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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   March 2011

Dip into a New Pool of Business

Two recent changes to SBA loans may bring alternative lenders to the table — and more business to brokers

Dip into a New Pool of Business

Since it was enacted this past September, the Small Business Jobs Act has had wide-ranging effects on the U.S. Small Business Administration (SBA) loan industry. Two provisions in the bill — the ability to refinance with the SBA’s 504 loan program and the creation of mortgage-loan pools — have opened up a myriad of opportunities for commercial mortgage brokers.

The act’s 504 program refinancing provision makes SBA loans available to more businesses, and the mortgage pools make SBA loans increasingly attractive to nonbank lenders. Brokers who understand these changes and other regulations regarding 504 loans can increase their business in this valuable sector.

"The biggest, albeit temporary, change is the provision that allows the SBA 504 program to refinance existing loans."

Refis with 504 loans

As most commercial mortgage brokers know, the SBA 504 loan program finances owner-occupied commercial real estate. To meet the SBA’s requirements, at least 51 percent of the subject building must be occupied by the small business being financed if the transaction is a purchase. If the project involves construction from the ground up, the requirement is 60 percent.

The total project costs can include not only the purchase price but also associated soft costs, such as appraisal, title, escrow, etc. The first-mortgage lender typically finances 50 percent of the total project costs. The SBA then finances 30 percent to 40 percent, depending on whether the property is considered multipurpose or special purpose; it also is contingent on if the business is a startup or an existing enterprise. The borrower typically provides the remainder of the funds.

Two benefits of the SBA second mortgage are high leverage, typically with no additional collateral, and a below-market, 20-year fixed interest rate.

Recent changes in the 504 program mean that far more applicants can qualify for financing, and those applicants can qualify for much larger loans. For instance, small businesses with a net worth of as much as $15 million and an annual net profit of as much as $5 million now qualify for SBA financing. The SBA also increased the maximum second-mortgage amount from $2 million to $5 million. That means that a $20 million transaction is possible. One other little-noticed change is that mini-storages are also now eligible for SBA loans.

The biggest, albeit temporary, change is the provision that allows the SBA 504 program to refinance existing loans. This refinance provision is in response to the billions of dollars in owner-occupied real estate loans that will come due in the next two years on properties with insufficient equity to qualify for conventional bank loans. SBA refinancing allows for a combined loan-to-value ratio (LTV) of as much as 90 percent on existing owner-occupied properties with no additional collateral (or as much as 125 percent LTV with additional collateral).

Final guidelines were to be introduced in mid-February, but what is considered eligible debt includes loans that:

  • Were incurred at least two years before the date of application;
  • Are commercial loans;
  • Are not subject to a federal guarantee;
  • Were made to a business in operation for at least two years; and
  • Were current for at least 1 year before application.

The refinance provision is so significant that the SBA is planning for a doubling of 504 program volume. SBA 504 first-mortgage volume for fiscal year 2010 was almost $5 billion. The refinance provision expires in September 2012, however.

Mortgage pools

The Small Business Jobs Act not only provided many enhancements to the SBA’s 504 loan program, but it also extended the first-mortgage loan-pool program originally authorized in the American Recovery and Reinvestment Act. The extension was critical because the original program was set to terminate before any pools had been sold. The new maturity date is the same as the refinance provision — September 2012.

This program allows SBA 504 first mortgages to be pooled and sold with the enhancement of an SBA guarantee. The first-mortgage lender sells 85 percent to a pool originator — an SBA-licensed broker/dealer who creates the pool for sale to investors — and keeps 15 percent of the loan. The first-mortgage lender receives a minimum of 50 basis points in servicing but can receive more than 300 basis points on the 85 percent interest sold to the pool originator. The pool originator aggregates at least two 504 first mortgages and applies to the SBA for a pool guarantee on 80 percent of each pool. The pool originator is then left with an unguaranteed 5 percent interest in each loan pool.

Government-guaranteed debt buyers purchase the 80 percent interest in each pool from the pool originator, with the benefit of a full faith and credit guarantee through the SBA.

The monetary benefit to the first-mortgage lender is premium income and/or servicing income on the 85 percent sold portion. More important, the program provides a ready secondary market for first-mortgage lenders to sell their originated paper, enabling them to make new loans.

Nonbank lenders

The first-mortgage loan-pool program does not just benefit banks. Nonbank lenders also benefit and, in some cases, have an advantage over banks. 

Nonbank lenders can make 504 first-mortgage loans just like banks. Unlike the SBA 7(a) program, there is no costly license for the nonbank lender to purchase, and there is no special SBA-approval process. The nonbank lender must be able to close, service and liquidate loans in a commercially prudent manner to participate in the first-mortgage loan-pool program, however.

A bank may or may not need to sell loans to the secondary market. Nonbank lenders, on the other hand, depend on being able to sell all or most of a loan because of the relatively expensive cost of capital. Most nonbank lenders couldn’t be long-term commercial real estate lenders if they were forced to hold 100 percent of every loan.

This new program provides a micro-securitization outlet on a loan-by-loan basis. A nonbank lender can finance a property acquisition with as little as 7.5 percent of the total transaction cost, making these loans attractive for lenders — and good business for brokers.

Banks historically have been the overwhelming source of small-balance owner-occupied commercial real estate loans, but the mortgage-pool program will allow nonbank lenders to participate in this underserved market. In fact, nonbank lenders have three advantages over banks:

  1. Regulatory scrutiny: Never before have banks been so scrutinized by the regulators. This, more than anything else, has led to a credit crunch for small-business borrowers. Nonbank lenders do not face this regulatory burden, which allows them to make common-sense loans.
  2. No legal lending limit: Community banks are limited to their regulatory imposed legal lending limit. Most community banks have a legal lending limit of less than $5 million. And unfortunately for many small-business borrowers, this is a soft cap. Most banks do not want to approach their limit except for the most-qualified applicants. Nonbank lenders do not have this type of cap and are free to lend based on their own determination of risk.
  3. No FASB 166 for most nonbank lenders: The Financial Accounting Standards Board issued Financial Accounting Statement 166 in June 2009. This rule limits the ability of banks and other publicly traded financial companies to get true-sale treatment for loan securitizations when the loan seller has recourse to repurchase the sold portion, or when receiving what is determined to be excess servicing.

The last issue is the most important. The loan-pool program is an inherently inefficient securitization structure because it allows for loan pools to consist of as few as two loans. End investors typically prefer to have their risk diversified across many loans to protect against any one loan defaulting. If a loan defaults, the investor likely will lose any premium paid.

The alternative to paying a premium is to purchase a loan pool at something close to a par rate. For example, assume a two-loan pool with a gross rate of 6 percent is brought to market. An investor would rather buy the guaranteed portion of the loan pool at a par rate (i.e., with no premium) of 3 percent with 3 percent servicing paid to the seller versus, for example, paying a premium of 5 percent with a much smaller servicing rate of 1 percent flowing to the seller.

Because banks are subject to accounting standards and must receive true-sale treatment to realize the economic benefit of selling a loan, they can’t choose the excess-servicing option. This means banks generally stay away from loans that do not fit in homogenous pools — i.e., those that do not fit readily into multi-loan pools because of a lack of similar characteristics. Examples include loans greater than $5 million or loans that do not meet current credit standards — such as turnaround properties, hospitality, special-use, projected income, etc.

Nonbank lenders can fill this niche because they have the option to sell into small loan pools and receive the economics of a loan over time through excess servicing.

• • • 

The enhancements of the SBA 504 program combined with more lenders and an expanded credit box mean that mortgage brokers can now serve an unprecedented number of applicants. In many ways, the credit crunch of the past two years has been replaced by a once-in-a-lifetime opportunity.

The opportunity is finite, however. The refinance provision and the first-mortgage loan-pool program expire in September 2012. Mortgage brokers should take advantage of this confluence of lenders willing to lend with liquidity to match and expand their business into the SBA 504 market.


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