The Wall Street Journal
By: Victoria McGrane & Deborah Solomon
December 2, 2010
WASHINGTON--The Obama administration's latest attempt to jump-start small-business lending is facing headwinds even before it launches.
The U.S. Treasury Department plans to release in coming days the criteria banks must meet to tap a $30 billion lending fund aimed at helping small businesses. The program is expected to include enticement for smaller banks to tap the fund, including an interest rate of as little as 1% and an opportunity for banks that still have Troubled Asset Relief Program funds to substitute new government funds with fewer strings and less stigma.
But it may not be enough to overcome banks' reluctance to make small-business loans.
Smaller banks have spent the past year complaining to regulators and lawmakers that examiners are being overly conservative, particularly in assessing commercial real-estate loans that many smaller banks hold on their books. The tough exam environment, they argue, has damped their ability to make small-business loans.
The regulators "have simply made it almost impossible for banks to freely do what they used to do--and that's underwrite small-business loans and take some risk, price for the risk, and go out and keep their local economies moving," said Steve Wilson, the newly elected chairman of the American Bankers Association and the chairman and chief executive of the 25-branch LCNB National Bank in Lebanon, Ohio.
Mr. Wilson said he is seeing an unprecedented level of toughness from regulators, including during his own bank's exam last year. For the first time in his 35-year career, Mr. Wilson said, he experienced an examiner classifying a performing loan--one that was continuing to make payments--as troubled. Such a designation requires a bank to hold more capital in reserve in case that loan goes bad, leaving less money for the bank to lend.
Many bankers say they have enough capital but have no demand from borrowers who meet the stricter bar set by examiners. Others say they could use more capital but fear Washington could retroactively change the rules for the program, as happened with TARP.
According to the Independent Community Bankers of America, a small-bank lobby group, an internal poll found 70% of respondents didn't plan to use the small-business lending fund, either because they didn't need capital or didn't have "sufficient" loan demand. About 24% said they would use the fund.
Banks' reticence to lend has been a constant problem for the Obama administration in its bid to aid small business. Administration officials have found themselves caught in a dilemma, urging banks to lend even as regulators toughen standards in the wake of the financial crisis.
Jim McKillop, president and CEO of Florida-based Independent Bankers Bank, which provides financial services to community banks in Florida and Georgia, said examiners began imposing tougher standards in April 2009, around the time Congress grilled the heads of the major federal banking regulators over failing to prevent the financial crisis.
Mr. McKillop said about 80% of the community banks he works with are shrinking their loan portfolios. "You've got huge question marks as far as the regulators are concerned," he said. Bankers are now afraid that underwriting a loan they would normally want to make "could cost [the bank] dearly" in terms of having to put extra capital aside.
The Treasury is hoping its new program will coax banks into lending by giving them extra capital at a relatively cheap cost, some of which banks are then supposed to turn into loans. Banks that boost lending by 10% will see their interest rate fall to as low as 1%. The legislation also includes an explicit out for banks if Washington changes the rules retroactively.
Treasury officials said they have received support for the program from community banks and plan to talk to bankers to make sure the program is a success. They said the extra cushion provided by the program is the best defense for any bank that wants to make loans but is worried about regulatory scrutiny.
Officials at federal banking agencies say the tougher exam environment is warranted, given the lax underwriting standards that preceded the financial crisis.
"Are our examiners bearing down and being tougher? Yeah," said Tim Long, the chief national bank examiner at the Office of the Comptroller of the Currency, adding that his examiners are doing what many wish they had done earlier. Mr. Long blamed bad loans, not his auditors' efforts. "Our examiners unfortunately are sometimes having to go into some banks--not all--and identify the problems" that a bank's own management failed to identify, he said.
Regulators say the problem for banks is demand. Banks are eager to lend since that is the only way they can make money with interest rates so low. But there isn't demand for loans from good borrowers, they say, in part because economic uncertainty has kept businesses from hiring, expanding or building up inventory. The most recent data show small businesses continuing to hire in November but at a much slower pace compared with prerecession years, according to payroll company Automatic Data Processing Inc.
The Federal Reserve has hosted more than 40 meetings across the country this year trying to figure out whether small businesses are getting the credit they need. The Fed heard from bankers who blamed tough examinations for limiting credit, especially to industries such as construction, real estate and retail services.
"Several banks mentioned that they consider their examiners' expected response before making new loans," a Fed report on the meetings concluded