Thursday, November 5, 2009

SBA Recovery Act Programs Finally Gathering Steam

On February 14, 2009, President Obama signed into law The American Recovery and Reinvestment Act of 2009 (Recovery Act). The Recovery Act contained a number of provisions intended to spur small business lending through SBA loan programs. After a slow start, there was a dramatic increase in new SBA loans granted under the 7(a) and 504 loan programs. A brief description of each of these programs follows:

Basic 7(a) Loan Guaranty: The 7(a) loan program is the most popular and flexible. Small businesses can use 7(a) loans for working capital, machinery and equipment, furniture and fixtures, land and building, leasehold improvements, and debt refinancing under certain conditions. Private commercial lenders provide 7(a) loans and determine whether to apply to the SBA for a guarantee during the loan underwriting process. The lender applies its own underwriting criteria when deciding to grant credit. In addition, the borrower and loan structure must also meet the SBA's eligibility requirements. Borrower requirements concern business size, eligible industries, use of proceeds, and availability of other funding sources. Loan requirements include amount, maturity, interest rate, percentage of guarantee, SBA fees, and prepayment penalties. As mentioned above, lenders often securitize the government-guaranteed portion of a 7(a) loan.

Certified Development Company (CDC), a 504 Loan Program: 504 loans provide long-term, fixed-rate financing to acquire real estate or machinery or equipment for expansion or modernization. Certified Development Companies (CDC) work with the SBA and private sector lenders to provide 504 loans to small business owners. A CDC is a nonprofit corporation set up to contribute to the economic development of its community. A 504 loan typically includes 50% financing from a private lender with a first lien position, 40% financing from a CDC funded by a 100% SBA-guaranteed debenture with a junior lien, and a contribution of at least 10% equity from the borrower. Because there is an active secondary market for 504 first lien position loans, banks can reduce their exposure on 504 loans to zero.

As shown in Exhibit 1, SBA Recovery Act lending was flat from June through August 2009. However, in September 7(a) loans increased 23% and 504 loans increased 81%. (Click on image to enlarge.)

It is not all that surprising that the 504 loan increase was triple that of the 7(a) loan increase. 7(a) loans are underwritten by private, commercial lenders looking focused on credit quality, loan covenant enforcement, risk-based pricing, and strong loan documentation. 504 loans are originated by nonprofit community organizations with the ability to securitize the 504 loans, reducing exposure on the loan to zero.

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