[Senate Hearing 118-91] [From the U.S. Government Publishing Office] S. Hrg. 118-91 OVERSIGHT OF SBA'S IMPLEMENTATION OF FINAL RULES TO EXPAND ACCESS TO CAPITAL ======================================================================= HEARING BEFORE THE COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP OF THE UNITED STATES SENATE ONE HUNDRED EIGHTEENTH CONGRESS FIRST SESSION __________ APRIL 26, 2023 __________ Printed for the use of the Committee on Small Business and Entrepreneurship [GRAPHIC NOT AVAILABLE IN TIFF FORMAT] Available via the World Wide Web: http://www.govinfo.gov __________ U.S. GOVERNMENT PUBLISHING OFFICE 53-225 WASHINGTON : 2024 COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP ONE HUNDRED EIGHTEENTH CONGRESS ---------- BENJAMIN L. CARDIN, Maryland, Chairman JONI ERNST, Iowa, Ranking Member MARIA CANTWELL, Washington MARCO RUBIO, Florida JEANNE SHAHEEN, New Hampshire JAMES E. RISCH, Idaho EDWARD J. MARKEY, Massachusetts RAND PAUL, Kentucky CORY A. BOOKER, New Jersey TIM SCOTT, South Carolina CHRISTOPHER A. COONS, Delaware TODD YOUNG, Indiana MAZIE HIRONO, Hawaii JOHN KENNEDY, Louisiana TAMMY DUCKWORTH, Illinois JOSH HAWLEY, Missouri JACKY ROSEN, Nevada TED BUDD, North Carolina JOHN W. HICKENLOOPER, Colorado Sean Moore, Democratic Staff Director Meredith West, Republican Staff Director C O N T E N T S ---------- Page OPENING STATEMENTS Benjamin L. Cardin, Chairman, U.S. Senator from Maryland......... 1 Joni Ernst, Ranking Member, U.S. Senator from Iowa............... 4 WITNESSES Mr. Patrick Kelley, Associate Administrator, Office of Capital Access, U.S. Small Business Administration..................... 5 Prepared Statement........................................... 8 Mr. Sheldon Shoemaker, Deputy Inspector General, Office of Inspector General, U.S. Small Business Administration.......... 11 Prepared Statement........................................... 13 Ms. Hilda Kennedy, Founder/President, AmPac Business Capital..... 43 Prepared Statement........................................... 45 Mr. Chris Pilkerton, Chief Legal Officer, Accion Opportunity Fund 52 Prepared Statement........................................... 55 ADDITIONAL LETTERS/STATEMENTS FOR THE RECORD National Association of Development Companies (NADCO) Letter dated April 26, 2023.................................. 62 National Association of Federally-Insured Credit Unions (NAFCU) Letter dated April 25, 2023.................................. 63 Senator Marco Rubio Statement.................................................... 65 QUESTIONS FOR THE RECORD Mr. Patrick Kelley Responses to questions submitted by Chairman Cardin, Ranking Member Ernst, Senators Hickenlooper, Risch, Young and Kennedy.................................................... 67 Mr. Sheldon Shoemaker Responses to questions submitted by Ranking Member Ernst and Senator Risch.............................................. 88 Ms. Hilda Kennedy Responses to questions submitted by Senator Hickenlooper..... 96 Mr. Chris Pilkerton Responses to questions submitted by Ranking Member Ernst and Senator Hickenlooper....................................... 99 OVERSIGHT OF SBA'S IMPLEMENTATION OF FINAL RULES TO EXPAND ACCESS TO CAPITAL ---------- WEDNESDAY, APRIL 26, 2023 United States Senate, Committee on Small Business and Entrepreneurship, Washington, DC. The committee met, pursuant to notice, at 3:33 p.m., in Room 428A, Russell Senate Office Building, Hon. Benjamin Cardin, chairman of the committee, presiding. Present: Senators Cardin [presiding], Shaheen, Hirono, Rosen, Hickenlooper, Ernst, Risch, Young, Hawley, and Budd. OPENING STATEMENT OF SENATOR CARDIN The Chairman. The Small Business committee will come to order. Let me welcome our guests today. This hearing is scheduled for the oversight of SBA's implementation of final rules to expand access to capital. So, today's hearing will examine two new rules SBA finalized this month that aim to address the gaps in small business lending. The first would lift the moratorium on the number of small business lending companies, or SBLCs, participating in the SBA's flagship lending programs. The second would loosen affiliation standards and streamline lending criteria requirements in SBA's small business loan programs. These rules first proposed six months ago and scheduled to go into effect on May the 12th, make significant changes that will affect which borrowers and lenders participate in SBA's lending programs going forward. Notably, the rule significantly reconfigured the Community Advantage Program, which has been successful in providing capital to small businesses and communities that historically have been left behind. While I recognize that the SBA issued these rules with the goal of expanding access to capital for businesses in underserved communities and increasing the number of small dollar loans, I am concerned that the final rules do not offer the stability or specifics necessary to ensure Community Advantage's future success. I also worry that the rules that leave so many decisions to the discretion of the agency would have unforeseen and possible regrettable consequences down the road. Like many of us, I was disappointed that the final versions of these rules are almost identical to those that were proposed. Giving the degree of interest from so many corners and the significance of changes under consideration, it is surprising that the agency wasn't more receptive of many of the constructive comments it received. In our hearing with Administrator Guzman last month, we received assurances that many of our concerns would be addressed, yet the rules were released without the SOP guidance, which detail how the rule will be implemented and without meaningful changes. Lenders and borrowers need to know what will be expected of them as these rules are implemented and scheduled to go into effect on May 12th. And while the SOP guidance will address some of the missing details from the final rules, the fact that the agency retains discretion to make critical decisions on a case-by-case basis means that many program participants will remain uncertain about where they stand. This is particularly true for Community Advantage lenders. While I appreciate that the SBA aims to give the program stability through the rulemaking, many lenders may not even be aware that the program will be transitioned into the SBLC lending program in the coming months or understand what that entails. Even more concerning, the rule allows the SBA to make case by case decisions about important matters like lenders' required loan loss reserves and capital requirements. It worries me that this program could be changed dramatically by subsequent Administrations without any notice to the public by issuing new SOP guidance. Furthermore, I am concerned that these rules do not ensure the long-term integrity of the Community Advantage's important mission. The final rule does not specify target markets or metrics for success, thereby eliminating the key markers and accountability measures that previously ensured the underserved markets were served. Access to capital in underserved communities has been a persistent weakness of SBA lending programs, but Community Advantage has been our most successful program in reaching these small businesses. The program allows mission-oriented nonprofits to make 7(a) loans up to $350,000, focusing on economic development for underbanked small business owners. Although it is smaller, more targeted program than 7(a), the Community Advantage program has been very effective in addressing the credit gap. As I have repeated since this rulemaking process began and long before, I believe the Community Advantage needs the stability that comes with statutory codification. The Community Advantage Program was created as a pilot more than a decade ago, and now in recognition of its success, connecting underserved small businesses with capital, Congress needs to make it permanent and establish fixed, transparent requirements. I will continue to push our community to do just that as part of our bipartisan reauthorization process. I just might point out that part of the reason we are here today talking about the rule and our concerns is that Congress has not acted in this area. We have a responsibility as Congress to give the guidelines. That is why I think it is absolutely essential that we move forward with our bipartisan reauthorization of the SBA laws, where we can speak to the specifics. And if we don't do that, we are ceding of our authority to the Executive Branch. This is not to take away from the many good ideas in these rules, some of which will speed up loan approvals for modernizing the underwriting process. However, the changes seem heavily focused on giving lenders greater autonomy and less guidance, enabling them to rely on automation. Absent proper oversight, it is easy to imagine a scenario in which these changes enable predatory lending practices to creep into the program. Efforts to increase speed and volume can help modernize SBA programs, but they must be accompanied by corresponding commitments to exercise caution and vigilance. The rule gives considerable new responsibilities to the Office of Credit Risk Management, or OCRM. However, according to a recent whitepaper released by the Inspector General, this office is currently short staffed and has been for some time. While Administrator Guzman told us earlier this month that SBA is confident that OCRM can handle both its current and future responsibilities with its existing staff levels, the Inspector General observed that the office is not currently keeping up with the oversight of the 7(a) loan program. Given this new direction, I remain concerned that the President's budget did not recommend an increase for OCRM, assuming the agency knew these rules were close to being finalized in the coming year, the budget request should have accounted for the growing importance of this office as a primary overseer of the agency's lending programs. Again, while we may not see eye to eye on all the particulars, I do want to commend the Administration for its commitment to expanding the reach of SBA lending programs to underserved communities. And I assure the Administration, I want to work together, I want this committee to work with the Administration in order to accomplish our mutual goal of extending credit opportunities, particularly to the smaller small businesses and those in underserved communities. Small businesses across the country rely on 7(a), 504, Community Advantage, micro loan programs. Lenders and small businesses alike need these programs to remain stable, transparent, and sufficiently empowered to reach underserved borrowers. These should be our guiding principles. I look forward to hearing from both panels of our witnesses today so we can better understand the concerns and we can move forward on a common agenda. And with that, let me recognize the distinguished Ranking Member, Senator Ernst. Senator Ernst. Thank you, Mr. Chair, and thanks to our witnesses for being here today. And given the importance of today's hearing, according to our committee's rules, any member of the committee shall be empowered to administer the oath to any witness testifying as to fact. So, if you both please would rise and raise your right hand, I will administer the oath. Do you solemnly swear to tell the truth, the whole truth, so help you God? Mr. Kelley. I do. Mr. Shoemaker. I do. OPENING STATEMENT OF SENATOR ERNST Senator Ernst. Okay. Thank you very much. Just one month ago, Administrator Guzman was before this committee, and Chairman Cardin and I both expressed concerns with the SBA's new proposed lending rules. Fast forward to our very next committee hearing today, and now the rules are final, and none of the concerns we discussed were considered or addressed. It is really disheartening to many of us on this committee, as we saw in a bipartisan manner, where numbers of our committee members raised issue with the proposed rules, and it shows that the Administrator and the SBA was not working in good faith with us. These final rules threaten to drastically change the SBA's flagship small business lending program. The Administration will allow for an unlimited amount of non-depository institutions, fintechs, to become permanently licensed SBA lenders. It also removes underwriting standards that will inevitably increase risk. Taxpayers recently witnessed the Federal Government lose more than $64 billion in paycheck protection program funds due to fintechs facilitating widespread financial fraud and improper loans. Yet before oversight investigations into these entities have crossed the finish line, the SBA has decided that now is the time to replace community lenders with artificial bots. The SBA is not prepared to evaluate the use of artificial intelligence or machine learning algorithms for underwriting and loan processing, nor does it have the capacity to enforce Federal anti-money laundering laws and know your customer compliance, which are vital controls in the U.S. financial system to keep money from flowing to and between bad actors. The rules state that it will fill the market gap for smaller dollar loans to underserved borrowers. But the rules do not limit the new non-bank lenders to small dollar lending. It begs the question, do we think fintechs will pursue small dollar loans or take up the opportunity to do $5 million loans if they have the ability to be repaid by the Government for a default? At the same time, the rule will allow for larger businesses to exploit these programs intended for truly small businesses. Lastly, the rules will give the SBA Administrator the authority to reverse loan decisions, forcing lenders to provide a loan, which is a backdoor way to direct lending by the agency. These sweeping changes will encourage risky lending behavior, causing subsidy rates to rise and increase fees on the very borrowers that SBA is trying to help. In spite of a bipartisan push for the SBA to exercise diligence and restraint, the SBA has ignored Congress, Democrats and Republicans, specifically this committee, every step of the process and is moving full speed ahead. Mr. Chairman, I do hope that we can work together to reign in the SBA's ill-conceived changes to these critical programs and actually address the gaps in small dollar loans and lending in rural America. Shifting loans from our banks on Main Street to bots in San Francisco isn't the best interest of our small businesses in Iowa, nor across the United States. And I want to be very clear about this, we need to come to a bipartisan agreement on a legislative response to these rules before we begin negotiations on other aspects of modernizing the SBA. Small business lending is the foundation of SBA's programs, and we can't undertake renovations to the rest of the agency until this dire problem is fixed. Thank you, Chairman. The Chairman. Let me thank the ranking member. We will now hear from our first panel of witnesses. Let me introduce both. Thank you both for being here. Mr. Patrick Kelley serves as the Associate Administrator for the Office of Capital Access at the Small Business Administration. In this role, he is charged for overseeing the office's operations, and the office is responsible for making capital available to small businesses through banks and other lending partners. This is his second stint at SBA, as he previously served in several positions during the Obama Administration. And Mr. Shelton Shoemaker serves as the Deputy Inspector General for the SBA's Office of Inspector General. He has been with OIG since 2011. He served in numerous positions at that agency before assuming his current role. As the Deputy Inspector General, he serves as a principal advisor to the Inspector General and assists in overseeing the office's operations. Without objection, both of your full statements will be made part of the record. You may proceed for approximately five minutes, leaving time for us to be able to ask questions. We will start with Mr. Kelley. TESTIMONY OF PATRICK KELLEY, ASSOCIATE ADMINISTRATOR, OFFICE OF CAPITAL ACCESS, U.S. SMALL BUSINESS ADMINISTRATION Mr. Kelley. Chairman Cardin, Ranking Member Ernst, members of the Small Business committee, thank you for the opportunity to appear here today on behalf of Administrator Guzman and the Biden-Harris Administration. I began as the Associate Administrator for the Office of Capital Access in March of 2021, and as the Chairman mentioned, I have been responsible for the Paycheck Protection Program, the COVID EIDL loan program, the Restaurant Revitalization Program, and now oversee the 7(a) program, the 504 program, micro-loans, and the Surety Bond Program. What I want to start first by saying today is for the first two years of this position, the number one priority from Administrator Guzman was to take care of the challenges that we inherited when President Biden took office regarding the CARES Act programs. Over the last two years, we have screened 49 million applications across the CARES Act programs, PPP, and COVID EIDL, as well as SVOG, and Restaurant Revitalization, which were part of the American Rescue Plan. We have flagged almost 6 million files for suspicious activity, we have conducted 3.5 million manual reviews, and we have referred over 3 million instances of attempted fraud in what we believe is fraud on disbursed loans. Close to 800,000 loans that were dispersed and 3 million more that were attempted. So roughly $40 billion is the fraud estimate that we believe was dispersed, and $60 billion of attempted fraud totaling $101 billion. And we intend to support, and our budget reflects that from President Biden, the Office of the Inspector General in their attempt to go get the bad guys that we have identified. Since Administrator Guzman took office, we have made every single piece of data available to the Office of the Inspector General. Our predecessors sued the Office of the Inspector General and the public to keep that information private, which I believe created and exacerbated the issues regarding the allegations and estimates of fraud. We have addressed all of the material weaknesses that we inherited, IP static address, failure to check business address, automated screening, data analytics to determine which supervised learning models, which prioritized files we need to manually review. So, I start there because it is important to understand that for two years, we have, through automated screenings, through data analytics tools, through manual reviews, referred now 3.5, 3.6 million applications to the Office of the Inspector General for them to go after, and we will continue to work with them on that. I start there because it is important to understand that the CARES Act program legacy will not simply be the management challenges that the Biden-Harris Administration handled, but what the Biden-Harris Administration did to stop that, to put an end to it, and then to take from there and make sure it never happens again. In our programs moving forward, and I look forward to discussing all of the issues that Ranking Member Ernst and Chairman Cardin addressed, I look forward to discussing how we will screen in all of our existing programs pre each ran authorization for eligibility and fraud moving forward. And I am happy to get into the details of that. We believe that that is an important step that will be reflected in my colleagues, Deputy Inspector General Sheldon's testimony regarding the need for reviewing borrower and lender certifications so that we never again go to the point where we are relying on lender or borrower certifications. So, the last thing that I will share with my remaining minutes that I think is important for the members of the committee to understand and is important for me to share with the rest of the folks here, my family comes from Manchester, Connecticut. My parents grew up in East Hartford, which is the home of John Larson, and my grandmother lived on Mitchell Drive there, and it was an FHA home, post-World War II. She worked as a clerk in a grocery store. My grandfather worked in Pratt Whitney as a firefighter. When my grandmother passed away, my mother was in the house or finishing up the estate, and at a certain point, maybe she wouldn't want me to share this, she was cursing a blue streak from the kitchen. In these houses, and for the kids here that don't remember, there were phones with cords, extension cords that would go throughout. And my mother was cursing a blue streak because she learned that my grandmother was leasing her phone, the phone on the wall, from the phone company. That phone company had taken advantage of my grandmother and cost her money that that Social Security check was precious. So, I remember this vividly, and I understand what our responsibility is to go after charlatans in the financial markets. And I have spent a career working on those issues, and I look forward to handling all the questions today and working with the committee as we move forward. Thank you. [The prepared statement of Mr. Kelley follows:] [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] The Chairman. Mr. Shoemaker. TESTIMONY OF SHELDON SHOEMAKER, DEPUTY INSPECTOR GENERAL, OFFICE OF INSPECTOR GENERAL, U.S. SMALL BUSINESS ADMINISTRATION Mr. Shoemaker. Thank you. Chairman Cardin, Ranking Member Ernst, and distinguished members of the committee, thank you for the opportunity to be here before you today on behalf of Inspector General Ware. IG Ware currently is part of a high-level delegation to promote law enforcement partnerships with foreign counterparts in furtherance of rooting out fraud in the pandemic response programs. I am honored to represent the dedicated men and women of OIG and their hard work as this committee examines SBA's implementation of two recently finalized rules. SBA's final rules rescind the moratorium on new SBLC licenses, remove requirements for a loan authorization, and remove control as an element of affiliation, among other various regulatory changes in the 7(a) and 504 loan programs. OIG provides independent and objective oversight of SBA's programs and operations. In doing so, our office provides recommendations to SBA leadership to improve the performance of SBA's programs and services for the benefit of the American people. SBA 7(a) lending program provides financial assistance to small business in the form of Government guaranteed loans. SBA's lending partners in this program where the basis of the Paycheck Protection Program, which delivered vital financial assistance through the lending partners to mitigate economic damage resulting from the pandemic. There has been no higher priority for our office than providing oversight of the pandemic response. In the past two years alone, OIG's work has resulted in an exponential return on investment to the taxpayer, which is valued at more than $9 billion. In doing so, we have published 49 reports. Our work also has played a major role in the return of more than $30 billion in pandemic relief funds from borrowers and financial institutions. This work and our decades of oversight of the lending programs, affirms SBA must take deliberate and intentional steps to design, implement, and operate an effective internal control system as it lifts the moratorium on new SBLC licensors and as the Community Advantage SBLC into the 7(a) program. When SBA placed a moratorium on approving SBLC licenses in 1982, it did so to reduce the administrative resources needed to prudently regulate and oversee nine depository lenders with a nationwide 7(a) lending platform. As recent as 2020, SBA stated in its rule aimed at the supervised lender application process, that it does not have the administrative resources needed to increase the number of SBLCs beyond 14 or to oversee their participation in a nationwide 7(a) lending platform. Such concerns are well founded, especially in context of increased risk that are associated with lending authorities available within a 7(a) program, which presently are not authorized by the Community Advantage pilot program. Concerns also are present in context removal of loan authorization during loan origination. OIG's white paper on risk awareness and lessons learned from prior audits of economic stimulus loans, which was offered by OIG at the outset of the pandemic response, sought to inform the policy decisions in implementing the Paycheck Protection Program. Among the considerations in this white paper was for SBA to issue clear requirements and ensure timely communication to lending partners. Clear guidance and program requirements following the current rulemaking will enable lenders to participate in the programs with confidence that guarantees are secure if terms and conditions are met. I have offered additional insights on risk in my written statement that are based on our prior work. We believe appropriate consideration should be given to mitigating this risk as SBA implements these rules. Solid rules and regulations, strong internal controls, and effective process for oversight and monitoring can mitigate risk and lead to efficiency and effectiveness. Technology also can be a powerful tool in establishing a robust internal control environment for program management, for responsibilities of monitoring oversight, and for regulatory enforcement. Such efficiencies can augment limited resources. However, technological tools can be limited by availability of essential data. To effectively employ artificial intelligence, comprehensive data must be available and be current. It is vital where data limitations exist, the internal controls also are not absent and are calibrated in a manner that provides necessary assurance. OIG has an established track record of providing oversight at the inception of new programs, such as the State trade expansion program. The transparency afforded by our work and our well-founded recommendations for corrective action improve program delivery to the nation's small businesses. The nation once again could depend on OIG to provide independent, objective, and timely oversight of SBA. Thank you for the opportunity to speak with you today. I am happy to answer any questions you may have of me. [The prepared statement of Mr. Shoemaker follows:] [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] The Chairman. Well, let me thank both of you for your public service. Thank you very much for being here. And thank you for the role you are playing on behalf of small businesses. Mr. Kelley, I appreciate your testimony in regards to going after those who have committed either fraud or mistake. That is something that was really the subject matter of our last hearing. This hearing, the subject matter of the two rules that have been promulgated. And I am somewhat disappointed that your statement doesn't really address that rule. It is more dealing with the fraud issues than it is the rule that is before us on this hearing. So let me try to drill down a little bit. This rule is going to take effect in two weeks. When do you expect the SOP to be available? Mr. Kelley. I think our deadline right now is May 3rd, or in and around that date. The Chairman. And can you tell me why the rule? How do we guarantee that we are going to see loans to small businesses, smaller loans? How are we going to guarantee that the CA lenders are concentrating in underserved communities? How are we going to assure CA lenders are borrowers of the cost of the loans or the underwriting rules? I don't see that in the rule itself. So, if I am a CA lender, what confidence do I have that this program is really geared towards my mission, which is to provide help in underserved communities and smaller, or small loans. What assurance do I have that someday it won't be turned over to the larger loans, as we saw what happened with the 7(a) program? Mr. Kelley. So first, as Administrator Guzman did share with you and we shared with staff, we intend to put in the SOP and you will see reflected the 60-40 rule that was reflected in the Community Advantage Program guide. We have also discussed with your staff your bill, the Cardin-Chu bill calls for a 70-30 ratio. One of the reasons that Administrator Guzman did not put a 60-40 requirement into the rule is because, as she shared with you and members of the committee, the current definition of underserved does not include women or minorities. And so, any definition of underserved, I think in the room, would include those two bodies, most especially since African Americans represent 12 percent of the population, they represent 41 percent of sole proprietors, and they see 2 percent currently of 7(a) loans. And so, for example, when my counterpart here in the private sector, Hilda Kennedy, testifies of her lending in California, if her shop wanted to focus on meeting that underserved gap regardless of income level, she would not be able to focus exclusively on that as a mission-based lender. And it is the same for women who are underrepresented as well in the seven loans for the same thing. The Chairman. So, I am a bit confused. You are saying you didn't want to put anything in here to protect the mission and to the rule itself because basically court concerns about target groups. So, we have had a program that has been successful. The CA program has worked with the guidance on a percentage of loans in underserved communities, and you are throwing that out and saying we are not going to have anything in the rule but trust us. Is that what I am hearing from you? Mr. Kelley. No. That is not what you are hearing. So, in the 7(a) program, all lenders make 50 percent of their loans to the current definition of underserved. So, the current definition of underserved is rural, low to moderate income, hub zone startup, those businesses in business less than two years, and veteran owned businesses. So regardless of lender type, regardless of loan size, roughly 50 percent of the loans---- The Chairman. Which is not in this rule, is it? Mr. Kelley. I am saying you are correct. It is not a requirement of the rule. And yet every year the lenders, through their lending activity by nature of the---- The Chairman [continuing]. But that is the pilot program-- that is the CA pilot program. Mr. Kelley. Correct. But the--what I am explaining is that if you did not have a 60-40 percent threshold in the Community Advantage program like we do not have in the 7(a) or the 504 program, when the lenders are making their loans, the outcome, the outcome of the loans, the standard 7(a) express 504 loans ends up meeting the underserved definition that is defined in the Community Advantage, 50 percent. What is better in the Community Advantage Program is the loans to women and minorities. But in that definition, they do not get credit in the 60 percent threshold of meeting that 60 percent---- The Chairman. But they are meeting--look, the communities-- the Community Program is working. We have the 60 percent and we also have the penetration to the target groups who would like to get the loans. And the loans are also smaller dollar amounts and are also costing less. But none of that is in the rule. Mr. Kelley. Yes. So, as I explained to you, and Administrator Guzman explained to you as well, we are putting that 60 percent--40 percent threshold in the SOP. Each lender is responsible for executing the form 750. The first line or first two sentences of that form, the form 750 requires that the lender comply with all statute, all regulation, and all SOP guidance regarding the rules. The Chairman. What assurance do I have as either a lender or a borrower about the cost of a low--a small loan which is competitive under the CA pilot program but not necessarily under 7(a) program? What assurance do I have on costs? Is there something in the rule that I haven't read? Mr. Kelley. When--so are you referring to rate and fees of a 7(a) loan or are you referring to the capital requirements, the fidelity insurance requirements? The Chairman. I am really referring to both, but right now I am talking about the cost of processing. Mr. Kelley. Okay. So historically, Community Advantage lenders have always enjoyed a higher interest rate than standard 7(a) lenders. Most recently, we promulgated rules to standardize that for all lenders. And so---- The Chairman. Is there something in this rule that I can look at that says that we are protecting the 7(a) CA program on costs, processing costs? Mr. Kelley. Yes, so---- The Chairman. It is in the rule? Mr. Kelley. So, the rates themselves are in---- The Chairman. Processing costs, I am talking about. Mr. Kelley. Yes. Okay. So, then that is the fidelity insurance and capital requirements and loan loss reserves. So, for example, in the Cardin-Chu bill, you do not call for a capital requirement threshold or a fidelity insurance threshold. So let me explain---- The Chairman. Are you supporting the statutory approach of our legislation? Mr. Kelley. We are absolutely--we were directed by Administrator Guzman to, after working with your staff on Build Back Better regarding making Community Advantage permit, to look for the areas where your bill could direct us in a way that would make the Community Advantage program stronger. So, for example, in your bill you call for a 5 percent threshold for the loan loss reserve requirements, which allows for over 36 months of performing loan performance for that loan loss provision to come down. The Chairman. Are you supporting us statutorily passing legislation to make permanent CA program similar to the legislation that has been--was filed? Are you supporting a statutory approach or not? Mr. Kelley. I would support anything that helps Community Advantage lenders with their mission. The Chairman. I will take that as a yes. Senator Ernst. Mr. Kelley. Good. Senator Ernst. Mr. Chair, Senator Risch does have another commitment, so I will yield my time to him. Senator Risch. Thank you, Mr. Chairman and Ranking member. First of all, I was hoping Ms. Guzman herself was going to be here because I wanted to thank her and congratulate her by accomplishing something that is very, very seldom done around here, and that is bringing Republicans and Democrats together to oppose what they are doing on this thing. This is a disaster in the making. What shocked me was--I mean, we were treated like chopped liver around here. Guzman told us, oh, they are going to pay close attention to the concerns that we have. And less than just ten business days later, they announced that the rule was moving forward without any consideration of what this committee input that is put in here. Look, the financial industry--if you were in front of the Banking committee, I think they would be taking your head off here. The banking industry, the financial industry needs really close oversight regulation. I am no fan of Government regulation, but when it comes to finances, this country has learned over and over and over again with the banks--start with the savings and loans disaster that we had. If we aren't looking over the shoulder of the lenders, this is a disaster waiting to happen. And that is exactly what you are doing bringing the fintechs in here. We certainly should have learned this from the PPP program. All of us knew when we voted for that, that it was--we were taking a chance because of the know your customer was going to be out when there were too many customers. And that is exactly what you are headed for here. I would hope that you back up on this. I suspect you are going to be facing the CRA if you don't. Probably a bipartisan CRA if this regulation comes down the pike. But you know, the--one of the things that struck me is you are Fiscal Year 2022 goal for 7(a) loans to underserved markets was how much? 43 percent. Do you know what the actual production was on it? It was 68 percent. So, there is no failure here. I mean, you far exceeded the goals of what you were trying to do. So, I am not sure who the geniuses that brought this up, but I wish you guys to take this back to the drawing board and listen to us. I think Senator Cardin is right. I think, you know, we trust the agencies generally to do the kinds of things that we don't have time to do. It looks to me like we are going to have to take the time to do this, and I agree with you, Mr. Chairman. I think this is going to take a statutory answer to this. I have some very specific questions for the record, and if it is okay, I will submit those, Mr. Chairman. The Chairman. Certainly. Thank you. Senator Hirono. Senator Hirono. Thank you, Mr. Chairman. I take it that the concerns being expressed by my colleagues regarding these new rules also have to do with whether or not there are enough protections in the new rules to guard against fraud. Is that correct, Mr. Chairman? So, Mr. Kelley, what is in these rules that is different from what happened during the CARES Act provision, which, by the way, we did not--it is not as though Congress put in a lot of resources for SBA to do this stuff. We just sort of said, here, go and do it. So, in these new rules, what kind of anti-fraud measures are in the rule, briefly? Mr. Kelley. So, the moratorium allows a lender to participate in the 7(a) program. And as such, they comply with all the statutes, regs, and SOP related to 7(a) loan. So, for example, what was different--what is different about a 7(a) loan than a paycheck protection loan program? First off, there is underwriting. Second, there is collateral. Third, there are personal guarantees for any owner of 20 percent or more. And then what I indicated in my testimony and the reason I began with the CARES Act programs is because I wanted the committee to understand one of the major lessons that we did take away at the agency from the challenges that the Biden-Harris Administration inherited with respect to fraud in the CARES Act programs, and that was that if we need to do speed and certainty both, not just speed. And certainty requires that we put in place systems that will screen automatically before we disburse the money. The notion that you can go get the money after it goes out the door was never a real strategy. So, what we are also putting in place with this SOP for the first time is for all delegated loans, all non-delegated loans, any loan that is going to be originated across 7(a) and 504 and we did this in PPP three, we will be screening 19 different categories of eligibility and fraud. And if there are alerts and flags, which there were in POP three and there were in COVID EIDL, then we will move to determine whether there is a false positive, meaning it was an error and the person can move forward and demonstrate that that was a false signal. Or if not, we will prevent that from moving forward. And what that addresses in the audit reports that we share and that they provide feedback for us, is the notion of improper payment related to ineligible loans or reasonable reassurance of repayment. Senator Hirono. So, Mr. Kelley, you are telling me that there are many checks, many more checks than that were in place during the whole PPP and EIDL and those programs, because we directed you to put all this money out there in the community during a very challenging time for our small businesses. Is that correct? Mr. Kelley. Yes, it is. Senator Hirono. It sounds like. Okay, good. Then, did I hear you say that the definition of underserved do not include women and minorities owned businesses? Mr. Kelley. Correct. Senator Hirono. So that is a change, isn't it, that you are making? Mr. Kelley. No, it is not--it is not a change. It is never included. It has never been included. Senator Hirono. Why wouldn't you include minority owned businesses as underserved in the underserved group? Mr. Kelley. The agency under the Obama Administration, when we created the Community Advantage program in 2011, determined that using class, race, and gender as a differentiator would not be considered Constitutional. Senator Hirono. Has that been tested in court? Mr. Kelley. Well, we were sued, as you know, in the Restaurant Revitalization Program, where we had economically and socially disadvantaged and women as a priority applicant. And two injunctions were issued by two different courts. So, it has not been directly tested because we have not included it, but it was tested in the Restaurant Revitalization Program. And that is one of the reasons that you do not see in the definition. So the point I was trying to make to Chairman Cardin--I didn't do a good job and I know we are in align on this, but I am doing a bad job communicating, is that when we think of my friend back here, Hilda Kennedy, who is going to testify in the next panel for Accion, for the other guy, their focus is in these marketplaces, rural women, minority borrowers. And from the Administrator's perspective, she does not believe that mission-based lenders are going to forget their mission when they go to lend. And she wants to make sure that they are not ever in a position where they are non-compliant with our threshold because they want to originate 100 percent of their loans for women, for example, women entrepreneurs. Senator Hirono. So, I understand that you do have some legal concerns, but when we are talking about wanting to expand access to capital for minority owned businesses, that speaks-- that says to me, you obviously have information relating to black owned businesses. I would like to know whether you have any data on hispanic owned businesses, Asian-American businesses. There are thousands of small businesses in these categories, but you are saying that you have a concern about keeping track of the kind of loans that are made to these groups of businesses, of which there are thousands, and they are not all in hubs or all in rural areas, or whatever other categories you have. Mr. Kelley. Yes. So, what I am saying is, is that that data today is--has always been voluntary. The CFPB 1071 rules that have just been passed, which to my friend from Idaho with respect to the Banking committee, the banks were not in favor of 1071 for reporting, right, but that is a rule that is going to give us transparency on this very issue. And the further point that I am trying to make for Administrator Guzman is that because there is a question of Constitutionality in the minds of the Biden-Harris Administration, the Trump Administration, and the Obama Administration, three different Administrations that kept the Community Advantage Program alive and did not include those definitions that, we think we might be undermining the mission based focus on race and gender, which we totally agree violently agree that is where the true gap is. So, this would be, to Chairman Cardin and Ranking Member Ernst, in their desire to pass a law to make Community Advantage permanent. If Congress wants to make the underserved definition to include race and gender, which, for example, we worked with Senator Cardin's staff on Build Back Better, it would have, then we will implement the law as it is passed. But from the standpoint of the beginning of the Community Advantage Program to now, that definition has not included those. Senator Hirono. Okay. Thank you, Mr. Chairman. I think you should think about including race and gender as factors. The Chairman. Senator Ernst. Senator Ernst. Thank you, Mr. Chair. And as you can see, there is a lot of concern across the board about our discussion at the last hearing and the issues that were raised by the Senators on this committee. I know there are concerns in the House as well about the issues with the rules, and yet no changes were made to those rules. So, Mr. Kelley, I am concerned you started making calls to stakeholders to garner support for these rules when you noticed that they weren't receiving support. At any point during the rulemaking, did you conduct outreach or have discussions with stakeholders that was not made public and part of the rule's records, yes or no? Mr. Kelley. The--did we conduct outreach? Yes, we made all of the folks available--all the folks aware that the rules were available. We conducted staff meetings with Senator Cardin, for example, with members of different Community Advantage working groups. There was various, Now CAB, other groups as well who provided feedback. And then that feedback was reflected in the public written record as it was put forward. Senator Ernst. So, okay. So, you did have discussions with stakeholders and it was made public. Mr. Kelley. Yes, I believe so. Senator Ernst. And part of the rules record? Mr. Kelley. I believe so. Senator Ernst. Did you make any promises or commitments concerning the standard operating procedure documents or agency procedural notices in order to garner support for these rules, yes or no? Mr. Kelley. In order to garner support, no. Senator Ernst. Will you provide the committee with copies of your schedule, phone logs, and email communications during the rulemaking period. Mr. Kelley. I will do that--as you know, all of that information is the agency's property and working with the committee, you can submit a request---- Senator Ernst. So, yes. Mr. Kelley. But I think for full transparency, as Senator Cardin's staff understands and knows, and as we have alluded to in these discussions, Administrator Guzman had discussions, as is mentioned, with all of members of the committee regarding the rules and the feedback and regarding the public comments that had come in. And we discussed the public comments that were in the public record with various members about their concerns and their questions to amplify whatever they had already raised in the public record. Senator Ernst. Okay. The Chairman. I just want to point out, I am not sure Mr. Kelley can fully answer that question. These are legal issues that I would want the SBA to be able to work with us to get the information that we need. So, I recognize that is a question that may not be under your specific decision making. Senator Ernst. I would also--thank you, Mr. Chairman. And I also would want to know, of course, if there were discussions with stakeholders outside of Congress as well. Moving on from that, the SBA under your direction ended debt collections on $1.1 billion worth of unforgiven PPP loans under $100,000, and according to the Inspector General, is planning to do the same with about $71 billion worth of COVID emergency disaster loans, or the EIDLs. So, I sent a letter to Administrator Guzman on this EIDL decision, and I did receive a response, but I consider it an insufficient response. And that response came this morning, conveniently today as you are testifying. The letter failed to answer any of my questions. So, let's make sure we are setting the record straight, Mr. Kelley. Is SBA going to pursue debt collections on EIDL program loans under $100,000? And have you reached out to every borrower to confirm their ability to repay these loans? Mr. Kelley. Yes, we have. And I would like to clarify this, too, because it is important that we don't mislead borrowers. Every single borrower of PPP loan and every single borrower of a COVID EIDL loan must repay the loan. If they do not repay the loan, they were referred to credit bureaus. If they do not pay the loan, they are referred to Treasury, do not pay. The decision we made with the law--the law calls for the agency to make a cost benefit analysis for instances under $100,000, where the cost of administering the Treasury offset would be higher than the recovered dollars. And we looked at the costs, which it was estimated to cost about $6 million to collect $3 million on that $1.2 million--or 1.2 billion or 77,000 PPP loans. And that is because when we took a more conservative loan portfolio snapshot, we took 2009 to 2022, loans that had been underwritten, loans that had personal guarantees, loans that had all available collateral but could be unsecured, and we looked at what Treasury offset wage garnishment had collected, in that 13-year period, had collected $65,000. We had no personal guarantees. We had no underwriting. We had no collateral. These were all by design. These were not bugs. These were features of these programs. And so, after someone has not made repayment and the lender has taken the servicing and liquidation action that they can take, they seek purchase. And when we estimated the cost of pursuing Treasury offset, or TOP, it would cost us more than the money we would collect. And that is why we opted to stop that so that we didn't waste $3 million of taxpayer money. Senator Ernst. Mr. Kelley, I don't think it is a waste to ask Americans to repay loans that they signed---- Mr. Kelley. We are asking them to repay. We are not--we are--I want to make this really clear. We 100 percent, I want everyone watching at home on C-SPAN, you must repay your loan. If you do not repay your loan, if you do not seek forgiveness, incidentally, if you miss 60 days of nonpayment in the PPP Program by design, ratified by the Economic Aid Act, you still have up to five years to come back and seek forgiveness. So, we would be referring to Treasury debt. You are then allowed to have an administrative hearing as a member of the public regarding that before that wage offset kicks in. That costs the agency $700,000 in fees. You then can seek forgiveness for which under $100,000, by law, under the Economic Aid Act, you need to submit a one-page form to the lender who then services the forgiveness decision. So, repayment is 100 percent required. We will put them in Treasury do not pay, which means that they are barred from seeking any other aspect of Federal programs until they make the Government whole on that. They are referred to the credit bureau, so their credit score goes down and we should make a distinction as well. If anyone is an LLC, s-corp, or c-corp and they borrowed money, less than $100,000, they can enter into bankruptcy. And because the program did not require any personal guarantees, they will be discharged. And because we are in subordinated position as a result of the program, we don't have any standing in order to recover anything from the senior debt holders. So, repayment is absolutely required. We are doing everything, as are the lenders, to get repaid. We have forgiven 10.6 million out of 11.4 million PPP loans to date. And as you know, the taxpayer already gave 103 cents on every PPP dollar to either be used for purchase or for forgiveness. So, the only step that we are foregoing seeking is where we are going to lose $3 million more dollars of taxpayer money. The signal is not that we are telling you not to repay. We are absolutely telling you repay. But when we decided as a country, Congress and the Executive Branch, that we were going to provide emergency relief and we weren't going to require any of the safeguards that are normally associated with these loans, that was going to impact our ability to collect on the back end, which is why the subsidy rate was 103 cents to 100 cents. So, it is important that we will absolutely seek repayment. Senator Ernst. Well, and I know we need to move on, Mr. Chair, but I think the message is out there, though, that we are not doing everything we humanly can. We would rather not spend the $3 million. It is just like the charlatan that went after your grandmother on the phone issue---- Mr. Kelley. That person got away. In the case of the PPP program, we have identified the folks that either attempted fraud or committed fraud and we have referred them to the IG so that we can all go get them. That is the distinction. Senator Ernst. Thank you. And we will go ahead, Mr. Chair. The Chairman. Thank you. Senator Hickenlooper. Senator Hickenlooper. Thank you, Mr. Chair. Associate Administrator Kelley, nice to see you again. I know that the SBA is only adding three additional SBLC licenses at the moment on top of the 14 licenses successfully managed for 30, 40 years, I guess, as part of its rulemaking. However, many of the comment letters on the SBLC's final rulemaking have argued that removing the moratorium completely risks the--risks letting too many firms into the program for the SBA to be safely able to manage it. Are you willing to commit to only adding additional SBLC licenses once and only after the SBA has conclusively demonstrated it can provide appropriate oversight of the new SBLCs? Mr. Kelley. Yes. So, we indicated the reason that we didn't, and we indicated this in the proposed rule, and that we felt we had the capacity to take on three additional lenders. And I think what is important to understand is that in the 40-year history of the SBLC licenses, there has been 14 licenses. Those licenses have been available for sale for that entire 40-year period and have transferred 61 times. Each time there is a transfer, you need to--the buyer and seller need to apply to the SBA. There is a process written out in the SOP in the standard operating procedures. It has been there. It is not changing. It is not going anywhere. You apply when the application is reviewed. So, when we look to see whether the buyer should be approved from the seller, we look at the safety and soundness. We look at their portfolio history. We look at their business plan approach. We look at whether or not they comply with all of the rules that they need to comply with as an entity. So, for example, State user laws. We look at Bank Secrecy Act and those types of things. So, all of those things are put into consideration today that was in existence when we were growing the Community Advantage program up into the moratorium. And that program, the high water mark of that program was 130 entities. It dropped down post moratorium through attrition to the low nineties and has since moved up to 108 entities. So, when we looked at the existing capacity, we looked at the oversight headcount. We see exactly what you see. Administrator Guzman, I, we all share the same concerns. We looked at the fact that we had the capacity under the ceiling and we set it at three because we understood clearly that we were going to be doing something different. But we should make no mistake about the following either. And I think it was a great point that Chairman Cardin and Ranking Member Ernst brought up. You know, how do we know that these lenders will make small dollar loans or how do we know that these lenders will fill the gap? Why are we not asking the same of the lenders who have participated in the program for years? We have not--we have not been called on to require a quota for any of the banks or credit unions. Credit unions make 500 loans a year in the SBA program, and yet there are north of 5,000 institutions out there. In the 90s, credit unions explained, against the bank wishes, that they were going to grow access to capital by serving underserved needs, and yet their average daily balance to high- net-worth individuals has grown. So, each time we look at these institutions, we are keenly aware that the lending intermediaries that we work through can make choices. But I don't know why we are limiting ourselves to being concerned about the lenders who in the marketplace are showing time and time again that they have created a comparative advantage. They think their business model is competitive and we are going to give them a conforming product, a product that has transparent terms, better amortization periods, better rates, better fees, and that is the only thing that they can originate. And as I said in my opening testimony, we can screen now, prior to each brand authorization, with digital tools, we do random audits of those files every time they file. So, to Ranking Member Ernst's concern, every time they make a bad loan, and Deputy Inspector General can echo this, if they make a bad loan in less than 18 months as an early default, it is referred to the Inspector General as well as us, and we look to repair and deny the guarantee. So, I think that we--I just want to make everyone aware that we completely agree with all members, bipartisan, that this is a thing that has to be taken soberly, has to be taken seriously. And we believe that we have systems that we have developed over time that can support that. And yes, we are going to move slowly. We are going to move judiciously to get it right. Senator Hickenlooper. Good. I think the question, which I think you have answered, is that we want to make sure that there that we are not losing anything in the transition, and that somehow the having the barn door open a little bit isn't going to lead to some level of, you know, uncontrolled transformation. And I am that is not a worry of mine. I think that you have demonstrated that you have the capacity to administer the program properly and that you are going to do so cautiously and expeditiously. I yield back, Mr. Chair. Senator Shaheen. Thank you. Senator Budd. Senator Budd. Thank you, Chair. Again, thank you both for being here. Mr. Kelley, I want to go back to a previous conversation you had with Chairman Cardin. Can you clarify of the 60, 40 split in the SOPs that applies to all lenders or just the SBLCs? Mr. Kelley. So currently right now, the 60, 40 requirement is in the Community Advantage program only. And so what I shared with Chairman Cardin, now I will repeat for you, Senator Budd, is that roughly 50 percent, right, in a given year of 7(a) loans and 504 loans, regardless of size and regardless of lender touch, the definition of underserved--and the definition of underserved includes low to moderate income, hub zone, startup, those businesses in business less than two years, and veteran owned businesses, and rural. Senator Budd. So that is 50 percent? Mr. Kelley. That is roughly 50 percent. Yes, there is--give or take. And so, my point to Chairman Cardin was that if minorities are seeing less loans or women are seeing less loans, then the census track is demonstrating that they are sole proprietor. So sole proprietors, as you know, seek smaller dollar amounts, right, by definition, right. And so, if those types of entities overindex, which they do in the census track, to minorities and women, and we are not seeing--when we are seeing a five-year decline of like 45 to 50 percent in terms of small dollar lending, then the outcome that is created by that, right, is that you are going to see less loans, right. And if those there are less loans to sole proprietors, you are going to see a disproportionate impact, right, or a disparate impact on classes that are overrepresented in that type of entity type. So, our position is that when we are choosing lender intermediaries, the whole point--I was there at the beginning of the Community Advantage, but the whole point of the Community Advantage Program was, don't try to figure out for the private sector entity how to--figure out the business model. They have established their business model. They are already showing you that they have a market niche for whatever their reasons are. That is how they make their money and that is how they serve their thing. And in the case of mission based CDFIs, their primary focus is often rural, veteran, minority, women, and they have all different types of strategies. And so, if we allow them to use the same tool, then they will reach a customer and they will enjoy the benefit of that tool no different than the bank or credit union that has enjoyed exclusivity historically. Senator Budd. Thank you for that. Mr. Shoemaker, thanks for being here. You know, some of the rules that have been discussed today would allow the SBA Administrator to review reconsideration of denial requests and make a final decision without transparency or justification. In other words, it provides the Administrator with the sole power to grant 7(a) loans or--regardless of the credit creditworthiness of the loan applicant. Mr. Shoemaker, should the SBA be required to be transparent to both borrowers and lenders by providing written justification when making final decisions on reconsideration of denial requests? Mr. Shoemaker. Certainly, transparency is a key. In regard to whether or not the Administrator has the authority to do the reconsideration, certainly there is always the chain of command that gets to that level. I believe that is actually already in place, that she has that ability to make that decision--if you want, but go ahead--thank you---- Mr. Kelley. Yes. So, yes, for reconsiderations, we do--so, for example, in the COVID EIDL program, all folks that were denied and were seeking reconsideration received a written justification for, you know--and we improved in the summer of 2021 the explanations of things that they need to do to cure-- yes---- Senator Budd. Mr. Shoemaker, and follow up if we needed, Mr. Kelley. Should the SBA Administrator have the authority to force a lender to provide a 7(a) loan regardless of the credit worthiness of the borrower, or if the application may be fraudulent or improper? Mr. Shoemaker. Again, the Administrator does have the authority to make the loans. I certainly wouldn't advocate for a loan---- Senator Budd. This is about forcing a lender to provide the 7(a) loan. Mr. Shoemaker. Sure. So, I wouldn't advocate for a loan that has any of those poor standards to be put out in the-- expose the taxpayer to that risk. Mr. Kelley. And speaking on behalf of the Administrator, no, we would not want to force a lending intermediary to make a loan that they don't want to make. Senator Budd. Thank you. I yield back. Senator Shaheen. Thank you. Mr. Kelley, the SBA played a critical role during the pandemic. I think we could all agree with that. And the benefits are still out there. We have seen a record number of new small businesses being formed over the last two years. But I am concerned that the recent affiliation rules that the SBA just finalized will allow larger companies and to your loan programs. So, can you explain the rationale for that? Mr. Kelley. Yes. And I encourage you, if you are able, in the second panel, Hilda Kennedy is testifying and she is part of a certified development corporation, serves on the board of Nabco, which I am sure you are familiar with as a trade association. Granite State is obviously a huge player in the 504 program. Beginning in 2011, during the Obama Administration, members of the National Association of Development Companies came to us coming out of the Great Recession, this is under the Obama Administration, and the board said that there are two critical challenges, amongst others, in the 504 program in terms of being able to do economic development. The first was affiliation. The second was the personal resource test. During the Obama Administration in 2004, we removed the personal resource test with respect to affiliation. We did not ultimately go forward with the affiliation change. The reason that affiliation has historically been complicated for lender and borrower alike is that the concept under the Small Business Act, independently owned and operated, was viewed as two separate prongs, so independently owned and independently operated. And what we have chosen to do is interpret the regulation as a non-severable clause, comparable to cruel and unusual punishment, because based on feedback from practitioners, lenders and borrowers, when you ask a small business owner who owns the business, the ownership test is key, and what we found is that the primary driver of size in our programs is determined by the Government contracting and business development size standards, which set based on the industry standard, either revenue or employee threshold. And under that, even counting affiliates, 97 plus percent of applicants are considered small, and that is by design. That is how the Government contracting, and the lending programs in particular. In 2010, under the Obama Administration, we passed the law, the Small Business Jobs Act, and that included an alternative size standard which allowed for a $15.5 million tangible net worth and $5 million income test. So, under the lending programs, the size standard has always enabled folks to qualify. What was confusing was the subjectivity of the concept of negative control on how a lender, without lawyers, could review management agreements that were entered into by third parties. And so, beyond the size standards, in practice, how this happens is the biggest inhibitor to large entities getting SBA debt is because any owner of 20 percent or more has to provide a personal, unconditional guarantee, and for medium sized entities or publicly traded companies, that is a do not pass go. And so that critical requirement, together with the fact that a credit not available elsewhere borrower, so somebody that is--can't find conventional credit, can seek today in the junk bond market a 9.3 percent total cost of borrowing versus the current rate for an SBA 7(a) or 504 all in fees plus interest rate, is closer to 11 percent. Senator Shaheen. I have some follow up questions on that that I would like to get explain, but I will do those for the record because I am almost out of time, and I have another question that I am very concerned about. Last August, we talked about staffing levels at district offices. And your--I think your response to my concern was that it was dependent on the Appropriations committee. Well, I sit on the Appropriations committee, and I want to be clear that I believe the committee thinks that SBA should focus on oversight of lending. And the SBA now appears to be able to shift resources to add staff in order to do that. But while it is doing that, it is also cutting district offices and small business development centers. So can you explain the tradeoff there and how we can make sure that our district offices and the small business development centers have the resources they need in order to operate, because they are the ones who really have boots on the ground in our States, who are working with small businesses. Mr. Kelley. I apologize. I am the Associate Administrator of the Office of Capital Access, and there is a lot of ground that I cover with the loan programs, the CARES Act programs. I am not the CFO of the SBA, and I am not the Chief of Staff. I am not the Administrator, and I don't make the budget determinations for the Office of Entrepreneurial Development or the Office of Field Operations. I also share with you that the district offices, as does the Administrator, are a valuable resource to assisting lenders and assisting borrowers, finding lenders, and we work through those 68 district offices. But I don't really---- Senator Shaheen. So last year when you told me that that was dependent on Appropriations, you didn't have the same issues that you do this year? Mr. Kelley. Well, it doesn't--doesn't my answer still hold? So, what I am saying is--what I meant by that is if you--if the appropriators disagree with the President's budget, my understanding is that they can appropriate money and in different buckets, in salary and expenses. And so, all I am trying to say there is that I don't have the ability to move money around at the agency. And I don't have--obviously, I am not a member of, I don't have the ability to appropriate. So that is what I meant by that. Senator Shaheen. Well, thank you for that clarification. I can assure you that I will be advocating that we adequately fund district offices and small business development centers. And I hope you will take the message back to the leadership at the SBA that this is a priority for the members of this committee and I believe for most of the members of Congress, because they are the folks who actually are working at, they are working with small businesses. And while we appreciate the support structure that the office gives to those offices, I don't think it ought to be a tradeoff that that we should take the operating expenses away from them so that work can be done in Washington. So, thank you, Mr. Chairman. The Chairman. Well, Senator Shaheen knows I strongly support the point that she is making. I think this whole committee does service in the community, and our States are the bedrock of the link between small businesses and the services that we can help provide. Mr. Shoemaker, the fact that no one asked too many tough questions of you, you should take that as a compliment. Just want you to know that I do hope, though, that there will be a working relationship between SBA and the IG in implementing any expansion of supervision over lenders. There is a concern about the resources, and I would hope that the Inspector General would work with the SBA to make sure there is adequate personnel to handle whatever responsibilities, whether it is under this new rule or legislative legislation that we pass in Congress. So, I heard you make that offer of help during your testimony. Just want you to know that we are going to be requesting that you keep us informed as to your observations. And Mr. Kelley, I have asked this question before of the SBA, and I always get a positive answer that you always want to work with the IG and you are willing to accept their recommendations and try to work in a cooperative spirit and let the record show you are shaking your head affirmatively. And then lastly, let me just point out, that on mission lending, the CA program has mission lenders. Now, I have confidence in mission lenders, I do, but we have a 60 percent requirement in there and it has worked. The CA program has a record of exceeding twice as many loans in minority small businesses than the CA--than the 7(a) program. So, they are reaching these groups that we cannot specify because of legal challenges. So, my concern is whether the rule itself will preserve mission lenders. And without being specific, I see the larger loans and the larger lenders may be consuming the mission lenders because they don't have the same type of volume and profit that the larger lenders have. That is my concern, that they could be consumed without protection built into the program. Mr. Kelley. Yes, so I think it is totally--I share and as does the Administrator, and it is a totally legitimate concern that we all care about producing a better set of outcomes than historically we have. And what I want to underscore is, as Administrator Guzman indicated to you, we intend to preserve the 60, 40 percent threshold in the SOP. Your bill called for 70, 30, as we have indicated to staff in conversations that we have had--as she did. That might be the right threshold. There are other elements of your bill, for example, with respect to cost that made total sense. And we are putting into the SOP as well. So today the loan loss reserve requirement in the Community Advantage program is 10 percent. We are putting 5 percent. And I do want to clarify something. There was a lot of comment, public comments in the rulemaking about requiring capital requirements for CA SBLCs and requiring fidelity insurance for SBLCs. That was part of the 100 comments that you are talking about. That was not in the proposed rule. We did reflect in the final rule the authority for the Administrator, that the person that holds my office or a designee, the right to set those thresholds, as we do in the for profit SBLCs. And the reason that we created a separate class was to build off of the 13-year pilot where we provided a temporary license, which part of what we waived was the moratorium in that program. And those lenders can't afford, quite frankly, the liquidity to meet the $5 million threshold that the for profit SBLCs are require for capital, as you know, and the fidelity insurance, which is $2 million and then goes up from there. The Chairman. So, lastly, let me mention the affiliation rule and my concern. Mr. Kelley. Sure. The Chairman. And that is, with the determination of affiliation now being primarily made by the borrower and the lender, rather than the SBA, my concern is that you are liable to see large entities through the use of affiliations that they really control. They may not have the ownership technically because they can do that through a lot of different mechanisms and policing financial mechanisms with the right to foreclose. My concern is that are we now going to be seeing more of the resources at SBA going to the larger small businesses rather than the smaller or small businesses, and maybe to businesses that are well beyond the size limitations through the use of affiliation? It is an issue that has me greatly concerned because I know that you always had the ability to audit, but I don't see, as we have seen before, it is not easy to catch this after the sources are out. Mr. Kelley. So, totally, totally agree. Historically, eligibility has been a borrower certification on the form 1919. There is a question regarding affiliate--affiliation, for example. There are subsequent questions to that. And then the lender was required in all but the franchise area to be responsible for determining whether eligibility had been met. And as is indicated, there have been instances over however many years there have been audit reports that there have been lenders who have approved ineligible loans. And those ineligible loans are, if they default, if they default in less than 18 months, they are referred to the Inspector General. If they default beyond that, right, we have the ability to repair the guarantee, lower the guarantee, or outright deny it based on the error. The only instance where eligibility was determined prior to--from 2018 to 2023, a franchise business model could prevent--could present the franchise or agreement, and an attorney at the SBA would review that franchise or agreement for two reasons, affiliation and ineligible business model. There are 212 instances from 2018 to 2023 where the businesses, the franchisee was disallowed based on ineligible business model. So, what we are putting in place, and this is what I opened with, and I apologize for starting with CARES Act, but what we were able to do beginning in Biden-Harris was put in 19 automated screening filters, which involves NAICS codes, affiliation, business address, those type of---- The Chairman. But here is the change. The changes--you have changed the standards on affiliation as well as not having a register. And when you change the ownership and control issues, it makes it easier for a large company through very sophisticated agreement to control a franchise but still be able to claim that they are independent for the SBA loan. That is my concern, and I don't think you are going to be able to pick it up under the way you are doing. Let me recognize Senator Ernst for any comments she wants to make, or questions. Senator Ernst. Yes. Thank you, Mr. Chair. And I do agree we have seen troubles with the affiliation rules in the last couple of years, so I would rather not revisit that. As we move forward, we need to make sure we are getting it right. So, yes, I don't want you to leave Mr. Shoemaker, or Shoemaker, without feeling you have gotten a fair shot at discussion today. So just very briefly, I am still having a little bit of trouble wrapping my mind around the $3 million investment for recovering the $71 billion in EIDL. Mr. Kelley. To only collect $3 million, to lose $3 million. That is what we are explaining---- Senator Ernst. But there is $71 billion hanging out there of EIDL. Mr. Kelley. The $71 billion is the amount of outstanding debt yet to be repaid in the COVID EIDL program. It hasn't defaulted yet. And then in order to get to Treasury offset, we have to--we have offered in compromise as far part of the repayment period where we can create partial payment plans to offset the loss to the taxpayer. So, it is--we can estimate that every single COVID EIDL loan outstanding under $100,000 is going to default. But we have subsidy models where we forecasted, beginning under the Trump Administration, what the likelihood of default was, and it is based on historic norms. And so, in the disaster loan program, we normally see 21 percent or higher. In the case of 9/11, it was upward--it was north of 30 percent, with respect to nationwide for default. Senator Ernst. Okay. So, you--and you are saying here today you will not be seeking loan forgiveness as SBA for EIDL loans under $100,000. Mr. Kelley. There is no loan forgiveness allowed in the COVID EIDL program. Senator Ernst. Nor in the PPP? Mr. Kelley. Correct. In PPP, the loan was by design, by statute, it was a forgivable loan. In the COVID EIDL loan program, there was never an option for forgiveness. So, what I am saying is every single borrower has to repay both the PPP loan or seek forgiveness. That is another option they have in PPP. In COVID EIDL, they only have the option to repay. If they do not repay, right, normally, in the normal disaster loan and in our core programs, we would have personal guarantees, we would have collateral, we would have all these other additional guardrails for collection, which is why we run a negative subsidy, which means we make money for the taxpayer. In this program, we don't have that. And then when you look at the wage garnishment results, so we can look at the Treasury money that has come back to us over the years for loans where we actually underwrote the loan, right, in the beginning and had these guardrails, and we see we only collected $65,000. That is why we are making the decision. We are not making the decision to forego offset because we don't want to collect--we would collect--there is no reason why we don't want to collect the money. We were looking at the cost, benefit and saying, why should we lose $3 million more dollars of taxpayer money? Mr. Shoemaker. If I may---- Senator Ernst. Yes. And I was going to redirect to you. We got into a conversation there, so. Yes, Mr. Shoemaker. Mr. Shoemaker [continuing]. Senator Cardin, we do have a healthy relationship inside of SBA between SBA and OIG, which means that there are areas of disagreement, and this is one. To that extent, we disagree that there was a comprehensive cost benefit analysis performed relative to the PPP. We have ongoing work in EIDL. And as you appropriately indicated, the area of risk is $71 billion. That area was actually $76.9 billion. My colleague just indicated, you know, that this is just a potential risk. The loans are performing. Right now, we are seeing more than $60 billion that are past due of that $76.9 billion. And we have seen close to $30 billion that have already defaulted. What that means is that that collections will not go forward through the Treasury offset program. Collections, you know, can always happen. SBA--and Patrick is absolutely right. You know, first of all, the borrowers should repay. And you know that is first and foremost. And there are other avenues and mechanisms to ensure that they don't gain access to other benefits. There is reporting as an indication and there is lots of different vectors that get into do not pay. One of them is the Treasury offset program. But what is important about the Treasury offset program, you know, unlike the conversation here is, Treasury offset is a means of collection. That is how you get the money back that has defaulted. You know, there are--the cost benefit analysis could show other models outside of the Treasury offset program. But our contention is that we believe that a comprehensive cost benefit analysis needs to be performed. There is an open recommendation on the PPP program. I expect it will probably be revisiting the same conversation when we issue the EIDL report. Senator Ernst. And I do understand, Mr. Shoemaker, that there is an IG report that is coming out very soon on EIDL collections. Is that correct? Mr. Shoemaker. That is correct. Senator Ernst. Okay. So, all of that will be spelled out, I assume, in that report. But I think this dialog today is just all the more reason that with these rules, we need to make sure that things are right. Because if we are seeing fraud in a hastily put together program such as EIDL during COVID, you know, we certainly can expect to see that through fintechs as well and some of the other methods that are coming out through the rules. We need to protect the taxpayers against fraud. We want to make sure that the dollars are going to those small business entities that are truly deserving and need those resources. Mr. Shoemaker. Right. The answer on the fintechs is, it requires--the lenders require strong oversight and monitoring by the SBA. The SBA is the supervised lender. PPP is completely different that than 7(a) program. You know, there is the 100 percent guarantee. You are dealing with self-certification. But one of the things that happened, you know, in the use of fintechs as financial technology companies is not--you know, it is a little bit of a misnomer in this idea of fintechs as just--as a lender. The regulated entity, the supervised entity by, you know, of SBA basically had contractual agreements that exported some of these lending responsibilities, the loans--you know, lending service provider. The lending service providers are under the oversight of the regulated entity. That regulated entity is under the purview of SBA. So strong oversight and monitoring within the lending community is key to this notion of financial technology companies, you know, being part of the program. Financial technology has been a part of, you know, the banking industry for a long time. You know, anytime that anybody logs on and does mobile banking, it is probably not the bank that is promulgating that technology. It is probably a contractual relationship. However, you know, in this model where we are talking about, you know, a relationship where an eligibility decision or know your customer, bank secrecy regulations, I mean, even questions about bank secrecy regulations on whether, you know, some of the loan companies may be even covered by it, I think that needs to be explicit in that regard. Because the know your customer was what was on the front end of that financial technology. This is where you see, you know, a fraudster hitting 35, 40, hundreds of, you know, loan portals to, you know, steal from the taxpayer. Mr. Kelley. Yes, I totally agree. And if you look at--so first, I worked for a bank prior---- The Chairman. We are going to need to wrap up. Mr. Kelley. Okay. Senator Ernst. Yes. I apologize. Thank you. The Chairman. No, sorry. We have two witnesses that have been extremely patient, and this is not the end of our discussion. I really do appreciate both of your testimony today has been extremely helpful, and I mean that. As I said in the beginning, I want to work in a constructive environment. I still feel the best ways for Congress to speak to policy. And we have been somewhat missing in action on this issue, so I hope that we will have a chance to express ourselves and we can get something that we are all in agreement with Democrats, Republicans, House, Senate, and the White House. That will give you greater guidance. And I know the frustration of some of the members and regards to targeted groups. It frustrates me as well, but we have to work within the legal confines to try to achieve these objectives. With that, let me thank both of our witnesses and we will call up the second panel who has been very, very patient. By the way, there is a vote going on. I have already cast my vote. Senator Ernst has not had a chance to cast that vote yet. So, every once in a while, we have to balance also the votes on the floor of the Senate. Let me welcome our two witnesses. First, Mrs. Hilda Kennedy. She is the Founder, President of Impact Business Capital, which is a nonprofit certified lender of SBA that participates in the SBA Community Advantage pilot program. Prior to founding AmPac Capital, Mrs. Kennedy worked in local Government in California. She has also served on the White House and SBA Council on Underserved Communities, and currently serves as the President elect for the National Association of Women Business Owners California. Ms. Kennedy received her degree from the University of California at Berkeley, completed a postgraduate fellowship with the Corow Foundation, and completed a master's coursework at the University of San Francisco. Our second witness is Mr. Chris Pilkerton, serves as the Chief Legal Officer for Accion Opportunity Fund, which is the nation's largest CDFI concentrating on small business support for underserved communities. Prior to his current role, he served as Senior Policy Advisor at the White House, and Executive Director of the White House Opportunity Now Initiative, as well as Acting Administrator and General Counsel of the SBA during the Trump Administration. He holds a BA from Fairfield University, an MBA from Columbia University, a J.D. from Catholic University School of Law. We will start with Ms. Kennedy. By the way, your statements all will be made part of the record, without objection. You may proceed as you wish. STATEMENT OF HILDA KENNEDY, FOUNDER/PRESIDENT, AMPAC BUSINESS CAPITAL, ONTARIO, CALIFORNIA Ms. Kennedy. Thank you very much. Chairman Cardin and Ranking Member Ernst in her absence right now, distinguished members of the committee in their absence, good afternoon and thank you for having us today. As President and Founder of AmPac Tri-State CDC in Ontario, California, as stated, we are an economic development and mission driven lender, and we participate in the SBA 504 Community Advantage and microloan programs, as well as a CDFI. In fact, as a 504 lender, we have done a little over $1 billion in SBA 504 lending in the past 16 years, and we have on balance sheet a little over $9.8 million in loans through our community impact loan programs from $5,000 to $350,000. And so, we care deeply about expanding access to SBA lending programs, and my faith is at the root of that. Knowing that with God all things are possible, we approach our work from an it is possible mentality, creating possibilities for the communities who need it most through entrepreneurship, small business formation, job creation, and building generational wealth. And that is why I believe so strongly that Congress and SBA must address the inequities for underserved businesses and must work in concert and complement each other, and that is my most urgent message today. Looking at the tenets outlined in the small business that it states, and I quote, ``that the opportunity for full participation in our free enterprise is essential if we are to obtain social and economic equality and improve the functioning of our national economy.'' So on this 70th anniversary of the Small Business Act of 1953, I believe the Community Advantage Loan Program Permanency Act of 2022, helmed by you Chairman Cardin, and its companion House bill, championed by my Congresswoman Judy Chu, and the SBA's expected May 12th launch of the final rule with the Community Advantage Small Business Lending License, and the other SBLC licenses, are parallel efforts that can provide the traction to finally hit the stride we have been seeking to elevate our nation. Chairman Cardin and Representative Chu have been seeking to diligently codify the CA program, and I thank you for your dedication to these communities that are often overlooked. Equally, I think Ranking Member Ernst, whose leadership and commitment to increasing access for rural small businesses, with the mission of the CA program. Just an example of one of our CA borrowers, Dr. Zuniga and Dr. Espinosa, they were five-year doctors. They had been practicing under a physician, and they wanted to buy their building, or they wanted to do a small business loan to start their practice, but they couldn't with their bank that they thought they had a relationship with. So, they came to us. They were turned down because they a startup. They had a lot of student loans, and they had recently purchased their home. But because of our work as a Community Advantage lender, we were able to give them a loan because of the transformational work of the community advantage reforms that happened back in March. And that really made a difference and I believe was the first and necessary step for the rulemaking process in considering this CA, SBLC, and other SBLC licenses. You will have more details in my written remarks, but I want to close by highlighting my recommendations in my remarks. First, I believe we need to shift the narrative from either, or to welcoming all efforts to improve access to SBA's lending programs for underserved communities, which was intended in the Small Business Act. Second, Congress should pass your bill, Chairman Cardin, and the House bill to make Community Advantage a permanent offering of SBA. Third, Congress should capitalize on challenges faced by mission-based lenders in accessing capital to provide to underserved communities. And finally, SBA should apply provisions from Chairman Cardin's bill in areas where the SBA, SBLC, and SBLC rules lack clarity, such as target market cap, capital requirements, loan loss, reserve requirements. Lenders need a bright line and metrics so that we can collectively know what success looks like. AmPac and the mission lending community will continue helping businesses access capital through the SBA's lending programs, and we look forward to working with the committee and SBA to create more opportunities for underserved businesses. Thank you. [The prepared statement of Ms. Kennedy follows:] [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] The Chairman. Thank you very much for your testimony. Mr. Pilkerton. STATEMENT OF CHRIS PILKERTON, CHIEF LEGAL OFFICER, ACCION OPPORTUNITY FUND, TILGHMAN, MARYLAND Mr. Pilkerton. Thank you, Chairman Cardin, and thank you, the Ranking Member, Ernst, for holding this committee meeting today. I am honored to be with Ms. Kennedy and to receive the invitation to this hearing, because I believe the thoughtful support for small businesses must be a bipartisan priority. Over the last several years, I have spent my career focusing on issues related to the small business community, with a particular focus on underserved populations. I served as the GC at the U.S. Small Business Administration under Linda McMahon, serving from 2017 to 2020, as well as the Acting Administrator of the agency from April 2019 into early 2020. During my tenure as Acting Administrator, I was particularly proud of our efforts to lead workforce development programs, for far too often, marginalized citizens, such as those returning from incarceration, young adults aging out of foster care, as well as workforce opportunities for disabled individuals. In March of 2020, I was asked to join the White House to lead a program called the Opportunity Now Initiative, which included significant outreach to underserved communities on the topics of access to capital and technical assistance through State and local officials, as well as webinars with minority focused trades such as the National Minority Supplier Diversity Council. Since leaving Government, I have continued this work in various capacities. First and foremost, I serve as the Chief Legal Officer for Accion Opportunity Fund, the leading nonprofit community development financial institution focused on small business lending to communities of color, low income-- low to moderate income borrowers all across the country, and women. I have also co-founded and developed an initiative called the Small Business Corps, a private sector led program to provide underserved small businesses with specific, goal focused technical support provided by fellows who are recent college and business school graduates. That program is housed at the Georgetown University McDonough School of Business and includes DMV engagement from schools such as Georgetown, Johns Hopkins, Old Dominion, as well as HBCUs, Howard, Morgan State and Norfolk State. I have also worked closely with the performing artist Ice Cube and his work to identify and secure opportunities for black owned businesses in the corporate supply chain. Our most recent success was a commitment from the National Football League to provide $150 million in contract opportunities to several black owned businesses, including Fearless, a technology company located in Baltimore, Maryland, that has gone on to incubate other minority and women owned companies in that city. We all agree that increased access to capital for underserved communities is important, but like anything, there is the goal and the execution of the plan to achieve that goal. I will begin by addressing the rule regarding the lifting of the SBLC moratorium and the creation of the new mission based SBLC category. While I understand the intention of the rule, it does not speak to the critical need to establish a consistent approach to responsible under review, but rather highlights that the agency needs flexibility in its lender evaluation to address unforeseen circumstances. While I appreciate the need to be flexible on certain components of such a program, underserved borrowers need that certainty of publicly articulated standards to ensure they are dealing with responsible and vetted lenders. As SBA Inspector General Hannibal said, for whom I have tremendous respect, in a House hearing last week in response to this issue, he said he has concerns with the inclusion of any lender that doesn't have clear rules, an internal control structure, and a proper oversight mechanism. In short, appropriate inspection and oversight on the front end can limit investigations, enforcement proceedings, and harm to borrowers on the back end. As such, I recommend that in consultation with Congress, the implementation of this rule will be delayed until there has been an independent study, a business plan, if you will, about the necessary guidelines and procedures that should be in place in order to secure a safe and responsible lending environment for those businesses and provide clear and consistent rules for those participating lenders that may, in fact, be new to the SBA landscape. When it comes to lending to underserved communities, we have frameworks to examine, such as the Treasury's CDFI pending certification program rules that are already in place and would serve as valuable data points for consideration. All this as set forth in the Responsible Business Lending Coalition letter for comment on this rule. I also have concerns with the bandwidth of the agency to oversee the influx of program participants contemplated in this rule. The SBA career staff are some of the most dedicated public servants I have ever worked with, but with limited resources, they may very well be stretched beyond their capacity. The agency needs to ensure that the staff has the resources they need to implement a program that can sensibly be regulated in a consistent fashion. I believe a thoughtful, independent analysis could calculate the required resources and provide necessary confidence to the marketplace. As to the rule on affiliation, Senator Cardin, I share your concern. I think it is important that this body consider the potential unintended consequences of removing this standard from SBA's analysis. The reason the rules are in place is to ensure that taxpayer guarantees are truly going to the statutorily mandated, independently owned and operated small businesses that need this unique Government program, and that it is not a subsidy program for larger corporations who already have a competitive advantage. The combination of these changes to the program as currently written, coupled with the trusted imprimatur of SBA, could undoubtedly result in a significant flow of capital. But I believe a thoughtful, independent study around these programs would help ensure the integrity of the admitted lenders, maximize the flow of responsible loans to small businesses, and minimize the potential for fraud. The results of such an analysis could ensure that Congress, the agency, and the American taxpayer have clarity on how the scope of this program can truly support our country's underserved communities in a way that is both responsive and responsible. Thank you very much. [The prepared statement of Mr. Pilkerton follows:] [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] The Chairman. Well, let me thank both of you. Mr. Pilkerton, good staff work. You mentioned Fearless. That was a--you got my attention early in your testimony. To both of you, your testimonies are extremely helpful. And I thank you for your patience because I think your contributions are so valuable. Ms. Kennedy, I want to agree with you. Look, the Biden Administration extended the CA program and gave it greater life. So, we are very appreciative of what they have done. This rule has the benefit of finding a home for the CA program, which is something that I think is important. That is why I have introduced legislation that I did. So, I think we are all in the same path here. It is not either or, it is how we get it done right. So, I appreciate the way that you said that. And Mr. Pilkerton, flexibility versus certainty. You are absolutely right. I can tell you certainty is critically important. If you are going to be in this business, you need to know what the rules are. You can't say, well, we want this to go right, and we will look at your individual case by case and determine whether we think it meets that standard. That is not the way you can get partners that are your partners. You are not going to enter that field. So, I agree with the points that both of you have reached. But here is my point. I am trying to make this as distinct as possible. This rule is going into effect and most likely will remain in effect. I think we have a responsibility to do exactly what the two of you have said, and that is by legislation. And we are going to work very hard to get legislation done. So, to Mrs. Kennedy, how do we--what additions would you like to see Congress impose to make sure that we are focusing on those who need, the underserved--focusing on the smaller of the small businesses? What changes would you like to see Congress entertain in order to make that possible? I appreciate your support of my legislation. I think we should make the CA program permanent. It is not inconsistent with the rule. So, I think we can do that--we can consider that, but what else should we be doing to make sure that we are focused on the goal of helping those who really need the help? Ms. Kennedy. Thank you, Senator--Chairman Cardin. I think that you--it is also in the legislation, really codifying standards. You know, lenders do need a bright line test. We do need to document how do we know we have been successful. So, the elements of loan loss reserve, the elements of the cash required, and then the definition of underserved, especially the definition of underserved. The fact is Community Advantage today does have a threshold--60 percent of your loan portfolio has to go to underserved communities. And I just believe if you aim at nothing, you will hit it every time. So, if you don't have guidelines, you are going to hit that. But if you do have guidelines, you are going to hit that. And that is what CA does today, and that is what has to happen going forward. So, codifying that legislatively is the right way to move that forward because discretion is discretion. And so, in the next Administration, that discretion may look different, but if we have the legislation to back that up, I think it is hugely significant and I appreciate the direction and your commitment to that. The Chairman. Thank you. Mr. Pilkerton, let me ask you a question of what would you recommend as we should take up for certainty? I mean, you mentioned the concern about knowing the rules. What rules are important for Congress to weigh in, to make clear that is not in the proposed rule? And then the second question I would ask deals with the affiliation rules. There are some good things in the affiliation rule, trying to make it streamlined just a little bit. What do you think-- what protections do we need to add to make it clear that we don't want the big corporations being able to come in under this revised rule? Mr. Pilkerton. So, I will start with what the agency I think should be looking at, as far as making loans in underserved communities. I think that this rule as written is going to have a lot of capital that goes into the system. And I think everybody touched on this. My biggest concern about these rules is OCRM, right, the Office of Credit Risk Management. They are the cop on the beat. You saw the Inspector General here today. They are the cop after the fact. So, giving OCRM what they need is really, really critical. And I think that is where an independent study could be incredibly helpful. Let's think about what just happened to the agency. For the last two years, the SBA became the tip of the spear on almost $1 trillion program. You have 2,000 people or so that work there. Many of them worked there for decades, and they were ready to retire in 2019, into 2020. They didn't. They didn't because they wanted to actually make it through PPP, help their colleagues, and help the American people. But they have retired. And so, you have got a lot of institutional knowledge, decades, I mean, probably hundreds and hundreds of years of SBA experience that has left because they have, you know, obviously had the right to and it has been good for them to retire. I really think OCRM should be a huge focus of this committee, in part too, because the rule doesn't address a lot of these rules that were put in place. I had the opportunity to listen to the earlier testimony. I learned stuff about what is going to be happening in these programs. And without putting that information into the notice and comment period, the public doesn't have the opportunity to opine on that. So, I think that is going to be a critical piece for the agency and for this committee. The second thing I will say about affiliation. I want to give you an example of something that we did in 2018. It was called the Franchise Directory, and Mr. Kelley made reference to it. Basically, what was happening was these borrowers were doing these eligibility reviews and you were getting inconsistent analysis. The people in my office when I was in the Office of General Counsel ended up putting together a list that got, I believe it was over 4,000 different franchises. We reviewed all of those agreements, and if the agreements didn't meet the standard that franchises were separate from the franchisors, then they would actually sign an addendum to the agreement to ensure that they were eligible. The thing about franchises is there a huge opportunity for underserved communities. A number of folks that actually work in a franchise, a really high percentage of those will go on to own a franchise. And the reason it was good policy was because if I wanted to open up a restaurant, for example, as a borrower, I could see there is that sandwich shop I want to open up and I could go into an SBA lender and say, look, it is on the franchise directory, so you have to make me that loan, assuming I meet all the other requirements. And that lender had the certainty of knowing that if I defaulted on that loan, they would get the SBA guarantee. So, I think it is really important. And the way the rules written now, I am very concerned that there is a bit of a slippery slope, particularly in that space. The Chairman. Thank you. Senator Ernst. Senator Ernst. Yes, thank you. This has been just a great discussion this afternoon. And I thank you both for being here and sharing your thoughts with us. Mr. Pilkerton, you have already answered a number of my questions. Senator Cardin had asked a number of those as well. So, I will move on to you, Ms. Kennedy. As part of the SBA's defense of the affiliation rule, part of that defense has been the 504 lenders welcome the underwriting and affiliation changes. It is important for all of us to differentiate between what is a 504 and what is a 7(a) loan program. The 504 loan program is an economic development program with job creation goals, and nearly every 504 loan receives approval from SBA before those funds are disbursed. So, this rule will create a more of a one size fits all approach to underwriting all of those SBA 7(a) loans and 504 loans. So, can you walk us through the 504 underwriting process, and why these changes might be acceptable for 504 but not for 7(a)? Ms. Kennedy. Thank you, Ranking Member Ernst. I want to thank you for this question because it is a really important question and a really critical distinction between the 504 program and the 7(a) program, the 7(a) being more of a general purpose loan program--the 7(a) program, and the 504 being targeted for job creation and economic development through ownership of commercial real estate and equipment. And that is significantly a difference with the 504 program, in that we are required statutorily to be an economic development and job creation program. And there are five components. There are several other differences between the programs, but I am going to focus on your question related to underwriting. There are five components of the underwriting program for 504 in this public private, partnership. So, there is a first trust deed lender, and then there is the SBA second. That is where the CDC, or certified development company--both lenders, underwrite the loans. So, the first trusted lender underwrites their portion of the loan. Typically, up to 50 percent of the loan amount, could be more. And it has to go through their underwriting, and underwriting policies according to their regulations. The SBA 504 portion by the CDC is underwritten by the CDC, and then it goes to an independent loan committee of the CDC that must have at least two commercially licensed bankers on that committee. And then that loan is sent to the SBA to review for eligibility and credit matters. So you can see it has several different steps in the underwriting process to ensure that it meets all of the eligibility requirements of the program, and so addressing those matters associated with the affiliation, there is no compromise of the loan in terms of eligibility and credit, and in terms of meeting the SBA size standards so that we are really targeting those businesses that are small under the SBA size standards. Senator Ernst. Yes. Thank you very much. And, Mr. Chair, I will go ahead and yield back the rest of my time. Thank you. The Chairman. Once again, let me thank both of you. We are going to be reaching out to you as we are working together. There is going to be a process in regards to this rule, and I think both of you can be extremely helpful to us. So, I hope that we can have communications beyond this hearing as we try to deal with this, because I think we all have the same objectives. We are all trying to achieve the same thing. I think Senator Ernst and I want to see more certainty. We want to see more direction. We think it is our responsibility. We are disappointed that the rule didn't provide that. And we understand the Administration will correct some of that on the SOPs, but it would be better, the more definitive legislations. The best second best is by regulation. So, we are going to try to correct that as we go forward. We will keep the record of the committee open for seven days for additional questions that may be asked by members of the committee. I expect that that will be more directed towards the first two witnesses and the second two witnesses, but we would ask that they be promptly responded to that. And if there is no further business, the committee will stand adjourned, with thanks. Senator Ernst. Thank you very much. [Whereupon, at 5:30 p.m., the hearing was adjourned.] APPENDIX MATERIAL SUBMITTED ======================================================================= [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] [all]