Small business lending

From Riski

Jump to: navigation, search

Contents

President signs small business lending act

President Barack Obama signed legislation that will cut taxes and provide credit help for small businesses, calling it an essential step for job growth in a slow economy.

Small businesses “have borne the greatest brunt of this recession” because of lower demand from consumers and less available credit, Obama said.

The government “can’t create jobs to replace the millions that we lost in the recession, but it can create the conditions for small businesses to hire more people,” the president said at the signing ceremony in the East Room of the White House.

The bill, which got final congressional approval last week, was the fourth jobs measure to clear Congress this year and is likely the last before the midterm congressional elections. While the economy is slowly recovering from the longest recession since the 1930s, much of the rest of the year likely will be dominated by debate over whether to extend income tax cuts passed under former President George W. Bush and set to expire at the end of the year.

The small-business legislation provides $56 billion worth of tax cuts over the next 12 months, with the bulk coming through “bonus depreciation,” which allows companies to more quickly write off the cost of purchases. It also revives stimulus provisions cutting fees and increasing limits on loan guarantees offered by the Small Business Administration.

Community Banks

Another provision creates a $30 billion program in which the Treasury Department would buy preferred shares in community banks, with participants paying the government dividends on a scale depending on how much they increase lending to small businesses. Republicans objected to that part of the legislation, saying it amounted to little more than a smaller version of the Troubled Asset Relief Program.

As a result of the legislation, the administration will be able to release more than $680 million in SBA loans to more than 1,300 businesses.

“When I sign this bill their wait will be over,” Obama said.

The measure will eliminate capital-gains taxes for some small-business investments, and about 4.5 million businesses will be eligible for faster write-off of expenses. Two million people can qualify for a new health-insurance deduction, the president said.

“It means jobs,” Michigan Governor Jennifer M. Granholm, a Democrat, told reporters at the White House after the signing.

She said auto suppliers, struggling with depleted credit, would benefit with hundreds of millions of dollars in new credit being pumped into the state.

The result is that those suppliers may be able to shift into other areas, such as medical devices or alternative energy, potentially creating or retaining 11,000 jobs in the state, she said.

House passes Small Business Lending Fund Act

Yesterday, the House of Representatives passed H.R. 5927, the Small Business Lending Fund Act of 2010. The legislation includes two key lending initiatives, a Small Business Lending Fund that will provide up to $30 billion to Treasury to purchase preferred stock or debt instruments from small banks, thereby enabling the extension of additional credit to small businesses, a program previously put forward by the Obama Administration this past February, and a State Small Business Credit Initiative to support innovative state small business programs, "many of which have been threatened by budget shortfalls." Secretary Timothy Geithner lauded the passage of the bill as "strong action to help continue moving our nation's economic recovery forward," in particular helping to "ensure that main street entrepreneurs are positioned to create new jobs and invest in their local communities."

House Fin Services Committee hearing - Feb 26, 2010

10:00 a.m., February 26, 2010, 2128 Rayburn House Office Building

S.2919 amend the Federal Credit Union Act to promote small business growth

  • Source: S. 2919 Senator Mark Udall, D-CO

S.2919 - A bill to amend the Federal Credit Union Act to advance the ability of credit unions to promote small business growth and economic development opportunities, and for other purposes.

Regulators directive on small business lending

The federal financial institutions regulatory agencies1 and the state supervisors 2(collectively, the “regulators”) are issuing this Interagency Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers (the “Statement”) to restate and elaborate their supervisory views on prudent lending to creditworthy small business borrowers.3 This Statement builds upon principles in existing guidance, including the November 2008 Interagency Statement on Meeting the Needs of Creditworthy Borrowers and the October 2009 Policy Statement on Prudent Commercial Real Estate Loan Workouts. The regulators note that while the October 2009 statement focused on commercial real estate, many principles articulated in that guidance are applicable to small business lending.

Some small businesses are experiencing difficulty in obtaining or renewing credit to support their operations.4 Between June 30, 2008, and June 30, 2009, loans outstanding to small businesses and farms, as defined in the Consolidated Report of Condition (Call Report), declined 1.8 percent, by almost $14 billion.5 Although this category of lending increased slightly at institutions with total assets of less than $1 billion, it declined over 4 percent at institutions with total assets greater than $100 billion during this timeframe. This decline is attributable to a number of factors, including weakness in the broader economy, decreasing loan demand, and higher levels of credit risk and delinquency. These factors have prompted institutions to review their lending practices, tighten their underwriting standards, and review their capacity to meet current and future credit demands. In addition, some financial institutions may have reduced lending due to a need to strengthen their own capital positions and balance sheets.

Supervisory Expectations

While the regulators believe that many of these responses by financial institutions are prudent in light of current economic conditions and the position of specific financial institutions, experience suggests that financial institutions may at times react to a significant economic downturn by becoming overly cautious with respect to small business lending. Regulators are mindful of the harmful economic effects of an excessive tightening of credit availability in a downturn and are working through outreach and communication with the industry and supervisory staff to ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound small business borrowers. Financial institutions that engage in prudent small business lending after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for loans made on that basis.

Underwriting and Risk Management Considerations

An institution should understand the long-term viability of the borrower’s business, and focus on the strength of a borrower’s business plan, including its plan for the use and repayment of borrowed funds. The institution should have an understanding of the competition and local market conditions affecting the borrower’s business and should not base lending decisions solely on national market trends when local conditions may be more favorable. Further, while the regulators expect institutions to effectively monitor and manage credit concentrations, institutions should not automatically refuse credit to sound borrowers because of a borrower’s particular industry or geographic location. To the maximum extent possible, loan decisions should be made based on the creditworthiness of the individual borrower, consistent with prudent management of credit concentrations.

For most small business loans, the primary source of repayment is often the cash flow of the business, either through the conversion of current assets or ongoing business operations. An institution’s cash flow analysis should cover current and expected cash flows, and reflect expectations for the borrower’s performance over a reasonable range of future conditions, rather than overly optimistic or pessimistic cases. Many small business borrowers also rely on their personal wealth and resources to support loan requests. A borrower’s credit history and financial strength, including credit score, are components of assessing willingness and ability to repay, and should be considered in conjunction with other judgmental factors, such as the strength of management. The loan structure should be appropriate for meeting the funding needs of the borrower given the type of credit and expected timing of the business’ cash flow. Further, an institution should analyze the secondary sources of repayment, such as the strength of any guarantor or collateral support, and the ability of the borrower to provide additional capital. Institutions should not place excessive reliance on cyclical factors, such as appreciating or depreciating collateral values.

An institution should have robust risk management practices to identify, measure, monitor, and control credit risk in its lending activities. Further, institutions should promote a credit culture in which lenders develop and maintain prudent lending relationships and knowledge of borrowers. This culture should encourage lending staff to use sound judgment during the underwriting process. While institutions may use models to identify and manage concentration risk, portfolio management models that rely primarily on general inputs, such as geographic location and industry, should not be used as a substitute for the evaluation of an individual customer’s repayment capacity.

Examination Reviews

Examiners will not discourage prudent small business lending by financial institutions, nor will they criticize institutions for working in a prudent and constructive manner with small business borrowers. Examiners will expect institutions to employ sound underwriting and risk management practices, maintain adequate loan loss reserves and capital, and take appropriate charge-offs when warranted. As with all lending, examiners are expected to take a balanced approach in assessing the adequacy of an institution’s risk management practices in its small business lending activities. As a general principle, examiners will not adversely classify loans solely due to a decline in the collateral value below the loan balance, provided the borrower has the willingness and ability to repay the loan according to reasonable terms. In addition, examiners will not classify loans due solely to the borrower’s association with a particular industry or geographic location that is experiencing financial difficulties.

2009 CRA Small Business and Small Farm Loan Data

The Federal Financial Institutions Examination Council has announced the availability of data on small business, small farm and community development lending reported by certain commercial banks and savings institutions, pursuant to the Community Reinvestment Act. An FFIEC disclosure statement on the reported 2009 CRA data, in electronic form, is available for each reporting commercial bank and savings institution. The FFIEC also has prepared aggregate disclosure statements of small business and small farm lending for all of the metropolitan statistical areas and non-metropolitan counties in the United States and its territories.

2008 CRA Small Business and Small Farm Loan Data

General description of the data

  • For 2008, a total of 965 lenders reported data about originations and purchases of small business and small farm loans, a 3 percent decrease from the 998 lenders reporting data in 2007 (see Table 1). As a consequence of amendments to the CRA regulations, beginning in September 2005, banking institutions with assets below the mandatory reporting threshold (and, beginning in October 2004, savings associations with assets below that threshold) are not required to collect or report data on their small business or small farm lending. However, institutions with assets below the mandatory reporting threshold may voluntarily collect and report such information, and they must report the information if they elect to be evaluated as "large" institutions. Of the 965 institutions reporting 2008 data in 2009, more than 40 percent were not "large" institutions under the applicable regulation and, therefore, reported either voluntarily or because they elected to be evaluated as "large" (see Table 3).
  • Reporting institutions' small business and small farm lending is a significant portion of total small business and small farm lending by commercial banks and savings institutions. Analysis of data from Consolidated Reports of Condition and Income ("Call Reports") indicates that loans by CRA reporters represent about 86 percent of the small business loans outstanding measured by number of loans and about 28 percent of the small farm loans outstanding measured by number of loans extended by all commercial banks and savings institutions (see Table 1). During 2008, commercial banks and savings institutions with assets of $1.061 billion or more (as of December 31, 2007) originated or purchased almost 94 percent, by dollars, of the small business loans reported under CRA (see Table 3).
  • In the aggregate, about 10.8 million small business loans (totaling $296 billion) and about 211,000 small farm loans (totaling $14.2 billion) were reported as being originated or purchased in 2008 (see Table 2). The number of small business loans reported in 2008 decreased by about 20 percent from the number in 2007, and the dollar amount reported for such loans in 2008 decreased by about 10 percent from the dollar amount in 2007. The CRA data indicate a significant reduction in small business credit card activity and reductions in lines of credit by some reporting institutions. Most reported small business and small farm loans were originations; about 3 percent of the small business loans and less than 0.5 percent of the small farm loans were reported as purchases from another institution (derived from Table 2).
  • The CRA data provide information about the size of small business and small farm loans. For small business loans, the maximum loan size reported is $1 million; for small farm loans, the maximum is $500,000. Measured by number of loans, almost 96 percent of the small business loans and almost 81 percent of the small farm loans originated were for amounts under $100,000 (see Table 2). Measured by dollars, the distribution differs: about 41 percent of the small business loan dollars and about 32 percent of the small farm loan dollars were extended through loans of less than $100,000 (see Table 2).
  • The CRA data also include information on how many of the reported loans were extended to businesses or farms with revenues of $1 million or less. About 32 percent of the number of reported small business loans (about 37 percent measured by dollars) and 76 percent of the number of reported small farm loans (about 73 percent measured by dollars) were extended to firms with revenues of $1 million or less (see Table 2).

Proportion of small business loans to smaller firms

  • The proportion of small business loans extended to smaller firms in 2008 (32 percent) reflects a decrease from the 38 percent so extended in 2007. Lending to small firms peaked in 1999 at 60 percent. The longer-term decline in the percentage of small business loans to smaller firms primarily is due to a substantial increase in lending to larger firms through lines of credit, renewals of credit lines with larger limits, and credit cards. The decline also reflects the fact that some banks no longer request revenue-size information from business customers. Therefore, these banks no longer report which, if any, "small business" loans were extended to small businesses.

Geographic distribution of small business and farm lending

  • The availability of information about the geographic location of businesses and farms receiving credit provides an opportunity to examine the distribution of small business and small farm lending across areas grouped by their socio-demographic and economic characteristics. Information on the distribution of businesses and population provides some context within which to view these distributions.
  • CRA performance assessments include an analysis of the distribution of small business and small farm loans (of all types) across census tracts grouped into four income categories: low-, moderate-, middle-, and upper-income.3 Overall, the distribution of the number (see Table 4.1) and the dollar amounts (see Table 4.2) of small business loans across these categories parallels the distribution of population and businesses across these four income groups. For example, low-income census tracts include almost 5 percent of the population and about 4 percent of the businesses, and received about 3 percent of the number and about 4 percent of the total dollar amount of small business loans in 2008. Each income category's share of the number and dollar amount of loans remained about the same in 2008 as in 2007.
  • Analysis of the CRA data shows that small business loans are heavily concentrated in U.S. principal city and suburban areas (about 88 percent, measured by number and dollar amount of all small business loans), as are the bulk of the U.S. population and the number of businesses (see Table 4.1 and 4.2). The majority of small farm loans (about 59 percent, measured by number of loans, and almost 63 percent, measured by dollars of loans) were extended in rural areas, with the remainder extended primarily in suburban areas (see Table 4.3 and Table 4.4).

Small business lending: Big banks vs. small banks]

Just before Thanksgiving last year, the U.S. Small Business Administration's flagship loan program, which provides banks with a government guarantee of up to 90 percent of the value of loans made to small businesses that fall just shy of qualifying for a standard bank loan, ran out of money.

SBA loan guarantees are arguably one of the most efficient uses of stimulus funds. The $325 million included in the Recovery Act of last February covered the cost of backing $16.5 billion in loans to small businesses. Yet, as loan volume spiked in the fall, reaching pre-recession levels, Congress let the pipeline run dry.

Within weeks, more than 1,000 small businesses found themselves in loan purgatory: their loans had been approved, but banks couldn't release the funds.

Such a turn of events seems unconscionable amid a recession. But it's about to happen again. An additional $125 million appropriated in December will run out toward the end of February unless the Senate moves quickly to approve legislation that would support SBA loan guarantees through the end of the year.

These days, all eyes are on small businesses, and for good reason. They've created the majority of new jobs over the last decade and, in past downturns, it's been small business growth that has pulled us out of recession.

The ability of small businesses to finance growth is, in turn, largely dependent on the capacity of local community banks to lend them money. Although small and mid-sized banks ($10 billion or less in assets) control only 22 percent of all bank assets, they account for 54 percent of small business lending. Big banks, meanwhile, allocate relatively little of their resources to small businesses. The largest 20 banks, which now command 57 percent of all bank assets, devote only 18 percent of their commercial loan portfolios to small business. (See our graphs for more detail.)

As big banks have consolidated the market, small businesses have had a harder time obtaining loans. In a study published in 2007 in the Journal of Banking and Finance, Steven G. Craig and Pauline Hardee examined different regions of the country and concluded, "Credit access in markets dominated by big banks tends to be lower for small businesses than in markets with a relatively larger share of small banks."

Other research has found that, all else being equal, regions with a robust network of small, local banks are home to significantly more small firms.

Why is it that community banks do so much more small business lending than their big competitors? One reason is that big banks rely on computer models to determine whether to make a loan. Because the local market conditions and the circumstances surrounding each borrower and his or her enterprise are so incredibly varied, this standardized approach does not work very well when it comes to understanding the nuances of risk associated with a particular small business.

By drawing on qualitative information - getting to know the borrower, learning about the business, and understanding the local market - small banks can better assess risk and successfully make loans to a wider group of small businesses.

"We don't use credit scoring, where certain parameters about the business are put in and the computer says yes or no. We still rely on a thorough understanding of the financial information that the borrower brings us. You get to know the borrower and understand what the numbers mean in the context of that business," said John Kimball, vice president of Park Midway Bank, a $272 million-asset bank in St. Paul, Minnesota.

Small banks regularly finance businesses that big banks have turned away. Andrew Atwood, who sought financing last year to expand his auto repair business in Phoenix, was rejected by seven large banks. "It was a nightmare," he said. "They had a 'you're lucky we're even looking at you' kind of attitude." Then a customer introduced him to Sonoran Bank, a small, locally owned bank. "From the get-go they treated us like your next door neighbor," he said. Not only did Atwood get the loan, but the rate, 5.25 percent, was lower than the 6.75 percent the big banks would have offered had he been approved.

At Sonoran, Atwood dealt directly with a senior loan officer empowered to approve his loan. This is another significant difference between small and big banks. "The decision-makers are at the community level," explained Fidel Gutierrez, senior vice president of Los Alamos National Bank, a 47-year-old locally owned bank in New Mexico. "At our bank, the bank president and the senior loan officers are visiting face-to-face with the borrowers. At larger banks, the person you deal with may take the loan request, but they do not make the decision."

Because big banks are run from afar, it's impossible, or at least very expensive, for them to obtain the kind of qualitative information about risk that local bankers pick up naturally by being part of the community and interacting with borrowers. As a result, there are no economies of scale in small business lending; just the opposite. Small banks are, on average, more efficient small business lenders and make a better return on their assets.

All of this makes plain the fallacy of thirty years of banking policy that has fueled mergers and consolidation on the grounds that bigger banks mean greater efficiency and more growth. Banking consolidation has in fact constricted the flow of credit to the very businesses most likely to create new jobs.

It's no surprise then that the money taxpayers have spent over the last 16 months shoring up big banks has done nothing to free up credit for small businesses. To do that, we need to focus on expanding the lending capacity of small banks.

The Obama Administration has finally grasped this, putting forward a flurry of proposals in recent weeks aimed at increasing the flow of loans from small banks to small businesses.

Although some community banks will benefit from Obama's plan to make $30 billion in low-cost capital available to them, for most small banks, the issue right now is not a lack of capital. Most small banks are in pretty good shape and have money to lend.

The problem is that loan demand is down and many of the small businesses that are seeking loans are not creditworthy by standard measures. Their cash flow has been battered by the recession. Many no longer have equity in their homes or businesses to borrow against. Through no fault of their own, small businesses are operating in an economy in which they are more likely to fail and thus constitute much riskier investments.

This is where SBA loan guarantees come in. They allow banks to absorb more risk. "For a bank, if more than one or two percent of your loans go bad, you're out of business," explained Kimball of Park Midway Bank. "The SBA guarantees allow you to get that into a range of 5-8 percent. It allows you a lot more leeway in terms of risk."

While SBA-backed loans constitute only about 8 percent of overall small business lending, they account for 40 percent of long-term loans and thus provide an essential source of patient capital for growing small businesses. Under the SBA's flagship 7(a) lending program, which backs loans of up to $2 million that small businesses can use for working capital, equipment or expansion, the payback period is 7 to 25 years, a longer term than most standard bank loans.

In the 12 months before the credit crisis, some 2,500 banks, mostly small community banks, made over 69,000 loans under the 7(a) program. Three-quarters were for amounts under $150,000, one-third went to minorities, and nearly 40 percent funded start-ups. In good economic times, fees paid by borrowers cover the cost of the program, including defaults.

When the credit markets froze in the fall of 2008, the volume of SBA-backed bank loans plummeted to about half of normal. Big banks, especially, sharply cut back their lending. SBA loan volume at JP Morgan Chase, for example, fell 66 percent.

The Recovery Act sought to bolster 7(a) lending by expanding the maximum guarantee from 75 to 90 percent of the loan and waiving the fees charged to borrowers. It worked: monthly loan volume climbed from $700 million during the darkest months of the crisis to an average of over $1.5 billion during the last six months - a higher volume than in the year before the collapse.

Yet, despite the fact that SBA loan guarantees effectively and inexpensively address one of the most debilitating aspects of this recession - reduced credit for small businesses - Congress has allowed the program to run dry once already and is on the verge of doing so again in the next few weeks.

Obama has called for extending the higher guarantees and fee waiver through the end of the year. The House has passed a bill to do so. And now, like so much of the legislative agenda, further action depends on the Senate.

Federal Reserve's Duke on small business lending

"... Still, access to credit for many households and smaller businesses that largely depend on banks for credit remains difficult. Risk spreads on some types of loans at banks have continued to rise, and the decline in bank loans outstanding has been stark. For example, our data show that total loans on banks' books fell at an annual rate of more than 11 percent during the third quarter of 2009, with all major loan categories contributing to the decline. In addition, unused credit lines at commercial banks have dropped almost 25 percent from their peak at the end of 2007; unused credit card lines, the biggest category, are nearly $1 trillion below their peak.

A number of factors are at work in explaining the reduction in bank loans. For instance, for most commercial banks, the quality of existing loan portfolios continues to deteriorate as levels of delinquent and nonperforming loans are still rising. In response, banks have reduced existing lines of credit sharply and tightened their standards and terms for new credit. In addition, banks with capital positions that have been eroded by losses or those with limited access to capital markets may be reducing risky assets to improve their capital positions, especially amid continued uncertainty about the economic outlook and possible future loan losses. During this financial crisis, a number of lending relationships have been severed as individual banks sought to reduce loan portfolios or concentrations within those portfolios or as banks failed or merged. Established banking relationships are particularly important to small businesses, who generally do not have access to broader capital markets and for whom credit extension is often based on private information acquired through repeated interactions over time. When existing lending relationships are broken, time may be required for other banks to establish and build such relationships, allowing lending to resume.

The reduction in the availability of credit, however, is not the whole story. There is also less demand for credit. As businesses reduced inventory levels and capital spending, they tended to pay down debt and build cash positions. Moreover, large firms replaced bank debt by accessing the bond market in considerable volume last year. Even small businesses, in a survey by the National Federation of Independent Business, report that while loans remain difficult to get, their most important business problem is lack of customer demand, a factor that has likely restrained their demand for funds. Furthermore, some consumers, perhaps in particular those who are highly leveraged, may be trying to pay down debt and rebuild their balance sheets. While some potential borrowers seek less credit, others are ineligible to borrow. Weakened balance sheets, reduced income, falling real estate collateral values, and in some cases, a recent history of payment problems, presumably have made it difficult for some businesses and consumers to qualify for loans, especially under current stricter standards..."

GAO Jan. 2010 report on SBA implementation of Recovery Act

Due to recent turmoil in U.S. credit markets, many lenders have been reluctant to offer conventional loans—that is, loans not guaranteed by the federal government—to small businesses so that they can finance their operations and capital needs. While the Small Business Administration’s (SBA) principal loan guarantee programs, the 7(a) and 504 programs, are intended to help small businesses raise critical financing that they may have difficulty obtaining from other sources, the availability of such loans has also declined. Under the 7(a) program, SBA traditionally has provided lenders guarantees on up to 85 percent of the value of loans to qualifying small businesses in exchange for fees to help offset the costs of the program. Under the 504 program, which generally applies to small business real estate and other fixed assets, SBA provides certified development companies with a guarantee on up to 40 percent of the financing of the projects’ costs in exchange for fees—the small business borrowers and other lenders provide the remaining 60 percent of the financing on an unguaranteed basis.1 Traditionally, lenders, such as banks, that participate in the 7(a) or 504 programs often sell qualifying small business loans on the 7(a) and 504 secondary markets to raise funds necessary for additional lending.2 However, from mid-2008 to early-2009, investors that had typically purchased securities collateralized by the pools of 7(a) guaranteed small business loans and certain 504 loans largely withdrew from the secondary markets due to potential losses, and as a result, many such loans remained on the balance sheets of the broker-dealers that package the securities or on the balance sheets of the original lenders.3 According to SBA, the dollar volume of 7(a) loans sold as securities on the secondary market dropped from $425.4 million to $85.9 million, or 79.8 percent, from the end of the third quarter of 2008 to the end of the first quarter of 2009.

Under the American Recovery and Reinvestment Act (ARRA), enacted on February 17, 2009, SBA was required to implement eight new authorities—referred to throughout this report, and by ARRA, as administrative provisions—to help facilitate small business lending and enhance liquidity in the secondary markets.4 The provisions included requirements for, among other things, (1) temporarily lowering or eliminating certain fees on 7(a) and 504 loans, as well as increasing the maximum guarantee on the former;5 (2) establishing new programs to facilitate secondary market activity;6 and (3) establishing a new, temporary guaranteed loan program for viable small businesses experiencing financial hardship, which SBA refers to as the America’s Recovery Capital (ARC) Loan Program.7 The administrative provisions took effect when ARRA was enacted, with certain provisions granting SBA emergency rulemaking authority to hasten their implementation. Specifically, ARRA required SBA to issue regulations implementing sections 503 (first-lien guarantee) and 506 (ARC Loan Program) within 15 days of enactment, or by March 4, 2009, and to issue regulations implementing Section 509 (loans to broker-dealers) within 30 days of ARRA enactment, or by March 19, 2009.

In April 2009 we issued a report on SBA’s development and implementation of the ARRA administrative provisions, which found that SBA had not completed required emergency regulations.8 While SBA had taken key steps authorized by ARRA—such as temporarily eliminating existing fees for 7(a) loans and increasing the guarantee on such loans—it had not issued regulations for the secondary market provisions or the ARC Loan Program. The report noted that SBA’s inability to implement these provisions was due to a variety of factors, including the challenges associated with developing and implementing new programs and the loss of key staff. However, the report also stated that SBA planned to complete these administrative provisions by June 2009.

Following the issuance of our report, you requested that we continue to review SBA’s efforts to implement the eight ARRA administrative provisions. You asked that we pay particular attention to the completion of emergency regulations that were due 15 and 30 days after ARRA enactment, including reasons for any implementation delays. This letter summarizes a November 2009 briefing we provided to your staff on the results of this work (see enclosure I for the briefing slides). Our objectives were to discuss the extent to which (1) SBA has implemented the eight ARRA administrative provisions, with a focus on those that granted SBA emergency rulemaking authority to issue regulations; (2) ARRA administrative provisions and other actions are enhancing liquidity in the markets for SBA 7(a) and 504 loans; and (3) SBA has implemented the ARC Loan Program and how its program terms appeal to market participants. We also updated the enclosed briefing slides to include activities undertaken by SBA to implement the provisions after the date of our briefing.

To address our objectives, we reviewed SBA's development of regulations, policies, and procedures for implementing the ARRA administrative provisions and interviewed SBA officials to obtain data and determine the status of efforts underway, time frames, program accomplishments, and planned activities. We also interviewed SBA officials regarding steps taken to increase liquidity in the 7(a) and 504 primary and secondary markets and reviewed relevant documents. Further, we interviewed market participants, such as primary SBA lenders and broker-dealers, on their views regarding SBA's implementation efforts and the effects of the ARRA provisions on the 7(a) and 504 primary and secondary markets. In addition, we interviewed SBA officials, and obtained and analyzed data on SBA’s efforts to develop and implement the ARC Loan Program. We also interviewed market participants on their views regarding the ARC Loan Program, including their views on the attractiveness of program terms and requirements.

We conducted this performance audit from July 2009 through December 2009 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

GAO on Small Business Administration risk rating system

SBA’s lender risk rating system uses some of the same types of information that federal financial regulators and selected large lenders use to conduct off-site monitoring, but its usefulness has been limited because SBA has not followed common industry standards when validating the system—that is, assessing the system’s ability to accurately predict outcomes. Like the federal financial regulators and 10 large lenders GAO interviewed, SBA’s contractor developed lender risk ratings based on loan performance data and prospective, or forward-looking, measures (such as credit scores). Using SBA data, GAO undertook a number of evaluative steps to test the lender risk rating system’s predictive ability.

GAO found that the system was generally successful in distinguishing between higher- and lower-risk lenders, but it better predicted the performance of larger lenders. However, the system’s usefulness was limited because the contractor did not follow validation practices, such as independent and ongoing assessments of the system’s processes and results, consistent with those recommended by federal financial regulators and GAO’s internal control standards. For example, the agency did not require a party other than the one who developed the system to perform the validation, and SBA’s contractor did not routinely reassess the factors used in the system as part of its validations.

Further, SBA does not use its own data to develop alternate measures of lender performance that could be used to independently assess or supplement the risk ratings, citing resource constraints. Because SBA does not follow sound validation practices or use its own data to independently assess the risk ratings, the effectiveness of its lender risk rating system—the primary system SBA relies on to monitor and predict lender performance—may deteriorate as economic conditions and industry trends change over time.

Although SBA’s lender risk rating system has enabled the agency to conduct some off-site monitoring of lenders, the agency does not use the system to target lenders for on-site reviews or to inform the scope of the reviews. Unlike the Federal Deposit Insurance Corporation and the Federal Reserve, which use their off-site monitoring tools to target lenders for on-site reviews, SBA targets for review those lenders with the largest SBA-guaranteed loan portfolios.

As a result of this approach, 97 percent of the lenders that SBA’s risk rating system identified as high risk in 2008 were not reviewed. Further, GAO found that the scope of the on-site reviews that SBA performs is not informed by the lenders’ risk ratings, and the reviews do not include an assessment of lenders’ credit decisions. The federal financial regulators use the results of off-site monitoring to identify which areas of a bank’s operations they should review more closely. Moreover, their reviews include an assessment of the quality of the lenders’ credit decisions.

Federal financial regulators are able to use review results to update their off-site monitoring systems with data on emerging lending trends. Regardless of the lender’s risk rating, SBA relies on a standard on-site review form that includes an assessment of lenders’ compliance with SBA policies and procedures but not an assessment of lenders’ credit decisions. According to SBA officials, it is not the agency’s role to assess lenders’ credit decisions. Without targeting the most risky lenders for on-site reviews or gathering information related to lenders’ credit decisions, SBA cannot effectively assess the risk posed by lenders or ensure that its lender risk rating system incorporates updated information on emerging lending trends.

Credit unions seek higher cap for lending

"...Credit unions, historically focused on consumer lending, increasingly are making loans to businesses, too. But the industry's potential role in fueling an economic recovery, and its opportunity to seize market share from struggling banks, is limited by federal limits on the share of a credit union's resources that can be devoted to business lending.

The industry now is mounting a vigorous campaign to lift the cap. Sympathetic legislators have introduced bills in the House and Senate that would more than double the business-lending capacity of credit unions. But banks vigorously oppose the idea, arguing that credit unions should remain focused on their traditional mission of making loans to consumers.

The Obama administration has made increased small-business lending a centerpiece of its economic agenda, and credit unions say raising the cap would instantly increase loan availability at no direct cost to taxpayers. But credit unions are barely mentioned in President Obama's proposals to increase small-business lending.

"We work very closely with credit unions and we have put forward a number of initiatives to help small businesses, but we are always willing to explore new ideas," Andrew Williams, a spokesman for the Treasury Department, said Monday.

Credit unions are tax-exempt, cooperative institutions that offer loans to members at low interest rates. Most of the nation's several thousand credit unions serve small communities, such as the employees of a particular company. In 1998, Congress passed a law making it easier for them to expand but requiring a focus on consumer lending, in particular by limiting business lending to 12.25 percent of assets.

That limit was largely hypothetical until regulators lifted a number of other limitations on business lending in 2003. Small-business lending by credit unions shot from under $10 billion at the end of 2003 to more than $35 billion as of the end of September, according to Bill Hampel, chief economist at the Credit Union National Association, a trade group. But CUNA warns that the growth is not likely to continue, as 180 credit unions already are bumping up against the federal cap.

Sen. Mark Udall (D-Colo.) introduced legislation in December that would lift the lending cap to 25 percent. A similar bill is pending in the House. An analysis by CUNA estimated that credit unions could make an additional $10 billion in business loans in the first year after the change took effect.

David Ely, a finance professor at San Diego State University who has studied the issue, said there was good reason to think credit unions had the capacity to increase small-business lending, though he cautioned that the impact on the economy would be modest. The banking industry holds more than $800 billion in small-business loans..."

Large bank lending to small firms declines

"...According to the latest Treasury survey of the 22 largest banks that were the among the biggest recipients of government aid, loan originations from those companies totaled $240.2 billion in October, down 11 percent from the average in the previous six months of $269.7 billion.

  • Citigroup’s new loans fell 18 percent in October to $12.5 billion from a month earlier, and *JPMorgan Chase & Co.’s dropped 3 percent to $48.8 billion, the report showed...."

Obama meets with small bankers

"President Barack Obama told a dozen community bankers that he’ll work to streamline regulations as Treasury Department data show there have been few takers for government funding meant to spur lending to small businesses.

Obama’s remarks yesterday came as Treasury Department officials seek new ways to use funds from the $700 billion financial-bailout program to get local banks lending to small businesses. So far, 49 of the nation’s 7,408 community banks have stepped forward to take advantage of two capital-injection programs started by the Obama administration, Treasury figures show.

The Treasury has not yet settled on a plan to use $30 billion from the Troubled Asset Relief Program that has long been earmarked for small-business lending, a Treasury official said today.

“The key sticking points have been what they have been from the beginning: the statutory restrictions that Congress has put on the TARP funds,” said Paul Merski, chief economist of the Independent Community Bankers of America. “It’s been very difficult to entice banks to engage in a small-business lending program that would have all of those strings attached.”

Banks that sign up for money from the TARP must pay dividends on the government’s investment and agree to executive compensation restrictions, among other conditions set out by Congress.

‘Do More’

Seventeen banks have accepted an average of $4.4 million each under a program Obama announced in October to provide capital to banks with small-business lending plans, according to Treasury data. Obama said “we must do more” to boost smaller banks when he rolled out the new initiative.

Another 32 banks have signed up for a similar program announced in May to provide extra government capital to small banks. Treasury Secretary Timothy Geithner said then that the Treasury sought to reuse government aid repaid by larger banks to help their smaller counterparts.

Banks including New York-based Citigroup Inc. and Charlotte, North Carolina-based Bank of America Corp. have repaid $116 billion to exit the TARP and its accompanying restrictions. By contrast, the two programs for small banks have used $326 million as of Dec. 22.

Another Treasury program aimed at community lending, a plan to buy as much as $15 billion in packaged small-business loans that was announced in March, never purchased any loans.

Reluctant Banks

Small banks “have been very reluctant to come and do business with the government,” Geithner said earlier this month, in testimony before the Congressional Oversight Panel, a TARP watchdog. Geithner said banks see a “stigma” in dealing with the government, particularly while their regulators are paying close attention to underwriting standards and capital levels.

The explanation was met with skepticism from Elizabeth Warren, the Harvard law professor who heads the panel. “Treasury has now announced three plans and, clearly, has not gotten the job done,” she said at the Dec. 10 hearing.

Obama said after yesterday’s White House meeting that he talked about the role banks play in making sure businesses “are getting the capital they need” while the U.S. economy recovers. The president said he recognizes that closer scrutiny of banking practices brought on by the financial crisis has made it harder for banks to lend, and that he’s looking at ways “to cut some of the red tape.”

Large Banks

Obama’s meeting with community bankers follows a similar session he had last week with executives from a dozen of the nation’s biggest financial institutions to spur lending to aid job growth.

The U.S. lost 7.2 million jobs since the recession began in December 2007. Economists surveyed by Bloomberg this month forecast the jobless rate will remain above 10 percent through the first half of next year.

According to the Washington-based ICBA, an advocacy group representing almost 5,000 community banks, lenders with $1 billion in assets or less make up about 12 percent of the total for the industry. They make 31 percent of all small-business loans below $1 million.

The “unanimous concern” of executives at the table with Obama yesterday was the regulatory environment, Deborah Wright, chairman and CEO of Carver Federal Savings Bank in New York, said in a Bloomberg Television interview afterward.

Bank Profits

Bankers also want to ensure that loans they make don’t go sour, she said. “We’re all concerned about our own profitability,” Wright said.

Obama said that, while he doesn’t “have direct influence over independent regulators,” he wants to “get the balance right” between curbing risks and getting credit to consumers and businesses. After an era of easy credit, “the pendulum may have swung too far in the direction of not lending,” he said.

Federal Deposit Insurance Corp. Chairman Sheila Bair said in a Dec. 3 interview that regulators are getting tougher.

“There need to be higher capital levels,” Bair said. “One of the other issues for me is getting smaller banks to have more diversified balance sheets.”

James MacPhee, president of Kalamazoo County State Bank in Schoolcraft, Michigan, said Obama’s message to the bankers was that the administration is listening.

“They know that the community banks of this nation did not create this train wreck,” MacPhee said outside the White House. “They know that we’re common-sense lenders.”


Small business lending "special purpose vehicles"?

"IN THIS week's print paper, I cover the credit crisis facing small businesses and the government's effort to address it:

Will Mr Obama’s latest ideas help? Most are extensions to current stimulus measures. The one exception is a new small-business tax cut for job creation, details of which have not yet been released. Mr Obama intends to provide a booster to the SBA loan programmes, offering more money to cover fee reductions and SBA guarantees for small-business loans made by commercial banks. All this is good. But lending is the chief problem. If regional banks are fighting to survive, lower fees will not be enough to get small-business finance flowing again. Ironically, it might have been better to use some of that TARP money for the banks after all.

In fact, the adminstration now appears to be moving in that direction. Today's Washington Post highlights the latest strategy being considered to direct credit where it's needed:

One plan under consideration involves spinning off a new entity from the Troubled Assets Relief Program that would give banks access to federal funds without restrictions, including limits on executive pay, as long as the money was used to support loans to small businesses. But officials are not yet certain whether carving the program out of TARP would be the best way to encourage banks to boost small-business lending, according to sources familiar with the matter who spoke on the condition of anonymity because the plans are not final...

The new program relies on a structure called a "special-purpose vehicle," an entity that is typically used by financial firms to achieve a temporary investment or business objective while separating the parent company from any legal risk of that activity. In this case, the vehicle would be financed by rescue funds and would lend to banks that provide small-business loans. In theory, this structure would free banks of the TARP conditions because they would be getting the money from a separate entity. They could also avoid being labeled as a TARP recipient.

Ah, yes, the return of the special-purpose vehicle. My concern is that current lending to small businesses is inadequate because smaller banks are worried about their exposure to growing commercial real estate losses. If those losses continue to mount, then additional lending to the banks may not produce the desired result. What you'd like to see, instead, is the removal of the troubled-assets from bank balance sheets.

But presumably the government will arrive at that stage next, after the SPV fails to get the job done. And after announcing the plan to purchase troubled assets, then they may move on to equity injections. We've all seen this playbook, have we not?"

Australian Senate inquiry into access of small business to finance

Introduction

The submission is in two sections reflecting the Inquiry’s terms of reference.

The first section summarises recent developments in small business finance. The second discusses the state of competition in small business lending.

The main conclusions are as follows:

  • Lending to small businesses has been little changed over 2009, after growing steadily over prior years. The slowdown reflects both reduced demand from small businesses and a general tightening in banks’ lending standards. Small businesses in most industries have been able to access funding throughout the financial crisis, albeit on less favourable terms than previously.
  • Since late 2008, the interest rates on small business lending have been below their averages over the past decade, as the large net reduction in the cash rate has more than offset the increases in banks’ lending spreads. Fees have risen, but for most businesses they are only a small part of the overall cost of a loan.

Competition in the small business lending market has eased from the strong levels just prior to the onset of the financial crisis, but should recover as the economy continues to strengthen.

Basel Committee on core principles for microfinance


References

Personal tools