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Anonymous Banker on SBA Loans

Joe Nocera has a blog in the New York Times called Executive Suite, and can also be heard on NPR. He has had what he calls an Anonymous Banker writing to him. Todays Topic:

Why Are S.B.A. Loans Disappearing?
By Joe Nocera

Anonymous Banker, who is fast becoming Executive Suite’s new best friend, is back, this time with a first-hand explanation about why banks aren’t making small-business loans. A.B. — who, as I’ve mentioned in previous posts, works for a major bank but does not want to be identified — sent me this e-mail message a few days after a previous exposé, about the coming credit-card debt, was published here. I’ve come to think of these missives as eyewitness reports from inside the belly of the beast. By the way, we need to find a better pseudonym than Anonymous Banker. Any suggestions?

As a business banker, I’m witnessing a tightening of credit throughout the industry. In recent months, I’ve seen a marked improvement in the supporting documentation banks are requiring when they review a loan, better processes to verify income and assets, and more stringent underwriting criteria over all. This is just as it should be. The banks could not continue their lax underwriting standards; they should never have used them in the first place.
The change can be quite painful to small-business owners, and I find myself too often in the role of managing customers’ expectations. As an adviser, I often help clients source loans outside of the financial institution I work for. Different banks have different levels of appetite for various kinds of credit. And in this case, I’d like to focus on Small Business Administration

loans.

When a business applies for a loan from a bank, the bank first reviews the credit to see if it meets its standard risk profile, and if so, the loan is made internally. However, if the bank determines that the request carries some additional risk, it can elect to mitigate that risk by applying for a guarantee from the S.B.A. ranging from 50 to 90 percent, depending on the loan. Proceeds can be used for purchasing/construction of buildings, working capital, term loans for equipment, etc. [You can find more information on what’s known as the S.B.A. 7A program

here.] Still, the S.B.A. can’t force a bank to make a loan it doesn’t want to make, guarantee or no.

While most banks say they are in the S.B.A. business, many of them simply are not and only participate at the lowest level they think they can get away with. Others are very involved with the S.B.A. programs, and see the benefit of receiving government guarantees. I make it my business to know who is making S.B.A. loans and who is not. And the banks that I previously referred my clients to all seem to have backed out of the S.B.A. business, some publicly and some quietly.

In 2007 the top nine S.B.A. lenders (BofA ranked #1 and JP Morgan Chase ranked #2) made a total of 49,234 S.B.A. 7A loans totaling over $3 trillion. As of March 31, 2008, approvals for 7A loans are down by 18 percent over 2007. And the dollar volume fell 9.3 percent, the steepest decline in 7A lending since 1992.
In other words, just when the small-business owner needs the most help, the banks are withdrawing their support. Why?
First, S.B.A. loans are held on the books of the banks. They may be securitized later, but in today’s market that is close to impossible to accomplish. And the S.B.A. has interest rate ceilings on their loans. For instance, a typical 7A loan for more than $50,000 has an interest ceiling of prime plus 2.75 percent. By contrast, a conventional line of credit offering by a bank is more likely to be anywhere from prime plus 5 percent to prime plus 12 percent, depending on the riskiness of the loan.
The S.B.A. provides some relief from conventional bank underwriting criteria. Still, banks are making between 2.25 percent and 5.5 percent more on their own loans than on those booked as S.B.A. loans. And when the banks are in a capital crisis, they will direct funds to the products that give them a better return. Additionally, S.B.A. loan fees do not get paid to the bank, but go directly to the S.B.A.
There is one more factor. When an S.B.A. loan fails to perform, if the banks did not meet all the underwriting criteria and documentation requirements at loan inception, the S.B.A. won’t pay up under their guarantee. Rightly or wrongly, this practice discourages banks’ participation in the S.B.A. programs. In this regard, the S.B.A. has taken the high road. After all, it is our tax dollars that support the guarantees. It does not cover imprudent decisions by the lender or misrepresentations by the borrower. If the banks applied reasonable credit criteria to the loan and obtained prudently mandated supporting loan documentation, the guarantee would not be an issue. The S.B.A. has worked diligently with the banks to overcome this obstacle – and has been unfairly criticized in this regard.
There has been a lot of discussion about how the banks are utilizing the billions of dollars they are receiving from the Treasury Department, and a growing sense of unease that the banks will not lend out those billions of dollars. We desperately need to ensure that the banks meet this fundamental role necessary to our nation’s economic recovery.
I have a suggestion. Instead of providing capital to banks that don’t need it, have the Treasury provide the capital to the banks that agree to earmark those funds, or a significant portion of those funds, specifically for loans granted through the S.B.A. programs.
The government has been doing everything it can to improve the capital positions of the banks. It bailed out Fannie Mae and Freddie Mac, whose securities represented the majority of capital held on the banks’ balance sheets. It reduced the federal funds rate to 1 percent. The banks will further improve their capital positions, over time, based on earnings from the spread between what they pay their depositors (1.25 percent on a typical money market accounts and zero percent on checking accounts) and what they charge their borrowers (credit card rates over 25 percent). The banks have enjoyed record earnings in the past years by behaving in such an irresponsible manner that our country’s economic soundness is now at risk. It is time that they pay us back. And if that means earning a smaller spread on S.B.A. loans that will revitalize our country, then they will just have to learn to live with less profitability and income. It’s what we’ve all had to learn to do because of them.

SBDC Comment: One might say after reading this column, good, let them do more conventional loans and let us out of it as taxpayers. Unfortunately, the lending environment we live in doesn’t give conventional loans. Other than borrowing from the equity in their homes for example, the only loans I see small businesses getting are SBA products. Banks are simply not inclined to take the risk, especially with startup businesses. It is hard to imagine the small business environment in the U.S. without SBA. The way things are going however, we just may find out.

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