Small Business Administration: Progress Made but Improvements	 
Needed in Lender Oversight (30-APR-03, GAO-03-720T).		 
                                                                 
The Small Business Administration (SBA) is responsible for	 
oversight of its 7(a) loan program lenders, including those who  
participate in the Preferred Lenders Program or PLP. SBA	 
delegates full authority to preferred lenders to make loans	 
without prior SBA approval. In fiscal year 2002, preferred	 
lenders approved 55 percent of the dollar value of all 7(a)	 
loans--about $7 billion. Small businesses are certainly a vital  
part of the nation's economy. According to SBA, they generate	 
more than half of the nation's gross domestic product and are the
principal source of new jobs in the U.S. economy. In turn, SBA's 
mission is to maintain and strengthen the nation's economy by	 
aiding, counseling, assisting, and protecting the interests of	 
small businesses. Providing small businesses with access to	 
credit is a major avenue through which SBA strives to fulfill its
mission. Strong oversight of lenders by SBA is needed to protect 
SBA from financial risk and to ensure that qualified borrowers	 
get 7(a) loans. SBA has a total portfolio of about $46 billion,  
including $42 billion in direct and guaranteed small business	 
loans and other guarantees. Because SBA guarantees up to 85	 
percent of the 7(a) loans made by its lending partners, there is 
risk to SBA if the loans are not repaid. SBA must ensure that	 
lenders provide loans to borrowers who are eligible and 	 
creditworthy to protect the integrity of the 7(a) program. Our	 
statement today is based on the report we issued December 9,	 
2002, Small Business Administration: Progress Made but		 
Improvements Needed in Lender Oversight (GAO-03-90). The report  
and our remarks will focus on our evaluation of (1) SBA's 7(a)	 
lender oversight program and (2) SBA's organizational alignment  
for conducting oversight of preferred lenders and Small Business 
Lending Companies (SBLC). In addition, we will comment on SBA's  
latest response to our findings and recommendations. Our overall 
objective is to provide the Senate Committee on Small Business	 
and Entrepreneurship with information and perspectives to	 
consider as it moves forward on SBA reauthorization.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-720T					        
    ACCNO:   A06759						        
  TITLE:     Small Business Administration: Progress Made but	      
Improvements Needed in Lender Oversight 			 
     DATE:   04/30/2003 
  SUBJECT:   Government guaranteed loans			 
	     Lending institutions				 
	     Loan accounting systems				 
	     Risk management					 
	     Small business loans				 
	     SBA 7(a) Loan Program				 
	     SBA Preferred Lenders Program			 

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GAO-03-720T

Testimony Before the Committee on Small Business and Entrepreneurship, U.
S. Senate

United States General Accounting Office

GAO For Release on Delivery Expected at 9: 30 a. m. EDT Wednesday, April
30, 2003 SMALL BUSINESS

ADMINISTRATION Progress Made but Improvements Needed in Lender Oversight

Statement of Davi M. D'Agostino Director, Financial Markets and Community
Investments

GAO- 03- 720T

This is a work of the U. S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.

Page 1 GAO- 03- 720T

Madam Chair and Members of the Committee: I am pleased to be here today at
this roundtable to discuss the results of our work on the Small Business
Administration*s (SBA) oversight of its 7( a) loan program lenders,
particularly those who participate in the Preferred Lenders Program or
PLP. SBA delegates full authority to preferred lenders to make loans
without prior SBA approval. In fiscal year 2002, preferred lenders
approved 55 percent of the dollar value of all 7( a) loans* about $7
billion. Small businesses are certainly a vital part of the nation*s
economy. According to SBA, they generate more than half of the nation*s
gross domestic product and are the principal source of new jobs in the U.
S. economy. In turn, SBA*s mission is to maintain and strengthen the
nation*s economy by aiding, counseling, assisting, and protecting the

interests of small businesses. Providing small businesses with access to
credit is a major avenue through which SBA strives to fulfill its mission.
Strong oversight of lenders by SBA is needed to protect SBA from financial
risk and to ensure that qualified borrowers get 7( a) loans. SBA has a
total portfolio of about $46 billion, including $42 billion in direct and
guaranteed small business loans and other guarantees. 1 Because SBA

guarantees up to 85 percent of the 7( a) loans made by its lending
partners, there is risk to SBA if the loans are not repaid. SBA must
ensure that lenders provide loans to borrowers who are eligible and
creditworthy to protect the integrity of the 7( a) program. Our statement
today is based on the report we issued December 9, 2002, Small Business
Administration: Progress Made but Improvements

Needed in Lender Oversight (GAO- 03- 90). The report and our remarks will
focus on our evaluation of (1) SBA*s 7( a) lender oversight program and
(2) SBA*s organizational alignment for conducting oversight of preferred
lenders and Small Business Lending Companies (SBLC). 2 In addition, we
will comment on SBA*s latest response to our findings and recommendations.
3 Our overall objective is to provide the Committee with information and
perspectives to consider as it moves forward on SBA reauthorization.

1 As of September 30, 2002. 2 SBLCs, which make only 7( a) loans, are
privately owned and managed, nondepository, lending institutions that are
licensed and regulated by SBA but not generally regulated or examined by
financial institution regulators. 3 Hector Barreto, SBA Administrator,
letter to The Honorable Susan Collins, Chair, Committee on Government
Affairs, U. S. Senate, March 12, 2003.

Page 2 GAO- 03- 720T

In analyzing SBA*s oversight of its preferred lenders, we defined
oversight to include both SBA*s reviews of preferred lenders for
compliance with SBA rules and regulations and SBA*s evaluations of lenders
to decide their initial and continued participation in the PLP. We focused
our reviews in part to follow up on recommendations made in our June 1998
report, where we found that SBA was doing few reviews of its preferred
lenders. 4 We analyzed a sample of review reports and PLP guidance, and
review and

lending data to the extent that they were available. We also interviewed
SBA headquarters and regional staff, PLP lenders, and representatives of
the National Association of Government Guaranteed Lenders.

SBA has made progress in developing its lender oversight program, but
there are still areas in need of improvement. While SBA has identified
appropriate elements for an effective lender oversight program, it has
been slow to change programs and procedures to fully incorporate all of
these elements. In addition, financial risk management issues have become
more critical for SBA, as its current loan programs focus on partnering
with lenders, primarily banks, that make loans guaranteed up to 85 percent
by SBA. However, our work showed that

 SBA had not yet consistently incorporated adequate measures of financial
risk into the PLP review process or the SBLC examination program.

 The current PLP review process, which SBA uses to ensure compliance with
the program mission, rules, and regulations, involves a cursory review of
documentation maintained in lenders* loan files rather than a qualitative
assessment of borrower creditworthiness or eligibility.

 SBA*s standards for borrower eligibility (the *credit elsewhere*
requirement) are broad and therefore subject to interpretation.

 SBA had not developed clear enforcement policies for preferred lenders
or SBLCs that would specifically describe its response in the event that
reviews discover noncompliance or safety and soundness problems.

4 U. S. General Accounting Office, Small Business Administration: Few
Reviews of Guaranteed Lenders Have Been Conducted, GAO/ GGD- 98- 85
(Washington, D. C.: June 1998). Summary

Page 3 GAO- 03- 720T

 SBA had been slow to finalize and issue SBLC examination reports. 5 In
addition, SBA had been slow to respond to recommendations for improving
the SBLC examination program.

Without continued improvement to better enable SBA to assess the financial
risk posed by 7( a) loans and to ensure that its lending partners are
making loans to eligible small businesses, SBA will not have a successful
lender oversight program.

Although SBA has listed the oversight of its lending partners as an agency
priority, the function does not have the necessary organizational
independence or resources to accomplish its goals. In our past work
analyzing organizational alignment and workload issues, we have described
the importance of (1) tying organizational alignment to a clear and
comprehensive mission statement and strategic plan and (2) providing
adequate resources to accomplish the mission. However, two different
offices* Lender Oversight and Financial Assistance, both of which are in
the Office of Capital Access (OCA)* carry out SBA*s lender oversight

functions (see fig. 1). OCA also promotes and implements SBA*s lending
programs. This alignment presents a possible conflict because PLP
promotion and operations are housed in the same office that assesses
lender compliance with SBA safety and soundness and mission requirements.
Additionally, split responsibilities within OCA and limited

resources have impeded SBA*s ability to complete certain oversight
responsibilities, which could result in heightened risk to its portfolio
or lack of comprehensive awareness of portfolio risk.

Our report made recommendations to improve SBA*s oversight of its lenders.
Specifically, we recommended that SBA:  incorporate strategies into its
review process to adequately measure the

financial risk lenders* portfolios of guaranteed SBA loans pose to SBA, 
develop specific criteria to apply to the credit elsewhere standard used
to determine borrower eligibility,

5 Since 1999, SBA has had an agreement with the Farm Credit Administration
(FCA) to conduct safety and soundness examinations of the SBLCs. FCA is an
independent agency within the executive branch; it regulates Farm Credit
System institutions. FCA also

contracts with other government agencies to provide examination services.

Page 4 GAO- 03- 720T

 perform qualitative assessments of lenders* performance and lending
decisions,

 clarify its enforcement authority and specify conditions under which it
would take enforcement action,

 make the preferred lender program more accessible to large national
lenders, and  better emphasize lender oversight in its organizational
alignment to

provide an oversight office with greater autonomy within SBA to match the
growing importance of lender oversight.

SBA essentially disagreed with part or all of our recommendations for
improving its assessments of lenders, said that it was *working to
address* issues we raised about enforcement and accessibility of the
preferred lender program, and disagreed with our recommendation to
separate lender oversight functions and responsibilities from preferred
lender program management functions.

Page 5 GAO- 03- 720T

Figure 1: Preferred Lender Oversight Responsibilities within OCA

The 7( a) loan program, which is authorized by Section 7( a) of the Small
Business Act, is SBA*s largest business loan program. 6 It is intended to
serve small business borrowers who otherwise cannot obtain financing under
reasonable terms and conditions from the private sector. In administering
the 7( a) program, SBA has evolved from making guaranteed loans directly
to depending on lending partners, primarily banks. 7 Under

7( a), SBA provides guarantees of up to 85 percent on loans made by
participating lenders.

Within 7( a), there are three classifications of lenders* regular,
certified, and preferred. SBA evaluates and grants preferred lender status
to 7( a)

6 15 U. S. C. S: 636 (2000). 7 Other types of financial institutions, such
as savings banks, are lending partners. In this statement, we refer to all
financial institutions that make 7( a) loans as banks. Background

Page 6 GAO- 03- 720T

lenders after receiving nominations and reviews from its 70 district
offices and a regional processing center. Of the three categories,
preferred lenders have the most autonomy in that they can make loans
without prior SBA

review or approval. Most preferred lenders are banks that have their own
safety and soundness regulators, such as the Office of the Comptroller of
the Currency. Those regulators, however, may not focus on the 7( a) loans
that SBA guarantees when they examine the bank. The other preferred
lenders, which are SBLCs, have no regulator other than SBA* making SBA
oversight more critical. As of August 2002, SBA had over 400 preferred
lenders. To give you an idea of this program*s scope, in fiscal year 2002,
7( a) loan approvals totaled approximately $12.2 billion, of which
preferred lenders approved $6.7 billion. However, preferred lending
activity is

concentrated in a few larger institutions. Less than 1 percent of 7( a)
lenders account for more than 50 percent of 7( a) dollar volume
outstanding. According to SBA, most of these lenders are preferred

lenders. Two offices within SBA have primary responsibility for 7( a)
lender oversight* the Office of Lender Oversight (OLO) and the Office of
Financial Assistance (OFA). OLO is responsible for many oversight
functions, such as managing all headquarters and field office activities
regarding lender reviews. However, OFA has retained some oversight
responsibilities. OFA*s current role in lender oversight is to provide
final approval of lenders* PLP status. Lenders are granted PLP status in
specific SBA districts for a period of 2 years or less. OFA collects
information about the lender prepared by the Sacramento Processing Center,
with input from one or more of SBA*s 70 district offices, and decides
whether to renew a lender*s PLP status or to grant status in an additional
district. OFA may also discontinue a lender*s PLP status.

Other lenders participating in the 7( a) program are subject to a
different oversight regime. Specifically, SBA divides SBLC program
functions between OLO and OFA. OLO is responsible for SBLC on- site
examination, and OFA handles day- to- day program management and
policymaking.

Ultimate responsibility for enforcement of corrective actions rests with
OCA. As participants in the 7( a) program, SBLCs are subject to the same
review requirements as other 7( a) lenders, and they are also subject to
safety and soundness oversight by SBA.

Page 7 GAO- 03- 720T

SBA has identified goals for its lender oversight program that are
consistent with appropriate standards for an oversight program; however,
SBA had not yet established a program that is likely to achieve them.
Since our last review, SBA had made progress in developing its lender
oversight program, but there are still areas in need of improvement if SBA
is to develop a successful program. SBA has highlighted risk management in
its strategy to modernize the agency; however, PLP reviews are not
designed to evaluate financial risk, and the agency has been slow to
respond to

recommendations made for improving its monitoring and management of
financial risk* posing a potential risk to SBA*s portfolio. PLP reviews
are designed to determine lender compliance with SBA regulations and
guidelines, but they do not provide adequate assurance that lenders are
sufficiently assessing eligibility and creditworthiness of borrowers.

Although SBA has identified problems with preferred lender and SBLC
lending practices, it has not developed clear policies that would describe
enforcement responses to specific conditions. Thus, it is not clear what

actions SBA would take to ensure that preferred lenders or SBLCs address
lending program weaknesses. Although the process for certifying lenders
for PLP status* another means by which SBA oversees lenders* has become
better defined and more objective, some lenders told us they continue to
experience confusing and inconsistent procedures during this process due
to varying recommendations from field offices.

Since our June 1998 report, SBA has responded to a number of
recommendations for improving lender oversight by developing guidance,
establishing OLO, and doing more reviews. SBA developed *Standard

Operating Procedures* (SOP) for oversight of SBA*s lending partners and
the *Loan Policy and Program Oversight Guide for Lender Reviews* in
October 1999.

SBA established OLO in fiscal year 1999 to coordinate and centralize
lender review processes for PLP and SBLC oversight. OLO created a
*Reviewer Guide* for personnel engaged in PLP reviews and does training
for all SBA staff involved in conducting preferred lender reviews. OLO
officials said that to effectively oversee and monitor SBA lenders, they
also evaluate lender- generated risk to the SBA portfolio, work with SBA

program offices to manage PLP oversight operations, and plan to conduct
regular and systematic portfolio analysis using a new loan monitoring
system. Additionally, to minimize the number of visits SBLCs receive
during a year, OLO combined PLP reviews with SBLC examinations performed
by FCA. Lender Oversight Is

Not Achieving All of Its Goals

SBA Has Made Progress in Developing Its Lender Oversight Function

Page 8 GAO- 03- 720T

In another effort to improve the lender review process, SBA developed an
automated, 105- item checklist that is designed to make its analysis more
objective. The questionnaire addresses lender organizational structure,
policies, and controls, but the answers are provided in a *yes- no* format
and generally refer to the presence or absence of specific documents. SBA
noted that the format makes assessments of lenders more consistent and
objective. However, we note that without a more substantive method of
evaluating lender performance, this approach does not provide a meaningful
assessment.

SBA also has increased the number of PLP reviews performed. In June 1998,
we reported that SBA had not reviewed 96 percent of 7( a) lenders,
including preferred lenders, in the districts we visited. SBA reviewed 385
reviews of 449 preferred lenders in its 2001-- 2002 review year. 8 While
elements of SBA*s oversight program touch on the financial risk

posed by preferred lenders, including SBLCs, weaknesses in the program
limit SBA*s ability to focus on, and respond to, current and future
financial risk to their portfolio. Neither the PLP review process nor
SBA*s off- site

monitoring efforts adequately focus on the financial risk posed by
preferred and other lenders to SBA. SBA oversight of SBLCs is charged with
monitoring how SBLCs administer their credit programs, identifying
potential problems, and keeping SBA losses to an acceptable level.
However, SBA*s progress in reporting examination results in a timely

manner and implementing other program improvements limits the
effectiveness of SBA*s SBLC oversight.

SBA officials stated that PLP reviews are strict compliance reviews that
are not designed to measure the lenders* financial risk. Our review and
that of SBA*s Inspector General (IG) confirmed this. The PLP review serves
as SBA*s primary internal control mechanism to determine whether preferred
lenders are processing, servicing, and liquidating loans according to SBA
standards and whether such lenders should participate in the programs.
While the review has questions that touch on the financial risk of a given
loan, review staff are not required to answer them; and SBA guidance
explicitly states that the answers to the questions are for

8 SBA*s review year runs from April 1 to March 31. SBA officials explained
that the initial date of its contract with the vendor that conducts PLP
reviews began on April 1, and they have since used this as the beginning
of their review year. SBA*s Lender Oversight

Does Not Adequately Focus on Financial Risk

Page 9 GAO- 03- 720T

research purposes only and are not to be considered in making any
determinations about the lender. By not including an assessment of the
financial risk posed by individual lenders during PLP reviews, SBA is
missing an opportunity to gather information that could help predict PLP
lenders* future performance, thereby better preparing SBA to manage the
risk to its portfolio. The SBA IG also suggested that financial risk and

lender- based risk should be considered as part of a comprehensive
oversight program. 9 SBA*s off- site monitoring efforts do not adequately
assess the financial risk

posed by PLP and other lenders. SBA currently uses loan performance
benchmarking and portfolio analysis to serve as its primary tools for
offsite monitoring. While SBA officials stated that loan performance
benchmarks are based on financial risk and serve as a measure to address a
lender*s potential risk to the SBA portfolio, we found that the benchmarks
were not consistently used for this purpose. 10 In addition, we found that
OLO does not perform routine analysis of SBA*s portfolio to assess
financial risk. At the time of our review, staff produced ad- hoc reports
to analyze aggregate lending data to look for trends and to try to
anticipate risk.

Currently, FCA staff responsible for SBLC safety and soundness
examinations also perform PLP reviews at SBLCs* these reviews are the same
ones that SBA contractors perform at preferred lenders and employ the same
review checklist. 11 Upon the completion of its examinations, FCA provides
a draft report to SBA for comment, incorporates any changes, and then
provides a final report to SBA, which, in turn, issues a final report to
the SBLC.

9 The SBA Inspector General defines financial risk as the composite risk
posed by loans and guarantees actually booked to SBA*s portfolio and how
they perform over time, and defines lender- based risk as the potential
financial injury due to the lender*s failure to perform its role properly.
U. S. Small Business Administration, Office of Inspector General, Audit
Report PLP Oversight Process, Report Number 1- 19, (Washington, D. C.:
September 27, 2001). 10 The five benchmarks are ratios for currency,
delinquency, default, liquidation, and loss. Each is defined in SBA*s SOP.
11 FCA conducts broad- based examinations and evaluates each SBLC*s
capital adequacy, asset quality, management, earnings, and liquidity. The
examinations are similar to safety and soundness examinations performed by
bank and government- sponsored enterprise regulators. SBA Has Not
Eliminated

Weaknesses in SBLC Oversight That Pose a Threat to the SBA Portfolio

Page 10 GAO- 03- 720T

SBA has not eliminated weaknesses in SBLC oversight, which were cited by
us and the SBA IG. We, and the SBA IG, found that final SBLC examination
reports were not issued in a timely manner. SBA*s IG reported that final
reports for fiscal year 2001 SBLC examinations were not issued until
February 2002, 10 months after OLO received the first draft report from
FCA. 12 Our work confirmed these findings. We found that OLO does not
maintain standards for the timely issuance of examination reports.
However, OLO has recently developed draft customer service goals calling
for SBLC examination reports to be finalized within 90 days of receipt of
a draft report from FCA. However, as of August 2002, none of the
examination reports from fiscal year 2002 had been issued. According

to the IG, because of the delays in finalizing the reports and SBA*s
policy to delay any necessary enforcement actions until final reports are
issued, two SBLCs were allowed to continue operating in an unsafe and
unsound manner, despite early identification of material weaknesses during
fiscal year 2001 examinations. The effectiveness of any examination
program is

measured, to a large degree, on its ability to identify and promptly
remedy unsafe and unsound conditions. By delaying reporting and remedial
action, SBA has significantly limited the effectiveness of its SBLC
oversight program.

SBA has been slow to implement recommendations from FCA for improving the
SBLC examination program. In addition to examining SBLCs, FCA was asked by
SBA to provide recommendations for changes in the SBLC program. Each year
FCA provides its views in a comprehensive report. FCA*s September 1999
report made 15 recommendations, 12 of which SBA agreed to implement. 13 We
reviewed the reports for fiscal years 2000 and 2001, in which FCA made
additional recommendations with which SBA agreed. Yet, the 2001 report
still lists 8 recommendations from the 1999 report and 2 from the 2000
report. SBA

officials explained that limited resources have contributed to the delay
in implementation of many of these recommendations.

12 U. S. Small Business Administration, Office of Inspector General,
Improvements Are Needed in the Small Business Lending Company Oversight
Process, Report No. 2- 12 (Washington, D. C.: March 20, 2002).

13 We listed the 15 recommendations in our November 2000 report. See U. S.
General Accounting office, Small Business Administration: Actions Needed
to Strengthen Small Business Lending Company Oversight, GAO- 01- 192
(Washington, D. C.: November 2000).

Page 11 GAO- 03- 720T

Assessing whether a borrower is eligible for 7( a) assistance is difficult
because the requirements are broad and variable, making a qualitative
assessment of a lender*s decision by a trained reviewer all the more

important. SBA regulations require a lender to attest to the borrower*s
demonstrated need for credit by determining that the desired credit is
unavailable to the borrower on reasonable terms and conditions from
nonfederal sources without SBA assistance. 14 These *credit elsewhere*
provisions are particularly difficult to assess and must be determined
prior to assessing other credit factors. 15 SBA guidance also requires
preferred lenders to certify that credit is not otherwise available and to
retain the explanation in the borrower file. 16 SBA does provide guidance
on factors that may contribute to a borrower being unable to receive
credit elsewhere. Factors that lenders should consider include the
following:

 The business requires a loan with a longer maturity than the lender*s
policy permits;

 The requested loan exceeds either the lender*s legal limit or policy
limit, regarding amounts loaned to one customer;

 The lender*s liquidity depends upon selling the guaranteed portion of
the loan on the secondary market;

 The collateral does not meet the lender*s policy requirements because of
its uniqueness or low value;  The lender*s policy normally does not allow
loans to new ventures or

businesses in the applicant*s industry; and  Any other factors relating
to the credit that in the lender*s opinion cannot

be overcome except by receiving a guaranty. Based on these criteria, the
credit elsewhere test could always be satisfied by structuring an SBA
guaranteed loan so that its terms and conditions differ from those
available on the commercial market. As a result, these

14 The SBA regulations do not further define *reasonable terms and
conditions.* See also 13 C. F. R. Section 120.101. 15 Section 7( a) of the
Small Business Act states that *no financial assistance shall be extended
if the applicant can obtain credit elsewhere.* 15 U. S. C. Section 636(
a). 16 SBA SOP 50- 10( 4)( E). PLP Reviews Do Not

Provide Adequate Assurance That Lenders Are Sufficiently Assessing
Eligibility and Creditworthiness

Page 12 GAO- 03- 720T

loans could be made available to businesses that could obtain credit
elsewhere on reasonable market terms and conditions, although not the same
terms and conditions offered with the SBA guarantee.

SBA officials stated that the credit elsewhere requirements are designed
to be broad so as to not limit a lender*s discretion and allow
flexibility, depending upon geographic region, economic conditions, and
type of business. For example, SBA officials said that when credit is more
readily available, businesses that require SBA assistance might be held to
a different standard, thereby making it more difficult to obtain the SBA
guarantee than when credit is tighter. Nonetheless, the flexibility that
lenders have along with the difficulty in assessing lenders* credit
elsewhere decisions further support the need for developing specific
criteria for a credit elsewhere standard. These changes would facilitate a
more qualitative assessment of eligibility decisions made by preferred
lenders.

Moreover, because it is a cursory review of documents in the file, the PLP
review also does not qualitatively assess a lender*s credit decision.
Preferred lenders are required to perform a thorough and complete credit
analysis of the borrower and establish repayment terms on the loan in the
form of a credit memorandum. SBA guidance requires, at a minimum,

discussion in the credit memorandum of a borrower*s capitalization or
proof that the borrower will have adequate capital for operations and
repayment, as well as capable management ability. 17 SBA officials said
that lender review staff focus on the lender*s process for making credit
decisions rather than the lender*s decision. SBA officials said that it is
unlikely that the review would result in a determination that the loan
should not have been made. An SBA official stated that review staff would
not perform an in- depth financial analysis to assess the lender*s credit
decision and that a lender*s process would only be questioned in the case
of missing documentation. For example, review staff would cite a lender if
it did not document the borrower*s repayment ability.

Some lenders we interviewed criticized the lack of technical expertise of
contract review staff. The lenders stated that review staff was unable to
provide additional insight into material compliance issues during the
review because of a lack of technical knowledge of the underwriting
process and requirements. For example, one lender said he was cited for

17 SBA SOP 50- 10( 4).

Page 13 GAO- 03- 720T

not signing a credit elsewhere statement, but the reviewer did not
evaluate a financial statement in the file substantiating the credit
elsewhere assessment. To improve PLP and SBLC oversight, we recommended
that SBA incorporate strategies into its review process to adequately
measure the financial risk lenders pose to SBA, develop specific criteria
to apply to the credit elsewhere standard, and perform qualitative
assessments of lender performance and lending decisions. SBA stated that
it believes the existing statutes, regulations, policies, and procedures
provide sufficient guidance to lenders. These are the same sources we
analyzed and found to be broad, making a qualitative assessment of a
lender*s decisions difficult. SBA has responded that it does measure
financial risk of SBLCs through the safety and soundness examinations
conducted by FCA and that the PLP lender reviews do estimate some degree
of financial risk. We had noted both of these measures in our December 9,
2002 report. We also noted that SBA had not acted on suggestions that FCA
had made to enhance SBA*s oversight of SBLCs. Only 3 of 15 preferred
lender review reports that we reviewed provided any evidence of such an
assessment. And, we note, SBA*s review guidance does not require such a
review. Thus, our recommendations remain open.

SBA has authority to suspend or revoke a lender*s PLP status for reasons
that include unacceptable loan performance; failure to make enough loans
under SBA*s expedited procedures; and violations of statutes, regulations,
or SBA policies. 18 However, SBA has not developed policies and

procedures that describe circumstances under which it will suspend or
revoke PLP authority or how it will do so. SBA guidance does not include
specific follow- up procedures for PLP lenders that receive poor review
ratings, but it does discuss recommended patterns of follow- up. SBA
officials said that, in practice, they request action plans to address
deficiencies for any ratings of *minimally in compliance* and *not in
compliance.* In addition, lenders with ratings of not in compliance are to
receive follow- up reviews. SBA officials explained that because they want
to encourage lenders to participate in PLP, they prefer to work out

problems with lenders, and therefore rarely terminate PLP status. And,
where a lender persists in noncompliance, SBA will generally allow the
status to expire, rather than terminating it. However, without clear

18 13 C. F. R. S: 120.455 (2002). SBA Has Not Developed

Clear Enforcement Policies for Preferred Lenders and SBLCs

Page 14 GAO- 03- 720T

enforcement policies, PLP lenders cannot be certain of the consequences of
certain ratings and they may not take the oversight program seriously. In
November 2000, we recommended that the SBLC examination program could be
strengthened by clarifying SBA*s regulatory and enforcement

authority regarding SBLCs. Although it has the authority to do so, SBA has
yet to develop, through regulation, clear policies and procedures for
taking supervisory actions. By not expanding the range of its enforcement
actions* which it can do by promulgating regulations* SBA is limited in
the actions it can take to remedy unsafe and unsound conditions in SBLCs.
SBA regulations only provide for revocation or suspension of an SBLC

license for a violation of law, regulation, or any agreement with SBA.
Without less drastic measures, SBA has a limited capability to respond to
unsatisfactory conditions in an SBLC. Unlike SBA, federal bank and thrift
regulators use an array of statutorily defined supervisory actions, short
of suspension or revocation of a financial institution*s charter or
federal deposit insurance, if an institution fails to comply with
regulations or is unsafe or unsound.

We recommended that SBA provide, through regulation, clear policies and
procedures for taking enforcement actions against preferred lenders and
SBLCs in the event of continued noncompliance with SBA*s regulations. Most
recently, SBA has responded that it does have clear policies and

procedures; however, the agency intends to expand upon them. We will
continue to followup and monitor SBA*s response to this recommendation.

SBA*s preferred lender certification process begins when a district office
serving the area in which a lender*s office is located nominates the
lender for preferred status or when a lender requests a field office to
consider it for PLP status. The district will then request performance
data regarding

the lender from SBA*s Sacramento Processing Center. The processing center
then provides the district office with data required to fill in part of a
worksheet developed for the nomination process. The district office sends
the completed worksheet, along with other required information, back to
the processing center. The processing center analyzes the nomination and

sends it with a recommendation to OFA for final decision. According to
SBA*s SOP, in making its decision, OFA considers whether the lender (1)
has the required ability to process, close, service, and liquidate loans;
(2) has the ability to develop and analyze complete loan packages; and (3)
has a satisfactory performance history with SBA. OFA

also considers whether the lender shows a substantial commitment to SBA*s
Process for

Administering PLP Status Presents Lenders with Challenges

Page 15 GAO- 03- 720T

SBA*s *quality lending goals,* has the ability to meet the goals, and
demonstrates a *spirit of cooperation* with SBA.

OFA and district office staff said that although district offices do not
provide final approval of PLP status for lenders in their districts, they
generally play an important role and district input is given significant
weight. Most of the district office staff we interviewed believed that
they had considerable influence on OFA*s decision regarding a lender*s PLP
status.

A PLP lender may request an expansion of the territory in which it can
process PLP loans by submitting a request to the Sacramento Processing
Center. The processing center will obtain the recommendation of each
district office in the area into which the PLP lender would like to expand

its PLP operations. The processing center will forward the district
recommendations to OFA for a final decision.

Lenders we interviewed had varying experiences in gaining and maintaining
their PLP status. While some lenders expressed general satisfaction with
the process and their understanding of it, others cited problems. For
example, several PLP lenders we interviewed said that they had their PLP
status declined in a specific district, although they had

already achieved PLP status in other districts. In some instances, lenders
said that they did not understand why they had been turned down, in light
of their proven performance. These lenders commented that some district
offices were not open to working with lenders from outside their districts

while others were. In our interviews with district offices, we sometimes
heard differing descriptions from district office officials on the level
of commitment required of a lender who wished to gain PLP status in their
district. Some district officials said that a lender had to maintain a
physical presence in the district, while others disagreed. However, all
district office

officials expressed the need for some regular discussion with a lender to
understand the lender*s commitment to the district.

Larger lenders, as well as the National Association of Government
Guaranteed Lenders (NAGGL), noted the administrative burden of maintaining
relationships with many of the 70 district offices to maintain PLP status.
The lenders noted that to receive and maintain PLP status in a given
district, it is generally necessary to meet at least annually with
district office staff to discuss status and plans for future lending. For
some large national lenders, this can amount to 40 or more visits per
year. In response to this concern, NAGGL has recommended a national PLP
status based on a uniform national standard to ease the administrative
burdens

Page 16 GAO- 03- 720T

on large national lenders that account for the largest volume of PLP
lending.

District office officials that we interviewed generally acknowledged that
they want to understand a lender*s plans for their district before
agreeing to endorse a lender that wishes to gain PLP status in their
district. District

officials explained that PLP status is an important marketing tool for
lenders. As advocates for the credit needs of small businesses in their
districts, the district office officials see PLP status as a *carrot* to
encourage lenders to make a sufficient volume of loans to their district.
They suggest that a *national* PLP lender might make a large volume of PLP
loans nationwide, but none in their district. The officials reason that
without a district- by- district PLP status, district offices would lose
an important tool for encouraging lenders to respond to credit needs in
their districts.

To hold lenders to a uniform national standard while maintaining
individual district office*s preferences and reinforcing their
relationships with PLP lenders, SBA developed a formula- driven lender
evaluation worksheet to facilitate the nomination, expansion, and renewal
processes. The worksheet replaces the former procedure that involved
written recommendations from district officials; however, it continues to
award points based on sometimes subjective criteria, such as the district
office*s assessment of the lender*s SBA marketing and outreach efforts,
rather than the formulas in the spreadsheet. Where this is the case,
district office staff are required to provide written justification for
the points awarded.

SBA has a Lender Liaison program, managed by its Office of Field
Operations (OFO), to assist large national lenders in managing
relationships with SBA. The program involves the assignment of a single
SBA official, generally a district director, to act as a liaison to a
large national lender. In the event that a large lender should experience

difficulty in managing its PLP status, it would have a single SBA official
to call to assist in resolving any problems. OFO staff said that feedback
they have received from lenders indicated that they like the program,
finding it useful for resolving difficulties. Two of the lenders we
interviewed participated in the program, and both expressed satisfaction
with it. SBA has designated lender liaisons for 20 PLP lenders and, at the
time of our review, intended to expand the program to 50 additional
lenders. OLO identified 70 lenders who have PLP status in 6 or more
districts and could benefit from the program.

Page 17 GAO- 03- 720T

We recommended that SBA continue to explore ways to assist large national
lenders to participate in the PLP. SBA has indicated that they are
reviewing the issues we identified with regard to large national lenders

and considering the best approach to address the issues. We will continue
to followup with SBA and monitor its response on this matter.

In our past work analyzing organizational alignment and workload issues at
SBA and other agencies* efforts to improve management and performance, we
have described the importance of tying organizational alignment to a clear
and comprehensive mission statement and strategic plan. By organizational
alignment, we mean the integration of organizational components,
activities, core processes, and resources to

support efficient and effective achievement of outcomes. For example, we
noted how agency operations can be hampered by unclear linkage between an
agency*s mission and structure, but greatly enhanced when they are tied
together. 19 We have identified human capital management challenges in key
areas, which include undertaking strategic human capital planning and
developing staffs whose size, skills, and deployment meet agency needs. 20
We have also noted the importance of separating safety and soundness
regulation and mission evaluation from the function of mission promotion.
While SBA*s role regarding PLP lenders is slightly

different from that of a safety and soundness regulator, two principles
still apply to SBA. First, oversight and program evaluation functions
should be organizationally separate and maintain an arm*s- length
relationship from program promotion. And second, in evaluating program
compliance, SBA needs to weigh the financial risks to the federal
government along with the 7( a) program*s mission to provide credit to
those who cannot get it elsewhere.

SBA officials have said and written that lender oversight is becoming an
increasing priority for SBA; however, the function is not housed in an
independent office with the exclusive role of providing lender oversight.
OLO was created within OCA in fiscal year 1999 to ensure consistent and

19 U. S. General Accounting Office, Small Business Administration: Current
Structure Presents Challenges for Service Delivery, GAO- 02- 17
(Washington, D. C.: October 2001). 20 Also included are leadership
continuity and succession planning, and creating resultsoriented
organizational cultures. U. S. General Accounting Office, Managing For
Results: Next Steps to Improve the Federal Government*s Management and
Performance,

GAO- 02- 439T (Washington, D. C.: February 15, 2002). SBA*s Organizational

Alignment Does Not Adequately Support SBA*s Lender Oversight Functions

Page 18 GAO- 03- 720T

appropriate supervision of SBA*s lending partners; however, OCA has other
objectives, including the promotion of PLP to appropriate lenders. OFA,
also part of OCA, is responsible for providing overall direction for the
administration of SBA*s lending programs, including working with lenders
to deliver lending programs, including 7( a), and developing loan policies
and standard operating procedures.

OFA*s lender oversight role is to provide final approval of lenders* PLP
status and to take necessary enforcement actions against SBLCs. Yet, in
its promotion role, OFA works with lenders to deliver lending programs.
Thus the only explicit enforcement authority* the authority to revoke PLP
status* resides with OFA rather than OLO. The presence of both OFA and OLO
within OCA does not afford the oversight function an arm*s- length
position from the promotion function. The organizational arrangement
presents a potential conflict, or at least the appearance of a conflict,
between the desire to encourage lender participation in PLP and the need
to evaluate lender performance (with the potential for discontinuing

lenders* participation in PLP). Evidence of overlapping responsibilities
and poorly aligned resources also can be seen in delays SBA has
experienced in completing certain tasks associated with lender oversight.
As noted previously, these delays could hamper effective PLP and SBLC
oversight by delaying corrective action that might arise from review
findings. Since some, but not all, responsibility for the lender oversight
function migrated from OFA to

OLO, both offices continue to mingle responsibilities for certain
functions. The division of responsibility between OFA and OLO has created
the need for more interoffice coordination to complete certain tasks. For
example, we found substantial delays in finalizing PLP review reports and,
as noted earlier, in SBLC examination reports.

SBA*s IG concluded that the delays in completing SBLC reports were at
least partially due to poor coordination between OLO and OFA, both of
which were involved in reviewing the reports. OLO and OFA, respectively,
are responsible for oversight and management of the SBLC program. OLO

is responsible for SBLC on- site examination and off- site monitoring,
while OFA handles day- to- day program management, policymaking, and
enforcement of corrective actions. Coordination between the two offices,
however, was not formally established and simply evolved over time. The IG
said that this informal structure contributed, in part, to the delays in
issuing the fiscal year 2001 examination reports. OLO staff said that
limited staffing also contributed to delays. For example, OLO began

Page 19 GAO- 03- 720T

operations with 3 headquarters staff in fiscal year 2000, a number that
increased to 12 by December 2002.

We recommended that SBA separate lender oversight functions and
responsibilities from OCA, including those currently done by OFA. This
would provide an oversight office with greater autonomy within SBA to
match the growing importance of lender oversight in achieving SBA*s goal
of ensuring that PLP lenders make loans to eligible borrowers while

properly managing the financial risk to SBA. While SBA did not respond
directly to this recommendation prior to the December 2002 publication of
our report, it recently stated in a response to congressional committees
that it believes OLO has adequate independence. In addition, SBA maintains
there is an advantage to having both OLO and OFA within the same office
and working in concert. SBA did state, in March 2003, that it was in the
process of drafting policies and procedures governing OLO program
responsibilities. We plan to follow- up with SBA on its response to this
recommendation.

Madam Chair, Members of the Committee, this concludes my prepared
statement. I would be happy to answer any questions at this time.

For information on this statement, please contact Davi D*Agostino,
Director, Financial Markets and Community Investment, at (202) 512- 8678
or Katie Harris, Assistant Director, at (202) 512- 8415. You may also
reach

them by E- mail at dagostinod@ gao. gov or harrism@ gao. gov. Other
individuals who made key contributions to this testimony include Toayoa
Aldridge, Tom Conahan, and Barbara Roesmann. Contacts and

Acknowledgments

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