Love may be lovelier the second time around. The same cannot be said about the Small Business Administration's updated direct lending proposal.
In 2022, the agency sought unsuccessfully to win approval for a plan letting it make loans under its flagship 7(a) program, as well as guaranteeing them. SBA renewed the push last month, only to see the staunch opposition that characterized the initial bid quickly resurface.
In addition to near unified condemnation from congressional Republicans, direct lending has triggered similarly strong, similarly negative reactions from financial services trade groups. The National Association of Government Guaranteed Lenders has come out against it, along with the American Bankers Association, Independent Community Bankers of America and America's Credit Unions.
Led by Sen. Tim Scott, R-South Carolina, and Sen. John Kennedy, R-Louisiana, Republicans in the Senate introduced a bill last month that would prohibit SBA from making direct loans as part of the $35 billion regular 7(a) program. Trade groups quickly signaled their support. Jim Nussle, America's Credit Unions' president and CEO, wrote in a March 19 letter to Scott that a move by SBA into lending threatens to disrupt a longstanding, finely tuned and highly successful public-private partnership, one where the agency's role is limited to guaranteeing loans private-sector lenders make.
"Direct lending would drive up program costs and disincentivize 7(a) authorization within financial institutions, draining the value of the public-private partnership," Nussle wrote. "Further, by becoming a direct lender … the SBA is likely to harm local financial institutions' relationships with small businesses."
In another letter to Scott, ICBA President and CEO Rebeca Romero Rainey cited the extensive network of banks, credit unions, community development financial institutions and other private sector lenders "already in place to meet demand for small-business borrowers."
"SBA direct lending is a poor and costly alternative to private sector lending and would reach fewer borrowers," Romero Rainey wrote.
The Scott-Kennedy legislation has 13 co-sponsors, all Republicans.
"Fraud and inefficiency characterize the Small Business Administration's history in direct lending," Kennedy said in a press release. "The government shouldn't crowd out private lenders that are already doing a good job getting funds to the small businesses that need them."
Mission driven
The 7(a) program is SBA's largest. It served as the operational platform for the massive Paycheck Protection Program, so it was central to the federal government's response to the COVID pandemic. It's continued to play a central role the past two years, distributing tens of billions of dollars in capital as the number of small-business entrepreneurs has exploded.
It's not too big a stretch to assert 7(a) has thrived in COVID's aftermath. The program has guaranteed 138,000 loans since October 2021 totaling more than $66 billion. Along the way, private-sector 7(a) lenders have made more small-dollar loans, reducing the average loan size by 40% since September 2021. They've also increased lending to African Americans and other traditionally underserved groups. Black borrowers' share of 7(a)'s lending volume jumped from about 2.6% at the end of fiscal 2021 to 4.9% through the first half of fiscal 2024.
Testifying last month before the Senate Small Business Committee, SBA Administrator Isabel Casillas Guzman touched on what some have termed a boom in small-business formation. Citing U.S. Census Bureau figures, the Center for American Progress estimated the number of employer business applications — measuring firms likely to hire employees — totaled 5.2 million between 2021 and 2023, up 34% over the three years preceding the 2020 pandemic year.
"These acts of hope, as President Biden calls them, are powered by entrepreneurs in every state, and especially by women and people of color, who are leading with the highest startup rates," Guzman said in her testimony.
Overall startup applications are up sharply, as well. "The first, second and third strongest years of new business applications on record ever is a pretty great testimony to what is happening in our economy," Sen. Cory Booker, D-New Jersey, said at the March 20 Senate Small Business Committee hearing.
All that may beg the obvious question, why mess with success? For Guzman, who has led SBA since March 2021, it's about access. While she lauds current trends, Guzman remains unsatisfied with the rate of progress.
"Too many times businesses are left to bootstrap or depend on high-interest credit cards or predatory lenders," Guzman said during a Feb. 26 interview on Philadelphia's WURD Radio. "The SBA was specifically started to fill gaps [in access to credit] during the Eisenhower administration, but really it has not done so effectively in underserved communities."
SBA did not respond to an interview request prior to the deadline for this story.
Guzman has made boosting access to capital a touchstone of her tenure. One of the administration's first acts, implemented just before Guzman's March 16, 2021, confirmation, was to adjust the funding formula for small-dollar PPP applicants, allowing them to use gross income, instead of net, to calculate their eligible loan amount. The switch opened PPP more broadly to the small-dollar applicants, sole proprietors, independent contractors and self-employed individuals. Average PPP loan size, about $101,000 in 2020, dropped below $42,000 in 2021.
In August 2023, Guzman and SBA implemented changes to the Small Business Investor Company program, which provides capital to privately owned and managed investment funds, to permit the creation of smaller "micro" funds focused on investing in underserved communities. The fiscal 2025 budget includes a proposed increase in SBIC funding to $7 billion, up from $5 billion in the current 2024 fiscal year.
Those reforms were relatively noncontroversial. Reaction to Guzman's plans for 7(a) has been a different story. In an April 2023 rule change, SBA ended a 40-year policy capping the number of nondepository Small Business Lending Companies permitted to participate in the program at 14.
The policy was aimed at further stimulating small-dollar lending, which is seen as benefiting underserved borrowers who tend to seek smaller-size loans. It was met, nevertheless, with harsh criticism, especially in banking and credit union circles, for opening 7(a) to participation by fintech lenders, some of whom were singled out as prominent sources of the fraud that marred the PPP. The policy took a further hit in March when senior executives at London-based Funding Circle, one of three nondepository lenders to receive a new SBLC license under the new rule, announced plans to emphasize operations in the United Kingdom and hinted at a possible sale of the company's U.S. subsidiary.
History lesson
The reaction to the revived direct lending plan has been similarly fierce, with some critics pointing out the practice was discontinued during the Clinton administration. Potentially resuming direct lending following the 2008-2009 financial crisis was rejected by no less an authority than President Obama.
"It's disappointing, but not surprising, to hear that direct loans are back on the table," Tad DeHaven, a policy analyst who has commented frequently on SBA issues, wrote last month in an email to American Banker. "I suppose it was only a matter of time until the special interests agitating for a drink straight from the U.S. Treasury's spigot found receptive political hacks in the White House."
For progressive Democrats, the roots of direct lending — especially when paired with the goal of advancing economic equity — extend back further than 2022, further than Obama's presidency, further than even Clinton, who occupied the White House from 1993 to 2001. In fact, they go all the way back to the heady opening phase of the War on Poverty, when Congress passed the landmark Economic Opportunity Act of 1964.
A core building block of President Lyndon Johnson's Great Society initiative, the Economic Opportunity Act included provisions encouraging loans to businesses that had struggled to obtain credit, even from SBA. Jean Heimlich, who worked at SBA in 1965 and wrote a dissertation on the origins and implementation of Economic Opportunity Loans two years later, traced their genesis to a desire among then-SBA Administrator Eugene Foley's senior advisors to create a vehicle "to provide equity-type financing for small firms, particularly sole proprietorships."
Foley proved receptive to the idea. "Foley wanted SBA to reach smaller businesses. He was especially interested in those concerns because he knew most [African American] firms fell into that category, and he felt SBA had not been doing enough for [African Americans]," Heimlich wrote in her dissertation.
Sixty years later, a history feature currently posted on the agency's website frames the Economic Opportunity Loan program in a positive light, concluding it "[provided] encouragement to new businesses that had been unable to attract financial backing but were sound commercial initiatives."
However, officials and scholars who administered and studied the effort during the program's two-decade existence, were frequently less glowing in their commentary. A December 1980 report prepared by the General Accounting Office noted "more borrowers have defaulted on the loans than repaid them," adding that many of the borrowers that did meet their repayment obligation subsequently folded.
According to the GAO report, the SBA had made approximately 62,000 Economic Opportunity Loans through the 1979 fiscal year, two thirds of which were originated directly by the agency, the remainder by private lenders. Only 31% of the portfolio had been paid in full. Another 39% had been placed in liquidation or charged off. In testimony before the Senate Small Business Committee in October 1981, Lowell Dodge, associate director of GAO's Community and Economic Development Division, stated the Economic Opportunity Loan program "had been a means of sustained economic progress for relatively few borrowers."
Similarly, an August 1979 GAO study of the wider 7(a) program found direct loans produced a significantly higher loss rate than the private-sector credits SBA guaranteed in each of the four fiscal years reviewed. In fiscal 1978, for instance, direct loans had a 6.61% loss rate, compared to 3.37% for guaranteed loans.
Bill Cunningham, founder and CEO of Creative Investment Research in Washington, D.C., said any assessment of programs like Economic Opportunity Loans have to be weighed against the discriminatory roadblocks that confronted minority entrepreneurs in the 1960s and 1970s. Even when they were able to get a loan, Black entrepreneurs rarely received all the capital they required. "If they needed $1,000, they got $500," Cunningham said in an interview. "I'm surprised by the number of businesses that did succeed."
To be sure, there are no indications that Guzman is modeling the SBA's current direct lending scheme after Economic Opportunity Loans. And while no Democratic senators stepped forward to defend the proposal during the March 20 Small Business Committee hearing, the plan does have its backers.
"Though we've seen record new business growth among minority-owned firms, the fact remains their businesses are more likely to be completely shut out of financing," Imani Augustus, director of the Alliance for Entrepreneurial Equity in Washington, D.C., said in a statement to American Banker. "Four-in-10 Black-owned businesses were denied loans and lines of credit in 2023 according to the Federal Reserve. Only 32% of those businesses were fully approved for all the financing they sought. Compare that to white-owned businesses who are fully approved 56% of the time and have a one-in-five chance of being denied.
"There are many reasons why underserved businesses are unable to access capital through traditional lenders," Augustus added. "Disparities in wealth can limit collateral options, some business owners lack established banking relationships, other businesses are more likely to be labeled a high credit risk. This is why the president's move to bring affordable capital to historically underserved businesses through SBA direct lending is so critical."
