A Jump Start for Stalled Small Business Lenders

In recent months President Obama has pressured banks to increase lending to small businesses in order to spur job growth. Now, a long-awaited program approved in the stimulus package last February is set to begin that could help make that happen by reassuring wary bankers with a new approach.

For the first time, the SBA will guarantee up to $3 billion in pools of banks’ 504 loans sold into the secondary market. That way, if borrowers fail to pay, investors who bought the loans would be made whole by the government. The SBA expects the program to start soon but doesn’t have a firm date, according to spokeswoman Hayley Matz. 504 loans give small businesses favorable financing to invest in fixed assets like property or machinery.

Commercial lenders have not been able to sell their portions of 504 loans since investors lost their appetite for asset-backed securities in the financial crisis, prompting many lenders to drop out of the 504 loan program. “In essence that market has not returned,” says Kurt Chilcott, CEO of San Diego-based CDC Small Business Finance, a nonprofit that partners with commercial lenders to make 504 loans. “We’ve gone from at least half a dozen active players who were willing to purchase those loans to maybe half a player,” he says. Because banks can’t resell their loans, Chilcott estimates that 40% of the banks his firm used to work with have stopped making 504 loans.

COLLATERAL LIMITS

Nationwide, 257 lenders that made 504 loans in the 12 months before Sept. 30, 2008, dropped out of the program the following year, a decline of 13%, according to the SBA. Loan volume dropped 28%, from $5.4 billion to $3.9 billion, in the same period. “If the bank wants to make these loans, they have to hold them on the books,” says Bob Coleman, publisher of the Coleman Report newsletter on SBA lending.

That’s a problem because regulators want banks to limit their exposure to the troubled commercial property market. “Most of your small business loans will be secured by some sort of commercial real estate. The regulators are asking us to reduce our concentrations in that,” says Cynthia Blankenship, vice-chairman of Bank of the West, a community bank in Grapevine, Tex.

While the Small Business Administration guaranteed loans are a small piece of total credit to small businesses, they are growing more important as fewer companies hammered by the economy qualify for conventional loans. The SBA’s 504 loans in particular fund expansion projects that are directly tied to jobs: Companies must demonstrate that one job will be created or retained for each $65,000 the SBA guarantees.

Borrowers in the 504 program pay 10% of a project’s cost. The rest of the financing is split between two lenders: 40% from a nonprofit known as a Certified Development Company and 50% from a commercial lender. The government guarantees the CDC’s portion, but private lenders have no such guarantee. Their loans are secured by the first claim on the property if a borrower fails to pay. The new program means SBA will guarantee 80% of commercial lenders’ stake in 504 loans, which would let them pool the loans into securities and sell them to investors.

RISK ON PRINCIPAL

Even that 80% guarantee may not be enough to lure lenders back. The SBA will require banks to keep 15% of the loans on their books and pool assemblers—the companies that buy loans and package them into securities—to assume 5% of the risk. “They’re not used to taking principal risk,” warns Chris Crawford, president of the McLean (Va.)-based National Association of Development Companies, the trade association for CDCs that partner with banks in 504 lending.

If lenders and pool assemblers aren’t willing to hold on to those unguaranteed pieces of loans, the program “could fall flat on its nose,” he says.

Last year’s stimulus package bolstered the SBA’s other main loan guarantee program, known as 7(a), by eliminating fees and raising government guarantees from 75% to 90% of the loan’s value. Small banks often sell the guaranteed portions of their 7(a) loans so they can use the proceeds to make new loans. The market for those guarantees froze last year but has largely thawed, thanks in part to the Federal Reserve program known as the Term Asset-Backed Securities Loan Facility, or TALF, which provides investors attractive financing to buy securities backed by assets like credit-card debt, student loans, and small business loans.

TALF has supported purchases of $1.5 billion in SBA-guaranteed loans—both 7(a) and 504—since May, according to the Federal Reserve Bank of New York. The program is scheduled to expire in March. “Nobody really knows what will happen to the market once the TALF program disappears,” says Bob Judge, a principal at Government Loan Solutions in Cleveland, which helps lenders and investors price SBA loan securities.

LESS INCENTIVE FOR BANKS

No one is predicting the kind of paralysis that halted the market a year ago, when Judge says dealers selling pools of SBA loans might have been lucky to get one or two bids, compared with 10 today. But TALF’s expiration could slacken demand and reduce the premium lenders get for their SBA loans, which in turn means less incentive for banks to make the loans to businesses. “You’ll probably see a softening in the market at least temporarily,” says Chris LaPorte, the head of government loan operations at Coastal Securities in Houston, one of a handful of firms that pools SBA loans into securities.

In addition, the increased guarantees and fee waivers that have helped revive 7(a) lending are set to expire at the end of February. The measures, supported by $375 million in stimulus funding, have already been extended once with an additional $125 million Congress approved after the initial funds ran out in November.  Pending legislation would extend those enhancements to the end of 2010 and increase the maximum size of SBA loans from $2 million to $5 million for 7(a) loans, and from $4 million to $5.5 million for 504 loans. The bill would also let businesses use 504 loans to refinance existing commercial mortgages on more favorable terms.

For now, lenders are waiting to see whether the SBA’s effort to unfreeze the market for 504 loans will allow more small business owners to invest in new property and equipment—and create jobs. “That lending has really been stymied and that’s where they could really help,” says LaPorte.

John Tozzi, Businessweek

Go Green With The SBA 504 Program!

The SBA 504 Loan Program has been assisting small business entrepreneurs for over 25 years by providing fixed rate, long-term financing for the purchase, construction and renovation of commercial real estate. SBA 504 loans provide a source of long term capital with typically only a 10 percent down payment from the small business borrower. The rest of the financing is arranged by a Certified Development Company (CDC) securing an SBA 504 loan for up to 40 percent of the project costs and a lender providing the remaining 50 percent of the project funding.

The maximum amount of an SBA 504 loan is normally $1.5 million unless a project meets a specific public policy goal such as assisting a business in a rural area or a minority, veteran or woman-owned business. If a project meets a public policy goal, then the SBA 504 loan can go higher. The good news is that as part of the Energy Independence and Security Act of 2007, Congress added three new public policy goals to the SBA 504 Loan Program to assist businesses willing to invest in going green.

For existing small businesses wishing to purchase or construct facilities incorporating energy saving technologies or retrofit existing facilities resulting in a 10 percent decrease in energy consumption, they are now eligible to obtain SBA financing of up to $4 million for the project. The total cost of a “green project” can go as high as $9 million using the new public policy goal since the $4 million cap on the SBA 504 loan represents only 40 percent of the project cost. Some of the most common ways to achieve a 10 percent decrease in energy consumption now include improved insulation and lighting, improved HVAC, energy efficient windows and a number of other design features. New energy conservation technologies continue to be developed to make buildings and businesses more energy efficient so even more options will no doubt become available in the future.

In addition, small businesses generating renewable energy such as solar, biomass, hydro power, ocean thermal, geothermal and wind are also eligible to finance their real estate purchase or construction project with up to $4 million from the SBA 504 loan program. Generating renewable energy does not need to be the company’s primary business activity, just a method of meeting its own energy needs. Projects in any industry could, for example, purchase solar panels for their own use and qualify for an SBA 504 loan of up to $4 million.

The last type of small business projects that qualify under these new green business incentives are those small businesses that incorporate sustainable design into their facilities as defined by the Leadership in Energy and Environmental Design (LEED) standards and the Green Building Certificate Institute. Working with qualified architects and engineers to create a “green building” will make a small business eligible for an SBA loan for up to $2 million in SBA 504 financing.

This is great news for small business entrepreneurs who have been considering the purchase or construction of a facility with an eye toward energy conservation. Incorporating energy efficient technologies today qualifies these businesses for special financing now as well as saving money in the long term.

Changes to SBA 504 Will Allow Businesses To Refi Existing Debt!

WASHINGTON – Small businesses seeking to expand will be able to refinance existing loans used to purchase real estate and other fixed assets as a result of permanent changes to the U.S. Small Business Administration’s 504 Certified Development Company loan program.  The changes were authorized in the American Recovery and Reinvestment Act of 2009.

The permanent changes will allow small businesses to restructure eligible debt to help improve their cash flow which, in turn, will enhance their viability and support growth and job creation. The 504 loan program can be used to purchase business real estate or fixed assets, such as heavy equipment or machinery, and expand current development projects.

“This is one more piece of the Recovery Act that is going to have a direct impact and put more money in the hands of small business owners just when they need it most,” SBA Administrator Karen G. Mills said. “Lower interest rates mean lower payments and less money going out the door each month in debt repayments. That means more cash on hand to keep their doors open, their employees working and to even expand and create more jobs.”

Mills pointed out that the 504 program’s refinancing changes are the latest in several Recovery Act provisions that have been implemented by the SBA in recent weeks. On March 16, the agency temporarily raised to 90 percent the guarantee level on many of its 7(a) program loans and reduced fees on both 7(a) and 504 loans, and also doubled to $5 million the surety bond guarantee level for small businesses competing for construction and service contracts.

Additionally, on June 15, SBA ARC loans became available for viable small businesses facing immediate financial hardship.

“All of these steps, along with other Recovery Act provisions, are aimed at increasing access to capital and giving small businesses just what they need to help lead our nation’s economic recovery,” Mills said.

The 504 loan program is administered through 271 Certified Development Companies across the nation. SBA today began implementation of the changes by publishing them as a permanent rule in the Federal Register.

The changes announced today include:

Debt Refinancing: Legislation allows 504 program projects to include a limited amount of debt refinancing if there is a business expansion and the debt refinanced does not exceed 50 percent of the projected cost of the expansion.  “Expansion” includes any project that involves the acquisition, construction or improvement of land, building or equipment for use by the small business. The following are some of the conditions under which borrowers will be eligible for refinancing:

*        The debt being refinanced was incurred to acquire land, to construct a building or to purchase equipment.  The assets acquired must be eligible for financing under the 504 program.

*        The existing debt is collateralized by fixed assets.

*        The existing debt was incurred for the benefit of the small business.

*        The new financing provides a substantial benefit to the borrower when prepayment penalties, financing fees, and other financing costs are taken into account.

*        The borrower has been current on all payments of existing debt for one year prior to the date of refinancing.

ARRA and the SBA 504 Loan!

SBA 504 Program Gets Big Boost from Stimulus Bill

The $787 billion American Recovery and Reinvestment Act of 2009 is now law. The good news for the 504 loan program is the Act contains several enhancements that will boost the program’s appeal for borrowers.

• Most up-front fees have been eliminated, including the lender participation fee and the certified development company (CDC) processing fee, which will now be paid directly by the federal government. This change will reduce upfront borrower costs by $10,000 on a typical 504 loan.
• Refinancing with a 504 loan is greatly expanded. Existing Small Business Administration loans are also eligible and projects that meet certain criteria may be refinanced into a low-rate 504 loan.
• The secondary market should be revived by the creation of a 100% guarantee on 504 first mortgages.

Following is a summary of the changes contained in the final bill.

Fee Reductions

• The Act provides $375 million for the elimination of fees for both the 7(a) and 504 programs through Sept. 30, 2010.
• For the 504 program, both the bank participation fee of 0.5% and the CDC servicing fee of 1.5% will be zero.
• What is not yet decided is how the $375 million will be distributed between the two programs, which will be at the discretion of the SBA.
• CDCs will have their servicing fees reimbursed by the SBA.

Low-Interest Refinancing

Another major change is to allow refinancing of existing government guaranteed debt, including 504 loans. Permissible debt financing includes:

(A) Any 504 project “may include a limited amount of debt refinancing.”

(B) If the project involves expansion of the small business, an amount not to exceed 50% of the project cost may be refinanced, if

• Proceeds will be used to acquire land, to construct or expand building or to purchase equipment.
• Existing debt is collateralized by fixed assets.
• Existing debt was incurred for benefit of small business.
• Proceeds will be used only for refinancing existing debt or costs related to the project.
• It will provide a substantial benefit when prepayment penalties, financing fees and other financing costs are accounted for.
• Borrower is current on all payments of the existing debt for not less than one year.
• New financing will provide better terms or interest rate.

The Act does not exclude government guaranteed debt from indebtedness that may be refinanced, making both 504 loans and 7(a) loans eligible for refinancing.

This is a permanent addition to the Small Business Investment Act.

Establishment of SBA Secondary Market Guarantee Authority

• The Act establishes a program to provide up to $3 billion in guarantees for 504 first mortgage pools that are to be sold to third-party investors. It appears these may be existing pools of loans, or new loans that may be pooled after the date of enactment.
• The seller of these pools must retain not less than 5% of the pool amount to be sold to investors.
• The seller must absorb all losses resulting from a shortage of monthly cash flows, but gets to keep any overage in monthly cash flows.
• The fee paid to the SBA must be not more than one half of 1% of the outstanding guaranteed balance per year (assumed bill change).
• The program ends two years after date of enactment.

Job Creation Goals

• The job creation ratio has been changed from one job per $50,000 to one job per $65,000. This is another permanent change to the Small Business Investment Act.

Timeline

From here, the next step is for policy-makers at the SBA to develop the regulatory changes that will be required to fully implement the provisions of this new law. The exact timeline isn’t known as of this writing.

Under the SBA’s new Energy Efficiency Public Policy Goals, small businesses that go green may now qualify for up to $4 million on the SBA/FFCFC (second mortgage) portion of their 504 loan.

Additionally, the SBA recently added new 504 public policy goals that benefit small businesses that go green.

There is still no limit on the amount of the bank’s first mortgage loan, and therefore no maximum project size. FFCFC 504 loans can be used for the purchase, renovation or construction of owner-occupied commercial real estate.

$2 Million Eligibility Requirements:

• LEED certified projects (or other rating system) that show the increased use of sustainable, low-impact design. (Examples: superior design/efficiency in a new or improved location.)

$4 Million Eligibility Requirements:

• Projects that reduce energy consumption by at least 10%.
• Projects that generate renewable energy or renewable fuels.
  (Examples: improved HVAC and improved insulation/lighting; solar; biomass; hydropower; geothermal; wind; and ocean thermal.)

For projects generating renewable energy, it does not need to be the business’s primary business