BILL ANALYSIS Ó SENATE BANKING & FINANCIAL INSTITUTIONS COMMITTEE Senator Juan Vargas, Chair SB 976 (Vargas) Hearing Date: April 11, 2012 As Introduced: January 19, 2012 Fiscal: Yes Urgency: No SUMMARY Would exempt certified development companies from the California Finance Lenders Law (CFLL). DESCRIPTION 1. Would add CDCs to the list of business entities exempt from the CFLL, where they would join other entities with exemptions from that law, including banks, trust companies, savings and loan associations, insurance premium finance agencies, credit unions, small business investment companies, California business and industrial development corporations, and licensed pawnbrokers. EXISTING LAW 2. Provides for the CFLL, administered by the California Department of Corporations (DOC; Financial Code Section 22000 et seq.). The CFLL authorizes both secured and unsecured consumer and commercial lending and loan brokering, subject to certain restrictions, depending on the type of loan (consumer versus commercial) and the loan amount. 3. Defines a commercial loan, pursuant to the CFLL, as one with a principal amount of five thousand dollars ($5,000) or more, or any loan under an open-end credit program, whether secured by either real or personal property, or both, or unsecured, the proceeds of which are intended by the borrower for use primarily for other than personal, family, or household purposes (Financial Code Section 22502). The CFLL does not cap the allowable interest rate, nor limit the loan length, nor otherwise regulate the terms of commercial loans. All of the loans made by certified development corporations meet the definition of commercial loans SB 976 (Vargas), Page 2 pursuant to the CFLL. 4. Requires all CFLL licensees to obtain and maintain a surety bond in a minimum amount of twenty-five thousand dollars ($25,000; Financial Code Section 22112), maintain a minimum net worth of $25,000; Financial Code Section 22104), and file an annual report with the commissioner of DOC, providing information that the commissioner reasonably requires concerning the business and operations of the licensee within the state during the preceding calendar year (Financial Code Section 22159). SB 976 (Vargas), Page 3 COMMENTS 1. Purpose: This bill is sponsored by CDC Small Business Finance, which is approved as a certified development company and a Small Business Lending Company by the federal Small Business Administration (SBA). CDC Small Business Finance is seeking an exemption from the CFLL, to eliminate what it views as costly and duplicative regulation. The company asserts that it is already heavily regulated by the federal SBA, and that the terms of the loans it makes are already established by federal statute and regulation. This bill's sponsor believes that continuing to subject CDCs to regulation by both DOC (through its oversight of the CFLL) and the federal SBA is unnecessary, and does not further the interests of either borrowers or lenders. 2. Background and Discussion: CDCs are nonprofit corporations, which are established to further economic development within the communities in which they operate. CDCs work with the SBA and private sector lenders to provide financing to small businesses, which accomplishes the goal of community economic development. The SBA is an independent federal government agency, which helps Americans start, build, and grow businesses. The SBA administers multiple loan programs to help aid small business development, including a microloan program, the 7(a) program, and the CDC/504 program. The sponsor of this bill administers both 7(a) and 504 loans on behalf of the SBA. The 7(a) and CDC/504 programs are discussed below, because they describe the types of lending activity that would no longer be regulated by the state, if this bill's author and sponsor are successful in obtaining an exemption from the CFLL for CDCs. The 7(a) Loan Program is the SBA's primary program to help start-up and existing small businesses obtain financing when they might not be eligible for business loans through normal lending channels. The name comes from section 7(a) of the Small Business Act, which authorizes the SBA to provide business loans to American small businesses. The SBA itself does not make loans, but rather guarantees a portion of loans made and administered by commercial lending institutions. SB 976 (Vargas), Page 4 7(a) loans are the most basic and most commonly used types of loans. They are also the most flexible, because financing can be guaranteed for a variety of general business purposes, including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements, and debt refinancing (under special conditions). Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets. Most American banks participate in the program, as do some non-bank lenders, which expands the availability of loans. Participating lenders agree to structure loans according to the SBA's requirements, and apply for and receive a guaranty from the SBA on a portion of each 7(a) loan. The SBA does not fully guarantee 7(a) loans; instead, the lender and the SBA share the risk that a borrower will be unable to repay the loan in full. The CDC/504 Loan Program is a long-term financing tool, designed to encourage economic development within a community. The 504 Program accomplishes this by providing small businesses with long-term, fixed-rate financing to acquire real estate or major fixed assets for expansion or modernization. Typically, a CDC/504 project includes: a) a loan secured from a private sector lender with a senior lien covering up to 50 percent of the project cost; b) a loan secured through a CDC (backed by a 100 percent SBA-guaranteed debenture) with a junior lien covering up to 40 percent of the project cost; and c) a contribution from the borrower of at least 10 percent of the project cost (equity). a. Summary of Arguments in Support: As noted above, the sponsor of this bill, CDC Small Business Finance, is approved as a CDC and a Small Business Lending Company (SBLC) by the SBA, and administers both 7(a) and 504 loans on behalf of the SBA. As part of its certifications, CDC Small Business Finance's officers and paid employees are subject to federal background checks and stringent ethical requirements intended to prevent self-dealing and conflicts of interest, and to ensure protection of the public. The company itself must maintain fidelity insurance of at least $2 million, as well as directors' and officers' liability insurance of at least $1 million. CDCs and SBLCs are also audited on a regular basis by the SBA and the SBA Office of SB 976 (Vargas), Page 5 the Inspector General. Onsite reviews and examinations cover portfolio performance, operations management, credit administration, compliance with loan program requirements, capital adequacy, asset quality, management quality, earnings, and liquidity. CDC Small Business Finance is seeking an exemption from the CFLL, to eliminate what it views as costly and duplicative regulation. The company asserts that it is already heavily regulated by the federal SBA, and that the terms of the loans it makes are all established by federal statute and regulation. Continuing to subject CDCs to regulation by both DOC (through its oversight of the CFLL) and the federal SBA is unnecessary, and does not further the interests of either borrowers or lenders. CDC Small Business Finance also observes that the proposed exemption is narrow; this bill's sponsor is one of only 27 CDCs in California. Finally, this bill's sponsor observes that the CFLL already contains an exemption for small business investment companies (SBICs), another type of entity approved and regulated by the federal SBA. According to the SBA, SBICs are privately owned and managed investment funds, licensed and regulated by SBA, that use their own capital, plus funds borrowed with an SBA guarantee, to make equity and debt investments in qualifying small businesses. 3. Summary of Arguments in Opposition: None received. 4. Prior and Related Legislation: None relevant. 5. Amendments: a. The Department of Corporations has requested a technical amendment, which would strike the paragraph designations in the subdivision of the Financial Code being amended by the bill. As proposed to be amended, the text of the bill would remain identical, but references to "(1)" and "(2)" would be deleted from Financial Code Section 22050(a). LIST OF REGISTERED SUPPORT/OPPOSITION Support SB 976 (Vargas), Page 6 CDC Small Business Finance (sponsor) Opposition None received Consultant: Eileen Newhall (916) 651-4102