Proposed legislation could expand the Small Business Administration's landmark loan guarantees, known as the 7(a) program, by bolstering quality controls on the program and allowing the agency to exceed its program budget cap during times of high demand.
The program is a key source of capital for higher-risk businesses that often lack collateral or operate in tougher industries with higher default rates. The Small Business Administration, or SBA, subsidizes banks that choose to service these borrowers by offering an 85% guaranty on loans of $150,000 or less and a 75% guaranty for loans greater than $150,000.
The legislation, passed by the U.S. House of Representatives on May 8, would allow the SBA to raise its spending cap for the 7(a) program by up to 15% during times of high demand, as long as the agency notifies Congress of its intention to do so. The 7(a) program is funded by fees from the loans themselves and not by the government, but Congress sets a cap on total program spending each year in an appropriations bill.
The change is aimed at preventing a repeat of the 2015 crisis in which the SBA hit its $18.75 billion spending cap for the program, forcing the agency to stop loan guarantees a few months short of the end of the fiscal year. Congress stepped in and passed legislation raising the cap from $18.75 billion to $23.5 billion.
The bill, sponsored by Ohio Republican Steve Chabot and New York Democrat Nydia Velázquez, would give the SBA more headroom to operate a rapidly growing lending program. In 2011, the SBA disbursed $16.41 billion in gross loans to corporations, individuals and partnerships. In 2017, the SBA approved $23.51 billion in 7(a) loans.
For the time being, Congress has mitigated the risk of another cap hit by setting higher limits. For the fiscal year 2018, legislators set a 7(a) spending cap of $29 billion.
The bill would also implement tighter supervisory controls by requiring staff dedicated to reviewing 7(a) loans to use the "credit elsewhere" standard, which states that a 7(a) loan should not be issued in instances where a borrower can access similar credit from non-Federal sources. The bill gives the SBA the power to issue enforcement actions against 7(a) lenders that do not adhere to the program's requirements, ensuring that financial institutions do not abuse the government guarantee.
The bank lobby broadly supports the bill, partially because of the increased checks.
"Our number one concern is creating a safe and sound 7(a) program," said Stephen Keen, vice president of congressional relations for the Independent Community Bankers of America.
The Senate will now move on passing similar legislation.
SBA data shows that as the 7(a) program has expanded, so has the charge-off rate. The 7(a) loans tend to be higher-risk because they are often issued in lower-income areas. But since 2016, 7(a) charge-off rates have plateaued.
Jim Fliss, national SBA manager at KeyBank NA, said in an interview that 7(a) lending can be challenging because of the "grey area" where an underwriter needs to determine if a borrower has too much money for an SBA loan or too little money for a conventional loan. Fliss added that he has seen other banks jump in and out of the 7(a) lending space because of inconsistency in judging asset quality.
"Some banks or institutions somehow think that a 75% loan guarantee makes you bulletproof and it doesn't," Fliss said, adding that KeyBank has a rigid training program for SBA-specific underwriters. KeyBank originated the 11th most 7(a) loans among U.S. financial institutions, based on SBA data.
Fliss said that despite the risks, 7(a) loans are often the first time a company has borrowed money and spark the beginning of a longtime banking relationship with a lender.
SBA lending can also earn banks credit on their Community Reinvestment Act scores. At the National Community Reinvestment Coalition, senior adviser Josh Silver said 7(a) lending fills gaps in underbanked communities where startup businesses may not be able to find credit. Although Silver says the NCRC does not oppose the legislative proposal to expand the program, he says he would like more checks on the program to make sure there is no "dual-track" lending system where wealthier, primarily white communities are only getting access to traditional loans while poorer communities are stuck with SBA loans.
SBA data shows that California, Texas and Florida have the highest concentrations of projects funded by SBA 7(a) loans, although they also rank among the most populous states in the country.
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Click here to access the SBA 7(a) and 504 loan data reports.