For the past five years, bar and restaurant owners in Columbia have binged on government-backed loans served up by commercial banks and insured by the federal Small Business Administration. Hailed by lenders as a signal of Columbia’s shift to a service economy, the feeding frenzy is banking an unusual amount of taxpayer dollars on one of America’s riskiest businesses.
In an effort to encourage banks to take chances and pump money into local economies, the federal government vows to cover losses on loans made through the SBA’s 7(a) program. If borrowers fail to pay back the bank, the government eats up to 85 percent of the bill. While it is undoubtedly moving money into the hands of local entrepreneurs, government auditors routinely criticize the SBA for poor oversight, and questions linger about how well regulators monitor the commercial banks operating with a safety net provided by the taxpayers.
Traditionally, SBA loans have been spread across a wide variety of businesses, from dentists’ offices to construction companies. Columbia’s business leaders credit SBA loans with the continued vitality of Ninth Street, where past recipients include Shakespeare’s Pizza and Ninth Street Video, as well as the commercial growth near Nifong Boulevard and Providence Road.
An analysis of the agency’s loan database shows that over the past five years the number of government-backed loans to Columbia’s bars and restaurants has skyrocketed far beyond previous levels. Between August 2000 and August 2005, 33 cents of every loan dollar the SBA backed in Columbia — more than $7.7 million of the $22.3 million total — went to finance bars and restaurants. That is more than double what was given out to Columbia bars and restaurants in the previous five years.
Columbia reflects — indeed surpasses — a national trend. Last year the agency’s inspector general found that restaurants received 9 percent of all government-backed loan dollars between 1996 and 2003, more than any other industry. And not only were restaurant loans the most common, they were also the most likely to go unpaid. Recent academic research has argued that restaurants aren’t as risky as the often-cited 90 percent failure rate, but even the most optimistic estimates rate them as more prone to failure than other businesses.
“I think restaurants are a greater risk. I don’t think that’s up for debate,” said Mike Schrader, a counselor at the Small Business Development Center, a joint operation between the SBA and MU. “Any type of restaurant makes a banker exceptionally nervous.”
Since borrowers are typically given at least seven to 10 years to pay back an SBA loan — much longer than comparable loans made without government protection — it’s too soon to say how much any sour investments will cost taxpayers. But of the 37 bars and restaurants that have received loans since August 2000, five have already gone out of business. And a sixth, Grindstone Brewing Co., has been shuttered for weeks.
While none of them had yet to officially charge off payments — in fact, one has already returned the principle in full — the government is still on the hook to repay millions if the investments fail.
The SBA already loses loans at a much greater rate than is standard on the commercial market. According to its own records, the agency has charged off 6.56 percent of the loans made in the program’s history. In contrast, the Federal Reserve Board reports that only 0.23 percent of standard commercial and industrial loans were charged off in the most recent quarter. In the past 20 years, lenders operating without the government guaranty have never reported losses greater than 2.15 percent, which happened in the quarter immediately after Sept. 11, 2001.
The big movers
Operating in a booming college town with plenty of demand for recreation, Columbia’s SBA lenders were already ahead of the curve in the 1990s. Over the past five years, they’ve shot ever further in front. And despite what business leaders say is an increased demand for food and entertainment, banks are hedging more bets with a government guaranty.
“The restaurant business is, from a banker’s perspective, about as risky an investment as you can find,” Schrader said. “With the reputation that bars and restaurants have, they want the comfort of that guaranty.”
Two Columbia lenders are leading the pack. Regions Bank and Boone County National Bank accounted for 18 of the 37 SBA loans made to bars or restaurants since August 2000. Regions loaned out more than $750,000 combined to three Jimmy John’s Gourmet Sandwich Shops and nearly $900,000 to Columbia’s two Tropical Liqueurs. Boone County National, Columbia’s largest bank, sent $1 million to the Deja Vu nightclub and more than $250,000 to both Sophia’s and Hoss’s Market and Rotisserie.
“I think what you’re probably seeing more than anything is residential housing development. That means more bodies that need to be fed and watered,” said Mary Wilkerson, vice president of marketing at Boone County National. Coming down contrary to that theory are city records that show the number of eating places inspected in Boone County has actually decreased over the past five years.
Both Regions and Boone County National work through the SBA’s Preferred Lenders Program. Banks that are certified as preferred lenders are allowed to offer loans with minimal government supervision. While the program has allowed banks to move more money into communities at less administrative cost for the government, its oversight has been repeatedly criticized as lax and ineffective in federal audits conducted by the nonpartisan Government Accountability Office. One report concluded that the SBA had “no firm criteria” for determining whether a loan should be guaranteed. Other investigations have found large businesses sneaking into the mix and banks lending to owners who have charged off loans in the past.
Jerry Lash, director of lender relations at the SBA’s regional office in St. Louis, said he didn’t know of any major lenders who have been disciplined by regulators.
“We were created to basically make jobs. That’s what we do.” Lash said. “The more oversight you get, the costlier the program. You give up something to get something.”
“Where do you draw the line?” Lash asked. “If we take nothing but golden loans, they don’t need us, because the banks do that. Where we try to fit in is not to take all loans, but sometimes we go from gold to silver and sometimes silver to bronze and sometimes bronze to copper.”
During his tenure, Lash has seen the agency’s portfolio swell in size while its staff has diminished. In early 2004, the 7(a) program had $28.7 billion in outstanding balances. Lash said the SBA lacks the personnel to closely review every application, particularly those from preferred lenders, who he thinks deserve the government’s trust.
“I honestly and totally believe that the local banker has a better grasp of what will work in his area and her area,” Lash said. “The primary interest now is that that’s their business and that they are also in a business for profit. They are not going to make loans that they think are losers.”
The early returns
Wing Zone, T.P.’s Bar and Grill Downtown and D’Agostino’s Italian Restaurant together received $498,000 from The Callaway Bank between 2001 and 2003. More than $400,000 of that money was underwritten by the SBA. All three businesses are now closed.
“That simply speaks to the risk inherent in lending in that area. It is a risky area,” said Bruce Harris, Callaway’s president. “We don’t create the loan demand, we sort of react to it. For some reason, there have just been a lot people wanting to build bars and restaurants in Columbia.”
Two other failed restaurants received SBA loans in the past five years: Dos Mundos and Los Bandidos. Together, they collected a total of $288,600 from Regions Bank, $221,250 insured by the SBA. Although they did charge off the remaining balance of the $728,000 loan made in 1999, the owners of Los Banditos are recorded as having repaid their loan from Regions. Dos Mundos’ debt is still outstanding. And the owners of the now-troubled Grindstone Brewing Co. were approved for a $125,000 SBA loan in March by Boone County National.
“By its nature the SBA loan is more risky,” Wilkerson said. “But there is no banker that will ever tell you that they want to make a loan they think is going to go bad. That just isn’t worth our time.”
Harris said his bank likes to look at the SBA guaranty as a way to seal a deal that is close but lacks an important element, which with bars and restaurants is often collateral.
“There are some banks out there that just say I don’t care anything about the deal, I’m putting an SBA guaranty on it and taking my chances,” Harris said. “Most banks use it judiciously. You try to say I like this deal for a lot of reasons but I need the extra protection to make this work.
“I don’t think (a total reliance on the banks) is the right response from the SBA. I understand their pain; Congress dictates to them. But at the end of the day it still is their responsibility.”
QUESTIONS AND ANSWERS
Q What is the SBA?
A The Small Business Administration was formed by the Small Business Act of 1953, which created a new agency from aging government programs designed to grapple with the Great Depression and mobilize the nation’s industry for World War II. The new department was charged with assuring that a percentage of government contracts be set aside for small companies, providing loans to victims of natural disasters and giving direct loans to business owners, a practice that has since given way to government-backed loans granted by private banks and lenders. In 2004, the department held a $60 billion loan portfolio combined from those efforts and other programs.
Q What qualifies as a small business?
A The government definition of a small business varies between industries, but the general standard is that any business with fewer than 500 employees qualifies. The SBA’s Office of Advocacy estimates that small businesses accounted for 99.9 percent of the approximately 24.7 million businesses in the United States in 2004.
Q What is the 7(a) program, and how does it work?
A The agency’s largest loan program is the Basic 7(a) Loan Program, which distributes money to entrepreneurs for opening or expanding businesses. It does not send money directly to business owners. Instead, the government encourages lenders to make loans they might otherwise avoid by promising to pick up a large portion of the investment should the business fail. The SBA can guarantee up to 85 percent of loans smaller than $150,000 and up to 75 percent of loans larger than that. The maximum amount the government can insure is $1 million. Depending on their use, the maximum length of the loans can range up to 25 years. The interest rate cannot exceed 2.75 percentage points above the lowest current rate, also known as the prime rate. Banks must pay a fee for the guaranty, which scales up from 2 percent of the guaranteed amount depending on the total size of the loan.
According to the agency’s 2004 fiscal report, the 7(a) program insured $7.8 billion in loans made by private lenders last year and charged off $197 million in new defaults. After all recoveries, it listed the loss rate of the program since its inception as 6.56 percent.
Q Where else has the SBA been in the news?
A Media reports in October about shortcomings in the SBA’s response to hurricanes Katrina and Rita led to investigations into its disaster loan program by the Government Accountability Office and the agency’s inspector general.
In an editorial on Dec. 9, The Washington Post dubbed the agency’s head, Hector Barreto, “the next Michael Brown.” After The New York Times reported on Dec. 15 that more than two-thirds of the SBA disaster loan applications made by homeowners since the hurricanes remained unprocessed, Barreto defended the program’s effort as “quicker to this event than any in our history.”