Department of Veterans Affairs: Credit Costs and Risks of Proposed VA
Small Business Loan Guarantee Program (Letter Report, 06/30/2000,
GAO/GGD-00-158).
Pursuant to a legislative requirement, GAO provided information on the
federal costs and risks of a proposed program for the Department of
Veterans Affairs (VA) to guarantee small business loans to veterans,
focusing on: (1) the federal credit costs and risks of the proposed
program; (2) the cost impact of alternative borrower requirements in the
implementation of the proposed program; and (3) the administrative
issues resulting from VA's implementation of the proposed program.
GAO noted that: (1) the federal credit costs and risks of the proposed
program could be similar to the Small Business Administration's (SBA)
7(a) or 504 loan guarantee programs, depending on which program it most
resembled; (2) a proposed VA program designed like SBA's 7(a) program
could require a similar federal credit subsidy because fees collected
from program participants likely would not cover federal guarantee
payments; (3) based on SBA's most recent estimates, the credit subsidy
rates for the 7(a) program for fiscal years 1992 through 1999 have been
under 2 percent; (4) alternatively, if the proposed program were
designed like SBA's 504 program, its credit subsidy rate would be harder
to predict; (5) SBA's most recent estimates showed the credit subsidy
rates were around 4 or 5 percent for fiscal years 1992 through 1996; (6)
fees charged to 504 program participants were increased in 1996, and the
program has not required a federal subsidy since 1997; (7) based on
historical patterns of the 504 program, it is uncertain whether a
federal subsidy will be required in the future; (8) based on historic
experience and the design of the program, including the differing fee
structures, the subsidy rate for SBA's 7(a) program is generally
expected to be higher than for SBA's 504 program; (9) GAO's analysis of
veteran loan performance indicated that credit costs resulting from
borrower defaults on loan payments would be about the same for veterans
who could participate in the proposed program; (10) an economic downturn
or other events could increase the proposed program's federal credit
costs; (11) alternative borrower requirements, such as requiring
personal equity as a down payment, have the potential to lower credit
costs; (12) GAO was not able to quantify the impacts of alternative
borrower requirements on federal credit costs of the proposed program
because SBA does not generally maintain these data for the benchmark
programs; (13) VA's lack of experience in administering a small business
loan guarantee program could create administrative challenges and may
lead to higher administrative costs than the benchmark SBA programs;
(14) VA officials said that while they have the expertise to adequately
evaluate mortgage applications, they do not have the knowledge of human
capital resources to adequately evaluate business loan applications; and
(15) in February 2000, VA, SBA, and the Association of Small Business
Development Centers entered into a Memorandum of Understanding to share
expertise with the intent to expand small business opportunities for
veterans.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-00-158
TITLE: Department of Veterans Affairs: Credit Costs and Risks of
Proposed VA Small Business Loan Guarantee Program
DATE: 06/30/2000
SUBJECT: Small business loans
Veterans
Government guaranteed loans
Loan accounting systems
Risk management
IDENTIFIER: SBA 7(a) Loan Program
SBA 504 Program
VA Small Business Loan Guarantee Program
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GAO/GGD-00-158
United States General Accounting Office
GAO
Report to Congressional Requesters
June 2000
GAO/GGD-00-158
DEPARTMENT OF VETERANS AFFAIRS
Credit Costs and Risks of Proposed VA Small
Business Loan Guarantee Program
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Contents
Page 201 GAO/GGD-00-158 VA Credit Cost and Risk
Letter 1
Appendix I 22
Background Information
on SBA and VA Loan
Programs and Loan
Requirements
General Description of SBA 7(a) Loan 22
Program
General Description of the 504 Loan 24
Program
General Description of the Department 25
of Veterans Affairs Guaranteed,
Single-Family Mortgage Loan Program
Appendix II 28
Loan Performance Is
Similar for VA and FHA
Fixed-Rate Residential
Mortgage Loans
General Description of the FHA 28
Mortgage Insurance Program
Appendix III 32
Comments From the Small
Business Administration
Appendix IV 34
Comments From the
Department of Veterans
Affairs
Appendix V 35
GAO Contacts and Staff
Acknowledgments
Tables Table 1: SBA 7(a) and 504 Subsidy 7
Rates for Fiscal Year 1992-2001 Loans
Table 2: Percent of 7(a) Loans Current 8
or Paid in Full for Fiscal Year 1990-
1999 Loans
Table 3: Percent of 504 Loans Current 9
or Paid in Full for Fiscal Year 1990-
1999 Loans
Table 4: SBA 7(a) and 504 Loans to 11
Veterans, Fiscal Years 1992-1999
(Dollars in millions)
Figures Figure II.1: Percentage of Outstanding 30
VA and FHA Loans Delinquent 30 Days
or More
Figure II.2: Percentage of Outstanding 31
VA and FHA Loans for Which
Foreclosure Was Started During the
Quarter
Abbreviations
ARM Adjustable Rate Mortgages
ASBDC Association of Small Business
Development Center
CDC Certified Development Company
FHA Federal Housing Administration
Ginnie Mae Government National Mortgage
Association
HUD Department of Housing and Urban
Development
MBA Mortgage Bankers Association
MOU Memorandum of Understanding
SBA Small Business Administration
VA Department of Veterans Affairs
B-284255
Page 19 GAO/GGD-00-158 VA Credit Cost and Risk
B-284255
June 30, 2000
Congressional Requesters
This report responds to a mandate in the
Veterans Entrepreneurship and Small Business
Development Act of 1999 that we analyze the
federal costs and risks of a proposed program for
the Department of Veterans Affairs (VA) to
guarantee small business loans to veterans for the
acquisition of fixed assets used in a business. As
agreed with your offices, our objectives were to
analyze (1) the federal credit costs and risks of
the proposed program, (2) the cost impact of
alternative borrower requirements in the
implementation of the proposed program, and (3)
the administrative issues resulting from VA's
implementation of the proposed program.
To address the federal credit costs and risks
of the proposed program, we reviewed the credit
costs, risks, and program features of the Small
Business Administration's (SBA) 7(a) and 504 loan
guarantee programs to provide financial
benchmarks. SBA's 7(a) program is intended to help
small business borrowers who cannot otherwise
obtain credit under suitable terms and conditions
from the private sector to start or expand a
business. SBA's 504 program provides long-term,
fixed asset financing through certified
development companies to new and existing small
businesses to contribute toward economic
development.
Results in Brief
The federal credit costs and risks of the
proposed program could be similar to SBA's 7(a) or
504 loan guarantee programs, depending on which
program it most resembled. A proposed VA program
designed like SBA's 7(a) program could require a
similar federal credit subsidy because fees
collected from program participants likely would
not cover federal guarantee payments. Based on
SBA's most recent estimates, the credit subsidy
rates for the 7(a) program for fiscal years 1992
through 1999 have been under 2 percent.
Alternatively, if the proposed program were
designed like SBA's 504 program, its credit
subsidy rate would be harder to predict. SBA's
most recent estimates showed the credit subsidy
rates were around 4 or 5 percent for fiscal years
1992 through 1996. Fees charged to 504 program
participants were increased in 1996, and the
program has not required a federal subsidy since
1997. Based on historical patterns of the 504
program, it is uncertain whether a federal subsidy
will be required in the future.
Based on historic experience and the design
of the program, including the differing fee
structures, the subsidy rate for SBA's 7(a)
program is generally expected to be higher than
for SBA's 504 program. Our analysis of veteran
loan performance indicated that credit costs
resulting from borrower defaults on loan payments
would be about the same for veterans who could
participate in the proposed VA program, as
compared with borrowers who participate in the
benchmark SBA programs. An economic downturn or
other events could increase the proposed program's
federal credit costs.
Alternative borrower requirements, such as
requiring personal equity as a down payment, have
the potential to lower credit costs. We were not
able to quantify the impacts of alternative
borrower requirements on federal credit costs of
the proposed program because SBA does not
generally maintain these data for the benchmark
programs. In any case, more stringent borrower
requirements could make the program less
attractive to possible program participants.
VA's lack of experience in administering a
small business loan guarantee program could create
administrative challenges and may lead to higher
administrative costs than the benchmark SBA
programs. VA officials said that while they have
the expertise to adequately evaluate mortgage
applications, they do not have the knowledge and
human capital resources to adequately evaluate
business loan applications. In February 2000, VA,
SBA, and the Association of Small Business
Development Centers entered into a Memorandum of
Understanding to share expertise with the intent
to expand small business opportunities for
veterans. Veteran service organization officials
said that they would like to see SBA place greater
emphasis on providing entrepreneurial outreach
assistance to veterans than on the implementation
of a new business loan guarantee program.
In this report, we have a matter for
congressional consideration addressing expertise
sharing between VA and SBA as an alternative to a
new program in VA at this time. To take advantage
of existing resources and administrative
infrastructures, it may be more cost effective to
use the current expertise of VA and SBA to expand
SBA guaranteed business loan opportunities to
veterans. SBA and VA provided technical comments,
which were incorporated where appropriate. VA
agreed with our conclusions.
Background
The federal government provides guarantees on
loans as a mechanism to achieve numerous
objectives, such as assistance for home ownership
and small business opportunities. Federal
guaranteed loan programs generally receive a
federal credit subsidy, which equals the estimated
present value of net costs to guarantee loans made
from an appropriation for the specific fiscal year
over the time the loans are outstanding. Each
fiscal year, federal agencies offering loan
guarantee programs are to calculate the subsidy
costs of these programs for budget and financial
reporting purposes. Federal agencies operating
loan guarantee programs are required to submit
annual re-estimates of subsidy rates for loans
guaranteed in fiscal year 1992 and forward. These
re-estimates are to adjust the original subsidy
rate estimates based on actual loan performance.
These re-estimates thus reflect the amount of
credit subsidy required from or returned to the
U.S. Treasury.
SBA operates loan guarantee programs that provide
financial assistance to small businesses. SBA's
7(a) program is its largest loan guarantee program
and primary vehicle for providing borrowers with
access to financing for small businesses. The 7(a)
program is intended to serve borrowers who could
not otherwise obtain credit under suitable terms
and conditions from the private sector. In the
7(a) program, SBA guarantees up to 80 percent on
loans made by participating private sector
lenders. This guarantee provides lenders partial
protection against loan losses when payments are
not made. SBA's 504 program provides long-term,
fixed asset financing through certified
development companies. These corporations are
sponsored by private-sector organizations or by
state or local governments to contribute to local
economic development.
A typical 504 loan requires borrowers to provide
at least 10 percent of the project's financing, 50
percent financing from a private-sector lender,
and the remaining share from the sale of
debentures guaranteed by the SBA.
The dollar volume of 7(a) and 504 loans that SBA
can guarantee each year is based on congressional
appropriations. SBA guaranteed about $9 billion in
7(a) loans annually in fiscal years 1997 through
1999. SBA guaranteed slightly more than $1 billion
in 504 loans annually in fiscal years 1997 and
1998. For fiscal year 1999, SBA guaranteed $700
million, as of February 29, 2000.1 Veterans
received about 15 percent of 7(a) loans and about
7 percent of 504 loans, between fiscal years 1992
and 1999. More detailed information on these
programs is presented in appendix I.
VA operates an entitlement program that provides
single-family, residential mortgage loan
guarantees for eligible veterans to purchase,
construct, repair, or refinance homes.
VA provides private-sector mortgage lenders with a
partial guarantee on mortgage loans when loans go
into foreclosure. In exchange for the guarantee,
VA encourages lenders to offer loans to veterans
on terms more favorable than conventional
financing, such as requiring small or no down
payment. In fiscal year 1999, VA provided loan
guarantees on 486,000 mortgage loans with a
principal balance of $54 billion. The average
loan size was about $110,000. VA officials stated
that fiscal year 1999 was one of the highest
levels of loan guarantee activity in the program's
history, as a result of interest rate decreases
that led to an increased level of refinancing
activity. Because the VA guaranteed mortgage loan
program is an entitlement program, Congress
provides VA with a supplemental appropriation when
the guaranteed amount exceeds the initial
appropriation. More detailed information on this
program is presented in appendix I.
The initial authority for VA to provide guarantees
for small business loans was made shortly after
World War II. In 1974, Congress repealed VA's
business loan guarantee authority due to the
decreased level of participation. In 1981, VA was
authorized to provide loan guarantees for small
business loans made to Vietnam era or disabled
veterans. This loan guarantee authority expired
on September 30, 1986. According to VA officials,
this small business loan guarantee program was not
implemented because Congress did not provide
federal appropriations. VA officials stated that
annual appropriations were provided to SBA to
guarantee loans to veterans because that agency
had greater expertise in business loan matters.
VA currently refers veterans to SBA for business
loan matters.
Scope and Methodology
The Veterans Entrepreneurship and Small
Business Development Act of 1999 mandated that we
analyze the anticipated federal costs and risks of
a proposed fixed-asset small business loan
guarantee program for veterans. We were to assume
that up to 10 percent of funds appropriated for
the VA guaranteed residential mortgage loan
program would be made available for a small
business loan guarantee program within VA. We
treated this amount as an additional cost and risk
to the federal government because the funds
appropriated for the VA mortgage loan program
cannot be reduced to serve other purposes.
Therefore, the government may need to provide an
appropriation for the proposed program. We also
assumed that the proposed program could take on
the design of either SBA's 7(a) or 504 loan
guarantee programs. By design, we mean that the
proposed program could have similar loan products,
terms, underwriting standards, and standard
operating procedures as the benchmark programs.
Similar to the experience of the 7(a) and 504
programs, the credit costs of the proposed program
would be affected by changes in economic
conditions.
To help us estimate federal credit costs and
risks of the proposed program, we analyzed SBA's
7(a) General Business Guarantee and 504 Certified
Development Company loan programs to provide
financial benchmarks. We interviewed SBA officials
and reviewed SBA information on the administration
of the benchmark programs, which included data on
fees, SBA standard operating procedures, and
program loan performance. We analyzed the
benchmark programs' costs and other financial data
presented in the fiscal years 1999 through 2001
Budget of the United States Government and the
corresponding Federal Credit Supplement: Fiscal
Year 2001. We referred to the credit subsidy re-
estimates contained in the latter document as
fiscal year 2001 re-estimates. Our analysis
included consideration of possible differences
between federal credit costs of the proposed
program and the benchmark SBA programs based on
different features of the programs and the small
business borrowers served.
To analyze how federal credit costs and risks
of the proposed program could be affected by
alternative borrower requirements, we reviewed
SBA's underwriting requirements.2 We discussed
with SBA officials their independent contractor
study of 7(a) and 504 loan programs.3 We also
reviewed the loan performance of veterans and all
borrowers who obtained SBA 7(a) and 504 loans. We
also analyzed loan performance of veterans
participating in VA's residential mortgage loan
guarantee program and the participants in the
Federal Housing Administration's (FHA) Mutual
Mortgage Insurance Program. Appendix II contains
our analysis of VA and FHA loan performance. We
also reviewed reports on the performance of SBA
7(a) loans from Moody's Investor Services and
Standard & Poors and discussed 7(a) loan
performance with an official from Moody's.
To identify potential administrative issues
resulting from implementation of the proposed
program by VA, we interviewed VA officials and
reviewed VA's information on its guaranteed
residential mortgage loan program. We also met
with veteran service organization officials from
the Disabled American Veterans, Veterans of
Foreign Wars, and Vietnam Veterans of America to
obtain their perspectives of the proposed program
within VA.
We did not report confidential SBA data
specific to veterans' loan performance. We relied
on SBA data on costs and loan performance as
reported to us by SBA. SBA loan performance and
credit cost information is reviewed as part of the
annual financial statement audits. SBA received
an unqualified opinion on its fiscal year 1999
financial statements. We also relied on VA data
on annual mortgage loan guarantee amounts and loan
performance as reported to us by VA.
We conducted our work in Washington, D.C.,
between September 1999 and May 2000 in accordance
with generally accepted government auditing
standards. We requested comments on a draft of
this report from the Administrator, SBA, and
Secretary of VA. SBA's and VA's written comments
are discussed near the end of this letter and are
reprinted in appendixes III and IV, respectively.
Credit Costs and Risks of Proposed Program Would
Depend on Proposed Program's Design
The federal credit costs and risks of the
proposed program could be similar to SBA's 7(a) or
504 loan guarantee programs, depending on which
program it most resembled.4 The design of the
proposed program will determine the level of
federal subsidy, if any, necessary to support the
program. The proposed program likely would
require a subsidy if designed like the 7(a)
program. However, based on historical data, the
proposed program with an SBA 504 design may or may
not require a credit subsidy. According to our
analysis of SBA data, veteran loan performance in
the SBA programs was generally similar to the loan
performance of the total loan portfolio for each
program.
SBA's 7(a) Program Has Required Federal Subsidies
SBA's 7(a) program has required federal subsidies.
As shown in table 1, SBA's original subsidy rate
estimates for the 7(a) program ranged from about 1
percent to about 5 percent for fiscal years 1992
through 2001. SBA's fiscal year 2001 re-
estimates of credit costs showed that the 7(a)
program required a federal subsidy of less than 2
percent for fiscal years 1992 through 1999.
Table 1: SBA 7(a) and 504 Subsidy Rates for Fiscal
Year 1992-2001 Loans
Subsidy rate (percent)a
7(a) 504
Fiscal Original Fiscal Original Fiscal
year Year 2001 Year
Re- 2001
estimate Re-
estimate
1992 4.85 1.81 0.49 4.96
1993 5.21 1.14 0.54 3.59
1994 2.15 0.82 0.51 5.05
1995 2.74 1.76 0.57 4.20
1996 1.06 0.34 0.00 3.59
1997 1.93 0.02 0.00 -2.71
1998 2.14 0.88 0.00 -1.63
1999 1.39 1.03 0.00 -1.12
2000 1.16 N/A 0.00 N/A
2001 1.24 N/A 0.00 N/A
Note: N/A represents no data available.
aThe subsidy rate is the credit subsidy received
by the program expressed as a percent of the total
dollars loaned through the program. It is
calculated separately for loans made from the
appropriations for the specific fiscal year,
called the fiscal year loan cohort. The figures
shown in the columns labeled "original" are the
estimated subsidy rates calculated for budget
purposes prior to the fiscal years. A
re-estimate of the subsidy rate is made in each
subsequent fiscal year that loans from the cohort
are outstanding. A negative rate means that funds
are returned to the U.S. Treasury.
Source: Federal Credit Supplement to the Fiscal
Year 2001 U.S. Budget.
SBA's 504 Program Has Not Required a Federal
Subsidy in Recent Years
SBA's 504 program has not required a federal
credit subsidy since 1997, but it did require a
subsidy for prior fiscal years. As shown in table
1, SBA's original subsidy rate estimates for the
504 program were less than 1 percent for fiscal
years 1992 through 1995. SBA's fiscal year 2001
credit subsidy rate re-estimates showed that the
program required a federal subsidy around 4 or 5
percent for fiscal years 1992 through 1996. The
504 program experienced higher than expected
credit costs for lending activity from
appropriations for fiscal years 1992 through 1996.
For fiscal year 1996 and forward, SBA
original subsidy rate estimates showed that the
504 loan program would require a zero credit
subsidy. The zero subsidy is required by federal
statute. As a result of the zero subsidy
requirement, SBA increased the fees charged to
borrowers and lenders.5 SBA's fiscal year 2001 re-
estimates showed negative subsidy rates for fiscal
years 1997 through 1999. For these fiscal years,
the 504 program is now estimated to collect more
in fees than paid out in default payments.
Subsidy Rate Re-estimates Provide Better Measures
of Credit Subsidy Costs Than Initial Subsidy Rate
Estimates
For our analysis of federal credit costs and risk,
we used credit subsidy re-estimates because they
reflect the actual performance of guaranteed loans
up to the date of the re-estimates.6 Federal
agencies' credit subsidy re-estimates are
generally different from initial estimates. For
example, actual defaults can differ from initial
expectations due to unanticipated events, such as
major changes in economic conditions that can
affect business performance and the borrowers'
ability to repay loans. Generally, defaults on
guaranteed small business loans increase during
economic downturns. When defaults are greater
than expected, guarantee program payments and
federal credit costs are also greater than
expected.
Veteran Loan Performance in SBA Loan Programs Has
Been Generally Similar to All Participants
Based on our analysis of SBA loan performance
data, veteran loan performance was generally
similar to the loan performance of the total loan
portfolio for each program. Tables 2 and 3 show
the percent of 7(a) and 504 loans guaranteed in
fiscal years 1990 through 1999 that were either
current in payment or paid in full, as of February
29, 2000. We calculated that an average of 87
percent of all 7(a) loans and an average of 96
percent of all 504 loans were either current or
paid in full. Veteran loan performance was
generally consistent with these averages for both
benchmark programs.7
Table 2: Percent of 7(a) Loans Current or Paid in
Full for Fiscal Year 1990-1999 Loans
Fiscal year Total number of Percent of 7(a)
7(a) loans current
loans guaranteed or paid in full
1990 15,832 81.3 %
1991 16,511 85.0
1992 21,357 87.9
1993 23,553 88.3
1994 32,270 86.1
1995 48,673 83.3
1996 39,577 83.9
1997 38,301 86.9
1998 34,979 90.7
1999 33,267 96.0
Note: Data as of February 29, 2000.
Source: SBA.
Table 3: Percent of 504 Loans Current or Paid in
Full for Fiscal Year 1990-1999 Loans
Total number of Percent of 504
Fiscal year 504 loans loans current or
guaranteed paid in full
1990 1,378 99.2 %
1991 1,346 98.7
1992 1,826 97.0
1993 2,199 97.5
1994 3,321 93.9
1995 3,803 83.9
1996 5,855 96.7
1997 3,413 98.1
1998 3,680 93.8
1999 2,040 96.2
Note: Data as of February 29, 2000.
Source: SBA.
Proposed Program Could Have Credit Costs Similar
to the Benchmark SBA Program It Most Resembled
Because veteran loan performance in the
benchmark SBA programs has been generally similar
to the loan performance of all program
participants, the proposed program could have
credit costs that are similar to whichever
benchmark program it most closely resembled. The
design of the proposed program would greatly
affect credit costs or the level of federal
subsidy needed, if any. If the proposed program
were designed like the 7(a) program, it would be
more likely to require a federal subsidy. If the
proposed program instead were designed like the
504 program, it would be less likely to require a
federal subsidy.
The Impact of Alternative Borrower Requirements on
Credit Costs Is Unclear
Because SBA statistics were limited, we were
not able to quantify the potential impact that
alternative borrower requirements, such as
requiring personal equity as a source of down
payment, could have on the proposed federal credit
costs, including program participation and loan
performance. Alternative borrower requirements
would appear to have the potential to affect
credit costs by affecting loan performance and
program participation by affecting the
attractiveness of the program. Veteran
participation in SBA's 504 program has been less
than veteran participation in SBA's 7(a) program.
Veteran participation in SBA's 504 program brings
into question whether the proposed program with a
504-type design would result in lower veteran
participation than needed to utilize the $3 to $5
billion annually.8 VA could provide inducements
to attract greater veteran participation, but such
actions likely would generate additional federal
credit costs.
Relevant Statistics Are Not Readily Available to
Evaluate the Impact on Credit Costs
SBA does not generally maintain readily
available data that could be used to determine if
down payments (i.e., equity contribution) affect
loan performance or program participation.
Instead, SBA officials said that they analyze
business loan performance by concentrating on cash
flows and information on the borrower and the
business. An official from Moody's that we
interviewed, who analyzes SBA 7(a) loan
performance, emphasized the difficulty associated
with measuring such variables as the loan-to-value
ratio on business loans consistently across loan
pools. He stated that lenders do not have
consistent methodologies for constructing loan-to-
value ratios. In addition, since the financial and
business skills of the small business operator
have a major impact on business success and
subsequently loan performance, collecting data on
the relationship between borrower down payments
and loan performance may be of limited use.
Due to the absence of SBA data that could be
used to determine if there is a relationship
between down payments and SBA loan performance or
program participation, we were unable to determine
how down payment requirements would affect credit
costs of the proposed VA small business loan
guarantee program. Although SBA's 504 program
requires a down payment of 10 percent, we could
not determine whether this down payment
requirement affected loan performance due to the
absence of data.
More Stringent Borrower Requirements Could Reduce
Credit Costs and Program Participation
In addition to increasing down payments, VA
could impose other more stringent borrower
requirements to reduce federal credit costs of the
proposed program. For example, VA could be given
the authority to require borrowers to provide
fixed-asset business property, such as real estate
or personal financial assets, as collateral. In
addition, VA could establish standards that limit
the number of years the borrower has for repayment
of a fixed-asset business loan or implement high
program fees paid by borrowers. While these
actions might reduce federal credit costs, such
actions also likely would reduce program
participation, especially if veterans have access
to alternative, more attractive sources of small
business loans. For example, veterans may choose
to participate in either SBA's 7(a) or 504
programs, if the proposed program had more
stringent borrower requirements, such as shortened
repayment terms. Furthermore, if VA imposed
stringent requirements, veteran borrowers may seek
unguaranteed, or conventional small business loans
from financial institutions.
VA might also reduce federal credit costs by
requiring lenders to pay high fees or offering a
low loan guarantee percentage. These actions,
directed at lenders, also have the potential to
reduce program participation. Such actions may
lead lenders to limit or eliminate use of the VA
program or charge small business borrowers higher
interest rates to cover credit risk exposure or
any additional lender fees charged by VA.
Veteran Participation in SBA's 7(a) Program Has
Been Greater Than Veteran Participation in SBA's
504 Program
Veteran participation has been greater in
SBA's 7(a) program than in SBA's 504 program in
terms of both dollar volume of loans guaranteed
and the percentage of overall participation in
both programs. As shown in table 4, during fiscal
years 1992 through 1999, veterans received 12 to
16 percent of SBA 7(a) and 5 to 9 percent of SBA
504 loan dollars. Total annual dollar volume for
veterans has been below $1.4 billion for SBA 7(a)
loans and below $200 million for SBA 504 loans.
Officials from veteran service organizations that
we interviewed did not specifically endorse either
SBA's 7(a) or 504 program as a preferred design
for the proposed program. They emphasized that
SBA's role in guaranteeing business loans to
veterans could be expanded by SBA's increasing
entrepreneurial assistance outreach efforts to
veterans. This emphasis appears to center on the
business opportunities provided by SBA's 7(a)
program more so than SBA's 504 program because
entrepreneurial assistance can be more valuable
for the start-up, less established small
businesses that SBA's 7(a) program is intended to
serve.
Table 4: SBA 7(a) and 504 Loans to Veterans,
Fiscal Years 1992-1999 (Dollars in millions)
7(a) 504
Fiscal Loans to Percent of Loans to Percent of
year veterans all loans veterans all loans
1992 $868.9 15 $35.1 5
1993 995.2 15 41.3 5
1994 1,306.1 15 84.9 6
1995 1,294.2 16 94.3 6
1996 1,191.7 15 172.9 7
1997 1,391.0 15 109.9 8
1998 1,226.7 14 144.4 8
1999 1,198.1 12 181.9 9
Note: Dollar amounts and percentages of loans are
based on gross amounts of initial loan approvals.
Source: SBA.
The Proposed Program's Federal Credit Costs Could
Be Affected by Inducements to Increase Veteran
Participation
As shown in table 4, veterans have annually
accounted for less than $1.4 billion in 7(a) loans
and less than $200 million in 504 loans. The
proposed program could provide about $3 to $5
billion annually in guaranteed small business
loans. Thus, the proposed program could represent
a large expansion in guaranteed small business
loans to veterans in relation to veteran
participation in SBA's 7(a) program and especially
in relation to SBA's 504 program. Therefore, if
VA were to implement the proposed program, there
could be incentives to establish low program
standards to expand guaranteed loans to veterans.
For example, VA may relax business plan standards
used in the evaluation of the business loan
application package. Such actions could increase
the credit costs of the proposed program.
Thus, more stringent borrower requirements would
appear to have the potential to improve loan
performance and lower credit costs; they also
could make the program less attractive to
participants. Conversely, less stringent borrower
requirements could make the program more
attractive to participants, but increase credit
costs if there were a decline in loan performance.
VA Would Face Administrative Challenges in
Implementing the Proposed Business Loan Guarantee
Program
VA's lack of experience in administering a
small business loan guarantee program likely would
create administrative challenges for the agency to
implement the proposed program. Further, the
demand for a new, small business loan guarantee
program within VA, which could be similar to
existing SBA programs, is uncertain. VA likely
would initially experience higher administrative
costs to implement the proposed program, in
comparison to the administrative costs associated
with the benchmark SBA programs. While VA has
administrative infrastructure and human capital
resources that specialize in the review of
mortgage loan applications, it does not have
similar resources that specialize in the review of
business loan applications or the servicing of
business loans. VA has access to information
regarding veterans' business concerns and a
network to facilitate outreach to veterans. VA
and SBA have an agreement to exchange expertise
pertaining to business loan matters for veterans.
Veteran Demand for a Small Business Loan Guarantee
Program Within VA Is Uncertain
Based on current dollar volume of SBA loans
to veterans in the 7(a) and 504 programs, it is
uncertain if veteran participation in the proposed
program would be in the $3 billion or greater
range. As shown in table 4, veterans have
accounted for less than $1.4 billion and less than
$200 million annually in SBA's 7(a) and 504
programs, respectively. Veteran service
organization officials said veteran participation
in the current set of SBA loan programs likely
would increase if SBA were to undertake better
outreach efforts to ensure that veterans are
provided the same assistance and information as
other group participants.
SBA's Office of Veterans Affairs is to
provide increased opportunities for veteran-owned
small businesses. This goal is to be achieved by
expanding small business procurement opportunities
and enhancing entrepreneurial development
assistance for veterans. For example, SBA has
initiated a new veterans business outreach
program, which is to provide business training,
counseling, technical assistance, and mentoring
assistance to service-disabled veteran
entrepreneurs. The Office could provide a focal
point within SBA for coordinating with VA in
outreach efforts and information dissemination to
veterans.
Administrative Costs Per Loan Dollar Likely Would
Be Higher Initially In Relation to the Benchmark
SBA Programs
VA likely would have higher administrative costs
per loan dollar to implement the proposed program
in relation to the benchmark SBA programs, even if
the proposed program's funding was fully utilized.
According to SBA, the cost of making a 7(a) loan
is about $1,000. The cost of making a 504 loan is
about $2,000. In addition, SBA incurs annual loan
servicing costs for the 7(a) and 504 loan
programs. 9 VA likely would initially incur
higher costs to perform these same functions until
it developed the necessary expertise and program
infrastructure.10 For example, SBA has staff and
monitoring systems in place to manage a business
loan guarantee program.
VA officials said that the agency does not have
the human capital resources to adequately evaluate
business loan applications and service small
business loans. Officials said that VA would need
to hire additional staff, seek technical
assistance from SBA, and develop an overall
infrastructure to perform the functions associated
with a business loan guarantee program.
VA's Lack of Expertise in Business Loan Matters
Could Make It Difficult to Evaluate Small Business
Loan Applications
A review of business loan packages would
require expertise in evaluating business
performance indicators that would reflect a
reasonable expectation of future business
prosperity. In contrast, federally guaranteed loan
programs for single-family, residential mortgage
loan applications require review to ensure
borrower credit worthiness and that adequate
collateral is present to obtain loan guarantee
approval. VA officials said that while the agency
has expertise to adequately evaluate single-family
mortgage loan applications, it does not have the
expertise to adequately evaluate business loan
application packages. Agency officials said that
they would have to seek expertise from SBA to
determine the administrative tasks associated with
operating a small business loan guarantee program.
If VA were to operate the proposed program without
sufficient expertise to adequately evaluate
business loan performance, the federal
government's credit costs and risk exposure likely
would increase.
Servicing Small Business Loans Is Different From
Servicing Residential Mortgage Loans
SBA also has experience in servicing business
loans, including loans with delinquent payments.
While the principal balances of SBA guaranteed
business loans generally are larger than VA-
guaranteed residential mortgage loans, business
loans generally offer less marketable forms of
collateral than mortgage loans when delinquent
loans default. SBA officials said that SBA makes
extensive attempts to keep the borrower in
business when loan payments are delinquent. For
example, SBA may offer interest rate restructuring
to allow the borrower to become current in payment
or allow loan payment deferments. 11 According to
SBA, for fiscal years 1990 through 1999, of the
delinquent 7(a) loans that were purchased by SBA
from lenders to fulfill SBA's guarantee
commitments, about one-third were cured-returned
to current payment or placed in deferment status.
Curing delinquent small business loans is
more difficult than curing delinquent residential
mortgage loans, as evidenced by a higher cure rate
for residential mortgage loans. SBA officials
said that SBA has the intent to keep the small
business borrower in business when loan payments
are delinquent. Likewise, VA officials said that
VA undertakes supplemental servicing to keep the
home borrower in possession of the borrower's home
when mortgage loan payments are delinquent.
However, the marketable collateral and direct
contribution to the borrower's quality of life
provided by an owner-occupied home provides
incentives for the borrower to bring delinquent
payments current and remain in the home.12
Therefore, cure rates on delinquent VA-guaranteed
residential mortgage loans are greater than cure
rates on SBA 7(a) loans. Cure rates on delinquent
VA-guaranteed residential mortgage loans have
averaged over 80 percent.
Managing collateral on defaulted small
business loans is also more difficult than on
defaulted residential mortgage loans, because
owner-occupied housing provides a better form of
marketable collateral. Loss severity rates-the
percentage of outstanding loan principal that is
lost when loans default are higher with business
loans. While SBA has not consistently collected
data on loss severity rates, a 1997 SBA-contracted
study suggested that SBA's loss severity rates for
the 7(a) and 504 programs are in the 70 to 100
percent range. 13 14
Veteran Service Organizations Seek Greater
Assistance From SBA to Help Veterans in Small
Business Matters
Veteran service organization officials that we
interviewed focused their concerns on SBA's
outreach efforts aimed at veterans rather than the
creation of a new small business loan guarantee
program within VA. Several officials said that
they would like to see SBA put greater emphasis on
providing entrepreneurial outreach and assistance
to veterans. They would like SBA to increase
emphasis on providing veterans with
entrepreneurial assistance, such as business plan
preparation. These officials believe increased
outreach efforts would make it easier for veterans
to obtain or expand their own businesses.
Officials said they believe that veteran
participation in SBA's programs likely would
increase with expanded outreach efforts.
Agreement Provides for SBA and VA to Exchange
Expertise on Business Loan Matters for Veterans
In February 2000, VA, SBA, and the Association of
Small Business Development Centers (ASBDC) entered
into a Memorandum of Understanding (MOU) to
provide entrepreneurial assistance and support to
veterans through the small business development
centers.15 The purpose of the MOU is for VA and
SBA to share collective expertise with the intent
to expand small business opportunities for
veterans. The MOU recognizes SBA's and VA's
specific missions and their developed
administrative infrastructures that are needed to
provide veterans with business loan opportunities.
For example, the MOU requires (1) VA to compile a
list of small business concerns owned and
controlled by service-disabled veterans that
provide products or services that could be
procured by the U.S. government, (2) VA to provide
facilities for entrepreneurial training, and (3)
SBA and ASBDC to provide training and information
to veterans on small business concerns. VA and
SBA officials said the MOU was needed to avoid
duplicating efforts related to offering
entrepreneurial assistance to veterans.
Conclusions
The proposed business loan guarantee program
within VA could have similar credit costs and
risks to SBA's 7(a) or 504 business loan guarantee
programs, depending on which program it most
resembled. More stringent borrower requirements
would appear to have the potential to reduce
credit costs; however, with the absence of data,
we could not quantify any such effects.
Alternatively, less stringent requirements to
induce veteran participation in the proposed
program, such as relaxing business plan standards
used in the loan application process could
increase credit costs.
VA would face administrative challenges in
implementing the proposed program. The evaluation
and servicing of business loans require different
skills, knowledge, and information than home
mortgage loan servicing. VA lacks the expertise
and infrastructure to adequately evaluate and
service small business loans. For VA to implement
the proposed program, it said it would have to
hire additional staff, seek SBA's business loan
expertise, and develop an administrative
infrastructure for a business loan guarantee
program. While VA has the infrastructure to reach
veterans, SBA has the expertise and infrastructure
for operating business loan guarantee programs.
SBA and VA have entered into an MOU to share
expertise with the intent to expand small business
opportunities for veterans. Coordination between
VA and SBA, such as enhanced training for veterans
as required by the MOU, could further expand SBA's
business loan opportunities for veterans.
Matters for Congressional Consideration
This coordination initiative when fully
implemented has the potential to achieve many of
the objectives of the proposed VA business loan
program by expanding veteran participation in SBA
guaranteed loan programs. Given the administrative
challenges and costs VA would face in establishing
a new program and the initiatives currently under
way between VA and SBA, it may be prudent to defer
consideration of a new VA loan program. In
addition, congressional committees with oversight
of veterans' affairs and small business matters
may want to encourage even greater expertise
sharing between VA and SBA that would take further
advantage of the small business loan opportunities
offered by SBA to provide business training and
funding options for veteran-owned small
businesses. Furthermore, the committees may want
to monitor closely SBA's outreach efforts aimed at
veterans.
Agency Comments
We requested comments on a draft of this report
from the Honorable Aida Alvarez, Administrator,
Small Business Administration and the Honorable
Togo D. West, Jr., Secretary, Department of
Veterans Affairs.
We received written comments on a draft of this
report from SBA that are reprinted in appendix
III. SBA also provided technical comments, which
we have incorporated where appropriate.
We received written comments on a draft of this
report from VA that are reprinted in appendix IV.
The letter stated that VA agrees with our
conclusions. In addition, VA provided technical
comments, which we have incorporated where
appropriate.
We are sending copies of this report to the
Honorable Aida Alvarez, Administrator, Small
Business Administration; the Honorable Togo D.
West, Jr., Secretary of Veterans Affairs; and
other interested parties. Copies also will be
made available to others upon request.
Please contact me or Bill Shear at (202) 512-8678
if you or your staff have any questions. Major
contributors to this report are listed in appendix
V.
Sincerely yours,
Thomas J. McCool
Director, Financial Institutions
and Markets Issues
List of Requesters
The Honorable Arlen Specter
Chairman
The Honorable John D. Rockefeller IV
Ranking Minority Member
Committee on Veterans' Affairs
The Honorable Christopher Bond
Chairman
The Honorable John F. Kerry
Ranking Minority Member
Committee on Small Business
United States Senate
The Honorable Bob Stump
Chairman
The Honorable Lane Evans
Ranking Minority Member
Committee on Veterans' Affairs
The Honorable James M. Talent
Chairman
The Honorable Nydia M. Velazquez
Ranking Minority Member
Committee on Small Business
House of Representatives
_______________________________
1 We relied on SBA data on loan disbursements,
rather than loan approvals. Loan approvals in
fiscal year 1999 equaled about $2 billion.
2 Underwriting standards are used to determine
which loans are made. Underwriting is the process
of identifying the potential risks of loss
associated with financial activities to determine
loan eligibility, interest rate, and other
factors.
3 Walker & Company, Independent Study of 7(a) and
504 Loan Programs for the Eleven Cohort Years
Ended September 30, 1996 (June 16, 1997).
4 The cost to the federal government of extending
or guaranteeing credit is called the subsidy cost.
This cost is defined as the estimated long-term
cost to the government, calculated on a net
present value basis. It excludes administrative
costs and any incidental effects on government
receipts or outlays. For loan guarantees, the
subsidy cost is the present value of cash flows
from estimated payments by the government (for
defaults and delinquencies, interest rate
subsidies, and other payments) minus expected
payments to the government (for loan origination
and other fees, penalties, and other recoveries).
5 The Small Business Investment Act of 1958, as
amended, requires SBA to charge additional fees to
offset the subsidy costs of the 504 program. SBA
is to annually charge certified development
companies a participation fee and development
company fee. These additional fees became
effective October 1, 1996.
6 SBA officials told us that SBA's methods and
data used to construct the initial subsidy rate
estimates have improved over time.
7 To provide further perspective on loan
performance of veterans and all borrower
participants, we compared the loan performance of
veterans participating in VA's residential
mortgage loan guarantee program to that of
participants in FHA's Mutual Mortgage Insurance
Program. The results are consistent with our
findings for veteran loan performance in the
benchmark SBA programs. Our analysis is presented
in appendix II.
8 The Veterans Entrepreneurship and Small Business
Development Act of 1999 specifies that the
proposed program would allow an amount equal to up
to 10 percent of the annual appropriation for the
guarantees provided by VA for residential mortgage
loans. For fiscal years 1994 through 1999, VA-
guaranteed mortgage loans have ranged from $25
billion to $55 billion annually.
9 Loan servicing involves tasks performed by
lenders while the loan is outstanding. Such tasks
generally include, among others, collecting and
recording interest and principal payments;
readjusting loan terms, if necessary; and taking
actions when borrower loan payments are
delinquent. According to SBA, loan servicing
costs about $125 annually for a 7(a) loan and
about $175 annually for a 504 loan.
10 VA and SBA delegate authority to lenders to
approve and service loans. In this case,
expertise required to develop and implement
requirements for lenders is similar to expertise
required to approve and service loans.
11 Deferment status results when SBA allows the
borrower to defer, or delay, loan payments in
return for the borrower's agreement to become
current on payment obligations at an agreed upon
future time.
12 VA-guaranteed residential mortgage loan
borrowers have other incentives to bring
delinquent mortgage loans current. If a VA
borrower defaults, the borrower's eligibility for
a future VA-guaranteed home mortgage loan can be
reduced or eliminated. In our analysis, we assumed
that if VA implemented a small business loan
guarantee program, a business default would not
restrict the veteran's eligibility for a VA-
guaranteed home mortgage loan.
13 Walker & Company, Independent Study of 7(a) and
504 Loan Programs for the Eleven Cohort Years
Ended September 30, 1996 (June 16, 1997).
14 An official at Moody's, who analyzes 7(a) loan
performance, said that loss rates on 7(a) loans
backed by real estate collateral have lower loss
severity rates than 7(a) loans not backed by real
estate.
15 This MOU was mandated by the Veterans
Entrepreneurship and Small Business Development
Act of 1999. ASBDC is a partnership program
uniting private enterprise, government, higher
education and local nonprofit economic development
organizations. ASBDC delivers educational and
technical assistance to small businesses regarding
business management.
Appendix I
Background Information on SBA and VA Loan Programs
and Loan Requirements
Page 23 GAO/GGD-00-158 VA Credit Cost and Risk
This appendix provides background information on
Small Business Administration (SBA) 7(a) and 504
business loan guarantee programs and on Department
of Veterans Affairs (VA) guaranteed single-family
residential mortgage loan program.
General Description of SBA 7(a) Loan Program
The 7(a) loan guarantee program is SBA's primary
business loan program. It provides guarantees
for loans to small business owners unable to
secure financing under reasonable terms and
conditions through conventional lending channels.
The 7(a) program operates through private-sector
lenders that provide loans that are, in turn,
guaranteed by SBA. SBA does not provide funds for
direct lending or grants.
For most SBA loans, there is no legislated limit
to the total amount of the loan that may be
requested from the lender. The maximum amount of
an SBA guarantee is generally $750,000. Thus,
with a lender receiving an SBA guarantee of 75
percent, the total loan amount available under
this program generally would be limited to $1
million. The proceeds of 7(a) loans can be used
for most business purposes. These may include the
purchase of real estate, machinery, inventory, and
working capital.
Business and Loan Applicant Eligibility
Most small businesses are eligible for 7(a) loans.
The Small Business Act defines an eligible small
business as one that is independently owned and
operated and not dominant in its field of
operation. Financial assistance, through 7(a)
loans, is available for businesses that propose to
be engaged in business in the United States or its
possessions and for those that operate for profit.
SBA determines eligibility based on type and size
of business, use of loan funds, and special
circumstances. The cash flow of the business is a
primary consideration in the SBA loan decision
process. SBA also considers other factors, such
as the loan applicant's character, management
capability, collateral, and owners' equity
contribution. SBA requires that all loan
applicants that have a 20 percent or greater
equity share in the business personally guarantee
SBA loans.
Prospective borrowers must take several steps
to obtain a 7(a) small business loan. For
example, in SBA's small business loan
prequalification program, prospective borrowers
generally work with a technical assistance
organization, designated by SBA, to assist in the
preparation of business plans and completion of
the loan prequalification application. The
technical organization reviews the applicant's
credit information, performs a loan analysis, and
submits the application to SBA. SBA reviews the
completed application to determine whether it
meets the requirements of a guaranteed loan and
makes an approval or denied decision. If the
application is approved, SBA is to issue a
prequalification letter stating the agency's
intent to authorize a guarantee on the loan.
Applicants are responsible for securing a lender
interested in making the SBA-guaranteed loan. In
addition to this program, borrowers can obtain
financing from participating lenders-business
lenders that have entered into lending agreements
with SBA to provide loans in conjunction with SBA
guarantees. Certified lenders are heavily
involved in the regular SBA guarantee loan
processing and meet certain SBA criteria.
Preferred lenders have SBA's full delegation of
lending authority and can decide unilaterally on
SBA participation in eligible business loans.
Fees, Interest Rates,
and Loan Maturities
SBA charges lenders a guarantee and a
servicing fee for each loan approved to offset the
costs of the loan program to the taxpayer.
Guarantee fees can be passed on to the borrower
after they have been paid by the lender. The
percent of the guarantee fee is determined by the
amount of the loan guarantee. When the guaranteed
portion of the loan is $80,000 or less, the
guarantee fee will be 2 percent of the guaranteed
portion. Loans more than $80,000 but less than
$250,000 are to have a 3 percent guarantee fee
charged. For the next $250,000 of the guaranteed
portion, a 3.5 percent guarantee fee will be
charged. For any loan portion greater than
$500,000, a 3.875 percent guarantee fee will be
charged. In addition, all loans will be subject
to a fifty basis point (0.5 percent) annualized
servicing fee, which is applied to the outstanding
balance of SBA's guaranteed portion of the loan.
Processing fees, origination fees,
application fees, points, brokerage fees, bonus
points and other fees that could be charged to
applicants are prohibited.
Interest rates, which may be fixed or
variable, are negotiated between the borrower and
the lender and are subject to SBA maximums. These
maximums are determined by the prime rate. Fixed-
rate loans must not exceed prime plus 2.25 percent
if the maturity is less than 7 years or prime plus
2.75 percent when loans mature in greater than 7
years. For loans of less than $25,000, the
maximum interest rate must not exceed prime plus
4.25 percent. For loans between $25,000 and
$50,000, the maximum rate is 3.25 percent and 3.75
percent, respectively.
Variable-rate loans may be pegged to the
lowest of either the prime rate or SBA's optional
peg rate. The optional peg rate is a weighted
average of rates the federal government pays for
loans with maturities similar to the average SBA
loan. The lender and the borrower negotiate the
amount of the spread, which can be added to the
base rate. An adjustment period is selected,
which identifies the frequency at which the
interest rate can change. It must be no more
often than monthly and must be consistent, such as
monthly, quarterly, or semiannually.
General Description of the 504 Loan Program
SBA's 504 Certified Development Company (CDC)
program provides growing businesses with long-
term, fixed-rate financing for major fixed assets,
such as land and buildings. A CDC is a
corporation set up to contribute to the economic
development of its community or region. CDCs work
with SBA and private-sector lenders to provide
financing to small businesses. There are about
290 CDCs nationwide.
Loan proceeds must be used for fixed asset
projects, such as purchasing land; improving
existing buildings, grading, and streets; parking
lots and landscaping; construction of new
facilities; or modernizing, renovating, or
converting existing facilities; or purchasing long-
term machinery and equipment.
A 504 project must have a loan secured with a
senior lien from a private-sector lender covering
up to 50 percent of the projects costs, a loan
secured with a junior lien from the CDC covering
up to 40 percent of the costs, and a contribution
of at least 10 percent equity from the small
business being helped. SBA guarantees a debenture
to finance the loan secured with a junior lien
from the CDC. The maximum SBA debenture generally
is $750,000 but can be up to $1 million, in some
cases. The SBA 504 program is designed to enable
small businesses to create and retain jobs. The
CDC portfolio must create or retain one job for
every $35,000 provided by SBA.
Business and Loan Eligibility
Businesses eligible for a loan under the 504
program generally must be operated for profit and
fall within size standards set by SBA. Under the
504 program, businesses with a tangible net worth
of less than $6 million and average net income not
in excess of $2 million after taxes for 2
preceding years are eligible to participate in the
504 program. Generally, the project's assets
being financed are used as collateral. Business
owners must provide personal guarantees.
Fees, Interest Rates,
and Terms
Loan fees total approximately 3 percent of
the debenture and may be financed with the loan.
Interest rates on 504 loans are pegged to an
increment above the current market rate for 5-year
and 10-year U.S. Treasury issues. Loan maturities
of 10 and 20 years are available.
General Description
of the Department of Veterans Affairs Guaranteed,
Single-Family Mortgage Loan Program
The principal objective of the VA-guaranteed,
residential single-family mortgage loan program is
to allow eligible veterans-including members of
the selected reserves, active-duty service
personnel, and spouses, an opportunity to
purchase, repair, or refinance homes for their own
personal occupancy. The program serves veterans
and military personnel who may not have the
financial resources to qualify for conventional
loans. The program also encourages private
lenders to extend favorable credit terms to
veterans for purchasing, constructing, or
improving homes. The VA loan guarantee program
operates by substituting the federal government's
guarantee for a down payment that would otherwise
be required when a veteran or reservist purchases
a home. The VA guarantee helps protect lenders
against partial losses when loans default.
The VA guarantee program provides benefits to
veterans and military personnel, but it does not
provide that a home is free of defects or that the
veteran is making a good investment, and it does
not provide legal services.
Guarantee Rates
The actual guarantee amount per veteran
depends on the loan amount and whether the veteran
had previously used the entitlement. VA will
guarantee up to 50 percent of the home mortgage
loan with a maximum guarantee amount not to exceed
$36,000 per veteran or $50,750 for certain loans
over $144,000. VA will guarantee 50 percent of
mortgage loans up to $45,000; $22,500 for mortgage
loans between $45,000 and $56,250; the lesser of
$36,000 or 40 percent for loans between $56,250
and $144,000; and the lesser of $50,750 or 25
percent for loans greater than $144,000. VA can
make a maximum direct loan of $33,000 to certain
severely disabled veterans to acquire specialty
adapted housing grants or $80,000 to Native
American veterans on trust land. Lenders will
generally limit VA-guaranteed mortgage loans to
$203,000 due to secondary market requirements. VA
lenders generally issue mortgage-backed securities
(MBS) backed by cash flows from VA loans in the
secondary mortgage market. The MBS are guaranteed
by the Government National Mortgage Association
(Ginnie Mae). Ginnie Mae is a government
corporation within the Department of Housing and
Urban Development (HUD).
Veteran Eligibility Requirements and Lender
Responsibilities
Veterans are considered eligible if they have
meet certain service requirements since 1940. The
maximum entitlement per veteran is $36,000 or up
to $50,750 for certain loans over $144,000.
Veterans must apply to VA to obtain a certificate
of eligibility. This certificate shows the
veteran's eligibility to receive the VA housing
entitlement and indicates the amount of guarantee
that VA can provide. Veterans are responsible for
selecting their home and a lender that would honor
the certificate of eligibility. Lenders review
the veterans' credit information and request VA to
assign a licensed appraiser to determine the
reasonable value for the property. Some lenders
can generally approve and automatically process
veterans' home mortgage applications when income
and credit requirements are met. Other lenders
must submit the mortgage application to local VA
regional offices, which are to notify the lenders
of their approval decision.
Fees, Interest Rates,
and Terms
The law requires that VA be paid a funding
fee for guaranteed loans. The funding fee is paid
by all but certain exempt veterans. All funding
fees must be paid to VA within 15 days of loan
closing. The funding fees for veterans who have
not previously obtained a VA-guaranteed loan and
whose loan eligibility is not derived from 6 years
of service in the Selected Reserve is 2.0 percent
of the loan amount for loans with down payments of
less than 5 percent. Veterans with at least a 5
percent down payment are to pay a funding fee of
1. 5 percent of the loan amount. Veterans with at
least a 10 percent down payment are to pay a
funding fee of 1.25 percent of the loan amount.
The funding fee for eligible reservist
personnel who have not previously obtain a VA-
guaranteed loan is about 0.75 percent higher for
each down payment category. Reservists are to pay
a funding fee of 2.75 percent of the loan amount
for loans with down payments of less than 5
percent. A funding fee of 2.25 percent of the
loan amount is charged for loans with at least a 5
percent down payment. A funding fee of 2.0
percent of the loan amount is charged for loans
with at least a 10 percent down payment.
The funding fee for subsequent use of the VA-
guaranteed mortgage loan program is higher. The
fees for subsequent use are 3.0 percent of the
loan amount for loans with down payments of less
than 5 percent. A fee of 1.5 percent of the loan
amount (2.25 percent for reservists) for loans
with at least a 5 percent down payment. A fee of
1.25 percent of the loan amount (2.0 percent for
reservists) for loans with at least a 10 percent
down payment.
The funding fee for interest rate reduction
refinancing loans is 0.5 percent. Veterans using
partial or restored entitlements for regular
refinancing loans will pay a 3 percent fee for
subsequent use. Veterans who have not previously
obtained a VA loan will pay a 2 percent fee (2.75
percent for reservists) as first time users in
conjunction with regular refinancing loans. Also,
veterans are charged 1 percent of the loan amount
for manufactured homes.
The interest rate of VA loans can be
negotiated based on prevailing rates in the
mortgage market. The maximum home loan term is 30
years and 32 days. While VA has previously issued
guarantees for adjustable-rate mortgages, it
currently only offers guarantees on fixed-rate
residential mortgage loans.
Appendix II
Loan Performance Is Similar for VA and FHA Fixed-
Rate Residential Mortgage Loans
Page 31 GAO/GGD-00-158 VA Credit Cost and Risk
In this report, we compared the loan performance
of veterans with all participants in SBA's 7(a)
and 504 programs. This appendix provides a related
comparison on residential mortgage loan
performance. Veterans participating in the VA-
guaranteed, single-family mortgage loan program
are compared with participants in the Federal
Housing Administration's (FHA) single-family
mortgage insurance program. Although this
comparison may not be directly related to loan
performance on federally guaranteed small business
loans, we include the comparison to provide
further perspective on the issue of veteran loan
performance. A detailed discussion of VA-
guaranteed, residential single-family mortgage
loan program is in appendix I.
General Description of the FHA Mortgage Insurance
Program
FHA is a government corporation within HUD.
FHA insures mortgages made by qualified lenders to
persons to purchase or refinance homes. The FHA
mortgage insurance program helps borrowers by
lowering some costs associated with obtaining
mortgage loans. FHA mortgage insurance protects
lenders against the risk of loan default. In the
same manner as VA-guaranteed loans, FHA-insured
loans generally sell on the secondary mortgage
market in the form of MBS guaranteed by Ginnie
Mae. FHA loans are protected by FHA's Mutual
Mortgage Insurance Fund, which is funded by
borrower premiums.
Terms and Conditions of FHA Mortgage Insurance
Program
The main advantage of FHA mortgage insurance is
that the credit qualifying criteria for borrowers
are not as strict as conventional financing. FHA
generally allows potential homeowners to finance
approximately 97 percent of the value of their
home purchase through their mortgage. Thus,
borrowers can make a minimum 3 percent of the
sales prices as a down payment. In addition, FHA
insurance also allows borrowers to finance many
closing costs; therefore, loan amounts can exceed
97 percent of home value.
FHA insurance also limits some of the fees lenders
may charge borrowers for making the loans. The
loan origination fee, charged by the lender for
the administrative cost of processing the loan,
may not exceed 1 percent of the mortgage amount.
FHA sets limits on the dollar value of the
mortgage loan. According to HUD, as of January 1,
2000, FHA established mortgage limits ranging from
$121,296 to $219,849. Borrowers seeking mortgages
that exceed FHA loan limits can increase their
down payment or finance under a conventional
mortgage. Borrowers pay an up-front insurance
premium at the time of purchase, which is
generally added to the regular mortgage payment.
While the VA program guarantees fixed-rate
residential mortgage loans, up to 30 percent of
FHA-insured mortgages annually can be adjustable-
rate mortgages (ARM). ARMs insured by FHA have
experienced higher loan delinquency and
foreclosure rates than FHA-insured, fixed-rate
mortgages.
Fees
To cover some of HUD's costs for FHA loans,
HUD assesses home buyers fees, such as up-front
and annual renewal mortgage insurance fees. The up-
front fee for a 30-year loan is 2.25 percent of
the loan amount (or 2.0 percent for a 15-year
mortgage). This fee is charged to borrowers when
they close on the mortgage loan and can be
included in the mortgage payment. Borrowers
purchasing a condominium are exempt from paying
the up-front mortgage insurance premium. Borrowers
pay a 0.5 percent annual renewal insurance
premium. The mortgage insurance premium collected
from the borrower is to help defray costs
associated with the program.
Loan Performance on Fixed-Rate Mortgages Is
Similar for VA and FHA Borrowers
The Mortgage Bankers Association (MBA)
conducts the quarterly National Delinquency Survey
(the MBA Survey). The MBA Survey collects data
from over 180 lenders, including mortgage bankers,
commercial banks, savings banks, savings and loan
associations, and life insurance companies. The
MBA Survey includes about 25 million mortgage
loans on single-family residential properties. We
used data for fixed-rate VA and FHA residential
mortgage loans because VA guarantees fixed-rate
mortgages. We collected data on loans with
borrower payments that were 30 days or more
delinquent and loans where foreclosure had been
initiated. The MBA Survey reports these measures
as a percentage of loans outstanding during each
calendar year quarter.
VA and FHA loan delinquency rates and loan
foreclosure rates are presented in figures II.1
and II.2, respectively. Veteran performance in
the VA residential loan program appears to be
fairly similar to loan performance for borrowers
in the FHA residential loan program. This finding
is consistent with veterans' loan performance in
SBA's guaranteed small business loan programs.
We also obtained loan performance data on VA-
guaranteed and FHA-insured, fixed-rate residential
mortgage loans included in Ginnie Mae guaranteed
MBS. These data indicated similar veteran loan
performance in the VA residential loan program and
FHA fixed-rate mortgages.
In addition, we obtained loan performance
data from VA that distinguished between active
duty borrowers and other veteran borrowers in the
VA-guarantee program. Active duty borrowers had
slightly higher foreclosure rates than other
veteran borrowers. However, based on our analysis,
we have concluded that excluding active duty
borrowers would not affect our findings based on
comparing VA borrowers participating in VA's
guarantee program and FHA borrowers participating
in FHA's insurance program.
Figure II.1: Percentage of Outstanding VA and FHA
Loans Delinquent 30 Days or More
Note: VA mortgage loans outstanding were
predominately fixed-interest rate loans. (VA no
longer guarantees variable interest rate loans.)
FHA guarantees both fixed and variable interest
rate loans. This graph shows all VA loans and only
fixed-interest rate FHA loans.
Source: MBA.
Figure II.2: Percentage of Outstanding VA and FHA
Loans for Which Foreclosure Was Started During the
Quarter
Note: VA mortgage loans outstanding were
predominately fixed-interest rate loans. (VA no
longer guarantees variable interest rate loans.)
FHA guarantees both fixed and variable interest
rate loans. This graph shows all VA loans and only
fixed-interest rate FHA loans.
Source: MBA.
Appendix III
Comments From the Small Business Administration
Page 33 GAO/GGD-00-158 VA Credit Cost and Risk
Appendix IV
Comments From the Department of Veterans Affairs
Page 35 GAO/GGD-00-158 VA Credit Cost and Risk
Appendix V
GAO Contacts and Staff Acknowledgments
Page 35 GAO/GGD-00-158 VA Credit Cost and Risk
GAO Contacts
Thomas J. McCool, (202) 512-8678
William B. Shear, (202) 512-4325
Acknowledgments
In addition to those named above, Joan M.
Conway, Christine J. Kuduk, and Sindy Udell made
key contributions to this report.
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