Ten Reasons for Banks to Focus on SBA Lending

lending-12-15-17.pngLending 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.

  1. 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.
  2. 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.
  3. 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
  4. 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.
  5. 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
  6. 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.
  7. Capital and loan loss reserve requirements are lower on SBA loans.
  8. A bank can grow its portfolio more rapidly through SBA lending.
  9. Guarantees on SBA loans increase liquidity for the bank.
  10. 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.

How is Your Bank Perceived by the D&O Underwriter?

hockey-goalie.jpgWhether you are an executive preparing for the upcoming directors & officers (D&O) liability insurance renewal or a board member preparing for the D&O discussion at the next meeting, there is one person you should be trying to impress. That’s the underwriter who is analyzing your bank and determining the D&O renewal terms and conditions.

The perceptions of this individual are going to determine whether the insurance policy that protects the personal assets of the directors and officers and the corporate balance sheet is comprehensive enough to include the most up-to-date coverage enhancements, or is so restrictive as to include a regulatory exclusion. Now before getting into what steps you can take to improve that perception, it is important to understand the claims and litigation trends that these underwriters are talking about before they start to take a look at your bank.

The top two claims leaders in the banking D&O marketplace continue to be regulatory exposures and M&A. With regards to regulatory concerns, the data provides an interesting dichotomy. While we see a decrease in 2011 for both class action claims relating to the credit crisis and to the number of failed banks (figure 1), we continue to see a very large spike in the number of FDIC D&O defendants (figure 2).


This is consistent with the fact that the FDIC reports that “most investigations are completed within 18 months from the time the institution is closed” (www.fdic.gov). And it is not just failed banks that concerns underwriters. Most underwriters would categorize a bank as a regulatory risk if any of the following exist:

  • Any open regulatory agreement
  • Consent order
  • Cease and desist order
  • MOU (memorandum of understanding relating to asset quality, earnings, or capital, but not so much for safety and soundness or the Bank Secrecy Act)
  • Severe degradation of asset quality following a regulatory exam or audit where the expectation would be a regulatory restriction on the following exam (Texas ratio close to 100 percent or Tier 1 capital/total loan ratio of <2 percent)

And once a bank is perceived as a regulatory risk, there is a good chance that the D&O liability terms would include the very restrictive regulatory exclusion.

As mentioned, the second significant risk exposure is M&A (mergers and acquisitions), which also demonstrates compelling data points. In 2010, M&A filings represented the largest broken out category with 40 such filings representing out of 167 filings or 24 percent. That percentage jumps to 30 percent in the first half of 2011. So if your institution has any regulatory exposures or is anticipating some type of M&A, you can expect a lot of questions during the upcoming renewal process.

And while there are many ways to address those questions, we believe that coordinating some type of underwriter meeting or call is the best way to improve underwriter perceptions and generate the most comprehensive D&O renewal with regards to terms, conditions and pricing. The process usually entails coordinating a meeting with the management team, the incumbent underwriter and all competing underwriters either at the bank’s office or a centrally located site. In order to make the meeting as productive as possible, your broker should obtain any questions the underwriters would have and present that to the management team prior to the meeting. The benefits of such a meeting are four-fold:

1. Unlike insurance lines such as property/casualty or workers’ compensation, where actuaries are able to somewhat predict the likelihood of a claim based on past trends, there has been no reliable model to mathematically predict when the next securities class action or next suit against a director/officer will be. So when an underwriter has an opportunity to meet or listen to the management team, this provides a gut feeling as to the quality of the management.

2. Having all of the underwriters in a room or on a call at the same time goes a very long way in fostering the competitive influences in the marketplace. One comment I hear is that it is unfair to include the incumbent underwriter in the same meeting as all of his/her competitors What we recommend instead is to then have a one-on-one lunch or dinner meeting with the incumbent underwriter(s) to further develop that existing relationship.

3. By meeting with the underwriter, you have now developed more of a personal relationship with the underwriter, which can be helpful in the future is in the event of there is a claim or a service request.

4. One of the frustrations I hear a lot from bankers is that the process to finally bind up the renewal often incorporates a lot of last minute questions or requests. At this meeting with the underwriters, you are basically saying, “speak now or forever hold your peace.” We find that once the meeting is completed, the remainder of the renewal process becomes very streamlined.

So as you prepare for that D&O renewal or discussion, don’t forget to think about that underwriter and what you can do to improve the perception of the bank.