There seems to be only one kind of loan that bankers want to make—SBA loans. SBA stands for Small Business Administration, a federal agency that guarantees certain loans made by banks that operate within its guidelines.
Lawmakers portray SBA lending as a boost for small businesses. The program is actually a form of corporate welfare for some of America’s largest banks. While banks reap profits, taxpayers cover the losses.
SBA lending is especially lucrative because, with a government guarantee, there are plenty of buyers for these loans in the secondary market. Borrowers are paying interest rates of 6 percent or more, and the government is standing behind the majority of the loan balance. Buyers will pay large premiums for that kind of risk-free yield.
Record Years for SBA
As hard as it has been to pry funds from lenders since the financial crash, the SBA had record years in 2011 and 2012, writing more than $30 billion in loans each year. Making a profit and collecting interest and principal are not included in the SBA’s goals. Instead, the agency’s three strategic initiatives for 2012 were as follows:
1. Growing businesses and creating jobs.
2. Building an SBA that meets the needs of today’s and tomorrow’s small businesses.
3. Serving as a voice for small businesses.
The agency’s flagship loan product is the 7(a) program that funds business loans. More than $15 billion in SBA 7(a) loans were disbursed in 2010. The two years following were brisk as well, nearly matching the boom years of ’04 through ’07. These loans were used, per SBA guidelines, “to establish a new business or to assist in the operation, acquisition, or expansion of an existing business.”
Why, in particular, was there a surge in 7(a) loans? The Congressional Research Service reports,
“Congressional interest in the 7(a) program has increased in recent years because of concerns that small businesses might be prevented from accessing sufficient capital to enable them to assist in the economic recovery. Some, including President Obama, argue that the SBA should be provided additional resources to assist small businesses in acquiring capital necessary to start, continue, or expand operations with the expectation that in so doing small businesses will create jobs.”
Somehow, people like those cited above have come to believe that small businesses are at a disadvantage in obtaining credit. It’s a “market failure,” if you will. So the Small Business Act of 1953 created the 7(a) loan guarantee wherein 85 percent of a loan’s principal up to $150,000 is guaranteed by the government; the guarantee drops to 75 percent for loans more than $150,000. During 2010 and 2011, the guarantee was bumped to 90 percent.
Big Names, Big Losses
Reams of paperwork are required of loan applicants, and of course approval can sometimes take months. First the bank does its investigation, and then the SBA does it all over again, unless the banker is an SBA preferred lender—then the agency will guarantee whatever loans the preferred lender makes, providing they followed the guidelines. Despite all of this rigorous underwriting, the SBA program has cost taxpayers $1.3 billion since 2000, according to an investigation by the Dayton Daily News.
The newspaper found a number of borrowers defaulted on their very first payment.
“Operators of national franchises like Quiznos and Cold Stone Creamery collectively received millions of dollars in loans through the program despite extensive default histories by the franchises,” write Lynn Hulsey and Ken McCall.
One would think there is always a market for sandwiches and ice cream. It turns out nearly 2,600 loans were taken out to fund Quiznos locations from 1990 to 2012, almost half as many as for Subway sandwich shops. According to Hulsey and McCall, these franchises dominated the list of businesses using government guaranteed financing. The 4.8 percent default rate for Subways is considered high. Quiznos’ rate is 23.4 percent.
“Quiznos also led all franchises with $43.5 million in defaulted loan guarantees that SBA had to pay the lending banks. Cold Stone Creamery was second with $29.6 million, followed by Days Inn with $16.9 million and Ramada Inn with $14.3 million.” Evidently, being a part of a household name franchise and benefiting from national advertising does not ensure success. It’s worth wondering just how careful the underwriting was on those loans.
Soaring Default Rates
Pat Newcomb, director of the Ohio Small Business Development Center at the Entrepreneur Center in Dayton, Ohio, told the Dayton Daily, “There were an awful lot of people who got small business loans during this period 2004 to 2007 that shouldn’t have gotten them.”
Default rates soared after the 200