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RESTAURANT FINANCE MONITOR
September 20, 2011
Shifting Credit Risk To The Government
Access to capital is still bandied about as the primary cause of economic malaise and high unemployment in the United States. The International Franchise and National Restaurant Associations have taken up the cause on behalf of their members, especially as it relates to start-up individuals who generally have the most trouble getting loans.
The number of small business loans made by community banks has declined since the recession, but it is difficult to say for certain whether capital access is the primary issue and borrowers are being turned down in greater numbers, or whether the economy is so stagnant that fewer small businesses find the need and business demand to borrow.
According to the Monitor’s review of recent FDIC statistics on community bank commercial lending activity, the dollar value of small business loans secured by real estate on the books of 6,413 community banks insured by the FDIC on June 30, 2011, declined from $307.3 billion in loans a year ago to $292.3 billion this year, a decline of 4.9%.
Commercial and industrial loans made to small businesses also declined from $277.0 billion last year to $250.1 billion this year, a decrease of 9.7%. The actual number of real estate and commercial industrial loans on the banks’ books decreased by 7.1% and 4.4%, respectively over the past year. Overall loan balances, according to the FDIC, have declined in 10 of the past 11 quarters for all types of loans.
Yet the story is different for loans guaranteed by the Small Business Administration. The SBA guarantees loans for small businesses up to 75% and have been doing their best to free up capital, and in turn make themselves a more relevant agency. The 7(a) program, a typical loan vehicle for small businesses, including restaurants and franchises, is generally used to obtain financing when a company does not qualify for conventional credit. The 504 program finances real estate, although real estate can also be financed in the 7(a) program, too.
According to the SBA’s statistics, 7(a) and 504 loans approved in 2010 increased nearly 19 percent over the same period in FY 2009, and dollar volume climbed 39 percent. So far in 2011, the dollar volume of approved loans is up 51% for the 7(a) program and 13% for the 504 program.
Why are the SBA programs so popular now, when in years past, the SBA was the lending program of last resort?
There are a couple of reasons for its popularity. First of all, the SBA 7(a) program increased the total amount a small business could borrow with a government guaranty from $2 million to $5 million. This has resulted in an increase in the average loan size from approximately $242,000 in 2010, versus an average loan size of $364,000 in 2011.
And, more businesses qualify for SBA funding these days. In 2010, the SBA redefined what it meant to be a small business in order to attract more borrowers to its program in light of the recession and calls by Congress for increased credit. Many businesses now qualify for SBA financing that previously had no chance of accessing the program because of their size. The SBA made it possible for borrowers who previously didn’t qualify for net worth and income reasons to qualify provided they had less than a $15 million net worth and $5 million of average net income over the past two years.
While the total dollar volume of 7(a) and 504 loans increased by $6.7 billion over last year, the actual number of loans was flat. Chris Hurn, CEO of Mercantile Capital, an SBA 504 lender and regular blogger, claims the increase in loan size in the 7(a) program is because of the willingness of banks to include real estate in the 7(a) loan package and bypass the 504 program, where the lender provides only 50% of the project. As for processing loans, most lenders we spoke to acknowledge that it’s just as much work to do a $1.0 million loan as a $100,000 loan in SBA, so they opt for the larger deals with the 7(a) program, including real estate, if possible.
It’s also very profitable for lenders to make SBA loans. The current secondary market for selling the government guaranteed portion of SBA loans is pricing loans at a “range of 8.5% on a two-year maturity and as high as 14.7% on a 25-year maturity,” says Mike Rozman, chief strategy officer of Boefly, an online lending platform. The nice premium makes a government-guaranteed loan profitable upon issuance and the bank can earn a fee for servicing the loan if it sells it. If the bank decides not to sell the loan, the loan guaranty makes it more valuable in the eyes of the bank regulators during audit time.
It’s no surprise that some banks are shifting their conventional small business loans to the Small Business Administration’s guaranteed lending program, which doesn’t necessarily result in more credit overall, but offloads more risk to the government. Loans that might be made anyway on a conventional basis are finding themselves in the SBA pool. “Banks are using SBA as a risk mitigation tactic in providing credit for existing business clients,” says Ron Feldman, CEO of Franchise America Finance.
Stephen Olear, Senior Franchise Counsel for the Los Angeles office of the SBA has heard stories of lenders shifting potential conventional loans to SBA, but doesn’t think it is very pervasive. “The interest rate and terms on an SBA guaranteed loan (prime + 2.75 and 25-year amortization) are much better for the borrowers right now,” says Olear.
Would banks take on a marginal credit if they could get the 75% guaranty offered by SBA? Laura Witmer, national franchise sales manager for Wells Fargo SBA Lending doesn’t believe a bank would take that risk, even with the guaranty. “No banker wants to get into a bad deal with all the work that comes with a default,” says Witmer.
So on one hand you have bank regulators acting tough with banks over capital requirements and impacting their ability to lend, and on the other hand, you have a government agency guaranteeing loans and making it easier for banks to put the loans on their books. In both cases, the government, not the market, is calling the shots.
—John Hamburger
