A Word from Arne
Another year is drawing to a close, and there are a few important items to spotlight as the calendar moves to 2018.
SBA Loans Remain Strong
Use of the various SBA loan programs continued to be strong for FY 2017, with over $25 billion extended in the 7(a) program, and over $5 billion put into service under the 504 program this year. More than 68,000 small business borrowers were assisted through SBA programs during last fiscal year ended 09-30-17.
SBA Oversight Expands
Congress has authorized the expansion of the SBA 7(a) program budget for FY 2018 to approximately $29 billion. Our legislators definitely understand that access to capital is the lifeblood of small businesses, and the role of SBA loan programs remains critical as our economic growth continues. It’s only natural for Congress to increase its fiduciary oversight proportionately – this would be expected of any funding authority. Holtmeyer & Monson welcomes this additional and reasonable Congressional oversight, especially as it applies to Lender Service Providers. Since 1982, we have taken pride in steadfastly adhering to the highest, most ethical business standards as we interact with our clients and the SBA. For example, H&M ensures that the originating lender stays in control over the flow of transactions and payments and that the lender is reporting status properly and allocating payments correctly. This is critical so that the lender knows loans are in balance with the SBA at all times.
We believe that great services, compliant standards, clear communications and accurate reporting are paramount to helping our clients take care of their customers. In large part, practices like these have earned us the endorsement of the Independent Community Bankers of America as a Preferred Service Provider for many years.
From all of us here at Holtmeyer & Monson, we want to thank our clients for the past year’s successes, and wish all of our readers a Merry Christmas and Happy New Year. 2018 could be an ideal time to make SBA lending a top priority for your organization. Please feel free to call on us for expert assistance and answers to any questions. We’re happy to help make your SBA lending program a huge success – at no net cost to you.
Ready and Waiting
Rate risk profiles are prepped for more Fed action
by Jim Reber, President and CEO, ICBA Securities
Have you heard? The Federal Open Market Committee (FOMC) of the Federal Reserve is telling us to get ready for three more hikes in 2018. If they’re good at their word, we’ll be looking at overnight rates approaching 2 percent by the end of the year. It’s been a full decade since we’ve seen those levels. Most community bankers that I’ve talked to can’t wait as they believe their earnings are going to improve.
I think their optimism is based on two separate but correlated beliefs: First, that community banks will continue to stick to their responsible loan underwriting standards, and second, that they’ll be able to control their margins, even as money-market rates are on the rise. So far, the FDIC confirms that there haven’t been any cracks in the credit quality dike among community bankers this time around. So maybe it’s time to check out the interest rate risk profile of a typical community bank to see how that’s shaping up.
Let’s review the regulators’ take on the subject. The counter-argument to bankers’ enthusiasm about margin improvement comes from your friends at the FDIC. The June 30, 2017 Quarterly Banking Profile mentioned that, “some banks have responded…by ‘reaching for yield’ through higher-risk and longer-term assets.” This was not really news as similar comments had been made in recent quarterly releases.
In a separate Supervisory Insight from last summer, the FDIC mentioned increased loan demand, shrinking supplies of liquid assets and increased use of wholesale funding. The report stated rather clearly that, “liquidity risk is generally increasing for [community banks] as a group.” It recommended that contingency funding plans be reviewed and tested, and that cash flow projections for the entire balance sheet be challenged.
From the view of ICBA Securities and its exclusive broker, Vining Sparks, you’ve already addressed these issues. Vining Sparks is the interest-rate risk modeler for about 300 community banks, so it has an eyewitness view of the rate risk exposure (or lack thereof) for a large segment of the industry. And I’m pleased to report that, for at least these banks, they’re built for the 2018 forecast.
Recent additions to the risk management lexicon include Earnings at Risk (EAR), Economic Value of Equity (EVE), and Capital at Risk (CAR). As we’ve come to learn, your examiners will expect you to know what your community bank’s posture is for these and other risk measurements. It’s also helpful to recall that the standard range of interest rate shocks that you’re expected to calculate is from “down 300” to “up 400” basis points.
Back to our sample of 300 community banks. As of September 30, 2017, this group is estimating that it’ll have a positive EAR in any rising-rate scenario of a parallel nature. It also is projecting to have a larger positive EAR than the previous quarter and year. This is a good thing if 1.) it’s accurate, and 2.) the FOMC does what it says it will. The exact same condition exists for this group’s EVE; in any rising-rate forecast, economic value of equity will increase.
What’s even more encouraging is that most banks had negative projections for these metrics in rising-rate scenarios just two years ago. This means that community bankers have been diligent and disciplined about addressing their interest-rate risk. And the ultimate backstop to risk, a bank’s capital, has similarly been fortified. The average community bank’s CAR shows a decline of only about 16 percent in a severe (up 400 basis point) rate shock. This is well under the regulators’ general guidelines about capital exposure to interest rate changes.
Observations and recommendations
It is true that the liquidity measurements for community banks are showing some ebb in the last two years. Your examiners have commented on it, and there is plenty of evidence to back it up. However, it’s not like the well has run dry. For example, while wholesale deposits are trending upwards, the typical community bank still has borrowing capacity of almost 40 percent of assets. It looks like contingency funding is in place.
If you’re unsure how much liquidity your balance sheet will produce over the next 24 months, here are some suggestions:
- Have a shocked cash flow ladder compiled by a third party, like your favorite broker.
- Take a good look at recent prepayment speeds on your mortgage securities.
- Consider adding securities that will produce near-term cash flow, like highly callable agencies, premium mortgages or well-structured collateralized mortgage obligations.
- Get indications of market prices on government-guaranteed loans or other liquid portions of your loan portfolio for possible future sales.
Your community bank is probably in relatively good shape for the interest rate environment. The industry has had plenty of time to prepare and the Fed these days is very transparent. Also, it’s never been easier to measure your exposure to a wide range of interest rate shocks. So remain vigilant, and here’s to a prosperous 2018.
Jim Reber is president and CEO of ICBA Securities and can be reached at 800-422-6442 or firstname.lastname@example.org.
Vining Sparks’ proprietary asset-liability model, Risk Manager, is currently being utilized by nearly 300 community banks. There are four different modules that are available based on the complexity of your bank’s balance sheet. For more information, contact your Vining Sparks sales rep or visit www.viningsparks.com.
Recent SBA SOP Changes
The SBA regularly updates its Standard Operating Procedures. SOP 50-10 5(J) will take effect on 01-01-18. The following is a summary of the major changes from this update:
In the past, SBA has not established standardized minimum equity injections for 7(a) loan approval. That has changed. A minimum 10% equity injection is now required for loans to startups and change-of-ownership transactions. A post-sale pro forma equity position of at least 10% is now required on all regular 7(a) loans (in excess of $350,000). This pro forma equity may be comprised of either buyer/borrower injected free equity or seller financing placed of full standby for the life of the SBA loan. Additionally, the dollar amount, and percentage of seller financing may not exceed the borrower free equity. Example, if a 10% equity injection is required – a minimum of 5% must come from the borrower, and seller financing placed on full standby may not exceed the borrower equity injection.
EPC/OC Structured SBA Loans (effective 09-20-17)
Often an Eligible Passive Concern or EOC (e.g. corporation, LLC, partnership, etc.) can be used to own or lease commercial real estate that domiciles the business of an Operating Company (OC), with common ownership between the EOC and OC. The resulting arrangement establishes an owner occupied structure. In an SOP that became effective in September of 2017,the SBA clarified situations when a 7(a) loan is used to finance a change of ownership between a seller and an EPC buyer, with the EPC and OC serving as co-borrowers. SBA loan proceeds may then be used not only to acquire commercial real estate, but also to purchase machinery and equipment, working capital and intangible assets. The SBA requires for the commercial real estate financed with a 7(a) loan to have been held by the seller for at least 36 months. This stipulation is intended to deter “flipping” of properties and investor flight.
SBA is establishing a Franchise Directory listing eligible franchises that have been previously approved as potential users of the 7(a) loan programs. If a franchise does not appear on the directory, it is not eligible for SBA financing. The agency has also established a process for franchises desiring to become listed on the Directory. This new Franchise Directory will remove the necessity of lenders having to review franchise information for eligibility purposes.
Changes to the SBA Standard Operating Procedures generally cause some confusion for a period of time after issuance. Please call your Holtmeyer & Monson Account Executive for any clarifications.
Two topics: (1) On December 14th, the prime rate was increased to 4.50%. This rate increase will take effect on 01-01-18 for SBA accounting purposes. (2) SBA lenders may unilaterally – without SBA approval - extend loan maturities at any time before the subject loan or line of credit reaches maturity. After maturity, lenders must receive SBA approval for maturity extensions.