The 504 loan program provides long-term, fixed-rate financing to new or  growing small businesses for fixed assets such as owner-occupied real  estate or long-term equipment and machinery. CDCs are generally nonprofit corporations that provide  funding to small businesses in order to contribute to economic  development within their communities. SBA Lending Standards Address 504 Requirements and Default Risk, but SBA Lacks Guidance on Determining Jobs Supported

SBA has established lending standards and guidance for CDCs that  address 504 program requirements and protect against default risk. Without clear  and specific guidance on compiling jobs supported data, SBA cannot  ensure that CDCs are compiling and supporting this information  consistently and in accordance with SBA’s expectations. Loans approved in fiscal year  2007 experienced the highest 18-month default rate at 4.9 percent. SBA Reviews CDC Eligibility and Loan Applications, but Does Not Confirm Compliance with Some Requirements

SBA has processes to review CDCs’ eligibility to participate in the 504  loan program but, as previously mentioned, does not require or examine  support for CDC-reported data on jobs created or retained. SBA Reviews CDC Eligibility, but Does Not Confirm Compliance with Jobs-Supported and Retained-Earnings Requirements

SBA has established a process for approving CDCs to participate in the  504 loan program, which includes a probationary period. However, federal internal control  standards require that federal agencies have control activities in place,  such as verification, to ensure compliance with key program  requirements. According to SBA officials,  SBA rarely declines to close a debenture. They also are to be used to assess CDCs for  renewal of their ALP authority. Creating and retaining jobs is a key economic  development goal of the 504 program. Further, SBA’s current  annual report review and risk-based review guidance do not require SBA  staff to request and review supporting documentation for CDC-reported  data on jobs supported or assess compliance with the requirement that  CDCs invest retained earnings in local economic development. Federal  internal control standards require agencies to establish control activities  to ensure that program participants report information accurately and  comply with requirements. Without developing guidance for CDCs and  reviewing at least some documentation on jobs data and compliance with  the retained-earnings requirement, SBA cannot be assured that self- reported information on jobs supported is consistent and accurate and  that CDCs are following program requirements. In addition, while SBA has established multiple reviews for 504 loan  applications, the agency does not verify certifications made by CDCs with  ALP authority that borrowers are still able to repay a 504 loan at loan  closing, which can take place years after the loan was initially approved. To help ensure that CDCs with ALP authority are taking the necessary  steps to determine whether there has been no adverse change to  borrowers’ financial condition prior to loan closing, we recommend that  the SBA Administrator include oversight of CDCs’ compliance with this  requirement in the agency’s process for renewing ALP authority. SBA  generally agreed with our recommendations and outlined steps it plans to  take to address them. In response to our recommendations regarding the  504 loan program’s jobs-supported requirement, SBA stated that it will (1)  work to provide guidance on the compilation of job creation and retention  information and document maintenance requirements and (2) consider  ways to phase in the implementation of jobs data sampling and review of  supporting documentation in its annual report and risk-based reviews. As noted in the report, a  504 loan is not closed until after project-related construction is complete,  which can be up to 4 years after initial approval. Appendix I: Objectives, Scope, and Methodology

Our objectives were to examine (1) the lending standards and  performance indicators that the Small Business Administration (SBA) has  established to help ensure that loans meet key requirements, as well as  504 loan program performance, (2) the extent to which SBA has  implemented procedures to help ensure that certified development  companies (CDC) are eligible to participate in the program and that loan  applications comply with program requirements, and (3) the extent to  which SBA has implemented procedures to monitor CDC compliance with  program requirements. We selected these CDCs to ensure a range of CDCs  based on factors such as size and geographic location. We  also reviewed SBA’s annual performance reports for fiscal years 2010  through 2012 to identify SBA’s performance measures for the 504 loan  program and assessed whether they addressed the program’s economic  development goals and were consistent with GAO standards for  performance measurement. Finally, we  compared SBA compliance processes to federal internal control  standards.
Why GAO Did This Study

Title V of the Small Business Investment Act of 1958 established what is commonly referred to as the “504 loan program” to provide small businesses with financing for long-term fixed assets, such as land and buildings. SBA oversees the program, and about 270 CDCs issue “504 loans” that generally cover up to 40 percent of project costs. The program aims to encourage economic development primarily by enabling small businesses to create or retain jobs within their communities. This report examines (1) the lending standards and performance measures SBA has established to help ensure that loans meet key requirements, as well as 504 loan performance, and (2) SBA's processes for reviewing CDCs' eligibility to participate in the program, loan applications, and CDCs' compliance with program requirements. GAO analyzed SBA data, SBA's lending standards and compliance process documentation, and interviewed SBA officials and 10 CDCs selected based on factors such as size and location.

What GAO Found

The Small Business Administration (SBA) has established lending standards to protect against default and has measured program performance, but lacks guidance on determining the number of jobs supported by 504 program-funded projects. SBA's guidance for certified development companies (CDC)—nonprofits that provide funding to small businesses to promote local economic development in their communities and are certified by SBA—includes credit underwriting standards for determining ability to repay. SBA also has established performance indicators—such as the number of small businesses assisted and jobs supported—for the 504 loan program. However, SBA does not describe how CDCs should calculate jobs created and retained by 504 projects, a key program requirement. Federal internal control standards require control activities that help participants report information accurately. Without specific guidance, SBA cannot ensure that CDCs are calculating this information consistently or accurately. GAO's analysis of SBA data showed that 504 loans approved in fiscal years 2006 through 2008 had the highest 18-month default rates, which correlated with trends in the private sector for commercial real estate loans.
SBA has processes to review (1) CDCs' eligibility to participate in the 504 program, (2) loan applications, and (3) CDCs' compliance with program requirements. The agency is revising some of these processes and expects to finalize the changes by June 2014. However, GAO identified two key areas where additional improvement is needed:
Jobs supported and retained earnings . SBA has guidance for reviewing CDCs' annual reports (used to assess CDC eligibility) and for risk-based reviews of CDCs' compliance with program requirements. However, this guidance does not require SBA staff to review supporting documentation on jobs supported or assess whether CDCs are investing retained earnings in local economic development, as required by regulation. Federal internal control standards require control activities to ensure that program participants report information accurately and comply with requirements. Without reviewing CDCs' information on jobs data and compliance with the retained-earnings requirement, SBA cannot be assured that information on jobs supported is accurate and CDCs are supporting economic development activities as required.
Certification by CDCs with delegated authority . SBA provides initial approval for a 504 loan upon application, but the 504 loan is not closed until after project-related construction is complete (which can be up to 4 years after initial approval). SBA has delegated to certain CDCs additional authority to close a 504 loan. For example, at closing CDCs with this delegated authority can certify that borrowers are still able to repay a 504 loan rather than submit documentation to SBA for approval, as regular CDCs are required to do. SBA renews delegated authority periodically but does not verify that CDCs can support these certifications. Federal internal control standards require agencies to verify compliance with requirements. Without verifying these certifications, SBA lacks assurance that CDCs with delegated authority are following program requirements.

What GAO Recommends

GAO recommends that SBA issue guidance on calculating jobs created and retained, expand its review of CDCs' annual reports and risk-based reviews of selected CDCs to include assessment of data on jobs supported and compliance with the retained- earnings requirement, and expand its process for renewing the delegated authority of certain CDCs to include a review of CDCs' certifications of borrowers' ability to repay made prior to loan closing. SBA generally agreed with the recommendations and outlined steps it plans to take in response.