Bankers throughout Koreatown are seeing warning signs on small business lending.
Restaurants, print shops, dentists, small manufacturers, law firms – almost every kind of small business – have sought to refinance the variable interest rate loans guaranteed by the U.S. Small Business Administration after four successive interest rate hikes by the Federal Reserve in 2018.
“The data is pointing out that we need to be cautious,” said Joanne Kim, chief executive of Koreatown-based CBB Bancorp Inc., parent of the $1.16 billion-in-asset Commonwealth Business Bank. “I still have vivid memories of 2008.”
Other bank leaders echoed her sentiment.
“We are starting to see some signs of late payments with our small-business loans,” reflected Min Kim, chief executive of OP Bancorp, the downtown-based parent of the $1.1 billion-in-asset Open Bank.
“Sales are either softening or (businesses’ profit) margins may have been squeezed in the last six months,” she said. “We’ve seen some prepayments pick up in the last six months.”
The longest government shutdown in history, which ranged from Dec. 22 to Jan. 25, also caused some indigestion for the banks. CBB Bancorp was preparing a contingency plan to offer some SBA borrowers temporary commercial loans that could be transitioned to SBA-guarantee financing once the government reopened. Just as the bank was readying the first of the loans on commercial terms, the government reopened, putting the plan on the backburner, according to CBB’s Kim.
Other local banks cited similar moves.
Min Kim said OP Bancorp actually funded a few small-business loans as commercial loans that had moved deep into the escrow process when the government closed down, only to convert to SBA loans once it reopened.
While the short-term headache of the government shutdown is over, the longer-term issue with SBA loan programs at banks such as OP and CBB remain.
As the economy has improved and real estate prices have soared since the Great Recession, businesses that once could only access credit via SBA loans, which are guaranteed by the federal government and capped at $5 million, can now shop around for better terms.
SBA loan terms are typically longer – often paid over 25 years – and have variable interest rates. As rates have risen – the Fed raised rates four times last year – monthly payments for borrowers have risen, driving many, according to bankers, to look for alternative lending arrangements. These arrangements are often commercial loans on a fixed rate and with shorter terms.
Joanne Kim said she is starting to see more prepayments of existing SBA loans as borrowers avail themselves of other options.
She believes the effect of the prepayments is a cause for concern and is a balancing act for her bank moving forward.
“The prepayments have been going on for some time, but it’s starting to accelerate,” CBB’s Kim said.
Community banks that made these SBA loans are shrinking the size of their SBA programs as demand dries up and are offering lower interest rates to stay competitive.
CBB forecasts a nearly 18 percent drop in guaranteed SBA loan production in 2019, down from $195 million in 2018, according to data shared with the Business Journal. Newly originated SBA loans have declined from an average premium of more than 10 percent for the quarter ended Dec. 31, 2017, to less than 7 percent for the comparable 2018 quarter, according to Joanne Kim.
Pacific City Financial Corp., parent of the $1.7 billion-in-asset Pacific City Bank, has seen a similar trend.
Henry Kim, Pacific City Bank’s chief executive, said total outstanding small business loan volume has fallen 47 percent to $100 million in 2018 from $180 million the year prior. Like his peers at OP and CBB, he underscored that the number of SBA transactions has declined, prepayments have picked up, and out-of-state competition has pushed aggressively into the L.A. market.
“There are a lot of mom and pop stores not doing well,” he said
As the number of SBA loans originated and interest rates on those loans drops for these lenders, they are also choosing to keep them on their books instead of selling them on the secondary market. That’s because, with loan churn slowing and rates on SBA loans dropping, it makes less sense for banks to sell on the secondary market because the income from the SBA loan interest payments is more predictable and the premiums banks make from securitization are dropping.
Besides CBB, Pacific City and Open Bank, other K-Town banks see the trend, including Hope Bancorp Inc., parent of the $15.3 billion-in-asset Bank of Hope; and Hanmi Financial Corp., parent of the $5.5 billion-in-asset Hanmi Bank.
Bank of Hope is believed to be among the first of local banks to begin holding small business loans on its books starting in late December.
Angie Yang, senior vice president and director of investor relations for Hope Bancorp, said her bank began holding SBA loans instead of selling them to the secondary market because premium rates dropped significantly from 8.8 percent in late 2016 to 5.6 percent in the final three months of 2018.
Anna Chung, chief small business manager with Hanmi Bank, points out that there is another worrisome trend emerging on the horizon: Fewer SBA transactions.
“Production has gone down a lot,” Chung observed. “I’m also seeing fewer inquiries this year,” she said.
“If you look at over SBA financing, there are more players,” Chung said. “The need is the same, but there are more of us doing this. The pie is being sliced a lot more, and you have to work harder to get better deals.”
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