(Updates the number of banks in the fourth paragraph.)
During his last State of the Union, President Barack Obama trumpeted a new $30 billion fund designed to boost small business lending. At the time outstanding loans to small businesses had declined 5 percent, or nearly $36 billion, since 2008, according to data from bank regulatory filings known as call reports. They continued to drop through the first three quarters of 2010 by another 4 percent, some $30 billion.
Now the money from the Small Business Lending Fund is about to start flowing, with investments expected to be made in the first quarter, according to Jason Tepperman, the Treasury program's director. The fund offers community banks capital that becomes cheaper as they increase their lending to small businesses. Tepperman won't say how many applications Treasury has received since it started accepting them in December 2010, although he said he was "pleasantly surprised" by how strong the response was. Banks have through the end of March to apply, and the Treasury will award funds on a rolling basis.
Although Congressional summaries suggested banks would lend out $10 for every dollar in new capital they received—meaning the $30 billion in the fund would result in $300 billion in new loans—Treasury officials declined to estimate how much the program would actually increase small business lending. Such observers as attorney Chris Jones, a partner who advises banks at Stinson Morrison Hecker in Kansas City, Mo., doubts the result will be that much. "The loan demand [from small businesses] has to be there for it to work," he says. Jones also suggests the program could encourage banks to make bad loans. "What got us into this mess to begin with was creating demand where it didn't exist." Still, Jones says the fund may be a good idea for banks that need more capital to make loans to healthy borrowers.
Refinancing TARP Capital
Banks with assets of less than $10 billion are eligible to apply for the Small Business Lending Fund. (Such institutions number about 7,000, although those that regulators consider "troubled" are disqualified.) Among banks eligible to apply are 473 that currently hold government money from the Troubled Asset Relief Program, according to the Treasury. "For institutions that have an interest in increasing their small business lending, they're likely to find this an attractive opportunity to refinance" TARP capital, says Tepperman. Banks generally pay Treasury an annual dividend of 5 percent for TARP investments (which take the form of preferred shares in the banks). Increasing small business lending even 2.5 percent would lower that cost under the new program.
Paul Merski, chief economist with the Independent Community Bankers of America trade group, expects banks will want to replace their TARP funds with lower-cost capital that they can hold on to longer—up to 4.5 years from the date of investment—without penalties. "It actually extends out your terms," Merski says. He estimates that about 100 banks, not all TARP recipients, have applied for the Small Business Lending Fund.
Rusty Cloutier, chief executive of MidSouth Bank (MSL) in Lafayette, La., is seeking $20 million from the fund to replace earlier government capital his bank took through TARP in 2009. He estimates MidSouth, which has 35 branches in southern Louisiana and Texas, would need to make $32 million in new small business loans to lower the dividend he must pay the government to 1 percent, from 5 percent now.
Knocking Capital Costs Down
"If we make these loans, we're talking $800,000 on the bottom line" that the bank would save by lowering the dividend from $1 million annually to $200,000, Cloutier says. Although publicly traded MidSouth could raise capital by issuing more common stock, Cloutier says, the 1 percent interest rate on government funds, which would take the form of preferred stock, is more attractive.
Banks that increase their small business lending will have their interest reduced from 5 percent to as low as 1 percent. Banks that don't boost lending at all will see their interest rates on SBLF capital rise to 7 percent after 2.5 years. After 4.5 years, the cost will jump to 9 percent for all SBLF recipients, an incentive for banks to exit the program before then. Business loans that qualify include loans up to $10 million to companies with $50 million or less in annual revenue. Loans that are guaranteed by the Small Business Administration do not count.
Ronald D. Paul, CEO of Eagle Bank (EGBN) in Bethesda, Md., says his bank is considering replacing the $23 million in TARP funds it holds with capital from the new program. "We've chosen not to pay off TARP, not because we couldn't, but because we thought that it's a cheap source of capital," he says. Based on the amount Eagle has already increased small business lending, he says, "we would qualify for a very, very low interest rate."