An Example of Loan Value: Construction through Perm – SBA 504

Driving Loan Value

Yesterdays’ article on branding loans generated many comments.  The most common question we received is to give finite examples of how to create a unique product in the marketplace to garner above average pricing.  One of our ten ideas was streamlining a loan process by taking disparate services and piecing them together to improve value for the customer, increase ROE for the bank and differentiate the bank from its competition.  One example of such a product is combining a construction through permanent (perm) loan with an SBA 504 loan.  We will highlight how a bank can offer an owner-occupied, construction through perm, 20-year fixed rate loan, with a 20% ROE, and 50% LTV.  The structure is relatively straightforward and national banks have been using this same structure for decades – at CenterState we have been successful for ourselves and working with community banks to obtain the same results on loans ranging in size from $500k to $25mm.

Piece One – SBA 504

For those not familiar, the SBA-504 program allows fixed rate financing on 90% LTV for commercial real estate (CRE) and equipment finance.  The loan can be structured as 50% bank finance, 40% community development corporation (CDC) finance (in the form of a subordinated debenture) and 10% equity.  Proceeds may be used to purchase existing real estate, land acquisition and ground-up construction, tenant improvement on existing real estate or to purchase equipment.  There are a number of program requirements which may differ state to state, and on category of collateral, but this is the general concept.   

As noted above, the SBA-504 program permits ground-up construction and the current effective rates for the 40%, subordinated debenture are 4.25% for 10-year fixed rates and 4.75% for 20-year fixed rates.  A hefty prepayment penalty in the form of declining balance does apply on the debenture.  The debenture, nonetheless, offers good value for the borrower given its pricing and its subordinated nature.

Piece Two – Construction-Through-Perm Loan

We (and any bank that wants to partner with us) are currently using forward rate locks to establish a fixed rate on construction loans.  Forward rate locks are used when a borrower wants a fixed rate of interest and the lender is willing to provide the loan, but the loan will not fund for a predetermined length of time (typically to accommodate construction, draft closing documents or complete other due diligence steps).  

Forward rate locks can be for as short a period as a week or as long as 24 months. The advantage of the forward rate lock is that it gives the borrower the certainty of fixed rate payments on loans expected to fund at some point in the future.  The lender also eliminates interest rate risk by locking a spread over a variable index.  Both borrower and lender are protected from unexpected interest rate changes.  Most importantly, the bank is at a much lower risk of losing the loan when it converts from a construction loan (the risky part of the project) to a term loan (as the cash flow is stabilized there is less to the bank).

Pieces One and Two Together

Now let’s put the pieces of the puzzle together to see how it fits.  We’ll use a live example and describe a loan recently closed through the SBA-504 program.  The borrower is in the business of manufacturing molds for the aerospace industry and was renting a building for manufacturing and distribution.  The bank brilliantly assisted the borrower identify a parcel for sale and decided to purchase the land and construct a larger manufacturing and distribution center.  The total financing costs were $4.2mm, and ground-up construction would take 12 months.  The financing was structured as a 12-month construction note for $3.78mm (90% LTV), with a second note that was signed concurrently with the construction note.  The second note is a take-out term loan for $2.1mm and is structured as 20-year amortization, 20-year fixed rate.  While the bank will advance the $3.78mm during the construction period, in 12 months, when the $1.68mm SBA debenture funds, the bank’s term note will drop to $2.1mm and the LTV will drop to 50% (based on current appraisal).  The borrower secured the construction loan at Prime flat, and the bank take-out is priced at 4.98%.  The debenture interest rate will be set after the construction is complete (there is a way of offsetting the interest rate risk on the debenture, but the borrower decided not to pursue this option).  Our bank’s proposal was chosen over three other options (one of which came from BB&T, which was priced at thinner spreads).

The end result will be borrower financing of $3.78mm, of which the bank will retain $2.1mm, have a first priority security interest in the collateral and an LTV of 50% post-construction.  The bank retains the customer, generates a sizable fee, maintains an earning asset with just under 20% return on equity.  The credit quality on this type of structure has historically been solid.  Historical default rates on SBA 504 loans range from under 90bps per annum, to 6% during the recession.  However, the loss rates are very low and largely attributable to documentation and fraud risk, not direct credit risk.  The borrower secures 20-year financing (that is largely assumable and 50% is also assignable if the borrower wants to take the loan to another project).  It’s a win-win situation for borrower and bank.


Piecing together different products can lead to superior results for both borrowers and banks.  The ability to use the SBA 504 program with forward rate locks for construction through perm can generate substantial returns for the bank and makes perfect sense in today’s low-interest rate environment where banks would prefer to generate an initial floating rate at Prime and borrowers want certainty of interest rates.  This is a concrete example of a way to create a fairly unique product in the marketplace that can set your bank apart from the competition. If you have not utilized this structure, but would like to provide this additional service to your customers, feel free to contact us as we can help by sharing our presentations, structure, documents and sales positioning.