Government business loans go to borrowers who defaulted

WASHINGTON -- Despite warnings that it is risking millions in bad debts, the Small Business Administration has approved dozens of loan guarantees annually for borrowers who should have been disqualified because they previously defaulted.

The agency designed to help America's small businesses rejected a recommendation last May from its inspector general to implement a system of intensive checks to screen applicants. SBA officials say they consider the failure to identify prior loan defaulters a minor problem.

"This is more the tip of an ice cube rather than the tip of an iceberg," said Jim Hammersley, director of the office of loan programs for the SBA.

The amount of bad loans the SBA has been forced to cover has almost doubled -- from $516 million in 1995 to more than $1 billion in fiscal 2002, which ended Sept. 30. Agency spokesman Mike Stamler said the increase reflects expansion of the overall lending program from $3 billion in 1990 to $12 billion last year.

Under agency rules, borrowers with prior defaults in any federal lending program should be ineligible for SBA-backed loans, unless an exception is granted.

The inspector general's report last spring identified as many as 166 loan guarantees the agency made to companies with prior federal loan defaults. It was unclear whether any of the 166 had received official exceptions.

"Providing loan guarantees to such applicants caused SBA to honor or be at risk to honor guarantees totaling about $22.4 million," the inspector general reported after reviewing loans approved between October 1995 and April 2001. The report said the amount represented only part of the risk, because auditors did not check for defaults in financial aid programs outside the SBA.

Indirect loans

If other programs were checked, the financial impact "could increase significantly in the future if not corrected," the inspector general warned.

The agency does not lend money directly to small business owners but issues loan guarantees: promises to pay commercial lenders if the borrower defaults. The SBA attempts to recover money from a defaulted borrower.

Hammersley, the SBA official, contended the number of prior defaults represented a minuscule portion of the 287,000 loans approved during the period.

He said intensive database checks were unnecessary because the agency is already catching 99.95 percent of those with prior defaults, a percentage derived from the figures in the audit limited to the SBA database.

Hammersley acknowledged the agency's position hasn't changed since last March, when another agency official, responding to a draft copy of the IG's report, said the problem "does not appear to rise to the level that would justify" any "substantial additional effort."

The inspector general pointedly disagreed, citing a loan that was approved for borrowers who had defaulted on three prior SBA guaranteed loans and a disaster loan at a cost to the government of $440,000. The borrowers then defaulted on the newest loan, costing the agency another $667,500.

"SBA cannot afford unnecessary losses of this magnitude," the inspector general concluded.

Stamler, the SBA spokesman, said the agency, to protect the privacy of people who default, does not publicize their names.

The investigators considered the problem severe enough to propose that private lenders be granted access to the SBA database to check for prior defaults. Hammersley suggested that proposal might violate privacy laws.

The number of loans where the SBA lost money rose from 2,489 in 1995 to 4,597 in 2002. While some of that money is recovered through negotiations with borrowers, the agency's unrecovered losses have risen from $267 million in 1995 to $481 million in 2002.

David Gray, counsel to the inspector general, said his office will continue trying to force changes in the loan approval system.

He said the watchdog will ask lower-level managers to carry out the recommendations, and, if unsuccessful, will take the matter to the agency's deputy administrator for a final ruling.