Senate Clears Way for $30 Billion Small Business Fund

Washington is poised to launch its most direct attempt to revive small business lending since the financial crisis with a plan to invest up to $30 billion of federal money in small banks and give them incentives to re-lend that money to Main Street companies.

The Small Business Lending Fund, outlined by President Obama in his State of the Union speech six months ago, cleared a key Senate vote to end debate July 22 as two Republicans broke with their caucus to support the measure.

The full bill, which includes business tax breaks and enhancements to Small Business Administration loan programs, could come to a vote as soon as July 27, according to Richard Carbo, spokesman for the Senate Committee on Small Business. The House passed a version June 18.

The fund would invest in small banks—those with less than $10 billion in assets—by purchasing preferred stock, which would pay the government a dividend of 5 percent. The cost of that money would decrease to a dividend as small as 1 percent if banks boost their small business loans over 2009 levels by 10 percent. For banks that do not increase their small business lending, the capital would become more expensive, with the dividend rising to 7 percent.

Bank lending to small businesses has dropped to $670 billion from $710 billion since 2008, according to data filed with regulators. Obama and Federal Reserve Chairman Ben Bernanke have connected the drop in small business credit to weak job growth and urged banks to increase the flow of loans to creditworthy businesses. “The formation and growth of small businesses depends critically on access to credit,” Bernanke told a forum on small business July 12. “Unfortunately, those businesses report that credit conditions remain very difficult.”

Banks say lending is down because fewer companies want to take on debt and fewer borrowers are good credit risks. “Loan demand has fallen dramatically since the start of the recession,” the American Bankers Association noted in a recent fact sheet. The lobby group supports the Small Business Lending Fund.

Analysts like Raj Date question whether the money will be effective, however. Date, a former managing director at Deutsche Bank who now runs the Washington research group Cambridge Winter Center, calls the program “well-intentioned” but says it won’t work as well as lawmakers claim. While the bill’s authors say the $30 billion in federal money invested in banks would spur $300 billion in private lending to businesses, Date estimates that the Small Business Lending Fund would support only $70 billion in new credit. Banks will use most of the money to cover losses on existing commercial real estate loans, he says.

“The amount of help is relatively small to the size of the problem,” he says in an interview with Bloomberg Businessweek. Date also says that taking government money will be most attractive to the banks in the most trouble. Originally conceived as a part of the Troubled Asset Relief Program, the Small Business Lending Fund was separated from TARP to avoid discouraging banks from participating because of restrictions and the stigma associated with the bailout.

Republicans opposed the measure on the grounds that it mirrors the Troubled Asset Relief Program and “injects capital into banks with no guarantees they will actually lend,” according to a policy statement. Senate Small Business Committee Chair Mary Landrieu (D-La.) said in a statement that the bill has strong protections for taxpayer money and is expected to raise $1.1 billion in dividend income over 10 years.

The bill includes other provisions intended to aid small businesses such as $11.7 billion in tax breaks on things like investing in new equipment or the sale of small business stock. The SBA provisions would increase the limits on government-guaranteed loans to $5 million from $2 million, and extend the reduced fees and higher guarantees passed last year in the stimulus bill. The law would also allow self-employed workers to fully write off their health insurance costs in 2010.

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New York Fed Survey Shows Credit Gap for Small Business

Small businesses in the New York area show “unabated demand” for loans and “widespread reports of unmet credit needs,” according to a new survey by the Federal Reserve Bank of New York. Of the 59 percent of businesses responding to the poll that applied for credit in the first half of 2010, only half got any loan approval at all, and three quarters said their full borrowing needs were not met. (The PDF of the report is available here.)

The online poll, which surveyed 426 small businesses in New York and neighboring states in June and July, adds some useful data points to what has become a central question of the recovery: Why has borrowing declined among small businesses? The volume of outstanding loans to small businesses has dropped by $45 billion, or about 6 percent, since 2008, according to data from bank regulatory filings.

The New York Fed survey suggests that the contraction isn’t driven by lack of demand from borrowers. Deteriorating business conditions for applicants may play a role. Two-thirds of business polled reported that their sales declined since 2008. Companies that successfully got credit tended to be more established, showed sales growth through the recession, or were able to use their profits to fund their businesses in 2008.

While the health of businesses influenced whether or not they succeeded in getting loans, it didn’t influence whether or not they applied for credit. “High sales performers and businesses that were having either stagnant sales or declining sales applied at roughly similar rates,” says Claire Kramer, a senior analyst at the New York Fed’s Community Affairs group, who co-authored the report. That finding, the report says, “casts doubt on suggestions that smaller, younger, financially weakened, or underperforming firms are drivers of credit demand.”

The forms of credit with the highest approval rates were financing for vehicles and equipment (63 percent of applicants were approved) and personal credit cards (46 percent approved). The forms that were approved least often were applications for business loans (20 percent approved) and new business credit lines (27 percent approved). Companies that had obtained credit successfully in 2008 were not any more likely to be approved, the survey found.

The survey concludes that the “second look” reviews that some banks have started, along with technical assistance for businesses, could help more applicants become viable borrowers.

The New York Fed’s findings about credit demand contradict other survey evidence, including from the National Federation of Independent Business, that suggests lending is down because businesses don’t want to borrow. The NFIB’s latest monthly member survey said that 91 percent of respondents reported that their credit needs were met, including 53 percent that were not interested in borrowing.

The survey, along with an earlier one from the Atlanta Fed, adds to the limited set of data about small business lending. The New York Fed plans to release a second report based on the same data in early 2011, and similar surveys are planned by other Federal Reserve Banks, including Boston and Cleveland, says Jeffrey Smith, a spokesman for the New York Fed.

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Fed: Small Business Credit Card Reform Not Worth Costs

Giving small businesses the same credit card protections that consumers now have is not worth the potentially higher costs and reduced credit, the Federal Reserve Board said in a report issued late last week.

Small businesses typically have higher credit lines than consumers, and it’s harder for banks to evaluate the risk of business borrowers, the Fed report said, so restricting banks’ ability to raise interest rates could mean higher costs and tighter credit up front:

[C]redit card issuers have more difficulty assessing the creditworthiness of small businesses than consumers. Therefore, the willingness of issuers to extend the relatively large credit card lines that small businesses require may depend importantly on issuers’ ability to adjust prices in the future, as they learn through experience about businesses’ ability and willingness to pay. Restricting the ability of card issuers to adjust interest rates may lead to higher initial interest rates, which would harm those firms that borrow on small business credit cards.

The report was due to Congress May 22 as part of the CARD Act, the consumer protection law passed last year. The CARD Act limits some practices by credit card companies most criticized by consumer advocates, like raising interest rates on existing balances and applying payments in a way that maximizes interest costs to the borrower. Those changes do not apply to small business credit cards, which account for about 15 percent of payment card spending, according to an estimate by Ken Paterson of research firm Mercator Advisory Group.

Bank lobbyists praised the Fed report. The American Bankers Association opposed the original credit card reform, warning that parts of the law “will undermine the availability of credit.”

Still, it’s not clear how much restricting banks’ ability to raise rates on old balances will curtail credit. Bank of America announced in April that it would voluntarily give small business cards the protections extended to consumers under the CARD Act. The bank doesn’t expect the change to hurt its ability to extend credit, spokeswoman Betty Reiss told me in April.

There’s some evidence small businesses could benefit from a ban on retroactive rate hikes. Advanta, the now-bankrupt credit card lender which once had 1.3 million small business customers, last year settled with regulators over accusations of “unfair and deceptive practices” involving repricing balances. That settlement affected at least 138,000 borrowers who signed up for cards at low interest rates that later jumped after they had run up balances. Some of them are still paying off charges at APRs over 30 percent.

Some more useful context from the Fed report: Most small businesses pay their cards off each month, rather than using them as a source of credit. Only 18 percent of firms with fewer than 50 employees carried a monthly balance on their credit cards in 2009, the report says (citing a survey by the NFIB). That’s about the same as in 1998, and less than the 23.6 percent that borrowed on credit cards in 2003, according to Fed surveys. The share of business owners that carry a balance on small business credit cards (rather than personal cards) has more than doubled from 5.9 percent to 12.3 percent since 1998, the report says.

Still, the Fed doesn’t recommend giving that growing share of business card borrowers the same protections consumers got through the CARD Act.

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