See What Mercantile Commercial Capital CEO, Chris Hurn, the 504 Expert has to say when the benefits of a 504 vs a 7a loan are challenged!

Below is a copy of the press release that was distributed on February 27. Below the press release is an email response I received from the Senior Vice President of an “unmentioned” Community Bank. I’ve also included Chris’s reply back to her, which I think you will find interesting and educational.

Large SBA Lender Says Congressional Reforms Misguided,

Proposes Simple Changes to Existing Loan Program for Major Economic Stimulus

ORLANDO, Fla. (February 27, 2008) —- The toll that the tightening credit market is taking on small businesses’ access to capital has spurred bills in the U.S. Congress aimed at curbing the fees and increasing the maximum size of Small Business Administration loans under the agency’s most popular lending program. The president and CEO of Mercantile Commercial Capital, one of the country’s largest SBA lenders, Chris Hurn is writing to congressional leaders and the SBA to indicate that the proposed changes are misguided and suggest reforms for the SBA 504 loan program that he believes would make a significant positive impact during the current economic downturn.

Specifically, Hurn indicates that the current bills before the U.S. Congress (H.R. 1332, S. 1256 and S. 2612) would exacerbate the existing problem of competition between the SBA’s two primary lending programs for small businesses. As it currently stands, private sector banks and lenders prefer to offer SBA 7(a) program loans over the agency’s 504 program loans because they can earn larger profits and fees with the 7(a). The current bills would make this profit disparity between the two loan programs even greater, so lenders will be less likely to recommend the 504 over the 7(a) even for commercial real estate acquisitions, for which the 504 was created to offer borrowers significantly better terms and rates than the 7(a).

“I’m writing Sen. John Kerry and the other congressional leaders behind the current bills to recommend a different set of reforms focusing on eliminating the competition between the SBA’s two largest lending programs,” said Hurn. “These reforms would entail making the 504 loan program the exclusive option for commercial real estate loans from the agency and enabling 504 loans to be offered for the refinancing of commercial property loans.”

According to Hurn, the 504 loan program is the most efficient job-creation program that the SBA offers, but it remains underutilized.

Hurn indicates that the reforms he proposes would boost the U.S. economy by helping small businesses to grow and add jobs without the creation of new programs or allocation of additional federal funds. He also believes that the changes would complement the recently enacted small business economic stimulus measures that allow investments in tangible property by businesses to be more speedily depreciated.

“With the declines in the housing market, small-business owners are now considering investments in commercial property for their businesses as opposed to risky investments in residential real estate,” said Hurn. “The changes that I suggest for the 504 loan program will work in conjunction with the recent tax breaks to create incentives for small businesses to acquire or develop their own facilities.”

Hurn also points out that allowing businesses to refinance their existing commercial property loan with a 504 loan would give thousands of businesses a new option that could significantly lower their monthly property payment, which would enable many to hire more employees or invest in growing their enterprise.

The 504 loan program is the primary economic-development and job-creation program of the SBA. The portion of each 504 loan funded by the government represents the least expensive financing option that is available for businesses.

Recently named to the Inc. 500 list of America’s Fastest Growing Companies, Mercantile Commercial Capital has been called the “Fastest Growing Commercial Lender in America,” the “most unique and entrepreneurial bankers around,” and the “fun bankers.” From its start in 2003, MCC has focused on providing SBA 504 loans for small business owners to acquire or enhance their own facilities. The company was named “Best Place to Work” by the Orlando Business Journal in 2005, 2006 and 2007.

Additional information on MCC and its loan offerings is available at www.504Experts.com or by calling (866) 622-4504 (toll free).

From: Anonymous
Sent: Friday, February 29, 2008 3:22 PM
Subject: 504 loans

Note: This e-mail is intended for the Mercantile Commercial Capital author of the recent article in The Coleman Report, an SBA Industry report. Please pass this on to the appropriate party, typically the SBA Department Manager, Bank Credit Administrator or President

Hello,

My name is _________, and my position is Sr. VP of ____________ located in _________ California. After reading your article that was included in the recent Coleman Report, obtained online, I felt compelled to write and share my thoughts.

The statement was made that other banks like to make 7a real estate loans instead of 504 loans because of the large profits they can make, and that real estate loans should only be made via the 504 program. Have you priced a 7a loan on the secondary market lately? The premiums have dropped in half! If you competitively price a deal at Prime + 1%, your premium is now about 4%, down from 8% in recent years. From that 4% on the guaranteed portion, we pay (as do most lenders) a 1% referral fee on the entire loan amount, as well as a BDO commission. Then the rest is GAAP accounted and a good portion is deferred for several years. To say that lenders are making 7a real estate loans solely for the purpose of receiving large premiums is erroneous and misleading.

For the past 30 years I have been involved in the SBA program, and have sought to use it in the best interest of the borrower. In addition to being an experienced 7a lender, I serve on the Board of Directors and Loan Committee for CDC Small Business Finance, the largest 504 CDC in the nation. Of our roughly $120 million in new loans generated last year, only about $15 million were 7a. Hopefully these numbers will demonstrate to you that we are not solely a 7a lender.

So why do we support 7a real estate loans? Have you ever dealt with a borrower who needs to sell their building within the 10 year prepayment penalty imposed by the 504 program? Do you have any idea the tens of thousands of dollars in a prepayment penalty that a borrower may have to pay at the close of escrow? This can have a severely detrimental effect on a small business. Everyone enters into a 504 loan with the greatest of intentions-they think they’ll own the building for 20 years, it’s their retirement vehicle, they custom built it to suit their needs, etc. So what happens when they outgrow it and need to move? Or they have to change locations because of other reasons? Or their business is diminishing and they have to cut expenses and sell? Or just need the cash and have to sell or refinance to get access to their equity? Not every buyer wants to assume the existing 504 loan. And some sellers may not be moving to a new building so they can take their 504 loan with them. Some businesses know for a fact they aren’t going to be in the building for 10 years, and truly need a lower prepayment penalty. What about those people? Should they not be allowed the benefit of the SBA program without being forced to pay a heavy penalty? Over the course of my participation in SBA I have seen times when a borrower can’t even close an escrow, because there are not sufficient funds to pay the liens on the building and the non-negotiable 504 prepayment penalty!

The 504 program, while it has many virtues, is not the best program for everyone. Removing the ability to choose which program is best for a borrower is like trying to fit a square peg in a round hole. Not all banks are greedy and trying to make a profit at the expense of putting a borrower in a product that benefits the bank more than the borrower. Some of us are truly looking to provide the best financing vehicle for their business taking into consideration their financial capabilities and future plans. And, as demonstrated above, the profits 7a loans used to generate are not as great as you may believe.

There are many benefits to each loan program, both from the standpoint of the bank and the borrower. I firmly believe the borrower should be given the opportunity to choose which is right for them. Removing the capability of financing real estate through the 7a program would be one of the greatest and most costly disservices we could do to a small business.

Anonymous –

Thanks for your email. I appreciate the dialogue, as I’m sure Bob [Coleman] does too. Since I’m just a bit busy today, please forgive me for responding to your points numerically below:

It seems as though, in your attempt to rationalize your critique, you make exactly my point. Immediately complaining about the premium compression taking place now, seems to suggest I might just know what I’m speaking of. Your second paragraph certainly suggests where your priorities lie, and yes, I am very aware of the premium compression occurring after years of out-sized premiums for 7(a)’s on the secondary market. Complaining of a 4% premium down from an 8% still seems like it would be rather difficult to justify to your small business clients – what would THEY think if they only knew. If my criticism is so “erroneous and misleading,” then why such pain and complaining? Why feel compelled to label my statements “misleading” just to tote the NAGGL party line? The problems with 7(a) appropriations would never have occurred years ago or perhaps in the future, if my simple solutions were enacted. I have never been against 7(a)’s, I just realize they serve a purpose and have a place, but it should NOT be to finance commercial property.
I’m glad to see that you mostly provide 504’s and not 7(a)’s. As you’re located in California, you may not realize that 504’s are still a much more accepted and utilized loan product there than in other parts of the country. As we lend nationwide, we have first-hand knowledge of the distortions taking place within the banking community. With commercial property values what they are in California, I’d imagine it’s much harder to promote 7(a)’s for commercial property-only transactions. We financed $102MM in total projects last year with 504’s and won NADCO’s “Banker of the Year” a couple years ago, so I think we can agree that we’re both “experienced enough” to know a thing or two on this matter.
You asked, so I’ll answer: yes, I have dealt with borrowers faced with the prepayment penalty of 504 loans, and I DO have an idea of the monetary costs of these penalties. In fact, I have a 504 loan myself and invest in other commercial developments as well… so I’m intimately familiar with the good and the somewhat bad – though the good clearly outweighs the bad. Saying 504’s can have a “severely detrimental effect on a small business” is taking things out of context and making a mountain out of a molehill. That’s like saying that computers in the workplace will let employees conduct administrative tasks much faster, so they will get tired more easily and that would have a “severely detrimental impact” on the health of office workers. I could and certainly do argue that 7(a)’s with Prime-based floating rates and pledges of A/R, inventory, seconds on homes and so forth (thereby restricting that same collateral to be used to secure additional growth capital elsewhere) is also “severely detrimental.” To get around your perceived issue here, we regularly tell our prospective borrowers that utilizing a 504 loan is generally a 5 to 10-year commitment, though if the price is right from a buyer that theory can go right out the window. Many folks ought to assume existing 504 loans as it’s virtually impossible to find less expensive capital elsewhere – that explains why some Fortune 500 companies carry 504 loans on their balance sheets after they’ve acquired smaller firms. When a seller doesn’t have enough at closing to satisfy their liens and pay off their prepayment penalties that strikes me as more of a sales and negotiation problem than anything else. In the rare instance it’s a fire-sale, then yes, your arguments are correct, but I don’t see you as vehemently bothered by yield maintenance and defeasance in CMBS deals or for that matter, as irritated about early withdrawal penalties on retirement accounts. Where do we draw the line and require good old fashioned personal responsibility? No one puts a gun to a business owner’s head and MAKES him buy commercial property! In the odd situation that it turns out for the worst, most make the best of it and move on. I think it’s simply easier for you to make a straw-man argument here than let business owners decide for themselves. When given the chance, business owners and entrepreneurs weigh the inherent benefits of a 504 loan with the few downsides, and make a decision – the same thing occurs with every entrepreneurial choice. “Coddling” them in an effort to “protect” them only hurts them more – entrepreneurs weigh the risks with the rewards; they don’t need bankers making that decision for them. If you were in business for yourself or were more empathetic of your borrowers’ circumstances, you might understand that better.
For non-“flippers,” the 504 IS the best commercial loan product for owner-users. I find that hard to argue and would hope in your capacity as a Board member of CDC Small Business Finance that you would stand with them, too. In fact, since you brought them up, I presume you’re aware that they quote the SBA-backed debenture pricing based on a 13-year lifetime of a typical 504 loan in their portfolio. Meaning, even your own CDC realizes that these loans aren’t regularly held to term and even felt compelled to reflect that in how they display their pricing to the marketplace, essentially dropping the final five-year traunch – so the very Board you serve on doesn’t believe their borrowers will necessarily own their building for 20 years, yet they still promote and educate and sell their loan product, rather well, I might add. Again, I know, as most CDCs do, that 504’s will always be the best overall loan product for business owners having a time horizon longer than ten years (and I can even crunch the numbers to show you that it still works if they don’t stay in the building that long). If you still don’t agree, then what are you doing on a CDC’s Board?
My final counter-argument to you is against the ridiculous accusation you and even _________, head of NAGGL, once made in a Wall Street Journal article against my rather simple solution to the competition between 7(a)’s and 504’s: he, and now you, have said the same thing – we need to let the borrowers choose. That’s fine and well as a matter of course, but you and I and every other head of a CDC in America know that 504’s usually don’t make it to the commercial loan “table.” When told of commercial loan options, most commercial lending officers mention their bank’s conventional loan products and the SBA 7(a) for commercial real estate projects less than $2MM. If you and all others REALLY believed in choice, then you’d also tell them about the 504 even if you might go from an 80% LTV conventional or a 90% LTV 7(a) down to a 50% first mortgage 504. What’s in the best interests of the borrower? That’s the eternal question, and I can point to far too many instances where America’s small businesses got an inferior loan product for their commercial real estate because their banker failed to mention the best commercial loan product, leaving America’s taxpayers are on the hook if it goes bad. It’s really that simple. Saying that “removing the capability of financing real estate through the 7a program would be one of the greatest and most costly disservices we could do to a small business” is quite the hyperbolic statement. It would do no such thing. In fact, it might just touch-off the kind of economic stimulus we’d all like to see about now. While bank profits might suffer, small businesses would be much better served… and after all, isn’t that the mission of the SBA – doing what’s right for small businesses?!?

Chris

From: Anonymous
Sent: Monday, March 03, 2008 2:11 PM
Subject: Making 504 the exclusive option for real estate financing

Dear Staff of MCC:

Your CEO’s claim that 504 should be the exclusive option for real estate financing is absurd. What is worse is his desperate attempts to portray 7a lenders as profit-driven opportunists who will purposely offer disadvantageous products to their clients. At the end of the day, the satisfaction and sense of achievements you get as a lender, from helping small business owners obtain the financing they deserve, is same whether you are a 7a lender or a 504 lender. So, I take it very offensive when Mr. Hurn tries to undermine the good intention of my colleagues, to help small businesses obtain financing they deserve. In order to sustain 7a lending operation or a 504 lending operation, lenders and CDCs alike, have to have profitable operations, and yes, profits are important. However, if helping small business owners is what drives you and makes you want to excel in what you do, we 7a lenders share that also.

7a and 504 have co-existed and complemented each other for decades. 7a is as efficient, if not more, in creating jobs and boosting small business economy. Both programs have their superior traits over each other, so lenders and small business owners can choose which program best fits their financing needs, just like they have been doing for the past 50 years. You often hear the phrase “Choice is good”. In this case, it is no different. What Mr. Hurn is trying to do is to limit these choices available to America’s small business owners. I do not see how that can help America’s small businesses or its economy.

Mr. Hurn also says that two programs are competing with each other. Although I see it more as “complementing” each other, I have to wonder what is so wrong with lenders competing for a chance of helping small businesses. The winner is clearly the small business owners themselves since they will get more attention and better service. Isn’t that what SBA wants? After knocking 7a lenders out of real estate financing industry, what comes next for Mr. Hurn? Disqualifying all other CDCs?

Lastly, I need to clarify one thing for the record, and it is that there are as much profits, if not more, in the 504 program as in the 7a program, when you consider all the premiums you can make from selling the senior T/D loans in the secondary market. Would the real motive behind Mr. Hurn’s attempts to demoralize 7a program be that it will help him expand his market share and increase his production, for his self-fulfilling profits? It sure makes me wonder.

Sincerely,

Your devoted SBA lending partner

From: Chris Hurn
Sent: Tuesday, March 04, 2008 2:22 PM
To: Anonymous
Subject: FW: Making 504 the exclusive option for real estate financing

Anonymous, or should I call you my “devoted SBA lending partner”? –

Thanks for your email. Glad I’ve stirred up the pot on an issue that has seemed so taboo for so long. I only hope the folks at the SBA and the politicians are watching. Incidentally, [the previous stats quo defender] and I have made nice and agreed to disagree. I have to say, your venomous comments and that of others on this topic seems to support my contentions – that taking real estate deals away from 7 (a) lenders really yanks your bread and butter deals away — hence, your strong reaction to this suggestion and the attempt to emotionally defend your current position. I’m not sure why you addressed my Staff (you’ve just proven what I’ve been telling them for years), but your claims should not go un-countered by us, so here goes:

The level of your rhetoric seems a bit much. “Absurd” claims, “desperate attempts to portray,” “profit-driven opportunists,” “purposely offer[ing] disadvantageous products” – WOW! So much for me just trying to point out a practical solution that would enable more SBA 7(a) funds be available for start-up businesses and other working capital needs (if enacted years ago, we’d probably never have had the appropriation issues of a few years ago).
I’ve never been accused of NOT supporting profits… I’m just on the side of small business profits, not necessarily bank profits. Sure, premiums have been cut, but over time 7(a)’s cost small businesses more in interest expense because of the variable nature of these loans and in loan fees as well. Additionally, as I pointed out in my response yesterday, requiring full-collateralization of 7(a) loans frequently means small businesses have to pledge additional collateral for their 7(a) loans they could otherwise use to pledge for more growth capital. I also take a more long-term view of bank profits, at least mine – meaning when we propose the best commercial loan product (a 504) for our owner-user customers, they often come back to us for additional projects in the future and also refer their friends and advisors to us. We aren’t in this game for a quick, short-term profit at the expense of a long-term relationship. Say what you will about yourself, but I wasn’t born yesterday… PLENTY of SBA loan officers promote 7(a)’s at the expense of 504’s for the quick buck. To think otherwise is completely delusional.
The SBA’s only established and official job creation and economic development loan program is the 504, not the 7(a). While both help with economic stimulation, the primary goal of the 504 is job creation.
Since you’re seemingly such an advocate for choice (as I am), let’s make a deal that for every commercial real estate loan you come across (not just for the ones above the $2MM cap), you offer a 7(a) option AND a 504 option. Then, we’ll see what “choice” the borrowers make. The problem with this “deal” for you is that you’re probably paid LESS on 504’s than on 7(a)’s as are virtually ALL bankers (80% LTV conventional, 90% LTV 7(a) or 50% 1st mortgage/Trust Deed 504 – you do the math). So, what I’m essentially asking you to do here is go against human nature: offer a loan product that pays you less and adds an extra layer of complexity (not necessarily a brake on our deals, but for many bankers, dealing with the CDC community causes added issues). Put that way, it shouldn’t exactly be surprising that 504’s are still in the shadows of 7(a)’s and that virtually EVERY SBA loan officer will ALWAYS lead with a 7(a) over a 504. That’s the natural way things happen when left to their own devices. As I mentioned yesterday, with this being the situation in every SBA loan scenario involving real estate that happens to be under $2MM in total project size, “choice” as you call it, doesn’t occur – the loan officer won’t give the borrower a choice. Therefore, the only way to do right by small business owners (and taxpayers who have less of a loan guarantee with 504’s) is mandate that bankers go against their basic human nature in these circumstances. SO… do we have a deal??? Or can you admit that human nature ALWAYS takes precedence over “good intentions?” As one of good friends, who happens to run one of largest CDCs in the county, emailed me yesterday, “How about we add a simple one-page affidavit to the closing package that the borrower signs indicating that on his commercial property transaction under $2MM, his banker offered him a choice of SBA loan programs?” Seems like THAT might be a great fix.
When I stated that the two loan programs compete with each other, I have merely stated that there is overlap of the programs that is rarely ever discussed. I am an advocate of abolishing the overlap. The overlap occurs on commercial real estate only projects under the $2MM cap. Like someone in a twelve-step program, the very first step is to admit there’s a problem. I’ve put myself out there admitting as much, while most bankers just hope no one like me ever brings it up. Small businesses “win” when given ALL choices, not just the one that makes the banker more money. And since you’re making up things about my intentions here, just for the record: there is no bigger defender of 504’s and the CDC community than me. To suggest I’d like to see the “disqualification of CDCs” is reckless and completely wrong. As proof of this, I’d turn your attention to our 2006 NADCO award as “Banker of the Year,” my on-going CDC coaching program, and my forthcoming book about this very subject – probably won’t be a book greeted warmly by the 7(a) community.
As for your last point about profits, perhaps you need some remedial math help. Since when does a 50% 504 first mortgage pay more in premium than a similarly structured 90% LTV 7(a)? I think you’re reaching here, but why should I expect otherwise. The truth hurts sometimes. The banks selling into the 7(a) secondary market enjoyed rather healthy premiums for some time and are having a hard time adjusting to change now. I’ll restate my earlier comment: any owner-occupying small business owner who plans to be in his commercial property more than five years and who knowingly chooses a 7(a) loan over a 504, and accepts a floating interest rate tied to Prime with the additional pledge of collateral to secure his loan and additional loan fees (to mitigate his banker’s risk), deserves the inferior loan product he is clearly getting. When he doesn’t know he has another, better option, then I view that as a banker taking advantage of the situation. I have my own 504 loan and chose it over a 7(a), conventional financing or life insurance financing. Put yourself in your borrower’s shoes, as I have, and tell yourself the truth. You don’t have to posture for me or the SBA lending community. I KNOW the truth. I just want America’s business owners to get a glimpse of it. The rest will take care of itself.

Chris

On Tue, Mar 11, 2008 at 3:30 AM, Andy Kron wrote:
We should all applaud Chris Hurn, in his statement letting people know that that what is best for the banks is not always what is best for the Small Business owner.
Andy Kron
Across Nations CDC

Sent: Monday, March 10, 2008 8:15 PM
To: Andy Kron Cc: Chris Hurn
Subject: Re: 7a V 504

Andy,
:)
He really struck a nerve.

Bob Coleman

Sent: Tuesday, March 11, 2008 11:55 AM
To: ‘Bob Coleman’; Andy Kron
Subject: RE: 7a V 504

Bob and Andy –

Thanks for the kind words of encouragement – there haven’t been many lately from the SBA lending community. Interestingly enough, we were just sent an email last night from Community South Bank, a secondary market lender, that because of what they deem as my “disparaging comments about the 7(a) program,” they no longer want do business with us. Seems interesting that someone would make an emotional decision, rather than an economic one, in a potential business relationship – not sure if I’ll have to run my ads by them next or what their possible reaction will be to my forthcoming book about this very subject. I’ve suggested that this EVP go back and actually read or listen to what was said, rather than just presume it was all one-sided because his retail loan officers got upset with me speaking about their dirty little secret – in the podcast and in my written replies, I’ve very specifically stated that the 7(a) program has its place, is beneficial to the small business community, and would actually be enhanced with my suggested reforms. Well, it’s not like we regularly do business with CSB, but we do happen to have a deal in there at the moment, so… we’ll see how extreme they’re willing to be in this matter where people can clearly agree to disagree… or at least we can. I think their behavior speaks volumes, and I’ll be suggesting that the CDC community tread very carefully in ever dealing with CSB in the future.

Chris

—–Original Message—–
From: "Jessica Armstrong
Sent: 3/13/08 4:44 PM
Subject: 7a vs 504

Chris: I just now got around to reading your Press Release as published in the Coleman Report; including the Answer and Rebuttal. It was like reading a novel. I couldn’t put it down! THANK YOU! There are so few people in this industry who really understand both the upside and the downside of each program as it applies to both the borrower and the bank. And, very few folks understand or at least will not admit how much compensation the banks, BDO’s, referral sources etc. gain at the expense of the borrower. Your points were concise and direct and well presented. Geography and the price of real estate have an enormous impact on how and when the 504 program is used, not something anyone in California can grasp. In Texas, particularly the lenders are loath to suggest a 504 and it’s easy for a business owner to buy a building for under $2MM!

Well, I know you are busy so I will not continue to "preach to the choir".
Just wanted to say" Atta’ Boy", "Way to go", and "Congratulations".

Jessica Armstrong
Alliance Lending Corporation

Jessica,

Thanks for your kind words. I’m at the airport so don’t have much else to say, but yes, the 7(a) has it’s place and is a great program — just not for hard assets like commercial real estate; that’s best financed with a 504 — that’s what I chose myself for all the benefits we try to educate others on. Take care.

The shocking thing is that there’s a secondary market lender so bothered by the truths I dared to speak of, that he’s choosing to refuse doing business with us anymore. I’ve suggested that he actually READ what I’ve written or listen to my podcast rather than just take the word of one of his retail loan officers as gospel. We’ll see if he can be a professional or not. Don’t place/lay any odds!

Chris

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