Small Business Administration: Model for 7(a) Program Subsidy Had Reasonable Equations, but Inadequate Documentation Hampered External Reviews

GAO-04-9 Published: Mar 31, 2004. Publicly Released: Mar 31, 2004.
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The Small Business Administration (SBA) approved about $8.6 billion in loan guarantees through its 7(a) loan program in fiscal year 2003. SBA must estimate the subsidy cost of this program. Since fiscal year 2003, SBA has been using econometric modeling to estimate the subsidy. This report reviews SBA's estimation methodology and equations, assesses the default and recovery rates the model produced, identifies ways to enhance the estimates' reliability, describes the process for developing the model, and analyzes SBA's data.

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Recommendations for Executive Action

Agency Affected Recommendation Status
Small Business Administration To further enhance the reliability of SBA's subsidy estimates, the SBA Administrator should determine how best to include in future subsidy models borrower-specific information, such as credit scores and loan-to-value ratios, to be collected in the new loan monitoring system.
Closed – Implemented
SBA has evaluated how to best include borrower-specific information in future subsidy models. As part of this evaluation, SBA determined that it could not use credit scores (a borrower-specific variable GAO suggested in its recommendation) because it was cost prohibitive. However, SBA determined that it can include information on borrower collateral in its future subsidy model. Further, collateral data will also be used to compute loan-to-value ratios for future loan sales. The agency has initiated collection of collateral data.
Small Business Administration To further enhance the reliability of SBA's subsidy estimates, the SBA Administrator should ensure that the model remains reasonable by establishing a process for periodically evaluating the model to correct any errors and revising it to reflect changes in the 7(a) business loan program or other factors that could affect the subsidy estimate.
Closed – Implemented
SBA has implemented a process for ensuring that its statistical model for estimating subsidy costs of the 7(a) Loan Guarantee program is free of errors and accounts for changes in the program. Specifically, SBA has procured a contractor to perform an annual independent verification and validation (IV&V) of the model. The IV&V process involves, among other things, reviewing model changes since the prior year's review, validating programming code used to estimate subsidies, and validating SBA's calculations and projection methodology.
Small Business Administration To demonstrate and explain the rationale and basis for the 7(a) econometric model and all other models developed, the SBA Administrator should prepare and retain adequate documentation of the model development process including a detailed discussion of the alternative variables or combinations of variables that were considered, tested, and rejected, as well as the reasons for rejecting them.
Closed – Implemented
SBA demonstrated that it has documentation that explains the development of its 7(a) subsidy model, the data variables used and their sources, and any changes to the econometric model. The documentation is generated and updated annually as part of its independent verification and validation reviews.
Office of Management and Budget To facilitate (1) validation of models used to generate credit subsidy estimates, (2) external oversight, and (3) financial statement audits, the Director, OMB, should revise OMB Circular A-11 to require that agencies document the development of their credit subsidy models, including the process followed for selecting modeling methodologies over alternatives, and variables tested and rejected, along with the basis for excluding them.
Closed – Not Implemented
It does not appear that OMB made any changes to the Circular A-11 as recommended.

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