What’s Wrong With the 504 Program?

Part 1, Special In-Depth Report

By Charles H. Green

The past is past and I’ve recently documented that fiscal year 2014 was a successful one for SBA lenders, with the 7(a) program finishing with an approved volume of $19.19 billion. Overall, SBA programs clocked in at $28.68 billion of total financing,  a significant foothold in the $1 trillion SME marketplace.

But the CDC/504 tranche of SBA offerings had a bad year, registering only $4.19 billion, a SBA 504 Loan Programsum that limped worse than in FY 2013 (see graphics here). That earlier year was expected following the record $6.71 billion year set in FY 2012 thanks to the once-in-a-lifetime refinancing privileges granted to date.

And remember that fiscal year 2014 got off to a rocky start for all SBA lenders due to the economic wounds inflicted by the Tea Party wing of conservative House Republicans, who engineered the government shutdown. That stunt ended after 17 days and resulted in the unintended consequences of further wounding an already limping recovery.

It took seven months for the 7(a) loan program to catch up and exceed the approved loan volume of the year-over-year results achieved in FY 2013. But the FY 2013 7(a) trajectory continued to flourish for the remainder of the year and produced the 2nd highest volume in the program’s history. The FY 2014 volume had only been topped in FY 2011 when there was a 90 percent loan guarantee with $0 fee, program modifications intended to jumpstart recovery from a recession that wouldn’t go away.

504 loan approvals have been another story.

The 504 program had a banner year in FY 2012 when allowed to use program dollars to refinance CRE loans for the first time. Although delayed by the SBA’s unbearably slow rule promulgation, lenders finally began to use 504 program loans to assist an impaired commercial real estate market, still feeling the side effects of significant value collapses that occurred in the midst of the financial crisis in 2008-2009.

Without the burden to meet strict supervisory LTV standards, 504 loans were permitted to be deployed to refinance maturing CRE loans that had been originally been extended with properly margined collateral and had successfully performed in the period leading up to their maturity. The rollover of these loans was ensnared by rigid adherence to the mark-to-market mentality of real property values that did not consider other loan metrics, such as owner cash flow, repayment history or business success.

SBA 504 program dollars stepped in to help many struggling banks grappling with a host of other capital problems, since they were otherwise unable to renew many performing loans due to depressed collateral values.

Concurrently, the First Mortgage Loan Program (FMLP) was activated to refresh the secondary market for 504 first mortgages, with SBA facilitating the purchase of the  majority portion of loans meeting credit conditions, which encouraged more lending.

In addition, during these challenging years for banks with wounded capital accounts, single-purpose properties were off the table. But the FMLP helped many lenders meet the still significant demand for special purpose properties due to the liquidity with which they could move the loans off their balance sheets.

Predictably, when these universally popular programs ended on September 30, 2012, the program approval volume fell off immediately. The FY 2013 results were couched with the expectation that the loss of 504 refinance authority was a temporary setback, because there was “bipartisan” support to reinstate it.

But they did expire, and while it’s hard to find who’s leading the opposition to reinstatement or any politician vocally against them, renewal and extension has languished for more than two years among much larger conflicts that have no concern about small business America or their financing marketplace.

The 504 loan volume has spiraled downward ever since.

To be clear, the poor prospects of the program has been due to a perfect storm of many factors. Over the next three days, I’ll discuss three of the leading causes, garnered from my conversations–on and off the record–with several interested parties in the CDC/504 business.

In the meantime, the National Association of Development Companies (NADCO) is gathering in Ft. Lauderdale, FL this week for training and presumably some conversation about many of these topics.

Will FY 2015 turn their fortunes around? It remains to be seen, but meanwhile, let’s discuss the problems they face.

Tomorrow: Stimulus2: Longest Low-Rate Period Hinders 504 Program?





This entry was posted in AdviceOnLoan, CRE, SBA
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