ABA Banking Journal - November/December 2017 - 40

>>> SMALL BUSINESS LENDING

Demystifying SBICs
for Community Banks
BY STEPHEN NEWTON

ith nearly $690 billion
in outstanding loans for
small businesses in 2016,
banks have a proven track
record of successfully
providing credit for small business
owners and entrepreneurs. For
nearly 50 years, one way banks have
done this is through small business
investment companies, or SBICs, which
are private organizations licensed by
the Small Business Administration
to stimulate small business growth
through long-term investments. Since
they were established in 1958, SBICs
have provided billions of dollars to more
than 100,000 businesses through
public-private partnerships that offer
banks a competitive asset class within
an attractive regulatory environment.

How are SBICs structured?
As privately owned and managed
investment funds that use capital with
an SBA guarantee, SBICs make debt
and equity investments in qualified
small businesses. Three types of
SBIC licenses allow for flexibility:
standard, impact investment and
early stage. Funds have the option
to supplement the private capital
with leveraged SBA-guaranteed
debentures. When forming funds,
banks traditionally use leveraged
SBICs, as they provide access to lowcost funding and maximize potential
returns. SBA debentures are nonamortizing securities with interest rates
fixed at a premium over the 10-year
Treasury note. They mature and are
payable in full by the end of the 10year term. The SBA will commit up to
two dollars of debt for every dollar a
40

ABA BANKING JOURNAL | NOVEMBER/DECEMBER 2017

fund raises, subject to a cap of $150
million. SBIC managers are required to
initially raise a minimum of $5 million,
though they typically raise significantly
more. The average debenture SBIC
raised $52.6 million in fiscal year
2016, while receiving $61.9 million in
SBA-guaranteed debentures.

What do SBICs invest in?
Funds must invest in small businesses
but have discretion to choose
companies across various industries
with limited exceptions for real estate
and financial intermediaries. A recent
Congressional Research Service report
showed 25.8 percent of SBIC financing
goes towards manufacturing, while
professional, scientific and technical
services receive 14.6 percent of
funding. SBIC funds typically focus on
industries in line with their managers'
expertise. Companies received funding
across 47 states in FY 2016, with
the South and Mid-Atlantic regions
claiming the most, followed closely by
the Pacific West.

How long does it take
to form an SBIC?
As of March 31, 2017, there were
317 operating SBICs, with typically
25-50 in the fundraising process
at any one time. The SBA generally
takes 6 to 12 months to grant an SBIC
fund license based on the applicant's
successful private equity investment
experience and business plan.
Once the license is received and a
debenture SBIC raises the required $5
million, funds may use the SBA-issued
leverage. The SBA issued twenty
licenses during 2016.

Why do banks invest in SBICs?
While SBICs' private investors range
from pensions to high-net-worth
individuals, banks should consider
the advantages these funds offer.
Performance data is not available for
individual SBICs, but the SBA Office
of Investment and Innovation's most
recent annual report in 2014 showed
a debenture SBIC's median internal
rate of return was 14.2 percent, with
a top quartile annual return of 26.3
percent from 2000 to 2010. This
closely resembled typical private
equity returns, according to the SBA.
SBICs also provide several regulatory
benefits. Banks can satisfy Community
Reinvestment Act credit requirements
by investing in SBICs as long as
the SBIC is either located or doing
business in a bank's assessment
area. Additionally, SBIC investments
are exempt from the Volcker Rule,
allowing banks covered by Volcker to
represent more than 3 percent of an
SBIC fund.
Other practical benefits enhance a
bank's participation in SBICs. Banks
may refer a small business that does
not meet the banks' underwriting
guidelines to the SBIC it invests in.
In turn, SBICs are more likely to
recommend the commercial banking
services of their bank investors to
firms in the SBICs' portfolio. This
provides an opportunity to develop
relationships with new firms early in
their business cycle.
STEPHEN NEWTON is an economic research
associate at ABA.



Table of Contents for the Digital Edition of ABA Banking Journal - November/December 2017

Chairman’s View
Upfront
Legal Briefs
Economic Outlook
Power Up Profile
Pitching In
Choices and Options Down on the Farm
Eager or Not, Every Board Needs an M&A Strategy
Adapting to Survive
More Than Just a Drink
Operations
Payments
Small Business Lending
Human Resources
ABA Compliance Center Inbox
From the States
Corporate Social Responsibility
Index of Advertisers
From the Vault
ABA Banking Journal - November/December 2017 - Intro
ABA Banking Journal - November/December 2017 - ebelly1
ABA Banking Journal - November/December 2017 - ebelly2
ABA Banking Journal - November/December 2017 - cover1
ABA Banking Journal - November/December 2017 - cover2
ABA Banking Journal - November/December 2017 - 3
ABA Banking Journal - November/December 2017 - 4
ABA Banking Journal - November/December 2017 - 5
ABA Banking Journal - November/December 2017 - 6
ABA Banking Journal - November/December 2017 - 7
ABA Banking Journal - November/December 2017 - Chairman’s View
ABA Banking Journal - November/December 2017 - 9
ABA Banking Journal - November/December 2017 - Upfront
ABA Banking Journal - November/December 2017 - 11
ABA Banking Journal - November/December 2017 - 12
ABA Banking Journal - November/December 2017 - 13
ABA Banking Journal - November/December 2017 - 14
ABA Banking Journal - November/December 2017 - 15
ABA Banking Journal - November/December 2017 - Legal Briefs
ABA Banking Journal - November/December 2017 - 17
ABA Banking Journal - November/December 2017 - Economic Outlook
ABA Banking Journal - November/December 2017 - Power Up Profile
ABA Banking Journal - November/December 2017 - Pitching In
ABA Banking Journal - November/December 2017 - 21
ABA Banking Journal - November/December 2017 - 22
ABA Banking Journal - November/December 2017 - 23
ABA Banking Journal - November/December 2017 - 24
ABA Banking Journal - November/December 2017 - 25
ABA Banking Journal - November/December 2017 - Choices and Options Down on the Farm
ABA Banking Journal - November/December 2017 - 27
ABA Banking Journal - November/December 2017 - Eager or Not, Every Board Needs an M&A Strategy
ABA Banking Journal - November/December 2017 - 29
ABA Banking Journal - November/December 2017 - Adapting to Survive
ABA Banking Journal - November/December 2017 - 31
ABA Banking Journal - November/December 2017 - 32
ABA Banking Journal - November/December 2017 - 33
ABA Banking Journal - November/December 2017 - More Than Just a Drink
ABA Banking Journal - November/December 2017 - 35
ABA Banking Journal - November/December 2017 - Operations
ABA Banking Journal - November/December 2017 - 37
ABA Banking Journal - November/December 2017 - Payments
ABA Banking Journal - November/December 2017 - 39
ABA Banking Journal - November/December 2017 - Small Business Lending
ABA Banking Journal - November/December 2017 - 41
ABA Banking Journal - November/December 2017 - Human Resources
ABA Banking Journal - November/December 2017 - 43
ABA Banking Journal - November/December 2017 - 44
ABA Banking Journal - November/December 2017 - ABA Compliance Center Inbox
ABA Banking Journal - November/December 2017 - From the States
ABA Banking Journal - November/December 2017 - 47
ABA Banking Journal - November/December 2017 - Corporate Social Responsibility
ABA Banking Journal - November/December 2017 - Index of Advertisers
ABA Banking Journal - November/December 2017 - From the Vault
ABA Banking Journal - November/December 2017 - cover3
ABA Banking Journal - November/December 2017 - cover4
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