SBA's rationale for raising fees: More loans will go bad

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The Small Business Administration is flashing a warning sign about credit quality in its flagship loan-guarantee program.

The SBA stated in its recently released budget plan that it must either charge higher fees, or receive $99 million from Congress, to cover credit costs for its 7(a) program for the 2020 fiscal year. Refinements to the model used to predict loan purchases, along with “sensitivities … to long term macroeconomic assumption” prompted the request, the agency said.

The determination, along with its underlying rationale, has drawn the ire of lenders who noted that the 7(a) program closed the 2018 fiscal year with a record-low 0.51% charge-off rate. The federal government’s fiscal year runs from October through September.

The request is “kind of shocking,” said Tony Wilkinson, president and CEO of the National Association of Government Guaranteed Lenders. “The portfolio’s performance has been quite good.”

Mention of credit concerns is an eye-opener, particularly when the Trump administration’s economic forecast calls for continued economic growth with unemployment remaining at or below 4% through 2023.

The 7(a) program, which offers guarantees of 50% to 85% on small-business loans of $5 million or less, is the SBA’s largest lending program. The last time the agency asked lawmakers for assistance covering 7(a) credit costs was the 2013 fiscal year, when it sought $236 million.

Since then, the SBA has relied on fees paid by borrowers. Over the five-year period that ended Sept. 30, the agency guaranteed $117 billion of 7(a) loans. Through the first six months of the 2019 fiscal year, 7(a) guarantees totaled $11.4 billion.

The SBA guaranteed $23 billion of 504 loans between the 2014 and 2018 fiscal years. The 504 program, the SBA's second largest, won’t require a credit subsidy in the 2020 fiscal year, according to budget documents.

The SBA charges an upfront fee when a loan closes and an annual fee as long as it stays on the books. To keep 7(a) in zero-subsidy status, the agency is asking Congress for authority to increase upfront fees on loans between $500,000 and $700,000 by 50 basis points, to 3.5% of the loan amount.

It’s also seeking a 25-basis-point increase in upfront fees on loans greater than $1.5 million and loans under a year in duration, to 3.75% and 0.50%, respectively. Finally, for loans greater than $1.5 million, the SBA wants to hike the ongoing annual fee by 14 basis points, to 0.69%.

The current fee structure generated $94 million more than the SBA needed to cover 7(a) credit costs in the 2017 fiscal year, and $757 million more the next year, according to budget documents. The agency is expected to collect an extra $143 million in the current fiscal year.

Wilkinson called the mounting surpluses a tax on 7(a) borrowers, while questioning the methodology behind the SBA’s credit subsidy calculations.

“They crossed the line with this budget,” Wilkinson said.

“Something as arcane and bureaucratic as a flawed financial model created behind closed doors is essentially dictating the parameters of access to capital,” he added. “With the proposed budget, borrowers will suffer and access to capital will be reduced.”

Wilkinson is promising an aggressive lobbying effort against the fee proposal. The issue was expected to receive a thorough airing at a Senate Small Business Committee meeting Wednesday afternoon. The House Small Business Subcommittee on Economic Growth, Tax and Capital Access plans to hold a hearing on April 10 to examine the budget and proposed fee increases.

An SBA spokesperson said the agency's policy is to withhold comment in advance of official testimony.

Congressional Democrats have been critical of the budget for the 2020 fiscal year.

Sen. Ben Cardin, D-Md., the ranking minority member on the Small Business Committee, said in a prepared statement that the agency’s budget “another sign small businesses are not a priority, but an afterthought for the Trump administration.”

The proposed increases “would shift costs onto small business borrowers and lenders,” Rep. Nydia Velazquez, D-N.Y., said in a separate statement. Velazquez is chairwoman of the House Small Business Committee.

The Senate hearing comes less than a week after SBA Administrator Linda McMahon announced plans to step down April 12 to work on Trump’s reelection campaign. McMahon won respect from Democrats and Republicans during the two years she has led the agency, so news of her departure triggered an outpouring of bipartisan praise.

“From what I saw, she was a very effective administrator,” Wilkinson said. “We’re going to be sad to see her go.”

“My hope is that President Trump will nominate a successor who is as committed to advocating for America’s small businesses as Administrator McMahon,” Cardin said.

Not everyone is incensed about the proposed fee hikes.

Bob Coleman, longtime editor of the Coleman Report, an SBA-focused newsletter, said Friday that he believes “cooler heads will prevail” in a way that lets the agency and its critics hammer out an acceptable budget.

Few government programs enjoy as strong and as deep a level of support as 7(a), Coleman noted, adding that legislators, the SBA and the Trump administration are “on the same page” when it comes to ensuring the program’s success.

Coleman, moreover, said the proposed fee increases aren’t as dire an issue as critics have asserted. There’s no guarantee any increase will be enacted, and if one is it will likely be modest enough for borrowers to absorb without too much difficulty, he added.

The 2020 budget also proposes nearly tripling the cap for the popular SBA Express program, a component of 7(a) that features a streamlined application process in exchange for a reduced, 50% guarantee, to $1 million.

Testifying before the House Small Business Committee in February, Associate Administrator William Manger said the Express program has underperformed in recent months largely because its current $350,000 size limit is too low.

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