[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/
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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

                              ----------                              

                                                                   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.]

                      APPENDIX MATERIAL SUBMITTED

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                       Additional Snowe Questions

Question
In April 2007, the Federal Deposit Insurance Corp. (FDIC) 
issued a cease and desist order to Oakland-based Innovative 
Bank, which makes SBA Express and Community Express loans, 
among other services. The FDIC order directed Innovative Bank 
to cease following ``unsafe and unsound'' banking practices. 
Though there are numerous media reports about the FDIC's 
efforts to reign in Innovative Bank's questionable lending 
practices, none of the reports mentioned any oversight activity 
by SBA. Did SBA's oversight mechanism detect a problem with 
Innovative Bank's loan practices? If so, what was SBA's 
response?

SBA Response
As you know, SBA's Office of Credit Risk Management monitors 
the SBA loan program performance of SBA Lenders and responds as 
needed. In general, financial institution examination 
information is confidential in accordance with law. 
Accordingly, SBA's actions with respect to Innovative Bank 
cannot be disclosed publicly. However, to assist the Committee 
in their oversight function, SBA is forwarding the financial 
institution examination information that you requested under 
separate letter to facilitate its confidential treatment 
together with a confidential explanation of the Agency's 
information and actions.

Ouestion
What has the SBA done to coordinate with FDIC, or the other 
bank regulators, to otherwise improve its oversight strategy in 
situations like these?

SBA Response
SBA has discussed the need to share information about regulated 
SBA lenders with FDIC and other regulators, and we continue to 
work with them in an effort to improve . communications between 
SBA and the regulators in matters concerning our lenders.
                              ----------                              


                        Questions for the Record

                        Lender Oversight Hearing

                         Senator Johnny Isakson

Question
Administrator Preston, would you please clarify what action(s) 
the Associate Administrator of the Office of Entrepreneurial 
Development stated to the U.S. Small Business Committee would 
be completed by 1/18/08?

Response
Not available at time of printing.

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                        COMMENTS FOR THE RECORD

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