B-140673, DEC 3, 1974

B-140673, DEC 3, 1974

GAO WOULD NOT OBJECT TO SBA REPURCHASE OF SBA-GUARANTEED PORTION OF LOAN ISSUED PURSUANT TO SECTION 7(A) OF THE SMALL BUSINESS ACT, 15 U.S.C. SEC. 636(A), FROM INNOCENT HOLDER WHEN BORROWER HAS NOT DEFAULTED BUT PRIMARY LENDER HAS FAILED TO FORWARD BORROWER'S PAYMENTS TO HOLDER IN VIEW OF BROAD AUTHORITY AND DISCRETION OF ADMINISTRATOR UNDER SECTION 5(B)(7) OF THE SMALL BUSINESS ACT, 15 U.S.C. SEC. 634(B)(7), AND SECTION 7(A), STATUTORY PROVISIONS FOR PARTICIPATION BY PRIVATE LENDING INSTITUTIONS CONTAINED IN SECTION 7(A)(2) OF SMALL BUSINESS ACT, 15 U.S.C. SEC. 636(A)(2), AND PROTECTION OF GOVERNMENTAL INTERESTS BY MONITORING PRIMARY LENDER PERFORMANCE AND SBA'S ULTIMATE RECOURSE AGAINST PRIMARY LENDER.

DEGREE OF RISK UNDERTAKEN BY THE SBA IN CARRYING OUT ITS FUNCTIONS UNDER THE SMALL BUSINESS LOAN GUARANTEE PROGRAM:

BY LETTER DATED NOVEMBER 13, 1974, THE ADMINISTRATOR, SMALL BUSINESS ADMINISTRATION (SBA), REQUESTED OUR CONCURRENCE IN HIS OPINION REGARDING THE DEGREE OF RISK WHICH MAY BE UNDERTAKEN BY THE SBA IN CARRYING OUT ITS FUNCTIONS UNDER THE LOAN GUARANTEE PROGRAM CONDUCTED PURSUANT TO SECTION 7(A) OF THE SMALL BUSINESS ACT, 15 U.S.C. SEC. 636(A).

UNDER THE SBA'S LOAN GUARANTEE PROGRAM, LENDING INSTITUTIONS MAKE LOANS TO SMALL BUSINESS CONCERNS WITH SBA'S GUARANTEE, WHICH MAY COVER UP TO 90% OF THE OUTSTANDING BALANCE OF THE LOAN. THERE IS A SECONDARY MARKET FOR THE SBA-GUARANTEED PORTION OF THESE LOANS, BY WHICH BANKS SELL NOTES REPRESENTING THE SBA-GUARANTEED PORTION TO MUTUAL FUNDS, PENSION FUNDS, ETC. THIS ASSIGNMENT OF THE LOANS IS ACCOMPLISHED BY MEANS OF A TRIPARTITE AGREEMENT BETWEEN THE PARTICIPATING LENDER, THE PURCHASER OF THE GUARANTEED PORTION AND THE SBA.

THE AGREEMENT PROVIDES, AMONG OTHER THINGS, THAT THE LENDER SHALL CONTINUE TO SERVICE THE LOAN FOR A FIXED FEE AND SHALL REMIT TO THE PURCHASER ALL PAYMENTS ON THE LOAN, LESS ONLY THE LENDER'S SERVICING FEE. IT STATES THAT IF THE BORROWER SHALL BE IN AN UNCURED DEFAULT FOR 60 DAYS OR MORE, THE LENDER WILL REPURCHASE THE PRO RATA SHARE OF THE UNPAID PRINCIPAL AND INTEREST ATTRIBUTABLE TO THE PURCHASER PORTION OF THE LOAN. THE AGREEMENT FURTHER PROVIDES THAT IF THE LENDER DOES NOT REPURCHASE THE GUARANTEED PORTION, THE SBA WILL REPURCHASE IT AND PAY DIRECTLY TO THE PURCHASER THE UNPAID PRINCIPAL AND INTEREST ATTRIBUTABLE TO HIS SHARE OF THE LOAN.

IN 51 COMP. GEN. 474 (1972), THE COMPTROLLER GENERAL APPROVED THE SBA'S REPURCHASE FROM A SECONDARY HOLDER OF AN SBA-GUARANTEED LOAN NOTE UPON THE BORROWER'S DEFAULT, EVEN WHERE THE SBA HAS KNOWLEDGE OF THE POSSIBILITY OF NEGLIGENCE, FRAUD, OR MISREPRESENTATION ON THE PART OF THE BANK WHICH MADE THE LOAN, PROVIDED THE PRESENT HOLDER OF THE NOTE DID NOT PARTICIPATE IN AND WAS NOT AWARE OF SUCH NEGLIGENCE, FRAUD OR MISREPRESENTATION AT THE TIME IT PURCHASED THE NOTE FROM THE BANK. AT PRESENT, THE SBA'S GUARANTEE TO REPURCHASE DOES NOT APPLY IN THOSE CIRCUMSTANCES WHERE THE BORROWER MAKES PAYMENTS AS REQUIRED, BUT THE LENDER FAILS TO FORWARD THEM OR OTHERWISE PAY THE PURCHASER.

THE CHIEF COUNSEL, DIVISION OF CORPORATION FINANCE, SECURITIES AND EXCHANGE COMMISSION, BY LETTER DATED OCTOBER 9, 1974, INFORMED THE ADMINISTRATOR OF THE SBA OF THAT DIVISION'S DETERMINATION THAT THE SBA GUARANTEED PORTIONS OF SMALL BUSINESS LOANS, WHICH ARE SUBJECT TO SALE OR ASSIGNMENT, AS WELL AS ANY INTERESTS IN SUCH FRACTIONAL PARTS, ARE "SECURITIES" WITHIN THE MEANING OF SECTION 2(1) OF THE SECURITIES ACT OF 1933, 15 U.S.C. SEC. 776, FOR WHICH THE "GOVERNMENT" EXEMPTION OF SECTION 3(A)(2) OF THE SECURITIES ACT OF 1933, 15 U.S.C. SEC. 77CA)(2), IS NOT AVAILABLE. THE LETTER STATED THAT:

"*** OUR VIEW IN THIS REGARD IS BASED ON THE FACT THAT THE SBA'S GUARANTEE, ALTHOUGH APPARENTLY BACKED BY THE U.S. GOVERNMENT'S FULL FAITH AND CREDIT, WOULD NOT BE OPERABLE IN THOSE INSTANCES WHERE A LENDER FAILED TO PASS THROUGH TO THE PURCHASER ALL PAYMENTS RECEIVED FROM THE BORROWER. IN ORDER FOR THE 3(A)(2) EXEMPTION FOR GOVERNMENT GUARANTEED SECURITIES TO BE AVAILABLE, THE GUARANTEE MUST COMPLETELY PROTECT THE PURCHASER IN ALL CIRCUMSTANCES. SINCE THE PURCHASER WOULD NOT BE FULLY PROTECTED BY THE SBA'S GUARANTEE, AS INDICATED ABOVE, THE EXEMPTION WOULD NOT BE AVAILABLE."

THE ADMINISTRATOR ADVISES US THAT THE SECURITY REGISTRATION REQUIREMENTS OF THE SECURITIES ACT OF 1933 ARE IMPRACTICAL FOR SBA GUARANTEED NOTES, AND THAT UNLESS THE SBA CAN COMPLY WITH THE "GOVERNMENT" EXEMPTION, THE ABILITY OF THE PRIMARY LENDERS TO RESELL THE NOTES WILL BE SO LIMITED AS TO SERIOUSLY INHIBIT SECONDARY MARKET OPERATIONS.

THE ADMINISTRATOR STATES THAT THE SECONDARY MARKET IS ESSENTIAL TO THE ACTIVITIES OF PRIMARY LENDERS, AND THAT ITS IMPAIRMENT WILL DRASTICALLY CURTAIL THE GUARANTEE LOAN PROGRAM, WHICH IN FISCAL YEAR 1974 INVOLVED $1,653 MILLION, REPRESENTING 96% OF THE ENTIRE BUSINESS LOAN PROGRAM. THE ADMINISTRATOR THEREFORE SEEKS APPROVAL OF SBA PLANS TO REPURCHASE THE SBA- GUARANTEED PORTION OF SPONSORED LOANS FROM INNOCENT HOLDERS WHERE THE BORROWER IS NOT IN DEFAULT, BUT THE PAYMENTS HAVE BEEN NEGLIGENTLY OR UNLAWFULLY WITHHELD BY THE PRIMARY LENDER.

THE LETTER OF NOVEMBER 13, 1974, STATES THAT:

"WE ANTICIPATE THAT THE COST TO THE GOVERNMENT OF SUCH AN IMPROVED SBA GUARANTY WILL NOT BE SIGNIFICANT. IN THE FIVE YEARS ENDING JUNE 30, 1974, APPROXIMATELY $250 MILLION OF SBA-GUARANTEED LOANS HAVE BEEN TRANSFERRED FROM PRIMARY LENDERS TO SECONDARY PARTICIPANTS. ALTHOUGH APPROXIMATELY 2500 TRANSACTIONS WERE INVOLVED, SBA PERSONNEL IN THE OFFICES OF PORTFOLIO MANAGEMENT, AND BUDGET AND FINANCE, ARE NOT AWARE OF A SINGLE COMPLAINT BY A SECONDARY PARTICIPANT THAT MONIES DUE THE SECONDARY PARTICIPANT HAD BEEN IMPROPERLY WITHHELD BY THE PRIMARY LENDER. WE CANNOT RULE OUT THE POSSIBILITY THAT SUCH INCIDENTS DID OCCUR SINCE INVESTORS MAY HAVE REALIZED THAT SBA WARRANTED ONLY THE PERFORMANCE OF THE SMALL BUSINESS BORROWER, AND NOT OF THE LENDER. IT IS ENTIRELY SPECULATIVE, BUT NOT IMPOSSIBLE, THAT THE PROPOSED EXTENSION OF SBA'S GUARANTY MAY PRODUCE CLAIMS AGAINST SBA IN THE FUTURE, AND THAT SBA WOULD THEN HAVE TO SEEK RECOURSE AGAINST THE PRIMARY LENDER. TO MINIMIZE LOSSES IN SUCH EVENT, SBA PROPOSES TO EXERCISE ITS RIGHT, AS PROVIDED IN THE TRIPARTITE AGREEMENTS (SIGNED BY THE PRIMARY AND SECONDARY PARTICIPANTS AND BY SBA, WHEN GUARANTEED LOANS ARE TRANSFERRED), TO REPURCHASE THE GUARANTEED PORTION OF THE BORROWER'S NOTE WHEN THE INNOCENT HOLDER FAILS TO RECEIVE A PAYMENT ***. ALSO, SBA WILL MONITOR CLOSELY THE PERFORMANCE OF PRIMARY LENDERS, TO PREVENT MULTIPLE DEFAULTS, AND TO GUARD AGAINST INADVERTENT OR FRAUDULENT OVERSELLING (I.E., WHERE MORE THAN 100% OF THE GUARANTEED PORTION WOULD BE SOLD). GIVEN SUCH SAFEGUARDS, WE ARE CONFIDENT THAT THE PROPOSED EXTENSION OF SBA'S GUARANTY WILL NOT LEAD TO SIGNIFICANT OUTLAYS."

SBA'S GUARANTEE PROGRAM IS A MODIFICATION OF THE PRIOR DEFERRED PARTICIPATION PROGRAM, WHICH WAS GIVEN PRIORITY STATUS AMONG SBA'S SMALL BUSINESS LOANS BY SECTION 7(A)(2) OF THE SMALL BUSINESS ACT, 15 U.S.C. SEC. 636(A)(2) WHICH READS:

"NO IMMEDIATE PARTICIPATION MAY BE PURCHASED UNLESS IT IS SHOWN THAT A DEFERRED PARTICIPATION IS NOT AVAILABLE; AND NO LOAN MAY BE MADE UNLESS IT IS SHOWN THAT A PARTICIPATION IS NOT AVAILABLE."

BY THIS RESTRICTION IT WAS INTENDED THAT PRIVATE LENDING INSTITUTIONS CONTINUE TO BE THE PRINCIPAL SOURCE OF CREDIT FOR SMALL BUSINESSES. SEE DISCUSSION OF A SIMILAR PROVISION IN THE PREDECESSOR STATUTE, SECTION 207(A)(1) OF THE SMALL BUSINESS ACT OF 1953, 67 STAT. 236, IN H.R. REPT. NO. 494, 83D CONG., 1ST SESS. 6-7 (1953). ALTHOUGH THE LAST QUOTED STATUTORY PROVISION HAS NOT BEEN SPECIFICALLY MODIFIED, WE NOTE THAT THE HOUSE COMMITTEE ON BANKING AND CURRENCY HAS RECENTLY EXPRESSED A DESIRE THAT MORE DIRECT LOANS (100% SBA FINANCED) AND IMMEDIATE PARTICIPATION LOANS (UP TO 80% SBA FINANCED) BE MADE IN ORDER TO LOWER THE INTEREST RATES AVAILABLE. H.R. REPT. NO. 93-1178, 93D CONG., 2D SESS. 5-6 (1974). IN FURTHERANCE OF THIS, SECTION 12 OF THE SMALL BUSINESS AMENDMENTS OF 1974, APPROVED AUGUST 23, 1974, PUB. L. NO. 93 386, 88 STAT. 742, REQUIRES DIRECT LOANS OF NOT LESS THAN $400 MILLION UNDER SUBSECTION 7(A) OF THE SMALL BUSINESS ACT DURING THE FISCAL YEAR ENDING JUNE 30, 1975, APPROXIMATELY ONE-THIRD OF THE AUTHORIZATION INCREASE REQUESTED BY SBA.

THE ADMINISTRATOR IS PROVIDED BROAD AUTHORITY TO TAKE ANY AND ALL ACTIONS DETERMINED BY HIM TO BE NECESSARY OR DESIRABLE IN MAKING, SERVICING, COMPROMISING, MODIFYING, LIQUIDATING, OR OTHERWISE DEALING WITH LOANS. SECTION 5(B)(7) OF THE SMALL BUSINESS ACT, 15 U.S.C. SEC. 634(B)(7). ALSO, AS WAS STATED IN OUR DECISION, B-140673, OCTOBER 12, 1959, THE POWER UNDER SECTION 7 TO MAKE LOANS IS BROAD AND VESTS IN THE ADMINISTRATOR CONSIDERABLE DISCRETION AS TO THE DETAILS FOR EXECUTING THE LOAN ARRANGEMENTS.

IN VIEW OF THIS BROAD AUTHORITY AND DISCRETION, THE STATUTORY PROVISION FOR PARTICIPATION BY PRIVATE LENDING INSTITUTIONS, THE PROTECTION OF GOVERNMENTAL INTERESTS BY MONITORING PRIMARY LENDER PERFORMANCE AND SBA'S ULTIMATE RECOURSE AGAINST THE PRIMARY LENDER, WE WOULD NOT OBJECT TO SBA'S REPURCHASE OF THE SBA-GUARANTEED PORTION OF SPONSORED LOANS FROM INNOCENT HOLDERS WHERE THE BORROWER IS NOT IN DEFAULT, BUT THE PRIMARY LENDER HAS FAILED TO PASS THROUGH TO THE HOLDER ALL PAYMENTS RECEIVED FROM THE BORROWER, IF OTHERWISE PROPER.