Steven Preston is not one to refuse a thankless task. While transitioning out of the CFO role at $3.6 billion ServiceMaster, he agreed to stay on after the implosion of the firm's auditor, Arthur Andersen, and then through what he calls the Sarbanes-Oxley "implementation war."
But then came an opportunity to make a different contribution, Preston says, in a job described to him as a "higher calling": heading up the Small Business Administration (SBA), the federal agency that guarantees bank-originated small-business loans, conducts lending in disasters, and ensures small businesses get their cut of government contracts. In July 2006, Preston took on what has to be one of the toughest jobs in the country.
Best known as the organization that botched the federal government's response to the 2005 Gulf Coast hurricanes, the SBA has the lowest employee morale of any agency and has been on the verge of closing for the last 20 of its 54 years. It has a multitude of missions, having been created by Herbert Hoover in 1932 as the Reconstruction Finance Corp., charged with lending to businesses hurt by the Great Depression. Congress has been adding to the SBA's duties ever since.
Coming over from the private sector, Preston says his biggest challenge as SBA administrator has been transforming the organizational mind-set into one that is "accountability-driven." In just a year and a half, the 47-year-old Preston has tried to refocus the agency on the customer, overhaul processes, set controls, and initiate audits. Complicating the task, the agency's workforce has been slashed by 27 percent since 2002 even as its workload — measured by number of loans — has grown by 93 percent.
"I think he's been honest and a fair person," says Sen. John Kerry (D–Mass.), chairman of the Committee on Small Business and Entrepreneurship. "Unfortunately for him, he inherited a troubled organization."
Preston joined the agency at a particularly low point. In 2005 it had received 420,000 loan applications from victims of hurricanes Katrina, Rita, and Wilma — twice the number triggered by the Northridge earthquake of 1994, the second-largest disaster-lending event. (As a result of this year's California wildfires, in contrast, by early December the SBA had approved only 415 loans, worth $49.3 million.
When Preston came aboard, the SBA was still mopping up and trying to get checks to hurricane victims. Constraints in the agency's disaster-credit management system and delays in staff hiring meant that homeowner and small-business applicants had to wait an average of 71 days for decisions on loans, instead of the standard 14 to 18 days.
It was a difficult situation for an executive indoctrinated in the "service profit chain" theories that came out of Harvard in the late 1990s. In the service profit chain, profit stems from customer loyalty, which depends on customer satisfaction, which is driven by satisfied and productive employees who have the right tools. In its current crisis, the SBA represented exactly the opposite.
Preston has moved quickly to apply the service-profit-chain principle to the operating model used by the disaster-lending division. He has created case managers and grouped credit analysts, lawyers, and clerical workers into teams working on individual loans for homeowners and businesses. "It's basically a surge-and-decline lending operation" that must be put in place on a day's notice, he says. "I think we have the credit skills and the field organization now."
Preston's next job is to help the SBA develop forecasting and response systems for natural disasters so that the agency's Gulf Coast performance is not repeated. It's a challenge more difficult than anything Preston faced in the private sector. "When you look at disasters in the private sector you look at them more in terms of a contingency and recovery plan," he says. But the business of the SBA is disasters.
"In certain kinds of disasters [like hurricanes and floods] it takes longer for people to move back and get on their feet, so it may take longer before we start seeing the [loan] applications," Preston says. That greatly complicates forecasting efforts.
Much of the trouble at the SBA originates in a back office that dates to the Sputnik era. "Our organization has dramatically increased the amount of activity in our programs without doing enough work in the back office to keep up with demand," Preston says. "And so it feels a little bit like we've shifted our car into third gear and we're on the interstate and we can't get it into fourth, fifth, or sixth."
Incredibly, the business-loan operation runs on a Cobol-based system and mainframe hardware, parts of which are more than 50 years old. Modernization of the system will extend to 2012 (by which time Preston will be gone) and cost more than $100 million.
While Preston's IT department is simplifying the front-end systems with Web tools that allow banks and other partners to access the SBA's systems, Preston is tackling the process side with some best-practice methodologies straight from the private-sector playbook. In what it calls a "major initiative" to improve "efficiency, effectiveness, and throughput," the agency is conducting a Six Sigma study of its loan-processing, servicing, and liquidation functions.
Some of those efficiency gains involve patchwork. Last October, Preston disclosed that there were 1,200 backlogged requests for purchases of SBA loans at the agency's Herndon, Virginia-based processing center. (When a borrower defaults, the SBA reimburses the bank for the amount it guaranteed, usually 50 to 85 percent of the loan's principal.) Preston temporarily authorized two additional guaranty purchase operations to be opened beginning last month.
The backlog highlighted a conflict in the organization. Over the previous three years, the SBA had consolidated the loan-purchasing operations in Herndon, removing them from local district offices and drastically shrinking staff from 200 to 40. The intent of the centralization is to create and enforce auditable standards for loan-purchasing decisions, which is easier to do when they're not being made all across the country, Preston says. But the change actually slowed the purchasing process. Bankers were submitting purchase packages to the SBA with information missing because of a lack of support from the district offices.
Preston is now building a customer-support group in Herndon from scratch, starting with four employees, and expects to spend more resources supporting banks at the front end. The agency is also examining workflows and trying to measure cycle times and response rates, as well as to track errors. It has publicly pledged to give banks a preliminary verdict on loan repurchase requests within 45 days.
Focusing on Outcomes
Lacking a profit-and-loss statement to measure its effectiveness, the SBA has traditionally gauged its success with activity-based measures, says Jovita Carranza, the SBA's deputy administrator. Now Congress is pushing the SBA to be more performance-based in its reporting. Since, as many critics have pointed out, only a little more than one percent of small businesses borrow via SBA-backed loans (either 7(a) or 504 loans) each year, the impact of the SBA in "bridging competitive opportunity gaps facing entrepreneurs" — one of the strategic goals listed in the SBA's annual performance report to Congress — is in question.
"The Administration tends to focus on output without looking at what is really needed in the market to grow the economy and create jobs," says Senator Kerry. The SBA is more likely to look at how many loans it guaranteed in a given year, for example, than to acknowledge that the average-size 7(a) loan has fallen more than 39 percent since 2002.
Although Preston professes to make the SBA "outcome-driven," critics claim its 7(a) lending program is anything but. "The SBA does not even try to measure the gains of its programs," says Veronique de Rugy, an economist at George Mason University. Preston says the SBA is working with an outside firm to examine the impact of its lending. However, he thinks looking at just one or two outcomes — such as survival of a small-business borrower or the jobs it creates — will shortchange the actual impact of the SBA's programs.
Of more concern to some critics is the SBA's burgeoning small-business loan portfolio, which was $67 billion at the end of fiscal 2007. That's not an insignificant chunk of taxpayer dollars at risk, compared with the $550 billion of small-business loans outstanding at U.S. commercial banks.
With recent legislation, Kerry's Senate committee is calling for more transparency on the default rate of the SBA's 7(a) and 504 loan portfolios. It wants to know how much of the portfolio is at risk, especially after a $76 million fraud involving SBA-guaranteed loans was uncovered last year. Some bankers want the SBA to also predict the probability that there will be dollar losses in the event of a loan default.
Peter Morgan, an executive vice president at Zions Bank, says it will be difficult for the SBA to calculate that number, since it currently has no information on whether loans are secured by accounts receivable and inventory — where the recovery, if any, is usually small — or by real estate, where it is likely to be higher. "[The SBA] has no idea what collateral is securing the loans or what the advance rate is," he says. "[Its] accounting mechanisms for honoring guarantees and [calculating] loan losses are so archaic no one has any degree of confidence in them."
Preston counters that the agency has a tremendous amount of data on delinquencies, liquidations, and charge-offs, but "we have a lot of work to do on the underlying operational processes."
Preston can take credit for spearheading some successes at the agency, and for having the temerity to take on the Department of Defense and every other federal agency over the accuracy of federal contracting data.
The day Preston was sworn in, CBS Evening News aired a report on the inaccuracy of data on small-business contracting awards. (The SBA has a key role in ensuring that 23 percent of all prime contracts in the federal government go to small businesses.) The errors in federal government procurement departments have become legend. In September 2005, the Federal Emergency Management Agency (better known as FEMA) awarded an $860,000 contract to a Baton Rouge, Louisiana, subsidiary of Burhmann NV, a company with $4 billion in North American revenue. The subsidiary was classified as a small business. While working to close regulatory loopholes by requiring that businesses recertify their "small" status at regular intervals, Preston launched, with a letter to the head of every federal agency, a data-integrity audit of federal contracting awards for the previous two years.
"You have millions of contract actions being put in computer systems every year and coded in various ways by clerks around the country. There hasn't been enough discipline or oversight of that process," says Preston. "A lot of the data in the Federal Procurement Data System [FPDS] was wrong. Large businesses were miscoded."
This year, SBA officials reviewed 11 million contract actions from fiscal years 2005 and 2006. They found about $5 billion in contracts miscoded as small business in the 2005 data (out of $390 billion awarded to all businesses). Those contracts were removed from the results of agencies' small-business contracting goals and the 2005 data was republished as a scorecard on a public Website.
For 2007, for the first time, all federal agencies had to submit their processes for data verification and validation to the Office of Management and Budget's Office of Federal Procurement Policy.
Still, the controls around data input in federal government procurement systems are lacking, illustrating the limits to what even the most effective manager can accomplish at the SBA. In the Burhmann case, the SBA's Office of the Inspector General found that the Central Contractor Registration (CCR) database, a repository of federal government contractors, allowed contradictory information on a business's size status to exist in the system. Contracting officers also rely on contractor self-certification of size status, unless there is an obvious error. What's more, the SBA doesn't "own" the data or the CCR database or the FPDS.
This is a problem Preston will probably not be able to fix. Some of the mandates imposed by the federal government on the agency over the years, such as disaster lending and minority contract set-asides, could be considered noncore businesses, says Jonathan Bean, a professor of history at Southern Illinois University. If the SBA were a private-sector conglomerate, Preston could divest these products; as it stands, he cannot.
Not that Preston would do so if he could. "It's a very important service to Americans at a time when they are in their deepest need," Preston says of disaster lending. "I don't know who's better suited to do it."
Vincent Ryan is a senior editor at CFO.
Thinking of taking a job in government? Think long and hard. Steven Preston, the Small Business Administration's top executive, assumed a host of responsibilities that would be alien to executives who have spent their careers in the private sector. Among Preston's particular challenges:
- Motivating government employees to be customer-focused and accountability-driven, without incentive pay as a tool.
- Measuring organizational performance absent the aid of a true bottom line.
- Implementing race- and gender-preference programs that are subject to constitutional challenges by federal courts.
- Managing the risk in a portfolio of small-business loans to borrowers that were deemed insufficiently creditworthy to be approved for conventional loans.
- Controlling the integrity of data entered into a federal procurement database, without owning the system or the employees inputting the data.
- Defending the organization's performance in public and to Congress.
- Serving two bosses: the President of the United States and the U.S. Congress. — V.R.
A Tumultuous Two Years
Hurricane Katrina, the costliest natural disaster in U.S. history, slams into the Gulf Coast.
Rep. Nydia M. Velázquez (D–N.Y.) calls for the resignation of SBA administrator Hector Barreto, citing the agency's sluggish response in helping Gulf Coast disaster victims.
Barreto resigns from the SBA; President Bush appoints Steven Preston, former CFO of a holding company for franchise businesses.
Aiming to reduce the incidence of misawarded small-business contract set-asides, the SBA enacts a rule that contractors must recertify as small businesses every five years.
A GAO report finds that large backlogs in disaster-loan processing were due in part to the SBA not using data from catastrophe-risk modeling and disaster simulations.
The Justice Dept. arrests 19 people in connection with a $76 million fraud involving SBA-backed loans. The SBA's lender oversight is criticized as being too lax.
The Bush Administration's $464 million budget proposal for the SBA includes a staffing increase — the first in more than five years.
The SBA submits a new Disaster Recovery Plan to Congress outlining the overhaul of its disaster-lending operation.
The SBA's Office of the Inspector General accuses the agency of too-hastily canceling 7,700 approved disaster loans in the Gulf Coast before the funds had been disbursed.
The SBA publicly releases the first Small Business Procurement Scorecard, in which it rates federal agencies' progress in awarding contracts to small businesses.
Preston discloses a backlog of purchase requests for small-business loans and announces a Six Sigma reengineering of the operations.
Preston appoints Eric Zarnikow, former chief risk officer and treasurer of ServiceMaster, to head the office that oversees small-business lending.