SBA May Save the Day
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Many industry players were surprised by the SBA-loan-volume decrease. After all, the government set up the program in 1953
in part to help small businesses by providing the kind of high-leverage loans that most traditional banks wouldn’t offer.
There were some supply-and-demand issues, however, that caused banks to curb even their SBA-lending activities. These are
the issues brokers must understand to help their small-business clients determine whether SBA loans are right for them.
Fees and costs affect demand
There are three key issues that affect borrowers’
demand, contributing to the slowdown in SBA-loan closings.
First, SBA loans are relatively expensive in terms
of fees when compared to conventional loans. The
7(a) loan program’s guarantee fee, for example,
can be as much as 3.75 percent. The 504 loan program, which small-business owners often use for
real estate, has fees of around 3 percent, according
to the SBA.
From a broker’s perspective,
selling a 3-percent guarantee fee —
which the lender often passes on to
the borrower — is not easy. Some
owner-user borrowers who have nowhere else to go for high-leverage,
low-interest-rate financing will even
forgo SBA financing because of the
fee. This occurs despite the fact that
the fee often is rolled into and financed with the loan amount.
As market realities settle in, however, this fee
may once again seem a reasonable cost for getting
a high-leverage loan.
Second, interest rates factor into many borrowers’ decisions to forgo SBA financing. For instance,
the 7(a) program’s quarterly adjustable rate scares
some borrowers as they contemplate where the
prime rate might go. Some hard-money borrowers,
for example, would rather pay double-digit rates
than refinance into an adjustable-rate loan.
The issue for many of these borrowers is that
they don’t want to have to refinance their loan now
and again in a few years — not to mention paying
the third-party costs and fees again.
This strategy may make sense if investors come
back and start buying commercial loans on the
secondary market soon. But brokers and their borrowers must consider whether that is likely, given
current market conditions.
With all the cheap assets available to investors
today, it may take a while for them to see the value
in commercial mortgage-backed securities.
A more reasonable way to look at the 7(a) variable rate may be to consider the fact that the prime
rate is at a historic low. If your client received a 7(a)
loan when the prime is near 4 percent, it would take
three years of quarterly 25-basis-point increases
to get the prime rate to 7 percent. At that time, the
declining 5/3/1-percent prepayment penalty would
have expired, and your client can refinance into
a better rate, if it’s available. If a better rate is not
available, your client can stay in the 7(a) loan for as
many as 22 more years, given that 7(a) loan terms
for real estate can be for as many as 25 years.
The third issue involves the SBA’s new standard
operating procedure (SOP), which took effect this
“This past November, [the SBA] started
to allow banks to use the one-month
LIBOR plus 3 percent, in addition to the
prime rate, as the loan’s base rate.”
past August. While the SBA reduced the size of
its SOP, it also reduced the required loan to value
(LTV) for most special-use-property purchases from
85 percent to 80 percent. This is delaying many
planned purchases because borrowers must build
up their cash to meet the new requirement.
The SOP also requires gas stations that are
more than five years old to obtain a Phase II environmental site assessment and indemnification
agreements. Many borrowers wishing to finance
gas stations that are older than five years are therefore looking for other financing options.
Supply issues
There also are supply-side liquidity issues on the
part of banks that have affected SBA loan volume.
Typically, banks that fund SBA loans intend to sell
the debt into the commercial secondary market. If
they don’t do this, they must account for the full
loan balance in their reserves.
By selling the guaranteed portion of the loan,
banks need only account for the remainder in
their reserves. For example, if the SBA guaranteed 75 percent of a 7(a) loan, the bank would
need only account for 25 percent in its own
reserves. This gives the bank higher liquidity and
more money for lending. Now that the secondary market has few buyers, however, more banks
are finding that they must portfolio their loans —
something they never intended to do.
A big reason that demand for SBA 7(a) loans
has fallen in the secondary market is that many
market investors have their funding sources tied
to the London Interbank Offered Rate (LIBOR).
And LIBOR has increased dramatically against the
prime rate to which most SBA 7(a) loans are tied.
When the LIBOR is 4. 3 percent and
prime is 4 percent, for example, it no
longer makes sense for foreign investors to purchase securities linked to
the prime rate.
The SBA has recognized this problem. This past November, it started to
allow banks to use the one-month
LIBOR plus 3 percent, in addition
to the prime rate, as the loan’s base
rate. This change should help to eliminate the LIBOR/prime spread issue and allow more
banks to sell these loans on the secondary market.
■ ■ ■
Despite these supply-and-demand issues, SBA
loans are still available to small-business owners,
and banks are still providing them.
Try getting your small-business clients a carwash, restaurant or hotel loan with straight conventional financing at any reasonable LTV — it
probably won’t happen. With limited options for
conventional lending for high-leverage loan requests, brokers likely will find the SBA to be
the funding choice for many owner-users in
today’s market.
Jeff Rauth is president of
Commercial Finance Advisors
Inc., a national commercial
mortgage broker. He also has
an online store for commercial
mortgage originators, where he
offers, books, fee agreements,
DVDs, spreadsheets, etc., for
brokers at www.cfa-commercial.
com/ store.html. Reach Rauth at jrauth@cfa-commercial.com or (248) 885-8797.
On the Web
Small Business Administration: www.sba.gov
