The administration’s proposed Small Business Lending Fund (SBLF) tops the Senate’s fall agenda, but is it good public policy? If banks aren’t already inclined to make sound business loans, must Congress provide an “incentive”, known outside Washington as a subsidy? Or is it just the latest example of our President’s penchant to strike poses and reward political supporters?
If we learned anything from the Frannies' mortgage subsidy debacle, it’s that good public policy demands that taxpayer subsidies be effective, transparent, and calculable. The SBLF is none of these.
As proposed, the Congress would redirect $30 billion in TARP funds to the SBLF, which the U.S. Treasury would use to buy preferred stock in community banks with less than $10 billion in assets. Initially, participating banks would pay a much-less-than-market 5% dividend on their preferred (the going rate is probably double that amount, if available at all). Unfortunately for taxpayers, the dividend would decrease 1% for every 2.5% increase in incremental small business lending, to a minimum after 8 years of 1%, with a corresponding reduction in taxpayer returns. But according to the plan’s supporters, participating banks would lever the $30 billion – the administration says “several”, the Senate as much as 10 times – increasing the supply of credit to small businesses.
Sound good? Let’s put some fact and dimension to small business lending in the U.S.:
- Small business loans are about 25% of total commercial and industrial loans outstanding. At the end of 2009, total commercial and industrial loans outstanding were approximately $1.3 trillion and trending lower. Of that total, small business loans outstanding were $311 billion, or about 25% of outstanding C&I loans, down -6.97% from $335.0 billion in 2008, and -5.45%% less than loans outstanding of $330 billion at the end of 2007.
- Large banks fund most small business loans. At the end of 2009, banks held about 14.4 million small business loans. Banks with assets exceeding $10 billion funded about 83% of all loans. Small community banks tend to fund larger loans, 62% of $100-$250 K loans and 57% of loans $250K-$1 million. According to regulatory call reports, large banks funded 86% of the smallest loans, those less than $100K. In dollar terms, at the end of 2009, large banks funded roughly half, with $155.6 billion in small business loans. Smaller banks had $156.1 billion on the books.
Separating political hype from financial reality, a few conclusions are apparent. Foremost, the SBLF can’t be levered 10 times, as that implies a near-doubling of small business loans outstanding over the next 8 years, and a tripling of loans by SBLF-qualified banks. Especially given the SBLF’s exclusion of small businesses’ primary lenders, it’s unlikely that the SBLF can be levered at all, that is, by more than $30 billion. A more reasonable expectation is that we’ll see about +1.5% compounded growth in community banks’ small business loans outstanding, to about $175 billion in 2018, with most of that growth the normal result of economic recovery and expansion. Such a result is too distant to reduce unemployment and too meager to justify any expenditure, let alone one of this size.
Note that there’s nothing in the SBLF that improves the credit worthiness of small businesses. Banks lend against cash flow, real estate, other valuable collateral, and personal guarantees. Most surveys show that lenders remain quite risk-adverse. So, an increase in small business lending really entails improved business conditions – many argue that the President’s many initiatives are failing in that particular – or governmental subsidies and guarantees to reduce the credit risk of lending to small businesses that otherwise haven’t adequate collateral.
A profoundly interesting aspect of the proposed SBLF is that the taxpayer subsidy goes to participating community banks, not small business borrowers, leading cynics to conclude that the SBLF is a political reward for the community bankers’ support of financial reform. While the government may be a poor business partner, the cost of a 5% preferred is low, even in this interest rate environment. And based on my conversations, it’s likely that many community bank CFOs will choose to participate, especially due to the added and onerous costs of the recent financial reform.
But if increased small business lending is good public policy, why create a new subsidy for community banks, which already receive myriad public subsidies, with insured deposits at the top of the list? If we must subsidize, to it directly to qualifying small business, with greater immediate effect and requisite transparency.
Through a preferred investment in favored community banks, we’ll never know what it cost us.
Disclosure: No stocks mentioned
