What the S&P Downgrade means for SBA Lending

David NayorSmall Business Lending

Small businesses, from mom-and-pop shops to independent franchise owners, have faced enormous challenges in seeking financing since the beginning of the credit crisis. When Standard & Poor’s downgraded U.S. sovereign debt on Friday August 5th, countless small business owners wondered whether access to financing would become even more difficult. Beyond the small businesses themselves, the larger economy seeks to understand if small business credit conditions will further degrade since small business creates 60 to 80 percent of new jobs and employ over half of the country’s private sector workforce.

The Financial Markets look to the rate of return on US Treasury Bills as the baseline for the rate of return an investor will accept on a zero risk investment. All other assets (equities, corporate bonds, commercial real estate loans and even small business loans) are priced at a premium to the T-Bill. S&P’s downgrade suggests that the U.S.’s cost borrowing would climb, i.e. T-Bills might require a higher return. If that were to happen, it would follow that the net cost to all borrowers would climb, and of course business loans and especially small business financing would be caught in this storm of rising debt costs.

Fortunately this did not happen in the immediate days following the downgrade. The U.S. has enjoyed lower borrowing costs since the downgrade. The yield on the 10 year treasury dropped more than 30 basis points, hovering near 2.2%, since the downgrade and the Federal Reserve just announced that it would keep the Fed Funds rate (the rate at which banks lend each other money, usually overnight) near zero through mid-2013 . Ironically, in the face of the market turmoil and uncertainty spawned by S&Ps unprecedented call, investors fled to the safety and right into the arms of newly “downgraded” asset: U.S. sovereign debt – the T-Bill.

The landscape for small business borrowers seeking SBA financing should not deteriorate further because of the downgrade – but not for the reason stated above. The reason, instead, lies in the inner workings of the investor market for SBA loans. A typical SBA loan originated by a local bank to their local small business owner is 75% guaranteed by the U.S. Government. While the interest rate the business borrower pays on their SBA loan is considerably higher than the T-Bill rate or the Fed Funds rate, the bank’s risk on 75% of the SBA loan is not meaningfully different than the risk on a T-Bill since both are backed by the full faith and credit of the U.S. Government. Investors have historically paid bankers a handsome premium for the guaranteed portion of these SBA loans…and why not when you consider the lender is receiving up to 6% interest while the commensurate risk of the U.S. backed asset commands only 2-3%.

So to fully understand how the small business borrower will fair in the face of S&P’s downgrade we need to look into the SBA’s secondary market. BoeFly, the only online marketplace connecting business borrowers and lenders and lenders with the secondary market is an open exchange with unprecedented visibility into the SBA secondary market. A review of loan sales on BoeFly by banks, spanning multiple geographic regions, reveals no negative impact on prices paid to banks for SBA guaranteed loans since the S&P downgrade. In fact, banks that issue SBA loans enjoy increased demand for these SBA loans just as Treasury themselves sees increased demand for its bonds.

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The bottom line for small business owners is that the S&P downgrade should have no immediate impact on their ability to obtain a business loan, particularly for SBA loans. The reason for this is because their banker is strongly incentivized to originate new SBA loans…that they can then sell on BoeFly at high premiums to cautious investors seeking to the safety of U.S. sovereign debt (yes, that same debt S&P downgraded!). However, business owners operate today in a difficult credit environment and it is critical for small business owners to leverage the proven technologies like BoeFly to most efficient connect with the widest array of lenders possible. Learn how BoeFly can help you find an SBA loan.