Small Business Administration (SBA) lending is one of the key lending activities that can quickly and dramatically improve the bottom line of a community bank. It is not that difficult for a bank to generate $20 million in SBA loans, which will earn the institution between $1.0 to $1.2 million in pretax net income, if the loan guarantees are sold. Some bankers get concerned because they have heard stories of the SBA denying loan guarantees and that the SBA loan process is too time consuming and complex.
Sourcing SBA Loans
The basic strategies that most successful SBA lenders use to source SBA loans are as follows:
- Hire an experienced SBA Business Development Officer (BDO), who can find loans that fit your credit parameters and geography.
- Source loans from brokers or businesses that specialize in finding SBA loans.
- Utilize a call center to target SBA borrowers.
- Train your existing staff to identify and market to SBA loan prospects.
I have put these in the order of which approach is likely to be the most successful. However, ultimately it is the speed of execution that enables one lender to beat out another in the SBA business. So if you want to hire that high producing SBA BDO, the bank needs to have a clear idea of the types of credits that they will approve and a process that can quickly get them approved.
This can create a catch 22 for the lender, since in order to justify hiring SBA underwriters and processing personnel, you have to make sure that you generate loans. But in order to recruit those top performing SBA BDOs, you will need to show them that you have a way of getting their loans closed quickly.
The most effective solution for solving these problems is to hire a quality SBA Lender Service Provider (LSP). This is the quickest way to add an experienced SBA back shop that will warranty its work and handle the loan eligibility determination, underwriting, processing, closing, loan sale and servicing. This gives the bank a variable cost solution, and allows them to have personnel to process 100s of loans per year. While some of the better LSPs will help the lender with the underwriting of the loan, it is solely the bank that makes the credit approval decision. SBA outsourcing is very cost effective and allows a bank to begin participating and making money with these programs immediately, even if they only do a few loans.
Making a Profit
Let us look at the bank’s profits from a $1.0 million SBA 7(a) loan that is priced at prime plus 2.0 percent with a 25-year term.
|Guaranteed portion||$ 750,000|
|Unguaranteed portion||$ 250,000|
|Gain on the sale of the SBA guaranteed portion||$ 90,000||(12% net 14% gross)|
|Net interest income(5.25%-0.75% COF = 4.5%)||$ 11,250||(NII on $250,000)|
|Servicing Income ($750,000 X 1.0%)||$ 7,500|
|Total gross income||$ 108,750|
|Loan acquisition cost (assumed to be 2.5%)||$25,000||(BDO comp, etc.)|
|Outsource cost (approximately 2.0%)||$ 20,000||(per SBA guidelines)|
|Annual servicing cost (assumed to be 0.50%)||$ 5,000|
|Loan loss provision (2.0% of $250,000)||$ 5,000|
|Total expenses||$ 55,000|
|Net pretax income||$ 53,750|
|ROE ($53,750/$25,000 risk based capital)||215%|
In this example the bank made a $1.0 million SBA loan and sold the $750,000 guaranteed piece and made a $90,000 gain on sale. The bank earned $11,250 of net interest income on the $250,000 unguaranteed piece of that loan that the bank retained. When an SBA guaranty is sold, the investor buys it at a 1.0 percent discount, so the lender earns a 1.0 percent ongoing fee on the guaranteed piece of the loan for the life of the loan. This example did not account for the amortization of the loan through the year.
I believe that the expenses are self explanatory, but you can see if the bank made $20 million of SBA loans using these assumptions, they would earn $1.075 million in the first year.
As you can see, SBA lending can add a substantial additional income stream to your bank; however, you need a certain amount of loan production and a high quality staff, or you need an SBA outsource solution to underwrite and process the loans. As you can see, the ROE and ROA for SBA loans is much higher than conventional financing, which is why you see community banks that have an SBA focus generate higher returns.