Graduate School of Colorado SBA lending Presentation

Graduate School
of Colorado SBA
lending
Presentation
SBA lending course
summary •  The course will provide an overview and comparison of SBA 7a,
SBA 504 and USDA Business & Industry (B&I) loan programs. •  SBA loan guaranty sales and yield. •  How SBA lending can improve a bank, from a CAMELS
perspective.
•  What is required to have a successful SBA lending operation,
including the SBA loan process and cost structure. SBA 7a Lending
SBA 7(a) Guaranty
Loan Program
•  Total guaranteed amounts may not exceed $3,750,000
Included outstanding SBA loans to borrower and its affiliated
businesses
•  Total loan amount may not exceed $5,000,000
•  Rates – typically up to WSJ Prime + 2.75%, Fixed and variable
rates allowed.
$150,000 or less Over $150,000 =
=
85%
75%
SBA Express
=
50%
•  SBA Express loan amount may not exceed $350,000
SBA 7a Maximum
Loan Terms
The loan term is based on the type of asset being financed. So the
term of the loan is driven by “use of proceeds” and not by collateral Based on Asset Type
•  Real Estate
25 years
•  Equipment
10 years
•  Working Capital Mixed loan use
•  Blended term
Or
•  Largest asset
7-10 years
SBA 7a Charging of
Fees
Prohibited Fees (may not to be charged to borrower)
•  Commitment, broker, referral fees
•  Contingency fees (fees paid only if loan is approved
•  Application fee
•  Points and add-on interest
•  Sharing of secondary market premiums
Allowable Fees (may be charged to the borrower)
Packaging fees (to prepare the loan application)
•  Extraordinary servicing fees
•  Direct expenses, such as legal fees
•  Late payment fee (part of Note language)
SBA 7a Eligibility
The SBA guaranty MUST be necessary
•  Credit elsewhere rule
The principals must not have excess liquid assets
•  Personal resources rule
The business must meet the SBA’s size standards and
type of business restrictions.
SBA 7a Size
Standards
Two approaches to determining size standard eligibility
SBA 7(a) – NAICS code driven
•  Retail: typically may not exceed $7 million in gross sales over last 3 years
•  Wholesale: typically may not have more than 100 employees
•  Manufacturing: typically may not have more than 500 employees
Alternative Size Standard
•  Tangible N/W may not exceed $15 million
•  Average net income not to exceed $5 million
Must include financial information for both business applicant AND its
affiliate businesses
SBA 7a, ineligible
Business Types
Ineligible businesses:
•  Non-profits
•  Financial businesses
•  Passive businesses
•  Life insurance companies
•  Pyramid sales distribution plans
•  Legal gambling businesses (more than 1/3 of annual revenue)
•  Business limiting access (private clubs)
•  Government owned businesses
•  Businesses engaged in teaching religious beliefs
•  Sexual oriented businesses
•  Businesses engaged in political or lobbying activities
•  Speculative businesses
SBA 7a Eligible
Business Types
Some ELIGIBILE Business Types:
Franchises
•  As long as the franchisor does not have power of control over the franchisee (your
borrower)
Businesses owned by non-U.S. citizens
•  Certain documentation required
•  Primary owner must be a “legal permanent resident” or US citizen
Eligible Passive Company (EPC)
•  All parties must be financially obligated
•  Operating company (OC) and 20% or more owners of OC and EPC
•  No return on investment (lease payment = loan payment)
SBA 7a Eligible Use
of loan Proceeds
•  Purchase real estate and improvements
•  Acquire equipment and fixtures
•  Purchase inventory
•  Acquire existing business
•  Provide working capital
•  Refinance existing debt
SBA 7a Restricted
Loan Proceeds
Refinancing:
•  The lender can refinance loans on its books and convert them to SBA loans
•  Long term debt – existing payment must be decreased by at least 10%
•  The loan being refinanced must be on unreasonable terms
•  Short term debt considered unreasonable (credit cards, LOCs, demand
notes, balloon notes)
Business Acquisitions:
•  Entire business vs. Entire interest
•  The seller may not remain involved in the business after loan funding
•  A business valuation is required, If intangible assets exceed $250,000 or the
transaction is between close family members, the valuation must be
performed by a third party
SBA 7a Restricted
Loan Proceeds
(cont.)
Purchase of Real Estate:
•  Space occupancy restriction
•  Existing building: business applicant must occupy at least 51%
•  New construction: business applicant must occupy 80%, eventually and
60% immediately
The Associate Rule:
•  Loans proceeds may never be funded to an associate of the business
•  Associate = officer, director, stockholder, key employee
SBA 7a Credit
Issues
Guarantors:
•  20% or more owners must provide full unlimited personal guaranty
•  Other owners of less than 20% may provide a full or limited personal guaranty
Collateral:
•  SBA requires the 7(a) loan be “fully secured” with all available assets
•  Fully secured means that the liquidation value must equal or exceed loan amount
Equity:
•  Cash, Debt, Assets, Standby Debt
Character of Principals:
•  Form 912 required for 20% or more owners and key people
•  The 912 is effectively a criminal background check
SBA 504
Lending 504 Loan Structure
•  Borrower 10%
•  SBA 40% (junior lien position on fixed assets)
•  Participating lender 50% (senior lien position on fixed assets)
•  Borrower may be required to provide up to 20%
•  Start up business
•  Single purpose real estate collateral
•  Generally the project assets being financed are used as collateral
SBA 504 Certified
Development
Companies - CDCs
•  CDC is a nonprofit corporation that promotes economic development
within its community through 504 loans
•  CDCs are regulated by the SBA
•  CDCs work with the SBA and participating lenders to provide financing
to small businesses
•  Over 260 CDCs nationwide
•  Serve specific geographic areas, typically the state where the CDC is
located
504 Loan Funds
May be Used
•  Purchase existing buildings
•  Purchase of land and land improvements, including grading, street improvements,
utilities, parking lots and landscaping
•  Construction of new facilities or modernizing, renovating or converting existing
facilities
•  Purchase of long-term machinery
•  Refinancing of debt in connection with an expansion of the business through new
or renovated facilities or equipment
•  Can not be used for working capital or inventory
504 Loan Eligibility
•  Business must be operated for profit
•  Business must not have tangible net worth of more than $15 million
•  Business must have average net income for the preceding two years of
less than $5 million
•  Business engaged in nonprofit, passive or speculative activities do not
qualify
Other 504 Specifics
•  Maximum SBA debenture is $5 million
•  Job creation of 1 job per every $65,000 guaranteed by SBA
•  Small manufacturers – 1 job per every $100,000 guaranteed by SBA
•  As an alternative to job creation or retention business may qualify if it meets a
community development or public policy goal
504 Secondary
Market
•  Zions First National Bank started purchasing the 504 loans made by
participating lenders in the early 1990s. They were soon followed by
Bank of the West, Lehman Brothers, GE Capital, and others
•  The great recession eliminated all of the secondary market buyers
except for Zions
•  In 2010, Morgan Stanley began purchasing the 504 first lien loans and
One West Bank has started purchasing 504 loans in California
USDA Business
& Industry (B&I)
Lending
USDA B&I Loan
Limits & Locations
•  USDA B&I loans have no minimum loan amount
•  $10 Million maximum without Administrator exception
•  Up to $25 Million to any one borrower
•  Up to $40 Million for rural cooperative organizations
•  Rural Area – Anywhere except within the boundaries of a city or town
with more than 50,000 inhabitants or the urbanized area of that city or
town. USDA B&I Typical
Loan Purposes
•  Real estate purchase and improvements
•  Machinery and equipment purchase
•  Working capital
•  Debt refinancing and business acquisitions under certain conditions
Fees and
Percentage of
Guarantee
•  Fees
•  Initial Guarantee Fee – 2% in most cases
•  Annual Renewal Fee – 0.25% subject to change
•  Percent of Guarantee Maximums
•  Greater than $10 MM – 60%
•  $5MM - $10MM – 70%
•  ≤$5MM – 80%
•  Under special circumstances, a higher guarantee percentage is awarded on
larger loans (i.e.: $10MM loan with 90% guarantee)
USDA B&I Loan
Structure
•  Negotiated by the lender and borrower
•  Rates can be Fixed/Variable/Combination, but cannot adjust more
often than quarterly
•  Origination fees and prepayment penalties are permitted
•  No balloon payments
USDA B&I Maximum
Loan Terms
•  Real estate – 30 years
•  Machinery and equipment – the lesser of 15 years or useful life
•  Working capital – 7 years
USDA B&I Collateral
Requirements
•  Must be sound and sufficient to protect interests of the lender and
Agency (normally discounted value will be at least equal to the loan
amount)
•  Must be appropriately discounted
•  Cannot secure unguaranteed portion with additional collateral
USDA B&I
Conditional
Commitment
•  Establishes Agency loan requirements and conditions
•  All conditions must be met before the Loan Note Guarantee is issued
USDA B&I
Secondary Market
•  There is a very active secondary market for the purchase of USDA B&I
Guaranteed loans, however, the loans are not pooled
•  Premiums are fairly consistent with those paid on SBA 7a guarantees
•  Lender can set and receive the prepayment penalty on an B&I loans •  Lender can set the level of servicing income on a B&I loan to be less
then 1.0%.
SBA 7a Guaranty
Loan Sales
SBA 7a Loan
guaranty sale
•  One of the most interesting aspects of SBA lending is that the guaranty on
the loan can be sold in an active secondary market and earn a premium
•  Currently, if a bank makes a $1,000,000 SBA loan at Prime + 2.75% for 25
years, they can sell the 75% guaranteed portion of that loan and generate a
premium of approximately 19.0%. However, the SBA requires the bank to
split any portion of the premium over 10.0% with the SBA. So the net
premium in this example would be 14.5
•  In addition, when the investor buys the guaranty, they don’t get the 6.0% note
rate, they actually get a 5.0% rate, and the 1.0% difference is allocated to the
bank to cover the cost of servicing.
Sample bid matrix
Fixed @ par
Variable @ Par (All Variable Rate premium quotes are based on 1.00 servicing)
How can SBA 7a
lending positively
impact a bank’s
CAMELS rating
CAMELS Earnings
Because the SBA guarantees 75% to 85% of each loan, lending institutions can use this
program as a tool to mitigate risk in their loan portfolio. The guaranteed portion of each loan
can be immediately sold on the secondary market. Let’s look at the math in this sample loan:
Loan Amount
$1,000,000
Guaranteed Portion $ 750,000
Net gain on sale of the guaranteed portion
$ 108,750 (14.5% premium)
The bank retained portion
$ 250,000 (60% ongoing interest income)
This is an example of a 25-year commercial real estate loan priced at Prime + 2.75%, or
6.0%.
Capital
SBA loans are always accretive to capital if the guarantees are
sold, which in turn will improve the bank’s Risk-Based and
Leverage capital ratios. If a bank’s growth is limited due to capital constraints, SBA lending
is a potential solution because it enables the bank to continue
lending and generating profits. This is especially beneficial when
you use an SBA loans to refinance existing conventional loans.
SBA loans are
always accretive to
capital.
A key advantage to making SBA loans is that if the guaranty is sold, the loans increase capital instead of
depleting capital. Here’s an example of how a conventional loan compares to an SBA loan:
Conventional loan
Loan Amount
$1,000,000
Risk Based Capital Required $100,000
SBA loan
Loan Amount
$1,000,000
Guaranteed Portion $750,000 (Net Gain on sale of guaranty $108,750)
Unguaranteed portion
$250,000
Risk Based Capital Required $25,000 (Lender increases its capital by $83,750)
SBA loan Example
Assume that ABC Bank has a Machine Shop commercial loan customer
that has a real estate loans and an equipment loan with the following
original terms:
1.  Commercial real estate loan was for $1,200,000 @ 6.0% interest with
5 year call and 25 year amortization, current payment is $7,732.
2.  Equipment loan was for $600,000 at 6.0% for 5 years, current
payment is $11,600. The combined payment is $19,332.
3.  Commercial R/E appraised for $2,000,000.
4.  Equipment appraised for $500,000.
SBA loan Example
The borrower is requesting a $100,000 working capital loan to help with
their cash needs, but the bank cannot provide the loan on a conventional
basis, because the business’s cash flow doesn’t support it. 2010 2011 2012
Revenues $2,000,000 $1,800,000 $2,200,000
Cash Flow $250,000
$200,000
$260,000
Current DSC
1.08:1
0.86:1
1.12:1
SBA loan Example
So the bank opts to restructure the borrowers debt and provide the
working capital with and SBA loans, as follows:
Refinance the Commercial Real Estate loan $1,000,000
Refinancing the Equipment loan
$ 500,000
Provide working capital $ 100,000
Total Request
$1,600,000
New SBA loan of $1,600,000 for 25 years at 6.0%, with a payment of
$10,309.
SBA loan Example
2010 Revenues $2,000,000 $1,800,000 $2,200,000
Cash Flow $250,000
$200,000
$260,000
Current DSC
1.08:1
0.86:1
1.12:1
2.02:1
1.62:1
2.10:1
DSC with SBA loan
2011 2012
SBA loan Example
Benefits to the bank:
1.  Improves asset quality, on a credit that might be considered Special Mention, to
a pass credit by significantly improving the borrowers cash flow. 2.  The bank’s asset quality is improved, since their exposure is reduced from
$1,500,000 to $400,000 ($1.6M X 25%).
3.  The bank’s capital position is improved, since the Loan Loss Provision is
reduced from $30,000 (2.0% X $1.5M) to $8,000 (2.0% X $400,000).
4.  If the bank sells the guaranteed portion of the loan, earnings are enhanced since
they will make a $174,000 premium ($1,200,000 X 14.5%) on the sale.
5.  The Bank’s Capital is improved, since the Risk Based Capital requirement for the
original $1,500,000 in loans would have been 10% or $150k and the new loan of
$400,000 has a capital requirement of $40k, a $110k savings.
6.  The total capital improvement from the SBA refinance would be $22K savings to
the ALLL, $174k gain on sale and a $110k savings of capital. The total capital
improvement will be $306k.
Servicing Income
When the guaranteed portion of an SBA loan is sold, the investor buys
the guaranty at a rate that is 1.0% less than the note rate. For example if you have a $1,000,000 SBA loan at an interest rate of
6.0% and the bank sells the $750,000 guaranteed piece, they would sell
it at a yield to the investor of 5.0%. This means that the bank will earn 6.0% on the $250,000 portion that
they retained and 1.0% on the $750,000 or $7,500 per year, not
accounting for amortization of the loan. If you compare that $7,500 per
year in servicing income to the $250,000 that the bank retains on its
books, you can see that it represents an additional 3.0% yield on the
retained portion. That 3.0% of servicing, plus the note rate of 6.0%,
shows that the bank’s gross yield on the retained portion of the loan is
now 9.0%.
Liquidity
Regulators recognize the strong secondary market for SBA
guarantees and will allow them to be counted as part of your
bank’s liquidity structure. This high-yielding substitute for other
securities can also be sold when extraordinary expenses occur.
Yield & Liquidity
Benefits
Yield and Liquidity benefits when an SBA loan is held. The following shows a
bank’s net yield after all costs have been considered.
Loan Amount
$1,000,000
Interest Rate
6.0%
SBA/Colson fee 0.4125 (0.55% of the guaranteed portion)
Loan acquisition costs 0.333 (2.0% amortized over 6 years)
Underwriting & processing costs
0.333 (2.0% amortized over 6 years)
Servicing costs
Net yield to the bank
0.50 (Estimated annual cost)
4.4215
Yield & Liquidity
Benefits (cont.)
The regulators consider SBA guarantees to be treasury equivalents and
recognize them as a component of a banks liquidity. Most banks keep at
least 15% of their assets liquid and generally keep them in low yielding
but safe investments, such as fed funds. Lets assume that you have a $200 million asset size bank, that earns a
1.0% return on their assets, or $2.0 million per year. They have $30
million in liquidity, which at the current fed funds rate earns the bank
$75,000 per year. Now lets say that the bank generates $10.0 million in SBA guarantees
and retains them as a portion of their liquidity. Now they are earning $50k
on the $20.0 million in fed funds and $442,150 in net yield from the $10
million in SBA guarantees, for a total of $492,150 or $417,150 more than
what they were previously earning.
Assets
The SBA loan guarantee can be used to refinance existing
loans in your loan portfolio to mitigate risk or to help retain
clients who are close to the bank’s legal lending limits. Using SBA lending to refinance existing bank loans can be
helpful in reducing real estate concentrations, since
properties like hotels, mini storage facilities and care facilities
are included as investment properties by regulators. If a bank
has these types of properties on their books, they can often
refinance the loan and sell the guaranteed portion to reduce
a concentration and free up capital.
Assets (cont.) Using the SBA guaranty to make loans that fall into an investment property category
is a good way of managing portfolio concentration growth. Conventional loan portfolio Risk Based Capital Requirement
ALLL Provision
$1,000,000
$ 100,000 (10.0%)
$ 20,000 (Assumes a 2.0% ALLL)
Refinance existing loan to SBA
Guaranteed portion to be sold
Gain on sale of guarantee Reduction in ALLL on sold portion
Unguaranteed portion
Risk based capital requirement
Overall capital improvement
$1,000,000
$ 750,000 (RBC 0.0%)
$ 90,000 (at current 12.0% Premium)
$ 15,000 (Assuming 2.0% ALLL)
$ 250,000 (10.0% RBC)
$ 25,000
$ 180,000
The capital improvement of $180,000 comes from the $90,000 loan premium, the
$75,000 of capital relief from reducing the loan by $750,000, a $15,000 reduction
of the ALLL. Mitigating risks related
to SBA lending. •  Credit Risk – The financial institution determines whether it is comfortable
with the credit risk, verifies that the financing is eligible for SBA and
structures the loan per SBA guidelines.
•  Guarantee Risk – The best way to reduce this risk is to submit the loan to
SBA for their approval. Some lenders have Preferred Lending status, which
allows them to approve loans on their own – this increases the risk that SBA
could come back and deny the guaranty in the event of default.
•  Documentation Risk – According to SBA, documentation errors are one of
the top three reasons for guaranty denial. •  Servicing Risk – Every time someone touches an SBA file, they potentially
put the guarantee at risk. The bank must have experienced staff to properly
maintain the loan portfolio and enable the institution to stay in compliance. Case Study
Improvement to a bank’s capital structure by refinancing SBA loans
Assume that you have a $100 million asset size bank, with $7.0 million in
capital and a 7.0% leverage capital ratio.
The bank has $8,000,000 of commercial loans that they want to refinance
into SBA loans and then sell the guaranteed portions. Assume a guaranty
percentage of 75% and calculate as a pretax number. Existing ALLL against the portfolio is 2.0%
Assuming that the refinanced SBA loans are priced at P+2.25% and they
are all 10 year loans.
Case Study (cont.)
1.  What is the premium % yield on the sale of the loans?
2.  What is the dollar gain on the sale?
3.  What is the reduction in assets?
4.  What is the reduction in ALLL?
5.  What is the increase in capital?
6.  What is the new leverage ratio?
The SBA loan
process & cost
structure
Sourcing SBA Loans
•  Experienced SBA business development officers than can
generate $10 million or more in closed SBA loans, will generally
receive a salary of around $80k along with a commission plan
that will pay them another $70k if they reach their $10 million
target.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Sourcing SBA Loans
(cont.)
•  That salary and commission totals $150k, for $10 million on
production or 1.5%. Many banks will consider SBA loans
referred by a broker, which will add an additional 1.0% or more
to your loan sourcing cost structure.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Sourcing SBA Loan
(cont.)
•  Obviously, using your existing lending staff to generate SBA loans
seems to be a more cost effective approach, since you avoid the
additional salary and large commissions. However, if you chose this
route, you must make sure to provide training to your staff to aid
them in identifying SBA loan prospects.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Sourcing SBA Loans
(cont.)
•  With either structure, the bank must also make sure that your credit
department has defined what types of SBA loans that they will
consider. However, in order to justify hiring SBA underwriters and
processing personnel, you have to make sure that you generate
loans. In order to enhance your likelihood for success, you should
provide your commercial lenders with SBA training, loan
production goals and a commission plan, so they will be motivated
to source SBA loans.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Underwriting &
Processing •  It is absolutely critical to hire the very best people that you can find
to underwrite and process your SBA requests. In terms of
experience, you will want to find staff that has underwritten or
processed at least 50 loans in their career.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Underwriting &
Processing (cont.)
•  Requiring a higher level of experience means that you will likely
have to pay salaries on the higher side of the market to get this
caliber of SBA staff. The salary costs for a strong underwriter and
processor are likely to be $150k combined.
•  When you add in benefits, office space, equipment, software,
ongoing training, etc., your cost for this two person back shop will
be around $200k. If the department generates $10 million in
production, then your back shop cost is an acceptable 2.0%.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Servicing
•  Once the loan is closed, the bank will still need to treat their SBA
portfolio differently from a conventional commercial term loan. The
bank will have to make sure that their core system will
accommodate SBA loans and accrue interest correctly.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Servicing (cont.)
•  The bank will need to prepare a monthly 1502 report to SBA’s
Fiscal Transfer Agent, Colson and be able to deal with SBA’s
servicing requirements related to modifications or changes to the
loan.
•  It is critical that the bank have someone in there note department
or servicing area that has experience handling SBA loans.
Loan source
Eligibility,
Underwriting
& Structuring
Packaging &
Processing
SBA
Approval &
Closing
Loan Sales
Post sale
accounting &
reporting
Servicing
Profitability Model
•  Lets assume that you hire your underwriting and processing staff
and the lending staff brings in $10 million in SBA loans. If the
bank sells the 75% portion of the loans that is guaranteed, or
$7,500,000, it should earn at least a 12% premium in today’s
market, or $900,000.
Profitability Model
(cont.)
•  For simplicity sake, we will exclude interest & servicing income
from this analysis. If you can generate the $10 million with an
internal lending staff, the bank will only have the $200k processing
and underwriting expense and therefore generate $700k in profit. Profitability Model
(cont.)
•  If you add in the SBA BDO cost and assume that half of the loans
come from brokers, then you are looking at an additional $200k of
expense and a reduced profit of $500k, but the bank is much more
likely to hit the $10 million production target.