ACD Financial: How the SBA is Inextricably Linked to Our Economic Future

Great post by Bill Siegel at The Receivables Exchange. We are a funder on the exchange.

Feed: BLOG | Capital Matters
Posted on: Tuesday, August 10, 2010 4:50 PM
Author: Bill Siegel
Subject: How the SBA is Inextricably Linked to Our Economic Future

Scientists in Britain were recently able to definitively solve one the world's oldest riddles: "Which came first, the chicken or the egg?" Using a supercomputer that analyzed the early formation of the shell, a team of scientists discovered that, in fact, chickens were around before the egg evolved as a means to incubate offspring.

If scientists can solve such ancient riddles, it stands to reason that we can solve some more modern ones, too. The U.S. unemployment rate has been hovering at 9.5% for two months now, down from a high of over 10% at the end of 2009, and, adjusted for one-time restocking of inventories, Q2 GDP remains anemic. So, here's the riddle: how do we create jobs when the demand simply isn't there?

Giving more money to employers so they can pay more salaries is a good place to start. Some quick analysis provides evidence that monthly employment figures and business lending statistics are inextricably linked. Extending credit allows business to not only buy more goods (capital spending and working capital), but also pay salaries to new workers, who in turn spend their salaries on consumer products. Business credit begets both corporate spending and consumer spending. Spending drives GDP. It's a less complicated chain of logic than the genetic work performed by the chicken and egg scientists, but perhaps more relevant.

If we agree that the above logic is reasonable, the place to start when tackling the job creation problem is by stoking credit, particularly to small and midsize businesses (SMBs). SMBs employ 52%[1] of the workers in the U.S., but they account for under 2% of the total issuance of credit. The dearth of small business credit is directly correlated to the poor employment picture. The past 24 months of data show a very strong correlation between the amount of SBA-backed 7(a) loans issued, and the rate of change in employment reported monthly by the Bureau of Labor Statistics. The below chart plots the two statistics against each other:

sba graph (2) resized 600

With a correlation coefficient of 66%, the relationship is not only practical, but visually and statistically[2] clear.

But the chicken-and-egg problem is that increasingly risk-averse banks will be reluctant to lend to small businesses that actually need capital to hire employees. We can solve this by providing incentives, but some of the more successful incentives we've devised are disappearing. At the end of June, a program started under TARP, which moved the SBA's loan guarantee to 90% from 75%, expired. The effect on lending to small businesses was dramatic, and rippled through to employment. In the first four months of the year, net new SBA loans covered by the 90% guarantee, averaged $1.2 billion per month. In June and July following the expiration of the program, new SBA loans have been running just over $300 million, a 75% drop.

Legislation to renew the program is currently stalled in the Senate. Meanwhile the Fed continues to support the credit markets which remain open to only those companies large enough to access them. The Fed's drive to keep rates as low as possible is actually creating a further drag on the ability for commercial banks to lend. One of the biggest obstacles for SBA lending is the lack of economic scale and profitability to the issuing bank. The loans are simply too small and time consuming to underwrite for the program to scratch the upper half of most banks' priority lists. The Fed's compression of the yield curve (the difference between short term rates and long term rates on Treasury notes) has made it difficult for commercial banks to create robust earnings from new lending. Net interest margins (the difference between what a bank earns on its loan portfolio, offset by the amount it cost the bank to borrow the money from depositors and other lenders) have been similarly compressed by the Fed's actions. Tight margins mean less profit, and result in more costly lending programs being curtailed. The scalability and cost of issuing lots of SBA loans make the programs easy targets to cut.

Could the problem be solved in reverse order perhaps? A rise in employment could finally give SMBs the resources to go out and take on new projects, thus increasing the demand and subsequent issuance of SBA loans. Sounds reasonable except for one thorny reality: Employees generally like to be paid first, so the money has to be in the bank before the employment letters hit the mailboxes and ripple through to the statistics.

No, unfortunately the current state of SMB balance sheets does not afford them the ability to hire in the absence of credit –- unless they can manage cash flow more effectively. The Receivables Exchange is just one tool SMBs are using to continue growing when credit is tight. In fact, receivables trading volume on our platform has increased 300% YTD as of July 31, which means there's a hunger for innovative ways to optimize cash flow and access growth capital. Companies are now lowering their cost of capital by 30%, on average, by selling receivables on the Exchange. SMBs may not solve this particular chicken-and-egg problem, but with innovative financing sources like The Receivables Exchange, perhaps they don't have to.

Bill Siegel, CFA, is senior vice president and head of the Liquidity Desk at The Receivables Exchange, an accounts receivable financing tool. The Exchange is the the world's first online marketplace for real-time trading of accounts receivable. Find out how to trade accounts receivable.

[1] U.S. Small Business Administration (SBA)

[2] Using N=24, df=22. Correlation Coefficient of .66 is statistically significant at a P-value of .01

http://blog.receivablesxchange.com/blog/bid/12937/How-the-SBA-is-Inextricably-Linked-to-Our-Economic-Future