SBA-backed loans give new boost to Southland banks.

Guarantees put banks back in small business arena

Several Los Angeles-area banks are experiencing an identity crisis. They used to make business loans, home loans, automobile loans. But little by little, competition has whittled away at banks' ability to make such loans.

Now, several commercial financial institutions in L.A. -- seeking new areas for "safe" lending -- are finding a new identity in an old business that is new to them: SBA lending.

SBA loans are made to small businesses and are guaranteed by the government. So, even if the borrower defaults on the loan, the bank can recoup between 70 and 90 percent of the amount of the loan from the U.S. Small Business Administration. Now larger banks are turning to such loans as a way to get their money out and into the hands of borrowers.

Banks have had to readjust to a new type of world. Many institutions have cut back operations and laid off employees. Borrowers are harder to find and, as a result, lending activity has slowed down. Large corporations look to Wall Street rather than to banks for capital. Individual borrowers have more options for financing home and car loans from mortgage banks and from automobile companies, respectively.

Meanwhile, regulators have stepped up the pressure on banks to make "safe" loans. In this environment, SBA lending has become an increasingly popular vehicle for making loans.

And, it is not just the small community banks that are involved.

In fact, most of the large commercial banks headquartered in Los Angeles are hoping to expand their SBA loan portfolios. Among them are Inglewood-based Imperial Bank, Beverly Hills-based City National Bank, Sherman Oaks-based TransWorld Bank and Beverly Hills-based First Charter Bank.

There are several other factors motivating commercial banks to beef up their SBA loan portfolios. The climate around small-business lending has changed.

More and more, the federal government is recognizing the contributions that small businesses are making to the economic recovery. And the Clinton administration has made getting funding to small businesses a high priority. As a result, the SBA has gotten increased funding for its loan programs.

Perhaps more importantly, especially where more mainstream banks are concerned, banks can receive Community Reinvestment Act credits for making SBA loans. As the banking committees in Congress, the Office of the Comptroller of the Currency and the Clinton administration are pushing for stricter enforcement of CRA, SBA lending is an appealing way for banks to receive such credits.

The CRA is a law which requires that banks meet the credit needs of the communities they serve, including low- and middle-income neighborhoods. Banks get credits toward satisfying CRA requirements by proving to federal regulators that they are making loans within the communities they serve, and not discriminating against lower-income areas.

However, besides being a means of satisfying CRA requirements, SBA lending is downright profitable, and considered by the banking industry to be one of the safest ways to make a buck in the current environment.

"Every bank wants to get into it," said Barry Rubens, president of California Research Corp., a Santa Monica-based banking consulting outfit. "If (SBA lending) is done correctly, it can be extremely profitable."

The loans are guaranteed by the federal government for up to 90 percent of the loan value. Additionally, as Rubens pointed out, "these loans can be sold into the secondary market and the banks can earn significant revenue on them. So a profit can be made very quickly."

As high as many local bankers are on SBA lending, one might conclude there is no danger and no downside to the program. Unfortunately, that has not been the case.

Paramount-based Mechanics National Bank, one of the largest SBA lenders in the area, was recently seized by federal regulators. Among the problem loans on Mechanics' books were those made under SBA lending programs.

The problem encountered by Mechanics was one that has been a sore spot for SBA lending in the past. SBA loans are often brokered by third parties, called "packagers," who put the loan applications together for the banks.

The packagers then receive a commission for the loans accepted by the bank and the SBA. In recent years, there has been a proliferation of fraudulent SBA loan applications, many of which were prepared and submitted by packagers. The applications contained falsified tax returns which generally inflated the incomes of the individuals applying for funding.

Bankers' mistrust of packagers has only increased in the wake of the Mechanics failure. Since the seizure of Mechanics, the bank has brought charges against a former officer of the institution, purporting that he and a loan packager conspired to win approval of loans by falsifying documents.

Campbell Chaney, a financial institutions analyst with Dakin Securities in San Francisco, said the Mechanics takeover "gave SBA lending a black eye."

The reality of the situation, he said, is that SBA lending can be a good way to make a profit, but it must be done with caution.

"It is a very specialized type of lending," said Chaney. "You really have to double check the work of the packagers."

The SBA has taken measures to prevent future situations like the Mechanics failure. A tax verification program was instituted by the SBA, which allowed SBA loan officers to check the authenticity of tax returns supplied by applicants by comparing them with returns filed with the Internal Revenue Service. "We corrected the situation," said John Tumpak, spokesman for the SBA. "It no longer exists."

Still, there are skeptics in the ranks. Several local SBA lenders insist on processing the applications in house. Among those insisting on such in-house processing are the veterans of the SBA lending world -- local Korean banks.

"We feel that we are pretty efficient without them (packagers)," said Han Park, vice president of Wilshire Center Bank. Last year, Wilshire State Bank made more SBA loans than all but four institutions in the Los Angeles area.

Likewise, Hong said California Center Bank has always refused to use packagers. Using packagers, he said, is only "more efficient in terms of production, but not in terms of quality."

Of the 10 largest SBA lenders active in the Los Angeles area in 1993, seven are based in Los Angeles County and three of the seven are Korean-owned.

The three large Korean SBA lenders -- Hanmi Bank, Wilshire State Bank and California Center Bank -- made a total of 95 SBA loans during the fiscal year ended Sept. 30, 1993. The 95 loans were guaranteed to the tune of $33.23 million by the SBA.

The fact that Korean banks have done more SBA lending than many other institutions is no surprise to local Korean bankers. Most of them have geared their loan portfolios toward securing loans for Korean businesses in Los Angeles, the majority of which are small businesses.

According to Han Park, "there is a large market for SBA lending to the Korean community."

One reason local Korean banks got the lion's share of that business was because language barriers prevented many clients from turning to non-Korean financial institutions, industry sources said.

James Hong, senior vice president of California Center Bank, explained that the location of the Korean banks also gave them a head start in SBA lending. Korean banks, he explained, were alerted to the needs of small businesses and also the potential for their growth because the majority of Korean bank customers are small-business owners.

The reason local Korean banks have been able to effectively exploit the SBA lending niche is not only because it has been under-explored by larger commercial banks, but also because of the stigma that has long been attached to government-backed funding.

"SBA lending for years was considered alternative financing," said Park. Customers seeking SBA loans "were considered second-class borrowers because (the loan) was guaranteed by the government. The fact that they needed governmental backing put a black mark against SBA loans."

That stigma has worked to the advantage of the three big Korean SBA lenders in Los Angeles. All three banks meet federal capital requirements necessary under current regulation. Hanmi Bank has been given a five-star rating by Bauer Financial Reports Inc., a Coral Gables, Fla.-based bank rating service.