Allied Capital 3rd Quarter Results Shifts BLX Away from SBA Loans
Indictment Moves BLX Away from Franchise Loans 
WASHINGTON, D.C. (Blue MauMau) - Yesterday morning, Allied Capital Corporation, the self-proclaimed backbone of the American entrepreneurial economy, held a conference call to announce its 2007 Third Quarter Results. Allied Capital and its portfolio company Business Loans Express, have been at the center of controversy recently, regarding BLX's connection to fraudulently originated loans through the Small Business Administration. According to Allied Capital Chairman and CEO William L. Walton, Allied's results were mixed for the third quarter. He explained, "The primary reason for the increased level of unrealized depreciation in the portfolio of this quarter was due to some changes we are making in our portfolio company, Business Loan Express. After an extensive evaluation of strategic alternatives for BLX, we have concluded that it needs to make a shift in its business emphasis to focus on conventional small business loans and small commercial real estate loans. BLX will significantly de-emphasize government guarantees lending going forward. We believe that the difficulties BLX is experiencing in government guaranteed lending has made that portion of its business too capital intensive."
Mr. Walton said it was with mixed emotion that they made the decision, that they remain a big supporter of the mission of the small business administration and of the program. He also announced that Bob Tannenhauser, former CEO of BLX, would now be moved to the chairman position for an interim period, and John Scheurer would take over as CEO. He stated, "This decision was taken mainly because BLX cost structure and capital requirements have become sub optimal."
The strategy shift is significant and Allied Capital expects that BLX will reduce loan origination volumes by about 30% in the short-term. Mr. Walton told the teleconferencing audience, "Consequently, we wrote BLX down by $84 million this quarter largely because of this repositioning." But he also projected that volumes and value will rebuild over time, but through a different product mix.
Financial Results Could Be Negatively Affected by BLX
In Allied Capital's latest SEC filing, it was reported that its total investment in companies may be significant individually or in the aggregate. It states, "As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. At June 30, 2007, our largest investments at value were in Mercury Air Centers, Inc. and Business Loan Express, LLC (BLX), which represented 6.3% and 4.4% of our total assets, respectively, and 1.9% and 1.2% of our total interest and related portfolio income, respectively, for the six months ended June 30, 2007."
Allied Capital Corp. has been investing substantially in the franchising sector over recent years, keeping in tune with its entrepreneurial investment theme. According to its prospectus, it lists numerous franchise companies representing tens of thousands of franchisees. Included in its portfolio is Bojangle's, Coverall, Huddle House, Meineke Care Care, Line-X Spray-on Truckliners, Healthy Pet, Worldwide Express, Elephant Bar restaurants, Border Foods, Sweet Traditions (Krispy Kreme), and Global Communications (Musak franchisees).
Government Investigates BLX for Corruption
But while Allied continued to increase its franchise portfolio companies, it ran into a snag with the government. In January 2007, the U.S. Department of Justice issued a federal indictment against 19 persons connected to BLX's Michigan office for fraud in connection with over $76 million in loans guaranteed by SBA. Allied Capital is one of the largest lenders participating in the SBA 7(a) Loan Guaranty Program. When the DOJ released its original indictment in January 2007, BLX entered into an Agreement with SBA. Shortly before the indictment, BLX was announcing its involvement with the International Franchise Association's Franchise Diversity and Development Initiative, a program set up to assist women and minorities in securing government-backed loans for purchasing franchises.
After the Justice Department concluded its investigation, BLX issued a statement last month that its former executive vice president, Patrick J. Harrington, plead guilty to fraud and making false statements to a grand jury. Harrington, an executive vice president of BLX headed the Troy, Michigan office until it was closed in August of 2006.
But according to Allied Capital's SEC reports,there are other investigations underway into the corruption. The Office of the Inspector General of the SBA and the United States Secret Service are conducting an ongoing investigation of allegedly fraudulently obtained SBA-guaranteed loans issued by BLX. The OIG and the U.S. Department of Justice are also conducting a civil investigation of BLX’s lending practices in various jurisdictions. In addition, the Office of the Inspector General of the U.S. Department of Agriculture is conducting an investigation of BLX’s lending practices under the Business and Industry Loan program. These investigations are ongoing.
The outcome of these investigations could have a big negative impact on BLX. The prospectus states, "As an SBA lender, BLX is also subject to other SBA and OIG audits, investigations, and reviews. These investigations, audits and reviews, changes in the laws or regulations that govern SBLCs or the SBA 7(a) Guaranteed Loan Program, or changes in government funding for this program could have a material adverse impact on BLX and, as a result, could negatively affect our financial results."
Shareholders Sue for Not Disclosing That BLX Fraudulently Secured SBA-Backed Loans
On February 26, 2007, attorneys for Dana Ross filed a class action complaint in the U.S. District Court for the District of Columbia in which she alleges that Allied Capital Corporation and certain members of management violated certain sections of the Securities Exchange Act. Thereafter, the court appointed new lead counsel and approved new lead plaintiffs. On July 30, 2007, plaintiffs served an amended complaint, claiming that between November 7, 2005, and January 22, 2007, Allied Capital either failed to disclose or misrepresented information about our portfolio company, Business Loan Express, LLC.
Throughout the Class Period, the class action states that Allied Capital and BLX knowingly or recklessly failed to disclose, among other things, that Allied’s financial results and condition were inflated, because a substantial amount of the income reported by BLX was from fraudulently procured SBA-backed loans. Defendants also misrepresented the nature and scope of the government investigations of both Allied and BLX, failing to disclose U.S. Attorneys and SBA Office of Inspector General investigations in the Eastern District of Michigan concerning the lending activities of BLX’s Troy, Michigan office. The lawsuit alleges that Allied Capital and BLX knew or were reckless in discovery demands in not knowing of the fraudulent loan origination practices at BLX.
Plaintiffs seek unspecified compensatory and other damages, as well as other relief. But according to an Allied Capital representative, they believe the lawsuit is without merit, and they intend to defend the lawsuit vigorously.
BLX's Impact on Franchising
But as Allied Capital and BLX face more federal investigations and a national class action lawsuit, the franchise community seems to be continuing its involvement with the two. As Allied continues to invest heavily in franchise companies, the International Franchise Association has recently continued its commitment to help assist partners in the FDDI minority program with the originator, Business Metropolitan Collaborative.
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