SBA blamed for flagging small-business investment program

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Activity within a popular Small Business Administration program has fallen off significantly amid claims of mismanagement.

Funding that SBA provides to small-business investment companies, or SBICs, fell more than 30% in the first half of the 2019 fiscal year from a year earlier, to $690 million, according to the Small Business Investor Alliance, an association of senior investment officials dedicated to promoting private capital. Licensing of new SBICs decreased by 42%, to just seven.

“There’s no market reason” for the declining numbers, Brett Palmer, the alliance’s president and CEO, told American Banker.

Palmer was more pointed in testimony before the Senate Committee on Small Business and Entrepreneurship in June, claiming mismanagement and "hostility to the functioning of the program" were to blame.

Other industry observers share Palmer's view.

The program's issues do not "appear to be programmatic, policy or partisan issues,” said Mark Kromkowski, a lawyer at McGuireWoods in Chicago and chairman of the firm’s SBIC practice.

Congress created the SBIC program in 1958 to funnel capital to small businesses unable to attract the attention of private venture capital. Investment companies licensed by the SBA combine their own capital with up to $175 million in leveraged funding from the agency. Each SBIC has a 10-year life span, investing during the first five years and harvesting returns over the remainder of their existence.

The program grew significantly after the financial crisis, peaking in the 2015 fiscal year, when it provided $6.3 billion in financing to more than 1,200 small businesses. While activity dipped in each of the next three fiscal years, the $5.5 billion in fiscal 2018 was more than double the total provided a decade earlier. (Those dollar figures include funding from the SBA and from SBIC investors.)

The decline grew more pronounced in the current fiscal year.

Critics are laying blame at the feet of Associate Administrator Joseph Shepard, who oversees the SBIC program. Palmer claimed that Shepard has frequently delayed decisions on licensing and funding requests. Average time for licensure has gone from less than seven months to nearly 10, while funding is on pace to decrease by 45%.

Until now, "we always had a constructive relationship with every regulator we’ve dealt with,” said Palmer, who has been the alliance's chief executive since 2008.

Former Administrator Linda McMahon named Shepard associate administrator for the Office of Investment and Innovation in March 2017. Shepard held a similar role in the final year of the George W. Bush administration.

Matters came to a head during a contentious June 26 reauthorization hearing held by Senate Small Business, with Sen. John Kennedy, R-La., suggesting that Shepard dislikes the program he manages.

“If you have a bias against SBICs, you ought to go run for the Senate or something," Kennedy said. "You shouldn’t be doing what you’re doing."

“I don’t know what caused" the SBIC metrics to decline, "but I know you’re in charge and the program is going in the wrong direction,” said Sen. Jeanne Shaheen, D-N.H.

Sen. Jim Risch, R-Idaho, did not attend the June 26 hearing, but spokeswoman Marty Boughton said the lawmaker shares many of the concerns expressed by his colleagues. That same day, Risch introduced legislation that would implement statutory timetables — a step advocated by the alliance — for licensing decisions.

“We’re optimistic about its prospects,” Boughton added.

Despite the criticism, Shepard said he was “glad” he attended the hearing.

“It really gave me a chance to come there and start this dialogue,” Shepard said Wednesday in an interview. “Talk about oversight, talk about risk management, talk about … reducing costs to taxpayers. … It was certainly positive, in my view."

For his part, Shepard said he has devoted much of his second tenure at the SBA to pursuing much needed upgrades of the SBIC program’s risk management and technological infrastructure, including a new licensing system he plans to start rolling out next year.

“There hadn’t been any new technology implemented into the SBIC program since 1994,” Shepard said. “It’s going to manage the entire life cycle of an SBIC on a single platform. There’s going to be improvements with data analytics. It’s going to improve our oversight. It’s going to improve our risk management capabilities. It’s going to improve transparency for the SBA, but also for the applicant.”

As of March 31, there were 304 licensed SBICs in operation with $30.1 billion of investments outstanding.

Banks, which have been heavily involved in SBICs throughout the program’s history, currently own more than 40 of the companies. Investments are eligible for Community Reinvestment Act credit and can lead to cross-selling opportunities, which might explain why more than 500 banks are currently invested in SBICs, according to the alliance. The program is exempt from restrictions on equity trading imposed by the Volcker Rule.

“Banks love the SBIC program,” Palmer said. “There already are bank-owned SBICs, and a lot more can be formed if we get licensing to work better.”

While Shepard said he has not authorized any specific changes to program operations since the hearing, the pace of licensing appears to have picked up, Kromkowski said.

"Over the past 30 days, there have been some signs of progress,” Kromkowski said. “There’s been some improvement in the timing and speed and velocity of licensing.”

He added that the program’s recent issues probably will not have much of a long-term effect — as long as they are fixed soon.

“It bounced back strongly after the 2008-2009 financial crisis, and a similar thing can happen here," Kromkowski said.

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