Systematic changes needed to fix broken loan program
Access to capital is vital to the success of small businesses. Without it, small business can’t grow in a way that helps them create or retain jobs, both of which are critical to the economic recovery of our state. Yet, providing small businesses with loans they can’t repay doesn’t help the business or the economy.
As executive director of Colorado Lending Source, a certified development company, I know hundreds of small business success stories and how loans have helped make those possible. I also am aware of the hazards associated with risky loans and have seen the destruction that results from them.
Certified development companies are nonprofit organizations set up to promote economic development within their communities. They work with the U.S. Small Business Administration (SBA) and private sector lenders to provide financing to small businesses. The SBA 504 loan program, which is designed to help small businesses finance the purchase of commercial real estate and major equipment, accounts for the majority of loans we provide.
There’s no question the SBA 504 loan program offers a valuable resource for small businesses. But that resource must be modernized to protect small businesses in this fragile economy.
The relatively low down payment requirements and fixed long-term rates bring these 504 loans within reach for businesses that might not be able to obtain other types of loans.
But a significant problem with the 504 loan program is that it does not include any provisions to discourage certified development companies from making loans to businesses that can’t realistically repay them.
Under the current system, certified development companies have nothing to lose by making bad loans. The SBA doesn’t hold them accountable in any way for the loans they make to companies that can’t pay them back. At no point are they required to prove that companies underwent in-depth loan review processes.
Furthermore, many certified development companies use commission-based salary structures for senior personnel. (Colorado Lending Source is probably one of the few in the nation that does not pay commissions to any of its employees — and yet still functions efficiently and effectively, contrary to the Wall Street perception you need to pay commissions to get the best people.)
If employees are paid based on their loan volume, basic economic theory would predict that many (if not most) certified development companies will process loans for short-term gains rather than making responsible long-term 504 loans.
The lack of accountability in the 504 loan program invites comparisons to the sub-prime mortgage loan packagers that helped precipitate the financial meltdown.
If we’ve learned anything from that experience, it’s that the model of taking no responsibility for loans made simply doesn’t work in today’s economy.
That is why Colorado Lending Source is committed to an in-depth review process of every loan it awards. But the 504 program isn’t structured in a way that requires all participating lenders to develop a thoughtful loan review process.
Because SBA 504 loans are primarily owner-user real estate loans, default rates have historically been relatively low. But in the current real estate and economic slump, this is no longer the case. Default rates have exceeded 9 percent and bad certified development loans have resulted in millions of dollars of losses for the SBA.
In the short term, this creates a burden for taxpayers. In the long term, it could result in higher fees for future users of the 504 loan program and those fees could, unless the practices cease, make the program a less attractive financing tool for small businesses in the years and decades to come.
It’s obvious to me the certified development company program is broken.
A simple fix could be congressional legislation that requires certified development companies who originate 504 loans to share some of the risk.
Not surprisingly, many industry groups oppose the idea of certified development companies being in any way shape or form financially responsible for the loans they make.
But times have changed.
The reality is we’ve all seen the havoc that lack of personal responsibility can create. Simply put, if certified development companies have skin in the game, they’ll make better loans. The benefit of this will trickle from small businesses to the nation as whole.
As we embark on the road to economic recovery, we have a perfect opportunity to improve our system and help small businesses succeed.