While it doesn’t always feel like it, the United States has officially been out of recession for three years now. And with economic growth (how-ever slow it has been) has come growing demand for small business loans in many areas of the country.
Community banks face the challenge of trying to create a lending package for businesses that can best be described as the walking wounded. Many such businesses managed to survive the recession by aggressively managing receivables and inventory, and delaying replacement capital expenditures. These businesses need to rebuild working capital in order to fund new receivables and inventory, and fill new orders. However, many no longer qualify for traditional bank loans or lines of credit due to strained liquidity, high leverage, deteriorating collateral and/or excessive losses.
Without some sort of external cash infusion, companies in this situation will eventually fail due to a lack of capital. But what can you, as a commercial lender, do to help them if they don’t meet your standard underwriting guidelines?
Rethinking SBA Loans
One solution many community banks are now turning to is the U.S. Small Business Administration (SBA). The primary objective of the SBA is to help banks make loans to businesses they normally wouldn’t be able to lend to based on normal small business underwriting standards.
If your first thought when you hear “SBA loans” is “cumbersome, expensive and not worth the effort,” you should think again. In recent years, SBA loan programs have been restructured, making them powerful financing tools that, in the right circumstances, can meet the needs of a broad range of small businesses — including the walking wounded.
For starters, the SBA loan application process has been streamlined and simplified, with less documentation now required on the part of borrowers. And the Small Business Jobs and Credit Act of 2010 increased the loan limits for SBA 504 and 7(a) loans:
- The maximum loan amount for regular 504 loans was increased from $1.5 million to $5 million, while the maximum loan amount for 504 loans made to small manufacturers and certain energy efficiency projects was increased from $4 million to $5.5 million.
- The maximum loan amount for 7(a) loans was increased from $2 million to $5 million.
In addition, the definition of a “small business” for SBA loan purposes was broadened. Any company that has a tangible net worth of less than $15 million and two-year average net income of less than $5 million may now qualify for an SBA loan.
Finally, the Jobs Act allows qualified owner-occupied commercial real estate mortgages to be refinanced with a 504 loan during a temporary two-year period ending on September 27, 2012. To qualify, the loan must have been incurred at least two years prior to the application to refinance and it must have been current for the last 12 months, among other criteria.
Lucrative Funding Vehicles
Besides enabling community banks to help companies that don’t meet more restrictive internal small business underwriting guidelines, SBA loans can also be lucrative funding vehicles for banks. The margins and fee income can be healthy, and by selling the SBA-guaranteed portion of the loan in the secondary market, your bank can loan this money back out to other small businesses, either traditionally or via more SBA loans.
Of course, you can hold the SBA loan in your bank’s loan portfolio instead. This may enable you to leverage your capital and reduce your portfolio risk, since the SBA-guaranteed portion of the loan features lower (20 percent) risk-based capital requirements.
There’s one important rule of thumb you must always keep in mind when making SBA loans: Never let an SBA guarantee lull you into making a loan that you don’t think will be repaid.
An SBA guarantee can help make up for weaknesses in a credit (like the startup nature of a business, a new management team or a lack of hard assets to be pledged as collateral) that wouldn’t enable you to lend to a business under normal circumstances. But it shouldn’t be used to justify making a bad loan that doesn’t cash flow.
Know and Follow the Rules
Be aware that the SBA has very strict rules and regulations in place for banks that make SBA loans, including stringent monitoring and reporting requirements. Therefore, make sure that your bank has the infrastructure and systems in place, as well as the expertise on staff, to meet all of these requirements. The SBA will likely look for a reason to deny the guarantee if problems arise. So be very careful not to give them one.
To learn more about the potential benefits of making SBA loans to small business borrowers, please give us a call.