SBA lending: know the risks, rewards

According to the Small Business Administration (SBA), the mission of the SBA Office of Capital Access is to get lending flowing to small businesses to foster their long-term success. However, they also have an obligation to taxpayers to ensure tax dollars are being used wisely by mitigating risk and conducting oversight of its programs. Additionally, and arguably most important to the banking industry, they have an obligation to make good on their portion of the failed loans that they have helped make available to small businesses.

A recent audit and evaluation of the SBA’s Portfolio Risk Management Program by the Office of the Inspector General (OIG) revealed that the SBA does not actually have a program in place to analyze risk across its $103 billion portfolio, and may have incurred unnecessary losses for taxpayers because it does not implement controls to avoid and monitor risk of default. For example, nearly 1,000 SBA 7(a) loans, totaling nearly $200 million, were disbursed to three national franchises (Petland, Cold Stone Creamery and Planet Beach). A total of 501 of these loans, or $84 million in SBA guaranties, defaulted and more than $39 million in guaranties were charged off. Still, the SBA did not analyze risk or implement controls and continued to guarantee loans for these franchises. Over a seven year period, the SBA also disbursed 10,529 7(a) loans to five retail industries totaling $860 million; 4,415 loans representing $300 million in SBA guaranties defaulted. Again, the SBA did not conduct any risk analysis and in FYI 2012 approved 792 loans worth $182 million to the same five retail industries.*

The risk to taxpayers is clear. What’s the risk to community banks?

Choosing to participate in SBA lending programs can bring a bank both rewards and potential issues. SBA lending is inherently higher in risk than other types of lending because by their very nature, these are loans that a bank would normally consider too risky to fund. It is solely up to the local lender to thoroughly research and review an applicant, and complete documentation in compliance with regulatory requirements. In the case of a default, the local lender is on the hook for their portion of the defaulted loan. Although the SBA guaranties their portion of the loan, the volume of paperwork required to claim a guaranty can be overwhelming, in addition to the intense SBA scrutiny of the local lender’s review and underwriting process; one misstep and the SBA may decline the guaranty or require additional documentation that is time-consuming and expensive to prepare.

Yet, SBA lending may also bring new business to community banks such as an uptick in deposits and fee income for business-related services, at least for the period of time that the business is up and operating. If the business defaults on a loan, it may be difficult if not impossible for the business to recover and continue operations, and therefore, will close its accounts.

An intangible benefit to participating in SBA lending programs is the community “good will” that a bank can foster by showing its support for local businesses. This may open the door for brand building and increases in name recognition within the bank’s local service area, and may possibly encourage other non-SBA loan customers to move their banking relationship. Then again, becoming known as an SBA lender may attract more entrepreneurs and start-ups and their higher risk business.

The bottom line: bank leadership should carefully consider SBA lending and its potential risks as part of a comprehensive risk assessment and management program.

*Following the OIG evaluation report, the SBA updated its 2014-2018 Strategic Plan to specifically address these concerns and take action to evaluate and mitigate the risk in its portfolio. Click here to read the 2014-2018 Strategic Plan.

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