With collateral crashing, credt tightening and many lenders cutting SBA lending altogether, the SBA loan market has become hostile for the increasingly rare investor willing to brave this economic storm. Read more on this topic in this article from Blue Maumau.
Small Business Administration loans have been shriveling up, and not just of late. SBA 7(a) loans have plummeted from 2005’s $15.4 million down to $12.8 in 2008, with the trend accelerating during the present credit crunch. Through early January in this fiscal year that began October 1, 2008 for the SBA, 7(a) loans plummeted 56 percent compared to the same period in the prior year.
What’s going on?
According to an industry expert, one reason is that small business demand for SBA loans has evaporated.
Mark J. Weiss, CEO of LeaseWise, LLC, a provider of small business funding solutions, states, "People are afraid to invest in new businesses. They’re taking a wait-and-see attitude while watching other businesses close up." Perhaps, he feels, investors would rather sit on the funds they still have, in case they need a personal reserve for other purposes. Perhaps the impact on their 401K is making them feel less secure. With housing values crashing, the collateral value to support loan requests isn’t what it used to be.
But there’s an even bigger problem besides skittish business buyers. "Many lenders have pulled out of SBA lending altogether—whether it’s secondary market issues or risk management, the result is the same," adds Weiss.
Chris Hurn, chief executive officer of Mercantile Commercial Capital, a lending institute specializing in SBA 504 real estate and equipment loans, agrees. "SBA loans normally take off in a recession, but this time around SBA lending has not taken off, mainly because of other issues relating to banks which are outside the SBA’s realm."
Franchising usually takes off in a recession, but not this time
According to Hurn, when the U.S. economy hits a downturn, franchising usually accelerates because people who lose jobs look for a new means of livelihood, such as starting a business. Many don’t want to start their business from scratch and find franchising more appealing. Quite often they have money, such as from a 401k, which can be used to finance a franchise. Says Chris, "You would think that franchising would be taking off."
But it isn’t. Chris thinks one of the major causes of the slide was a glut by big banks and lenders in the SBA Express program, a type of 7(a) loan that is a line of credit with the convenience of being on credit cards. There was a boom in these loans that were extended through business credit cards. That boom was followed by the continuing credit bust.
Explains Chris, "All these were credit card applications for business customers. For example, in conjunction with office supply stores, you’d go in as a business customer and you’d be approved for a credit card. Lenders would issue a credit card with a 50 percent express loan guarantee on the card. Banks flooded the marketplace with this stuff from ’03 through ’05. Then they radically retrenched. That’s part of what is being seen in the numbers."
This bust has seen some three hundred lenders, who previously were issuing 7(a) loans, stop.
Many SBA loans were sold to the secondary market, a sort of clearing house mechanism for those loans. But over the last 12 months there has been a severe thinning of the interest rate gap between the SBA charge on interest and the premium lenders could charge, resulting in many lenders feeling that SBA-backed loans were no longer worth their time and effort.
Unfortunately, that came just at the time that the SBA-backed loans were needed to stimulate the small business economy the most.
Says Hurn, "There were SBA loan officers making $200-$400k a year." But with the compression of premiums in the secondary market, the bonuses and salaries headed south. The business model lost its viability, compounded by the credit crisis of the last 14 months. "When you look at these drops in numbers, it’s what you would expect when the specialists who had been doing these SBA loans have left," adds Hurn.
The 7(a) loans are used regularly by the franchise world. But according to Hurn the problem from a banker’s perspective is that the collateral from a franchise owner is light. That is to say that if a franchise is located in a retail strip mall and all that the borrower will do is make leasehold improvements and add furniture, fixtures, equipment and a little working capital, there’s not a lot for the lender to fall back on should the franchise owner default on payments, other than being partially reimbursed with the SBA guarantee. In a worst case scenario, if the lender has to foreclose the property, he will have to discount a lot of the collateral assets. In a normal market, there are specialist lenders that will do 7(a)’s for the franchise market.
But this is not a normal market, and lenders are nervous.
Suggestions to the SBA to jump start the small business economy
The initial House version of the economic stimulus bill would give the Small Business Administration more money to revive its ailing loan programs.
The bill would increase the government guarantee on the SBA 7(a) loans and empower the agency to make loans directly to small businesses, a function that is now performed by private sector lenders.
George Cloutier, founder of American Management Services, which specializes in consulting turnaround and profit improvement programs for small businesses, thinks the stimulus bill is woefully thin. "The current proposed stimulus bill offers $630 million to support the loan guarantee program of the SBA, although ‘the SBA’s two largest business loan programs were down 40 percent so far this year,’ and over 30 percent last year," states Cloutier. "The proposed bill fantasizes that by cutting the loan fees to small business, volume will skyrocket. Loans are down because banks don’t want to take the risk on marginal credit, with only a 75 percent guarantee from the government."
"Small Business Inc. employs 60 million people, accounts for 70 percent of new jobs each year, and clearly represents the backbone of almost every regional and local economy," he declares. "For this vital industry the administration has allocated less than 1 percent ($700 million earmarked vs. $1 trillion in proposals)."
Rather than $620 million, Cloutier thinks the stimulus package should immediately release $25 billion in direct loans to small business.
The franchise industry’s Hurn is considerably more modest in his suggestion on how to fix the small business economic problem.
"The government needs to take the TALF [Term Asset-backed securities Loan Facility] funds and start competitively bidding in the secondary market to unfreeze it so that it starts functioning properly again. Candidly, I’d much rather have my tax dollars in the government buying SBA guaranteed loans. You are probably going to be made whole. They get paid back, in contrast with the toxic mortgages of subprime. This makes a heck of a lot more sense from a utilization of taxpayer funds. If you did that, you would jump start the secondary market all over again."
"We don’t need to create new SBA programs. All the SBA needs to do is slightly tweak them, if they first take away the duplication of the programs in the overlap of 7a and 504s. Secondly, allow refinances under 504s. Third, get the government to use TALF funds to competitively bid in the secondary market. It would unlock the secondary market for a lot of this."
The first mortgage of 504s has no government guarantee at all. Hurn says that there is an amendment to a bill that would give an 80 percent guarantee to a 504 first mortgage. He explains, "That would make 504s more competitive with 7(a) loans from a guarantee perspective." He feels that would bring more lenders into the market. Banks would begin to offload their risks and spend money to train their people to do SBA specialized lending."
According to Hurn, SBA loans have a 75 percent guarantee on them. He feels that if it is moved up to a 90 percent guarantee, it would stimulate lenders back into the 7(a) market.
Cloutier thinks the current SBA bank loan guarantee program should be altered even higher to a 100 percent guarantee by the government rather than the current 75 percent to 85 percent allowed. "This guarantee program is down 40 percent not because of the fees involved, but because the banks are risk averse to losing 25 percent on marginal loans that are costly to collect anyway," he declares. He adds, "Small businesses would willingly pay the bank’s fees if they can secure the money they need."
Another proposal being circulated is to have the SBA move the lending cap from $2 million to $3 million for an individual loan. Mr. Hurn expects little in positive results from that.
This article has been reposted from Blue Maumau. View the article on Blue Maumau’s small business and franchise news website here.