Canary in the Coal Mine

Canary in the Coal Mine

Loans backed in part by the U.S. Small Business Administration should be easy to make. One Fort Myers group that helps coordinate these kinds of loans warns that tough times are ahead.

Thomas Wallace feels like the canary in the coal mine.

When banks start making more loans to small businesses again, his not-for-profit company will be the first to see it. That's because Fort Myers-based Independent Development Services Corp. coordinates loans that are backed in part by the U.S. Small Business Administration.

For now, though, Wallace doesn't forecast a recovery in small-business lending until at least the second half of 2009. The problem is not the lack of money, it's the poor credit of prospective borrowers. Assets that collateralize loans are falling and sales are declining, resulting in fewer creditworthy borrowers. "We don't need liquidity," says Wallace, IDS' president.

Small businesses often turn to SBA loans when they can't get conventional loans. But in many cases their fragility in an economic downturn may mean even these government-backed loans won't be available to them.

The issue is complicated by the lack of investors to buy banks' loans. The market for so-called collateralized mortgage obligations has evaporated, which means banks that make these kinds of loans will be forced to keep them in their portfolios and can't pawn them off on other investors.

You would think that bank loans made in partnership with the U.S. government would be an easy sell on Wall Street. Wallace's firm specializes in a kind of SBA loan for fixed assets such as land and buildings that is funded at 50% by a private-sector lender and 40% by a company such as IDS that is 100% backed by the SBA. The borrower generally contributes 10% equity.

But private-sector lenders such as banks have tightened credit and can't sell the loans on the secondary market. "Fifteen to 25% of the market has been driven by banks' ability to securitize," Wallace says. Two of the biggest investment banking firms in the securitization business were Lehman Brothers and Bear Stearns.

Although IDS' business is down about 30% so far this year, it's still lending. In the past two years, the company has generated 100 loans totaling $59 million. It has another $25 million in the pipeline.

But Wallace acknowledges that the economic downturn is slowing loan growth, especially in hard-hit areas like Florida. "The next year will be all about consolidation," Wallace says. An economic recovery for small business isn't in the cards until late 2009 or 2010, he says.

But you can be sure that when things turn around, IDS will be the first to feel it. "We will lead the way out of this," Wallace says.

IDS is one of about 270 nonprofits called certified development corporations to contribute to the economic development of a community. IDS arranges the loans, sells its portion of the government-backed loans in the secondary market and manages the loans for a fee. So far, investors have kept buying the portion of the loans that are 100% backed by the SBA.

Less than 1% of the loans in IDS' portfolio are delinquent, Wallace says. Underwriting has always been strict and the firm monitors borrowers carefully. "If they're past due, we're on their doorstep," he says. "It's not terribly sophisticated, but it works."

The economic downturn has slowed IDS' expansion plans. The firm has developed proprietary software that streamlines the loan process for its lending partners. That has helped IDS expand beyond Florida to 18 states by partnering with other certified development corporations. "The eventual plan would be to have a national platform," Wallace says. For now, though, Wallace is waiting for the dust to settle.

-Jean Gruss