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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   March 2012

Stepping in to Fill the Void

Nonbank lenders are playing a growing role in government-guaranteed loans

In today’s tight lending environment, nonbank lenders are taking the lead in offering government-guaranteed financing. It is essential for commercial mortgage brokers to understand the reasons that have encouraged this growing role. There are two top factors: the decline in overall bank lending to small businesses in response to tighter regulations, and the expanded government-guarantee authority in Small Business Administration (SBA) 7(a) and 504 loans.

Traditional bank lending to small businesses has been limited as a result of overreaction by banking regulators after the 2008 credit crisis, and the subsequent fear of making small-business loans. Banks that traditionally concerned themselves with the likelihood of loan repayment are now concerned with regulatory oversight.

"Nonbank lenders are not overregulated, have no mandatory legal lending limit and have no regulator-mandated loan committee."

Take, for example, a growing small business that earns a reasonable profit at its current location. If this business needs to expand its facilities to accommodate growth in production, it would approach a bank for a loan to buy a second facility or a larger building. The revenue to pay for the new building will necessarily come from the profit of the expanded facility; hence, the business submits projections to the bank that can evaluate the business’s ability to repay the loan. 

This was a standard operating procedure and a crucial component of creditworthiness before the credit crisis. Now, most traditional lenders avoid any loan request that relies on projected income. Because many small businesses can only grow if they take on capital projects that will result in increased income, and whereas these projections are a critical component for evaluating credit risk, there is a definite disconnect between the needs of a small-business borrower and lender resources.

This “regulator hangover” is a major reason why banks have been stuck on the sidelines while nonbank lenders have rushed in to fill the financing gap. Nonbank lenders are not overregulated, have no mandatory legal lending limit and have no regulator-mandated loan committee. Nonbank lenders are free to make lending decisions based on the overall credit qualifications and needs of the borrower rather than how regulators may view the loan.

The second reason for the growth in government-guaranteed lending by nonbank lenders is the expanded government-guarantee authority granted to the SBA 7(a) and SBA 504 programs. The American Recovery and Reinvestment Act and the Small Business Jobs Act provided significant changes to the programs — although temporary in some circumstances. 

The SBA 7(a) program

The SBA 7(a) program can be used for the construction or acquisition of owner-occupied commercial real estate, business start-ups, equipment, working capital and so on. Owner-occupied is defined as a small business occupying 51 percent or more of the net rentable square footage if the transaction is an acquisition — or 60 percent if it is ground-up construction.

The SBA 7(a) lender will make one loan that is typically 75 percent guaranteed by the SBA. All SBA loans are fully amortizing, varying in length from seven years for working capital to 25 years for real estate. SBA 7(a) loans are typically at the prime rate and adjust quarterly.

There are few nonbank SBA 7(a) lenders. A nonbank SBA 7(a) lender must be licensed by the SBA as a Small Business Lending Company (SBLC) to make SBA 7(a) loans, however, there are only a limited number of SBLC license holders in the country. The SBA indicated that no more SBLC licenses will be issued, which gives an edge to the entities that already have received their licensing.

"It is not uncommon for an SBA 504 transaction to finance a project as large as $20 million with as much as 90 percent LTV."

The major change in the SBA 7(a) program occurred as part of the Small Business Jobs Act passed in September 2010, which increased the maximum SBA availability per borrower/guarantor from $2 million to $5 million. This availability can be for one loan or multiple loans.

The SBA 504 program

Similar to a 7(a) loan, an SBA 504 loan can only be used for owner-occupied commercial real estate. The major difference between a 7(a) loan and a 504 structure is that the lender makes a conventional (not guaranteed) first mortgage. Then the SBA funds a subordinate loan in second position. The borrower receives the benefit of the government’s credit cost on the second. The current pricing for an SBA 504 debenture (second mortgage) is 4.85 percent, which is fixed for 20 years. The first mortgage can be fixed or adjustable and is funded by a bank or nonbank lender.

There is no special licensing requirement by the SBA to make SBA 504 first-mortgage loans. Consequently, there are far more nonbank SBA 504 lenders than SBA 7(a) nonbank lenders. 

The 504 program has seen three major changes over the past three years. 

  1. The First Mortgage Loan Pool (FMLP) program passed as part of the American Recovery and Reinvestment Act of February 2009. The FMLP program allows bank and nonbank lenders to sell 85 percent of the first mortgage to an SBA licensed and approved pool originator. The pool originator retains 5 percent of the loan for life. This retention is not guaranteed. The pool originator then sells 80 percent of the pool to an investor with the benefit of the full faith and credit guarantee of the SBA. While the first-mortgage lender’s loan is not guaranteed, the ability to sell off 85 percent of the loan provides the nonbank lender with the leverage not afforded in the current mortgage-backed securitization market. In reality, nonbank lenders would not be able to fund SBA 504 first mortgages without this benefit. The FMLP program is due to expire this September. While talk of a short-term extension is in process at the SBA, brokers or applicants should submit their applications as soon as possible in order to meet the deadline.
  2. The Small Business Jobs Act that was passed in September 2010 included language that temporarily allows the SBA 504 program to refinance existing debt. This in itself would amount to a sea-change in the allowable use of loan-program dollars. But in addition to the ability to refinance existing real estate debt, the legislation also allows the 504 program to refinance other business debt and secure working capital for future business expenses. The maximum loan-to-value ratio (LTV) is 90 percent regardless of the property type. Rarely has a small business been able to restructure its balance sheet with the benefit of long-term, below-market, fixed-rate financing.
    The program also expires this September, so brokers and applicants must submit their applications as soon as possible.
  3. The increase in the maximum SBA second mortgage is the last major change in the SBA 504 program. A borrower can now obtain $5 million on a single transaction — or even more if the borrower is a manufacturer or can show at least 10 percent in energy savings. It is not uncommon for an SBA 504 transaction to finance a project as large as $20 million with as much as 90 percent LTV. This breaks down to $13 million in first mortgage, $5 million in the SBA, second mortgage, and $2 million,in equity.

• • •

A confluence of events has occurred to allow nonbank lenders to fill the void left by banks in small-business financing. SBA 7(a) and SBA 504 financing has grown substantially exactly when it’s needed most by America’s small businesses.

Commercial mortgage brokers and borrowers are encouraged to act before access to these critical financing options expires.


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