A Jump Start for Stalled Lenders

In recent months President Obama has pressured banks to increase lending to small businesses in order to spur job growth. Now, a long-awaited program approved in the stimulus package last February is set to begin that could help make that happen by reassuring wary bankers with a new approach.

For the first time, the Small Business Administration will guarantee up to $3 billion in pools of banks’ 504 loans sold into the secondary market. That way, if borrowers fail to pay, investors who bought the loans would be made whole by the government. The SBA expects the program to start soon but doesn’t have a firm date, according to spokeswoman Hayley Matz. 504 loans give small businesses favorable financing to invest in fixed assets like property or machinery.

Commercial lenders have not been able to sell their portions of 504 loans since investors lost their appetite for asset-backed securities in the financial crisis, prompting many lenders to drop out of the 504 loan program. “In essence that market has not returned,” says Kurt Chilcott, CEO of San Diego-based CDC Small Business Finance, a nonprofit that partners with commercial lenders to make 504 loans. “We’ve gone from at least half a dozen active players who were willing to purchase those loans to maybe half a player,” he says. Because banks can’t resell their loans, Chilcott estimates that 40% of the banks his firm used to work with have stopped making 504 loans.

Collateral Limits

Nationwide, 257 lenders that made 504 loans in the 12 months before Sept. 30, 2008, dropped out of the program the following year, a decline of 13%, according to the SBA. Loan volume dropped 28%, from $5.4 billion to $3.9 billion, in the same period. “If the bank wants to make these loans, they have to hold them on the books,” says Bob Coleman, publisher of the Coleman Report newsletter on SBA lending.

That’s a problem because regulators want banks to limit their exposure to the troubled commercial property market. “Most of your small business loans will be secured by some sort of commercial real estate. The regulators are asking us to reduce our concentrations in that,” says Cynthia Blankenship, vice-chairman of Bank of the West, a community bank in Grapevine, Tex.

While the Small Business Administration guaranteed loans are a small piece of total credit to small businesses, they are growing more important as fewer companies hammered by the economy qualify for conventional loans. The SBA’s 504 loans in particular fund expansion projects that are directly tied to jobs: Companies must demonstrate that one job will be created or retained for each $65,000 the SBA guarantees.

Borrowers in the 504 program pay 10% of a project’s cost. The rest of the financing is split between two lenders: 40% from a nonprofit known as a Certified Development Company and 50% from a commercial lender. The government guarantees the CDC’s portion, but private lenders have no such guarantee. Their loans are secured by the first claim on the property if a borrower fails to pay. The new program means SBA will guarantee 80% of commercial lenders’ stake in 504 loans, which would let them pool the loans into securities and sell them to investors.

Risk on Principal

Even that 80% guarantee may not be enough to lure lenders back. The SBA will require banks to keep 15% of the loans on their books and pool assemblers—the companies that buy loans and package them into securities—to assume 5% of the risk. “They’re not used to taking principal risk,” warns Chris Crawford, president of the McLean (Va.)-based National Association of Development Companies, the trade association for CDCs that partner with banks in 504 lending.

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