Small Business Administration:

Credit Subsidy Estimates for the Sections 7(a) and 504 Business Loan Programs

T-RCED-97-197: Published: Jul 16, 1997. Publicly Released: Jul 16, 1997.

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Judy A. England Joseph
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GAO discussed the Small Business Administration's (SBA) estimates of credit subsidies for the agency's guaranteed business loan and certified development company programs-more commonly called the "7(a)"and "504" programs, respectively, focusing on: (1) how SBA calculates the estimates of credit subsidies for the 7(a) and 504 programs; (2) what factors accounted for the increases in the estimated cost of the loans to be guaranteed by these programs in fiscal year FY 1997; and (3) what additional changes, if any, SBA made during the 1998 budget process when estimating the costs of its loans.

GAO noted that: (1) SBA bases its estimate of the credit subsidy for each program on projections of cash flows--that is, the amounts of cash that SBA expects to take in and pay out during each year that the loans are outstanding; (2) cash outflows occur when borrowers default on their loans and SBA pays claims filed by lenders; (3) cash inflows occur when the collateral for defaulted loans is liquidated and when borrowers and lenders pay mandatory fees to SBA; (4) these cash flow projections are based largely on the historical performance of the programs' loans; however, SBA adjusts the projections to reflect the estimated influence of changes in the programs' provisions and other factors; (5) the cash flows are discounted to determine their net present value using a computer model established and maintained by the Office of Management and Budget (OMB); (6) the factors contributing to the increases in the estimated credit subsidy rates for FY 1997 differed somewhat between the two programs; (7) for the 7(a) program, SBA projected fewer recoveries (the amounts realized when defaulted loans are liquidated) and less revenue from fees than it had assumed in previous years; (8) these changes, which accounted for about 60 percent of the increase, resulted primarily from SBA's use of a new database on historical loan performance that expanded and improved on existing data, according to SBA and OMB officials; (9) in addition, an error in applying SBA's cash flow projections to OMB's discounting model caused the estimated credit subsidy rate for the 7(a) program to be even larger; (10) this error accounts for the remainder of the increase; (11) on the basis of its appropriated budget authority of $198.5 million, SBA announced that it could guarantee an additional $2.47 billion in 7(a) loans because the credit subsidy rate estimate should have been lower; (12) for the 504 program, SBA projected both more claims and fewer recoveries for defaulted loans than it had assumed previously; (13) for the FY 1998 budget request, SBA further revised its projections of cash inflows and outflows for the two programs; (14) for 7(a) loans, SBA decreased its estimate of expected fee revenue, on the basis of data on loans that are paid off prior to maturity, or prepaid; (15) because SBA would have to cover more of the cost of loan defaults if revenues from fees are less than originally expected, this change had an upward effect on the subsidy rate estimate for the 7(a) program; and (16) for the 504 program, SBA increased the estimated prepayments and slightly reduced expected claim payments and recoveries.

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