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SBA Loan Programs Keep Getting Better

On September 27th, 2010, President Obama signed into law the Small Business Jobs and Credit Act, also known as HR 5297. There is still a bit of ambiguity about the particulars of this legislation. I’ve read the text of the legislation, and it’s hard to say exactly how the technicalities in this law will be applied.

Unfortunately, that’s often how legislation works: Congress determines WHAT the law will accomplish, and another government agency (the SBA in this case) gets to determine HOW it will be executed. That said, it seems SBA Administrator Karen Mills still has some details to work out before we can know fully how America’s small businesses will be helped with this new law.

However, this much I do know: there are seven things that will have an immediate impact on our commercial mortgage industry. Here’s a run-down:

1. The bill allows refinancing of commercial mortgage debt with SBA 504 loans, which business owners can use to tap the embedded equity in their commercial properties.

1. SBA 504 and 7(a) loan eligible dollars are permanently increased to $5 million ($5.5 million for manufacturers and “green” projects).

1. SBA 504 loan and 7(a) loan size standards are permanently increased (tangible business net worth to qualify was increased to $15 million and the two-year average net income eligibility threshold was increased to $5 million).

1. SBA loan fee abatements were appropriated ($505 million or until the end of this calendar year).

1. The SBA 504 secondary market program for first mortgage guarantees was extended for two years from the date of the first sale, which happened in late September.

1. 7(a) loan program guarantees were temporarily increased to 90% (until January 1, 2011).

1. A $30 billion fund was established for direct money to participating community banks on the condition they lend it out to small businesses.

Again, there are some things the SBA needs to hash out before we’ll see just how all this is put into action. By the time you’re reading this, further details from Washington may have already arrived. In the meantime, I’d like to elaborate on the importance of one of the provisions I believe will be extremely significant to a large portion of commercial mortgage professionals.

SBA 504 Refinancing

One of the most important things you should know about the Small Business Jobs and Credit Act is that the SBA has made it possible to refinance existing commercial mortgage debt with SBA 504 loans (a provision I’ve championed since 2004). This is big news first and foremost, because it will finally give owners of small and mid-sized businesses the ability to efficiently tap the embedded equity in their commercial real estate. This access to capital will help stimulate these businesses (the backbone of our economy), and the larger economy will follow suit. I often refer to the SBA 504 loan program as “the best-kept secret in commercial property financing” because it offers the highest cash-on-cash return financing available, along with long-term fixed interest rates and longer amortizations. The opportunity to use these loans for refinancing is a great one for business owners as well as commercial mortgage professionals.

A Second Chance for Some

I’d like to tell you a story about a business owner named Fred. A couple years back, Fred decided that it’d be a good idea to own the commercial property his business occupies. By doing so, he would turn his monthly lease payments into mortgage payments that would build equity.

He would start creating wealth for himself instead of making his landlord rich. It was a decision that made great business sense, so he went ahead with it. Fred got a loan from his commercial bank, and purchased the property.

Fast-forward to the present. Fred’s facing a ballooning note payment, but if he could only refinance and take advantage of today’s historically low interest rates, he might be able to cut his expenses enough to stay afloat or pull some cash out of the equity he has built-up in the property. The only problem is he can’t find any bank that will do it conventionally. Today’s tighter underwriting standards have made it increasingly difficult for Fred to qualify with most banks.

Now, this story is fictional, but there are many real business owners today who are facing the same situation as Fred. To make matters worse, their initial down payments on their conventional loans were two to three times what they would have been if they’d used a 504 loan the first time around. The SBA is giving these business owners the chance to get some of their capital back by refinancing up to 90% loan-to-value, and up to 125% with additional collateral pledged. This is a major benefit for some of the “challenged” owners of small and mid-sized businesses.

Larger Implications

Now, I’ve mostly focused here on how this provision helps business owners, but I’m sure you can easily see how it translates into opportunities for us in the commercial mortgage industry. If someone (one of your Clients or simply someone you know of) has purchased commercial property in the past few years, he or she probably did so because it made good business sense. That person will likely see the benefits of refinancing now with an SBA 504 loan because they’ll lock-in today’s low interest rates (meaning less interest expenses); their monthly mortgage payments will stay low (meaning increased cash flow); and they’ll get back some of the extra cash they put into their project initially. It’s a no-brainer for some people you know (and I’ve pretty much spelled out your sales pitch here, too).

There’s one other thing you should know: this refinance provision also helps banks. It’s no secret that banks are being forced by regulators to increase their capital, lower their risks, and generally strengthen their balance sheets. In many cases, that means reducing their exposure to commercial real estate. A business owner who approaches their bank to refinance their commercial mortgage into a 504 loan with you or another lender might just be doing that banker a huge favor. And working with a lender who specializes in 504 lending but doesn’t require any change in banking relationships will lessen any perceived “threat” in such a situation.

Preliminary Guidelines

Here are some preliminary guidelines to note when using an SBA 504 loan for refinancing (some of these are basic SBA 504 requirements):

• The borrower must occupy at least 51 percent of the property.
• The existing loan must be at least two years old.
• The borrower must be current during the previous 12 months.

• Proceeds from the new SBA 504 loan must used for eligible fixed assets (real estate, equipment, FF&E) and for other “business expenses.”
• It will not be possible to refinance existing loans made possible by an SBA guarantee [so no refinancing of existing 504 or 7(a) loans].
• The borrower’s tangible net worth must not exceed $15 million, and their two-year average net income must not exceed $5 million (these limits are increased, as noted above).
• It is estimated that the maximum refinance amount will be $12 million (higher for manufacturers and “green” projects).

It’s clear to me that SBA 504 refinancing will be a boon for the commercial mortgage industry and will likely help our economy make great strides toward a full economic recovery.

Why the 504 is the Right Tool for This Job

The beauty of the 504 program, other than its beneficial terms for small business borrowers, is that it is a zero-subsidy program. In other words, it costs the taxpayers nothing. The program fees have carried the program for years without any federal subsidy, and the program has run such a surplus at times that the government redirected some of it for entitlement spending just a few years ago. In addition, the loan loss rate is historically about a third of that of the 7(a) program — the SBA’s other flagship loan program, which has allowed refinancing for quite some time.

From the taxpayer’s perspective, 504 refinancing is a better deal, and the borrowers benefit as well. The 7(a) is mostly a floating-rate loan program, which isn’t the best option for long-term, hard assets like commercial property, and often requires additional collateral from borrowers (oftentimes, this takes the form of a second lien on their home, or liens against inventory and receivables). This ties up those assets and can ultimately be problematic for borrowers down the road, when they need a line of credit or other short-term financing. By making 504 refinancing possible, the Small Business Jobs and Credit Act is doing a world of good for small businesses.

Some critics will argue that this provision will only cause business owners to use their commercial real estate like an ATM, much like homeowners did during the credit boom. But that analogy doesn’t really apply here. Many small business owners have cut expenses and have leveraged-up so they can simply stay in business during this economic crisis. Plus, entrepreneurial business owners make decisions in order to maximize profits and grow the business. I, for one, trust these businesspeople to make the right decisions with these new opportunities for credit and capital. Small businesses historically create the lions’ share of jobs in America, and I don’t see that changing any time soon as long as the government continues to remove obstacles that impede them.