Availability of Credit to Small Businesses
This section examines some developments in small business credit markets that have affected the delivery and availability of credit to small businesses and are likely to continue doing so: government initiatives to support credit access for small businesses, securitization of small business loans, and the role of personal wealth in new business formation. First, government initiatives such as the CRA and SBA lending programs are reviewed. These programs focus on the financing needs of small firms in underserved communities and the financing needs of young firms without much, or any, financial history. New legislation specifically targeted to improve small business access to credit that was passed during this period is also discussed. Second, the securitization market is examined. A well-functioning secondary market increases small businesses' access to credit by providing an efficient funding supplement to direct lending. The willingness of banks to make small business loans can be reduced if securitization markets seize up, as happened during the recent recession. Finally, the personal wealth effects of the large decline in home prices over the recent period may be reflected in borrowing difficulties of potential new firms; the final part looks at the relationship between the recent decline in real estate prices and new business formation.
Government Initiatives to Support Credit Access for Small Business
In this Section:
Several long-standing government initiatives exist to help support credit access for small businesses, particularly small businesses owned by historically underserved groups such as women and minorities. Two such initiatives of particular importance are the CRA and several loan programs sponsored by the SBA.
Community Reinvestment Act
The Congress enacted the CRA in 1977 to encourage federally insured depository institutions to help meet the credit needs of their local communities, particularly low- and moderate-income (LMI) neighborhoods, consistent with safe and sound operations. These local communities, referred to hereafter as CRA assessment areas, are generally identified as the areas where banking institutions have a physical branch office presence and take deposits. LMI neighborhoods have been defined for regulatory purposes as census tracts with a median family income of less than 80 percent of the median family income of the broader area according to decennial census data.64
Under the CRA, the bank regulatory agencies regularly review institutions' performance in this endeavor and prepare publicly available written evaluations, which include ratings. The CRA requires that supervisory agencies consider a financial institution's CRA performance when evaluating an institution's application for expansion or relocation of depository facilities through branching, mergers, or acquisitions. Decisions on these applications are made public.
Although much of the small business lending of financial institutions occurring in LMI areas cannot be directly attributed to the CRA, bankers and community representatives indicate that some of it is the result of individual banks responding to their CRA obligation. Some lending activity also results from interaction with community representatives and government agencies familiar with the CRA and the possible roles that financial institutions can play in community development and reinvestment.
A common type of community reinvestment intermediary used by banks to help finance small businesses in lower-income areas is the bank-owned or bank-affiliated community development corporation. Under certain conditions, bank holding companies, national- and state-chartered commercial banks, and savings institutions may make equity investments in small businesses through a community development corporation or a limited liability company. Generally, these entities can make debt and equity investments in small businesses when the firms are located in LMI areas and the jobs created and services provided benefit primarily LMI persons.
Another form of intermediary is the consortium lending organization that specializes in financing young or start-up small and minority businesses. By participating in such consortiums, banks can mitigate the risks and costs of lending to small firms. These loan consortiums are usually organized in corporate form and may be nonprofit or for-profit organizations. Although many are organized primarily by banks, they often have nonbank participants such as insurance companies, utilities, other corporations, religious institutions, and other institutional investors. Other loan consortiums are quasi-public arms of state, regional, or local governments.
Because many institutions do not have the expertise or cannot bear the development costs of special small business finance programs, especially those focusing on reinvestment areas, many banks have created or assisted intermediaries that support small businesses in their communities. Indeed, a notable development in bank reinvestment programs has been formal and informal working partnerships among banks, regional or neighborhood nonprofit organizations, and community-based development corporations. These organizations identify prospective borrowers, provide loan counseling, serve as experienced developers in low-income and minority areas, and assist banks in marketing loan programs. One such program is based in Philadelphia, where five major banks started a 2010 Capacity Building Initiative to increase the ability of FINANTA, a community development financial institution lender in Northeast Philadelphia, to grant loans and provide technical assistance to small businesses in underserved areas. This initiative provided critical resources to FINANTA in the forms of operating grants, technical assistance, loan capital, and loan loss reserve funds. Following the success of this initiative, the local banks will seek to provide assistance to another community lending partner in 2013. These types of partnerships have also been effective in helping reduce the high transaction costs often associated with lending to very small firms. Such organizations also frequently package financial resources for small firms from several public and private sources. Overall, these types of partnerships enable banks to make small business loans that might not otherwise have been financially feasible.
Analysis of Community Reinvestment Act Data on Lending in Lower-Income and Minority Neighborhoods
CRA regulations require larger commercial banks and savings associations to collect and report data regarding the geographic location of their small business lending. As a consequence of amendments to CRA regulations in 2005, banking institutions with assets less than $1.16 billion are no longer required to report data on their small business and small farm lending. However, many smaller institutions still elect to report these data. Analysis of Call Report data indicates that lenders reporting CRA data account for over two-thirds of the dollar volume of small business loans outstanding at all commercial banks and savings associations.
Each reporting bank makes an annual report on the total number and dollar volume of small business loan originations by census tract. As in the Call Report data, small business loans encompass C&I loans and CRE loans whose original amounts are $1 million or less. However, unlike the Call Report data, the CRA data provide information on originations, or the flow, of small business credit rather than the stock.65 The CRA data also provide information on the number and dollar volume of small business loans originated to businesses with revenues of less than $1 million, to the extent that the reporting institution collects such information when making credit decisions.
Figure 11, panel A, shows that the dollar volume of small business loan originations peaked in 2007 and declined sharply thereafter, falling about 45 percent by 2010, the latest year for which data are available. Originations to the smallest businesses dropped more than 50 percent between 2007 and 2010. Panels B and C disaggregate these two series by whether loans were made in a bank's CRA assessment area and whether loans were made in LMI neighborhoods (see previous section for assessment area and LMI definitions).
Although the decline within assessment areas has been considerable, both panels show a more precipitous decline in small business loan origination volume outside of assessment areas. The downturn in lending has been similar across LMI and non-LMI neighborhoods inside and outside of assessment areas, suggesting that small business credit access in lower-income areas has not worsened disproportionately relative to upper-income neighborhoods.
Panels D and E display the trend in lending across neighborhoods with higher (at least 30 percent) and lower (less than 30 percent) shares of minority residents. Since 2007, small business lending has declined somewhat more in higher-minority-share neighborhoods. The difference is more pronounced for loans to the smallest businesses--those businesses with revenues less than $1 million. Lending in higher-minority-share neighborhoods has dropped about 60 percent since 2007, compared with a drop of roughly 50 percent in lower-minority-share neighborhoods.
Table 21 provides additional data on small business lending in LMI versus non-LMI neighborhoods, and inside versus outside of CRA assessment areas. The top panel shows data for 2007, while the bottom panel shows data for 2010. Comparing across columns, the volume of lending is considerably higher in non-LMI neighborhoods than in LMI neighborhoods in both years, reflecting, at least in part, that roughly three-fourths of the population and businesses reside in non-LMI neighborhoods.
|Inside AA||Outside AA||Total||Inside AA||Outside AA||Total|
|Small business loans|
|Dollar volume (millions)||45,463||21,645||67,108||144,246||111,089||255,335||325,774|
|Share by credit card lender (percent)||1.8||56.2||19.4||1.9||56.2||25.5||24.1|
|Share by top 10 bank organizations (percent)||32.2||39.5||34.6||31.2||39.5||34.8||35.2|
|Number of loans (thousands)||468||1,943||2,411||1,674||9,065||10,739||13,284|
|Average loan amount (thousands)||97.1||11.1||27.8||86.2||12.3||23.8||24.5|
|Loans to businesses with revenues less than $1 million|
|Dollar volume (millions)||16,645||8,966||25,611||61,205||48,307||109,512||136,411|
|Share of all (percent)||37.0||41.0||38.0||42.0||43.0||43.0||42.0|
|Share by credit card lender (percent)||3.8||52.5||20.8||3.1||50.8||24.1||23.3|
|Share by top 10 bank organizations (percent)||31.7||43.6||35.9||30.6||39.1||34.3||35.1|
|Number of loans (thousands)||275||632||907||1,071||3,055||4,126||5,081|
|Average loan amount (thousands)||60.5||14.2||28.2||57.1||15.8||26.5||26.8|
|Small business loans|
|Dollar volume (millions)||29,026||7,825||36,851||92,006||42,629||134,635||174,817|
|Share by credit card lender (percent)||.1||37.2||8.0||.1||33.5||10.6||10.1|
|Share by top 10 bank organizations (percent)||30.8||32.4||31.2||30.7||32.0||31.1||31.9|
|Number of loans (thousands)||248||480||728||933||2,421||3,354||4,216|
|Average loan amount (thousands)||117.0||16.3||50.6||98.6||17.6||40.1||41.5|
|Loans to businesses with revenues less than $1 million|
|Dollar volume (millions)||9,043||2,556||11,599||35,425||16,267||51,692||64,579|
|Share of all (percent)||31.0||33.0||31.0||39.0||38.0||38.0||37.0|
|Share by credit card lender (percent)||.0||22.8||5.0||.0||19.5||6.1||5.9|
|Share by top 10 bank organizations (percent)||28.4||38.5||30.6||30.5||34.8||31.9||32.7|
|Number of loans (thousands)||132||114||246||570||625||1,195||1,489|
|Average loan amount (thousands)||68.5||22.4||47.2||62.1||26.0||43.3||43.4|
Note: LMI is low and moderate income; AA is assessment area.
1. Includes lending with unknown income and assessment area status. Return to table
Source: Federal Financial Institutions Examination Council, data reported under the Community Reinvestment Act.
Within each income group, assessment area lending generally exceeds non-assessment area lending in dollar terms, but not in terms of the number of loans. This pattern results from specialized credit card lending institutions making up a large portion of non-assessment area lending. A dozen or so such institutions issue business cards nationwide but generally do not have an extensive network of bank branches and therefore have limited CRA assessment areas.66 Comparing LMI with non-LMI areas, table 21 indicates that credit card lenders made up a larger share of loan origination volume in non-LMI areas than in LMI areas in both 2007 (25.5 percent versus 19.4 percent) and 2010 (10.6 percent versus 8.0 percent).
Finally, table 21 also shows the share of small business lending by banks in the top 10 banking organizations according to total assets, by neighborhood income group. These data reveal that the top 10 organizations accounted for just over one-third of dollars loaned in both LMI and non-LMI neighborhoods in 2007 and for just under one-third of lending in both tract groups in 2010.67
Small Business Administration Programs
Support for small business development has been a priority of policymakers for several decades, and federal, state, and local agencies have sponsored programs that assist in channeling capital to small business. At the federal level, the agency with the most direct role in this objective is the SBA, which the Congress created in 1953 to help entrepreneurs form successful small enterprises. The SBA provides financing to young and growing small firms through several channels such as the 7(a) Loan Program and SBA 504 Certified Development Companies (CDCs). Among the policy objectives of the SBA loan programs are the goals of promoting entrepreneurship opportunities for women and minorities.
SBA 7(a) Loan Program
The largest SBA program is the 7(a) Loan Program, which provides lenders with a partial loan guarantee for extending credit to small businesses that meet the SBA's underwriting and eligibility criteria. Participating lenders agree to structure loans according to the SBA's requirements, and apply for and receive a guarantee from the SBA on a portion of this loan. The SBA does not fully guarantee 7(a) loans--the lender and the SBA share the risk that a borrower will not be able to repay the loan in full. The SBA provides a guarantee of as much as 85 percent for loans less than or equal to $150,000 and a guarantee of as much as 75 percent for loans greater than $150,000.68 The maximum loan amount is now generally $5 million, increased in 2010 from $2 million under the Small Business Jobs Act of 2010. However, under the Express loan program, which requires less loan documentation and provides quicker turnaround time, only 50 percent of the loan is guaranteed, and the maximum loan amount is $500,000.
Figure 12, panel A, shows that although the dollar volume of SBA 7(a) loans jumped dramatically between 2009 and 2011, with gross loan approvals increasing from about $9 billion to nearly $20 billion, the number of loans has remained at subdued levels relative to 2007 and earlier. Thus, the average 7(a) loan size has increased sharply, especially from 2010 to 2011, which may partly reflect increases in the maximum loan size allowed.
Panel B shows time trends in the fraction of 7(a) loans reported to have gone to minority- and women-owned businesses, and the fraction of loans below $150,000, which qualify for a larger guarantee percentage and are more likely to have gone to smaller businesses. The share of loans to women-owned businesses has declined somewhat from 23.0 percent in 2007 and 2008 to 16.7 percent in 2011, while the share of loans to minority-owned businesses has declined more noticeably--from 34.3 percent in 2007 to 21.4 percent in 2011. This panel also shows that the fraction of loans under $150,000 has been declining steadily since 2007.
SBA 504 Certified Development Companies
Banks often work with CDCs to leverage funds for small business financing. CDCs are generally nonprofit corporations specializing in small business finance and are certified by the SBA to participate in the agency's section 504 financing program. The SBA 504 program is intended to help small businesses expand and to create jobs by providing CDCs with the ability to issue SBA-guaranteed long-term debentures to fund small firms' purchase of plant, equipment, or real estate. These loans are typically structured with three components: (1) a first mortgage or lien, which is made by a private commercial lender for 50 percent of the total project and does not come with a government guarantee; (2) a second mortgage or lien, which is made by a CDC for 40 percent of the total project and is backed by a 100 percent SBA-guaranteed debenture; and (3) borrower equity for the remaining 10 percent of the total project. SBA 504 loan volume peaked in 2007 with about $6.5 billion in gross approvals. Lending under this program in fiscal year 2011 was at $4.6 billion in gross approvals on 7,676 loans, similar to the level in 2010 and about 18 percent higher than in 2009.
In 2011, the 504 program was temporarily changed to allow small business owners to use 504 loans to refinance up to 90 percent of the appraised value of available collateral. This temporary expansion authorizes up to $7.5 billion in financing and is available until September 27, 2012.
Small Business Investment Companies
The Small Business Investment Company (SBIC) program was initiated in 1957 to provide debt and equity capital to young and growing companies. Although the venture capital market has matured, the SBIC program remains important because many small, growing firms find it difficult to obtain equity financing from venture capital companies. Banks and bank holding companies can own and operate SBICs, which are licensed and regulated by the SBA. SBICs can be organized as separate subsidiaries of one institution, or of multiple institutions and other private investors, or can be controlled by private interests not affiliated with financial institutions. To obtain capital, SBICs often sell long-term debentures that are guaranteed by the SBA. The proceeds of these debentures are used to provide longer-term financing for small businesses, often in conjunction with the issuance of equity interests in the small business to the SBIC. In fiscal 2011, SBICs provided $2.6 billion of financing to small businesses. This figure represents an increase of more than 60 percent over the $1.6 billion from fiscal 2010 and well above the $1.3 billion averaged between 2006 and 2009.
Disaster Recovery Assistance
The SBA has a long-standing program to assist businesses recovering from disasters. In fiscal 2007, the SBA funded just over 1,400 loans totaling nearly $14 billion for this purpose. A significant portion of the demand in fiscal 2007 stemmed from Gulf Coast hurricanes in 2005. In fiscal 2008, the SBA funded just over 15,000 loans totaling just over $800 million for this purpose. Severe tornadoes and flooding in the Midwest and tropical storms and hurricanes in the Southeast, along the Atlantic coast, account for a large part of those damages. In fiscal 2009, the SBA funded over 21,000 loans totaling $1.1 billion for this purpose. Damages caused by Hurricanes Ike and Gustav and the flooding in the Midwest were responsible for many of these loans. In fiscal 2010, the SBA funded almost 14,000 loans totaling nearly $600 million for this purpose. The largest component of these loans stems from damages sustained during the flooding in Tennessee, Rhode Island, and Massachusetts and the BP oil spill. In fiscal 2011, the SBA funded 13,643 loans totaling $739 million for this purpose. During fiscal 2011, nearly 14,000 loans were made, totaling about $783 million. These loans were mainly associated with damages caused by tornadoes in Alabama and Missouri and flooding in North Dakota, as well as Hurricane Irene.
The SBA's Microloan Program provides small businesses with small short-term loans for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery, or equipment. The SBA makes funds available to specially designated intermediary lenders, which are nonprofit community-based organizations with experience in lending as well as management and technical assistance. These intermediaries make loans to eligible borrowers. The maximum loan amount is $50,000, but the average microloan is about $13,000. In fiscal 2012, the SBA budgeted $3.8 million to support the Microloan Program.
Small Business Credit Access Legislation
Support for small businesses has recently come in the form of more-significant small business legislation. The American Recovery and Reinvestment Act of 2009 (ARRA) and the Small Business Jobs Act of 2010 both provided resources to small businesses through increasing credit availability, providing capital to small business lenders, and putting in place tax cuts for small businesses.
American Recovery and Reinvestment Act of 2009
With the overarching goal of spurring job creation, ARRA included some specific provisions directly targeted at small businesses, including increased small business financing as well as tax breaks. The increased financing was implemented in the form of funding for the SBA, which received $730 million, more than doubling its 2008 budget. The funds were divided among many programs, with $375 million for temporarily eliminating fees on SBA-backed loans and raising the guarantee percentages, up from the 75 percent maximum to 90 percent on some loans. Another $255 million was used to create the America's Recovery Capital (ARC) Loan Program. ARC loans were designated to help businesses in distress pay off existing debt, and could be a maximum of $35,000.69
The SBA ran out of funding to waive fees and raise guarantee percentages in late November of 2009, but the next month the Senate extended the funding, allotting another $125 million to continue the program until February 2010. Other components were less successful. The SBA estimated that the $255 million appropriated for the ARC program would lead to 10,000 loans worth $340 million, but by the time the program expired at the end of September 2010, only 8,869 loans worth $287 million had been made. Anecdotally, small businesses expressed desire to participate in the program but cited cumbersome paperwork and banks' unwillingness to cooperate as hindering their ability to receive an ARC loan.70
Small Business Jobs Act of 2010
In September 2010, the Small Business Jobs Act was signed into law. This act again provided funding for the SBA and expanded small business tax cuts, as well as authorized the creation of the Small Business Lending Fund (SBLF) of the Treasury Department, with the aim of increasing the availability of credit for small businesses. A $505 million subsidy for the SBA supported over $12 billion in small business lending and allowed the SBA to increase maximum sizes in several of its loan programs. Employment and revenue size standards were also raised, increasing the amount of small businesses eligible for SBA loans. According to self-reported data, Small Business Jobs Act loans went to rural (22 percent), minority-owned (21 percent), women-owned (16 percent), and veteran-owned (7 percent) businesses.71 The SBLF was created to encourage lending to small businesses by providing capital to community banks and community development loan funds (CDLFs) with assets under $10 billion. The fund was supplied with $30 billion but in total provided just over $4 billion to 332 community banks and CDLFs. In April 2012, the Treasury reported that institutions that received capital from the SBLF significantly increased small business lending in 2011, with $1.3 billion more lent in the fourth quarter than in the third quarter and a total of $4.8 billion more lent over the 2010 average.72
In addition, the Act created the State Small Business Credit Initiative (SSBCI), which was funded with $1.5 billion to strengthen state programs that support lending to small businesses and small manufacturers. Under the SSBCI, participating states will use the federal funds for programs that leverage private lending to help finance small businesses and manufacturers that are creditworthy, but are not getting the loans they need to expand and create jobs.
Jumpstart Our Business Startups Act
The most recent piece of small business legislation is the JOBS Act. Signed into law in early April of 2012, this bill is intended to make it easier for start-ups and small businesses to raise funds, especially through crowdfunding online. This legislation is a departure from the two earlier bills, as it is focused on access to finance through less conventional channels.73
Securitization of Small Business Loans
The securitization of small business loans has the potential to substantially influence the availability of credit to small businesses. Potential benefits exist for lenders, borrowers, and investors. However, the obstacles to securitizing small business loans are large. Between 2002 and 2007, securitization of SBA loans increased at a moderate pace each fiscal year. Then, in late 2008, the securitization markets nearly collapsed. Unable to sell their loans in the secondary market, banks that relied on selling asset-backed securities (ABS) packages to provide them with additional lending funds were forced to pull back on their lending. Outstanding business loans fell substantially through the second quarter of 2010 and recovered to near pre-recession levels by the fourth quarter of 2011. Outstanding small loans to businesses began increasing only in the fourth quarter of 2011 and remain nearly 15 percent below pre-recession levels.74
Process of Securitization
Securitization is the process of packaging individual loans and other debt instruments, converting the package into a security, and enhancing the credit status or rating to further the security's sale to third-party investors (Kendall and Fishman, 1998). This process has become an efficient funding supplement to direct lending in markets for certain financial assets--notably, residential mortgages, credit card receivables, and automobile loans.
Active secondary markets in these assets can benefit all parties. Lenders profit from scale economies or from originating and servicing loans without having to add all of the loans to their own balance sheets. They can therefore improve their return on capital by substituting off-balance-sheet, fee-based sources of income for riskier capital-intensive direct lending. This practice potentially results in added liquidity and greater balance sheet diversity. Borrowers whose loans are eligible for securitization typically enjoy lower financing costs. Investors in the securities, while still earning attractive returns, may receive greater liquidity and lower risk than they would by investing directly in the individual loans. Overall, risk may be allocated more efficiently.
Successful securitization requires that the costs of pooling individual loans and administering the securities collateralized by the loans be less than the spread between the average contract rate on the underlying loans and the yield investors demand on the securities. Besides various expenses for administration, costs stem from obtaining a high credit rating to reassure investors of the reliability of a security's cash flow. High ratings are often obtained through the provision of "credit enhancements" to the security's purchaser by the originator or others. These enhancements sometimes involve an agreement by the originator or other party to absorb, through the portion of the pool held by them, specified first dollar losses of the pool before any loss falls on the investors in the securitized pool.
Securitization generally has thrived in markets in which the costs of acquiring and communicating information to investors about loans and borrowers are low. These conditions usually occur as a result of standardized loan underwriting criteria; advances in information technology, which make estimating default probabilities and prepayment patterns easier under various economic conditions; and experience in developing and selling loan pools in the secondary market. Most small business loans cannot readily be grouped into large pools that credit agencies and investors can easily analyze: Loan terms and conditions are not homogeneous, underwriting standards vary across originators, and information on historical loss rates is typically limited. The information problems associated with small business loans can be overcome, or offset to a degree, by some form of credit enhancement, as in the case of the SBA's 7(a) loans. However, the more loss protection needed to sell the securities, the smaller are both the net proceeds from the sale of the securities and the incentive for lenders to securitize their loans. Small business loans are an asset for which the high transaction costs of providing credit enhancements have made many potential securitizations unprofitable.
A significant step in encouraging the development of markets for securitized small business loans has been the removal of certain regulatory impediments. The Riegle Community Development and Regulatory Improvement Act of 1994 (Riegle Act) extended some of the regulatory accommodation provided by the Secondary Mortgage Market Enhancement Act of 1984 to issuers of securities backed by small business loans (and commercial mortgages). The 1984 act applied only to issuers of residential mortgage-backed securities. The benefits of the Riegle Act include the elimination of state-level investment restrictions and securities registration requirements as well as the establishment of favorable federal regulatory treatment. Investment restrictions for federally regulated banks, thrifts, and credit unions and for state-chartered thrifts, insurance companies, and pension funds were relaxed as well. Also, risk-based capital requirements for depository institutions that securitize loans but retain "recourse" on subordinated classes of securities were reduced.
A remaining impediment to the development of markets for securitized small business loans has been the lack of more-uniform standards for underwriting and loan documentation. However, the use of credit-scoring systems in the origination of small business loans could address this problem, at least to some extent, by providing a credible, low-cost measure of the expected performance of small business loans. As a result, the information gap associated with small business lending could be lessened, and the volume of securitizations could increase. To date, however, this practice has not been broadly adopted.75
By 2006, new secondary-market dollar volume for 7(a) loans had risen to a record high of $4.6 billion. Conventional, non-SBA-secured small business loan securitizations were growing at a moderate pace, although at a much smaller rate than that of SBA-backed loans. In late 2008, the secondary market for small business loans slowed substantially. The top two issuers of small business loan ABS--Lehman Brothers Small Business Finance and Ciena Capital--both filed for bankruptcy earlier in the year. In addition, Bayview Financial, another large player in the market, closed down its securitization operations in 2008.
SBA 7(a) Loans
Historically, most of the small business loans that have been securitized involved the guaranteed portion of loans made under the SBA's 7(a) Loan Program. These securitizations have been fairly common because they do not involve the risk and information impediments typically associated with the securitization of small business loans. SBA 7(a) loans tend to be highly standardized because the underlying loans are often backed by similar types of collateral and loan documentation. In addition, the originators are SBA "preferred lenders" and are perceived to have clear and rigorous underwriting standards that are consistently applied. Despite this preferred status, the SBA secondary market also dropped off substantially in September 2008.
As the secondary markets froze and regulators attempted to restore financial stability, several actions were undertaken, with important implications for the SBA 7(a) secondary market:
November 2008. As financial markets became more globalized, increasing shares of SBA lenders' cost of funds became tied to the London interbank offered rate (LIBOR). In a more stable financial environment, the LIBOR was consistently 3 percentage points lower than the prime rate, which was the rate required to price 7(a) loans. However, as the financial markets became increasingly volatile, the spread was reduced, thereby reducing the profitability of SBA loans. This reduction in turn led to increased difficulty in selling the loans on the secondary market. In order to reduce some of the risk and uncertainty to lenders, the SBA began allowing lenders to price loans based on the LIBOR rather than requiring the prime rate (U.S. Small Business Administration, 2008a). Around the same time, the SBA also announced that it would allow weighted-average coupon pools in order to make the SBA pools more attractive and more consistent with other types of securities sold on the secondary market (U.S. Small Business Administration, 2008b).
2008-09. The Federal Reserve established the Term Asset-Backed Securities Loan Facility (TALF) to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more-normal interest rate spreads. The facility was announced on November 25, 2008, and began lending operations in March 2009. TALF lending was authorized through June 30, 2010, for loans collateralized by newly issued commercial mortgage-backed securities and through March 31, 2010, for loans collateralized by all other TALF-eligible securities.76 Between March 2009 and June 2010, the Federal Reserve lent a total of $71.1 billion, $2.2 billion of which went toward SBA loans.
June 2009. The Financial Accounting Standards Board announced two new provisions (Statements of Financial Accounting Standards Nos. 166 and 167) intended to provide increased transparency for investors about a company's risks. In effect, the new provisions required that banks that sold the guaranteed portion of their 7(a) loans on the secondary market have to defer recognizing the income until after the 90-day warranty period required by the SBA. In addition, regulatory capital must be held until the sale can be recognized. Banks argued that these requirements made the income from servicing the loan more attractive than reselling it and reduced secondary market sales. In January 2011, the SBA removed the 90-day recourse period from the standard secondary-market agreement, allowing banks to recognize the income when the sale occurs.
As seen in figure 13, the secondary market for SBA 7(a) loans experienced a great deal of volatility over the past five years. Prior to September 2008, an average of $328 million settled in the secondary market each month. Between October 2008 and May 2009, less than $200 million settled each month. By mid-2009, average monthly settlements had returned to their previous levels. Settlements rose again throughout 2011, reflecting the record-high dollar volume of 7(a) loans approved with the increased funding from ARRA and the Small Business Jobs Act.
A similar pattern can be seen in looking at pricing premiums over this period. Because the guaranteed portion of the 7(a) loan is secured by the full faith and credit of the U.S. government, the loan is generally sold at a significant premium. During the peak of the crisis, a large fraction of the loans that were able to be resold in the secondary markets were sold at premiums at or below 103. By December 2009, the majority of loans were sold at or above a premium of 106--the prevailing premium level in 2007. Into 2010 and 2011, a growing portion of loans were being sold at or above a premium of 110, indicating investors' preference for a relatively low-risk asset.
Looking forward, the secondary market for 7(a) SBA loans appears to be healthy and operating well. With no programmatic changes in the foreseeable future, the market should continue to move along smoothly at current levels.
SBA 504 Loans
The other large loan program from the SBA is the 504 program, which primarily finances real estate. As noted earlier, 504 loans are typically funded through a combination of funds from a private lending institution, the SBA CDC, and the business owner. CDCs assist small business borrowers in preparing and submitting the SBA 504 loan applications. The debentures are packaged with other debentures into a national pool and sold monthly to investors. As the traditional markets become more volatile, the demand for these safe investments generally increases.
As a provision of ARRA, a new program was created to encourage sales into the secondary market of the "first mortgage" portion of 504 loans. Under the new program, portions of eligible 504 first mortgages pooled by originators or broker-dealers could be sold with an SBA guarantee to third-party investors in the secondary market. Lenders will retain at least 15 percent of each individual loan, pool originators will assume 5 percent of the risk, and the SBA will guarantee the remaining 80 percent. To be eligible to be included in a pool, the first mortgage must be associated with a 504 loan disbursed on or after February 17, 2009.
As seen in panel C of figure 13, the secondary volume for 504 debentures dropped off significantly in late 2008. It remained relatively flat throughout 2009 and 2010. Since 2011, it has been rapidly climbing but has not yet reached its peak level of 2007-08. With the first mortgage program, volumes are likely to increase throughout 2012 and then level out going forward.
With the bankruptcy of Lehman Brothers and Ciena Capital, new issuance of small business ABS not backed by an SBA guarantee has been quite limited since 2008. In its latest outlook for the small business loans ABS market, Moody's Investors Service forecasts that securitizations of these assets will remain "stressed" throughout 2012.77
Personal Wealth and New Business Formation
There is always a high degree of churning in the small business population, with firms going in and out of business. However, during the recent period, the rate of new business formation has declined. What has caused the lack of activity is not clear. There has been much speculation that the decline in home prices--and consequently home equity--has constrained potential entrepreneurs' ability to finance a new business. However, existing business owners consistently report that lack of demand and economic uncertainty are the largest problems facing their business in recent periods, not access to capital.78 The lack of demand, increased uncertainty, or both could have caused fewer business ideas to have a positive expected value and thus fewer businesses to be formed.
From a practical perspective, when starting a small business, entrepreneurs are faced with certain difficulties in obtaining the initial funding. Due to the informational opacity surrounding young small businesses, obtaining start-up capital is often difficult. Without existing financial records for the firm, new businesses are generally not able to secure funding through traditional sources, and owners must often rely on personal savings and assets. It is difficult to obtain financial information from existing small businesses, but exponentially more so to get such information from businesses that were never established.
The financial history and resources of existing owners becomes the only real source of credit information. Assuming that potential business owners are similar to existing owners, a small amount of data does exist. These data provide some evidence of the importance of personal wealth for start-ups. According to the Census Bureau's 2007 Survey of Business Owners, 62.0 percent of employer business owners reported tapping into their personal savings to start their businesses, and 8.3 percent reported using a home equity loan taken out against their personal residences (table 22). Among the most recently formed firms, personal savings and home equity were even more important, with 67.1 percent of firms using personal assets or savings and 12.4 percent using a home equity loan.
To get a sense of how this reliance of new business owners on personal wealth and home equity played out over the recent period, figure 14 looks at the number of establishment births relative to overall home prices. As home prices increased, the number of establishments born in each period increased slightly. As home prices started to decrease, the number of establishments born each period decreased rapidly. While the data indicate that there is a positive relationship between housing wealth and business formation, it is not possible to determine the extent to which home price declines caused fewer businesses to be formed, as there are many other factors at play. However, it does seem likely that the home price declines had some effect on the level of firms established over the recent period.
|Source of start-up capital||Year business formed|
|Before 1980||1980 to 1989||1990 to 1999||2000 to 2002||2003||2004||2005||2006||2007||All firms|
|Personal/family savings of owner(s)||49.4||63.0||66.3||67.0||67.9||68.3||67.9||67.0||67.1||62.0|
|Personal/family assets other than savings of owner(s)||7.9||8.6||9.9||10.5||11.9||11.3||12.0||11.6||11.7||9.7|
|Personal/family home equity loan||4.7||6.0||7.6||10.0||12.6||12.9||14.0||13.6||12.4||8.3|
|Personal/business credit card(s)||2.9||6.6||11.9||15.3||17.3||16.1||17.1||17.0||16.5||10.5|
|Business loan from federal, state, or local government||1.3||1.2||1.3||1.4||1.4||1.3||1.5||1.2||1.3||1.3|
|Government-guaranteed business loan from a bank or financial institution||1.3||1.2||1.6||1.7||1.9||1.7||1.7||1.7||1.9||1.5|
|Business loan from a bank or financial institution||21.2||20.1||18.4||17.9||17.8||16.9||17.2||17.4||18.1||19.0|
|Business loan/investment from family/friends||5.5||4.5||4.4||4.5||4.6||4.7||4.9||4.7||4.9||4.8|
|Investment by venture capitalist(s)||.4||.5||.7||1.0||.9||1.1||1.1||1.4||1.3||.7|
|Other source(s) of capital||4.2||2.9||3.3||3.7||3.8||3.9||4.0||4.5||5.2||3.7|
Note: Totals may sum to more than 100 because firms could indicate that multiple sources were used to start the firm.
† Estimate is withheld due to insufficient cell sizes.
Source: U.S. Census Bureau, special tabulation of the 2007 Survey of Business Owners.
64. For census tracts in an MSA, the MSA would be considered the broader area. For census tracts outside of an MSA, all non-MSA counties within the same state would be considered the broader area. Return to text
65. For credit cards and lines of credit in the CRA data, banks report new and renewed line sizes (the maximum amount of available credit) as the amount originated. More details on CRA reporting requirements and standards are available on the Federal Financial Institutions Examination Council's website at www.ffiec.gov/cra/default.htm. Return to text
66. One example is FIA Card Services, which is a subsidiary of Bank of America Corporation and specializes in credit card issuance for the Bank of America organization. Return to text
67. It is important to keep in mind that the CRA data exclude a large number of smaller banks that may account for a significant number of loans, and therefore the share of lending attributed to the top 10 organizations is overstated in the CRA data. Return to text
68. As a special provision of the American Recovery and Reinvestment Act of 2009, guarantees were temporarily increased. Return to text
69. More information on implementing ARRA is available on the SBA's website at http://archive.sba.gov/recovery/REC_LEARN_PROGRAMS.html. Return to text
70. Additional details are in Mandelbaum (various years). Return to text
72. For more details on the Small Business Lending Fund, see the Treasury Department's website, www.treasury.gov/resource-center/sb-programs/Pages/Small-Business-Lending-Fund.aspx. Return to text
73. More information on traditional and nontraditional financing sources can be found earlier in this report in the section "Providers of Credit to Small Businesses." Return to text
74. As previously mentioned, Call Reports do not provide information on loans by the size of the firm but rather by the size of the initial loan; loans with original values of less than $1 million are used as a proxy for small business lending. Information by the original size of the loan was available only yearly until 2010, at which time it became available every quarter. Return to text
75. Although credit scoring has the potential to increase the uniformity of underwriting procedures and standards for small business loans, thereby expanding access to secondary markets, Cowan and Cowan (2006, p. viii) report that "there is no indication of any momentum in the development of secondary markets for small business loans." Their survey finds that respondents generally did not view secondary-market sales as an important reason for adopting small business credit scoring. Return to text
77. For more information on Moody's forecast, see Moody's Investors Service (2012). Return to text
78. For example, see Dennis (2011) and Dennis (2012). Return to text