Is SBA Loan Performance a Proxy for the Broader Economy?

Many academic papers have been written about SBA guaranteed lending programs. They explore everything from loan failure rates to the impact on the availability of finances in a lower-income area.

But when we take a step back, it’s possible to examine this topic from an even wider perspective and ask the question: Is SBA loan performance a proxy for the broader economy? Here are some possible answers.

The SBA Guaranteed Lending Program

Let’s start with a short overview of what the SBA Guaranteed Lending Program does. To encourage lenders to provide funding to small businesses, the SBA guarantees that they will repay a substantial percentage of the loan amount –  in the event the borrower defaults – when the lender adheres to the program guidelines. For financial institutions, this provides an opportunity to mitigate losses in the event of default.

There are a couple of benefits here. First, financial institutions can reduce their institutional risks when they make a small business loan using the SBA program, as they know a portion of the outstanding loan amount can be saved from loss by the guarantee. Second, the borrower gains the opportunity for funding they might not otherwise qualify for.

It is a reality that some businesses that take out loans will inevitably fail. But, the risk-mitigating effect of the SBA program,  allows financial institutions to widen their lending activities for small businesses, ultimately benefitting the community around them. 

The SBA Guaranteed Lending Program is driven by the SBA’s two most popular loans: the SBA 7(a) and the SBA 504. The latter promotes funding for business growth and job creation. With the former, borrowers can:

  • Access long- and short-term working capital.
  • Purchase equipment or supplies for their small business.
  • Construct a new building or renovate an old one.
  • Obtain revolving funds based on the value of inventory and receivables.
  • Purchase a piece of real estate (either land or buildings).
  • Start a new business or acquire, operate, or expand an existing one.
  • Refinance business debt (under certain conditions).

For a short time, COVID-19 Economic Impact Disaster Loans (EIDL) took center stage, but the program ended in 2022. This unique loan brought widespread attention to the SBA and its lending products from those who might not have been aware of them previously.

The Economy’s Role

The demand for loans by small businesses varies with changing economic cycles. In a prospering economic cycle, the demand for business financing increases as more entrepreneurs start small businesses. Also, existing small businesses may want to expand product offerings or output, reach new markets, or expand their footprint. To do so, they need working capital. Additionally, the type of loans financial institutions offer to small businesses will change through economic cycles as risk appetite and tolerance change with the prevailing economic conditions. As such, the applicability and use of the SBA program by financial institutions for businesses can ebb and flow with these prevailing conditions.

Also, interest rates play a factor in a small business’s decision to borrow. As rates are adjusted to combat inflation, the small business borrower must consider the cost and benefit of taking on the additional debt and the higher payments those elevated interest rates will create. The borrower’s risk increases in that case, as higher payments, can affect cash flow and, ultimately, net profits.

Add in factors like disruptions in the supply chain, the rising cost of goods, and reductions in consumer spending, and business owners have a lot to consider before they take out a loan. Financial institutions consider the same factors while making their lending decision.

Most businesses carry debt around 70% of the time. Debt can help businesses grow more cost effectively than an equity injection and help a business owner build a solid credit performance history with proper repayment. As credit offerings for conventional lending shrink during tough economic cycles, SBA-guaranteed loans can promote the extension of credit to small businesses. They can help business owners successfully bring a new idea to fruition, continue (or grow) business operations, or acquire another business. Working capital can make all the difference to a small business, and favorable repayment terms often assist them in meeting their business goals.

Implications for the Future of the Financial Industry

Small businesses will always need money. That demand won’t be going away. And SBA-guaranteed loans will continue to be a part of the lending landscape. The risk mitigation of these loans for lenders combined with the support the SBA provides for borrowers – not only for entrepreneurs but for business owners in the wider economy – makes them an important feature of a financial institution’s product set. The SBA has again awarded a historic amount of loans this year, and there’s no sign that lending will slow down – even with higher interest rates, soaring inflation, and a recession on the horizon. 

SBA Loan Performance

Is SBA loan performance a proxy for the broader economy? Some would say yes, adding that SBA loan performance tells us something about the health of businesses overall. However, others might argue that SBA loan performance is more directly related to who took out the loan and why.

Either way, there is no doubt that SBA-guaranteed loans and the SBA loan performance have an impact on both the local and national economy and vice versa. The demand for financing by small business owners without conventional financing on favorable terms will continue. Financial institutions have a great opportunity to fulfill a need in the market. The understanding of that need and creating a strategic plan to meet the demand can be obtained through more accessible insights from complicated data sets.

Here at Lumos, we strive to transform the small business lending space and become a leading expert in SBA and banking data. Want to tap into the previously unusable data at your organization and unlock new capital opportunities for your clients? Schedule a demo today. With over 30 years of combined banking and small business lending experience, we’re here to help you grow.