In an increasingly competitive environment, many community banks are exploring new business lines in an effort to expand their lending options and boost fee income. A few opportunities that might lead to improvements in your bank’s bottom line include SBA lending, municipal finance and insurance premium financing.
The U.S. Small Business Administration (SBA) operates several programs designed to help small business owners grow or maintain their businesses. The SBA’s two flagship lending programs — 7(a) and 504 — also offer significant benefits for community banks.
Under the 7(a) program, the SBA guarantees a portion (up to 75% or more) of loans to eligible small businesses. These loans, which can reach as high as $5 million, can be used for a variety of business purposes, such as:
- Acquiring or starting a business,
- Purchasing machinery, equipment or supplies,
- Improving land or buildings,
- Financing receivables,
- Augmenting working capital, or
- Refinancing existing debt (under certain conditions).
Benefits to banks that make 7(a) loans include:
- Expanded customer base. The program allows banks to serve customers that wouldn’t otherwise satisfy conventional underwriting criteria.
- Improved risk management. The SBA’s guaranty on 7(a) loans mitigates the lender’s risk.
- Increased lending business. In many cases, the guaranteed portion of a 7(a) loan doesn’t count toward a bank’s legal lending limit, helping it boost its lending capacity.
- Reduced capital requirements. Guaranteed loans have a lower risk weight than unguaranteed loans for regulatory capital purposes, so 7(a) lending can make it easier for a bank to meet capital requirements.
- Increased liquidity. Banks are allowed to sell the guaranteed portion of 7(a) loans into the secondary market, providing an alternative source of liquidity.
Under the 504 program, lenders partner with not-for-profit certified development companies (CDCs) to help small businesses expand and modernize by offering favorable financing for real property and major fixed assets. In a typical transaction, the lender and CDC each make a loan to a qualifying small business. The lender’s loan usually is secured by a first lien covering 50% of project costs, while the CDC’s loan is secured by a second lien covering up to 40% of project costs and backed by a 100% SBA-guaranteed debenture.
The 504 program benefits banks by creating opportunities to serve customers that would not otherwise satisfy conventional underwriting criteria. In addition, because banks enjoy a 50% loan-to-value (LTV) ratio, the program minimizes collateral risk. And, like 7(a) loans, 504 loans can be sold into the secondary market, providing an alternative liquidity source.
Community banks are increasingly pursuing opportunities to finance capital projects of state agencies, local governments and schools. Although yields on municipal loans tend to be lower than those of other types of loans, they generally enjoy higher credit quality.
They also enable community banks to diversify their business loan portfolios beyond commercial real estate. The added local visibility can attract new customers as well.
Insurance Premium Financing
As the name suggests, premium financing involves lending money used by the borrower to pay life insurance premiums. The loan is secured by the policy’s cash surrender value plus, if necessary, additional collateral (such as publicly traded securities or letters of credit).
Typically, these arrangements involve indexed universal life policies, which offer guaranteed minimum returns. This makes them safe assets that support high LTV ratios — even as high as 100% in some cases.
Explore Your Options
Recently, American Banker listed the business lines discussed above, as well as equipment finance and senior care construction loans, as attractive opportunities for community banks. If your bank is pursuing new sources of loans and fee income, these business lines may be worth a look.