On March 16, 2009, the Treasury announced the terms of new program, Unlocking Credit for Small Businesses, aimed at helping jump start credit markets for small business loans. The program includes the following significant provisions:
- The Treasury will purchase up to $15 billion in securities backed by Small Business Administration (SBA) loans;
- The SBA may guarantee up to 90% of Section 7(a) loans, which are loans to support the business operations of small businesses;
- The SBA will temporarily eliminate loan fees for certain Section 7(a) loans and 504 Program loans, which provide long-term financing to directly support economic development within a community;
- The largest Financial Stability Plan Assistance recipients must weekly report their SBA lending activities, and all financial institutions may have to monthly report their SBA lending activities; and
- The Treasury will issue guidance for the tax-related provisions, aimed at providing liquidity to small businesses and encouraging investments in small businesses.
Together, these provisions are aimed at increasing small business lending, which is extremely important in these flagging economic times because small businesses have generated approximately 70% of net new jobs annually over the past decade. These provisions should also provide a liquidity boost for community banks, credit unions, and small lenders, who together account for approximately 40% of all SBA-backed loans, by allowing these institutions to sell existing SBA loans and then to extend more credit to other borrowers.
On February 5, 2009, the Office of the Special Inspector General Troubled Asset Relief Program (SIGTARP) began issuing letters to TARP Capital recipients requesting information on how the institutions have used the TARP funds and how the institution was addressing the executive compensation limits. The requested information is due 30 days following the request; as a result, the first responses are due the week of March 2, 2009. On February 25, 2009, SIGTARP provided a Frequently Asked Questions supplement to their initial request.
As noted in the FAQ, SIGTARP is not tasked with monitoring whether any individual bank is in compliance with TARP requirements. However, the responses provided to SIGTARP may ultimately result in political and regulatory pressure against institutions that expressly rebut the presumption that TARP funds should be used to spur lending (despite the recession). Institutions should absolutely provide a good faith effort to tell their story regarding the anticipated and actual uses of funds; especially as a senior executive officer is asked to certify to the accuracy of the responses under Title 18, United States Code, Section 101. This code section makes it a felony to provide false statements to federal officials, and was the statute ultimately used to send Martha Stewart to jail. However, institutions should also be aware of the political environment in which these responses will be read (and potentially more widely circulated).
On February 17, 2009, the Treasury Department released its first monthly bank lending survey, comprised of the largest 20 recipients of TARP Capital funds. The survey found that despite the economic deterioration in the fourth quarter of 2008 and news of doom and gloom nightly, banks “continued to originate, refinance and renew loans.”
These originations, refinances and loan renewals were not, however, always sufficient to offset loan payoffs, resulting in lower overall balances of residential mortgage and commercial loans. “Over the period, the median change in residential mortgage loan balances was a decrease of 1 percent, while the median change in corporate loan balances was a decrease of 1 percent. Meanwhile, the median percent change in loan balances for U.S. credit cards was an increase of 2 percent, reflecting greater reliance on existing credit lines by consumers.”
While only the top 20 banks are currently included, the Treasury indicates that it “is in the process of developing a more streamlines snapshot for smaller institutions.”
The Treasury’s analysis, as well as several of the individual responses, can provide useful guidance on how to explain the difficulties of lending in this economy, both generally and in response to the SIGTARP request. In response to the question, “Are banks doing what they’re supposed to do, providing credit to borrowers in a safe and sound manner?”, the Treasury explicitly notes that answering the question “is difficult because we are in an economic downturn, during which it is common for lending levels to contract.” The Treasury goes on to note that “the demand for credit by consumers and businesses typically falls during an economic downturn, reflecting caution by both lenders and borrowers to take on new risk during uncertain economic times.”
While many community banks still have not received any TARP Capital investment, many of those that have may be able to demonstrate to Congress why investments in community banks are key to getting money circulating on main street again. One such community bank, Citizens South Bank in Gastonia, North Carolina, and its President, Kim Price, were highlighted in a recent opinion piece in the Washington Post.
And that got Price to thinking: What if Citizens were to use its federal bailout money to offer below-market mortgage rates with no closing costs to consumers who would buy a house, or a house lot, from builders and developers who had borrowed money from Citizens?
Price asked some of his loan officers to check with the builders and developers, who not surprisingly were excited enough about the project to be willing to chip in some money to help cover a portion of the forgone closing costs. So last week, Citizens launched its marketing campaign for the $20.5 million program, in collaboration with its builder-developer customers, offering 30-year loans with an initial teaser rate of 3.5 percent for the first two years, rising to a fixed 5.5 percent rate (the current market rate) for the balance of the loan.
“As we see it, it’s a win-win-win situation all round,” Price explained to me. The builders and developers win by having a tool to help move their unsold inventory. The consumer wins by getting a cut-rate loan. And Citizens wins because it lowers the risk that it will have to write off even more of its commercial loans while taking a modest step to help stimulate the local economy. And, of course, the public relations bump isn’t bad either.
Offering special mortgage rates to consumers who buy lots from the bank’s builders can be a great way to address the slowing real estate market generally, with or without TARP Capital.
Neil Barofsky, the Treasury Department’s Special Inspector General for the Troubled Assets Relief Program, plans to ask all TARP fund recipients to “account for their use of TARP funds and to describe their efforts to comply with applicable executive compensation restrictions.” Mr. Barofsky describes the initiatives of the Office of the Special Inspector General for the Troubled Assets Relief Program in a letter, dated January 22, 2009, to the raking member of the Senate Finance Committee.
Specifically, the Treasury intends to request from each entity that has received TARP funds to provide, within 30 days of the request:
- a narrative response outlining their use or expected use of TARP funds;
- copies of pertinent supporting documentation (financial or otherwise) to support such response;
- a description of their plans for complying with applicable executive compensation restrictions; and
- a certification by a duly authorized senior executive officer of each company as to the accuracy of all statements, representations, and supporting information provided.
One issue that seems to be gaining traction is the need for banks to show how they are using TARP Capital, with a strong preference for the banks to be using TARP Capital to make loans. While the fungibility of bank capital makes it virtually impossible to directly tie any particular dollar of capital with any particular dollar lent, that fungibility also gives great leeway to community banks to demonstrate the lending impact of TARP Capital. Despite the political hot potato, we expect very few, if any, community banks to be criticized for their use of TARP Capital funds.
We do not believe that TARP Capital should fundamentally change the way in which bankers run their banks. Solely because they have TARP Capital, banks should not approve loans that they otherwise would turn down. However, any bank with additional capital, which TARP Capital provides, is in a better position to make or renew loans than that same bank would have been without TARP Capital.
A bank should be able to show that TARP Capital is “working” so long as its total loans are higher than they would have been without the TARP Capital infusion. In recognition of the current economic environment and capital restraints, we believe many banks would be actively attempting to shrink the size of the bank were they not to receive TARP Capital infusions. As a result, merely maintaining the current levels of loans could, in reality, be the result of TARP Capital increasing bank lending activity. Even Barney Frank’s proposed reform legislation acknowledges that TARP Capital may simply minimize the decline in lending that normally accompanies economic recessions. While this metric may be difficult for the Congressional Oversight Committee to accept, anytime the question is asked whether a new program is working, you have to make assumptions about what the situation would look like without the program.