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Thursday, Mar 28, 2024

Fear of Risk, Credit Standards Slow SBA Loans

When Mike McMaster decided to buy the company where he worked, a friend suggested he finance the transaction with a loan guaranteed by the Small Business Administration. Now he wonders: Was it worth the ordeal? It took 16 months of weekly conference calls to assemble the paperwork, and in the end, no local bank would fund him. But McMaster finally obtained $750,000 from NewTek Business Services Inc. in New York and acquired Wilshire Home Entertainment Inc. in Thousand Oaks. “For my type of transaction, it took way too long,” he said. “A lot of local banks weren’t interested because the business didn’t fit their profile or risk tolerance. The paperwork was pretty onerous, but I don’t like paperwork in general so I’m biased.” Ultimately, McMaster bought the big-screen TV store from his father-in-law. A major sticking point for the loan was the recession, which caused the store to lose money for several years after the housing and home furnishing market slumped. Indeed, even as local banks are desperate to grow their businesses amid the recovery, many remain risk averse following the nightmare of the financial crisis. That unwillingness is exemplified in figures provided by the SBA’s Los Angeles District office for the number of loans issued by private lenders guaranteed by the office, which is in Glendale and is the largest in the country. It backed 2,510 loans worth $1.5 billion for fiscal year 2013. But that figure was nearly identical to the previous year’s figures, according to data from the agency. Ben Raju, deputy district director of the Glendale office, said the SBA has worked to streamline the loan process, but in the end the agency doesn’t make loans – banks do. And their paperwork can go beyond SBA standards. “We are constantly improving the process, working with our lending partners and being good stewards of taxpayer dollars,” Raju said. “The process is in place to be diligent on our part.” Reg Byrd, president of Direct Connect Ventures, the Thousand Oaks consulting firm that helped McMaster assemble his loan application, said his story is typical for SBA borrowers these days. Every bank has particular criteria for the kinds of SBA loans they want, so fund-seekers need to shop the deal around until they find a lender. “Some don’t want less than $250,000, others less than $500,000; some will only lend in the local community, others want a national footprint,” Byrd said. “Their underwriting guidelines are not wishy-washy anymore.” For example, even though Byrd’s company has arranged loans for more than 70 franchisees of Menchie’s Frozen Yogurt, some banks won’t touch food operations and others specifically avoid yogurt shops. As for the paperwork, Byrd calls it “an exercise of much diligence” by the banks, but they do it because they want a federal government guarantee on the loan. With that guarantee, they can turn a profit quickly by selling their SBA loans. “Because the lenders have righted their guidelines, the secondary market really wants their loans,” Byrd said. Skewed numbers? The SBA has two loan programs. The 7(a) program is designed to provide an entrepreneur with money for working capital, to buy real estate or another business, or for construction. The maximum loan amount is $5 million, but the average is about $335,000. There are sub-programs designed for microloans or for economic development projects. The 504 loan program provides money only for real estate, either the purchase of an existing building or construction, with the attraction that the business owner only has to put up 10 percent of the amount. A bank typically loans 50 percent and a certified development company – a non-profit that encourages economic development in a specific area – puts up 40 percent. If the business owner has more than 10 percent, the bank usually opts to fund a conventional 7(a) loan. Roberto Barragan, chief executive of non-profit Valley Economic Development Corp. in Van Nuys, said the new lending criteria at banks have left a lot of entrepreneurs outside the program. For example, anyone who had a personal home foreclosure or loan modification during the recession faces a tremendous obstacle, because to get a loan mod the mortgage had to default – a red flag for SBA lenders. Barragan said another problem is that lots of small companies lost money in 2012 and broke even in 2013, so they’re exiting the recession but don’t have an established record of profitability yet. “Prior to the recession, the banks were lending a lot on collateral and equity. Now the pendulum has swung to the opposite extreme – cash flow,” he said. “We see continued cash flow challenges at companies.” In general, Barragan said SBA loans aren’t going to restaurants or startups. The most likely receivers are small manufacturers, distributors, retail and service firms. Also, the new lending criteria favors hard assets for collateral, so a lot of borrowers only want to finance real estate or inventory. David Um is manager of SBA lending at Commonwealth Business Bank in Los Angeles, which made 27 loans in the greater Valley region last year for $18.2 million, ranking the bank No. 6 on the Business Journal’s list of SBA lenders. At his bank, Um sees a lot of SBA loan applications for real estate, construction projects and buyouts similar to McMaster’s. Working capital loans are not as popular among bankers. “A lot of times restaurants come in asking for $100,000 or $200,000 and they just want it put in their bank account,” he explained. “Those are very difficult to get approved.” For borrowers, the lesson is that they should come to the bank with a clear purpose for the money. However, even those borrowers who can answer the purpose question often err on the follow-up. When the banker asks “How much?” their response is, “As much as you can give me.” “That really puts a banker’s guard up,” Um said. “You should already have a dollar amount in mind.” Despite the delays in securing an SBA loan to buy the big-screen TV business, McMaster sees plenty of upside in it. The loan is for 10 years, the longest business loan he’s ever had, and the interest rate is good. The only glitch is that his, like nearly all 7(a) loans, is a “prime plus” loan with a variable interest rate that’s likely to go up in the coming years. “It’s pretty nice because the payments are low,” he said, pegging his current interest rate at about 6 percent. “I’d sleep a little better at night if it was fixed-rate, but I don’t think in the next three to four years rates will go astronomical.”

Joel Russel
Joel Russel
Joel Russell joined the Los Angeles Business Journal in 2006 as a reporter. He transferred to sister publication San Fernando Valley Business Journal in 2012 as managing editor. Since he assumed the position of editor in 2015, the Business Journal has been recognized four times as the best small-circulation tabloid business publication in the country by the Alliance of Area Business Publishers. Previously, he worked as senior editor at Hispanic Business magazine and editor of Business Mexico.

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