Small Business Administration: Actions Needed to Improve the Usefulness of the Agency's Lender Risk Rating System

In 2013, SBA completed a redevelopment of its lender risk rating system. Consistent with our recommendation, SBA's contractor used sound validation practices. For example, the contractor validated the new models on two separate SBA loan pools that were not a part of the original pool utilized to develop the models. In addition, during the development and validation process the contractor considered numerous variables and identified those that were the most predictive of lender performance. Finally, the contractor documented the results of the initial validation, and SBA's contract calls for independent annual validations of the model going forward.

In 2013, SBA completed a redevelopment of its lender risk rating system. When validating the new models, SBA's contractor used two separate SBA loan pools that were not a part of the original pool utilized to develop the models. The models performed well on both samples. In addition, consistent with our recommendation, SBA has completed its own assessments of how well the lender risk ratings predict individual lender performance. For example, SBA used 2013 and 2014 data to complete analyses showing how the lender risk ratings for 7(a) and 504 lenders correlated with loan performance.

Since our report, SBA has revised its procedures for conducting risk-based reviews of lenders. Consistent with our recommendation, one change that the agency made was to rely more on its lender risk ratings when targeting lenders for review. For example, lender risk ratings were one of the primary criteria used to select 7(a) lenders for review in fiscal year 2014. Similarly, lender risk ratings were one of the criteria used to select certified development companies for review under the 504 program.

In 2013, SBA began revising its procedures for conducting reviews of lenders, now known as risk-based reviews. Specifically, consistent with our recommendation, SBA developed a risk measurement methodology and rating guide for 7(a) lenders and a separate methodology and rating guide for the certified development companies (CDC) that issue 504 loans. PARRiS is the acronym used to describe the specific risk areas or components that SBA reviews for 7(a) lenders. The components are: Performance, Asset Management, Regulatory Compliance, Risk Management, and Special Items. SMART is the acronym covering the specific risk areas or components that SBA reviews for CDCs: Solvency and Financial Condition, Management and Governance, Asset Quality and Servicing, Regulatory Compliance, and Technical Issues and Mission. Each PARRiS and SMART component generally has three metrics that are compared to benchmarks and scored. One of the metrics considered for both 7(a) lenders and CDCs is the lender risk rating. Those lenders with composite risk ratings above an established threshold will undergo a targeted review specifically focused on the areas of risk or a full review if risk is potentially more pervasive. According to SBA, the new risk-based reviews also include the review of a judgmental sample of loans targeting specific risk characteristics.