July 6, 2010
Authored by: Barry Hester and Bryan Cave
On June 29, 2010, the Senate voted to commence debate on the Small Business Jobs and Credit Act of 2010, a bill passed by the House on June 17, 2010 which includes a $30 billion fund for small business lending through the provision of capital to community banks. This legislation would implement the program described in President Obama’s State of the Union address earlier this year. Obama has promoted the program by saying that it “takes money repaid by Wall Street banks to provide capital for community banks on Main Street” that can in turn help small businesses create jobs. In the latest version of the bill presented to the Senate, certain banks with less than $10 billion in assets would be eligible for government infusions of capital, dividend payments on which would decrease with increasing levels of small business lending. Banks are also generally permitted to use this capital to refinance existing TARP obligations. The substitute amendment currently before the Senate cuts out a provision of the House bill to permit eligible banks to amortize recent real estate loan losses over as many as 10 years.
The original Obama proposal called on Congress to transfer TARP money to create the fund, but the fund has evolved as a completely separate initiative. Acknowledging this possible confusion, Section 3111(a) of the bill specifically provides that the fund “is established as separate and distinct from the Troubled Asset Relief Program established by the Emergency Economic Stabilization Act of 2008” and that an institution “shall not, by virtue of a capital investment under the Small Business Lending Fund Program, be considered a recipient of the Troubled Asset Relief Program.” Proponents continue the political battle to detach this potentially negative association from a bill that would target recovery on Main Street.
The Small Business Lending Fund
Title III of the bill currently before the Senate establishes the fund and authorizes the government to make up to $30 billion in capital investments into eligible institutions. These investments would be similar to TARP infusions but would not result in executive compensation and other restrictions. Banks up to $10 billion in assets would generally be eligible to apply for funding. However, the Small Business Lending Fund will not be a source of capital for the banks most in need of additional capital. Banks on the FDIC’s Troubled Bank List (generally those with composite CAMELS ratings of 4 or 5) would be ineligible to participate. As with the Capital Purchase Program, the program is designed to provide assistance to otherwise healthy institutions. Each institution’s primary federal banking regulator will continue to have a significant say in whether the institution should receive any funds under the Small Business Lending Fund.
The investment vehicles, which could take the form of preferred stock, equity equivalent capital or debt, would have a ten-year repayment schedule and carry interest, an element proponents say will lead to taxpayer profit in the long run. To incentivize the use of this capital for small business lending, the dividend payments owed to the government on its investment would decrease with increasing use of the funds for such purposes. Specifically, Section 3103(d)(4)(A) of the bill provides for an adjustment to the payable dividend rate within the first two years of the government’s investment from an initial 5 percent to as little as 1 percent. That decrease would be triggered by a 10% or more increase in the bank’s small business lending during that period. Smaller, incremental reductions are also contemplated. Changes would be measured against the bank’s average amount of “small business lending” during the four quarters immediately prior to the bill’s enactment, minus adjustments for small business loan chargeoffs and gains due to merger, acquisition, or purchase. Under the bill, “small business lending” generally includes all commercial, industrial, and agricultural loans for less than $10 million except any loan to a business with more than $50 million in revenues.
Institutions with less than $1 billion in assets would be limited to a capital infusion not greater than 5 percent of risk-weighted assets, less any TARP investment. The cap would be 3 percent, less TARP funds, for the larger eligible banks ($1-10 billion). Holding company limits would be based on consolidated asset totals. Any funds could generally be used to refinance existing TARP investments, however (i) TARP recipients that are now on the Troubled Bank list would not be eligible for funds, and (ii) TARP recipients are not permitted to refinance if they have missed more than one dividend payment due under the CPP.
Loss Amortization Under the House Bill
Under the version of the bill passed in the House, “eligible” institutions would also be permitted to amortize losses and write-downs. Accordingly, the capital hits resulting from losses and write-downs could be offset in future periods by future earnings. Importantly, the substitute amendment introduced by Sen. Harry Reid (D-NV) does not contain a comparable provision, the most significant departure from the bill adopted by the House.
Set forth in the House bill’s Section 113, the loss amortization provision would permit banks to amortize or write-down losses on certain OREO and NPAs secured by real estate on a quarterly straight line basis over—depending on measured increases in small business lending—between six and ten years. Loans eligible for this amortization would be those originated between January 1, 2003 and January 1, 2008. However, as discussed above, any bank on the FDIC’s Troubled Bank list would be ineligible to amortize losses or write-downs. Accordingly, even if the Senate ultimately adopted the House provision, troubled institutions would not benefit.
Proponents have attempted to distinguish this specific proposal from the widely available and poorly supervised “forbearances” launched at the failing savings and loan industry in the 1980s. Added by an amendment sponsored by Rep. Ed Perlmutter (D-Co.), supporters say this GAAP sidestep would have broad-reaching stabilizing effects on the economy at a fraction of the cost of TARP. However, the ultimate impact would appear to be minimal given the exclusion of currently troubled banks.
Future of the Plan
As Congress considers this plan, regulators and commentators will continue to debate an underlying question: is weak demand for small business loans the primary explanation for declines in such lending activity? Other parts of this bill would extend $900 million to state programs encouraging small business lending, and a companion bill increases the permissible tax deduction for small business “start-up” expenses. Some estimates are that banks could use the proposed fund to leverage up to $300 billion in small business loans. All together, this proposal should generate an interesting follow-on debate to the “big bank” discussion that has dominated the larger and still-pending Dodd-Frank bill.