Q&A with SBA Lender George Harrop, CapitalSource
Tell us about CapitalSource.
CapitalSource Inc. (NYSE: CSE) is a commercial lender that provides financial products to middle-market businesses and offers depository products and services in southern and central California through its wholly owned subsidiary CapitalSource Bank. The company is headquartered in Chevy Chase Maryland.
CapitalSource recently purchased MainStreet Lender LLC, which is the company I founded five years ago. With this acquisition, my team is able to leverage the deep reach and financial stability of the CapitalSource platform and add small business lending expertise to the organization.
The Small Business Lending group understands the challenges facing small business owners and is an expert at structuring a wide range of financing options available to entrepreneurs. We have an experienced and well-respected team of originators, underwriters and servicers, and to date have originated more than $3 billion in small business loans.
What is the SBA 7(a) program?
The SBA 7(a) program facilitates loans to America’s small businesses by guarantying a portion of the loan made by a bank to a qualified small business. Because some small business loans are perceived as more risky for banks, the Small Business Administration provides up to a 75% guaranty to the lending institution as an inducement to make the loan. The SBA does not originate the loan. The participating bank underwrites and makes the loan, and in the event the loan defaults, the SBA agrees to limit the banks loss to 25% of the loan amount.
SBA 7(a) loans can be used to purchase commercial real estate, machinery and equipment, fixtures, furniture, inventory and other business assets, for working capital, business expansion, partner buyout, and even for the refinance of existing debt. Any “for profit” business that meets SBA eligibility requirements can apply for an SBA 7(a) loan. Most small businesses that are for profit enterprises will qualify for SBA loans.
Loans can be as small as $50,000 and cannot be more than $2,000,000. SBA 7(a) loans are fully amortizing, either fixed or variable rate, with terms of up to 25 years depending on the purpose of the loan. Loan to value can be up to 90%. This combination of long amortization and high LTV makes SBA loans very attractive for businesses wishing to preserve cash flow. Because there are no balloons or calls on SBA loans, they provide a stable, long term source of financing for small businesses.
Every SBA loan requires a personal guaranty from the borrower. The lender cannot charge origination fees on SBA 7(a) loans. However, there is a onetime SBA fee of up to 2.75% of the loan. In addition, lenders typically require at least a 1.25 projected debt service coverage.
What is the SBA 504 program?
The 504 loan program provides financing for major fixed assets such as owner-occupied real estate and long-term machinery and equipment. In utilizing the 504 program, banks partner with a local Community Development Company (CDC) – a private, non-profit corporation set up to help small businesses and promote economic development in communities.
A 504 project is funded by a loan from a bank secured with a first lien typically covering 50% of the project’s cost, a loan from the SBA secured with a second lien (backed by a 100% SBA-guaranteed debenture) covering a maximum of 40% of the cost, and a contribution of at least 10% of the project cost from the small business being financed.
Proceeds from 504 loans must be used for purchasing land and improvements, constructing new facilities, converting or renovating existing facilities, purchasing long-term machinery and equipment, or limited refinancing of existing eligible 504 debts. The 504 program cannot be used to fund working capital or inventory.
While the bank’s loan can be unlimited in size, the SBA’s portion cannot be more than $1.5 million. For this reason, the majority of 504 loans are in the $2MM to $4MM range.
504 loans are similar to 7(a) loans in that they are fully amortizing (typically 20 years for real estate and 10 years for machinery and equipment). Often the bank portion will be a 25 year amortization. The SBA piece is a fixed rate loan, and the bank piece can be either fixed or variable. Lenders typically require at least 1.25 projected debt service coverage.
What are their pros and cons?
It really depends on the situation. Since 504 loans can only be used for the purchase of long term fixed assets, they are more limited in their application than a 7(a) loan. Because of their structure, however, they can provide financing for large purchases with very little money down.
7(a) loans are limited to $2MM, so if a borrower is financing a hotel, or a larger manufacturing property, the 504 program is necessary to fund the larger cash need.
When you apply for a 504 loan, you are dealing with multiple entities, instead of just one bank the way you are with a 7(a) loan. This can cause some delays depending on the efficiency and professionalism of the local CDC your bank is counting on to partner for the loan. So you want to be sure the bank you are dealing with knows the local SBA CDC they will be working with. This can save a lot of time and hassle.
What are some benefits of SBA financing over a traditional bank loan?
Traditional bank loans are almost always at a lower LTV. One of the great benefits to SBA financing is that it provides a high loan to value, and a steady, lower payment thanks to the fully amortizing, long term nature of the loan. Not having to worry about a balloon payment provides peace of mind for small business owners.
Most banks don’t want to finance more rural businesses, or gas stations, dry cleaners, some manufacturing facilities, and startups. With the SBA as a partner, they are more willing to provide financing to these industries.
What separates you from other SBA lenders?
All of our underwriting is digital. We hardly use any paper in our process. We built proprietary, state of the art software which allows us to scan and link all parts of a loan. By doing this, we don’t lose files, we don’t ship files, and we can process and turn a deal in a matter of weeks, instead of months. We have offices in Chevy Chase, Maryland, Dallas, Texas, and Denver, Colorado. Any of our underwriters or closers can work on a deal, even at the same time, because they all log into our central servers and look at the same information. It’s very cool, and extremely efficient.
Most SBA lenders do very few loans, so they find the SBA world intimidating and bureaucratic. That’s why SBA lending gets a bad rap. Since most lenders don’t become efficient at it, they don’t like it. Of the 2,600 lenders who participated in the program last year, 780 lenders (one third) made only one SBA loan! Because we are a top 25 SBA lender, and because we have excellent software, we are more efficient, which means our borrowers get their deals done faster, and with less hassle.
We’re also an SBA Preferred Lender. Certain select lenders, after careful review and oversight, are placed in a special status called the Preferred Lender Program. CapitalSource has been named a National Preferred Lender which means we have authority to underwrite, close, service and liquidate loans on behalf of the U.S. Small Business Administration anywhere in the United States. Because of this, we don’t need to send our loan packages to the SBA for their review and approval. This translates into much faster closing for our borrowers. It’s a big deal because it means we make our own decisions on what is, and is not, eligible for an SBA loan.
Can you provide a detailed example of a recent SBA loan you funded?
In June we closed an SBA loan in a very unique industry. The borrower was an Oregon-based helicopter equipment manufacturer that was not only looking for equipment financing, but also had the desire to purchase the building that houses their manufacturing operation. Their local lender had turned them away. The economy had negatively impacted their business results, and the bank would not agree to provide financing – even with a significant cash outlay on the borrower’s part.
In approaching CapitalSource, the borrower not only sought financing, but financing with a minimal cash outlay to preserve their liquidity for operations. CapitalSource was able to provide the financing they needed, with a cash outlay of less than 10%, but also achieved a monthly cash savings for the manufacturer – the loan payment was less than what they paid in rent! The loan was made at Prime plus 2.75%, 25 year term, fully amortizing, SBA 7(a) structure.
What properties will you NOT lend on via SBA?
We don’t lend to non-profits, gambling establishments and adult entertainment. We have a limited appetite for hotels/motels, C-stores, gas stations, car wash and restaurants, especially start-up restaurants. Other than that, we really look at the quality of the transaction, the character of the borrower, and the structure of the deal.
What are the latest developments in SBA lending?
Congress is in the process of wrangling over legislation that will increase the SBA 7(a) loan size to $5MM from the current cap of $2MM. This would be a major change to the program, and would dramatically increase the types of borrowers who could benefit from an SBA 7(a) loan. In addition, it’s likely the fee waivers that have been in effect for much of the past 18 months will be re-instated. Borrowers pay a fee to the SBA to cover program costs, and the fee waiver makes an SBA loan less expensive for the borrower, which is a stimulus to the economy.
The legislation would also continue the current 90% guaranty that the SBA provided as an inducement for banks to make more small business loans. It was very effective over the last 18 months, but the waiver and 90% guaranty ran out in May. All of us are very hopeful that the politicians will get this figured out when they return in September because these stimulus measures have been an effective boost to lending, and we need small businesses to be borrowing, hiring, and thriving if they are going to pull us out of this recession.
On the 504 side, legislation is pending that would increase the size limit of the SBA portion of 504 loans from $1.5MM to $5.5MM. Again, this would dramatically expand the universe of borrowers who could take advantage of this loan product.
How much can brokers charge on SBA loans?
On 7(a) loans, brokers cannot charge the borrower anything. Brokers can receive a fee from the lender but not the borrower. On the 504 side, brokers can charge a fee to the borrower for the first lien, bank piece of the transaction.
In today’s lending environment, brokers are less the gatekeepers they used to be. A good broker, who provides value to the transaction, and there are a lot of real pros out there, can charge anywhere from a half a point to a point. We rarely see brokers paid 1.5 points today. The market just won’t bear it.
Do you have an outlet for non-SBA loans such as investment property financing?
Yes, we can usually find a home right here at CapitalSource for loans that don’t fit our box. However, we also have relationships with other lenders to place our borrowers for whom we are not the right fit.
How did you end up at CapitalSource? What is your background?
I started MainStreet Lender LLC in 2005 and grew it into the 9th largest SBA 7(a) lender. We were one of 14 non-bank lenders authorized by the SBA to make 7(a) loans. Over the last two years, it became clear that the non-bank lending model was in serious trouble. Closed securitization markets and expensive/restrictive debt facilities all made me realize we needed to join forces with a more stable source of funds. CapitalSource was the perfect fit. CapitalSource is an entrepreneurial, stable, well-run organization with a national reach. They are interested in specialty lending and saw the value in our systems, our people, and our products as a complement to their other lending groups.
My background is entrepreneurial. I’ve started several companies and worked in high growth environments my whole career. Real estate and finance are common themes of my career. I really like the challenge of starting, growing, building something.
Over the next five years my team and I plan to grow CapitalSource Small Business Lending into a top 5 SBA and small business lender! We are really excited to be here.
What changes in SBA financing and/or financing in general are you seeing post-financial crisis as compared to before?
A lot of banks are getting into SBA lending because it’s the current buzz word, and they see it as a way to deflect risk. But you can’t look at SBA lending as a way to do “risky” or “shaky” loans. Yes, there is a government guaranty, but that doesn’t mean credit is any less important on these loans. I think there are going to be a bunch of disappointed lenders in a year or two who got into this program without a long term perspective, and without the proper appreciation and respect for small business lending, and all of the nuances that go into it. SBA lending is unique. If you don’t commit the resources to it, you can make costly mistakes.
Post financial crisis, real estate is deflated in value. Many small business borrowers rely on real estate, either the real estate of their business, or their homes, for equity to get a loan. With that value down, their options are limited – especially in the conventional marketplace. Add to this banks that are skittish to make any loans at all, and you have a real slow-down. The SBA program mitigates this and provides a vehicle for borrowers to get the money they need to thrive. That’s why we are hoping the Small Business Bill passes in the very next two weeks. It really works!
Finally, the financial crisis was a little like a wildfire. It was devastating to many, but it also cleaned out a lot of opportunists in the small business lending world. There were so many people – borrowers, brokers, lenders, appraisers, etc. – who were looking to ride the bubble and make a fast buck, and they are gone. Those for whom this is a career, for whom this is serious business, are still here. And as we get out of this recession, our industry will be healthier as a result.
What do you do in your free time?
I like to play tennis, and I also like to cook. I have two kids involved in sports, so my wife and I spend a lot of our free time on the sidelines of soccer fields and hockey rinks!
Thanks for the interview. How should borrowers/brokers reach you to discuss a loan?
They can learn more about CapitalSource Small Business Lending by visiting our website at www.capitalsource.com/sbl or contact us by calling 866/590-1566.
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