The Credit Solution

By Bizbox

New York Times columnist Joe Nocera's Anonymous Banker is back. When last we quoted this "small business banker and credit underwriter" at "one of the country’s biggest banks," he was angling for the government to direct its bailout dollars to the small community banks who can in turn lend it out to the small businesses in their communities. Naturally, we were highly sympathetic to this line of argument. And whether or not the Treasury Department reads Nocera's wonderful blog, they have taken limited steps to encourage smaller banks to apply for infusions of government capital.

Today, Anonymous Banker attempts to explain the precipitous drop in so-called 7(a) loans, the main credit program of the Small Business Administration. We reported on the drop here, noting that while the average loan size actually increased this year, the total amount loaned dropped 13%. Anonymous Banker's explanation for the drop is farily commonsensical, though it's nonetheless useful to hear it from him (and he is, according to Nocera, a him). AB's proposed solution, meanwhile, deserves wider airing.

Anonymous Banker's explanation for the drop is a combination of the SBA's own explanation, our explanation, and some important technical information.

The SBA pointed directly to the credit crisis (which has choked lending) and the generally poor economy (which has choked demand for loans). The news since this earlier announcement that we've been in a recession for a whole year now certainly only lends this explanation credence; and to be sure, AB doesn't rule it out.

Both Anonymous Banker and we have pointed to the combination of community banks not getting their share of federal funds and to the fact that the big banks who are getting those funds--and, lo and behold, the two biggest SBA lenders also happen to be the two biggest banks, Bank of America and JPMorgan Chase--are uniquely poorly suited to lending to small businesses. It is the community banks who are willing to look beyond impersonal numbers, credit scores, and the like and instead really to understand a small business's market niche and specific balance sheet when considering a loan application.

Finally, Anonymous Banker cites the specific dynamics of 7(a) loans as a reason why banks have cut back on them so starkly:
Interest rate ceiling. The upside of issuing an SBA loan, if you're a bank, is that you can get the SBA--possessing as it does the full faith and credit of the federal government--to guarantee between half and 90% of the loan amount. The downside is there's a loan ceiling: prime plus 2.75% in the event of loans greater than $50,000, according to AB. That's paltry compared to what banks can currently get for normal loans in this credit climate.
No fees. Well, there are fees: 7(a) borrowers pay them, and the SBA gets them. The banks simply don't get a cut. This seems like a poor idea if we're trying to encourage banks to make them voluntarily.
Bad for the books. The loans go on the banks' books until they are securitized. And you try securitizing SBA loans right now.
Bad loan protocol=no guarantee. If a loan defaults and it turns out that the bank had failed to take all the necessary steps--from documentation to auditing--then the SBA retroactively withdraws its guarantee. In theory, the solution is just for banks to do what they're supposed to do. But apparently that's asking too much?

Now, things should be slightly better after the SBA's relaxing of standards. The prime-plus-2.75% isn't required anymore; the more bank-friendly Libor may also be used. And securitizing the loans was made easier as well. But still, this is a daunting set of obstacles for banks to be facing, especially when we recall, again, that no bank is required to make any SBA loans in the first place.

So, in the immortal words of Lenin, what is to be done? Anonymous Banker essentially reiterates what he said last time: give the money--those billions and billions in taxpayer capital you've been hearing so much about--to the banks that are actually going to lend out to that Main Street you've been hearing so much about. That's the plan you've not been hearing enough about.

Except there's a subtle modification to AB's strategy. Whereas he previously wanted the money to go more to banks more likely to lend to small businesses, now it appears the dire situation has activated his big-government gene (we mean that in a good way) and he wants the money to go to banks who have pledged to loan x% of it to small businesses.

This, of course, is what we've been screaming out. The government has been asking banks nicely to extend credit to these businesses, when it should have been behaving like, y'know, a government, which gets to compel action if it sees fit do so.

The allocation idea is basically a slightly more free market version of Sen. Chuck Schumer's vague idea to loan "tens of billions" directly to small businesses through the SBA. We can live with that. What we can't live with is anything short of the government requiring increased lending to small businesses, as opposed to suggesting it meekly.

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December 2, 2008 2:01 PM