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SBA’s Risky Franchise Lending
By Nicole Kaeding of Cato.
"The Small Business Administration’s
(SBA) stated mission is to aid small businesses and strengthen the
economy. Under its popular 7(a) program, SBA provides private lenders
with loan guarantees. In the case of default, SBA steps in to cover up
to 85percent of the lender’s losses.
This structure encourages lenders to provide more loans, but also
encourages the approval of riskier loans. The lenders are insulated from
most of the risks of default.
A new analysis conducted by the Wall Street Journal
confirms that this arrangement induces SBA to provide loans that result
in a large number of defaults. Default rates for some franchise
companies can be as high as 40 percent. According to the Wall Street Journal:
Quiznos, Cold Stone Creamery, Planet Beach Franchising
and Huntington Learning Centers Inc. ranked among the 10 worst franchise
brands in terms of Small Business Administration loan defaults.
Franchisees of the 10 brands in the ranking defaulted at more than
double the rate for SBA borrowers who invested in all other chains,
according to a Wall Street Journal analysis of charge-offs of all
SBA-backed franchise loans in the past decade.
Put another way, franchisees of those 10 brands have left taxpayers
on the hook for 21% of all franchise-loan charge-offs in the past
decade, collectively failing to pay back $121 million in SBA-guaranteed
loans from 2004 through 2013.
Thirty percent of the loans provided to Quiznos and Cold Stone
Creamery franchises ended in default. The losses from loans to Quiznos
franchises totaled $38.4 million during the 2004 to 2013 period, while
losses to Cold Stone Creamery amounted to $34.1 million.
This is not the first time that SBA’s franchise lending has been
criticized. In a report focused on franchises, SBA’s Inspector General noted
in 2013 that SBA “had not implemented a program or process to monitor
risk in its portfolio.” The report continues: “SBA did not monitor
portfolio segments to identify risk based on default statistics…SBA
continued to guarantee loans to high-risk franchises and industries
without monitoring risks, and where necessary, implementing controls to
mitigate the risks.”
Franchise businesses are an important component of SBA’s activities. In its new analysis, the Wall Street Journal points out that “SBA guaranteed nearly $18 billion in 7(a) loans [in 2013], including $2 billion for franchisees.”
Taxpayers are picking up the costs of these government loan
guarantees. SBA charges lenders fees to mitigate the costs of default,
but the fee amount seem to be too low. Most recent years, SBA has
received a net outlay, or subsidy, from Congress.
What should be done? At the very least, SBA should take its inspector
general’s recommendations and review its practices regarding franchise
loans to reduce the number of defaults. Ideally as argued on www.downsizingovernment.org, SBA should be closed down."
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