[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
AN EXAMINATION OF THE SMALL BUSINESS
ADMINISTRATION'S 7(A) LOANS TO POULTRY FARMERS
=======================================================================
HEARING
before the
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
__________
HEARING HELD
APRIL 18, 2018
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 115-068
Available via the GPO Website: www.govinfo.gov
_________
U.S. GOVERNMENT PUBLISHING OFFICE
29-636 WASHINGTON : 2018
HOUSE COMMITTEE ON SMALL BUSINESS
STEVE CHABOT, Ohio, Chairman
STEVE KING, Iowa
BLAINE LUETKEMEYER, Missouri
DAVE BRAT, Virginia
AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
STEVE KNIGHT, California
TRENT KELLY, Mississippi
ROD BLUM, Iowa
JAMES COMER, Kentucky
JENNIFFER GONZALEZ-COLON, Puerto Rico
BRIAN FITZPATRICK, Pennsylvania
ROGER MARSHALL, Kansas
RALPH NORMAN, South Carolina
JOHN CURTIS, Utah
NYDIA VELAZQUEZ, New York, Ranking Member
DWIGHT EVANS, Pennsylvania
STEPHANIE MURPHY, Florida
AL LAWSON, JR., Florida
YVETTE CLARK, New York
JUDY CHU, California
ALMA ADAMS, North Carolina
ADRIANO ESPAILLAT, New York
BRAD SCHNEIDER, Illinois
VACANT
Kevin Fitzpatrick, Majority Staff Director
Jan Oliver, Majority Deputy Staff Director and Chief Counsel
Adam Minehardt, Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Steve Chabot................................................ 1
Hon. Nydia Velazquez............................................. 2
WITNESSES
Mr. Hannibal ``Mike'' Ware, Acting Inspector General, United
States Small Business Administration, Washington, DC........... 4
Mr. William M. Manger, Associate Administrator, Office of Capital
Access, United States Small Business Administration,
Washington, DC................................................. 5
APPENDIX
Prepared Statements:
Mr. Hannibal ``Mike'' Ware, Acting Inspector General, United
States Small Business Administration, Washington, DC....... 15
Mr. William M. Manger, Associate Administrator, Office of
Capital Access, United States Small Business
Administration, Washington, DC............................. 20
Questions and Answers for the Record:
Questions from Hon. Chabot, Hon. Velazquez, and Hon. Comer to
Mr. Hannibal ``Mike'' Ware and Mr. Hannibal ``Mike'' Ware
Answers.................................................... 40
Questions from Hon. Chabot, Hon. Velazquez, and Hon. Comer to
Mr. William M. Manger and Mr. William M. Manger Answers.... 44
Additional Material for the Record:
Hon. James Comer............................................. 48
Steven D. Etka, Policy Director, Campaign for Contract
Agriculture Reform......................................... 49
W. Scott Marlow, Senior Policy Specialist, The Rural
Advancement Foundation International - USA................. 52
AN EXAMINATION OF THE SMALL BUSINESS ADMINISTRATION'S 7(A) LOANS TO
POULTRY FARMERS
----------
WEDNESDAY, APRIL 18, 2018
House of Representatives,
Committee on Small Business,
Washington, DC.
The Committee met, pursuant to call, at 11:00 a.m., in Room
2360, Rayburn House Office Building, Hon. Steve Chabot
[chairman of the Committee] presiding.
Present: Representatives Chabot, Leutkemeyer, Velazquez,
and Schneider.
Chairman CHABOT. The Committee will come to order.
The Ranking Member is in another hearing. She will be here
after a while, and my understanding is she just wants to submit
her opening statement for the record. If she would want to give
it we will, of course, give her that opportunity should she
wish to do so. And we will probably be joined by additional
members from both sides of the aisle here shortly, but we are
going to go ahead and get started in the interest of everyone's
time.
The mission of the Small Business Administration is to help
small businesses compete and succeed in the marketplace. As we
have heard many times from small businesses testifying before
this Committee, access to capital is one of the biggest
challenges small businesses face when starting or expanding
their businesses.
To address the financing gap that small businesses can
face, the SBA offers the 7(a) loan program for small businesses
that have a plan in place for growth but lack the
qualifications for conventional lending. SBA offers these small
businesses government guaranteed loans through private lending
partners.
Recent growth in the program has led to a closer look at
the SBA's oversight tools. As a result of multiple hearings,
meetings, and briefings, I, along with the Ranking Member, Ms.
Velazquez, introduced H.R. 4743, the Small Business 7(a)
Lending Oversight Reform Act of 2018. We could not come up with
a shorter name. Our Senate counterparts have introduced similar
legislation.
By strengthening the SBA's Office of Credit Risk Management
and refocusing on the credit elsewhere test, this bicameral and
bipartisan legislation aims to ensure the integrity of the
program while bringing stability to small businesses that truly
require the services of the SBA.
H.R. 4743 and the Senate version unanimously passed through
both the House and Senate Small Business Committees in March of
2018, and I hope they will soon be brought before the both the
Full House and the Senate.
The subject of today's hearing is further justification
that more oversight of the SBA is needed to ensure that
taxpayer dollars are preserved only for small businesses that
cannot qualify for traditional lending.
A recent evaluation by the SBA's Office of Inspector
General confirmed what the Committee had already suspected;
that the SBA may have allowed nearly $2 billion of ineligible
guaranteed 7(a) loans to non-small businesses.
The OIG's findings are troubling as it appears that many
small poultry farmers were unable to operate their businesses
independently, thus violating the SBA's affiliation rules and
other regulations.
Today, members will have an opportunity to hear from the
OIG about their findings and from the SBA about how the agency
intends to implement the OIG's recommendations to ensure that
future 7(a) loans meet the statutory, regulatory, and SBA
requirements for eligibility.
I appreciate very much the witnesses' testimony here
shortly, and we look forward to your testimony.
And again, we will allow the Ranking Member's opening
statement to be admitted for the record when she gets here.
And if Committee members have an opening statement
prepared, I would ask that they be submitted for the record.
And I will take just a moment to explain the lighting
system which is very, I think, yeah, you have both testified.
Five-minute rule. The green light will be on for 4 minutes. The
yellow light will come on letting you know you have a minute to
wrap up, and then the red light will come on to let you know
that your time is up. And we would like you to stay within that
if at all possible.
Since the Ranking Member got here so fast, it would be
appropriate if she would like to, to go ahead and, whenever she
is ready, to give her opening statement.
I will yield to the Ranking Member.
Ms. VELAZQUEZ. Thank you so much, Mr. Chairman. And thank
you all for being here.
Chicken is America's favorite protein, topping beef and
pork for the past 30 years. In 2016 alone, the USDA reported
that American farmers raised over 8.8 billion chickens valued
at $26 billion for domestic consumption and export. Public
demand has resulted in significant changes to the poultry-
growing industry.
Where there were once 1.6 million independent farms across
the country, a rapid shift to a vertical integration model has
resulted in just 25,000 contract farms raising the vast
majority of America's poultry.
The very nature of the industry is what brings us here
today. Growers need capital to buy firms, build chicken coops,
and buy feed to run their operations.
Over the past 4 years, the 7(a) program has experienced
significant growth in poultry lending. As noted by the IG's
report, SBA has guaranteed over 1,500 poultry loans totaling
$1.8 billion from 2012 through 2016.
On the surface, this seems like we are helping small firms
get access to capital. However, the nature of these growers'
relationship with integrators suggests that loans may not be
assisting what most of us consider small businesses.
As we will hear from Mr. Ware, the level of control
exercised over the growers is significant, from how to design
and build their chicken coops to feeding and watering
schedules, integrators have their hands in almost every aspect
of a grower's business.
Let's be clear about what is going on here. Large
integrators own the chickens, sell the feed to the farmers,
dictate the specifications of how to build the grow houses--all
while pushing the costs and risk of financing and owning these
very capital-intensive structures onto the farmers. Every
report I have read, and discussions I have had with
stakeholders, indicate there is little in the way of
traditional lending to poultry growers. The industry relies
almost exclusively on the government guaranteed lending from
USDA and SBA used by growers to buy farms, construct chicken
houses, and fund operations. This raises serious red flags.
While we all support the SBA program for delivering credit
to small businesses that cannot get it elsewhere, it is
troubling if the program is being used to displace the growth
of a traditional lending market and put taxpayers' money at
risk.
I look forward to hearing more from the IG about the
details of their report and findings. I am also very interested
in hearing from SBA on why they relied on a 1993 regional
agency decision based on one contract to determine affiliation,
or lack thereof, in these contracts for so long.
Further, I am interested in how the regulatory changes from
2016 are applied to poultry loan applications, and what SBA
plans to do to address the affiliation concerns raised by the
IG going forward.
Thank you both for being here. Mr. Chairman, I yield back
the balance of my time. Thank you.
Chairman CHABOT. Thank you. Thank you very much. The
gentlelady yields back.
And I would now like to introduce our distinguished panel
here today. Since both have testified here before I am going to
keep these relatively short.
Our first witness will be Mr. Hannibal ``Mike'' Ware, who
currently serves as the acting inspector general for the Small
Business Administration. The President has nominated him to
serve as the permanent inspector general, and both the Senate
Small Business and the Homeland Security and Governmental
Affairs Committees have favorably reported his nomination to
the Full Senate. So congratulations, and hopefully everything
will go smoothly for you there, and we look forward to hearing
your testimony here today.
And our second witness will be William Manger, who is the
associate administrator for the Office of Capital Access at the
SBA. One of the programs Mr. Manger's office administers and
oversees is the 7(a) loan program. So we also appreciate your
testimony and your response to questions here shortly.
So we would now like to turn to Mr. Ware, who is recognized
for 5 minutes.
STATEMENTS OF HANNIBAL ``MIKE'' WARE, ACTING INSPECTOR GENERAL,
UNITED STATES SMALL BUSINESS ADMINISTRATION; WILLIAM M. MANGER
ASSOCIATE ADMINISTRATOR OFFICE OF CAPITAL ACCESS UNITED STATES
SMALL BUSINESS ADMINISTRATION
STATEMENT OF HANNIBAL ``MIKE'' WARE
Mr. WARE. Thank you, Chairman Chabot, Ranking Member
Velazquez, and distinguished members of the Committee. Thank
you for the opportunity to be here today and for your continued
support of the Office of Inspector General.
We recently published the results of our evaluation of
SBA's 7(a) loans made to poultry farmers. We independent
initiated this review after speaking with the staff of this
Committee, who raised the question about the controlling nature
of contracts between large chicken companies, known as
integrators, and poultry farmers.
We performed a preliminary assessment and took note of the
increases to the size of this segment of the loan portfolio, to
the size of these loans, and to the terms of these loans. We
subsequently sought to gain an understanding of the operations
of this industry and the practical application of SBA's
regulations for loans to farmers within the industry. We
reviewed Federal laws and regulations, SBA policies and
procedures governing the 7(a) loan program, files of performing
and defaulted loans, as well as grower-integrator contracts,
agreements, and communications.
We further reviewed U.S. Department of Agriculture's loan
program guidance, industry-related economic and analytical
publications, relevant publications from state university
agricultural extensions and publications from industry trade
associations. We also reviewed SBA internal communications,
guidance, and selected SBA Office of Credit Risk Management
lender reviews.
We found that 7(a) loans made to growers did not meet
regulatory and SBA requirements for eligibility. The
integrators in our sample exercised such comprehensive control
over the growers that we believe the concerns appear
affiliative on their SBA regulations. Therefore, SBA and
lenders approved 7(a) loans that were apparently ineligible
under MBA-sized standard regulations and requirements.
Specifically, in our review of 7(a) loans made to growers, as
well as review of defaulted 7(a) loans to growers, we found
integrator-control exercised through a series of contractual
restrictions, management agreements, oversight inspections, and
market controls. This control overcame practically all of the
grower's ability to operate their business independent of
integrator mandates. This control was enforced through close
integrator oversight, management agreements, and grower-
integrator communication.
A grower's failure to comply with these requirements could
result in a significant decrease in integrator payments, a
reduction in flock placements, or a cancelation of the
contract. A grower's economic viability was based upon a
performing production contract with an integrator and is the
true basis for grower income and facility value. As a result,
from fiscal year 2012 to fiscal year 2016, SBA guaranteed
approximately $1.8 billion in loans that may be ineligible.
To improve SBA's oversight of the 7(a) loan program, we
made two recommendations to the associate administrator for the
Office of Capital Access. The first, to review the loans cited
in the evaluation sample to determine whether SBA loan
specialists and lenders made a proper size determination given
the apparent affiliation based upon comprehensive contractual
oversight and market control and take the appropriate
corrective actions. And the second, to review the arrangements
between integrators and growers under the revised regulations
and establish and implement controls, such as supplemental
guidance to ensure SBA loan specialists and lenders make
appropriate affiliation determinations.
SBA management agreed to both of these recommendations.
Both of these recommendations remain open in a resolve status,
meaning OIG has agreed to management's plan of corrective
action. I am proud of the work performed by our auditors. We
certainly appreciate the broader implications of this review on
the availability of 7(a) lending resources and on SBA's
oversight of the various segments of the loan portfolio.
Thank you for the opportunity to speak to you today, and I
look forward to your questions.
Chairman CHABOT. Thank you very much.
Mr. Manger, you are recognized for 5 minutes.
STATEMENT OF WILLIAM M. MANGER
Mr. MANGER. Thank you. Good morning, Chairman Chabot,
Ranking Member Velazquez, and members of the Committee. Thank
you for the opportunity to speak with you today.
The recent inspector general report examined the agency's
poultry loans and lending history. From their examination, two
recommendations were issued, both of which SBA has agreed to.
One, SBA was asked to look at 11 loans that served as the
sample size and basis of their review; and two, SBA was asked
to consider further guidance to ensure that appropriate
determinations of affiliation are being made.
The loan activity highlighted by the inspector general
occurred over a 5-year period beginning 7 years ago. Having
joined the agency in March of 2017, I will need to rely on
program office background and data, particularly during the 5-
year timeframe.
Before discussing the IG recommendations, it might be
helpful to share some data and provide an overview of our
lending. Today, our overall 7(a) loan portfolio has a loan
count of just over 265,000 loans, and an outstanding balance of
$88 billion. Within that, poultry loans represent 1 percent of
the entire 7(a) portfolio.
The performance of poultry loans has been very good. These
loans have a delinquency rate of .34 percent. This compares
favorably to the 7(a) average of .7 percent.
These loans are being made across 32 states and Puerto
Rico. The top five states are Mississippi, Georgia, Arkansas,
Texas, and North Carolina.
Examples of the types of loan being made include a $600,000
loan to a Kentucky couple who were employed in farming but
wanted to start their own business. Another was a $1 million
loan in Mississippi to help save a local family-owned, but
failing, poultry operation.
The IG report questioned whether the nature of the
agreement between the poultry farmer and the business supplying
the chicks is so controlling that SBA should consider the two
businesses to be affiliated. This concept of affiliation is
relevant in determining whether a business is small, because
size is determined by aggregating the revenues or employees of
the business with those of all of its affiliates.
In the Small Business Act, Congress specifically included
agricultural enterprises in the definition of small business.
Agricultural enterprises are identified under the NAICS code
system as including poultry and egg, forestry and logging,
cattle ranching, and hog and pig farming, to name a few.
In our lending, SBA has adhered to longstanding policy
guidance that the grower-integrator contract standing alone
does not bring about affiliation. In addition, SBA, in 2016,
removed from the affiliation regulations the provision that
considers contractual relationships that may cause economic
dependence of one business on another.
The agency concluded that, in general, only firms that had
common ownership or common management should be considered
affiliated when determining eligibility for SBA financial
assistance. As a result, SBA's current regulations do not
consider whether the contract between an integrator and a
poultry farmer results in economic dependence when determining
the size of the poultry farmer that applies for financial
assistance.
Soon after joining the SBA, I began an examination of
various loan policies and practices in my office. On issues
like franchise agreements, we made changes that were well-
received by borrowers, lenders, and other interested parties.
We also took action to update our standard operating procedures
last fall with several aspects that improve program compliance
and ensure prudent lending for all loans, including poultry.
First, we changed some loan terms to a maximum of 15 years,
tying that to the useful life of equipment. Second, we provided
guidance that our financing is limited to farmland used only in
the operation of a business. And third, for businesses with a
change of ownership or with startups, we now require at least
10 percent equity.
As we continue to conduct our review of poultry lending, we
want to hear from all our stakeholders, and we certainly
welcome your views and want to hear from this Committee.
Thank you for the opportunity to testify today. I look
forward to working with all of you.
Chairman CHABOT. Thank you very much. I appreciate it.
And I will now lead off the questioning by recognizing
myself for 5 minutes. And I will go to you first, Mr. Manger.
What specific steps has the SBA taken since you were made
aware of the inspector general findings? I know you discussed
that to some degree, but if you could go over those.
Mr. MANGER. Certainly. So we did look at the 11 loans, as
requested by the IG's report. In fact, I have a report on the
11 loans. And again, under our evaluation, using the 25-year
longstanding policy of the agency, we determined that the
contract in place did not create affiliation between the small
rural farmer and the integrator, because the ability to profit
and bear the risk of loss due to their own efforts was still
apparent with the small rural farmer.
Chairman CHABOT. Mr. Ware, let me go to you.
Are you aware of any other industries, either agriculture
or otherwise that extend such control over their growers? Are
those growers eligible for SBA loans, and do you have any plans
to examine any of those loans as well?
Mr. WARE. Our review in this case was specifically to the
poultry loans. So we did not look at others, although we came
across, of course, the hog industry being one that is kind of
close but it was not our intent to review that because of how
closely they line up. So we think that the findings of this
report could be used by the agency the same way.
Chairman CHABOT. Thank you.
Back to you, Mr. Manger.
Since being made aware of the inspector general's findings,
have you provided any guidance for any lenders? Do you intend
to publish any kind of guidance or communicate with lenders or
their trade associations going forward? Is there any
communications effort that you think should be made there?
Mr. MANGER. After the report was released, we did make a
statement again that we were reviewing the 11 loans. Upon
completion of that review we found that they had been done
according to longstanding policy of the agency. We also
informed the lenders that, for loans that were made under
similar circumstances, in that case we would also honor the
guarantee because obviously there was a lot of concern from the
lenders that guarantees would not be honored. But we wanted to
assure them again that the loans that we looked at, all 11
loans were done properly, and so therefore, the guarantee would
be honored.
Chairman CHABOT. Mr. Ware, did your office examine whether
or not the credit elsewhere test was being applied properly to
lenders? And should some of these growers have been able to
qualify for conventional loans or USDA loans?
Mr. WARE. As part of this review, we did not look
specifically at the credit elsewhere test. We looked simply
based on were they eligible for these types of loans. Eligible
for the 7(a) loans.
Chairman CHABOT. Do you think you should have gone and
looked at the credit elsewhere?
Mr. WARE. Well, the credit elsewhere test, we have a
separate review that is doing that, not only for poultry but
across the board. So running in separate lanes but touching
everything.
Chairman CHABOT. Mr. Manger, are lenders properly applying
the credit elsewhere test before offering 7(a) loans for
poultry farming or other related industries as far as you are
aware? And why are these growers oftentimes unable to obtain
credit elsewhere, particularly when they already have been
offered a contract from a large poultry company with a long
history in the industry?
Mr. MANGER. No, I appreciate the question. And certainly,
Mr. Chairman, credit elsewhere is always something that the
agency and my office is looking at because we want to ensure,
as the Ranking Member said in her opening statement, we want to
make sure that we are making loans available to those that need
the capital, that are unable to access the capital
conventionally.
Again, our office takes great pains in ensuring that loans
are only being made to those that are unable to obtain credit
elsewhere. In evaluating the loans, we have looked at them, and
again, these people had in their files the proper certification
that they were unable to--the lender makes the certification
that these lenders would be unable to make the loan without the
SBA guarantee. And so that is what we have seen, and again,
these loans are to small rural farmers that many times there
are not lots of other ways that they can access the capital
except through our program.
Chairman CHABOT. Mr. Ware, did you want to comment on that?
Mr. WARE. Yes. I thought I needed to expound quickly on
what I said before.
So the basis of this review was their eligibility, and once
we ran into the affiliation concerns that in our review were so
clear based on the Code of Federal Regulations and what is
detailed in there, the credit elsewhere did not become a
primary function for us to look into for this particular
review.
Chairman CHABOT. Thank you very much. My time is expired.
The Ranking Member is recognized for 5 minutes.
Ms. VELAZQUEZ. Thank you, Mr. Chairman.
Mr. Manger, you stated in your testimony that the
delinquency rates are very low on SBA poultry loans. I think
you mentioned .3 percent compared to others, right? So if these
loans are such a safe bet, why do they need to have an SBA
guarantee? So if you are telling me that they are so good and
they make so much sense, why is it that they cannot get a loan
through traditional lending?
Mr. MANGER. So Ranking Member, many times these loans are
made for the acquisition of land, and in some cases actually
the land is quite a large piece of property. And again, the
individual does not have the collateral and some of the other
prudent lending standards that a conventional loan would be
made under in order to acquire not only the property but then
to build the broiler houses on the property and all that goes
into creating one of these farms. So in those situations,
again, the lender makes the determination that they would not
be willing to make that loan because of the risk inherent in
making the loan unless they have the guarantee provided by the
Small Business Administration.
Ms. VELAZQUEZ. Okay.
Can you tell me, Mr. Manger, what reasons are typically
cited by lenders to fulfill the credit elsewhere test to make
these loans?
Mr. MANGER. So I would have to get back to you to see
exactly----
Ms. VELAZQUEZ. Well, this is an important issue.
Mr. MANGER. Absolutely.
Ms. VELAZQUEZ. Because it determines whether or not you are
following the law. If you cannot answer me, if you cannot
answer this question, how could you tell me that those loans
were----
Mr. MANGER. Ma'am, I can tell you that we take the credit
elsewhere standards extremely, extremely serious in my office.
Ms. VELAZQUEZ. But you cannot answer--you cannot give me--
--
Mr. MANGER. I cannot give you some of the specific----
Ms. VELAZQUEZ. Thank you.
Mr. MANGER.--examples----
Ms. VELAZQUEZ. Thank you.
Mr. MANGER.--of what the reasons were.
Ms. VELAZQUEZ. Okay.
Mr. Ware, the Pew Charitable Trust has also published
reports that examine the poultry industry. They stated that
government subsidies were a significant driver of the growth we
have seen over the past years, 50 years. Did your investigators
find many instances of nongovernment-backed lending in the
poultry-growth industry?
Mr. WARE. We did not.
Ms. VELAZQUEZ. Are either of you concerned the growth of
SBA involvement in poultry farms is pushing traditional lending
out of this market?
Mr. WARE. If I was to answer that, that is probably a
viable concern but it was not the focus of our review.
Ms. VELAZQUEZ. Okay.
So Mr. Manger?
Mr. MANGER. Ma'am, as I stated in my opening statement,
this is only 1 percent of the overall 7(a) portfolio
representing 1.7 percent of the dollars.
Ms. VELAZQUEZ. How much dollars?
Mr. MANGER. 1.7 percent of the overall portfolio is in
dollars. And that is not crowding out other businesses that
need to access capital. The poultry industry is not crowding
out----
Ms. VELAZQUEZ. That is not my concern. My concern is if you
comply with the credit elsewhere test. That is my concern.
Mr. MANGER. And I can give you one reason probably why a
lot of these loans were made this way, because many of the
loans were given a longer term than a conventional loan would
offer, and that is one reason in credit elsewhere where we
allow for an SBA loan to be made because the ability to repay
the loan by the small farmer needs a longer term and it would
not be available in a conventional loan. It is only available
in an SBA loan. So that is one of the reasons in credit
elsewhere why these loans would be eligible because in some
instances the term of the loan was up to 21 years.
Ms. VELAZQUEZ. So let me ask you this question.
Mr. MANGER. Yes.
Ms. VELAZQUEZ. Should there be similar requirements
aligning contract length with poultry loan length to protect
the farmers and taxpayers?
Mr. MANGER. As a matter of fact, I will just restate what
we did in the SOP that became effective on January 1st of this
year. We have now limited the term of the loan to 15 years,
tying that to the life of the useful equipment. In this case it
would be the broiler houses. That was not the case before
January 1st of this year. We also have now limited the amount
of farmland that can be acquired only to the farmland that is
necessary for the specific business. We found in some instances
additional farmland was being acquired. We do not allow that
except for what is necessary with the specific operation.
And finally, and importantly, to talk about the risk, we
are now requiring for a change of ownership or a start-up--many
of these poultry businesses were start-ups--we are now
requiring a 10 percent equity injection from the borrower. That
is equity coming from the borrower, not from the taxpayer.
Chairman CHABOT. The gentlelady's time has expired. Does
she need an additional minute? Or we can go to a second round
if you like.
Ms. VELAZQUEZ. Yes.
Chairman CHABOT. All right. We will probably go to a second
round.
The gentleman from Missouri, the Vice Chairman of this
Committee is recognized for 5 minutes.
Mr. LUETKEMEYER. Thank you, Mr. Chairman.
It would seem to me that the discussion today centers
around the difference between a franchise and an affiliate.
Mr. Ware, can you explain to me at the very essence here
what your definition of affiliate is and why you believe that
these farms do not comply?
Mr. WARE. Sure. Thanks for the question.
So the OIG does not have a problem necessarily with the
relationship between a franchise or a franchisee as long as the
contracts are not controlling by the franchiser.
Mr. LUETKEMEYER. Well, what is your definition of
controlling? I mean, because every franchise controls its
franchisee to a certain extent. It depends on whether you are
talking about an auto dealer, or you are talking about
McDonald's, or are you talking about Cargill or Tyson? Those
folks all have control over the people that are doing business.
Mr. WARE. Correct, sir. However, if the control is
comprehensive, by rule and by the law, it is so comprehensive
that it----
Mr. LUETKEMEYER. Well, what is your definition of
comprehensive?
Mr. WARE. Comprehensive means--so it is not every franchise
that will qualify for a Small Business Administration loan. My
definition----
Mr. LUETKEMEYER. Do you make loans to McDonald's? Do you
make loans to car dealerships?
Mr. WARE. I am not certain exactly who the SBA makes
loans----
Mr. LUETKEMEYER. Mr. Manger, do you make loans to car
dealers and McDonald's franchise folks?
Mr. MANGER. We have just started making loans available to
car dealerships.
Mr. LUETKEMEYER. Okay.
Mr. MANGER. As we have reviewed----
Mr. LUETKEMEYER. Does anybody know the business model of a
car dealership? There is nobody that is controlled more than a
car dealership by their company.
Mr. WARE. I would suggest that from our vantage point,
based on our review on poultry loans, right, that if that is
controlling to the point where even the very specifications of
your broiler house is controlled, when you can walk into your
broiler house is controlled, where you can walk in your broiler
house is controlled, when the chicks are fed, when they are
given medicine is controlled, and if you do not adhere to
anything you can lose your flock placement, you can lose your
flock and that automatically will cause you to default, that is
controlling.
Mr. LUETKEMEYER. Mr. Ware, you are talking to somebody who
has got millions of turkeys growing in his district.
Mr. WARE. Yes.
Mr. LUETKEMEYER. I know exactly what you are talking about.
And the reason that they do this, because those birds are not
owned by the individual.
Mr. WARE. Correct.
Mr. LUETKEMEYER. Those birds are owned by the company that
puts them in there and they require certain things. Just like
if you were building a building. If you are the contractor, the
owner says I want this building built a certain way. I need
these kinds of materials and I want it built a certain way. I
am going to have the architect to make sure that it stays
there. These buildings and these birds, there is a model, a
business model that they want you to, just like any other
franchise, with McDonald's, or whether it is a Ford dealership,
there is a certain level of integration of all of the different
requirements that the franchise wants you to, as a franchisee,
to put into your business model.
The thing that concerns me here is you are forgetting about
the rest of this business model. These people do not raise just
turkeys and chickens. They also normally have a cattle
operation affiliated with this because they normally have
enough land to spread the manure out, which is a commodity that
is an inexpensive way to fertilize your farm and they will have
an integrated cattle operation as well. And that is usually
financed separately from this.
So the answer to the Ranking Member's question a while ago,
the reason that these farmers come to SBA for this is usually
they are highly leveraged. They are trying to get a new
building, buy a new farm next to them, and they cannot get this
financing because of the amount of debt they are incurring
because of the size of these buildings, which are several
hundred feet long. So I am trying to figure out here how you
can get to this affiliated definition whenever you have got so
many other businesses out here that are franchise operations
that are much more controlled by the franchise company than
what these folks are because I know this model.
Mr. WARE. Can I answer?
Mr. LUETKEMEYER. Absolutely. I am looking forward to your
answer, sir.
Mr. WARE. We do not have an issue with any of those things.
What we have issue with is that by definition, by the code, by
the CFR, they are not considered small. So from our----
Mr. LUETKEMEYER. Okay. What is your definition of small
then?
Mr. WARE. Well, the CFR, in particular, concerning this
with affiliation again goes back to such comprehensive control
that management agreements is the exact term that is used in
there.
Mr. LUETKEMEYER. They do not control the entire operation
though, Mr. Ware. That is what I am trying to get at. They
control only the poultry part of this operation. The operation
may be several hundred acres with several hundred head of
cattle on it.
Mr. WARE. But that is now what the Small Business
Administration would be putting their guarantee for.
Mr. LUETKEMEYER. They are guaranteeing the land and the
poultry buildings that are on there. The real estate and
buildings. You are not guaranteeing the operation. The
operation is completely different.
Mr. WARE. Well, Congressman, when these contracts, these
same contracts that they are guaranteed, when the flock
placement is not right and the flock placement goes away, so
does the loan. And here comes the guaranty.
Mr. LUETKEMEYER. Mr. Ware, if I have got a car dealership
and I am not meeting my quotas, do you know what happens? I
lose my franchise. I have got to sell X number of units per
month; otherwise, at the end of the month I am going to get a
few more from the company who says now you have got another 30
days to sell those on top of it or else.
Mr. WARE. But I am not sure your car dealership qualifies
as a small business.
Mr. LUETKEMEYER. Mr. Manger said they are starting to do
that now.
Mr. WARE. And we would like to take a look at that.
Mr. LUETKEMEYER. I mean, I could go through a whole list of
franchise companies and we can talk about this all day, but my
concern is that I think we are losing, we are nitpicking on
this affiliate definition. I am not sure you really understand
the business model of what a poultry farmer really is all
about.
Mr. WARE. I do understand the business model pretty well. I
do understand it, and I am saying that that business model
makes it affiliative by nature.
Mr. LUETKEMEYER. My time is expired.
Chairman CHABOT. The gentleman's time is expired.
Since we have a relatively few number of members here
today, we are going to go to a second round.
I have just got one or two questions myself and then I am
going to turn it over to the other members that are here.
My question is this. I note that the terms for poultry
loans over the last few years have been getting longer, going
up to 20 years; whereas, the contracts oftentimes are
relatively short. In fact, your flock, my understanding is 5 to
9 weeks or so. And I think if one of these small farmers, you
know, goes out of business or whatsoever, if the contract is
not renewed, it can be a pretty tough business to sell and you
may get 6 percent on what you invested, the other 94 percent
going away. So it is pretty challenging.
So would both of you comment on the lengthening of these
loans and the short period of the contract? And would the small
business farmer in this case not be better protected if the
contracts, if that is something you took into consideration,
that they were longer, so they had more of an assurance that
they could remain in business for a longer time to support
their time?
Mr. Manger?
Mr. MANGER. Sure, Mr. Chairman.
So the regulations stipulate that the lender must evaluate
the ability of the borrower to repay the loan. In some of the
instances, specifically on the 11 loans that were analyzed,
there was also the purchase of land involved. It was not solely
for the construction of broiler houses. For the purchase of
land, many times it would be necessary to a small rural farmer
to be able to extend those payments out for a longer period of
time in order to be able to acquire the property. So it is not
solely based on contracts that the individual may have or the
business may have. It is based on, again, their ability to
repay the loan. And in this instance, in the loans I am citing
with the acquisition of property, that is really the main
reason why such a long term was needed on the loan.
It also does not control what other businesses the small
business may enter into. As was said earlier by Congressman
Luetkemeyer, many times they would have a portion of the
property maybe be for poultry, but they could be involved in
other enterprises on other parts of the property, whether it be
manure harvesting or other ventures. So again, it is not so
reliant only on this one contract, especially in the
acquisition of property and the lender must again certify that
the borrower has the ability to repay the loan.
Chairman CHABOT. Thank you.
Mr. Ware, did you want to comment on that at all?
Mr. WARE. Sure. Yes. I need to comment on it because when
the agency is giving loans to poultry farmers, it is for that
purpose. In the defaulted loans that we reviewed, when the
contracts went away, so did the poultry farm. So I think that
is a very vital piece of whatever review would be made, and I
believe that in the industry, from what I have studied, in the
industry they are moving toward their contracts in terms of the
integrator and the farmers as being a little bit longer because
of more conventional lending methods that are out there and
that is the only way that they would qualify for those.
Chairman CHABOT. Thank you very much. I am going to yield
back.
The Ranking Member is recognized for 5 minutes.
Ms. VELAZQUEZ. Mr. Manger, I heard you talk about some of
the changes about excess land equity injection, those issues
have nothing to do with the affiliation issue. I know that you
were not there in July 2016 when the IG presented its report,
but I would just like to ask you, who signed off on the changes
that were made, particularly knocking out the economic
dependence of business contract affiliation? Who did that?
Mr. MANGER. That was done by the previous administration. I
am not sure if it was signed off by the person that had the
associate administrator position in Capital Access or----
Ms. VELAZQUEZ. Can you get back to us?
Mr. MANGER. Yes.
Ms. VELAZQUEZ. Okay.
Mr. MANGER.--or possibly the administrator at the time.
Ms. VELAZQUEZ. Well, if those changes were made, I would
like to know who signed off on accepting those changes because
this is a very important issue, the issue of affiliation, and
if I have to introduce legislation to go to the original
affiliation issue, I am going to do that. Okay?
Thank you, Mr. Chairman.
Chairman CHABOT. The gentlelady yields back.
We have one other member who we thought was on his way but
in light of the fact that he is not here I think we are going
to wrap up this hearing.
We appreciate the gentlemen giving their testimony here
this morning.
An important industry, there are obviously some questions
here we would ask our Committee staff to continue to work with
the SBA to make sure that all the appropriate regulations and
the loans that are being made are being made in a proper manner
and that the dollars that we have available are going to
actually help small businesses and the families that they
support. So we will continue to follow this topic.
I would ask unanimous consent that members have 5
legislative days to submit statements and submit supporting
materials for the record.
Without objection, so ordered.
If there is no further business to come before the
Committee, we are adjourned. Thank you.
[Whereupon, at 11:46 a.m., the Committee was adjourned.]
A P P E N D I X
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INTRODUCTION
Chairman Chabot, Ranking Member Velazquez, and
distinguished members of the Committee, thank you for the
opportunity to be here today and for your continued support of
the Office of Inspector General (OIG). We recently published
the results of our audit of the Small Business Administration's
(SBA's) evaluation of 7(a) loans made to poultry farmers. I am
happy to discuss our findings with you today.
OIG's ROLE
OIG was established within SBA by statute to promote
economy, efficiency, and effectiveness and to deter and detect
waste, fraud, abuse, and mismanagement in the Agency's programs
and operations. During fiscal year (FY) 2017, OIG achieved over
$82 million in monetary recoveries and savings and made 72
recommendations for improving SBA's operations and reducing
fraud and unnecessary losses in the Agency's programs.
OIG audits are conducted in accordance with Federal audit
standards established by the Comptroller General, and other
reviews generally are conducted in accordance with standard
established by the Council of the Inspector General on
Integrity and Efficiency (CIGIE). In addition, we coordinate
with the Government Accountability Office to avoid duplicating
Federal audits. We also establish criteria to ensure that the
non-Federal auditors that OIG uses (typically, certified public
accountant firms) comply with Federal audit standards.
OIG's EVALUATION OF 7(A) LOANS MADE TO POULTRY FARMERS
OIG report 18-13, titled Evaluation of SBA 7(a) Loans Made
to Poultry Farmers presents the results of our review of loans
made to poultry farmers under SBA's 7(a) Loan Program. The 7(a)
Loan Program is SBA's primary program for helping startup and
existing small businesses, offering financing guarantees for
loan amounts up to $5 million to fund startup costs, expand
existing businesses, purchase equipment, repair existing
capital, and other uses. Participating lenders enter into an
agreement with SBA to make loans to small businesses in
accordance with SBA rules and regulations. Some 7(a) loans are
made by lenders using delegated authority, which undergo
limited review by SBA prior to loan disbursement. Other 7(a)
loans are subject to more extensive underwriting and
eligibility review and approval by SBA before the loan is
disbursed.
Our evaluation objective was to determine whether 7(a)
loans made to poultry farmers (growers) met statutory,
regulatory, and SBA requirements for eligibility. To accomplish
our objective we reviewed Federal laws and regulations, SBA
policies and procedures governing the 7(a) Loan Program, files
of performing and defaulted loans, as well as grower-integrator
contracts, agreements, and communications. We further reviewed
U.S. Department of Agriculture's (USDA) loan program guidance,
industry-related economic and analytic publications, relevant
publications from state university agricultural extensions, and
publications from industry trade associations. We also reviewed
SBA internal communications, guidance, and selected SBA Office
of Credit Risk Management lender reviews.
We interviewed officials and staff from the SBA Office of
Capital Access, SBA Office of General Counsel, USDA Economic
Research Service, USDA National Agricultural Statistics
Service, USDA Farm Service Agency, USDA Office of Rural
Development, and the USDA Office of Inspector General. We also
interviewed executives and loan officers at various lending
institutions, certified assessors, integrators, and growers.
We analyzed the population of 7(a) loans made to
agricultural enterprises, and to the agricultural subset of
poultry farmers, to obtain an understanding of the SBA loan
portfolio, and its characteristics, for FYs 2012 through 2016.
This population was limited to approved regular 7(a), Certified
Lender Program, and Preferred Lender Program loans. Further,
for this analysis, we defined agricultural enterprises to
include North America Industry Classification System (NAICS)
codes 111110 through 114210. The subset of poultry farmers was
defined with NAICS codes 112320 and 112390. From this
population, we judgmentally selected a sample of 11 loans; this
sample was populated by loans at either the median size or the
largest size for its fiscal year. We used this sample to guide
a review of loan files, grower contracts, and grower-integrator
communications, and interview parties to these loans, Further,
we reviewed a sample of defaulted poultry loans to understand
the degree to which integrator contracts affect facility value.
We conducted this evaluation in accordance with the Council
of the Inspectors General on Integrity and Efficiency's quality
standards for inspection and evaluation. These standards
require that we adequately plan inspections; present all
factual data accurately, fairly, and objectively; and present
findings, conclusions, and recommendations in a persuasive
manner. We believe that the evidence obtained provides a
reasonable basis for our findings and conclusions based on our
evaluation objective.
What OIG Found
We found that 7(a) loans made to growers did not meet
regulatory and SBA requirements for eligibility. SBA
requirements state that the small business applicant must be
small under SBA size standards. The applicant combined with its
affiliates must not exceed the size standard designated for
either the primary industry of the applicant or the primary
industry of the applicant and its affiliates, whichever is
higher.
The large chicken companies (integrators) in our sample
exercised such comprehensive control over the growers that the
SBA Office of Inspector General believes the concerns appear
affiliative under SBA regulations. Therefore, SBA and lenders
approved 7(a) loans that were apparently ineligible under SBA
size standard regulations and requirements. Specifically, in
our review of a sample of 11 7(a) loans made to growers, as
well as review of defaulted 7(a) loans to growers, we found
integrator control exercised through a series of contractual
restrictions, management agreements, oversight inspections, and
market controls. This control overcame practically all of a
grower's ability to operate their business independent of
integrator mandates. A grower's failure to comply with these
requirements could result in a significant decease in
integrator payments, a reduction in flock placements, or a
cancellation of the contract. A grower's economic viability was
based upon a performing production contract with an integrator
and is the true basis for grower income and facility value. As
a result, from FY 2012 to FY 2016, SBA guaranteed approximately
$1.8 billion in loans that may be ineligible.
OIG Recommendations
To improve SBA's oversight of the 7(a) Loan Program, we
recommended the Associate Administrator for the Office of
Capital Access (1) review the loans cited in the evaluation
sample to determine whether SBA loan specialists and lenders
made a proper size determination given the apparent affiliation
based upon comprehensive contractual, oversight, and market
control, and take the appropriate corrective action(s), and (2)
review the arrangements between integrators and growers under
the revised regulations, and establish and implement controls,
such as supplemental guidance, to ensure SBA loan specialists
and lenders make appropriate affiliation determinations.
Agency Response
SBA management agreed with both recommendations made by
OIG. Regarding Recommendation 1, SBA will perform a review of
the loans cited in the evaluation to determine whether SBA loan
specialists and lenders made proper size determinations. For
Recommendation 2, SBA will review the arrangements between
integrators and growers in light of the current affiliation
rules and regulations. If needed, SBA will establish additional
controls to ensure SBA loan specialists and lenders make the
appropriate affiliation determinations.
CONCLUSION
I am proud of the work performed by our auditors to raise
awareness of this growing segment of SBA's 7(a) loan portfolio.
In performing this work, they obtained a deep understanding of
the operations of this industry and the practical application
of SBA's regulations for loans to farmers within the industry.
We found that 7(a) loans made to growers did not meet
regulatory and SBA requirements for eligibility. Integrators
were ineligible to participate in the SBA 7(a) Loan Program due
to their size; however, integrators exercised such
comprehensive control over the growers that the SBA OIG
believes the concerns were affiliated. Therefore, SBA and
lenders approved 7(a) loans to growers that appear ineligible
under SBA size standard regulations and requirements.
OIG will continue to provide independent, objective
oversight to improve the integrity, accountability, and
performance of the SBA and its programs for the benefit of the
American people. Our focus is to keep SBA leadership, our
congressional stakeholders, and the public currently and fully
informed about the problems and deficiencies in the programs as
identified through our work. We value our relationship with the
Committee and the Congress at large, and we look forward to
working together to address identified risks and the most
pressing management challenges facing SBA.
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April 26, 2018
House Small Business Committee
Statement for the Record
Hearing: ``An Examination of the Small Business
Administration's 7(a) Loans to Poultry Farmers''
Wednesday, April 18, 2018
Statement for the record by Hon. James Comer, Kentucky
Barriers to entry in agriculture are very high, especially
for small businesses. While large companies can use capital
markets to raise financing, small businesses typically use
traditional banking and often have trouble obtaining financing
through the traditional lending market. Many do not have the
credit history or large collateral necessary to obtain private
financing and overcome these barriers. Small businesses are
then either unable expand their farm, must obtain their
financing through the Small Business Administration's public-
private partnerships with private lenders, or are shut out from
agriculture entirely.
The 7(a) loan program fills a lending gap in the market for
poultry growers by offering guarantees of repayments made to
the lenders. By doing so, banks are provided the ability to
extend credit to otherwise unproven entrepreneurs, farmers are
provided a cash flow and access to capital they otherwise
couldn't find, and the government makes its money back on an
investment in American agriculture at no cost to the American
taxpayer. The 7(a) program minimizes uncertainty to small,
independent family farms and incentivizes young Americans who
want to start their own business in agriculture.
Particularly when the farm economy is experiencing a
downturn, as it is now, we should be doing all we can to
provide certainty and stability to America's farmers, and
administering necessary loan guarantees to poultry growers to
maintain this stability.
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