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.)
The program's attractiveness to lenders raises another question: Is it too good for them? Because of the premium investors pay to buy SBA loans, lenders last year made about $70 million in premiums by selling half of them. The lenders' stake is only a small fraction of the sold loans, so that $70 million translates into an immediate return of about 20% on the lenders' funds (which, if the loans are good, will be repaid anyway at between 2¼ and 2¾ above prime). If that money could be recouped by the government, it would defray a good portion of the annual cost of the loan program.
However, such issues are of concern to would-be SBA borrowers only in their role as taxpayers. For borrowers, the fact that the SBA 7(a) loan program is profitable for smart lenders is good news. After all, what company wouldn't want a loan officer to view its business as valuable and profitable?* * *
A Hint of Reform
Nobody knows what to do about health-insurance costs. So instead, expect to hear more discussion on the state and federal level about health-insurance access. Here, major players can agree on the problem, the outline of a solution -- and that it won't cost the government anything.
Here's the problem: In the past few years insurers have, for competitive reasons, begun effectively refusing to cover any members of a small group who have a history of high claims. That way insurers can offer lower initial rates to healthy groups. But as soon as one group member incurs significant claims, the rates go way up.
The situation has gotten chaotic enough that both the National Association of Insurance Commissioners and the Health Insurance Association of America are proposing state-level reforms. They would require insurers to offer coverage to all groups and their members, as well as to make prices and rate increases more uniform for all small groups.
Connecticut took the lead last year, but now at least a third of the states are considering such reforms, according to Dick Merritt of the Intergovernmental Health Policy Project at George Washington University. On the federal level, Senator Dave Durenberger (R-Minn.) and Representative Nancy L. Johnson (R-Conn.) have both introduced small-group health-insurance-market reform bills.* * *
When did you last hear someone get excited about intrapreneuring? The odds are, it's been a few years. Back in 1985, when Gifford Pinchot III published a best-seller by that name, intrapreneuring -- the process of creating new businesses within a large corporation -- was hot, a potentially revitalizing force in big business.
Today many of the large companies that jumped onto that bandwagon in the early 1980s have scuttled their programs. Even well-publicized new-venture programs -- at Eastman Kodak, Allied-Signal, and Air Products & Chemicals -- have shut down or have been scaled way back in recent years.
What went wrong? Pinchot predicted some of the pitfalls in his book. Separate new venture units within established corporations, he wrote, too easily become targets for hostility and cost cutting.
Then, too, the times have changed. In the early '80s corporate planners watched enviously as venture capitalists got great returns by investing in start-ups involving some of the big companies' best people and best technology. Today few corporations would envy the venture capitalists' returns. In addition, notes Robert Mast of Venture Economics, based in Needham, Mass., corporations have found other ways to tap into innovative technology, as the explosion in strategic alliances between big and small companies shows.
Even Pinchot acknowledges that he has learned it is harder to launch a new business within a corporation than he once thought. "I've died too many deaths. . . . I've had too many of my friends get beaten up too badly for doing what I thought was right," he says. "Terrible violence is done to these internal ventures. You see decisions being made which are just crushing." He now believes that unless a new idea fits a company's overall corporate strategy, it should be spun out or licensed, or the proponents should "grit their teeth and let it die."