On June 13, 2011, the Federal Reserve published an interim final rule nominally offering some relief from the capital effects of the Tier 2 treatment for SBLF funds for Sub S and Mutual bank holding companies.

As recognized by the Federal Reserve, “the SBLF Subordinated Securities, like the CPP Subordinated Securities, are issued to Treasury as part of a nationwide program to provide capital to eligible banking organizations that are in generally sound financial condition in order to increase the capital available for lending to small businesses, thereby mitigating the ongoing effects of the financial crisis on small business and promoting financial stability.”  The Federal Reserve also acknowledged that “the SBLF Subordinated Securities are in terms and substance substantially equivalent to the CPP Subordinated Securities.”  Not withstanding these goals and similarities, the SBLF Subordinated Securities will only be eligible for Tier 2 capital treatment, as required by the Collins Amendment portion of the Dodd-Frank Act.

Notwithstanding the Tier 2 treatment, as a result of the Small Bank Holding Company Policy Statement, small bank holding companies (less than $500 million in consolidated assets) can still downstream the SBLF funds as Tier 1 capital into their subsidiary bank(s).  By adopting this rule, the Federal Reserve confirmed that a Sub S or Mutual BHC that otherwise qualifies for the small banking holding company policy statement will not have to treat the SBLF funds as “debt” for purposes of complying with the policy statement (which limits the ability to pay dividends if the debt to equity exceeds certain ratios.

On May 26, 2011, almost two weeks after the deadline for C-Corporation financial institutions to apply, the Treasury further restricted eligibility for participation in the Small Business Lending Fund.  The Treasury has determined that only institutions without any dividend restrictions may participate in the SBLF.

In order to be eligible to participate in the SBLF, the Treasury has determined that applicants must be able to pay dividends without being subject to approval by any third party, including the federal banking regulators. This requirement goes beyond the eligibility standards included in the authorizing statute, which provided that banks on the FDIC’s troubled bank list were ineligible.  In light of the Federal Reserve’s propensity to impose dividend restrictions, Treasury’s decision will further limit the potential positive impact of the Small Business Lending Fund.

This decision was communicated to applicants via an “Inquiry Regarding Dividend Payments” and an undated update to the SBLF Frequently Asked Questions website. While the Treasury’s communication makes it sound as though the decision was out of its control, it appears to be Treasury’s determination that the ability to pay dividends should be an eligibility factor, as nothing in the original SBLF documentation provided similar requirements.

On May 12, 2011, the Treasury department got around to posting term sheets for Subchapter S and mutual institutions that desire to participate in the Small Business Lending Fund.  The Treasury intends to use subordinated debentures for both Subchapter S and mutual institutions, and has adjusted the interest rates to reflect after-tax effective rates equivalent to the dividend rate that will be paid by other institutions participating in the Small Business Lending Fund.

The terms and eligibility restrictions are generally otherwise comparable to the term sheets provided for Subchapter C corporation banks and thrifts, with one major exception: the securities issued to Subchapter S and mutual institutions will only qualify for Tier 2 capital treatment.  Not only does this make the Small Business Lending Fund significantly less attractive to Subchapter S banks, it also may make it more difficult for a Subchapter S bank holding company to consider replacing any existing TARP Capital Purchase Program funds with the Small Business Lending Fund.  Unless such a bank holding company qualifies under the smaller bank holding company policy statement (generally for those with less than $500 million in assets), replacing a Tier 1 capital instrument with a Tier 2 capital instrument will be a hard pill to swallow.

Subchapter S and mutual institutions are also given less than a month to apply, with an application deadline of June 6, 2011.  The application deadline for C corporation banks and thrifts is Monday, May 16, 2011.

Treasury is currently recruiting unpaid summer interns to help administer the Small Business Lending Fund (SBLF).  Qualified undergraduate and graduate student volunteers “will be working closely with investment managers on the SBLF’s Application Review Team and will be expected to make a meaningful contribution to the program.” 

While we are all happy to see Treasury develop talent and conserve its resources, we think this may send the wrong message.  At a time when Subchapter S and mutual application guidelines are still unpublished, and over 600 SBLF applicants (all “healthy” and in a position to increase lending to America’s small businesses) are still waiting for disbursement of funds in “early 2011,” we would much rather be hearing about additional paid staffers who can actually get the program implemented.  We wonder whether the added responsibility of training and supervising interns will improve existing personnel’s ability to roll out the SBLF. 

On the other hand, perhaps the interns can provide the program with the spark it needs.  Just don’t tell them about Senator Snowe’s plan to ruin their summer, too.

Senator Olympia Snowe (R-Maine) has introduced an amendment to the enabling legislation for the Small Business Lending Fund (SBLF) that would disqualify TARP recipients from receiving SBLF investment, move the program’s small business lending benchmark from the current four quarters ending June 30, 2010 to the calendar year 2007, establish a non-discretionary 10-year repayment deadline, and sunset the entire fund in 15 years.  As drafted, however, investments made under the SBLF’s current terms would not be affected.  That may give greater import to the recently extended application deadline for C corporation banks.  The current version of the proposed amendment, SB 681, is available here.  Senator Snowe says she would like to do away with the SBLF entirely but that her proposed “fixes” are more politically realistic.

Clearly these changes, if enacted, would make a limited program even more limited.  Much of the interest among SBLF applicants to date has been from CPP/CDCI recipients looking to refinance TARP funds.  In addition, while Snowe’s press release says moving the lending benchmark date back to 2007 “would address concerns that the existing [June 30, 2010] benchmark may be too low, by historical standards, and that an adjustment could result in additional small business lending,” the SBA’s 2011 report on small business lending (which is based on Call Report data) shows that such lending was $18 billion greater in 2010 than in 2006 and $50 billion greater in 2010 than in 2005.  

We do not think this bill stands a substantial chance of passage as a standalone measure, although its attachment to the pending Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) Reauthorization Act, as Snowe has also proposed, could give it a different outlook.  The vote on the current SBLF legislation was sharply divided along party lines, with only two Senate Republicans in support (Voinovich-OH and LeMeiux-FL).  We doubt Snowe will be able to gather bipartisan support in an election year for a measure that would hurt both small businesses and community banks in one fell swoop.

On March 30, 2011, Treasury announced that it was extending the deadline for C corporation banks to apply for participation in the Small Business Lending Fund (SBLF) program to May 16, 2011.  Previously, this deadline had been established as March 31, 2011.   According to the SBLF website, Treasury is still developing terms and guidance for mutual institutions, Subchapter S corporations, and community development loan funds.  The site maintains that terms for such institutions and funds may vary from those currently published and that separate application dates will apply.

We have previously described the SBLF application requirements for C corporations, which are otherwise unchanged.  As a reminder, eligible institutions must generally have had less than $10 billion in consolidated assets as of 12/31/09 and a composite CAMELS rating of 3 or better.  In addition, any institution intending to refinance its TARP obligations with SBLF funds: (i) must be compliant with the material terms and covenants under its CPP/CDCI agreement; (ii) must be current in its dividend payments to Treasury; (iii) can’t have missed (i.e., can’t have been 60 days or more delinquent in) more than one dividend payment; and (iv) must fully refinance or repay its CPP or CDCI investment.

For banks that may still be considering applying for SBLF funds, we have had considerable experience with the application process and provide these general guidelines and anecdotal experience:

• Processing time is still an unknown.  Even our clients that applied very early on in the program are still awaiting meaningful feedback.  We understand that, to date, Treasury has received around 600 SBLF applications.  Treasury previously announced that processing time would vary by applicant but that disbursement of funds would begin in “early 2011.”  We are unaware of any disbursements thus far or how Treasury defines “early.” 
• Interest from our Sub-S clients has been great, and we hope that Treasury will soon release application details applicable to such corporations.
• Most applicants of which we are aware have been TARP participants looking to refinance those obligations, but the program has some limitations in this respect even for very healthy banks.  An SBLF investment is capped at 5% of risk-weighted assets for institutions with $1 billion or less in total assets and 3% of risk-weighted assets for institutions with more than $1 billion but less than $10 billion in total assets.  At the same time, capital outstanding from prior CPP/CDCI investments will be deducted from these limits but must be used to repay a bank’s obligations under those programs, and SBLF participants must either repay or refinance outstanding TARP securities.  Moreover, although total assets are measured as of the end of the fourth quarter of 2009, risk-weighted assets are measured as reported in the bank’s most recent Call Report.  At least one of our clients hoped to refinance TARP funds through the SBLF but ran into a size trap here; it had declined in asset size since the end of 2009 such that its maximum SBLF investment would have been insufficient to refinance its TARP funds.  As a result, it is unable to participate in the SBLF program.
• As we saw with TARP, we have seen certain SBLF applicants come under increased supervisory scrutiny possibly as a result of their SBLF applications.  Applicants should be prepared for possible regulatory review beyond the contents of their application.

 We will continue to follow the evolution of the SBLF and will post updates here as appropriate.  In particular, we are monitoring the pending proposal by Senator Olympia Snowe (R-Maine) to amend the SBLF (and in short, make a limited program even more limited).  If you have further questions about the program, please contact Katherine Koops, BT Atkinson, Barry Hester or any other member of the Bryan Cave Financial Institutions practice.

We previously summarized Treasury’s December 21, 2010 release of application and other details regarding the Small Business Lending Fund (SBLF). On January 11, 2011, Bryan Cave attorneys participated in a 45-minute telephone briefing given by SBLF Director Jason Tepperman and Deputy Assistant Secretary of Small Business, Housing and Commercial Development Don Graves, Jr. Mr. Tepperman presented an overview of the program and addressed questions regarding Treasury’s prior SBLF release.

In no particular order, here are a few “nuggets” of information that were conveyed in response to participant questions:

• Processing Time.  Processing time will vary by applicant, with disbursement of funds to begin in “early 2011.” Transaction documents are still in development, however, and will be posted on Treasury’s SBLF website as soon as they are available. Treasury expects that the $30 billion fund will meet anticipated demand, so it does not expect to have to “ration” investments among participating banks.
• De Novo Eligibility.  So long as they meet the general eligibility criteria (less than $10 billion in assets, not on the FDIC’s problem bank list, etc.), de novo institutions can apply, even if they are subject to dividend restrictions. Banks will be evaluated on a case-by-case basis in conjunction with applicable federal and state regulators.
• Baseline Calculation. The “Baseline,” which is the average of Qualified Small Business Lending (QSBL) amounts outstanding for the four quarters ending June 30, 2010, is the metric for determining small business lending increases and thus dividend rates payable to Treasury under the program. In calculating the Baseline, participants should use end-of-quarter balances as reported in Schedule RC-C of the Call Report as opposed to averages over the quarterly period. In other words, the calculation would average the QSBL amounts reported as of 9/30/09, 12/31/09, 3/31/10 and 6/30/10 to compute the Baseline. Participants need to go back and cull from those Call Reports the particular types of loans that are included in the QSBL definition—they include more than just the Call Report categories of “loans to small businesses” and “loans to small farms.”  Because the Baseline calculation is included in the enabling legislation, there isn’t flexibility on the dates and loan categories that are included.
• TARP Dividend Issues.  Similarly, the requirement that applicants proposing to use SBLF investment to refinance CPP or CDCI funds be current in TARP dividends and not have missed more than one payment is set by the enabling legislation and will not be excepted. Note that the requirement relating to missed dividends refers to “more than one”—i.e., “two or more” missed payments (or payments more than 60 days delinquent).
• Participations and Government Guarantees.  Portions of loans for which the risk is assumed by a third party (e.g., portions of loans that have been participated) and guaranteed portions of government-guaranteed loans are not included in Baseline or QSBL calculations. If the guaranteed portion of a loan is lowered during its term, however, the additional non-guaranteed portion will count as a QSBL increase.
• Additional Guidance to Come.  Additional guidance is forthcoming on the 90% holding company pushdown requirement for TARP participants; the impact of post-SBLF funding growth that results in borrower or loan relationship size exceeding eligibility criteria; treatment of portions of lines of credit approved but not used prior to SBLF funding; and required borrower certifications under the program.

As a reminder, the SBLF application deadline is March 31, 2011.  Based on our experience with CPP funding, we recommend that institutions apply sooner rather than later as this deadline approaches. We will continue to follow the implementation of the SBLF and relate important developments here and of course on an individual basis if you feel that this program might be a fit with your institution.

On December 21, 2010, the U.S. Treasury published the application form, term sheet and other guidance for participation in the $30 billion Small Business Lending Fund (SBLF) that was authorized under the Small Business Jobs Act earlier this year.   As a result, banks considering participation in the program have a variety of new resources available to them via Treasury’s website for the SBLF.   These resources include:

• Fact Sheet
• Comprehensive Getting-Started Guide for Banks
• Preferred Stock Terms
• CPP/CDCI Participant Preferred Stock Terms
• Application Form and Instructions
• Lending Plan Form and Instructions
• FAQ’s
• SBLF Information Line:  1-888-832-1147.

A summary of the SBLF’s principal provisions follows, but is not exhaustive.  Please see the documents listed above and Treasury’s SBLF website for more detailed information about the program and application process.

Eligibility

Asset size: Total assets of less than $10 billion as of the end of the fourth quarter of 2009.  Holding company assets are measured on a consolidated basis.

Type of Institution: Current terms and guidance apply to insured depository institutions and their holding companies.  Treasury is developing separate provisions for mutuals, S corporations and community development loan funds, which will have their own terms and application time frames.

On September 16, 2010, the Senate adopted H.R. 5297, the Small Business Jobs Act of 2010, which includes the creation of the $30 billion Small Business Lending Fund.  The House passed the Senate’s version of the bill in full on September 23, 2010, thereby sending it to President Obama for his signature.  This legislation would (finally) implement the program described in President Obama’s State of the Union address (and first announced almost one year ago) from the beginning of the year to provide additional funds to community banks to lend to small businesses.

The version of the legislation is generally comparable to the version the Senate began considering in July but contains many differences from the version previously adopted by the House in June.  Most significantly, the Senate-adopted bill does not permit eligible institutions to amortize losses and write-downs on certain OREO and NPAs secured by real estate.  For convenience, we have posted the text of the Small Business Lending Fund provisions contained in the Senate-passed bill.

Eligibility.

Under the terms of the Senate-adopted bill, eligible depository institutions with $10 billion or less in consolidated assets (as of December 31, 2009) may apply to receive a capital infusion of up to between 3% and 5% of the institution’s risk-weighted assets, less any existing TARP CPP or CDCI funds.  Institutions with $1 billion or less in consolidated assets are eligible for up to a 5% investment, while those institutions between $1 and $10 billion are only eligible for 3%.  (Under TARP, only institutions with $500 million or less in consolidated assets were eligible for capital up to 5% of risk-weighted assets, so this potentially represents an increase in available funding for institutions between $500 million and $1 billion.)

Institutions on the FDIC’s problem bank list are explicitly excluded from eligibility under the Small Business Lending Fund.  The bill defines the problem bank list as the list of depository institutions having a current CAMELS composite rating of 4 or 5, or such other list designated by the FDIC.  The bill explicitly emphasizes that merely because a bank has a CAMELS rating of 3 or better does not limit the discretion of the Treasury Department to deny an application for funds.

Matching with Private Funds.

The Small Business Lending Fund explicitly authorizes the Treasury and federal regulators to consider making an investment conditioned on private matching investments.  This authorization is not available for institutions that are specifically ineligible (i.e., those on the troubled bank list) but rather is only available to otherwise eligible institutions that the regulators or Treasury determine not to recommend to receive capital infusions.

On February 5, 2010, the federal banking regulators and the Conference of State Bank Supervisors issued an Interagency Statement on the Credit Needs of Creditworthy Small Business Borrowers.  The Statement builds upon principles set forth in the October 2009 Policy Statement on Prudent Commercial Real Estate Loan Workouts.  After noting the overall decline in loans to small businesses and the reasons for that decline the regulators suggested that lenders may have become overly cautious with respect to small business lending.  They encourage lenders to engage in prudent small business lending and that that examiners will not criticize lenders for working in prudent and constructive manner with small businesses.

The decline in small business lending has many reasons, not the least of which is that loan demand is actually down.  Lenders are also naturally cautious of lending to those businesses that are reliant solely on cash flow that has slowed due to the slowdown in consumer spending and the decline ion the personal wealth of the owners of the businesses.  Despite the assertions to the contrary by the regulators, lenders are concerned that there is a disconnect between statements from Washington, DC and what actually happens in the field when examiners are onsite at financial institutions.  Our experience seems to show that local federal regulators do not see any upside in being flexible when faced with making decisions about how to rate credits.  Lenders are therefore naturally reluctant to maker decisions based on guidance until they see it actually implemented on the ground.