Rules could stifle SBA lending revival

loans(Business Week) A revival in Small Business Administration lending could be thwarted by new limits on the loans’ use for business acquisitions and unfavorable terms for secondary market investors.

“If the Fed trims the haircut and cuts the interest rate on TALF loans to just slightly above the federal funds rate, “investors will come to the table”. This would enable broker-dealers to sell more than $2 billion of inventory that is now backed up on the secondary market and free them to buy additional SBA loans”.Bob Judge, a principal at Government Loan Solutions, a Cleveland Consulting Firm

The recently enacted economic stimulus package tried to make SBA loans more attractive to lenders and borrowers by reducing fees and increasing the government guarantee on 7(a) loans to 90 percent. The new law also calls for the SBA to offer loans to dealers who buy the government-guaranteed portion of 7(a) loans and pool them for sale on the secondary market.

The provisions aim to reverse a decline in SBA lending. Since Oct. 1, the start of the agency’s fiscal year, the number of loans made through the SBA’s 7(a) program is down 57 percent compared with the same period a year earlier.

Lenders contend high fees and other program costs have reduced the profitability of making SBA loans. Plus, the secondary market for SBA loans froze up last fall along with other credit markets. This meant lenders couldn’t sell their existing SBA loans and get capital to make new loans. As a result, many lenders have slashed or halted their SBA lending.

Eric Zarnikow, the SBA’s associate administrator for capital access, said the agency will implement the stimulus package as quickly as possible in order to make capital more available to small businesses. But two other recent government actions – one by the SBA and one by the Federal Reserve – could make this mission harder to achieve.

On Feb. 6, the SBA advised lenders that, in cases of business acquisitions, no more than 50 percent of a 7(a) loan should be used to finance goodwill – the intangible assets of a business that create cash flow. Hard assets, such as real estate or equipment, are not included in goodwill. In no case should goodwill account for more than $250,000 of the loan amount, according to the SBA’s guidance.

Lenders and business brokers contend this goodwill limit will make it impossible to use SBA loans for many business acquisitions, particularly those of service businesses or professional practices. As a result, it will be harder to buy or sell a business, said Matt Ottaway, general manager for Sunbelt Business Brokers, which has 200 offices across the U.S. This could lead to a decline in the value “of every small business that’s out there,” he said.

Many successful businesses have few hard assets, said Scott Gabehart, a certified business appraiser in Phoenix, Ariz.

“Why do you want to punish companies that are highly profitable?” Gabehart said. “That’s basically what this boils down to.”

The SBA has received considerable feedback, both pro and con, on its new goodwill limit and will issue further guidance soon, Zarnikow said.

The agency had not previously addressed goodwill in its guidance to SBA lenders and felt it needed to do so in order to encourage prudent lending, he added. It also wants to encourage sellers to finance the purchase of their businesses because that gives them a stake in the new owners’ success.

Meanwhile, efforts to unfreeze the secondary market for SBA loans could fail unless the Federal Reserve changes the terms for loans made to investors through the Troubled Asset-Based Securities Loan Facility (TALF) program. The terms require investors to put in too much of their own money up front and pay too high of an interest rate, critics complain.

Under the initial terms announced by the Fed, investors who buy pools of SBA loan guarantees would have to take a haircut of 5 percent to 8 percent of the securities’ value.

“That’s not a fair haircut given the quality of the paper,” said Mike Thomas, CEO and portfolio manager of United States Arbitrage Finance II, an Atlanta firm that buys SBA loans.

The haircut should be less than 1 percent since the government fully backs the guaranteed portion of SBA loans, he said.

If the Fed trims the haircut and cuts the interest rate on TALF loans to just slightly above the federal funds rate, “investors will come to the table,” said Bob Judge, a principal at Government Loan Solutions, a Cleveland consulting firm specializing in the SBA secondary market. This would enable broker-dealers to sell more than $2 billion of inventory that is now backed up on the secondary market and free them to buy additional SBA loans, he said.

Christina Romer, who chairs President Barack Obama’s Council of Economic Advisers, got an earful about TALF’s shortcomings when she attended a “Credit Crisis on Main Street” summit Feb. 19 at George Washington University.

“Message absolutely received,” Romer told SBA lenders and small businesses.

The TALF program is scheduled to begin in March, so there still is time for the Fed to make the terms more favorable to investors.

Meanwhile, broker-dealers – the middlemen in the secondary market – eventually will be able to get loans from the SBA in order to purchase SBA loan guarantees from lenders. The economic stimulus legislation called for the SBA to offer these loans, but creating a new program from scratch will take some time, Zarnikow said.

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