ViewPoint: Spotlight: Small Business Lending

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Small Business Lending

Supporting Small Businesses and Job Creation

In September 2010, the Treasury Department announced the creation of the Small Business Lending Fund (SBLF), a $30 billion fund to encourage lending to small businesses by providing tier 1 capital to qualified community banks with assets less than $10 billion. Applications were processed through September 2011, but demand for the funding was less than anticipated despite the fact that under certain conditions an eligible financial institution could refinance preferred stock issued to the Treasury through the Capital Purchase Program (CPP) or the Community Development Capital Initiative (CDCI).

A little more than $4 billion of the available funds were distributed to 332 community banks nationwide. In the Sixth District, 29 firms were funded at an amount of $402 million; nine of those firms substituted CPP or CDCI capital. In total, 933 institutions nationwide applied for $11.8 billion in funding. The KBW Bank Index has estimated that $2.2 billion of capital by 137 Troubled Asset Relief Program (TARP) recipients was replaced by financing from the SBLF, representing 67 percent of the fund's investments.

Similar to any new business venture, the risks of this new program must be managed. In December 2010, the federal banking agencies issued guidance titled "Underwriting Standards for Small Business Loans Originated under the Small Business Lending Fund Program." The guidance defines small business lending by type—commercial and industrial (C&I) loans; owner-occupied nonfarm, nonresidential real estate loans; loans to finance agricultural production and other loans to farmers; and loans secured by farmland—with original amounts less than $10 million or to a business with less than $50 million in gross revenues. The priority should be placed on prudent risk selection and sound credit risk management, in addition to strong board support and direction.

One of the program risks is that failure to increase lending to small businesses will result in the payment of a higher dividend rate on the SBLF funds. For those firms replacing TARP, which had no incentive for small business lending, the SBLF could be profitable. With an initial dividend rate of 5 percent at most, if a firm's lending increases by 10 percent or more, the rate will fall to as low as 1 percent. Firms that increase their lending by less than 10 percent can benefit from rates between 2 percent and 4 percent. However, if lending does not increase in the first two years, the rate will increase to 7 percent; and, it will increase to 9 percent after four and a half years if funding has not already been repaid.

A firm may exit the program at any time by repaying the funding provided plus any accrued dividends with the approval of its regulator.

By Cynthia Goodwin, vice president in the supervision and regulation division of the Atlanta Fed