Will success spoil Low-Doc's future if SBA cuts loan guarantees to 75%?

CNY Business Journal (1994-95), Jul 24, 1995 by Fitting, Beth

SYRACUSE--"With the six-fold increase in the number of Low-Doc loans this year, we must ask, 'Are we growing too fast?'" This comment, from Anthony Wilkinson, president of the National Association of Government Guaranteed Lenders (NAGGL), echoes the concerns of many of its members.

Low-Doc is a program of the U.S. Small Business Administration (SBA) that provides loans of $100,000 and under to small businesses through applications requiring reduced documentation.

At a recent NAGGL conference, when members were asked "How many of you believe the Low-Doc program will have higher-than-average default and loss rates and will cause the subsidy rate to rise?", almost everyone raised his hand, according to Wilkinson. He adds that there have been troubling comments from lenders in the field as well. For instance, one lender commented, "If the loan application is submitted on a Low-Doc form it is sure to be approved [by the SBA]. My district office is approving over 95 percent of the applications it receives."

One problem with the program, claims Wilkinson, is that the influx of small-business borrowers, encouraged by the SBA's Low-Doc program, has some banks transferring their business-development people into the loan office. He says, "They are not loan officers and are not experienced in doing credit analyses." Yet these people are approving loan applications on their single signatures alone.

James Cristofaro, branch manager of the Elmira office of the SBA, adds, "With Low-Doc loans, rather than duplicate effort by providing another credit judgment, the SBA relies on the bank's internal process."

In effect since September 1994, the Low-Doc program allows businesses that are seeking loans under $100,000 to submit a condensed, one-page version of the loan application to the SBA. Michael E. Walsh, assistant district director for economic development of the SBA's Syracuse regional office, explains: "Over the past few years, the average SBA loan has dropped from $250,000 to $145,000. There was a concern that it was too difficult for small businesses to get the smaller loans they needed. The process was cumbersome, expensive, and time-consuming. Since small business is the fastest-growing segment of the business community, the Low-Doc program was instituted to make it possible for these people to get the financing they need."

Wilkinson, in a memo to NAGGL members, wrote that the association "has and will continue to support the concept of the Low-Doc program. Small businesses' need for capital is expanding and SBA staff is shrinking, so the agency must develop products that rely more on the private sector for delivery."

Walsh doesn't believe there will be an inordinate number of defaults on Low-Doc loans. He points out, "There are various safeguards built into the system. We get a two-page credit report from the bank for loans of $50,000 or less. For those over $50,000 and up to the $100,000 limit the bank furnishes its internal credit analyses. In addition, field audits are conducted periodically by SBA's Washington, D.C. office."

Walsh and Wilkinson agree that it is too early in the program to tell if abuses are occurring. "Loans usually go into default after the second year," says Walsh.

Cristofaro adds that Low-Doc loans are high-risk loans to begin with; there will always be those in default, "but it is too soon to determine what the loss ratio will be. In my judgment, based on the types of loans made and the dollar amounts, there is no unusual risk with this type of loan. The bank has the same amount of paperwork and processing. There is less paperwork for the SBA."

But Walsh admits that some potential for abuse is there. Under the Community Reinvestment Act (CRA), lending institutions are being pressured to lend to small urban businesses-loans that would fall within the limits of the Low-Doc program. He says that he doesn't believe any of the local lenders have been approving hasty, marginal-type credit just to satisfy the CRA, however.

Stephen Markley, vice president, Syracuse district community banking, Key Bank of New York, explains that the program has other safeguards. The bank wants to rely on the SBA guarantee. "If we haven't done our job, the SBA could renege on its guarantee to the lender. Key Bank treats Low-Doc loan applicants like any others."

Markley says that the advantage of the Low-Doc program is that it is a good way for the bank to get the customer in the door. What makes the procedure easier for the applicant is that there are no advance forms to fill out before the applicant can complete the Low-Doc application. "Customers are reluctant to get into the process," says Markley, "and go through all those forms, before they are even allowed to apply. The paperwork is daunting for a small-business person."

He points out that the Low-Doc application still requires a business plan, along with income and expense projections, "but they go with the application--no upfront documentation."

The bank, says Markley, relies on credit history in approving its applicants for loans under $50,000, whether they are SBA-guaranteed or not. Markley says that the credit record is as important as getting three years of financial statements.