In today’s challenging banking market, community banks are always looking for ways to increase profits, minimize expenses and diversify their loan portfolios. One solution many banks are utilizing is to add an SBA lending department into their mix of loan products.
The primary SBA lending program is the SBA 7(a) loan program, which allows the bank to make small business loans and receive a 75 percent guarantee from the U.S. government. The guaranteed portions of these loans can be sold in a secondary market, with current gain on sale premiums of 13.5 percent net to the bank.
SBA lending is not only a great way to increase the number of business clients that your bank can serve, but can also be very profitable.
Let’s assume that you hire your underwriting and processing staff and the lending staff brings in $10 million in SBA loans. If the bank sells the 75 percent portion of the loans that is guaranteed, or $7.5 million, it should earn at least a 12 percent premium in today’s market, or $900,000. For simplicity sake, we will exclude interest and servicing income from this analysis. If you can generate the $10 million with an internal lending staff, the bank will generally have the $200,000 processing and underwriting expense, and therefore generate $700,000 in profit.
Impact on Stock Price
Let’s say your bank currently makes $1.5 million per year in income from its current activities and has 3 million shares outstanding, or an earnings per share (EPS) of 50 cents. At a typical price/earnings ratio of 10, the bank’s stock should be trading at around $10 per share. If the bank were to create an SBA department and generate the additional $700,000 in pre-tax profits, the after tax affect would be an increase in income of $455,000 or $1.96 million in total profit. This would boost the banks EPS to 65 cents and should move the stock price up to $6.50, which will certainly make your board and shareholders happy.
Other Benefits of SBA Lending
Beyond enhancing profitability and mitigating risk, many banks use SBA lending as a tool to provide better loan structuring for their loan clients. So what are some common ways to utilize the SBA 7(a) guaranty?
Some loans may be better suited to being structured as SBA loans and they may be eligible for refinancing. Converting existing conventional loans or lines of credit by refinancing them into SBA guaranteed loans is one way to improve your portfolio and generate fee income. Banks are allowed to refinance their own debt, but it is important to note that the loan needs to have stayed current within 30 days for the last 36 months. If not, SBA would consider the lender to be putting itself in a preferential position.
We recently had a client refinance a mini-storage loan they had on their books that was coming up for renewal. Their regulator had criticized the bank for having a concentration in mini-storage loans. We completed the refinance of this mini-storage loan for approximately $1.6 million and sold the $1.2 million guaranteed portion for a premium in excess of $133,000.
Many times banks have good clients that need financing for equipment the bank doesn’t feel comfortable relying on as collateral. Some examples of this might be food processing and bottling equipment, car washes, MRI machines or unique manufacturing equipment. However, the SBA guaranty can mitigate the risk of taking unique assets as a form of collateral.
Smaller banks can also use the SBA 7(a) guaranty program as a way to provide funding beyond their legal lending limit. Since the guaranteed portion of an SBA loan is excluded from calculating this limit, it frees up the ability to make more loans to a quality customer.
It is clear that creating an SBA lending group can increase your bank’s profitability and provides some significant advantages. All community banks are looking for new ways to better serve their clients and increase profits. SBA lending provides an opportunity to accomplish both of those objectives and potentially improve the bank’s stock price at the same time.