Last years commercial mortgage slowdown was reflected in the statistics for the US Small Business Administration (SBA), which reported a year-over-year decline in approved loans of 29%. This surprisingly high reduction in loan volume was also noticeable in the 13% drop in the programs combined loan value. In the current economy, should you consider a SBA 7 (a) loan when financing the purchase of a property for business use?
Jeff Rauth, president of Commercial Financial Advisors Inc., cites the supply and demand issues that caused banks to reduce their SBA lending. These need to be understood as you evaluate SBA funding.
On the supply side, banks have liquidity issues that have resolved in their reducing their SBA 7 (a) loan volume. If a bank sells the guaranteed portion of a loan into the secondary market, it must only reflect the reminder in its reserves. However, the secondary market slowdown is partly due to the fact that many investors have funding sources joined to LIBOR (London Interbank Offered Rate). LIBOR has risen dramatically in comparison to the prime rate, which is the rate to which the majority of SBA 7 (a) loans are linked. This has made it disadvantageous for foreign investors to purchase commercial-mortgage backed securities tied to the prime rate, as well as creating a more difficult environment for banks offering SBA loans.
Fortunately, the SBA addressed this issue. In November, 2008, it changed the loans base rate calculation to eliminate the LIBOR / prime rate spread. Banks are now allowed to use the one-month LIBOR plus 3% (in addition to the prime) as a loans base rate. Banks are once again able to tap into the secondary market to sell the guaranteed portion of these loans, resulting in increased availability of SBA 7 (a) funds.
The demand for SBA loans is affected by three factors. The first is that SBA loans have higher associated fees than conventional loans, which can create a difficult sales situation for a commercial mortgage broker. In reality, given current conditions, this may be the sole option for your clients that require a high-leverage loan. The fees can be advanced by rolling them into the loan amount and recent proposed changes to the program have dramatically reduced fees on the SBA portion of the loan.
Interest rates are the second obstacle for the broker to overcome, since many borrowers are reluctant to accept the 7 (a) programs quarterly adjustable rate. They are concerned about having to refinance in the future, which can be a time-consuming and costly process. It is important for borrowers to realize that with the prime rate at a historic low, it will take a significant ongoing rise in interest rates over several years for the favorable SBA interest rate differential to be eliminated.
The SBAs recent standard operating procedure (SOP) created a third issue, since it had been resolved in a decline in the loan to value ratio. This meant that borrowers had to come up with additional cash. However, an SBA loan is often the sole alternative to the double-digit interest rates and lower loan to value financing available elsewhere. Recent proposed changes have brought the maximum combined loan to value back up to 90% on both the 7 (a) and 540 programs, which may mitigate this issue.
Banks are still providing SBA loans to small business owners. It is important to consider this option, given the prospect that the secondary market is not likely to rebound soon. The limited choices currently available make it important to look beyond conventional funding for your business expansion needs.