Storm clouds gathering over leader of SBA investment program
Joseph Shepard has a big fight ahead: Congress badly wants to overhaul a key investment program he leads for the Small Business Administration, but many lawmakers consider him part of the problem.
The Small Business Investment Company program has shrunk in recent months, alarming community-development-minded members of the House and Senate. Outstanding leverage to individual SBIC funds fell 6% between Oct. 1, 2018, and June 30 to $11.4 billion. The amount earmarked for future draw-downs — a key indicator of future activity — totaled $958 million in the first nine months of the 2019 fiscal year, a 39% year-over-year decline.
The leading indicators for fund formation also appear to be trending downward. There were 28 so-called green light letters, which grant funds-in-formation the OK to begin raising private capital, in the first nine months of the 2018 fiscal year but only 11 over the same span in the fiscal year.
“If we intend to continue enhancing access to affordable capital for small businesses, it is clear we must take a hard look at the SBIC program — especially the way it is currently being administered,” House Small Business Committee Chairwoman Nydia M. Velazquez, D-N.Y., said at a recent hearing where Shepard, the program's associate administrator, was put on the spot.
The SBA argues that some of the problems preceded Shepard and that he is making changes. Whether he can convince critics that his policies will take the program in the right direction will be the key question in coming weeks. If the program continues to struggle, lenders and other business interests may weigh in in favor of leadership or other changes.
The SBIC program receives strong support from banks. Commercial banks own more than 40 SBICs outright, according to a July 24 report by the Congressional Research Service. Hundreds more invest in nonbank SBICs, attracted in large part by exemptions from the Volcker Rule and other Dodd-Frank requirements as well as the Community Reinvestment Act credit their stakes earn.
Over the past few years, lawmakers have sent strong signals they want to see the 60-year-old program — which supplements investment companies’ lending by providing funding, or leverage, the companies can deploy alongside their private capital — significantly expanded.
In December Congress passed and President Trump signed the Spurring Business in Communities Act, which was sponsored by Sen. Marco Rubio, R-Fla., and requires the SBA to prioritize SBIC applicants from underlicensed states and to exempt them from full certain capital requirements. In January, the House passed a bill sponsored by Rep. Judy Chu, D-Calif., that would permit banks to invest up to 15% of their capital, triple the current 5% limit, in one or more SBICs.
Though Chu’s bill, the Investing in Main Street Act of 2019, is awaiting action by the Senate, its progress, along with that of Rubio’s earlier Spurring Business in Communities Act, serves to indicate the high Level of bipartisan support SBIC enjoys in Congress. Lawmakers view it as a critical tool for funneling venture capital to underserved regions and groups.
Their expectations have contributed to the pressure on Shepard. Three months after a rocky Senate oversight hearing, he underwent an even tougher grilling from House Small Business members last week.
“I’m very supportive of what the SBIC is and what it’s about, but I’m also very concerned about the lack of utilization,” said Rep. Kevin Hearn, R-Okla.
At least one lawmaker suggested his days at the SBA may be numbered.
“Small business is the engine of our economy. When you don’t support them the way we’ve asked you to, it’s a detriment to Main Street America and Main Street Minnesota," Rep. Pete Stauber, R-Minn., said Thursday. “I’m just going to say this member of Congress is extremely disappointed in what’s happening in this program. It needs to be fixed, and I don’t think you have a lot of time to fix it.”
Criticism of Shepard didn’t stop there. It was bipartisan and sharp.
“Current management is exactly what I’m concerned about today,” Rep. Abby Finkenauer, D-Iowa, said, echoing the comments by Velazquez.
For his part, Shepard told the members of the committee that he has focused on streamlining his office’s examination process and updating the program’s information technology infrastructure “because those improvements will better position the agency to advance the SBIC mandate into the future.”
In March 2017, when he took office, barely more than half of the operating small-business investment companies had undergone a mandatory two-year safety and soundness examination, Shepard said Thursday.
“I’m pleased to say in just over a year we were able to get 100% compliance,” Shepard said. He plans to create a senior examiner position “to maintain our progress," he added.
Shepard’s focus on supervision has played out against a backdrop of strong credit quality within SBIC. Charge-offs totaled 0.31% of the unpaid principal balance in the 2018 fiscal year. Through June 30, the first nine months of the 2019 fiscal year, charge-offs dropped to 0.01%.
An SBA spokesman said after the hearing that certain SBIC activity began slowing down a few years before Shepard's arrival. The program approved 34 funds in the 2013 fiscal year, but then that figure fell each of the next four years, hitting 15 in 2017, the spokesman said. It jumped up to 25 in 2018 before settling back to 18 in the fiscal year that ended Monday.
The time it takes to process those applications is shortening, the spokesman also said. Processing time has averaged 6.68 months during Shepard's tenure, compared with about 7.5 months in the previous eight years.
Whether Shepard's moves will strengthen the program quickly enough is unclear. It's not just elected officials who have questioned Shepard's stewardship of the SBIC program.
“This has been a mess for two and a half years,” Brett Palmer, president of the Small Business Investor Alliance, an SBIC trade group based in Washington, testified at the House hearing.
“I think you need a change of management,” Palmer said. “I think you just need someone who is willing to let the staff do their job and do the regulation that they need.”