Sharp Increase in Default Rate on SBA Loans

Not always the best solution

The Coleman Report, which provides lenders with small business data and Small Business Administration news, found that 11.9% of the SBA’s loans in the 2008 fiscal year went into default. The failure rate was determined by dividing the number of loans liquidated or charged off last year by the total number of loans made through the SBA lending programs. This is a different methodology than that used by the SBA, which measures only the dollar volume of loans charged off or liquidated, resulting in the appearance of a lower default rate at 5%. Both methods of computing failure rates show sharp increases over the previous year. In the 2008 fiscal year ended September 30, the SBA’s 7(a) and 504 programs approved 78,324 loans, totaling $18.2 billion. The performance for small business loans in the franchising industry deteriorated with franchisee defaults on SBA-guaranteed loans increasing 52% in the fiscal year 2008 as compared with 2007, according to the Wall Street Journal. The franchise industry attributed this poor performance to resales of franchises in which small business owners paid goodwill over and above the franchise fee to acquire a franchise from an existing operator rather than purchasing the a new franchise at cost directly from the company.

While this report did not specifically address the SBA’s disaster loans, the default rates suggest an interesting parallel. I generally recommend that small business owners carefully consider the alternatives before taking on an SBA disaster loan. While the interest rates and payment terms may be attractive, the small business owner has to pledge collateral and provide personal guarantees. Disaster recovery is typically a much longer process than one imagines and the recovery does not always follow a linear path. I would be reluctant to take on debt given the uncertainty about cash flows, the timely payment of insurance claims, the disbursement of disaster aid or the resumption of normal commercial activity in the aftermath of a major disaster. What the Coleman Report alludes to is an economic disaster in which small business owners assumed comparable risks. Unfortunately, the soaring default rates justify the caution lenders have in extending more credit to their small business loan portfolios, thereby making it more difficult for healthy, viable businesses to access the capital they need.