[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
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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).
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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).
---------------------------------------------------------------------------
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.
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\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.
---------------------------------------------------------------------------
\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).
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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).
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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\
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\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).
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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).
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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).
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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\
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\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\
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\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).
---------------------------------------------------------------------------
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.