Small Business Administration: Improvements Made, but Loan	 
Programs Face Ongoing Management Challenges (06-APR-06, 	 
GAO-06-605T).							 
                                                                 
The Small Business Administration's (SBA) purpose is to promote  
small business development and entrepreneurship through business 
financing, government contracting, and technical assistance	 
programs. SBA's largest business financing program is its 7(a)	 
program, which provides guarantees on loans made by		 
private-sector lenders to small businesses that cannot obtain	 
financing under reasonable terms and conditions from the private 
sector. In addition, SBA's Office of Disaster Assistance makes	 
direct loans to households to repair or replace damaged homes and
personal property and to businesses to help with physical damage 
and economic losses. This testimony, which is based on a number  
of reports that GAO issued since 1998, discusses (1) changes in  
SBA's oversight of the 7(a) business loan program; (2) steps SBA 
has taken to improve its management of information technology,	 
human capital, and financial reporting for business loans; and	 
(3) SBA's administration of its disaster loan program.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-605T					        
    ACCNO:   A51097						        
  TITLE:     Small Business Administration: Improvements Made, but    
Loan Programs Face Ongoing Management Challenges		 
     DATE:   04/06/2006 
  SUBJECT:   Business development loans 			 
	     Internal controls					 
	     Program management 				 
	     Risk management					 
	     Small business assistance				 
	     Small business loans				 
	     Loan management					 
	     Policies and procedures				 
	     SBA 7(a) Loan Program				 
	     SBA Disaster Loan Program				 

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GAO-06-605T

     

     * Selected GAO Products

Testimony

Before the Subcommittee on Federal Financial Management, Government
Information, and International Security, Committee on Homeland Security
and Governmental Affairs, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 2:30 p.m. EDT

Thursday, April 6, 2006

SMALL BUSINESS ADMINISTRATION

Improvements Made, but Loan Programs Face Ongoing Management Challenges

Statement of William B. Shear, Director Financial Markets and Community
Investment

GAO-06-605T

Mr. Chairman and Members of the Subcommittee:

I appreciate the opportunity to be here today as you consider the
effectiveness of the Small Business Administration (SBA). Established by
Congress in 1953 to fulfill the role of several previous agencies, SBA's
purpose is to promote small business development and entrepreneurship
through business financing, government contracting, and technical
assistance programs. In addition, SBA's Office of Disaster Assistance
(ODA) makes loans to households to repair or replace damaged homes and
personal property, and to businesses to help with physical damage and
economic losses. For over a decade, SBA has been centralizing some
functions to improve efficiency and has moved more toward partnering with
outside entities, such as private-sector lenders, to provide direct
services to small businesses. Significant changes in SBA's management of
its loan programs, information technology, human capital, and financial
resources have occurred, and we have studied various aspects of these
changes.

My statement today is based on a number of reports that we have issued
over the past decade addressing SBA's administration of its major loan
guarantee and disaster loan programs. I will discuss (1) changes in SBA's
oversight of the 7(a) business loan program; (2) steps SBA has taken to
improve its management of information technology, human capital, and
financial reporting for business loans; and (3) SBA's administration of
its disaster loan program after the September 11, 2001, terrorist attacks
and the recent Gulf Coast hurricanes.

In summary:

           o  Since the mid-1990s, when we found that SBA had virtually no
           oversight program for its 7(a) guaranteed loan program, SBA has,
           in response to our recommendations, established a program and
           developed some enhanced monitoring tools. The oversight program is
           led by its Office of Lender Oversight (OLO), which was established
           in 1999. Strong oversight of SBA's lending partners is needed to
           protect SBA from financial risk and to ensure that qualified
           borrowers get 7(a) loans. In addition to its bank lending
           partners, loans are made by Small Business Lending Companies
           (SBLC)-privately owned and managed, non-depository lending
           institutions that are licensed and regulated by SBA. Since SBLCs
           are not subject to safety and soundness oversight by depository
           institution regulators, SBA has developed such a program under a
           contract with the Farm Credit Administration. Although we have not
           comprehensively reviewed the 7(a) program in some time, over the
           years, SBA has implemented many of our recommendations for lender
           oversight and continues to make improvements toward addressing
           others.
           o  Since the late 1990s, SBA has experienced mixed success in
           addressing other management challenges that affect its ability to
           manage the 7(a) program. With respect to using information
           technology to monitor loans made by 7(a) lenders, between 1997 and
           2002, SBA was unsuccessful in developing its own system to
           establish a risk management database as required by law. However,
           SBA awarded a contract in April 2003 to obtain loan monitoring
           services. Regarding SBA's most recent workforce transformation
           efforts begun in 2002, we found that although SBA applied some key
           practices important to successful organizational change, it
           overlooked aspects that emphasize transparency and communication.
           SBA has implemented some related recommendations for improvements
           in those areas. SBA has made good progress in response to our
           recommendations addressing financial management issues.
           o  With respect to SBA's administration of its disaster loan
           program after the September 11, 2001, terrorist attacks, we found
           that SBA followed appropriate policies and procedures for disaster
           loan applications in providing approximately $1 billion in loans
           to businesses and individuals in the disaster areas, and to
           businesses nationwide that suffered economic injury. Our
           preliminary findings from ongoing evaluations of SBA's response to
           the 2005 Gulf Coast hurricanes indicate that SBA's workforce and
           new loan processing system have been overwhelmed by the volume of
           loan applications. We identified three factors that have affected
           SBA's ability to provide a timely response to the Gulf Coast
           disaster victims: (1) the volume of loan applications far exceeded
           any previous disaster; (2) although SBA's new disaster loan
           processing system provides opportunities to streamline the loan
           origination process, it initially experienced numerous outages and
           slow response times in accessing information; and (3) SBA's
           planning efforts to address a disaster of this magnitude appear to
           have been inadequate.

           SBA was established in 1953, but its basic mission dates to the
           1930s and 1940s when a number of predecessor agencies assisted
           small businesses affected by the Great Depression and, later, by
           wartime competition. The first of these, the Reconstruction
           Finance Corporation, was abolished in the early 1950s; SBA was
           established by the Small Business Act of 1953,1 to continue the
           functions of the previous agencies. By 1954, SBA was making
           business loans directly to small businesses and guaranteeing loans
           banks made, making loans directly to victims of disasters, and
           providing a wide range of technical assistance to small
           businesses.

           Today, SBA's stated purpose is to promote small business
           development and entrepreneurship through business financing,
           government contracting, and technical assistance programs. SBA
           also serves as a small business advocate, working with other
           federal agencies to, among other things, reduce regulatory burdens
           on small businesses. Most SBA financial assistance is now provided
           in the form of guarantees for loans made by private and other
           institutions, but the agency's disaster program remains a direct
           loan program and is available to homeowners and renters that are
           affected by disasters of any kind; and to all businesses,
           regardless of their size, to cover physical damages.

           At the end of fiscal year 2005, SBA had authority for over 4,000
           full-time employees and budgetary resources of approximately 1.1
           billion.2

           Providing small businesses with access to credit is a major avenue
           through which SBA strives to fulfill its mission. The 7(a) loan
           program, which is SBA's largest business loan program, is intended
           to serve small business borrowers who cannot obtain credit
           elsewhere.3 Because SBA guarantees up to 85 percent of each 7(a)
           loan made by its lending partners, there is risk to SBA if the
           loans are not repaid.

           SBA is to ensure that lenders provide loans to borrowers who are
           eligible and creditworthy. Therefore, strong oversight of lenders
           by SBA is needed to ensure that qualified borrowers get 7(a) loans
           and to protect SBA from financial risk. As of September 30, 2005,
           SBA's portfolio of 7(a) loans totaled $43 billion. In
           administering the 7(a) program, SBA has evolved from making loans
           directly to depending on lending partners, primarily banks that
           make SBA guaranteed loans.4 SBA's other lending partners are Small
           Business Lending Companies (SBLC)-privately owned and managed,
           non-depository lending institutions that are licensed and
           regulated by SBA and make only 7(a) loans. Unlike SBA's bank
           lending partners, SBLCs are not generally regulated by financial
           institution regulators.5

           Since the mid-1990s, when SBA had virtually no oversight program
           for its 7(a) guaranteed loan program, the agency has established a
           program and developed some enhanced monitoring tools. We have
           conducted four studies of SBA's oversight efforts since 1998 and
           made numerous recommendations related to establishing a lender
           oversight function and improving it. Although we sometimes
           repeated recommendations in more than one report because SBA had
           not acted to address them, SBA has now addressed many of the
           outstanding recommendations and is in the process of addressing
           others.

           Prior to December 1997, SBA's procedures required annual on-site
           reviews of lenders with more than three outstanding guaranteed
           loans. But in a June 1998 study, we could not determine from the
           district offices' files which lenders met this criterion and
           should have been reviewed.6 In the five SBA district offices we
           visited, we found that about 96 percent of the lenders had not
           been reviewed in the past 5 years and that some lenders
           participating in the program for more than 25 years had never been
           reviewed. When we did our study, SBA was implementing a central
           review program for its "preferred" lenders (those SBA certifies to
           make loans without preapproval).7 The Small Business Programs
           Improvement Act of 1996 required SBA to review preferred lenders
           either annually or more frequently.8

           In our 1998 report, we recommended that SBA establish a lender
           review process for all of its 7(a) lenders, including the SBLCs.
           In 1999, SBA established OLO and charged it with, among other
           duties, managing lender reviews, including safety and soundness
           examinations of SBLCs. In the same year, SBA contracted with the
           Farm Credit Administration-the safety and soundness regulator of
           the Farm Credit System-to perform examinations of SBLCs. Numerous
           deficiencies were identified in those first examinations, but the
           SBLCs and SBA responded positively to address the recommendations.
           SBA continues its contracting arrangement with FCA.

           It was during our 2000 study on oversight of SBLCs that we first
           recommended that SBA clarify its authority to take enforcement
           actions, if necessary, against SBLCs, and to seek any statutory
           authority it might need to do so.9 We made this recommendation
           again in 2002 and in 2004 and included a call to clarify
           procedures for taking actions against preferred lenders as well.
           We recommended that SBA provide, through regulation, clear
           policies and procedures for taking enforcement actions against
           preferred lenders or SBLCs in the event of continued noncompliance
           with its regulations. During this time, SBA sought appropriate
           authority from Congress to take enforcement actions against SBLCs
           similar to those of other regulators of financial institutions,
           such as cease-and-desist and civil money penalty powers. Congress
           provided SBA enforcement authority over non-bank lenders in late
           2004, and SBA announced related delegations of authority in the
           Federal Register in April 2005 to clarify responsibilities within
           the agency.10 SBA officials have told us that they will issue
           related regulations in 2006.

           Our 2002 study focused more broadly on the relatively new OLO and
           found that the agency had made more progress in developing its
           lender oversight program.11 OLO had developed guidance,
           centralized the lender review processes, and was performing more
           reviews of its lenders. We did, however, find some shortcomings in
           the program and made recommendations for improving it. For
           example:

           o  While elements of the oversight program touched on the
           financial risk posed by preferred lenders, weaknesses limited
           SBA's ability to focus on, and respond to, current and future
           financial risk to its portfolio. Neither the lender review process
           nor SBA's off-site monitoring adequately focused on the financial
           risk lenders posed. The reviews used an automated checklist to
           focus on lenders' compliance with SBA's 7(a) processing,
           servicing, and liquidation standards. The reviews did not provide
           adequate assurance that lenders were sufficiently assessing
           borrowers' eligibility and creditworthiness. We recommended that
           SBA incorporate strategies into its review process to adequately
           measure the financial risk lenders pose to SBA, develop specific
           criteria to apply to the "credit elsewhere" standard, and perform
           qualitative assessments of lenders' performance and lending
           decisions.12 By 2004, as I will discuss in a moment, we found that
           SBA had made progress in its ability to monitor and measure the
           financial risk lenders pose but had not developed criteria for its
           credit elsewhere standard.
           o  Although SBA had taken a number of steps to develop its lender
           oversight function, the placement of its OLO within the Office of
           Capital Access (OCA) did not give OLO the necessary organizational
           independence it needed to accomplish its goals. OCA has other
           objectives, including promoting the lending program to appropriate
           lenders. We recommended that SBA make lender oversight a separate
           function and establish clear authority and guidance for OLO. SBA
           has taken several steps to address this recommendation but has not
           made OLO an independent office. In the 2005 delegations of
           authority published in the Federal Register, SBA specified that a
           Lender Oversight Committee (comprised of a majority of senior SBA
           officials outside of OCA) would have responsibilities for
           reviewing reports on lender-oversight activities; OLO
           recommendations for enforcement action; and OLO's budget,
           staffing, and operating plans. SBA officials believe that these
           and other measures will ensure sufficient autonomy and authority
           for OLO to independently perform its duties. These measures appear
           to provide the opportunity for more independence for OLO, but we
           have not evaluated how the measures are actually working.

           Our most recent review of SBA's oversight efforts, completed in
           June 2004, focused on the agency's risk management needs and its
           acquisition and use of a new loan monitoring service.13 Using an
           assessment of best practices, we determined that SBA would need to
           base its capabilities for monitoring its loan portfolio and lender
           partners on a credit risk management program.14 Largely because
           SBA relies on lenders to make its guaranteed loans, it needs a
           loan and lender monitoring capability that will enable it to
           efficiently and effectively analyze various aspects of its overall
           portfolio of loans, its individual lenders, and their portfolios.
           While SBA must determine the level of credit risk it will
           tolerate, it must do so within the context of its mission and its
           programs' structures. Since SBA is a public agency, its mission
           obligations will drive its credit risk management policies. For
           example, different loan products in the 7(a) program have
           different levels of guarantees. These and other differences
           influence the mix of loans in SBA's portfolio and, consequently,
           would impact how SBA manages its credit risk.

           Such a credit risk management program would likely include a
           comprehensive infrastructure-including, skilled personnel, strong
           management information systems, and functioning internal controls
           related to data quality-along with appropriate methodologies and
           policies that would ensure compliance with SBA criteria.

           In 2003, SBA contracted with Dun and Bradstreet for loan
           monitoring services. These services could enable the agency to
           conduct the type of monitoring and analyses typical of "best
           practices" among major lenders, and are recommended by financial
           institution regulators. The services SBA obtained reflect many
           best practices, particularly those related to infrastructure and
           methodology, and can facilitate a new level of sophistication in
           SBA's oversight efforts.15 The services also give SBA a way to
           measure the financial risk posed by its lending partners, and
           analyze loan and lending patterns efficiently and effectively.
           However, SBA did not develop the comprehensive policies it needed
           to implement the best practices as we recommended.

           SBA officials have told us that they have taken steps to address
           this recommendation. For example, the management plan governing
           the agency's relationship with Dun and Bradstreet addresses a
           process for continuous improvement. SBA has also established the
           Lender Oversight Committee and a Portfolio Analysis Committee to
           review portfolio performance. SBA officials told us that these
           committees meet frequently. They also described the type of
           analyses of the loan portfolio and individual lenders made
           available for review and discussion by the committees, and
           provided examples of these analyses. Although these developments
           could provide the tools for risk management that we envisioned, we
           have not evaluated them.

           Since the late 1990s, SBA has taken steps to address other
           management challenges that affect its ability to manage its
           business loan program and the technical assistance it provides
           small businesses. Information technology, human capital, and
           financial management have posed challenges for SBA, as we have
           noted in special reports to Congress.16

           SBA has now acquired the ability to monitor its portfolio of
           business loans through its arrangement with Dun and Bradstreet, as
           mentioned earlier. SBA took this positive step after an
           unsuccessful attempt to establish a risk management database as
           required by the Small Business Programs Improvement Act of 1996.17
           We monitored the agency's progress as it attempted to meet this
           challenge on its own. When we reviewed SBA's plans in 1997, we
           found that it had not undertaken the essential planning needed to
           develop the proposed system.18 We periodically reported on SBA's
           progress in planning and developing the loan monitoring system
           since 1997.19 From 1998 to 2001, SBA's estimate for implementing
           the system grew from $17.3 million to $44.6 million. By 2001, SBA
           had spent $9.6 million for developmental activities, but had never
           completed the mandated planning activities or developed a
           functioning loan monitoring system.

           In 2001, Congress did not appropriate funds for the loan
           monitoring system and instead permitted SBA to use reprogrammed
           funds, provided that SBA notify Congress in advance of SBA's use
           of the reprogrammed funds.20 Congress also directed SBA to develop
           a project plan to serve as a basis for future funding and
           oversight of the loan monitoring system. As a result, SBA
           suspended the loan monitoring system development effort. Of the
           $32 million appropriated for the loan monitoring system effort,
           about $14.7 million remained. In 2002, SBA contracted for
           assistance to identify alternatives and provide recommendations
           for further developing a loan monitoring system. This effort led
           to SBA awarding a contract to Dun and Bradstreet in April 2003 to
           obtain loan monitoring services, including loan and lender
           monitoring and evaluation; and risk management tools. The contract
           includes four 1-year options at an average cost of approximately
           $2 million a year.

           In 2001 we reported on SBA's organizational structure and the
           challenges it presented for SBA to deliver services to small
           businesses.21 We reviewed how well SBA's organization was aligned
           to achieve its mission. We found a field structure that did not
           consistently match with SBA's mission requirement. This was caused
           by past realignment efforts during the mid-1990s that changed how
           SBA performed its functions, but left some aspects of the previous
           structure in place. Among the other weaknesses we identified were:

           o  ineffective lines of communication;
           o  confusion over the mission of district offices; and
           o  complicated, overlapping organizational relationships.

           SBA began realigning its organization, operations, and workforce
           to better serve its small-business customers in the 1990's. With
           less responsibility for direct lending and a declining operating
           budget, SBA streamlined its field structure by downsizing its 10
           regional offices, moving the workload to district or headquarters
           offices, and eliminating most of the regional offices' role as the
           intermediate management layer between headquarters and the field.
           SBA created the Office of Field Operations, largely to represent
           the field offices in headquarters and to provide guidance and
           oversight to field office management. In 2002, the agency planned
           to approach its 5-year transformation efforts in phases, testing a
           number of initiatives in order to make refinements before
           implementing the initiatives agencywide. These efforts are
           ongoing. SBA's current transformation objectives are to:

           o  streamline ODA by realigning offices, employees, and space to
           better serve disaster victims and leverage use of the new disaster
           loan processing system;
           o  centralize all 7(a) loan processing in two centers to
           standardize procedures and reduce the workforce required for this
           program;
           o  centralize all 504 loan liquidations in two centers to
           standardize processing and increase efficiency;
           o  centralize disaster loan liquidations in one center to
           standardize processing and increase efficiency; and
           o  transform the regional and district offices by standardizing
           their size and function.

           In October 2003, when we reported on SBA's transformation, SBA was
           near completion of the first phase of its transformation
           process.22 This initial phase aimed to

           o  transform the role of the district office to focus on outreach
           to small businesses about SBA's products and services, and link
           these businesses to the appropriate resources, including lenders;
           and
           o  centralize some of its loan functions to improve efficiency and
           the consistency of its loan approval and liquidation processes.

           We found that the agency had applied some key practices important
           to successful organizational change, but had overlooked aspects
           that emphasize transparency and communication. For example, SBA
           had top leadership support and a designated
           transformation-implementation team, but the makeup of the team was
           not communicated to employees and stakeholders, and the team's
           leadership was not always consistent. Also, SBA had developed a
           transformation plan that contained goals, anticipated results, and
           an implementation strategy--but the plan was not made public, and
           employees and stakeholders were not apprised of the details of the
           plan. Also, certain aspects of the plan were revised, causing
           further confusion among non-management employees. Further, SBA had
           developed strategic goals to guide its transformation, but these
           goals were not linked with measurable performance goals that would
           demonstrate the success of the agency's plan to expand the focus
           of the district offices on marketing and outreach.

           Based on our findings and the possibility that further progress
           could be impeded by budget and staff realignment challenges, we
           recommended that SBA:

           o  ensure that implementation leadership is clearly identified to
           employees and stakeholders;
           o  finalize its transformation plan and share it with employees
           and stakeholders;
           o  develop performance goals that reflect the strategic goals for
           transformation, and budget requests that clearly link resource
           needs to achieving strategic goals;
           o  use the new performance management system to define
           responsibilities;
           o  develop a communication strategy that promotes two-way
           communication; and
           o  solicit ideas and feedback from employees and the union, and
           ensure that their concerns were considered.

           SBA officials have told us of the Administrator's increased
           efforts to communicate with staff by holding agencywide meetings
           with employees, for example. In addition, the agency plans to
           finalize a transformation plan and share it with employees in
           June. These actions could address some of the recommendations we
           made to SBA, but we have not documented or evaluated the efforts.

           SBA has made good progress towards addressing financial management
           issues that for several years prevented it from obtaining an
           unqualified audit opinion on its financial statements. We reported
           on some of these issues in our January 2003 report on SBA's loan
           sales.23 Specifically, we found that SBA lacked reliable data to
           determine the overall financial results of its loan sales.
           Further, because SBA did not analyze the effect of loan sales on
           its remaining portfolio, we reported that its credit program cost
           estimates for the budget and financial statements may have
           contained significant errors. In addition, SBA could not explain
           unusual account balances related to the disaster loan program,
           which indicated that the subsidized program was expected to
           generate a profit. These issues raised concerns about SBA's
           ability to properly account for loan sales and to make reasonable
           estimates of program costs.

           In response to our findings and several recommendations, SBA
           conducted an extensive analysis to resolve the issues we
           identified and implemented a number of corrective actions. For
           example, SBA developed a new cash- flow model to estimate the
           costs of its disaster loan program, and implemented standard
           operating procedures for annually revising the cost estimates for
           its credit programs. SBA also revised its approach to determine
           the results of loan sales and found that loans were sold at
           losses, which was contrary to the original determination that the
           sales generated gains. These findings prompted SBA to eventually
           discontinue its loan sales program. We reviewed the improvements
           made by SBA and reported in April 2005 that the loan accounting
           issues we previously identified were resolved, and that the new
           cash-flow model improved its ability to prepare more reliable cost
           estimates and to determine the results of prior loan sales.24
           However, we recommended additional steps that would improve the
           long-term reliability of the cost estimates, such as routine
           testing of the model. According to SBA officials, steps have been
           taken to address each of our recommendations, including the
           development of policies and procedures on how to operate and test
           the model.

           These improvements helped SBA achieve an unqualified audit opinion
           on its fiscal year 2005 financial statements, which represents
           significant progress from prior years. However, for fiscal year
           2005 SBA's auditor continued to note weaknesses in SBA's overall
           internal controls. The auditor noted three areas involving
           internal controls that are considered to be weaknesses.25 The
           first area, which the auditor considered to be a significant
           weakness, related to financial management and reporting controls.
           Specifically, the auditor found that SBA needed to improve its
           funds management (i.e., canceling loan amounts not disbursed and
           closing out grants), its review process for accounting
           transactions, and its financial statement preparation process. The
           other two less significant control weaknesses related to SBA's ODA
           administrative expenditure controls and agencywide information
           system controls. While these internal control weaknesses were not
           severe enough to impact SBA's audit opinion for fiscal year 2005,
           it is important for SBA to address them to help ensure that SBA
           continues to be able to generate reliable financial data.

           Disaster assistance has been part of SBA since its inception, and
           SBA's physical disaster loan program is the only form of
           assistance not limited to small businesses.26 Through the ODA, SBA
           provides low-interest, long-term loans to individuals and
           businesses to assist them with disaster recovery. Unlike the 7(a)
           program, the disaster loan program provides loans directly to
           disaster victims. Businesses can apply for "physical loans" to
           repair or replace business property to pre-disaster conditions, as
           well as economic injury disaster loans (EIDLs) to obtain working
           capital funds to meet their normal operating expenses. The maximum
           loan amount for both physical business loans and EIDLs is $1.5
           million, but SBA was given federal authority and supplemental
           appropriations to increase the amount for 9/11 disaster loans.
           Homeowners and renters can also apply for loans to cover their
           uninsured losses. The maximum amount available for home loans is
           $200,000, and personal property loans to replace items such as
           automobiles, clothing, and furniture are available up to
           $40,000.27 SBA offers terms of up to 30 years for repayment.
           According to SBA, although ODA aims to provide loan funds to
           disaster victims as quickly as possible, its focus is on long-term
           recovery, and not on emergency relief.

           Since SBA provides low-interest loans, the agency is required to
           determine whether each applicant is able to obtain financial
           assistance at reasonable rates and terms from non-government
           sources prior to assigning an interest rate. A higher rate applies
           for physical loan applicants if they are determined to have other
           credit available, and economic injury loan applicants are
           ineligible if they have other credit available. Physical business
           loans--where the applicant has credit available from other
           sources--are also subject to a maximum 3-year term for
           repayment.28 SBA also has standard procedures and requirements for
           disaster loans, including verification of losses claimed,
           verification of repayment ability, and collateral to secure loans
           for economic injury loans over $5,000 or for home loans or
           physical disaster business loans over $10,000.29 SBA verifies
           losses for physical loans and also deducts certain forms of
           compensation, including insurance recoveries, from the eligible
           loan amount. Federal Emergency Management Agency (FEMA) is the
           coordinating agency for presidential disaster declarations, and
           most disaster victims register with FEMA initially before
           receiving a referral to SBA.30 SBA can review FEMA's information
           to determine if an applicant has already received federal
           assistance or insurance proceeds to avoid duplication of
           benefits.31 If insurance reimbursement is undetermined at the time
           of application, SBA can approve a loan for the total replacement
           cost, but any insurance proceeds must be assigned to SBA to reduce
           the loan balance. In considering any loan, SBA must have
           reasonable assurance that the loan can be repaid. To make this
           determination, SBA examines federal tax returns and income
           information and reviews credit reports to verify the manner in
           which an applicant's obligations, including federal debts, have
           been met. One of the reasons that SBA may decline a loan
           application is unsatisfactory history on a federal obligation. The
           law does not require collateral for disaster loans, but SBA policy
           establishes collateral requirements in order to balance the
           agency's disaster recovery mission with its responsibility as a
           lender of federal tax dollars. For example, for physical disaster
           loans over $10,000, applicants are required to provide collateral
           that will best secure the loan, and multiple loans totaling over
           $10,000 also require collateral to secure each loan. Real estate
           is the preferred form of collateral, but SBA will not
           automatically decline an application if the best available
           collateral is insufficient in value to secure the loan.

           Following the terrorist attacks of September 11th, SBA provided
           approximately $1 billion in loans to businesses and individuals in
           the federally declared disaster areas and to businesses nationwide
           that suffered related economic injury.32 Home and business owners
           in the federally declared disaster areas received just under half
           of the disbursed loans; the remainder went to eligible businesses
           around the country. Congress and SBA made several modifications to
           the programs in response to complaints from small businesses. For
           example, the EIDL program was expanded to the entire country and
           to industries that had not previously been covered, size standards
           for some eligible business were changed, and loan approval and
           disbursement were expedited. 33

           In 2004, in response to concerns that about half of the loan
           applications submitted by small businesses were declined or
           withdrawn, we reviewed a representative sample of these
           applications and found that SBA had followed the appropriate
           policies and procedures in making loan decisions.34 We compared
           SBA's loan requirements to those of selected nonprofit agencies in
           the New York area that provided financial assistance to local
           small businesses following the disaster. Generally, we found that
           SBA had loan requirements that were similar to these nonprofits,
           but the nonprofits' programs allowed some additional flexibility
           to address the particular needs of their small business
           constituents.

           We also currently have work under way to identify and assess the
           factors that have affected the SBA's ability to respond to victims
           of Hurricane Katrina and the other 2005 Gulf Coast hurricanes in a
           timely manner.35 As part of our work, we are evaluating how SBA's
           new Disaster Credit Management System, which has been in use since
           January 2005, affected SBA's response. As the primary federal
           lender to disaster victims, including individual homeowners,
           renters, and businesses, SBA's ability to process and disburse
           loans in a timely manner is critical to the recovery of the Gulf
           Coast region. As of February 25, 2006, SBA faced a backlog of
           about 103,300 applications in loan processing pending a final
           decision, and the average time these applications had been in
           process was about 94 days. During the month of March, SBA
           continued to process applications. By March 25, 2006, SBA had
           mailed out more than 1.6 million loan applications, received over
           350,000 completed applications, processed more than 290,000
           applications, and disbursed about $600 million in disaster loan
           funds. Although SBA's current goal is to process loan applications
           within 7 to 21 days, as of March 25, 2006, SBA faced a backlog of
           about 55,000 applications in loan processing pending a final
           decision and the average age of these loan applications was about
           88 days. SBA also has more than 43,000 loan applications that have
           been approved but have not been closed or fully disbursed. As a
           result, disaster victims in the Gulf Region have not received
           timely assistance in recovering from this disaster and rebuilding
           their lives.

           Based on our preliminary analysis of SBA's disaster loan
           origination process, we have identified several factors that have
           affected SBA's ability to provide a timely response to Gulf Coast
           disaster victims. First, the volume of loan applications SBA
           mailed out and received has far exceeded any previous disaster.
           Compared with the Florida hurricanes of 2004 or the 1994
           Northridge earthquake, the hurricanes that hit the Gulf Coast in
           2005 resulted in the issuance of roughly two to three times as
           many loan applications. Second, although SBA's new disaster-loan
           processing system provides opportunities to streamline the loan
           origination process, initially it experienced numerous outages and
           slow response times in accessing information. However, we have not
           yet determined the duration and impact of these outages on
           processing. SBA officials have attributed many of these problems
           to a combination of hardware-and telecommunications- capacity
           limitations as well as the level of service SBA has received from
           its contractors. Third, SBA's planning efforts to address a
           disaster of this magnitude appear to have been inadequate.
           Although SBA's disaster planning efforts focused primarily on
           responding to a disaster the size of the Northridge earthquake,
           SBA officials said that it initially lacked the critical resources
           such as office space, staff, phones, computers, and other
           resources to process loans for this disaster. SBA has participated
           in disaster simulations on a limited basis only and it is unclear
           whether previous disaster simulations of category 4 hurricanes
           hitting the New Orleans area were considered.

           We are also assessing other factors that have affected SBA's
           ability to provide timely loans to disaster victims in the Gulf
           region including: workforce transformation, the exercise of its
           regulatory authority to streamline program requirements and
           delivery to meet the needs of disaster victims, coordination with
           state and local government agencies, SBA's efforts to publicize
           the benefits offered by the disaster loan program, and the limits
           that exist on the use of disaster loan funds.

           Mr. Chairman, this concludes my prepared statement. I would be
           happy to answer any questions at this time.

           For further information on this testimony, please contact William
           B. Shear at (202) 512-8678. Individuals making key contributions
           to this testimony included Katie Harris, Assistant Director, and
           Bernice Benta.

           SBA Disaster Loan Program: Accounting Anomalies Resolved but
           Additional Steps Would Improve Long-Term Reliability of Cost
           Estimates. GAO-05-409 . Washington, D.C.: April 14, 2005.

           Small Business Administration: SBA Followed Appropriate Policies
           and Procedures for September 11 Disaster Loan Applications.
           GAO-04-885 . Washington, D.C.: August 31, 2004.

           Small Business Administration: New Service for Lender Oversight
           Reflects Some Best Practices, but Strategy for Use Lags Behind.
           GAO-04-610 . Washington, D.C.: June 8, 2004.

           Small Business Administration: Model for 7(a) Program Subsidy Had
           Reasonable Equations, but Inadequate Documentation Hampered
           External Reviews. GAO-04-9 . Washington, D.C.: March 31, 2004.

           Small and Disadvantaged Businesses: Most Agency Advocates View
           Their Roles Similarly. GAO-04-451 . Washington, D.C.: March 22,
           2004.

           Small Business Administration: Progress Made, but Transformation
           Could Benefit from Practices Emphasizing Transparency and
           Communication. GAO-04-76 . Washington, D.C.: October 31, 2003.

           Small and Disadvantaged Businesses: Some Agencies' Advocates Do
           Not Report to the Required Management Level. GAO-03-863 .
           Washington, D.C.: September 4, 2003.

           Small Business Administration: Observations on the Disaster Loan
           Program. GAO-03-721T . Washington, D.C.: May 1, 2003.

           Small Business Administration: Progress Made but Improvements
           Needed in Lender Oversight. GAO-03-720T . Washington, D.C.: April
           30, 2003.

           Small Business Administration: Response to September 11 Victims
           and Performance Measures for Disaster Lending. GAO-03-385 .
           Washington, D.C.: January 29, 2003.

           Small Business Administration: Accounting Anomalies and Limited
           Operational Data Make Results of Loan Sales Uncertain. GAO-03-87 .
           Washington, D.C.: January 3, 2003.

           Major Management Challenges and Program Risks: Small Business
           Administration. GAO-03-116 . Washington, D.C.: January 1, 2003.

           Small Business Administration: Progress Made but Improvements
           Needed in Lender Oversight. GAO-03-90 . Washington, D.C.: December
           9, 2002.

           September 11: Small Business Assistance Provided in Lower
           Manhattan in Response to the Terrorist Attacks. GAO-03-88 .
           Washington, D.C.: November 1, 2002.

           Small Business Administration: Workforce Transformation Plan Is
           Evolving. GAO-02-931T . Washington, D.C.: July 16, 2002.

           Loan Monitoring System: SBA Needs to Evaluate the Use of Software.
           GAO-02-188 . Washington, D.C.: November 30, 2001.

           Small Business Administration: Current Structure Presents
           Challenges for Service Delivery. GAO-02-17 . Washington, D.C.:
           October 26, 2001.

           Small Business Administration: Actions Needed to Strengthen Small
           Business Lending Company Oversight. GAO-01-192 . Washington, D.C.:
           November 17, 2000.

           SBA Loan Monitoring System: Substantial Progress Yet Key Risks and
           Challenges Remain. GAO/AIMD-00-124 . Washington, D.C.: April 25,
           2000.

           Small Business Administration: Planning for Loan Monitoring System
           Has Many Positive Features but Still Carries Implementation
           Challenges. GAO/T-AIMD-98-233 . Washington, D.C.: July 16, 1998.

           Small Business Administration: Mandated Planning for Loan
           Monitoring System Is Not Complete. GAO/AIMD-98-214R . Washington,
           D.C.: June 30, 1998.

           Small Business Administration: Few Reviews of Guaranteed Lenders
           Have Been Conducted. GAO/GGD-98-85 . Washington, D.C.: June 11,
           1998.

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                                   Background

SBA Has Developed and Continues to Improve an Oversight Program for Its Business
                                  Loan Program

1Pub. L. No. 83-163, tit. II, 67 Stat. 232 (July 30, 1953), as amended,
which was withdrawn as part of that Act and made a separate Act known as
the "Small Business Act" by Pub. L. No. 85-536, 72 Stat. 384 (July 18,
1958) (codified at 15 U.S.C. S:S: 631 - 657e).

2Budgetary resources include new budget authority and unobligated balances
of previous budget authority.

315 U.S.C. S: 636(a).

4Within the 7(a) program, there are three classifications of
lenders-regular, certified, and preferred lenders. The Small Business
Administration continues to provide final approval of loans made by its
regular lenders. Certified lenders have the authority to process, close,
service, and may liquidate SBA guaranteed loans. Preferred lenders are
given full authority to make loans without prior SBA approval.

5Small Business Lending Companies that are subsidiaries of bank holding
companies are subject to Federal Reserve Board oversight.

6See GAO, Small Business Administration: Few Reviews of Guaranteed Lenders
Have Been Conducted, GAO-98-85 (Washington, D.C.: June 11, 1998).

7The percentage of loans accounted for by preferred lenders represented
about 30 percent of 7(a) loan approvals and 50 percent of loan volume in
1997.

8The assessments are to include, among other things, defaults, loans, and
recoveries of loans made by the lender. Pub. L. No. 104-208, div. D, title
1, S: 103(h), 110 Stat. 3009, 3009-728 (Sept. 30, 1996) (codified at 15
U.S.C. S: 634 note).

9GAO, Small Business Administration: Actions Needed to Strengthen Small
Business Lending Company Oversight, GAO-01-192 (Washington, D.C.: Nov. 17,
2000).

10See Small Business Reauthorization and Manufacturing Assistance Act of
2004 (Pub. L. No. 108-447, div.K, S: 161, 118 Stat. 2809, 3458 (Dec. 8,
2004) (codified at 15 U.S.C. S: 650); and 70 Fed. Reg. 21262, 21263 (Apr.
25, 2005).

11See GAO, Small Business Administration: Progress Made but Improvements
Needed in Lender Oversight, GAO-03-90 (Washington, D.C.: Dec. 9, 2002).

1215 U.S.C. S: 636(a)(1)(A) prohibits SBA from providing financial
assistance to an applicant that can obtain credit elsewhere. 13 C.F.R. S:
120.101 states, in part, "SBA provides business loan assistance only to
applicants for whom the desired credit is not otherwise available on
reasonable terms from non-Federal sources."

13See GAO, Small Business Administration: New Service for Lender Oversight
Reflects Some Best Practices, but Strategy for Use Lags Behind, GAO-04-610
(Washington, D.C.: June 8, 2004).

14"Credit risk" is the risk of financial loss due to borrower default.

 SBA Has Experienced Mixed Success in Addressing Other Management Challenges to
                             Its 7(a) Loan Program

15The best practices include continuous improvements in the service and
its tools, frequent and routine portfolio reviews, and active involvement
of senior managers in reviewing how the information from the service is
used.

16GAO, Major Management Challenges and Program Risks: Small Business
Administration, GAO-03-116 (Washington, D.C.: Jan. 2003); see
www.gao.gov/pas/2005 for a 2005 update. We first addressed these
management challenges in 2001. See GAO, Major Management Challenges and
Program Risks: Small Business Administration, GAO-01-260 (Washington,
D.C.: Jan. 2001).

SBA Has Made Advancements in Information Technology Critical to Business Loans

17Pub. L No. 104-208, div. D, title I, S: 102,110 Stat. 3009-724,
3009-725, (Sept. 30, 1996) (codified at 15 U.S.C. S: 633(b)(3).

18GAO, Small Business Administration: Better Planning and Controls Needed
for Information Systems, GAO/AIMD-97-94 (Washington, D.C.: June 27, 1997).

19GAO, Small Business Administration: Mandated Planning for Loan
Monitoring System Is Not Complete, GAO/AIMD-98-214R (Washington, D.C.:
June 30,1998); Small Business Administration: Planning for Loan Monitoring
System Has Many Positive Features but Still Carries Implementation
Challenges, GAO/T-AIMD-98-233 (Washington, D.C.: July 16, 1998); SBA Loan
Monitoring System: Substantial Progress Yet Key Risks and Challenges
Remain, GAO/AIMD-00-124 (Washington, D.C.: Apr. 25, 2000); Loan Monitoring
System: SBA Needs to Evaluate the Use of Software, GAO-02-188 (Washington,
D.C.: Nov. 30, 2001).

20 See Pub. L. No. 107-77, 115 Stat. 748, 796-799 (Nov. 28, 2001); and
H.R. Conf. Rep. No. 107-278 at 164 (2001).

SBA Has Applied Key Practices but Overlooked Transparency and Communication
During Its Workforce Transformation

21GAO, Small Business Administration: Current Structure Presents
Challenges for Service Delivery, GAO-02-17 (Washington, D.C.: Oct. 26,
2001).

22GAO, Small Business Administration: Progress Made, but Transformation
Could Benefit from Practices Emphasizing Transparency and Communication,
GAO-04-76 (Washington, D.C.: Oct. 31, 2003).

SBA Addressed Major Financial Management Issues, but Additional Steps are
Necessary to Sustain Progress

23GAO, Small Business Administration: Accounting Anomalies and Limited
Operational Data Make Results of Loan Sales Uncertain, GAO-03-87
(Washington, D.C.: Jan. 3, 2003). Between fiscal years 1999 and 2003, SBA
conducted seven loan sales, divesting itself of about 166,000 loans with
an outstanding balance of about $5.7 billion. Approximately 86 percent of
the amount sold was from disaster assistance loans.

24GAO, SBA Disaster Loan Program: Accounting Anomalies Resolved but
Additional Steps Would Improve Long-Term Reliability of Cost Estimates,
GAO-05-409 (Washington, D.C.: Apr. 14, 2005).

SBA Provided Disaster Loans in Response to September 11th and Now Is Responding
                          to the Gulf Coast Hurricanes

25There are two types of internal control weaknesses. A "reportable
condition" is a significant deficiency in the design or operation of
internal controls that could adversely affect the organization's ability
to provide reasonable assurance on the reliability of its financial
reporting, performance reporting, and compliance with laws and
regulations. The more significant weakness, referred to as a "material
internal control weakness," is a reportable condition that does not reduce
to a relatively low level the risk that errors, fraud, or noncompliance
involving significant amounts may occur and may not be detected in a
timely manner, by employees in the normal course of performing their
assigned functions.

26The economic injury disaster loan (EIDL) program under 15 U.S.C. S:
636(b)(2) covers small business concerns and small agricultural
cooperatives located in a disaster area.

2713 C.F.R. S: 123.105.

2813 C.F.R. S: 123.203(a).

2913 C.F.R. S: 123.11.

30Non-business disaster victims initially register with the Federal
Emergency Management Agency (FEMA) and are directed to apply for an SBA
disaster assistance loan if they meet certain basic criteria. Business
owners are also encouraged to register with FEMA. Applicants not approved
for an SBA loan are referred back to FEMA for possible grant assistance.

31ODA's new Disaster Credit Management System (DCMS) has a direct link to
FEMA's database, which allows SBA to conduct the duplication of benefits
(DOB) review electronically.

32GAO, Small Business Administration: Response to September 11 Victims and
Performance Measures for Disaster Lending, GAO-03-385 (Washington, D.C.:
Jan. 29, 2003).

33SBA was given supplemental appropriations to make loans after September
11th and the 2005 Gulf Coast hurricane disasters.

34GAO, Small Business Administration: SBA Followed Appropriate Policies
and Procedures for September 11 Disaster Loan Applications, GAO-04-885
(Washington, D.C.: Aug. 31, 2004). In addition to SBA disaster loans,
Congress allowed SBA to collect reduced annual fees on 7(a) loans made by
lenders to small businesses "adversely affected" by the terrorist attacks
and their aftermath (see Pub. L. 107-117, S: 203, 115 Stat. 2230,
2297-2298 (Jan. 10, 2002)). These loans were designated by SBA as
"Supplemental Terrorist Activity Relief" or STAR, loans. When the STAR
program expired on January 10, 2003, approximately $3.7 billion in STAR
loans had been approved. In a review of the STAR loan program, SBA's
Office of Inspector General found that most lender files did not contain
sufficient information to demonstrate that borrowers were adversely
affected by the attacks and their aftermath, and that SBA did not
establish specific requirements to review or verify lenders' STAR
justifications. See SBA, Office of Inspector General, Audit of SBA's
Administration of the Supplemental Terrorist Activity Relief (STAR) Loan
Program, Rept. No. 6-09 (Washington, D.C.: Dec. 23, 2005). We did not
review the STAR program.

35 Hurricane Katrina struck the Gulf Coast on August 29; Hurricanes Rita
and Wilma struck the U.S. Mainland on September 24 and October 24,
respectively.

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Highlights of GAO-06-605T , a testimony to the Subcommittee on Federal
Financial Management, Government Information, and International Security,
Committee on Homeland Security and Governmental Affairs, U.S. Senate

April 6, 2006

SMALL BUSINESS ADMINISTRATION

Improvements Made, but Loan Programs Face Ongoing Management Challenges

The Small Business Administration's (SBA) purpose is to promote small
business development and entrepreneurship through business financing,
government contracting, and technical assistance programs. SBA's largest
business financing program is its 7(a) program, which provides guarantees
on loans made by private-sector lenders to small businesses that cannot
obtain financing under reasonable terms and conditions from the private
sector. In addition, SBA's Office of Disaster Assistance makes direct
loans to households to repair or replace damaged homes and personal
property and to businesses to help with physical damage and economic
losses.

This testimony, which is based on a number of reports that GAO issued
since 1998, discusses (1) changes in SBA's oversight of the 7(a) business
loan program; (2) steps SBA has taken to improve its management of
information technology, human capital, and financial reporting for
business loans; and (3) SBA's administration of its disaster loan program.

Since the mid-1990s, when GAO found that SBA had virtually no oversight
program for its 7(a) guaranteed loan program, SBA has, in response to GAO
recommendations, established a program and developed some enhanced
monitoring tools. The oversight program is led by its Office of Lender
Oversight, which was established in 1999. Strong oversight of SBA's
lending partners is needed to protect SBA from financial risk and to
ensure that qualified borrowers get 7(a) loans. In addition to its bank
lending partners, loans are made by Small Business Lending Companies
(SBLC)-privately owned and managed, non-depository lending institutions
that are licensed and regulated by SBA. Since SBLCs are not subject to
safety and soundness oversight by depository institution regulators, SBA
has developed such a program under a contract with the Farm Credit
Administration. Over the years, SBA has implemented many GAO
recommendations for lender oversight and continues to make improvements
toward addressing others.

Since the late 1990s, SBA has experienced mixed success in addressing
other management challenges that affect its ability to manage the 7(a)
loan program. With respect to using information technology to monitor
loans made by 7(a) lenders, between 1997 and 2002, SBA was unsuccessful in
developing its own system to establish a risk management database as
required by law. However, SBA awarded a contract in April 2003 to obtain
loan monitoring services. Regarding SBA's most recent workforce
transformation efforts begun in 2002, GAO found that SBA applied some key
practices important to successful organizational change but overlooked
aspects that emphasize transparency and communication. SBA has implemented
some related GAO recommendations for improvements in those areas. SBA has
also made good progress in response to GAO recommendations addressing
financial management issues.

With respect to SBA's administration of its disaster loan program after
the September 11, 2001, terrorist attacks, GAO found that SBA followed
appropriate policies and procedures for disaster loan applications in
providing approximately $1 billion in loans to businesses and individuals
in the disaster areas, and to businesses nationwide that suffered economic
injury. GAO's preliminary findings from ongoing evaluations of SBA's
response to the 2005 Gulf Coast hurricanes indicate that SBA's workforce
and new loan processing system have been overwhelmed by the volume of loan
applications. GAO identified three factors that have affected SBA's
ability to provide a timely response to the Gulf Coast disaster victims:
(1) the volume of loan applications far exceeded any previous disaster;
(2) although SBA's new disaster loan processing system provides
opportunities to streamline the loan origination process, it initially
experienced numerous outages and slow response times in accessing
information; and (3) SBA's planning efforts to address a disaster of this
magnitude appear to have been inadequate.
*** End of document. ***