For better or worse, the SBA loan landscape was transformed with the onset of the COVID-19 pandemic. Relief programs offered forgivable and low-interest loans to keep small businesses afloat. But there were challenges and even recipients who misused or abused the system.
As a result, things may look different going forward. Here’s how COVID-19 reshaped the SBA loan landscape for financial institutions.
Pre-Pandemic Lending and Demand
Lending practices for SBA loans are pretty stringent. If you were purchasing or starting a small business, several options were available. The most popular was and still is the SBA 7(a) loan. It’s the most flexible loan for buying a business, expanding, or getting some much-needed working capital, and financial institutions that offer them have benefited through the government guarantee while providing credit to businesses that would struggle to find it elsewhere on favorable terms.
Lending institutions have to protect themselves though, which can make the process time-consuming, depending on the borrower’s preparedness. Lenders also tend to specialize, enabling them to focus on businesses they know something about and can have some confidence in whether or not they will succeed. Just as entrepreneurs also work in niche areas, lenders often do the same. In reality, demand for some types of business loans has always been greater than others, but the pandemic widened that divide.
SBA 7(a) and the COVID Response Programs
During the pandemic, the SBA responded to the crisis with several programs to help America’s small business manage the impact. Two of these responses were the Economic Injury Disaster Loans (EIDL) program and the Paycheck Protection Program (PPP).
The SBA offered two types of COVID-EIDL:
- The EIDL program consisted of funds that could be used for working capital and other day-to-day operations. These loans were not forgivable and had to be repaid. Eligibility depended on requirements that varied with the amount of the loan.
- EIDL Advance funds were awarded to certain EIDL customers who met specific requirements. These funds were like a grant, but without the regular grant process, and did not need to be repaid.
The SBA’s PPP offered an SBA-backed loan that helped small businesses keep their workforces employed during the COVID-19 crisis. During the active periods for PPP lending, financial institutions dispersed $793 billion of SBA-backed loans to 11.5 million small businesses.
While demand for the COVID-EIDL program superseded demand for SBA 7(a) loans during the pandemic, the program – along with PPP – has since ended.
Now? SBA 7(a) and 504 loans. Demand over the past several months has soared, and the forecast is that this will continue into 2023.
Part of the reason for this influx in demand is that traditional, large bank lenders have tightened lending requirements, interest rates are rising, and many lenders continue to focus on SBA lending rather than conventional business loans.
Pain Points for Financial Institutions
While many SBA lenders saw significant growth from PPP and COVID-EIDL funding during the pandemic, the boom also came with challenges. There were millions of applications to evaluate, and several pain points developed along the way.
A significant uptick in loan applications and a more streamlined lending process led to an increase in fraud in the EIDL program. While a private contractor hired to handle the relief applications (RER Solutions) quickly became overwhelmed, financial institutions worked to minimize cases of abuse against challenging odds.
Instances of fraud included identity theft, fake businesses, exaggerated employee counts, and misuse of program funds. Lenders, caught in the middle, worked to protect their own reputations while still serving the needs of real business owners. Many even alerted the SBA of fraud cases that otherwise might have been missed, preserving funds for those businesses who actually deserved the assistance.
COVID-19 EIDL was confusing from the outset, a problem that only grew as applications flooded in. Miscommunication from the SBA about eligibility and approvals was a significant hurdle during the lifetime of the program, creating challenges for financial institutions and their clients. Despite being stretched thin, many financial institutions hired the personnel needed to handle not only the number of applications they received but the questions and inquiries that went with them.
Another pain point for financial institutions was the abuse of funds. This was either intentional and bordered on fraud or was due to a lack of understanding on the part of businesses about how the funds awarded could be used.
Some businesses that applied for a COVID-19 EIDL did not actually meet the definition of a small business but attempted to take advantage of the funding anyway. Many cases made headlines as PPP and EIDL rolled out, and while some companies apologized, and returned funds, others did not.
For the most part, the EIDL program was a lifeline for small businesses during COVID-19 and even beneficial for financial institutions, since guaranteed loans offered little risk and high returns. But, there were clearly issues. Financial institutions, the SBA, and even borrowers learned valuable lessons throughout the process that have resulted in overall process improvements.
What the Future Holds
What does the future of the SBA loan look like, and how will financial institutions adapt? One huge change was an increase in awareness. A little over two years ago, many small businesses had never heard of or applied for an SBA loan. Now, Congress is approving more funding for SBA 7(a) loans as more business owners are utilizing them than ever before.
SBA 7(a) loans have myriad uses – more than most people realize. From starting a small business to investing in commercial real estate to purchasing machinery and supplies to expand current operations, 7(a) loans offer borrowers a wide runway to get their dream off the ground. Financial institutions would benefit greatly from continuing to inform their customers about their options, as increased awareness of SBA loans would create an influx of applications and a larger client base.
The New Normal
From increased demand to increased awareness, the COVID-19 pandemic reshaped the SBA loan landscape. Borrowers discovered and applied for loans to keep their doors open, employees left their jobs to start small businesses, and the demand for SBA 7(a) loans soared.
With that demand comes the need to educate borrowers and new business owners on what it takes to get a loan, what they must have prepared, and what repayment looks like. There’s a whole new generation of business owners, and for many of them, SBA 7(a) loans are a perfect fit for getting their financing in order.
Helping your clients achieve their financial potential requires a strong partnership. It’s a two-way street: When your clients succeed, you succeed – and vice versa. Data can be used to build those relationships and strategies. Lumos empowers financial institutions to discover actionable insights through their data so they can leverage the right information to build and strengthen their lending portfolios and confidently provide capital to underserved businesses.
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