SBA Lending Matters Newsletter
A Word from Arne

The holiday season is here again, and those of us involved in the SBA lending business have much to be thankful for. We know that access to capital is the lifeblood of small businesses, and FY 2015 was a record-breaking year for the SBA. Gross loan approvals for the agency’s 7(a) program totaled $23.6 billion – a 23% year-over-year increase! During the last three years, the dollar volume of the 7(a) program increased 55%, while the number of loans increased 43%.

Amid all this growth, it’s apparent that the Small Business Administration continues to be a model government agency. The SBA consistently operates at a zero subsidy level, funding its operations through the assessment of guaranty fees. Congratulations to Director Maria Contreras-Sweet, and the entire SBA staff, on their efficiencies.

On the subject of efficiency, I’d like to let you know about a couple of observations Holtmeyer & Monson has made when processing applications for clients. It seems that a couple of items regularly require additional analysis: the Credit Elsewhere Test and Debt Refinancing Eligibility.

Credit Elsewhere Test: The SBA is required by statute to provide assistance only to borrowers who are unable to obtain credit on reasonable terms elsewhere. Previously, the SBA’s Personal Resources Test denied loan eligibility because a business owner (one with 20% or more equity) had liquid resources that could be injected in the business. That test went away in 2014. However, the Credit Elsewhere Test asks lenders to explain why cash from the owner is not required and an SBA loan is needed. Analysis of SBA loan applications involves an amount of subjectivity, and lenders should take care to adequately document their files.

Debt Refinancing Eligibility: Refinancing debt with an SBA loan requires some additional scrutiny as well. The SBA’s SOP is clear about that certain requirements must be met to refinance existing debt with a new SBA guaranteed loan. We’ve seen instances when a borrower’s request to refinance debt meets the SBA requirements, but the current credit terms are deemed to be reasonable and not eligible for refinancing via an SBA loan. We encourage borrowers and lenders to have us seek clarification from the SBA when refinancing debt. This will avoid your wasting time and effort on an ineligible application.

The ins and outs of SBA requirements are things we’ve learned over many years. We’re glad to share that knowledge. If you have any SBA-related question or issue, please call on us. In addition to supplying answers, as a qualified Lender Service Provider we can also serve as your out-of-house SBA loan department – another reason why Holtmeyer & Monson is a Preferred Service Provider of the Independent Community Bankers of America.

From all of us here at H&M, you have our best wishes for a merry Christmas and happy holiday season.

Featured Article

The Long and the Short of It: SBA Pools Can Create an Instant Barbell
by: By Jim Reber, President/CEO, ICBA Securities

Military strategists are always reminding those under command to “guard the perimeter.” Ensuring that the outside boundaries of an army’s territory are secure is essential in protecting its position. Great attention, and resources, are dedicated to guarding the flanks. In investment portfolio parlance that translates into creating reasonable performance out of short-term and long-term investments (and here’s the trick) simultaneously.

For the past eight years, the shape of the yield curve (steep) and the policies of the Federal Open Market Committee (“accommodative”) have created an environment in which all yields on investments popular with community banks are compressed in absolute terms. Some portfolio managers have been tempted to stretch beyond their duration comfort zones to attain yield. This column, fortuitously, suggests a strategy that many community bankers have employed that produces an acceptable risk/reward tradeoff.  And it all involves securities guaranteed by the full faith and credit of Uncle Sam.

Short, sweet
The Small Business Administration (SBA) issues securities backed by loans it guarantees, made to qualifying small businesses. The flagship program, 7(a), produces true floating rate securities. These 7(a)s are unique in that they float based on Prime, either monthly or quarterly, and have no caps whatsoever. The typical investor of these pools wants a very short duration, and some (i.e., not a lot) current yield.

The risk in these pools is the price. Most have substantial premiums, often over 10 points, and since they can prepay at any time, the investor could conceivably have its yield hammered if a number of loans prepay sooner than expected. Two ways to protect yourself are to: (1) Purchase newly-issued pools, as history shows that new SBA loans have several years after origination in which payoffs are very slow, and (2) Purchase large pools that have a limited number of large credits. The seller should be able to produce a detailed loan list for a given pool.

On the other hand
And now for you fixed-rate fans, the SBA also issues bonds known by the alphabetic DCPCs, which are backed by the guaranteed portion of SBA 504 program loans. These have either 10- or 20-year maturities, so their average lives can be quite long. This is especially so since they contain prepayment penalties for the first five years of their term, which effectively shuts down all prepay activity in the early going.

A new 20-year DCPC will have an average life of about six years initially. A feature that makes these a good pairing with 7(a) pools is that they can be purchased with little or no premium, so that the average book value of a combination of the two can be more palatable to a community banker. Like their floating rate brethren, they are quite liquid and generally pledgeable. Because of their longish durations, they are often viewed as municipal-bond surrogates for institutions that can’t benefit from tax-free bonds or simply wish to layer in some zero-percent risk weightings.

What to expect
A recent barbell strategy utilizing equal amounts of floating- and fixed-rate SBAs that has been employed by community banks had the following metrics:

• Average coupon:   3.037%
• Average book price:  106.785
• Average yield: 2.05%
• Average duration: 3.16 years

There are two additional points to put into the hopper. The first is to remind you that half of these investments are floating rate, so that their yields will improve immediately whenever Fed Funds (and Prime) rise. The second is that a three-year Treasury note yields about 1.30 percent at the moment, so you would be significantly improving your income in a similar duration vehicle, with no drop in credit quality.

A final reminder is that, for you 7(a) lenders, a sellers’ market is in session. Premiums have remained near their all-time highs, given the increased demand for the floating rate pools and the slow prepayment histories since 2009. If you have one or more 7(a)s in your bank’s loan portfolio, I strongly recommend asking your favorite broker for a bid. Fee income is a significant part of any bank’s strategy of protecting the perimeter.

Jim Reber is president/CEO of ICBA Securities and can be reached at 800-422-6442 or [email protected]. ICBA Securities, through its exclusive broker Vining Sparks, models barbell investment strategies for community banks each week. Contact Jim directly for the latest DCPC/7(a) barbell model.

Regulatory Corner

Update on Franchise Affiliates
A hot issue has arisen over the past several months and we at Holtmeyer & Monson, along with others in our industry, are actively seeking a common-sense change in a proposed SBA rule: affiliation based on franchise agreement and license agreements.  This rule would require borrowers to meet the affiliation test for franchise ownership interests completely unrelated to the applicant business. For example, we recently served a well-qualified applicant seeking to finance an SBA-approved franchise business. The borrower’s fellow owner also had a passive affiliate ownership interest in another franchise business that was not SBA approved. To become eligible for the SBA loan, the applicant had to make changes to the affiliated franchise agreement. On its face, this rule is unreasonable, and we are pushing hard to limit franchise or license agreement reviews to the immediate loan applicant.

Please call your Holtmeyer & Monson representative for additional details on this issue.

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SBA Hot Topic
Occasionally, a 7(a) Authorization needs to be modified after issuance and before loan closing. SBA can handle these modifications on an expedited, 48-hour basis — but only one time per Authorization. Additional modifications will take about 5 days per request.  We are happy to handle these for you, but caution clients to review your Authorization carefully and address all modifications in one request.


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