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Wasteful Government: Duplication at the SBA and What to Do About It…
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You and I both know that the SBA is a helpful resource for small businesses. Many, many business owners have gotten a financial “hand-up” from this government agency, and these small businesses have long been the “backbone of the American economy” (pardon the cliché, but it’s true).

Despite the benefits of the SBA’s loan programs, it can do MUCH better. It needs to do better for the sake of our country’s small businesses and our overall economy. As I’ve explained before, there’s some overlap between the SBA 7(a) loan program and the SBA 504 loan program that is NOT helpful, and is actually downright wasteful. Watch the video below to hear my full argument and see if you agree:


Full disclosure: I specialize in the 504 loan (aka our SmartChoice® Commercial Loan). But that doesn’t mean that I oppose the use of 7(a)s at all…under the correct circumstances. You can do things with a 7(a) loan you can’t with a 504 (working capital and business acquisitions, for example), and these loans are necessary to help small business owners grow and succeed. When it comes to owner-occupied commercial real estate, however, choosing a below-market, fixed-rate 504 loan over a floating-rate 7(a) loan is a no-brainer.

The 504 loan was designed specifically for this purpose (financing commercial real estate and equipment), and gives small business owners the benefits of long-term, below-market, fixed-rate financing with as little as 10% down. 7(a)s typically have variable rates (not good for keeping monthly expenses low) and require much more collateral to be pledged. Plus, as I mentioned in the video, billions of SBA 504 loan dollars go unused every year while the 7(a) program is regularly in need of additional “allocations.” I believe we can make better use of these monies by finally drawing a clear distinction between these two great loan programs, and we’ll help more small business owners in the process.

Whether you agree with me or not, I want to hear what you think. Lively debate is one of the reasons I started this blog in the first place. I love hearing well-thought-out arguments and responses from our readers, so have at it. Leave a comment below or email me at ChrisHurn@MercantileCC.com to add your voice to the debate.

Thanks in advance for commenting and for sharing this blog with someone you know. And DO share it…if we want our government to work more efficiently, then it’s incumbent upon people like you and me to expose issues and present solutions.

Dedicated to Your Continued Success,

Chris

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24 Comments

  1. Clifford Kearns says:

    Always good to hear from you, keep up th good work!!! Mid-Atlantic Commercial Capital L.L.C

  2. Craig Longwill says:

    Chris, while i agree with you that the 504 program has distiinct benefits espeially when it comes to interst rate risk it has been very difficult in this credit market to get the bank to fund the conventicle piece of the capital stack. It would be rally nice if the SBA would at least give some guarantee to the conventional loan. We broker quite a bit of SBA paper but have not had success utilizing the 504 program due to the banks unwillingness to fund the c0nvenaitol mortgage. Any thoughts?

    • Chris Hurn says:

      Thanks for your email, Craig. I DO have some thoughts:

      1. As part of the Small Business Jobs and Credit Act of 2010 (passed in late September 2010), Congress and the President signed into law $3 billion of guarantees (80%) of SBA 504 first mortgages. These guarantees have a separate borrower fee to cover losses, but it’s called the First Mortgage Loan Pooling (FMLP) program.

      2. We happen to be doing lots of these transactions, so there IS hope. Trouble is, there’s only so many (actually very few) people who know about this and who understand this.

      3. Give us a call and we’ll see if we can help get these 504 first mortgages done for you.

  3. Ronald Neufeld says:

    If the SBA504 second mortgage were changed from RECOURSE to NONRECOURSE,
    this would be an extremely useful mortgage plan, in particular because the second
    mortgage already has a SBA guarantee.

    In particular regarding the acquisition of self storage complexes in which I am interested.

    • Chris Hurn says:

      Thanks for your email, Ron, but I think your suggestion of making the second mortgage on SBA 504 loans “nonrecourse,” a bit irresponsible. I think the US taxpayers deserve better than that. And, incidentally, ANY time ANYONE complains about personally guaranteeing a small business loan, that sends up a MAJOR red flag to me about their willingness to repay my prospective loan to them. As someone who’s had nearly $40 million in contingent liability at one point in time, I’m a little, shall we say “less patient” when someone only wants (and/or thinks they deserve) a nonrecourse loan.

  4. Dave Berkley says:

    Sorry sir, but I don’t share your view that the organization is “helpful” in any real sense of that word. Keep the frickin’ government as far away from business as possible! Let markets do what they do best—allocate resources on merit.

    • Chris Hurn says:

      Thanks for your email, Dave. Couple remarks to your feedback:

      1. That’s perfectly “okay” if we don’t share the same opinion of the SBA, but in dealing with them almost daily for 15 years, I might have a bit more perspective… and trust me when I say that they’re a much more “user-friendly” and efficient governmental agency than they were only a few years ago.

      2. I don’t necessarily disagree with your “keep the friggin’ government as far away from business as possible,” but I think they are clearly examples where some governmental agencies actually work well… the SBA happens to be one of them. See, the loan programs they offer are made by private sector businesses (like mine, which didn’t get TARP money, by the way) and the “guarantee” part is really a misnomer: borrowers pay loan fees which cover the losses. In fact, only a few years ago, the Feds were using these “excess” fees (before they reduced the loan fees the following fiscal years) for other government interests. Put another way: these loan programs are actually what are called “zero-subsidy” programs; meaning they don’t cost the taxpayer money. Sure, the agency has a relatively small budget for staff (and maybe certain things there could be cut back further – no question or debate on that from me), but the SBA runs yearly on what it costs the DOD to buy about 20% of just one Nimitz class aircraft carrier… yet in doing so, it routinely helps tens of thousands of small businesses who employ millions. I’d venture to say that the SBA’s loan programs are one of the better public-private partnerships around.

      a. And by the way, I’m VERY sympathetic to libertarianism, but I suspect you (like me) will still drive on federal highways and still collect our Social Security checks (assuming they’re even available) when they’re offered to us (since we paid into them), right? Those are just a couple of examples off the top of my head.
      b. And don’t you also sell to the government (the military)? Does your mantra (“keep the friggin’ government as far away from business”) extend to that? I didn’t think so.
      c. It’s too easy and simplistic to say what you did (much as we both may want limited government), but certain things operating in the government aren’t nearly as bad as the popular perception (actually, misperception) might be.

      3. Lastly, glad you brought up merit because one of things commercial lenders such as ourselves have been criticized for during the downturn is a lack of lending (completely inaccurately for us, however – we’ve lent more year-to-date than any other year in our 8-year history). Part of the reason for reduced lending nationwide to small businesses is the fact that many small business applications show an inability to repay the loans they’re seeking. In other words, we’re objectively reviewing applications on merit (what you’re suggesting we do), but then being criticized for doing so… can’t have it both ways. Wish some people got that.

      Best of luck to you and thanks again for commenting!

  5. Timothy Long says:

    Speaking as one who has never gotten the hand up requested I am not sure the EVA means that much.
    I continue to struggle and continue to get nowhere.
    Thanks for the opportunity to vent.

    • Chris Hurn says:

      Thanks for the email, Timothy, but what do you mean by EVA?

  6. Brian Bare says:

    Nice work Chris. You should get paid advertising by NADCO. Will share.

    • Chris Hurn says:

      🙂 You would think by now… but not sure they quite feel the same way, unfortunately.

  7. Philip Ison says:

    DO YOU REALLY THINK THE SBA IS OUT TO HELP ANY ONE IT IS JUST FOR. GETTING PUBLISCITY FOR THEGOVERNMENT

    I HAVE A START UP FACTORY MAKING UPHOLSTERY AND CREATING JOBS. DO YOU REALLY THINK THESE IDIOTS IN WASHINGTON REALLY CARE ABOUT THIS.

    IT IS SO HARD TO MEET THE NON EXISTENT RULES THE BANKS MAKE UP AS THEY GO NO ONE NOT EVEN YOU WILL GET AN SBA BACK DEAL.

    • Chris Hurn says:

      Yes, Philip, I KNOW the SBA helps business owners. Perhaps you’ve spoken with/visited the wrong lenders and/or your business isn’t showing the ability to repay the commercial loans you seek? I don’t have any further details from you, nor want to speculate further. However, I understand MANY people are angry at those elected officials in Washington these days (and have every right to be) — I’m not sure DC has a larger percentage of “idiots” than the “regular” population (they might), but they certainly have too many people who aren’t living on Main Street and understanding how their regulations and rhetoric affect it. Best of luck to you.

  8. Rosemary Mohl says:

    Chris-

    Most of the borrowers I’ve had prefer 7a over 504 loans for real estate because they are realistic about long term planning. They have an accurate vision for the first 3-5 years, but see potential for many changes.Foremost on their minds is the notion of getting into more business friendly conventional loan asap. If they had the $, they’d do a conventional loan; but as SBA allows a bit less down and longer amortizations, it works for them now. Variable without a ten yr. prepayment penalty fits their needs for flexibility.

    • Chris Hurn says:

      Thanks for your comments, Rosemary. Unfortunately, I think you’re misinformed on several things:

      1. The vast majority of our past clients from 6 to 9 years ago (when I started my company) are still in their commercial real estate we financed and with their same 504 loans we provided for them. These people had perfectly reasonable long-term plans, namely replacing a rental payment with a mortgage payment that could actually create wealth for themselves. If a small business owner is fickle enough to only have a 3 to 5-year time horizon on buying commercial property for their business, then I’d consider them more of an investor, rather than an owner-user looking to build long-term wealth for themselves. “Flippers” are more prevalent in residential lending and are a reason I’ve never bothered with residential mortgages. 504 loans are meant for owner-users — that’s why the US government gets involved and “guarantees” them (even though these guarantees come from the collection of borrower fees to cover-off losses).

      2. The great myth that has somehow perpetuated is that conventional bank financing is “more business friendly” (to use your words). Conventional financing these days typically requires 35% to 20% down-payments; 15 to 20-year amortizations; 3 to 5-year balloon payments; and enough call provisions and loan covenants to make an attorney blush. By contrast, our 504 loans require 10% down (so small business borrowers can keep more of their precious cash); have 25 and 20-year amortizations (so monthly payments are lower); are fully-amortizing (so no worry and cost to refinance principal in a few years); have below-market, long-term fixed interest rates (no banks anywhere in the nation are able to do 5.13% fixed for 20 years, which is what the SBA 504 debenture rate was this month); and have no call provisions or loan covenants. Looking at these distinctions, I know which loans are “more business friendly” for sure.

      3. Plenty of my past borrowers were very “bankable” customers, but why should they put 20% or more down to buy property when they can get better returns by investing elsewhere (often times, in growing their business)? What most people don’t understand about real estate investing are the notions of greatest cash-on-cash return and trying to best utilize your capital (which is finite). I think it’s a pretty smart business decision to try to maximize your ROI on your real estate investment — that’s why I have a 504 loan over other types (including a 7(a)), and it’s why we’ve rebranded the 504 as the “SmartChoice Commercial Loan.” Smart business owners choose a 504 loan over an ordinary conventional bank loan because it has many more advantages to them — is truly “business friendly.”

      4. Flexibility is a tad “over-rated” here and something 7(a) lenders push all too often (because their motives are questionable when they’re selling-off the guaranteed portion and making up to 14% in premiums). 504 loans allow for assumability (and yes, I’ve been involved with these previously), so a prepayment penalty doesn’t have to be a reason not to choose this loan type. Additionally, we will soon be headed into a rising rate environment (they have nowhere to go BUT up), so locking in bond rates on 504 loans below 5.5% fixed for 20 years becomes a HUGE selling advantage down the road, if need be (I’ve lent in rate environments where Prime is 10% or more — “flexibility” may be the buzzword now, but borrowers will be PISSED later when their Prime + 2.75% rate goes from 6% today to 9% or higher in the next couple years) . I consider the ten-year prepayment on the debentures of 504s to be the “cost” of getting the least expensive financing vehicle available in the marketplace for small business owners wanting to buy commercial property (remember: I actually use my own loan product, so I’ve been in my borrowers’ shoes before — this isn’t just academic or some BS sales pitch). And let’s not forget: these are true prepayment penalties (that decline yearly — about 10% of the note rate each year until burned off after year 10 of the loan) NOT yield maintenance fees and defeasance… the folks who chased CMBS deals a few years ago have seen what the difference is.

      So in sum, Rosemary, I think it’s not so easy to dismiss 504 loans when compared to 7(a)s for real estate. In fact, it would be a very wrong-headed decision, and one I hope you won’t encourage your clients to make.

      • Walter McLaughlin says:

        Chris —

        Actually, although average life of CRE loans is very long right now and has been since the interest rates were pushed to historic lows, over a long-term horizon they’ve been relatively short, in the range of 4-6 years. Market forces have created factors which have kept them, generally speaking, much shorter than you’d empirically expect. I know this because I have done FASB adjustments to portfolios which require that data as a component of the calculations.

        As for the selling of 7(a) loans, I think that’s a very fine line that needs to be walked. You imply the lender might be tempted to be less-than-forthright because of the premiums, which I would disagree with. 504 1st mortgages can be sold for substantial premiums as well. I believe that 99% of the lenders feel they are offering the borrower the correct product for their circumstances. Perhaps due to biases, we just don’t always happen to agree upon what that is.

        • Chris Hurn says:

          I can assure you, Walter, that 504 first lien portion premiums are a fraction of what they’d be if those transactions were made as 7(a)s. First of all, premium dollars are paid on only 50% of the project with a 504, as opposed to 75% (currently) on a 7(a). Secondly, the secondary market currently pays up to 14.25% premium on real estate-backed 7(a)s; 504s max-out at 6% at the moment. I’d say this “substantial” (to use your word) difference provides most of the “evidence” necessary to support my contention. Perhaps your bank would never act this way (steer borrowers into one program over another for primarily profit-seeking reasons, irrespective of the inherent negatives to the borrower by doing so), but I’m afraid you’re the exception, Walter.

          If we can ever be of assistance to your bank (for interim seconds, for instance), please don’t hesitate to contact me. We really DO walk our talk.

          • Walter says:

            Chris —

            I spent more time discussing this issue in the other thread, but I think it borders on conspiracy theorism to assume that all 7(a) lenders steer their clients. Incidentally, by no means to all 7(a) lenders sell their loans. In fact, the larger ones typically don’t. That takes much of the wind out of the 14% vs. 6% argument.

            You absolutely feel doing a 7(a) real estate loan is wrong. Many on the other side are firmly convinced it is right — both borrowers and bankers. That doesn’t mean either side is “wrong”.

  9. David says:

    Hello Chris.Never a dull or uniformed moment with you.I watch your blogs daily and they are very very educational.My question is this:How are the two mortgage peices of the sba 504 loan paid?Do you pay the lender who in turns pay the CDC or do you send of seperate mortgages?

    • Chris Hurn says:

      Yes, never a dull moment indeed… you can tell how much of a nerve I hit (and how accurate my position really is) by the outrage expressed by some.

      To your question: there are two mortgages (or trust deeds, depending on the state) which are paid separately: the SBA’s portion (the second lien position) is ACH’d through Colson Services; while the conventional portion (the first) is paid directly to the Third Party Lender (whether by check or ACH). Hope this helps explain things some.

      • Walter says:

        Chris, let me preface this by saying that I do enjoy your blog, and I appreciate your conviction. Again, we do 504’s here, so to some degree, I share them.

        However, when you say this:

        “you can tell how much of a nerve I hit (and how accurate my position really is) by the outrage expressed by some”

        I’m reminded of the old line about specious reasoning: I am waving my spoon in the air. No bears are attacking me. Thus, waving a spoon must ward off bear attacks.

        I’ll agree you may have hit some nerves, but that doesn’t automatically mean you are accurate. Certainly some of what you say is, I’ll agree to that, but when you delve into absolutism, you start waving a spoon into the air.

        • Chris Hurn says:

          Thanks for your, now, nice comments, Walter.

          Oops, now you’ve just gone and said my reasoning is “specious.”

          Look, most of the disparaging remarks that get hurled at me aren’t nearly so reasonable as the ones you’ve made. Most of them are unprintable and not exactly “family-friendly.” And, shockingly enough, very few ever go through and attempt to counter what I’ve said, as you have done. These idiots just attack and if they make a coherent remark, it’s often rather hypocritical (or completely misinformed) given their past associations. I’m not so sure I “delved into absolutism” as much as I’ve attempted to solve a problem… one I see few others addressing. Rather than your “spoon and bear attack” story, I’m reminded of the old adage about how far your ass hangs out, for others to shoot at, as you go up the totem-pole. THAT may be a more accurate picture of what’s occurred here. 🙂 Be good and enjoy the Labor Day holiday — perhaps that day will finally bring some attention to the need for public policies that encourage job creation!

          • Walter says:

            You too, Chris. Let me know if you ever get to the Seattle area. I think you’d be a very interesting guy to take to lunch.

            I’ll be at the NAGGL conference this October as well.

  10. Michael Burt says:

    I am on your list for your 504 blog and appreciate the news sharing.

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