On February 2, 2010, President Barack Obama outlined a proposal for a Small Business Lending Fund ("SBLF"), which is expected to support lending by banks with assets under $10 billion. Under the proposal, the SBLF will utilize $30 billion from the Troubled Asset Relief Program ("TARP") that was repaid by banks that participated in TARP to support lending to small businesses. In the wake of the President's proposal, on February 4, 2010, the federal financial institutions regulatory agencies and the state supervisors issued an Interagency Statement on Meeting the Needs of Creditworthy Small Business Borrowers (the "Interagency Statement"). The Interagency Statement represents efforts by regulatory agencies to encourage "prudent" small business lending by financial institutions and clarify standards regarding the same.
Small Business Lending Fund. Under the President's proposal, the SBLF is expected to be separate and distinct from TARP, which will not subject participants to TARP restrictions. Nonetheless, the proposal includes similar features to the U.S. Department of Treasury's ("Treasury") Capital Purchase Program ("CPP") launched under the Emergency Economic Stabilization Act, including that the $30 billion would be provided to qualifying banks in the form of additional capital injections. Dividend payments required on the investment would be smaller when compared with the Treasury's investments in financial institutions made under TARP. Certain details of the President's proposal include the following:
- Banks with less than $1 billion in assets would be eligible to receive capital investments up to 5% of their risk-weighted assets, while banks with between $1 billion and $10 billion in assets would be eligible to receive 3% of risk-weighted assets.
- Existing CPP participants would be able to convert the capital received from Treasury in the CPP to the SBLF.
- Initial dividend payments made by participants in the SBLF would be 5%, but could be reduced by one percentage point for each 2.5% increase in lending over a baseline determined using 2009 data.
- After five years, the dividend rate would be increased to encourage timely repayment.
- Banks will need to receive approval from their primary federal regulator in order to participate in the SBLF.
Although the White House released details on its proposal, it expects to discuss the specifics with Congress in the weeks ahead. The proposal did not include information on the type of instrument Treasury would receive in exchange for its investment, where the investment would be made (parent holding company or bank level), or whether financial institutions that have elected subchapter S corporation status would be eligible for participation. Creation of the SBLF and the transfer of funds from TARP will require approval of legislation by Congress.
Interagency Statement. In addition to confronting the economic downturn, financial institutions have faced tension between public statements from government officials and regulatory agencies regarding the need for banks to make more loans and the operational impact of increased regulatory criticism of loan portfolios and operations occurring during examinations. The Interagency Statement acknowledges the economic effects of excessive tightening of credit availability in small businesses and notes that the regulators are working to ensure that supervisory policies and actions do not inadvertently curtail availability of credit to sound small business borrowers.
According to the Interagency Statement, between June 20, 2008 and June 30, 2009, loans outstanding to small businesses and farms (as defined in the Consolidated Report of Condition) declined almost $14 billion, or 1.8 percent. The Interagency Statement outlines underwriting and risk management considerations to be taken into account by financial institutions in lending to small businesses. It also acknowledges that examiners are expected to take a "balanced approach" in assessing the adequacy of an institution's risk management procedures for small business lending. Specifically, the Interagency Statement notes that examiners will not adversely classify loans due solely to the decline in the collateral value below the loan balance, provided that the borrower has the willingness and ability to repay the loan according to "reasonable terms." The Interagency Statement also states that examiners won't classify loans due solely to a borrower's association with a particular industry or geographic area experiencing financial difficulties.
The Interagency Statement represents another step taken by regulatory agencies to minimize the impact of the economic downturn and its impact on banks. On October 30, 2009, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of Thrift Supervision and the FFIEC State Liason Committee jointly released a Policy Statement on Prudent Commercial Real Estate Loan Workouts. This policy statement, which was intended to promote supervisory consistency, enhance the transparency of commercial real estate workout transactions, and ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound borrowers, was released as many financial institutions faced increased criticisms from regulatory agencies based on Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk and Management Practices, which jointly issued by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation on December 12, 2006 (the "Joint CRE Guidance"). The Joint CRE Guidance, among other things, provides that banks with loans for construction, land development, and other land and loans secured by multifamily and nonfarm nonresidential property (excluding loans secured by owner-occupied properties) in an aggregate amount in excess of 300 percent or more of total capital, would be considered to have a commercial real estate concentration and should employ heightened risk management practices.
Although the SBLF and the Interagency Statement represent efforts to free up credit for small businesses, in order for the SBLF to be successful, we believe that it will be necessary to do the following:
- Treasury will need to make the capital investments available not just to so-called "healthy" banks as was the case with the CPP program, but also to banks that can demonstrate that they will become healthy by receiving the capital.
- Treasury will need to publish clear standards that must be met to qualify for the capital so that the process is much more transparent than that for the CPP.
- Regulatory agencies will need to moderate the currently harsh examination practices by bank examiners. Most of the banks that need capital have been downgraded by examiners, put under restrictive enforcement actions by the agencies and ordered to raise capital to levels substantially above those prescribed in current regulations. Capital for small banks with poor ratings and subject to enforcement actions is hard to come by and the SBLF could provide a material benefit to those banks.
While the specific terms of the SBLF have not been approved, we can hope that the Interagency Statement may signal that bank examiners will take a more meaningful account of the impact of enforcement actions in order to prevent curtailing the availability of credit to sound borrowers. Or it could represent the continuation of mixed regulatory and political signals creating uncertainty for financial institutions.
As financial institutions with less than $10 billion of assets take into account the impact of the Interagency Statement on their own short-term and long-term planning, they should be mindful of the status of the SBLF. To the extent that a final proposal regarding the SBLF eliminates uncertainties that have been associated with the CPP, the SBLF may provide a source of inexpensive capital. The SBLF may also present an opportunity for financial institutions that participated in the CPP to lower the cost of the capital previously received as well as eliminate the need to comply with the corresponding restrictions.