[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]



 
                 AN EXAMINATION OF THE SMALL BUSINESS 
             ADMINISTRATION'S 7(A) LOANS TO POULTRY FARMERS

=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                             UNITED STATES
                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED FIFTEENTH CONGRESS

                             SECOND SESSION

                               __________

                              HEARING HELD
                             APRIL 18, 2018

                               __________
                               
                               

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]                     


                               

            Small Business Committee Document Number 115-068
             Available via the GPO Website: www.govinfo.gov
             
             
                              _________ 

                   U.S. GOVERNMENT PUBLISHING OFFICE
                   
 29-636                      WASHINGTON : 2018                  
             
             
             
             
                   HOUSE COMMITTEE ON SMALL BUSINESS

                      STEVE CHABOT, Ohio, Chairman
                            STEVE KING, Iowa
                      BLAINE LUETKEMEYER, Missouri
                          DAVE BRAT, Virginia
             AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
                        STEVE KNIGHT, California
                        TRENT KELLY, Mississippi
                             ROD BLUM, Iowa
                         JAMES COMER, Kentucky
                 JENNIFFER GONZALEZ-COLON, Puerto Rico
                    BRIAN FITZPATRICK, Pennsylvania
                         ROGER MARSHALL, Kansas
                      RALPH NORMAN, South Carolina
                           JOHN CURTIS, Utah
               NYDIA VELAZQUEZ, New York, Ranking Member
                       DWIGHT EVANS, Pennsylvania
                       STEPHANIE MURPHY, Florida
                        AL LAWSON, JR., Florida
                         YVETTE CLARK, New York
                          JUDY CHU, California
                       ALMA ADAMS, North Carolina
                      ADRIANO ESPAILLAT, New York
                        BRAD SCHNEIDER, Illinois
                                 VACANT

               Kevin Fitzpatrick, Majority Staff Director
      Jan Oliver, Majority Deputy Staff Director and Chief Counsel
                     Adam Minehardt, Staff Director
                     
                     
                            C O N T E N T S

                           OPENING STATEMENTS

                                                                   Page
Hon. Steve Chabot................................................     1
Hon. Nydia Velazquez.............................................     2

                               WITNESSES

Mr. Hannibal ``Mike'' Ware, Acting Inspector General, United 
  States Small Business Administration, Washington, DC...........     4
Mr. William M. Manger, Associate Administrator, Office of Capital 
  Access, United States Small Business Administration, 
  Washington, DC.................................................     5

                                APPENDIX

Prepared Statements:
    Mr. Hannibal ``Mike'' Ware, Acting Inspector General, United 
      States Small Business Administration, Washington, DC.......    15
    Mr. William M. Manger, Associate Administrator, Office of 
      Capital Access, United States Small Business 
      Administration, Washington, DC.............................    20
Questions and Answers for the Record:
    Questions from Hon. Chabot, Hon. Velazquez, and Hon. Comer to 
      Mr. Hannibal ``Mike'' Ware and Mr. Hannibal ``Mike'' Ware 
      Answers....................................................    40
    Questions from Hon. Chabot, Hon. Velazquez, and Hon. Comer to 
      Mr. William M. Manger and Mr. William M. Manger Answers....    44
Additional Material for the Record:
    Hon. James Comer.............................................    48
    Steven D. Etka, Policy Director, Campaign for Contract 
      Agriculture Reform.........................................    49
    W. Scott Marlow, Senior Policy Specialist, The Rural 
      Advancement Foundation International - USA.................    52


  AN EXAMINATION OF THE SMALL BUSINESS ADMINISTRATION'S 7(A) LOANS TO 
                            POULTRY FARMERS

                              ----------                              


                       WEDNESDAY, APRIL 18, 2018

                  House of Representatives,
               Committee on Small Business,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 11:00 a.m., in Room 
2360, Rayburn House Office Building, Hon. Steve Chabot 
[chairman of the Committee] presiding.
    Present: Representatives Chabot, Leutkemeyer, Velazquez, 
and Schneider.
    Chairman CHABOT. The Committee will come to order.
    The Ranking Member is in another hearing. She will be here 
after a while, and my understanding is she just wants to submit 
her opening statement for the record. If she would want to give 
it we will, of course, give her that opportunity should she 
wish to do so. And we will probably be joined by additional 
members from both sides of the aisle here shortly, but we are 
going to go ahead and get started in the interest of everyone's 
time.
    The mission of the Small Business Administration is to help 
small businesses compete and succeed in the marketplace. As we 
have heard many times from small businesses testifying before 
this Committee, access to capital is one of the biggest 
challenges small businesses face when starting or expanding 
their businesses.
    To address the financing gap that small businesses can 
face, the SBA offers the 7(a) loan program for small businesses 
that have a plan in place for growth but lack the 
qualifications for conventional lending. SBA offers these small 
businesses government guaranteed loans through private lending 
partners.
    Recent growth in the program has led to a closer look at 
the SBA's oversight tools. As a result of multiple hearings, 
meetings, and briefings, I, along with the Ranking Member, Ms. 
Velazquez, introduced H.R. 4743, the Small Business 7(a) 
Lending Oversight Reform Act of 2018. We could not come up with 
a shorter name. Our Senate counterparts have introduced similar 
legislation.
    By strengthening the SBA's Office of Credit Risk Management 
and refocusing on the credit elsewhere test, this bicameral and 
bipartisan legislation aims to ensure the integrity of the 
program while bringing stability to small businesses that truly 
require the services of the SBA.
    H.R. 4743 and the Senate version unanimously passed through 
both the House and Senate Small Business Committees in March of 
2018, and I hope they will soon be brought before the both the 
Full House and the Senate.
    The subject of today's hearing is further justification 
that more oversight of the SBA is needed to ensure that 
taxpayer dollars are preserved only for small businesses that 
cannot qualify for traditional lending.
    A recent evaluation by the SBA's Office of Inspector 
General confirmed what the Committee had already suspected; 
that the SBA may have allowed nearly $2 billion of ineligible 
guaranteed 7(a) loans to non-small businesses.
    The OIG's findings are troubling as it appears that many 
small poultry farmers were unable to operate their businesses 
independently, thus violating the SBA's affiliation rules and 
other regulations.
    Today, members will have an opportunity to hear from the 
OIG about their findings and from the SBA about how the agency 
intends to implement the OIG's recommendations to ensure that 
future 7(a) loans meet the statutory, regulatory, and SBA 
requirements for eligibility.
    I appreciate very much the witnesses' testimony here 
shortly, and we look forward to your testimony.
    And again, we will allow the Ranking Member's opening 
statement to be admitted for the record when she gets here.
    And if Committee members have an opening statement 
prepared, I would ask that they be submitted for the record.
    And I will take just a moment to explain the lighting 
system which is very, I think, yeah, you have both testified. 
Five-minute rule. The green light will be on for 4 minutes. The 
yellow light will come on letting you know you have a minute to 
wrap up, and then the red light will come on to let you know 
that your time is up. And we would like you to stay within that 
if at all possible.
    Since the Ranking Member got here so fast, it would be 
appropriate if she would like to, to go ahead and, whenever she 
is ready, to give her opening statement.
    I will yield to the Ranking Member.
    Ms. VELAZQUEZ. Thank you so much, Mr. Chairman. And thank 
you all for being here.
    Chicken is America's favorite protein, topping beef and 
pork for the past 30 years. In 2016 alone, the USDA reported 
that American farmers raised over 8.8 billion chickens valued 
at $26 billion for domestic consumption and export. Public 
demand has resulted in significant changes to the poultry-
growing industry.
    Where there were once 1.6 million independent farms across 
the country, a rapid shift to a vertical integration model has 
resulted in just 25,000 contract farms raising the vast 
majority of America's poultry.
    The very nature of the industry is what brings us here 
today. Growers need capital to buy firms, build chicken coops, 
and buy feed to run their operations.
    Over the past 4 years, the 7(a) program has experienced 
significant growth in poultry lending. As noted by the IG's 
report, SBA has guaranteed over 1,500 poultry loans totaling 
$1.8 billion from 2012 through 2016.
    On the surface, this seems like we are helping small firms 
get access to capital. However, the nature of these growers' 
relationship with integrators suggests that loans may not be 
assisting what most of us consider small businesses.
    As we will hear from Mr. Ware, the level of control 
exercised over the growers is significant, from how to design 
and build their chicken coops to feeding and watering 
schedules, integrators have their hands in almost every aspect 
of a grower's business.
    Let's be clear about what is going on here. Large 
integrators own the chickens, sell the feed to the farmers, 
dictate the specifications of how to build the grow houses--all 
while pushing the costs and risk of financing and owning these 
very capital-intensive structures onto the farmers. Every 
report I have read, and discussions I have had with 
stakeholders, indicate there is little in the way of 
traditional lending to poultry growers. The industry relies 
almost exclusively on the government guaranteed lending from 
USDA and SBA used by growers to buy farms, construct chicken 
houses, and fund operations. This raises serious red flags.
    While we all support the SBA program for delivering credit 
to small businesses that cannot get it elsewhere, it is 
troubling if the program is being used to displace the growth 
of a traditional lending market and put taxpayers' money at 
risk.
    I look forward to hearing more from the IG about the 
details of their report and findings. I am also very interested 
in hearing from SBA on why they relied on a 1993 regional 
agency decision based on one contract to determine affiliation, 
or lack thereof, in these contracts for so long.
    Further, I am interested in how the regulatory changes from 
2016 are applied to poultry loan applications, and what SBA 
plans to do to address the affiliation concerns raised by the 
IG going forward.
    Thank you both for being here. Mr. Chairman, I yield back 
the balance of my time. Thank you.
    Chairman CHABOT. Thank you. Thank you very much. The 
gentlelady yields back.
    And I would now like to introduce our distinguished panel 
here today. Since both have testified here before I am going to 
keep these relatively short.
    Our first witness will be Mr. Hannibal ``Mike'' Ware, who 
currently serves as the acting inspector general for the Small 
Business Administration. The President has nominated him to 
serve as the permanent inspector general, and both the Senate 
Small Business and the Homeland Security and Governmental 
Affairs Committees have favorably reported his nomination to 
the Full Senate. So congratulations, and hopefully everything 
will go smoothly for you there, and we look forward to hearing 
your testimony here today.
    And our second witness will be William Manger, who is the 
associate administrator for the Office of Capital Access at the 
SBA. One of the programs Mr. Manger's office administers and 
oversees is the 7(a) loan program. So we also appreciate your 
testimony and your response to questions here shortly.
    So we would now like to turn to Mr. Ware, who is recognized 
for 5 minutes.

STATEMENTS OF HANNIBAL ``MIKE'' WARE, ACTING INSPECTOR GENERAL, 
UNITED STATES SMALL BUSINESS ADMINISTRATION; WILLIAM M. MANGER 
ASSOCIATE ADMINISTRATOR OFFICE OF CAPITAL ACCESS UNITED STATES 
                 SMALL BUSINESS ADMINISTRATION

              STATEMENT OF HANNIBAL ``MIKE'' WARE

    Mr. WARE. Thank you, Chairman Chabot, Ranking Member 
Velazquez, and distinguished members of the Committee. Thank 
you for the opportunity to be here today and for your continued 
support of the Office of Inspector General.
    We recently published the results of our evaluation of 
SBA's 7(a) loans made to poultry farmers. We independent 
initiated this review after speaking with the staff of this 
Committee, who raised the question about the controlling nature 
of contracts between large chicken companies, known as 
integrators, and poultry farmers.
    We performed a preliminary assessment and took note of the 
increases to the size of this segment of the loan portfolio, to 
the size of these loans, and to the terms of these loans. We 
subsequently sought to gain an understanding of the operations 
of this industry and the practical application of SBA's 
regulations for loans to farmers within the industry. We 
reviewed Federal laws and regulations, SBA policies and 
procedures governing the 7(a) loan program, files of performing 
and defaulted loans, as well as grower-integrator contracts, 
agreements, and communications.
    We further reviewed U.S. Department of Agriculture's loan 
program guidance, industry-related economic and analytical 
publications, relevant publications from state university 
agricultural extensions and publications from industry trade 
associations. We also reviewed SBA internal communications, 
guidance, and selected SBA Office of Credit Risk Management 
lender reviews.
    We found that 7(a) loans made to growers did not meet 
regulatory and SBA requirements for eligibility. The 
integrators in our sample exercised such comprehensive control 
over the growers that we believe the concerns appear 
affiliative on their SBA regulations. Therefore, SBA and 
lenders approved 7(a) loans that were apparently ineligible 
under MBA-sized standard regulations and requirements. 
Specifically, in our review of 7(a) loans made to growers, as 
well as review of defaulted 7(a) loans to growers, we found 
integrator-control exercised through a series of contractual 
restrictions, management agreements, oversight inspections, and 
market controls. This control overcame practically all of the 
grower's ability to operate their business independent of 
integrator mandates. This control was enforced through close 
integrator oversight, management agreements, and grower-
integrator communication.
    A grower's failure to comply with these requirements could 
result in a significant decrease in integrator payments, a 
reduction in flock placements, or a cancelation of the 
contract. A grower's economic viability was based upon a 
performing production contract with an integrator and is the 
true basis for grower income and facility value. As a result, 
from fiscal year 2012 to fiscal year 2016, SBA guaranteed 
approximately $1.8 billion in loans that may be ineligible.
    To improve SBA's oversight of the 7(a) loan program, we 
made two recommendations to the associate administrator for the 
Office of Capital Access. The first, to review the loans cited 
in the evaluation sample to determine whether SBA loan 
specialists and lenders made a proper size determination given 
the apparent affiliation based upon comprehensive contractual 
oversight and market control and take the appropriate 
corrective actions. And the second, to review the arrangements 
between integrators and growers under the revised regulations 
and establish and implement controls, such as supplemental 
guidance to ensure SBA loan specialists and lenders make 
appropriate affiliation determinations.
    SBA management agreed to both of these recommendations. 
Both of these recommendations remain open in a resolve status, 
meaning OIG has agreed to management's plan of corrective 
action. I am proud of the work performed by our auditors. We 
certainly appreciate the broader implications of this review on 
the availability of 7(a) lending resources and on SBA's 
oversight of the various segments of the loan portfolio.
    Thank you for the opportunity to speak to you today, and I 
look forward to your questions.
    Chairman CHABOT. Thank you very much.
    Mr. Manger, you are recognized for 5 minutes.

                 STATEMENT OF WILLIAM M. MANGER

    Mr. MANGER. Thank you. Good morning, Chairman Chabot, 
Ranking Member Velazquez, and members of the Committee. Thank 
you for the opportunity to speak with you today.
    The recent inspector general report examined the agency's 
poultry loans and lending history. From their examination, two 
recommendations were issued, both of which SBA has agreed to.
    One, SBA was asked to look at 11 loans that served as the 
sample size and basis of their review; and two, SBA was asked 
to consider further guidance to ensure that appropriate 
determinations of affiliation are being made.
    The loan activity highlighted by the inspector general 
occurred over a 5-year period beginning 7 years ago. Having 
joined the agency in March of 2017, I will need to rely on 
program office background and data, particularly during the 5-
year timeframe.
    Before discussing the IG recommendations, it might be 
helpful to share some data and provide an overview of our 
lending. Today, our overall 7(a) loan portfolio has a loan 
count of just over 265,000 loans, and an outstanding balance of 
$88 billion. Within that, poultry loans represent 1 percent of 
the entire 7(a) portfolio.
    The performance of poultry loans has been very good. These 
loans have a delinquency rate of .34 percent. This compares 
favorably to the 7(a) average of .7 percent.
    These loans are being made across 32 states and Puerto 
Rico. The top five states are Mississippi, Georgia, Arkansas, 
Texas, and North Carolina.
    Examples of the types of loan being made include a $600,000 
loan to a Kentucky couple who were employed in farming but 
wanted to start their own business. Another was a $1 million 
loan in Mississippi to help save a local family-owned, but 
failing, poultry operation.
    The IG report questioned whether the nature of the 
agreement between the poultry farmer and the business supplying 
the chicks is so controlling that SBA should consider the two 
businesses to be affiliated. This concept of affiliation is 
relevant in determining whether a business is small, because 
size is determined by aggregating the revenues or employees of 
the business with those of all of its affiliates.
    In the Small Business Act, Congress specifically included 
agricultural enterprises in the definition of small business. 
Agricultural enterprises are identified under the NAICS code 
system as including poultry and egg, forestry and logging, 
cattle ranching, and hog and pig farming, to name a few.
    In our lending, SBA has adhered to longstanding policy 
guidance that the grower-integrator contract standing alone 
does not bring about affiliation. In addition, SBA, in 2016, 
removed from the affiliation regulations the provision that 
considers contractual relationships that may cause economic 
dependence of one business on another.
    The agency concluded that, in general, only firms that had 
common ownership or common management should be considered 
affiliated when determining eligibility for SBA financial 
assistance. As a result, SBA's current regulations do not 
consider whether the contract between an integrator and a 
poultry farmer results in economic dependence when determining 
the size of the poultry farmer that applies for financial 
assistance.
    Soon after joining the SBA, I began an examination of 
various loan policies and practices in my office. On issues 
like franchise agreements, we made changes that were well-
received by borrowers, lenders, and other interested parties. 
We also took action to update our standard operating procedures 
last fall with several aspects that improve program compliance 
and ensure prudent lending for all loans, including poultry.
    First, we changed some loan terms to a maximum of 15 years, 
tying that to the useful life of equipment. Second, we provided 
guidance that our financing is limited to farmland used only in 
the operation of a business. And third, for businesses with a 
change of ownership or with startups, we now require at least 
10 percent equity.
    As we continue to conduct our review of poultry lending, we 
want to hear from all our stakeholders, and we certainly 
welcome your views and want to hear from this Committee.
    Thank you for the opportunity to testify today. I look 
forward to working with all of you.
    Chairman CHABOT. Thank you very much. I appreciate it.
    And I will now lead off the questioning by recognizing 
myself for 5 minutes. And I will go to you first, Mr. Manger.
    What specific steps has the SBA taken since you were made 
aware of the inspector general findings? I know you discussed 
that to some degree, but if you could go over those.
    Mr. MANGER. Certainly. So we did look at the 11 loans, as 
requested by the IG's report. In fact, I have a report on the 
11 loans. And again, under our evaluation, using the 25-year 
longstanding policy of the agency, we determined that the 
contract in place did not create affiliation between the small 
rural farmer and the integrator, because the ability to profit 
and bear the risk of loss due to their own efforts was still 
apparent with the small rural farmer.
    Chairman CHABOT. Mr. Ware, let me go to you.
    Are you aware of any other industries, either agriculture 
or otherwise that extend such control over their growers? Are 
those growers eligible for SBA loans, and do you have any plans 
to examine any of those loans as well?
    Mr. WARE. Our review in this case was specifically to the 
poultry loans. So we did not look at others, although we came 
across, of course, the hog industry being one that is kind of 
close but it was not our intent to review that because of how 
closely they line up. So we think that the findings of this 
report could be used by the agency the same way.
    Chairman CHABOT. Thank you.
    Back to you, Mr. Manger.
    Since being made aware of the inspector general's findings, 
have you provided any guidance for any lenders? Do you intend 
to publish any kind of guidance or communicate with lenders or 
their trade associations going forward? Is there any 
communications effort that you think should be made there?
    Mr. MANGER. After the report was released, we did make a 
statement again that we were reviewing the 11 loans. Upon 
completion of that review we found that they had been done 
according to longstanding policy of the agency. We also 
informed the lenders that, for loans that were made under 
similar circumstances, in that case we would also honor the 
guarantee because obviously there was a lot of concern from the 
lenders that guarantees would not be honored. But we wanted to 
assure them again that the loans that we looked at, all 11 
loans were done properly, and so therefore, the guarantee would 
be honored.
    Chairman CHABOT. Mr. Ware, did your office examine whether 
or not the credit elsewhere test was being applied properly to 
lenders? And should some of these growers have been able to 
qualify for conventional loans or USDA loans?
    Mr. WARE. As part of this review, we did not look 
specifically at the credit elsewhere test. We looked simply 
based on were they eligible for these types of loans. Eligible 
for the 7(a) loans.
    Chairman CHABOT. Do you think you should have gone and 
looked at the credit elsewhere?
    Mr. WARE. Well, the credit elsewhere test, we have a 
separate review that is doing that, not only for poultry but 
across the board. So running in separate lanes but touching 
everything.
    Chairman CHABOT. Mr. Manger, are lenders properly applying 
the credit elsewhere test before offering 7(a) loans for 
poultry farming or other related industries as far as you are 
aware? And why are these growers oftentimes unable to obtain 
credit elsewhere, particularly when they already have been 
offered a contract from a large poultry company with a long 
history in the industry?
    Mr. MANGER. No, I appreciate the question. And certainly, 
Mr. Chairman, credit elsewhere is always something that the 
agency and my office is looking at because we want to ensure, 
as the Ranking Member said in her opening statement, we want to 
make sure that we are making loans available to those that need 
the capital, that are unable to access the capital 
conventionally.
    Again, our office takes great pains in ensuring that loans 
are only being made to those that are unable to obtain credit 
elsewhere. In evaluating the loans, we have looked at them, and 
again, these people had in their files the proper certification 
that they were unable to--the lender makes the certification 
that these lenders would be unable to make the loan without the 
SBA guarantee. And so that is what we have seen, and again, 
these loans are to small rural farmers that many times there 
are not lots of other ways that they can access the capital 
except through our program.
    Chairman CHABOT. Mr. Ware, did you want to comment on that?
    Mr. WARE. Yes. I thought I needed to expound quickly on 
what I said before.
    So the basis of this review was their eligibility, and once 
we ran into the affiliation concerns that in our review were so 
clear based on the Code of Federal Regulations and what is 
detailed in there, the credit elsewhere did not become a 
primary function for us to look into for this particular 
review.
    Chairman CHABOT. Thank you very much. My time is expired.
    The Ranking Member is recognized for 5 minutes.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman.
    Mr. Manger, you stated in your testimony that the 
delinquency rates are very low on SBA poultry loans. I think 
you mentioned .3 percent compared to others, right? So if these 
loans are such a safe bet, why do they need to have an SBA 
guarantee? So if you are telling me that they are so good and 
they make so much sense, why is it that they cannot get a loan 
through traditional lending?
    Mr. MANGER. So Ranking Member, many times these loans are 
made for the acquisition of land, and in some cases actually 
the land is quite a large piece of property. And again, the 
individual does not have the collateral and some of the other 
prudent lending standards that a conventional loan would be 
made under in order to acquire not only the property but then 
to build the broiler houses on the property and all that goes 
into creating one of these farms. So in those situations, 
again, the lender makes the determination that they would not 
be willing to make that loan because of the risk inherent in 
making the loan unless they have the guarantee provided by the 
Small Business Administration.
    Ms. VELAZQUEZ. Okay.
    Can you tell me, Mr. Manger, what reasons are typically 
cited by lenders to fulfill the credit elsewhere test to make 
these loans?
    Mr. MANGER. So I would have to get back to you to see 
exactly----
    Ms. VELAZQUEZ. Well, this is an important issue.
    Mr. MANGER. Absolutely.
    Ms. VELAZQUEZ. Because it determines whether or not you are 
following the law. If you cannot answer me, if you cannot 
answer this question, how could you tell me that those loans 
were----
    Mr. MANGER. Ma'am, I can tell you that we take the credit 
elsewhere standards extremely, extremely serious in my office.
    Ms. VELAZQUEZ. But you cannot answer--you cannot give me--
--
    Mr. MANGER. I cannot give you some of the specific----
    Ms. VELAZQUEZ. Thank you.
    Mr. MANGER.--examples----
    Ms. VELAZQUEZ. Thank you.
    Mr. MANGER.--of what the reasons were.
    Ms. VELAZQUEZ. Okay.
    Mr. Ware, the Pew Charitable Trust has also published 
reports that examine the poultry industry. They stated that 
government subsidies were a significant driver of the growth we 
have seen over the past years, 50 years. Did your investigators 
find many instances of nongovernment-backed lending in the 
poultry-growth industry?
    Mr. WARE. We did not.
    Ms. VELAZQUEZ. Are either of you concerned the growth of 
SBA involvement in poultry farms is pushing traditional lending 
out of this market?
    Mr. WARE. If I was to answer that, that is probably a 
viable concern but it was not the focus of our review.
    Ms. VELAZQUEZ. Okay.
    So Mr. Manger?
    Mr. MANGER. Ma'am, as I stated in my opening statement, 
this is only 1 percent of the overall 7(a) portfolio 
representing 1.7 percent of the dollars.
    Ms. VELAZQUEZ. How much dollars?
    Mr. MANGER. 1.7 percent of the overall portfolio is in 
dollars. And that is not crowding out other businesses that 
need to access capital. The poultry industry is not crowding 
out----
    Ms. VELAZQUEZ. That is not my concern. My concern is if you 
comply with the credit elsewhere test. That is my concern.
    Mr. MANGER. And I can give you one reason probably why a 
lot of these loans were made this way, because many of the 
loans were given a longer term than a conventional loan would 
offer, and that is one reason in credit elsewhere where we 
allow for an SBA loan to be made because the ability to repay 
the loan by the small farmer needs a longer term and it would 
not be available in a conventional loan. It is only available 
in an SBA loan. So that is one of the reasons in credit 
elsewhere why these loans would be eligible because in some 
instances the term of the loan was up to 21 years.
    Ms. VELAZQUEZ. So let me ask you this question.
    Mr. MANGER. Yes.
    Ms. VELAZQUEZ. Should there be similar requirements 
aligning contract length with poultry loan length to protect 
the farmers and taxpayers?
    Mr. MANGER. As a matter of fact, I will just restate what 
we did in the SOP that became effective on January 1st of this 
year. We have now limited the term of the loan to 15 years, 
tying that to the life of the useful equipment. In this case it 
would be the broiler houses. That was not the case before 
January 1st of this year. We also have now limited the amount 
of farmland that can be acquired only to the farmland that is 
necessary for the specific business. We found in some instances 
additional farmland was being acquired. We do not allow that 
except for what is necessary with the specific operation.
    And finally, and importantly, to talk about the risk, we 
are now requiring for a change of ownership or a start-up--many 
of these poultry businesses were start-ups--we are now 
requiring a 10 percent equity injection from the borrower. That 
is equity coming from the borrower, not from the taxpayer.
    Chairman CHABOT. The gentlelady's time has expired. Does 
she need an additional minute? Or we can go to a second round 
if you like.
    Ms. VELAZQUEZ. Yes.
    Chairman CHABOT. All right. We will probably go to a second 
round.
    The gentleman from Missouri, the Vice Chairman of this 
Committee is recognized for 5 minutes.
    Mr. LUETKEMEYER. Thank you, Mr. Chairman.
    It would seem to me that the discussion today centers 
around the difference between a franchise and an affiliate.
    Mr. Ware, can you explain to me at the very essence here 
what your definition of affiliate is and why you believe that 
these farms do not comply?
    Mr. WARE. Sure. Thanks for the question.
    So the OIG does not have a problem necessarily with the 
relationship between a franchise or a franchisee as long as the 
contracts are not controlling by the franchiser.
    Mr. LUETKEMEYER. Well, what is your definition of 
controlling? I mean, because every franchise controls its 
franchisee to a certain extent. It depends on whether you are 
talking about an auto dealer, or you are talking about 
McDonald's, or are you talking about Cargill or Tyson? Those 
folks all have control over the people that are doing business.
    Mr. WARE. Correct, sir. However, if the control is 
comprehensive, by rule and by the law, it is so comprehensive 
that it----
    Mr. LUETKEMEYER. Well, what is your definition of 
comprehensive?
    Mr. WARE. Comprehensive means--so it is not every franchise 
that will qualify for a Small Business Administration loan. My 
definition----
    Mr. LUETKEMEYER. Do you make loans to McDonald's? Do you 
make loans to car dealerships?
    Mr. WARE. I am not certain exactly who the SBA makes 
loans----
    Mr. LUETKEMEYER. Mr. Manger, do you make loans to car 
dealers and McDonald's franchise folks?
    Mr. MANGER. We have just started making loans available to 
car dealerships.
    Mr. LUETKEMEYER. Okay.
    Mr. MANGER. As we have reviewed----
    Mr. LUETKEMEYER. Does anybody know the business model of a 
car dealership? There is nobody that is controlled more than a 
car dealership by their company.
    Mr. WARE. I would suggest that from our vantage point, 
based on our review on poultry loans, right, that if that is 
controlling to the point where even the very specifications of 
your broiler house is controlled, when you can walk into your 
broiler house is controlled, where you can walk in your broiler 
house is controlled, when the chicks are fed, when they are 
given medicine is controlled, and if you do not adhere to 
anything you can lose your flock placement, you can lose your 
flock and that automatically will cause you to default, that is 
controlling.
    Mr. LUETKEMEYER. Mr. Ware, you are talking to somebody who 
has got millions of turkeys growing in his district.
    Mr. WARE. Yes.
    Mr. LUETKEMEYER. I know exactly what you are talking about. 
And the reason that they do this, because those birds are not 
owned by the individual.
    Mr. WARE. Correct.
    Mr. LUETKEMEYER. Those birds are owned by the company that 
puts them in there and they require certain things. Just like 
if you were building a building. If you are the contractor, the 
owner says I want this building built a certain way. I need 
these kinds of materials and I want it built a certain way. I 
am going to have the architect to make sure that it stays 
there. These buildings and these birds, there is a model, a 
business model that they want you to, just like any other 
franchise, with McDonald's, or whether it is a Ford dealership, 
there is a certain level of integration of all of the different 
requirements that the franchise wants you to, as a franchisee, 
to put into your business model.
    The thing that concerns me here is you are forgetting about 
the rest of this business model. These people do not raise just 
turkeys and chickens. They also normally have a cattle 
operation affiliated with this because they normally have 
enough land to spread the manure out, which is a commodity that 
is an inexpensive way to fertilize your farm and they will have 
an integrated cattle operation as well. And that is usually 
financed separately from this.
    So the answer to the Ranking Member's question a while ago, 
the reason that these farmers come to SBA for this is usually 
they are highly leveraged. They are trying to get a new 
building, buy a new farm next to them, and they cannot get this 
financing because of the amount of debt they are incurring 
because of the size of these buildings, which are several 
hundred feet long. So I am trying to figure out here how you 
can get to this affiliated definition whenever you have got so 
many other businesses out here that are franchise operations 
that are much more controlled by the franchise company than 
what these folks are because I know this model.
    Mr. WARE. Can I answer?
    Mr. LUETKEMEYER. Absolutely. I am looking forward to your 
answer, sir.
    Mr. WARE. We do not have an issue with any of those things. 
What we have issue with is that by definition, by the code, by 
the CFR, they are not considered small. So from our----
    Mr. LUETKEMEYER. Okay. What is your definition of small 
then?
    Mr. WARE. Well, the CFR, in particular, concerning this 
with affiliation again goes back to such comprehensive control 
that management agreements is the exact term that is used in 
there.
    Mr. LUETKEMEYER. They do not control the entire operation 
though, Mr. Ware. That is what I am trying to get at. They 
control only the poultry part of this operation. The operation 
may be several hundred acres with several hundred head of 
cattle on it.
    Mr. WARE. But that is now what the Small Business 
Administration would be putting their guarantee for.
    Mr. LUETKEMEYER. They are guaranteeing the land and the 
poultry buildings that are on there. The real estate and 
buildings. You are not guaranteeing the operation. The 
operation is completely different.
    Mr. WARE. Well, Congressman, when these contracts, these 
same contracts that they are guaranteed, when the flock 
placement is not right and the flock placement goes away, so 
does the loan. And here comes the guaranty.
    Mr. LUETKEMEYER. Mr. Ware, if I have got a car dealership 
and I am not meeting my quotas, do you know what happens? I 
lose my franchise. I have got to sell X number of units per 
month; otherwise, at the end of the month I am going to get a 
few more from the company who says now you have got another 30 
days to sell those on top of it or else.
    Mr. WARE. But I am not sure your car dealership qualifies 
as a small business.
    Mr. LUETKEMEYER. Mr. Manger said they are starting to do 
that now.
    Mr. WARE. And we would like to take a look at that.
    Mr. LUETKEMEYER. I mean, I could go through a whole list of 
franchise companies and we can talk about this all day, but my 
concern is that I think we are losing, we are nitpicking on 
this affiliate definition. I am not sure you really understand 
the business model of what a poultry farmer really is all 
about.
    Mr. WARE. I do understand the business model pretty well. I 
do understand it, and I am saying that that business model 
makes it affiliative by nature.
    Mr. LUETKEMEYER. My time is expired.
    Chairman CHABOT. The gentleman's time is expired.
    Since we have a relatively few number of members here 
today, we are going to go to a second round.
    I have just got one or two questions myself and then I am 
going to turn it over to the other members that are here.
    My question is this. I note that the terms for poultry 
loans over the last few years have been getting longer, going 
up to 20 years; whereas, the contracts oftentimes are 
relatively short. In fact, your flock, my understanding is 5 to 
9 weeks or so. And I think if one of these small farmers, you 
know, goes out of business or whatsoever, if the contract is 
not renewed, it can be a pretty tough business to sell and you 
may get 6 percent on what you invested, the other 94 percent 
going away. So it is pretty challenging.
    So would both of you comment on the lengthening of these 
loans and the short period of the contract? And would the small 
business farmer in this case not be better protected if the 
contracts, if that is something you took into consideration, 
that they were longer, so they had more of an assurance that 
they could remain in business for a longer time to support 
their time?
    Mr. Manger?
    Mr. MANGER. Sure, Mr. Chairman.
    So the regulations stipulate that the lender must evaluate 
the ability of the borrower to repay the loan. In some of the 
instances, specifically on the 11 loans that were analyzed, 
there was also the purchase of land involved. It was not solely 
for the construction of broiler houses. For the purchase of 
land, many times it would be necessary to a small rural farmer 
to be able to extend those payments out for a longer period of 
time in order to be able to acquire the property. So it is not 
solely based on contracts that the individual may have or the 
business may have. It is based on, again, their ability to 
repay the loan. And in this instance, in the loans I am citing 
with the acquisition of property, that is really the main 
reason why such a long term was needed on the loan.
    It also does not control what other businesses the small 
business may enter into. As was said earlier by Congressman 
Luetkemeyer, many times they would have a portion of the 
property maybe be for poultry, but they could be involved in 
other enterprises on other parts of the property, whether it be 
manure harvesting or other ventures. So again, it is not so 
reliant only on this one contract, especially in the 
acquisition of property and the lender must again certify that 
the borrower has the ability to repay the loan.
    Chairman CHABOT. Thank you.
    Mr. Ware, did you want to comment on that at all?
    Mr. WARE. Sure. Yes. I need to comment on it because when 
the agency is giving loans to poultry farmers, it is for that 
purpose. In the defaulted loans that we reviewed, when the 
contracts went away, so did the poultry farm. So I think that 
is a very vital piece of whatever review would be made, and I 
believe that in the industry, from what I have studied, in the 
industry they are moving toward their contracts in terms of the 
integrator and the farmers as being a little bit longer because 
of more conventional lending methods that are out there and 
that is the only way that they would qualify for those.
    Chairman CHABOT. Thank you very much. I am going to yield 
back.
    The Ranking Member is recognized for 5 minutes.
    Ms. VELAZQUEZ. Mr. Manger, I heard you talk about some of 
the changes about excess land equity injection, those issues 
have nothing to do with the affiliation issue. I know that you 
were not there in July 2016 when the IG presented its report, 
but I would just like to ask you, who signed off on the changes 
that were made, particularly knocking out the economic 
dependence of business contract affiliation? Who did that?
    Mr. MANGER. That was done by the previous administration. I 
am not sure if it was signed off by the person that had the 
associate administrator position in Capital Access or----
    Ms. VELAZQUEZ. Can you get back to us?
    Mr. MANGER. Yes.
    Ms. VELAZQUEZ. Okay.
    Mr. MANGER.--or possibly the administrator at the time.
    Ms. VELAZQUEZ. Well, if those changes were made, I would 
like to know who signed off on accepting those changes because 
this is a very important issue, the issue of affiliation, and 
if I have to introduce legislation to go to the original 
affiliation issue, I am going to do that. Okay?
    Thank you, Mr. Chairman.
    Chairman CHABOT. The gentlelady yields back.
    We have one other member who we thought was on his way but 
in light of the fact that he is not here I think we are going 
to wrap up this hearing.
    We appreciate the gentlemen giving their testimony here 
this morning.
    An important industry, there are obviously some questions 
here we would ask our Committee staff to continue to work with 
the SBA to make sure that all the appropriate regulations and 
the loans that are being made are being made in a proper manner 
and that the dollars that we have available are going to 
actually help small businesses and the families that they 
support. So we will continue to follow this topic.
    I would ask unanimous consent that members have 5 
legislative days to submit statements and submit supporting 
materials for the record.
    Without objection, so ordered.
    If there is no further business to come before the 
Committee, we are adjourned. Thank you.
    [Whereupon, at 11:46 a.m., the Committee was adjourned.]
    
                            A P P E N D I X
                            

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                              INTRODUCTION


    Chairman Chabot, Ranking Member Velazquez, and 
distinguished members of the Committee, thank you for the 
opportunity to be here today and for your continued support of 
the Office of Inspector General (OIG). We recently published 
the results of our audit of the Small Business Administration's 
(SBA's) evaluation of 7(a) loans made to poultry farmers. I am 
happy to discuss our findings with you today.

                               OIG's ROLE


    OIG was established within SBA by statute to promote 
economy, efficiency, and effectiveness and to deter and detect 
waste, fraud, abuse, and mismanagement in the Agency's programs 
and operations. During fiscal year (FY) 2017, OIG achieved over 
$82 million in monetary recoveries and savings and made 72 
recommendations for improving SBA's operations and reducing 
fraud and unnecessary losses in the Agency's programs.

    OIG audits are conducted in accordance with Federal audit 
standards established by the Comptroller General, and other 
reviews generally are conducted in accordance with standard 
established by the Council of the Inspector General on 
Integrity and Efficiency (CIGIE). In addition, we coordinate 
with the Government Accountability Office to avoid duplicating 
Federal audits. We also establish criteria to ensure that the 
non-Federal auditors that OIG uses (typically, certified public 
accountant firms) comply with Federal audit standards.

         OIG's EVALUATION OF 7(A) LOANS MADE TO POULTRY FARMERS


    OIG report 18-13, titled Evaluation of SBA 7(a) Loans Made 
to Poultry Farmers presents the results of our review of loans 
made to poultry farmers under SBA's 7(a) Loan Program. The 7(a) 
Loan Program is SBA's primary program for helping startup and 
existing small businesses, offering financing guarantees for 
loan amounts up to $5 million to fund startup costs, expand 
existing businesses, purchase equipment, repair existing 
capital, and other uses. Participating lenders enter into an 
agreement with SBA to make loans to small businesses in 
accordance with SBA rules and regulations. Some 7(a) loans are 
made by lenders using delegated authority, which undergo 
limited review by SBA prior to loan disbursement. Other 7(a) 
loans are subject to more extensive underwriting and 
eligibility review and approval by SBA before the loan is 
disbursed.

    Our evaluation objective was to determine whether 7(a) 
loans made to poultry farmers (growers) met statutory, 
regulatory, and SBA requirements for eligibility. To accomplish 
our objective we reviewed Federal laws and regulations, SBA 
policies and procedures governing the 7(a) Loan Program, files 
of performing and defaulted loans, as well as grower-integrator 
contracts, agreements, and communications. We further reviewed 
U.S. Department of Agriculture's (USDA) loan program guidance, 
industry-related economic and analytic publications, relevant 
publications from state university agricultural extensions, and 
publications from industry trade associations. We also reviewed 
SBA internal communications, guidance, and selected SBA Office 
of Credit Risk Management lender reviews.

    We interviewed officials and staff from the SBA Office of 
Capital Access, SBA Office of General Counsel, USDA Economic 
Research Service, USDA National Agricultural Statistics 
Service, USDA Farm Service Agency, USDA Office of Rural 
Development, and the USDA Office of Inspector General. We also 
interviewed executives and loan officers at various lending 
institutions, certified assessors, integrators, and growers.

    We analyzed the population of 7(a) loans made to 
agricultural enterprises, and to the agricultural subset of 
poultry farmers, to obtain an understanding of the SBA loan 
portfolio, and its characteristics, for FYs 2012 through 2016. 
This population was limited to approved regular 7(a), Certified 
Lender Program, and Preferred Lender Program loans. Further, 
for this analysis, we defined agricultural enterprises to 
include North America Industry Classification System (NAICS) 
codes 111110 through 114210. The subset of poultry farmers was 
defined with NAICS codes 112320 and 112390. From this 
population, we judgmentally selected a sample of 11 loans; this 
sample was populated by loans at either the median size or the 
largest size for its fiscal year. We used this sample to guide 
a review of loan files, grower contracts, and grower-integrator 
communications, and interview parties to these loans, Further, 
we reviewed a sample of defaulted poultry loans to understand 
the degree to which integrator contracts affect facility value.

    We conducted this evaluation in accordance with the Council 
of the Inspectors General on Integrity and Efficiency's quality 
standards for inspection and evaluation. These standards 
require that we adequately plan inspections; present all 
factual data accurately, fairly, and objectively; and present 
findings, conclusions, and recommendations in a persuasive 
manner. We believe that the evidence obtained provides a 
reasonable basis for our findings and conclusions based on our 
evaluation objective.

    What OIG Found

    We found that 7(a) loans made to growers did not meet 
regulatory and SBA requirements for eligibility. SBA 
requirements state that the small business applicant must be 
small under SBA size standards. The applicant combined with its 
affiliates must not exceed the size standard designated for 
either the primary industry of the applicant or the primary 
industry of the applicant and its affiliates, whichever is 
higher.

    The large chicken companies (integrators) in our sample 
exercised such comprehensive control over the growers that the 
SBA Office of Inspector General believes the concerns appear 
affiliative under SBA regulations. Therefore, SBA and lenders 
approved 7(a) loans that were apparently ineligible under SBA 
size standard regulations and requirements. Specifically, in 
our review of a sample of 11 7(a) loans made to growers, as 
well as review of defaulted 7(a) loans to growers, we found 
integrator control exercised through a series of contractual 
restrictions, management agreements, oversight inspections, and 
market controls. This control overcame practically all of a 
grower's ability to operate their business independent of 
integrator mandates. A grower's failure to comply with these 
requirements could result in a significant decease in 
integrator payments, a reduction in flock placements, or a 
cancellation of the contract. A grower's economic viability was 
based upon a performing production contract with an integrator 
and is the true basis for grower income and facility value. As 
a result, from FY 2012 to FY 2016, SBA guaranteed approximately 
$1.8 billion in loans that may be ineligible.

    OIG Recommendations

    To improve SBA's oversight of the 7(a) Loan Program, we 
recommended the Associate Administrator for the Office of 
Capital Access (1) review the loans cited in the evaluation 
sample to determine whether SBA loan specialists and lenders 
made a proper size determination given the apparent affiliation 
based upon comprehensive contractual, oversight, and market 
control, and take the appropriate corrective action(s), and (2) 
review the arrangements between integrators and growers under 
the revised regulations, and establish and implement controls, 
such as supplemental guidance, to ensure SBA loan specialists 
and lenders make appropriate affiliation determinations.

    Agency Response

    SBA management agreed with both recommendations made by 
OIG. Regarding Recommendation 1, SBA will perform a review of 
the loans cited in the evaluation to determine whether SBA loan 
specialists and lenders made proper size determinations. For 
Recommendation 2, SBA will review the arrangements between 
integrators and growers in light of the current affiliation 
rules and regulations. If needed, SBA will establish additional 
controls to ensure SBA loan specialists and lenders make the 
appropriate affiliation determinations.

                               CONCLUSION


    I am proud of the work performed by our auditors to raise 
awareness of this growing segment of SBA's 7(a) loan portfolio. 
In performing this work, they obtained a deep understanding of 
the operations of this industry and the practical application 
of SBA's regulations for loans to farmers within the industry. 
We found that 7(a) loans made to growers did not meet 
regulatory and SBA requirements for eligibility. Integrators 
were ineligible to participate in the SBA 7(a) Loan Program due 
to their size; however, integrators exercised such 
comprehensive control over the growers that the SBA OIG 
believes the concerns were affiliated. Therefore, SBA and 
lenders approved 7(a) loans to growers that appear ineligible 
under SBA size standard regulations and requirements.

    OIG will continue to provide independent, objective 
oversight to improve the integrity, accountability, and 
performance of the SBA and its programs for the benefit of the 
American people. Our focus is to keep SBA leadership, our 
congressional stakeholders, and the public currently and fully 
informed about the problems and deficiencies in the programs as 
identified through our work. We value our relationship with the 
Committee and the Congress at large, and we look forward to 
working together to address identified risks and the most 
pressing management challenges facing SBA.

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    April 26, 2018

    House Small Business Committee

    Statement for the Record
    Hearing: ``An Examination of the Small Business 
Administration's 7(a) Loans to Poultry Farmers''
    Wednesday, April 18, 2018

    Statement for the record by Hon. James Comer, Kentucky

    Barriers to entry in agriculture are very high, especially 
for small businesses. While large companies can use capital 
markets to raise financing, small businesses typically use 
traditional banking and often have trouble obtaining financing 
through the traditional lending market. Many do not have the 
credit history or large collateral necessary to obtain private 
financing and overcome these barriers. Small businesses are 
then either unable expand their farm, must obtain their 
financing through the Small Business Administration's public-
private partnerships with private lenders, or are shut out from 
agriculture entirely.

    The 7(a) loan program fills a lending gap in the market for 
poultry growers by offering guarantees of repayments made to 
the lenders. By doing so, banks are provided the ability to 
extend credit to otherwise unproven entrepreneurs, farmers are 
provided a cash flow and access to capital they otherwise 
couldn't find, and the government makes its money back on an 
investment in American agriculture at no cost to the American 
taxpayer. The 7(a) program minimizes uncertainty to small, 
independent family farms and incentivizes young Americans who 
want to start their own business in agriculture.

    Particularly when the farm economy is experiencing a 
downturn, as it is now, we should be doing all we can to 
provide certainty and stability to America's farmers, and 
administering necessary loan guarantees to poultry growers to 
maintain this stability.

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