Commercial Loans and Fun Blog

The Latest Skinny on SBA Loans and SBA Lenders

A buddy of mine in the SBA loan business called me today, and we chatted about a number of very important changes to the SBA loan program. The Federal government is trying to get credit flowing again to the economy, so they have made SBA loans much more attractive.

First of all, until the end of the year or until money runs out, the SBA is now waiving its guarantee fees (points) on 7a loans and on the debenture portion (the second mortgage portion) of 504 loans. You will recall that the 504 loan program involves a conventional first mortgage loan from a bank up to 50% loan-to-value and a piggy-back second mortgage loan from a certified development corporation up to 90% loan-to-value.

The second thing the Federal government has done to make SBA lending more attractive is that the SBA has increased its guarantee of SBA loans from 75% of the loan amount to 90% of the loan amount. This should encourage SBA lenders to start approving more deals.

The third incentive is the SBA has effectively extended the repayment term of its loans. In the past, the real estate portion of an SBA loan had a term of 25 years, but that portion of the loan used to finance the acquisition of machinery or equipment had a term of just 10 years. If the borrower also wanted some working capital, the repayment of this portion of the loan had to be amortized over just 7 years. A weighted-average loan term was used. Now, if more than 50% of the loan is being used to acquire real estate, the entire SBA loan can be amortized over 25 years.

The SBA also announced two weeks ago that 504 loans can now be used for refinances, as opposed to just the purchase, of real estate and/or equipment. The announcement was somewhat unclear, however, and further clarification is expected from the SBA.

In general, the volume of SBA lending is way down. CIT Financial, the largest SBA lender in the country, is back in the market. CIT is now a national bank with one branch in Utah. More importantly, CIT, as a bank, now has access to the discount window at the Fed.

Banco Popular, the second largest SBA lender, has severely trimmed its SBA lending infrastructure. While the bank is still in the market for SBA loans, their SBA loan volume is down by more than half. So is the SBA loan volume of Bank of America and JP Morgan Chase.

Former giants in the SBA lending market - Temecula Valley Bank, UPS Financial, Small Business Loan Source, and Business Lenders - have all closed down their SBA lending divisions.

The secondary market for the conventional portions of 504 loans has completely dried up. These attractive first mortgage loans used to sell for 6 to 15 point premiums because of the implicit guarantee of having the SBA in a second mortgage position. The good news is that the Obama administration has earmarked a sizable amount of money aimed at buying up these 504 first mortgages in hopes of jump-starting this market.

The second mortgage portion of 504 loans are being written at a fixed rate of 5.67% today (3/31/09) for 20 years. The underlying first mortgages are typically written at an interest rate that is 1% to 1.5% higher than the 504 second mortgages. Wait a minute? Higher than the second mortgage? Yes, because unlike the second mortgages, these first mortgages are not credit-enhanced by the SBA.

I learned today that SBA 7a loans have a modest prepayment penalty during the first three years. It's a declining prepayment penalty of 5% in year one, 3% in year two, 1% in year three, and no prepayment penalty thereafter.

The SBA 504 program has a stiffer prepayment penalty. The bank making the underlying first mortgage is not allowed to charge a prepayment penalty. The second mortgage, however, has quite a stiff prepayment penalty - 10% in year 1, 9% in year 2, 8% in year 3, and so on. There is no prepayment penalty on the second mortgage after 10 years.

Gas station loans are still not being guaranteed by the SBA.  (Blackburne & Brown is happy to finance gas stations right now.)

While the SBA will still guarantee hotel loans, very few SBA hotel loans are being made by SBA lenders. SBA lenders are worried about declining trends. In other words, they are comparing this year's revenues to last year's revenue - and the trend is usually too negative. The expression - declining trends - is the hot, new buzzword in SBA lending.

If an SBA lender were to finance a hotel today, it would probably be a hotel highly visible from a busy highway. Many more business travelers are driving rather than flying because of the recession. The hotel lucky enough to get SBA financing would probably be a limited service hotel, typically without a restaurant and with far lower nightly rates. It would probably have less than 100 units.

The more expensive full service hotels, typically close to airports, are suffering far worse than the cheaper limited service hotels off of busy highways. These full service hotels would also require large loans, and lenders are loathe to make large hotel loans today.

Finally, if an SBA lender were to finance a hotel today, it would probably be a hotel with interior corridors. Older hotels and motels usually have exterior corridors, and women traveling on business today are likely to avoid such hotels due to security concerns.

The maximum SBA 7a loan is $2 million. Therefore, if a borrower wanted more than $2 million or if he wanted a fixed rate loan, the SBA 504 program would be the right program.

C-Loans recently received a loan that otherwise would have been perfect for the SBA; however, the borrower was a non-profit organization.  The SBA will not guarantee loans to non-profit organizations.

Conventional commercial real estate lending is down by more than 80% from early last year. SBA lending is also down by 60% or more. The Federal government's efforts to increase SBA lending is a noble effort. Let's hope it works.

Need an SBA loan? You can apply to dozens of different SBA lenders in just four minutes using C-Loans. And C-Loans is free!

DIP Financing Can Be Used to Maintain a Property During Bankruptcy

Debtor in possession financing (DIP financing) is a special form of financing granted to companies in financial trouble. Usually these companies are in a Chapter 11 bankruptcy. The unique feature of a DIP loan is that the bankruptcy court usually grants a super-priority status to the new loan. This means that the new loan gets to jump in front of any mezzanine financing and any senior mortgages in the debt stack.

"Gee, George, does this mean that if I have a first mortgage that some crazy bankruptcy judge can just push my loan back into a second mortgage position and allow the DIP lender to be the new first mortgage?"

Bankruptcy courts don't just approve debtor in possession loans willy-nilly. Usually the debtor has to obtain the permission of the existing lenders.

"Gee, George, why, if I had a first mortgage position, would I ever agree to be pushed back into a second mortgage position?"

Let's suppose that your bank had a $10 million first mortgage on a huge RV manufacturing facility in Elkhart, Indiana. As you know, the RV industry is in shambles and there are millions of square feet of empty industrial space in Elkhart right now. If you're the bank, you could easily be looking at seven years before you'll ever be able to sell or lease the property.

Now let's suppose that, right before the RV manufacturer went into bankruptcy, the company received an order from FEMA for 1,000 movable trailers that could be rushed to disaster areas as emergency housing. The RV company was poised to make millions of dollars on that order, but they didn't have the dough to order the parts and supplies. All of their suppliers had put them on a cash-only basis.

A DIP lender might come in and make the RV company a DIP loan of $1.5 million, secured by a first mortgage on the property. The company could then use this new money to fill the FEMA order and to restore itself to financial heath. The bank might very well agree to subordinate their $10 million first mortgage loan to this new debtor-in-possession financing because it would prevent the company from a total dissolution.

"But George, why wouldn't the bank just agree to increase the size of its first mortgage?"

There could easily exist at the bank an unwillingness to throw good money after bad. In addition, many banks are short of lendable funds right now because few of their existing loans are getting paid off at maturity.

Blackburne & Brown is happy to make debtor-in-possession loans (DIP loans). Simply complete this mini-app.

When Money is Tight, Wraparound Loans Get the Job Done

A good way to understand wraparound mortgages ("wraps") is to follow a little story. Once upon a time Ida Investor bought an office building. The cost of the office building was $1,400,000 and she put down $350,000 (25%) in cash. Hometown Bank made a $1,025,000 new first mortgage for ten years at 6.25% interest.

Ida Investor made a shrewd investment. The City of Hometown started to boom. The value of her office building skyrocketed, and just four years later Bobby Buyer offered to purchase the property was a whopping $2 million.

The problem was that commercial loans had dried up. Neither Hometown Bank, nor any of the other banks near Hometown, Montana, were making any new commercial loans.

Fortunately Ricky Realtor, Ida's real estate broker, had a solution. Bobby Buyer would give Ida Investor $400,000 in cash (20%) as a down payment.

Ida Investor would then carry back an all-inclusive mortgage (wraparound) in the amount of $1,600,000 at 7.25%.

Bobby Buyer would pay Ida Investor one payment every month, an amount sufficient to amortize a mortgage of $1,600,000 at 7.25% over 25 years. It would then be Ida Investor's responsibility to make the payment on the existing first mortgage, which had been paid down from $1,025,000 to just $1,000,000.

Since Ida Investor's existing first mortgage balloons in just six years, the all-inclusive mortgage (wraparound mortgage) would have a similar due date. These two mortgages would be coterminous; i.e., they have identical maturity dates.

Why bother with the wraparound structure?  The reason is because Ida Investor really wanted all cash on the sale. She didn't want to carry back a garden-variety second mortgage at a lousy 7.25% interest. Bobby Buyer, however, would never agree to pay Ida Investor 9% interest on the second mortgage.  He was way too stubborn.

The wraparound structure solved the problem. How? Remember, Ida Investor's old first mortgage had an interest rate of just 6.25%. The amount of the old money - wrapanese for the existing mortgage being wrapped - was $1,000,000.

The amount of the new money - wrapanese for the amount of the equity inside Ida Investor's new all-inclusive mortgage - is $600,000. Remember, the gross wrap was for $1,600,000 and the existing mortgage was $1,000,000. Therefore Ida Investor's equity in the wrap is $600,000.

Now let's get back to Ida Investor's return on her equity in the wrap. She's earning the wraparound interest rate of 7.25% on her $600,000 equity inside the wrap, which works out to be $43,500 per year in interest income.

But Ida is also earning 1% interest - the difference between 7.25% and 6.25% - on the existing $1,000,000 first mortgage that is being wrapped. This is an extra $10,000 per year in interest. If you add $10,000 to $43,500 you get $53,500 in annual interest income on Ida Investor's $600,000 equity in her wrap, or an annual interest return of almost 9%.

Look for more wraparound mortgages to be made on commercial properties in the coming years, as the banks remain tight-fisted about making commercial loans.

Need a commercial loan?  You can apply to 750 different commercial lenders in just four minutes using the same mini-app by using C-Loans.com. C-Loans is the internet's most popular commercial mortgage portal. And C-Loans.com is free.