New GAO Report on SBA “Credit Elsewhere” Rules

June 20, 2018

On June 5, 2018 the U.S. Government Accountability Office (GAO) reported the results of a nearly year-long review of the U.S. Small Business Administration’s (SBA) 7(a) Loan Guarantee Program. The 7(a) program is SBA’s flagship lending program that helps entrepreneurs and small businesses access credit to start and grow their businesses where they otherwise wouldn’t be able to through traditional lending avenues.

Following the continual growth of the 7(a) program, Congress commissioned the GAO to conduct a thorough study of the compliance standards SBA lenders follow for ensuring 7(a) loans are offered to the businesses which need them. The SBA requires its 7(a) lenders to document and verify that borrowers meet the program’s “credit elsewhere” requirement, meaning the  borrower is unable  to obtain some or all of the requested loan funds from non-SBA  sources without causing undue hardship. This requirement is in place to ensure SBA-backed loans are used as a “lender of last resort” instead of banks routing loans through the SBA program to reduce their lending risks.

The report was authorized to identify how SBA monitors lenders’ compliance with the credit elsewhere requirement and the extent to which SBA evaluates trends in lender credit elsewhere practices, among other things. Thus, GAO analyzed the latest available data on approved 7(a) loans from 2007-2016, interviewed lenders, and reviewed the administration’s procedures for the internal oversight of lender compliance with the eligibility requirements of the 7(a) program. A copy of the report can be found here.

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, along with other reviews. GAO, however, noted a number of concerns with the oversight process by the SBA:

  • 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.

GAO found that the SBA does not routinely collect or analyze information on the criteria used by lenders for credit elsewhere justifications—meaning, without better information on lender’s procedures, SBA may be limited in its ability to promote compliance with the requirements designed to ensure 7(a) loans are reaching the necessary small businesses. Noncompliance with the provision means that capital-starved small businesses could be crowded out of the 7(a) Loan Program by companies which may be able to find the same funding elsewhere.

GAO suggested SBA document and track lender compliance with the requirement in the future, ensuring borrowers do meet the credit elsewhere criteria and are in need of SBA financing to grow and run their businesses. A bill to address deficiencies in the SBA 7(a) Loan Program, -the Small Business 7(a) Lending Oversight Reform Act of 2018 (H..R. 4743), currently awaits the President’s signature, and would directly focus on some of the concerns found in this report. The bill would give the SBA the tools it needs to run the program more efficiently and effectively, while continuing to provide the financing that entrepreneurs need in order to build and grow their businesses. More information on the bill can be found here.

As NSBA found, for one-quarter of small U.S. firms, financing still remains elusive, and SBA loans through the 7(a) program are a crucial resource in small-business access to capital. The SBA needs to ensure these loans are going to those businesses which directly depend on them, and not those which can find reasonable access to capital elsewhere. As SBA programs continue to grow, the combination of this study and the Small Business 7(a) Lending Oversight Reform Act of 2018 begins a shift toward increased oversight from the SBA over lenders in the 7(a) program.