A potential crunch in SBA loans - Small Business Administration

Nation's Business,  August, 1993  by Jesse H. Sweet

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Five years ago, Douglas Myron patented an energy-saving electronic device to turn office lights on when people enter and off when they leave. But before his employer could launch the product, the company went bankrupt, leaving Myron with an idea and no capital.

Today, Myron's fortunes are reversed. He is the founder and president of MyTech, an Austin, Texas, firm that has become the largest domestic manufacturer of "occupancy sensor" devices. Over the past five years, MyTech has grown by a re- markable 850 percent, with annual sales now exceeding $1.5 million.

Myron, whose company now has 25 employees and plans to hire 20 more over the next 12 months, made the transition from capital-starved inventor to successful business owner with the help of four separate bank loans backed by the Small Business Administration (SBA); they ranged from $60,000 to $235,000. While banks issue such loans, the SBA pays off most of the unpaid balance in the event of default.

"Without the SBA [loan guarantee], we would not be in business today," says Myron. The same could be said for many of the 22,460 small businesses granted a total of $5.6 billion in SBA-guaranteed loans last year.

But proposed changes in SBA's General Business Guaranty loan program-- also known as the 7(a) program--would make it more difficult for small-business owners like Myron to obtain similar loans in the future, according to bankers who issue such loans.

Most controversial is the SBA's proposal to cut the average amount of a bad loan it would cover to 75 percent from 81 percent, in effect forcing banks to tighten their standards for approving loans. The SBA calculates that this proposal would translate into fewer loan defaults, saving the agency $102 million in fiscal 1994.

"Requiring lenders to assume a greater share of the risk will increase their scrutiny of potential borrowers, thereby reducing the default rate," said SBA Administrator Erskine Bowles during a recent Senate subcommittee heating on the agency's budget.

John Shivers, president of the Independent Bankers Association of America, a Washington, D.C., group that represents small, community banks, told a House subcommittee that tougher standards would do more harm than good. "The practical effect of the change in the guarantee levels would be to drive [those] deserving credits out of the SBA system altogether," he said.

Shivers warned that tighter credit for small businesses would mean fewer new jobs because small firms are the primary source of job growth in the U.S. economy.

In addition to tougher credit standards, the SBA wants, to charge a new fee to investors who purchase bundles of 7(a) loans from banks. The proposed 0.5 percent annual fee on the outstanding loan balance would generate a projected $67 million in 1994, money that would be plowed back into the 7(a) program.

Bowles acknowledged that the tougher loan standards and the new fee would make the 7(a) program slightly less attractive to bankers. But he insisted that 7(a) would not suffer a decline in its ability to meet small-business loan demand.

The 7(a) program is designed to make capital available to small firms whose loan applications have been denied by at least two banks. Bankers like the program because the SBA assumes most of the risk for loan defaults, which accounted for 2.5 percent of all loans in 1992.

The program has been so popular over the past two years that Congress has been forced to make supplemental appropriations to prevent it from running out of money.

In fiscal 1992, Congress initially appropriated $198 million for the 7(a) program. When the program ran out of money, Congress approved an additional $94 million.

In the current fiscal year, which began Oct. 1, the program's $197.9 million appropriation was depleted by late April. A supplemental appropriation of $175 million was approved by the Senate in early July, which will enable the program to guarantee $6.8 billion in loans this year.

For fiscal 1994, the SBA has asked for only $154.8 million, $43.1 million less than its initial fiscal 1993 appropriation, yet it estimates total loan volume of $6.6 billion. Reaching this goal would require $169 million in combined savings and new revenue from the pending program changes in addition to its funding request.

The proposed changes received lukewarm approval from lawmakers at recent congressional hearings, but no votes were taken. At a Senate Appropriations subcommittee hearing, Sen. Dale Bumpers, D-Ark., expressed concern that tougher loan standards would cause banks to make fewer loans to small firms that need the money, and in turn there would be a ripple effect in the economy. "When it comes to job creation," he said, "there's nothing like the 7(a) program."

But even opponents of the changes concede that the proposals will probably win approval when Congress acts on the federal budget for fiscal 1994.

Says Shivers, who believes the proposals will pass: "This is going to work a hardship against new start-up businesses. They're probably going to have the door shut on them."