More Funding For Small Business Loan Programs – A Dysfunctional SystemAugust 23, 2011 | By: Sean Murray
Posted on March 24, 2011 at 11:19 PM There’s only one way a bank would ever lend a small business money, and that’s if somebody covers all the losses. As part of the Small Business Jobs Act, two states were just recently notified that they are the lucky recipients of $26.5 Million. It wasn’t so much luck as it was earned. The Federal Government issued all 50 states a serious challenge to come up with a plan to turn $1 of investment into $10 worth of new lending. The winners would receive millions in funding.
There’s only one way a bank would ever lend a small business money, and that’s if somebody covers all the losses. As part of the Small Business Jobs Act, two states were just recently notified that they are the lucky recipients of $26.5 Million. It wasn’t so much luck as it was earned. The Federal Government issued all 50 states a serious challenge to come up with a plan to turn $1 of investment into $10 worth of new lending. The winners would receive millions in funding.
So let’s hear it for Vermont and Connecticut for their outstanding proposals! It took the greatest financial minds of our time to put them together. Their systems to spur lending are so genius that you…will…not…believe…it…
Vermont and Connecticut will make more loans so long as…. the Government will pay for all the defaulted ones!
Yes, according to an article on CNN, their plan is to direct the $26.5 Million into loan portfolio insurance entities. That will allow banks to lend more because they are insured against more losses. While we guess it seems logical (hey if these states can get away with it, why not?), it doesn’t confront any actual issues as to why banks aren’t lending in the first place. It also delays an inevitable bursting bubble of business lending. That’s right, the small business lending market is actually overheating. Remember where you heard it first.
The Small Business Administration is already protecting banks against defaults on over $80 Billion worth of business loans. That means that the entire business lending market is inflated and market interest rates do not actually reflect what is profitable or fair. If the government is ready to absorb all the losses, then 2% over prime does not factor in any risk of default, just an acceptable rate of profit for the banks. There’s a secret formula for how to structure a profitable deal when there is no one there to cover the losses, and it’s called a Merchant Cash Advance(MCA). The entire MCA industry represents what is fair and sustainable but that’s a discussion we’ve had before.
Our point is that the Federal Government can’t hand out free money forever and expect for the system to at some point start working on its own. One wonders if the Merchant Cash Advance Resource should apply for government funding. We have a very good way to spur bank lending and our plan is so genius, you might think we stole it from aliens in the future.
How to Spur Lending – By the Merchant Cash Advance Resource:
1. Place business owners in credit rebuilding programs and educate them on credit’s importance. Too many business owners have poor credit. Whether the result of a partnership gone sour, a divorce, a crisis, a recession, employee theft, identity theft, bad bookkeeping, medical reasons, or pure defiance, bank underwriters do not have the discretion to approve a loan if the score is not at a certain level. All business owners should have protections like LifeLock and be constantly tuned into their score by using a cheap program like CreditKeeper. Better credit implies greater financial responsibility. That creates more qualified borrowers at the bank and more loans for all!
2. Educate business owners on basic accounting techniques. Too many shopkeepers are quick to hand over their bills and receipts to an accountant to manage the finances. We understand that in smaller businesses, the owner may also be the head chef or auto mechanic and therefore not much time or consideration can be given to the books. That is no excuse to be removed from the finances of the business. We asked a few banker and MCA underwriting friends of ours to find out how savvy applicants were with financial statements. Of all the applicants that prepared a Balance Sheet on their own, not one of them in the past 3 years had ever done it correctly. In an unreasonably high percentage of cases, their accountants could not do them correctly either. If the owner of the business is busy in the kitchen and the accountant is asleep at the wheel, then how can any bank expect to see better results with their funds and lower default rates? With a better understanding of accounting and financial principles, businesses will be more qualified for a loan and more aptly prepared to grow.
3. Allow banks to charge more than 2.25% above Prime. For 7(a) SBA Loans, the maximum allowable interest rate is 2.25% over the Prime rate. The Prime rate is currently 3.25%, creating a maximum allowable rate of 5.5% APR. Keep in mind this rate is only available because of an 80-90% default guaranty. If Bank A approves a client under the 7(a) program at 5.5%, how can Bank B compete if there is no guaranty against losses? There is no competition because guaranties are artificially killing the market. Remove the guaranty, save the government $80 Billion in waste, and let banks compete against eachother at rates that are actually sustainable. As soon as the Government stops handicapping the fight, banks will be able to lend more. Government handouts to loan portfolio insurance companies and the SBA actually do more to kill business lending than they do to grow it.
4. Promote alternative financing structures. Sometime back in the caveman era, loans were invented by having the borrower make monthly payments to the lender. Over several thousand years, banks are still…. having the borrower make monthly payments to the lender. If you take a stodgy one dimensional system and try to apply it to all small businesses in the country, nothing is likely to be spurred any time soon. There is a reason why the MCA industry is able to finance businesses with lower credit and do so with a lower default rate than banks;They innovated. By automatically withholding a percentage of each credit/debit card sale the business generates, multitudes of risk are eliminated. Lower risk, more funding.
These 4 steps were brainstormed in about 7 minutes. We hope Connecticut and Vermont took some good notes. Until we address the issue, the lending market will remain drunk on handouts. Drunk you might say on Government juice… a drink that comes Shaken, Not Spurred.
– The Merchant Cash Advance ResourceLast modified: February 21, 2013
Sean Murray is the founder of deBanked, an 11-year veteran of the merchant cash advance industry, a casual Lending Club and Prosper note investor, the co-founder of Daily Funder, an alternative lending speaker, consultant, writer, and enthusiast. Connect with me on LinkedIn or follow me on twitter.