It’s a poorly kept secret that federal bank examiners are telling banks to exercise more caution in lending, and politicians are delivering another, conflicting message as a sop for the public. Case in point: the recently enacted Small Business Jobs Act of 2010 includes a $30 billion small business lending fund, which is characterized as a TARP-like capital infusion designed to stimulate small business lending — but it has been met with mixed reviews.
The law also contains tax incentives for small businesses, but its best feature is an expansion of Small Business Administration programs that has begun to address a backlog of 1,900 small business loan applications. However, few in the local banking industry believe the law will have much of an impact beyond SBA loans due to uncertainty over pending tax and regulatory changes and a dampened appetite for business borrowing. Only 4% of small business owners cite lack of financing as their top concern, according to a recent survey of the National Federation of Independent Business.
“The issue is uncertainty, and there isn’t much lending demand out there,” agreed Mark Meloy, president and CEO of First Business Bank. “The uncertainty exists on a lot of different fronts for business owners. That uncertainty is equated to risk, a risk business owners aren’t ready to accept and capital providers aren’t ready to accept.”
Regulatory Risk
Major concerns still exist about the credit quality of bank portfolios and the federal government’s ability to head off trouble, in spite of the regulatory thrusts of recent legislation.
James Johannes, director of the Puelicher Center for Banking Education at the UW-Madison School of Business, said the cost of regulatory compliance will go up for banks, which does not bode well for smaller institutions. In order to compete, they will have to spread those fixed costs over larger asset bases.
The new Bureau of Consumer Protection, created in the new financial reform law, is likely to result in more protections for credit card holders, but also more homogeneous, plain-vanilla credit products for consumers. This will take discretion for tailoring products out of the hands of institutions, including the smaller ones, Johannes, noted.
By creating special regulatory oversight of the largest institutions, Johannes believes the government has created a cozier regulatory environment between those institutions and their regulators, raising new concerns about regulatory capture. “The idea that we can create new super agencies to monitor systemic risk and the risk of big institutions is a pipe dream,” he stated. “We had institutions in place to monitor these people, and they were not ahead of the curve. They didn’t see what was going wrong, and to expect a different result with new regulators is wishful thinking.”
As part of the Small Business Jobs Act, the U.S. Treasury could buy stock in willing community banks that qualify, with those banks having to pay an annual dividend of 5% to the government. If those banks make loans to small businesses, the dividend payment might drop to 4%. If they don’t use the money for loans, the dividend payment becomes a penalty at 7%.
But will it stimulate lending in a period in which small business owners are trying to deleverage and improve their financial flexibility, and banks are under heavy scrutiny from federal bank examiners?
Due to the volatility in the economy, more people have taken their money out of the stock market and placed it into federally insured instruments like CDs and savings accounts, which is why deposits, a bank’s primary lending source, have increased. The offshoot is that banks have money to lend to qualified borrowers. They are collectively sitting on an estimated $1.1 trillion in excess reserves, Johannes said, but remain under pressure from federal bank examiners, who are visiting more frequently these days, to justify their lending decisions. Banks are still lending to strong businesses with solid business plans, but they also have their own internal pressures because they have to get it right on virtually 99% of their loans to make their narrow profit margins. The industry standard for a well-run bank is a mere 1% return on assets — during normal times.
Daryll Lund, president and CEO of the Community Bankers of Wisconsin, said it’s up to each bank whether to participate in the small business lending fund. “We’re all waiting for the regulators to come up with the term sheets and rules for how they are going to put that into place,” he said. “We don’t know what those are going to be.”
Lund said there is a TARP-like stigma associated with it, and if a bank is already in a tough financial situation, it may not be eligible to participate. Lund also noted there is another tall hurdle that stands in the way of participation. “The program is such that it only works if there is small business loan demand in the market,” he added, “so the cost of the capital would be high if there is no loan demand.”
Kurt Bauer, president and CEO of the Wisconsin Bankers Association, agreed that many bankers are leery of the strings attached and the TARP label, a situation that is not of their doing. “In a sense, because you saw the President really pushing this, I think this $30 billion fund is more politically motivated than it is market-driven,” he said. “The irony is that many of the politicians who attack banks over the TARP program have made it difficult for bankers to participate in the fund because of the TARP criticism.”
One community banker doubts that many banks will be interested in going to the federal government for capital. “We don’t have a need for capital, and even if we did, going to the federal government for capital, or the Treasury Department, would be the last avenue that I would explore,” said Bob Gorsuch, chairman and CEO of Oak Bank.
SBA Pump
Due to a federal guarantee, banks have relied more on SBA programs during the downturn, which has enabled them to lend more to small businesses. While the final rules are still being written, the law will pump more money into the SBA’s two main lending programs, 504 and 7(a). Wisconsin banks aren’t shy about tapping into SBA lending programs, and higher loan limits, combined with more favorable lending terms and a stronger guarantee make it more attractive.
The lending ceiling for SBA loans will be permanently increased from $1.5 million to $5 million maximum for 504 loans (manufacturer loans and energy loans will have a limit of $5.5 million), and to $5 million for 7(a) loans.
Also under the new law, fees associated with borrowing will either be reduced or eliminated, size standards will increase so that more companies qualify for the loans, and SBA lending now can be amortized over longer periods, providing for lower debt service and more certainty as to the length of the loan.
For borrowers, the measure essentially lowers the cost of business expansion and debt consolidation. For banks, the federal guarantee provides more government backing for extending the credit.
Bauer said the federal guarantee is not a license to make risky loans, but makes it easier for banks to help small businesses in a lending environment that has changed dramatically in two short years. “When you have that guarantee,” he said, “it inoculates the bank from the examiner coming in and second guessing its decisions.”
Dan Schneider, executive vice president of the Wisconsin Business Development Finance Corp., said the allocation should benefit owner-occupied commercial real estate interests with loans scheduled to be repriced.
“They will now have the ability to go back to the SBA to refinance their current debt or expand,” Schneider said. “A number of them have been at the limit, so that will free it up quite a bit.” Schneider’s corporation has had a record year in 2010, handling $110 million in SBA loan approvals just for the 504 program. In 2007, it handled $94 million in loan approvals.
Changing Rules
The tougher terms of bank credit, including personal guarantees, are unlikely to ease in the foreseeable future. That’s a partial explanation for healthy capital-to-asset ratios among Wisconsin banks, and it’s an indication that underwriting was lax before the recession hit, according to Terry Taylor, president of Oak Bank.
“If you were banking with an institution with loose credit underwriting in good times, that didn’t require personal guarantees or down payments, and suddenly those institutions are requiring those things, then it probably feels like the rules have changed,” he said. “There’s no doubt there were some institutions not underwriting credit risk the way they should have been and now are doing things they should have been doing all along.”
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