[Senate Hearing 111-639]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-639

 
   RESTORING CREDIT TO MAIN STREET: PROPOSALS TO FIX SMALL BUSINESS 
                     BORROWING AND LENDING PROBLEMS

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                            ECONOMIC POLICY

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                                   ON

   EXAMINING RESTORING CREDIT TO MAIN STREET: PROPOSALS TO FIX SMALL 
                BUSINESS BORROWING AND LENDING PROBLEMS

                               __________

                             MARCH 2, 2010

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia             JUDD GREGG, New Hampshire
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                    Edward Silverman, Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

                    Subcommittee on Economic Policy

                     SHERROD BROWN, Ohio, Chairman

         JIM DeMINT, South Carolina, Ranking Republican Member

JON TESTER, Montana
JEFF MERKLEY, Oregon
CHRISTOPHER J. DODD, Connecticut

                      Chris Slevin, Staff Director

                Andrew Green, Professional Staff Member

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                         TUESDAY, MARCH 2, 2010

                                                                   Page

Opening statement of Chairman Brown..............................     8

Opening statements, comments, or prepared statements of:
    Senator Merkley..............................................     1

                               WITNESSES

Carl Levin, U.S. Senator from the State of Michigan..............     2
    Prepared statement...........................................    23
Debbie Stabenow, U.S. Senator from the State of Michigan.........     5
    Prepared statement...........................................    24
Arthur C. Johnson, Chairman and Chief Executive Officer, United 
  Bank of Michigan, Grand Rapids, Michigan, on behalf of the 
  American Bankers Association...................................    10
    Prepared statement...........................................    26
Eric A. Gillett, Vice Chairman and Chief Executive Officer, 
  Sutton Bank, Attica, Ohio, on behalf of the Independent 
  Community Bankers Association..................................    11
    Prepared statement...........................................    34
Raj Date, Chairman and Executive Director, Cambridge Winter 
  Center for Financial Institutions Policy.......................    13
    Prepared statement...........................................    43

                                 (iii)


   RESTORING CREDIT TO MAIN STREET: PROPOSALS TO FIX SMALL BUSINESS 
                     BORROWING AND LENDING PROBLEMS

                              ----------                              


                         TUESDAY, MARCH 2, 2010

                                       U.S. Senate,
                           Subcommittee on Economic Policy,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 9:38 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Jeff Merkley, presiding.

           OPENING STATEMENT OF SENATOR JEFF MERKLEY

    Senator Merkley. I will call to order the Subcommittee on 
Economic Policy for this hearing, ``Restoring Credit to Main 
Street: Proposals to Fix Small Business Borrowing and Lending 
Problems.'' Senator Sherrod Brown is delayed in transit, but we 
expect him to be here in a few minutes, however many that might 
be.
    I will give my opening statement, and then Senator Levin 
will be here to give his testimony--he is here to give his 
testimony, and we are expected to be joined by Senator Stabenow 
in due course.
    We are in the midst of a crisis for small businesses. Just 
this past week, the FDIC released its latest quarterly report 
showing that bank lending has dropped by $578 billion last 
year, the largest annual decline since the 1940s. This drop in 
lending has hit the small business community very hard. These 
companies are the engine of growth in our economy, and we need 
to enact aggressive policies that ease the credit conditions 
facing small businesses and get our economy back on track.
    I was out this weekend in central Oregon meeting with a 
group of small business owners--a restaurant owner, the owner 
of an organic coffee company, the owner of a market, and so 
forth--and the stories about access to credit just continued 
one after the other: reduced credit lines, difficulty in 
getting loans to seize business opportunities, even when there 
are longstanding relationships with lenders.
    The story of one Oregon company tells it all. Kitchen 
Kaboodle sells cookware and kitchen appliances with five 
locations around the Portland metro area. They are locally 
owned. Their flagship store is on one of Portland's most 
popular shopping streets. They have prudently reacted to the 
downturn in the economy, making some unpleasant decisions, 
cutting staff, cutting salaries, cutting back on health 
insurance. The company is still showing a profit, but banks are 
cutting their credit lines across the board. This is a healthy 
company with a long history of success in the Portland area 
with competent management and a strong credit history, and we 
have to do more to make sure that companies like Kitchen 
Kaboodle can gain access to credit.
    This hearing will help us examine the proposals my 
colleagues and I have offered, along with the Administration, 
providing strategies to support small business lending. As many 
of you know, Senator Boxer and I introduced the Bank on Our 
Communities Act which would help recapitalize healthy community 
banks and incentivize these banks to grow their small business 
loan portfolios. But solving this credit crisis on Main Street 
is going to require multiple strategies, and I look forward to 
hearing from and working with my colleagues, Senator Levin, 
Senator Stabenow, Senator Warner, and others who have had ideas 
on how to take this on.
    In conclusion, thanks to Senator Brown for holding this 
hearing, and I look forward to hearing from our panelists this 
morning.
    With that, I would like to invite Senator Carl Levin to 
speak. He was born in Detroit, Michigan, elected to the Senate 
in 1978, and has been a tireless voice in the Senate for 
American manufacturing. Senator Levin has been working closely 
with colleagues in both chambers to address access to credit 
issues for small businesses. Welcome, Senator.

    STATEMENT OF CARL LEVIN, U.S. SENATOR FROM THE STATE OF 
                            MICHIGAN

    Senator Levin. Thank you very much, Chairman Merkley--I 
thank Senator Brown also--for convening this hearing. I have a 
rather lengthy statement which I would appreciate being put in 
the record, and also since Senator Brown is here, I am sure he 
would want to read every word of my statement as well. But 
being caught in traffic is nothing new, I am afraid, around 
Washington.
    You have laid out the problem very well. Your bill 
addresses the problem in a very important way, and I am pleased 
to cosponsor your bill, which I believe is S. 1822.
    Senator Merkley. Thank you for your cosponsorship.
    Senator Levin. It is one way of addressing this issue, 
which, as you pointed out in your comments, we have got to look 
at various ways of addressing this decline, this tightening of 
credit for small businesses. We have done a lot for the big 
banks, but the lifeblood of our local communities are these 
small banks, community banks--some of them not so small, but 
these are our community banks, our local banks.
    I want to just address one part of the problem which 
frequently is not seen. We talk a lot about banks that do not 
have the capital to loan or the banks which have gotten, in the 
case of large banks, large capital infusions from the Federal 
Government sometimes, but that have not lent that money out. 
There are a lot of efforts going around to see if we cannot, as 
you point out, Mr. Chairman, incentivize these banks or in some 
way or other get the banks that have capital, and particularly 
those that have been helped by the Federal Government, to use 
that capital to get loans flowing again.
    The percentage of the reduction in the number of loans 
going to small businesses is dramatic. In my State of Michigan, 
I believe it is down to something like a 74-percent reduction 
in business loans in the last 2 years. We have got a 15-percent 
unemployment rate, and there is a connection between those two 
figures. We all hear about gross domestic product going back up 
again. This has not affected our job creation yet because, as 
you point out, Mr. Chairman, the engine of that creation is 
small business, and we have not seen loans again flowing to 
small business on Main Street.
    One of the reasons for this is what I want to just leave 
with the Subcommittee this morning. We all know what has 
happened to home values in America. Most of our homes have gone 
down in terms of their value. The housing bubble reduced the 
value of homes typically by 15 or 20 percent or 25 percent in 
America, and I think most homes, the vast majority, have seen 
that decline.
    Well, the same thing has happened with the assets of 
businesses. The value of their machinery or the value of their 
equipment has gone down because of the recession. And so just 
as you pointed out, business after business after business 
comes into our offices or meets with us when we get home on 
weekends and says, ``We have a good business going. We have 
never missed a payment. We have customers. But our lines of 
credit have been cut.''
    Now, there are a couple of reasons for that. One could be 
that the banks do not have capital, and your bill and other 
efforts are intended to try to get some more capital into those 
banks. But another reason why banks do not loan is because the 
collateral value of the borrower has gone down. It is the same 
collateral. It is the same machinery. It is the same equipment. 
But the value of that collateral having gone down, the banks 
are unable because of our regulatory reasons to make the loan. 
The regulators will say, ``Hey, wait a minute. The value of 
that collateral is down. You are going to have to either not 
make the loan or use more of your bank's capital in order to 
make the loan.''
    So what we need to do is find ways to support the 
collateral of the borrower as well as to infuse more capital 
into the banks. And there is a program we have had in Michigan 
that does exactly that. It is called the Capital Access 
Program. We have a new version of that program that is now 
underway where the State is actually depositing funds in 
reserve accounts, and that is the key to this. It is funds 
going into reserve accounts to support loans to businesses that 
need collateral support.
    So it is addressing the problem in a way which has not yet 
been addressed as far as we know, which is to help the 
borrowers that have decreased collateral values where, again, 
they have the customers, they have never missed payments, and 
they have the same collateral. But because of the economy, the 
value of that collateral has gone down, and so this program, 
which my brother, Sandy Levin in the House, on the Ways and 
Means Committee, is working very hard there with colleagues. We 
are working hard here with colleagues to put the finishing 
touches on this collateral support program where funds would be 
actually placed with the bank, put in reserves, either through 
the State, which is the case with our Michigan Capital Access 
Program, or where the source could be Federal funds funneled 
through the State.
    We have a small business loan program. It is a loan 
guarantee program. It is very valuable. This in no way is in 
conflict with or undermines that. It would be another arrow in 
the quiver of ways of supporting the small businesses that seek 
loans and that have had lines of credit that are no longer 
available.
    So I wanted just to highlight that one specific element 
that has not had enough attention paid to it. Art Johnson, who 
is a banker from Grand Rapids, is on your second panel, and I 
am very glad that he has been invited, and he will make a 
wonderful presentation. And whether he addresses the Capital 
Access Program or other things, I know he is familiar with that 
program and could perhaps answer questions about it.
    Senator Merkley. Thank you very much, Senator, for your 
testimony, and are you needing to depart?
    Senator Levin. Yes, and I thank you.
    Senator Merkley. Could I ask you a question before you go?
    Senator Levin. Of course.
    Senator Merkley. Do you envision this collateral support 
program would help address commercial investors who own 
buildings, if you will, where the value of the building has 
gone down and they have 7-year or 10-year balloon loans that 
are traditionally rolled over, they have made every payment, as 
you say, like many small businesses have, but the collateral of 
the building, the value of the building has dropped and is 
making it very difficult for them to find rollover lending?
    Senator Levin. I think it can be used for that purpose as 
well. We are still working out the final language of it, but I 
see no reason why, where you have that same building, it cannot 
be the same as the same collateral where it is inventory or 
other kinds of collateral.
    Senator Merkley. Thank you very much for bringing this idea 
forward. I have signed on to the letter in support of your 
collateral support idea. It certainly helps address a challenge 
that I am hearing from small businesses throughout Oregon. 
Thank you for your testimony.
    Senator Levin. And thank you again for chairing this. I put 
my entire statement in the record. I want you to know, Senator 
Brown, because I know how you will want to read every word of 
it, but thank you, Senator Brown and Senator Merkley both, for 
hosting this. You have touched on a very, very significant 
problem in our country where you have got businesses with good 
credit records who suddenly find their lines of credit cut 
based on the--in my testimony, I point out that the value of 
their collateral has gone down because of the economy, just the 
way the value of our homes has gone down. And so the amount of 
the loan which can be made to them from the banks is reduced 
because of the regulatory requirements because the value of the 
collateral--same assets, same machinery, same equipment, same 
building. They have the same business and they have customers. 
They never missed payments, but suddenly their collateral has 
gone down. So we not only have to--and forgive me for repeating 
this, Senator Merkley, but I do want to make just this--
summarize the point to Senator Brown. Just the way our home 
values have gone down for the most part, the same home, and we 
are paying our mortgage payments in most cases where there is 
no foreclosure, so you have got businesses in business, same 
customers, they are doing fine, never missed a payment, but the 
value of their collateral has gone down, and that leads to the 
lines of credit being cut, and that makes it impossible for 
them to pay for their payroll, which is usually funded through 
credit, or their inventory has been supported through lines of 
credit. And that is what our effort is intended to address, to 
support that collateral.
    I commend you and Senator Merkley for all you are doing 
here to get these small businesses the kind of support that 
they need and that is so essential to our country.
    Thank you.
    Senator Merkley. Thank you.
    We have the Michigan dream team here this morning, so for 
the second half, Senator Stabenow, who was born in Michigan, 
elected to the Senate in 2000 as Michigan's first female 
Senator. Just last week, she introduced the American Job 
Creation and Investment Act, a bill to allow companies to 
utilize existing AMT credits do they can invest in new 
manufacturing facilities and create jobs. And I know that you 
have been hearing a lot of stories back home about the 
challenge of access to credit, and we appreciate your testimony 
this morning.

 STATEMENT OF DEBBIE STABENOW, U.S. SENATOR FROM THE STATE OF 
                            MICHIGAN

    Senator Stabenow. Well, thank you very much, Senator 
Merkley and Senator Brown, for convening what is a very 
important meeting, a very important hearing. And I would first 
just say that, to follow up on what Senator Levin was saying, I 
had a conversation yesterday with a banker in Michigan who was 
right on point with what we are talking about in terms of 
collateral. This bank CEO said that a business person, a small 
manufacturing supplier came in to refinance their properties, 
and they had just 3 years ago received a loan based on $1 
million worth of assets, their physical assets of the plant. 
They had been given about an $800,000 loan, and now when they 
come in and it is time for them to refinance, that property of 
$1 million was worth barely $600,000, and they were able to get 
a loan legally under the rules now of some $400,000, and so it 
was roughly half of what the loan was, what they owed on the 
principal.
    And so this is a situation that we have happening all 
across Michigan. I am sure that is happening in Ohio and Oregon 
and all across the country where we have equipment, facilities, 
you know, business properties, commercial entities that are 
operating under one valuation and loans set accordingly who now 
find themselves underwater even though they own the same 
property, and nothing has changed other than the economy, and 
the same this with families and homes. So I appreciate very 
much that both of you are very open and, I know, supportive of 
addressing this as part of what we do for small business.
    I am pleased that the chairman of the American Bankers 
Association, Art Johnson, is, in fact, testifying today. As the 
CEO and Chairman of United Bank of Michigan and United 
Community Financial Corporation in Grand Rapids, Art 
understands and is on the front lines of tackling the serious 
problems facing community banks and small businesses in some of 
the hardest-hit areas certainly of our State and the country, 
and I am sure he can speak more specifically to this important 
issue of collateral.
    The fact that we are holding the hearing, we all know why 
we are here. Small businesses create 64 percent of the jobs in 
the country. Small businesses tend to get loans from their 
local community banks, not the big Wall Street banks. According 
to FDIC call reports, banks with less than $1 billion in 
assets, making up about 12 percent of the banking assets, make 
nearly half the small business loans.
    So I very much appreciate both of your leadership, and, 
Senator Merkley, I am very proud to be a cosponsor of your 
legislation as well.
    Federal regulations have, rightly, cracked down on the big 
banks who caused the financial crisis. According to the FDIC 
data, the amount of lending by the banking institution rating 
industry fell, though, by $587 billion, or 7.5 percent, last 
year, which is the largest decline since the 1940s, which is 
why we find ourselves here. And, ultimately, it is America's 
small business and workers who are suffering the most. They 
cannot get the capital they need up front to make the products 
that they need.
    Another very common story that I hear in Michigan, we have 
a small supplier making gear boxes, and they get a contract 
from an auto maker. Normally they get a signed contract, they 
take it to the bank, they get the capital up front to be able 
to buy the materials and pay to make the product, and then they 
get paid and they pay it back. Now those loans are not being 
made on too many occasions, and it is stopping us from creating 
jobs. We are actually seeing job loss because of the inability 
to be able to get the capital that is needed.
    It is so important that we separate the large financial 
institutions that benefited from TARP from the vast majority of 
banks. And I know that is what you are focused on as well. The 
smaller banks who did not receive nearly as much support, if 
any, from TARP as the larger banks originate the vast majority 
of loans. Thankfully, our community banks are still lending 
despite dealing with these incredible pressures to increase 
capital and reduce risk, and they too are suffering from an 
economic environment that makes it hard to raise capital for 
them. So I look forward to hearing from the next panel as well.
    As Senator Levin emphasized and I would just emphasize 
again, our small businesses are dealing with reduced cash-flow 
compounded by collateral whose value has decreased in recent 
years. And as we move forward on our small business jobs bill, 
I think it is absolutely critical that we deal with both of 
those issues if we are actually going to begin to see lending 
occurring, as we all want to see it.
    As I am sure our next panel can attest, even a healthy bank 
will not make a loan to a borrower who does not have enough 
collateral value. That is why what we have done in Michigan is 
so important. We have seen that the new regulations on our big 
banks make sense, but a one-size-fits-all is hurting the 
ability of small banks to help small business. And we have been 
working through our Michigan Economic Development Corporation 
and the Governor's office to find a way to support and to 
tackle this issue of collateral.
    I would suggest to you the theory of ``too big to fail'' 
now means that many of our businesses are too small to grow. 
That is the reality of what is happening. And it is urgent that 
we fix that.
    Nearly 700,000 Americans work for parts suppliers, more 
workers than any other types of manufacturing company. And I 
would just share with you one example of how this credit crunch 
is affecting our small manufacturers.
    Wes Smith, who is the president of E&E Manufacturing, a 
metal stamping company in Plymouth, Michigan, is looking to 
expand his business, but might not be able to because his long-
term lender recently reduced his line of credit and changed his 
loan covenants. Although sales picked up at the end of the 
year--and we are very pleased that we are seeing an uptick in 
manufacturing for the first time in many, many years, and they 
are expecting a 20-percent increase in sales projections--he is 
having trouble getting the capital to rehire about 200 people 
he was forced to lay off in the worst of the recession. That is 
200 people at just one plant who could go back to work right 
now if this company was able to get the credit that they have 
received in the past.
    Senator Levin mentioned Michigan started a successful 
program last year that targets businesses that have a good 
credit risk but have collateral or cash-flow shortfalls. The 
first $13 million of that fund was fully committed within the 
first 5 months, and it was oversubscribed by nearly 300 
percent. So the need is out there, and that is just in 
Michigan.
    Our program has taken $13.3 million in public funding to 
leverage $41 million in private loans, which is leverage of 
about 3:1 and very important for us to look at.
    So when we consider the authorization of the President's 
small business lending fund, which I strongly support, I would 
urge that we take some of those dollars and direct them toward 
programs like the one we have in Michigan to address collateral 
depreciation issues.
    We also need to address the separate problem of small 
businesses being able to qualify for loans. I hope as we 
address this issue we also extend the Small Business 
Administration loan guarantee that expires this month and 
increase the maximum loan size of SBA 504 and 7(a) programs, 
which the SBA estimates would create up to $5 billion in growth 
for small businesses and as many as 160,000 jobs. That is what 
this debate is really all about, as both of you know so well, 
and it is about creating jobs, growing the economy. And small 
businesses and our ability to support small business are really 
at the heart of our economic engine and the ability to grow.
    So I thank you very much for allowing me to testify today, 
and I would be happy to work with you in any way possible.
    Senator Merkley. Thank you very much, Senator, for your 
advocacy for small businesses and for access to credit. Does my 
colleague have any questions?
    Chairman Brown. No questions, but a special thanks to both 
of you for your focus especially on manufacturing, what it 
means to the auto supply chain and helping those companies get 
credit and transition into other industries when possible and 
necessary, and how you have really led the charge on that. 
Thank you, Senator Stabenow.
    Senator Stabenow. Thank you.
    Senator Merkley. I would like to ask just one question 
before you leave, and that is, given that the program is now 
oversubscribed, is Michigan planning on expanding that fund? 
And is the source of the funds coming from general funds, or 
how is that being established?
    Senator Stabenow. Well, at this point, in order for them to 
expand it, they would need support from the Federal Government 
to do that given the economic crisis in the State as well. I 
think they have gone as far as they can. They have put aside 
some dollars and have approached us, have approached the White 
House, and would like very much to see a part of what is done 
in what we do with the President's program redirect some 
dollars that would allow the Economic Development Corporation 
to partner and leverage funding, as they have been doing.
    Senator Merkley. Thank you so much. Thank you for your 
testimony.
    Senator Stabenow. Thank you.
    Senator Merkley. At this point we will ask the second panel 
to come forward and take their seats at the table. Thank you.
    [Pause.]

          OPENING STATEMENT OF CHAIRMAN SHERROD BROWN

    Chairman Brown [presiding]. I thank you all for joining us, 
and special thanks to Senator Merkley for always doing his job 
the way he was elected to and beyond. I appreciate that. And I 
apologize. My flight was a little late. I think I learned a 
lesson today. Don't fly on the morning of the hearing, with 
traffic and all that. But I apologize for any delay in the 
schedule to all three of you. Special thanks to Senator 
Stabenow and Senator Levin, who, as I had said, have been so 
tuned in to what we need to do in terms of credit and with a 
special focus on manufacturing.
    I know that Senator Merkley touched a lot of these, as did 
our two Senate colleagues, but we know the problem. Bank loans 
and leases have declined for six straight quarters. We know 
what that means to banks. We know what that means particularly 
to community banks in small-town Ohio and in Michigan and in 
Oregon. We know what it means for businesses that are looking 
for credit. The NFIB Research Foundation found that 60 percent 
of businesses last year did not have all their credit needs 
met, and we know what that means.
    A brief story and then we will begin the testimony. The 
Wall Street Journal ran an above-the-fold front page article 
featuring the story of a Cincinnatian named Nick Sachs, who is 
the owner of a health-care franchise in southwest Ohio. He 
opened his business in 2008 with the help of a loan from a 
small bank. He now has 25 employees. He is in a position to add 
to pretty much double that number. Unfortunately, his original 
lender isn't big enough to support a second loan. He hasn't 
been able to find another bank willing to make that loan. I 
mean, that clearly is a real obstacle to our recovery, 
obviously, in States like ours, but States across the country.
    Again, thanks for all of those and apologies for starting a 
bit late. I would like to introduce each of the panel members. 
Each of you take roughly 5 minutes for your testimony and then 
we will begin the questions.
    Arthur Johnson, whom Senator Stabenow mentioned already, is 
Chairman and CEO of United Bank of Michigan in Grand Rapids. 
His testimony is on behalf of the American Bankers Association. 
He is Chair of the American Bankers Association, Chair and CEO 
of United Bank of Michigan, and President and CEO of United 
Community Financial Corporation in Grand Rapids. He has 
previously served in the ABA Community Bankers Council and its 
administrative committee, is the past Chair of both the ABA 
Government Relations Council and the Bank PAC Committee. He 
volunteers his time to benefit several organizations, including 
Habitat for Humanity and Public Radio. He is the Director of 
the Employers Association, both the Michigan District of the 
SBA, he has had special attention there, and the Grand Rapids 
Area Chamber of Commerce named Mr. Johnson the Financial 
Services Advocate of the Year in 1988. He holds a BA in Finance 
from Michigan State in East Lansing and an MBA from Western 
Michigan in Kalamazoo.
    Eric Gillett is Vice Chairman and Chief Executive Officer 
of the Sutton Bank, which, I would add, has offices, as he 
said, in my hometown of Mansfield. He is Vice Chair and CEO. He 
is located in Attica, Ohio. He has 35 years of banking 
experience, currently serves on the ICBA Payments and 
Technology Committee and on the Board of Directors of EPCOR, 
the regional payments association. He served on the Board of 
Trustees as Chairman of the Investment Committee for the East 
Ohio United Methodist Foundation, the Board of Directors of 
NACHA, and on the Fannie Mae National Housing Advisory Council. 
He has risen through the ranks of Sutton Bank to become an 
industry leader. He holds a Bachelor of Science degree from the 
Ohio State University.
    Raj Date is Chairman and Executive Director of the 
Cambridge Winter Center. He was Managing Director in the 
Financial Institutions Group at Deutsche Bank Securities, where 
he led the firm's investment banking coverage for the largest 
U.S.-based banks and thrifts. Prior to joining Deutsche Bank, 
Mr. Date was a Senior Vice President for Corporate Strategy and 
Development at Capital One Financial, where he led merger and 
acquisition development efforts across the U.S. banking and 
specialty finance markets. He began his business career in the 
financial institutions practice of the consulting firm McKinsey 
and Company. He is a graduate of the College of Engineering at 
Berkeley with highest honors, and the Harvard Law School, where 
he graduated Magna Cum Laude. He lives in New York with his 
wife, an Assistant U.S. Attorney, and their twin son and 
daughter.
    So welcome to all three of you. Mr. Johnson, you begin, 
please.

 STATEMENT OF ARTHUR C. JOHNSON, CHAIRMAN AND CHIEF EXECUTIVE 
 OFFICER, UNITED BANK OF MICHIGAN, GRAND RAPIDS, MICHIGAN, ON 
           BEHALF OF THE AMERICAN BANKERS ASSOCIATION

    Mr. Johnson. Good morning. Chairman Brown, Members of the 
Subcommittee, my name is Art Johnson. I am the Chairman and CEO 
of United Bank of Michigan and Chairman of the American Bankers 
Association.
    This recession is one of the worst we have ever faced. 
While the statisticians will say that the recession has ended, 
that is little comfort to Michigan, where we are at a 14.6 
percent unemployment rate, and we are not alone. Across the 
United States, people are still suffering from high levels of 
unemployment and business failures. The impact of the downturn 
is being felt by all businesses, banks included.
    The cumulative impact of eight straight quarters of job 
losses, over eight million nationwide since the recession 
began, is placing enormous financial stress on many individuals 
and businesses. This has caused business confidence to drop and 
loan demand to fall. Many businesses either do not want to take 
on additional debt or are not in a position to do so, given the 
falloff of their customer base.
    There are, however, some positive signs. We have heard from 
bankers that small businesses are returning to test the market 
for loans. It will take time for this interest to be translated 
into new loans. In previous recessions, it took 13 months for 
credit to return to prerecession levels.
    Banks have many pressures to face in the meantime. The 
commercial real estate market will pose a particularly 
difficult problem for the banking industry this year. The CRE 
market has suffered after the collapse of the secondary market 
for commercial mortgage-backed securities, and because of the 
economic slowdown, that has caused office and retail vacancies 
to rise dramatically.
    We have heard anecdotes from our members of examiners, bank 
examiners, who take an inappropriately conservative approach to 
their analysis of asset quality and who are consistently 
requiring downgrades of loans whenever there is any doubt about 
the loan's condition. This is especially true for CRE loans. 
Examiners need to understand that not all concentrations in CRE 
loans are equal and that setting arbitrary limits on CRE 
concentration has the effect of cutting off credit to 
creditworthy borrowers, exactly at the time when Congress is 
trying to open up more credit.
    ABA appreciates the initiative of President Obama outlined 
in his State of the Union Address that would provide additional 
capital to small banks who volunteer to use it to increase 
small business lending. A key factor to this proposal is 
removing it from the rules and restrictions of TARP and its 
related stigma. As this program is developed, ABA recommends 
that Congress and the Administration create criteria that allow 
all viable community banks to participate. We also propose that 
Treasury offer assistance to those banks that did not qualify 
for Capital Purchase Program funds, but that can demonstrate 
the ability to operate safely and soundly and survive if given 
the chance to obtain necessary capital.
    Another idea is to use existing State lending programs to 
target small businesses in local markets, such as has been done 
in Michigan. One such program, the Capital Asset Program, uses 
small amounts of public resources to generate private bank 
financing. This program supported over $628 million in bank 
lending, a public-private ratio of 27-to-one.
    Another Michigan program, the Michigan Collateral Support 
Program, supplies cash in collateral accounts to lending 
institutions to enhance the collateral coverage of borrowers. 
Loan flow in Michigan's pilot program has been high, with close 
to 300 inquiries and at least $150 million in requests in the 
first 2 months of the program. These two programs may serve as 
models for other programs that could be implemented across the 
United States.
    We appreciate the work this Congress has done to increase 
the guarantees on SBA's 7(a) loan program. Subsequently, the 
SBA expanded eligibility to small businesses by applying the 
standard used in the 504 program. These positive changes mean 
that an additional 70,000 small businesses will be eligible.
    The success of small businesses in local economies depends 
in large part on the success of their community banks. We must 
all work together to get through these difficult times, and I 
would be happy to answer any questions that you might have.
    Chairman Brown. Thank you very much, Mr. Johnson.
    Mr. Gillett.

STATEMENT OF ERIC A. GILLETT, VICE CHAIRMAN AND CHIEF EXECUTIVE 
     OFFICER, SUTTON BANK, ATTICA, OHIO, ON BEHALF OF THE 
           INDEPENDENT COMMUNITY BANKERS ASSOCIATION

    Mr. Gillett. Chairman Brown, Senator Merkley, Members of 
the Subcommittee, thank you for the opportunity to testify on 
behalf of the 5,000 members of the Independent Community 
Bankers of America. My name is Eric Gillett and I am the Vice 
Chairman and CEO of Sutton Bank.
    Sutton Bank is a $355 million S Corporation bank 
established in 1878, focused on small business and agricultural 
lending. The bank is located in Attica, Ohio, a rural bedroom 
community of Cleveland with a population of 900. The largest 
community in our market is Mansfield, whose population is 
nearly 50,000. Our institution has $215 million in loans, the 
bulk of which are commercial and farm loans. We use the USDA 
Business and Industry and SBA loan programs to assist our 
customers and have consistently been named one of the top small 
business lenders in Ohio, according to the U.S. Small Business 
Administration.
    Mr. Chairman, community banks serve a vital role in small 
business lending and local economic activity not supported by 
Wall Street. While community banks represent about 12 percent 
of all bank assets, they make 40 percent of the dollar amount 
of small business loans of less than $1 million made by banks.
    Notably, nearly half of all small business loans under 
$100,000 are made by community banks. In contrast, banks with 
more than $100 billion in assets, the Nation's largest 
financial firms, make only 22 percent of small business loans. 
However, while the overwhelming majority of community banks are 
well capitalized, well managed, and well positioned to lead our 
Nation's economic recovery, there are certain hurdles in place 
that are hindering our efforts.
    Many community bankers report the examination environment 
is hindering lending. In a recent informal survey of bankers 
conducted by ICBA, 52 percent said they have curtailed 
commercial and small business lending as a result of their 
recent safety and soundness examinations. Also, 82 percent 
answered that the Federal banking agency's guidance on 
commercial real estate loan workouts has not improved the 
environment for commercial real estate loans.
    Bankers are also impacted by examiners' increasing capital 
requirements above the statutory and regulatory limits. 
Therefore, community banks with sufficient capital to be 
considered well capitalized are being classified as only 
adequately capitalized. This change in capital status may 
create higher FDIC premiums, lowering earnings and ultimately 
the capital of the institution. Examiners who raise leverage 
capital ratios do so at the expense of lending. More capital 
required in reserve means less is available to lend to small 
businesses.
    Community bankers also report aggressive write-downs of 
performing commercial real estate loans based solely on 
appraisals and absorption rates. Examiners may be ignoring the 
borrower's ability to repay its loan, the borrower's history of 
repaying other loans, and favorable loan-to-value ratios. 
However, community banks believe they do a better job in 
monitoring and offering loans than do large nationwide lenders 
because they are more likely to work one-on-one with customers 
and they have a better understanding of the local economic 
conditions in their communities.
    Small business lending is down because community banks have 
witnessed a decrease in demand from loans from qualified 
borrowers. In a recent ICBA survey, 37 percent of banks 
responding said that lack of loan demand was constraining small 
business lending. A healthier economic climate and increased 
confidence in the future will increase loan demand.
    In my written statement, I have listed several 
recommendations for boosting small business lending. ICBA 
believes the Administration's new small business lending 
program, if properly structured, can be very successful. ICBA 
strongly supports the extension of the SBA loan program 
enhancement included in the American Recovery and Reinvestment 
Act. My written statement also includes recommendations to help 
community banks and small business preserve and raise valuable 
capital.
    Mr. Chairman and Members of the Subcommittee, community 
banks form the building blocks of communities and support small 
businesses around the country. Community bankers are ready, 
willing, and able to meet the credit needs of small businesses 
and the communities they represent. ICBA stands ready to work 
with you on these important issues and I look forward to your 
questions.
    Chairman Brown. Thank you, Mr. Gillett. I have never heard 
Attica referred to as a rural bedroom community of suburban 
Cleveland, or however you said that.
    Mr. Gillett. It is a geographic reference.
    [Laughter.]
    Chairman Brown. Close to Mansfield makes way more sense.
    Mr. Date, thank you.

    STATEMENT OF RAJ DATE, CHAIRMAN AND EXECUTIVE DIRECTOR, 
   CAMBRIDGE WINTER CENTER FOR FINANCIAL INSTITUTIONS POLICY

    Mr. Date. Thank you, Chairman Brown, Members of the 
Subcommittee, for inviting me today. My name is Raj Date. I am 
the Chairman and Executive Director of the Cambridge Winter 
Center, which is a boutique think tank focused exclusively on 
U.S. financial institutions policy.
    Small business credit is an important issue and this is a 
critical time. We believe that we are at a crossroads, at the 
point in the economy where the decline in commercial credit 
will become less driven by a very rational decline in demand 
and more driven by a structural deficit in the supply of small 
business loans.
    My written statement provides some tedious detail on both 
the supply and demand issues, but the core problem we face is 
easy to summarize. A large fraction of small business finance 
provided over the last decade was supplied by both products and 
firms that are shrinking fast or no longer exist. The products 
that are shrinking are consumer products, for the most part, 
that bleed over into small business finance: two in particular, 
the high-line credit card business and the cash-out home equity 
business.
    Aside from those products, there are categories of nonbank 
lenders that specialize in commercial finance that are 
shrinking, as well. GE Capital and CIT are the biggest 
examples, but you may recall that a number of Wall Street firms 
had big commercial finance businesses, too. AIG and Merrill 
Lynch both had very large commercial finance outfits. These all 
seemed like terrific products and terrific business models--
during the bubble. They are decidedly less competitive in 
normalized times, and they don't particularly work well at all 
now.
    The retreat of those products and those firms from the 
marketplace should create an opportunity for regional and 
community banks to step in and fill the void. In my written 
statement, I call that phenomenon the relocalization of small 
business lending. Over the long term, relocalization of small 
business lending is a great thing. The financial system and all 
of us would be better off if it were less reliant on very large 
finance companies and broker dealers that fund themselves in 
confidence-sensitive wholesale markets. Plus, regional and 
community banks are better underwriters of small business risk 
because of their in-market presence and their in-market focus.
    But that is the long term. Over the near term, we have a 
problem. The most serious is capital. Small banks' capital is 
pressured in a number of ways and those pressures are not going 
to resolve themselves soon. The bank market will eventually 
clean up its collective balance sheet and recapitalize on its 
own, but that is going to take years and not months. So the 
question for us is what we had ought to do in the interim.
    With that context in mind, and mindful of the track record 
of past policy efforts, I would like to suggest three criteria 
to evaluate alternative solutions to the small business credit 
crunch.
    First, we should recognize the limits on the Government's 
ability to quickly and competently direct the flow of 
commercial credit on its own. Unlike in education finance, say, 
there is no existing Government apparatus by which to generate 
and evaluate and negotiate and close small business loans. Even 
for the SBA, which would be the most relevant existing agency, 
building and scaling up an effort like that would take time and 
it would be a very complicated and massive undertaking. Given 
the severity and urgency of this issue, working through bank 
intermediation would seem the more logical course.
    The second principle: not all banks are the same and we 
should not treat them as though they were. I would argue that 
the central conceptual failing of the original TARP capital 
infusion plan had nothing to do with executive compensation or 
anything else. It had to do with creating an investment 
structure that was deliberately a one-size-fits-all model that 
became, as a result, disproportionately valuable to exactly the 
worst banks. As a result, the TARP investments managed to 
create neither a credible endorsement that could entice private 
capital back into the market, nor did they provide any 
competitive benefit to the banks that had actually demonstrated 
that they knew what they were doing in the first place.
    Third principle: we should be careful about and explicit 
with incentives. Many people who supported the original TARP 
capital infusions believed, or were led to believe, that credit 
would thereby be restored. They are irritated by continued 
declines in bank lending. The lesson is straightforward. If 
taxpayers are asked to subsidize any particular activity, well, 
then that subsidy should be narrowly tailored to that 
objective. Of course, when the desired activity is lending, we 
need to be especially careful because we don't want to create 
such artificially strong incentives that it goads banks into 
making otherwise irresponsible decisions, which, of course, 
creates more harm than good in the long run.
    Let me then turn quickly to the Administration's proposal 
for a small business lending fund with those principles in 
mind. I think it is a logical proposal. It is an internally 
consistent proposal. But it does not in its current form meet 
either the second or the third principles that I just 
mentioned. As described in my written statement, the capital 
provided to banks under the proposal is so large and the amount 
of required lending so small that it is likely that most of the 
Government-supplied capital would be used to bolster 
preexisting weakness in a firm's capital position rather than 
to support incremental credit. Because of that, the program 
would disproportionately be valuable to precisely the banks 
that have proven themselves the worst at making credit 
decisions. I fear that it would, therefore, quickly devolve 
into a back-door bailout for the most dubious balance sheets 
and the most dubious management teams in what is actually a 
very large industry with plenty of good ones, and I think that 
that result, obviously, would be unfortunate.
    The Administration proposal, then, is going to require some 
refinement before it is ready to implement and that 
implementation is going to take some time to do right. Given 
the urgency of this issue, though, the committee may want to 
consider in parallel an interim measure that might be rather 
more simple to implement. My written statement describes one 
such interim solution. It isn't without risk, but I think that 
it might be specifically tied to the outcome we desire, 
incremental small business credit.
    I will end my remarks there and obviously I look forward to 
your questions.
    Chairman Brown. Good. Thank you, and thank you all for 
staying very close to the 5 minutes in your testimony. We will 
do a pretty wide-open question period.
    I will start with Mr. Johnson. Again, thank you for joining 
us. You heard Senator Levin in his sort of synopsis of his 
remarks, and I know in the central thesis of his remarks, talk 
about the value of collateral declining. Give me a reaction to 
that in what you think--what kinds of solutions do you see to 
that?
    Mr. Johnson. Well, I think he hit the nail on the head. As 
has been mentioned in one form or another by both our Senators 
from Michigan, it really strikes a point. There are many 
instances where borrowers, as Mr. Merkley described earlier, 
that have performed and yet they are having trouble obtaining a 
loan now because of the fall-off of their collateral value.
    A program like the pilot program in Michigan, where funds 
are deposited into the bank in an interest bearing account that 
is, in turn, pledged to be additional collateral for the 
business loan, fills that collateral gap that is a problem with 
many of the anecdotal businesses that we are hearing about now 
that have the opportunity to expand, have the business acumen 
to be able to do that, and yet they don't have sufficient 
collateral for the bank to be able to make the loan, because 
very often, if we were to be able to make that loan, and 
believe me, we know these businesses. The community banker 
knows their business. They have been out there. They understand 
what is going on.
    But we can't make a loan that would be classified 
substandard based on collateral values by our regulators the 
day we make it. And so filling that collateral gap is certainly 
one of the things that needs to be done in order for us to be 
able to fill the supply gap that may very well be upcoming, as 
has been mentioned by one of the other panelists.
    Chairman Brown. And the situation that both Senator 
Stabenow--all three, Senator Merkley, Senator Stabenow, and 
Senator Levin mentioned--is pretty common in the area you serve 
in Grand Rapids and the auto supply industry, I assume, where 
you are.
    Mr. Johnson. I wouldn't say it is real common, but it does 
occur. There is no question. And it is not just isolated to the 
auto industry. I mean, it is other small businesses, as well.
    Chairman Brown. One other question for you. I was speaking 
yesterday with someone from the old National City in Cleveland, 
a banker, an executive at National City, now PNC in Cleveland, 
about SBA and lifting the caps on loans, especially for 
manufacturing, and taking it to the next step. There is 
discussion of SBA, one, lifting the cap, which I think is 
likely, but a discussion also of SBA doing direct lending. Give 
me your thoughts on that. Is it prudent to do that? Is it going 
to lead to higher default rates? What are your thoughts on more 
direct lending from SBA?
    Mr. Johnson. Well, our bank is a preferred SBA lender and 
we have been for quite some time, and I have the benefit of 
being around and being engaged in SBA lending nearly 30 years 
ago when the SBA did, in fact, do some direct lending. And I, 
frankly, think it is a mistake to go back in that direction, 
particularly from the perspective of needing to do something 
that has immediate impact.
    The delivery channel, the banking sector, is already in 
place. I do think that it would be a more prudent path and a 
more effective path would be to gear up the SBA's resources in 
terms of supporting the banking delivery channel. You know, 
there have been huge cutbacks in the staff of the SBA over the 
last several years, and to ramp that back up to where they can 
support the existing channel, where the expertise already 
resides, would, it seems to me, have the greater impact, 
probably the more prudent impact, because even on a 90 percent 
guaranteed loan, we still have 10 percent of our money at risk 
and that makes us want to underwrite, as well.
    Chairman Brown. OK. Thank you.
    Mr. Gillett, you mentioned the examination environment, is 
the term you used, that roughly in the survey, you cited some 
50 percent of bankers, of responding bankers said that was a 
problem. Give me a couple of examples where that may have been 
a barrier to lending.
    Mr. Gillett. I think it is a matter of interpretation and 
classification of credits. Just as Mr. Johnson mentioned, you 
don't want to book a loan on day one and have it classified 
substandard and it works against your capital ratios at a time 
when capital is king, and in the community bank sector, capital 
is very hard to generate.
    In our own shop, you know, I can say that we have a very 
good working relationship with the regulators. We don't always 
agree, but at the end of the day, we seem to be on the same 
page. I have read the commercial real estate guidance that was 
issued last September, I believe, and believe it to be very 
straightforward.
    So from the other 52 percent, Senator, I don't know that I 
can necessarily speak for them in their particular instances. I 
can only refer to the experiences that we have had internally 
in Sutton Bank.
    Chairman Brown. OK. The Associated Builders and Contractors 
cite access to capital as a major factor contributing to the 
decrease in lending for private sector construction projects. 
Many of these projects obviously rely on community banks for 
access to credit. What do we do about that?
    Mr. Gillett. As I mentioned in my opening remarks, we 
utilize the USDA Business and Industry and SBA programs to the 
extent that we can. It helps the customers, favorable terms, if 
you will, and it also allows the banks to manage their balance 
sheets. We have utilized that extensively in my career, and 
when programs fit, we will obviously use them. I will leave it 
at that.
    Chairman Brown. OK. Mr. Date, and then I will yield to 
Senator Merkley for his questions. One question. I want to hear 
your perspective on those manufacturers who are facing this 
credit environment who have plans to diversify and transition 
from, say--and I don't mean to make this all about autos, as it 
is a matter in our States but aren't everything in our States, 
obviously--but they want to transition to clean energy supply 
chain manufacturing or assembly, either, for that matter.
    There is legislation I introduced called the IMPACT Act, 
which would set up a Federal revolving loan fund that would pay 
its--it would be paid back, obviously, to help companies go 
into clean energy manufacturing. If they are glassmakers in 
Toledo for trucks, they could be solar panel manufacturers in 
Toledo, as there is much of already.
    How can we help these manufacturers make that transition, 
short of legislation like that, but even as a companion, if you 
will, with legislation like that? How do we help manufacturers 
who want to do that in these more difficult credit times?
    Mr. Date. It is a twofold answer. The first thing to 
recognize is that the bank system and traditional bank lending 
has very little to do with business model shifts like the one 
that you are describing, and the reason for that is, in 
general, the risk profile. That kind of borrower is going to be 
something that is a lot more appropriate for something that 
looks like venture capital or a mezzanine-type investor as 
opposed to the traditional debt that is available through the 
banking system. So I think you are right to think about 
addressing it through a means that is separate from and apart 
from the ongoing effort to recapitalize and reorient the 
banking system.
    One of the things that will allow the, what I will call 
broadly sort of the small business venture capital supply to 
increase--I mean, there really has been a fall-off in the 
amount of investing in that piece of the capital structure 
among small businesses--one of the things that will enable it 
to come back is a stabilization in the financial markets more 
broadly. If you are a venture investor, at some level, you want 
your money back, and part of the way you get your money back 
is, as the business model shift that you are describing takes 
place, well, then you should be able to access and refinance 
higher cost debt into lower cost debt. And so a lot of the 
efforts that you have talked about in terms of making the bank 
market more stable and productive would have an indirect effect 
on the kind of needs that you are talking about.
    Chairman Brown. Good. Thank you.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chairman. Thank 
you all for your testimony.
    Mr. Johnson, in your testimony you lay out the very 
dramatic decline in SBA's flagship 7(a) loan guarantee program. 
I had assumed that under the stress of the economy there would 
have a shift into that guaranteed program. Obviously, that is 
not the case. Does this decline pretty much match the overall 
declines in lending, or is it a different pattern? And what can 
we learn from that?
    Mr. Johnson. Well, I can speak most authoritatively, I 
guess, about what has happened in my own bank. Frankly, over 
the past 5 years or so, we were not as actively engaged in SBA 
lending because of a variety of factors, but most of them were 
competitive within our local marketplace. But since the 
economic downturn, since the initial change in SBA 7(a) 
programs where the guarantee was raised to 90 percent and where 
the fee to the borrower was dropped to zero, we held a series 
of three seminars around our marketplace, which are all within 
about 30 miles of each other, to give you some perspective of 
what our footprint is. And we had 60 to 80 people at each one 
of these to talk about what the new programs from the 7(a) 
program looked like and to generate some interest and 
discussion.
    Frankly, these were much, much more heavily attended than 
we anticipated, which we thought was wonderful, and I believe 
we have made at least one loan from each one of those groups or 
we are at least talking to people about something.
    A good number of them I think were not looking for credit 
right at the moment, but were looking down the road a little 
ways, as small business people do, to when things got a little 
bit better, they would be ready to go.
    Senator Merkley. Thank you very much. And you also pointed 
out in your written testimony that you had some comments 
regarding SBA's no refinancing rule and that that was a 
challenge: ``The SBA allows no refinancing of existing debt by 
the bank that currently holds the debt. This restriction . . . 
prohibits the borrower from obtaining new financing critical to 
continued success.'' Can you expand a little bit on that?
    Mr. Johnson. Well, yes, there is--you can do in certain 
circumstances--and I do not want to get too far down in the 
weeds here because, believe me, we really could. But, in 
general, there are some limitations on refinancing. There are 
sometimes some ways around that if you really know your way 
through the rules. But, frankly, any restriction in that regard 
is probably one restriction too many right now.
    Senator Merkley. What is the underlying theory behind those 
restrictions on refinancing?
    Mr. Johnson. I am not sure that I understand that.
    Senator Merkley. OK. I will flag that for something, and we 
will try to get some more--anything that somebody has raised as 
an obstruction at this point, I think we need to pursue it and 
understand it and see if it needs to be changed.
    Mr. Johnson. We would be happy to work with you on that.
    Senator Merkley. Now, Mr. Gillett, you referred to 
commercial real estate loans as often being the bread and 
butter of community banks. We had testimony from the two 
Senators from Michigan about collateral support programs as one 
way to help address the drop in collateral that has been 
plaguing commercial real estate. Can you give your insights on 
whether that strategy would be effective?
    Mr. Gillett. Senator, I believe in one of their testimonies 
they discussed the fact that the program was oversubscribed, 
and I think that statement alone speaks to the value of the 
program. That is something that we would utilize if made 
available.
    Senator Merkley. And, Mr. Johnson, a similar experience 
from your feet on the ground?
    Mr. Johnson. Yes.
    Senator Merkley. OK. Thank you. Mr. Date, you noted we have 
to be careful about subsidies. Is it your concern that the 90-
percent guarantee leaves too little exposure and might lead to 
loans that are not wise investments? Is that the point you are 
trying to drive home?
    Mr. Date. It is two concerns. With respect to the 90-
percent guarantee or any of the SBA programs as enhanced at 
this point, I think my principal concern is that, you know, $5 
billion in a quarter for the SBA is probably a pretty good 
number. Compare that to Fannie and Freddie together, which are 
producing some $5 billion a day in the residential mortgage 
markets. Small business credit is very big business. I mean, 
depending on how you think about this, it is somewhere between 
$2 and $3 trillion, and I think that realistically there is no 
way to really imagine the SBA expanding to something that fills 
the gap anytime soon.
    With respect to direct lending programs, that concern just 
becomes more enhanced for me. I do not think that we are going 
to be particularly good arbiters of credit, and I am concerned 
that even if we were, it would take a long time to build that 
infrastructure.
    Senator Merkley. One of the reasons that I have been 
advocating for the Bank on Our Communities Act, which is 
similar to the President's proposal, is that we needed the 
experience and the relationships of the community banks in 
order to evaluate lending, so helping to recapitalize community 
banks and using community banks as the--employing their wisdom, 
and I think that goes to the point you are making about not 
doing direct lending in the small business arena.
    But you also raised some concerns about that model of 
recapitalizing banks and concern that that would help the banks 
that need it the least or are unprepared to make the best 
decisions. Can you kind of elaborate on that a little bit more?
    Mr. Date. Sure. In general, anytime we choose to infuse 
capital into an institution and, in general, if we have the 
same set of conditions and pricing applied to everyone, that 
capital is going to be the most valuable to exactly those 
institutions who have the biggest capital deficits today. And 
this is not a credit crisis that has kind of come in out of the 
blue and impacted us. We--and I say ``we'' because I was in 
this industry for most of my career--We kind of created this 
credit crisis. And if you are the kind of person and the kind 
of bank that was lending more even as asset prices on real 
estate got increasingly comically detached from fundamentals, 
chances are you are still a bad credit underwriter and we, the 
taxpayers, should not be supporting you. So, hence, I like the 
idea of more finely tuning capital infusions.
    Senator Merkley. Well, you might be familiar with--we have 
a stress test in the Bank on Our Communities Act to avoid 
putting funds into banks that are failing, and perhaps failing 
because they have made unwise decisions or have made decisions 
that were wise at the time but the market changed in 
unanticipated ways and put them in a very difficult spot. But 
to protect against the taxpayer--the wisdom of the taxpayers' 
investment, is that type of a stress test something along the 
lines that you think would be wise?
    Mr. Date. I think that that, frankly, is a very good idea. 
I think that one of the singular successes of the Government's 
response to the crisis, though it was derided at the time, was 
the stress tests applied to the largest institutions. And 
although there are--I think there are people--I will not put 
words in their mouth--I think there are people at the Fed who 
would view that the idea of a more broad stress test 
methodology being applied to smaller firms would be too 
difficult to carry out. I just do not see why that would be.
    Senator Merkley. Thank you very much. Thank you all.
    Chairman Brown. Thanks, Senator Merkley.
    Let me ask a general question of all three of you, and then 
if Senator Merkley has some more questions, we can end with 
that.
    I spoke yesterday with the top executive at a large 
national company, head of its Ohio operations, a major 
manufacturing company, and he was talking about his concern 
about the supply base for his company once the economy gets 
better again. He has seen several of his suppliers go out of 
business--not most of them, but a significant number of them--
that he is concerned they are able to keep it together once the 
economy gets better. His interest partly is, you know--I mean, 
they are paying special attention to these companies, extending 
perhaps equity arrangements, perhaps other kinds of 
arrangements with them.
    Putting that aside for a moment, talk, each of you--and I 
will start with you, Mr. Date, and work this way this time, but 
ask each of you to sort of address the issue of what we do 
about those small businesses that are in the supply base for 
any number of large assembly, large manufacturers, and bringing 
in to the answer do we utilize TARP funds to get them credit. 
Some, like the National Federation of Independent Business, 
will argue that it is not a question of encouraging lending to 
these small businesses. They do not have the customers, and 
they do not have the sales. That is beginning to change. They 
are partly right, to be sure, but there is more to it than 
that, of course. So talk about what we do with TARP funds, 
perhaps extending credit, working with community banks, with 
all the reputation that TARP might have to a community banker, 
and just to the ultimate user of the TARP funds. Talk about 
what that might mean for expanding eligibility on loan limits 
for SBA. Work any of that into your answer and kind of give 
this Subcommittee some advice on what we might do to partner 
with some of these companies so that when the economy does 
begin to grow in earnest, we are more ready than we might be 
today. Mr. Date.
    Mr. Date. Let me just suggest two things. One is that we 
need to put some real effort into understanding a number of 
these non- real estate lending categories, which really impacts 
manufacturing, I would argue, a little bit more than most. 
Early on in the crisis, you had this phenomenon where every 
business in the supply chain was just trying to extend its 
payable cycle. That does not really work forever, so sooner or 
later somebody is going to have to relearn how to lend against 
receivables and against inventory, frankly, in a market that 
had been eaten up by the finance companies over the last decade 
because they were playing by a different set of capital rules 
than the banks. So now, unfortunately, we are in a situation 
where the banks have to get back into these businesses, but it 
is hard. And I think that to the extent that I was going to 
create a Government guarantee program or some loss sharing, it 
is really in those non- real estate lending categories that I 
would focus.
    As it relates to TARP's stigma, I have never been 
especially a believer in that. If a firm needs the capital to 
grow, at some level the bottom-line interest of shareholders 
predominates. Of course, bank executives sometimes have a 
different perspective than shareholders.
    Chairman Brown. Well, thank you, Mr. Date.
    Mr. Gillett, your thoughts generally?
    Mr. Gillett. I think there is a possibility that we could 
utilize the financial institutions as maybe the collection 
points, if you will, or the distribution network for access to 
TARP monies to be approved at some level, whether that would be 
through SBA or whatever office. It might be a way to get 
capital into the small business, the manufacturing companies 
that you are alluding to.
    As it relates to financial institutions, however, you know, 
our bank--and I will go back to what Raj just mentioned, you 
know, the stigma of TARP. Our bank chose not to participate in 
TARP because of more so the nonmonetary costs. So I think we 
need to address that somehow in addition or as part of this 
process.
    Chairman Brown. You were concerned about the stigma 
attached to Sutton or the stigma attached to people who you 
lend to?
    Mr. Gillett. To Sutton.
    Chairman Brown. OK. Fair enough.
    Mr. Johnson.
    Mr. Johnson. There will be a lot of community banks that 
will think long and hard about participating in any program 
that has any connection to TARP funds. The stigma that was 
attached, the demonization that many banks went through 
following that program's initiation, the changing of the rules, 
is not something that will be looked upon kindly. So anything 
that can distance any program from TARP I think would have a 
much higher degree of potential success.
    One of the points that I would like to make is just to 
reiterate a phrase that Senator Levin used, and that phrase was 
to have as many possible arrows in our quiver as we can. I do 
not think that one-size-fits-all solutions are likely to be 
found here because there are a number of different problems. We 
have talked about the collateral problem. We have talked about 
the capital problem. There is also at some point--when we get 
further into the recovery, there may very well be a funding 
problem in some community banks. We do not know what is going 
to happen to the rates on deposits. So our ability to be able 
to raise, actually have the funds to be able to lend, may--it 
is not a question now, but it may come into question at some 
point.
    So there is a number of different problems that may arise 
in terms of filling the supply gap that may very well develop, 
as Raj has, I think very artfully, laid out in his written 
testimony.
    The other thing is that in terms of a small business, not 
all credit is exactly the same. There is long-term credit for 
the building. There is intermediate-term credit for the 
equipment that may be in that building. And then there is 
short-term credit that is rolling over based upon a particular 
job that they may have. So we have to have programs and answers 
that fit all of those needs.
    Chairman Brown. Thank you, Mr. Johnson.
    Senator Merkley, any more questions?
    Senator Merkley. No.
    Chairman Brown. OK. Well, thank you all for joining us. I 
want to note that statements for the record have been submitted 
from the independent sector, the Associated Builders and 
Contractors, the National Association of Home Builders, the 
Credit Union National Association, and the National Association 
of Realtors.
    Chairman Brown. The hearing record will remain open for 7 
days, so if any of you want to expand on any of your answers or 
on your opening statements or submit any other information or 
statement for the record, you are welcome to do that for the 
next 7 days.
    I thank Senator Merkley, again, thank the three of you very 
much for your contribution. Thanks very much. The hearing is 
adjourned.
    [Whereupon, at 10:50 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]

                PREPARED STATEMENT OF SENATOR CARL LEVIN

    Chairman Brown, Ranking Member DeMint, Members of the Subcommittee, 
thank you for inviting me to speak to you this morning about the 
important issue of ensuring that small businesses have access to the 
credit they need. On behalf of the Michiganders and Americans whose 
livelihoods are at stake, thank you for taking up this enormously 
important issue.
    I'd like to tell you a little bit this morning about the truth on 
the ground in my State, the word we're getting from small business 
owners and from community banks who are, even as macroeconomic 
indicators show our economy is recovering, struggling with the effects 
of the worst economic crisis in decades. And I'd like to suggest some 
strategies that I believe, after a great deal of research and 
discussion, can help relieve those struggles and get our economy, and 
our constituents, working again.
    But first, I want to try to impress upon each of you just how 
important I believe this issue to be. Recent economic data suggests 
that, from a technical standpoint, our economy is rebounding. Gross 
domestic product is starting to grow, and the flood of layoffs and 
business closings that hammered us for so many months has slowed to a 
trickle. But for many Americans, things haven't gotten any better, and 
for far too many, the situation is worse. Unemployment in my State is 
almost 15 percent, and it is unacceptably high in most States. So far, 
despite the fact that our economy is becoming productive again, it is 
not providing the job growth necessary to restore hope and opportunity 
for the millions of Americans who were caught up in the economic 
hurricane of financial collapse.
    If we do not act, and quickly, to help restore employment, the 
``green shoots'' for which we have so much hope will not blossom. They 
will wither.
    What stands in the way of job growth? When I talk to employers in 
Michigan, often the first problem they discuss with me is the 
difficulty in obtaining the capital they have traditionally relied on 
to finance their operations: capital to meet payroll, to finance 
inventory, to update their equipment or to expand their business. 
Dozens upon dozens of businesses have come to us, worried about their 
inability to keep their lines of credit or get new ones. Even those 
with good credit and paying customers often cannot get the financing 
they traditionally have obtained, or sometimes can get it only by 
agreeing to unaffordable terms. Let me mention just one typical 
Michigan example of the problem: a small manufacturer based in the 
Thumb region of our State. The company's longtime bank lender told the 
company it could not renew the firm's 5-year loan, instead offering 90-
day renewals at a much higher interest rate, even though the company 
had never missed a payment and had adequate business revenue. The 
company, with 77 workers and 150 customers, sought a loan elsewhere, 
but other banks--28 of them--rejected its application. That story can 
be repeated 100 times throughout the State.
    At times my staff has worked on a one-on-one basis with individual 
businesses and local banks, trying to find solutions that can keep 
business humming. We have had discussions with the Michigan Bankers 
Association and with State officials to try to match worthy businesses 
with banks willing and able to lend. But the problem persists. And it 
is especially damaging in Michigan, where so much of our job base 
consists of small and midsized manufacturers. These companies form the 
economic backbone of communities across the State, and they are in 
capital-intensive industries that make access to capital absolutely 
vital.
    This is frustrating on many levels, but perhaps most frustrating 
for me, not to mention the businesses involved, is that the local banks 
they have done business with for years want to continue to lend, but in 
many cases cannot. For much of this crisis, our attention has been 
focused on the largest financial institutions in our country. Programs 
like TARP provided large sums of capital to these institutions because 
their failure would endanger the entire economy. We've also focused on 
them because, in many cases, it was their actions that precipitated the 
crisis.
    But now, while giant firms such as Citi and Goldman Sachs report 
massive profits, the real lifeblood of many local economies--local 
banks--don't have it nearly so good. Recently, the FDIC released a 
report that demonstrates the scope of the problem. At the end of 2009, 
the report said, 702 banks across the United States were in at least 
some danger of failure. That was up from 252 banks at the beginning of 
the year, and up 27 percent from just 3 months before. The FDIC warned 
that this jump is largely the result of a crisis that began on Wall 
Street spreading throughout the country. And as a result of that 
spread, bank lending has plummeted, down 7.5 percent from 2008 to 2009. 
Nationally, business loans--again, the lifeblood of business and 
employment--declined 18.3 percent.
    And in Michigan, the situation is worse. One estimate is that 
overall bank loan volume in Michigan declined by 74 percent from 2007 
to 2009!
    The first point I would make is that while those large banks have 
gotten most of the help so far, they are also the ones pulling back the 
most on lending. I agree strongly with FDIC Chairman Sheila Bair, who 
said, ``Large banks do need to do a better job of stepping up to the 
plate here.'' But that is not all of the problem. I agree with Senator 
Merkley and with the Administration that we must to something to 
support community banks so that they can lend to the small businesses 
that are key to creating jobs in our communities.
    We can help businesses that are being turned down for credit 
despite having excellent credit histories and adequate orders and 
revenues or viable plans to diversify into emerging growth industries. 
In many cases, the banks that have long serviced these companies are 
simply unwilling or unable to lend, not because they fear an increased 
risk of default, but because the business's collateral has fallen in 
value. Just as the value of our homes has fallen in this recession, so 
has the value of the inventory, equipment and buildings held by 
businesses. Because those assets are worth less, banks are less willing 
to provide loans that use them as collateral. Even if a bank has enough 
capital to lend to small businesses, they are unlikely to do so for 
businesses--like so many in my State--whose assets have fallen so 
rapidly in value.
    In Michigan, our Michigan Economic Development Corporation has a 
program that is designed to help support the collateral values of 
borrowers in this situation. And for years, the State has operated a 
Capital Access Program, which also helps borrowers with decreased 
collateral values. That program funds reserve accounts to support loans 
to businesses that need collateral support. I think we can learn from 
these programs, and those in other States, and work together to craft 
legislation that will directly help businesses whose depleted 
collateral values are inhibiting not only their abilities to survive 
and grow, but also our economy's.
    There are other policy details that I have strong feelings about, 
but again, my strongest feeling is that this is a problem requiring 
urgent attention. I congratulate the Subcommittee on holding this 
important hearing, and encourage you all to push hard for a solution 
that will get capital to struggling businesses so that they can do what 
we need them to do: put more people to work. Thank you.
                                 ______
                                 
             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW

    Thank you, Mr. Chairman, for your leadership on this issue and for 
holding this important hearing. And thank you, Senator DeMint (ranking 
member), for being here today as well. I appreciated hearing from my 
colleague from Michigan, Senator Levin, and I also want to thank 
Senator Warner and Senator Merkley, who have also been working so hard 
to fix this problem.
    I'm also pleased that the Chairman of American Bankers Association, 
Art Johnson, is testifying today. As the CEO and Chairman of the United 
Bank of Michigan and United Community Financial Corporation in Grand 
Rapids, Art understands the serious problems facing community banks and 
small businesses in some of the hardest-hit areas of the country.
    The subject of today's hearing is so important to our efforts to 
rebuild our economy. We know that small business create 64 percent of 
jobs in this country. We also know that small businesses tend to get 
loans from their local community bank, not big Wall Street firms. 
According to FDIC call reports, banks with less than $1 billion in 
assets--making up only 12 percent of all bank assets nationwide--made 
nearly half of the small business loans.
    Federal regulations have--rightly--cracked down on the big banks 
who caused this financial crisis. According to the FDIC data the amount 
of lending by the banking industry fell by about $587 billion or 7.5 
percent in 2009, which is the largest annual decline since the 1940s.
    Ultimately, it is America's small businesses, and American workers, 
who suffer the most. I continue to hear from small businesses in my 
State who can't access credit to grow their company. Some of them have 
orders in--they have customers ready to buy their products--but they 
can't get the capital they need up front to make the products.
    However, it's important to separate the large financial 
institutions that benefited from TARP from the vast majority of banks. 
As I mentioned, the smaller banks, who did not receive nearly as much 
support from TARP as the larger banks, originate the vast majority of 
small business loans.
    Thankfully, our community banks are still lending, despite dealing 
with increased pressures to increase capital and reduce risk. They, 
too, are suffering from an economic environment that makes it hard to 
raise capital. I look forward to hearing more about this from the 
witnesses on the next panel.
    I am also looking forward to hearing follow-up about the issues 
raised by Senator Levin--especially how small businesses are dealing 
with reduced cash flow and collateral whose value has decreased in 
recent years. Many small business owners have used their homes as 
collateral for loans to keep their business opened, and as home prices 
decline, so too does their ability to keep credit flowing.
    But, as we know, the housing market isn't the only place where 
values are declining. The commercial real estate market has also been 
hard-hit, which hurts manufacturers particularly hard. The value of 
manufacturers' property, factories, and equipment has dropped as much 
as 80 percent in the last 18 months.
    As I'm sure our next panel can attest, even a healthy bank will not 
make a loan to a borrower who does not have enough collateral value.
    In Michigan, our manufacturers are trying to retool and diversify. 
They are moving into high growth industries like health care, defense, 
and clean energy. But they are having trouble growing because they are 
having trouble getting credit. New regulations imposed on big banks 
make sense, but a one-size-fits-all approach is hurting the ability of 
small banks to help our small businesses. The theory of ``too big to 
fail'' now means that many of our businesses today are ``too small to 
grow.''
    These are the companies who create jobs in America. If we are going 
to create jobs, we need to let those small businesses grow.
    Nearly 700,000 Americans work for parts suppliers, more workers 
than in any other type of manufacturing company. Let me give you just 
one example of how this credit crunch is affecting these small 
manufacturers.
    Wes Smith, who is the President of E&E Manufacturing, a metal 
stamping company in Plymouth, Michigan, is looking to expand his 
business, but might not be able to because his long-time lender 
recently reduced his line of credit and changed his loan covenants. 
Although sales picked up at the end of last year, and they are 
expecting a 20 percent increase in sales projections, he is having 
trouble getting the capital he needs to rehire about 200 people he was 
forced to lay off during the worst of the recession.
    That's 200 people at just one plant who could come back to work 
today if their company had better access to credit. As Senator Levin 
mentioned, Michigan started a successful program in 2009 that targets 
businesses that may be good credit risks, but have collateral or cash 
flow shortfalls.
    The first $13 million of that fund was fully committed within the 
first 5 months, and was oversubscribed by nearly 300 percent. 
Michigan's program has taken $13.3 million in public funding to 
leverage $41 million in private loans, which is a leverage ratio of 
about 3 to 1.
    When the Senate considers authorization of President Obama's Small 
Business Lending Fund, I hope we can take some of these funds and 
direct them toward programs, like the one we have in Michigan that 
would address these collateral depreciation issues.
    We also must address the separate problem of small businesses being 
able to qualify for a loan. I hope that as we address this issue, we 
also extend the Small Business Administration loan guarantee that 
expires this month and increase the maximum loan size of SBA 504 and 
7(a) programs, which the SBA estimates would create up to $5 billion in 
growth for small businesses and as many as 160,000 jobs.
    That's what this debate is really about--creating jobs and growing 
our economy. I hope this hearing can uncover ways that we can help 
small banks and small businesses create jobs and opportunity throughout 
America.
                PREPARED STATEMENT OF ARTHUR C. JOHNSON

 Chairman and Chief Executive Officer, United Bank of Michigan, Grand 
    Rapids, Michigan, on behalf of the American Bankers Association
                             March 2, 2010

    Chairman Brown, Ranking Member DeMint, and Members of the 
Subcommittee, my name is Arthur C. Johnson. I am Chairman and Chief 
Executive Officer of United Bank of Michigan, headquartered in Grand 
Rapids, Michigan. I serve as Chairman of the American Bankers 
Association (ABA), and I chair the ABA Community Bank Solutions Task 
Force, a committee dedicated to finding ways to address problems most 
acutely affecting community banking during this economic downturn. I am 
pleased to be here today representing ABA. ABA brings together banks of 
all sizes and charters into one association. ABA works to enhance the 
competitiveness of the Nation's banking industry and strengthen 
America's economy and communities. Its members--the majority of which 
are banks with less than $125 million in assets--represent over 95 
percent of the industry's $13.3 trillion in assets and employ over two 
million men and women.
    We are pleased to share the banking industry's perspective on the 
condition of small business and commercial real estate lending in local 
markets. As President Obama recognized in his recent State of the Union 
address, it is imperative to find ways to ensure that small businesses 
get the credit they need. Small businesses of all kinds--including 
banks--are suffering from the severe economic recession. While some 
might think the banking industry is composed of only large global 
banks, the vast majority of banks in our country are community banks--
small businesses in their own right. In fact, over 3,000 banks (41 
percent) have fewer than 30 employees.
    This is not the first recession faced by banks. Most banks have 
been in their communities for decades and intend to be there for many 
decades to come. United Bank of Michigan has survived many economic ups 
and downs for more than a century. We are not alone; there are 62 banks 
in Michigan that have been in business for more than 50 years, 20 of 
which have been in business for more than a century. Nationwide, there 
are 2,556 banks--31 percent of the banking industry--that have been in 
business for more than a century; 62 percent (5,090) of banks have been 
in existence for more than half a century. These numbers tell a 
dramatic story about the staying power of banks and their commitment to 
the communities they serve. My bank's focus, and those of my fellow 
bankers throughout the country, is on developing and maintaining long-
term relationships with customers, many of which are small businesses. 
We cannot be successful without such a long-term philosophy and without 
treating our customers fairly.
    This recession is certainly one of the worst we have ever faced. 
While the statisticians will say the recession has ended, that is 
little comfort to areas in our country that suffer from very high 
levels of unemployment and business failures. As the economy has 
deteriorated, it has become increasingly difficult for consumers and 
businesses to meet their financial obligations. The cumulative impact 
of eight straight quarters of job losses--more than 8 million since the 
recession began--is placing enormous financial stress on some 
individuals. With jobs lost and work hours cut, it does not take long 
for the financial pressure to become overwhelming. This, in turn, has 
increased delinquencies at banks and resulted in losses and reduced 
capital at banks.
    In this severe economic environment, it is only natural for 
businesses and individuals to be more cautious. Businesses are 
reevaluating their credit needs and, as a result, loan demand has 
fallen dramatically since the recession began. Banks, too, are being 
prudent in underwriting, and our regulators demand it. With the 
economic downturn, credit quality has suffered, and losses have 
increased for banks. Fortunately, community banks like mine entered 
this recession with strong capital levels. As the Subcommittee is 
aware, however, it is extremely difficult to raise new capital in this 
financial climate.



    The difficult recession, falling loan demand, and loan losses have 
meant that loan volumes for small businesses have declined somewhat 
this year. Let me be very clear here: even in a weak economy there are 
very strong borrowers. Every bank in this country is working hard to 
ensure that our customers--particularly the small businesses that are 
our neighbors and the life blood of our communities--get the credit 
they deserve. The Small Business Administration (SBA), in partnership 
with America's banks, can play an even larger role in helping small 
businesses meet the challenges of this economic downturn by expanding 
their guarantee program and by reducing some of the restrictions 
currently built into the system.
    The success of many local economies--and, by extension, the success 
of the broader national economy--depends in large part on the success 
of community banks. We believe there are actions the Government can 
take to assist viable community banks to weather the current downturn. 
Comparatively small steps taken by the Government now can make a huge 
difference to banks, their customers, and their communities--keeping 
capital and resources focused where they are needed most.
    In my statement, I would like to focus on the following points:

    Lenders and borrowers are exercising a prudent approach to 
        credit.

    Recent proposals can help to stimulate lending to small 
        businesses.

    Changes that enhance bank participation in SBA programs 
        have made strides in creating opportunities for small 
        businesses, yet more needs to be done.

    Changes in the regulatory environment will improve the 
        situation for small business lending.

    I will address each of these points in turn.

I. Lenders and Borrowers Are Exercising a Prudent Approach to Credit
    In every community, banks are actively looking for lending 
opportunities. Business confidence is down, of course, and many 
businesses either do not want to take on additional debt or are not in 
a position to do so given the falloff of their customer base. Thus, 
loan demand has fallen dramatically since the start of the recession. 
There are some positive signs beginning to appear. We have heard from 
bankers that small businesses are returning to test the market for 
loans, even though they may not wish to borrow at the moment. It will 
take time for this renewed interest to be translated into new loans 
made, however. Previous recessions have shown that it typically takes 
13 months after the recession for business confidence to return and 
credit to return to prerecession levels.



    Both banks and their regulators are understandably more cautious in 
today's environment. Bankers are asking more questions of their 
borrowers, and regulators are asking more questions of the banks they 
examine. Given the economic conditions, it is clear that the risk of 
lending is much greater today than several years ago when the economy 
was much stronger.
    This means that the credit terms are different today, with higher 
down payments required, and smaller loans consistent with diminished 
collateral values. Banks are looking at the risk of a loan and 
reevaluating the proper pricing of that risk. This is a prudent 
business practice and one expected by our bank regulators. But it means 
that some projects that might have been funded when the economy was 
stronger may not find funding today. The NFIB recognized this, stating, 
``[T]he continued poor earnings and sales performance has weakened the 
credit worthiness of many potential borrowers. This has resulted in 
tougher terms and higher loan rejection rates (even with no change in 
lending standards)'' \1\
---------------------------------------------------------------------------
     \1\ NFIB Small Business Economic Trends, November 2009. National 
Federation of Independent Business.
---------------------------------------------------------------------------
    Moreover, access to credit is not a driving concern of most 
businesses. In a recent survey of 750 businesses by Discover, only 5 
percent said the main issue facing their business was access to 
capital. \2\ NFIB's survey confirmed this finding: ``Although credit is 
harder to get, `financing' is cited as the `most important problem' by 
only 4 percent of NFIB's hundreds of thousands of member firms.'' NFIB 
notes that this is extremely low compared to other recessions. For 
example, in 1983--just after the last big recession--37 percent of 
business owners said that financing and interest rates were their top 
problem.
---------------------------------------------------------------------------
     \2\ Discover Small Business Watch, October 2009. Discover 
Financial Services.
---------------------------------------------------------------------------
    We recognize that there are some consumers and businesses in the 
current situation that believe they deserve credit that is not being 
made available. We do not turn down loan applications because we do not 
want to lend--lending is what banks do. In some cases, however, it 
makes no sense for the borrower to take on more debt. Sometimes, the 
best answer is to tell the customer no, so that the borrower does not 
end up assuming an additional obligation that would be difficult if not 
impossible to repay.
    To help manage the risk of loss, lenders have lowered credit lines 
for businesses and individuals. However, even with the cutbacks in 
lines of credit, there is still $6 trillion in unused commitments made 
available by FDIC-insured banks to businesses and consumers. The 
utilization rates have declined for business lending, particularly, 
reflecting the decreased demand.


    The commercial real estate (CRE) market will pose a particularly 
difficult problem for the banking industry this year. The CRE market 
has been the victim of a near total collapse of the secondary market 
for commercial mortgage backed securities and of the economic slowdown 
that has caused office and retail vacancies to rise dramatically. These 
stresses will affect many small banks, as CRE lending has been an 
important part of the portfolio for community banks for many years.
    Typically, a commercial real estate project in the construction and 
land development phase receives bank financing with an loan maturity 
between 3 to 7 years. After the project is completed, it is common for 
take-out financing to come from insurance companies or through the 
Commercial Mortgage Backed Securities (CMBS) market. This take-out 
financing focuses on income-producing properties and, thus, usually 
occurs once there are stable and sufficient cash flows for full debt 
servicing. The CMBS market practically disappeared in 2008 and is now 
just starting to rebuild slowly.



    This highlights the current dilemma: as market conditions have 
deteriorated, vacancies have increased, valuations have plummeted, and 
rent renewals have slowed. This in turn has made take-out financing 
increasingly scarce, leaving banks with loans that are stressed and 
facing refinancing. With transaction prices down dramatically, 
appraisal values have also fallen, making refinancing of loans much 
more difficult without significant additional equity contributions from 
borrowers--which, of course, are difficult if not impossible for many 
borrowers to put forward in this economic climate.
    As I will discuss in the last section of this testimony, regulators 
will continue to be nervous about the trends in CRE lending as the 
economy struggles to regain its footing and will be critical of banks' 
CRE portfolios. The 2009 guidance from the regulators signals a prudent 
but flexible approach. However, we continue to hear that the 
translation of the guidance to the field examiners has been missing. 
However, we remain hopeful that this guidance could help banks work 
with borrowers to find solutions.
    As the economy begins to improve, we expect loan demand to 
increase, and with it, credit volumes as well. ABA's Economic Advisory 
Committee (EAC) forecasts that nonresidential fixed investment will 
increase 3.8 percent in 2010, and businesses will begin to expand and 
grow inventories. The EAC believes this will coincide with an increase 
in business lending, which it expects to increase modestly this year at 
a 2.3 percent rate. The group also expects consumer credit to grow at a 
rate of 3.2 percent. As the economy grows and loan demand increases, 
the ability of banks to meet these needs will be stunted if adequate 
capital is not available to back increased lending.

II. Recent Proposals Can Help To Stimulate Lending to Small Businesses
    Capital is absolutely critical to any bank, as it is the financial 
underpinning of any loan that is made. While conditions have improved 
over the past year in the economy overall, many community banks are 
seeing elevated levels of loan delinquencies and loan losses as a 
result of the lagging impacts of job losses, business failures, and 
declines in property values. The result has been stresses on bank 
capital. Given the severity of the downturn, particularly in certain 
parts of this country hardest hit by the recession, it is very 
difficult if not impossible for community banks to find new sources of 
capital.
    ABA appreciates the initiative President Obama outlined in his 
State of the Union address that would help to resolve this issue by 
providing additional capital to small banks who volunteer to use it to 
increase small business lending. However, using TARP money to fund it 
raises the very real possibility that the TARP stigma will discourage 
banks from participating. This is because hundreds of banks that had 
never made a subprime loan or had anything to do with Wall Street took 
TARP capital with their regulator's encouragement--even though they did 
not need it--so they could bolster their lending and financial 
position. Then within weeks, they were demonized and subject to after-
the-fact restrictions. Community banks will be disinclined to 
participate if there is any possibility of TARP-related stigma being 
attached to it. We would urge Congress to distinguish any new proposal 
it considers from TARP in order to avoid creating a program that 
permits after-the-fact restrictions.
    Another idea is to use existing State lending programs to target 
small businesses in local markets. The State of Michigan has developed 
a number of programs that could be used as a model for this kind of 
proposal. Michigan has two programs, the Capital Access Program (CAP) 
and the Michigan Collateral Support Program (MCSP).
    The CAP uses small amounts of public resources to generate private 
bank financing, providing small Michigan businesses access to capital 
that might not otherwise be available. Participating banks throughout 
Michigan offer CAP loans directly to companies that need credit 
enhancement. Similar to a loan loss reserve fund, the bank, the company 
and the MEDC pay a small premium into a reserve that makes it possible 
for the company to receive fixed asset and working capital financing. 
Under the CAP, more than 11,211 loans have been provided to Michigan 
businesses over the past 22 years. The $24.3 million in public/state/
MEDC/MSF resources committed to the program supported approximately 
$628.7 million in bank lending--a private/public ratio of 27 to one.
    The MCSP supplies cash collateral accounts to lending institutions 
to enhance the collateral coverage of borrowers. These accounts cover 
all or a portion of a calculated collateral shortfall as described by 
the lending institution. Borrowers with a collateral shortfall apply 
for coverage through the Michigan Economic Development Corporation 
(MEDC), on behalf of the Michigan Strategic Fund (MSF). If approved, 
the MSF deposits the cash into an interest bearing account with that 
lender and this account will then be pledged as collateral on behalf of 
the borrower. Based on an amortization schedule, the MSF will draw down 
the account as the loan principal is paid. In the event of full 
default, the lender will have rights to the account less a liquidation 
fee. Loan-flow in Michigan's pilot program has been high, with close to 
300 inquiries and at least $150 million in requests in the first 2 
months of the program. The loans in which Michigan banks have 
participated have created or saved jobs at a ``cost'' of approximately 
$6,000 per job. That is particularly exciting when you consider that 
the $6,000 is in the form of a loan/deposit which we are confident will 
be repaid with interest. This creates a real negative cost per job.
    As these and other future programs are developed, ABA recommends 
that Congress and the Administration create criteria that allow all 
viable community banks to participate. We propose that Treasury offer 
assistance to those banks that did not qualify for Capital Purchase 
Program (CPP) funds but that nevertheless can demonstrate the ability 
to operate safely and soundly and survive if given the chance to obtain 
necessary capital. The focus should be on whether a bank is viable on a 
postinvestment basis. Otherwise, Congress will miss an opportunity to 
help the customers and communities of many banks across the country.
    Community banks, like mine, are the backbone of our economy and are 
critical to the overall improvement of our economy. For a nominal 
investment by Treasury, viable community banks can be preserved, which 
in turn would provide more resources for lending and would help create 
jobs in our communities.

III. Changes That Enhance Bank Participation in SBA Programs Have 
        Created Opportunities for Small businesses, Yet More Needs To 
        Be Done
    The SBA program has struggled over the last several years. SBA's 
flagship 7(a) loan guarantee program reported a 41 percent decline in 
volume from its 2008 to 2009 fiscal year, after reporting a 30 percent 
decline from 2007 to 2008. The dollar amount outstanding declined 28 
percent from its 2008 to 2009 fiscal year, following an 11 percent 
reduction over the previous year. The changes made have helped to stem 
the reductions and show promise for more lending should the program be 
extended, as we recommend. In particular, the changes have helped to 
facilitate 12,374 loans made totaling $3.8 billion in its first fiscal 
quarter of 2010.



    In order to show further improvements, the SBA needs go beyond an 
increase in the amount of the guarantee; it needs to offer an improved 
value proposition. Current restrictions involving cost, collateral, 
refinancing, and prepayment penalties, among others, should be 
addressed.
    Although many improvements are needed, much has already been done. 
This Congress has consistently worked to maintain the integrity of the 
7(a) program and we applaud your efforts on the Recovery Act to enact 
the small business provisions.
    The act temporarily increased the guarantees to up to 90 percent on 
SBA's 7(a) loan program, which have been helpful as banks work to 
extend credit during the recession. It also temporarily cut fees for 
borrowers on 7(a) loans and reduced fees for both borrowers and lenders 
on 504 Certified Development Company loans. SBA Administrator Karen 
Mills noted that average weekly loan volume has increased both in the 
7(a) program and the 504 program following passage of the Act, and that 
participation among banks had likewise increased.
    Further, the SBA expanded eligibility to small businesses in the 
7(a) program by applying the broader standard used currently in the 504 
program. Now, businesses will be able to qualify with a net worth that 
does not exceed $8.5 million and an average net income under $3 million 
(after Federal income taxes) for the preceding two fiscal years. These 
very positive changes mean that an additional 70,000 among the largest 
of our small businesses will be eligible to participate in the 7(a) 
program.
    Other provisions from the Act include provisions that raised the 
maximum contract that can qualify for an SBA Surety Bond guarantee from 
$2 million to $5 million and provided additional funding to microloan 
intermediaries, as well as funding for the technical assistance needed 
to accompany these loans.
    All of these initiatives help small businesses during this 
recession, and should be funded and continued past their current 
authorization periods in order to reach even more small businesses. 
Moreover, there are a number of improvements that would provide 
additional incentives to small businesses and banks that would enable 
even broader participation:

    Extend the Provisions of the Stimulus Package. As part of 
        the economic stabilization package, Congress increased the loan 
        guarantee level in the 7(a) program to 90 percent and also 
        decreased the fees for both the borrowers and the lenders. Both 
        actions have provided a much needed boost for lender 
        participation in the program. Funding for the guarantee and fee 
        relief was exhausted on February 28. We thank the Senate for 
        including additional additional funding in the recently passed 
        jobs bill. We believe these provisions that expand both the 
        guarantee and fee relief should be funded and extended for an 
        additional 2 years beyond the 2010 expiration date. While we 
        are all hopeful that the economy will regain its footing over 
        the next 12 months, we are also realistic in understanding that 
        the recovery may be very slow. Additional capital through 
        lending will create an environment where small businesses will 
        begin to rehire or add new jobs.

    Eliminate or Reduce the Restriction on Refinancing. The SBA 
        allows no refinancing of existing debt by the bank that 
        currently holds the debt. This restriction often prohibits the 
        borrower from obtaining new financing critical to continued 
        success. In many circumstances banks would like to make new and 
        consolidated advances, but if the bank already has a deal on 
        the books, that loan cannot become part of the new deal. This 
        restriction often causes the bank to write new loans without 
        the help of the SBA, or ask the borrower to seek help from 
        another lender.

    Enhance the Human Resources Capacity of the SBA. There is a 
        very practical barrier to the success of these programs: having 
        the staff necessary to implement, promote, market, and manage 
        the many initiatives of the SBA. We request that the 
        Subcommittee investigate the human resource needs of the SBA. 
        Over the last 8 years, the SBA staff has been reduced by nearly 
        1,000, roughly one-third of its employees. This has been done 
        through consolidation, retirements and attrition. Since January 
        2009, the SBA has taken on many new loan programs and seen a 
        sizeable increase in their budget allocation to implement and 
        carry out these programs. Yet, the number of staff assigned to 
        carry out the old and new programs has not been increased and, 
        in fact, the program responsibilities of these employees have 
        increased. SBA has thousands of partners and many more that 
        desire to establish or reestablish a relationship with the 
        agency. Without adequate levels of personnel to meet the needs 
        of these partners, the small businesses that they serve will 
        suffer.

    The initiatives and new programs launched by the Administration and 
by Congress have great potential to help thousands of small businesses. 
These programs should be improved further and given the time to work. 
In addition, the SBA must be given the human resources to implement 
these initiatives, many of which are new to the SBA. ABA is prepared to 
work with Congress to find ways to improve the SBA program, with the 
goal of enhancing credit availability to small businesses throughout 
our Nation.

IV. Changes in the Regulatory Environment Will Improve the Situation 
        for Small Business Lending
    As I noted above, banks are not immune from the economic downturn; 
job losses and business failures have resulted in greater problem loans 
and much higher loan losses. Nonetheless, banks are working every day 
to make credit available. Those efforts, however, are made more 
difficult by regulatory pressures and accounting treatments that 
exacerbate, rather than help to mitigate, the problems. ABA has raised 
the issue of overzealous regulators in hearings last year and through 
letters to the agencies. We are pleased that on February 5, 2010, the 
Federal financial regulatory agencies and the Conference of State Bank 
Supervisors issued a joint statement emphasizing that financial 
institutions that engage in prudent small business lending after 
performing a comprehensive review of a borrower's financial condition 
will not be subject to supervisory criticism for small business loans 
made on that basis. This joint statement, along with earlier statements 
concerning lending and loan workouts, can give bankers a powerful tool 
to help them in their exams.
    ABA will work to make sure that this announcement is meaningful in 
the field, as we have seen numerous examples of the similar agency 
policies emanating from Washington not being carried out during field 
exams. The challenge should not be underestimated, as the reaction of 
regulators in the current economic environment has been to intensify 
the scrutiny of community banks' lending practices. For example, we 
have heard anecdotes from our members of examiners who continue to take 
an inappropriately conservative approach in their analysis of asset 
quality and who are consistently requiring downgrades of loans whenever 
there is any doubt about the loan's condition.
    This inappropriately conservative approach is nowhere more visible 
than in the supervision of commercial real estate (CRE) loans. We are 
hearing from our bankers that the 100 percent and 300 percent 
thresholds are being applied by examiners as caps. ABA foresaw this 
problem when the guidance on CRE concentrations was released in 2006, 
and we were assured that the thresholds would be applied judiciously. 
Examiners need to understand that not all concentrations are equal, and 
that setting arbitrary limits on CRE concentrations has the effect of 
cutting off credit to creditworthy borrowers, exactly at a time when 
Congress is trying to open up more credit.
    Just as too much risk is undesirable, a regulatory policy that 
discourages banks from making good loans to creditworthy borrowers also 
has serious economic consequences. Wringing out the risk from bank loan 
portfolios means that fewer loans will be made, and that only the very 
best credits will be funded.
    Worsening conditions in many markets have strained the ability of 
some borrowers to perform, which often leads examiners to insist that a 
bank make a capital call on the borrower, impose an onerous 
amortization schedule, or obtain additional collateral. These steps can 
set in motion a ``death spiral,'' where the borrower has to sell assets 
at fire-sale prices to raise cash, which then drops the comparable 
sales figures the appraisers pick up, which then lowers the ``market 
values'' of other assets, which then increases the write-downs the 
lenders have to take, and so on. Thus, well-intentioned efforts to 
address problems can have the unintended consequence of making things 
worse.
    What the regulators want for the industry is what the industry 
wants for itself: a strong and safe banking system. To achieve that 
goal, we need to remember the vital role played by good lending in 
restoring economic growth and not allow a credit crunch to stifle 
economic recovery. We must work together to get through these difficult 
times. Providing a regulatory environment that renews lines of credit 
to small businesses is vital to our economic recovery. We are hopeful 
that the joint statement from the State and Federal bank regulators 
will establish the framework for a more positive regulatory approach to 
bank lending in these difficult times.
Conclusion
    I want to thank the Subcommittee for the opportunity to present the 
views of ABA on the challenges ahead for the banks and the communities 
they serve. These are difficult times and the challenges are 
significant. We stand ready to work with Congress and the 
Administration on finding ways to facilitate credit availability in our 
communities.
    I am happy to answer any questions the Subcommittee may have.
                                 ______
                                 
                 PREPARED STATEMENT OF ERIC A. GILLETT
 Vice Chairman and Chief Executive Officer, Sutton Bank, Attica, Ohio, 
       on behalf of the Independent Community Bankers Association
                             March 2, 2010

    Chairman Brown, Ranking Member DeMint, and Members of the 
Subcommittee, I am Eric Gillett, Vice Chairman and CEO of Sutton Bank, 
Attica, Ohio. Sutton Bank is an S Corporation bank dating back to 1878 
with a focus on small business and agricultural lending. The bank is 
located in Attica, Ohio a rural bedroom community of Cleveland with a 
population of 900. Over the years, the bank has expanded full service 
offices in Ashland, Huron, and Richland Counties. The largest community 
in our market is Mansfield whose population is nearly 50,000. We also 
have loan production offices in Tiffin and West Chester, Ohio. Sutton 
Bank has a total of $355 million in assets comprised of $215 million in 
loans. Sutton Bank has consistently been named one of the top small 
business lenders in Ohio according to the U.S. Small Business 
Administration (SBA). I am pleased to testify on behalf of the 
Independent Community Bankers of America and its 5,000 community bank 
members at this important hearing.
    Sutton Bank, like almost all community banks, specializes in small 
business, relationship lending. Community banks serve a vital role in 
small business lending and local economic activity not supported by 
Wall Street. Even during these challenging times, our Nation's nearly 
8,000 community banks remain committed to serving their local small 
business and commercial real estate customers, who are pivotal to our 
country's economic recovery.
    But, Sutton Bank and all community banks face serious challenges 
that can hinder the ability to make new small business and commercial 
real estate (CRE) loans and to refinance existing loans. Community 
banks confront a very tough regulatory environment. While Washington 
policymakers exhort community banks to lend to businesses and 
consumers, banking regulators, particularly field examiners, have 
placed very strict restrictions on banks. In many instances, the 
banking agencies have moved the regulatory pendulum too far in the 
direction of overregulation at the expense of lending. It is important 
to return to a more balanced approach that promotes lending and 
economic recovery in addition to bank safety and soundness.
    While the tough regulatory environment is inhibiting new loans in 
many instances, community banks have also witnessed a decreased demand 
for loans from qualified borrowers. Many of the best small business and 
real estate customers cite uncertainty about the recovery as the key 
reason for not seeking additional credit.
    Commercial real estate (CRE) lending presents special challenges 
for the community banking sector. Many community banks rely on CRE 
loans as the ``bread and butter'' of the local banking market. 
Community bank CRE portfolios are under stress. The downturn in the 
economy affects the ability of CRE borrowers to service their loans. 
Regulatory overreaction adds further stress to community bank CRE 
portfolios. For example, field examiners continue to require community 
banks classify and reserve for performing CRE loans solely because 
collateral is impaired, despite guidance from Washington to look beyond 
collateral values. Community banks all over the country, even those 
located in areas that have relatively healthy economies, are under 
regulatory pressure to decrease CRE concentrations.
    Community banks are the key to economic recovery. It is vitally 
important policymakers create an environment that promotes community 
bank lending to small businesses, rather than inhibit lending. ICBA has 
several recommendations to improve the commercial lending environment 
and address problems related to CRE.

    The country needs a balanced regulatory environment to 
        encourage lending. In a balanced environment, regulators do not 
        exacerbate credit availability through procyclical increases in 
        bank capital requirements. And, bank examiners consider the 
        total circumstances of loans and borrowers, and not just 
        collateral values, when determining the value of loans in 
        banks.

    The Term Asset Liquidity Facility (TALF) should be expanded 
        to cover purchases of a wider range of Commercial Mortgage 
        Backed Securities (CMBS). Extending TALF for a 5-year period 
        would help the debt refinancing of CRE, and help stabilize the 
        CRE market.

    The American Recovery and Reinvestment Act (ARRA) contained 
        several tax relief and SBA reform measures to help boost small 
        businesses. Congress should adopt legislation to extend these 
        beneficial measures.

    The entire amount of the allowance for loan and lease 
        losses (ALLL) should be included as part of risk-based capital. 
        The risk-based capital rules should take into consideration the 
        entire amount of ALLL and not just the amount up to 1.25 
        percent of a bank's risk-weighted assets. This would encourage 
        banks to reserve more and recognize the loss-absorbing 
        abilities of the entire amount of the ALLL.

    The FDIC Transaction Account Guaranty (TAG) Program has 
        been an important tool for protecting and promoting the 
        interests of small businesses by guaranteeing payroll accounts 
        and providing community banks additional liquidity to make 
        loans to creditworthy borrowers. It should be extended another 
        12 months beyond its June 30th termination date.

    SBA reforms should be enacted to meet the needs of 
        community bank SBA lenders. For example, the SBA ``low-doc'' 
        program should be revived to help smaller banks that do not 
        have a dedicated SBA lending staff.

    As policymakers decide the status of Fannie Mae and Freddie 
        Mac going forward, a reasonable value should be given to 
        community banks for the preferred shares, which were rendered 
        worthless by the Government's takeover of the GSEs. 
        Additionally, dividend payments should be resumed for preferred 
        shares.

    ICBA applauds the recent expansion of the net operating 
        loss (NOL) 5-year carryback for 2008 or 2009. ICBA recommends 
        extending this beneficial NOL reform through 2010. This would 
        allow many more small businesses to preserve their cash flow 
        and ride out this difficult business environment as the economy 
        recovers.

    The law governing Subchapter S banks should be amended to 
        permit IRA investments in Subchapter S banks without regard to 
        timing and to permit Subchapter S banks to issue preferred 
        shares. These reforms would give Subchapter S banks new sources 
        of capital at this critical time.

    Congress should preserve the top marginal tax rate for 
        Subchapter S income at 35 percent and maintain parity between 
        corporate and individual tax rates to prevent costly shifts in 
        business forms for Subchapter S businesses, including 
        Subchapter S banks.
Administration's Small Business Lending Fund
    In addition to these ideas, ICBA strongly supports the proposal 
announced by the President and Treasury to further stimulate lending to 
the small business sector through community banks. ICBA believes the 
program could be successful, if structured properly. ICBA has several 
recommendations for a successful program, including allowing community 
banks to participate in the new program without the restrictions 
associated with the Troubled Asset Relief Program (TARP) Capital 
Purchase Program (CPP). This would encourage broad participation. All 
of ICBA's recommendations for the new small business program are 
discussed more fully below.
Small Business and Community Banks Key to Recovery
    America's small businesses are the key to supporting the country's 
economic recovery. Small businesses represent 99 percent of all 
employer firms and employ half of the private sector workers. The more 
than 26 million small businesses in the U.S. have created the bulk of 
new jobs over the past decade. With many of the largest firms stumbling 
and the U.S. unemployment rate at nearly 10 percent, the viability of 
the small business sector is more important than ever.
    Community banks serve a vital role in small business lending and 
local economic activity not supported by Wall Street. For their size, 
community banks are prolific small business lenders. While community 
banks represent about 12 percent of all bank assets, they make 40 
percent of the dollar amount of all small business loans less than $1 
million made by banks. Notably, nearly half of all small business loans 
under $100,000 are made by community banks. In contrast, banks with 
more than $100 billion in assets--the Nation's largest financial 
firms--make only 22 percent of small business loans.
    Community-based banks have played a vital role in the stability and 
growth of each of the 50 States by providing a decentralized source of 
capital and lending. This wide dispersion of our Nation's assets and 
investments helps preserve the safety, soundness, fairness, and 
stability of our entire financial system.
    With that said, the positive attributes of our Nation's community 
banking sector are currently at risk. While the overwhelming majority 
of community banks are well capitalized, well managed and well 
positioned to lead our Nations' economic recovery, there are certain 
hurdles in place that are hindering our efforts.
Examination Environment Hinders Lending
    Mixed signals that appear to be coming from the banking agencies 
have dampened the lending environment in many communities. A November 
12, 2008, Interagency Statement on Meeting the Needs of Creditworthy 
Borrowers established a national policy for banks to extend credit to 
creditworthy borrowers as a means to help our Nation get back on its 
economic feet. It stated, ``The agencies expect all banking 
organizations to fulfill their fundamental role in the economy as 
intermediaries of credit to businesses, consumers, and other 
creditworthy borrowers.'' Again, in November 2009, the banking agencies 
issued the Guidance on Prudent Commercial Real Estate Loan Workouts, 
which was intended to ensure examiners look at factors other than just 
collateral values when evaluating commercial credits and to ensure 
supervisory policies do not inadvertently curtail credit to sound 
borrowers. Two weeks ago, the regulators repeated some of these same 
messages in the context of small business lending generally in another 
interagency statement.
Some Field Examiners Second Guessing Washington
    However, these messages seem to be lost on examiners, particularly 
in parts of the Nation most severely affected by the recession. In a 
recent informal survey conducted by ICBA, 52 percent of respondents 
said they have curtailed commercial and small business lending as a 
result of their recent safety and soundness examinations. Also, 82.5 
percent of respondents answered that the Federal banking agencies' 
guidance on CRE loan workouts has not improved the examination 
environment for CRE loans.
Higher Regulatory Capital Standards
    Bank examiners are raising required capital levels well above the 
capital standards established by statutes and regulations. As a result, 
community banks with sufficient capital to be considered ``well-
capitalized'' are being classified as only ``adequately capitalized.'' 
Some ICBA members report examiners have increased the leverage ratio 
requirement a bank must meet in order to be considered ``well-
capitalized.'' Instead of the five percent leverage ratio called for by 
statute, some bank examiners have increased the leverage benchmark to 
ten percent. This is, unfortunately, done so at the cost of reducing 
lending.
    Being downgraded to ``adequately capitalized'' impacts a bank's 
liquidity, and its ability to make loans and raise new capital from 
investors. ``Adequately capitalized'' institutions may not accept 
brokered deposits or pay above market interest rates on deposits 
without a waiver from the FDIC. The FDIC is being very tough on 
granting brokered deposit waivers causing further liquidity problems 
for banks. The interest rate restrictions limit many banks' ability to 
attract good local deposits. These deposits will likely migrate out of 
the community to other financial firms not subject to this restriction. 
In addition, to meet the higher capital standards, banks decrease the 
number of loans on their books and are forced to turn away quality 
borrowers.
    The examiner-imposed capital standards may force banks to seek 
additional outside capital. Raising unnecessary capital dilutes the 
interest of existing shareholders, which erodes wealth that could be 
deployed by the shareholders to support other economic activities in 
the local economy. Furthermore, the prospect that regulators might 
increase capital requirements in the future makes raising capital 
difficult as potential new investors consider whether their investment 
in the bank might be diluted in the future.
Aggressive Writedowns of Loans; High Loan Loss Reserves
    While the banking regulators in Washington have been very willing 
to discuss safety and soundness examination policies with the ICBA and 
have reassured they are taking measures to ensure their examiners are 
being reasonable and consistent with recent guidance, ICBA continues to 
hear from community bankers that examinations are unreasonably tough.
    For example, despite the guidance on CRE loan workouts, community 
banks continue to report they are forced to write down performing CRE 
loans based solely on appraisals and absorption rates (lots sold). In 
those cases, examiners are ignoring the borrower's ability to repay its 
loan, the borrower's history of repaying other loans with the lender, 
favorable loan-to-value ratios and guarantors. When a recent appraisal 
is unavailable, examiners often substitute their own judgment to 
determine collateral value.
    Further, commercial credits that show adequate cash flow to support 
loan payments are being downgraded because of collateral values, or 
because the examiner believes the cash flow will diminish in the 
future. Other bankers complain that otherwise solid loans are being 
downgraded simply because they are located in a State with a high 
mortgage foreclosure rate. This form of stereotyping is tantamount to 
statewide redlining that ignores any differences among markets within a 
State.
    Many community banks report examiners are not only requiring an 
aggressive write down of commercial assets, they are also requiring 
banks to establish reserves at historically high levels. Banks, which 
were rated CAMELS 1 or 2 on prior examinations and had loan loss 
reserves of 1 to 1.5 percent of total loans, report they are being 
required to more than double their loan loss reserves. Aggressive 
write-downs of commercial assets and large loan loss reserves have a 
serious negative impact on bank earnings and capital and the ability of 
community banks to meet the credit needs of small businesses.
Banks May Avoid Good Loans To Satisfy Regulators
    Examiner practices not only undermine the fundamental goal of the 
interagency policies, they are costing community banks money, leading 
to a contraction of credit, and forcing many of them to rethink their 
credit policies. Under this climate, community bankers may avoid making 
good loans for fear of examiner criticism, write-downs, and the 
resulting loss of income and capital.
Demand for Credit Down
    Community banks are willing to lend, that is how banks generate a 
return and survive. Community banks have witnessed a decrease in demand 
for loans from qualified borrowers. The demand for credit overall is 
down as businesses suffered lower sales, reduced their inventories, cut 
capital spending, shed workers and cut debt. Small business loan demand 
is down as well. In a recent National Federation of Independent 
Business (NFIB) survey, respondents identified weak sales as the 
biggest problem they face. Only eight percent of respondents said 
access to credit was a hurdle. In a recent ICBA survey, 37 percent of 
banks responding said lack of loan demand was constraining small 
business lending. The FDIC Quarterly Banking Profile showed a $129 
billion decline in outstanding loan balances in the fourth quarter of 
2009 after a record $210.4 billion quarterly decline the previous 
quarter. Net loans and leases declined across all asset size groups on 
a quarterly basis in the second half of 2009.
    All community banks want to lend more. Less lending hurts profits 
and income. Many community bank business customers cite the key reason 
for not seeking credit is their uncertainty about the economic climate 
and cost of doing business going forward. Until confidence in the 
economic outlook improves, businesses will be unlikely to seek more 
loans.
Commercial Real Estate
    One issue of increasing concern in the community banking sector is 
commercial real estate and the potential for overexposure. Many 
community banks rely on commercial real estate (CRE) as the ``bread and 
butter'' of their local markets. The degree of borrowers' ability to 
service their CRE loans is closely tied to the performance of the 
overall economy, employment and income. Notably, retail sales declined 
0.3 percent in the important December 2009 figure and unemployment 
remains near a 26-year high. So the sales at stores and businesses 
occupying commercial space is under stress and rents are suffering, 
putting increased pressure on paying loan and lease commitments. Until 
individual spending (which makes up 70 percent of GDP) and employment 
numbers improve, CRE loans set for renewal are likely to see continuing 
rising defaults.
    This adds stress to the community banking sector as they rely on 
commercial real estate as a significant portion of their overall 
portfolio. However, bank regulators have much more aggressively 
examined community banks for CRE concentration dating back to 2006. For 
example, an institution whose total amount of reported construction, 
land development, and other land loans represents, approaches, or 
exceeds 100 percent or more of the institution's total capital will be 
subject to greater regulatory pressure and oversight. An institution 
whose total CRE loans represent, approach, or exceed 300 percent or 
more of the institution's total capital and whose outstanding balance 
of CRE loans has increased by 50 percent or more during the prior 36 
months will also come under even greater regulatory scrutiny.
    It is not uncommon to have community banks exceed the 100 percent 
of regulatory capital threshold, but few have seen very rapid growth in 
CRE exceeding 50 percent in the past 3 years. Many community banks 
survived the CRE stress in the 1980s and 1990s, and have much better 
controls over their CRE concentration. Community bankers report today's 
CRE troubles are nowhere near the magnitude of the late 1980s and 
1990s.
    CRE credit in the economy has already shrunk by about $45 billion 
from its 2007 peak. However, CRE exposure will be a significant reason 
banks will remain under stress in 2010 and is a key reason 702 banks 
are on the FDIC problem bank list.
    Community banks report they underwrite and manage commercial real 
estate loans in a conservative manner, requiring higher down payments 
or other steps to offset credit risks and concentrations. Community 
banks believe they do a better job monitoring CRE loans than do large 
nationwide lenders because they are more likely to work one-on-one with 
the customer, and they have a better understanding of the economic 
conditions in their communities. The vast majority of community banks 
have the capital to ride out the depressed CRE market. However, 
community banks all over the country, even those located in areas that 
relatively healthy economies, are under regulatory pressure to decrease 
CRE concentrations.
    Should real estate prices stabilize with economic growth, the CRE 
concerns will abate. Many community banks report CRE loan payments are 
regularly being made (so the loans are performing) but the underlying 
collateral value has declined. Therefore, as CRE loans are due for 
renewal, borrowers as well as banks are often forced to put up 
increased capital to be able to refinance and prevent default.
ICBA's Recommendations
    Community banks are the key to economic recovery. Despite a Fourth 
Quarter 2009 decline of net loans and leases at 8.2 percent compared to 
the previous year among all banks, community banks with less than $1 
billion in assets showed only a narrow year-over-year decline in net 
loans and leases of 1.4 percent after being the only group to post 
increases in each of the previous three quarters. The Nation's biggest 
banks cut back on lending the most. Institutions with more than $100 
billion in assets showed 8.3 percent decrease while $10-100 billion-
asset-banks had net loans and leases decline at 11.4 percent compared 
to the previous year. Policymakers need to create an environment to 
promote community bank lending to small businesses, rather than 
inhibiting lending. ICBA has several recommendations to improve the 
commercial lending environment and address problems related to CRE.
Regulatory Relief Is Top Priority
    Community bankers' top concern is that bank regulators have swung 
the pendulum too far toward regulatory excess, inhibiting new small 
business lending and making the small business and CRE problems worse 
rather than helping resolve the problem. Community bankers report bank 
regulators are forcing write-downs on performing commercial loans and 
treating all loans in many hard hit States the same regardless of a 
loan's performance. Also the FDIC practice of dumping properties at 
``fire sale'' prices onto a market can trigger a counterproductive 
downward spiral in real estate values and further bank write-downs. 
Banking regulatory staff in the field is paying little heed to the 
policies established in Washington put in place to promote lending. 
Field examiners are imposing arbitrary capital standards on community 
banks, requiring those banks to shrink their assets rather than 
increase lending.
    If community banks are to increase small business lending, the 
regulatory environment needs to change. The country needs a balanced 
regulatory environment to encourage lending and economic recovery, in 
addition to bank safety and soundness. In a balanced environment, 
regulators do not exacerbate credit availability through procyclical 
increases in bank capital requirements. And, bank examiners consider 
the total circumstances of loans and borrowers, and not just collateral 
values, when determining the value of loans in banks.
Extend and Expand TALF Program
    The TALF program was designed to keep the secondary markets open 
and vibrant for a variety of loan and investment products. Secondary 
markets for commercial debt must be robust so CRE debt refinancing can 
take place at reasonable borrowing rates. Like residential real estate, 
commercial real estate loans were bundled into securities, pooled and 
sold. Specifically, the market for CMBS has not fully recovered. 
Expanding the TALF to cover purchase of a wider range of CMBS and 
extending TALF for a 5-year period would help the debt refinancing of 
CRE, and help stabilize the CRE market. Notably, community banks can 
sell very few of their whole CRE loans; more likely they are engaged in 
loan participations, so policies should focus on stabilization of CRE 
valuations.
Extend Small Business Changes in the ARRA
    The severe economic recession justified a sizable economic 
stimulus, including tax relief measures for individuals and small 
businesses. ICBA was pleased the American Recovery and Reinvestment Act 
(ARRA) enacted last February contained several tax relief and SBA 
reform measures to help boost small businesses. Specifically, the major 
SBA loan program enhancements enacted are all helping many small 
businesses ride out this deep recession. ICBA also supports the 
extension of the key incentives for SBA 7(a) and 504 lending 
programs.ICBA also applauds the legislation to extend the beneficial 
SBA enhancements included in ARRA. Specifically:

    Extending the SBA fee reductions through fiscal year 2011;

    Extending the higher guarantee levels through fiscal year 
        2011;

    Making permanent the SBA secondary market facility 
        authority.

    If enacted, these measures would all help community banks expand 
their SBA lending to small businesses and would stimulate much-needed 
economic activity and job creation.
SBA Reforms
    ICBA supports additional measures to enhance SBA lending. The key 
to meeting small business capital needs is to have diversity in SBA 
lending options. The SBA should be able to meet the needs of both large 
and small SBA loan program users. This was our objection to the SBA's 
elimination of the successful ``LowDoc'' program. It was used most 
often by banks that did a small number of loans and did not have the 
dedicated SBA loan staff.
    If community banks could more easily use SBA programs, since there 
are more than 8,000 community banks nationwide, a larger number of SBA 
loans could be made. In other words, we do not want an SBA with a one-
size-fits-all cookie cutter approach that only the biggest-volume SBA 
lenders can fully use. Before this financial crisis hit, nearly 60 
percent of all SBA loans were concentrated in just ten banks. If we are 
concerned with supplying small businesses with a steady source of 
capital, the SBA needs to do a better job of embracing the more than 
8,000 banks nationwide so all lenders can easily participate.
Enhancements to Community Bank Capital
    Of course community banks and small businesses rely on raising 
capital in this difficult capital market. Therefore, we would like to 
recommend several reforms to help community banks and small businesses 
preserve and raise capital.
Restore Reasonable Value to Fannie Mae and Freddie Mac Preferred Stock
    Community banks were encouraged by bank regulators to hold Fannie 
Mae and Freddie Mac preferred stock as part of their Tier 1 capital and 
were severely injured when the U.S. Treasury placed these entities into 
conservatorship in September 2008. Some $36 billion in Fannie Mae and 
Freddie Mac capital held in banks, including many community banks, was 
largely destroyed by Treasury's action. As policymakers decide the 
status of Fannie Mae and Freddie Mac going forward, at a minimum, a 
reasonable value should be given to the preferred shares. Dividend 
payments should be resumed for these preferred shares. Importantly, 
this will help restore capital needed for additional small business 
lending. For each dollar of value restored some eight to ten dollars in 
new lending can occur.
Extend the 5-Year NOL Carryback Through 2010
    ICBA applauds the recent expansion of the NOL 5-year carryback for 
2008 or 2009 that President Obama signed into law on November 6. The 
FDIC reports 30 percent of banks had a net loss for 2009. ICBA 
recommends extending this beneficial NOL reform through 2010. This 
would allow many more small businesses to preserve their cash flow and 
ride out this difficult business environment as the economy recovers.
    Specifically, ICBA recommends allowing community banks and small 
businesses with $10 billion in assets or less to spread out their 
current losses with a 5-year carryback allowed through tax year 2010, 
including TARP-CPP programs participants to increase small business 
lending. It makes little sense for Congress to encourage community 
banks to lend more to small businesses by participating in the TARP 
program and then to punish them by not allowing the potential use of 
the NOL 5-year carryback tax reform. Allowing all interested small 
businesses with $10 billion or less in assets to use an expanded NOL 
through 2010 will help free up small business resources now to help 
support investment and employment at a time when capital is needed 
most. Expanding the NOL 5-year carryback to include tax year 2010 and 
allowing TARP participant banks with $10 billion in assets or less 
simply allows these businesses to accelerate the use of allowable NOL 
deductions that can be claimed in future years under current law. 
However, by accelerating the use of NOLs it will free up much needed 
cash flow now when businesses need it most.
    A recent report by the Congressional Research Service helps support 
the net operating loss tax relief. The May 27 CRS report notes most 
economists agree that U.S. companies would benefit from a longer net 
operating loss carryback than the current 2-year period. The CRS report 
says the carryback period should last through the typical business 
cycle (6 years) to help smooth the peaks and valleys in income.
The Entire Amount of the ALLL Should Be Included as Part of Risk-Based 
        Capital
    Under the current risk-based capital rules, a bank is allowed to 
include in Tier 2 capital its allowance for loan and lease losses 
(ALLL) up to 1.25 percent of risk-weighted assets (net of certain 
deductions). Consequently, some community banks are now being 
downgraded based on capital inadequacy even though they have excess 
amounts of ALLL. The risk-based capital rules should take into 
consideration the entire amount of ALLL and not just the amount up to 
1.25 percent of a bank's risk-weighted assets. This would encourage 
banks to reserve more and recognize the loss-absorbing abilities of the 
entire amount of the ALLL.
Extending the FDIC TAG Program One Additional Year
    The FDIC Transaction Account Guaranty (TAG) Program, which 
guarantees noninterest bearing transaction accounts, certain NOW 
accounts and IOLTA accounts, has been an important tool for protecting 
and promoting the interests of small businesses by guaranteeing payroll 
accounts and providing community banks additional liquidity to make 
loans to creditworthy borrowers. Banks pay a separate fee to the FDIC 
for this additional coverage. Accounts guaranteed under the TAG are not 
considered in determining the deficit in the FDIC's Deposit Insurance 
Fund, so continuing the TAG would not increase the deficit in the 
Deposit Insurance Fund (DIF) or affect the FDIC's regular insurance 
premiums. ICBA is concerned that an expiration date of June 30, 2010, 
would not provide enough time to restore and maintain liquidity and 
customer confidence in the banking system. Particularly in those areas 
of the country like Georgia, Florida, California and the Southwest, it 
is very important this program continue an additional 12 months to 
allow additional time for those areas to stabilize. The TAG program 
ensures community banks are not at a competitive disadvantage in this 
fragile economy. The safety of transaction accounts continues to be one 
of the most important concerns for customers. The public perceives too-
big-to-fail institutions can provide unlimited protection because these 
banks will ultimately be bailed out if they become financially 
unstable. Community banks should be afforded the same opportunity to 
guarantee their customers' transaction accounts.
Allow New IRAs as Eligible S Corporation Shareholders
    The challenging economic and credit markets make it difficult for 
many community banks to raise additional capital to support small 
business lending. Unfortunately, Subchapter S community banks are 
disadvantaged in raising additional capital by onerous shareholder 
restrictions. Current law restricts the types of individuals or 
entities that may own S corporation stock. \1\ S corporation community 
banks seeking to raise capital may not allow new IRA shareholders. 
Traditional and Roth IRA stockholders are permitted only to the extent 
that IRA stock was held on or before October 22, 2004. Therefore, 
Subchapter S community banks are put at a disadvantage relative to 
other less restrictive business forms in their ability to attract 
capital due to the rigid IRA shareholder restriction.
---------------------------------------------------------------------------
     \1\ Internal Revenue Code 1361(b)(1).
---------------------------------------------------------------------------
    ICBA recommends new IRA investments in a Subchapter S bank be 
allowed regardless of timing. ICBA believes this reform will grant more 
community banks the needed flexibility in attracting IRA shareholder 
capital, especially from existing shareholders.
Allow Community Bank S Corporations To Issue Certain Preferred Stock
    Another obstacle preventing S Corp. banks from raising capital is 
the restriction on the type of stock they can offer. Current law only 
allows S corporations to have one class of stock outstanding. \2\ C 
corporations that want to make the S corporation election must 
eliminate any second class of stock prior to the effective date of the 
S corporation election. Likewise, issuing a second stock class by an S 
corporation terminates its S corporation status. Community banks must 
maintain certain minimum capital ratios to be considered a well-
capitalized institution for regulatory purposes. As a community bank 
grows in size, its earnings alone may not provide sufficient capital to 
fund its growth. Banks needing more capital can raise additional 
capital by issuing common stock, preferred stock, or, in some cases, 
trust-preferred securities.
---------------------------------------------------------------------------
     \2\ Internal Revenue Code 1361(b)(1)(D).
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    Many community banks avoid issuing additional common stock to fund 
growth so they can protect their status as an independent community 
bank and serve their local community lending needs. Instead, they 
frequently use preferred stock to fund growth and retain control. 
However, S corporation banks are not allowed to issue commonly used 
preferred stock because preferred stock is considered a second class of 
stock. This prevents small community banks from having access to an 
important source of capital vital to the economic health and stability 
of the bank and the community it serves.
    ICBA recommends exempting convertible or ``plain vanilla'' 
preferred stock from the ``second class of stock'' definition used for 
S corporation purposes. This would help more community banks become 
eligible to make the S corporation election as well as help those 
current S corporations seeking to raise additional capital. Allowing 
community bank S corporations to issue preferred stock would allow them 
to reduce the burden of double taxation like other pass-through 
entities and, at the same time, fund future growth.
Preserve 35 Percent Top Marginal Tax Rate on Subchapter S Income
    Small businesses are facing difficult economic times. A troubled 
credit market combined with a slowdown in U.S. economic growth, high 
energy prices, and sharp inflationary costs across-the-board for inputs 
are crimping small business profits and viability. Maintaining cash 
flow is vital to the ongoing survival of any small business and taxes 
are typically the second highest expense for a business after labor 
costs. As pass-through tax entities, Subchapter S taxes are paid at the 
individual income tax level. Marginal income tax rates do play a 
critical role in a small business' viability, entrepreneurial activity, 
and choice of business form. Today more than half of all business 
income earned in the United States is earned by pass-through entities 
such as S corporations and limited liability corporations.
    The top corporate income tax rate and individual income tax rate 
are currently set at thirty-five percent. Much attention has been given 
to addressing the corporate tax rate for international competitiveness 
concerns and raising the individual income tax rate. Significant shifts 
in the existing marginal tax rates and parity between corporate and 
individual tax rate can trigger unwanted and costly shifts in business 
forms. It is important to consider maintaining parity between the top 
corporate and individual income tax rates in the Code. Additionally, 
during this difficult economic period, at a minimum, the current top 
tax rate of thirty-five percent should be preserved on both small 
business Subchapter S income and C corporation income, not increased.
Administration's Small Business Lending Fund
    ICBA strongly supports the proposal announced by the President and 
Treasury to further stimulate lending to the small business sector 
through community banks. ICBA believes the program, if structured 
properly, could be successful. ICBA made several recommendations to the 
Administration for a successful program:

    The new program should impose no TARP-like restrictions on 
        community banks that participate in the program. For example, 
        the program should not require stock warrants, restrict 
        compensation or bank dividends, or limit access to tax benefits 
        like the NOL carryback.

    The Government should not have the right to change the 
        contract to impose unilaterally new conditions and 
        requirements.

    Bank dividend payments to the Government should be 
        suspended for 1 year until the small business loans can be 
        underwritten and put in place.

    Community banks should be able to repay the Government's 
        investment without penalty and should be able to retain the 
        Government's investment for at least 5 years or more to support 
        long term small business loans.

    The broadest number of community banks should be eligible 
        to participate. CAMELS-rated 3 banks should be automatically 
        eligible and 4-rated banks should be allowed to participate on 
        a case-by-case basis. When considering applications to 
        participate in the program, a bank's post investment capital 
        position should be used to determine eligibility.

    Special consideration should be given to minority banks 
        given their role promoting the economic viability of minority 
        communities.

    Treasury should have the ability to make the final capital 
        injection decision after consultation with the banking 
        regulators.

    The eligibility criteria and approval process must be well 
        defined and transparent so bank access to the program will be 
        fair and transparent.

    All forms of banks, including Subchapter S and mutual banks 
        and mutual bank holding companies, should be included in the 
        program.

    Existing TARP CPP participants should be able to transfer 
        to the new program and be relieved of the TARP restrictions.

    All participants should be allowed to treat the investment 
        as Tier 1 capital.

    Agricultural loans should be included within the program.

    Reporting of small business lending should be made simple.

    Finally, credit unions should not be allowed to participate 
        in the programs because credit unions commercial lending is 
        restricted, in the first place, and secondly, because credit 
        union lending is already subsidized through a broad tax 
        exemption.
Conclusion
    Community banks serve a vital role in small business lending and 
local economic activity not supported by Wall Street. Community banks 
form the building blocks of communities and support small businesses 
around the country. The community banking industry is poised to serve 
as an economic catalyst to lead our Nation's economic recovery. 
Community bankers are ready, willing and able to meet the credit needs 
of small businesses and the communities they represent. But, it is 
important to move away from a restrictive, procyclical regulatory 
environment to one that actually promotes small business and CRE 
lending in community banks. In addition, ICBA believes the 
recommendations in this testimony, if adopted, would go a long way to 
strengthen the community banking sector and increase small business 
lending. ICBA looks forward to working with Congress and the 
Administration on these and other initiatives to support small business 
and CRE lending by community banks.
Attachment
 Community Bank Comments From an ICBA Survey on Exam Issues and Small 
                   Business Lending: January 8, 2010
    1. A large unsecured loan that was performing as agreed with 
monthly payments of principal and interest and had never been past due 
was required to be charged off as a loss.
    2. We have had a number of businesses who were long term customers 
and whose loans performed according to terms. The regulators looked at 
1 year's tax return from a particular customer that does not fully 
support cash flow but is marginally close. The regulators had us move 
this to substandard when we believed a watch rating would be prudent 
based only on 1 year's results. We should then monitor the customer 
next year and it either goes to a substandard or back to a pass. This 
is way too aggressive an approach.
    3. An insurance company. The regulators criticized the credit due 
to uncertain collateral position. The credit had never been 15 days 
past due in over 10 years with the bank. The collateral is short, but 
payment history and cash flow was satisfactory.
    4. Our bank had a number of commercial loans that have not missed a 
payment. However, the examiners have indicated they do not believe the 
real estate is worth the same value as 1 or 2 years ago and they 
required us to place the loan in a substandard classification and set 
aside reserves which reduces our capital. They also want the bank to 
stress test all commercial loans with suggested limits that would 
require a 50 percent plus + down payment on any commercial loan. The 
examiners certainly did not read the press release issue on 10-30-09 by 
the Federal Reserve on prudent commercial real estate loans; they were 
negative on every commercial loan they reviewed. Very few commercial 
loans received a passing grade.
    5. Performing (owner-occupied) loans were criticized because the 
value of collateral had fallen.
    6. In our bank, any loan that was speculative construction or 
development was automatically classified as substandard. A number of 
loans that have never been delinquent and are not dependent on the 
subject project to service the debt were classified.
    7. Examiners are so focused on capital ratios, earnings liquidity, 
and reserves for losses that our bank is very unwilling to allow much 
growth at this time.
                                 ______
                                 
                     PREPARED STATEMENT OF RAJ DATE
Chairman and Executive Director, Cambridge Winter Center for Financial 
                          Institutions Policy
                             March 2, 2010

    Thank you, Chairman Brown and Ranking Member DeMint, for inviting 
me to speak to you about the causes of, and potential solutions to, 
small business credit contraction.
    My name is Raj Date, and I am the Chairman and Executive Director 
of the Cambridge Winter Center. Cambridge Winter is a nonpartisan think 
tank dedicated exclusively to researching U.S. financial institutions 
policy issues. \1\ Before Cambridge Winter, I had spent virtually my 
entire career in and around financial services--in consumer finance, in 
commercial banking, and on Wall Street. Based on that experience, and 
on the work of Cambridge Winter, my hope is to provide you with a few 
practical observations on the state of the marketplace, and to suggest 
some principles by which you might measure alternative solutions.
---------------------------------------------------------------------------
     \1\ The Cambridge Winter Center is a nonprofit, nonpartisan 
organization with a pending application for tax exempt status under 
Internal Revenue Code section 501(c)(3). Cambridge Winter does not 
engage in lobbying activities, it has no clients, and it does not 
accept fees or other compensation for any of its work.
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    This is, as you know, an important issue. Small business credit is 
tight. FDIC data shows that banks' commercial loan balances, which 
include small business loans, have already declined by more than $500 
billion since the onset of the crisis. \2\ I fear that we are at 
something of a transition point in the marketplace today: the point at 
which credit contraction becomes less driven by a rational decline in 
demand for loans, and becomes more driven by a structural shortfall in 
supply.
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     \2\ FDIC-insured banks' and thrifts' on-balance sheet commercial 
loans declined by a cumulative $504 billion over the past five 
quarters. FDIC, Quarterly Banking Profile Graph Book, p. 33 (``FDIC 
GraphBook'') (December 2009).
---------------------------------------------------------------------------
    Absent structural remedies to that supply problem, the lack of 
small business credit could become a serious impediment to both the 
timing and speed of a recovery in the real economy.

1. Demand Issues
    Let me begin by discussing the demand for small business lending. 
Small business people, in general, are a financially conservative lot. 
As their own revenue prospects become uncertain, as happens in every 
recession, they quite prudently tend to shy away from debt financing. 
Given that natural decline in demand, relatively few small business 
owners today see the lack of small business credit as their most 
significant or pressing issue. \3\
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     \3\ See, National Federation of Independent Businesses, ``Small 
Business Credit in a Deep Recession'', p. 3 (``NFIB Survey'') (February 
2010).
---------------------------------------------------------------------------
    The typical recession-driven decline in demand has been accentuated 
in this downturn by a disconnect on pricing. It is probably not 
surprising that borrowers, in general, believe that they are more 
credit-worthy than do their lenders. That is human nature, and in small 
business lending it is especially true. Prudent lenders should, 
implicitly or explicitly, consider a number of factors in pricing 
credit: (1) the small business's cash flow trajectory and resilience; 
(2) performance history; (3) existing debt load; (4) collateral value 
and stability; (5) credit quality and character of guarantors; (6) cost 
of funding; (7) structural interest rate risk; and (8) the asset-
liquidity of the loan, once originated. But small business borrowers, 
which almost definitionally lack professional financial management, 
typically do not appreciate some of those factors (funding costs, rate 
risk, and asset liquidity chief among them), and as a result are 
dissatisfied when those factors drive pricing dramatically higher, as 
they have in the crisis.
    Over the last decade, moreover, small business borrowers' most 
frequent market signal about their own credit-worthiness came from 
billions of direct marketing messages from prime credit card issuers. 
The prime credit card business had come to be dominated by teaser-rate 
pricing practices, coupled with nontransparent risk mitigation features 
(e.g., universal default repricing, double-cycle billing, unilateral 
line decreases). One of the many negative features of teaser-rate 
marketing is that, when small business owners are, today, confronted 
with more transparent risk-based pricing, the result is sticker shock. 
Thankfully, given recent legislation that mandates decidedly more 
transparent card pricing practices, \4\ this pronounced disconnect 
between borrowers and lenders should reduce over time.
---------------------------------------------------------------------------
     \4\ Credit Card Accountability Responsibility and Disclosure Act 
of 2009, Pub. L. 111-24, 123 Stat. 1734 (May 22, 2009).
---------------------------------------------------------------------------
    Of course, some apparently credit-worthy small businesses have had 
a difficult time securing financing over the past year. We have all 
seen considerable anecdotal evidence to that effect. On balance, 
though, it is quite likely that the decline in commercial credit so far 
has been more driven by a drop in demand than any other factor.

2. Supply Issues
    Over the coming quarters, however, the binding constraint on small 
business lending will shift from a deficit of demand, to a deficit of 
supply.As the real economy begins to recover, we should expect 
demonstrably credit-worthy small business owners to begin to demand 
credit in greater amounts. As that demand materializes, however, it is 
quite possible that it will go unmet by the financial system. Indeed, 
it seems likely that the threat of a shortfall of credit supply will be 
more pronounced in small business than anywhere else in the credit 
markets. The reason for this is a structural shift that has been 
catalyzed by the crisis: the ``relocalization'' of small business 
lending.

a. Contraction in national-scale products and firms
    Small business finance is, for many firms, tightly intertwined with 
consumer finance. Because most small businesses are often quite small 
indeed, their liquidity sources and uses are frequently related to, and 
even commingled with, the liquidity positions of their owners. \5\ As a 
result, the rapid expansion of consumer financial products in the 
decade leading up to the crisis--especially revolving prime credit 
cards, and cash-out home equity loans--satisfied an increasing fraction 
of small business credit needs. \6\
---------------------------------------------------------------------------
     \5\ See, NFIB Survey, supra note 3, at page 17.
     \6\ For example, nearly half of small businesses use personal 
credit cards for transactions or credit extension. Federal Reserve 
Board, ``Report to the Congress on the Availability of Credit to 
SmallBusinesses, pages 29-31 (October 2007); see also Charles Ou and 
Victoria Williams, ``Lending to SmallBusinesses by Financial 
Institutions in the United States'', SBA Office of Advocacy (``SBA 
Advocacy Finance Report'') (July 2009).
---------------------------------------------------------------------------
    Unfortunately, neither the prime credit card business nor the cash-
out home equity business appear to have been particularly suited to 
withstand an economic downturn. Both businesses, which had become 
marked by high credit line strategies during the bubble, came under 
major pressure as unemployment rates climbed. For a lender, high open 
lines of credit are a recipe for disaster during a recession. In 
essence, high credit lines tend to be drawn down disproportionately by 
borrowers facing adversity, while borrowers in solid financial shape do 
not draw their lines, and therefore do not add to lenders' net interest 
margins. Credit losses increase, but net interest margins do not grow. 
As a result, when faced with climbing unemployment, prudent lenders cut 
credit lines dramatically. \7\ Industry-wide, available home equity and 
credit card lines have declined by an astonishing $1.6 trillion, or 30 
percent, over the past 2 years. \8\ Massively reduced consumer credit 
availability, of course, also impacts small businesses.
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     \7\ See, Ed Gilligan, American Express Financial Community 
Meeting, slides 15-20 (February 3, 2010) (illustrating importance of 
credit line decreases to credit risk mitigation among high-line prime 
accounts). Some academics appear to have linked credit line decreases 
to the reforms enacted by the Credit CARDAct. See, Todd J. Zywicki, 
``Testimony Before the U.S. House of Representatives Committee on 
FinancialServices and Committee on Small Business'', pages 5-6 
(February 26, 2010). In reality, line decreases began well before the 
legislation was passed, and extended beyond credit card to other asset 
classes. See, infra note 8.
     \8\ FDIC, ``Assets and Liabilities of FDIC-Insured Commercial 
Banks and Savings Institutions'', Quarterly Banking Profile (December 
2009).
---------------------------------------------------------------------------
    In addition to the rapid diminution of important lending 
categories, the past 2 years have seen the disruption of a wide swath 
of small business and middle-market commercial finance firms. For 
decades, much commercial finance activity--like equipment finance, 
inventory finance, or receivables finance--migrated from deposit-funded 
banks to capital market-funded finance companies. With a benign credit 
environment, accommodating ABS market investors, and a substantial 
regulatory capital arbitrage versus banks, many of these firms grew to 
extraordinary size. The commercial lender CIT, for example, boasted 
after its crisis-driven conversion into a bank holding company that it 
was the seventh largest bank in the Nation, ranked by commercial and 
industrial loans. By that metric, CIT was a larger commercial lender 
than such major regional banks like SunTrust or Regions Financial. \9\
---------------------------------------------------------------------------
     \9\ Jeffrey M. Peek, CIT's Presentation at the Credit Suisse 
Financial Services Conference, slide 14 (February 2009). Despite the 
conversion of its Utah ILC into a state-chartered bank, the attendant 
conversion of the CIT parent company into a bank holding company by the 
Federal Reserve, and the infusion of $2.3 billion in TARP capital by 
the Treasury, CIT filed for bankruptcy. Taxpayers lost the entirety of 
their TARP capital investment. See, e.g., Michael J. de la Merced, 
``Creditors Back CIT's Bankruptcy, New York Times (November 1, 2009).
---------------------------------------------------------------------------
    Once the capital market bubble collapsed, unfortunately, these 
large nonbank finance companies were forced to retreat from the market. 
GE Capital, for example, apparently plans to shrink its portfolio by 
some $80 billion over the next few years. \10\ Although that down-
sizing would only represent 15-20 percent of GE Capital's current size, 
it implies a reduction in GE's aggregate lending that is roughly 
equivalent to the entire combined commercial and industrial loan books 
of the large regional banks Fifth Third, Comerica, and KeyCorp. \11\
---------------------------------------------------------------------------
     \10\ Jeffrey R. Immelt, ``GE Renewal'', GE Annual Outlook Investor 
Meeting, slide 14 (December 15, 2009).
     \11\ ``Bank Holding Companies with the Largest U.S. Business Loan 
Portfolios'', American Banker, (February 19, 2010).
---------------------------------------------------------------------------
    The credit crisis, then, has simultaneously and dramatically 
reduced the availability of important nationally marketed lending 
products, as well as the credit capacity of large national finance 
companies. Structurally, the market for small business credit would 
appear to shifting away from national-scale products and firms, and 
``relocalizing'' to regional and community banks.

b. Constraints among regional and community banks
    Over the long term, the relocalization of small business lending is 
good news. The financial system would be more resilient if it relied 
less on very large nonbanks that fund themselves in confidence-
sensitive wholesale markets, and instead relied on deposit-funded banks 
that are not ``too big to fail.'' \12\ Regional and community banks are 
also the most natural underwriters of small business credit risk, given 
their in-market presence and focus.
---------------------------------------------------------------------------
     \12\ See, generally, Raj Date and Michael Konczal, ``Out of the 
Shadows: Renewing Glass-Steagall for the 21st Century'', Make Markets 
Be Markets, Roosevelt Institute (March 2010).
---------------------------------------------------------------------------
    Over the near term, unfortunately, such banks face major 
challenges. Without intervention, regional and community banks will 
almost certainly not be able to replace the small business credit 
capacity that has otherwise disappeared from the market.
    There are two problems.
    The most serious problem is small banks' capital constraints. Small 
banks tend to be heavily concentrated in commercial real estate, and 
those portfolios will continue to be pressured. \13\ Notably, small 
banks tend to lack the capital markets businesses of larger 
competitors, which have been major project centers lately. Small bank 
margins have also been compressed, relative to larger firms, by an 
exceedingly low rate environment, which tends to disproportionately 
harm banks with high-quality commercial deposit bases. \14\ Given this 
bleak outlook, and the relative difficulty of small banks' accessing 
new pools of equity capital, it is much more likely that small banks 
will shrink their lending books over the coming years, not grow them. 
\15\
---------------------------------------------------------------------------
     \13\ See, FDIC Graph Book, supra note 2, at pages 5, 21, and 37; 
Congressional Oversight Panel,``Commercial Real Estate Losses and the 
Risk to Financial Stability'' (February 10, 2010).
     \14\ Commercial deposits typically are not interest-bearing, so a 
low rate environment does not create lower funding costs (because the 
interest paid does not become negative). A low rate environment can, 
however, encourage lower asset yields. The result is a net interest 
margin squeeze.
     \15\ It is important to note that although bank capital is 
pressured, bank funding is not, in general, a constraint for banks 
today. The FDIC-led measures to backstop a wider range of liabilities 
have had their intended effect. Banks are holding substantial cash 
positions, and have invested in steadily growing portfolios of low-risk 
Government and GSE securities, rather than more capital-intensive 
consumer and commercial loans.
---------------------------------------------------------------------------
    There is a second, and less remarked-upon, problem with small 
banks' small business lending growth: missing capabilities. It is true 
that the smallest banks (those under $1 billion in assets) are 
disproportionately concentrated in business lending, as compared to 
their larger brethren. But most of small banks' concentration in 
business lending is attributable to their heavy focus on commercial 
real estate lending. \16\ By contrast, the credit capacity that has 
most dramatically left the market is in non- real estate lending--that 
is, the lending that had been satisfied, during the bubble, in major 
part by credit cards, home equity loans, and nonbank finance companies. 
And it is non- real estate lending that constitutes the majority of 
small business finance, particularly in certain capital-intensive 
sectors, like manufacturing. \17\
---------------------------------------------------------------------------
     \16\ ``Commercial real estate constitutes fully 29 percent of the 
loan portfolios of banks with under $1 billion in assets; larger banks 
have only 13 percent of their portfolios in commercial real estate.'' 
FDIC Graph Book, supra note 2, at page 21.
     \17\ See, SBA Advocacy Finance Report, supra note 6, at page 28.
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3. Evaluating Alternatives
    With this context in mind, and mindful of the track record of past 
policy efforts, I would suggest three criteria to evaluate alternative 
policy solutions to the small business credit crunch.
a. Recognize the limits of direct Government credit-decisioning
    First, we should recognize the limits on the Government's ability, 
on its own, to quickly and competently direct the flow of commercial 
credit. \18\
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     \18\ The credit-fueled downfall of Fannie Mae and Freddie Mac is a 
useful case study on this issue. See, Raj Date, ``The Giants Fall: 
Eliminating Fannie Mae and Freddie Mac'', Make Markets Be Markets, 
Roosevelt Institute (March 2010).
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    Given the generally negative reaction of both banks and the public 
to the original TARP capital infusions, it is tempting to imagine that 
small business credit might be extended by the Government directly, 
without requiring bank intermediation at all. Unlike in education 
finance, however, there is no existing Government apparatus by which to 
generate, evaluate, negotiate, and close small business loans in the 
primary market. Even for the SBA, which would be the most relevant 
existing agency, building and scaling up such an effort would be a 
massive and complicated undertaking. Given the growing size and urgency 
of small business credit contraction, working through bank 
intermediation would appear far more practical. To its credit, this is 
the approach adopted by Administration's proposed Small Business 
Lending Fund (the ``SBLF''). \19\
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     \19\ Fact Sheet titled ``Administration Announces New $30 Billion 
Small Business Lending Fund'' (``FactSheet'') (February 2, 2010).
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b. Do not reward the worst banks
    The second principle we should remember is that not all banks are 
the same; we should not treat them as though they were.
    The central conceptual failing of the original TARP capital 
infusion plan was that it deliberately created a one-size-fits-all 
investment structure disproportionately valuable to the worst banks. 
All banks received the same amount of capital; all banks paid the same 
price. As a result, the TARP investments managed to neither create a 
credible endorsement that could entice private capital, nor did they 
provide any competitive benefit to firms that actually had demonstrated 
an ability to make wise credit risk-return decisions. \20\ The 
Administration's SBLF proposal--at least as it has been described so 
far--risks a similar problem: it would appear the most valuable to 
those small banks with the most pressing credit-driven capital 
problems, irrespective of whether those particular banks have any 
demonstrated capabilities in small business lending. Nor does the 
proposal calibrate the size of its investments according to any ground-
up evaluation of capital needs (through a simplified stress test 
methodology, for example).
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     \20\ Not until the ``stress tests'' on the largest banks were 
these fundamental problems addressed. See, RajDate, ``Stress Relief'', 
Cambridge Winter Center, pages 1-2 (April 20, 2009) (``Although the 
Administrationdoes not describe the stress tests in this way, the 
initiative has the potential to help undo the most profoundly damaging 
strategic errors of the original Paulson capital purchase plan'').
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c. Create an explicit link to desired behavior
    Third, we should be careful and explicit with incentives.
    Many policy-makers and citizens who supported the original TARP 
capital infusions, and who believed at the time that credit would, as a 
result, be stabilized, are unsurprisingly irritated by continued 
declines in bank lending volumes. The lesson is straightforward: if 
taxpayers are asked to supply subsidies to support any given activity, 
those subsidies should be narrowly tailored to achieve that end, and, 
if possible, be made contingent upon it. Of course, when the desired 
activity is lending, policy-makers should simultaneously be careful not 
to create such strong incentives that they inadvertently goad banks 
into irresponsible credit decisions, which ultimately do more harm than 
good.
    On its face, the SBLF proposal tries to strike this balance this by 
varying a bank's cost of Government-supplied capital according to its 
percentage increase in small business lending off a 2009 baseline, but 
to keep the percentage increase modest enough as to not encourage 
cavalier decision-making. But the percentage amount of increased small 
business lending appears so modest--at least in the initial proposal--
that it appears likely that most of the Government-supplied capital 
could be used to bolster preexisting weakness in a firm's capital, 
rather than to support incremental credit.
    Indeed, the example provided in the initial description of the SBLF 
entails a bank with $500 in assets, $250 million of which are small 
business loans. The bank, after receiving a $25 million capital 
infusion from the SBLF, manages to increase its small business lending 
10 percent, to $275 million, and thereby receives a full 400 basis 
point annual reduction in the cost of the Government's capital stake. 
\21\ But regulatory capital required to support that incremental $25 
million in loans is probably something close to $2.5 million. So the 
bank has received, net of the $2.5 million capital support required for 
the $25 million in new lending, an excess $22.5 million in capital from 
the Government, which presumably is being used, in the Administration's 
example, to plug holes in the bank's existing capital position.
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     \21\ Fact Sheet, supra note 19, at p. 2.
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    The SBLF proposal, then, will require some refinement before it is 
ready to implement. And it will take time to implement well.

4. An Interim Approach
    Given the urgency of this issue, though, Congress may want to 
consider, in parallel, an interim measure that might be rather simpler 
to implement.
    Rather than investing taxpayer capital directly into banks, we 
could reduce the regulatory risk weighting on some finite quantum of 
incremental small business lending. For those banks that find 
regulatory capital their binding constraint, \22\ but who do see 
economically attractive lending opportunities in the marketplace, a 
temporary reduction in regulatory capital requirements related to that 
lending would spur counter-cyclical credit extension. \23\ In essence, 
we would enable otherwise economically attractive loans that are today 
held back by the legacy of poorly performing, capital-intensive assets 
on bank balance sheets. \24\ By limiting the percentage increase in 
small business loans eligible for this risk weight-reduction, we could 
prevent small banks from abusing this program by taking on outsized 
small business portfolios.
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     \22\ For some institutions carrying low risk weightings on their 
existing assets, it is possible that reductions in leverage ratio 
requirements might be required in addition to a reduction in risk 
weightings. In other words, incremental credit can only be encouraged 
if the binding regulatory capital constraint is relaxed.
     \23\ Static minimum regulatory capital ratios are frequently 
criticized because they encourage procyclical lending volumes. 
Providing regulatory capital relief for small business credit at this 
point in the cycle would help mitigate that problem, albeit in an 
admittedly ad hoc manner.
     \24\ Changing regulatory capital requirements does not, strictly 
speaking, itself transform economically unattractive loans into 
economically attractive ones. It simply relaxes regulatory capital 
constraints on otherwise attractive loans. Conceivably, an interim 
reduction in risk weightings could be coupled with an interim 
Government or public/private guaranty on the credit losses associated 
with incremental small business lending. That would transform, on the 
margin, economically unattractive loans into attractive ones; but it 
would also be every bit as complicated as the Administration's proposal 
itself.
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    By reducing regulatory capital requirements on new lending, of 
course, we would be increasing the ``tail risk'' of loss borne by the 
FDIC's Deposit Insurance Fund, and, indirectly, increasing risk to the 
taxpayer. \25\ But that incremental risk would at least be tied 
specifically to the outcome we desire--incremental small business 
credit.
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     \25\ The Deposit Insurance Fund (the ``DIF'') is protected, in 
part, by a bank's capital cushion. So in the event of a bank failure, 
the DIF would be more exposed to losses by the magnitude of the capital 
relief provided under this proposal. Of course, Congress could choose 
to compensate the DIF in that amount.
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    I hope this statement helps you as you consider these critical 
issues. I look forward to your questions.
