Banks Rush to the Exit as SBLF Dividend Spike Looms

The low interest rate environment may be challenging for lending, but it is also providing smaller banks with an affordable way to exit the Small Business Lending Fund.

A steady stream of community banks have been redeeming shares they issued the Treasury Department in order to participate in the SBLF. The program, launched in late 2010, offered relatively cheap capital in the aftermath of the financial crisis, with the larger goal of increasing loans to small businesses.

About a fifth of the 332 institutions that participated in the program have fully exited, and many others are evaluating financing options before the dividend rate increases early next year, industry experts said. A strong subordinated debt market has played an important role for banks that have already left.

"It was just a matter of being proactive and getting it done," said Thomas Osgood, chief financial officer at Xenith Bankshares in Richmond, Va. The $989 million-asset company decided to issue subordinated debt last month to guard against the potential of a "market disruption" or a spike in bond rates.

 Xenith used the proceeds from its debt issue to redeem $8.3 million in SBLF stock.

"We thought we just shouldn't run it too close" to the dividend rate increase, Osgood said.

The program's dividend rate initially started at 5%, but banks were able to lower it to 1% by increasing loans to businesses with less than $50 million in annual revenues. After four and a half years, the rate jumps to 9%. For banks still in the program, that spike is set to occur early next year, industry experts said.

The higher rate will be "a very burdensome cost" for remaining participants, said Collyn Gilbert, an analyst at Keefe, Bruyette & Woods.

At least 15 banks have left the program in the past six months. Several of them, including ConnectOne Bancorp in Englewood Cliffs, N.J., and CoBiz Financial in Denver, issued debt to fund the redemption of SBLF shares.

"I think it's just the cost and potential return of alternative sources of capital," Gilbert said. "The rates on some of the sub debt have been attractive, assuming banks can really leverage it."

The refinancing activity comes as investor demand for community bank debt has increased "substantially" as of late, said Jacques de Saint Phalle, a principal at Sandler O'Neill. Rates on debt issuance now range from 4% to 6% for well-known banks with more than $2 billion in assets, while smaller banks have gotten deals done for 6% to 8%.

Xenith, for instance, refinanced its SBLF capital by issuing 10-year subordinated notes with a 6.75% coupon. In comparison, the company's SBLF dividend was set to hit 9% in March.

Coupon rates on community bank debt hovered around 10% just a few years ago, de Saint Phalle said. "Broadly speaking, for the last two years the majority of the buy-side market has been caught off guard on where [coupon] rates were going," he added.

Rates are expected to remain low into the foreseeable future, though they've edged up slightly in the last year. "My personal view is that the market is going to stay very stable for these banks," de Saint Phalle said.

That's encouraging news for small banks keen on refinancing their SBLF shares.

Senior debt is another option for banks eager to leave the SBLF.

Hilltop Holdings redeemed $114.1 million in SBLF shares in April, using proceeds from an issuance of 5% senior notes. At the time of the transaction, the Dallas company was paying a 5% dividend on its SBLF capital, though the increase was looming.

"The market for debt issuance was attractive," said Jeremy Ford, the $12.5 billion-asset company's president and chief executive. "We knew that the [rate increase] was coming."

The recent wave of departures draws more attention to the SBLF, which has been the target of criticism from policymakers in Washington since its creation. A special investigator's report two years ago blasted the program for producing anemic loan growth, observing that several banks had used the funds to exit the Troubled Asset Relief Program or to issue dividends to shareholders.

The program was also criticized in its early years for having a low acceptance rate among qualifying banks, as well as for being slow to distribute funds.

Additionally, Treasury only distributed $4 billion of the $30 billion that Congress allocated for the SBLF. Nearly 60% of all applicants were rejected, largely because they failed to meet program's requirements, including the ability to pay dividends, the agency said in 2011.

In retrospect, however, a number of bankers are willing to give the SBLF some credit, and a recent Treasury report found that the program has increased small-business lending by $16.4 billion.

"I think it was very beneficial," said Alan White, Hilltop's vice chairman. "It was cheap funding, and the more money we loaned the better." 

"I found Tarp and SBLF to be useful capital tools for our growing community bank," said William Marsh, chief executive of Emclaire Financial in Emlenton, Pa., though he admitted that the Treasury's capital-injection programs — especially Tarp — included some "bad political connotations."

The $589 million-asset Emclaire, which initially used the $10 million it received from the SBLF to fund its exit from Tarp, has redeemed half of its SBLF funding. It plans to fully exit the program before the rate jumps from 2% to 9%. 

Emclaire also credits SBLF funds for allowing it to help small businesses in rural Pennsylvania, Marsh said.

"The program had specific criteria for the types of loans that qualified," he said. "We took our normal potential business targets and narrowed it with respect to those characteristics."