ACCION Esteban Cruz provides rental equipment such as chairs, tables, linens, and moonwalk machines through his EC’s Moonwalk business in San Antonio, Texas.

Ammar Askari, Community Development Expert, Office of the Comptroller of the Currency

Authorized in the Small Business Jobs Act of 2010, the State Small Business Credit Initiative (SSBCI) provides almost $1.5 billion to fund state programs that support lending to small business. Many state programs are eligible for this funding, including portfolio insurance programs known as Capital Access Programs (CAP); loan guarantee programs; loan participation programs; cash collateral programs; and state-funded venture capital programs.

The initiative strengthens state programs that leverage private lending to creditworthy small businesses who are unable to obtain financing through traditional channels. Funds under this initiative are permitted only to extend new credit. The funds are distributed through two channels:

• Capital Access Programs.
• Other Credit Support Programs (OCSP).

Loans originated in conjunction with CAPs may be desirable for community banks. These loans enable the banks to serve small business borrowers whom the banks deem creditworthy but are unable to approve for a variety of reasons. Banks use their own underwriting process and documentation to issue the loans. CAPs create reserve funds that are kept at the lending banks and are used to provide portfolio insurance for all loans enrolled in CAPs, giving banks flexibility when managing loans that default.

By helping to capitalize loan loss reserves, the federal government encourages small business lending while ensuring banks use sound lending practices.

Banks, credit unions, and Community Development Financial Institutions (CDFI) are eligible to participate. There are no size limitations for lenders in the SSBCI.

Financial institutions participating in the SSBCI process must possess sufficient commercial lending experience, financial and managerial capacity, and operational skills to meet the program’s goals. The state CAP is expected to review participating banks’ Uniform Banking Performance Reports and their peer analysis; credit unions’ Financial Performance Reports; and the CDFI Assessment and Rating System, along with audited annual reports.

Lenders must have a meaningful amount of their capital at risk in the loan. Private lenders who have 20 percent or more loss exposure will satisfy this requirement. Most lenders automatically meet this requirement unless their loan is guaranteed by some other program.

States must obtain assurances from lenders that the borrowers will indeed use the loans for business purposes. These include start-up costs, working capital, business acquisitions, franchise financing, equipment loans, inventory financing, commercial real estate acquisitions, and construction and expansion. See the Treasury Department’s list of prohibited purposes in the “Guidelines for State Small Business Credit Initiative.”

The funds are allocated according to a formula that guarantees each participating state 0.9 percent (or about $13 million) of the available funds, in addition to a sum calculated using the state’s relative employment in 2008 and 2009. Expected allocations range from the minimum of $13 million in Idaho to $169 million in California. Funds must be used by the state within two years; otherwise, the money is returned to the U.S. Department of the Treasury’s general funds.

All 50 states, the District of Columbia, the Commonwealth of Puerto Rico, the Commonwealth of Northern Mariana Islands, Guam, American Samoa, and the U.S. Virgin Islands are eligible for funding. Each participant must have a designated office to implement the program. Each allocation agreement must conform to set standards, internal controls, and compliance, audit, and reporting requirements.

The “notice of intent” submission deadline for the program was November 26, 2010. The expected allocations are listed on the Treasury Department’s Web site. The full application deadline was June 27, 2011.

To take advantage of this initiative, states that do not have an existing CAP may start one by seeking technical assistance from the Treasury Department. State programs should be fully operational within 90 days of allocation agreements.

Participating CAP programs must meet the following conditions:

• For the new loan to be enrolled in this loss reserve program, the lender and the business borrowers are asked to split insurance premiums equal to a minimum of 2 percent and a maximum of 7 percent of the loan amount.
• Participating states have to provide matching contributions to the reserve fund in an amount at least equal to the total of the insurance premium charges paid by the borrower and the lender for any new loan.
• This portfolio insurance is available only for loans to borrowers with 500 employees or fewer at the time that the loan is enrolled in the program and where the loan amount does not exceed $5 million.
• The lender cannot use the new loan to pay off a prior debt or refinance an old loan to the small business borrower.

A participating state may be eligible for federal contributions for OCSPs. These programs include collateral support programs, loan participation programs, state-sponsored venture capital programs, and loan guarantee programs. States may opt to apply for funds in use with OCSPs when they don’t have an established CAP, or when the CAP does not have the capacity to distribute the new funds.

To be approved to OCSPs, states must:

• Demonstrate reasonable expectation that OCSPs will meet a 1 to 10 leveraging requirement, where state programs generate $10 in new private lending for every $1 in federal funding. Although this requirement does not apply to CAPs, states may include leverage achieved by CAPs in calculating the multiples in leverage.
• Ensure lenders have some capital at risk. OCSP lenders are expected to bear at least 20 percent of the loss from default. Under this program, if a lender participates in a Small Business Administration (SBA) loan guarantee program, the OCSP loan guarantee program may not guarantee the unguaranteed portions of the SBA-guaranteed loans.
• Use federal funds to extend credit support that
• Targets an average borrower size of 500 employees or less.
• Does not extend credit support to borrowers with more than 750 employees.
• Targets loans with an average principal amount of $5 million or less.
• Does not support loans that exceed a principal amount of $20 million.

In determining the state eligibility for these OCSPs, the Treasury Department considers the benefits to the states and other participating geographic locations (new jobs, new loans, increased income, and tax revenues); the participants’ operational capacity (management qualifications, experience, adoption of best practices); the capacity of the participants’ existing OCSPs (financial strength and operational capacity); internal accounting and administrative control systems (internal and independent audits); and the soundness of the programs’ designs (established business models and no significant weaknesses).

States must provide quarterly and annual reports to the Treasury Department detailing the use of funds; number of borrowers; amount of these loans; and loan breakdown by industry, size, zip code, and borrower’s number of employees.

Participating states must provide a plan showing how they will use the allocated funds to provide access to capital in low- to moderate-income and other underserved communities, including to women- and minority-owned small businesses.

Finally, SSBCI participants are encouraged to employ best practices in risk-based pricing of loans or insurance premiums; credit scoring to assess creditworthiness; and financial modeling for loan performance, risk-based capital adequacy standards, and standardized reporting.

The SSBCI ends September 26, 2017, seven years after the initiative’s enactment.

To learn how some experienced states run SSBCI-type programs, we interviewed program administrators in Indiana and North Carolina.

These two states use the CAP program primarily as credit enhancement for small business borrowers who are creditworthy but unable to meet traditional underwriting guidelines. Matt Tuohy, Program Manager of the Indiana Economic Development Corporation, says, “CAPs tend to be hands-off, very easy to use, credit-enhancement programs targeting small loans.” In Indiana, such loans would average around $50,000.

A typical borrower in the Indiana CAP is the “mom and pop” business. “The CAP dispenses a relatively small amount of funds [$600,000 per year on average],” says Tuohy. “This makes it unlikely that the Indiana CAP will be the primary channel for this large federal injection of funds. Instead, Indiana will use OCSPs as the channel of choice for the SSBCI funds.”

This is not the case in North Carolina. The North Carolina CAP administration has a decade of experience managing the program and has been able to lend a state-appropriated $3.3 million in two seven-year cycles. According to Scott Daugherty, the North Carolina Small Business Commissioner, the program has produced 1,800 loans with $103 million in commercial lending, with losses well within allotted reserves. This strong track record is why the program administration opted to channel the federal funds through the North Carolina CAP.

The North Carolina Rural Economic Development Center administers the new funds with oversight from the state’s small business office. “Thus far, nearly 40 banks have expressed interest in participating, and we expect about 60 to 70 financial institutions to participate eventually,” Daugherty said. The interested financial institutions include community banks, a few large regional banks, 10 credit unions, and a handful of CDFIs.

The program parameters regarding loan size and eligibility mirror those set by the federal legislation. The North Carolina program emphasizes extending loans to underserved populations. To do this, the North Carolina CAP uses an extensive network of community college small business and entrepreneurship centers, the state’s Small Business and Technology Development Centers, and other state managerial and technical assistance resources. This network’s client base includes nearly 30 percent minority-owned businesses and 39 percent female-owned businesses.

“Having an extensive outreach and service delivery channel is an important factor in the success of this program,” Daugherty said. The program targets companies with 200 employees or less—a cohort that has proven to be a major contributor to job creation.

To enhance the chances of success of the CAP, the program administrators sought private sector support for the new round of funding. “One of the challenges facing the CAP in North Carolina is that the credit scores of many businesses have been negatively impacted during the recent recession,” Daugherty said. “Banks will have to bring a broader time frame view to their credit decisions to review financial performance both before the recession and current growth opportunities. Many leaders in the North Carolina financial industry have been supportive of the CAP program and think that it can help offset modest credit degradation related to the recession.”

Lenders interested in learning more about the Indiana and North Carolina CAPs may contact the Indiana Economic Development Corporation and the North Carolina Commissioner for Small Business. For those interested in other state programs, visit the Treasury Department online Resource Center.

The OCC will publish links to states operating SSBCI in its Small Business Resource Directory on the OCC Web site.