1 in 6 Small Business Administration Loans Fail, Study Finds

Loans backed by the U.S. Small Business Administration’s 7(a) program are the gold standard for Main Street entrepreneurs seeking cash to start a business or grow. The loans are coveted for low interest rates and long repayment terms, and are highly competitive. The application process is time-consuming, and applicants often walk away empty-handed.

Getting one of these SBA-backed loans, however, is no guarantee of success: More than 1 in 6 loans (17.4%) awarded from 2006 through 2015 went into default, which in this analysis means that the issuing lender determined that it wasn’t likely to be repaid, a recent NerdWallet study shows.

That’s an improvement from the default rate for the 10-year period ending in 2008, when nearly 1 in 4 (24.7%) SBA loans weren’t paid back. But still worse than the 10-year default rate ending in 2000, when slightly more than 1 in 10 loans (11.5%) went bad, the data analysis found.

The findings emerge from an analysis of over 1 million loans issued since 1991 by banks participating in the SBA’s flagship loan program. To understand how SBA 7(a) loans fail over time, NerdWallet calculated the percentage of defaulted loans in a series of 10-year periods, starting from the fiscal years that covered 1991 through 2000, through the 10-year period ending with the fiscal year for 2015. NerdWallet obtained the data from the SBA.

Loans took 4.7 years, on average, to fail

Data from 2016 and 2017 were excluded from the analysis because the loans are too new for meaningful default rates — the average failing loan took 4.7 years to default; the median failure time was 4.1 years, according to our research.

This report focuses on the small businesses that attracted the most SBA loans and what kinds of businesses had the best and worst rates of loan defaults.

The data show the chaos that led to the Great Recession, echoed in high default rates for loans to real estate-related businesses. Mortgage and other loan brokers had the worst default rate with nearly 2 in 3 loans failing (65.6%) from 2006 to 2015. This default rate was followed by residential property managers (46.2%) and real estate offices of agents and brokers (45.5%), the analysis found.

In all, NerdWallet found that loans to 221 kinds of businesses that received 200 loans or more during the 10-year period went to debt collection at rates higher than average (17.4%), including loans to debt collectors themselves — 25% of collection agencies defaulted on their loans from 2006 through 2015. The businesses with the lowest rate of defaults over the same time period were breweries (3.9%), businesses that support oil and gas operations (4%) and veterinary services (4.3%).

A key funding source for U.S. small businesses

Small businesses created 60% of the nation’s new jobs from 2009-2013, according to the SBA, and the 7(a) loan program is designed to stoke that economic engine by supporting those who are starting a business or expanding one. The program backed $24.1 billion in loans in 2016, up from $14.5 billion in 2006.

The SBA doesn’t make the loans; rather, banks and other financial institutions choose the businesses to fund as long as they meet 7(a) loan eligibility requirements. In return, the SBA guarantees to pay participating banks 85% of unpaid loans for $150,000 or less and 75% of unpaid loans for over $150,000.

The 7(a) program guarantees loans of up to $5 million made for working capital, company expansion or equipment purchases. The program is designed to pay for itself — fees paid by participating banks are used to cover SBA guarantees on loans that go bad.

The SBA guarantees allow banks to charge interest rates far lower than the rates entrepreneurs will get from online small-business lenders or by using credit cards. SBA loan interest rates range from 6.5% to 9%, and the loans have long repayment terms, ranging from 7 years for working capital loans to 25 years for real estate loans, according to the SBA.

Other funding options like online small-business loans have an average APR of about 50%, according to a NerdWallet analysis. And merchant cash advances have APRs as high as 350%, with repayment terms measured in months rather than years.

Default picture improving, but not for all

Banks primarily look at the financial health and credit history of the business and its owners when considering a loan application, no matter the industry. But when loan approval and default rates are examined by specific business types, some clear winners and losers emerge.

To understand defaults by industry, this data analysis eliminated business categories that recorded fewer than 200 loans in total from 2006 through 2015 (306 kinds of businesses received 200 or more loans).

Default rates were under 15% until the 10-year period ending in 2005, when the percentage of failed loans began to climb, peaking at 24.7% in 2008. The 17.4% rate of failed loans recorded in the decade ending in 2015 was the lowest since 2005 (17.3%).

Other key findings

Consumers move toward online services and shopping. The trend appears to have hit businesses like videotape and disc rental stores, which saw 42.7% of loans go into default from 2006 to 2015, along with travel agencies (39.4%) and bookstores (31.4%).

Brick-and-mortar stores struggle. When looking at 221 businesses with higher than average default rates, different categories of stores appear under pressure as consumers turn away from visiting department stores (40.6% defaulted from 2006 through 2015), women’s and men’s clothing stores (33.6% and 32.9%, respectively) and shoe stores (31.6%).

Health care providers appear to be doing well. Loans to optometrist (4.9%), dentist (5.2%) and physician offices (5.6%) from 2006 through 2015 had some of the lowest default rates, as did loans to pharmacies (5.3%) and home health care services (8.8%).

What businesses attract the most SBA loans?

To find what businesses attract the most loans, we sorted loan approvals by business type in 2016, the latest full year of data. We then telescoped out to see approval rates by business type, or category, across the first 16 years of the new century — a time frame that includes two presidential administrations and two cycles of recession and recovery — to see how they compare.

Some observations

Restaurants are top draw for SBA loans. Loans to both full- and limited-service restaurant categories (think table service versus counter service) accounted for 8.7% of all loans in 2016, and 9% of SBA loans issued since 2001.

Nearly 1 in 3 loans went to the top 20 business types. Over 1,000 business categories received 7(a) loan funding from 2001 to 2016, but the 20 that received the most accounted for 30.4% of approved loans.

Top 2016 recipients mirror the 16-year picture. Comparing last year’s top 20 loans by business category to the top 20 from 2001 to 2016, 19 categories dominate both lists.

Trending: Lawyers, bars and health clubs

To chart the fastest-growing industries in recent years by increase in SBA-backed loans, we measured 2016 loan data against 2011, when the job market had its first full year of recovery after the Great Recession, according to U.S. Bureau of Labor Statistics. We also looked to see how 2016 industry approval trends compared with 2001 data.

Successful loan applications surged in recent years to businesses that focus on personal services, beverages and delivery. Overall, the number of loan approvals for these businesses increased 30% from 2011 through 2016. Some trends of note:

Fitness and recreational sports centers gain strength. This business category was the fastest-growing in 2016 by increase in SBA-backed loans. Approved loans jumped 128.5% from 2011; the growth rate from 2001 was even higher (228.7%).

Loans to lawyers chart highest 16-year growth. SBA loan approvals to offices of lawyers in 2016 were up 246.9% over the rate in 2001. Law firms ranked 19th among businesses receiving loan approvals from 2001 through 2016.

Companies on the move. In the past six years, loans to local freight trucking companies grew 91.2% and charted 208.2% growth since 2001.

Bars, coffee shops and liquor stores serving more. Places to sit down for a drink, be it a bar (68.2%) or a snack and nonalcoholic beverage bar like a coffee shop (68%), charted the fourth- and fifth-fastest growth in SBA loan approvals from 2011 to 2016. Similarly, places to pick up a cold one (beer, wine and liquor stores) were among the top 20 fastest-growing categories (41.1%) of loan recipients in the past six years.

Rise of personal-service businesses. “Other personal care services” — a catch-all business category that includes day spas, hair weaving and tattoo shops — was the third-fastest growing category (76.2%) since 2011. “All other personal services” — another broad category that includes wedding planners, personal trainers and house sitters — charted the ninth-highest increase for the past six years.

Important notes for businesses

Some industries get far more SBA loans. SBA loans funded hundreds of business categories from 2001 through 2016. But the fact that nearly a third went to just 20 kinds of businesses suggests entrepreneurs in these fields might want to consider an SBA loan.

Size to qualify depends on industry. SBA definitions of qualifying businesses by number of employees or annual receipts vary widely — prohibiting borrowing by businesses that have more than 500 employees in some cases and more than $7.5 million in average annual receipts in others. Check with the SBA to see if your business qualifies.

Average loan amounts vary widely. For example, the highest average loan size in 2016 was to hotels, with a loan amount of $1.9 million, on average. By comparison, limited-service restaurants received about $350,000, on average, per loan.

Find the right 7(a) lender for you. Banks follow SBA guidelines but use their own underwriting criteria to evaluate loan applications. Ask your SBA district office or consult the SBA LINC tool to find potential 7(a) lenders. (Want to know more? This SBA loan guide will help.)