Are SBA loans for underserved in jeopardy?
Lenders are worried a plan by the Small Business Administration to restructure a 7-year-old program could make it harder to provide capital to businesses in underserved markets.
The SBA said changes to its Community Advantage program, including a moratorium on new lenders and a 20-point increase in the minimum credit score borrowers need to receive credit directly from lenders, are intended to remedy credit-quality issues with an eye on making it a permanent offering. The changes take effect on Monday.
The moves, which were announced earlier this month in the Federal Register, still have supporters worried about the program's future. For the 12 months that ended June 30, Community Advantage had a 4% default rate — more than double the rate for conventional 7(a) loans. Its rate of early problem loans hovered around 8% at June 30.
Community Advantage, which is part of the 7(a) loan guarantee program, was created in 2011 to focus on startups, as well as women-, veteran- and minority owned small businesses that often struggle to obtain capital from conventional sources. While relatively small — $138 million in loans were originated in fiscal 2017 — industry observers maintain the program plays a critical role for underserved groups.
“It’s a real important niche meeting the needs of borrowers who aren’t able to obtain credit otherwise,” said Brett Theodos, a principal research associate at the Urban Institute.
The program's supporters argue that the credit statistics should be considered in context, noting that a higher occurrence of problem loans was always anticipated, given the typical borrower's risk profile. They remain committed to securing permanent status for the program, which is currently set to expire on Sept. 30, 2022.
“We were surprised to see this rule come out that was so focused on risk mitigation,” said Alison Feighan, a lobbyist who advises the Mission Lenders Working Group, a consortium of Community Advantage lenders.
“These mission lenders from the beginning have been asked to take on more risk," Feighan said. "We always knew that the risk profile of the borrowers that mission lenders are serving would be higher than the risk profile of a bankable business.”
Kurt Chilcott, president and CEO of CDC Small Business Finance in San Diego, one of the program's biggest lenders, said he was “uncomfortable with the notion that simply because we’re seeing a slightly higher default rate that somehow that’s a problem with the program.”
With a $250,000 cap, Community Advantage is one of the SBA’s most prominent small-dollar loan programs. Despite credit issues, officials are forecasting record volume in the current fiscal year, though the numbers will not be available until after fiscal 2018 ends Sept. 30.
“We’ve done extremely well with our small-loan programs lately,” said William Manger, associate administrator for the Office of Capital Access.
Even so, the average size of 7(a) loans continues to climb, increasing from $375,000 five years ago to $422,000 this year. Through Sept. 21, the SBA had guaranteed 2,801 loans larger than $2 million, or roughly double the number backed in 2013.
The increase in average loan size was concerning enough that Congress earlier this year enacted legislation that toughened the credit standard lenders must meet to ensure that loans strong enough to qualify for conventional bank financing aren’t being considered for SBA guarantees.
The SBA rolled out Community Advantage in February 2011 to replace another program, Community Express, that was plagued by default rates as high as 40%. The SBA reasoned at that time that “mission-oriented” community-based groups that knew their markets intimately would bring a unique perspective to delivering capital to targeted groups. Eligible lenders include nonbank community development financial institutions, certified development corporations and nonprofit microlenders.
That expectation has been borne out to a large extent. The volume of Community Advantage loans approved has grown every year, with the aggregate total surpassing $600 million in 2018.
Banks are barred from making Community Advantage loans, but they are hardly uninterested parties. They provide capital in the form of grants and loans to Community Advantage lenders. In March, for example, Fifth Third announced it would lend $4.7 million to Growth Capital Corp., a Cleveland-based Community Advantage participant, to support its lending programs.
Banks are also the program's biggest source of referrals.
The goal of most Community Advantage lenders is to move their clients into banking relationships, Feighan said.
“We see the value of that,” she added. “It’s really a steppingstone for these businesses.”
Along with the moratorium and higher minimum credit score, the SBA will also increase the loan-loss reserve required for Community Advantage loans sold in the secondary market from 3% to 5% of the outstanding guaranteed portion.
The SBA “needed to take some actions to mitigate some of the risks we saw,” Manger said. The agency’s review found that loans with a FICO liquid origination credit score below 140 made up the lion’s share of Community Advantage’s problem credits.
Secondary market loans “are the riskiest loans to SBA," Manger added. "If one of those loans default, the SBA has to pay that investor immediately before recouping anything from the small business.”
In the program’s early days, the SBA required a 15% loan-loss reserve on individual loans and did not allow sales to the secondary market.
Manger said he believes fears about the program are overblown, noting that there are still ways for lenders to provide credit to borrowers with a credit score below the new 140-point minimum. Lenders “who believe strongly in a small business” can submit the borrower's application to the SBA, where agency officials can underwrite it.
“All we’ve done is tried to be responsible and prudent and make sure the program is strong and healthy and able to gain long-term sustainability,” Manger said.
That makes sense to some backers.
“None of us ... want the program to fail because the losses are deemed to be too high,” Chilcott said.
Still, in a mission-driven program, some supporters remain apprehensive.
“Mainstream lenders don’t take loans to 7(a) unless they’re slam dunks,” said Mark Pinsky, president and CEO of FiveFour Advisors in Philadelphia. “I’m very concerned this will restrict the flow of capital to people of color, women and other disadvantaged groups.”