In addition, lenders must certify that small businesses meet  the “credit elsewhere” requirement. SBA describes the 7(a)  program as contributing to an agencywide goal to “increase small business  success by bridging competitive opportunity gaps facing entrepreneurs.”  As reported annually in SBA’s Performance and Accountability Reports  (PAR), the 7(a) program contributes to this strategic goal by fulfilling each  of the following three long-term, agencywide objectives:  increasing the positive impact of SBA assistance on the number and  success of small business start-ups,   maximizing the sustainability and growth of existing small businesses that  receive SBA assistance, and   significantly increasing successful small business ownership within  segments of society that face special competitive opportunity gaps. In  recognizing the difficulty of estimating credit subsidy costs and  acknowledging that the eventual cost of the program may deviate from  initial estimates, FCRA requires agencies to make annual revisions  (reestimates) of credit subsidy costs for each cohort of loans made during  a given fiscal year using new information about loan performance, revised  expectations for future economic conditions and loan performance, and  improvements in cash flow projection methods. The 7(a) Program’s Policy Objectives Reflect Legislative History, but Its Performance Measures Do Not Gauge the Program’s Impact on Participating Firms

The legislative basis for the 7(a) program recognizes that the conventional  lending market is the principal source of financing for small businesses  and that the loan assistance that SBA provides is intended to supplement  rather than compete with that market. Outcome-based goals or measures showing a  program’s impact on those it serves should be included in an agency’s  performance plan whenever possible. However, all of the 7(a) program’s  performance measures are primarily output measures. Limited Evidence Suggests That Certain Market Imperfections May Restrict Access to Credit for Some Small Businesses

We found limited information from economic studies that credit  constraints such as credit rationing could have some effect on small  businesses in the conventional lending market. This study’s results suggested that firms  with longer relationships received more favorable terms—for instance,  they were less likely to have to provide collateral. However, the studies we reviewed regarding credit rationing used data  from the early 1970s through the early 1990s and thus did not account for  several recent trends that may have impacted, either positively or  negatively, the extent of credit rationing within the small business lending  market. A Higher Percentage of 7(a) Loans Went to Certain Segments of the Small Business Lending Market, but Conventional Loans Were Widely Available

Certain segments of the small business lending market received a higher  share of 7(a) loans than of conventional loans between 2001 to 2004,  including minority-owned businesses and start-up firms. For example, 22 percent of all 7(a) loans went to small women-owned  firms, compared with an estimated 16 percent of conventional loans that  went to these firms. Also, similar proportions of 7(a)  and conventional loans went to small businesses with different types of  organizational structures and in different geographic locations. SBA officials said that based on  analyses of these scores, the difference in the repayment risk of lending  associated with 7(a) loans was higher than the risk posed by small firms  able to access credit in the conventional lending market. Nearly 90 percent of  7(a) loans had variable rates compared with an estimated 43 percent of  conventional loans, and almost 80 percent of 7(a) loans had maturities of  more than 5 years, compared with an estimated 17 percent of conventional  loans (fig. Loan guarantees can result in subsidy costs to the federal  government, and the Federal Credit Reform Act of 1990 (FCRA) requires,  among other things, that agencies estimate the cost of the loan guarantees  to the federal government and revise its estimates (reestimate) those costs  annually as new information becomes available. As  we have seen, the original credit subsidy cost that SBA estimated for fiscal  years 2005 and 2006 was zero, making the 7(a) program a “zero credit  subsidy” program—that is, the program no longer required annual  appropriations of budget authority. Since the 7(a) program primarily provides variable rate  loans, changes in the prevailing interest rates would result in higher or  lower loan payments, affecting borrowers’ ability to pay and subsequently  influencing default and prepayment rates.
Why GAO Did This Study

The Small Business Administration's (SBA) 7(a) program, initially established in 1953, provides loan guarantees to small businesses that cannot obtain credit in the conventional lending market. In fiscal year 2006, the program assisted more than 80,000 businesses with loan guarantees of nearly $14 billion. This testimony, based on a 2007 report, discusses (1) the 7(a) program's purpose and the performance measures SBA uses to assess the program's results; (2) evidence of any market constraints that may affect small businesses' access to credit in the conventional lending market; (3) the segments of the small business lending market that were served by 7(a) loans and the segments that were served by conventional loans; and (4) 7(a) program's credit subsidy costs and the factors that may cause uncertainty about these costs.

What GAO Found

As the 7(a) program's underlying statutes and legislative history suggest, the loan program's purpose is intended to help small businesses obtain credit. The 7(a) program's design reflects this legislative history, but the program's performance measures provide limited information about the impact of the loans on participating small businesses. As a result, the current performance measures do not indicate how well SBA is meeting its strategic goal of helping small businesses succeed. The agency is currently undertaking efforts to develop additional, outcome-based performance measures for the 7(a) program, but agency officials said that it was not clear when they might be introduced or what they might measure. Limited evidence from economic studies suggests that some small businesses may face constraints in accessing credit because of imperfections such as credit rationing, in the conventional lending market. Several studies GAO reviewed generally concluded that credit rationing was more likely to affect small businesses because lenders could face challenges in obtaining enough information on these businesses to assess their risk. However, the studies on credit rationing were limited, in part, because the literature relies on data from the early 1970s through the early 1990s, which do not account for recent trends in the small business lending market, such as the increasing use of credit scores. Though researchers have noted disparities in lending options among different races and genders, inconclusive evidence exists as to whether discrimination explains these differences. 7(a) loans went to certain segments of the small business lending market in higher proportions than conventional loans. For example, from 2001 to 2004 25 percent of 7(a) loans went to small business start-ups compared to an estimated 5 percent of conventional loan. More similar percentages of 7(a) and conventional loans went to other market segments; 22 percent of 7(a) loans went to women-owned firms in comparison to an estimated 16 percent of conventional loans. The characteristics of 7(a) and conventional loans differed in several key respects: 7(a) loans typically were larger and more likely to have variable rates, longer maturities, and higher interest rates. SBA's most recent reestimates of the credit subsidy costs for 7(a) loans made during fiscal years 1992 through 2004 indicate that, in general, the long-term costs of these loans would be lower than initially estimated. SBA makes its best initial estimate of the 7(a) program's credit subsidy costs and revises the estimate annually as new information becomes available. In fiscal years 2005 and 2006, SBA estimated that the credit subsidy cost of the 7(a) program would be equal to zero--that is, the program would no longer require annual appropriations of budget authority--by, in part, adjusting fees paid by lenders. However, the most recent reestimates, including those made since 2005, may change because of the inherent uncertainties of forecasting subsidy costs and the influence of economic conditions such as interest rates on several factors, including loan defaults and prepayment rates.