Small businesses in lower-income L.A. neighborhoods will likely face a credit crunch after the closure of Innovative Bank, one of the top local small-business lenders.
Executives at Center Financial Corp., which acquired Innovative’s assets April 16 after regulators shuttered the institution, told the Business Journal last week that they do not plan to continue Innovative’s high-volume small-business lending program.
Unlike most lenders, Innovative specialized in small, working capital loans through the U.S. Small Business Administration’s Community Express program, which targets minority-owned companies and businesses in low-income areas. Through the program, Innovative, one of just three highly active Community Express lenders nationwide, made more than 1,800 SBA loans to L.A. companies since 2007, far more than any other lender.
Analysts said the loss of Innovative comes at a time when many small businesses still are contending with a decline in lending.
“It’s going to hurt,” said industry analyst Bob Coleman, who runs an independent publication examining SBA lending. “The purpose of Community Express is to make capital available for underserved communities. When you don’t have an Innovative Bank, who was committed to the program, there’s no one to step up and provide capital.”
The Community Express program, started by the SBA more than a decade ago, has become increasingly popular with very small businesses due to the ease with which loans can be obtained. The loans, which generally range from $5,000 to $50,000, typically require little paperwork and no collateral. What’s more, borrowers’ credit scores do not need to be top-notch.
According to Innovative’s Community Express application guide, prospective borrowers “do NOT need either a tax return or business plan.”
Loan proceeds can be used for, among other things, starting franchises, and buying inventory and equipment, or as simple working capital.
In case of default, the SBA will repay the lender 85 percent of the loan amount. Still, many large banks, wary of the types of borrowers attracted to the program, have steered clear of the risky loans.
“Smaller loan borrowers are weaker in terms of credit, so there will be a higher default rate on those,” said Jason Kim, Center’s chief credit officer.
In 2009, Center originated 37 SBA 7(a) loans, the agency’s standard program that provides larger loans of sometimes more than $1 million. Center’s 7(a) loans had an average value of $370,000 last year.
With assets topping $2 billion, Center is the fourth largest Korean-American bank in Los Angeles. The institution targeted Innovative, which was owned by Korean-American investors, because executives saw an opportunity to broaden its reach in California.
Center, which has large business and commercial real estate loan portfolios, expects to expand its 11-person SBA division after the acquisition of Innovative, Kim said. But due to the higher default risk and greater servicing time required for Community Express loans, Center does not plan to enter the program.
“The smaller loans – we are not interested,” Kim said.
Innovative, headquartered in Oakland, had one branch in downtown Los Angeles and three Northern California locations. The institution, founded in 1982 as Bank of Oakland, was small, with just $269 million in assets at the end of 2009.
Still, the bank was the third largest SBA lender in Los Angeles last year by volume, originating 148 loans – mostly through the Community Express program – for $16.4 million. The year prior, Innovative was the top local lender, making 777 SBA loans for $22.5 million.
The bank, which quickly embraced the Community Express program, took pride in consistently ranking among the largest SBA lenders in the country. But the high volume also caused problems.
Under federal law, the number of Community Express loans cannot exceed 10 percent of the total 7(a) loans in a given year. As a result, the SBA placed caps on some lenders, including Innovative.
Sharon Peterson, lead business adviser and loan packaging specialist for the small-business development center at El Camino College, said Innovative had been turning away increasing numbers of otherwise eligible applicants over the past two years as the institution ran up against loan caps.
Cease and desist
Meanwhile, Innovative got into trouble with regulators.
In March 2009, the institution received a cease-and-desist order from the Federal Deposit Insurance Corp. and the California Department of Financial Institutions over its record keeping.
Then, with rising losses and falling capital levels, Innovative received another cease-and-desist order this March directing it to revise its lending practices, raise capital, reduce classified assets and overhaul management. Less than a month later, regulators seized the bank.
Analysts interviewed for this article said that Community Express loans, which made up a relatively small portion of Innovative’s total portfolio, were not responsible for the bank’s failure. Innovative had been experiencing significant losses in its commercial real estate and business loan portfolios.
While the loss of the institution may hurt the business community, Peterson said she had already begun steering small-business borrowers to Borrego Springs Bank, a smaller Community Express lender that was not facing the same loan cap problems as Innovative.
“It’s a bit of a blow, (but) I had kind of shifted focus over to Borrego Springs,” she said.
Still, some are worried that no other lenders will step in and pick up the slack left by Innovative’s departure. Industry analyst Coleman said the high risk and razor-thin margins of the Community Express loans are major deterrents for most lenders.
“These banks aren’t making a lot of money off of it,” he said.
Indeed, the loss of Innovative leaves a gaping hole in the local SBA lender landscape at a time when loans can be difficult come by.
Jack Kyser, chief economist at the Los Angeles County Economic Development Corp., said small businesses, which make up the vast majority of L.A.’s business community, are having a much tougher time securing loans in this economy. The tightened credit environment is making government-backed loans more popular among small-business borrowers.
“The availability of credit is still a major issue,” he said. “Banks are continuing to be very cautious about extending credit. If you are a small business in Southern California, these SBA programs can be a lifesaver, and with this (lender) going away, that’s very, very sad.”
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