Lending teams are often unable to underwrite loans that don’t fit within the bank’s commercial lending policy, but many of these loans could be done as Small Business Administration loans. For example, 10-year equipment financing is an option with the SBA program, but most banks only provide terms of up to 5 years. Providing low risk alternative financing structures for borrowers can increase profits for the bank.
Banks can quickly begin an SBA lending operation by outsourcing through a lender service provider. This ensures that the bank’s SBA loans are done correctly. Fees are only incurred when the loans close, and the bank is making money.
As chief executives and their management teams consider how to increase the bank’s profitability in the coming year, here are 10 reasons to include SBA lending as a tool for success.
- A small SBA lending department underwriting $8 million to $10 million in loans annually can expect to generate $600,000 to $750,000 per year in pretax income.
- The SBA guaranty can mitigate the bank’s risk on any loan, but especially on under-secured loans. The SBA will cover 75 percent of the loss if there is a default on the loan.
- For smaller banks, the SBA guaranty program expands the legal lending limit, since only the unguaranteed portion of an SBA loan is counted against a bank’s lending limit. Given the SBA’s 75 percent guaranty on loans, a bank with a $1 million legal limit could underwrite a $4 million SBA loan.v
- SBA loans can help a bank improve its activities under the Community Reinvestment Act (CRA) by reducing risk, and providing small businesses with longer terms and enhanced cash flow.
- The SBA allows banks to refinance existing loans in their portfolios. This can help the institution to restructure its loans with longer terms, manage loan concentrations and reduce risk.v
- SBA loans typically have a variable rate and provide the bank with a higher yield than a conventional loan. Given this, creating an SBA portfolio can help improve a bank’s interest yield on its portfolio.
- Capital and loan loss reserve requirements are lower on SBA loans.
- A bank can grow its portfolio more rapidly through SBA lending.
- Guarantees on SBA loans increase liquidity for the bank.
- SBA loans produce more fee income.
To illustrate these benefits, let’s consider the following example. A $300 million asset bank earns $2.4 million in net income annually, a 0.8 percent return on assets (ROA). If the bank starts an SBA department the next year, funds $10 million in SBA loans and then sells the guarantees, the bank will likely earn an additional $600,000 in after-tax income. That additional income will push the bank to the 1 percent ROA level. If the same bank has 3 million shares of stock outstanding, the increased earnings will likely move the stock price from $8 to $10 a share, assuming a price to earnings (P/E) ratio of 10. This improvement in financial performance will reflect positively on management, and the SBA loan portfolio only increases by $2.5 million, or one-quarter of SBA loans that are not guaranteed.
All bankers come across loans they would like to fund, but can’t, or loans they are confident are good loans but don’t quite fit into the bank’s commercial lending policy. We have seen many banks utilize SBA lending to provide better financing terms to their clients, mitigate risk and make these loans bankable. The result is more satisfied clients and higher profits.