Why Are SBA Loans Drying Up?

Critics say that the agency should be lending more now that credit is tight.

Loans made under the Small Business Administration's flagship credit program have fallen dramatically in the first six months of fiscal 2008 -- and none of the interested parties can agree on the cause. As of March 31, approvals for 7(a) loans are off nearly 18 percent compared to fiscal 2007, while the total dollar volume of 7(a) loans has fallen by 9.3 percent. If these trends hold for the rest of the year, 2008 will mark the steepest decline in 7(a) lending since 1982. And it would make this the third straight year for falling loan approvals, as measured in dollars. The last time the SBA saw such a streak was in the early 1970s.

The SBA has long been promoted as a counter-cyclical stimulus -- when traditional credit is tightened, the agency loosens its spigot -- but because the SBA guarantees loans made by commercial banks instead of making them directly, its ability to counteract an economic downturn is limited. Moreover, there's no consensus that small businesses are finding it harder to borrow this year. Even so, Sen. John Kerry (D-Mass.), chairman of the Senate Committee on Small Business & Entrepreneurship, accuses the SBA of being asleep at the tap. "The lack of available credit is making it more difficult for small businesses to create new jobs," Kerry said in a statement to Inc.com. "Unfortunately, the Bush Administration and Republicans in Congress have been too busy bailing out big businesses on Wall Street to help small businesses on Main Street." Kerry blames the slowdown in part on high fees levied in the 7(a) program, and has introduced legislation that would cut those fees for the rest of fiscal 2008, which began last October. The assessments, which include a servicing fee paid by the bank and a guaranty fee that's passed on to the borrower, are used to offset losses from loan defaults.

A close look at the loan numbers, however, suggests that these fees have had little effect on the steep drop since 2007. Most of this fall-off occurred with one new type of 7(a) loan known as SBAExpress. In exchange for a smaller guaranty, banks are able to use their own application forms and credit scoring models to make SBAExpress loans and can approve them immediately. In this arrangement, a borrower who doesn't qualify for a conventional loan may receive an SBAExpress loan, often without even realizing he's applied for one. The SBA has guaranteed 24,069 of these loans this year, 30 percent fewer than last year. Dollar volume is off by 23 percent.

There's no clear explanation for this. The agency contends that most of the reduction came from small, often revolving credit loans, made principally by five large lenders. "When they modeled their expected losses based upon credit scoring levels, these banks found that the losses are greater than what they had expected," says Eric Zarnikow, associate administrator for the SBA's Office of Capital Access. "So they've raised their credit standard, which has reduced the volume of loans in that area."

But at least one industry analyst believes that the problems with the SBAExpress program are widespread, because credit scoring has made banks lax. "Lenders who years ago limited the debt-to-income ratio on a consumer to 40 percent, max, have come over the past two or three years to see a 50-55 percent ratio as acceptable," says Joel Pruis, a consultant at Baker Hill who advises banks on small business lending. As a result, "We've seen an increase in charge-offs among our clients -- it went up about 40 percent from the end of 2006 to the end of the 2007. " Indeed, the SBA's own lender statistics show that 18 of the 20 banks that appear to be the most prolific SBAExpress lenders have issued fewer loans in 2008. (Such analysis is limited because some banks make several kinds of 7(a) loans, and the figures aren't broken out by category. Zarnikow, for his part, declines to name the banks.)

On the other hand, executives at two top SBAExpress lenders insist that slackened demand accounts for the drop. At US Bank, where SBAExpress loans have fallen 23 percent, "We've not changed our credit policy," says SBA division national sales manager Eric Daniels. Adds Wells Fargo vice president Tom Burke: "This was a great tool, but what 's happened is that a lot of small businesses -- services and retailers -- that didn't get line of credit loans in the past were getting them now. And they've been impacted by the economy." Burke says that the decrease in Wells Fargo's SBAExpress loans -- even greater than at US Bank -- had nothing to do with the fees, and lowering them would not have affected lending.

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