SBA’s primary guidance for the 7(a)  program outlines six reasons lenders can use to substantiate that a  borrower cannot obtain credit elsewhere. Together, the statute,  regulations, and guidance allow lenders to use their own conventional  lending policies to determine which borrowers need an SBA guarantee. Lenders Cite Similar Reasons to Substantiate Credit Elsewhere Decisions

Using information collected from 238 recently approved 7(a) loan files  from 18 lenders, we found that the most common reasons lenders cited to  substantiate that borrowers could not obtain credit elsewhere were (1)  that the business needed a longer maturity than the lender’s policy  permitted, (2) that the borrower’s collateral did not meet the lender’s  policies, and (3) that the lender’s policies did not normally allow loans to  new businesses or businesses in the applicant’s industry (see table 1). SBA requires lenders to explain in a borrower’s loan file  why the borrower could not obtain credit elsewhere on reasonable terms,  but its guidance does not provide specific information on what lenders  should include in their explanations. Guidance on Documenting Credit Elsewhere Decisions Is Limited

Internal control standards for federal agencies and programs state that  good guidance (information and communication) is a key component of a  strong internal control framework. Although SBA’s guidance requires lenders to document the reasons that  borrowers cannot obtain credit elsewhere, it does not specify what exactly  lenders should include in their explanations. We analyzed reports from all the on-site lender reviews SBA  conducted during a six-quarter period from October 2006 to March 2008 and  found that 31 of the 97 lenders reviewed did not consistently document that  borrowers met the credit elsewhere requirement or personal resources test. Lenders’ Documentation of Credit Elsewhere Decisions Generally Was Not Specific Enough to Reasonably Support the Determination That Borrowers Could Not Obtain Credit Elsewhere

Although all but one of the lenders we visited documented their credit  elsewhere decisions in some way, our review of documentation provided  to support credit elsewhere decisions in 238 loan files showed that most  lenders did not provide detailed information on why borrowers could not  obtain credit elsewhere. For instance, a number of lenders we met with  used a checklist to document their credit elsewhere decisions. Given the broad authority granted to  lenders, more information specific to the borrower’s or the lender’s  financial condition would help support the lender’s assessment that the  borrower could not obtain credit elsewhere. Conclusions

The 7(a) program is intended to serve creditworthy small business  borrowers who cannot obtain credit through a conventional lender at  reasonable terms and do not have the personal resources to provide it  themselves. Absent detailed guidance on what exactly SBA wants lenders to  document in their credit elsewhere determinations, lenders will likely  continue to offer limited information in their files, making meaningful  oversight of compliance with the credit elsewhere requirement difficult. Appendix II: Objectives, Scope, and Methodology

In this report, we (1) describe SBA’s criteria for determining that  borrowers cannot obtain credit elsewhere and practices lenders employ to  determine that borrowers cannot obtain credit elsewhere and (2) examine  SBA’s efforts to ensure that lenders are complying with the credit  elsewhere provision.
Why GAO Did This Study

The Small Business Administration's (SBA) 7(a) program is intended to provide loan guarantees to small business borrowers who cannot obtain conventional credit at reasonable terms and do not have the personal resources to provide financing themselves. In fiscal year 2008, SBA guaranteed over 69,000 loans valued at about $13 billion. To assist in oversight of the 7(a) program, GAO was asked to (1) describe SBA's criteria and lenders' practices for determining that borrowers cannot obtain credit elsewhere and (2) examine SBA's efforts to ensure that lenders are complying with the credit elsewhere provision. To meet these objectives, GAO reviewed applicable statutes and guidance, visited 18 lenders and reviewed 238 of their loan files, reviewed 97 on-site lender review reports, and interviewed SBA officials. GAO's samples of lenders and loan files were not generalizable.

What GAO Found

The Small Business Act and 7(a) program regulations and guidance allow lenders to use their conventional lending practices to determine whether borrowers can obtain credit elsewhere at reasonable terms. On the basis of a review of 238 loan files at 18 lenders, GAO observed that the most common reasons these lenders cited to substantiate that borrowers could not obtain credit elsewhere were that the borrower needed a longer maturity than the lender's policy permitted and the borrower's collateral did not meet the lender's requirements. These factors are two of the six listed in SBA's guidance as acceptable to substantiate that a borrower could not obtain conventional credit. SBA has issued little guidance on how lenders should document in their files that borrowers could not obtain credit elsewhere. Internal control standards for federal agencies specify that good guidance (information and communication) is necessary to help ensure the proper implementation of program rules. While SBA's guidance requires lenders to explain why the borrower could not obtain credit elsewhere in the loan file, it does not specify what exactly lenders should include in their explanations. Between October 2006 and March 2008, SBA reviewed 97 lenders and determined that 31 of them had failed to consistently document that borrowers met the credit elsewhere requirement or personal resources test. All but one of the lenders with whom GAO met documented their credit elsewhere decisions in some way; however, given the broad authority granted to lenders, the explanations were generally not specific enough to reasonably support the lender's conclusion that borrowers could not obtain credit elsewhere. A number of these lenders used a checklist that simply listed the six acceptable reasons cited in SBA's guidance for substantiating that a borrower could not obtain credit elsewhere and did not prompt them to provide more information specific to the borrower--for example, details on insufficient collateral. Absent detailed guidance on what exactly SBA wants lenders to document in their credit elsewhere determinations, lenders likely will continue to offer limited information in their files, making meaningful oversight of compliance with the credit elsewhere requirement difficult.