AFFAIRS
COMMITTEE, NATIONAL ASSOCIATION OF DEVELOPMENT COMPANIES,
WALNUT CREEK, CALIFORNIA
Mr. Baird. Chairman Kerry, Ranking Member Snowe, thank you
for the opportunity to appear before you to talk about this
important subject. I am Jim Baird, the executive director of
Bay Area Employment and Development Company of Walnut Creek,
California, and the vice chair of Legislative Affairs for
NADCO, the National Association of Development Companies for
Legislative Affairs.
Our industry has a significant and ongoing interest in
maintaining the highest standards of industry oversight and
loan program performance. The purpose of my remarks today are
not to tear down the efforts that SBA has made to date, but to
try to add comments to strengthen the oversight program of the
SBA.
Obviously, over the last 4 years, there have been dramatic
program changes and dramatic growth in the 504 program. This
has been growth in both number of loans, dollars of loans, and
economic development impacts of the program. But this growth
magnifies the importance and also the danger of growing a
program without optimal oversight in place.
The 504 oversight program has evolved and is evolving, but
it is still lacking in several important ways. For example, the
Office of Credit Risk Management reviews the credit and
eligibility of all the loans that they audit in their routine
onsite audits. However, they review these factors independent
of one another. I can't overstate the importance of taking a
look at the whole, the adequacy of the overall project
structure. To me, it is analogous to analyzing all the separate
parts of a car without taking the time to ask if the car runs.
In PCLP, there are also significant lost oversight
opportunities. PCLP has grown dramatically, but it has grown in
only a few markets of the country and only by a small portion
of CDCs participating in the program. There are rampant rumors
of PCLP lenders doing 504 loans that are not properly
underwritten. PCLP lenders are routinely providing 100-percent
loan-to-value financing without any reasonable basis for doing
so and rumored to be and obtaining SBA approval with incomplete
information, incomplete analysis, and incomplete underwriting.
So how do we improve PCLP oversight? I would suggest we
take a look at some of the processes in place at the Sacramento
Loan Processing Center. They have been operating in an
environment of substantially increasing volume while having
substantially decreasing staff. They have developed a very
efficient method of loan program overview called the Abridged
Submission Method, or ASM.
In this process, CDCs submit limited packages rather than
whole packages, but are required on 48 hours' notice and on a
random basis to submit complete packages to Sacramento for
review and audit. This is a proactive, real-time program that
heads off problems before they occur, and lenders never know
which loans are going to be chosen, so they are always acting
diligent in order to preserve their status, whether it is ALP
or ASM, or whatever their CDC status is.
However, the chronic staff shortages that have occurred in
the Sacramento Loan Processing Center have caused, even for ALP
lenders, the ASM program to be suspended. Somehow, we need to
find the resources to fully staff the Sacramento Loan
Processing Center. We need to fully staff the center so that it
can reinstate the ASM program and so that it can, for the first
time, apply the ASM audit process to PCLP lenders.
Comments have already been made on the D&B model, which in
my opinion, looking at the big picture, represents an agency
attempt to use modern technology and apply it to portfolio
management, which is a good thing. It is a good direction, but
there are issues with it, and we have already gone through. I
would suffice it to say that we need disclosure and daylight,
number one, to see if the model actually works; and number two,
to allow lenders and CDCs to put the data to productive use.
We need the passage of S. 1256 and S. 2288. After 27 years,
for the first time, S. 1256 defines the structure and
expectations for the 504 program and its participants, and it
is a critical foundation to establish proper 504 loan
oversight. S. 2288, as introduced by the Ranking Minority
Member and Chair, will also dramatically improve loan
oversight. It also authorizes oversight fees, and we are
concerned about the effect of those fees, particularly on small
and rural CDCs. We would like to work with the Committee on
this provision, but in our opinion, both bills need to be
adopted in this session to strengthen oversight and NADCO
endorses both bills.
The newly proposed loan oversight regulation is something
that we are going to need some time to go through, given its
recent introduction and its length, frankly. Our preliminary
concerns are that it seems to identify the D&B system as the
sole system of CDC initial oversight and it also requires
compliance of CDC audits, with OMB Circular A-133, which would
have substantial cost effects for all CDCs, and again,
particularly small and rural CDCs. We believe it would drive
many of them out of the program. The regulatory finding of no
significant impact on CDCs or on small business is, frankly, in
error.
In summary, there is currently no liquidation or default
crisis whatsoever in the 504 program. We are here today to try
to offer suggestions to improve oversight and enforcement, and
we hope to continue to work closely with the Committee and the
agency to obtain the best possible practices.
I would like to thank the Chairman and the Ranking Minority
Member for holding this hearing and we would be happy to answer
any questions you have.
[The prepared statement of Mr. Baird follows w/attachment:]
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Chairman Kerry. Thank you, Mr. Baird. We certainly
appreciate the testimony and the observation, obviously, that
you think that the program is fundamentally sound and not in
any kind of liquidation crisis, and I think that is very
important news for people to know and understand.
Mr. Wilkinson, I want to cut to the sort of heart of this
thing, in a way, if we can a little bit. I think your
observation about the default rate relative to the total
portfolio measured against the commercial industry is an
important one. So let me ask you sort of a summary question, in
a sense, about that. Are you satisfied that the procedures in
place within the SBA itself and/or the lender structure are
sufficient to protect the taxpayer dollar with respect to these
loans?
Mr. Wilkinson. Well, one of the benefits that we have in
the----
Chairman Kerry. You gave some recommendations. Maybe you
want to highlight the most important ones that would either
guarantee that, if you don't, or----
Mr. Wilkinson. We have the benefit in the 7(a) program in
that almost all of our members are regulated institutions who
have to deal with OCC, FDIC, NCUA, so they already have systems
in place for their entire institutions. So that is a benefit
that we get in the 7(a) program.
Chairman Kerry. How do you feel--what about the non-bank
lenders?
Mr. Wilkinson. Not having been through each of their
institutions, that would be a tough call, but it does look like
that could be where the SBA is trying to put in place some of
the regulations that we as bankers have been subjected to for
quite some time.
Chairman Kerry. Is it your judgment that the program would
be advantaged by having some additional oversight in that
regard? I mean, you have heard the testimony today. You have
obviously followed this issue. What is your judgment as to
procedures already in place?
Mr. Wilkinson. Again, having gone through a good part of my
career in the commercial banking world, when we get an onsite
review from a bank examiner, it is a very detailed loan-
specific report that is also a management tool, so that we get
an independent look at the loans and they come through and
really make a judgment on the asset quality and it puts us in a
position to then take actions to correct what they might see as
a deficiency that we hadn't seen before. So it is a very useful
tool and that is not something we get with the Dun and
Bradstreet model that gives us a score that we don't know how
it was derived, or what it means, and it does not provide a
management tool, yet we get the privilege of paying for it.
Chairman Kerry. But specifically with respect to the SBA,
your written testimony says that in the current onsite review
process, the SBA is essentially looking for the completeness of
the file----
Mr. Wilkinson. The bulk of the----
Chairman Kerry [continuing]. Not for the----
Mr. Wilkinson. Quality of the asset.
Chairman Kerry [continuing]. The quality of the asset.
Mr. Wilkinson. That would be correct. The bulk of the
onsite review----
Chairman Kerry. Is that a problem?
Mr. Wilkinson. Well, it is----
Chairman Kerry. I mean, is that the extent of SBA's job?
Does the other fall to somebody else? Are we missing something?
Are we going down the wrong track here?
Mr. Wilkinson. Well, we would prefer to see more review of
the asset. Is it a quality asset? What problems do you see, as
opposed to, do we have this certain form in the file? I mean,
that is something that if there is documentation missing,
should the loan ever go into default, that SBA would say, hey,
you didn't get a mortgage. You didn't get a UCC. You caused us
harm. We will repair the guarantee.
Chairman Kerry. And you also believe--I think you asserted
that there ought to be better coordination between the SBA
oversight and the other oversight entities?
Mr. Wilkinson. Absolutely. The bank examiners are already
in the bulk of 7(a) lenders. We would like to see the SBA work
with the agencies and perhaps come up with a cooperative way
that perhaps the banking agencies could expand their reviews to
cover what SBA would need.
Chairman Kerry. Mr. Tannenhauser, I appreciate your
testimony. I know that BLX and the SBA both consider themselves
essentially to have been victims of a fraud here, and
obviously, you were in the sense that one of your employees
took a flyer. But the question is, where do you believe--what
judgment do you make about the company's own sort of processes?
You have spent a lot of money, and you have talked about the
things you have done to try to correct that. Were there some
signs that you believe that BLX should have picked up on [such]
as $28 million in repurchases of loans originating out of one
branch, all for the same kind of industry, i.e., gas stations?
Was there something here that you think might have been done
more effectively, or do you just think this was so hard to peg
that somehow it escaped scrutiny?
Mr. Tannenhauser. Well, Senator, the issue of the
performance in the Detroit office is something that we had
looked at early on, and they did specialize in making loans to
borrowers in the gas station/convenience store industry, and
primarily these borrowers were of Middle Eastern descent. We
looked at the performance of these loans and especially we were
concerned after 9/11. Was there any impact as a result of that?
And we did monitor the performance pretty clearly. And as a
result of that, we did shut down the gas station operations
well before any indication of fraud or wrongdoing came to
light.
Also, prior to that, we conducted a--had an independent
investigation of the Detroit office, which we utilized in
making our decisions. We also removed Mr. Harrington as head of
the office and from loan originations.
Chairman Kerry. What prompted that? What was the----
Mr. Tannenhauser. That was strictly loan performance. We
historically do close down offices and terminate business
development officers on a performance basis, again, with no
indication of fraud, but we are in business to make good loans
and if people are giving us loans that don't perform well, that
doesn't serve us very well, nor the program.
Chairman Kerry. But you nevertheless kept him on?
Mr. Tannenhauser. We kept him on--well, he had a contract
and there was no reason under his contract to terminate him,
but we did keep him on in a role which took him out of the loan
origination process.
Chairman Kerry. Does BLX monitor the performance of loans
by branch?
Mr. Tannenhauser. Yes, we do. We monitor it by branch. We
monitor it by underwriter. We monitor it by closer. We monitor
it by referral sources. And, in fact, we keep a blacklist of
referral sources that we no longer do business with, some of
which were involved in this fraud.
Chairman Kerry. So in other words, you break them out, your
loans from other loans, such as USDA and other non-Government
guaranteed loans?
Mr. Tannenhauser. Yes. Well, we slice and dice in every
possible way we can. We have been dedicated to process
improving since 2000----
Chairman Kerry. Were the SBA loans the bulk of the Troy
office loans?
Mr. Tannenhauser. Yes, they were, but there were
conventional loans, also, which I believe were alleged to be
involved in the fraud and which we take the full loss.
Chairman Kerry. When did BLX first notice that they were
one-industry focused?
Mr. Tannenhauser. We knew that right away. The Troy
office----
Chairman Kerry. Did you also know they were linked to one
specific employee?
Mr. Tannenhauser. Well, he was head of the office. The Troy
office came to us as a merger. BLX is really an amalgamation of
four different companies and the Troy office came to us in a
merger of one of these companies that we integrated and their
primary focus was gas station/c-store loans. Mr. Harrington was
really the rain maker for that office.
Chairman Kerry. With respect to the settlement agreement
between you and the SBA, it requires you, number one, to cover
any losses to the SBA related to the Troy, Michigan fraud, and
two, to repurchase the guaranteed portion of BLX loans that
default after being sold in the secondary market if they are
related to the fraud scheme. So you have to repurchase----
Mr. Tannenhauser. No, actually, I believe it requires us to
repurchase any loans that default after March 6 in the
secondary market.
Chairman Kerry. So in effect, was this obligation an
obligation that you assumed under the law, or was it an
obligation that was required of you as part of the settlement
with the SBA itself?
Mr. Tannenhauser. No, this was not required in the law.
This was negotiated in connection with the settlement
agreement.
Chairman Kerry. Now, initially, when the fraud was first
discovered, BLX hired a law firm to look into the lending of
that branch. What were the findings of that and what prompted
you to do that?
Mr. Tannenhauser. Well, the independent investigation by
this law firm occurred prior to any indication of fraud. The
reason we did that is there were several--we had been
foreclosing on several loans and several of the borrowers had,
over the course of, I think, 2 or 3 years, several of the
borrowers had put in counter-claims alleging wrongdoing on the
part of Mr. Harrington. So we engaged a nationally known law
firm to conduct an independent investigation of the office.
Chairman Kerry. Did they find at that point any fraudulence
in those loans?
Mr. Tannenhauser. No, they didn't. They found no evidence
of wrongdoing. In fact, in the lawsuits, they were disposed of
with no finding of wrongdoing, either. But that did not stop us
from shutting down the Detroit gas station operations because
of performance.
Chairman Kerry. What did you see that caused you to move in
and to shut it down? What was it that you saw?
Mr. Tannenhauser. Well, we do gas station/convenience store
loans all over the country and the performance of the loans
from the Detroit office was well below the performance levels
we had been seeing elsewhere, so----
Chairman Kerry. So this was a performance-related return on
investment decision?
Mr. Tannenhauser. That is correct. I mean, I believe as
late as December 2005, we were under the impression that Mr.
Harrington was a witness on behalf of the prosecution
investigating certain of the loans, not a target of the
investigation.
Chairman Kerry. Now, here you are. What is the total
business that you have been doing with the SBA?
Mr. Tannenhauser. We have done over $3.6 billion worth of
loans.
Chairman Kerry. And what percentage of your business is
that?
Mr. Tannenhauser. I am sorry?
Chairman Kerry. Of the overall business you do.
Mr. Tannenhauser. Oh, that is the bulk of the business,
although lately we have been moving more toward a conventional
loan product, and that is becoming the majority of our----
Chairman Kerry. Now, here you are, sort of an important
player in a small family of--this will be my last question; I
just want to get to you, Senator Snowe--you have been the key
player in this effort and this is an aberration, according to
you and other folks. So the question I think looms large, why
have you effectively said you are going to get out of the 7(a)
business?
Mr. Tannenhauser. The problem, Senator, is really the
confluence of several events over this past year which have
really made it extremely expensive for us to remain in the
business. One of the events is obviously the impact of the
Detroit indictments and the plea, the cost of us complying with
the March 6 agreement with the SBA, the delay in our ability to
securitize our SBA unguaranteed portions, which we didn't get
permission until the end of August, and of course as you are
obviously aware, the capital markets disintegrated by then, so
we couldn't get those off. Our obligation to repurchase loans,
which we will continue even if we are in the business or out of
the business, creates a situation where we keep these loans on
our balance sheet now at the highest possible cost of funds to
us. We are not a bank, so we have to borrow to make loans. The
delay in selling the guaranteed portion of the loans until
after reviews by Deloitte and others keeps these loans on our
balance sheet longer. Again, we are paying the highest possible
rate that we can. And, of course, the increased cost of credit
to us as a lender that needs to access the credit markets have
all really caused us to think about scaling down, at least
temporarily, our operations in the SBA business.
We regret having to do this because we are dedicated to
serving this community and we have been servicing minority
borrowers throughout our existence, and I think we are one of
the larger members----
Chairman Kerry. Well, we are certainly very sensitive to
that and we certainly want to acknowledge that. I think there
is a component of this that if this is a narrow and singular
individual kind of event, one hates to see an entire operation
diminished as a consequence of that and we ought to try to be
smart about how we go forward with that.
Let me cede to Senator Snowe.
Senator Snowe. Thank you, Mr. Chairman, and I will just ask
a few questions. Mr. Tannenhauser, just to follow up, I notice
in your testimony that you felt that the Inspector General's
report was inaccurate and incomplete. Am I right in saying
that?
Mr. Tannenhauser. Yes, that is what I testified to.
Senator Snowe. OK. You raised your eyebrows and I thought
maybe----
Mr. Tannenhauser. No, no. That is correct.
Senator Snowe. And because they excluded the Farm Credit
Administration's analysis, I gather, of your operation, as
well?
Mr. Tannenhauser. Yes, and----
Senator Snowe. And also obviously for the confidential
information that has been redacted from the report, and we
understand all that. But in the IG's report, it did indicate
that there were recommendations to not renew the preferred
lender status for BLX.
Mr. Tannenhauser. Again----
Senator Snowe. So it wasn't an indiscriminate analysis, I
don't think, from that standpoint.
Mr. Tannenhauser. If I may, Senator, again, this is one of
the issues that I take with the report as far as the inaccuracy
and the incomplete presentation, and I will go back to maybe a
little bit of that to correct what I believe is a misconception
in what Tony said.
Farm Credit does a very, very complete review when they
come into a non-bank lender. They spend approximately 6 weeks,
seven or eight people going through our files who safety and
soundness audit review our files for loans for credit quality,
make recommendations. The reports that they issue over this 5
to 6-year period consistently supported renewal of our PLP
status. Yes, we do- make mistakes. There are human errors. But
in these reports, I believe if you review them, you will see
that they acknowledge that we address the issues that are
presented, that we consistently take steps to improve the
quality of our loans and our processes.
Now, with respect to what the IG set forth about guidelines
in the Sacramento Center, those are at odds with what were the
benchmarks in place under the lender oversight SOP and those
were not generally the benchmarks that we used. For some
reason, they used these benchmarks, which are not the ones used
for PLP renewal, and applied it against BLX when with other
lenders they used different benchmarks.
So I believe that perhaps they may have been confused about
what the actual benchmarks were, and if they had used the real
lender oversight benchmarks, they would find that we did comply
with them and were entitled to renewal of our PLP status.
If I can further state, that is not all that we went
through when our PLP status was renewed. We spent countless
hours with the SBA going over our portfolio performance,
reconciling our numbers with them, showing them the
improvements that we have made over the years. This was not
just an idle rubber stamp. They spent time and effort, and
believe me, after the year we had, I am no great fan of the
SBA, but they did their job in overseeing us. So I can't
criticize them for that.
Senator Snowe. Well, would the Farm Credit Administration
have done anything any different, I mean, in terms of
evaluating something that raised a real concern? I mean, you
can understand from a public interest standpoint----
Mr. Tannenhauser. Well, again, Senator, I urge you to read
the Farm Credit report----
Senator Snowe. I will.
Mr. Tannenhauser [continuing]. And read the conclusions and
they will--I believe you will find that they support our
contention that our lending practices were safe and sound and
that we were one of the lenders in the industry that deserved
to have PLP status----
Senator Snowe. The IG report raises significant issues that
had surfaced with BLX. I mean, wouldn't you say from the
standpoint of the Government that those would be legitimate
interests to be concerned about?
Mr. Tannenhauser. Well, there will always be issues raised
because when you do the volume of loans that we do, there will
always be human error--excuse me, there will always be
mistakes. We do take the steps necessary to address those
mistakes when we become aware of them and we do constantly try
and improve our processes. That was discussed at length with
the SBA during our renewal process and they took that into
account and----
Senator Snowe. No, I understand that they might have taken
it into account. What I am saying is that you understand from a
public perspective, I mean, representing the public's interest
and the American taxpayers, that there would be some serious
issues. Would you not view those issues that manifested itself
back then on the part of BLX might have been a precursor, a
predictor for some of the problems that emerged ultimately? Did
you see that as a bad sign, or did people in your organization
see it as a bad sign in any way, or just that?
Mr. Tannenhauser. We are always concerned with a high
purchase rate, but we make loans to a segment of the population
that is higher risk. However, our loss rate is significantly
lower than the industry averages, so that is the real risk to
the Government and we have maintained that over the 10 to 14
years that we have been doing this, and that is really--no one
has taken that into account and everybody seems to ignore that
fact. What is the risk to the Government? How much money are
you going to lose on the loan? Well, guess what. On BLX's
loans, the loss rates are below the industry averages.
So you can pick a particular statistic and say, oh, this
company is doing terribly, but you have to take the overall
picture and I believe that is what Farm Credit did and I
believe that is what SBA did, and I don't believe that is what
the Inspector General did. And I don't say they did it with
malice or for any reason other than perhaps they didn't have
access to those facts and records.
Senator Snowe. Again, you can understand what is at risk
here, ultimately. We have a public obligation to the American
taxpayer to explore those issues, to have the Inspector General
provide an independent evaluation. Consequently, we have to
make sure that we are doing our jobs in pursuing these negative
activities. Obviously, when you have fraudulent activities
emerge, it is certainly going to garner attention in addition
to everything else to making sure that we have got appropriate
procedures in place. That is our public obligation.
I thought it was interesting that you said the IG report
was incomplete. We will look at the Farm Credit Administration
report. But I think you should know that others at the SBA saw
serious issues emerging with BLX. That is what I need to bring
to your attention based on the IG report now----
Mr. Tannenhauser. Absolutely. Again----
Senator Snowe. That is what I am saying----
Mr. Tannenhauser. There is no question, but you have to
look----
Senator Snowe. Reservations within the SBA were not
indiscriminate. They were based on the factors that they were
considering at the time.
Mr. Tannenhauser. Well, some areas we do less loans. You
may have a higher repurchase rate in that area. I mean, there
are different aspects. But if you take our portfolio
performance as a whole, I think you will find that it is quite
satisfactory.
Senator Snowe. I appreciate that, and I know that you are
taking remedial measures and hiring an independent party to
evaluate all of your procedures.
You also mentioned in your testimony that BLX agrees to
make SBA whole. Where does that stand now?
Mr. Tannenhauser. Well, where it stands now is we have paid
them over $8 million. I believe there was one loan which Mr.
Harrington pleaded to which was not in the original eight. We
will be making them whole on that. And to the extent that there
are any other loans in which fraud is found, there is a $10-
million escrow plus we are obligated beyond that. So the SBA
will not lose money as a result of fraud by any of our
employees. We will lose that money.
Senator Snowe. Thank you, and I think that is important, as
well, in all of that. So you stand prepared to reimburse the
Government for any losses that occur----
Mr. Tannenhauser. Absolutely, and that obligation is there
whether we continue to make loans in the program or not.
Senator Snowe. OK. Well, I think that is an important
issue. Thank you.
Mr. Wilkinson, you mentioned in your testimony about SBA's
projected repurchase rates, between the actual and projected. I
gather from what you are saying is that the SBA consistently
provides inaccurate projected repurchase rates compared to what
is actual and in reality?
Mr. Wilkinson. SBA issues what is called a portal report,
and I was able to get the portal reports on the entire 7(a)
portfolio going back in time for 18 months and was able to go
back and look--and I forget the exact date, but say at 3/31/06
where they predicted that defaults, or there would be a
repurchase rate of X over the next 12 months, well, when 3/31/
07 rolled around, we went and said, OK, what was our actual
repurchase rate, and it was 25 percent less than what had been
predicted, and that has now happened quarter and quarter. So it
appears that whatever is in this Dun and Bradstreet predictive
model, it is overestimating defaults.
Senator Snowe. So what would be the basis? They are using a
Dun and Bradstreet model.
Mr. Wilkinson. That is where that number comes from.
Senator Snowe. So it becomes less, in your estimation, less
reliable?
Mr. Wilkinson. I don't know what we could rely on out of
that number. I mean, we just--I don't know what is in the
model, don't know how that number is derived, and thus far,
comparing actual performance to their previous predictions,
they are at least 25 percent off.
Senator Snowe. Well, it is interesting because of what I
mentioned earlier in the question to Administrator Preston that
there are projected increases from 9 to 167 percent by the
SBA's lender monitoring system.
Mr. Wilkinson. I don't have the actual numbers in front of
me, but the Dun and Bradstreet model had predicted about a 2.3
percent repurchase rate, and I believe our actual number came
in around 1.6, quite a bit less than what had been predicted.
Senator Snowe. So obviously, if that is the case as you are
saying, that----
Mr. Wilkinson. And that would be a gross repurchase rate.
You would net out from that any recoveries we would get from
liquidation of collateral.
Senator Snowe. From what you heard here this morning in
terms of the questions and answers in Administrator Preston's
and Inspector General Thorson's responses, where do you think
the SBA stands in terms of being prepared and able to provide
effective oversight and monitoring?
Mr. Wilkinson. They are a lot better today than they were
just a few short years ago. So there has been improvement. One
of our concerns is that the agency's budget is continually cut,
and they now continue to rely on an outsource function and then
try to pass those fees along to the lending community. So our
fees have gone up dramatically, and rather than SBA staff
handling the review functions, they now outsource that, which
some would argue leads to inconsistent application.
Senator Snowe. So we have argued for years about the
staffing.
Mr. Wilkinson. Absolutely.
Senator Snowe. Ultimately, this lack of staffing will
produce consequences.
Mr. Wilkinson. They can only cut so far.
Senator Snowe. I know. Exactly. One of the issues that
emerges consistently is underwriting. I want Mr. Baird to
comment on underwriting. Is the SBA's underwriting sufficient?
Is there enough guidance or standards or criteria? If not, what
can be done to improve it?
Mr. Baird. I think that what we can do first and foremost
to affect and improve 504 underwriting is to fully staff the
Sacramento Loan Processing Center. I hate to sound like a
broken record here, but that is really critical. We have taken
the 200 processing loan officers and support staff in 69
district offices and compressed them into about 15 people in
Sacramento, and they are 15 of the hardest-working people that
you will find in Government, but they have had problems keeping
that office staffed, I think in part because of the workload,
perhaps in part because the positions may be rated at lower
levels than they need to be rated to retain staff. Then there
have been issues replacing staff who have left. The result is
trying to do so much more with so much less that it just can't
be done.
Senator Snowe. OK. Well, thank you all very much. I
appreciate it. Thank you, Mr. Chairman.
Chairman Kerry. Thank you so much, Senator Snowe.
So in other words, something is wrong here. There is either
a gap in the Administrator's understanding of what he needs, or
there is a gap in the availability of people out there, one or
the other. Mr. Baird.
Mr. Baird. Yes.
[Laughter.]
Chairman Kerry. I respect your reluctance to comment.
Just a last question, Mr. Baird. You say lenders are not
adhering to SBA guidelines?
Mr. Baird. Yes. I think that with all of the changes that
the 504 program has gone through, opening up all the markets to
Statewide competition, CDCs going into contiguous States, the
centralization of the processing, and just basically
competitive pressures, I think that all those have contributed
to--caused CDCs and to some extent their lending partners to
start competing against one another with credit criteria and
underwriting criteria, and that is not really the proper role
of the CDC.
The proper role of the CDC for a, let us say a more
challenging small business credit, part of our role is to put
credit where the private sector alone won't provide it. But
for, let us say a tougher project, rather than providing 95 or
100, or even 90 percent financing without additional
collateral, one of the critical roles of the CDC is to balance
the interest of the small business concern and the community
and the SBA in a fiscally responsible manner and it takes the
right policy and it takes, in my opinion, optimal oversight in
order to make sure that abuses in underwriting aren't happening
for the competitive advantages of certain CDCs.
Chairman Kerry. Very important observation, and the
Committee will take note of it. What I would like to do is ask
the SBA and IG to respond to these observations in writing for
the Committee as part of this record. We will leave the record
open in order to submit additional questions in writing so that
this record is complete.
We have just run out of time. Both Senator Snowe and I have
to be at our respective caucuses, but I do want to emphasize
the need in these next days to complete this record and get
some responses to some of the comments that have been made and
various specifics so we can kind of chase down the hard facts
here.
So we thank you, all of you. Mr. Baird, Mr. Wilkinson, Mr.
Tannenhauser, I know this is not the most pleasant experience
in the world, going over some of this stuff, but on the other
hand, it is very important for the Committee and very important
to the taxpayers and to all of us to understand how the SBA can
do a better job and we need to do that.
Thank you. We stand adjourned.
[Whereupon, at 1:12 p.m., the Committee was adjourned.]
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Additional Snowe Questions
Question
In April 2007, the Federal Deposit Insurance Corp. (FDIC)
issued a cease and desist order to Oakland-based Innovative
Bank, which makes SBA Express and Community Express loans,
among other services. The FDIC order directed Innovative Bank
to cease following ``unsafe and unsound'' banking practices.
Though there are numerous media reports about the FDIC's
efforts to reign in Innovative Bank's questionable lending
practices, none of the reports mentioned any oversight activity
by SBA. Did SBA's oversight mechanism detect a problem with
Innovative Bank's loan practices? If so, what was SBA's
response?
SBA Response
As you know, SBA's Office of Credit Risk Management monitors
the SBA loan program performance of SBA Lenders and responds as
needed. In general, financial institution examination
information is confidential in accordance with law.
Accordingly, SBA's actions with respect to Innovative Bank
cannot be disclosed publicly. However, to assist the Committee
in their oversight function, SBA is forwarding the financial
institution examination information that you requested under
separate letter to facilitate its confidential treatment
together with a confidential explanation of the Agency's
information and actions.
Ouestion
What has the SBA done to coordinate with FDIC, or the other
bank regulators, to otherwise improve its oversight strategy in
situations like these?
SBA Response
SBA has discussed the need to share information about regulated
SBA lenders with FDIC and other regulators, and we continue to
work with them in an effort to improve . communications between
SBA and the regulators in matters concerning our lenders.
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Questions for the Record
Lender Oversight Hearing
Senator Johnny Isakson
Question
Administrator Preston, would you please clarify what action(s)
the Associate Administrator of the Office of Entrepreneurial
Development stated to the U.S. Small Business Committee would
be completed by 1/18/08?
Response
Not available at time of printing.
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