United States. Congress. House. Committee on Small.

The effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 online

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Online LibraryUnited States. Congress. House. Committee on SmallThe effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 → online text (page 19 of 21)
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obtaining a loan would increase The technical assistance programs offered from the various Government
Agencies are very helpful in achieving this objective and should be continued. At the same time there is
duplication and confusion as to what assistance is possible and how to access it. Improved coordination
among the Agencies and organizations at all levels, and improved communication of the available
assistance would make a difference. It is equally important that such assistance be available on an on-
going basis, to assist owners after they have been established and encounter the many challenges of
operating a small business. While access to capital is critical to success, management ability is even more
important. Knowing that business owners have resources to help them succeed increases the comfort level
of lenders and. in turn, enhances credit availability.

There may be a greater role that banks could play in providing technical assistance, beyond the help
provided by relationship managers as they work with their borrowers to help them succeed. However, for
the smaller businesses and those struggling to get established, the process is very time consuming and
costly Perhaps providing tax or other incentives should be considered to make a greater role feasible.


3. Reporting Small Business Loans

Your third question seeks my views on the 1993 small business disclosure rule that requires banks to
annually report all loans made under $1 million. The disclosure rule, in my opinion, is viewed as a
regulatory requirement having little or no impact on helping small businesses obtain capital. Decisions on
how aggressively small businesses are pursued for customer relationships are a result of how management
assesses market opportunities, and whether it has or can develop the right products and services, and
resources to succeed in the marketplace As with any business, we are constantly seeking ways to improve
our share of the market. We continuously survey small business owners to determine how we can best win
their business, and we regularly monitor changes in our market share as well at that of our competitors.
Even with the many bank mergers, the competition for small business customers is very keen, and will
remain so, as long as the outlook for small business is attractive and profitable.

Alternatively, detailed small business reporting at the local level may be subject to misinterpretation and
misuse in the analysis of the responsiveness of banks to small business in that the credit quality of business
applications reflect market considerations, management capacity, capitalization, and other issues not
equally inherent in all geography's served by banks. If Congress were to consider banking regulatory
reform, 1 would recommend the disclosure rule be modified. All, or almost all, small to mid-sized banks
have lending limits to small businesses that do not exceed $1 million, so the report is only showing all
business loans made by those banks. This information is available from annual reports or from reviews
performed by bank regulators. Even many large banks such as ours have a $1 million limit on loans made
by their small business departments, and in some cases, loans for less than $1 million are made by
corporate or commercial lending departments to businesses that are not considered small according to
revenue size. If the report is continued, the categories to be included need to be clarified, since in the past
some banks included categories that others did not, and the results were inconclusive.

Thank you again for the opportunity to add further testimony to your hearing. I hope the above is helpful
to the objectives of your Small Business Committee. As in the past, I will be happy to answer any
questions you may have.

Director, New
Bank of Boston



BOSTON, MA 02109
Kenneth J. Smith, President

Capital Access Program May 1993

Peter Hollingworth

(617) 350-8877
Fax (617) 350-0052


Detailed Description


Under Chapter 19 of the Acts of 1993 signed into law on March 9, the Massachusetts Business
Development Corporation (MB DC) was designated as administering agent for the state for that part of the
act known as The Small Business Capital Access Program (CAP).

CAP was created in Massachusetts, modeled in large part upon an established similar program in
Michigan, specifically to unleash the capacity of the private sector to do a more comprehensive job in
meeting the financing needs of Massachusetts business, most particularly small business. This unique
approach emphasizes private sector lending and private decision making which would result in a large
number of companies receiving their full financing needs with an absolute minimi mi of public funds

The Capital Access Program is designed to give banks a flexible and extremely non-bureaucratic tool to
make business loans that are somewhat riskier than conventional bank loans or that may not meet classical
underwriting standards, in a manner consistent with safety and soundness.

It is designed to use a small amount of public resources to generate a large amount of private bank
financing, thus providing access to bank financing for many businesses that might otherwise not be able to
obtain such access. Currently, in Michigan under their CAP, more than 2,000 businesses have received
financing, and the state's original S5 million appropriation committed to the program has supported over
S100 million in bank lending. In Massachusetts, S5 million has been committed, and we expect the same
leverage to occur.

23-344 96-9


This document describes the program in detail, and is designed to help interested parties' to understand the
program. The underlying legal document is the 'Agreement* between MBDC and the participating
financial institutions, and this document in no way supplants that Agreement.

Basic Concept of Program

Although the Capi'" 1 Access Program is based on an insuring concept, it is fundamentally different from the
traditional type of insurance or guarantee program, such as the SB A 7(a) program, which guarantees
individual loans. Capital Access is based on a portfolio concept.

If a bank participates in the Capital Access Program, a special reserve fund is set up to cover future losses
from a portfolio of loans that the bank makes under the program. The CAP reserve fund is not specific to
individual loans, but is used to offset losses on any loan in this portfolio The special reserve is owned and
controlled by the state but it is earmarked in that bank's name. Thus, each bank participating in the
program has its own earmarked reserve. A bank can withdraw funds from its reserve only to cover losses
on loans made under the program.

Payments are made into a bank's earmarked reserve each time the bank makes a loan under the program.
The borrower makes a premium payment, the bank matches that payment and then MBDC matches the
combined total of the borrower's payment and the bank's payment. The bank is allowed to recover the cost
of its payment from the borrower, such as through a higher interest rate, up-front fees, or some
combination thereof. Up-front premium payments and fees can be financed as part of the loan.

The actual level of payments to be made into the reserve at the time of making any loan is determined by
the bank, within certain parameters. At the minimum, the borrower pays an amount equal to 1 5% of the
loan amount, the bank would match that with another 1.5% and then MBDC would contribute 3%, for a
total of 6%. At the maximum, the borrower contributes 3.5%, the bank another 3.5%, and MBDC 7%, for
a total of 14%. Thus, for any loan made under the program, an amount equal to anywhere from 6% to
14% of the loan amount is paid into the bank's earmarked reserve. After a bank has made a portfolio of
loans under the program, it might have a reserve equal to, say, 10% of the total amount of that portfolio.
In such a situation, the bank could absorb a dollar loss rate of up to 10% on that portfolio and still be
completely covered against loss. A key feature of the program is that the full amount in the bank's total
reserve is available as needed to cover any loss from any of the loans made under the program. If loam get
paid off without loss, the funds stay in the reserve .


This reserve enables a bank to be more aggressive in making loans and expanding its market. However, if a
bank's loss rate were to exceed the coverage provided by the reserve, the bank would be at risk for that
excess loss. Thus, there is a built-in incentive for the bank to be prudent.

Nevertheless, since the reserve would enable a bank to withstand a substantially higher loss rate than it
could tolerate under its conventional loan portfolio, the program enables a bank to prudently make "almost
bankable loans". For example, these might be loans to companies with good management and a good
direction, but for one reason or another, such as lack of adequate collateral, lack of sufficient track records,
lack of sufficient net worth, or other reasons, may not quite qualify for a conventional bank loan.

Because the program is structured to provide a built-in incentive for the bank to be prudent, there is no
need for MBDC or the state to be involved in reviewing the bank's decision on the loan. The reserve is
there for the bank to protect and use. The bank makes the loan and simply files a one page Loan Filing
Form with MBDC within 10 days after the loan is made. Enrolling loans under the program is thus
designed to work as essentially an automatic process. There is no processing delay, and virtually no

Flexibility is a key characteristic of the program. It is completely up to the bank to determine how it wants
to use the program. The bank sets hs own criteria for determining whether to make the loan, determines
what types of loans it wants to make under the program, and decides the interest rate, fees, term of
maturity, collateral requirements (If any), and other conditions of the loan. Thus the market is allowed to
work, and intelligent private sector decision making is facilitated The loan can be short-term or long-term,
fixed or variable rate, secured or unsecured, amortizing or balloon, term loan or line of credit, etc.

When filing a loan for enrollment under the program, the bank has the option of covering an amount under
the program which is less than the full amount of the loan. This provides added flexibility, since borrower
and bank premium payments would then be based on this smaller amount For example, a bank makes a
$100,000 loan under the program, but is convinced that under a worst case scenario the maximum possible
loss on the loan would be $60,000. The bank could decide to specify a covered amount of $60,000 on the
loan. In such an event the funds in the reserve could be used to cover the first $60,000 in principal loss on
the loan, plus accrued interest up to six months on that part, plus documented out-of-pocket expenses.


A key feature of the program is the flexibility it provides to enable a bank to work with a borrower after the
bank has made a loan to the borrower under the program. After a loan has been made under the program
the bank can subsequently recast it as often as may be desirable. The bank can extend the term of the loan,
amend covenants, release collateral, etc., without having to obtain approval from MBDC or even reporting
the change

The bank also has the flexibility to refinance the loan, adding funds. Indeed, if the total amount of the
refinanced loan does not exceed the covered amount of the loan as previously enrolled, no new borrower or
bank premium payments need to be made into the reserve, and the fact of the refinancing does not even
need to be reported. (Quarterly, the bank may be asked to file a simple report with MBDC containing
merely a list of the outstanding balance for each loan enrolled under the program). For example, if a
$100,000 loan covered under the program has been paid down to $30,000, and then is refinanced back up
to $100,000, then no premium payments are owed. However, if the loan were instead refinanced up to
$150,000, then premium payments would be owed on the incremental $50,000 above the $100,000, but
only if the bank wanted to cover that additional $50,000 under the program.

lines of credit are treated with similar flexibility. In establishing a line of credit and filing h for enrollment,
the amount of the loan, for the purposes of determining premium payments and the maximum covered
amount, shall be the maximum amount that can be drawn against the line of credit. Banks could use their
normal approach, including informal arrangements as applicable, in establishing a line of credit. A line of
credit, once established, could then be renewed each year, staying covered under the program, without new
premium payments being required (unless the covered amount under the program is to be increased).

The collection and claims process is also designed to work in a routine, nonbureaucratic way. The bank
simply uses its normal method for determining when and how much to charge off on a loan. At the same
time that a bank charges off all or part of a loan, the bank files a one page Claim Form with MBDC
including evidence of the charge-off, and the payment will be handled in a prompt and routine fashion.

Because of the payments that must be made into the reserve, a loan made under the Capital Access
Program is likely to be a bit more expensive to the borrower than a conventional bank loan. The premium
payments into the reserve are one-time, up-front payments, the costs of which can be financed. Thus the
longer the financing stays on the books, the smaller is the increase in the borrower's effective interest rate.
However, the transactioa is still likely to be more expensive than a conventional


loan. Borrowers who can obtain conventional bank financing to meet their needs would normally be bettia -
off with such financing, and competition within the banking industry will work to steer such borrowers to
conventional financing. From the perspective of borrowers, the central thrust of the Capital Access
Program is that h can provide access to financing for many companies that otherwise might not be able to
obtain bank financing to meet their needs. Moreover, financing under the Capital Access Program is likely
to be much less expensive for a company than alternative non-bank sources of financing, if any are

It is important that prospective borrowers under the program understand that the loan is a private
transaction between the bank and the borrower. While the program may assist a bank in being able to take
more risk than normal, it is still the bank that is bearing the risk of the loan, and is responsible for the
decision making

Allocation of Funds

When the law was passed, $5 million was appropriated for the program. When the Michigan CAP Fund
was passed in 1986, $5 million was allocated as well. As of this writing, their program has resulted in o^r
2,000 loans exceeding $100 million, approaching a 22 to 1 private to public funding leverage ratio. The
Michigan legislature subsequently increased their funding another S9 million because of the program's
acceptance and success. In Massachusetts, we expect over time to achieve similar leverage, similar bank
acceptance, and a wide Massachusetts geographic dissemination.

In Michigan the original $5 million allocation lasted for over six years. We expect our program to last a
good number of years, with the possibility of expansion both on the state and possibly the federal leVd in
the near future Some ten states are currently offering or developing a similar program.

Eligible Loans and Borrowers

The fundamental thrust of the program is to make eligibility as broad as possible so as to maximize the
impact on Massachusetts economy and to avoid the second guessing of private market decisions. The
borrower can be a corporation, partnership, joint venture, sole proprietorship, cooperative or other entity
that is for profit and is authorized to conduct business in the State of Massachusetts.

There are, however, a relatively small number of restrictions that are either mandated by statute or are
necessary to protect the basic integrity and purpose of the program. These restrictions are described


1. The borrower's principal place of business must be in Massachusetts.

2. The borrower's annual sales in the latest fiscal year cannot exceed $5 million.

3. Total loans from the lender (or affiliated to the borrower cannot exceed S500.000.

4. The loan must be for a business purpose in Massachusetts.

5. Refinancing Prior Debt Which is Not in Program - A bank is not permitted to take an existing lo¬їn
on its books (or on the books of an affiliate) which is not in the program and simply refinance it, without
adding new money, and put the refinanced loan under the program. However, if a bank refinances an
existing loan and adds new money by increasing the outstanding balance, it is permissible to cover under
the program an amount not exceeding the amount of the new money. For example, if an existing loan, not
under the program, has an outstanding balance of $ 1 00, 000 and that loan is refinanced with a new balance
of $ 1 50,000. the refinanced loan can be enrolled under the program, but the covered amount could not
exceed $50,000.

6. Conflicts of Interest - A bank is not permitted to use the program for "insider" transactions.
Insider transactions are defined to include a loan to an executive officer, director or principal shareholder of
the bank, a member of the immediate family of such an executive officer, director or principal shareholder,
or to a company controlled by any of these people. The basic definitions used in this conflict of interest
prohibition tie in to basic terms used in the Federal Reserve's Regulation O.

7. Passive Real Estate Ownership - The loan cannot be used to finance passive real estate ownership.
Passive real estate ownership would occur if a company were to buy land or buildings simply as an
investment, without developing or improving the real estate in any way, and without intending to use it for
its own business operations.

It is important to stress, however, that except for the restrictions against passive real estate
ownership, the program can be used for real estate financing. For example, the program can be used to
assist a company to finance the acquisition of land or buildings intended to be used in the business
operations of the company.

The program also can be used to finance the activities of a developer or builder in acquiring real
estate for development or in constructing or renovating a building. In the case of a loan to a developer for
construction or renovation financing, the loan under the program should be intended to

cover the period through the construction or renovation phase. The permanent financing can also be
included, only if the borrower will be the company that will use the real estate for its own business


Collection and Claims

The process for a bank getting reimbursed for losses on loans made under the program is intended to be as
routine and nonbureaucratic as the process for enrolling loans under the program. MB DC simply relies on
the bank to exercise reasonable care and diligence in its collection activities. If a loan gets into trouble, the
program calls for the bank to determine when and how' much to charge off on an enrolled loan in a manner
consistent with the bank's normal method for making such determinations on its conventional business
loans. A bank would file a claim under the program at the time it charges off all or part of a loan. The
claim may include the full amount of principal charged off, plus up to 6 months accrued interest, phis
out-of-pocket expenses. (If the amount of the loan that the bank covered under the program is less than
the amount of principal charged off, then the amount of principal and accrued interest included in the claim
shall not exceed the principal amount covered under the program, phis accrued interest attributable to such
covered principal amount).

In keeping with the extremely nonbureaucratic nature of the program, the Claim Form submitted by the
lender to MBDC is only a half-page form. The program provides for prompt and routine payment. Copies
of Board minutes authorizing the charge-off accompanies the form.

The program is structured so that when the bank makes a loan and then enrolls it in the program, the back
is automatically making a small number of representations and warranties to MBDC that the loan complies
with program requirements. If the bank later suffers a loss on that loan and property files the claim, the
only grounds for denial of the claim would be if the representations and warranties made by the bank at the
ori ginal time of the enrollment of the loan were known by the bank to be false at the time the loan was

The claim process allows a bank to recover its loss at the time it recognizes the loss, prior to having to
exercise its collateral rights or other legal remedies in connection with the loan. However, the bank would
be expected to continue to exercise its collateral or other rights in a manner such as it would do for a
conventional bank loan. If there were a subsequent recovery from the exercise of such rights, so that the
amount of loss ultimately were less than the amount for which the bank had been reimbursed from the
earmarked reserve, the bank would put the relevant amount of the recovery, net of out-of-pocket expenses,
back into the reserve. This is similar to the process that a bank would follow in putting recoveries on
conventional loans back into the bank's internal loan loss reserve.


As described above, the intent of the program is for the bank to be fully responsible for collection activities
and for MBDC to stay out of the bank's way. However, as a safeguard against the extreme situation where
a bank is abusing the intent of the program by ignoring its obligation to exercise reasonable care and
diligence in its collection activities, MBDC will reserve for itself, in limited circumstances and as a last
resort, the right to be subrogated to the rights of the bank. The subrogation would apply to any collateral,
security or other right of recovery, in connection with a particular loan, which has not been exercised by the
bank. This provision could only take effect after the bank has filed a claim and has had its loss fully
covered. It is hoped that MBDC will never have to use this right of subrogation.

Maintenance of the Reserve Fund

A central concept of the program is that the state owns the funds in the bank's reserve, but that these funds
are legally dedicated solely to cover losses on loans made by the bank under the program. The state
actually pledges the funds in the reserve to be available to pay claims on loans under the program.

For compliance and administrative convenience for both MBDC and the bank, and to provide an extra
benefit to the participating bank, it is the plan of MBDC to open up an account at the bank, and deposit the
monies in the bank's earmarked reserve right at the bank. The plan, as it will be implemented, involves
establishing a money market deposit account in MB DCs name at the bank's published rate of interest.

All of the interest earned on the funds in the reserve will stay there until taken back quarterly by MBDC to
offset expenses and to then revert back to the original CAP fund allocation to extend the life of the

Although the state technically owns the funds in the reserve, it is intended and expected that banks will
develop a proprietary interest in the reserve. The reserve earmarked for a bank takes on the character of an
off-balance sheet asset of the bank, which enables it to be more aggressive in its lending activities. The
bank controls the amounts of payments going into the reserve and the reserve is reduced oaly when the
bank suffers a loss on a loan made under the program. The program rewards good performance, in that as
loans are successfully paid off the funds stay in the reserve and increase over time. However, if at some
point in the future the bank were to completely drop out of the program, and after all of the loans
previously made had been paid off MBDC would ultimately be able to withdraw the funds from the


Bankers sometimes ask why the bank would not be able to get back some or all of the funds from the

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Online LibraryUnited States. Congress. House. Committee on SmallThe effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 → online text (page 19 of 21)