SBA 504 Loans can help mitigate risk and support overall risk management practices while simultaneously providing a great opportunity for banks to expand their service to small business customers.
Let’s face it, banks are handling a heavy load of problems and are more selective about extending credit. In fact, many banks are walking away from possible loan projects and reducing their exposure in an attempt to mitigate risk. With the credit crunch many banks are facing, it can be nearly impossible for small business owners to get a conventional loan due to more stringent loan terms and higher credit standards. However, since small businesses are what drive our local economies, it’s counterproductive to trim down this vital aspect of the banking industry.
Wouldn’t it be nice if you could utilize a program that would provide security against loss with a loan-to-cost basis of 50 percent and a willing second position security interest? How? By utilizing a program established over 30 years ago by the U.S. Small Business Administration (SBA).
An Overview of the SBA 504 Loan Program
The SBA 504 Loan Program is an economic development tool that provides small businesses with long-term, fixed rate loans to help them acquire major fixed assets for expansion or modernization of their businesses. These loans are most frequently used to acquire land and/or buildings, machinery/equipment,or to refinance commercial mortgages.
The SBA 504 Loan Program can be the ideal solution to meet the financing needs of your borrower, while still delivering significant benefits to you as their lender. These loans essentially consist of three key elements:
- 50% of the project’s total cost is provided by a lending institution, usually a bank;
- 40% is provided through the SBA’s 504 Loan Program; and
- 10% equity is provided by the borrower. (Start-up businesses and single-purpose facilities require a slightly higher equity contribution.)
A 504 loan can be a 10-, 20- or 25-year term, which is beneficial for small business owners. Pairing the fixed rate aspect with these term lengths gives small business owners stability, allowing them to budget and manage cash flow without concerns about rising rates or balloon payments.
Most types of businesses are eligible to receive 504 financing. Businesses with a successful track record and growth potential can generally qualify for the 504 Loan Program if they are for-profit and average less than $5 million in annual after-tax profits and $15 million in net worth. Projects that qualify must, according to SBA guidelines, promote economic development, which generally means the creation or retention of jobs. There is no limit on the size of the deal, but the SBA participation is limited to $5 million.
Essentially, the 504 Loan Program is a smart way to differentiate your bank. Not only will you be helping local small businesses achieve their goals and fulfill their dreams, you’ll help your bank power ahead as well. Here’s why…
Six Ways Banks Can Mitigate Risk and Expand Service
Overall, 504 loans benefit banks by helping to mitigate risk, manage liquidy, generate fee and interest income, and improve customer retention. With the current economic conditions, the 504 is a great counter to increased margin spreads on conventional loans. In addition, the 504 Loan Program provides risk management advantages by limiting your credit exposure to a single customer and providing good collateral coverage for your retained portion of the loan. The 504 Loan Program promotes economic development while simultaneously providing numerous benefits to banks and business owners — a program perfectly designed to fuel the small business lending market. Let’s dig in…
1 – SBA 504 Loans Help Minimize Collateral Risk
- Lenders typically have a 50% loan-to-value ratio, which helps to mitigate risk
- Lenders get first lien on the assets financed
- The lender sets the interest rate for their portion of the loan
- By participating with the SBA, the bank also meets economic development and community reinvestment goals
2 – SBA 504 Loans Help Manage Concentration Issues
- The structure of the 504 reduces lenders’ exposure, thereby managing commercial real estate concentration issues and opening up lending availability.
- Lower exposure means you can reach out to new borrowers or better serve existing clients.
3- SBA 504 Loans Help Maximize Middle Market Lending
Middle market lending is becoming the bread and butter for many banks. Therefore, let’s dispel the rumor that the 504 is just for small businesses. With high size limits and high caps for 504 loans, the middle market segment is a perfect match for the 504.
- High Lending Limits: The 504 portion cannot exceed $5 million or $5.5 million, depending on whether your business meets an approved public policy goal or is classified as a small manufacturer (NAICS codes beginning with 31, 32 or 33). Remember, this limit is for the SBA portion only. There is no overall maximum project size.
- High Business Size Limits: to be eligible, businesses must have a tangible net worth of less than $15 million and profit after taxes of less than $5 million (including affiliates)
4 – SBA 504 Loans Help Attract and Retain Customers
Because 504 Loans are designed to finance growing companies, they can be the basis of a long banking relationship when that entrepreneur places their deposits in your bank and returns for additional business financing as the company grows.
Many banks attract new customers with SBA 504 Loans. They provide the ability to offer an attractive financing package with up to 90% long-term, fixed-rate financing. In addition, the 504 can help close tougher deals like special-use properties and/or those in need of credit enhancement.
Meeting with your existing clients regularly and knowing their goals, roadblocks and challenges can also allow you to proactively retain customers…
- Are your clients looking to grow and when?
- What types of loans do they currently have and when do they mature?
- Do they rent their business property? Have they been facing skyrocketing rent increases? If so, can you help them invest in their own facility?
- Will they soon be forced to comply with costly renovations set forth by a franchise agreement?
- Do they need to replace a piece of equipment?
- Is a future road construction project going to hinder the ingress/egress of their business?
- Do they have a balloon payment coming due?
- Is there a pending partner buyout involving commercial real estate?
These are just a few of the obstacles new and existing clients may be facing. Do they have them on their radar? Or is this an opportunity for you to be the change agent and turn commercial lending on its head?
5 – SBA 504 Helps Your Bank Earn CRA Credits
- Banks that participate in the SBA 504 Loan Program are eligible for Community Reinvestment Act (CRA) credit on certain projects
6 – SBA 504 Is In Partnership with a Local Certified Development Company
- Certified Development Companies, such as Growth Corp, work in conjunction (not in competition) with local banks to offer financing through the SBA 504 Loan Program.
- CDCs save you valuable time because they package and process loan applications through the SBA, and then close and service those loans once they’ve been approved.
- Growth Corp has been focused on SBA 504 Loans for 30 years. We’ve proudly helped thousands of businesses facilitate expansion. In fact, our existing portfolio is over $830 million…particularly impressive considering every dollar is tied to a small business in the Midwest.
- As the largest 504 Lender in Illinois, we have dedicated ourselves to making the 504 Loan Program as efficient and seamless as possible. In fact, Growth Corp has long held Accredited Lender status with SBA. This means, after a thorough review of our policies, procedures, and prior performance, SBA granted us increased authority to process and close 504 loans, which results in an expedited process for both our borrowers and our lending partners.
Whether this is your first experience with the SBA 504 or it’s been awhile since you’ve been through the process, we’re here to help. We’ve put together a Lenders Guide that will help guide you through the SBA 504 process. And remember, any time you have questions, our Lending Team is ready to assist.
About Growth Corp
Small Business Growth Corporation (Growth Corp) is a nonprofit, mission-based lender dedicated exclusively to connecting small businesses with quality expansion capital through administration of the SBA 504 Loan Program. With a commitment to economic development, job creation and the small business sector, Growth Corp is ranked a Top 10 National CDC for SBA 504 loan volume and is Illinois’ largest 504 loan provider. In fact, Growth Corp’s substantial portfolio ($830+ million) is particularly impressive because every dollar was utilized by Midwest entrepreneurs to open and expand their small businesses.