For the past 48 years, banks seeking guarantees on small-business loans
have had one option: the U.S. Small Business Administration.
But that suddenly changed this year when a small California start-up, in
partnership with Kemper Insurance Cos. of Chicago, started selling its
own guarantee product to banks and other small-business lenders.
Business-Backers Management Corp. of Solana Beach, near San Diego, began
positioning itself in January as a "private-sector alternative" to the
SBA. Its goal is not to steal business from the SBA's popular 7a
program, said its president, Larry A. Prosi, but to capture the share of
the market that is "unserved."
"The SBA does $9 billion to $10 billion a year in its 7a program, and
the demand is far greater than that -- perhaps as much as $15 billion,
$20 billion, or $25 billion," said Mr. Prosi, a former commercial lender
at several San Diego-area banks.
Though Business-Backers has made only a handful of deals, it appears to
be getting its product on the market at the right time. President Bush
-- an opponent of corporate subsidies -- has proposed cutting the SBA's
2002 budget by 40% and specifically eliminating 7a subsidies so that the
loan guarantees would be entirely self-funded by premiums.
Modeled after the 7a program, Business-Backers' "collateral value
protection insurance" guarantees up to 75% of a small-business loan, to
a maximum of $500,000. (Most 7a loans are guaranteed up to 75%, with a
maximum of $1 million.) Kemper, through its KEMPES Inc. subsidiary,
writes a policy to cover a lender's losses if a borrower defaults. For
that protection, a lender pays an average policy premium of 3%. The
similarities to the 7a program are not coincidental, said
Business-Backers chief executive officer Steven J. Appel.
He explained that any new guarantee product must mirror one offered by
the SBA if it is to catch on and, until the SBA revised its policies a
few years ago, the private sector had little incentive to compete.
The SBA once guaranteed up to 90% of a small-business loan, so lenders
were only on the hook for 10% if a borrower defaulted. The result: Banks
were less careful with the underwriting, which led to high default
rates. But the SBA has been gradually lowering the guarantee levels
since the mid-1990s. Now lenders are employing stricter underwriting
guidelines, which has led to fewer defaults.
"As the SBA has become more like a business in the last five to seven
years, it has created more of an opportunity for the private sector to
come into the picture," Mr. Prosi said. "Someone could have done this
five years ago, but they wouldn't have made any money at it."
Of course, profits are still a ways off for Business-Backers, too.
Though some 30 banks have agreed in principle to work with it, including
$50 billion-asset LaSalle National Bank in Chicago and $70 billion-asset
PNC in Pittsburgh, only four are using its loan guarantees. The SBA, by
comparison, guaranteed nearly 44,000 of its 7a loans last year.
Indeed, Mr. Appel and Mr. Prosi can attest that building an alternative
to the venerable SBA was no easy feat. The two have been at it for five
years, working to find investors, compile loan-loss data, and develop
the business plan.
In 1999, Business-Backers' first insurance partner, Reliance Group
Holdings of New York, ran into financial troubles and backed out of its
commitment -- a week before the product's scheduled rollout. In late
2000 its deal with a second insurer, ACA Financial Guaranty Corp., also
of New York, was terminated after Business-Backers concluded that ACA
didn't have enough name recognition to attract lenders.
And amid that turmoil, Business-Backers' co-founder and progenitor,
California lawyer Morton Rible, died.
"We've had a number of stops and starts," said Mr. Appel, a former
consultant with Arthur Andersen LLP who, like Mr. Prosi, joined the
company when it was founded in 1996.
Bill Mecklenburg, senior vice president at KEMPES, in Scottsdale,
Ariz., said his company was sold on the partnership after viewing
Business-Backers' loan-loss data. Using a database of SBA transactions,
Business-Backers was able to determine which industries are riskiest to
lend to, and as a result, opted to steer clear of loans involving crop
financing, start-up businesses, or single-location eateries.
"They've made it so there is a high degree of predictability" with the
loans KEMPES insures, Mr. Mecklenburg said.
He added that Business-Backers is under fewer restrictions than the SBA.
For example, the SBA is prohibited from guaranteeing loans that
refinance existing debt. It also cannot back loans for a minority owner
in a business to buy out a majority owner. Business-Backers, on the
other hand, is eagerly pursuing such deals.
"These are needs in the small-business marketplace that the SBA wasn't
fulfilling," Mr. Mecklenburg said.
Thomas J. Doherty, senior vice president for business banking at
LaSalle, agreed. Though the bank remains an active SBA lender, it signed
its deal with Business-Backers in May mainly so it could use its
guarantees on refinancing deals.
"It's just one more thing we can offer to our customers," he said.
For now, Business-Backers is primarily targeting 7a participants. Mr.
Appel said the best way to get the program off the ground is to work
with lenders who are already comfortable using loan guarantees. "When
you go to someone who isn't using the product at all, you're asking them
to change their culture internally and to use a new product," he said.
"Those are two pretty big hurdles for banks to clear."
But the company is courting other lenders as well. Mr. Appel pointed out
that only 4% of commercial banks are SBA preferred lenders, which means
that 96% either do not work with the SBA or do so for only a handful of
deals a year.
One institution sold on Business-Backers' guarantees is $1 billion-asset
State Financial Bank in Milwaukee. An active small-business lender,
State Financial rarely seeks 7a guarantees from the SBA, "because the
approval process can take anywhere from three to six weeks," said
president John Beckwith. It felt that Business-Backers "would be
potentially easier to work with and that the turnaround would be
He was not disappointed. Business-Backers approved the bank's
application for a loan guarantee in two days.
Business-Backers is getting the word out mainly through its 10-person
sales team, which has a combined 125 years of banking experience. (The
only employees who are not former bankers are Mr. Appel and senior vice
president Michael S. Hearne, a former director of finance at the SBA.)
The company is also marketing to community banks through bankers'
banks; in April it set up a booth at the annual convention of the
National Association of Government Guaranteed Lenders.
Nevertheless, Business-Backers has other hurdles to clear before it can
declare itself a legitimate competitor to the SBA.
For example, SBA loans are actively sold on the secondary market, and at
the moment no such market exists for Business-Backers' loans. Also,
because SBA loans are backed by the "full faith and credit" of the U.S.
government, banks' capital requirements against those loans are lower.
"No private enterprise could ever compete with that," Mr. Prosi said.
One banker voiced concern about how regulators would perceive loans
guaranteed by an entity other than the SBA. Bob Ostertag, senior vice
president at $750 million-asset Colorado Business Bank in Denver, said
some national banks might be skittish about partnering with
Business-Backers, because the Office of the Comptroller of the Currency
has not commented on how it might treat these loans during examinations.
"It would be nice if the OCC blessed this," he said.
Others downplayed such fears. Richard Fulkerson, Colorado's banking
commissioner, said that though regulators cannot "endorse" a product, he
would not have any supervisory objections to loans guaranteed by
Business-Backers. "We're open to any new product that would enhance the
creditworthiness and asset quality of banks," he said.
LaSalle's Mr. Doherty added that the Kemper name should be enough to
satisfy most regulators.
"It's not a difficult program to understand," he said. "You have to take
into consideration the insurance company that's backing this and the
quality you're dealing with."
Source: Copyright 2001 Thomson Financial. All Rights