"Questionable Opportunity for Community Banks Under Small Business Lending Fund"
Peter J. Rivas
Jones Walker Banking & Financial Services E*lert, September 30, 2010

Despite much criticism, on September 24, 2010, the House of Representatives passed its final version of the Small Business Jobs and Credit Act of 2010 by a vote of 237–187, almost entirely along party lines, with only one Republican supporting the bill. The legislation creates the $30 billion Small Business Lending Fund (“SBLF”) that will provide government money to small banks in order to, theoretically, encourage banks to loan money to small businesses throughout their communities. On September 27, 2010, President Obama signed the final version of the bill into law.

The SBLF will allow Treasury to use $30 billion to purchase preferred stock or subordinated debt from community banks, defined as banks with less than $10 billion in total assets. The bill then directs Treasury to charge the banks a rate of interest (or determine a dividend) that varies depending on how aggressively new loans are made. The more aggressively banks lend, the lower dividend payment, and vice versa. The dividend or interest payment increases if banks do not increase lending to small businesses. Supporters of the bill argue that banks could leverage the $30 billion to make up to $300 billion in available loans.

Small banks have expressed concerns about the many strings attached to taking government money. Much of this fear stems from small banks’ experience under the Troubled Asset Relief Fund (“TARP”), formed at the height of the financial meltdown to pump money into banks. Banks accepting TARP money had to later cut dividends to shareholders and limit compensation to top executives. They were also penalized for early repayment of the government’s investment. Bankers also remain concerned as to the exact regulatory criteria that will be used to approve any government investment. Banks on the FDIC's problem bank list, typically those with Camels of 4 or 5, or banks that have been on that list within the past 90 days, are excluded from participation in the SBLF. But, the bill does permit Treasury to approve capital injections on a case-by-case basis in conjunction with bank regulators, leading many community bankers to wonder if an even higher Camel rating might preclude participation in the program because of subjective regulatory concerns. However, Treasury officials acknowledge that the SBLF bill is without statutory basis for the myriad of restrictions promulgated under TARP, such as executive compensation limitations and dividend restrictions. Treasury is currently developing a method by which outstanding preferred stock issued under TARP could be converted into new funds available under the SBLF, which, presumably, would create more favorable dividend or interest terms to a bank should the bank be able to demonstrate increased lending. However, as of September 27, 2010, Treasury had not put forth a securities purchase agreement establishing the final form of investment, so it is not clear whether the government’s investment will take the form of preferred stock or subordinated debt, and what, if any, conversion terms may be available. Treasury officials also acknowledge that SBLF’s fewer statutory restrictions, as compared to TARP, could inhibit the government’s ability to achieve a favorable return and eventual repayment of its principal investment.

While House Financial Services Chairman Barney Frank has stated the SBLF investment is intended to and will count as Tier 1 capital, questions remain as to whether that capital treatment would conflict with upcoming Basel III rules, which emphasize tangible common equity rather than Tier 1 capital. As currently proposed, the form of investment is neither a hybrid instrument or tangible common equity.

In order to qualify for a SBLF investment, Treasury will require each bank applying for funds to submit a small business lending plan “describing how the applicant’s business strategy and operating goals will allow it to address the needs of small businesses in the areas it serves, as well as a plan to provide linguistically and culturally appropriate outreach, where appropriate.” The bill specifies that this outreach must include advertising in print, radio, television, or electronic media targeting minorities, women and military veterans. Furthermore, the bill instructs Treasury to give priority to banks serving “small businesses that are minority-, veteran-, and women-owned and that also serve low- and moderate-income, minority, and other underserved or rural communities.”