Posts Tagged ‘SBA loans’

What’s Not to Like?

Wednesday, June 17th, 2009
They Turn Very Slowly

They Turn Very Slowly

100% risk-free to the lender and interest-free to the borrower – what is not to like about America’s Recovery Capital Loans, the new program of the U.S. Small Business Administration? Well, for one thing, it is hard to find a bank that will underwrite the loans. SBA loans are guaranteed by the SBA, but issued by participating banks. I have called most of the institutions on the SBA’s preferred lender list and I have yet to identify one that has decided it will participate in the program.  The banks have identified four problems: first, they have to navigate the thicket of SBA rules with little guidance for this new program. That is a lot of work to do for loans capped at $35,000. Second, while the loans are interest-free for the borrowers, the SBA will pay the lenders prime plus 2%, a lower interest rate than the SBA charges for its other loan programs. Third, 100% of the principal is guaranteed and should the default rate continue to rise, a not unlikely prospect given that unemployment is high and rising, bankers don’t want to be blamed for shifting more losses to taxpayers. Finally, there may be relatively few qualified applicants for this program given the criteria established by the SBA and the risk for small businesses to assume more debt in such an uncertain market.

Lack of Enthusiasm Among Lenders

Friday, May 29th, 2009
Lots of Paperwork, Few Results

Lots of Paperwork, Few Results

According to a recent survey conducted by Coleman Publishing, 80% of small business lenders are not committing to participate in the emergency loan program of the U.S. Small Business Administration. Known as the “America’s Recovery Capital Program” the emergency loan program for small businesses was authorized in the stimulus bill passed in February. 35% of lenders surveyed decided categorically not to participate in the program; 45% had not taken a decision, as there was a lack of clarity about the program specifics, although loan applications are to be made available to participating banks on June 15. Only 20% of small business lenders surveyed stated that they would participate in the program. The issue is that the SBA itself does not make loans; it guarantees them to participating bank lenders. I had written in a blog entry on March 23 that I thought it unlikely that banks would want to participate in this program. With the principal guarantees on the loans being raised, taxpayers would assume a greater share of the losses. Presumably bank executives are sufficiently savvy to know how the public would assign blame for that outcome. I doubted that they would want to be once again on the receiving end of the pitchfork. Add to that other reasons for the lack of enthusiasm in the banking sector for this program: its complexity, the lack of fees or interest to compensate banks for their investment of resources in processing these loan applications, the definition of viable business and so on.  It is a substantial amount of work for relatively small loans with a limit of $35,000 and funding sufficient for only 10,000 small businesses to participate. That works out to 200 businesses per state. We could have that many small businesses apply for New York alone. This program appears to be an ill-conceived effort to throw a bone to the small business constituency that is understandably outraged about the bail outs of Wall Street and Detroit.

U.S. Government: Punish the Prudent Small Businesses

Thursday, May 21st, 2009

In his testimony yesterday to the U.S. Senate Banking Committee, Treasury Secretary Timothy Geithner acknowledged that “small businesses account for most of the jobs in this country. That is why are trying to expand these programs for them.” Reflecting the popular anger at the bailouts of the rich and the reckless, Geithner appears to be repeating message points about how the “prudent” who did not become over-extended and behaved responsibly are suffering as a result of the behavior of the less prudent. At the hearing yesterday, he specifically referenced “viable businesses” that were “prudent” and “did not take on too much debt” now need to be helped because their access to capital has been hindered by the choking up of the credit markets.

Except that is not what the federal government has done.

The stimulus bill passed by Congress in February requires the Small Business Administration to create a new “business stabilization” program to back loans of up to $35,000 to small businesses “experiencing immediate financial hardship”.  Known as America’s Recovery Capital (ARC) Loan Program, this emergency SBA program restricts the use of the proceeds of the loan. It rewards debtors in an unusual way. Small business owners cannot use new ARC loans to cover payments on existing SBA-guaranteed debt. However, as I posted on this blog on March 23, private loans made for any legitimate business purpose — including credit card debts, bank loans and real estate loans — would be eligible for the program.  So if you managed your small business carefully and avoided taking on debt, or you took on less expensive (relative to credit card debt) SBA loans, this program is of no help to you.

This is exactly at odds with what Secretary Geithner said about the administration’s plan to help “viable businesses” that were “prudent”.

Perhaps reflecting their own lack of familiarity with the legislation they had passed, not one senator on the banking committee called him on it.

Small Business at the Top of the U.S. Senate Banking Hearing

Wednesday, May 20th, 2009
Blowing In The Wind

Blowing In The Wind

Today, U.S. Treasury Secretary Timothy Geithner testified before the U.S. Senate Banking Committee. I watched the hearing in its entirety and was amazed that 80% of the questions the senators put to Mr. Geithner concerned small business lending. The senators made it clear that this was a major issue of concern to their constituents. Committee Chairman Senator Chris Dodd of Connecticut opened the session by asking what could be done to “catalyze more small business lending”. On the one hand, I was heartened to see that the senators clearly got the message that their constituents were outraged about the Troubled Asset Relief Program (“TARP”), the bailouts of large, irresponsible financial institutions, and the choking off of credit to the small business sector, which creates more than half of all employment in the U.S.

But at the same time, the federal government appears to be at odds with itself and is pursuing measures that can undermine its stated policy goal of unblocking credit to the small business sector.

Consider the opening statement of Secretary Geithner (the text of his remarks is available on the website of the U.S. Treasury) in which he announced that Treasury policies, including raising the amount of guaranteed loan principal to 90% and reducing or eliminating fees, raised weekly loan volumes of the U.S. Small Business Administration (“SBA”) by over 25 percent since March 16. In fact, loan volumes on March 16, or at any other date in 2009, were anemic. This is not the right baseline for comparison and suggests that the Treasury Secretary is attempting to manage public perceptions rather than confront the problem.

Another concern is that the Treasury and the SBA appear to be on a different timeline than the small business owners reporting their “frustration” (Chairman Dodd’s term) to their elected representatives. Secretary Geithner reported a start in the small business emergency loans that Congress had authorized in February’s stimulus bill. The SBA has been working since then to draft guidance for this program to distribute to the banks by June 8. They intend to accept loan applications starting June 15. Cashflow is critical to a business and an economic disaster is not terribly different from a natural or other man-made disaster. Consider that after the 1993 bombing in the World Trade Center, of those small businesses that could not resume operations and cash flow within five days, 90% of them were out of business one year later. The fact that the SBA took four months to develop guidance to disburse loans enabled by legislation passed in February suggests that it doesn’t have a sense of urgency.

Another issue that Secretary Geithner raised in his testimony was that guarantees on SBA loans had been raised from 80% to 90%. The most recently reported default rate on the SBA loan portfolio was 12%. Now the taxpayer will be on the hook for a higher amount of bad loans. Presumably, bank executives are sufficiently savvy to know how the public will assign blame for that. If you don’t want to be on the other end of the pitchfork, intertia is a sensible response to the government’s various initiatives.

Unlimited Risks or Empty Gestures?

Wednesday, May 6th, 2009

In an earlier posting, I wrote of the complications of the Small Business Administration’s new loan program. New details have emerged that the risks may be greater than the public appreciates. SBA loans were the main topic at a recent town hall meeting at which President Obama noted that the annual volume of loans backed by the Small Business Administration was trending below $10 billion, down from $18.2 billion last year and $20.6 billion the year prior.

To stimulate the flow of credit to small businesses, the administration endorsed provisions in the stimulus bill. The legislation attempts to unblock the flow of credit to small businesses by temporarily raising government guarantees from 80% to 90% on the SBA’s flagship loan programs. In addition, it’s temporarily waiving SBA loan fees to reduce the cost of capital.

The Treasury now requires the 21 largest banks receiving funds under the Troubled Asset Relief Program to report their small business loan volumes on a monthly basis. Other banks receiving TARP funds must report this information quarterly. Treasury advised banks not participating in TARP that they too should make every effort to increase their small business lending. This push suggests that after the banks repay their TARP obligations, Treasury will continue to take an interest in SBA loans.

Critics of SBA programs charge that SBA loan guarantees create a moral hazard in incentivizing lending that’s harmful to U.S. taxpayers who must bear any losses. The most recent default rate reported on the SBA loan portfolio is 12%.

Further compounding the moral hazard risk is that some of the 21 largest banks have limited experience with small business lending. With the SBA principal guarantee on loans increased to 90% from 80%, taxpayers could potentially be underwriting a steep learning curve for the banks. Bank executives presumably appreciate how the public would likely assign blame for loan losses requiring additional taxpayer support.

This raises the question: is this a sincere effort to unblock the flow of credit to small businesses or an empty political gesture?


Delays in the SBA Stimulus

Sunday, May 3rd, 2009
Pushing Pencils, It Seems

Pushing Pencils, It Seems

In a previous blog entry, I expressed skepticism about the Small Business Administration’s forthcoming emergency credit facility, tentatively named “America’s Recovery Capital (ARC) Loan Program”.  The legislation enabling this program, the stimulus bill, requires the SBA to create a new “business stabilization” program to back loans of up to $35,000 to small businesses “experiencing immediate financial hardship”. Now there is another reason to question the value of this program.

A recently released  Government Accountability Office report announces that the Small Business Administration will be a few months late installing some new regulations meant to revive SBA lending, which has dramatically declined over the past year. Two changes mandated by Congress, including eliminating loan fees and raising loan guarantees for borrowers, were enacted in the required 15-to-30-day period. But the SBA failed to increase guarantees on secondary market real estate and equipment loans and to issue regulations involving “systemically important” broker-dealers in the secondary market in a timely manner. SBA officials stated that it was too complicated to enact such rules in the short period required by Congress and that they hoped to have these matters resolved by June.

If You Are Gasping for Air, This May Not Help

Monday, March 23rd, 2009
Gasping for Air

Gasping for Air

The Small Business Administration continues to work on guidelines for its forthcoming emergency credit facility, tentatively named “America’s Recovery Capital (ARC) Loan Program”.  The legislation enabling this program requires the SBA to create a new “business stabilization” program to back loans of up to $35,000 to small businesses “experiencing immediate financial hardship”. The proceeds of these loans are to make up to six months of interest and principal payments on a “qualifying small business loans”. This program was conceived as a stopgap measure to assist small businesses struggling to service existing debt. Congress allocated $255 million in the stimulus to fund the ARC program, paying for the program’s loan guarantees and interest subsidies, thereby levering up the amount available to lend. As the SBA is still developing the ARC loan guidelines, it does not yet know when the funds will be available.  While this may appear to be welcome news to small businesses that have thus far not benefited from the government bailouts, hold your applause. There are several issues to consider:

  • Defining “viable businesses” to mitigate moral hazard risk. For the first time in its history, the SBA will offer issuing banks a 100% guarantee on ARC loans that they extend to small business owners. If the business owner defaults, the SBA will repay the bank for the full value of the loan. The SBA will also fully subsidize the interest on the loans, making them effectively free of cost to the small business borrower. No payments on the loans will be due for a year and businesses will have up to five years to repay the loans. However, the full guarantee of the taxpayer to the SBA program raises the moral hazard risk: the risk that banks will lend to borrowers that are not creditworthy because the government will pay the loan losses. This is particularly troubling, as the SBA has already reported soaring default rates on its traditional loan programs. To mitigate this risk, the SBA stipulates that ARC loans are to be extended only to “viable” small businesses, which it defines as those that have “demonstrated an earnings history and a proven record for success that may just need a little extra help to get through a short-term downturn”. (Shouldn’t all loans be limited to “viable” businesses? And how did the SBA determine that the current economic downturn will exist only for the “short-term”?)

We dealt with this issue in the aftermath of 9-11 as disaster aid programs were defined as corporate welfare for the Fortune 500 and loans (with personal guarantees) for the small businesses. However, in order to qualify for the subsidized loans, you had to prove that yours was a “viable” small business. My business, which was newly incorporated and had a short history prior to 9-11-01, did not qualify, nor did other start-ups. (Although eight years later, we are still in business, which is not true for certain of the financial services corporations in the Fortune 500 that received 9/11 handouts.) In other words, in order to qualify for the loan, you had to prove that you didn’t need it.

  • Limited qualifications for the use of the loan proceeds. You won’t be able to use the new ARC loans to cover payments on existing SBA-guaranteed debt. The stimulus bill, the American Recovery and Reinvestment Act, contains a provision written into the bill by Congress that explicitly prevents the use of ARC loans to pay down existing SBA debt incurred before the bill’s passage. CNN quoted a staffer with the House Small Business Committee who explained that the provision was mandated by the Congressional Budget Office to comply with pay-as-you-go restrictions against increasing the federal deficit through new direct-spending legislation. He added “it is one of the most complicated things I’ve heard in a long time”. Businesses with existing SBA-loans can still apply for the new ARC loans, but they cannot use the latter to pay down the former.
  • Rewarding debtors. The House Committee staffer added, “private loans made for any legitimate business purpose — including credit card debts, bank loans and real-estate loans — would be eligible for the program”.  So if you managed your small business prudently and avoided taking on debt of any kind, this program is of no help to you.  If you did take on debt, you should probably be negotiating new terms and forbearance with your creditors, even if you think you won’t need it. Take the breathing room while you can.

And of course, like all government programs, this one is complicated. I would prefer to invest my time in growing my revenues than attempting to decipher the requirements of another government program.

Sharp Increase in Default Rate on SBA Loans

Thursday, February 26th, 2009
Maybe not the right solution

Not always the best solution

The Coleman Report, which provides lenders with small business data and Small Business Administration news, found that 11.9% of the SBA’s loans in the 2008 fiscal year went into default. The failure rate was determined by dividing the number of loans liquidated or charged off last year by the total number of loans made through the SBA lending programs. This is a different methodology than that used by the SBA, which measures only the dollar volume of loans charged off or liquidated, resulting in the appearance of a lower default rate at 5%. Both methods of computing failure rates show sharp increases over the previous year. In the 2008 fiscal year ended September 30, the SBA’s 7(a) and 504 programs approved 78,324 loans, totaling $18.2 billion. The performance for small business loans in the franchising industry deteriorated with franchisee defaults on SBA-guaranteed loans increasing 52% in the fiscal year 2008 as compared with 2007, according to the Wall Street Journal. The franchise industry attributed this poor performance to resales of franchises in which small business owners paid goodwill over and above the franchise fee to acquire a franchise from an existing operator rather than purchasing the a new franchise at cost directly from the company.

While this report did not specifically address the SBA’s disaster loans, the default rates suggest an interesting parallel. I generally recommend that small business owners carefully consider the alternatives before taking on an SBA disaster loan. While the interest rates and payment terms may be attractive, the small business owner has to pledge collateral and provide personal guarantees. Disaster recovery is typically a much longer process than one imagines and the recovery does not always follow a linear path. I would be reluctant to take on debt given the uncertainty about cash flows, the timely payment of insurance claims, the disbursement of disaster aid or the resumption of normal commercial activity in the aftermath of a major disaster. What the Coleman Report alludes to is an economic disaster in which small business owners assumed comparable risks. Unfortunately, the soaring default rates justify the caution lenders have in extending more credit to their small business loan portfolios, thereby making it more difficult for healthy, viable businesses to access the capital they need.