Banks Turn to Small Biz Investment Companies in Search of Greater Returns

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Byline: Kevin Wack

At a time when banks are struggling to find quality loans, a decades-old program that lets them invest in small businesses alongside government-backed bonds is looking increasingly attractive.

Small business investment companies, or SBICs, as they are known, offer a better proposition for banks today in part due to recent changes in the regulatory landscape, according to industry and government officials. Specifically, an economic stimulus measure passed by Congress in 2009 made the program more enticing to banks and other investors, and a provision in the so-called Volcker Rule is expected to spur even more activity.

"I would say there certainly is increased interest," said Kristi Craig, a senior vice president at the Small Business Investor Alliance, a trade group for the investment companies. "It hasn't been a 15-fold increase, but it's been significant."

The U.S. Small Business Administration, which licenses small business investment companies, does not keep aggregate data on how much money banks have invested in the firms. But other sources confirm that many banks are looking to get up to speed on the opportunities available.

To educate banks about the program, the Office of the Comptroller of the Currency last week released a 24-page report that lays out what they need to know about the investments. That followed an online seminar hosted by the agency in February that attracted hundreds of bankers.

The OCC's report states that as of July 31, there were 299 small business investment companies that had capital of $18.3 billion, both from private sources and from bonds backed by the Small Business Administration.

The companies invest in a wide range of small businesses, which must have a net worth of $18 million or less. Investments by the companies generally range from $1 million to $10 million per small business.

Last week's report notes that when banks invest in small business investment companies, they are eligible for credit under the Community Reinvestment Act. It also states that investments in the firms can yield higher returns as a result of the leverage provided by the government-guaranteed bonds a an appealing prospect for banks in an environment of narrow margins and tepid loan demand.

But those two aspects of the program have long been in place. What's changed for banks in the last few years?

Some in the industry point to the passage in 2010 of the Volcker Rule provision in the Dodd-Frank Act, which prohibits banks from investing in private equity funds, but provides a carve-out for small business investment companies. While the Volcker Rule has yet to be finalized, banks must prepare now for its enactment.

Bank investments in small business investment companies would continue to be allowed under the proposal from regulators on how to implement the Volcker Rule, said Brett Palmer, president of the Small Business Investor Alliance. …