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SBA's 7 (a) Loan Program in Jeopardy Again!!


22 March 2002

Faulty calculations by the Administration and OMB significantly increase the SBA's 7 (a) loan program subsidy rate and cut lending authority for SBA's 7 (a) loan program from $10 billion to $4.85 billion for FY 2003!

The Administration recently released their proposed budget for FY 2003. Despite various recommendations for the US Small Business Administration, and what initially appears to be a nominal increase in appropriations for the SBA's 7 (a) Loan Program (the Agency's most prominent and effective loan guarantee program), a more in-depth review of the Administration's proposed budget reveals drastic cuts in the 7 (a) budget of the SBA.


Background information:

The 7 (a) loan program is the premiere loan guarantee program managed by the SBA. It provides guarantees for a percentage of the total loan made by commercial lenders to small businesses. This loan program specifies: loan guarantee amounts, total loan size, allowable interest rates to be charged for the loan, relevant fees and charges, etc. The SBA does not make direct loans to small businesses, rather, this program provides a level of security for the commercial lenders making the loans by providing them with a guarantee for a percentage of the loan. The funds for the loan come directly from the lenders participating in this program. It is an excellent way to leverage private capital to make loans available to small businesses.

Congressional appropriations to the SBA in support of this program determine the total amount of loans the SBA is able to guarantee. In FY 2002, Congressional appropriations allowed the SBA to guarantee approximately $10 billion in 7 (a) guaranteed loans. The amount appropriated for this was approximately $85 million.

In the Administration's FY 2003 proposed budget, this amount was nominally increased to $87 million. At first look, one would assume that this increase would translate to an increased lending guarantee ceiling for the 7 (a) loan program. This is not the case!


Fees and Subsidy Rate:
In order to effectively manage this loan program, fees are charged to both the borrower and the lender for each 7 (a) loan. In December 2001, after realizing that these fees had been excessive, Congress reduced these fees. Additionally, in order to compensate for anticipated defaults on 7 (a) loans, a portion of the 7 (a) appropriations is required to be set aside as a form of security for anticipated losses: a "subsidy rate" is used to calculate how much needs to be set aside to cover anticipated losses.

There has been much dissension on how to effectively calculate the subsidy rate. Analysis has been performed by the SBA, GAO and OMB. OMB has been responsible for setting the final subsidy rate calculation.

In a recent GAO Report (8/01) reviewing the subsidy rate for the past decade, it was identified that the subsidy rate which had been used for projected loan defaults far exceed the actual default rate. In other words, the subsidy rate which has been used, has resulted in the collection of far more funds than what were actually needed to cover actual defaults. After almost 10 years, almost $1.5 billion in excess funds were collected via the subsidy rate. These funds were returned to the US Treasury.

The problem is this: a subsidy rate is established to cover projected loan defaults. After a period of time, a comparison is made between what the projected losses were versus the actual losses. What has occurred during the past decade is that the projected loss rate and related subsidy rate to cover those losses was far greater than what actually occurred. In other words, actual loan defaults were far less than what was projected, and the subsidy rate collected far more funds than what was needed to cover the actual defaults (losses). This has resulted in almost $1.5 billion in excess funds being generated by the subsidy rate.

One would assume that these funds would be used to further fund the 7 (a) loan program of the SBA. This is not what has occurred. These funds have been removed from the SBA and returned to the US Treasury. This translates to an over-charging of the 7 (a) loan program, and an excess additional tax to small business borrowers.


Look-back (Re-estimate):
One of the issues where disagreement exists in setting the subsidy rate, is in how many years back (historical analysis) does one look to review the performance of the 7 (a) loan program. Currently, OMB performs a 13 year look-back to review the performance of this loan program. This means that loan defaults or the respective default rate from 13 years ago is still averaged into the calculation to determine the current subsidy rate. Over the past 13 years, the default rate for 7 (a) loans has significantly decreased by almost 50%. Unfortunately, this 13 year look-back process, combined with recent Congressional reductions in borrower and lender fees, the subsidy rate has been increased! This archaic method of calculating the subsidy rate has resulted in the generation of excessive funds which have not been needed to offset actual loan defaults.

In a recent GAO Report (8/01) which calculated what the subsidy rates should be if a 3 year or 5 year look-back process was used, (which is what most commercial lenders use as a measure of default rate) it was determined that the subsidy rate (based upon actual loan performance and actual loan defaults) would be NEGATIVE! In other words, no subsidy rate would be required to support actual losses since more than adequate fees were being charged to the lenders and borrowers to offset actual losses!


Outlook:
If nothing is done to revise the Administration's proposed budget and OMB's dictated subsidy rate, the 7 (a) loan program will only be able to guarantee $4.85 billion in loans for FY 2003. This is a significant reduction in small business loans from the previous year, and would have a drastic negative impact on small business's ability to access much needed capital. The resulting national economic impact would certainly be devastating!

Additionally, if nothing is done to revise OMB's dictated subsidy rate for the 7 (a) loan program, funds will continue to be generated via the 7 (a) loan program which are not needed to support the actual loan defaults of this program, and these funds will continue to be conveyed to the US Treasury rather than being reserved for use by the 7 (a) loan program.


Administration's claims with counter points:

Administration:
The subsidy rate needs to be set per current OMB projections because if the 7 (a) loan program default rate increases in future years, a lower subsidy rate will be inadequate to cover losses.

Counter Point:
The subsidy rate has accumulated over $1.5 billion in excess funds (funds not needed to cover actual loan defaults) during the past decade. If these funds were set aside in a reserve fund to be used to compensate for any significant future increase in the loan default rate, there would be no need to maintain such an excessively high subsidy rate. Because the Administration and OMB have not used these surplus funds in their calculation of the subsidy rate, they are ignoring the fact that the 7 (a) loan program has already generated significant funds to cover any serious increase in the loan default rate even if the subsidy rate does not adequately cover the default rate for a specific period of time.


Administration:
The SBA will attempt to re-direct larger loans which would have been made under the 7 (a) loan program to the SBA's 504 loan program. The re-direction of these loans to the 504 loan program would result in a smaller loan authority required for the 7 (a) loan program.

Counter Point:
The loans made under the 7 (a) loan program vary in size. The average 7 (a) loan is approximately $220K, although there are many loans as small as $50K and others as large as $1 million. Logistically, the smaller loans require the same amount of administrative oversight by the lender as do the larger loans. The smaller loans generate smaller revenues to the lenders, whereas the larger loans generate larger revenues to the lenders. The revenues generated by the smaller loans to the lender do not adequately cover the administrative expenses required to administer these loans, but, the revenues generated by the larger loans allow the lenders to off-set the expenses from the smaller loans,....thereby making it advisable for the lender to make larger loans. If the larger loans are re-directed from the 7 (a) loan program, there would be no incentive for the lenders to make only the smaller loans. Eliminating the larger, more profitable loans from this program would discourage lenders from participating in a loan program where they could not generate adequate revenues to administer the smaller loans. A blending of small, medium and larger 7 (a) loans results in a net profit for the lenders.

The 7 (a) loan program and the 504 loan program are 2 separate and distinct loan programs. There is very little if any similarity between these 2 loan programs. Most of the larger 7 (a) loans could never be financed under the 504 loan program based upon legislated requirements and restrictions. Eliminating or re-directing the larger 7 (a) loans to the 504 loan program would only preclude access to capital for many small businesses. The 504 loan program is not a viable lending alternative for most of the larger 7 (a) loans.

Click here for the specifications and requirements of the 7 (a) loan program:
http://www.sba.gov/financing/fr7aloan.html

Click here for the specifications and requirements of the 504 loan program:
http://www.sba.gov/financing/frcdc504.html


Administration:
The SBA will carry-over certain funds from the 7 (a) loan program from FY 2002 to FY 2003 to increase the amount of funds available to support the 7 (a) loan program in FY 2003.

Counter Point:
Although this carry-over of funds might provide additional funding for the 7 (a) loan program in FY 2003, it effectively reduces the funds available for this program in FY 2002 and artificially increases funding for FY 2003. This carry-over of funds results in a net reduction in funding for the 7 (a) loan program in FY 2002, and offsets the actual reduced funding of the 7 (a) loan program in FY 2003.


Recommendations:
  1. Congress should appropriate adequate funding to maintain a minimum of $12 Billion in lending authority for the SBA's 7(a) Loan Program. Based upon the critical role which small business plays in the stability of the Nation's economy, any action which restricts access to capital for this vital business sector would result in a devastating financial impact on the overall national economy.

  2. Congress should not allow the proposed restriction of, or re-direction of larger 7 (a) loans to the 504 loan program. Congress has legislated a maximum limit of $1 million for the guaranteed portion of a loan in the 7 (a) loan program. No restrictive efforts should be made to reduce this maximum guaranteed loan amount.

  3. Congress should re-emphasize the primary distinctions between the SBA's 7 (a) loan program and the SBA's 504 loan program. A clear understanding of the reasons behind the creation of these 2 programs should be identified, with specific attention given to the Congressionally mandated technical requirements for each of these loan programs. The 7 (a) loan program was developed and funded by Congress to accomplish one set of economic goals, whereas the 504 loan program was developed by Congress to accomplish an entirely different set of economic goals. These loan programs are not similar in nature. Each loan program needs to be adequately funded to meet the economic objectives as established by Congress.

  4. Congress should aggressively address the excessive surpluses which have been generated during the past decade from the subsidy rate which has been assessed against 7 (a) loans. The GAO Report (8/01) regarding the subsidy rate should be reviewed in detail. Congress should request an immediate re-calculation of the subsidy rate (as established by OMB) to more accurately reflect the actual funds necessary to cover loan defaults in the 7 (a) loan program.

  5. Congress should initiate an investigation into the disposition of and/or use of the approximate $1.5 Billion in excess fees collected under the 7 (a) loan program as a result of an excessive subsidy rate during the past decade.

  6. Congress should research the possibility of the creation of a 7 (a) loan program default reserve fund (similar to what exists with the FDIC), in an effort to establish an insurance fund adequate enough to cover existing and projected loan defaults in the 7 (a) loan program. The existing $1.5 Billion which has already been collected as a result of an excessive subsidy rate could be used to initially finance this fund, with a revised subsidy rate calculation used to maintain a current reserve fund balance to secure any additional negative changes in the default rate. The balance of this fund should be used to calculate a realistic subsidy rate necessary to insure against potential loan losses, and it should be periodically adjusted accordingly.

  7. Congress should investigate whether or not the $1.5 Billion in fees generated by the subsidy rate for the 7 (a) loan program, which have been returned to the US Treasury, violate any of the tenets of the Authorization Act of the SBA restricting revenue generation by the SBA.


Commentary:
The Administration and Congress have continually credited the Nation's small businesses with being the backbone of the US economy. Unfortunately, appropriations to the Agency specifically created to support the needs of small business, the US Small Business Administration, have continually been subjected to budgetary reductions, inadequate funding for Congressionally mandated programs, and excessive fees.

There are many dedicated members of Congress who truly believe in the mission of the US SBA in support of our Nation's small businesses. Despite this plurality of support, this Agency created to assist the backbone of the US economy continues to receive a minuscule amount of funding in relationship to the entire Federal Budget. The US SBA is the only Federal Agency which provides a definitive ROI (Return on Investment) in the form of job creation and retention and increased tax revenues both local and federal, while also returning to the Federal Government funds necessary to maintain and sustain this Agency. Many of the loan programs of the SBA leverage private sector funds 99 to 1 in providing access to capital for small business. Despite the millions of jobs which have been lost during the past few years, our Nation has experienced a positive job growth which the small business sector is solely responsible for.

Unfortunately, there continue to be $22 billion bailout plans for large corporations, subsidized by the US Government, and little if any additional appropriations for the SBA which assists small businesses in CREATING jobs, not eliminating them! The ROI regarding appropriations to the SBA is unprecedented when reviewing any other US Government Agency.


Q & A:

Query:
Why does the SBA not receive the necessary funding it so justly deserves?

Response:
Despite the positive impact many of the SBA's programs have had in assisting the Nation's small businesses, and despite the positive ROI from appropriations to the SBA, the SBA continues to be the target of budget cuts. There is no reasonable answer to why the SBA does not receive increased funding based upon positive program performance.


Query:
Why does the small business sector not rise up in protest to the lack of funding for the SBA?

Response:
Many small business owners and associations DO make their voices heard regarding the positive outcomes resulting from the efforts of the SBA. Although, it is difficult for many small business owners to operate their businesses while also exerting significant time and efforts convincing government about the value of the SBA. Many small business owners are far too busy attempting to maintain and grow their businesses, fund their payrolls and expansion efforts, rather than spending time and money to let the Government know how much they have accomplished. After all, if a business is successful, employs people, pays taxes, and has a positive impact on the local and national economy, should they also have to expend time and money to let the US Government know what they've accomplished? The positive impact of small business on the US economy should speak for itself! After all, hasn't Congress and the Administration stated that "Small Business is the backbone of the US Economy? " If this is true,...then small business is wondering what else needs to be said or done to convince the US Government to give small business the appropriate recognition and funding support for having become the backbone of the economy!


Query:
If the SBA has been so successful, and if small businesses have had such a positive impact on the US economy, why does the SBA receive such a nominal appropriation to fund the only business sector which has demonstrated positive job development and positive tax revenues for the US Government?

Response:
We don't know! Maybe you should ask Congress and the Administration.


Action Plan: What can you do?

This is where you come in! .......

Write your elected officials, local, state and national. Let them know that you don't want the only positive and growth-oriented sector of the US economy to be under-funded, penalized with excessive fees, and forced into a scenario where they can't obtain financing to fund their businesses. After all, it is these small businesses which hire you! Without them, there is no positive job growth in this nation. Without them, there is no tax base to support your community. Without them, there is no economy!


Resources:

Some of these documents will require Adobe Acrobat Reader
Click here to download the Free Adobe Acrobat Reader



US SBA 7 (a) Loan Program description and requirements:
http://www.sba.gov/financing/fr7aloan.html

US SBA 504 Loan Program description and requirements:
http://www.sba.gov/financing/frcdc504.html

GAO-01-1095R SBA's 7(a) Credit Subsidy Estimates
Read the GAO Report reviewing the subsidy rate analysis. This is an excellent resource which outlines the overpayment of funds to the US Treasury from the 7 (a) loan program.
http://www.gao.gov/new.items/d011095r.pdf

National Association of Government Guaranteed Lenders (NAGGL)
Read the legislative updates and congressional testimonies of Anthony R. Wilkinson CEO of NAGGL.
http://www.naggl.com/tvyn/legupd.asp

National Association of Small Business Investment Companies (NASBIC)
Read the legislative updates and congressional testimonies of Lee Mercer President of NASBIC
http://nasbic.org/resources/legislative_rep/updates.cfm

US House Committee on Small Business (Hearings and Testimony)
Select the appropriate hearing and access testimony.
http://www.house.gov/smbiz/hearings/index.html

US House Committee on Appropriations:
Sub Committee on Commerce, Justice, State, The Judiciary and Related Agencies
(Hearings Schedule)
http://www.house.gov/appropriations/

US Senate Committee on Small Business & Entrepreneurship
Select the appropriate hearing and access testimony.
http://www.senate.gov/comm/small_business/general/hearings/107hear.html

US Senate Committee on Appropriations:
Sub Committee on Commerce, Justice, State, The Judiciary
http://www.senate.gov/~appropriations/commerce/index.htm



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