SAN DIEGO – A two-step funding process which not only provides much needed capital to small businesses but also protects a credit union's loan-to-value ratio are some of the perks of an increasingly popular SBA loan program. The SBA's 504 loan program provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings. Nearly 270 Certified Development Companies (CDC), which are nonprofit corporations set up to contribute to the economic development of communities, work with the SBA and private-sector lenders to provide financing to small businesses. For fiscal year 2004, the SBA backed 8,168 loans worth $3.9 billion. Congress approved $5 billion for 504 loans for fiscal year 2005. While a number of credit unions are currently offering the loans, the SBA said it does not track their participation because the loans they provide in the project financing is not subject to SBA rules and regulations. They are viewed as a conventional first mortgage loan provided by a third-party lender. Here's how the loan works: typically, a 504 project includes a loan secured with a senior lien from a private-sector lender covering up to 50% of the project cost; a loan secured with a junior lien from the CDC, backed by a 100% SBA-guaranteed debenture, covering up to 40% of the cost; and a contribution of at least 10% equity from the small business being helped. Proceeds from 504 loans must be used for fixed asset projects such as purchasing land and improvements or purchasing long-term machinery and equipment. In 2002, the $1.5 billion North Island Financial Credit Union became the first credit union in San Diego 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 for approval totaling $9.7 million, which includes its portion and SBA funds. “It's a relationship product for us,” Stone said. “When we do the loans, it leads to building core deposit relationships and we like the lower risk perspective.” Stone recalls when 504 loans came on the scene in the late 1970s when they were known as 503 loans. During his banking days, he remembers hearing about the loans during a tour of a bank branch. The following day the Wall Street Journal ran an article on the SBA's newest offering and Stone urged his bank to consider offering them, which they eventually did. The credit union typically works with established business owners with 504s but occasionally a start-up will be approved. One recent approval came to a member who had been working in the particular industry for 25 years. Another loan closing came through even though the “underwriting was a little thin,” Stone said. “It was a fairly small loan and because it was a member, we decided to approve the loan,” Stone said. Interest rates on 504 loans are pegged to an increment above the current market rate for five-year and 10-year U.S. Treasury issues. Maturities of 10 and 20 years are available and fees total approximately 3% of the debenture and may be financed with the loan. The maximum SBA debenture is $1.5 million when meeting the job creation criteria or a community development goal. Generally, a business must create or retain one job for every $50,000 provided by the SBA except for small manufacturers which have a $100,000 job creation or retention goal and very specific criteria. The maximum SBA debenture is $2 million when meeting a “public policy goal,” which includes business district revitalization, expansion of women-and veteran-owned businesses. To be eligible for the loans, the business must be operated for profit and fall within the size standards set by the SBA. Under the 504 Program, the business qualifies as small if it does not have a tangible net worth in excess of $7 million and does not have an average net income in excess of $2.5 million after taxes for the preceding two years. For $1.8 billion Eastern Financial Florida Credit Union(EFFCU), which launched its business services department in January, 2004, 504 loans are ideal for growing businesses, said Elvis Calvi, loan operations manager. “If they have the cash flow, it can be a beautiful product,” Calvi said. “The risk to the credit union is minimal because 40% of the loan funding is covered and 100% is funded when the debenture is created.” EFFCU has approved two 504 loans and three more are in the pipeline. The two loan amounts approved were $368,000 and $207,000 respectively. Ironically, three applicants were approved for the loans but decided on more conventional loans. “They didn't want to deal with the double closing costs,” Calvi said. “Really, it's a process and some people find it to be too much.” What helps is working with a very strong CDC, which can help move the process along smoother and faster, she added. NCUA has encouraged credit unions to offer 504s. In April 2004, the regulator encouraged its regional directors to grant waivers that would allow FCUs to fully fund the loans. SBA's 504 loan program is structured to use a combination of credit union and SBA financing in a two-step funding process. However, for up to the first four months of the process, the credit union would need to hold the entire loan balance – which would exceed the loan-to-value limits in NCUA's member business lending regulation. In the second step of the 504 loan process, SBA funds a junior lien from a community-based non-profit organization. This would reduce the credit union's loan-to-value ratio to 50%-80% – which is within NCUA's regulatory limits. [email protected]