Because the 7(a) program is required to serve borrowers who cannot  obtain conventional credit at reasonable terms, lenders making 7(a) loans  must take steps to ensure that borrowers meet the program’s credit  elsewhere requirement. The 7(a) program accounts for a small portion of total small business  lending. 3). In fiscal year 2016, SBA conducted 40 on-site  reviews of 7(a) lenders, representing approximately 35 percent of SBA’s  total outstanding 7(a) loan portfolio. For example, 4 reviews found that for at  least one loan reviewed, “the Lender failed to document justification that  credit was unavailable elsewhere.” Another review found that for “three  SBA Express loans and one Small Loan Advantage loan   reported “other factors relating to the credit that in the lender’s opinion  cannot be overcome except for the guaranty’ without specific identification  of the factors.”

		Lack of Internal Controls Led to Lender Noncompliance, but Were Not Documented by SBA’s Reviews

Based on our review of on-site review reports and an interview with one  reviewer, the key factors underlying lenders’ high rate of noncompliance  with the credit elsewhere documentation requirement were lenders’ lack  of proper internal controls and procedures and lack of awareness of the  credit elsewhere documentation requirement. For example, one lender was required to “correct its policy,  modify its procedure, and amend its internal controls to ensure that its  consideration and documentation of credit unavailable elsewhere  identifies the specific fact(s) which are applicable to the specific loan and  the determination is rendered and accurate for each individual SBA loan  that it originates.” Another lender was required to “improve underwriting  processes and controls to ensure that the borrower meets the [credit  elsewhere] requirement” and to “document the loan file with the reasons  for the determination.”
Similarly, for the six targeted reviews in 2016 that included corrective  actions, SBA issued a general requirement for the lender to “identify the  causes for the Findings and implement corrective actions.” Based on our  review of these targeted reviews, lenders generally remedied or intended  to remedy the issue by amending their internal controls or procedures. Federal internal control standards state that management should design  control activities to achieve objectives and respond to risks, including  appropriate documentation of transactions and internal control. Because  SBA does not require reviewers to document their assessment of lenders’  policies and practices for complying with the credit elsewhere  documentation requirement, the agency does not have good information  to help explain why so many lenders are not in compliance. For its on-site reviews, SBA does not collect sample  data on lenders’ use of the credit elsewhere criteria. Federal internal control standards state that management should use  quality information to achieve the entity’s objectives. Representatives of these lenders also agreed that  the criteria generally serve the types of small businesses that would  otherwise have trouble obtaining conventional credit, such as new  businesses or those with a shortage of collateral. Conclusions

SBA’s 7(a) loan program is required to serve creditworthy small business  borrowers who cannot obtain credit through a conventional lender at  reasonable terms, and SBA largely relies on lenders with delegated  authority to make credit elsewhere determinations. Without better information from lender reviews on  how lenders are implementing the requirement to document their credit  elsewhere decisions, SBA may be limited in its ability to promote  compliance with requirements and, in turn, use such information to help  ensure that 7(a) loans are reaching their target population. Furthermore, SBA does not routinely collect or analyze information on the  criteria used for credit elsewhere justifications to evaluate patterns in  lender practices. SBA recently began collecting some information on  lenders’ use of the criteria, but this information is limited, and SBA does  not analyze the information that it does collect to better understand  lenders’ practices. Without more robust information and analysis, SBA  may be limited in its ability to understand how lenders are using the credit  elsewhere criteria and whether 7(a) loans are reaching borrowers who  cannot obtain credit from other sources at reasonable terms. SBA generally agreed with the  recommendations. We revised the  Highlights by adding that SBA provides oversight to the on-site  reviews conducted by third-party contractors. As a result, we did not revise the footnote. GAO staff who made key contributions to this  report are listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

This report discusses (1) 7(a) lending to selected categories of small  business borrowers from fiscal years 2007 through 2016; (2) how the  Small Business Administration (SBA) monitors lenders’ compliance with  the credit elsewhere requirement; (3) the extent to which SBA evaluates  trends in lender practices related to the credit elsewhere requirement; and  (4) lenders’ views on the criteria used to determine eligibility for 7(a) loans  and other issues related to the 7(a) program. To assess how SBA monitors lenders’ compliance with the credit  elsewhere requirement and criteria, we reviewed SBA’s standard  operating procedures and other guidance on 7(a) program regulations  and lender oversight. Nine of the banks were selected by us  using a random process that concentrated on larger lenders.
Why GAO Did This Study

SBA's 7(a) program is required to serve creditworthy small business borrowers who cannot obtain credit through a conventional lender at reasonable terms. The Joint Explanatory Statement of the Consolidated Appropriations Act, 2017 includes a provision for GAO to review the 7(a) program.
This report discusses, among other things, (1) how SBA monitors lenders' compliance with the credit elsewhere requirement, (2) the extent to which SBA evaluates trends in lender credit elsewhere practices, and (3) lenders' views on the credit elsewhere criteria for 7(a) loans.
GAO analyzed SBA data on 7(a) loans approved for fiscal years 2007–2016, the latest available, and reviewed literature on small business lending; reviewed standard operating procedures, other guidance, and findings from SBA reviews performed in fiscal year 2016; and interviewed lender associations and a nonrepresentative sample of 7(a) lenders selected that concentrated on larger lenders.

What GAO Found

For its 7(a) loan program, the Small Business Administration (SBA) has largely delegated authority to lenders to make 7(a) loan determinations for those borrowers who cannot obtain conventional credit at reasonable terms elsewhere. To monitor lender compliance with the “credit elsewhere” requirement SBA primarily uses on-site reviews conducted by third-party contractors with SBA participation and oversight, and other reviews. According to SBA guidance, lenders making 7(a) loans must take steps to ensure and document that borrowers meet the program's credit elsewhere requirement. However, GAO noted a number of concerns with SBA's monitoring efforts. Specifically, GAO found the following:
Over 40 percent (17 of 40) of the on-site lender reviews performed in fiscal year 2016 identified lender noncompliance with the requirement.
On-site reviewers identified several factors, such as weakness in lenders' internal control processes that were the cause for lender noncompliance.
Most on-site reviewers did not document their assessment of lenders' policies or procedures, because SBA does not require them to do so. As a result SBA does not have information that could help explain the high noncompliance rate.
Federal internal control standards state that management should design control activities, including appropriate documentation, and use quality information to achieve the entity's objectives. Without better information on lenders' procedures for complying with the documentation requirement, SBA may be limited in its ability to promote compliance with requirements designed to help ensure that the 7(a) program reaches its target population.
SBA does not routinely collect or analyze information on the criteria used by lenders for credit elsewhere justifications. SBA recently began collecting some information on lenders' use of the criteria, but this information is limited, and SBA does not analyze the information that it does collect to better understand lenders' practices. Federal internal control standards state that management should use quality information to achieve the entity's objectives. Without more robust information and analysis, SBA may be limited in its ability to understand how lenders are using the credit elsewhere criteria and identify patterns of use by certain lenders that place them at a higher risk of not reaching borrowers who cannot obtain credit from other sources at reasonable terms.
In general, representatives from 8 of 11 lenders that GAO interviewed stated that SBA's credit elsewhere criteria are adequate for determining small business eligibility for the 7(a) program. These criteria help them target their lending to small businesses that would otherwise have difficulty obtaining conventional credit because they are often new businesses or have a shortage of collateral. However, they also said that other factors—such as lender policies and economic conditions—can affect their decisions to offer 7(a) loans. In January 2018, SBA issued revised guidance for the 7(a) program and has provided training on this new guidance to lenders and trade associations. Lenders told GAO they are still in the process of understanding the new requirements.

What GAO Recommends

GAO recommends that SBA (1) require its on-site reviewers to document their assessment of lenders' policies and procedures related to the credit elsewhere documentation requirement, (2) collect information on lenders' use of credit elsewhere criteria, and (3) analyze that information to identify trends. SBA generally agreed with the recommendations.