Letter to SBA re: Express Loan Programs & Affiliation Standards

Dear Administrator McMahon:

The American Bankers Association wishes to express our appreciation for the ability tocomment on the proposed rule issued by the U.S. Small Business Administration (SBA) thatseeks to amend several regulations concerning its business loan programs.

Small businesses are an engine of growth and job creation for the U.S. economy and they requiresafe and reliable funding. The SBA loan programs are an important part of business lending formany banks. These programs help fill a critical gap, particularly for early stage businesses thatneed access to longer-term loans. The guarantee helps reduce the risk and capital required forbanks and facilitates loans that might never have been made without this important level ofsupport.

Preserving ongoing, cost effective, and easily accessible government guaranteed loan programsfor small businesses remains a top priority of ABA. As part of our ongoing mission, this letterfocuses on four areas of concern with this proposed rule, which, if left unchanged, will causeunintended and significant harm to small businesses across the country.

This letter focuses on four critical issues in the proposed rule:

• Credit Elsewhere and Personal Resources;
• Permissible Fees;
• Reforms to Affiliation Principles.

If SBA fails to make changes to these areas of the proposed rule, we will see a reduction inaccess to capital for those small businesses that need it most, and an overall decrease ineconomic growth.

Credit Elsewhere and Personal Resources

ABA urges the SBA to reconsider its proposed revisions to the personal resource test due to thesignificant additional expense to the lender to comply, while providing potentially littleadditional assurance with the SBA regarding personal resources. These proposed changes willlikely make the loan program less attractive to borrowers, thereby eliminating those most in needof an SBA loan from taking advantage of the programs.

Under the proposed rule, the SBA expands the definition of the personal resources test to requirelenders to “analyze the resources of individuals and entities that own 20 percent or more of theApplicant business in order to determine if any of the owners have liquid assets available thatcan provide some or all of the desired financing.” The addition of “entities” to the test creates anew, ambiguous standard that will be difficult for lenders to apply.

In addition to lenders’ concerns regarding the ambiguity or subjectivity to the inclusion of“entities” to the personal resource test, the new 20 percent threshold will also cause issues withtaking needed working capital out of other businesses, or in this case, entities with otheroperational concerns beyond just a loan application. Moreover, seasonal businesses or othertemporary high-liquidity events could distort the applicant’s/owner’s “normal” liquidity position.

Like other portions of this proposed rule, these changes will hurt the smallest borrowers themost. Those applicants seeking loans up to and including $350,000 will be frozen out of accessto capital as the change will add significant additional cost to the lender on a marginallyprofitable loan product. Simply put, many lenders in rural and small communities will no longerbe able to provide loans at the lowest threshold amounts.

ABA also objects to the inclusion of new language that requires every loan with an exception tothe personal resources test to be processed by the Loan Guaranty Processing Center (LGPC).This revision unnecessarily complicates the applicant’s experience and extends the originationprocess. Further, the SBA already has the ability to challenge a lender’s judgement in wrap-up.

For these reasons, ABA encourages the SBA to strike “entities,” reconsider the 20 percentthreshold, and remove the requirement that exceptions to the personal resources test go throughthe LGPC.

Permissible Fees

While there is some variance in views among ABA’s membership on permissible fees, theygenerally prefer free market solutions. The proposed rule fails to consider the complexity of atransaction, but instead just places an arbitrary threshold in place. Limiting agent fees as proposed will ultimately harm small businesses most in need of access to the SBA loanprograms.

Efforts to limit such fees inevitably result in the emergence of business models developed for thepurpose of finding ways to work around such limits. In this digital age, a simple internet searchcan put a potential borrower in direct contact with authorized SBA lenders. They can also contactlenders through the SBA’s lender match referral tool. However, if small business borrowersprefer to pay likely higher fees because of the benefits from using an Agent, the market shouldregulate the cost of these services – not the SBA.

If the SBA places an arbitrary limit on fees, it will prevent lenders from spending the necessaryresources to make small business loans. Fee caps make the low profitability that much smallerand makes offering loans below $350,000 that less attractive. This change in turn will drivelenders away from making these smaller dollar loans.

In addition to the cap on permissible fees, SBA’s elimination of the “two-master” rule isambiguous in intent. Loan service provider (LSPs) and lenders can provide different services anddifferent fees to a prospective borrower. Much like the cap on fees, elimination of this rule couldlead to a reduction in smaller loans being made because many community banks rely on agentsor other third parties to find small businesses in need of loans.

For the reasons stated above, ABA suggests the SBA reconsider its approach to capping fees aswell as its proposed elimination of the “two-master” rule. When taken together, these changeswill likely result in increased market uncertainty and decreased access to capital for smallbusinesses, particularly those seeking loans of $350,000 or below.

Lender Responsibility When Purchasing 7(a) Loans from the Federal Deposit InsuranceCorporation (FDIC)

ABA has concerns with SBA’s proposal to revise the section pertaining to lender responsibilitywhen purchasing 7(a) loans from the Federal Deposit Insurance Corporation (FDIC). As written,this change may preclude the SBA from entering into agreements with the FDIC with respect toloan sales or whole bank transfers to affirm the validity of the guarantee at the time of such loansales or transfers. The current language is satisfactory for a typical transaction between a willingSBA-authorized buyer and a going-concern seller. An FDIC-directed loan sale or whole banktransfer is another matter entirely, and rather than creating the perception that most of the loanswill continue to have a valid guarantee, this proposed change would create in the minds ofqualified purchasers a presumption that a large number of guarantees will be denied.

This proposed revision would create a strong disincentive for qualified SBA lenders to enter intosuch transactions and would likely create greater losses to the SBA, and certainly to the FDIC.

For the reasons above, ABA requests that SBA make the necessary changes to this portion of theproposed rule to allow for the concept that notwithstanding the proposed language, the SBA and the FDIC may enter into agreements to preserve the validity of the guarantee on specific loansinvolved in loan sales or whole bank transfers.

Reforms to Affiliation Principles

ABA encourages SBA to withdraw its proposed reforms to the affiliation principles. Specifically,ABA has concerns with expanding the definition of “identity of interest,” and reinstating the“totality of the circumstances” test. If SBA implements these changes, they will have severe, andfar reaching impacts across several types of small businesses.

Expanding the Definition of Identity of Interest

Since 2016, the SBA has defined “identity of interest” as arising in instances where “closerelatives” have substantially identical or identical economic or business interests. This currentproposal seeks to expand this standard to include instances where individuals or firms that areeconomically dependent through contractual or other relationships. Additionally, the proposedexpansion would find affiliation in instances where a small business applicant derived 85% of itsrevenue from another business over the previous three fiscal yea When combining thesechanges, the small business borrower is left with a new reality where their ability to accesscapital is squeezed and lenders are faced with an uncertain marketplace.

One industry in which these proposed changes will have a crippling impact is agriculture. Due tothe current nature of small, family-owned poultry farming operations, SBA would likely be ableto find affiliation based upon the expansion of the “identity of interest” test. However, whenexamining the nature of many existing loans made to these types of farmers, they areindependently owned and operated businesses. These loans are necessary to provide small farmers as many opportunities as possible when financing their operations. If SBA expands the“identity of interest” test beyond its current scope, and ultimately prevents these farmers fromobtaining SBA-backed loans, we will see a decrease in access to capital as well as a significantblow to portions of our country’s agriculture economy.

While SBA has specifically gone out of its way to highlight poultry lending when discussing theexpanded definition of identity of interest, these changes will impact broad swaths of industriesand business relationships, finding affiliation where previously there had been none. Forexample, SBA could determine affiliation between a security firm and a management companythat owns and operates several office buildings. If the security firm derives 85% of its revenuefrom the management company, under the current proposal, the security firm would be deemed an affiliate and unable to qualify for an SBA loan. However, reaching this conclusion should beconsidered absurd as the security firm is its own independently operated business.

The example listed above is just one of many scenarios that can be envisioned in which SBAwould determine an affiliation and deprive a small business access to capital when it is mostneeded. Furthermore, the proposed rule fails to lay out adequate ground rules as to whenaffiliation can be determined. This lack of clarity creates too much uncertainty that couldpotentially drive many ABA members out of the marketplace for offering SBA loans.

Reinstating the Totality of the Circumstances Test

As part of the proposed rule, SBA suggests that it can utilize the totality of the circumstances testwhen considering whether to find an affiliation between businesses. Moreover, the rule statesthat in using this test, SBA may find an affiliation even though no single factor points to thattype of relationship. This type of broad analysis is too subjective and fails to create a bright lineby which lenders can determine whether the borrower is affiliated.

Not only is this test too vague, but the appeal procedure will also lead to a slowdown in theoverall financing process. The overall process will discourage small businesses from seekingadditional capital and it will make it harder for lenders to provide that capital.

For the reasons stated above, ABA requests that SBA withdraw this portion of the proposed rule.ABA encourages SBA to work with interested stakeholders to address concerns related to likelyunintended consequences to ensure continued access to capital for small businesses.

Conclusion

The SBA has always maintained its goal is to protect small businesses while encouraging thestrength of the overall economy.5 While this proposed rule is well intentioned, it falls short inseveral areas to uphold the SBA’s Mission Statement. Significant revisions must be made toensure continued access to capital for small businesses and consistent standards for our nation’slenders.

Thank you for your consideration. Please do not hesitate to contact us with any questions orrequests for further information.

Sincerely,

James C. Ballentine