Why SBA Loans Are a Lot Harder to Obtain After the Great Recession

One of the reasons that (expensive) alternative loans like merchant cash advances became so popular was because banks dramatically reduced their small business lending after the great recession. I spoke to a former CEO of a community bank. He told me when he first started at the bank back in 2006, they would issue loans based on stated income. Originally from Europe, he asked his colleague: "What is stated income?" It turned out stated income is whatever the income the business owner told the bank. It could be $50K, $100K, $150K or anything seemingly believable. The bank would just take it.

He was shocked, but during the go-go years of real estate, nobody questioned the insanity seriously enough. Then in 2007, the subprime mortgage crisis hit, followed by the prime mortgage crisis in early 2008, the credit default swap crisis in late 2008, etc. The government had to bail out big banks while a bunch of small banks failed. Many business owners had a very tough time maintaining their revenue while the banks tightened their credit policy. The bar became a lot higher for getting any loan, and business loans become extremely hard to obtain.

The following graph shows the number of SBA 7(a) loans by year. As you can see, the number of 7(a) loans peaked in 2007 and dropped dramatically in 2008 and 2009. The number of loans issued in 2009 is only 41.5% of the number in 2007, and has been hovering around 50% of the peak in the past couple of years. The total loan amount did come back and exceeded the pre-recession level . What this means is that banks are issuing a larger number of SBA loans in the past couple of years.

The following graph shows the charge-off rates of the 7(a) loans by year approved. As you can see, the charge-off rates for loans approved in 2006 and 2007 are staggering. 30.57% of 7(a) loans that were approved in 2007 are already charged off with 13.15% principal loss. The loss rate is going to go even higher, as the SBA loans are typically in 10 year terms. It's totally understandable why banks slowed down on small business lending, because the loss from loans in 2006-2007 is ginormous.

Now, let's look at the distribution of the size of loans as we observed in the first graph, that banks seem to issue bigger loans in the past few years. As you can see, from 2000 to 2007 there was a great growth of loans under $50K while other bigger loan enjoyed steady growth over the years. Then in 2008 and 2009, number of loans approved under $50K dropped dramatically and never really came back, while the number of $1M+ loans set new records in 2011.

So, what happened to the small size SBA loans? The following two graphs show the repayment performance for loans by size. As you can see, while all loans approved in 2006 and 2007 underperformed, loans with size <$50K performed extremely poorly. Historically, the small size loans have consistently underperformed larger loans. In 2007, 36.82% of the <$50K loans approved are already charged off with 32.54% overall principal loss. $50K-$150K loans did slightly better but still had 28.88% charge-off rate and 22.59% principal loss. These metrics are brutal for banks as they are only charging interest rate of (Prime + 2.75-4.75%). On the other hand, the $1M+ loans have only 8.99% charge-off rate and 5.94% principal loss. These businesses are stronger to weather the recession.

After experiencing the great recession, if you were a bank, would you lend to small businesses who requested <$150K? After reviewing the statistics from SBA loans, we could empathize why banks are reluctant. After all, banks are in business to make a profit. But this reluctance drove small business owners to really expensive funding options like merchant cash advances or daily debit loans. Fortunately, the alternative online term loan lenders are currently filling the gap between banks and MCAs, and online SBA options like SmartBiz started to pop up. Hopefully, this time banks learned to manage the risk better so when the next credit cycle troughs, we won't see the 30% loss again.