A Small Business Administration plan to update 7(a) rules could weaken underwriting standards and open the loan-guarantee program to the kinds of fintechs that approved too many fraudulent Paycheck Protection Program loans, two top lawmakers say.
The warning — sent this week by Small Business Committee Chairman Sen. Ben Cardin, D-Md., and the panel's ranking Republican, Sen. Joni Ernst, R-Iowa, in a letter to SBA Administrator Isabella Casillas Guzman — was likely a signal to slow down and reconsider things. But SBA officials defended their plans and appear to have no intention of changing course.
Cardin and Ernst complained that a pair of proposed rules that would revise affiliation standards and increase the number of nondepository small-business lending companies eligible to participate in 7(a) were drafted without "congressional input or authorization."
The lawmakers suggested implementing any changes as a pilot program, which would limit the time they would be in effect and the amount of SBA resources they could command. Cardin and Ernst made clear there is little enthusiasm on either side of the aisle for expanding fintech participation in SBA's flagship 7(a) program, or for overhauling underwriting standards.
"Coupled together, these sweeping regulatory changes could have a negative impact on loan performance causing the program subsidy rates to go up, resulting in higher fees to borrowers and lenders, impacting the ability for future small-business borrowers to access the program," the two senators wrote.
Cardin and Ernst raised the prospect of service interruption if the changes SBA contemplates led to increased loan losses, requiring Congress to provide a subsidy to keep 7(a) functioning. "It could be challenging for Congress to provide a timely appropriation in the event that a positive subsidy rate results from an increase in risky lending behavior," they wrote.
According to one senior SBA official, the agency appreciates the fact Monday's letter comes from both Cardin and Ernst, a sign that the cross-party collegiality that has characterized much of the committee's work remains alive and well.
"We're happy they expressed their concerns," the official said. "We're going to answer them."
Nevertheless, the official, who spoke on background, defended the proposed rule changes as doing no more than broadening use of existing policies and procedures, both to streamline operations and extend capital to disadvantaged borrowers who might otherwise miss out on SBA capital.
"There is nothing in the proposed rules that has not been — however you want to characterize it — piloted or currently implemented and executed against, for which there is learned experience on the part of lenders, Capitol Hill oversight committees as well as the agency, with a massive record and body of evidence to look at," the official said.
Rulemaking versus legislating
SBA's oldest and largest lending program, 7(a) has grown steadily in recent years, with annual loan volume regularly topping $20 billion, including $25.7 billion in fiscal 2022. Through the first five months of fiscal 2023, which began Oct. 1, SBA has approved 21,800 loans for $10.8 billion. The program cap for the fiscal year is $35 billion.
Under 7(a), SBA guarantees loans up to $5 million made by participating lenders, almost all of whom are banks and credit unions.
According to the senior official, SBA possesses wide discretion to amend its rules. But Cardin and Ernst argued that there is a difference between periodically tweaking operating procedures for the sake of efficiency and making major policy decisions. Doing the latter usurps legislative prerogatives, the senators wrote, adding the proposed rules come "dangerously close to authorizing through the regulatory process."
SBA proposed changes to its rules governing affiliation and lending criteria in October. A key change highlighted by Cardin and Ernst involved allowing 7(a) lenders to use in-house underwriting standards in place of the current agency guidelines. Lenders would be able to evaluate their 7(a) credits "in the same manner in which [they] underwrite similarly sized non-SBA-guaranteed commercial loans," according to the rule.
The senators referred to SBA's current standardized underwriting policies as critical guardrails ensuring "lenders make responsible underwriting decisions, protect small businesses from loans that may become financially burdensome, and protect taxpayers from the costs of significant loan losses."
SBA, however, noted lenders that participate in the agency's SBA Express and Community Advantage program, which approve thousands of loans annually, already possess authority to underwrite loans using in-house guidelines. Congress, moreover, granted lenders similar flexibility under the PPP, the SBA senior official said.
"There is no information in this letter, and no question in this letter, that cannot be answered by multiple decades of lending," the official said.
Fintech worries
A month after unveiling the affiliation and loan criteria plan, SBA proposed another rule change
Critics of the proposed rule change, including bank and credit union trade associations, have raised questions about SBA's ability to underwrite a host of new nondepository lenders. The agency has traditionally outsourced responsibility for overseeing the banks and credit unions that participate in its programs to their statutory regulators, the Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., Federal Reserve and National Credit Union Administration.
Cardin and Ernst sounded a similar concern about supervisory capacity. "We are concerned that SBA, and particularly its Office of Credit Risk Management, would be tasked with overseeing an unlimited number of non-federally-regulated entities," they wrote.
The senior SBA official said the agency's plans currently call for only three new for-profit SBLCs, bringing the number to 17, though it was acknowledged that future administrations and administrators could add more SBLCs if the moratorium rule is enacted.
There are no plans to limit the number of mission-based SBLCs, but the agency already oversees 100 nonprofit lenders under the Community Advantage program, all of which would be automatically "grandfathered" as mission-based SBLCs under the proposed rule. The official added that the number of Community Advantage lenders has declined in recent years from a peak of 130 about six years ago.
Much of the scrutiny surrounding the affiliation rule has focused on the possibility of fintech lenders securing some of the new SBLC licenses. Indeed, Cardin and Ernst claimed that the proposed rules appear to be laying groundwork for participation by fintech lenders — even as they have come under heavy criticism after some were tabbed as negligently opening PPP and other pandemic-era relief programs to fraudsters.
"We are worried that SBA continues to press forward with a strategy aimed at granting more fintech entities access to the 7(a) program without taking into account the risks these types of entities pose to consumer protection or program integrity," the Senators wrote.
From SBA's perspective, the decision to add new categories of lenders, including fintechs, is aimed at boosting access to capital for underserved groups and markets. Nondepository lenders tend to make more small-dollar loans, a significant portion of which typically go to women, minorities and veterans, agency officials said.
"The Biden-Harris Administration and the SBA are committed to addressing the market failure of declining small-dollar lending by using existing statutory authority to cut red tape, simplify complex rules, and increase competition for lenders in our programs which will ultimately help American small businesses create jobs," SBA Press Secretary Christina Carr wrote in a statement.
Guzman has no desire to favor one group of lenders over another, according to the senior official. "Administrator Guzman loves all lenders equally, wants them all to succeed…She is totally focused, though" on remedying gaps in access to credit.
