SBA Direct Lending a Bad Idea

Today’s Wall Street journal (3.4.2010, page B6) had a very scary article. The author seemed to promote the idea of allowing the Small Business Administration to lend directly to small business and not make small businesses go through local banks to obtain an SBA loan.  Clearly, the SBA needs fixing but this is not the repair for what ails it.  This (direct lending) would be a disaster.

What the SBA needs is a real guarantee program that banks can rely on for payment.  The current rules can be very onerous (just ask anyone who tried to get an ARC loan).  Ongoing compliance is a maze of paperwork seemingly designed to trip-up the lender so the SBA can avoid paying on its guarantee.

Furthermore, small businesses, especially start-ups, need to understand that they are not guaranteed a loan just because the SBA offers a guarantee to the bank that makes the loan.  Believe it or not, the SBA does not want to loose money due to higher than anticipated credit defaults and clearly start-ups have the highest default rate of any loan type.   The only small business owner quoted in the WSJ article wanted a $500,000 loan to fund marketing and business expansion costs.  Sorry, but aren’t those costs supposed to be funded with equity?  What is the collateral value for a marketing plan?  Can you just imagine what the OCC regulatory audit would be on a file with marketing costs as the loan purpose?  And therein lies the problem.

The regulators need to be brought into the solution here.  If businesses are to get access to credit when their financial condition is weakest, the regulators need to be less harsh when evaluating credit files.  If they are not more lenient then any new loans will only get downgraded the next time the OCC ’s audit team comes through the bank and when the loans inevitably get downgraded the bank will have to set aside additional capital thereby weakening the bank.  It is a downward spiral that feeds on itself, but there are simple answers to fix this problem.

Firstly, SBA loan guarantees should be more like the HUD guarantees, that is they actually pay when a default occurs.  HUD guarantees pay the lender when an account becomes 120 days past due, period, end of story.  Secondly, the OCC needs to have more lenient standards when reviewing an SBA credit file because it has an SBA guarantee.  Thirdly, the SBA guarantee should not be a fixed percentage of the loan amount.  Instead it should be on a sliding scale reflecting the fact that credit risk declines over time as long as the business stays in business.  This would enable the SBA to better manage its aggregate guarantee exposure.  For example, a loan may start with 100% guarantee for the first year, 90% year two, 80% year three and then 50% years 4 through maturity.  This technique would match the risk with the guarantee to induce banks to lend more knowing the riskiest portion of their loan terms are adequately guaranteed.

I call this the small business CAP (Connelly Austerity Plan).  Well, it is my idea, why shouldn’t my name be associated with it? These three simple changes would get the banks lending, get businesses re-started and not break the government’s back by guaranteeing loads of debt.

But, what do you think?

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avatar Posted by on Apr 6 2010 Filed under Economics. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry

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