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Small Business Lending Fund Presents an Opportunity for Inexpensive Capital

Through the Small Business Jobs Act of 2010 (the “Jobs Act”), Congress made up to $30 billion of funding available to community banks for the purpose of encouraging small business lending. This funding has the potential to be one of the cheapest sources of capital available today. The funds are available through the Small Business Lending Fund (the “SBLF”), and the program works very much like the Troubled Asset Relief Program Capital Purchase Program (the “CPP”) of the U.S. Department of the Treasury (the “Treasury”) but without many of the same restrictions. The Treasury recently issued guidance for depository institutions and holding companies who are interested in participating in the SBLF. Applications are due by March 31, 2011.

The SBLF program is available to any insured depository institution (other than an institution on the FDIC’s Problem Bank List) with assets of $10 billion or less who meets certain eligibility requirements, subject to the Treasury’s consultation with the institution’s regulators. Eligible institutions with assets of $1 billion or less can receive up to 5% of their risk-weighted assets from the SBLF, while eligible institutions with assets of more than $1 billion but less than or equal to $10 billion can receive up to 3% of their risk-weighted assets.

The program contemplates that Treasury will provide Tier 1 capital through the purchase of preferred stock (or equivalents). The initial dividend rate on the preferred stock is 5% per year, but the rate decreases as the participating institution’s small business lending increases. If the institution’s small business lending increases by 10% or more, then the rate will fall to as low as 1%. If the institution increases its lending by amounts less than 10%, then the rate will decrease to between 2% and 4%. If lending does not increase in the first two years, however, then the rate will increase to 7%. After four and a half years, the rate will increase to 9% if the institution has not already repaid the SBLF funding.

Importantly, the SBLF funding can be used to refinance an institution’s CPP obligation, provided that the institution has not missed more than one quarterly dividend payment on the CPP preferred stock (the Jobs Act includes a 60-day grace period). This ability to refinance presents an opportunity for institutions who participated in the CPP and who engage (or desire to engage) in small business lending, not only because of the potential to significantly reduce the institution’s cost of funds (through the rate reduction that can be achieved on the preferred stock) but also because the Jobs Act does not impose the types of restrictions that apply under the CPP, such as the restrictions relating to executive compensation.

Please contact Andy Bulgin, a member of the Firm’s Financial Services, Business Law and Securities Law Groups, if you would like to discuss whether and how your institution can take advantage of the SBLF.