Today, there are an estimated 33 million small businesses in the U.S., according to the U.S. Small Business Administration (SBA). In fact, according to the U.S. Census Bureau, over the last three years the average number of new business applications has reached 440,000, a 46% increase between 2017 and 2020. These businesses need fast, affordable financing to develop and grow.
Credit unions have long played a vital role in providing financial services to communities. However, in the evolving financial landscape, they face significant challenges, including continued liquidity constraints and margin compression. One powerful tool that can help credit unions drive growth and enhance their competitive edge is the SBA’s 504 Loan Program. 504 Loans allow credit unions to expand their loan portfolio, manage collateral risk, drive fee income and grow member acquisition while members benefit from access to capital with minimal equity requirements, a broad range of eligible uses, extended repayment terms and competitive interest rates.
Here, we breakdown how:
- SBA 504 loans work and how they benefit businesses and credit unions; 2. These loans differ from SBA 7(a) loans and microloans; and
- Credit unions can streamline their SBA 504 loan program.
How SBA 504 Loans Work and Their Benefits
SBA 504 loans are long-term small business loans with a fixed rate. The 504 Loan structure typically involves three parties: A borrower, a Certified Development Company (CDC) and a third-party lender (such as a credit union). Here’s how it works:
1. Borrower contribution: Borrower typically contributes 10% of the project costs.
2. CDC portion: The CDC finances 40% of the project costs through a fixed-rate loan, backed by a 100% SBA guarantee.
3. Lender portion: The credit union (or other third-party lender) finances the remaining 50% of the project costs through a variable or fixed-rate loan.
This unique structure reduces the risk for credit unions, as the CDC/SBA portion is subordinate to the credit union’s loan, meaning the credit union has the first lien on the collateral at roughly 50% LTV/LTC. Credit unions further benefit from being able to:
- Diversify and expand their loan portfolio with high-quality, fixed-asset loans without proportionally increasing risk;
- Establish themselves as a “go-to” resource for business loans in their region, enhancing member engagement and further deepening the relationship; and
- Generate origination fee income and interest rate income.
Generally, a small business will use an SBA 504 loan to build new facilities, purchase equipment, buy land or improve existing infrastructure. This financing option is favorable to small businesses because it allows them to benefit from:
- Fixed-rate financing that reduces interest rate risk;
- A small 10% equity requirement from the borrower, conserving funds to reinvest in their business; and
- A long-term repayment schedule of up to 25 years.
Credit unions can participate in the growth of small businesses in the U.S. by partnering with these entrepreneurs. Now is the time for this kind of collaboration, given that 93% of small business owners expect moderate or even significant growth over the next 12 months, according to recent research from the U.S. Chamber of Commerce.
How SBA 504 Loans Differ From Other Loans
Small businesses can also choose from other SBA loan offerings, such as SBA 7(a) loans and microloans.
SBA 7(a) loans allow a business to access up to $5 million, slightly less than the $5.5 million maximum available for the CDC/SBA portion of the SBA 504 loan. SBA 504 loans are for companies that do not exceed a net worth of $15 million, whereas this requirement doesn’t apply to SBA 7(a) loans.
These two options also have different loan terms. An SBA 504 loan has a term of 10, 20 or 25 years. With an SBA 7(a) loan, these terms depend on the use of capital. The term is 10 years for a working capital or inventory or equipment loan, and 25 years for a real estate loan. SBA 7(a) loans can also be used for a wider variety of needs, including working capital and refinancing business debt; however, these loans are also typically tied to a quarterly-adjusting index such as the Wall Street Journal Prime Rate.
Microloans are much smaller than SBA 504 and SBA 7(a) loans. These loans are for $50,000 or less. Because they are smaller, the maximum term is just six years. The funds can be used for supplies, furniture, working capital, fixtures, machinery, inventory and equipment.
How Credit Unions Can Streamline Their SBA 504 Loan Program
To capitalize on the growth of small businesses, credit unions need a clear and efficient plan for building their SBA 504 loan program. Partnering with experienced CDCs, which are nonprofit entities certified and regulated by the SBA, can provide valuable insights and support. This collaboration can help credit unions navigate the complexities of the program, ensuring smooth and efficient loan processing and execution. Furthermore, the partnership between a credit union and a CDC is natural, as part of a CDC’s mission is to help local businesses thrive and bring economic growth to the communities they serve.
Today, about 230 CDCs are serving specific geographic areas in the U.S. Collaborating with an experienced CDC is crucial for the success of an SBA 504 loan program. Choosing the right CDC means understanding their history of SBA 504 loan issuance, knowing if the CDC is an Accredited Lender (ALP) with the SBA, and knowing the CDC’s first-pass approval rates for applications.
An Opportunity for Credit Unions
SBA 504 loans offer a compelling opportunity for credit unions to drive growth, mitigate risk and strengthen their community ties. By participating in SBA 504 lending, credit unions can enhance their competitive position, diversify their loan portfolios, and fulfill their mission of serving members and supporting local economic development. As credit unions continue to adapt to the ever-changing financial landscape, SBA 504 loans can be a pivotal element in their growth strategy.
Chad Witcher is COO at the Peoria, Ariz.-based AVANA Companies.
Leave a Reply