Small Business Administration:

Actions Needed to Ensure Planned Improvements Address Key Requirements of the Development Company (504) Loan Program

GAO-14-233: Published: Mar 6, 2014. Publicly Released: Apr 7, 2014.

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William B. Shear
(202) 512-8678
shearw@gao.gov

 

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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.

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 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.

For more information, contact William B. Shear at (202) 512-8678 or shearw@gao.gov.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In response to our recommendation, SBA issued an information notice in February 2016 on certified development company (CDC) reporting of job creation and retention. The purpose of the notice is to clarify previous guidance concerning CDC reporting of job creation and retention as a result of a 504 project. In the notice, SBA defines jobs created and retained and provides examples of how to calculate them. Taking these steps should help SBA ensure that CDC information on jobs supported is consistent and accurate.

    Recommendation: To help ensure that CDCs are meeting the 504 loan program's jobs-supported requirement, the SBA Administrator should develop specific guidance on how CDCs should compile information on jobs created or retained and on the documentation CDCs should maintain to support these data.

    Agency Affected: Small Business Administration

  2. Status: Closed - Implemented

    Comments: In response to our recommendation, SBA instituted a process to assess the supporting documentation for a sample of the jobs data that certified development companies (CDC) report and communicated the process to staff in December 2015. Specifically, during the annual report review process, SBA staff plan to select five loans that have reached the 2-year anniversary of the funding of the debenture and request supporting documentation from each CDC. CDCs are to be notified by email of the five loans selected and are required to provide the supporting documentation within one week of the request. For supporting documentation, CDCs must provide written confirmation from the borrowers on the borrowers' letterheads or copies of email confirmations received from selected borrowers. In addition to describing the new process, SBA provided a diagram outlining the process and an example of a request for documentation from a CDC. Taking these steps should help SBA ensure that CDC information on jobs supported is consistent and accurate.

    Recommendation: To help ensure that CDCs are meeting the 504 loan program's jobs-supported requirement, when reviewing CDCs' annual reports, the SBA Administrator should implement a process to assess the supporting documentation for a sample of the jobs data that CDCs report.

    Agency Affected: Small Business Administration

  3. Status: Closed - Implemented

    Comments: In response to our recommendation, SBA has included a requirement to review supporting documentation on the number of jobs created or retained by 504 loan projects in its revised risk-based review procedures. Specifically, in June 2015, SBA provided a template for off-site reviews of certified development companies (CDC) that calls for SBA staff to review documentation on five loans to assess the sufficiency of jobs documentation. In addition, the template for on-site reviews calls for examiners to review a larger sample of loans to determine if the jobs created/retained report provided by the CDC in its last annual report appeared to be accurate. The checklist used when reviewing these loans requires examiners to determine whether (1) the CDC obtained documentation from the borrower supporting the number of jobs created and/or retained at the two year anniversary of the loan and (2) the documentation of jobs created and/or retained provided supports the job numbers at the two year anniversary of the loan that was reported by the CDC in its annual report. Taking these steps should help SBA ensure that the data that CDCs report on jobs created and retained by 504 loan projects are accurate.

    Recommendation: To help ensure that CDCs are meeting the 504 loan program's jobs-supported requirement, when finalizing the agency's risk-based review procedures, the SBA Administrator should include in the checklists or guidance for examiners a requirement to review supporting documentation on the number of jobs created or retained by 504 loan projects.

    Agency Affected: Small Business Administration

  4. Status: Closed - Implemented

    Comments: In response to our recommendation, SBA revised its annual report review template in February 2016. Questions that SBA staff must answer on the new template include whether the certified development company (CDC) invests in other economic activity and whether the level of investment is satisfactory to SBA. In addition, staff are to record whether the CDC meets the requirement for investment in local economic development and the dollar value of other economic investment in a database. Taking these steps should help SBA ensure that CDCs are supporting economic development activities as required.

    Recommendation: To help ensure that CDCs are meeting the 504 loan program's requirement that CDCs invest retained earnings in local economic development, when reviewing CDCs' annual reports, the SBA Administrator should add an item to its annual report review template requiring SBA staff to assess compliance with this requirement.

    Agency Affected: Small Business Administration

  5. Status: Closed - Implemented

    Comments: In response to our recommendation, SBA has included a requirement in its revised risk-based review procedures to review compliance with the retained-earnings requirement. Specifically, in February 2016, SBA provided excerpts from templates for off-site and full reviews of certified development companies (CDC) that call for SBA staff to describe the CDC's level of investment in other local economic development activity in its area of operations and list a sampling of local economic development activities. The templates also call for staff to assess whether the CDC has demonstrated commitment to and compliance with its mission and SBA loan program requirements for community economic development and the encouragement of job creation. Taking these steps should help SBA ensure that CDCs are supporting economic development activities as required.

    Recommendation: To help ensure that CDCs are meeting the 504 loan program's requirement that CDCs invest retained earnings in local economic development, when finalizing the agency's risk-based review procedures, the SBA Administrator should include in the checklists or guidance for examiners a requirement to review compliance with the retained-earnings requirement.

    Agency Affected: Small Business Administration

  6. Status: Closed - Implemented

    Comments: In response, SBA provided documentation in February 2016 showing that it had updated its Accredited Lenders Program (ALP) renewal process. In documentation outlining aspects of the ALP renewal process, SBA stated that if the certified development company (CDC) being reviewed for ALP renewal has an early problem loan rate (calculated using the most recent quarterly data available to SBA) higher than the portfolio average, the CDC is to be subject to testing of its no adverse change determination on a random sample of its early problem loans. (Early problem loans are loans that have had a deferred, delinquent (60 or more days past due), catch up, purchase, or charged off status within 18 months of disbursement.) One exception to this approach is if the CDC has been subject to a risk-based review issued within the previous 12 months that reviewed the CDC's no adverse change determination for a sample of loan files. SBA also provided an example of a letter requesting early problem loans to review and a letter outlining the results of such a review. Taking these steps should help SBA ensure that CDCs are in compliance with SBA credit analysis requirements established to help protect against default risk.

    Recommendation: To help ensure that CDCs with Accredited Lenders Program (ALP) authority are taking the necessary steps to determine whether there has been no adverse change to borrowers' financial condition prior to loan closing, the SBA Administrator should include oversight of CDCs' compliance with this requirement in the agency's process for renewing ALP authority.

    Agency Affected: Small Business Administration

 

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