A Primer on Changes to SBA-Backed LoansTom Taulli
President Barack Obama and Treasury Secretary Timothy Geithner recently announced sweeping changes for the Small Business Administration's loan programs. Are these changes simply smart public relations or will they benefit small business owners whose access to credit has dried up? Opinions vary within the business community, but entrepreneurs should still consider applying for these loans—as long as they meet certain criteria. Bear in mind: The SBA doesn't make loans directly to business owners; it guarantees them to commercial and nonprofit lenders that participate in its programs.
Before I explain the specific changes, let's step back and review the relevant parts of the announcement: Obama plans to commit up to $15 billion to make direct purchases of SBA-backed loan securities in the secondary markets. Keep in mind that lenders often sell their loans to Wall Street, which frees up capital to make even more loans. But in September this market froze as the financial system went into cardiac arrest. The Obama Administration is now committing the money in hopes that by supporting the secondary market, lenders will gain their confidence back and make new loans.
The plan will also require that the largest 21 banks—that received federal bailout money—will now have to detail their small business loans on a monthly basis. Additional banks may be required to do this quarterly. In other words, this measure is meant to pressure lenders to make more loans.
Another change is a boost in the loan guarantees, to a maximum of 90% on 7(a) loans (see below for more on these). To encourage these loans, which are generally considered riskier than most by lenders, the SBA is increasing the amount of its guarantee, which helps to encourage lending. While this increase sounds small, it is important. "Lenders are concerned about default rates on loans," says Scott Gabehart, a business appraiser who operates TheNewSBARules.com. "But an extra 5% of coverage may be enough to provide comfort for lenders."
The Obama plan also has important changes for different types of loans. To understand them, here's a rundown on the main loan programs. You can find a list of preferred SBA lenders—lenders that don't need to consult the SBA on each loan application—at the bottom of this page on the SBA's Web site.
7(a) loans Up to $2 million. The purpose for the capital is broad (expansion, acquisitions, startups, franchises, equipment, and even partner buyouts).
504 loans Up to $4 million. The main focus is on construction, renovation, or purchase of commercial property.
Microloans Up to $35,000. Typically for working capital needs—that is, cash to pay for short-term needs such as payroll and vendors.
The changes also mean the government will eliminate SBA fees you would normally pay your lender on 7(a) and 504 loans (to the extent of the guarantee). Generally, the fees will range from 2% to 3.7% on 7(a) loans and 1.5% for 504 loans. That means, for example, you could save $6,600 on a $200,000 7(a) loan and $3,000 on a 504 loan (assuming a 90% guarantee).
When you account for the new depreciation regulations, eliminating those fees makes these loans attractive, right? The Obama plan allows for up to $250,000 in deductions for business expenses for one year. For example, if you use an SBA-backed loan to purchase a business or property, you can take larger depreciation expenses, and these tax benefits will help to boost cash flow. Another favorable factor: The valuations for businesses and land are much lower now than in the recent past.
Still, the fact remains that banks will likely focus on what they deem the safest customers—at least at first. So a borrower will need a strong business plan and detailed financials to be considered. Moreover, the owner should have a background in the industry. Even if you meet this criteria, expect much scrutiny. The banking industry is in the process of healing. So it will take some time to warm up to more risk-taking. "Lenders will look for skin in the game," says Chris Reilly, president of CIT Small Business Lending (CIT), the country's largest 7(a) lender. "This means providing a personal guarantee or collateral."
During downturns, great opportunities arise. And this time is no different. If anything, the federal government is willing to make substantive changes to spur lending to small business. If you can demonstrate that extra funding will lead to growth, then an SBA loan is certainly a worthy option.