Banker's Delight

Information on the SBA's improved 7(a) guaranteed-loan program.

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The SBA's guaranteed-loan program is good for lenders. That makes it good for you as well

The U.S. Small Business Administration doesn't exactly have a stellar reputation. It's the agency Reagan budget director David Stockman once called "a billion-dollar waste." Then there was Wedtech Corp., the widely publicized fraudulent contractor in the SBA's minority-set-aside program. Now the agency is making headlines again with the problems of the Small Business Investment Companies, the SBA-backed venture capital units. Top it all off with the business community's perception that the SBA is full of red tape.

But a funny thing has happened in the agency critics love to hate. During the last decade, the SBA has improved substantially its workhorse program, the 7(a) loan guarantee. Last year the program successfully encouraged lenders to make $3.8 billion in long-term loans to small businesses. More than that, the agency has created a thriving capital-market mechanism through which cash-rich pension funds, among others, invest in small businesses across the country.

Ironically, that success had its roots with David Stockman, who sought to shut the agency down. That gave SBA bureaucrats a big incentive to change the agency and tighten its lending standards. Its emphasis began to shift away from direct-loan programs -- which have very high losses -- to the 7(a) loan-guarantee program. The great majority of SBA loans are now made through that program, in which financial institutions submit the loan applications and accept the risk for 10% to 20% of the loan. Because of the private-sector involvement, the annual loss rate on 7(a) loans was 2.8% in 1990, which is about a quarter of the loss rate in the direct-loan program; over the past five years, the 7(a) loss rate was 2.5 times a bank's expected rate. According to the General Accounting Office, the SBA reduced its loan delinquencies by 23% between 1985 and 1988.

In addition to altering its lending patterns, the SBA has made some important changes in program administration. In 1979 it launched the Certified Lender Program (CLP), and then in 1983 the Preferred Lender Program (PLP). Both are designed to reward banks for becoming frequent SBA lenders. Once a bank has made enough good loans to become a CLP lender, the SBA tries to turn its loan applications around in three days. If a bank becomes a preferred lender, it can make the loan decisions itself, subject to later SBA review. (In return for that privilege, banks accept a lower guarantee.) Today, although more than 8,000 lenders have made at least one SBA loan in the past five years, the 650 CLP and PLP lenders are the mainstay of the guaranteed-loan program. They make close to 60% of the 7(a) loans.

The SBA also has encouraged the development of a market for the guaranteed portions of its loans. In the mid-1980s the agency began allowing brokers to pool SBA loans to sell to institutional investors such as pension funds, which like the security of the government guarantee. Today about half of all 7(a) loans are resold.

For bank and nonbank lenders, the development of the secondary market makes the program much more attractive. By making SBA loans and selling the 80% to 90% portion that is government-guaranteed, they can make far more loans, since by doing so they use their own funds at one-tenth to one-fifth the rate of ordinary commercial lending. It gets even better: since SBA loans have a government guarantee yet yield business interest rates, investors find them so desirable they are willing to pay extra for them. Lenders make a premium of about 5¢ on every dollar of the guaranteed portion they sell.

Sound like a good deal? Some bankers have figured that out, too. As a writer for Bankers Monthly put it:

The good old Small Business Administration loan -- long considered the businessman's loan of last resort -- is now the loan of first priority at many banks across the nation. . . . Banks in areas where loan demand is healthy often sell their SBA loans to raise capital and reap profits. And are there ever profits to be made!

That is all very nice for lenders -- but it's also good for companies seeking SBA loans. While historically borrowers complained that they couldn't find a banker willing to deal with the SBA paperwork, the past decade's changes have given participating lenders a strong incentive to become experts in the program. By calling the nearest SBA district office, a company owner can get a list of all the institutions in the area that are certified or preferred lenders. With them, a borrower can be confident his or her lender knows the program and its paperwork and can get a good deal approved quickly. One caveat: getting an SBA loan is much easier in some parts of the country than in others; the district-office staffs, which approve the loans, vary widely.

That doesn't mean an SBA loan is easy to get. The focus on higher standards and guaranteed, rather than direct, loans means that with some SBA lenders the biggest thing that differentiates the SBA loan from a conventional loan is term, not the credit quality of the borrower. (The loans have an average duration of 12 years -- longer than the average commercial small-business loan.) Although lenders are not supposed to use the program for loans they would make anyway, they can use the SBA to give an otherwise creditworthy borrower a term longer than they normally would feel comfortable with. (All in all, however, SBA loans are still riskier than average; for example, 27% go to start-ups.)

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