Is the Small Business Lending Fund Right For My Bank?
On December 21, 2010, the U.S. Treasury (“Treasury”) released the application form and instructions, preferred stock terms and other guidance on the $30 billion Small Business Lending Fund (“SBLF”). The goal of the SBLF is to stimulate small business lending by qualified community banks with assets of less than $10 billion. The SBLF was created, in part, to provide community banks access to Tier 1 capital that many have been unable to tap in recent years. Dividend rates for SBLF participants can be as low as 1%.
Most of you have already been overloaded with information on eligibility requirements, dividend rates and application procedures, so we are not regurgitating those to you here. The Treasury’s program website (available by clicking here) contains most of the specific business points you need; we have also embedded links to some of the core documents below. While the SBLF’s goals are admirable and the prospect of cheap capital is undeniably attractive, it is our view that banks should go beyond the terms and strategically consider whether participation is right for them. Having waded through many of the available details so you don’t have to, below are some issues your bank might consider before diving headfirst into SBLF.
Is the SBLF Right for My Bank?
- Small business lending exclusion of participations and guarantees. The Treasury’s interpretation of what constitutes small business lending is critical to your ability to obtain low dividend rates. Under SBLF, “qualified small business lending” includes loans of less than $10 million to borrowers with less than $50 million in revenues who fall in one of the following four categories: (1) commercial and industrial loans, (2) loans secured by owner-occupied nonfarm, nonresidential real estate, (3) loans to finance agricultural production and other loans to farmers and (4) loans secured by farmland. However, if any portion of the loan is guaranteed by the U.S. Government or if a third party has assumed an economic interest in any part of the loan, that portion is subtracted from the calculation of your bank’s small business lending and will not factor into your ability to obtain a reduced dividend rate. Keep this in mind as you compile your small business lending projections and estimate your future cost of capital.
- Dividend rates—they can increase too. One of the more publicized portions of the SBLF is the potential for dividend rates as low as 1%. For most banks, the initial dividend rate will be 5%, followed by 9 quarters of adjustments based upon the extent to which a bank’s small business lending increases—down to as low as 1% for banks that increase small business lending over 10% and to between 2% and 4% for many others. But remember that the dividend rate can increase as well. If a bank has not increased its small business lending after 8 quarters, the rate will increase to 7%. The dividend rate kicks up to 9% for all banks that have not repaid SBLF funds within 4.5 years from the date received (without regard to small business lending levels). In addition, TARP recipients who replace CPP with SBLF funds will be subject to an added 2% quarterly lending incentive fee if the bank’s small business lending has not increased in the 8th quarter after SBLF funding is received.
- What does the reduced Dividend Rate apply to? Less famous is that the potential lower dividend rates will only apply to the amount by which your bank’s small business lending has increased. For example, say a bank initially obtains a 5% dividend rate on $50 million in SBLF funds. The bank thereafter increases qualified lending by $10 million, representing a 5% increase over its small business lending baseline and decreasing its dividend rate from 5% to 3%. The 3% dividend rate, however, only applies to $10 million—the amount by which the bank’s small business lending increased—and the 5% rate continues to apply to the remaining $40 million.
- 90% Downstream Requirement and CPP Participants. Holding company recipients of SBLF funds are required to contribute at least 90% of the funds they receive to insured depository institution subsidiaries that originate the small business loans. At the same time, the Treasury appears to permit CPP participants to use SBLF funds to refinance CPP securities. However, the Treasury has not provided an exception for TARP recipients from the 90% downstream requirement; such recipients are still required to contribute 90% of SBLF funds received to subsidiary bank(s). Our expectation, and likely that of many bankers’, was that the SBLF funds could be used to refinance CPP and that CPP recipients would not be required to look beyond SBLF for funds to repay CPP (one clear rule is that participants in SBLF cannot have both CPP and SBLF securities outstanding). While that may be the Treasury’s intent, it is far from clear in the guidance released thus far. We have inquired with the Treasury on this point and will post on our blog when a definitive answer is provided.
- Dividend Restrictions. SBLF recipients may only make dividend payments or share repurchases if, after such repayment or repurchase, its Tier 1 capital is at least 90% of the amount existing at the time immediately after the closing date. After 2 years, the 90% requirement decreases by an amount equal to 10% of the bank’s SBLF funding for every 1% increase in small business lending over the baseline level. There are additional restrictions for recipients who miss dividend payments on their SBLF shares.
- Look Backs. The amount of your bank’s increase in small business lending is measured by your loans outstanding each quarter versus the average amount outstanding in the four quarters ending June 30, 2010. Thus, institutions that have increased qualified small business lending since then may already qualify for an initial dividend rate of less than 5%. For those institutions who will be required by Treasury to raise “matching” funds, they are allowed to include capital raises consummated after September 27, 2010.
- Is there an untapped market in Small Business Lending? As part of your application process, you will be required to submit a small business lending plan to your primary state and federal regulators. In connection with the SBLF, the FDIC recently issued guidance reminding SBLF participants that qualified small business loans must be made in accordance with safe and sound lending practices. Can you adequately grow your small business lending with creditworthy borrowers over the next two years? Is your primary regulator cautioning you about increasing agricultural lending? If your management does not foresee an opportunity in the small business lending markets, are the dividend rates still attractive? Will you be able to earn your way to a repayment in 4.5 years (when the dividend rate ticks up to 9% for all SBLF participants) or will you be required to hit the capital markets?
Please contact one of our financial services attorneys if you would like to consider in more detail whether the SBLF program is right for you, or if you otherwise have any questions on eligibility requirements, the application process or the terms of the program. Note that Treasury is still developing terms and guidance for mutuals, Subchapter S corporations and community development loan funds.
Relevant Treasury links regarding the SBLF program:
- Fact Sheet
- Comprehensive Getting-Started Guide for Banks
- Preferred Stock Terms
- CPP/CDCI Participant Preferred Stock Terms
- Application Form and Instructions
- Lending Plan Form and Instructions
- SBLF Information Line: 1-888-832-1147.
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