Inspection Audit Report 96-06-002: 7(a) General Business Loan Program Loss Rate
Date Issued: Tuesday, June 4, 1996
Report Number: 96-06-002

In June 1996, the OIG issued Inspection Audit Report 96-06-002, 7(a) General Business Loan Program Loss Rate.  This inspection focused on the methodology used to compute loss rates for the 7(a) general business loan program and on the use of these rates by SBA officials.  While there are minor differences in the way the SBA and the banking industry compute the commercial or one-year loss rate, the OIG found that the methodology used by the SBA is fundamentally valid and consistent with methods used by Federal banking regulators.  The OIG also found, however, that SBA’s commercial loss rate is not comparable with banking industry loss rates due to significant differences in their respective loan objectives and portfolios.  The objectives for the SBA and the banking industry vary substantially because the latter are for-profit businesses charged with providing dividends to their shareholders.

The SBA’s loan guarantee program is designed to promote small business formation and growth.  More importantly, SBA’s loan portfolio differs significantly from that of the banking industry in several important aspects: (1) the SBA’s portfolio includes only small businesses, whereas the industry rate reflects losses on loans to businesses of all sizes; (2) the SBA’s loans are concentrated in only two industries—retail trade and services—while private lender loans cut across all industries, and (3) the SBA’s portfolio includes real estate loans, which are excluded from industry loss rates.  Differing charge-off policies also affect the timing of charge-offs and, therefore, the loss rates. 

The commercial loss rate is also a misleading indicator of current 7(a) loan program performance because of the rapidly expanding portfolio and the three-to-four year lag between loan disbursals and charge-offs.  For example, the SBA’s portfolio has increased by 118 percent in the past 10 years, while the banking industry portfolio has grown only 5percent, and most losses on unseasoned loans are unlikely to have occurred.  It should also be noted that SBA program officials no longer used the commercial loss rate for internal management purposes.  Instead, their focus is on cohort performance and other indicators such as purchase, currency, and subsidy rates, which appear to be more useful measures.

 

For these reasons, the OIG recommended that the SBA discontinue the use of the commercial loss rate for the 7(a) loan program.  While officials from the Office of Financial Assistance (OFA) acknowledged the validity of the position presented by the OIG, those officials believed that there are practical reasons for continuing the use of the commercial loss rate.  For example, OFA officials believed that the commercial loss rate is useful for comparisons with the commercial lending industry because the methodologies are similar and the rate is easily understood—whereas the subsidy rate and its derivatives are not.

 

Further, OFA officials believed that the commercial loss rate could still be used if caveats were provided to indicate that SBA’s loan portfolio, unlike that of commercial lenders, includes only small business loans, and that there are differences in charge-off policies. However, simply adding these caveats is not sufficient to justify SBA’s continued use of the commercial loss rate for comparing its loan losses with those of the private industry.  Officials from Office of the Chief Financial Officer agreed with the OIG’s conclusions on the use of the 7(a) commercial loss rate, and indicated that they would circulate a decision document to SBA’s top management to seek concurrence.  They indicated that the OIG’s conclusions apply to the Disaster, 504 Development Company, and Small Business Investment Companies programs.

 

Because loss and default rates are sometimes used interchangeably, the OIG included a discussion of default rates in this inspection. The OIG found that loss and default rate data were not always properly identified, and may have inadvertently misrepresented 7(a) program performance.  The OIG recommended that the OCFO and OFA ensure that information on loss and default rates is more clearly defined and labeled.

 

Each year the OCFO publishes an Annual Loss Study that includes not only the commercial loss rate, but also "actual" (cumulative) and "ultimate" (cumulative plus projected) loss rates for each of SBA’s loan programs.  Credit reform, however, has significantly changed the way loan information is tracked, necessitating two different methods of presenting loan information in the Annual Loss Study—one for pre- and one for post-credit reform data.  The OIG recommended that the OCFO determine whether revisions could be made in the format of the Annual Loss Study to clarify loan loss data.