SAN DIEGO – A two-step funding process which not only providesmuch needed capital to small businesses but also protects a creditunion's loan-to-value ratio are some of the perks of anincreasingly popular SBA loan program. The SBA's 504 loan programprovides growing businesses with long-term, fixed-rate financingfor major fixed assets, such as land and buildings. Nearly 270Certified Development Companies (CDC), which are nonprofitcorporations set up to contribute to the economic development ofcommunities, work with the SBA and private-sector lenders toprovide financing to small businesses. For fiscal year 2004, theSBA backed 8,168 loans worth $3.9 billion. Congress approved $5billion for 504 loans for fiscal year 2005. While a number ofcredit unions are currently offering the loans, the SBA said itdoes not track their participation because the loans they providein the project financing is not subject to SBA rules andregulations. They are viewed as a conventional first mortgage loanprovided by a third-party lender. Here's how the loan works:typically, a 504 project includes a loan secured with a senior lienfrom a private-sector lender covering up to 50% of the projectcost; a loan secured with a junior lien from the CDC, backed by a100% SBA-guaranteed debenture, covering up to 40% of the cost; anda contribution of at least 10% equity from the small business beinghelped. Proceeds from 504 loans must be used for fixed assetprojects such as purchasing land and improvements or purchasinglong-term machinery and equipment. In 2002, the $1.5 billion NorthIsland Financial Credit Union became the first credit union in SanDiego and Orange County to offer 504 loans, said Jeff Stone,executive vice president of member business services. Since then,the credit union has approved seven loans with two waiting forapproval totaling $9.7 million, which includes its portion and SBAfunds. “It's a relationship product for us,” Stone said. “When wedo the loans, it leads to building core deposit relationships andwe like the lower risk perspective.” Stone recalls when 504 loanscame on the scene in the late 1970s when they were known as 503loans. During his banking days, he remembers hearing about theloans during a tour of a bank branch. The following day the WallStreet Journal ran an article on the SBA's newest offering andStone urged his bank to consider offering them, which theyeventually did. The credit union typically works with establishedbusiness owners with 504s but occasionally a start-up will beapproved. One recent approval came to a member who had been workingin the particular industry for 25 years. Another loan closing camethrough even though the “underwriting was a little thin,” Stonesaid. “It was a fairly small loan and because it was a member, wedecided to approve the loan,” Stone said. Interest rates on 504loans are pegged to an increment above the current market rate forfive-year and 10-year U.S. Treasury issues. Maturities of 10 and 20years are available and fees total approximately 3% of thedebenture and may be financed with the loan. The maximum SBAdebenture is $1.5 million when meeting the job creation criteria ora community development goal. Generally, a business must create orretain one job for every $50,000 provided by the SBA except forsmall manufacturers which have a $100,000 job creation or retentiongoal and very specific criteria. The maximum SBA debenture is $2million when meeting a “public policy goal,” which includesbusiness district revitalization, expansion of women-andveteran-owned businesses. To be eligible for the loans, thebusiness must be operated for profit and fall within the sizestandards set by the SBA. Under the 504 Program, the businessqualifies as small if it does not have a tangible net worth inexcess of $7 million and does not have an average net income inexcess of $2.5 million after taxes for the preceding two years. For$1.8 billion Eastern Financial Florida Credit Union(EFFCU), whichlaunched its business services department in January, 2004, 504loans are ideal for growing businesses, said Elvis Calvi, loanoperations manager. “If they have the cash flow, it can be abeautiful product,” Calvi said. “The risk to the credit union isminimal because 40% of the loan funding is covered and 100% isfunded when the debenture is created.” EFFCU has approved two 504loans and three more are in the pipeline. The two loan amountsapproved were $368,000 and $207,000 respectively. Ironically, threeapplicants were approved for the loans but decided on moreconventional loans. “They didn't want to deal with the doubleclosing costs,” Calvi said. “Really, it's a process and some peoplefind it to be too much.” What helps is working with a very strongCDC, which can help move the process along smoother and faster, sheadded. NCUA has encouraged credit unions to offer 504s. In April2004, the regulator encouraged its regional directors to grantwaivers that would allow FCUs to fully fund the loans. SBA's 504loan program is structured to use a combination of credit union andSBA financing in a two-step funding process. However, for up to thefirst four months of the process, the credit union would need tohold the entire loan balance – which would exceed the loan-to-valuelimits in NCUA's member business lending regulation. In the secondstep of the 504 loan process, SBA funds a junior lien from acommunity-based non-profit organization. This would reduce thecredit union's loan-to-value ratio to 50%-80% – which is withinNCUA's regulatory limits. [email protected]