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Redundancy in SBA Programs Stalls the Recovery…
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I wrote an article that was published on American Banker’s BANKTHINK blog last Friday. It’s about the redundancy that continues to plague the SBA’s flagship loan programs and why it’s hurting our economy.

In my opinion (which you’re probably aware of if you’ve read this blog for any length of time), the SBA needs to do more to increase efficiency and make it possible for small business owners to get the capital they need to grow their businesses.

I’d like to find out if you agree with me, so read the full text of the article below and let me know what you think:

American Banker: Redundancy in SBA...

Redundancy in SBA Programs
Stalls the Recovery

The buzz word “duplicative” has been making the rounds lately, employed by watchdog groups and politicians to describe government programs which overlap and offer redundant services at taxpayer expense.

One situation that hasn’t yet been cited involves government small business lending programs.

The U.S. Small Business Administration has two commercial lending programs which both fund commercial real estate loans, but one offers a decidedly better deal for business owners and taxpayers. The SBA 7(a) loan program and the 504 loan program often compete against each other for small business real estate loans.  Both programs are zero subsidy to the government and fully supported by user fees, which negate the need for a government appropriation.

This may sound like benign duplication, but the reality is that every 7(a) loan that funds a real estate project is taken from a pool of money that could be used as a working capital loan for start-ups or struggling small businesses. Sadly, this situation helps lenders at the expense of small business borrowers   who cite a lack of working capital as a main obstacle toward growth.

Historically the 7(a) program served as a working capital loan source, but during its infancy it was also regularly used for commercial real estate financing. The SBA launched the 504 program more than 30 years ago with a singular focus on real estate and equipment financing. However, the SBA never stripped 7(a) loans of real estate deals.

The main opposition to an intelligent shift in policy comes from 7(a) lenders who have found a profit-making machine that they don’t want to give up.  The secondary market for these government-guaranteed loans offers significant premiums, which drive the decisions to place real estate loans in the 7(a) program rather than the 504.

Many lenders are, indeed, struggling right now, but the government should not be propping them up at the expense of small business owners in need of growth capital.

Day after day, we hear politicians proclaim that our economic recovery rests on the shoulders of our small business owners. These entrepreneurs decry that financial institutions are too tight with working capital loans. Meanwhile, our national small business agency is allowing its working capital guarantees to be eaten up by real estate deals. The breakdown is clear.

The 504 program can come to the rescue. It offers 20-year, fixed rate loans for owner-occupied commercial real estate, compared to variable 7(a) rates; and the 504 program has lending capacity which has never been reached. Each year, 504 program funds go untapped despite its superior terms and interest rates for small business borrowers.

Changing 7(a) lending rules to move owner-occupied commercial real estate loans exclusively to the 504 program would immediately free up millions, if not billions, of dollars in potential working capital and start-up loans for small businesses.

Detractors of the 504 program will quickly wield tired arguments to attack this proposal. The main complaint is usually that 504 loans supposedly take longer to close and are more cumbersome for the borrower. This may have been true a few years ago. The SBA has since switched to a centralized processing system that helps loans close in 45-60 days. The application process mirrors that for typical real estate loans, so it is no more cumbersome than any other conventional loan.

The SBA’s main commercial loan programs continue to be instrumental in helping small businesses, but with duplication eliminated, more working capital and start-up loans will be available to help feed a faster economic recovery.

So, what do you think? Whether you agree or disagree with me, I want to hear your side of it. Leave a comment below and be sure to share this with someone you know, whether via email, Facebook, Twitter, Google+ or some other way. (You’ll find some social media buttons at the bottom of this post, right above the comments section, which you might find useful.)

Thanks in advance for reading, commenting and sharing!

Dedicated to Your Continued Success,

Chris

P.S. If you’re on Twitter, be sure to follow us there and be the first to know about what’s going on in the small business lending industry.

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56 Comments

  1. Doug says:

    Chris, why haven’t you written this previously. Nicely written and concise.

    Thanks and I will be passing this along.

    Regards.

  2. rebecca says:

    I agree, if the economy’s rebound “rests on the small businesses” why not do everything possible to help them. Well put Chris!

  3. Jeff Emhoff says:

    Good thought. Not surprising to me. I lose energy just thinking about how to correct some of the enormous duplication of programs/costs/etc. And I get frustrated beyond measure when I realize that forces will stand against this kind of intelligent restructuring of programs in order to serve themselves, the political leaders included.

  4. David Ruggieri says:

    I have been fortunate to be able to use both 7a and 504 effectively in the past, but am now getting a lot of resistance to 7a because of the fluctuating rate and the uncertainties of the economy.

  5. Wynn LaTorre says:

    I agree with Jeff. The thought process of our political leaders? always leaves me frustrated abd bewildered. Is it any wonder?? Go you Cris !!!!

  6. john says:

    the loans are good if you meet the criteria. where the program falls short is helping in the development of real estate for speculation. the program would benefit the economy if it would open up to the development of property.

    • Chris Hurn says:

      John – it was never intended for speculators, only owner-users. We have enough problems already NOT to need to guaranty speculators.

  7. Tyrone Ramotar Singh says:

    Brilliant ! I agree with every word of it. People from the SBA are so accustomed to do nothing and getting paid for it, why change now ? Some Brains are priceless and we know why, they were never used.

  8. Dan says:

    Come on folks, make more loans to start ups and struggling businesses, guess what will happen? Lots of defaults, of course. Lack of capital is often the problem small businesses struggle with, especially in the start up stage. The 7(a) program is and should be based on cash flow, and it is not charity based. Sorry, but I can’t believe another give away program is the answer.

    • Chris Hurn says:

      7(a)s are LOANS Dan, not “giveaways.”. In fact, they require personal guarantees of the individuals getting the loans, PLUS they’re required to be fully-collateralized, which means seconds are often placed on the business owner’s personal residence and other assets of their business are pledged as well. Perhaps you’re thinking of government grants? These SBA loans are far from that… AND they’re rather extensively underwritten before any dollar goes out the door. SBA loans ARE based on debt service coverage ratios (commonly referred to as “cash-flow”), but in the event of a start-up, detailed projections can be used… but they’re scrutinized quite a bit (as some of the “negative” responses to this post seem to attest). With start-ups, however, the down-payment is greater (which reduces the loan amount) and the collateral requirements are still present. Careful not to paint anything “government-related” as automatically bad.

  9. Kurt Chilcott says:

    Of course I like the article – but I do worry that if push comes to shove that the duplicative program they will eliminate will be 504 not 7a!! keep up the good fight.

  10. Jim Cramer says:

    Why don’t you do a series of pieces on why the credit reporting agencies get away with filing false data, inaccurate data, and simply not fixing the data they post in people’s credit report. Maybe in fixing what they do, other entities will be forced to fix what they do.

    • Chris Hurn says:

      While that’s a terrific idea, Jim, I’m afraid my area of expertise falls woefully short. I would certainly LOVE to see that done, however, because I’m not a big fan of their practices or their power… and I wish there were much more competition for the credit agencies than there is at the moment.

      • Jim says:

        Why am I not surprised.

        • Chris Hurn says:

          Sorry, Jim, if my area of expertise has let you down some. Perhaps, if it’s such a great idea, you should take it up yourself?

  11. Sabrina Kent says:

    Hi Chris,
    Just a short story, I will never support the SBA, and my tax dollars should not either. I went to our local SBA office hear in Savannah only to get no where! This SBA does not help many minorities if they have I’ve never met them. What our SBA does here is discourage your ideas, when you leave thier office you leave think I better remain on someone job.

    • Chris Hurn says:

      I’m sorry you had a bad experience, Sabrina. I’m confident that was the exception — certainly people and their governmental agencies aren’t perfect. I don’t know what your idea was, but I also know entrepreneurs are prone to come up with some doozies sometimes… and most do NOT work. I believe it’s better to get realistic advise, even if it’s discouraging, then encouragement for something that’s doomed to be a miserable failure. Maybe whoever you spoke with at the SBA felt much the same way? Hopefully the USPS won’t let you down quite as much as the SBA did, or I’m afraid you’ll refuse to receive any mail. 🙂 best of luck to you!

  12. Patricia Forte says:

    I agree. SBA, for several years have made it difficult to obtain assistance and in certain areas are not available for assisting business owners with business plan writing etc….

    • Chris Hurn says:

      Patricia – try your local SBDC for help with a business plan, which incidentally, is part of the SBA.

  13. Gary Attardo says:

    The SBA is a Joke. When you really need help, SBA is not there.
    Thank You

    • Chris Hurn says:

      I think that’s quite the over-generalization, Gary. We (MCC) have helped MANY small businesses over the years (to the tune of nearly $700 million worth of projects)… and it would have been much less were it not for the SBA.

  14. kim says:

    I went to a SBA workshop for information about helping me start a business. And basicly they said that I will need 15 to 20 as a down payment and I though that they were there to help. So leaving there I though to myself I might as well save my money and try and find a build or a little stop for that 12,000 that I will have to put down.

    • Chris Hurn says:

      Sorry, Kim, there aren’t (or at least shouldn’t be) any free rides. These are LOANS, not grants, which means you’ll have to make a down-payment… and pay it back. I don’t know your exact situation, so won’t comment further, but the SBA ISN’T giving hand-outs, nor should they.

  15. Ronald Fruend says:

    WHAT ARE YOU THINKING. THIS IS A GOVERNMENT PROGRAM
    WE HAVE PEOPLE RUNNING IT THAT ARE OVER PAID OVER BENEFITED . THAT WERE PLACE THERE BY POLITICAL PEOPLE
    THAT ARE LOOKING TOO BENEFIT THEM SELF . . .IT JUST NORMAL BS GOVERNMENT I JUST WISHED IT WAS A JOKE!! FDIC WITH THE BANKS IS RUN THE SAME AND MOST OTHER GOV, DEA

    • Chris Hurn says:

      I wish it were quite that simple, Ronald. Yes, it’s a government program (7(a) and also the 504), but both have operated at what are called “zero-subsidies” for some time. That means the user fees cover the losses on the program, not the American taxpayer. Frankly, we need MORE not LESS programs like these — where the public AND private sectors can work together in harmony. Only some people in the SBA are political appointees — others are career bureaucrats (no debate here) — some maybe over-paid; most certainly “over-benefitted” as you say (compared to the private sector).

  16. Ray says:

    Chris, what happens to 7a loss severity if you strip CRE finaning from the 7a loan program? It goes through the roof an takes the 7a subsidy rate with it. If your goal is to kill the 7a loan program and all of the working capital, equipment and business expansion loans it provides, then the surest way to do that would be to strip CRE from the 7a program. Your proposal would ultimately result in fewer working capital loans and tighter underwriting standards for the very same small businesses you’re trying to help.

    • Chris Hurn says:

      Then a bank, like yours Ray, has to rely on the government guarantee if it’s a loan they normally wouldn’t make without one.

      See, your logic is that 7(a) loans are made mostly when commercial real estate is involved and without that collateral, the program’s losses go up and the user fees go up (so it doesn’t go back to a subsidized program) — I think that’s silly. You want to have your cake and eat it, too, and it normally doesn’t work that way. I realize banks would like to have the real estate collateral too (belt and suspenders approach to credit), but that often means a much worse deal for small business borrowers. And are we helping ourselves first and foremost or are we attempting to help America’s small business owners (while we help ourselves in the process)? That’s the better question.

      In instances where there’s real estate and other non-real estate loan proceeds, the Agency allows (and good business practice ought to dictate) splitting up the project into a 504 (that includes the real estate) and the rest (working capital, business acquisition, etc.) that gets included into a 7(a). I’ve never tried to “kill the 7(a)” — what my proposal was suggesting was a way to expand the number of businesses 7(a) loans would help, while not running out of money at the program level (or asking for more in a difficult climate in Washington to do that these days). Too many banks (it sounds like yours included) bastardize the 7(a)s and offer a worse deal to borrowers by forcing real estate deals into 7(a)s, when the small business borrower should be getting a 504 for that portion of their project. As I’ve said before many places, this practice occurs because of the terrific secondary market premiums on 25-year amortization (i.e. real estate) 7(a)s — currently up to 14.25% paid on the guaranteed portion. That’s one heck of a motivation to tell borrowers to “go 7(a)” for their real estate needs, despite them getting floating rates over Prime and having to pledge much more collateral. I think most small business borrowers would rather get a 5.13% fixed for 20 years 504 loan (when blended with their first mortgage piece, get high 5% financing all-in), while they get their Prime + 2.75% (6.25% for now, but floats) for their working capital portion. THAT’S the better deal for borrowers, for American taxpayers, and even bankers get to make a few bucks on it (maybe not the egregious 14% premiums, but plenty still).

      What you bring up is exactly why Congress and the Agency need to alter this situation and soon. Left to it’s own devices, most bankers are NEVER going to structure a deal like I’ve suggested above… because it would mean eating into their pocketbooks and their credit officers would NOT get every single piece of collateral possible (in part, to keep their regulators at bay). Therefore, deals get put on the street with floating interest rates that WILL GO UP in the coming years (they have nowhere to go BUT up) all for near-term egregious profits. Banks need to better rely on the guarantee — that’s why it’s there; otherwise just make the loan conventionally.

      Look, I’m all for profits IF you can still sell that small business owner on what I think (and know, since I chose a 504 loan myself over a 7(a)) is an inferior 7(a) loan for their property. Put a conventional, 7(a), and a 504 loan option on the table and see which option the borrower picks. I think you’ll be SHOCKED, SHOCKED! that the borrower doesn’t want to risk sky-rocketing interest rates in a few years when they can get sub-6% fixed rates now. Yes, that may mean you lose some premium dollars now, but maybe it’s the right thing to do for all involved… and maybe that borrower doesn’t go bankrupt later on when Prime goes back to 8% or 9% and he’s struggling to make his payments to your bank. Part of the answer here lies in the Agency convincing banks to truly rely on their guarantees — without much confidence in them, the Agency has also contributed to this problem.

      • Ray says:

        Chris, I don’t have the time to respond to that email point by point, although it would be easy to do. The simple fact is if you removed CRE from the 7a program and had that program focus exclusievely on under-secured w/c, equipment, business expansion and start-up loans, both loss frequency and severity would soar and the 7a program would die. I agree that the 504 is a better loan for CRE, which is why I’ve funded just under $20MM in 504 1sts YTD vs virtually no 7a. I even brought in MCC to the tune of $2.3MM on one of them. 🙂 That said I’m not interested in seeing the 7a program lose the ability to finace CRE. Prime + 1.5% variable with a 5,3,1 prepay has its place, not to mention the fact that several of the large banks are offering fixed rate 7a’s that are really starting the crowd our space. I think that’s your real concern here, not the P + 2.75% straw man you present. Good luck and keep up the good fight. I have 4 more 504′s I’m closing this month so I need to get back to work!

        • Chris Hurn says:

          Thanks, Ray. Certainly we both need to get back to work. I’m not that concerned with the Big Banks doing fixed-rate 7(a)s — you and I KNOW that’s only going to last fir a short period of time. I think the Prime plus 2.75% “straw man,” as you put it is much more prevalent than you realize from state to state.

  17. Ed says:

    well chris have to say, i got a sba loan last year when i bought the shop. have to say it was tough. took just about a year, and come to find out. mine was pushed threw,so the loan officer would get that large rebate. but in the end i had no working capital.so since august last year i have been just hagging on, so i called wells fargo my loan carrier, and was just about laughed at for asking for some working capital, ned to say if i dont a 7a loan or line of credit. i will have to close my doors and lose my shop and house in just i swift shot.

    • Chris Hurn says:

      Thanks for your comments, Ed. I don’t know anything about a “large rebate” — maybe that was something Wells (your lender) was doing internally? I won’t speak for what your lender should or shouldn’t have done (since I don’t know all of the specifics of your situation and/or loan request), but no one should EVER be laughed at by their lender. Your lender probably should have made sure you had adequate working capital, in order to make the loan to you in the first place. Why they didn’t, I don’t know, but that’s something we (and other quality lenders) certainly do. Best of luck to you… it sounds like you’re going to need it. And, I’m very sorry you’re in this situation.

  18. Charles says:

    Small businesses are the key to helping a struggling economy but the problem is these banks are not lending to small businesses. SBA loans are next to impossible to get unless your business is picture perfect. All these banks want the debt to be reduced down on small businesses before lending money, how the heck are small business supposed to pay down debt if banks are not lenging for working capital that will help pay down debt. Is anyone getting SBA loans done? I am trying and it seems to be next to impossible.

    • Chris Hurn says:

      Yes, Charles, we’re getting SBA loans done, but only our specialty: 504 loans for owner-user commercial property and/or equipment. There are others getting SBA loans done, but it’s certainly a challenge — much harder than it “used to be.” Please keep in mind: the banks’ regulators aren’t going to let banks just lend to anyone — there HAS to be standards and unfortunately some of those standards are difficult to meet in light of the Great Recession we’ve just come through. There’s definitely a bit of a “catch-22″ going on here, but keep at it and maybe your luck will change soon.

  19. Charlie says:

    In theory it sounds like a great idea but how many 504 loans are closing in 45-60 days, not many that I’ve seen. Right now the 7(a) program is the most viable option for the borrower, it can close in 60-90 days.
    We need to address the devaluation of assets due to the market downturn. Many prospective borrowers won’t qualify for an SBA loan due to the fact that their real estate LTV has gone from 75% to 100%+ and they are out of covenant with their current lender. These borrowers need the SBA to ammend their policy. The SBA can’t guaranty a loan if a “discount” must be taken by the current lender. What if the discount reflects the change in value of the asset, which was not the fault of the borrower, especially if the borrower has remained current with the current lender ?
    I would like to see some dialogue regarding this issue as well.

    • Chris Hurn says:

      I would say just about ALL of our 504 loans close within 45 to 60 days, Charlie, otherwise it’s a delay on the part of the borrower. Perhaps you’ve been working with the wrong 504 lenders? The Small Business Jobs and Credit Act of 2010 (passed into law in late September 2010) actually allows 504 loans to lend up to 125% LTV with additional collateral pledged — this addresses your “negative equity/devaluation” point. However, the regs from the Agency haven’t been released on how to “handle” this yet (it’s only been 11 months — I’m being sarcastic here), but hopefully it’s coming soon. Hang in there, Charlie… and perhaps it’s time you start working with a more competent SBA 504 lender? 🙂

  20. Leo says:

    We’re into hospitality…We had to fund our business(and some private borrowing) …Because we were underfunded..we discontinued operating…over 50 people are out of work… the lack of “bank or SBA Funding”…destroyed our “Credit score”… We have the collateral..we just don’t have the “Intelligent banker….”who can ignore “The credit issues” tightening our personal position…The Banks Had Their “Tarp” rescue plan…The business world…doesn’t…unless your “goldman Sachs” type or high credit score etc…that’s the bottom line.

    • Chris Hurn says:

      I don’t necessarily disagree with you, Leo, though I don’t recall being contacted by you about your situation. It certainly is wrong that most small businesses have been deemed “too small to bother,” while others were helped because of being “too big to fail.” If you spend some time on this blog or on my YouTube channel, you’ll see I’ve been one voice fighting against this unfairness for some time… but I can only do so much. Best of luck to you!

  21. Matthew Reid says:

    Great blog post yesterday, by the way! Really enjoy reading them.

  22. Bill Ebersole says:

    Chris, this is an important message that needs to be heard. The 7a program and its secondary market premiums incentivize banks to conceal from borrowers the advantagtes of the 504 program, to the detriment of the borrower. Most high volume SBA 7(a) lenders, in fact, prefer to do commercial real estate loans under 7(a) because they earn the highest premiums on those loans. Many do not offer working capital loans at all! A policy shift as you suggest would be greatly beneficial to the business community.

    • Chris Hurn says:

      Thanks for your comments, Bill!

  23. Andy Kron says:

    We can all gripe about inefficiency with different agency’s etc. why banks don’t push SBA 504, as a CDC in New Jersey we know we have to educate the borrowers to contact there local CDC’s for obtaining the best loan for Small Business Owners. Because of our program, we just closed on a $27,500.000 (project cost) refinance and Our CDC is funding $5,000,000 on Aug. 17th. We were able to help our client who was shopping at banks for 2 year’s with no luck, until he found Across Nations CDC. We where able to retain 160+ jobs. We are working with what we have and we are doing some good.

    • Chris Hurn says:

      Thanks, Andy.

  24. Sheila Cross Reid says:

    Great article Chris. Lets cut to the chase – the SBA
    is simply a systemic deterrent to small businesses
    having access to capital. TheSBA guarantee the loans,
    however, the banking regulations make it almost impossible for any minority small business who may need funding for marketing, promotion, technology
    etc. in order to be competitive and to survive and/or
    grow. In DC for example we have witnessed numerous
    small businesses go under on 14th Street and H Street
    due to massive construction and obstruction of their
    businesses. Therefore, their bottom line began to
    suffer and guess what? The banks used their “set
    regulations” to deny business loans not taking into
    consideration any extenuating circumstances that may
    have causes a downturn in the business’ bottom line.
    The lesson here is that institutional regulations and
    unyielding guidelines are the traditional “gatekeepers” for access to capital for
    small, minority owned businesses that are historically the most vulnerable.

    • Chris Hurn says:

      I think you’ve over-reached here in your comments, Sheila. The SBA is the primary avenue for funding for small businesses from our government (yes, the USDA has a program and there are a few more minor ones), but “simply a systemic deterrent to small businesses having access to capital”? Tell THAT to the tens of thousands of small businesses who’ve been funded with SBA loans since the Great Recession/Panic began. And yes, banking regulations have become too extreme as well, but to make statements like “institutional regulations and unyielding guidelines are the traditional gatekeepers for access to capital for small, minority owned businesses” — that’s stretching the truth quite a bit. We DO need SOME regulation and/or guidelines to make sure we don’t just throw capital away, you know. That means there will ALWAYS be SOME businesses that won’t get funded — probably because of poor credit, poor financials, unproven business model, or a host of other reasonably reasons. Now, I don’t need to get into a racial discussion here with you, but suffice to say, there are MANY minor-owned small businesses that banks and the SBA have helped just in the past few years, alone. Until the Great Recession/Panic, minority ownership of small businesses was growing tremendously yearly — and the SBA was a prime driver of that. Now, if you want to say that the same financial metrics that Big Banks use to approve small businesses would have resulted in denials to themselves until the Federal government bailed them out, then yes, we are in agreement over the obvious hypocrisy in our midst. But be careful how broad you paint the situation. It’s too easy to pull out the race card — often times, it’s just not correct to do so — and in this case, I know the data doesn’t back-up your arguments. Some exceptional denials do not make the rule.

  25. Ben Gecy says:

    Chris – Your articles are very interesting and you seem to care a lot about small business.

  26. Joda Connell says:

    Great article. By the way, I read your blog for the first time and you get some real crazies that comment. Be careful out there!

  27. Melanie Brown says:

    This sounds very reasonable but as a lender who has specialized in both programs, I can point out a few things which this article did not take into consideration. First and foremost, the 7a program allows a lender to combine all of the use or proceeds into one note and provide a client with the longest term possible to improve cash flow. Generally, a lender is not going to make a pure working capital loan or inventory loan without some additional collateral. The additional collateral has historically been supported by real estate, either being purchased or already owned by the business. By bundling all of the needs of a business into one loan and extending the term, I have had many borrowers who have been able to achieve significant reductions in their overall monthly debt payments. I had a borrower who had basically financed his A/R by using several company credit cards. When he purchased a building, I was able to refinance the company credit card debt in with the purc
    hase and only increased his monthly payment by 15% over what he was already paying the creditors’ monthly. I have a client now who has a very expensive start up loan for FF&E with a balloon balance coming due. Through the 7a program, I can refinance this note in with the purchase of his building and his overall monthly note only increases by 21%. The actual savings achieved annually is $66,000 a year and he will own his property vs. paying an expensive lease. Debt refinance has just become an eligible use of 504 proceeds and the rules are very cumbersome and the approval rate I have heard is running around 30%. If you want to combine the programs into one program, then offer a program similar to the 7a where all the business needs are eligible for financing. The lender can decide whether to portfolio or sell the guarantee. The bank’s needs may change from time to time and as in any business, a good employee will change focus with the needs of their company.
    Balance Sheet growth vs. Profitability, they are both necessary components to a successful bank!

    • Chris Hurn says:

      Thanks for your email, Melanie. My apologies for the delayed reply — I’ve been traveling most of this week.

      1. Longer cash-flow may be possible with a 7(a) by blending the amortizations, but do we really think working capital ought to be put on a 25-year amortization? Is that really good lending?
      2. There are some lenders who really do rely on the government guarantee, as they should, when making pure working capital loans. But regardless, the SOP requires additional collateral be taken anyway… I just don’t think that’s a justification for doing a commercial property loan with a floating-rate 7(a).
      3. The scenarios you mention are certainly good ones to do with a 7(a), but I maintain that the best (most fair) structure for all involved is to split-out the real estate piece into a 504, while doing the remaining proceeds under a 7(a). I don’t think American taxpayers should be guaranteeing inventory, receiveables, business acquisitions, business goodwill, etc. on 25-year commercial real estate repayment schedules — none of those assets have useful lives that long and it is done merely out of convenience to the bank (justified by “cashflow” improvements, perhaps… but a “ticking time bomb” when rates leap).
      4. I guess my last criticism is that your analysis fails to take into account when those debt consolidation 7(a)’s rise in interest rate as the Prime rate surely increases over the coming years. I can recall lending 7(a) paper when Prime was 10%, so 12% interest rates are NOT impossible in the near future. This is when, incidentally, we’ll start to see significant defaults on 7(a) loans again.
      5. I sincerely doubt the Agency would entertain combining the programs into one, but I’d welcome it.
      6. The new refinance rules ARE cumbersome (I’ve written/spoken about it previously), and the Agency is clearly stubbing its toe so far with these, but I still have some modest hope they’ll get it right soon.

  28. Simone Peront says:

    Thank you for your newsletter.

  29. Ed Hays says:

    I agree with your point of views on this issue, with that being said, please continue keeping us up-to-date with whats happening on the political front as it relates directly to small businesses.

    • Chris Hurn says:

      Thanks, Ed.

  30. Walter McLaughlin says:

    Chris —

    I’ve worked with SBA lending for over 23 years. I didn’t read all of the replies, but I will say that it’s not as cut-and-dried as you make it out to be.

    First, given that the two programs have co-existed for over thirty years, the market has spoken. This is far and away enough of a sample size to make a economic determination as to whether or not there is a “need” for both programs as they are currently constructed. If the 504 program was as superior as you make it out to be, the demand for 7(a) real estate loans would be non-existent. I don’t think you can assuming “steering” here, either, at least not with 30 years’ worth of history. Right NOW, the 504 is (on balance) the better deal; however, when rates rise, the pendulum shifts. Borrowers don’t want to be locked into what they perceive to be expensive fixed-rate loans and would rather have the opportunity for their rates to drop when the prime falls.

    Second, both programs have advantages and disadvantages, regardless of the environment. The 504 has the low down payment and fixed rate advantages; the 7(a) offers a slightly longer term, the ability to finance multiple purposes into one loan, a simpler structure (one loan versus two) and if the lender is PLP, a likely faster turnaround time. 504 disadvantages include very high prepayment penalties, whereas the primary 7(a) disadvantage (in low-rate environments) is the variable rate.

    Third, previous posters are correct: remove what’s perceived to be the most profitable segment of 7(a) lending (since the loans can be sold at the highest premiums) and you could actually reduce the amount of 7(a) lending made to riskier segments. If the department model doesn’t work as well, the SBA lender will have to reduce its scope — if not eliminate it altogether.

    Fourth (and to build upon #3 above), it is highly unlikely the recovery is literally being “stalled” due to this issue. As the world is shrinking and capital is diminishing along with it, lenders remain cautious. That caution will very possibly continue for the near term. Also, you said it yourself: the programs are zero subsidy. Therefore, the 7(a) doesn’t tap a “pool of money” that could be diverted to riskier purposes. Again, market forces are at work. You may not like them (I’ve seen the 504 numbers myself, and we do those loans at my bank), but they are what they are.

    In summary, there’s a place for both programs with respect to real estate lending. We are an active 504 lender, as well as 7(a). I see instances where one works over the other, which go both directions. Eliminating CRE lending through 7(a) would be a boon to the 504 lender, but reducing competition and choices aren’t in the best interests of the consumer.

    • Chris Hurn says:

      Walter —

      Thanks for your comments. My apologies for not responding sooner — been a CRAZY week (story for another time). Anyway, here we go with my responses:

      1. I’ve been in SBA lending for 15 years and on your first point, we clearly have to agree to disagree. I’ve seen small business lenders steer their clients into 7(a)s over 504s for real estate so many times, I’ve lost count. The unstated (unspoken) reason for this is the amount of premiums made on selling the guaranteed portion of real estate-backed 7(a) loans. Yes, the market has spoken, no disagreement from me there: when a small business lender can get up to 14% of premium on 75% of the 7(a) loan made, he steers the borrower to that product; and when the small business loan officer (in the trenches) is compensated based on the size of the assets they book for their bank/lender, they will steer borrowers to a 90% product (7a) where they put 90% of the loan on their books (rather than a 90% product [504] where only 50% stays on their books). I’ve worked for SBA lenders that do both loans. I’ve made both loans previously and have been quite successful at it. But, I can assure you there are VERY few lenders that pay their BDOs irrespective of the amount/size of the loans made by their institution — it is purely mathematics and capitalistic what most small business lenders do here… but it is NOT right. Additionally, if you think Prime will fall from where it is today, we should make some bets. 🙂

      2. Again, we disagree… and this time, I think it is your facts that are inaccurate (you are entitled to have whatever opinions you want): for real estate, BOTH programs have 25 and 20-year terms (sure, a portion of a 504 loan has only 20 years, but it is at significantly below-market, long-term fixed rates [currently 5.13% fixed for 20 years], so few seem to quibble with it); PLP turnaround time for 7(a) was ONCE a great advantage, but no longer — since the 504 industry had authorizations centralized in Sacramento about five years ago; and “very high prepayment penalities” is a straw man argument which forgets that all 7(a)s have these too — again, on 504s, these prepayment penalties are only on the vastly superior second portion and once you monetize it for borrowers, few of my borrowers have ever had issues with it burning off over 10 years (and that’s well over 400 borrowers to date). Remember: these are owner-occupied real estate loans, so the concerns so many have about “flexibility” in selling in a few years, strikes me as concerns coming from investors in investment properties — it really should be a minimal concern here, and it even fails to acknowledge that these loans can be (and are often) assumed.

      3. So your argument on your point number three is that banks will stop doing 7(a)s if they can only get the government guarantee on riskier non-real estate transactions? I would think for risk management purposes, they’d STILL want to get the guarantees on those types of transactions… ESPECIALLY, on those types of transactions. Yeah, I suppose you’re right: getting a guarantee to limit your downside risk; getting only 4% to 8% on the secondary market in premiums for these non-real estate transactions; and reducing your liabilities, while increasing your liquidity WILL result in decreased 7(a)s. 🙂 Are you KIDDING me, Walter?!? This is just scare-mongering and complete silliness. If a bank actually acts this way, then it’s a pretty safe statement to say they were ONLY in the 7(a) lending market to try to get 14% premiums, damn the consequences to borrowers, taxpayers or anyone else who stood in their way.

      4. That was, admittedly, a bit of a “sensational” headline to grab attention. The argument can be made (and was made) that keeping real estate-backed 7(a) loans flowing, has diminished the otherwise available capital for non-real estate 7(a) loans. That was my “stalling” point regarding the economy, as working capital and start-up needs are currently not being met (much more demand than supply). And when another SBA program exists to “divert” those real estate deals to (which has PLENTY of capital to absorb this AND is a better overall program for borrowers and taxpayers [and even banks, from a risk profile perspective]), it seems rather foolish that this has yet to occur. I know there are people who wish I’d rather not bring this whole subject up, but…

      5. So, I’m really glad you brought up “choices,” because that’s the response NAGGL made years ago to this issue when I brought it up in an article in the Wall Street Journal. Back to my point 1 (above), I think the small business borrowers of America deserve to have them — choices, that is — and they don’t normally get them. Too many small business lenders ONLY offer conventional or 7(a) financing to borrowers and completely fail to mention 504s, because borrowers typically choose the 504 when given the choice (when buying real estate or equipment). So again, the “choice argument” is a great one… but it should start at the borrowers’ offices. NAGGL and apparently you here, are elevating the “choice” interests of the banking community over those of the small business community. I think that’s wrong. My company has not and continues not to make as much money as we could have over the years, if we’d ONLY offered 7(a) loans for real estate transactions like PLENTY of others have done and do. We believe in offering a superior product and being authentic about this (and I even “buy” what I “sell” — I have a 504 loan myself, NOT a 7(a)). We, at MCC, will NOT get into situations where our potential profits are in direct conflict with the borrowers’ loan choices. We are consistent. If we ever do 7(a) loans, they will be for non-real estate proceeds only. For us, “doing right by our clients” isn’t just a meaningless marketing slogan like it is for many others. And therein lies the rub. Perhaps the small business community and the public at large wouldn’t be so angry at banks these days if more shared my views on this subject, rather than try to curtail and counter it?

  31. Walter says:

    Now that’s a long response! Ok, let me counter-respond:

    1) Let me rephrase: “steering” does happen. But you are seriously arguing that it happens the majority of the time? You’re overrelying upon the low fixed rate you keep touting. Borrowers want more than just a low interest rate, and the market has proven that with over 30 years of data. I’ve seen the numbers — 504 lending is flat or trending down slightly nationally. Why? No way it’s all steering, that would border on conspiracy theory were you to actually believe that. The factors I cite in my previous response are largely the reason.

    The low fixed rate isn’t the panacea you think it is. If it were, borrowers would literally demand the loans, and stomp their feet until they get them.

    As for prime falling, think long-term, not short-term. I wasn’t talking about today.

    2. As I said above, not everything revolves around interest rate. 25 years at P+1.5% with three years of penalties could be perceived by some borrowers as superior to your 20 year, 5.13% with TEN years of penalties. Again, given how the market is determining this issue, I’d say that happens a lot more often than you are willing to admit. Especially when a PLP lender can auto-approve the loan and have the loan number instantly. Unless you can argue the 504 lender is able to do the same, you still are at a competitive disadvantage in this area.

    Correction: not ALL 7(a) loans have penalties. I’ve booked a few at 14 years when cash flow warranted it. Voila — no penalty.

    3. Sorry, your argument in #3 is uninformed, but I understand why you have to make it, as it’s the entire basis of your philosophy. Have you ever run an SBA department before? I have, several times (including right now). Like any profit center, the economics have to work. If all I get to make is the very riskiest of the loans, guess what? The economics change. Why wouldn’t they? So yes, I would absolutely have to re-think my model if all I could make were start-up loans, business expansions, buy-outs, etc. It’s not “scaremongering”, it’s fact. In most economic environments, business lending is riskier than real estate lending. Relying heavily on the SBA guarantee carries its own level of risk, as they monitor performance in various risk metrics. Blending the risk of that segment with the (normally) lower-risk real estate segment provides for an adequate risk/reward tradeoff. Honestly, I don’t understand how you can’t see that.

    4. It’s a false premise, tying the usage of 7(a) toward real estate with the alleged lack of loans for working capital, etc. As I said in #3 above, it’s all about risk and reward, and always has been. Risk, right now, is front-and-center. The borrowers for those types of loans frequently don’t look as good as they did 4-5 years ago, and the banks have struggled with capital issues. *That* is the reason those loans are more scarce, not the fallacious argument that resources are being diverted.

    5. I’m glad you are so passionate in your conviction that 504 is the best product in the world, and that then makes sense as to why you argue so strongly for it and against 7(a) with respect to real estate. I respect you for that. However, it doesn’t make you right, it just makes you passionate. Right now, your arugments are bolstered by the lowest rate environment this country has ever seen. In several years, that will no longer be the case. Again, borrowers today will benefit, but if I’m borrowing $1 million in three years, I probably would prefer P+1.5 at that time, over (let’s just presume here) 7.5% fixed with ten years of penalties. My rationale would be sound: rates will probably trend downward, and I’ll ride the yield curve down when they do.

    Lastly, the community is “angry” at banks because the perception that they are heartlessly foreclosing on everyone, not because they won’t offer low fixed-rate real estate loans to everyone. Doing “right” means meeting needs in a timely manner, professionally and carefully. As I said many times over, it truly isn’t all about offering low fixed rates.

    • Chris Hurn says:

      Walter —

      We BOTH have better things to do than banter back and forth about this, so I’ll respond to this message and your last one, but no more. Some people might begin to question our sanity! 🙂

      1. Yes, in my experience, sad to say, it (“steering”) happens a majority of the time. The typical compensation model is mostly to blame. And no, I’m not “over-relying upon the low fixed rate” now — 504s typically have lower rates AND happen to be fixed (whether in high interest rates periods or low). BOTH programs’ numbers are down — that’s due to weaker credits, lender reluctance to lend, economic uncertainty, and other things — I didn’t say it was because of “steering.” I’m certainly aware that borrowers need to “buy” on variables beyond just price (rate) — I give presentations and speeches on that quite regularly. I think you’re trying to put words into my mouth, metaphorically-speaking.

      2. I know of few PLP 7(a) lenders that operate as quickly as my firm does (with CDCs’ approvals as well) to approve 504 loans. Again, I have nothing to demonstrate beyond my personal experience, that of my borrowers, and that which I see on a daily basis all across the country. I also rarely see P+ 1.5% presented — in this environment it’s almost always the max (P+2.75%).

      3. I not only “run” an SBA department, I founded my firm to make ONLY SBA loans and I’ve been in this industry, rather successfully I might add, for 15 years. I know there’s way too much concern about the SBA pulling guarantees and in the current banking regulatory environment, most lenders want the “belt AND the suspenders.” My point is that it isn’t necessary. And it’s not as if I’ve suggested something that would kill one SBA program. I only suggested that more capital could be put to better use by clarifying the loan proceeds of each program (7(a) for non-real estate proceeds and 504 for real estate and equipment). The business model certainly works as it exists today — the most profitable banks typically have great SBA departments that sell their loans on the secondary market… perhaps that’s my point: it works too well and there’s too much pressure to push real estate-backed 7(a) loans, no matter how much you (or others) want to dress-it-up and say you do them solely to mitigate risks. I understand that’s what regulators want to hear, but regulators also want profitable banks, too, and this is one way to “juice” them. What I’ve made public is something I know PLENTY of others wished I’d stay quiet about. How do I know? Because every time I comment on this matters, we get phone calls from pissed-off bankers; I get threatened; bankers disparage me; bankers swear at me in various public forums (always concealing their identity, ironically enough); and so forth. I think that’s rather telling. Few have appeared as rational as you mostly do.

      4. It’s NOT a false premise — it’s a fact… and it’s one that was first put in the Wall Street Journal by then-Administrator Barreto (back in 2004). Large real estate-backed 7(a) loans eat up more of the 7(a)’s allocations each year (see the cries by NAGGL currently about needing to get some supplemental appropriations before the fiscal year-end). On the other hand, 504s leave billions “on the table” each year. Hmmm… seems you could effectively shift the real estate-backed SBA loans over to 504s and free-up “space” on the 7(a) side of the equation. Saying I’m “uninformed,” making “false premises,” and calling my argument “fallacious” doesn’t make it so — I don’t think you and I need to resort to name-calling. Doing those things just gets you lumped in with the other haters.

      5. “Best product in the world”? Now you’re just being condescending. Yes, I AM passionate, but I also know what’s right. Perhaps your bank likes 7(a) loans that combine real estate and other proceeds because of the risk-mitigation that hard collateral provides (and it is the smokescreen that others throw up as well), but I DO know that others use the loan program with real estate purposes to mostly pad their profits. I have nothing against that, by the way, I just think America’s small business borrowers ought to have all the facts to make the most informed decision they can. “Steering” doesn’t exactly lend itself well to borrowers getting all the facts. Again, back when I was making 11% 7(a) loans, many years ago, 504s had lower interest rates and they were fixed — so your comments about rates appear to be truly bizarre here.

  32. Walter says:

    Chris –

    Answers underneath yours below. I agree, we both have better things to do. The problem with this discussion is we both believe we are right! I think I’m balanced (since we do them both) but you think you are as well, so we’re even there. In the end, it’s an argument that can’t be won. Having said that, I do appreciate that you’re sticking to what you believe, and that you are (also mostly 🙂 ) reasonable within your arguments.

    Still a fan of your blog, even if we aren’t going to see eye-to-eye on this.

    1. Actually, 7(a) numbers will be up, this year over last. To be fair, though (and the SBA won’t provide data to segregate this) the Jobs Act is probably the reason. As for steering, you’re just not going to convince me that in the information age with everything just a click away, almost all borrowers are “steered” (and thus, uninformed) by greedy lenders who want higher commissions. That is what you are saying, and there’s no way that’s true in a majority of the cases. Does it happen? Absolutely. Is it rampant? Well, at my bank we don’t pay commissions. At my previous bank we didn’t pay them. Other SBA managers at area banks have the same setup. Lenders have incentive goals, but they are in the aggregate, not loan-by-loan. In fact, some models reward on asset accumulation, which would actually provide disincentive to sell the loans. I should know: that’s how it’s done here.

    2. If you can get a loan approval through SBA in 7-10 days like I can get a PLP number (and have many times; my record is two days), then you’re right and I am wrong. As for P+1.5%, I am working on one at that very rate right now. I also have one at P+1.75%, and another at P+2.25. Another one not yet approved by the Bank is at P+2.5%. I’ve seen a few with five-year adjustments. It’s all over the board.

    3. Fair enough, you’re definitely experienced. I go back to 1988 in the industry. With zero subsidy now, isn’t the resource issue an anachronistic argument? What “resources” are you referring to, now that each program self-funds and neither are fully utilized? If I were to question motives, I would say that the 504 lenders would LOVE what you are proposing, as you’d have a total monopoly. Think of it this way: by your argument, you are keeping the wheat and giving us the chaff. We get the riskiest segment, you get to keep doing the same thing you are currently doing, but a LOT more of it – no changes, other than to ramp up. As for motives, as I said before, none of our lenders receive commissions on their deals. In summary, I don’t think things are as black and white as you paint them to be.

    I guarantee you that I’d have to change my entire department assumptions were this to be enacted. It would absolutely be a complete net loss for me, just as it would be a complete net gain for you.

    4. I agree about name-calling, so perhaps “uninformed” was close to that (although I was referring to the opinion, not you). I apologize using the word. However, Barreto’s comments were made well before both programs became zero subsidy. With zero subsidy and with neither program coming close to being tapped out over the past few years, I don’t see how resources are being affected. Sure, there’s no doubt the 504 program has excess capacity. But so does 7(a).

    5. Now, now, I thought we weren’t going to name call? 🙂 We’re going to have to agree to disagree here. It’s not a “smokescreen” to “pad” profits, it’s part of the business model. If all I get to make is the crappiest of a generally-risky segment of lending (you’d have to agree, SBA lending is – on balance – riskier, even when doing real estate loans), it WILL affect the model. I am referring to my department’s feasibility, not a BDO’s commissions. As for rates, I guess I am not as fervently convinced that in EVERY market and EVERY situation, EVERY borrower has to have them, or even wants them. I don’t find it “bizarre”, because I’ve seen it (see below). My point was that it’s an easy sell now, but that’s because everyone correctly assumes rates will rise. What about when rates are 5% higher? Borrowers assume rates will eventually drop. I know this to be true because I’ve seen my bank’s portfolio bend and churn as the preference for fixed vs. variable changes when the yield curve shifts. I have absolutely had borrowers refinance their variable to a fixed rate (in one case that I can recall, 8.5%) and then come back 3-5 years later wanting to refinance their “high” fixed rate with a P+2 variable.

    Good discussion, though. I can appreciate your perspective, I just don’t happen to agree that your industry should have all of the most desirable segment, and mine should only have what’s left. The market should determine this sort of thing, not the legislature.

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